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China Still Rising?
Address by ADB Vice-President Stephen P. Groff on 14 August 2013 at the Sydney University in Sydney, Australia
Good afternoon, ladies and gentlemen.
As we all know, the rise of the People’s Republic of China (PRC) is the economic story of our times, with its remarkable growth driving not only its own success, but much of the world’s as well in recent years. Australia has, of course, been one of the major beneficiaries, with a large proportion of its resources boom fuelled by sales to the world’s second largest economy.
But the factory and investment-driven growth model is clearly reaching its limit. We are now seeing a new ‘normal’ of single digit growth in the PRC, with exports and investment slowing amid weak global demand and tighter monetary policy. The country’s GDP expanded 7.6% in the first half of this year and ADB estimates full year growth at about 7.7%, easing to 7.5% in 2014. In 2012, the economy expanded 7.8%. These numbers are a far cry from the average double-digit growth rates recorded for the previous 20 years.
Obviously there is short-term pain from this downward adjustment in the economy. But in the longer term, a shift to steadier, more balanced growth, which is both inclusive and environmentally sustainable, is essential for the PRC’s continued prosperity and development, and by extension, the rest of the world’s too.
The big unanswered question is: how will the PRC achieve this? Today, I would like to detail some of the structural adjustments needed to put it on the right path. But before I do so, let me lay out the fundamental challenge facing the country today.
Even with the incredible reduction in the number of extreme poor over the past 3 decades, about 10% of the country’s rural population still lives below the national poverty line. There remain sharp divides in income, infrastructure and development between urban and rural areas, and coastal and inland regions.
The recognition that the old growth model is no longer appropriate and must be changed is clearly being embraced by the PRC’s new leaders. Premier Li Keqiang has announced a new ‘upgraded model’ for economic growth, which makes balance and inclusivity key tenets.
The country’s 12th Five Year Plan lays out the roadmap with a focus on financial market reforms, fiscal reforms and greater deregulation to foster more private sector participation in the economy. These are all critically important areas and I would like to elaborate on some of them.
The first is the role that fiscal policy can play in supporting inclusive growth, balancing income distribution and improving living standards. In our view, without an overhaul of taxation and fiscal transfers, China’s growth is unlikely to be sustainable.
We have seen headway--fiscal revenues have increased from less than 10% of GDP in the mid-1990s to 20% today. But a lot more is needed. Fiscal revenues are still low compared to OECD countries. Less than 3% of the PRC population pays income tax. And while the percentage of government revenue spent on social security, education and health is up, it is well below the average of other middle-income countries. To address this, the tax base should be broadened by curtailing tax evasion, reducing the informal sector in the economy and strengthening tax administration.
Secondly, taxation should be more progressive with taxes on capital gains and property, and the introduction of inheritance and gift taxes to help balance income distribution. The government is piloting some important initiatives, such as the introduction of a property tax on luxury housing in Shanghai and Chongqing. But the ultimate goal must be a genuine property tax based on home values and universally imposed on all urban homes.
An increased tax take would allow for higher social spending in areas such as education and health, which in turn would increase private consumption and support more domestic demand-led growth. Right now, the PRC’s fiscal spending on education and health amounts to about 5.6% of GDP. It would be desirable to get it closer to OECD averages of about 12.5%.
There is also a need to overhaul the tax revenue sharing system between the central and local governments. One approach here would be to increase existing transfers of fiscal resources from the central government, and the share of value-added tax revenue accruing to local governments, to provide more funds for social services at the local level. Without such change, big disparities in public social spending will emerge and perpetuate inequality.
Improved tax collection, further liberalization of energy and resource prices, the introduction of environmental taxes and the transfer of state-owned enterprises’ dividends into social expenditure would all allow for an increase in social spending without straining public finances. This is important for ensuring fiscal sustainability.
The financial sector, meanwhile, remains heavily bank-dominated with 80% of the PRC’s total financing in 2012 coming from bank loans. The capital market, by contrast, remains relatively underdeveloped.
The priority here should be to make finance and financial intermediation more market-based. Recently the People’s Bank of China took a step in the right direction by abandoning the floor of the lending rate. But other steps are needed, too, such as an overall reduction in shadow banking which is estimated at about 40% to 55% of GDP and as much as 30% of bank sector assets. Improved financial safety nets, including deposit insurance are also required, along with further development of the bond and equity markets, gradual deposit rate liberalization, and greater exchange rate flexibility.
