How Beijing’s overmanagement is doing China’s economy and businesses more harm than good

China’s economic growth is expected to have slowed to just over 6 per cent, and it is unlikely to accelerate any time soon. In fact, analysts generally agree that China’s economic performance last year – its worst in nearly 30 years – could be its best for at least the next decade.

What observers cannot seem to agree on is how worried China should be, or what policymakers can do to improve growth prospects.

Optimists point out that, given the size of China’s economy today, even a 6 per cent growth in gross domestic product translates into larger gains than double-digit growth 25 years ago.

That may be true, pessimists note, but slowing GDP growth hampers per capita income growth – bad news for a country at risk of becoming mired in the middle-income trap – and compounds the fiscal risks stemming from high corporate and local government debt.

Whichever side of the fence one falls on, one thing is indisputable: policy inconsistencies and governance errors have contributed significantly to China’s economic slowdown. The problem lies in the slow progress of structural reforms.

Long-term growth depends on the decentralisation of government authority, increased marketisation and greater economic liberalisation, with the private sector gaining far more access to finance and other factors of production.

The Chinese government’s shift towards economic overreach can have immediate adverse effects – and often does. Consider the rise in China’s consumer price index, driven partly by sharply higher pork prices owing to lower-level governments’ decisions to shut down small pig farms over violations of environmental rules over the past few years, as reported by a former spokesman of the National Bureau of Statistics.

In recent years, environmental and air-quality regulations have taken a heavy toll on many Chinese businesses, especially the small and medium-sized manufacturing firms so vital to China’s future economic dynamism.

Of course, protecting the environment is important, not least for the sake of public health, and government-induced institutional changes have improved air quality.

But the central government’s top-down approach, which imposes a rigid set of indicators on subnational governments, is a blunt instrument that might be undermining local authorities’ incentive to support real growth.

China owes much of its past success to local-level experimentation and competition, fuelled by the promise of promotions for officials presiding over the most successful regions. Nowadays, local officials reap greater rewards for meeting environmental targets, rather than growth targets – and it shows.

The short-term consequences of Chinese government overreach can also be seen in the financial sector.

After the 2008 global financial crisis, the government urged banks to ramp up lending, and companies to accumulate large amounts of debt, to offset the external shock. While this kept the growth engines running, it caused a sharp increase in financial risk.

By 2016, however, the government had reversed its position. Even as the People’s Bank of China kept its policies neutral, banks were ordered to pursue drastic deleveraging and credit contraction, and China’s sizeable shadow banking sector shrank considerably.

This aggressive approach damaged many businesses’ balance sheets, raising the risk of a debt crisis. It also prompted substantial capital flight and weakened private investment, including in real estate, thereby undermining nominal GDP growth. As a result, China’s broad money supply has not declined as a share of GDP.

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Beyond the growth impediments stemming from how the government pursues its goals, moreover, is the problem of how rapidly, unexpectedly and frequently those goals change. This disrupts investor expectations and erodes market confidence. Not only are companies hesitating to invest, many are scaling back their workforces.

In recent years, lay-offs have increasingly become unavoidable even among China’s internet giants.

Far from opening the way for progress on structural reform, the Chinese government’s excessive top-down interventions are reinforcing structural imbalances. Indiscriminate and unpredictable top-down dictates hurt all businesses, but private companies suffer the most. After all, state-owned enterprises enjoy powerful official protections, making them more likely to survive, despite their inefficiencies.

Like an overprotective parent, China’s government needs to learn to let go. Yes, a more conventional approach to macroeconomic management carries some risks. Companies might decide to accumulate excessive debt and banks might issue too much or too little credit. But the resulting fluctuations are likely to be largely temporary.

In the longer term, such an approach will strengthen investor and market confidence, enable the most dynamic companies to thrive and support the stable economic growth needed for China to become a high-income developed country by mid-century. To achieve this goal, the central authorities may eventually have to get out of their own way.

Zhang Jun is dean of the School of Economics at Fudan University and director of the China Centre for Economic Studies, a Shanghai-based think tank. Copyright: Project Syndicate