Implementing the Eleventh Five Year Plan (2006-10)

The Eleventh Five Year Plan for the period 2006-10, launched in early 2006, is the main formal vehicle by which the Chinese Government has attempted to address many of these issues. It outlines a vision of development that is socially and environmentally sustainable and that contributed to maintaining a harmonious society, and outlined broad programs to be implemented towards achieving such a form of development. As one observer has written, China’s Eleventh Five Year Plan proposals for the period 2006-2010 are remarkable: There emerges from this Plan document a rich and comprehensive vision of a sustainable development process in China, and a glimpse of the kind of government role that would be required by this development process. The vision is of a society that is more creative, more focused on human resource development, and treads with a lighter and more environmentally benign step (Naughton 2006, p. 9).

It is, even in an autocratic state, one thing to outline a vision of a sustainable economy and a harmonious society and quite another to define and implement a detailed set of programs to give effect to this vision. This is especially so in such a diverse, vibrant and internationally engaged society as contemporary China. The forces shaping the current growth pattern – from the role of local governments and the limited power of the central government, the strong influence of foreign companies and investors and the level of the exchange rate to the popular desire for a strong China and a better life – are complex and inter-related, and it will take a major effort to re-align them. Given the unprecedented nature of the changes taking place in China, and their integration into complex global processes, limited knowledge is available of the factors driving change and hence of the ways in which policymakers can intervene effectively to shape the pattern of change.

The Eleventh Five Year Plan does not commit to all of the elements distinguished in Table 3.1, although most elements are being addressed to some extent in government statements and policy initiatives. Four important objectives of current government policy as expressed in the Plan are as follows:

to make growth more sustainable and environmentally benign, and to reduce the rate of energy and water use, and of pollution;

to increase innovation within all sectors, including industry, and shift the pattern of activity from low value added output based on low labour costs towards higher value added activities based on knowledge;

to change the structure of growth towards the service sector, and accelerate the growth of particular service sectors that directly contribute to individual welfare; and

to improve the position of people in the countryside, and to build structures to ensure that the benefits of growth flow to people in rural areas.

It is not possible to explore all of these objectives in any depth in this report, and some aspects (agriculture, health and education) have been touched upon in Chapter 2. Here we comment on three matters critical to the implementation of such a revised approach – reducing the energy intensity of the economy, bringing about an effective change in fiscal priorities and finding the right balance between public goods and market processes in different sectors of the economy.

3.2.1 Energy Use and the Environment

As discussed above, after two decades in which China’s total energy use grew at only about half the rate of growth of GDP, over the past five years, energy use has grown at double-digit rates, implying an elasticity of energy use with respect to GDP of more than one. This explosive growth in energy use caught policymakers, energy analysts and energy providers in China unaware, power shortages began to develop in 2002 and a massive expansion in energy production capability has been put in train. However, the reasons for the abrupt shift in the elasticity of energy use are by no means fully understood, and as a result forecasts of the future level and pattern of energy demand cannot be made with much assurance. This limits the Government’s ability to intervene effectively, even though continued growth in energy use in line with the growth of GDP would, if it occurred, have major implications for China’s economy and environment, and indeed for the global environment.

This difficulty can be illustrated by developments in respect of energy consumption during 2006. In his March 2006 Work Report cited above, Premier Wen Jiabao made a key target for 2006 a reduction of 4% in energy consumption per unit of GDP. This meant that, on expected GDP growth in 2006 of 8%, the increase in energy consumption would be held to 4%.

On 31 July 2006, the government announced that in the first half of the year energy consumption had risen by 11.7%, relative to the same period of 2005, on GDP growth of 10.9%, so that energy consumption per unit of GDP had risen by 0.8% (NBSC et al. 2006). As a result, the government urged all regions and departments to adopt the energy-saving target, promote structural adjustment, to focus on energy-saving in key industries and enterprises, and generally to make great efforts to achieve the energy-saving target for the year (ibid). However, it is clear than that target for 2006 will not be achieved.

There is clearly a long road between the Government’s intention to move to a more sustainable growth path and the reality of changing the direction of the Chinese juggernaut. Limited knowledge of the drivers of energy use constrains the pace of change. Nevertheless, the economic and social pressures for reduced energy intensity and for an improved environment remain central realities in contemporary China.

3.2.2 Changing Fiscal Priorities within China: The Constraint of the Federal Structure If there is to be a change in the structure of growth to a more broadly based, sustainable form, which reaches people across the whole country, this is likely to require revised governance and fiscal arrangements. Effective change in development strategy needs to be driven by the central government. For this to be achieved in a decentralised, market economy appropriate instruments and incentives need to be in place for each level of government, as well as for the private sector. An important issue is the role of specific purpose payments to local governments in achieving the strategic objectives of the central government, and how such payments fit within China’s fiscal reforms.

