China’s premier Wen Jiabao called for continued “reform and opening up” of the economy in his final policy address to the National People’s Congress on Tuesday. The speech lacked new policy prescriptions and was largely consistent with the prevailing language on the development of the economy as “key to solving all of our problems” and the government’s “central task” to advancing its cause.
In reforming the economy, the government fears the unforeseen consequences that looser controls could have for the Communist Party’s monopoly on power once the proverbial genie is let out of the bottle.
China is in the middle of a once a decade leadership transition with Wen and President Hu Jintao relinquishing their posts to Le Keqiang and Xi Jinping, respectively. The transition is occurring at a critical time as China has reached an inflection point in its economic development after three decades of unprecedented double digit growth.
A few years ago, China overtook Japan to become the world’s second largest economy after the United States. The International Monetary Fund expects it to become the largest economy on a purchasing power parity basis within the next decade.
But as growth has slowed during the last two years, corruption is becoming endemic and more known to the public. Moreover, pollution is spreading and growing inequality is leading to protests over land appropriations and an assortment of other issues. There is a sense that China’s “growth at all costs” model is at an end and a new model needed to keep instability at bay and avoid the “middle income trap.”
How to accomplish this and remain in power is the burning question before the Communist Party as its leaders meet in Beijing. Even if he is leaving, Wen’s address to the delegates represents the current thinking of senior officials in the ruling party including the incoming leaders.
Wen detailed the many accomplishments of the last five years in his speech: China built thousands of miles of road and railways as well as millions of homes in its urbanization. As Xi did days before, Wen also warned that mounting corruption, environmental damage and a slowdown in growth need to be confronted. Left out altogether was any mention of political reform.
The greater disappointment was in Wen’s lack of any mention of structural economic reform. An increase in domestic consumption over the continued reliance on state led investment is needed, an imperative that Wen has previously references. But the premier offered no specifics on how to achieve this on Tuesday.
Those advocating reform also believe that China’s banking system needs to allow interest rates to float more freely to offer higher deposit rates to consumers. China’s households sector, in search of higher returns, is being encouraged to invest its savings in real estate in second and third homes in which people have no intention of living but under the assumption that home prices will continue to rise. This is occurring because of the state’s control over deposit rates to protect its state-owned banks from having to pay out more on deposits to consumers. As a result, the proliferation of “ghost cities” has deepened fears of a bubble in the real estate sector.
The Chinese government last week announced that it would more vigorously enforce a 20 percent capital gains tax on home sales and raise interest rates on second and third home sales, in addition to other rules expected in the near future, in order to curb speculation.
On a macro level, China is losing its competitive labor advantage against other emerging economies faster than expected. Its increasing manufacturing costs were illuminated last year when factory workers protested over pay and working conditions at factories in Guangdong Province. Government officials stepped in, fearing the prospect of industrial action spreading, and forced company managers to placate the striking workers by raising their hourly wages and improving working conditions.
While not directly related to the strikes, there are recent reports of a labor shortage of 1.2 million workers in Guangdong with Foxconn and others major manufacturers said to be considering relocating to western China or elsewhere in Asia.
With its export model seen as unsustainable in addition to the internal imbalances in the financial system, the government is no doubt feeling the pressure to stimulate innovation to create jobs higher up in the value chain and maybe loosen interest rate controls too. However, it is understandably reticent to start down that path lest it open a Pandora’s box with the thinking being that greater economic freedoms may lead to demands for democracy which could threaten the survival of the Communist Party.