Download China`s Mixed Economy – its Economic and Social Consequences

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Key-note speech at Chinese Economists’ Association Congress, Shanghai, July 2006
Assar Lindbeck‫٭‬:
China’s Mixed Economy – its Economic and Social Consequences
This lecture applies a system-oriented, “holistic” approach to China’s radical economic
reforms during the last quarter of a century (approximately 1980-2005). It deals with
both the nature of the reforms and their economic and social consequences. Generally
speaking, the paper focuses on the interaction between the economic and the social
system. I also consider China’s options for continued economic and social reforms,
whereby I draw heavily on relevant experiences over the years in developed countries.
Of course, in a short lecture it is only possibly to scratch on the surface of various
issues.
The Nature and Economic Consequences of the Economic Reforms
Since the economic reforms in China are best characterized as a change of economic
system, it is useful to analyze the reforms in the context of a typology of economic
systems. I will then regard an economic system as a multi-dimensional phenomenon,
defined in terms of a nine-dimensional vector; see Figure 1.1 The first two dimensions
concern the ownership of firms and assets, respectively – contrasting public
(government) and private ownership. The third dimension deals with the choice
between centralized and decentralized economic decision-making, and the fourth with
the related choice between administrative processes and market mechanisms for
transmitting information, coordinating economic decisions, and distributing goods and
services among households. The fifth and sixth dimensions concern the extent to which
economic behavior is influenced by non-economic motives and economic incentives,
respectively – in the case of individuals as well as firms. The seventh and eighth
dimensions refer to one crucial aspect of the relation between the economic agents
within the domestic economy: the role of competition. The ninth dimension, finally,
concerns the relations between domestic economic agents and the outside world,
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contrasting autarkic and internationally integrated (“internationalized”) economic
systems.
In terms of Figure 1, I depict the initial (“standardized”) position in the late 1970s by
the vertical vector of circles to the far left in the figure. Today’s position (2006) is
schematically depicted by stars in the case of agriculture, and by squares for the rest of
the economy. Generally speaking, the economic system has gradually shifted from
public ownership towards private ownership of firms and assets, towards more
decentralized decision-making and more reliance on markets, economic incentives and
competition, as well as from autarky to internationalization. I have indicated that the
shifts have been of different magnitude in different dimensions of the economic system,
as well as in different production sectors. Needless to say, the figure is only illustrative.
In the case of agriculture, the most characteristic feature of today’s ownership structure
is the combination of private ownership of firms and public ownership of the most
important physical asset in the sector – the land that is leased by family farms from
local authorities. In the figure, this feature of the ownership structure in agriculture is
illustrated by a much larger shift to the right in the first dimension than in the second.
Deng Xiaoping is famous for the metaphor that the color of the cat does not matter as
long as it can catch mice. But when it comes to the ownership in agriculture, the “color
of the cat” still seems to be important. As we know, there is also considerable
uncertainty concerning property rights of land-lease contracts in China due to the risk
of expropriation, in particular in connection with the re-zoning of land for other
purposes. Indeed, available estimates indicate that at least 34 million farmers (partly or
completely) lost their land-lease contracts between 1987 and 1991 due to such
expropriation (UNDP, 2005, footnote 120).
Clearly, the move to private ownership of firms has been slower in industry than in
agriculture. The role of private firms in industry has, however, gradually increased by
the privatization of a number of small and medium-sized state-owned enterprises,
SOEs; the entry of private firms including foreign-owned ones; and the increasingly
private nature of so-called “collective” firms, mainly town-and village enterprises,
TVE’s. After the mid-
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Figure 1
Dimensions of economic systems
1.
*
of firms
of firms
Public
ownership
2.
Private ownership
of assets
of assets
*
3.
Centralized
*
Decentralized
4.
Administrative
processes
*
Markets
5.
firms
Noneconomic
motives
6.
individuals
7.
8.
9.
firms
*
individuals
*
firms
Cooperation/
collusion
*
Economic
incentives
firms
Competition
individuals
*
Autarky
*
O
*
China before 1978
Chinese agriculture today
Chinese non-agriculture sectors today
individuals
Internationalized
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1990s, many SOE’s have also been considerably downsized. It is fair to say that the
bulk of aggregate production (GDP) today takes place in the private sector,
approximately 60 percent. Moreover, while the privatization of firms has been smaller
in industry than in agriculture, the privatization of assets has been larger.
The delay of the privatization of firms and assets has not prevented fairly speedy
reforms in other dimensions of the economic system. For instance, economic decisionmaking has largely been decentralized to households (in the case of consumption) and
to firms (in the case of production) – schematically depicted in dimension 3 in Figure 1.
Of course, an important prerequisite for the success of this decentralization has been
that markets have replaced administrative processes as the dominant mechanism for
allocating resources and coordinating decision-making. In most of the dimensions, the
reforms have gone further in agriculture then in industry, largely because the process
has been held back in industry by the frequent interventions by politicians and publicsector administrators in industrial firms; indeed, this is the background for Chows’
characterization of China’s economy as a “bureaucratic market economy” (1997; 2002,
chapt. 19).
