The Third Plenum of the 18th Party Congress of the People’s Republic of China has come and gone. The third plenum of what is now traditionally a ten year government cycle, in which the c.200 member Central Committee of the communist party discusses and agrees key policies, is laden with historic symbolism. During the third plenum held in 1978, Deng Xiaoping launched the initial reforms that opened up China’s economy post the Cultural Revolution, followed by the third plenum of the Jiang Zemin era, which endorsed the socialist market economy and opened the door to the reforms of Premier Zhu Rongji. Accordingly, the expectations for this plenum were high with everybody from policy makers and journalists to politburo standing committee members promising “unprecedented” reforms . At first glance the reforms subsequently announced by the party represent a bewildering array of economic, financial, social and security initiatives. While China bulls see them as reason to rejoice and bears as reasons for despair, a closer look at the announcement shows a leadership making a series of critical moves in a multi-generational game that shift power in their plan to take the country to the next phase of its development while managing a range of opposing forces.
The recently completed Third Plenum marks the clearest indication of the priorities of the Xi government, and ties back into the beginning of his appointment, when President Xi Jinping personally launched the “China Dream” as the key theme of his administration. In this sense, the reform blueprint issued in the wake of the Plenum, manifests what exactly the “China Dream” is, or at least what the parts that will be realized in the next decade are. President Xi had vowed to increase the prosperity and power of China, and had stated that the Third Plenum would “comprehensively deepen [the] reforms” required for China to reach its goal. In recent years, the headwinds facing the country on its development path have increased significantly, however and the list of issues expected to be addressed was long: rebalancing the economy from investment to consumption, urbanisation and land reform, tax reform, social welfare, foreign investment, environmental protection, corruption, innovation, income inequality, state assets and governance. Unsurprisingly, perhaps, virtually the only issue that was not widely expected to be discussed was political reform and on this they were right; in this regard, President Xi is seen as standing in line with his predecessors who have sought to strengthen and develop the economy while maintaining the communist party’s firm grip on power.
Given the size of the economic challenges China is facing and the high expectations of President Xi , the excitement over the plenum and the likely depth of reforms reached a fever pitch in the weeks running up to the event, stirred by statements like the one made by Premier Li Keqiang that reform “should feel like slitting your wrists.” The tone of the initial, high level communiqué, was unsurprisingly more toned down, but many were disappointed by the vagueness of the reforms and policies it contained. However, it is important to realize that traditionally Plenums do not hand down ready-made laws and all of what has been announced requires further development and clarification before being in any way implementable. Further, a second, more concrete reform document was released within days of the first, which provided both more detailed information as well as a wider set of reform topics. Reading both documents in context make it clear that the scope of planned reforms is ambitious and that the direction the announced reforms seek to achieve and, in some cases accelerate, is a series of power shifts that are shaping China today. These shifts include:
- The power shift to the president within the senior leadership of the party.
- The power shift between the traditionalists and the reformers.
- The power shift between the centre and the regions.
- The power shift between the state and the markets.
- The power shift between oligarchs and entrepreneurs.
- The power shift between the party and the people.
These power shifts are buried in the reform announcements; some of them are bold and others only directional. The analysis of the major reform initiatives that the Plenum has committed to launch provides an indication of priorities and potential issues. The major reforms and initiatives are presented in our summary analysis in the form of a “reform scorecard” that measures the individual reforms against what might be the “ideal” , given China’s long term development requirements.
The Reform Blueprint of The Third Plenum: Assessment of the Agenda
Reform Focus Area 1. Reform Roadmap and Management
Reform Scorecard. 80%
|Key Issues at Stake. Looking back, historians may well depict the Hu Jintao era as a "lost decade" in terms of the market and economic reforms necessary to address vested interests and the illegitimate use of power. This now leaves the current leadership with the need to more aggressively manage the required changes.||Plenum Position and Statement. Creation of a centralised top level reform committee in the party to oversee and coordinate reform policies, "designing reform on an overall basis, arranging and coordinating reform, pushing forward reform as a whole and supervising the implementation of reform plans."|
Analysis. President Xi has shown a determination to push through reform and is creating the apparatus to do so. The creation of a powerful and central body is critical to pushing through reforms in the face of political and economic vested interests at both local and central government levels. The high priority level and powers are reflected in the expectation that the committee will either be headed by or report directly to Premier Li Keqiang or President Xi himself, further centralising power. The creation of such a committee in itself is a clear sign of the consolidation of power of President Xi, less than one year after officially taking over as China’s president. Moreover, the committee provides a potential means of redefining the relationship between the central and local governments on key issues as well as local governments’ roles and responsibilities. Local government’s economics and incentives have been one of the critical blocks to economic, legal and environmental reform in the past and despite clear prioritization of their agenda they have sometimes been publicly unaligned with the national agenda.
