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The following is the Introduction from the OECD publication Challenges for China's Public Spending: Toward Greatere Effectiveness and Equity.
Public expenditures are one of the key instruments by which governments seek to achieve their economic and social goals. Through their impact on the allocation of resources, the distribution of income, and on aggregate demand, public expenditure policies play a potentially major role in sustaining sound macroeconomic performance and promoting economic development.
The OECD Secretariat has done extensive work on expenditure policies of member countries, through special chapters in the Economic Surveys prepared by the Economics Department and in a number of Public Expenditure Reviews by the Public Governance and Territorial Development Directorate. These analyses have identified three sets of issues concerning public expenditure policies.*
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Macroeconomic implications: whether the overall level of public expenditure is appropriate to a country’s economic circumstances; whether public expenditure growth is sustainable and controllable; and the degree and nature of any risks public expenditure policies may pose to macroeconomic stability.
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Allocative efficiency: whether public expenditures are distributed optimally with respect to social and economic goals; and the degree to which public spending in particular areas is the most efficient manner of accomplishing government goals versus alternatives such as regulation or reliance on the private sector. Issues about the appropriate allocation of expenditures across various levels of government could also be included under this heading.
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Technical efficiency: whether public expenditures are planned and implemented in an efficient manner. Public sector management issues, such as the budgeting process, oversight and evaluation of spending, fall under this heading.
This study examines issues concerning China’s public expenditure policies falling mainly under the first two headings. The analysis is based on information gathered at the sub-national level in a number of provinces as well as official statistics published by the central government. The first two chapters examine the macroeconomic and allocation issues from a national perspective, while the third chapter provides an in-depth look at the current state, problems, and issues concerning expenditure relations among various levels of government. In addition, four annexes provide more details on fiscal relations among sub-national governments, spending in major categories, the estimation of financing gaps and the classification of expenditures. As with its fiscal policies generally, China’s current expenditure policies reflect a not yet complete transformation from the extensive government intervention characteristic of the previous centrally planned economy to the much more limited and focused intervention appropriate to a market-based economy. Completing this transformation is the greatest overall challenge to making China’s public expenditure policies more effective in supporting its development and achieving its social goals.
The analysis in the following three chapters identifies five conclusions and related issues in these areas.
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While the overall scope of China’s government spending does not appear excessive in relation to GDP when measured in terms of explicit government spending, the government controls or heavily influences a substantial amount of off-budget spending in various forms which, in other countries, are more typically left to private or non-state entities, or are carried out through the explicit government budget. The extensive resort to extrabudgetary and off-budget spending results in a severe lack of transparency in China’s public spending and undermines accountability and efficient administration of that spending. This lack of transparency is accentuated by the continued use of systems for compiling and reporting government expenditures derived from the central planning era, which are based on administrative criteria that often make it difficult to determine how much is being spent on key economic functional areas, such as education or science, and by which government entities.
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China’s public spending has recorded rapid growth over the past ten years and, although the rate has moderated somewhat since 2002, expenditures are significantly higher now relative to GDP than they were in the mid-1990s. These trends raise questions about the future prospects for aggregate spending and whether it is adequately controlled. The analysis suggests that growth in general government expenditure could slow significantly in coming years but that expenditure associated with contingent liabilities, primarily from the financial system, constitutes an important risk to the expenditure outlook.
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The horizontal allocation of public expenditure among key activities appears out of line with China’s development needs and priorities in some important respects. International benchmarks and some other indicators suggest that China’s government may need to spend more on key social services such as education, health, and science and technology if it is to achieve its development objectives.
The two other issues concern the vertical allocation of spending among central and sub-national governments but have an important bearing on the first three.
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There are substantial gaps between the expenditure responsibilities of subnational governments and the resources they have to finance these responsibilities. These gaps have been an important factor behind the growing resort to off-budget funds and to the growth in contingent liabilities. The gaps vary widely across provinces and are particularly severe for township and county governments. Disparities among provinces in these gaps are substantially the result of the uneven decentralisation of expenditure versus revenue assignments and the inadequacy of the central-local government transfer system. The disparities are further magnified for lower levels of government within provinces by the general lack of objective criteria to ensure that revenues are allocated in accordance with expenditure needs and by inefficiencies and distorted incentives in the allocation of spending by sub-national governments.
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The fiscal decentralisation system also creates adverse incentives and limits accountability for expenditure decisions at the sub-national level. Unfunded mandates from the central government have added to fiscal strains at the sub-national level. At the same time, sub-national governments’ lack of discretion over tax rates together with China’s top down system of evaluation and promotion of government officials creates strong incentives for sub-national governments to spend as much as they earn in revenue, without adequate regard to the social trade-off between the benefits of their expenditures versus the costs of the taxes that pay for them.
* See Atkinson and van den Noord, 2001. See also Joumard et al., 2004, for a synthesis of the findings from OECD country analyses of expenditure policies.
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