Beyond a Change in Policy: What Will it Take to Reform China’s Economy?

April 30, 2014

Host: The Brookings Institution

Event:  The Future of State Capitalism in China


Dr. Xu Xiaonian, Professor of Economics and Finance, China Europe International Business School

For the past three decades China has been the economic wonder of the world. Since emerging from global isolation in the 1970s, the country has assembled a large working force, embraced modernization across a number of key sectors, and cemented itself as the world’s second largest economy. Recently experts looking at China’s economic growth, have attributed the country’s success to its particular style of state sponsored capitalism, which includes system of state owned enterprises (SOE’s) and government-targeted investments. The common narrative is that sweeping government control has succeeded in creating a strong economy – focused on developing railroads, highways, and other large scale infrastructure projects – while circumventing the need for strong rule of law, oversight of corruption, and other hallmarks of Western economies. However, when one thoroughly examines China’s economic history, it becomes apparent that strong central government planning was not always a necessity for growth.

In his research, Dr. Xiaonian argues that in the first phase of China’s economic makeover (1978-1995), the economy was being guided by a need for efficiency. Under this model, resources were reallocated away from the state, and low yield ventures such as agriculture, and were instead funneled into the private sector, where individual industries were encouraged to compete and grow. However, these macro policies – built around privatization and liberalization of the economy – are not enough to guarantee success. In the case of China, a lack of institutional support, namely a lack of respected private rights and a government that could not be kept in check, limited China’s open market economy.

This absence has only been further stressed, as China experienced two large financial crises in 1997 and 2008, and has since become more dependent on the government to direct investments and generate economic growth. This dependency is very problematic in Dr. Xiaonian’s eyes. Since the 1997 crisis, increasingly large government stimulus packages have become the norm – today such packages total over $570 billion (4 trillion yuan). This spending is considered by many experts to be irresponsible, unsustainable, and a large driver of corruption. However, in this current system of governance, party leaders and high ranking officials are directly responsible for the economy – their legitimacy as rulers is tied to successful economic ventures like solar panels, high-speed rail systems, etc. Due to this precarious relationship, corruption and inefficiencies must be tolerated in order to maintain officials’ reputations and stature. The economy is now seen as a reflection of the government, and is now becoming a liability, as income inequality grows and high-level officials become increasingly embroiled in corruption.

It is for this reason that Dr. Xiaonian is urging Chinese leaders to rethink their approach to the economy and government. The current system of government-targeted investments is proven to be unsustainable, but there are currently no institutions that can hold the government responsible, nor are there any politicians with the strength or will to tackle the issue. What is needed more than anything is structural reform, rather than the policy changes currently being discussed. The economic zones currently being proposed cannot succeed unless businesses feel that their investments and merchandise are protected by strong laws and courts. Similarly, entrepreneurs cannot succeed in an area that has no respect for individual’s ideas and does not run on innovation and efficiency. China has demonstrated in the past that it can function as an open economy. For the sake of both economic and governmental stability, it must start trying to return to those times.


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01. May 2014 by Will Houstoun
Categories: East Asia, Economics, Government | Comments Off on Beyond a Change in Policy: What Will it Take to Reform China’s Economy?