China's Economy

China’s Economy: Complacency, Crisis & the Challenge of Reform

Barry Naughton

Abstract: China’s economic success has bred a new complacency and resistance to change. This in turn has created a credibility crisis, as many Chinese citizens believe the opposition of vested interests makes reform impossible. However, proponents of economic reform argue that the current economic strategy is unsustainable. They point to reform backsliding, overinvestment, and ½nancial fragility as problems that will collide with an inevitable economic slowdown caused by rapid demographic changes, and that will potentially cause economic and political crisis. Renewed economic reform is thus the only prudent and viable choice. The November 2013 Third Plenum shows that China’s leaders have tentatively accepted the need for reform.

At ½rst look, it seems that China’s new leadership assumed power at the pinnacle of economic success. Immediately upon putting their new administration in place, General Secretary Xi Jinping and Premier Li Keqiang made clear their belief that China’s new economic clout entitles it to a position of greater respect and global influence than ever before. In fact, China’s economy had already become a certi½able “growth miracle” when the previous administration of General Secretary Hu Jintao and Premier Wen Jiabao took power in 2003. At that time, China’s economy had already sustained a torrid annual growth rate of 9.6 percent over twenty-four years, a period begun by the major economic reforms of BARRY NAUGHTON is Professor 1978. But in the decade spanning 2003 to 2012, of Chinese Economy and the Sok- which included the global ½nancial crisis, China’s wanlok Chair of Chinese Interna- growth actually accelerated, reaching 10.4 percent tional Affairs at the University of annually.1 China overcame the global crisis by California, San Diego. His books pouring resources into investment and accelerating include The Chinese Economy: Tran- the already eye-watering speed of its infrastructure sitions and Growth (2007), Growing gdp Out of the Plan: Chinese Economic build-out. Per capita has pushed over the upper- Reform, 1978–1993 (1995), and the middle income threshold. Not surprisingly, then, edited volume Wu Jinglian: Voice of an air of triumphalism began to creep into Chinese Reform in China (2013). attitudes and government proclamations. Surpassing

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 the Japanese economy in aggregate size, But nothing much happened, and there Barry and becoming the second largest economy was no follow-through. Today, in Beijing, Naughton in the world, was a particular point of pride there is a widespread perception that the for China. past ten years have been a “lost decade” Transformation at this pace inevitably insofar as market-oriented economic re - creates enormous stresses and strains. form is concerned. This does not mean that Besides the dislocation, the inequities, and Wen Jiabao presided over a do-nothing the environmental costs, headlong growth administration. Rather, on the social front, also led to another problem: as incomes Wen cut taxes on the rural economy and grew, the impetus for market-oriented eco- boosted spending on education and med- nomic reforms diminished. As Wu Jinglian, ical care; he created the foundation for the dean of China’s reform-oriented econ- rudimentary national systems of health omists, put it, “As life got comfortable, insurance and pensions; and he increased reforms stopped.”2 During the 1990s, defense outlays, contributing to a stronger driven by profound economic and politi- military, which most Chinese citizens cal crises, the Chinese government had certainly see as a positive. The Hu–Wen pushed through a procession of funda- administration was energetic in spending mental economic reforms. Under Premier money, which was acceptable simply Zhu Rongji, China between 1993 and 1999 because they had the money to spend. enacted a series of deep and dif½cult However, in terms of creating the institu- reforms of the ½scal, ½nancial, and market tional framework on which future pros- systems. These reforms culminated in perity would depend, the outgoing admin- the massive downsizing of the Chinese istration achieved almost nothing. state enterprises sector from 1996 to 2001, and were sealed by China’s entry It is common for Chinese citizens to into the World Trade Organization in 2001, explain reform stagnation, or the defeat thereby locking in many of the most of individual reform initiatives, by refer- important reforms. As a result of these ring to the increased strength of “vested reforms, the Hu–Wen administration interests.” Even the current Chinese pre- inherited a highly favorable economic mier, Li Keqiang, regularly refers to the position when it took power in 2003: the need to manage and minimize interest previous administration had paid a sub- group opposition if his current reform stantial price to break down the old system proposals are to advance successfully.3 But and lay the foundation for a new, better- who, exactly, are these vested interests? functioning economy, but had only just The idea of “vested interests” covers a begun to enjoy the bene½ts. Hu and Wen broad spectrum. At one extreme, the op- were poised, as the Chinese saying puts it, position of interest groups to reforms to enjoy the shade of the trees planted by shades into and becomes identical with the ancestors. the problem of corruption. Some vested At ½rst, the Hu–Wen administration interests are well-connected families, cor- seemed ready to follow the reform trajecto- rupt of½cials, and even criminal gangs. But ry of the previous Jiang Zemin–Zhu Rongji at the other end of the spectrum, the prob - administration, retaining many of the lem of vested interests is created by the same economic technocrats. The admin- stabilization of the entire Communist istration’s initial economic proposals were Party–dominated economic and govern- full of good ideas, and represented a robust mental system. The easiest way to see this program for a continuation of reform. is through China’s budgetary history

