In our previous blog post, China: Imminent Doom or Necessary Adjustments?, we discussed some observations surrounding the current status of China’s Foreign Exchange Reserves and debt. As we continue our analysis, we address China’s future challenges as the country transitions to a more sustainable economy.

China’s Future Challenges:

• Fighting corruption
  • The ongoing anti-corruption campaign has gone higher and deeper into government and government enterprises than expected. The battle is brave and popular with the public.
• Restructuring the economy
  • Thirty years of rapid growth has created imbalances that need to be remedied. The government is intent on:
    • Weaning the economy off export-led growth – because low-wage manufacturing has been a victim of the success in raising incomes – and off reliance on government investment stimulus to manage economic weakness.
    • Changing the emphasis from heavy industry to services, which will make the economy much more difficult to manage for a government accustomed to being in control.
    • Creating a more livable environment, with more service industries, more aggressive environmental policies, etc.
    • Floating the currency.
  • Reforming state enterprises
    • Replacing political management with professional (including foreign) managers.
    • Compensating management at globally competitive levels, but only as professionals are put in charge.
    • Creating corporate governance mechanisms that limit the intervention of local and national government officials.
    • Creating disincentives to bank borrowing for uneconomic projects.
    • Closing those debtor enterprises that cannot be rescued.
  • Controlling debt
    • Close the open checkbook for state enterprises and local governments.
    • Write off debt that is uncollectible and develop a system for forcing banks to avoid further bad debt.
    • Develop a credit system to evaluate and extend credit to private enterprises.
  • Confronting the demographic time bomb
    • Proving that the government can move quickly once a policy is determined, China ended the one-child policy earlier this year. This restriction was creating a demographic time bomb of too few young individuals (and too many males) to support the older population. It is far too early to judge the public’s response.

The above list would be daunting to any country, but the Chinese government, as noted above, still has considerable control over the economy with which to manage a transition to a more sustainable future. And it is moving actively on each front.

It’s more apparent that global macro shocks caused by China are mistakes from attempting to over-manage change. For instance, the Chinese want the economy to be dynamic and innovative, so they are intent on setting up incubators to foster start-up enterprises. However, their instinct is for the government to set up and manage those operations, recruit professors who have good ideas to be “employees”, and use that model to copy Silicon Valley. Specifically, the mindset is to force market behavior from above. The speed of change to a more sustainable and dynamic economy will depend on how quickly lessons from other environments can be applied correctly.

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