World Bank Adds Its Voice To Those Calling For China To Slow Its Growth

THE WORLD BANK is lending some international credibility to China’s likely switch to a 7% annual GDP growth target next year. In its latest economic update the Bank says 7% growth would not hurt China’s labor market, an indicator watched closely by the leadership in Beijing for any sign of incipient social unrest.

Attempting to sustain the current offical target of 7.5% annual GDP growth hampers the government efforts to rebalance the economy towards being driven by domestic consumption, the Bank says. “The current emphasis on meeting short-term growth targets will make it more challenging to implement the policies necessary to shift growth to a more sustainable medium-term path.”

In that the Bank echoes the words of the International Monetary Fund. In July the Fund said that Beijing should set a growth target of 6.5%-7% for 2015 and not introduce any stimulus measures unless the economy looked likely to decelerate to a pace below that.

Xi Speaks Of 7% Growth

An unexpected signal from President Xi Jinping that China’s growth this year may slow more than the official forecasts have let on. Speaking informally at the Asia-Pacific Economic Cooperation meeting in Indonesia, he said that a 7% growth rate was “within a reasonable and expected range.” And, this Bystander expects, on plan. Xi dismissed any notions that China’s economy was facing a hard landing, saying that a “seven percent annual growth rate will suffice” to meet China’s medium-term goal of doubling per capita income by 2020. “The slowdown of the Chinese economy is an intended result of our own regulatory initiatives,” he said.

This Bystander also recalls the fuss in July when finance minister Lou Jiwei spoke of 7% annual growth for this year after the U.S.-China Strategic & Economic Dialogue. Xinhua swiftly added to the record the missing half a percentage point from this year’s official growth target. We doubt that in this case Xi misspoke (or that state media will do any after-the-event re-reporting of Xi’s words), and it should be noted, the president did not specifically forecast 7% as the growth rate for this year. That number is also the annual growth target in the current five-year plan. But it is the clearest public signal to date of where the leadership sees the economy headed.

Meanwhile, the World Bank has joined the caravan of those cutting their forecast of economic growth for China. In its latest semi-annual regional economic update, the Bank says it now expects GDP growth to be 7.5% this year and 7.7% next. That is down from 8.3% and 8% in its previous forecast published in April. The Bank expects the slowdown in China to cast its shadow over the region. It now forecasts growth for East Asia of 6.0% this year and 6.4% in 2014. That is down from 6.5% and 6.7% respectively in its previous forecast.

The Bank also highlights the increasingly conventional wisdom that China’s growth model of investment-heavy stimulus supported by credit expansion has run its course. Beijing must focus on containing the rapid growth of credit and tighten financial supervision, it says. The Bank  remains concerned by the levels of local government debt and the rapid rapid expansion of the shadow banking system. This, the Bank said, posed “serious challenges”. The Bank also credits China with making some progress in rebalancing its economy, though “the economy has yet to make the decisive turn toward consumer-based growth”.

World Bank Raises China Growth Forecast For 2013

The World Bank raised its forecast for China’s GDP growth in 2013 to 8.4% from its projection of 8.1% made in October. In the latest edition of its East Asia and Pacific Economic Update, the Bank says it expects China’s growth rate to be 7.9% this year, down from 2011’s 9.3% and the lowest rate since 1999. Weak export growth and government efforts to deflate the housing bubble weighed on growth. A sign of how much global demand has weakened during this year is that back in January, the Bank had forecast 8.4% growth for 2012.

The Bank says that a pick-up in factory output and investment suggests that the recent slowdown in the economy has bottomed out in the wake of easier credit conditions and public spending on infrastructure. The effects of both of these stimuli will be felt more powerfully next year. Beyond that, the Bank projects that China’s potential growth will gradually slow, as investment levels off and productivity increases and labor force growth start to slow. Its 2014 projection of 8% growth reflects that.

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.

