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China’s Economy: Complacency, Crisis & the Challenge of Reform

Barry Naughton

BARRY NAUGHTON is Professorof Chinese Economy and the Sok-wanlok Chair of Chinese Interna-tional Affairs at the University ofCalifornia, San Diego. His booksinclude The Chinese Economy: Tran-sitions and Growth (2007), GrowingOut of the Plan: Chinese EconomicReform, 1978–1993 (1995), and theedited volume Wu Jinglian: Voice ofReform in China (2013).

At ½rst look, it seems that China’s new leadershipassumed power at the pinnacle of economic success.Immediately upon putting their new administrationin place, General Secretary Xi Jinping and PremierLi Keqiang made clear their belief that China’s neweconomic clout entitles it to a position of greaterrespect and global influence than ever before. In fact,China’s economy had already become a certi½able“growth miracle” when the previous administra-tion of General Secretary Hu Jintao and PremierWen Jiabao took power in 2003. At that time, China’seconomy had already sustained a torrid annualgrowth rate of 9.6 percent over twenty-four years, aperiod begun by the major economic reforms of1978. But in the decade spanning 2003 to 2012,which included the global ½nancial crisis, China’sgrowth actually accelerated, reaching 10.4 percentannually.1 China overcame the global crisis bypouring resources into investment and acceleratingthe already eye-watering speed of its infrastructurebuild-out. Per capita gdp has pushed over the upper-middle income threshold. Not surprisingly, then,an air of triumphalism began to creep into Chineseattitudes and government proclamations. Surpassing

© 2014 by Barry Naughtondoi:10.1162/DAED_a_00269

Abstract: China’s economic success has bred a new complacency and resistance to change. This in turnhas created a credibility crisis, as many Chinese citizens believe the opposition of vested interests makesreform impossible. However, proponents of economic reform argue that the current economic strategy isunsustainable. They point to reform backsliding, overinvestment, and ½nancial fragility as problems thatwill collide with an inevitable economic slowdown caused by rapid demographic changes, and that willpotentially cause economic and political crisis. Renewed economic reform is thus the only prudent andviable choice. The November 2013 Third Plenum shows that China’s leaders have tentatively acceptedthe need for reform.

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the Japanese economy in aggregate size,and becoming the second largest economyin the world, was a particular point of pridefor China.

Transformation at this pace inevitablycreates enormous stresses and strains.Besides the dislocation, the inequities, andthe environmental costs, headlong growthalso led to another problem: as incomesgrew, the impetus for market-oriented eco-nomic reforms diminished. As Wu Jinglian,the dean of China’s reform-oriented econ -omists, put it, “As life got comfortable,reforms stopped.”2 During the 1990s,driven by profound economic and politi-cal crises, the Chinese government hadpushed through a procession of funda-mental economic reforms. Under PremierZhu Rongji, China between 1993 and 1999enacted a series of deep and dif½cultreforms of the ½scal, ½nancial, and marketsystems. These reforms culminated inthe massive downsizing of the Chinesestate enterprises sector from 1996 to2001, and were sealed by China’s entryinto the World Trade Organization in 2001,thereby locking in many of the mostimportant reforms. As a result of thesereforms, the Hu–Wen administrationinherited a highly favorable economicposition when it took power in 2003: theprevious administration had paid a sub-stantial price to break down the old systemand lay the foundation for a new, better-functioning economy, but had only justbegun to enjoy the bene½ts. Hu and Wenwere poised, as the Chinese saying puts it,to enjoy the shade of the trees planted bythe ancestors.

At ½rst, the Hu–Wen administrationseemed ready to follow the reform trajecto-ry of the previous Jiang Zemin–Zhu Rongjiadministration, retaining many of thesame economic technocrats. The admin-istration’s initial economic proposals werefull of good ideas, and represented a robustprogram for a continuation of reform.

