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Fulbright Visiting Scholar 2011 Presentation
Another Look at China’s 12th 5-Year Plan
China - Hong Kong Nexus Again
Prof Y C Richard Wong
The University of Hong Kong
17 October 2011
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The Distribution of World GDP 1978 & 2009
1978
2009
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Source : UNSD Statistical Databases
Super Growth Forecasts
• Citi Investment: (assumed 5% per capita growth rate in a
growth convergence model) China in 2040 dominant
economy $58 trillion (PPP) ; US $31 trillion (PPP) in
2040. By 2050 India dominant economy.
• Subramanian (FA): (assumed growth rate 7%) China in
2030 dominant economy with 20% world’s GDP; 15% for
US; per capita GDP at $33,000 will be half of US.
• Robert Fogel: China will produce $123 trillion GDP by
2040 assuming an average annual growth rate of about
10.8 percent a year for more than 30 years
• Fogel: "Beijing has proven quite adept in tackling
problems it has set out to address."
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Danny Quah’s Economic Centre of Gravity, 1980-2007
(in black) and Extrapolated to 2050 (in red)
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China Opens and Reforms
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Sustained opening and reform for 30 years
High growth and high frequency fluctuations
China’s 12th 5-Year Plan
Role of pre-conditions
Logic and criticisms of the Chinese approach
De-collectivization and de-centralization
– Fiscal role of provincial and local governments
• Reforms incomplete and need for rebalancing
• Will high growth continue for another 30 years?
• Hong Kong’s role?
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Fast Growth High Freq-Amp Fluctuations
• Average Real GDP growth rate was 10.8%
• 4 big economic cycles (peak-peak in 8 years)
• Is there a unified explanation for 30 years of fast growth
and high frequency-high amplitude fluctuations
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China – GDP by Industry
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Source : CEIC
Highlights of China’s 12th 5-Year Plan
• China wants to sustain 7% growth by stimulating
domestic demand
• Urbanization rate to rise 4% to reach 51.5%, create 45
million jobs in urban areas
• Price stability, 5% unemployment rate
• Promote private consumption
• Minimum wage to rise by 13% p.a.
• Pensions schemes to cover all rural residents and 357
million urban residents
• Construct 36 million low-income homes
• Service sector to account for 47% of GDP up 4%
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• Coastal regions to turn from “world’s factory” to hubs of
R&D, high-end manufacturing and service sector
• Foreign investment welcomed in modern agriculture,
high-tech and environment protection industries
• Breakthrough in emerging strategic industries. Valueadded output to account for 8% of GDP
• R&D expenditure to account for 2.2 %of GDP
• 3.3 patents per 10,000 persons
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Favorable Revolutionary Pre-Conditions
• Landlord class destroyed (Olson institutional sclerosis
hypothesis)
• Leninist party and state apparatus survived (Huntington
political institutionalization hypothesis)
– Rebuilding the party and state through rehabilitation of old
cadres
• Successes in East Asia and the role of Hong Kong
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Ideas on benefits of markets, openness and globalization
Spearhead economic opening
Built institutional infrastructure for trade and investment
An offshore international financial center
Re-build civil society
• Mao’s Cultural Revolution had severely weakened the
bureaucracy and becomes a plus factor
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Policy Choices
• Social and economic damage and turmoil of the Great
Leap Forward and Cultural Revolution presented some
obvious policy choices at the beginning
– Facts not ideology gained ascendancy
– Reversing egalitarianism Deng: “Let some get rich first”
– Huge gains to be reaped from investing in obviously neglected
sectors, i.e., economic distortions from the past era
– De-collectivization and De-centralization left open some room for
markets to rapidly develop
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Assumed “Logic” of the Chinese Model
• A gradualist step by step ad hoc approach more or less
controlled from the top, but no blue print
• Experimentation to reduce political risk
• False starts and backtracking
• Followed path of least resistance
• Consolidation of achievements and articulation of goals
for the next stage as a pragmatic strategy to keep reform
alive
• Some called it “crossing the river by feeling the pebbles
in the water.”
