China has been a slow reformer, an economy that seems to be in perpetual transition. The Chinese see this gradualism of reform as a virtue, in stark contrast to the sheer brutality of “shock therapy” that other communist economies like Russia have attempted unsuccessfully. Critics would however see this “Chinese-style capitalism” as a euphemism for inefficient legacy systems held in place by powerful interest groups.
Urban governments, for example, in big cities like Beijing are fighting hard to keep the brakes on internal migration (and migrants’ rights, including their ability to buy things like cars) alive. China has production quotas for the provinces for things like steel, which leads to sub-optimal resource allocation. Provincial governments use weight to prevent ineffective units from shutting down in their provinces.
This has a clear negative impact on efficiency, productivity and, finally, on “long-term structural demand,” to use a phrase from David Li of Tsinghua University.
For an economy that has often been seen as the poster child of FDI success, the number of restrictions on foreign investment is surprisingly large. The financial sector offered limited access to foreigners and was dominated by monolithic state-owned banks. Deregulating interest rates was a slow process that ended in 2015.
China’s ranking in the World Bank’s Ease of Doing Business Index was perhaps 31 in 2019. But as of 2017, it was 78 and 96 in 2013. (Eight trade reforms in 2019 were responsible for the decline.) Despite this, China recorded an average growth of 10% between 1978 and 2010.
Contrary to Western predictions, neither the Chinese economy nor any of its key sectors like housing imploded. The CCP has survived many premature obituaries. This could raise uncomfortable questions about the need for the neoliberal Washington Consensus (which underpinned liberalization efforts) for high or sustained growth.
Dragon Slow Speed
China’s growth has slowed over the past decade. But this could be the inevitable result of an aging population, not bad macroeconomics or bad structural policies. The risk is that slowing growth will eventually expose distortions and inefficiencies, a risk that must be taken seriously in assessing future growth prospects.
What is China’s current growth model? The powerful combination of modern commercialism with undervalued exchange rates, a steadfast export orientation, and strict labor market controls that led to its first phase of unbridled growth is outdated.
The Chinese currency has remained overvalued for most of the past decade. Wages increased in high growth areas, further reducing competitiveness. As early as 2004, Chinese party leaders decided to turn in on themselves and view domestic consumption as an engine of growth – “inbound traffic” in Chinese political jargon, rather than “world traffic”.
What emerged in its place? In terms of concrete strategies, the new Chinese model seems to consist of a set of different projects with no major theme to tie them together. A successful project is its transition from imitator to innovator. This has been done through massive investments in technological education. China now has the second highest number of unicorn startups in the world after the United States.
A second project involved locking down markets outside of China through initiatives such as the Belt and Road Initiative (BRI). Devoid of its political agenda, it is a question of debt financing of projects in the BRI, for the benefit of guaranteed orders for Chinese construction companies and investments for manufacturers of goods. The internationalization of the yuan, a somewhat difficult aspiration for an economy with capital controls and non-transparent capital markets, was a third. The last on this list is to rapidly develop its financial markets, allowing independent operations of global financial majors and offering new “products” such as metal futures. Some of these projects fuel the broader macroeconomic objective of accelerating domestic consumption.
startups could provide credit to underbanked people, reduce the need for excess savings, and help retail demand. However, these bottom-up successes may not be enough. Good old-fashioned internal reforms – dismantling inefficient production, ensuring much greater labor mobility, reducing regional disparities and creating an efficient financial sector – must be accelerated for sustainable growth.
Unlearn and learn
There are insignificant doubts about whether Chinese political leaders have enough confidence in the very idea of rapid reform. The suspension of Ant Group’s IPO in November 2020 and the crackdown on messenger-taxi app DiDi earlier this month, days after its IPO, suggest some unease with business logic in a framework of free enterprise. The fear is that this resistance to change and ad hocism could spread to other areas.
Despite India’s legitimate disgust and anger at its neighbor’s bullying tactics, it still has a lot to learn from China – the latter’s hard-line approach to project implementation, for example. However, despite its many shortcomings, India has been a more committed reformer and there is greater support from political classes to the very idea of reform. He has to rely on that. As with China, gradualism can be an obstacle to unlocking its potential.