But nothing much happened, and therewas no follow-through. Today, in Beijing,there is a widespread perception that thepast ten years have been a “lost decade”insofar as market-oriented economic re -form is concerned. This does not mean thatWen Jiabao presided over a do-nothingadministration. Rather, on the social front,Wen cut taxes on the rural economy andboosted spending on education and med-ical care; he created the foundation forrudimentary national systems of healthinsurance and pensions; and he increaseddefense outlays, contributing to a strongermilitary, which most Chinese citizenscertainly see as a positive. The Hu–Wenadministration was energetic in spendingmoney, which was acceptable simplybecause they had the money to spend.However, in terms of creating the institu-tional framework on which future pros-perity would depend, the outgoing admin -istration achieved almost nothing.

It is common for Chinese citizens toexplain reform stagnation, or the defeatof individual reform initiatives, by refer-ring to the increased strength of “vestedinterests.” Even the current Chinese pre-mier, Li Keqiang, regularly refers to theneed to manage and minimize interestgroup opposition if his current reformproposals are to advance successfully.3 Butwho, exactly, are these vested interests?The idea of “vested interests” covers abroad spectrum. At one extreme, the op -position of interest groups to reformsshades into and becomes identical withthe problem of corruption. Some vestedinterests are well-connected families, cor-rupt of½cials, and even criminal gangs. Butat the other end of the spectrum, the prob -lem of vested interests is created by thestabilization of the entire CommunistParty–dominated economic and govern-mental system. The easiest way to see thisis through China’s budgetary history

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(Figure 1). From the beginning of reformin 1978 until 1995, budgetary revenues as ashare of gdp declined nearly every year.Indeed, the productive era of the 1990sreforms was driven by an acute budgetarycrisis. Zhu’s reforms included a new taxsystem and new ½nancial discipline thatstaunched losses in the state enterprisesector. As state ½rms were chopped backand restructured, the few that survivedmade a sustained return to pro½tability,which increased resources available to na -tional leaders both directly and indirectly.Figure 1 also shows that after 1995, thetrend turned dramatically, and budgetaryrevenues as a share of gdp increased everyyear between 1995 and 2012. The resultwas an enormous increase in the volumeof resources available to the system.

A few numbers can give a sense of themagnitude of this transformation. AsFigure 1 shows, Chinese budget revenuesincreased from 10.8 percent of gdp in 1995to 22.6 percent of gdp in 2012. Doublingthe budget’s take of gdp in seventeenyears is a substantial achievement, butwe must also consider the rapid growthof gdp itself: real budgetary revenues(deflated by the Consumer Price Index)were almost exactly twenty times in 2012what they had been in 1995. In 2012-con-stant usd, the value of Chinese budget-ary revenues has increased from $113 bil-lion in 1995 to $1.86 trillion in 2012. Thesenumbers look like some kind of spread-sheet error, but they are not.4 Chinesegovernment revenues (central and localconsolidated) are about equal to the U.S.federal government on-budget revenues,excluding social security, which are esti-mated by the Congressional Budget Of½ceat $1.97 trillion for 2012.

Less than two decades since the coun-try faced a potential crisis of state capacity,the Chinese system is now awash in cash.Money is available not just for the criticalnecessities, but for elective projects as well.

Technology megaprojects, cultural vanityprojects, global propaganda initiatives: ifa top leader wants it badly enough, themon ey can be found. Even the universi-ties have plenty of money. Virtually every-one in a position of authority has a biggerbudget, is better off, and has plenty to do.Bitter disputes over resource allocation areless salient, and side payments can bemade to buy off dissenters. As the flow ofresources through the party- and state-dominated sectors of the economy in -creased and stabilized, the system naturallybecame organized around that flow. State-owned enterprises returned to ½nancialhealth, bene½ting from the radical down-sizing and restructuring that Zhu Rongjihad pushed through at such cost in the late1990s. With a few entry barriers, and a lit-tle manipulation, combined with genuinebottom-up economic growth, the state-owned enterprises were transformed froma burden to an asset. The most extremeexample is China Mobile, the state-runcom pany that not only is by far the largesttelecom operator in the world, with over700 million subscribers, but also sits onone of the biggest corporate cash piles inAsia, with $64 billion in the bank.5

