Inside Xi Jinping's Reform Strategy

Peter Martin, David Cohen 

Chinese President Xi Jinping has set out to be a transformative leader. While he is, in his own words, no Gorbachev, he is equally committed to breaking free of the Brezhnevian stagnation that many Chinese feel characterized politics under Hu Jintao. In his speeches and in the official decisions of November’s Third Plenum (reported to have been prepared under his close guidance), he has promised to establish a “decisive” role for market forces—under the guidance of the Party. Doing so, by his own analysis, requires overcoming and controlling “vested interests” which stand in his way.

As his concept of the “China Dream” explains, Xi aspires to restore China to its rightful place among the world’s nations—and restore the Chinese Communist Party to its own rightful place as the vanguard of the nation. Like his predecessors, Xi aspires to revamp China's political economy not to weaken the Communist Party, but to strengthen it and the nation it rules by “rectifying the relationship between markets and the state.”

Debate about the Xi leadership has, until recently, focused on the question of whether or not it was serious about reform. Since coming to power in November 2012, the Xi administration has answered this question by laying out a bold agenda for economic change which would, if carried out, profoundly alter the role of the State in the Chinese economy.

This vision will not always be attractive to outsiders. It will likely mix markets with robust nationalism and a reinvigorated state-owned sector. What is now clear, however, is that it will represent a significant break with the status quo. For Xi and those around him, the easy part is over. Having laid out their agenda, they must now focus on implementing it.

Delivering effective reform won’t be easy. As Americans can testify, achieving change is difficult in any political system. In order to make ambitious changes, Xi will have to overcome an array of ideological, bureaucratic and industrial groups with stakes in maintaining the status quo. This challenge appears to be much on his mind: He has repeatedly spoken of the threat posed to reform by “vested interests,” a poorly defined but important combination of government ministries in Beijing, local governments and state-owned enterprises (SOEs).

Over the last decade, the structure of the Chinese political system has offered vested interests multiple avenues to resist change. In short, power was diffuse and interests varied wildly. Decision-making at the top levels of the Communist Party was driven by consensus, often resulting in a lowest common denominator approach to policy-making. Central ministries in Beijing amassed significant power over the economy and were not eager to give it up. Powerful local governments were frequently responsible for implementing policies and focused on short-term growth rather than long-term reform. And managers of state-owned enterprises were able to leverage political clout in both Beijing and the provinces to preserve the status quo.

In facing these challenges, Xi has some natural advantages. As the son of Xi Zhongxun, one of China’s revolutionary elders, Xi is better connected and—to some extent—enjoys more natural legitimacy in the Party system than his immediate predecessors. He also has several close allies on the Politburo Standing Committee, especially China’s top antigraft official Wang Qishan and former Shanghai Party Chief Yu Zhengsheng, many of whom share a common patron with Xi in former President Jiang Zemin, as well as ties to his native Shaanxi province. More importantly, however, after a year in office he is also proving himself to be a gifted political strategist in his own right.

As it shapes its own approach to promoting reform, the Xi leadership is drawing on strategies employed by previous generations of Chinese leaders who have succeeded in effecting change. While much has been made of Xi’s Maoist language over the last year, he has also taken tips Mao’s political playbook. This makes sense. Whatever his flaws, Mao knew a thing or two about political leadership. In less than three decades, Mao turned China’s economy, as well as its political and social structure, on its head.

In looking to undo Mao’s damage, the Deng and Jiang leaderships set themselves equally ambitious goals, and largely achieved them, in the face of strong resistance from powerful entrenched interests. They did so not by fiat, but by deploying sophisticated political strategies that weakened existing interest groups, created new ones with a stake in reform, and created opportunities for many insiders to profit by taking part in market reforms.

Below we outline seven emerging strategies for implementing reform. These strategies are still taking shape, a process made more complex by the fact that, despite Xi’s strong leadership, China’s reformers are not a cohesive bloc. They, like the “vested interests” they seek to overcome, are divided along personal, ideological and factional lines, meaning that different people favor different strategies for reform. This is also proving to be a process of trial and error, as the leadership figures out which approaches are most likely to gain traction and which are best left by the wayside.

