The Story So Far
In the decades following China’s 1978 decision to reform and open, its growth was driven by demographics and structural adjustment – letting market logic reshape the economic landscape. But in recent years, as the easier phase of development gave way to middle-income challenges, Beijing has attempted to reassert control over investment and markets. This was not the first choice. President Xi Jinping’s inaugural 2013 Third Plenum economic plan – while still couched in Communist Party nomenclature – was distinctly geared toward a decisive role for markets. Implementation of those goals, rather than aspiration, has been most lacking. By tracking China’s own 2013 objectives across 10 economic domains, The China Dashboard seeks to inform public debate with objective data on just how close to or far from those aspirations China is trending.
Gauging China’s policy progress objectively is essential for understanding what sort of economy – and polity – China will have domestically in the future, and just as critically what role China will play in the international community. The current tensions between China and the United States represent the sort of situation we previously anticipated at the conception of the Dashboard project and seek to temper through the dissemination of respected data indicators and interpretation. For this reason, we eschew normative advice or prognostication about the future of the Chinese economy, though we do point out clear conundrums in the outlook.
China’s economy was the first hit by COVID-19 and the first to rebound. Reform proclamations issued in April and May by implication acknowledged that myriad past plans had never been accomplished, and that work to reorient China to market-based systems remained to be done – urgently. The recovery seen today is not the result of marketization. Quite the opposite, it is the result of emergency government interventions that have buoyed activity in recent months. However, by further placing the burden of public policy on ostensibly commercial or murky quasi-governmental balance sheets, the interventions have made it even harder to realize market allocation reform ambitions without risking a meltdown. Given the hostility leveled at the Communist Party of China from the United States, and China’s superior economic performance amid the pandemic, leaders in Beijing could be forgiven for thinking they had made the right call. But in the long-term picture, China’s deferral of reform is not a response to international hostility but a cause of it, and today’s economic expediency will make the net cost of righting China’s policy foundations much greater tomorrow.
Winning the Battle, but Not the War
As we go into the autumn of 2020, the outlook for China’s economy is more important than ever. The prognosis for recovery from the COVID-19 recession is crucial: even before the pandemic, China accounted for more global growth than the United States, Europe, and Japan combined, and with the rest of the world in various stages of lock down, it is the only place reporting positive year-on-year (yoy) activity.
But just as important as the quantity of China’s growth is the question of what is fueling it: reform or statism? Because a statist recovery, if it displaces and delays important policy reform, will sacrifice China’s future growth and will further provoke a protective backlash from the liberal market world. Consider the quantity and quality dimensions of China’s economic recovery.
As of this writing, we have official data partway into the third quarter, through July 2020. China’s recovery has been uneven and driven mainly by government-juiced infrastructure and property construction. Investment contributed 5% to China’s 2Q2020 GDP growth of 3.2% yoy, while consumption subtracted 2.3%. Net exports also contributed positively to growth, as foreign consumers’ need for products from China – especially medical supplies and equipment – remained strong while domestic demand remained unrecovered. Weak household consumption was evident in the 1.1% yoy decline in headline retail sales in July. This imbalance points to slower growth in the second half of the year, though from this low baseline and thanks to good virus control, China’s consumption will continue to gradually pep back up.
The bottom line is that China has achieved a partial recovery from the COVID-19 recession. The sharpest uptick was seen in June as pent-up demand from five months of closure was released, quickly tailing off starting in July. China’s positive numbers were made possible by diligent lock-downs to break virus transmission in 1Q2020 and massive testing to contain new outbreaks, allowing growth-promotion policies to do their work. Debt burdens still mounting from the past stimulus made it impossible to restore 6%+ growth this year, but the 1%–2% full-year outcome Beijing is now tracking would be the world’s most impressive in this catastrophic year.
However, there is a problem with this strong showing. Unlike the advanced market economies, China is years behind on long-term structural economic policy reforms essential to future growth and stability. Everyone needs statism to steer through a pandemic; efficient markets remain crucial, and too distant, thereafter.
Beijing announced reforms in April and May that tacitly acknowledge that decades of past effort to instill market economy systems have failed to succeed. On April 9, 2020, the Communist Party and State Council jointly released guidance on making market mechanisms more important. On May 18, the Party Central Committee and the State Council issued a more comprehensive reform decree (“Guidance on Speeding Up the Improvement of the Socialist Market Economic System in the New Era”). The long list of critical reforms identified in this plan is similar to the 2013 Third Plenum Decisions plan. It other words, the promised 2013–2020 reform did not happen, as this Dashboard has been noting. The May guidance stressed employment priorities, the limits of monetary and fiscal policy for sustaining growth, and a host of reforms to the marketplace needed to staunch an exodus of private and foreign firms. These included greater sanctity for private business property; improved intellectual property (IP) and trade secrets protection; serious reduction of informal, illegal but common market entry barriers; and better competition review mechanisms.
Current Chinese policy essentially validates the conclusions we have drawn in the China Dashboard since our inaugural publication in mid-2017: reform work has not progressed sufficiently to date and has even regressed in important areas.
