The global financial crisis and the climate crisis are twin concerns: we cannot solve one without solving the other.

Green growth must be recognised as part of the solution to the current global financial crisis. To overcome these dual problems, both developed and developing countries should progress to a greener model of development, and move beyond traditional ways of thinking about these issues.

The global financial crisis is to some extent a crisis of the traditional development model that brought prosperity to the industrial world and which is now bringing ‘prosperity’ to the emerging world. Consumers in industrialised nations devour cheap goods that are often produced by developing countries in an emission- and resource-intensive way. As a result, developing countries achieve rapid growth through producing and exporting these emission-intensive goods. On the surface, it looks like a ‘win-win’ situation; the industrial world has high standards of living, and the emerging world has impressive GDP growth, foreign reserves and sovereign bonds. But this results in global imbalances, and these in turn have led to the global financial crisis. 

There are two major reasons why green growth is difficult in this context. First is the failure of conventional analysis on climate change. This analysis sees carbon mitigation as conflicting with economic growth. It fails to recognise the possibility that mitigation may drive the economy to become even more competitive, such that countries undertaking strict mitigation policies will benefit economically. In this sense, mitigation could become a form of self-interested behaviour for key countries. Second, since green growth is not yet a widespread reality, policy makers usually see ‘green’ as a risk and are reluctant to take decisive action.

But mitigation and green transformation represent enormous opportunities. Green transformation is a comprehensive and fundamental transformation of the development pattern established during the Industrial Revolution. It includes social, economic, environmental and political transformations — not just the adoption of a few cutting-edge green technologies, as some seem to think.

Responding to doubt over green-growth potential requires us to revisit old energy debates. Most economists are not concerned about the eventual exhaustion of fossil fuels, since based on economic logic they believe there will be a strong incentive to invent or find alternative energy when fossil fuels begin to run out. These incentives will guarantee green growth in the future. But now, with the current climate and financial crises, we cannot afford to wait for green growth to occur organically further down the track — we need immediate action to find solutions. Global carbon mitigation will ensure the ‘natural process’ of green growth happens earlier, and this new reality must be addressed within established energy narratives.

In China, more and more people have realised the opportunities green growth represents. Green transformation is not just seen as a burden — it is also seen as a new source of growth. Compared to industrial economies, which to some extent are locked into a high-carbon economic structure, China can still gain the ‘late-comer’s advantage’ in avoiding lock-in effect and promoting green growth. This is the key message in a forthcoming green-growth report being jointly produced by the Development Research Centre (the Chinese government think tank) and the World Bank. And affected as we are by these twin crises, the world urgently requires a new breed of great thinkers and visionary politicians who are capable of moving beyond the current economic and political rut.

Yongsheng Zhang is Senior Research Fellow at the Development Research Centre of the State Council, China.

1. Financial crisis an opportunity to move on climate change
2. Financial crisis driving emissions up or down?
3. Climate finance: Getting to $100 billion a year by 2020

China’s 12th Five Year Plan enshrines a commitment to transforming China’s development model.

A top priority is commitment to moving from the current low-efficiency, high-growth model of development to a more balanced approach that addresses a wider range of concerns. The targets of the new model include economic growth, structural adjustment, social services development, carbon mitigation and environmental protection, and transparency and governance reforms.

Calls for the transformation of China’s economic development model are actually not new. China has aimed to improve efficiency and move from a GDP and export-oriented economy to a ‘wellbeing’ and home-market-oriented model of growth since the early 1980s and Asian crisis in 1997, respectively. Nonetheless, previous calls for the transformation were not so successful since a self-enforcing mechanism for the transformation has failed to be established through reforms, and vested interests have formed a major obstacle to change. Now, new momentum is needed in the reform process to make the new Chinese development model a reality.

Three sets of reforms need to top the new development agenda.

First, and most fundamentally, are governance reforms. Without transformations in governance, the shift to a new development model will be impossible. Horizontal reforms will have to clearly define the border between government and the market by limiting government power and improving the functioning of the market. Vertical reforms will have to establish a balanced relationship between different levels of government to prevent intergovernmental opportunism.

Second are reforms to establish fair market competition. As long as state owned enterprises (SOEs) monopolise competition, it will be impossible to have fair markets in China. The fundamental reason why SOEs should be restructured is not, as many argue, their inefficiency, but the need to build fair, competitive markets. The American Chamber of Commerce recently stated, ‘The United States should focus less on China’s currency practices and more on the threat to US companies posed by Beijing’s support for state owned enterprises’. According to them, support includes ‘regulatory and other barriers to promote ‘domestic champions’ in high-tech areas such as electric cars, green energy and high-speed rail’.

Third are sector-specific policy reforms. These include the need to reform the distorted pricing systems for factors of production, and the tax, investment, and fiscal policy systems.

These reforms will not be easy to achieve while two main impediments persist. Firstly, during early reforms, benefits were spread widely throughout the community. After decades of reforms, the ‘cake’ is much bigger, stakeholders have become diversified, and the privileges of vested interest groups have been largely institutionalised. Reforms that benefit the majority but not vested interest groups will be opposed. Secondly, easier low-level reforms have been mostly completed. What remains on the reform agenda are deeper, more difficult reforms that face even stronger resistance from vested interests.

New momentum is needed to overcome these obstacles. The pressure for reform that China needs is currently coming from four principal directions.

The first is the fear of economic crisis. The high-export, high-investment economy is unbalanced and unstable, and the accumulation of existing risks will become dangerous in time. Another risk is from the potential slow-down of growth. Existing risks are masked by high growth. For instance, huge local government debt is underwritten by sale of government land, the high revenue of which is based on high growth. Once growth slows down, this arrangement will be unsustainable.

Second is the need to enhance the ruling party’s legitimacy. As China’s economy grows rapidly the needs of its people are changing. Economic success will not be enough to guarantee the legitimacy of party rule. Korea and Taiwan are both examples in which the ruling parties were unable to sustain their legitimacy on the basis of economic success. As we can see in China, the regions with more social conflicts are not the poor regions, but the regions with a relatively more advanced economy. Reforms directed to build democratic processes and the rule of law are needed to deepen the legitimacy of the CCP.

