China's Third Plenum reforms are well received


  • Business
  • Saturday, 14 Dec 2013

But, the new deal flashes danger signals

ON Nov 15, soon after the Third Plenum of the Communist Party of China’s Central Committee had completed deliberation on its massive document “Resolution concerning some major issues in comprehensively deepening reforms” (the Resolution), it published an impressive 22,000-worded blueprint of decisions for social and economic change over the next decade, unpromisingly entitled “Decision on major issues concerning comprehensively deepening reforms” (the Decision): its mission is to return the state to the golden era of wealth and power (fuqiang). Indeed, it attempts to resolve an ongoing contradiction: advance both power of the state and freedom of the individual. Hints of this direction in reform were already made known in the “383 plan” of China’s official think-tank (Development Research Centre of the State Council, i.e. China’s Cabinet). The symbol “383” reflects the plan’s contents: viz interaction among the nation’s three economic drivers – government, market and business; the eight major areas of reform-competition, governance, finance, fiscal, urban-rural divide, state-owned enterprises (SOEs), liberalisation and innovation; and finally, the inter-play of three inter-related objectives – inclusiveness, domestic-external balance, and eradication of inequality and corruption. True to its billing, the Decision pledged wide-ranging reforms.

Now for the action

I see at least four major breakthroughs. First, clarity on the relationship between the government and the market: to allow the market, in shaping the economy, to play a “decisive” role in allocating resources (as against just a “basic” role when it first adopted the socialist market economy in 1993), while letting the government play its part better. And so, the market will determine prices of key resources such as water, oil, natural gas, electricity and transport. In any event, government “should not make any improper intervention.” Indeed, the role of government is to be confined to maintaining economic stability, providing public services, guaranteeing fair competition, ensuring well functioning markets, and stepping in when there is market failure.

Second, the Decision elevates the private sector’s role in full recognition that both public and private sectors are important components of the socialist market economy. It is expected that business will be given bigger market access, and state monopolies will be held well in check.

Third, the urban-rural divide needs rebalancing, with a unified trading market for land to give farmers more proprietary rights to realise equal exchange of factors of production, achieve fair allocation of public resources, and promote healthy urbanisation.

Fourth, accelerate the pace of opening up, both internally and externally, through widening investment access, relaxing investment barriers (including a “negative list” to attract foreign players), accelerating the building of more free-trade zones, and rapidly expanding the opening up of inland and border regions to the outside world.

A major motive for SOEs to invest abroad, ironically, is to strengthen competitiveness at home. Competition from abroad will only increase in the domestic market if conditions improve for private investment, allow SOEs to acquire strategic assets and opens up new industries to foreign investment.

Leadership charts the path

To unlock the “middle-income trap” with its potentially explosive social and political consequences, the Plenum called for comprehensive deepening of reforms but reflecting “socialism with Chinese characteristics.” Among them:

1. Granting farmers their overdue property rights on collective land, making way for modern agriculture. They can now sell or mortgage village land.

2. Accelerating moves to let the market determine interest rates and exchange rate of the yuan which will eventually lead to its full convertibility. Justifiable fears of destabilising capital outflows will slow down the process. Banks are already allowed to determine lending rates. Soon, deposit rates will be similarly liberalised to benefit savers, who will be protected by deposit insurance. With the relaxation of interest rates, financial institutions (particularly state-owned large banks) will be moved to compete for deposits and lend on the basis of risk-adjusted returns. This should drive credit towards the most productive enterprises and over time, reduce the government’s (and the party’s) control over big business.

3. Introducing more competition into financial services, especially at state-owned banks, will ensure small and medium enterprises can have ready access to credit at a competitive price (and reduce shadow-banking).


4. Reaffirming the dominant role of about 100,000 SOEs which contribute 26% of national industrial output, 80% of the value of Chinese-listed companies and have near monopoly in energy, transportation, electricity, banking and other sectors considered critical to economic stability. Reform of SOEs is contentious, with reformers pushing for some of their assets to be passed-on to the national social security fund and private investors to be given greater opportunity to engage in business dominated by them, including banking. All they got was for SOEs to hand over by 2020, 30% of their profits (US$400bil today) as dividends to government (from up to 15% now), and private sector to be allowed to invest up to 15% in SOEs. But the pledge to “incessantly strengthen” SOEs’ vitality remains. New efforts at boosting competition should make SOEs more efficient, hopefully.

5. Allowing mutually-beneficial urban-rural integration whereby industry will promote agriculture development, and cities promote development in the countryside. This way, farmers have equal chance to share in the fruits of modernity and improve their livelihood. In 2012, 52.6% of China was urban; but only 27% of its population had hukou (or household registration) to fully enjoy public services available to urban residents. Hukou ties employment, healthcare, education and welfare to the place where one is born. It deprives some 300 million migrant workers of social benefits. It is now being abandoned in small towns and cities; hukou restrictions will be gradually relaxed towards the large cities. This practice of experimenting – to “cross the river by feeling the stones” – is not uncommon in China.

6. Setting up a sustainable social welfare system. China’s national health insurance plan boasts nearly universal coverage but benefits are negligible, with wide disparities among regions and professions, and the scheme is underfunded. Its retirement scheme is equally inadequate, considering some 500 million (35% of population) will be aged 60+ by 2050.

7. Revamping the fiscal and taxation system to optimise resource allocation in the face of the many reform measures being implemented, including a new tax base for local government (which can no longer rely on land transfers for revenue and need new property and resource taxes). Furthermore, there is over-reliance on borrowing especially by local government; often, over borrowing to invest in projects with very low returns. Financing of most infrastructures will need to be privatised and market funded.

