China’s Governance Model and Market Reforms: Insights from the Third Plenum of the 20th Central Committee

The 3rd Plenum of the 20th Central Committee of the Chinese Communist Party (CCP), held in July 2024, issued a Resolution of the Central Committee of the Communist Party of China on Further Deepening Reform Comprehensively to Advance Chinese Modernization (hereinafter, the Resolution). The Resolution can provide insights into the direction of China’s economic and political strategies for at least the next five to 10 years under the leadership of Xi Jinping. Below I provide some potential lessons and takeaways from this Plenum, with the focus on the role of market and government in China’s economy. This essay reflects what I wrote for China Currents 10 and five years ago, respectively, on the earlier 3rd Plenums (Liu, 2014 & 2019). In the original essay (Liu, 2014), I pointed out that the dominant role played by state ownership stated in the Resolution (or Decision) contradicts somewhat with the decisive role of the market in the same Decision. In 2019, I expressed concerns about a constitutional change which removed the term limits for top leader in China; and, on the economy, I expressed concerns about the emphasis on state-owned sectors and industrial policies.

This article continues the discussion on similar topics. My main concern is still the apparent contradiction between deepening the market reform and a larger role of the government in the economy. More specifically, while there are promising signs of domestic market opening in areas such as commerce and labor markets, and potential for greater foreign firm presence in certain sectors and regions, the plenum’s emphasis on the government’s role in industrial policies may undermine its growth objectives. This approach could restrict transparency and innovation, potentially hindering China’s domestic and international economic aspirations. The resolution emphasized enhancing higher-standard opening up and expanding international cooperation, signaling a commitment to continued reform and opening policies. However, specific details on policy changes were not disclosed, suggesting that no drastic policy shifts were immediately expected.

On the economy, the Plenum covers continued comprehensive reforms, high-quality growth, industrial policy, welfare system reform, and state vs. private sectors, etc. Some policy changes are anticipated. For example, the Plenum emphasized the need for a transition from rapid economic growth to high-quality development. This includes prioritizing innovation, technological advancement, and sustainable practices over sheer GDP growth rates. Beijing has realized that economic growth is no longer its singular priority, as long as it can keep a baseline growth rate to sustain population growth, consumption, investment and social responsibility. The Plenum also reaffirmed the “common prosperity” agenda, which aims to reduce income inequality and ensure that the benefits of economic growth are more evenly distributed across society. This may involve more targeted social welfare programs, tax reforms, and efforts to uplift rural areas. Considering China’s still relatively underdeveloped welfare system, the government’s increased involvement in these areas is understandable.

However, in other areas, caution should be exercised when expanding government’s role. For instance, China will continue to upgrade its manufacturing capabilities in large measure by focusing on innovation and reducing dependency on foreign technology, but likely through top-down and centralized industrial policies. Quality upgrading has become one of leading goal of China’s next phase of economic development. This includes investment in critical sectors like semiconductors and green technologies. China has achieved some success in several sectors such as green technology and electric vehicles (EVs) in recent years, and even before Xi Jinping in sectors such as shipbuilding through top-down and centralized industrial policies. Although it is widely recognized that industrial policies often fail due to governments’ inability to accurately identify successful sectors, leading to misallocation and waste of resources, these policies have seen a resurgence in recent years. This revival is driven by the need to tackle diverse challenges such as the green transition, supply chain resilience, the creation of quality jobs, and geopolitical competition. (For a recent comprehensive review of the literature on industrial policies, see Juhász, Lane, and Rodrik 2024.)

These centralized industrial policies could also escalate trade tensions and prompt retaliatory measures from other nations. In earlier decades, the West was generally accommodating toward China’s industrial policies, perceiving no immediate threat when China was far behind in scientific research and innovation. However, the gap was rapidly closed in some areas. In recent years, particularly after the launch of the Made in China 2025 plan, Western nations began to scrutinize these policies more closely and respond with countermeasures including their own industrial strategies, such as the EU’s Digital Decade and Industrial Strategy in 2020 and the U.S. CHIPS and Science Act in 2022. Bilateral and multilateral negotiations could help alleviate tensions among major economies if industrial policies, such as government subsidies, are made transparent. A precedent for this is the Boeing-Airbus subsidy agreement between the U.S. and the EU, which demonstrated how clear terms can ease conflicts. Liu (2019) discussed the additional complications in potential disputes between China and the Western economies in trade, intellectual property rights, production and export subsidies, arising from the lack of transparency in China.¹ For instance, the WTO said earlier this year that it was unable to get a clear picture of China’s financial support for key industrial sectors, such as electric vehicles or aluminum and steel production due to an “overall lack of transparency.”² If China and Western countries cannot reach an agreement on industrial policies such as subsidies — owing to differences in economic and political systems and a lack of transparency — these policies could escalate trade tensions and prompt retaliatory actions from other nations, as shown by the new tariff measures on Chinese electric cars by the EU. This can even lead to trade wars or sanctions that ultimately harm the very industries the policies were meant to support. China’s deteriorating relations with the collective West have already restricted its future access to markets and technological innovation. In response, Beijing is relying on a “national system” strategy by mobilizing all available national resources to support domestic high-tech sectors; and the West also came up with a list of support for their own sectors (e.g., microchip sectors in the U.S.), which may lead to a global “subsidy war.” The result may not be in China’s favor, especially if the West works collectively with an aim to alienate China (or decoupling). To enhance transparency and fair competition, China should implement policies on public consultation, independent audits, and data sharing, avoid state-driven market distortions, and reduce subsidies and preferential treatments that disadvantage foreign and private firms. China should also strengthen IP protection to safeguard innovations and foster a culture of creativity.