Third, China needs to integrate with the international community. Although China is on its way to becoming the world’s economic powerhouse, this will not be enough to convince the world to embrace its success. Its values and institutions need to be acceptable to the rest of the world as well. The boycott of the Olympic torch relay and some rejections of attempted overseas acquisitions by China’s SOEs exemplify the difficulties faced.

The fourth driver for momentum is regional competition. Baechler argues that competition by political units with the same cultural background in Western Europe led to the development of modern growth and constitutional rule. Some analysts see competition among ambitious regional leaders in China as potentially providing a similar impetus for economic growth and institutional evolution.

Regional institutional experiments have been emerging throughout China in the last few years. These include land reform in Chengdu, grassroots elections in Jiangsu and Yunnan, crackdowns on organised crime and the promotion of ‘red’ (revolutionary) songs in Chongqing, free medicare in Shenmu, official property openings in Aletai. The successes and failures of these pilot reforms are valuable learning experiences for other regions, and for national institutions.

Despite the good intentions behind these projects, the success of reform schemes will continue to be haphazard in the absence of strong rule of law, and checks and balances on government power. Regional experiments tend to be initiated, controlled, and dominated by strong regional leaders, so there is probability that some initiatives might lead to bad outcomes and high social costs if these strong leaders make poor decisions or simply pursue populism. Government economic opportunism presents another serious challenge, but without the kind of civil society that can flourish under strong rule of law, it will be difficult to curb government power.

China’s economic miracle is the result of three decades of reform. As its economy grows, it is reaching a crossroads with its development model. Whether China will continue its modernisation through transforming its development agenda depends on whether it can overcome the challenges presented by vested interests. New sources of momentum will therefore be needed to overcome these challenges and continue reform.

Yongsheng Zhang is senior research fellow at the Development Research Centre of the State Council, China.

This article was published in the most recent edition of the East Asia Forum Quarterly, ‘Governing China’.

1. G20: East Asian and Pacific countries should pick up momentum of reforms
2. China’s economic reforms pushed by civil society
3. Stability and social governance in China

China recently wrapped up the National People’s Congress (NPC) and Chinese People’s Political Consultation Conference (CPPCC) with the approval of the 12th Five Year Plan (FYP) (2011-2015).

At the top of the new blueprint is a commitment to transforming China’s development model from the current low-efficiency, high-growth model to a more balanced model that seeks to address a whole range of increasingly important concerns. The targets of the new model include economic growth, structural adjustment, social services development, carbon mitigation and environmental protection, and transparency and governance reforms.

Calls for the transformation of China’s economic development model are not new. Since the early 1980s, China has been aiming to improve efficiency, and move from a GDP-oriented, export-oriented model of growth to a ‘well-being’-oriented, home market-oriented. This time the call has different implications.

In the past, calls for development were for marginal improvement of the development model. This time, in addition to the efficiency improvement, is to avoid potential economic crisis. Behind China’s average 9.8 per cent GDP growth over the past three decades lie a host of issues that have the potential to lead to serious problems in the future.

New economic risks and imbalances are emerging beneath the surface of China’s high growth economy. Trade surpluses have resulted in huge foreign reserves, excess liquidity, high inflation pressure, and bubbles in the capital and property markets. High GDP growth has not brought about a proportionate increase in human well-being across society, and public services are facing supply bottlenecks. Regulation and monopolies have unbalanced industry, and while there is an oversupply in the manufacturing industry, there is a shortage of service sector providers, particularly in medicine, education, finance, and banking. Finally, there is now a huge and growing level of risk associated with local government debts.

If these issues are not dealt with properly, they may lead to real crisis in two ways. First, the risks associated with these issues may simply accumulate until they are untenable. Second, if growth slows down — likely to happen as China’s industrialisation cycle ends — the problems that are now hidden will be plain for all to see.

Rapid growth has also brought about rapid environmental degradation, a fact that makes China’s shift to a low carbon economy increasingly imperative.

China must achieve two transformations. First, it must take the economically and socially ‘balanced’ model of high-income Western societies as a benchmark. But this is not enough. All countries, including China, need to initiate low-carbon growth, both to lower emissions and to deal with fossil fuel depletion.The 12th Five Year Plan has set a target for reduction in carbon intensity by 17 per cent, and an increase in the share in consumption of renewable energy options. This is in the broader context of China’s 2020 goal of reducing carbon emissions by 40–45 per cent.

China sports distinct advantages in the move to a low carbon growth model. The transition cost will be lower for China than for advanced economies, as it is not locked into a high carbon model to the same extent. It also does not face a competitive disadvantage relative to advanced economies in ‘green’ industries. Green technology levels are relatively similar in the developed and developing worlds. China has a dynamic economy, and it has the opportunity to continue to feed growth with new renewable energy industries.

Nonetheless, if these advantages for green growth could turn to reality depends on whether China could improve its institution through deepening its reform. In his report on the NPC and CPCC, Premier Wen Jiabao urged the government to ‘comprehensively deepen the reforms and open up,’ and ‘to further enhance the governmental reform.’ In the past, calls to transform China’s development model have not been so successful as the self-enforcing mechanism for transformation has not been established through reforms. Now, there is real impetus for change. The potential crises hidden in the current development model are being more widely recognised.

If these challenges could be properly responded through reforms, then China should be able to transform its economy successfully, and maintain a relatively high growth in the future. If that is the case, then the time for its size of economy to be the largest in the world may be much earlier than many thought, given its size is already as big as US$ 6 trillion. Still, China has a long way to go to catch up to the Western world in terms of per capita GDP. Given its big economic size and its deep integration into the world economy, the 12th Five Year Plan is not just a domestic issue; it is an issue for the rest of the world as well.

Yongsheng Zhang is Senior Research Fellow at the Development Research Center of the State Council (DRC), PRC.

1. The scale of China’s economic impact
2. Governance of China and the momentum of reforms
3. Korea’s ambitious plan on climate change

China’s intergovernmental relationships are undergoing rapid change. Having officially endorsed ‘socialist democratic politics’, grassroots elections and internal democracy in the ruling Chinese Communist Party (CCP) are continuing to develop. The rule of law is strengthening and a civil society is being established.

