10 Things You Need to Know About Third Plenums

7. Government reform may well be the focus in 2013.

"Give me a lever and the right place to stand, and I can move the world." So said Archimedes, allegedly. We guess that Premier Li would agree.

Based on discussions in Beijing, we believe much of the strategic discussion among reformers in 2012-13 has focused on how to generate self-propelling reforms -- policy changes that generate momentum for other changes to the growth model.

We believe the lever in this case is government reform. We hope the Third Plenum document will include an extended section on this area that deals with the following issues:

• Streamlining government. China has five levels of government, each with their own budgets and staff. Experiments to reduce these to three -- central, provincial and county -- have been conducted in some 900 counties over the past few years. Zhejiang Province is leading the way.

Streamlining government reduces needless repetition of functions and saves costs. Beijing may press ahead with slowly reducing the budgetary autonomy of prefecture and township governments in other parts of the country, too. Once these budgets are controlled by other parts of the government, wasteful spending should fall. We note with interest what Shandong province is doing in this regard. From this September, the provincial government will allow counties to retain the bulk of new corporate and individual income tax revenues, the Economic Observer reported. Previously, all taxes were shared among the province, prefecture and townships, based on fixed ratios. The idea is to increase fiscal responsibility at the local level, provide funding to pay for local public services such as education and health care and gradually defund the middle tiers of government. Shandong is now run by Guo Shuqing, who worked with Zhou Xiaochuan and Lou Jiwei on reform in the 1980s.

• Re-orienting government functions. The core of this idea, championed by Vice Premier Wang Yang when he worked in Guangdong Province, is to steer the government away from direct intervention in the economy. Premier Li has reportedly already approved several rounds of cancelling requirements for certain approvals and licenses. Opportunities for corruption naturally decline as these powers are scaled back.

• Providing sustainable sources of local fiscal resources. Ensuring that county governments have the funds they need to provide public services may require raising local taxes -- the main idea behind the much-discussed property tax -- and weaning them off their reliance on land sales. Another idea circulating in Beijing is to centralize some of local government current spending responsibilities. It makes sense for Beijing to assume greater responsibility for primary and secondary school spending, for instance. At the very least, the central government should give extra funds to cities to encourage them to integrate rural migrants into their social welfare systems.

• Creating disciplined budgets that ensure money is well spent. China's government budgets are generally a bit of a mess. They are usually late, always lacking in detail and often unsupervised. Good ideas being discussed include:

§ More detailed and transparent budgets. "Want to issue a local government bond? Let's see your financials then."

§ Medium-term fiscal planning so that local governments are forced to budget for future liabilities

§ Government asset audits. We know even less about local government assets than we know about local government debt.

§ Independent assessments of government spending

• Improving evaluation of local cadres. Something has to change here, in our view. Evaluation has to be shifted from spending to outcomes and from infrastructure to the quality of government services.

• Sorting out local government debt, now and in the future. A formal framework for local government debt is likely to be introduced in the next three years, including debt amounts, repayment sources, guarantees and debt-to-equity ratios. The numbers will be collated and monitored by the Ministry of Finance. In the short run, central government officials have made it clear in public comments that they expect local governments to pay off their own debts rather than

being bailed out. Central controls on access to increased credit facilities for infrastructure vehicles, though not waterproof, appear to be having an effect. This stance is already triggering sales of local state assets.

• Finding ways to allow private-sector participation in infrastructure projects.

Instead of building infrastructure through off-balance-sheet vehicles, thought is also being given to how to encourage private firms to build. This would require clear contracts with local governments, bringing officials' liabilities into the open.

The core idea behind all these measures is to limit administrative involvement in the economy at the local level, reduce government staffing, limit the ability of local governments to become indebted and push more resources towards social spending. All this should promote further change in the growth model.

8. Enterprise reform is still a sensitive subject, and is unlikely to appear explicitly in the plenum document.

The last plenum to trigger serious state-owned enterprise reform took place in 1993. The meeting signed off on the development of a "modern enterprise system," a phrase that opened the door for private companies to grow, small state firms to be sold, and large SOEs to incorporate, list and get much bigger. The 1993 plenum was critical to re-establishing economic reform momentum after the crackdown of 1989. Under Deng's watchful eye, Party Secretary Jiang Zemin presented the "Decision on Issues of Building a Socialist Market Economy." which called for "the market to be a fundamental factor in the disposition of resources under state control." This marked a clear break from the planned economy and public ownership.

We do not expect SOE reform to be explicitly discussed in the 2013 Third Plenum document. The subject is too sensitive. We think of SOE reform as a Darwinian process rather than something to be prescribed in a document or tackled head-on.

The idea appears to be change the environment in which SOEs operate so that they either adapt or die. Policies like raising utility prices, cracking down on overcapacity by steering banks away from certain sectors, introducing interest rate reform and opening up sectors like rail and health to private-sector competition all change the relatively comfortable environment in which many SOEs operate.

Squeezing local government investment vehicles will force local governments to sell off state assets. A first wave of sales of hotels, malls and office blocks has begun. We expect the second wave to involve industrial assets. Corruption investigations into a wide range of sectors -- pharmaceuticals, petrochemicals and telecoms, for instance -- may open the door for more serious SOE reform.

The likely outcome and the goal of reformers are that SOE reform will be facilitated, quietly and indirectly, by other reforms. The only problem with evolution is that it usually takes ages and the results cannot be predicted.