At the same time, the reconstruction ofthe party apparatus and the rationaliza-tion of party-state career paths have giventhe system a new stability and predictabili-ty. Trajectories of a career in governmenthave become more knowable, as the re -quirements for promotion have becomeincreasingly routinized. Steady promotion,in turn, leads to abundant and increasingopportunities to earn outside income. Stu -dents in elite universities have increas-ingly come to see government as the mostattractive career option. In other words,the stagnation of reform was not merelyshort-run complacency and procrastina-tion; rather, it reflected the long-term sta-bilization of the system. The hierarchicalChi nese political system, which had to be

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constantly remade in the 1980s and 1990s inorder to adapt to new challenges, is todayno longer driven by any immediate, inter -nal sense of crisis. Instead, the Chinese sys -tem–perhaps like most systems in theworld–is engaged primarily in reproduc-ing itself more or less as it is. The biggestvested interest, then, is the interest repre-sented by the Communist Party itself.

The new stability of the system is viewedwarily by those outside its embrace. Inthe ½rst place, there is a widespread perception–both inside and outside China

–that it is increasingly dif½cult to do busi-ness in China without political connec-

tions. Of course, at the same time, theprivate sector has grown tremendously;and while the state sector has stoppedshrinking in absolute terms, the growingprivate sector makes up a steadily largershare of the overall economy. However,private business owners now sense in -creased competition from state ½rms, andan increased need for accommodationwith savvy power holders–with “vestedinterests”–who can help extract bene½tsfrom the booming economy and from pri-vate businesses.

Even more important, an awareness ofthe stagnation of reform in China overthe past decade has gradually seeped into

Figure 1China’s Budget Share in gdp, 1978–2012

Source: Chinese of½cial data, updated most recently with the National Bureau of Statistics, Zhongguo TongjiZhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013).

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public consciousness, producing an inter -esting disconnect. Over the past ten years,the government’s propaganda organshave continued to trumpet the indispens-ability of economic reform. Every fewyears, major new reforms are discussed,and policies are implemented, but theyhave little impact. As a result, of½cial pro-nouncements have lost credibility, andthis loss, combined with the stabilizationof China’s system and the greater influ-ence of interest groups, has led to a crisis ofcon½dence in China’s ability to change.This type of credibility crisis is somethingquite new in China, although it has beencommonplace in the United States andother economically developed societiesfor some time. Such a crisis in con½denceis characterized by the belief that prob-lems are peculiarly entrenched and in -tractable, and nothing really can be doneabout them, with only the extremelynaive believing otherwise. This type ofcynicism was, until recently, almost com-pletely absent in China. China had beenchanging so rapidly that it was apparentto everyone that the future was, if nothingelse, full of different possibilities, even ifthe present was impoverished. That senseof con½dence about the future seems tohave vanished in China.

Understanding this facet of the publicmood is important to understanding therecent pronouncements of China’s newleaders, and their reception. Both Xi Jinping and Li Keqiang made rather boldpronouncements in favor of restartingmarket-oriented reforms in the earlystages of power transition in late 2012.Yet the popular response to these procla-mations was only mildly positive: “Really?We’ll believe it when we see it.” A palpa-ble skepticism about reform is thus partof a broader crisis of con½dence. CanChina change? Has government and pol-icy been captured by interest groups, suchthat no change is possible? Is China slip-

ping backward? Acutely aware of thispublic sentiment, both Xi Jinping and LiKeqiang have been critical of the gapbetween rhetoric and action: Xi spent his½rst months in power denouncing “emptytalk.” It is clear that those engaging inempty talk are, in fact, Xi’s predecessors,but is it clear that Xi will be any different?More broadly, why would those whobene½t so abundantly from the currentsystem act to change it? Why would any-body change a model that seems to havedelivered such abundant resources andsuccess?

Remarkably, economic reform is notdead in China and is in fact experiencinga resurgence. Reformers have importantpositions in the new government and inthe country’s most influential businessmedia. At their core, these reformershave only one argument, but it is a pow-erful one: that the current economic situ-ation and policy trajectory are simply notsustainable. Economic conditions arechanging rapidly, and the current way ofdoing business risks serious crisis. Themost dangerous course of action is there-fore not to reform, in effect remaining onthe current course. If policy-makers do notpreempt the changes that are coming, thenchange will be disruptive and potentiallydevastating. But there is still time to act.

