Victor Shih on Xi Jinping, AGI, and China's Debt

TL;DR

China spends roughly 85% of government money at the local and provincial level versus 15% national, compared with a 50/50 split in the US, yet local fiscal autonomy has fallen since the 1994 tax centralization that handed the value-added tax to Beijing. Victor Shih argues the Party's instinct to preserve power, not lack of technical expertise, drives its worst policy choices.

Transcript

Today I'm talking with Victor Shih, who is the director of the 21st Century China Center at UC San Diego. China is obviously one of the most important economic and geopolitical issues of our time, doubly so if you believe what I believe about AI. I was especially keen to talk to you because you have deep expertise not only in Chinese elite politics... Read More

Key Insights

• Chinese government spending is about 85% local and provincial and 15% national, while in the United States state and local spending is 50% and federal spending is 50%, a split that makes China look fiscally decentralized on paper despite its authoritarian structure.
• The 1994 tax centralization was driven by fear of Soviet-style disintegration. The central government decided it needed to control fiscal income, seized the value-added tax as the most lucrative revenue source, and over subsequent decades took collection of nearly all other tax categories.
• Central reimbursements to provinces are conditional in practice. Provinces are nominally told they can spend as they wish, but the real arrangement is that money arrives only if the locality does what the center wants, so fiscal autonomy has been falling since 1994.
• Land sales substituted for tax autonomy between 2000 and 2020. Localities could not control tax revenue but could control land revenue while the real estate market was strong, until the central government killed the land market in 2022 and left them dependent on Beijing.
• Political acumen, not technical credentials, determines who rises in the Chinese Communist Party. Some officials combine engineering expertise with that acumen, but it cannot be predicted in advance, and Peking and Tsinghua graduates are overrepresented in the Politburo without dominating it.
• Suboptimal Chinese policy comes from the Party's instinct to preserve its own power rather than from missing expertise. Channels exist to feed lower-level expertise upward, but the leadership will accept deaths and slower growth rather than lose control over banks or independent scientists.
• Chinese education tracks students into STEM or into social science and humanities, so an official with a doctorate in nuclear engineering may never have studied supply and demand. Government ideology is the one universally required subject, and that requirement has been ratcheted up recently.
• Xi Jinping's dominance has stripped Politburo members of the domain autonomy they once had. If Xi expresses a policy preference, officials must follow it, because visible foot-dragging or a slightly different agenda leads to purging, and such cases have already occurred.

Questions & Answers

Q: Is China more decentralized than the United States?

By spending shares it looks that way: about 85% of Chinese government spending happens at the local and provincial level against 15% national, while in the United States state and local spending accounts for 50% and the federal government for the other 50%. But the appearance is misleading. China was genuinely decentralized from the mid-1970s until the mid-1990s, when local governments both generated and spent large revenues. Since the 1994 tax centralization, spending happens locally while the money and the conditions attached to it come from the center.

Q: What was the 1994 tax centralization in China and why did it happen?

In 1994 the central government concluded that the existing fiscal arrangement was untenable, saying in effect that it did not want to end up like the Soviet Union and fall into different pieces, and that it needed to control fiscal income. It grabbed the most lucrative source of taxation at the time, the value-added tax, which remains the most lucrative today. Over subsequent decades essentially all other tax categories also came to be collected centrally, with a portion reimbursed to provinces afterward.

Q: Why did fiscal decentralization help China's growth before 1994?

Local governments generated a lot of revenue and also spent a lot of money, which gave them direct incentives to do broadly productive things. They competed to attract as much foreign direct investment as possible, to attract as much local investment as possible, and to offer tax breaks. According to the understanding of most economists, this fiscal decentralization is why China had a very good period of growth driven mainly by the private sector, running from the mid-1970s to the mid-1990s.

Q: How did Chinese local governments fund themselves after losing tax control?

From 2000 until around 2020, localities gained autonomy through land sales. They could not control tax revenue, but they could control land revenue, and the real estate market was performing very well during that stretch, which made land the practical substitute for fiscal independence. That channel closed when the central government killed the land market in 2022. Since then localities in China have been highly dependent on the central government for their finances.

Q: Are Chinese Politburo members real technocrats or holders of fake degrees?

It varies. Former Premier Li Keqiang held an undergraduate degree in economics and studied under one of the best economists in China, so he understood economics. Today's Politburo includes a wing of military-industrialists trained as engineers in genuinely top Chinese programs: Ma Xingrui, Party Secretary of Xinjiang, graduated from Tsinghua University, and Zhang Guoqing worked in the military industry for years after graduating from one of China's top science programs. Whether such scientific knowledge translates into governing ability is a separate question.

Q: What actually determines promotion inside the Chinese Communist Party?

Political acumen is the decisive filter. As people rise through the ranks they must have it, and without it they will not make it, regardless of technical expertise. Some officials turn out to possess acumen on top of their technical training, but this cannot be known in advance. The exception is princelings, the children of high-level officials, who are special not because of genes but because they honed political acumen from parents who could teach it. Some of them succeed without the best degrees.

Q: Why does China resist rebalancing toward consumption if its leaders study economics?

There is a traditional reason and a newer one layered on top. Traditionally, Chinese education tracks students into STEM or into social science and humanities, and STEM students may never learn anything about supply and demand, studying math and engineering instead with perhaps one elective economics class. Learning economics was popular in the 1990s, but officials trained earlier would not have. The one universally required subject is government ideology, and that requirement has been ratcheted up rather than relaxed.

Q: How has Xi Jinping's power changed the way Politburo members operate?

Being a Politburo member used to confer some autonomy over the domain you governed, and that is no longer true. If Xi Jinping expresses a preference about a policy direction, that is the direction officials must take, no matter what. If he observes someone dragging their feet or pursuing a slightly different agenda, that person will be purged, and such cases have already been seen. Xi also runs Leading Small Groups, gathering heads of ministries and commissions to identify bottlenecks on specific projects.

Q: Why did China stick with Zero-COVID policies for so long?

The explanation is not an absence of expertise. There is a lot of expertise at lower levels that can feed into the higher level, and there are many channels for doing so, so the system is not especially dysfunctional on that score. What repeatedly produces suboptimal policy is the Party's instinct to preserve itself and, worse, to preserve its power. The calculation is that even if a different course would let the Party survive politically, it will be rejected if it means losing control over banks or letting scientists become more independent.

Summary & Key Takeaways

• China was genuinely decentralized from the mid-1970s to the mid-1990s, with local governments raising and spending large sums, which pushed them to attract foreign direct investment and local investment and grant tax breaks. Most economists credit that fiscal decentralization for a strong period of private sector driven growth in China.

• The 1994 tax centralization moved the value-added tax, and later almost every other tax category, to central collection, with partial reimbursement to provinces attached to conditions. Localities regained some room through land sales from 2000 until 2020, but the central government killed the land market in 2022, leaving them highly dependent on Beijing.

• Politburo members include real technocrats trained in top Chinese programs, such as Ma Xingrui of Tsinghua University and Zhang Guoqing from the military industry, but technical training does not guarantee governing skill. Political acumen is the real filter for promotion, and princelings acquire it from parents rather than from elite degrees.