Guidelines set by Premier Wen Jiabao at a State Council meeting this month might indicate where China's economy is heading. 'Stabilise our policies and continue to monitor the results,' he told economic experts. 'Consolidate the economic achievements to prevent a reverse. Adjust the economic structure and differentiate our policies in various sectors. Carry on reforms to improve the system.'
From his message, we can draw the following conclusion: Beijing is unlikely to roll out further constrictive measures in the near future. This is comforting news to an economy that has longed for a breather from stifling government control.
Facing economic overheating, the central government does need to exert a certain degree of macroeconomic management to iron out fluctuations. But it needs to choose the least-costly combination among the measures at its disposal. History has shown that market-oriented management, by means of adjusting price variables, works most effectively under a market economy.
Although China has embarked on the road towards a market economy, its faith in free markets tends to crumble at moments that call for stronger macroeconomic management - in favour of the old ruse of heavily administrative constraints. One good case in point is the assertion - widely voiced in China in recent years - that 'interest rates are useless'. On the contrary, as one of the most vital variables in the market, interest rates have a direct bearing on economic players, and guide their behaviour. Detractors cite structural problems in the Chinese economy that negate the utility of interest rates.
In fact, interest rates have been a critical factor in every economic cycle since China's 'reform and opening' began. This latest spell of overheating is no exception. The motivating factor behind the explosive surge in investment, and behind some local officials' desperate gamble to ignore the directives of the central government, is the anticipation of high returns and fat profit margins. Even unsound projects with modest returns appear profitable and fetch crowds of investors. Why? Because interest rates are abnormally low and have not been adjusted.
Raising interest rates can generate healthy competition among investment projects. This not only imposes a limit on the overall volume of investment, but also helps rationalise the economic structure. On the other hand, a control strategy marked by government approvals, loan curbs and even administrative penalties may yield some immediate results, but at a steep long-term cost. Without a competitive selection mechanism, administrative controls cannot separate the bad projects from the good ones. Moreover, it is impossible to exercise flexibility in the administrative regime, which can easily hinder economic growth.