Trump’s 3-D Re-engagement with Asia: Development, Defence and Diplomacy

THE BELT AND Road Initiative and the United States’ vision for the Indo-Pacific have a common end if different means.

Both are critical components of establishing the two powers’ respective influence over a region that is already well on its way to becoming the world’s economic centre. The former uses state-led infrastructure; the latter seeks to unleash the commercial might of private business, primarily US private business.

The Trump administration’s withdrawal from the Trans-Pacific Partnership, one of its earliest acts, cemented regional fears among the United States’ allies that the ‘America First’ rhetoric of the Trump campaign in 2016 presaged US withdrawal from the region, leaving a vacuum that China would need little encouragement to fill.

Whatever the validity of that fear — and US commercial imperatives were always going to mitigate against significant disengagement — Washington has had a struggle to reassure its traditional regional allies, who, after all, still have to live cheek-by-jowl with their huge neighbour, regardless of the tweet-du-jour coming from Washington.

The uncertainty surrounding the outcome of both Trump’s putative trade war with Beijing and his intervention in North Korea through a summit with North Korean leader Kim Jong-un have kept nerves taught.

While the political scientists hijacked the term Indo-Pacific from the marine biologists and oceanographers slightly more than a decade ago, it has only been over the past five years than it has gained currency with political leaders in the four key Into-Pacific powers, the United States, India, Japan and Australia. In the past year, it has started to take shape as an economic entity.

Today, US Secretary of State, Mike Pompeo, put some more flesh on those bones by announcing $113 million of investment in technology, energy and infrastructure investments in the region. This was, he said, a ‘down payment’ on a new era of US economic commitment to peace and prosperity in the region.

US officials say that this commitment is not aimed at countering the Belt and Road Initiative, but the underlining of the transparent and commercially led nature of the investments and the choice of phrases such as ‘strategic partnerships, not strategic dependence’ speak for themselves, as does Pompeo’s assertion that the United States would oppose any country that sought to dominate the region.

The money will go to improving partner countries’ digital connectivity and expanding US technology exports to the region ($25 million), helping regional energy production and storage (some $50 million) and creating a US government agency to support infrastructure development ($30 million). Much of the remainder of the money will go to a fund to let regional nations access US private legal and financial advisory services.

There will not be, it seems, a return of the United States to TPP. Pompeo said that the Trump administration would only be doing bilateral trade deals in the region.

He did, though, trail a coming announcement by US President Donald Trump on regional security assistance, reaffirming the administration’s emerging three-D approach to the region: development, diplomacy and defence.

Compared to, say, the $62 billion that China is providing for the China-Pakistan Economic Corridor and the estimated $1 trillion of Belt and Road Initiative projects underway, $113 million looks like small beer, and especially as much of the money will end up delivering export sales of goods and services to US firms. An America First foreign policy is still an America First policy.

The question becomes then, can US business leverage that into a credible competitive alternative model for regional development. Washington’s traditional regional allies will still take some convincing as much as they would like to have a strong counterweight in the United States to China’s growing regional power and influence.

A Better Quality Economy

WHAT CAUGHT THIS Bystander’s eye from the annual Central Economic Work Conference, the key closed-door economic policy meeting of the year held in the PLA’s Jingxi Hotel in Beijing last week, was that economic policy priorities were set for the next three years rather than the usual one.

That will take policymaking to the midpoint of President Xi Jinping’s second term and the start of what should be the next cycle of leadership regeneration. It likely signals that there will be no alternative economic path than the one that leads to making good on Xi’s promise to build a “well-off society” by then.

The work conference was the first gathering of the Central Committee since the 19th party congress. It marked a start to translating Xi’s concepts of the next stage of China’s development being a transition from ‘rapid growth’ to ‘high-quality growth’ into plans and targets that each province and ministry will then have to turn into tasks and initiatives.

Xi has greatly tightened his grip over economic policy since taking power five years ago.The State Council, the mechanism through which the prime minister had formed economic policy, has become an implementation agency. The Central Leading Group of Financial and Economic Affairs, headed by Xi, is where the decisions that matter now get taken.

The outcome of the discussions at the work conference, which involved the 400 most important officials in the country, will not be disclosed until next March when they will be announced within the government’s work report to the annual parliamentary session as the economic targets for 2018.

All that is known at this point from state media is the already well-advertised transition from rapid to high-quality growth involving an economic model with “more focus on fairness, the environment and a joyful life”. The top three priorities for delivering that are alleviating poverty, pollution and financial risks.

