Download Haenle: Following the stock market crash, many observers pointed

Carnegie-Tsinghua Center for Global Policy
China in the World Podcast
Episode 53: What Is Going On With China’s Economy?
August 19, 2015
Guest: Yukon Huang
Host: Paul Haenle
From the Carnegie-Tsinghua Center in Beijing, China, this is the China in the World Podcast hosted
by Paul Haenle.
Haenle: Following the stock market crash, many observers pointed to the 2013 Third Plenum
document, which for the first time stated that the market should play the "decisive" role in the
Chinese economy. Yet, the Third Plenum also stated that there would be a continued "dominant"
role for the state sector in the economy. What should we make of this language and the
government's heavy handed intervention in the stocks? Is there a contradiction between rhetoric
and reality?
Huang: For many observers of the China scene, there seems to be a contradiction between the
Third Plenum statement of the increased role of the market, while at the same time saying the
state should have a dominant presence. From a Chinese perspective, it doesn’t necessarily seem
like a contradiction, because you have to ask what do they mean by “the market?” And what they
mean is the prices of goods, energy should be freed up. That has been the case most recently in
terms of energy prices. Interest rates, exchange rates, capital flows, capital markets should
become more liberal and free and they have been over the past few years. The equity markets,
what they’ve tried to do is to say we’re going to make the equity market a stronger and deeper
market, which actually was a reasonable intention because really wasn’t playing a role. So in the
sense of saying “let the market play a greater role” even the equity bubble, the origins of it were
grounded in the view of making the market stronger in the system.
Now, what about the concept of the state still plays the dominant role. And what they’re
basically saying of course is that the state ownership of key assets and raw materials and the
major state enterprises is not going to change—it’s going to remain dominant. The role of the
state in these markets – in shaping policies and in how you deal with it, will remain dominant. So
you have this apparent contradiction—yes the markets are going to be broader, deeper, and more
pervasive in the system. But the state’s role in these markets and or shaping the outcomes of
these markets will continue to be strong.
Now in the West we would not think these two concepts are compatible: markets should be left
to themselves, the state should not be intervening. But this is actually their concept. The same
thing is applying to the rule of the law. From a Western perspective they thought the rule of the
law meant that this would provide a more neutral framework for everyone to operate, whereas
it’s actually a framework for the state or government to control others, rather than the reverse. So
I think it’s a bit of wishful thinking, and we’re seeing the reality now.
Haenle: The Chinese government is eager for its market to be a global player and for its
financial system to be on par with the world. Given the experience with the ability to regulate
capital markets over the past month, do you think there's been a change the leadership’s thinking
about how ready China is to oversee something like an opening of one's capital account to global
capital markets?
Huang: I am sure there is a re-thinking or trying to understand out what went wrong with the
equity markets. The objective of opening up the financial markets, the capital markets, I think
that remains serious and the government will continue on this vein. This has very strong political
support because the concept of a “China rising” or China playing a greater role includes China’s
financial system playing a greater role. Internationalizing the RMB is a key objective. To
internationalize the RMB you also have to have an equity market that is linked to the global
equity markets so I don’t think that will change.
But what the lesson is, is how you implement this objective has to be done more carefully. And
the major issue they have to face is the following: is the role of the government to regulate these
markets to make sure that it performs sensibly, or is it to influence the outcomes? And I think the
lesson from this is that it’s very dangerous for the state to try to influence the outcomes. It needs
to actually provide proper regulation.
Now regulating markets is not easy. Even in the West you can see what happened in Europe and
the United States—the strongest and deepest financial systems still had instability and problems.
So it’s not a task that can be handled fairly easily and now we see a similar kind of example of a
different nature in China. So I think the debate is going to be not on the objective or what they
want to do, the debate is going to be how – we need to implement this better and how do we
create institutions that can make it work better? And the answer is this is not easy, this is going to
take more time. I think the implementation will therefore slowdown, because you cannot create
the kinds of rules and regulations and institution to make this work taht quickly.
Haenle: Let’s step back and talk about the Third Plenum—the overall, broad and ambitious
reform plan with many goals and objectives. It appears that while some reforms are making
progress, others have not been advanced or have hit roadblocks. After about two years of
implementation for the Third Plenum reforms, how do you take stock of the government's
scorecard? In which areas have reforms moved quickly, in which important areas is reform not
moving, and why?
Huang: The Third Plenum document is impressive in the scope of the reforms that it proposes. I
think it correctly identified practically all of the problems in the system and it basically indicated
an intention to act on them. It also laid out what I call a time frame—this is going to take 10
years or more. Xi Jinping also talks for example about achieving these goals in the year 2049.
This is a long-term issue, so they don’t think in terms of one or two or three years.
Now what has happened in the last couple years? What we see is that in areas where there is
strong leadership and reform minded officials, who have at their disposal technical expertise or
institutions that can follow through, then you can have some change. So you’ve seen this in the
financial system: they’ve been able to deal with liberalizing interest rates, deepening some of the
capital markets, they’ve been able to bring shadow banking under control, they’ve been able to
liberal capital movements into and out of China—it’s lot easier to move money both in and out
of China— and they’ve put in a framework for reforming the fiscal system (it’s going to be
complicated, it’s going to affect the localities and the central-local relationships, lots of laws and
implementation). That particular reform will take several years to design fully, several years to
implement, but more or less they’ve signaled their intention to move forward.
