Why Effective Government Interventions Can Lead to Efficient Market Reform in China

Abstract

This paper argues that the current Chinese government believes market reform has the best chance to succeed if it is gradual, experimental and aided by government interventions. In 2016, for the first time in over a decade, state investment has overtaken private investment in China in terms of growth rate. China is facing some unique challenges not only relative to the previous Asian developmental states but also to its own experiences of reform. Lackluster external demand and rising costs of labor, land and other means of production are pushing China to find new growth engines by upgrading its economy from labor-intensive to more capital- and technology-intensive. Meanwhile, ballooning housing bubble coupled with local debt accumulation have pressured the central government to be cautious with de-leveraging the inefficient and debt-laden state firms and marketization. Therefore, China is carrying out the so-called “dual-track” reform: on the one hand, China is pushing through the supply-side reform, with five major tasks: cutting industrial capacity, destocking, de-leveraging, lowering corporate costs and improving weak links; on the other hand, China, as always, stresses “stability” whenever possible because the government is aware of the financial and fiscal risks associated with reform that may prevent the country from achieving its growth target, which is set at 6.5% for 2017. To establish realistic expectations for the next phase of China’s reform, policymakers and business leaders must understand the major risks ahead in carrying out market-oriented reforms.