The Relationship Between the Government and the Market—The Core of Economic Restructuring

From: English Edition of Qiushi Journal Updated: 2013-05-28 18:40
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The core of economic restructuring lies in balancing the relationship between the government and the market. On the one hand, we must fully exert the role of the market in regulating the economy; on the other, we must properly define the role of the government and ensure that this role is performed effectively, as the correct combination of the two constitutes the fundamental means for ensuring the sound and sustainable development of the economy.

I. Streamlining administration and delegating power to boost the vitality of enterprises is what we have learnt from the success of China’s reform

China’s reforms over the last 34 years have transformed China from a highly concentrated planned economy to a socialist market economy. This transformation has released the massive potential that was locked away amongst China’s population of over one billion people, giving rise to China’s miracle development.

The entire process of China’s reform has revolved around attempts to adjust and change the relationship between the government and the market. A major characteristic of the old system was the fact that the government took responsibility for everything. Under that system, the state was solely in charge of the purchase and sale of material resources, the distribution and management of human resources, and the collection and allocation of funds. Moreover, all authority to make investments rested with the central government. This policy repudiated the production and exchange of commodities, had a suffocating effect on micro economic activities, and the result was that economic development was hampered.

China’s reforms began with a push to streamline administration, delegate power, and foster market forces. In rural areas, the institution of the household contracting system for farmland, which links remuneration to output, allowed Chinese farmers to become independent producers and sellers of commodities. This represented the first step in breaking away from the constraints of the old system. Shortly afterwards, reforms moved into the field of industry and commerce, leading to the emergence and rapid development of township and village enterprises. China’s urban reforms began by breaking the “iron rice bowls” of employees in state-owned enterprises (SOEs), and by dismantling the “big pot” that everyone ate from under egalitarianism. These efforts prompted reforms in regard to planning, investment, personnel, wages, taxation, and other aspects of macroeconomic management.

The much anticipated State Council Institutional Reform and Function Transformation Plan was published on March 10, 2013. The scheme sent out the clear message that China will make a larger, wider, and more penetrating effort to speed up the transformation of the functions and roles that the government assumes. / Xinhua (Drawing by Jiang Yuexin)

In 1992, the Fourteenth National Congress of the CPC clearly defined the establishment of a socialist market economy as the goal of China’s economic reforms. At the Third Plenary Session of its Fourteenth Central Committee, the Party proposed the cultivation and development of entities for market competition, a market system, a macroeconomic regulatory system, and a framework of laws, which were referred to collectively as the four pillars of the market economy. With this, China entered a new phase of rapid but steady reform. Through the establishment of a modern corporate system, SOEs became entities for market competition alongside collective, private, and foreign-funded companies, taking charge of their own production and management and assuming responsibility for their own profits and losses. Subsequently, a unified, open, competitive, and orderly market system began to take shape. At the same time, a macroeconomic regulatory system integrating planning, taxation, and banking as complementary but mutually restraining policy tools was formed, and has been progressively fine-tuned through the course of efforts to curb inflation and boost domestic demand. During China’s response to the global financial crisis, close collaboration between the government and the corporate sector has enabled the market economy to withstand the test posed by the crisis and the government to gain new experiences in macroeconomic regulation. 

Experience demonstrates that the key to our success has been our continued adherence to market-oriented reforms. Continued economic reform is the correct choice for China during the primary stage of socialism. By implementing a market economy, and making use of the law of value as an invisible hand in regulating the economy, we have significantly boosted the vitality of the economy and built up a strong source of momentum that will drive our economic development forward. In the space of just ten-odd years, we have put an end to the economy of scarcity that plagued China for decades. 

II. Expanding the basic role of the market in allocating resources  

The market is the source of economic vitality. Through more than 30 years of reforms, we have learned that the fastest growing sectors are always those which are more oriented to the market and which allow factors of production to enter freely; while sectors that experience slow growth are always those which are relatively closed to external participation and which restrict the entry of factors of production. At present, we are seeing a large surplus of factors of production in many sectors of the economy, but acute shortages in others owing to restrictions on the entry of factors of production into those sectors. As a result, the demand for factors of production in these sectors is unable to be met. 