143 (2) Spring 2014 15

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 China’s (Figure 1). From the beginning of reform Technology megaprojects, cultural vanity Economy: in 1978 until 1995, budgetary revenues as a projects, global propaganda initiatives: if Compla - cency, share of gdp declined nearly every year. a top leader wants it badly enough, the Crisis Indeed, the productive era of the 1990s mon ey can be found. Even the universi- & the Challenge reforms was driven by an acute budgetary ties have plenty of money. Virtually every- of Reform crisis. Zhu’s reforms included a new tax one in a position of authority has a bigger system and new ½nancial discipline that budget, is better off, and has plenty to do. staunched losses in the state enterprise Bitter disputes over resource allocation are sector. As state ½rms were chopped back less salient, and side payments can be and restructured, the few that survived made to buy off dissenters. As the flow of made a sustained return to pro½tability, resources through the party- and state- which increased resources available to na- dominated sectors of the economy in- tional leaders both directly and indirectly. creased and stabilized, the system naturally Figure 1 also shows that after 1995, the became organized around that flow. State- trend turned dramatically, and budgetary owned enterprises returned to ½nancial revenues as a share of gdp increased every health, bene½ting from the radical down- year between 1995 and 2012. The result sizing and restructuring that Zhu Rongji was an enormous increase in the volume had pushed through at such cost in the late of resources available to the system. 1990s. With a few entry barriers, and a lit- A few numbers can give a sense of the tle manipulation, combined with genuine magnitude of this transformation. As bottom-up economic growth, the state- Figure 1 shows, Chinese budget revenues owned enterprises were transformed from increased from 10.8 percent of gdp in 1995 a burden to an asset. The most extreme to 22.6 percent of gdp in 2012. Doubling example is China Mobile, the state-run the budget’s take of gdp in seventeen company that not only is by far the largest years is a substantial achievement, but telecom operator in the world, with over we must also consider the rapid growth 700 million subscribers, but also sits on of gdp itself: real budgetary revenues one of the biggest corporate cash piles in (deflated by the Consumer Price Index) Asia, with $64 billion in the bank.5 were almost exactly twenty times in 2012 At the same time, the reconstruction of what they had been in 1995. In 2012-con- the party apparatus and the rationaliza- stant usd, the value of Chinese budget- tion of party-state career paths have given ary revenues has increased from $113 bil- the system a new stability and predictabili- lion in 1995 to $1.86 trillion in 2012. These ty. Trajectories of a career in government numbers look like some kind of spread- have become more knowable, as the re - sheet error, but they are not.4 Chinese quirements for promotion have become government revenues (central and local increasingly routinized. Steady promotion, consolidated) are about equal to the U.S. in turn, leads to abundant and increasing federal government on-budget revenues, opportunities to earn outside income. Stu- excluding social security, which are esti- dents in elite universities have increas- mated by the Congressional Budget Of½ce ingly come to see government as the most at $1.97 trillion for 2012. attractive career option. In other words, Less than two decades since the coun- the stagnation of reform was not merely try faced a potential crisis of state capacity, short-run complacency and procrastina- the Chinese system is now awash in cash. tion; rather, it reflected the long-term sta- Money is available not just for the critical bilization of the system. The hierarchical necessities, but for elective projects as well. Chi nese political system, which had to be

