An advertisement poster promoting China’s renminbi (RMB) or yuan , U.S. dollar and Euro exchange services is seen outside at foreign exchange store in Hong Kong, China August 13, 2015. REUTERS/Tyrone Siu.
In my recent The Week column, “Why China will never be as rich as America,” I addressed some of the big challenges facing China’s economy. Particularly this one: “But it is actually China that is increasingly favoring state intervention over market reforms as the path to greater national prosperity.” In recent testimony, AEI’s Derek Scissors outlined what a market reform agenda might look like:
1) State intervention into the economy brought China to this point. More state action, such as interest rates cuts or yet more infrastructure spending, will not reverse it. Reversal requires a resumption of market reform. … And a reforming, thriving China can still be achieved. But strong words are hardly enough. Neither the reforms implemented to date nor those promised will reverse stagnation. In fact, the reform re-start praised by many was fundamentally flawed from the outset. Greater labor mobility could mitigate aging’s blow to growth by letting the right workers move freely to the right jobs. China still discourages labor mobility by denying education, pension and other benefits to those living and working in the ‘incorrect’ place. Pledged changes to this system retain many barriers between rural and urban areas until 2020 and keep the most popular urban centers cordoned off to those born elsewhere. This may be due to continued fear of labor migration breeding social instability. If so, the Party will restrict labor markets indefinitely despite China aging.
2) Reform could sharply increase the value of China’s natural resources, along the same lines as in the U.S. China has the shale to vitalize its energy industry and curb import dependence. But this would require mimicking the American model at least in part, involving private ownership of rural land, an end to the state’s energy monopoly, and legal protection of innovators. The reform platform and actions to date show no progress in any of these areas. It is true that outright environmental damage is being reduced but this translates to less harm to future growth, rather than a boost.
3) There has been some market reform in finance. The most important element is the issuing of bank licenses to private companies. While interest rate liberalization wins headlines, it has little value when so much of the financial system still must follow the Party’s orders. What is needed is the truly commercial, not political, lending that can only come from independent institutions. The licenses could bolster the return on capital, and thus growth. It could take decades for private banks to substantially erode the state’s 90 percent share of banking assets; all the while, unsound lending will be creating a colossal amount of debt. Much more radical action is necessary. One possibility is allowing money to leave the country freely, which would pressure financial institutions to be more responsible or lose assets. For this to greatly improve financial efficiency, however, liberalization must be total. Fearing rapid and heavy capital outflow, the Party has to now always opted for only partial liberalization.
4) The state sector is the clearest area of reform failure. The Party’s pledges here go in precisely the wrong direction. Rather than shrinking the state sector to make room for private competition, they call for private investment in SOEs and state-led projects. This is essentially an attempt at a private bailout of the public sector’s mistakes. Further, rather than being allowed to fail or be sold off, SOEs are being merged with each other to get even bigger. There is no sign of the market being given a decisive role in the corporate sector, quite the opposite. This error affects innovation. Beijing sees super-large SOEs as offering advantages in competition overseas. But faced with no competition at home, these firms have no reason to innovate. Chinese consumers will therefore continue to be discouraged by inferior products and prices and the state giants will progressively lose ground overseas, no matter their size. Only private Chinese firms, forced to compete both at home and overseas, will succeed fully. If reform does not include a smaller state sector, innovation will be stunted.
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