The Biggest 'If'
The core of the decision from the third plenary session of the Communist Party's 18th Central Committee was that the government would not interfere in anything that the market can decide by itself. Important moves including opening the factor market and breaking up administrative monopolies will propel the previous "economic miracle" toward "normal development," achieving a transformation in the growth model. The pace of growth of the Chinese economy may gradually slow, and inflationary pressure may increase accordingly. Income distribution and the economic structure may improve continuously, and the pace of industrial upgrading will accelerate, while cyclical economic fluctuations will become increasingly apparent. These changes in the country's economy ultimately may fundamentally alter the pattern of the international economy.
The decision to comprehensively deepen reform exceeded previous expectations from the market and academia. We found that the economic reform plan has three salient features. First is its top-level push. The decision to establish a central leading group for the comprehensive deepening of reform lies in party'spush for reform and relies more on top-level design. Second is comprehensive market orientation. The position of the market mechanism has changed from fundamental to decisive. The government will only play an adjustment and control role when necessary. Third is that fairness and justice takes precedence over efficiency. Previous policy documents were mainly aimed at economic development, while this one seems to place more emphasis on fairness and justice.
If these measures can be implemented, they will fundamentally change the Chinese economy and truly release the "reform dividend." But this dividend will not necessarily increase the rate of short-term economic growth. What is more important is the sustainability of growth in the medium and long-term. Over the past three decades of reform and opening, China's economic growth model has exhibited two distinct characteristics. On the one hand, we have achieved rapid economic growth, with GDP growing nearly 10 percent annually and earning the country the moniker of the "economic miracle." On the other hand, the contradiction of economic structural imbalance is prominent, and problems like income inequality and environmental pollution are worsening.
How was China's unique pattern of growth formed in the past? There are various explanations in academia. My guess is that it is closely related to the asymmetric market liberalization reform strategies employed by the government during the period of reform. After three decades of reform, product markets have basically been liberalized, with prices for agricultural products, manufactured products and service products mostly set by the relationship between supply and demand. But distortion in factor markets is ongoing and serious, reflected in the household registration system that restricts the movement of labor between cities and rural areas, the direct control system for bank lending rates, regulation of energy prices (particularly oil) by government agencies, as well as land use fee concessions offered to investors. Some distortions, such as the household registration system, are inherited from the planned economy era. Others, such as preferential land use rights, have only been seen since the reform period.
These distortions have a common feature, which is that they depress factor prices and the cost of production. Low factor costs are equivalent to a disguised subsidy for businesses, especially producers, exporters and investors. For citizens, they are a tax in disguise. Thus, we have been insisting that moving toward the market, and liberalizing factor markets in particular, is the fundamental way to transform the Chinese economic model.
In reality, the economy has already changed, but unfortunately, this has not been widely accepted. We can describe the change to this model through growth and structure. First, GDP growth began to slow in 2011. Policymakers remained relatively calm, tolerating a moderate slowdown, probably for three reasons. First, after implementing the 4 trillion yuan stimulus plan during the global financial crisis, many government officials were unwilling to employ further radical measures to support economic growth. Second, officials and academia estimate the current economic growth potential to be in the range of 6 to 8 percent. Third, although GDP growth slowed to less than the 8 percent level, there has been no significant deterioration in employment and other macroeconomic indicators. In fact, the labor shortage has persisted.
More importantly, the issue of economic structural imbalance has gradually eased in recent years. We can provide evidence in three areas. First, the current account surplus has decreased significantly. In the past we worried that the huge current account surplus meant that the country's economic growth was largely dependent on external demand, making sustainability a problem. Additionally, politicians in some other countries used the current account surplus to accuse China of undervaluing the yuan and to force it to accelerate the pace of yuan appreciation. But the current account surplus as a percentage of GDP has fallen from 10.8 percent in 2007 to 2.8 percent in 2011 and 2.6 percent in 2012. In the future, there exists a certain risk of a rebound in the current account surplus, but I believe that most of the external account rebalancing has been completed.
The second piece of evidence of economic rebalancing is that the distribution of income has improved. In mid-January, the National Bureau of Statistics (NBS) released estimates fof the Gini coefficient between 2003 and 2012. The data show that the coefficient increased from 0.479 in 2003 to 0.491 in 2008, indicating that income inequality continued to deteriorate during this period. Thereafter, the Gini coefficient fell each year to 0.474 in 2012. Many Chinese economists are skeptical of this result. A recent Southwest University of Finance and Economics study put the figure at 0.61. One criticism of the NBS data is that the agency overlooks differences in household property income, such as real estate. Another criticism is that it underestimates the incomes of high-income groups. We believe it is indeed possible that the official Gini coefficient is undervalued. But since 2008, the trend of unequal distribution of income has been stymied. This finding should be reasonable.
The third piece of evidence of rebalancing is that the proportion of consumption may have started to pick up. Official consumption statistics have many suspicious parts. Official statistics show that the ratio of total consumption to GDP fell from 62 percent in 2000 to 47 percent in 2010. But our recent studies have shown that if we re-estimate service consumer spending, the ratio of consumption to GDP began to rise in 2008.
So far, the main force promoting the transformation of the economic model has been the Lewisian turning point in the labor market and the consequent growth in wages. Wage growth, especially among wage workers, has significantly compressed profit margins, thereby slowing the pace of economic activity. But it has also had a major impact on the economic structure. We think this is the most significant reason for the increase in the proportion of consumption in the economy.
However, changes to the economic model have only just begun, and much remains to be done in adjusting the economic structure. Although the macro significance of labor market adjustment is far-reaching, many other factor market distortions have not been corrected. This is why we hold high expectations for the decision for thorough market orientation at the third plenum. The core is only one provision, which is that where the market is able to decide prices, the government will not interfere. Of course, this doesn't mean the government will do nothing. The government will maintain market order, carry out macroeconomic regulation and control and compensate for market failures.
Among all the factor markets that should be liberalized, the most important is financial reform. Among all the distorted factors, distortions in the financial sector are the most severe, including interference in interest rates and the exchange rate and controls on capital allocation and capital flows. Of course, financial reform does not mean simply abandoning government intervention in interest rates and exchange rates. Concurrent with reform, strong financial infrastructure must be built. For example, the government bond yield curve, the deposit insurance system, effective governance mechanisms for financial institutions and others are all necessary conditions for market-oriented interest rates.
If we can truly implement the reforms decided at the third plenum, the economy will look very different. First, with the maturation of the economy, the economic growth rate will fall further. We can expect that even if the growth rate falls to 6 percent, it will not mean serious unemployment problems. This is still a relatively high growth rate among emerging economies. Second, future inflationary pressure may increase. Of course, the result ultimately depends on the trade-off between growth and inflation. Third, income distribution will improve further. Increasing wages and market-oriented interest rates will improve primary distribution, but government intervention in reallocation will continue to increase. Fourth, rebalancing of the economic structure will continue, and the contribution of consumption to economic growth will continue to grow. Fifth, the pace of industrial upgrading will continue to accelerate. With the sustained, high-speed increase in costs, only those companies able to climb the value chain are likely to remain competitive. Finally, China's economic cycle will become increasingly apparent. The economic cycle is a normal phenomenon of the market economy.
The author is Professor at Peking University National School of Development
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