16 Dædalus, the Journal ofthe American Academy of Arts & Sciences

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 Figure 1 Barry China’s Budget Share in gdp, 1978–2012 Naughton

Source: Chinese of½cial data, updated most recently with the National Bureau of Statistics, Zhongguo Tongji Zhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013).

constantly remade in the 1980s and 1990s in tions. Of course, at the same time, the order to adapt to new challenges, is today private sector has grown tremendously; no longer driven by any immediate, inter- and while the state sector has stopped nal sense of crisis. Instead, the Chinese sys- shrinking in absolute terms, the growing tem–perhaps like most systems in the private sector makes up a steadily larger world–is engaged primarily in reproduc- share of the overall economy. However, ing itself more or less as it is. The biggest private business owners now sense invested interest, then, is the interest repre- creased competition from state ½rms, and sented by the Communist Party itself. an increased need for accommodation with savvy power holders–with “vested The new stability of the system is viewed interests”–who can help extract bene½ts warily by those outside its embrace. In from the booming economy and from pri- the ½rst place, there is a widespread vate businesses. perception–both inside and outside China Even more important, an awareness of –that it is increasingly dif½cult to do busi- the stagnation of reform in China over ness in China without political connec- the past decade has gradually seeped into

143 (2) Spring 2014 17

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 China’s public consciousness, producing an inter- ping backward? Acutely aware of this Economy: esting disconnect. Over the past ten years, public sentiment, both Xi Jinping and Li Compla - cency, the government’s propaganda organs Keqiang have been critical of the gap Crisis have continued to trumpet the indispens- between rhetoric and action: Xi spent his & the Challenge ability of economic reform. Every few ½rst months in power denouncing “empty of Reform years, major new reforms are discussed, talk.” It is clear that those engaging in and policies are implemented, but they empty talk are, in fact, Xi’s predecessors, have little impact. As a result, of½cial pro- but is it clear that Xi will be any different? nouncements have lost credibility, and More broadly, why would those who this loss, combined with the stabilization bene½t so abundantly from the current of China’s system and the greater influ- system act to change it? Why would any- ence of interest groups, has led to a crisis of body change a model that seems to have con½dence in China’s ability to change. delivered such abundant resources and This type of credibility crisis is something success? quite new in China, although it has been commonplace in the United States and Remarkably, economic reform is not other economically developed societies dead in China and is in fact experiencing for some time. Such a crisis in con½dence a resurgence. Reformers have important is characterized by the belief that prob- positions in the new government and in lems are peculiarly entrenched and in- the country’s most influential business tractable, and nothing really can be done media. At their core, these reformers about them, with only the extremely have only one argument, but it is a pow- naive believing otherwise. This type of erful one: that the current economic situ- cynicism was, until recently, almost com- ation and policy trajectory are simply not pletely absent in China. China had been sustainable. Economic conditions are changing so rapidly that it was apparent changing rapidly, and the current way of to everyone that the future was, if nothing doing business risks serious crisis. The else, full of different possibilities, even if most dangerous course of action is there- the present was impoverished. That sense fore not to reform, in effect remaining on of con½dence about the future seems to the current course. If policy-makers do not have vanished in China. preempt the changes that are coming, then Understanding this facet of the public change will be disruptive and potentially mood is important to understanding the devastating. But there is still time to act. recent pronouncements of China’s new The unsustainability argument has four leaders, and their reception. Both Xi key components. First, the failure to sub- Jinping and Li Keqiang made rather bold stantially improve the quality of China’s pronouncements in favor of restarting economic institutions will begin to grad- market-oriented reforms in the early ually erode the pace of productivity im- stages of power transition in late 2012. provement. China’s total factor produc- Yet the popular response to these procla- tivity has increased dramatically during mations was only mildly positive: “Really? the reform era, and grew strongly through We’ll believe it when we see it.” A palpa- most of the ½rst decade of the century. ble skepticism about reform is thus part This productivity improvement has been of a broader crisis of con½dence. Can diffuse and attributable to multiple causes, China change? Has government and pol- including the learning and adoption of icy been captured by interest groups, such new technologies, as well as improved that no change is possible? Is China slip- institutions. A key link has been the will-