This evolution will have a profound influence on China’s long-term development. Four scenarios are possible.

Scenario 1: Top-down dimensions
This scenario involves the continuation of the current intergovernmental relationships into the future. In this structure the central government controls the majority of fiscal resources and the appointment of major officials. Within provinces, the provincial government controls the appointment of major local officials and most of the province’s fiscal revenue.

The structure differs to the former planned economy as it involves rule by law and a market economy. Because of these two factors, the central government can effectively realise the ‘State’s will’ and push forward with national reforms and development in areas such as social security, education and trans-regional infrastructure.

Nonetheless, as discussed previously, this scenario is not sustainable in the long run. It induces vertical and horizontal governmental opportunistic behaviour. The social cost of remaining in this structure would also be quite high.

Many economic and social problems in China — such as massive conflicts, petitions, farmer questions, local governments’ huge debts and risks, distorted markets and corruption — are the result of two-type governmental opportunism.

Without grassroots democracy and a checks-and-balances mechanism for government through constitutional rule, these problems might develop into crises. As Weingast points out, crisis shocks are the driving force for evolution towards a self-enforcing federalism or nation. To build up the so-called ‘harmonious society’ in China a sustainable intergovernmental relationship must be established.

Scenario 2: A good market economy
As far as we can see from the practices around the world, this structure is probably the most sustainable. It features a stable vertical structure and an effective horizontal checks-and-balances mechanism. China already has some of the conditions in place required for evolution towards this structure.

The key for China to shift to Scenario 2 is to reform its arrangement in the personnel dimension, or to develop its democracy. Although grassroots elections are developing steadily in China, they are still at a relatively early stage. To what level, and when, direct elections can develop in the future in China is still unclear.

At the horizontal level, China needs to establish effective checks-and-balances mechanisms at various levels of government through the rule of law, so that the market can function well. The expansion of civil society and liberty with rapid economic growth will allow the rule of law and democracy eventually to be well established in China.

Scenario 3: A bad market economy
This structure looks sustainable in terms of vertical intergovernmental relationships, but is not effective for economic growth. Under this scenario, the rule of law is not well established and the law institutionalises the privileges of interest groups, even with democracy. This produces opportunistic behaviour on the part of horizontal government.

At present, vested interests (instead of ideology) are the biggest impediment to China deepening its economic and political reforms. Corruption and social injustice are serious issues. The law has already institutionalised the privileges of some interest groups and the market has serious distortions. If this situation does not change, China is likely to evolve to Scenario 3.

If constitutional rule cannot be established and liberty cannot be guaranteed, democracy alone will not be sufficient to eradicate corruption and the privileges of interest groups, since horizontal governmental opportunistic behaviour will prevail. This would produce poor economic performance and social injustice.

Scenario 4: mixed efficiencies
This is a mixed structure with different relationships coexisting at different levels of government. The central–provincial relationship would be as in Scenario 1, while the provincial–local relationship would be as in Scenario 2. This structure is very likely to occur in China in the future.

With the central–provincial relationship already reaching Scenario 1, two further steps are needed to shift to this mixed structure. One is that grassroots democracy spreads up to the county level in the near future. Another is that the fiscal relationship between provincial and local governments becomes institutionalised. If this were to happen, the vertical intergovernmental relationships within each province would be substantially similar to those in Western countries.

At the central–provincial level, the vertical relationship would not be substantially changed, but the horizontal checks-and-balances mechanism would be effectively established through a strengthening of the rule of law.

This mixed structure implies that China could develop a unique vertical intergovernmental arrangement deeply rooted in its 5000-year history, tradition, culture and vast population. This mixed structure also provides room for the central–provincial relationship to further evolve as conditions mature. This is consistent with China’s gradual approach to reform since 1978.

In this mixed structure, avoiding vertical governmental opportunistic behaviour remains a major challenge and is dependent largely on the rule of law and the moral merit of the top leaders.

A sustainable federal nation requires different levels of government to balance in order to prevent vertical opportunistic behaviour between them. Meanwhile, it is equally essential to establish a checks-and-balances mechanism through the rule of law and democracy to prevent horizontal governmental opportunistic behaviour in the market. Economic performance is conditioned on preventing endogenous transaction costs resulting from these two types of behaviour.

In terms of fiscal arrangements, China’s central–provincial relationship is already very similar to that in Western countries. The central government controls most of the nation’s fiscal resources and, financially, the provinces rely heavily on transfer payments. The key difference between China and Western countries is in the personnel dimension. The dual top-down arrangements in the personnel and fiscal dimensions in China have resulted in a very strong central government. Preventing vertical governmental opportunistic behaviour is therefore a major challenge for China—and it will not be sufficient to simply borrow the top-down fiscal arrangement from the West.

This chapter sees four major possible scenarios for the future evolution of intergovernmental relationships in China. A mixture between Scenarios 1 and 2 is very likely to emerge as grassroots democracy grows in China. It also provides room for further evolution towards a stronger structure based around the rule of law in the more distant future.

Yongsheng Zhang is a Senior Fellow of the Development Research Centre, State Council, China. This essay has been adapted from the authors contribution to ‘China: The Next 20 Years of Reform and Development‘, Ross Garnaut, Jane Golley and Ligang Song (eds).

1. Will China change the region or end up changing itself?
2. Changing realities for China’s women leaders
3. US-China relations: the outlook for harmony

The Kyoto Protocol, as ‘the first game in town’, represents significant progress towards reducing global emissions. Its cap-and-trade mechanism and flexible market-based implementation have been valued highly.

Meanwhile, its flaws have also been widely criticised. Particularly its small coverage and ineffectiveness, and the lack of incentive for countries (especially developing countries) to participate. To effectively fight against global warming, we need a more effective post-Kyoto architecture.

The DRC team has proposed an architecture that attempts to improve on these shortcomings. All countries, including developing countries are covered, and the unclear ‘common but differentiated responsibilities’ of each country are clearly represented by the balances of their National Emission Accounts (NEAs). An open-and-compatible solution on both international collaborative mechanisms and domestic approaches is also established.