Turning to the last dimension in Figure 1, the pronounced internationalization of the
Chinese economy is one of the most remarkable features of the reforms – in terms of
the export share as well as of foreign direct investment (FDI).2 We would also expect
that the internationalization of the economic system would result in increased
international cultural influences on Chinese citizens. One example is more
individualistic (and perhaps also hedonistic) values, in particular among the urban
young – a process that already seems to be underway.
Two other characteristics of China’s economic system – not explicitly highlighted in
Figure 1 – should also be emphasized. One is that factor markets have been reformed
much less than product markets. For instance, the flexibility of the labor market is still
constrained by the privileges of employees in state firms, which creates a pronounced
insider-outsider nature of the urban labor market. Moreover, although the residence
registration system in urban areas, urban-hukou, has recently become more lenient,
individuals without permanent residence permits, usually migrants from agriculture,
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are less rewarded for their effort and their investment in human capital than permanent
residents. They also enjoy much less social protection (if any), and they have to pay
much more than others in urban areas for human services, such as education and health
care. All this means that the hukou system considerably accentuates the insideroutsider nature of the urban labor market.
During a comparable phase of industrialization, today’s developed countries in Europe,
of course, also experienced a huge outflow of labor from agriculture. A considerable
share of the rural population could then, however, migrate to other continents with
ample availability of agricultural land and subsequently expanding urban labor markets.
China’s current agricultural population does not have the same opportunities, so that
the gradually increasing leniency of the hukou system is bound to contribute to a
situation similar to Arthur Lewis’s (1954) model of “unlimited supply of labor” in
urban areas. If China does not shift to a much more labor-intensive growth strategy,
with an increased role for services, a further increase in unemployment is unavoidable.
Largely as a result of the huge public ownership of banks and financial assets, financial
markets in China are even less developed than labor markets. For instance, in the
second half of the 1990s two thirds of all bank credit seems to have been granted to the
state sector – in many cases in the form of “soft” loans, which is the background to the
notorious problem of “non-performing” loans (Lardy, 2000). Although these loans are
an indicator of moral hazard and inefficient allocation of resources, the Chinese
government has considerable financial resources to prevent the situation to result in an
acute financial crisis; however, the bailing out financial institutions always run the risk
of creating new problems of moral hazard in the future.
Another characteristic feature of the economic system in China is the heavy reliance
on informal networks, partly as a substitute for “ the rule of law ” (i.e. the
enforcement of contracts through the legal system). Observers of the Chinese business
culture often refer to the so-called guanxi – the Chinese variety of “social capital”; see,
for instance, Walder (1996) and Chow (1997, 2002). More specifically, economic
relationships among economic agents are largely founded on social norms of
cooperation, with roots in traditional kinship and community institutions. Indeed, such
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norms may function as de facto property rights, thereby stabilizing expectations
regarding the behavior of other economic agents (Wank, 1999). Such networks of
individuals are often extended by close ties with local officials – ties that are crucial in
a society where legal rights are often enforced in a haphazard manner.
Naturally, such networks are not unproblematic. “Kickbacks” and other types of
corruption are difficult to avoid with “clientele-like” relations between public-sector
representatives and private entrepreneurs. Moreover, as emphasized by Zhang (2006),
while such networks favor economic transactions among influential individuals, they
may take place at the expense of weak groups of citizens. The most obvious example is
perhaps the earlier mentioned expropriation of land-tenure contracts when local
politicians and administrators (“cadres”) want to turn over land-lease contracts to
developers in industry, retailing, and housing. Although such interventions often speed
up the reallocation of resources from agriculture to other sectors, this occurs at the
expense of farmers’ economic security. Social concerns are relinquished for other
purposes, such as a fast rate of structural change – and the enrichment of local cadres.
However, we cannot rule out the possibility that corruption in China has speeded up
the transition to private entrepreneurship by helping create a class of private capitalists,
for instance, when public funds have been diverted to private individuals (“asset
stripping”), often in connection with management buy-outs of SOEs. Still, it is
reasonable to argue that well-functioning “rule of law” in a long-term perspective is
likely to be more efficient than network relations with strong elements of corruption.
Indeed, there is no lack of official commitments to fight corruption in China. But as
long as public-sector politicians and public-sector administrators have something to
“sell”, such as various types of permits and help to get loans, corruption is difficult to
avoid. Thus, here is an additional argument for further deregulation of the Chinese
economy – on top of the conventional arguments in terms of improved economic
efficiency. Experiences from many countries also suggest that political competition
and free and pluralistic media are highly conducive for minimizing corruption.
How, then, should today’s economic system in China be labeled? Some observers have
called it “state capitalism”. While this label may have been appropriate in the 1980s, it
is rather misleading today. The system is more appropriately characterized as a rather
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special type of a “mixed economy” – with more private ownership of firms than of
assets; frequent political and bureaucratic interventions in public-sector firms; poorly
developed factors markets; and, finally, business networks that partly replace “the role
of law”, although often at the costs of widespread corruption.