Reference: Sign of the Times. Multiple prior Signs (see ”The Planning and Development Model of China” and ”China Miracle Ends”) have outlined the core political and economic restructuring challenges facing China today, particularly the shift from government driven investment to consumption driven growth, which will fundamentally impact existing vested interests in China’s banks, state-owned enterprises, and local governments driving the current policy.
Reform Focus Area 2. Markets
Reform Scorecard. 70%
|Key Issues at Stake. Rebalancing China's economy from a state driven investment growth model to a demand driven consumption model has been the top level priority for China's leaders for year given the ongoing slowdown in growth and the apparent maturity of the old model, characterized by top-down government planning and resource allocation.||Plenum Position and Statement. The core issue is to straighten out the relationship between government and the market, allowing the market to play a decisive role in allocating resources and improving the government's role". In previous policy statements, the Communist party had described markets as playing a "basic" role in allocating resources.|
Analysis. The country’s leadership has indicated a clear willingness to move to market driven economics rather than government driven top down resource allocation. The communiqué also lays out that the key focus of government should be restricted to “macroeconomic management”, market regulation rather than direct participation, public service delivery, supervision of society and environmental protection. While the communiqué lacks detail on where and how the government will implement the expansion of market mechanisms, the underlying change in the party's outlook implied by the statement represents a significant shift along the spectrum between a planned economy and free market economy.
Reference: Sign of the Times. The May 2013 Sign (“The Planning and Development Model of China”) had explored a number of policy challenges China faces with regards to planning and creating leading industries, including the shrinking scope for creating protected national champions or protected industries, which calls into questions the continued relevance of a state driven economic planning model.
Reform Issue 3. Role of State-owned Enterprises
Reform Scorecard. 20%
|Key Issues at Stake. China's state-owned firms control 26% of economic output with monopolies in critical sectors. These mainly industrial companies are often inefficient employment and investment vehicles for local government and are widely recognised to be sources of significant government abuse of power, corruption and in many cases stifle the development and growth of the fast growing innovative private companies required to help China transition to a more market based and knowledge based economy.||Plenum Position and Statement. State industries will remain at the core of the economy, as the “dominant form of ownership”. Other statements include pledging to "incessantly strengthen their vitality", while acknowledging the "important" role of the private sector. Additionally the government will “promote price reforms for water, oil, natural gas, electricity, transportation, telecommunications and other” state-owned monopolies.|
Analysis. The lack of direct SOE reform is a disappointment to many private firms who would have benefited from a levelled playing field – the creation of which was likely not politically or even economically feasible for China's reformers at this time, given the strength of vested interests and the fundamental role of SOEs in legacy communist economic policy. However, the increasing commitment to the market and the announcement around pricing liberalisation for key services indicates the leaderships intent that over time, the advantages enjoyed by SOEs will be eroded and that market mechanisms will drive bottom-up restructurings, with companies either becoming more efficient or being swallowed by competitors.
Reference: Sign of the Times. The August 2012 Sign (“Fighting for Position: Size is Not Enough”) had identified a number of requirements for China’s largest companies, often domestic leaders and monopolists, to become internationally competitive leaders in their respective industries, including investments and capital, the creation of IP and know-how, improved corporate governance and inorganic growth to build scale.
Market Reforms - Overall Assessment. The Plenum’s position on market reforms can best be described as a small step in terms of action, but a potential step-change in philosophy. Direct state involvement in the economy has historically been one of the cornerstones of communist planning policy and the “socialist market economy” that followed it. The intent that the state should play an only indirect role in economic execution is revolutionary in this regard. The fact that the initial steps being taken are small and potentially vague as well as the apparent lack of direct reform of SOEs, is likely the result of significant resistance from a wide range of vested interests, rather than by the lack of willingness by the reforming factions in the government. The lesson holds that not everything benefits from announcing ones full intent; some things are best described only directionally and this provides the framework and freedom to decide the speed and radicalness of change. The strategy now adopted appears to be a long term one, in which markets, thanks to their increasing role, are intended to eventually drive the reforms of public assets that China’s politicians cannot implement directly. However, while China’s leaders may enjoy ten year rules in which they can implement policies thoughtfully and over the long-term, events move at their own pace, and it is unlikely that the window for SOE reform is ten years long. China’s SOEs are central to many of the urgent underlying economic, legal and regulatory challenges the country is facing (credit bubble, lack of consumption through low wages, declining productivity, abuse of position and even land price speculation), and China’s leaders will face the challenge of setting a reform pace that is accepted politically and effective economically. Nevertheless, without change here, the overall shift to a higher value added market economy will be stalled.
