The Rise of Chinas Reformers [608369]

The Rise of China's Reformers?
Why Economic Change Could Come Sooner Than You Think
Evan A. Feigenbaum and Damien Ma
April 17, 2013
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Essay
Democratize or Die
Yasheng Huang
Li is far too confident in the benefits of Chinese authoritarianism. So far, what has held China
back is not any l ack of demand for democracy, but a lack of supply. That gap should start to
close over the next ten years.
Essay
The Life of the Party
Eric X. Li
In the next decade, China will continue to rise, not fade. Its leaders will consolidate the one –
party model and, in the process, challenge the West’s smug certainty about political
development and the inevitable march toward electoral democracy.

A security guard stands in
front of a stock ticker while watching Xi Jinping speak during a news conference. Huaibei,
Anhui province, 2012. (Courtesy Reuters)
With China’s political transition now complete, the country – and the world economy – is
left with a pressing question: Does the new team in Beijing have the vision and the political
will to revive stalled yet crucial economic reforms? Few observers are optimistic about the
answer.
A growing chorus of pessimists, in China and elsewhere, has coalesced around three central
arguments. The first group, call them the “economic cy nics,” argues that the bar for reform is
just too high. This is because several underlying economic problems, including a real estate
bubble, have worsened at precisely the moment that China’s economic growth has slowed.
Chinese officials’ traditional solu tion to economic slowdowns – accelerating exports – has
become harder in light of declining demand in advanced industrial countries.
What is more, these pessimists argue, even if China’s new leaders want to undertake bold
reforms, economic problems have become so dire that they will overwhelm the new team’s
ability to forge consensus around a fresh approach. According to China’s National Audit
Office, for example, provincial, county, prefectural, and municipal governments are some 11
trillion yuan ($1.8 t rillion) in debt. This problem could lead to another round of exploding bad
loans that would constrain the banking sector and forestall financial sector reforms.
The second group, call them the “social doomsayers,” argues that bad policies and poor
governa nce are fueling unprecedented social unrest – with more than 100,000 protests taking
place each year by some estimates. This group insists that since preserving political stability is

Beijing’s top priority, the government will avoid undertaking reforms t hat risk short -term
economic dislocation and might further exacerbate social discontent.
According to this group, China’s leaders are caught in a bind: if they reform too much, they
risk opening the floodgates to more protests; but if they reform too littl e, they risk leaving
intact the underlying causes of the unrest. Two oft -cited examples of the latter dilemma are
environmental degradation and land seizures by local officials, which have been the major
reasons that ever more Chinese have taken to the str eets. But local governments are still
focused on economic growth at all costs rather than cleaning up the environmental costs of
this growth. Unless Beijing devolves independent fiscal authority to provincial and municipal
governments – a very tough refor m, by any standard – and changes the political incentives
that reward growth above all other objectives, local officials will continue to seize and sell
land to developers to raise revenue. So under either scenario, this group insists, political
caution w ill constrain the new leadership’s options for reform.
The final group, call them the “political doubters,” questions the new leadership’s resolve to
overcome powerful vested interests that will resist reforms, especially among China’s state –
owned enterpri ses. These powerful corporate players, this argument goes, will obstruct the
leadership’s well -intentioned goal of boosting household incomes, defeating efforts to force
state firms to pay more dividends that can be redistributed into social welfare progra ms.
None of these three camps is entirely wrong. Each describes a certain facet of the
considerable challenges China’s new leaders now confront. But their pessimism ignores a
central lesson of China’s recent history – one that undoubtedly resonates with a t least some
members of the new policy team: reform is possible when the right mix of conditions comes
together at the right time.
Indeed, China has had significant bursts of economic reform in the past, most notably in the
late 1990s during the premiershi p of Zhu Rongji. That era proved that bold reform is
achievable when three conditions are present: a crisis of political credibility at home,
vulnerability to an economic or financial crisis abroad, and a leadership savvy enough to
recognize the need for c hange.

