Herbert Poenisch, IMI International Committee, former senior economist, BIS

1. General remarks

The Work Report 2020 and Outlook for 2021 and the 14th Five Year Plan (FYP) offer the big picture, plenty of what has been and needs to be done, but is rather sparse on how to achieve this. Economic activity has always aimed at improving peoples livelihood with limited resources. Reading this report, in particular the outlook and FYP are rather a paradigm, a framework of ideas and thoughts to rally the stakeholders, consisting of enterprises big and small, farmers, workers and academia under a common understanding of the economic situation in the country as defined by the Government under the guidance of the CPC. Comprehensive quantified objectives can be matched with performance at the end of the plan. They are the hallmark of a society based on scientific decisions but they are scarce even in the published version of the 14th FYP itself. Tables in each chapter give only selected quantitative targets.

An economic plan usually has quantitative targets for sources and uses in an input output matrix as was practiced by the Socialist countries. As society moves away from basic needs planning becomes more complicated but not impossible with use of big data and computing technology. China can use its technological prowess to spell out multiple targets to be achieved with defined inputs. China’s mixed economy has allowed this strict link to be broken by technological improvements, in particular the widespread adoption of information technology but also increased indebtedness. In addition, capital inflows allow growth beyond domestic constraints. China already tops those countries which achieved growth with further indebtedness according to the credit to GDP gap indicator published by the BIS.

Total debt over GDP is above 300% and rising.  While there is no immediate risk of a crisis, the asset side of debt is worrisome. What is the quality of assets backing this debt? There are hawks such as Liu He and Guo Shuqing who question the sustainability of this model, citing bubbles in key sectors such as real estate. If they burst China’s growth ambitions will suffer a major setback.

The recent 2021 IMF country report China offers sharper analysis of the choices which need to be made, rather than a wish list, the financing of which is unclear. In this comment I will not repeat this analysis but rather use traditional Chinese dialectical thinking such as the relationship between Yin and Yang. This thinking was expressed in Mao Zedong’s 10 great relationships in 1956 and Jiang Zemin’s 12 relationships in 1995 . In the first part I will spell out present day 12 relationships at this important juncture at the beginning of the 14th FYP. In the next part available evidence will be added to highlight the choices made. Finally, experts’ opinions will be added to address the most pressing issues. China has arrived at a middle income status and needs to take courageous decisions to escape the middle income trap.

2. The 12 great relationships of present day China

2.1. Accelerated growth versus consolidation

While advancing growth was predictable in the 13th FYP, recent events have cast doubt over the feasibility of high growth necessary to achieve the 2035 goal of a modern socialist society. While moving from quantitative growth to quality growth there is uncertainty whether efficiency gains made through technological progress will drive the economy or conservation of less efficient sectors, such as SOE will allow growth only by incurring higher indebtedness. The drivers of growth, domestic consumption, investment and net exports have become less predictable due to the constraints in other relationships.

2.2.Central growth versus regional growth

While central projects attract the attention, local governments, municipal and countries provide the major investments affecting peoples lives. These are enterprises providing local employment, social infrastructure providing welfare, local housing projects at affordable prices which need financing, either by local taxes, transfer from the centre or borrowing.  The tussle over building high speed railway infrastructure is a case in point. Local governments end up paying for the bulk of costs by incurring further debts.

2.3.Dual circulation: domestic versus foreign driven growth

The boom in export industries in very limited regions has been a driver of growth ever since the opening up started 40 years ago. Facing headwinds in foreign trade together with a loss of competitiveness has started a reorientation towards domestic demand. However, this component was lopsided with domestic investment leading and producing bubbles, such as in the real estate sector. Admitting more capital inflows allows growth beyond domestic constraints but brings risks if these funds are borrowed, such as portfolio inflows.

2.4.State versus private sector

Since the beginning of reforms the importance of the private sector has increased to the extent of providing 60% of economic growth and 80% of urban employment. They dominate not only among the micro, small and medium enterprises (MSME), in big conglomerates such as Wanda, HNA, Anbang, Fosun, but are also among the leading big tech companies. The MSME were most vulnerable during the Pandemic and resources as well as finance have to be assured to sustain recovery.

2.5.Wages versus profits, income and wealth distribution

During the period of export driven and investment driven growth profits have surged and wages have lagged behind. Private consumption for the majority of the population has been concentrated on housing, education and health with little left over for further stimulus. The urban population with recourse to credit has entered indebtedness to sustain their style of life. Profits on the other hand have been concentrated among the rich and have been searching for profitable investment opportunities in the real estate and financial sector.

2.6.Consumption versus investment

Investment by enterprises, central and local government as well as by households in the form of real estate has absorbed the main allocation of funds, raised as well as borrowed. Consumption in the classical sense, public and private consumption had to manage with the rest. Government consumption such as defence and security has kept up but private consumption had to be financed increasingly by consumer credits as wages did not keep up with growth. Relying on more investment might create excess capital stock and also face headwinds in the form of rising raw material prices across the board.

