Remarks by Alvaro S. Pereira,
Director, Country Studies, Economics Department
21 March 2017
I am delighted to be back in Beijing to launch the OECD’s 5th Economic Survey of China. I would like first to acknowledge that our analysis has benefited greatly from the insights and contributions of NDRC’s Comprehensive Department and the State Information Centre. Thank you for your support ─ we look forward to many more years of fruitful collaboration!
Let me start with the global context.
Our latest Interim Economic Outlook confirms that a modest upswing is underway: we project global GDP growth of 3.3% in 2017, rising to 3.6% in 2018. But many risks, vulnerabilities, and policy uncertainties remain. And many of the hallmarks of the ‘‘low growth trap’’ persist. Trade growth has remained sluggish, reaching just 2% in 2016. Investment growth remains volatile. There is also a disconnect between financial markets and fundamentals. And, perhaps most worryingly, we are experiencing a rise of protectionism that threatens to derail the modest recovery.
In our Economic Outlook at the end of last year we estimated that an average rise of trade costs and tariffs to the bound tariffs effective in 2001, the year when the trade negotiations under the Doha Round started, would make the world economy significantly worse off. And the United States, China and Europe would suffer GDP losses of 1 to 2%. Exports for these regions and countries would fall more than 10%.
In other words, reverting to protectionism would be very, very costly to everyone. Hence, we hope that dialogue prevails and the rise in protectionism should be avoided.
With this caveat, and if our go back to our Economic Survey, we believe that China is standing strong.
GDP is set to increase by around 6.5% in 2017 and 6.3% in 2018. The rebalancing of the economy (from investment to consumption, from external to internal demand, and from manufacturing to services) continues. The implementation of the ambitious programme of structural reforms set out in China’s 13th Five-Year Plan is also progressing relatively well. Financial market liberalisation has been supported through deregulation of all major interest rates, increased exchange rate flexibility, and enhanced macro-prudential regulation of bank and non-bank financing activities. Essential reforms to the one-child policy and the hukou household registration system have been undertaken. And intergovernmental fiscal relations have been strengthened. The urban-rural income divide continued to narrow and growth is increasingly driven by consumption and services.
These are noteworthy achievements, but much more remains to be done. As we always say in the OECD, for a country to continue to be successful, reforms have to be a state of mind.
Our 2017 Economic Survey of China identifies three key areas for action.
First, improving corporate performance by boosting innovation, reforming SOEs, and supporting more robust corporate governance.
China put innovation on the global agenda during its highly successful G20 Presidency in 2016, which culminated in the G20 Blueprint on Innovative Growth. Gross expenditure on R&D in China reached just over 2% of GDP in 2014, well-above countries with a similar level of GDP per capita ─ such as South Africa, Turkey and Chile ─ and at around the OECD average. China is also a global leader in patents, accounting for one third of the world’s total patent filings in 2015. However, low patent utilisation rates raise questions about their quality and relevance. Moreover, the share of invention patents is relatively low.
To boost innovation economy-wide, our 2017 Economic Survey recommends directing support to a broader range of sectors – not just new and high-tech industries. It also suggests strengthening intellectual property rights protection to encourage innovators to register their patents, and to ensure the prosecution of intellectual property rights violators.
Barriers to entrepreneurship in China have been falling rapidly and more than 16 million new businesses were registered in 2016. Nevertheless, there is ample room for more reforms: for instance, there is still some way to go to achieve a one-stop shop and for enhancing competition in many sectors, in particular network industries. Zero licencing, or silence is consent procedures, could also be introduced in many sectors.
State-owned enterprise (SOE) reform is also critical to improving the quality and resilience of China’s growth. Implicit government guarantees for SOEs have led to excess capacity and skyrocketing SOE debt. Corporate debt now stands at over 170% of GDP. These barriers to private businesses distort resource allocation and harm growth. As such, the market exit of unviable SOEs should be facilitated so that resources can be reallocated to more productive firms.
Efforts to strengthen corporate governance must also continue. Minority shareholders remain at risk from expropriation given the high concentration of ownership: in over half of all listed companies, the largest shareholder owns at least one third of shares. Further, almost all Chinese companies choose to have the minimum number of independent directors required by law. This not only undermines transparency. It also affects profits! Indeed, firm-level analysis conducted for our 2017 Economic Survey shows corporate profitability improved following the Security and Regulatory Commission’s decision to mandate the independence of at least one third of directors in 2002.
The second area for action highlighted by our survey is addressing mounting financial risks.
China’s total private and public debt now exceeds 250% of GDP, up from 150% prior to the Global Financial Crisis. Non-performing loans (NPLs) have been growing since 2013, partly reflecting overcapacity in some heavy industries. Our analysis shows that banks’ loan-loss provisions (as of mid-2016) would be fully wiped out if 80% of reported NPLs and 40% of special-mention loans were to default.
The rapid expansion of shadow banking is also troubling. China’s new macro-prudential framework requires the disclosure of off-balance activities by banks and is expected to strengthen systemic stability. Nevertheless, in the never-ending race between financial innovation and regulation, the authorities must remain vigilant. A key lesson from other countries is that financial deregulation can proceed safely only if macro-prudential supervisory institutions and policies are properly designed.
Skyrocketing property prices are potentially problematic. However, the systemic risk of a sharp decline is partially mitigated by moderate household indebtedness (40% of GDP in mid-2016), and stringent prudential regulations for mortgage loans.
The third area for action is to make growth more inclusive, or tackling inequality.
While China has achieved remarkable reductions in poverty rates, the benefits of growth have not been equitably distributed. Income inequality remains high, with the richest 20% earning close to 11 times more than the poorest 20%, versus 5.5 times in OECD. And available estimates suggest wealth inequality is even greater, with the richest 1% of the population holding one third of total wealth. The equivalent for OECD countries is 18%. Redistribution by the tax-and-transfer system is also very limited, and social contributions are not proportional to income and therefore regressive.
Our 2017 Economic Survey makes several recommendations to tackle financial inequality, including measures to enhance the progressivity of the personal income tax system, environmental taxes, and the introduction of a broad-based nationwide recurrent tax on immovable property. Social assistance programmes must also be better targeted, and calibrated to achieve the right balance between adequacy and providing incentives to work.
A striking aspect of inequality in China is the divide between urban and rural living standards. This is related to inferior access and quality of public services in rural areas. Our 2017 Economic Survey stresses that rural education opportunities must be improved, starting from pre-school education, and migrant children should receive public education no matter where they reside. Furthermore, rural wellbeing and labour mobility could be boosted by providing easy access to pension payments anywhere across the country, not only where they were earned.
Ladies and Gentlemen:
In the last 30 years, China has amazed the world with its rapid development. It first became the world’s factory, lifting hundreds of millions out of poverty and now it is emerging as a global centre for innovation.
But as Confucius said: “The gem cannot be polished without friction, nor man perfected without trials.” Accordingly, our 2017 Economic Survey concludes that the continued evolution of China’s economy should be accompanied by fundamental structural reforms that deliver more efficient, more sustainable and more inclusive growth. As China continues on this important journey, please count on the OECD’s support. We stand with you every step of the way.