There is plenty of reason for concern. GDP growth has slowed sharply; corporate-debt ratios are unprecedentedly high; the currency is sliding; equity markets are exceptionally volatile; and capital is flowing out of the country at an alarming pace. The question is why this is happening, and whether China’s authorities can fix it, before it is too late.
The popular – and official – view is that China is undergoing a transition to a “new normal” of slower GDP growth, underpinned by domestic consumption, rather than exports. But this interpretation, while convenient, can provide only false comfort.
China’s problem is not that it is in transition. It is that the state sector is choking the private sector. Cheap land, cheap capital and preferential treatment for state-owned enterprises weakens the competitiveness of private firms. So many private firms have turned away from their core business to speculate in the equities and property markets.
Chinese households are also squeezed. In just 15 years, household income has fallen from 70% of GDP to 60%. Unless Chinese households are able to reap their fair share of the benefits of economic growth, it is difficult to imagine how a consumption boom is supposed to happen.
In the late 1980s, falling GDP growth (the annual per capita rate reached a low of 2% in 1989) and a rising volume of non-performing loans (NPLs) fuelled expectations of an economic implosion.
It never came. Instead, the Chinese government launched radical reforms including large-scale privatisation of industry and elimination of price controls and protectionist policies and regulations. As the state’s share of non-agricultural employment fell, private-sector productivity rose at an average annual rate of 3.7% from 1998 to 2007. State-sector productivity grew even faster, at 5.5% per year. This productivity growth contributed about one-third of China’s total GDP growth – which accelerated to double-digit rates – over this period. China’s entry into the World Trade Organization in 2001 was a major factor in this success.
Now, however, the task facing China’s government is complicated by political and social constraints. The economic reforms China needs now presuppose political reform; but those reforms are hampered by fears of the social repercussions. If China is to avoid economic decline, it will have to overhaul its governance system without triggering excessive social instability.
China has a promising track record on this front. After all, it was a fundamental ideological shift that enabled China’s 35-year-long economic boom.
That shift emphasised economic development above all else, with the champions of growth being protected, promoted, and, if necessary, pardoned.
A similar ideological shift is needed today, only this time the focus must be on institutional development. Only by overcoming vested interests and building a more efficient bureaucracy, bound firmly by the rule of law, can the reforms China needs be pushed through.
The potential for mass protests and civil unrest is now hampering the government’s determination to create change. But with a concerted effort to create a level playing field that gives more people a bigger piece of the economic pie, China’s government could reinforce its legitimacy and credibility. That, in turn, would strengthen the authorities’ capacity to ensure stability.
China’s experience in the 1990s suggests that the country can bounce back from its current struggles. With major reforms only half-complete, there are significant opportunities for stable growth based on efficiency and productivity gains, rather than merely on consumption. Once key distortions are eliminated and resources – including labour, capital and talent – are being allocated more efficiently, China will be able to continue its march toward high-income status.
Keyu Jin is a professor of economics at the London School of Economics and a member of the Richemont Group Advisory Board
Copyright: Project Syndicate 2016, project-syndicate.org