China in 2012: Political Challenges in China’s Economic Governance

Just as in the political and social arenas, the economic focus of the Hu Jintao-Wen Jiabao administration in 2012 will be upholding stability. In view of factors including the Eurozone debt crisis—which will impact on China’s exports to Europe adversely—top priority is being put on preventing a hard landing of the economy. The big question for this year is, with the Chinese Communist Party (CCP) leadership preoccupied with holding the fort, will new initiatives still be introduced to attain the long-standing goal of rationalizing and reforming the economy?

The tension between preserving stability and furthering reforms has been highlighted by Beijing’s efforts to prevent a hard-landing of the economy. Recently announced figures by the State Statistical Bureau showed China’s GDP grew year on year by 8.9 percent in 2011, down from the comparable figure of 9.1 percent for 2010. In anticipation of a further economic downturn, a series of high-level financial meetings held by the party and state leadership in December recommended a significant loosening of the country’s tight monetary policy. For example, the “loan target” for 2012—the extent of credit that Chinese banks are allowed to extend to domestic enterprises—is fixed at 8 trillion yuan ($1.27 trillion), or 500 billion yuan ($79 billion) more than that of 2011. And the M2 money-supply growth rate is set at 14 percent compared to 13.5 percent the year before (Reuters, January 11; Ming Pao [Hong Kong], January 12).The newly available credit—which could be used to prop up the stagnant housing market as well as to finance more infrastructure-related ventures—represents a continuation of the much-criticized strategy of realizing GDP expansion through state investment. 

Despite the obsession with stability and the penchant for sticking with time-tested means to re-inflate the economy, this year could be a watershed in the Chinese Communist Party (CCP) administration’s long-standing effort to restructure the economy. Major targets for 2011 to 2015 have been laid down in the 12th Five-Year Plan (12FYP) released in late 2010. Traditionally, the second year of every five-year plan is deemed crucial for its satisfactory completion. While Executive Vice Premier Li Keqiang is not expected to become premier—and China’s economic czar—until March 2013, the key protégé of President Hu’s was already given more authority over economic planning and  “macro-level adjustment and control” (hongguan tiaokong) early last year. To both consolidate power and boost his national stature in the run-up to the 18th Party Congress in late 2012, it is possible that Li will map out far-reaching economic strategies in the coming months. Similarly, other prospective Politburo Standing Committee (PBSC) members with known ambitions to reform the economy, such as Vice-Premier Wang Qishan, also might want to turn the current crisis into an opportunity for showcasing their talent for ushering in new solutions.

The foremost indicator of China’s economic health— and the sustainability of the so-called Chinese economic miracle—will be the extent to which domestic consumption will play a bigger role in GDP expansion. For some 30 years, the CCP leadership has depended on government cash injections—mainly fixed-assets investments in infrastructure, housing and other areas—in addition to exports as engines of growth. In the past decade, government outlays have consistently taken up at least 50 percent of GDP. Indicative of the leadership’s determination to retool the economic is the frank admission by President Hu last month that “at this stage of China’s economic development, questions of imbalance, lack of coordination and unsustainability are still very pronounced” (Xinhua, January 13; China News Service, December 14, 2011).

In spite of the consensus within the leadership that the key to sustainable growth is boosting domestic spending, household consumption as a percentage of GDP has declined from 50-odd percent in the 1980s to just 34 percent (New York Times, December 18, 2011; Financial Times, March 14, 2011). To encourage Chinese – particularly workers and farmers – to spend more, the government has repeatedly raised the minimum wage as well as social-insurance payouts. For example, Beijing pledged at the outset of the 12th FYP that worker’s income will increase annually at least at the same rate as GDP. Medical insurance, once available only in the cities, has the past few years been extended to more than 90 percent of rural townships and villages (Global Times, November 16, 2011; Beijing Morning Post, December 13, 2011).

Yet the main reason behind Chinese consumers’ tepid spending is that the bulk of the wealth generated by the “world factory” in the past two decades has gone to state coffers as well as yangqi conglomerates, or state-owned enterprise (SOE) groups that are directly controlled by the party-state apparatus. Equally detrimental to consumers’ spending power is the deliberately low interest rates set for Chinese citizens’ 80-odd trillion yuan’s ($12.7 trillion) worth of bank deposits. This has resulted in the equivalent of up to 7 percent of GDP being siphoned off annually from households to benefit government banks and their SOE borrowers. Moreover, for the past decade or so, the salaries of workers as a proportion of GDP have fallen by an estimated 1 percent each year (China Youth Daily, January 5; Xinhua, September 27, 2011; Businessweek, August 6, 2010). Whether Premier Wen and Vice Premier Li will roll out policies to reverse the trend of “rich state; poor citizens” (guofu minqiong) is a good yardstick of Beijing’s commitment to rationalizing the economic structure and promoting more equitable income distribution.

