A Chinese pressure cooker heats up

Tensions between the United States and China have again flared, as Washington ramps up the pressure on Beijing to use the upcoming shift in its political leadership to radically alter its economic policies.

In Davos last Friday, US Treasury boss Timothy Geithner attacked the Chinese economic model, saying that although it had become more of a market economy, it remained "overwhelmingly dominated by the state”. He added that China's policies, such as subsidising energy and land prices, and providing companies with preferential access to capital, had been "very damaging” to its trading partners.

It was, he said, "very important that we get China to move comprehensively, not just on the exchange rate but on dialling back its subsidies and distortions.”

His comments echoed previous criticisms made by US President Barack Obama, who used his State of the Union address to attack China for violating US intellectual property rights, and for unfairly subsidising its manufacturing industry. He also announced plans to set up a US government task force that would monitor China for possible trade and commercial breaches.

The strident US criticisms come just weeks ahead of an important US visit by Chinese vice president, Xi Jinping, and as China is about to embark on a once-in-a-decade transition in its political leadership.

Towards the end of this year, Chinese President Hu Jintao is due to retire. Washington wants to make sure that the 58-year old Xi – who is in line to become China's new top leader – is acutely aware of the mounting US frustration with Chinese policies.

But the US isn't the only critic. As China gets ready for its leadership transition, there is a growing chorus of economic reformers within China itself who are calling for a major shift in economic policy.

Reformers argue that large state-owned enterprises are given preferential treatment by China's state-owned banks, and have little trouble tapping loans at extremely low interest rates. As a result, they often make wasteful investment decisions.

Meanwhile, smaller and medium-sized companies have to scramble to raise funds, and often pay exorbitant interest rates in the shadow banking system. Due to this trend, smaller private firms which are typically more innovative and labour-intensive than large corporations are being squeezed.

But this is sapping the overall vitality of the Chinese economy, and leading to lower growth and employment rates. According to reformers, China will only be able to maintain strong economic growth rates if it acts decisively to reduce the power and dominance of its big state-owned enterprises.

As a result, both the US and China will be closely scrutinising Xi's visit to Washington later this month in the hope of gleaning some indication of his commitment to reform.