Daily Archives: October 18, 2012

Markets are fixated on whether the falling growth rate of China’s economy finally bottoms out this quarter but when the next generation of China’s senior leaders takes centre stage next month, this will be a trivial matter compared with three key policy choices they will face over the coming years. These are recalibrating the respective roles of the state and the private sector; reducing Beijing’s reliance on the banking and finance system in favour of the government’s own budget; and allowing the pace and pattern of urbanisation to be shaped more by market forces than centralised directives.

For the public, the overriding concerns are widespread corruption and increasing disparities. For the economic growth process to be enduring, it cannot continue to foment the kind of social unrest that now requires more to be spent on internal security than on the military. There is no simple solution for these concerns, but acting on the three choices will go far in addressing the root causes.

Beijing has succeeded in making the right choices in these three areas before. China became the world’s second-largest economy because its leaders allowed the private sector to play a greater role. It skilfully used its financial institutions to secure the resources to rebuild its basic infrastructure when its fiscal position was too weak to play this role. And improving connectivity and labour mobility across regions allowed China to benefit from the economies of scale that came with urbanisation.

Yet as successful as these initiatives have been, their impact has faded in recent years largely because of the emergence of vested interests which are now milking the system. The choices facing the incoming leadership are tough, not so much because of their analytical complexities, but because of the political capital required to tackle them.

Perhaps the most sensitive issue concerns the role of the state. A decade ago it was ideology that made scaling back the state’s dominance difficult. Now, with so many state entities having benefited from their privileged position, it is the potential for self-gain that is holding needed reforms hostage. The fate of these state-owned enterprises has become so interwoven with the interests of well-connected Communist party officials and state-controlled banks that many reformers have given up on the possibility that these unholy relationships can be broken. But the outlines of what needs to be done are known, including creating intermediary agents to separate ownership and operating responsibilities for state enterprises, and promoting more competition by opening up activities restricted to the state to private sector entry.

The financial sector has been the glue binding together various vested interests. China has relied on its banks to fund state-mandated initiatives, including many that should have been supported through fiscal channels. While critics have complained that this was achieved through financial repression, this strategy did make possible a massive investment-led growth process. But the weaknesses of this approach are now becoming more apparent. Funding biases have limited the opportunities for the private sector to drive innovation while the budget has been inadequate in meeting the escalating demand for social services at local levels, thus contributing to the sense of widening disparities.

Reducing the excessive dependence on the banking system requires overcoming the vested interests of the party which finds it easier to deal with a handful of state banks than two dozen provincial level budgets – even though a revitalised fiscal system would offer more transparency and accountability.

Managing the growth of cities including establishing more reliable sources of revenue is another important challenge. Many in China see rapid urbanisation as a mixed blessing. On the plus side it spawns more economic activity but this comes with emotionally tinged perceptions about increased congestion, environmental degradation and deteriorating services. Thus the debate has been about curtailing the pace of urbanisation and altering its pattern by promoting secondary cities while restricting growth in the larger ones. China’s mega-cities are generally perceived to be too large, but the problem lies more with flawed urban management practices than absolute size limits.

This year the proportion of China’s population living in urban areas reached 50 per cent, but given its enormous population relative to arable land, the urbanisation rate is still too low. Excessive numbers of Chinese are still working in rural areas for low returns. Their movement to more productive urban-based activities is the easiest option to secure the productivity increases needed to keep the economy growing at about 8 per cent over the coming decade.

The greatest barrier to China’s urbanisation process is its unique “hukou” system which makes it difficult for the country’s 250m migrant workers to establish legal residency and access services in the major cities. Liberalising the residency system would go far in ameliorating social tensions and stimulating expansion in services which is the key to unlocking China’s longer-term growth potential. But here too, strong vested interests are holding back reforms. Municipal leaders are reluctant to lift hukou restrictions because of unwarranted fears about reduced job opportunities for established residents and budgetary pressures for additional programmes.

With each generational change in the leadership, there is a burst of wishful thinking that major reforms may now materialise. The more cautious realise that China’s collective leadership system reduces the likelihood of game-changing shifts, and history tells us that progress is more likely to come from initiatives that are piloted locally and then adopted nationwide. This pragmatic approach has worked well in the past but for these three policy choices, vested interests create an imposing gridlock. Just one or two strong signals of policy direction coming from the new leadership can pave the way forward.

