AFTER a summer of tumbling stockmarkets and gloomy data, the Chinese economy has the rest of the world on edge. The value of imports sank by 14.3% in August year on year, reinforcing worries that a sharp slowdown is under way. Those years of double-digit growth are firmly in the past. The question many ask is whether China can find a new model of growth to replace the old one. The good news is that it already exists. It is called the private sector. In our special report in this week’s issue we show how the private sector has created almost all new urban jobs in the past decade, and now employs about four-fifths of urban workers. Average growth in output at private industrial firms since 2008 has been double that seen at state-owned enterprises (SOEs). The returns on assets at private firms are higher than those at SOEs, where they are below the cost of capital. The country’s manufacturing sector, which is almost entirely controlled by private firms, remains the world’s most formidable: China’s share of global exports rose from 11.5% in 2011 to 14.3% in June.

Important as private firms already are, the onus on them to propel China’s economy forward will only grow, for three reasons. The first is China’s transition away from investment-led growth and towards consumption-led industries and services. SOEs have been central to China’s long investment boom: they account for perhaps a third of capital spending, against a figure of 5% or less in most rich countries. Consumer industries, by contrast, are the province of world-class private enterprises such as Tencent, an online-gaming and social-media giant, and Xiaomi, a smartphone trailblazer.

Second, China needs to become more inventive. McKinsey Global Institute, a think-tank, reckons that, if China is to sustain annual growth of 5.5-6.5% until 2025, a third to a half of this increase must come from improvements in total factor productivity—essentially, innovation. China’s nimble entrepreneurs are brilliant at coming up with new products and services to cater to exacting consumers: a Chinese firm commands half the burgeoning global market for commercial drones, for example. Chinese businesses are also good at business-process innovations designed to increase efficiency.

The third reason for thinking that private firms will become more central is that China’s debt-driven growth model is sputtering. The SOEs are the channels through which much official credit has been shovelled into the economy, often aimed at white-elephant projects. The average debt-to-equity ratio at state firms is roughly 1.6; at private firms it is below 0.8. If China is to keep growing fast, credit will need to be withdrawn from state-owned zombies and directed to flourishing private firms.

China’s leaders know all this, of course. The lash of competition is what turned Chinese exporters into world-beaters. Officials have publicly vowed to give markets a “decisive role” in the domestic economy, too. The problem for them is that, if China Inc is fully to realise its potential, the Communist Party must ease its grip. The tension between liberalisation and control has long existed—successful private firms themselves carefully cultivate good relations with the party. But the slowdown has sharply raised the cost of sacrificing output for dominance.

Brain not brawn

Take innovation. China’s central planners are spending more than $200 billion a year on R&D, and want to triple the number of patents awarded in China by 2020. But patents and PhDs get you only so far. If world-class innovation is to flourish, private companies must have access to the best ideas and the brightest people in the world. Yet the party ultimately controls what is taught at the country’s universities, and state censors routinely block access to international websites and useful collaborative tools like Google Docs. China also makes it too difficult for foreigners to immigrate.

It is a similar story in other areas. The government has embarked on much-needed reform of the SOEs, of China’s legal regime and of the country’s financial system. But conflicts, compromises and questions abound. On SOEs, the details are fuzzy but reports this week suggest that the government is minded to split firms into two camps, one commercially oriented and the other focused on something vaguely defined as the public good. The real problem is that vested interests inside the SOEs parry reform. Even if the proposed changes were fully implemented, they do not go far enough. The leadership is still loth to see any state-owned firms go bust, for example.

On the rule of law, the government wants to curb the meddling of city and provincial party officials in local courts. That is welcome, yet China’s legal system and courts remain subservient to the party. On financial reform, interest rates are being liberalised and internet finance is vibrant, but what investors will remember from this summer are the bans on selling shares and the investigations into market participants.

If China is to sustain strong growth—and with it the high employment that buttresses social stability—the only option is to encourage more enterprise and innovation. Such dynamism will not come from stodgy state firms. It can be generated only by the China that works.