Economic reform is the key to China's development and political reform is hopeless without it

China is often criticized for it's lack of political reform. More importantly, however, is that much of the energy spent on viewing China is through a political lens. If you are in China, reading Chinese sources, then it's quite clear what the rising regime is aiming for: social stability via an economic transition that builds a domestic consumer economy. Against that are entrenched party interests that are happy with the current setup. Even without internal opposition, that is a hell of a challenge and one that may be assisted by some political reforms that touch on economics, but not something that needs the added chaos of serious political reform. That doesn't mean there won't be deep reforms: the reaction of the head of a defense industry SOE, warning that SOE privatization is a foreign assault on the Party and the PLA, shows how serious SOE and banking reform can be. Politics and economics are intimately linked in China and simply separating the two is a massive undertaking requiring years of determined effort.

In the NYTimes yesterday, Jonathan Fenby crystallized part what I would view as the typical Western view of China, although he goes on to accurately describe the reform movement afoot:

The Bo Xilai Sideshow

But the Bo affair is, essentially, a sideshow, a distraction from the essential challenges facing China under its changing leadership. Nobody can deny the country’s huge material achievements, and individuals live far better and freer lives than they did under the Great Helmsman. But the economic model is out of date.

China is gripped by a major environmental crisis and an acute water shortage is building up in the north of the country. Beijing lacks a coherent foreign policy. Corruption is rife. Regulation and safety standards are weak. There is a broad lack of trust in institutions. The falling birth rate and increasing longevity mean that the demographics will shift during this decade so that the People’s Republic may become old before it gets rich.

I disagree that Bo's take down is a distraction because the crackdown on leftist websites shows a larger force at work, it shows that the reformers have the power to remove their political enemies and that means they have the power to push through reforms. It is no accident that less than one month after Bo is taken down, the Wenzhou reforms halted in 2011 are restarted and expanded. That Wen Jiabao is speaking more boldly and the PBOC is in the spotlight on financial reform.

The second paragraph is a laundry list of Western concerns about China, not necessarily keys to growth or reform. Almost nothing in it is important to the point of being crucial. Demographics are key, but China does not have a pension system like the West. Demographic transition will be hugely important, but it will help with the transition to a consumer economy because it's a natural force pushing wages up. The environment is bad, but improving; in any event, Westerners place a high non-economic value on the environment and usually list it far too high on the priority list, exhibit A being the global warming hysteria. Corruption, regulation and safety standards, lack of trust and foreign policy all will improve with development and at least on this score, the current reforms are aimed in this area.

Party control over the economy leads to corruption and attendant costs such as lack of trust; high ranking party officials control the major SOEs; many SOEs are economically inefficient and rely on easy credit from state owned banks; state owned banks take their orders from the party. The current Wenzhou reform and rhetoric from Wen Jiabao and PBOC governor Zhou Xiaochuan are focused on creating a private financial sector. Even if there is no direct assault on the state owned banks, the rise of a private financial sector will reduce the importance of the banks relative to the economy. A key reform is underway, but many in the West want to rush China into a disaster of rapid reform. China won't be swayed by international pressure that grows weaker over time and my intent is not to beat up on China critics. Rather, it doesn't really matter and people who want to understand where China is headed should stick to looking at what's taking place on the ground and what leaders are saying, especially the rising leaders, men such as Li Keqiang who have spoken extensively of their reform plans for years.

As one example, take the property tax. It is a major assault on corruption and instability because it ends government reliance on a single sector of the economy. Right now the local governments rely heavily on land sales, which gives them an incentive to keep capital flowing to developers, to encourage real estate development and home buying. Since the government decides which land is sold, this also gives developers a reason to want to influence the decision. In contrast, while a property tax doesn't eliminate corruption, it reduces the government's need to keep the real estate sector and developers happy. Also consider the economic impact of high land prices. The government incentive was to drive up prices to increase revenue, pricing ordinary Chinese out of the market and increasing rent costs for factories, to say nothing of the financial bubble that accompanied it. China won't be bubble free in future, but the transition to a property tax system is a major component in economic reform and political reform, because down the road, an expanded tax base is what will eventually lead the push for expanded political rights.

Fenby's article does go on to address the reform efforts:

I even found myself pulled into the debate in a minor way when editors at China Daily, the state English-language newspaper, read an advance copy of my new book on China and asked me to write an article arguing the need for change. It ran exactly as written.

The reformers face formidable opposition. Wen and Li may talk of change, but the Communist Party is more powerful than the government, and the once-revolutionary movement has become an agent of the status quo. Interest groups are strong. State enterprises exercise monopolies or oligopolies entwined with the political system. Rule by consensus impedes adoption of tough measures.

How this process evolves will determine whether China finds a new future for itself or gets caught in the fallout of its own success. Given its place in the world, the outcome has major implications for the rest of the globe. If Bo’s fall has helped to open the door to change, it will have done some good.

He ends by hitting the nail on the head. Rule by consensus during rising social mood is what killed financial reforms in the middle of the last decade. With social mood more negative than before, conflict is favored over consensus and the reformers are moving fast, but they will focus on economic reform—and that is exactly what China needs, economically and politically.