Tuesday, July 29, 2014
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Re-Governing China

BEIJING – This year’s China Development Forum in Beijing revealed the clearest vision yet of how China’s leaders intend to deliver the “Chinese Dream,” which President Xi Jinping has described as “national rejuvenation, improvement of people’s livelihoods, prosperity, construction of a better society, and military strengthening.” The question is whether the government can follow through on its ambitious reform and development plans.

Last November’s Third Plenum of the 18th Central Committee of the Chinese Communist Party produced more than 330 major reforms in 60 areas for implementation by 2020 – a package of unprecedented scale, depth, and complexity. Orchestrating China’s transformation from a manufacturing- and export-based economic model to one driven by consumption and services – and that is inclusive, environmentally sustainable, and creates more than 13 million jobs annually – is a massive undertaking. Add to it the challenge of upholding financial and social stability – and accomplishing all of this while managing one of the world’s largest bureaucracies – and the task ahead becomes truly mind-boggling.

Consider the effort last summer to assess the government’s financial condition. The National Audit Office had to mobilize 55,400 staff members to review not only the central government’s accounts, but also those of 31 provinces and autonomous regions, five central municipalities, 391 cities, 2,778 counties, and 33,091 rural communities. The investigation covered 62,215 government departments and agencies, 7,170 local-government financing vehicles, 68,621 public finance-supported reporting units, 2,235 public business units, and 14,219 other entities – responsible, altogether, for 730,065 projects and 2,454,635 items of debt.

Clearly, public-sector governance in China is radically different from that in the West, where the rule of law, democratic elections, and free markets are structural norms. And, though 35 years of major reforms have brought about considerable change, with the private sector now accounting for the bulk of job creation, there remains much to be done – exemplified in the fact that the state, especially local governments and state-owned enterprises, still command most of China’s credit resources.

One way to appreciate the complexity of China’s governance ecosystem is to examine the matrix of relationships among institutions, the tiao tiao kuai kuai – literally, “lines and pieces.” Tiao tiao refers to the vertical lines of control from the central government through national ministries or agencies to local-level institutions. They include central planning concerning development and reform; the nomination and promotion of officials to important posts in ministries, state-owned enterprises, and local governments at all levels; and macroeconomic tools, particularly fiscal, monetary, exchange-rate, and regulatory policies. Kuai kuai refers to the lateral, highly competitive relationships among regional entities, to which the central government delegates a certain amount of autonomy.

In order to achieve genuine stability, China’s leaders must strike a delicate balance between tiao tiao control and kuai kuai autonomy. But this has proved difficult, with relaxation of tiao tiao often leading not just to rapid regional growth and improvements in local public services, but also to widening imbalances and a heightened risk of overheating, owing to pro-cyclical herding behavior, such as excessive fixed-asset investment. The government is then forced to re-impose central control abruptly, bringing about a sudden stop. If China’s economy were a car, the country’s leaders would always be either flooring the accelerator or slamming on the brakes.

With its latest set of reforms, China’s government is attempting finally to fine-tune its approach. The package centralizes some responsibilities, such as managing resistance from vested interests, while expanding local-government autonomy in other areas, including procedures for licensing and planning approval. With the creation of free-trade zones – which entail lower tariffs, reduced customs barriers, and less administrative intervention – the government is attempting to give market forces a decisive role in resource allocation.

This effort to ease unnecessary constraints on regional entities will lead to market and institutional innovations. These innovations, together with increased transparency and the implementation of cutting-edge technologies, are likely to reduce rent-seeking and corruption, while boosting productivity and employment significantly.

The government’s recent decision to phase out the household registration (hukou) system will augment these gains further, as it gives workers and private business-owners alike the opportunity to choose where to live, work, and invest. As China’s leaders explicitly recognized at the Third Plenum, the removal of arbitrary tiao tiao controls can enable cities and local communities to evolve according to their own comparative advantages.

But China’s gradual opening up will increasingly allow companies and individuals to cross national borders in search of more lucrative opportunities, complicating the country’s governance matrix further. Indeed, coping with global competition for markets, resources, talent, and respect will require a two-way interaction between Chinese and global governance systems.

China’s leaders have already demonstrated that they understand the need to implement modern management techniques, and that doing so requires them to update and recalibrate the tools of central control on which they have long relied. With the right adjustments, China’s governance system can effectively address market failures like air and water pollution, food safety, energy efficiency, and social inequality, while ensuring the country’s long-term prosperity.

This process is only beginning, but it is off to a strong start.

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