The quiet revolution
WITH China, the received wisdom belongs to the pessimists. Figures this week revealed that growth has slowed sharply and deflation set in, as the economy is weighed down by a property slump and factory production is at its weakest since the dark days of the global financial crisis. In the first three months of 2015, GDP grew at “only” 7% year-on-year. Growth for 2015 will probably be the weakest in 25 years.
Fears are rising that, after three soaring decades, China is about to crash. That would be a disaster. China is the world’s second-largest economy and Asia’s pre-eminent rising power. Fortunately, the pessimists are missing something. China is not only more economically robust than they allow, it is also putting itself through a quiet—and welcome—financial revolution.
The robustness rests on several pillars. Most of China’s debts are domestic, and the government still has enough sway to stop debtors and creditors getting into a panic. The country is shifting the balance away from investment and towards consumption, which will put the economy on more stable ground (see article). Thanks to a boom in services, China generated over 13m new urban jobs last year, a record that makes slower growth tolerable. Given China’s far bigger economy, expected growth of 7% this year would boost the global economy by more than 14% growth did in 2007.
However, the real reason to doubt the pessimists is China’s reforms. After a decade of dithering, the government is acting in three vital areas. First, in finance, it has started to loosen control over interest rates and the flow of capital across China’s borders. The cost of credit has long been artificially low, squashing the returns available to savers while, at the same time, succouring inefficient state-owned firms and pushing up investment. Caps on deposit rates are becoming less relevant, thanks to an explosion of bank-account substitutes that now attract nearly a third of household savings. Zhou Xiaochuan, the governor of China’s central bank, has said there is a “high probability” of full rate-liberalisation by the end of this year.
China is also becoming more tolerant of cross-border cash flows. The yuan is, little by little, becoming more flexible; multinational firms are able to move revenues abroad more easily than before. The government’s determination to get the IMF to recognise the yuan as a convertible currency before the end of 2015 should pave the way for bolder moves.
The second area is fiscal. Reforms in the early 1990s gave local governments greater responsibility for spending, but few sources of revenue. China’s problem of too much investment stems in big part from that blunder. Stuck with a flimsy tax base, cities have relied on sales of land to fund their operations and have engaged in reckless off-books borrowing.
The finance ministry now says it will sort out this mess by 2020. The central government will transfer funds to provinces, especially for social priorities, while local governments will receive more tax revenues. A pilot programme has been launched to clear up local-government debt. It lays the ground for a municipal-bond market—despite the risks, that is better than today’s opaque funding for provinces and cities.
The third area of reform is administrative. In early 2013, at the start of his term as prime minister, Li Keqiang pledged that he would cut red tape and make life easier for private companies. It is easy to be cynical, yet there has been a boom in the registration of private firms: 3.6m were created last year, almost double 2012’s total.
The high road of lower growth
In time, these reforms will lead to capital being allocated more efficiently. Lenders will price risks more accurately, with the most deserving firms finding funds and savers earning decent returns. If so, Chinese growth will slow—how could it not?—but gradually and without breaking the system.
Yet dangers remain. Liberalisation risks breeding instability. When countries from Thailand to South Korea dismantled capital controls in the 1990s, their asset prices and external debts surged, ultimately leading to banking crises. China has stronger defences but nonetheless its foreign borrowing is rising and its stockmarket is up by three-quarters in six months.
And then comes politics. Economic reforms have high-level backing. Yet the anti-corruption campaign of President Xi Jinping means that officials live in fear of a knock on the door by investigators. Many officials dare not engage in bold local experiments for fear of offending someone powerful.
That matters because reform ultimately requires an end to the dire system of hukou, or household registration, which relegates some 300m people who have migrated to cities from the countryside to second-class status and hampers their ability to become empowered consumers. Likewise, farmers and ex-farmers need the right to sell their houses and land, or they will not be able to share in China’s transformation.
Ever fond of vivid similes, Mr Li says economic reforms will involve the pain a soldier feels when cutting off his own poisoned arm in order to carry on fighting. “Real sacrifice”, he says, is needed. China’s quiet revolution goes some of the way. But Mr Li is right: much pain lies ahead.