Parsing that suggests that poverty relief will take precedence over maximising overall GDP growth, and financial stability over reform and liberalisation. Thus financial policy will focus on deleveraging through controlling credit growth rather than reducing existing corporate debt. Monetary policy will tighten in 2018; the external account will be kept stable, rather than opened up.

Systemic financial industry corruption will be tackled, particularly by cracking down on murky practice within shadow banking; more regulation in this area, particularly for asset management products, is likely next year. The introduction of a 3% value-added tax on some financial products will also provide a useful administrative tool for policymakers to bring shadow banking more in line.

It all adds up to a gamble on steering the real economy clear of financial risk through controlled growth and economic management. The gamble is probably most vulnerable to an external economic shock such as a deterioration in economic relations with the Trump administration in the United States.

The concern for Beijing is not the general macroeconomic one from US monetary policy ‘normalising’ but the danger that Washington’s China hawks get the upper hand in the administration and attempt to constrain China’s access to and trade in technology thereby crimping the innovation so necessary to rebalancing the economy.

What is less uncertain is that Beijing’s efforts to tackle environmental problems, and particularly air pollution, will be driven forward aggressively, regardless of the cost. That is for reasons of domestic stability, new-industry development and international leadership.

Hu Next?

THE CRITICAL PROMOTIONS for China’s next generation of leaders are still a year away when five of the seven Politburo Standing Committee members reach mandatory retirement age, but the jockeying for position will be continuing at the party plenum now being held.

One of the front-runners to be the country’s next president, Hu Chunhua (left), is taking a leaf out of the incumbent Xi Jinping’s playbook for how to become China’s top leader. Hu has been talked of for several years as a likely successor to Xi, but the Guangdong Party boss is maintaining an ultra-low profile, just as Xi did as he eased ahead of the early front-runner to succeed President Hu Jintao, the now prime minister Li Keqiang.

In many ways, Guangdong is the bellwether for China’s economic reform. Hu’s success — or otherwise — in restructuring the provincial economy and sustaining the economic parity of its capital, Guangzhou, with Beijing and Shanghai will be a litmus test of whether he could do the same with whole economy — and whether he could do so while maintaining social stability in a rich, coastal and relatively liberal province that looks more like tomorrow’s China than the under-developed tough-to-govern inland provinces that Hu has previously run.

Hu has pursued cautious economic reform in Guangdong since taking over at the end of 2012 from the sloganeering Wang Yang. He has promoted unglamorous small and medium-sized businesses but also been careful to align with the edicts of central leadership. Hu’s policies for the province have echoed Xi’s line about the “quality and efficiency” of economic growth and in setting lower growth targets. He has promoted the move up the value chain by Guangdong’s manufacturers and into services while moving labour intensive businesses into poor inland districts.

His predecessor Wang’s setbacks — he failed to get promoted to the Politburo Standing Committee at the November 2012 party congress at around the same time as the high-flying Chongqing party boss Bo Xilai was being brought low — will not have been lost on Hu. He has already survived two incidents that could easily have finished a political career.

He was governor of Hebei when the tainted baby formula scandal started there. In his next job, party chief in Inner Mongolia, violent protests broke out against the destruction of traditional Mongol grazing lands by Han-controlled mining interests. Hu cracked down on these and tripled per capita income in his five years but established a dubious record on environmentalism, a factor that now weighs more heavily in political calculations for promotion.

There is no doubt that Hu’s rise has been rapid. A staff position with the Communist Youth League (CYL) in Tibet in 1983 led to governor of Hebei province in 2008, party boss of Inner Mongolia by 2010 and then the same role in a high-profile province, Guangdong, in 2012 along with promotion to the Politburo. In 1996-99, Hu studied for a master’s degree in economics at the Central Party School, where officials marked out for future high office get sent.

Still in his early 50s he is young even by the standards of the prospective sixth generation of leaders. A career in the CYL, where he became a protege of Hu Jintao (no relation), is the bureaucrat’s rather than a princeling’s to power.

Hu has demonstrated both the caution and the orthodoxy of officialdom and his deeper policy beliefs remain somewhat obscure. Both in Tibet and Inner Mongolia, he took a hard line on security and in Guangdong, which has long had a more vibrant local press than most of the rest of China, he has been criticised for tightening censorship.

Hu has also cracked down on Guangdong’s drugs and sex industries and gone after officials who have done well enough out of their offices to be able to keep and support their families abroad. Hu has bought some 800 ‘luoguan’ to book, again moves in line with Xi’s anti-corruption drive.