18 Dædalus, the Journal ofthe American Academy of Arts & Sciences

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 ingness to let underperforming entities for more than a couple of years. In 2007, Barry fail, concentrating production in the most Premier Wen Jiabao described China’s Naughton competitive and productive ½rms. How- economy as “unstable, unbalanced, un- ever, the strength of this competitive coordinated, and unsustainable,” and mechanism seems to have waned in recent since that time, the unprecedented de- years, and without a new wave of reform, pendency on state investment has only productivity growth will continue to slow. further unbalanced the economy. Productivity is not simple to measure; What’s wrong with this investment- there are time lags both in the appearance driven, unbalanced growth? After all, of productivity effects and in our ability investment-led growth has served the to measure them. So by the time econo- Chinese economy well over the past two mists have formed an academically rigor- decades. One of the great paradoxes of the ous judgment, it is quite late to do any- Chinese economy is that although house- thing about it. But in the interim, policy- hold consumption is an unusually low makers will look at growth rates com- share of total gdp (35 percent), household pared to investment rates. There are many consumption has also grown extremely reasons why growth should slow, but as rapidly over the past decade, only not as long as investment rates stay high, policy- fast as overall gdp. And if you can have makers will take declining growth rates both more consumption and more in - as evidence that something is wrong with vestment, why not have it all? Well, be - their system’s productivity, and will be cause it is probably just not possible. motivated to push harder for reforms. Economists do not have any logical limit Second, the limits to investment-driven to how high a country’s investment rate growth are appearing. China was able to can be, or for how long. But all previous sidestep the worst of the global ½nancial high-growth economies have eventually crisis by increasing domestic investment. come to a point where investment rates gdp growth scarcely dropped because the subside, and usually at levels well below increase in domestic investment almost the current Chinese level. In the past, with completely offset the drop in net exports. unlimited supplies of labor, investment But this success was achieved at substan- was the key growth driver. All that was tial cost. Because the stimulus program needed to bring that labor out of the coun- was so rushed, some unknown proportion tryside was new industrial plant and infra - of new investment was doubtless wasted structure. Moreover, as a follower econo- on useless projects, although we have no my, planners and businesses could focus way of knowing how large that propor- on transplanting business models, tech- tion is. More fundamental, as Figure 2 nologies, and infrastructure layouts from shows, the investment surge of 2009 was developed countries. The system delivered not a one-off stimulus. Instead, China’s investment, and investment delivered investment rate moved more or less per- growth. That equation is no longer so sim- manently to a higher level. Since 2009, ple. Matching the right investment to the China has been investing a remarkable 48 evolving needs of the economy is becom- percent of gdp. An investment effort of ing much more dif½cult. The fundamental this magnitude is completely unprece- infrastructure framework China’s plan- dented for a large economy. Japan, Korea, ners copied from more advanced econ- Malaysia, and Thailand all drove growth omies is nearing completion. Meanwhile, with investment, but none of them ran excess capacity has emerged in many in - investment rates that exceeded 40 percent dustrial sectors as the economy has slowed.

143 (2) Spring 2014 19

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 China’s Figure 2 Economy: Investment and Net Exports (Share of gdp), 1978–2012 Compla - cency, Crisis & the Challenge of Reform

Source: Chinese of½cial data, updated most recently with the National Bureau of Statistics, Zhongguo Tongji Zhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013).

