Deregulation

This strategy is Beijing’s latest bid to rejuvenate and develop rural regions through 2022. Rural policy has enjoyed an exalted status since 2004, when, for 14 years, the first policy document issued by the Communist Party Central Committee each year has been on rural issues. However, compared to previous documents that tended to focus more exclusively on agriculture and rural economy, this new document takes a more holistic approach and includes the development of rural governance, environment, culture, and public services as well.

Although many of the goals and approaches in this document are not new, one highlight is the renewed focus on rural residential land reforms. Rural land reforms have progressed in fits and starts over the years. But now with 30% of rural residents already settled in urban areas, vacant land is increasing in Chinese villages. The ownership rights of such rural residential land belong to the rural collectives, but rural residents are given the land for free to build their homes. The size of rural residential land nationally is around 130,000 square kilometers (32.1 million acres), or about 160 square meters per rural resident.

As idle rural land increases, existing regulation continues to forbid the transfer of such idle residential land to residents who aren’t from the village. This makes it difficult, if not impossible, to sell such land. For cash-strapped rural residents, this land is basically a stranded asset that otherwise could be sold to start a business or purchase a new home in urban areas.

Part of this new rural strategy, then, aims to remove some of the existing restrictions. First, rural residents will be allowed to sublease their residential land to people from outside the village. In addition, rural residents will also be allowed to convert their idle residential land for business and industry use, which was previously illegal without government approval.

Second, rural residents can also profit from their residential land by first converting it into farmland and selling the so-called land quota to property developers in urban areas. Previously, farmland quota transactions were geographically restricted and couldn’t take place across regions. In the future, that geographic restriction will be removed, so a village in interior, remote China will be able to sell its farmland quota to developers in coastal cities, which will pay many times more than developers from local cities.

This change is taking place because China has a strict arable land protection policy, which mandates any expansion of urban area to be offset by the creation of new farmland elsewhere. Since the least costly place of creating new farmland is in interior regions, not highly developed coastal areas, it makes sense to allow farmers to more fully use that land for other purposes.

Additionally, a larger share of land sales revenue, which has been a major source of local government revenue, will be used for rural development. Previously, much of that revenue had been spent on urban development.

Beijing’s price reform agenda has two phases. The priority of the first phase, which is now largely complete, was to reduce the scope of administrative price setting. For example, caps on the retail price of natural gas and electricity have been lifted. According to the National Development and Reform Commission (NDRC), the government agency that is still nominally in charge of administrative price setting, the completion of the first phase is manifest in the fact that the catalogue of administrative prices has been whittled down by 80% and 55%, respectively, at the central and local levels. Still, prices such as agricultural water usage and electricity transmission remain administratively controlled.

The latest policy advances the reform into the second phase, which will focus on changing the way that administrative prices are set and adjusted. The goods and services that will continue to be administratively controlled can be categorized into three types. First, in monopolistic or near-monopoly sectors, which include public utilities like power transmission and railway, the price will be set based on a fairly standard cost-plus model. Although such a pricing approach already applies to electricity and natural gas transmission, the latest measure expands this pricing model to the railway sector as well. Given that railway has been a staunchly state-dominated sector, even modest pricing reform that can provide investors reasonable returns will be necessary to attract private investment into this sector.

Second, prices for goods and services that affect the cost of living for average households will also see some changes. This category includes residential electricity and water fees. These prices have traditionally been subsidized or cross-subsidized to ensure even poorer households had access to basic needs. But Beijing, less willing to shoulder such subsidies, now plans to gradually raise these prices to at least cover their cost, with tiered residential water pricing to be implemented nationally.

Third, Beijing wants prices to play a bigger role in incentivizing environmental protection and conservation. To more efficiently allocate environment-related permits, market platforms will be established for renewable energy credits, pollution permits, carbon emissions permits, and acquiring the usage rights of energy and water resources. Such a market trading mechanism will help to reduce the total cost for meeting these environmental targets. For example, polluters that have higher pollution reduction costs can purchase pollution permits from lower-cost polluters on such a platform. This, in principle, should lower the overall cost of pollution mitigation. In addition, Beijing will gradually begin to collect pollution and waste treatment fees in rural areas, which will be used for spending on local environmental protection.

Inadequate property rights protection in China has been a longstanding and well-known problem. Entrepreneurs are hesitant to invest and expand their business for fear of possible expropriation of their assets, while innovators are often discouraged by the potential for intellectual property theft.

This new “opinion” on property rights—which calls for equal treatment for public and private property—is aimed at assuaging both the public and business community about the safety of their assets, both physical and intellectual. For instance, it calls for raising the severity of punishment for violating intellectual property rights.

