New Mission, New Challenges

1. New Mission, New Challenges What new generation Chinese leaders really face in the next decade Dr. QIN Xiao Chairman, Boyuan Foundation New York, 7 January 2013

2. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

3. New leaders, new political cycle • The debut of China’s new leaders following the 18th Party Congress marks the start of a five- to ten-year political cycle. • At the same time, China’s 30 years of rapid economic growth has reached a turning point, due to changes in some fundamental factors and endogenous problems which means China will enter a new era of economic development.

4. China at the juncture • China’s modernization process has come to a juncture. On the one hand, problems accumulated over a long period of time have resulted in economic slowdown and build up social tension. On the other hand, institutional reform can lend fresh impetus to economic growth and social progress. • People are concerned about whether the nation’s new leaders will be able to recognize the problems and challenges China is facing from an institutional point of view and find ways to solve these problems.

5. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

6. Positive signals of change • In as little as two months, China’s new leaders have sent many positive signals of change, which include reaffirming Deng Xiaoping’s idea of reform and opening-up, promising cooperative partnership with the U.S., strengthening anti-corruption measures, and aiming to improve people’s livelihoods and a change in leadership style, etc. • This shows they are aware of the inability of the current system to support sustainable economic growth, as well as the tension between the government and the public due to a lack of fairness and justice. • However, in order to reach deeper understanding and wider consensus, and to come up with specific policies, constraints from traditional ideologies and special interest groups will have to be overcome.

7. Causes of reform • Although reform may not be an inevitable and established trend, we have reasons to hope for it. • This hope isn’t based on the assumption that there will be another Deng Xiaoping among the new leaders, but on the possibility of their rational judgment and correct decision to respond to public pressure and an unsustainable economic growth model. • That is to say politicians’ willingness and determination to reform largely depends on public pressure and the unsustainability of the economic growth model. In this sense, rather than focusing on the new leadership’s personal characteristics, such as background, experiences, preferences, etc, we should focus on the fundamental problems in China and their possible consequences.

8. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

9. The structural changes of external factors • First, we must face up to the challenge of the “middle-income trap” to conduct the transformation from a growth model driven by large-scale factor inputs to a model characterized by technological innovation. • Secondly, the advent of the “Lewis turning point” as the annual growth of urbanization rate will slow from 1.45 percentage point to 0.8 percentage point in the next 5 years.  • Third, demographic dividends diminish as China approaches an aging society. China is expected to see a decline in the working-age population growth by 2015. By that time, nearly 10% of the population will be over 65 years of age.

10. The structural changes of external factors, cont... • Additionally, the growth model with an emphasis on scale and speed faces constraints regarding the environment, resources and energy. • Finally, China’s double-digit growth in exports will be over and the percentage of net exports to GDP will fall below 2% as the export-oriented economy faces constraints from balance of international payments for both buyers and sellers after the global financial crisis. • The above structural changes will have profound impact on the supply and demand of China’s economy. On the supply side, the era of abundant and low-cost capital and labor, thanks to a high savings rate and cheap workforce provided by migrant workers, has come to an end, while TFP (total factor productivity) is relatively low. On the demand side, due to global rebalancing, the investment- and export-driven growth model will become untenable, while domestic demand and consumption will grow slowly.

11. China’s endogenous problems • While China’s traditional economic growth model gradually loses support from external factors, its endogenous problems have also begun to emerge. These problems can be found in: • First, the low quality and structural imbalance despite rapid growth and large size of its economy. • Second, widening income gap, growing corruption, and lack of social equality and justice. • These problems are rooted in a “locked-in” economic model , in which special interest groups have gained both public power and capital as a result of a government dominated economic system, while at the same time, market-oriented reform is stagnant, the promotion of the rule of law is insufficient and there is a lack of public goods and services.

12. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

13. Key elements of consensus: institutional infrastructure • To establish a modern society has been the ultimate goal of China’s reform and opening-up since the late 1970s. • The market system is an indispensable component of a modern society. The market’s free trading system, however, requires the support of institutional infrastructure, including democracy, rule of law, protection of property rights, open and transparent information, clear boundaries between the government and the market, etc. • In this sense, China's market-oriented reform still has a long way to go. The promotion of the rule of law, and a new round of comprehensive reform in the political system and in social governance, is inevitable.

