[MUSIC] How has China been so successful, despite clear shortcomings in its institution? This is a puzzle of China's governance. And it refers to the fact that there are several dimensions, where people have pointed out, that China's institutions are weak. For instance, there is a lack of democracy and accountability. There is a lack of property rights protection. And finally, there is a fair amount of corruption, which of course, the government in recent years has been actively combating. Now if we look at the rating of China compared to other countries in terms of corruption by Transparency International, you can see that China is one of the red colored nations, which puts it kind of in the lower part of the range. Among 167 countries in the world, China is ranked 83rd in terms of its transparency, or lack of corruption. Now, there are a couple of very large questions related to the importance of democracy and economic performance. The first is, does democracy promote economic growth? And the second is, does the demand for democracy increase with income? So we can see that this relationship goes in two directions. On the one hand, democracy can influence the economy. On the other hand, economic performance or growth or rising incomes or greater education can lead to greater demands for democracy. Now, we're not going to settle these issues today, but since we're focused on trying to understand China's outstanding economic performance, I think it's worth thinking about the importance of democracy in economic performance. And here we can think of both positives and negatives. The positives include the check on corruption that public accountability provides. You can kick corrupt leaders out by voting them out. Also noted that in a country where there's a free press, it's easier to avoid disastrous mistakes because there will be an objective presence to monitor and report on things that are happening that endanger the population. That democracy is also credited with helping to manage social conflict. And finally, that it creates pressure for more equitable and sustainable growth, because that's what after all people care about and they exert pressure on their political leaders to achieve that vision of development. On the negative side, people have pointed out that democracy often leads to redistributive polices which can reduce the incentives. So, if rich people are taxed too much, or everybody's taxed too much, it may hamper their incentives to exert effort. Also in many democratic systems, interest groups can organize and exert a very strong influence on policy choices well out of proportion to their kind of share of the population. Third, democracy can often lead to populist policies that really try to pander to the population in the short term, but may not be in the long term economic interest of the economy. And finally, in divided societies, elections can be very divisive and pit different competing groups against each other, where the groups are interested not in the general welfare, but just bettering the welfare of their own group and own interest. So, of course, China to greater or less extent does not achieve these positive aspects of democracy, but avoids some of these negative aspects of democracy. Now what does the data tell us about the relationship between democracy and growth? Well there was a very famous study by Robert Barrow where he looked at the cross country evidence. He looked at a bunch of determinants of economic growth in different countries in the world, and he found this very interesting inverse U-shaped relationship. Where at low levels of political rights, more democracy or political freedom increases the economic growth rate. But at high levels of rights, it's actually declining. So there isn't a definite relationship, positive or negative, between democracy and economic growth empirically. And what about the other way around? Well, there was a study done by several authors that looked at the change in income and how it affected the change in democracy across countries. And they found almost no relationship. So they also concluded that GDP growth or rising incomes does not necessarily lead to greater democracy. Although if you look at the cross section, it's true that on average, richer countries do tend to be more democratic. If you look at the relationship between changes in GDP and changes in freedom, that relationship disappears. Suggesting that this cross sectional pattern maybe reflecting other factors, not directly the relationship between democracy and growth. Now, let's compare the two most prominent examples of a democratic system and a authoritarian system among the major emerging markets. So China, of course, is the high growth champion of emerging markets. India is now growing also very well and has had a very stable democracy for many years. If we think about what China has done well, we know that it's achieved high rates of growth, higher than India, and they've had very decisive and purposeful economic reforms, with a very steady and pragmatic insistence to improve economic performance. They have been able to mobilize resources for huge infrastructure investments to support economic growth. And on the downside, some worry that because of the political insecurity of authoritarian governments, that they can be more fragile, or they may overreact to crisis because they're very worried about the possibilities of organized opposition. Now on the India side, the citizens generally really believe in the legitimacy of the system because their leaders are elected and so broadly, people are very happy with the political system. However, the system has not been able to deliver many important inputs that lead to economic growth. For instance, there's a very poor record of delivery of local public goods and social services like education, health, etc., which China has done very well at. They have not been as successful as China in mobilizing large infrastructure projects. And they've also, because they're a very diverse society socially, much more diverse in fact than China, they've had issues where this diversity has led to conflicts which undermine collective action based on consensus about what the goals should be. Finally, concerns about equity have led to regulatory excesses that have stifled reforms without really solving the fundamental equity problem. Now in this context, what have been the most important features of China's governance system that have helped China achieve rapid growth, despite these institutional shortcomings? Well most people have focused on the incentives of local leaders in China, but it really starts at the top. Leaders at all levels have been incentivized to pursue economic growth as a main goal of government leadership, and this has been successfully transmitted to all levels of government by the top leadership. In addition, China has been able to select very capable individuals to serve in the government bureaucracy in the different government departments. And many of the top talent in the country has viewed a career in the government as being a very desirable one. And finally, China through its decentralization, as we learned earlier, has really empowered local officials to pursue economic growth and to support local enterprises, although there's some concern about the extent to which they are accountable to local populations. The big question really going forward is, are these institutions, or these successful dimensions of China's government system, enough to sustain China to achieve high rates of growth in the next stage of economic development, where China really needs to become an innovation economy? And that may require a more sophisticated set of institutions.