Unveiling China's Political Structure and the 19th Party Congress

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1 OCT Unveiling China's Political Structure and the 19th Party Congress Tracy Chen, CFA, CAIA» China s 19t h Party Congress has convened, and the transition of party leadership is critical for the future direction of where the world s second largest economy is heading. A substantial part of our global outlook is predicated on China s economic health, and the policies of 19t h Party Congress will play a significant role in the country s growth trajectory. The goal of this blog is to lift the veil from the oft opaque political structure of China s Communist Party by sharing the key signs on what we will be watching for during and after the 19t h Party Congress, and then explaining four important aspects of the system. What to Watch for in the Outcome of the 19t h Party Congress We don t foresee a big policy change as the 19th Party Congress transitioned to power. As the new congress was unveiled, we have already seen Xi Jinping focus on raising China s profile on the world stage, and talking about a globally shared destiny. His globalist rhetoric stands in stark contrast with increasingly domestic-focused policies from the developed world. What is interesting is that both China and developed markets have struck a nationalist tone in their policymaking, but with very different outcomes. Xi wants to elevate China to the status of a world superpower while also renouncing any potential shift toward democratization. Overall, he envisions a new era of Sino-socialism, one that will consolidate the party s power and mainland China s power which should help Xi achieve his ambitious agenda. Part of his detailed plan, a Beautiful China, was outlined in his report, Secure a Decisive Victory in Building a Moderately Prosperous Society in All Respects and Strive for the Great Success of Socialism with Chinese Characteristics for a New Era. Xi s pledge for a Beautiful China encompasses environmental reform, technological advancement, and income equality. China will undoubtedly need economic growth to fund his ambitious infrastructure reform. While Xi was reticent in pegging Chinese gross domestic product growth (GDP) to a specific target, he did pledge to spur consumption in his ongoing effort to transition the economy away from manufacturing further liberalize markets to foreign investment, and tackle the speculative nature of the real estate market. However, Xi has yet to address deleveraging, particularly for debt-laden state-owned enterprises (SEOs). Once the 19t h Party Congress adjourns in one week, here s what we will be watching for over the next few months: Institutionalization: Whether Xi can truly establish the rule of law and rule of institutions rather than continue with the personalization of power will be a very important factor in determining China s political future. Succession: We don t expect Xi to hint of his intention to serve beyond his second term in the near future, for fear of disrupting the succession plan. The fact that the sixth generation leaders were put in place in various Party leadership levels bodes well for his succession plan. If Wang Qishan stays, that should be a bullish sign in the short-term, as Wang is a very capable leader, but a bearish sign in the long-term as it portends the rule can be bent and Xi can indeterminately stay beyond his second-term. Re-centralization: Xi has re-centralized leadership with less tolerance for dissent, which also reflects his sense of insecurity and the constraints on his reform agenda. Factionalism: The current scandal, uncovered by exiled billionaire Guo Wengui and revolves around Wang Qishan, is a sign of the infighting between the two factions. If the PSC is balanced by two factions, Xi s power will be weakened and he will face challenges and constraints; he may not be able to implement his agenda smoothly. If there aren t two factions to balance each other in the Politburo, there could be a winner-take-all strategy, whereby Xi could become the core of everything. In other words, there would no longer be a system of checks and balances to limit his power.

2 1. Political structure: Hierarchy and composition The Chinese Communist Party (CCP) holds a monopoly on power, and yet the party only has 89 million members, which is 6% of China s population. The party leadership is not a monolithic group, and the system is based on meritocracy. Party leaders are selected from a range of political institutions, socioeconomic backgrounds, professional credentials, geographic locations, and political orientations: Forty delegations were formed out of the 89 million party numbers to select the 2,300 Party Congress members. The 40 delegations are selected to enable a broad range of representations from the following areas: Regions: 22 provinces, five autonomous regions, three municipalities, two special administrative regions (SARs) Hong Kong and Macau and six special economic zones. Institutions: central party organs, central government, national level state-owned enterprises (SOEs), national level banks, the People s Liberation Army, the People s armed police, and ethnic Taiwanese. The 2,300 members of the Party Congress then select 350 members of the Central Committee, who then select 25 members of Politburo. The center of the decision-making body is the seven-member Politburo Standing Committee, which is headed by the core leader, Xi Jinping, who is the General Secretary of the Party, the President of the Central Government and the Chief of the Central Military Commission. He is also known throughout the world as the President of the People s Republic of China. The core leader designation was only previously used by Mao Zedong and Deng Xiaoping. This title suggests that Xi has consolidated his power in his first term, but this does not mean his power should be overstated. Xi still faces constraints. The simple fact of his accumulating so many titles also shows his sense of insecurity.

