Tag Archives: Reform

China’s Economy Seeing Slowing Faster Than Expected

The World Bank works closely with China’s economic policy makers which gives its latest cut in its forecast for the country’s growth rate this year additional weight. The Bank is now estimating 7.7% growth for this year, sharply down from the 8.2% it forecast as recently as May. Its forecast for some recovery in 2013 has been similarly cut, to 8.1% from its previous 8.6%. With weak international demand for China’s exports and lower investment growth causing the slowdown, the Bank also fears that there is a risk that the slowdown could be deeper and longer lasting than expected.

The consequences of this on growth in the region are laid out in its latest report on the economies of East Asia and the Pacific.The Bank now expects developing East Asia to grow by 7.2% this year and 7.6% in 2013, down from earlier estimates of 7.6% and 8.0%, respectively. The Bank does not expect Beijing to introduce a large stimulus project, but thinks it will continue to rely on easier monetary policy and the bringing forward of planned infrastructure projects to prod growth into moving at a faster pace.

That is in keeping with the Bank’s belief that because growth in developed countries will remain modest, at best, continued growth in the region’s developing economies will driven mainly by strong domestic demand. It also calls for continued structural reforms, improvements in the business climate and investments in infrastructure and education systems, which it says will become more important.

A bolder version of the some of the same policies has been urged on China’s leader presumptive, Xi Jinping, by Strategy and Reform, a domestic think thank. They say that China risks economic malaise, deepening unrest and ultimately a crisis that could loosen the Party’s fast grip on power unless stalled economic reforms are pushed forward. Whether Xi is prepared to take on the vested interests that that will involve, or instead treat China’s economic problems as cyclical rather than structural will define his leadership as much as achieving the apex of its fast growth has done for the outgoing Hu-Wen generation of leaders.

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Breaking Up China’s Railways Behemoth

This Bystander suggested in January that China’s scandal-plagued railway ministry’s monopoly over the rail system might be due for a shake-up, highlighting a World Bank working paper as a trial balloon. So we note this sentence on the to-do list set out in the work report of China’s most powerful economic planning agency, the National Development and Reform Commission, to the recent National People’s Congress.

We will study and formulate a plan for reforming the railroad system in accordance with the principle of separating government functions from enterprise management and state asset management.

As the Bank’s paper pointed out, China’s is the only significant rail network in the world where the railways ministry makes policy, builds and owns the infrastructure, operates the services and regulates the system. Beyond the obvious conflicts of interests, which have shown themselves most prominently in the problem-beset build-out of the high-speed rail network, China’s rail system is now just so massive it is beyond the management of a single entity. The Bank’s paper, however, argued for rail to be put under a new transport ministry with multi-modal responsibilities for coordinating transport. If China is to make the most of all the transport infrastructure it has built over the past two decades, and that to come, it needs to integrate its road, rail and internal air and shipping with the sort of national transport strategy that is common in other countries.

That would be a mighty big to-do for the current leadership to leave to their successors. They would, no doubt, be happy to duck the bureaucratic civil war that carrying it out would involve. “Study and formulate a plan” is usually a euphemism for kicking hard decisions down the tracks, but they are none the less necessary for that. Breaking up the behemoth that is the railways ministry would be a good start.

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The One Question That Matters About China’s Model Of State Capitalism

Monday’s publication will push the World Bank’s report, China in 2030, to center stage in the emerging, if ultimately pointless debate about whether China’s state-directed capitalism is better than the U.S.’s free-market capitalism. The later has undeniably damaged its case with the self-inflicted injuries that caused the 2008 global financial crisis. The revival of the 1930’s blend of banker and gangster, bankster, is timely and apt, in that regard, just as are the Occupy protests that have sprung up around the free-market world. But, in their rush to throw out some fetid bathwater, capitalism’s critics risk tossing out the baby, too. Nor is the Chinese model a proven substitute. For all that it has seen China though the post-2008 crisis period with higher growth rates than the Western Economies, the long-term costs have yet to fall due.