China possesses several strengths in innovation, including a large domestic market, ample supply of STEM students and professionals, and strong public support for quality improvements. China’s advancements in sectors like electric vehicles and artificial intelligence have positioned the nation at the forefront of global technological competition. Despite its impressive economic growth and advancements in technology, China also faces several challenges in its quest to become a global innovation center. As we can see from the Resolution, some of the obstacles to innovation remain. First, heavy state intervention in the economy, particularly through state-owned enterprises (SOEs), can stifle competition and innovation, but this is precisely the approach China plans to follow as stated in the Resolution. While state support can provide resources, it often comes with strict supervision and bureaucratic inefficiencies along with a lack of market-driven incentives. For instance, the Chinese government has actively integrated DeepSeek’s AI models into various state-owned enterprises and municipal government systems, reflecting strong institutional backing. However, China’s emphasis on technological self-reliance and stringent data governance policies may have complex implications for its global growth. Second, the regulatory environment in China can be unpredictable, with frequent changes that can create uncertainty for businesses, as shown by the frequent shifting public attitudes toward private firms in recent years.³ Innovation thrives in stable environments where companies can plan long-term strategies without fear of sudden regulatory shifts. Third, improved but still weak IPR enforcement in China can deter both domestic and foreign innovators from investing in research and development, as they fear their inventions might be copied without proper legal recourse. Related, the copycat culture (i.e., imitation is often favored over innovation) reduces the incentives for companies to invest heavily in original R&D. Fourth, censorship and restrictions on free speech in China can limit the flow of information and ideas, which are crucial for innovation. Fifth, growing geopolitical tensions, particularly with the West, can limit China’s access to international collaboration, markets, and advanced technologies. Restrictions on Chinese companies in key markets, coupled with a more inward-looking approach, could hinder China’s ability to become a global innovation hub. Finally, there are related factors on culture and education system (e.g., respect for authority and hierarchy, risk aversion, and focus on rote learning). Therefore, while China has the resources, talent, and ambition to become a global innovation leader, these challenges create significant obstacles. Overcoming them will require not only continued investment in technology but also deep structural reforms to foster a more open, competitive, and collaborative innovation environment.

Chinese government, both at the central and local levels, will likely continue to play a large role in production and wealth distribution, especially in sectors considered the “commanding heights” of the economy. One of the obvious obstacles, however, is funding. China’s economic woes are already exacerbated by persistent fiscal deficit, especially at local level. Many local governments are now facing severe financial strain, leading to cutbacks in essential services and delays in paying civil servants. In response, Beijing is urging local authorities to get their finances in order and reduce off-balance sheet debts. Without major fiscal reforms to establish reliable and sustainable revenue sources, these governments will likely need to drastically curtail infrastructure spending and other critical investments. Reforming fiscal and taxation systems is crucial to securing sustainable funding for central and local governments, especially as the ongoing recession in the real estate sector erodes land sale revenues — a key income source for many of these governments in previous decades. The current policy of issuing long-term central government bonds to gradually replace local government debt will also be maintained as part of this comprehensive strategy. With debt levels reaching crisis points in some regions, the scope for government to support target sectors through subsidies and other fundings may be limited.

On politics, the Plenum reinforced the idea that the CCP’s leadership is central to China’s governance model. This includes emphasizing the importance of Party discipline, and the integration of the Party into all aspects of governance and society.In line with recent trends, the Plenum underscored the importance of maintaining national security, including cybersecurity, economic security, and ideological control. This reflects concerns over both domestic stability and external pressures. There is a continued emphasis on controlling social narratives, reinforcing CCP ideology, and promoting social cohesion under the Party’s leadership. This includes regulating online spaces and managing dissent to prevent social unrest. This governance model determines a special relationship between market and government, that continues to make China special compared to western market economies.

