The China Dashboard evaluates progress toward economic reform imperatives Chinese leaders set out in 2013. The full data available for this edition – fourth quarter 2017 – mark four years since President Xi announced his 60 Decisions reform program that year. Political developments in China and abroad are raising the stakes around implementation. With the March 2018 National People’s Congress (NPC) complete, a new team of economic officials is in place, and the wait for new policy leadership should be over. Overseas, the United States has declared an end to its patience for a substantive opening of Chinese trade and investment markets that has steered strategy for the past 25 years and backed that up with restrictive policies aimed at trade and investment. U.S. businesses and other advanced economies find themselves jammed between these two giants and anxious about taking sides and becoming objects of retaliation, although many share Washington’s concerns. Meanwhile, macroeconomic data from Beijing suggest business conditions are excellent amid officials’ claims that the next generation of reforms is largely on track, but these claims are questionable and not backed up by underlying data.
Our fourth quarter 2017 indicators continued to diverge from official reports: fundamental reforms are lagging while stated growth never seems to change. This does not make good sense, statistically or logically. We see eight of our ten policy assessments in neutral or negative territory in this edition, the same as last quarter. Of those eight, three moved further in a negative direction: Trade and SOE reforms were neutral last quarter but now show backtracking. Labor reform moved even deeper into negative territory. The other five of eight in the neutral or negative categories (Competition, Fiscal, Land, Finance, Investment) held steady with our assessments from the last edition. Only two indicators showed positive movement: Environment (based on improved air and water quality readings) and Innovation. However, the innovation story is fraught with foreign complaints that it relies on coercing foreign firms to hand over their technology and intellectual property in order to earn some access to the important Chinese marketplace, thus making progress in this dimension somewhat disputable.
Whether China will respond to economic policies from the United States and other advanced economies with tit-for-tat retaliation or, rather, more ambitious reform is an essential question – perhaps the most important of our time. Policy dynamics in this period under review were primarily about the turnover in Communist Party leadership, with Xi’s new team set for his second term, and an expanded role for the Communist Party in “guiding” the economy and even individual firms (including private and foreign). The March 2018 NPC abolished term limits for China’s presidency and vice-presidency (Xi and Wang Qishan). This elevation of the Party and attenuation of constraints on leaders may well generate long-term negative reactions from Chinese elites. It has also driven international reactions to Xi Jinping more generally, causing global opinion to harden that China is heading in an increasingly “authoritarian capitalist” or “state capitalist” direction. This, in turn, has implications concerning China’s medium-term political resolve to fully implement the market reform agenda announced back in 2013. Beijing, by contrast, claims up front that it is simply employing an alternate development model. Seemingly in the hope of tamping down foreign pressure, China announced some new investment opening in autos and a few other sectors at the Bo’ao Forum in April, but this piecemeal approach is outdated and not likely to mitigate the shift toward more confrontational U.S. policies toward China or a broader revision of existing strategies from other advanced economy governments.
Note: The chart above is a visualization of the China Dashboard’s conclusions about reform progress in each of the ten clusters we monitor. These assessments are based on the study’s primary indicators. The movement in the chart tracks how our assessments change over time. Clusters listed near the “neutral” center line display no meaningful progress or backtracking; clusters slightly in positive or backsliding territory display outcomes that we assess might be fleeting based on the extent of data changes or policy direction, while clusters deeper in positive or backsliding territory show changes we assess are more likely to last in future quarters.
The Dashboard Gauges: Primary Indicators
Our Dashboard approach to gauging China’s progress on reform – now in its third quarterly iteration – is read widely in China, and people ask what reactions we receive. Chinese officials generally understand the constructive goal: to use objective, publicly available data to underpin a point of view about reform dynamics. While reasonable people will interpret data in different ways, this quantitative approach is less prone to politicization than purely qualitative approaches. For each of the 10 reform clusters we examine, we use a primary indicator that is suited to evaluate the state of reform and add supplemental gauges to enrich the picture.
Our lenses on Environment and Innovation show positive movement. On environmental policy, our water pollution index reverted to a positive trend from a poorly performing 3Q2017, driven by flooding that faded in the latest review period. Air pollution indicators showed the best regional improvements in two years. We attribute this to factory closures and mandated fuel-switching efforts in the Northeast, which made for bluer winter skies in Beijing and surrounding areas. Innovation policy also remains on the bright side, although for complicated reasons. We watch the weight of innovative industries as a share of all industrial sector value added. Every innovative industry in our dataset grew above the industrial average in 4Q2017. At this pace, our indicator suggests China will reach parity with 2012–2015 U.S. averages by the end of 2018. However, this achievement reflects costly government guidance and intervention, such as large-scale industrial policies to promote innovation in sectors such as integrated circuits and transportation equipment, and perpetuates a tradition of pressuring foreign firms to transfer technology and intellectual property in exchange for market access. Advanced economy governments are now beginning to push back hard on China’s practices, and innovation would be set back if China’s partners cut intellectual property flows – even the most benign ones resulting from normal business decisions and routine Chinese acquisitions abroad.
