Why is it difficult for China’s central government to make local leaders listen?

The ancient Chinese proverb “the emperor is far away and the mountains are high” signify the perennial power struggle between China’s central leadership and local officials and rings true even today. Due to having a history of regional government-led separationist movements, and a deep-seated national fear of chaos, China’s central government holds tighter onto power than in other large countries. The central government, however, often find – and accept – that local leaders slip out of its policy iron-fist. Although many assume that China exemplifies harsh authoritarianism, then leading scholars argue that China is actually a fragmented authoritarian state (link): local leaders are often not listening to the directives coming from the capital. Or according to a popular Chinese saying: “policy from above, opposition from below”.

Yet why is it so difficult for Beijing to control its localities? While many reasons undoubtedly exist, then China’s size, lack of effective checks and balances and information asymmetry are here argued to play large roles. China’s size – the average population of China’s 31 provinces is 44 million – is one reason why it is difficult for the central government to effectively monitor local politics and ensure compliance with central directives. But in contrast to other large countries such as the US, then China does not have effective checks and balances. The monopoly on power that the Chinese Communist Party has, ironically, makes it more difficult for it to control local leaders. Whereas democracy helps establish effective checks and balances, then the ultimate authority at the local level in China – the Communist Party – is supposed to monitor itself, creating conflicts of interest. Finally, as a result of the country’s vast size it is challenging for the center to understand local conditions as deeply as local officials, why the central government at times allow localities to deviate from central policy to better suit reality on the ground.

Chinese Local Government Debt: Introduction

This briefing is the first in a series of two that aims to introduce the non-specialist reader to Chinese local government debt. This briefing aims to shed light on why local governments in China borrow and why it is a problem and the second briefing will discuss the reform wave that began in 2013. Before proceeding, then local governments are here defined as the lower four of five levels in the Chinese political administrative structure: central, province, prefecture, county, township (source).

1. Why do we care about local governments in China in general?

One major reason that local Chinese governments are interesting is that most fiscal responsibility is held by local governments in China. More specifically, in 2015, 86% of government expenditure occurred at the sub-national level, while the sub-national government received only 54% of total government revenue (source). Two points arise when looking at these numbers. Firstly, China is much more decentralized in terms of both revenue and expenditure than all other major economies. In OECD countries, the average subnational share of revenue was 65% in 2015, whereas the share of expenditure was 31% (source). Secondly, the gap between subnational revenue and expenditure is larger in China than in other large economies. Whereas the 2015 local government fiscal deficit was 32% of GDP for China, then the average OECD country had a local government fiscal surplus of 34% of GDP. The below figure provides a more detailed overview of revenue and expenditure at different government levels in China.

Diagram 1: China is fiscally decentralized (2015 data) (source)

2. Why do Chinese local governments need to borrow?

The previous section gave a hint as to why local governments in China borrow: they have to spend more than they “earn”. Yet the revenue-expenditure gap is not the whole story. While there are likely many reasons for the increase in local government debt, the 1994 fiscal reform and post-2008 fiscal stimulus are two main causes. Examples of other frequently mentioned reasons include 1) that the central government implicitly guarantees local debt, leading to moral hazard among local governments, 2) that economic growth is emphasized in the evaluation of local politicians, leading to debt-fueled growth, and 3) that local officials can influence banks, allowing local governments to access financing on non-market terms. This briefing argues that these three factors, while important enabling contextual factors, are not root causes as they have existed for decades in China.

2.1. Long term: 1994 fiscal reform

The massive fiscal deficit faced by local governments in China can be traced directly to fiscal reforms implemented in 1994. While China experienced real economic growth that averaged around 10% per year between 1979 and 1993, government revenue as a share of GDP fell from 28% to 12% during the period (source). The fall in government revenues led the government to implement major fiscal reforms in 1994, something that enabled the central government in Beijing to increase its share of total government revenue from 22% to 56% during 1993-1994 and nearly double the ratio of government revenue to GDP in the following 20 years (source). The 1994 reforms achieved its goal of fiscal centralization, although local governments until today face “expenditure responsibilities [that] exceed their assigned revenues” (source), why the local governments have had to find ways to fill their revenue gaps. Local governments have plugged their funding gap by borrowing from banks and shadow banks, and selling land (often by expropriating land from citizens and compensating them at below-market rates).

