China’s dramatic crackdown on the country’s tech firms is turning into a broader reform of the welfare system and a greater policy focus on social equality. The term for that shift is common prosperity, which has been used frequently by China’s President Xi Jinping, but which gained more prominence after he declared in a speech in August that ‘common prosperity’ was one of the main hallmarks of modernisation with Chinese characteristics.

The re-emergence of a term that was widely used during the Mao era has sparked discussions about its meaning for China’s future. Whether the Chinese government can truly push through the reforms needed to address the growing inequality at home remains open to debate.

Nonetheless, the increased emphasis on social equality sends a clear signal that the government is unwilling to procrastinate and that it wants to see progress on some of the more contentious reforms — including the long-discussed but never fully enacted property tax and the even trickier pension reform. This alone merits full attention.

Background

Common prosperity (共同富裕 gongtong fuyu) isn’t a new term in Chinese political vocabulary. Its first appearance was as early as 1953, when it was used as a rallying cry in support of China’s impoverished peasantry, according to the China Media Project. But the events of the 1960s and 1970s gave the term a bitter aftertaste and an intrinsic association with violent class struggle and stifling collectivism.

Even Xi’s frequent reference to common prosperity in recent years — the first being in his inauguration speech as Party Secretary in 2017 — and its emphasis in the 14th Five-Year Plan did little to change this perception.

How difficult it might be to reframe an established political term in China became clear in late August when state media started to circulate a polemical and ultra-nationalistic essay by a previously unknown blogger, Li Guangman. Li apparently took the renewed stress on common prosperity as a sign that the current tax investigations into Chinese media personalities such as actress Zhang Wei was not just a crackdown on notorious tax evaders but the beginning of a “profound revolution” that would end China being a “paradise for capitalists” and turn it back into a people-oriented society.

Although Li’s blog post was widely quoted by official state media, including the state-backed Xinhua news agency, it also attracted criticism. Hu Xijin, the nationalist editor of Global Times wrote on his personal Weibo account that Li’s language was incendiary and not in line with the Chinese government’s official reform agenda. Hu stressed that ‘Reform and Opening-up’ remains the guiding principle of the country’s policies and that any change, including the current crackdown on China’s tech giants, would be carried out in accordance with Chinese legal procedures, and not in a Maoist ‘campaign-style revolution.’

Hu wasn’t the only one spooked by Li Guangman’s essay. Vice-premier and Xi Jinping’s chief economic advisor Liu He reassured private businesses saying that their role in China’s economic development had not been diminished and it would remain crucial in the future. Even the announcement of a new Beijing stock exchange by Xi himself has been considered by some as a subtle sign in support of private entrepreneurs.

What does common prosperity mean?

One way to understand what common prosperity means is to look at Zhejiang province. In late May, the State Council designated the province a “high-quality development and common prosperity demonstration zone.” On 20 July, the government in Hangzhou (Zhejiang’s capital), followed up by releasing its own five-year action plan for achieving common prosperity.

The plan’s focus is on reducing income gaps between wealthier and poorer areas, as well as between cities and rural regions, through economic upgrading and more investment in local businesses. For example, the plan includes a target to increase the per capita GDP from the equivalent of £12,200 to more than £15,000, and the average annual income of residents from the current £6,825 up to £8,500. While this means that disposable incomes will have to grow by 24.5% over the next five years, the annual growth rate is estimated to be around 4.6%, which is lower than the projected annual GDP growth in the coming years. What’s more, some of the targets, like the urban-rural income ratio, have already been met.

Cai argues that China should combine its policy to promote innovation-driven growth with the creation of a modern welfare state

Besides the modest social targets, the plan offers little that is new in terms of broader welfare reforms. Although the document includes some references to fiscal policies and transfer payments, it largely follows the conventional Chinese ‘workfare’ approach of promoting jobs and employment as the main strategy to reduce social inequality. In fact, Zhejiang’s Party Secretary Yuan Jiajun stressed in an interview in July that economic growth remains the cornerstone of the province’s common prosperity strategy.

Not everyone agrees with this strategy. For example, Cai Fang, vice-president of the Chinese Academy of Social Sciences, wrote in a recent essay that economic growth alone would not be enough to reduce income inequality. Cai notes that China’s Gini coefficient, which measures the distribution of income, is now estimated to be 0.46, meaning that China’s income inequality is worse than that in most advanced economies, including the US.

Cai further emphasised that, in order to bring per capita GDP levels in line with a medium-sized developed country by 2035, per capita GDP would have to increase by at least 14.7% every year. This is nearly three times as much as the target set by the Zhejiang government.

Although Cai does not dismiss the importance of economic growth and social responsibility programmes by Chinese private businesses — the so-called ‘tertiary contribution’ — he nonetheless points out that no country has yet managed to bring down its Gini coefficient without transfer payments which would allow low-income households to move up the social ladder into the lower/middle-income group, a key advancement which is generally considered the principal prerequisite for upward social mobility.

Cai therefore argues that China should combine its policy to promote innovation-driven growth with the creation of a modern welfare state. According to Cai, an increase of government spending on welfare from the current 26% up to 36% to fund better access to social services such as childcare, education, healthcare and support for the elderly would be enough to turn China into a welfare state.

