The 12th five-year plan was released last week for general review, and though its short on details there are a few specifics that we can pull out of it. Overall many of the goals look more likely to succeed than the 11th five-year plan, which saw consumption as a share of GDP decrease significantly despite the plan’s call for it to increase. Still, obstacles remain.
There are three main categories for reforms – Promoting consumption, upgrading industry, and balancing regional development – there are also several important reforms planned to local market systems. Below I list the reforms and some obstacles to their success.
The most concrete component of China’s consumption promotion plan is the development of a domestic insurance market and the growth and reforms of the social safety net. This has been an ongoing process in China for at least the past five years, and progress has been made, but there are no signs that progress is going to be faster over the next five-years. The insurance sector furthermore faces trust issues that will be hard to overcome. Still we will likely see concrete gains in this area.
The second component is promoting consumption growth through income growth, which is likely to be much more difficult. There are a few aspects to this part of the plan.
- Promoting small and medium sized enterprises (SMEs)– we’ve heard this line for a while, but promoting SMEs requires a reform of the banking system, which the government has thus far been unwilling to do. Also, some of the country’s industrial plans (below) are likely to ensnare SMEs
- Gradually raise minimum wages– this depends a lot on what the definition of gradual is, and how well the industrial restructuring goes (see below)
- Increase public distribution of money from SOEs– likely meaning increased dividends. This should be rather easy to do, and rather effective. It should also force better governance and more competitive behavior from SOEs. But it could run into problems because of the government’s dependence on the SOEs for revenue.
- Increase rural incomes, through higher agriculture prices, non-agricultural industries, and land reform– higher agricultural prices would mean more inflation, which the government is keen to avoid. Endemic corruption is likely to ensnare other rural reforms.
- Manufacturing sector– A lot of the reforms to this sector reek of planned economy measures, and so i expect they will either be toned down or have some unintended consequences. Planned “industrial consolidation” or “closing old capacity” could prove to be anti-competitive, and increased government R&D spending could drown out the private sector.
- High-tech sector– The focus on the clean technology sectors are more than welcome, though my largest concern there is that China’s goal of producing a home-grown sector will prove detrimental to collaboration with developed markets, where the relationship is already rather tense due to technology transfer regulations and poor IP protection. A clean technology sector that combines the competitive advantages of China and developed markets would prove far more effective than China going alone, but China has always wanted patent money to stay within the country. The government also seems to be planning to stimulate these economies through bank lending measures, which goes to show that banking sector reform is low on their list of priorities.
- Service sector– The reforms in this category are all good things, particularly the adjustment of land, water, and electricity prices for the service sector. But the services economy still has a long ways to go.
The plan for China’s regional development has long been a transfer of low cost manufacturing – of the type that is exported to most development markets – to inland provinces, while coastal manufacturing would be upgraded to target higher end demands in the developed world. The 12th five-year plan pushes that scheme forward through infrastructure development, selective liberalization of the household registration scheme (to ease migration into smaller inland cities), and the use of special tax incentives. There is also discussion of a fourth national level special development zone (after Shenzhen, Shanghai Pudong and Tianjin Binhai) which would almost certainly be in Chongqing.
The problem with this plan is that it’s unclear that central China can take advantage of the same supply chains which have made the Pearl River Delta (PRD) and the Yangtze River Delta (YRD) such manufacturing powerhouses. Building such supply chains would take time, and the lack of easy port access means logistics will be considerably more difficult. Furthermore, the rise of South-East Asia as a manufacturing base – often one used by Chinese companies – poses a very real challenge to the development of central and western China as a manufacturing center. The supply chains of the PRD and the YRD will likely expand with developing infrastructure to encompass bordering provinces – Hunan, Hubei and Anhui especially – but creating a new Shenzhen in the mountains around Chongqing seems unlikely.
These are the biggest reforms on the menu, and perhaps the most executable.
- Factor Price Reform– Pollution and over-investment in China would take a major hit if the country used market pricing for coal, oil gas, electricity, and water. The next five year plan is supposed to “continue reforms” in this area, which will run up against difficulties from certain entrenched interests, but is probably the most necessary component of China’s economic rebalancing.
- Tax reforms– The government said it plans to reform taxes to promote consumption and discourage heavy industry. Again this will run up against vested interests, but it is eminently doable.
- Financial market reforms– The proposal isn’t particularly clear in this area, but mentions liberalizing exchange rates and interest rates, as well as developing capital markets. Liberalizing interest rates is a particularly big part of banking sector reform, and I believe is likely to occur faster than exchange rate liberalization. Who knows what “developing capital markets” means.
- 7% yearly growth –If the government was really serious about rebalancing then they’d kill the growth target all together. But with most analysts calling for 5-9% growth over the next 10-years, mostly front-loaded, 7% seems about right.
The caveat to all these predictions is that when the political transition happens in 2012, the new leadership could either take rebalancing less seriously, or feel that it has to shore up support among the special interests that make money off China’s heavy industry sector. If that were to happen one could imagine a very ugly 2015.