Today, Beijing does face enormous obstacles, and the forces arrayed against reform are
numerous and entrenched. But each of these three conditions is once again present in China,
potentially boosting the prospects for real and enduring economic chan ge.
A CRISIS OF CREDIBILITY
Consider the first condition: a crisis of domestic political legitimacy. In the early 1990s,
Beijing faced one of its toughest tests of popular support as it attempted to recover from a
series of political challenges to the Chin ese Communist Party (CCP) during the tumultuous
1980s. At the time, Beijing was in the throes of both a political crisis and a revenue crisis as
dwindling tax receipts remitted by provinces and cities to the central government hollowed
out the central gove rnment’s coffers.
Throughout the 1980s, dizzying changes moved the country away from major elements of
centralized planning toward greater reliance on market forces, including price liberalization.
These changes ushered in a wave of inflationary pressures and rampant social discontent,
which culminated in the protests of 1989.
In the aftermath of the political tumult, reforms were briefly shelved before being revived in
1992 as Beijing sought to restore economic momentum and win back popular support. By the
late 1990s, a capable premier, Zhu, had begun to restructure China’s weak and unwieldy state
sector and to reform the banking system, notwithstanding the destabilizing effects of laying
off millions of Chinese government workers.
This period is instructiv e because today’s Chinese leadership – under pressure from rising
expectations, social dislocation, and popular discontent – again finds itself trying to bridge a
credibility gap with the Chinese public. And the new team, not least the new president, Xi
Jinping, has publicly recognized that the stakes are high. With worsening social and economic
inequality, abysmal food safety, corruption, and rising middle -class expectations, Chinese
governance is being tested in unprecedented ways. And since merely deli vering growth is no
longer sufficient to assure the government’s mandate, the leadership has good reason to look
to reforms as a means of addressing social cleavages and environmental degradation.
EXTERNAL ECONOMIC SHOCKS

A second important factor that drove China’s reforms in the 1990s involved the aftereffects of
the Asian financial crisis of 1997 –98, which exposed the inherent vulnerability of the Chinese
economy to such shocks. Zhu and other Chinese leaders leveraged t he moment of that crisis to
move China toward its long -standing goal of membership in the World Trade Organization.
They successfully pushed for a credible package of reforms that both prepared Chinese
companies for global competition and opened the door t o foreign capital inflows. Put simply,
an external crisis enabled homegrown economic reformers to push forward serious economic
and institutional changes.
That formative experience is especially pertinent today, as China continues to deal with
ripples from the global economic crisis that began in 2008. Despite emerging from the crisis
earlier and stronger than nearly any other major economy, China remains vulnerable in two
ways: it can no longer rely on exports, and it lacks the flexible monetary and financ ial tools
that could help it fight inflation and forestall the shock of another financial crisis.
Beijing has weathered the most recent storm largely because it injected huge sums of cash
into the economy – about $600 billion in stimulus and billions more in other bank lending,
both of which helped to stave off a wholesale collapse in economic growth. But the
effectiveness of these tools will diminish in the years ahead. The government cannot simply
rely on stimulus after stimulus, and such a strategy woul d only further deepen imbalances in
China’s economy. In the five years since China achieved its peak GDP growth rate of 13
percent in 2007, its growth rate has dropped significantly and the leadership now targets a
more balanced 7.5 percent.
TOUGH -MINDED L EADERSHIP
Many of China’s reforms in the 1990s would not have been possible without a few hard -nosed
leaders who not only correctly assessed the country’s economic ailments but also had the
political will to take strong actions. Zhu, for instance, was know n to berate local officials for
their mistakes and inefficiencies – and his confrontational style was supported by a number of
his colleagues in Beijing. It is already apparent that Xi and the new premier, Li Keqiang,
differ from their immediate predecess ors in both style and tone. But more than that, their
programs and speeches suggest that, at minimum, they have accurately diagnosed the ills that
currently beset the Chinese economy. And on paper at least, they have prescribed many of the

right solutions. In March, Li invoked “reforms” nearly two dozen times during his first press
conference as premier.
But translating rhetoric into credible actions will be more difficult. China’s new leaders have
risen to the top only to inherit a growth model that is run ning out of steam, undermined by a
combination of aging populations and weak consumption in developed countries. At the same
time, many Chinese companies, especially in the state sector, remain uncompetitive or could
face serious financial difficulties if state subsidies, including for energy and land, are
withdrawn.
It is important to consider, moreover, why the last group of Chinese leaders seemed to
overlook structural maladies in the Chinese economy. Despite a recognition that, in former
Chinese Premier Wen Jiabao’s words, the economy was “unbalanced, uncoordinated,
unstable, and unsustainable,” previous leaders could rest easier in the knowledge that China
could still mostly grow its way out of its immediate problems. In fact, growth was so stellar in
the 2000s that the leadership cohort under former President Hu Jintao judged that it could
probably afford to coast on the reform dividends of previous decades.
But although China’s economy grew rapidly throughout the first decade of the twenty -first
centur y – largely on the basis of investment and soaring exports – it did not grow much
stronger in a fundamental sense. It remained relatively exposed to disruptions in global
demand because domestic demand in China was too low, and it reflected new inequalit ies and
imbalances. The costs of the capital -intensive and export -led growth model are now so
obvious and startling that they can no longer be ignored or swept under the rug. For instance,
recent estimates have put the environmental cost of China’s growth at at least $230 billion, or
about 3.5 percent of China’s GDP in 2010.
So it is beyond doubt that Xi and Li understand, and even acknowledge, that reform is no
longer a choice but a necessity. The scope, scale, and depth of those reforms, however, will
ultimately depend on whether the new team shows some of the nerve and sense of timing that
yielded the ambitious decisions of the 1990s.
DEVOLUTION, CHINESE STYLE
What are the signposts of real economic reform? Several indicators will be important to watch
over the next year and a half. One major indicator will be the degree to which Beijing reduces

