The government of China said this weekend that it will take steps to address the country's extreme pollution problems. Years of rapid industrial expansion have left many parts of the country contending with thick smog and dirty water. This move comes at a time when China is trying to shift away from the investment-led model that has generated huge growth over the past two decades. But the global economic downturn has made the transition a lot more challenging.

Here's NPR's Jim Zarroli.

JIM ZARROLI, BYLINE: At a time when much of the world is mired in economic torpor, China still enjoys enviable growth rates. And yet there's no question that its economy is growing more slowly these days. Just ask Yan Liwei, a salesman for a construction materials company who was visiting a park in Shanghai this weekend.

YAN LIWEI: (Through translator) The number of new construction projects is declining somewhat. It's taking longer for many of our clients to pay us what they owe. Many small and mid-sized developers are feeling a cash crunch.

ZARROLI: This slowdown is partly due to the global economic downturn. But economist Michael Pettis of Peking University believes there's something more fundamental taking place. Pettis says China is at a stage in its economic growth that every fast-growing country eventually reaches.

Three decades ago, China was badly underdeveloped and to catch up with other countries it had to pour vast sums of money into roads, bridges, office buildings and factories. This meant dizzying rates of job creation and growth. But eventually Pettis says all this building reaches a point of diminishing returns.

MICHAEL PETTIS: When that happens, the investment ends up becoming not so much wealth creating but in many cases wealth destroying. In other words, the increased productivity generated by that investment is less than the cost of the investment.

ZARROLI: At this point, Pettis says, countries like China need to fundamentally change their growth strategy. They need to stop building all those roads and shopping malls.

PETTIS: So if you want to rebalance the economy, you have to sort of kill the engine of all of that growth.

ZARROLI: Instead, Pettis says that if China is to keep growing, its growth has to come from consumption. It needs to make a whole lot of policy steps that will make it easier for Chinese people to spend money, like raising wages, or eliminating residency laws that penalize people who move. Pettis says this kind of fundamental change in economic direction is very difficult to pull off.

PETTIS: The transition period for every country that's gone through this process has been politically very, very difficult. And quite frankly, very few countries have gotten through this phase successfully.

ZARROLI: The good news is that China knows it has a problem and is trying to do something about it, says economist Eswar Prasad of Cornell University and the Brookings Institution. It has tightened credit to slow down the construction of all those office buildings and shopping malls. But Prasad says with the global economy so vulnerable, China can't afford to try anything too risky.

ESWAR PRASAD: The Chinese government is facing this very delicate balance. They know that the way they're growing right now is creating some problems, but if they slow down the growth, all of those problems come and hit them in the face right away.

ZARROLI: Prasad says there's another problem. A lot of Chinese companies depend on the flow of easy credit to stay afloat and he says they're likely to fight any effort to change the system. In fact, the reform efforts have led to vicious infighting among political and business interests.

PRASAD: The system, as it is structured right now, works really well for the large state-owned enterprises, the large banks, and for many provincial governments. And these are all politically very powerful. So they have every incentive to maintain the status quo and not change anything.

ZARROLI: In the face of this opposition, China seems to have backtracked a bit, recently easing credit conditions again. Economist Todd Lee of IHS Global Insight doesn't believe China's leaders have shown the resolve they need to tackle the big problems.

TODD LEE: What they really need to do is to continue push through the next wave of significant structural reforms, and they haven't done that.

ZARROLI: Still, China has navigated its way through the global economy with considerable success in recent years. Now it needs to find a way to change course and do so once again. Jim Zarroli, NPR News.

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