Diagram 2: impact of the 1994 fiscal reform (source)

2.2. Medium term: post-2008 stimulus

During 2008-2010 the Chinese government decided to implement major fiscal stimulus programs worth almost $600 billion (source) to counteract the financial crisis, with around three-fourths of the money going to local governments. While this initially might sound positive for local governments, despite “the significant outlays, the money the center [gave was] nowhere near enough to fund all the local projects” that it approved (source). Despite the stimulus package resulting in local governments taking on more debt through a range of direct and indirect channels, then most of the money was spent on infrastructure and other public goods – projects on which “the income-earning potential of the projects is limited” (source). According to one estimate, local government debt increased by around 60% in 2009 (source).

3. Why is local government debt a problem in China?

Although the aggregate national debt burden is not a cause for huge concern at the current debt levels (source), then this briefing argues that the rapid increase, geographical variation, reliance on land sales and opacity of debt are concerning.

Increase in size

The increase in size of local debt, and the ability of local governments to cover such debt is a rather straight-forward story: the debt burden has increased significantly as both a share of GDP and as a share of local government revenue, however measured.

Diagram 3 and 4: increase in size of debt (source)

The national average of local debt, however, covers a broad range of provincial debt levels, as seen in diagram 5 below. The broad variation in debt burden could easily resemble the variation in debt across a sample of countries, making this author ponder whether a potential local debt crisis in China might be idiosyncratic or systematic across only a subset of provinces, particularly given clustering in the economic profiles of Chinese provinces.

Diagram 5: provincial variation in debt burden (source)

Reliance on land sales

Further supporting the above narrative is that local government revenue is heavily reliant on land sales; according to one estimate, “land sales accounted for about 30 percent of local government revenue in 2016” (source). The supply of land available for the local government to sell, however, is expected to be fully exhausted by around 2021 (see diagram 7 below).

Diagram 6 and 7: reliance on land sales for local governments (source 1; source 2)

Increased opacity

Local governments in China are “legally prohibited from borrowing or running deficits” (source) following the 1994 fiscal reforms. So how do local governments escape this oxymoron? While local governments have obtained “much of their debt in the form of bank loans”, then this is not a cause for concern as direct local government debt only increased from 16.5% of GDP in 2006 to 18.6% of GDP in 2013 (ADB, 2014). The main concern comes from opaque financing accessed through shadow banking. Following the stimulus plan announced in 2008 the central government authorized local governments to access debt through formal channels (source). As formal financing channels were not sufficient, local governments increasingly sought credit outside the formal banking system.

One common shadow financing structure is a local government financing vehicle (LGFV), which are enterprises set up by the local government and implicitly guaranteed by the central government. As LGFVs are not officially part of the government they can borrow on behalf of the local government. While the central government is no doubt aware of LGFVs, LGFVs have been overlooked as they have allowed local governments to fulfill their fiscal commitments. The next briefing will include a discussion on the decreasing reliance on LGFVs of local governments.

The increased reliance of local government finances on shadow banking is an issue for multiple reasons, some of which are described below. While estimates of the size of shadow banking are available, it is difficult to have a high degree of confidence in any single estimate given that estimates of the size of shadow banking has a large variance (source). An examination of estimates of shadow bank financing accessed by both government and corporates in 2013 found figures ranging from 8% (Standard Chartered) to 82% (JP Morgan) of GDP, with the average figure being around 50% (source). Another issue is that shadow banking can be argued to embody uncertainty and not risk: although case studies on shadow financing structures can be developed, then it is difficult to develop a credible view on the macro-level risk features of shadow banking. Finally, while LGFVs are widely assumed to be implicitly guaranteed by the central government, LGFV bond yields reflect provincial characteristics such as reliance on real estate, corruption, liquidity indicators and macroeconomic variables (source), indicating that markets do not view the central government implicit guarantee as fully credible. The central government has indeed recently argued that it is willing to let LGFVs fail; while analysts believe that the central government might allow a small number of LGFVs to fail (source), consensus is that widespread defaults would not be allowed.

