18 reforms for China’s 18th Congress

A worker cleans near a poster of the late Chairman Mao Zedong at a thermal power plant of the Nanjie Cun Group in Nanjie ...
A worker cleans near a poster of the late Chairman Mao Zedong at a thermal power plant of the Nanjie Cun Group in Nanjie village of Luohe city in China’s central Henan province. China is finding it difficult to break free from the ‘low price, low cost, low quality’ situation. Photo: Reuters
by Liu Shengjun

The 18th National Party Congress is taking part at a time described by the economist Wu Jinglian as “a tipping point for China’s economic and social conflicts". Whether the new government will make the right decisions and whether it can restart reform will determine whether China will enjoy another decade of stable growth.

In this new phase of reform, the goal is to promote the transformation of the economic development model: transition from manufacturing to innovation and transition from an investment-driven economy to one that is consumer driven.

Over the past 10 years, China has enjoyed the benefits of entering the World Trade Organisation, but it is still difficult to break free from the awkward “low price, low cost, low quality" situation. We shouldn’t complain about companies not meeting expectations, and we must review what’s wrong with the system. Companies are entitled to maximise profits, and corporate behaviour depends on the path set by the regulatory framework. The existing framework does not provide strong enough incentives to promote innovation.

There are five reasons for this: intellectual property protection is weak; state-owned enterprises expand rapidly based on their monopoly of the market, making it much harder to protect fair play in a market economy; prices of land, capital, labour, the environment and other factors of production are severely distorted; the government has controlled a large number of economic resources and the right of approval, and rent-seeking has become the most efficient business model for companies with strong government connections; and the rule of law is weak.


Entrepreneurs see rent-seeking as the norm and lack a sense of security. Chongqing’s notorious campaign on organised crime demonstrated that entrepreneurs are vulnerable to abuse of power. That’s why immigration of rich Chinese has become a trend.

Although the people’s incomes have increased, their share of economic growth continues to decrease. Between 1992 and 2008, the amount that people’s disposable incomes represented as part of gross national income has dropped 12 percentage points.

In addition, because of long-term interest rate controls, people can hardly preserve the value of their wealth against rapidly rising inflation. Coupled with the fact the messy stockmarket is not oriented towards value creation, people cannot share the fruits of economic growth through equity investment.

Another reason for low consumption is high housing prices, which are a serious overdraft of people’s income over the next 20 years. The middle class is deeply in debt. And finally, China’s development in the fields of medical insurance, education and pension lags.

Here is a wish list for reforms for after the congress:

1. Interest rate marketisation

Under the present interest rate control, lending rates are artificially low, which encourages excessive investment. But because interest rates do not reflect supply and demand, a large number of small and medium enterprises (SMEs) can’t get access to capital, which has stimulated the growth of the number of loan sharks. Apart from this, interest rate controls are not conducive to increasing the value of a household’s wealth. Essentially, the people (the depositors) are subsidising the corporate sector (the borrowers).

2. Tax cuts

Forbes says China ranks second in the world on the tax misery index. Fiscal revenue as a percentage of GDP fell from 31 per cent in 1978 to 10 per cent in the mid-1990s, but in recent years it has risen to 20 per cent. Expanding government spending and the usual year-end rush to spend money on government projects have led to public backlash. It’s not just about the money spent, but local governments’ involvement in micro-economic activities is undermining fair competition in the market. The government needs to cut taxes immediately and significantly.

3. Introduction of inheritance and gift taxes

Competition in the market economy will eventually increase the gap between the rich and poor. The gap between China’s rich and poor is already too big, and more and more entrepreneurs are leaving their wealth to their children. By imposing an inheritance tax, the gap between the rich and poor will narrow, which is an essential step for building a harmonious society.

4. Break the monopoly of SOEs

Although China implemented the Anti-Monopoly Law in 2008, the country has since failed to make any headway in breaking the monopoly of the state-owned enterprises. In fact, the essence of state-owned enterprises’ monopolies is the administrative control of market entrance. Although the State Council has issued several decrees to break up monopolies, the “glass door" for private enterprises still exists. Breaking up monopolies and eliminating the discrimination of private ownership is at the core of building a market economy.

5. SOE reforms

In the last round of SOE reform in the 1990s, joint-stock holding structures were set up and many were listed on the stockmarket. SOEs experienced a fundamental change, moving from big losses to big profits. However, studies show SOEs’ profits mainly come from favourable policies they enjoy in obtaining land, loans, government subsidies and other advantages. The next round of reform of SOEs should make efforts to solve three problems: they must withdraw from real estate and other competitive fields, and they must be separated from the government. In particular, the party’s organisational departments should give up their right to appoint management of SOEs and their board of directors, cancel SOE leaders’ official ranking, and hire professional managers. And third, curb corruption and the benefits SOE leaders enjoy.

