Customers shop at the Hennes & Mauritz store during the chain's debut in Beijing on April 23. While China's economy is expected to rebound from its slowest growth in almost a decade, economists see new challenges in the aftermath of the global economic crisis. Bloomberg News

There are three big stories about the Chinese economy now. One is that China is performing well compared to the rest of the world during the current crisis. The second is that the driver of growth in China is shifting to poorer inland provinces so China can maintain momentum. Finally, there is danger of reform complacency - even without the crisis, growth in China will gradually slow and the government needs to redouble efforts to implement its economic reform plans.

Economic policy makers around the world are facing an enormous problem, something beyond unemployment, the collapse of world trade or the severe damage to the global financial system.

Policy makers are so distracted by the short-term downturn in the economy that we are getting little focus on real reform to boost long-term growth. It is understandable that politicians want to act quickly to arrest the rise in unemployment, but short-term stimulus measures cannot last. Repairing financial systems is crucial, but governments need to do more than just repair damage and sit back waiting for the next wave of innovation.

China is caught up in this problem. It is relatively well placed in that it has been less severely hit by the global crisis and policy makers here do have a reform plan that while not perfect, has at least been well thought through. On the downside, China's reform challenges are larger than most other countries, reflecting its rapid transition from a planned economy and in its aging population. Like everywhere else, implementation of reform has taken a back seat while policy makers focus on short-term stimulus measures.

Outside China, the global preoccupation with climate change policy has had an unintended side effect of reducing the attention policy makers pay to measures to boost long-term productivity. So the worldwide economic reform effort is now dangerously weak and the inevitable result will be poorer growth in coming decades.

Focus of global growth

China itself is looking very good at the moment compared to the rest of the world, but that should not give rise to policy complacency. Its true China has quickly become the focus of global growth. Most of the rest of world is now in severe recession. India is still growing only a little slower than China, but it is a much smaller economy. Although China is not yet big enough to pull the world out of recession it is helping. This development is not an aberration. There is a long-term trend that began before the crisis where the center of gravity in global growth was shifting to China, and within China it is shifting to the poorer inland provinces.

Governments need policies to ensure growth reaches its full potential and business needs. Geographically the opportunities will be focused on China as its domestic market grows and the poorer inland provinces undergo the investment booms that have transformed the coastal regions.

This is illustrated by the fact that global industries hard hit by the current downturn - such as cars, tourism and banking - are still doing relatively well in China. While trend for growth in China will slow over the next decade, it will do better than the developed world.

The Economist Intelligence Unit recently boosted its capacity to provide forecasts on China by developing econometric models for every province of China integrated with our global forecasts. This project clearly shows that the time has passed to treat China as a single market - individual provinces are now behaving quite distinctly.

Why is China an oasis of growth in the world at the moment? China's financial sector is intact. China is not an export led-economy, although the export sector is still very important. Domestic demand, particularly real estate investment, is the key to China's economic cycle. Monetary stimulus is working. Fiscal stimulus is focused on investment that will bring returns, and the recently unemployed are adaptable and motivated.

China will recover later this year. It won't be a return to boom times next year as net exports and the winding down of stimulus will be a drag on growth. But construction should drive a recovery.

For the short term a key issue to watch is the exchange rate. If the US dollar continues to weaken and drags the Chinese currency down with it, China will need to act decisively to resume a path of appreciation. This is particularly important to send a signal to businesses in China that the government will not artificially prop up the export sector and that a stronger exchange rate will encourage domestic consumption by reducing the cost of imports.

Slow long-term growth

For the longer term China has many decades of strong growth ahead, but it will slow down from the fast rates of a few years ago. China's rapidly aging population will moderately reduce growth rates, and as China becomes richer it will become harder to generate fast growth.

China needs to speed up implementation of policies to boost productivity to partly offset this long term slowing of growth. China's long-term reform needs include health, education, the financial sector and State-owned enterprises.

The State-owned sector is particularly tricky. On the one hand China is still committed to maintaining dominance of the State sector, but it is clear from the statistics that the private sector generates most of the new jobs in China and gives a better return on investment than the State sector. For a government concerned about unemployment and boosting productivity, all signs point to the need for a stronger and larger private sector. That said, China can still undertake major market reform of its State-owned sector short of privatization. The government should extract significant dividends from State-owned enterprises (SOEs) - particularly important given the fiscal challenge of an aging population - to make them use their capital more efficiently. The CEOs of SOEs should also be given full authority to hire and fire staff based on performance.

The education sector in China is puzzling, particularly given China's traditional cultural emphasis on education. China has by international standards a very low proportion of the population in tertiary education, and yet there are constant reports of rising graduate unemployment. There appear to be problems with the quality of the system in terms of delivering the right mix of workplace skills. Once again greater private sector competition should be experimented with. China already has a vibrant market for private education, so why not let the private sector establish new universities and expand vocational training options? As China's workforce begins to shrink, China will need to raise the productivity of its workers through better education.

China should use the global economic crisis to accelerate much needed reforms at home and to urge other countries to press ahead with market liberalization. Around the world real economic policy reform has been sidetracked by the focus on short-term stimulus and poorly informed debates on climate change.

G20 leaders mouthed concern about protectionism while at home some of them promote policies to restrict foreign competition and even launch ideological attacks against capitalism. Globalization and free markets cannot be taken for granted. China's leaders can still remember how bad the economy can become when free markets are suppressed, and should continue to urge leaders elsewhere to push on with liberalization.

The author is director of China Forecasting Service, Economist Intelligence Unit, the UK-based Economist Group

(China Daily 06/22/2009 page5)