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The China Dashboard – Winter 2021

In 2013, a year after Xi Jinping came to power, China set out an ambitious market-oriented reform program. In the final instalment of the China Dashboard, we assess China's progress against the reform goals it set out for itself.

The idea of a “dashboard” to gauge Beijing’s progress in implementing its economic reform plans was born from the hopeful Sixty Decisions of the Chinese Communist Party (CCP) issued in November 2013. The Party Decisions, accompanied by a personal essay by President Xi Jinping explaining them, committed to make markets the “decisive” factor in the country’s long-term economic direction. As optimists cheered and pessimists snickered, Rhodium Group and the Asia Society Policy Institute set out to track implementation to see if China actually did it. We began in late 2015 with design work and then published quarterly evaluations from the fall of 2017. This winter 2020–2021 edition is the last in a five-year program. We offer final observations on the march from 2013 pledges to 2020 deadlines, a look at new policy announcements at the margin today, and our perspective on the future.  

Yesterday: Avoid the Blind Alley

Observers were unsure what to expect of Xi Jinping when he came to power in 2012. The global financial crisis had disrupted growth, triggering a wave of stimulative debt that was undermining productivity. Internal politics were a challenge, with powerful vested interests able to block needed reforms just as the middle-income trap arrived. Some intellectuals advocated liberal solutions for the economy administered by a regulatory state. Other so-called ”new left” voices counseled a more doctrinaire course emphasizing China’s brand of Marxist-Leninist authority. President Xi’s inaugural economic plan issued in November 2013, discussed at length in our report Avoiding the Blind Alley, had something for both sides. There were hundreds of pro-market objectives, but a commanding role for the state was retained as well. On the whole, the plan’s liberal elements were a surprise on the upside. We surmised this was intentional: expectations like these are not set by accident or as a feint.

Seven years have passed since then. Efforts to make good on the Decisions have come and gone, and in some cases come again. Reforms have generally been halted when they led to instability, which is most of the time. Industrial policies such as Made in China 2025 grew ever more heavily weighted in explaining China’s directions as the counterbalancing role of reform diminished. And over these seven years, with China breaking the $10 trillion GDP mark in 2014 (approaching $15 trillion today) and now taking off as a global direct investor, the less-liberal forces shaping outcomes inside China have begun spilling ever more quickly abroad.

Of the 10 clusters into which we consolidated the many commitments in the Party’s 2013 Decisions, six have seen reform run backwards (or stalled) on net, while four have seen some modest advancement.

The Good

Fiscal affairs, cross-border investment, innovation, and environment are the four areas that showed some progress. In fiscal affairs, the biggest improvement came from moving local government financing on the balance sheet by shifting from shadow financing to local government bond financing. While local bonds were introduced in 2015, bond financing did not take off until 2018 to offset the reduction in illicit financing due to deleveraging. This has helped bridge the local fiscal gap with more revenue and increased transparency and has helped with overall debt sustainability.

The improvement in cross-border investment is recent. Two-way capital flows relative to GDP fell consistently from 2016 to early 2019, but they have picked up in the past four quarters due to reduced barriers to inbound portfolio investment – reinforced by a dearth of opportunities worth investing in elsewhere in the world.

In innovation policy, China also achieved consistent progress. This reflects the strong state role in driving investment and rapid growth in innovation-intensive activities, but all at the cost of low investment efficiency, overcapacity, and market discrimination.

In environmental reform, China has reduced air and water pollution since 2015, though progress stalled in 2020 during the government’s response to the Covid-induced economic downturn. Water quality laws and local enforcement and testing have improved water quality, and this is likely to last. Beijing is trumpeting long-term carbon neutrality goals by 2060. Nonetheless, China simultaneously has been undermining those goals in the near-term by building extra coal power capacity and weakening environmental enforcement to stoke growth.

Reform progressed in these areas out of necessity: this is the overarching story of China’s reform implementation to date. The massive 2009–2010 stimulus left local governments with a decade of unprofitable legacy investments, and the proliferation of informal financing starting in 2013 meant authorities had little visibility into how localities funded activity. This is a recipe for crisis if left unchecked, and cleaning up local balance sheets was necessary to avoid that. Beijing dragged its feet on cross-border investment liberalization for years but finally accepted that it could not otherwise attract the capital it needed for the long-term balancing of China’s current account. Air and water pollution got bad enough to threaten Party legitimacy before it was addressed, with worldwide attention adding pressure. In innovation, the change is yet to come: ostensibly it is still improving, China’s technology prowess has drawn a global pushback that is rapidly changing production chains, with huge consequences still to come.

