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Economic Reforms in China: which model of development?

Professor Daniele Schilirò, University of Messina


This article takes inspiration from the panel on “Economic Reforms in China: Spearheading or Aligning Capitalism? “ at the Horasis Global China Business Meeting held in Cernobbio on October 14, 2014

China has embraced widespread reforms to make its market economy stronger. The task of the current leadership is to turn what was once a lumbering command economy into a dynamic society of innovators and entrepreneurs.

It is well known that China is a centralized capitalism system that achieved astonishing goals in the last thirty years. Thus, China has become the second biggest economy, a real economic superpower not only for its exports, but also for its infrastructures, its technology and so forth. However, the country is still a big socialist economy, with a Communist party made of 90 million members and with the delegates of the National Congress elected in a democratic manner, where the state owned enterprises play a major role, since they represent a large share of the economy.

Since 2013 China’s economy has entered a new phase of growth: from high growth to moderate growth, the Chinese Communist Party’s Central Committee, gathered in November 2013 and guided by the new President Xi Jinping, aimed to design a new economic strategy.

Mr. Xi Jinping made some positive decisions in the direction of free market economy and aligning capitalism. He decided to give private companies bigger stakes in sectors that were once the exclusive preserve of state-owned enterprises, also limiting the influence of firms owned by local governments and favoring the SMEs in the private sector. Moreover, he has started to overhaul the household registration system, which was a legacy of the Mao era, with the purpose of favoring the migration of the population from campaigns in the new towns. In addition, President Xi relaxed the one child-per couple-policy.

Thus China’s new administration has delivered to abandon a growth model that had successfully guided the country’s economic development for more than thirty years. The government recognized the need to switch from a model that focused mainly on export-and investment-led production (via manufacturing) to one led by private consumption (via services). Plus, entrepreneurs will play a more important role in the reformed economy. Therefore, the government has introduced reforms to investment financing, taxation and logistic systems and, further, opened the gate for the development of the service sector and other emerging industries. It has also strived to remove market obstacles and make the market to play a decisive role in resource allocation. Somehow, reforms in China represent an opportunity for the country for competing with itself.

Furthermore, the slower growth, which characterizes the GDP’s trend today is tolerated and accepted as “normal” from current China’s leaders. However, even if the growth rate is diminishing, a process of structural change is continuously characterizing the evolution of the China’s economy.

As a matter of fact, China’s three decades of annual hyper-growth led to unsustainable strains: outsize resource and energy needs, environmental degradation and pollution, mounting income inequality. Huge Chinese current-account surpluses resulted from too much saving and too little consumption. China has in fact a low consumption because the per-capita income is still low and the people do not have welfare protection. Lastly, the growth of jobs and the employment have been unsatisfying and have had a pace lower than the growth of the economy, until the slowdown caused by the global economic crisis in 2008-2009. So the new model pursued by the Chinese government has become a quality growth model with an economy driven by internal consumption rather than exports. This change should give China a much better chance of avoiding the dreaded “middle-income trap”, which ensnares most developing economies. Chinese leaders are content with a normal growth because labor market conditions have held up well in the slowdown. Therefore, they are realizing that output targets are not necessary for meeting employment objectives. The Chinese government is abandoning the old target of growth, which represented the State approach to growth and the inflexibility of the central planning . Now the government aims at three macroeconomic goals: creating employment, stability of prices, GDP's growth; wherein the GDP's growth is the last one. To the extent that there have been stimulus measures, they have mostly targeted areas with the greatest impact on employment, especially small businesses. Over the past two years, the State Council announced a number of high profile tax cuts and targeted credit easing measures directed at small and micro enterprises. Since the vast majority of small and micro enterprises are in the service sector, they are in a strong position to absorb new jobs generated by growth in services. However, Xi Jinping will not demolish the State-enterprises, because they are a great reality, but they must not be anymore a government monopoly. In addition, he is not likely to decrease significantly the incentives for public companies because this avoids the dreaded excessive drop of growth. The transition towards the new reformed economy requires a complex balance between the past and the future. However, it is still far from clear whether Xi Jinping’s economic policies will succeed in preventing a sharp slowdown in growth.

China has excess of credit and the economy has a rising dependence on debt ( the debt soared more than 200% of GDP), so the government wants to create the conditions for growth that does not depend on debt. The banking sector, for instance, is highly exposed in the construction industry, especially in new towns. The reform of the credit system promoted by the Chinese government, which involves the birth of five new private banks, should favor the private enterprises and their growth, making the credit system more efficient. In fact, until now, the state banks tended to help the state-owned enterprises offering them loans at lower interest rate with respect private companies. The state-owned enterprises, in turn, lend their loans to private companies at much higher interest rates. Then, the SMEs were not helped by the credit system, thus they have been operating in a shadow system. Moreover, there are too many local state banks and these banks compete with other local banks; all this creates problems. In China you should have few banks, not many like in China now. It is also better to have a system of good supervision for the credit sector. But this reform of the credit system, to operate at full capacity, will require many years, since it will be necessary to overcome the resistance of the public enterprises and the culture of opacity and the lack of transparency in which the private companies have grown in the country. At the same time, the new young generation in China is not using the old banking system, they use Alibaba. So they follow the global trend very fast. China also has a great potential in the financial sector, but it needs to make the right structural adjustments. It also needs more confidence.The financial sector must serve the real economy and therefore the development. The government is opening the financial sector, so it will be more easy to enter the sector, it will also be easier to open financial activities and to participate in the international financial market. Within the month of October 2014, will be operating the Shanghai - Hong Kong Stock Connect; this will become a broader and liquid Chinese stock market with a market capitalization of almost 4 trillion dollars.

China is a huge country and it is not easy to manage. China is doing well after all. Its rate of growth in 2014 is 7.4% which is more than double of the rate of growth of the world economy, according to recent figures of IMF. Growth slows for several reasons (i.e. troubles in the property sector, which directly accounts for about 15% of China’s GDP, is one of the major single factor), but also because in China the cost of living is increasing. At the same time, there is a process of global disinflation, also fueled by the drop in oil prices which, in turn, is nothing more than a reflection of a slowdown in the global economic cycle. China is not an exception to this trend, so disinflation is also characterizing China’s economy (the inflation has slowed at a rate of 1.6%). The monetary easing from the Central bank did not seem to have a lasting effect in terms of inflation and growth.

The impression one has on the reforms, initiated by President Xi , is that there are important issues, in a medium - long term perspective, which relate to the context, that the government is trying to address. But it is still far from clear whether Xi Jinping’s economic policies will succeed. Much will depend on how much President Xi will be able to establish the rule of law, that in the new reformed China will become a very important hallmark. This, in fact, is the central theme, together with fighting corruption, of the annual meeting (on 20th October 2014), of the Plenum of Communist Party. The effect of such reforms would be very important and deep. They would signal a willingness by the party to begin loosening its monopoly of power and accepting checks and balances.

In conclusion, thanks to its reforms, China is looking for its way to Capitalism, trying to determine a structural change of the economy that transforms the country into a dynamic society of innovators and entrepreneurs. There is no a western model to follow for China. The new leadership aims to pursue a new long-term strategy that gives China economic development and widespread prosperity. But the problems that China is facing (population, environment, innovation, education, consumption and so forth) need cooperation with the Western economies and the developing countries. Even more, China needs a win-win strategy at a global level to achieve a sustainable development.


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