Gearing up for China's economy in new era

By Stephen Roach Source:Global Times Published: 2018/2/16 11:08:38

Modern China's economic miracle is defined by the powerful reforms that began under the leadership of Deng Xiaoping. While there are some who believe that post-Mao reforms didn't make much of a difference, a simple extrapolation exercise says otherwise. Over the 1997 to 2015 period, China's real per capita GDP expanded at a 9.6 percent average annual rate - more than 50 percent faster than the 6.1 percent trajectory recorded from 1952-76. As a result, by 2015, overall output per person was fully 3.4 times higher under the "Deng takeoff scenario" than would have been the case had the Chinese economy stayed on the previous more subdued growth path. 

The debate is not whether Deng Xiaoping's reforms made a difference to China's economic growth trajectory, but over which reforms were most important in sparking the take-off. At work was a powerful combination of both inward- and outward-facing reforms. Both strains of reforms had one important thing in common - unlocking market-based efficiencies by driving a wedge into the collectivization of a Soviet-style planned economy. Starting in agriculture with the Household Responsibility System adopted in the early 1980s, internal reforms spread quickly to urban areas and industry. At the same time, the creation of Special Economic Zones set the stage for an influx of foreign capital and technologies that proved crucial for the development of the now dominant Chinese export machine. 

The payback was unprecedented in the annals of economic development - 30 years of 10 percent growth in the real economy. But takeoffs, by definition, are transitory for any developing economy, and China is no exception. Starting about 10 years ago, the Chinese leadership engaged in active debate over its post-takeoff growth strategy. Drawing on the experience of Deng Xiaoping's gambit, there was a widespread consensus that a major shift in the growth structure was required - from manufacturing-led exports and investment to services-led consumption. There was also a consensus that it would take a new round of reforms to promote the requisite rebalancing of the Chinese economy.

The Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) ratified a comprehensive agenda of reforms that was aimed at China's new growth imperatives.  Implementation has been challenging. While many new initiatives have been put in place - such as interest rate liberalization, hukou and family planning reforms - other areas have lagged behind, such as social security and State-owned enterprise (SOE) reform. At the opening of the 19th Party Congress in October 2017, General Secretary of the CPC Central Committee Xi Jinping left little doubt that China was in need of refocusing its efforts on a round of reforms aimed at sustaining a new era of Chinese growth and development. 

Reform strategies are a moving target as nations progress down the road of economic development. What works in the early "catch-up" stage is very different from what is required to achieve the aspirational objectives of a "moderately well-off society" and avoid the dreaded "middle-income trap." While China has long stressed its own unique approach to economic development with Chinese characteristics, the greater the progress it makes, the more it stands to gain from the experience of others who have traveled a similar road.       

One such lesson is particularly important in the current environment — the twin perils of financial instability and asset-dependent real economies. Japan's lost decades of the 1990s and the 2000s are an obvious and important case in point, as are the wrenching adjustments during and after the global financial crisis of 2008-09. In both of those cases, policymakers and regulators made serious mistakes in their search for new sources of economic growth. They failed to distinguish between financial engineering and growth-enabling reforms. Just as Japan placed enormous emphasis on building and protecting its interlocking networks of businesses, the US stressed new financial instruments such as subprime mortgages, and Europe turned to new institutions as part of its monetary union. The results in all cases were painfully similar - the confluence of asset bubbles, excess leverage, and protracted post-bubble aftershocks bordering on secular stagnation.

China is well aware of the pitfalls of financial instability and has taken major steps to avoid the disruptive outcomes that have afflicted the advanced economies repeatedly over the past quarter century. The State Council has established a new financial stability oversight committee to address a multiplicity of related issues - from excess leverage and shadow banking to local government finance and coordinating issues between monetary and regulatory authorities. In contrast to the US which still has a very fragmented regulatory structure that leaves its system vulnerable to cross-product and cross-market spillovers, China's new focus on an oversight authority should be better positioned to address the complexity of systemic risks that proved so damaging during the Global Financial Crisis of 2008-09.

As always, the challenge for reforms will come in implementation. SOE reform is near the top of the list, touching many different aspects of the growth challenge that China faces - excess debt, excess capacity, and the inefficiencies that plague the supply side of the equation. 

The current strategy seems to be coalescing around the so-called mixed-ownership restructuring followed by China Unicom last August. In light of the lessons noted above, this approach could well be problematic. The $11.7 billion capital injection into China Unicom came mainly from 10 other companies, with 46 percent of the funds provided by other SOEs. This is very reminiscent of the Japanese structure, which spawned a massive problem with zombie enterprises in the aftermath of the bursting of the Japanese equity bubble in the 1990s. With China having experienced two major equity bubbles in the past 10 years, this is not a risk to take lightly. Moreover, like the financial engineering of the West, this refinancing does more to rearrange China Unicom's equity structure rather than refocus the company on more strategic growth objectives.  

China has made extraordinary progress in a relatively short period of time. As its economy has grown and the base of economic activity has broadened, its reform challenge has become exceedingly complex. Once again, it is important to stress that financial engineering is not a substitute for the heavy lifting of reforms. There are no shortcuts on the road to China's new era. 

The author is a faculty member at Yale University, former chairman of Morgan Stanley Asia, and the author of Unbalanced: The Codependency of America and China (2014). 


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