Can China take on reform?

The much-awaited 18th National Congress of the Communist Party of China opened Thursday to herald a new leadership for China that will set the course for the world’s most populous country and second largest economy for the next decade. The congress anoints the leadership and hands it the challenge of guiding the country through a transitional period with sweeping socioeconomic reforms.

China’s economy has stopped its galloping pace of double-digit annual growth and is expected to slow to growth in the range of 7 percent this year. Depressed overseas demand due to economic and financial crises in Europe has delivered an immediate blow to the industrial powerhouse. But even without Europe’s problems, China’s own socio-economic problems are as colossal as the country’s size.

An interventionist state played the key role behind China’s 30-year miracle of development by pumping in massive financial incentives to stimulate industrial activities and exports and accelerated growth through a deliberate appropriation of capital. Easy and cheap lending, low wages, restraints on labor unions and a deliberate weakening of the local currency through market intervention were the main ingredients of the country’s economic success.

But they produced various side effects, many of them serious. Corruption has become rampant and wealth is seriously imbalanced, settling around lenders instead of borrowers, employers instead of employees and manufacturers instead of consumers. China’s income distribution is more imbalanced than emerging economies in Latin America. Workers go without welfare benefits and taxes are barely collected from companies or the nauseatingly super-rich. Real estate prices have shot to sky-high levels, generating millionaires and nouveau riche who don’t have to fret about heavy taxes on their fast fortunes. China may be a strictly-controlled socialist state in name, but in terms of economic policies for the wealthy, there’s nothing socialist about it at all.

China faces the urgent imperative to transform its growth model. The economy is seriously unbalanced because of a state-led quantitative expansion policy. The country is the world’s largest surplus saver because individuals need their personal savings in the face of poor public pensions and health care infrastructure and because companies are cash rich from low lending rates, wages and exchange rates. Savings take up more than 50 percent of the gross national disposable income, contributing to the country’s enormous current-account surplus.

China will have to shift its growth engine from exports to domestic consumption, but such a task requires a fundamental rationalization of the state’s role. The state must reduce its intervention in capital distribution and allow more freedom in the money markets to determine interest rates, wages and foreign exchange rates. The financial and manufacturing sector should be allowed to move through capitalist and commercial principles through a restructuring of ownership of state banks and enterprises. State-owned banks account for nearly 85 percent of loans in China, and state enterprises dominate key industries. The Chinese economy, in short, is led by the state-controlled segment. In other words, it is at the mercy of the Communist Party and government bureaucrats.

The practical Chinese have been incremental in economic reforms over the last three decades. But the fruits that naturally fell from the trees has already been gobbled up. For the economy to move forward, it inevitably has to reform its socialist system. No socialist society in the past has succeeded in overcoming the middle-income trap. China needs to share its prosperity with its average citizen by returning property rights to residents who hold stakes in local companies and by reforming the residential permit system that restricts migration to prosperous cities.

The state must reduce its stakes in public enterprises or privatize them. State enterprises can easily fall prey to the temptations of moral hazard because they have no danger of going bankrupt. Without restructuring the segment, further liberalization would only deepen inequalities in resources and worsen management. But privatization could also undermine the foundation of China’s socialist system.

It’s not easy to give up a model that has succeeded. South Korea and Japan both failed to do so. They were forced to reform when faced with crises. The dizzy pace of development over the last 30 years has bred sprawling groups of vested powers across China. The elite group in the Communist Party that led past reforms now enjoys enormous wealth and prestige from interests in state enterprises that have grown to a global scale. By cozying up to them, businessmen and executives of state enterprises also share their fortunes.

British Prime Minister James Callaghan, upon losing to his conservative opponent Margaret Thatcher, famously said, “There are times, perhaps once every 30 years, when there is a sea-change in politics.” The wave of neo-liberalism led by U.S. and British leaders Ronald Reagan and Thatcher that led the global economy for the last 30 years is said to have outlived its day. A new model is being called upon to change the current of the global economy.

The same goes for the model that has worked so well for China for 30 years. Unlike the tide in the Western Hemisphere, China is called on to move toward a smaller state and bigger market. But both hemispheres face strong resistance from vested interests. The question is whether the new Chinese leadership is ready to take on the challenge or real reform.

Translation by the Korea JoongAng Daily staff

* The author is an economics professor at Sogang University.

by Cho Yoon-jae