While climate change may be a diabolical problem, the essence of any solution can be stated simply: how to equitably allocate the right to emit green house gasses (GHG).

This problem is best dealt with by nations in cooperation. No matter how much an individual country emits, the harm from those emissions is borne by everyone on earth. Equity requires that no country has the right to harm (through emissions) to others without compensation. We offer the following proposition:

A country does not impose extra external emission harm to any others, if and only if each country’s per capita emissions are equal.

Accordingly, equal per capita emissions determine a country’s emission entitlements. If a country’s actual emissions is greater than its entitlements, it should compensate the others for its extra emissions, and vice versa.

Time is an essential element of our proposal. Equal per capita emissions should apply both across countries and over time. We consider both past and future. According to each country’s initial emission rights, actual emissions, and traded emissions, we can establish a NEA for each country. The current balance on a countries NEA exactly represents its country’s differentiated responsibilities’ to reduce emissions.

By the target year (say 2050), each country’s balance on its NEA is the past emission balance plus the quota allocated between now and the target date. Countries must stay below their cap, unless they purchase permits from other countries through the international emission trade scheme (IETS) or any other channel.

Under the DRC’s scheme, three steps are proposed towards a global agreement:

Step 1: Define each country’s emission rights from a starting point to the present, according to a per capita principle. We can then establish an NEA for each country, and turn the unclear ‘historic responsibilities’ of the over-emitted countries into clear NEA deficits, and into surpluses for others. The balance of each country exactly represents its ‘historic responsibilities’ or rights.

Step 2: Based on advice from science, allocate a global emission budget for the years to the target date. The global emissions budget then needs to be allocated according to the per capita principle. The balance of past NEAs plus the future allocated budget determines each country’s new emission quotas to the target date.

Step 3: Establish an open and compatible solution for both the international collaborative mechanism and domestic emission reduction approach which incorporates the various existing proposals. The various solutions can then co-exist and compete with each other.

A numerical example may help to explain. Consider a hypothetical world consisting of two countries: a developed country and a developing country.

The developed country has a population of 200 million and currently emits 2 tons of GHG per capita. Until now, it has emitted a sum of 28 billion tons of GHGs (140 tons per capita).

The developing country has a population of 400 million and currently emits 1 ton of GHG per capita. Until now, it has emitted a sum of 14 billion tons of GHGs (35 tons per capita).

This equates to a total of 42 billion tons of GHG emitted to date (28 plus 14), or 70 tons per capita (42 billion shared by 600 million people). On an equal per capita basis, the developed country has over-emitted by 70 tons per capita, while the developing country has a surplus entitlement of 35 tons per capita. This represents the respective NEA balances over the past.

Based on scientific estimates, the hypothetical world can sustain a further 30 billion tons of emissions to the target date (50 tons per capita). This entitles the developed country, with 200 million people, to 10 billion tons, and the developing country with 400 million people to 20 billion tons.

Combining the current balance with future entitlements, the developed country target is 14 billion tons less than zero, while the developing country target is 14 billion tons above zero. If these targets are met (allowing for trading and other mechanisms) both countries will have equal per capita emissions over the entire period: an equitable outcome. Note that the developed country does not have to significantly reduce its real emissions – it only needs to balance its NEA through various channels, such as international emission trading system (IETS), international emissions reduction funds, technology transfer, clean development mechanism (CDM).

Our proposal is based on the fair, simple and consistent principle of equal per capita emissions. It encompases all countries and eliminates the need to classify countries into developed and developing categories. It would also be effective, since the global reduction target is built into the proposal.

Replacing the vague ‘common but differentiated responsibilities’ with clearly defined responsibilities derived from historic action would be a major step forward and is a significant advantage of our proposal. Each country’s emission balance exactly represents its responsibility for emissions reduction.

Further, both developed and developing countries will have sufficient incentive to reduce their emissions, since the more a country reduces, the more it can sell (or the less it is required to buy) in the IETS market. Emissions reduction then becomes a self-interested behavior.

It also solves a problem of history. For the countries not being covered by the Kyoto Protocol or that have failed to meet their commitments, their contribution and responsibilities on emission reduction are clearly measured by their NEAs.

This article is drawn from the paper ‘Greenhouse Gas Emissions: A Theoretical Framework and Global Solution’ in Ross Garnaut, Ligang Song and Wing The Wood (eds) ‘China’s New Place in A World in Crisis‘

1. Managing China’s per capita carbon emissions
2. Bush wrong on India and China and climate change
3. Australia drags, China leads on global action to reduce emissions

When the proposal for the Rio-Chinalco deal was first emerging, the so-called national interest issue was hotly debated in Australia. Some people warned that the deal was not in Australia’s national interest. With Rio Tinto’s rejection of the offer, the deal has now fallen through.

Does the rejection really serve Australia’s national interest, as suggested by key members of the Opposition and some sections of the Australian press?

The reasons why some Australians think China’s SOE investments in Australia, especially in the resources sector, are not good for Australia look convincing. Australia is a free market economy. It welcomes foreign investment, but that mostly (though not always) means foreign private investment, not investment by foreign government-controlled SOEs.

Though Australia maintains an open foreign investment regime for foreign private capital, it remains wary of investment from government-controlled entities. The general perception is that ‘Chinalco is a state-owned enterprise’, and hence ‘the Australian economy is in danger of being taken over by Communist China’. This is a simplistic view to take. People who hold such opinions must not have a great deal of knowledge about China’s SOEs, and are unaware of the implications of investment from China’s SOEs in Australia.

China’s SOEs have been undergoing restructuring. The reasons for this are twofold: the first one is the profitability problem – enormous and unprofitable SOEs and laid-off workers were a heavy drain on the state coffers before the late 1990s. The second reason is the need to build a market economic system in China. Due to possible government bias towards SOEs at the expense of their private sector competitors, a market economy based on fair play cannot be achieved with the presence of so many SOEs.

After massive privatisation and bankruptcies in the late 1990s, only 138 SOEs remain in central government ownership, and the numbers will be further reduced to between 80 and 100 by 2010. These SOEs are dominant in some of the most lucrative and strategically important sectors of the economy, such as telecommunications, banking, resources, oil, aviation, infrastructure, public service sectors, and so on.

