Free Enterprise or State Enterprise? The Third Plenary Takes the Bull by the Horns

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Danni Gao's picture

   The Third Plenary Meeting has emphasized the empowerment of the “decisive role” of free enterprise in China’s economic reforms. Free enterprise without free enterprises cannot survive. I believe the future success of China’s economy hinges on the flourishing free enterprises started by its people for its people. Hence, the benchmark to judge the implementation of today’s economic reforms is the activity of free enterprises, which will lead China’s economy to a new era. Free enterprises can bring about a renaissance of novelty, cost efficiency, and a booming domestic market in China. This would gradually substitutes China’s current unsustainable economic growth models of export orientation and government investment on fixed capital (e.g. infrastructure) to stimulate China’s economic growth.

   While the Chinese leadership has accurately pinpointed current economic problems and proposed economic reforms, implementation is of great concern. A single big factor that determines whether the economic reforms will be implemented is the political evolution that China is going through, which includes defining the role of politics in economy, devotion of power to local authorities, setting up of an independent judiciary and possessing strong political will. In my opinion, until China really implements economic reforms, it is critical for her to successfully push through political reforms that lay down the foundation for economic reforms.

   Before looking into implementation, let’s examine the gap between the real and the ideal that the economic reforms aim to close. There are a few realities that hinder China’s development. First, China’s current economy has witnessed much market distortion done by the government, especially shown in its State Owned Enterprises (SOEs). SOEs can easily get loans from state commercial banks. Indeed, 85% of the loans in 2009 were issued to SOEs[i]; leaving free enterprises with little access to low-interest state capital. This has thwarted the development of free enterprises. Politics in China still plays a pervasive “Big Brother” role while China has moved out of command economy. The political system has yet to catch up with China’s economic development.

   Second, there is lack of accountability as well as empowerment of local governments. China’s government is a hierarchical pyramid. At the top is the central government, follows by the province, city, county and town at the bottom.[ii] Local governments at the bottom of the pyramid do not have much political power to carry out independent reform, as their main job is to follow the leadership of the central government and be an “order taker” in fulfilling its assigned responsibilities. Nonetheless, the local governments need not worry much about their economies as they can always rely on borrowings from the central government. The indebtedness problem was compounded by the central government’s post-2008 stimulus injection where the estimated local government debt amounted to 10.7 trillion yuan ($1.75 trillion). [iii] Local governments keep afloat by borrowing more. Over-budgeting and increasing government’s debt breed corruption, which afflicts China’s slowing economic growth.

   The aforementioned realities are preventing China from achieving her ideal economy of free market, economic equality and higher standard of living. The bridge between the real and the ideal is economic reform. The purpose of an economic reform is to benefit and empower the people of a country. Admittedly, the open-up policy and the decision to join WTO have brought more economic power to China’s people, in terms of enjoyment of greater variety of goods and services as well as the access to foreign markets. China has adopted an outside-in reform approach where global competition is used to drive down its own production cost. However, I doubt this approach will work for China in current time due to its vulnerability to world economy for export income and increasing scarcity of natural resources that impedes the usual energy-consuming low-cost production. In my view, an inside-out approach will work better where internal political reforms promote greater competency of businesses.

   An inside-out approach needs political reforms as the backbone for economic reforms. That said, what are the factors that lay down the foundation for economic reform implementation? First, there must be a clear-cut government role. Under the current SOEs-driven economy, the central Chinese Communist Party (CCP) government is like a managing director who participates in decision making of business. The China’s government gives SOEs unfair advantages over foreign companies and small free enterprises. This has created a false illusion that SOEs are financially sound. In reality, wastage of resources and corruption arisen from the handling of state capital and collusions with government officials make SOEs less competitive or efficient. According to Goldman Sachs, Chinese SOEs’ return on assets was 6.5% below that of other Chinese firms in 2012 and their shares traded at a growing discount.[iv] While China welcomes more external competition and pressure to improve SOEs, such external forces can only help to a limited extent if China internally resists change.

   In addition, the inside-out approach to reforms requires the China government to draw a clear line between politics and business. Compared to Singapore’s Temasek model, the investment arm of the Singapore government, while the government owns the corporate; the corporate operates independently of politics. The Economist says that the Temasek model avoids the state involvement in the management of its related enterprises, who are free to hire independent directors.[v] Therefore, instead of being like a company director, the Chinese government can be a target setter and Key Performance Indicator (KPI) measurer to incentivize SOEs. The purpose is to let SOEs earn the right to get state capital instead of taking it for granted. If the targets are not met, government can reallocate resources from the SOE to other more profitable investments to create competition.

