Xi Jinping's Economic Challenge
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Xi Jinping's Economic Challenge

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For months, China watchers have been vying to predict whether reformers or reactionaries would prevail at this week's Party Congress – and now that it's here, analysts have had to begin debating what has actually happened.  Despite the importance of factional politics within the Party, what will determine whether major economic reforms are able to take place in the next year is not a contest of ideologies, but a test of political acumen – specifically, the power of China's top leaders to control the three vast machines of China's party, government, and state-owned entities (SOEs).  If Xi is to achieve even the economic policy goals that already appear to enjoy consensus support in Beijing, he will need to find ways of overcoming some of the largest entrenched interest groups in contemporary China.  To do so, he may have to set about creating new entrenched interest groups.

I'm ready to predict today that Xi's government will pursue policies intended to reduce corruption, allow more private competitors into sectors monopolized by the state, and rebalance the economy away from its focus on public investment.  This is, I think, a fairly safe projection – these policies have already been announced.  Reforming state-dominated industries to allow private-company market entry was the subject of March's “New 36 Clauses,” a series of fairly strong demands the State Council that the SOEs produce plans (which have been due for years) soon, and last week SASAC, the body that formally owns and regulates China's largest state-owned companies, announced plans to strengthen oversight in the interests of competition.  Barry Naughton discusses the rebalancing problem at length in the current issue of China Leadership Monitor and concludes, fairly convincingly, that Prime Minister Wen Jiabao's policies have widespread support among top leaders, who see them as critical for long-term growth, and, thus, their continued hold on power. 

Corruption has been a hobbyhorse of the Hu-Wen administration – few major party events go by without President Hu Jintao warning that corruption threatens to undermine the legitimacy of the Communist Party, and the political report at this year's Party Congress was no exception.  But years of declarations that the Party must reckon with corruption have done nothing to stop local officials from enriching themselves with bribes – nor stopped the families of top leaders from accumulating fortunes measured in hundreds of millions or billions of dollars.

There is little question that China's top leaders see a need for a stronger private sector, and that they are uncomfortable with the extent to which the SOEs have come to dominate huge parts of the economy.  But unless changes reach deep into the structure of government, edicts from the top often have little effect in China.  I spoke a few weeks ago with James McGregor, a Senior Councilor at the public affairs consulting firm APCO Worldwide and author of a new book criticizing the growing dominance of the Chinese state sector, “No Ancient Wisdom, No Followers.”  He said that many in the Chinese government are worried about the shrinking role of private companies in the economy.  But, he said, the power of the SOEs may be enough to frustrate proposed reforms: “It's a game of power politics now. In China, it's not unlike the U.S and Europe – this place has a lot of big-money politics, a lot of vested interests that don't want change.”

Economic reform may meet the same fate as the reforms to local government of the Hu-Wen administration, intended to reduce corruption and deal with controversial land seizures: many announcements and little change.  Both Hu and Wen have talked about corruption in public venues for most of their term, and have proposed numerous laws to police officials, while other new laws have created a right to substantial compensation for people whose land is seized.

But what has not changed in the last ten years is the fundamental incentives that make corruption and land seizures inevitable.  Land sales made up around 40 percent of the annual funding of local governments in 2010, according to the China Real Estate Information Corp.– and it is therefore no surprise that local officials still participate in land seizures to fund programs of investment and development.  Provincial-level officials still have little reason to look too closely at the affairs of their subordinates – as the Bo Xilai case demonstrates, to do so risks driving them to expose your own hidden affairs.

Economic reform will face similar obstacles, and it is whether the new generation of leaders succeeds in overcoming these that will determine the shape of China's economy for the next ten years.

One major obstacle is the power of the state sector, still supercharged from China's immense stimulus package.  SOEs now serve Chinese officials at all levels as wellsprings of investment to boost local economies, avenues for promotion – a stint running a major SOE has become a common step on the ladder to the Party's highest ranks – and a source of income for leaders' families. 

Their role as the main driver of growth during the past few years has made SOEs heroes, to a certain extent, or at least too important to threaten – and made them a powerful lobby group whose interests are strongly protected by high-level policy-making.  McGregor compared the chiefs of the SOEs to generals and provincial governors: “In a way, they're like the military – they report only to the Party, not the government.  They outrank the government people who are supposed to keep an eye on them.”

Equally strong is the resistance from lower-level officials, who depend heavily on SOE investments to support local economies.  Naughton's article in CLM has a good account of the problem: while China's top leaders fret about the collapse of Chinese growth model and the Party's legitimacy as the manager of the economy, ambitious officials at every other level of government have horizons limited to their district and term – thus, local governments constantly lobby SOEs and private companies to continue to build new factories and real estate developments.

Effective reforms will have to take on both of these interest groups – and, most likely, to find or create new ones with incentives to lobby for the private sector.  These challenges are similar to those faced by Deng Xiaoping's market reforms and the Jiang Zemin effort to streamline and privatize inefficient SOEs – and in order to overcome the resistance of local officials and SOE administrators in those cases both created new ways for them to get rich by reforming.  It was the success of these reforms that created the wealthy, profit-driven central SOEs that are now China's one of biggest economic headaches.

It will certainly be an uphill fight.  But it is one I think Xi may well seek out – to avoid it will be to accept that the President of China and the Politburo Standing Committee are bystanders in the making of China's economic policy.

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