The economic challenge for China's new leaders

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Xi Jinping and China’s other new leaders take charge of a slowing economy and an increasingly vocal populace demanding cleaner government, better welfare and more affordable housing. Only modest progress has been made at shifting the economy from an investment-led, industrial model to one driven more by consumers and the services sector. Yet Louis Kuijs, Chief China Economist at RBS says investors expecting the incoming administration to respond with rapid reforms or a major fiscal stimulus are likely to be disappointed.

Louis Kuijs, Chief China Economist at RBS
The government of Xi Jinping, who will succeed Hu Jintao as president in March, may take a more comprehensive approach to reform and do more to rebalance the economy but it is important not over-play the impact of new leaders. Gone are China’s strongmen, Mao and Deng Xiaoping. Leadership is now collective, headed by the Communist Party’s all-powerful Politburo Standing Committee.

China’s economic plan for 2011 to 2015 serves as an important reference point, much in the same way the reforms championed by Hu Jintao and his premier Wen Jiabao were outlined before they took office ten years ago. Respect for the outgoing leaders and their continued influence lessens the likelihood of sharp U-turns. Allied to that, Xi Jinping and Li Keqiang, who is likely to take the economic brief as premier, are drawn from the existing Standing Committee.

These factors suggest Xi Jinping and Li Keqiang may find it hard to change course and accelerate reforms. Reducing the nine-strong Standing Committee to seven members during this once-in-a-decade transition, is a tacit admission that consensual rule can hinder decision making.

Decisions might be needed. Most agree that Xi’s team faces a cloudier outlook than the one Hu and Wen inherited. China’s conomy quadrupled in size over the subsequent decade, but now trend growth that has hovered around 10 per cent since the 1990s is expected to ease to around 7 per cent by 2020.

China's leaders are increasingly fretful of the impact a slowing economy may have on internal social tensions. Some have called for another round of stimulus to mimic the boost provided by the last package two years ago. That seems unlikely, not because of the leadership transition, but because China’s recent economic slowdown seems to be bottoming out. Though the outlook for exports remains weak, a decline in the property sector is easing and infrastructure spending has been picking up. The labour market is strong and wages have continued their steady rise, lifting consumer spending. I expect Beijing to maintain pro-growth policies through measures such as infrastructure investment and relaxed monetary conditions, but to go no further. That has something to do with the ill effects of the last stimulus programme and also because the government seems more relaxed about lower growth in return for quality growth.

The shortcomings of stimulus have strengthened the hand of those, including Li Keqiang, who argue for greater structural reform to rebalance the economy. This is where the new government may seek to make its mark. Current and past economic plans have already made some progress in rebalancing the economy, for example improving health and education and in encouraging wage growth. This is starting to show up in the data. After a long decline, consumption as a proportion of GDP edged up last year and should increase further in 2012. That growth is in turn encouraging investment in the burgeoning service economy which should help shrink the relative size of industry and China´s trade surplus.

The big question mark remains the willingness, and ability, of China's new leaders to change China’s economy significantly by accelerating new reforms. In that respect, industrial policy could be an important litmus test. The current plan is designed to push manufacturers in China up the value chain. Yet greater government intervention there could clash with efforts to change China´s pattern of growth away from a reliance on industry.

More is needed to level the playing field between state-owned and private companies, better financing is required for smaller firms and Beijing must better delineate the division between state and market. Despite a vast improvement in the welfare provision over the past 10 years, much more needs to be done for the millions flocking to China’s mega-cities every year who are denied proper housing and state-based services. Giving local governments the means and incentives to integrate migrants would transform them into fully-active consumers and provide a further boon to the domestic economy.

The next six months should tell us just how ambitious the new government is likely to be. Change will be gradual. However recent comments by Li Keqiang and the lessons of China’s transition in 2002/03, suggest there is a reasonable chance the new government may embark on more ambitious and comprehensive efforts to restructure the economy.

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