Article

China’s ‘Big Bang’

Daniel H. Rosen February 3, 2014

Xi Jinping’s fingerprints are all over the reform agenda unveiled after the Third Plenum, but they must be implemented soon to meet the country’s 2020 deadline

With the endorsement of “big bang” reforms by November’s Party Plenum, it is safe to anticipate more volatility in the Chinese economy. There are many questions about what comes next, and a close analysis of the reforms, from which one can sketch a pattern for growth in 2014, provides answers.

The reform agenda laid out in the key Plenum policy document, the Decisions, is less anodyne than the Plenum Communiqué, which came out first and baited some pessimists to declare victory prematurely and erroneously. Some 40 percent of the Decisions deal with economic policy matters and political processes, essentially consolidating power in Xi Jinping’s hands through the creation of executive office-type policy implementation bodies above the traditional bureaucracies, including the National Development and Reform Commission (NDRC). Traditionally, the Third Plenum has been dedicated to economics, and this one certainly was — as well as the politics key to passing meaningful economic reforms.

Some observers had predicted the scope and timing of Beijing’s actions as far back as December 2012, but most were taken by surprise by the breadth of reform. The formal Decisions and Xi’s informal gloss together present an unequivocal statement that economic reform and domestic and external opening to market forces, not state intervention, have been the source of China’s success the past 35 years.

Moreover, they made clear that continued reform and opening to market forces is the only way to succeed in the future — for the people, for the Party and for China as a great power. Our favorite maxim is from President Xi Jinping: “Reform and opening up was a crucial decision that decided the destiny of contemporary China.”

That is unambiguous. And this is Xi Jinping’s baby — not the tagline of some technocrats, negotiated into the rhetoric by committee decision. Xi’s personal ownership of the Plenum and the reform program is everywhere to be seen. He is responsible for tightening the leash on civil society, which he believes is necessary to maintain order as the nation dives into a period of necessary structural adjustment and military and security modernization to become more powerful, perhaps with more political oversight and less corruption.

On the foreign policy front, there have been discussions about whether China would “hide its capabilities and bide time” — a diplomatic strategy that Chinese government attributed to Deng Xiaoping — as it did in the past two decades. Keep in mind that political leaders faced with severe domestic adjustment risks sometimes emphasize external tensions to distract attention away from internal challenges.

The deadline

The Plenum documents only mentioned 2020 as a completion date for the reform goals. If Beijing is serious about 2020, there must be immediate, meaningful implementation on most fronts.

The People’s Bank of China on December 2 issued implementation guidance for the Shanghai Free Trade Zone (SFTZ), for example, setting out aggressive cross-border capital flow policy changes for Shanghai. Shanghai PBOC Chief Zhang Xin said the goal was to implement most of the measures in three months, and then forge a financial management model applicable to the rest of China in one year from now. This is far more aggressive than the two- to three-year timeline laid out in the initial SFTZ development plan by the State Council in September.

Looking forward, our short-term assessment is that China will average GDP growth around 7 percent in 2014. Most analysts are looking for higher numbers bolstered by growth drivers unleashed by the Plenum package, ranging from 7.2 percent to 7.8 percent, and the IMF has it at 7.3 percent (down from 2013, which should come in around 7.6 or 7.7 percent). To us, those higher numbers suggest less restructuring.

The lower outcome would be significant for two reasons: it would acknowledge a trend that potential growth is slowing as a result of moderation in the unproductive components of fixed investment; and it would demonstrate that Beijing is not palliating the economy with policy-driven offsetting investments to counter that reality. To do so would undermine that structural adjustment and reform imperatives they are committed to, and which are critical in order to buttress sustainable growth over the medium-term and beyond.

The upside

Looking to the medium-term (2015-2017), assuming that Beijing sustains its commitment to the reform course — which we do assume — the arithmetic supports a 7 percent trend GDP growth average. We would expect the end of 2014 and 2015 to be on the higher side of the trend line, as investment appetite surges from the volatility and dislocations of the first half of 2014 as businesses digest the upside opportunity created by reform.

By the end of 2017, we are on the lower side of the period average, call it the high 6s, and for the three years 2018-2020 we are looking at 6 to 6.5 percent potential real GDP growth. For 2021-2025 we are between 5.5 and 6 percent.

These growth rates are off a much higher base (at some point in that period China is very likely to have surpassed the nominal size of the US economy), and a much different base of activity than the heavy industry, heavy footprint we know China for today.