China’s “TwoSessions” – the annual gatherings of the National People’s Congress and the Chinese People’s PoliticalConsultative Conference held every March – have always drawn globalattention. But the meetings this year seemed particularly significant, owingnot only to the country’s leadership transition, but also to its economicslowdown amid calls for deeper reform. How, then, will China’s new leadersrespond?
The problem is simple: No one canpredict accurately how long the slowdown will last. The authorities, lackingconfidence in their ability to restore pre-2009 rates of annual GDP growth,have lowered the official target to 7.5%.
Many economists arebecoming even more pessimistic, pointing to Japan as evidence that, after threedecades, China’s breakneckgrowth may be coming to an end. Japan’s economy, they point out, achieved morethan 20 years of sustained rapid growth; but, in the 40 years since 1973,annual growth has exceeded 5% only a handful of times, and output has stagnatedfor the last two decades.
But today’spessimists need to account for some fundamental differences between the twoeconomies. For example, Japan was already a high-income country in 1973, with per capita income(in terms of purchasing power parity) at roughly 60% of the United States’level. The “Four Asian Tigers” (Hong Kong, Singapore, South Korea, and Taiwan)experienced a slowdown in GDP growth at a similar relative income level. Bycontrast, China’s percapita income is only about 20% of the US level. In other words, weshould not underestimate the Chinese economy’s potential to converge towarddeveloped countries.
The pessimists,however, doubt that China can maintain catch-up economic growth. They arguethat the current growth model, if not the economic system more broadly, isdriving the country into a “middle-income trap.”
Attributing problemsto systemic causes is a typical habit of thought in China. But can a systemthat has sustained 30 years of hyper-growth really be worse than those systemsadopted in Japan and the Four Tigers?
China’s economicsystem, which developed from the institutions of central planning, must havehad some merits during this period. But the development and ultimate structureof economic institutions are closely related to a country’s income level orstage of economic development. If some aspects of the current system cannot beadapted to support further economic development, they could end up hinderingit. What really matters for economic growth is not whether a system is the“best,” but whether it can be adjusted to serve a new phase of economicdevelopment. From this perspective, it is vital to ensure that an economicsystem is open to institutional reform.
No economic system,however “optimal,” can sustain long-term growth once it is no longerreformable. After its extraordinary post-1945 economic miracle, Japan fell intoa pattern of ultra-slow growth because it lacked the flexibility to adapt itsinstitutions for a new phase of economic development, characterized byheightened global competition. By contrast, South Korea has maintained itsgrowth momentum since the Asian financial crisis of the late 1990’s. Westerneconomists often criticize its economic system, but the key point is that itsinstitutions are flexible and open to change, which implies a high degree ofeconomic resilience.
Why is one system amenable to reform, whileanother is not? In recent years, research has indicated that vested interestsand powerful lobbies distort economic policies and cause governments to missgood opportunities. A system receptive to reform requires the government tohave greater power or wealth than any interest group, thus enabling it topursue long-term policy goals and ensure the success of reform.
For example, Yao Yang ofPeking University has argued that the Chinese government is able to decide theright policies at critical points, because it is not unduly swayed by any interest group. It isthis neutrality, he says, that explains the success of China’s economictransition and its three decades of rapid economic growth.
But what about now?China is entering a new phase of development, and institutional reform in keyareas – particularly the public sector, income distribution, land ownership,the household registration system, and the financial sector – has becomeimperative.
Obviously, reform ismore difficult today than it was when China began its economic transition.State-owned enterprises, for example, currently account for 40% of totalcorporate assets, but only 2% of all firms, which implies significant policyinfluence. But China seems unlikely to go the way of, say, Russia. On thecontrary, the accumulation of wealth in the Chinese government’s hands shouldenhance its ability to press ahead with reform.
Institutional flexibilityhas been the key to China’s economic transition and rapid growth over the lastthree decades, and it is vitally important that the Chinese government remainsneutral and avoids being captured by interest groups. In short, the authoritiesmust ensure that the system remains open to change in the long run. Successfulimplementation of another round of far-reaching reform depends on it.