Before his first year as leader of China was out, and three years before Donald Trump was elected president of the United States, Xi Jinping laid out a historic vision for market forces to rule the $13 trillion Chinese economy.
Now, Trump is demanding Xi finish the job, making a sweeping overhaul of China’s economy a key condition for ending the U.S.-China trade war.
As Trump’s negotiators, led by Trade Representative Robert E. Lighthizer and Treasury Secretary Steven Mnuchin, sit down with their Chinese counterparts for a second day of trade talks Friday, U.S. demands for such structural reforms will be at center stage.
During a Chinese Communist Party conclave in November 2013, Xi declared that he would restructure the economic system “to let the market play the decisive role in the allocation of resources.”
Although he reiterated the party’s commitment to socialism, Xi’s pronouncement was viewed as an epochal moment for the world’s second-largest economy.
“After the Third Plenum, there were a lot of great expectations — albeit unrealistic — that the state was finally going to retreat and the market would thrive,” said Jane Golley, head of the Australian Center on China in the World at Australian National University, referring to the meeting by its official name.
But today, just a year before the event’s 330-plus major reforms are scheduled to be completed, the Third Plenum symbolizes the gap between Chinese promises and performance. It also shows how Trump’s hopes of winning genuine structural changes in China’s economic model are colliding with the entire thrust of Xi’s rule, which has been all about bolstering Beijing’s role in the economy while preserving Communist Party control.
Securing Xi’s assent to abandon the economic model that lifted China from Maoist impoverishment to become the world’s fastest-growing major economy would crown Trump’s confrontational diplomacy with success.
But few analysts anticipate such an outcome.
China has made genuine progress in only two of the 10 areas where it has promised reforms: innovation and environment. On labor, land, fiscal affairs, competition and state-owned enterprises, it has regressed, according to an analysis by Rhodium Group for the Asia Society Policy Institute.
Reforms of the kind that Xi envisaged in 2013 — and that Trump wants now — are hard for the party to push through as the economy slows. Growth decelerated to 6.4 percent last year, and a state-run paper this week warned it could sink to 6 percent in 2019.
“Xi wants to steer the economy toward a high-tech and dominant position,” said Barry Naughton, an expert on China’s economy at the University of California at San Diego. “But when it comes to paying any kind of cost in terms of reduced growth rates or, even worse, any kind of economic turbulence, he seems quite ready to step back.”
In 2016, China halted a key financial liberalization and restricted outflows from its capital account, apparently spooked by an outflow of nearly $1 trillion, the erosion of its foreign exchange reserves and a weakening currency.
Negotiators are racing the March 1 deadline Trump set for a “comprehensive” deal that includes more than just amped-up Chinese orders for U.S. farm, energy and industrial goods.
But it is not clear how committed Trump is to that goal. Some of the administration’s China hawks fear the president, worried about the impact of a prolonged trade dispute on U.S. financial markets and economy, will settle for something less than fundamental changes in China’s economic model.
Chinese negotiators appear to be hoping Trump will do just that and settle for large purchases of U.S. soybeans and liquefied natural gas to narrow the $375 billion U.S. trade deficit with China.
One of the main points of contention in the protracted trade discussion has been the role of China’s state-owned enterprises.
Rather than empower the market, as he promised in 2013, Xi has lavished aid on state companies. That’s been especially true in strategic sectors such as aerospace, energy, heavy industry and telecommunications.
“Xi is a modernizer more than a reformer,” said Michael Hirson, Eurasia Group’s director for China. “He wants to modernize the tools the party uses to stay in power and keep China on its trajectory of being a stable, rising power.”
As a result, state-backed companies continue to enjoy preferential access to astonishing amounts of credit.
Less than a month after Xi toured northern regions last year, Chinese banks extended a $144 billion credit line to FAW Group, the state-owned maker of the iconic Red Flag cars favored by Communist Party leaders since Mao Zedong.
“A fundamental issue remains the Xi administration’s belief that the political value of maintaining SOE dominance still outweighs the economic costs,” said Wendy Leutert of Harvard’s Fairbank Center for Chinese Studies, referring to state-owned enterprises.
State companies are now growing faster than private companies for the first time since Deng Xiaoping launched China’s economic reforms four decades ago, said Nicholas R. Lardy, an economist with the Peterson Institute for International Economics.
“[Xi] decided party control was more important than economic growth,” said Lardy.
The results have contributed to China’s economic slowdown. Resources poured into state companies have rewarded inefficiency, acting as a drag on China’s performance. Even as state companies bulked up via mergers, their return on assets fell from 6 percent in 2005 to less than half that figure by 2017, according to Lardy.
Within key industries, the iron nexus linking Communist Party officials at the helm of major state-owned enterprises, state banks, regulatory agencies and provincial and municipal governments have kept private-sector companies — Chinese and foreign — at a disadvantage, according to Craig Allen, president of the U.S.-China Business Council.
After years of promises, China this year began loosening limits on foreign participation in its financial services industry. Regulators lifted the cap on foreign stakes in securities firm, mutual fund companies and insurers, answering repeated U.S. demands. But Allen said more is needed.
“It’s really late, and it’s much less than we bargained for” when China joined the World Trade Organization in 2001, he said.
U.S. officials complain that Chinese authorities funnel generous subsidies via state banks to government-owned companies while bureaucrats craft regulations that discriminate against their foreign competitors.
Under China’s state-led system, foreign companies are often required to surrender proprietary technology before being allowed into the market, and hackers working for the state pilfer trade secrets from their corporate computers.
Getting China to agree to stop doing this will be close to impossible, analysts say, because Beijing flatly denies that it happens.
When it comes to intellectual property rights protection, another key issue for the United States, China is likely to make promises, analysts say. But how to make sure these agreements stick is tricky.
But the biggest factor holding reforms back might be Beijing’s belief that its industrial policy is indeed giving it an advantage, said Naughton of the University of California. “They think that one of the motivations for the U.S. to be so aggressive in recent months is that the U.S. also thinks China’s industrial policy plans are working.”