Thursday, September 18, 2014
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Reforming China’s State-Market Balance

BEIJING – No country in recorded history has grown as fast – and moved as many people out of poverty – as China over the last thirty years. A hallmark of China’s success has been its leaders’ willingness to revise the country’s economic model when and as needed, despite opposition from powerful vested interests. And now, as China implements another series of fundamental reforms, such interests are already lining up to resist. Can the reformers triumph again?

In answering that question, the crucial point to bear in mind is that, as in the past, the current round of reforms will restructure not only the economy, but also the vested interests that will shape future reforms (and even determine whether they are possible). And today, while high-profile initiatives – for example, the government’s widening anti-corruption campaign – receive much attention, the deeper issue that China faces concerns the appropriate roles of the state and the market.

When China began its reforms more than three decades ago, the direction was clear: the market needed to play a far greater role in resource allocation. And so it has, with the private sector far more important now than it was. Moreover, there is a broad consensus that the market needs to play what officials call a “decisive role” in many sectors where state-owned enterprises (SOEs) dominate. But what should its role be in other sectors, and in the economy more generally?

Many of China’s problems today stem from too much market and too little government. Or, to put it another way, while the government is clearly doing some things that it should not, it is also not doing some things that it should.

Worsening environmental pollution, for example, threatens living standards, while inequality of income and wealth now rivals that of the United States and corruption pervades public institutions and the private sector alike. All of this undermines trust within society and in government – a trend that is particularly obvious with respect to, say, food safety.

Such problems could worsen as China restructures its economy away from export-led growth toward services and household consumption. Clearly, there is room for growth in private consumption; but embracing America’s profligate materialist life-style would be a disaster for China – and the planet. Air quality in China is already putting peoples’ lives at risk; global warming from even higher Chinese carbon emissions would threaten the entire world.

There is a better strategy. For starters, Chinese living standards could and would increase if more resources were allocated to redress large deficiencies in health care and education. Here, government should play a leading role, and does so in most market economies, for good reason.

America’s privately-based health-care system is expensive, inefficient, and achieves far worse outcomes than those in European countries, which spend far less. A more market-based system is not the direction in which China should be going. In recent years, the government has made important strides in providing basic health care, especially in rural areas, and some have likened China’s approach to that of the United Kingdom, where private provision is layered atop a public base. Whether that model is better than, say, French-style government-dominated provision may be debated. But if one adopts the UK model, the level of the base makes all the difference; given the relatively small role of private health-care provision in the UK, the country has what is essentially a public system.

Likewise, though China has already made progress in moving away from manufacturing toward a service-based economy (the GDP share of services exceeded that of manufacturing for the first time in 2013), there is still a long way to go. Already, many industries are suffering from overcapacity, and efficient and smooth restructuring will not be easy without government help.

China is restructuring in another way: rapid urbanization. Ensuring that cities are livable and environmentally sustainable will require strong government action to provide sufficient public transport, public schools, public hospitals, parks, and effective zoning, among other public goods.

One major lesson that should have been learned from the post-2008 global economic crisis is that markets are not self-regulating. They are prone to asset and credit bubbles, which inevitably collapse – often when cross-border capital flows abruptly reverse direction – imposing massive social costs.

America’s infatuation with deregulation was the cause of the crisis. The issue is not just the pacing and sequencing of liberalization, as some suggest; the end result also matters. Liberalization of deposit rates led to America’s savings and loan crisis in the 1980’s. Liberalization of lending rates encouraged predatory behavior that exploited poor consumers. Bank deregulation led not to more growth, but simply to more risk.

China, one hopes, will not take the route that America followed, with such disastrous consequences. The challenge for its leaders is to devise effective regulatory regimes that are appropriate for its stage of development.

That will require the government to raise more money. Local governments’ current reliance on land sales is a source of many of the economy’s distortions – and much of the corruption. Instead, the authorities should boost revenue by imposing environmental taxes (including a carbon tax), a more comprehensive progressive income tax (including capital gains), and a property tax. Moreover, the state should appropriate, through dividends, a larger share of SOEs’ value (some of which might be at the expense of these firms’ managers.)

