What will be China’s future under president Xi Jiping? Answer to this question should start from a review of the principles and their effects on China’s reform set by China’s later paramount leader Deng Xiaoping.

A vibrant and chaotic fusion between government and market     

Deng Xiaoping, architect of China’s reform always believed that the one party political system was of great advantage to China as it allowed the authority to concentrate resources on to strategic directions. In addition, Deng believed that the market mechanism, as a tool, could be combined with long-term central planning under the authoritative political system.

The challenge Deng faced then was to find a way making the one party political system and state owned economy compatible with the market. Deng’s invention was to massively deregulate the central control of state owned enterprises and make local governments effectively economic entities through economic decentralization while kept their political functions intact.

Under such a framework, Chinese local governments of different levels (province, municipality, and county) have been granted with great autonomy in sharing tax revenue with the central government, privatizing small and medium sized state owned enterprises and approval of foreign investment and etc.

In particular, thanks to the state control of land, local governments can massively acquire land from rural and urban residents with limited compensation and sell such land to developers at significantly increased prices. Wu Jinglian, an influential Chinese economist, estimated that the Chinese local governments had reaped a huge profit of 30 trillion yuan from land sale in a speech in 2013.

Thanks to “land finance” local governments were able to create “low-cost basin” to international and domestic businesses through tax exemptions, cheap loans, offer industrial land for free or extremely cheap and compensate redundant workers in millions as a result of large-scale close down of state owned enterprises or turning them into private entities. The business friendly environment in combination with huge labor supply facilitated China to embark on an unprecedented economic expansion led by heavy investment and strong export. Development of a private sector and massive foreign direct investment made fusion between government planning and market competition possible.

However, despite of being extremely vibrant, the Chinese economy was “unstable, uncoordinated, unbalanced and unsustainable” labelled by the former premier Wen Jiabao in a speech in 2007.

The primary weakness is that the reform has performed poorly in delivering a shared prosperity to all but widened social division.

China’s economic reform is actually a process of reshuffling the control over the assets once state owned. The excessive dependence upon government in this process provides a shortcut to the formation of interest groups among privileged social class who have or close to power. Given abandonment of the traditional political controlling mechanisms and avoidance of a multi-party power balancing system, gaining unfair advantage by those privileged becomes inevitable in the reshuffle process.

For instance, it is common for businessmen to bribe government officials to win the bid for ideal land for commercial projects. Many insiders either from the government or the original management have tuned into owners of mines and factories that once was public owned. There is a high density of children from families of high ranking government officials in lucrative industries such as banking, international trade and real estate.

The rate of those privileged in their wealth accumulation is astonishing. Wang Xiaolu, an influential Chinese economist in a report published in 2011 estimated that the grey income which was about 3-6% of China’s GDP was mainly shared by 20% of Chinese families of privileged background through illegal, immoral and improper ways. The difference in income between the top 10% families and the lowest 10% was 26 times. It climbed to 65 times when the rural residents were included.

The massive polarization of the society and widespread of corruption makes people critical of the government. The cases of mass protest (defined as over 100 people involved) increased significantly after 2008 and reported to be over 200 in 2012. In many of these cases thousands of people turned violently against government officials and resulted in crack down with the deployment of armed polices.

The government response then to the social tension was to “make cake large”, in anticipation that improved living standard through economic expansion would dilute the problem. However the government propelled economic expansion often made situation worse. The most criticized move was the 4 trillion yuan government expansionary package in 2009 in response to the sharp downturn of the export as a result of the global financial crisis.

The intensified government intervention which was highly local orientated reduced the entry barrier to a wide range of industries that require heavy initial investment and large operational scale. For instance, there are 70 automobile makers in China which is more than all that combined in advanced countries.

Such local orientated projects are normally small in size but combined they can easily push the aggregate supply far beyond the demand and make overcapacity a stubborn problem. These sub-sized companies are normally dependent on foreign technology due to their limited capability in innovation. The gain of such low-value added manufacturing can hardly justify the damage they imposed upon China’s environment.

