China’s embrace of sweeping reform could stall

by Chris Sorensen on Saturday, January 4, 2014 5:00am -

For China, it was a brief respite after an uncomfortable stretch of sluggish growth. In November, factory exports surged nearly 13 per cent over the year before, as overseas-bound containers crammed with everything from smartphones to sweatpants gave China its biggest trade surplus in nearly five years. But while investors cheered, the uptick in economic activity could come back to haunt China’s new leadership in the year ahead, since it could once again distract from the need for long-overdue reforms.

Over the past decade, China has overwhelmingly relied on exports, as well as huge, debt-laden infrastructure projects—such as industrial parks, airports, high-speed rail systems, condos and subdivisions—to fuel eye-popping growth. In order to be sustainable over the long term, though, China must boost household consumption, which currently accounts for just 35 per cent of GDP, the lowest level of any major economy in the world. (By comparison, households account for 60 to 70 per cent of GDP in Japan, Germany, Hong Kong, the U.S. and Canada.) That will require convincing ordinary Chinese to unlock their savings and spend more on food, clothes and cars at home.

The trouble is, accomplishing the transition means China will almost certainly have to accept GDP growth far lower than the 10 per cent averaged over the past few decades, and perhaps even below the seven per cent annual target that’s been set for the next five years—easier said than done in a vast nation of 1.3 billion, where the promise of a better tomorrow has proven to be a unifying force, in spite of a widening gap between rich and poor. “I think there’s a recognition that there will be slower growth rates,” says Elizabeth Economy, the director for Asia Studies at the New York-based Council on Foreign Relations, a foreign policy think tank. “But if people continue to feel that the benefits of China’s economic growth, whatever it may be, aren’t being distributed evenly, and that their children won’t be able to do better than they did, then there’s going to be rapid rise in social unrest.”

The stakes for China—and the world—are high. When the engine of the global economy seized in 2008, it was Beijing’s massive $586-billion stimulus package that helped get things running again, and many world leaders are once again hoping a rebounding China can help pull the global economy out of its current funk. But economists have been warning for years that China’s strategy of investment-led growth is at risk of overstaying its welcome. Building new factories and other core infrastructure was once necessary to take advantage of China’s huge, untapped labour pool and meet rising global manufacturing demand. Now it just threatens the profits of existing factory owners by creating excess capacity in the system, threatening the jobs of millions of workers.

So it came as little surprise last month when, after four days of meetings, China’s new leadership, led by President Xi Jinping, released a document outlining a bold-sounding reform agenda for the next decade. Among other things, it promised a greater role for private companies in the Chinese economy, more market influence over prices and better access for foreign companies. A 60-point list of policy goals that was released later included ending the unpopular one-child policy for most parents—a reform that could be enacted as soon as 2014. The pronouncements excited investors, initially sending Hong Kong’s Hang Seng Index and the Shanghai Composite Index soaring. “China’s reform boat has finally set sail,” wrote Société Générale economist Wei Yao.

There were, however, few specifics on how, exactly, the reforms will be implemented. There were also several seemingly contradictory statements. Adam Wolfe, an analyst at Roubini Global Economics, noted in a report that China promised markets would play a “decisive” role in allocating resources, but also that the country’s state-owned enterprises would continue to play a leading role in the economy.

Nor are there any guarantees the central government will be able to force local governments to fall in line. “China, in contrast to many democracies, is often very good at developing a coherent plan of action at the very top,” Economy says. “Where things tend to fall apart is in the next stages. It’s two or three years before they are able to develop regulations to implement a given policy objective. And then you discover, six months later, that it’s not being implemented very well, and that, in fact, there’s a lot of resistance from local governments that the central government can’t seem to overcome.”

It should also be noted that similar reforms outlined back in 2003 under president Hu Jintao never materialized at any level. Wolfe says the reason usually given is that, prior to 2008, China’s economy was running so hot that there was little sense of urgency. After the crash, Beijing decided that getting people back to work was a bigger priority. He called it the “Goldilocks theory of economic reform.”

In Beijing’s defence, the task is truly daunting. Remaking China as a country built on innovation and consumption, while at the same time reducing the influence of all the various interests in the old system, will require literally dozens of simultaneous reforms and sub-reforms. They include developing a social safety net, fixing China’s underfunded pension system, developing an effective income-tax system and rooting out corruption, to name a few. “The problem is that they’re all interlocking and they need to happen simultaneously,” Economy says. “And all of them really require rejigging the bases of power. So, fundamentally, even if we’re talking about economic reform, it’s also political reform.”

Given the myriad challenges, forecasts for temporary relief in China’s manufacturing sector could be just the thing to make Beijing’s bitter medicine for the economy go down easier—or just another reason to put off reforms a little bit longer.