Friday, Jul 25, 2014, 8:15 AM CST – China

Commentary

Liberalization is the real growth engine

China should learn from its recent history and go back to developing its economy by letting it off the hook

urrently, China’s economic planners are challenged by two major tasks. The first is to maintain a certain level of growth, and the second one is to transform an unbalanced investment-driven growth model into a more diversified one. While all are agreed such a transformation will benefit China in the long term, concerns over short term risk and the influence of vested interest groups may still lead to the central authorities resorting to stimulus over a shake-up.

China’s leadership should learn from its recent history. Since the late 1970s, China has experienced three periods of rapid growth. Between 1983 and 1988, China experienced an average GDP growth rate of 11.9 percent, which was largely the result of liberalization of price controls. The second period, between 1992 and 1996, which saw an average GDP growth rate of 12.4 percent, resulted from market reforms which dismantled swathes of the planned economy.

A notable phenomenon in these two periods was an accompanying decline in governmental expenditure as a percentage of GDP, a rate which fell from 23.8 percent in 1983 to 11.7 percent in 1997. In this period, the government adopted a policy of frugality and kept monetary and fiscal policy as tight as it could without derailing growth. Economists have subsequently concluded that the rapid growth rate in these two periods was largely due to the efficiencies of the market supplanting the shortcomings of a lopsided planned economy.

In the third period, between 2003 and 2007, China witnessed an average growth rate of 11.7 percent. At the same time, monetary and fiscal policy was loosened, with the government and its legion of State-owned enterprises collectively becoming the country’s single biggest investor. These policies, launched as temporary measures in response to the Asian financial crisis, soon became seen as all-important as they all but guaranteed maximum short-term growth. In the meantime, government expenditure started to expand. In 2012, it reached 24.2 percent of the annual GDP, about the same level as it had in 1983, when China was still operating an inefficient, planned economy.

As State-owned enterprises swallowed up smaller companies and morphed into gargantuan monopolies, the government took and held the lead in land appropriation, meaning resources were slowly being reclaimed for distribution by the government. In response to the global financial crisis in 2008 and fearful of the impact in its backyard, the Chinese government further deepened its entrenchment in investment-driven growth by launching a massive stimulus plan of unprecedented scale which overwhelmingly favored State-owned enterprises and government-led construction projects.

Private enterprise, to this day the largest and most vibrant sector in China’s economy, remained out in the cold. 

The apparent success of these plans, which secured a growth rate of 9 percent or higher, won much applause, leading to the emergence of concepts like “the Chinese Model” and “Beijing Consensus.”

The celebrations, as we now see, were premature.

Cleaving to such a one-note model has led to a massively distorted growth rate, for which China is now paying the price. Economically, as the government now controls the majority of available social resources, domestic consumption has stagnated, leading to a crippled service industry. The service sector in China is a negligible contributor to GDP, unlike in developed and emerging economies – both Brazil and India are currently building economic miracles of their own thanks in no small part to booming service industries. Politically, the resulting income gap in China has increased social tension.

 It is now clear that China’s growth rate is not sustainable. GDP growth has declined for six successive quarters since 2011. In 2013, China’s new leadership tried to decrease the reliance of local governments and State banks on stimulus while advocating economic restructuring. But, as growth rate in the second quarter of this year dropped to 7.5 percent (slightly over the central government’s widely-publicized “bottom line” at 7 percent), the leadership may find its hand is forced, leading them to pump more ultimately destabilizing stimulus money into the faltering economy.

Decision makers must have the courage and wisdom to resist the temptations of stimulus. An economic slowdown is inevitable, but, if the government can deliver effective economic reforms, the impact and duration of the slowdown will be limited. China weathered a slowdown in 1989, which was followed by a boom resulting from further liberalization. It can repeat this cycle again.

Although China does not have much of a demographic dividend left, its “reform dividend” is far from exhausted. For example, there is ample room for growth in slow-burning industries which ultimately generate wealth such as healthcare, childcare and education. Through further economic liberalization, more efficient resources distribution would be able to unleash new growth engines while improving the standard of living.

Growth is crucial to China’s success – but only sustainable growth can ensure that success.

Cleaving to such a one-note model has led to a massively distorted growth rate, for which China is now paying the price.

(The author is an economist with the Chinese Academy of Social Sciences )

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