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SEB report: Continuity and reform awaits China

SEB report: Continuity and reform awaits China

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Published by SEB Group
SEB’s senior economist Klas Eklund writes in a new research report about China that not only is the Hu-Wen era drawing to a close, but that the entire growth strategy that has dominated the past 30+ years must be reformulated. China’s new leaders also face the task of dealing quickly with the corruption that threatens the legitimacy of the Communist Party.
SEB’s senior economist Klas Eklund writes in a new research report about China that not only is the Hu-Wen era drawing to a close, but that the entire growth strategy that has dominated the past 30+ years must be reformulated. China’s new leaders also face the task of dealing quickly with the corruption that threatens the legitimacy of the Communist Party.

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Published by: SEB Group on Dec 17, 2012
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This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document
 are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted forany direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice.Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in theUS. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct ofinvestment business in the UK.
China after the leadership change:Continuity and reform
DECEMBER 17, 2012
I spent the first week of December in a chilly but snow-free Beijing. This article presents my impressions fromconversations with analysts, economists and academics,among other things at a Stockholm-China Forum seminar with Chinese colleagues. My main conclusion is that not only is the Hu-Wen era drawing to a close, but that theentire growth strategy that has dominated the past 30+ years must be reformulated. China’s new leaders alsoface the task of dealing quickly with the corruption that threatens the legitimacy of the Communist Party.My assessment is that at first, the new leaders will prioritise continuity and stability, but that starting next autumn they will gradually push through economic reforms. Implementing the entire reform agenda that isnecessary will take time, however. One important crossroads is the next party congress in five years, whenmost of the recently appointed top leaders will bereplaced. This may provide an opportunity for younger,perhaps more reform-minded leaders to move up.
The legacy of Deng
The People’s Republic of China has existed for more than60 years, with two clearly distinct phases. During the firstphase, lasting nearly 30 years, Mao Zedong ruled as anautocrat. The Great Helmsman created a peasant-basedcentrally planned economy and caused chaos during theCultural Revolution. The next generation of leadersdecided to break with the planned economy and thewhims of an autocratic leader. Their two main goals wereto build economic prosperity and to preserve politicalstability under the control of the Party, with collectiveleadership. They have achieved both goals, but in waysthat make it impossible to use the same methods in thefuture. Growth must become more inclusive andconsumption-based. Meanwhile the regime must listento growing protests against corruption and increasingdemands for freedom of expression.Since China under Deng Xiaoping chose the path ofmarket reforms, the country’s GDP has grown by about10 per cent annually for three decades (averaging 9.7 percent annual growth during the 1980s, 10.0 per cent inthe 1990s and 10.3 per cent in the 2000s). Only twonations have come close to these figures: Taiwan (9.6per cent annual growth in the 1950s, 9.0 per cent in the1960s and 10.1 per cent in the 1970s) and South Korea(8.1 per cent annually in the 1960s, 10.1 per cent in the1970s and 8.6 per cent in the 1980s).Both Taiwan and Korea saw their annual growth ratesdrop somewhat lower during their fourth decades ofgrowth: Taiwan to 7.7 per cent in the 1980s and Korea to6.7 per cent in the 1990s. Now China seems to beheading towards a similar slowdown. In 2012, GDPgrowth will probably be somewhat below 8 per cent, andthe country’s Twelfth Five Year Plan (2011-2015) aims for7 per cent annual growth. Official statements mention atarget of doubling China’s GDP in 10 years, which in factwould require about 7 per cent annual growth.This deceleration is partly due to cyclical and externalfactors, such as the impact of the global financial crisisand a hangover in key sectors following the country’s2008-2009 stimulus measures. But more important inthe long run is that the existing growth strategy – basedon enormous capital spending and rapid export growth –is no longer sustainable. Massive investment initiativeshave led to chronic overcapacity and low capitalproductivity (i.e. waste). Now that China has become theworld’s largest exporter, there is simply no longer roomin the world market for the same rapid export growth.The strategy has also resulted in growing income gapsand terrible environmental destruction. This is why itmust change: growth must become greener as well asmore equitable, resource-efficient and consumption-based.The goal of political stability has been achieved,although the system was shaken in 1989. Theconfrontation with Maoism almost reached the pointwhere the supremacy of the Communist Party was beingquestioned and spontaneous calls for democracy couldbe heard. Deng decided to crush the protest movement,and in the eyes of party leaders the subsequent collapseof the Soviet Union confirmed that they had actedcorrectly by not allowing the same breakdown ofauthority to occur in China. During the following two