Therefore, only by expanding the basic role of the market in allocating resources will we be able to create better conditions for the free flow of factors of production and further release our huge potential for economic growth. At present, with respect to expanding the regulatory role of the market, we should take the following actions.

1. We should deepen the reform of the financial system to unlock the potential of our capital. China has amassed a huge stock of financial capital. However, this capital has poor liquidity and a low rate of utilization, tending to converge towards SOEs, key projects, cities, and coastal areas whilst rural areas, small and micro enterprises, and central and western regions experience fund shortages. This has created and exacerbated unbalanced economic development in the country. Therefore, we need to identify the reform of the financial system as the breakthrough point for the next step in our overall reforms, and see this as a means of increasing the ability of the market to allocate resources over a wider scope. Furthermore, in setting out to implement financial reform, we should make the development of private financial institutions a priority.

2. We should reform the urban and rural management system to unlock the potential of our labor force. China’s labor force still boasts huge potential for development. If we can accelerate the pace of agricultural modernization and realize the intensive use of land, the area farmed by each rural laborer in China will have the potential to be increased by several 10-fold, and maybe even by 100-fold. Over the next 20 years, another 200 million rural workers will be liberated from their land and move into secondary and tertiary sectors. Some of them, together with their families, will move to the cities. The transfer of agricultural workers to non-farming sectors will give us significant leverage for promoting industrialization, urbanization, and agricultural modernization, becoming the fundamental means by which we will narrow the gap between urban and rural incomes. Such efforts hold the key to whether China can succeed in raising its GDP per capita from US$5,400 to US$12,000 over the next 12 years, thereby avoiding the “middle income trap” and establishing itself as a high-income country.

3. We should reform the management system for science and technology to unlock our potential for technological innovation. China has increased its spending on scientific research by significant margins over recent years. This has resulted in a constant succession of new advances in science and technology, with China now filing more domestic patent applications than any other country in the world. Private enterprises have become a major force for independent innovation, accounting for 67% of the country’s patent applications. However, there are still two major sectors whose potential for innovation desperately needs to be tapped: One is SOEs, and the other is universities. Placing the focus on key generic technologies, government departments should organize collaborative innovation between enterprises through the formation of industrial alliances. All state policies that encourage innovation should be fully implemented. The government should increase fiscal incentives to encourage enterprises to invest more in scientific research, thereby creating a social atmosphere in which technological innovation is encouraged. 

4. We should reform mechanisms for the pricing of resource products to promote resource conservation and environmental protection. The low prices of certain resource products at present have encouraged the irrational and even wasteful use of resources. By making use of pricing mechanisms, we need to promote keener public awareness with regard to resource conservation and environmental protection, and make efforts to achieve higher efficiency in the utilization of resources, so that ecological progress can be secured. Given China’s large population and its shortage of arable land, we must establish a stringent system for the protection of farmland in order to secure the supply of food. We must also depend on market forces to ensure that land for urban and rural construction projects can be developed more intensively. Northern China faces serious water shortages. But despite this, the amount of water that goes to waste in these areas is still considerable. Therefore, spending on water-saving projects should be increased, and mechanisms for the pricing of water resources need to be reformed in order to promote water conservation. Projects for the recovery of mineral resources from waste, which have been launched in some cities, represent an important means of turning waste into a valuable resource. Such projects should be expanded to more cities.

