But the model is no longer working that well. Partly, this is the product of success. China has become the world’s second-largest economy; its per capita income is that of a middle-income country. It cannot grow at the pace it did when it was much poorer.
But growth has dropped faster and deeper than many had predicted. This month, the International Monetary Fund forecast China’s annual growth around 7.75 percent for the next two years. But it could slow further because, the truth is, China’s authoritarian system has made significant mistakes in recent years.
When the financial crisis hit in 2007 and growth began to drop from a giddy 14 percent, Beijing responded with a huge expansion of credit and a massive stimulus (as a percentage of gross domestic product, it was twice as large as the 2009 American Recovery and Reinvestment Act). These two forces have created dangerous imbalances. Ruchir Sharma, who runs Morgan Stanley’s emerging markets investments and who predicted China’s slowdown a couple of years ago, says the crucial signal to watch is the pace of growth in private credit as a share of GDP. Over the past five years, that share has risen by an astonishing 50 percentage points in China, twice as fast as any other country.
To economists, the solution is obvious: reduce credit and investment, open up the economy, spur domestic consumption. In other words, stop favoring state-owned behemoths and exporters and encourage the Chinese people to spend more money at home. But that’s easier said than done. Nicholas Lardy of the Peterson Institute for International Economics notes that wages have declined faster than GDP, so Chinese might find it hard to ramp up spending right now. More important, all the investment and credit of the past decade has entrenched companies, industries and sectors that will resist any change. Can Beijing turn off the tap in the face of opposition from economically powerful groups, many of whom are politically well-connected or even related to members of the Politburo?
One of Beijing’s greatest strengths is that it constantly and honestly analyzes its economy. In fact, this critique could have been made by China’s new leaders. Li Keqiang, an economist who became premier in March, has given several surprisingly frank and critical speeches. The reforms he outlines would open important sectors of the economy to market forces, reduce the state’s role and provide incentives for domestic consumption. The question is whether these goals can be met and whether the reforms will be implemented after opposition gathers, as it surely will. Li’s predecessor, Wen Jiabao, made similar warnings, but nothing ever came of them.
Reform is hard in any country — as can be seen from Italy to India. It often means short-term pain for long-term gain. Most big developing countries — China, India, Brazil, South Africa — have slowed down in the past few years. In almost all cases, the cause was the same. When their economies were booming, these countries’ leaders avoided tough decisions. China had been the exception to this rule. But now it faces its biggest test. Success will suggest that there is still life in its unique brand of authoritarian capitalism and will extend the power of its ruling Communist Party. If it fails, well, China becomes just another emerging market with a model that worked for a while.
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