CLM Insights Interview with Tao Wang
Tao Wang. Making Sense of the Chinese Economy. London: Routledge, March 2023.
306 pp. ISBN-10-1032317043; ISBN-13-978-1032317045
There have been many misperceptions about the Chinese economy and its development during the last four decades. What are the three most prevailing misperceptions your book seeks to correct?
I did not set out to correct misconceptions per se, but the book does seek to offer a holistic and multi-dimensional view of China’s economy. I find people often describing China's economic success in a simplistic narrative, attributing it to things like the demographic dividend or WTO entry. These are, of course, part of China's success story, but they may not be the most important factors. The book demonstrates that it was due to the market-oriented reforms and opening-up that China was able to break out from the inefficient central-planning system that then spurred the economy on a high growth path. Along the way, adaptive and pragmatic policy adjustments helped to sustain economic development.
Second, China’s government is often seen as one monolithic apparatus run from the top, with policies changing at the whim of the top leadership. In reality, the various government agencies often have competing priorities and different constituencies, and local governments have a huge influence in shaping and implementing economic policies. Policies also tend to respond to issues emerging in the economy or in society, influenced by the various stakeholders.
Third, many think that the current multitude of headwinds, including population aging and restricted access to technology, will stop China from growing in the future. True, these are enormous challenges that will negatively impact growth. However, while the working-age population will continue to decline, China still has labor to transfer out of the rural sector and it can extend the retirement age, which averages at only 54 years. The technology restrictions will make innovation at the cutting edge extremely difficult. But China can still move up the value chain by applying automation and mature technology more broadly. Arguably, a bigger challenge may be pushing through the necessary structural reforms, including the reform. I expect China will more than 4 percent per year during this decade and it will remain the biggest contributor to global growth.
The Chinese system appears to promote economic development, but it can also hinder progress in some areas. Can you explain what are the strengths and the flaws of the Chinese system in promoting development? When during the last four decades did the Chinese state get the balance relatively right, and how?
One important strength of the Chinese system is its ability to mobilize national savings and resources toward economic development, building infrastructure and industrial capacity from a very underdeveloped position. Once the government decided that economic development is the top objective, local governments were empowered to invest and attract investment, individuals and companies were incentivized to pursue economic goals, and the financial system was set up to channel savings into investments. Another strength of the Chinese system is that it seeks to ensure a stable macroeconomic environment and a decent business climate, especially compared to those in many other developing countries.
A flaw is that it can also hinder developments in other areas and create imbalances. The overriding focus on economic growth in the 1980s and 1990s meant that environmental and labor standards were sacrificed, and social protections were lacking. This is why Premier Wen Jiabao said in 2007 that China’s growth was unbalanced and unsustainable. More recently, when the focus was shifted to controlling risks, policies swung in another direction and growth appeared to be sacrificed. Another flaw of the system is that the government, especially local governments, tend to become too involved in the economy. This hinders the development of markets and private businesses and it leads to repetitive and wasteful investments.
It is difficult to say when the Chinese state got the balance closer to right because what is the right balance also shifts with time. In the 1990s, economic growth was most important for the population, and China embarked on market-oriented reforms that led to rapid economic growth. But that period also produced a lot of wasteful investment and bad debt, which then led to a painful clean-up in the late 1990s. In recent years, the Chinese have increasingly aspired to more than simple growth, demanding a better environment and better public services. Both this and having to deal with the legacy problems of the rapid-growth era then require different policy balances.
In general, China should let the market play a bigger role in allocating resources and allow the state to play an adequate role in setting the rules and providing public services. Getting the balance right is difficult.
“State-capitalism” has become a label that many use to describe the Chinese economy. Is this an accurate characterization? Where is the state most influential and where has its role diminished significantly? Can you provide an illustrative example?
I am not sure “state-capitalism” is a good label to describe the Chinese economy or a key source of China’s economic success. Compared to other countries, the state in China is definitely more present in the economy, even though its role has diminished since the 1980s and 1990s. The state owned everything and controlled every aspect of the people’s lives in the late 1970s. It was precisely the reduction of the role of the state in the economy and the encouragement of market forces, competition, and private enterprises that led to China’s rapid development in subsequent decades.
