Chinese President Xi Jinping, right, shakes hands with Treasury Secretary Jack Lew before a meeting at the Great Hall of the People in Beijing on Tuesday. (Saul Loeb/Associated Press)
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OF ALL the threats facing the global economy, none has more destabilizing potential than China’s decelerating growth rate. After years of booming by exporting and investing, the People’s Republic has begun accumulating debt and excess industrial capacity; yet the Communist leadership in Beijing seems unwilling or unable to make the necessary transition to greater reliance on services and domestic consumption. China’s bloated state-run industries, especially steel and aluminum, are desperately trying to raise cash by flooding the United States and Europe with cheap products, a global fire sale that threatens jobs in those countries, triggers retaliatory measures — and adds to geopolitical tensions already high over the maritime boundary dispute in the South China Sea.

The United States and China this month concluded their annual “strategic and economic dialogue” in Beijing, and Treasury Secretary Jack Lew took the occasion to warn his hosts in terms that were relatively blunt, by the standards of such confabs. “Excess capacity has a distorting and damaging effect on global markets,” he said, and “implementing policies to substantially reduce production in a range of sectors suffering from overcapacity, including steel and aluminum, is critical to the function and stability of international markets.” In response, China pledged “to undertake further steps,” even as senior officials protested that they shouldn’t be blamed for overcapacity because it resulted from China’s stimulus spending during the global financial panic in 2008 — for which it was praised by the United States and Europe.

Beijing has a point about that; indeed, some state factories and mines have downsized in recent months, laying off thousands. No one should doubt the sheer difficulty, both economic and political, of restructuring the vast Chinese economy — or that U.S. domestic political interests are behind the Obama administration’s demands, just as the Chinese complain.

Nevertheless, those U.S. demands are legitimate, and the proof is that Beijing itself has repeatedly acknowledged the need for a new economic model, based more on private-sector investment and private household demand. But entrenched special interests enjoy privileges under the existing system and resist and undermine reform, with alarming success. Meanwhile, President Xi Jinping steadily reduces the space for political debate in China, which decreases his government’s legitimacy, which makes it all the harder to disarm the special interests.

What leverage does the United States have beyond words such as Mr. Lew’s? More than you might think. China badly wants to be recognized as a “market economy” by the World Trade Organization. This designation would entitle Chinese export industries to greater legal protection from WTO-authorized retaliatory trade measures by the United States and Europe, thus relieving some of the pressure on them to restructure. Beijing claims that, under the 2001 agreement by which it joined the WTO, the “market economy” designation should happen automatically at the end of this year. The United States and many of its Western allies are balking, because they don’t share China’s view of the law, because they don’t want to give up this particular source of clout — and because China is not, in fact, a market economy.

The Obama administration should not yield on this point, unless and until China shows irreversible progress on economic reform, including, specifically, its subsidized excess industrial capacity. For the sake of prosperity in both countries, it’s a fight worth having.

Read more on this topic: The Post’s View: ‘Authoritative’ pessimism in China Fred Hiatt: China’s lawless path David Ignatius: The U.S. is heading toward a dangerous showdown with China Joshua Kurlantzick: Let China win. It’s good for America.