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China Enters the Market



China Enters the Market

Recently there have been more and more talks about the fact that the unprecedented growth of the Chinese economy is slowing down, and soon the country will lose its economic attractiveness. However, already in November 2013 Chinese leaders worked out a number of reforms designed to foster growth at a level comparable with the previous decade. Whether it is a direct consequence of the reforms or just coincidence is not yet clear, but in the second quarter of this year, China′s economic growth rate was 7.5%, which is a rather low figure for China. But at least it exceeded the forecasts of experts.


According to a recent study by Standard & Poor′s, China ranked first in the world in terms of the size of its corporate debt, which by the end of 2013 amounted to $14.2 trillion. Together with excess production capacity, the increasing size of the shadow banking sector, the credit crisis, and noticeable signs of a real estate bubble, the growing debt clearly shows that everything is not that rosy in the Middle Kingdom. In order to save the Chinese economy from a possible financial crisis and find new incentives for economic growth, China′s leadership in November 2013 announced a program of large-scale transformation.

John Holden, Associate Dean, The Yenching Academy, Peking University, and Nonresident Senior Associate, Carnegie Endowment for International Peace, noted the following in an interview with WEJ: “At the Third Plenum of the 18th National Party Congress in November 2013 an extremely ambitious program was outlined, which aims to give the market priority over planned economics. At the same time, China is trying to destroy the established patronage system by conducting an unprecedented anti-corruption campaign targeting both ‘tigers and flies” (i.e., both senior figures and minor officials). Chinese leaders have said that economic reform is a matter of life and death, both for the Communist Party and of China as a whole. Whether they succeed in overcoming the resistance of vested interests remains to be seen. Nevertheless, there is little doubt about their resolve.”

The entire package of reforms outlined at the Third Plenum is aimed at liberalization and development, along with increasing the role of market mechanisms in the economy. In addition to the fact that China’s ′s leaders pledged to provide a new focus for the country’s ′s economic model, which has been largely dependent on public investment in private business, steps were also taken to mitigate the state′s demographic policy and to generally improve the human rights situation. Importantly, the final communiqué of the Plenum makes clear that China is determined to abandon its previous export-oriented model and place more emphasis on the domestic market and meeting domestic consumer demand.

A number of important industries, such as energy and railways, are expected to be de-monopolized. The creation of small and medium-sized private banks has now been permitted in order to increase competition in the financial services market, and non-state capital can now be used to fund investment projects under the same terms as state funding. It is also important that private investors will be permitted to obtain a 10-15% stake in state-owned companies. However, though private entities will increase their economic presence, the dominance of the public sector is not being questioned. But this does not exclude the possibility of creating an open, transparent, and competitive market system.

This is a big step for Communist China, as it confirms that stable economic development is only possible using market mechanisms. It is appropriate to recall in this regard the American political scientist and political economist Francis Fukuyama, who recently wrote that “China′s model once looked promising, but long-term economic growth will require China to implement larger democratic reforms.” Generally speaking, this statement is true not only for China but also for all states that ignore the role of the private sector and democratic institutions. This confirms the research of economists from MIT and Harvard, who, guided by examples from the past, concluded that democratic transformations statistically always lead to an increase in GDP.

The goals of the Chinese leadership are very ambitious, but so far their implementation has been very slow. No other significant measures have been taken other than the partial liberalization of the private sector, the enacting of regulations establishing five fully private banks, and the opening of a free trade zone in Shanghai. The problems of the Chinese economy remain pressing and must be addressed as quickly as possible. According to Mr. Holden, “The primary task is to overcome the credit crunch, which was the result of years of over-investing in underperforming assets and a hypertrophic stimulus program ($568 billion), which was established in response to the financial crisis that originated in the United States. The longer-term and more difficult task is to reform the system of financial intermediation, which is concentrated more in politics and patronage than in markets.”

“China Expects an Unprecedented Shift”

WEJ correspondent spoke with Yukon Huang, Senior Associate at the Carnegie Endowment and a former World Bank Country Director for China, in more detail about the problems of the Chinese economy, the new economic course of the country, and how it is being implemented.

