By Matthew P. Goodman & David A. Parker
The Chinese economy has gotten off to a bumpy start in 2015. There are signs of a deepening slowdown, from lower-than-expected retail sales figures to an unexpected slide in employment. After 35 years of spectacular economic success, it appears that China’s old model of rapid, investment- and export-led growth is no longer sustainable. This has raised questions in Washington about whether the current leadership in Beijing will be able to manage the challenging transition to a “new normal” of slower and more sustainable growth.
From Washington’s perspective, it is clear that President Xi Jinping and China’s current leaders face an array of economic challenges that are qualitatively different from those encountered by any previous generation. Few countries have escaped the so-called “middle-income trap” that China today is struggling to break through. The demands on economic policy have burgeoned from a single-minded focus on growth to a multitude of goals including clean air, clean government and greater equality. Moreover, China’s political economy has become increasingly pluralized over the past decade; the range of actors competing to influence economic policy, from state-owned enterprises to environmental activists, has proliferated. All of this makes economic reform as challenging – and as imperative – as any time since Deng Xiaoping launched the “reform and opening” strategy in 1979.
Surprising many observers, the Xi administration got off to a fast start on reform in its first year. The Third Plenum in November 2013 unveiled an ambitious reform agenda – what China scholar Barry Naughton has referred to as a “vision statement with a to-do list” – organized around a central pledge to give the market a decisive role in resource allocation. Through the creation of a “Comprehensively Deepening Reform Leading Small Group” and other institutional changes, Xi reorganized the structure of the Chinese economic policymaking apparatus to position himself at its apex and to sidestep a gridlocked state bureaucracy. At the same time, he took an early and impressive command over the levers of Communist Party power, from personnel to propaganda, and has demonstrated a keen sense of political stagecraft.
More than a year after the Third Plenum, a “Xi Jinping style” of economic decision-making is gradually emerging. Due in no small part to his efforts to strengthen Communist Party control over economic policymaking and pursue a top-down reform model, decision-making under Xi is significantly more rapid, opaque and personalized than under the Hu-Wen administration. He has reversed the longstanding trend toward greater state control of economic policy, relying instead on the Party and, where necessary, empowering select ministries in priority areas (such as fiscal reform). At the same time, Xi has relied on the traditional tools of experimentation, incremental reforms, reshaping incentives to direct local economic actors and external pressure, to push a comprehensive economic and governance reform agenda. In many respects, this approach echoes successful reform drives of past eras, including that overseen by Zhu Rongji in the late 1990s and early 2000s.
Based on these and other changes (discussed in more detail in our full report), our assessment is that Xi’s efforts so far have increased the likelihood of achieving Beijing’s goal of “major progress” on the Third Plenum agenda by 2020. This is in spite of strong resistance from vested interests, such as state-owned enterprises, and an implementation process that has been uncertain, uncoordinated, and, in many respects, unenthusiastic on the part of the bureaucracy and local governments.
However, there are serious risks to this outlook. The Chinese economy is in the midst of a secular slowdown, and it is likely to slow further over the coming years. The rate at which this occurs – and whether or not Beijing can sustain a “middle-high” GDP growth rate while slowing the rapid buildup of debt – has major implications for the Chinese and global economy. Xi’s centralization of power, the anti-corruption campaign and his efforts to exercise stricter control over policy design and implementation have also produced unintended consequences, notably discouraging local officials from taking risks to implement market-oriented reforms. In the near-term, this could harm growth and undermine Xi’s reform agenda.
Like many in Washington, we also see an underlying tension in Xi’s agenda. Even as his administration has pledged to give the market a decisive role and is seeking to build an “innovative society,” greater restrictions on such things as foreign firm participation in the economy and debate in university classrooms could undermine China’s ability to innovate, improve efficiency and generate unique intellectual property. This could have a negative impact on the economy’s long-run growth potential and ability to compete in the high value-added sectors that will help it escape the middle-income trap.
The major economic changes under way in China have made it clear that Washington needs a new mindset in dealing with the China of 2015 and beyond. No foreign nation will have more impact on American interests over the coming decades, and how the two countries engage on economic policy will have important implications for the overall relationship. On the one hand, Washington should continue to support Beijing’s reform efforts in areas where we share interests, such as in advancing financial reforms that will support China’s transition to a more balanced growth model. On the other hand, the U.S. government should be prepared to have frank conversations with Chinese counterparts and apply pressure when we disagree. Perhaps most importantly, Washington should continue working with its partners on initiatives like the Trans-Pacific Partnership that will create incentives for Beijing to adopt a high-standard model of financial and economic integration and eventually create a pathway toward a Free Trade Area of the Asia-Pacific.
Mr. Matthew Goodman holds the William E. Simon Chair in Political Economy at CSIS, with particular emphasis on Northeast Asia. Follow him on twitter @MPGoodman33. Mr. David A. Parker is research associate in political economy. Follow him on twitter @AllardParker.
Matthew P. Goodman is senior vice president and William E. Simon Chair in Political Economy at CSIS, with particular emphasis on Northeast Asia.