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A Chinese Puzzle: Why Economic “Reform” in Xi’s China Has More Meanings Than Market Liberalization

When Beijing says the words “economic reform,” it doesn’t mean what market and political players beyond its borders might wish it meant.

published by
 on February 26, 2018

Source: MacroPolo

Imagine, for a moment, that you’re writing a short history of reform euphoria in China. Your essay would be, well, pretty short.

From my vantage point, at least, in the last decade there have been just two notable moments of exuberance about the prospects for economic reform in China. One was in 2011, when China issued its 12th Five Year Plan (2011-2015). This document marked a noteworthy shift in the underlying thinking about China’s growth model and distribution priorities. And it came at an important juncture in China’s post-1978 economic history: Four years earlier, in 2007, then Premier Wen Jiabao had called China’s economy “unstable, unbalanced, uncoordinated, and unsustainable”—a searing indictment of the prevailing growth model that seemed to lay the political groundwork for a much-delayed shift in strategy.

By 2011, that shift seemed finally to have come—at least on paper. Beijing issued a new five-year plan that placed its emphasis squarely on rebalancing from production to consumption and from energy intensity to energy efficiency. The plan shifted its regional focus from privileging China’s coastal provinces to a more broadly “continental” approach that aimed to help poorer interior provinces grow. And it identified income inequality as a gathering economic and political challenge.

To be sure, many of us who closely watched China’s political economy expressed skepticism about Beijing’s sheer will and capacity to implement a new strategy. But the rhetorical commitment—premised, as it was, on a clear recognition that the post-1978 growth model needed to change—was exciting. And after a decade of stillborn reform talk—compounded by Beijing’s decision to fight the global financial crisis by pumping some $586 billion in fiscal stimulus mostly into state-backed institutions—the 12th Five-Year Plan yielded an important, if very short, wave of reform exuberance.

The second such wave came two years later.

By 2013, nearly all of the excitement of 2011 had dissipated. And with a handful of exceptions, market participants, even though they continued to invest in China, were expressing renewed skepticism about whether the country’s Communist leaders had the capacity and political stomach for deep reforms.

Renewed hope emerged at this point because a new leader, Xi Jinping, seemed politically stronger than his predecessor and thus better positioned to take tough decisions, but also because the conditions that had enabled reform in the 1990s appeared to be re-emerging. Notably, these had included both internal and external crises that served as action-forcing drivers for tough policy decisions. In the 1990s, a reform-minded premier, Zhu Rongji, leveraged an internal crisis of confidence but especially the external requirement to prepare China for accession to the World Trade Organization (WTO) to make painful political decisions, including to lay off tens of millions of workers from state-owned enterprises while restructuring large swathes of China’s economy. By the time of the November 2013 Third Plenum of the 18th CCP Central Committee—the first major policy decision juncture of the Xi Jinping era—China again faced both internal and external challenges. And these seemed—with renewed hope and vigor—to be pushing Beijing toward another round of reforms.

In one sense, at least, the 2013 Third Plenum delivered on this promise: on paper, it offered a number of significant new reform commitments. And importantly, the plenum made a major conceptual contribution by replacing the word “basic” with “decisive” in its 60-point “Decision on Major Issues Concerning Comprehensively Deepening Reforms,” describing the market’s role in allocating resources in dramatically enhanced terms.

This had the ring of a doctrinal breakthrough because it meant, at least in theory, that China’s leaders were prepared to allow the market to have a greater role in resource allocation and in parts of the economy that had hitherto been largely reserved for the state. One example involved the allocation of capital, which has long been concentrated in government-backed banks or else in informal lending channels. Rhetorically, at least, the 2013 Third Plenum committed to bolster the formal role of private capital.

But as with the first instance of reform exuberance, this second occasion has been stanched by subsequent developments.

If Beijing is serious about making the market “decisive,” then, by definition, the state must retreat. But in the five years since the plenum, the reverse seems to have happened in many areas. Above all, state-owned enterprises (SOEs) have been consolidated and strengthened. And Party committees within these firms have been strengthened too.

That is why, as I wrote in an essay in Foreign Affairs shortly after the plenum with my colleague Damien Ma, the question of the role of the state is now the defining one for China’s reform challenge.