Reform Issue 4. Financial Sector Liberalisation
Reform Scorecard. 40%
|Key Issues at Stake. China's banking sector remains tightly controlled and largely owned by the government, with state owned banks serving largely SOE clients at the expense of smaller entrepreneurial companies focusing on services and innovation. The ensuing mismatch of capital supply and demand has driven the creation of an unregulated shadow-banking sector, which has been a significant factor in China’s sizable credit bubble. In addition, financial inclusion remains an issue with over 35% of China’s population having no bank account.||Plenum Position and Statement. "Under strict regulatory oversight, [China would] permit private capital to set up small and medium-sized banks and other financial institutions." Further, the creation of a bank deposit insurance system protecting depositors was announced.|
Analysis. China’s banking sector today remains a government controlled industry, with the vast majority of total banking assets held by state owned banks. Given the high level of control the government has sought to exercise over the banking industry historically, the decision to permit private investment in the space is a positive acknowledgement that the current model is no longer working. China’s state-owned banks have struggled to lend to privately owned, typically smaller businesses, which contribute over half of China’s total output, and these companies have either been starved for cash or needed to turn to shadow-banks for informal loans. China’s leader’s willingness to open the banking sector to real competition should provide broader access to debt financing for private businesses as well as decrease the size of the unregulated shadow banking sector. However, the announcements total up to what is only the first of many necessary steps required to create a real liberalized financial system as well as efficiently served the unbanked. Further, the lack of apparent initiatives to directly address the current credit bubble through shadow banking (which Fitch estimates may now have reached 60% of GDP) is disappointing.
Reform Issue 5. Capital Markets
Reform Scorecard. 60%
|Key Issues at Stake. China's capital markets remain closed, inefficient and opaque, with an approval based stock issue system, significant state involvement in listings and capital allocation. This limits the attractiveness of capital markets for private companies, while interest rate controls on the banking side enable banks to lend regardless of risk adjusted returns, again favouring less competitive state-owned enterprises over private sector businesses and smaller innovative companies.||Plenum Position and Statement. Commitment to liberalise listing rules by moving to a registration based system allowing companies to list their shares freely, and relaxing the controls on interest rates to create a more competitive market for debt capital.|
Analysis. The combination of currency conversion, banking reform (above) and interest rate reform should drive competition in the banking sector, forcing banks to lend at market rates and allowing productive (smaller and more efficient) private enterprises to access debt financing. This, combined with the proposed relaxing of listing requirements, has the potential to provide significant growth impetus for the private sector and help to further restructure China's SOEs. These initiatives, if managed well (e.g. China has a significant backlog of companies waiting to list) will drive companies’ ability to access capital markets; what was missing from the Plenum was any sign of reforms that would attract or reassure investors to actually provide the required capital. China’s A-share market lacks liquidity, transparency and credibility with both international and domestic investors. Real capital market reforms will require solving these demand side challenges through an increase in harmonization of standards to international benchmarks levels, (e.g. accounting standards and listing requirements) and the increased compliance and enforcement of rules, (e.g. around insider trading and collusion). China’s current equity capital market reforms represent an important step in the right direction but leave half the problem yet to address.
Reference: Sign of the Times. The May 2013 Sign (“The Planning and Development Model of China”) had laid out the importance of competitive and market driven funding for the creation of internationally competitive companies and sectors, particularly in high value added industries.
