We began the last chapter with the story of Mr. Nian, the impoverished and self-deprecating rural entrepreneur who created a marketing storm in the early 1980s with his Idiot's Seeds. The decade also ended with him. In September 1989, Mr. Nian was arrested. The local procuratorate of Wuhu city where Mr. Nian's business was headquartered charged him with crimes of corruption and “embezzlement of state property.” In 1990, the city government shut down his firm. It was an inglorious end to a once sensational brand – and brand-name – of Chinese indigenous capitalism.

The charges against Mr. Nian were so trumped up that they did not even pass muster with the low evidentiary threshold of the Chinese courts.

In 1998, during my field research in Shanghai for my last book, Selling China, I asked a government official whether he could introduce me to some private entrepreneurs. He gave me a quizzical look and asked, “Are you a Harvard professor?” (I was teaching at Harvard then.) “As a Harvard professor,” he continued, “why are you interested in those people selling watermelons, tea, and rotten apples on the street?”

Somewhat taken aback by his response, I gently reminded him that companies such as Microsoft and Hewlett-Packard were all founded and run by private entrepreneurs. I then ventured to him that maybe the reason private entrepreneurs in Shanghai were just selling watermelons and tea is because these were the only activities the government allowed them to do.

The comment by that Shanghai official has always stayed with me, and it provided the initial inspiration to write this book. (One chapter in this book is entitled, “What is wrong with Shanghai?”) It is striking how his comment contrasts with much of the theorizing about Chinese reforms in the West. A prevailing view among Western academics, especially economists, is that the goal of the Chinese state was to create a market economy based on private ownership, but the reforms were blocked by political obstacles. For political expediency, policy makers then settled for the second-best options to achieve the same goals – such as partially privatizing state-owned enterprises (SOEs), introducing foreign competition, and encouraging new entrepreneurship while retaining SOEs.

Nowhere else in the world has Shanghai inspired more imagination – and despair – than in the Indian city of Mumbai (particularly during its monsoon season). Indian intellectuals and business people ask, often in great exasperation, “Why cannot Mumbai be more like Shanghai?” Prime Minister Manmohan Singh, an Oxford-trained economist and a man steeped in humanistic values, nevertheless sees the heavy-handed Shanghai as a model. This is an excerpt from a speech he gave in March 2006:

This chapter begins with a quote by Jayant Patil, the finance minister of the Indian state of Maharashtra. His observation of Shanghai is fascinating.

One day in August 2006, Mr. Cui Yingjie, a small-time street peddler, suddenly lunged toward a market regulator in the Beijing municipal government and knifed him to death. Mr. Cui had lacked a business license to operate his stall and the market regulator had confiscated his three-wheeled dolly – worth about US$50. This was the trigger to this tragic event.

Media reports of clashes between stall operators and market regulators are increasing in frequency. In one report, market regulators in Qingdao city were fitted with bullet-proof vests and helmets as protection against rebelling private merchants. On March 20, 2006, according to a Hong Kong newspaper, thousands of traders in Dongguan, a city in Guangdong province, clashed violently with the police. The protest was triggered when the market regulators beat and inflicted severe injuries on an unlicensed trader. The riot lasted for 12 hours and hundreds of police officers eventually prevailed by using tear gas to disperse the crowd. According to the Hong Kong newspaper, this was the third large-scale riot in the city of Dongguan in 2006 (and the article was published in March).

We have seen this type of violent clashes between government regulators and small traders before but not usually in an economy widely viewed as dynamic, rapidly growing, and liberalizing. The Stanford economist, John McMillan, in his book Reinventing the Bazaar: A Natural History of Markets (2002), describes how in 1979 the military government of Ghana resorted to violence and brutality to shut down the Makola marketplace in the city of Accra.

In 1982, there was a commercial sensation in Shanghai – sunflower seeds. Sunflower seeds, stir-fried and salted, are one of the most popular snack foods in China. People munch on them when watching TV or playing cards, not unlike the way potato chips are consumed in the United States. But this sensation in Shanghai had a distinct flavor as well as a distinct brand-name – Idiot's Seeds. Idiot's Seeds was the invention of Nian Guangjiu, a farmer in the agricultural and impoverished province of Anhui. Nian held a rather low opinion of himself. He thought that he was good at nothing but making sunflower seeds, hence the brand-name.

