Will China’s New Economic Reforms Be Enough?
Western observers have a history of misinterpreting events in China. Even so, three announcements from this week's meeting of the Chinese Communist Party look promising.
According to Xinhua, the government's official press agency, private investors will be permitted to establish regulated banks to serve small and medium enterprises, state-owned lenders will be forced to pay larger dividends to the government and the one-child policy will be effectively replaced by a two-child policy. While these three changes aren't sufficient to put China on the path to sustainable growth, they would definitely help solve China's biggest problem: too much investment and not enough personal consumption.
It might seem strange to criticize the economic policies of a country that has delivered decades of blisteringly fast growth. But thoughtful observers have long worried that the government's focus on big infrastructure projects has wasted resources and needlessly deprived households of a decent standard of living. These thinkers, most notably Peking University's Michael Pettis, believe that this excessive investment needs to be replaced with initiatives to raise the incomes of regular people.
But isn't high investment the best way to ensure long-term growth? Not necessarily: The best benchmark of economic success is whether a society satisfies the needs and wants of its members now and in the future.
So some investment is necessary to ensure that consumption can increase over time. (Think of sea walls that protect against flooding.) But any investments beyond what's needed start becoming equivalent to digging giant holes in the ground: In addition to wasting everyone's time and energy, all that earth-moving probably caused a bunch of pollution. Society will end up having to divert future resources away from things that would make people happy and instead be forced to spend more on health care and environmental cleanup.
The Chinese government enables excessive investment by funneling capital to state-owned enterprises and local governments, through the four big state-owned banks. Regulations ensure hefty profits for the banks, subsidized borrowing costs for wasteful projects, and systematic confiscation of household savings.
The result is that regular people have to save more and more of their incomes just to keep up with inflation, while companies with Party connections get preferential access to funding for useless vanities. Smaller companies that lack influential friends can't get bank loans and are forced to rely on expensive lenders that occupy a space somewhere between loan sharks and pawnbrokers.
Ideally, the government would privatize the financial system, deregulate interest rates, and force state-owned companies to disburse most of their profits to the regular people who theoretically have a claim on those earnings. The banking reforms announced by Xinhua are a poor substitute but nevertheless a step in the right direction.
Under those reforms, new private banks may offer more competitive financing to the small and medium-sized private companies responsible for most of China's productivity gains. The government's plan to spend a greater share of the big banks' profits to "improve people's livelihood" should also raise the cost of capital for bloated businesses, while providing additional income to regular people.
China could also boost the value of its excessive infrastructure by making sure there were more Chinese people around to use it. Under the one-child policy, China's population was projected to shrink by about one-third before the end of the century at the same time as it rapidly ages. The result would be a country with about two people of working age for every one person older than 65 by the year 2050, and possibly more old people than young people capable of supporting them in their dotage by the year 2100.
The obvious solution would be to allow everyone to have more children and remove the financial incentives for people who only have a single child. To its credit, the government is moving in that direction. Under the proposed reform, anyone who is an only child would be allowed to have two children. Since the one-child policy dates to the late 1970s, this should mean that almost everyone who is thinking of having a second child will be allowed to do so.
This restriction is still too severe, since countries need to produce at least 2.1 children per mother on average to keep the population from shrinking. Encouragingly, the Xinhua report quotes an official saying that China's population should be prevented from falling, which suggests that there may be further scope for reform.
China can't avoid the consequences of its past policy mistakes, but these three changes all suggest that the leadership is willing to take small steps to address the country's challenges. The question is whether the pace of reform will be fast enough.
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