China: Addressing Backlash Against Reform
Andy Xie (Hong Kong)
Summary & Conclusions
China is experiencing the most intense debate in a decade on the merits of its reform and open-door policy. Rising inequality and rising household financial burdens are the triggers. The debate is another factor that will shift China's priority from growth to non-growth issues, I believe.
The growth target in the 11th five-year plan (2006-2010) is 7.5%, compared with 9.5% for the past 25 years. By setting a low target, the government has room to focus on urgent issues, such as income inequality, education, healthcare, housing, and pollution. By addressing these issues, the Chinese economy will shift away from investment and exports to consumption, in my view.
Debating the reform and open-door policy
China's GDP expanded by 57.3% in constant price terms and 83.8% in current price terms between 2000 and 2005, according to China's National Statistics Bureau. Negative sentiment towards the economy has increased rapidly, despite the fast growth. The latest manifestation of this is the resurgence of anti-reform sentiment.
Extreme income inequality and other ills in China's economy have always elicited strong opinions. However, until recently, the reform and open-door policy had not been questioned seriously for a decade. The current debate centres on whether the reforms have caused the problems and have gone too far -- that is, questioning the merit of the reform and open-door policy.
One concrete example of the backlash is the negative sentiment towards the sales of state-owned assets to foreign capital. Private equity firms, for example, are facing more difficulty in acquiring state-owned enterprises. Even the IPOs of state-owned companies in Hong Kong are being questioned. The rallying cry is that China is selling its assets to foreign capital too cheaply.
Concerns about structural problems in the economy are often linked to doubts about foreign capital, since the rising influence of foreign capital in China's economy is one of the most visible signs of its open door policy. I estimate that one-fifth of China's GDP (over half in the export sector) is produced by foreign-owned firms, which would make China the most open large economy in the world.
Negative sentiment over foreign capital seems to derive mostly from a small elite, worried that foreign capital may be undermining the development of indigenous companies. The lack of internationally competitive Chinese firms has fanned the flames of such suspicion.
The sentiment towards foreign capital among the population is mostly positive. Most local governments still tout the amounts of foreign capital that they attract to their populations.
'Retreating is no way out'
China's top leaders have reaffirmed their commitment to the reform and the open-door policy. The Premier has stated that retreating is no way out. The risk of a substantial policy reversal is still low, in my view. Despite the ills in the economy, most people are far better off than 15 years ago, when China was still quite closed. There is little popular support for a step backwards.
While the public at large support the reform and open-door policy, they also want their concerns to be addressed. I believe the main concerns are (1) rural poverty, (2) rising income inequality, (3) escalating costs of education and healthcare, (4) declining property affordability, (5) pollution, and (6) work safety. Public demand for government action on these issues looks likely to escalate in the coming years.
China's economic policy has tended to be about sustaining fast growth. Whenever growth has looked like slackening, the government has introduced another wave of reforms to revive momentum. China has trusted in growth as the solution for the country's problems.
Developments in the current boom have shaken this faith in growth. Despite the magnitude of the boom, popular discussions about the economy relate mostly to escalating problems rather than the accomplishments of growth (e.g. infrastructure development). This shift in sentiment is likely to have a significant impact on China's policy development in the coming years, I believe.
The growth target in the 11th five-year plan (2006-2010) is 7.5%, compared with a realized growth rate of 9.5% over the past 25 years. The government's aim in setting a relatively low target is to leave room to address non-growth issues. The 11th five-year plan is likely to be a period of consolidation for the Chinese economy, in my view.
Over the next five years, I think the Chinese government needs to implement policies to address the issues that negatively affect livelihoods. If the problems continue to escalate, the doubts about China's reform and open-door policy could spread from a small elite to the masses.
Diverging trends of economy and household welfare
The fixation with growth is to blame for many of today's problems. To mobilize resources to support investment-led growth, central and local governments have been shifting financial burdens to the masses. Education, healthcare and housing are the most important items. Merely 10 years ago, most people took for granted that the public sector would finance these three necessities. Today, they have come to represent the biggest outlays in household expenditure. This is why, despite income growth, most people feel under more pressure than they did 10 years ago.
As the state sector has shed its burdens, it has used its improved financial situation to list assets on the stock market and increase investment. The rise in expenditure on infrastructure, for example, is due partly to the state sector shifting its financial burdens to the household sector.
The privatization of the housing market has played an important role in increasing investment. Sales of residential properties increased from 2% of GDP in 1998 to 6.2% in 2005. As household income is about 56% of GDP, this implies that property purchases equate to around 11.1% of household income. The fear of rising property prices is a major driver of rising demand for properties. This item clearly features very prominently in household expenditure, but did not exist 10 years ago.
The 1Q06 central bank survey on urban consumption and saving behaviour showed that willingness to consume has reached a historical low and education expenditure is the principal deterrent against consumption. China's education system has a serious flaw, in my view. Schools are state-owned monopolies, but have flexibility when it comes to charging students. Considering the importance that Chinese households attach to education, schools have great pricing power to raise charges on all sorts of pretexts. Chinese schools behave neither like public schools, which have a mission to serve, nor private schools, which must compete to succeed.
The latest report from the World Health Organization ranks China fourth from bottom among over 190 countries on social equity of healthcare. China had a healthcare system completely funded by the government only 10 years ago. The dramatic reversal has had a traumatic impact on livelihoods. Similar to schools, Chinese hospitals are state-owned monopolies that have pricing flexibility. In healthcare, the bargaining position of the patient is essentially nil. It is not surprising that the current system is the cause of considerable resentment.
The new and large burdens from shouldering education, healthcare and housing expenses explain why China's impressive growth has not generated the same increase in household welfare -- because the growth has taken place partly at households' expense. The China Youth Daily recently published a survey showing that 85.3% of the population feel a heavier financial burdens now than 10 years ago.
The contrast between economic growth and household welfare is due to the three 'mountains' of education, healthcare and housing, which weigh down on household pocketbooks. Indeed, one major reason behind China's fast economic growth is the shift in these financial burdens from the state to the household sector.
Change appears to be in the air. The recently completed National People's Congress focused on the big social issues rather than growth per se. I expect most policy changes in the coming months to address the imbalances in China's economy.
The first area likely to see action move is minimum wages. The city of Shenzhen has just announced an increase in its minimum wage from Rmb 690/month to Rmb 800/month. Senior government leaders are increasingly expressing support for increased minimum wages. I see this as a key ingredient in addressing China's economic imbalances.
More affordable housing is the next objective that needs to be met to increase household welfare, in my view. Many cities are talking about this, but not doing enough, because such a solution is not sufficiently profitable for either property developers or city governments. I would expect to see some new policies implemented this year.
The central government is targeting commercial corruption in hospitals and schools as a temporary measure to respond to popular unhappiness. However, reforms are necessary to make these two sectors function efficiently on their own. I believe China needs to introduce government-funded basic education and healthcare and to promote private capital market competition as much as possible to make these two industries efficient.