Reform of Public Finances is a Must

Whether the US quantitative easing is to continue (and now the US Federal Reserve says it is), Chinese shares are most likely to experience a small high tide between now and the third plenary session of the Communist Party of China Central Committee scheduled for November.

Many expectations have been built up since mid-March, when a new cabinet replaced an old one remembered more for its huge stimulus to the State-owned enterprises during the world financial crisis than for many reform efforts.

Some people expected quick results: a new overall reform strategy; a comprehensive urban development program in which up to 200 million migrant workers and their families are to be settled in their adopted cities; a reform in public finance, especially the redefining and sharing of financial powers between central and local governments (and a solution to the mounting local government debt); reform of the domestic stock market; reform of the land system and urban residential housing program; an effort to narrow down the gaping income discrepancy between the rich and poor (along with a new tax scheme); reforms in public health, social security, education, and in virtually all things.

There were reports, now and then, that the top-to-bottom design of such-and-such a reform was ready and would soon be made public after the leaders signed their names to it. And now and then, the naivety was dampened by the simple reality that no government in the world could have undertaken so many innovative efforts at once, far less take on a single effort that easily.

The thing that has been talked about most often seems to be urbanization, although the definition of the word may differ widely between central and local governments.

The central government's intention is that urbanization can usher in all sorts of changes that one can expect from an enlarged urban society, including consumer demand to drive the economy's further growth. What the local governments can see is primarily the mark-up they can make by auctioning out suburban farmland to real estate developers.

The different definitions of urbanization point to another reform, namely the re-division and rebalancing of financial resources and responsibilities between central and local governments.

It seems that things have begun to change in this direction recently. The need for an overhaul of the public finance system has stood out, as reflected by mounting government debt. A hefty part of the debt has been accumulated by local governments in projects that they started with the revenue from land auctions.

They cannot refinance the projects unless they can continue to sell land, because they do not know for certain about their share of the tax collected by the central government and they are bound by a well-developed set of budgetary disciplines.

It is not an exaggeration to say that a lack of central-local division of financial powers is the cause of many problems in this society - social, economic and even those of official corruption. Not many people realized this, because for years those problems were dealt with by separate bureaucracies as if they were unrelated to each other.

However, on the financial websites, more and more commentators have been saying that the focus is to be on public finance reform. One example comes from Li Yang, a leading economist at the Chinese Academy of Social Sciences, who said he would expect the coming CPC Central Committee plenum to address the imbalance between the local governments' responsibilities and resources.

Indeed, public finance reform is perhaps more important than progress in any other reform. If any progress in this reform can be delivered by the top decision-makers' meeting in November, it would be a great service for the country and for investors.