I have just posted this for my students so why shouldn’t I share it here. For anyone doing a conventional course in economics, specially one which does not include any history of economics, they would find what’s going on in China almost incomprehensible. It is an excerpt from a story in the Australian Financial Review by Angus Grigg published on Wednesday, May 21, 2013. I have added the bolding:

The key for China watchers will be how the new leadership, led by Premier Li Keqiang, plans to allow private enterprise to play a greater role in the economy. In a speech last week Li indicated this would begin by reducing red tape, which he labelled “informal barriers” and “glass doors”.

Li described how one company needed 50 separate administrative approvals across 27 different government departments before being able to begin a project.

“We need to get rid of the controls which are not needed,” he said.

Speculation is mounting that China will abolish one of its five layers of government to help achieve this.

But the market won’t be satisfied with cutting red tape. Economists are looking for reforms that will drive productivity gains over the next decade and allow China to keep growing at elevated levels.

That means the pressure is on the leadership to articulate how it will reduce the role of state-owned enterprises, which control more than one-third of the economy and are given preferential access to the most lucrative areas, such as energy and financial services.

“Private capital has money but nowhere to invest, it can’t invest,” Li said in his speech last week.

This was interpreted as strong support for markets, which the Premier said had a “self-adjusting mechanism”.

“The market is the creator of social wealth, it’s the internal source of economic development,” he said.

While Li’s comments were likened to Adam Smith, they are also perhaps an acknowledgement that China’s system of state-sponsored capitalism has run its course. This can be seen in how the government has been unable to significantly boost the economy in recent months, despite directing state-owned banks to massively increase new loans.

At the end of last year China’s credit to GDP ratio topped 180 per cent – up 60 percentage points in just four years – but it is having less and less impact.

Fitch Ratings estimates that each new yuan of lending between 2009 and 2012 only generated 0.3 yuan of additional GDP. This is less than half the figure achieved between 2005 and 2008. This supports theories that China is like a junkie that needs increasingly larger hits of credit to have the same impact.

And it’s leading to dire warnings on the state of China’s banking system.

The latest to join to throng was famed short-seller Carson Block of Muddy Waters Research, who says China’s financial institutions hold more toxic assets than Western banks did before the 2008 financial crisis.