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China’s Economic Reforms Take on New Urgency, Analyst Says

03 February 2012
Demolished old houses and new apartment buildings in Shanghai (AP Images)

Old houses were demolished to make way for new apartment buildings in Shanghai.

Washington — China must address major economic challenges to make its own and global economic expansion more sustainable, according to a new book by a U.S. specialist on China.

China’s economy has withstood the global financial crisis and economic downturn relatively well and continues to expand at a fast but slower pace, Nicholas Lardy, a senior fellow at the Peterson Institute of International Economics in Washington, said in Sustaining China’s Economic Growth after the Global Financial Crisis. But the lack of reforms designed to address distortions created by China’s export- and investment-oriented growth model could undercut the country’s and global growth prospects, according to Lardy. In the United States, this could also limit the government’s ability to gradually reduce its debt.

China’s fiscal and monetary stimulus of 2009–2010 has not addressed the longer-term structural problems of the country’s economy, according to Lardy. Instead, it has exacerbated some of these problems, such as overinvestment in residential property and a low share of private consumption.

At a February 1 book presentation, Lardy said the United States, which experienced the crash of its own housing market in 2008, can help China understand the full impact of unwinding real estate overinvestment. But a similar rapid crash is less likely in China, where the housing sector is not as closely linked with the financial sector as it is in the United States, Lardy said. However, even if real estate overinvestment unwinds in a more orderly way over an extended period, this will have a major impact on China’s economy.

China’s trade surpluses could grow again after a recent break if China doesn’t address the underlying problems related to its exchange and interest rate policies and its investment strategy. Addressing these problems would put China on a more sustainable path of economic growth that relies to a higher degree on domestic consumption, Lardy said.

He said China’s leadership is well aware of these problems and necessary reforms, including interest rate liberalization, the end of indirect subsidization of energy and other industrial inputs, greater exchange rate flexibility and a more rapid expansion of a social safety net. Such reforms were written into the 12th Five-Year Plan for 2011–2015. But so far the government has done little to implement the reforms as the risk from overinvestment in residential real estate has increased, Lardy said.

The book says that major beneficiaries of the existing growth model, such as the manufacturing sector and export-import industries, the real estate and construction industries and commercial banks, “have acquired a disproportionate influence over economic policy and to date have been able to block most needed policy reform.” Lardy said that policymaking by consensus in recent years has replaced policymaking driven by strong individual leaders, which also has contributed to reform inertia.

(This is a product of the Bureau of International Information Programs, U.S. Department of State. Web site: http://iipdigital.usembassy.gov/iipdigital-en/index.html)

A security guard walking past the Bank of China head office building in Beijing (AP Images)

China's banks have benefited from the current economic growth model.