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5 White Paper on the Business Environment in China
around 50 percent,” and that “Under such a strategy, vulner- wages, borrowers at the expense of savers, and manufacturing
abilities will likely grow in the form of hidden deadweight at the expense of services.”21
that will have to be paid in future in one form or another. e
cost of nancing such an elevated level of investment could Still, Mr. Pettis argues, rebalancing is likely to be harder,
undermine overall economic stability.”19 rather than easier, than precedent cases in other countries:
Reuters notes that “ e potential for severe internal eco- [After many years] several groups within China have
nomic imbalances in China stemming from an extended pe- bene tted mightily from the distortions associated
riod of investment-driven growth, plus the risk that the excess with the current growth model, especially distortions
capacity it creates spills into the global economy, are a recur- in interest rates, the currency, and China’s heavy de-
ring theme of IMF research.”19 pendence on investment. Given how deep these dis-
tortions have been, and how long they have been in
“Many countries in the past one hundred years have gone place, it would be surprising if these groups had not
through periods of extraordinary growth, powered by very become extremely powerful.
high and rising levels of investment,” observes Peking Univer-
sity professor of nance Michael Pettis. “In every case these ese distortions need to be reversed. e historical
countries developed serious imbalances, either internally, if precedents for developing countries that have attempt-
the investment was nanced by consumption-constraining ed to reverse similar distortions, however, suggest that
policies, or externally, if they were not.”20 the biggest impediment to the adjustment process will
be opposition from these groups. Je rey Frieden in his
He continues: 1993 book on Latin America, for example, argues that
the Latin America adjustment in the late 1970s was
In the early stages, it was always relatively easy to nd extremely slow and painful precisely because power-
economically viable investments, but as institutional ful vested interests were so successful in retarding or
constraints required the persistence of high levels of diluting reform.21
investment, and as it became increasingly di cult to
ensure that investment was economically viable, in “ e intellectual case for an accelerated pace of economic
later stages investment was always misallocated and reform has been well established in China,” argues Mr. Lardy.”
debt grew faster than debt servicing capacity. “If Xi and Li can overcome the entrenched vested interests
that have slowed reform to a crawl in recent years they will be
is combination of extreme imbalances and high lev- laying the foundation for stronger economic growth over the
els of debt, driven by misallocated investment, result- medium term.”20
ed in a subsequent period of rebalancing that turned
out to be far more di cult than even the skeptics had Problematically, “It is still unclear what Beijing can do
predicted. China’s development model has di ered to replace the source of growth [after the required dramatic
from its predecessors only in that the imbalances have transformation of the nancial sector and the relationship be-
exceeded any that we have seen in prior history, and tween the state and the economy].” One option, a consump-
the amount of misallocated investment may have also tion-driven model, is possible but unlikely in the short term
exceeded all precedents. as “China would have to not just to maintain the last decade’s
consumption growth rate [but] substantially to increase it.”21
For this reason it would be surprising, and an histori-
cal anomaly, if China’s rebalancing were not a very “A massive transfer of wealth from the state sector and
di cult one. Not only has China pushed the imbal- from China’s economic elite to the household sector would
ances associated with the investment growth model of course do the trick,” says Mr. Pettis, “But it may well be
to extremes that exceed any seen before, but it is be- the only way.”21
coming increasingly clear that the obstruction to any
meaningful adjustment by sectors that have bene tted Mr. Lardy argues that major policy changes, including
most from domestic economic distortions will make “further [reducing] and eventually [eliminating government]
the adjustment politically very di cult.20 intervention in the foreign exchange market; [eliminating]
subsidies to industrial energy consumption; [continuing] to
Nick Lardy, a China expert with the Peterson Institute, build out the social safety net [and] ending the extreme -
takes the position that “Rebalancing is a medium term project nancial repression of recent years—re ected in a real one-year
that will not be easy. To be successful the government will deposit rate that has on average been in the negative territory
need to phase out policies that favor pro ts at the expense of beginning in 2004” will all contribute to a controlled rebal-
ancing on the back of increased domestic consumption.21
18
around 50 percent,” and that “Under such a strategy, vulner- wages, borrowers at the expense of savers, and manufacturing
abilities will likely grow in the form of hidden deadweight at the expense of services.”21
that will have to be paid in future in one form or another. e
cost of nancing such an elevated level of investment could Still, Mr. Pettis argues, rebalancing is likely to be harder,
undermine overall economic stability.”19 rather than easier, than precedent cases in other countries:
Reuters notes that “ e potential for severe internal eco- [After many years] several groups within China have
nomic imbalances in China stemming from an extended pe- bene tted mightily from the distortions associated
riod of investment-driven growth, plus the risk that the excess with the current growth model, especially distortions
capacity it creates spills into the global economy, are a recur- in interest rates, the currency, and China’s heavy de-
ring theme of IMF research.”19 pendence on investment. Given how deep these dis-
tortions have been, and how long they have been in
“Many countries in the past one hundred years have gone place, it would be surprising if these groups had not
through periods of extraordinary growth, powered by very become extremely powerful.
