The One-Year Plan

Six major trends to watch in 2014, as China embarks on monumental economic reform.

If one thing defined China in 2013, it would be how the current and future state of its economy inspired sharply divergent views. Although the Chinese economy will have grown to about $9 trillion at the end of 2013, it is clearly slowing down. Opinions differ widely on whether the slowdown can be managed and orderly or whether it will be precipitous and destabilizing. Some analysts, like Nouriel Roubini, have been predicting for years "a meaningful probability of a hard landing in China after 2013," while former World Bank Chief Economist Justin Lin, an outlier even for optimists, argues that China can maintain near 8 percent growth for decades to come.

The landing in 2014 will be soft, but much still hinges on how Beijing navigates its structural economic reforms and how disruptive they will be to the broader economy. Major change is almost always uncomfortable for those that benefit from the status quo. But the Chinese government feels it has to shake that up -- to reform its way out of potential economic bottlenecks like the middle-income trap, the difficulty that moderately-developed nations face in reaching the elite league of high-income economies.

That's why reform will be the central task as China gallops into 2014, the Year of the Horse. As Chinese leaders have repeatedly exhorted the government to "roll up its sleeves" and get things done, 2014 will prove to be a pivotal year in how the balance between reforms and economic growth plays out. Here are six areas to watch:

The economic slowdown is real, but is it all bad?

In 2014, pundits will go to battle again over how much more deceleration the Chinese economy can withstand, and what will cause that inevitable slowdown. But it seems relatively certain that macroeconomic policy will tilt "pro-reform" rather than "pro-growth." Premier Li Keqiang said in November 2013 that China only needs 7.2 percent GDP growth -- less than the 2013 target of 7.5 percent -- to sustain momentum and create the number of jobs needed to absorb an expected 12 million new workers.

The official mantra for 2014 macroeconomic policy remains "stabilizing growth while progressing" on reforms (wenzhong qiujing), strongly implying that top policymakers are focused on creating the conditions for reforms instead of stepping hard on the growth accelerator. Look for Chinese policymakers to set a 7 to 7.5 percent target for 2014 GDP growth -- if they continue the tradition of setting an official target -- as the ship of state redirects to contend with economic reforms.

Local debt is ballooning and the government aims to deflate it

What exactly is the size of China's local debt? The Chinese Academy of Social Sciences, a leading government think tank, estimated it reached roughly $3.3 trillion at the end of 2012; the market consensus expected it to be around $3 trillion. And in late December 2013, the Chinese government finally provided its own official tally when it released the results of its highly anticipated national audit: $2.95 trillion. Even though slightly below expectations, the official number is nonetheless disconcerting because it shows an increase of almost 70 percent since the end of 2010, when the last audit was conducted. (China's total public debt is an estimated 53.3 percent of GDP -- while it's growing rapidly, it's still quite a bit lower than that of the United States and many European countries.) 

Even if the central government eventually rolls over a large portion of the debt, local governments will still need new sources of revenue to sustain their spending and investments, which is why fiscal reforms will be another priority in 2014. One reason that debts have piled up is that local governments have not only borrowed from state banks but also from shadowy investment vehicles to sustain investment on infrastructure and other construction. If they continue to rely on state bank financing, much of that funding could find its way into nonproductive local investments -- further raising the liabilities on their balance sheets.

Beijing remains officially sanguine over its ability to get the debt under control. But its credibility could easily be called into question in 2014 if it doesn't quickly and clearly articulate a path toward controlling the situation and ensuring that debt does not severely constrain future growth. If Beijing can't convince the market that it considers the debt a serious problem deserving of a swift response, investor confidence in the resilience of the Chinese economy could weaken.  

End of the 12th Five-Year Plan cycle looms

While the reform-focused November 2013 plenum captured most of the attention, international observers seem to have ignored the 12th Five-Year Plan (FYP) -- the massive blueprint that is meant to guide macroeconomic policies from 2011-2015. It is laden with specific targets on energy and environmental goals, including the ambitious call to cut energy and carbon intensity by 16 percent and 17 percent, respectively.

