The Chinese Communist Party's plans to tighten discipline could have unintended consequences

The Chinese Communist Party (CCP) released a slew of plans this year to overhaul governance of key strategic areas, including finance, science and technology (S&T), data, intellectual property, and social affairs. Many of the reforms are aimed at rationalizing longstanding problems of bureaucratic fragmentation and overlapping responsibilities. However, the tightening of central oversight might also bring unintended consequences such as overzealous implementation or risk aversion. These potential problems might create a new set of challenges.

The first theme of the regulatory overhaul underscores the CCP's ultimate authority over policymaking. New party commissions now oversee both finance and S&T to "strengthen the centralized and unified leadership of the party center." New work rules for the State Council, the executive arm of the government, stipulate that the party's Central Committee is to be consulted on all important matters. The second theme is to streamline channels of authority in key policy arenas, or as the reform plan notes, to promote the "modernization of the national governance system."

Accordingly, a new financial regulatory administration has been established, consolidating functions that used to be distributed across three agencies. The People's Bank of China's supervision over its subnational units has also been tightened. Overlapping bureaucratic functions in the S&T space have been rationalized.

Two scenarios emerge for how this reconfiguration might impact economic policymaking in China. In the first scenario, the party-state apparatus becomes more nimble and responsive. Centralization reduces intra-bureaucratic competition, while active party oversight regularizes procedures for higher-level authorities to resolve bureaucratic differences. The party-state gains more capacity to tackle pressing national issues such as rising inequality, hidden financial risks, and a more hostile geopolitical situation.

But while this consolidation of authority might resolve some principal-agent problems, in a second scenario new, unintended coordination challenges might emerge. Tightened discipline might reduce the flexibility needed to calibrate policies appropriately to local contexts. Centralization might also lead to risk aversion, causing bureaucrats to avoid taking action without clear political signals from the top. When Beijing does give that signal, a rush to comply might result in sudden, campaign-like regulatory waves that take firms and households by surprise.

Which of these scenarios might prevail? China's structural governance challenges can help answer this question. The country's massive size means that the one-party state has a quasi-federal structure. Decision-making bodies are replicated at subnational levels from provinces down to cities, counties, and townships. As a result, policymakers have always faced challenges aligning incentives across myriad bureaucratic actors. Often, authority over an issue is dispersed across different state agencies. Provincial governments and central ministries share equal rank, so conflicts between the two need to be negotiated. Decentralization impedes the flow of accurate information, hampering good decision-making: When formulating industrial policy, which firms should be selected as national champions? When selecting experimental zones, which locations are most likely to succeed? And then there are hidden action problems. With over 30 province-level authorities, over 300 city-level governments, and thousands of counties to oversee, central bureaucrats in Beijing are chronically overstretched. In many issue areas, local officials can distort, subvert, or even outright defy central directives with low risk of punishment.

From a historical perspective, different leaders have approached these structural challenges in distinct ways, producing their own problems. Mao Zedong, the founding leader of the People's Republic of China, associated the bureaucracy with feudalism and sought to harness the energies of the people instead, launching mass campaigns to remake China in alignment with socialist ideals. On the other hand, Deng Xiaoping, the paramount leader who transformed China's economy starting in the late 1970s, sought to empower the bureaucracy. Deng pursued a separation of the economy from the party-state. His policies provided a clearer delineation of responsibilities, giving the bureaucracy more autonomy in economic matters even as the country shifted toward market economy principles. Under Deng, substantial authority was also delegated to local leaders, allowing for experimentation and regional variation. This approach partially addressed information asymmetry problems, as local governments could develop reforms suited to their specific contexts. High-performing firms and regions could adopt solutions through a bottom-up process, and these solutions could be shared with others and scaled up. Indeed, some of China's global success in renewable energy has been attributed to a looser policy environment allowing local deviation from central directives.

