[A slowing economy commands headlines, but the
real story is reform]
The Economist
 |
| Economist.com |
WITH China, the received wisdom
belongs to the pessimists. Figures this week revealed that growth has slowed
sharply and deflation set in, as the economy is weighed down by a property
slump and factory production is at its weakest since the dark days of the
global financial crisis. In the first three months of 2015, GDP grew at “only”
7% year-on-year. Growth for 2015 will probably be the weakest in 25 years.
Fears are rising that, after
three soaring decades, China is about to crash. That would be a disaster. China
is the world’s second-largest economy and Asia’s pre-eminent rising power.
Fortunately, the pessimists are missing something. China is not only more
economically robust than they allow, it is also putting itself through a
quiet—and welcome—financial revolution.
The robustness rests on several pillars. Most of China’s debts
are domestic, and the government still has enough sway to stop debtors and
creditors getting into a panic. The country is shifting the balance away from
investment and towards consumption, which will put the economy on more stable
ground (see article).
Thanks to a boom in services, China generated over 13m new urban jobs last
year, a record that makes slower growth tolerable. Given China’s far bigger
economy, expected growth of 7% this year would boost the global economy by more
than 14% growth did in 2007.
However, the real reason to
doubt the pessimists is China’s reforms. After a decade of dithering, the
government is acting in three vital areas. First, in finance, it has started to
loosen control over interest rates and the flow of capital across China’s
borders. The cost of credit has long been artificially low, squashing the
returns available to savers while, at the same time, succouring inefficient
state-owned firms and pushing up investment. Caps on deposit rates are becoming
less relevant, thanks to an explosion of bank-account substitutes that now
attract nearly a third of household savings. Zhou Xiaochuan, the governor of
China’s central bank, has said there is a “high probability” of full
rate-liberalisation by the end of this year.
China is also becoming more
tolerant of cross-border cash flows. The yuan is, little by little, becoming
more flexible; multinational firms are able to move revenues abroad more easily
than before. The government’s determination to get the IMF to recognise the
yuan as a convertible currency before the end of 2015 should pave the way for
bolder moves.
The second area is fiscal.
Reforms in the early 1990s gave local governments greater responsibility for
spending, but few sources of revenue. China’s problem of too much investment
stems in big part from that blunder. Stuck with a flimsy tax base, cities have
relied on sales of land to fund their operations and have engaged in reckless
off-books borrowing.
The finance ministry now says
it will sort out this mess by 2020. The central government will transfer funds
to provinces, especially for social priorities, while local governments will
receive more tax revenues. A pilot programme has been launched to clear up
local-government debt. It lays the ground for a municipal-bond market—despite
the risks, that is better than today’s opaque funding for provinces and cities.
The third area of reform is
administrative. In early 2013, at the start of his term as prime minister, Li
Keqiang pledged that he would cut red tape and make life easier for private
companies. It is easy to be cynical, yet there has been a boom in the
registration of private firms: 3.6m were created last year, almost double
2012’s total.
The high road of lower growth
In time, these reforms will lead
to capital being allocated more efficiently. Lenders will price risks more
accurately, with the most deserving firms finding funds and savers earning
decent returns. If so, Chinese growth will slow—how could it not?—but gradually
and without breaking the system.
Yet dangers remain.
Liberalisation risks breeding instability. When countries from Thailand to
South Korea dismantled capital controls in the 1990s, their asset prices and
external debts surged, ultimately leading to banking crises. China has stronger
defences but nonetheless its foreign borrowing is rising and its stockmarket is
up by three-quarters in six months.
And then comes politics.
Economic reforms have high-level backing. Yet the anti-corruption campaign of
President Xi Jinping means that officials live in fear of a knock on the door
by investigators. Many officials dare not engage in bold local experiments for
fear of offending someone powerful.
That matters because reform ultimately requires an end to the
dire system of hukou, or household registration,
which relegates some 300m people who have migrated to cities from the
countryside to second-class status and hampers their ability to become
empowered consumers. Likewise, farmers and ex-farmers need the right to sell
their houses and land, or they will not be able to share in China’s
transformation.
Ever fond of vivid similes, Mr
Li says economic reforms will involve the pain a soldier feels when cutting off
his own poisoned arm in order to carry on fighting. “Real sacrifice”, he says,
is needed. China’s quiet revolution goes some of the way. But Mr Li is right:
much pain lies ahead.