Railroading China’s Environment

Construction of the Harbin-Qiqihar railway was suspended at the beginning of this month because its work camps threatened the Zhalong nature reserve (above), a wetlands nesting ground for red-crowned cranes. Perhaps surprisingly, the Ministry of Environmental Protection is proving itself a diligent guardian of the environment in the face of the rapid expansion of the country’s rail network. Even more surprisingly, the scandal-tainted railways have shown themselves to be pioneers in adopting environmental impact analysis and management into their expansion, according to a new paper* by the World Bank.

The world’s largest national railway development program for more than a century poses significant challenges to the environment and humans alike. There is no sugar-coating that. Some new lines cross sensitive ecosystems, are built in fragile mountain ecosystems, pass through densely populated areas, or threaten the traditional social and geographical connections of the countryside.

Environmental and social protection has been integrated into rail infrastructure development on six fronts, the paper says:

• The simplest and most obvious one: routing lines around environmentally sensitive sites.
• Implementing mitigation measures where social and environmental impacts are unavoidable, such as the provision of safe crossings under or over the new lines for humans, domesticated animals, wildlife and irrigation.
• The use in mountainous areas of tunnel-bridge-tunnel schemes instead of embankments, which are at risk of landslides and erosion, despite bridges and tunnels costing half as much again to twice as embankments.
• Recycling of waste materials.
• Minimizing the impact of noise, vibration and erosion during construction.
• Preserving of cultural resources and historical artifacts. The environmental impact assessment that every infrastructure project has to have includes a physical cultural resources survey. Where relics are suspected and impacts probable, detailed site investigation and excavation by experts is conducted prior to construction.

Building railways is disruptive and destructive, beyond doubt. Few residents who have had new lines pushed through where they live would argue with that. While the World Bank paper, No 6 in its series on China transport topics (Nos. 3 and 4 here), casts the efforts of the railways in a favorable light in terms of their sensitivity to the environment, its authors have a number of recommendations for further improvement:

• Current environmental regulations and procedures remain specific to each railway administration. The authors suggests introducing an industry-wide code of practice for railway construction environmental management to standardize good practice and ensure uniform application.
• Environment impact assessment documents are technically strong, but focus on the biophysical environment. Assessments would benefit from deeper analysis of the broader social and cultural impacts, such as land acquisition and involuntary resettlement, and on induced or cumulative impacts.
• The environmental management plan that is often prepared in connection with any bank financing for each project should become mandatory. Such plans turn the conclusions of an environmental impact assessment into measures incorporated in to project design, bidding documents and implementation.

* China: The Environmental Challenge of Railway Development  by Peishen Wang, Ning Yang and Juan D. Quintero, World Bank Office, Beijing. China Transport Topics No. 6,  June 2012.

World Bank Cuts 2012 GDP Growth Forecast For China

Hard on the heels of the OECD’s latest economic outlook, comes the World Bank’s biannual regional economic update. This cuts the Bank’s forecast for China’s GDP growth for this year to 8.2% from 8.4%, bringing it in line with the OECD and IMF’s forecasts. But the Bank is less sanguine than the OECD about fast-tracking state infrastructure projects to stimulate the economy if necessary–which some in Beijing are promoting in the face of the economic slowdown. (Update: State Council moving in that direction.) The Bank remains nervous about inflation, which it sees ticking up in 2013 to 3.6% from 3.2% this year, though not regaining last year’s 5.4% and under the government’s 4% target.

The Bank thus also calls for restraint in easing monetary policy further, suggesting only using further cuts in banks’ capital reserve ratios, unless further falls in inflation turn real interest rates substantial higher. Instead, it says more reliance should be placed on easing fiscal policy in areas that match long-term social policies.

“Fiscal measures to support consumption, such as targeted tax cuts, social welfare spending and other social expenditures, should be viewed as the first priority,” the Bank says. “Stimulus would ideally be less credit-fuelled, less local government-funded, and less infrastructure-oriented.”

