Commentary | 25 October 2017

Uncertain future for China's state capitalism

Originally published in the Nikkei Asian Review.

Originally published in the Nikkei Asian Review.

Xi Jinping used China's 19th Party Congress to herald a new era. Xi not only cemented himself as the most powerful Chinese leader since Mao Zedong. He also used the occasion to effectively declare the triumph of Chinese state capitalism (or "socialism with Chinese characteristics for a new era" if you prefer).

Xi said China would keep reforming but emphasized it wouldn't be importing discredited foreign ideas. In fact, Xi now sees things going in the opposite direction. Though he supports the current open international economic system, China under Xi will also be more assertive and influential, in line with both its rising stature and the success of its development model.

Market-oriented reforms got favourable mentions in Xi's work report, but it would be naive to read too much into this. Not only did Xi provide mixed messages by continuing to reinforce the importance of state-owned enterprises but this has officially been on Xi's agenda since 2013, with limited progress to show. Meanwhile there have also been important steps backward, with the state increasingly encroaching on private enterprise and the market.

Optimists believe Xi's strategy may have been "turning left to turn right," first consolidating his power with the aim of pushing through deeper reforms in his second term. If that's the case, the Party Congress left us to keep speculating.

State-led economic rebalancing

One argument in favour though is that, while Xi may be politically all powerful, he cannot defy the economics at play. In particular, the need to 'rebalance' the economy away from fixed asset investment and heavy industry and towards consumption, services and productivity as more sustainable sources of growth. The view amongst many foreign analysts is that this won't be possible without further liberalising reforms, particularly to SOEs and the markets in which they operate.

However, significant immediate progress in rebalancing can be made within Xi's state-centric approach, including: cutting excess capacity, deleveraging, and improving efficiency by restructuring SOEs and their finances; boosting consumption through a stronger social safety net; and driving productivity through industrial policy.

So far there appears to be good progress. Corporate financial health is starting to improve, consumption and services are providing the majority of growth, there has been rapid uptake of new technologies (e.g. robotics) and domestic innovation has been taking-off.

Meanwhile, despite mounting debt levels (by some estimates now about 270% of gross domestic product) and a few serious hiccups, Chinese policymakers have proven themselves still quite adept at quelling proximate stability risks, thanks again to the virtues of the state capitalist model.

Powerful administrative and informal controls and a domestically-financed and state-dominated banking system have provided a solid base for authorities to cool the property market, reign in the rapid growth of shadow lending, reflate the economy, and stabilise the Renmimbi and capital outflows.

The issue is whether all this can last. The current growth rate of 6.8% has still required substantial policy stimulus, indicating things remain unsustainable and raising questions about how robust consumption-led growth really is. Perhaps that's why Xi seemingly left the door open to accepting slower growth going forward, switching the performance benchmark from rapid growth to high quality development.

State capitalist dream

Yet China will likely have to return to gradually ceding greater influence to the market if it is to sustain even moderate rates of growth. Contrary to popular discourse, China's history of rapid growth has been based on gradually ceding more, not less, control to the market. It was only in the wake of the global financial crisis that China was forced to switch to state-led activity. That was useful for avoiding a disorderly adjustment but the imbalances it created are now the problem.

The tension between state capitalism and China's continued rise also plays out in the international sphere. Deep economic imbalances mean China remains vulnerable to an external shock (e.g. a trade war or geostrategic uncertainties) so it needs to do what it can to maintain a conducive external environment.

Meanwhile, capital controls and a shrinking current account surplus (last year only 1.8% of GDP versus 9.9% in 2007) will stall the Chinese yuan's challenge to the primacy of the U.S. dollar as well as constrain Chinese outbound investment. More fundamentally, the conflation of economic and security objectives in China's industrial policies risk an international backlash that could hurt both.

Even ambitions to export lessons from China's model to other developing economies face inherent limits. China has much to offer in terms of trade and investment ties. But there's much less to offer in its authoritarian development model which, at minimum, is predicated on the historical foundation of a capable state that most developing economies simply lack (those that have this have largely already taken off - e.g. most of East Asia). And, in any case, China's economic success over the longer term has still been about moving towards the market, rather than away.

China will hopefully succeed in rebalancing its economy and delivering high quality development for its people. But the state capitalist dream, at least in its current form, will probably end up being just that.