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Reforms to Public Finance Key to Sustained Progress

China, the world's fourth-largest economy and third-largest exporter, requires reforms to government finance to meet its dynamic needs, says Public Finance in China: Reform and Growth for a Harmonious Society, a new World Bank book.

China's growth rate of about 9 percent a year over the past decade helped reduce its poverty rate from 60 percent of the population to less than 10 percent today. However, such rapid growth has increased inequalities in income and access to basic services, and strained natural resources.

In its 11th Five-Year Plan (2006-10), the government seeks to resolve these issues by shifting priorities from the overriding pursuit of growth to more balanced economic and social development—an undertaking that will require strengthened public finance.

In the new book, policymakers and academics explore the many dimensions of public finance, from fiscal reform and revenue assignments to fiscal transfers, delivering public services, and maintaining growth and tackling inequality. The editors are Jiwei Lou, former executive vice minister of Finance and currently chairman of China Investment Corporation, and World Bank Senior Economist Shuilin Wang.

"Contributors to this book include some of China's most important economic reformers – people who actually designed policy during the country's successful emergence. This book represents an excellent example of how China takes active policy debate and follows it up with experiments on the ground," said Jim Adams, World Bank Regional Vice President for East Asia and the Pacific.

As China transformed from plan to market, the separation of enterprise budgets from government budgets and the shift in responsibility for providing social goods from firms and other units to the governments marked a profound shift that was not always smooth.

For example, public spending on health as a percent of GDP and limited social insurance coverage for rural inhabitants and migrants have meant that China's health and social services improved just moderately in the past quarter century. More revenues will be needed to tackle these challenges, as well as an anticipated spike in pension payments as the population ages.

In China, where social security, education, public health, and justice are largely decentralized, intergovernmental relations and fiscal transfers are vital. The authors argue that improving the efficiency of these transfers will require getting more resources to local governments while keeping them accountable to communities.

"A key lesson learned in the fiscal reform process was that a well-developed fiscal system at the sub-provincial level is indispensable," explains Mr. Lou in the chapter on intergovernmental fiscal relations.

Regarding public services, the authors call for the government to move from being the controller and sole provider to being the architect, coordinator, and quality assuror. The book cautions that expanding and improving China's education, training, and retraining system will entail about 6 to 9 percent of GDP, which is beyond the scope of government finance. Filling that finance gap will require building broad partnerships and multiple pathways to tap different financial sources.

Another major challenge will be to overhaul China's inadequate health care system via staged reforms, ultimately adopting a universal basic medical care system, the book says.

Acknowledging that China's resource-intensive growth pattern of the recent past cannot be sustained, the authors explore how the country's medium- and long-run growth and firm competitiveness will be linked to innovation and technological capability. This will require better allocation and monitoring of direct public R&D. It also requires viable ways of supporting private sector R&D.

Former World Bank Chief Economist Francois Bourguignon notes that the rise of inequality in China since the 1990s – for example, between cities and the countryside and between the coastal areas and inland provinces – is similar to that of the Western developed nations in their initial growth stage. Bourguignon discusses possible lessons from the Nordic countries while exploring innovative policies appropriate to China's vast circumstances.

Policy actions that move people out of poverty are already being implemented, for example, 'Di Bao,' an urban minimum living standard guarantee program. The authors describe this program as a good starting point from which to create a full social insurance system that preserves market incentive. In addition, they argue that steps like guaranteeing equal access – to education, health care, credit, and decision making about public goods – are essential to helping people fully realize their economic potential.

"The authors should be highly commended for their deep understanding of China's financial, economic, and social issues. This book will no doubt greatly promote the further exchange of ideas on these important topics," noted Jinglian Wu in his endorsement to the book. Mr. Wu is the vice chairman of the Committee for Economic Affairs, National Committee of the Chinese People's Political Consultative Conference, as well a senior research fellow at the Development Research Center of the State Council, Beijing.

(China Development Gateway February 1, 2008)

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