Below is my translation of an interview that Li Zuojun (李佐军) gave to the Sanlian Life Weekly (三联生活周刊). As far as I know, this is the first time it’s been translated into English. It’s a long and at times dense interview, but I think the ideas expressed within it could prove very important for future economic reforms. I’ll give a bit of background on Li and then a brief statement of why I think his ideas are important before the interview.
Li Zuojun is the deputy director of the Resource and Environmental Policy Research Institute at the State Council Development Research Center. He’s gotten a lot of press recently because of a 2011 prediction that during the summer of 2013 the Chinese economy would experience an economic crisis. During the June credit crunch he was hailed as having predicted it, though I think a careful reading of that earlier prediction shows he was talking about something different (though still very interesting).
In this and other recent interviews Li has articulated a new framework for analyzing the challenges to the Chinese economy. He makes a case for a number of shifts in macro-economic analysis: away from demand-focused/Keynesian analysis and toward supply/productivity-focused analysis; away from the “three-horse carriage” (三驾马车) paradigm (exports, investment and consumption), and toward a focus on the “three engines” (三大发动机) of productivity, which he defines as institutional change, structural optimization and factor upgrades (制度变革, 结构优化, 要素升级).
This framework could provide insight into how the administration will approach economic reforms. So far the Xi-Li administration stated that it will initiate economic reforms in order jump-start a new age of balanced economic growth, but that slogan has yet to be put into a well-defined framework. The paradigm advanced by Li Zuojun could very well be adopted as an intellectual backdrop for future reforms.
I want to emphasize that I’m not a professional translator, but I did put in a lot of time to come up with what I think is a faithful translation of the original. I’ve highlighted one or two places where I’m really not sure what the correct translation would be. I’d love to hear suggestions for improvement.
Original interview: http://www.lifeweek.com.cn/2013/0718/41558.shtml
Sanlian Life Weekly (SLW): You’ve said that looking at short-term trends in the Chinese economy, 2013 will be a “first-high,then-low”trend. What do you base this judgment on?
Li Zuojun (LZJ): I think that in 2013 the economy will follow a “first-high, then-low”trend, with shocks ahead (前高后低、震荡前行的趋势). This includes both the market’s own cyclical adjustment and the government’s own pro-active adjustment. You can’t push forward transformations in the economic development model without having that development slow down.
There are a few reasons for the “first-high”: First, there was still some impetus from the rebound at the end of 2012. Path dependency means this growth can continue for a period of time. Second, the ascension of the new leadership has given investors and consumers some new confidence. Third, the central government has said that it wants to push forward urbanization. After they emphasized this urbanization push, local governments, capital markets, real estate developers all got some encouragement, and they gave a push to growth. Fourth, the international economic situation was improving, especially the continuation of the recovery in America, the stabilization of the Euro-zone, and Japan’s short-term economic improvements. These stimulated exports and boosted economic growth.
SLW: Why will the “then-low” emerge?
LZJ: As to the reasons for the “then-low”, I think one aspect is last May’s stimulus, when China utilized some growth-stabilizing measures. This was a certain degree of economic stimulus, and the effects of this kind of stimulus usually last about one year. For example, the 4 trillion yuan stimulus of early 2009 brought about a fast rebound in the economy, and that lasted for about one year. In reality, starting from the second quarter of 2010 the Chinese economy already exhibited a downward trend. Economic growth dropped from 12.1% in the Q1 2010 all the way to 7.4% in Q3 2012. You can see that the economic stimulus only cured the symptoms in the short-term but not the fundamental problem. As soon as the stimulus wore off, the economy began a downward trend. This time the growth-stabilization measures brought about a clear rebound in Q4 2012, but in reality Q1 2013 didn’t continue that rebound, the effects didn’t last as long as last time.
Another aspect can be seen from the attitude expressed by the central government. The government’s tolerance for a GDP slow-down is strengthening, and there’s a lot of will to move forward with changes. Recently the central government has squeezed the bubble in the financial system. This will sacrifice the speed of present GDP growth, a highly necessary step to boost long term healthy growth.
SLW: You’ve mentioned that there will be changes to Chinese economic growth: 2015-2020 growth will be 6-8%, 2020-2030 growth will be 4-6%, 2030 onwards growth will be 2-4%. That says that we’re in a transitional period from high growth to medium and low growth. What do you think are some signs of the new stage the Chinese economy has entered?
LZJ: One is that the Chinese economy has just changed from a high-growth stage to a medium-growth stage. These last two years it’s been stepping down, and the 10+ percent growth rates of the past 30 years are already gone and not coming back.
