Nicholas R. Lardy: The Third Plenum Reform Plan

Nicholas R. Lardy is Anthony M. Solomon Senior Fellow with the Peterson Institute for International Economics and the author of Markets Over Mao: The Rise of Private Business in China (Peterson Institute, 2014).

Nicholas R. Lardy

The economic reform program endorsed at the Third Plenum is quite comprehensive and, if implemented, would go a long way toward assuring China’s continued rapid economic growth over the medium term. In my view the most important of the many commitments is to ensure that the market is the decisive factor in the allocation of resources and to eliminate all but natural monopolies. While most of China’s economic growth and virtually all of the growth of employment in the reform era are due to the rise of market forces and expanding private businesses, the state has maintained extensive controls that prevent the market from playing a major role in a handful of industries and in large swaths of the service sector, notably telecommunications and financial services. Largely as a result of restrictions on entry, the share of investment by the state in services accounts for four times its share of investment in manufacturing, which has been very open to entry by private firms that now account for about four-fifths of output.

But the efficiency of state service providers is about half that of private players. Since investment in services now accounts for over half of all investment in the Chinese economy, the relatively large share of investment in services undertaken by the state constitutes a substantial drag on China’s economic growth.

Allowing private services firms, including foreign firms, into the service sector domains where state firms have long enjoyed protection from competition will not only lead to an expansion of the service sector, but will mean that the rest of the economy will benefit from less costly modern business services as increased competition drives down prices. And an expanding service sector, which is more labor intensive than industry, is positive for employment growth likely leading to an increase in the wage share of GDP and thus a rise in the consumption share as well. Thus acceleration in the growth of consumption will help to offset a needed moderation in the expansion of investment, putting China’s growth on a more sustainable path.