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 administra- tion 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 © 2014 by Barry Naughton doi:10.1162/DAED_a_00269 14 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 com pany 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.