Tuesday, August 25, 2015

Limits to growth with Chinese characteristics

Another carnage, and the China doomsday season accelerates. George Magnus writes the latest obituary. Michael Schuman joins the bandwagon questioning the infallibility of the Chinese technocrat. The collateral damage from China's travails are everywhere - equities are plungingcommodities are declining unabated, currencies are being battered, and the retreat from emerging market bonds may have been triggered. So are we near the end of capitalism with Chinese characteristics?

In very simple terms, the nearly thirty years of China's rapid economic growth was underpinned by a top-down (guiding hand of the communist party at all levels) and inputs-driven (infrastructure and manufacturing investments) structural transformation that capitalized on the country's vast supply of cheap and skilled labor, high savings rate, and a continental sized markets. An opportune moment in world history, coinciding with the high-noon of the latest round of globalization, boosted global trade and China was best positioned to capture its benefits. It is fair to assume that China is nearing the end of, or has already exited, this phase of its economic growth. 

Thanks to the benign leadership of the same technocrats, China seized the moment to achieve more than a quarter century of spectacular growth that has pulled hundreds of millions out of poverty. The externalities from the juggernaut were just as impressive - it sucked commodities spurring a boom in commodity prices and driving up the fortunes of the commodity exporters, its cheap exports contributed in no small measure to fueling the extended low-inflation period of Great Moderation, and its huge trade surpluses financed the credit appetites of countries like the US. In a just world, instead of celebrating its obituary, the world economy should have left the biggest "Thank You" note at the door-step of Beijing. 

Leave that aside. Moral-politik is rarely the nature of international relations. The more relevant issue for consideration is whether the next phase of China's growth is amenable to similar benign guidance. It would arguably involve transition into more knowledge and technology-intensive manufacturing, diversification and expansion of the services sector especially the creative knowledge-based activities, deregulation and external opening up of its financial markets, and domestic structural adjustment towards a normal and more consumption-based economy. And all this will have to be achieved without upsetting the socio-political balance that is essential to managing change and reforms with the least discordance. 

The challenge is whether the pacing and sequencing of this new phase can be managed in the same way as was possible with the manufacturing and infrastructure investment led current phase. More precisely, the challenge is whether such trends can be achieved in a socially-repressed and politically-controlled environment. Each of the aforementioned transitions contain too many moving parts and involve behavior and perception changes that are normally achieved through the dynamics of incentives and market mechanism, with adequate regulation, and may be beyond the powers of even the best of the Communist Party's technocrats. 

Will the communist party be willing to loosen its iron-grip on the country's society and polity? And more importantly, if that happens, will the disruption, which will inevitably follow, be acceptable enough for the mandarins in Beijing to allow the transition to progress? Or can the mandarins in Beijing manage a calibrated social and political deregulation, just as they did the economic deregulation? It is difficult to credibly prophesy all this except through backward-looking assessments, which may not be as relevant given China's uniqueness. 

I am not sure whether the Communist Party has the stomach, much less the enlightened self-interest, to bite the bullet. Encouragingly, in this context, China has precursors. Japan and a few North and South East Asian neighbors achieved similar long-periods of top-down, inputs and exports-driven growth which laid the foundations for a phased transition towards a more deregulated and liberal democratic environment. But then, these countries were smaller and far less authoritarian than China when they embarked on their similar growth phases. 

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