In this RadioFinance dialogue, the discussion revolved around China’s 14th Five-Year Plan, which detailed the government’s next phase of development to become a higher income advanced economy.

Bert Hofman, director of the East Asian Institute at the National University of Singapore, pointed out that the emphasis of the five-year plan is on the country’s quality of growth. The focus shifts to a “dual circulation” strategy, particularly on creating indigenous innovation and increasing domestic consumption to drive growth.

John Gong, professor of economics at the University of International Business and Economics in Beijing, stated that the five-year plan is a vision statement which sets the goal of elevating China qualitatively into a modern economy and society.

Here are the key points that were discussed during the interview:

• China is focusing on domestic technology and innovation as it plans to lessen reliance on external sources
• China is prepared for the worst when it comes to food and energy security
• How long can China maintain its GDP growth rate as its increasingly higher income economy will inevitably slow down?
• The government’s unique monetary policy and quantitative easing that target financing to particular economic sectors, such as SMEs and green finance
• Competition between enterprises is not driven by the central government, rather is between municipal governments.
• Fintechs such as Ant Financial play important role in providing financial access to SMEs
• Has China’s rural revitalisation done enough to bring up its agriculture sector and narrow income inequality with urban cities?
• A growing middle class is driving increase in household consumption but more to be done to encourage household spending
• Personal taxation and social safety nets in China are still at very low levels

The following is the edited transcript of the interview:

Emmanuel Daniel (ED): Welcome to another session of RadioFinance. Today we have a very important conversation to be had, which is the result of the documents that were put together at last week's two very important meetings in Beijing. I'm here in Beijing, and so is one of my guests, Dr. John Gong, and another guest, Professor Bert Hofman, is joining us from Singapore. He's the director of the East Asia Institute at the National University of Singapore.

Both are professors, academics, economists and have a very strong contribution to make to the conversation we need to have today. We want to be able to decipher some of the implications and some of the long-term issues that the rest of us have to incorporate into our thinking, as we imagine and try to make sense of a China that is maturing into a sustainable economy. The documents that were put together last week were the 14th Five-Year Plan for National Economic and Social Development for 2021 to 2025 and a very interesting document called The Long-Range Objectives Through the Year 2035. This is a new document in that it tries to project China's growth economic priorities for another 15 years. This was not done before. But it's a draft document. It's a document written in pencil to sort of outline the priorities that the country will have. Some introductory comments that I'd like to make is this, that every time these centrally-planned documents were put together in the past, I think the rest of the world did not take these as seriously as they should have. Central planning was discredited many years ago by the way in which it was managed in other economies. But I think China has come to a point where the process, the two consultative forums that were put together to validate this documentation and validate the thinking of this documentation are highly representative of the feel of the ground, and both accountable, as well as democratic in that there is a buying process by the respective stake owners in the system. You would see that at least the Five-Year Plan is actually distilled down to the provincial and local levels, where the key performance indicators of the local administrators are aligned with the objectives that are put together. If you had missed the importance of this process in the growth that China has seen since it joined the World Trade Organization (WTO) in 2001, you would have missed the tremendous growth that it has been able to put together. 

The difference between all that China has achieved from 2001 to today, has been mostly in the physical realm, in the buildings, in the infrastructure. The features of the 14th Five-Year Plan and also the long-term objectives are that these are starting to focus more on the soft aspects of the economy: skill sets, salaries, wages, productivity. Also, of course, the environment and making sure that this is a sustainable economy. 

I have with me two professors who have been wrapping their minds around the issues that we are confronted with, both domestically for China and all of us who are counterparties of China in one way or another, whether we run businesses, we are part of the financial system or we’re entire economies looking at China and trying to make sense of our own place in a new world where China is an engine of growth for the rest of the world. 

I'm going to start by inviting Professor Bert Hofman, to outline for us what his thoughts are, in terms of what we need to be looking at. Then I'll ask professor John Gong to tell us what his priorities are. I will decipher the issues that I see speaking to people on the ground here in Beijing and what the rest of us need to be paying attention to. Bert would you like to start for us? 

Now I'm very interested to hear the priorities that you've made sense of the final documents that were put together?

Dual circulation strategy to strengthen domestic economy 

Bert Hofman (BH): Thank you for your kind introduction. The plan is indeed a very good strategic document. If you are governing a 1.4 billion-people economy, you have to pull together some sort of a unified vision, and that's the plan. It is no longer a plan as in the old planned economy. It is a strategic plan. In that sense, it has a very good function. 

Second, I think that the highest priority for the Chinese government is no longer growth, but it is the quality of growth. If I were to summarise the whole plan in one word, it is quality of growth, i.e., moving away from heavy emphasis on the quantity of growth. Yes, it's still there. Implicitly, there is still a growth target for the next Five-Year Plan. But explicitly, it is no longer there, which is quite significant. It just says that from year to year, we will set a growth target, but no longer for the whole of the five years. 

