On China's recent reforms push

Friday, 29 November 2013 - 1:36pm IST | Agency: DNA Webdesk
Lalit Contractor looks at the issues raised by the sweep of proposals put forward by Xi Jinping to enable China's long mach forward
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Last week, China released two eagerly anticipated documents at the end of their plenary session that drew contrasting responses from analysts and markets. The documents were meant to be viewed as a signal of intent on the part of the new leadership, to show that they were aware of what needed to be done amid fears that the breakneck growth that so spectacularly launched China on its path to superpower status may be evening out (a growth rate of 7.7% over the first three quarters of this year marginally outperformed state estimates).
 
Analysts were disappointed by the vague tone of the document released last Wednesday, which while reflecting awareness of the bumps on the country’s march to prosperity, was couched in the characteristic ‘exhortative banalspeak’ that often seems deliberately ambiguous. Two days later, however, Paramount Leader Xi Jinping released a considerably more detailed 60-point plan that had many analysts and China watchers in rapturous disbelief about the scope of the proposals, ranging from the conditional relaxation of the controversial One-Child policy to a reevaluation of the ‘re-education policy’ first instituted by Mao (a euphemism for forced labor camps), from relaxing interest rate controls to allowing the market to decide prices of natural resources and utilities like oil, water, and electricity, while also covering rural-urban migration reform, judicial reform, ‘social organizations’ (i.e. NGOs) and the convertibility of the Yuan. 
 
The sweep of the proposals seems staggering, especially to observers in a country who are sadly au fait with the term ‘policy paralysis’. The imprimatur of Mr. Xi is significant and has undoubtedly contributed toward the flow of reactions rushing out from all interested corners of the world, as it suggests a personal vision and drive behind these proposals from a hitherto inscrutable individual. This is reinforced by the fact that the Premier Li Keqiang was not mentioned in the official release, especially as economic policy has traditionally been the province of the Premier (with the Leader of course having the final say). It has also reassured analysts and markets that Mr. Xi does not wish to alter course from the liberal policies enacted by his predecessors over the past few decades despite his rather pro-authoritarian utterances over the past year. Some have interpreted the popularity that the disgraced conservative leader Bo Xilai enjoyed till recently as indicative of the presence of an atavistic Maoist sentiment that despaired over both the loss of traditional values and rising levels of corruption instigated by liberalization.
 
As China grows into its role as a leader, the increased awareness of its citizens and public opinion, bolstered by the Internet and microblogging sites like Weibo, has become a force to reckon with for the Communist Party of China (CPC) leaders. It seems likely that the inclusion of such social proposals not directly related to growth (e.g. labor camp reevaluation, de-escalation of capital punishment as a form of justice, judicial reform and allowing ‘social organizations’ to operate) is an attempt to signal cognizance of & accommodate these new tests that have accompanied the development process. 
 
By far the most eye-catching proposal has been the selective relaxation of the One-child policy, first introduced in 1979. While this was eased even earlier for couples in rural areas, who were allowed to have two children if the first child was a girl or if both partners were single children themselves, the new proposal intends to expand this feature to couples with only one single-child partner. This may be an attempt to counter the increasing age profile and loss of demographic dividend advantage, but authors like Meng (2012) have argued that the One-child policy didn’t have much of an impact, particularly in rural areas, and rich couples often preferred to pay fines in order to have more children. The cost of raising children has been going up as well, so the impact of the proposed reform seems uncertain. However welcome this proposal is, it basically re-emphasises the control of the CP over reproductive decisions, and will remain an item of intense debate.
 
The prickly issue of migration has also been broached. Urban residency is governed by the hukou system of permits, for rural and urban areas. Rural hukou holders are often denied benefits that urban employees enjoy, particularly work-related benefits. This, coupled with the seasonal nature of rural migration, has led to rural migrants returning to their homes after an average duration of seven years. The desire to keep key city sizes (like Beijing, Shanghai and Guangdong) within reasonable limits, as well as property price appreciation concerns have led to the creation of several smaller cities to accommodate the migratory trend. However, the denial of these benefits in an increasingly prosperous and aware society has been criticized, spurring more egalitarian action. So, farmers now will enjoy greater freedom to transfer their property rights, which will potentially make migratory moves irreversible. The desire to expand the safety net and reduce differences between private and public pension schemes will require innovative steps given the ageing demographic structure, for e.g. an increase in the retirement age. 
 