4. Conclusion

The problem of local Chinese government debt can be traced back to the 1994 fiscal reform, resulting in unbalanced fiscal mandates being forced upon local governments. The problem accelerated following the 2008 fiscal stimulus program, which led local governments to tap the shadow banking system to fulfill a centrally underfunded fiscal stimulus program. While the average national level of local government debt is not worrying by itself, the growth rate, regional variation, reliance on land sales and opacity could be sources of issue in the future.

China's 19th Party Congress

China’s 19^th Party Congress

Briefing

The following briefing was finished on October 17, 2017

1. The problem

The 19^th National Congress of the Communist Party of China (NCCPC) will begin on October 18, 2017 in Beijing, and much uncertainty exists with regards to key political, policy and personnel decisions to be made during the meeting.

2. Conclusions

This paper hypothesizes that Xi Jinping’s main goal since 2012 has been the pursuit of the “China Dream” – the great rejuvenation of the Chinese nation – an endeavor enabled by China slowly moving from a fragmented authoritarian state to one led by a modern, digitally-enabled Leninist vanguard party. In the absence of contradictory evidence, this author argues that it is reasonable to assume that China will remain on a path consistent with that of the 18^th Party Congress (2012-2017) going forward. The extent to which the 19^th party congress supports a China Dream implemented by a Leninist Chinese Communist Party (CCP) will help test the popular hypothesis that Xi Jinping is the most powerful Chinese leader since Mao Zedong.

2.1. Top leadership and elite turnover

2.1.1. Xi Jinping

Xi Jinping is the General Secretary of the CCP, the President of China and Chairman of the Central Military Commission.

• Xi Jinping is certain to be mentioned as a leader in the CCP constitution, although it would be norm breaking for his ideology to be enshrined already, whether by name or not
• At this point it would not be rational for Xi Jinping to signal his intention, if any, to stay in power after his term is supposed to end in 2022
• Xi Jinping has amassed large amounts of power, yet leading analysts do not believe Xi is becoming a norm-breaking Mao Zedong-style totalitarian leader

2.1.2. Politburo Standing Committee (PSC)

The PSC is widely considered to be the apex of political power in China. The PSC has historically consisted of 5-9 men, and consisted of 7 men during the 18^th NCCPC (2012-2017). The below statements assume that historical succession norms are followed:

• 5 out of 7 PSC members will retire; Xi Jinping and Li Keqiang will remain
• The 2017-2022 PSC, if constant at seven people, will consist of Xi Jinping, Li Keqiang, Xi’s successor-in-training, Li Keqiang’s successor-in-training, along with three other members
• Often-mentioned successors-in-training to Xi Jinping include Chen Min’er, Zhang Qingwei and Hu Chunhua
• Five people fulfill historical norms for entering the PSC, yet it is guesswork to try to predict which three of the five will enter the PSC
• The five candidates are: “Propaganda Department chief Lu Qibao, PRC Vice President Li Yuanchao, Xinjiang party boss Zhang Qunxian, party General Office chief Li Zhanshu, and Shanghai party boss Han Zheng” (Miller, 2016)

2.1.3 Leading Small Groups (LSG)

LSGs are issue-based groups that are nominally tasked with policy coordination across the CCP, the state and the military. In May 2017 there were 45 LSGs of varying influence (Stepan & Batke, 2017).

• Xi Jinping has used the LSGs to advance his own authority by chairing, or placing allies in, important LSGs
• Xi Jinping has used LSGs to supersede Premier Li Keqiang’s initial authority on economic policy-making (Naughton, 2016), a move unprecedented since Mao Zedong

2.2. Politics and policies

This briefing argues that Xi Jinping’s political and policy goals are to pursue the China Dream and that policy developments during 2012-2017 reflected this. However, the current policy trajectory within economic, SOE and the financial sector reforms are not comprehensive enough to support the long-term pursuit of the China Dream. There is much uncertainty surrounding the future development of policy in China, yet this briefing argues that a least-bad hypothesis is that Xi Jinping is committed to pursuing the China Dream, particularly given the extensive public commitment made to this goal.

