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Huihua Nie says Beijing must reate room for market and encourage births
The Renmin University Professor also advises Chinese youth to manage expectations, prioritize physical well-being, master English, and read more about history.
Huihua (Fred) NIE 聂辉华 is Professor at School of Economics in Renmin University of China (RUC). He got his degrees domestically and conducted postdoctoral work for a year at Harvard University under Professor Sir Oliver Hart, a Nobel Prize winner.
Below is a translation from the transcript posted on his WeChat blog.
Lack of Long-Term Vision in Fiscal Expenditures
The Paper: In recent years, the media has frequently reported on a peculiar phenomenon: impoverished counties, typically characterized by population outflows, are zealously engaged in large-scale construction projects. Some of these infrastructure developments far exceed the local developmental requirements, resulting in substantial debt accumulation. Many people question why local governments are so eager to implement such construction projects.
Huihua Nie: I believe that the massive buildup of debt by local governments mainly has two reasons—the "prisoner's dilemma" in their competitive environment and moral hazard. The prisoner's dilemma manifests as a situation where, compared to peer governments, those who refrain from going into debt end up at a disadvantage. The moral hazard is evident in the current officials depleting financial resources allocated for the upcoming years during their tenure.
Firstly, due to the inherent uncertainty in the tenure of local officials—despite the legal stipulation of a 5-year term—our statistical analysis reveals that, on average, County Committee Secretaries of the Communist Party of China (CPC) serve only 3 years, mayors and Municipal Committee Secretaries of the CPC serve for 2.8 years, and governors and Provincial Committee Secretaries of the CPC serve for approximately 3 years. Again, these figures are just averages. For specific officials, the uncertainty of tenure is even more pronounced. Officials have no idea when they might be reassigned, leading to a lack of long-term perspective in formulating local policies.
Of course, our institutional arrangement is primarily designed to prevent collusion between officials and local interest groups. Therefore, in China, officials at levels below the province, specifically at the city and county levels, cannot be natives of the respective areas. County Committee Secretaries, County Mayors, Directors of the Organization Department, Political and Legal Committee Secretaries, Discipline Inspection Committee Secretaries, Public Security Bureau Chiefs, Court Presidents, and Procuratorate Chief Prosecutors—none of these positions must be held by locals.
Such institutional arrangements, compounded by the uncertainty of tenure, have resulted in officials being less inclined to prioritize the long-term interests of the local community. If the tenure were fixed, it would be more manageable. Within a guaranteed five-year term, at least, development would proceed in an orderly manner, mitigating the risk of hasty decision-making.
Secondly, due to the reasons mentioned earlier, in practice, just like using short-term loans for long-term purposes, local governments direct a significant portion of financial resources to sectors that may not yield immediate returns. For instance, in the past, the focus of local governments was predominantly on GDP as the central metric for their initiatives, emphasizing profit-driven investments. Nowadays, local governments not only emphasize GDP growth but also consider other aspects such as environmental protection, culture, tourism, and comprehensive governance. In many cases, GDP growth is no longer the primary priority. This shift has diversified the competitive landscape among regions, introducing a broader set of criteria for comparison.
Take, a county that faces financial constraints, for example. Despite limited financial resources, it has invested significantly in dredging water channels and implementing greening projects along the roadsides. These expenditures may not offer immediate returns. It's not that environmental protection and greening are unimportant, but rather that local officials often prioritize their own political achievements over considering how to recover the expenses.
Normally, businesses adhere to the principle of balancing income with expenditure, but local governments often lack this sense. So, when you ask me why there is an imbalance in fiscal revenues and expenditures, the main reason is that many resources are not optimally utilized.
Why do localities face operational difficulties? Well, a big chunk of finance goes into repaying interest on municipal bonds. That is to say, local governments have borrowed a hefty sum for non-productive activities that don't bring in quick returns. Naturally, they find it tough to settle the interests in the short run. Plus, the interest rates on local debts are usually high, which means the available funds are mostly earmarked for servicing debt interest.
The competitive system among local governments has sparked a substantial increase in local debt. This surging local debt, undoubtedly, brings about financial challenges. Additionally, considering the current international geopolitical relations, it also affects exports.