6. Close the pension gap

Deutsche Bank economist Ma Jun has forecast that by 2013, China’s pension shortfall will reach 18.3 trillion yuan ($2.8 trillion). As the elderly population increases, figuring out how to cover the pension hole has become a real challenge. SOE profits and high stock valuation should be used to make up the empty pension accounts. The government should cash out some stakes in SOEs and put the money into the pension fund. This way, one can kill two birds with one stone: not only provide capital for the national pension fund, but also let the state exit from SOEs.

7. Abolish the system of examining and approving IPOs

Although the intention of the IPO approval system is to protect the interests of investors, over the past 20 years the system has not only failed to protect investors, but it also distorts the relationship between supply and demand, and has given rise to many problems, including rampant rent-seeking. It is indeed the source of chaos in the securities market.

8. Allow private capital into banking

Indirect financing dominates China’s capital market, accounting for 78 per cent of the market total. But banks are largely state-owned, and it’s incredibly hard for new banks to get approval. This leads to a “quasi-monopoly" in the banking industry. To a certain degree, the banking system becomes a burden on the real economy. China should allow private capital to open banks. This will not only promote competition in the banking sector and add depth to the financial market, but also provide better service for small and medium-sized enterprises.

9. Encourage residents’ overseas investment

Bubbles are obvious in China’s housing sector and stockmarket. The major reasons are excessive money supply and capital account control. Large quantities of capital need to find places to invest, but they are limited to domestic vehicles. This makes things difficult for residents to see their wealth preserved and appreciating. Meanwhile, more than $US3 trillion in foreign exchange reserves have been used to buy US Treasury bonds and other low-yielding assets – the opportunity cost is enormous.

If the country would relax restrictions on residents’ overseas investments, it would kill three birds with one stone: reduce the domestic property bubble and financial risks; bring about a diversification of residents’ wealth allocation and preserve value; and lessen forex reserves and promote global economic balance.

10. Protect intellectual property

In the early stages of China’s economic development, enterprises generally copied, and comparatively weak IP protection allowed them to grow quickly. But today, innovation and transformation have become a bottleneck for Chinese enterprises – a lack of IP rights protection has seriously weakened the incentive for R&D and innovation.

11. Restrain local government Inc.

Local economies are all about GDP growth, which has turned local governments into mega companies – they are obsessed with investment promotion, building infrastructure and venturing into domains such as private equity investment. Excessive involvement of local governments with economic activity destroys fairness in marketplace competition and creates corruption. In addition, this also leads local government to consider their own interests instead of justly enforcing the law, and allows them to turn a blind eye toward environmental pollution, food safety and other issues resulting from reckless development.

12. Financial democratisation

Local governments sit atop an astonishing amount of financial resources. Over the past few years, while tax revenue has rapidly increased, financing from land transfer fees has risen as well. In 2010, the government took in 2.9 trillion yuan in land transfer fees.

The checks and balances of congress are weak and the government budget is opaque, which gives rise to corruption of officials. Only with public exposure of financial spending and taxpayer supervision can we ensure efficient and good use of financial resources.

13. Environmental protection

In a drive for GDP growth, environmental protection and law enforcement are increasingly marginalised. With the rapid rise of manufacturing, environmental pollution has become widespread. Over time, the problems caused by environmental pollution have become increasingly apparent, and if we do not improve the enforcement of environmental protection, more social conflicts will inevitably erupt.

14. Corruption and housing

In recent years, a surge in housing prices has triggered a public outcry because the price-salary ratio in so-called first-tier cities can be more than 20 times. Against this backdrop, many local officials are found to be hoarding houses. Corrupt officials are the real support behind high housing prices. There are a large number of vacant houses, but resources concentrated in the hands of a small number of people means real estate is in short supply for ordinary citizens.

15. Urbanisation

China’s economy needs a new growth engine. The hope is urbanisation is the engine of growth for the next decade. There is great potential, since the urbanisation rate is slightly higher than 50 per cent. However, in order for urbanisation to make substantive progress, we must start housing, education and healthcare reforms.

16. Kill the NDRC

The essence of a market economy is the pursuit of maximum profits, and effective competition and innovation will follow suit. The government cannot be both the referee and the player, and it shouldn’t interfere in micro-economic activity. The National Development and Reform Commission’s main responsibilities have been reduced to “examination and approval", similar to its predecessor, the State Planning Commission. To make breakthroughs in reform during the next 10 years, a feasible approach is to dismiss the NDRC and set up an institution that is dedicated to design and review of structural reform.

17. Judicial independence

Due to excessive government involvement in the economy, coupled with a lack of an independent judicial system, there exists a phenomenon of selective and flexible law enforcement. As a result, people don’t trust the legal system any more and repeatedly resort to petitions to officials or mass incidents. To strengthen the legal system, first we need to establish constitutional review as a starting point.

18. Downsize and decentralise

The government is too large. It has too much power and control of resources, an arrangement that will eventually strangle the vitality of the market economy. Reform essentially comes down to the government downsizing, decentralising and giving up profits.

The Australian Financial Review