Part 3: Reforming China – Changing the Software

Part 3: Reforming China – Changing the Software

Beyond purely economic and financial objectives, the reform process in China must meet welfare, demographic, environmental and governance challenges. 

The People’s Welfare…

Increasing consumption requires increases in household income, reduced savings or a combination. This requires increasing wage levels and employment levels. 

Increasing consumption will require reform of the welfare system, especially health, education and pensions. 

Chinese workers lost their state-provided health care and education when the SOEs were reformed in the 1990s. Chinese save to cover the expected costs of education, retirement and health care. Despite the fact that government expenditure on health, education and social security has doubled, it remains around 6% of GDP compared to an OECD average of 25%. The government is increasing pension coverage and extending basic health care but new spending remains modest.

Many reforms will require increased government spending, creating further pressures on a budget which is already in deficit. Recapitalisation of banks and SOEs will add to claims on the budget. 

China’s government debt is lower than many developed nations. According to a 2013 report from China’s National Audit Office (“NAO”), Chinese government debt, including local government debt, is around 55% of GDP (around US$5 trillion). But if all obligations are currently included, then China’s government debt including contingent liabilities would be higher, perhaps 90% of GDP, limiting China’s fiscal. 

Public finance reform also requires reallocation of revenues and spending responsibilities between the central and local governments. Currently, local governments have responsibility for around 80% of expenditure but only receive around 40% of tax revenues, forcing them to promote industrial activity especially property development. It also results in wasteful overcapacity, duplication and uneconomic competition between local governments. 

One way to correct this problem would be to enact a land tax based on property values, providing a stable and reliable source of revenue for local governments to finance public amenities and services. However, such an initiative requires an authenticated land registry system and objective property valuations.

Labouring Over Reforms…

The effects of favourable demographics and rapid urbanization are slowing. China’s workforce will peak within 4-5 years and then shrink. 

The government has taken steps to relax the one-child policy, allowing couples with only one partner without a sibling to have a second child. But any meaningful change will take a generation to have any real effect.

A portion of China’s rapid growth was driven by the benefits from urbanization as subsistence farmers moved into cities and manufacturing jobs, creating large output-per-worker gains. China’s urban population had reached 51%, having increased from less than 18% in 1978. China’s degree of urbanization may be misleading in several ways due to complex statistical classification, multiple indicators of city/urban population and a complicated administrative system, which are also periodically adjusted. 

A crucial element is China’s hukou system which requires each citizen to register in one and only one place of (permanent) residence. This hukou classification defines an individual’s rights and eligibility for welfare and services (such as public education and housing) in a specific administrative area. 

Under the system, 250-300 million workers resident in urban areas still retain their rural hukuo registration and are unable to participate fully in the economy. Non-hukuo internal migrants are generally part of a poorly remunerated, economically cyclical transient workforce which provides cheap labour. Due to birthplace-related restrictions, they have no access to welfare benefits. Lacking residency status, they cannot also sell their rural property, excluding them from purchasing houses or cars on the grounds that this manages demand and reduces price pressures.

The hukuo system means that the true degree of urbanization is unclear. It also means that increases in the degree of urbanization may not equate to an increase in a growing middle class with rising incomes, assumed by foreign analysts.

Authorities have moved to reduce discrimination against migrant workers, relaxing restrictions on rural labour mobility moving to townships and small cities. They will have increased access, in time, to “middle-sized” cities but not large cities where the greatest opportunities for employment and increased income lies. Even this modest reform of the residency system is likely to encounter resistance.

First, local governments oppose relaxing hukou restrictions fearing reduced job opportunities for local residents and budgetary pressures to meet the demand for welfare, services and amenities.

Second, a crucial element of any change is the ability of rural citizens to sell their rural property to free up capital. The previous administration, under President Hu Jintao, at the 2008 plenum declared that individual farmers’ rights to farmland, hitherto restrained by investment-inhibiting 30-year leases, could be extended indefinitely, effectively allowing sales. 

Vested interests have held up changes in the Land Administration Law necessary to implement the reform. Defined and transparent property rights would make it more difficult for local government to arbitrarily appropriate land for building infrastructure, factories and urban housing. Local governments are reliant on using this land as a source of revenue, either by selling requisitioned land to developers or using it as collateral.

