China's leaders have been struggling with the same essential dilemma for some time: They want steady growth and short-term stability, but they also want far-reaching economic reform. Those aims can’t easily be reconciled.

Up to now, the government has put growth and stability first and moved cautiously on reform. During the National People’s Congress, which ends this week, Chinese policy makers seemed reluctant to recalibrate. But that’s what they need to do. They should accelerate the pace of reform, even at some short-term cost in economic disruption. 

Officials promised during the meeting to boost lending and spend billions on new roads and railways in pursuit of a target for growth in output that’s still high, albeit lower than before. This short-term stimulus is meant to provide a cushion to cut overcapacity in sectors such as steel and coal mining. The government’s new economic plan also includes tax cuts to encourage private-sector entrepreneurs. Meanwhile, the government says its efforts to open up China‘s financial system are proceeding on schedule.

That would be fine, except that the spending targets are specific and concrete, while, for the most part, the reform plans aren’t. The money set aside to support factory closures -- around $15 billion -- probably isn’t enough. Planned cuts in steel production are too small: They’d leave the industry with idle capacity equal to twice U.S. annual output. Additional stimulus is likely to exacerbate the very problems officials keep promising to tackle: over-investment, rising bad loans and loss-making “zombie” companies that squander financial resources and hold the economy back.

According to Bloomberg Intelligence, new lending this year will push aggregate debt to nearly 60 percent of gross domestic product. Every increase makes the ultimately unavoidable deleveraging harder, and adds to the risk of a financial crisis. And time is not on the economy’s side. Moody’s recently downgraded China’s ratings outlook. With an aging population and diminishing opportunities for catch-up growth, the sooner China bears the cost of restructuring, the better.

Rather than wasting money on rolling over bad loans, the authorities should develop a detailed plan for restructuring ailing state-owned companies. The government would rather merge and reorganize such firms than shut them down, to avoid putting millions out of work. This approach can’t do it all. A good investment would be to spend more on retraining workers for jobs in services (a sector that’s growing fast) and on further strengthening China’s social safety-net. Beijing should also further shore up the finances of local governments, so they don’t need to keep weak companies going just for the taxes they pay.

Most important, China’s leaders need to show they’re serious about ceding power to the market. Lately, they’ve put their commitment to doing this in doubt. The government is thought to be intervening more than before in the stock market, and regulators have again delayed plans to liberalize new company listings. Despite the economy’s troubles, the number of bankruptcies in China is decreasing –- which isn’t a good sign. Banks can’t clear their books of bad borrowers and capital is diverted from more productive purposes.

The government knows what’s required, and keeps promising to do it. The need is now urgent. China’s continued success depends on a faster pace of reform.
 
(Bloomberg)