In the winter of 1978, China’s top decision-making figures convened to discuss possible reform after emerging from a decade of social unrest and political restructuring. The Third Plenum of the 11th CPC Central Committee emphasised economic policy over ideological adherence, which was taken to the extremes during the Cultural Revolution, and confirmed Deng Xiaoping as de facto leader of the Communist Party. Known for his pragmatic approach, Deng Xiaoping enacted a series of controversial reforms based on capitalist principles such as private ownership, investment and trade. The opening up of China to the world economy set the country’s new development path on foreign investment. Over the next three decades, the country underwent economic and social metamorphosis from a relatively isolated command economy to the world’s largest manufacturer and exporter, raising millions out of poverty in the process.
In November of 2013, the Party is scheduled to hold another third plenum, this time of the 18th Communist Party of China (CPC) Central Committee, under the leadership of the General Secretary incumbent Xi Jinping. Topics of discussion range from land reform to the role of state-owned enterprises to environmental issues. The plenum suggests China is reaching another crossroads in its road of economic growth. While Xi Jinping is unlikely to be as radical a game changer as Deng Xiaoping, his outlook is still reformist within the limits of the current economic system. The 18th Central Committee recognises that many of the reforms instituted in the Deng era are unsustainable and perpetuating imbalances in the Chinese socioeconomic structure. Widening gaps between consumption and investment, exports and imports, as well as geographic and demographic factors, top the agenda of the plenum.
In 2013, investment continues to play an integral part in the Chinese economy, accounting for over half of GDP growth. Yet recent economic data show a marked slowdown in growth. Quarterly growth ‘rebounded’ to 7.8% in the 3rd quarter, the highest it has been for 10 consecutive quarters, but still comparatively low to the ‘double-digit rates’ enjoyed during the 1990s. This can be understood intuitively; an economy cannot spend indefinitely on investment projects such as highways, airports and factories, as its returns will diminish over time and cease to remain profitable. Yu Yongding, director at the Chinese Academy of Social Sciences provides a telling example of overcapacity in the steelmaking industry, of which only 70% of its capital was utilized in 2012, generated a profit rate of 0.04% that same year. The profit reaped from two tons of steel would not be enough to buy a Cadbury’s Wispa. Underutilization of capital and general inefficiency is a recurring theme of government designated ‘strategic industries’ such as the steelmaking industry or telecommunications industry. While the role of state-owned enterprises was heavily reduced by privatization reforms enacted by Deng Xiaoping, SOEs have seen a recent resurgence since the government provided a stimulus package to safeguard these industries from the effects of the financial crisis.
Exports are also a shaky foundation to base the world’s second largest economy on, as it is dependent on global demand and an undervalued currency. In fact, recent exports have been fluctuating precisely because of these two factors. The Chinese renminbi has appreciated over 30% in value against the dollar since 2005, affecting the competitiveness of Chinese exports as they become relatively expensive to global importers. With the Eurozone still stuck in its debt crisis and the U.S. only beginning to recover from recession, global demand for imported goods remains unstable at a lower base level, fluctuating according to how these major trading partners assess their economic outlooks. China’s dependence on foreign demand is exemplified by the solar panel industry, where 88% of all solar panels produced in 2011 were shipped overseas. This summer, Chinese authorities were accused by the E.U. of predatory pricing of solar panels and encouraging dumping practices in the European market. The dispute remains unresolved with both parties threatening to raise tariffs on their respective imports of solar panels and wine. While the strict definition of dumping is selling below cost and thus making a loss on each unit sold, it is more probable that Chinese manufacturers were still able to turn a profit at very low prices, which were sustained by government subsidies. The prevalence of government subsidies and state-owned enterprises in the export industry links the imbalance of exports to the issue of overcapacity at home.
Summarised in one word, the proposed remedy to the variety of imbalances China faces today is rebalancing. In order for China to continue growing, albeit at a slower rate, it must counterbalance excessive investment with higher household consumption. The logic to this argument is that domestic consumption will avert a ‘hard landing’ by keeping the economy afloat, while reining in on unsustainable investment projects in industries that have reached their productive capacity. With higher demand for goods and services at home, exporters will turn to domestic markets over foreign markets experiencing diminished demand.
The Xi administration has already taken tentative steps in prioritizing household consumption over investment. It pledges to raise dividend pay-outs made by state-owned enterprises and transfer the raised funds to social security programs as a direct channel of redistributing income from firms to consumers. The government is considering reducing or fully cancelling subsidies to state-owned enterprises in the energy sector. This would liberalise the market by allowing smaller suppliers to compete as well as reduce the implicit wealth transfer from household to firm entailed in subsidies. The Ministry of Finance also proposes to raise funds for welfare purposes through a carbon tax to be enacted within the next two years.
While these policies are taking steps in the right direction, the Xi administration should not overlook the systematic predominance of state-owned enterprises in the economy. Relatively low bank earnings suggest that the banking sector continues to provide preferential treatment to SOEs through low-interest loans. In the third quarter, net interest income only grew by 5% at the Industrial and Commercial Bank of China (ICBC), China’s largest bank by assets, which is less than a third of last year’s growth rate. The banking sector illuminates the current economic system’s continued support for SOEs, which is sustained at the expense of consumers who are subject to higher interest on their loans. One of the main challenges faced by the Xi administration will be to make a decisive break from the SOE lobby and reform the banking sector.
There is no doubt that China is reaching a pivotal point on its path of economic growth. The Deng era reforms were initially very successful in ushering China’s transition to a mixed market economy. However, China’s rapid economic rise driven by foreign investment and exports imposed implications on its socioeconomic structure by perpetuating imbalances. In other aspects of the economy, the Deng era reforms were reversed after the financial crisis and allowed for the survival of inefficient institutions such as the state-owned enterprise. The Xi administration has already taken commendable steps in leading the transition from an investment driven economy to one of more sustainable growth based on household consumption. A truly successful transition akin to that of Deng Xiaoping will depend on the Xi administration’s perseverance in pursuing widespread reform, notably to reduce the predominance of state-owned enterprises and placing the consumer at the centre of the economic fabric of China.