The 19th Party Congress set out the principles that will define the approach to what Deng Xiaoping described as the third phase of China’s modern economic development. This is the phase when China seeks to achieve income levels on par with the OECD average. The National People’s Congress last week gave President Xi Jinping an unprecedented and extended mandate to deliver by removing the term limits on China’s presidency.

The next phase in China’s economic development involves a complicated transition in the Chinese economy and society. Success would see China become the largest economy in the world.

These ambitions are important to the welfare of the people of China. But they are also critically important to the welfare of the global community. China is already central to global economic welfare and opportunity. It accounts for a large proportion of global economic growth. It is the world’s largest trading nation.

It is the world’s second-biggest economy. It is the world’s biggest supplier of manufactured goods. It is the world’s biggest consumer of energy and a large range of industrial raw materials. China’s economic activity impacts on every aspect of global economic life.

China can therefore be confident that the rest of the world wants China to succeed in its ambition for economic development, both because of what it will do for the welfare of the Chinese people and the opportunities it will deliver to people all around the world. 

We are also all interested in how China manages the next phase of its development. Can China achieve its goal of becoming an advanced, socialist, democratic state by the middle of the century, 100 years after the founding of the People’s Republic in 1949? Many believe it can be done. There is no technical impediment to success. The question is how the transition will be managed, both economically and politically.

The first two phases of reform that Deng defined were easy compared to the challenge of the third. In the first and second phases of development China doubled national incomes each decade. During this period, economic reforms were designed to ensure rapid catch-up from a poor to a moderately well-off lower middle income country.

The next phase — transition to advanced-economy status — will be much harder. Xi will need to oversee a shift from factor-driven to productivity-driven growth to avoid the ‘middle-income trap’ that has confounded most countries reaching China’s level of income. Domestically there will be new winners and losers, putting social and political stability at risk. Xi will also need to manage spillovers on the global commons.

Success depends on getting the sequencing right, managing complex economic and social change domestically and developing strategies and policies that allow far deeper integration and interaction with the international community. These changes are already underway. But they are only in their early stages.

The 19th Party Congress acknowledged the new imperatives and set out important and appropriate principles for international engagement. But the pathway forward is less certain.

Consider, for example, the pressing challenge of financial reform and stabilisation, which is critical for lifting economic potential through the release of capital to productivity-enhancing enterprise. Financial reform is connected at the hip with the reform of underperforming SOEs — a base of powerful vested interests within the state. Dealing with the massive debt problems in the SOE sector will require step-by-step financial reform.

Financial reform is a necessary prelude to integrating the Chinese capital market into the global capital market, not only to lift productive potential but also to manage the macroeconomic interaction between the Chinese economy and the international economy through flexing the Chinese currency. A system of macroeconomic management that relies on capital market and other controls is less and less viable. 

China’s failure to deliver on this agenda for reform will increase fragilities in the global trading and financial system. It will intensify the effects of macroeconomic shocks in China and aggravate their impact globally. Incomplete financial system reform in China could be a trigger to bigger global system instability.

Beyond China’s borders, the Belt and Road Initiative (BRI) is similarly fraught politically and economically. China has opened to international engagement on managing this huge new dimension of its economic relations with neighbouring economies and economies around the world. That’s an entirely welcome initiative. 

The challenge will be to get the terms of engagement between China and its partners right so that the BRI’s potential to lift global connectivity and development does not end in diplomatic and political tears. In earlier times Japan found that this was no easy task, even on a much more modest scale than that China is now attempting.

All of the initiatives necessary for China to achieve advanced economy status will be fraught with technical problems and risks. And many are not purely technical in character: they have important political implications.

In our lead essay this week, Ryan Manuel worries that the changes Xi has made to the Constitution and the way in which his control of the Communist Party is being brought to bear on control of the Chinese state may have adverse consequences for economic innovation and reform. The concentration of power under Xi may in the end make navigating these huge changes more difficult not less. 

Consolidating Xi’s power under the Party might make more people follow what he has to say, Manuel argues. But it will also mean that more people will expect him to solve China’s many problems when he simply won’t be able to. ‘As those expectations grow’, says Manuel, ‘Xi might well have driven away the officials and others [inside China and outside China] who have precisely the knowledge and the entrepreneurship that he needs to solve problems that face China now’.

More centralised political control will certainly help manage some of the challenges better, including the pernicious problem of spiralling local government debt. But there will be many inside China as well as outside who worry about how Xi’s political enthronement could chafe against the dynamism of the markets that have underpinned the Chinese economic miracle  thus far and are essential to achieving the goals of China’s third phase of development.

(Courtesy East Asia Forum)
(The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University)