We do not really know which specific elements of China’s economic reforms during
the last quarter of a century best explain the county’s successful growth performance –
officially recorded as a yearly growth rate of 9.5 per cent during a quarter of a century.
We can only say that the actual combination of elements in the reform package,
schematically illustrated in Figure 1, has been conducive to GDP growth, at least so far.
It is also rather generally agreed among observers that the gradual and experimental
approach to economic reforms – across regions and sectors, as well as across reform
areas – have served China well, as compared to the Big Bang transition strategy in
former Soviet republics and Eastern Europe.
When evaluating China’s success in terms of GDP growth, it is, however, also
important to take into account the resource costs of the chosen growth strategy – i.e.,
the efficiency of the growth path. China has followed a highly resource intensive
growth path, characterized by an exceptionally large capital intensity of firms, with an
investment ratio of 43 per cent of GDP today, and a marginal capital-output ratio of 4-5.
This should be compared to investment in education of about 5 percent of GDP, in
spite of evidence that the return to such investment is very high (Heckman, 2005)
The limitations of the efficiency of the Chinese economy are also reflected in the large
overstaffing and the excessive inventories of finished and intermediary products in the
SOEs. Another indication of limitations in economic efficiency is that many production
sectors in China use several times as much energy and raw materials per unit of output
as in corresponding sectors in developed countries. It is true that total factor
productivity (TFP) growth seems to have been reasonably good, probably 2.5-3.0 per
cent per year during the reform period. However, this figure also reflects temporary
spurts in the connection to two special productivity-enhancing reforms – in the early
1980s during the shift from collective farms to family farms, and in the early 1990s in
the connection to the comprehensive price reform.
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Moreover, the huge differences in economic and social development across
geographical areas remain an important aspect of the general characteristics of the
country – with the eastern (coastal) provinces as the leaders, and the mountainous
provinces in the west, along with the “rustbelt” areas in the north as the laggards.
Official statistics suggest that while GDP has grown by about 11.5 percent per year
during the reform period in the most successful provinces (Fujian, Guangdong, Jiangsu
and Zhejiang), the growth rate has been about half that size in the least successful
province (Quinghai). The level of per capita GDP is currently reported to be about
seven times higher in the most developed than in the least developed province, even if
we exclude the very poorest province (Guizhou). Indeed, the regional differences
among China’s provinces (and large cities) are so large that China looks like a
continent with a mixture of fairly advanced industrial countries and some of the
poorest countries in the world. It is also well known that per capita income differs
drastically between urban and rural areas within provinces. For instance, official
statistics suggest that the ratio of average income in urban areas is about the three times
as high as in rural areas. These regional differences are an important background for a
discussion of the social situation in the country – an issue to which I now turn.
Social Policy Options
Naturally, the economic reforms also have had drastic social consequences. Even to a
larger extent than in the Soviet Union and the socialist countries in Eastern Europe,
social arrangements in China during the pre-reform period were dominated by work
units (danwei). Since government authorities during that period were responsible for
major production and investment decisions (a rough type of input-output planning) we
may, with some exaggeration, say that the division of tasks between the government
and the work units in China was just about the reverse of the corresponding division in
developed countries today, where firms are in charge of production and investment,
and the government (particularly in Western Europe) runs most of the social
arrangements.
It is easy to understand why the economic reforms rendered these social arrangements
dysfunctional. Benefits tied to specific work units simply do not sit well in a market
economy, since an efficiently functioning labor market requires social benefits to be
portable. Ad hoc selective subsidies and soft loans to firms with financial problems
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have functioned as a “stop-gap solution” to the problem. But as a result, the
discrimination of private firms in credit and capital markets was accentuated, which
further reduced their ability to expand production and employment. The “double
bind” – state firms constrained in shedding labor, and private firms constrained in
acquiring loans – has implied a kind of catch-22 situation during much of the reform
period. It is difficult to remove this “double bind” until non-state firms expand their
employment sufficiently to absorb a much larger fraction of the redundant labor force,
and before a more comprehensive system of income security is in place.
Inadvertently, households have also helped finance firms’ social obligations, since
households’ deposits in state banks (at low, and during some periods even negative,
real interest rates) have been intermediated into loans to state firms. As a result, the
social obligations of state firms have, in fact, been partly financed by an “inflation tax”
on households’ financial saving (although less so during years with low inflation). This,
in turn, implies that much of the real return on household saving has been transferred to
the beneficiaries of various social arrangements – much like a tax-financed pay-as-yougo (“paygo” for short) system, although in this case the “tax” was imposed on the
return on saving rather than on work.
The provision of “human services”, such as education and health care, also
encountered serious problems in the connection to the economic reforms. Individuals
have been forced to finance a large fraction of their consumption of such services with
out-of-pocket money and, in the case of health care, voluntary or occupational
insurance policies (Zhang and Kanbur, 2005). For instance, the government share of
financing of education is reported to have fallen from about 65 to 53 percent between
1990 and 1998, and private out-of-pocket expenses to have increased from about 2 to
about 13 percent, largely to finance tuition fees, school books, transportation, and
school uniforms. (Most other sources of spending – such as by firms and their
subsidiaries – remained rather constant.)
