Thanks to China analyst David Cowhig for sending following translation to CDT:

“Reform of the Chinese Political System” by Zhou Tianyong , vice director of research at the Central Party School and collaborators was published in September 2004 by the Zhonguo Shuli Shuidian Chubanshe.

Zhou Tianyong, an economist, puts political reform in its economic context to explain the goals of reform, the current situation, and suggestions on how to get there from here. Zhou’s book also raises questions about what kinds of new thinking are appearing at the most important school of the Chinese Communist Party. Reform is a topic of intense interest to all Chinese. Comments about creating a fair system seem to echo of Hu Jintao’s saying “Take People as Fundamental”. Is Zhou explicating Hu’s ideas or is Zhou dressing up his own ideas in Hu’s clothes? Maybe both. The criticism of the Chinese system in Reform is so strong that if a journalist wrote it, the book might have been banned. Academics aren’t censored as much as journalists, and perhaps Central Party School academics have more leeway than most academics.

Zhou’s book reminds me of the comment that Tsinghua University Professor Qin Hui made in his 1999 book Issues and Ideology [Wenti yu Zhuyi]. Qin wrote (p. 118 – 119) that Hayek’s book the Road to Serfdom is much appreciated in China. Unfortunately, adds Qin, Hayek didn’t write the book the Chinese need — The Road Out of Serfdom.

I found this chapter fascinating.

See also: David Cowhig – Introduction to “Reform of the Chinese Political System”

Reform of the Chinese Political System [Zhongguo Zhengzhi Tizhi Gaige] ISBN 7-5084-2346-1 is available from the Chinese online bookstore Dangdang at here.

Reform of the Chinese Political System

Chapter II Some Serious Problems in Public Finance

(p. 47)

Chinese public finance formerly suffered from government expanding into many functions it that should have been handled by private enterprises. Later, with reform, public finance in China was characterized by a very large proportion of its funds being spent on administrative costs, large expenditures on eating and drinking, and essentially a public finance system that serves the government rather the public.

Public finance has several roles:

1) Public finance should serve the taxpayers and not be the slush fund for government departments or for the private purposes of officials.

2) From the standpoint of economic efficiency, public finance should aim at compensating for market failures by providing public goods – just those things that individuals and the market are not able or willing to provide.

3) Public finance should be a democratic, rule by law, and open public finance. This is the key difference between public finance and finance in a dictatorship or a system where there is rule by man instead of rule by law.

Public finance is built on the foundation of a modern budgeting system. In order to establish government that serves society and manages it properly, the first step is to transform government finance to public finance at each level of government in China.

In a very large developing country with large regional inequalities in development, government intervention needs to be much deeper and broader than in other comparable developing countries. Developing energy resources, railroads, telecommunications and other infrastructure depends upon government investment since private persons or companies are unwilling to make these investments. However, once development has reached a certain level, state enterprises should be sold off and government intervention should gradually decrease.

P. 49

Since the mid 19th century, the government spending as a proportion of GDP increased sharply in the 23 countries now members of the OECD. Before 1860, government expenditures share of GDP was 2.5% – 6.5%. In 1920 it was 15%, 1937 20% and in 1980 40%. Public expenditures in areas such as defense, education and housing during 1960 – 1995 were stable at 15% of GDP. Investments in education and S&T rose early. Japan in 1901 had 98% of the elementary school age children in school. Per capita official spending on education increased by about 50% in the US, UK and Germany between 1960 and 1971.

Over the past several decades, the major factor (60%) in the growth of government spending in OECD countries has been the increase in transfer payments from government to households. The experience of the western developed countries shows that public expenditure priorities need to be prioritized according to the stage of development. Especially important is that development needs to give the highest priority to the livelihood of the people, taking people as fundamental (Note: in text yi ren wei ben — a Hu Jintao key principle). Since resources are limited, this priority needs to be kept in mind.

[P. 51]

Chinese public expenditures as a proportion of GDP are small compared with the developed countries and with other developing countries. China has a very irrational structure of public expenditure – there are problems with both things the government does and shouldn’t be doing and with things the government isn’t doing and should be doing. The prioritization of expenditures is chaotic. This makes it harder, especially given the low level of public expenditures overall, for public expenditures to have the desired effect. No matter whether one examines the budget, the structure of personnel positions, or the execution of policy, the government still operates in the pattern of the old planned economy. The division of labor is poor, operations are not rational [“scientific”], and transparency is low. It is very hard to get complete information on government revenues and expenditures. To get an idea of the problem, however, we need to look at government revenues and expenditures.

