What will be done to solve the macroeconomic imbalances in China? Finally, there is an answer. The Chinese leadership has recently unveiled a comprehensive and structural economic reform program in the Third Plenum of the Eighteenth Central Committee. However, whether the progressive proposed reforms can be ever implemented is still a mystery. In my opinion, there are serveral crucial factors on the national, regional and global level that determine the feasibility of the program. In order to understand what factors will determine the feasibility, first of all, we need to understand what the reforms are. The summary of the important reforms is as follows.
To sum up, the program embraces Washington Consensus. The functions of market and government are clearly delineated. Market will play a decisive role in allocating resources. Prices of some natural resources such as oil and electricity will be determined by market forces. Government will intervene less and remedy possible market failure. Fair competition is encouraged in order to attain market efficiency. Monopolisitc advantages of state-owned enterprises wil be undermined. Liberlization of interest rate and Reminbi will be fostered. It is an unprecedented step towards a more sophiscated and capitalistc economy.
However, it is expected that the restructuring of the economy will face great resistance. On the national level, local protectionism, a curse to sustainable long-term growth, would be a great obstacle to the reforms. Aside from the serious corruption of local officals, the long lasting institutional fault line between central government and local governments has always been a trouble to Beijing. The point is that the incentives of local governments may not align with those of the central authority. While the central authority announced the economic program in order to solve the fundamental weakness of the economy, local governments might act otherwise if this violates their interest.
By executing their administrative power, they distort market mechanism. Their tricks include setting up entry barriers, restricting fair competition, offering preferential treatments to local enterprises, imposing prohibitive tariff to foreign enterprises, and even establishing laws and documents to limit the choice of product. Sometimes they might even break laws to achieve their goals. Surely they are harmful to the economy as a whole, and the situation is getting worse. According to Professor Larry Hsien Ping Lang, a renowned expert in Chinese economy, “local characteristic” may be used as an excuse to counteract the economic reforms.1 If Xi Jinping and Li Keqiang cannot deal with this deep-rooted problem of fragmented economy properly, it is impossible for the reforms to be proceeded effectively.
State-owned enterprises (SOEs) which have a vested interest would also be a powerful counteracting force. Part of them are well-known for serious corruption and inefficency in governance. Before the reforms, due to preferential treatments and protection of the government such as entry barrier and price regulation, SOEs has been enjoying from the ‘visible hand’. Several traditional industry such as electricity, telecommunication, transportation and fossil fuel industries are monopolized by SOEs. For instance, fossil oil industry is monopolized by China National Petroleum Corporation (CNPC), Sinopec and China National Offshore Oil Corporation (CNOOC). Market entry is restricted. Oil price is determined by the National Development and Reform Commission (NDRC) at a high level.
Imagine those reforms are realized, those benefit must be taken away. Once the market entry is opened and price is endogenously determined by the market, they need to face severe competition in the market. Their market shares will be competed away. This is also applicable to other industries. All they want is to remain the status quo. Thus, it is easy to envisage how strong the SOEs will oppose to it. The leadership has to recognize this obstructive factor and figure out a solution.
On the regional level, the possibility of a war between Japan and China, due to the deteriorating Snio-Japanese relations and the escalating war fever, may become a very decisive factor in hindering the progress of the reforms. Recently, the Senkaku Islands dispute between China and Japan has been intensifying. In November 2013, China set up the "East China Sea Air Defense Identification Zone" which composes of the Senkaku Islands. This has aroused great discontent in Japan, which claims the sovereignty of the islands. Furthermore, Shinzō Abe, the Prime Minister of Japan, has adopted an extremely strong and aggressive attitude towards the dispute. Japan has normalized its military posture. On the other hand, China has also increased its frequency of cross-nations military practices. War fever has been escalating in Asia-Pacific region. If there is a war, economic reforms must be put behind. Resources will be diverted for military purpose. Implementation of the reforms becomes impossible.