The Bad

This progress was outweighed by significant problems emerging in other critical areas of economic reform announced in the 2013 blueprint. Labor system improvement – defined as workers benefiting proportionally or better than economic growth – has seen the least progress. The gap between wage and GDP growth is larger than ever. Migrant workers still experience slower wage growth, and government spending on social welfare as a percentage of GDP has declined from 2015 levels. This was not for lack of effort. The government relaxed household registration (hukou)restrictions in mid-size cities. Beijing is making progress on pension fund centralization, expanding health insurance coverage, and raising social security contribution requirements from state-owned enterprises. Beijing assumed some welfare spending obligations from local governments and pushed the bureaucracy to spend more efficiently. But all these efforts have failed to increase worker compensation, job security and protections, and shared welfare.

Beijing remains far from realizing its 2013 state-owned enterprise (SOE) reform goals. SOEs were to be kept in “key and pillar” industries but removed from normal “commercial” sectors of the economy. Restructuring SOEs to ensure they operate efficiently was a goal, as was increasing their contributions to the social safety net. Actions taken so far have diluted state shareholding in a number of SOEs, reduced SOE financial leverage, linked SOE employee salaries to productivity, and forced SOEs to transfer 10% of state equity to social security funds. However, SOE presence across industries has barely changed, their efficiency has not improved, and more than 70% of the dividends they pay were reinvested back into SOEs themselves, not used for social spending.

Land reform never got off the ground. While the 2013 Third Plenum promised to allow rural residents to sell their land through markets, authorities have only piloted this reform in 33 counties, accounting for just 0.1% of China’s total rural nonagricultural land. These pilots concluded with a modest revision of the Land Management Law last year, which removed the main legal obstacles for transferring rural land in the urban market but reinforced the strong governmental role. Beijing even delegated more power to provincial governments to speed up the urban land use approval process in 2020, which may give them more room to profit from land sales at the expense of rural residents.

These reform failures share a common theme: China’s financial and economic institutions at this stage are too weak to overpower politically entrenched interests.  Fiscal imbalances constrain labor reforms, and despite progress on the revenue side, local governments are still overburdened by unfunded spending mandates imposed by the center. Changing local government incentives is the only way to redirect spending to China’s workforce. SOE reforms have failed because SOEs lack incentives to leave commercial industries to more competitive private firms. On land reform, there is no sign that Beijing is prepared to unleash rural households, and any attempt to do so would face strong resistance from local governments that have become more reliant on land sales than they were five years ago. These problems are systemic, not individual.

Today: Winter/2Q2020 Arguments

The eight years from 2013 to 2020 have been tumultuous. Xi Jinping did not so much avoid market reform as retreat in the face of instability. The important question is not whether China established a record of reform over the past decade, but whether the lessons it learned trying are being applied today. Crises present a chance to push ahead with difficult changes. The COVID-19 pandemic presented such an opportunity. The virus lockdown offered a compelling reason to adjust policy, while the strength of the current recovery presents an opening to build momentum. With reform promises behind schedule and potential growth slowing, proof of market-friendly intentions could convince foreign and private firms to remain engaged.

But despite a robust economic performance in the second-half of 2020 that puts the United States to shame, Beijing is not using the moment to invigorate its policy agenda. On the contrary, it is signaling rising reliance on statist solutions.  The role of SOEs is resurgent, and the dual circulation campaign emphasizes self-reliance over openness and a free, international market. Furthermore, the state’s response to the ANT Financial float, and the opening of an anti-monopoly case against it, sends a message that China’s party-state is intolerant of private firms becoming too influential.

Each quarter we have looked at these policy dimensions through two lenses to reach a fair assessment that reasonable readers from outside and inside China could embrace: first a strict tally of outcomes using data alone and then a broader review of the policy landscape. By-the-numbers, the most negative story is now labor. The positive indicators are cross-border investment, fiscal, environment, and innovation.

