Victor Shih is one of the few Western scholars who has a strong understanding of how the different factions in the Chinese government influence and affect economic policy decisions.  He took some time out of his busy schedule to answer a few of our questions on how different government factions have shaped and will affect the most recent economic stimulus plan going forward.

TCP: In your posts and writings you’ve done a good job of explaining how the Chinese government can’t be looked at as a single entity but instead is a group of factions each with their own agendas and priorities from both a policy perspective and in terms of the tug-of- war for resources.  Can you give us a brief overview of these factions or at least the ones which are likely to be the biggest players in helping the Chinese economy get through the current global slowdown?

Hi, currently, the most influential faction are the princelings.  They are close to the property developers and private enterprises because many of their friends and relatives are in business.  Thus, they have put enormous pressure on Premier Wen to relax monetary policy. 

Like in the past, there is a faction of central technocrats whose main interest is to control inflation, and this faction is now led by Premier Wen (Zhu and Chen Yun before him).  They are losing influence because inflation is falling, and growth is slowing.

TCP: Since 1998, when the government had a big role to play in supporting the economy during the Asian financial crisis, what changes have taken place in terms of which government departments are dictating policy.  And how much more, or less, control do they have over the economy?

I think their influence is more now due to strong growth in fiscal revenue.  For the past few years, fiscal revenue growth, most of which accrued to the central government, has grown at twice the speed of GDP growth.  Thus, central budget is now a much higher share of the economy than before.  So, the government has greater capacity to generate growth through investment.  However, this type of investment tends to be extremely wasteful and may not be a sustainable engine for long term growth.

TCP: Even with these increased resources the Central government has left a majority of the economic stimulus to be funded by local governments.  What frictions do you see between local government and central government policies in terms of promoting economic growth?

Obviously, the central government has an interest in seeing central money used where it is supposed to be used.  However, local governments may want to siphon some of the money to repay the debt of local SOEs.  This is going to be a huge problem for public services provision.  The central government wants to boost things like rural health care with some money.  Local governments in some places will siphon some of the money toward construction or paying off debt. 

TCP: As part of the government’s recently announced US$586 billion fiscal stimulus package the government has lifted the ceiling on bank loans to ensure cash-strapped smaller provinces can access investment financing (most of the stimulus package will be funded at the provincial government and private sector level). Can you see a potential downside to this move, such as a new round of non-performing loans and what repercussions might we see from these downsides?

Yes, this will create problem for the future.  Banks will now predominantly lend to government investment companies, since these loans will have implicit guarantees.  The problem si that government investment companies will turn around and invest the money into real estate or high interest loans.  Also, the center is encouraging banks to lend to SMEs, which are in trouble.  With no end in sight for the global recession, many SMEs will go under, generating NPLs. 

TCP: How do you think the current global financial crisis will reshape economic policy in terms of a shift of power from one faction to another, and what will be the likely repercussions of such a shift?

Basically, the princelings are bearing down on Wen for reacting too slowly.  Hu Jintao is sitting on the sideline while Wen gets criticized.  Basically, if Wen is weakened, Li Keqiang benefits by getting more power from Wen. 

If Wen were to be significantly weakened would there still be a group technocrats who would be in a position to advocate for lower inflation and how might Li Keqiang’s economic policies differ from Wen’s?

Li Keqiang, having served several stints as provincial administrators, will be much more sympathetic to the interests of the provinces.   However, if he is indeed going to take over Wen’s job, he has to establish a reputation for being a tough centralizer.  This is a hard time to do so now because the elite has decided to pull out all the stops to revive local growth.  As such, besides the issue of monitoring local implementation of central projects, there are not so many sources of conflict between the center and localities for now.  When inflation spikes up again, however, he will need to somehow establish his own reputation as a tough centralizer.