Third, further urbanization would affect over-crowding in cities, environmental problems and also social problems such as rising levels of income inequality. It would also strain the ability of local authorities to manage congestion and provide adequate services.

Environmental degradation and resource constraints, especially water, have increasingly been identified as limitations on current rates of growth. Only three cities in China meet national air quality standards. Air pollution levels in major cities are frequently 10 to 20 times worse than World Health Organisation standards.

The authorities have spoken repeatedly of their commitment to improving environmental conditions. But in reality, it clashes with other objectives. Dealing with environmental issues would adversely affect economic growth. 

Dealing with pollution requires reducing reliance on coal fired electricity generation plants which would create power shortages. It would also make it impossible for heavily indebted power generators and coal mines to service their borrowings triggering financial system problems. Switching to cleaner but more expensive energy sources would increase prices, increasing domestic price pressures and reducing competitiveness of Chinese exporters. 

Polluters are often large taxpayers and employers. Frequently, they are SOEs or have close links with the government. 

A More Limited Menu…

Rising social inequality and growing criticism has forced the Chinese government to implement measures to control corruption. The focus is on prostitution, gambling and drug trafficking. There have been some initiatives to reduce extravagance and punish “tigers and flies” (officials at all levels of the party) suspected of corruption. 

President Xi has banned excessive spending on entertainment, banning expensive dishes such as shark fin and birds’ nest soup at banquets, counselling cadres to make do with “four dishes and one soup”. During Chinese new year, traditional gifts in red envelopes (known as tǎo hóngbāo or yào lì shì in North China and lai see in the South) were forbidden as a sign of official frugality. 

Public displays of opulence are now officially discouraged, resulting in a sharp fall in business at expensive hotels and restaurants as well as reduced sales of luxury products such as luxury cars, watches and imported alcohol such as Cognac. Amusingly, 56 five-star hotels in China requested a rating downgrade to avoid being classed as luxury hotels, preventing them from hosting government functions or officials.

The CCP’s Central Commission for Discipline and Inspection has punished nearly 200,000 officials for disciplinary violations, including hosting lavish banquets, weddings and funerals, spending public funds inappropriately on travel, the improper use of government vehicles and constructing luxurious government buildings. 

The Stalinist purges and show trials have been effective in showcasing the government’s efforts but also in removing or neutering political opponents. But the anti-corruption drive faces difficulties in removing deep-seated systemic corruption, much of it associated with the CCP which plays a pivotal role in dispensing economic opportunities within China.

Stealing by public officials amounts to as much as 2% of GDP, according to studies published by the Chinese Academy of Social Sciences. Over the last decade, perhaps more than 50 million households have had their land seized, without or with minimal compensation, by authorities, typically local officials. 

The International Consortium of Investigative Journalists (“ICIJ”), an American organisation, released information on allegedly secret offshore holding of individuals, closely related to President Xi’s brother-in-law and the son of former premier Wen Jiabao. It is not clear whether these identified overseas entities were used to invest abroad legitimately or secretly transfer cash and conceal wealth.

There is rising dissatisfaction with the government. There is widespread distrust of the court system, which is explicitly controlled by the CCP. In response, the government was forced to introduce a system of petitions allowing aggrieved citizens the right to appeal decisions of local officials to higher authority. But only 3 out of every 10,000 petitions lodged are heard. Rising anger is evident from the over 100,000 cases of mass unrest each year, a large increase from the few thousand 10 to 20 years ago. 

The government has responded with increased suppression. Authorities have commenced criminal actions against independent anti-corruption activists who campaigned for public disclosure of official assets. Journalists and analysts critical of China’s economic prospects have been aggressively suppressed. The government has blocked the access to Bloomberg and the New York Times websites that published allegation of governance breaches. They have implemented a crackdown on micro-blogs, once hailed as “an inescapable snare for corrupt officials” by Xinhua, the state’s official news agency. 

These measures cast doubt on the efforts of the government to deal with corruption in a transparent and independently accountable manner.

© 2016 Satyajit Das

Satyajit Das is a former banker and author of The Age of Stagnation (Prometheus Books).