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Summary

An entire superstructure that roots the state in almost all aspects of the economy has developed over the last three decades of state-led growth. While this may have served to support the state-led model of development, it serves to impede the factors that China needs to foster a new model of development based on greater consumption, higher quality manufacturing and value-added innovation.

The European Chamber believes that wider economic restructuring requires a decrease in government control and the natural functioning of a fair and open competitive marketplace. Giving much greater play to market forces would assist the development of private enterprises, lead to a more equitable distribution of wealth, force efficient usage of capital and resources, and give companies the freedom and incentives to strive for productivity-enhancing innovation to develop the tools, technologies and systems to meet China’s societal needs.

The European Chamber believes that the primary roles the government should play are as an agency to develop regulations to provide a framework for equal competition and as an agency to ensure enforcement of these regulations. In this sense, the government should focus on its roles as rule-setter and rule-enforcer. It should not be a game-player.

As first steps, the European Chamber proposes three reforms that need to prioritised. The first is financial reform, in particular interest rates liberalisation, to restrain current high levels of credit growth and incentivise economic efficiency by requiring banks to act as real banks―to borrow Deng Xiaoping’s wording―to better evaluate returns on investment and direct capital to productive areas of the economy.

Secondly, there should be sweeping industrial policy reforms to eliminate interventionist―and frequently discriminatory―government measures that distort the market in attempts to develop domestic industries.

Finally, and most importantly, is SOE reform. A steady withdrawal of SOEs from many areas of the market and increased competition in sectors currently dominated by SOEs is required. This is necessary to allow private enterprises to fully develop alongside SOEs in an environment of fair competition to create the conditions to ensure that the most productive, efficient and innovative companies can prevail.

It will not be easy to implement such reforms, in particular because those that have benefitted from the old model of development are now very strong and stand opposed to changes that will diminish their power and alleviate the partisan treatment they have received. It is certainly feasible that China can implement reforms but the key question is whether China’s policymakers will be able to do so at the speed necessary. These reforms must happen now. It is not possible to wait for a crisis to implement changes. However, the necessity of such forward-planned changes is made more difficult by a still relatively stable economic environment that plays into the hands of those that would like to convince others that current economic fundamentals are still sound.

Many countries have fallen at this hurdle before and become ensnared in the middle-income trap. To make the leap, China needs to follow the example of countries that have managed to find new and sustainable drivers of growth and so must ensure that resources are better directed to those companies that can drive productivity and efficiency gains and develop innovation.

If China doesn’t reduce its reliance on investment, boost consumption, improve economic efficiency and develop more value-added in its economy, then it will not be possible to maintain the level of growth necessary as returns from technology upgrading and investment projects decline and as the labour force shrinks and costs increase. However, if China speedily makes the reforms necessary, then China is well-placed to continue to grow steadily.

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