8. Building an “ecological civilisation” involving a system of land development which conserves resources, reduces emissions and protects the environment through the extensive use of incentives rather than taxes and fees.

Early concessions

Deng Xiaoping is reported to have said in 1992 that without further reform, China would reach a “dead-end.” Holistically, reforms need social and political change to reflect government’s sensitivity to dissent, and to demand for checks and balances. As China grows more complex and as more wealth is generated, the growth of civil society has not just become more obvious but begins to act as a bridge linking today’s reforms to the politics of accountability tomorrow. The plenary Resolution noted: “Dare to grow through even tough bones, dare to ford dangerous rapids, break through the fetters of ideological concepts with even greater resolution.” Hence, the decision to allow the emergence of “social organisations” but under the watchful eye of “government management;” and to float the concept of “judicial jurisdiction systems that are suitably separated from administrative areas.” Judicial reform will make officials more accountable. But the Decision did allow two concessions on human rights to abolish laojiao, the “re-education through labour” camps, and to relax the one-child policy by allowing couples to have two kids as long as one of the parents is an only child. The impact is not expected to be significant because of the high cost of housing, healthcare and education.

Power to implement

It’s now all about execution. President Xi’s credibility, his leadership’s legitimacy and China’s future are all on the line. To ensure effective implementation, the Plenum established two high level groups:

1. The Central Reform Leading Group, charged to plan and carry-out reform on modernising China’s “governance system” and “governance capability,” with the view to designing and co-ordinating China’s “great revolution” of reform and opening up. However, it threatens to marginalise the long dominant technocrats of the National Development and Reform Commission, successor of the old State Planning Commission. It is likely to be positioned at the same level as the Central Finance and Economy Leading Group.

2. The State Security Committee to co-ordinate foreign and defence policy as well as “improve the national security system and national security strategy to maintain and protect national security.” It is intended to have the power to co-ordinate government organs at the highest level in order to respond to any major emergency and incidents that pose a serious threat to national security, such as border conflicts and major terrorist attacks, including social conflict due to the widening wealth gap and corruption. It seems like President Xi will head both groups.

What then, are we to do?

Overall, the reform package is robust and substantive. It’s the most ambitious attempt at reform in two decades. Despite the stunning progress since Deng’s historic opening up to the outside world in 1978, China still has a way to go. So it’s not surprising that in 2007, the then Premier Wen Jiabao labelled China’s economy with the “4-uns”: unstable, unbalanced, uncoordinated and unsustainable. Such a China is not good for Asia or for Asean. The five-year plan 2006-2011 made little progress in rebalancing the economy as encapsulated in the much reported “bird cage economy” (coined by Deng’s ally Chen Yun) where the free-market bird is given limited room to flutter within the confines of a centrally-planned environment. The bird outgrew the cage soon enough as market forces began to surround and overwhelm Chinese life – not quite fully enough though. This time the Plenum got it right – the market allocates resources far more efficiently than government can. Better still, China needs open, competitive and well-functioning markets to perform. It is reassuring that China has embraced such far-reaching structural reforms. These are not perfect but seem workable. As now positioned, President Xi stands confident enough to deliver serious changes to a sclerotic system.

President Xi can expect stiff resistance. There is evidence that growing wealth has emboldened dissent, rather than stifle it. Beijing will set the overall policy direction but it is the central and provincial government agencies who are charged with putting the plans into effect. Not unlike most bureaucrats, Chinese ministries are rife with conflicting interests and jealousies, wedded to traditional ways of doing things, and frequently beholden to vested interest that benefits from the status quo, which today also carry environmental problems, dangerous debt levels and potential housing bubbles. Implementation of strategic reforms is a hard slog; indeed it’s hard to push them pass interest groups. There is already disappointment on the apparent lack of determination to reduce the dominance that SOEs hold and control over many areas of the Chinese economy. SOE reform appears timid, reflecting the old thinking that state ownership should remain as the mainstream. This is not sustainable. Without forcing SOEs out to really compete, private enterprise will remain disadvantaged in an unlevelled playing field. Also, faster reform of the hukou system that deny rural migrants access to urban welfare will meet resistance especially from local government (unless they get greater financial support for schools, hospitals and other services) and middle-class urbanites who resent having to share resources with outsiders. SOEs, recalcitrant bureaucrats and party ideologues will all resist market reforms that appear to threaten their interest.

To be fair, some reforms in the financial sector are already moving ahead; but many other changes are on a slower track especially those encountering strong vested interests or are involved in designing criteria to meet new environmental protection and healthcare standards, and technical innovation. Indeed, it is far from clear that they are able to come out with meaningful ways to quantify the new criteria or at worse, that officials will even take them seriously. The risks are high. History tells us that the last Chinese dynasty (Qing) fell after it reached the height of its power in the final years of the 18th century, after delivering living standards similar in some places to those in Britain. It was the familiar rot in terms of corruption, population pressure, internal dissent and environmental exhaustion that undermined the Qing dynasty. But China’s success at reform is good for Asia and Asean. President Xi can take comfort from the French historian Alex de Tocqueville who wrote in “The Old Regime and the Revolution” that the French Revolution came about not from a popular clamour for change, but by the regime’s own efforts at reform.

Former banker, Dr Lin See-Yan is a Harvard-educated economist and a British Chartered scientist who speaks, writes and consults on economic and financial issues. Feedback is most welcome; email: starbiz@thestar.com.my.

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