Xi Jinping gave an interview last year after a big party meeting on the plan and he said that by 2035, I would not be surprised if we can still double our economy. That's how he put it. That would mean for the long term, it’s still a relatively high growth, i.e., it literally translated to 4.75 percentage growth per year for the next 15 years. So that's still a relatively ambitious target. 

There are some issues that China needs to work on. For the next five years, there's emphasis to the quality of growth. There was already a little bit there in the13th Five-Year Plan, but it has been reinforced now. The big new thing is the dual circulation strategy. It's important for people to know that term because it will come back for many, many more times. Whereas, basically, the thinking earlier was we rely more on the external circulation, we rely on exports, we rely on foreign investment for growth, we now are shifting the priority to the domestic circulation. There will be more emphasis on domestic demand, particularly consumption, there will be more emphasis on domestic supply chains, particularly in critical supply chains, such as integrated circuits and other sensitive areas. There will be more emphasis on what China calls indigenous innovation or domestic innovation by the Chinese. To some extent, this is what's happening when a country gets richer. That should not put it as if you want alarm bells ringing or a protectionist direction of China. Now this is what happens if China or once a country gets richer, you become less trade dependent, you start innovating more at home. It's what Japan went through, it's what the United States went through when they got richer in the 19th century. In that sense, it is quite normal. But of course, these are circumstances. The external circumstances are a bit special this year and in the drafting of the plan, there is tension between China and the United States. So there is a concern from China's side that they might not have access to critical technology, so they want to make them at home. Second, China looks at how the rest of the world has managed COVID-19, and they don't see much of a strong rebound in growth in the rest of the world. That external demand will also be less. Also from a more practical point of view, this dual circulation strategy will help China grow over the next five years.

Food and energy as main concerns

ED: You'll see our top line points, right? John, would you like to get in there and add your perspective, especially since you're in Beijing, and you're quite associated with the people who attended these two conferences.

John Gong (JG): Thank you, Daniel, for the invitation. First of all, this is a very long document, 147-plus pages, a tome, I guess. I’m in total agreement with what has been said so far, that emphasises digital innovation. But in addition to this, I want to also mention two things. One is that this document, it's basically a vision document that lays out a whole bunch of targets, unlike some of the older Five-Year Plans that have set out very detailed targets, and also things on how to do this. It's not like that. It's really a vision document, in my view. Call it planning or not, it really doesn't matter. It sets out a goal of basically elevating China to a modern society to put it very bluntly, in terms of economic metrics and also other types of metrics, reflecting different aspects of a modern society. 

I want to mention two things, in addition to what Bert has said. One is that this very much reflects President Xi Jinping’s central theme of a people-centered growth agenda. If you look at the targets set out in this document, pages and pages are devoted to a lot of social welfare-type of targets for things like education, medical care, environment, all these things. Now these things are not so much quantitative in nature, but it just described a lot of the nice things that you would expect of a modern society. This also resonates very well with a very popular phrase these days in Beijing, with the radical circles, which is called a new development concept. What does new development concept mean? New development really means the gross domestic product (GDP) target. Now it didn't even mention the real target other than what he said about trying to double the economy within 15 years or so. But it talks about other aspects of growth that are directly relevant to people's lives: about housing, urbanisation, medical care, the number of kindergartens for a certain number of population. These are very concrete things that are directly relevant to people's life. My first impression is that this would definitely create a lot of opportunities in the service sector. All the things he's talking about are the sort of people-relevant aspects of a new growth model. These are all very much service oriented. Certainly, in my view, China is moving towards a direction for modern society that's heavily service centric. For example, if you compare the size of the medical sector in the United States as a percentage of GDP, compared with China, there's no comparison. Clearly, China is moving towards that direction. This is one thing I want to emphasise. Second, in this 14th Five-Year Plan, it’s the first time it really mentioned these two, independent kinds of ideas. One is food security. The other one is energy security. These are quite new concepts. They haven't really talked about these. What does that mean? I keep thinking why these are so important? I think behind these two security concepts, there's quite a strong signal that China is properly prepared for the worst. That's a very significant development, in my view. We have never had any problem with food security. But I think for the first time these two securities represent the major opportunities, but I think it sends out a very strong political signal. And also, marketing has strong implications for the energy water market in the future. I don't think that China is going to be massively reliant upon imports. The country has a plan to be robust and to be resilient towards any future actions in energy market from other countries. 

