The Third Plenum reforms and China's Global Competitiveness

The Third Plenum reforms and China's Global Competitiveness

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Introduction:

Since 2012, the soaring Chinese dragon has begun to drift. As a result, the Communist party leadership is rejecting its ideological namesake further to implement reforms that enable the “decisive role of the market in resource allocation”1 in the Chinese economy, in the Third Plenary Session of the 18th CPC Central Committee.

China, being a one-party centralized ‘democracy’, has a fairly efficient line-of-command, such that reform demands from the top-order are effectively implemented in the lower orders, provided the centre is keen on the implementation of these reforms. However, transforming the Chinese economy into a decisively market economy involves ambitious reforms for an export-driven economy that still depends on tremendous regulation, investment and support from the government.

The reforms affect two crucial factors that drive Chinese economy today: the China price and technology transfers. The degree to which the centre will implement reforms is constrained by the effects they have on these factors that grant China necessary competitive advantages in the ultra-competitive global economy.

 

The China Price

After the Chinese liberalization in the late 1980s and 1990s, low production costs due to abundant labour and resources, and a large market allowing paper-thin profit margins and high-volume sales, has attracted and created large amounts of domestic and foreign businesses that have set a new ‘China price’. Chinese goods have since flooded global trade with their iconic ‘China price’, at half or one-third the previous market price, sometimes as low as 3% of the American price.2

However, not just market forces create the China price: it is further sustained by government practices. In the highly competitive environment between provinces/municipalities to attract investment and growth, local government officials regularly offer businesses in their zones substantial benefits such as subsidized land/equipment or tax exemptions. Sometimes these are offered to select ‘worthy’ firms that maintain good relations with the local government, to cut the massive costs of subsidizing all businesses. Guanxi, or social connections, between officials and certain businessmen and women may also provide state benefits for the latter, as mandated by traditional Chinese culture.3 The Third Plenum reforms, which stress on market deregulation, reducing ‘illegitimate favourable policies’ and decreased regional protectionism, do reduce the likelihood of business inefficiency, corruption, favouritism and ‘ghost cities’.1 But, they cancel the forces that provide the support for businesses to slash costs, set a China price, and drive a super-exporting Chinese economy. Proposed ‘price reforms’ to gradually siphon away government subsidies for oil, natural gas, electricity, and transportation1, and ‘market-based exchange rate systems’1 to reduce dependence on deliberate currency undervaluation, will also rise and destabilize the China price.

Growing national unrest over rural suicides due to forced evictions4 has prompted a proposal for real property rights reforms in the Third Plenary session. Local government officials forcefully evict residents to provide land for businesses, with the justification that land is ‘state owned’. Low prices for businesses are often ensured by inadequate compensation to evicted residents. Therefore, even the rural property rights reforms will affect the China price.

 Most market economies implement intellectual property rights legislation to encourage innovation and protect certain exclusive competitive advantages of businesses. China, however, is the kingpin of a global counterfeit trade of $600 billion (est.) a year.5 Its government allows a mammoth counterfeit industry, which can set a China price that does not include any patent or copyright fees, to flourish. Local officials often deliberately ignore counterfeit establishments in their regions, or are submerged in counterfeit dealings themselves.6 Effective implementation of intellectual property rights, as proposed in the Third Plenum, would demolish a major industry that produces and exports high volume goods at an unbeatable China price.

A rising China price would be especially unfavourable now, given China’s low growth situation, as it would result in investment shifting to other low-cost destinations, sales losses, and large-scale unemployment. Only the Third Plenum’s interest rate liberalization that removes a minimum floor for interest rates (a measure to transform the nation’s obsessive savers into consumers) to reduce borrowing costs for businesses7, lowers the China price. It has already been implemented. Therefore, it is doubtful whether the Third Plenum’s market reforms – despite encouraging ethical and sustainable practices- will be completely implemented by the Chinese government, because of their adverse effects on the China price.

 

Technology Transfers:

         Technological innovation, and high-technology industry (biotechnology, automobile, aerospace, semiconductors, computing) growth are important catalysts for the sustained growth of the Chinese economy. They will reduce dependence on and technologically advance a low-technology labour-intensive manufacturing sector that does not provide adequate wages for the workforce, opportunities for China’s large graduate population8 or long-term stable growth. To enable this, the latest technology must first be available in China and this is possible only through technology transfers from technologically advanced foreign firms (mainly Korean, Japanese, European and American), upon which the Chinese government places great importance.

         The Third Plenum reforms seek to privatize China’s backward and inefficient state-owned enterprises (SOEs) partially, to form “mixed-ownership firms”1 that can extract the best technology and expertise from foreign and domestic firms, in return for market access. However, highly inefficient firms that require the most of this technology and expertise may attract few competitive buyers, and the government will be reluctant to privatize its largest, best firms in the energy sector.