Reform Issue 6. FDI and Currency Reform
Reform Scorecard. 40%
|Key Issues at Stake. China's wide ranging FDI restrictions cover a range of industries (logistics, services, healthcare, financial services) the country is currently seeking to drive its economic rebalancing. To attract additional capital and/or international best practices to grow and prosper into these sectors, these restrictions would need to be removed or eased. Further, the Chinese renminbi, while open on the current account, remains closed on the capital account.||Plenum Position and Statement. Stated commitment to “promote the orderly opening up” of the finance, education, culture and health sectors, among others. Further commitment “to accelerate the reform of the exchange rate” making the renminbi fully convertible.|
Analysis. The promotion of additional FDI is a welcome reform, and one that builds on the recently announced initiatives such as the Shanghai Free Trade Zone, which will likely host a series of loosened FDI restrictions on a trial basis. Rates of FDI flows as well as outbound investment remain closely tied to China’s managed exchanged rate and the country’s closed capital account. Capital controls may have helped insulate China from foreign capital driven bubble and crashes like the Asian Financial Crisis but also restrict the country’s ability to attract the smart long-term capital and expertise required to build the sectors critical to a post-industrial developed economy. The announced FDI and forex reform initiatives are clearly both critical and potentially far-reaching, but the lack of clarity around timing or information about specific sectors opening up means that it is too early to call whether what the government actually to do will be sufficient.
Reference: Sign of the Times. The September 2013 Sign (“China's Overseas Population”), had highlighted China's need to the factors driving its ability to attract foreign capital and talent, including the need for further deregulation and privatisation. Increased foreign investment and competition have the potential to help create and grow competitive world class industries in sectors China is seeking to develop as laid out in the May 2013 Sign (“The Planning and Development Model of China”).
Financial Reforms – Overall Assessment. The financial reform package announced is consistent and supportive of the thrust of the Plenum’s economic reforms. Having declined to restructure SOEs directly, the government is deregulating the financial sector and other markets to reduce the advantages enjoyed by state owned business, and promoting private investment in the hopes of growing the private sector and increasing competitive pressures on SOEs. Importantly, China’s private sector is seen as a key driver of economic rebalancing, with private companies expected to create more jobs, more growth and more innovation than state-owned ones. Private companies have significantly higher returns on capital than state-owned ones, and allowing private and foreign entrants into key sectors can significantly accelerate their development and global competitiveness. More importantly over the long term, China’s state-owned enterprises have little or no presence in the potential high growth sectors such as clean-tech, biotechnology, alternative energy, and high end electronics. Developing these sectors will require the growth and development of innovative private companies, which in turn require access to competitive debt and equity capital. However, the reform of the financial services sector does not go far enough to address the rapidly growing, dynamic and pervasive shadow banking sector nor does it address the need for financial inclusion across the country’s rural and massive urban migrant population.
Reform Issue 7. Social Stability Maintenance
Reform Scorecard. N/A
|Key Issues at Stake. Growing income inequality, a slowing economy, ongoing issues over land seizures and regional separatist movements are all major sources of potential political unrest that threaten the stability and peaceful continuation of the CCPs rule.||Plenum Position and Statement. Creation of a centralised State Security Council to "perfect the national security system and national security strategy and safeguard national security."|
Analysis. The centralisation of state security is a further consolidation of power for President Xi, who will presumably head the newly created council. The move follows the recent purges of associates of Zhou Yongkang, the former head of China's security forces and the demotion of the latter's former position (from politburo standing committee to politburo member). President Xi is now widely believed to be the most powerful Chinese leader since Deng Xiaoping, who also ushered in widespread economic reforms while overseeing a crackdown on political freedoms.
Reform Issue 8. Censorship, The Open Flow of Information and Innovation
Reform Scorecard. 0%
|Key Issues at Stake. China has recently significantly stepped up its online and media censorship, cracking down harshly on online protests and free speech advocates and introducing new rules and regulations monitoring social media. Motivated to mitigate the empowering effects of open information on individuals and society, it also stifles the open flow of information and ideas that is a prerequisite for the creation of innovation and hinders their stated aim of a knowledge-based economy.||Plenum Position and Statement. The Internet poses “a new comprehensive challenge” to the country’s stability. China needs “a robust system to manage sudden occurrences on the Internet" and better guide public opinion online.|
Analysis. China looks set to continue its course of increasing media censorship, which has been significantly stepped up since President Xi took power and expanded to enable closer monitoring of internet communications. Recent initiatives include new rules against “internet rumours”, allowing tough penalties for posting information online that leads to mass protests, ethnic or religious clashes, damages China's image or "causes a bad international effect". These initiatives, combined with an army of internet censors that is said to be larger than the actual People’s Liberation Army, indicate that China’s leaders are determined to a keep a firm grip on the flow of information. However, China’s leaders have yet to reconcile these initiatives with their efforts to create knowledge and innovation driven industries, one of the cornerstone goals of economic reform (hence the slew of market and financial reforms supporting smaller, private more nimble and innovative companies). Closed societies, that did not embrace the open flow of ideas and information, despite being cohesive and some cases powerful, have not been history’s innovators. Accordingly, China’s leaders increasing attempts to censor the flow of information and control society will make it difficult, if not impossible, to develop innovation as a cornerstone of the country’s future growth and development.