These suggest that China may be ap - rises that investment from the private sec- proaching the limits of this development tor will drop. strategy. Moreover, investment has an in - Third, past investment excesses have herent tendency toward instability, since already created ½nancial fragility. The huge it is driven by investors’ expectations of quantity of new ½xed assets the Chinese the future. While consumption is relatively economy has created over the past ½ve stable, investment is subject to the “ani- years is just now coming onstream. Many mal spirits” of those making decisions. In of these assets are housed in corporate China, the government’s willingness to structures that have no good business serve as the reliable investor of last resort model. The extreme example is China’s has also kept the investment propensity gleaming new high-speed rail network. of private businesses high. The two have The system has a current debt load equiv- been in a productive symbiosis that thus alent to $429 billion. Whether or not a far has served the economy well. As the massive high-speed rail is worth building momentum of the economy slows and is one question–about which opinions existing opportunities close off, the danger differ–but whether there is a revenue

20 Dædalus, the Journal ofthe American Academy of Arts & Sciences

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 model to service this enormous debt is Fourth, China is going through profound Barry another question altogether. Outside of a changes in its labor markets that point to Naughton few high-capacity lines like Beijing-Shang- substantially slower growth. For decades, hai, most observers doubt it. The challenge employers had been able to hire at will is mirrored by literally thousands of local new workers migrating from the country- government projects and “funding plat- side, offering a wage that changed little forms” around the country. Encouraged to through the 1990s and early 2000s. But invest following the global ½nancial crisis, some time after the mid-2000s, competi- these local governments now face debts tion for workers began to drive up un - they cannot service with the income skilled wages. By 2012, real wages for mi- streams they can plausibly generate grant workers were two and a half times through user fees and sales revenues. In the what they had been in 2003, increasing aggregate, this debt amounts to more than by 10.8 percent annually. This dramatic $1.6 trillion, by of½cial estimates. Put to - change in labor market conditions led gether, these two debt loads amount to 25 many observers to proclaim “the end of percent of China’s gdp. cheap China.” The sudden change also Chinese regulators and ½nancial sector revived interest in a so-called Lewis turn- of½cials are well aware of these problems. ing point, a structural shift that occurs They have been pushing China’s state when the reservoir of surplus labor in the banks to increase bad loan provisions and countryside is ½nally depleted, and em - raise capital; they will certainly not be ployers have to pay higher wages to draw caught by surprise. Nonetheless, the hard people out of agricultural work.6 In past work of actually restructuring these cor- Asian growth “miracles,” the arrival of a porations has barely begun. Indeed, it can Lewis turning point often signaled the end hardly proceed in the current inherited of the very-high-growth period. Rapid environment: credit is still flowing freely; growth of unskilled wages tends to force shambolic state-backed corporations have the end of an early growth phase led by the easy access not just to bank loans but also export of labor-intensive manufactures. to nascent bond markets; and govern- Economies start to lose comparative ad - ments turn to short-term ½nancial mar- vantage in clothing, shoes, and toys, and kets to fund long-term debts. Some kind export growth becomes a less important of credit squeeze will be necessary to demand-side driver of growth. These drive forward ½nancial restructuring, forces are now operating in China, and and both the squeeze and the restructur- since export demand from the European ing will be painful. Yet the longer ½nancial Union, Japan, and the United States is likely restructuring is delayed, the longer re- to be weak for the immediate future, ex - sources will flow into low-productivity or ports will make a much smaller contribu- no-productivity projects and corporations. tion to China’s future growth than they did The creation of a vast sector of “zombie during the past decade. ½rms,” neither dead nor alive, would ulti- Just as rural labor surpluses were be - mately create a far larger and more dan- ginning to disappear, China reached gerous risk of ½nancial panic and collapse. another crucial turning point. In 2012, the The relevant comparison is with Japan in population at working age began to de - the 1990s, when the delay of ½ nancial re - cline. This is an entirely different type of structuring kept numerous zombie ½rms demographic transition, accelerated by alive, and kept the economy from recover- China’s draconian birth control policies. ing for an entire “lost decade.” Previously, China had been experiencing