The SOEs’ profitability problem has largely been resolved. The 138 SOEs that remain are among some of the most profitable firms in the world, thanks partly to improvement in their corporate governance, but more importantly because of their monopolistic position in the market and extensive support from the state. Private sector competitors experience difficulties in accessing these protected sectors due to a host of visible and invisible barriers, even though their access is nominally allowed by Chinese law.

The opportunity costs for shoring up the bottom line of SOEs are considerable. China’s economy could have been more efficient if stronger competition was introduced through the liberalisation of monopolistic sectors dominated by SOEs. Many problems, such as economic and structural imbalances, inefficient growth, and an underdeveloped service sector could be solved through reform in SOE-monopolised sectors.

China’s national interest therefore lies in the opening up of monopolistic sectors and through SOE reform. According to ‘China’s Guideline for Reforms in 2009’, recently released by the State Council, China is now engaged on the work ‘to deepen the reforms in monopolistic sectors, and broaden the sectors and channels for private investors’ on the top of its reform agenda.

The reform of China’s SOEs, however, has different implications for Australia. Would it be better for Australia if Chinalco was a private company, or and SOE in the process of being privatised? The answer is that it would not, since in that case Chinalco could no longer hold a monopolistic position and be eligible for special support from the government. To make money in the Chinese market, it is easier for an Australian company to engage with an influential monopolistic Chinese SOE than to work with a private Chinese company.

The so-called ‘threat’ from China’s SOE investment is an illusion. The motivation of China’s SOEs is actually quite simple: to secure a supply of resources, rather than to control a market or the economy. Actually, subject to the laws and policies in Australia, China’s investment could never be ‘out of control’. China has a low share in Australia’s FDI and Chinalco’s would have had a minor stake in Rio. In contrast, some Chinese scholars doubt whether SOE-driven overseas investments are really helpful for China to secure its global resource supply, and suggest that some SOEs are merely cash cows in some overseas M & A cases.

The further reform of SOEs is critical for China to establish an effective market economic system. But now China’s reforms confront strong opposition from vested interests. SOEs are supposed to serve the interests of all Chinese people, but in reality they have somehow been manipulated by an elite group pursuing its own interest in the name of national interest. This makes reform in monopolistic sectors hard to achieve. It might also be familiar to Australians.

A real worry for China’s institutional reform is that the vested interests from both China and the West will work together to make China’s reforms even harder. Multi-national companies usually play a positive role in pushing forward China’s reforms. But once they are married with China’s SOEs and enter into China’s monopolistic sectors and benefit from the monopoly they naturally oppose moves, similar to the SOEs, to open up those sectors. Like the SOEs quoting national interest as an excuse to defend their own interests, foreign companies would hold the Chinese state stake as hostage to seek extra benefit from the Chinese government.

Throughout history, many mistakes have been made in the name of national interest. Some people may treat the rejection of the Chinalco deal as a success in defending Australia’s national interest (even though the decision was not made by the Australian Government). But if national interest means economic benefit, then they have made a mistake. Rio may benefit from its ‘smart’ tactics in the short run. But its opportunistic behaviour will definitely harm mutual trust and its long term interest in China. As Peter Drysdale has suggested, ‘Australian policymakers… will have to work hard to restore confidence in the Australian investment environment’.

It is hard to say whether the outcome of the Rio-Chinalco deal is actually good for Australia. The frustration of some Chinese SOEs’ overseas investments in recent years suggests that economic success is not sufficient for China to be recognized by the world. The interaction between China and the world through overseas investment could exert a positive influence on China’s institutional reforms at home. As for the supply of resources, this is determined predominantly by market forces.

1. Chinese media’s response to the Rio-Chinalco deal
2. Corporate governance and Chinese FDI in Australia
3. Australia needs to get its act together on China, and fast

The Chinese people had high expectations for smooth and fruitful year at the beginning of 2008 – the year of the Beijing Olympics, the 30th anniversary of China’s reform, and a number in Chinese culture signifying good luck and good fortune.

As it turned out, 2008 was a year in which there was as much bad luck as good. In February, southern China was lashed by a severe snow storm; in March, social turmoil in Tibet; in May, the devastating earthquake hit Sichuan; and the Olympic torch was met by protests in some Western countries.

The Olympics in August were a stand-out and government and land reforms were welcomed. But after the Olympics, the world was thrown into economic crisis, and China had to turn to fighting the rapid onset of economic recession.  The poisoned milk scandal also took place.

These were no trivial tests of the achievements of 30 years of reform. The scale of China’s growth and its speed is without precedent in world history. But the question remains: how resilient to natural and social disasters is the new China ? And what further reforms are needed to assure a harmonious role in the world?

Natural disasters

The two natural disasters that preceded the Olympics revealed China as a big economy, but not a strong one. The snow storm left millions of travelers and families shivering and stranded; and a large part of the country in shambles, its people exposed to the vagaries of nature.

The deadly 8.0 M Sichuan earthquake on 12 May, claiming almost 100,000 lives, also exposed the fragility of Chinese infrastructure – despite the worldwide admiration of China’s rescue efforts and the formidable courage and compassion of the Chinese people at its epicentre. During the first couple of days, no contact was possible with the outside world from the earthquake zone and many lives were lost because of poor rescue equipment and the collapse of low-quality buildings.

Milk scandal

The melamine milk scandal broke in July and by November China reported an estimated 300,000 victims: many infants died from kidney stones and other kidney damage. The World Health Organization referred to the event as one of the largest food safety events it has had to deal with in recent years.

The milk scandal exposed a host of problems: poor governmental supervision, inadequate law enforcement, and the power of special interests amongst them. The milk scandal also exposed a more general problem of food safety in China, and China has moved to adopt stricter measures to ensure the food safety. After all, GDP is only part of the story of development: people’s lives, protection and living standards are the ultimate purpose of economic development.

Olympics, China and the world

With the Olympics, China moved to centre stage in living rooms around the world.

