Two main reasons drive the calls for rebalancing: the first is that China’s surplus labour era is closing rapidly, thanks in part to its fertility policy, and so a transition is inevitable that will require good policy to avoid disruption. Second, slower European and North American growth means that there is no longer the global market for such rapidly expanding manufactured exports from what is now a large global player.

So the Chinese are turning to the principal source of global growth, which is their own economy, to support their continuing strong performance. Yet looking inward for growth is harder than the model from which they are transitioning, requiring politically unpalatable economic reforms that have thus far been avoided. This unpalatability has, in other cases, led to policy failures and settlement into a ‘middle income trap’. Considering the role of Chinese growth in global economic performance, this outcome would be very undesirable indeed.

Of course, as developing countries converge with industrialised ones their growth rates slow naturally. They experience diminishing returns to physical and human capital that reduce incentives for ‘catch-up’ investments and often difficult economic policy reforms are needed to complete the final phase of economic transition. Such ‘natural’ slowdowns must be distinguished from those where premature stagnation occurs due to powerful vested interests that oppose the necessary reforms. So where are the vested interests that could retard China’s future growth?

The financial sector is one such place. Very high savings rates challenge the financial sector to allocate efficiently across investment opportunities. The protection of highly profitable state-owned financial institutions is to blame for many of the sector’s weaknesses.

Another priority is the extension of China’s industrial reform process into heavy manufacturing and services. State-owned firms in these sectors have been extremely profitable since WTO accession because they supply essential materials and services to an economy expanding rapidly, courtesy of its highly competitive light manufactures export sector. But these firms return little in the way of dividends to the central government. Instead, their earnings are reinvested. The decision to save or consume from this component of national income is consequently denied households, contributing substantially to China’s extraordinary saving rate.

Substantial future growth could stem from the redistribution of rents accruing in heavy manufacturing and services. Chinese intermediate products and services would be cheaper and this would foster overall output growth while raising the labour share of income and therefore private consumption. A number of approaches are possible, some of which are already being tried. Pure privatisation would return the profits of state-owned enterprises (SOEs) to private households and foster consumption, raising domestic demand for China’s goods and services. The fragmentation of SOEs forces more competition between firms and thus reduces mark-ups. And tighter regulation of SOE pricing could force firms to price nearer their average costs, substantially reducing rents and reducing the price level.

Alongside reforms in these specific areas of the economy, there is an urgent need for some more general policy improvements. Institutional development to support domestic innovation and human capital accumulation are especially important because they are the engines of steady growth. It is also urgent that the government address the undersupply of key public goods, such as facilities and regulatory institutions to support basic and higher education, transport and telecommunications infrastructure, retirement insurance, health insurance and environmental protection.

Compared with other developing countries, China is in the fortunate situation of having implemented a sensible tax law in 1994, which is accessing an increasing share of all economic activity. In other words, the central government’s tax revenue is rising faster than GDP. This feature of the Chinese tax regime explains why the 2009 stimulus package did not require a large increase in the fiscal deficit. A rise in government activity is feasible in this context.

Increased provision of public goods, including more open financial markets, would help expand China’s GDP by reducing the rate at which home income is spent on foreign assets and products, thereby bolstering aggregate demand at home rather than abroad.

Thus, with the impending end to export-led growth and conflicts due on the one hand to rising domestic inequality and, on the other, to growing resistance abroad to its exports, China needs a further stage of transformative growth that will maintain the pace of its catch-up and address its internal and external conflicts. Delivering this will be a tall order politically, but Chinese governments have overcome the constant political and economic challenges they have faced since the early 1980s. The fundamentals behind Chinese growth to date are sound and the obstacles to continued transformation are known to the government and its branches.

Rod Tyers is Winthrop Professor of Economics at the University of Western Australia and Adjunct Professor of Economics at the College of Business and Economics at the Australian National University.