143 (2) Spring 2014 21

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 China’s a “demographic dividend” in which the economies such as Japan, Korea, and Tai- Economy: population at working age was growing wan moved out of their very-high-growth Compla - cency, more rapidly than the overall population. phases, they each faced major challenges Crisis As a result, dependency ratios decreased to their growth models. Japan’s growth & the Challenge and the work force became younger and rate dropped sharply in 1973, and then of Reform better educated. However, as the essay by again in the 1990s. Never again did Japan Deborah Davis in this issue details, China’s come anywhere close to replicating the demographic dividend is now exhausted– high growth rates of the 1950s and 1960s. as it eventually had to be–and China’s Similarly, the end of the Korean high- population has begun to age and experi- growth phase in 1997 arrived with the ence a higher (elderly) dependency ratio. Asian ½nancial crisis, massive ½nancial The working age population has reached distress and restructuring, and a perma- a plateau, and will start to decline rapidly nently lower growth rate. The evidence is in absolute size by 2020. The fact that the clear that if China does not handle this tran- Lewis turning point and the end of the sition well, it could have a substantial eco- demographic dividend are occurring at nomic price to pay. the same time means that the shift in labor force conditions will be unusually At this point, a broader argument about abrupt. For comparison, Japan’s labor the nature of China’s economy and society force began to shrink about twenty-½ve comes into play. Typically, as forerunner years after the end of its high-growth era– economies have reached the end of their when the country was already quite rich– high-growth phases, they have upgraded and Korea’s labor force began to shrink into high technology and more sophisti- about ½fteen years after the end of its high- cated sectors. China clearly hopes to follow growth era. In China, these two changes this lead. To prepare, China has invested are occurring simultaneously. massively in university education since The structural changes in China’s labor 2001, and has also begun to pour govern- force mean growth is bound to slow; but ment money into research and develop- this does not have to be a bad thing. After ment in promising “emerging” industrial all, higher wages mean that incomes are sectors. Last year, China invested just shy growing, that people are better off, and of 2 percent of its gdp into research and that there is an opportunity to shift the development, a sum much greater than pattern of economic development so that that of other economies at comparable it provides a greater share of output for levels of gdp per capita. But ordinarily, household consumption. Moreover, China forerunner economies have facilitated this is a huge continental economy and does upgrading process by transitioning into not have to tie its economic growth only more of a “light touch” role for government to its export strategy. Chinese incomes support for development, and a broader overall are still relatively low and there is liberalization of economic and social con- plenty of room for catch-up. So this struc- ditions. Thus, the government typically tural change is a huge challenge, but not hands off more of the responsibility for necessarily a looming disaster. This is a development to the private sector, and transition that must be managed carefully, relies on dispersed entrepreneurship to but one that can lead to a much more pro- identify and exploit the promising new ductive and capable society overall. Here, sectors. In China, the movement in recent though, the record of Asia’s earlier “mir- years has not been in this direction. Gov- acle economies” advise caution. When ernment, flush with money, has stepped

