China’s People’s Daily recently announced major new guidelines to improve the economy’s market-based allocation mechanisms. These measures signalled Beijing’s determination to liberalise the economy and implement supply-side reforms that will strengthen the private sector. They follow several years of slowing growth and surging debt, both likely to be made worse by the impact of the Covid-19 pandemic.
Mainstream economists have long called for Beijing to improve China’s market mechanisms, and they have deplored the rolling back of the private sector over the past decade. But despite years of supply-side proposals and repeated reform pledges, there has been little evidence of a substantial reversal in the trend towards greater government control of the economy.
This shouldn’t surprise anyone. Over the long term, Chinese growth might indeed benefit from a stronger private sector and a more market-oriented economy. Yet in the near and medium term, this approach will do almost nothing to address either the real causes of China’s slowdown or its growing reliance on debt. Nor would it diminish Covid-19’s economic effects.
This is because China doesn’t have a supply-side problem. It has a demand-side problem, which the coronavirus pandemic has only made worse. What is more, the rolling back of the private sector in recent years is a consequence, not a cause, of China’s underlying demand-side problem.
Until this problem is resolved, it will be almost impossible for Beijing to reverse course and overturn the trend towards greater government involvement in the economy.
Economists have known since at least 2007, although perhaps they have forgotten in recent years, that China has an extremely unbalanced economy. At the heart of this imbalance lies the very low share of income that ordinary households retain of China’s gross domestic product, compared with that of local governments, businesses and the very wealthy.
At roughly half of GDP, it is among the lowest of any country in history. As a result, sustainable household consumption, typically the largest component of overall demand in a large economy, also drives a very low share of total Chinese demand.
This low consumption has knock-on effects on private-sector investment. Most private investment goes either to increase export capacity or to serve consumption. Yet exports were never going to persist as a major source of growth in a large economy such as China’s, and today its prospects are dimmer than ever. At the same time, the relatively low share of household consumption constrains private investment too.
In other words, the healthiest sources of demand — consumption, exports and private-sector investment — are together unable to generate the level of growth that Beijing considers to be politically necessary, which until recently was deemed to be 5 to 6 per cent.
So what are the other sources of growth? In China’s case only two: infrastructure investment and real estate development.
With China already massively overinvested in infrastructure, only the government will directly or indirectly promote more. Meanwhile the real estate sector, with nearly one-quarter of all urban apartments already empty, is also crucially dependent on state support. Because an economy in which resources are allocated by market forces is unlikely to devote much effort to either sector, the only way to keep growth high is via more state support.
This is why the state has played and will continue to play an expanding role in China’s economy. As long as Beijing requires growth that is substantially higher than the economy’s real, underlying growth rate (probably around half reported growth rates) China has no choice but to expand the government’s presence. This will also reduce the market’s role in allocating resources.
Market-based reforms, no matter how aggressively implemented, will not drive sustainable growth in China. An economy in which the market allocates resources and capital can generate high growth rates. But only after Beijing completes a politically difficult but necessary redistribution of wealth — and with it power — from local governments and elites to ordinary households.
Local elites have long resisted this. But without it, promises to reduce government control in China’s economy and to increase the role of the markets will remain empty. Until demand is rebalanced, only expanding the government sector and increased debt can guarantee high levels of growth.
The writer is a finance professor at Peking University and a senior fellow at the Carnegie-Tsinghua Center
Source: Economy - ft.com