Of the remaining eight clusters, only two are in neutral territory – Finance and Investment. In Finance, our primary indicator tracks how much investment capital is needed to generate subsequent GDP growth. This quarter it took almost RMB 7 of investment to generate RMB 1 of growth – a high and unsustainable level. Tighter regulation and debt deleveraging are cleaning up some risk but are not yet much improving the financing efficiency ratio. In cross-border Investment, the ratio of total flows to GDP was flat quarter-on-quarter (qoq), and the full-year 2017 ratio fell to 6.2% from 9.5% in 2016, reflecting Beijing’s prioritization of balance of payment stability over liberalizing two-way investment. Policy commitments to lift equity caps in financial services, aviation, auto manufacturing, and ship building showed potential to liberalize inbound investment in the coming quarters, so we score this neutral.
The remaining six clusters were in negative territory: Trade, SOE, and Labor moving deeper in that direction, while Competition, Fiscal Affairs, and Land reform holding steady in the negative column.
We moved Trade to negative from neutral as our primary indicator shows the ratio of highly protected goods and services imports to GDP falling below 100 – lower in 4Q2017 than it was when the Third Plenum Decisions were originally announced in 2013. U.S.-China trade tensions went into high gear after this coverage period and are likely to color our indicators further in the subsequent edition.
Our assessment of SOE reform also moved to negative from neutral. Our primary indicator looks at the ratio of state to non-state share of revenues for various groups of listed firms. The dataset was incomplete this round, but available numbers and our supplemental indicators suggest the listed SOEs in China are not withdrawing to make room for private firms, even in non-strategic industries. Mixed ownership reform is not yet delivering results in this regard, and SOE leverage ratios did not improve. The March NPC was a missed opportunity to offer new thinking on SOE reform.
Our assessment of Labor and Shared Welfare reforms was already negative and is now more so. The primary indicator – migrant worker wage growth relative to GDP growth – fell further. Migrant worker wages have lagged behind GDP growth for seven consecutive quarters. Our supplemental indicators suggest that weak wage growth was not driven by insufficient job creation but by the fact that many job applicants were forced to accept lower-paying jobs outside of major urban centers – which means that worker mobility is constrained, and thus China’s labor market is still not operating at its best. We see limited policy progress, pointing to a negative outlook.
Our primary Competition indicator shows China’s Ministry of Commerce (MOFCOM) continued to disproportionally target foreign firms in merger & acquisition (M&A) reviews, and to issue divestment requirements only for foreign-involved mergers. We also measure judicial transparency, which is critical for businesses to be able to understand and anticipate regulatory enforcement, and find less transparency than previously – not the hoped-for trend. Competition policy was subject to significant action at the NPC, with a consolidation of entities responsible for M&A review, and empowerment of the intellectual property regulator. This might augur well for improvement in future quarters if these bureaucratic fixes are implemented faithfully, moving this metric out of negative territory.
Our primary Fiscal Affairs indicator looks at the gap between what local governments spend and the revenues they collect. The data show that local governments spent 43% more than total local resources, close to an all-time high, and that central transfers to local governments fell from the previous quarter. Policy efforts to limit risky financing practices and deleverage local governments will remain only marginal improvements until the massive local government funding gap is fully addressed. Authorities announced a plan to increase the central government’s share of the burden for local social welfare spending this year, but skeptics expect it to codify existing practices rather than offer a fundamental improvement.
Finally, on Land reform, Beijing‘s stated 2013 Third Plenum goal was to allow market forces and participants to steer land allocation. Our indicators show only slim progress toward that goal, and data are inadequate to confidently analyze the situation. The amount of rural nonagricultural land made available to the market remains almost undetectable, despite the country’s massive supply of rural land. Beijing unveiled some new thinking on land-related issues at the 19th Party Congress in October 2017, but policy signs suggest gradualism and no rapid improvement.
Our overall catchphrase for this review period is political preoccupation. Policymakers focused on Party and government transitions and political correctness, not bold initiatives.