The CBBC View

China wants to increase domestic consumption and reduce income inequality. The central government hopes that promoting a common prosperity strategy can achieve this. Yet instead of a ‘profound revolution,’ current pilot schemes like the Common Prosperity Demonstration Zone in Zhejiang and Shenzhen’s plan to become a Socialist Model City remain surprisingly supply-side oriented.

It is true, however, that central authorities have dialled up the pressure on businesses and local authorities alike to improve the working conditions of gig workers and implement better tax compliance. They have also accelerated plans to introduce a long-debated but never really implemented property tax. And even a change to China’s comparatively low retirement age is not inconceivable anymore, despite fierce public opposition to any such changes.

But the ability of China’s central government to change social policy remains limited, not least because of the system’s fragmented and de-centralised nature. Without a convincing plan to finance increased spending, most initiatives will probably remain underfunded.

The post What does ‘Common Prosperity’ actually mean? appeared first on Focus - China Britain Business Council.

The arguments over reform in China throughout the 1980s and since have been much commented upon both within China and abroad. Now, the reform movement has its most complete history to date in Assistant Professor of Economics at the University of Massachusetts Amherst Isabella Weber’s new book ‘How China Escaped Shock Therapy: The Market Reform Debate’ (Routledge). The book is a deep-dive into China’s post-1976 economics with a staggering array of interviewees including both domestic economists and those that advised them.

‘How China Escaped Shock Therapy’ is a must-read if you want to comprehend China’s contemporary economy in all its complexity and understand where reform might be headed in China’s short and medium-term.

Paul French caught up with Weber to talk about just how much the China business environment of today owes to the debates of the 1980s. 

Throughout the book, you talk about the vehemence of the debate between both pro-reformers and those more cautious about change. Do you think economic policy is still as vehemently argued among senior economists within Xi’s administration today?

As I show in my book, when reform first began in the 1970s, what China’s future would look like was very open. It was clear that the revolutionary era of Maoism was over but how to go from there was an open question. This was a crossroads at which the future path was only starting to take shape. In such a moment, debate is fierce and fundamental.

Deng Xiaoping suggested early on that there should be a great role for markets, but how markets should be introduced was vehemently contested. Some followed an idea grounded in mainstream economics, that markets had to be universal and protected by the state. Others thought of markets as a tool that could be used by the state to further its policy goals. These two broad positions have continued to prevail over the years. As the market was becoming a more and more important tool in the hand of the state, there were repeated calls to complete reform and move towards universal marketisation. But as China’s reform era system was taking shape the great openness of the 1980s closed. The path was set. It is hard to know what exactly the arguments are within Xi’s administration today. Recent events around the tech sector and the private tutoring sector suggest that the state is reasserting its leading position over private business.

During the decisive years of the reform debate, the argument about how far China can have, or tolerate, an activist state as opposed to a less invasive state was significant. It seems this is a perennial debate in China, though many may think that the advocates of a more activist state have ultimately won in 2021. What do you think?

We have certainly seen a shift to a more activist state policy but this is not a complete break with the past trajectory. China’s reform has followed the logic of keeping control and actively reshaping the essential parts of the economy and letting go of the non-essential. But what is essential is not given by some physical characteristics that remain the same across time. Instead, it evolves with the development of the economy and with changing political goals.

For example, when only a few people were in a position to hire private tutors this was a marginal phenomenon. But once private tutoring became so pervasive that it became necessary to enter university, it became an essential part of the education system and thus of economy and society. Furthermore, the broad political agenda has shifted from an overarching goal of building up an education system that can compete internationally to creating more equity not least to foster domestic demand.

When only a few people were in a position to hire private tutors this was a marginal phenomenon. But once private tutoring became so pervasive that it became necessary to enter university, it became an essential part of the education system and thus of economy and society

What we see is the expression of a victory of the more state activist side while also part of a reorientation of the growth model. If the market is meant to remain a tool in the hands of the state and not the other way around, a tipping point will eventually be reached when the power balance between the two is redefined. That tipping point seems to have arrived.

China still has so many elements of a command economy, such as some state-set prices, fairly rigid and long term economic plans, and goals and SOEs. Do these ‘overhangs’ of the more overtly socialist economy continue to reduce the effectiveness of true market reform in China?

I don’t think we should think of the elements of state planning and price steering in China as simple remnants of the past command economy. They are part of that legacy, but as the Chinese system has undergone a fundamental change over decades of gradualist experimentalism, their role has also changed. SOEs have turned from socialist production units that are meant to fulfil a central plan into market-oriented enterprises, often global players. The model of economic governance has changed from planning and command to state market participation. The state steers the market by participating in it and by structuring markets. This is very different from a traditional planned economy.

Economic and market reform, of course, was never going to be a ‘Big Bang’ moment, but was always seen as a long term project. Is reform still on the agenda and, if so, how is reform manifesting itself now in the Chinese economic debate?

The common wisdom is that there was never a Big Bang moment in China, but in my book, I attempt to show that this is not quite correct. In the 1980s, when China’s market reforms were first defined, a Big Bang in price liberalisation was very much part of the discussion; and in fact, China came close to implementing it twice – once in 1986 and again in 1988. In 1988, attempts at price liberalisation gave way to the first episode of very high inflation and a reversal in reform course.

