Huang Yiping on reduced local government roles and market-oriented reforms
PKU National School of Development Dean says centralised coordination and restricted local government resources might facilitate marketisation and address overcapacity.
Below is a speech at the National School of Development (NSD), Peking University, on September 9, 2024, by Huang Yiping, Professor and Dean of the NSD.
The NSD published the Chinese transcript in its WeChat blog on December 2, 2024.
黄益平:地方政府角色转型与经济政策新导向
Huang Yiping: The Transformation of Local Governments' Roles and the New Direction of Economic Policy
New Policy Signals from the Third Plenary Session of the 20th Central Committee of the Communist Party of China (CPC)
A careful study of the documents from the third plenary session of the 20th CPC Central Committee reveals three important policy signals:
In future financing activities in the market, projects involving government credit and state-owned assets should be coordinated at the central level.
The central government should refrain from directly delegating responsibilities to local governments unless accompanied by corresponding fiscal revenue adjustments.
Local governments' investment attraction activities should be regulated, with a particular emphasis on prohibiting subsidies that are non-compliant with regulations and laws.
These three policy signals, taken together, are a direct response to some of the challenges currently facing the Chinese economy.
Looking back at the history of reform and opening up, local governments have consistently played a crucial role in China's economic development. The third plenary session of the 11th CPC Central Committee, held in December 1978, is widely considered the starting point of the reform and opening up policy. However, the terms "reform" and "opening up" were not mentioned in the communiqué of that plenum. The most significant proposal was the shift in focus from class struggle to economic development, with the specific goal of improving work efficiency by enhancing the initiative of local governments, enterprises, and workers.
In hindsight, many scholars consider "administrative decentralisation" to be one of the key successes of China's economic reform. This process involved transferring economic decision-making authority from the central government to local governments. The shift significantly enhanced local enthusiasm and provided a major boost to the economy. Local governments, in making decisions, were better positioned to align with regional realities, optimise resource allocation, and respond more flexibly to emerging economic conditions. As a result, both work efficiency and economic performance saw marked improvements.
Moreover, in the first few decades of reform and opening up, local governments played a highly proactive role in driving economic growth. Research by Professor Li-An Zhou and others from Peking University's Guanghua School of Management uncovered a unique phenomenon among local governments in China—the "GDP tournament." The logic behind this is that the growth rate of local GDP increases the likelihood of local officials receiving promotions. This has fostered intense competition among regions, with local government heads effectively becoming the CEOs of their local economies, striving to outperform both past economic performance and that of neighbouring regions. As a result, this tournament-styled competition became a key driving force behind China's economic growth over a prolonged period. Therefore, the positive impact of administrative decentralisation in stimulating economic growth is an undeniable objective fact.
The policy signals from the third plenary session of the 20th CPC Central Committee, mentioned earlier, must be understood in the context of the current economic reality. The policy regarding financing being coordinated by the central government primarily pertains to fiscal revenue distribution. The effort to prevent the central government from arbitrarily increasing burdens on local governments relates to the allocation of administrative responsibilities. Meanwhile, standardising investment attraction addresses the specific methods of resource allocation to support economic activities. These points suggest that the economic landscape has evolved, and the primary contradictions have shifted as well.
The Historical Role and New Challenges of Local Governments in China's Economy
A significant change currently is the evident weakening of local governments' financial capacity, with many local finances being stretched thin. The reasons behind this phenomenon are complex, but they are closely linked to economic system reforms.
Since the reform and opening up in 1978, China has undergone a profound process of decentralisation. Thanks to the decentralisation of fiscal revenues, local governments' financial capacity reached unprecedented levels in the early 1990s, while central finances remained relatively weak. In response to this imbalance, the tax-sharing reform was introduced in 1994, with the core goal of re-centralising a significant portion of fiscal power to the central government. This reform aimed to strengthen the state's macro-management capabilities and enhance the effectiveness of transfer payments to local governments. At the time, this move was seen as a necessary step to maintain national unity and ensure economic stability.
However, over time, the drawbacks of the tax-sharing reform became more apparent, with the most prominent issue being the mismatch between local governments' fiscal capacity and administrative responsibilities. Many local governments face the dilemma of having significant responsibilities but limited fiscal power, which has greatly affected their ability and efficiency in fulfilling duties. There have even been instances where the central government issued documents increasing responsibilities for local governments, but the corresponding funding was not provided, further exacerbating local governments' financial pressure.
At the beginning of my career, when I joined the Rural Development Research Centre of the State Council, my first task was to study and analyse the then-existing grain procurement and sales system—the "unified procurement and sales system." This historic economic policy may be unfamiliar to many young people today, but it is well remembered by the older generation. In essence, unified procurement and sales meant that the State Administration of Grain was responsible for the centralised procurement and distribution of grain. The underlying motivations for this system are quite complex, and Professor Song Guoqing [Professor at the NSD, Peking University] has offered unique insights into this matter.
Looking back to 1986, the unified procurement and sales system faced a major challenge: during the process of reform and opening up, the grain procurement price continued to rise, while the sales price remained unchanged. This phenomenon is not difficult to understand in the context of the time: the goal of raising procurement prices was to incentivise farmers to increase production, while the inability to raise sales prices stemmed from urban residents' incomes not having increased sufficiently. As a result, an inverted grain market emerged, where the procurement price was higher than the sales price. The subsidy burden arising from this was primarily borne by local governments.
