Har­ness­ing China’s com­pet­i­tive streak

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China’s State Coun­cil re­cently un­veiled a com­pre­hen­sive blue­print for cap­i­tal-mar­ket re­form un­til 2020, in which it iden­ti­fies two key ob­jec­tives: “to sup­port open, fair, and in­te­gral mar­ket pro­cesses, and to pro­tect in­vestors, par­tic­u­larly the le­gal rights of small in­vestors.” Achiev­ing these goals, as the blue­print recog­nises, will re­quire pol­i­cy­mak­ers to weigh mar­ket au­ton­omy against state author­ity, in­no­va­tion against sta­bil­ity, in­vestor pro­tec­tion against caveat emp­tor, and the temp­ta­tion of rapid re­form against the need for prag­ma­tism. Can it be done?

From a pol­icy per­spec­tive, the goal should be to strike a bal­ance be­tween com­pe­ti­tion (which spurs growth-en­hanc­ing in­no­va­tion but can also gen­er­ate in­sta­bil­ity) and co­op­er­a­tion (which pro­motes long-term so­cial co­he­sion but can also lead to stag­na­tion). In do­ing so, China’s lead­ers must ac­count for three lev­els of com­pe­ti­tion: in­ter-en­ter­prise com­pe­ti­tion, in­ter­sec­toral com­pe­ti­tion, and com­pe­ti­tion among the in­ter­ests of cit­i­zens, businesses, and the state.

The im­ple­men­ta­tion of a com­pe­ti­tion frame­work for en­ter­prises is a work in progress. In 2008, the govern­ment en­acted an anti-mo­nop­oly law aimed at pre­vent­ing an­ti­com­pet­i­tive or “mo­nop­oly” agree­ments among en­ter­prises, min­imis­ing abuse of mar­ket dom­i­nance, and block­ing merg­ers and ac­qui­si­tions that would elim­i­nate or un­duly re­strict com­pe­ti­tion.

But man­ag­ing com­pe­ti­tion in a mar­ket that has three ma­jor play­ers – state-owned en­ter­prises (SOEs) and do­mes­tic and for­eign pri­vate com­pa­nies – is a com­plex task. Pri­vate-sec­tor firms are frus­trated with the priv­i­leges that SOEs en­joy, while for­eign-owned en­ter­prises com­plain that they are at a dis­ad­van­tage vis-à-vis do­mes­tic com­pa­nies.

The man­age­ment of in­ter-sec­toral com­pe­ti­tion is even more com­pli­cated. In bank­ing, for ex­am­ple, com­pe­ti­tion is ex­tremely fierce, and China is one of the few economies where con­cen­tra­tion (the mar­ket share of the top five play­ers) has de­clined in re­cent years. But, more than a decade af­ter China’s ac­ces­sion to the World Trade Or­ga­ni­za­tion, for­eign banks’ share of the Chi­nese mar­ket stands at a minis­cule 2% – a re­flec­tion of Chi­nese reg­u­la­tors’ fail­ure to cre­ate a level play­ing field.

The chal­lenge is in­ten­si­fied by tech­no­log­i­cal ad­vances and reg­u­la­tory ar­bi­trage. E-com­merce plat­forms like Alibaba have not only breached banks’ pay­ment busi­ness; they have also be­gun to of­fer wealth-man­age­ment prod­ucts. And reg­u­la­tory ar­bi­trage has fu­eled the emer­gence of shadow bank­ing, which is com­pet­ing ac­tively with tra­di­tional fi­nan­cial in­sti­tu­tions for wealth-man­age­ment and lend­ing busi­ness.

Reg­u­la­tory ar­bi­trage arises from com­pe­ti­tion among cen­tral-govern­ment agencies for the author­ity to reg­u­late – com­pe­ti­tion that of­ten de­lays mar­ket re­forms and in­sti­tu­tional change, ow­ing to agencies’ un­will­ing­ness to ac­cept one an­other’s author­ity. For ex­am­ple, over­lap­ping reg­u­la­tion by at least five agencies and min­istries has de­layed the de­vel­op­ment of China’s bond mar­ket con­sid­er­ably.

