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Society & Culture

China’s Formidable Reform Agenda

Mar 13 , 2014
  • Kerry Brown

    Professor of Chinese Studies, Lau China Institute at King's College, London

The meeting of the Third Plenum late in 2013 made clear that the reform agenda that Li Keqiang and his colleagues are facing is a formidable one – formidable enough to have set up a leading group entirely focused on reform alone. Reform as a concept is a good one in contemporary China. But when you talk of the details, it becomes much more difficult to know what reform actually means. This is the reason why the National People’s Congress, the annual parliamentary meeting, held this year in early March was important. It is the highest profile opportunity to hear what specifics this relatively new administration is going to aim for within the generic reform aspiration.

Some things which were already known have become clearer. For this administration, the key issue is that growth will now be more modest. The era of double digit expansion is now over. So on a 7 to 7.5 per cent annual base, the key challenge is to find growth through efficiencies in the economic structure. And that means looking to the state owned enterprises in particular as places where reform needs to be performed.

State owned enterprises (SOEs) still dominate the key strategic sectors of the economy, from resources to telecoms to finance. Since the global economic crisis of 2008 they have been regarded in China as protective bulwarks against the vagaries of the external unpredictable international financial environment. But as the world returns to better growth, the SOEs are a problem for one reason: they are profitable. The quality of that profit however is not as good as the non state sector in China, and in raw terms they are delivering lesser amounts. In early 2013, the SOE sectors profits were 5 per cent, that of the non-state over 7 per cent. So while politically Li Keqiang has made it clear he wants to support the SOEs as a source of control for the economy, in terms of a return on investment, the non-state is the best bet. How do you manage to have a framework that gets the best from both realms? So far, very little has been said about this.  

This is probably because reform of SOEs will involve stepping on the toes of some powerful vested interest. The petrol sector has recently been receiving a lot of attention, with the purge of a network associated with Zhou Yongkang, former Politburo security chief. The petrol sector is extremely important for China, with its vast resource needs. But in recent years it has become overwhelmed by illicit profits and by corruption. This is precisely the sort of inefficiency the Party must now concentrate on controlling. For Xi Jinping and the leadership around him, corruption is not so much a moral issue as one of inefficiency. Corruption eats away at growth and profits eventually. But there will be powerful political and money networks that will be affected by this. And so the unity and will of the leadership will be under pressure. Reform in this area in highly political and it is too early for Li to say anything explicit about how this aim is to be realized.

Reform for this leadership also means equity, and that was also clear from the NPC. China’s growth model for all its successes in the last decade has been one in which growth has been privileged over balance and sustainability. There are now social and environmental issues (and the two are connected) which need urgent attention. Under Hu Jintao and Wen Jiabao, China became a rich country, but also a highly unequal one – a country of billionaires but also of poor and malnourished. This stark difference between the winners and losers of the whole reform process has created great contention in society, leading to unrest and protest which, according to the NPC of 2013, cost over 100 billion USD to address.

Inequality in China while growth is high is manageable because everyone can at least hope that tomorrow will be better than today, and that the sufferings of poverty now will end with a richer and brighter future. But as growth falls, so does optimism that things will get better. In order to address this imbalance, China will need to finally reform its household registration system which institutionalizes a great deal of inequality between rural and urban residents. This will involve local governments finally having the incentives to have rural migrants moving into their areas have access to health and other social welfare. That, in the end, will mean a reform of the governance structures so that provinces and sub-provincial entities are able to have more control over their fiscal affairs. China is currently a highly centralized system in terms of fiscal powers. At the plenum meeting last November there were important announcements about the reform of this fiscal system. But there was less information about precisely how the provinces would be given more powers. This process of decentralization will become more important from now on for one very simple reason – China is currently too large to administer in a highly centralized way under the current system. And on this critical issue, once more Li Keqiang did not delve into specifics, but just reiterated the importance of the overall objective.

This is probably because decentralization of powers, particularly fiscal ones, will be a vast administrative and political challenge. Beijing will have to balance the rewards of having more decisions made locally where they can be informed by local conditions and knowledge against the threats of having over mighty provinces start to act more unilaterally. The specter of fragmentation in China is an ancient and terrifying one, and so the Li government will want to find a framework that balances more decentralization in some areas against control in others. This will be a complex negotiation and not one that can be dealt with at one meeting.  

Associated with this is the issue of urbanization. If there is one policy area where Li Keqiang has spoken more consistently in the last few years it has been about the need to make China an urban economy soon. In the 2010 census China was, for the first time, fifty per cent rural and fifty per cent urban. But the ambition of the government is to lift this figure to as high as 70 per cent by 2020, when China is due to become a middle income country with a per capita income of USD12 thousand. Li Keqiang has made it clear that this dream of middle income country status is only realistic if China is predominantly urban.

The reason an urban China is so important as an objective for reform for this government is simply because only an urban China will deliver the sort of rising consumption, more service sector orientated economy that China needs. An urban China will be an easier country to administer and a place where many of the fiscal challenges will be soluble – or at least more soluble than if China were to remain purely rural. So the concentration on allowing more people to move to cities and to find their economic destinies there is important.

Underneath this is also the vast challenge of the environment. Beijing’s recent plight of smogs shows that the last three decades of rapid industrialization have taken a terrible toll on the natural environment. Many Chinese are now distressed by the quality of the air, of their water, of the food they eat and the natural environment in which they live. This needs urgent attention. Li Keqiang talked of the need to support fast, sustainable growth. But that needs to be growth that balances the rising expectations of people towards their material lifestyles with the environment and its ability to serve these aspirations.

In terms of energy efficiency, China needs to have a different energy model, and one in which the addiction to fossil fuels which still supply from 70 to 75 per cent of the country’s needs is reduced. Renewables or energy sources like nuclear still only contribute a tiny part of China’s energy needs. There needs to be a period of radical innovation, where China is able to create a different energy profile. But this will be almost unimaginably challenging.  The 2007 15 year innovation plan will need to be revised and rethought because so far China’s innovation record, particularly in this area, has been disappointing.

Finally there is the issue of creating a finance sector in China. Shanghai has established its free trade zone, which supplies at least one framework. But finance will continue to be important as an urbanizing China develops and the need to have more sophisticated products grows. Finance will be a huge producer of GDP growth in China in the future, but finding the right model before China attempts to liberalise controls on its capital account is crucial. Shanghai’s role as a major finance centre here will be important, and more details will now need to be given in this area. The future of finance in China is important to the modernization of the economy, and for this reason any indications that the 2014 National People’s Congress give in this area will be very significant.

It is almost certain that the Chinese leaders are now entering into a period of tactical reform. Some things they can solve today. Some they will need to put off for the longer term. But the simple fact is that as China grows richer and its challenges clearer and more profound, so too does the need for a well thought-out reform plan. The current leadership has the institutional structures for pushing reform and they have made, last year and this, a broad political and economic argument for doing this. Now they just need to do it.

Kerry Brown, PhD is the Executive Director of the China Studies Centre and a Professor of Chinese Politics at the University of Sydney.

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