The federal structure of China’s governance impacts strongly on these issues of strategy. Competition between local governments at various levels has been an important factor in, for example, uncontrolled and often sub-optimal expansion of energy intensive, polluting industries (such as aluminium smelting and some chemical industries), of inefficient forms of energy production (such as small, dirty coal mines) and of other industries not well adapted to China’s needs (such as large luxury cars). Expenditure at both levels of government is also heavily concentrated on capital formation and on capital transfers to the enterprise sector. Like many other federations, the Chinese federal system suffers from vertical fiscal imbalance, with the central government receiving 55% of budget revenue but being responsible for only 30% of budgetary expenditure. In particular, virtually all operating expenditure for health and environmental services and about 90% of such spending on education, is the responsibility of local governments. These issues, and their implications for the revision of the development strategy, are documented further below.

Table 3.2 Share of local government in total budgetary expenditure, China, 1995 and 2002

1995 2002

Selected functions Local government share of total expenditure (%)

Capital construction 52.0 60.1

Innovation 90.3 97.0

Science and technology 5.1 44.5

Enterprise support 19.2 11.1

Agriculture 89.2 89.1

Culture, education, science and health

(operating) 90.0 89.1

Government administration 92.0 83.4

Price subsidies 72.3 57.9

Urban maintenance and construction 100.0 100.0

Total 70.8 69.3

China’s current fiscal arrangements derive primarily from the fiscal reforms of 1994, which redefined the expenditure responsibilities of central and local governments and set up the new tax system (ADB 2005; OECD 2005b). In expenditure terms, while key items such as defence and debt servicing are retained for the central government and infrastructure is shared, most other major responsibilities such as health, education, urban maintenance and the environment, are the responsibility of sub-national, and to a large degree sub-provincial, governments. Table 3.2 summarises the position for major items in both 1995 and 2002, in terms of the share of total budgetary expenditure that is undertaken at the sub-national level. While the overall split of government expenditure remains about 70% local and 30% central, and the centre has a higher than average share in areas such as capital construction, science and technology and price subsidies, in the key areas of operating expenditure on culture, education, science, health and agriculture sub-national governments account for about 90% of the total. This lack of direct control reduces the ability of the central government to expand public spending in these areas, if this was deemed appropriate.

In Chapter 2 we noted the importance of private financing in health and education in China, and the rising reliance on private funds in education. These common trends in education and health – primary responsibility at the sub-national, and indeed sub-provincial level, concentration of government revenue sources at the central level and heavy reliance on private funding – are significant in shaping economic and social outcomes in China. On the one hand, these key services cannot expand as rapidly as China’s current circumstances and the needs of individuals require. On the other, the need for families to meet future commitments in relation to education and health contributes to an already high propensity to save out of household income, constrains access to these services severely and contributes to the growth of poverty in low-income families. These aspects of the current federal arrangements thus have a major impact on economic and social outcomes.

Figure 3.1 Components of public expenditure, selected countries, 2002, share of GDP

0 2 4 6 8 10 12 14 16 18

Sweden OECD Japan China

(% o f G D P )

Culture, education, health, science Public admin Capital formation and transfers

The other related aspect of spending by all levels of government in China is the heavy concentration on construction and related capital activities. This spending, while important in maintaining growth over the 1997-2001 period, is now clearly adding to the boom in the construction sector, and exacerbating problems in that area. Figure 3.1 brings out the extent of focus in public sector spending in China on capital formation and capital transfers to enterprises, especially in relation to key service sectors. For the OECD countries as a whole, public spending on culture, education, health and science is four times greater than capital spending (and 4.5 times greater in Sweden and 2.3 times greater in Japan, for example), whereas in China this spending is only 60% of capital spending. While the comparison with OECD countries is not entirely appropriate, these data are an indicator of the bias in Chinese public spending towards capital.

Thus the structure of China’s federal system has shaped the present development strategy and constrains changes to that strategy. To the extent to which this is so, changes to the arrangements of fiscal federalism – such as improved coverage of the personal income tax and the introduction of energy related taxes, both at the central level, together with revised arrangements through which the central government invests heavily in, and influences, education and health – could improve China’s ability to move to a revised development strategy, although there are many issues about how they might be implemented. Mechanisms by which the central government might also exercise greater direct influence on investment, energy and environmental decisions are also required.

3.2.3 Finding the Balance Between Public Goods and the Market

While China has achieved rapid growth in industrial output through the use of market processes, the application of such an approach in some service sectors has been less successful. The case of health is particularly relevant, for several reasons. Better health and longer lives are a main benefit to individuals of economic development, and also contribute further to growth. But market failures and information asymmetries pervade health provision, so that finding the right balance in the roles of the public and private sectors in health is a key issue around the world. In addition, biomedicine is now the focus of global technological change, even as many of China’s citizens lack adequate access to basic technologies.

Similar trends are also apparent in health, and reflect a reform in the health sector in 1996 aimed at establishing a market-based system. China’s total health spending of 4.8% of GDP in 2003 is a good deal lower than in OECD countries, but not far removed from that, on average, of other transition or developing countries. But what is distinctive about it is the very low share of government funding, only 0.8% of GDP or 17% of the total, and the heavy reliance on non-government funding, especially direct payments by individuals from their disposable income, which contributed 56% of total spending in 2003.