China: A Roadmap For Continued Economic Reforms

Last month’s meeting of China’s ruling elite reconfirmed several trends which are important for global investors. Xi Jinping is the strongest Chinese leader since Deng Xiaoping, but he is not a dictator. There will not be significant changes to economic policy, with Xi continuing to emphasize quality over quantity; gradual progress toward a more market-driven, entrepreneurial economy; and financial sector de-risking. Xi will play a more visible role on the global stage, taking the opportunity to step up where Washington steps back, including on climate change.

The 19th Congress of the Chinese Communist Party, a twice-a-decade event, provided a roadmap for economic policy during Xi Jinping’s second five-year term as Party chief. In this article, we discuss the key takeaways in the areas of politics, economics and foreign policy.

China Politics: Xi Is Strong, But Not A Dictator

Xi Jinping clearly consolidated his political power over the past few years, a process which was formally recognized at the Congress. Xi is the most powerful leader since Deng Xiaoping died in 1997. There are, however, limits to Xi’s power within the Party. Wang Qishan, one of his closest confidents and director of Xi’s anti-corruption campaign, was forced to retire from the Politburo Standing Committee last month, having reached the Party’s informal retirement age. There was widespread speculation that Xi hoped to persuade his colleagues to break with past practice and permit Wang to remain in the leadership, but that did not happen.

It’s important to acknowledge that in addition to enhancing his power as head of the Party, Xi has been working to strengthen the Party and its control over China’s economic and political infrastructure. Unique among one-party, authoritarian regimes, since 1989 there have been three peaceful, efficient transfers of power between leaders, none of whom was from the same family.

The Party has broken with recent precedent and did not anoint a successor to Xi. There isn’t, however, enough visibility into internal Party politics for us to understand what this means. One possibility is that Xi is aiming to ignore the retirement rules and stay on for a third term. It’s also possible that Xi will retire in five years, but does not want to be a lame duck leader, with his successor watching over his shoulder throughout that time.

Economics: Focus On Quality Over Quantity

One of the most significant developments of the Congress was the decision to change (for the first time since 1981) the Party’s mission statement, or in Party jargon, the “principal contradiction facing Chinese society.”

In 1981, the Party’s mission was to bridge the gap between people’s material needs and insufficient goods to meet those needs. That kicked off three decades of policies intended to achieve the fastest growth and the greatest industrial output possible. China’s amazing economic boom followed, but the negative consequences of that approach are well-documented.

During the just-concluded Congress, Xi explained that the Party’s mission statement had to be revised to focus on the quality of growth, rather than just on the speed of growth and quantity of output.

“While Xi is not proposing to adopt Western-style rule of law or representative democracy, he is reaffirming his commitment to dealing with inequality in income, health care, education and pensions, as well as the consequences of horrific air, water and soil pollution.”–Andy Rothman

This is not a new focus for Xi, as government spending on these programs rose at double-digit annual rates during his first term. But Xi has confirmed that these issues will remain priorities during his second term.

We tend to focus more on what politicians (in any country) do, rather than what they say. And over the last five years, the role of state-owned enterprises (SOEs) has continued to shrink while the role of China’s entrepreneurs has continued to rise. The Chinese consumer, fueled by incredible income growth, has also surpassed industry as the primary economic engine.

We also think it is significant that Liu He, Xi’s top economic advisor, and a strong proponent of market-based reforms, was promoted to the Party’s senior ranks. Additionally, while five heads of major SOEs were in the Party’s leadership during the last Congress, no SOE representatives are in the current political lineup. This is the first time in at least 15 years that SOEs have not had a representative on the Party’s Central Committee.

Xi mentioned the residential property market in his speech, reiterating his government’s principle that “housing is for living, not for speculation.” This, too, is not new, and is consistent with our view that the government will continue tapping on the policy brakes, but will not take dramatic steps. Since the start of 2011, prices are only up by 13% in China’s smaller cities, which account for two-thirds of the country’s new home sales. Nominal income, meanwhile, has risen by about 10% every year. And even if new home sales are flat year-on-year in 2018, most Chinese would still buy an estimated total of more than 12 million homes with a lot of cash down.

Foreign Policy: A Bigger Role On The World Stage

Xi made clear that he intends to play a larger role on the world stage in the coming years. He said that China’s economic success provides an alternative model to developing countries, and sharing this experience with other nations is part of the “great rejuvenation of China.”

Xi’s plan is somewhat opportunistic: where Washington is retreating from the global arena, he hopes to step up. For example, Xi pledged China would continue to embrace globalization and trade, and he also expressed a desire to lead international efforts to respond to climate change.

But we don’t anticipate Xi will become more antagonistic toward his regional neighbors or the U.S., recognizing that his recent aggressive moves have been counterproductive. For example, to manage the North Korea problem, Xi is likely to continue working cooperatively with Washington, largely because he values a positive relationship with President Trump.

About Andy Rothman

Andy Rothman is an investment strategist at Matthews Asia, based in San Francisco. He is principally responsible for developing research focused on China’s ongoing economic and political developments while also complementing the broader investment team with in-depth analysis on Asia. Prior to joining Matthews Asia in 2014, Andy lived and worked in China for more than 20 years analyzing the country’s economic and political environment first as a US diplomat, including as head of the macroeconomics and domestic policy office of the U.S. embassy in Beijing, and later as investment strategist for CLSA. He earned an M.A. in public administration from the Lyndon B. Johnson School of Public Affairs and a B.A. from Colgate University. He is a proficient Mandarin speaker.

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