Commentary | 31 October 2017

Xi Jinping's state capitalism is here to stay

Originally published in the Australian Financial Review.

Originally published in the Australian Financial Review.

Xi Jinping's declaration of a new era at the 19th Party Congress is being met in the West with a mix of trepidation and awe at how far China has come and what may be next. Xi not only cemented himself as the most powerful Chinese leader since Mao Zedong. He also seemed to declare the triumph of China's particular model of politics and state capitalism, with a strengthened one party state at the centre of both.

A few decades ago, Western thinking was dominated by the "end of history" view that liberal democracy and capitalism had triumphed. Today, in the long wake of the global financial crisis, it is the Chinese model that seems ascendant to many. Xi certainly used his opening address to hammer this through, making clear that China had no intention of moving towards the Western model.

While touting grand economic ambitions, Xi provided mixed messages on how he intended to get there. The market and the state sector would both be strengthened. But Xi's track record to date and his clear emphasis on the centrality of the party create a strong impression that state capitalism is here to stay.

Optimists believe Xi's strategy may have been "turning left to turn right", first consolidating his power with the aim of pushing through deeper economic reforms in his second term. If that's the case, the Party Congress left us to keep speculating. Certainly, the major imbalances that have built-up in China's economy warrant urgent attention, with some estimates putting total debt at about 270 per cent of GDP.

Xi may indeed accelerate reform during his second term but it's not clear whether that would necessarily entail the kind of market liberalising reforms that many foreign observers would like to see, particularly to state-owned enterprises (SOEs) and the sectors they operate.

It might instead involve an acceleration of the existing approach of tighter financial regulation, cutting excess capacity, restructuring SOEs, increasing social spending, and driving productivity through industrial policy. These are all fully consistent with Xi's state-centric approach but also important areas for deleveraging and rebalancing China's economy. And indeed there are positive signs that growth is shifting in a more sustainable direction.

Grander ambitions

The key question though is whether this will be enough to sustain the kind of growth needed to realise Xi's grander ambitions for China's future. The current growth rate of 6.8 per cent still involves substantial policy stimulus, creating a risk that the underlying sustainable pace of growth is possibly much lower.

While Xi hinted at accepting slower growth, sustaining even a more moderate pace will likely still require a return to market-oriented reforms. A large state sector and extensive administrative controls have proven useful for maintaining short-term stability and engineering medium-term adjustments, but it has not been a source of sustainable long-term economic progress. Contrary to popular contention, China's economic rise over the long-term has been predicated on gradually ceding greater influence to the market, not less.

The view that Chinese state capitalism is on the ascendancy extrapolates a situation that is both only recent and unsustainable. It was only in the wake of the global financial crisis that China was forced to switch to state-led activity. That was useful for avoiding a disorderly adjustment. But the imbalances it created are now the problem.

This tension also plays out in the international sphere. Deep economic imbalances mean China remains vulnerable to an external shock (e.g. a trade war or geostrategic uncertainties) so it needs to do what it can to maintain a conducive international environment. Meanwhile, capital controls and a shrinking current account surplus will stall the Renminbi's challenge to US dollar primacy as well as constrain Chinese outbound investment. More fundamentally, the conflation of security objectives with China's outward economic policies (e.g. the Belt and Road Initiative and technology policies) risk international resistance.

Lesson of success

Ambitions to export lessons from China's model to other developing economies also face inherent limits. China has much to offer in terms of trade and investment ties and perhaps reform lessons in targeted areas that may help balance out Western-dominated advice.

But there's much less to offer in its state capitalist model itself. At minimum, China's achievements are predicated on the historical foundation of a capable state that most developing economies simply lack (those that have this have already long taken off – e.g. most of East Asia). And, in any case, the lesson of China's economic success over the longer term has still been about moving towards the market, rather than away.

That's not to say that China must or will ever jump to the other extreme of laissez-faire economics or anything similar. That is both unlikely and inconsistent with the institutional foundations of China's economy.

But it does suggest that the current apparent penchant for state capitalism may eventually have to be tempered in important ways if China is to deliver on its economic ambitions.