China's Tight-Rope Walk: Balancing the Contradictions in Chinese Growth

As the country's economy decelerates, its leaders are once more trying to navigate competing interests, conflicting goals, and a political system that might have to start changing.

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A security guard stands in front of an electrical board displaying stock information at a brokerage house in Huaibei. / Reuters

Over the weekend, China responded to reports of its economic slow-down by reducing something called the "reserve ratio," which restricts the ratio of deposits that Chinese banks must set aside as reserves rather than lending out. Lowering the ratio -- which is far higher in China than in Western economies -- is meant to spur banks to lend more money. It's a form of economic stimulus, a proactive response to news that Chinese imports have stalled out between April 2011 and April 2012, and that its exports have grown half as quickly as expected.

But, in recent years, China had actually been raising the reserve ratio, increasing it on six separate occasions through last July. The increases were part of China's vigorous efforts to slow inflation (which is accelerated by lending), something that the government takes so seriously that it has handed out death sentences to illegal lenders and borrowers in China's "shadow banking" system, a trillion-dollar underground lending network that circumvents official borrowing restrictions.

The reverse in policy for the "reserve ratio" represents a larger effort within China to simultaneously pursue two competing -- and sometimes contradictory -- economic goals: maintain growth and avoid inflation. Economists outside of China, and political leaders inside of it, have debated for years how China can keep growing while controlling growth's most destabilizing byproduct: inflation. The consensus, especially within Beijing, seems to be for more market reforms (current Premier Wen Jiabao and predecessor Zhu Rongji have both said as much). But Chinese leaders will also have to deal with the industries and politicians whose vested interests currently run counter to those reforms.

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It's a tight-rope walk that economists call the "transition trap." It's a transition from an economy based on exports (which relies on Chinese goods, and thus the Chinese currency, staying cheap), to an economy based on domestic consumption and investment. It's a transition from state capitalism, which can marshal amazing industrial output at the flick of a central planner's pen, to something a little more market-based, where private businesses and private consumers drive growth. It's about selling iPhones to Chinese consumers rather than to Americans, or better yet about founding the Chinese Apple.

This would be a monumental challenge for any country, and the nature of Chinese governance can make it both easier and tougher. Easier because Chinese leaders have been openly discussing and working on how to see the transition through, and the Chinese government has already walked a few economic tightropes, most famously by opening up their economy in the early 1990s. Tougher because, to make this transition work, many of the same groups of people who have profited so nicely off of the 20-year liberalization may have to start giving up some of their new-found power, by allowing rule-of-law to check corruption and allowing the market to edge out state planners, and some of their wealth.

"Powerful stakeholders will resist any attempt to transfer wealth to new constituencies," warned a pessimistic Eurasia Group report on China's latest Five-Year Plan, which set goals to accelerate the country's transition. Those stakeholders are the big industries, the local and regional officials who sponsor them, and their friends in Beijing; people like Bo Xilai, the Chongqing party chief who was recently ousted after using his power to make himself supremely wealthy. The Eurasia Group report goes on, "China's leaders are unlikely to deal with these powerful 'losing' interest groups holistically. Nor is a strongman or tightly knit group of leaders likely to be able to overcome them." Unless, that is, Chinese leaders can make "significant changes to governance structures" -- namely, by boosting rule-of-law and fighting corruption, both of which would mean surrendering a bit of their own power.

"Many economic problems that we face are actually political problems in disguise, such as the nature of the economy, the nature of the ownership system in the country and groups of vested interests," Beijing political scientist Zhang Ming told the New York Times. "The problems are so serious that they have to be solved now and can no longer be put off." As Walter Russell Mead put it, "Authoritarian modernization always works until it quite suddenly doesn't."

Still, this is not China's first apparently insurmountable economic challenge, and Beijing has amazed the world before. China-watcher Bill Bishop wrote in response to the news of China's economic deceleration, "Things have always been messy here, they always will be, and [I suspect] that the economy, and the government, are more likely to muddle through than to either collapse or take over the world. But the Coming Muddle-Through of China will never sell as a book." That's a play off of Gordon G. Chang's famously China-skeptic book, The Coming Collapse of China, which came out in 2001, more than 10 Chinese-collapse-free years ago.

Still, this latest potential economic crisis gets to the very heart of the Chinese system and its leaders' willingness to collectively surrender some power for the greater good. It's not exactly George Washington giving up office after two terms when he could have become president-for-life, but there's a reason we still celebrate that decision two centuries later. It's not something that happens often.