2022: Small-Medium Enterprises and Mistakes in Economic Development

Authors: Ibrahim Chowdhury, Ekaterine T. Vashakmadze and Li Yusha

After a strong rebound last year, the global economy is entering a challenging 2022. Advanced economies have recovered quickly thanks to major stimulus packages and rapid progress in immunization, but many developing countries continue to struggle.

The spread of new variants amid significant inequalities in vaccination rates, high food and commodity prices, volatile asset markets, the prospect of tighter policies in the United States and in other advanced economies and ongoing geopolitical tensions provide a challenging backdrop for developing countries, as the World Bank’s Global Economic Prospects report released today highlights.

The global backdrop will also weigh on China’s outlook in 2022, dampening export performance, one of the main drivers of growth last year. After a strong cyclical rebound of 8% in 2021, the World Bank expects growth in China to slow to 5.1% in 2022, closer to its potential – the sustainable growth rate of production at full capacity .

Indeed, growth in the second half of 2021 was below this level, and our forecast therefore assumes a slight policy easing. While we expect momentum to pick up, our outlook is subject to domestic and global downside risks. New national outbreaks of COVID-19, including the novel Omicron variant and other highly transmissible variants, may require broader and longer-lasting restrictions, leading to greater disruptions to economic activity. A severe and prolonged downturn in the real estate sector could have significant repercussions for the entire economy.

Faced with these headwinds, Chinese policymakers should nevertheless keep a firm hand. Our latest update on China’s economy argues that the old game plan of boosting domestic demand through investment-led stimulus will only exacerbate risks in the real estate sector and generate ever-lower returns as China’s public infrastructure stock approaches saturation point.

Instead, to achieve sustained growth, China must stick to the difficult path of rebalancing its economy along three dimensions: first, the shift from external to domestic demand and investment and industry to greater dependence on consumption and services; second, a greater role for markets and the private sector in driving innovation and allocating capital and talent; and third, the transition from a high-carbon to a low-carbon economy.

None of these acts of rebalancing are easy. However, as China’s economic update points out, structural reforms could help reduce the trade-offs needed to transition to a new, high-quality growth path.

First, tax reforms could aim to create a more progressive tax system while strengthening social safety nets and health and education spending. This would contribute to reducing households’ precautionary savings and thus promote the rebalancing towards domestic consumption, while reducing income inequalities between households.

Second, following the tightening of antimonopoly provisions targeting digital platforms and a series of restrictions imposed on online consumer services, the authorities could consider focusing their attention more broadly on the remaining obstacles to competition in the market in order to stimulate innovation and productivity growth.

Greater openness of the sheltered services sector, for example, could improve access to high-quality services and support the rebalancing towards high-value service jobs (a particular point of the World Bank report). Eliminate remaining restrictions on labor mobility by removing hukou, China’s household registration system, for all urban areas would also support the growth of vibrant service economies in China’s largest cities.

Third, the wider use of carbon pricing, for example, through broadening the scope and tightening of the rules of the emissions trading system, as well as reforms in the energy sector. electricity to encourage the penetration, trade and delivery of renewable energy nationwide, would not only generate environmental benefits but also contribute to China’s economic transformation towards a more sustainable and innovation-based growth model .

In addition, a stronger corporate and bank resolution framework would help mitigate moral hazard, thereby reducing the trade-offs between monetary policy easing and financial risk management. Addressing distortions in access to credit—reflected in persistent gaps between private and public borrowers—could support a shift to more innovation-driven, private sector-led growth.

Productivity growth in China over the past four decades of reform and opening up has been driven by the private sector. The potential for future productivity gains through the diffusion of modern technologies and practices among small private enterprises remains significant. Realizing these gains will require a level playing field with state-owned companies.

Although the latter have been instrumental during the pandemic in stabilizing employment, providing essential services and, in some cases, filling local government budget deficits, their ability to drive the next phase of growth is questionable given the declining profits and productivity growth rates in the country. pass.

In 2022, the authorities will face a much more difficult political environment. They will need to remain vigilant and ready to recalibrate financial and monetary policies to ensure that the difficulties in the real estate sector do not turn into broader economic distress. Recent policy easing suggests that policymakers are well aware of these risks.

However, in aiming to keep growth on a stable path close to its potential, they will also have to be attentive to the risk of accumulating ever-higher levels of corporate and local government indebtedness. The transition to quality growth will require an economic rebalancing towards consumption, services and green investments. If the past is any guide to the future, relying on markets and private sector initiative is China’s best bet to achieve the structural change needed quickly and cheaply.

First published on China Daily, via World Bank