Many of these measures will be particularly welcome to the private sector, which needs to be much more actively engaged in driving the economy. The government’s plan to deregulate certain areas of the economy, increasing opportunities for private business, is a welcome step in the right direction.
Sustainable, inclusive growth
Aside from fiscal and financial barriers, there are a number of other key challenges that the PRC must overcome if it hopes to make growth sustainable and inclusive.
It needs to close the large technology and productivity gaps with advanced countries and to keep wage growth generally in line with productivity growth. Labor productivity in the PRC’s is only about 10% of the US level in 2009. Promoting innovation and developing local capabilities by investing more in human capital will be essential for creating value-added products and services. These in turn will help the country avoid becoming mired in the middle income trap, a fate that has befallen many developing countries.
China also needs to find ways to address resource constraints and to reverse the alarming environmental degradation that often sees the PRC make headlines for the wrong reasons. The country is now the world’s largest source of CO2 emissions and is ranked 28th out of 179 countries in the world for air pollution. However, it is also leading the way in transitioning to renewable energy. We hope this will continue. Despite substantial up-front costs, the long-term gains will be huge. It should be noted here that the government’s current five year plan lays out a number of policy options to promote renewable energy, emissions trading, energy price reform and a ‘green tax’--all of which show its commitment to gradually change the current pattern of energy use.
Reforming the country’s household registration system or hukou, and taking steps to make cities more livable, green, and financially sustainable are equally critical, with more than 20 million people moving into cities every year as a result of expanding urbanization.
The need to make urban centers more financially viable has become especially important in light of the soaring levels of debt incurred by local governments as a result of the global financial crisis and pressures to accelerate investment in infrastructure. From 1996 to 2010 local government debt rose from 3.5% of GDP to nearly 27%. This in turn has created substantial credit risks for the central government.
To counter this trend, local governments and their lenders should look to find ways to broaden the maturity structure of existing debt. They should also be encouraged to sell assets, including infrastructure projects and state-owned-enterprises, to strengthen their fiscal positions. More stable revenue sources, such as property or green taxes, should be considered.
Creating a more conducive enabling environment for the issuance of infrastructure bonds, securitization and public–private partnerships; more regular disclosure of debt information; and increased capacity building to help governments plan and implement investments and manage debt, are other important initiatives that should be pursued.
As the PRC’s economy has grown, so has inequality. The lack of social protection systems for the vulnerable, including rural dwellers and those in the informal sector, needs urgent attention. As noted earlier, public spending on social protection remains relatively small, and the approach to the development of programs has been segmented and uncoordinated. Some progress has been made, with medical insurance now covering almost the whole population, and some rural dwellers now enjoy pension benefit, but the overall level is low.
What are needed are portable social security entitlements within and across provinces and expanded pension system cover for rural residents, migrants and other urban informal sector workers. Greater fiscal and financial sustainability of existing urban pension systems is also a must. With widespread aging set to impact the country by the mid 2020s, there is a pressing requirement to develop pension systems to support the elderly as well.
Need for development assistance
While on the surface the PRC would seem to require little outside assistance given its impressive economic record of recent years, it still has substantial development needs. ADB continues to maintain a strong partnership. More than 90% of ADB’s assistance [cumulative lending of $12 billion at end-2012, and over $4.2 billion planned for 2013-15] focuses on less-developed interior regions to help address income inequality and regionally unbalanced development within China. Emphasis on environmental protection is another key feature to help improve urban air quality and protect major river basins. ADB’s support for pilot-testing in areas such as concentrated solar power plants, clean coal technologies, carbon-trading platforms, and bus rapid transit systems has significantly strengthened China’s contribution to the global fight against climate change. The focus on innovation and demonstration has maximized the impact of ADB’s modest assistance and enriched the knowledge sharing experiences between China and other developing member countries under South–South cooperation. ADB also provides some technical assistance to government agencies for project preparation and advisory support for policy and regulatory reforms.
Quite clearly the PRC is now at a crossroads, and its next economic steps will have a huge bearing over its own future and that of the rest of the world. Restructuring and rebalancing the economy so that growth comes more from domestic sources than from the volatile ebb and flow of factory-driven exports and investments will make that growth far more sustainable. Ensuring the fruits of growth are made available to all will help build a fairer and more equitable country.
Ultimately such a course will ensure the PRC remains a pivotal player in the global economy, which will bring benefits to all nations--not least here, in Australia.