The report China: Country Economic Memorandum-Promoting Growth with Equity, takes stock of China's performance and presents a set of policy options that could help accomplish China's objective of growth with equity. The report recommends policy actions centered on three themes: domestic market integration and flexibility, improving conditions for growth in the less developed regions and localities, and addressing the risks to future growth and distributional performance in China.

Yukon Huang, Director of the World Bank China Program said: "China's growth and poverty reduction performance have been excellent. Although some increase in income inequality is inevitable during rapid growth, China is now focusing more sharply on narrowing such inequalities and enhancing the quality of its economic growth. This is taking place in the context of globalization and rapid structural reforms. A movement to greater domestic market integration-to match the rapid global integration that is taking place-and to providing better social protection, human capital development and risk mitigation is needed to support the next stage of China's development process."

Large-scale poverty reduction has been one of China's greatest accomplishments during the post-1979 reform period. About 400 million people have been lifted out of poverty at the $1 a day expenditure level. Inequalities, however, have deepened as the distribution of income and opportunities has shifted in favor of urban areas and coastal regions, leaving rural areas and less developed regions farther behind. Distortions and rigidities remaining in the domestic market are partly the cause. The report suggests that, if recent trends in widening rural-urban inequality and the disparate growth of per capita incomes across provinces continue, income inequality would rise sharply, with essentially equal contributions to national inequality from the rural-urban and inter-provincial disparities.

Hana Brixi, leading author of the report said: "The Chinese Government has a unique opportunity and capacity to make China's expanding economic opportunities accessible to a larger share of China's population. For inhabitants of China's rural areas and less developed regions, migration and skills are the main route to better incomes. Productive jobs across China would be created more easily with effective market regulation and competition. The prospects of those who remain in agriculture will mainly benefit from better enforcement of land use rights and environmental law at the local level."

The report suggests that China needs domestic market integration and flexibility for both growth and equity reasons. It notes the following reasons: Although exports are likely to continue grow rapidly, more than 70 percent of China's output will still be intended for the domestic market by 2007. Obstacles to efficient allocation of labor and capital and to competition reduce the speed of technological upgrading and China's competitiveness in the global economy. Market integration and flexibility can ease the pain of restructuring and promote the flying geese pattern of industrialization. The results of domestic structural adjustment are more likely to be viable in the long term if they occur in harmony with broader market forces, both national and international. With respect to equity, migration is particularly important to narrow the farm/non-farm wage gap.

In this context, the report identifies the main problems in the form of: a) local government protectionism, which arises from local government dependence on own enterprises and local government control of market regulations, enterprise management and courts, and which fragments China's domestic market for goods and services; b) shortage of low-income housing in urban areas, weak execution of land use rights in rural areas, and the direct and indirect discrimination of migrants, which all inhibit migration; and c) government control over resource allocation and inadequate information on enterprise performance which inhibit efficient allocation of capital.

The report points out that achieving a better distribution of incomes and opportunities - the essence of a xiaokang society - depends on the creation of productive jobs, especially for people in the lagging regions and mainly within such regions, and on returns to farm labor. In this context, the report presents the government with a policy package focusing on five areas: investing in people, promoting the diffusion of technology, facilitating urban agglomeration, expanding services, and enhancing farmers' prospects.

As for financing this policy package, the report admits that the government's current fiscal position offers limited room for continuing fiscal expansion. Therefore, the role of the government in the economy needs re-examination to give greater play for other economic players, which would allow the aggregate amounts of public sector spending to remain unchanged while affecting its composition in a substantial way. The effort to promote high growth with equity in China is likely to be effective if the government focuses on the delivery of core public services, while being only indirectly, if at all, involved in commercial activity in the economy.

Finally, the report addresses the main risks to China's future growth and distributional performance. Gaps in social security may erode risk-taking in an increasingly market-oriented society and could undermine social cohesion and public support for further reforms. Inadequate delivery of public services in poor localities could constrain future economic growth. Macroeconomic risks - particularly financial sector vulnerability and government contingent liabilities - could escalate, raising uncertainty and exacerbating fiscal pressures.

To reduce the risks, the report suggests to expand the coverage of social security for the urban non-state sector and to offer some basic insurance schemes, such as protection against catastrophic illness and injury, for rural areas. With respect to overall public services delivery, the report points out that a comprehensive inter-government finance system reform is needed, along with some centralization in financing of core public services, such as education and social security, and with greater autonomy and accountability. To preserve macroeconomic stability, the report reinforces its case for reforms in the banking sector, which are needed before bank recapitalization is attempted. It indicates that such reforms, along with pension reform and adequate government attention to fiscal risk monitoring and management, can reverse the trend of rising government contingent liabilities and ensure future macroeconomic stability.

Homi Kharas, Chief Economist for the East Asia Region, reiterated that the purpose of the Country Economic Memorandum is to make an assessment of China's recent developments, and some of the major economic challenges for the medium-term. Periodic stock-taking exercises of this kind build on more detailed analytical and advisory work that the World Bank is conducting on China, in collaboration with the government and Chinese technical experts. They help in the design of future work, and also help to maintain a policy dialogue on China's development challenges.

(China.org.cn September 9, 2003)