In addition, the policy urges the government to approach seizing private property with great caution. When a firm’s assets is seized as part of a legal investigation, the owner’s personal assets should be clearly separated and remain intact, according to the policy. It also calls for reopening past cases of property rights violations that may have been mistrials.

To further reassure private entrepreneurs, many of whom have violated laws and regulations in their early hardscrabble years, the opinion states that transgressions committed before the promulgation of related laws should not be retroactively penalized. In other words, this “let bygones be bygones” provision hopes to remove entrepreneurs’ latent fear of potential prosecution for past wrongs so that they can continue to invest in their businesses.

In addition, Beijing will enhance property protections by extending land-use rights after they expire and by revising regulations on state-sanctioned land seizures. In particular, the issue of urban land leasing is addressed. Because all land in China is technically owned by the state, urban households have “soft property rights” in that they purchase land leasing rights for a fixed term, usually up to 70 years.

This system of “good enough” property rights nonetheless begets anxiety among urban home owners who have little certainty over what will happen to their property after the land lease term is up—which is typically counted from the time the home/building is built. They worry that their apartments might get confiscated, which has happened frequently during China’s urbanization process. To mitigate this concern among urbanites, the policy also clarifies that the land lease right will be extended after it expires, even though it offers scant details on the cost of a lease renewal.

Airfare liberalization has now been expanded to long-distance passenger routes. For flight routes less than 800 km or longer distance (>800 km) that also compete with high-speed rail routes, the benchmark ticket price will no longer be determined by an administrative formula.

However, in a given six-months period, airlines can only raise airfares on no more than ten routes, and the cumulative price increase within that period should not exceed 10%. The rationale for this provision is that regulators are worried that this new policy could lead to a one-time large hike in ticket prices and would prefer to spread modest price increases over a longer period.

The salt market has been effectively monopolized by the Chinese state for thousands of years. This policy aims to partially lift restrictions on salt wholesalers and retailers so that they no longer need to operate within specified geographical boundaries.

Previously, China’s one hundred or so salt producers could only sell to an approved and designated wholesaler. Starting in 2017, salt producers can sell to any wholesaler or engage in wholesale business themselves, meaning they can now tap the entire national market. Moreover, the price of salt will be determined by market demand and supply.

However, salt producers will still be regulated, requiring a special license to operate. Thus, this new policy is akin to moving from a monopolistic industry to a somewhat more competitive oligopolistic structure—a modest step toward a market-based industry.

China formally issued its first negative list for market access, which contains 96 barred items in 17 sectors and 232 restricted items in 22 sectors. The list will be first adopted by the existing four FTZs until the end of 2017, when subsequent national adoption will be be complete in 2018. That’s because domestic Chinese firms that have registered in the FTZs are entitled to the same regulatory benefits.

Although the move to a negative list means less onerous approval for starting a new business or investing in projects, companies nonetheless may need to spend more on compliance. If a firm is caught engaging in business activities that are considered restricted on the negative list, the Chinese government is expected to mete out severe penalties. In other words, the onus of compliance for firms and investors has shifted from the approval process to the actual business conduct and operations stage.

Water usage in the agriculture sector accounts for more than 60% of China’s total water consumption. But agriculture water price historically has been kept very low or nearly free as a form of subsidy for China’s large population of farmers. As a low-income cohort, Chinese farmers are particularly price sensitive. So raising water prices can be a delicate political issue, as the central government fears knock-on effects on food price inflation that can threaten a rural household’s livelihood.

But the downside of such a policy is the classic “tragedy of the commons” problem—that is, when property and resource rights are not well defined, it tends to lead to over consumption of limited resources. In China’s case, depletion of an already scarce resource such as water is a serious problem.

To mitigate resource depletion, all rural collectives will now be assigned usage rights for a specific amount of water. If a rural collective does not use up all the water granted under the usage rights, they can trade the usage rights among collectives or sell back to the local government—a concept not so dissimilar from a carbon emissions trading scheme.

In addition, water prices will also be increased to further encourage conservation. To limit the impact of price hikes on farmers, a tiered pricing system will be implemented whereby prices will rise only when water consumption goes above a certain level. For populations where water affordability is less of a concern, such as those in wealthier coastal regions and cash crop farmers, water prices will be allowed to be more expensive.

A negative list approach, initially only applied to determining market access for foreign investors, is now being applied to managing the general investment climate, irrespective of firm ownership. Business activities on the negative list are either completely barred or restricted, anything that is not on the list is allowed by default and does not require further approval.

Under the restricted category, some business activities would be allowed through an application process. Investments in sectors related to national security, strategic natural resources, and the public interest will be subject to review, with some areas that are outright prohibited. To encourage innovation, emerging technologies, products, and business models will not be immediately added to the list. This is the first such list that applies equally to domestic and foreign investors, and it clarifies specifically what is allowed or not allowed.