Bo’s disgrace opened avenues for loyalists, down which Hu has advanced. Whether he completes the journey to the highest offices may turn on the influence that Hu Jintao can wield in the inevitable factional horse-trading. The corruption charges against another Hu Jintao protege, Wan Qingliang, the party boss of Guangzhou, may suggest Xi is constraining his predecessor, even if not as publicly as he is Hu Jintao’s predecessor, Jiang Zemin.

It will also depend on Hu’s own ability to keep his head down and out of trouble and Guangdong’s economy thriving.

A third factor, unknown at this point, is where Xi will come down. Will he consider Hu’s conservatism and reformist credentials suitable to carry on his policies? Will he back a fellow princeling or acknowledge that the presidency is due to return to Hu Jintao’s CYL faction?

Hu is regarded as a Hu Jintao version two and is familiarly known as ‘Little Hu’. Both men come from humble backgrounds. Hu was the son of a poor farmer in Hubei who made it to the elite Beijing University, where he took a bachelor’s degree in Chinese language and history, by dint of outstanding exam scores. Both were student leaders in their university days, rose through the CYL and cut their political teeth in troublesome provinces with ethnic minority populations, Gansu and Tibet, in the elder Hu’s case, Tibet and Inner Mongolia in the younger Hu’s case. Unusually for a senior Han official, he speaks fluent Tibetan. He also doesn’t die his hair.

Politically, they a both low-key, consensual leaders who advocate policies of social justice and economic equality. Both of those may be in tune with the party’s needs in 2022 when Xi’s successor starts to take over, and some rough edges to China’s economic rebalancing will be in need of smoothing.

China’s Economy Labors Under Its Demographic Pressures

It is tempting to gloss over the conclusion of the newly published report of the International Monetary Fund’s most recent annual Article IV consultations with China’s economic policy makers. That the managed slowdown of China’s economy to more sustainable long-term growth rates has run into stronger than expected headwinds from the euro crisis and that China remains too dependent on unsustainable investment for growth is now conventional wisdom.

This Bystander’s eye was caught by a short note in the report about labor supply and the extent to which fast intensifying demographic pressures are squeezing out the supply of cheap rural labor available to transfer to the urban industrializing economy that has underpinned China’s three decades of rapid growth. The point at which the excess subsistence labor in the countryside is fully absorbed into the modern sector is known as the Lewis Turning Point (LTP).

It is a critical point along the path of a developing nation. Once the pool of low-cost labour runs dry, employers and the state have to raise wages and benefits, and the country loses its low-cost competitive advantage. Made in China will be replaced by Made in Myanmar as the label of cheap everything, just as Made in China replaced Made in Japan decades back. The subsistence and industrializing parts of the economy merge. Overall growth is driven increasingly by the marginal productivity of labour. Increased purchasing power in workers’ pockets means that consumption increases. The country transforms itself from a producer to a consumer, while services become a larger part of the economy as the industrial sector diminishes relatively. This is a point China wants to get to. The IMF asks if when it will do so.

Source: IMF Country Report No. 12/195, PRC 2012 Article IV Consultation

In short, its answer is that China will be approaching it by the end of this decade, and hit it sometime between then and 2025 (see chart, left). Despite labour being in short supply in some regions and wages being pushed up for reasons of social stability, the IMF reckons the country’s surplus labour to be in excess of 150 million at present. But it says it will fall to 30 million by 2020.

As a result there will be pressure to unlock surplus labour between now and then. An easing of the one-child policy, further reform of the hukou system of residency rights and with it easier access to social benefits such as subsidized housing, schooling and healthcare, and an end to informal but widespread discrimination in job recruiting based on gender and looks are likely. All will delay the onset of the LTP, just as liberalizing financial services and improving productivity could advance it as it would raise net household wealth. But wherever the LTP lies, it is an unescapable point in China’s future, just as the country will have to navigate another tipping point, when per capita income reaches $10,000-12,000 a year, the level at which developing economies tend to stop developing without institutional change.

What It Would Take To Build Greener, More Liveable Cities in China: A Lot

This Bystander likes a hypothesis that can spread its wings and take flight. That land-use reform and reform of local government finances are key to developing sustainable, efficient, livable, and competitive cities in China would be one such proposition.

