Though many of my arguments for the US economy argue for a larger government role, when it comes to China, I found this to be a hopeful development for China.
In a bold speech to party cadres, the country’s new prime minister, Li Keqiang, said this month that the central government would reduce the state’s role in economic matters in the hope of unleashing the creative energies of the nation. On Friday, the Chinese government issued a set of policy proposals that appeared to be intended to show that Mr. Li and other leaders were serious about giving market competition and private businesses a bigger role in investment and setting prices.
Of course, the extent of this rebalancing of the state’s role in their economy will have to be seen, but numerous recent developments are pushing the Chinese government in this direction, so I suspect there will be some follow through. Their export/mercantile model is faltering, slowing growth and investment. Higher labor costs and currency appreciation have also dampened external competitiveness.
In other words, the hope here is that China is moving away from dependence on excessively high savings and currency management to generate trade surpluses (mercantilism) toward developing more internal markets. As Nick Lardy, someone who thinks clearly about this point, put it:
…government controls on interest rates, the exchange rate and the price of energy had resulted in a huge misallocation of capital and imbalanced growth. Making those prices more market-driven would help rebalance and improve the economy…“These reforms would raise household income and reduce savings, providing a double-barreled boost to private consumption, helping to offset the drag of moderating investment expenditure…“
So, part one here is the need to see Chinese savings go down and consumer spending go up. Remember, we consume about 70% of our GDP; in Europe it’s about 55%; in China, it’s under 40%. Now, no one’s talking about their replicating the Mall of America or embracing American consumer habits. But part of the imbalance to which Lardy is referring is a policy that implicitly subsidizes “everyday low prices” here in the US leading to underinvestment, underconsumption, and too much poverty in China.
One other thought—a less enthusiastic one—came to mind here: economic liberalization in Russia, which hasn’t gone so well. The reminder is that, as economist Dani Rodrik argues, national institutions matter when closed economies open up to market forces. There is a risk, especially if, as in Russia, oil reserves are involved, that imbalanced power restricts the benefits of more market forces from flowing to the people. That type of imbalance is even more dangerous and intractable than the imbalanced current accounts and trade flows.
So, a key factor to watch as this unfolds—besides the fundamental question of precisely what is unfolding here—is how much these potential new developments help the Chinese poor and evolving middle classes. In other words, don’t just watch the aggregate shares in the national accounts. Watch the power.