As China enters year four of this cycle, there will likely be a concerted push to meet many of those targets. In the previous administration, former Premier Wen Jiabao made it his mission to achieve the energy-intensive reduction target during the last years of the 11th FYP. At the time, many observers believed Beijing would easily shift back to pro-growth and industry-friendly policies. But Wen instead put significant pressure on heavy industry, which slowed economic activities in certain areas where these industries were concentrated. (Sure enough, the targets were met, at least according to officially published figures.)

A similar push in 2014 could well cause more disruptions to heavy industry, especially as Li and President Xi Jinping have prioritized environmental issues. If anything, pollution and environmental damage have worsened since the last FYP cycle. If policymakers assess that China risks missing its key targets on energy intensity and pollutant reduction, expect stronger environmental and energy regulations to curtail industrial activity and limit the use of coal. At the same time, China is expected to significantly boost the role of cleaner energy, such as natural gas, as a coal replacement.

Shanghai Free Trade Zone will need to show that it means business

The Shanghai government, with the full support of top leaders, inaugurated its newest and biggest free trade zone last September -- to a lukewarm reception from investors and foreign companies. Many observers were underwhelmed by the lack of concrete policies that followed, even as the zone billed itself as a launch pad for meaningful financial liberalization.

Still, the zone has not faded away. Chinese leaders intend it to be a proxy for how key financial reforms proceed in the rest of the mainland and many observers view it as an important step in turning Shanghai into a global financial hub that can rival Hong Kong. In late December, the People's Bank of China, the country's central bank, said that within three months it could formally initiate some of the most important pilot reforms in the zone, including those allowing experimentation with the free flow of capital, market-based interest rates, and an easily convertible currency. If successful, the bank said, the reforms could reach other regions in roughly a year. Expect any reform that makes it out of Shanghai to have a strong chance of receiving the top leaders' blessing to go national.

Urbanization continues to be a key -- and contentious -- driver of growth

Over the next several decades, an estimated 10 million rural Chinese are expected to move into cities and townships each year. Consequently, urbanization remains a key pillar of China's growth, and of the government's strategy of rebalancing away from investment and toward domestic consumption.

By the end of 2013, top policymakers appeared to have become more convinced that a "people-centric" approach to urbanization was better than one focused on infrastructure. Expect more emphasis on social policies, like job creation and welfare protection, and on fixing the hukou -- the household registration system that discriminates against new arrivals to urban areas.

Focusing more on people marks a shift from previous policy, and will trigger contentious debate on the core elements of the urbanization plan in the months leading up to the National People's Congress, an important party meeting held in March. The comprehensive -- though likely vague -- plan that will be released around the meeting will be a good occasion for companies and investors to see how they can benefit from China's renewed push to accelerate a slightly different kind of urbanization.

The anticorruption campaign kicks into high gear

With the release of the 2013-2017 Anticorruption Work Plan, which outlines ways to tackle systemic corruption, Beijing has sent another message demonstrating that fighting graft is a major objective of the top leadership. And the timeframe of the plan suggests that the pressure on fighting corruption will be turned up for the remainder of the current administration, to make progress before another major personnel turnover in 2017.

A full-throttled push should be expected in 2014, potentially culminating in netting the biggest "tiger" -- what Xi calls corrupt high-ranking officials -- of them all: Zhou Yongkang. A former member of the Politburo Standing Committee, China's most elite governing body, Zhou is reportedly under investigation for various actions taken while in the oil industry and then as a top politician.

Even without a Zhou bombshell, anticorruption efforts, so long as they train their fire primarily at the state sector, will continue to pave the way for gradual reforms of the state sector. Indeed, the anticorruption campaign is part of economic reforms: it can help to clear certain roadblocks -- vested interests -- by literally removing those who might oppose change.

In 2014, look for reforms to be much more politicized. After all, whether reforms succeed or not has always been a political question, not an economic one.

WANG ZHAO/AFP/Getty Images


Reckless Reforms

Why the Obama administration should ignore recommendations from the panel it established to review NSA surveillance.