   The second determining factor of reform implementation is the setup of local governments’ accountability. Instead of the current loose budget and debt systems based on local governments’ proposals, the China government should base funding on local governments’ merit. If China really wants to have a flourishing scene of free enterprises, the infrastructure of a fair market for all must be in place. This cannot be achieved if local governments behave indifferently to the challenges faced by local free enterprises such as lack of access to capital and the red tape in applying for government permits. Local governments must be empowered to carry out political reforms at the grass-root level to empower the local people. This includes tying local political leaders’ tenure with their abilities to meet KPIs related to good local economic performance and growing free enterprise activities. Another equally important measure is to have a meritocratic budget system that rewards good local governments and investigate non-performing governors. In this way, local governments are incentivized to add value to their local business community and grow with them.

   In the meantime, all political and economic reforms discussed earlier would not succeed unless China develops an independent and impartial judiciary that is segregated from its politics, just like the Supreme Court in the United States. Although President Xi Jinping has announced several anti-corruption campaigns,[vi] corruption cannot be effectively detected under the current judicial system where government officials are interconnected with each other across functions of execution and jurisdiction. An independent jurisdiction with zero tolerance for corruption and full accountability to Chinese people instead of only to the Party[vii] will safeguard public interest and societal justice. An independent jurisdiction will serve as a check and balance to ensure that political and economic activities are conducted properly.

   Last but not least, the implementation of political and economic reforms hinges on the political will of the China government. As mentioned, the required political reforms need to segregate government duties and decentralize the central government’s power in order to empower local governments. An independent judiciary, if successfully implemented, will dilute the political power of the central CCP government, contrary to the interests of people at the top. Thus, the proposed reforms can only happen with strong political will to forgo certain power in return for a more sustainable and prosperous economy. By then, China will create a ready environment for burgeoning entrepreneurship with ample support from local government and a more competitive and fair economy.

   In conclusion, China is at the crossroad of economic development where her competitive advantage in low-cost production cannot be sustained for long. China needs to search for new sustainable competitive advantages to meet the world economic competition. I believe that China’s competitive advantage relies on her people and the growth of free enterprises in China that cherish innovation and efficiency in a free market. The success of China’s economic reforms today hinges on the political reforms to empower China’s people. Such political reforms will require a more transparent and refrained role of politics. In addition, there must be grass-root level reforms to empower the local governments and hold them more accountable for local economic reforms. The future of China depends on a holistic and collaborative change to all players of China’s economy: the politics, the business, the jurisdiction and the people.

References: 

[i] Cary, E. (2013, June 19). Reforming China's State-Owned Enterprises. The Diplomat. Retrieved February 13, 2014, from http://thediplomat.com/2013/06/reforming-chinas-state-owned-enterprises/1/

[ii] Local Government in Asia and the Pacific - China. (n.d.). The United Nations Economic and Social Commission for Asia and the Pacific (ESCAP). Retrieved February 13, 2014, from http://www.unescap.org/huset/lgstudy/country/china/china.html#cat

[iii] Build a System to Control Gov't Debt Now. (2013, August 21). Caixin Online. Retrieved February 13, 2014, from http://english.caixin.com/2013-08-21/100572382.html

[iv] From SOE to GLC-China’s rulers look to Singapore for tips on portfolio management. (2013, November 23). The Economist. Retrieved February 13, 2014, from http://www.economist.com/news/finance-and-economics/21590562-chinas-rule...

[v] From SOE to GLC-China’s rulers look to Singapore for tips on portfolio management. (2013, November 23). The Economist. Retrieved February 13, 2014, from http://www.economist.com/news/finance-and-economics/21590562-chinas-rule...

[vi] Lu, Y. (2013, December 31). Xi Jinping Is Flying High Into the New Year. China Real Time Report RSS. Retrieved February 13, 2014, from http://blogs.wsj.com/chinarealtime/2013/12/31/xi-jinping-is-flying-high-...

[vii] World Savvy Monitor. (n.d.). World Savvy Monitor. Retrieved February 11, 2014, from http://worldsavvy.org/monitor/index.php?option=com_content&view=article&...