In the decades following China’s 1978 decision to reform and open, its growth was driven by demographics and structural adjustment – letting market logic reshape the economic landscape. But in recent years, as the easier phase of development gave way to middle-income challenges, Beijing has attempted to reassert control over investment and markets. This was not the first choice. President Xi Jinping’s inaugural 2013 Third Plenum economic plan – while still couched in Communist Party nomenclature – was distinctly geared toward a decisive role for markets. Implementation of those goals, rather than aspiration, has been most lacking. By tracking the 2013 objectives across 10 economic domains, The China Dashboard seeks to inform public debate with objective data on just how close to or far from those aspirations China is trending.
Gauging China’s policy progress objectively is essential for understanding what sort of economy – and polity – China will have domestically in the future, and just as critically what role China will play in the international community. The current escalation of tensions between China and the United States is the sort of situation we previously anticipated at the conception of the Dashboard project and seek to temper through dissemination of respected data indicators and interpretation. For this reason, we eschew normative advice or prognostication about the future of the Chinese economy, though we do point out clear conundrums in the outlook.
The China Dashboard offers a regular assessment of China’s progress or regress on its own critical policy goals. The record to date, five years after the Third Plenum plan was laid down, remains on balance in negative territory against the objectives set in 2013.
China’s private sector is shrinking for the first time in two decades – an extraordinary development contrary to the hopes seeded by the 2013 economic reform objectives and decades of talk about withdrawing the state from the marketplace.
As of this Fall 2018 Dashboard edition, reform is not moving forward in 8 of the 10 areas we track. This continues the pattern previously observed. We see modest forward movement only in two areas: Cross-Border Investment liberalization and promotion of Innovation.
Measured by the sum of two-way investment flows as a share of GDP, cross-border investment increased slightly this year after stagnating through 2017. The level of these flows is an indicator of how financially engaged China is with the world. Despite this year’s uptick, China stands below where it started in 2013 (flows at 7% the value of GDP versus 8.25% during the 2013 Third Plenum, and a peak of 10.6% in 2015) and below advanced economies, while even this most recent quarter is a step down from the beginning of the year. Increased flows this year are on the inbound side and prone to reversal as worries about China’s economy and exchange rates kick in. Nonetheless, the modest improvement in outcomes over last year allows us to score this as positive for the first time.
China’s effort to adjust toward more weight for innovation-oriented sectors continues to bear fruit. At its current pace, China will reach parity with the United States in the proportion of innovative industries to all industrial value added by the end of 2018. However, this comes with caveats. Innovation success has been achieved through protective industrial and financial policies that impinge on needed reform in other areas such as liberalizing capital flows and empowering competition policy. What’s more, other nations allege that China’s gains have resulted from illicit technology acquisition and are threatening to delink with China in response. This presents a huge potential long-term risk for everyone.
In our last edition, we saw improvement in environmental policy outcomes: both air and water quality showed improvements through the first quarter of 2018. As of midyear, this hard-won environmental progress had slipped as authorities let up on industrial sector restructuring out of concern for falling economic growth rates, causing a minor recovery in pollution-intensive activity.
In other areas, we find that reforms are either stuck in neutral (for example, Financial System) or worsening (Fiscal Affairs, State-Owned Enterprises, Trade, Competition, Land, and Labor). Each one of these clusters is explored in greater depth on its respective section of the Dashboard.
Note: The chart above is a visualization of the China Dashboard’s conclusions about reform progress in each of the ten clusters we monitor. These assessments are based on the study’s primary indicators. The movement in the chart tracks how our assessments change over time. Clusters listed near the “neutral” center line display no meaningful progress or backtracking; clusters slightly in positive or backsliding territory display outcomes that we assess might be fleeting based on the extent of data changes or policy direction, while clusters deeper in positive or backsliding territory show changes we assess are more likely to last in future quarters.
The Dashboard Gauges: Primary Indicators
Noteworthy in this edition is our finding that on net, the current policy mix, including measures targeted at cutting overcapacity and curbing pollution, is disproportionally benefiting SOEs and hurting private firms. There is heated debate about whether or not this is intended: some observers think squeezing out private firms is a goal of central authorities; others think it is an inadvertant side effect of attempts to shore up growth. Regardless, the outcome is that China’s private sector is shrinking for the first time in two decades – an extraordinary development contrary to the hopes seeded by the 2013 economic reform objectives and decades of talk about withdrawing the state from the marketplace.
We move trade from neutral to negative due to failure by China’s General Administration of Customs to provide key trade data. Especially in light of the prospect of a hugely disruptive trade war between China and the United States and possibly other countries, the ability of the public to have transparent access to basic data on trade flows is paramount.
The United States is closing the door to the prospect of compromise with China over economic practices and henceforth insisting on a decisive return to the earlier spirit of reform and opening as it was understood internationally.