The role of private financing is even more striking in the case of health care –
preventive as well as curative. The share of private expenditures on health care (out-of
pocket money and insurance) seems to have increased from about 16 percent in 1980 to
no less than about 60 percent in 2001 – with a corresponding fall in spending by local
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governments and other institutional sources, such as firms. The figure is even higher in
the countryside than in cities: 87 percent as compared to 44 percent.
Thus, when China gradually shifted to a new economic system and the old
arrangements for education and, in particular, health care broke down, the authorities
were very slow in building up new arrangements, in particular in rural areas – a parallel
to the slowness in constructing new systems for income security. In both cases, lowincome groups were particularly harmed. The Chinese experience is consistent with the
traditional inference in microeconomic textbooks that a market economy does not
automatically generate arrangements for either income security or the provision of
education and health care. These developments are, of course, an important
background factor for recent attempts to build up new social arrangements.
When discussing the possibilities for the Chinese authorities speed up improvement in
social conditions, it is useful to classify policies into three categories: (i) interventions
that boost the factor income of citizens, in particular among low-income groups; (ii)
policies that stabilize and redistribute disposable income for given factor incomes
(”income security”); and (iii) improved and more evenly distributed provision of
various types of human services.
i. Policies to Influence Factor Income
Since China is still a very poor country, there is a strong social case for opting for a
continuation of fast factor-income growth, and hence GDP growth. Against this
background, China probably has much to gain in the future by gradually shifting from
an extensive to a more intensive growth path – with more emphasis on human relative
to physical capital, a more efficient allocation of resources including less use of raw
materials and energy per unit of output, as well as a faster introduction of new
technology and organization. More labor-intensive production is also necessary to
mitigate the risk of even more serious unemployment problems in the future. It is
paradoxical that such a labor abundant country as China has chosen an extremely
capital-intensive growth path.
The case for fast factor-income growth is especially compelling for rural areas through
rapid productivity increase in agriculture, although there are also large pockets of
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poverty within urban China – not just among the “floating population”. This makes a
case for combining general growth-promoting policies with targeted interventions to
boost factor income growth in specific regions and among specific socio-economic
groups of citizens, regardless of where they live.
Better functioning factor markets – for labor as well as capital – would facilitate a shift
to a more intensive and innovative growth path. It is also likely that such a shift could
be speeded up considerably by a greater role for private ownership of both firms and
assets (physical and financial), as well as by generally better working conditions for
private entrepreneurship. For instance, evidence from various developed countries
indicates that private entrepreneurship is highly conducive to innovations; see, for
instance, Baumol (2000). Moreover, at least a partial privatization of the banking
system would, most likely, reduce the bias in lending in favor of state enterprises.
As compared to many other types of redistributional interventions, policy measures
particularly designed to boost the factor income of low-income groups through higher
productivity often have the advantage of enhancing rather than harming economic
efficiency. Indeed, empirical studies in China indicate that targeted infrastructure
investment in poor geographical areas (including investment that increases market
access) tend to boost productivity considerably among both family farms and firms in
other sectors in such areas. There is also empirical evidence from China of productivity
improvements as a result of better nutrition, sanitation, basic health services and
education in geographical areas with a large incidence of impoverished social groups.3
Removal (or at least further softening) of the urban-hukou could also be expected to
boost per capita factor income, not only for those who move to urban areas, but also (as
a result of diminished labor supply in rural areas) for those who remain in the
countryside, at the same time as the upward drift of urban wages would be mitigated.4
Moreover, in a similar way as the shift from collective farms to family farms in the
early 1980s released productivity gains in agriculture, a shift to private ownership of
agricultural land is likely to have the same outcome. Not only would farmers be
encouraged to make long-term investments in the land that they cultivate. It would also
be easier to consolidate fragmented patches of land cultivated by individual farms, with
productivity improvements as a predicted result through better exploitation of returns
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to scale, for instance, in the case of wheat, vegetables and animal products. (Already
full transferability of land-lease contracts would help achieve some such
consolidation 5 ). It is also likely that a shift to outright ownership of land would
strengthen farmers’ property rights, and hence create better investment incentives.
