Now, China must act on its pledge of reform
Andy Xie says China can demonstrate its pledge of reform made at the third plenum by continuing to fight corruption, liberalising the economy further and bursting the asset bubble
The communiqué issued at the end of the third plenum of the Communist Party's 18th Central Committee is a general statement about the desire to solve the current economic and social difficulties through reforms.
Expectations at home and abroad had been running feverishly high prior to the plenum. And the communiqué, which mostly repeats generalities that have been said before, may be interpreted as a disappointment. I would advise patience.
Firstly, the government has demonstrated its commitment to tackle corruption. As virtually all of China's economic challenges can be traced to the misuse of government power, a credible anti-corruption campaign is the only effective means to contain the economic malaise.
Institutional reforms are obviously the solution. But they take a long time. The continuation and escalation of the anti-corruption campaign buys time for other reforms to catch up. Thus, slowing or even halting the campaign would be viewed as a lack of commitment to serious reforms.
Second, concrete and meaningful measures may come within a few months. Excessive government and expansion of state-owned enterprises are the root causes of China's economic difficulties. Without decreasing government power and shrinking the reach of state-owned companies, economic reforms cannot be meaningful.
Shanghai's free-trade zone is taking a first step in this regard. It has done away with cumbersome government approvals and introduced for the first time a "negative list" on foreign investment, that gives businesses freedom of conduct unless specifically prohibited.
The approval process for any economic activity has led to massive distortions in resource allocation. For example, the National Development and Reform Commission (NDRC) approves any investment of significant size. As its approval confers government support, and therefore is used to obtain financing from the state-owned banks, it has led to overexpansion of most industries. China's overcapacity crisis can be attributed to the NDRC process. Reform of the commission is one concrete measure that could come soon.
Import deregulation should be another quick path to better efficiency. Prices in China are extremely high. It is a major reason for the low share of consumption in the economy. China, the world's largest export economy, has low production costs. Thus, high domestic prices reflect the layers of costs in the distribution process. Opening up to import competition will help equalise local and international prices.
Third, pro-reform cyclical policies could be forthcoming. The property bubble and related monetary inflation are pushing China's economy towards stagflation and crisis. Both have institutional origins.
China has been prone to inflation ever since reforms began three decades ago. It reflects the burning desire for investment. With holdings of cash and bonds bringing negative returns, people have turned to property and other investment. The property bubble is one manifestation of this "inflation tax". It also accounts for the falling share of household consumption in gross domestic product.
The asset bubble is being funded by a vast shadow banking system. A new risk is that money borrowed offshore, at a low interest rate, is being pumped onshore for "loan-sharking". Such carry trades have probably funded the rise in land prices in the past two months. By tolerating such a vast bubble funded with such high-risk money, the government is pushing the economy towards a precipice.
Reform is supposed to move the economy forward. Tolerating the bubble will move it backwards. Hence, the most productive measure is to let the property bubble burst and stop the Ponzi scheme in the shadow banking system.
China's leaders have stated repeatedly that the current state of affairs is not sustainable and only serious reforms can prevent an economic collapse. Such statements have served to shore up confidence in a difficult economy. Without such words, money and talent would have left in droves, and the economy could already have collapsed. But confidence cannot be sustained by hope alone; concrete action must take its place.
The time for such action is running out. After the third plenum, only dramatic reform measures can sustain confidence and keep China's economy stable.
Chinese people are highly productive. Opening up has led to the repricing of Chinese workers, the driving force for the rise of China's economy. However, the accumulation of internal inefficiencies has offset Chinese people's competitiveness, causing the current difficulties.
Eradicating these stumbling blocks - mainly due to the misuse of government power - would unleash Chinese people's inherent productivity. A per capita income of US$20,000 can be reached before 2030.
But a lack of, or insufficient, reforms would escalate the cost of these domestic inefficiencies, leading to a general economic collapse. Private companies and white-collar talent who understand this are highly sensitive to the follow-through from the third plenum. If the communiqué remains just words, like so many promises for reform before, the outflow of money and talent will accelerate, which may cause an economic hard landing.
Andy Xie is an independent economist