Two is that China has started to enter a period of economic adjustment. It’s working through a couple years of economic structural and strategic adjustment, digesting the bubbles and contradictions that exist in the economy. This kind of adjustment needs to occur during a period of reasonable growth rates.
Third, China has entered a delicate period in terms of the “middle-income trap”. According to international experience, you enter this period when average incomes exceed $4,000. Up until now China has just stepped into this delicate period. In reality, China has already seen the appearance of problems that occurred in other countries caught in the middle-income trap, for example increases in the income gap, the intensification of social conflicts, difficulties in transforming and upgrading production processes.
Fourth, China has just entered a period of high costs. The cost of land, raw materials, energy resources, labor, capital, and intellectual property are all going up. It means China’s competitive advantage from low costs isn’t that obvious anymore.
Fifth, China’s industrialization has entered the middle and late stages, and “the second half stages of heavy industrialization.” The characteristic of this stage is that you need the blending of development in heavy industry and productive service industries. The first half of heavy industry’s development was a period of expanding capacity, the second half is about elevating quality, and economic growth will accordingly decrease. After these phases end, you enter a “post-industrial society”, and this is the reason that after 2020 we’ll see economic growth rates continue to decline.
Sixth, China’s urbanization has entered the second phase of its acceleration. According to international experience, urbanization is in its accelerating phase when urbanization rates are between 30 and 70%. In 2012 China’s urbanization rate was 52.6%, meaning it’s just transition from the first half to the second half of this acceleration. It’s the same as industrialization: the first half of this phase is about expanding quantity, but when you enter the second half, even though speeds are pretty fast, you’re already transitioning to the phase of elevating quality. When you enter this phase, the scope of basic infrastructure and real estate development will correspondingly shrink, causing economic growth to slow down.
SLW: Other than reasons originating in the Chinese economy, are there external factors influencing this?
LZJ: External factors are playing a role, for example, the decline in demand from abroad. After the international economic crisis passed a portion of external demand returned to China, but there’s also a portion that’s been lost forever. As America and other countries are reflecting on the international financial crisis, they’re reflecting on the past economic development model of “high consumption, advance consumption, debt-driven consumption”. The result is that they won’t again have such high consumption, advance consumption and debt-driven consumption. This means that even though the international financial crisis is over, there’s a portion of demand for Chinese exports that’s gone forever.
This means that the potential growth rates for China have declined. This is the best growth rate that various environmental resources and factors of production can support. In the past the constraints from the resource environment weren’t that great, and you added on the large dividend from institutional changes that released productive capacity, so one could maintain high growth rates for such a long period of time. But now resource constraints are constantly growing, and the space for boosts from transformations that release productive capacity is also relatively shrinking. Because of this China’s potential growth rates have dropped.
“Squeezing the bubble” and “soft landings”
SLW: In the last few years as academics started to call out that China’s competitive advantage in the world would decline steeply, they referred to a decrease in the “demographic dividend.” Are changes in the demographic dividend, an important factor causing China’s growth rates to decline?
LZJ: Demographic dividends are just one factor influencing China’s growth rates. The objective forces behind Chinese growth rates involve a wide range of things. They include the drivers of demand, what people often call the “three-horse carriage” [investment, consumption, exports]. Second you have the drive from structural optimization, including industrialization, urbanization, regional economic integration, industrial upgrading, etc. Third, the increase in factor inputs. Fourth, the upgrade in factor inputs, such as technological progress, growth in human capital, information technology, etc. Fifth, is institutional change. Institutional changes can mobilize each person’s pro-activeness and creativity, and these can boost economic growth. Sixth, distortions, especially those that suppress prices for the factors of production. Seventh, suppressing expenditures on welfare can increase expenditures on economic development. Eighth, the use of economic stimulus. Ninth, the corporatization of government and the pursuit of excessive growth rates.
Looking at it today, six of these have already experienced problems on some level. All you have left is institutional change, structural optimization and factor upgrades. In the future these three forces will be the main drivers, and the most important will be institutional change, because structural optimization and factor upgrades both rely on institutional change.
SLW: So that’s to say the economic stimulus methods we used in the past, the things that kept our low-price competitive advantage are disappearing, and the expenditures on welfare that have been squeezed out in the future need to be made up. Left over we just have institutional change, structural optimization and factor upgrades, these three aspects can push forward economic growth. So in the future when we do macro-economic analysis, should we be paying more attention to changes in these three factors?