So, while a Big Bang was not ultimately implemented it was very seriously considered by the highest leadership. Ideas for radical market reforms gained more momentum in the 1990s with the privatisation agenda and in the 2000s around trade liberalisation and finally more recently around financial liberalisation. At each step along this way, there have been intense intellectual struggles and these struggles are by no means over.

I find it interesting that when we look back at reform, so much is about agriculture and heavy industry or the relationship between the rural population and burgeoning urban population. That China is now mostly gone, so I’m interested as to how the past debates on reform can be applied to new fields like personal financial services, mass-market retail and technology. Are the original debates of value here, or is this new territory to be discussed differently?

The specific topics and challenges have of course changed and so has China’s development level and the international context. However, basic principles such as state market participation, control over the essential, unleashing markets and new forms of governance in an experimental fashion, calibrating experiments and creating new national policies continue to be practised. The basic logic of this is to keep the key parts of the old institutions in place while creating new dynamics in the margins.

Let’s use a metaphor of the game of Jenga. The Chinese reform approach of experimentalist and gradualist market creation is based on an analysis of the structures of the old system and starts by removing loose stones from the old tower and moving them somewhere else. In this process, the tower grows, but its structure fundamentally changes. However, the spaces left empty began to be filled with market activities that unleash a dynamic that eventually also transforms the structure of the stones that were initially left untouched. This approach can be seen in the initial creation of goods markets and again in the creation of financial markets. This approach always leaves open the possibility of tearing down the whole tower in radical marketisation or leaving the old tower in place in its initial form.

Therein lies the origin of the continuous tension between radical reformers, those who want to preserve the old ways and those who want to create a new system in an experimentalist fashion.

The post Isabella Weber on how China avoided ‘shock therapy’ economics appeared first on Focus - China Britain Business Council.

The publication of China’s 14th Five-Year Plan (FYP) has attracted plenty of international attention, with much of the external commentary on the plan focusing on its emphasis on self-reliance and domestic consumption. One area which has received far less scrutiny is China’s tax regime.

That is an oversight. In fact, a recent decision by China’s State Council has revived the debate over the need for tax reform in China, given the government’s spending plans. On 21 April 2021, Premier Li Keqiang announced that the central government would expand the fund it set up last year to directly help local authorities in supporting employment and economic recovery. The government added that the fund’s scope would be expanded to include the salaries of local civil servants and pension payments.

The fund’s expansion not only increases the central government’s involvement in local government finances, it also raises questions regarding the planned increase of social spending under the new FYP. In particular, the lifting of hukou restrictions for most Chinese municipalities is expected to increase the fiscal burden for local governments. Without a proper tax base, many will struggle to achieve the FYP’s targets.

What is the current tax policy situation in China?

China’s local governments have long struggled with rising debt levels. By the end of 2020, local governments had amassed RMB26 trillion (approx £2.9 trillion) in official debt, up 8% from the year before. Since 2015, this debt has risen by nearly 63%, according to data from China’s Ministry of Finance.

Official debt of central and local Chinese governments, 2015-2020

What’s more, most observers agree that these figures are only the tip of the iceberg. Many local governments are known to have considerable off-balance sheet debt, often hidden in so-called local government financing vehicles (LGFV). Between 2015 and 2020, local governments issued over RMB16 trillion (approx £1.8 trillion) in LGFV bonds on China’s onshore market, over 60% more than it accumulated in official debt.

China’s central government has tried to get local debt under control, with varying degrees of success. It has halted expensive infrastructure projects, such as subways and luxury housing projects. It has also signalled that it will not pick up the bill when bonds issued by local governments go into default. Yet reining in spendthrift municipalities has become more difficult just as local government revenue has been dwindling. China’s last major tax reform in 2016 replaced the business tax – which was paid into local coffers – with a value-added tax (VAT) paid directly to the central government. At the same time, the central government’s supply-side reforms further reduced the local tax base by abolishing licensing fees and reducing social welfare contributions.

Even more painfully, Beijing has also started to restrict local governments’ land sales and the conversion of rural land into urban land. Land sales had turned into a major revenue source for local governments, accounting for 55% of revenue last year.

On the same day that the State Council announced the expansion of its subsidy fund for local governments, it also published a new draft regulation making it more difficult for them to seize agricultural land for construction projects. A new law on promoting rural revitalisation would also ban local governments from further reducing agricultural land.

As the fiscal base for municipalities has narrowed, the central government’s reach into local finances has been repeatedly extended. In 2019, the State Council decided that it would share 50% of VAT revenue with local governments. However, most of the transferred money is not shared with local governments directly but is allocated at the provincial level. Unfortunately, owing to the provinces’ own budgetary constraints, most of these shared revenues fail to reach the local level, according to a 2020 working paper from the Asian Development Bank.

LGFV onshore bond issuance, 2015-2020

The Chinese government, therefore, decided to establish a fund to help local governments directly. This became particularly urgent during last year’s lockdown when the majority of municipalities had to halt most of their economic activity. Initially, the government earmarked RMB1.7 trillion (approx £190 billion) for the fund, which was aimed at supporting local employment and small businesses hit by the pandemic.  Since last year, however, the fund’s value has increased to RMB 2.7 trillion (£300 billion) – an increase of nearly 60%. Its purported use has also been broadened to include social welfare payments and education – two areas which previously were borne exclusively by local governments.

