Question 1:
Kogan
Page has just published the fourth edition of your new book China
in the World Economy, An OECD Economic and Statistical Survey. You were part of the original team that worked
on this large and very informative new release. Can
you explain to us a little what the Organization for Economic
Co-operation and Development (OECD) is and why it is involved in this
analysis of
China and its economy and what your role as one of the authors was in
this important study?
Answer:
The OECD is a multilateral institution comprising the
more advanced industrial economies that was created in 1961 as a forum for
discussion and analysis of a wide range of economic issues
of common concern. The organisation has
expanded considerably in recent years and now includes 30 member
countries drawn from all the regions of the world. Its primary mission
is to help governments to deal with the economic, social, and
governance challenges of a globalised
economy.
The OECD has relations of various forms
with nearly 70 other countries and economies. A major focus of these
efforts has been larger non-member countries, including China,
whose importance in the world economy is growing, and whose governments
increasingly look to OECD experiences and best practices in economic
development and management for potential lessons and insights for their
own policies. The OECD presently has a strong working relation with the
Chinese government and its agencies in a wide range of areas, involving
every OECD directorate.
My role as head of the
non-member Asian desk in the OECD economics department was to lead the
OECD study and to contribute, with other colleagues in the economics
department,
several of its chapters. The team that produced the study consisted of
nearly 25 experts drawn from across the OECD Secretariat and including
a number of experts from Chinese government agencies.
Our group in the economics department prepared the
chapters
on the banking system, the overview of the impact of WTO on China’s
industries,
part of the chapter on financial system development, and the chapter on
macroeconomic policies, as well as chapters on the distribution system
and central-local government fiscal relations.
Question 2:
I’ve just returned from a week in China
touring the Economic Development Areas (EDAs) in the coastal regions
around the Middle and North Coast of China. I
was impressed by the large amount of building going on and relocation
of factories. Many of the Chinese I met in
these
coastal cities expressed their feeling that China
could not be denied as the coming Economic Leader in Asia
if not the world. However, after reading
your book I see that many problems still remain. With
respect to China,
what is your overall impression “Is the cup half full as they say or
half empty”?
Answer: The
basic message of the OECD study is that China
has great potential but that realisation
of that potential is not automatic and will require substantial further
reforms to achieve it. For example, China’s
government has set a long term goal of increasing per-capita GDP
four-fold by the end of the first two decades of this century, which
will require growth in real GDP at an average annual rate of about 7.2
percent through 2020. This is perfectly feasible – even in recent years
China’s growth
rate has been above that pace—particularly given China’s high saving
rate
and rapidly increasing foreign investment. However to continue to grow
this
rapidly, China will need to overcome very serious challenges, to
improve
the efficiency of the business sector, to absorb the large numbers of
workers
who will be leaving agriculture or displaced from state owned
enterprises,
and to increase the effectiveness of the financial system—to mention
only
some of the most important.
Question 3:
In your teams very thorough book, you
divide your teams work into two parts, part one contains Sector studies
on such sectors as agriculture, industry, technology, banking,
insurance, distribution and Foreign Direct Investment (FDI) and then on
economy-wide issues, such as the role of regulatory reform, role of
competition, environmental priorities, etc. Why
did the team choose this organization and are you happy with the final
result and if so why?
Answer:
This division reflects the fact that China’s
reforms are proceeding on two levels which are complimentary and need
to be mutually reinforcing. In the first part of the study we examined
the problems of the main individual sectors of the economy and the
policies to deal with them, for example measures to promote adjustment
in the agricultural sector and policies to improve the efficiency of
state owned enterprises. However all of the chapters in the first part
repeatedly highlight the crucial importance of economy wide policies--
to develop and improve the basic institutions and processes essential
for a market economy -- to
the success of policies toward individual sectors. For example, the
chapter on technology challenges emphasises
the need for better governance and management of enterprises and
improvement of intellectual property rights protection as essential to
raising China’s
technological capabilities. Indeed, the interdependence among policies
in different areas, and the consequent need to pursue reforms on a
broad front in a carefully co-ordinated
fashion,
is a key message of the study. The division of the study into sector
and
economy-wide issues is intended to help underscore that interdependence.
