Blame Where Blame Is Due

It’s one thing to pillory the US for borrowing money. It’s even more imprudent to ignore the surpluses Beijing is running due to a faulty liberalization agenda.

It is critical to understand that the root cause of the imbalances and inefficiency problems is factor-market distortions. Therefore, the fundamental solution to deal with the imbalance problem is to implement a comprehensive package of factor-market reforms. This essentially calls for an end to the asymmetrical approach to market liberalisation. Steady liberalisation of factor markets and the elimination of cost distortions should be top priorities for the next stage of reform.

In specific terms, what should be done?

Labour-market liberalisation is a fundamental way to stimulate consumption. The government has planned to make new breakthroughs in reforming the Household Registration System and propelling urbanisation in 2010. It also intends to extend the social welfare systems to all rural residents. This is a positive step.

Another positive breakthrough could be the introduction of market-based interest and exchange rates. The China Interbank Offered Rate has been a good starting point for a government trying to form a market-based term structure for interest rates. But the financial system needs to cater better for the needs of the private sector, which will be the backbone of the Chinese economy. This means market-based interest rates. It also means that the the exchange rate regime should be more flexible.

Clearly defined land ownership in the countryside could reduce distortions to land use. Collective ownership is vague, creating room for corruption and hinders the modernisation of the rural economy. In the cities, the government should stay out of the direct negotiation of land prices and private property development.

Other related reforms are also needed as a supplement to abolish cost distortions.

For instance, the state sector needs further reforms in order to share profits with households. One option is for the State to collect more taxes from state-owned enterprises and then redistribute the gains to broader society. In broader terms, the state sector should gradually give up much of its monopoly power or be privatised.

The complete liberalisation of factor markets and the elimination of cost distortions are likely to take years to complete. When completed, they will signal China’s full transition to a market economy and will help lock China’s growth onto a more sustainable path.

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Filed under: Business/Economy, East Asia Tagged: china, factor, liberalization, prc