Two related areas where seminal developments may take place this year with significant impact on economic reform merit scrutiny. One is the globalization of the renminbi, or yuan. The renminbi’s internationalization will mean not only that it will be freely convertible but also that its valuation will be less subject to state fiats. The yuan appreciated by 4.27 percent against the U.S. dollar in 2011. Full liberalization will make for a higher rate of appreciation. While this may hurt exports in the short run, it also will lessen Beijing’s dependence on trade surpluses as a locomotive of growth. Moreover, a freely convertible yuan will expedite the development of Shanghai and other mega-cities into international financial centers. Equally significantly, a stronger yuan will boost consumer spending in view of the fact that imports will become significantly cheaper (Reuters, December 26, 2011; The Economist, October 16, 2011).

Yet a tug-of–war has erupted within the central government over the pace of yuan globalization. The Ministry of Commerce and other departments close to China’s powerful export section do not favor a drastic reform of the yuan. It also is not surprising that many experts have spoken out against a faster pace of currency reform. For instance, Huang Yiping, Economics Professor at the China Center for Economic Research at Peking University, noted in New York last week that it would be hard to argue the yuan was undervalued when China’s trade surplus was only 2 percent of GDP. There are indications, however, that more forward-looking officials are toying with bolder visions. Several senior government officials and advisors have the past year leaked to the overseas media rough “deadlines” for the yuan’s internationalization. These have ranged from 2015 to the end of this decade (Bloomberg News, September 8, 2011; Businessweek, September 25, 2011). Premier-in-waiting Li will have no better platform for demonstrating his reformist credentials than a resolute and speedy resolution to the long-standing question of the internationalization of the Chinese currency.

The other touchstone of Beijing’s commitment to economic liberalization is whether a brake will be put on the disturbing trend of guojin mintui, or the state sector making advancements at the expense of privately owned enterprises (POEs). “In recent years, China seems to be embracing state capitalism more strongly, rather than continuing to move toward the economic reform goals that originally drove its pursuit of WTO membership,” said the U.S. Trade Representative’s Office in its annual report on the Chinese economy. The enhanced status of the state sector is a major reason why China was ranked a lowly 138th in the Heritage Foundation’s annual world index of economic freedom (Associated Press, December 13, 2011; Globalpost.com, December 1, 2011; Heritage Foundation, January 12).

While the number of government enterprises has decreased significantly from the early 1990s, the remaining state-held firms—about 130 yangqi and several thousand regional SOEs—have been given much more monopolisitc powers. Particularly since the onset of the global financial crisis, SOEs have gone on a spree of nationalization during which they have snapped up thousands of relatively well-run and lucrative POEs. The bulk of the government’s investments as well as bank loans is still going into the state sector. For example, close to 90 percent of the 4 trillion yuan ($633 billion) that the State Council pumped into the economy in late 2008 has benefited SOEs rather than non-state-sector firms (Sina.com, October 9, 2011; Southern Metropolitan News, September 23, 2011). By contrast, some of the most active and efficient POEs in quasi-capitalist havens in the coastal provinces of Zhejiang and Guangdong have gone bankrupt due to factors including failure to secure financing from state banks (See “Beijing Battles Brewing Crisis in Financial Sector,” China Brief,  October 14, 2011).

In the past few years, the guojin mintui trend has been supported by the 130 or so yangqi, many of whose chairmen and CEOs are either princelings or ministerial-level cadres who have already been inducted into the CCP Central Committee. Highly respected economists, who have the ears of reformist leaders such as Wu Jinglian and Li Yining, however have upped the ante in their critique of the nationalization trend (Yangcheng Evening Post [Guangzhou], September 29, 2011; China Daily, September 2, 2011; Xinmin Evening Post [Shanghai], March 4, 2010). A reversal of the guojin mintui policy could help realize pledges by both Hu and Wen to spread the wealth more evenly. Given that the great majority of Chinese workers are hired by POEs, a bigger role for the private sector will not only advance the goal of social justice but also enable ordinary citizens to have more money to spend. Equally significant is that a healthy and vibrant private sector is essential to boosting indigenous innovation, which is another major goal of the 12FYP. It is true that in tandem with the leaps-and-bounds expansion of the economy, Chinese technology has scored some impressive triumphs. Spectacular high-tech breakthroughs since the late 2000s have ranged from the world’s fastest computer and speediest train service to the installation of a semi-permanent scientific station in outer space (The Guardian [London], November 3, 2011; New York Times, October 28, 2011).