3.  Introduction to the NCCPC

The five-yearly meeting of The National Congress of the Communist Party of China is widely considered to be the most important recurrent formal event in Chinese politics.

How does the NCCPC fit into the Chinese political system?

China’s political system is nominally divided into a state, Communist Party, and military, although the Communist Party is widely argued to hold de facto power in Chinese politics. At the NCCPC its 2,300 members reappoint the Central Committee (around 200 members), Politburo (25 people), the Standing Committee of the Politburo (5-9 people) and the Central Military Commission for the following five years. The NCCPC is nominally the highest organ of power within the Communist party, although decisions made by it follow suggestions from incumbent top party members (Lawrence & Martin, 2013).

The NCCPC – where the Communist Party meets – should not be confused with the National People’s Congress (NPC), also elected for terms of five years, a Chinese state institution that meets in the Spring following the NCCPC. The NPC is nominally “the highest organ” of state power (The State Council, 1982), although it is frequently criticized as merely rubber-stamping decisions made in advance by top Communist Party officials (Lawrence & Martin, 2013).

Why does the Party Congress matter?

The two most noticeable tasks of the NCCPC meeting is to (re)elect new Chinese Communist Party top leaders and to approve the political priorities for China until the next NCCPC conference (Stepan, 2017). While the NCCPC merely approve decisions made ahead of the congress, useful information can be extracted from the conference by observing who are (not) appointed to powerful positions, and what policies are (de)emphasized.

Furthermore, the Chinese political system uses “staggered elections”. This means that the leaders that have served alongside Xi during his first term (2012-2017) were chosen by the 2007-2012 leadership team. While Xi was a member of the powerful nine-person PSC during 2007-2012, then he was officially ranked as the 5^th most powerful person, why his ability to influence leadership selection was likely more constrained that it is now. The 19^th party congress therefore provides the first opportunity for Xi to take part in the leadership selection as China’s top leader, providing him with opportunity to place allies in powerful positions.

4. Discussion

4.1. Top leadership and elite turnover

4.1.1. Xi Jinping

Will Xi Jinping be incorporated into the constitution of the CCP?

Xi Jinping is “certain” (Miller, 2017) to be added to the Communist Party’s constitution by mentioning his leadership during 2012-2017, and while it is possible that his ideology will be added to the CCP’s “Guiding Ideology” during the 19^th NCCPC, then the foundations for such a step have not been made (Fewsmith, 2017; Miller, 2017). If Xi’s rule follows historical norms then his ideas will be enshrined late in, or after, his rule. If his ideology appears in the constitution during the congress, however, it would be a break from historical norms.

When Xi Jinping’s ideas are added to the constitution they will appear alongside “Marxism-Leninism, Mao Zedong Thought, Deng Xiaoping Theory, the important thought of Three Represents and the Scientific Outlook on Development” (CCP, 2012). Two things should be noted. While Mao and Deng’s ideas were named, then the contributions of Jiang Zemin (Three Represents) and Hu (Scientific Outlook on Development) were added, but without mentioning Jiang or Hu’s name. Secondly, while Mao thought was added, then Deng theory was enshrined. Given that Mao is considered more important than Deng, who in turn is considered more important than Jiang or Hu, then it can be inferred that Xi is viewed as a more important part of CCP’s legacy if his name is mentioned alongside his ideological contribution (e.g. “Xi Jinping’s China Dream” indicates more importance than “China Dream”), and more importance if his ideas are called thought rather than theory (e.g. Xi Jinping Thought indicates more importance than Xi Jinping Theory).

Will Xi Jinping stay in power past 2022?

