The Third Plenum
Prospects for Reform in China

The Central Committee of the Chinese Communist Party recently met during November 9–12 for the Third Plenum, the third large-scale meeting since the current committee was named late last year. A few days after the Third Plenum concluded, an official statement on its work was published, titled “Decision on Major Issues in Comprehensively Deepening Reform.” Senior leaders and the official media had encouraged high expectations. They were met. The full authority of the Central Committee is now behind the objective of accelerating structural reform through a long list of specific, interrelated, and consequential changes. Many will be challenging to the status quo.

While Xi Jinping stated that he personally led the drafting group for the document, the announced reforms have political and intellectual roots in recent policy discussions. They are founded on two widespread views: first, that China is at an inflection point requiring major changes in its economic development model; and second, that little of significance was accomplished to change the model during the second five-year term of Hu Jintao and Wen Jiabao. There existed thus both a developing consensus on the need for change and a gathering sense of urgency. However, China still exhibited divergent views on the best way forward and uncertainty about the views of the new leadership.

With behind-the-scenes support from Premier Li Keqiang, the Development Research Center of the State Council—China’s leading official policy think tank—embarked on a joint project with the World Bank to outline the challenges facing China and make recommendations for macroeconomic policy. The resulting report, China 2030, provided a detailed analysis of the difficulty in moving from being a middle-income country to being a high-income country, argued that the only path to success is to complete the transition to a market economy, and made detailed recommendations for major reforms and the sequence in which they should be carried out. While the report immediately became the most downloaded title on the World Bank’s website, it was initially published only in English, an indication of political sensitivity.

After the new Central Committee led by Xi Jinping and Li Keqiang was named, the first two plenary meetings were occupied mainly by personnel decisions. In recent tradition, the third such meeting is the moment for the new leadership to roll out policy priorities and a five- or ten-year program of specific goals. Rather than downplay expectations, the current leaders repeatedly said that their program would be comprehensive and ambitious. The Development Research Center returned to the debate a few weeks before the Third Plenum, offering a report called the “383 Plan.” Reading like an executive summary of China 2030 recast in party terminology, the plan recommended three broad areas for reforms (the roles of markets, government, and enterprises), identified eight sectors in need of special attention (finance, taxation, state assets, social welfare, land, foreign investment, innovation, and good governance), and described three desired breakthroughs (broader market access, a basic social-security scheme covering both urban and rural people, and the ability to sell collectively owned rural land).

The “Decision on Major Issues in Comprehensively Deepening Reform” is a continuation of this trend of policy analysis. In his speech, Xi highlighted the following aspects: greater reliance on market forces to allocate resources; maintaining, improving, and strengthening state-owned enterprises while simultaneously supporting, encouraging, and guiding the dynamism and creativity of the private sector; deepening fiscal reform by making budgets more transparent and changing the taxation system so that it better corresponds with the current economic situation (code for changing the revenue split between central and local governments); supporting urbanization by moving away from the dual tracks of urban and rural household residency toward a unified system fair to all; strengthening consultative democracy; strengthening judicial reform; broadening the anti-corruption drive; and tightening management of Internet content. The broad themes were creating more efficient government, hewing more closely to the public, and asserting stronger party leadership.

In the late 1970s, Deng Xiaoping launched a period in which bold economic reforms and rapid social change were paired with the authoritarian suppression of actual or potential opponents and a rejection of political change. Xi Jinping now offers an updated version of this approach. This does not rule out some more progressive changes, such as the phasing out of the labor camp system, often subject to abuse by local officials to get rid of troublesome individuals without legal process. However, the announced reforms often straddle both sides of politically sensitive issues—for example, supporting greater independence of the judiciary and stronger party supervision over it, or reaffirming the role of state-owned enterprises while proposing to strengthen competition and the role of the private sector. The document signals the beginning of a process rather than clear outcomes.

Xi’s speech also emphasized two institutional steps, establishing a leading group to direct the reform process and a national security committee under the Central Committee. Leading groups are regularly used as tools to coordinate bureaucratic silos. The national security committee responds to the need for a mechanism to coordinate the military, intelligence, paramilitary, police, and foreign policy agencies in a crisis, some in the party, some in the government, often with overlapping or competing jurisdictions. China’s new body differs from the U.S. National Security Council in that it is explicitly concerned with domestic security as well as international strategic affairs. These new institutions support the belief that Xi intends to be an effective leader and to strengthen the role of party institutions.

What now? Among the likely early steps are reform of the financial system (especially interest rate liberalization and capital market reform), greater market access for private capital, opening of service sectors to more rapid development (especially logistics, education, elder care, and healthcare), reform of the household registration system as part of unifying urban and rural society, and reform of energy and raw-material pricing to rely more on market forces.

U.S. companies in China have been investing heavily on the thesis that urbanization will continue, adding an additional 250–300 million residents to urban areas before stabilizing. Urban consumer demand for goods and services will drive both personal consumption and government investment in coming years. There will be even greater emphasis on energy efficiency and environmental protection in years ahead. The role of the central government in the day-to-day management of the economy will be reduced. Rather than focusing on the Beijing, Shanghai, and Tianjin conurbations, companies see potential in more than one hundred cities across China with populations above one million people.

This investment thesis is supported by the program of the Third Plenum. Yet the question remains, Will it be successfully implemented? Not all the objectives announced at previous plenums have been met, and this plenum prudently sets no strict deadlines. Observers will be looking for progress toward greater foreign and private-sector market access, especially in services; a slower, more sustainable rate of GDP growth; market-determined capital allocation and foreign exchange rates; an end to enormous global trade surpluses; and the establishment of a new fiscal basis for local governments. Progress in bilateral investment treaty negotiations and Chinese participation in the Trans-Pacific Partnership would strengthen the framework of the reform process.

There is no doubt at this point that the senior leadership has the will, the unity, and the institutional platform to attempt implementing the announced reforms. However, China, like other countries, is subject to event risk, both domestically and internationally. A renewed global recession, political instability at home, a local government debt crisis, or a conflict over Taiwan or territorial claims in the South China Sea—that is, any large, unexpected crisis—could disrupt reform. China is attempting an ambitious transition; most countries that have reached a similar stage in the past 40 years remain caught in a middle-income trap. On the other hand, since 1979, China has a track record of sound economic policy, rapid industrial and technological development, and dynamic social change.