Strategy One: Centralize power under your own leadership

The most distinctive element of Xi Jinping’s strategy for implementing reform is his move to centralize power under his own leadership and use this to drive forward his agenda. Within six months of the November 2012 leadership transition, Xi had assumed leadership of China’s top Party, military and government positions. Hu Jintao and Jiang Zemin, in contrast, spent their first years in office overshadowed or undermined by their predecessors.

After assuming these roles, Xi centralized the policy-making process in key areas by creating new top-level central bodies. He created a National Security Committee to oversee domestic and foreign threats to security and—more recently—announced the formation of a central Internet security and informatization leading group. Most importantly from an economic perspective, Xi established the new “Leading Small Group for Comprehensively Deepening Reform.” In doing so, Xi is following a well-trodden path around the power of established bureaucracies.

By creating small committees dominated by his presence, Xi has given himself platforms to issue decisions without negotiating with the State Council and its ministries—a tactic used by Mao to outmaneuver opponents of the Cultural Revolution in 1966 with the creation of the Central Leading Small Group on the Cultural Revolution, led first by Chen Boda, and then by Mao’s wife Jiang Qing.

By directing China’s provinces to establish counterpart bodies answering directly to the Central Small Group, Xi has also created a chain of command that does not run through China’s central economic planning agency, the National Development and Reform Commission (NDRC), a nerve center for heavy state intervention into the economy whose power is threatened by reforms.

Xi has also proved effective in using his role as General Secretary of the Communist Party to overcome entrenched interests in the government. Xi consolidated his role in the Party directly following the November 2012 leadership transition, but had to wait until the March 2013 National People’s Congress to formally take over as China’s head of state. He used the interval to launch a massive anticorruption campaign designed to reestablish the legitimacy of the CPC, as well as to signal the risks of opposing his program. The campaign is being spearheaded by Wang Qishan, head of the Party’s Central Discipline Inspection Commission, the CPC’s top antigraft body which reports directly to the Party leadership and is institutionally separate from the government.

Launching a series of high-profile anticorruption cases in China’s state-dominated oil sector signaled that SOEs would not be exempt from the antigraft drive. The downfall of Liu Tienan, a Deputy Director of NDRC, also illustrated that central ministries in Beijing would not be exempt. Indeed, the crackdown reached even further. The spate of arrests in China’s state-owned oil sector led to the removal of Jiang Jiemin, head of China’s key SOE regulator, and former state-owned oil company executive, and look likely to lead ultimately to the removal of former Politburo Standing Committee member Zhou Yongkang. Zhou amassed huge power over China’s political-legal apparatus under during the Hu-Wen era, and reached a rank usually thought to be untouchable on anticorruption charges. In the eyes of Chinese officials, if Zhou is not safe, no one is safe. On March 15, Wang instructed disciplinary inspectors to consider themselves "the sword of Damocles," announcing a hit list of ministries, provinces and SOEs for investigation in 2014.

Xi is not the first leader to push an anticorruption drive to push forward a reform agenda. In fact, the CDIC was created in 1979, at the outset of China’s “reform and opening” process under Deng Xiaoping. It was given the task of re-consolidating and disciplining the Party’s rank and file, which was then in organizational disarray after the Cultural Revolution, and needed to be unified behind Deng’s agenda of gradual reform and economic restructuring.

Strategy Three: Change the terms of the debate by wrapping yourself in the flag

In addition to dominating key institutions, Xi has also seized the rhetorical high ground, defining his project not in terms of reform, but in terms of the future of the Chinese nation and the Communist Party. Facing a skeptical public, Xi has the deployed the aspirational message of the “China Dream,” which describes a nation on the verge of attaining its historic destiny as a wealthy and respected world power. In his speech at the Third Plenum, he said that “the Center has repeatedly stressed that reform and opening up are crucial in deciding the destiny of contemporary China.” This message aligns Xi's agenda with the “rebirth of the Chinese nation,” a mission that has been articulated as a basic purpose of the Communist Party since Mao’s famous declaration that “The Chinese people have stood up.”

By preemptively claiming the mantle of patriotism—and by pursuing an aggressive course toward Japan—Xi also insulates himself from accusations that have previously dogged reformers. Zhu Rongji, Jiang Zemin's reformist premier and enforcer, was labelled a “traitor” for embracing globalization, liberalizing the economy, and leading China into the WTO.