Question 4:
In your teams study, one of your
conclusions is that “the important engines that have driven China’s
growth in the past are losing their dynamism.” Could
you explain this conclusion and how the team feels China
should address it?
Answer:
A distinctive characteristic of China’s
traditional reform strategy has been the development of certain
segments of the economy outside of the constraints of the central
planning, in order to catalyse the growth
and development of the economy as a whole. This process has been characterised by a well known China
scholar, Barry Naughton, as ‘growing out
of the plan’. A prime example is the development of township and
village
enterprises (TVEs), which became the single
largest contributor to industry growth and
employment
in the late 1980s and early 1990s, and whose growth was spurred by the
substantial advantages they had
vis a vis state owned enterprises. Another example is
the progressive opening of the economy, in part through the granting
of tax exemptions and other preferential terms, to foreign investment,
which together with the TVEs developed China’s
export sector. However as the economy has become
more market oriented and as problems not adequately addressed by
reforms
have accumulated, the impetus to growth from this ‘separate
development’
strategy has progressively waned. In particular, job creation by
TVEs has virtually come to a halt
since
the mid-1990s, as their previous advantages have been eroded by SOE
reforms
and as limited technology, constraints on their scale, and high debt
loads
have become increasing problems.
In our view, future reforms need to move
away from preferential policies for individual sectors toward leveling
the playing field among businesses and focusing on economy wide
policies
to improve the overall economic environment.
Question 5:
In the early years of Deng Xiaoping’s
reforms the farm economy and later rural non-agricultural enterprises
(RE’ or TVE’s as they are called) were important engines of Chinese
economic growth. How important are changes
in how China
deals with the rural economy to improving China’s
economic performance going forward?
Answer: At
various points, the rural economy has provided an important boost to China’s
real growth. It did so when agricultural prices were raised early in
the reform era and later on with the development of TVEs. Now, however, the rural sector’s
performance
has deteriorated considerably and has become a serious drag on growth
in the overall economy. Two basic challenges have to be met to revive
the rural economy. First, there will need to be a reallocation of
production
within the agricultural sector, away from land and water intensive
grains
such as wheat and soybeans and toward more land intensive crops such as
fruits and vegetables. Second, and most critically, jobs outside of
agriculture
will have to be found for those workers who are now employed, and for
the
millions more who will be leaving agriculture —as many as 70 million
over
the next decade according to an estimate cited in the study. This is
likely
to require major changes in traditional policies, in particular to make
it easier and more productive for rural workers to move to cities to
find
work.
Question
6: One of the strengths of
your team’s new work is the large amount of tables and the use of
graphics
that assist in demonstrating the points your team is trying to make. In fact, the book even includes a CD with
extensive additional tables and data that is very useful to any
business, investor or researcher. On
page 16, you use a five sided pentagon that explains the vicious cycle
of poor enterprise performance (Figure
2: The vicious cycle of poor enterprise performance). Can you explain the
graphic and how poor enterprise performance is reinforcing a vicious
cycle that will hamper Chinese economic development if not resolved?
Answer:
China
faces several major challenges that are made all the more difficult by
the fact that they result from a number of separate problems that are
mutually reinforcing. For example in the graphic, government
interference
in enterprise management weakens the incentives and the capabilities
of the enterprise itself to make economically sound plans and
decisions.
This in turn leads to inefficient operations and poor performance,
which
in turn leads to low profits, increased borrowing, and consequently
high
debt. To get out of this vicious circle, enterprises need to
restructure
their operations, but their ability to do so is severely constrained by
their low profits and high debt. This throws much of the burden on the
government, which reinforces (or at least makes it harder to curtail)
the government interference in enterprise management.
The difficulty of breaking through the
vicious circle is made all the greater by other factors that sustain
it, notably the interaction between the non-performing loans of banks
and the poor performance of a large segment of their business customers
that is illustrated in another graphic (Figure
4: The vicious circles of bank and enterprise problems) in the study.
