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Former Chairman of Morgan Stanley Asia Stephen Roach: China’s Economic Identity Crisis

Stephen S. Roach 1Unlike the West, where former US President George H.W. Bush once mockingly referred to “the vision thing, ” China takes economic strategy very seriously. That much was clear at the recent China Development Forum (CDF) in Beijing, an important gathering held each year since 2000, immediately after the conclusion of the annual National People’s Congress.

Originally conceived by former Premier Zhu Rongji – one of modern China’s most strategy-minded reformers – the CDF quickly became a high-level platform for engagement between senior Chinese policymakers and an international lineup of academics, foreign officials, and business leaders. It is, in essence, an intellectual stress test – forcing Chinese leaders to defend newly formulated strategies and policies before a tough and seasoned audience of outside experts.

It’s not always easy to distill a singular message from an event like this, especially as the CDF, once a small intimate gathering, has morphed into a Davos-like extravaganza of some 50 sessions spread out over three days. But, having attended 16 of the 17 meetings (I missed the first one), my sense is that CDF 2016 was especially rich in its strategic implications for China’s daunting economic challenges. And, as I saw it, the elephant in the room was the core identity of China’s economic model – a producer-led versus a consumer-led model.

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China’s 30-year development miracle – 10% real annual GDP growth from 1980 to 2010 – was all about the country’s prowess as the ultimate producer. Led by manufacturing and construction, China enjoyed a uniquely powerful impetus. In 1980, exports and investment collectively accounted for 41% of Chinese GDP; by 2010, the combined share was 75%. The export portion increased the most – by nearly six-fold, from 6% in 1980 to a pre-crisis peak of 35% in 2007 – as new capacity and infrastructure, low-cost labor, and accession to the World Trade Organization made China the world’s greatest beneficiary of accelerating globalization and surging trade flows.

Yet the producer model was not the definitive formula for achieving China’s aspirations of becoming a moderately prosperous society by 2020. This realization was foreshadowed by the now-famous “Four Uns” critique of former Premier Wen Jiabao, who back in 2007 correctly diagnosed the producer model as “unbalanced, unstable, uncoordinated, and unsustainable.”

Those, of course, were code words for surplus saving, excessive investment, open-ended resource demand, environmental degradation, and mounting income inequalities. A new model was needed not only to escape such pitfalls, but also to avoid the dreaded “middle-income trap” that ensnares most fast-growing developing economies when they reach income thresholds that China was rapidly approaching.

Wen’s critique triggered an intense internal debate that resulted in a key strategic decision to rebalance the Chinese economy by shifting to a consumer-based model, as framed by the 12th Five-Year Plan of 2011-2015. This new approach stressed three major components: a shift to services to boost job creation; accelerated urbanization to raise real wages; and a more robust social safety net to provide Chinese families with the security needed to channel their newfound income from fear-driven precautionary saving into discretionary consumption.

The results of the now-completed 12th Five-Year Plan were impressive – especially in light of the formidable challenge that structural change implies for any economy. But that’s where China’s strategic focus is most effective – providing an over-arching framework to guide the economy from point A to point B.

But this journey is far from complete. While China’s targets for services and urbanization were exceeded, the end results fell short on many aspects of building a more robust (that is, fully funded) social safety net. As a result, personal consumption inched up from just 35% of GDP in 2010 to only about 37% in 2015.

Notwithstanding the unfinished business of consumer-led rebalancing, China now appears to be embracing yet another shift in its core economic strategy – driven by a broad array of “supply-side initiatives” that range from capacity reduction and deleveraging to innovation and productivity. That emphasis was formalized in Premier Li Keqiang’s recent “Work Report, ” which outlined the new strategy of the just-enacted 13th Five-Year Plan (covering the 2016-20 period).

In identifying the top “eight tasks” for 2016, Li put supply-side reforms at number two – second only to the government’s focus on economic stability in countering China’s growth slowdown. By contrast, emphasis on boosting domestic demand – long the focus of China’s consumer-led rebalancing strategy – was downgraded to third place on the so-called work agenda.

In China, where internal debates are carefully scripted, nothing happens by accident. In the keynote speech at this year’s CDF, Vice Premier and Politburo Standing Committee Member Zhang Gaoli drove this point home, emphasizing the need to direct supply-side initiatives at China’s “main threat.” By contrast, there were only passing mentions of consumer-led rebalancing.

Maybe I am guilty of splitting hairs. After all, every economy needs to focus on both the supply and the demand sides of its growth equation. But this shift in emphasis – in the 13th Five-Year Plan as well as in the debate and messaging at this year’s China Development Forum – appears to be an important signal. I worry that it could indicate a premature shift away from the consumer-led model back to China’s comfort zone of a producer model that has long been more amenable to the industrial engineering of central planning.

Strategy is China’s greatest strength, lending credibility to its commitment to structural transformation. Yet much remains to bring the Chinese consumer to life. Yes, it is a tough challenge. But de-emphasizing that strategic commitment could call into question a crucial shift now required of China’s core economic identity.

Copyright: Project Syndicate 2016 – China’s Economic Identity Crisis

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