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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 1 The Distribution of World GDP 1978 & 2009 1978 2009 2 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." 3 Danny Quah’s Economic Centre of Gravity, 1980-2007 (in black) and Extrapolated to 2050 (in red) 4 China Opens and Reforms • • • • • • 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? 5 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 6 China – GDP by Industry 7 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% 8 • 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 9 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 – – – – – 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 10 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 11 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.” 12 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 13 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 14 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 15 Employment Distribution by Sector 1952-2010 16 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) 17 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 18 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 • • • • 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? 19 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 20 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 21 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 22 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 23 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 24 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. 25 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 26 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 27 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 28 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 29 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 30 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 31 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 32 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 33 China : Consumption vs Investment 34 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 35 THANK YOU 36