Rumors about Xi Jinping staying on as China’s paramount leader beyond 2022 abound, yet there is no upside for Xi to signal such intentions already (Bishop, 2017a). The historical norm in China is that leaders retire after two terms (10 years) in the NCCPC, meaning that Xi should retire in 2022. If Xi wishes to stay in power beyond 2022, he may initiate such a move closer to the end of his second term through either formal (e.g. attempting a formal third term) or informal (e.g. wielding power from behind the scenes) means.

Is Xi Jinping becoming a Mao Zedong-like totalitarian leader?

Xi Jinping has amassed “overwhelming personal power” (Miller, 2016) and “reinforced the party’s dominance over the country’s destiny” (Rolland, 2017) – at the same time it has been argued that his “rule will continue to respect established leadership constraints” (Miller, 2016). It is difficult to know how much of the power consolidation under Xi is due to CCP party line, genuine ideological dedication on the part of Xi or simply a power grab for personal benefit, although the background of Xi and the CCP can provide perspective on the issue.

Analysts have provided anecdotal evidence that CCP conservatives, Xi included, felt that “sloppiness… got in” (Osnos, 2016) during the Jiang and Hu eras as a result of opening up the party to society, leading some CCP members to describe Hu’s rule as a “lost decade” (Paulson Institute, 2016). During the Jiang and Hu era collective leadership norms started by Deng Xiaoping were continued, a trend that stands in contrast to the personalization of power under Mao. One analyst argues that so “much of what Xi is doing stems from Party policies that predate him… it is a huge mistake to believe China’s policies and behaviors stem from him alone” (Bishop, 2017b). It has been argued that the current consolidation of power around Xi aims to make the CCP strong enough to “implement major reforms”(Stanzel, 2016).

With regards to Xi Jinping, there are no records of him demonstrating the egotistical tendencies that Mao displayed during his later years (Walder, 2015), although the reasons behind Xi’s power grab, if personal, might of course never become public knowledge. What there is evidence of, however, is Xi Jinping demonstrating fierce loyalty – ideological and otherwise – to the CCP going all the way back to his childhood (CIA, 2009). Xi is additionally the child of former propaganda minister Xi Zhongxun (Osnos, 2015).

4.1.2. Politburo Standing Committee (PSC)

Who will be Xi Jinping’s successor?

The successor to the General Secretary of the CCP is usually chosen five years in advance of him taking up the position. The 19^th party congress should therefore signal who is supposed to take Xi’s place in 2022.

It is speculation to try to predict the actual person who will succeed Xi, yet it is possible to identify candidates that would adhere to three historical succession norms. Firstly, while members of the PSC are normally chosen from the full Politburo, then successors-in-training have historically been chosen from the around 200 members of the Central Committee (Miller, 2016). Additionally, prior candidates have also served as provincial CCP secretaries and have been 58 years old or younger when chosen for the position (Stepan, 2017). Chen Min’er (Chongqing CCP Secretary) and Zhang Qingwei (Heilongjiang CCP Secretary) fulfill the above criteria. While Hu Chunhua is already a Politburo member then he is also viewed as a top candidate (Stepan, 2017). Sun Zhengcai was also considered a top candidate, but was removed from his official position following corruption allegations that began in July 2017. According to Cheng Li, a leading analyst, it is difficult to conclude whether Sun was ousted because of actual corruption or as a result of political infighting (Phillips, 2017).

Who will be the new PSC members?

Five of the seven members of the PSC are supposed to retire, while Xi Jinping and Li Keqiang should remain. Two of the remaining five seats are likely to be filled with successors-in-training for Xi and Li. The best guesstimate of who will be chosen for the remaining three seats can be based on four historical succession norms (Miller, 2016).

Historically, members of the PSC have had to retire when they were 68 years old. Secondly, PSC members have been chosen from the Politburo. Thirdly, among those in the Politburo within the acceptable age range, people have been promoted on the basis of age. Finally, no woman has ever been selected to the PSC. Five candidates fit the above criteria: “Propaganda Department chief Lu Qibao, PRC Vice President Li Yuanchao, Xinjiang party boss Zhang Qunxian, party General Office chief Li Zhanshu, and Shanghai party boss Han Zheng” (Miller, 2016). There is no reasonable way to predict which three of the five will be chosen for the PSC.

