Looming Stagnation

Looming Stagnation

by Author(s): Minxin Pei

This means the government will be unable to continue its practice of subsidizing industrial growth with private wealth. When coupled with an aging, increasingly dependent society and poor social services, stagnation and, eventually, abysmal failure loom.


IF SEVERAL years ago few would concede that China’s rapid economic growth was achieved at very high social cost, such as deteriorating social services, potentially catastrophic environmental degradation and rising income inequality, today this is no longer a disputed fact. Even the Chinese government has admitted that its economic growth is socially costly.

The accumulation of social deficits since the early 1990s was the unavoidable outcome of government policies that deliberately shift resources away from providing socially beneficial services (education, health care and environmental protection) to projects and activities that could produce immediate and visible signs of progress (infrastructure, commercial development in cities and industrial parks). Such policies were perfectly aligned with the imperative of regime survival and the incentives of individual government officials. For the Communist Party, policies that could generate rapid short-term economic growth even at the expense of long-term social costs were preferable because of the party’s dependency on growth as a source of legitimacy. For government officials whose promotion critically depends on their ability to deliver visible and measurable signs of growth, diverting scarce resources away from social services to investment projects offers a guaranteed ticket to higher offices and greater power.

As a result, these policies have worked wonders for both the party and its members, but their social costs have been horrific.

Official data indicate that the government’s relative share of health-care and education spending began to decline in the 1990s. In 1986, for example, the state paid close to 39 percent of all health-care expenditures while individuals paid 26 percent. By 2005, the state’s share of health-care spending fell to 18 percent, and the share of individuals’ spending rose to 52 percent. This dramatic shift in cost has placed significant burden on household budgets and consequently reduced access to health care. Per capita health-care expenditures as a share of consumption more than tripled in urban areas from 1990 to 2006 (from 2 percent to 7.1 percent) and increased 30 percent in the countryside. Unable to pay for health care, about half of the people who are sick choose not to see a doctor, based on a survey conducted by the Ministry of Health in 2003. The same shift has occurred in education spending. In 1991, the government paid 84.5 percent of total education spending. In 2004, it paid only 61.7 percent. During the same period, tuition and fees (costs borne by individuals) rose significantly. In 1991, they accounted for 4.4 percent of spending. By 2004, they contributed about 19 percent. One key indicator that reduced government spending has restricted access to education is the percentage of middle-school graduates who go on to enroll in high school (since students have to pay for high-school education). In 1980, almost 25 percent of the middle-school graduates in the countryside went on to high school. In 2003, only 9 percent did. In the cities, the percentage of middle-school graduates who enrolled in high school fell from 86 to 56 percent in the same period.

On the natural-resources front, the extent of China’s environmental degradation is now fairly well-known. Although estimates of the cost of pollution vary, they all suggest that environmental degradation is exacting a huge toll on Chinese society. The most recent study, a joint effort by the World Bank and the Chinese government, shows that the aggregate cost of pollution in China in 2004 was roughly 5.8 percent of GDP. Another study undertaken by two Chinese government agencies and released in 2004 estimates that the amount of underinvestment in environmental protection is roughly 1.8 percent of GDP a year. To fully treat all pollutants discharged in 2004 alone, China would need a one-time expenditure of 6.8 percent of its 2004 GDP—RMB 1.086 trillion, or $158 billion. The Chinese government’s poor stewardship of the environment has added huge stresses to the country’s fragile ecological system. Although a continental-sized country, China is resource scarce on a per capita basis. In particular, it suffers from serious water scarcity and uneven distribution of water resources: the per capita water availability is only 30 percent of the world average, and the area north of the Yangtze River, which accounts for 64 percent of China’s land surface, has only 19 percent of the country’s water resources. Truly alarming is the Chinese government’s growth-at-all-costs strategy that has devastated the country’s already-scarce water resources. The 2004 joint study reports, “About 25,000 kilometers of Chinese rivers failed to meet the water quality standards for aquatic life and about 90 percent of the sections of rivers around urban areas were seriously polluted.” Without prompt and effective measures, environmental degradation will not only pose an insurmountable hurdle for future economic growth, but also precipitate large-scale social unrest and political conflict.

Then there is rising inequality—a mainstay of many countries experiencing rapid economic development and social change. Although the causes are complex, government policies that fail to ameliorate the effects of economic-growth inequality can further exacerbate the trends. In China, the government has consistently undercut social services to the general public, and left the poor bearing the brunt of the deterioration in the provision of public goods. Additionally but inexplicably, Beijing has failed to counter rising inequality by instituting a relatively progressive tax system. China has no capital-gains tax, property tax or inheritance tax. Its income tax is so ineffectively enforced that it generates only a very small portion of government revenues. At present, income inequality in China has reached a level close to that of Latin America. The overall level of income inequality from 1985 to 2006 rose 39 percent (averaging a 1.8 percent increase per year). Although “within” (intraurban and intrarural) income inequality remains lower than national inequality, it has also risen significantly. In fact, the rate of increase in urban income inequality from 1985 to 2006 was twice that of rural income inequality (63 percent compared with 27 percent). The distribution of wealth in China is even more unequal than income. Household surveys and academic research show that the Gini coefficient of wealth rose from 0.40 in 1995 to 0.55 in 2002 (the higher the Gini coefficient, the more unequal the distribution of wealth or income). The distribution of financial assets is particularly skewed. In 1995, the Gini coefficient for financial assets was 0.67; it rose to 0.74 in 2002. These trends do not bode well for China. If they are not reversed by effective policy, China will likely suffer a rising crime rate and increasing social conflict closely associated with frustrations and tensions generated by inequality and high perceptions of social injustice.


THE COMBINATION of accumulated economic imbalances, misguided growth strategies, deteriorating fundamentals and social deficits makes it difficult to imagine that China will be able to maintain its current rate of economic growth without significant policy changes and reforms. Even with effective policy adjustments, China is unlikely to keep growing at a high single-digit rate for the next two decades. As we have seen, such high growth in the past has been obtained through artificial means. It is inflated, not just by creative accounting, but by discounting and excluding consumer welfare, social costs and environmental damage.

If China does not make the necessary changes, it will face something far worse than low single-digit growth—the delicate coalition among the ruling elites will unravel, the legitimacy of the Communist Party will erode and social unrest will rise. If it does make adjustments, we will merely see lower rates of growth.

But neither Beijing nor the outside world should worry about China’s reduced rate of growth in the coming decades because, to the extent that the Chinese government has improved the quality of growth at the cost of speed, it will be able to sustain a respectable rate of growth while addressing the economic and social problems caused by past policy mistakes.

Incidentally, this is what the current Hu Jintao government has pledged to do. However, based on the modest achievements of Beijing’s efforts to rebalance its growth strategy so far, it is becoming increasingly clear that the current growth strategy is rooted in the existing political system. It would take much more than rhetorical exhortation to reverse course. As long as Chinese government officials are assessed and promoted based on their ability to deliver economic growth, often within the two-and-a-half-year tenure of a party chief, the short-term obsession with the rate of growth will continue. In addition, so long as Chinese officials are accountable to their superiors, but not to the general public, they will have little incentive to pursue policies that would benefit their constituents. State monopolies on key sectors and the distortion of factor prices (such as energy, land and capital) will continue as long as the Communist Party believes that further withdrawal from these sectors and price liberalization will undermine its ability to influence the economy and maintain an expansive patronage system which benefits its supporters. Finally, good governance, measured in terms of adequate delivery of public goods and sound environmental stewardship, will be difficult to achieve without greater participation by China’s embryonic civil society and major social groups.