Furthermore, an end to the rationing of land-lease contracts would partly remove an
important source of corruption. There thus seems to be a conflict between lingering
socialist ideology with respect to land ownership on one hand, and concern for longterm efficiency and higher per capita factor income in agriculture on the other.
ii. Income Transfers and Social insurance
The most important policy devise for creating income stability and bringing about
redistributions of income in developed countries has, of course, been income transfers,
mainly in the form of social insurance. Indeed, in urban areas, China has recently
started to build up mandatory systems of income insurance akin to the systems in
developed countries in the west (“social insurance”), although with important elements
borrowed from the so-called “provident funds” in Singapore and Malaysia. It should
also be noted, however, that in their early phases of economic development, today’s
rich countries relied mainly on (modest) safety nets – rather than on arrangements for
income protection (i.e., benefits in some proportion to previous earnings). It was only
after these countries had become rather well off, mainly after World War II, that
comprehensive arrangements for income protection (social insurance) became
common.6
Since China has already started to build up systems of income protection, the
experiences of similar systems in developed countries should be of interest. I refer, for
instance, to the importance of designing these systems so that they are financially
robust to various types of “unfavorable” exogenous shocks, such as in demography,
productivity growth and macroeconomic developments. One conceivable way of
achieving this could be to make the benefits automatically contingent on the
development of variables such as the rate of growth of the tax base, the number of
individuals above retirement age, and the number of individuals living on various types
of benefit systems (Lindbeck, 2005).
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Another lesson from developed countries in the west is to importance of avoiding
transfer arrangements that generate long-term behavior adjustments among citizens
that could seriously harm the efficiency or growth of the domestic economy, and hence
damage the tax base for the social arrangements themselves. Disincentive effects of
high marginal tax rates might be the most obvious example. One straightforward
method to limit such effects is to have a rather tight link between contributions and
benefits for the individual. Moral hazard, i.e., “non-desired” behavioral adjustments
(such as increased leisure financed by the insurance systems), seem to be an even more
severe problem, however, in particular in the case of unemployment benefits, sick pay,
and early retirement benefits. Over time, individuals in countries with highly generous
schemes of income protection may gradually develop a more “liberal” interpretation of
their rights to live on various types of benefits from the government, rather than work.
More specifically, in a long-term perspective, moral hazard may be accompanied by a
weakening of social norms in favor of work or against living off government benefits. I
have hypothesized elsewhere that contemporary welfare-state problems in several
developed countries are due to such endogenous weakening of social norms in favor of
work, and that this tends to accentuate the problems of moral hazard (Lindbeck, 1995;
Lindbeck, Nyberg and Weibull, 1999).
These lessons from developed countries may seem self-evident at first sight, but
experience has shown that they are not easily learned, and even less easily adhered to.
Contemporary experiences in several countries in Western Europe also expose the
political difficulties in cutting the generosity of various welfare-state arrangements,
even after both experts and many politicians have become convinced that existing
arrangements are not sustainable. It is important also for China to watch out for such
problems in the future – if possible before they have become serious.
There are, however, also a number of country-specific problems with China’s
emerging systems of social insurance. One example is that risk pooling often takes
place only across limited geographic areas, such as a city, or possibly a province. At
first glance, this may seem to be a trivial problem, since the geographical domains
across which risk pooling then takes place are often more populous than many
European nations. However, the composition of industries often differs strongly across
geographical areas, so that the payroll taxes also vary strongly across such areas. In
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particular, firms in areas with many unemployed or pensioners are exposed to much
higher social costs than firms in other areas. For instance, payroll taxes are relatively
high in regions with old industries, such as mining and steel, whereas they are
relatively low in regions with new industries, such as banking, electronics and civil
aviation. This tends to influence the relative competitiveness of firms in a rather
arbitrary way, especially if local wages do not adjust fully to differences in payroll
taxes. The variations in benefits across firms and regions also limit the portability of
pension entitlements, and hence impede the emergence of a national labor market.
The most acute problem inherent in China’s emerging arrangements for income
security is, however, the bias in favor of urban insiders. First, within urban areas,
individuals with temporary residence permits are covered to a very small extent, and
those without permits not at all. Second, per capita social transfers are about 10 times
as large in urban as in rural areas (UNDP, 2005, p. 3), and the dispersion of publicsector spending across provinces seems to have widened rather than narrowed in recent
decades (UNDP, 2005, p.25).
Moreover, the generosity of emerging system of unemployment insurance in urban
areas, is likely to create financing problems in the future, since structural
unemployment in China is bound to be high. 7 Presumably, the rationale for this
generosity is to create an acceptable substitute for the receding job guarantees by stateowned enterprises. But perhaps it would have been financially safer if China, at its
present stage of economic development, had chosen a less generous system. It would
then also have been possible to cover a larger share of the labor force (outside
agriculture). Recently (2004), the system has covered about 105 million individuals
(China Compendium, 2004). Since unemployment insurance is particularly difficult to
extend to the farm population, improved crop-failure legislation and/or improved
natural-disaster relief might be (imperfect) substitutes for unemployment insurance in
the farm sector.
There are also looming problems with the emerging mandatory pension system in
China, which also mainly covers urban citizens; see, for instance, OECD (2005a, pp.
187-190). The first layer of the system consists of a strongly redistributive paygo
system, and a second layer is supposed to consist of a fully funded, actuarial system
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with individual accounts, hence a system without intended (ex ante) redistribution.
