Room for Improvement

With an 8-percent growth rate all but secured, China needs to focus more on improving the quality of its economic growth

By HUANG YIPING

China experienced a successful economic rebound in 2009, thanks to the government's mobilization of resources to support the growth. During the second and third quarters of this year, investments contributed 85-90 percent to economic growth. GDP growth is likely to exceed 8 percent in 2009 and may even reach 9-10 percent next year. Almost all investment banks now have upbeat economic outlooks for China, although many of them were less than optimistic a year ago.

However, China currently faces a bigger challenge: How to rebalance the economic structure, improve the growth quality and make the rapid growth sustainable? Since 2003, the Chinese Government has dealt with the structural risks of the economy. Unfortunately those risks expanded over time. And the recent government stimulus policies aggravated some of the problems, such as an even higher investment share of the GDP.

The problem in the short run has become finding a replacement for the state-dominated investment that will carry China's economic growth forward. The possibilities are limited to exports, consumption and private investment or a combination of the three. But the outlook for the export market is grim. The growth potential of the global economy is shifting lower. Risks of protectionism are rising. And American consumers are saving more and spending less. Consumption growth remains stable but lacks a growth impetus of its own, and the increase of private investments owes its success to the government's stimulus package.

The quarter-on-quarter GDP growth experienced a dramatic decrease in the third quarter. According to the State Bureau of Statistics, China's GDP scored a 5.1-percent increase quarter on quarter in the third quarter, much lower than the growth rate of the second quarter.

After achieving an annual GDP growth of 8 percent for this year, the adjustment of the economic structure was once again on the agenda, which was discussed this December when the Central Economic Work Conference agreed the government would focus more on structural adjustment and improving the quality of economic growth. The annual year-end conference aims to set the tune for macroeconomic policies for the coming year.

Policymakers at the conference also said China would adhere to its current proactive fiscal and appropriately accommodative monetary settings next year. That is to say, China will still look to domestic demand for its growth impetus. As we all know, government investment takes up a large portion of the domestic demand. In an effort to bring government investment into full play, major adjustments should be taken. Top priority should be given to a combination of forceful macro-policy measures, namely its loose fiscal and stringent monetary policies. An excess of liquidity has demonstrated the necessity to tighten the money supply whereas structural adjustments, including securing people's livelihood and supporting preferential industries, could not do without the support of loose financial operations.

In spite of the fact that structural adjustment has been listed as a major task of the government for several years, almost all efforts and attempts to bring about changes ended in vain. China seems to be trapped between a rock and a hard place—the more endeavors it makes, the more imbalanced the economic structure becomes. According to the State Administration of Foreign Exchange, China's current account surplus reached $162.9 billion in the first half of 2007, a staggering increase of 78 percent year on year.

From my point of view, the essential problem may simply be the afflicted incentive mechanism associated with the asymmetric liberalization of product and factor markets during China's reform period.

China has successfully liberalized product markets, with almost all products regulated by a free market mechanism. But factor markets remain heavily distorted, as is the case for labor, land, capital, energy and even the environment. Factor prices are significantly depressed, which has provided additional incentives for producers, investors and exporters. Meanwhile, such distortions lower households' income share of the GDP but raise enterprises' income share.

Fortunately, the conference realized this point and stated that the essential means to structural adjustment will be through the marketization of production factors. The country hopes to achieve this goal in the next five to 10 years, in which it will fundamentally rectify the distorted incentive mechanism and promote economic development.

The author is a professor with the China Center for Economic Research at Peking University.