The wisdom of “making cake large” was increasingly under challenge as China had to slow down its pace around 2012 when its labour supply was peaked. The rise of the minimum wage has gone over 60% since 2011 as the government has to deal with the social tension. China’s manufacturing and export are contracting as a result of the rise of production cost.

The contraction of the manufacturing sector has brought the Chinese financial sector to the spotlight. China’s total debt now is at 260% of its GDP. China’s money supply increased from 47.5 trillion yuan in the end of 2008 to 170 trillion by 2017.

The housing sector in China which have received one fourth of the total Chinese fixed investment or 70% of the social finance has long served as a reservoir for the circulation of massive amount of money. Without a vibrant real economy, the Chinese yuan and yuan dominated assets would devaluate. This might trigger downturn of the Chinese property market and outflow of capital to overseas. The heavily indebted Chinese local governments, businesses and households would find themselves unable to pay back loans which would produce domino effects on those shadow banking institutions and banks.

Xi Jinping’s doctrine

When taking office in later 2012, President Xi Jinping faced a very serious situation. On the surface China was on its way to overtake the US as the world largest economy but in reality the economy was under great pressure; the society was highly divided and level of dissatisfaction was high.

Millions of disadvantaged people were effectively denied of access to quality healthcare and education while emigration became a fashion among the rich who admire better environment, social services and order abroad. Millions of Chinese tourists spent billions abroad on services and products ranging from luxuries to basic white goods, even toilet seat.

The divorce rate was on the rise as sex revolution in China got its way. Business cheating was widespread while millions turned to Christianity and Buddhism.

The daunting reality prompted the left-wing openly denounced Deng Xiaoping for his reform approach causing weakening of the communist power, draining of state assets and polarisation of the society.

The right-wing claimed the only way-out for China was to total privatize state owned economy, free media from political control and set up a multi-party parliament system to check the abuse of power.

President Xi Jinping’s handling of the situation has been accurate. Xi has repeatedly emphasized that China should not make fundamental mistake by discarding the one party political system. Any hesitation in this regard would open the floodgate of criticism and lead to formation of organized oppositions capable of challenging the party.

However it is obvious that fusion of the one party government with market under the terms defined by Deng Xiaoping has caused serious problems. Meaningful corrections have to be made to deal with following fundamental issues: First, how to prevent abuse of power in the context of adoption of market economy in a one party state and ensure a shared prosperity to all; second, how to adjust the relationship between the government and market so as to ensure a sustainable and balanced economic development.

Xi Jinping’s answer to the first issue is to wage an unprecedented anti-corruption campaign. In Xi’s theory the communist party government should continue to be the backbone of China’s reforms and the ultimate mediator in the distribution of national wealth. Only an effective and highly disciplined party can carry on and accomplish such duties. Otherwise China will again fall into a disunited nation and see precious time and resources being wasted in internal clashes between political forces of different backgrounds.

Following the conclusion of the 18th national congress of the party in 2012, Xi has initiated the largest anti-corruption campaign in new China’s history. Up to date, the campaign has ‘netted’ over 240 high-ranking officials ranging from government ministers, governors of provinces, senior executives of major state owned corporations and to military generals. The disgraced includes more than 10 leaders and generals at the very top level. More than 140,000 government officials at medium and lower rank have been indicted for corruption.

The anti-corruption campaign has won president Xi Jinping wide support. Having witnessed the collapse of Soviet Union, the majority of Chinese are not supportive to a radical course of setting up a multi-party parliament system in China for fear it could bring in chaos and split of the nation. But on the other hand, people are strongly demand actions to be taken to address corruption, unfair distribution of wealth, social disparity and pollution.

Xi’s anti-corruption campaign has satisfied people’s needs in following ways: first, it has rolled out the possibility of having a Soviet Union style collapse in China; second, it offers the hope that the new leadership could make the government system relatively clean and effective which are preconditions to a fairer distribution of national wealth.

Xi has also raised the concept of “Chinese dream”, calling on the party and ordinary Chinese to unite and carry on hard work to realize rejuvenation of the nation. This nationalistic slogan has reinforced the position of the party in the journey of returning China to the center of world stage. After all, it is widely recognized that the one party political system has its merits as it has made China stronger and richer in comparison with the past.

