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New State Activism

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									Chinese Economic Policy since
 the Global Financial Crisis:
   The New State Activism
           Barry Naughton
  University of California, San Diego
            Rio de Janeiro
 Since the Global Financial Crisis…
• The financial crisis was a major turning point
  in Chinese economic policy.
• Government has become much more actively
  engaged in shaping the trajectory of economic
  development.
• Two simple points:
  – This change is new and significant.
  – It represents an enormous gamble, with costs and
    benefits that are not yet known.
   1. Background: The Big Picture
• By the turn of the 21st century, China had
  accomplished two remarkable things.
• No. 1, it had established the fundamental
  framework of a market economy, including
  – A substantial role for private business
  – A solid foundation for public finances
  – Agreement on a framework for international
    exchanges, through W.T.O. accession.
  – Rudiments of a domestic legal and regulatory
    framework.
       Diverse Ownership Structure
Table 1: 2009 Industrial Output and Employment

All Large-Scale Industry (Output above 5 million RMB)
                              Output Value Share         Employment Share
Total                                54,831                     88.3
State Owned & Controlled             14,663        26.7%        18.0    20.4%
Domestic Private                     16,203        29.6%        29.7    33.6%
Foreign-Invested                     15,269        27.8%        24.5    27.7%

   Table 2: Exports by Ownership Category (Percentage Share)

                                          1997          2005         2010
  State Owned Enterprises                56.5%         22.2%        14.9%
  Foreign-Invested Enterprises           40.8%         58.3%        54.6%
  Private and Collective Firms            2.8%         19.5%        30.5%
                                           Percent of GDP




                                             15%
                                                                      30%
                                                                                            35%




                                     10%
                                                      20%
                                                            25%
                                                                                                  40%




       0%
                              5%
1978
1979
1980
1981
1982
1983
1984
1985
1986




            Industrial SOE Profits
1987
                                                                       Budgetary Revenues




1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
                                                             reform




1998
1999
2000
2001
                                                             Launch new tax
                                                             system and SOE




2002
                                                                                                        Fiscal Revenues and Industrial SOE Profits