LZJ: I think our angle for doing macro-economic analysis should be more diverse. In the past we relied too much on Keynes’ macro-economic framework. In reality, there is exist some major defects in it. Keynes’ macro-economic analytical framework over-emphasized exports, investment and consumptions, these three forces acting on demand. In contrast, it overlooked the role of supply, and in reality economic development is the result of the overlap between supply and demand. The elements of supply include technological development, increases in human capital, structural upgrades and institutional innovation, etc etc.
In the past we over-emphasized short-term analysis and overlooked medium and long-term analysis. We overemphasized economic factor analysis and overlooked non-economic factor analysis. In the past we overemphasized the government’s role and overlooked the market’s role. As we combated the crisis for the past few years, the government clearly applied Keynesian theory: the crisis began, economic growth slipped, unemployment rose, and we just started emphasizing the role of government. The government initiated large-scale investment, construction and money printing. This brought about two results: On the one hand, the economy had a quick rebound and recovery, the results were almost immediate. On the other hand, the economy began to display or prepared to display large-scale asset price bubbles, inflation, non-performing loans, debt, over-capacity, and a retreat of marketization.
Also, in the past we over-emphasized total macro-economic analysis, and overlooked the micro-analysis of individual behavior. In reality economic development is always about the integration of macro and micro, the macro results are built on a foundation made of micro behaviors.
SLW: During the era of high economic growth, we were always scared by the thought of an economic downturn. In reality what kind of challenges will an economic downturn bring about? Are we going to be able to deal with it calmly?
LZJ: The challenges faced during an economic downturn are all encompassing. They include long-term inflation, accumulated economic bubbles, increasing resource and environmental constraints, an increase in the social expenditures of economic development, and the deterioration of the international environment, to name a few. The problems and the challenges aren’t frightening, but what’s frightening is that we don’t know where they are. Once we see clearly what the problems and challenges are, we can absolutely handle these challenges.
SLW: These days a lot of people are wondering, will the bubbles accumulated in the economy pop?
LZJ: If the government applies macro-controls in an extremely skillful way, slowly squeezing the bubble, while also not letting them cause an economic crisis or social unrest, while also cultivating in a timely way new sources of economic growth and competitive advantage, pushing forward industry structural changes and upgrades, then this is what you’d call a “soft landing,” the bubbles won’t pop. During the so called “money panic” of late June, in the process of resolving it the central government expressed the determination to squeeze the bubble. The central government hopes to use reforms to make the real estate market turn into a regular industry, and also give a fairer competitive environment in the real economy. This affects reforms to monopoly privileges for example, and a whole set of questions about institutional reform.
SLW: Some people see the decrease in economic growth and inflation, and they think this is a necessary expression of a “soft landing”.
LZJ: The problem might not be that simple, a drop in growth rates and inflation doesn’t necessarily mean a complete soft landing. A soft landing has to be a safe landing, and a safe landing means that as growth rates slide, economic structures are smoothly adjusted, new sources of growth slowly appear. If it doesn’t happen like this, it will cause business losses and bankruptcies to increase, debt burdens to grow, financial dangers to grow. This is what they call a “hard landing.” In addition, as the new sources of growth appear, they have to rely on institutional change, factor upgrades and structural optimization, the “three big motors” (not the “three horse-carriage of short-term exports, investment and consumption). This requires a process.
SLW: In the past the government said that in maintaining economic growth, a very important indicator was that GDP growth had to stay above 8%. Only then could China resolve employment issues. Right now economic growth has already slipped, have the challenges in terms of employment grown bigger?
LZJ: The slide in growth rates means that demand will shrink, orders will shrink, and markets will contract. Lots of businesses might end up taking losses and going bankrupt. Employment opportunities will shrink, work will be hard to find. Right now our economy will have a hard time pursuing high-speed growth. From here on out the difficulties in employment will grow. Western countries are already so developed, and there it’s still hard to resolve employment problems, the unemployment rates are still high. So from now on as China’s economy slows down, employment pressures will in fact grow.
SLW: But now these kinds of pressures will need to rely on the market to make adjustments. It’s not that the government can simply apply controls and resolve things.
LZJ: After changing the mode of economic development, from now on we’ll have to rely on social investment to drive economic growth, not like in the past when we relied on government investment. Bu social investment means using one’s own money, so investors will be very cautious, they’ll want to evaluate whether the returns will be great, whether the risk is high. If investors feel that the risk is too high, that the returns aren’t great enough, they just won’t invest, they’d rather choose to wait and see or to engage in speculation.