On China’s foreign policy and global positioning, the Plenum reiterated the importance of self-reliance, particularly in critical technologies and industries. This ties into the “dual circulation” strategy, which focuses on boosting domestic consumption while maintaining strategic engagement with global markets. Self-reliance is a double-edged weapon, improving China’s negotiation power in global commerce if successful, while at the same time running the risk of losing its central position in global value chain and international specialization based on its comparative advantage. Second, the Plenum addressed how China plans to navigate global challenges, including geopolitical tensions, trade disputes, and the impacts of climate change. Adapting foreign policy (e.g., U.S.-China and Russia-China relations), economic strategy, and domestic governance in response to these challenges remain crucial. Third, China will likely continue to expand its influence through initiatives like the Belt and Road Initiative (BRI).⁴ On one hand, the BRI involves massive investments in infrastructure projects, which can significantly enhance connectivity, facilitate trade, and accelerate economic development in participating countries. It also allows China to extend its geopolitical influence by strengthening economic ties with participating countries. On the other hand, many BRI projects are financed through loans from Chinese banks or other financial institutions. Participating countries may face significant debt burdens, leading to concerns about debt sustainability and potential “debt traps” where countries are unable to repay loans.

After addressing the above concerns, I would like to highlight several positive aspects of the Resolution. First, in the Resolution, Beijing intends to ease the tension with private and foreign firms in high-tech sectors. For example, the Plenum is expected to result in a further reduction of the negative list for foreign investment and provide additional incentives for doing business in China’s free-trade zones. In the past, the CCP under Xi Jinping has implemented policies that favor SOEs, aiming to reinforce the Communist Party’s control over the economy and mitigate what it views as risks associated with free market. The intention to ease tensions with the private sector is an encouraging sign. Second, the Resolution highlights the importance of an integrated national market. The unification of its national market through the elimination of internal barriers to commerce could help to unleash the potential for enhanced domestic production, distribution, and consumption. Although the labor costs in many coastal areas and major inland urban hubs have increased significantly over the last few decades, other areas have lower labor and living costs. It is critical for China to establish a cohesive national labor market and reform the restrictive hukou (household registration) system. By enabling a more efficient and equitable allocation of labor across the country, such reforms would significantly boost labor productivity.⁵ It is stated in the Resolution that, “Integrated urban and rural development is essential to Chinese modernization. We must pursue coordinated progress in new industrialization, new urbanization, and all-around rural revitalization, facilitate greater urban-rural integration in planning, development, and governance across the board, and promote equal exchanges and two-way flows of production factors between urban and rural areas, so as to narrow the disparities between the two and promote their shared prosperity and development.” Third, advancing land reforms that allow farmers to benefit from rising land values is key to fostering urban-rural integration. Although these opportunities cannot help China to bypass the market-government issue discussed above, they could buy China more time to correct the issues under Xi Jinping through political and economic reforms. China is a vast country with tremendous opportunities. Its central position in the global value chains is indispensable, at least in the short term. If proper policies are in place, China still has the potential for continued growth at a steady rate.

Overall, the Resolution outlines the government’s ambitious objectives, but it contains contradictions in several areas. The emphasis on industrial policies, along with political and social controls, does not appear to align with the aim of deepening and comprehensive reform. On the contrary, these measures are more likely to intensify global concerns about China’s growth model and exacerbate societal anxiety within the country. Although some of these measures are arguably a response to unfriendly Western policies toward China in recent years (e.g., restrictions on chip exports to China), the top leadership under Xi Jinping could have managed better these tensions by adjusting its domestic and foreign policies. For example, to regain trust from the West and maintain its position in global value chains, China should consider reversing the recent constitutional changes to reinstate term limits for its top leader and reassess its relationship with Russia, especially in the context of the Russia-Ukraine war; additionally, China should continue to reform its governance model by enhancing policy transparency. China cannot afford to decouple from Western economies, which serve as the center of technological innovation and are also its largest export markets. China’s real challenge today is to implement policies within the framework of the Socialism with Chinese Characteristics to balance the roles of the market and government and reestablish society’s confidence in market reform.

Reference

Funabashi, Yoichi, 1988. “Managing the Dollar: From the Plaza to the Louvre. Peterson Institute for International Economics, Washington D.C.

Juhász, Réka, Nathan Lane, and Dani Rodrik, 2024. “The New Economics of Industrial Policy.” Annual Review of Economics, 16: 213-242.

Liu, Xuepeng, 2014. “Market vs. Government in Managing the Chinese Economy.” China Currents 13(2).

Liu, Xuepeng, 2019. “Market vs. Government in Managing the Chinese Economy: Domestic and International Challenges Under Xi Jinping.”China Currents, 59.

Naughton, Barry. 2021. The Rise of China’s Industrial Policy, 1978 to 2020. Boulder, CO: Lynne Rienner Publishers.