The Dual Dragon

With China again facing the specter of an economic hard landing, the country's leaders must devise a reform strategy that improves credit allocation, without creating new systemic risks. They should begin by eliminating the two-tier credit system, which is generating serious risks.

HONG KONG – China’s economy is again facing the specter of a hard landing. Property bubbles, mounting local-government debt, and wayward shadow-banking activities are generating considerable financial risk, complicating the government’s efforts to address rising labor costs, excessive credit, overwhelming pollution, rampant corruption, an undeveloped tax system, and rising international competition. And additional risks seem to lurk at almost every turn.

Any strategy for mitigating the threat of a sharp slowdown must account for the dual nature of China’s economy. On the one hand, Chinese cities are becoming increasingly modern and globally engaged. Indeed, China’s 17 most dynamic cities – which together account for 11% of the population and about 30% of GDP – have already reached high-income status, as defined by the World Bank, and the country is set to overtake the United States as the world’s top e-commerce market.

On the other hand, half of China’s population remains rural, deriving a large share of income from agricultural activities. According to MasterCard, 25% of consumer payments are still made in cash, implying that China’s informal economy remains much more robust than believed.

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