The unsustainability argument has fourkey components. First, the failure to sub-stantially improve the quality of China’seconomic institutions will begin to grad-ually erode the pace of productivity im -provement. China’s total factor produc-tivity has increased dramatically duringthe reform era, and grew strongly throughmost of the ½rst decade of the century.This productivity improvement has beendiffuse and attributable to multiple causes,including the learning and adoption ofnew technologies, as well as improvedinstitutions. A key link has been the will-

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ingness to let underperforming entitiesfail, concentrating production in the mostcompetitive and productive ½rms. How-ever, the strength of this competitivemechanism seems to have waned in recentyears, and without a new wave of reform,productivity growth will continue to slow.Productivity is not simple to measure;there are time lags both in the appearanceof productivity effects and in our abilityto measure them. So by the time econo-mists have formed an academically rigor-ous judgment, it is quite late to do any-thing about it. But in the interim, policy-makers will look at growth rates com-pared to investment rates. There are manyreasons why growth should slow, but aslong as investment rates stay high, policy-makers will take declining growth ratesas evidence that something is wrong withtheir system’s productivity, and will bemotivated to push harder for reforms.

Second, the limits to investment-drivengrowth are appearing. China was able tosidestep the worst of the global ½nancialcrisis by increasing domestic investment.gdp growth scarcely dropped because theincrease in domestic investment almostcompletely offset the drop in net exports.But this success was achieved at substan-tial cost. Because the stimulus programwas so rushed, some unknown proportionof new investment was doubtless wastedon useless projects, although we have noway of knowing how large that propor-tion is. More fundamental, as Figure 2shows, the investment surge of 2009 wasnot a one-off stimulus. Instead, China’sinvestment rate moved more or less per-manently to a higher level. Since 2009,China has been investing a remarkable 48percent of gdp. An investment effort ofthis magnitude is completely unprece-dented for a large economy. Japan, Korea,Malaysia, and Thailand all drove growthwith investment, but none of them raninvestment rates that exceeded 40 percent

for more than a couple of years. In 2007,Premier Wen Jiabao described China’seconomy as “unstable, unbalanced, un -coordinated, and unsustainable,” andsince that time, the unprecedented de -pendency on state investment has onlyfurther unbalanced the economy.

What’s wrong with this investment-driven, unbalanced growth? After all,investment-led growth has served theChinese economy well over the past twodecades. One of the great paradoxes of theChinese economy is that although house-hold consumption is an unusually lowshare of total gdp (35 percent), householdconsumption has also grown extremelyrapidly over the past decade, only not asfast as overall gdp. And if you can haveboth more consumption and more in -vestment, why not have it all? Well, be -cause it is probably just not possible.Economists do not have any logical limitto how high a country’s investment ratecan be, or for how long. But all previoushigh-growth economies have eventuallycome to a point where investment ratessubside, and usually at levels well belowthe current Chinese level. In the past, withunlimited supplies of labor, investmentwas the key growth driver. All that wasneeded to bring that labor out of the coun-tryside was new industrial plant and infra -structure. Moreover, as a follower econo-my, planners and businesses could focuson transplanting business models, tech-nologies, and infrastructure layouts fromdeveloped countries. The system deliveredinvestment, and investment deliveredgrowth. That equation is no longer so sim-ple. Matching the right investment to theevolving needs of the economy is becom-ing much more dif½cult. The fundamentalinfrastructure framework China’s plan-ners copied from more advanced econ -omies is nearing completion. Meanwhile,excess capacity has emerged in many in -dustrial sectors as the economy has slowed.

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These suggest that China may be ap -proaching the limits of this developmentstrategy. Moreover, investment has an in -herent tendency toward instability, sinceit is driven by investors’ expectations ofthe future. While consumption is relativelystable, investment is subject to the “ani-mal spirits” of those making decisions. InChina, the government’s willingness toserve as the reliable investor of last resorthas also kept the investment propensityof private businesses high. The two havebeen in a productive symbiosis that thusfar has served the economy well. As themomentum of the economy slows andexisting opportunities close off, the danger

rises that investment from the private sec-tor will drop.

