A Market Economy – What, How and Why

The recent hubbub about granting ‘market economy status’ for China has promulgated quite a debate. The concept of distinction between a market economy and a non-market economy was first embedded during the time when transition economies were considering their role on the global trade platform. It all started with the introduction of anti-dumping investigations and laws thereof; the distinction between a non-market and market economy status lies in the process of determination of prices. When the prices are determined by demand and supply in the market and not (thoroughly) by government intervention, the economy is a market economy. Normal value of goods is arrived by government intervention, in a non-market economy. There is a chance that prices may be distorted due to this intervention. However, this is just for the sake of definition. The really difficult part is to know that for an economy to transition to (into) a market economy from a non-market economy, there are several changes or transitions to be experienced and witnessed. Transition towards a MES requires a lesser political hand and a more social and economic hand. However, without a strong political development, neither social nor economic reform is possible in the long-run. Therefore, more than economic challenges, political challenges come to play during such transition. And then there are issues that accompany transition. Some notable consequences of transitioning to a market economy are new levels of inequality, regional imbalances, unemployment/employment, environmental issues like increased levels of pollution, rapid energy consumption, neo-political empowerment, and others alike.

The fear of ‘market failure’ is always imminent when there is a nouveaux transition. To counter market failure and the potential outcomes as stated above, both government intervention and market strategies may be followed. One of the main objectives of a transition is (ideally), not just making the economy independent, but also making it sustainable in the long-run. A combined, innovative approach that addresses several of these issues comprehensively, may be a plan.

The goal of a market economy is inclusiveness and equality, and therefore, self-sustenance. A better way to put it would perhaps be, a market economy is ‘where one gains without the other losing’. Nevertheless, one of the looming demerits of such an economy is that there is a chance that there are imbalances of wealth, opportunities and performance.

Debt-stricken Worries

Known for its brilliant debt management strategies, China, one of the most influential economies of the world, now is in the shackles of more debt. As of April 2016, corporate debt in China is 160 percent of GDP, and is only going to rise, according to the IMF. This has been predicted so, because of the increasing number of firms that are coming under the purview of ‘risky’ or ‘high-risk’ category of firms.  Non-performing loans (NPLs) had been managed by China back in 1999, by creating asset management companies, which purchased state-owned banks, with 10-year government bonds. Writing off these bonds had been easier in 2009, because of their value decreasing from 20 perc of GDP to less than 5 perc of GDP. However, with the global financial crisis hitting China, the 10-yr bonds were rolled-over to another 10 years, they being potentially reckoned in 2019. However, the NPLs and the debt overhang faced in the aftermath have been huge. Though the plan was to shrink this huge debt overhang by a further percentage, making it more manageable.

A recent estimation by IMF states this much at risk, as far as China is concerned: 15 perc of Chinas overall commercial lending and banking sector losses of more than 7 perc of GDP; this, in essence meaning that NPLs will rise.

IMF points out that one debt management method may be conversion to equity. How much this method will help in reducing NPL stress is a substantial question. The method has been a popular one in the last few years. Debt to equity conversion is perhaps the first welcome step in tackling NPLs in several financial systems. But, when the corporates involved are already in distress and are non-viable or vulnerable, conversion to equity will only entail more risk to the investors. For example, when this method was sought for in India, market capitalisation of firms in the vulnerability or known stress levels of the considered corporates was at an average of 90 perc.

Part liquidation, and part shareholder ownership would probably suit the existing conditions. Rating companies on the basis of stress, and deciding on liquidation and/or equity ownership will reduce the stress on investors. Getting an outside management team to oversee the functions, performance and profitability of the managed companies would further boost investor confidence.