It is not so fanciful an idea. The argument runs thus:

Low-carbon cities need compact urban form and smart spatial development. But related concerns linked to the rapid expansion of cities such as congestion, local pollution, and safety also increase when public transport becomes less competitive as a result of poor spatial growth. Rural agricultural land is over-consumed. Cities expand into areas with higher risks of disasters or higher ecological values. Contingent liabilities increase from off-budget borrowing linked to land expansion. And equity concerns arise over the compensation of rural land users on the urban periphery. Reforms in land-use planning, municipal financial frameworks, and changes in spatial development can address these concerns and promote low-carbon growth.

Its proponents, Axel Baeumler, Ede Ijjasz-Vasquez and Shomik Mehndiratta, are three of the authors of  Sustainable Low-Carbon City Development in China, a new book looking at the development of low-carbon cities in China. It is published by the World Bank and is a 500+-page miscellany of urban development projects the Bank has been involved with in China and elsewhere. We suspect it has been somewhat hurriedly assembled so that publication could happen early in China’s current five-year plan, which calls for both continued urbanization and a significant lowering of the country’s carbon intensity. Aimed at city officials, the book is a why and some starter ideas type of book. A second edition promised for a couple of years time is intended to be a more detailed how-to manual.

The first edition doesn’t break much if any new ground. Its value lies in pulling together so many disparate aspects of sustainable urban development that have to be connected for success. For example:

• Encouraging a cleaner and greener supply of electricity;
• Continuing the gains of industrial energy efficiency;
• Promoting residential energy efficiency and building district heating;
• Better land-use planning and compact city development;
• Supporting low-carbon transport–walking, cycling, and various forms of public transport;
• Reducing emissions from private vehicles;
• Tempering current rates of growth in waste generation, including water and wastewater;
• Preserving and reusing existing buildings;
• Promoting urban agriculture and forestry;
• Developing information and communication technologies, such as smart grids.

If coordinating all those isn’t challenge enough for city officials–and just think of how many ministries, administrations, agencies, departments and offices they cut across–there is also the perennial question of the country’s scale. China is set to add an estimated 350 million residents to its cities over the next 20 years–and that after three decades of unprecedented urbanization, modernization, and economic development. Some 13 million people move from the countryside to the city each year, putting sustained pressure on all forms of public services: energy, water, transport and waste.

At the same time, China has set itself ambitious goals to reduce the carbon and energy intensity of the economy and to transition to low-carbon growth. The current five-year plan, which runs to 2015, sets a target of creating of 45 million jobs in urban areas. It also contains, for the first time, an explicit target to reduce the carbon intensity per unit of China’s GDP. A 17% cut is the goal by the end of 2015, as a milestone on the road to a  40%–45% reduction by 2020.

China’s cities will have to lead the way if these goals are to achieved. They have a sufficiently high degree of autonomy, and, as the authors note, they are “politically, financially, and administratively organized to act quickly and to realize national policy goals”. The true secret to why China’s so-called state capitalism has delivered three decades of double digit economic growth is that its city officials’ career advancement (promotion to a more powerful level of connections) depends on delivering local economic growth. Collectively on a city basis they are given a fairly free hand by central government to create raw GDP growth regardless of the environmental and social cost (up to the point it threatens the Party’s legitimacy to rule). As a market-based incentive it is pretty red in tooth and claw. But it has worked.

If China is to achieve its twin goals of larger but greener cities, it will have to change the incentives dangled before city officials. That, in turn, means dismantling the underlying mechanism that now allows them to work so effectively–the link between land use, finance, and urban sprawl.

Local governments are overdependent on land development for revenue, and particularly on sales of collectively owned rural land to property developers. As a result many Chinese cities have more than doubled their built-up area in no more than 10 years. Changing how cities finance themselves needs to be rethought fundamentally. That means tax reform, better direct access to debt and capital markets for cities, and new ways to facilitate fiscal transfers from higher levels of government.

Bits of that, such as greater municipal bond issuance, are starting to happen. But a lot of stars will have to fall into alignment for it all to come together so the sum of the parts is greater than the whole. A lot of vested interests are challenged. They will have ample opportunity to frustrate the process. Not only will it require new sets of both administrative and market-based incentives to encourage the development of low-carbon cities, with the market-based ones becoming increasingly more important, it will also require an administrative culture that facilitates cooperation across what are now largely independent fiefdoms.

It will also require one more thing. Residents who want to live in more liveable, energy-efficient cities like, and are prepared to be active in creating them.

China’s New GDP Growth Rate: Which One?

The 7.5% GDP growth target for this year set by China’s prime minister, Wen Jiabao, in his speech opening the National People’s Congress (NPC), above, is an exercise in expectations management. The expectation being set is that China will continue on its steady path of moving the economy up the development ladder with its commensurate long-term slowing of growth.

