The US, under President Donald Trump, seems to be withdrawing from its leadership role on global integration and is turning inward. This is, of late, quite visible from the policies that the US is undertaking towards the world economy and its exit from the Trans-Pacific Partnership (TPP). This, somewhat, gives an idea that China is well placed to take the position. It is the world’s largest exporter and, by some measures, the world’s largest economy—both the IMF and the World Bank now rate China as the world’s largest economy based on Purchasing Power Parity (PPP). It is time for China to play a bigger role in setting international rules. China appears ready to take up the mantle with the meteoric rise of Xi Jinping. China is mentioning all the right things, explaining the benefits of free trade—from consumer gains to economic growth—and calling for stronger international rules. Premier Li Keqiang recently said, “Free trade is the foundation of economic globalisation.” China is planning to enter into new openness by signing free trade agreements with several countries, including Mexico.
By reducing transportation costs, China’s One Belt One Road initiative could be as important as any major trade agreement. As tariffs have come down, transportation costs have become the binding constraint to trade, so creating extensive infrastructure by bridging the infrastructure gap will help integrate isolated countries into the world economy and could create a new wave of globalisation. China now needs to take bold action on domestic reform to match its global initiatives. To be sure, it has made significant progress towards becoming a market economy since joining the WTO in 2001. It no longer runs an enormous current account surplus—after hitting 10% of GDP in 2007, its current account surplus fell below 2% of GDP in 2016. Private and foreign-invested firms now account for over 80% of exports, up from roughly 50% before China joined the WTO.
In recent years, however, economic reform has rather slowed. Reform of behemoth state-owned firms in the field of the energy, heavy machinery, coal and steel sectors has taken the form of mega-mergers, which has reduced the number of firms without reducing the share of output coming from the state sector. Of the 1,000 largest firms in the world by revenue, 136 were Chinese in 2014, as compared with only 41 in 2006, and 70% of these giants are state-owned. The strategy of creating super-sized state-owned firms is neither good for growth, nor good for global business. The problem is particularly acute in some industries where Chinese state firms have become export powerhouses and are distorting global markets. Consider steel, where production grew at double-digit rates in the mid-2000s as China industrialised. As recently as 2004, China was a net importer of steel. It is now the world’s largest producer and exporter of steel products. The four largest Chinese steel companies are all state-owned.
Like steel, civil engineering and construction is an industry that grew out of the infrastructure boom in China. The four largest firms in the world in this industry are all Chinese state-owned firms. As construction has slowed in China, these firms have started bidding on global roads, bridges and metro systems, making their foreign competitors anxious. The presence of these large state-owned firms in construction and steel raise concerns that the real intention of the One Belt One Road initiative is to export excess capacity. Reforming state-owned enterprise sectors would be good for China and for the stability of the world economy. For China, the state firms crowd out financing to more productive private firms. China would grow faster if the most productive firms also absorbed the most capital. Indeed, as economic studies have shown, private firms accounted for most of China’s rapid growth during the 1990s and 2000s.
The large state firms are also straining the global trade system. Private firms facing competition from Chinese state-owned firms are justified in believing that there is no level-playing field. State-owned firms typically are more focused on jobs and revenues than profitability, and are not subject to the same hard budget constraints as private firms. Reforming the remaining state-owned firms, through closures and privatisation, would help China maintain strong growth and go a long way towards showing the world that it is serious about being a good global leader. It could be the belief of the US that world trade is currently unfair, hence it is turning protectionist. But there could be some iota of truth that China is competing unfairly in steel and a handful of other sectors. Trade in principle is a win-win situation but economic studies have proved it is unfair. It is noteworthy to know that China, which was once a harbinger of inward-looking and protectionism, is defending free trade, and investing in better global infrastructure and becoming the world’s leader on free trade.