Reforms to Build a Xiaokang Society in China

March 4, 2016

Bert Hofman, Country Director for China, Mongolia & Korea China Daily

China aims to build a xiaokang (moderately prosperous) society in a comprehensive manner and eliminate extreme poverty by the end of the 13th Five-Year Plan (2016-20) period. The reforms laid out in the Suggestions of the Fifth Plenum of the 18th Communist Party of China Central Committee and Decisions of the Third Plenum provide the solid basis for achieving these objectives. The 13th Five-Year Plan, to be discussed in the coming days, will include the concrete reforms that China decides to pursue in the years ahead.

Here are some reflections on how some of those reforms could help achieve China's objectives.

First is achieving moderately rapid growth during the 13th Five-Year Plan.

Though China's GDP growth is likely to slow further from 2016-20, the World Bank projects that continued implementation of reforms would keep growth high enough to achieve the targeted doubling of GDP between 2010 and 2020. Growth projections are not exact, and if there is to be any indicative growth target for the 13th Five-Year Plan, presenting a range rather than a point would provide policymakers the space to balance reforms and demand management.

People's welfare is likely to improve more rapidly than GDP growth. In recent years, wages grew 3 percent faster than GDP. Furthermore, China's labor force is now shrinking and growth is shifting to more labor-intensive services. As a result, less growth is needed to create the jobs that can boost people's livelihoods.

Second is policy and institutional reforms to increase productivity and innovation.

Since 1978, China has boosted productivity through policy and institutional reforms that decentralized decisions and opened up the economy. The Third Plenum called for a decisive role of the market in resource allocation, and the 13th Five-Year Plan period offers the opportunity to build the institutions needed for that role. Key institutional reforms that can drive productivity and innovation are those that increase competition, improve the management of State-owned enterprises, better protect intellectual property rights and raise labor mobility.

Competition is an important driver of productivity and innovation in a market economy. China has recently enhanced competition by reducing administrative burdens for start-ups, which sparked a wave of new businesses. To further increase competition, China could establish a negative list of sectors reserved for State investment and gradually shorten that list. Moreover, other countries have found that an agency solely dedicated to the enforcement of competition policy is beneficial for competition, productivity and innovation.

Beyond restructuring of SOEs in overcapacity industries, which the government has already embarked on, raising productivity in SOEs would call for mainstreaming better governance to realize higher returns on State capital. Already, the government is getting SOEs to deliver higher dividends, and assigning SOE shares and dividends to pension funds would allow for lower pension premiums, which increases workers' take-home pay and raises demand for labor.

As recognized in the Fifth Plenum, protecting intellectual property rights will gain importance as innovation takes center stage in the country's development. China needs to determine what IPR protection suits its current level of development, but whatever these rights may be, enforcing them in a consistent and impartial manner is crucial for innovation. The government could consider centralizing enforcement of those rights, similar to what was recently decided on enforcement of environmental protection.

Moving to where one is most productive can dramatically increase labor productivity and wages, as China's experience has demonstrated. Also, international experience suggests that enabling people to move to jobs is more conducive to reducing poverty than moving jobs to people. China is already reforming its hukou (household registration) system, and aims to absorb another 100 million migrants in cities by 2020. The joint World Bank Group-Development Research Center study, Urban China, suggests integrating all migrants in cities and giving them access to social services, like South Korea and Japan did during their rapid urbanization phase, is feasible and affordable.

Third is fiscal policy to support demand and reforms.

As structural reforms and institutional innovations are transforming the supply side of the economy, the demand side may need further government support. Export demand growth will remain modest in the coming years, and household consumption will only gradually play a bigger role. Investment growth is likely to further slow down, as lowering leverage in the economy is a priority for reducing risks. Since central government deficits and debt levels remain manageable, fiscal policy can play a more prominent role in supporting demand, and government is already actively using that tool.

Besides, China's transition to a more productive and innovative society is likely to require a considerable number of people to seek new jobs. Supporting them and their families during the transition can help accelerate reforms, and investing in a stronger safety net is a priority.

Finally, current low energy prices and low inflation offer an opportunity to reinforce the government's impressive environmental agenda by better pricing environmental scarcity through higher environmental taxation, such as taxes on coal and fuels. This would foster environmental sustainability and fiscal sustainability alike.