Author: Susan Shirk, University of California, San Diego
All eyes are on Premier Li Keqiang and the economic team that is drafting the proposals for a new set of economic reforms to be rolled out at the Third Plenum of the 18th Chinese Communist Party (CCP) Central Committee, convening in October 2013.
The individuals designing the reform package are well-respected market-oriented economic experts, and the central authorities are sending signals of resolve. Hopes are stirring that the reforms will be serious and substantive.
Yet scepticism remains about whether China’s political leaders have what it takes to actually implement the reforms. Analysts argue that today’s leaders lack the authority that Deng Xiaoping had in the 1980s when he was the moving force behind the first wave of China’s market reforms. This is certainly true. But to attribute the success of those reforms to Deng alone is to misunderstand the Chinese system of that time. Deng was not a dictator. He and his reformist lieutenants had to formulate a strategy to get different powerful groups on board
Many people also predict that the vested interests in the current state-dominated economic system will thwart a new round of market reforms. But are the vested interests of today — state owned enterprises, corrupt officials and their families — any more entrenched than the vested interests in the command economy that existed in China in 1979 — central planners, government bureaucrats, heavy industry?
The greatest challenge to economic reform is always the political one: How to overcome the resistance of powerful groups favoured under the current system and build constituencies for reform?
What kind of strategy will Xi Jinping and Li Keqiang adopt to create a reform coalition? Who are the groups that might potentially support the reforms?
The logical first place to look is the private business sector. Private business is frustrated by the systemic bias toward state owned companies in obtaining bank loans and other preferential treatment. In the absence of a functioning domestic capital market and legal system, private businesspeople have to invest much of their effort in cultivating relationships with government officials. They also reduce their risk by sending their wives and children, and their fortunes, overseas. But private business has no voice in the Chinese Communist Party or the central government and therefore can’t serve as a political counterweight to the powerful state sector.
What about provincial and local officials? The officials who run China’s 33 provinces are a very important potential constituency in China — they constitute the largest bloc in the CCP Central Committee. Where do provincial and local officials stand today? Are they a vested interest in the status quo or a potential constituency for a new reform drive?
The 1980s reforms succeeded because Deng Xiaoping and his lieutenants counterbalanced the political weight of the central bureaucracy by the power of provincial leaders within the Central Committee – a strategy that at that time, I called ’playing to the provinces’. They won the support of provincial officials by making the decentralisation of economic decision-making and fiscal revenue a key component of the reform package. Decentralisation created incentives for provincial and local governments to promote growth through the market.
Some provincial and local officials also were rewarded with special economic zones and other targeted preferential policies, which greatly benefited them and their regions. Special zones and opportunities to access the market were allocated selectively only to some particular regions, not to everywhere across the country. Once local officials started envying those regions that had been granted special treatment, they clamoured to get some of these lucrative market opportunities for themselves. Over time this strategy of playing to the provinces built a bandwagon of support from provincial and local officials for the market reforms, which subsequently overwhelmed the vested interests in the command economy that were once so strong in the central planning bureaucracy and the heavy industrial ministries.
Of course fiscal decentralisation had a serious downside. The central government became very poor because most of the revenues were left at the local level. Beijing lacked the funds to build the infrastructure, social safety nets and modern national defence that China needed. To increase the central government’s share of total government revenue, fiscal reforms were introduced in 1994, whereby value-added tax was shared between the central and local governments. While these reforms were an important and necessary readjustment for increasing central revenues, they left local governments without an adequate revenue base as the tax-sharing scheme was enormously skewed in favour of the central government.
How will this imbalance be addressed in the 2013 reforms? Local governments face a severe mismatch between revenue and expenditure. They are responsible for providing pensions, education and health care, and addressing environmental concerns, but do not have the adequate fiscal revenue to pay for them. They adapted as best they could by depending on earnings from land development — many local officials are making good money privately and for their localities from land development. But this dependence on land development is unhealthy and distortionary.
After the 2008 global financial crisis, Beijing stimulated the economy by ordering the banks to open the spigots of credit for local projects; as a result, local governments started relying once again, as they had under the pre-1994 system, on a blank cheque from local banks.
A new wave of fiscal reform could introduce new local revenue sources such as property taxes, a value added tax on services, and a higher share of the total value added taxes. Another approach would be to relieve the financial burden on local governments by increasing transfer payments from the central treasury and shifting responsibility for education, health, and pension spending to Beijing. Another crucial issue is whether local officials will be left holding the bag for repaying these past bank loans.
As they design the reform package, Xi Jinping and Li Keqiang have to be thinking about what would constitute an effective political strategy of reform. What kind of fiscal changes would turn provincial and local officials into a powerful constituency for the overall market reform?
Where will provincial and local governments stand on the new reform proposals? Will they find the plans a better solution than the status quo in which they rely on land development and cozy relations with local bankers? Or will they worry that the reforms will leave them in a tighter, more financially constrained situation than the situation they are living with today?
Given the limited options of other groups who could help build a reform bandwagon to overwhelm the vested interests in the status quo, won’t China’s central leaders decide to once again ‘play to the provinces’?
Susan Shirk is Chair of the 21st Century China Program and Professor of China and Pacific Relations at the School of International and Pacific Relations, University of California, San Diego. She is the author of The Political Logic of Economic Reform in China.