Chinese social security expenditures are very low. The 70% of the population in the rural areas are excluded from the pension system. The 100 million covered are in a system that is severely under funded by at least 13 trillion RMB (approximately US 1.5 trillion). In 2002, China spends 1.3 percent of GDP on relief of severe poverty – half of the usual level of a low to medium income country.

China spends a lower proportion of its GDP on education than almost any country 2.2% vs. [from table on p. 52 on years 1998 – 2000] 4.8% in the USA, 3.5% in Japan and 4.1% in India. Compulsory education, especially in the rural areas, is declining. Many children are not going to school. In some places it is worse than when reform began in 1978.

[P. 53]

Only 15% of the Chinese population has medical insurance. In recent years, health care in rural China has stagnated. In many areas it isn’t as good as when reform began in 1978. Many people cannot afford medical care and so when they get sick they become poor.

Administrative expenses consume 24.7% of Chinese government expenditures. This is the highest in the world. Compare with 10% in the USA, 6.5% in France, and 8.2% in Russia. The amount of money Chinese official spend on personal eating and drinking has been estimated conservatively at 300 billion RMB (USD 35 billion). The amount spend on official cars is at least another 300 billion RMB. In recent years has spent 800 billion RMB on building a 20,000 km highway network while local governments have spend another 200 billion RMB on local infrastructure such as subways.

P. 53 – 54

These infrastructure projects are important but they are far less important than attacking China’s severe problems of social security, poverty alleviation, compulsory education and public health. Despite the severely inadequate level of social services spending, the government persists in spending very large sums on economic construction. Since the beginning of the 1980s (during 1981 – 1985 the figure was 56.08%), the proportion of government expenditures devoted to economic construction has declined (by 2002 it was 30.26%), but it is still far higher than any other country, be it developed or developing.

The large quantity of state assets is a carryover from the old central planning system. Actively managed state assets are found throughout the economy, not just in areas such as defense or in key economic sectors where the state needs to assert control. The proportion of state owned enterprises is still too high. State properties are mostly in competitive fields while state investment in basic and strategic industries is inadequate. Thus the state participates too much in competitive fields, and especially in manufacturing but not enough in infrastructure.

P. 55

Examining the pattern of increased investment, the proportion devoted to the benefit of all society has been declining sharply. It is very difficult to get a good idea of the pattern of government investment from published statistics. What is certain, however, is that a significant portion of government investment is allocated very arbitrarily, without being attached to any policy goal. This phenomenon is even worse than the decrease in government investment since it shows that the government’s ability to apply macroeconomic controls is decreasing.

Before reform began, China was a centrally planned economy. The government concerned itself with close control of economy, society and politics. Special focus was put on the economy on forcing consumption to as low a level as possible so as to accumulate as much capital as possible in order to serve the absolute priority of economic development. For a long time after reform and opening began, the Chinese government characterized itself as an “economic development type” government with a laser-like focus on rapid economic development and a high GDP growth figure, expecting that with high GDP growth, other aspects of development would basically take care of themselves. The exclusive focus on GDP growth resulted in a neglect of the livelihood of the people and social welfare.

Market reforms require that government steadily relinquish many of its planned economy roles. However due to inertia in the system and people’s way of thinking, this retreat of government could not be done quickly. Government was pushing reform and government internal reforms consumed much of its attention and resources. Many of the problems of the reform could not depend simply on whether the government was aware of a certain problem, as we learn from public choice theory. One result was the continuous swelling of government expenditures after reform began.

The problem of fiscal expenditures has far reaching consequences. The objective of public expenditures is to ensure that most members of society share in the benefits of development. Public expenditures promote social tranquility and improve the quality of the development of the entire society. In a poor developing country, a high level of public expenditures focused on development projects is a great waste since it consumes a great deal of public resources and so has a negative impact on the livelihood of the people. Building a social security network depends upon the extent of public expenditures and how rationally those expenditures are allocated.

China’s priorities in public expenditures are both part of the problem and part of the solution for the weakening of some groups in society and the for the great difficulty in finding solutions to problems such as poverty, social security and compulsory education. The problem is not so much the size of public expenditures but in the relative priority given different kinds of expenditures. The irrational public expenditure priorities threaten the trust people have in government. Government should be a public service government. The basic task of modern government is maintaining social fairness.