While a deteriorating external trade environment has gotten much of the blame (or credit – depending on your perspective) for China’s economic headwinds, the core internal areas of financial and fiscal reform are the most worrisome locus of policy stasis today. China’s financial system is not directing credit efficiently; thus, debt problems mount and the foundations of a sustainable economy for tomorrow go underfinanced. Local government fiscal policies that greatly increase long-term liability and risk are tolerated – along with hazardous financial activity in general – because leaders fear the immediate consequences of the cure (reforms that shut down bad lending, for instance) more than the long-term threat of the disease.
In the first half of 2018, the state-directed deleveraging effort started in late 2016 focused on squelching shadow banking started to choke off growth. Throughout modern market economy experience, that is to be expected when meaningful, quality-enhancing reforms are implemented. In China’s case, political authorities required deleveraging to be achieved without slowing growth. If that is possible, no economy – now including China’s – has been able to figure out how. Unprepared for this hard truth, authorities struggled to support growth without appearing to abandon deleveraging through the second quarter and beyond. Their policy mix is less and less credible to the extent they insist they can have it both ways or pretend that indications of stress in the economy are not concerning.
A “crisis” is not an inevitability in China. However, a combination of lower GDP growth and greatly altered rules, incentives, and power structures in the economy probably is. The point of reform is to usher those changes in, not defer them indefinitely. Whether that reform lifts expectations for the future, thereby crowding-in investment and activity from inside China and around the world or scares it away has everything to do with perceptions of the quality of the reform plan and the leaders who will oversee it. The good news is that unlike advanced economies that needed such an adjustment once they had reached high income and thus a lower growth plateau, China still has a vast distance to go to catch up to rich world levels, and the prospect of relatively high GDP growth for decades is reasonable. And critically, the 2013 Third Plenum plan demonstrated a thorough understanding of the full spectrum of policy reform required.
Despite those positives, our overall assessment paints a troubling picture for China’s medium-term prospects. The domestic financial travails we discuss, which are apparent in the equity markets, peer-to-peer lending market, pressure on exchange rates, and many other indicators, are going to get more daunting. Reforms in one area will often succeed, like rolling back the risks arising from shadow banking activity, only to push problems into a neighboring channel, like the local fiscal burden. China’s policy shortcomings are not for a lack of administrative effort. We observe copious effort to introduce reforms. The problem is trying to sustain the level of Party and government control that was possible at an earlier stage, at the same time. Chinese leaders have repeatedly come to the conclusion that they need to decrease the heavy role of the state in markets and tolerate the economic instability this invites, only to revert back to believing there must be an alternative.
There is now a U.S. strategy to call out China for diverting from reform, and to coordinate an international pushback on China’s economic and political model.
The View from Abroad
On October 4, 2018, U.S. Vice President Mike Pence gave a speech on China and the American interest. The speech laid out in public and direct terms a strategic conclusion about China that until then had been muddled. To date, the Trump administration had mixed the prospect of a breakthrough commercial deal with offers to go easy on economic matters provided geostrategic alignment was forthcoming. But that shifted in 2Q2018. In May, a Trump cabinet delegation went to Beijing and demanded a far-reaching set of structural policy changes, not just a shift in the level of the trade balance. Over the summer, the case against long-term engagement was built up with a succession of confrontations over how China’s system works, technology theft, behavior by leading firms like ZTE, competition policy, and other matters. This created great uncertainty about where Washington was going.
Pence’s speech resolved many of the doubts. The United States is closing the door to the prospect of compromise with China over economic practices and henceforth insisting on a decisive return to the earlier spirit of reform and opening as it was understood internationally. The speech was directed at a broad range of other political concerns as well, from religious freedom inside China to political interference in the United States. Pence argued that China’s authoritarian system permits coordinated use of the economy, political leadership, and the military to accomplish this in overt and covert ways. The vice president presented this as a Faustian bargain, where the long-term loss of economic and other freedoms outweighs short-term market opportunities.
Just before and after the Pence speech, Washington framed its new depth of animus on China with positive movement on alignment with Mexico and Canada (the new United States–Mexico–Canada Agreement revision to NAFTA), Japan, the UK, and the European Union (with commitments to negotiate FTAs). This built on a three-way U.S.-EU-Japan statement of fundamental concerns with nonmarket economies in September. In sum, there is now a U.S. strategy to call out China for diverting from reform, and to coordinate an international pushback on China’s economic and political model.
This evolution in U.S. foreign policy is hugely important. Given the unconventional dynamics evinced by the Trump administration so far, with lurching changes of direction with regard to both allies and adversaries, observers in China, the United States, and abroad will watch closely to see if this new approach sticks. But just as important will be observation to see if China is demonstrating convergence with market economy reforms again. It is clear that the 2013 Third Plenum program covered much of the economic ground Pence’s speech was concerned with. It is also clear that China is wrestling with the need to rekindle a sustainable economic growth model at home for its own sake, regardless of what the United States hopes for. That coincidence of requirements offers a pathway for a constructive future. And it is precisely what The China Dashboard was built to identify.