The Policy Picture
Major political events filled the past six months, including the 19th Party Congress in October, the Central Economic Work Conference in December, and the NPC in March. Our overall catchphrase for this review period is political preoccupation. Policymakers focused on Party and government transitions and political correctness, not bold initiatives. That domestic fixation was coupled with rising international pressure, as Washington announced the beginnings of a deep strategic shift toward China. A new U.S. National Security Strategy (NSS) defined China as a strategic competitor, giving Beijing whiplash coming right after a seemingly chummy “state-plus-plus“ visit from President Donald Trump presented a more promising picture. Europe partly echoed these concerns, with member states voicing stronger concerns about trade, industrial policy, and direct investment. In our framework, both the completion of China’s political housekeeping and the uptick in foreign pressure should promote policy reform. We flag promising policy commitments in the review period that could improve our indicators in future periods.
The March NPC ushered in a massive restructuring of the bureaucracy that codified a stronger role for the Communist Party, ostensibly to reduce overlap and better implement policies. This included elevating four Party “leadership small groups,” ad hoc conclaves of senior leaders, into more permanent commissions, creating two new bodies with direct responsibility for economic and reform policies – the Financial and Economic Affairs Commission and the Comprehensively Deepening Reform Commission. These two bodies are both chaired by President Xi. The NPC ratified constitutional amendments to remove term limits on the presidency and vice-presidency, suggesting Xi may stay in office beyond 2023, and created a new National Supervisory Commission intended to bring permanence to anti-corruption work. It also restructured numerous other ministries and commissions, including empowering environmental regulators and consolidating insurance and banking sector oversight. Reinforcing the theme of “Party over government,” the head of that newly merged banking and insurance regulator, Guo Shuqing, was appointed Party secretary of the People’s Bank of China (PBoC), while long-serving Deputy Governor Yi Gang, lower in the Party’s hierarchy, was appointed governor.
With this reorganization, the leadership at one level is signaling reform momentum rhetorically. But commitments made to date are gradualist and unlikely to forestall international trade and investment action against China significantly. At the Bo’ao forum in April, Xi pledged to lift equity cap requirements in important sectors including financial services and auto production and to cut tariffs on auto imports. A day later, new PBoC Governor Yi Gang provided an accelerated timetable for the financial services sector opening. These developments could drive some marginal improvements in our indicators of trade, investment, and financial sector openness; however, given the gradual timeline and implementation uncertainties, results may not be evident for years. The release of more details in recent weeks would also indicate that proposed new openings for foreign investment in banks and insurance firms in the Chinese market will be highly circumscribed.
The leadership also promises continued deleveraging and supply-side structural reform (closure of overcapacity sunset factories) in 2018. A mid-April cut in reserve requirement ratios for banks (100 basis points) is, contradictorily, a monetary easing move to prop up growth, but Beijing maintains that deleveraging will be achieved through tighter regulation and fiscal restraint on SOEs and local governments instead. As this Dashboard update approached publication, the Party Politburo announced more support for growth following a meeting to manage the economy, but once again it asserted that the fight against financial risk would remain the top priority for the year.
Whether China will respond to economic policies from the United States and other advanced economies with tit-for-tat retaliation or, rather, more ambitious reform is an essential question – perhaps the most important of our time.
The View from Abroad
Core international complaints about Chinese industrial and trade policies remain a glaring concern. Western nations are starting to define what they want from China – not piecemeal, incremental change, but more substantive and comprehensive reform. They are increasingly serious about changing business as usual. These acid tests of market-oriented “like-mindedness” include the primacy of market forces instead of government guidance in determining commercial outcomes, protecting shareholder profit interests from politics in corporate governance, and the importance of gauging economic outcomes by objective metrics rather than pledges. These broad qualities are characteristic of an economic model above and beyond the elements of our Dashboard, but they will show up as progress in our Dashboard indicators.
For want of evidence of real reform in U.S.-China trade relations, the United States is now threatening unilateral trade action that would profoundly change the nature of U.S. economic engagement with China. These include actions applied to all nations but inspired by China’s overcapacity industries (Section 232 tariffs on steel and aluminum) and China-specific actions aimed at intellectual property (Section 301 tariffs on as much as $150 billion of U.S. imports). Other mooted U.S. actions include enhanced direct investment screening and potential reduction in student visas. Many advanced nations are gravely concerned by aggressive U.S. unilateralism, with its threats to upend multilateral institutions and precipitate a global trade and investment protection battle. But at the same time, most would be willing to make common cause in pushing China to deeper reform if they could be assured of better U.S. respect for the liberal international economic system.
Success in this global brinksmanship is poorly defined at best. The yardstick for estimating the costs is also unclear. China‘s implementation of its 2013-vintage economic reform goals is one benchmark that would be important in moderating the current inflamed debate. Our Dashboard will make clear whether that is the case.