Zheng Yongnian on what China needs to do for a domestic demand-driven society

The well-known professor deplores China's inadequate marketization, inefficient and monopolistic SOEs, unfair distribution, regressive taxation, etc.

As China confronts mounting economic challenges, the Institute of Public Policy (IPP), South China University of Technology, on Tuesday, July 25, shared an article by its academic leader Zheng Yongnian. The article is part of Professor Zheng’s book 保卫社会 Society Must Be Defended published in June 2016 and originally titled 中国建设内需社会需要做什么? What does China need to do for a domestic demand-driven society?

Below is a translation of the Tuesday WeChat blog post by IPP.

On July 24, the Political Bureau of the Communist Party of China (CPC) Central Committee on Monday held a meeting to analyze the current economic situation and make arrangements for economic work in the second half of the year. Regarding the present economic situation, the meeting pointed out that "China's economy has been continuing to recover, showing a generally upward trajectory," but “the Chinese economy is facing new difficulties and challenges, which mainly stem from insufficient domestic demand, difficulties in the operation of some enterprises, risks and hidden dangers in key areas, as well as a grim and complex external environment.”

Concerning the economic work for the second half of the year, the meeting stressed the importance of "focusing on expanding domestic demand, boosting confidence, and preventing risks, continuously propelling the economy towards sustained improvement, continuous enhancement of endogenous dynamism, sustained improvement of societal expectations, and sustained resolution of potential risks, to drive the economy towards achieving qualitative and effective improvements while ensuring reasonable growth in quantity.”

How can we better boost domestic demand in China? How can China achieve a structural transformation in its economic development? How can we establish a demand-driven society in China? Professor Zheng Yongnian has put forward a series of reform paths to these questions.

After emerging from the shadows of the 2008 financial crisis, the Chinese government has begun to intensify economic structural adjustments, aiming to achieve sustainable development through these measures. Although these adjustments cover various aspects, such as environmental protection and a low-carbon economy, their ultimate objective is to establish a domestic demand-driven society. Without such a goal, the efforts put into structural adjustments may yield limited results. China is the world's largest exporter, and efforts on promoting exports will continue, but the realization of a domestic demand-driven society becomes challenging if the domestic market remains undeveloped. Regardless of the success achieved in other areas, the absence of a domestic demand society makes it challenging to maintain sustainable development. More importantly, if the construction of a domestic demand-driven society is not effectively pursued, various social problems within Chinese society could worsen, thereby affecting both political and social stability.

In building a domestic demand society, China faces three major issues and tasks.

The primary issue is the rationality of the economic structure and the sustainability of economic development. China currently confronts a myriad of economic and social problems, most of which necessitate further development as the means of resolution. Without development, these issues are bound to exacerbate.  However, at the same time, the question of "What kind of development?" must also be addressed. Some forms of development contribute to problem-solving, while others not only fail to address existing issues but also give rise to new ones. As a widely acknowledged metric for economic growth, GDP itself is neutral. Nevertheless, the economic growth measured by GDP can exert either positive or negative impacts on socio-economic development. Positive development arises when GDP results from innovation in technology, innovative management approaches, and enhanced labor productivity. Conversely, negative development emerges when GDP stems from the destruction of society, such as the excessive commercialization of education, healthcare, and real estate. Clearly, China must pursue positive development and avoid negative development.

Overcoming the obstacles of inadequate marketization

Many measures can foster positive development.

In the economic field, it is essential to persist in reforms focused on deepening marketization. China confronts a challenge where there is insufficient marketization in the economic field while excessive marketization exists in the social sphere. The so-called "crony economy" stands as a significant barrier to inadequate marketization, particularly evident in the field of state-owned enterprises. 