Third, past investment excesses havealready created ½nancial fragility. The hugequantity of new ½xed assets the Chineseeconomy has created over the past ½veyears is just now coming onstream. Manyof these assets are housed in corporatestructures that have no good businessmodel. The extreme example is China’sgleaming new high-speed rail network.The system has a current debt load equiv-alent to $429 billion. Whether or not amassive high-speed rail is worth buildingis one question–about which opinionsdiffer–but whether there is a revenue

Figure 2Investment and Net Exports (Share of gdp), 1978–2012

Source: Chinese of½cial data, updated most recently with the National Bureau of Statistics, Zhongguo TongjiZhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013).

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model to service this enormous debt isanother question altogether. Outside of afew high-capacity lines like Beijing-Shang-hai, most observers doubt it. The challengeis mirrored by literally thousands of localgovernment projects and “funding plat-forms” around the country. Encouraged toinvest following the global ½nancial crisis,these local governments now face debtsthey cannot service with the incomestreams they can plausibly generatethrough user fees and sales revenues. In theaggregate, this debt amounts to more than$1.6 trillion, by of½cial estimates. Put to -gether, these two debt loads amount to 25percent of China’s gdp.

Chinese regulators and ½nancial sectorof½cials are well aware of these problems.They have been pushing China’s statebanks to increase bad loan provisions andraise capital; they will certainly not becaught by surprise. Nonetheless, the hardwork of actually restructuring these cor-porations has barely begun. Indeed, it canhardly proceed in the current inheritedenvironment: credit is still flowing freely;shambolic state-backed corporations haveeasy access not just to bank loans but alsoto nascent bond markets; and govern-ments turn to short-term ½nancial mar-kets to fund long-term debts. Some kindof credit squeeze will be necessary todrive forward ½nancial restructuring,and both the squeeze and the restructur-ing will be painful. Yet the longer ½nancialrestructuring is delayed, the longer re -sources will flow into low-productivity orno-productivity projects and corporations.The creation of a vast sector of “zombie½rms,” neither dead nor alive, would ulti-mately create a far larger and more dan-gerous risk of ½nancial panic and collapse.The relevant comparison is with Japan inthe 1990s, when the delay of ½ nancial re -structuring kept numerous zombie ½rmsalive, and kept the economy from recover-ing for an entire “lost decade.”

Fourth, China is going through profoundchanges in its labor markets that point tosubstantially slower growth. For decades,employers had been able to hire at willnew workers migrating from the country-side, offering a wage that changed littlethrough the 1990s and early 2000s. Butsome time after the mid-2000s, competi-tion for workers began to drive up un -skilled wages. By 2012, real wages for mi -grant workers were two and a half timeswhat they had been in 2003, increasingby 10.8 percent annually. This dramaticchange in labor market conditions ledmany observers to proclaim “the end ofcheap China.” The sudden change alsorevived interest in a so-called Lewis turn-ing point, a structural shift that occurswhen the reservoir of surplus labor in thecountryside is ½nally depleted, and em -ployers have to pay higher wages to drawpeople out of agricultural work.6 In pastAsian growth “miracles,” the arrival of aLewis turning point often signaled the endof the very-high-growth period. Rapidgrowth of unskilled wages tends to forcethe end of an early growth phase led by theexport of labor-intensive manufactures.Economies start to lose comparative ad -vantage in clothing, shoes, and toys, andexport growth becomes a less importantdemand-side driver of growth. Theseforces are now operating in China, andsince export demand from the EuropeanUnion, Japan, and the United States is likelyto be weak for the immediate future, ex -ports will make a much smaller contribu-tion to China’s future growth than they didduring the past decade.