We originally relied on normal factors (like resources, labor, etc.), but from now on we’ll have to rely on high-level factors (like technology, human capital, etc.), in order to drive the economy. With normal factors China has a few advantages, but we have a scarcity of high-level factors. If we want to make the change to relying on high-level factors for economic development, the first question we have to deal with is how to engage in positive competition with developed countries. If China wants to make use of high-level factors, it has to resolve problems related to incentive mechanisms, especially intellectual property, but also many more.
The challenges for local government reform
SLW: We’ve been talking about reform for so many years, the main question for each phase of reform is different. Now growth rates are going down, it’s said that reform has entered the deep water phase, what changes have there been to the target of reform?
LZJ: The target of the new phase of reforms isn’t the planned economic system, instead it’s the transitional distorted system. It’s shown certain characteristics, for example: “privileged and elite market economy systems” (power mixed in with buying and selling), “monopoly market economy systems” (powerful monopolized industries), “preferential market economic systems” (preferential policies have a far-reaching impact on fairness in markets), “urban-rural split market economic systems” (urban-rural residence permits, land, welfare systems aren’t united), “spreading market economy systems” (education, healthcare, religion, and other public goods are overly marketized), “pricing benefits in market economic systems” (electricity, water, oil, natural gas, and other important energy sources have had prices suppressed, they’ve become a form of disguised welfare).
SLW: With so many problems requiring reform, what area should be the starting point for reforms?
LZJ: In terms of finance, we need to reduce non-performing assets, deleverage, and find new areas for investment. In terms of local governments, efforts need to be focused on reducing the debt burden, get rid of the reliance of land-fueled finances, and find new sources of growth. In terms of businesses, we need to reduce the burden, reduce overcapacity, and find new sources of profit.
SLW: Talking about local governments, everyone has been criticizing “land-fueled finances” for quite a few years, but it’s always proved hard to change. In the end, is it because we can’t resolve the problem of mismatch between responsibilities and finances?
Local governments do in fact face a lot of problems. There debt burden is heavy, and the revenue-expenditures gap brings a lot of pressure. From last year’s Two-Meetings up through the central government work conference, Politburo meetings have all emphasized the dangers of local government debt. This means the central government is putting a lot of focus on this problem. International organizations have also reduced China’s ratings because of the dangers of local government debt. If the dangers from local debt keep growing, the next step is the chance of danger to the whole government finance system or to localities.
“Land-fueled finances” is an old problem. With such little money, local governments can’t do all the much. When GDP is the main assessment metric, selling land is the most realistic method. But our land system is far from perfect, rural land isn’t really completely collective. A lot of legal loopholes exist, and governments can set high prices when reselling land.
SLW: Nowadays land-sale polices have become difficult to sustain.
LZJ: It is difficult to sustain. High housing prices have caused a lot of problems in today’s society. On the one hand there’s a great danger in terms of local government debt. Wealth has become overly-concentrated in government, and that’s created problems of unsound distribution. If you want to resolve the problem at a deeper level, you’ve first got to have reforms to the land system itself, let rural collectives truly own the land, make it the same as the system in the cities with identical rights, local governments can’t use land to generate wealth. Also, the finance and tax system needs reform. Make central vs. local government financial powers match their responsibilities. Right now there’s low-efficiency in some financial transfers and that creates waste. Furthermore, the central government’s system for assessments needs to be changed. Lots of governments have become corporatized. Governments should primarily rely on taxes from businesses and the people for their sources of income, it shouldn’t be that governments go out and directly earn money. If from now on our assessment system can become a 360-degree assessment, lower-tier governments assessing upper-tiers, the people assessing the government, this kind of government would set goals and work hard on improving employment and people’s livelihood.
SLW: The central and local governments are in the midst of this transition, it’s a bit like a game of chess.
LZJ: Right now lots of local governments see pressures on expenditures continually growing, administrative expenditures, infrastructure expenditures, affordable housing construction expenditures, social welfare expenditures, stability maintenance expenditures and others are all growing. But government revenues are actually shrinking. Because small and medium enterprises aren’t doing well industrial and commercial taxes have gone down, and because housing prices went down they brought down revenue from land sales. The “medium-growth phase” has arrived and relieved local governments of a portion of the pressure from the great GDP-growth competition. It’s made the more engaged in social management, and this will also create a good environment for transforming the economic development model.
The national government has the nation to consider, local governments have local concerns. Some places originally were major coal or steel provinces. If you want to adjust the structures, the bulk of economic growth is gone. So local governments start from their own GDP, government revenue and social stability maintenance, meaning the push-back against structural adjustment will be great. Whether or not you’re the central or local government, you want to set out considering the big picture, the long-term.
