Wednesday, Jul 26, 2017, 8:44 PM CST – China


China’s current reforms may not be adequate to sustain its growth target in the long run

A persistent economic slowdown, which may continue in 2016 and beyond, may threaten the long-term sustainability of ambitious overseas projects

Chinese President Xi Jinping’s ambition to extend China’s global influence is obvious. However, China’s aspiration to reshape the geopolitical order of Asia, mainly through infrastructure diplomacy such as the One Belt, One Road initiative, will require a fairly high rate of sustained economic growth. An important question is whether China will be able to keep its growth fast enough to finance continuous expenditure on construction projects that deliver a minimal short-term return.

From one angle, the answer to this question is a simple and unqualified “yes” – it will. To fund international projects, all China has to do is keep running huge current account surpluses. Instead of devoting these reserves to low-yield US treasury bonds, Beijing can easily funnel them into low-yielding infrastructure investments abroad that deliver a higher political return.

Over the longer run, though, it is probably necessary to keep the economy humming. Otherwise the demands of international expansion will increasingly conflict with domestic needs.

In early November the Communist Party released the sketchy outlines of its next Five-year Plan (2016-20), with an average annual growth target of 6.5 percent. But since the current official growth rate is barely above this figure, and all indicators suggest that growth will continue slowing through 2016 and quite possibly beyond that, the only thing that will enable China to stabilize GDP growth at anywhere near 6.5 percent is structural reform that improves the productivity of capital.

Currently, three strands of reform have now emerged in a clear-cut way: financial liberalization, industrial upgrading via the Made in China 2025 initiative, and a tuned-up State sector with increased emphasis on financial performance, but with little privatization.

The question is whether these add up to generators of the kind of growth the government says it wants. Of the three objectives, action on financial liberalization is easily the most advanced, to a degree underappreciated by most outside observers. Interest rates were fully deregulated in October. In August, the exchange rate mechanism was substantially liberalized. After intervention in the yuan exchange rate diminished after the IMF’s Special Drawing Rights basket of currencies was issued at the end of November, the Chinese yuan will likely start trading much more like the Singapore dollar, with the central bank intervening mainly to curb volatility.

What impact financial liberalization will have on the real economy is yet to be seen, but in theory at least it should improve returns on capital and hence boost the GDP growth rate. Similarly, the industrial policy initiative Made in China 2025 ought to help growth by redirecting the energies of Chinese industry into higher value-added products, with more components produced locally.

The biggest uncertainty relates to reform of State-owned enterprises (SOEs), which are a major drag on economic efficiency, using twice the leverage of non-State firms to deliver only half the financial returns. It is hard to see how the present deceleration of growth can be arrested without a major cleanup of this sector. Unfortunately, the SOE reform program that was released in September struck most analysts as unconvincing.

The key slogan for SOE reform for the last two years has been “mixed ownership,” and many believed that this would mean the gradual introduction of private shareholders into State companies, with full privatization of non-strategic firms. What is emerging now is something quite different: Local governments will transfer shares of their enterprises to consortia of commercially oriented SOEs.

A template was provided in September by the restructuring of Jiangxi Salt, previously 100 percent owned by the Jiangxi provincial government. The province transferred a 47 percent shareholding to a set of SOEs including China Asset Management, China Merchants Group, and investment companies controlled by the Xiamen and Beijing governments. Another 6 percent shareholding went to the firms’ managers.

The obvious objection to this sort of deal is that the swapping out of one set of State shareholders for another amounts to little more than re-arranging the deck chairs on the Titanic. It is hard to get too enthusiastic about “reforms” like this.

All in all, and despite the impressive progress of financial reforms, the Five-year Plan target growth rate merits skepticism. China’s economy is in no danger of collapse, but growth is almost certain to continue slowing for the next couple of years.ê

 The only thing that will enable China to stabilize GDP growth at anywhere near 6.5 percent is structural reform that improves the productivity of capital.

The author is the managing director of GaveKal Dragonomics, an independent global economic research firm, and editor of its journal, China Economic Quarterly


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