The Paper: As discussed earlier, many regions are currently facing financial difficulties. You also mentioned publicly that developed areas are implementing salary cuts, while less developed regions are defaulting on payments. In a few economically challenged regions, public servants even have to take loans to cover their own salaries. In this situation, how can localities ensure their basic operations?
Huihua Nie: Faced with financial difficulties, governments at all levels should ensure basic living needs are met, government employees' salaries are paid, and normal government functioning is maintained “三保”. They must find viable means of raising funds while tightening their belts. This involves:
1) Increasing revenue through borrowing money, defusing debts, or selling state-owned assets.
2) Cutting expenditures by downsizing and reducing public spending (such as suspending public transportation, among other measures).
To secure funds, governments can borrow money from the their treasury departments, higher-level departments, banks, and local state-owned enterprises, prioritizing the payment of civil servants' salaries. According to incomplete statistics, China's central and local treasuries currently supports over 80 million people, with their salary accounting for over 40% of national tax revenue.
The Paper: This year, regions across the country are actively engaging in large-scale investment attraction. Does this signify a gradual shift of focus in local work back towards prioritizing economic development?
Huihua Nie: From my observation, no. It's simply due to local governments facing financial constraints and struggling to maintain their basic operations. It's not that they have suddenly deemed GDP more important.
The Paper: You mentioned that since the 18th National Congress of the CPC, the system for assessing officials' performance has gradually shifted from outcome assessment to process assessment, and accountability-driven mechanisms have replaced performance-driven ones. While there is still room for innovation at the grassroots level, the associated risks have increased. Why has this change occurred?
Huihua Nie: Firstly, there are technical reasons behind this shift. Digital technology has reduced information asymmetry, instilling greater confidence in the "central planners." This is evident in the article "Grassroots Officials: Land Consolidation, I Can't Even Convince Myself."
(Note: Since 2019, nationwide efforts have been underway to more effectively protect arable land and ensure food security. This involves rectifying the outflow of arable land, combating various illegal land occupation activities, and guaranteeing the quantity of arable land. The primary method employed is the use of satellite images to determine changes in land use. Specifically, arable land on satellite images appears green, and any construction work or changes to other uses result in the image changing to a soil yellow color. When there is a change in a particular area, the system automatically extracts the plot. These satellite images are then distributed to the grassroots level, where enforcement is carried out based on the information from these images. The determination of whether it is arable land relies on statistical data from the Second National Land Resource Survey in 2009 and the Third Survey in 2019.)
Secondly, governance reasons contribute to this change. China has strengthened its central authority, reduced the significance of economic indicator assessments, and emphasized national security. Assessments of the process heavily rely on technological means and follow the Weberian bureaucratic system, with the precondition that the direction is correct. However, they do not strongly encourage local innovation.
Population is the Key Factor for Sustaining China's Economic Growth.
The Paper: A large, highly skilled, and qualified workforce plays a pivitol role in sustaining the growth of the Chinese economy. Nevertheless, concerns have arisen due to the diminishing working-age and overall population. Many fear that prolonged demographic decline might impede economic growth. What is your stance on this matter?
Huihua Nie: Over the past four decades, China's enduring economic growth can be attributed to two primary driving forces—a plentiful population of young and middle-aged individuals and China's integration into the global division of labor. Notably, these two factors are interlinked.
Because of China's abundant young labor force and the advantage in labor-intensive industries, coupled with the global demand for a world factory specializing in labor-intensive production, the international division of labor has been a natural fit for China.
During that era, China strategically aligned itself by leveraging the abundance of its workforce at the right moment. The two factors were intricately connected, as substantial labor resources were crucial for integration into the global trade system. However, the dynamics of both factors are currently undergoing changes.
1) The labor force is rapidly declining, with both the overall population and the working-age demographic decreasing—a matter of significant concern. I firmly believe that the population issue is China's most critical "gray rhino," yet it lacks sufficient attention from the relevant authorities.
2) The international environment is exceptionally challenging, less favorable than before. We are facing new challenges such as decoupling and supply chain disruptions.
The Paper: Regarding the population issue, what specific recommendations do you have?
Huihua Nie: There are various ways to boost population growth, such as improving social support for childcare, reducing occupational discrimination, and promoting flexible employment. To encourage childbirth, the government should first motivate individuals in government agencies, state-owned enterprises, and public institutions to have more children. If these people lack the desire to have children, who else would? Teachers, a significant group within the system, provide an opportunity for a cost-effective initiative. For all female teachers, delaying the performance assessment by one year for each additional child they give birth to can be implemented without spending any government money. This practice is common in European and American countries but is absent in Chinese universities. It doesn't require financial spending; it simply needs the implementation of relevant policies.