The World Bank report reportedly argues that the dirigiste model that has seen China through a remarkable three decades of economic development has run its course. We don’t yet know the details of the Bank’s arguments, but this Bystander has long argued the necessity of structural change if China is to move up the development ladder. The heart of the real test for China’s state capitalism is not whether it is better than banksterism. It is, can it vault the country from the ranks of poor countries to rich. To do so, it will need to clear the middle-income trap or the economic Great Wall–choose your metaphor–something no developing country has done without institutional change. This Bystander thought it timely to republish China’s $10,000-12,000 Question, first published in January last year, examining whether China can defy history:

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

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China And America In 2030; Which Will Be Ready First?

Compare and contrast. This weekend, in Washington, President Barack Obama and his advisors will have been putting last-minute touches to a speech he is to make later this week about dealing with unemployment in the U.S. Their preoccupation would not have been with the long-term structural changes the U.S. economy needs but with the finer calculations of the politics of what can be got through a recalcitrant and divided U.S. Congress barely a year out from elections. Meanwhile, in Beijing, policy makers have spent the weekend in conclave with outside experts, including those from the World Bank, to consider what China’s economy will need to look like in 2030.

Writing in the Financial Times, Robert Zoellick, president of the World Bank, previewed that meeting and the ‘the big questions” China has to answer:

The drivers of China’s meteoric rise are waning: resources have largely shifted from agriculture to industry; as the labour force shrinks and the population ages, there are fewer workers to support retirees; productivity increases are declining, partly because the economy is exhausting gains from the transfer of basic production methods. Then there are other challenges, including serious environmental degradation; rising inequality; heavy use of energy and production of carbon; an underdeveloped service sector and an over-reliance on foreign markets.

While that is well known, including to the Party’s leaders, “without fundamental structural changes, China is in danger of becoming caught in a “middle income trap”. Zoellick says, adding that “China’s policymakers are well aware of “what” they need to do…Their challenge now is “how” to do it.”

A critical question is how China can complete its transition to a market economy. A broad agenda needs to include redefining the role of the government and the rule of law, expanding the private sector, promoting competition, and deepening reforms in the land, labour, and financial markets.

China has three five-year plans after the current one ends in 2015 to implement the how. Not that it will be easy or painless. Not only will those changes have to be navigated through the current leadership transition, they will also have to go through another one in a decade’s time. But the constant through that is the Party’s need to survive as China’s paramount ruler.  There is no guarantee that China will be able to pull off the transition. While countries like Japan and South Korea have undergone a similar process of transformation from developing to developed economy, the political primacy of their governing institutions has not escaped unscathed. No country that has avoiding the middle income trap has yet done so without making its political institutions more transparent and accountable to it population.

As we noted before in a post on the middle-income trap, if the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and it is right that China’s economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

America, too, is, arguably, a generation ahead in this process, trying to deal with what we could call the high income trap, trying to overcome the results of the profligacy that comes with the assumption that good times continue for ever, an assumption that has been brought up short by the current sluggish growth in the U.S. economy.

The lessons of the last two devastating economic downturns in the U.S. that preceded its current  Great Recession — the Long Depression of the 1870s and the Great Depression of the 1930s — is that when prosperity returned it, first took a long time to come back and, second, looked different from what it was before.  Both China and America should be looking at what their economy’s will need to be like in 15-20 years time. On the evidence of this weekend, only China seems to be doing so. Compare and contrast.

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China’s $10,000-12,000 Question

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and, as Dan Harris from China Law Blog points out, the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

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30 Years Of Opening Up To The World

It is 30 years to the day that the 3rd Plenary Session of the 11th Communist Party of China Central Committee opened, a meeting that would usher in the opening of China under Deng Xiaoping and see the closing of the unhappy chapter of China’s history that was the Cultural Revolution.

It may be difficult for anyone under 30 to grasp how great the transformation of the country and the economy has been over those three decades. President Hu Jintao held a celebration of the anniversary in the Great Hall of the People in Beijing (CCTV video here), though he might have preferred for such an event to be held against a backdrop other than the worst  global economic slowdown in living memory.

China Daily has the official history of the watershed event in this special report. For a different view, try Forbes‘ four-part series keying off the anniversary by Gordon C. Chang, author of “The Coming Collapse of China”.

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