October 2005

China’s labor-intensive economic growth over the last two decades allowed the transfer of a vast amount of low-wage labor from both the rural sector and the declining state-owned enterprise (SOE) sector. That allowed China to grow by “walking on two legs”: by keeping the SOE sector alive while the nonstate enterprise leg was growing stronger. It thus avoided the loss in output and employment and the attendant social disorder that had characterized other transition economies’ move from plan to market. But that strategy is now running into some serious obstacles, which, if not tackled, could lead to the erosion of the miracle. After briefly outlining those problems, the author presents a simple way in which China could avoid such problems by creative use of its large buildup of foreign exchange reserves and questions the current trend in Chinese policy of using those reserves to convert some SOEs into world-class national champions by acquiring foreign companies and assets.