China: Leveling the playing field through reforms

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China: Leveling the playing field through reforms

China: Leveling the playing field through reforms

Asia Pacific Economic Outlook, January 2014

China’s leaders have provided some details about the reforms they intend to implement—which, if fully undertaken, could completely change the economy.

China_spotAfter much anticipation, China’s leaders have provided some details about the nature of the reforms they intend to implement. They haven’t said when or how these reforms will take place, nor is it known to what degree China’s leaders will generate the internal support necessary to undertake the reforms. But what we do know is that the plans are quite ambitious and, if fully undertaken, could lead to a very different Chinese economy. China could become more market driven, more consumer driven, more transparent, and more prone to invest in projects with a positive return rather than those that employ lots of workers. This would be all for the better.

What is important, however, is the impact that these reforms are likely to have on global companies that do business in China. Will the reforms create a more level playing field for foreign operators? Will they benefit companies that export from China, those that sell into the Chinese market, or both? In which industries will the reforms create opportunities?

First, it is worthwhile to consider the broad sweep of the proposed reforms. Here are some of the major reform elements and their likely impact:

  1. Reducing the influence of state-owned enterprises (SOEs) and creating a more level playing field for private enterprise—The government proposes to increase taxation of SOEs, increase transparency of SOE finances, boost professional management of SOEs, and allow private companies to invest in SOE projects. For global companies selling into the Chinese market, this could mean a greater opportunity to compete, particularly in such long-protected areas as heavy industry and a variety of services. SOEs currently have an advantage in terms of access to credit, pricing power, political connections, and low tax rates. While the reforms won’t end all such privileges, and the reform agenda says nothing about further privatization of SOEs, it seems likely that the reforms will boost the competitiveness of private enterprise—including foreign companies.
  2. Allowing the market to determine the prices of many goods and services—The government will retain price controls for monopolies, but will allow free movement of prices in areas where there is competition. For global companies with efficient distribution and inventory management, this could mean a significant competitive advantage.
  3. Allowing private investors to create commercial banks in competition with state-run banks—This will be part of a larger reform of the financial system. Such reform is likely to include liberalization of deposit interest rates, creation of deposit insurance, and liberalization of cross-border capital flows. The goal will be to suppress inefficient investment, promote more efficient allocation of capital, provide savers with higher returns, and reduce financial risk. For global financial services companies, there could be greater opportunity to compete within China—especially in the burgeoning free-trade zones. For China in general, these reforms suggest that private enterprise would gain greater access to capital and credit, thereby leading to more efficient investment.
  4. Protecting private property rights, including creating a court to adjudicate disputes over intellectual property—This is critical to global companies, many of which generate much of their value from their intellectual capital. While the Chinese government’s goal clearly is to promote Chinese innovation, one side effect of this policy could be to help global companies operating in China. Of course, the devil will be in the details and in the implementation.
  5. Promoting more rural-urban migration by providing more public services to migrants—This will be critical to maintaining a steady supply of inexpensive labor. Absent further migration, China faces a shortage of labor in its cities, which is already causing a significant rise in wages. China’s labor shortage is causing global companies that source goods there to search for cheaper production locations. More urbanization would suppress urban wages and boost productivity growth. More services to migrants will be part of a larger effort to address rising income inequality—although it will be costly to provide such services. Reversing the rise in income inequality could create new opportunities for consumer-oriented businesses selling into the Chinese market.

If implemented successfully (and this is by no means a given), the reforms could lead to faster economic growth, less financial risk to the economy, and a shift in growth away from investment in fixed assets. For global businesses, the reforms would create a more level playing field in a number of industries. This would come about by boosting the ability of private enterprise to compete with SOEs, restricting the power and boosting the transparency of SOEs, allowing more market pricing, and undertaking efforts to protect intellectual property rights. Such reforms would be particularly beneficial to companies that attempt to sell into the Chinese market rather than those that focus on exporting from China. SOEs have a high share of heavy industry and domestic services, both of which could soon succumb to more competition.

The potential economic impact of the reforms depends on how fast and to what degree they are implemented. Many of the reforms will bear fruit only over a relatively long period of time. Successful implementation will require political support that could be difficult to engender. Reform of the financial system, however, might have more immediate implications for the functioning of financial markets. Given the problems in the Chinese banking system, the faster China improves the efficiency of its financial services industry, the more likely that China will avoid serious economic problems stemming from severe imbalances in the financial sector.

The potential economic impact of the reforms depends on how fast and to what degree they are implemented.

About The Author

Dr. Ira Kalish

Dr. Ira Kalish is chief global  economist of Deloitte Touche Tohmatsu Limited.

Asia Pacific Economic Outlook, January 2014: China
Illustrations by Jessica McCourt (Cover), Stephanie Dalton Cowan (China)