Like the OECD, the Bank sees the economy regaining momentum next year. Its conservative stance to dealing with the current slowdown leads it to forecast 8.6% GDP growth in 2013. The more stimulus-accepting OECD forecasts 9.3% GDP growth for next year.

The Bank’s big concern is that a slump in Europe will be transmitted through China to the rest of Asia. China accounted for two-thirds of the region’s $592 billion shipments to Europe in 2011. It would be the first to suffer if the crisis in the eurozone worsens, the Bank says, before passing the effects on to others in Asia by dint of its position as  the centre of the region’s production networks.

The World Bank’s numbers:

What It Would Take To Build Greener, More Liveable Cities in China: A Lot

This Bystander likes a hypothesis that can spread its wings and take flight. That land-use reform and reform of local government finances are key to developing sustainable, efficient, livable, and competitive cities in China would be one such proposition.

It is not so fanciful an idea. The argument runs thus:

Low-carbon cities need compact urban form and smart spatial development. But related concerns linked to the rapid expansion of cities such as congestion, local pollution, and safety also increase when public transport becomes less competitive as a result of poor spatial growth. Rural agricultural land is over-consumed. Cities expand into areas with higher risks of disasters or higher ecological values. Contingent liabilities increase from off-budget borrowing linked to land expansion. And equity concerns arise over the compensation of rural land users on the urban periphery. Reforms in land-use planning, municipal financial frameworks, and changes in spatial development can address these concerns and promote low-carbon growth.

Its proponents, Axel Baeumler, Ede Ijjasz-Vasquez and Shomik Mehndiratta, are three of the authors of  Sustainable Low-Carbon City Development in China, a new book looking at the development of low-carbon cities in China. It is published by the World Bank and is a 500+-page miscellany of urban development projects the Bank has been involved with in China and elsewhere. We suspect it has been somewhat hurriedly assembled so that publication could happen early in China’s current five-year plan, which calls for both continued urbanization and a significant lowering of the country’s carbon intensity. Aimed at city officials, the book is a why and some starter ideas type of book. A second edition promised for a couple of years time is intended to be a more detailed how-to manual.

The first edition doesn’t break much if any new ground. Its value lies in pulling together so many disparate aspects of sustainable urban development that have to be connected for success. For example:

• Encouraging a cleaner and greener supply of electricity;
• Continuing the gains of industrial energy efficiency;
• Promoting residential energy efficiency and building district heating;
• Better land-use planning and compact city development;
• Supporting low-carbon transport–walking, cycling, and various forms of public transport;
• Reducing emissions from private vehicles;
• Tempering current rates of growth in waste generation, including water and wastewater;
• Preserving and reusing existing buildings;
• Promoting urban agriculture and forestry;
• Developing information and communication technologies, such as smart grids.

If coordinating all those isn’t challenge enough for city officials–and just think of how many ministries, administrations, agencies, departments and offices they cut across–there is also the perennial question of the country’s scale. China is set to add an estimated 350 million residents to its cities over the next 20 years–and that after three decades of unprecedented urbanization, modernization, and economic development. Some 13 million people move from the countryside to the city each year, putting sustained pressure on all forms of public services: energy, water, transport and waste.

At the same time, China has set itself ambitious goals to reduce the carbon and energy intensity of the economy and to transition to low-carbon growth. The current five-year plan, which runs to 2015, sets a target of creating of 45 million jobs in urban areas. It also contains, for the first time, an explicit target to reduce the carbon intensity per unit of China’s GDP. A 17% cut is the goal by the end of 2015, as a milestone on the road to a  40%–45% reduction by 2020.

China’s cities will have to lead the way if these goals are to achieved. They have a sufficiently high degree of autonomy, and, as the authors note, they are “politically, financially, and administratively organized to act quickly and to realize national policy goals”. The true secret to why China’s so-called state capitalism has delivered three decades of double digit economic growth is that its city officials’ career advancement (promotion to a more powerful level of connections) depends on delivering local economic growth. Collectively on a city basis they are given a fairly free hand by central government to create raw GDP growth regardless of the environmental and social cost (up to the point it threatens the Party’s legitimacy to rule). As a market-based incentive it is pretty red in tooth and claw. But it has worked.