In mid-December, the President's Review Group on Intelligence and Communications Technologies released its findings to great fanfare. The panel, established to evaluate government surveillance activities, joined a growing chorus of critics of the National Security Agency (NSA) and the Obama administration's aggressive approach to intelligence. Yet the group's report is seriously flawed. It reflects a misunderstanding of the function of foreign intelligence activities and offers some recommendations that are likely to harm these activities, while also doing little to nothing to protect individual rights.

The review group's report calls for an end to bulk collection of metadata -- information about when one person called another, but not the content of their conversation -- as well as new steps to protect Americans against what panelists fear is unjustified government surveillance. The panelists recognize the tricky tradeoff between better intelligence and civil liberties, especially in an era of rapid technological change. Yet the unmistakable theme in their report is that policymakers and intelligence officials have gone too far in the direction of security. Now is the time to put the brakes on programs the panel believes create "risks to public trust, personal privacy, and civil liberty." 

The report also calls for more stringent criteria about when the NSA can intercept the communications of foreign individuals. This recommendation is a response to news that the NSA listened in on cell-phone conversations of world leaders like German Chancellor Angela Merkel. Policymakers and intelligence officials, we are told, should be much more careful about whom they target and how much they data collect.  

Already, the report has prompted criticism from those who see it as threatening the capabilities of the intelligence community. One of the report's authors, former CIA deputy director Michael Morell, has recently attempted to rebut this criticism. He notes in a Dec. 27 Washington Post op-ed that the report does not say the NSA's collection of metadata "is not important to national security, which is why we did not recommend its elimination."

Morell is right that the report did not find the metadata program worthless (and it is noteworthy that he goes on to argue that the program would have prevented the 9/11 attacks). Yet his argument that the review group did not recommend the program's elimination is either disingenuous or backpedaling away from the report itself.

In its executive summary, the report clearly calls for an end to "government collection and storage of mass, undigested, non-public personal information about U.S. persons for the purpose of enabling future queries and data-mining for foreign intelligence purposes." Instead, the report calls for such information to be held by a third party, such as a private contractor. This outsources a large part of the NSA's core business of signals intelligence. If not exactly elimination, this plan is quite close, preserving just some elements of the program in private hands.

More important than whether the plan constitutes an end to metadata collection, however, is the fact that it is perhaps the worst of all possible worlds. A public-private metadata-sharing protocol would face serious practical and legal obstacles, which is one reason both intelligence officials and industry leaders are opposed to the idea. At the same time, it would increase the risk of future leaks because more individuals (public and private sector alike) would have to be involved in sharing information. After the Snowden affair, it is bizarre that the review group finds putting more information in the hands of contractors comforting.

In addition, the review proposes two additional reforms that could inflict grave harm on U.S. intelligence collection, neither of which is mentioned by Morell in his op-ed. First, the panelists call for extending the protections enjoyed by American citizens and those living in the United States, such as the Privacy Act of 1974, to foreign citizens living abroad. The Privacy Act sharply restricts the government's ability to collect data on Americans, while giving people the right to access whatever information the government does have on them. The report notes that the Department of Homeland Security already accords these protections to non-U.S. citizens and that the intelligence community is already bound by the Privacy Act in matters like background investigations it conducts on employees. By extension, the report asserts that it would not be too much for the intelligence community to extend similar protections to non-U.S. citizens outside our borders.

While this position is fashionably cosmopolitan, in practice, it would turn out to be either meaningless or extremely damaging to intelligence collection. The intelligence community would not be likely to collect significant data from non-U.S. citizens through voluntary means like background investigations. As the report itself notes, the Privacy Act does not apply to systems related to national security, such as networks used for storing and transmitting classified information; if this exemption were continued, in most cases, the information available to non-U.S. citizens would be trivial or nonexistent, as most intelligence is classified and would be held in systems that the Privacy Act does not cover.

On the other hand, if the intent is to make some information from national security systems available, then the impact would be devastating. The Privacy Act, for instance, permits "any individual to gain access to his record or to any information pertaining to him which is contained in the system." If the intelligence community faithfully implemented the act, it would also have to allow a target of its espionage and "a person of his own choosing to accompany him, to review the record and have a copy made of all or any portion thereof in a form comprehensible to him."