III. Deepening the reform of the administrative system and building a service-oriented government with scientifically defined functions

The key to balancing the relationship between the government and the market lies in deepening reforms aimed at separating government administration from the management of enterprises, state assets, public institutions, and social organizations and building a well-structured, clean, efficient and service-oriented government that has scientifically defined functions and that the people are satisfied with, as is required by our goal of establishing a socialist administrative system with Chinese characteristics. At present, we should focus on deepening reform in the following areas:

1. We should make improvements to our macroeconomic regulatory system and institutionalize regulatory goals and policy measures. We should improve our framework of plans, which includes mid- and long-term plans, annual plans, and dedicated plans, and strive to formulate plans that are more scientific, more feasible, and more tailored to future needs. Doing so will ensure that the plans we make are able to serve as a basis for our macroeconomic regulation. In addition, the reform of the fiscal and taxation system should be accelerated. We should establish a sound public finance system under which the financial resources of the central government and local governments accord to their respective responsibilities, access to basic public services is made available to more people, and the building of development priority zones is promoted. We should form a taxation system that is conducive to improving the economic structure and promoting social equity. Also, the reform of the financial system needs to be deepened. We should establish a modern financial system in which the money market, the capital market, and the insurance market develop in a coordinated fashion. Under this system, we will strive to maintain a basic equilibrium in total supply and demand, promote macroeconomic stability, and support the development of the real economy.

2. We should streamline administrative reviews and reduce government intervention in the management and operation of enterprises. Many enterprises complain that new projects are subject to too many administrative reviews and are required to go through superfluous formalities. There are also complaints that some industries are not accessible owing to stringent entry criteria and “invisible walls,” and that problems that the market can address are still being habitually addressed via administrative means. To address these concerns, we should streamline administrative reviews, and leave matters that can be regulated by the market and decided by enterprises to the market and enterprises.

3. We should regulate market practices and create an environment in which all types of enterprise can compete fairly. Bearing in mind that the government is there to serve the people, the related government departments should formulate strict and scientific standards for product quality, intensify market oversight, leverage the role of the public in monitoring the quality of commodities, and raise public awareness with regard to the importance of honesty and trustworthiness. Enterprises under all forms of ownership should be given equal treatment with regard to taxation, financing, land use, and market access, and should enjoy equal access to factors of production. In so doing, we will ensure that advanced enterprises develop to their full potential while backward ones are eliminated. 

IV. Important principles for balancing the relationship between the government and the market

All countries face the problem of how best to balance the relationship between the government and the market. Having built up a wealth of experience during more than 30 years of reform and development, China has formulated several tried and tested principles with regard to addressing this problem.

1. In balancing the relationship between the government and the market, due consideration should be given to the extent to which productive forces are developed. At different stages of development the market demonstrates different levels of maturity. For this reason, in setting out to handle the relationship between the government and the market, we must take actual market conditions into consideration and display flexibility in adopting measures that can effectively develop productive forces, as opposed to following any one theory or model. Proceeding from reality, keeping pace with the times, and being realistic and pragmatic—these are the important principles that China must follow in properly balancing the relationship between the government and the market.

2. Significant efforts should be devoted to fostering market entities, a market system, industrial associations, and social organizations, so as to put society in a better position to develop and regulate itself. The government cannot stretch itself too far. The more dynamic enterprises we have, the more wealth we will be able to create. A sound market system will allow us to bring potential of factors of production into play and allocate them based on the needs of the market. A good range of social organizations will be able to exert a role that the government cannot in rating, arbitrating, maintaining order in the market, and coordinating the interests of all related parties. China lags far behind developed countries in this regard, and so more must be done to encourage the development of social organizations.

3. Provided that a unified national market is maintained, local governments should be given appropriate administrative powers. The free flow of commodities and factors of production in a unified nationwide market constitutes a prerequisite for sustainable economic development. Therefore, we should do more to remove barriers in regional markets, and encourage different regions to draw on each other’s strengths and develop side by side. Meanwhile, powers need to be appropriately split between the central government and provincial, prefectural, and county governments, so as to address the over concentration of financial resources at the central level, which has led to the overuse of transfer payments and fund shortages in local governments, particularly at the county level. A local tax system also needs to be established. County finances should be placed directly under the management of provincial governments in areas where conditions permit. Local governments should be given greater powers in economic management. 

(Originally appeared in Qiushi Journal, Chinese edition, No.2, 2013)

Author: Executive Vice-Chairman of the China Center for International Economic Exchanges

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