China's Best-Laid Plans

China's Best-Laid Plans

By ANDREW PEAPLE

China's economy lacks "balance, coordination and sustainability." Not the words of some perennial China-basher, but those of Premier Wen Jiabao himself in a recent interview.

It's not the first time Mr. Wen has been disarmingly open about the structural issues China faces. Nonetheless, it adds to the sense Beijing is becoming more concerned about quality, not quantity, when it comes to economic growth. That, in turn, will inform the Chinese government's next five-year plan, due in outline this month ahead of formal adoption in spring 2011.

The plan could see Beijing target a lower annual growth rate over the medium term while setting out reforms needed to rebalance China's economy toward more reliance on domestic consumption, rather than exports. Doing so will involve challenging strong vested interests, however.

A lower growth target—potentially down to 7% per year for the next five years—doesn't necessarily portend a sharp slowing for China's economy. China's grown at 11.4% per year on average over the last five years, according to UBS, way above the last five-year plan's projection for 7.5% annual growth.

Still, Chinese growth will likely be closer to target in the future, primarily because of a weaker contribution from net exports, as major Chinese trading partners remain in the economic doldrums. Investment, China's other key economic driver, should remain strong, as inland provinces increase manufacturing capacity and industries upgrade equipment.

But there should also be a sharper focus on encouraging domestic consumption—which has fallen to around 35% of GDP, very low by the standards of large economies—as the major force in China's economy. Reforms here, though, may prove easier to plan than enact.

Take plans to bolster China's social security system, giving consumers more confidence to spend. That could be funded by asking China's state-owned enterprises to pay higher dividends. Fine in theory, but it's hard to get SOE chiefs, keen to protect their fiefdoms, to part with their cash.

Reform of China's household registration system is also in the cards, helping grease the wheels of urbanization by making it easier for people to change residence, hopefully leading to higher household wealth. Resistance here may come from local governments facing increasingly congested cities with inadequate social housing.

Further liberalization of interest rates is another possible target for the five-year plan, to reflect market forces. Initially it's thought this could result in higher deposit rates: good for boosting the income of Chinese savers, but not so good for China's powerful banks, which will suffer from narrower net interest margins.

Fast growth may, in retrospect, come to be seen as the easy part for China's economic policy makers. Encouraging sustainable growth is going to require some heavy policy lifting.

Write to Andrew Peaple at andrew.peaple@dowjones.com