Since 2010, global financial circles have been obsessing about China’s slowing economy. But, while the country barely met the official target of 7.5% annual GDP growth in the second quarter of this year—generating significant anxiety worldwide—China’s government seemingly remains calm, showing no indication that it plans to launch yet another stimulus package. Do China’s leaders really have the situation under control?
In fact, the Chinese government’s stance—based on Premier Li Keqiang’s “Likonomics”, which prioritizes structural reform over rapid GDP growth—will prove to be in the best interests of China and the rest of the world. China’s structural problems—including restrictions on labour mobility, a rigid and risk-laden financial system, and excessive reliance on government investment—are threatening its stability and economic development. Given that China’s GDP growth rate remains respectable relative to the rest of the world, the need to emphasize structural reform is clear.
But, despite well-intentioned statements and narrow gestures, China’s new leadership has yet to establish a concrete, bold reform plan capable of resolving the economy’s deep-rooted problems.
For example, last February, the state council announced plans to reform the hukou (household registration) system, which assigns legal residency according to a person’s place of birth. The system makes relocating very difficult, as those who do not manage to acquire local residency permits face major hurdles in gaining access to public services when they migrate to other provinces. Indeed, their children are even prohibited from taking college entrance exams.
The reform plan was supposed to improve the situation by allowing migrants in towns and small cities to acquire local residency permits more freely, while easing the requirements in medium-sized cities. But efforts to reform the system have been met with strong resistance, especially from local governments and residents, who fear the strain that unregulated migration to their cities will have on resources, employment, and services. As a result, a genuine hukou reform strategy remains elusive.
Similarly, the government has been slow to formulate and implement effective financial market reforms. Hopes were high early this year, when the state council announced a strategy aimed at liberalizing the capital account, establishing a more flexible exchange rate policy, and opening the financial sector to domestic private capital. But the government then heeded influential economists’ warnings of the risks of relaxing capital controls too hastily.
In fact, the opposite should be happening. Narrow policies like the government’s recent credit tightening will make it difficult to direct financial resources to the real economy—one of the primary objectives of “Likonomics”. Genuine progress depends on Chinese leaders’ willingness to address the structural flaws—namely, the restrictions on domestic private capital—that are impeding the financial system’s ability to channel savings to the most promising economic sectors.
Despite several rounds of deregulation, it remains very difficult to establish private banks in China, and rules on non-banking financial institutions are often unclear. As a result, shadow banking, which provides capital at triple the cost implied by the official base interest rate, is flourishing—and generating significant uncertainty and risk. Although the government recently attempted to attract capital back to the official banking sector by eliminating the lending rate’s lower bound, more substantial reform is needed—and that will likely have to wait until the interest rate on deposits is fully liberalized and the financial sector is open to private banks.
In many other areas, too, China’s government either remains indecisive or is offering only rhetoric and small gestures. For example, the devolution of some project-approval powers to local governments will not solve the underlying problem of excessive state intervention in the economy; on the contrary, it may even enhance the state’s role by giving local governments more freedom to carry out investment projects.
China’s leaders know what is wrong with the country’s economy. But, as their efforts over the last several months have highlighted, they are uncertain as to how to go about fixing it—a fact that is generating significant anxiety in financial markets and among the general public. As senior Chinese officials gather for their annual summer meeting in Beidaihe, a coastal resort near Beijing, they must recognize the need for a bold plan for genuine structural reform. Otherwise, anxiety will eventually give rise to mistrust, making a comprehensive reform strategy even more difficult to implement.
Yao Yang, a professor at the China Center for Economic Research, is dean of the National School of Development at Peking University.