Prospects for Chinese Economic Reform: It’s the Politics, Stupid

Last week the World Bank released a massive 400-page report, China 2030, outlining a vision for reforming the country’s economy over the next two decades to ensure continued success. As is typical in these kinds of reports, the main findings are completely reasonable if not exactly ground-breaking: China needs to increase the share of consumption in its economy, lessen the grip of state-owned enterprises, move toward letting the market more accurately price energy and capital, deal more seriously with environmental degradation, and just generally become a more market-oriented economy.

All of which makes perfect sense, and indeed very sensible people have been suggesting more or less this same package of reforms for several years now. But this is all easier said than done, which is why, despite the fact that everyone knows that China needs to shift its development path, there hasn’t really been much progress. The problem is that translating these abstract, widely accepted economic principles into actual concrete policy basically means turning against the country’s exporting class, the very people who have been driving – and profiting handsomely from – China’s economic emergence.

The political economy challenges here are huge. It’s difficult for any government to pursue a reform agenda that will cut into the profits of entrenched special interests. (For exhibit A, see the process of healthcare reform in the US, which we can safely say has been considerably less than Pareto optimal.) But when those special interests are deeply entwined with the government – which, under state capitalism, is pretty much true by definition – it’s exponentially more difficult. Changes in economic policy create winners and losers; when the would-be losers are a powerful bloc within the government, the push for reform is going to have trouble finding traction. You don’t have to be an expert in public choice theory to understand that when the government owns companies that directly benefit from economic distortions, the incentives to remove those distortions are pretty low.

To come back to the China 2030 report, what’s most interesting about it is perhaps not what’s actually said but who’s saying it: the report was co-authored by China’s Development Research Council, a government think tank. So we can start to see some hints about which elements of the government are in the pro-reform camp. And the report has engendered considerable pushback from precisely those groups which a straight forward political-economy analysis would suggest should be opposed, namely the State-Owned Assets Supervision and Administration Commission. The battle lines are being drawn for the fight over economic policy which will play out over this transitional period for China’s leadership.

Understanding these internal political dynamics also raises interesting questions about which Western foreign policy strategies are likely to be most effective in encouraging economic reform within China. Take, for example, the contentious issue of currency appreciation. Let’s assume, perhaps overly charitably, that US politicians routinely raise the issue of China’s currency because they legitimately believe yuan appreciation would be in the United States’ national interest, rather than because they’re simply trying to score some cheap domestic political points via China-bashing. Given the domestic political debate within China, does such a strategy make sense?

To the extent that it allows the opponents of reform to paint the issue of currency appreciation as bowing to outside pressure, the answer is likely no. Given the rise of nationalism in China in recent years – and particularly economic nationalism – it’s easy to see how such a strategy could backfire. Indeed, there’s a parallel to the debate over how enthusiastically the US should endorse opposition political movements looking to overthrow Middle Eastern dictators, where the drawbacks of too close an embrace are more immediately apparent. The last thing Iran’s Green Movement needs is a stamp of approval from the US, which will only undercut their domestic political support. Similarly, the more currency appreciation is perceived as “the policy which the United States is asking for”, the more difficult it will likely be for the reform-oriented wing within China to win the internal political fight. So instead of issuing laughably ill-informed statements on the need for China to increase the value of its currency, maybe politicians should just shut up and let the currency quietly appreciate, as it’s in fact been doing rather nicely of late…

This post also appears on Politics in Spires, the joint Oxford/Cambridge politics and international relations blog.

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