In a speech this month to Communist party officials (reported in yesterday’s New York Times), Li Keqiang, the recently chosen Prime Minister of China, called for greater reliance on the private sector and reduced dependence on governmental regulations and oversight of the economy. In a remarkable admission he said “The market is the creator of social wealth and the wellspring of self-sustaining economic development.” Several troubling developments in the Chinese economy led to Li’s speech.
China has had very rapid economic growth during the past 30 years that lifted many hundreds of millions of Chinese out of dire poverty. However, during the first quarter of 2013, China’s GDP expanded by “only” 7.7% compared to a year earlier. Although China’s rate of growth is still fast compared to other nations, it is considerably lower than its growth during earlier years. For example, from 2003 to 2011, China’s GDP grew at rates that ranged from about 9% to over 14%. While the last quarter may be only a temporary decline in China’s growth rate, it is consistent with a slowing of growth during the past several years, and with other adverse developments in the Chinese economy.
The Chinese economy has used low wages to specialize in labor-intensive products for the export market. This model is breaking down because wages have risen greatly during past decade, and export markets have shrunk because of reduced demands from the sluggish economies of the European Union, Japan, and the United States.
Chinese growth has been very uneven, as urban areas have prospered much more than rural areas. This has greatly increased income inequality, especially between farmers and factory workers. The increase in inequality has been magnified by China’s policy of restricting migration from farms to cities, and by not providing the same education and health care to these migrants that is available to other city residents.
China has encouraged investment and discouraged consumption by allowing the state-run banking system to provide investors with low interest rates and easy credit terms, and by price controls and other restrictions on the provision of consumer goods. As a result, private consumption accounts for only about 35% of China’s GDP, compared with over 70% in the United States. Since China’s exports are expected to rise more slowly in the future, in part because its currency will appreciate in value relative to the dollar and other major currencies, the domestic market will become a more important destination for China’s production.
These are some of the problems that explain Prime Minister’s Li desire to unleash the power of the private sector to galvanize China’s economy. A good place to start is with the state-owned enterprises (SOEs) that are still very important in manufacturing, banking, energy, and telecommunications. These SOEs frequently have protected economic positions because competitors are not allowed to enter; for example, three state-operated enterprises divide up the telecom sector. Studies indicate that SOEs are on the whole considerably less efficient than private companies, partly because SOEs get many subsides, including loans on subsidized terms from the state-run banking system, and soft budget constraints.
Therefore, it is particularly important to curtail the lending and other practices of state-owned banks, and to allow private domestic and foreign banks to become more important providers of credit. This would encourage private enterprises by giving them access to credit on terms that are market driven, and that are more comparable to the terms available to the SOEs.
The many millions of migrants from rural sectors to urban areas should be fully legitimatized, so that they have the same rights to education, health, and credit as persons born in cities. This would help reduce inequality and increase productivity by speeding up the migration out of the less efficient parts of the rural sector into more efficient factories and service activities.
The financial crisis and major recession that was brought about in part by excesses in the private banking sector in the United States and some other developed countries led to a widespread reaction against capitalism and the private sector. This happened as well in China for a couple of years as the state sector expanded relative to the private sector.
China’s new leaders have now made clear that the country needs to rely much more on the creativity and resourcefulness of the private sector if it is to move beyond middle income status, and become a major economic power as measured not only by aggregate GDP, but also by per capita GDP. It remains to be seen whether even the new leaders can overcome the strong opposition of SOEs and other special interest groups to the implementation of a major shift toward the private sector.