China’s critics are united on one point: The country’s central problem is that it’s moving too slowly to embrace free markets. For now, however, the bigger risk lies in moving too fast.
It’s important to remember how China reached this point. For any big economy, coordination poses a steep challenge. The problem is particularly acute at early stages of development, when a combination of poverty and a past record of underperformance mean no one has an incentive to invest.
What’s required is a big push strategy that moves government, business and banks in the same direction at the same time. Only through that kind of coordinated action can countries generate the network effects and economies of scale that make individual investments pay off — and thus attract more.
In smaller Asian nations such as Japan and South Korea, technocrats steered the way. The Ministry for International Trade and Industry solved Japan’s coordination problems by deciding which industries and companies would get access to credit, trade quotas and other resources.
It’s often assumed that China followed the same model. The reality, though, is that China’s population is too large, geography too vast and governance too chaotic for such an approach to work.
Instead, the government has historically employed a looser coordination mechanism. At its heart, the system involves setting ambitious targets for growth, directing lending through state banks to catalyze key sectors, and strictly controlling information — including on the state of the economy — to maintain confidence both inside and outside the country. In China’s early stages of development, this approach worked wonders.
Its costs, however, have since become apparent. Sectors from steel to automobiles to sportswear are grappling with massive overcapacity. With economy-wide debt now close to 250 percent of GDP, the consequences are increasingly difficult to manage.
The long-term solution does indeed lie in a greater role for the market, which should increase efficiency. The government has already made significant moves in that direction: Interest rates have been liberalized, the exchange rate is more flexible and prices for land and energy have been freed up.
Further empowering the market, however, is no panacea.
Contrary to dogma, markets aren’t an unequivocal good. When they’re working properly, they allocate resources more efficiently. When they function ineffectively, though, manias and panics can create even greater distortions. It shouldn’t be a surprise that a country experimenting with markets for the first time will suffer more of the second and less of the first. Witness the 2015 boom and bust in Chinese stocks.
For markets to drive greater efficiency, they require high-quality information. Yet providing better data could undercut a crucial component of the government’s big push strategy — controlling information to maintain confidence.
And China is being urged to embrace markets at a particularly awkward time. A shrinking workforce and stretched banking system are dampening growth. The result, predictably, is that markets have grown increasingly skeptical about China’s prospects. Pessimistic markets return the economy to its dismal starting point, where no one has the faith to invest and no one benefits.
Given those challenges, a cautious pace of reform makes a lot of sense. Take the growth target. China has committed to 6.5 percent annual GDP growth, not just in 2016 but in every year to 2020. Many economists fear the goal is unrealistically high and will lock the government into a cycle of never-ending stimulus.
But what’s the alternative? The target is rallying point for all the disparate arms of the Chinese state, from the central and local governments, to state-owned banks and enterprises. It’s the economywide put option that underpins every new venture. Abandon it and the government risks the very downward spiral it’s trying to avoid.
True, continuing old bad habits and adding some new ones — deepening leverage, or fudging economic data to support sentiment rather than reflect reality — undermines confidence as well. But at this stage, allowing novice markets to spin out of control would have disastrous consequences.
The reality is that for the foreseeable future, China will need to inhabit a messy in-between space. Targets will continue to play a role in coordinating activity. Communication, including control of the message on the economy, will continue to play a role in supporting confidence. The government will remain active in tamping down market turbulence.
Within those constraints, reform-minded policymakers will have to find areas where they can push ahead, building on substantial achievements in interest rate liberalization and other areas. The hope has to be that they come out the other side having boosted both confidence and market efficiency. Rush ahead too fast, and they risk sacrificing the former without gaining the latter.
By Tom Orlik
Tom Orlik is the chief Asia economist for Bloomberg Intelligence and author of “Understanding China’s Economic Indicators,” a guide to Chinese economic data. He is based in Beijing. — Ed.
(Bloomberg)