China Third Plenum Wrap: Not Much Has Changed

The Chinese Communist Party's Third Plenum has come and gone. The communiqué was, as expected, vague on details, but the market reaction in Asia was less than impressed as stock prices tanked. Here were my key takeaways:

What role for the markets?
While the Party was said to have pledged a "decisive" role for the market, Ting Lu of BofAML was underwhelmed and confused (via FT Alphaville):

The communique changes the role of “Market Economy” from “基础性 (Jichuxing)” (used in the past 20 years) to “决定性 (juedingxing)”. For native Chinese speakers like us with years of intensive training in Chinese (and we did well on the grueling GRE too), we found it very difficult to tell the real difference. Bloomberg translated “ 基础性 (Jichuxing)” to “basic”, but we think it could be translated to “fundamental (foundational)” or “essential” as well. Regarding “决定性 (juedingxing)”, it could be translated to “deciding”, “determining” or “decisive”. We suspect the Chinese people won’t interpret too much from this change.

No SOE reform
What I found more interesting was the Party's affirmation of the dominant role of public ownership, which was a signal that any reform of state owned enterprises (SOE) was unlikely. The reason why that is significant? Since the time of the Deng Xiaopeng reforms, China has grown in leaps and bounds, but most of the wealth have accrued to the Party cadres and insiders. The combination of regulated prices and a crony capitalist culture has made many Party officials obscenely wealthy, with most of the funds stashed offshore. It has only been recently that the term "naked official" has crept into common usage.

In order to achieve its stated goal of re-focusing growth from export and infrastructure to the consumer, the authorities would have to stop, or at least lessen, the financial repression of the household sector with higher wages and interest rates for household savings. All those steps would hurt the interest of the Party insiders who got filthy rich.

Andrew Sheng and Xiao Geng put it this way in a Project Syndicate article:

A successful transition to the next phase of wealth creation – driven by the services sector and knowledge-based industries – will require a more market-oriented approach, in which the state cedes some control over the economy and focuses instead on protecting property rights, administering welfare services, reducing pollution, and eliminating corruption. Improved governance, together with greater support for market-based innovation, is needed to sustain a thriving economy.

Instead, what did we get? No SOE reform. Instead of ceding some control over the economy, we got an affirmation of dominance of public ownership. Moreover, the Party tightened control, instead of ceding control, over the economy via the establishment of a state security committee and a leading group on deepening reform. Depending on how the "leading group" is composed, it could be a mechanism for which market liberalization efforts are obstructed and buried by the bureaucracy.

If China's top leadership really wanted to signal the seriousness of its intention of re-balancing growth and market based reforms, maybe what it needs is a Night of the Long Knives, which refers to an event in 1934 when Adolf Hitler instituted a purge of his enemies. One of the victims of the purge was the SA, otherwise known as the brown-shirts, because they had outlived their usefulness.

Maybe what China needs is its own purge of Party cadres, because they have outlived their usefulness and become an impediment to stable long-term growth.

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

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