Economic Insights
decades, political stability truly seemed to go hand inhand with growing economic prosperity, just as the partyintended.But in recent years the system has once again becomeshaky. China’s growing middle class is increasingly welleducated and verbal, has access to the Internet and hasstarted to become accustomed to a certain (thoughlimited) freedom of expression. There is widespreadoutrage at conspicuous corruption. Farmers are furiousabout unfair expropriation of land. Entrepreneurs andacademics want greater intellectual freedom. More andmore people in China are travelling abroad, gaining newimpressions and returning home with a feeling that therigid Chinese system is incapable of providing adequateresponses to the challenges ahead.There is no large-scale democracy movement in theWestern sense. Instead, there is a desire for freedom ofexpression, a clean-up of rampant corruption and a moreattentive, inclusive leadership. It is obvious to more andmore people that today’s rigid top-down control must bereplaced by greater dialogue and partnership, but how toget there is far from self-evident; different commentatorsmean different things when they speak of “politicalreform”.My conclusion is that the cornerstones of Deng’s strategyare crumbling. The Chinese model has to be updated. Inhis day, Deng broke with the centrally planned economy.Today’s leaders face the task of updating Deng’s model,which was so successful for decades. According to a newdebate anthology, the task is to build a “China 3.0” afterMao’s “China 1.0” and Deng’s “China 2.0”.
In thefollowing sections I will discuss what this means,especially for economic strategy, but also for the battleagainst corruption. Demographics, security policy andenvironmental issues are highly important but have beenomitted from this account, since I primarily discussedeconomic issues during my Beijing visit.
The new leaders
In November the 18
Congress of the Communist Partyof China elected a new Central Committee and a newPolitburo. At the top of the power pyramid is thePolitburo Standing Committee, which was reduced fromnine to seven members – presumably signalling that theparty leadership wants a firmer decision-making process.Of these seven, only two were members of the previousStanding Committee: those who are ranked No. 1 andNo.2:
Xi Jinping
has apprenticed as vice president for thepast five years and has been groomed as the next
Mark Leonard (ed):
China 3.0
, European Council on ForeignRelations, 2012.
party leader. The choice of Xi as party generalsecretary was thus completely expected. He is theson of a prominent revolutionary leader, has servedas a provincial governor, organised the BeijingOlympics and has good contacts with the military.He appears more charismatic than his predecessor,is a better speaker, is more well-travelled – and ismarried to one of China’s most famous singers. Inpolitical terms, Xi has not stood out in any way. Hethus appears to be a person capable of keeping theleadership together and uniting different factions.
Li Keqiang
has apprenticed as first vice premier inthe same way. He has a more humble backgroundand comes from the Party’s youth league, like theretiring party leader (many claim he was Hu’spersonal favourite for the top position). Li is themost explicitly reformist member of the newleadership. He has occasionally faced criticism – heis said to have been slow in dealing with the SARSepidemic in his province – and Li’s detractorsaccuse him of having inadequate leadershipqualities.Some of the five new Standing Committee memberswere relatively unexpected by Western pundits.Commentators in the West have generally expresseddisappointment that more reform-minded leaders, suchas Guangdong provincial governor Wang Yang, did notreach the top. But it is hard to avoid the suspicion thatsome of their displeasure is a kind of “sour grapes”reaction. Some of the new Standing Committeemembers have a
de facto
track record as economicreformers, though not as political reformers.
Wang Qishan
helped tackle China’s banking crisisof the 1990s. He is thus called the “fire-fighter” –the person sent in to clean up and solve difficultproblems. He is regarded as capable and reform-minded. Many observers thought Wang would begiven responsibility for economic matters, but onthe new team he will be in charge of the Party’sdiscipline commission and will thus responsible forfighting corruption – a signal that a tougherapproach can be expected.
