• Saturday, April 20, 2024
businessday logo


Dreaming of economic reform in China


  As a new leadership takes charge in Beijing, all eyes are on President Xi Jinping and his team to see how they plan to change China into a consumption-led, bubble-free and clean economy.

After a soft patch last year, China’s economy has now settled into an acceptable growth pace of around 8 percent, defying critics who have been forecasting a hard landing for some time now. Growth can continue at a slightly slower, but more sustainable, pace given the momentum generated by rapid urbanisation, industrialisation in western China, and rising aspirations of a growing middle class. But we all know that the current investment-led growth model cannot continue to drive the economy over the longer term. So, how does the new leadership begin to solve the looming problems and ensure that China stays on the right road?

China’s economy has faced multiple imbalances: between the east coast and the west, between investment and consumption, between the city and the countryside, and between rich and poor. Over the past decade, policy makers have tried to rebalance the economy by building an urban social welfare system, by incentivising manufacturing investment in western China, by cutting taxes and boosting subsidies in rural areas, and by encouraging rural-urban migration. There were some successes.

The challenges now facing the economy, though, are more complex. There are dynamics in play that are undermining the sustainability of growth. Rapid economic development generates pollution – a lot of it over time if regulation is weak, a fact that Beijingers now understand all too well. Loose monetary policy that saved the economy from a nasty recession in 2009 has pushed up land prices. It is time to re-engineer the system, instead of implementing one-off policy changes, so that positive outcomes are generated again.

However, the reformers face big stumbling blocks in the form of interest groups that are blocking such large-scale re-engineering. Powerful state-owned enterprises, for instance, like to retain all their profits – even if the monies could be much better spent on boosting health-care and education spending. The other big challenge is that reform these days is complicated: allowing farmers to grow their own food was a tremendous reform in the 1970s, but was easy to do. Setting up a national health insurance system is a little more complicated. To surmount the obstacles, the leadership will need some deft political manoeuvring to garner popular support. Co-ordinating the reforms would be crucial too, as the problems are increasingly interconnected. The focus should be on building long-term institutions and establishing the rules of the game.

Putting these principles into practice is easier said than done. Recent steps to revamp the Railway Ministry and spin out its commercial operations wing, or the move to give more powers to the food and drug regulator to improve safety are a good start. We hope the reformers will carry on. Indeed, they must focus on five broad areas of reforms in the next couple of years.

First, abolish the one-child policy and close down the National Population and Family Planning Commission. The recent decision to merge the Commission with the Health Ministry goes only half way. Demographers say that abolishing the Commission would not cause China’s birth rate to explode – bringing up kids is expensive these days. Most importantly, this move would send a clear message, that of personal freedom, to both the bureaucracy and the populace. It is a message of change – that the government now has no business to tell you how many children you can have. It is also a message that the government is willing to close down parts of the bureaucracy that are no longer useful.

Second, support urbanisation through meaningful policies that attract more people to the cities and help them to integrate into urban life. This would entail offering social welfare to the new migrants, perhaps starting with partial access to pension and health-care services in the first five years and then upgrading them to full-benefit status. The government would also need to provide a larger supply of housing, perhaps funded through government-guaranteed bonds that are paid for with the rental income from social housing and a subsidy from the Finance Ministry. Additionally, they could let villagers living in the outskirts of large cities build low-storey, for-rent housing.

Third, deliver a level playing field for the private sector to compete with state-owned companies. China has big ambitions to build a 21st century industrial base made up of safe food-processing companies, patent-filing biotechnology firms and clean-energy producers. However, the current rules that seek to encourage greater private participation are like opening the door to a room full of lions and encouraging mice to enter. First, a few lions need to be removed, and the remaining ones need to be tied up. This can be achieved by a range of measures: selling non-strategic companies that are seen to be adding no economic value; cutting back on over-regulation; shifting the ownership of profitable state companies to the National Social Security Fund to boost funding for future pensions; charging both the state and private companies the market price for land, water, electricity and capital, thus encouraging them to conserve resources and forgo wasteful projects; and openly investigating corruption and allowing companies that get into difficulty to fail.

Fourth, raise sufficient funds for targeted social investments. This can be done by ensuring that state companies pay dividends into the government budget by incentivising the top contributors and by tolerating a larger budget deficit – even 3 percent of GDP is acceptable if the money is invested properly. The deficit can be funded through bonds sold exclusively by the central government and by broadening tax collection through the introduction of inheritance and capital gains taxes and by expanding property taxes across more cities. Such taxes should help address inequality, but they should also be accompanied by a discernible improvement in the quality of government services.


Last but not least, centralise and prioritise public spending on the things that matter. Much of the fiscal revenue flows into the central government, but local governments account for 70 percent of all spending, including 60 percent for education and 40 percent for health-care spending. Centralising this spending would make it balanced across the country and would direct it to targeted areas.

Countries like Japan and Korea were sending all children to secondary school for free by the time they had reached China’s current level of development. Only 10 percent of migrant children are currently completing junior high school in China. The workforce will be unable to upgrade without better education, and inequality will become more entrenched. The government needs to offer compulsory education through to senior high school, and private universities should be allowed to blossom.

The public health-care sector needs to be made more attractive for talented individuals, and private providers who offer treatment at reasonable prices need to be gradually brought into the public insurance system.

Additionally, infrastructure spending should be taken off commercial banks’ books and put on the Finance Ministry’s books. The government could fund these projects through long-term bonds. Banks should not lend to any project that is not going to pay for itself. Eventually, the banks will need to be weaned away from local-government interference, making them truly commercial.

China’s economic model has delivered unprecedented prosperity to a large cross-section of its citizens over the past three decades. But this has also fostered the dynamic imbalances that now threaten to undermine the economy. Policy makers therefore need to adjust these imbalances to set in motion new growth dynamics. This is a huge task. Senior officials in Beijing understand these challenges – it’s now a question of gathering enough political will to confront them. The world is watching. 



Green is head of Greater China Research at Standard Chartered Bank.


Send reactions to:

[email protected]/en