Large and In Charge

The Third Plenum ended in Beijing on Nov. 12, and observers in China and abroad are still scratching their heads over what, if anything, it achieved. Instead of the sweeping reform package many analysts expected from the crucial four-day Communist Party meeting, Beijing released a brief communiqué filled with gristly socialist rhetoric and lacking specific responses to China’s many urgent economic and social problems.

On the surface, the plenum failed to answer the three key questions analysts have been asking since the leadership transition a year ago: Are President Xi Jinping and his six colleagues on the Politburo Standing Committee, China’s top ruling body, accurately diagnosing China’s structural economic and social ailments? Do they have sensible plans for addressing these problems? And do they have the political muscle to push reforms past the state owned enterprises (SOEs), tycoons, local government officials, and other interest groups whose comfortable positions would be threatened by change? So far, the consensus answers to the first two questions are "we’re not really sure," and to the third, "quite possibly not." Xi, the reasoning goes, either has a timid vision or is so hemmed in by special interests that he is unlikely to achieve much.

But this view is too pessimistic. The evidence from his first year suggests that Xi is far more powerful than his predecessor Hu Jintao, and is swiftly building the centralized bureaucratic machinery needed to overcome institutional resistance and achieve his aims, which include an ambitious revamp of China’s governing structures. 

Despite all the hoopla, the plenum communiqué is just one of many bits of evidence indicating the leadership’s intentions. Crucially, it is not even the most important document of this Party meeting. Far more illumination will come from the Central Committee’s Decision on Reform, a detailed policy document approved at the plenum, which will probably be made public within a week or two.

While the contents of this year’s Decision are still unknown, there is an instructive precedent: 1993’s third plenum, overseen by reformer Deng Xiaoping, first released a bland communiqué. But soon after, Beijing issued a dramatic Decision, which set the stage for sweeping market reforms.

The plenum communiqué itself, despite its vagueness, gives hope that reform is forthcoming.

Most economic commentators agree China’s principal problems — declining productivity growth and exploding debt — are both due in large part to the bloated SOEs, which gobble up a disproportionate share of bank credit and other resources but deliver low returns on investment.  

While the SOE problem is real, it is a symptom of a deeper issue: China’s economic and social ills stem mainly from problems in governance. Beijing interferes too much in resource allocation; excessive regulation and local protectionism make markets inefficient; and a fouled-up fiscal system encourages local governments to indulge in land-grabs, promote speculative property development, and build excessive infrastructure. 

The communiqué identifies all these governance issues as reform priorities, calling for assigning the market a "decisive role in resource allocation" and improving the government regulatory system. These aims build on repeated statements over the past several months by top leaders that the functions of market and government should be more clearly delineated, and that market forces be given a freer hand. And one of the government’s main policy initiatives has been to sweep away a host of regulations — such as licensing and registered-capital requirements — that impeded the formation of new private businesses.

Entrenched interests needn’t worry. As has been the case since China embarked on market reforms in the late 1970s, the agenda of economic reformers is to boost competition, not sell off state enterprises. The logic is straightforward: in an increasingly competitive environment, poorly performing SOEs must either improve their efficiency or disappear (often by absorption into a larger, more profitable SOE rather than through bankruptcy). This erodes the economic role of SOEs while avoiding epic and costly political battles over privatization. The key insight — validated by 30 years of dynamic economic growth — is that effective competition, not private ownership, is the bedrock of a successful modern economy.

The communiqué also indicates that the leadership has more on its mind than mere economic efficiency, important as that may be. It points to the government reorienting away from building infrastructure and towards service provision, and promises reforms of the urban residence permit (hukou) and rural land tenure systems, which in their present form contribute to a chaotic and wasteful pattern of urbanization.

Xi appears to have a cogent diagnosis of China’s governance problems, and a reasonably well developed strategy for addressing them. And there is good reason to believe he is building the infrastructure to deliver on his promises. The communiqué also announced the formation of two high-level bodies: a "leading small group" to coordinate reform, and a State Security Commission to oversee the nation’s pervasive security apparatus.

At first glance, this seems a classic bureaucratic shuffle — appoint new committees, instead of actually doing something. But in the Chinese context, it is potentially quite significant. In the last years of the Hu era, two entrenched problems stymied reforms: turf battles between different ministries and interference by security forces under their powerful and conservative boss, Zhou Yongkang. Neither Hu nor his premier, Wen Jiabao, was strong enough to supervise the squabbling ministers or quash the suffocating might of the security faction. By establishing these two high-level groups (and presumably leading them), Xi is making clear that he will be the arbiter of all disputes, and that security issues will be taken seriously but not allowed to obstruct crucial economic or governance reforms.

And by conducting a determined anti-corruption campaign, Xi has shown the costs of crossing him. The campaign has netted dozens of important officials, many of whom were closely aligned with Zhou, including a bevy of senior executives at China National Petroleum Corporation, one of the biggest SOEs, and the head of the State-Owned Assets Supervision and Administration Commission, the agency which oversees SOEs. The message is obvious: Xi is large and in charge. Get on the wrong side of him or his policies and even the patronage of another senior leader or a big state company won’t save you. Xi’s promptness in dispatching his foes is impressive: both of his predecessors waited until their third full year in office to take out crucial enemies on corruption charges.

There is plenty of evidence Xi has an ambitious agenda for reforming China’s economic and governance structures, and the will and political craft to achieve many of his aims. His program may not satisfy market fundamentalists, and he certainly offers no hope for those who would like to see China become more democratic. But it is likely to be effective in sustaining the nation’s economic growth, and enabling the Communist
Party to keep a comfortable grip on power.

Arthur Kroeber is the Beijing-based managing director of Gavekal Dragonomics, a global macroeconomic research firm, and a non-resident fellow of the Brookings-Tsinghua Center.