The anti-corruption campaign and persistence on one party political system should not be interpreted as end of reform. In fact president Xi and his colleague premier Li Keqiang repeatedly made assertions that market orientated reforms should be pushed ahead. The most significant move in this regard is the establishment of eleven “free trade districts” so far in major cities including Shanghai, Shenzhen, Tianjin, Chongqing, Guangzhou ant etc.

In those free trade districts, a negative list is formulated clarifying all the area that government intervention is prohibited. The central government clearly requires that reapplicable systems for the advancing of market economy should be developed in these free trade districts and to be promoted nationally in later stages. In 30 years ago, business registration required approval from more than 200 government departments, now it only needs 40 minutes in those free trade districts.

New era

President Xi Jinping has reinforced his statue as China’s most powerful leader since Mao Zedong in the 19th national congress of the party. He declared that China has entered a “new era” in which the fundamental issue is “the contradiction between unbalanced and inadequate development and the people’s ever-growing needs for a better life.”

President Xi sets China a 30-year plan. The “first step” is to build an all-round well-off society in three years. The main tasks in this period are to end poverty in China by lifting up living standard to a population of 40 million; achieve a turning point in the fight against pollution; prevention of financial crisis and build an innovative economy.

The second step is to build China into a “basically modernized country” by 2035; and third is to make China the most powerful country in the world by 2050.

It all comes down to if the Chinese economy could support the realization of these ambitious plans. China has the reason to be optimistic in this regard.

China’s economic growth is gradually decoupling from the pattern of heavy investment, high level energy consumption and pollution. The growth rate of investment has dropped for eight consecutive years, down from 17% in 2010 to 7.5% in the first three quarters of 2017. Many of the traditional manufacturing industries such as steel, coal, petrochemicals, nonferrous metals and building materials have peaked or will quickly reach their peak.

In the contrast consumption has increasingly taken a key role in the growth of the Chinese economy and such a trend will continue along with the advance of China’s urbanization which will lift from the current level of 57% to 70% in the foreseen future. By the time China will have an urban population of more than 1 billion. The middle class in China which is now standing at 240 million will be further expanded. It is no doubt improvement of living standard to all will push China’s consumption to new high.

Lack of capability in innovation has been long blamed as the key weakness to the Chinese economy. To a great extent this problem was originated from the pattern in the past as use of foreign components and technology was the most efficient way for Chinese companies to expand their market share.

Such a time has passed. The rapid increase of production cost has either driven those Chinese companies competing on the basis of low cost out of the market or relocating to other low cost countries. The remaining Chinese companies are increasingly embracing high technology and innovation. China’s total expenditure on research and development registered 1.56 trillion yuan in 2016 up by 10.6% from previous year. Hundreds of thousands of graduates, engineers and scholars, some of which have returned to China from the US and other advanced countries, are initiating high tech-startups in China.

There is a common misconception in the west that the Chinese government coordinated strategic investment on strategic industries is often ineffective and wasteful.

China’ records show otherwise. The majority of successful Chinese innovative corporations are those major state owned corporations in strategic industries. A wide range of their products has reached to international competitive level, such as high speed railway system, advanced nuclear power station, power generators and long distance power transmission, construction of bridges and highways and military equipment such as stealth fighters, various types of missiles, destroyers and submarines.

It is likely that the Chinese government coordinated plan “China Manufacturing 2025” will be a success within 10 years which targets advanced technology such as artificial intelligence, chips, 5G telecommunication, new materials, renewable energy, large passenger airplane, aviation engine, robot and digital machining, biotech medicine and etc.

The critical time for China will be the next 5 years. During the period, China is still being troubled with high level of overcapacity, high level of debt, high stockpile of empty apartments and high level of dissatisfaction.

Therefore the anti-corruption campaign which should provide political cushion to the Chinese authority is extremely important. As long as in control of political power the communist government will have sufficient room to deal with changed environment, even very tough at times, and finally reach decisive successes.