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The quiet revolution that's shaping China’s future

Peking University Finance professor Michael Pettis' brilliant essay "The four stages of Chinese growth" not only details the current state of the country's economic miracle, but also provides a blueprint for the future.

It appears China's leadership is, if not listening, then following Mr. Pettis' game plan of their own volition. In a far more ethically palatable homage to Mao Zedong's Cultural Revolution, current President Xi Jinping's pervasive corruption crackdown is paving the way for a new stage of economic growth.

Mr. Pettis believes China's growth cycle has come full circle. Stage one, from the late 1970s to mid-1980s, he calls "The First Liberalization." It was followed by the "Gerschenkron period" a reference to Russian economist Alexander Gerschenkron, who led an infrastructure investment boom in the Soviet Union in the 1950s.

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According to the Pettis template, China is now in the "Investment Overshoot" era. His definition of this growth stage as it applies to China's wealthy elites provides vital context for understanding the current leadership's anti-corruption campaign.

"Continued rapid increases in investment directed by the controlling elites created the illusion of rapid growth. Because this growth was backed by even faster growth in debt, however, it was ultimately unsustainable," he wrote. "This period began around the beginning of the last decade, I would argue, and it is the period in which we currently find ourselves."

Mr. Pettis points to a number of the policy initiatives discussed at last year's Third Plenum government meetings as a sign the next surge in China's economic development will result from a second period of liberalization. This includes legal and land ownership reform, the consistent application of business laws, privatization of state assets and also more emphasis on the future economic viability of investment.

There is, however, a big hurdle in the way of more economic change: "ferocious resistance from those who have benefited enormously from constraints on Chinese productivity growth, and who consequently stand to lose the most from real reform."

There are clear signs that President Xi is not only aware of this problem but is already taking steps to remove entrenched opposition to reforms. The Financial Times reports, "In his efforts to clean house, Mr Xi is targeting a broad swath of individuals, families, factions and societal forces that do not answer directly to him. The tantalizing signs of a full-blown political purge are coming thick and fast, even if they are still mostly hidden between the lines of the country's tightly controlled state media."

President Xi's task is daunting. He must wield the anti-corruption campaign to tame the powerful business and government leaders standing in the way of market-oriented reform, and do so before the country's wobbly financial system becomes completely dysfunctional. While the process will be largely hidden from public view, it appears he is on the right track.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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