China cannot afford to let itself be hobbled by inertia in economic reform

Twenty-two years ago I attended a conference in London on business opportunities in China. It was the first China conference I had been to, and I was interested to see how many business people attended, most from Britain and some from the rest of Europe.

At the end, the conference chairman asked everyone who was optimistic about the business future in China to raise their hands. Not one hand was raised that day in December 1989. Looking back now, it is obvious that the people in that conference were short-sighted and wrong. Even the most optimistic China-watcher then would not have predicted how successfully the Chinese economy would develop.

But after three decades of change and growth, do the Chinese people still have the appetite for the further radical changes necessary for China to reach its potential as a "modern, balanced, harmonious and creative high-income country"? That is the question implicitly posed by the report China 2030, co-authored by the Development Research Center of the State Council and the World Bank, which was published late last month.

The 468-page report shows the steps that China needs to take to join the club of higher income countries by 2030. Describing China's economic emergence over the past three decades as "remarkable", the Development Research Center and the World Bank outline the enormous further changes that China's economy and society must undergo to avoid running into the environmental and technological wall that otherwise stands in the way of progress.

But after the huge changes of the 1980s and 1990s, are Chinese people ready for another series of difficult disruptions? Can the government summon the energy, the unity and the willpower to launch a new set of fundamental social and economic reforms? Or will the China success story fade away, by dint of inertia and vested interests? With China now firmly established as the world's largest exporter and second largest economy, these are questions that affect not just the Chinese, but the whole world.

The Development Research Center/World Bank report projects that if China is able to carry out the necessary fundamental reforms over time, an annual GDP growth rate of between 4 percent and 6.5 percent will be enough for it to meet its development goals. But at the same time, the report shows how easy it would be for China to fail to achieve its high-income potential. Of 101 countries in 1960 that were at the same income level as China is today, only 15 went on to become high income (defined by the World Bank as having per capita national income of more than $12,276, or 9,380 euros).

The ones that failed to make it and fell victim to the so-called middle-income trap include Argentina, Brazil and Peru in South America, Jordan and Syria in the Middle East, Iran in Central Asia, and Malaysia and Thailand in East Asia.

What makes the difference between achieving high-income status and staying stuck in the middle-income bracket? The simple answer is productivity growth, defined as the increase in output that can be generated from the same or fewer inputs of the elements of production - capital, labor and equipment. Maintaining Chinese productivity growth, and at the same time reducing environmental damage and overcoming the aging of the population, is going to require huge changes to the economy and society, to increase its efficiency and reduce its high and unsustainable levels of resource consumption. To reach that objective, the report says, China must change its policy framework and development strategy. Its next phase of development will need to build on its considerable strengths - high savings, plentiful and increasingly skilled labor, and the potential for further urbanization - and capitalize on external opportunities that include continued globalization, the rapid growth of other emerging economies, and promising new technologies.

What is needed, though, is a change in the relationship between the government and society. The report demonstrates that the private sector is much better at improving economic productivity than the State-owned sector. It calls for the Chinese government to move its economic involvement away from direct economic intervention via the State-owned sector, toward providing public goods like defense, education and a modern legal system that can release the dynamism of China's entrepreneurs.

In order to become a high-income country, China must introduce more competition and private sector activity. China's State-owned enterprises will have to undergo another wave of restructuring and reform as great as the changes of the late 1990s, which involved huge personnel redundancies estimated at 50 million workers, and economic costs estimated at 2 trillion yuan. The dominant positions of the State-owned companies within key or pillar sectors of the economy should be reduced, even in areas such as defense and electricity production, where the experience of developed economies has shown that private companies operating within a clear framework of regulation can add considerably to efficiency, while reducing waste.

The innovation that China needs to achieve a higher level of development, while using fewer resources, can only be achieved by encouraging competition. For this to happen, the government's role has to change from being a direct provider of goods and services to being the architect and controller of a system that encourages competition and innovation.

In the countryside, land reform is an essential part of the report's message. Against a background of increasing land scarcity and environmental degradation, the report comments on the economic dependence of local governments and municipalities on the acquisition of farming land cheaply, to be sold for urban development at much higher prices. A system of local taxation should be introduced that can provide local governments with the income that they now get from buying and selling land. To encourage innovation and higher productivity in the countryside, security of farming land tenure needs to be increased. The policy decision made in 2008 to grant indefinite land use rights to farmers needs to be put into law, and extended throughout China.

In the financial sector also, the government's direct involvement in rationing credit and setting interest rates needs to be replaced by policies allowing both domestic and non-Chinese banks and other financial service companies to freely compete with each other to provide Chinese consumers and business with quality services at competitive prices. Interest rates, the report says, should be set by supply and demand.

The report shows that government spending in China lags behind countries at a comparable level of development in every area except economic goods and services. For example, China's health spending, at 1 percent of GDP, compares with average health spending in middle-income countries of 3.2 percent, and in high-income countries of 6.3 percent of GDP. At the same time, China has to reduce the environmental damage that its fast but wasteful economic growth has created.

The author is a visiting professor at Guanghua School of Management, Peking University. The views do not necessarily reflect those of China Daily.