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Economy

China’s Four Traps

Nov 27 , 2018
  • Andrew Sheng

    Distinguished Fellow at the Asia Global Institute at the University of Hong Kong
  • Xiao Geng

    President of the Hong Kong Institution for International Finance

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HONG KONG – On the 40th anniversary of the launch of China’s “reform and opening up,” the country is well on its way to recapturing its former status as the world’s largest economy, having made substantial progress toward modernizing its agricultural sector, industry, defense systems, and scientific capabilities. But four major traps lie ahead.

The first is the middle-income trap. With a per capita annual income of around $9,000, China remains significantly below the threshold for high-income status, set at around $12,000-$13,000 by the World Bank. Only a few countries in history have managed this leap during the last half-century.

A major reason is that reaching high-income status demands a strong network of modern institutions that define individuals’ rights and obligations, enable market exchange and non-market interactions, and enforce the rule of law by resolving disputes fairly. While China has been working to develop its institutions for four decades, it still has a long way to go.

Second, China may become ensnared in the so-called Thucydides Trap: when an established power (Sparta in Thucydides’ time; the United States now) fears a rising power (Athens then; China now), war becomes inevitable. With US President Donald Trump’s administration targeting China with trade measures that are clearly designed to reduce China’s access to markets and technology, this outcome seems increasingly plausible.

The third potential trap is what Joseph Nye calls the Kindleberger Trap. Charles Kindleberger, an architect of the Marshall Plan, blamed the breakdown of the international order in the 1930s on America’s failure to match its provision of global public goods to its new geopolitical status as the world’s dominant power. If China does the same, according to Nye, chaos could erupt again, especially at a time when the US is withdrawing from global leadership.

Finally, there is the climate-change trap. High-income countries in general, and great powers in particular, consume a disproportionately large share of resources. But China’s economy and influence are growing at a time when, as dire warnings by bodies like the Intergovernmental Panel on Climate Change demonstrate, that is not really an option. China’s leaders thus have an additional imperative to support international cooperation and adopt forward-thinking policies that account for environmental realities.

Avoiding these four traps will be extremely difficult. China’s leaders must navigate complex and conflicting pressures, as they seek to address domestic economic inequalities, manage relations with an insecure and isolationist US, cooperate effectively with the rest of the world, and pursue effective climate action.

The good news is that China’s governance system – characterized by centralized policymaking and decentralized experimentation and implementation – has proved well-suited to rapid decision-making in times of crisis. Over the last four decades, the Chinese model has proved more practical and efficient than democratic systems, which have often been paralyzed by dysfunctional and polarized politics. Its success in guiding China to high-income status will be determined largely by four factors – talent, competition, public goods, and accountability – all of which the country has managed to harness effectively in the past.

Adhering to thousands of years of tradition, China has devoted considerable resources to the identification, selection, and grooming of administrative and technical talent. This has been essential to China’s ability to develop the strong state capacity needed to manage large-scale public projects. As China confronts the four traps, its ability to develop and retain human talent will be vital to success.

China has also effectively used competition among individuals, companies, cities, and provincial bureaucracies to ensure that all stakeholders are contributing to productivity and GDP growth. But China’s markets have developed faster than its regulatory framework, so that now policymakers must close loopholes and resolve weaknesses that are undermining fair competition. At the same time, they need to tackle the consequences of those loopholes and weaknesses, such as corruption, pollution, excessive debt, and overcapacity.

This is the other side of the public-goods challenge: while China has plenty of experience delivering physical infrastructure, it has been less successful in delivering soft infrastructure, such as competition rules, accounting standards, tax systems, and regulatory norms. China will not achieve high-income status unless and until this changes.

When it comes to accountability, China has an indirect and imperfect system that is poorly understood by outside observers. Chinese leaders earn their legitimacy not by winning the most votes, but by delivering results such as economic prosperity and progress on implementing reforms. As China’s global influence grows, international pressure will become another mechanism for accountability.

The challenge China faces in this area relates to some of the tradeoffs Chinese leaders have made in their pursuit of results. In particular, monopoly is on the rise, with Internet platforms that provide social benefits in the form of low transaction and communication costs (Alibaba, Tencent, and Baidu) securing massive market share. That, together with policy subsidies, has created monopoly rents that are subject to capture by small interest groups.

This escalating market concentration – which, to be sure, is not limited to China – can lead to worsening inequality of income, wealth, and opportunities. China’s leaders will thus have to make significant progress toward addressing it in the coming decades.

During its 40 years of reform, China has mastered learning by doing, using dynamic markets as a guide for price signaling and problem-solving. It has engaged in bold policy experiments, such as the creation of special economic zones. And it has become steadily more integrated into the global economy. As it attempts to avoid the pitfalls that lie ahead, it will need to bring all of this experience to bear.

Copyright: Project Syndicate, 2018.
www.project-syndicate.org

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