22 Dædalus, the Journal ofthe American Academy of Arts & Sciences

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 up its own direct role in technology Structural changes in the growth poten- Barry research and innovation. Entry barriers tial are intersecting with ½nancial fragilities Naughton that have long since fallen away for ordi- linked closely to the post-2009 investment nary manufacturing sectors are still in surge. Growth slowdown will force the place for high value services such as ½- hand of policy-makers. Otherwise, the nance and information (including Internet danger that unaddressed problems will businesses). There is a very real danger lead to a broader loss of con½dence may that a top-down, state-directed program grow, and threaten the system’s ability to of innovation, combined with state con- stably reproduce itself. The reformers trol of large swathes of the economy, will argue that without further market-oriented end up retarding China’s essential gradu- reform, there is no way to resolve these ation toward an innovative, diverse, and challenges. In a sense, Xi and Li have in- resilient economy. herited a situation that is the exact oppo- Today’s China clearly faces a set of site of the one inherited by Hu and Wen ten challenges that are different from those years earlier. The Xi–Li economy looks in the past. China must upgrade the quality good, but it comes with a legacy of deferred of its human resources; identify the sec- problems and unresolved issues. Xi and Li tors, products, and services where oppor- still have a chance to address these prob- tunities lie; and transition from a follower lems, to move China toward a path of sus- economy to a position at the global fron- tainable, but slower, growth, but they have tier in numerous sectors. Can it do those to do so promptly, before a host of bills things without also further scaling back comes due. The timing of this is not under the power of the state, eliminating visible the control of Chinese policy-makers. and invisible barriers to the growth of By tradition, one year after the Com- innovative businesses, and empowering munist Party Central Committee is ½rst households to make more of the funda- empanelled, each new Chinese adminis- mental economic decisions? It seems un- tration convenes a Third Plenary Session likely, which leads us back to the problem in order to lay out its economic program. of economic reform. In the past–especially in 1978 and 1993– this Third Plenum has marked a turning The reform proponents’ arguments point, the initiation or revitalization of a about sustainability have a high degree of major reform program. Xi Jinping and Li internal coherence, and also great immedi- Keqiang convened their own Third Plenum acy. In the ½rst place, the current changes from November 9 through November 12, in the external economic environment 2013, and produced a strong reform docu- are obvious for all to see. Slowing labor ment that addressed key economic issues force growth, soaring wages, and rapidly while also expanding well beyond the changing cost structures and competitive- strictly economic realm. The document ness are part of daily life for all Chinese that emerged is best characterized as part citizens. But these changes directly imply vision statement and part to-do list. The that the existing economic strategy has vision statement is an essential part of a reached its limits. In fact, all four of the document of this type, which emerges out fundamental challenges described above of a long consensus-building process with- are reaching a climax at the same time. in the Communist Party leadership. This Investment-led growth is running out of process tends to generate broad statements steam just as the productivity dividend of principle, plus (at best) a few compelling from previous reforms risks reversal. slogans. To a certain extent, the 2013 Third

143 (2) Spring 2014 23

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 China’s Plenum resolution shares these features, out the core economic elements of this Economy: but the content is surprising. It calls for a initial reform package. It is striking that Compla - cency, rede½ned role for government, with gov- the framers of the document have provided Crisis ernment playing a reduced role in micro- a number of tangible commitments that & the Challenge economic decision-making, the market will serve as benchmarks by which to of Reform playing a “decisive role” in resource allo- judge whether or not the reforms are cation, and the development of new actually implemented. Further, Xi Jinping models of social governance. It does not personally and publicly identi½ed with shy away from key areas of ½nancial and the resolution in a remarkable account he ½scal reforms, and it marks a clear effort published the week following the Third to revitalize reform in the state-owned Plenum, stressing his chairmanship of the enterprise sector. This vision is surprising drafting committee and his deep engage- because it revives a rhetoric and vocabu- ment with the entire process. Xi, we would lary not much in evidence in China lately, say, took personal ownership of the docu- and it charts a course that is very different ment. By crafting a document designed to from many of today’s policies. The to-do impress, by including concrete and observ- list, meanwhile, is extremely ambitious. able contents along with the more abstract Laid out in sixty articles and comprising goals, and by encouraging personal iden- well over three hundred policy measures, ti½cation with the resolution, Xi Jinping the to-do list commits the regime to an is clearly signaling his intention to pur- impressively broad array of actions, rang- sue this agenda.7 ing from relaxing the single-child birth Of course, actually implementing these control policy to increasing the share of ambitious goals is far more dif½cult than dividends that state-owned enterprises merely stating them. This, in turn, leads hand over to the government and its social to our ½nal question: can Chinese policy- welfare funds. makers act preemptively, dismantling their The Third Plenum resolution is best own special privileges, before the arrival understood within the context of achieve- of a serious economic crisis? The ques- ment, change, and credibility crisis de- tion is not only whether reform propo- scribed above. Xi Jinping and Li Keqiang nents can overcome the entrenched power –and their secretaries and advisers– of vested interests, but also whether they clearly exerted a major effort to make the can overcome such power in the absence Third Plenum resolution a credible docu- of a full-blown crisis. If the chances for ment that would generate momentum for renewed market reforms were assessed the reform process. In the ½rst instance, solely on the basis of short-run economic they did so by producing a plenum docu- and political conditions, it would be hard ment that was simply bigger than many to be optimistic. In that sense, both the people expected: it was both broader and complacency and the crisis of con½dence more detailed than most previous docu- would be justi½ed; it is dif½cult to make ments. Moreover, the overall approach of an argument for change based on a crisis the document has the potential to create that has not yet hit. a coherent response to the multiple eco- But at the end of the day, the reformers nomic challenges that China faces. Fi - are right that only major institutional nancial reforms, ½scal reforms, and state- changes that make the economy more enterprise reforms are all cued up in the open, competitive, and rule-bound can Third Plenum, and pricing reforms and a avoid the serious problems looming over - reduction in administrative barriers round head. Even these reforms will require

