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| Thought Leaders: Economy |
Trouble in China
William H. Hess
11/01/2007
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Almost 30 years since the advent
of market-based economic reforms, China’s economic ascent is an imperfect
miracle. The dynamism of the Chinese economy continues to outpace the capacity
of China’s regulatory regime, and the mood in Beijing is far from triumphal. Recent economic news provides deeper signals that the Chinese economy has
outgrown the central authority’s ability to control it. Some have suggested that
the success of the Chinese model of development is tantamount to the "end of
economic history," but such a notion looks increasingly implausible as systemic
risks continue to gather quarter after quarter.
Jarring headlines bring into question the capacity of the
central government to rein in the national economy: a 13-year high for GDP
growth for the second quarter; scrapping efforts to track green GDP that would
measure environmental impacts; a tarnished "made in China" branding over food
and product safety scares; rising inflation; and warnings over asset price
bubbles.
The Chinese government has made significant reforms where the
external sector of the national economy is concerned, but this progress has come
at the cost of delayed domestic reforms, including the creation of a meaningful
social safety net and a range of other economic policies. Legislators in China
have been far from idle, but where actual governance is concerned—meaning the
enforcement of the laws that it creates—the performance of the country’s authorities has been mediocre at best.
At the provincial level, continuing emphasis on growth as an
end in itself, with little regard for the cost of the means employed, has meant
that rules—whether environmental, from the State Council or another organ of
government—are flexible, helping to drive the symptoms of economic
overzealousness. Moreover, the depth of Chinese civil society (measured by the
ability of social institutions to absorb disturbances) remains dangerously
shallow, as indicated by the unfolding of recent disturbances, at the same time
that the fissures created by decades of rapid social change continue to widen.
Overall, rapid economic growth over a span of decades has obviated the need for
many in government and industry to make a fallback plan.
The depth of Chinese civil society remains dangerously
shallow. |
Kingdoms and Fiefdoms
The story behind recent economic news also indicates that
regulators in China now find themselves in a policy trap, created by an exchange-rate regime that puts policy measures to achieve internal and external
balance at cross purposes. In reality, in order to achieve policy targets for
unemployment, the Chinese economy must remain addicted to investment and
exports. This helps drive China’s external surpluses and the high levels of
domestic liquidity that push prices for equities and real estate skyward.
Meaningful efforts to reform the currency regime might help lessen this
pressure, but immediate domestic political needs serve to increase the systemic
risks that accompany inefficient investment practices. It is inherently
difficult to restrain the pace of exchange-rate appreciation without taking
steps that will ultimately fuel the rapid expansion of domestic credit.
Not even the most optimistic observers believe that the
cur-rent growth party can last forever, and expect that macroeconomic
shocks—even recessions—will eventually punctuate China’s business cycle. If this
were to occur, China, like its neighbors in the past, would face perhaps the
biggest challenge from the underdeveloped state of its regulatory
infrastructure. Policy options at the central government level that would leave
the macroeconomy healthier in recovery appear to be few. The more effective
government response would come at the regional level, as provincial governments
are better-positioned to serve as stabilizers of last resort.
Though China’s growth miracle is in many ways unique, the same
self-serving factions that were present before similar emerging market train
wrecks are firmly in play with its economy as well. This is not to imply that
the country is on the verge of a major economic event, but rather that when the
Chinese experience converges with the rest of the world, it will occur within
the context of an untested system. Greater emphasis on real governance at the
provincial level would help insulate the Chinese economy from future
instability, but kingdoms have always encountered difficulties in telling
fiefdoms what to do.
William H. Hess, based in Beijing, is Global Insight’s senior
China analyst.
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