What are the chances of tax reform in China?

Centralisation has been a general feature of administrative reforms under Xi Jinping. But the recent measures represent the largest appropriation by central authorities of local prerogatives so far. Even though the demographic disparities – for example in local pension funds – warrant stronger coordination at the national level, the inability of many local authorities to even meet basic fiscal needs has increased the need for a more sustainable tax system.

Yet the 14th FYP contains little to suggest that tax reform is on the agenda. The term ‘demand-side reform,’ which briefly appeared in the communique of last year’s Central Economic Work Conference and could have indicated significant changes to China’s welfare regime, was quietly dropped from the FYP. This year’s legislative plan does not mention any tax-related items either.

Instead, Chinese policymakers continue to call for further tax cuts and fee reductions. At a press conference in early April, Assistant Secretary of the Ministry of Finance, Ou Wenhan, rejected calls for broader tax reform and reiterated the government’s avowed goal to reduce costs for manufacturers and small businesses.

Nonetheless, the government wants to support charitable activities – so-called ‘tertiary wealth distribution’ – and crack down on tax fraud and tax evasion by China’s wealthiest. A planned property tax, which has been debated for years, would probably also target the well-off middle class in China’s rich coastal regions. As China research director for Gavekal Dragonomics Andrew Batson wrote in a recent blog post, the government’s current agenda seems to be one of tougher legal and political scrutiny of high-income and high-net-worth individuals rather than of generalised welfare reform.

Such an approach, however, does little to address China’s structural and regional inequalities. Especially China’s ambitious hukou reform – bringing hundreds of millions of new entrants into the country’s urban welfare network and education system – will make such an approach difficult to sustain. Worse, it could boost the coffers of already rich cities like Beijing or Shenzhen while leaving their poorer peers in a perpetual state of fiscal penury.

The CBBC view

Although tax reform is currently not on the Chinese government’s agenda, growing fiscal pain and rising costs for local governments will increase the pressure on Beijing to design a more sustainable tax system.

In the short term, the Chinese authorities are likely to focus on improving the efficiency of tax collection from high-net worth individuals. High-profile cases like that of actress Fan Bingbing, who in 2018 was fined £98.9 million for tax evasion, might become more commonplace. We should also expect more pressure on China’s large companies – both private and state-owned – to spend more on social and educational projects.

But given the enormity of Chinese local debt, such measures amount to little more than a drop in the ocean. China’s current central state apparatus is also unable to effectively supervise the correct use of its direct funds. A full 90% of last year’s direct funds were distributed within 20 days, according to China’s Finance Minister Liu Kun. This suggests that there was only minimal verification of whether the money really went to the right places.

We therefore expect that more comprehensive tax reform is needed to meet the growing fiscal commitments of local governments.

The post How likely is tax reform in China? appeared first on Focus - China Britain Business Council.

China’s draft energy law is really a consolidation of lots of other things that were already in place or that had already been developed. So for example, renewables in the electricity sector have been a focus of the government for some time, and the law on the gas sector was really an amalgamation of lots of laws that were already in place but hadn’t yet been consolidated. So it is really a home for existing legislation. Therefore, when it was put out for public comment there weren’t any real surprises.

The overall tone in prioritising renewables, the environment, and energy security was not a surprise, as these themes were identified in the last 5-year plan and can be seen in existing legislation. Whilst the previous draft talked about energy conservation, the focus now is on energy security and how to get private companies into the sector.

Previously, China’s economic drive was on infrastructure and was export-focused. Now, as we know, it has moved to consumption and the domestic market, and this law aims to get the private sectors to talk up some of that slack.

China’s oil and gas consumption has grown significantly over the last 15-20 years and there has been growing concern about energy security, which runs through decision making. There has been a push to reduce the rising import dependence of oil and gas and increase domestic production.

Privatisation and the NOCs

For private companies – international or Chinese – the big barrier was how to reduce the dominance of the three big National Oil Companies or NOCs – Sinopec, CNOOC and CNPC – and increase incentives for private entities to have ownership of resources rights.

We saw in December that there were legislation rules removing obligation with production-sharing agreements with the three NOCs. This is welcome as it has been a major barrier in international investment in the upstream, and is a step in the right direction. It does, however, have to be one part of a number of measures such as increasing tax incentives.

Gas demand has grown significantly in China in recent years as China aims to clean up Chinese cities,  reducing smog and air pollution. The measures put in place to curb coal production in the north led to a big uptick in Chinese gas demand in 2017-2018.

The gas demand in China 15-20 years ago was something similar to Belgium’s. Now it is a 300 billion cubic metres a year market – the biggest growth market for a number of years.

Demand overtook ability to meet demand both in infrastructure and market, so the Chinese government is now focused on trying to increase demand. Whilst it is trying to reduce reliance on coal, China is simultaneously trying to increase gas and renewables as a share of the total energy market.

To increase the gas market, long term measures are needed. It took the UK ten 15 years to do this, to ensure there is a framework to incentivise investment, and to make sure participants can get a rate of return on their investments on infrastructure for things such as pipelines,  storage facilities, LNG (Liquified Natural Gas) terminals, power stations and so on. Every participant wants to know what rate of return is going to be.

