Why China will never heed World Bank advice on 'reforms'

by Minxin Pei

Claremont, California: When sound economic advice is divorced from political reality, it probably will not be very useful advice. The history of multilateral financial institutions like the International Monetary Fund and the World Bank is littered with well-intentioned and technically feasible economic policy prescriptions that political leaders ignored. But that has not stopped these institutions from trying.

The latest attempt is the World Bank's just-released and much-applauded report China 2030: Building a Modern, Harmonious, and Creative High-Income Society. As far as technical economic advice goes, the report is hard to top. It provides a detailed, thoughtful, and honest diagnosis of the Chinese economy's structural and institutional flaws, and calls for coherent and bold reforms to remove these fundamental obstacles to sustainable growth.

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Unfortunately, while the Bank's report has laid out a clear economic course that Chinese leaders should pursue for the sake of China, the Bank has shied away from the most critical question: Will the Chinese government actually heed its advice and swallow the bitter medicine, given the country's one-party political system?

[caption id="attachment_249674" align="alignleft" width="380" caption="Will the Chinese government actually heed its advice and swallow the bitter medicine, given the country's one-party political system? Reuters"][/caption]

For example, among the most urgent reforms that China 2030 recommends is reduction of the state's role in the economy. This can be achieved by eliminating privileges for state-owned enterprises (SOEs), such as subsidised capital and monopolies, and by allowing the private sector more freedom. But, curiously, the report's authors seem to forget that this would entail prohibitive, if not disastrous, costs for the ruling Chinese Communist Party (CCP).

China's giant SOEs may have some economic usefulness, but their existential value is political. The CCP uses the SOEs to provide good jobs and perks for its members. Of the CCP's roughly 80 million members, more than five million hold executive positions in state-owned or affiliated firms. Factoring in the regulators and local administrators whose jobs similarly depend on maintaining the current level of state intervention in the economy, World Bank-style reforms would jeopardise probably close to ten million official sinecures.

There is little doubt that reducing the SOEs' power would make the Chinese economy far more efficient and dynamic. But it is hard to imagine that a one-party regime would be willing to destroy its political base.

Fiscal reform is another urgent priority highlighted by China 2030. China's highly regressive fiscal system (the poor are taxed more than the wealthy) entails excessive revenues for the central government and relatively little expenditure on social services. In nominal terms, aggregate tax and non-tax revenues collected by both the central and local governments exceed 35 percent of GDP. But the bulk of the revenues is spent on administration, fixed-asset investment, domestic security, defence, and assorted lavish perks - entertainment, junkets, housing, cars, and high-quality healthcare - for government officials.

China 2030 suggests that China should gradually increase its spending on social services by 7-8 percent of GDP over the next 20 years. But why should the CCP do so? After all, the overall real taxation level in China is already quite high, which means that doubling social spending from the current level without raising taxes further would require severe cuts in expenditures that chiefly benefit the ruling elites.

The budgetary transparency that the World Bank has recommended will most likely not be realised for the same reason. Current public spending is so skewed toward the ruling elites that the CCP would risk losing its legitimacy should the budget become subject to public scrutiny.

Making China a "harmonious" society - the aim of the report's advice on reducing inequality - is clearly a desirable goal. However, it is a tired slogan even by Chinese standards. Trotted out by China's rulers many years ago, the "harmonious society" campaign has yielded, at best, modest changes in policy. The underlying political drivers of social frustration and conflict - disenfranchisement, repression, pervasive official corruption, unaccountable rulers, and predatory state institutions and policies - remain unchanged.

Addressing these fundamental causes of social discontent and unsustainable economic performance requires not advice and pleas to the ruling elites, but a change in China's political reality that compels those who benefit from the status quo to surrender their privileges for the good of the country.

Only two likely developments could lead to this outcome. One is the political empowerment of the Chinese people. But democratisation is currently unlikely, given the CCP's clear determination to defend one-party rule.

That leaves political change at the mercy of a system-threatening crisis, brought on by China's failure to tackle the pathologies the World Bank has so ably diagnosed. And, alas, China's ruling elites are almost certain to dismiss China 2030 as politically undesirable and irrelevant.

Minxin Pei is Professor of Government at Claremont McKenna College.

Copyright: Project Syndicate