China’s current premier, Li Keqiang, has declared war on powerful “vested interests” that, he says, oppose market reforms. But the biggest vested interest in the Chinese economy is, in fact, the state itself. And so the state must transition from being an “administrative” state to a “regulatory” one—to an umpire among contending interests rather than being an active participant in the economy that referees itself.

The Meaning of “Reform”

It’s now 2018, which means another five years have passed since the Third Plenum. And you have to squint hard indeed to find a market participant or leading international observer of the Chinese economy who believes these ambitious reform commitments are, in fact, moving decisively forward. Whatever exuberance there has been since 2011 has mostly evaporated. Turn on a CNBC or Bloomberg program, or pick up any financial or business newspaper, and you’ll find talking head after talking head reporting that “there is no reform in China.”

Indeed, our own MacroPolo team basically shares that grim assessment, as a quick perusal of some of our interactive ReformPedia timelines and reports, especially on the fate of state-owned enterprises (SOEs), will quickly show.

But here’s the rub: China’s leaders continue to insist precisely the opposite.

Xi Jinping, Li Keqiang, and others argue not just that “reform” is in full flower today but that many of the reform goals they laid out in 2013 have actually been met.

Here’s how Xi put that at the most recent Chinese Communist Party (CCP) congress last November: Beijing has undertaken some 1,500 “reform measures” since 2012, made “breakthroughs in key areas,” taken “comprehensive steps to deepen reform,” pursued reform “in a more systematic, holistic, and coordinated way,” and “removed institutional barriers in all areas.”

And that raises a crucial question: What is going on that produces such a gaping disconnect between Beijing’s story about reform and the views of so many in the markets?

Or to put that point as bluntly as possible: are Chinese politicians and bureaucrats, as some international observers would have it, uniquely dissembling?

I’d like to argue that a major part of this disconnect stems from a yawning gap in the definition of what actually constitutes “reform” in the Chinese political context of today.

To put it as directly as I can, “reform” simply does not have the same meaning in China today that it does to many of us, and especially to a lot of market observers. Unsurprisingly, we tend to focus on market liberalization, to the exclusion of most else. But economic “reform” in Xi Jinping’s China has at least two additional meanings—and these can actually contradict and undermine market goals.

To Beijing, “reform” means:

  1. market liberalization;
  2. administrative measures to increase bureaucratic and operational efficiencies; and
  3. a rebalancing of authorities and decision powers among central and local levels of government.

Viewed in those broadened terms, there is actually quite a lot of “reform” happening in China today. But much of that reform simply does not implicate the market. And more important, these three distinct Xi-era “reform” goals can frequently contradict each other.

That, in turn, leaves Beijing often trading off one kind of reform in pursuit of another. And more often than not, it is market liberalization that slips to a (distant) third priority between administrative reform and changes to Chinese-style “federalism.”

There’s a straightforward way to explain this overemphasis on the second and third “reform” objectives over the first one: Xi Jinping has put a very clear premium on political aims, not economic goals. In fact, the central project of Xi’s first term in office (2012–17) was not economic rebalancing at all but rather consolidating, rebuilding, and broadening the reach of the CCP. Whatever rebalancing has taken place has mostly happened organically rather than by policy intervention or design.

This means that the Chinese president’s top three priorities—a cleaner CCP, a more disciplined CCP, and a stronger and more enduring CCP—have yielded a deeper connection between political goals and economic policy outcomes than China has witnessed in a generation. Inevitably, this leads to an overemphasis on the administrative aspects of reform.

Reform in Xi’s China

For the rest of us, one takeaway is that if we actually want to better understand the elements of China’s trajectory, then it’s necessary to take a harder look at all three categories of so-called “reform” measures on their own terms, not ours.

Clearly, the Xi-era brand of “reform” does not mean unleashing Adam Smith’s invisible hand of the market across the many nooks and crannies of the Chinese economy. And so while the first of these three types of “reform” should involve permitting the market to assume roles hitherto played by the state, it’s hard to deny that, in the aggregate, efforts to expand the role of market forces have floundered in recent years.