Strategy Four: Generate a “sense of crisis” within the Party

When speaking to insiders, Xi has a different task: convincing them to give up some of their privileges. To explain why this is necessary, he has promoted the paranoid message ofDocument Number 9, an internal Party document, which recounted a litany of threats to Party rule inside and outside China’s borders. He has therefore suggested that the fate of Party rule is staked on the success of his agenda. Its implementation, he said “will be a new test for the Party’s ability to rule and lead the country.”

Xi has called upon cadres to treat the situation as a crisis. In a June 18 speech about the mass line campaign he called for “a sense of urgency at all levels.” His political campaigns against corruption, and an ongoing crackdown on liberal dissent, have also served to generate this feeling. While the widespread anticorruption campaign threatens officials with “double detention” (shuanggui)—disappearance into feared Party prisons—the crackdown on dissentfeeds paranoia by identifying new threats, and demonstrates the Party’s commitment to defending its members from them.

Strategy Five: Create new constituencies in favor of reform

Central authority, however, is not enough to effect change on a national scale. Chinese officials have decades of experience at evading oversight, submitting optimistic reports while concealing actions and outcomes that go against the priorities of their superiors. In order to effect change, previous top leaders have made calculated decisions to create new interest groups with incentives to support reform.

Deng Xiaoping demonstrated the possibility of a new basis for growth by playing the countryside against the cities through the creation of Town and Village Enterprises (TVEs), and then pushed past vested interests in Beijing by creating new constituencies for reform in the coastal provinces which housed the new Special Economic Zones (SEZs) of the 1980s. By creating opportunities for local authorities to get rich by sponsoring market enterprises, Deng harnessed self-interest to create allies at the provincial and local levels.

Some reformist voices have been explicit in calling for the leadership to emulate Deng’s strategy. Zhou Qiren, Dean of the National School of Development at Peking University and a well-known economic reformer, speaking at Caijing’s annual conference in Beijing in November 2013, argued that the successful implementation of reforms will rely not only on overcoming existing vested interests, but on the ability of this generation of reformers to create “new vested interests in favor of reform,” just as the leadership succeeded in doing with rural reform in the 1980s.

Under the current leadership, this strategy is most closely associated with Li Keqiang and the Shanghai Free Trade Zone (FTZ), which many see as his personal initiative. Announced soon after the new administration came to power, it looked at first like the FTZ would be the flagship policy of this generation of reformers. Events over the last six months have called this into question, however, especially the fact that Li Keqiang did not attend the Zone’s opening ceremony, as well as discontent at the contents of the Zone’s “negative list” for foreign investment which failed to deliver meaningful concessions for investors.

More recent developments suggest that it is too early to write off this particular strategy, however. China’s provinces have been vying for the approval of their own proposed zones - at least twelve applications have been filed so far. The Third Plenum itself also endorsed FTZs as a means of promoting reform and, most recently, Xi Jinping publicly encouraged Shanghai’s flagship zone when meeting with the city’s delegation at the National People’s Congress (NPC).

Strategy Six: Change the context for actors too powerful to reform

State-owned enterprises have long been public enemy number one for proponents of reform, both inside and outside China. While the current leadership includes SOE skeptics, such as Liu He, a prominent economic reformer and close advisor to Xi, the overall agenda appears to favor continued state ownership in key sectors of the economy. Last November’s Plenum document itself, while calling for a “decisive” role for market forces, also stated that “public ownership” should be the “core” of China’s economic system. Xi Jinping himself is on record referring to SOEs as “an important foundation of Communist Party rule” in a 2009 speech at Daqing oilfields.

Nonetheless, there has been considerable discussion of SOE reform, and the anticorruption campaign has hit SOEs hard. The leadership is clearly not satisfied with the state sector as it is. Xi appears to consider them corrupt, inefficient, and overly reliant on monopoly rents. Xi’s reform goals call for making them competitive—transforming them from cash cows for cadres into streamlined enterprises capable of acting as “national champions” in global markets. Xi summarized this goal at this year’s NPC when he told the Shanghai Delegation that, “deepening the reform of SOEs is a major task; not only should SOEs not be weakened, they must be strengthened.”