Question
7: One
of the further points made in your teams book is that “the evolution of
the financial system has lagged that of the real economy”.
Can you explain this observation, what implications it
has for China
and how your team would recommend that China
resolve this issue?
Answer: Following
the initial creation of the major
state owned banks (SOCB) early in the reform
period, the further development of the financial system was given a
lower
priority than industrial development in China’s
reforms through much of the first half of the 1990s. Partly as a
result, China’s
financial system has in important respects lagged behind the profound
changes in the business sector over the past twenty years. A graphic
illustration is the fact that more than 70 percent of bank loans go to SOEs, even though their contribution
to overall output in the economy is much less than that of non-state
enterprises, which have much more limited access to credit. The four
major SOCBs continue to dominate the
financial
system and although no longer subject to explicit central planning
requirements, their lending continues to be influenced by government
mandates in certain areas. As a result of
these and other conditions, China’s
financial system has some way to go before it can effectively support
the extensive changes the business sector will need to undergo over the
next ten years.
At least three challenges will need to be
met to produce a fundamental improvement in the effectiveness of the
financial system. First, the high level of non-performing loans and low
capital of the major banks (and some other segments of the financial
system) will need to be dealt with, since banks and other financial
institutions need to be financially viable if they are to operate
effectively on commercial principles. Second, the system needs to
develop greater diversity, through a greater role for smaller banks and
other financial institutions relative to that of the four major SOCBs, and through the further development of
capital and other financial markets. And third, the governance and
accountability of financial institutions needs to improve considerably,
and this will require less government interference, improvement in
management and internal control systems, improved supervisory
oversight, and stronger market discipline.
Question 8: Your new
book is not just a “think-thank” study but in my opinion after having
read
and used the book also a book with real life applications to business
people, consultants and business executives. As
an example of this, I note your table on page 145 titled
Prospects for selected industries in light of China’s WTO accession (Table
4.3: Prospects for selected industries in light of China's WTO
accession) which shows how domestic demand, China’s exports,
China’s import’s and
FDI Inflow all will be affected by China’s entry into the WTO. Can you explain a little who your intended
audience was for this new book and a little about the table and what
implications it may have for Western investors considering investments
in China?
Answer:
We aimed our work at several audiences, both within
and outside of China.
Within China, the large and growing
community of government officials, policy-makers, experts, academics,
and others concerned with formulating, implementing, and analysing economic policies was a key audience
we have tried to reach. We benefited greatly from discussions with and
support from many of these people.
Outside of China,
our major target audiences include officials and experts from OECD
member countries, along with the wider community of scholars and
practitioners in areas concerning China.
While our study is not intended as a manual for potential investors,
we think it provides background and insights on issues that will have
an important bearing on the conditions and future developments that
will be important for those doing business with China
to be aware of.
Question 9: Countless stories in the press are
appearing about China
becoming the workshop to the world but one of your team’s conclusions
is that Chinese businesses are not really investing enough in
technology
and that the government is investing insufficient amounts in education. Could you explain these observations and how
the team recommends the Chinese government respond to this?
Answer: As
a result of the large amounts of foreign direct investment it has
received, China
has become a major venue for the processing and assembly of products
for export and its importance in this respect is likely to continue to
grow. Large amounts of products that were produced and shipped directly
from other Asian economies are now finished or assembled in China,
using imported parts from those other economies. Nearly 40 percent of China’s
imports now go to producing exports.
This is a favourable
development for China,
and for the region as a whole, but China
needs to find ways to improve the spillovers to the domestic economy
from its growing exports. In particular, local content is often low and
technology transfer has been limited. To improve in these areas,
reforms
to improve quality of products from domestic suppliers, to bolster
enforcement
of contracts and protection of intellectual property so that foreign
businesses
are encouraged to form alliances with domestic companies, and other
measures to improve the business climate are likely to be needed.
Question
10: The
above question brings up another conclusion of the team, that there is
a need for greater Chinese government revenue and expenditure at the
local, provincial and national level if China
is to adequately address the issues facing it. How
exactly does this fit into your team’s conclusions?