Recently (2004), these systems have covered about 165 million individuals. The longterm financial viability of the new pension system may be questioned, however,
because of the combination of expected future changes in demography (the “graying”
of the population) and the low pension age (formally 60 years for males and 55 for
females, with an effective retirement age of only 55 for the former). This problem
could, of course, in principle be solved by a higher effective retirement age. Another
problem is that contributions originally paid into the funded part of the system have, in
fact, been used to finance deficits in the paygo part of the system – resulting in the
“problem of empty individual accounts”. As a consequence, the funded part of the
mandatory pension system, so far, looks more like another paygo system with
“notional” rather than real accounts.
In principle, there are several alternative solutions to the problem of “empty accounts”.
One suggestion (Bottelier, 2002) is to let the National Council of Social Security Fund
take over the shares in a number of state firms. The Fund could then be instructed to
sell the shares gradually on the open market, at appropriate intervals to avoid strong
negative effects on share prices. In fact, the shift to a funded pension system would
then partly be financed by gradual privatization of state firms. A more modest version
of this idea has, in fact, already been implemented: the collective fund in China is
entitled to receive 10 percent of the proceeds from the sales of shares in state-owned
companies every time there is an initial public offering (IPO), or new share issue.
A more general problem with funded government-run pension systems is whether the
government should opt for one central or several mutually independent (decentralized)
funds. Decentralized pension funds run by non-government agents are, of course, more
consistent with the notion of a competitive market economy than either one central
fund or several separate government-operated funds. Government-operated funds
always run the risk of being “high-jacked” by politicians who insist that they should
decide the portfolio policy of the funds, appoint the members of the board of the
fund(s), and perhaps also appoint board members in firms where the funds have bought
shares.
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The most promising way of significantly reducing the probability of political
intervention in government-created pension funds, and hence de facto nationalization
of the national economy, is to opt for a number of decentralized, non-government
funds from the very beginning. Considering China’s recent tradition of government
ownership and political intervention in individual firms, the risk (or “hope” among
some observers) that a funded, government-created pension system, in fact, will result
in a strongly nationalized economy is hardly less in China than in other countries.
iii. Human Services
Awareness of the deficiencies in the provision of human services in China is quite
strong today – among Chinese citizens, the authorities, as well as foreign observers.
Clearly, these problems cannot be solved without increasing the government share of
the financing (taxes and mandatory insurance) of services, and without larger financial
transfers from central to local governments in poor geographical areas. At the present
time, suggestions and promises abound for improving the volume, quality, and
accessibility of human services, also in poor geographical areas and among disfavored
population groups. Continuation of about the current rate of GDP growth in China
would certainly make this economically feasible. Sooner or later, however, China will
encounter the same types of problems in this sphere as developed countries have
already experienced. One example is gradually rising relative costs of human
services – reflecting William Baumol’s celebrated “cost disease” (or Baumol’s law)
regarding labor-intensive services for which rationalization is particularly difficult
(Baumol, 1967).
There are also a number of specific Chinese problems in connection with the provision
of education and health care. For instance, in the case of education, most observers
seem to agree that the most pressing task today is to reduce the financial burden of
schooling for low-income parents. Related major tasks for the education system are to
expand the number of students in secondary and tertiary education; and to improve the
quality of education at all levels. When considering ways of dealing with these
problems, a number of well-known trade-offs are unavoidable. One is to determine the
number of years students should follow a single track and when (and how) students
should be separated according to interest and ability (dual or multiple tracks). Another
important trade-off is between “basic skills”( in reading, writing and mathematics) and
17
broader, more vague “social abilities” (including preparation for citizenship and leisure
activities). A third trade off is whether vocational skills should be taught in schools or
under apprenticeship arrangements in firms.
In all these cases, it is probably a good idea to avoid extreme solutions. For instance,
there is rather general agreement among specialists in education today that an early
separation of schoolchildren (as, for instance, in Germany) into different tracks (in
some countries already after the fourth grade) disfavors children from homes without
an academic background. Moreover, several countries that have emphasized general
“social abilities” rather than “basic skills” among students seem to regret that today. It
is interesting to notice that today’s rich countries did emphasized “basic skills” when
they were poor 50 or 100 years back, largely for the purpose of boosting the ability of
the entire population to read, write and count.
Most countries have also serious problems with their systems of vocational training.
Today in China, such training is still largely provided by SOEs, and training centers
affiliated with such firms (Fleisher and Wang, 2001). There seem, however, to be farreaching variations in quality in this system.8 The frequent deficiencies in vocational
training may explain why many individuals have recently chosen to finance vocational
training themselves. 9 China is, I believe, well advised to take inspiration from the
German experience with apprenticeship work at firms, combined with general
education in school (i.e., two days a week in school and three on the job, or the
reverse). This could be accomplished without very early separation of students into a
two-track system (as in Germany).
As I indicated above, the problems in health care in China are much more severe than
the problems in education. As a result of the stagnation of public-sector health services
during the period of economic reform – indeed a regress in many rural areas – the
private sector has taken over most of the responsibility for about a third of the
production of such services (Kin et al., 2002) – although some assets (medical facilities)
are still owned by public-sector authorities, and rented to private agents. In itself, this
shift to private producers is not necessarily a problem. The real problem is rather that
the public sector has reduced, and decentralized, its responsibility for the financing of
these services. Since no more than about 105 million individuals had “basic” health-
18
care insurance in 2004 (China Compendium, 2004), private financing usually takes the
form of pocket money.
