The future is in their hands

China's new leaders have a long journey ahead, and they need to take public with them

Xi Jinping's first official trip after being elected Party chief could turn out to be a good indicator of his policy focus. He went to Shenzhen and Guangzhou, the scene of Deng Xiaoping's symbolic and famous journey in 1992 which pushed China back onto a path of successful reform. To emphasize the message, Xi even laid a wreath in front of Deng's statue in Shenzhen, and planted a tree nearby. Since the Party Congress in November, a sense of anticipation has been created by the positive signals emanating from Xi, and Li Keqiang, elected president and premier last week.

What lies ahead?

The first priority is to create a foundation for sustainable, long-term economic growth which does not depend on continuous and massive infrastructure spending by the state, and which loosens the grip of the state-owned sector on the economy. The new government should take steps to introduce more competition into the economy.

Most economic sectors - telecoms, banking and other financial services, upstream and downstream petroleum, auto and aerospace - should be fully opened up to domestic and foreign competition. Incumbent state-owned enterprises and their parent ministries will naturally resist increased competition, arguing that lowering entry barriers in key economic sectors will damage state security and reduce safety standards, harm profitability and limit the employment capacity of the SOEs. But if the government puts a well-considered, strong and fair regulatory system in place for each major sector of the economy, there's no reason why consumer safety or national security should be endangered by introducing more competition.

The potential economic benefits for China of greater competition are huge and well documented. You only have to look at the United States and Europe from the 1970s to see how the dramatic economic and social impact from increased competition brings more consumer choice, lower prices and faster economic growth. An SOE which learns to compete will end up making much more money in a competitive world than it did when it dominated a restricted market. The reason? Markets with a number of strong competitors grow much faster than markets with a few dominant players, because dramatic price reductions, continuous product improvement and good marketing attract customers, who spend more.

Market revenues multiply, and successful companies make more money because their sales grow much faster, while good cost control preserves margins. A falling consumer savings rate provides a powerful, long-term underpinning to economic growth. Corporate profits and the government's take from corporate and sales taxes increase. Greater competition spurs product innovation, and this meets a major long-term goal of Chinese policy.

If a state-owned company can make adjustments to compete successfully in an open marketplace, SOE privatization need not necessarily be part of this liberalization process. In theory, a company owned by the state can compete with foreign or private companies without changing its ownership. In fact, though, much historical evidence shows that government bureaucrats do not manage companies as well as professional managers do. Often, the true reason for limiting competition is to protect the state sector at the expense of consumers and the economy as a whole. If the economy becomes more competitive, the government may find itself reducing its ownership in many SOEs to minority stakes of 30 percent or less, in order to improve operating efficiency.

If the new government makes a start by improving competition in most economic sectors, consumers will quickly start to benefit. This benefit for consumers will bring the support of the general public to the government's reform program. Strong public support is essential to a sustained reform process.

Tax changes sound unspectacular, but they are fundamental to the corruption battle, as well as to the strength of government finances. The dependence of local government revenues on land sales encourages corruption. Land developers bribe local officials in order to pry valuable greenfield sites away from farmers and villages, by way of compulsory purchases and official relocation demands, both of which are sometimes unfair and lead to social unrest.

Local governments in China need to change their revenue base, to reduce the importance of selling land, and to increase recurring income from local taxes which are fairly assessed and administered, starting with taxes on property ownership, and continuing with local value added taxes, like those levied in certain US states. At the central level, the revenues from business tax need to be gradually augmented by value-added tax, with financial support in place for those poorest members of society who are disproportionately affected by sales taxes.