Currently, state-owned enterprises (SOEs) make up a relatively large share of output in key sectors, such as mining, energy, transport, telecommunications, health care, education, and banking. This picture corresponds with the state’s large role in allocating resources – since the state-owned banks dominate the financial system, they often are asked to carry out “national services,” for example, to provide funding to sectors favored by the government. As private and foreign companies grew faster, State ownership in the industrial sector diminished the most, although the SOE share has not moved much since the mid-2000s. During the past decade, the SOEs accounted for only a little over 30 percent of assets and 12–15 percent of employment in the industrial sector, down from 90+ percent in the early 1980s. The state’s role in commerce and consumer services has also diminished sharply, accounting for about 8 percent in assets and 2 percent in employment in wholesale and retail trade and the lodging and catering sectors, respectively.
However, the state also withdrew from the provision of some public services during the first twenty-plus years of the reform era. The government tried to reduce its fiscal burden and operate more commercially, with lifetime employment and entitlement being eliminated in the late 1990s. During the past fifteen years or so, the role of the state in public services and regulations has risen again. Nevertheless, social spending accounts for only about 17 percent of the government budget, far less than the one-third in the EU and the 28 percent in the OECD countries.
The Chinese economy has become vastly bigger and more complex than it was three decades ago when most of the mechanisms of economic policy making were constructed. How has China’s economic policy making evolved to catch up with the growing complexity of the economy? Where is economic policy making still most in need of an upgrading?
As China’s economy moved from a centrally planned to a more market-oriented system, planning and direct control became much less prevalent in economic policy making. Prices are now mostly set by the market rather than by the government. Most investment decisions are made fully by commercial enterprises; even though large projects still require investment approvals, the process has been simplified and become much easier.
Distinct monetary policy making did not really exist in the 1980s and 1990s as monetary policy largely consisted of formulating and implementing lending quotas according to the government plan. Since then, with the development of financial markets and commercial banks, China’s monetary policy has focused on a combination of quantitative and interest-rate instruments as well as macro prudential rules. Over the years, China has also set up and improved a tax and budgetary system to help with fiscal policy management.
To keep up with the increasingly complex and evolving economy, the fiscal policy framework needs to be updated. First, while the official government budget is subject to open discussion and accountability, a lot of other fiscal activities, financed by land sales or debt at the local levels or carried out by public institutions, are much less so. Also, given China’s aging population and pending increase in social spending, a medium-term fiscal framework is critical to ensure adequate public services and a sustainable fiscal position.
The monetary policy framework needs to be simplified and the use of discretionary structural tools and micro-management by the People’s Bank of China (PBoC) should be reduced. In addition, policy makers need to develop clear and effective channels to communicate with the markets, especially the financial markets, to avoid misunderstandings and significant unintended consequences. China also needs better coordination between the fiscal and monetary authorities as well as between the central government policy makers and the local governments.
The world in which the Chinese economy experienced phenomenal growth no longer exists. What does China need to do to sustain a moderate level of growth in the coming decade? Are there signs that the current leadership is ready to implement such policies?
Indeed, both the external environment and China’s own economic fundamentals have changed. China’s population is aging rapidly. While still greatly lagging the rich economies, China is now a much more developed economy than it was earlier. This means a lot of the low-hanging fruit in terms of investment and productivity growth as well as reforms has already been picked. Externally, China is now facing a lot of protectionism and decoupling pressures, even as the economy is being led by domestic demand.
To sustain a moderate level of growth, China must push through some tough domestic reforms, encourage innovation, support the private sector, and remain open.
Key reforms include the hukou reform and an extension of the retirement age. The government has pushed for a gradual relaxation of the hukou system, is working on providing more equal public services, and has announced plans to gradually extend the retirement age. SOE reform and letting the market play a more important role in allocating resources are also important reforms to improve economic efficiency, but progress has been very slow and no major new initiative is yet visible.
The health of the private sector is critical to sustain growth. Although the government has pledged “unwavering support,” private-sector confidence remains low due to tougher regulations and emphasis on party control in recent years. Businesses are now looking for concrete measures to level the playing field.
Despite the government’s push for innovation, China’s domestic innovations will face constraints due to restricted access to advanced foreign technology. Nevertheless, China’s relatively low productivity level, rapid increase in R&D spending, and application of mature technologies including automation should support China’s continued move up the technology ladder and value chains.
China continues to embrace globalization and it promises a further opening to foreign trade and investment. However, this may be tested if the external environment sours further. It may also be challenging to remain open to different ideas and competition.
Disclaimer: The views expressed here are the author’s and do not necessarily represent the views of UBS investment bank.