The Chinese approach to innovation however is still reminiscent of that of the former Soviet Union. Within the 12FYP period, Beijing is spending $1.5 trillion to boost research and development (R&D) funding for seven key sectors that range from green energy to IT-related technologies. This dovetails with the long-held tradition that the bulk of China’s technological innovation emanates from laboratories and R&D facilities in SOEs as well as military units. Yet state-dominated innovation may not be working that well. For instance, while China boasts the world’s largest number of scientists and engineers—more than 53 million—most of the core technologies used in China still have to be imported from the United States, Europe, Japan and South Korea (Reuters, July 7, 2011; Qdcaijing.com [Qingdao], February 19, 2011; Forbes, January 20, 2011). Not a single Chinese firm was featured in the “Top 100 Global Innovators” list of the world’s innovation-driven companies compiled by the Thomson Reuters agency late last year. As is well-illustrated by the Silicon Valley model, the great majority of of innovative and technologically advanced products and services in Western countries hails from private firms (New York Times, January 1; Reuters, November 15, 2011).

Apart from formulating more market-oriented policies, the CCP administration needs to reform China’s tradition-bound and unwieldy government structure. The conventional wisdom that one-party authoritarian rule makes for efficient policymaking does not seem to apply to China—or at least not oversight of policy implementation. Take monetary and fiscal policy. Decision-making powers in this crucial area are split among at least the following departments: the CCP’s Leading Group on Finance and Economics, the premier’s office, the National Development and Reform Commission, the People’s Bank of China, the Finance Ministry, and the China Banking Regulatory Commission. Moreover, despite well-established top-down command-and-control mechanisms, central authorities often have a hard time monitoring the finances of sub-national administrations. This accounts for the fact that theoretically illegal underground banking institutions have cobbled together a credit market worth 10 trillion yuan ($1.6 trillion). Additionally, local governments along with 6,587 government-related investment and financial companies have run up debts totaling an estimated 14 trillion yuan ($2.2 trillion) (Bloomberg News, December 19 2011; Wall Street Journal, December 10, 2011).

It is significant that, immediately upon being promoted to Executive Vice Premier in March 2008, Li helped Wen formulate a master plan to restructure government departments with a view to centralizing authorities in a number of “super-ministries” (See “Beijing Unveils Plans for Super Ministries,” China Brief, February 4, 2008). One proposal entertained at the time was the establishment of a Super-Ministry of Finance to take charge of monetary and fiscal policies. The creation of a Super-Ministry of Transport also was proposed to unify and coordinate policymaking affecting railways, highways, aviation and marine transport. Owing to opposition from vested interests, however, most of Wen and Li’s plans failed to materialize (China Daily, March 11. 2008; China.org.cn, March 5, 2008). Nonetheless, the National Energy Commission, which was set up in 2010, was an effort to unify decision-making on energy-related matters under one roof. Whether premier-in-waiting Li would soon give another big push to restructuring the central-government bureaucracy merits careful attention.

The near-universal condemnation of the Ministry of Railways in the wake of the July 23, 2011 high-speed train disaster in Wenzhou has given institutional reformers within the State Council a God-sent pretext to revive the old agenda of setting up a Super-Ministry of Transport. Vice Premier Wang Qishan, who is in line to become Executive Vice Premier after his expected induction into the PBSC at the 18th Party Congress, is known to favor the creation of a Super-Ministry to handle monetary policy. It is thus possible that Li and Wang soon join forces to lay the groundwork for a thorough restructuring of central government units in the near to medium term.

As Premier Wen has reiterated, “without reform of the political structure, achievements attained in economic reform could suffer a serious setback” (Chinanews.com.cn, September 14, 2011; China.com.cn, August 23, 2010). Factors key to the rationalization and reform of the Chinese economy, such as boosting the private sector and allowing ordinary citizens to enjoy a bigger share of the economic pie, hinge upon whether the CCP leadership is willing and able to resuscitate political and structural reform. However, given the apparent consensus among disparate factions that political liberalization would jeopardize the CCP’s “perennial ruling party status,” the possibilities for resolute steps in this direction may not be high this year.