China: The Reform Trap.(Point of View)(China's economy)

Free-market reforms have unleashed growth--but have eroded Beijing's control over its economy.

Last month Chinese revelers welcomed the new lunar year with a few more candles than usual. The country was gripped by California-style blackouts across the central and southern parts of the country. Power plants could not keep up with demand, especially because they didn't have enough coal on hand to burn. The immediate causes of China's power crisis are straightforward. Snowstorms disrupted the railroads that carry coal to power plants. Record low temperatures also boosted demand for electricity and coal. But there was a deeper cause at work. China's free-market policies have unleashed extraordinary growth in the past decade--but have eroded the government's ability to control economic activity, which is shifting by design away from state-owned enterprises and central planning. With no way to control firms it doesn't own, Beijing is less and less relevant to what's really going on in the economy, threatening to turn China into a "weak state." The phenomenon is a dark cloud on the Asian century.

If this all sounds abstract, consider that China's blackouts were mainly a byproduct of the government's struggle to manage the planned and market-based parts of the economy side by side. Today, the Chinese leadership is worrying about inflation, but they have few useful tools to slow the rise in prices. A few years ago, Beijing might have dampened industrial growth by closing the spigot of finance from state-owned banks. But many newly deregulated state enterprises, as well as new privately owned firms, have found other sources of capital, including caches of massive profits accumulated over the years. One of the few industries Beijing still controls is the power grid--from generators to distributors--so it tried to quell inflation by lowering electricity prices.

The energy sector, however, is bigger than just electricity generation and distribution. It includes the coal industry--the main fuel for power plants. In 2006, market reforms lifted coal price controls and allowed suppliers and buyers to negotiate their own terms. With electricity demand skyrocketing, coal prices rose. Since Beijing still caps the price of electricity, power plants could not pass these costs to the consumer. They responded by cutting back on coal orders, which forced them to cut power output, and before long the lights went out.

Beijing's lack of practical control over large swaths of industry explains an increasing number of China's woes. The environment is another case in point. The government has an elaborate apparatus for environmental regulation, with strict laws on the ...