P. 56

In China government needs to retreat from areas in which it is still too much engaged and focus its resources in providing more public goods. China’s spending priorities should be allocated according to four levels of priority. On the first, highest level, are strengthening public administration, public order, basic education and national security. Next, on the second level, is quickly building a social security network so as to increase transfer payments to impoverished people. Third, improve the methods for control of the economy at the macroeconomic level so as to reduce the impact of business cycles. Also, public expenditures need to be focused on narrowing the gap between the city and the countryside, resolving the problems of China’s dual urban/rural economy by for example, increasing support to agriculture, environmental protection and social infrastructure such as transportation and electric power networks. Support for transition from the planned economy to the market economy should focus on supporting the livelihood of laid off state enterprise workers.

P. 57

Openness, transparency, democracy and rule by law are the basic requirements for a successful public administration. Government should be an agent of the people that accumulates financial resources and then allocated according to how the people want that income allocated. The budget process must be open, rigorous and include all revenue and expenditures. The budget should reflect the priorities of the people and control the behavior of the government. This is ensured through a thorough legislative process and a strict system of audits, revisions, and approvals. If transparency is absent, there is a lack of public input and influence and so there is really no real “public” administration.

p. 58

China’s fiscal processes fall far short of the requirements of openness, democracy and rule by law. Very often the Chinese government is involved where it shouldn’t be involved and not involved where it should. In the creation of administrative structures and in expenditures there are no real legal constraints, much is arbitrary and so government institutions expand and expenditures are out of control. The root problem is the personalization of public policy. Lacking openness and transparency, very much depends on the whim of one leader or another. Therefore the root cause of government being involved where it shouldn’t be and not being involved where it should is lack of openness and transparency. Fiscal reform doesn’t really depend upon various administrative reforms but rather on whether openness and transparency become a fundamental operating principle for the entire government revenue collection and expenditure process.

Chinese government fiscal operations are deeply rooted in the opaque allocation structures of a centralized system. Government operations are not open and transparent and the public is not asking for openness and transparency. Even after these many years of reform, the public, and especially government officials are still mired in a traditional mentality. Once money goes into the state treasury, it is the “state’s money” and “has nothing to do with me”. The idea that “this is the taxpayer’s money” has not taken root. There is no consciousness of democratic rights. Oversight doesn’t even come up so there is no demand on the government that is be open and transparent. The government is far behind the market in opening up and becoming transparent in its operations.

(p. 59)

The key problem is lagging reform of the budget process. The whole process very much resembles the pre-reform process so there is very little openness and transparency. Reform of the budget process didn’t start until 1999 beginning with ministerial budgets and procurement budgets. Budget problems are very serious.

(1) The budget is incomplete. Many government revenues and expenditures are not included in the budget. There is no reliable figure for overall government revenues and expenditures. The public has no idea why the many fees collected now are being collected and what the money is used for. Fee collections have spread “public finance” over very many departments, really making it the private finance of the various departments – no outsider knows what is collected, how it is allocated and where it goes.

(2) The process of drawing up the budget is very crude. China has not established a system for giving a budget two readings. Budget items do not meet the needs of the market economy and are not detailed enough to be useful. The result of this crude budget process is that some departments have gotten too large a budget while other departments don’t get enough. The budget is largely a black box.

(3) The execution of the budget is very arbitrary. The budget is not reviewed in time. When the National People’s Congress reviews the national budget, that budget has already has been in execution for three to four months. As a result money is spent arbitrarily and so the budget does not create hard constraints to government operations. Without acceptance of the principle of openness and transparency, no order can be brought to government revenue collections and expenditures through laws and regulations.

A government budget is a law. If the law is not passed, the government shuts down. How does this work in China?

P. 61

The first issue is how the Chinese Communist Party leads the fiscal budget process. In the Chinese political and administrative system, the Communist Party represents the people in its exercise of all government and administration. At the provincial level, the Provincial Party Secretary and the head of the provincial people’s congress is often the same person. In Party and government administration, the Party Secretary is number one and the head of the government administration is number two. In fact, the Communist Party has the final say in the allocation of fiscal resources, and in fact monies spent on Party activities and government finance are mixed together.

The fundamental question is the Party responsible to the people for the budget or is the People’s Congress responsible to the people for the budget? Considering the direction of reform, the answer should be that the will of the Party is expressed through the actions of the People’s Congress. The Party should by and according to law lead fiscal and economic work. Therefore in fiscal matters, the People’s Congress is responsible to the people. If problems arise, the head of government bears legal responsibility.

Secondly, the budgets of the various levels of government are composed of budgets drawn up by the different departments at those levels. The quality of the overall budget depends upon how well budgets are drawn up at the department level. Proper department budgets make department operation adhere more closely to plan, improve openness, and improve accountability.

