Third Plenum decision: A reform manifesto

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In an unexpected, two-step jig, the Chinese Communist Party followed the oblique 3rd Plenum Communiqué with a much more detailed and coherent formal Decision and guide to action. The Decision can be read as a Reform Manifesto. Having reaffirmed the correctness of the reform policies of the past 35 years, the Decision describes the next phase as “a new magnificent revolution”. The Decision places the market at the centre of policy, saying that “the market has a decisive role in allocating resources [and] in deepening economic structural reform.”

The Decision went on to say that “The market deciding resources allocation is a common law of market economics” and to “complete the Socialist Market economic system, we must respect this law, and strive to resolve the problems of imperfect market systems [and] excessive government intervention.”

It sets out to “reduce direct government allocation of resources” and instead to base resource allocation on “market principles, market prices and market competition”. It limits the government’s role to ensuring “macro-economic stability, … [provision of] public services [and] guarantee[ing] fair competition…”

For the myriad of officials in China now studying every sentence of this long Decision, there can be no doubt that the leadership has firmly nailed China’s future to an economy driven more by the market and involving less government meddling and regulations than at any time since 1949.  This Plenum must rank among the historically most significant Plenums, such as 1978 when reform in the agriculture sector was launched and again in 1984 when reform was extended to the entire economy.

About 40 per cent of the document deals directly with the economy, the rest with a range of issues from culture, to education and science, to the military.  Winding back the Government’s role and giving greater scope to the market and private initiative to solve problems and generate wealth is the key theme running throughout it.

The Leadership has set itself a seven-year target to do the job.  “By 2020, decisive results are to be obtained in reform [and] the reform tasks put forward [are] to be completed.”

The aim is for an economy in which the state sector is still dominant (the “Socialist Market Economy”), but the private sector will be larger than today and more dynamic.  While giving “… full rein to the guiding function of the State-owned economy …, [the Party] must unwaveringly encourage, support and guide the development of the non-public economy, and arouse the vitality and creativity of the non-public economy.”

To these ends, the Decision commits to strengthening protection of property rights for all sectors, including rural as well as intellectual property rights.  Experiments in setting up an intellectual property court are foreshadowed.  There is to be “equality of rights, equality of opportunity and equality of regulations” between state and privately owned enterprises.

SOE reform

In supporting mixed-ownership, the Document foresees SOEs continuing to be dominant but at the same time proposes some reforms.  Some (unspecified) SOEs will now be “permitted” to adopt “mixed ownership” arrangements.  They are also encouraged to adopt shareholding schemes for their employees to align better the interests of “capital owners and labourers”.

SOEs will also be required pay 30% of their income back to the State.  Presumably this is in the form of dividends on net profits retained, but the Decision is unclear on this point.

SOEs are exhorted to adapt to the market, embrace competition, raise efficiency and “eliminate” monopolies.  They are also instructed to “explore” adopting transparent “finance and budgeting” methods. So that only the “fittest survive”, a system will be introduced to permit bankruptcy.

The non-state sector is encouraged to participate in SOE reform by taking equity positions.

Opening the market

The Decision foreshadows a negative list of sectors which are sensitive and will continue to be state-owned, with sectors outside the list being opened “on an equal basis” to foreign investment.

National treatment pre-entry, not post-entry, however, will continue apply as at present.  Foreign firms will therefore continue to be exposed to discrimination compared with their domestically owned competitors.  On the other hand, the Decision calls for action against “unlawful acts of extending preferential policies” and is opposed to “local protection, … monopolies and unfair competition.”

Price reform is to be extended under the principle that prices are to be “mainly” determined by the market and that governments are to resist intervention in price setting.  In a rare case of detail in the Decision, it was announced that the market should set prices of water, oil, natural gas, electricity, and telecommunications.

Financial Sector Reform

Domestic and international “financial openness” is to be “expanded”.  The government will bring shadow banking into the light by permitting the establishment of private “… small and mid-sized banks and other such financial organs.”  The Decision also calls for “financial innovation [to] enrich financial markets … and products”.  Areas specifically identified for reform include equities and bonds. 

The RMB exchange rate as well as interest rates are to be determined by market conditions.  In another specific statement, the Decision calls for “… national debt yield curves [to] reflect the relation between market supply and demand.”  Capital markets are to be more open for capital in and out of China.  The convertibility of the RMB for the capital account is to be accelerated.

Fiscal reform

The Decision addresses the need to reform the taxation system to make it fairer and more transparent.  Among measures specified to modernize fiscal matters is an instruction to move from focusing on bottom line balances to appropriations and use of funds.  Carry-over balances from reporting periods will also now be permitted in order to remove need for government departments to spend everything in the current reporting period.

A central focus is also on sorting out fiscal arrangements between the centre and the provinces.  Specific measures mentioned include introducing a standardized debt management system for the centre and provinces together with a “debt warning mechanism”.

On taxation, the Decision aims to deepen tax revenue.  Specific measures include local taxation and increasing the share of direct taxation in revenues while “progressively” decreasing value-added tax.  Reflecting the Decision’s emphasis on strengthening environmental protection, heavier taxes are foreshadowed for heavy polluting and energy-intensive industries.