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Critics of Gradualist Transformation
• Process may be stalled as opponents have time to
stiffen their resistance
• Gradualist meant inevitably partial reforms and
inconsistencies that become future obstacles to reform
or even chaos and paralysis
• (Merton Miller: changing from driving of the left hand side
of the road to the right hand side; neighborhood by
neighborhood)
• How can transition be made without convulsive threats to
the authority of the state
• Momentum would be lost and rampant growth of
corruption
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Logic of Stalinist Planning
• Stalinist strategy was a heavy industry first strategy
• Work against a poor country’s comparative advantage by
emphasizing capital intensive sectors when labor is
abundant
• Adopting the command economy and state ownership
therefore provided a compelling institutional logic
• It was not Oscar Lange’s rational socialist calculation
• Price controls were pervasive and supervised by layers
and silos of bureaucracy
• Widespread shortages were managed through full scale
rationing
• Agricultural collectivization necessary to extract surplus
and peasants must not be allowed to exit
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Dismantling Stalinist Planning
• Reversing the Stalinist command economy:
– Shifting from heavy to light industries
– De-collectivizing agriculture
– Allowing rural to urban migration to support growth of light
manufacturing and services (Landlords were no longer
obstacles)
– Outsourcing state provided services
– Outsourcing non-business services from state owned
enterprises
– Empowering provincial and local officials as the instrument
to affect change
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Employment Distribution by Sector 1952-2010
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Source : China Statistical Yearbook 2011
Dismantling Stalinist Bureaucracy
• Attempts at decentralizing decision making powers lead
to chaos, recentralizing decisions recreated the
bureaucratic status quo
– (Role of provincial and local government officials in
promoting growth)
– (Privatized or outsourced many peripheral state services to
quasi-monopoly “SPVs”; retaining influence, less control
and market driven)
– (State employees became entrepreneurs and joined the
private economy; staff quarters became quasi private
assets)
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Fiscal institutions and government behavior
• Role of provincial and local governments
• Greater fiscal decentralization in China than in the US
– Only about one-third of government spending done by the
central government in China
– Provincial and local governments play an important role in
the Chinese economy
– In comparison two-thirds done by federal government in
the US
• Pre-1994 and post-1994 period dividing line due to
tax reforms and banking reforms
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Fiscal Federalism: Chinese Style
• Local governments commonly credited with some of the
key successes and key failures of the economic reforms
– A key success: explosive entry of collectively owned
Township Village Enterprises
– Key problems
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Trade barriers
Poor access to education in rural areas
Stagnation of incomes in agriculture
Instability in land markets
• How do we best explain these outcomes, given the
incentives faced by local officials?
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Alternate Tiebout and Exit-Voice Models
• Two possible alternates:
– Voice: from central government rather than from voters
(obvious limitations)
– Exit: of economic activity rather than of people (due to
hukou system), causing loss in tax revenue (firm centered
not citizens)
• Provincial and local government policy choices:
• Spending on public services aiding
– Firms
– Farmers
– Households
• Allocation of bank loans (prior to 1994)
• Allocation of land
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Behavior Pre-1994
• Efficient incentives to invests capital in collective firms
– Local governments the residual claimant
– Firms operated in a competitive national market
• Neglect of agriculture
– Tax rate is higher on industry, so gain from shifting activity
from agriculture to industry
– Lowering the marginal product of farmers lowers the cost
of labor in industry, raising profits of collective firms
• Opposition to entry of private firms
– Receive only tax payments, instead of the full profits
received from collectives
– Control over land can prevent most entry
– But side-payments can induce support for these firms
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Behavior Pre-1994
• Public services
– Efficient provision of services and infrastructure to
collective firms
– Minimal services to agriculture, unless can charge high
enough user fees
– In general, no services (education, housing, health) to
households unless they pay the full cost
– Education raises future excise tax payments by firms, but
may risk future exit from the jurisdiction
• Officials have a short horizon; can’t legally sell position
– With fixed pool of local funds available for new investment,
incentive is to make investments with a quick payoff
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Major Policy Changes Around 1994
• Major changes in tax structure VAT introduced
• Bank loans (in principle) now controlled by banks rather
than local governments
• Privatization of smaller state-owned firms, and implicit
central support for entry of new private firms
• Introduction in 1998 of the right to sell lease-holds on
land
• Recently, elimination of taxes on agriculture
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Provision of Services Post-1994
• Favor firms with higher tax payments per worker
– Favor capital-intensive firms
– Favor firms facing higher VAT rate
– Weaker incentives, though, than before 1994
• Continue to neglect agriculture, particularly after end of
agricultural taxes
• Limit shift of land to industry
– to keep land prices high
– to keep required compensation to farmers low
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Provision of Services Post-1994
• Implications of short time horizon of officials
– Prefer sale to lease of land
– Prefer rapid sale of land.
