China’s New Reforms in Theory and Practice

HONG KONG – On November 12, the Third Plenary of the 18th Central Committee of the Chinese Communist Party (CCP) announced a major turn to market-oriented policies: interest-rate and currency liberalization, reform of banks and state enterprises, clearer land ownership for rural inhabitants, and a better deal for urban migrants.

Behind this landmark decision was a potential crisis. China’s success has been driven by cheap exports based on cheap labor, infrastructure built by state enterprises with low-cost bank funding, and government budgets funded by land sales. But labor is no longer cheap, road construction to connect major cities has given way to building large shopping malls in small towns, and land sales based on rezoning are reaching both economic limits and the limits of villagers’ tolerance.

Cheap money with limited investment outlets now risks fueling property bubbles and industrial overcapacity. Without fundamental change, China faces slower economic growth, inadequate job creation and innovation, and popping bubbles.

The solution is a rapid shift from China’s export-based growth model to one based on domestic demand; from infrastructure to consumption; from the dominance of large state-owned enterprises (SOEs) to that of small and medium-size private enterprises; from industry to services; and, more broadly, from bureaucratic control to market control.