In the 1990s, Jiang Zemin and Zhu Rongji faced a similar challenge in getting the People’s Liberation Army out of the economy. Bloated and sprawling, it was less a military than an enormous conglomerate with soldiers working in its factories and farms. Unable to force the PLA to give up its business interests, Jiang and Zhu instead changed the context in which they operated. By reducing China’s tariff levels, they reduced incentives for smuggling—a major source of PLA income until that point. This cut off a major source of its money and power, making further reforms easier. During Jiang’s term, the PLA eventually reduced its force size by half a million, and gave up most of its previously vast subordinate businesses, focusing on developing itself into an effective military.

Reforms introduced in the Plenum document and NPC likewise aim to push SOEs into remaking themselves as efficient businesses. The Plenum document introduced limited reforms aimed at encouraging financial discipline among SOEs, including forcing them to pay higher dividends to the state (30 percent by 2020, up from 5-15 percent today), and expanding private investment in state-owned companies.

More importantly, the leadership has followed the example of Jiang and Zhu by removing regulations that protect SOEs from competition. The Plenum laid out measures to reduce barriers to entry in state-dominated markets by removing cumbersome administrative approvals, allowing private companies easier access to credit, and forcing SOEs to pay market prices for key inputs such as land and energy.

Most recently, the leadership appears to have made a push for interest-rate liberalization, firstembracing new online investment vehicles, such as Alibaba’s Yu’e Bao, as a means of putting pressure on state-owned banks to accept liberalized interest rates. The People’s Bank of China (PBOC) has so far rejected a series of regulatory proposals from the banks that would limit the growth of funds like Yu’e Bao—although there are reports that the central bank is pursuing some limits on these funds despite having identified them as desirable innovation. On March 12, the PBOC announced plans to bring more private competition into the finance sector, seeking fully liberalized interest rates within two years. In addition to directly putting pressure on banks to make a desired change, interest-rate reforms could could have consequences throughout the state sector by unwinding a system that effectively taxes Chinese savers in order to provide subsidized access to capital to SOEs.

Strategy Seven: Use external leverage to lock in reforms and push further.

In the face of significant domestic opposition to reforms, Jiang Zemin and Zhu Rongji used the promise of WTO membership to win support for domestic reforms and used membership itself as a way of locking in their achievements.

The Xi administration has shown signs of emulating this strategy. Shortly after entering office, the administration signaled its willingness to enter into Bilateral Investment Treaty (BIT) negotiations with the United States on the basis of a ‘negative’ investment list. This suddenly made the possibility of negotiating a BIT with China, an initiative stuck in the weeds since the George W. Bush administration, a much more realistic possibility. The administration has also made more positive noises about the possibility of joining the Trans-Pacific Partnership (TPP), the Obama administration’s landmark “21st Century trade agreement.”

Members of the Party’s top leadership have also been explicit in spelling out this strategy. A Politburo meeting on August 27, ahead of China’s Third Plenum meeting, called on the Communist Party to “fully mobilize all positive factors that can be mobilized inside and outside the country to form a great cohesive power for promoting reform.” Key figures in Xi’s inner circle have also addressed this strategy. Liu He told China’s Caixin magazine in 2010, “Domestic drive often needs to be activated by external pressure.” Explicitly drawing lessons from previous reform efforts, Liu explained, “From the perspective of China's long history, a unified domestic drive and external pressure has been key to success.”

Conclusion

Xi Jinping and his supporters have laid out China’s most ambitious reform agenda in more than a decade. Implementing it will not be easy. Overcoming the vested interests stacked up against reform will test Xi’s skills as a politician and as a political strategist. He has already demonstrated significant talent on these fronts, but success is not guaranteed. As he seeks to push through his reform agenda, he must also do so while maintaining political stability in the face of huge changes to the political and economic arrangements that have underpinned the Party’s power over the last decade. If successful, he may be judged as this generation’s Deng Xiaoping. But he will be haunted by the specter of Mikhail Gorbachev, whose attempt to reform the Soviet system ended in its collapse.

David Cohen is the editor of China Brief at The Jamestown Foundation. Previously a freelance journalist in Beijing, he has written for The Diplomat, The Christian Science Monitor, and a number of Asian newspapers. Follow him on Twitter: @JTChinaBrief.

Peter Martin is a government relations consultant for APCO Worldwide in Beijing. His client work focuses on elite politics, state-owned enterprises, and investment policy in China. Follow him on Twitter: @PeteMartin7.

Source: National Interest, March 20, 2014