Just as rural labor surpluses were be -ginning to disappear, China reachedanother crucial turning point. In 2012, thepopulation at working age began to de -cline. This is an entirely different type ofdemographic transition, accelerated byChina’s draconian birth control policies.Previously, China had been experiencing

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a “demographic dividend” in which thepopulation at working age was growingmore rapidly than the overall population.As a result, dependency ratios decreasedand the work force became younger andbetter educated. However, as the essay byDeborah Davis in this issue details, China’sdemographic dividend is now exhausted–as it eventually had to be–and China’spopulation has begun to age and experi-ence a higher (elderly) dependency ratio.The working age population has reacheda plateau, and will start to decline rapidlyin absolute size by 2020. The fact that theLewis turning point and the end of thedemographic dividend are occurring atthe same time means that the shift inlabor force conditions will be unusuallyabrupt. For comparison, Japan’s laborforce began to shrink about twenty-½veyears after the end of its high-growth era–when the country was already quite rich–and Korea’s labor force began to shrinkabout ½fteen years after the end of its high-growth era. In China, these two changesare occurring simultaneously.

The structural changes in China’s laborforce mean growth is bound to slow; butthis does not have to be a bad thing. Afterall, higher wages mean that incomes aregrowing, that people are better off, andthat there is an opportunity to shift thepattern of economic development so thatit provides a greater share of output forhousehold consumption. Moreover, Chinais a huge continental economy and doesnot have to tie its economic growth onlyto its export strategy. Chinese incomesoverall are still relatively low and there isplenty of room for catch-up. So this struc-tural change is a huge challenge, but notnecessarily a looming disaster. This is atransition that must be managed carefully,but one that can lead to a much more pro-ductive and capable society overall. Here,though, the record of Asia’s earlier “mir-acle economies” advise caution. When

economies such as Japan, Korea, and Tai-wan moved out of their very-high-growthphases, they each faced major challengesto their growth models. Japan’s growthrate dropped sharply in 1973, and thenagain in the 1990s. Never again did Japancome anywhere close to replicating thehigh growth rates of the 1950s and 1960s.Similarly, the end of the Korean high-growth phase in 1997 arrived with theAsian ½nancial crisis, massive ½nancialdistress and restructuring, and a perma-nently lower growth rate. The evidence isclear that if China does not handle this tran-sition well, it could have a substantial eco -nomic price to pay.

At this point, a broader argument aboutthe nature of China’s economy and societycomes into play. Typically, as forerunnereconomies have reached the end of theirhigh-growth phases, they have upgradedinto high technology and more sophisti-cated sectors. China clearly hopes to followthis lead. To prepare, China has investedmassively in university education since2001, and has also begun to pour govern-ment money into research and develop-ment in promising “emerging” industrialsectors. Last year, China invested just shyof 2 percent of its gdp into research anddevelopment, a sum much greater thanthat of other economies at comparablelevels of gdp per capita. But ordinarily,forerunner economies have facilitated thisupgrading process by transitioning intomore of a “light touch” role for governmentsupport for development, and a broaderliberalization of economic and social con-ditions. Thus, the government typicallyhands off more of the responsibility fordevelopment to the private sector, andrelies on dispersed entrepreneurship toidentify and exploit the promising newsectors. In China, the movement in recentyears has not been in this direction. Gov-ernment, flush with money, has stepped

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up its own direct role in technologyresearch and innovation. Entry barriersthat have long since fallen away for ordi-nary manufacturing sectors are still inplace for high value services such as ½ -nance and information (including Internetbusinesses). There is a very real dangerthat a top-down, state-directed programof innovation, combined with state con-trol of large swathes of the economy, willend up retarding China’s essential gradu-ation toward an innovative, diverse, andresilient economy.

Today’s China clearly faces a set ofchallenges that are different from thosein the past. China must upgrade the qualityof its human resources; identify the sec-tors, products, and services where oppor-tunities lie; and transition from a followereconomy to a position at the global fron-tier in numerous sectors. Can it do thosethings without also further scaling backthe power of the state, eliminating visibleand invisible barriers to the growth ofinnovative businesses, and empoweringhouseholds to make more of the funda-mental economic decisions? It seems un -likely, which leads us back to the problemof economic reform.

The reform proponents’ argumentsabout sustainability have a high degree ofinternal coherence, and also great immedi-acy. In the ½rst place, the current changesin the external economic environmentare obvious for all to see. Slowing laborforce growth, soaring wages, and rapidlychanging cost structures and competitive-ness are part of daily life for all Chinesecitizens. But these changes directly implythat the existing economic strategy hasreached its limits. In fact, all four of thefundamental challenges described aboveare reaching a climax at the same time.Investment-led growth is running out ofsteam just as the productivity dividendfrom previous reforms risks reversal.

