Success of China’s economic reforms depends on better governance

Since beginning to reform its economy in 1978, China has been on a catch-up growth trajectory that has made it an economic superpower. The country now accounts for 15.4 percent of global GDP and 28 percent of annual growth in global GDP, and its international trade and investment ties are deep. Reform lifted at least 330 million people out of poverty over the past 35 years.

But today the forces that drove China’s three-decade-plus economic boom are losing potency. Favorable demographic factors – rapid workforce expansion and a mass shift of labor from the agricultural sector into more productive jobs – have run their course, and China’s working-age population is poised to shrink. Investment-driven growth centered on infrastructure and heavy industry shows rapidly diminishing returns, while new financing for services, higher-value manufacturing, and public welfare will take time to put to work.

{mosads}China has not exhausted its growth potential. Far from it: many more years of high-quality growth are not only possible but vital, as China’s economy remains underdeveloped and inefficient in problematic ways. However, unlocking this future potential requires a profound change in how China manages its economy, since business as usual is failing to deliver growth today, let alone resolving structural challenges that impede growth ahead.

China’s leaders recognize this conundrum. A year ago, at the Communist Party’s Third Plenum, President Xi Jinping announced a comprehensive program of economic reform that went well beyond what most observers anticipated. This top-down overhaul, combined with President Xi’s evident willingness to tackle political resistance to change, increases the odds that China can find its way to household consumption-driven growth that can substitute for antiquated investment- and export-led models. Encouragingly, by unpacking China’s reform proposals from their bureaucratic framework and reorganizing them thematically, as we have done for a report published today, one finds they are broadly convergent with advanced-economy practice. If implemented successfully, this program will bring China much closer to a modern, market-oriented model.

The economic stakes in China’s shift are enormous. We estimate that reform will make a positive difference across most measures of 2020 economic performance. The economy will be $2 trillion larger. Some $700 billion will be added to outbound investment flows, along with trillions more dollars of foreign investments into China. China’s exports and imports are boosted by $347 billion and $1.1 trillion, resulting in a balanced current account with modest trade deficits and offsetting investment income surpluses rather than a massive external surplus.

Some observers express reasonable skepticism about China’s commitment to implement its economic initiatives. One source of doubt is precedent: some of China’s current goals – such as anti-corruption, environmental protection, and rationalization of state-owned enterprises – were set out previously to little effect. Will this program be different?

After reviewing the evidence of action since November 2013, we believe the program already is different: China is making progress on an economic overhaul. Beijing has moved decisively to reform the fiscal relationship between the central and local governments, and followed through on reforms to the financial system. In competition policy and treatment of state-owned enterprises, China has started clearing away impediments to market forces, but the path toward even-handed treatment of all companies – especially foreign firms – is uncertain. For land, labor, environmental and innovation policy, China has made initial changes and issued aggressive timetables, though the reform challenges are so great that it is too soon to celebrate.

This unmistakable but uneven progress points to a second source of doubt about how far and fast it will go: these regulatory reforms depend on better governance. The Third Plenum program would transform China into a modern economy and regulatory state, where bureaucrats and administrators put the rule of law and due process ahead of politics and special interests. The program sets out a revised mission statement for government and the need to rebalance power between central and local authorities, between the state and the Communist Party, and between the government and the populace.

Will these necessary economic and governance reforms take hold? As we approach the one-year anniversary of the Third Plenum, which focused on economics, the Fourth Plenum, on the outlook for rule of law, is taking place in Beijing this week, and the outcome from it will provide an indication. A fresh approach to due process and rule of law is clearly necessary to fulfill China’s economic potential.  While such a new direction seems unlikely to some, bold accommodations to the necessities of growth have defined China’s choices since 1978. Whether the political system is ready to implement such change again today is the decisive question.

Sheeran is president and CEO of Asia Society. Rosen is co-founder and partner at the Rhodium Group, and author of the new Asia Society Policy Institute study Avoiding the Blind Alley: China’s Economic Overhaul and its Global Implications.