4.2. Politics and Policies

What is the China Dream?

The China Dream has been defined as “the great rejuvenation of the Chinese nation” (Kallio, 2015), and this analysis argues that its policy implications can be captured by four themes. The degree to which the following themes are reflected in the political report presented at the NCCPC “will allow conclusions to be drawn on whether Xi has broad-based support among the party elite” (Stepan, 2017):

1. Capable China: strengthen state capacity to keep the CCP in power by continuing the anti-corruption campaign, making the legal system able to more effectively serve the CCP, securing outer provinces, centralizing leadership and solidifying military reform.
2. Prosperous China: pursue moderate and equitable prosperity by 2021 and full development by 2049 (Ross, 2015) – by shifting to a higher value-added, consumption-based economy that is environmentally sustainable, goals supported by existing policies such as Made in China 2025 and ambitious environmental and sustainable energy initiatives.
3. Inspiring China: develop an inspiring and distinctively Chinese ideological alternative to Western thought by strengthening the belief in “the ideals of communism and socialism with Chinese characteristics” (Xinhua, 2016), deepening control over (online and offline) civil society (Stanzel, 2016), ensure ideological loyalty in teaching and among academics, and develop think tanks with “Chinese characteristics” (Xinhua, 2015)
4. Influential China: expand China’s global influence by a combination of economic (One Belt One Road, AIIB), political (increasing leadership in international relations), and strategic (South China Sea, Taiwan) initiatives. Instead of Deng’s “hide and bide” approach to foreign policy then Xi’s principles appear more similar to Mao’s principle of “avoiding the solid main force and instead moving toward the empty spaces” (Heilmann, 2017). This author argues that the current increase in Chinese leadership in international relations align well with current Chinese domestic interests, and ponders what would happen to China’s behavior in international affairs were Chinese domestic interests to change.

How can an authoritarian party be part of a “dream”?

Although a country where, according to Xi, “the Party leads all affairs—Party, political, military, civil, and academic—east, west, south, north, and center” (Daly, 2016) might not sound like much of a dream to Western observers, then an omnipotent party is not inconsistent with Chinese political philosophy in a historical context. The CCP may be viewed as a patriarchal power that, while omnipotent, has the responsibility to carry China towards a better future – the China Dream.

Which policy trends are not consistent with the China Dream?

Unless China engages in more comprehensive reform of its SOEs and financial markets then the longer-term sustainability of equitable prosperity, a tenet of the China Dream, might not be realistic. If the China Dream hypothesis is to become true then such concerns need to be addressed.

General SOE reform cannot be said to be successful – many large SOEs are “zombies” in overcapacity sectors and are the main contributors to China’s corporate debt problem (IMF, 2017a). SOE reform is important for "reducing debt vulnerabilities and containing financial risks, but also to raising productivity and growth" (IMF, 2017b). Although China’s “high savings, current account surplus, small external debt, and various policy buffers" (IMF, 2017b) help protect China against a debt crisis in the near future, then the SOE and debt problems are a major risk factor for obtaining the long-term growth goals associated with the China Dream, and “if left unaddressed, these factors will likely not eliminate the eventual adjustment, but only make the bomb larger and last longer”(IMF, 2017b).

In terms of broader financial policies then the five-yearly Financial Work Conference that took place in July 2017 could have been a turning point for institutional and policy reform, yet it “must be judged a disappointment” (Naughton, 2017) as no major institutional restructuring took place as a result.

Some China watchers argue that the current internal migration (mainly Hukou) reforms do not sufficiently support equitable prosperity – a tenet of the China Dream. This author argues that Hukou reform is currently occurring at a pace that does not threaten social stability, something placed higher in CCP’s policy hierarchy than Hukou reforms. It can be argued that the numerous lower-tier cities in China can absorb many rural migrants, whereas first-tier cities might easily become overcrowded – a view reflected by authorities increasing the “carrying capacities of smaller cities and counties while controlling the population sizes of mega cities” (Brookings Institution, 2015).

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