The "incorporation" or "corporatization" of state-owned enterprises that began in the mid-1990s proved highly effective. However, due to a lack of sustained reform, large state-owned enterprises gradually transformed into entities enjoying certain monopolistic status, possessing independent decision-making capabilities, and leveraging powerful political and economic resources. In the absence of effective corporate governance reforms, state-owned enterprises have fallen under the control of multiple layers of state "agents". At the national level, monopolistic central enterprises have largely eluded effective state supervision and regulation. Ideally, state-owned enterprises should align their actions with the public interest, but the current state-owned enterprises no longer represent the public interest or the broader national interest. Instead, in many respects, public interest and the overall national interest go in opposite directions. To a significant extent, state-owned enterprises have undergone "privatization" in disguise, where agents of these enterprises operate with the primary goal of serving their personal interests. This pursuit of private interests is camouflaged under the guise of national interests. 

The labor productivity of state-owned enterprises is low. Their wealth accumulation relies on administrative monopoly and the use of state power and financial advantages to expand into other sectors and areas, resulting in today's situation where wealth is transferred from the people to the state (the state is rich, the people are poor), from the majority to the minority (leading to an increasing gap between the rich and the poor), and from the local to the central (the local is poor and the central is rich).

How can we break this vicious cycle? First, it is essential to establish clear boundaries for state-owned enterprises. Without proper boundaries, these enterprises are certain to abuse their power. In areas where private capital can operate effectively, we should encourage the involvement of private capital as much as possible, and let state-owned enterprises withdraw from those sectors. Additionally, fostering competition between different state-owned sectors and between state-owned and non-state-owned sectors is crucial. Only through competition can we drive improvements in labor productivity.

To facilitate competition, openness is imperative. Areas currently monopolized by state-owned enterprises must be opened to private capital. China currently faces a surplus of capital, with a substantial amount of private capital flowing aimlessly. Without providing new investment opportunities for private capital, it may enter sectors with significant political and social implications, such as the real estate sector, potentially having a negative impact on the normal social order.

Even for some sectors where it is necessary to retain a certain state monopoly, such as energy, electricity, transportation, and communications, participatory development can be achieved, such as allowing a certain proportion of private capital to enter. The current opening-up of state-owned enterprise is very unreasonable. The doors of state-owned enterprises are open to international investors but do not allow or restrict the entry of Chinese private capital. This is equivalent to international companies also using China's state power to obtain benefits in China but at the expense of China's own interests. In order to acquire technology and management experience, it is rational for state-owned enterprises to open to international capital, but China should not close its doors to its own private capital.

Addressing the Issue of Unfair Distribution

The second major issue is the sharing of economic development results.

If the results of economic growth cannot be shared by all people, income disparity will increase, and polarization will become inevitable. A highly polarized society will only fail to become a domestic demand-driven society, but it will also be a very unstable society. The existence of these two characteristics is itself a structural obstacle to sustainable economic growth. Historical experience shows that any consumption-driven society must possess a minimum degree of social fairness. From an economic perspective, this minimum degree of social fairness stems from society's sharing of economic development results.

China faces two major challenges in sharing economic results.

The first is the unfairness in primary distribution. China's guiding ideology for a long time has been efficiency in primary distribution, and fairness in secondary distribution. This is a huge mistake. The primary distribution is structural. If minimum fairness cannot be achieved in primary distribution, then no matter how hard China tries in secondary distribution, it will be futile. The Chinese economy obviously has many problems with primary distribution.

The first issue is the uneven development of large enterprises, especially state-owned enterprises, and small and medium-sized enterprises. The development of small and medium-sized enterprises is the most effective method to achieve fair income distribution. However, China's small and medium-sized enterprises, especially those in the private sector, have been discriminated against by state policies and regulations. Most of the advantageous resources and support policies of the state flow to large state-owned enterprises. For example, the majority of the 4 trillion yuan to deal with the financial crisis flowed to central enterprises and local governments, not benefiting small and medium-sized enterprises.

