Written by Lauren Johnston.

In economics the impossible trinity describes how governments can set only two of three macroeconomic policy variables, even if they are all independently desirable. Those three variables are 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, there are three forces 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 single formula exists for creating or sustaining a knowledge economy, there is a broad consensus that corruption and innovation are incompatible bedfellows. Instead, innovation is driven by open interaction and competition, backed up by legal protection of intellectual property rights and profits. The need to crackdown on corruption and consistently implement the rule of law in China relates to the need to change the drivers of China’s economy.

How the Party will adapt itself to 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 to be the 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.

Xi, like Central Bankers, 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 and incentives 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 a Peking Dux, transforming the Chinese and world economy in the process.

Lauren Johnston holds a PhD in Economics from Peking University, is a freelancer for the EIU, and co-founder and Director of Education and Economics of Sinograduate.


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