But as growth took off in the 1980s and following decades, other problems emerged. One major downside of decentralization is that central priorities can be neglected. Hence the popular saying in China is: "Where higher authorities have a policy, lower authorities have a counter-policy." As localities pursued economic growth to great success, other priorities from Beijing were ignored. Environmental degradation accelerated in spite of numerous national laws and regulations targeting pollution. China's local governments continued to rely on infrastructure and property development as a source of growth, even as the central government called for rebalancing toward a more consumption-led economy.

Since President Xi Jinping has been in power, starting in 2012, he has not sought to bypass or empower the bureaucracy but rather to discipline it. The CCP has placed great emphasis on compliance with party guidelines. The Xinhua News Agency reported that in remarks to the party's internal disciplinary commission in January, "Xi ordered measures to effectively remove bottlenecks, obstacles and difficulties in implementation and enforcement, and to refine the mechanisms through which the Party Central Committee's major decisions and plans are implemented." Last year the CCP disciplined over 592,000 officials for misconduct, compared to 627,000 in 2021 and 604,000 in 2020. Since its fourth plenum on the rule of law in 2014, the CCP has also emphasized legal discipline in ordering the state and society, narrowing the space for officials to exercise policy discretion.

This reduced scope for discretion is taking place alongside a proliferation of goals, as the central government tackles challenges on multiple fronts. Many priorities are cast in broad terms, and some call for simultaneously achieving competing objectives. The 14th five-year plan, for example, calls for policies to better "coordinate security and development," while China's dual circulation strategy emphasizes self-reliance and external liberalization. Efforts to build a "new whole-of-nation system" for S&T call for state guidance and market forces to work in tandem. What should the optimal balance between these competing objectives be? China's high-level guidance is often broad in scope, but previous periods had allowed officials some autonomy to flexibly calibrate policies to fit local conditions. Now that authority for major decisions has been further centralized, it might become more challenging for government officials to adjudicate between competing goals or policy tensions.

The emphasis on discipline might also breed risk aversion, especially if officials perceive that they are being assessed on how well they have abided by higher-level directives rather than on the effectiveness of their policies. To avoid missteps, bureaucrats might prefer to wait for clearer guidance or political cover from the top before taking any major actions. Xi is reported to have expressed frustration at bureaucratic inaction at an internal meeting in 2021, saying: "Some only get moving when they receive written edicts issued by the leadership and they would do nothing without such instructions…. If I didn't hand out instructions, would these officials do any work?"

The combination of narrowed discretion and risk aversion might lead to herd behavior in financial and industrial sectors. In finance, guidance warning against the "disorderly expansion of capital" strengthens incentives for credit to flow disproportionately toward sectors perceived to be "safe." As a result, a reduction in risk diversification could undermine financial stability. In industrial policy, China has adopted public-private investment funds (or "industrial guidance funds") in recent years, signaling the government's desire to invest capital on more market-driven terms. However, the government has also made clear that these funds are meant to support nationally prized sectors, implying that high rates of return are not the ultimate goal. These mixed signals dilute market incentives for fund managers to take risky bets in pursuit of the largest commercial payoffs. Start-ups engaging in new, untested but potentially groundbreaking innovation are therefore less likely to be funded as managers channel investments instead toward mature companies that are safer, even if they deliver lower rates of return.

The emphasis on discipline might also mean that when the central leadership does send a strong political signal, risk aversion is quickly replaced by a rush to demonstrate compliance. A regulatory wave ensues, in a campaign-like manner. Some recent examples include the 2021 crackdowns on platform companies and the tutoring industry. In both cases, the policies enacted were in part aimed at addressing legitimate public policy concerns – anti-competitive behavior of platform companies and rising education costs for the middle class, for example. However, the speed of the antitrust probes, data security investigations, prohibitions on for-profit tutoring and similar entities took markets by surprise, wiping out over $1 trillion of market value from the private sector. China's senior leaders have sought to reassure markets in the following months, but the business community remains nervous and cautious.

China's ongoing centralization drive, therefore, reflects a tricky balancing act. Some of the regulatory restructuring addresses longstanding problems of bureaucratic fragmentation. The heightened focus on disciplined implementation, however, might generate a new set of coordination challenges that are equally difficult to resolve.