3 2. Dynamics of Party Leadership China s CCP leadership is very dynamic with unusually high turnover. The average turnover rate is about 65% in recent years; the rate this year is as high as 70% due to the anti-corruption campaign. The campaign is designed to pump new blood into leadership and avoid stagnation within the system. Control Mechanism for Membership Leadership roles have a two-term limit, with five years in each term. Terms are longer than a lower-house U.S. congressional term, because the Chinese government believes a longer-term ensures policy continuity and allows the leader to have a more long-term focus. In addition, there is an age limit on members of 68 years. The Paradox of Institutionalization versus Personalization Xi s predecessor Hu Jintao s regime was based on consensus, collective leadership, and institutionalization; however, it did not end well because of pervasive corruption. Xi reversed the trend and re-centralized power. We think it s worth monitoring what Xi will want his legacy to be, particularly as the 100th anniversary of the Communist Party is looming in 2021, and even further down the road in 2049, when the People s Republic of China will celebrate its centennial. Chinese System of Checks and Balances The CCP consists of two factions: the Youth League faction versus the princeling faction. Hu Jintao and Li Keqiang belong to the Youth League faction; Xi Jinping and Jiang Zemin belong to the princeling faction. The Youth League faction is more populist whereas the princelings are more elitist. The two subdivisions have always balanced each other in the power struggle and they complement each other with different skillsets and backgrounds. Evolution of the Leadership Composition There are three trends in the composition of Party leadership: 1. The shift away from technocrats to professionals specialized in social science. As China needed technocrats to industrialize and quadruple per capita gross domestic product (GDP) in Deng and Hu s era, China now needs leaders with social science backgrounds to deal with rebalancing its economy and social problems like wealth redistribution.

4 2. The shift away from coastal area leaders to the hinterlands: this regional migration has also been dictated by the shift of the center of growth from coastal areas to the country s interior. 3. The shift away from leaders who held stewardship positions at SOEs to high-ranking provincial roles. This change reflects the shift in focus from SOE to provincial chieftains who have passed Xi s hardship test a series of hardships and adverse experiences his chosen leaders must undergo. Top party leadership is also known collectively as the Politburo Standing Committee (PSC). These charts below show how the demographics of this group have changed over three decades according to the three trends listed above. 3. China s Paramount Leaders: An Evolution of Five-generations of Leaders There are six generations of CCP leadership, and the behavioral characteristics, mind-set, and political agendas of each leader reflect the difference in his ideological formative years. First generation leader: Mao Zedong An emperor who constantly purged and purified the party with revolutions and class struggles; Mao focused on smashing the atom to release enormous energy to do miracles. He had strong confidence in the capabilities, resilience, and tolerance of the Chinese people. Mao created chaos and famines he was a total failure on economic matters. Based on what he perceived as humiliating foreign relations from prior centuries, Mao did not trust foreign