In spite of the deterioration of health services in important respects, there has been a
rapid increase in total health spending – today amounting to 5.3 percent of GDP, which
is 2-3 percentage points higher than in countries with a similar level of per capita
income in Southeast Asia (except for Vietnam). The apparent paradox of increased
spending and stagnating – and in some areas even deteriorating – health services
suggests inefficiencies in the organization and deficiencies in the incentive structure of
health care. One indication of inefficiency is that about 68 percent of government
funding is reported to have gone to hospitals rather than health clinics and preventive
health, in spite of the fact that many experts regard the latter activities as potentially
more important (on the margin) for the overall health situation (UNDP, 2000, p. 3).10
The inefficiencies in health care are also a result of the uneven distribution of such
services, with a concentration of health resources to large and medium-sized cities
(UNDP 2000, p. 3), which cannot possibly reflect the regional distribution of the need
for health-care resources. Indeed, about 80 percent of the resources in health care seem
to be used in urban areas.
Most likely, there are also severe problems of moral hazard in the health care sector.
One example is that strict price controls on many types of health services have induced
hospitals and health clinics to finance much of their health-care provisions by revenues
from the sale of drugs. This, in turn, has created strong incentives to charge high prices
for drugs and to over-prescribe drug medication (Hesketh, and Zhu, 1997) 11. Clearly, a
new price system for health services is required, where a more symmetric price system
for drugs and other types of treatment would improve allocative efficiency of the
health-care sector.
Indeed, reforms are announced and to some extent underway in health care, including
promises to improve the situation in rural areas. So far, very little has, however,
happened outside urban areas. As in the case of pensions, the financing of future
health-care insurance in urban areas is supposed to rely on a combination of paygo and
funding (with individual accounts), the latter organized along similar lines as in
Singapore and Malaysia.12 Presumably, individual accounts are particularly useful for
19
relatively inexpensive, mainly “out-patient”, rather than expensive treatment. Costly
treatment (including “catastrophic health care”) is supposed to be covered by the paygo
(“risk pooling”) part of the system. However, the individual accounts already seem to
have run into financial difficulties (in a similar way as the pension system), thereby
forcing the government to inject new money from the general budget into the paygo
part of the system.13 The state also encourages enterprises to establish supplementary
medical insurance for their employees, mainly to settle medical expenses not covered
by mandatory medical insurance.
As in the case of education, a number of well-known trade-offs have to be addressed? I
refer, in particular, to the trade-offs between preventive and curative care, and between
basic (relatively inexpensive) curative health care and more sophisticated (relatively
expensive) curative health care. In the case of developing countries, including China, it
is natural to argue that both ethical and efficiency concern make a case for preventive
health services and basic curative health services rather than sophisticated (specialized)
curative health care. Not only general health conditions but also aggregate labor
productivity would then be expected to be improved.
Whereas preventive health care in developed countries is mainly an issue of
individuals’ life style (smoking habits, diet, exercise etc.), in poor countries it is also a
question of sufficient nutrition, sanitation and effort to combat transmitted diseases.
Not least in China, it is also an issue of serious pollution. Indeed, some research
indicates that China’s air pollution problems are among the most damaging in the
world. Although the costs of such policies would be considerable, so would the gains
in terms of improved health (Brajer and Mead, 2004). The severe environmental
problems are, of course, partly side effects of China’s one-sided emphasis on capitalintensive, raw material-intensive and energy-intensive industry – another illustration of
interaction between growth strategy and social developments. These problems are also
a result of the limited priority assigned to environmental protection as compared with
production and consumption of goods and services – a historical parallel to similar
neglect during the early phase of industrialization in today’s developed countries.
The Chinese authorities have recently tried to deal with this problem by quantitative
regulations and graduated pollution charges when emissions exceed certain mandated
20
ceilings. But many SOEs do not seem to be particularly sensitive to such charges,
simply because profit considerations do not dominate their objectives. (This resembles
the insensitivity of state firms to monetary and fiscal incentives in the context of
stabilization policy.) There have been recent experiments (conducted in cooperation
with the World Bank) to exert social pressure on firms, rather than simply relying on
quantitative restrictions and economic incentives.14 In other words, as a complement to
the latter types of policy measures, the idea seems to be that firms’ pollution behavior
can be influenced by social norms, which are supposed to be upheld by the general
public’s approval or disapproval of firms’ behavior. In the future, when most firms in
China are likely to be profit-oriented, it will be easier to pursue successful
environmental policies using (Pigouvian) tax/subsidy programs.
Concluding Remarks
If the gradual transformation of China’s economic system continuous along the same
lines as during the last quarter of a century, the role of the government is likely to
become more “traditional”. By that I mean that the government then is likely to
concentrate on encouraging market-supporting institutions, improve the infrastructure,
stimulate investment in human capital (education, health and basic research),
contribute to a stable macroeconomic environment, mitigate major market failures,
including those in insurance markets, and redistribute income across geographical
areas and among individuals.
