To grow, China must walk state-market tightrope

To maintain its growth trajectory, China must rein in credit expansion, increase tax and invest in public services

By Joseph Stiglitz  / 

Tue, Apr 08, 2014 - Page 9

No country in recorded history has grown as fast and moved as many people out of poverty as China over the past 30 years. A hallmark of the country’s success has been its leaders’ willingness to revise the country’s economic model when and as needed, despite opposition from powerful vested interests. Now, as China implements another series of fundamental reforms, such interests are already lining up to resist — can the reformers triumph again?

In answering that question, the crucial point to bear in mind is that, as in the past, the current round of reforms will restructure not only the economy, but also the vested interests that will shape future reforms — and even determine whether they are possible. Today, while high-profile initiatives such as the Chinese government’s widening anti-corruption campaign receive much attention, the deeper issue that the country faces concerns the appropriate roles of the state and the market.

When China began its reforms more than three decades ago, the direction was clear: The market needed to play a far greater role in resource allocation — and it has, with the private sector far more important now than it was before. Moreover, there is a broad consensus that the market needs to play what officials call a “decisive role” in many sectors where state-owned enterprises (SOEs) dominate. Yet what should its role be in other sectors and in the economy more generally?

Many of China’s problems today stem from too much market and too little government. Or, to put it another way, while the government is clearly doing some things that it should not, it is also not doing some things that it should.

For example, worsening environmental pollution threatens living standards, while inequality of income and wealth now rivals that of the US, and corruption pervades public institutions and the private sector alike. All of this undermines trust within society and in the government — a trend that is particularly obvious with respect to, say, food safety.

Such problems could worsen as Beijing restructures the economy away from export-led growth toward services and household consumption. Clearly, there is room for growth in private consumption, but embracing the US’ profligate materialist lifestyle would be a disaster for China, as well as the planet. The country’s air quality is already putting peoples’ lives at risk and global warming from even higher Chinese carbon emissions would threaten the entire world.

There is a better strategy: For starters, Chinese living standards could and would increase if more resources were allocated to redress large deficiencies in healthcare and education. Here, the government should play a leading role and does so in most market economies, for good reason.

The US’ privately-based healthcare system is expensive, inefficient and achieves far worse outcomes than those of European countries, which spend far less. A more market-based healthcare system is not the direction in which China should be going. In recent years, Beijing has made important strides in providing basic healthcare, especially in rural areas, and some have likened China’s approach to that of the UK, where private provision is layered atop a public base.

Whether that model is better than, say, the French-style government-dominated provision may be debated, but if one adopts the British model, the level of the base makes all the difference. Given the relatively small role of private healthcare provision in the UK, the country has what is essentially a public system.

Likewise, although China has already made progress in moving away from manufacturing toward a service-based economy (the GDP share of services exceeded that of manufacturing for the first time last year), there is still a long way to go. Already, many industries are suffering from overcapacity, and efficient and smooth restructuring will not be easy without government help.

China is restructuring in another way: rapid urbanization. Ensuring that cities are livable and environmentally sustainable will require strong government action to provide sufficient public transport, public schools, public hospitals, parks and effective zoning, among other public goods.

One major lesson that should have been learned from the post-2008 global economic crisis is that markets are not self-regulating. They are prone to asset and credit bubbles, which inevitably collapse — often when cross-border capital flows abruptly reverse direction — imposing massive social costs.

The US’ infatuation with deregulation was the cause of the crisis. The issue is not just the pacing and sequencing of liberalization, as some suggest, the end result also matters. The liberalization of deposit rates led to the US’ savings and loan crisis in the 1980s, while the liberalization of lending rates encouraged predatory behavior that exploited poor consumers. Bank deregulation led not to more growth, but to more risk.

One hopes China will not take the route that the US followed, with such disastrous consequences. The challenge for Beijing’s leaders is to devise effective regulatory regimes that are appropriate for its stage of development, a move that will require the government to raise more money. Local governments’ current reliance on land sales is a source of many of the economy’s distortions and much of the corruption.

Instead, the authorities should boost revenue by imposing environmental taxes (including a carbon tax), a more comprehensive progressive income tax (including capital gains) and a property tax. Moreover, the state should appropriate, through dividends, a larger share of SOEs’ value — some of which might be at the expense of these firms’ managers.

The question is whether China can maintain rapid growth — though somewhat slower than its recent breakneck pace — even as it reins in credit expansion that could cause an abrupt reversal in asset prices, confronts weak global demand, restructures its economy and fights corruption. In other countries, such daunting challenges have led to paralysis, not progress.

The economics of success are clear: higher spending on urbanization, healthcare and education funded by increases in taxes could simultaneously sustain growth, improve the environment and reduce inequality. If Beijing’s politics can manage the implementation of this agenda, China and the entire world will be better off.

Joseph Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University.

Copyright: Project Syndicate