The CCP Reforms The Business Practices Of Local Governments

A near standstill in new capital spending has begun to worry the Chinese Communist Party (CCP). It should. Without capital spending by business, China’s productive capacities will stagnate, and the economy will struggle even more than it already is. Government orders to state-owned businesses has increased their capital spending, but that is not enough. China needs an expansion of the private business sector – about 60% of the economy – as well as foreign investment inflows. Private capital spending from domestic sources is barely above zero, while foreigners are largely avoiding China.

To help remedy these shortfalls, the CCP has issued new guidelines to radically reform the way local authorities deal with businesses. The new rules will certainly alter the behavior of local governments, but it is not at all sure whether the new approach will achieve the goals set by the party.

Local authorities in China have long used a wide range of benefits to encourage capital investment by Chinese-based and foreign-based businesses. These included tax exemptions and tax reductions in the early years of production. Some local governments have offered rent free space for offices and production. Some have offered subsidies to prospective companies or loans payable over sometimes very long periods. Some localities through local sourcing laws have offered protection from competition by firms in other regions or overseas. These practices, the party planners have asserted, open too many opportunities for corruption, create what the planners describe as “market fragmentation,” and are an impediment to “high quality economic development.”

Speaking for the authorities in Beijing, the government-owned publication, Economic Daily, has demanded an end all selective and differentiated financial rewards, especially tax incentives and subsidies. Ridding the investment environment of such practices, the party planners assert, will foster a “unified domestic market” and curtail the investment impediments imposed by uncertainty. Amid the usual feel-good language of such missives, references to “new horizons” and the like, the new guidelines want “standardized tax incentives.” They insist, not unreasonably, that the best way for localities to foster capital investment spending is by providing better government services and a fair, transparent, and predictable business environment.

The reforms possess several virtues. Giving local authorities less discretion on matters of subsidies and taxes will close many avenues for corruption. Insisting on a transparent and predictable business environment can only reduce business risk and so encourage business to spend on expansion and modernization. Other aspects of these reforms, however, raise questions. Uniform practices across all regions could impede the ability of local governments to create business clusters to which the planners allude that are best suited to their region and by nature are different from other regions. Strictures against the protections of buy-local laws may force these local authorities to go back on earlier promises and in so doing undermine the trust between these local governments and the broad business community.

Whatever the effect on China-based producers, these reforms are not likely to have much impact on foreign-based businesses. The foreign reluctance to invest in China has little to do with the practices of local governments. Rather it reflects a determination of western and Japanese businesses to improve the security of their supply chains by diversifying away from what had been an almost exclusive reliance on Chinese sources. Separately, this reluctance also has something to do with staffing costs in China that are rising faster than elsewhere in Asia. Also having effect is the rise of uncertainties stemming from Beijing’s seeming obsession with security as well as the anti-China hostility in Washington, Tokyo, London, and Brussels. Even the most effective reforms at the local level can have little effect on these considerations.

These reforms are certainly worth a try. Since the old practices have long since lost their effectiveness, the planners have little to lose with a new approach. As a broad remedy for China’s deep financial and economic problems, however, local government reforms offer a small part of what is needed.