The Story So Far
In the decades following China’s 1978 decision to reform and open, its growth was driven by demographics and structural adjustment – letting market logic reshape the economic landscape. But in recent years, as the easier phase of development gave way to middle-income challenges, Beijing has attempted to reassert control over investment and markets. This was not the first choice. President Xi Jinping’s inaugural 2013 Third Plenum economic plan – while still couched in Communist Party nomenclature – was distinctly geared toward a decisive role for markets. Implementation of those goals, rather than aspiration, has been most lacking. By tracking China’s own 2013 objectives across 10 economic domains, The China Dashboard seeks to inform public debate with objective data on just how close to or far from those aspirations China is trending.
Gauging China’s policy progress objectively is essential for understanding what sort of economy – and polity – China will have domestically in the future, and just as critically what role China will play in the international community. The current tensions between China and the United States represent the sort of situation we previously anticipated at the conception of the Dashboard project and seek to temper through the dissemination of respected data indicators and interpretation. For this reason, we eschew normative advice or prognostication about the future of the Chinese economy, though we do point out clear conundrums in the outlook.
After a year jockeying for leverage in their trade negotiations, the United States and China stumbled into major tariff escalation in May 2019. Debate devolved into recriminations: was there really a deal to break, and if so who broke it? To answer these questions, we must analyze China’s movement toward or away from the implementation of its economic reform commitments in response to the economic stress of the past year.
China is facing tremendous economic challenges. Economists have warned for a decade that reliance on ever-growing debt levels to fuel expansion would have to end, and when it did, GDP growth would fall. Having grown the banking system to 45% the size of global GDP, from little more than 5% a decade ago, the marginal return on further investment in China has been greatly diminished. The question is whether Beijing intends to fix this low-productivity situation by stepping-up market reforms or by reverting to state planning.
China’s leaders insist that nothing about its “reform and opening” policy has changed in recent years. But the China Dashboard indicators we evaluated to track policy directions suggest that many reform objectives have gotten bogged down or even reversed in recent years. Today’s reform challenges are increasingly difficult and structural. As China’s economy grows more powerful and competitive globally, it must increasingly converge with the levels of economic openness of other advanced economies. That has simply not been happening.
Beijing is prioritizing short-term results over durable fiscal policy.
The Dashboard Gauges: Primary Indicators
China’s economic growth fell steeply in 2018 as a result of a necessary reduction in the growth of imprudent financing. We are now six months into a recovery, with first quarter 2019 GDP growth reported at 6.4%. Which strategy got us here? On net, we are seeing short-term stimulus at work, not reform. Three of the four Dashboard indicators that shifted in this period moved away from reform, not toward it.
Of these, the most concerning is our fiscal assessment — one of the best barometers of whether stimulus policies are being deployed at the expense of structural reform. We downgrade our assessment of Fiscal Affairs in this Dashboard edition because, once again, local government expenditures are rising faster than revenues. This indicates that Beijing is prioritizing short-term results over durable fiscal policy. Spending on infrastructure drove local fiscal deficits. Falling land-sales revenues sound an alarm for the property market outlook, but they are just as concerning for local government capacity to ongoing debt service obligations. Beijing will likely have to turn to even more stimulus and local fiscal support (including bailouts) in the months ahead to maintain stability.
Other clusters with negative movement were Cross-border Investment and labor market reform. While we saw a new foreign investment law and some capital market and financial services openings in this period, gross cross-border capital flows as a percent of GDP declined to the lowest level in six years. Foreign investors remain hesitant about China due to concerns about restrictions on outflows, exchange rate fluctuations, and the overall growth outlook.
Labor reform, meanwhile, has long been one of our most negative assessments and now is even more so. Our primary indicator shows migrant worker income growth is currently 30 percent below the headline GDP growth. China’s workers are seeing their share of national income shrink despite labor shortages across the country, a sign of continued inefficiencies in labor markets.
The only reform area where we upgrade our assessment this round is, ironically, Trade. In areas of our highly protected product import tracker where data is available (agricultural goods and services), we saw moderate improvement in import intensity, and we observed considerable tariff cuts in other product areas. It is fair to observe that this reform movement coincides with the tremendous pressure for liberalization coming from abroad, especially from the U.S.-China trade war, but also from Europe and other advanced economies.