2.7.Structural conservation versus environmental advance

Employing environmental advanced technology in new projects, smart green growth and declaring carbon peaking in 2030 and carbon neutral growth by 2060 have been advanced by the Chinese government. However, tackling the existing stock of environmentally polluting sectors, such as coal fired plants has proved far more difficult as it would lead to a loss in growth and vested interests in the short run.

2.8.Urban versus rural development

While China has made great advances in urbanisation reaching 65% in the 14th FYP, the rural sector has been neglected. Agricultural self sufficiency is under threat. This concerns land use, investment, pricing and subsidies, social policies for rural residents, the hukou system but also in the preservation of administrative obstacles, such as urban rural divisions by invisible walls.

2.9.Land use: conservation versus opening up

Arable land and water are the scarcest resources in China. They are in public ownership. However, land use has been increasingly subject to commercialisation. This takes the form of agro industrial enterprises for food production, embracing new agro technology, land grab for building and infrastructure and other fixed investment but also declaring development zones. In all these cases traditional agriculture has been replaced by cash crops, modern agricultural production, over fertilisation, pollution of lakes and rivers and finally removing the land from agricultural use altogether.

2.10. Military spending versus social welfare

While spending on modernising the military and security has been absorbing an increasing share of government spending, spending on social welfare, such as affordable housing, health, education, pensions, unemployment payments has been lagging behind. Country wide solutions are not in place and it remains the responsibility of the local governments and thus subject to their funding constraints.

2.11. Market mechanism versus planning

The Chinese economy has been experimenting with market mechanisms in various reforms in various sectors ever since the opening up 40 years ago. Allowing markets to function has been like ‘feeling the stones while crossing the river’. However, when push comes to shove, the security of planning versus the insecurity of markets has determined the choice. As the declared goal is stability in the economy, choosing markets always risks more volatility.

2.12. Material versus spiritual civilisation

As the material side of life has been getting visibly better, in particular for the urban elite and the large part of the population who have ben lifted out of poverty there is concern that the spiritual civilisation has been lagging behind. The are many reminders of this cultural gap in the 14th FYP. The accelerated implementation of technology has highlighted this trend.

3. Measures announced for Workplan 2021 and 14th FYP

Premier Li Keqiang’s address to the NPC and CPPCC contains certain indications and some targets on how to resolve the 12 relationships. Statistics supporting the arguments have also been taken from other sources, such as the IMF.

3.1.Growth versus consolidation

Even in view of the ambitious 2035 goal current necessities have prevailed, with more emphasis on consolidation than on growth. Although a quantitative goal of more than 6% was given for the first year of the FYP, such a goal for the whole FYP is absent. This shows that uncertainties about the economic environment as well as the sustainability of the debt financed growth have prevailed in setting priorities. Constraints are the bubbles in the real estate sector as well as survival of zombie firms which pose major macro economic risks.

3.2. Central versus regional growth

This basic direction was followed by decisions on the basic monetary and fiscal stance. In the latter, the central government deficit will be reduced from 3.6% in 2020 to 3.2% in 2021. The IMF augmented fiscal deficit, ie covering all fiscal responsibilities reached 18.6% in 2020 and is not expected to drop back to the level of 12.6% of 2019 for the duration of the FYP. Fiscal spending by municipal and county authorities are boosted by a direct fund transfer of RMB 2.8tr from the central authorities in 2021. In addition, local governments are allowed to issue RMB 3.65trillion new special development bonds. Monetary policy should reduce the lending to the real estate sector while supporting the private sector, manufacturing under the upgrade machinery 2025 programme, MSME, poverty alleviation, rural vitalisation and green investments.

3.3.Dual circulation, domestic versus foreign growth

The foreign sector had experienced headwind before the new FYP due to trade frictions, widespread recession in exports markets due to COVID 19 and rising raw material prices. Although the export performance was unexpectedly good in 2020 due to special factors, the whole external sector is expected to produce a negligible contribution to GDP growth in the new FYP according to the IMF. China should become a magnet for foreign resources. Capital inflows, particularly portfolio investment in China are projected to continue, but causing increasing foreign indebtedness. Following up earlier policy shift to boosting domestic demand there will be promotion of infrastructure spending at the city and county level, measures to support urbanisation, such as creating jobs and improvement of peoples’ lives through health care and education spending.

3.4.State versus private sector

While the contribution of private MSME to growth has been acknowledged by special treatment in monetary and fiscal policy, the big private conglomerates and private big tech companies have been facing strong headwinds before the new FYP. In the area of leading edge technology the leading role of the state in science and technology has been confirmed. Government will also support R&D to increase by more than 7% a year. The IMF calls for greater competitive neutrality between SOE and private enterprises.

3.5.Wages versus profit, income and wealth distribution

The growth of real wages has lagged behind real growth over the past few years leading to a deterioration of the income and wealth distribution measured by the Gini coefficient which is one of the highest in Asia. As a result the top 10% of the population own 48% of total assets and 58% of financial assets, the bottom 40% own only 9% and 5% respectively. With a regressive tax system and welfare expenditures only 3.5% of GDP the redistribution effect is much lower than in other countries. The propensity to consume is much higher for the lowest 40% of the population and a redistribution in their favour would thus contribute more to domestic consumption demand. Raising the spending by the rural population and low paying jobs has been declared a priority. However, household income as a share of GDP is projected to decline by the IMF over the next few years.

