CHINA´S BEST BET : DOUBLING DOWN ON REFORM, NOT STIMULUS / THE WALL STREET JOURNAL OP EDITORIAL

Opinion

China’s Best Bet: Doubling Down on Reform, Not Stimulus

Slowing growth isn’t a sign of disaster, but it also can’t be cured by pumping money. What’s needed is freedom.

By Henry M. Paulson Jr.

April 13, 2015 7:24 p.m. ET


Last month, in his annual report to China’s legislature, Premier Li Keqiang set the target for 2015 growth at just 7%—the slowest rate in 25 years. But Mr. Li wasn’t finished: He also told the world that slower Chinese growth would be a “new normal.” Predictably, many observers of the Chinese economy overreacted.

One group argues that China’s leaders simply cannot tolerate such a slowdown. Inevitably, they predict, Beijing will return to its old tool kit, pumping out billions of stimulus in a futile effort to reinflate growth.

A second group argues that China’s economy is falling off a cliff. By recent standards, these skeptics maintain, 7% growth is disturbingly slow. That, in turn, suggests China’s economy must be in truly desperate straits.

But here’s the reality: We need to get used to slower Chinese growth, which in itself is no reason to fret, even though Mr. Li’s 7% target is probably too optimistic to be “normal” over the long term. If, as Beijing has promised, the slowdown is accompanied by deep and serious structural reform that opens up new growth opportunities, such as allowing the private sector to compete against state monopolies in service sectors like banking and telecommunications, then China will still grow robustly compared with all other major economies. Here’s why: China is engaged in a historic transformation, a politically fraught effort to reboot a $10 trillion economy beset by debt, overcapacity and structural inefficiencies. By any measure, turning such a ship around is no small or simple task.

China stands at a critical juncture. The country’s model for nearly four decades of growth has run its course, a victim of a sharp, cyclical downturn and structural flaws laid bare by the 2008 global financial crisis. The prevailing model relied heavily on government investment, exports, industrial policy and privileges for a bloated state sector that gobbled up land, energy and credit at subsidized prices. The Chinese economy became energy intensive but is energy inefficient, a toxic combination that damaged both the economy and the environment.

So reform is needed—but at a moment when the days of double-digit growth have disappeared, probably forever. Quality growth that can be sustained over the long haul is President Xi Jinping’s goal. Beijing aims to establish a new model, one that is compatible with a clean environment, based on consumption, competition and a fairer shake for the private sector.

In my new book, “Dealing with China,” I describe more than 20 years of economic change through the prism of my own experiences, beginning with my time as an investment banker at Goldman Sachs. In those days, investors and businesspeople in China grew accustomed to breakneck growth. But things are changing. Consider the policy on competition. China’s leaders have committed to unshackle the private sector.

As Mr. Li put it to me in a November 2013 meeting, “we have to remove all those unreasonable and irrational shackles and constraints” to “unleash the creativity of the market.” But freeing private firms requires genuine competition in sectors long dominated by state-led oligopolies.

And that also means ending their preferential access to energy, land and other resources.

Nor are these the only prices that will have to rise: Letting the market play its proper role also means liberalizing interest rates. That is something my longtime counterpart Zhou Xiaochuan, currently governor of China’s central bank, has committed to. Beijing has removed the floor on lending rates. In recent weeks, Mr. Zhou has also committed to liberalizing deposit rates, an important signal about reform.

As growth slows, Beijing essentially has three choices: It can try to pump up growth through yet another massive stimulus; it can try to muddle through; or it can double down on reform.

The first will exacerbate imbalances and distortions in China’s economy, postpone the inevitable reckoning and send Beijing hurdling toward an economic cliff. The second puts at risk the country’s economic and political stability because reforming too slowly poses a greater risk than reforming too quickly. So the third route is China’s best, and probably only, course.

Ultimately, that is why I remain cautiously optimistic about the prospects for reform, despite the gloom and doom that pervades so many analyses. China’s leaders understand what they need to do. In my book, I put this point as bluntly as I know how: The success of China’s reforms will be determined by how fast and to what extent the country rolls back subsidies and regulatory advantages for state-owned enterprises, opens key industries like energy and finance to the private sector, and fosters competition from foreign companies.

Can Mr. Xi do it? I wouldn’t bet against him. He has amassed power at a rate and to an extent unprecedented, at least since Deng Xiaoping and possibly even Mao Zedong. But Mr. Xi will need every bit of that power to make the fundamental changes necessary in a country where vested interests are deeply dug in and there is no consensus on the most difficult economic reforms ahead.

I believe the market can work magic. And paradoxically, the Chinese Communist Party says it wants to rely on that magic too. In the most important economic policy statement in decades, the November 2013 Third Plenum, it declared that the market would henceforth play the “decisive role” in the economy. So the Communist Party must face this paradox: For all its efforts and successes since launching economic reform in 1978, what the party must do, if it truly wants China to evolve into a global leader, is the hardest thing yet. It must commit itself to setting the economy free.


Mr. Paulson, chairman of the Paulson Institute and a former U.S. Treasury secretary (2006-09), is the author of “Dealing With China: An Insider Unmasks the New Economic Superpower,” published this week by Twelve.