The communiqué issued after the Communist Party of China’s behind-closed-doors Third Plenum — intended to set out a blueprint for the next decade of the country’s economic reforms — perfectly captured the contradictory challenges facing the leadership of the world’s second-largest economy. The reforms, the communiqué said, would give markets a “decisive” role in the economy but also “unceasingly increase the energy, control, and influence of the state economy.” With a likely unintended touch of irony, it added that “the core issue is to straighten out the relationship between government and the market.” Quite.
President Xi Jinping and Prime Minister Li Keqiang know that the current iteration of “Socialism with Chinese characteristics” — the rubric for the state capitalism that has delivered three decades of rapid growth, lifted millions of Chinese out of poverty and legitimized the Party’s monopoly of political power — has all but run its course. It has left China, though, with a politically entrenched public sector of state-owned enterprises that dominate the economy, particularly in banking, energy, telecommunications and transport.
Key industries all. The glaring issue, however, is that the big state-owned players within them are not particularly profitably run, and are getting less so. Their rate of return on assets has fallen to less than half that of privately owned Chinese companies. If China is to rebalance towards a consumption- and innovation-driven economy to power its next phase of growth, state-owned enterprises will have to be scaled back to provide more room for the private sector.
The absence after the plenum of more detailed plans for reform, and in particular reform of the public sector, was not unexpected. It is nonetheless a marker of how entrenched are the big state-owned enterprises, including the banks. Their power, privileges and connections are too intertwined in the Party and government’s power structures for the new leadership to confront directly, no matter how urgent the need.
Not that the leadership has any intention of dismantling them. In several sectors of the economy, state-owned giants are China’s national champions and proto-multinationals, and will continue to be so. Nor is privatizing them wholesale on the cards. Xi is no Thatcher in that regard. China has noted the lesson of Russia, where full privatization, particularly in the pillar industries, created large areas of privately owned property beyond officialdom’s sway — areas which subsequently had to be reined in at the expense of considerable political effort.
What is most likely to happen is that China’s state-owned enterprises will continue to be opened up to more diversified (though never majority) ownership with the aim of bringing in new capital and management expertise. That latter will, it is to be hoped, bring more market disciplines with it. The growing liberalization, internationalization and innovation in the economy demands an increasing degree of professional managerial expertise and governance from state-owned enterprises. Cadre core skills such as price controls, plan fulfillment and quota-setting are not the functional skill set required in a modern multinational.
The headlines from the plenum have made much of the elevation of the markets’ role from a “basic” to a “decisive” one. Despite the conservative-sounding rhetoric of much of the communiqué, this change in language is a significant advance for the reformers. It is important to realize, though, its precise import: markets will take over from government the leading role in pricing, particularly of interest rates, land, energy and water, with the intention of promoting more efficient allocations of those resources than the present system of subsidies. It decisively does not mean throwing open China as a free-market economy.
A top working group to co-ordinate “comprehensively deepening reform” is to take charge of this process. Such teams are typically set up to coordinate important policy implementation among the multitude of Party and government agencies that run China. What is as yet unknown: who the group’s members will be and how much power they will have over the setting and implementation of the detailed policies needed to flesh out the overall reform agenda. A nagging question here is whether the effort will be just another iteration of the standoff between conservatives and reformers so much in evidence at the plenum.
The areas highlighted for reform — fiscal and tax reform, unified land markets, a sustainable social security system, and rural property rights — are more directly amenable to Party and central government discipline, and impinge less directly on the state-owned enterprises’ immediate interests with the exception of the banks. (Their trade-off for reforming will be to absorb business from the shadow banking system.) These are all significant areas of reform. Collectively they should, over time, change fundamentally an institutional environment based on formal and informal personal connections — one where political capital is as important as financial capital. Loosen the grip over both, and the rest, eventually, will follow.
The long game for Xi and Li — and China’s economic reform will continue to be cautious and measured — is that this will open up enough space for private and foreign firms and market disciplines to chip away at state monopolies. This will, when done to a sufficient degree, get the state-owned enterprises to modernize themselves; it will also give time for the political elite, which has gained an extensive stake in the economy, to adjust to the new realities by absorbing the new wealth that will be created by the new growth model, just as the old elites absorbed the wealth creation of the infrastructure-driven economy of the past 30 years.
The Party has so far proved remarkably adept at absorbing the rise of private wealth that elsewhere in industrializing economies has led to the creation of new centers of political power. But its Catch-22 is that it has to continue to create that wealth to sustain its claim to its legitimacy of monopoly rule. Reform is as essential to the Party’s survival as it is to China’s development. But free-market capitalism has no meaning in China, if by free is meant free from the Party’s leading role.