China is holding the Third Plenum of the Communist Party’s 18th National Congress next month. The meeting will bring a large amount of social, political, and economic reforms to the country, but nobody is quite sure what they will be. Analysts, economists and even Chinese politicians have been clear about what needs to change in the Asian giant, but the extent to which the state apparatus is able to change the situation is not certain.

ETF China

In his most recent letter, economist Michael Pettis argues that the incentive structure may not be there for China to make the needed reforms. According to Pettis, China is slowing down. The country needs to rebalance, but he expects “it will be much more difficult to maintain the consensus in favor of reform” this time around than it was in 1978. This time the incentive structure is not as advantageous.

China slowdown

The fact that China is slowing down is well-supported by Pettis. Major markers of economic growth, one of the most important being electricity consumption, have slowed in recent quarters. Industrial usage grew by 81% year-on-year in September. August saw 12% growth. For the year through September industrial power growth comes in at around 7.9%.

The relationship between power consumption and GDP is an important one, and it leads Pettis to believe that the GDP figures in China have been overstated for the year so far. Chinese growth is slowing down and it is a structural rather than a cyclical problem.

Elite incentives in China

The key word for Pettis and the Chinese administration is rebalancing. Chinese economic policy needs to be rebalanced to ensure stability of the country’s growth and development. The unbalanced nature of the current growth model is untenable, and it is necessarily leading to the current slowdown in the economy. Without a change, the country will continue to slow, and the entire project may be in danger.

Chinese economic adjustment requires a reversal of the process in which, for thirty years, the state sector and the economic elite received a rapidly growing share of rapidly growing economic pie. We must now enter a process in which they will receive a declining share of a much more slowly growing pie,” says Pettis. 

The incentive structure this time around means that political reform will be difficult. It represents the elites giving up some of their power in order to get less of the resulting growth. The huge and essentially fractured nature of Chinese politics means that the problems with the incentive structure could be difficult to overcome.

Chinese reform and the future of growth

China is rebalancing the relationship between the value of its currency, its interest rate, and its growth. The current relationship between the three will likely end in disaster. Reform will cause political schisms in the country. The Third Plenary Congress is next month, but, if Pettis is right, the regime may not be able to make the reforms it needs to set the economy on the right path.