Zhang Gaoli
comes from the post of party chief inthe major port city of Tianjin. He was previouslyparty chief in Shenzhen, for many years the mostdynamic city in southern China and something of atest-bed for market reforms. Zhao has kept a lowprofile, but his background puts him in what mightbe called the pro-market camp. He is the favouriteto become first vice premier in charge of theeconomy.
Economic Insights
Yu Zhengsheng
is an engineer and party chief inShanghai. He is regarded as supporting privatisationand judicial reforms, i.e. giving more power to thecourts.
Zhang Dejiang
worked in Beijing as one of China’svice premiers until last spring, when he succeededthe ousted Bo Xilai as party chief in Chongqing.Zhang is reputed as wanting to preserve the strongposition of state-owned enterprises.
Liu Yunshan
stands out among the others. He isnot a governor, but instead has worked as thedirector of the party’s propaganda department andhas thus been in charge of the regime’s increasinglytough policies towards dissidents on the Internet.One should be careful not to make too much of thesebrief evaluations. Firstly, collective leadership is moreimportant than individual personalities nowadays.Secondly, please note my deliberately vague language:“is regarded as”, “is reputed as”, “appears to be”. Thereason is that what has been happening behind thescenes in the party leadership is hidden to us. We cannevertheless state that a majority of the StandingCommittee consists of the sons of earlier prominentparty cadres. Six of them have worked in large, fast-growing coastal cities and four (including both Xi and Li)were sent out to perform manual labour in thecountryside during the Cultural Revolution. They are thusfirmly rooted in the party apparatus, with a backgroundthat is likely to make them sympathetic towards gradualeconomic reforms – but sceptical towards major politicalshifts.
The new Politburo Standing Committee being introduced at the 18
Party Congress in November 2012: From theleft: Zhang Gaoli, Liu Yunshan, Zhang Dejiang, Xi Jinping,Li Keqiang, Yu Zhengsheng and Wang Qishan.
Most of these new top leaders are protégés of the now86-year-old Jiang Zemin (who served as Communistparty leader before Hu Jintao). Only Li belongs to HuJintao’s circle. Jiang is described in the West as aconservative force, and it is probably true that he is noteager to make growth greener. However, he has clearlyshown his displeasure that the economic reforms ofrecent years have seized up and that growth hasdecelerated.In light of this, I think it is too early to make sweeping judgements about the new Standing Committee being“conservative”, as some Western observers have done.Instead I foresee a leadership that will gradually showgreat interest in the economy, tougher competition andtechnical development – but that is not so interested inpolitical reforms. A politically traditionalist leadership,yes, but at the same time a technocratic and “business”-oriented group of managers who will want to update atleast parts of China’s economic strategy.
When will the reforms come?
Recently, Xi Jinping made a symbolic trip to southernChina, exactly as Deng Xiaoping did in the early 1990swhen he wanted to push through reforms. Xi visitedShenzhen, where his own father helped build up the firstspecial economic zone, and declared that “far-reachingreforms” are necessary.His trip was a clear signal about long-term strategy. Butwe should not expect any rapid shift. During theWeekend of December 15-16, the party leadership heldits annual “Central economic work conference” to decidethe direction of economic policy during 2013. Thestatement issued after the meeting said reforms shouldbe pursued with “greater political courage and wisdom”;investments, domestic demand and taxes will be guided“proactively” to secure steady growth, and urbanisationwill continue. While commitment to reform thus wasaffirmed in general terms, no major new initiatives werelaunched.This was not surprising. In this initial stage, the newleaders are prioritising continuity. Furthermore, China’sgovernment posts have not yet been allocated. This willnot occur until this coming spring, after the secondplenary session of the new Central Committee and themeeting of the National People’s Congress (China’s“parliament”). Once they are formally named presidentand head of government, respectively, Xi and Li willprobably hold policy speeches and signal the direction inwhich reform work should proceed. After that, newlyappointed technocrats and planners in ministries andpublic authorities, state-owned enterprises and thinktanks will be put to work shaping and devising the detailsof the new strategy.This is why I am guessing that not until next autumn, atthe time of the 18
Congress Central Committee’s ThirdPlenary Session, will the government launch any majorreform initiatives. Economic developments during the

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