China/Hong Kong Market Pulse: Symbolism at Play Approaching the Third Plenary Session China/Hong Kong Market Pulse: Symbolism at Play Approaching the Third Plenary Session China/Hong Kong Market Pulse: Symbolism at Play Approaching the Third Plenary Session

China/Hong Kong Market Pulse: Symbolism at Play Approaching the Third Plenary Session

Macro 7 minutes to read
Redmond Wong

Chief China Strategist


"You know my method. It is founded upon the observation of trifles."

- Sherlock Holmes in Conan Doyle (1891) The Boscombe Valley Mystery


Key Points:

  • A new institutional economics professor’s appearance at Xi’s consultative carries symbolism
  • China's success is attributed to institutional reforms, not just low-cost labour.
  • Reforms lower system costs, boosting competitiveness and economic growth.
  • Current challenges include rising system costs, stifling economic progress.
  • The upcoming 3rd Plenary Session could somewhat echo the reform decision ten years ago

A Notable Symbolism in Xi's Consultative Meeting on May 23

As China's leadership prepares for the long-awaited Third Plenary Session of the 20th Central Committee, announced on April 30 to be held in July, a consultative meeting on May 23 with private entrepreneurs and economists, chaired by General Secretary Xi Jinping, has stirred speculation that the top leadership might be preparing the country for a shift towards more pro-market reforms.

In recent years, communications from the Chinese leadership have predominantly emphasized the state sector and industrial policies. These industrial policies are state actions meant to allocate resources in support of selected industries to achieve goals determined by political processes with significant political stakes. While the focus on industrial policies will continue to be the core pillar of China’s development strategies, the inclusion of economics professor Zhou Qiren as one of the nine selected speakers at the consultative meeting suggests that the top leadership might make use of his market-oriented views and the symbol he carries to send a signal.

Zhou contends that the drastic fall in transaction costs, organization costs, and most importantly system costs was the primary driver of China's astonishing growth rate in the three decades since its reform and opening started in 1978. He claims that system-wide institutional reforms are crucial for the Chinese economy to regain cost advantages and achieve breakthroughs, rather than relying on aggregate demand stimulus and industrial policies.

While we caution against putting too much weight on Zhou himself or academia in general regarding the Chinese leadership’s deliberation on economic development models, the signalling implication is hard to ignore. Zhou has been absent from the spotlight for quite some time and is well known for his alternative views on the driving forces of the Chinese economy. His new institutional economics roots, which were first popularized by Ronald Coase, emphasize the central roles of institutional arrangements in the economy, property rights, transaction costs, and political economy in economic development. This approach is markedly different from the New Keynesian approach that dominates the mainstream economic profession or the Marxist political economy that the Chinese Communist Party (CCP) maintains as the overarching guiding principle in economic thought.

Furthermore, Xi rarely chairs consultative sessions with private entrepreneurs himself. Over the past decade, besides this recent one, the previous consultative session with the private sector chaired by Xi was in July 2020 during the COVID-19 pandemic, and the one before that was in November 2018 when China and the US were embroiled in a trade war. This time, Xi held the meeting right before the Third Plenary Session, which will formulate the long-term strategic direction and development model of China. The selection of Zhou as a speaker at this meeting carries significant symbolism and could serve to send out signals. What Zhou said at the meeting is not as important as what Zhou is perceived to represent.

What Professor Zhou Represents

According to Zhou, China's economic miracle is not a result of low-cost labour but a consequence of system-wide institutional reform and the opening up of the economy that lowered the ‘system costs’ of China’s economy. Zhou (2017) defines ‘system costs’ as the costs incurred in the operation of the institutional framework of enforcing property rights and contracts. The essence of China’s reform is to “redefine property rights by decentralizing the power of the super state-firm” (Zhou, 2010). The narrative that China's economic success is solely due to cheap labour is overly simplistic. Before the economic reforms, China's labour was even cheaper, but the country did not experience the same economic boom. Today, many countries around the world also offer cheaper labour, yet they do not replicate China's success. This discrepancy underscores that low labour costs alone are insufficient for economic transformation.

As Zhou(2023) points out, the critical factor is the transformation of these inputs into more products that are competitive. This requires effective organization and functioning within a supportive institutional framework to lower transaction costs, organization costs, and most importantly system costs. Before reforms, China's highly centralized economic system, akin to a "super state-firm," was plagued by inefficiencies and high organizational costs. By decentralizing economic control and redefining property rights, China significantly lowered these costs, thereby enhancing its competitiveness. China's initial reforms, such as the shift from collective farming to a household farm production contractual responsibility system, followed by allowing the establishment of private enterprises to absorb the labour freed from farm activities, exemplify the impact of institutional change. These reforms not only increased agricultural productivity but also released labour for the growing industrial sector, creating a foundation for China's manufacturing boom. Moreover, China's opening to and engagement with global markets, highlighted by its economic and regulatory reforms which earned its accession to the WTO, illustrate the importance of institutional support in leveraging low-cost labour.

The problem China is now facing, according to Zhou (2023), is that system costs in China have been rising fast due to dramatic increases in costs incurred by higher taxes and charges, local governments pushing up land prices, and more regulations, as well as inconsistencies in dealing with new technologies in the private sector and the inefficiency of state-driven urbanization. These changes have stifled economic progress. His prescription for the Chinese economy is to lower system costs through reform and opening the economy and to innovate. Reducing system costs through streamlined regulations, greater transparency, and better definition and enforcement of property rights is essential for fostering growth and innovation.

Echoes of the Potentially Transformative 2013 Decision that Peters Out

In our article published in October 2023, we asked if the upcoming Third Plenary Session could mark a pivotal moment for China's economic strategy, potentially embracing pro-market reforms and emphasizing the market's "decisive role" in allocating resources, as outlined in a blueprint unveiled by the Chinese leadership 10 years ago. The “Decision of the Central Committee of the Communist Party of China on Some Major Issues Concerning Comprehensively Deepening the Reform,” adopted at the Third Plenary Session of the 18th Central Committee held in November 2013, pledged to deepen marketization and privatization. However, these initiatives have petered out over the years. The May 23 meeting, as discussed above, gives a glimmer of anticipation that the upcoming Third Plenary Session this July might echo the 2013 Decision, contrary to the downbeat expectations of investors regarding its outcome.

Concluding Remarks

Once again, we want to emphasize that the Chinese top leaders' adherence to focusing on fostering new productive forces, a concept rooted in the Marxist political economy, and their commitment to state-driven industrial policies to boost self-reliance and comprehensive national security, along with their strategic initiatives in deleveraging the economy and containing the monopoly power of large private enterprises, will remain. What we are exploring is the plausibility that the top leadership is sending signals that they are preparing to fine-tune their strategic development model, at least tactically, to foster the market and the private sector. It is important to remember that the Chinese leadership has demonstrated remarkable pragmatism over the past few decades in steering the gigantic Chinese economy. A tactical change to green in the “traffic light” that regulates the reform of the institutional frameworks in which the economy functions is plausible.

We are not predicting what will happen at the Third Plenary Session in July because Zhou spoke at Xi’s consultative meeting on May 23. We are simply exploring what might have happened that made Zhou’s high-profile appearance at the meeting possible. We hope that thinking through this non-consensus observation as one of the possibilities of what has been going on will better prepare investors to interpret the outcome of the Third Plenary Session when it arrives in July.


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