A practical guide to 3rd Plenum’s Decision for investors and business leaders

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Last week, the 3rd Plenum of the Communist Party of China’s 20th Central Committee concluded, with a much anticipated “Decision” on further deepening reform and pushing for Chinese-style modernization (the “Decision”). The final detailed version of the Decision was made public last Sunday.

So far, it has been met with mixed reactions. Some observers might have the impression that the long, 22,000-Chinese-character document amounts to a nothing-burger. I think such a reaction is understandable, especially for someone who is removed from the internal logic and context of policy-making in China. There are 300-something decisions, so it could seem overwhelming. Yet, not all decisions are created equal, and important ones are buried in cliche ones, so it might seem underwhelming at the same time. At the same time, different parts that are logically interconnected may be spread out in different corners, so it may not be easy to spot the “hidden” common themes.

My job today is to tell you why, from the perspective of an entrepreneur, I think the Decision has lived up to (and in some places even exceeded) the expectations. My analysis will revolve around 5 areas that I think the Decision has the most impact on, in the order of my own perceived importance:

1. fiscal reform

2. demand side

3. total factor productivity

4. entrepreneurship

5. market economy

Before I start, one thing we need to bear in mind is that this type of document should not be treated as a working plan that can go straight into implementation. It’s a top-level document setting goals and standards for the later years (in this particular case, there is a deadline of implementation by 2029). There are 300-something decisions in this paper, and one of them comes in the form of only one sentence, so it could be hard to decipher the specifics just by looking at this one sentence. But you should treat each sentence as sort of the title of a whole set of more detailed implementation plans to be prepared by different ministries and bodies.

In this article, the translations of relevant clauses in the Decision are directly taken from

Ginger River Review

, by Xinhua Journalist

Jiang Jiang

who burnt some midnight oil last Sunday to quickly translate it.

Fiscal reform: re-alignment of central-local government relationship

Without a doubt, this is the single most important part of the Decision. I explained the context for it 2 weeks ago in my personal newsletter

China Translated

, in which I argued that China’s local governments are facing a real debt crisis, that despite a well-financed central government and a generally healthy consumer sector, local governments (and the whole real estate sector that their finances depend on) become a real drag on the Chinese economy and risk bringing the whole economy into a deflationary spiral.

This is what I wrote:

Our current problem can thus be very simply summarized as a lack of aggregate demand. Households are not spending as desired, but producers keep producing, leading to higher trade barriers so foreign buyers may only buy less. At normal times, the government should step in to spend more in order to stimulate demand. But in our case, (local) governments themselves are facing a financial problem, and thus have no resources to spend. (And even when they have the money to spend, they tend to spend on production, not consumption.) It is already tough just to maintain an adequate level of spending, and to achieve that it already involves tougher law enforcement action, which can only inhibit demand even more. A vicious cycle is thus formed.

…

We have a central government that is rich. Our people are also “rich” in cash but cautious about spending. The real missing link here is the “poor” local government. If we can’t solve local governments’ fiscal situation, the one systemic defect will threaten to make the whole economy ground to a halt.

I think the significance of this point is still far under-appreciated by outside commentators, probably because China’s central-local government structure is quite unique in the whole world.

For several millennia, the central-local relationship has been at the very core of China’s political economy, a powerful force behind prosperity and poverty, stability and chaos, war and peace, and the rise and fall of dynasties. One could also argue that it’s the fiscal decentralization of the 1980s that caused large government deficits and hyperinflation that eventually set the main stage for the political crisis of in the late 1980s. Then, it was the 1994 Tax-Sharing Reform that centralized fiscal resources but also led local governments to a then novel revenue model dependent on land sales, leading to the rapid rise of China’s real estate sector and infrastructure buildup.

Clearly, you won’t understand China unless you appreciate the importance of the issue of central-local government relations. Any reform program at this point in time that claims to be real and sincere will need to tackle this issue front and center.

And front and center it does. I believe here, the Decision has lived well up to expectations, signaling a clear decision for the central government to shift more fiscal resources to local governments while shouldering more responsibilities. The most important clauses include:

提升市县财力同事权相匹配程度。

These will help ensure that the fiscal resources of prefecture- and county-level governments are commensurate with their powers.

推进消费税征收环节后移并稳步下划地方，完善增值税留抵退税政策和抵扣链条，优化共享税分享比例。研究把城市维护建设税、教育费附加、地方教育附加合并为地方附加税，授权地方在一定幅度内确定具体适用税率。

We will take steps to move consumption tax collection further down the production-to-consumption chain, with the power of collection steadily being passed to local governments. We will improve the value-added tax credit refund policy and free up the channels for making tax deductions. The ratio for taxes shared between the central and local governments will be optimized. We will look into rolling the urban maintenance and construction tax, education surcharges, and local education surcharges into one single local surtax. Local governments will have the authority to set the rate for this tax within a predetermined range.

规范非税收入管理，适当下沉部分非税收入管理权限，由地方结合实际差别化管理。

In regulating the management of non-tax revenue, we will delegate, as appropriate, some management authority to local governments and allow them to tailor their practices to local conditions.

Concurrently, the Decision also addresses many loopholes that local governments exploited to gain “shadow” finances. In this regard, power has been more centralized. This simultaneous centralization of power and de-centralization of resources are logically connected: Only when the central government can be assured it stays in control and can always see the complete picture, can it comfortably allow more fiscal resources to stay at the local level:

健全预算制度，加强财政资源和预算统筹，把依托行政权力、政府信用、国有资源资产获取的收入全部纳入政府预算管理。

We will further improve the budget system and strengthen unified management of all fiscal resources and budgets. All revenues generated on the basis of the exercise of administrative power, government credit, and state-owned resources and assets will be placed under government budget management.

规范招商引资法规制度，严禁违法违规给予政策优惠行为。

We will bring local regulations and institutions for attracting investment under regulation and strictly prohibit policy incentives in breach of laws and regulations

The latter clause about prohibiting “policy incentives” is quite notable. It addressed a prevalent situation in China, where local governments used all sorts of tax rebates and incentives to compete for businesses to be set up there, putting long-term strains on local finances, creating an atmosphere of over-investment (and over-capacity) into the same sector, defying the goal of setting up the “unified national market” and ultimately is a waste of resources and a fiscal “tragedy of commons”.

Demand side: rural-urban relations, real estate and social welfare policies

Demand-side reform is also something observers have kept a close watch on.

Although the word “demand” did not appear that often in the Decision, I believe it’s actually intimately connected with many important parts of it.

[The rest of the article about the Decision’s impact on domestic demand, total factor productivity, entrepreneurship and overall market economy is reserved for paying members of Baiguan. Please subscribe to access it. Paying subscribers also enjoy access to our Discord community]