Answer: Although
total government revenues have been rising in recent years, China’s
governments are still unable to adequately fund some key needs, such
as education.
The problem is greatly compounded by the
fact that revenues are raised inefficiently and badly distributed among
various government levels. There are huge disparities in per-capita
revenues
between richer provinces on the coast and those in the central and
western
regions. Local governments typically lack the on-budget revenues needed
to meet their obligations and this has led to growing reliance on
ad-hoc
fees and charges that are often illegal and often imposed on the
poorest
segments of the population. In effect, China’s
government doesn’t have enough money to meet its obligations while at
the same time much of the population is overtaxed. This is a classic
symptom of a very inefficient system of public finances..
If the government is to adequately support
China’s
development, it needs to increase its on-budget revenues while reducing
burdensome and inefficient off-budget charges. This will require tax
reforms, to broaden tax bases and equalise
treatment. It will also require
fundamental reform of central-local government
fiscal relations to ensure that local governments have adequate
resources to meet their spending obligations and to reduce inequalities
among regions.
Question
11: Your team looked very
deeply at the issue of corporate governance, the need for transparency,
the role of corporate officers, need for outside Board of Directors,
etc. in Chinese companies. What were your
team’s conclusions in this area and do you feel that there really is
sufficient understanding for the need for change in China’s
boardrooms and are you optimistic that much of this will occur in the
short term?
Answer: Despite
strong backing from Chinese officials, reforms to institute modern
corporate governance in China
have had mixed, and in some respects disappointing, results for several
reasons. First, there are some important differences between the way
governance structures have been instituted in China
and international best practices. For example, top managers of state
owned enterprises continue to be appointed by political officials
and/or
local government officials. A second set of problems concerns the lack
of clarity of about who actually is entitled to control the assets of
state owned enterprises and to make key decisions about employment
levels
and certain other matters. Presently, management of state enterprises
are not free, that is without government approval,
to lay off workers, close plants, or take other measures
that may be essential to improve their performance. A third set of
problems
lie with the still limited market discipline that many enterprises
face.
Enterprises in competitive industries have strong incentives to improve
their governance because it is important to operating effectively in
the
market. These incentives are much weaker for those SOEs
that are sheltered from competition and have favoured access to bank loans, the stock market,
and other credit, and corporate governance reforms seem to have worked
less well in these cases.
China’s
officials are aware of the present weaknesses in corporate governance
and are seeking to address them. However, as other countries, including
OECD members, have found, it is very difficult to get state owned
companies
to be as profit oriented and efficient as their counterparts in the
private sector. The difficulties are probably even greater in China,
given the long history of close relations between state owned
enterprises and government agencies.
Question
12: Chapter 13 of your book
talks about the current tax system and priorities for reform. For a practitioner, this is very useful as it
gives a very good detailed outline of current tax policy as it affects
a potential project and also gives your teams suggestions on how tax
policy may change in the future. Could you
state briefly what the major issues affecting the tax system are at the
current time and how you see China’s
tax system changing to deal with these challenges?
Answer: There
are three major issues concerning tax policy. First, as indicated
earlier, there is a shortage of on- budget revenue, which is most
easily allocated to the areas of greatest need, while there is way too
much off-budget revenue and its collection and use is very inefficient
and inequitable. Second, there are serious
weaknesses in the mechanisms and institutions for collecting taxes with
the consequence that the government raises less on-budget revenue than
it is owed. And third, there are distortions and unequal treatment in
the tax system itself. For example, foreign
controlled enterprises enjoy significant tax concessions, in the form
of tax exemptions for the initial years of their establishment and
exemptions
from duties on imported inputs, not granted to domestic firms.
Some of these issues are now being addressed. In
particular, there has been a major effort to improve collection that
has resulted in a significant boost in revenues. Over time, authorities
have said
they will phase out the special tax advantages given to foreign
businesses. Efforts are also likely to be made to broaden the tax base
and to reduce the present reliance on the value-added and business
(services) taxes,
in part by increasing the importance of personal income taxes, which
are
now a relatively small share of the total.
