by John West, Asian Century Institute
The Chinese economy is caught between a rock and a hard place. Extricating itself from this predicament will not be easy.
Since the Lehman shock of 2008, China’s economic growth has seemed very impressive, especially when compared with the sluggish Western economies. Growth was around 10% from 2009 to 2011. It has since slipped down to the 7-8% range, and will likely be around 7% over the next year or so. This is consistent with economic maturation, and appears a more sustainable.
The problem is that these good growth rates have been induced by heavy doping from fiscal and monetary stimulus. The government is keen to maintain steady employment growth to maintain “social stability”.
Short term stimulus to maintain economic stability does indeed make sense. But six years after Lehman, the government is still prodding and nudging the economy forward with mini-stimulus packages. The consequence has been excess capacity in some sectors (notably real estate), wasteful infrastructure projects, bad debts, and financial fragility in the corporate, banking and local government sectors. Combined government, corporate and household debt has jumped from 150% to 250% of GDP these past six years. This cannot go on forever.
One year ago at the Third Plenum, the government announced a much-needed impressive reform agenda. The objective is to improve the quality of growth and to unleash new sources of growth. Growth should be more consumption-driven, less reliant on investment, and more balanced and sustainable.
Market forces will be programmed to play a decisive role in the economy. This should involve market liberalisation and deregulation, and policies for greener growth. It should also include further progress in the very impressive internationalisation of the renminbi currency, and also capital account convertibility.
However, for reform to be effective, it must also entail “creative destruction”, that is, letting some firms and financial institutions fail. Productivity growth and innovation require that the old must make way for the new. Finance should be allocated to efficient and dynamic enterprises, not to keeping troubled enterprises afloat.
The reform program is challenging, but unavoidable if China is to continue climbing the development ladder — even though reform might slow growth in the short-term. While the government’s goal is to implement the reform program by 2020, implementation to date has been very slow. Well-connected vested interests are lining up blocking reform, even if some are being neutralised by the anti-corruption campaign. And it can seem safer for the government to postpone reform, while the economy remains fragile.
But delaying reform runs great risks. The ultimate risk is not so much one of financial crisis. China’s immense foreign reserves protect it from externally generated financial crises (it also unfortunately insulates it from international market discipline).
The main risk is that of prolonged stagnation due to the failure to quickly deal with a large buildup of domestic debt, the very inefficient allocation of resources, the lack of productivity-stimulating structural reforms, and wide income inequality. This is what happened to Japan following its financial crisis in the 1990s, and was then exacerbated by Japan’s rapidly aging population. It is often called the “Japanization” syndrome. Japan’s Abenomics is a belated and tame attempt to tackle this syndrome.
But Japan was already a very prosperous country when Japanization struck. In China’s case, there is a severe risk of a case of Japanization and a very rapidly aging population, while China is still a much poorer country in terms of GDP per capita.
Today, the Chinese economy stands at a turning point. Radical market-oriented reform is urgently to boost productivity and innovation to continue economic catchup and avoid falling into a “middle income trap”.
We can only hope that President Xi Jinping still has sufficient political capital left when the anti-corruption campaign is completed. In China’s system, economic prosperity is not only important in itself. It is also key to social and political stability.