Hopes that China will follow through on plans for urgently needed economic reforms are receding. In their place, fears are rising that the country will get stuck in the same kind of stagnation that has trapped Japan since the 1990s. The prospect of a failed economic transition in China poses a serious threat to global growth, dwarfing the impact of Brexit.
The Communist Party’s Third Plenum meeting released the Decision in November of 2013, that appeared highly promising. It proposed a wide range of reforms aimed at curtailing the role of the government in the economy.
While previous plenums had described the market as having a “basic role” in the economy and allocation of resources, the Decision spoke of it playing a “decisive role.” Market forces were hailed as the “invisible hand” that would catapult the Chinese economy past the dreaded middle-income trap.
But the Decision has yet to live up to more than a fraction of its potential to drive the sort of long-term and sustainable economic growth that China needs. Some reforms to the tax system have moved forward, but far more still needs to be done.
Achieving this will require taking on institutional reforms that are both difficult and necessary. China needs market rules that are fair, open and transparent, something Chinese investors enjoy in the EU while European companies remain straight-jacketed in numerous sectors of the Chinese economy. It needs to allow the market to determine prices more broadly, and reduce the dominant role of state-owned enterprises (SOEs). In short, more market forces.
China’s 13th Five-Year Plan (2016–2020) recognises that the outdated investment- and export-driven economic model will not enable China to become a modern, industrialised economy. However, and in direct contradiction to the priorities established by the Third Plenum, the plan envisions the government playing an expanded role in the economy, especially when it comes to driving innovation.
This includes picking winners by deciding which high-technology industries are priorities for government support and investment. As Japan’s experience shows, this approach is less effective than establishing an effective regulatory environment and leaving it to entrepreneurs and private investors to determine where the next big opportunity lies.
In its recent report China’s $5 Trillion Productivity Opportunity, McKinsey outlined the vast opportunities that beckon if the country successfully transitions away from an investment-led economy to one driven by productivity instead. This would be in everyone’s interests.
The fact that China has built up such high levels of total debt over the past decade is also in part attributable to the failure of reforms. Inefficient SOEs insulated from market forces continue to borrow on noncommercial terms. And with a rapidly ageing society, the country will not be able depend on comparatively low labour costs to drive growth for much longer.
Global economic growth remains fragile. If China does not live up to its full potential, the consequences would support doom and gloom scenarios. In short, China needs to win. The European Chamber continues to advocate for market-orientated reforms to be pushed through without delay.
A version of this article was originally published on the Opinion page of the Wall Street Journal on Wednesday 13th July.