It is, however, an open question of whether a gradualist strategy will be as successful
in the future as in the past. For instance, gradualism may prevent the exploitation of
important complementarities, such as among reforms in product markets, labor markets
and financial markets. There is always a risk that a gradual reform process will come to
a halt, if interest groups gradually build up resistance to further changes. This risk is
particularly severe if China does not deal with its serious social problems among urban
outsiders and underemployed and poor people in rural areas – both groups with little
income security, poor provision of human services and strong expose to arbitrary
interventions in their lives by public-sector administrators and local party officials.
Because of the urgency to deal with these problems, gradualism may not be enough, in
the sense that the tendencies to social unrest may increase; there is already clear signs
21
of such unrest, recently being reported to about 80,000 “social incidents” during a
single year (in China Daily). Fortunately, at China’s present stage of economic
development, more ambitious social programs in these dimensions are probably fully
compatible with, or possibly even conducive to, economic efficiency and economic
growth.
Sooner or later, the authorities are, however, likely to be confronted with trade-offs
between these aspects. I have emphasized two important concerns when dealing with
these trade-offs. The first is to make various welfare-state arrangements reasonably
robust to exogenous shocks – such as unfavorable changes in demography,
productivity
growth,
unemployment,
and
international
interdependencies
(“globalization”). The other concern is to create, as far as possible, welfare-state
arrangements that do not by themselves induce “undesired” endogenous behavior
adjustments, for instance, as a result of tax distortions and moral hazard. To minimize
such risks, there is a case both for keeping the generosity of the benefits within
“reasonable” limits, and for tying various insurance benefits to previously paid
contributions (i.e., to opt for “quasi-actuarial” social insurance systems). Then, it may
also be possible to contain tendencies to a softening of social norms in favor of work
and against benefit dependency. Countries in early phases of building up welfare-state
arrangements, including China, have particularly strong reason to be aware of various
strong disincentive effects when they begin the route towards more advanced welfarestate arrangements.
22
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‫٭‬
The paper is a summary of a study, “An Essay on Economic Reforms and Social Change in China”,
commissioned by the World Bank.
1
I follow here, in principle, the typology in Lindbeck (1975).
2
The export share has recently hovered around 30 percent of GDP (when measured by the official
exchange rate). FDI has recently been about 25 percent of yearly investment in manufacture (about 5
percent of GDP) – although most of this probably consists of purchases of already existing real capital
assets rather than “greenfield investment”.
3
For instance, Jalan and Ravallion (2002) find that investment in both infrastructure and human capital
has significantly raised the return to farmers’ investment in physical assets (other factors held constant).
4
On the basis of a computable general equilibrium (CGE) model, Whalley and Zhang (2004) find nontrivial redistibutional effects of this type as a result of an assumed removal of the hukou.
5
Wan and Cheng (2001, p.191) estimate that a consolidation of fragmented patches of land would
increase labor productivity by as much as 12-17 percent, depending of the types of crops.
6
Germany under Bismarck introduced social insurance for industrial workers earlier than other countries,
and the United States built up universal social security, mainly in the form of old-age pensions as early
as in the mid-1930s.
7
The replacement rate of about 50 percent for a large fraction of those insured, and with a maximum
duration of between 12 and 24 months (depending on how long premiums have been paid for a
particular individual).
8
For instance, Li (2004) reports many examples of poor supervision, considerable disorder and
inefficiencies, as well as large mismatches between the demand for skills and the availability of training
opportunities for different types of skills. The number of vocational schools has also fallen gradually –
by at least 50 percent since the early 1990s.
9
In a sample used by Li (2004), about a third of the individuals engaged in vocational training
participated in programs financed mainly by out-of-pocket money.
10
Of China’s total health expenditure (in 2002), 50 percent is reported to have been allotted to urban
hospitals, and only 7 percent to health centers. It also appears that only about 7 percent was devoted to
“public health” (preventive health care) in spite of the fact that such treatment is particularly important
in poor countries (UNDP, 2005, p. 58).
11
As much as half of total spending on health care is reported to consist of costs for drugs, while more
normal figures in developed countries are usually 10-15 percent (Blumenthal and Hsiao, 2005).
25
12
The individual’s entire contribution (two percent of earnings) and a third of the contribution covered
by the employer (six percent of the wage bill) are supposed to be paid into an individual’s (funded)
personal account, while the remaining two thirds of the employers’ premium is allotted to the paygo part
of the system (i. e., the common “health insurance pool”). See, for instance, Social Insurance Research
Team (2003).
13
The payroll tax that finances health insurance is currently 8 percent of the wage rate (OECD, 2005,
Table 4:3). Social Policy Research Centre (2002, p. 9) estimates that it would have to be considerably
higher than 10 percent in the future to avoid deficits.
14
One attempted method is to rank firms (publicly) according to their degree of environmental concern –
the so-called “Green Watch Program” (Wang et al., 2004).