As China stepped up onto the international stage, the inevitable question was how should China seek to understand the world, and how should the world seek to understand China. The Beijing Olympics was a good first test in examining this question.

As the Chinese people were preparing to show their hospitality to the world, the torch relay was met by violent protests in some western countries about a range of political issues. Some western politicians even called for a boycott of the opening ceremony. This caused many Chinese people to rethink the relationship between China and the west.

Eventually, China hosted an ‘exceptional’ Olympics with a spectacular opening ceremony, and efficient organization, involving thousands of dedicated volunteers. The Olympics saw many western people change their view of China after experiencing the reality in China and seeing Chinese people up close. Thanks to the Olympics, China has also become a more open and tolerant, as well as a more tolerated, society.

Reforms in 2008

In 2008, China restructured government through the creation of ‘mega-departments’. The number of ministries was reduced from 31 to 27. The target is to establish a service-oriented government and improve governance efficiency through streamlining the overlapped functions of different government departments.

An important milestone event in 2008 was the land reform at the 3rd plenum of central committee of CPC. The duration of farmer’s land use right was extended from 30 years to ‘long term’, and farmer’s interests and rights are to be strictly protected under new laws. Though the transaction of land use rights is not the focus, the door is now open for transaction in land and for capitalist agriculture.

Other major reforms included: value-added tax reform to eliminate the overlapping taxes and encourage equipment investment, and fuel tax reform to abolish the road maintenance fees and other charges.

Tacking and jibing economic policy

This was a year to test the ability of China’s economic team in tackling new and complex economic problems. Though these tests were huge and are ongoing, 30 years of experience in policy development has created, it is fair to say, a considerable legacy in policy management skills within the leadership team.

At the beginning of last year, the priority of macroeconomic policy was to control inflation and prevent overheating of the economy (so-called two ‘prevents’). The Chinese boom was driven by export-oriented growth and related investment spending. Two interdependent steps were required: one to balance China’s trade surplus through RMB appreciation, reducing export-tax rebate, and other trade policies; the other to transform China’s economy from export-oriented to domestic market based growth. If it hadn’t been for the financial crisis, the expectation was that this might be achieved smoothly within 3 to 5 years.

Mid-year, there were already signs that overheating was no longer a serious problem, and China’s economic growth was about to slow. The central government promptly adjusted the policy from ‘two prevents’ to ‘ensure stable economic growth and control inflation’. Monetary and fiscal policies were relaxed accordingly.

In the fourth quarter, the world economic crisis deteriorated rapidly and China’s downturn was worse than expected. The central government initiated 4 trillion yuan economic stimulus package in November and introduced measures to stimulate consumption and exports.

The estimated 9 per cent growth in 2008 is not bad, but many investors suffered in the stock market collapse as the Shanghai Composite Index plummeted by 65.5 per cent. The ups and downs of international commodity market also had a negative impact on the Chinese economy and taught Chinese investors a serious lesson on market risk.

The challenges ahead

The most immediate challenge is to tackle the current economic crisis and hold growth up at around 8 per cent in 2009. The medium and long term challenge is how to improve China’s market system and political institutions.

This year is the 60th anniversary of the foundation of the People’s Republic of China. The economic blueprint for 2009 was outlined at the three-day Central Economic Work Conference at the end of 2008. The primary goals are ‘ensuring high growth, expanding domestic demand, and upgrading the economic structure’.

The growth target in 2009 is set at 8 per cent. Though 8 per cent would be the lowest growth rate in China since 1997, it would be a relatively high growth in the context world recession. The biggest uncertainty for China’s own performance is where the world crisis heads in 2009.

The inflation target is 4 per cent. If exports continue to drop, there could be deflation but the proposed reforms in resources sector could be inflationary. The acceleration in government spending could also translate into inflation.

Though China’s trade surplus in November 2008 reached a record high, the overall contribution of the trade surplus to its GDP growth is likely to have been negative or zero in 2008. Though the transformation of China’s economic growth pattern requires balanced trade, trying to achieve trade balance through the financial crisis would have a negative effect on the economy. In 2009, China will try every effort to stimulate its export.

The biggest challenge is employment. China needs to create about 10 million new jobs each year to absorb labor growth. A sizable proportion of the unemployed are migrant workers who have land in their hometowns. This is one reason why China is very cautious in dealing with the issue of land privatization. Access to land plays a role in security for migrant workers.

Chance for reform

The 4 trillion yuan stimulus package ushered in an ‘active fiscal policy and appropriately easy monetary policy’. Government and government-related investment is growing quickly, but private investment remains in the doldrums. A major problem for China’s economic growth is how to stimulate private investment (a core element in growth in the past) and private consumption.

The key will be further reform. The recession actually provides the chance to wind up the momentum of reform in 2009. Expanding the domestic market and upgrading industrial production requires reforms in line with ‘liberalization, deregulation and decentralization’. These reforms are necessary to make the market system work better.

To stimulate private investment, China needs to get rid of barriers to entry barriers in sectors that are monopolized (such as telecommunications, transport, urban utilities, financial sectors, healthcare, education), and reform its investment system. To expand domestic consumption, social security and healthcare system must be reformed. As inflationary pressure is alleviated, energy and resource price reforms can also be introduced.

Building soft power

If economic power can be called hard power, then what China most needs to improve is its ‘soft power’ through strengthening institutions and instigating a cultural renaissance. China is a country with 5,000 years of civilization. It was one of the most prosperous countries in the world until industrial revolution in the 18th century. The economic success in the past 30 years has imbued the Chinese people with a strong sense of optimism and confidence in the future. A civilization that has survived 5,000 years, can now build a culture compatible with the pillars of modern civilization in a globalised world: a strong market economic system and democracy.

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Yongsheng Zhang is Senior Research Fellow at the Development Research Center of the State Council (DRC), PRC and Professor of Economics at Renmin University, Beijing.

This is part of the special feature: Reflections on developments in Asia in 2008 and the year ahead

1. Indonesia steps onto the world stage
2. China’s role in running the world economy
3. Does China really aim to take over the world?

Over the past three decades, institutional changes have been the major driving force for China’s economic development. But, as Ross Garnaut recently stated in Beijing, “many foreign analysts have underestimated the importance of institutions in economic development, and the inevitably gradual nature of successful institutional change”.

