China economy at crossroads after 30 years of reform

BEIJING - Who would have thought a few months ago that China might end up remembering 2008 not for the Beijing Olympics or May's Sichuan earthquake but for the demise of the country's model of economic development?

Might is the operative word. China's attachment to investment, exports and heavy industry runs deep.

After all, these have been the drivers of the remarkable growth of 10 percent a year that China has enjoyed since it embarked on market reforms 30 years ago this month, lifting hundreds of millions of people out of poverty in the process.

Weaning the economy off exports in favor of domestic consumption driven by services is easier said than done.

But the closure of thousands of factories as export demand evaporates has dealt a serious blow to China's confidence. President Hu Jintao has gone so far as to say that turning the challenges posed by the global credit crisis into opportunities would be a test of the Communist Party's capacity to govern.

China, in short, realizes it needs to stand on its own feet.

So expectations are running high that a meeting starting on Monday of China's top leaders to chart economic policy for 2009 will finally get serious about boosting home-grown spending.

The scale of the task is daunting. Household consumption last year made up just 35.3 percent of China's gross domestic product, a record low for a major country in peacetime. In the 1980s, it was over 50 percent.

By comparison, the U.S. ratio last year was 72 percent. If America spends too much for the sake of global economic balance, China has taken thrift to new extremes. That needs to change.

Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong, cites the pending nationwide expansion of a scheme offering a 13 percent tax break to rural buyers of televisions and washing machines as evidence that China is already looking to tap its own potential.

The initial pilot program in a handful of provinces led to a 40 percent increase in sales of household appliances.

"The fact manufacturers are turning to Chinese villagers rather than American consumers is a symbolic milestone in the global rebalancing story," Simpfendorfer said.

"This is a slow burn story. It won't save the global economy from its current problems. But it may help to shape the global economy over the next decade," he added.

GETTING READY

Raising the income tax threshold; pay rises for state workers; increases in housing subsidies and minimum income support; and extra outlays on health, pensions and education are among other ideas this week's strategy sessions will examine to get people to spend more freely.

But, skeptics ask, if Beijing is so serious about increasing disposable incomes, why is the state budget for health care and education so puny? These are the two largest out-of-pocket expenses for most Chinese.

Public spending on health care and education comes to just 1.8 percent and 2.5 percent of GDP respectively, well below the global average. And only 1 percent of China's new 4 trillion yuan ($586 billion) stimulus plan is earmarked for the two sectors.

One of the rationalizations is that China has not had the bureaucracy in place to ensure extra money is used wisely.

It's easy to pour concrete to build a clinic. It's tougher to train doctors and nurses and administer a medical insurance scheme across a sprawling, developing country -- to say nothing of making sure the money is not siphoned off.

But Calla Wiemer, a visiting scholar at the University of California-Los Angeles Center for Chinese Studies, says China has made notable progress in recent years by shifting responsibility for the delivery of social services from towns and villages to the county level, where personnel are better trained.

By last year, 86 percent of rural counties had established cooperative medical schemes, she said in a recent opinion piece.

"While these have not been ambitious in terms of the dollar amounts -- the level of coverage is typically under $10 per person per year -- they've contributed importantly to administrative capacity building," Wiemer wrote.

SPENDING, NOT STEEL

David Dollar, head of the World Bank office in Beijing, makes a similar point.

"The institutional structures are in place so that the government could increase spending quite significantly and quite effectively," he said. "It would be both good fiscal stimulus and it would help with the whole social development agenda."

That sounds like common sense, but some scholars wonder whether China has the political set-up needed to accommodate a switch from infrastructure to social spending.

Zhiwu Chen, a finance professor at Yale School of Management, argues that returning money to the people -- through lower taxes or spending on social programs -- is not a priority in China because its leaders do not have to stand for election.

This explains not only why democracies such as Brazil and India lag behind China in infrastructure but why China's economic stimulus package is concentrated on road and rail building.

"In a non-democracy, officials are held accountable to their superiors, not voters. And for one's superiors, tangible projects are the easiest to recognize," Chen said in a syndicated column.

For 30 years, concentrating resources in the hands of the government through state ownership and taxes has served China well. But the private consumption needed to power self-sustained growth is lacking. For that, Chen argues, China must boost incomes and increase people's sense of financial security.

"Building a nation demands more than steel and concrete," he wrote.

(Reuters)