Steering the ship and changing course

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Pierre Della Bianca's picture

As China has just announced her most ambitious set of reform since its big opening to the world in 1978, many remains sceptical regarding her capacity to implement them. Proposing sweeping changes, the reforms aim at helping China to face her many challenges and to foster the transition of the country towards its next step of development; namely more of a free-market consumption-driven economy (Forbes Asia, 17th Nov. 2013). In essence, what the reforms are proposing is to gradually break with the Chinese model of state capitalism. This however, will inevitably undermine the power and privileges of some part of the Party’s establishment, notably at the local and provincial governmental level. Building on these vested interests, this paper focus on three main factors that will contribute to what extend the reforms are to be successful.

To begin with, the peculiar Chinese political structure makes the Chinese government obsess with internal political stability. As it is not democratically elected, much of its legitimacy ensue from its ability to deliver better living standards; which is predominantly achieved through a robust and regular economic growth. Yet, liberalizing the interest and exchange rate represents a threat to growth in the short term. Indeed, the upper limit imposed by China on interest rate provides banks with funds for a cheap price. Liberalizing such a practice would increase the cost of capital and ultimately have a dampening effect on borrowing (The economist, 18th May 2013). The same rationale applies to the exchange rate. If liberalized, the already under evaluated Yuan is likely to appreciate against other currencies and in turns, will hamper exports. In that context of output legitimacy, Mr. Xi’s ability to reinsure fellow party members that the short-term effects of the reforms will not translate into social unrest is key to their success.

To do so, Mr. Xi will have to consolidate his power with respect to his fellow party members. As the rhetoric of the necessity of economic reform to ensure the longevity of the present political system reappears, the parallel with Deng Xiaoping becomes obvious. Similarly, the extent to which Mr. Xi will be successful at convincing or coercing the traditional ruling class to embrace the reforms will determine the extend of their implementation. Greater economic freedom, so the argument runs, does not pose a risk for the continuation of the leadership but rather a tool for maintaining it. Indeed, loosening the party control on the economy by allowing the private sector to play a more important role in the economy, giving more rights to the farmers over their lands or liberalising the hukou system challenges the traditional understanding of the state in China. This antinomy between state control and economic freedom that the reforms advocate for is at the core of the issue. Although the Party speaks with one voice, internal opposition to the reforms is a reality and acts as an impetus for Mr. Xi to strengthen his power.

Since his investiture, Mr. Xi has amassed a tremendous amount of power. He is said to be the most powerful Chinese leader since Deng Xiaoping (The Economist, 16th Nov. 2013). For that matter, the creation of a new state-security committee, expected to coordinate the police and the army and insure a certain degree of coherence between the different the state security apparatus, can be interpreted as a successful move to secure Mr. Xi predominance within the party. Similarly the reforms push forward the creation of small leading groups serving the purpose of overseeing their progress. The particularity of these groups lies in their composition. Indeed, composed of local and senior party leaders as well as SOEs’ bosses, their true purpose might well be to bound together different stakeholders to better serve the purpose of the reforms. Another powerful element of coercion is Xi’s fight against corruption. As in the case of the former Chongqing Municipality party secretary Bao Xilai, the tone is set from the outset; dissents will not be tolerated. In a country prey to rampant corruption, nobody is safe (Reuters, 15th Sept. 2013). In sum, the successful implementation of the reforms will be strongly correlated with the power struggle within the Chinese Communist Party itself. For the moment Mr. Xi and his fellow reformists have the upper hand; their ability to preserve it is crucial for the reforms.

Secondly, the financial cleavage between the national and local level plays an equally important role in the implementation of the reforms. Indeed, they will not come cheap and, as questions regarding their financing seem unresolved, local officials are increasingly worried. The liberalisation of the hukou household registration system is the perfect illustration of these fears, for it will require cities to provide social services to a whole range of newly urbanised migrants, not to mention the many more to come. Furthermore, the greater loosening of state control over state owned enterprises (SOEs) is not to reinsure cities and provinces about future tax income. Indeed the reforms foresee that by 2020, SOEs will be required to pass on 30% of their profit share to the central government; the current rate being of 15% (Bloomberg, 18th Nov. 2013). Acknowledging that this is not a mere zero-sum game, more money for the central government will inevitably leave the SOEs with less money for local government taxes.

A further element of worry for local governments lies in the reform of the land laws, with particular regard to the farmers’ rights. What has been a lucrative business for years is now challenge by the latest set of reform. Local governments expropriate farmers at a ridiculous rate before selling their land to property developers with large profits. This system allowed them to secure billion Yuan property development deal and thus an essential source of government revenue. The bottom line is here that, as long as cities are not convinced that they will dispose of sufficient finance to meet their possible new obligations, they will remain reluctant to the reforms. The design of the financial relation between the national and the local government is thus likely to play a determinant role in the implementation of the reforms.

As importantly, the pace, timing and order in which reforms will be implemented is going to play a crucial role. In view of the unprecedented scope of the latest set of reform, there is little hope for implementing them all at the same time. Indeed the order of implementation matters. In the case of the financial relationship between local and central government, the reforms include the possibility for local government to issue bonds (Ibid.). This would considerably sweeten the deal for local governments, making them less resistant to the reforms. Similarly, the pace at which implementations take place matters. The liberalization of the hukou system, the interest rate reform or the speeding of the Yuan convertibility reform is only likely to succeed if gradually enforced.

In all, as in the position of the captain of a ship, President Xi has drawn the roadmap for where to take China. As he wants to negotiate this strategic change in direction, the ship will eventually have to slow a bit down to give him some slack for the maneuver. The extend to which the maneuver will become a success depends on his ability to maintain his prevailing position onboard, on his ability to reinsure the local crewmembers about the practicability of the plan, and on his ability to implement it at the right pace.

Good news is that, whenever the captain announces a change in course, the Helmsman, as great it might be, steers the wheel accordingly.

 

References: 

“China's Bold Reforms Are Bad News For Markets”. Forbes Asia. Nov 17th 2013. Web. Feb 15th 2013.

“China's Xi Jinping stamps authority on party with Bo Xilai verdict” Reuters Beijing. Sep 23th 2013. Web. Feb 15th 2013

"Economic reforms walking the talk: Can China’s leaders revive the economy and reform it at the same time?" The Economist Hong-Kong. May 18th 2013. Web. Feb 15th 2013

"Reform in China: Every move you make”. The Economist Hong-Kong. Nov 16th 2013. Web. Feb 15th 2013

"The Trouble With China's Reform Plan”. Blomberg Businessweek. Nov 18th 2013. Web. Feb 15th 2013

Credit cover picture: The Economist