5 powers, but he dared to let barbarians fight barbarians and juggled between two superpowers with nuclear capabilities during the Cold War. Mao established China s military prowess despite the country s rampant poverty. Second generation leader: Deng Xiaoping He was not obsessed with titles; instead, Deng was sick and tired of the class struggles from Mao s era. He was very pragmatic in liberalizing and releasing the economic incentive of labor productivity, stating, Let some people get rich first. Deng opened up and reformed China s economy. Third generation leader: Jiang Zemin Born before 1949, Jiang was ideologically less dogmatic, and more open to new ideas because of his bourgeois intellectual background. Fourth generation leader: Hu Jintao Considered the good kid of the Party, Hu s formative years were in the 1950s, the golden age of the Communist party, during which time he was trained to be loyal and obedient. Hu was low key and reserved, focused on collective leadership and consensus-based decision making. He relied on technocratic competence. Fifth generation leader: Xi Jinping He is a princeling, as his father was a revolutionary general. Xi s leadership is more confident, assertive, and bold; these traits are reflected in his recentralization of power and assertive foreign policy. The hardship he endured when his father was purged by Mao surprisingly internalized Maoism into his second nature and internalized the Party doctrine in his psyche. Xi was and still is obsessed and paranoid with the collapse of the Soviet Union, and wants to reestablish the legitimacy of the Party by rebuilding it through an anti-corruption campaign and reviving the ideological doctrine of communism. He views the Soviet Union as a cautionary lesson, and does not want China to follow the same path. Contrary to the goal of his predecessors who focused on building a moderately prosperous China by quadrupling per capita GDP per capita by 2020 Xi is more focused on rejuvenating the Chinese dream by establishing the country s national discourse on the world stage. He has also had to deal with the consequences of the go-go years of fast growth, including debt binges, overcapacity, environmental pollution, social inequality, and the heavy reliance on the real estate market in creating household wealth. Sixth generation leader: to be determined The new crop of leadership will consist of members who were born in the 1960s. These candidates attended college during the ideological turmoil of the 1980s, and are expected to be less partisan and more open-minded. As of August 2017, an impressive 80% of China s province-level party standing committees were born in the 1960s. The rapid rise and strong presence of sixth-generation leaders suggest that Xi recognizes the importance of smooth political succession. 4. Political cycle China s political cycle is marked by the Party Congress, which occurs every five years, as well as the five-year plans. Usually during every even-numbered year of the Party congress, there is a change of leadership at the top. There are seven plenums for each Party Congress, with the third and the fifth plenums as the most important ones. The third plenum usually announces important long-term strategies and the fifth plenum drafts the next five-year plans. Leaders usually consolidate power in the first term and implement their political agenda in the second term.

6 Historically, China s GDP growth usually slowed down after every Party Congress, except after the 16th Party Congress, when China entered the World Trade Organization (WTO) and benefited from Zhu Rongji s SOE reform. We will be interested to see whether GDP growth can buck its trend this time around. There is no sign of increased fiscal spending after the previous 18th Party congress under the Xi regime. Groupthink is bad, especially at investment management firms. Brandywine Global therefore takes special care to ensure our corporate culture and investment processes support the articulation of diverse viewpoints. This blog is no different. The opinions expressed by our bloggers may sometimes challenge active positioning within one or more of our strategies. Each blogger represents one market view amongst many expressed at Brandywine Global. Although individual opinions will differ, our investment process and macro outlook will remain driven by a team approach Brandywine Global Investment Management, LLC. All Rights Reserved. Social Media Guidelines Brandywine Global Investment Management, LLC ("Brandywine Global") is an investment adviser registered with the U.S. Securities and Exchange Commission ("SEC"). Brandywine Global may use Social Media sites to convey relevant information regarding portfolio manager insights, corporate information and other content. Any content published or views expressed by Brandywine Global on any Social Media platform are for informational purposes only and subject to change based on market and economic conditions as well as other factors. They are not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy. This information should not be considered a solicitation or an offer to provide any Brandywine Global service in any jurisdiction where it would be unlawful to do so under the laws of that jurisdiction. Additionally, any views expressed by Brandywine Global or its employees should not be construed as investment advice or a recommendation for any specific security or sector. Brandywine Global will monitor its Social Media pages and any third-party content or comments posted on its Social Media pages. Brandywine Global reserves the right to delete any comment or post that it, in its sole discretion, deems inappropriate or prevent from posting any person who posts inappropriate or offensive content. Any opinions expressed by persons submitting comments don't necessarily represent the views of Brandywine Global. Brandywine Global is not affiliated with any of the Social Media sites it uses and is, therefore, not responsible for the content, terms of use or privacy or security policies of such sites. You are advised to review such terms and policies.