China’s New Reforms in Theory and Practice

Read Time:5 Minute, 0 Second KONG – On November 12, the Third Plenary of the 18th Central Committee of the
Chinese Communist Party (CCP) announced a major turn to market-oriented policies:
interest-rate and currency liberalization, reform of banks and state enterprises,
clearer land ownership for rural inhabitants, and a better deal for urban migrants.

Behind this landmark decision was a potential crisis. China’s success has been
driven by cheap exports based on cheap labor, infrastructure built by state
enterprises with low-cost bank funding, and government budgets funded by land sales.
But labor is no longer cheap, road construction to connect major cities has given
way to building large shopping malls in small towns, and land sales based on
rezoning are reaching both economic limits and the limits of villagers’ tolerance.

Cheap money with limited investment outlets now risks fueling property bubbles and
industrial overcapacity. Without fundamental change, China faces slower economic
growth, inadequate job creation and innovation, and popping bubbles.

The solution is a rapid shift from China’s export-based growth model to one based on
domestic demand; from infrastructure to consumption; from the dominance of large
state-owned enterprises (SOEs) to that of small and medium-size private enterprises;
from industry to services; and, more broadly, from bureaucratic control to market

All successful Asian countries have made this shift; South Korea and Taiwan are
models. But rapid change entails immense pain. SOEs will lose their low-interest
loans, subsidized land, monopoly protection, and privileged housing. Party and state
bureaucracies will lose power (and income).

Local governments are particularly desperate. They have huge debts, which they
amortize by rezoning and selling land. Already squeezed by exorbitant property
prices and popular resistance to land takings, they now face higher interest rates,
property taxes, villagers empowered by stronger rights, and expensive new
requirements to provide social services to migrants. The desperation of local
potentates and SOE executives has created powerful resistance to reform.

At a plenary reportedly marked by acrimony, China’s political leaders sided with
reform. As one economic planner said, when asked about resistance before the
decisive meeting, “In the end, all of our leaders understand numbers. The
implications of the numbers are clear.”

The Third Plenum’s announcement of its decisions took the form of a statement of
broad principles, leaving many observers concerned by the lack of detail. But the
CCP’s role is to set the direction of policy; executing the Party’s decisions is the
government’s job. And the Plenum did establish a top-level group to coordinate and
enforce implementation of its decisions.

While implementation will be a long struggle, with occasionally fierce resistance,
key reforms are already underway. The current 12th Five-Year Plan calls for annual
wage increases to average at least 13.4%; this year, wages are rising at an average
rate of 18%, which will squeeze out industries characterized by obsolescence or
overcapacity. Moreover, the government’s anti-corruption campaign is targeting some
of the most powerful industry groups, such as the petroleum faction, thereby
weakening their resistance to reform.

Most important, economic outcomes are becoming increasingly aligned with the
authorities’ goals. Services already account for more output and employment than
industry – the Internet company Alibaba, for example, is empowering both consumers
and smaller companies on a previously unimaginable scale – and recent growth has
been driven by domestic demand rather than net exports. Reform is not just a plan;
it is already happening.

Economic openings to Central Asia and to ASEAN (specifically to Vietnam) are well
underway, and reform will include further international opening. The Third Plenum’s
decisions follow the launch in September of the Shanghai Free-Trade Zone, which will
open new sectors to foreign investment and permit largely market-based financial
transactions and capital flows. The liberalization of capital flows is intended to
be a gradual national policy, channeled through trusted institutions in Shanghai.

For trade in goods, the new free-trade zone is intended to compete directly with
Singapore and Hong Kong. China fears dependence on those entrepôts in the event of
conflict. For foreign investors, the policy will be to expand greatly the range of
opportunities while curtailing foreign control; foreign companies, for example, may
hold minority stakes in the telecoms sector, while dominant foreign companies like
Monsanto will face constraints.

President Xi Jinping faces the politically risky task of pushing the CCP’s reform
agenda against fierce opposition while the economy slows. By emphasizing Party
control – through a crackdown on SOEs, government opponents, and critics in the
media and academia – Xi seeks to maximize his ability to impose economic reforms
while minimizing the risk of a challenge from conservative forces.

Above all, he is determined to avoid the fate of previous Chinese leaders like Hu
Yaobang and Zhao Ziyang, who lost their jobs after a critical mass of their
opponents came to believe that economic and political reform jeopardized Party
control. So, at least for now, China will focus on another great wave of economic
reform, whereas political reform will mostly be limited to reorganization of
government agencies to boost efficiency and strengthen efforts to reduce corruption.
(There have been some steps toward reform, including a decision to remove judges
from local political control.)

And yet China will find it increasingly difficult to postpone stronger measures that
would appease popular demands for fairness, including the establishment of an
independent judiciary, which could prove to be no less an imperative than structural
economic reforms. Likewise, the leaders must either accept much of the information
revolution’s swamping of controls or engage in far more costly repression.

Hopes for political reform rest on the possibility that Xi’s second term will see
the accession to top leadership of reformers like Politburo member Wang Yang and
Vice President Li Yuanchao. For now, however, China will focus on another great wave
of economic reform.

William H. Overholt is a senior fellow at the Fung Global Institute and the
Harvard University Asia Center.

Copyright: Project Syndicate

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