The Second Coming of Zhu Rongji?

Zhu’s success means that Li must focus on a different challenge. Li must ensure that China’s economy, which still boasts significant growth potential, does not sink into lethargy and fall into the so-called middle-income trap. A developing economy may slow prematurely when external factors alter the conditions supporting growth. Wages continue to rise, reducing competitiveness vis-à-vis low-income economies, but the growth model is not yet equipped to support competitiveness in high-skill industries, leading to stagnation.

In order to avoid such an outcome, Li must adapt China’s growth model to current conditions, which include intensifying trade friction with the European Union and the United States, greater pressure to allow the renminbi to appreciate, an aging population, slowing urbanization, and rising labor costs. The new normal that has emerged from the global financial crisis, characterized by sluggish GDP growth and diminished import demand in the West, makes reform even more urgent.

Li should begin by redistributing industrial capital from high-productivity coastal areas. This would instantly augment growth in less-developed regions and boost overall productivity. But, with competition in the global supply chain fiercer than ever, China will need more than capital transfer to achieve high-income status. It will need policies and mechanisms that encourage and guide technological and industrial upgrading.

Fortunately, Li seems to understand this. Indeed, industrial and technological upgrading forms the core of Likonomics. But significant uncertainty remains over how to achieve it within the constraints of China’s state-led economy.

Over the last decade – especially since 2008 – China’s central government has been tightening its grip on industrial policy, while enhancing the State Council’s dominance over local governments. By contrast, Li seems intent on returning power to local governments and the market, transforming vertical control into horizontal coordination. Thus, instead of trying to control technological and industrial upgrading with central mandates, Li is giving local governments and the market the space to drive China’s economic transformation.

Zhu and Li do have one thing in common: they both came to power at a critical juncture in China’s development. But, whereas Zhu had to grapple with local officials to increase the central government’s authority and revenue, thereby stabilizing the economy and unleashing China’s growth potential, Li must cooperate with local governments to create a system that fosters and protects new sources of innovation and economic dynamism at all levels. Just as Zhu’s reforms two decades ago laid the foundation for today’s growth, whether Li succeeds may well determine China’s economic trajectory for the next 20 years.

Zhang Jun is Professor of Economics and Director of the China Center for Economic Studies at Fudan University, Shanghai.

Copyright: Project Syndicate, 2013.

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