Local Government Debt: China resembles Europe
Notes of the speech by Prof. Lu Ming in the seminar of “China’s Urbanization and Local Government Debt Risk” hosted by SIFL on January 19th, 2013
Local Government Debt: China resembles Europe
The European economy's competitiveness lags behind the US largely because it is a collection of independent sovereign nations while the US is one country. However, China resembles Europe, not only in that its demography and culture vary a great deal from region to region, but also that a great disparity exists in different regions in terms of productivity.
The result is that Chinese provinces with lower productivity, such as those in the central and western regions are like Greece - they are unable to raise their export competitiveness by lowering their exchange rates because they are part of a larger, unified monetary system.
China's exchange rate is largely based on the much higher productivity levels of the more industrialized eastern regions that account for the lion's share of exports. As it is impossible to have separate local monetary policies, the competitiveness of China's central and western provinces is actually dropping in relation to the rise in value of the RMB.
At the same time, due to the limited free flow of labor, those provinces still have to create new jobs for local residents, and invest in new industries. Emboldened by low interest rates, local governments have become too reliant on borrowing, the result of which has been growing levels of local debt, which now pose a potential threat to the national economy. This is the logic that dominated many parts of Europe too, referring to the mounting debts being accumulated by some of the area's southern members.
When the economy is doing fine, the debt can be repaid and everything is OK. But when the economy is not doing well, everything turns sour.
Such a development strategy, as everyone has seen, has created the classic "beggar-thy-neighbor" economic scenario, whereby one country's attempts to remedy its own economic problems tend to worsen the economic problems of others.
The Future Way
China should follow the US model - that is, to build up an integrated market with free flows of labor, capital and land use rights.
In China, the government should move quickly to abolish all impediments to the free movement of labor, most notably its Hukou (household registration) system. There are estimated to be 250 million migrant workers who currently work and pay tax in cities, who still have their Hukou registered in their home villages, often in rural areas. This denies them the same social security, education and healthcare benefits as registered urban residents. Those who oppose reform of the Hukou system are shortsighted in their failure to understand that city economies would benefit hugely by more people being able to work in them, with all the benefits included. They would spend more on products and services, for instance, and property demand will rise.
If more people migrate to the developed provinces and settle down, pressure would ease on officials to create so many industrial jobs.
With smaller populations, the rural provinces may also seek development in relatively easier and more competitive ways, such as in modern agriculture and tourism. The productivity per capita of those provinces may rise more rapidly as a result, narrowing the gap with developed industrial provinces, without being forced to attempt to copy their business models.
China's ongoing urbanization process is expected to generate tremendous domestic demand. But its urban ambitions will not be realized unless major reforms are made to integrate its markets, and allow a freer flow of labor.
The above is excerpted from Zheng Yangpeng’s report titled “Expert suggests caution over 'fragmented' urbanization” on China Daily.
