Author: Peter Drysdale, East Asia Forum
Those in the international policy community whose professional responsibility it is to keep abreast of political developments in China have been in a tizz over the past few weeks about the prospects of a return to the command economy. This might seem strange to the economic observer. The most vibrant part of the second largest market economy in the world, generating around two thirds of its industrial product, is its private sector. The United States might not designate China a market economy in its trade dealings, though Australia and many other countries do, but it palpably is.
So what omens are there that we might see a retreat from the market in China?
The response to stock market tumble is seen to be the first sign that management of the Chinese economy is heading backwards.
There’s nothing unusual about governments stepping in to cushion stock market collapses. Central banks in the United States, Japan and Europe have all moved in recent times to buy shares and ease credit in order to turn around stock market crashes. But there was more than a touch of panic about the moves to stop the stock market rout in China. Aside from easing interest rates (a move that might be taken further in a deflationary economy that is operating under potential), the regulators capped short selling; pension funds were instructed to buy more stocks; initial public offerings were suspended, and brokers were cashed up by the central bank to buy more shares. The security bureau was thrown in to investigate illegal dealings. More ominously, with the rescue measures directed at putting a floor under the stock market collapse, investors in China face risks that are commonly associated with market conditions in developing countries rather than the second largest economy in the world. Asset seizure, insider trading, and rampant leveraging are still sanctioned by the Chinese government. Securities regulators seemed to rely increasingly on arbitrary enforcement from which investors have little legal recourse.
At the bottom of the crash in early July, China’s stock regulator rolled out ‘Announcement 18′ which threatened ‘severe punishment’ for any senior management or controlling shareholder — one with a stake of 5 per cent or greater — for selling the shares of a listed company over the following six months. With that announcement, trillions of RMB in assets belonging to some of China’s wealthiest investors were frozen for at least half a year. In essence, there would seem absolutely nothing to stop the Chinese government from freezing the shares of major shareholders for any period they chose.
Yet the rush of the worrywarts to the judgment that these represent serious steps backward to a control and command economy is premature. The truth is that all these elements were present in the Chinese market before the latest developments; they are characteristic of a developing country financial market (and, indeed, some more developed markets in Northeast Asia not so many years ago); and the important questions are about how the authorities respond in prosecuting the financial reform agenda in the medium term.
The burst of the leverage-driven stock market bubble is not closely connected from the realities of economic activity or corporate earnings. Fears of contagion from the bear market in stocks via its negative wealth effects through households and firms on the real economy are also misplaced. Given the continued vitality of trading activity, value added in financial services — which boosted GDP a bit during the bull run — does not look likely to drop that much.
The devaluation of the yuan and delinking it from its peg to the US dollar the week before last has also perversely been seen as a sign of reversion to state intervention in the economy.
As Sourabh Gupta points out this week, the most important driver of this move, which should have come as no shock to the markets, was ‘the imperative to signal to the international economic community that China has formally — and irrevocably — graduated to a managed float currency regime…There should be no misgivings regarding the PBoC’s commitment to a more market-determined exchange rate. The instances of change in China’s currency regime have been few and far between, and each instance has resolutely embraced a progressively liberalising tendency’.
Paul Hubbard, in our lead essay this week, reviews a study from the US National Bureau of Economic Research that suggests that ‘contrary to common misconceptions, productivity growth under Mao, particularly in the non-agricultural sector, was actually pretty good’. Yet a conclusion that reversion Mao-style policies would lift productivity in China today, Hubbard argues, is farcical. Without proper product and factor market signals, as the Chinese leadership well understands today, there will continue to be colossal waste and resource misallocation. The whole thrust of the Chinese policy making machine is pointed towards strengthening the operation of markets, although the challenges in implementing these reforms are of course huge.
At the core of the task ahead will be China’s steady-handed delivery of its financial, foreign exchange regime and capital account reform agendas. Financial repression results in an enormous misallocation of capital. Foreign exchange regime and capital account reform are essential to create instruments for managing, and capturing the benefits of, integration into international capital markets.Premier Li Keqiang has, with good reason, emphasised the growth and reform of the stock market as a facilitator of the emergence of the new, entrepreneurial edge of the Chinese economy. But this is no short-term job. There will be missteps. Pinning policy over-reaction on President Xi’s inclination to reach for the armoury of the state is too simple (though for some, politically convenient) an explanation of how the Chinese state has responded to events of the past two months.
Indeed, the talk at the top of the economic policy making apparatus in China right now — with a softening of economic performance — is of the need for, and commitment to, intensification of market reform, not retreat from it.
This week we also featured a series analysing Japanese Prime Minister Shinzo Abe’s speech on the occasion of the 70th anniversary of the end of World War II which can be found in the list below. The consensus is that Abe went further than many expected but missed an important opportunity to clear the decks and make amends and set Japan’s relations with Japan’s neighbours in Northeast Asia on a totally new course, though the door is still ajar.
Peter Drysdale is Editor of the East Asia Forum.
Go here to read the rest:
Back to the future in managing the Chinese economy?