Reference: Sign of the Times. The January 2013 Sign (“Protests in India and China”) had looked at the increasing intangible cost China's government is paying for these efforts, a cost that has only increased with the recent step-up in censorship activities, as over the long term, increasing economic reform and tightening civil freedoms are not reconcilable. An earlier Sign in Apr 2012 (“China and The Freedom Advantage”) has sought to quantify and link the relation between economic development and personal freedom. Without the open flow of information and the free exchange of ideas in society, both of which are dependent on the freedom of speech, it is unlikely that China will successfully develop real innovation driven industries and migrate to the next level of economic development.
Reform Issue 9. Criminal Justice
Reform Scorecard. 80%
|Key Issues at Stake. The country's re-education through the “labour system” (or lajiao), which allows local governments to potentially detain individuals for up to four years without trial, has become increasingly controversial domestically, following increased publicity over significant abuses by local officials.||Plenum Position and Statement. The country will "abolish" the system of re-education through labour in order "to improve human rights and judicial practices."|
Analysis. China's leaders' abolishing the labour camp system is a welcome step and one that indicates that its leaders are listening to popular opinion when formulating reform policies. The re-education through the labour system has been a hold-out from Mao's days and one of the more odious components of the Chinese security system, which for decades has been used to effectively silence dissenters without the benefits of public hearings or due process. However, it is unlikely that this move will be followed up by more sweeping reforms of the criminal justice system strengthening the rule of law any time soon. The other judicial objectives mentioned in the reform document are similarly over-due, for example announcing the step by step reduction in the number of capital crimes from a current 55 or working to ban extorting confessions through torture and physical abuse. Issues citizens in most developed countries take for granted today.
Reference: Sign of the Times. The January 2013 Sign (“Protests in India and China”) highlighted the impact of fairness and injustice on stability. The Arab Spring demonstrated that such acts were potent triggers with extreme unintended consequences for public unrest.
Security Reforms – Overall Assessment. The initiatives announced, particularly the centralization of state security in the new council, appear to be part of a strategy by the central government to consolidate security power and control on the one hand but to use it more sparingly on the other, focusing on the maintenance of internal security. President Xi has stated that state security and social stability are the preconditions for reform and development, effectively linking the establishment of strong internal control to the broader reform effort and thereby setting the scope for China’s domestic security efforts. The consolidation of power is evident here too as it is most likely that the new measures will be coordinated by the new state security council and controlled by President Xi himself. While official statements on the state security council have focused on “extremists, separatists and others who threaten or harm the country” , there are a wide number of factors - including corruption, income inequality and the rural-urban divide among others - that threaten China’s social stability, all of which are part of the broader domestic security agenda and therefore likely to be impacted by the announced security reforms. However, creating international security stability over the long term is not a function of quelling unrest, the cost of which escalates with each occurrence, but of addressing the root causes of instability. The social reforms announced by the Plenum have a critical role to play in this regard.
With regards to specific reform initiatives, none of the announced reforms give much hope of more sweeping reforms in the near future. The incremental approach to criminal justice reform, other than the long overdue abolishment of the laojiao system indicate that the road will be long and gradual, while the government’s intent to increase rather than reduce censorship does not bode well for the country’s human rights, civil society, and over the longer term, ability to innovate and create a knowledge-based economy.
Reform Issue 10. Land Reform
Reform Scorecard. 30%
|Key Issues at Stake. China's rural land remains collectively owned, with leasehold farmers unable to sell or borrow against their holdings thereby reducing their opportunities to participate in the economy. Further, local governments act as middlemen in land sales following re-zonings, providing a significant source of income to them at the expense of citizens.||Plenum Position and Statement. Plan to create “an integrated urban-rural construction land market” and give “rural dwellers more property rights" and establish a unified land market in cities and the countryside.|
Analysis. Although the announced plan does not touch the core of the problem, namely the collective ownership of agricultural land, it does envisage greater property rights for farmers and the potential to mortgage real estate, both of which are issues facing China's rural populations. Given the importance of land sales to local government finances and the cautious approach China has traditionally taken with regards to reforms that have the potential for major social upheaval, it is likely the land reform will be pushed forward in a series of moves, of which the announced initiatives represent the first steps. Given China’s current geographic and demographic challenges, it is likely that more will need to follow shortly.