3.6.Consumption versus investment

For years, boosting private consumption has been a declared goal. However, all kinds of investment have been and will still be a major driver of growth, but projected to grow less than GDP in the FYP, whereas consumption, including government consumption is expected to grow more than GDP. In order to reduce the high savings rate and capital formation the IMF has called for progressive taxes and strengthening of the social safety net.

3.7.Structural conservation versus environmental advance

Environmental orientation is central to the 14th FYP to achieve the 2030 and 2060 carbon objectives. There are quantitative targets such as reduction of energy input in growth by 13.5% and CO2 emissions by 18%. Even a new power system has been announced. However, traditional polluters are powerful and cannot easily be replaced. There is a target for reforestation of 24% of total land but the regeneration of polluted rivers and lakes will take years, if not forever.

3.8.Urban versus rural developments

There are some quantitative targets for urbanisation, such as providing 11million  more jobs in 2021 for urban employment and hukou reforms to promote labour mobility. Migrant workers should benefit from an orderly transition from countryside to cities. Such targets are absent for the rural sector and farming.

3.9.Land use: conservation versus opening up

The only reference to land use was the farming ‘red line’ of 120million ha. This will hopefully reduce the land grab for investment projects, first and foremost building commercial and residential property, but not stop the creation of further development zones in addition to the ones already announced.

3.10. Military spending versus social welfare

In view of the external threats and internal challenges spending on defence and security has been declared a priority. Modernisation of the defence forces by 2027. Defence spending has an investment component, such as military installations, equipment and technology, but also a consumption component, such as software and staff costs of military and security personnel. In 2021 these expenses are planned to grow by 6.8%. Actual spending is estimated to be much higher. Defence, security as well as social welfare are components of government spending in the national accounts (SNA). It is uncertain how much will be left for social welfare once the fiscal deficit will be cut.

3.11. Market mechanism versus planning

Allowing the market mechanism to function more widely has been declared but when it comes to solving particular problems, such as reigning in lending to the real estate sector, central decision resembling planning are taken, such as credit allocation to various groups of banks. If the market were to play a greater role, mechanism have to be in place to correct the market outcome to achieve national priorities, such as a fairer income and wealth distribution. However, these are not in place and corrections are rather administrative decisions.

3.12. Material versus spiritual civilisation

While modernisation, in particular through technology and creativity has been singled out as the major feature of the Report and the 14th FYP, many sections are devoted to strengthening moral leadership of the CPC and socialist thinking and behaviour of the people, citing intellectual and cultural needs. Even President Xi has lamented the misuse of technology for gaming and entertainment. Some sources say that young people spend about 30% of their time on this.

4. Major challenges which need to be addressed

While Premier Li Keqiang has alluded to resolving major challenges, they lack clarity and a transparent policy framework for resolution. They have been brushed under the carpet.

4.1.Ageing problem

While the strategy to address ageing has been mentioned and old age insurance for 95% of pensioners,  the FYP lacks any backlash from the inevitable demographics of China’s population. After all, supply of labour can be manipulated only to a certain extent, but the implications for labour supply, productivity and demand for social welfare are not clear. Thee proposed raising the retirement age might serve as a temporary remedy.

4.2.Reduce debt levels

Although there are indications for reducing the dependence of growth on further indebtedness, any meaningful reduction of indebtedness in the medium term, such as the deflation of the real estate bubble are not clear. Furthermore, the increase of foreign borrowing has not been accounted for. In addition, many private enterprises borrowed in offshore zones which is not included in the total external debt. A drastic reduction in debt could put economic growth at risk.

4.3. Fiscal imbalances

The inconsistency between the fiscal responsibilities of the centre and local governments has not been addressed. Cities and countries continue to receive presents from the centre, local governments continue incurring debt through bond issues and LGFV as their fiscal responsibilities are not met by an adequate share of taxation. Fees from land use continue to constitute an important income for them.

4.4.Inequality of income and wealth

This has been identified as major drag on boosting domestic consumption. This needs courageous measures rather than a declaration to augment low incomes.  The primary income distribution needs to be corrected by progressive taxation and by providing adequate social safety net, public health and education for all.

4.5.Role of private enterprises and markets

While a hybrid economy offers many advantages as mentioned in the FYP, it has many drawbacks. First and foremost is the uncertainty which one will prevail. In addition, choosing one will determine other choices. As the private sector is the backbone of China’s economy, it cannot be starved of finance. If banks are reluctant to lend extensively to the private sector, the financial markets as well as FinTech should fill this gap.

Literature used

Li Keqiang (2021): 2021 zhengfu gongzuo baogao (in Chinese), March

Zhongguo quanguo renmin daibiao dahui (2021): zhonghua renmin gongheguo guomin jingji he shehui fazhan di shisige wunian guihua (in Chinese), March

IMF (2021): PRC 2020 Article IV Consultations, January