To rebalance its economy, China must do more than regulate the market – it must reform the state

Uneven economic development and US pressure have prompted China’s turn back towards the state amid harsh crackdowns on tech, tuition and property
But the state, perhaps as much as the market, has been at the centre of China’s unbalanced growth and must be an integral part of any lasting solution

Winston Mok

Published: 2:30pm, 8 Nov 2022

Why you can trust SCMP

After China’s 20th party congress, there was a global sell-off of Chinese stocks from Hong Kong to New York. Among the most affected were Chinese internet platform companies, the subject of regulatory crackdowns in recent years. A common perception among foreign investors is that China’s economy may take a back seat to ideology and stability in the coming years.

In 2013, Beijing announced that the market would play a “decisive role” in allocating economic resources. The same language appeared in the latest work report for the party congress – but was given scant notice or little credence by investors.

For many observers, the market in China has been retreating in recent years. Beyond ideology, what could be the context for this seemingly unsettling turn?

Despite decades of high growth, China’s economy is highly unbalanced with deep contradictions. As early as 2007, then-premier Wen Jiabao argued that China’s economic growth was “unstable, unbalanced, uncoordinated and unsustainable”. Should Beijing wait for the day of reckoning or take some tough rebalancing decisions now?

Imposing financial guidelines on a runaway real-estate sector is perhaps such an attempt of rebalancing – although the unintended consequence is the unravelling of an important sector. Defaults on property-related loans funded by trusts are also undermining the stability of the financial sector. The magnitude of the crisis only highlights the unsustainability of the financing of the property sector.

The clampdown on property speculation may also have been to prevent mainland China from developing the intractable social problems of unaffordable housing seen in Hong Kong. Homes in leading mainland cities are already among the most expensive in the world relative to income.

07:21

Growing anger over China’s unfinished ‘rotten tail’ buildings: ‘We really need this home’

The crackdown on private tuition was another recent regulatory move that meant well but had dire economic consequences. For the middle class, private tuition had become an unsustainable race to arm their children for the future, aggravating social inequality. Regulating the industry may have spared Chinese children the fate of their South Korean cram school counterparts, but also wiped out market value and destroyed jobs.

Important as the internet, tuition and other affected sectors are, they tend to have a domestic orientation. Meanwhile, national competitiveness tends to be shaped by export-oriented industries instead.

Against the backdrop of big-power competition, Beijing understandably focuses on strategic sectors with the greatest impact on its long-term competition against the United States.

The US has escalated its economic warfare against China with sweeping export restrictions on semiconductor technology, equipment and personnel. China’s doubling down on industrial policy must be partially understood as a reaction to this. In criticising China’s turn from the market, Western media has failed to reflect upon the role of the US in the development.

01:36

AI chip maker ordered by US government to halt exports to China

While all these may have provided the impetus for China’s turn back towards the state, the state itself, perhaps as much as the market, has been at the centre of China’s unbalanced growth. Rather than solely blaming market failures, the state must be an integral part of any lasting solution.

China’s local governments are important economic actors – attracting enterprise, developing infrastructure and monetising land. It is impossible to understand China’s property sector outside the context of local governments’ reliance on land sales for income – necessitated by their disproportionate fiscal responsibilities relative to their share of tax revenues.

Thus, the property bubble was much more than that – it was at the centre of how China financed its economic growth for decades. It cannot be resolved without a fundamental rebalancing of China’s fiscal architecture.

Beijing should guide the development of the market through fair, transparent and predictable regulations. Arbitrary state interventions must be constrained. Regulatory uncertainty undermines investor confidence.

It may be fine for China’s state-owned enterprises (SOEs) to play an even more prominent role in the economy if they are as efficient and transparent as Singapore’s government-linked companies. But more often than not, they are inefficient and less innovative, and corruption remains an issue.

More so than for private enterprises, SOEs should face tighter regulations, greater oversight and more rigorous reforms to improve their governance and management. And a greater share of the profits of these supposedly people-owned SOEs should be used to fund pensions.

Faced with the problem of overleveraged sectors such as property, China cannot impose a few simple financial “red lines” and hope to fix unsustainable market development. The root of such problems often lies in state-market interactions at the local level.

Beyond a few financial ratios, a far more complex set of realignments involving multiple state actors may need to take place before an industry can be restored to health. More than harsh regulations, coordinated reforms at the deepest levels are needed to address long-standing problems.

China, which is nominally socialist, has been widely seen as a de facto capitalist state since Deng Xiaoping’s reforms. The turn towards common prosperity is arguably a return to its socialist roots. As a relatively poor country, it is still a long way from the Nordic model.

But common prosperity is perhaps better achieved through taxation and redistribution than excessive state intervention. An inadequate tax base is at the root of China’s fiscal imbalances – which grow into broader imbalances in the economy. A key challenge is expanding China’s tax base – by introducing taxes on personal assets such as property and inheritance – without triggering a backlash from the middle class.

Winston Mok, a private investor, was previously a private equity investor