Cost Distortions and Structural Imbalances in China

Abstract

This paper attempts to explain the fundamental cause of China's growing imbalance problems. Economic data confirm that the key structural imbalance problems, such as overinvestment, large current account surpluses, low consumption share of GDP and income inequality, have all deteriorated over the past few years, despite continuous policy efforts to correct these problems. We argue that the key determining factor is repressed factor cost, which is associated with heavily distorted markets for labor, capital, land, resources and the environment. These are like implicit subsidies for producers, investors and exporters. They boost growth and, at the same time, lift investment and exports. Previous policy efforts have focused more on administrative measures, which have not been sustainable. Therefore, a more fundamental solution to the imbalance problem lies in completing market-oriented reforms for production factors and allowing free markets to determine prices of labor, capital, land and resources.