China’s Economic Magicians Have Lost their Touch
Xi Jinping is botching his country's time-tested recipe for continued growth.
China’s normally competent policymakers have had a rough time recently. First, against a backdrop of inexorably slowing economic growth, they encouraged ordinary Chinese to buy into a short-lived stock-market bubble. When the bubble began to burst in June, they organized a massive $400 billion program to support stock prices. Two months later, they abandoned this program, and since Aug. 20, the Shanghai Composite Index has fallen by 22 percent, the steepest four-day drop since 1996.
Then there’s the People’s Bank of China’s (PBOC) abrupt Aug. 11 announcement of a 1.9 percent devaluation of the renminbi (RMB), the country’s currency. The PBOC declared that henceforth the currency’s daily rate would be set mainly by the market, rather than arbitrarily by the PBOC, as in the past. The move received a favorable reception from the IMF, which has long pushed China to make its exchange rate more flexible (and which requires this flexibility as a condition for the RMB’s entry into its artificial reserve currency, the “special drawing right,” later this year). But after economists and analysts around the world denounced China for deliberately depreciating its currency to boost exports, the PBOC reversed course. It has spent an estimated $200 billion in currency markets to defend the RMB at about the rate it set on August 11. In theory, it remains committed to a “market-driven” yuan, but in practice it is pulling out all the stops to prevent the market from pushing the currency down.
Many commentators have taken this confusion as a sign that China’s economy is in worse shape than its headline 7 percent growth figure suggests, and that officials are desperately clutching at any means to prop it up. There is some truth to this, but we should not exaggerate. China is in the midst of long and painful transition from an economy driven by capital spending and heavy industry to one driven by services and consumer spending. The regions most dependent on resources and heavy industry have been badly hit, a fact already evident in official data. The country’s three northeast provinces are reporting negative nominal GDP growth, and two other provinces are close to zero. In other words, parts of China are already in recession. Other provinces, however, are adapting better and still report solid, though slowing, growth. The most likely trajectory is that China’s economy will continue to slow for the next two years, but avoid the collapse predicted by some pessimists.
Yet the outlook is clouded by a basic uncertainty: Are China’s leaders committed to economic reform, or not? In the first three decades after late paramount leader Deng Xiaoping inaugurated a policy of “reform and opening,” this was rarely in question. Through all sorts of ups and downs, China’s general direction has been towards more markets, and less state. More important, at a series of crucial turning points, the ruling Communist Party surrendered control over economic levers, gambling that a bit less control would lead to a lot more growth. They did this in the 1980s by freeing farmers to grow their own crops and start small businesses; in the 1990s by eliminating most price controls, opening the door to foreign investment, and reforming state enterprises; and in the 2000s by encouraging private entrepreneurs and freeing the nation’s markets through entry into the World Trade Organization.
The Third Plenum reform roadmap unveiled by President Xi Jinping in 2013 seemed at first to offer a similar tradeoff, with its promise that markets would gain a “decisive role” in resource allocation. But that document also affirmed that the state sector would maintain its “dominant role” in the economy. In the subsequent two years, that obvious contradiction appears to be resolving in favor of the state. Market reforms have proceeded in fitful increments. Reforms to the state-owned enterprises — which embody most of China’s economic problems — have failed to materialize. Meanwhile, Xi’s efforts to centralize political authority in his hands, and build up China’s prestige as an international power, have continued without pause.
Xi’s bargain is more state control now, in return for a vague hope that it will eventually be used for beneficial ends. This is exactly the opposite of the recipe his predecessors used to conjure up 35 years of extraordinary growth. The result is the mish-mash we saw this summer, when celebration of “market forces” turned instantly to massive intervention when markets delivered results not to Beijing’s liking. If growth is to revive, a convincing and consistent embrace of market mechanisms — whatever their short term outcomes — will be required.
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