If China’s reforms prior to 2000 for establishing a market economic framework could be called the first generation of reforms, then subsequent reforms aimed at improving the market economic system could be called the second generation of reforms (2G), designed to eradicate the hardest institutional barriers incompatible to a market economy.

But the 2G reforms need momentum. For instance, it is not so easy to break the vested interests. However, proper application of the rule of law and civil society measures can provide the momentum and act as a warranty for the success of the 2G reforms and for China’s long term economic prosperity.

The recent strikes of taxi drivers in some places in China is a good example.China has always put economic development and social stability as the top priority. But in the past, stability was achieved even through times of high pressure. This kind of stability was not real stability and not sustainable. The real social stability needs to be achieved through rule of law and civil society (or, as Hu Jintao put it at the 17th congress, “socialist democracy”). When the first strike happened in Chongqing, the party chief of Chongqing, Bo Xilai, solved it in a different way to what is sometimes expected in China — to listen to the appeal of the taxi driver and reform the regulation of the government, rather than put pressure to stop the strike in the first place. These kind of examples can be seen as definite progress toward civil society in China.

Chongqing’s solution encouraged taxi drivers elsewhere to take action. In Hainan, Guangdong, Jiangxi and other places, taxi drivers followed Chongqing and organised strikes. In the old thinking, the strike means instability. But, actually, strikes are a sign that the Chinese society is becoming more and more open, transparent and democratic, since now the people can protest publicly, and the government has to solve problems through reforming and disciplining their own behaviour. Some western media may report the strike from a different angle and deem the strikes as the evidence of instability in China, or even the evidence of the crisis of Gongchandang’s rule. This kind of conclusion is incorrect and misleading.

Behind the strike, there are complex economic reasons. The taxi sector is a franchised sector in China and the taxi companies need to obtain the franchise from the government. The taxi driver pays a monthly fee to the taxi company: for instance, about 5,000 yuan in Beijing (the vehicle are usually owned by the taxi driver and the costs of running including repair are the driver’s responsibility). The remainder after the monthly fee is the driver’s income —- about 3,000 yuan per month, working for 13 hours a day (different places have different situations).

It is extremely hard for the individual to enter the taxi sector because of the government’s quantity control on taxi numbers. If one wants to enter the sector, he/she has to engage in a taxi company that has a certain quota. The quantity control results in a high taxi price, but the taxi company takes most of the revenue generated after that high price has been paid.

Therefore, the underground or “black” taxi appears, not paying the high monthly fee. What the drivers are protesting is the high monthly fee and the “black” taxis. If there was free entry, the taxi price would drop and the driver’s income may increase side by side. But this would not be easy to achieve, since the interests in the sector have been so distorted. The root reason is the distortion resulted from the bad regulation, not the “black” taxi. To introduce free entry is only part of the answer.

As a result of the taxi strike, the monthly fee was sharply decreased in Chongqing. At the national level, the problem in the taxi sector has drawn high attention and become a media focus in China. It looks like a national wide reform on taxi regulation is going to be started.

The taxi sector is only one example of how China’s reform is pushed by the civil society. It is expected that, as China’s economy rapidly grows, more and more reforms will be initiated and pushed by the civil society from the bottom-up. More particularly, many situations in which the farmer can defend their right on land are expected to occur after the farmer’s land use right was significantly reinforced at the 3rd Plenary of the 17th CPC Central Committee in 2008.

The most essential element for good economic performance is preventing governmental opportunism. To achieve this, the government needs to be limited by rule of law and civil society. A better institution for long-term economic prosperity can thus gradually evolve in a civil society.

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See also:
Reform in China: Experience with economic system reform
The market, state owned enterprises and Chinese reform
Taking a punt on political transition in China

1. What does China want in international economic reforms?
2. Governance of China and the momentum of reforms
3. North Korea’s currency reforms: risky return to a money-less society

The Chinese government has adopted ten major new measures to pump 4 trillion yuan (A$950 billion) into stimulating economic growth through to 2010. And this is just the government expenditure! Economic growth will not be a problem in China.

The New York Times reports:

In a bold move at a time when major projects are being put off around the world, Beijing said it would spend an estimated US$586 billion by 2010 on wide array of national infrastructure and social welfare projects, including constructing new railways, subways, airports and rebuilding depressed communities.

The package, announced by the State Council Sunday evening, is the largest economic stimulus effort ever undertaken by the Chinese government and would amount to about 7 percent of the country’s gross domestic product during each of the next two years.

Beijing also said it was loosening credit and encouraging lending and that it needed to have a more ‘pro-active fiscal policy’ in order to strengthen its economy.

Government expenditure is only part of the story. If further deepening of reform through liberalisation, deregulation and decentralization takes place, private investment will boom as well, given China’s huge domestic market potential, and growth is likely to be even stronger. China is in a process of rapid industrialisation and urbanisation. This process will continue until the economy is industrialised, though there will be some noise in the process. There is no need to worry about China’s growth, but there is need to worry about the quality of growth.

High quality growth can only be achieved in a well-functioning market. Yet, China’s market economic system is far from perfect and the reforms need to be substantially deepened. For instance, a priority is to get rid of the practical barriers for private investment entering into the monopolistic sectors, mainly in services.  Now is an opportune time to push further with much needed market-oriented reforms sufficient to ensure China’s high growth in the future. A significant reform that will have a long-run effect on China’s economic growth is the reform package on rural economy released last month at the 3th plenary of 17th Central Committee of CPC. It will facilitate China’s urbanisation and the transformation of China’s traditional agriculture into commercised modern agriculture.

Because of the financial crisis, China’s economic growth will indeed slow down but it will continue to be high enough not to cause significant problems in China. China will likely be an exception during world recession, maintaining high growth, as it did after East Asian Financial crisis in 1997. The difference between the 1997 East Asian crisis and now is that China needs to stimulate growth more through reforms, not just rely on government expenditure. If the private investors are able to freely access the investment in freeways, high speed railways and infrastructure, then it will be a strong driving force for growth. But this can only be achieved through deepening reform.

