It has come at a time when both China and the world’s economies are entering a new phase of uncertainty. The slowdown of the developed world is unlikely to pass quickly. The fiscal cliff in the United States, mounting public debts in Japan and prolonged recession in Europe imply significant risks in the world economy. It may take a decade or more for countries in the developed world to put their economies back on track.
Against this background China may have to face a situation that for its exports, which have been an engine for the entire economy, a growth rate of around 10 per cent per annum may be the new norm. The contribution of exports to China’s growth rate, which has been around 3 percentage points in the last decade, is likely to fall to about 1 percentage point in the next. As such, China needs to find new ways to power its growth.
Continuing institutional and economic reform is one of the ways for China to sustain its future economic growth. China’s last 30 years witnessed three phases of progress. The 1980s saw the start of the reform era. The second phase ran from 1992–2003, when swift reforms were carried out in the urban sector. These reforms greatly improved the efficiency of the Chinese economy, but also left the social safety net shattered and millions of workers without a job. The third phase has taken place with the outgoing administration in office. One of the achievements of this administration was rebuilding the social security system in both the city and the countryside. In addition, discriminatory policies toward migrant workers were abolished. However, government intervention into the economy has greatly increased and the pace of reform has slowed down substantially.
The good news is that the need for further reform has gained momentum inside China, and has been recognised by both the official and popular media. The remaining questions are what to reform and how to reform it. The following three reforms are imperative for sustainable and equitable growth in the next ten years.
The first is hukou reform. The central government has already announced a new hukou policy to allow migrants in small cities to obtain local hukou once they have a stable job and a place to live (including rental accommodation). This reform is not just about restoring social justice, but could also lead to a healthier Chinese economy. In particular, it will significantly boost domestic consumption. Currently, migrants from the countryside save considerable sums in preparation for their return home. Allowing them to obtain permanent residential status in the city will stabilise their expectations and induce them to consume more. In addition, hukou reform will accelerate the rate of urbanisation, and thus also boost the growth of the service sector. The share of manufacturing in China’s economy will probably start to decline by 2020 and the service sector must fill the resulting gap.
The second is financial reform. The Chinese financial system has not been fully opened to domestic capital — for example, private investors cannot open a commercial bank — although it has been opened to foreign capital. The government should expedite the Wenzhou experiment and put in place a concrete reform plan. China’s crippled financial system is one of the key reasons that China runs a large current account surplus — it is too inefficient to process savings domestically, so China is forced to export capital to other countries.
The third is a reduction of subsidies to producers. The Chinese government subsidises producers heavily by suppressing the costs of inputs and providing monetary incentives to selected industries. For example, interest rates are tightly controlled and a comfortable profit margin is guaranteed for banks’ lending. Also, environmental laws are loosely implemented so firms save costs if they do not pay attention to waste treatment. Yiping Huang has shown that the total amount of subsidies through suppressed input prices is as much as 10 per cent of China’s GDP. This is equivalent to a high and regressive tax that transfers income from ordinary people to capital owners. It is one of the reasons why the household share of national income is declining and income distribution has been worsening.
None of the above reforms will be easy. Hukou reform faces strong resistance from both local governments and local residents. Local governments claim that migrants distress local public finance; local residents feel that migrants will reduce employment and educational opportunities. Further, interest groups will strongly oppose the reduction of any government subsidies that they currently enjoy. In addition, many still believe that government subsidies are necessary to accelerate China’s development. While financial reform may involve less conflict between different groups of people, the uncertainties implied by a more open financial system can be a strong impediment stalling the reform.
It will thus take great courage and political wisdom of the new leadership to carry out the needed reforms. But there are reasons to remain hopeful. The central government has sanctioned parts of all three of the reforms; now it is only a matter of implementing them.
Yang Yao is Director at the China Center for Economic Research, Peking University.