Sudip Bandyopadhyay’s Blog

The economic reforms launched in China by Deng Xiaoping celebrate their 30th anniversary this year and there are plenty of reasons to think the country could enjoy  another 30 years of high growth.  Urbanisation has been one of the main driving forces and by some calculations the process is only half-complete.  Despite all the progress since 1978, China is still a much poorer country than most people realize – it is not even in the top 100 in the International Monetary Fund’s ranking of gross domestic product per capita.   That means plenty of room to keep playing catch-up.  So it is important not to panic at the news that the Chinese economy is cooling more rapidly than expected in the face of the global financial meltdown after five years of double-digit expansion.  This 9 per cent growth in the third quarter is still exceptional by historical standards, higher than Japan or South Korea’s growth during their boom years.  The last time the US grew that quickly was more than half a century ago.  But it also seems clear that the Chinese economy has reached a turning point.   The growth machine that has brought China this far needs to be retooled if it is to keep up its remarkable record.  China’s leaders are facing questions that go to the core of how the economy is managed.  China’s economy is sometimes described as being dependent on its export-machine.  It is certainly true that China cannot keep expanding exports at 20 per cent a year in the face of a prolonged global recession.  But the real story of the last five years has been the investment binge at home, most notably in heavy industry.

Aluminum, steel, cement and glass have all nearly doubled production in the past few years – which was also one of the root causes of the boom in commodity and energy prices.  Even industry insiders were sometimes surprised by the rate of expansion.  A couple of year ago, China’s steel industry association decided to investigate the output of the hundreds of small, new plants that had sprung up but which were not included in the official statistics: it discovered extra capacity equivalent to more than the entire US steel industry.  Space missions and skyscrapers are not the symbol of China’s recent boom; it is the steel mill.  But this turbo-charged investment has had negative side-effect that make it had to sustain.  Energy-use has become more inefficient, pollution is rising – causing political instability and these heavy  industries create fewer jobs than services.  That is where the global financial crisis comes in.  For the past five years, the government has recognized the need to shift the balance of the economy.  Officials  have admitted that China should place less emphasis on investment and low-cost exports and more on consumption, services and innovation.  Now that transition can no longer be delayed.

There already is a laundry list of policy proposals to boost consumption.  The top priority for many economists is healthcare reform.  Just how dilapidated the health system has become in many rural areas was brought home this week by new research published in The Lancet,  the medical journal.  In richer rural areas, infant mortality rates were 26 per 1000 live births, similar to the rate in Mexico: in poor rural areas the level was 123, the rate in the Democratic Republic of Congo. If people are more confident about avoiding medical bills, so the theory goes, they will save less and spend more of their incomes. Huge investment in healthcare even has a fashionably Keynesian ring to it.  Yet shifting the balance of the economy will demand more than well-executed policies.  It will oblige shifts in political culture and in the institutions that govern the economy. Civil law will be one of the main battlegrounds.  In the aftermath of the recent scandal over poisoned milk, officials have managed to prevent many of the parents of hopitalised babies from lodging lawsuits.  But legal action over issues such as product liability will become more important in the society where consumers are given grater priority.  And if Chian wants its companies to be more innovative, it will need to provide stronger guarantees that intellectual property will be respected.  China’s Communist party has outlined a new economic model, which requires less interference in the legal system by party leaders.

In much of the service sector, from finance to telecoms, the state still dominates.  Even creative industries are trapped in its shadow.  The hit film in China this summer was Kung Fu Panda and its success also prompted an anguished debate about why the US and not China had made a successful and hip comedy about one of China’s national symbols.  Critics blamed everything from an education system that stifles imagination to censorship.  During the Olympics, there was a lot of discussion about whether capitalism would bring democracy to China.  Yet there are lots of different types of capitalism. An economic strategy based on encouraging producers – cheap land, cheap energy, cheap credit – is well suited in lots of ways to an authoritarian political system.  But defending the interests of consumers will place new pressures of China’s party state.  In the US and parts of Europe, the financial crisis has led governments to play an activist role in the economy that would have been unthinkable even a few months ago.  It would be ironic if it also encouraged the Chinese state to loosen up.