Rural reform

On rural reform, the objective of the Decision is to breakdown what it calls “the binary” relationship between town and country to create “unified rural and urban development”.  In China it is as if town and country belong to two different worlds, with respect to property rights, laws, regulations, taxation and so on.

Although the language of the Decision is convoluted on the key question of rural land reform, it does call for greater protection for peasants’ land rights and foresees markets for the use-rights to land.  It seeks to “endow peasants with “the powers of possession, use, profit, transmission, mortgage and [the] guarantee of operating and contracting powers” with regards to their land.

Peasants will also gain the right to own shares in collective farm assets and to share in the profits and have the right to withdraw from collectives, and to mortgage and bequeath land.  Villages are to establish “property rights trade and transfer markets”.

Farmland consolidation, which is a major policy objective is to be encouraged by permitting peasants to transfer land-use rights to “specialized large households, household farms, peasants collectives and agricultural enterprises.”

Rural credit markets are to be opened further and cooperatives are encouraged to establish rural credit cooperatives.  Investment from outside of the rural sector in agriculture is also to be promoted.

Labour is to be able to move from the countryside to cities more freely with the proposed reforms (if not abolition) of the hukou system.  Restrictions will be completely removed on settling in townships and small cities and will gradually be eased for “mid-sized” cities but not for large cities where movements will continue to be “strictly controlled”.  Peasants who have settled in cities will have access to urban housing and social security.

Open Door Policies

Noting the deepening trend of globalization, the Decision calls for opening the economy further to support economic reforms.

Foreign investment is to be encouraged.  The Decision specifically mentions opening finance, education, health care, culture and other services to foreign investment and to lift limits on foreign investment in child and elderly care, architecture, accounting and auditing, commerce and logistics, electronic commerce” and other services and “general manufacturing industry”.

Government regulations on investing offshore will be eased to “establish the dominant position of enterprises and individuals in foreign investment.  They will be permitted to go abroad to invest without restrictions on destinations and activities.  Both M&A and greenfield investments are encouraged.

The Shanghai Free Trade Zone is to be advanced as a key experimental area “… to move reform and opening up forward”.  More free trade zones are also to be opened, with an emphasis on the interior.  Special policies will also apply to “border regions” which will open them further for people movements and local trade.

Political, Social and Judicial Policy Reforms

Almost half of the Decision deals with these areas of reform.  On political reform, while much is said about “democracy” it applies mainly to representative processes within the Communist Party, not opening competition with the Party.  Most of the political reform section deals with organizational matters within the Party structure and People’s Consultative Committees.

On social policy,  the “one-child policy” is relaxed for couples where just one is an only child.  While this adjustment to the policy has been criticized for not going far enough, it effectively abolishes the “one-child policy” as almost all couples today in China of childbearing age would have at least one partner without a sibling.  Although capped at two, again in reality very few couples would wish to have more than two children.  In a further step in burying the policy, the Family Planning bureaucracy has been folded into the Ministry of Health.

Social welfare reform is also foreshadowed with a strengthening of the social insurance system.  It is proposed to “establish a fairer and more sustainable social security system, focussing on old age pensions supported by insurance schemes.  Reflecting growing concern about an ageing population and rising middle class aspiration, medical care receives attention in the Decision.  It also opens up the sector to private suppliers and removes restrictions on doctors’ employment.   Raising the retirement age is to be “researched”. 

Judicial reform attracts special attention in the Decision.  Much is said about the importance of the “rule of law” but this is still within the context of a “Socialist legal system”.  As already beginning to happen, the judiciary is to become more professional (that is judges are to be drawn from trained lawyers).

In future, trials are to be open.  Obtaining confessions by torture is “strictly prohibited”.  The number of charges carrying the death penalty is to be reduced.  Significantly, punishment through the “re-education through labour” system is to be abolished.

Assessment

The Decision is not a blue print for further reform, although in places it provides detailed guidance for policy, but rather an exhortation from the top of the Party that in order to sustain high rates of economic growth reform needs to be pushed further. 

In doing so, it authorises reform policies and experiments.  It also seeks to redefine the relationship between the state and the market, curbing the former while clearly and strongly legitimising the latter.  Officials at all levels of society are now on notice.  In addition to eschewing corruption and the arbitrary exercise of power, they have now been told not to meddle in the market, or to meddle less than before.

An obvious point of caution to make, which is being made in most commentary, is that it all depends on implementation.  While that is correct and self-evident, it misses the bigger picture which is that the top leadership has set both the direction and most importantly the tone for future reform policies.  Its proposals in social policy and legal reform are also intended to modernise society.

Some Implications for Foreign Business

  • Contribution to sustaining high rates of economic growth.  Growth to continue above 7 per cent;
  • Promoting rural to urban migration, including by making it easier to move (reform of the hukou system)
  • Stronger emphasis on rule of law, including greater independence of the judiciary;
  • Strengthening intellectual property protection;
  • Establishment of formal rural credit markets, consolidation of farm lands including by trading in land-use rights, opening agriculture to investment from other sectors and foreigners
  • Greater openness on the capital account, increasing internationalisation of the RMB, domestic interest rates to be formed increasingly by markets, informal financial sector to regulated and normalized, opening the financial sector to more foreign participation
  • Opening a range of service industries, including education, health, old-age care, architecture and so on to foreign participation;
  • Encouraging greater offshore investment, both via M&A and greenfields investment.


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The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.


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