China’s defenders are putting an optimistic spin on the country’s tilt toward one-man rule. Now that President Xi Jinping has set himself up to remain in power indefinitely, they suggest, he will have the runway to see through painful but necessary economic reforms that have long been resisted by various actors within China’s political system. In other words, even if last weekend’s scrapping of term limits for the presidency dooms hopes for political liberalization, it increases the prospects for economic liberalization.

Such faith is misplaced. Xi’s economic agenda has been clear for a while -- and it doesn’t include the type of marketizing reforms that would structurally improve Chinese growth. In fact, his power grab makes such reforms less likely, not more.

Xi reiterated his priorities at a Communist Party congress last October, when he stressed that deepening “supply-side structural reform” should be the government’s central focus. That edict was even added into the Party’s constitution -- a document that supersedes the official state constitution when it comes to governing China.

The supply-side program has provided the overarching economic policy framework in China since late 2015, when it was first introduced. Given Xi’s recent championing of the strategy, it will continue to do so for the foreseeable future. The architect of supply-side structural reform, Liu He, is Xi’s top economic adviser and is widely expected to become the county’s most powerful economic official at the annual meeting of the National People’s Congress next month.

The program has several goals. They include reducing risks in the financial system (and eventually deleveraging); consolidating and cutting capacity in upstream industrial sectors such as coal and steel; reducing housing inventories; lowering administrative costs for businesses; and fixing the economy’s “weak links,” which include barriers to trade and investment between provinces.

These are worthy priorities, and significant and important progress has been made in several areas. The financial system saw interbank leverage decrease by over 3 trillion renminbi in 2017 -- the first such decline since 2010. Efforts at eradicating subpar production in steel and coal have reduced air pollution and boosted profitability in the industrial sector, as prices have risen by 111 percent and 153 percent, respectively, since the beginning of 2016. China’s 40 to 50 biggest cities are now trying to build property inventories back up rather than running them down.

The fact that economic growth accelerated last year for the first time since 2010 has reassured officials that they’re on the right course. The problem is that while these developments are positive in the short run, they do nothing to address the fundamental, long-term challenges that China’s economy faces: the institutional impediments to sustainable productivity growth.

When most Western economists talk about the “reforms” China needs, they have in mind productivity-enhancing adjustments such as genuinely improving the governance of state-owned enterprises, hardening budget constraints, and fully marketizing pricing mechanisms. Such changes aren’t on the table. Even as they laud the valued role of the market, policymakers seem to believe their more interventionist supply-side strategy will reduce risks enough that the economy can continue to grow without being opened up further.

What’s more, moving toward one-man rule in China will make any kind of liberalizing reforms harder. To be effective, such reforms would require strong regulatory institutions that are backed by the rule of law. Cleaning up state-owned enterprises, for example, would require managers to focus on their fiduciary responsibilities and legal dividend requirements over strategic Party imperatives -- and to be held accountable if they don’t. Reducing local-government spending would similarly require provincial cadres to fully respect both the letter and the spirit of recent updates to the budget law. Neither of these critical areas is seeing much, if any, progress at present.

Already, most asset managers cite the lack of legal clarity as a key reason for avoiding portfolio investment in the mainland. And the uneven legal and regulatory environment is a well-documented headache for foreign companies that have no choice but to try and serve one-fifth of the world’s consumers.

That lack of confidence is being reflected in weaker capital flows to the mainland: Growth in foreign direct investment in 2017 was a dismal 4 percent. Even as foreign capital would help to sustain China’s economic engine, it’ll continue to be less forthcoming -- thanks in large part to the unsure legal environment.

Xi’s administration has often spoken about its desire to improve legal mechanisms. But those efforts are fundamentally undermined by moves to bend or change the law to comport with immediate political concerns. Even if China’s leaders did have a secret master plan to liberalize the economy, their recent political decisions would pose one big hurdle to implementing it. 


Andrew Polk
Andrew Polk is a founding partner of Trivium/China, a Beijing-based research firm. -- Ed.

(Bloomberg)