The State Council has sole authority to promulgate and adjust the negative list, which will be a composite of various lists and regulations that currently exist. The idea is to integrate them into a single list under the State Council’s authority. Local governments and other entities cannot adjust or issue alternative lists without the State Council’s prior consent.

Foreign investors, however, still need to first comply with the foreign investment negative list, which specifies the sectors and activities in which foreign capital is not allowed or requires administrative approval. Therefore, foreign investors need to comply with both the foreign investment and the general market access negative lists.

The sweeping opinion calls for further opening up of services and industrial sectors to foreign capital. Beijing plans to grant foreign capital more equal treatment in the majority of business sectors. This will be achieved through a combination of so-called pre-establishment national treatment and the negative list approach.

Pre-establishment national treatment means that foreign investors will receive the same treatment as domestic ones. However, there will also be a negative list of activities and sectors that are still restricted to foreign capital.

Foreign investment restrictions in sectors ranging from transportation and telecommunication to financial services, culture, healthcare, and logistics will be modestly scaled back. These sectors fall into two baskets: those where supply is insufficient in China, such as healthcare and senior care, and those that the foreign business community have had longstanding complaints, such as financial services.

In financial services, for example, the most significant change is that restrictions on foreign ownership will be relaxed. Currently, foreign financial services firms are only allowed to establish joint ventures with domestic firms where the foreign ownership is usually capped at 50%. In addition, foreign investors will be allowed to enter certain domestic future and derivatives markets.

Another objective of this policy is to encourage more imports and outbound investment. To facilitate the latter, the Chinese government stipulates that, with just a few exceptions, outbound investments will no longer be subject to onerous administrative review and approval. Instead, Chinese companies investing overseas only need to provide the relevant information to designated government agencies.

As part of the outbound investment push, Beijing will also lend its support to expanding overseas markets for the country’s high-speed rail technology, nuclear power generators, aviation, machinery, and agricultural firms. In addition, Beijing will continue to promote the international adoption of certain Chinese technology standards.

More than a year after launching the Shanghai FTZ, the Chinese government has decided to scale up the experimental zones in Guangdong, Tianjin, and Fujian. In addition to adopting most of the policies implemented in the SHFTZ, the three zones have also developed policies and features that are specific to its local conditions.

As all three new FTZs already have special economic zones status, their new mandates are, in fact, quite similar what’s already in place. For example, the Guangdong FTZ aims at strengthening its cooperation with Hong Kong and Macau. The Fujian FTZ is positioned to enhance economic connectivity between the mainland and Taiwan. All three new FTZs have received blessing from the National People’s Congress, China’s legislator, to experiment with policies on foreign investment, and neither is bound by existing laws and regulations.

Now that these new FTZs have gained renewed authority and more latitude for experimentation, it bears watching what additional innovations and policy revisions emerge from these zones.

Foreign investment has long been subject to the Chinese government’s formal approval process, which can be inefficient and stalls the formation of new businesses. To ease the process and demonstrate its continued embrace of foreign investors, the Chinese government has moved to a negative list approach for foreign investment that, so far, only applies to the four FTZs.

The negative list, a model adopted from the United States, contains all sectors in which foreign investors are still prohibited from entering. As long as sectors are not on the negative list, foreign investment no longer requires government approval. Moreover, the previous Catalogue Guiding Foreign Investment, which is a list of what sectors are encouraged, restricted, and prohibited to foreign capital, has been abolished in the four FTZs.

Although an improvement, the negative list nonetheless still contains 122 restrictive measures (e.g. what type of activity is prohibited and requirements for conducting certain types of business) within 15 industries, including mining, manufacturing, telecommunications, broadcasting, nuclear energy, transportation, and finance.

Under this policy, the most significant change is abolishing the minimum requirement for paid-in registered capital and the verification of whether the owner actually contributed the capital. Paid-in registered capital is the amount of capital contributed by equity owners, who, previously, had to submit evidence of the amount invested to the local administration of industry and commerce (AIC) under the Ministry of Commerce. Some sectors, such as financial services, are exempt from this change.

In addition, a public national enterprise credit information system will be established, which is essentially a registry of business ownership and records of wrongdoing or red flags such as trademark infringement. The digitization of such a system is meant to streamline processes and improve administrative efficiency. For instance, currently all businesses need to submit annual reports, a simple firm ownership form, and other basic information to the local AICs for review.

With the creation of this new online system, the review process is no longer required, as firms just need to upload the relevant reports to the digital platform. Companies that fail to do so will still face punishment, and the Chinese government will conduct random reviews to sort out false or inaccurate firm information.