Structural changes in the growth poten-tial are intersecting with ½nancial fragilitieslinked closely to the post-2009 investmentsurge. Growth slowdown will force thehand of policy-makers. Otherwise, thedanger that unaddressed problems willlead to a broader loss of con½dence maygrow, and threaten the system’s ability tostably reproduce itself. The reformersargue that without further market-orientedreform, there is no way to resolve thesechallenges. In a sense, Xi and Li have in -herited a situation that is the exact oppo-site of the one inherited by Hu and Wen tenyears earlier. The Xi–Li economy looksgood, but it comes with a legacy of deferredproblems and unresolved issues. Xi and Listill have a chance to address these prob-lems, to move China toward a path of sus-tainable, but slower, growth, but they haveto do so promptly, before a host of billscomes due. The timing of this is not underthe control of Chinese policy-makers.

By tradition, one year after the Com-munist Party Central Committee is ½rstempanelled, each new Chinese adminis-tration convenes a Third Plenary Sessionin order to lay out its economic program.In the past–especially in 1978 and 1993–this Third Plenum has marked a turningpoint, the initiation or revitalization of amajor reform program. Xi Jinping and LiKeqiang convened their own Third Plenumfrom November 9 through November 12,2013, and produced a strong reform docu-ment that addressed key economic issueswhile also expanding well beyond thestrictly economic realm. The documentthat emerged is best characterized as partvision statement and part to-do list. Thevision statement is an essential part of adocument of this type, which emerges outof a long consensus-building process with-in the Communist Party leadership. Thisprocess tends to generate broad statementsof principle, plus (at best) a few compellingslogans. To a certain extent, the 2013 Third

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Plenum resolution shares these features,but the content is surprising. It calls for arede½ned role for government, with gov-ernment playing a reduced role in micro-economic decision-making, the marketplaying a “decisive role” in resource allo-cation, and the development of newmodels of social governance. It does notshy away from key areas of ½nancial and½scal reforms, and it marks a clear effortto revitalize reform in the state-ownedenterprise sector. This vision is surprisingbecause it revives a rhetoric and vocabu-lary not much in evidence in China lately,and it charts a course that is very differentfrom many of today’s policies. The to-dolist, meanwhile, is extremely ambitious.Laid out in sixty articles and comprisingwell over three hundred policy measures,the to-do list commits the regime to animpressively broad array of actions, rang-ing from relaxing the single-child birthcontrol policy to increasing the share ofdividends that state-owned enterpriseshand over to the government and its socialwelfare funds.

The Third Plenum resolution is bestunderstood within the context of achieve-ment, change, and credibility crisis de -scribed above. Xi Jinping and Li Keqiang –and their secretaries and advisers–clearly exerted a major effort to make theThird Plenum resolution a credible docu-ment that would generate momentum forthe reform process. In the ½rst instance,they did so by producing a plenum docu-ment that was simply bigger than manypeople expected: it was both broader andmore detailed than most previous docu-ments. Moreover, the overall approach ofthe document has the potential to createa coherent response to the multiple eco-nomic challenges that China faces. Fi -nancial reforms, ½scal reforms, and state-enterprise reforms are all cued up in theThird Plenum, and pricing reforms and areduction in administrative barriers round

out the core economic elements of thisinitial reform package. It is striking thatthe framers of the document have provideda number of tangible commitments thatwill serve as benchmarks by which tojudge whether or not the reforms areactually implemented. Further, Xi Jinpingpersonally and publicly identi½ed withthe resolution in a remarkable account hepublished the week following the ThirdPlenum, stressing his chairmanship of thedrafting committee and his deep engage-ment with the entire process. Xi, we wouldsay, took personal ownership of the docu-ment. By crafting a document designed toimpress, by including concrete and observ-able contents along with the more abstractgoals, and by encouraging personal iden-ti½cation with the resolution, Xi Jinpingis clearly signaling his intention to pur-sue this agenda.7

Of course, actually implementing theseambitious goals is far more dif½cult thanmerely stating them. This, in turn, leadsto our ½nal question: can Chinese policy-makers act preemptively, dismantling theirown special privileges, before the arrivalof a serious economic crisis? The ques-tion is not only whether reform propo-nents can overcome the entrenched powerof vested interests, but also whether theycan overcome such power in the absenceof a full-blown crisis. If the chances forrenewed market reforms were assessedsolely on the basis of short-run economicand political conditions, it would be hardto be optimistic. In that sense, both thecomplacency and the crisis of con½dencewould be justi½ed; it is dif½cult to makean argument for change based on a crisisthat has not yet hit.