In the wake of financial crisis, the case for government intervention has again become pervasive worldwide. The lesson from the financial crisis is not the failure of the market as some people suggest, but the failure of government regulation. The crisis is a punishment of market for bad regulation. The solution is to further strengthen market mechanisms, rather than to be suspicious of the market and to embrace the Keynesim and government intervention. It is critically important that all countries should have firm belief in the market economy as it heads towards exit from the crisis.

1. Chinese Growth and the Financial Crisis
2. Private sector investment in China: Unshackling the engine of growth
3. Indigenous innovation for sustainable growth in China

Climate change is a common challenge for all countries. All industrial countries, except the US, have signed the Kyoto Protocol to take responsibility for reducing greenhouse gas emissions. US President George W Bush defended the America’s inaction at the G8 summit in early July 2008 in Japan, saying that he wouldn’t agree to cutting emissions unless China and India did so too. ‘I’ll be constructive. I also am realistic enough to tell you that if China and India don’t share the same goal then we’re not going to solve the problem,’ Bush said. Defending US policy by targeting India and China does not make sense.

The problem of carbon emission rights allocation among all countries is a problem in how to clearly define property rights so as to prevent the externalities of emissions. The principle that should be applied is ‘whoever benefits, pays’. According to this principle, it is not fair, at the stage, to impose the same obligations on developing countries to reduce emissions as on the developed countries, though voluntary emission cuts by developing countries are necessary.

There are three current US stances which are inconsistent with this principle of ‘whoever benefits, pays’.

Firstly, it is inconsistent with this principle simply to compare the aggregate emissions of different countries. A characteristic of greenhouse gas emission is that no matter how much an individual country emits, the harm that emission does is borne by everyone on earth. To prevent externalities from emissions among different countries, the emissions quota of a country should equal to the average harm it does. If country A and country B both emit 2,000 units of greenhouse gas each and country A has 100 people, then its per capita emission is 20 units while if country B has 200 people, its per capita emission is 10 units. The overall per capita emission of the global (or the average harm of greenhouse gas emission) is about 13 units. Although the aggregate emission of both countries are the same, the harm (13) on the people in country B is higher than its own contribution to the problem, or its average emissions (10 ), while the harm (13) imposed on people in country A is much lower than the damage it does (20). People in country B are actually covering the costs for people in country A. These are the externalities involved. All other things equal, country A ought to reduce its per capita emission from 20 to 13, while country B has right to increase its per capita emission from 10 to 13 to eliminate the externalities. Alternatively, country B could transfer rights to emit (quota) to country A. This has nothing to do with whether a country is wealthy or poor. If country A is the US and country B is India or China, which of them has the right to ask the other to reduce emissions or to be compensated for emissions?

Secondly, it is inconsistent simply to compare emissions in production rather than to compare emissions embedded in the industrial goods each country consumes. An important reason why the unit GDP energy consumption and emission in the industrial countries is relatively low compared with developing countries is because their economies are service-based, and most of their high energy-consuming manufacturing industries have been transferred to the developing countries. As a ‘world factory’, about half of China’s emissions result from producing manufactured goods for industrial countries including the US. The developing countries benefit from the FDI and trade with the industrial countries but so do the developed countries. The embedded emissions in traded goods need to be re-considered when defining emission rights among countries.

Thirdly, it is inconsistent simply to compare the ‘current emissions’ without taking into account the ‘accumulated emissions’ of different countries. Greenhouse gas emissions are a result of industrialization. Since the industrial revolution in 18th century, industrial countries have been emitting without limitations and have benefited from the emissions. Accumulated emissions are overwhelming a product of industrial countries. This is a kind of externality between developed and developing countries. It is extremely difficult to estimate the accumulated emissions of the industrial countries. A simpler solution is to use the ‘benchmark’ approach to compensate developing countries, removing them of the obligation to cut their emissions by international treaty until their per capita GDP has increased to the level of industrial countries (the minimum level defined by the World Bank).

A fairer system for allocating emissions permits would use the concept of ‘per capita emissions’ to replace the ‘aggregate emissions’; use the concept of ‘embedded emissions in consumption’ to replace ‘ emissions in production’ and use ‘accumulated emissions’ to replace ‘current emissions’.

Most people accept the ‘right of developing countries to develop’ and special treatment for developing countries in cutting emissions. Accepting ‘development rights’ might lead to the same result as that suggested here but the rationale of ‘whoever benefits, pays’ is different and has nothing to do with if a country is developed or not.

Nonetheless, this argument is not to suggest that developing countries should not reduce their emissions. Rather, since climate change is a common challenge confronting all mankind, developing countries should also try their best to reduce greenhouse gas emissions, together with their developed counterparts.

To achieve this goal, we need a more constructive international mechanism. World emissions cuts can be classified into two different categories. One is an obligated cut to emissions imposed on the industrial countries. Another is a voluntary cut to emissions applicable to the developing countries. Though China is not required by the Kyoto Protocol to reduce its emission, the Chinese government has voluntarily set a target to reduce its unit GDP energy consumption and emissions by 20 per cent during the period of ‘11th-five year plan’ (2006-2010). Yet, effective collaboration on emissions reduction between the industrial and developing countries needs to be enhanced and expanded. Industrial countries need to provide technology and funding to assist the developing countries to reduce emissions.

The existing clean development mechanism (CDM) suggested in the Kyoto Protocol is indeed a good mechanism for the collaboration between developed and developing countries, and provides strong incentive for the two groups of countries to reduce the emissions. Nonetheless, CDM is far from sufficient and more channels need to be provided for all firms especially the SMEs in the developing countries to collaborate with their developed counterparts. An international emission trading system (IETS) between the developed countries and developing countries should also be established. At this stage, IETS only exists within the developed countries. If developing countries can establish their own domestic emission trading systems for voluntary emissions reduction, and these systems can be connected with the ETS in the developed countries such as EU ETS, this would significantly facilitate emissions reduction in developing countries and in the world as a whole.

1. Roadmap for US-China cooperation on climate change
2. An important international climate change funding proposal from China
3. Dispelling illusions on China and climate change