China's Coming Economic Shift: Control versus market forces.

• Author: Lo, Chi

Most China observers may not notice a structural change in China's economic policy that could potentially revive the economic prowess of the Middle Kingdom and underscores the fear of the coming threat of China in the global system. This change is reflected in the difference between China's recent economic management policies and those in the previous economic cycles, which indicates that Beijing's policy might have evolved toward a commitment to structural reform even at the expense of economic growth.

But skeptics still doubt Beijing's willingness to make structural changes, as many of the new policy initiatives continue to look at odds with market-determined resource allocation. The real question is whether market forces will work to improve China's system, as conventional wisdom has assumed. What if the market fails in China? Meanwhile, U.S. President Donald Trump's "America First" policy is aggravating the risk of Chinese hardliners pushing for policies to protect national security over continued opening up. If market forces do not work as intended in China and if China really goes back on liberalization, what would all this mean for the world?

A STRUCTURAL CHANGE

In the past easing cycles (2008-2009, 2011-2012, 2014-2015), Beijing used the same bailout tool kit of subsidies for corporate investment, measures for boosting the property market, and subsidies for household consumption. along with instructions for the People's Bank of China to pump liquidity and cut interest rates significantly, for the commercial banks to engage in a lending frenzy, and for the state-owned enterprises and local governments to borrow and invest in infrastructure. The purpose was to boost growth.

However, in managing the economic downturn that started in July 2018, China has been highly selective in the fiscal, monetary, and regulatory stimulus it has provided. Hawkish policy messages that insist on no wholesale reflation have often accompanied the targeted easing measures. This new easing approach shows Beijing's commitment to prioritizing growth quality over quantity via structural reforms and debt reduction. Massive liquidity injection, for example, appears to be a thing of the past.

There are two main reasons for this change in policy tactics. First, Beijing's policy objective has changed significantly, with Chinese President Xi Jinping's administration prioritizing growth quality and financial stability through reduction in excess capacity and debt growth maximization. Second, there are policy...