In Conversation with AGI's Experts: On the Fifth Plenum

Asia Global Institute's Distinguished Fellow Andrew Sheng

Q: Do you think the ongoing plenum will result in a government reaction to the lower GDP? What form is this reaction likely to take?

I think the Chinese authorities need to educate the public that actually, 6 per cent is as good a number as 7 per cent, because there is nothing magical about these numbers.

There is a fundamental demographic issue – if you don’t have demographic growth, then you can’t meet the resource needs of a growing number of young, or the funding for a growing ageing population. Growth is always seen as a means by which the government is able to tax or mobilize resources in order to redistribute resources or compensate for those lagging in society by providing more healthcare, more education and such. This is why the Chinese understand that they must get their act together and promote growth or they risk getting into a debt deflation trap. At slower rates of growth, not only does the government fail to extract new revenue from growth, those that are being taxed may see further taxation as a zero sum game, leading to possible capital flight and a loss of creativity, entrepreneurship and innovation.

The Chinese do understand that they still have growth, but this growth may come in different elements and from different sources. To a large extent, we need a bit more humility about the statistics and become more pragmatic. It is not the number or statistic of growth that matters as the quality of growth. In the short-run, structural adjustments that raise productivity may lead to slowdown in growth as the laggards and inefficient industries get weeded out. Some job losses may be the price of such adjustment, as what happened in the late 1990s, when China undertook major reforms in the state-owned enterprises.  The key lies in finding out at what number are you able to undertake structural adjustments and reforms that create enough winners in the system without affecting social stability.

A lot of the numbers game is mindset. If you run an economy the size of China growing at over 8 per cent, you’ll get overheating, because China is already a huge US$10 trillion dollar economy. The world has never seen an economy of this size and scale running at 8 per cent and higher. When China was a US$5 trillion economy, growth at 8 percent was sustainable. But at US$10 trillion, every one percent of additional growth rate means adding $100 billion dollars to global growth. The Chinese economy was growing at speeds which the world may have been too complacent about.  Now we’re entering into a period of new normality of slower, and hopefully higher quality growth.

Q: What would a reasonable growth percentage be for you?

I am not fixed on any number, because I think the GDP numbers which are now calculated on the UN System of National Accounts of the United Nations still do not reflect changes in the Chinese economy.   As you will recall, Nobel Laureate Joe Sitglitz led a group to look at the way current GDP numbers do not reflect the quality of development. I am not convinced that the statisticians that have made all the reforms necessary to capture the qualitative changes in the Chinese economy as it moves into a service-driven and internet-based economy, away from the current Factory Asia manufacturing export-driven model. I think that we should not be obsessed with a particular number, but we should be much more concerned about the quality of growth.

Q: If China wanted to measure its growth – what should it be looking for?

For an economy like China, a growth of somewhere between 5 to 6 per cent growth is a good number already. Which means some parts of the economy may be growing at 6-8 per cent, and others may be growing at 2-3 per cent, but that is offset by growth elsewhere. People forget that China is a continental economy that is one-fifth of mankind. It’s not a small economy.

Q: What sectors does China need to be nurturing and looking out for?

The success stories in the new economy are already there. The problem is that if you don’t encourage them, and you keeping alive the old, polluting inefficient industries that have too much labor force and using obsolete technology, you’re just going to drag down the whole system. That’s what’s happening in some of the advanced countries. They are not willing to get rid of the old, inefficient industries, and so the resources that should have gone into the high-growth new industries are going through these sinkholes.

HKU Professor Xiao Geng

Q: Why did the Chinese government intervene after it specifically said it would let the market find its own level?

All governments intervene cyclically when macroeconomic indicators show signs that conditions are not stable. That is the situation for China now: the PPI has been in decline for the last 43 months and the risk of debt deflation is rising. So the policy makers’ priorities have shifted slightly, from enacting very aggressive structural reform and market opening, to short-term stabilization policies. Given this, I don’t think reforms have stalled, it just means that the implementation of reforms will be carried out in a way that will have a less disruptive impact on the country’s growth momentum.

In any case, I don’t think rapid declines in product prices can maintain an environment which encourages further structural reform and market opening. There is a danger that growth – and prices – could fall further if the macro environment is not relaxed enough to offset expected reductions in consumption, investment, and government expenditures due to aggressive and long lasting structural adjustments. That’s why we now see China trying a balancing act: it has relaxed monetary and fiscal policies on the one hand and has taken the opportunity to increase investment in public infrastructures on the other. These new macro policies are intended to deal with the cyclical downturn, and would help offsetting short-term disruptions to growth caused by enacting reforms to State Owned Enterprises (SOEs), cleaning up local debts and overcapacity, and imposing tougher regulations on the environment.

Slower growth is fine as long as it is at a stable and sustainable level without creating new problems of overcapacity, pollution, and excessive debts. My worry is that if the growth continues to slow down in a way that disturbs market expectations and the normal growth process, the economy could face the danger of debt deflation. The relaxation of both monetary and fiscal policies is meant to reduce that risk but not to encourage wasteful investment. That is why China now needs smart investments that would not only benefit future growth but also restore the confidence of the investors, producers, and consumers.

Q: Is China compromising reform for the sake of stimulus to keep the economy afloat?

I don’t think so. I think the risk is the other way, which is that China is trying out too many tough reform measures within too short of a timeframe. As an analogy, if you have a sick patient, you want to do a number of major operations in order to eliminate cause of his illness. But if the patient wasn’t very healthy to begin with, the necessary procedures, if not planned carefully, might actually put the patient at grave risk.

Given China’s determination, and progress it has already made, in carrying out structural reforms covering anti-corruption, cleaning up the environment, and dealing with overcapacity and local debts over last few years under the leadership of President Xi, the short-term risk for China now is not on the lack of reform. Instead, the risk is on how to manage market volatility and expectations so that reasonable volatility can be tolerated without leading to runaway deflation or the creation of another bubble.

Q: How is this playing out in the coming plenum?

The focus of the Fifth Plenum will be on the 13^th Five Year Plan and economic growth will still be a priority because that is crucial for the China Dream articulated by President Xi, which would transform China into a high-income country with growth that is  inclusive and sustainable.

Key for the new growth model is innovation and creativity although the 13^th Five Year Plan will cover major issues, including S0E reform, financial reform, market opening, urbanization, regional integration, and other social issues. I have no doubt that quality of market completion, government accountability, and provision of public goods and services in China will be significantly improved during the 13^thFive Year Plan period because of the expected implementation of many substantive reform initiatives proposed at the Third Plenum.