– One explanation for sales now in spite of rapid increases
in land prices
• Still no incentives to provide services to households
without sufficient user fees
• In particular reluctance to finance tuition-free education.
• In order to implement tuition-free education, central
government in the end forced to cover full cost. But local
governments may divert funds.
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Provision of Services Post-1994
• Government responses to migration pressures
– Migrants increase tax base but can create extra costs for
public services
– Governments have incentive to discourage entry
(encourage exit) of migrants that are net recipients, but
encourage entry of migrants who are net contributors to
budget
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Voice from Central Government
• Promotions under control of central government
– Means for central government to exercise influence
– In practice, information poor, limiting direct oversight to
egregious cases
– Threat also weak for most officials, given that most future
assignments close substitutes
– Tenure length too short for making long-term investments
in social services, education, health, housing for low
income households
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What additional incentives result?
• Promotion may be positively correlated with future tax
revenue for higher levels of government
– Current tax payments to central government
– Growth rate in tax payments
• Local officials favor sectors facing a high central tax rate
because of promotion incentives so they favor high-end
industries
• Business profits taxes and even property taxes on
businesses play little role in other countries because
competition drives down these taxes, but in China they
play a central role in driving local economic policy
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Local Taxes and Migration
• With little migration competition among localities will
undermine:
– taxation of business income
– VAT paid based on local production, since compete for
industries paying VAT
• Taxation of employment income can be made
independent of the industry one works in if it is based on
consumption, e.g., retail sales tax or a consumptionbased VAT
– This runs counter to pressures for a progressive income
tax
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Competition for migrants
• Localities will seek to attract residents who are net tax
payers,
– Provide better services to richer households, and poorer
services to net recipients
– Reallocate more land, in order to raise wage rates and
lower residential rents
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Re-understanding the 12th 5-Year Plan
• Financial incentives do seem to matter for government
officials
– Help explain striking initial success of collective firms
– But also help explain continuing neglect of agriculture and
education, leading to growing inequality.
• The current design of these incentives is a potential
threat to future growth, especially if the creation of a
coastal region with high-end industries falters due to
destructive competition among localities
• Many aspects of the 12th 5-Year plan are better
understood as a reflection of the political demands and
present incentives of provincial and local governments
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Re-balancing the Chinese Economy
• Stimulating consumption is key to addressing the
imbalances it faces internally and externally
• Most critical internal imbalance is the heavy reliance on
investment growth, especially capital-intensive SOEs
• Resources will then be transferred to households and
labor-intensive SMEs
• Raising consumption, lowers savings, and lowers the
current account surplus
• Raising real interest rates is a positive move
• Raising real wages is a positive move
• Raising RMB is a positive move; but a “forced” move can
be countered domestically by an expansion of credit at
lower real rates and would be a negative outcome
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Can Consumption be Stimulated?
• Most critical imbalance is the heavy reliance on an
investment driven growth model (A Stalinist legacy that
still haunts China 30 years after reform)
• Private consumption’s share of GDP is now 35%, and
investment’s share is 40%
• In part this reflects the legacy effects of the not totally
dismantled Stalinist institutions in the form of ministries
and the state owned enterprises
• To bring Chinese consumption in 5 years up to 40% it
would need to grow by 10% each year assuming a 7%
annual GDP growth rate
• To bring Chinese consumption in 20 years up to 50% it
would need to grow by 9% each year assuming a 7%
annual GDP growth rate
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China : Consumption vs
Investment
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Another Miracle is Needed
• Consumption must grow much faster than GDP
for rebalancing
• The fiscal incentives for cooperation between
central and local authorities are not in place
• Households when faced with a high growth rate
of income, but few opportunities to invest their
savings to yield a return to match the high
growth rate will have to save even more
• Low consumption and high savings/investments
is of course the other side of the equation
reflecting large current account surpluses
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THANK YOU
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