14. Key elements of consensus: change of growth model • The traditional growth model, characterized by a government-dominated economy, used to play a positive role when China introduced market-oriented reforms and promoted industrialization. • However, as the economy becomes more market-oriented, this model has led to various political, economic, social, and environmental conflicts because regulation on prices and trade under this model has distorted resource allocation, become an obstacle to trading and innovation, and led to business-government collusion.

15. Key elements of consensus: role of government • The waning of the traditional economic growth model foreshadows the coming of a new era for China’s economic development, with emphasis on quality, efficiency, balance, green initiatives, and fairness. • The key to achieving this goal is to change the functions of the government, which means the government’s role must transform from dominating economy to a role to provide public goods and services.

16. Key elements of consensus: costs and risks of reform • Reform is more than just a concept renewed. It also means readjusting the distribution of benefits among multiple interest groups in society. • China’s current problem is that the government-dominated economic structure has led to the collusion of public power and capital, and hence special interest groups have been formed. In order to address this problem, we must harness a sense of responsibility among the elites together with the voice of the general public to push forward reforms. The willingness and determination of politicians to reform is of utmost importance.

17. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

18. The goals of medium terms reform • One goal of the medium-term (three-year) reform is to enhance and exemplify the fundamental role of the market in resource allocation in order to boost the quality and efficiency of economic development. The key is to establish a price mechanism based on market supply and demand, and the corresponding fiscal and taxation system. • Another goal is to achieve a better balance between economic and social development. That is to build a fiscal resource allocation system aiming to provide equal access to public services, to establish systems that ensure fair and equal opportunities of business start-up, employment, social security, and income distribution, as well as to create a favorable ecological environment. The whole range of reforms could start with the deregulation of factor prices, tax reform, and budget management system of the public sector.

19. A to-do list • Reform and deregulate the price system of resources (including mineral products, energy and some utility goods) to reach market equilibrium prices.   • Achieve interest rate liberalization. • Make the Renminbi convertible under capital accounts. • Increase the share of fiscal expenditure on social security, health care, education, and the ratio of spending on energy conservation, and environmental protection, to GDP. • Reduce the share of fiscal expenditure on official consumptions.

20. A to-do list, continued • Change business tax to value-added tax in the service sector. • Lift resource tax(fee) on minerals and start levying green taxes. • Lower the macro tax burden. Cut tax rates for individuals. Financial disclosure of senior officials. • Lower import tax rates. • Allocate a certain portion stock of listed SOE to the social security system, in order to narrow the huge funding gap in the pension system in the medium to long term, and to accumulate experience for subsequent privatization of state-owned enterprises.

21. A to-do list, continued • Establish a fully-covered fiscal and budget management system including general fiscal budget, budget of government-managed funds, and capital management budget of SOEs. • Allow qualified local governments to issue their own local government bonds, to reform the acquisition and development of rural land system in the urbanization process, make local public fiscal more transparent via the market mechanism.

22. Call for a “Reform Committee” • In order to ensure a smooth progress of the reform and to overcome constraints from special sectional interests, a “reform committee” that transcends sectional interests should be formed to design the reform and supervise its implementation. • Quantitative analysis shows the above reforms can improve economic efficiency, achieve a more balanced economic development, and reverse the trend of growing income distribution disparity. At the same time, the costs of these reforms are affordable and the risks are controllable. • More importantly, these reforms will lay the foundation for further deeper and more comprehensive reforms.

23. Agenda • China at the juncture • Causes of reform: public pressure and an unsustainable growth model • The end of the traditional growth model • Achieving consensus on reform • Medium-term reform agenda • A bright future despite serious challenges

24. China: A Tale of Two Cities • China has become the world’s second-largest economy after 30 years of high-speed economic growth. Many wonder when China can surpass the U.S. in terms of both the size of the economy and comprehensive national power. • Of course, there are also pessimistic scholars who believe such a government-dominated economic growth is unsustainable because of a lack of the rule of law and democratic constitutionalism. • This reminds me of Charles Dickens’ famous opening in his A Tale of Two Cities:“... it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way.”

25. Bright future despite serious challenges • Regarding China’s problems, I agree with the latter view, that China does currently face serious challenges, but as to the future of China, I am confident that China will continue to surprise the world with her successful transformation into a modern society.

26. Thank you!