China still awaits genuine reform; Change can only come if Communist party loosens its grip

November 7, 2013 6:05 pm

China still awaits genuine reform

Change can only come if Communist party loosens its grip

It has been nearly a year since Xi Jinping led the seven-strong standing committee on to the stage of the Great Hall of the People as the new head of China’s Communist party. At the time there was much speculation, partly encouraged by Mr Xi’s more down-to-earth manner, about whether his appointment might herald a fresh attempt toimplement economic and political reform. Those hopes have not yet been answered. Mr Xi has shown himself rather more adept at consolidating his grip over the Communist party than at opening up either China’s economic or political system. He has brought cadres to heel with an anti-corruption campaign, established what looks like a firm grip on the People’s Liberation Army and launched a campaign against bloggers in order to stifle criticism of the party. He has even revived sloganeeringreminiscent of the Mao era. Some speculate that Mr Xi has tacked to China’s political left in order to provide cover for market-oriented reforms. But if he is a closet reformer he has a funny way of showing it. There have been intimations of changes to policy – a liberalisation of banking licences here, the announcement of a free-trade zone there. But nothing that amounts to much.China is supposed to be rebalancing its economy away from an investment-led model towards one driven by domestic demand. Some positive steps have been taken. The renminbi has strengthened, so much so that some exporters are genuinely hurting. But, if anything, China has moved in the wrong direction. The huge stimulus it implemented following the 2008 financial crisis has engorged already bloated state-owned enterprises and made growth more, not less, contingent on investment.

The problem is, China is getting less bang for its (non-convertible) renminbi. More and more investment is required for less economic output. That situation cannot continue indefinitely. It will lead to bad loans. Chronic overcapacity in sectors such as steel is killing profitability and could plausibly result in deflation. Nor are SOEs likely to provide the ramp-up in innovation China needs. It is no accident that Alibaba, China’s most entrepreneurial big company, should have emerged from the private sector.

Making necessary changes will mean taking on vested interests. Ideally, some SOEs should be privatised. At the very least, they should be forced to focus more on efficiency and be opened to competition. China needs related banking reforms. Beijing has followed a classic catch-up model in which deposit rates are suppressed so that state banks can funnel cheap finance to favoured industries. While change is fraught with risk and should be approached carefully, it is time for China to wean itself off such practices. If deposit rates rose, consumers might feel richer. Meanwhile, banks lend to SOEs knowing that such loans are guaranteed. Instead, they might lend to smaller, private enterprises that are much more likely to be a source of innovation. To achieve this, banks must become better at pricing risk. Non-state players should be allowed a bigger role.

This is just the start of it. Long-discussed changes to the hukou registration system are needed to enable those in the countryside to live in the cities on equal terms with existing residents. Local governments should be able to impose a property tax to put their finances on a better footing. China needs a more robust and neutral legal system able to arbitrate both commercial disputes and those between companies and government. The list goes on.

Much of this is difficult, for one important reason. It requires the Communist party to loosen its grip. Yet it has little choice. Unless meaningful reform can be implemented, the chances of China’s economy running out of steam are high. That would be the ultimate challenge to party legitimacy.