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«The Influence of the Chinese Government Needs to Be Limited»

Professor Wu Jinglian, China’s most renowned and influential economist, has been at the center of the economic reform for 30 years, moving between academic and policy roles. He received «Finanz und Wirtschaft» in Beijing for an interview and talked about the proposal on further reforms he presented to the government in April. He is worried about the Chinese economy and sees significant dangers, if the reforms are not pushed forward. Wu considers comprehensive economic reforms as inevitable to avoid social crises.

Professor Wu, which are the most pressing economic issues the Chinese government has to address?

First, market oriented commodity and factor prices must be achieved. Then, the existing laws must be cleaned up to ensure that all forms of ownership and enterprises have equal access to the production factors. Third, the land rights must be reformed and clarified. The antimonopoly legislation must be improved and strictly enforced, because the current administrative monopoly seriously hinders the functioning of the market. Then, the authority of the watchdogs must be focused on ensuring healthy competition and protecting investors and consumers. Right now, e.g. the CSRC, the stock market regulator, decides almost everything.

Therefore, the influence of the governmental bodies must be limited?
Yes. The core reform is to install a competitive market system. The main flaw of China’s current economic system is the government’s excessive administrative intervention and deep involvement in micro-economic activities. The wide range of administrative intervention and administrative monopoly of large state owned enterprises suppresses the initiative and creativity of independent enterprises as the main market players. This makes the market loose its competitive nature.

How about the judicial system?
The localization tendency of jurisdiction must be overcome. The national court system should be led by the National People’s Congress. It must ensure that judges exercise judicial power independently.

How long will it take to implement these reforms?
We are starting. However, my proposal is only a suggestion. In November, the Central Committee will make decisions at the Third Plenum about how comprehensive the reforms will be. And after that they will announce the decisions, probably in January. High-ranking officials are now discussing the reforms.

Are these officials open and willing to embrace the reforms?
No, not all of them.

European and American economists say the Chinese economy is overinvested.
I fully agree with that.

How can the government turn this trend around and stimulate consumption?
The government has the ability to increase consumption, but it mainly pushes investment. In market economies, the ability of governments to increase investment is limited.  But in China the government has large resources, so they can invest a lot. That’s why we need to limit the ability of the government to do so. The government’s influence on the private sector should be reduced. It should only provide public goods and not interfere with markets which could be supplied by private companies. This is also the reason why we need a fiscal reform.

What are the most important elements a fiscal reform must include?
The boundaries between the public sector and the private sector must be clearly described. The government expenditure on economic construction currently still accounts for a large proportion of spending on all levels of government. This must be changed. The budgets of local governments must return to normal public finances. Local fiscal revenues must increase. The level of central government expenditure responsibilities should also be increased and special financial transfer payments reduced. Also, budget transparency and the supervision from the People’s Congress must improve.

Is this fiscal reform under way?
Not yet.

Is one of the problems, that nobody in charge wants to give up power?
It depends. There are different people with different intentions and goals.

Many Chinese economists consider the Hukou System reform to be one of the most pressing issues.
It is widely acknowledged that migrant workers must be given access to social services in the cities they live. If you don’t give these migrant workers education and social security guarantees, how can peasants become qualified workers in the industry or service sector? So, this is a very important issue. But for local governments this means significant expenditures, therefore they are reluctant to give the right to urban residence to these people.

Is the new government also seriously addressing environmental issues?
Yes, but there are some difficulties to deal with pollution and other things, because local governments always want the fast GDP-growth. And this, of course, is a typical conflict of interest.

How do you rate the condition of the financial sector? Is there a problem with bad credit in the banking system?
Yes, I think so. The reason is our national balance sheet. The leverage rate grew too fast. State owned enterprises and especially local governments received too much cheap credit. Banks used their short term resources to give long term credits – over 20 and 30 years ­– to local governments. There is a huge mismatch between assets and liabilities.

What could happen due to this mismatch?
Under some circumstances, there could be a serious crisis. This would not only result in slower growth rates, but also in a systematic crisis of the financial system. This is a dangerous possibility. But if we can implement our comprehensive reform, maybe we can get rid of this danger in time.

What would this comprehensive reform of the financial sector include?
Interest rates and an exchange rate determined by market forces, the promotion of the internationalization and convertibility of the RMB and the acceleration of the process of capital account convertibility. In addition, a unified national corporate bond market based on the development of the interbank bond market must be developed.

Will the opening of the capital account lead to heavy capital outflows?
Heavy capital outflows would be a good thing for China because they would put the government under a lot of pressure to push forward the reforms. If the economy does not become more competitive, the capital outflows will be very dangerous and lead to heavy casualties. Capital outflows are already a very serious problem for the government. But this puts pressure on the necessity of domestic reforms.

Twenty years ago, would you have imagined how China looks today?
Yes and no. In 1993, we knew that the economy would develop very fast if we could implement the decisions of the Third Plenum of CPC Central Committee’s 14th Congress. But I never thought that after 2002 or 2003 the trend would slip back to more government intervention.

In the last 30 years, what was the biggest achievement of the Chinese economy, and what was the biggest mistake?
After the economic reforms of 1992 we made big progress. The reforms led to the high-speed development of the economy. This is the main achievement. The failure in the field of economic reform was going partly back to the old system – going back to state interventions and strengthening the government power of resources allocation. Another problem is that political reform is still very, very limited or even on a standstill.

Were the comeback of government interventions and the power of the government a consequence of the world financial crisis in 2008?
No, this happened even before the crisis. In 2003/2004 and especially in 2006 the state resources were put to strengthen the power of state owned enterprises.

Will big state owned sectors like telecom or oil only be privatized if the government desperately needs money, as it often happened in the West?
Maybe. If we had a financial crisis like in Russia two years ago, some of the shares of the state owned assets might be sold off. I suggest that the government sells some of the stocks of state owned enterprises and use the proceeds for social pension funds.

To endow the social security system?
Yes. Individual social security accounts should be enriched by state owned equity and profits of state owned assets. To strengthen the social security system, also the enterprise supplementary pension system and the investment management of the funds must be improved and an overall social pooling achieved.

Are you in general positive about the future of China?
It depends. I am positive and pessimistic at the same time.

Can you elaborate?
If we could push the reforms ahead, our future will be very bright. But there will be serious offsets, mainly from vested interests groups.

Does the new leadership stand behind the necessary reforms?
That remains to be seen.

What will happen, if the reforms you are calling for are not implemented fast enough?
There could be serious social crises with incalculable consequences.