Investors need signals from both the state and provincial-level government and that has been absent to a certain degree. The market has traditionally been controlled and planned. It is heavily regulated and monopolised by the three NOCs and by provincial governments. When a market is heavily regulated there are no market signals which means there are no signals on the rate of return.

When a market is heavily regulated there are no market signals which means there are no signals on the rate of return.

A number of things need to be put in place, and one of the things we have seen in reforms that have been implemented into the draft energy law is directed at transforming the infrastructure, and specifically the main pipeline network.

In order to stimulate investment and for private companies to feel comfortable, they need to be able to get access to the infrastructure. If the infrastructure is dominated by the three NOCs forcing private companies to build out their own infrastructure, it is not appealing to most private companies. To build out your own domestic customer base and market share has been a real inhibitor.

China has the biggest gas market in the world with demand at 300 billion cubic metres a year

A national pipeline corporation

One thing that has been put in place is the creation of one national infrastructure company. It was announced in December and it amalgamates ownership of CNPC, SINOC and Sinopec. The China Oil and Gas Pipeline Corporation will oversee the main gas trunk line. If you have one company overseeing the trunk link that offers access to the pipeline network to private companies, it creates a more level playing field.

In any market that starts to deregulate, the official timelines are always very ambitious: In China, if it wants to do something, it gets it done. However, even the Chinese administration realise all of this will take time. There are a number of signals you have to make to create a deregulated market where pricing signals match demand. There needs to be the correct incentives for investment, and everyone has to get access to infrastructure to be able to import to the customer base.

Further reforms needed

The draft energy law includes a number of measures that advance this but we think that there are a number of things that it still doesn’t include.

It doesn’t include things that we know might slow the process down or slow down bringing international investment into China; it doesn’t mention whether this new pipeline corporation has control over the trunk assets. It would presumably have control over the main part of the infrastructure, importing gas internationally from Central Asia or Russia, but what hasn’t been clear in the draft law is whether this new pipeline corporation will have ownership of all provincial pipelines rather than just the national pipeline.

If bringing in gas from overseas, you still have a barrier to get it to the end customer because the local pipeline grid is owned by provincial-level governments. There’s a more complex ownership process – all of the 20 local provincial owners are both distributors and shippers – which causes a conflict of interest. At some point, these roles will have to be separated.

Regulation challenges

It also doesn’t really explain who oversees this process. What is the ability of the provinces to enforce and penalise non-compliance and who deals with dispute resolution? Is it the NEA or the transmission company? What are the powers and who is the authority or overseeing body? This is something that needs to be clarified and needs to be addressed before we will see significant private investment.

The reason that deregulation and reform of the energy sector in the UK, the US or Europe worked so well was because there were clear divisions between what the regulator did and what the transmission operator did. The body overseeing it is independent. In the UK it’s Ofgem. Until there is an independent energy regulator that has powers to enforce and oversee reforms, it will slow down the deregulation process and therefore the international willingness to invest.

Currently, the National Energy Administration is doing the regulating – in other markets, it is split out. The regulator tends to be independent and has the powers to fine or set tariffs, as well as the costs to access the network and rate of return if you invest in the infrastructure. And decisions on tariffs and pricing is generally consultative, whereas at this point they are not consultative or clear.

There are various ministries and government bodies who have been involved in the draft energy law. The National Development and Reform Commission has been involved alongside various ministries including the Ministry of Justice, and it was the National Energy Administration that published the law. But there are a number of stakeholders and when embarking on a reform like this, having clear lines of responsibility, indicating what powers each body has, and what responsibilities fall under state or provincial bodies is essential. Currently, the draft law does not do that and it will take time for this to be clarified which will be one of many things that will restrict investment.

Opportunities for private business

Overall, the report is focused on getting the private sector to take more of the heavy lifting in terms of energy security, but when you look at the details it is clearly a long term process.

Much of the supply of LNG coming into China has been signed on long term deals by the big three NOCs who all play a dominant role in providing energy security in China. Many of the deals to import gas from Russia, Australia, Qatar and other places are 20-year deals, meaning that the opportunities to supply gas to China is still limited for other private international companies. The pipeline network is going to be full with existing clients, which means that there needs to be an unbundling of those supply contracts. But forcing the monopolists to give up some of the market share will be a tough process.

Many of the deals to import gas from Russia, Australia, Qatar and other places are 20-year deals, meaning that the opportunities to supply gas to China is still limited for other private international companies.

A significant amount of UK Inc’s gas exports or projects are in places such as Australia, where Shell has interest, or Indonesia where BP has a big interest. BP has an interest in one of the import companies that brings LNG into China in Guangdong. As China continues as a growth importer in oil and gas, there will be interest from these big British companies

If the Chinese government is determined to open up for private investment and we start to see city gas companies – such as Beijing Gas – responsible for providing gas to Beijing, they will start to invest in private solutions, so there is an interest from international suppliers, to structure their own agreements with these potential customers and circumvent the three NOCs.

If the draft energy law creates an efficient market, it will unlock more demand and create a customer base. And as you go further downstream, you can come to the logical conclusion that it will unlock investment opportunities for companies that make equipment and provide services.