Nian's sunflower seeds caught on, not just in Shanghai but also nationwide. This is a fascinating story about how a humble rural entrepreneur succeeded within a few years of the reforms. First, Mr. Nian came up with a brand-name. Whether conscious or not, he introduced the most rudimentary idea of marketing to China. Until Mr. Nian, sunflower seeds had been viewed as an undifferentiated product. The labeling in Chinese stores was by product – sunflower seeds, peanuts, walnuts, and so forth. There was no recognition that the same products might have been made differently. (Nian's brand-name was not always helpful. In 1987, he was considering setting up a scholarship fund at a local school. The teachers balked at the idea of awarding students with an “Idiot's scholarship.”)

Since 1978, the Chinese economy has grown phenomenally. This is not in dispute. By exactly what mechanisms has China managed to grow so fast? There is more room for debate on this question. The near-consensus view – or the view that has achieved the greatest traction – among economists is that China has grown by relying on unique, context-specific local institutional innovations, such as ownership by the local state of township and village enterprises (TVEs), decentralization, and selective financial controls. The conventional mechanisms of growth, such as private ownership, property rights security, financial liberalization and reforms of political institutions, are not central components of China's growth story.

Much of the economic research on the Chinese reforms revolves around the following question: Given the manifest inefficiencies in the Chinese economy, how do we explain its growth? The answer, often backed up by formal, mathematical models, is that seemingly inefficient policies, practices, and institutions – such as public ownership of TVEs and financial controls – perform underlying efficient functions in the specific context of China. The approach is typically inferential – these efficient functions of observably inefficient forms are inferred from China's excellent economic performance.

In 2004, Lenovo, a computer maker based in China, acquired the manufacturing division of IBM. This event, coming off the heels of the news that China had contributed more than the United States to global GDP growth, took the world by storm. Richard McGregor (2004), a reporter for the Financial Times, captured a widespread sentiment when he wrote that the purchase was “a symbol of a new economic era, of how a fast-rising China had suddenly grown powerful enough to subsume an iconic American brand.” Princeton economist and New York Times columnist Paul Krugman (2005) had not been alarmed with Japanese acquisitions in the 1990s but he was about Chinese investments. He believed that the Chinese corporate acquisitions posed a great threat to the United States. There are even those who hailed the Lenovo acquisition as heralding a new world order with China at its center (Shenkar 2006).

Business-school academics are particularly enamored with Lenovo. For them, Lenovo is proof positive of China's fertile entrepreneurial environment and rising competitiveness. In his book, The Chinese Century, Oded Shenkar, a professor at Ohio State University, rejects the notion that China lacks its own homegrown corporate giants. Lenovo, he argues, is just as homegrown as the best of the Indian corporations, such as Wipro or Infosys (Shenkar 2005). Lenovo is also featured prominently in Made in China: What Western Managers Can Learn from Trailblazing Chinese Entrepreneurs, a book by Donald Sull, a business professor at INSEAD (Sull 2005).

A central theme in the current literature on the political economy of growth is the relationship between the government and the private sector. Governments that create the appropriate conditions for private risk taking foster capital accumulation, efficient allocation of resources, and sustained growth. Governments that arrogate “too much” economic activity to themselves risk low levels of investment, inefficiencies in the state sector, and defensive private strategies, such as capital flight and nonproductive investments.

There is substantial debate, however, on how to structure business-government relations in an optimal way, or even what dimensions of the relationship might be consequential (Maxfield and Schneider, 1997). One strand of the institutional economics literature emphasizes the importance of the government's role as a protector and enforcer of private property rights (Barzel, 1997, for an overview). Such protections, if credible, provide assurances to private agents that assets and income will not be expropriated and thus incentives for investment. A growing body of empirical literature attempts to document these claims. These studies show the role that property rights protection and other aspects of the institutional setting that support these protections, such as transparency or even democracy, might play in checking the predatory tendencies of the state (Keefer, 2004).

However, a very different body of theoretical and empirical literature identifies the key barrier to growth not in an overbearing state, but in the capture of public institutions by private actors and the introduction of various policy-induced distortions (e.g., Murphey, Schleifer, and Vishny, 1993).