Therefore, if the population continues to grow, the economy will naturally thrive, and China's debt is fundamentally not a problem because our total debt is not excessively high. However, if the population shrinks and the economy declines, it's going to be very tricky. This principle applies to personal purchases of treasury securities or national debt. If the country's population increases and is passed down from generation to generation, the economy can sustain growth. Inter-temporal value exchange is the essence of financial dynamics. If contemporary people borrow and repay within the same generation, it is not even considered debt and lacks financial attributes.
The Paper: Can debt be understood as an expectation for the future?
Huihua Nie: Debt essentially functions as an intergenerational inheritance contract, symbolizing a value exchange spanning across time and space. For instance, if I borrow money this year and repay it in three years, it inherently extends into the future. Nevertheless, we cannot close the door for future generations, depleting the capacity for borrowing across time, especially when the population is no longer increasing.
We conducted a survey and found that nearly half of our counties have stagnant populations. While the population growth in these counties remains stagnant, the total number of personnel supported by the local treasury, although not increasing, is also unlikely to decrease significantly. Therefore, their finances face significant challenges.
About 90% of county areas are experiencing a net outflow of population. I'm saying the situation in counties, not districts [in China, districts are urban units of a city/municipality, while counties are rural units of a city/municipality.]. So, this is indeed a very troublesome situation.
Reducing Government Intervention in Enterprises
The Paper: Every year, you and your team assess the business environment in key cities nationwide. When it comes to evaluating the business environment, what factors do you consider to be the most critical references?
Huihua Nie: The quality of the business environment is essentially determined by the degree of government intervention in businesses. To illustrate, in Shenzhen, it's often likened to the experience of ordering food in a restaurant. The government is comparable to the restaurant owner – if the food is unsatisfactory, you notify the owner. On the other hand, if the food is excellent, there's no need to involve the owner; you can simply settle the bill.
In essence, an optimal business environment is achieved when the government intervenes when businesses genuinely need assistance and remains inconspicuous when businesses are self-sufficient. To illustrate this, I borrow from Daoist philosophy, specifically Laozi's words: "The best leaders are those the people hardly know exist. The next best is a leader who is loved and praised. Next comes the one who is feared. The worst one is the leader that is despised."
Simply put, the best relationship between businesses and the government is when businesses operate seamlessly without even being aware of the government's intervention. In a slightly less ideal scenario, businesses actively engage with and appreciate the government, as it results in favorable outcomes. The next level involves a healthy respect and, at times, fear of the government by businesses. The least favorable situation is when businesses and the government are in direct conflict. Unfortunately, in many instances, we have not yet achieved the highest level of this ideal state.
Therefore, when assessing the business environment of a region, the key factor is the extent of government intervention in businesses. Generally, the less intervention, the better the business environment.
The Paper: Can property rights protection also be considered a form of intervention?
Huihua Nie: Intervention occurs when the government exceeds the normal scope and imposes excessive regulations on businesses. The key responsibilities of the government are to respect property rights and protect competition. These are fundamental duties that the government must fulfill. Beyond these aspects, the government should minimize interference as much as possible.
But in many places, the government may exert excessive control. For example, in a vice-provincial-level municipality (mostly provincial capitals or megacities in big provinces), a sub-district office, two low-level officials possess the authority to mandate that all shops on a street replace their signs with a standardized, but horrible design. Just how ugly is it? Picture this—every shop name is rendered in uppercase Pinyin, accompanied by a small line of Chinese characters underneath. Imagine the scene! Despite businesses expressing dissatisfaction, they find themselves powerless to resist.
The Paper: We often hear the phrase "investment does not go beyond the Shanhai Pass," indicating that as one ventures into the central and western regions, the business environment might face more challenges compared to the eastern coastal areas. What causes this phenomenon? Is it due to the superior endowments of the eastern regions in comparison to the central and western regions?
Huihua Nie: Not entirely. Based on my research, a fundamental conclusion is that the business environment is influenced by two conditions: economic foundation and the government having long-term expectations.
