The Sino-American Mirror

HONG KONG – November was a month of major leadership changes around the world, including Xi Jinping’s confirmation as China’s top official and US President Barack Obama’s re-election. The changes highlighted the sharp differences between the two countries’ political systems. Yet the two countries share similar national development goals:increasing their citizens’ prosperity, narrowing social inequities, and addressing environmental sustainability.

The fact is that rapid social, technological, and environmental change is challenging both the Western and Chinese models of governance and development, with both requiring significant reform. And both countries’ leaders must deliver reforms within a limited tenure, with limited resources, and within a global context of trade rivalry and interdependence.

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In the United States, where markets, the judiciary, and regulation are highly developed, the imperative is not institutional reform, but policy reform – addressing the weak fiscal position, income and wealth inequities, unemployment, health care, and deteriorating physical infrastructure.

For China, the issue largely concerns the design and implementation of the next stage of institutional reforms to sustain economic growth and efficiency, reduce social inequality, remove market distortions, address environmental deterioration, and combat corruption. As China becomes a more urban and elderly middle-income society, the challenge for the new leadership is not only to meet the population’s need for employment, health care, and social security, but also to improve governance and state effectiveness by establishing checks and balances on political power.

Both countries face formidable resistance to reform from formidable vested interests and lobby groups. Both also face major price distortions, owing to quantitative easing by monetary policymakers, which has led to negative real interest rates.

To some extent, the two countries’ problems are mirror images of each other. The US lacks investment in infrastructure and has excess investment in financial derivatives – the result of opaque leverage from over-consumption. China suffers from under-consumption and possible over-investment, and needs to strike a balance between the state-owned sector and private enterprise.

American democracy’s emphasis on short time horizons is costly, with tax cuts and increased welfare benefits giving rise to chronic fiscal deficits, with future generations forced to foot the bill for years of excessive consumption. In China, the one-party system has been effective in delivering strong growth, but it must now address the rampant corruption and excessive bureaucracy that has crowded out the private sector and limited creativity and innovation.

China and the US can draw important lessons from the strengths and weaknesses inherent in both systems. First, in both countries, the challenge is not one of state versus market, but about finding complementarities between the two. The state performs best when it delineates, protects, and adjudicates property rights, while the market works best when it allocates property rights and aligns people’s incentives.

Second, both countries must find the right metric to balance short-term and long-term interests. Given inter-generational demands, large spillover effects between different communities, and interdependence with the rest of the world, any governance system must weigh the interests of ruling elites and lobbyists against those of weaker groups without voice, and popular demands against long-term planning.

Finally, the issue for both countries is not corruption or inequality – which are universal – but equal opportunity and, in China’s case, respect for property rights. Opaque and unfair delineation and allocation of land rights in China, together with state monopolies and burdensome bureaucracies, create distortions that give rise to corruption and inequities. China’s main priority should be to strengthen its legal institutions to protect property rights, while reducing state ownership and control of resources and large enterprises.

So far, Xi’s down-to-earth approach has raised hopes that China will enter a new phase of reform that will address economic imbalances, increase social inclusion, and tackle endemic corruption. In the US, Obama’s re-election has led some to believe that much-needed policy reforms will bring the country back from the brink of the “fiscal cliff” and ignite a new era of growth.

Yet the two leaders and their administrations must overcome monumental challenges as their countries strive to reach the next stage of their development. How they use monetary, fiscal, structural, institutional, and regulatory policies may differ, but each will ultimately be judged by how close he comes to achieving that goal.