The best ex­am­ple of healthy com­pe­ti­tion in China is that which oc­curs among cities. China has 287 pre­fec­ture-level cities, with a me­dian pop­u­la­tion of 3.7 mil­lion and me­dian per capita GDP of $5,800. Six­teen cities have al­ready crossed the World Bank’s thresh­old for high-in­come sta­tus, with an­nual per capita in­comes of more than $12,616, and four – Bei­jing, Shang­hai, Guangzhou, and Shen­zhen – have global reach. These cities hold the key to the abil­ity of China as a whole to avoid the mid­dle-in­come trap.

That should come as no sur­prise. The se­cret of China’s eco­nomic suc­cess since 1979 has been the eas­ing of cen­tralplan­ning rules to em­power cities, mar­kets, and pri­vate businesses to ex­per­i­ment, in­no­vate, and grow. Given the dif­fi­culty of iden­ti­fy­ing which of the old rules needed to be re­formed or elim­i­nated, the process de­pended on the del­e­ga­tion of cen­tral-govern­ment pow­ers to lo­cal gov­ern­ments, which were bet­ter equipped to ex­per­i­ment with mar­ket rules to boost eco­nomic growth. At the same time, in or­der to pre­serve the sys­tem’s sta­bil­ity and in­tegrity, these ef­forts were ac­com­pa­nied by the cen­tral­iza­tion of fis­cal author­ity and cer­tain over­sight pow­ers. This bal­ance be­tween hor­i­zon­tal com­pe­ti­tion and ver­ti­cal reg­u­la­tion was crit­i­cal to pro­mot­ing growth and dy­namism in Chi­nese cities.

But the bal­ance has been far from ideal. In­deed, com­pe­ti­tion among cities – in­ten­si­fied by the large role that mu­nic­i­pal-level GDP growth plays in de­ter­min­ing lo­cal of­fi­cials’ ca­reer paths – went too far, cre­at­ing desta­bi­liz­ing im­bal­ances.

Yes, lo­cal au­ton­omy fa­cil­i­tated bold pro­duc­tiv­ity-en­hanc­ing ac­tiv­i­ties, such as the use of ru­ral land for in­dus­try and com­merce and the cre­ation of pub­lic-pri­vate part­ner­ships to fi­nance ma­jor in­fra­struc­ture projects; pri­vate en­ter­prises were thus able to seize mar­ket share from SOEs in the ser­vice and man­u­fac­tur­ing sec­tors. But cities’ hasty ef­forts to im­i­tate one an­other’s growth mod­els also led to overwhelming en­vi­ron­men­tal pol­lu­tion, mount­ing debt, ex­cess in­fra­struc­ture ca­pac­ity, ris­ing in­equal­ity, de­ple­tion of farm­land, and ram­pant cor­rup­tion, in­clud­ing ad­min­is­tra­tive abuses that en­croached on cit­i­zens’ property rights.

Com­pe­ti­tion-fu­eled growth pro­pelled China’s emer­gence as the world’s sec­ond-largest econ­omy. But it is un­sus­tain­able. The im­per­a­tive now is to re­bal­ance com­pe­ti­tion to ad­dress the neg­a­tive ex­ter­nal­i­ties of state and mar­ket ac­tiv­i­ties that harm cit­i­zens’ in­ter­ests.

The cen­tral govern­ment’s re­cent re­moval of cer­tain ju­di­cial pow­ers from lo­cal gov­ern­ments, thereby strength­en­ing pro­tec­tion of property rights, is an im­por­tant step in this di­rec­tion. But it is not enough. En­abling the mar­ket to drive re­source al­lo­ca­tion, while en­sur­ing a level play­ing field for all par­tic­i­pants, will re­quire the es­tab­lish­ment of clear com­pe­ti­tion prin­ci­ples, pos­si­bly sup­ported by a pow­er­ful “com­pe­ti­tion com­mis­sion.” No com­pe­ti­tion can work with­out clear, fair rules. That is the real chal­lenge fac­ing China’s lead­ers to­day. If they suc­ceed, a high-in­come China will be only a mat­ter of time.

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