China’s trial-and-er­ror econ­omy

Financial Mirror (Cyprus) - - FRONT PAGE -

Chi­nese Prime Min­is­ter Li Ke­qiang’s work plan for 2015, re­vealed at this month’s Na­tional Peo­ple’s Congress, high­lighted the coun­try’s shift to a “new nor­mal” of 7% eco­nomic growth. The shift to slower growth poses se­ri­ous chal­lenges, but it also cre­ates an im­por­tant op­por­tu­nity for China to en­sure its long-term eco­nomic devel­op­ment.

China’s lead­ers rec­og­nize this op­por­tu­nity, and are tak­ing ac­tion to sup­port the shift to more sus­tain­able growth mod­els. The fi­nance min­istry has raised the cen­tral­go­v­ern­ment bud­get deficit from 1.8% of GDP in 2014 to as much as 2.7% in 2015, and will al­low highly lever­aged lo­cal gov­ern­ments to swap CNY 1 tril­lion ($161.1 bil­lion) of debt ma­tur­ing this year for bonds with lower in­ter­est rates.

Like­wise, the Peo­ple’s Bank of China (PBOC) has pro­vided mon­e­tary sup­port, grad­u­ally low­er­ing in­ter­est rates and re­serve re­quire­ments. Be­cause wages are still ris­ing, the in­fla­tion tar­get for 2015 has been set at 3% – higher than the ac­tual 2014 in­fla­tion of 2%, even though pro­ducer-price in­fla­tion has been neg­a­tive for 36 months. The PBOC also has pro­jected a sta­ble ex­change-rate en­vi­ron­ment for this year – de­spite the steep de­pre­ci­a­tion of the Ja­panese yen, the euro, and emerg­ing-econ­omy cur­ren­cies against the dollar – thereby pro­mot­ing global sta­bil­ity.

Th­ese poli­cies re­flect a re­mark­able de­ter­mi­na­tion to con­tinue on the path of struc­tural re­form, de­spite strong head­winds from the de­te­ri­o­rat­ing ex­ter­nal en­vi­ron­ment and do­mes­tic struc­tural ad­just­ments. In short, China’s gov­ern­ment seems to have a clear long-term vi­sion.

But not ev­ery­one is op­ti­mistic about China’s tra­jec­tory. Vet­eran China watcher David Sham­baugh re­cently went so far as to warn that the chal­lenges fac­ing the po­lit­i­cal sys­tem, led by the Chi­nese Com­mu­nist Party (CCP), may be se­verely com­pro­mis­ing the gov­ern­ment’s abil­ity to im­ple­ment the pack­age of am­bi­tious eco­nomic re­forms that it un­veiled in 2013.

And yet the claim that China’s eco­nomic and po­lit­i­cal devel­op­ment is in jeop­ardy seems to ig­nore the coun­try’s adap­tive learn­ing process, which shapes ev­ery eco­nomic, diplo­matic, mil­i­tary, and so­cial pol­icy. This process – char­ac­ter­ized by ex­per­i­men­ta­tion, as­sess­ment, and ad­just­ment – emerged from the CCP’s mil­i­tary ex­pe­ri­ence of the 1930s, was ap­plied by Deng Xiaop­ing to his re­form pro­gram in the 1980s, and has been re­fined by sub­se­quent Chi­nese lead­ers. Be­cause no econ­omy had ever ex­pe­ri­enced such rapid growth on such a large scale, the only way to man­age China’s devel­op­ment was, as Deng put it, to “cross the river by feel­ing the stones.”

China’s adap­tive pol­i­cy­mak­ing ap­proach has pro­duced both spec­tac­u­lar fail­ures, with en­tire mar­kets be­ing shut down, and re­mark­able suc­cesses, yield­ing mod­els that could be ap­plied across the coun­try. Some ex­per­i­ments have had less clear re­sults, mak­ing, say, a pos­i­tive con­tri­bu­tion to GDP growth, but also con­tribut­ing to prob­lems like ex­cess industrial ca­pac­ity, pol­lu­tion, cor­rup­tion, and the cre­ation of ghost towns.

