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Re-Engineering China’s Economy

By Andrew Sheng and Xiao Geng
The recent “phase one” trade deal between the United States and China does not resolve core outstanding bilateral issues, and the two countries’ strategic rivalry will likely intensify in the medium to long term. But the accord gives China’s leaders a new opportunity to develop better and more open domestic markets.
BEIJING, CHINA – DECEMBER 9: Chinese migrant workers wait in a bus as they leave after their shift at a construction site on December 9, 2014 in Beijing, China. It is estimated that there are more than 40 million construction laborers in China, many of whom come from smaller centers to the country’s larger cities to find work. (Photo by Kevin Frayer/Getty Images)

On January 15, US President Donald Trump and Chinese Vice Premier Liu He signed a “phase one” agreement aimed at containing the two countries’ long-running bilateral trade war. But no sooner had the deal been concluded than China was confronted with an emergency in the form of the deadly coronavirus outbreak in Wuhan.

These recent developments indicate that China is still struggling with what the father of the country’s nuclear program, Qian Xuesen, called in an influential 1993 paper an “open complex giant system” issue. Qian, a leading student of systems engineering, argued that because human brains have one trillion interacting neural cells, individual humans are themselves open complex giant systems that are open to complex material, energy, and informational exchanges with other humans. Likewise, a social system is a macroscopic open giant system that interacts with other social systems, and thus is too complex for any computer to model.

Indeed, any systems engineering aimed at civilizational development would have to address even more complex material, political, and spiritual aspects of transformation and interaction that are not reducible to quantitative terms. The only solution, therefore, is a process of qualitative analysis followed by rigorous and reiterative testing against empirical facts until different paths or policy options are found – or, as Deng Xiaoping famously said, “crossing the river by feeling the stones.”

Qian’s analysis was far-sighted. “All this shows that the one-track mind and piecemeal reform just does not work,” he wrote. “Reform needs overall analysis, overall design, overall coordination, and [an] overall plan. This is the realistic significance of […] social systems engineering to the reform and opening policy in China.”

In a recent blog post on how to reform the United Kingdom’s civil service, Dominic Cummings, an adviser to British Prime Minister Boris Johnson, cited Qian’s observation that social systems engineering must be deeply integrated into Chinese national planning. “If you want to change Whitehall from 1) ‘failure is normal’ to 2) ‘align incentives with predictive accuracy, operational excellence, and high performance,’” Cummings wrote, “then systems management provides an extremely valuable anti-checklist for Whitehall.”

From Beijing and Whitehall to Brussels and Washington, policymakers are struggling with problems – such as climate change, inequality, and technological and ideological rivalry – that seemingly defy simple solutions. They are thus buying time, which may be sub-optimal for the world as a whole.

For example, the “phase one” US-China trade deal does not resolve core outstanding issues such as the persistent bilateral trade imbalance, fair competition in technology and related sectors, and deep and comprehensive institutional and governance reforms. Moreover, the two countries’ strategic rivalry will likely intensify in the medium to long term. But the accord does give China’s leaders a new opportunity to develop better and more open domestic markets.

For starters, China’s commitment under the agreement to stabilize the renminbi’s exchange rate and open up its financial-services sector recalls the 1999-2005 period, when a stable exchange rate anchored important reforms. (This period ended – and the reforms subsequently stalled – when the renminbi was allowed to float after July 2005.)

Moreover, China needs a period of stable trade and economic relations with the US in order to tackle the growing systemic risks of rising debt, declining public and private investment, housing-market imbalances, and weak technological innovation. The recent deal (if it holds) gives the authorities two years to continue transforming China into a modern market economy in a way that would benefit both its own citizens and the international community.

Further clarifying and distinguishing the respective roles of the state and the market will be key to this transformation. China’s leaders recognize the usefulness of relying on the market as the dominant mechanism for allocating resources, but also emphasize the state’s essential role in providing public goods such as national security, hard and soft infrastructure, and social-security programs, including timely responses to public-health hazards such as the coronavirus outbreak.

China’s central and local governments therefore must harness the rapid growth of markets, private businesses, and information technology to work off the deadweight loss of non-performing loans and excess capacity in obsolete industries – the result of misguided, poorly designed, or outdated policies and regulations. If these efforts succeed, the newly released resources could be deployed to encourage local and national technology innovation, thereby creating new jobs and green products and services.

Clearing out the deadwood in China’s economy will be critical, and central and local governments’ role in allocating losses is vital to controlling systemic risks. Deadweight losses are sunk costs and should not affect investments that are essential to making future growth and development more sustainable. Moving financial and real resources from low- to high-productivity projects would deepen the financial system and make it more efficient (with much lower interest rates), thereby creating more open, transparent, and market-oriented conditions for development.

Qian’s systems-engineering approach to reform suggests that boosting energy efficiency and producing more green products and services would enable China to make a major contribution to global public goods and reduce its dependence on imported energy. By linking water, energy, health, and social aspirations within a material, political, and spiritual/civilizational systems approach, China would become less confrontational and competitive vis-à-vis the rest of world and more focused on forging mutually respectful relationships that do not threaten other countries’ national security.

Although China’s strategic options in addressing major global challenges are essentially similar to those of many other states, the country’s scale and unique complexities set it apart. In particular, the size of China and America’s combined carbon footprint means that the recent bilateral trade truce is crucial to the world’s chances of tackling the existential threat posed by global warming.

That threat is rising at a time when slower global growth and increasing social unrest – in part triggered by climate change and natural disasters – are being exacerbated by failing governance. The phase one trade deal will not end great-power rivalry between the US and China, but it could help prevent that rivalry from destroying the planet.

(Authors Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission. His latest book is From Asian to Global Financial Crisis and Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor and Director of the Research Institute of Maritime Silk-Road at Peking University HSBC Business School.)

Published Date: Monday, January 27th, 2020 | 07:43 AM

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