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Rebuilding the Reform Momentum

Mar 27 , 2013

When former President Hu Jintao took over the reins of China in 2003, the country ranked sixth in GDP globally at $1.4 trillion. It sat just below France. By the time President Xi Jinping ascended to the official head of state in March 2013, China had the second-largest economy at $8.3 trillion. In the time between Hu and Xi, the country added more than three Frances to its economy. Not bad for a decade’s work. 

Yet what emerged from the just-concluded National People’s Congress, capping off China’s political transition, was far different in tone from the usual emphasis on the growth imperative. For one, the government set the 2013 growth target at 7.5% again, signaling that it no longer prioritized full-throttle economic growth. Instead, it made a case for why absent serious reforms, the Chinese economy risks sputtering. In fact, during the first full meeting of the new government, Premier Li Keqiang sounded a sobering note that having advanced this far, the Chinese economy will face significant troubles without changing the growth model. 

The recipe for that model–call it the “Panda Boom”–is well known by now. They included an abundance of cheap capital and labor, low inflation (in part by state intervention in the price of inputs such as energy and capital controls), relatively open attitude to foreign investment and technologies, and an institutional arrangement heavily biased toward unbridled rather than sustainable growth. Less remarked upon but just as instrumental to the Panda Boom’s success was a benign external environment that endured for more than three decades. Indeed, Asia’s rising prosperity of the past decades was anchored in a period of peace and stability that allowed economies to flourish and the region to integrate. The cumulative effect of these elements for China was catch-up growth on steroids.

 However, overindulgence in steroids brings deleterious side effects, many of which have been left untreated over the last decade. Or they were simply ignored because uninterrupted growth proved to be the panacea that numbed any number of the symptoms. Whatever China was trying to achieve, it was getting there in a hurry. In its haste, China’s growth imposed considerable costs on the environment, taxed finite resources, and increased inequality. Periodically, signs emerged that the growth machine was too overwhelming—for instance, when China’s freshwater dolphin, the Baiji, was discovered to be extinct in 2006. But the economy barrel ahead, barely missing a beat.   

Environmental despoliation and voracious energy consumption may have been a passing concern when the entire nation intently focused on development and wealth accumulation. But when it came to pocketbook issues, the Panda Boom also didn’t particularly reward households’ wealth. That’s because fiscal resources and cheap capital went to state-directed development, much of it funneled through behemoth state-owned enterprises, at the expense of raising household wealth. To be sure, real income did rise, but not nearly as quickly as they could have. Add to this financial repression in which interest returns on household savings was essentially negative and a dearth of financial assets in which those savings could be parked. Little wonder the property market then became the preferred choice of where households parked their money, viewed both as a secure store of value as well as an induction into the ranks of the middle class. The housing market boomed as a result, a little too well, leading to astronomical prices and several rounds of government policy to impose restraint. 

Stark inequality, too, was a reflection of a growth model that not only enriched state coffers at the expense of middle class households, but also exacerbated social stratification in terms of access to opportunity and social goods. As fiscal resources were devoted to hard infrastructure, soft infrastructure such as healthcare and pensions were neglected. Healthcare costs have skyrocketed and the fragmented pension system is seriously underfunded, especially as China is aging faster than anticipated. Recent reports estimate that a quarter of Shanghai’s population is now considered elderly. 

The ingredients in the Panda Boom’s recipe are approaching their expiration date. For instance, demographic trends already in motion are eroding China’s longstanding labor advantage, and uncharacteristically low inflation is showing signs that it cannot be maintained. While few paused at the news of the Baiji’s disappearance, the noxious air that envelopes the Chinese capital has become a top social and political concern and a regular reminder of what current growth has wrought. What’s more, the meticulously crafted peaceful regional environment is rapidly shifting in a way that may not serve China’s development interests. 

Governing China has never been easy, and the new leadership is inheriting a powerful country that is more uncertain of its prospects than in the decade before. The silver lining is that the new team assembled is highly competent and acutely conscious of the challenges it confronts, both economic and institutional. In his first press conference, Premier Li invoked “reform” more than 20 times and has repeatedly reiterated that reform has been China’s biggest dividend. With many arguing inside China that the reform momentum has been sapped, the new leadership is clearly intent on reinvigorating it. 

Reform, however, is also a call to adjust the institutional arrangements in the economy so that the state interests cede to the market what it can do better. But precisely because the Panda Boom has been so successful, a web of strong vested interests do not like what reform may bring and are bent on resisting change. They make arguments that when modest, discredit market forces as unsuitable for China, and when extreme, charge that market forces are but a western plot to destroy the Chinese economy. All this for the sake of maintaining the status quo. For the new leadership, building a political and ideological consensus on how reform is in China’s own interests will again be crucial, as it did in decades past. 

So far, the Chinese public and the cognoscenti seem to like what they have heard and are willing to give the new leadership team a real chance to bank on their pledges. That change is necessary and urgent to perpetuate China’s economic dynamism seems beyond debate. But rhetoric alone cannot sustain the reform momentum, only execution will. 

Damien Ma is a Fellow at The Paulson Institute, focused on investment and policy programs and the Institute’s research and think tank activities.

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