The question is whether China can maintain rapid growth (though somewhat slower than its recent breakneck pace), even as it reins in credit expansion (which could cause an abrupt reversal in asset prices), confronts weak global demand, restructures its economy, and fights corruption. In other countries, such daunting challenges have led to paralysis, not progress.

The economics of success is clear: higher spending on urbanization, health care, and education, funded by increases in taxes, could simultaneously sustain growth, improve the environment, and reduce inequality. If China’s politics can manage the implementation of this agenda, China and the entire world will be better off.

Read more from "China's Challenges"

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  1. CommentedFrank O'Callaghan

    China faces many issues. The wave of productive energy released by the export-driven and market reforms over the last three decades has created a class of wealthy beneficiaries as well as moving many from poverty. The class of excessive wealth is now a threat to the stability that China prizes so highly. Urban unemployment of the young and ambitious haunts the regime. Increasing affluence of a minority will not suffice to quell the demands of a new generation who do not participate in the bounty. Glaring inequality breeds discontent. Control of media and community organisations can only delay the reckoning. China must also deal with it's demographic shock. The one-child policy is leading it to the gerontification that has overwhelmed Japan. It has taken three decades for China to grow powerful and now it is in a race against itself to grow rich before it grows old. As it moves towards a stable population, that population will be increasingly aged. There will be an increasing need for a stable and efficient State to manage this. Social stability has been based on a strong central authority, family cohesion, limited aspirations and a tradition of deference. These factors may not be counted upon in a gobalised China where change is the new constant.

  2. CommentedDavid Donovan

    Perhaps free speech and democracy could be an aid to reducing pollution and corruption in China? When people can feel free to stand up to, speak out again, and vote against these things without pervasive fear, no doubt they will go away.

  3. Commentedsrinivasan gopalan

    With due deferene to the illustrious commentator and renowned economist, let me contend that Prof.Stiglitz's contention that the challenge for Chinese leaders is to devise effective regulatory regimes that are appropriate for its stage of development is easier said than done. Even countries as big as the United States had failed in regulatory agencies' remit when the financial meltdown supervened in 2008, it would not be fair to expect other governments with different models of development to put in place any efficacious regulatory machinery to check market aberrations. In fact, the Chinese biggest structural deficiency remains lack of political freedom and choice to its billion-plus citizenry with the State refusing to 'wither away to ensure the ascendancy of the people (proliterait!). As long as the ruling dispensation is content with experimenting esoteric models of development mixing market forces with control regimes, the resulting skewed pattern of development is inevitable. Again, mere regulation is no salvation to the fundamental maladies plaguing the system and unless governance itself is garnished in a democratic fashion involving the willing participation of all and sundry, the future and fortune of the Middle Kingdom would remain at best unexplored bonanza to both China and the rest of the world!.
    G.Srinivasan, Journalist, New Delhi

  4. CommentedMr Econotarian

    Perhaps free speech and democracy could be an aid to reducing pollution and corruption in China? When people can feel free to stand up to, speak out again, and vote against these things without pervasive fear, no doubt they will go away.

    Also hopefully China will not reproduce the US example of linking health care to employment, as the US did during WWII through making employer-paid health care benefits tax free.

  5. CommentedRonald Abate

    re: embracing America's profligate materialist life-style would be a disaster" that assumes the world remains as it is, which is never the case. Chinese demand will create price signals that will generate major changes in consumption and lifestyle patterns without the need for government and it's cadre of intellectual elites telling people how they should live and consume.

