China’s Communist leaders like to point out that American-style democracy is chaotic, and that western capitalism causes manic booms and busts. Yet they’re borrowing heavily from the American playbook as they remake China’s huge, state-dominated economy.

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China recently announced a series of reforms meant to speed the transition from a fast-growing yet still-spottily developing nation to a wealthier and more mature economic powerhouse. Among other things, new policies are meant to scale back Beijing’s role in the economy, open state-run industries such as finance and energy to more private businesses, and provide more ways for foreign investors to participate in the Chinese economy. Eventually, market forces would set interest and exchange rates, which are now controlled by the government.

Chinese companies--often owned or partially controlled by the government--have also been splurging on western firms lately. Chinese meat processor Shuanghui International Holdings announced it is buying Smithfield (SFD), the big U.S. pork producer, for $4.7 billion. And the Chinese investment firm Fosun International is part of a group buying the French resort company Club Mediterranee (CU.PA), allowing the troubled travel firm to focus more on upbeat Asian travelers rather than Europeans besieged by recession.

China has tried before to liberalize its economy, with varying degrees of success. It has clearly become integral to the global supply chain, making it the world’s leading producer of many goods. Virtually every big multinational company has operations in China, with some of them earning impressive profits there.

But China still remains handicapped by shortcomings more typical of a banana republic. “There’s no guarantee China is truly going to become a developed economy along the lines of South Korea or Japan,” says Nariman Behravesh, chief economist at forecasting firm IHS Global Insight. “For China to continue to evolve, they’ve got to make some major changes and become a freer, more market-based economy.”

The government's role

The Chinese government’s role in the economy makes Washington look like a laissez-faire paradise. It controls banks, railroads, oil companies and many other conglomerates, using those companies to advance what it feels are national priorities. By managing a quasi-capitalist economy more closely than other governments, Communist party leaders are able to harness wealth creation for political purposes.

But state-run capitalism can also cause major disconnects between supply and demand, along with other distortions that undermine the whole economy. China, for instance, lacks many of the legal protections consumers and businesses have long demanded in the West. Theft of intellectual property is rampant, which makes many western companies reluctant to develop new technology or do proprietary research in China. That’s why the nation is considered far better at stealing other people’s ideas than generating its own.

Corruption within the ruling Communist party is widespread, leading to deep distrust of the government. Choking industrial pollution is the dirty little secret of a muscular manufacturing sector. Wrenching poverty is common in the countryside, where pre-industrial subsistence farming still sustains millions.

An exaggerated 'might'

Few outsiders see those problems, however, which might explain why Americans have an exaggerated sense of China’s economic might. In polling by Pew Research, 42 percent of Americans said China is the world’s leading economic power, compared with only 36 percent who said the United States is. Yet China’s GDP per capita is just $9,100, which ranks 122d in the world. U.S. GDP per capita is $49,800, tops among large countries (unless you include Norway and Switzerland). The size of China’s economy could eclipse that of the United States in a few years, yet even then China would be nowhere near as rich as America.

China’s leaders realize that, which is why there’s an aggressive new push to embrace reforms Western experts have been advocating for years. Some economists argue that China is heading for an economic phenomenon called the “middle-income trap,” in which fast-growing economies suddenly stagnate, unable to evolve beyond a seemingly fixed level of prosperity. China may be encountering that now. After several overheated years when China’s GDP grew by more than 10 percent per year, growth has fallen back to less than 8 percent. Some economists think it will fall further as efforts that worked economic miracles before – such as massive government-financed infrastructure projects — enter a phase of diminishing returns.

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