From outside China, the Bo Xilai trial looks like the Chinese news event of the year, one of the preoccupations of Western media, along with corporate corruption and the clampdown on American and European companies. Yet these issues are no more than sideshows to the most important economic event of recent times, the unveiling and ratification of a major program for reforms for the next decade, which will occur at the Chinese government’s third plenum in November. The reforms promise to bring another great leap forward in China’s dramatic ascent.
Chinese officials will reveal how long China will need to make the transition from an investment-led, middle-income country to an innovative, consumer-driven, high-income one — and thus when it will become the world’s largest economy. Can China circumvent what we know as “the middle-income trap” that has for decades denied high-income status for Latin America and Asian countries like Malaysia and Thailand?
The challenges that China’s new leadership faces in pushing for rising levels of innovation, entrepreneurship and skills will be the main discussion points this week at the New Champions summit in Dalian, China, organized by the World Economic Forum under the leadership of executive chairman Klaus Schwab. The summit recognizes the important truth that China’s degree of success will determine global growth: it will determine whether the twenty-first century will be the Asian century, and whether by mid-century Asia — which not long ago represented just 10 percent of the world economy — will represent half or just a third.
On paper the November plenum of the 18th party committee is just the latest in a sequence of party events that celebrate China’s new leadership. Yet it is the culmination of a carefully planned process of deliberation on reforms. It started with the Central Work conference last year, the second plenum in March, the National People’s Conference in June and, most recently, this summer’s brainstorming session at the seaside Beidaihe retreat. Historically, third plenums have turned out to be much more than run-of-the mill events. At the third plenum of the 11th party committee in 1978, Deng Xiaoping launched the market reforms that set China on its industrial course to becoming the world’s second-largest economy. During the third plenum of the 14th committee in 1993, under Zhu Rongji, Chinese leadership ratified a “socialist market approach” of combining markets and state decisions, which led to an unprecedented era of industrial growth.
Now with the third plenum focusing on China’s next challenge — the shift to a high-productivity, high value-added, consumer-based economy — the aim is to double average incomes by 2020, to achieve 70 percent-plus urbanization by 2025 and to have the world’s largest supply of graduates. If it succeeds, China will quickly surpass America as the world’s largest economy. By 2025 it will probably move from middle-income status to high-income status and make around 1 billion of China’s 1.3 billion population “moderately prosperous” middle-income citizens on their way to realizing what President Xi Jinping has called the “Chinese dream.”
By “deepening reforms in all aspects” across those remnants of the command economy that survived the market push from the 1980s, economic policy — once focused exclusively on rapid growth — will now give priority to structural change, reinforcing what President Xi calls “socialism with Chinese characteristics.” According to this week’s statement by the new premier, Li Keqiang, “[China] can no longer afford to continue with the old model of consumption and high investment.” Reform, as he puts it, is “the driving force.” A self-imposed revolution will “let go of administrative powers and return to the market whatever can best be handled by the market,” bringing China closer to the European model of a “social market economy.”
It is, of course, inevitable that as China moves from a focus on export-led growth, it will have to address structural issues, such as restrictions on labor mobility and private credit. In recent years, under the first wave of modernization, China’s progress to middle-income status has been astounding and dramatic. In the first decade of the century, China became the world’s largest manufacturer. In 2009, China surpassed Germany as the world’s largest exporter. In 2010 it passed the U.S. to become the world’s largest car producer. But already, even before this next stage of modernization — diversification — is underway, China is gradually reducing its role as a processor of lower-value-added technological goods. As a share of national income, services have just overtaken manufacturing, and since 2011 consumer spending has been a bigger driver of growth than investment. In the future, China will depend less on exports to the West. In the last 10 years, merchandise exports to developing economies have already doubled, to 25 percent. And China is now sending capital around the world. Its portfolio of $110 billion in loans since 2000 rivals that of the World Bank.
