Reaping the Reform Dividend Is the Key to China’s Growth

From: English Edition of Qiushi Journal Updated: 2013-08-20 15:38
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I. Huge economic and social changes bear testament to China’s reform “dividend”

Over the past 35 years of reform and opening up, China has undergone historic economic and social changes that have captured the world’s attention. The Chinese economy has sustained rapid growth of around 10% per year on average for more than three decades, propelling China to become the world’s second largest economy. Meanwhile, China’s overall national strength has increased significantly, and the material and non-material living standards of its people have witnessed remarkable improvements. Internationally speaking, China’s development has changed the landscape of the global economy, turning the country into an important engine behind global economic growth.

Numerous factors have contributed to these achievements, such as an ample supply of low-cost labor, a huge market, fairly high rates of saving and investment, and certain favorable natural conditions. However, the most important factor in China’s success has been the implementation of reform and opening up, and the fact that China has identified the path of socialism with Chinese characteristics. Past experience both in and beyond China tells us that even if a country enjoys good, or even superior, initial conditions for economic development, these conditions do not necessarily lead to rapid economic growth; rather, the key to growth lies in whether the country in question is able to create a sound set of systems and mechanisms, and whether it is able to effectively combine and make use of the various factors that are required for economic growth, thereby releasing potential for the creation of social wealth. In fact, the entire point of reform is to create sound systems and mechanisms. We have frequently seen how a change in system can lead to extraordinary rises in productivity, even when labor, land, and other material conditions remain constant. This extra is what we refer to as the reform “dividend.”

The historic changes that have taken place in China over the past 30 years represent an example of this reform “dividend.” Following the launch of the reform and opening up drive in 1978, thanks to our constant trials and painstaking efforts, we identified the establishment of a socialist market economy as the goal of our reforms. As a result, a unified market system has essentially been put in place across the country, with the supply and demand of most products being subject to market forces; the reform of the state-owned sector of the economy has been deepened, prompting the rapid growth of the self-employed and private businesses, collectively-owned undertakings, foreign-funded ventures, joint-stock companies, and other economic sectors; the framework of a modern macro-economic regulatory system has taken shape, with a wealth of experience having been gained in macro-economic regulation; and efforts to open the economy up have continued, with China gradually becoming integrated into the global division of labor. These huge changes to our systems have laid down the foundations for China to reap the “dividends” of reform.

Studies show that since the reform and opening up drive began in 1978, China has experienced three periods of rapid growth in total factor productivity, all of which were attributable to the implementation of important reform and opening up measures. The first period was from the early days of reform and opening up to the mid-1980s, when the institution of the household contracting system for farmland, which linked remuneration to output, brought about huge increases in agricultural production and allowed some Chinese farmers to leave agriculture and seek employment in township and village enterprises, thereby leading to huge increases in labor productivity. The second period was from the early to mid-1990s, when the goal of establishing a socialist market economy allowed the non-public sector to enjoy significant growth and enabled great progress in the opening up of the economy, thereby bringing about a rapid increase in total factor productivity. The third period began following the turn of the century, when China’s entry into the WTO, coupled with the domestic reforms that followed, placed Chinese enterprises under greater pressure from competition and allowed them to import technology and close the gap with foreign enterprises at a faster pace, which in turn led to improvements in the distribution of factors of production and made it possible for factors of production to be used more efficiently.

II. The delivery of the reform “dividend” depends on an intensive growth model

In order to accomplish the building of a moderately prosperous society in all respects, it is essential that we deepen reform and opening up across the board. Although China will continue to enjoy an important period of strategic opportunity going forwards, it should be noted that the connotations and conditions of this period have undergone certain changes.

Picture: Incubation

The report to the Eighteenth National Congress of the CPC contains 86 mentions of reform in total, averaging more than once per page. Reform is an “incubator” for new dividends.

/ Xinhua (Drawing by Xie Zhengjun)
After having sustained rapid growth for more than 30 years, China’s economy is now beginning to enter a new period of more moderate growth. This shift in growth speed will bring with it new opportunities and unprecedented challenges. On one hand, the inherent uncertainty and instability of this transitional period could trigger major fluctuations in economic growth and expose risks that remained hidden in the rapid growth phase, such as fiscal and financial risks and the danger of excessive production capacity. On the other hand, although growth in the period of moderate growth will be slower, we will actually need to rely more on domestic demand, particularly consumer demand, and more on innovation and the upgrading of industries to drive growth. In other words, more emphasis needs to be placed on increasing the quality and efficiency of growth. During this new period, a group of new growth points will emerge, including urbanization that lays stress on quality as well as quantity, the upgrading of the manufacturing sector, the accelerated development of the service sector, and China’s integration into the process of economic globalization at a more advanced level. All of these growth points will significantly expand the potential scope of China’s economic growth. Therefore, although the shift to a new phase will inevitably see a slowdown in growth speeds, in no way does it amount to the “decline of the Chinese economy,” as some have suggested; instead, this shift will usher in a new and even more extensive period of strategic opportunity.