Thirdly, governments are composed of people. The fatal flaw in the Chinese budget system today is that nobody is responsible. The head of each department or agency is responsible for the execution of the budget. Although this is required by the “Budget Law of the PRC” in practice this requirement of the law is generally not observed. Going back to the first question, does responsibility for the budget being carried out properly fall on the head of government administration (who is really the number two oveall) or on the party secretary? Not holding people responsible for their fiscal responsibilities is an important cause of corruption. Strengthening accountability will be an important part of making fiscal administration operate according to the rule of law.

Addressing these problems will requires designing a new framework for a balanced budget system that will enable the people’s congresses, the auditors, society and the people to have truly effective oversight of the work of the Party and the government. All fiscal activities should be open so that the people will understand just how the government spends the money the people give to them and whether those expenditures serve the welfare of the nation and the people. If this does not occur, the people will certainly have a crisis of confidence towards their government.

p. 62

China’s township governments have an average debt of over 6 million RMB. At the county level the average government debt is over 200 million RMB and at the regional level over 300 million RMB. With various tax reforms that converted fees to taxes, reduction in the arbitrary assessment of fees on the population, and ever greater demand on government at all level to provide more public goods including social security, local government public finance has become less and less solvent. After reform, subsidies from the central government declined and the needs to support failing public enterprises increased. There is no real system of budgeting and public finance at the local level and revenue resources have dried up. Many local governments are borrowing more to cover basic administrative costs and new construction.

Local government take on projects far beyond their capacity without thinking of the consequences. An example is impoverished Gu County in Shaanxi Province which had an annual budget of 900 million RMB, barely enough to pay employee salaries. Nonetheless the county undertook a big road and building project. As a result thousands of workers have been waiting for 4 million RMB in back wages for four years. Many counties when they were prevented from collecting fees arbitrarily fell back on borrowing money to meet the basic costs of government.

P. 63

Consequences of overspending by local government include debt piling up that is a drag on development; more fiscal pressure results in local government assessing more illegal fees on the populace; more unpaid workers leading to instability; more bad debts held by banks; and excessive government investment using methods such as forcing down land prices and embarking on big construction projects for which the workers can’t be paid, results in a government generated overheating of the economy.

Can this problem of local governments borrowing money for operating expenses and construction be brought under control without outside intervention? Not likely because of the deep institutional reasons this is going on. Every group of local Party and government leaders wants to look good so they are unwilling for it to be said that they could not meet a payroll. By the time the loans come due, this set of Party and government leaders will have moved on to another assignment. If officials can invest great sums in infrastructure and get the local economy moving, those achievements will help them get a promotion and they won’t be there when the debt comes due. The status of the local people’s congress and the poor qualifications of the people in it mean that the local people’s congress is unable to impose constraints on Party and government leaders. New measures are needed to bring local government borrowing under control so that the accumulation of these debts does not cause a national fiscal crisis. Local Party leaders should not decide themselves on large projects. Approvals should go through local assemblies such as the local party committee and the local people’s congress. A national law should establish procedures for government borrowing and repayment of money including oversight procedures.

P. 64

Many of the problems of local finance such as the uncontrolled expansion of personnel slots in government agencies, low efficiency and excessive burden imposed on peasants and local companies arose from during the transition from a planned economy to a market economy. Many individuals and government departments used their own authority to enrich themselves at public expense. Government approvals and permissions became a tool for extracting fees. Fees for administrative services and enforcement should be eliminated. Only fees for semi-public goods such as water, higher education and special medical services should be collected.

P. 65

A study by the State Council found that over 4000 types of fees were being collected in China. Most of the 2000-odd fees at the provincial or local level had no legal basis. Each year 700 billion RMB are in fees and fines are collected. Some scholars estimate the real figure is about one-half of all government revenue, which would put fees and fines as high as 1 trillion RMB. In their reliance on fees and fines, local government see no hard limit to their revenues. This results in a steady expansion in the number of employees in government jobs.

The fees collected to support government lead to corruption as officials buy fancy cars and go to expensive restaurants and people lose their trust in the government.

Some local governments don’t give enough budget to courts or public security, telling them to go collect fines and fees to support yourself. Some townships depend upon fees and fines for construction offices, labor offices and family planning offices to cover the costs of running local government.

Why is it so hard to set up a business in China? There are so many permissions to obtain and fees to pay that businesspeople get discouraged. The solution is to convert all fees into taxes to put government on a sound fiscal basis. The size of fines should be greatly reduced. A large fine should be set for certain items only after discussion at a public hearing.

Party, government, legal and military organizations should live within their budgets. Organizations should provide services to the extent of their budget and no more. No organizations should be allowed to assess fines to support themselves. Fines should go to the state treasury.