Reforming China’s State-Market Balance

Read Time:5 Minute, 14 Second – No country in recorded history has grown as fast – and moved as many
people out of poverty – as China over the last thirty years. A hallmark of China’s
success has been its leaders’ willingness to revise the country’s economic model
when and as needed, despite opposition from powerful vested interests. And now, as
China implements another series of fundamental reforms, such interests are already
lining up to resist. Can the reformers triumph again?

In answering that question, the crucial point to bear in mind is that, as in the
past, the current round of reforms will restructure not only the economy, but also
the vested interests that will shape future reforms (and even determine whether they
are possible). And today, while high-profile initiatives – for example, the
government’s widening anti-corruption campaign – receive much attention, the deeper
issue that China faces concerns the appropriate roles of the state and the market.

When China began its reforms more than three decades ago, the direction was clear:
the market needed to play a far greater role in resource allocation. And so it has,
with the private sector far more important now than it was. Moreover, there is a
broad consensus that the market needs to play what officials call a “decisive role”
in many sectors where state-owned enterprises (SOEs) dominate. But what should its
role be in other sectors, and in the economy more generally?

Many of China’s problems today stem from too much market and too little government.
Or, to put it another way, while the government is clearly doing some things that it
should not, it is also not doing some things that it should.

Worsening environmental pollution, for example, threatens living standards, while
inequality of income and wealth now rivals that of the United States and corruption
pervades public institutions and the private sector alike. All of this undermines
trust within society and in government – a trend that is particularly obvious with
respect to, say, food safety.

Such problems could worsen as China restructures its economy away from export-led
growth toward services and household consumption. Clearly, there is room for growth
in private consumption; but embracing America’s profligate materialist life-style
would be a disaster for China – and the planet. Air quality in China is already
putting peoples’ lives at risk; global warming from even higher Chinese carbon
emissions would threaten the entire world.

There is a better strategy. For starters, Chinese living standards could and would
increase if more resources were allocated to redress large deficiencies in health
care and education. Here, government should play a leading role, and does so in most
market economies, for good reason.

America’s privately-based health-care system is expensive, inefficient, and achieves
far worse outcomes than those in European countries, which spend far less. A more
market-based system is not the direction in which China should be going. In recent
years, the government has made important strides in providing basic health care,
especially in rural areas, and some have likened China’s approach to that of the
United Kingdom, where private provision is layered atop a public base. Whether that
model is better than, say, French-style government-dominated provision may be
debated. But if one adopts the UK model, the level of the base makes all the
difference; given the relatively small role of private health-care provision in the
UK, the country has what is essentially a public system.

Likewise, though China has already made progress in moving away from manufacturing
toward a service-based economy (the GDP share of services exceeded that of
manufacturing for the first time in 2013), there is still a long way to go. Already,
many industries are suffering from overcapacity, and efficient and smooth
restructuring will not be easy without government help.

China is restructuring in another way: rapid urbanization. Ensuring that cities are
livable and environmentally sustainable will require strong government action to
provide sufficient public transport, public schools, public hospitals, parks, and
effective zoning, among other public goods.

One major lesson that should have been learned from the post-2008 global economic
crisis is that markets are not self-regulating. They are prone to asset and credit
bubbles, which inevitably collapse – often when cross-border capital flows abruptly
reverse direction – imposing massive social costs.

America’s infatuation with deregulation was the cause of the crisis. The issue is
not just the pacing and sequencing of liberalization, as some suggest; the end
result also matters. Liberalization of deposit rates led to America’s savings and
loan crisis in the 1980’s. Liberalization of lending rates encouraged predatory
behavior that exploited poor consumers. Bank deregulation led not to more growth,
but simply to more risk.

China, one hopes, will not take the route that America followed, with such
disastrous consequences. The challenge for its leaders is to devise effective
regulatory regimes that are appropriate for its stage of development.

That will require the government to raise more money. Local governments’ current
reliance on land sales is a source of many of the economy’s distortions – and much
of the corruption. Instead, the authorities should boost revenue by imposing
environmental taxes (including a carbon tax), a more comprehensive progressive
income tax (including capital gains), and a property tax. Moreover, the state should
appropriate, through dividends, a larger share of SOEs’ value (some of which might
be at the expense of these firms’ managers.)

The question is whether China can maintain rapid growth (though somewhat slower than
its recent breakneck pace), even as it reins in credit expansion (which could cause
an abrupt reversal in asset prices), confronts weak global demand, restructures its
economy, and fights corruption. In other countries, such daunting challenges have
led to paralysis, not progress.

The economics of success is clear: higher spending on urbanization, health care, and
education, funded by increases in taxes, could simultaneously sustain growth,
improve the environment, and reduce inequality. If China’s politics can manage the
implementation of this agenda, China and the entire world will be better off.

Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at
Columbia University. His most recent book is The Price of Inequality: How
Today’s Divided Society Endangers our Future.

Project Syndicate,

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