In a con­text of ex­per­i­men­ta­tion, such un­in­tended con­se­quences are un­der­stand­able. The mere fact that they have emerged in no way sug­gests that China is headed for dis­as­ter; that would be the case only if th­ese prob­lems were al­lowed to persist.

Pre­vent­ing such an out­come re­quires that ef­forts to ad­just to China’s “new nor­mal” go be­yond poli­cies in­tended to sus­tain eco­nomic growth. Re­forms must aim to bol­ster in­clu­siv­ity, ad­vance en­vi­ron­men­tal sus­tain­abil­ity, pro­mote in­no­va­tion, and boost com­pet­i­tive­ness. And this is pre­cisely the four-pronged ap­proach that China’s lead­ers seem to be tak­ing.

In­deed, from slash­ing coal con­sump­tion to ad­dress air pol­lu­tion to plans for in­te­grat­ing in­for­ma­tion tech­nolo­gies with mod­ern man­u­fac­tur­ing, the gov­ern­ment has shown time and again that it rec­og­nizes its re­form im­per­a­tives. And, by re­main­ing dogged in its ef­forts to root out of­fi­cial graft, it has demon­strated its will to do what is needed to en­sure that China suc­ceeds.

This is not to say that it is all smooth sail­ing ahead. The Chi­nese bu­reau­cracy must adapt rad­i­cally to cope with the risks – and take ad­van­tage of the benefits – of tech­nol­ogy and glob­al­iza­tion, with the big­gest chal­lenge be­ing the shift to a knowl­edge-based, en­vi­ron­men­tally con­scious, in­clu­sive, and sta­ble industrial base. And China’s gov­ern­ment must take steps to en­able mar­ket forces to play a greater role in di­rect­ing eco­nomic ac­tiv­ity, in­clud­ing by re­duc­ing li­cens­ing and reg­u­la­tory re­quire­ments in the pri­vate sec­tor.

Mar­ket forces will also ben­e­fit from the growth in house­holds’ spend­ing power. In­deed, con­tin­ued real-wage growth is forc­ing in­ef­fi­cient in­dus­tries that re­lied solely on cheap la­bor out of the mar­ket, while bol­ster­ing the com­pet­i­tive­ness of pro­duc­ers that ap­peal to the evolv­ing tastes of China’s in­creas­ingly po­tent con­sumers. To sup­port this process, China is now im­ple­ment­ing de­posit in­sur­ance, for ex­am­ple.

At the same time, China is re­form­ing its in­ef­fi­cient ap­proval-based sys­tem of ini­tial public of­fer­ings to one based on reg­is­tra­tions. A more ac­tive and ef­fi­cient IPO mar­ket will al­low com­pa­nies to meet their fi­nanc­ing needs with­out bank in­ter­me­di­a­tion – a step that is vi­tal to help­ing firms elim­i­nate their debt over­hangs.

In fact, re­duc­ing the role of banks is es­sen­tial to bal­anc­ing China’s econ­omy. De­spite the re­cent re­bound, China’s stock­mar­ket cap­i­tal­iza­tion amounts to only 40% of GDP, while bank­ing as­sets to­tal 266% of GDP. Mean­while, only 10% of to­tal so­cial fund­ing comes from the eq­uity mar­ket.

But there is one im­por­tant com­po­nent miss­ing from the gov­ern­ment’s re­form agenda for 2015: im­proved bank­ruptcy pro­ce­dures for failed bor­row­ers. Un­less failed bor­row­ers and projects exit the sys­tem quickly and smoothly, the mar­ket will be sad­dled with bad debt and in­com­plete projects, un­der­min­ing its per­for­mance.

China has re­peat­edly proved its dura­bil­ity and adapt­abil­ity. Now, it must do so yet again, by en­sur­ing that its “new nor­mal” is as sta­ble, sus­tain­able, and in­clu­sive as pos­si­ble. This en­tails strength­en­ing China’s in­sti­tu­tional foun­da­tions and es­tab­lish­ing clear, trans­par­ent rules, in or­der to en­cour­age ex­per­i­men­ta­tion and in­no­va­tion, en­sure the smooth exit of failed projects, and man­age the fall­out of er­rors. Fail­ure may be the mother of suc­cess – but only if one makes the ef­fort to learn from it. For­tu­nately, China’s lead­ers seem in­tent on do­ing just that.

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