TO:
Wen Jiabao
Premier of China

FROM:
Barry Naughton

RE:
Cooling the Chinese Economy

As perhaps the best-prepared Chinese leader since Deng Xiaoping, you became premier 18 months ago set to preside over an ambitious reform agenda, impressive institutional development, and a major economic boom. You and President Hu Jintao positioned the government as supportive of the weak and disadvantaged, fair to ordinary citizens, and less tolerant of the corruption that permeates the ruling elite. Yet today, a wave of problems—from resurgent inflation and electricity shortages to wasteful investment and continued corruption—has swamped your carefully prepared economic program. Moreover, you’re bogged down in an effort to impose central government administrative controls over local governments. Your political rivals are taking potshots. What went wrong? How can you fix it?

Your term certainly started off well. You initiated policies to improve living standards in rural areas and began work on the financial sector reforms essential to restoring confidence in China’s banking and corporate governance systems. You also developed some of the regulatory muscle needed to manage the economy now that China has joined the World Trade Organization (WTO). Even the SARS epidemic last year was only a minor setback, because once you took charge, you handled the crisis effectively and with as much candor as possible. In mid-2003, economic and institutional reform seemed well on its way.

Fast forward to today’s discontent. There is no question that the economy is seriously overheated. Inflation is back. In July 2004, the consumer price index surged above the 5 percent...