Reference: Sign of the Times. The November 2013 Sign (“China Dream: The Role of Urbanisation”) has previously looked at land reform as one of the challenges facing China's urbanisation planners in the next decade, with the current system being a substantial source of corruption, income inequality and social unrest, as well as a key impediment to China achieving its medium-to long-term urbanisation targets
Reform Issue 11. Hukou System
Reform Scorecard. 30%
|Key Issues at Stake. China's household registration system effectively excludes the country's 300m migrant workers from receiving basic social services, decreasing their ability to take industrial jobs in urban environments and to drive consumption through discretionary spending.||Plenum Position and Statement. Commitment to provide “fully” equal treatment to migrant workers in urban areas in counties and small cities, implying the expansion of basic and social services to formerly excluded migrants.|
Analysis. The government has committed to setting “reasonable” requirements for rural residents to obtain hukou in large cities, while also committing to strictly controlling the size of population in its tier one cities. By reforming the hukou requirements and extending service provision to migrants, the government is effectively seeking to bring back into the fold the 300m urban migrants currently living outside of the system of government benefits and effective control. However, over the longer term, China's leaders will need to recognise that winning the loyalty of its citizens requires not just the hand-out of government services but the creation of economic growth opportunities for these workers to prosper. Fundamentally, the announced reforms are only an initial step, with no indication of the further path: even with “reasonable” hukou change requirements, China will still have urban inhabitants that don’t meet the requirements. Further, the two tier hukou system with preferential rights for urban inhabitants will continue and perhaps most fundamentally, there is no indication of a reform of the abolishment of the basic hukou system itself, which enables the government to control population flows and restrict the freedom of movement for its citizens.
Reference: Sign of the Times. Last month's Sign (“China Dream: The Role of Urbanisation”) had examined the hukou issues and the growth of China's migrant workers as a class of citizen independent of the government.
Reform Issue 12. One Child Policy
Reform Scorecard. 70%
|Key Issues at Stake. The one-child policy continues to deepen China's existing demographic problem: while low birth-rates have slowed population growth, an increasingly ageing population is creating a range of social and longer term economic challenges, not unlike those faced by much more developed economies such as Japan.||Plenum Position and Statement. The number of couples allowed to have two children under the law will be expanded to include families where only one parent is an only child. Previously the law only granted this concession to couples where both parents were only children.|
Analysis. Following 34 years of Mao's one child policy, China's demographic time bomb is ticking. By 2050 the population above 60 years of age is set to triple. Unlike India, which many believe will enjoy a demographic dividend, China's working population will decrease, driving the dependency ratio, increasing wages and decreasing competitiveness. Total fertility today is below 1.2 children per women, far below the 2.1 required to maintain a stable population. While a loosening of the one child policy is a step in the right direction, at current development levels, China risks, even with the slight increase in the birth-rate the new policy could drive, getting old before it gets rich.
Social Reforms – Overall Assessment. The social reforms planned are welcome and necessary. Creating a prosperous and powerful China requires not only internal stability but also prosperous (and largely content) citizens. The implied bargain on offer by the regime for its citizens appears to be one of mutual non-involvement: China will loosen social control measures like the one child policy and the hukou system which restricts the freedom of movement but citizens need to continue to accept the Communist Party’s rule without too many public questions. While this bargain provides lots of benefits to individuals’ lives, the approach is necessary but not sufficient for the overall strategy of creating an advanced and wealthy economy and society. If China is to meet this goal it will need to create a much more open society that fully leverages its people to innovate and solve complex problems. The lesson from other countries is that real innovation requires real freedom and open societies. Singapore is often touted as a development benchmark for China, being a prosperous developed country with an authoritarian government. It is, however, not only the exception to the rule, it is also not comparable to China: Singapore is small, rich, with the least corrupt government in Asia and a personally liberal society. China today is none of these things. It will therefore need to quickly build on and expand the reforms announced by the Plenum if it is to foster the society required for China to achieve its long-term development objectives.
Reform Issue 13. Environment and Pollution
Reform Scorecard. 30%
|Key Issues at Stake. The economic and political cost of China’s environmental pollution, the by-product of 30 years of rapid industrialisation, is unsustainable and quickly becoming untenable. Public awareness of and discontent with the environmental consequences of industrialisation are increasing and China’s leaders will need to balance environmental management with continued economic growth.||Plenum Position and Statement. The country will harshly penalize heavy consumers of natural resources and polluters, and improve monitoring and the accountability of local government in environmental protection.|
Analysis. The plenum's statement is short on specifics, but is in keeping with the overall approach of increasing role of markets in solving China’s problems, e.g. by proposing to appropriately tax consumption of resources rather than restrict the supply side directly. However, lessons from other countries have shown that a market driven approach and increased monitoring and compliance will likely be insufficient to reverse decades of degradation and more importantly create sustainable alternatives to polluting industries. Successfully, fighting and reversing environmental degradation and pollution will likely require more direct government action, including both legislation and enforcement activities.
