Why China Works.(China's management of the financial crisis and its economic growth and policies )

Byline: Rana Foroohar; With Melinda Liu and Mary Hennock in Beijing and Duncan Hewitt in Shanghai

A look at bright spots in the recession begins with Beijing, where state control is looking smart.

China is the only major economy that is likely to show significant growth this year, because it is the only one that routinely breaks every rule in the economic textbook. There is no truly free market in China, where the state doctors statistics, manipulates the stock markets, fixes prices in key industries, owns many strategic industries outright, and staffs key bank posts with Communist Party members and tells them to whom they should lend, and in what they should invest. In fact, the main reason China is not slowing as fast as the other big five economies is its capacity for what economists ridicule, in normal times, as state meddling: it limited foreign investment in the banking sector and didn't embrace the exotic financial innovations that are the melting core of the global credit crisis.

Why does China's brand of command capitalism work? The question has long intrigued economists, who tend to cast the state as hopelessly stupid, the market as naturally brilliant. Now that the United States and Europe are moving toward state control--by nationalizing the banking and car industries, and imposing heavy new regulation on the financial industry--the question has a new urgency. China, the poorest and most chaotic big economy, looks like the one best positioned to navigate what may be the worst global downturn in seven decades.

In a time of crisis, China's bureaucrats can pick from traditional market tools, like their Western counterparts, and from the arsenal of command capitalism. Early last year, as the housing market was overheating, they simply ordered bankers to cut back on housing loans: then as home sales began to fall, they offered market incentives, like lower taxes on home purchases. In recent weeks they launched economic rescue efforts similar to those in the west, including a huge ($600 billion) plan to ramp up government spending and big interest-rate cuts. But they've also issued orders that would be seen as improper "intervention" in the West--for example, calling last week on state industries, including steel and construction, to "actively increase" their roles in the economy by buying up new assets at home and abroad.

Once seen as the bad habit of an immature economy, China's state meddling is now seen as a bulwark of stability. "Government control of the most capital intensive sectors leaves me optimistic about China's prospects," says CLSA economist Andy Rothman. "The government can say to companies in these sectors, 'Continue to spend, don't defer your investment plans'." Despite the falls in its biggest export markets and its own stock markets, China's economy looks likely to grow more than 7 percent in 2009--down from the double-digit pace of recent years, but stronger than most. Corporate loan rates are actually up, as state banks loosen credit. In a nation where investment is "the backbone of sustainable growth," accounting for 40 percent of GDP, the state is once again ramping up investment to fight serious threats to growth, says Morgan Stanley Asia chief Stephen Roach. "What we're seeing is that the Chinese command-and-control system can actually work more effectively than other market based systems in times of economic stress," he says.

When the original capitalist roader, Deng Xiaoping, said "It doesn't matter if a cat is white or black, as long as it catches the mouse," he put economic growth above ideology purity. Now Chinese leaders quote Deng to defend the basic deal he offered the Chinese people: autocratic capitalism would provide economic growth, while the Communist Party would retain absolute political power. Many of these leaders now argue that a democratic China couldn't have survived--let alone flourished--in a global recession. "China isn't ready for a democratic free-market system," says Fang Xinghai, the Western-trained director of the Shanghai Financial Services Office. "Think about what happened in the U.S. elections in 2000--if that had happened in China, there would be a war. The genius of Deng is that when he put China on the path to a market economy 30 years ago, he knew the country needed a stable political system [to withstand the changes of reform]. Whatever our system is, it is suitable for China."