For example, the state of liberalizing and competition reforms since the Third Plenum has been pretty dismal, especially when compared to the sweeping changes made to China’s state sector during Zhu Rongji’s premiership of the late 1990s and early 2000s. Beijing has sought not so much to extend the reach of private capital by “privatizing” SOEs as to pool it with state capital, thus bolstering the state-owned firms, not ceding control of them to private players.

There are exceptions, of course—my colleague, Dinny McMahon, has artfully explored the bankruptcy of a nonferrous metals SOE in southwestern Guangxi province.

But in the main, SOE reform has lagged since the Third Plenum—first, because Beijing has been unwilling to bear the political cost of major restructuring; second, because those who lead China today, especially from the center in Beijing, seem to be committed statists; and third, because the CCP will have to pay the piper for massive layoffs and any consequent outbreak of popular discontent.

Still, this does not mean, as some would have it, that market measures aren’t part of the Xi era toolkit.

They are.

Just take prices—a signal of the relationship between supply and demand.

China has had a complicated system of distorted prices. But Beijing has, in fact, liberalized the price mechanism for several crucial commodities that previously were set by the state or heavily subsidized. These include agricultural commodities, such as cotton and corn. They include residential water, which is now priced through a tiered system that relies on market signals and is set to be scaled up nationally. And some healthcare and transportation-related prices have been liberalized too.

Meanwhile, Beijing has moved to decontrol electricity and gas tariffs by lifting caps on their retail prices, permitted private investment in electricity distribution, allowed private refineries to import crude oil, and slashed the catalogue of administrative prices by 80% and 55%, at the central and local levels respectively.

Prices on agricultural, as opposed to urban, water, as well as electricity transmission prices, are administratively controlled, yet the latest price reform plan, announced in November 2017, aims at a second phase of liberalization that, among other steps, will modestly extend pricing reform into monopolistic or near-monopoly sectors, such as a railways and public utilities, relying on a “cost-plus” model. And the state has encouraged rural water conservation through some reforms to agricultural water prices.

Thus it is not true, as some argue, that there has been “no market reform” in Xi Jinping’s China.

Still, this is just one of three distinct meanings of “reform”—and not necessarily the most important to China’s authorities.

Often, market-related changes are of instrumental utility, serving longer-term state-guided strategic goals rather than being, as, say, a University of Chicago economist might have it, an end in itself. And that is precisely because “reform” encompasses the additional two meanings and purposes described above.

Here’s why: Even as China needs to curtail certain state powers and leverage market mechanisms, it still requires a resilient state—to enforce standards, provide public goods, and perform administrative functions. And so administrative measures are viewed as necessary to reduce red tape and streamline project approvals, especially where these run into the greatest number of bottlenecks, which is at the local level.

It is sometimes said that China has had an “export-led” growth model. But the reality is that in recent decades, and especially after the 2008 financial crisis, it has been vastly more investment-led than export-led. Critics often rubbish Beijing for authorizing bridges to nowhere, building infrastructure in places that don’t need it, and permitting state agents to run up the tab in a debt-fueled investment binge. But precisely because this is the case, administrative measures will ultimately be needed that grant localities more authority to approve investment projects and licenses for private businesses that make sense for this or that local economy.

That is why, in Premier Li Keqiang’s rendering of “reform,” Beijing argues that cutting red tape and slashing the number of administrative approvals is as important as market measures. And it is true, I suppose, that these would be necessary prerequisites of bolstering the center’s prospective regulatory role while demonstrating greater effort to reduce Beijing’s meddling in local projects.

Certainly, that is how Beijing now sees it. Thus, even though such administrative reforms are by no means “liberalizing” in any sense of “making the market decisive,” they are viewed as part and parcel of undertaking “reform” by China’s current brand of Xi era “reformers.”

That ties to the third and last meaning of “reform” in Xi’s China—the emphasis on realigning central and local government roles and functions.

As I’ve argued with Damien elsewhere, China faces enormous problems of unfunded mandates, confusion about who’s in charge, and policy paralysis as Beijing and the provinces pass the buck to each other to formulate, fund, and implement various policy tasks.

