The Chinese government's intervention in the stock market and devaluation of the renminbi this summer provided a loud reminder that economic developments in China affect everyone. Now, China is set to take some more world-shaping decisions at this month's Fifth Plenary Session of the 18th Communist Party of China Central Committee.
Two years ago, at the third plenum, China's leaders committed to pursue far-reaching reforms, declaring that markets must "play a decisive role in allocating resources". Last year, the fourth plenum focused on leveling the economic playing field - in terms of rights, opportunities, and regulations - by strengthening the rule of law and improving the accountability, transparency, and legitimacy of government decision-making. Specific reforms included establishing circuit courts to reduce local governments' control over the legal system.
This year, the party must agree on the direction of China's 13th Five-Year Plan, which is to be launched in 2016 and is supposed to enable the country to graduate from middle-income status by 2020. The question is how to balance the need for continued growth with the imperative for reforms that disrupt traditional pro-growth incentives.
China certainly faces serious challenges. Economic growth has slowed to below seven per cent, at a time when the rest of the world is facing the threat of secular stagnation (very low growth and near-zero inflation). Internal debts are rising; the renminbi is facing continued depreciation pressure; and investors are still digesting the implications of the recent stock-market intervention. Add to that the bureaucracy's increasing reluctance to take bold action - an unintended consequence of President Xi Jinping's aggressive anti-corruption campaign - and the scale of the task China is facing becomes clear.
But, despite worrying short-term signals, China seems to be in the midst of a major transformation into a "lean, clean, and green" consumption-driven economy. Of course, the process will be far from easy, owing not just to the complexity of China's economy, but also to its globally integrated nature, which makes it vulnerable to external shocks. But, despite the difficulty of coordinating China's huge bureaucracy, the government has made considerable headway in addressing four serious challenges: corruption, environmental degradation, excessive local-government debt, and overcapacity.
Mr Xi's anti-corruption campaign has gone as far as taking down a retired member of the Politburo Standing Committee, China's most powerful body. Likewise, carbon-dioxide emissions have fallen dramatically since the beginning of this year, and the authorities appear to be well on the way to hitting the carbon-intensity target established in 2010. Regulatory reforms are beginning to mitigate shadow-banking risks, and even some ghost towns are being revived by market forces.
At the upcoming fifth plenum, China's leaders must build on this progress. To succeed, the government must, as Mr Xi put it, "gnaw even tough bones" - that is, overcome vested interests that are resisting change.
At the same time, China's rulers must recognise that reforms have significant short-term deflationary effects. Officials initially underestimated these effects, resulting in this summer's unanticipated volatility. If China is to avoid the debt-deflation trap, its leaders must make some adjustments.
Beyond setting a slightly lower growth target of six per cent per year, the authorities must provide more monetary and fiscal support to offset the expected slowdown in investment, consumption, and government expenditures. At the same time, they must deal with the disruptions associated with technological advances.
As it stands, China's inland cities are benefiting considerably from the improvements in market access and distributional efficiency enabled by the rise of e-commerce. By contrast, China's coastal cities, where manufacturing activities are concentrated, are experiencing creative destruction - a necessary process that nonetheless presents significant short-term challenges. To cope, the government must create incentives for officials to overcome their risk aversion and become proactive in managing change.
Finally, as China's leaders seem to recognise, an increase in real wages is vital to bolster domestic consumption. Beyond reducing China's dependence on external demand and helping to propel the country up the value chain, more spending in renminbi would help spur the use of renminbi in trade and investment.
With the right approach, the 13th Five-Year Plan can bring about significant improvements in the quality of market competition, government accountability, and the provision of public goods and services in China. Given China's global influence, this is good news for everyone.
Andrew Sheng is distinguished fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance. Xiao Geng, Director of the IFF Institute, is a professor at the University of Hong Kong and a fellow of the Asia Global Institute at HKU.
Copyright: Project Syndicate, 2015.
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