China puts economy at risk by spurning market-oriented reforms it once promoted, long-time observer Nicholas Lardy warns

China’s move away from market-oriented reforms has undermined the country’s economy, and Beijing’s leaders must reverse course soon to prevent a tailspin, a prominent US economist has warned.

The resurgence of China’s state sector followed a series of supportive measures to make them bigger and stronger, which sidelined the private sector, said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics who has written about the Chinese economy and financial sector for four decades.

In his latest book – The State Strikes Back: The End of Economic Reform in China? – Lardy also suggested that Chinese officials address the long-standing grievances of its trading partners on industrial policies and state subsidies.

In a key Communist Party document in late 2013, Chinese leaders vowed to allow market forces to play a decisive role in resource allocation, but the reality was a shrinking private economy sector and an expanded role for state enterprises whose managers “appear to be asset maximisers, borrowing ever larger amounts to expand their business even if the returns do not cover the cost of capital”, Lardy said.

The share of bank lending to state firms more than doubled from 2013 to 2016, while private firms had been squeezed out, he said. But the productivity, in terms of return on assets, of state players was steadily lower than private-sector rivals.

“The resumption of state-led growth, in which a growing share of resources is flowing into investment by relatively low-productivity state firms, and an increasingly omnipresent party are contributing to China’s growth slowdown,” Lardy said in his book.