Why China’s Reforms Aren’t Enough

CLAREMONT, California—As U.S. Vice President Joe Biden visits Asia amid growing tensions between Beijing and Tokyo, another possibly more important development in underway in China. In mid-November, the third plenum of the Central Committee of the Chinese Communist Party (CCP) endorsed a blueprint of economic reform. At first glance, it is a bold step forward. After a year in office, Chinese President Xi Jinping has finally produced an action plan that, if fully implemented, should transform the Chinese economy.

The document not only endorses the principle of allowing market forces to play a decisive role in allocating economic resources, but also announces several major social and administrative reform measures. For instance, the system of “reform through education,” which has been abused by local authorities to lock up protestors and minor offenders for up to three years without judicial review, is set to be abolished. The infamous one-child policy will be relaxed, although not eliminated. And rural migrants will be allowed to obtain full residency rights where they work and will have access to public services in small towns and cities, although not in medium-sized and large cities for now.

But even as Xi is to be applauded for his political courage in formulating this bold plan, there are limitations and difficulties involved in translating reform rhetoric into specific policies and outcomes. The plenum’s outcome represents a political compromise among competing interests in the CCP. The plenum’s final document leaves several critical reforms unaddressed, imposes substantial limits on some announced measures, and lacks specifics and a timetable.

The issue that is most conspicuous by its absence is the reform of state-owned enterprises (SOEs). While SOEs’ corporate governance should be strengthened and they will increase their dividend payment to the social security fund by 30 percent over the next seven years, they will essentially continue to enjoy their monopoly protection and access to various subsidies. Maintaining the special status of the SOEs both contradicts the spirit of allowing market forces to allocate resources and dilutes other reforms. Obviously, SOEs will make it harder for private firms and foreign companies to compete on a level playing field. To the extent they keep their monopolies and access to cheap capital, they will hamper China’s efforts to make its economy more productive and innovative.

Another critical short-term macroeconomic issue that is omitted is local government debt, which is estimated to have reached around 20 to 25 percent of GDP. Because local governments have no capacity to pay such debt, Beijing should have announced a plan of financial deleveraging and bank recapitalization to reduce the anxiety prevalent in the market that this mountain of debt will trigger a financial crisis. But this tough issue was left totally unaddressed.

Other decisions — including the relaxation of the one-child policy — arguably do not go far enough. The new regulations allow couples to have a second child if one of the parents is an only child. This decision will, at best, have a modest impact on boosting births (by about 1 to 2 million new births a year). Given China’s dire demographics, Beijing needs to go further. Similarly, the reform of the urban residency system is too cautious. Since most migrants now work in medium-sized and large cities, giving them residency rights in only small towns and cities, while helpful, provides limited help in boosting their real incomes and social status.

The most troubling aspect of the plenum’s final document is its lack of specifics and a timetable. While it is understandable that such a document cannot spell out every specific policy, many of its principles and guidelines are too vague and subject to varying interpretations. Not announcing a timetable reduces the plan’s credibility and raises its uncertainty. The Chinese bureaucratic system is a gigantic discounting mechanism: the good intentions of its leaders are progressively and significantly watered down as they are turned into policy and implemented at the lower levels of the government. By not providing specifics and a timetable, decisions are likely to be sabotaged by bureaucratic subterfuge in the process of implementation.

It is not too late for Xi, whose political fortune is now tied to the reform package, to devise a separate political strategy to ensure the success of his plan. Relying on China’s bureaucracy to reform itself is a hopeless proposition since the bureaucracy represents the entrenched interests that are the targets of his reform. To generate and maintain political pressure on these groups, Xi will need to mobilize the Chinese public and media as his political allies. To be sure, this strategy has real political risks, including possibly energizing conservative forces against Xi’s leadership. But without this strategy, a reform plan that depends solely on the compliance and cooperation of members of privileged groups has a slim chance of success. Xi has raised hopes, but the real test of his plan is yet to come.

Minxin Pei is a non-resident senior fellow with the Asia program of the German Marshall Fund of the United States.

 

The views expressed here are the views of the author alone and do not necessarily reflect the stance of the German Marshall Fund of the United States.

  • samir01

    Another critical short-term macroeconomic issue that is omitted is local government debt, which is estimated to have reached around 20 to 25 percent of GDP.