SLW: Right now we’re about to commence large-scale urbanization, will this be a new opportunity for local governments? Will they use this to slowly shed the dangers of their debts, look for new sources of growth?
LZJ: Recent urbanization has been given a new historical mission: expand domestic demand and cultivate new sources of growth. All over you have property developers and capital market investors moving at the first whiff, all clamoring to raise the banner of urbanization. This has got to arouse our vigilance. New urbanization at root is a good thing, but if we don’t pay attention to guidance, under the force of big investment, big demolition, big construction, and “build the city campaigns”, the development of housing and property might go astray and bring with it hard to predict consequences.
Our earlier urbanization showed some problems, for example urbanization of land replaced urbanization of people, stratification in cities replaced fairness in cities. In lots of countries cities aren’t given an administrative rank, they compete fairly. The difference is that China’s urban centers are separated by rank; there are directly-administered cities, sub-municipal cities, prefectural-level cities, sub-prefectural level cities, county-level cities, towns, villages, lots of different administrative ranks. High-ranking cities can use non-market trading methods to extract funds, resources and talent from low-ranking municipalities. This has meant that in the majority of Chinese cities their scale is proportional to their administrative rank, not their actual competitiveness. The factors of production aren’t distributed according to economic zones, but according to administrative zones or the certain configurations of power. This distorts the deployment of resources and reduces national and regional overall competitiveness. If you don’t destroy the urban administrative ranking system and let small municipalities become cities, it might become just another method for creating government posts.
SLW: So that’s to say that the new urbanization will require a portion of subsidies from local governments?
LZJ: The new urbanization is people-centered urbanization, and it will actually bring a lot of challenges to local governments. New urbanization is a natural historical process; you can’t independently move ahead, and you need to deal with the connection between marketization, industrialization and agricultural modernization.
Because the government has to figure out how to turn rural residents into city residents, the current cake enjoyed by urban residents has to also be distributed to peasants, housing prices also can’t be so high. The core of local governments is developing competitive industries. Urbanization should be a natural result of industrialization. If there aren’t industries, how are you going to have jobs for people entering the cities? Right now the hukou system has become the tiger standing between rural residents and welfare benefits, so we fundamentally want to slowly unify the urban and rural social welfare system.
SLW: You mention that the core of urbanization is developing competitive industries, but nowadays industry development has run into ever-increasing environmental protection demands. Will this add to the difficulties of developing these industries?
LZJ: Low-carbon development is a trend in today’s world, and in regards to this you don’t want to believe all the clamor of the conspiracy theorists. If we cling to what the conspiracy theorists say, when most of the countries in the world have already entered or applied new low-carbon rules and procedures, in the end we’ll be the ones to lose out. The essence of low-carbon development is to solve the problem of sustainability on Earth. This is a universal value, but in advancing low-carbon development China will face some unique challenges.
In developed countries, industrialization and urbanization are basically complete, they’ve already entered a low-carbon phase. At this point emphasizing CO2 emissions is like taking a knife to the throat, while to developed countries it’s just taking a knife to the tail. Also, China’s resource endowment creates a high-carbon structure. China has plenty of coal but little oil and gas, and the proportion of new energy sources is also low, right now just around 9.8%. Coal mining and consumption is a major source of carbon emissions, and China’s coal-abundant structure doesn’t help advance low-carbon development.
In addition, in the international distribution of labor, China is a part of the low-end manufacturing segment, that doesn’t help low-carbon development. In the international division of labor, manufacturing and assembly create the most emissions. In reality this means that developed countries have moved a lot of the carbon emitting phases to China, creating the problem of international transfers of carbon emissions.
SLW: But overall you’ve expressed optimism about the Chinese economy, you think that over the next 20 years China can maintain around 4-8% growth rates. Is that to say that China won’t fall into the middle-income trap?
LZJ: In industrial development phase, we’re still in our robust youth. We’re still going to see a major liberation of China’s productive forces. What we call productive forces is the capacity that industrialization, urbanization, and regional economic integration will unleash. China’s industrialization, urbanization, regional economic integration is still in a middle-phase, and western countries have already basically finished this. This is our country’s advantage.
The productive forces of institutional change will also be liberated. In the past our focal point was pushing forward reforms of the economic system. In the future we also want to push forward political, cultural, economic, social, environmental/resource, these five-in-one reforms. In addition, the productive forces of factor upgrades will also see a big liberation. Technological progress, human capital, and information networks all have lots of space for development.