China has sufficient fiscal resources to afford the level and type of spending that would be commensurate with a harmonious society. But achieving this spending requires a major redistribution of resources, not just among provinces but also below
-1.5 -1.0 -0.5 0 0.5 1.0 1.5
-3
Investment climate index Harmonious society index
-2 -1 0 1 2 3
Figure 3.3 Relation between Investment Climate and Social and Environmental Conditions in China, 2005
Source:World Bank 2006.
Note:The harmonious society indicator is the average of normalized values of nine indicators: the percentage of days a city has good or excellent air quality; the percentage of females in total stu- dent enrollment; the share of permanent workers with health insurance; the percentage of indus- trial waste disposal that meets environmental standards; per capita green space; per capita spending on education; infant mortality; the rate of unemployment; and the annual average wage.
the province level. This reallocation of resources can be done only gradually. It must go hand in hand with a better specification of roles and functions of the various levels of government and stronger mechanisms for accountability, to ensure that poorer local governments use the resources given to them well.
Notes
This chapter is based in part on the forthcoming World Bank report Reforming Subnational Finance: Lessons from Northeast China, written by Dana Weist, Roy Bahl, Ines Kudo, Magnus Lindelow, Mei Wang, and Christine Wong.
1. China’s flow of fund accounts for 1996–2002 shows that taxes net of noncontribu- tory transfers—the amount available for government consumption and investment—
represented some 18 percent of GDP in 2002. This is comparable to Germany (18.6), France (18.3), the United States (17.9), and Japan (17.5). The authors thank François Bourguignon for the OECD data, which were taken from the OECD national accounts for 1994.
2. These countries’ regions are much smaller than the average province in China, and indications are that the smaller the subnational entity in a country, the larger the meas- ured inequality.
3. Half of this amount is owed to the center. Not all of the 14 percent should therefore be viewed as additional general government debt.
4. It is largely because of the extrabudgetary funds that the government sector in the national accounts is some 5 percentage points larger than in the fiscal accounts.
5. This extent of equalization may not be desirable from the perspective of incentives for revenue mobilization; an equal per capita amount may not necessarily equalize expenditure needs.
6. This by itself could be problematic, although many countries have similar arrangements (see Hofman and Manuelyan 1995 for a comparison between practices in China and other countries).
References
Hofman, Bert, and Susana Cordeiro Guerra. 2005. “Fiscal Disparities in East Asia: How Large and Do They Matter?” In East Asia Decentralizes: Making Local Government Work in East Asia.Washington, DC: World Bank.
Hofman, Bert, and Tamar Manuelyan. 1995. “Issues in Natural Resource Taxation.” In Reforming China’s Public Finances, ed. E. Ahmad. Washington, DC: International Monetary Fund.
Martinez-Vazquez, Jorge, and Jameson Boex. 1998. “Fiscal Federation in the Russian Federation: Main Trends and Issues.” Paper prepared for Economic Development Institute/World Bank, Washington, DC.
National Bureau of Statistics. 2005. China Statistical Yearbook. Beijing: China Statistics Press.
Persson, Petra, and Anna Erikson. 2006. “From Blind Pursuit of Growth to Balanced Development?” Department of Economics, Stockholm School of Economics.
Shah, Anwar. 1999. Expenditure Assignment. Decentralization Briefing Notes, World Bank, Washington, DC.
World Bank. 2002. China: National Development and Sub-National Finance: A Review of Provincial Expenditures.Report 22953–CHA, Washington, DC.
———. 2006. “Governance, Investment Climate, and Harmonious Society: Compe- titiveness Enhancement for 120 Cities in China.” Report 37759-CN, Washington, DC.
———. Forthcoming. Reforming Subnational Finance: Lessons from Northeast China.
Washington, DC: World Bank.
Fiscal Policy and Reforms:
Toward Realizing a Harmonious Society
TERESA TER
-
MINASSIANANDANNALISA FEDELINOC
hina’s macroeconomic achievements over the past two decades have been impressive. Since the late 1970s, when reform began, China has been the world’s fastest-growing economy, with real annual GDP growth averag- ing more than 9 percent.As a result, 400 million people have been lifted out of poverty, and China is now the fifth-largest economy in the world, accounting for 8 percent of world trade, up from less than 1 percent in 1979 (Prasad 2004). China’s success has been the result of a carefully crafted growth paradigm that has advanced the transformation of a state-planned system into a dynamic, private sector–led economy that is integrated into a globalized world.Notwithstanding these achievements, challenges remain. Income disparities, across provinces and between urban and rural areas, have been widening;
considerable horizontal and vertical fiscal imbalances have emerged across levels of government; and the provision of social services, once assigned to and delivered by the state-owned enterprise (SOE) sector, has lagged, as this sector has been undergoing restructuring as part of the transition to a market economy.
More generally, China’s growth model—based largely on export-oriented sectors and investment and centered, at least initially, in the coastal regions—has led to imbalances and exposed vulnerabilities that need to be addressed if China is to sustain its achievements.
Aware that China’s potential can be fully realized only if these challenges are tackled, the Chinese government is moving toward implementing reforms that aim to attain sustainable and equitable growth. Toward that end, the 11th Five-Year Plan, approved in March 2006, sets out a strategy to secure economic development that is “comprehensive, harmonious, and sustainable.” Policy priorities include
“accelerating the transformation of the economic growth pattern” toward growth that is less energy, resource, and capital intensive; more knowledge and innovation driven; and more equally shared, in particular by ensuring the creation of a new
“socialist countryside” through the improvement of services and infrastructure in rural areas. The government also intends to move away from excessive reliance on export-led growth toward self-sustaining domestic demand, which would require
4
household consumption to make a much larger contribution to growth. Within this new policy framework, fiscal reforms have an important role to play to rebalance growth and strengthen the provision of social services.
This chapter examines reform options and their implementation in the context of the current fiscal framework. It is organized as follows. The first section provides a general overview of recent fiscal policy, with a view to highlighting the main vulnerabilities and challenges ahead. The second section discusses the main tax policy issues, prospective reforms, and their implications. Major expenditure policy options are reviewed in the third section, including the planned strengthening of the provision of social services (health care and education) and social security. Reforming and introducing new spending programs will need to be supported by sound institu- tional arrangements, including appropriate budgeting and reporting mechanisms and the imposition of hard budget constraints at all levels of government; these and other public financial management reforms are covered in the fourth section. The last section concludes that the time is ripe for more decisive and coordinated action across the fiscal spectrum, building on progress achieved in specific reform areas.