Local Governments in China to Take a New Approach to Investing

With very little fanfare, Beijing has issued guidelines to local governments on how to spur business investment in their region. Whether the effort will bear fruit is an open question.
A paucity of capital spending in China has caught the attention of the Chinese Communist Party (CCP). Well, it should. Without capital spending by businesses, China’s productive capacities will stagnate, and the economy will struggle. Government orders have increased such spending among state-owned enterprises, but that is not enough. China needs an expansion of the private business sector—about 60 percent of the economy—and foreign investment inflows. However, private Chinese businesses have shown extreme caution, while foreign investment monies are avoiding China altogether.
To remedy these unwelcome trends, the CCP has enlisted local governments and issued guidelines for radical reform of past practices. The information available will certainly alter local governments’ behavior, but it is not clear whether the new approach will achieve the Party’s goals.
Previously, local authorities in China encouraged capital investment by Chinese- and foreign-based businesses through a wide range of benefits. These included tax exemptions or tax reductions in the early years of production. Some local governments offered rent-free space for offices and production. Some offered subsidies to prospective companies or loans payable over sometimes very long periods. Some localities, through local sourcing laws, offered protection from competition by firms in other regions of China or overseas. These practices, the CCP 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.”
As outlined in the state-owned publication Economic Daily, CCP planners want local governments to end all selective and differentiated financial rewards, especially tax incentives and subsidies. Ridding the investment environment of such practices, the planners assert, will foster a “unified domestic market” and curtail the investment impediments imposed by uncertainty. Amid the usual feel-good language of “new horizons,” the new guidelines want “standardized tax incentives.” They insist 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.
Giving local authorities less discretion on matters of subsidies and taxes will close many avenues that have facilitated corruption in the past. Insisting on a transparent and predictable business environment can only encourage businesses to take risks and accordingly advance the planners’ goals.
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 different from other regions. At the same time, 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.
However well or poorly this mix works on China-based producers, they are unlikely to have much effect on foreign-based business. The foreign reluctance to invest in China has little to do with the practices of local governments. Rather, it reflects a determination by Western- and Japanese-based 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 reflects rising staffing costs in China compared with elsewhere in Asia. Also having an effect is the rise of uncertainties stemming from Beijing’s seeming obsession with security and the anti-CCP hostility in Washington, Tokyo, London, and Brussels. Even the best reforms at the local level can have no effect on these considerations.
The planners’ reforms are certainly worth a try as a policy experiment. Since the old practices have long since lost their effectiveness, the planners have little to lose with a new approach. However, as a broad remedy for China’s deep financial and economic problems, local government reforms can constitute only a small part of what is needed.