BEIJING — Now for the hard part. After three decades of astonishing economic growth, powered by a first set of radical reforms in the late 1970s and early 1980s and a second set in the mid-1990s, China's incoming leaders are facing what might be the country's greatest economic and political challenge. They must create a new growth model, with a very different financial system, a substantially modified state sector, and the political reforms necessary to accommodate both.
How these seven (or nine) men respond to these challenges in the next five to 10 years will determine the country's long-term growth prospects. If they succeed, China will continue to grow, albeit more slowly, and could even one day join the tiny club of formerly poor countries like South Korea that have attained developed-country status. If they mismanage the adjustment, growth will evaporate, leaving China stuck in the notorious "middle-income trap" from which few developing countries have ever escaped.
Given its astonishing success in implementing economic reforms and engineering rapid growth, it is tempting to believe that Beijing has the talent, far-sightedness and determination to make the transition successfully. History, however, suggests otherwise. Many countries that followed variations of China's investment-driven model have grown miraculously for a decade or more, but few managed the move to developed-country status.
Take the Soviet Union. By the 1960s, the USSR had generated nearly three decades of exceptional growth, leaving most analysts convinced that it would soon surpass the United States economically and technologically. It didn't happen. Real productivity growth stalled by the late 1960s, and today, nearly 50 years later, Russia's GDP is smaller in relative terms from its peak. Brazil saw extraordinary growth from the late 1950s to the late 1970s, but fell back during the "Lost Decade" of the 1980s and has still not achieved the economic successes many expected nearly a half century ago.
China's spectacular growth over the past 30 years, like that of the USSR and Brazil before it, was made possible mainly by the ability of policymakers to control credit and unleash waves of investment when needed. This allowed Beijing to keep growth rates high regardless of the circumstances and no matter how the leadership managed domestic problems. It was able to avoid a surge in unemployment when it restructured the hugely inefficient state-owned industries in the 1990s by sharply increasing infrastructure investment. Investment spending helped it smooth over the social dislocations caused by its rigid and antiquated political structure. It eased political conflicts and factional fighting by directing billions of dollars into pet projects, much of which the politically connected have since siphoned off. China grew vigorously through the Asian crisis of 1997, the Chinese banking crisis a few years later, and, the collapse of the global economy in 2007-08. In each case, unrestricted access to savings allowed China to power growth by pouring cash into the projects of its choice.
But no longer. Officially, government debt is under 25 percent of GDP, but it's likely much higher. Investment has reached its limit, and now excess investment has itself become China's greatest economic problem. Many years of high and often wasted investment in such baubles as empty airports, bridges to nowwhere, vacant office buildings, and underutilized steel factories have resulted in debt levels growing much faster than the ability to service that debt. And more "investment" only worsens the problem.