Nevertheless, in order to respond to the challenges posed by this shift and seize upon the opportunities of a new growth phase, we must make corresponding changes to our existing systems and mechanisms. At present, China still faces the problem of unbalanced, uncoordinated, and unsustainable development, and this problem is particularly evident in certain sectors. The core of the problem is found in institutional barriers, including long-standing problems that can be traced back to the planned economy of the past. Whereas in the past China’s rapid economic growth depended primarily on an extensive growth model under which modern, non-agricultural industries were expanded on an enormously large scale, inevitably resulting in extensive and inefficient economic operations, China’s economic growth in a new growth period must rely mainly on an intensive growth model under which growth is driven by the upgrading of modern industries, achieved through competition within the modern industrial sector and between modern industries on the basis of survival of the fittest. This transformation from an extensive growth model to an intensive growth model will require significant changes to our systems and mechanisms, as intensive growth lays more emphasis on stimulating the enthusiasm and creativity of businesses and individuals, and on ensuring equality with regard to rights, opportunities, and rules. Therefore, to gain a reform “dividend” during a new period of growth, we need to rely on intensive growth. Proceeding along these lines, the next round of reforms will differ from previous reforms in terms of priorities and features.

With regard to the market, we should seek to further integrate factors of production into the market. Through the reform of the land system, the household registration system, and the financial system, among other things, factors of production such as land, labor, and capital should be allowed to circulate more freely in the market, which will bring about greater efficiency in their distribution and utilization. For instance, although huge potential demand can be unlocked through urbanization, such demand is limited to effective demand, which is dependent on increases in earnings and productivity. The major advantage of urbanization is that it allows for production, distribution, innovation, infrastructure, public services, and domestic consumption to be clustered in one place, thereby generating a level of productivity that cannot be matched by the traditional rural economy. Therefore, the key to promoting high-quality urbanization is to ensure the better flow and distribution of labor and land, the two basic factors of production, which will bring about increases in cluster effects and productivity, and thereby allow demand potential to be fully unlocked. 

With regard to the government, we should promote the major transformation of the fiscal and taxation system in terms of both revenue and expenditure. In line with efforts to reposition the role that the government plays, we should direct more government spending towards public services and gradually increase government funding for education, medical care, and social security, while at the same time practicing frugality and cutting official expenses. Of course, we should also be wary of the excessive levels of welfare that have been seen in some countries. Social expenditure should be kept within the limits of our financial capabilities, so as to prevent government dependence from becoming too high. With regard to revenue, we should gradually increase the proportion of direct taxes, such as the property tax, in light of the steady growth of personal property against the backdrop of slowing economic growth and the decreasing scale of production volume. Increasing direct tax will help us to maintain steady sources of tax revenue whilst reducing income disparity.

With regard to businesses, we should work to create an institutional and policy environment that is favorable to upgrading industries and driving innovation. What matters most is the fostering of a fair business environment that is conducive to innovation, one under which various different forms of enterprise can enjoy equal access to factors of production and resources for innovation. Wherever elements of innovation emerge in great numbers, government officials must have the courage to break away from convention and support innovation in these areas with insight and passion. In recent years, influential innovations have emerged in sectors that the government has tended to ignore or look down upon. Such cases give us much food for thought. In a sense, the creation of an inclusive policy environment is more important than the provision of large government grants for research and development.

III. Several relationships that need to be balanced in the deepening of reform

1. The relationship between reform and development. Reform can generate dividends—tangible benefits of growth, which in turn constitute the necessary conditions to sustain reform and ensure its eventual success. While some reforms are able to bring about quick results, others require a certain period of time or process before their effects can be felt. As such, reform should, if possible, begin with measures that can easily generate results, so as to create the conditions for the introduction of more difficult reform measures. Our next round of reforms should revolve around new growth points, the aim being to provide the impetus and vitality that we will need during our transition between growth periods and in a new period of growth.  

2. The relationship between courage and wisdom. Compared to previous reforms, we will go into our next round of reforms with a generally better understanding of the market economy. However, we will also face a more complicated situation in balancing the interests of different parties. The reason we have been unable to push ahead with many reforms is not because we do not understand the reasoning behind those reforms, but because they have been obstructed by those with vested interests. Therefore, balancing the interests of different parties is the key to ensuring the progression and ultimate success of reform in the future. We must remain strongly committed to reform, press ahead with great courage, and take bold steps to eliminate barriers that impede the overall and long-term interests of the country. In doing so, it is important that we create new systems and mechanisms and establish new expectations, so that everyone can achieve what they deserve through their honest work and diligence.

3. The relationship between top-level design and grassroots creativity. The socialist market economy is a cause that hundreds of millions of Chinese people have played a part in creating. Respect for the creativity of those at the forefront of the market economy is essential for developing and improving the market economy. Many of our successful reforms in the past saw local governments and ordinary people being allowed to lead the way in trying new things. When these experiments gave rise to favorable new practices, the relevant experiences were refined and then adopted as national policies. This is an approach that should be carried forward in our next round of reforms, so that local governments and ordinary people can be given more space to exert their initiative and their inventiveness. 

(Originally appeared in Qiushi Journal, Chinese edition, No.6, 2013)

Author: Deputy Director of the Development Research Center of the State Council of the People’s Republic of China

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