SOEs are more complicated. I don't think a real strategy yet has emerged as to how you deal with
SOEs. There’s a conflict here because I think the leadership feels that the big SOEs are going to
be the leaders on innovation and drive the financial system and help elevate China to a major
economic power. At the same time, many of these large SOEs can eat up a lot of resources;
they’re not very efficient. Many of these large SOEs are controlled by the central government.
So my feeling is you’re not going to see much change there.
The question then becomes the locally owned SOEs. They’re not necessarily strategic powers.
They generate a lot of jobs and tax revenues for local authorities. The local authorities are
finding themselves having a very difficult financial situation. The question is: are they going to
say, we’re going to solve our financial problems by selling these SOEs or putting them under
more pressure to make more revenues (in that case this might actually be good). Or are they
going to cling to the SOEs and subsidize them indirectly and perpetuate a problem? I think the
SOE area is a major area where I still don’t think there’s a consensus.
Streamlining government procedures is moving fairly rapidly. The other area is urbanization.
Urbanization has slowed down in China. It has slowed down for some good reasons- one good
reason is incomes in rural areas and the inner portions of China have risen a lot, so the urge for
people to move into the big cities and along the coast has moderated. But it’s also slowed down
for bad reasons: it’s a lot easier to get hukou and gain residencies in smaller cities, harder to get
it in bigger cities. But the better jobs and higher incomes are in the bigger cities, so people are
not necessarily willing to go to the smaller areas; they might as well stay where they are, and
that’s part of the reason why urbanization has slowed down.
Haenle: Hukou reform is a part of the broader economic reform plan. Is this an area that has
slowed down?
Huang: They set out the [hukou] objectives: support movement for smaller cities and build them
up, but be very strict on moving to the bigger cities. So I think in terms of the objectives this is a
problem because if higher productivity is in the larger cities and people want to go there, you
don’t allow them to go there. But how do you implement this? And the answer is implementation
and how you interpret the rules is left to the localities. So provinces have their own pace and
their own guidelines. Some are more favorably disposed and some are less. So each is actually
coming up with their own plans and figuring it out. And therefore you have what I call
differentiated reform issues.
There’s also a very fundamental problem. For this to work, you have to resolve the question of
rural land and farmland—who owns it? And can people sell their rights and thereby move? That
hasn’t been fully resolved but areas are experimenting with this. But if you can’t solve that issue,
people won’t move, because they won’t give up the title to land they own in rural areas. But
suppose they could—suppose they could sell that land. Then they’d have a little nest egg, so if
they wanted to go to a different city or province then they’d go there with some resources, and
then it’s going to be very attractive. But that particular issue has not been resolved. So the next
round of movement depends upon whether rural residence can monetize their assets and leave.
And if they can do that, then I think you’re going to see the next round of urbanization in China.
Haenle: The implementation of these ambitious economic reforms and the major economic
transformation of the economy is happening at the same time the Chinese economy is slowing.
According to the recently released data, GDP grew at 7% in Q2. How will this impact the
leadership's goals for economic and financial reforms? To what extent is the central government
prepared to tolerate the slowdown while continuing to push for the reform?
Huang: Many people think that there’s a conflict between reforms and growth—that is, the more
rapidly you reform the slower the economy will grow. I think that’s actually misguided. The
issue is more like the following: should I push out more credit and encourage firms or local
authorities to borrow and spend in order to keep the economy growing? That’s not reform. But
increasingly that’s not even growth, because firms don’t want to borrow anymore because
they’re not quite sure whom they’re going to sell to. Localities are heavily in debt; they also
realize that building more houses or property that are vacant isn’t going to generate any wealth.
So in fact expanding the debt or credit, unlike 5-10 years ago, doesn’t actually lead to more
growth. In that sense it’s not a choice; it doesn’t work.
So how can you change this? The only way you can change this is to increase the returns from
people who do want to invest. And then they’ll [invest] because they think they have a market
for it, or it’ll lower their costs and they’ll be more efficient and therefore they will be more
competitive. This is where things like more sensible urbanization policy comes in—more
sensible urbanization policy means I am going to let people go to opportunities or areas where
there are higher returns, and because that is the case, they will want houses, they will demand
more roads, and they will be making something so that the taxes will show it; it’s going to solve
its own in some ways.
In the private/enterprise sector, it’s a question like: there are a lot of areas where the state is very
dominant and it discourages private entry and foreign private entry. If you actually allowed
people to operate in there, they know that they can make money and they will invest. But if you
don’t let them in, they won’t invest in other areas because that’s almost already exhausted. So
you have to find these things where people say: I can see room for profit. Reform should be
measures that allow them to realize that. And then, investment will occur and it will be higher
return investment, in which case you‘ll grow and you won’t have a debt problem because you’re
generating more output than the credit expansion.
So right now the real issue is for me is—debt financing or excessive credit expansion doesn’t
work anyway. It doesn't actually lead to more sensible investment. Reforms will work—so
reforms in my view are growth enhancing. It’s not like they are contradictory—they are growth
enhancing. You just have to decide whether or not you are willing to take these political risks
and do these reforms, and if you do you are going to get the best of both worlds: both faster
growth as well as reforms.