A Free Press Could Help China's Economy

By Professor Zhiwu Chen

Originally published in the Financial Times September 20, 2005

China has recently stepped up efforts to control the press and cyberspace. What does this mean for China's economy, and is press freedom really relevant at a time of surging economic growth? For centuries, press freedom has been viewed as a fundamental political institution, providing checks and balances on authorities. But the media's role in facilitating economic development is often overlooked.

China's growth has been impressive in many ways. Since reforms began in 1978, gross domestic product has grown an average 9 per cent a year, raising per-capita GDP from Dollars 338 to about Dollars 5,000 in 2003. While the global economy has slowed recently, China's has not only maintained its momentum but spurred growth in many countries. China is not known for having market-friendly institutions and yet its growth challenges the conventional view that "institutions matter for development." What is going on?

The answer lies in the industrial structure. The main drivers of China's growth have been export-oriented manufacturing and construction. The economy depends heavily on the industrial sector. China's service sector, meanwhile, is one of the least developed in the world, comprising only 33.5 per cent of GDP in 2004 (compared with a service sector share of 79.4 per cent in the U.S.). This structure has enabled China to grow even without a free press or reliable institutions.

Market development in manufactured goods is much less demanding than in services, especially financial services. The physical tangibility of a product leaves little room for cheating, giving such a market a natural informational advantage. In contrast, the intangible nature of "services" presents the buyer with severe informational disadvantage. In this case, both legal institutions and free media are critical.

Markets in tangible goods therefore depend much less on legal and informational institutions than markets in intangible services. Countries with undesirable institutions can develop only by focusing on "hard" industries, whereas countries with a free press and reliable institutions can focus on industry or the service sector, whichever offers higher value added. Indeed, if we divide 106 countries into three groups according to their 1990 press freedom ratings by Freedom House, the average service-sector share in 2002 is 62.4 per cent for free-press countries, 57.1 per cent for countries in the middle and 48.5 per cent for countries that censor their media. Thus, the freer the press, the better developed a country's service sector. Press freedom facilitates service development by reducing information asymmetries among transacting parties, bringing confidence to the marketplace. Unbiased information enhances trust, which is fundamental to the deepening of a service market.

China's growth story does not reject the "institutions matter" thesis. With its vast, cheap labor force, China has been able to take advantage of manufacturing's low dependence on institutions and grow without adopting political reforms. However, this "hardware" approach is already being challenged.

First, being the "world's factory" has taken its toll on China's environment.

Second, China faces tough hurdles to further expanding its world market share in manufactured goods. Finally, manufacturing can no longer create new jobs. While manufacturing output has grown annually, manufacturing employment peaked at 98m jobs in 1995 and declined to 83m jobs by 2002. With 200m jobless peasants in China, manufacturing cannot solve the problem.

China must develop its service sector for job creation. With 1.3bn people to service, this sector offers the greatest potential. But, it also requires reliable law enforcement, judicial independence and freedom of the press. Institutional reform is clearly the way to go. China has resisted political reforms so far. But, in a largely state-run economy where regulations are intrusive, it is difficult to separate business from politics. For example, with the governors of commercial banks being minister-rank political appointees, investigative reporting on their conduct is often subject to political censorship.

Corporate governance has received much attention in China. But, again, with most of the 1,400 public corporations majority-owned by the state, top management is often government-appointed. If journalists dare to report on these corporations in a negative light, they can jeopardize their careers. Censorship limits the supply of useful information and distorts the information available in the marketplace, thereby hindering the development of markets - especially financial markets.

Extensive road, rail and air networks have truly integrated China's regions into one national market. Like goods and services, financial products are sold beyond geographical boundaries. In this environment, no government can employ enough regulators to monitor and correct wrongdoings in the marketplace. Neither can the government do enough to provide sufficient information for the market.

A free press can not only provide independent information, but also act as a corrective mechanism for the economy in a way that the government cannot. Thus, media freedom is not only politically necessary, but also good for growth and job creation.

The writer is a professor of finance at the Yale School of Management.