It says that Beijing sees a ‘soft’ not a ‘hard’ landing for the economy in the near term, that a quick repeat of the post-2008 global financial crisis stimulus is unlikely, and that the new leadership will continue on the course the outgoing one is leaving it, as outlined in the current five-year plan. That may seem like a lot of signaling for a single number to undertake, but 7.5% GDP growth should be considered more a floor below which central government doesn’t want to see growth fall than as a number to be hit.

Growth consistently exceeds the targets Beijing sets for it. The 2006-10 five-year plan targeted an average annual growth rate of 7.5% annual growth; 9.1% in 2009 was the slowest it managed. That was also faster than the 8.0% rate Wen has announced on each opening of the NPC since 2004 until this year. The current five-year plan (2011-2015) targets a annual average target GDP growth rate of 7%, incidentally. There are central government targets, and central government targets.

Then there are provincial government targets. China’s provinces have set, on average, 11% annual growth rates for their 2011-2015 five-year plans. Not one of them is planning for less than 8% average annual growth. This Bystander is not sure who, if anyone, will be setting foot on Wen’s new floor. That is the least one should expect.

China’s Reform, The World Bank And Vested Interests

The World Bank’s report on China in 2030 is a political manifesto disguised as an economic blueprint. Even the title, Building a Modern, Harmonious, and Creative High-Income Society, hits political not economic buttons. Not that the Bank casts it in that light, but it does provides China’s reformers with both strong arguments and influential backing to press ahead with reviving the economic reform. That has slowed to a glacial place now it has hit the hardest rocks of vested interest.

The World Bank gives the document intellectual and international heft. The participation of the State Council’s Development Research Centre, a prestigious government think tank, and with that the involvement of some of the most prominent technocrats who drafted the current five-year plan, lets the report avoid criticism leveled at recent International Monetary Fund recommendations for stepping up economic reform. That was castigated for being being an outside view that didn’t understand the realities of China. That can’t be said of the Bank’s report. It also gives it the implicit imprimatur of Li Keqiang, the man expected to take over from Wen Jiabao as prime minister in the current leadership transition and thus the Politburo member in charge of the economy. He signed off on the current five-year plan. He also told World Bank president Robert Zoellick, in Beijing to present the report, that China has “a long way to go before realizing modernization”.

Li is being realistic about the challenge ahead for China’s reformers. The World Bank report offers them a strategic description of the way forward rather than policy prescription. Its six strategic directions for China’s future are:

• Completing the transition to a market economy;
• Accelerating the pace of open innovation;
• Going “green” to transform environmental stresses into green growth as a driver for development;
• Expanding opportunities and services such as health, education and access to jobs for all people;
• Modernizing and strengthening its domestic fiscal system;
• Seeking mutually beneficial relations with the world by connecting China’s structural reforms to the changing international economy.

They are goals familiar to anyone who has read China’s current-five year plan, even if that couches them in terms that give more prominence to reductions in income inequality, universal social services, greater environmental protection and more energy efficiency. The Bank’s overarching message, though, lays out the unstated sub-text behind the five-year plan: structural reform is needed to promote a market-based economy, redefine the role of government, lessen the power of state enterprises and develop the private sector.

There is no doubt that China’s economy has reached the point in its development at which the dirigiste methods that have delivered 30 years of double digit growth need to change. Growth will inevitably slow in the coming years. All industrializing nations run into the law of large numbers. The exports and fixed asset investment that have driven growth cannot be sustained at that pace. Growing a $6 trillion economy by 10% in a year is a far greater task than growing a $350 billion one that much. That latter number is, best guess, roughly the size China’s economy was in 1981 in nominal terms. That is was 30 years of 10% growth does to $350 billion economy: turn it into $6 trillion one.

It is a remarkable achievement. Yet the arc of China’s development is not that different from the rapid industrialization phase of countries such as South Korea, Japan or even, much earlier, western Europe and the U.S., even if the magnitude of China’s arc is on an unprecedented scale. The country’s well of cheap labor, transferred from farm to factory, is starting to run low. Demographics, too, are working against growth. The value of foreign-developed technologies diminish as they age. Most of all, the economy needs to move up the value chain if it is to clear the barrier at which so many developing economies fall, that point where per capita income reaches at $10,000-12,000 a year. Vault it, and a nation becomes a middle income country on the road to being a rich one. Fail, and the country ends up stuck on a plateau of disappointed expectation.