high and rising levels of investment,” observes Peking Univer-
sity professor of nance Michael Pettis. “In every case these ese distortions need to be reversed. e historical
countries developed serious imbalances, either internally, if precedents for developing countries that have attempt-
the investment was nanced by consumption-constraining ed to reverse similar distortions, however, suggest that
policies, or externally, if they were not.”20 the biggest impediment to the adjustment process will
be opposition from these groups. Je rey Frieden in his
He continues: 1993 book on Latin America, for example, argues that
the Latin America adjustment in the late 1970s was
In the early stages, it was always relatively easy to nd extremely slow and painful precisely because power-
economically viable investments, but as institutional ful vested interests were so successful in retarding or
constraints required the persistence of high levels of diluting reform.21
investment, and as it became increasingly di cult to
ensure that investment was economically viable, in “ e intellectual case for an accelerated pace of economic
later stages investment was always misallocated and reform has been well established in China,” argues Mr. Lardy.”
debt grew faster than debt servicing capacity. “If Xi and Li can overcome the entrenched vested interests
that have slowed reform to a crawl in recent years they will be
is combination of extreme imbalances and high lev- laying the foundation for stronger economic growth over the
els of debt, driven by misallocated investment, result- medium term.”20
ed in a subsequent period of rebalancing that turned
out to be far more di cult than even the skeptics had Problematically, “It is still unclear what Beijing can do
predicted. China’s development model has di ered to replace the source of growth [after the required dramatic
from its predecessors only in that the imbalances have transformation of the nancial sector and the relationship be-
exceeded any that we have seen in prior history, and tween the state and the economy].” One option, a consump-
the amount of misallocated investment may have also tion-driven model, is possible but unlikely in the short term
exceeded all precedents. as “China would have to not just to maintain the last decade’s
consumption growth rate [but] substantially to increase it.”21
For this reason it would be surprising, and an histori-
cal anomaly, if China’s rebalancing were not a very “A massive transfer of wealth from the state sector and
di cult one. Not only has China pushed the imbal- from China’s economic elite to the household sector would
ances associated with the investment growth model of course do the trick,” says Mr. Pettis, “But it may well be
to extremes that exceed any seen before, but it is be- the only way.”21
coming increasingly clear that the obstruction to any
meaningful adjustment by sectors that have bene tted Mr. Lardy argues that major policy changes, including
most from domestic economic distortions will make “further [reducing] and eventually [eliminating government]
the adjustment politically very di cult.20 intervention in the foreign exchange market; [eliminating]
subsidies to industrial energy consumption; [continuing] to
Nick Lardy, a China expert with the Peterson Institute, build out the social safety net [and] ending the extreme -
takes the position that “Rebalancing is a medium term project nancial repression of recent years—re ected in a real one-year
that will not be easy. To be successful the government will deposit rate that has on average been in the negative territory
need to phase out policies that favor pro ts at the expense of beginning in 2004” will all contribute to a controlled rebal-
ancing on the back of increased domestic consumption.21
18
