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Unfinished reform threatens Chinese growth

A man cleans bird cages in Guangzhou's Old Town. Photo by Sjekster on flickr.
29 January 2013
A man cleans bird cages in Guangzhou's Old Town. Photo by Sjekster on flickr.

China needs to implement major reforms and develop demand-driven growth if it is to maintain its unprecedented economic rise, writes LIGANG SONG.

At 7.8 per cent, China’s GDP growth rate in 2012 was slightly higher than the target rate of 7.5 per cent set by the government earlier in the year; its average consumer price index fell to less than 3 per cent, one percentage point lower than the government target; and its industrial value-added output increased by 10 per cent.

But the rate of increase in fixed asset investment has been slowing down. China’s exports also continued to soften because of weak demand in its major industrial country markets and the appreciation of the RMB later in the year. At the macro level, demographic change, internal and external imbalances and environmental concerns are impelling China to alter its trajectory of growth. At the micro level, Chinese enterprises are feeling mounting pressure to perform because of increased competition and the subdued international market environment.

Many, including the World Bank, predict that the Chinese economy will continue to grow at a rate of around 8 per cent in 2013 (the Bank’s latest forecast sees China growing at 8.4 per cent this year). But questions about the key drivers of growth and their long-term implications remain. Will future growth depend upon the continuation of expansionary government fiscal and monetary policies? Or will increases in private investment, encouraged by market conditions, be a more reliable driver of growth?

Although it has helped China to sustain relatively high growth rates despite various adversities, heavy reliance on government intervention to boost growth has brought with it many structural problems. These include increasing inefficiency in the economy, rising public debt at both the central and local levels, an increase in the non-performing loans of commercial banks, the crowding out of private investment, the distortion of price signals in allocating resources and excessive direct government intervention in the economy.

To move toward private demand-driven growth and development, China needs to deepen its reforms of institutions affecting private sector development. Among them is the priority that attaches to China’s enterprise system reform, both the privatisation of state-owned enterprises (SOEs) and the development of non-state enterprises.

In the past 30 years, there has been a remarkable transformation in Chinese enterprise. Reform of ownership in the state sector has unleashed strong, productive forces through improved incentives, which, together with the rising private sector, laid the micro-foundation for China’s rapid economic growth. Reform has nurtured the entrepreneurship that has powered the Chinese economy’s strong growth. Reform has also led to a shift in the relative importance of the state versus the non-state sector, with the non-state sector contributing an increasing share to the national economy.

But there are a number of key unfinished tasks in reforming both the state and the non-state sectors of the Chinese economy. These include the fixing the relationship between the state and state-owned enterprise, dealing with state monopoly and competition, improving corporate governance, reforming business finance and the regulation of enterprise, and  improving China’s legal system and its enforcement as it affects the way the market functions. Existing Chinese institutions, despite progress in the past, are still not entirely compatible with a well-functioning market economy.

Vested interests, informational asymmetry, abuse of power, and disrespect for laws and regulations are still endemic in the Chinese market and have serious effects on the way the market works as well as government decision-making and expenditure. It will require a great deal of courage and wisdom to push the political reforms that are needed to address these problems, although they are now essential to entrenching a modern and sustainable enterprise system in China.

If China wants to take economic development to its next stage, it will have to nurture the market-based economy and establish a more robust and adaptable regulatory framework, providing fair access for both SOEs and private companies to capital and technology and creating a social culture that builds entrepreneurial capabilities and extends respect to the contribution that entrepreneurship makes.

The economic gains from the reorganisation of SOEs would be larger if policies were directed at more rapid and broader withdrawal of SOE monopolies from competitive industries (including in the services sectors) and wider and deeper participation of private capital in the restructuring of the SOE sector. In 2005 and 2010, the State Council formulated policies to encourage the non-state economy and private investment flows into monopolised industries. In reality, there are still many barriers that prevent private investment from penetrating state-monopolised industries in China.

Large state-owned banks dominate China’s banking sector and are a drag on the economy due to their inefficient management and operation. Private businesses need the freedom, and access to finance, that would allow them to invest in high-end areas, such as finance and telecommunication.

Corporate governance remains weak in China. There is weak external discipline on corporations; state shareholder and regulatory functions have in practice yet to be sufficiently separated; and institutional and regulatory weaknesses prevent effective enforcement of the rights and obligations that are normal under modern corporate governance mechanisms.

Failure to tackle these institutional reforms will see growing distortions and inefficiency in the allocation of resources in the Chinese economy and lower medium to long term growth. It is also inconsistent with the ultimate objective of China’s economic transformation: to achieve an improved standard of living for the Chinese people in the most efficient and equitable way.

Ligang Song is Director of the China Economy Program and Associate Professor at the Crawford School of Public Policy in the ANU College of Asia and the Pacific.

This article was first published at East Asia Forum.


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