Reference: Sign of the Times. In the April 2013 Sign (“China's Potential Green Future”) we had looked at China's environmental challenges and laid out a number of specific priorities for the country to address to reduce pollution and develop into a leader in clean-tech and environmental services.
Conclusion: The Power Shifts Underlying China’s Fifty Year Game
A deeper look at the reforms announced by the Third Plenum indicates six shifts to the power structures of China. In some cases reforms are being enacted as a result of these shifts, while in others, reforms are being enacted to further enable shifts that the parties in power have deemed necessary.
- The power shift to the president within the senior leadership of the party. President Xi has consolidated power quickly since assuming office earlier this year. The creation of top level coordination and policy bodies for both economic reform and state security, the two most critical issues facing the party, under his effective command indicate that the president now holds the reins of power more tightly than his predecessor. If President Xi uses this platform to further build-out his power base into the execution level of the bureaucracy, his vision has the greatest chance of being executed in full. Previous leaders have faced compromises as well as a slow execution and been forced to settle for less.
- The power shift between the traditionalists and the reformers. The tension that Deng Xiaoping’s initial economic reforms created within the communist party between its conservative (considered left-wing) and its more market driven (considered rightist) factions has never been fully resolved. Given the conservatism of China’s communist traditionalists, the scope and scale of the Plenum’s reform package is a sign of the growing power of the country’s rightist reforms, even though individual market and financial reforms fell far short of their potential due to likely compromises between the factions.
- The power shift between the centre and the regions. The plenum announced a series of changes to begin pushing power from the regions to the centre in an attempt to address many national agenda items including financial, security and corruption related issues. China has always been a country of competing geographic sources, with the central government seeking to establish control over strong independent regions and provinces. Local governments today are key implementers and executors of policy and accordingly one of the country’s strongest vested interests. The Plenum, as a central government event, has announced a series of reforms that will strengthen the centre’s relative position, particularly financially. Examples of how power will be shifted to the centre and allow for more central policy execution include rural land reform which will reduce local government revenues and increased SOE dividends which will increase central government revenues. As the example of the United States, where questions of state vs. federal responsibilities are among the top political issues, shows however, these shifts are not permanent, and powerful local governments in the future may well stem or even reverse the current flow of money and power away from the regions.
- The power shift between the state and the markets. This Plenum has asserted the importance of the market and the need to curb and contain the role of the state in the market. The leadership has clearly acknowledged the state’s inability to fully direct China’s growing and increasingly complex economy and has paved the way for state control to cede to market forces, allowing the state to focus on macro-economic management and regulation. The timing of the shift is a gradual and long term one. The power shift from the state to the markets lay at the heart of the economic reforms that kicked off in 1978 and have been central to every economic reform since initiated then. The plenum has made a strong statement to continue and accelerate this shift.
- The power shift between oligarchs and entrepreneurs. China’s economic power has in the past been closely guarded by the state and its industries have been dominated by individuals with close government relationships. In sectors with significant state-involvement these companies have been state-owned incumbents, while newer and high growth sectors without much direct government participation have seen the emergence of private oligarchs with close government relationships. China’s millions of current and potential entrepreneurs reside on the other side of a vast competitive divide from the oligarchs who have preferential access to capital, labour, regulators, raw materials and other critical inputs. The capital market, banking, goods market and other financial and economic reforms announced are all designed to move towards levelling this playing field, allowing entrepreneurs to compete on innovation and execution and increasing the competitiveness of the market overall. The shift is clearly signalled although the moves required to dismantle the inequity will no doubt take much time.