2003
2004
2005
2006
2007
2008
2009
2010
   No. 2: High Input, High Growth
• An institutional framework that was highly tailored
  to support investment and growth.
• Highest physical capital investment rate in the world;
• Very rapid labor force growth.
• Highest sustained growth rate ever achieved by any
  economy.
• High cost: Consumption/GDP low; energy and
  materials usage high; pollution serious; income
  distribution bad & deteriorating.
• Not sustainable: Labor force growth and structural
  transformation must slow down; as incomes and
  wages rise, will China face “middle income trap”?
2.Hu-Wen Administration (2003-13)
Sought to Modify Economic Strategy
Reform Fatigue: High unemployment after mass
  lay-offs; health system collapsed; anxiety
  about impending WTO membership.
Sought a “people-oriented” policy (以人为本),
  and a “harmonious society (和谐社会).
What was the content of these new policies to
  be? How radical a departure from the 1990s?
  Examine three key policy areas to find out:
    A. Rebuild Welfare Institutions
Cautious and incremental effort to rebuild social service
  institutions and reduce the large urban-rural gap. Moderate
  but unambiguously positive effects:
• Agricultural taxes reduced, then abolished.
• To accommodate the reduction in local revenues the national
  fiscal system became much more redistributive.
• Pilot program to promote universal free elementary education
  created and gradually expanded.
• Pilot rudimentary rural cooperative health insurance scheme
  created and gradually expanded.
These initial programs were highly consistent with, and
  complementary to, a well-functioning market economy.
  A more fundamental re-thinking?
The 11th Five Year Plan, to cover 2006-2010, came out at the end of 2005.
The Plan was the product of a surprisingly wide process of consultation and
   brain-storming, more of a vision statement than a traditional five-year
   plan.
Innovative elements included an emphasis on environmental improvement
   and sustainability.
Most important was an emphasis on investment in human resources. This
   reflected both a backward-looking critique of China’s physical capital
   investment-driven growth model, as well as a forward-looking awareness
   of the need to shift to a more sophisticated development strategy as China
   approached middle-income status.
The plan was very general, so it was left unclear what measures government
   would take to implement the plan; there was an ambiguity here is
   between social policy (adapted to these changes) and social engineering
   (driving the changes).
       B. Stabilize State Ownership
State Asset Supervision and Administration Commission (SASAC)
   created to exercise authority over the large central-run firms.
   A reform step in that SASAC is an “ownership agency,”
   independent of the government administrative apparatus,
   with control limited to defined set of subordinate companies
But SASAC was also a step toward decelerating ownership reform.
   Core mandate to “maintain and increase of the value of public
   assets.” End of managerial buy-outs for large firms, and new
   commitment to maintain a significant state sector.
SASAC never succeeded in articulating clear limits to public
   ownership, failed effort in 2007. Too many sectors included,
   and list never publicly released.
Ambiguity between further reforms of state firms through
   improved corporate governance, versus protecting and
   rebuilding the size of the state sector.
C. Technology / Industrial Policy: Medium - Long
 Term S&T Development Program (2006-2020)
• Introduces “indigenous innovation.” Argues: “Experience shows us
  that we cannot buy true core technologies in the key fields that
  affect the lifeblood of the national economy and national security.”
• Lays out 16 Engineering “Megaprojects.” These are “to be
  completed within certain time frames through core technology
  breakthroughs and resource integration in order to achieve national
  goals; they are the priority of priorities in China's S&T
  development.” Including:
   –   very-large-scale integrated circuit manufacturing technologies
   –   nuclear power stations with large-scale advanced pressurized water reactors;
   –   prevention and treatment of AIDS, viral hepatitis, and infectious diseases;
   –   large civilian aircraft; etc.
• Instruments such as taxation relief; procurement preference; and
  subsidized credit.
• Ambiguity: Nationalist, centralized and top-down, but incremental.
    An Ambiguous Shift in Direction
By the middle of the decade, the Hu-Wen Administration had engineered a
   coherent shift in overall economic development policy. The 1990s
   emphasis on building market institutions and reforming the economy had
   been replaced with a new emphasis on rebuilding social institutions and
   investing in human resources and technology.
The shift away from economic reform was not large and it did not undo any of
   the major achievements of earlier reforms. Moreover, it was concentrated
   in areas where market failures are known to be severe: health care,
   insurance, education, and investment in new technology.
The new development strategy had many positive aspects. The emphasis on
   human capital investment was a positive alternative to over-investment in
   physical capital. The shift to sectors with a higher skill content was a
   natural step in China’s rapid development, and consistent with evolution
   to a more diverse and sophisticated labor force, that would also create a
   more diverse and sophisticated domestic consumer market.
More government steerage and intervention in the economy was compatible
   with a modest course correction, and a positive synthesis between a
   market economy and government intervention.
    3. The U.S. financial crisis changed
                everything.
It shattered a 30-year-old presumption that the US model was the
    best & that China would move steadily in this general direction.
It elicited a very strong stimulus response in China, which was
    successful in insulating China from the worst of the crisis. We
    would consider this a strongly Keynesian response to crisis (to
    be wound down after the crisis is past).
The Chinese leadership concluded that this was evidence of
    broader strength, and for the first time argued that their
    current system of strong government and market economy is
    superior to a U.S.-style system (no need to scale it back).
China’s current successes and problems all trace back to the
    choices made in late 2008-early 2009. First among these is a
    surge of liquidity.
   Crisis caused the acceleration and
   reformulation of the development
    strategy shift already underway.
Increasingly common rationales included:
• We have to pump money into the economy to avoid
   crisis anyway, so we can do the things we’ve always
   wanted to do.
• The advanced countries will pump money into their
   economies to support their strategic industries of the
   future, so we have to do the same, or we will be left
   behind.
• The ability to shape the macroeconomic trajectory is a
   strength of our system, so we should use it pro-actively.
The emphasis on re-balancing was played down; the
   emphasis on direct government intervention to
   restructure the economy was increased.
                            40%
                                                      Growth of Credit and CPI
                            35%


                            30%
                                                                                               Growth of Domestic
                                                                                               Currency Bank Lending
                            25%
Growth over Year Previous




                            20%


                            15%


                            10%
                                                                                                                        Growth of Consumer
                                                                                                                        Price Index
                            5%