If China is to achieve its twin goals of larger but greener cities, it will have to change the incentives dangled before city officials. That, in turn, means dismantling the underlying mechanism that now allows them to work so effectively–the link between land use, finance, and urban sprawl.

Local governments are overdependent on land development for revenue, and particularly on sales of collectively owned rural land to property developers. As a result many Chinese cities have more than doubled their built-up area in no more than 10 years. Changing how cities finance themselves needs to be rethought fundamentally. That means tax reform, better direct access to debt and capital markets for cities, and new ways to facilitate fiscal transfers from higher levels of government.

Bits of that, such as greater municipal bond issuance, are starting to happen. But a lot of stars will have to fall into alignment for it all to come together so the sum of the parts is greater than the whole. A lot of vested interests are challenged. They will have ample opportunity to frustrate the process. Not only will it require new sets of both administrative and market-based incentives to encourage the development of low-carbon cities, with the market-based ones becoming increasingly more important, it will also require an administrative culture that facilitates cooperation across what are now largely independent fiefdoms.

It will also require one more thing. Residents who want to live in more liveable, energy-efficient cities like, and are prepared to be active in creating them.

China Half-Heartedly Falling In Behind Kim To Head World Bank

One way to look at Jim Yong Kim (left), the U.S.’s surprise nominee to be the next president of the World Bank, is that he represents a transition from the leadership of the multilateral development agency being a Washington sinecure to a merit-based selection from developing countries. That is how it seems to be being seen in Beijing. Kim’s nomination “demonstrated that [U.S. President Barack Obama] has begun to take heed of the demands from the developing world for an expanded role within the global institution,” Xinhua said in a commentary.

Kim, though a U.S. citizen, is Korean-born. Currently president of one of American’s elite Ivy League universities, Dartmouth College, he is a health professional with long experience in the developing world, including running the HIV/AIDS department at the World Health Organization. More importantly, he is neither a Washington nor Wall Street retread.

One reason for the post-World War II gentleman’s agreement between the U.S. and Europe that the former would get to put an American in as head the World Bank and the later a European as managing director of the IMF, was that the Bank needed to secure the confidence of Wall Street, then its primary supplier of capital. That world has changed. Washington’s gift of the Bank’s presidency, along with Europe’s of the IMF’s managing directorship, is a 20th century convenience but a 21st century anachronism.

Kim is one of three candidates. Nigeria’s finance minister, Ngozi Okonjo-Iweala, and Colombia’s former finance minister, Jose Antonio Ocampo, are the other two. Such is the voting structure of the Bank that it would take a broad-based European veto to block Kim. Even in the highly unlikely event of that happening, the U.S. could, in turn, veto either of the other two candidates. A new Bank president needs a supermajority of the Bank’s executive directors, 25 representatives of its member nations with voting power weighted in accordance to the capital they subscribe to the Bank.

Beijing has yet to tip its hand publicly. The decision it has to take is whether to get behind what looks to the winning horse, in the expectation that Kim may introduce further reform in the governance of the Bank from which China would be a beneficiary, perhaps the big winner, or to stand by one of the other two candidates in a show of developing-nation solidarity, though that would force it to make a choice between its friends in Africa and those in Latin America. We expect Beijing to go, along with the Europeans, with the first choice. The biggest hint in that direction came earlier this month from central bank governor Zhou Xiaochuan. He said that it wasn’t worth paying much attention to the selection of a new head of the Bank as the job had always gone to an American. Coverage in state media has been correspondingly light and scarcely more interested.

As others have pointed out, the World Bank matters less to China now than China does to the World Bank. It may also matter less to the world than China. The commentator and academic, Martin Jacques, captures the point succinctly: “in 2009 and 2010 the China Development Bank and the China Exim Bank lent more to the developing world than the World Bank”.

