All Eyes on China

This week’s other big election kicked off Thursday, when the Chinese Communist Party opened its 18^th National Party Congress—the venue where party members select the next generation of leadership.

And right in time, October economic data suggest economic growth is rebounding. Industrial production grew 9.6% year over year, retail sales grew 14.5% and electricity output—a key indicator—jumped 6.4%. Fixed asset investment for 2012 (year to date) rose to 20.7%, suggesting recently announced fiscal stimulus is flowing more to the broader economy, and inflation cooled to 1.7%, giving officials room to further loosen monetary policy as needed. Overall, it appears leaders will meet their goal of boosting growth during the undemocratic transition, and the economy should enjoy the fruits of their efforts for a while.

Longer-term, the key issue is how a leadership change will affect Chinese economic policy. The outgoing leadership accelerated financial reform this year, building out China’s corporate bond market, lowering barriers to foreign investment, expanding domestic equity investment options and taking steps toward deregulation in some industries. It wasn’t a full free-market push—this is China—but it likely did help expand private firms’ access to credit, addressing a key problem area. But these were only baby steps toward economic liberalization. To remain on a sustainable long-term growth path, China will need many, many more reforms.

Whether this happens will depend largely on the makeup of the Central Politburo’s Standing Committee (PSC), which makes all policy decisions. PSC appointments are brokered through backroom deals where retired leaders exert considerable influence, and at this week’s congress, President Hu Jintao and his predecessor, Jiang Zemin, are duking it out over whose protégés will get more seats.

Jiang, who rose to prominence during Tiananmen (he was, shall we say, decidedly not on the side of the students), is a conservative hardliner. Having joined the party in the 1940s—before the founding of the People’s Republic—he skews to the party’s left, though he supported Deng Xiaoping’s initial economic reforms. He’s also brought many of the party’s so-called princelings—the high-profile children of the original party elite—under his wing, creating a strong conservative faction (including, once upon a time, Bo Xilai). Hu, by contrast, is from the party’s Youth League, the members who worked their way up and tend to be more open to continued economic reform.

Hu and Jiang have wrangled behind the scenes for years. In fact, one such power struggle determined Hu’s and outgoing Premier Wen Jiabao’s successors. Hu wanted Vice Premier Li Keqiang, a Youth Leaguer and political reformer, to inherit the presidency, but Jiang preferred Vice President (and princeling) Xi Jinping. Jiang—by all accounts more powerful and influential than Hu—won. Xi will likely be the next President and Li the next Premier.

Of course, that’s not news—the change was widely telegraphed years ago. The incoming PSC’s makeup, however, appears murkier. Hu expanded the PSC from seven to nine members when he became Party General Secretary in 2002 to settle another power struggle with Jiang, who wanted to stack the group with his conservative protégés. Then, Hu accepted Jiang’s appointees but added two seats for his Youth Leaguers. Now, party leaders want to revert to seven seats to increase efficiency—the PSC governs by consensus, and consensus likely comes faster to seven people than nine. But fewer seats also means the wrangling between Jiang’s and Hu’s factions is much more heated. Leaders reportedly brokered a provisional power sharing deal at a secret seaside meeting over the summer, but leaks from Beijing suggest Jiang’s pushing hard to overturn that accord and oust two of Hu’s top picks, Wang Yang and Li Yuanchao—two men widely considered likely to drive Chinese economic liberalization.

Whether Jiang is successful won’t be clear until the new PSC takes the stage November 15. Either way, Chinese economic policy shouldn’t go backward. Even without Wang and Yuanchao, reformers will have a voice in the PSC. Xi may be Jiang’s preferred successor and hold a doctorate in Marxism, but he also saw Mao Zedong purge his father from party leadership, and he, like the Youth Leaguers, spent his childhood toiling in the fields before working his way up. He’s also held leadership posts in Fujian and Zhejiang provinces, testing grounds for many of China’s economic reforms. He’s seen the benefits of liberalization firsthand. Li Keqiang, Wang Qishan and Zhang Gaoli have also historically favored economic reform. Hardliners like Liu Yunshan, Zhang Dejiang and Yu Zhengsheng likely can’t drive policy.

Any changes will, however, be painstaking. The consensus approach ensures this—groups embrace change at a glacial pace. For example, the current administration had a very strong political and economic reformer in Wen Jiabao, but his was a lone voice (and occasionally censured). The consensus was far less eager for change. Officials likely only expanded corporate financing this year because private firms’ inability to access credit was a such a glaring problem, garnering heavy media attention and compounding the government’s engineered slowdown. Plus, each incremental move toward financial liberalization weakens the state’s control over the economy—something leaders are loath to do, considering their political power’s closely tied to their economic power. And as time passes, judging from past behavior, every growing pain China experiences—and every threat of a global slowdown—will likely heighten the call for more state control over the economy, as we witnessed in 2008.

The PSC selection is an intriguing political event, and we’re keen to see who makes the cut. But regardless of the final lineup, China’s ongoing economic liberalization likely remains slow-going, with many fits and starts.