Arthur Kroeber
Arthur Kroeber

China is ahead of a range of challenging decisions, writes economist Arthur Kroeber in BloombergView. There is a real danger China will enter economic stagnation just like Japan did in the past, and Kroeber is not sure China´s leadership can avoid the same mistakes Japan made.

Arthur Kroeber:

Whether China can avoid a Japan-like slide from world-beater to also-ran will ultimately depend on the courage of its leaders. Unfortunately, on that front, the Chinese regime also seems to be repeating Japan’s mistakes.

One is hubris. By the end of the 1980s, Japanese officials, and many analysts, were convinced that Japan had come up with a new, hybrid economic model superior to traditional free-market capitalism. This proved not to be so. Foreign diplomats and businessmen consistently say that today’s Chinese leaders are similarly self-righteous, deaf to criticism and convinced of the virtues of their model of state-led development. Public discussion of the debts weighing down state companies is muted. Ambitious plans to introduce private shareholders into the state sector have diminished into a timid reshuffling among existing players. History teaches that when the captain and his mates start congratulating themselves on the superior design of their ship while ignoring obvious icebergs, it’s time to haul out the lifeboats.

Another fatal mistake is timidity. The obvious solutions to both countries’ problems all involve a scaling back of state control. Japan could probably have achieved higher growth in the 1990s if it had deregulated services, opened up the financial sector and permitted much more foreign investment. It chose not to do so, for fear of upsetting the cozy ties between government and corporate elites.

The same reluctance is obvious today in Beijing, where Communist leaders say they intend to let market forces “play a decisive role in resource allocation,” but in practice have intervened in the equity and foreign exchange markets to prevent prices from falling. The reluctance to reform the state sector reflects a fear of letting markets, rather than the Party, decide who gets to control important assets.

China is still fundamentally an economy with a lot of dynamic potential. Vigorous policy in the next few years could arrest the rise of leverage and enable growth to stabilize at around 5 percent by 2020. The crucial steps would be to shut down or privatize the least productive state-owned enterprises (cutting the state sector roughly in half), open up protected service sectors to private and foreign competition, and liberalize the financial system so that it reliably channels credit to the most productive firms. The problem, from the Party elite’s point of view, is that these reforms would require that the regime surrender much of its ability to direct economic activity. China may yet be able to avoid the Japan trap, but only if its rulers learn to lighten up.

More in BloombergView.

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