But at the end of the day, the reformersare right that only major institutionalchanges that make the economy moreopen, competitive, and rule-bound canavoid the serious problems looming over -head. Even these reforms will require

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adept policy-maneuvering to avoid sub-merged obstacles. The reformers are rightabout impending changes and potentialcrises, and they are right about the type ofeconomy and society that China mustbecome in order to be technologicallycreative, institutionally flexible, and sup-portive of a high standard of living for amajority of its citizens. China must make

the transition to a lower growth rate, butin the context of a wealthier, better-offsociety. It absolutely has the capability todo so, but policy-makers must summonthe will and determination, craft an ef -fective proposal, and push for a reneweddomestic and foreign opening of theeconomy.

endnotes1 National income, expenditure, and ½scal data in this paper, including those used in Figures

1 and 2, are Chinese of½cial data, updated most recently with the National Bureau of Statistics,Zhongguo Tongji Zhaiyao 2013 [China Statistical Abstract 2013] (Beijing: Zhongguo Tongji, 2013).gdp from the production and expenditure side, see p. 19, 33–35; ½scal data, see p. 72–73.

2 Wu Jinglian, “Toward a Renewal of Reform,” in Wu Jinglian: Voice of Reform in China, ed. BarryNaughton (Cambridge, Mass.: mit Press, 2013), 12. Wu is quoting his close friend ZhangZhuoyuan.

3 Li Keqiang’s remarks reported in Du Yongtao, Fu Yingnan, Wei Xi, and Liu Yang, “Li KeqiangEmphasizes that the Biggest Dividend that China Enjoys is the Reform Dividend” (in Chinese),People’s Daily Online, November 22, 2012, http://½nance.people.com.cn/n/2012/1122/c1004-19667962.html.

4 Chinese currency values have been converted to U.S. dollars at prevailing exchange rates,and deflated by the U.S. Consumer Price Index.

5 Daisuke Wakabayashi and Min-jeong Lee, “Samsung’s ‘Good’ Problem: A Growing Cash Pile,”The Wall Street Journal, May 8, 2013, http://online.wsj.com/article/SB10001424127887323798104578454440307100754.html.

6 Migrant wages from Feng Lu, “Consolidation or Stimulation? Remarks on China’s macro-economic situation and policy,” U.S.-China Economics Dialogue, Beijing, June 19, 2013. For agood collection of academic articles on the Lewis turning point, see the 2011 special issue ofChina Economic Review, especially the article by the leading proponents of this view, Cai Fangand Du Yang, “Wage Increases, Wage Convergence, and the Lewis Turning Point in China,”China Economic Review 22 (4) (2011): 601–610. The empirical evidence in favor of the Lewistheory in other developing economies is mixed, but China ½ts many of the Lewis model’spredictions. Moreover, China has unique institutions that make the basic Lewis assumptionof surplus rural labor more plausible, including collective land ownership and institutionalbarriers that retard rural-to-urban migration.

7 Chinese Communist Party Central Committee, “Resolution on Several Important Issues onComprehensively Deepening Reform” (in Chinese), November 12, 2013, http://news.xinhuanet.com/politics/2013-11/15/c_118164235.htm. Xi Jinping emphasizes his personal role inXi Jinping, “An Explanation of the ‘Resolution on Several Important Issues on Comprehen-sively Deepening Reform’” (in Chinese), November 15, 2013, http://politics.people.com.cn/n/2013/1115/c1001-23559327.html. As of mid-December 2013, there is still no of½cial Englishtranslation of the Third Plenum resolution.

BarryNaughton