Will stagnation force China to turn free-market?


Amid a struggling global economy, China is faltering. Since December, retail prices have fallen aggressively while the entire consumer goods market descended into deflation. The roots of such a problem are twofold. Since the Maoist era, the Chinese state has brutally enforced regulations on reproductive rights to control population growth. China’s annual population growth rate has come tumbling down from 1.5% in 1990 to precisely 0% in 2021, particularly threatening the retail market, which accounts for a whole tenth of the nation’s GDP and has played a dominant role in sustaining growth.

The second cause of China’s stagnation relates to economic policy. The country’s economic framework is extremely state-centred and hostile to market freedom, with the state possessing a 96% stake in the assets and market value of the top 10 firms. This level of state ownership has undoubtedly inhibited private entrepreneurship, seriously dragging productivity growth, innovation, and dynamism.

To combat the problem, Premier Li Qiang has announced an ambitious plan to achieve a 5% growth rate for this year. The plan includes aggressively expansionary fiscal policies and pro-market institutional reforms: a 7.2% increase in defence spending, maintaining a 3% deficit, raising 1 trillion Yuan in new ultra-long-term Treasury bonds, and abolishing most restrictions on foreign investment to boost manufacturing output.

On the side of institutional reform, the government shows a promising desire to unleash much of China’s repressed entrepreneurial energy. 

On the fiscal policy side, the government intends to act as a substitute for declining consumer spending. However, such policies are misdirected: defence spending is unlikely to provide a meaningful stimulus to the Chinese economy since a mere 0.3% of the workforce is in the military. Meanwhile, issuing long-term bonds is bound to have confusing results.

On the one hand, additional government investment into sectors besides the military will empower consumers with spending potential. Yet, at the same time, increasing demand for the Chinese Yuan within international currency markets to purchase bonds could compress exchange rates with the rest of the world, damaging the vibrant exports sector, which has driven Chinese growth for decades. The international reaction to such a phenomenon will ultimately depend on the next American presidency.

Plausibly, a protectionist Trump White House would welcome reducing Chinese exports to isolate American manufacturing from global competition. Yet, a second Biden presidency — less oriented in such a direction — would probably react by loosening US foreign reserves to maintain the Dollar’s exchange rate with the Yuan.

Democratic leaders may perceive robust free-market reforms as a signal of nascent political liberalisation and […] for China to normalise relations

On the side of institutional reform, the government shows a promising desire to unleash much of China’s repressed entrepreneurial energy. Although China has significantly risen in terms of business freedom since its gradual transition towards capitalism — initiated in the 1970s under Deng Xiaoping — China still ranks far lower than most other Western nations on metrics relating to trade openness, the degree of economic regulation, the security of private property rights, and the rule of law. It also has some of the most restrictive regulations on foreign investment in the whole OECD.

However, the new reforms seek to change this, and it will have mixed results. The positive impacts include significantly higher productivity within Chinese manufacturing. Studies indicate that the acquisition of firms in low-income countries by multinational corporations yields considerably greater productivity and managerial efficiency. Yet the negatives could include reductions in net exports as foreign investors’ demand for the Yuan in China will narrow the massive exchange rate gap with the Western world that has sustained exports for decades.

Indeed, the international reaction to China’s reforms will likely be positive. Although there is a risk of China exacerbating capital flight from the West, many democratic leaders may perceive robust free- market reforms as a signal of nascent political liberalisation and an opportunity for China to normalise relations with the West.

Image: Pexels

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