China needs to do all that is recommended in the World Bank report if it is to clear that so-called middle-income trap, or economic Great Wall. The report doesn’t put it in these exact terms, but its message is that without reforms, growth will slow to the point where there isn’t the momentum to make the leap. This in not about whether there will be a hard or soft landing in the near term, though the Bank warns that responses to short term problems could undermine long-term strategy.

It is the politics that is the quagmire. There are clear implications for the Party in adopting market reforms. No country has done so successfully and remained a one party state. Even Japan’s Liberal Democratic Party, the closest approximation any democracy outside a city-state has had to one-party government, was eventually put into opposition at the ballot box. There is a difference between political rights and civil liberties, and the Party may find a seam in that distinction in which to work. But it would be a brave Bystander that bets on it.

The Bank does not push an overtly political agenda of what elsewhere in the world would be seen as neoliberal reforms. It hopes instead to push on an open door, offering practical steps to further an agenda China’s economic policymakers, if not all its leaders, have frequently endorsed. It does, though, call for the government “to redefine its role to focus more on systems, rules and laws” and for “redefining the roles of state-owned enterprises (SOEs) and breaking up monopolies in certain industries, diversifying ownership, lowering entry barriers to private firms, and easing access to finance for small and medium enterprises.” Those are all overtly political acts. The Bank recognizes the extent of the political opposition from vested interests to its proposed reforms. Even getting to this point with its report has been a political to and fro. The text is still a “conference edition”, i.e. subject to further revision, for which read political to and fro. State media’s reports on the report are low key (you’ll have to read to the final paragraph to find mention on it).

Reining in the power of the SOEs provides a particular challenge to the reformers. SOEs, like the military, are a source of power, money and influence for the princelings, the descendants of Mao’s original revolutionary leaders, an elite collective dynasty of some 400 families who hold extensive sway over the Party, army and the economy. Xi Jinping, the assumed successor to Hu Jintao as president, is one of their number. The princelings are neither a monolithic block nor are all opposed to reform. But modernizing the governance of the PLA to make China’s military internationally competitive is an easier sell for the reformers, and a creates more winners among the incumbents, than modernizing the state-owned enterprises and banks to the same end.

Yet without removing the structural distortions that the increasing sway of the of SOEs and banks hold over the economy, the sustainability of China’s growth remains in doubt. The double challenge is that the side effects of the twin forces of untrammeled infrastructure investment driven by SEOs and local governments that are little more than property developers–high energy consumption, inefficient capital allocation, unfettered real estate development and environmental degradation–also put economic growth at risk and threaten greater social unrest and thus the Party’s political legitimacy. Breaking the vested interests will be extremely hard for the reformers. Where they are not corrupt, they are systemic. Or both. That is one reason that reform has slowed to the extent it has.

Development of the private sector, giving more freedom to businesses to be innovative, changing the deeply rooted attitude of officials at the lower levels of the Party and government that quantity of economic growth matters more than quality of growth, more transparency to local government finances and governance, are all big changes from the way officials have done things for 30 years, 30 years that from inside China look immensely successful. China’s resilience to the post-2008 global financial crisis, and the authorities response to it, has, if anything, only further set back the case for structural reform.

That changes that China needs to rebalance its economy and go to the next phase of development go the nub of the nexus of government, Party and state, don’t make them any less necessary. How the new leadership handles it will be the measure of its success as custodian of the Party, state and government for the next ten years. The Bank is being politically adroit in casting its timetable for reform to well into the leadership term of those now about to assume the reins of power. Yet how, and whether, President Xi resolves the inevitable factional infighting between the inevitable winners and losers from reform, will determine the cast of his successors long before then.

If there is one thing a state-planned economy should be good at it is producing plans. Beijing has so many accomplished technocrats, and especially among its economic policymakers, that producing really good blueprints for change isn’t a problem for it. Implementing them is the challenge. For all the World Bank’s backing, an institution that may well be led by a Chinese before 2030, these are going to need strong domestic political leadership to be brought to fruition. That means the emergence of a modern-day Deng Xiaoping figure, singly or collectively, or, what no one wants, wrenching crisis. Otherwise China’s economy will stall, and wrenching crisis of another kind ensue. China will then look very different in 2030 from what anyone now is planning for.