24 Dædalus, the Journal ofthe American Academy of Arts & Sciences

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021 adept policy-maneuvering to avoid sub- the transition to a lower growth rate, but Barry merged obstacles. The reformers are right in the context of a wealthier, better-off Naughton about impending changes and potential society. It absolutely has the capability to crises, and they are right about the type of do so, but policy-makers must summon economy and society that China must the will and determination, craft an ef - become in order to be technologically fective proposal, and push for a renewed creative, institutionally flexible, and sup- domestic and foreign opening of the portive of a high standard of living for a economy. majority of its citizens. China must make

endnotes 1 National income, expenditure, and ½scal data in this paper, including those used in Figures 1 and 2, are Chinese of½cial data, updated most recently with the National Bureau of Statistics, Zhongguo Tongji Zhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013). gdp from the production and expenditure side, see p. 19, 33–35; ½scal data, see p. 72–73. 2 Wu Jinglian, “Toward a Renewal of Reform,” in Wu Jinglian: Voice of Reform in China, ed. Barry Naughton (Cambridge, Mass.: mit Press, 2013), 12. Wu is quoting his close friend Zhang Zhuoyuan. 3 Li Keqiang’s remarks reported in Du Yongtao, Fu Yingnan, Wei Xi, and Liu Yang, “Li Keqiang Emphasizes that the Biggest Dividend that China Enjoys is the Reform Dividend” (in Chinese), People’s Daily Online, November 22, 2012, http://½nance.people.com.cn/n/2012/1122/c1004 -19667962.html. 4 Chinese currency values have been converted to U.S. dollars at prevailing exchange rates, and deflated by the U.S. Consumer Price Index. 5 Daisuke Wakabayashi and Min-jeong Lee, “Samsung’s ‘Good’ Problem: A Growing Cash Pile,” The Wall Street Journal, May 8, 2013, http://online.wsj.com/article/SB10001424127887323798 104578454440307100754.html. 6 Migrant wages from Feng Lu, “Consolidation or Stimulation? Remarks on China’s macro- economic situation and policy,” U.S.-China Economics Dialogue, Beijing, June 19, 2013. For a good collection of academic articles on the Lewis turning point, see the 2011 special issue of China Economic Review, especially the article by the leading proponents of this view, Cai Fang and Du Yang, “Wage Increases, Wage Convergence, and the Lewis Turning Point in China,” China Economic Review 22 (4) (2011): 601–610. The empirical evidence in favor of the Lewis theory in other developing economies is mixed, but China ½ts many of the Lewis model’s predictions. Moreover, China has unique institutions that make the basic Lewis assumption of surplus rural labor more plausible, including collective land ownership and institutional barriers that retard rural-to-urban migration. 7 Chinese Communist Party Central Committee, “Resolution on Several Important Issues on Comprehensively Deepening Reform” (in Chinese), November 12, 2013, http://news.xin huanet.com/politics/2013-11/15/c_118164235.htm. Xi Jinping emphasizes his personal role in Xi Jinping, “An Explanation of the ‘Resolution on Several Important Issues on Comprehen- sively Deepening Reform’” (in Chinese), November 15, 2013, http://politics.people.com.cn/ n/2013/1115/c1001-23559327.html. As of mid-December 2013, there is still no of½cial English translation of the Third Plenum resolution.

143 (2) Spring 2014 25

Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/DAED_a_00269 by guest on 29 September 2021