China: what long-term policies and reforms are needed to sustain growth?

In a previous blog I summarized our views on China’s growth prospects, developed while writing the World Bank’s recent China Quarterly Update economic report. We think that China is likely to continue to see respectable growth in a difficult global environment. At this important juncture for China and the world economy, what is the upshot of this for policymaking?

At any point in time, governments need to work on short-term macroeconomic policies and on more medium- and long-term policies. There are trade-offs. More attention to short-term policies typically means less attention to the policies and reforms that are important for the medium and long term. We think that, given that China has already put in place a forceful short-term stimulus that seems effective in keeping growth respectable, China can put more emphasis on the structural reforms to promote continued, sustainable growth.

There continues to be a lot of discussion in China whether GDP growth will reach the government target of 8 percent this year, and whether the government should put in place more stimulus measures, typically presumed to be the kind of infrastructure-oriented stimulus that characterizes the package already in place.

I think it would not be a good idea to add more traditional, infrastructure-oriented fiscal stimulus in 2009. Why?

• First, growth is already on course to be close to the government’s target, despite the global weakness.
• Second, it would be good to keep room for fiscal stimulus in 2010, given the uncertain global prospects. The higher the fiscal deficit is in 2009, the less room there is for an additional increase 2010 – given limits on the size of deficits, even for China.
• Third, there are limits on how much additional infrastructure-oriented stimulus can be spent effectively and efficiently. If the government wants to address the adverse consequences of the downturn for households, this can more efficiently be done by using and beefing up the social safety net. That would also fit well with China’s medium- and long-term objectives.

I think that, in responding to the global crisis, China should emphasize forward-looking policies and structural reforms. With global demand likely to be subdued for a while, China needs more growth from domestic demand – consumption in particular. Also, the government’s rebalancing objectives call for changes in relative prices – especially higher prices for energy, land, water, resources, and the environment. The pattern of growth emerging in this setting would be driven more by the service, and less by industry (especially heavy industry).

To make the transition to such a pattern of growth easier and faster, two types of structural policy adjustments are needed. The more that these are pursued, the more China could sustain growth in the changed global setting.

First, measures that help channel resources to sectors that should grow in the new setting, instead of to sectors that have traditionally been favored and done well. The World Bank has in recent years has talked about (i) financial sector reform, to improve access to finance for private sector, service oriented, and smaller firms; (ii) adjustment in prices and taxation, to remove subsidization of industrial inputs; and (iii) state-owned enterprise (SOE) dividend policy, to ensure a good allocation of capital.

In addition, I think there are important reforms China could take in many service sectors, to open them up to the private sector and to remove unnecessary regulation and restrictions. I am not an expert in this field. But it strikes me that consumers and the economy overall would benefit a lot from opening up many service sectors to more competition, just as opening up the manufacturing sector to competition has served the economy so well, introducing new technologies and products and higher productivity. Sectors whose opening up should have a major positive impact on the overall economy include the financial industry, including insurance; transport and logistics, and network industries (including telecom).

More subjectively, other sectors where, as a consumer, I personally would benefit much from opening up include cinemas (the repertoire of movies is heavily restricted, presumably to protect the local movie industry, but going to the movies in China is really very expensive) and gas stations (it would be nice to go to less industrial-looking stations).  

Second, policy reforms that support thriving domestic markets and successful, permanent urbanization. To get a more thriving, service sector-oriented domestic economy, China needs more migrants to settle themselves permanently in the cities. Urban people consume more than rural people, and in particular spend more on services. In addition to service sector opening up, other key policies to promote successful, permanent migration are further liberalization of the Hukou system; land reform; and reform of the inter-governmental fiscal system, to give municipalities the resources and incentives to provide basic public services (education and health) to migrants.

In my view, the more these types of reforms are pursued, the more China is able to rebalance the pattern of growth, getting more growth out of the domestic economy, thus keeping growth up even with demand for exports more subdued.