It is telling that Beijing didn’t put a candidate of its own forward, nor was one of its own, save perhaps for Zhou, much talked about even as an outside possibility. The prize Beijing has its eye on is the top job at the IMF.

China’s Reform, The World Bank And Vested Interests

The World Bank’s report on China in 2030 is a political manifesto disguised as an economic blueprint. Even the title, Building a Modern, Harmonious, and Creative High-Income Society, hits political not economic buttons. Not that the Bank casts it in that light, but it does provides China’s reformers with both strong arguments and influential backing to press ahead with reviving the economic reform. That has slowed to a glacial place now it has hit the hardest rocks of vested interest.

The World Bank gives the document intellectual and international heft. The participation of the State Council’s Development Research Centre, a prestigious government think tank, and with that the involvement of some of the most prominent technocrats who drafted the current five-year plan, lets the report avoid criticism leveled at recent International Monetary Fund recommendations for stepping up economic reform. That was castigated for being being an outside view that didn’t understand the realities of China. That can’t be said of the Bank’s report. It also gives it the implicit imprimatur of Li Keqiang, the man expected to take over from Wen Jiabao as prime minister in the current leadership transition and thus the Politburo member in charge of the economy. He signed off on the current five-year plan. He also told World Bank president Robert Zoellick, in Beijing to present the report, that China has “a long way to go before realizing modernization”.

Li is being realistic about the challenge ahead for China’s reformers. The World Bank report offers them a strategic description of the way forward rather than policy prescription. Its six strategic directions for China’s future are:

• Completing the transition to a market economy;
• Accelerating the pace of open innovation;
• Going “green” to transform environmental stresses into green growth as a driver for development;
• Expanding opportunities and services such as health, education and access to jobs for all people;
• Modernizing and strengthening its domestic fiscal system;
• Seeking mutually beneficial relations with the world by connecting China’s structural reforms to the changing international economy.

They are goals familiar to anyone who has read China’s current-five year plan, even if that couches them in terms that give more prominence to reductions in income inequality, universal social services, greater environmental protection and more energy efficiency. The Bank’s overarching message, though, lays out the unstated sub-text behind the five-year plan: structural reform is needed to promote a market-based economy, redefine the role of government, lessen the power of state enterprises and develop the private sector.

There is no doubt that China’s economy has reached the point in its development at which the dirigiste methods that have delivered 30 years of double digit growth need to change. Growth will inevitably slow in the coming years. All industrializing nations run into the law of large numbers. The exports and fixed asset investment that have driven growth cannot be sustained at that pace. Growing a $6 trillion economy by 10% in a year is a far greater task than growing a $350 billion one that much. That latter number is, best guess, roughly the size China’s economy was in 1981 in nominal terms. That is was 30 years of 10% growth does to $350 billion economy: turn it into $6 trillion one.

It is a remarkable achievement. Yet the arc of China’s development is not that different from the rapid industrialization phase of countries such as South Korea, Japan or even, much earlier, western Europe and the U.S., even if the magnitude of China’s arc is on an unprecedented scale. The country’s well of cheap labor, transferred from farm to factory, is starting to run low. Demographics, too, are working against growth. The value of foreign-developed technologies diminish as they age. Most of all, the economy needs to move up the value chain if it is to clear the barrier at which so many developing economies fall, that point where per capita income reaches at $10,000-12,000 a year. Vault it, and a nation becomes a middle income country on the road to being a rich one. Fail, and the country ends up stuck on a plateau of disappointed expectation.

China needs to do all that is recommended in the World Bank report if it is to clear that so-called middle-income trap, or economic Great Wall. The report doesn’t put it in these exact terms, but its message is that without reforms, growth will slow to the point where there isn’t the momentum to make the leap. This in not about whether there will be a hard or soft landing in the near term, though the Bank warns that responses to short term problems could undermine long-term strategy.