In our writing, we two authors have emphasized the problem of unfunded mandates in particular: Chinese localities are expected to adhere to Beijing’s mandates to provide services, such as healthcare, but often lack sufficient revenue to do so; for its part, Beijing worries that dispensing more tax and bond-raising power will fuel corruption and lead to the accumulation of more local debt—a staggering problem that threatens China’s medium-term fiscal stability. China’s former finance minister, Lou Jiwei, is widely said to have made himself deeply unpopular during Xi’s first term by trying to overhaul aspects of China’s fiscal and tax systems.

Meanwhile, these challenges of fiscal “federalism” (who raises money for investment and who pays the tab?) have become joined to the challenges of administrative federalism (streamlining and reallocating project approvals) and enforcement federalism (making sure local authorities follow national environmental standards, for example).

Taken together, these intertwined challenges have made debates about “reform” in Xi Jinping’s China into something much more encompassing than a debate about market liberalization:

One line of debate concerns the relationship between state and market.

The other concerns the relationship between Beijing and localities.

Is Beijing’s “Reform” Anything like Our Brand of Reform?

Here are three big things I take away from the fact that debates about “reform” in China are now much broader than the one we are having outside its borders:

One takeaway is that reform is, quite simply, about Beijing’s priorities, not ours. And that means that while reform might eventually mean more openness through competition reforms, we should certainly not assume that will be the case and would be rather naïve to do so.

The fact is, China could very well increase domestic competition while retaining high walls, strong barriers, and non-tariff protectionist obstacles to foreign competition. And while we will then argue that this is anti-competitive and anti-reform, Beijing will argue, in its unique “reform” discourse, that it is indeed undertaking competition reforms, just not in ways that are geared to the needs or demands of foreign firms.

In many sectors, for instance, I suspect that Beijing will try to hold off opening its markets until domestic competitors have been so strengthened that they can dominate foreign rivals in the Chinese market, even without the same levels of government support.

Here at MacroPolo, we sometimes put this point pretty bluntly when kicking it around in our office chatter: Deng Xiaoping’s policy was “reform and opening up” (gaige kaifang); by contrast, Xi’s policy aims to decouple reform from opening up.

Second, Beijing is not nearly as attuned to foreign firms as it used to be. That means the reforms American and European multinationals want are just not going to happen without a lot of backstopping from their home governments.

That, in turn, means that multinational firms will need a serious negotiating process between their governments and Beijing. And this will need to be aimed at fostering the sorts of competition reforms that matter for market access but not necessarily to those now promoting China’s current brand of domestically-oriented reform.

The Bush and Obama administrations tried to do this by negotiating a Bilateral Investment Treaty. The Trump administration has preferred to emphasize penalties and coercion, which has actually had a quite constructive effect by getting Beijing’s attention. But ultimately, I predict this will produce little new market access unless it is leveraged to support an intensive negotiation that offers more in exchange for our brand of reform, while exacting real consequences for a failure to move.

In that way, punishments and consequences would be deployed as a function of a failed negotiation, not just unilateral action. They could establish a firmer footing for bargaining. And Washington would logically focus such an effort on access to sectors where the United States is most competitive—services, healthcare, technology, and so on.

Even the more market-oriented among Chinese reformers do not, in my view, really welcome foreign competition any longer. But they do need to foster competition in their economy generally, since aspects of statism that undercut their domestic objectives have continued to advance.

Third, reform in China will, for at least the next five years, be viewed almost exclusively through a domestic lens.

When Xi Jinping and his colleagues toss and turn at night, I suspect their major policy nightmares and preoccupations are entirely homegrown: (1) how to stay in power and overcome dissent; (2) how to create some 12 million new jobs each year; (3) how to maintain sufficient growth to support those employment goals; (4) how to manage the demographic challenges of an aging country through welfare and “entitlement” reforms; and (5) how to mitigate pollution and environmental challenges.

These five priority agendas implicate reform in all three of the senses I outlined above. But they do not all implicate market liberalization equally, and some of them not very much at all.

If Beijing’s principal reform priorities aren’t solely about the market, in any case, then the task of reform will involve trading off this or that market measure for other “reform” priorities.

In such a calculus, the marketizing goal is likely to be the loser much of the time.

Now, the decision to change China’s constitution to remove term limits on the presidency almost certainly means that Xi Jinping is going be leading the country for a very long time to come. Like it or not, this is what I suspect “reform” will mean in China for a long time to come as well.

This article was originally published in MacroPolo.