The draft energy law improves the investment climate a little bit. It is by no means a panacea – we won’t see a tidal wave investment in upstream blocks or building out own subsidiaries to capture a city gas company. But it unlocks private investment potential and we may yet see more joint ventures emerge.

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In April, China released its draft energy law that aims to regulate, control and reform the energy sector.

“The aim of this law is to reform a sector that is very traditional but is going through a lot of change,” explains Jessica Henry, First secretary for energy policy for the FCO, based in the Embassy in Beijing. “That involves working with some of the large, state-owned enterprises, some of which are keen to stick to their traditional models and are quite reluctant to change. So it needs a gentle and nuanced approach to moving forward that reform effort.

“The lead drafting party on this law is the Ministry of Justice, which shows how seriously they are taking it and how they are convening and managing the different ministries and the input from lots of different interest groups. The Ministry of Justice should be more objective in setting the legal basis for this law which would include ministries not only in charge of energy, but also in charge of everything from the environment to forestry, to the oceans.”

Adds Henry: “It’s very complicated to provide a legal basis for the world’s largest energy consumer and producer.” It is, after all, “quite a big job.”

Indeed it is. Henry, who is responsible for government-to-government relations on energy policy, explains that the bill has been 15 years in the making, with the first draft being published around the same time the National Energy Administration (NEA) was created as a separate energy ministry.

“At that time, it was very short and was more of a declaration than a comprehensive energy law, but has had many revisions since then. In 2017 there was a major revision that took into account technological and market developments over the period. It included context from the Paris 2015 Climate Conference, but also reflections on Xi Jinping’s speech on the four major energy revolutions from 2014, so you could see it become broader and reflect some of the wider political and economic features of the time.”

This latest revision continues to reflect current themes, including energy security and low carbon development as key parts of China’s energy strategy.

One of the reasons it has taken such a long time is because it is trying to keep up with fast-paced technological developments. The cost of renewables has fallen dramatically, and China has become a world leader in renewables and low carbon transport in recent years, so it’s a challenge to update laws as fast as technological developments.

This version is the latest in a draft law that has been open for comments. As of now, there has been no specific timeline laid out for when the draft will actually be turned into law.

As of now, there has been no specific timeline for when the draft will actually be turned into law.

The drafting process is done by officials from various different ministries who work with research institutes and academic experts. Having drafted the law, there was a period until May 9^th during which people could comment on this law either directly, informally or through trade and lobbying organisations.

What does the law include?

The law focuses heavily on plans to open up, reform and liberalise the energy sector in China. Foreign investment will be welcomed into the sector, which has traditionally been dominated by state-owned enterprises. Allowing foreign investment into the market will not only allow foreign companies to compete, but will also force Chinese companies to become more competitive.

“It is welcome that the draft law is to reform the energy sector and lower investment barriers,” says Dr Zhi Shengke, director of strategy and development at energy company Wood Plc. “British companies such as BP, Shell and Wood can take advantage of China’s energy market reform and introduce various technologies and engineering solutions to the sector. Meanwhile, this draft law delivers a clear message that the Chinese energy sector won’t just focus on energy security and energy transition, but also invest more on decarbonisation and digital solution. The government is sending a clear signal to domestic companies that they need to be more competitive in terms of technology and digital.”

“There is a welcome focus on low carbon development,” adds Henry. “There are new measures to monitor emissions and limit environmental damage and to promote low carbon technologies, including renewables. There is also a welcome focus on continuing market reform making markets more open and more competitive,” she says.

“However I think there are still a few areas that need more detail. At the moment the draft is still quite high-level and we’d like to see a bit more detail on how markets will be regulated, and the enforcement mechanisms for those,” she says.

But overall the law, “is about creating a more open, transparent, competitive market so that (both Chinese and international) private companies are able to compete with state-owned enterprises on more of a fair basis. State owned enterprises are going to have to make improvements if they are going to keep competing with private companies.”

What does it mean for British business and intergovernmental collaboration?

“This could be the start of the transformation,” says Dr Zhi. “A rapid energy transition is happening due to the impact of COVID-19, environmental pressure and the development of digital and decarbonisation technology. China is positioning to be a dynamic energy market, which is attractive to foreign investment.

“Over the last decade, many international oil companies, chemical companies and engineering companies have invested in the China market. Lower trading barriers means that cost benefits from using the latest technologies and supply chain are less constrained.  Hence, more low carbon technologies could be brought into the Chinese energy industry.

“In China, the overall energy demand is still growing but the energy production predominantly relies on coal for power generation, as it’s low cost and plentiful. It is delightful to notice that the energy law is to spearhead and develop decarbonisation technology and digital technology to reduce the greenhouse gas emissions while meeting developing nation’s growing needs for energy. I look forward to the transformation led by Chinese SOEs,” says Zhi.

Matt Ashworth, commercial counsellor for energy and infrastructure at the Department for International Trade (DIT) explains that new marketisation opportunities will arise for competitive businesses who are able to bring in international expertise and find collaborative projects.

“We have a lot of strong relationships in the energy sector between UK and China from large multinationals to SMEs,” he says. Companies like BP and Shell have been taking advantage of some of the opening up and the relaxation in terms of foreign investment into retail oil and gas markets,” he explains. “Both BP and Shell will be opening petrol stations in parts of China and both are actively looking at expanding their operations.