More interesting to the markets have been the attempts to increase the competitiveness of the economy, in particular interest rate decontrol and currency convertibility. This has been a long-standing desire of several economists, who have observed that as China integrates into the world economy and becomes more advanced, the crude measures that were previously used to control the economy will no longer remain suitable. In particular, Chinese monetary policy-makers have been unable to use interest rates as an instrument, because of the pegging of the Yuan (which started in 1995). Therefore, the People’s Bank of China (PBC), facing the ‘Impossible Trinity’ has been reliant on direct control over lending decisions of banks, capital outflows etc., which have created their own distortions.
 
China has received record levels of FDI over the past few years, as speculators anticipated impending Renminbi appreciation. This, along with the restrictions on operations of foreign financial service providers have led to a paucity of investment options for domestic savers aside from deposits in State-run Banks. This has led to a surplus of liquidity in the banking system, which has been channeled back into capital investment, leading to overcapacity issues and crucially Non-Performing Loan (NPL) problems in the event of growth deceleration, as had been the case recently. Large inflows have also stoked fears of bubbles, particularly in real estate, which might be terribly damaging in the event of negative shocks. By allowing interest rates to be market determined alongside the equally important currency reforms, China is signaling its intent to have a more effective, independent monetary policy while also allowing its financial sector to develop better, perhaps at the cost of some short-term pain for state-run lenders. It is also keen on managing inflation, which recently touched 3%, sparking liquidity tightening expectations.
 
Also, by sanctioning investment abroad by native Chinese and opening up the financial sector, the CPC is facilitating the growth of a strong financial sector. The massive State owned banks will likely face increased competition as a proposal to open up the banking sector to established private players has been mooted, quite similar to the RBI’s decision to invite applications for banking licenses earlier this year. More competition may also affect State Owned Enterprises (SOEs), whose profits have been channeled into the party’s various redistributive schemes.
 
In an attempt to keep enjoying the scale economies and agglomeration benefits, Free Trade Areas (FTAs) like the recently inaugurated one in Shanghai will be promoted. FTAs are essentially test grounds where market forces hold sway, and where decontrol measures are enacted. In addition, the document also mentions measures to bring the benefits of trade to the hinterland, through improved transport and connectivity.
 
Despite these measures, CPC leaders are well aware of the need to move to a consumption-oriented growth model, especially after the experience of the recent recession, which required massive intervention to prevent a significant downturn. Savings rates have been high for a country at its stage of development for the various reasons mentioned above.
 
It remains to be seen whether and when these wide-ranging measures will actually be enforced, although the tone of the proposals is one of decisiveness and a clear understanding of the problems. Sinologists like Barry Naughton have argued that political motivations are inextricably linked with reform proposals, citing evidence from both the late 1970s-early 1980s, and the Jiang Zemin era of the 1990s. According to this perspective, there is a symbiosis between the forwarding & nature of reforms, and the strengthening of the CPC. Although both agriculture and industry were incentivized via the market, they were both tied down to the regime in numerous ways (advancement prospects, discretionary financing etc.), thereby keeping power in its hands. Thus, potential alternative power structures were never really allowed to form, but were integrated into the incumbent system, often through flexible interpretations of ideology. It is not surprising then that neither Deng nor Jiang made significant attempts to alter the political status quo despite democratic voices growing louder during their tenure. The recent proposals too do not mention political reforms, and some of the measures like the formation of a National Security Council, and the constitution of a small group to oversee economic reforms suggest that the CPC does not intend to weaken its hold anytime soon. Nevertheless, they represent a crucial juncture that will do much to shape the future trajectory of the Chinese growth story.
 
 
References for the curious reader
 
For an overview of the Chinese economy and explanations behind its spectacular rise, see Barry Naughton’s ‘The Chinese Economy: Transitions and Growth’, 2007, MIT Press and the chapters in ‘China’s Great Economic Transformation’, edited by Loren Brandt and Thomas Rawski, 2008, Cambridge University Press. Eswar Prasad and Justin Yifu Lin, among many other economists, have written extensively on China’s macroeconomy. The symposium on China in the Journal of Economic Perspectives, Fall 2012 issue, which includes the Meng study cited above, is illuminating. The Wall Street Journal has been particularly good in its coverage of the key recent reforms. Finally, a comprehensive account of the evolution of policy and its interaction with politics, among other things, can be found in Jonathan Fenby’s ‘Penguin History of Modern China’, 2008.
 
 
Lalit Contractor has a MPhil in Economics from Oxford University and is curious about the relationship of Economics in the areas of Politics and Society.

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