The State Strikes Back: The End of Economic Reform in China?

180 Pages·2019·3.32 MB·English

by  Nicholas Lardy

THE
STATE
STRIKES
BACK
THE END OF
ECONOMIC REFORM
IN CHINA?
NICHOLAS R. LARDY
THE
STATE
STRIKES
BACK
THE END OF
ECONOMIC REFORM
IN CHINA?
Peterson Institute for International Economics
Washington, DC
January 2019
Nicholas R. Lardy, called “everybody’s guru on China” by the National Journal, is the Anthony M.
Solomon Senior Fellow at the Peterson Institute for International Economics. He joined the Institute in
March 2003 from the Brookings Institution, where he was a senior fellow from 1995 until 2003. He was the
director of the Henry M. Jackson School of International Studies at the University of Washington from
1991 to 1995. From 1997 through the spring of 2000, he was also the Frederick Frank Adjunct Professor of
International Trade and Finance at the Yale University School of Management. He is author, coauthor, or
editor of numerous books, including Markets over Mao: The Rise of Private Business in China (2014),
Sustaining China’s Economic Growth after the Global Financial Crisis (2012), The Future of China’
Exchange Rate Policy (2009), China’s Rise: Challenges and Opportunities (2008), Debating China’s
Exchange Rate Policy (2008), and China: The Balance Sheet——What the World Needs to Know Now
about the Emerging Superpower (2006). Lardy is a member of the Council on Foreign Relations and of the
editorial boards of Asia Policy and the China Review.
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Library of Congress Cataloging-in-Publication Data Name: Lardy, Nicholas R., author. Title: The state
strikes back : the end of economic reform in China? Nicholas R. Lardy. Description: Washington, DC :
Peterson Institute for International Economics, [2019] Includes bibliographical references and index.
Identifiers: LCCN 2018039390 (print)
LCCN 2018056104 (ebook)
ISBN 9780881327373 (paper)
ISBN 9780881327380 (ebook)
Subjects: LCSH: China—Economic policy—2000– | China—Economic conditions—2000– Classification:
LCC HC427.95 (ebook) | LCC HC427.95 .L369 2019 (print) | DDC 338.951—dc23.
This publication has been subjected to a prepublication peer review intended to ensure analytical quality.
This publication has been subjected to a prepublication peer review intended to ensure analytical quality.
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Contents
Preface
Acknowledgments
Introduction
1 Understanding China’s Economic Slowdown after the Global Financial
Crisis
China’s Global Economic Role
Causes of the Slowdown
The Rebalancing Strategy
Explaining the Rebalancing Progress
2 China’s Convergence Potential
Approaches to Analyzing China’s Growth Potential
International Convergence in Asia
Disparities within Groups of Chinese Firms
Explaining the Weaker Performance of State Firms
Potential for Domestic Convergence
3 China’s Failing Strategy to Reform State-Owned Enterprises
Corporatization
Mergers
Mixed Ownership
Debt-to-Equity Swaps
Governance Reforms
Financial Reforms
Conclusion
4 The Path Back to Market-Oriented Economic Reform
Reduce Barriers to Entry
Promote Mergers and Acquisitions and Bankruptcy
Reform the Financial Sector
Improve Governance
5 Prospects for Further Economic Reform
Obstacles to Reform of State-Owned Enterprises
Reasons to Be Optimistic
Appendices
Appendix A Assets in China
Appendix B Enterprise Subsidies
References
Index
Tables
Table 1.1 Factors affecting China’s growth
Table 2.1 Losses of state firms, 2005–16
Table 2.2 Return on assets of state and private service sector firms, 2008
Table 3.1 Corporatization of state-owned industrial enterprises, 1995–
2016
Table 3.2 SASAC-orchestrated mergers, 2015–17
Table 3.3 Return on assets of central SASAC enterprises, 2005–17
Table 4.1 Domestic merger and acquisition activity, 2007, 2015, and 2016
Table A.1 State assets, 2014
Table A.2 Assets of state nonfinancial enterprises, 2008–15
Box
Box 2.1 Metrics for judging economic performance
Figures
Figure 1.1 State and private investment, 2006–16
Figure 1.2 Private consumption as a share of GDP, 1978–2016
Figure 1.3 Services share of GDP, 1978–2016
Figure 1.4 GDP growth and services growth, 1978–2016
Figure 1.5 Household disposable income as a share of GDP, 1992–2015
Figure 1.6 Household saving as a share of disposable income, 1992–2015
Figure 1.7 Share of private investment in modern business services, 2012–
16
Figure 2.1 China’s catch-up potential from a historic perspective
Figure 2.2 Return on assets of state-owned enterprises by sector, 2003–16
Figure 2.3 Return on assets of state and private industrial enterprises,
1996–2016
Figure 2.4 Nonfinancial corporate credit, 2006Q1–2017Q3
Figure 2.5 Leverage ratio of industrial companies by ownership, 1998–
2016
Figure 2.6 Interest payments of industrial firms as a share of pretax profits,
2006–16
Figure 2.7 Benchmark interest rate on one-year loans, January 1990-
November 2017
Figure 2.8 Return on assets of steel industry by ownership, 2000–16
