China’s New Chapter: Rebalancing and Unleashing Market Forces

Distinguished guests, ladies, and gentlemen. It's an honor to be here. I want to thank the China Development Forum for inviting me to speak today.

We meet at a time of unrelenting change. The forces reshaping the global economy-in trade, geopolitics, technology, and demographics-are moving faster than at any point in recent history.

However, as recent weeks have shown, this era of rapid change has also been an era of more frequent shocks. And although I had planned to speak today more about change than shocks-and in particular about the historic and rapid rise of China in the global economy-let me first offer some thoughts on recent developments in the Middle East.

The conflict in the Middle East has introduced a significant new source of risk into the global economy, that until recently, had looked reasonably resilient.

The full consequences are still difficult to assess, but we expect these developments to pose complicated trade-offs for policymakers.

Of course, the first line of defense against supply disruptions is prices. Demand should be allowed to adjust to a certain degree to ensure that the marginal uses of energy are the most productive ones.

But understandably, fiscal policy might need to play a role in adjusting to the energy shock. Governments may try to protect households with energy caps and subsidy schemes. This may cushion cost of living pressures in the short run, but these measures are fiscally costly at a time when many government budgets are stretched. And because they suppress price signals, they often prevent an orderly reduction in energy usage and may keep overall energy prices-and demand generally-elevated for longer.

For central banks, the policy environment is particularly challenging. If energy prices remain higher for longer, central banks may have to balance risks to price stability against a downturn in the economy and a potential tightening of financial conditions. Former U.S. President Teddy Roosevelt once said that in moments of decision, the "worst thing you can do is nothing." While this logic might have applied to the combat or high-stakes political situations for which President Roosevelt is famous, it does not apply to central banks facing an energy shock.

Doing nothing is perfectly logical if it is the best available alternative, and for central banks in the current moment, there is veryhigh option value to waiting for now. Central banks with less firmly anchored inflation expectations and that have been struggling with persistently high inflation may need to respond faster. But central banks that were on hold or in the process of gradually adjusting policy can likely afford to take their time and receive additional clarity about the rapidly evolving situation before deciding whether a pivot-either toward a more restrictive stance to address inflation risks or a more accommodative stance to address output risks-is warranted.

Critically, all central banks should articulate their potential reaction functions, including with scenario analysis, to sensitize the market to potential policy paths should risks to inflation and output materialize.

Of course, it is early days, and much could change. But what is clear is that policymakers and businesses alike will need to adapt, underscoring a lesson successive shocks have taught us: that robust policy frameworks and agility are essential. Recent experience has also shown that allowing the private sector to adapt and innovate in response to shocks can enhance the overall resilience of the economy.

It is with these lessons in mind that I turn to China. China has proven resilient in the face of massive shocks in past decades, due in part to the adaptability of its private sector. Giving market forces an even greater role going forward could provide a deeper and more durable foundation for that resilience.

China's meteoric rise

Over the past 40 years, China's policymakers engineered one of the most impressive achievements in the history of the global economy.

In 1978, on the eve of the launch of the "reform and opening up" campaign, China had one of the lowest per capita income levels in the world. Skillful, long-term leadership as well as the hard work of the Chinese people powered decades of rapid growth and transformed China into the world's second largest economy. Over 800 million people were lifted out of extreme poverty and the middle class expanded dramatically.

Behind these achievements was a deliberately constructed policy mix that combined both market-oriented reforms and state direction of resources, with a general trend toward a greater role for the private sector. For example, from 1999 to 2015, the share of total industrial revenues of state-holding enterprises went from approximately 50 percent to approximately 20 percent. Yet in recent years, the increased role of the private sector has stalled.

This has coincided with the slowing of China's overall growth amid less efficient resource allocation, declining returns on investment, and demographic pressures. Significant challenges remain, including from deflationary pressures that risk becoming entrenched if domestic demand-and especially consumption-stays weak. Reforms are more important now than ever to foster new engines of growth.

Rebalancing and unleashing the power of market forces

Indeed, China's policymakers recognize these challenges and are taking steps to address them. They adopted a more expansionary fiscal policy stance in 2025 and 2026 and began their anti-involution campaign to reduce over-investment in some industries. Their 15th Five-Year Plan prioritizes increasing consumption as a driver of economic growth, which would also help reduce China's external imbalances.

These are helpful measures, but China can do more to increase consumption and domestic demand-especially for services-by boosting household incomes and reducing incentives for precautionary savings. That means shifting resources away from industrial subsidies and infrastructure and toward social safety net programs and stabilizing the property sector to give citizens the confidence to spend more and save less. It also means shifting the incidence of taxes from already heavily taxed middle-income households toward higher-income households and reducing corporate tax exemptions.

Productivity is another essential part of the reform effort. And here, deeper market-oriented structural reforms are critical. Enabling a greater role for markets to direct resources to areas of greater productivity could be transformative for China's growth and prosperity. We see three pillars of reform that could be particularly impactful.

First, authorities should continue to level the playing field across firms. China has relied heavily on a mix of subsidies, tax breaks, and cheap credit to support priority sectors. These were helpful in some cases to correct market failures and support policy aims like national security, but they have not been costless. IMF estimates suggest that scaling back preferential treatment provided to specific firms and sectors could boost aggregate productivity by over 1 percent, in turn raising China's level of GDP by up to 2 percent. Allowing a more level playing field, where private firms, small and medium enterprises, and even foreign companies can compete fairly is key for innovation and productivity and will generate higher incomes and give consumers more choices. The government's Private Economy Promotion Law is a useful start.

The second pillar is greater reliance onmarket-based pricing. One of the most important prices in any economy is the cost of capital. It shapes investment decisions and influences where resources flow. In China, the direction of capital toward less-productive borrowers has led to rising debt, weakened financial institutions, and contributed to involution as weaker firms are supported at the expense of stronger and more efficient firms. Market-oriented reforms that enable a larger share of funding to go to more productive enterprises and that reduce incentives for overproduction-by for example, doing away with targets for GDP growth and production in specific sectors-could make better use of Chinese savings. In the property sector, accelerating the exit of unviable developers and allowing greater housing price flexibility would help clear the overhang that has weighed on household and business confidence.

A third pillar is to strengthen the services sector to create more durable economic growth. The Chinese service sector overall is significantly smaller than other major economies, and with China already accounting for approximately 30 percent of global manufacturing output, the service sector has much more room to grow. Indeed, total factor productivity in market services in China is already growing faster than in manufacturing. With less regulation and by allowing the market to play a much larger role, other sectors in the service economy could grow faster, including healthcare, education, and professional and technical services, which would durably raise productivity.

China's next chapter

Market forces are the key to unlocking the next phase of China's economic growth. The state's role will need to evolve. Rather than directing investment toward specific industries, government should instead build the conditions that enable private sector innovation and market forces to direct China's immense resources to where they can generate the most value.

This transition would be good for China, and in a rapidly changing and shock-prone world that needs durable sources of dynamism and stability, it would be good for us all.

Thank you very much.