At the risk of stating the obvious, this would demolish the whole purpose of spying.

The second major flaw in the report that Morell does not address is its call to eschew in almost all instances the exploitation of so-called "Zero Day vulnerabilities" in software. A Zero Day vulnerability is one whose existence is not known and therefore has not been addressed by the developer in a patch. These vulnerabilities can be used to infiltrate computer systems to collect intelligence, inflict harm, or both. The report asserts, with very little supporting argument, that fixing these vulnerabilities is more important than intelligence collected by exploiting them in all but a handful of cases. Though not discussed specifically in the report, this policy approach would likely rule out programs like the alleged exploitation of Microsoft Windows error reporting by NSA's Tailored Access Operations, used to gain insight into target systems.

Put simply, the exploitation of vulnerabilities is the core of intelligence. The panel's recommendation is akin to arguing that if one discovered a highly placed official of a foreign government with a drinking and gambling problem, then rather than attempting to exploit that problem, the intelligence community should guide him into rehab. Certainly, if a Zero Day or other system vulnerability affects sensitive U.S. government systems, then the NSA should act to repair it, but a general policy of non-exploitation needlessly handicaps the intelligence community. It flies in the face of the sort of careful analysis of costs and benefits that the review group's report calls for in other circumstances.

The root of these flaws in the report is the failure to distinguish between domestic law enforcement and foreign intelligence. Law enforcement, by definition, is meant to uphold the Constitution and protect the civil liberties of U.S. citizens. Policemen and prosecutors must obey strict guidelines on how they conduct surveillance on suspects and what kind of evidence they can use in court. Foreign intelligence, on the other hand, operates by breaking other countries' laws. Human intelligence organizations like the CIA try to convince foreign nationals to pass secrets to the United States. And signals intelligence organizations like the NSA consciously and deliberately steal private communications abroad without the target individuals' knowledge or consent.

The review group, however, recommends that the same criteria be used to determine when the government can collect information about U.S. citizens and foreign individuals on the grounds of protecting rights. In addition to recommending extending the Privacy Act to non-U.S. persons, it declares that intelligence agencies "must not target any non-United States person solely on that person's political views or religious convictions." While this is obviously crucial in terms of safeguarding the civil liberties of U.S. citizens, it makes no sense in the world of foreign intelligence. Intelligence agencies always collect information on foreign individuals because of their political views and other beliefs. Why else would they care about particular people, if not for the way they see and interact with the world?

Up to now, the debate about the NSA has focused on the balance between discovering information about terrorists and protecting the rights of citizens. This is understandable, as the legal basis for the NSA programs is the Patriot Act, and because the White House justifies metadata collection on the same grounds. But characterizing the issue as a choice between counterterrorism and civil liberties is simplistic and misleading. The review group admirably stresses that there are security concerns that go beyond terrorism, but it then fails to consider the value of metadata in addressing a host of challenges the intelligence community is facing. Efforts to combat state-sponsored industrial espionage, for example, require painstaking counterintelligence work. Efforts to break up transnational proliferation networks are also likely to benefit from metadata collection; this is a logical way to map the networks and see how they operate, which may be one reason why the Obama administration is fighting so hard to keep the NSA programs alive.

What's more, despite some fears that the NSA could use metadata to create a "mosaic" of someone's activities, in reality, this is a pretty inefficient way of encroaching on anyone's privacy. In the past, when the intelligence community has violated civil liberties, it hasn't bothered with such a roundabout approach. In the 1960s-1970s, for example, the CIA infiltrated various domestic political organizations, and the NSA intercepted the telegraphs of individual citizens. We have plenty of experience with intelligence agencies behaving badly, and they haven't been very subtle about it. Collecting and storing metadata is thus very different from what we've seen in the past -- and, in fact, Occam's Razor suggests that it is not a violation of civil liberties at all.

Ultimately, while generated with an admirable desire to preserve people's rights and privacy, the flawed recommendations in the review group's report threaten to do more harm than good. As the Obama administration considers reforming the NSA, it would do well to ignore them.