the state’s role in the economy by devolving fiscal and budgetary authority to local officials.
Steps in this direction would include passing off the power to appr ove infrastructure projects
to local governments, cutting unnecessary administrative red tape, and prohibiting ad hoc
administrative fees levied by local governments.
Some form of decentralization will also likely take place on the fiscal side. Many provin ces
have seen their fiscal coffers wither in the years since 1994, when a major tax overhaul
redirected revenues toward the central government in Beijing. Local governments now
depend on transfers from the central government to pad their budgets. And when these
transfers prove insufficient, as they usually do, they often turn to selling land to developers
and relying on debt financing through shadowy lending channels to secure the revenue they
need. Given that China lacks a well -developed municipal bond mar ket or a strong
independent local tax base, it is easy to see how a local fiscal system in disarray – one that
provides incentives to sell land for housing development – has contributed to the country’s
overheating property market.
Another area ripe for reform is energy pricing. Throughout China’s economic boom, Beijing
has artificially suppressed energy prices because energy is a critical input in China’s capital –
intensive growth model. So with Beijing’s persistent fear of spiraling inflation, the
govern ment has often intervened to ensure that the prices of electricity and coal, among other
energy sources, remain stable. But the fact that energy is cheap means that Chinese industry
has little incentive to improve efficiency. Instead, the country’s compani es have turned into
energy guzzlers and decimators of the environment. Raising the price of energy to reflect its
true cost would force Chinese businesses to improve efficiency and develop cleaner
production methods.
A third area to watch is China’s social welfare system, particularly health care and pensions.
Beginning with reforms in 2009, China’s broken health -care system has been gradually
stitched back together and will likely enter a new stage under the new government. Similarly,
the fragmented and wo efully inadequate pensions system will also need to move beyond its
current state as a large -scale unfunded mandate. Both reforms are necessary if Beijing is to
deal with an aging society and to support consumption by drawing down precautionary
savings.
BEIJING DREAMIN’

In isolation, each of these reforms would be modest. Yet their cumulative effect could be
enormous. It is worth noting, however, that expectations for economic reforms should be
tempered by the reality of China’s present economy – an $8.3 t rillion behemoth that is more
complex and mature than it was 15 years ago. In this sense, windfalls from today’s reforms
will likely be more limited in scope than when the country was starting from a lower base in
the 1990s.
But that is what the new leader ship confronts – a wide -ranging set of reform alternatives that
include, but are not limited to, the options noted here. The constraints on reform in China
have never been intellectual – there are plenty of good economists in the country pushing a
wide a rray of creative ideas. The principal obstacles remain political. The lesson of the 1990s
is that it takes the right mix of domestic and external challenges, combined with a healthy
dose of bold leadership, to induce significant reforms.
But those conditio ns are again present today. And recent statements suggest that a longer -term
reform agenda is likely in the works and could be unveiled during the CCP’s third plenum this
fall. (Capital market reforms, such as an expanded use of corporate and government bo nds
and a further relaxation of restrictions on foreign institutional investors, are thought to be
probable.) If Chinese leaders do choose the third plenum as the place to announce new
reforms, it will be because it is pregnant with political symbolism: it was at another third
plenum, in 1978, that Deng Xiaoping, the architect of China’s market reforms, won consensus
around the vision that set China on its course to becoming the world’s second -largest
economy.
It would be impossible for any Chinese economic reform program to be completed
expeditiously and without resistance. Reform, by definition, will rearrange the playing field
for powerful political and economic interests. But if the new team is serious about revitalizing
China’s economy and realizing its much -touted “Chinese dream,” then deeper economic
reforms are necessary. Beijing would do well to heed the words of Li, its new premier: “It’s
useless screaming about reform until you’re hoarse. Let’s just do something about it.”
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