In terms of policy pledges, the 2020 picture is bright despite COVID-19. Many reform initiatives were announced, responding to foreign pressure and domestic urgency. In April and May, guidelines once again promised “market allocation of factors of production” – land, labor, capital, and data. Beijing’s inclusion of data as a production factor is novel. The notion of a major government just now turning to the task of creating allocation mechanisms for everything that flows through the economy is ponderous. Many other ostensibly reform-oriented pronouncements were made this year as well. The new Shenzhen Comprehensive Reform pilot, introduced in October, sends a reform message to private investors but is little different from past efforts. The Party’s Guidelines for the 14th Five-Year Plan (FYP) released in early November for the next five-year period elevated “reform” as a priority, second only to growth among the 14th FYP’s primary goals (after being absent in 2015).

Financial sector opening has gotten the most credit for demonstrating reform this year. With a wider door to securities investment and high COVID-era yields, portfolio inflows surged in 2Q2020-3Q2020. With current conditions driving capital inflows enough to greater strengthen the renminbi, Beijing has an opportunity to open further, but risks of a financial reversal are accelerating too, and reform could bring more pain than Beijing can tolerate.

The pattern of statist signals overshadowing market messages is evident today, as it has been since 2013. The SOEs are the firms stepping up to support recovery. Their footprint remains in commercial sectors where state influence was to be rolled back. In September, the Party and State Council jointly issued Opinions on strengthening “United Front Work” to bolster Party influence over private businesses. The focus has shifted from reducing state presence to making it more efficient and “market economy like.” Ideology is increasingly broadcast into the private sector. The last-minute intervention in the listing of Ant Financial reveals the primitive state of financial maturation. Foreign demand for high-yield Chinese debt is elevated, but this is not the sort of moderate-risk value proposition that will attract long-term investment at scale.

We save for last the major new policy design that emerged two quarters ago: the dual circulation strategy. Should this be classed as positive or negative for reform? Like many signature Chinese economic policy campaigns, the dual circulation strategy has become a Rorschach test for commentators.

The concept involves driving growth momentum through domestic demand, domesticized supply chains, and indigenous innovation, with both “external circulation” (accessing global demand and foreign capital and technology) and “internal circulation” (domestic demand and domestically developed technology). Engineering such a shift in sources of growth is sure to be difficult, and despite the rhetorical importance the campaign has been given by leaders as an elixir to China’s challenges, it has not been well defined. So far, it is impossible for economists to say how it will play out. On balance, its core organizing principle appears to be national self-reliance, rather than a robust re-commitment to the next generation of market-based reforms.

Tomorrow: Systemic Convergence or Divergence?

Some believe China’s leaders do not have economic reform in their DNA, and that World Trade Organization accession and the commitments like the 2013 Sixty Decisions were smokescreens. If nothing else, our Dashboard experiment has shown this to be wrong. Beijing has come up short on its reform pledges, true, but in a number of areas it has tried.

This seemingly modest assertion is crucial to the future. If China has tried to shift economic policy in a market-oriented direction in the past, it may well have motive and opportunity to do so again tomorrow. What compelled China to reform in the past was the historical evidence that illiberal, politicized economies have stagnated and become less productive, tied with the boldness of its leaders in trying to avoid that dead end. The historical record remains, especially when one takes a hard look at the recent and present record of China’s performance and acknowledges the likelihood of growth overstatement, risk underestimation and the enduring role of the state rather than the market.

In our 2015–2020 Dashboard, we measured China against its self-stated goal of moving to decisive markets. Since the premise of economic convergence is not on the table at present in Beijing or, increasingly, in open market economy capitals, the yardstick going forward will not be Beijing’s stated goals, but the gap between China and the norms of market-orientation as defined by the market economies themselves. There will very likely be points of convergence and points of divergence. China appears committed to opening to global capital inflows despite its resurgent preference for state planning.

Finally, it will be crucial to consider that we do not have to be like-minded in our economic systems to recognize we are in the same global boat, and on many matters, we must work together closely regardless of our systemic differences. The great majority of products for which China or the United States has clear comparative advantage are not strategically concerning to either.  This is a point well worth remembering as policymakers contemplating decoupling (in the United States) or dual circulation (in China) consider closing doors on engagement.

Click here for the full Winter 2021 China Dashboard report