Our current period (1Q2020) Dashboard indicators and observations on present policy dynamics reinforce this story.
The announcements in April and May rekindled expectations for policy change, but so far implementation has only proceeded in limited policy areas. For example, in land reform two provinces are experimenting with rural land-use transfers, consistent with the April/May guidance to make land use more market driven. Nevertheless, that is just a limited experiment, and the basic problem built up over decades – that local authorities drag their feet on reform because they need illiberal land conditions to help them raise revenues – remains. Flexible rural property-use transfers are being piloted in limited areas but are years from widespread implementation.
More germane to the question of whether China is serious about adjusting the way its system works, and its implications for other nations, is the case of innovation policy. Innovation is one of two areas where we have reported progress since 2013; in the recent period, we saw a slew of commitments and plans, and even some encouraging admissions that too much emphasis is put on the number instead of the quality of patents in China. But consider how radically the world is changing in this area. The United States is ratcheting up restrictions on high-technology commerce with China and urging third countries to disrupt their engagement with Chinese production chains in telecommunications and to exclude Chinese vendors, on national security grounds. That is just one front in an expanding innovation showdown that is stretching beyond the United States. By ponderously including data as a new factor of production to be allocated by a yet to be explained new Chinese government mechanism, the April/May reform guidance raises more questions than answers. This is a classic case where Chinese policy response seems significant compared to past practice but is in fact very modest when gauged against current international circumstances.
The April and May policy pledges did not offer new fiscal and financial policy goals—most objectives, such as “clarifying local/central fiscal responsibilities” and “establishing a modern central bank system”—are the same as stated in 2013. The most important actions in finance this year have been continued cleanup of shadow banking and tighter controls on speculative investment. But in response to COVID-19, banks were instructed to extend loans and prevent defaults, even as bank runs and solvency issues mounted. In the fiscal space, Beijing has resorted to the same fiscal stimulus approach as in recessions past by channeling money to fund infrastructure construction. Those moves can certainly be credited with buoying infrastructure activity, which has been the workhorse of the present recovery. But they have nothing to do with making the market more central in capital allocation. And in fact, by further saddling banks, local government finance vehicles, and struggling firms with additional debt incurred in lieu of proper public sector financing of support, they will make the wholesale financial system reform China requires that much more difficult.
The View from Abroad
At a mid-year meeting on the economy, the Politburo Standing Committee announced a policy encouraging exporters to turn inward. Policy rhetoric around a shift to internal circulation has picked up in 2020; at the May 14 Politburo meeting, it was described as taking advantage of China’s “enormous” domestic market and demand as a new source of growth. The strategy says China’s manufacturing sector must focus more on serving the domestic market and securing critical technology supply chains. There are three ways to interpret this. First, it could be argued that the rest of the world economy is in serious trouble, and Beijing is preparing its firms and workers for that by steering them to the only market still growing – the home market. Second, this could be seen to reveal China’s expectation that it has no chance of satisfying foreign demand for economic reform, market access, political liberalization, and security pacifism, and so a backlash is inevitable and China must prepare for that. The third explanation for an inward turn is that leaders realize that it is reasonable and overdue that they ramp up domestic consumption instead of relying on foreign demand. If that is the case, Beijing is conceding to long-standing U.S. and other advanced economy demands for a more balanced trade picture but is couching the change in nationalistic terms rather than appear pliant.
Whichever of these hypotheses best explains China’s thinking, the underlying reality is that a trend toward less international engagement will persist for some time to come. If China does seriously attempt reform (whether admitting it or not), the same impediment remains that prevented movement in 2012–2020: stability trumps market efficiency. Fears of crisis prevent bold action. Political insecurity precludes open discussion and adaptation, as ideological loyalty to the Party’s unimpeachable judgment is treated as paramount.
A shift to internal circulation would not necessarily mean closing domestic markets to the world. It could result in a shift toward increasing consumption without more protectionism but requires first raising household incomes. But that change likely remains distant given Beijing’s track record on Dashboard indicators. In the meantime, by propping up domestic production while other countries remain in recession, China risks another buildup of overcapacity.
In the short term, China’s statist turn has helped achieve an unbalanced but enviable recovery. But problems are certain to erupt. In fact, they already are, internally. After the failure of Baoshang Bank last year—the first bank default since 1998—China has experienced a slow-motion banking crisis, as new companies and types of assets default, raising questions about government guarantees. Unemployment and labor market conditions have not created a firestorm for the Party yet, but the risk of popular ire is growing.
The Dashboard was born in the hope that China would prioritize convergence with liberal economic norms, and when it did so, that would be observed abroad in a timely manner so that an international consensus about mutual interdependence could be achieved. At a time of profound systemic dilemmas around the world, our indicators do present a conclusion, and it is consistent with China’s own policy pronouncements: China has not implemented reform in recent years and under the flag of COVID-19 is further deferring market liberalization even while talking about the importance of market allocation efficiency. This reality is driving the systemic rivalry with market democracies and will likely do so for some years to come regardless of electoral outcomes in any given nation.