In terms of domestic policy, addressing the growth slowdown means correctly diagnosing its causes. Yet the advice from China experts on what has caused the steady decline in China’s growth rate since 2010 is all over the place.
Peking University economist Justin Lin identifies ‘external and cyclical factors, not some natural limit’ as the primary causes of the growth slowdown. He therefore urges boosting domestic demand through ‘improvements in infrastructure, urbanization efforts, environmental management, and high-tech industries’ to reach official growth targets.
Michael Spence and Fred Hu argue similarly that ‘the economy is experiencing a bumpy deceleration, not a meltdown’ — ‘bumpy’ meaning a temporary deviation from the norm. The focus, therefore, should be on moderating the bump rather than raising the norm. They advise Beijing to simply increase the transparency of its decision making and communicate its policy decisions more effectively. They do not emphasise any specific structural or institutional reforms.
Others claim that the slowdown is caused by both ‘the long-term issue of a declining potential growth rate and the immediate problem of below potential actual growth. Hence, ‘another stimulus package that increases aggregate demand through infrastructure investment is needed’.
But enthusiastic endorsements for more macro-stimulus fail to consider the trade-off between short-term macroeconomic stability and long-term economic dynamism. Experience shows that Chinese macro-stimulus as it stands helps keep unprofitable ‘zombie firms’ alive and supports the disproportionate growth of the state-owned enterprise (SOE) sector. This type of macro-stimulus reduces the potential growth rate of the economy, and hence accelerates the decline in the actual growth rate.
Instead, Chinese policymakers should replace the stimulus-through-SOEs mechanism with three new interrelated growth drivers. First, fostering new private entrepreneurs; second, promoting urbanisation according to the principles of future home ownership and consumer location choice; and third, developing a modern financial system in which the private sector has an enhanced role.
Taming SOEs is the most common policy advice offered to China to raise its potential growth rate. This common element does not reflect ideological bias but recognition of a ‘new domestic normal’. The negative effects of China’s large SOE sector are increasingly burdensome because the offsetting positive effects from surplus agricultural labour and demographic dividends have reduced and continuing to decrease. The answer to this ‘new domestic normal’ (which is labelled the ‘new normal’ in official Chinese terminology) is to create reform dividends to boost growth.
China can partly offset the contractionary effects of the shrinking state sector by mobilising the laid-off workers to form an entrepreneurial force. Many of these workers could start their own factory workshops to take advantage of increased cost competitiveness in China’s inland provinces.
The second strategy is urbanisation based on the principles of affordable future home ownership. The prolonged rapid growth of the real estate sector and the large increases in housing prices reflect not just speculative demand but also genuine pent-up demand for housing.
As financial sector development is a protracted process, efficient markets for mortgage loans are a long way off. Meanwhile, China should significantly scale up its low-cost housing program by allowing new arrivals to cities to rent for seven years and then have the first right to buy these units at a price based on the cost of construction. This ‘future ownership’ form of urbanisation would prevent speculative purchasing of empty housing that escalates into non-performing loans.
The third new macro-tool is the true legalisation of privately owned financial institutions. Legalising private banks is fundamental to promoting two new growth drivers: dynamic entrepreneurs and an efficient mortgage market. But it is also an independent driver of growth in its own right.
The healthy development of new private banks would of course require that the system of prudential supervision be strengthened and that interest rates be deregulated. Further, the emergence of a strong small–medium banking sector would reduce the dominance of the state-controlled banks and hence make the economy less vulnerable to their collapse from potential non-performing loans.
The entry of private banks, domestic and foreign, would also reduce the soft budget protection enjoyed by the monopoly state banking system. This would in turn increase the quality and the quantity of bank loans.
On a broader level, environmental protection — from severe air pollution to Beijing’s management of water on the Tibetan Plateau — and harmonious international relations will be integral to increasing the rate of China’s economic catch-up.
But these problems also require cooperation with foreign partners.
This is increasingly difficult with absence of a global hegemon to guide cooperation. The ‘new international normal’ is a multipolar world. Instead of a monopoly economic power that could act as the global hegemon, an oligopolistic distribution of economic power will become the norm. The most common outcome in a situation of oligopolistic distribution of power is the division of the world into spheres of influence because of the security concerns of each major power. But with the right agreements in place to address these security concerns, a new form of benign globalisation could emerge.
The sphere of influence of each major power could become a geographical cluster for economic development rather than economic exploitation or political domination. Given the existence of economies of scale in production, every geographical cluster must practise open regionalism to maximise economic prosperity.
China’s engagement with its neighbours through the Belt and Road Initiative, the Asian Infrastructure Investment Bank and the Regional Comprehensive Economic Partnership is very much in line with a multipolar world in which each development-oriented cluster practises open regionalism. But for globalisation to deepen and widen, China must take greater leadership in the supply of global public goods — fighting climate change, preventing nuclear proliferation and international terrorism, and stabilising the international monetary system.
The disappearance of the ‘old normal’ need not herald doom for Beijing. With the right policy settings, Beijing can use the ‘twin new normals’ not only to sustainably grow itself, but to engage more positively with a still globalised world.
Wing Thye Woo is a Professor of Economics at University of California, Davis; Professor at Sunway University, Malaysia; Professor at Fudan University, Shanghai; and Senior Research Fellow at the Institute of Population and Labour Economics, CASS, Beijing.
A longer version of this article will appear in China’s New Sources of Economic Growth, Volume 2: Human Capital, Innovation and Technological Change, a collection of papers from the China Update conference series.