Introduction:

China’s economic model of decentralization once played a crucial role in driving its economic growth. However, over time, this model has run into significant issues that have slowed down its progress and contributed to overcapacity. In contrast, India''s Prime Minister recently urged competition among its states to attract investment, illustrating a sharp divergence between the two nations'' approaches.

Decentralization in China vs. India:

While decentralization in China contributed to its economic rise, the extent of decentralization differs significantly between the two countries:

• China’s Sub-provincial Spending: In China, 51% of government spending occurs at sub-provincial levels. Local governments are tasked with a broader range of responsibilities, including unemployment insurance and pensions, which are often managed by the national government in India.
• India’s Subnational Role: India’s city-level governments account for less than 3% of total government spending.

China’s Extreme Decentralization and Its Effects:

China’s decentralization does not make it a federal country, as higher-level governments can retract the powers of local governments at will. In the Tax-Sharing Reform of 1994, China’s central government restricted local governments’ ability to raise funds. As a result, local governments sought alternative sources of revenue, prioritizing industrial construction to fuel economic growth, often at the expense of public services.

Structural Overcapacity and Competitive Growth:

The investment-led growth model that China adopted is prone to structural overcapacity:

• Cheap Land and Industrial Growth: Local governments offered industrial land at discounted rates to attract investments, hoping for increased regional growth and future tax revenues.
• Export-Led Growth: Firms took advantage of these cost benefits, producing goods at low rates and exporting them globally. This boosted regional growth but also led to overcapacity, with industries producing more than domestic and international markets could absorb.

Benefits of the Model:

Despite its flaws, this model worked well during China’s earlier growth phases, particularly during the Hu Jintao period, for two key reasons:

1. Broad Central Directives: The central government’s directives were flexible enough to allow local governments to experiment with different ways of achieving growth.
2. Favorable Geopolitical Climate: Foreign markets absorbed China’s excess capacity, especially in sectors like steel, where China became the world’s largest steel exporter by the early 2010s.

Challenges Under Xi Jinping:

When Xi Jinping came to power, the flaws of the model became more apparent:

• Ineffective Investments: Between 2009 and 2013, half of all investments were deemed ineffective, leading to a waste of nearly $6.9 trillion.
• Increased Central Control: Xi’s administration began tightening control over local governments, limiting their ability to invest freely. Central directives became more specific, particularly in sectors such as semiconductors, which were prioritized for self-sufficiency. However, China has yet to master the production of advanced chips, and many local firms continue to rely on government funding.

Geopolitical and Economic Struggles:

China’s overcapacity is now seen as a national security threat by other nations. This is evident in industries like telecom equipment and electric vehicles, where geopolitical tensions have increased scrutiny of Chinese products. China’s deteriorating international relationships have also worsened perceptions of its exports and investments.

Belt and Road Initiative (BRI) Shortcomings:

Xi Jinping’s strategy to shift away from western markets by boosting domestic demand and expanding into new markets through the Belt and Road Initiative (BRI) has faced significant setbacks:

• Domestic Demand: Increasing domestic demand has proven difficult, as China’s economy is more supply-side driven.
• BRI Challenges: The countries participating in the BRI are often economically weak and cannot generate the demand needed to offset the loss of western markets.

Conclusion:

China’s decentralized economic model, once a source of rapid growth, has reached its limits due to structural overcapacity and poor international relations. If China fails to transform its political and economic relations with major world powers, it risks facing an economic decline, despite occasional surges in exports from certain sectors.