Opinion & Commentary

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Revitalising the China story

Edward Fang | ON LINE Opinion | 27 November 2012

Almost 40 years after Deng Xiaoping 'opened up' China to the world, the debate between pro-reformists and party conservatives entered a pivotal phase last week with China's widely anticipated once-in-a-decade leadership transition.

At the centre of the debate lies a fundamental ideological divide over the future of the nation.

Conservative hardliners advocate a return to traditional Maoist policies against the backdrop of rising social instability and mistrust in the political system.

The liberal 'right', on the other hand, argue that the oppressive, iron-fisted policies of the Communist Party are strangling economic growth and exacerbating the risks of wider social unrest.

Despite the disorienting rhetoric between the opposing factions, both sides accept that the economy is decelerating and social challenges are brewing.

The new leadership faces a plethora of economic challenges moving into the next decade.

After experiencing double-digit expansion for the better part of the last decade, cyclical stresses and structural deficiencies that have been masked by robust headline growth figures are beginning to emerge. Industrial production, fixed capital investment, and energy output have fallen sharply against the backdrop of external macroeconomic headwinds stemming from both sides of the North Atlantic. Chinese manufacturing output as measured by the HSBC purchasing managers' index has been contracting for the last 12 months.

If China is to avert the hard landing being widely predicted by the doomsayers, it desperately needs to find the political solidarity to pursue a fundamental restructuring of its economic model.

First, much of the structural weaknesses lies with the dominance of large, inefficient state-owned enterprises (SOEs) that benefit from exclusive assistance, easy access to funding channels, and shielded markets. These state-sponsored behemoths distort competitive market dynamics, stifling the growth of free enterprise, fuelling the mal-investment of capital resources, and encouraging an ingrained culture of low productivity.

Second, rebalancing growth away from the fickle nature of global trade and investment towards a more diversified growth model underpinned by domestic consumption will be a key priority for the new leadership. Consumption as a percentage of GDP has fallen from 45% to just 35% in the 10 years to 2012 as the economy expanded at an average annualised rate of 10.5% during the same period. Furthermore, China's export-orientated development model is becoming increasingly outdated because of rising wage and input costs that have not been met with corresponding productivity increases.

Lastly, the severe demographic challenges China will face in the next decade are likely to create a persistent drag on growth. Over the next 10 years, the size of the labour force is expected to plateau, meaning that future growth must be derived from a more productive workforce. The Wall Street Journal reports that between 2015 and 2030, the labour force is expected to contract by 69 million with the working-age population shrinking from 72% in 2011 to just 61% by 2050, placing pressure on wages and dampening the competitiveness of the nation's export sector.

The set of development challenges facing the Chinese economy are enormous. Departing Premier Wen Jiabao has been highly critical of China's growth model, repeatedly labelling it as 'unstable, unbalanced, uncoordinated and unsustainable.' A lack of political consensus, complicated by the vested interests of power brokers within the Communist Party, has created a rigid reform agenda that has struggled to adapt to changing dynamics within the world's second-largest economy, resulting in long overdue reforms.

To accelerate the rebalancing of the growth model towards domestic consumption, policymakers must lower price thresholds by alleviating excessive administrative taxes on consumption, promote greater competition in key product markets, and control housing affordability.

Marketisation, or pricing reform to reduce the state's influence over economic outcomes, must occur more aggressively, which would alleviate non-market driven distortions, foster free-market competition, and create the impetus for long-term productivity gains. The liberalisation of the financial sector would support the structural shift towards domestic consumption. More importantly, it would sever the link that funnels private savings into the inefficient state sector, providing the rationale for the gradual dissolution of the SOEs while improving capital allocation and the efficiency of credit markets. Reducing the dominance of state enterprises and extending support to small-to-medium enterprises will be vital as private sector firms are the fundamental pillars of innovation, productivity growth, and ultimately, long-term sustainable development.

Similarly, social reforms and investments in upscaling human capital, particularly in health care, education and support for the elderly, would lift productivity rates while simultaneously curbing mounting social tensions. Health care spending as a percentage of GDP remains at just 2.1% compared to the OECD average of 9.5%, with just one physician for every thousand people. Expanding the allocation of social services should in theory encourage households to reduce savings in favour of consumption, which would complement the recalibration in the growth model towards domestic consumption.

China's development story has been truly remarkable. As Professor Richard Levin of Yale University put it, 'Let's remember, this is a nation that has taken more people across the poverty line in 30 years than across the poverty line in a hundred years of industrial revolution in Western Europe and North America.' Moving forward into the next 30 years, China faces profound challenges that will most definitely require bold action on the part of party leaders with a willingness to overcome cognitive inertia and accept the obsolescence of socialist-economic policies.

Edward Fang is an intern at The Centre for Independent Studies.