Simple reasons why reform is not always pursued

December 23, 2013 by Timothy Beardson

While reform is in the air in Beijing, we should realistically accept that there are contradictions in society which weaken and delay the ability to introduce radical reform. Often the reforms which Beijing should introduce seem obvious but they are not adopted. There are generally good reasons which make reform difficult.

Why do policy makers not pursue the policy paths which – to the wider world – might seem self-evident? It is often because they are constrained by a prism formed by their own cultural or ideological preconceptions. Sometimes they cannot see the wider range of advantages and disadvantages, threats and opportunities for the nation. It is not that they are necessarily ill-disposed, but that they frequently see constraints which are not internationally evident.

Let’s look at a few examples.

If farmers own the right to use their land, even if they are not allowed to own it, surely reforms could be adopted allowing them to monetise this in some way – either to mortgage in order to acquire modern equipment or to sell the land use rights and then go to the cities? If only it were so simple. What really happens is that local governments are so short of money due to the official (inadequate) transfers from Beijing that in practice they supplement their income substantially by compulsory acquisition of farmers’ land for development purposes at a low price before selling it on to developers at a huge mark-up. This partially explains the popularity of “urbanisation”. It is estimated that by 2010, land sales provided a further 74% of income on top of on-budget revenue.

Take the example of population. Faced with a wholesale collapse in its population within the next 20 years, officials’ genuine belief in the effectiveness of the one-child policy should have led them not to amend it, but to scrap it by now. There are two problems: the demographers are not policy makers and fines for breaching the one-child policy are a major source of local government income. One estimate is that by 2012 they had totalled $314bn, which is approximately $10bn for every province.

Interest rates have been managed to low levels by the authorities to advantage the producer over the consumer. As a result, household savers gain derisory income on their substantial bank deposits but the principal bank borrowers, the state-owned enterprises (SOEs), are able to borrow large amounts at low rates for projects which are subject to little market oversight. Unsurprisingly the consumer doesn’t feel affluent enough to spend and the SOEs over-invest in projects of questionable value.  Another by-product is the low cost of taking out a mortgage and the paucity of investment alternatives such as bank deposit, which might give property investors an alternative.

Further reasons for a mandatory low interest rate regime stem from China (like the US) having huge financial liabilities – including those owed by local and national government and off-balance sheet liabilities. This is particularly germane to the liabilities which support China’s mammoth foreign exchange reserves. Beijing currently pays internal investors higher interest rates on its domestic debt than it receives on its external assets. Indebted nations do not normally vote for higher interest rates.

China’s indebtedness is impeding interest rate liberalisation and thus valuable economic reforms.

The education system is currently being strangled by the dreaded gaokao, or national university entrance, examination. It is a rigid and data-intense system, widely recognised as encouraging rote-learning and discouraging critical thinking.  As a result it contributes substantially to the stifling of creativity and innovation. These are areas in which China is deficient and needs to improve. However, parents are so sensitive to the widespread corruption that they fear anything less than totally objective examinations would increase the advantages well-connected insiders have to play the system.

It is often observed that the hereditary dual household registration system – the hukou – labelling citizens as urban or rural with varying social benefits and rights, is somewhat comparable to divisive social policies such as apartheid. The system seems to many to be easily overdue for reform.

However, it is little appreciated that two forces stand in the way of hukou reform. First, local governments are usually highly resistant to allowing mass ‘temporary’ rural migrants access to urban social rights as the additional cost is not coverable by any increased revenues. Second, urban citizens are highly cautious about sharing their benefits with the millions of rural migrants living in their midst for fear of finding less access to hospitals, schools and other scarce social benefits. As a result, from Beijing’s perspective, their core constituency – the urban middle classes – rejects a fairly obvious looking reform. Thus it resembles reforming entitlements for the elderly in the US – a political non-starter. We should not underestimate the Chinese authorities’ wish within reason to give their (defined) public what they want.

The Third Plenum recently offered a number of reform ideas but it is still too early to tell what the results will be. Certainly it was depressing to read that crucial results should be expected by 2020. Why do leaders not see the need for urgent reform, scythe through the policy debris and change the country?

The principal reason is that the architects of the post-Mao Communist Party in the late 1970s were united in one matter – namely that never again would the Party, and thus the country, be run by one man in the arbitrary, quixotic and dangerous way that it was under Mao. Collective leadership would be the way forward. The price for such stability is that tough decisions are difficult to agree.

There are often simple reasons why seemingly obvious policy reforms are not executed. However, eventually many issues will need to be confronted if China is to become a modern, strong nation, at peace with itself.

Tags: hukou, reforms,

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