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China’s Other Economic Agenda: Priorities, Progress, and Policies

By Jean-Marc F. Blanchard, Ph.D.

China’s troubled state-owned enterprises (SOEs) and state banks, its unemployment woes, and the pressures unleashed by its World Trade Organization (WTO) accession tend to dominate conversation when China’s economic difficulties are discussed. These problems present genuine threats to the country’s economic prosperity and political stability. They are, however, only three of the many economic challenges that China confronts as it moves to a market-based and globally integrated urban economy.
The interlinked nature of China’s economic problems means that the leadership cannot deal with the more visible economic threats in isolation from lesser-known problems. A recapitalization of the banking system, for instance, will not spur growth unless the government succeeds in fostering a more favorable business environment for private firms. China’s less familiar economic difficulties include private sector constraints, rural underdevelopment, and public finance problems.

The private sector is a ray of light on China’s contemporary economic landscape. It produces about one-third of China’s GDP, dominates the service sector, and, more importantly, is a major source of job creation. Yet private enterprises operating in China face substantial obstacles. These include a lack of access to capital, underdeveloped markets, too little or too much market supervision and regulation, restrictions on market entry and access to government resources, inadequate infrastructure, and corrupt officials. Currently, many SOEs that are trying to become normally functioning private businesses cannot get the investment they need, the managerial training they require, or the asset divestment powers they seek.

In rural areas, underdevelopment has many facets: poverty, high levels of income inequality, inadequate health and education, energy shortages, and ecological crises. If rural areas cannot provide adequate opportunities, rural residents will migrate to urban areas. This places great strains on local governments, job markets, and the urban infrastructure. Additionally, rural underdevelopment implies a lack of money to support education, health care, and environmental programs. Either this money will come from higher government levels or these programs will remain underfunded. This will make it extremely difficult to create an educated workforce, to deal with costly health problems like HIV/AIDS, and to reduce air pollution, water shortages and farmland losses.

We should not forget that rural underdevelopment has provoked political unrest in recent years. This is one reason decision makers gave it great attention in the 10th Five-Year Plan (2001-2006) and last November’s 16th Party Congress, and repeatedly mentioned it at the ongoing National People’s Congress. It would be farfetched to assume that just because rural areas served as the base for the 1949 Revolution that rural problems will once again become the wellspring of another revolution. Many of the conditions present in 1949 are simply are not there today. Nevertheless, severe problems exist. Ironically, development programs may fuel the fire if they cause rural inhabitants to feel they are entitled to more, but fail to deliver and do not furnish political channels for them to pursue any resulting grievances peacefully.

It is not well known that government units beneath the national level account for almost three-quarters of public expenditures in China. Furthermore, government units below the provincial level account for more than half of all public spending. Unfortunately, these sub-national units are spending far in excess of their resources. To restore balance, they need to cut spending, raise taxes/fees, or draw more money from an already hard-pressed central government. Aside from their adverse consequences in terms of social spending, cuts could diminish spending on the infrastructure that promotes growth and sustains the creation of a national market. Moreover, tax and fee hikes may stifle business creation, causing corruption, and encouraging wasteful efforts to evade taxes and fees.

Cognizant of these problems and the risks of inaction, Chinese leaders have embraced numerous initiatives. They have worked to establish a functioning legal and judicial system, to create additional financing options for small and medium enterprises, to open previously closed sectors like energy, and to improve transportation and logistics. They also have striven to increase access to education, to encourage the production of higher-value crops, to produce better socio-economic indicators, and to protect natural resources. Finally, they have endeavored to stabilize the financial situation of the country’s subnational units through increases in general and project specific transfers, new revenue sharing arrangements, and shifts in expenditure obligations.

Going forward, the economic agenda remains packed. The government needs to improve the business environment by eliminating internal trade barriers, reducing government monopolies, and increasing import and export privileges. On the public finance front, policymakers must balance subnational spending obligations with subnational resources, improve information and management systems, and establish more effective tax systems. In the realm of rural underdevelopment, officials need to do more with respect to health and education spending, the creation of non-farm employment opportunities, and the protection of individual property rights.

To address these outstanding items, the government is pursuing various options. For instance, it is giving space to private financial institutions in the insurance, banking, and securities industries and considering reforms in the tax laws applied to financial institutions. It also is reducing the footprint of SOEs in many markets. It is also accepting market prices for energy and transport, which reduces government subsidy burdens and creates new opportunities for private entrepreneurs. Furthermore, it is curbing special fees and user charges and strengthening land-use rights. Moreover, it is dramatically streamlining the bureaucracy and allocating more resources to infrastructure, environmental, and education. Finally, it is enacting additional business and environmental laws and creating more transparent regulations and guidelines.

There is no reason to doubt the new Communist Party leadership’s commitment to these and other reform initiatives. Past economic crises have discredited administrative economic solutions. The internal and external pressures for continued economic reforms are great. The new leadership and China’s power brokers are pragmatic and uniformly support a reformist agenda. And these elites have the support of powerful patrons including Jiang Zemin and Zhu Rongji. Nevertheless, their reformist zeal will be tempered by government fiscal constraints and their wariness of potentially destabilizing change.

Successful progress on China’s other economic issues could offer many opportunities to businesses that operate in, or want to conduct business with, China. First, it should create new buyers and suppliers. Second, it should increase investment opportunities, either individually or in partnership with domestic companies. Third, it should increase the country’s overall rate of economic growth. Fourth, it should stabilize the rural, ecological, and government fiscal situation. Fifth, it should allow progress on the country’s more visible economic problems. Where China is concerned, then, 2+2 indeed may make 5.

Editor: Dr. Scott B. MacDonald, Sr. Consultant

Deputy Editors: Dr. Jonathan Lemco, Director and Sr. Consultant and Robert Windorf, Senior Consultant

Associate Editor: Darin Feldman

Publisher: Keith W. Rabin, President

Web Design: Michael Feldman, Sr. Consultant

Contributing Writers to this Edition: Scott B. MacDonald, Keith W. Rabin,
Jonathan Lemco, Jean-Marc F. Blanchard, Barry Metzger, Russell Smith,
Ilissa A. Kabak, Andrew Novo, Jonathan Hopfner, C. H. Kwan, Dominic Scriven and Andrew Thorson

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