Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate. The author thanks Sohaib Nasim for research assistance.
October 23, 2023 — Ten years ago this November, the 18th Central Committee of China’s Communist Party held its quinquennial Third Plenum. The meeting decided on a set of reforms that were well-chosen to sustain the national growth rate. But the reforms have not been implemented, contributing to a big slowdown in the economy.
- The decline in Chinese growth
As of ten years ago, 2013, a naive extrapolation of the differential in growth rates between China and the US suggested that the number two economy would overtake the number one economy by 2021 (when GDPs are compared using nominal exchange rates). Some even said the cross-over year would be 2019. This did not happen; the US economy remains far ahead. Goldman Sachs and others now project that China’s GDP will not catch up with US GDP until 2035, if ever. Even if the crossover occurs, it may be only temporary. The Chinese economy is forecast to peak sometime in the middle of the century, after which the ongoing decline in the labor force will outweigh productivity growth. This drastic revision of crossover forecasts is one indication of how sharply trend growth in the Middle Kingdom has been revised downward since 2013.
To be sure, China’s GDP has already passed US GDP if the two are measured in PPP terms (in 2017, reported in 2020). But for many purposes, such as projecting military force or determining the size of quotas at the IMF, the comparison at current exchange rates is more important than the comparison at PPP rates.
It was probably inevitable ten years ago that the Chinese economy would slow down in the subsequent decade, relative to its preceding three decades of growth averaging 10 percent per annum, a globally unprecedented accomplishment. Among the likely reasons to expect the slow-down were technological catch-up, diminishing returns to capital, aging of the population, diminishing returns to rural-urban migration, a possible middle-income trap, and simple regression to the mean. But the slowdown has been more severe than expected (even if one trusts the official numbers), or than it need be.
- The promises of 2013
The reforms that were announced by the Third Plenum in 2013, supposedly with a deadline of 2020, were sensible, whether judged from the standpoint of Chinese or foreign economists. The role of the state in the economy was to be reduced, and the market was to become the “decisive force in the allocation of resources.” The importance of State-Owned Enterprises (SOEs) in the economy was to shrink, relative to the importance of private firms. For example, private investors were to be given a rising equity share in SOEs and the SOEs were to return more profit to their owners as dividends. The government was to simplify approval procedures, to state explicitly which industries would remain under state control, and to deregulate prices for energy and other inputs that firms buy from utilities (thus curtailing one form of SOE subsidies).
The financial system was to be liberalized, allowing more cross-border capital mobility. Rural residents were to be granted better land rights, hopefully allowing them the right to own and sell property, rather than facing confiscation by local officials, who sometimes expropriate land to build unneeded apartment towers. The hukou system was to be reformed so as to allow urban newcomers access to the same health, education, and other public services as long-time residents. The disastrous One Child policy was to be eliminated. Emphasis in the economy was to shift from heavy investment and export components to household consumption. The environment was to be cleaned up.
- Reforms retracted
A few of these reforms have been pursued during the intervening ten years. Some initial progress has been made on the environment. The one-child policy was ended (though, for some reason, families are still limited to three children).
There has been a re-balancing toward domestic consumption, as opposed to over-dependence on export demand. This shift is evidently what is implied by the slogan “dual circulation,” adopted in 2020. The more fundamental driving force behind the reduced importance of international trade has been adventitious developments: Trump’s trade war, the Covid pandemic, over-extended international supply chains, and the general decline in relations with the United States and its allies.
But most of the reforms have not taken place; in fact, the reverse. This helps explain the growth slow-down.
The role of the state in the economy has increased relative to the private sector. For example, the flow of loans to SOEs rose after 2013 while the share of loans going to private firms fell. Productivity tends to be higher among private firms than among SOEs; thus, the reality of greater emphasis on SOEs, rather than less, is one of the reasons why productivity growth has slowed since 2013.
American trade negotiators have objected to an overactive role for the state in the Chinese economy (particularly the “Made in China 2025” campaign). This is ironic, if the economists are right and the aborted market-minded reforms would have been good for Chinese growth.
- Macro stimulus missing in 2023
If China’s government has enlarged its role in microeconomic and structural policies since 2013, its inclination to follow activist macroeconomic policy has diminished. During the first 13 years of the century, the authorities made good countercyclical use of monetary and fiscal policy. The People’s Bank of China responded in a timely manner to overheating in 2007-08, by raising interest rates as well as tightening reserve requirements on banks and loan-to-value ratios on mortgages, successfully curtailing inflation. It did it again in 2010-11. In between those two overheating episodes, monetary and macro-prudential policies were loosened in 2008-09 in response to the Global Financial Crisis. At the same time, the government undertook a big old-fashioned Keynesian increase in spending. As a result, China recovered rapidly from the recession.
In 2022-23 output has fallen even below the slowed path of potential output, in the aftermath of a burst housing bubble and the contractionary effects of the zero-Covid policy. Yet, monetary and fiscal policy have not responded to the most recent recession with the usual counter-cyclical adroitness. In other words, GDP is currently depressed both by the failure to enact the structural reforms and by the failure to follow countercyclical macroeconomics.
How can one explain the contrast between a new wariness toward fiscal stimulus, on the one hand, and a generally enhanced long run role for the national government structurally, on the other hand? It can be partially reconciled by observing that much of the spending in 2008-2009 and other past expansions has come from local governments, which are not under the full control of the central government. A further reconciliation is to note that a natural way to stimulate the economy would have been to implement transfers to raise the disposable income of households and thereby stimulate their consumption; but this would mean increasing the role of the private sector, which is not the government’s revealed preference.
Ultimately, there is a genuine tension between the roles of the market and the government. Financial liberalization was halted in part as a reaction to financial instability such as the crash of a stock market bubble in June 2015. And in part to impede the switch to net capital outflow and yen depreciation, which began in late 2014 and disrupted foreign exchange markets in August of 2015.
- Chinese politics
If the reversal of the 2013 reforms has slowed growth, why has President Xi Jinping chosen this path? Deng Xiaoping, leader of China from 1978 to 1989, famously made “getting rich” the national priority, which it was to remain for 40 years. The Third Plenum of 2013 did not constitute the ascendance of Xi Jinping thought, even though he had already taken office by then. That ascendance came in 2017, as he consolidated his power. Xi is said to emulate Mao Zedong more than Deng. It used to be said that the Chinese government was committed to delivering continued economic prosperity, as a means of retaining popular support for the repressive regime. But, for Xi, it is the other way around: political control by the Chinese Communist Party takes precedence over the economy.
This month is not the 10th anniversary of a watershed shift in China toward greater emphasis on market reforms. It is, rather, the 10th anniversary of their zenith.
This post written by Jeffrey Frankel.