Comparison of Economic Reform Sequencing in China
Andrew K. Rose from NUS Business School compares China's economic reform sequencing with the Washington Consensus. The optimal reform sequencing includes stabilization before reform, real before financial reform, and domestic before international reform. China's approach aligns oddly with the Washington Consensus. The Target resembles Williamson's Washington Consensus with principles like fiscal discipline, liberal trade, and secure property rights. The discussion also touches upon the absence of a clear Beijing Consensus, the style of reforms (piece-meal or simultaneous), and the role of crises in driving liberalization efforts.
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Sequencing Economic Reform: How does China Compare? Andrew K. Rose NUS Business School
What is the Optimal Sequencing of Reform? THREE RULES OF THUMB 1Stabilization before reform 2Real before financial reform 3Domestic before international reform Macroeconomic stability a precondition for success So international financial liberalization comes last In these senses, China is conventional Oddly consistent with Washington Consensus as endpoint Rose: Sequencing Economic Reform
Target: Williamsons Washington Consensus 1. Fiscal policy discipline (avoid large deficits); 6. Liberal foreign direct investment, especially inward; 2. Government avoids broad subsidies in favour of pro-growth, pro-poor services: a) primary education; b) health care; and c) infrastructure investment; 7. Market interest rates with moderate positive real rates; 8. Limited regulation (focus on safety, environmental and consumer protection, prudential oversight of financial institutions); 3. Tax a broad base with moderate marginal rates; 4. Competitive exchange rates (either fixed or floating); 9. Privatized state-owned enterprises; 5. Liberal trade with little NTB protection; 10. Secure property rights. Rose: Sequencing Economic Reform
Tangent: is there a clear Beijing Consensus? Most prescriptions not economic in nature Others not specific, consistent with WC as end-point an absence of political liberalization; strong leading role of ruling political party; population control; down-to-earth pragmatic concern with serving the people; constant trial and error experimentation; gradual reform, not shock therapy; a strong and pro-development state; "selective cultural borrowing" of foreign ideas. Rose: Sequencing Economic Reform
Style of Reforms Piece-meal or simultaneous? Critical Insight: behind many inefficiencies lie vested interests A single reform (e.g., eliminating employment protection) may increase national welfare but reduce welfare of interest group with political sway So simultaneous reforms may spread wealth, provide payoffs for most/all Piecemeal reforms may lower credibility, induce fatigue and backlash Crises are terrible things to waste Liberalization often follows crisis which provides impetus temporarily Often external, IMF China an exception Rose: Sequencing Economic Reform
What is the Optimal Speed of Reform? Fast or slow? Key Insight: reform is typically good in long run but not short run So, partial reforms tend to stall; train never arrives Big bangs only work rarely (Poland, Baltics, UK) Motivation: shock therapy too fast for political resistance to build But usually means reforms end because of short-term pain (Russia) Still, some reforms must be dramatic, swift to be irreversible (Russia privatization) Slow also works rarely (France, Italy, Japan) Time allows losers to coalesce and block reform China is the exception (as in so many things!), also New Zealand Tangent: Need social safety to sustain reform for both fast and slow Rose: Sequencing Economic Reform
Nexus of Reforms: Factors or Products? Inputs (land, capital, labor) or output (goods and services)? Diamond-Mirrlees: want to keep production close to optimal In practice everyoneis a consumer, but not all are employed/capitalists Labor market reforms very costly, hence delayed (forever? Europe) Product market reforms tend to reduce producer rents, often difficult to legislate (large number of reforms, each often bitterly opposed by well- organized lobby groups) Starting point matters: communism has fewer producer rents, underdeveloped financial markets True in China; early financial repression translated to growth via financial stability (later repression lead to inefficiency) Rose: Sequencing Economic Reform
Financial Liberalization Domestic before International Reduce domestic macroeconomic imbalances before international opening Otherwise provide avenue for capital flight to savers suffering from domestic financial market repression Need strong domestic financial system with supervisory framework, prudential regulation and controls, risk-management, bankruptcy laws, proper accounting system, capitalized banking system Banks first: interest rate ceiling/floor decontrol Bond markets next; then equity Crises that precipitate reform often external (balance of payments/fixed exchange rates) Fear of reversal if liberalization precipitates crisis Rose: Sequencing Economic Reform
International Dimension Consensus: Current account (trade in goods and services) should be liberalized before the capital account (trade in financial assets) Trade barriers create uneconomical import-competitors With these distortions, capital could be attracted by rents to flow into wrong sectors, lowering welfare and growth (McKinnon) Also capital flows can adversely affect exchange rate (Diaz-Alejandro) More generally capital flows MUCH faster than goods/services Irrelevant for China, since China liberalized trade first Rose: Sequencing Economic Reform
Chinese Liberalization China has dual-track reform strategy in three senses 2 1 3 Partial liberalization in factor markets to support SOEs leads to financial repression State presence maintained; non-state has grown Financial repression leads to formal and informal sectors Initial stability gains can lead to longer-term inefficiency costs More reform in product than factor markets Rose: Sequencing Economic Reform
Chinese Financial Reform Legacy ( big four ) banks important VERY large Substantive state control for loans, interest rates Substantive (if declining) financial repression Poor performance, corporate governance Still, change has been rapid Off balance products (wealth management), informal sector Big FinTech presence Growing capital markets Equity markets can absorb risk/bubbles easier than loan/debt markets Improving regulatory, supervisory capacity Rose: Sequencing Economic Reform
Chinese International Financial Liberalization International liberalization proceeding gradually Capital controls shrinking slowly Currency international (RMB in SDR) Sensible focuses: Maintain official presence in FX market (RMB managed) Encourage buy and hold investors Inflows not outflows Swap arrangements with foreign central banks Promotion of offshore financial centers Outflows, short-term, bond and equity markets the last stage Rose: Sequencing Economic Reform
Summary for China China has reformed slowly along conventional lines Unusually successful to have such a long gradual period of reform Continued growth has allowed all boats to rise Perhaps because of political monopoly? Connection between political and economic liberalization big issue in literature Still, no doubt of tremendous progress Longest period of high growth experienced in history (Pritchard and Summers) Largest experience of welfare increase/poverty reduction in human history Standard sequencing (real before financial, domestic before international, growing safety net, WC as target) as facilitator? Rose: Sequencing Economic Reform
Conclusion: Chinese Dilemma China looks like the epitome of conventional wisdom Heading to Washington Consensus Seems like China is close to end of reform journey Hence WCY Forum focus on advanced financial markets Prelude to international financial liberalization, final stage But, despite growth, Chinese reform has been inadequate at each stage Factor markets for land, labor, and capital still need massive reform Ex: financial: need to regulate shadow banking; create clear resolution mechanism; better information, regulation, supervision Ex: environmental externalities hard to handle without appropriate property rights Length without breadth: China could end reform having skipped steps Slowing momentum a danger, since reform consists of many small fights against vested interests; productivity growth becoming more difficult Rose: Sequencing Economic Reform