Some argue that a war between the two countries is impossible. Firstly, Japan is under the protection of the United States by the Treaty of Mutual Cooperation and Security between the United States and Japan. So China dare not start a war. Secondly, Japan cannot launch a war against other countries under its current constitutional law. Thus the above worry is redundant.
Nonetheless, a war between them can be regarded as a ‘black swan’ event.2 According to the Black Swan Theory, a black swan event is an unpredicted and rare event, an outlier in statistical perspective. Even though the possibility of its occurrence is very tiny, it can have a tremendous impact. One should not overlook a black swan event. For instance, no one could predict the Sarajevo Assassination which eventually led to the outbreak of World War I. Again, no one could predict the dissolution of Soviet Union which led to a dramatic change in the political scene in Eastern Europe. These are the famous examples of black swan event and a war between them can be one of them. In addition, it is reported that Shinzō Abe has been planning to modify the constitutional law to legalize the expansion of military force. It seems that Abe has been preparing for a war. Thus, the situation may not be as optimistic as it seems.
On the global level, The uncertainty in global economic landscape affects the feasibility of the reforms. First of all, one needs to understand the cruel fact that the structural reforms will foster long-term growth at the expense of short-term growth. It takes time for the economy to adapt to the new structure and the mode of operation . Readjustment to the equlibrium level is also time-consuming, especially for this giantic economy. Xi Jinping also admitted the structural reforms would mean a slower growth in the 8th G20 Summit. Undoubtedly, China does not want to see a hard landing in GDP growth.
Reports from financial institutions seem to be optimistic. According to World Economic Outlook by International Monetary Fund, it is expected that there will be a slight growth in world output.3 China is also expected to grow at a rate of 7.5% in 2014 in terms of GDP, just a slight decrease comparing with that of 2013. The Investment Strategy Group of Goldman Sacs also expects a 6.8-7.8% growth.4 Beijing’s wish is likely to become true. However, the effect of the tapering of Quantitative Easing by the Federal Reserve is still uncertain. The potenial capital flow reversals in emerging economies, such as India and Indonesia, may also lead to a devaluation of their currencies, which undermine the competitiveness of China’s exports. The crisis in the Eurozone remains unsolved. All these factors must not be neglected.
From my point of view, the feasibility of the reforms depends positively on the performance of the world economy and, more specifically, the demand for China’s goods and services. If the global economy performs better than what Beijing expected, the structural reforms will be acclerated, especially those which hinder short-term economic growth, vice versa. The most related reform would be the liberlization of RMB. Currently, the People’s Bank of China (PBoC) is adopting a managed float regime. RMB is being allowed to float around a central parity with reference to a basket of currenies. However, RMB is now deemed as undervalued. (Although there has been continuous, if little, appreciation) The big discrepancy in The Big Mac Index published by the Economist is a strong evidence.5 The reasons bebind its undervaluation are so apparent: to stimulate export and attract foreign investment. Thus it is certain that the liberlization of RMB will lead to short-term fall in export and investment. The reform will probably be fostered when the world economy is booming.
Change is always difficult, and maybe painful, but necessary. Whether the reforms can be sucessfully implemented depends on how Beijing will do. It is hoped that Beijing can show its perseverance in restructuring the economy.
1. Larry Hsien Pang Lang : <谁是三中全会《决定》执行的最大阻力？>, <<郎咸平_新浪博客>>, http://blog.sina.com.cn/s/blog_4120db8b0102eb3n.html
2. Nassim Nicholas Taleb : <<The Black Swan: The Impact of the Highly Improbable>>, Random House, 2007
3. International Monetary Fund : <<World Economic Outlook>>, http://www.imf.org/external/pubs/ft/weo/2014/update/01/pdf/0114.pdf
4. Investment Management Division, Goldman Sachs : <<Outlook: Within Sight of the Summit>>, http://www.goldmansachs.com/what-we-do/investment-management/private-wea...
5. The Economist : <<Interactive currency-comparison tool :The Big Mac Index>>, http://www.economist.com/content/big-mac-index
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