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CommentInsight & Opinion

Four 'battlefields' hold the key to China’s future economic success

China’s new leaders will have to wage war on four key “battlefields” if they are going to successfully reform her economy, writes Dr Shuaihua Cheng.

PUBLISHED : Thursday, 25 October, 2012, 3:45pm
UPDATED : Thursday, 25 October, 2012, 3:58pm

After three decades of rapid growth, China’s economy faces three major problems: it is “unbalanced”, “uncoordinated”, and “unsustainable”.

Hu Jintao and Wen Jiabao, the outgoing president and premier, have both publicly acknowledged that China, the world’s second largest economy, faces these challenges. Many business leaders and economists also believe China needs to re-adjust its economic model soon.

But how soon? Will the once-in-a-decade leadership transition put China on a more sustainable path for long-term economic development? What should the new leaders try to fix first? Some commentators argue there are four main “battlefields” the new leaders should focus on.

Firstly, China's use of old-fashioned Keynesian economics should be abandoned.

Over reliance on investment and exports is now viewed as a major reason for China’s unbalanced economy. Why do these problems persist when the causes have been diagnosed? Professor Zhang Weiying at Peking University blames Keynesian economics – long the main economic theory implemented in China. Zhang once noted that Keynesian theories – when governments spend money they don’t have – saved capitalism in the 1930s. But today, Keynesian economics has its limitations.

In China, policymakers have misinterpreted Keynesian theory, using it as a guideline for economic growth, assuming that growth always comes from investment, consumption, and net exports. Whenever the economic numbers drop, the first response of governments is to increase investment and stimulate GDP growth. But the role of exports in economic growth has been overemphasized. It seems that only net exports make a positive contribution to economic growth, while trade deficits do not contribute to growth.

Professor Zhang and other economists argue that a successful economic transition requires a return to the free-market theories of classical economist Adam Smith. These argue that economic growth comes from an increase of productivity, innovation, a better division of labour, and the expansion of markets. The Keynesian ideas that economic growth comes from investment, consumption, and net exports are misleading and dangerous. Keynesian economics may be good medicine when you are sick, but taking it all year is like drinking poison!

The second battlefield is China’s “urban-rural” economic divide. The country’s new leaders should do more to address this.

Sadly, the divide between urban and rural society remains almost unchanged, despite China’s success in industrialisation. After 30 years of development, the income per capita of rural residents is only one third of urban residents. Considering living conditions, education, and medical services, the gap between urban and rural areas has widened in recent years, as noted by Xu Xiaonian, a professor at China Europe International Business School in Shanghai.

China has urbanised very rapidly. But, two critical issues need to be resolved. The first is the urbanisation of “people.” So far, urbanisation has focused on “materials,” such as building infrastructure. Wang Tao, chief China economist for UBS, recently stated in Caijing Magazine that 160 million rural migrant workers should have been urbanised, but 30 years later they are still called “peasant workers” (nong min gong) and unable to enjoy the salaries, welfare, and right to education for their children as other urban residents.

The second issue relates to unifying urban and rural areas into one market with a free flow of capital, labour, goods, and services. Guo Shuqing, chairman of China Securities Regulatory Commission and former chairman of China Construction Bank, said the urban and rural dual system was an impediment for improving China’s economy. He suggested breaking down all barriers and letting labour and capital move freely between urban and rural areas.

Industry regulators and watchers including Guo, Professor Xu and UBS’s Wang have suggested three reforms to reduce urban and rural disparities: market-oriented land reforms of rural areas; a unified labour market without discriminatory treatment against people whose registered residency (hukou) is from rural areas; and nationally, a unified welfare system which treats urban and rural residents equally.

This way, rural residents can live in cities equally with urban residents, and urban residents can invest in land, buy houses, and live in the countryside. This will help improve poverty in rural areas.

Such a transition is crucial. Rural residents should not be treated as second-class citizens. The domestic market and consumption cannot expand if the rural people remain poor or inferior to urban residents politically, socially, and economically.

Thirdly, correcting price distortions is vital to re-balancing China’s economy.

Liu Shijin, a vice president of the Development Research Centre of the State Council, China’s cabinet, recently wrote that China should transform itself from a “speed economy,” where profits rely mainly on rapid growth, to an “efficiency economy” focused on innovation based on higher profit margins. He suggests reforms aimed at correcting the distortions of factor prices, such as natural resources, wages, rents, interest rates, and the exchange rate.

The key to China’s future industrial transition lies not just with industrial leaders, but with the economic and financial system, argues political economist, Xue Lei, of the Shanghai Institute for International Studies. The old system had long favoured state-owned sectors and ensured their access to huge amounts of investment by pushing up the price of labour, natural resources, and capital.

Finally, perhaps the toughest battlefield is political reform. “Without political reform, economic reform won’t succeed, and what we have achieved may disappear,” Premier Wen told a press conference at the 2012 People’s Congress. He cited corruption as the biggest danger.

A successful economic transition cannot “bypass political reforms,” said Professor Li Daokui of Tsinghua University in Beijing and a former advisory member of the People’s Bank of China, the central bank, at the 2012 Tianjin Meeting of the World Economic Forum. Li emphasised that political reforms should establish a modern market economy, improve the rule of law to regulate the behaviour of government, and ensure judicial independence.

Free elections are fundamental to any modern democracy, and election-based democracy within the Communist Party can be a starting point for political reform, argues Professor Hu Wei of Shanghai Jiaotong University in the People’s Forum (Renmin Luntan) in 2010. It may be possible to expand the election of officials at sub-national levels. This would mean elected officials will be more responsive to local constituencies – who care more about air quality, green playgrounds for children, and education than just GDP statistics.

If the new leadership is victorious on these four battlefields, a new China will emerge. China will not only become a bigger export market for developed countries, but can offer more space for poorer countries to develop labour intensive manufacturing sectors.

 

Dr Shuaihua Cheng is a managing director for China and Asia region at International Centre for Trade and Sustainable Development (ICTSD), a think-tank headquartered in Geneva, Switzerland. Dr Cheng was educated at the Fudan University in Shanghai and the University of Oxford. His recent publications include From Rule Takers to Rule Makers: The Growing Role of Chinese in Global Governance (co-edited with Scott Kennedy). He can be reached at scheng@ictsd.ch.

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babyhenry
Keynesian Economics only create delusions of prosperity and push issues further and further away until its too big hide and everything collapses much more strongly than it was suppose to.

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