Beijing’s Reform Struggles

The Party is torn between fiscal stimulus and supply-side reforms.

Tibetan monks and ethnic minority delegates leave the Great Hall of the People in Beijing, China on March 3.Tibetan monks and ethnic minority delegates leave the Great Hall of the People in Beijing, China on March 3. Photo: European Pressphoto Agency

Premier Li Keqiang’s speech Saturday opening China’s annual rubber-stamp legislature should tell us much about the internal debate over economic policy. Will “supply-side structural reform,” a program pushed by Party General Secretary Xi Jinping since last October, prevail? Or will Beijing emphasize fiscal and monetary stimulus?

Mr. Xi and his advisers want to use tax cuts and deregulation to promote growth and encourage innovation. But the more controversial part of their plan involves closing “zombie companies.” Such firms are losing money and have no hope of paying off their debts, yet banks continue to lend them money to make payments on old loans. This restructuring will mean laying off five to six million workers, according to a recent Reuters report. It will also hurt managers of state-owned and private firms as they are deprived of bank loans.

Many cadres oppose Mr. Xi’s policy and want China to increase the size of government and bail out troubled firms. One reason Mr. Xi has pursued an anticorruption campaign with such zeal is the need to weaken and subdue Party officials who are on the state-company gravy train so that reforms can advance.

The outcome is unlikely to be one-sided. Even if Mr. Xi prevails, China’s next budget will likely include some new government spending. The People’s Bank of China also cut reserve requirements earlier this week so banks can increase lending, the fifth such cut in a year.

But there are signs that Mr. Xi’s forces are trying to restrain the stimulus. On Wednesday the People’s Daily posted an article criticizing the central bank for inflating an asset bubble and harming business efficiency. The article said China’s real economy needs more supply-side reform such as reducing the inventories of real-estate developers.

This throws light on other recent developments. On Feb. 19 Mr. Xi made a high-profile visit to China’s three most important media organizations—China Central Television, Xinhua News Agency and the People’s Daily—to emphasize that the media must serve the Party, not the government. A high-profile property developer, Ren Zhiqiang, used social media to criticize Mr. Xi’s remarks, and implicitly Mr. Xi’s reforms. Mr. Ren’s writing has been scrubbed from the Internet and a Beijing Party committee said he will be “dealt with seriously.”

Statistics released this week suggest that the Chinese economy continues to slow. The purchasing managers’ index for manufacturing fell to a post-2009 low of 49.2 in the first two months of the year, indicating contraction. And while the services PMI figure is still positive at 51.2, it too is falling. On Wednesday Moody’s MCO 2.77 % cut its outlook for Chinese government debt, citing growing deficits and capital outflows.

Moody’s also doubted Beijing’s resolve to carry out economic reforms and contain the explosion of debt. As Michael Pettis writes nearby, credit has become a tool to create unsustainable economic growth. If Mr. Xi doesn’t tackle the zombie problem, the banking system will require such a huge recapitalization that the central government’s resources could be tested.

Many observers interpret Mr. Xi’s efforts to crush dissent and enforce personal loyalty as signs that he is the most powerful Chinese leader since Mao Zedong. That’s one way of looking at it. Another is that the internal struggle over the Party’s economic direction is fiercer than at any time since Mao’s death.

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