         The Chinese government uses the bargaining chip of its huge market to extract technology transfers from foreign firms. This is achieved by mandatory joint ventures with domestic firms in certain industries; public tenders where Chinese contractors must be employed; and compulsory and in-depth review of designs of machines and equipment by Chinese design institutes.9 Foreign firms are not allowed to participate in the economy unless they possess the latest technology and are willing to divulge them to local collaborators.9 However, the Third Plenum reforms emphasize deregulation of the market to provide equal opportunities for all firms and abolish ‘unreasonable regulations’.1 This is unlikely to be implemented completely as the Chinese government requires these crucial technological transfers for its industrial growth and further domestic innovation, and therefore cannot provide equal market opportunities to foreign firms.

         Intellectual property infringements also result in huge, illegal technology transfers. This is especially the case in the pharmaceutical industry, where billions of dollars spent on research by ‘big pharma’ is rendered redundant in the Chinese market by immediate counterfeiting and sale of medicines at a fraction of the cost at which the innovating firms produce.10 In case of life-saving medicines, these technology ‘transfers’ are a big boon for Chinese consumers who would be priced out of the market in case of appropriate patent legislation, but sometimes goods can be spurious. In automobile manufacturing, where foreign firms are forced to tie up with local manufacturers, the same firm may supply parts for rival firms, resulting in technology transfers to a competitor – usually a domestic firm.9

However, despite their enviable benefits to the Chinese economy, foreign firms are frightened away from China by intellectual property theft and government mandated technology transfers, because they lose exclusive market power and profits gained from possessing advanced technology. In the long-term, this concedes crucial market share to competitors who have no research costs to cover, and so sell the same technology at lower prices. Lack of intellectual property rights also discourages private domestic innovation, because any technology produced will be copied.11 Hence, these investment and innovation losses will certainly spur the government to lighten market regulation and enforce stricter intellectual property rights.

 

A set of binoculars:

         Analysts claim that the Third Plenum reforms aim to fulfil the party leadership’s objective to make the export-driven Chinese economy increasingly dependent on the domestic market12, for sustainable growth in the long term. In an increasingly open trade environment, Chinese firms will fiercely compete with imports into the Chinese economy, instead of firms in export markets. This spells a sustained, maybe enhanced need for the competitive advantages of China price and technological transfers to attract the largest market in the world. Therefore, complete withdrawal of government regulation from the economy through the Third Plenum reforms would be unlikely at this difficult stage of transition. The currently nascent Chinese service industry, which has huge potential growth, also requires government subsidies and support to grow and overcome the market advantages of early birds from more advanced service economies.

The real danger to the Chinese economy that these reforms address, however, is the unhealthy credit practices of Chinese local governments13 that have borrowed liberally to splash subsidies on businesses. The large local government debt could be easily dissolved by the central government, with its ample reserves, yet the government chooses the more efficient path of the Third Plenum’s deregulation reforms. With a set of binoculars in hand, the Chinese government looks to sacrifice present growth driven by the state-supported China price and forced technology transfers, for a future economy that can sustain a China price and innovation on its own. For now, the reforms prove risky for China’s global competitiveness.

References: 

References:
1. The Decision on Major Issues Concerning Comprehensively Deepening Reforms in brief, 2013. China.org.cn [online] Available at: http://www.china.org.cn/china/third_plenary_session/2013-11/16/content_3...
2. Fishman, T. C., 2005. China Inc. New York: Schribner. Pg 194.
3. Kwong, J., 1997. The Political Economy of Corruption in China. New York: M.E. Sharpe. Pg 99
4. ‘Picking Death over Eviction’, 2013. New York Times. [online] Available at: < http://www.nytimes.com/2013/09/09/world/asia/as-chinese-farmers-fight-fo...
5. Counterfeiting Intelligence Bureau. International Chamber of Commerce. [online] Available at: < http://www.iccwbo.org/products-and-services/fighting-commercial-crime/co...
6. Fishman, Pg 237
7. ‘China loosens grip on interest rates’, 2013. BBC. [online] Available at: < http://www.bbc.co.uk/news/business-25296000>
8. ‘Employment in China’, 2013. China Labour Bulletin. [online] Available at: < http://www.clb.org.hk/en/content/employment-china>
9. ‘Technology transfer to China: Guidance for Businesses’, 2013. China IPR SME Helpdesk [online] Available at: < http://www.china-iprhelpdesk.eu/docs/publications/Tech_transfer_English....
10. ‘Counterfeiting in the Pharmaceutical Industry; a look at the Bitter Pill in China’. Baker and McKensie [online] Available at: http://www.bakermckenzie.com/RRChinaCounterfeitingPharmaceuticalBitterPill/
11. Fishman. Pg 240-243
12. ‘Bringing the Chinese Consumer to Life’. Stephen Roach, 2013. Project Syndicate [online] Available at: http://www.project-syndicate.org/commentary/stephen-s--roach-praises-the...
13. ‘Fears after key China debt level soars to 70%’, 2013. Financial Times [online] Available at: <http://www.project-syndicate.org/commentary/stephen-s--roach-praises-the...

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