Mega Trends of China: Evolution of China’s Growth Model

06 Apr 2018

                       In formal logic, a contradiction is the signal of defeat, but in the evolution of real knowledge it marks the first step in progress toward a victory. – Alfred North Whitehead

Summary

  • Chinese President Xi Jinping has changed the government’s policy objective function from maximising growth rates to improving growth quality, subject to the reform and debt-reduction constraints.  Many players are expecting China’s GDP growth to fall below 6% soon.  Really?
  • What is revolutionary about Mr. Xi’s approach is his forceful change of the political and economic incentives that had governed the country for over three decades.  He has a much bigger agenda than what most analysts see as the power-grabbing move.
  • China’s new economic model is based on strategic usage of markets under state guidance with very limited privatisation of state-owned assets.  Key-man risk is the ultimate China risk that the world has to face in the future.

To ensure President Xi Jinping has enough time and power to make the necessary structural changes, the Communist party revised the constitution to remove the presidential term limit at the National People’s Congress in March 2018.  The move not only showed that Mr. Xi had the power to break with past conventions and change the constitution, but also that he dared to challenge and to alter the unwritten rules that have long guided the Party bureaucracy.  For better or worse, he is moving China to a more centralised and top-down system.

Two crucial questions follow from these changes.  First, as China’s policy moves from maximising growth rates to improving growth quality, when will its growth rate fall below the 6% mark that Beijing has vowed to protect?  Second, why does President Xi want to re-centralise power?  Is this simply power-grabbing with self-interest to crown himself the emperor of modern China?

 

Will growth fall below 6% soon?

Many players expect that China’s growth rate would fall below 6%, or even 5%, in the next three to five years if not sooner because of various reasons, including capacity constraints due to economic distortions and Beijing’s desire for slower growth in exchange for structure reforms.  Indeed, at the 19th Communist Party Congress in October 2017, President Xi announced his vision of a “new era” in which China will achieve national supremacy by pursuing high-quality growth and de-emphasising high-speed growth.

In practice, the focus on high-quality growth will not end the pressure to deliver economic growth, nor does it mark a shift to a smaller role of the government/Party in the economy.  There is a Party goal of doubling China’s per capita real GDP in 2020 from its 2010 level.  This is a hard target for the President to deliver.  This means that China will have to grow by an average of 6.3% a year between now and 2020 to hit that target.

Structurally, China’s GDP growth may remain at around 6% for much longer than most players have expected.  Firstly, China is going through a creative destruction process that will generate an inherent growth momentum.  For example, China’s tertiary sector, a proxy for the new economy, has grown bigger than the secondary sector, a proxy for the old economy, since 2013.

Secondly, there is a developing trend of industrial migration towards the inland provinces, leading to reverse-migration of labour, uncovering and employing cheaper and untapped resources, spreading job creation, income growth and consumption to the poor parts of the country.  They are signs of economic rebalancing.  The combination of the growth of the new economy and industrial migration will likely generate growth momentum to offset some of the growth drag from structural reforms, deleveraging efforts and even an ageing population in the medium-term.

 

Is it simply power-grabbing?

The media has mostly framed the discussion on Xi Jinping’s scrapping of the presidential term limit as a power-grabbing move to make himself the life-time ruler of China.  The move is a shock even to many Chinese because he is uprooting one of Deng Xiaoping’s most important legacies of institutionalising leadership succession that was meant to end the political instability stemming from chronic power struggle in the Mao Zedong era.  For the West, the term limit is a mechanism that constrains a system from moving towards dictatorship.

From Mr. Xi’s perspective, the de-centralised power structure that evolved after Deng Xiaoping has become a set of outdated political conventions that need to be overturned so that he can deliver his “Chinese Dream” to make China a global power because de-centralisation has not worked as intended.  For the two decades before him, Beijing delegated more autonomous power to the regional governments to encourage them to try out economic reforms.  They were given powers to run major regional affairs, including land allocation, business development, infrastructure construction, local fiscal policy, law making and enforcement, and allowed to own state companies.

The central government had an explicit policy of encouraging regional competition to get rich as a reform motto.  Hence, GDP growth became the predominant political objective with appointment and promotion of government officials being tied to local growth performance.  This created an incentive scheme of “chasing growth at all cost”.  It also created powerful provincial officials, who acted like regional warlords, defying the central decrees.  Indeed, Chinese bureaucrats have a long history of skillfully resisting orders from above and abusing power.  The ancient Chinese proverb of “the mountains are high and the emperor is far away” has been manifested in modern day practice of “whenever there are decrees from above there are counter-measures from below”.

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