The One Question That Matters About China’s Model Of State Capitalism

Monday’s publication will push the World Bank’s report, China in 2030, to center stage in the emerging, if ultimately pointless debate about whether China’s state-directed capitalism is better than the U.S.’s free-market capitalism. The later has undeniably damaged its case with the self-inflicted injuries that caused the 2008 global financial crisis. The revival of the 1930’s blend of banker and gangster, bankster, is timely and apt, in that regard, just as are the Occupy protests that have sprung up around the free-market world. But, in their rush to throw out some fetid bathwater, capitalism’s critics risk tossing out the baby, too. Nor is the Chinese model a proven substitute. For all that it has seen China though the post-2008 crisis period with higher growth rates than the Western Economies, the long-term costs have yet to fall due.

The World Bank report reportedly argues that the dirigiste model that has seen China through a remarkable three decades of economic development has run its course. We don’t yet know the details of the Bank’s arguments, but this Bystander has long argued the necessity of structural change if China is to move up the development ladder. The heart of the real test for China’s state capitalism is not whether it is better than banksterism. It is, can it vault the country from the ranks of poor countries to rich. To do so, it will need to clear the middle-income trap or the economic Great Wall–choose your metaphor–something no developing country has done without institutional change. This Bystander thought it timely to republish China’s $10,000-12,000 Question, first published in January last year, examining whether China can defy history:

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.

China In Africa: A New Model For Development

We made reference earlier this week, if not by name, to what some call the “Beijing consensus”. This is a development model for Africa in which private-sector investment by Chinese companies, albeit often state-owned enterprises, takes the place of traditional government or multilateral agency aid. As private investors, the Chinese firms don’t need to interfere with the domestic governance of the African countries in which they are doing business. For its part, Beijing can operate though the internationally less restricted area of trade and bank financing instead of official aid, and is less constrained by any needs to impose conditionality on its assistance, such as requiring human rights improvements and labor or environmental safeguards.

A new report from the African Development Bank (AfDB) on China’s trade and investment in Africa acknowledges these changing winds. “The emergence of China and other new development partners  requires us to rethink, and in some cases, gradually adjust our approach. The African Development Bank Group stands ready to engage in this process and help to leverage the financial, technological, entrepreneurial, and knowledge resources from China to the benefit of the African economies.” Other development partners refers to China’s fellow Brics, India and Brazil, who are pursuing a similar approach.

One value of the report is to take an (exhaustive) inventory of China’s trade and investment in Africa. It is not as ubiquitous as popularly supposed:

China’s burgeoning trade and investment relationship with Africa does not benefit all sectors or countries equally. About 70 percent of Africa’s exports to China come from Angola, South Africa, Sudan, and the [DR C0ngo], and are heavily dominated by raw materials (e.g., oil, copper, cobalt, and cotton). And 60 percent of imports from China, largely manufactures, are destined to South Africa, Egypt, Nigeria, Algeria and Morocco. Most other African economies have only a limited trade relationship with China. Chinese outward FDI to Africa shows a similar pattern of concentration, with 50 percent flowing to the mining sectors of just a handful of resource-rich countries (Nigeria, South Africa and Sudan).

Africa accounts for only 4% of China’s trade. The EU and the US are still the largest trade and investment partners for many African economies.

The report notes the “significant benefits” that China is reaping from its relationship with Africa, “through access to raw materials, expanded markets for exports of manufactures, the establishment of investment relationships which could generate significant profits over time and diplomatic influence.” But it also sends a call to action to the recipient countries:

Leadership from African governments, particularly to strengthen domestic policies and governance and to harmonize regional policies so as to improve the continent’s bargaining position with China, are required to ensure that the China-Africa relationship contributes to sustainable growth and poverty reduction.

The AfDB’s to-do list for African nations is:

• Improve coordination between aid and investments from China and from traditional development partners.

• Enhance technology transfer and maximize the positive spillover effects from foreign investment through local labor and content requirements, as is done in several African countries.

• Achieve greater export diversification by identifying niche markets for African manufacturing products in China, and by expanding preferential trade access to Chinese markets.

• Build negotiation capacity, for example by obtaining specialized legal services, to ensure that large, complex commodity deals with China can be negotiated with favorable terms for the exporting African country.

• Build backward and forward linkages between the domestic economy and the Special Economic Zones supported by Chinese investment.

China’s to-do list from the AfDB:

• Prioritize the development challenges of Africa within the established Forum on China-Africa Cooperation (FOCAC) framework, including addressing issues such as food insecurity, climate change and adaptation technology and infrastructure.

• Integrate “best practices” of traditional development partners, notably through the China Development Assistance Committee (DAC) Group, which would share knowledge on development finance.

