Beijing Set to Announce Reform Blueprint

Chinese President Xi Jinping will soon mark the one-year anniversary of his ascension to the top of the Chinese Communist Party, or CCP, hierarchy. It has certainly been an interesting year thus far. President Xi came into office promising to reignite the economic reforms that stalled under the previous administration, to stamp out corruption within the party, and to help the entire nation achieve a new “Chinese Dream.”

On the anti-corruption front, President Xi is already on a roll. Chinese officials at every level are scrambling to abide by Beijing’s new public spending restrictions and to avoid any and all activities that could be criticized as overly lavish. Officials are suddenly so leery of attending the normally de rigueur fancy banquets and receiving pricey gifts from business constituents that prices for high-end Chinese liquor have been on a downslide in 2013.

Short-term anti-graft campaigns are fairly easy to execute in China, however, and are therefore never a good indicator of a new leader’s political strength. No politician in China dares argue against cleaning up the government. Just voicing opposition would make any Chinese official appear to have something to hide.

When the issue at hand is how best to manage the Chinese economy, however, there are no clearly correct answers, and that makes economic policy much more complicated. Top Chinese leaders are generally united behind the idea that their economy needs to be rebalanced, which means the country needs to shift away from its current over-reliance on state-funded heavy infrastructure investment and export-oriented manufacturing. Different interest groups have different opinions about how and at what speed to execute that shift, however, and sorting out those differences to build a broad political consensus for one particular reform path will take real leadership.

The question at hand is whether President Xi and Premier Li Keqiang have what it takes to exert that leadership. Starting November 9, the 205 cadres that make up the top echelon of the CCP will gather to listen to these two leaders and issue a public signal of their support—or lack thereof—for the new team’s economic vision.[1]

President Xi and Premier Li’s ability or inability to win the backing of this larger group and push new economic reform policies forward will have big implications for the United States. If China’s new leaders roll out much-needed changes and successfully rebalance their economy, new growth opportunities for U.S. businesses will be created, and the current U.S.-China trade frictions will likely be reduced. If Beijing fails, China will remain addicted to the resource-intensive, export-oriented growth model that has diminishing returns; that will be a bad thing for both nations.

What is a plenum, and why is this particular meeting so important?

Plenary meetings are CCP leadership conferences. The party has a 205-member Central Committee that gathers a few times every year to discuss and vote on major policy decisions. The gathering scheduled to occur from November 9 to November 12 is attracting more attention than normal for two reasons.

First, this will be the first committee meeting to take place since the full completion of China’s 2012–2013 party and government leadership transitions. The current 205 central committee members were appointed in November 2012, and will serve a five-year term. This 2012–2017 group held a first gathering in November, when their primary order of business was voting on party leadership positions, and a second gathering in February, when their primary objective was to agree on government appointments. Now that the party and government personnel business no longer dominates the committee’s agenda, the third meeting can finally dig in on actual policy.

Second, over the past few decades, Chinese leaders have traditionally used their third plenary meeting to launch major economic reforms. Former leader Deng Xiaoping kicked off this trend when he launched China’s post-Mao modernization at the third plenary session of the 11th Central Committee in 1978 and the first round of major market economic reforms at the third plenary session of the 12th Central Committee in 1984.[2] Former President Jiang Zemin and former Premier Zhu Rongji launched another round of marketization at the third plenary session of the 14th Central Committee in 1993.[3]

Based on past precedent, if economic reform is on the agenda, the third plenum is the natural launch pad. President Xi and Premier Li claim to be economic reformers, so all eyes are on this new team to see what they will manage to roll out at their own third plenum.

Reform speculation is particularly hot in 2013 because China is at an economic crossroads

China’s gross national income per capita is now around $5,600 in U.S. dollars. According to the World Bank, that means China has made it into the ranks of upper-middle-income countries, which brings new challenges. As Chinese citizens rise up into the middle class, they demand higher wages that drive up production costs and erode China’s export competitiveness. Simultaneously, the country is running out of high-return, fixed-infrastructure investment opportunities. Twenty years ago, when China lacked well-designed highways and other basic infrastructure, those investments could reap big benefits. Now the basic infrastructure is in place, and expanding existing assets—such as expanding an existing four-lane highway into a six-lane version—does not provide the same payoff.

China’s old economic model is generating diminishing returns, and the only way forward is to generate new sources of growth.[4] Beijing must dial up the support for new growth sectors—including domestic consumption—and dial down support going toward the old guard, particularly heavy industry and the state-owned sector. If Beijing can bring in new jobs with higher wages, that would unlock domestic consumption growth, and if that happens, the market potential is absolutely huge.

