From the economy to judicial reform, China is settling into a ‘new normal’

What are some of the highlights of this year’s meetings of the National People’s Congress and the Chinese People’s Political Consultative Conference? First, the economy. The rate of real GDP growth held steady at 6.7 per cent in 2016. This year, the target is “around 6.5 per cent”. The macroeconomic situation has begun to stabilise and the economy has essentially entered the horizontal part of the L-shaped recovery, at a flat but high rate of growth that is still the envy of the world.

The inflation rate, as measured by the consumer price index, remained tame at 2 per cent. Retail sales have continued to grow at 1½ times the rate of growth of real gross domestic product. Net exports are only 3 per cent of GDP. China can readily survive a trade war, since it is no longer as dependent on exports as it used to be.

All of this means that the transition of the Chinese economy to a “new normal” is well under way and that the goal of achieving a “moderately prosperous” society by 2020 is within reach.

Two key indicators point to growing stability in China’s economy

The unemployment rate remained low at about 4 per cent. More than 13 million new jobs have been created each year since 2013. Many of these new jobs are in the service sector, which has been growing faster than the manufacturing, mining and construction sectors, and accounted for 51.6 per cent of GDP last year.

The renminbi exchange rate has also stabilised when measured against the exchange rate of a trade-weighted basket of currencies. The US dollar will continue to be the strongest currency in the world in the next year or two. However, it does not make sense for the renminbi to follow the US dollar slavishly. Chinese exports to the US constitutes about a fifth of total Chinese exports. If the renminbi follows the US dollar in lock-step fashion, it will imply increasing Chinese export prices for all of China’s other trading partners, simply because the US dollar has appreciated.

By using the exchange rate of a trade-weighted basket of currencies as a reference, when the US dollar appreciates against most other currencies, the renminbi will also appreciate, but to a lesser extent. This implies that the renminbi will devalue relative to the US dollar. When the US dollar eventually devalues against most other currencies, say in a couple of years, the renminbi will also devalue, but to a lesser extent, and thus will appreciate relative to the US dollar. The net result is that the volatility of the renminbi will be less than that of the US dollar, when viewed from the perspective of a third currency, thus making the renminbi more desirable as a store of value.

There is also no compelling reason for the renminbi to undergo a significant devaluation relative to all other currencies, as China still has a large trade surplus of about US$600 billion a year.

Given all the excess production capacities in China, aggregate supply is not a constraint. As long as there is demand, there will be supply. The Chinese government has many instruments at its disposal and can act quickly to increase aggregate demand if necessary. While problems may arise from housing price bubbles and non-performing loans, they all appear controllable. A hard landing is unlikely.

China’s central bank chief plays confident, longer-term game on yuan stability

Supply-side structural reform, intended to increase the efficiency in the use of capital, is a worthy but long-term effort. Similarly, letting the market play a more decisive role is also a long-term effort.

However, there is a paradox: in order for the market to play a more decisive role, the central government must also play a more decisive role. This is because the current excess production capacities in many industries were the result of investments supported by different local governments practising different forms of protectionism. The local governments would not want the market to play a decisive role because that might mean bankruptcies, closure of factories, loss of GDP and rising unemployment in their own jurisdictions.

Only a strong and determined central government can curb local government intervention and enable the market to play a decisive role in the resolution of the “zombie enterprises”. Thus, re-centralisation may be necessary until both governmental and market discipline can be firmly established. Decentralisation will make things worse rather than better.

Death by a thousand job cuts: the human cost of China’s zombie firms

In the current 13th five-year plan, the only mandatory targets are in the areas of the environment and poverty alleviation. According to the work report of the National Development and Reform Commission, much progress has been made on the environmental front. Energy consumption, carbon dioxide emissions, and water consumption per unit of GDP have all been declining over the past five years, cumulatively by 23 per cent, 29 per cent and 33 per cent respectively. Environmental preservation, protection and restoration can create significant aggregate demand directly and indirectly. The Chinese commitments in the Paris agreement on climate change have the same effect.

More generally, public goods consumption can take up the slack in aggregate demand caused by a fall in gross fixed investment. Furthermore, public goods can effectively reduce the inequality in real income distribution, since, for example, the same air is breathed by both the rich and poor. However, in many urban areas, smog is a serious problem which will take time to solve.

Progress has also been made in poverty alleviation – 12.4 million people were lifted out of poverty last year. Another 10 million are expected to be lifted out of poverty this year. The goal is to eliminate poverty completely in China by 2020. At the current rate, it looks quite feasible.

Why the early success of China’s supply-side reforms may not last

Second, we also learnt about encouraging developments in judicial reform from the work reports of the Supreme People’s Court and the Supreme People’s Procuratorate. The reports reiterated the government’s zero tolerance for corruption in the judiciary. Lifetime responsibility of the judges for their judgments and mandatory registration of any contacts with them by other officials, as well as the ongoing anti-corruption campaign, have all helped deter and reduce judicial corruption significantly.

One indicator is that the number of people from the provinces who visit Beijing to appeal against unjust or unfair judgments (shangfang) has steadily declined – by 25.1 per cent in 2014, 12 per cent in 2015 and 9.8 per cent in 2016.

The establishment of cross-administrative-district courts and the practice of change of venue, both of which have the effect of reducing the influence of local government officials on the courts, are also important factors. The hope is that, eventually, this can lead to the establishment of courts that transcend provincial boundaries.

Both the Supreme People’s Procuratorate and the Supreme People’s Court have worked hard to reinvestigate and retry cases of potential wrongful conviction. One person wrongly convicted of rape and murder and sentenced to death had his case reopened, retried and was found innocent. State compensation for this person is pending. In another wrongful conviction case, the victim was offered state compensation amounting to 2.75 million yuan (HK$3.1 million). All of this helped to increase confidence in and respect for the judiciary and the judicial system.

The prosecutors and the judges have also been getting tough on environmental violators. A firm was fined almost 22 million yuan for flouting the established standards and polluting the air. These large fines should hurt and should deter potential violators.

In addition, Michael Jordan successfully pursued a case of trademark infringement by a Chinese sports goods company that used his phoneticised name in Chinese. The verdict, which reversed the lower-court rulings, demonstrates the determination of the Chinese government to protect intellectual property rights.

Watch: Michael Jordan wins rights to his name in China

However, a common complaint is that the fines and compensation are too low and insufficiently punitive to serve as an effective deterrent to patent, trademark and copyright infringements.

In another improvement, the Supreme People’s Procuratorate is trying to ensure that investigations are speedily completed. In 2013, the number of people held in custody for over three years but had not been charged was 4,459. It declined to six in 2015 and to zero in October 2016. However, while the prosecutors’ office should be congratulated, it should not be complacent. To hold people in custody without any charge for even three months is too long. Additional efforts in this direction are welcome.

Another noteworthy development is the legislature’s adoption of the draft general provisions of civil law. This is a prelude to the systematic codification of China’s civil laws. In the draft, in addition to natural and legal persons, non-profit and non-corporate civil entities are also recognised to have legal standing. The rights, including property rights, of individuals and other entities are explicitly defined. These principles govern the interactions and exchanges in a civil society, applying not only to the relationships among individuals and civil entities, but also to the relationships between the state and individuals and other civil entities.

The civil law is another step towards the full implementation of the rule of law. It should contribute to promoting a harmonious society in China.

Lawrence J. Lau is the Ralph and Claire Landau Professor of Economics at the Lau Chor Tak Institute of Global Economics and Finance, the Chinese University of Hong Kong