    As for climate change or, if you prefer, global warming, if the truth be told, there is no "real" consensus that it will be catastrophic, which is all that we need be really concerned about. In fact, a slightly warmer world, which would mostly mean warmer nights and warmer temperature in the Northern Hemisphere, may, on balance, be beneficial. What we do know about the climate is that it is far more complex than the warmists want to admit. We do not have thermometers that provide the amount of warming cause by the burning of fossil fuels and what is natural variation. Dr. Richard Lindzen of MIT (now retired) has testified on numerous occasions that the warming during the 20th century was within the bounds of natural variability. Dr. Judith Curry, head of the climate sciences department at Georgia Tech University, has, since the ClimateGate e-mails were made public, become a skeptic that is awed by the complexity of the climate system. Russ Roberts, moderator at econtalk.org recently interviewed Dr. Curry and you follow her posts at judithcurry.com. Russ Robert also moderated a first: a debate between an alarmist (warmist) and a skeptic which was held at the University of Alabama. That debate can be accessed at econtalk.org It was not a slam dunk for the alarmist.

    Finally, anyone concerned about climate catastrophe should read Rubert Darwall's book "The Age of Global Warming, A History" to appreciate how unbelievably common warnings of apocalypse has been down through human history. Dr. Matt Ridley also has a chapter (9) in his book "The Rational Optimist", on how humans believe far more readily predictions of catastrophe than optimistic predictions, which is why there have been so many in the past that have never materialized. It seems to be part of our genetic makeup.

  6. CommentedEli Levine

    Unfortunately, the CCP quashed the Populists under Bo Xilai and put into power a conservative who only seems concerned with tightening things under him while neglecting to effectively tend to the problems within his society and geographical territory. Lots of sword rattling against Japan, the Philippines, and Vietnam; lots of putting down dissidents and Tibetan/Uigher nationalists. There are some high profile corruption cases being put out. However, nothing systemic or far reaching or sustainable seems to be being done for the sake of the people of China. One would wonder what would indeed happen to the reigns of the CCP if they let market liberalization allocate resources out of the hands of the CCP members, such that new factions take ownership. China is not a country that has historically done well when a multitude of factions are competing for the centralized control of the government. One can only shudder at the implications for the rest of the world's economy and geo-political/social-political orders as a result of that kind of collapse.

  7. CommentedJason Gower

    Perhaps ideal but the assumptions are huge; so huge in fact that they are probably unrealistic. Economic policy has shown that China is just as obsessed with the headline GDP number as anybody else. We all just assume that China is going to make this shift from export to consumption driven growth but what basis do we really have to assess the future behavior of the Chinese consumer, savings, etc? How much do we really even know about the true debt (and any other for that matter) statistics that we get out of China? Like all emerging economies, China faces challenges; the political element given the size of China's population could make the coming decades all the more interesting.

  8. CommentedCanyon Bosler

    Isn't it pretty shallow to pin the savings and loan crisis on lifting Regulation Q without looking at how the incentives created by Regulation Q incentivized bad behavior and severe maturity mismatches? Yes, lifting Regulation Q hastened the demise of zombie S&Ls, but part of the reason they became zombies in the first place was their guaranteed access to cheap deposits which allowed them to engage in high-risk, high-return behavior. If interest rates had been flexible during the stagflation period, S&L lending behavior would have been much different (possibly good, possibly bad). Regardless, the damage done by liberalization of interest rates was not simply because flexible interest rates are bad (maybe) -- it was more about the shift from illiberal to liberal rates, combined with the maturity mismatch that kept the rates on their 15-30 year fixed-rate mortgages low while their short-term deposit rates spiked.

  9. CommentedJohn Shin

    Professor Stiglitz's prescription for China, though valid, will not see its day under the sun; replacing land sales with higher tax collection is anathema to vested interests; instituting environmental taxes equally revolting (to status quo); raising taxes and installing property taxes dangerous to the regime's stability. Perhaps the greatest resistance is going to occur if and when SOEs are privatized; the managers of these firms are probably plotting to take privatization as opportunities to take what they can. Chinese society today is one without an astute moral persuasion; and as such, they are doomed to greater instability in the coming future.

  10. CommentedMarc Laventurier

    Thanks to Prof. Stiglitz for countering Prof. Feldsteins' recent article in these pages entitled 'A Healthy Path to Chinese Consumption Growth', a doctrinaire right wing formula for disaster. Disastrous and moronic.

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