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Learning from History

As the Chinese leadership sets out a new tranche of lofty development goals, a Peking University professor looks to the past for insights

By NewsChina Updated Dec.1

China has set the goals of achieving “socialist modernization” by 2035 and building a “great modern socialist country that is prosperous, strong, democratic, culturally advanced, harmonious and beautiful” by 2050. They were set out at the 19th National Congress of the Communist Party of China held in Beijing in October.
Looking forward 30 years, how will the efforts to achieve these goals affect life in China? What will drive economic and social development during this process? In an interview with NewsChina, Professor Yao Yang, dean of the National School of Development of Peking University, said a historical perspective, not only domestically but also internationally, offered profound insights into the future. He also explained what tasks must be accomplished during this journey to meet these long-term goals. 

NewsChina: The report approved by the 19th CPC National Congress set forth a two-stage development plan. The first is to take 15 years between 2020 and 2035 to build a “moderately prosperous society in all respects,” followed by another 15 years to build a “modern socialist China” by 2050. However, economic development, industrial transformation and technological progress all display cyclical changes. How feasible are these economic goals?
Yao Yang: I predicted last year that China would join the club of middle-income powers by 2035, and the high-income club by 2050. Even if China’s growth rate declines gradually to a similar speed to that of the US, China will still see its per capita income reach 45 percent that of the US by 2049. 
Why 45 percent? This is the threshold of a high-income economy. Thirty-six economies around the world have reached or surpassed this threshold so far, constituting what we call the high-income club. 
Because the US per capita income will be higher in 2050 than it is today, China will need to grow at a faster rate than the US to reach this 45 percent threshold, up from 25 percent in 2016. Even if China’s growth rate slows down gradually from 6.5 percent to two percent, which is the rate of growth in the US today, it will be no problem for China to achieve that goal by 2049. 
When China’s per capita income reaches 45 percent that of the US, China’s economy will be double that of the US in real terms [considering price changes], and even higher in nominal terms. This will change the world’s economic, political and military landscapes.  

NC: What specific achievements will be needed to build a modern China?
YY: The top priority must be a high-quality social safety net for all. Endowment insurance only covers three-fifths of China’s urban residents. There is a long way to go. 
The second is environmental protection. This means improving air and water quality to help the environment recover to 1980 levels by 2035.
Regional inequality is a problem yet to be solved. Per capita income in more developed coastal regions is 1.8 times that of the less developed mid-west. The gap is even bigger in terms of public services.
The urban-rural gap remains. Urban residents have a per capita income as much as 2.9 times that of rural dwellers – a decrease on five years ago, but nevertheless an alarming figure. And the gap is even bigger in terms of public services. Removing this gap is a major indicator of modernization.
NC: The CPC report vowed to deepen supply-side structural reform. What must be done now to drive reform in the long term?
YY: The first thing, I think, is to improve the structure of the economy by eliminating risks that could threaten economic expansion, like driving ‘zombie enterprises’ out of the market. The second is to create better conditions to facilitate market access and growth for innovation-oriented companies and start-ups. We need to lay a good foundation for an innovation driven economy. It is also important to improve legislation and law enforcement, for example in intellectual property rights.  

NC: What are the biggest problems still to be addressed following two years of supplyside structural reform?
YY: Supply-side structural reform involves five tasks: cutting excess capacity, destocking unsold housing inventory, reducing corporate debt ratio, reducing business operation costs and strengthening weaknesses [moving local manufacturing up the value chain]. The impressive progress on tackling overcapacity has relied largely on administrative tools dictating how much steel can be produced by which enterprises. In contrast, not enough proper policy tools have been found to reduce the debt ratio.
A historical view is necessary to help supply-side structural reform succeed in the way we expect. China has built up strong industrial and technological strength. The past two decades of rapid growth have created wealth for China the likes of which has never been seen in history. These elements combine to provide the foundation that China needs to lead the world in technology advancement.

Supply-side structural reform is supposed to remove systematic barriers that prevent China from becoming a world leader in technology. Critical to this reform is defining the government-market relations in the sector. Scientific and technological breakthroughs often follow huge risks. A market-oriented system is the best way to deal with such risks. 
China’s research institutes have a great deal of know-how. A lot has been achieved in the research part of R&D, but development lags far behind. The biggest barrier to development is systemic. Supply-side structural reform must address how to give the market full play in development. This does not mean that the government should do nothing. Rather, it should focus on promoting basic research.
Put simply, supply-side structural reform is intended to improve the long-term growth of China’s economy and empower technological innovation. It is much more than a tool for short-term economic adjustment. It will not work without boosting demand [consumption and investment].  