The majority of China’s railways is ultimately owned by China Railway, a central state-owned enterprise (SOE). Although the railways are operated by the SOE’s many subsidiaries, little competition exists in the sector.

This is in part because rail freight prices are fixed. During boom times, a fixed price tends to lead to excessive demand. On the other hand, during economic slowdowns—like over the past few years—the price cannot be lowered to spur demand, even as freight volume falls on the back of an industrial slowdown.

Therefore, the government has decided to give railway companies more leeway in determining their own freight prices, in part by raising the benchmark price by about 7%. At the time, Beijing implemented a partial liberalization by allowing rail companies to charge up to 110% of the benchmark and also scrapped the price floor. These measures, in theory, should create more room for railways to engage in price competition, which the government hopes can also address the idle railway capacity problem.

Up until recently, the Chinese government still controlled airlines’ freight and passenger ticket prices. For example, the benchmark passenger ticket price is determined by a formula based only on distance and altitude, without really accounting for market demand conditions. Thus, the latest policy completely liberalizes freight airfare, but also devolves price-setting power to airlines for certain short-distance flights.

For the remaining routes not covered by the policy, airlines can still charge up to 125% of the administratively set benchmark price. Finally, a price floor for airfare has been abolished. These measures cumulatively allow market demand and supply factors to play a bigger role in determining airfares.

In a bid to incentivize private sector buy-in of the much touted PPP program, the central government has pledged to limit monopolies, lower barriers of entry, and provide subsidies.

The broad policy also seeks to diversify financing channels by reforming financial services and agricultural finance, as well as encouraging private equity (PE) and venture capital investment in key sectors. Local governments are hoping to jointly set up PE funds with private capital participation to invest in infrastructure and other emerging sectors.

The seven key sectors in which private investment is encouraged are as follows: 1) environmental protection, including the trading of carbon and pollution permits; 2) agricultural irrigation projects; 3) municipal infrastructure, including the private management of infrastructure through the Transfer-Operate-Transfer model; 4) transportation, including rail, highways, and water transport; 5) energy, including hydropower, nuclear, and oil and gas pipeline projects; 6) telecommunications, including in broadband networks; and 7) social enterprises, including elderly care and sports and cultural facilities.

The Chinese government has long supported the country’s cotton farmers by directly purchasing from the market when the price of that commodity fell below a certain level. This practice is of course distortionary and often led to cycles of excessive cotton inventory.

Under the new policy, the state will no longer purchase cotton from the market. Rather, the government is moving to a subsidies system whereby farmers will get paid when the market price for cotton is below a predetermined level. This subsidy system will be first implemented in the Xinjiang region, where more than 80% of China’s cotton is produced.

The subsidy is also designed with the intent of solving the existing problem of illegal cotton farming, particularly on land that is state protected. To qualify for this subsidy, farmers are mandated to report the size and location of their cotton field. No illegal cotton planters will be entitled to the subsidy.

The first zone of its kind on mainland China, the SHFTZ was established with the backing of Premier Li Keqiang. Its purpose is less about promoting free trade per se, but is more about experimenting with economic governance reforms. The apparent mandate for the SHFTZ includes: 1) opening up the market to foreign capital; 2) liberalizing RMB capital flows; and 3) transforming the state’s role in the economy.

As a contained experiment, foreign investment within the SHFTZ will be encouraged in sectors that have been previously restricted, including finance, legal services, healthcare, and entertainment. Moreover, except for banking and communications, restrictions on foreign ownership will be abolished (outside the SHFTZ, foreign investors currently must establish a joint venture with domestic firms). A negative list approach will be implemented in the SHFTZ—that is, foreign investors do not need official approval for investing in Chinese businesses unless they appear on the negative list.

This is, in principle, a significant shift in the government’s approach to foreign investment, which it hopes could be scaled up nationally if successful in the SHFTZ. That’s because the current default setting of the Chinese government’s approach to foreign investment is that “you are not allowed to do anything unless you get specific approval.” The negative list approach essentially says, “you’re allowed to invest in anything you want except for the few areas we specify.” In other words, this is behavior economics applied to a real-life experiment in economic governance.

Another purpose of the SHFTZ is to attempt greater liberalization of cross-border RMB capital flows, such as allowing FTZ-based companies greater freedom to conduct cross-border RMB financing. The SHFTZ is considered outside the jurisdiction of Customs but still within China’s sovereign borders. Therefore, authorities will ease restriction on the flow of goods between the SHFTZ and foreign countries to facilitate trade, while strengthening the supervision of goods that move between the SHFTZ and the rest of China.