“Then you have new energy opportunities. Offshore wind is a key area of strength in the UK.” There are many major offshore wind programmes planned in China, Ashworth points out, and the UK has world-beating technology in this area. There have been some great examples of collaboration already.

For example a UK-China joint centre on offshore renewable energy has been established in Yantai, Shandong province in a collaboration between the UK’s Renewable Energy Catapult and TusPark, anchoring the relationship in science, innovation and trade as well.

“There are lots of opportunities on energy transition, not just from offshore wind, but other aspects of renewables, including energy storage and how that is transmitted and connected to the grid. Areas we have a lot of experience and expertise in, which we can share with China,” says Ashworth.

“Our strategy has a high alignment focusing on decarbonisation, energy transition and digitisation, including connected design, connected work and connected operation into China,” says Dr Zhi. “We are in discussion with one of our clients about how to digitise their large scale complex asset. We also believe there is a huge potential for offshore wind and floating wind in China. Therefore, the transformation for the Chinese energy industry is a welcome change as it is highly aligned with our expertise.”

Ashworth goes on to explain that there are many other interesting areas of innovation that the DIT are keen to watch develop, including a collaboration between BP and Chinese ride-sharing company Didi on electric vehicle charging stations in Guangdong.

Britain is a global leader in renewable and wind farm technologies

Another key UK strength is building a strong regulatory environment that creates certainty for investors and also being very open to international investment, explains Henry. “It goes both ways – it’s not just about the UK exporting to China but about the role that China can play in the UK’s own energy infrastructure. So whether that’s major projects like Hinkley Point C and the nuclear sector or investment into North Sea oil and gas, into offshore wind – there is a very healthy two-way relationship there on trade and investment, which underlines how much collaboration there is between the two countries that plays to our mutual strengths.”

“We have a lot of different types of collaboration, whether that’s science and innovation, or early-stage research; on policies and regulation and providing the right framework for investment into clean technologies; or on the DIT commercial side. It’s a broad range of collaborations, not just in Beijing but in all consulates (Shanghai, Guangzhou, Chongqing and Wuhan). Given that the UK has so many strengths on low carbon energy and China is also a global leader on low carbon energy, it’s a natural area for practical collaboration.”

International collaboration

The law also included a plan to set up a ‘cross-nation energy information service system,’ which will hopefully see China becoming more involved in international cooperation platforms and committing to open markets and foreign competition:

“Article 89 says that the energy department will establish an information platform for international energy cooperation,” says Henry. Our first response is to say that this seems to be a positive step and we would love to have more data transparency around how China engages internationally. It looks like a great initiative and if they are open to working with others on the platform then we would be interested to work with the Chinese government.”

However, according to Dr Zhi from Wood, there are still obstacles that could make collaboration difficult. “Cybersecurity is one of the hot topics in the energy industry in China. More and more, clients are required to keep their project data and engineering data in China, which is a challenge to international companies like Wood. A mega project normally requires global assistance, meaning project data often flies through systems that are located in multiple countries. If the data must remain within the Chinese border, it will take more time and push a higher budget.”

Dr Zhi also says that it is vital for China to think about how to retain the total values that can benefit social and economic development, contribute to the national capability, and stimulate productivity of local economy when more inbound investments come: “In-country values could help China to further develop its supply chain and benefit local communities.”

Britain has stringent long-term targets such as the legal commitment to reach net-zero emissions by 2050. Although China doesn’t have a net-zero target, it does have Nationally Determined Contributions under the UN climate change agreement, which fulfil medium-term contributions.

“The value of a long term net-zero target is something we are talking to China about as part of our wider climate change collaboration,” says Henry. “There’s some very positive activity at the sub-national level, with some cities and regions adopting very ambitious targets and plans for low carbon development. This draft law doesn’t include a net-zero target, but the focus on low carbon development and measures to integrate renewables integration and greater use of clean technology does lay the foundation for moving towards this in the future, so that’s really positive.”

Finally, Ashworth is keen to point out that this law is just a draft, and that ultimately, we will have to see how it is implemented and how it might work in practice:

“There’s a lot of interest in what it might mean for the next stage in terms of goods and services that we might be able to provide, and business environment or market access issues. And that’s what we (DIT) are here to help with,” he says.

The post What does China’s new draft energy law actually mean? appeared first on Focus - China Britain Business Council.

It seems to be working. Already the Chinese government has reduced value-added tax across a range of industries thanks to the additional tax revenue coming in, and stronger enforcement is also seen as a key factor in plans to further reduce corporate income taxes and various social security rates.

A brief history of Chinese tax reform

Beginning with the “Golden Tax 3” plan in 2016, which officially transitioned China from being a “fapiao driven tax system” to an “information-driven tax system”, the new tax policies signal a new era for taxation in China. Chiefly characterized by increased financial oversight and greater efficiency when identifying tax evasion and resolving tax disputes, the “Golden Tax 3” reforms also allow tax authorities to include the personal bank account of a business’s legal representative within the scope of a company audit.

Since July 2018, China’s state and local tax bureaus have been integrated, allowing them to consolidate the sets of data from different financial reports filed by a business. This restructuring has significantly improved the efficiency of tax administration, enabling speedy identification of inaccurate reporting and the quick resolution of tax disputes.