The new leadership appears to be aiming for that. Major reforms that are rumored to be on their wish list include:

• Relaxing price caps on natural resources: If the Communist Party would relax its hold over commodity prices, then electricity rates and other production input costs would increase. That would shift investment incentives away from low-wage, resource-intensive sectors such as steel and cement manufacturing and toward higher-wage, resource-efficient sectors such as high-end technology manufacturing and financial services.

• Relaxing interest-rate controls and increasing financial market competition: Current regulations cap the interest rates that China’s state-owned banks pay on consumer savings and lock competing alternatives out of the market. Chinese citizens deposit their money in state banks at very low returns, and that gives the banks access to cheap capital, which they then loan out to state-owned enterprises at very low interest rates. This system subsidizes the state sector at the consumer’s expense, and that will have to change if Beijing wants to ramp up domestic consumption as a new growth driver.

• Relaxing the household registration system: Under the current system, Chinese families have a permit to live in a certain district. If the best job opportunities are elsewhere, people can certainly move, but they will have to do so as illegal migrants. They will not have official residency permits or access to social services in the new location. Freeing up this system would allow for more labor mobility, particular rural-to-urban labor mobility. It would also expand the number of Chinese citizens who benefit from higher-quality social services such as urban schools and hospitals, and reduce China’s urban-rural income divides.

• Leveling the playing field for private capital: Under the current system, state-owned enterprises enjoy preferential access to bank financing, government contracts, and so-called “strategic” market sectors such as rail, telecommunications services, electricity, and natural resource development, such as oil and gas development. The types of start-up private enterprises that drive innovation in the United States often struggle to get off the ground in China. If Chinese leaders really want to build a modern innovation economy, they will have to reduce at least some of the privileges enjoyed by the state sector to allow more room for private enterprise expansion and free-market competition.

The new leadership is already experimenting with these and other reform policies. Beijing increased commercial natural gas rates by 15 percent in July, and the central government is already rolling out “urbanization” projects designed to help China’s cities cope with rural-to-urban migration. The steps taken thus far, however, are only the tip of the iceberg.

What the above reforms share in common is that they all add up to a major redistribution of the Chinese economy. If executed correctly, these policy changes will take economic benefits away from some interest groups, such as state banks and state-owned enterprises, and transfer them to new beneficiaries. Thus far, China’s new leaders have tinkered with energy prices and other issues, but they have not pushed hard enough to generate real distributive loss. For that, they will need the support of the larger Central Party Committee. The upcoming plenary meeting will signal whether they have that support, and if so, in which policy areas.

November’s meeting will reveal macro-level political signals but not micro-level details

Over the past few months, President Xi and Premier Li have circulated working drafts of their preferred economic reform plan among key CCP leaders, ministerial officials, and select policy experts. The circulating document is called the “Central Committee Decision Regarding Some Critical Issues in the Deepening of Comprehensive Reform,” and its contents are strictly confidential.[5] The final version of that document—which will reflect months of internal debate—will be discussed formally and voted on by the full committee at the November plenary session.

The Center for American Progress brought a delegation to China in September and discussed economic reform with multiple top party and government leaders. All refused to divulge the specifics of the circulating draft. What they did divulge was that President Xi and Premier Li were trying to build support for major redistributive reform, but that wrangling among interest groups was ongoing, the final plenum document was still evolving, and state-owned enterprise reform, in particular, would be very hard to achieve in the near term.

They also stated that President Xi and Premier Li designed the new Shanghai free-trade zone to serve as a test bed for key economic reforms that they hope to eventually roll out across China.

Based on those conversations, the final plenum document will most likely present a range of cautious distributive reforms designed to slowly turn China’s economic ship without inflicting too much damage too quickly. We are unlikely to see full liberalization of energy prices, a complete dismantling of the household registration system, or a major dismantling of the state sector in the near term.

If the plenum can at least send a strong political signal that the party is headed in that direction, however, that alone will be a major step forward. A pro-reform plenum document would send a signal that President Xi and Premier Li have enough high-level backing to move forward with at least some major change, and that would give the new leadership enough momentum to get started on some of these programs.

We will have to wait until next week to find out what the final version actually entails. For China’s sake—and the United States’—let’s hope this meeting kicks off a new wave of change in Beijing.

Melanie Hart is a Senior Policy Analyst at the Center for American Progress.

Endnotes