At the second Belt and Road Forum in late April, President Xi Jinping even acknowledged that China had “anti-competitive, market-distorting, unreasonable subsidies, regulations, and practices,” which he promised to remove. This was an unusual public recognition by China’s president that validated the urgency and sense of grievance that China’s trading partners have expressed and that the Dashboard points to.
While structural reform has not taken off, there has been an uptick in talk about helping the private sector, reducing the overreach of Beijing on industrial policy (i.e. Made in China 2025), and addressing other elements needing reform. Yet, most of the improvement in private sector conditions over the past nine months has been from lower interest rates and increased access to short-term working capital loans, which represents loose financial policy, not structural reform. This is akin to a blood transfusion that provides short term sustenance but does not address the fundamental pathology at play.
The National People’s Congress (NPC) is the signature annual opportunity for China to show its institutional directions, and the 2019 session occurred during the drafting of this edition of the Dashboard. On the whole, the NPC was a missed opportunity to demonstrate reform progress. China's leaders point to several elements of this year’s Congress as proof of their reform commitment, including passage of a new unified Foreign Investment Law meant to address long-standing global concerns regarding technology transfer and intellectual property theft. As highlighted in our Cross-border Investment and Innovation clusters, the global response was tepid given vague language and uncertainties about implementation. Premier Li Keqiang also promised to better “balance the relationship between government and market” and committed to accelerating the restructuring of oil, electricity, and railway state-owned enterprises (SOEs).
These would be positive moves. But at China’s current stage of development and competitiveness, piecemeal steps are not sufficient. The question is not just what is being done, but also what major imperatives are going unaddressed. Here are three. First, while the leadership promises structural reform and privatization of at least some SOEs, it has yet to even classify publicly which industries are to be state-directed and which left to the market. Without this clarity, private investors cannot be confident of fair treatment when participating in “mixed ownership” reform trials. Second, U.S. and Chinese officials are negotiating the relaxation of some joint venture requirements for foreign investment in some sectors, but an explanation for why an economy of China’s size and dynamism still has mandatory joint venture requirements in the first place is missing. And third, while leaders talk about bankruptcy reform and the need for fiscal prudence, they are not talking about the proliferation of trillions of renminbi in “government guidance funds” and other sources of soft budget support that keep zombie firms afloat.
So we can see recovering growth in 2019, but due to fiscal, monetary, and regulatory stimulus, not reform. This approach cannot last. The difficult policy choices required to put China on a sustainable track, which are the same things needed to land a meaningful “deal” with Washington and other partner governments, have not yet been made and are not assured.
The difficult policy choices required to put China on a sustainable track, which are the same things needed to land a meaningful “deal” with Washington and other partner governments, have not yet been made and are not assured.
The View from Abroad
In the May meltdown in U.S.-China trade negotiations, Washington asserted it had gotten the concessions it needed only to have China “break the deal.” China, meanwhile, insists that Washington changed its position on the scale and content of its proposed additional purchases of American goods.
Any deal would entail meeting somewhere between the two ends of the spectrum and compromising. The trick is to figure out where the middle is. Neither side has yet made available what was agreed upon and what was not.
If the Chinese starting point for compromise is the ambition for reform, opening, and marketization that Xi Jinping set out at the November 2013 Third Plenum, then meeting in the middle might well be possible. Mostly, it would mean agreement on temporary, interim measures needed to bridge the gap until China implemented its self-declared policy reform objectives.
If, on the other hand, Washington is asked to split the difference based on where Chinese policy is trending today – as seen through the China Dashboard lens – then a deal is less likely, given how far Beijing has diverged from even its own reform intentions of six years ago.
President Trump’s bellicose public handling of the last round of negotiations in Washington has not helped the process of finding a way through. Beijing, in response, published its own red lines on which it will not compromise. This has been reinforced by a patriotic call to action in China and public admonitions not to be intimidated by the United States. These and other chest-thumping gestures are compounding the political difficulty of reaching agreement, as internal critics in China argue that they have already conceded too much. Now, more than ever, both sides would be much better served by talking about an objective framework for gauging reform alignment and the work that needs to be done. The China Dashboard will be waiting when the two sides are ready for a more constructive dialogue.