Although this case is now a thing of the past, the fiscal difficulties and coping strategies it reflects are still frequently seen today. Especially in the past decade or so, local governments, faced with limited fiscal capacity and heavy responsibilities, have demonstrated strong innovation in revenue generation. They either actively seek central government transfer payments, rely on land sales to raise funds, or establish financing platforms to gather resources. Although these measures did support economic growth to some extent, as fiscal pressure increased—especially with the cooling of the land market and tighter regulation of financing platforms—the financial situation of local governments has become increasingly dire.
Pros and Cons of Investment Attraction Policies
Since 2018, the Chinese central government has begun deepening fiscal reforms, particularly local fiscal reforms, with the goal of regulating local government debt management. Using the approach of "opening the front door, closing the back door," which means setting clear quotas on local government debt while strictly controlling new debt issuance to prevent disorderly borrowing, these measures have undoubtedly created challenges for local governments in their fiscal operations. However, from an overall perspective, they have laid a solid foundation for establishing a healthier and more sustainable fiscal system.
From a risk control perspective, the necessity of limiting local governments' financing space is obvious. Many local governments, when borrowing, often do not directly bear the ultimate debt repayment responsibility, which is fundamentally different from the bankruptcy risks faced by local governments in the United States. In China, local governments cannot go bankrupt but can still amass significant debt, revealing the inequality between rights and responsibilities in the borrowing process. Therefore, strengthening the supervision of local government financing is a reasonable measure.
However, in the process of strengthening management, if local governments face severe funding shortages, it can easily lead to a range of problems. The most significant change is that the role of local governments in macroeconomic regulation has progressively weakened.
In the past, when central policies were introduced, local governments could often respond swiftly and even amplify their implementation, effectively stimulating the economy. Today, however, local governments are stretched thin, and this phenomenon has undoubtedly had a profound impact on the economic operating mechanism, leading to a clear weakening of economic vitality.
Additionally, local governments' policies to attract investment remain active and strong, but this area also faces new challenges. For example, during U.S. Secretary of the Treasury Janet Yellen's visit to the NSD in April 2024, she highlighted the issue of overcapacity in the "new trio" (Chinese-made electric vehicles, lithium batteries and solar photovoltaic products). In her view, the expansion of this overcapacity is partly fueled by substantial national subsidies, raising concerns about unfair competition. Moreover, as an economic powerhouse, China's vast production capacity has had a significant impact on international markets, influencing industries, markets, and employment conditions in other countries.
This situation reflects the dual predicament currently facing China's new energy products: domestically, their contribution to economic growth remains insufficient, while internationally, their scale has become large enough to provoke concerns and competitive pressures from the global community. The subsidy issue raised by Yellen is even more complex, involving multiple areas, including policy direction, market mechanisms, and international rules.
According to research by domestic and international scholars on electric vehicle subsidies, the actual subsidy per electric vehicle provided by the Chinese central government does not show a significant difference when compared to European and American countries. However, while explicit subsidies are relatively few, there is a complex array of implicit support. Local governments' investment attraction policies include various forms of implicit subsidies, such as tax reductions and lower land usage fees.
The consequence of these investment attraction policies has been the serious issue of redundant construction in certain sectors. For example, there are currently around seventy to eighty electric vehicle companies in China, almost all of which are backed by local governments. While government support for industrial development is not uncommon, and industrial policies are widespread, the problem arises when local governments, lacking independent balance sheets, heavily invest resources in replicating production capacity rather than focusing on technological breakthroughs. As an official from an international organisation pointed out, China's "new trio" in the new energy sector is not large enough to sustain the country's economic growth, but it is too large for the global market to absorb easily. The core issue is not the development of innovative industries, but the excessive concentration of innovative industries through local government support.
Industrial policies can indeed have a positive impact in certain contexts, but their effectiveness is contingent upon the presence of market failures. When market failures occur, industrial policies, if they help address these failures, can yield positive results. However, such policies often deviate from their intended goals, leading to less-than-ideal outcomes.
The root of the issue lies in the tendency of these policies to go beyond merely correcting market failures, especially in the case of new energy products. The sectors most in need of policy support are projects with high technological barriers that individual companies cannot shoulder alone or those with prohibitively high costs. However, many local governments' investment attraction policies tend to focus on replicating and expanding existing mature technologies, which has led to overcapacity and inefficiency. As a result, regulating investment attraction practices has become critically important.
Further Reform Opportunities
At first glance, the weakening of local fiscal power may appear detrimental. However, from another perspective, it could present a fresh opportunity to advance market-oriented reforms. The administrative decentralisation implemented in the past played a crucial role in promoting China's economic growth, but the transfer of resource allocation authority from the central government to local governments does not necessarily signify the completion of market reforms. The key is to shift decision-making power more toward the market and enterprises, rather than keeping it concentrated solely within the government. The reduction in local government resources and their limited capacity to intervene may not necessarily be a negative development.
Looking ahead, local governments could concentrate their limited resources on three key areas: first, maintaining social order and ensuring fair competition; second, providing public services; and third, developing public infrastructure. If local governments have the capacity and resources, they can, of course, still formulate and implement industrial policies. However, this should only be done under the condition that they assume full responsibility for both the sources of funding and the resulting consequences of their actions.
In conclusion, if local governments can gradually reduce their focus on investment attraction and concentrate more on core functions such as addressing market failures, maintaining market order, and providing public services, this would create an important condition for the market mechanism to fully play its part. As emphasised in the document from the third plenary session, the decisive role of the market in resource allocation should be upheld, while the government's role should be effectively leveraged. This shift will have profound significance for enhancing China's innovation capabilities.