Regarding the first condition, a region with more businesses tends to have a better overall business environment. Let me illustrate. If you have a flock of sheep, each sheep needs only a bit of wool to be sheared, and that's sufficient. But if you have only a few sheep, you might aggressively shear their wool and keep a close eye on them to prevent them from escaping. Similarly, whether a government fosters an environment of abundance or exploits limited resources depends not on the competence of local officials but on the overall circumstances. A favorable business environment indicates that there are more "fish" (businesses) in the local "waters".
The second condition is that the government needs to have long-term expectations. If the government anticipates that the nurtured fish will be theirs in the future, they are likely to cherish and protect it. On the contrary, if the government has low expectations and is uncertain about the future, it might opt to consume the fish without consideration for long-term sustainability. We have an article that attempts to illustrate these two principles. Underdeveloped regions often share similar characteristics. Therefore, when examining the western and northeastern regions, we observe that places with poor business environments exhibit common traits. The claim that "investment does not go beyond the Shanhai Pass" is somewhat exaggerated. In fact, in terms of economic development, the three provinces in the northeast of China (Heilongjiang, Jilin, Liaoning) are not relatively poor nationwide but at a moderate level. When considering per capita GDP, many places in the northeast even outperform my hometown, Jiangxi.
The Paper: Nowadays, the job market in big cities is not living up to expectations, leading many young people to opt to return to their hometowns while awaiting employment opportunities. There's also concern about the potential emergence of social issues if they remain unemployed for an extended period without a stable income. How can this challenge be addressed?
Huihua Nie: The high youth unemployment rate is also irreversible. Economic studies suggest that when someone remains unemployed for a year, they are prone to missing out on more job opportunities and becoming socially isolated. A high unemployment rate discourages ordinary people from having children, creating a vicious cycle. This is indeed a pressing issue. Solutions need to be multifaceted: enhancing the social security system to offer a safety net for individuals and families, actively fostering the growth of the private sector, promoting participation in the gig economy, and encouraging individuals to start their own businesses.
The Paper: Some also believe that the main reason for the current slowdown in China's economic growth goes beyond cyclical factors and involves deep-seated structural issues, such as market confidence. If you view policy uncertainty as the primary factor, then it's clear that relying solely on traditional countercyclical measures might not be enough. So, how should we address this?
Huihua Nie: A lack of confidence stems from policy uncertainty, mainly concerns about the overall direction of the country and the international environment. What to do? Internally, continue to emphasize "pursuing economic development as our central task," avoid over-securitiztion of issues, and boost confidence in private enterprises. Externally, improve the international environment – the more friends, the better; the fewer enemies, the better. The key is to handle China's relations with the United States, Europe, and Russia well.
From a broader perspective, there is a rising skepticism regarding the commitment to a market economy and the continuation of the policy of reform and opening up. Some have even proposed the nationalization of all private enterprises, and there are voices advocating for the retreat of private economies. This is the least desirable scenario, as China has already undergone 45 years of reform and opening up.
During the economic challenges of the 1990s, the situation was even more difficult than it is now. The three-year reform of state-owned enterprises in 1998 was an exceptionally tough period, with many people facing layoffs. Did people doubt or waver? No. That's because everyone understood that the course of market-oriented reform was right and should be upheld.
In terms of specific policies, there have been significant fluctuations. For example, in the past, when there was a shortage of pork, there was encouragement to increase pig farming. However, pig farming often leads to environmental pollution. Consequently, the relevant authorities ceased approving land for pig farms. Later, when there was another shortage of pork, the encouragement to establish pig farms resurfaced. For market participants, the dilemma arises: should they venture into pig farming or not? If initiated today, and in the future when pork becomes plentiful, pig farming might be deemed a violation of regulations.
Therefore, I suggest that in the post-pandemic era, more freedom should be given to society and the market to recuperate. In other words, the government should reduce regulatory burdens imposed on market participants to increase economic vitality. The Chinese people are diligent, and whenever there is a glimmer of hope, they will exert their full efforts to make a living. If there are issues with economic growth today, it is undoubtedly because our people lack the opportunities to make a living.
The Paper: How should young people navigate the challenges of the current uncertain environment? Do you have any suggestions?
Huihua Nie: I do have six recommendations for them: manage expectations; hone their skills; prioritize physical well-being; value time; master English; and read more about history.