Mr. Huang, how do you currently assess the state of the Chinese economy?
Headline news on China’s economy frequently suggests that a financial collapse is imminent or that the property bubble will cause a sharp decline in GDP growth. Indeed, China’s GDP growth rate, at 7.5% this past quarter, has declined steadily since 2010, and its debt has grown dramatically since the government’s 2008 stimulus package. However, though addressing its current debt problems would likely put a drag on growth, the financial reforms laid out by the 18th National Congress of the Communist Party of China Third Plenum last November, open the possibility for China to realize gains in productivity that would allow it to maintain growth rates of at least 7 percent for the remainder of this decade.

What areas are affected by the adopted reform package?
The Third Plenum identifies potential productivity gains in three main areas: urbanization, a greater role for the private sector, and a more efficient allocation of government resources. From an ideological standpoint, the communiqué makes a strong statement about the market’s “decisive” role in the economy — resolving a longstanding issue in China and potentially creating an unprecedented shift in the nature of its economic institutions.

When speaking about urbanization, do the reforms also provide relief for those migrating to the cities? How does this work?
The Plenum’s liberalization of the Chinese hukou system — which governs residency rights — and provisions for selling use rights to collectively owned plots in rural areas, would make migration to cities easier, initially to second-and third-tier cities. Urban incomes are more than three times the amount of rural incomes, the highest disparity of any major economy, which illustrates the potential for productivity gains by allowing freer movement of labor to higher wage activities both industrial and services. The increase in migrant worker incomes and access to social services would also help stimulate domestic consumption.

You noted that the decision of the Plenum allows for increasing the role of the private sector. In what areas will this occur?
Additionally, the Third Plenum agenda provides for greater competition between state and private sectors. Though it reaffirmed that “public ownership” was still at the “core” of China’s economic system, the communiqué signaled that the government would allow private interests to take an increasing share of protected state enterprise positions. It confirmed the central government’s intention to eliminate price distortions and curb interventions, while also calling on the private sector and markets to be the driving force behind developing higher-value financial, media, telecommunications, education, and health services. The plenum further supports the emergence of new private banks that could help provide funding for small and medium-sized enterprises to enter the market.

If the economy becomes more open to private capital, this, of course, will stimulate growth. But are there any fundamental problems now on the agenda that may hinder the further growth of China′s economy?
The rise in China’s domestic debt to around 210% of GDP in 2013, the increase in shadow banking, and the property bubble lend themselves to worries about a potential financial crisis. However, China’s debt problems are grounded in its weak fiscal system. Unless the budgetary process can be reformed, we should expect a slow hemorrhaging of financial resources, with a rise in banks’ nonperforming loans and defaults in the bond and shadow banking market.

What specific measures have been adopted to address these problems in particular?
China’s financial and fiscal problems will be easier to resolve if its growth process is put on a more sustainable footing. If properly implemented, the Third Plenum reforms would not only provide the needed productivity gains but also help curb corruption and promote a sense of a more just society. Fiscal reforms and reduced dependence on banks could improve transparency and promote accountability; rolling back the power of the state enterprises and streamlining government procedures could restrain opportunities for rent-seeking; urbanization could strengthen the voice of the middle class and apply pressure to liberalize the flow of information; promotion of a services-oriented economy would reduce dependence on energy-intensive industries and help mitigate environmental degradation.

What concrete steps have already been taken to implement innovations?
Since last November, reforms in China’s economy have already been set in motion. The government has been moving aggressively in liberalizing the financial sector and a major fiscal reform has been recently announced. But less progress has been made on the structural agenda, which holds the key to productivity increases. Piecemeal measures to encourage more private participation are being piloted, but more ambitious efforts have been held back. In other areas such as urbanization, a broad framework has been developed to improve the process, but implementation has been spotty.

Will President Xi Jinping’s team be able to overcome the many vested interests holding back change and realize the objectives laid out in the Third Plenum and thus fulfill his so-called “China Dream”? Therein lies the real question.

Text: Olga Irisova

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