• Coordinate Chinese aid and investment flows more centrally instead of the current practice where over 20 Ministries, public banks and agencies provide support to Africa. A good example might be South Korea, which is also an emerging development partner, where aid is coordinated jointly by the Ministry of Foreign Affairs and Ministry of Strategy and Finance.

• Support additional investment in Africa in labor-intensive manufacturing industries. Currently, as wages are rising in China, labor intensive manufacturing is “relocating” to other Asian countries such as Cambodia and Vietnam.

• Coordinate with multilateral and bilateral institutions on debt sustainability analyses and debt relief.

• Untie aid gradually and open bids to international tender. This approach would enhance transparency, development effectiveness and ownership by the recipient African country.

• Enhance communication between management of Chinese-owned enterprises in Africa and African civil society organizations, including labour unions. Often these tensions reflect different traditions in Africa and China concerning engagement with civil society organizations, as well as cultural and linguistic differences. One way to improve African understanding of Chinese policies is to expand scholarship opportunities for Africans to study in China.

• Expand the implementation of the Equator Principals, a voluntary set of standards for determining, assessing and managing social and environmental risk in project financing, to Chinese investments. This approach could reduce tensions with local civil society groups as well as improve the sustainability of projects financed by China.

• Elevate China’s status in the Infrastructure Consortium for Africa (ICA) from an observer to full membership. This would enable better coordination between various infrastructure projects financed by China and traditional development partners.

Addressing all these points would help answer some basic questions on the Beijing consensus. Is it effective for promoting development? Does it provide job opportunities for Africans? Does it improve the quality of the business environment in Africa? Does it improve governance and lessen corruption? Does it promote African industrial diversification? Does it fill Africa’s infrastructure gap meaningfully? Does it alleviate or magnify African nations’ debt problems? Does it harm Africa’s environmental and social conditions? Does it mostly serve China’s national interests to Africa’s cost? And is it sufficiently transparent so those questions can be answered accurately.

These are all questions that traditional western approach to aid, let’s tag it the Washington consensus to be inclusive of institutions based there such as the World Bank, needs answer, too. The fact that it doesn’t pass all these tests with flying colors is why there is room for Beijing’s approach to find favor. What strikes this Bystander most, however, is that both the Beijing consensus and the Washington consensus aim to promote economic growth in their separate ways and mirror their domestic expectations of governance.  While developed economies would hold that economic development leads to democracy, China would hold that democracy retards economic development, at least for lesser developed economies, even if democracy would to a better job of encouraging development in more advanced economies, a transition that China itself is heading towards so uncomfortably.

In the meantime, there is no consensus on which consensus is right for Africa now, but the arrival of the Beijing version has at least got western donors reconsidering their aid and development models, and African nations benefiting from competing sources of development aid.

More Questioning Of Growth At Any Cost

Protesters who got authorities in Dalian to promise to relocate the Fujia chemical plant may have been pushing at an open door. Officials had already been discussing the closure of the plant, whose protective seawall was breached by Typhoon Muifa earlier this month. Beyond the typhoon damage, which threatened a spill of the toxic chemicals used in the plant’s production of paraxylene, an ingredient of polyester film and fabrics, there have been questions of whether the plant was operating before it had received the necessary safety approvals, whether local officials had turned a blind eye to the illegal production, and whether all was as it should be with the granting of the final approval. The plant is a joint venture between the Dalian Chemical Co. and Fujia, a large and well-connected local real-estate developer.

At the same time, the protests against the plant’s siting, in the Dagushan industrial zone in the city’s suburbs no more than 20 kilometers from the city center, are another example of the popular questioning of the dash for economic growth regardless of the environmental and social costs. The plant is part of a drive to create a vertically integrated petrochemicals industry in the city to replace old rustbelt industries, and only one of some three dozen chemical plants in the Dagushan industrial zone.

Typhoon Muifa is only the latest intervention by nature to highlight the environmental dangers of such industrial concentration. Last year an oil pipeline exploded causing serious pollution to local waters and beaches. Nor is the plant the first paraxylene production facility to be relocated away from residential areas. One in Xiamen was moved after local protests there in 2007.

While neither place nor time has been given for moving Dalian’s–it is China’s largest such plant, so it can’t just be picked up and put down somewhere else overnight–it might well also not be the last to come under the scrutiny of a public decreasingly trustful of large-scale industrial development projects. China has 14 paraxylene plants, half a dozen of which, like Dalian’s, have been built in the past five years.