Secondly, there is excessive grey income within the state-owned sector. State-owned enterprises act like independent kingdoms, and many of them, although nominally state-owned and enjoy the administrative monopoly and financing advantages granted by the state, allow their executives significant freedom to dispose of enterprise income. Even within large and monopolistic state-owned enterprises with relatively high average income, there is a stark contrast between the high salaries and benefits of management personnel and the low wages and benefits of frontline workers. This not only creates inequality in society's distribution but also hinders the development of large state-owned enterprises themselves.

More importantly, laborers earn too little for their work. The government is more pro-business than pro-people. Particularly, the local governments that focuses on GDP growth, in order to attract investment, excessively lower various resource prices. Many local governments and capital have overly close relationships, often standing on the side of the capital, desperately suppressing workers' wages and welfare levels while disregarding the protection of ordinary workers' dignity and legitimate interests. This seems to help businesses in the short term, but in the long run, it hurts businesses because businesses can sufficiently suppress labor costs so there is the lack the incentive to improve technology and labor productivity. As a result, the government is helping businesses to maintain their low technologies. The Pearl River Delta is a typical example in this regard. It used low-tech migrant workers 30 years ago and is still doing so today. Workers' income growth lags far behind GDP output because there has been no technological progress. Today, the Pearl River Delta already feels overwhelmed and its development is unsustainable.

Secondary distribution is also important in sharing the benefits of economic development. China's current tax system is still largely regressive rather than progressive. Value-added tax and sales tax, as the primary taxes now, have limited effects on income regulation. As for direct taxes, the current situation is that the "personal income tax" threshold for ordinary workers is too low, while taxes on the wealthy, such as various wealth and property taxes, are either not yet established or cannot be collected. This leads to a situation where the rich consume excessively, and the poor consume insufficiently. Compared to income inequality, China's wealth concentration has already surpassed that of the United States. Private wealth is concentrated in the hands of a few, but the investment field of private capital is very limited, so it forms a blind flow of private investment, resulting in speculative private investments heavily focused on real estate or any readily available daily consumption goods, which disrupts market order.

Finally, there is also the issue of "privatization" of taxation. Tax collection is originally the government's responsibility, but many local officials use their power to oppress private investors, even using various illegal means to seek private gain. The "privatization" of taxation not only affects the country's tax revenue but also hinders the development of private enterprises.

Establishing Policies to Defend Society

The third major issue in establishing a domestic demand-driven society is the need to establish social policies.

Under the guidance of GDP-focused ideology, government at various levels have persistently blurred the lines between economic and social sectors, resulting in an excessive marketization of the social sphere. Due to strong resistance from state-owned enterprises with significant administrative and political power, Western-style neoliberalism has not been able to dominate the economic sphere in China. However, it has gained momentum in the social sphere, influencing areas such as housing, education, social security, healthcare, etc. These social sectors should have been supported by substantial government funding and protected by appropriate regulations and policies, but they have fallen into the trap of excessive marketization. The government not only failed to take on the responsibility of social protection but also introduced GDP-focused ideology into these areas, turning them into a few “wealthy” sectors of the Chinese economy. As a result, the marketization of these social sectors over the past decade has eroded the foundations of Chinese society, leading to countless social problems.

Without an effective society-defending mechanism, it is challenging to foster the growth of the middle class. The current situation reveals that the middle class is gradually being "proletarianized" under the burden of soaring housing prices. Without a robust middle class, how can we expect to have consumption and promote a "domestic demand-driven economy"? Clearly, the establishment of a domestic demand-driven society must first establish social policies that can defend the society.

Although relevant government departments are aware of these issues and have started to implement some policies, most policies still possess a piecemeal character, treating symptoms rather than causes. There are still no clear policy strategies for the coordinated development of China's economy and society, let alone practical and effective policies. Only when economic structural adjustment is considered in the context of China's overall societal development will China liberate its thinking, have effective policies, and generate sufficient policy momentum. (Enditem)

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