China's reforms amid turmoil in the West

  2013/11/14 source：China Daily

As the Third Plenum begins a decade of reforms in China, the United States and Europe are coping with a lost decade of liquidity traps, growth stagnation, and sluggish recoveries.

In the 1980s, the then-Chinese leader Deng Xiaoping's economic reforms and opening-up policies enabled China to industrialize through investment and export-led growth. Those reforms were supported by three decades of globalization, which rested on the ability of the West to absorb Chinese exports.

In the coming decade, the economic reforms led by President Xi Jinping and Premier Li Keqiang will seek to fuel China's transition to consumption-led growth. However, these reforms will occur in a challenging international environment, amid what might be a lost decade in the West.

What can we expect in the near term?

In the past few months, China's new leadership has provided glimpses of economic reforms, which have now been officially launched.

According to the communique announced at the close of the Third Plenary Session of the 18th Communist Party of China Central Committee on Tuesday night, there will be reforms of the market, government and State-owned companies.

The key goal is to clarify the government's role in the economy. These are accompanied by reforms in finance, taxation, State assets, social welfare, land, foreign investment, innovation and good governance. In turn, the reform packages seek to relax control over market access, launch social security and allow sales of collectively owned rural land. The household registration system, which continues to discourage migration, will be phased out beginning with easier access to urban registration in third-tier cities.

The reforms come with increasing financial deregulation. A market-driven financial sector is vital to support the social model and consumption-led growth. Concurrently, China is opening doors for foreign investors and financial institutions, and the intention is to make the renminbi fully convertible and a major international and reserve currency within a decade.

Since early fall, these reforms have been fueled by the creation of Shanghai's free trade zone, along with 18 new policy initiatives, which seek to reduce restrictions in half a dozen key industries, including financial services and telecommunications.

These reforms, which will be spearheaded by a central team, are likely to be phased in over the next decade.

In the United States, the 2.8 percent annualized growth rate in the third quarter was well above the expected 2 percent. However, more than one-third of the growth can be attributed to a buildup in inventory, while the annual growth rate in consumer spending slowed sharply. Last month, US employers added 204,000 jobs, but a robust recovery would require 250,000-300,000 new jobs per month. The unemployment rate remains at 7.3 percent, while labor participation rates have plunged.

After the government shutdown, the debt debacle and the appointment of Janet Yellin as Ben Bernanke's successor, the US Federal Reserve may not consider hiking rates until the unemployment rate plunges to 6.5 percent, or inflation hits 2.5 percent. As a result, quantitative easing could continue until March 2014, which implies lower rates for longer.

Recently, the Dow Jones Industrial Average has soared close to 15,800 as individual investors have rushed back to the markets. But as the debt debacle is likely to start anew at the end of the year, the ensuing volatility will dampen the retail investors' irrational exuberance.

In mid-October, after the credit rating agency Fitch put the US on a "negative ratings watch", Congress agreed on a deal to reopen the government. The deal forced the lawmakers into long-term budget negotiations, with recommendations due by Dec13. While the US government is funded through Jan 15, its borrowing authority was extended until February 7 - that's when the debt wrangling will begin anew.

Similarly, in Europe, the current calm is mainly a result of the European Central Bank throwing its full muscle behind the euro in 2012. Amid low inflation, the ECB President Mario Draghi has halved the key interest rate from 0.5 to 0.25 percent, its lowest level in history.

Until recently, most European economies engaged in front-load austerity measures, which has caused stagnation across the region. While unemployment rate remains at 12.2 percent across the eurozone, it is twice as high in the ailing Southern Europe.

As the crisis spotlight has shifted to Spain and Italy, which together account for almost 30 percent of the regional GDP, bailouts are no longer an option. Even France is not immune to escalating pressures, as reflected by Standard & Poor's recent downgrade of its credit rating from AA to AA.

In the coming months, debt burdens in Greece and Portugal will require soft restructuring, while Spain's unsustainable debt must be addressed by mid-decade. As Brussels continues to muddle through, it hopes to contain political risks - particularly in Italy - by gradual reforms and adjustments.

Despite record-low interest rates and non-traditional monetary measures to stimulate economic growth, both the United States and the eurozone are coping with a liquidity trap, growth stagnation and lingering recovery.
In the near future, the grim international environment will not help drive reforms in China. In the mainland, these reforms must also be carried out amid a partial bailout of local debts, the gradual opening of State-owned enterprises to competition, and a 7 percent growth floor which will pace rebalancing.

However, China's reforms will be fueled by deep and decisive implementation, which will be reinforced by accelerating urbanization, a nascent social model, increasing innovation in the private sector and the mainland's growing attractiveness for foreign investment.

Like the reforms in the 1980s, the new-generation reforms are not a disruptive sprint, but a steady marathon. However, the coming year will provide a glimpse of the future - even amid the challenging international environment.