                            0%

                                                                                                                       Jan 09




                                                                                                                                          Jan 10
                                            July 05




                                                                                     July 07




                                                                                                                                July 09




                                                                                                                                                   July 10
                                                                 July 06




                                                                                                           July 08




                                                                                                                                                             Feb 11
                                  Jan. 05




                                                       Jan. 06




                                                                           Jan. 07




                                                                                                 Jan. 08




                            -5%
 Rapid expansion and acceleration of
 local projects and national programs
Planned infrastructure investment of 4 trillion RMB
  (US $586 Billion) was announced quickly, but the
  overall response was much bigger, more complex.
Tens of thousands of local infrastructure projects
  were launched; but so were hundreds of large-
  scale central government projects.
Example: “16 Mega-Projects” to be rolled out
  gradually over 15 years 2005-2020. In early 2009,
  decided to begin all 16 by year-end.
Agreed to give Chongqing aid and policy breaks
  worth 800 B. RMB through 2020 to support
  “Chongqing Model”
Shanghai-Hangzhou line, October 13, 2010. (Just Opened for passengers.)
   China’s high speed rail is an example of a project under
   development for a long time, that was suddenly
   accelerated in the wake of the global financial crisis.
Stimulus Policy was Successful, and
 success was interpreted broadly.
We learned from the crisis the need to
“fully bring to bear the superiority of the
socialist system in effective decision-
making, a powerful organization and
concentrated power to accomplish big
things.”
“充分发挥我国社会主义制度决策高
效、组织有力、集中力量办大事的优
势。”
  – Wen Jiabao, Government Work Report, March 2010,
   4A. Expansion of Social Policies
Health: Within the last three years, China has rolled
  out two new health insurance plans that
  complement the existing urban formal sector
  insurance. Together these cover more than 90% of
  the population by the end of 2010.
The level of individual coverage is modest, but the
  total outlays of $60 billion projected for 2011 is
  substantial. Only 1% of GDP, but up from almost
  nothing a few years ago.
Government has taken over direct management of
  most clinics, as well as procurement of a list of 307
  categories of drugs, and enforced an average price
  reduction of 40%. This was the major source of
  clinic revenue that government is now replacing.
Expansion of Social Policies (cont.)
Housing: Major move into provision of public
  housing. For sale at subsidized prices, and
  creation of public housing rental sector.
  Plans: 2010: 5.9 m. M2
         2011: 10.0 m. M2
Ambitious plans—calling for about 15-20% of all
  2011 construction to be public housing—
  probably will not be fulfilled.
Similar trends apparent in education, social
  welfare and pension spending.
            4B. State Ownership
• A lively discussion has emerged in China about “the
  state advancing at the expense of the private sector”
  (国进民退). State firms bulked up on credit and
  expanded their business lines.
• Central SASAC has substantially more employees
  now (about 12 million) than it did when it was
  created in 2002 (8.6 million).
• As important as the quantitative dimension is the
  newly vindicated ideological position of state firms,
  who can lead technologically. For 2011, SASAC’s
  primary task is grow central state firms into “globally
  competitive national champions.”
 4C. Technology / Industrial Policy
“Indigenous Innovation”: Policy was always
  vague with multiple strands. New in 2009-10
  was: “the degree of intensity and
  simultaneous use of multiple tools” (Scott
  Kennedy), used with overlapping, and
  unpredictable impact.
• Technical Standards
  – Used strategically to privilege local technology and
    increase bargaining power over royalty payments.
  – Full roll-out of TD-SCDMA (indigenous 3G telecom
    standard) is green lighted at beginning of 2009.
   Overlapping Policies of Indigenous
          Innovation (Cont.)
• Patent rules that require disclosure of
  technologies used in vital national standards.
• Required disclosure of sensitive technology for
  information security.
• Procurement preference for products with
  “indigenous technology” content; combined with
  an indigenous innovation product list.
• Collusion among government agencies with the
  objective of protecting local producers.
• Rapid increase in subsidies to individual firms and
  to R&D process in general.
   “Emerging Strategic Industries”
7 Designated Sectors, with
   35 sub-sectors or
   projects:
   – Clean energy (solar and
     wind)
   – Electric vehicles
   – New materials, esp.
     nanotech, composites and
     rare earth.
   – Precision Machinery,
     including Aeronautics and
     high-speed rail.
   – Biotech industries, esp.    These sectors account for only
     transgenic plant breeding   2% of China’s GDP today, but
   – Advanced                    planners call for growth to 8% by
     telecommunications
     networking                  2015 now written in to 12 FYP. Is
   – Environmental protection    this realistic?
     equipment
  Commitments to Large Programs
The government explicitly commits, in the 12th Five Year Plan
   “Suggestions” to finishing up the many projects initiated during the
   stimulus program of 2009.
The 12th FYP also commits to increasing the degree of financial and
   policy commitment to the “Strategic Emerging Industries.” (It even
   slips in an eighth emerging industry, “oceanic industries,” which gets
   its own section after failing to make it into the Strategic Emerging
   Seven.
The other major social initiatives, including about $60 billion for health
   care (400 B. RMB) in 2011 are built into upcoming plans.
Public housing is projected to build 10 million units in 2011.
Government commitment to a range of industrial policy measures is
   strong, and perhaps accelerating>
   --16 Megaprojects
Total budget of projects under construction was 126% of GDP by the
   end of 2009; and 130% of GDP at the end of 2010.
Projects begun, or accelerated, as stimulus measures now seem to have
   become part of long-run development plans.
               A New Direction
Taken together, these changes amount to a breath-taking
    gamble on the ability of the Chinese government to
    shift the pattern of economic development.
Ideas that had been accepted by the government but
    were being cautiously and partially implemented are
    now being accelerated across the board.
It is clearly the intention of the Chinese government to
    maintain the far higher level of government
    involvement with the economy that was triggered by
    the global financial crisis.
More ambitiously, the objective is to accelerate the shift
    to knowledge-intensive industries; avoid a growth slow-
    down; and catapult China into the front ranks of the
    world’s economies. A new gamble.
                       Can it Work?
Yes, parts of it will work. China will continue its movement towards the
   front ranks of world economies and the world technological frontier.
However, China would have continued its catch-up under any scenario.
   Will these policies accelerate technological absorption? It is far from
   clear and will not be smooth.
Chinese planners will be disappointed in the success rate of their state-
   sponsored research projects. How many of the 16 mega-projects
   will be successful in an economic sense? Will it be two or six? The
   answer to this question will determine the distribution of power and
   resources in tomorrow’s world.
Planners are under-estimating the risks and the costs, but nevertheless,
   China has made enough investment in human resources,
   entrepreneurial innovation, and engineering skills, that they will be
   able to move ahead rapidly in some of the target sectors.
But what are the costs?
             5. Costs and Risks
• This gamble has a potentially large upside.
  Graduates from colleges and Universities in China
  have soared from only a million to over 5million in 7
  years. Graduates are reasonably well trained and
  having a hard time find work. Can this help them?
• More hard-headed evaluations are not to positive.
  These commitments conflict with the desire to make
  China’s economy more “balanced,” if balanced
  means with a greater role for consumer demand
  (quantitatively) and consumer choice (qualitatively).
  Prediction: We won’t see much “rebalancing” in the
  next two years.
                         Costs
 The commitment of resources put pressure on
  macroeconomic balances, and reduces the
  government’s flexibility in dealing with inflationary
  pressures. Total budget of projects under
  construction was 130% of GDP at the end of 2010.
 The Central Bank is stepping on the brake, while the
  government initiatives are stepping on the gas.
 With multiple, inconsistent policy-levels extending
  over different sectors, it is hard to tell which sectgors
  are privileged and which are handicapped.
                 Costs (Cont.)
• These types of mildly protectionist policies have
  benefits at the beginning and only show costs at the
  end. (Politically, they are the opposite of reforms,
  which their short-run costs and long-run benefits).

