Growth Challenges

Xi’s Impossible Trinity – Innovation, Anti-Corruption and Political Stability

In economics the impossible trinity describes how governments can set only two of three macroeconomic policy variables despite that are each otherwise independently desirable. Those three variables are a fixed exchange rates, independent monetary policy and free movement of capital. Amid calls from former Chinese leaders Hu Jintao and Jiang Zemin that President Xi should ease his anti-corruption agenda, here I look at the three forces in China that may be shaping an impossible trinity within China’s governance and economic reform agenda.

The financial crisis of 2008 brought China’s export-driven growth model to a near halt. It did not however halt the flow of millions of job-hungry consumer-lifestyle-expectant Chinese graduates arriving annually on the labour market. Indigenous innovation, urbanization and expansion of the services sector are targeted areas of growth going forward.

While no one formula exists for creating or sustaining a knowledge economy, there is a broad consensus that “corruption and innovation are incompatible bedfellows”. Instead innovation has in general been driven by open interaction and competition, backed up by legal protection of intellectual property rights and profits. The need to crackdown on corruption and to more consistently implement the rule of law in China relates also therefore to the need to change the drivers of China’s economy.

How the Party will adapt itself amid this new type and level of accountability within its own rank and file is unknown for the very fact that it is new territory. Privileged access and favours are said even to be the very glue that holds the Party together. Yet, too much of a good thing can drive a wedge between the Party and the people, not least may undermine the shift toward more bottom-up innovation and entrepreneurialism. Ironically that is it seems the pendulum must shift in favour of the people for the economy to continue growing and thus relatedly also for the Party to sustain itself.

In other words, Xi, like Central Bankers all over the world, faces an impossible trinity: 1) the need to more transparently implement the rule of law across all of society; 2) the pressing need to transform the driver of China’s economy toward domestic and more innovative sources of growth; and 3) the need to maintain Party unity amid shifts in accountability (1) and incentives (2) that have otherwise helped hold the Party together for decades.

As one of China’s more powerful recent leaders, Xi may yet identify new means and paths to navigate that seemingly contradictory terrain. In Roman history a military leader of a frontier province was called a Dux. Should President Xi successfully steer China’s economy and politics through these contradictory challenges he will have avoided the risk of become Peking’s duck and instead have arisen as Peking Dux. China’s and the world’s economy will have been transformed in the process.

This piece first appeared here.

Lauren has worked in economic policy and research at the World Bank, World Economic Forum, EIU and for the governments of Sierra Leone and Guyana. She has learned Chinese since 1995, and lived in Beijing for almost six years, on and off since 1997. Lauren has a PhD in Economics from Peking University, an MSc in Development Economics from the School of Oriental and African Studies (SOAS) and a B.A/B.Com from the University of Melbourne.

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