For 35 years, China’s export-led growth — almost 10 percent annually – has been spectacular, lifting 500 million Chinese out of poverty. But as the World Bank “China 2030” report acknowledged (in conjunction with China’s economic ministry), productivity per worker and income per head are still far below America’s, so the second wave of modernization must break China out of that feared potential “middle-income trap.” Typically, a country’s growth slows as soon as its income is among the top 30 percent in the world. This slowdown occurs because as a country’s income rises, it is no longer able to compete on low wages, and it is unable to compete on value-added because of low productivity. Indeed, the China 2030 report forecasts the loss of 80 million of China’s 130 million manufacturing jobs to lower-wage Asia and Africa.
Despite international worries — most recently about both off-balance-sheet debt and the impact of the withdrawal of the West’s quantitative easing — China’s leadership believes it can beat the odds. Many economists, like Ruchir Sharma, author of Breakout Nations, believe that within fifteen years China will make it to a $20,000 average per capita income by combining its current manufacturing dominance with its future role at the geographic center of a global supply chain.
Of course, China no longer can rely on “one-off” advantages such as the move from an agricultural to an industrial economy, comparatively low-cost labor, and the boost from membership in the WTO. With its urban population expected to expand by 300 million, and aspirations rising among the Chinese people, China knows it will have to move quickly to exploit the “Third Industrial Revolution” from 3D printing and digital design to nanotechnology, biotechnology and genetics, hence its one million research and development workers and its plans for 100 million more graduates. The new growth agenda will need that talent, but it will also need an obsessive focus on innovation, enterprise and social reform — the topics under discussion at the World Economic Forum. The requirements are:
Liberalization of interest rates and the prices of producer goods and utilities;
A fairer competitive environment for private enterprises;
The opening up of the land ownership and household registration systems;
Local government fiscal reforms and the end of an overreliance on highly volatile land sales through the creation of a solid local tax base; (Debts owed by all levels of administrations, government financing vehicles and other public entities are estimated at twice the annual gross domestic product.)
The gradual internationalization of the yuan, most recently with free convertibility with the Australia dollar and the UK currency swap agreement;
But perhaps the most important barriers to long-term success are the disparities in wealth, now being addressed under the premier’s desire to “promote social equity.” This is a prompting for tax reform and plans for better health and welfare benefits. A phrase unfamiliar to the West, but now increasingly the subject of official pronouncements, is “the mass line” – a campaign that encourages Communist Party leaders to prioritize the needs of the people.
But like other emerging (in China’s case, re-emerging) market economies in an increasingly interdependent world, China’s success depends not just on a new reforming government, but on a continuously expanding world economy. China’s historic decision to join the G20 was not just a recognition of the country’s new status in the world, but the start of a new era of Chinese world leadership. Chinese leaders are too shrewd to believe post-2008 stories about the decoupling of the West and the rest. But, with the West looking inwards, recent G20 meetings, including last week’s in Russia, have done little to halt the slowdown in world growth from a potential 5 percent to 3 percent. Without concerted global action, Japan is expected to grow by only 1.8 percent annually until 2025, with Europe doing little better. Even the now faster-growing America may record little more than 2 percent average growth during that time period.
The global way forward is through cooperation comparable to the creation of the liberal trading orders in the years after World War Two. The West — once the world’s biggest producer and consumer — could stimulate world growth. In the mid-2020s Asia — already the world’s biggest producer and soon to be the world’s biggest consumer — will be strong enough to drive the world economy forward. But today we are at a transition point. The majority of production is now outside of the West. But with the majority of consumption still in the West, neither the West nor the emerging markets can prosper in isolation from each other. China and America should return to the idea pioneered by the G20 of 2009: a global growth compact under which China agrees to boost growth, increasing its consumer imports in return for America and Europe boosting growth through expanding investment and infrastructure The IMF calculated that strategy would increase growth by 3 percent over 3-4 years and create up to 50 million jobs. Today inflation is low, there is surplus of savings and if, as one study suggests, the United States could increase its share of China’s imports from its current 7 percent to 10 percent, that increase alone would over time boost U.S. exports by an additional $100 billion, and support almost 500,000 new jobs, a win-win for both countries.
Instead of struggling through the fallout from yet another failed G20, heightened cooperation would raise growth, increase employment, raise living standards all round and address poverty — the rocket the post-crisis world now needs.