- The power shift between the party and the people. The party has clearly decided in favour of itself at the Plenum. Maintaining power is effectively the most important priority of CPC, and for this reason, China’s leaders since Deng Xiaoping have tried to disaggregate economic from political reform; Deng himself overseeing both the first wave of economic opening up as well as the crackdown on Tiananmen Square. The governance lessons from the Soviet Union’s demise serve as stark reminder to China’s reformers, who continue to attempt to avoid the peril of combining Glasnost (political reform and transparency) with Perestroika (economic restructuring). The relationship between the party and the people is not static, however: The internet and the free flow of information it enables are significant forces for popular empowerment, increased transparency and ultimately greater government accountability. Given the internet’s growing reach in China, the communist party has had to run in order to stand still in term of maintaining power, putting in place increasingly stricter controls on communications and media to at least try to arrest what has likely become an irreversible trend. The financial, political and economic costs of doing, however, may soon outgrow the leadership’s ability to pay. China’s leaders do not yet seem ready to embrace Toffler’s Third Wave and unlock the value of information.
These six power shifts provide some clarity on the apparent contradictions inherent in the package of reforms announced - e.g. the decisive role of markets along while keeping SOEs as the dominant form of ownership - due to the compromises between traditionalists and reforms. China’s “turning right while signalling left”, the bifurcation of political and economic development, also makes more sense when seen in this light. Ultimately, a well-informed population will decide what they want in matters political, economic, social and personal and in an interlinked internet world there will be a limit to how less-informed they can be kept. This power shift is at the core of the question on China’s development and one which “safe play” has traditionally and still is leading to a continuation of control politics.
In conclusion, the reforms of the Third Plenum represent a play to accelerate a series of critical power shifts to prepare China for the next phase of its development. The sum of the intended moves by China’s current leadership over the next decade demonstrate that this game is part of a much longer multi-generational one. In this sense the reforms not only build on but are a response to moves by previous leaders and also set the board upon which the next generation of China’s leaders will play. Coming back to China’s ambition of building a modern competitive and internationally powerful nation, the game today is in its middle phase. Looking at the reforms of the third plenum as a whole, China’s leaders, as inheritors of the world’s longest reigning political party, clearly recognise this, too.
1. See appendix for definitions and sources
2. Yu Zhengsheng, Chairman of the CPPCC and fourth ranked member of the standing committee
3. Based on a speech in which he exhorted to “strive to achieve the Chinese dream of great rejuvenation,”
4. Quoted in http://asiasociety.org/blog/asia/what-does-chinas-third-plenum-suggest-about-prospects-reform
5. Reforms from the Plenum were announced in a two stage process: an initial communique issued immediately after its conclusion, a document lacking many of the expected concrete reform proposals, and a more detailed blueprint, labelled the “Decision on Major Issues Concerning Comprehensively Deepening Reforms”, issued several days later. This article draws on initiatives announced in both documents.
6. The communiqués, particularly the second document, named the “Decision” are both dense and vague at the same time, touching upon many issues from a principal driven perspective with much left to the interpretation and imagination. Depending on one’s interpretation, the document potentially contains a much longer list of initiatives than the ones outlined below, including tax reform, judicial reform, and even political reform. The Sign has attempted to restrict itself to the clearer announcements and to those for which recent precedents establish some sense of likely government actions. Further, the reform groupings below do match those in the Decision, which for example treated censorship as a cultural reform and the abolition of labour camps as a political reform (the sign has deemed these both security reforms.) We have attempted to group reforms in a way that best illustrates their role in China’s broader development objectives, as well as the relationships between individual reforms.
7. The only major positive news on the SOE front was the announcement that the dividend payout ratio for SOES will be gradually increased from the current 10-15% to 30%, decreasing the power of SOEs in favour of the central government, which directly owns the largest 117 SOEs through SASAC
8. In the nomenclature typically used by the Chinese government, the term “state” in the State Security Council implies a body focusing on internal rather than external security. Subsequent citations in English however refer to a “National” Security Council and states explicitly that the body will focus on both internal and external security.
9. With are reported 2m “public opinion analysts” and 1.5m conventional troops in the PLA as reported by CNN http://edition.cnn.com/2013/10/07/world/asia/china-internet-monitors/
10. Stated by Foreign Ministry spokesman Qin Gang http://www.reuters.com/article/2013/11/13/us-china-reform-security-idUSBRE9AC0AP20131113
11. Best exemplified by a 13th century proverb on regional political power: “The mountains are high and the emperor is far” (“天高皇帝远”)
12. The Russian labels are convenient for the sentiment, if not totally accurate. Perestroika actually included both major economic reforms as well as political reforms including the introduction of multi-candidate elections and the separation of CPSU and government functions.
13. The Third Wave is the post-industrial society, following the agricultural and industrial societies, as defined by Alvin Toffler in the eponymous book. See: http://www.toffler.com/aboutus/our-founders.html
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