Recent months have been unkind to China's economy. It has suffered a massive stock market crash, which has wiped out all the gains this year to the dismay of thousands of citizens who enthusiastically invested in the stocks.

Meanwhile, declining manufacturing output and shrinking year-on-year exports have put doubt into whether China will remain as the "world's factory" for the foreseeable future. A growing number of investors around the world no longer see China as the place to be.

Reflecting its low tolerance for wild economic swings, China's leadership introduced draconian measures to arrest panic in stock markets, ranging from suspension of trade in domestic equity markets and caps on short-selling, to the arrest of journalists, including Wang Xiaolu of the prominent Caijing financial magazine, on bizarre charges of "rumour-mongering".

China Rising - Power and People

In the eyes of many market watchers, the response belied the Xi Jinping administration's earlier promise of a more "decisive" role for markets. Far from instituting a "laissez-faire" system, Beijing displayed its "visible hand" in the national economy.

Prior to the recent economic shocks, there was already an uptick in complaints over growing Chinese restrictions on and harassment of foreign investments, with many observers lamenting the rise of economic nationalism in the country.

From GlaxoSmithKline, Cisco, IBM and Qualcomm to Starbucks and a myriad of Japanese companies, multinationals have been facing corruption investigations, punitive litigation, hostile state media, and shrinking profit margins. Meanwhile, Chinese companies such as Xiaomi, Huawei, and Sany have been making major inroads in the domestic and international markets.

Fearful of an economic decline, and intent on showing its commitment to market reforms, the government, however, has announced its push for restructuring state-owned enterprises (SOEs), which have played an outsized role in China's economy. It is a risky measure that could fuel greater social discontent.

The cost of reform

Deng Xiaoping's decision to open up China's economy in the late-1970s gave birth to a capitalist miracle, unleashing the long-suppressed entrepreneurial spirit of the Chinese people. Within a single generation, China saw a massive transformation in its economy, lifting 500 million people out of poverty and introducing a new role in the global economy.

By enhancing their 'innovation capability and international competitiveness', China aims to raise productivity and private capital amid slowing growth.

 

Yet, the Chinese leadership was careful to ensure economic opening didn't come at the expense of its grip on power and social stability in the country. They took notice of how Russia, under Gorbachev and Yeltsin, suffered massive instability as a result of misguided reforms, which led to the disintegration of the Soviet Union and, later, the emergence of mafia-style capitalism in post-Soviet Russia.

China opted for multiphased, carefully planned stages of reform, which gradually opened up various sectors of the country's economy to international markets.

The first stage of reforms saw the revival of enterprises at the township and village levels, while the Chinese diaspora in Hong Kong and Southeast Asia were encouraged to invest in newly-established "special economic zones" along China's strategically-located coastal areas.

By the 1990s, China decided to more decisively open up its economy, anchored by privatisation of publicly controlled factories, land, and enterprises in the urban centres, inflow of foreign direct investments from Taiwan, Japan and the West, and the modernisation of the banking system. This was the second stage of reform, largely overseen by the Jiang Zemin administration.


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But the partial privatisation of publicly owned factories led to large-scale layoffs, corruption, and economic uncertainty, while price hikes on basic commodities and housing, thanks to price deregulations and land privatisation, went hand in hand with a rollback in state welfare and wild swings in financial markets.

National champions

Each stage of reform was met with public backlash, paving the way for the Tiananmen protests in 1989 and a growing frequency of demonstrations and unrest over the years. This is why the ruling Communist Party - concerned with its legitimacy - has been reticent with a full liberalisation of its economy, which could potentially create greater social dislocations and political headache.

Despite the growing contribution of the private sector to the Chinese economy, the country's leadership long resisted a full-scale reform of its SOEs. To begin with, there were concerns over massive layoff and employment insecurity for state employees, who have served as the backbone of the one-party state.

Aside from providing employment, these enterprises also represent the last vestiges of socialism - state ownership and control of commanding heights of the economy - in a capitalist country that still pretends to be communist.

There are also strategic considerations. Through SOEs, the Chinese state has been able to build comparative advantage in key industries such as steel and electronics, expand its investment footprint around the world, and gain a foothold in strategic sectors of its rivals and friends.

Thanks to generous state support, these enterprises can think more long-term and overcome short-term volatilities, which affect privately controlled, profit-driven multinational companies.

When he was still a provincial chief, Xi insisted that SOEs were national champions that can remain competitive. He called for a "two hands" model of development, where private enterprises and state intervention can "function in a 'unified, mutually complementary and coordinated' manner".


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After its earlier decision to devalue the renminbi, which has made Chinese exports more competitive to the consternation of its trading partners, the recent announcement that the Xi administration is pushing ahead with partial privatisation of SOEs, however, signals growing worries over their performance.

By enhancing their "innovation capability and international competitiveness", China aims to raise productivity and private capital amid slowing growth. But also, it carries the risk of social instability and growing discontent if proposed privatisation schemes are mishandled and lead to a massive layoff of hundreds of thousands of employees, as more profit-driven managers cut on redundancies and hand out big bonuses to new corporate bosses.

Desperate times in China call for desperate measures, after all.

Richard Javad Heydarian is a specialist in Asian geopolitical/economic affairs and author of "How Capitalism Failed the Arab World: The Economic Roots and Precarious Future of the Middle East Uprisings."

The views expressed in this article are the author's own and do not necessarily reflect Al Jazeera's editorial policy.

Source: Al Jazeera