William H. Hess
11/01/2007
Almost 30 years since the advent of market-based economic reforms, China’s economic ascent is an imperfect miracle. The dynamism of the Chinese economy continues to outpace the capacity of China’s regulatory regime, and the mood in Beijing is far from triumphal. Recent economic news provides deeper signals that the Chinese economy has outgrown the central authority’s ability to control it. Some have suggested that the success of the Chinese model of development is tantamount to the "end of economic history," but such a notion looks increasingly implausible as systemic risks continue to gather quarter after quarter.
Jarring headlines bring into question the capacity of the central government to rein in the national economy: a 13-year high for GDP growth for the second quarter; scrapping efforts to track green GDP that would measure environmental impacts; a tarnished "made in China" branding over food and product safety scares; rising inflation; and warnings over asset price bubbles.
The Chinese government has made significant reforms where the external sector of the national economy is concerned, but this progress has come at the cost of delayed domestic reforms, including the creation of a meaningful social safety net and a range of other economic policies. Legislators in China have been far from idle, but where actual governance is concerned—meaning the enforcement of the laws that it creates—the performance of the country’s authorities has been mediocre at best.
At the provincial level, continuing emphasis on growth as an end in itself, with little regard for the cost of the means employed, has meant that rules—whether environmental, from the State Council or another organ of government—are flexible, helping to drive the symptoms of economic overzealousness. Moreover, the depth of Chinese civil society (measured by the ability of social institutions to absorb disturbances) remains dangerously shallow, as indicated by the unfolding of recent disturbances, at the same time that the fissures created by decades of rapid social change continue to widen. Overall, rapid economic growth over a span of decades has obviated the need for many in government and industry to make a fallback plan.
The depth of Chinese civil society remains dangerously shallow. |
The story behind recent economic news also indicates that regulators in China now find themselves in a policy trap, created by an exchange-rate regime that puts policy measures to achieve internal and external balance at cross purposes. In reality, in order to achieve policy targets for unemployment, the Chinese economy must remain addicted to investment and exports. This helps drive China’s external surpluses and the high levels of domestic liquidity that push prices for equities and real estate skyward. Meaningful efforts to reform the currency regime might help lessen this pressure, but immediate domestic political needs serve to increase the systemic risks that accompany inefficient investment practices. It is inherently difficult to restrain the pace of exchange-rate appreciation without taking steps that will ultimately fuel the rapid expansion of domestic credit.
Not even the most optimistic observers believe that the cur-rent growth party can last forever, and expect that macroeconomic shocks—even recessions—will eventually punctuate China’s business cycle. If this were to occur, China, like its neighbors in the past, would face perhaps the biggest challenge from the underdeveloped state of its regulatory infrastructure. Policy options at the central government level that would leave the macroeconomy healthier in recovery appear to be few. The more effective government response would come at the regional level, as provincial governments are better-positioned to serve as stabilizers of last resort.
Though China’s growth miracle is in many ways unique, the same self-serving factions that were present before similar emerging market train wrecks are firmly in play with its economy as well. This is not to imply that the country is on the verge of a major economic event, but rather that when the Chinese experience converges with the rest of the world, it will occur within the context of an untested system. Greater emphasis on real governance at the provincial level would help insulate the Chinese economy from future instability, but kingdoms have always encountered difficulties in telling fiefdoms what to do.
William H. Hess, based in Beijing, is Global Insight’s senior China analyst.