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China’s Bumpy New Normal

SHANGHAI – China’s shift from export-driven growth to a model based on domestic services and household consumption has been much bumpier than some anticipated, with stock-market gyrations and exchange-rate volatility inciting fears about the country’s economic stability. Yet by historical standards, China’s economy is still performing well – at near 7% annual GDP growth, some might say very well – but success on the scale that China has seen over the past three decades breeds high expectations.

There is a basic lesson: “Markets with Chinese characteristics” are as volatile and hard to control as markets with American characteristics. Markets invariably take on a life of their own; they cannot be easily ordered around. To the extent that markets can be controlled, it is through setting the rules of the game in a transparent way.

All markets need rules and regulations. Good rules can help stabilize markets. Badly designed rules, no matter how well intentioned, can have the opposite effect.

For example, since the 1987 stock-market crash in the United States, the importance of having circuit breakers has been recognized; but if improperly designed, such reforms can increase volatility. If there are two levels of circuit breaker – a short-term and a long-term suspension of trading – and they are set too close to each other, once the first is triggered, market participants, realizing the second is likely to kick in as well, could stampede out of the market.