Balancing State power and the market

The dilemma facing Chinese economic policymakers has been clear since the ruling Communist Party’s “Third Plenum” meeting in late 2013. That meeting supported giving markets a “decisive role” in allocating resources but it also emphasised that public ownership had to play a “dominant role” and a powerful State was needed.

The recent reform of currency setting and the bursting of the share market bubble have displayed the tension between accepting market outcomes and letting the State have the final say. Allowing a greater role for the market in setting the currency – which promptly fell, triggering fears of heightened “currency wars” between the economic superpowers – can be seen as a win for pro-market liberal reformers. Or was it clever timing to get the RMB into the exclusive club of currencies allowed into the IMF’s SDR currency basket at the same time as boosting China’s flagging export sector by letting the RMB slide?

The official response to the bursting of the share market bubble has been anything but market oriented with a raft of highly interventionist measures designed to prop up share prices, market liquidity and funding for margin purchases. Although the impact of the massive changes in equity market wealth on household finances, corporate funding and the financial system look manageable, the government has not hesitated to tell market participants what to do, use public funds to support what look like over-valued share prices and generally stop people from doing what they might want to in a free market.

Reconciling these differing approaches to the currency and share markets is not easy – over the medium term the authorities do face a balancing act between losing control through market oriented reform and running the risk of political intervention that wastes public funds. This could result in an ossified economy and China falling into the same middle income trap of other once fast growing nations. In the near term, however, the RMB depreciation and propping up the share market can easily be reconciled, both are good for short term growth in a slowing economy.

For further details, please see the attached document.

China’s currency and share market  – 17 August 2015 (PDF, 705KB)