Figure 4.1 Flow of loans to nonfinancial enterprises by ownership, 2010–
16
Figure 4.2 Loans outstanding by microfinance companies, 2010–17
Figure 4.3 Profits and investment of state-owned enterprises, 2011 and
2015
Figure 4.4 Leverage ratio of state industrial companies, 1998–2016
Introduction
The world has never seen anything like the rise of China from an impoverished
and politically unsteady country in 1978 to a confident and ambitious economic
superpower 40 years later. Its economy has grown faster for longer than any
other country on record, persistently defying widespread warnings of a drastic
slowdown that was supposedly to occur at any moment. To date these
predictions have not been borne out. China’s growth rate has been declining
since its peak on the eve of the global financial crisis, but it has continued to
make an outsized contribution to powering worldwide economic expansion. The
world has become so dependent on Chinese economic growth and stability that
analysts around the world carefully analyze even mild fluctuations in its
domestic economy, concerned that these could contribute to a recurrence of
global financial instability. When China’s domestic stock market melted down in
2015 and again in 2018, many experts fretted that the government would once
again resort to exchange rate manipulation to lower the value of Chinese
currency to drive more exports. More recently international concern also has
focused on the unusually large increase in the ratio of domestic credit to GDP,
and the supposed attendant financial risks that could flow from a debt crisis.
Many experts fear that a resulting domestic financial crisis would spread turmoil
in international markets.
China’s stellar growth since 1978 has been driven by market-oriented
economic reform. In the era before Deng Xiaoping’s introduction of market
reforms, the state fixed prices for virtually all commodities and products. That
regime gave way to prices determined by supply and demand in the market. The
marketplace for factors of production—such as labor and capital—was
substantially reformed. The system of job placement run by state agencies
yielded to a robust labor market in which workers were able to move from rural
to urban areas or within cities and wages were determined by supply and
demand—rather than rigidly fixed by the state. Investment, once largely
determined by the State Planning Commission and its various successor agencies
and financed almost entirely through the state budget, has also been transformed.
By 2012 almost half of all investment was undertaken by profit-oriented private
firms with financing provided by retained earnings and ever growing access to
credit provided by the state-owned banking system. Because of this
transformation, by 2012 private firms contributed an estimated 70 percent of
China’s GDP (Lardy 2014, 94).
Since 2012, however, this picture of private, market-driven growth has given
way to a resurgence of the role of the state in resource allocation and a shrinking
role for the market and private firms. Increasingly ambitious state industrial
policies carried out by bureaucrats and party officials have been directing
investment decisions, most notably in the program proclaimed by President Xi
Jinping known as “Made in China 2025.” This drive has been financed by many
government-guided funds, of which the National Integrated Circuit Investment
Fund, created in 2014, is perhaps the best known. In 2015, 297 new government-
guided funds were created with more than RMB1.5 trillion in capital (Kozul-
Wright and Poon 2017). President Xi assumed the office of the General
Secretary of the Chinese Communist Party in late 2012. Since then he has
consistently championed the role of state companies, arguing these firms “should
be supported and not abandoned” (Economy 2018, 118). Local political leaders
have been only too happy to follow his lead by leaning on local financial
institutions, such as city commercial banks, to prop up underperforming state
companies, most of which are administered at the local rather than central level.
This book mobilizes a wealth of data to evaluate this resurgence in the role
of the state, applying an analysis of China’s medium-term growth potential and
the implications of this growth for the global economy.1 Its core conclusion is
that absent significant further economic reform returning China to a path of
allowing market forces to allocate resources, China’s growth is likely to slow,
casting a shadow over its future prospects. Of major importance for the rest of
the world newly dependent on China’s economic ups and downs, the goal of
reducing financial risks, which have accumulated in the years since the global
financial crisis, will be far more difficult. Alternatively, a well-designed
economic reform program can rescue the world’s most populous country from
that dubious fate. Such a program would largely eliminate remaining domestic
economic distortions foisted on the economy by the state, raising the average