It is this kind of administrative restructuring and data sharing across different government bodies that is going to make taxable income more difficult to manipulate and revenue harder to conceal. For many businesses, this will mean paying more taxes. However, as a direct result of the additional tax revenue collected, the tax authorities have announced they will be further reducing corporate tax rates later in 2019, so the tax burden will be reduced for those who are already accurately declaring their tax.

Reform will bring benefits to foreign companies in China who currently adhere to the regulations and pay their taxes

From February 2019, the Peoples Bank of China (PBC) began abolishing the “Corporate Bank Account Opening License” in Jiangsu Province and Zhejiang Province, and will have abolished it nationwide by the end of the year. Originally intended for the central bank to exercise control of all new accounts created in China, with the cancellation of the license, the Chinese central bank will instead exercise control through increased monitoring of both company and personal transactions on a day to day basis. Transactions that exceed predetermined amounts and frequency will be flagged and reported to the PBC for investigation. The predetermined limits are as follows:

• Corporate bank account: A single or cumulative transaction that reaches or exceeds RMB 2 million in a single day.
• Personal bank account: A single or cumulative transaction that reaches or exceeds RMB 500k for domestic transactions in a single day; RMB 200k or USD 10k for overseas transactions in a single day.
• Cash transactions: A single or cumulative cash transaction that reaches or exceeds RMB 50k in a single day.

It’s not uncommon for legitimate transactions to exceed these preset limits and is therefore essential that businesses have sufficient evidence to support the authenticity of transactions if questioned.

Building a credit system

The Chinese government has also been working to build a social credit system within the business environment. Real name authentication for legal representatives, business owners (including the “real” business owner if the majority shareholder is a placeholder), registered finance directors, and even the registered tax accountants have been made an important part of this. Complete and accurate financial reporting has, therefore, become very important for the business owner and the accountant as it directly impacts their personal credit.

Detailed within the Measures for the Information Disclosure of Major Taxes and Untrustworthy Cases (State Administration of Taxation [2018] No. 54) are the thresholds for tax evasion and dishonest behaviour that will result in a credit rating decreasing to class “D”, the lowest class. These include:

• An accumulated tax shortage in excess of RMB 1 million, or exceeding 10 percent of the total tax payables in a year.
• Preventing the authorities from collecting overdue taxes exceeding RMB 100k.
• Either issuing over 100 pieces of false VAT fapiaos or false VAT fapiaos that amount to RMB 400,000 or more
• Other serious violations of tax law with a significant social impact

Companies with a credit rating of D will not only face many difficulties in their business operations but these will also affect the owner and responsible accountant’s personal life. Such restrictions include limitations on travelling outside of China, reduced access to loans, domestic travel restrictions and limited access to their own cash. Thus, proper financial management has become very important for the business owner and also accountants.

Eventually, reform will bring benefits to foreign companies in China who currently adhere to the regulations and pay their taxes. The flip side of this is that, with more stringent oversight, it will be increasingly common that poor accounting practices and non-compliance will result in financial penalties. Business owners are therefore advised to review their compliance status and correct any issues sooner rather than later.

By Lily Li, FCCA, managing partner and director of small business finance advisory at Axel Standard. She has an MBA in finance and has served as CFO for multiple MNCs in China.

 For more information about tax issues speak to CBBC’s Avi Nagel on avi.nagel@cbbc.org

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In December 1978, China’s leader Deng Xiaoping, announced that China would start a period of ‘Reform and Opening Up’. This policy sees a de-collectivisation of agriculture, allows foreign investment into the country, and permits entrepreneurs to set up private businesses. By the early 1990s, certain policies and regulations were lifted and state-run businesses were privatised allowing the private sector to boom. The transformation was, as Lord Michael Heseltine says “on a scale without human precedence.”

Year on year, double-digit GDP growth was the norm for much of the 1990s and 2000s and over the last decade, the Chinese economy has tripled in size. Britain has benefitted from China’s growth over this time, with UK-China trade more than doubling from £32 billion in 2008 to £67 billion in 2017.

“The reform and opening up creates huge opportunities for China’s international trading partners and the UK benefits deeply from that,” said the UK’s Ambassador to China, Barbara Woodward.

“The UK economy is very strong in financial services, legal services, education, tourism services and so on. As China opens up in years ahead, that will really help UK-China trade and investment grow even further,” she said. “As the Chinese economy opens to the services sector it will obviously be beneficial to the UK but also for China because it will then be able to develop a more balanced economy and indeed a more cutting edge one.

“As China opens up or relaxes its restrictions on Intellectual Property development, R&D collaboration and demonstrates that it really can protect intellectual property then I think there is more scope for collaboration between UK and China in that area.”

During last month’s British Business Awards, organised by the British Chamber of Commerce in Beijing, a new award was established to celebrate the anniversary of China’s Opening Up.

The winner of the 40 Years of Reform Award was Rolls Royce. The engine maker has been operating in China since 1963 when it was making engines for China’s Vickers Viscount aircraft. Today, China has become the company’s second largest market making up 12 percent of its global revenue.

“Reform and opening-up has connected China to the world in an unimaginable way,” says Julian McCormack director of Rolls-Royce China.

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