Asia Program

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China's Economy: Retrospect and Prospect

March 02, 2005 // 12:00pm4:45pm
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China's large and rapidly growing economy has posed both opportunities and challenges to the United States, as highlighted by the recent $1.25 billion purchase of IMB's PC business by the Chinese Lenovo Group. Over the past 25 years, the Chinese economy has claimed an inflation-adjusted average annual growth rate of more than eight percent. On the other hand, China is beset by shortages of energy resources, severe environmental degradation, a widening gap between urban and rural areas, inefficient governance, and problematic banking and financial systems.

Is China on a path to overtake the U.S. economy? Is China's rural economy healthy enough to avoid impeding that country's drive to modernization? Under what conditions might China suffer a financial crisis and an economic collapse? What difference does this make for the United States?

To assess China's economic potential and its implications for the United States, six distinguished experts presented papers at a March 2 seminar co-hosted by the Asia Program of the Wilson Center and the China Project of the University of Pittsburgh and the University of Toronto. Two of the speakers, Rawski and Rozelle, spoke on the same subject at a Capitol Hill breakfast meeting for congressional staff earlier that day.

Rozelle argued that Chinese leaders face two challenges in developing the rural economy, which is more market oriented than 20 years ago. First, they need to reorganize government and reform rural fiscal policy, while establishing new partnerships with rural citizens through interest groups, such as farmer professional associations. Second, the Chinese central government must take responsibility for investment in rural education and health, which has been left mostly on the shoulders of local governments and households. China also needs to raise rural productivity, regulate water rights, and encourage off-farm employment. If the government can accomplish these tasks, the rural economy will continue to drive China's modernization, Rozelle concluded.

Rawski observed China's industry has recorded both an impressive growth of output and export, and a dramatic upgrading of product quality and labor productivity. These gains have occurred despite many obstacles, including excessive official intervention, extensive corruption, and weak systems of law, management, finance and corporate governance. According to Rawski, China's rapid growth has been achieved principally by adding more resources to the production process rather than gaining higher productivity. Such a Soviet-style process of formulating and implementing investment projects appears capable of disrupting the core mechanism of China's dynamic economic growth, Rawski cautioned.

Huang maintained that China's gradual reform on economic regulations, while reducing discrimination against the private sector, has never fully created institutional conditions for the private economy to mature and prosper. The successful development of the Chinese Lenovo Group based in Hong Kong, according to Huang, is due to Hong Kong's healthy financial institutions. Huang argued that the inefficiency of China's financial and legal institutions has lowered the average level of competitiveness of domestic firms in China, which ironically creates a number of propitious conditions for foreign firms and thus drives up foreign direct investment (FDI) inflows to that country.

Allen noted that China's large but inefficient banking sector has been the dominant force in that country's financial system, and the Chinese stock market, while growing quickly since 1990, has only played a limited role in supporting economic growth. It is the alternative financing channels based on trust, reputation and human relationships that have had great success in supporting the growth of the "hybrid" sector of firms with various types of ownership structures. According to Allen, the growth of the hybrid sector has been much higher than that of the state sector or the publicly listed and traded firms. These alternative finance mechanisms should be encouraged by the government.

Clarke pointed out that courts play an interesting role in the Chinese political economy in transition—they are seen as authoritative but not necessarily fair. Although Chinese legal institutions are generally weak, they are stronger than in pre-reform China and are used by economic actors to a surprising degree. Attitudes of business people toward the legal system as a whole are solidly average: 56.3 percent of respondents in Shanghai and Nanjing rated the legal system as average, while 25.3 percent found it to be low or very low, and 18.3 percent found it to be high or very high. Clarke concluded that the Chinese legal system does appear to have some role to play in the country's economic life, and that the Chinese experience supports a theory that development induces law.

Naughton argued that China's recentralization policy since 1993 has achieved important successes in the fiscal, financial and corporate governance sphere. However, this policy has also planted the seeds of its own failure. For example, few truly independent agencies were created, and the government's attempt to restructure the management of public assets did not achieve a breakthrough success. China's economic development now requires creating a virtuous environment, with more diversified and transparent financial markets, stronger international competition, more sophisticated interactions with international capital markets, and a more stable and predictable macroeconomic policy. These changes are required to vault China to the top ranks of world economies, Naughton maintained.

In addition, Rawski presented two other papers on behalf of Nicholas Lardy of the Institute for International Economics and Loren Brandt of the University of Toronto, who were unable to come to the seminar as planned. The paper by Lardy and his coauthor, Lee Branstetter of Columbia Business School, stresses that because China cut tariffs, broadened trading rights, and liberalized the FDI regime even prior to its formal accession to the World Trade Organization (WTO) in 2001, the impact of WTO per se on China has been smaller than some might have predicted. According to Lardy and Branstetter, the combination of China's pre-WTO and post-WTO reforms is making it arguably the most open large developing economy. The paper by Brandt suggests that the process of structural transformation—the reallocation of labor from agriculture to the non-agriculture sector—has provided an important source of growth in the Chinese economy over the past two decades.

While speakers at the seminar recognized China's problems in governance, banking, finance, law and institutions, they did not predict a quick collapse of that country's economic boom. None of them anticipated that China is on a path to overtake the U.S. economy. On balance, China's economy, with its dynamics and openness, is likely to increase its global competitiveness, and thus pose a challenge to the United States.

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