On Economy, Will Government Walk The Walk?

With China posting its lowest quarterly GDP rise since 2009, The Diplomat’s Minxin Pei writes that while state control of the Chinese banking system may help to avoid a seizure in the short-term, the economy’s structural inefficiency poses more severe long-term problems in the absence of a demonstrative commitment to reform:

In this model, the Chinese state collects an excessive amount of revenue (the current estimate puts effective aggregate taxes at nearly 35 percent of GDP), provides inadequate social services, and allocates most of the capital inefficiently through a highly politicized banking system (in which loans are made on the basis of government policy and political connections, not market principles). To use a medical metaphor, this model is the cancer that will kill China’s long-term prosperity.

By all accounts, the Chinese people have already paid a huge price for this cancer. Their share of the national income has fallen to 42 percent of GDP. That is why Chinese household consumption, at 35 percent of GDP, remains the lowest of the world’s major economies. The investments made by the Chinese state may have given the Communist Party a lot of prestige (think of the country’s modern infrastructure and ambitious high-tech plans), but delivers preciously few real benefits to its people. Chinese state-owned enterprises have thrived because of their access to practically free capital, but their efficiency remains abysmal compared with domestic private firms or their Western rivals.

In a crisis, a far-sighted government should have the courage to push through tough reforms and remove these “cancerous cells” in the Chinese economy. So today, Beijing must try a different strategy to revive its growth. Tax cuts, deregulation, privatization, and increasing funding for social services can all help raise domestic consumption and promote growth. The other option – repeating the folly of stimulating the economy through state-led investment – would make China’s economic cancer all but incurable.

More negative news arrived for China’s factory sector today, with the official purchasing managers’ index (PMI) falling more than expected in May.


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