• The early benefits make it easier to assemble
  supporters and clients. Decision-making becomes
  more politicized while poductivity (may) slow down.

• There are substantial lag effects, in whih harmful
  behaviors slowly return: the soft budget constraint
  makes a comeback.
             Costs (cont, again)
• Crucially, the technology interventions come near
  technological frontier. We don’t even know which of these
  technologies will be technically feasible or economically
  profitable, much less the cost-benefit rate.
• Many other countries have relied on government
  mobilization to coordinate efforts to borrow and assimilate
  foreign technologies. Industrial policy, effectively
  executed, can accelerate the movement to the frontier.
  Only rarely has government coordination effectively
  nurtured firms with frontier technologies. Costs will are
  likely to be much higher, and benefits uncertain.
• Ultimately, the concern must be with the exit mechanism.
  Will China be able to pull the plug on underperforming
  projects and companies? If so, costs can be limited. If not,
  the Chinese economy risks being burdened for a long time
  by a large array of under-performing sectors.
     Finally, the Impact of Indigenous
       Innovation on foreign parties
Inevitably, these protectionist policies will create friction
  with foreign partners and technology providers
On one side: Foreign businesses, particularly in high-tech
  sectors, find it is increasingly difficult to navigate the
  maze of discretionary preferential policies. They feel
  constrained in their ability to cooperate profitably with
  Chinese firms. Public complaints by, among others, GE
  and Siemens, indicate the depth of dissatisfaction.
On the other side: A major change is taking place in
  patterns of resource allocation in China, particularly
  those that link China to foreign technology suppliers.
  China is already buy less technology abroad and
  investing much more domestically. This change will
  end up imposing substantial unanticipated costs on
  Chinese development.
                     5. Conclusion
China has embarked on a major re-orientation of development
    strategy in the wake of the 2008-2009 global economic crisis.
    The full implications of this shift will not be evident for several
    years.
If China were to succeed in all its high technology initiatives, the
    result would be a profound upheaval in global relations.
More likely, China will succeed in a handful of cases, and will have
    to manage the after-effects of mixed results and outright
    failure for the majority of these bold initiatives.
Even on this account, however, five to ten years from now, China
    will have moved decisively up the global technology rankings,
    contributing a far higher share of sophisticated value-added.
    The main credit for this, though, will be the investment in
    human resources and the innovation in business models in the
    market-oriented parts of the Chinese economy.

								
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