More Sustainable Growth

Last year, the National People's Congress (NPC) and the Committee of the Chinese People's Political Consultative Conference (CCPPC) were dominated by the launch of the 12th Five-Year Plan (2011-15), one of the most critical plans since the foundation of the People's Republic of China.

The plan reflects government efforts to make growth more inclusive and sustainable by setting an annual GDP growth target of 7 percent, and by increasing by 4 percentage points the share of the service sector over GDP. Industrial policy is expected to lead innovation-driven growth supported by increased spending on research and development. Improving people's livelihoods stands as a priority, with income distribution reform being approached through wage rises in line with gains in labor productivity gains, and gradual increases of minimum wages. Environmental protection also features prominently in the reform agenda moving toward the establishment of a low-carbon economy.

A year after the plan's endorsement, policymaking has focused on designing blueprints for the implementation of the main policy guidelines. To foster economic restructuring, new tax policies have been introduced to support the development of a modern service industry. Similarly, the recently launched Industrial Restructuring and Upgrading Plan (2011-15), the first mid- to long-term plan of its kind, targets 8 percent average annual growth of industrial value-added and a 10 percent average annual increase in labor productivity over the next four years. To increase living standards and boost the role of consumption as a driver of economic growth, income taxation has been reduced, and minimum wages will be gradually increased until they are 40 percent of the average wage of urban residents by 2015. To help meet the daunting environmental challenge, the newly introduced nationwide resource taxation scheme is expected to reinforce energy efficiency.

Looking ahead, reform will be challenged by the poor global economic prospects, and greater efforts will be necessary to successfully implement the policy guidelines embedded in the plan. In addition, the recent reclassification of 100 million rural people as poor under the government's new poverty line serves as a useful reminder of the need for the growth process to become more inclusive. In this connection, the ongoing NPC and CPPCC annual sessions present a unique forum for policymakers to discuss further policy actions to consolidate and continue the commendable progress achieved to date under the plan.

Innovation-driven growth, which is essential to sustain longer-term growth and avoid the middle-income trap, would benefit from greater private sector participation because private companies, in particular small and medium-sized ones, generate the largest share of GDP growth, employment, and innovative products in the market. In this process, further liberalizing the financial sector will improve the allocation of capital in support of the transition to an innovation-based economy while lowering the cost of, and improving access to, finance. More sophisticated capital markets will also foster innovation through wider access to international and domestic capital markets and new financial options. Success will depend heavily on achieving comparative advantage in global markets, which in turn requires substantial investments in R&D, and the upgrading of human capital through education policies bridging learning with the needs of the labor market.

Greater private sector participation and increased human capital will also benefit the development of services, one of the cornerstones of economic restructuring in China. Services entail large employment generation potential, and are 90 percent less emissions-intensive than manufacturing. Hence, a stronger service sector would not only help reduce the carbon footprint of the expanding cities, but also absorb the rural-urban migration stemming from urbanization, buttressing government plans to create 45 million new jobs by 2015. However, meeting the ambitious target set in the plan for the service sector's expansion demands far-reaching reforms, including removing barriers to entry, and opening the sector up to foreign direct investment in the same way manufacturing was opened to foreign direct investment over two decades ago.

It will be important to continue prioritizing social spending to increase living standards as higher wages will not boost consumption if precautionary savings remain high. Only about 38 percent of government revenue is spent on social security, education and healthcare, against an average of 52 percent in countries with similar income levels. Therefore, achievement of universal social security coverage and equal access to social benefits in urban and rural areas requires increased budget support, which should not be a constraint given China's strong public finance position. Given the rise in the number of people classified as poor, the effectiveness of social spending will also need to be strengthened by improved targeting. From the reform angle, while social welfare policies have progressed significantly in recent years, including enactment of the Social Insurance Law in July 2011, further actions are vital to correct the excessive segmentation of the social security framework. Unified systems and larger benefits are required to address the needs arising from increased labor mobility, including those of migrant workers, the challenges of accelerated urbanization, and the impacts of rapid population aging.

On progress toward establishing a low-carbon framework, while the plan contains a wide range of targets for environmental protection, there is scope for more ambitious goals. This is particularly important in light of plans to accelerate urbanization, as more efforts are needed to facilitate a sustainable process for this under the framework of a low-carbon economy, including improved water and land management. For instance, removing administrative controls on the price of water and electricity would rationalize their use and consumption, and including coal under the new resources taxation scheme would have similar positive effects. In this context, the introduction of green taxation should be given consideration as even a modest carbon tax would prove to be an effective tool to improve energy efficiency while generating significant yields that could be invested in developing low-carbon technologies.