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China’s Real Reform Challenge

LONDON – It is often assumed that emerging-economy living standards are bound to converge with those in developed countries. But, leaving aside some oil exporters and the city-states of Hong Kong and Singapore, only three countries – Japan, South Korea, and Taiwan – have come from far behind to achieve per capita GDP of at least 70% of the developed-country average over the last 60 years. China hopes to do the same, but it faces a distinctive challenge: its sheer size.

Japan, South Korea, and Taiwan depended on export-led growth to catch up with the developed economies. But China – home to almost 20% of the world population and responsible for 15% of global output – is simply too large to depend solely on external markets. To reach the next stage of development, it will need to forge a different growth path – and that will require more difficult reforms than those on which attention is often focused.

To be sure, export-led growth has fueled China’s economic rise so far, with its current-account surplus growing to 10% of GDP in 2008. But such high surpluses are ultimately impossible to sustain. There simply is not enough import demand in the world to absorb ever-growing Chinese exports.

The global financial crisis exposed that reality. Before 2008, China’s massive surpluses were matched by unsustainable credit-fueled deficits in developed economies. When boom turned to bust, falling global demand hit China’s export sector, and threatened to increase unemployment.