HONG KONG: The current meeting of China's National People's Congress has shown a leadership that is pragmatic and aware of the challenges confronting China. But the meeting has also underscored China's political and economic contradictions, which make it difficult to address acknowledged problems.

Overreaction by Beijing to democratic sentiments in Hong Kong and Taiwan, for example, risks foreign-policy problems as well as alienating "compatriots" in both places. At the congress, President Hu Jintao and Prime Minister Wen Jiabao have used cautious, moderate language that was favorably noted in Taiwan and Hong Kong. But it contrasted with the "patriotic" and threatening bombast from others, notably those whose views have found a ready outlet in Xinhua, the official news agency. The leadership has been undermined by those who are anxious, for whatever reasons, to emphasize nationalistic issues.

The need to keep the military and nationalistic interests happy was reflected in the state budget, which provides for an 11 percent rise in defense spending while overall outlays have been held to a tight 5 percent increase.

Fiscal rectitude makes macroeconomic sense at a time when the economy has been overheating, thanks in part to massive public infrastructure as well as other investment spending. But it makes less sense in the context of the government's expressed desire to address income inequality.

China has been frank in admitting that it now has the world's worst urban-rural income gap. But it is taking a very incremental approach to addressing the problem. Taxes on farmers will be reduced, but only gradually. Freedom to migrate to the cities is being increased little by little, so as not to upset existing urbanites. More money will go to infrastructure and education in disadvantaged areas, but within the limits of a tight budget.

The National People's Congress provides a safety valve for a moderate level of discontent and gives the leadership an opportunity to show that it is not complacent. But power resides in the cities, and particularly in large, high-profile ones, such as Shanghai. They continue to receive, in one form or another, whatever resources they want, for Olympic stadiums, opera houses and state-of-the-art transit systems, as well as easy credit for favored new industries. The skewing of the economy is a direct result of the skewing of political and economic power.

It is not just the rural majority that is paying the price for skewed development. So, too, are workers in labor-intensive industries. Their low wages have helped the development of export and high-technology industries, which have led to the amazing development of a high-income urban services sector with a high savings rate. This, in turn, together with foreign capital, has financed China's investment boom.

But development has been excessively capital-intensive. Credit, distributed mostly by state banks, has been poorly invested in low-yielding projects in manufacturing and real estate. The implicit subsidies for foreign investment in high-tech enterprises, such as computer chips, are paid for by lower-tech industries and farmers.

For the past two years, investment has been growing at three times the rate of retail sales. The government badly needs to see investment fall to sustainable levels, and incomes rise to create consumer demand. But it is having mixed success in reining in credit, which is still too wedded to headline growth in gross domestic product. Credit is also too closely linked to export growth for the government to be able to revalue the yuan, which would help consumers offset the impact of fast-rising commodity prices, or push for higher wages.

China's unusual combination of party political power, state-controlled banks and business-minded officials has enabled rapid development but has stored up future problems, in banking and the environment, for example, as well as appalling income distribution, which Beijing has yet to address rigorously. Even China's vaunted use of foreign reserves to recapitalize its banks is a dubious accounting device, not a cure for the lack of an open, market-driven credit system.

That is not to understate China's extraordinary progress in many fields. As Brazil showed in the 1960s, two-speed economies driven by infusions of capital into the modern sector can be successful for extended periods. But the leadership's realistic analysis of problems is not matched by policies designed to achieve balanced growth. Nor does the latest bout of foreign "irrational exuberance" about investment prospects in China help the leadership keep its feet on the ground and its over-confident nationalists on the leash.