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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
The Distribution of World GDP 1978 & 2009
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."
Danny Quah’s Economic Centre of Gravity, 1980-2007
(in black) and Extrapolated to 2050 (in red)
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?
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
China – GDP by Industry
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%
• 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
Favorable Revolutionary Pre-Conditions
• Landlord class destroyed (Olson institutional sclerosis
• Leninist party and state apparatus survived (Huntington
political institutionalization hypothesis)
– Rebuilding the party and state through rehabilitation of old
• 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
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
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
• Some called it “crossing the river by feeling the pebbles
in the water.”
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
• How can transition be made without convulsive threats to
the authority of the state
• Momentum would be lost and rampant growth of
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
• 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
• Agricultural collectivization necessary to extract surplus
and peasants must not be allowed to exit
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
– Outsourcing state provided services
– Outsourcing non-business services from state owned
– Empowering provincial and local officials as the instrument
to affect change
Employment Distribution by Sector 1952-2010
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
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
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?
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
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
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
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
• Recently, elimination of taxes on agriculture
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
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.
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
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
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
• 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
Local Taxes and Migration
• With little migration competition among localities will
– 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
Competition for migrants
• Localities will seek to attract residents who are net tax
– 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
Re-understanding the 12th 5-Year Plan
• Financial incentives do seem to matter for government
– 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
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
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
China : Consumption vs
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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