China’s ‘reform deficit’ is fuelling current global tensions

The global economic system has for some months been moving ever closer towards a precipice from which nobody wants to fall. The escalation of tariffs on an additional USD 200 billion worth of American imports from China is an acceleration towards the edge of global economic disorder. However, as misguided as the application of tariffs may be, it is in large part a consequence of the slow pace of external opening up and internal economic reform in China.

China’s 2001 WTO accession agreement was reached with an acknowledgement of China’s development status at that time, and a series of compromises were reached to protect Chinese firms still in their youth. Concessions were made with the understanding that China would eventually move beyond the minimum level of compliance with this arrangement and emerge as a market-orientated economy on par with its international peers. Nearly 17 years later, China’s economy has grown rapidly while reform and opening has struggled to keep pace. This gap has created a ‘reform deficit’ that is fuelling global tensions.

It is true that some advances have been seen over the last two years in China’s investment system, such as equity caps being raised in financial services and the manufacturing sector. Improvements have also been made to the R&D environment, and better enforcement of higher quality standards, paired with lower tariffs on consumer goods, has given a boost to China’s middle class.

As welcome as such progress is, China has a long way to go to become the open and fair market that the international community expects from the world’s largest economy by PPP, particularly at a time when China is asserting itself as a responsible economic power.

Access to licences, for example, acts as a secondary barrier to doing business across wide swathes of the economy. For instance, six years after a 2012 WTO ruling to allow foreign investment in credit card services in China applicants are still waiting for licences. Even when access is technically open it can be far beyond the reach of even large global firms: capital requirements for cross-border financial services and insurance providers, for example, are much higher than international norms, blocking all but those with the deepest pockets.

The government’s recent restructuring of state-owned enterprises (SOEs) is a clear reflection of the shortcomings of China’s internal reforms. Although SOEs have always dominated certain segments of the economy, their rapid consolidation is doing little more than turning oligopolies into monopolies. Furthermore, while recent policies have created a healthy distance between SOEs and the state itself, the resurgence of the Party in SOE governance has called into question the high-profile commitments that China has made to let market forces prevail. It has also raised concerns that political interests may be asserting control over the commanding heights of the economy. Finally, even in industries devoid of SOEs, the footprint of the state-owned sector is evident. A worrisome amount of financing is flowing towards SOEs, which is draining more and more of the lifeblood from China’s increasingly dynamic private sector.

The reform deficit goes far beyond just these examples, and each mark on the ledger hits the bottom lines of both international and domestic private firms in China. Continued reliance upon certain aspects of China’s old economic growth model has formed a ceiling over the rapidly maturing private sector. If the leadership truly subscribes to the idea that the market should play the decisive role in resource allocation, then the country’s economic framework needs to be modernised to facilitate further development.

It is therefore incumbent upon the Chinese leadership to pursue a comprehensive approach that lays the foundations for progress while not creating any justification for further conflict. This can best be done by implementing reforms that lead to results on the ground for international enterprises.

European businesses are ready to help facilitate change and work with China to address the reform deficit and create the environment necessary for the private sector to flourish, but China is in the driver’s seat and only it can decide when and how to divert from its current course.