NC: The 19th CPC National Congress report vows to build an innovation-oriented country. What must be done to achieve this? 
YY: As I have repeatedly advocated since last year, China must do both disruptive innovation and evolutionary innovation. How? Again we can learn from history. The experience of German industrialization [before WWI] was applied to China for the 30-year planned economy that followed the founding of the People’s Republic of China in 1949. China started modernization efforts by building her industrial system and research results on the experience of Japan. Japan had followed the example of Germany [which rose to a power on the back of heavy industry and strong government intervention]. In the latter part of the 30-year planned economy, China resorted to the Soviet model, which had also learned from Germany. China’s economic system resembled Germany’s in those years as a result. This changed once China started to reform, and was attracted by the US model.
Chinese culture is more diverse and sophisticated than the American and German cultures. That means we can do both disruptive innovation, a model exemplified by the US, and the evolutionary innovation, a model represented by Germany. For example, the BAT firms [Baidu, Alibaba and Tencent, leading Chinese Internet companies] are typical success stories of disruptive innovation. For most Chinese companies, evolutionary innovation in the vein of German companies has focused on what is more feasible for progress. It means you can take a lead in the middle between the existing 1 and the endless possibility of N, instead of starting from zero. When innovation combines with the world’s leadership in high-end equipment manufacturing, disruptive innovation and evolutionary innovation become a perfect match.  

NC: How about China’s three main rural issues – agriculture, the countryside and farmers? What urgent problems do you think have to be put on the top of the agenda when it comes to revitalizing China’s rural areas?
YY: In my view, eliminating the urban-rural gap is the most difficult task. A lot of rural land has been left idle. Rural households are scattered around rural areas. Too many villages are nearly empty. Public services are inaccessible there. I would suggest that rural households be more centralized.
In addition, rural communities are poorly organized. Social and political structures in rural areas need to be rebuilt. 

NC: The 19th CPC National Congress reiterated its commitment to further reform State-owned enterprises (SOEs), including diversification of their ownership. What are your thoughts on SOE reform?
YY: It’s a very important part of China’s economic reform. Some Chinese SOEs still lack a modern corporate governance system, which has resulted in ineffective use of capital and talent in those SOEs. More diversified ownership is expected to improve the corporate governance and efficiency of SOEs by inviting private investment through shareholding. Although progress has been made in some places over the past few years, it is not going as well as hoped. The biggest reason is the high debt ratio of these SOEs.
By the end of June 2016, the ratio of total assets, US$19 trillion, to total liabilities, US$13 trillion, of State-owned and State-held enterprises in China stood at 66 percent on average – 15 percent higher than private enterprises with annual revenue of US$3 million on average. Although many SOEs have good products that sell, their profits are unable to service their massive debts, which are close to suffocating them.
The high debt ratio of SOEs did not come about overnight. SOEs succumb to the cycles of China’s macro-economy. Capital turnover was fast [companies are generating sales effectively from their assets], bringing the debt ratio down when the economy was expanding. This was the case for the decade from 2003, during which corporate debt ratios, including those of SOEs, fell in the face of rapid economic growth. However, the corporate debt ratio generally halted its decline, and the debt ratio of SOEs started to rise in 2012, when China’s growth began to taper off.
I have advocated transforming some corporate debts into equity as a way to reduce the excess debt ratio. If this is adopted to diversify ownership of SOEs, it could push forward SOE reform and lower the debt ratio, and it will also provide investment opportunities for private capital.
Various concerns seem to have hindered the implementation of the debt-to-equity policy. 
One is about the possible loss of State-owned assets during the implementation of the policy, and the other is that the policy may exempt SOEs from being held responsible for their bad performance in the past. I believe openness and transparency in the debt-to-equity process are key to avoiding these risks.
When banks sort through SOE debts for sale, the best way is to open the debts to bidding from private asset management companies. Enterprise assets belong to all of society, no matter whether they are in State or private hands. Too much emphasis on ownership only causes harm.
Moreover, the fact is that poor SOE performance is a result of poor policies of the past, and thus society will simply have to absorb the sunk cost. Improving corporate governance of SOEs by diversifying their ownership is definitely a crucial step toward preventing similar mistakes being made in the future.