It is the politics that is the quagmire. There are clear implications for the Party in adopting market reforms. No country has done so successfully and remained a one party state. Even Japan’s Liberal Democratic Party, the closest approximation any democracy outside a city-state has had to one-party government, was eventually put into opposition at the ballot box. There is a difference between political rights and civil liberties, and the Party may find a seam in that distinction in which to work. But it would be a brave Bystander that bets on it.

The Bank does not push an overtly political agenda of what elsewhere in the world would be seen as neoliberal reforms. It hopes instead to push on an open door, offering practical steps to further an agenda China’s economic policymakers, if not all its leaders, have frequently endorsed. It does, though, call for the government “to redefine its role to focus more on systems, rules and laws” and for “redefining the roles of state-owned enterprises (SOEs) and breaking up monopolies in certain industries, diversifying ownership, lowering entry barriers to private firms, and easing access to finance for small and medium enterprises.” Those are all overtly political acts. The Bank recognizes the extent of the political opposition from vested interests to its proposed reforms. Even getting to this point with its report has been a political to and fro. The text is still a “conference edition”, i.e. subject to further revision, for which read political to and fro. State media’s reports on the report are low key (you’ll have to read to the final paragraph to find mention on it).

Reining in the power of the SOEs provides a particular challenge to the reformers. SOEs, like the military, are a source of power, money and influence for the princelings, the descendants of Mao’s original revolutionary leaders, an elite collective dynasty of some 400 families who hold extensive sway over the Party, army and the economy. Xi Jinping, the assumed successor to Hu Jintao as president, is one of their number. The princelings are neither a monolithic block nor are all opposed to reform. But modernizing the governance of the PLA to make China’s military internationally competitive is an easier sell for the reformers, and a creates more winners among the incumbents, than modernizing the state-owned enterprises and banks to the same end.

Yet without removing the structural distortions that the increasing sway of the of SOEs and banks hold over the economy, the sustainability of China’s growth remains in doubt. The double challenge is that the side effects of the twin forces of untrammeled infrastructure investment driven by SEOs and local governments that are little more than property developers–high energy consumption, inefficient capital allocation, unfettered real estate development and environmental degradation–also put economic growth at risk and threaten greater social unrest and thus the Party’s political legitimacy. Breaking the vested interests will be extremely hard for the reformers. Where they are not corrupt, they are systemic. Or both. That is one reason that reform has slowed to the extent it has.

Development of the private sector, giving more freedom to businesses to be innovative, changing the deeply rooted attitude of officials at the lower levels of the Party and government that quantity of economic growth matters more than quality of growth, more transparency to local government finances and governance, are all big changes from the way officials have done things for 30 years, 30 years that from inside China look immensely successful. China’s resilience to the post-2008 global financial crisis, and the authorities response to it, has, if anything, only further set back the case for structural reform.

That changes that China needs to rebalance its economy and go to the next phase of development go the nub of the nexus of government, Party and state, don’t make them any less necessary. How the new leadership handles it will be the measure of its success as custodian of the Party, state and government for the next ten years. The Bank is being politically adroit in casting its timetable for reform to well into the leadership term of those now about to assume the reins of power. Yet how, and whether, President Xi resolves the inevitable factional infighting between the inevitable winners and losers from reform, will determine the cast of his successors long before then.

If there is one thing a state-planned economy should be good at it is producing plans. Beijing has so many accomplished technocrats, and especially among its economic policymakers, that producing really good blueprints for change isn’t a problem for it. Implementing them is the challenge. For all the World Bank’s backing, an institution that may well be led by a Chinese before 2030, these are going to need strong domestic political leadership to be brought to fruition. That means the emergence of a modern-day Deng Xiaoping figure, singly or collectively, or, what no one wants, wrenching crisis. Otherwise China’s economy will stall, and wrenching crisis of another kind ensue. China will then look very different in 2030 from what anyone now is planning for.

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.