China’s Economic Policymaking at a Time of Transition

China’s economy has grown rapidly for 30 years due to a combination of smart politics and favorable economics. By pursuing a policy of “reform and opening” and allowing the first green shoots of a market economy to flourish in the late 1970s, Deng Xiaoping united China’s people and policymakers behind the pursuit of a single overarching goal: growth. Fuelled by a nearly unlimited supply of cheap labor, a high savings rate and massive investment, and access to large and growing export markets, the Chinese economy subsequently took off, averaging double-digit growth rates between 1980 and 2010. This enormous economic achievement has lifted more than 500 million people out of poverty, catapulted China into the ranks of the world’s middle-income countries, and made it the second-largest economy and single-largest trading nation in the world.

But today these traditional sources of Chinese advantage are fading. Labor markets in China’s coastal industrial clusters are tightening and wages are rising quickly. An unbalanced growth model favoring investment over consumption has produced rampant overcapacity in heavy industry and an underperforming service sector, along with mountains of questionable loans. External demand from advanced countries remains subdued and is no longer sufficient to absorb endless Chinese exports. The country is also facing the deeper structural challenges that then-Premier Wen Jiabao warned of as far back as 2007, when he called China’s growth “unstable, unbalanced, uncoordinated, and unsustainable.” These structural difficulties range from an aging population to the “middle-income trap,” in which the benefits of surplus labor are dwindling before China can compete with advanced countries in high-value-added production.

At the same time, the negative consequences of China’s breakneck development have undermined the consensus surrounding growth as a national project. Land seizures used by cash-strapped local governments to boost development and fund local investment have become a major source of social unrest. Income inequality has risen sharply nationwide and deepened the divide between inland provinces and richer coastal areas, between urban and rural citizens, and even within individual cities. Industrial activity has tainted China’s arable land and waterways, while high concentrations of airborne particulate now routinely produce choking haze and grounded flights along the coast. Meanwhile, a parade of high-profile corruption investigations and numerous safety scandals over everything from tainted milk powder to disastrous train crashes have undermined public trust in government.

At the Communist Party’s Third Plenum meeting in November 2013, Chinese leaders announced an ambitious program of economic and social reform designed to comprehensively address these challenges and give the market a “decisive role” in allocating resources. This 60-point vision statement, together with high-level institutional changes to the Chinese economic policymaking apparatus, provide early indicators of the seriousness with which the current leadership under Xi Jinping is approaching reform. Leaders have taken pains to stress that the 2014 national growth target of 7.5 percent – a far cry from the double-digit rates of the past but still too high in the view of many analysts – is non-binding, urging local leaders instead to place greater emphasis on job growth and price stability.

Alongside the broader array of economic challenges and built-up imbalances, Chinese leaders must also grapple with a more pluralized policy environment and an economy that is many times more complex than during the last major round of reforms that took place in the late 1990s. Today, influential state-owned enterprises (SOEs), large private-sector actors, empowered provincial leaders, fractious government ministries, and a more vocal civil society are all competing intensely to influence policy. Meanwhile, the Chinese economy has more than quadrupled in size since 1998, with the scope of its activities becoming ever more diverse, dynamic, and interconnected, thus making the design and sequencing of reforms significantly more complicated.

Whether China’s policymaking institutions can steer the country towards a more sustainable and balanced growth path has major implications for both China and the world. Hundreds of millions of Chinese have yet to enjoy the full fruits of the nation’s economic success, and the health of the global economy in the years ahead will depend on Beijing’s ability to engineer a shift towards a new, consumption-led economic model. Against this backdrop, there is a rising premium on understanding how Chinese economic policy decisions are made and whether the current cadre of policymakers has the wherewithal to navigate the turbulent waters ahead.