The author is senior associate at the Carnegie Endowment and a former World Bank country director for China

As European leaders gather once again in Brussels to discuss the eurozone crisis, a shift to an anti austerity stance is urgently required. Yet whatever the fate of the single currency, the current crisis is set to transform the European Union. If the euro is kept intact, it will be because of a shift to more federal structures within the eurozone. If it fractures, there will need to be a serious redesign, in a federal direction, if what’s left of the euro is to be saved.

In either case, we will need new thinking about the way the European Union works.

For fifty years the European Economic Community, and then the EU, have steered by the star of ‘ever closer union’. By any historical standard, it has been a dramatically successful navigation. The idea of a Europe whole and free has actually happened. What is more, Europe is more integrated and in many areas interdependent, than ever before.

But the political and institutional ambiguity inherent in ever closer union has been exposed by the idea of a “two-speed” Europe. The fiction was that opt outs, transitional arrangements and other legal innovations recognised different speeds of travel but not different destinations. That metaphor must now be given a decent burial. The question is what is the alternative to a two-speed vision?

One answer is to say that the future is a ‘two-tier’ Europe. Joschka Fischer, former German Foreign Minister, describes a vanguard Euro group and a rearguard of the rest. David Owen, one of my predecessors as UK Foreign Secretary, argues for a top tier of countries who merge their governance arrangements into a “single government”. A second tier, including Norway and Turkey, would embrace a “restructured single market”, along with a set of norms associated with social and environmental policy.

The Owen plan founders on a number of points. One is practical: I don’t see other countries embracing this vision. A second is more substantive: requiring countries to chose between a minimalist European Economic Area and a fully integrated European Union is a recipe for decline not renewal. It would simply deepen the divide between the euro ins and outs.

Instead the diversity of the EU’s membership, and the breadth of areas of policy cooperation, require flexibility not rigidity.

There is an alternative to two-speed and two-tier. In 1994 two parliamentary leaders of Germany’s conservative Christian Democratic Union, Wolfgang Schäuble (now Finance Minister) and Karl Lamers, produced a paper that reiterated the traditional German commitment to a federal state structure, but also embraced ‘elasticity and flexibility’.

“Those countries which are willing and in a position to go further than others in their cooperation and integration should not be blocked by the vetoes of other Members” they wrote.

In English, or at least diplomatic English, we call this “variable geometry”. In the European Treaties it is called enhanced cooperation. In plain English, it is the idea that the EU is a club of clubs.

It means that the European Union has a group of founding rules – from the single market, which is decided by qualified majority voting, to foreign policy cooperation, where each nation has a veto. On that foundation, further integration is possible – on currency, on defence, on migration and the like.

There are two major objections to this vision. One is that the euro is such a big exercise that its members will inevitably overrun the rest of the EU. But this is to forget that on issues such as the single market, the most important member of the eurozone, Germany, may have more in common with countries like Britain or Poland than with euro members such as Italy or even France.

A club of clubs solution accepts that membership of the euro, or a eurozone hard core, is not the end game for all EU members. But it avoids imposing second-class status on those countries outside the euro, which is not in the interest either of the eurozone or the wider EU.

But the second objection is that a club of clubs does not resolve the democratic deficit. That is true, but is an argument for developing more transparent political structures – whether formalising the role of national parliamentarians or directly electing the President of the Commission – rather than ditching the idea.

Time is now of the essence in this debate for Britain, but also for countries like Sweden, Denmark and Poland.

The key for my own country, and our interests in the development of the EU, is to ensure that being out of the euro does not become a prelude to being out of influence in Europe, and then out of the European Union altogether.

Unfortunately that is now a serious danger.

David Cameron’s botched ‘veto’ of the Fiscal Pact last December, botched because the Fiscal Pact went ahead anyway, weakened Britain and weakened Europe. His plan to opt out of Justice and Home Affairs agreements, announced earlier this week, adds further distance.

The stance Mr Cameron is expected today and tomorrow at the European Council, to privilege the repatriation of powers above all other issues, is dramatically to miss the point. It is vital that we learn the right lesson: the debate about the redesign of the European Union must be conducted on broader terms than the Prime Minister’s need to appease eurosceptics (and europhobes) in his own party.

The current UK Government is chronically weakened by its inability to empathise with any vision of the European project recognisable on the continent. That cannot stop the rest of us. If we cannot make a flexible EU work then we end up locking ourselves out of Europe altogether. So we need to argue for it with vigour and urgency.

The writer is the MP for South Shields, and former British foreign secretary.

 

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