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Will the Third Plenum Redefine the Role of Local Governments in China?

by | November 5th, 2013 | 12:45 pm

One of the most important breakthroughs of the third plenum could be a change in the role of local governments in the Chinese economy. Since Xi jinping and Li Keqiang took office their most prominent initiatives have been: (1) redefining urbanization (新型城镇化) (2) changing the function of government (政府职能转变) (3) maintaining an appropriate pace in order to improve the quality and effectiveness of growth (坚持正确速度观 实现有质量有效益增长). All these issues are an assault on the way local governments have functioned in China for the past decade.

Local governments played a key role in the last decade of urbanization in China. Without a market for rural land, local governments act as brokers between farmers and developers. Their commission fees – land transfer fees – then helped fund the buildup in city infrastructure. Hukou restrictions allow local governments to focus on infrastructure, while skimping on the services for the 200 million migrant workers flooding into the cities. The Xi and Li administration are now talking about changing this. Rural land reform has been talked about prominently in the press and is number three on the State Council Development Research Center’s 383 reform plan.

Changing the function of government is also a direct assault on local government’s role in industrial planning. Much of China’s problems with overcapacity have been driven by local governments taking an active role in supporting local companies either in financing, land concessions, administrative fees, or other forms of subsidies. Today, the National Development and Reform Commission (NDRC) and the Ministry of Industry and Information Technology (MIIT) came out urging local governments to comply with the State Council’s recent guiding opinion to tackle overcapacity in steel, flat glass, cement, electrolytic aluminum and shipbuilding. Changing the role of government is top on the 383 reform plan agenda and has been top on Li Keqiang’s agenda since he took office in March. This year the State Council has progressively reduced administrative approvals for many projects. This will give companies more freedom to invest and build their business without requiring as much local government or ministry involvement.

Finally the Xi and Li administration has made clear that local governments should look to the quality of growth over the quantity of growth.  They have made great pains to ensure that growth does not return to double digits by resisting the temptation for large-scale stimulus. Even after a modest rebound in growth in the third quarter few expect China to return to the double-digit growth of the past. Authorities have been very selective in allowing new local investment projects this year. Relaxation on local investment has emphasized specific urban infrastructure projects such as wastewater systems  – most of which are already in the 12th five-year plan. Few have noticed that fact that many of the growth rates released by regional governments – historically known for being inflated – are actually more in line if not slower than national rates now. For example, Sichuan’s GDP growth rate actually continued to slow in 3Q12 even as national output rebounded.

The interesting question will then be what is the new role of local governments? What we are seeing so far is a much greater emphasis on public services. Earlier this year a guiding opinion called for strengthening the provision of public services. To help fund these services the central government has mulled over the expansion of property and resources taxes.  But there is a question as to whether this will be enough to support the onerous burden of local government in social spending and infrastructure. A bolder move would be for the central government to directly take on the national health care and pension systems, freeing local governments to focus on education and running infrastructure. Right now the new role of local governments remains unclear. We may see a clearer picture begin to emerge in the weeks and months following the third plenum this weekend.

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