Sustaining the GDP growth rate

ED: Thank you very much for that, John, because I went through the document and you're right. These are incredibly large documents and read like three- or four-year degree programs in governance or in statehood. Every chapter is very detailed. And thank you for that comment on energy and food security. In fact, the long-range document just puts one of the most important goals that it set itself, to be carbon neutral by 2060 and to peak carbon emission by 2035. You're right, they sort of veered away from setting GDP growth targets. But let me draw on both of you on a number of themes that I thought would warrant a discussion or your general idea or input. First on GDP growth. What was very interesting during the sessions was that Li Keqiang found himself having to defend that this year, they will do 6% and the media was asking him again and again, “Are you sure it’s 6%?” And he said, “Yes, I'm sure it's 6%.” Given the several human capital themes that are in these documents, like wage increase, and as John pointed out, the rural urban growth and sustainability, or rural revitalisation. Then there is health care, education kindergartens and of course, the consumption economy. 

If you take these soft themes, which are different from infrastructure-based growth that defined the last 20 years, what sort of GDP growth should we expect China to be galloping at or trotting to in order to achieve these things? As economists and as people who have seen other societies evolve, where general income goes up and then that has to be tapered off with productivity, and then expectations go up in healthcare and education, how do you think that scenario is going to play out in China in the next five years and the foreseeable future? 

I noticed that China introduced social security a few years ago, and then insurance. The services component of personal wealth is increasing in that regard coupled with a consumption. Talk us through a little bit on how that's going to play out? 

JG: First of all, speaking of the GDP goals, this year Premier Li actually said above 6%. That's what he said. And the journalists were pressing him that it should be more than that. There is a quite wide consensus that China is likely to achieve something way better than 6%. It's actually not quite surprising because last year was horrible, right? At 2.3%, and historically, right after the pandemic or something like this, economies tend to bounce back very strongly. For example, after the 1918-1920 Spanish flu, the United States experienced a very long stretch of high growth for over 10 years, all the way up into the 1930s, the Great Depression. I think this is going to happen among better off economies, more advanced and richer countries, basically. Usually, after a natural disaster, the great countries do even better and the poor countries get a little bigger and I would put China into the category with the other more advanced economies at this point. I would expect that the United States and China would both do very well after this pandemic. 

But typically after a strong recovery, the first or second year after a pandemic, things will taper off, and then slow down substantially in the future but will still do very well. I want to mention two theories relevant to this GDP forecast. One is that in economics, we have this convergence theory. In other words, as the economy does much better, as China becomes part of the developed world, even though this is still very controversial, you're not going to see the kind of growth rates, typically, that we saw in the last 10 years or so. Inevitably, things are going to slow down. Things have been slowing down at this point. If you look at a typical developed world’s annual growth rate, 2% or 3%, it's a very good growth, actually. Sooner or later, China's going to move into that world. That's going to be the norm for China. The question is, how long is it going to take? How long can China sustain a 6% or even a 5% or 4% in the next 15 years, before it moves into that world? This is one theory. China is converging to the growth rate that is typical of a developed world. 

Second is the demographic change. On top of the slowdown growth, China's population is going to peak, if it’s not already peaking. You're going to see quite a significant drop in population size, in the next 10 to 15 years, and that has a significant impact on economy. We all know what's happened to Japan, for example, right? These are major challenges. The question is, how fast will China's economic growth rate slow down? That's anybody's wild guess. In my own view, for the next 10 years, it's probably still going to be above 4%, hopefully. By the end of the next decade, if China is still able to maintain above 4% that's already a tremendous achievement, surpassing the United States for the next 10 years. A difference in economic size at this point. 

ED: Very good two top line points. Let's ask Bert to jump in there with his comments and then we'll add these up. 

BH: The reason why people think that 6% is actually a very low target is that it's already in the bag. If you have the last quarter of last year and China would not grow from that point, it would give 6% annual growth. In that sense, it's going to be more. The market consensus is around 8% and that sounds about right. With the US stimulus, which is very positive for the rest of the world, it might actually be a little bit higher. Now that the stimulus has come through, which adds one percentage point growth to the world, it adds three percentage point to the US. But for one percentage point to the world, it might actually be a little bit higher, because the expectations in drafting the government reports were that we're not going to get that much growth on the outside world. That may yet change. In the medium term, were looking for the next five years. Our estimate of potential growth rates, that's what concept economics use, is over around 5%. The way to look at that is to say, how much can you get out of investment? How much do you get out of the increase in the labour force? Or in this case, it's a decrease in the labour force. And how much can you expect in productivity increase. Then if you add that up, sort of based on historical experience, you come to sort of around 5%. It's not a very solid estimate. Frankly, it's hard to pin these things down, especially productivity. 

One of the key problems in China's economy has been total factor productivity, as economists call it. But it's not just China, it's been around the world. Ever since the global financial crisis, productivity increases have come down. Despite all the innovation, despite the great fintech and other stuff going on in China, it doesn't seem to translate that much into economy-wide productivity. One key reason is that there's still quite a few protective sectors in China. So the exit of firms is not that easy in China. Despite the fact that a number of companies are doing very well, a lot of non-performing or weak performing companies still hang on, therefore productivity levels overall don't increase that much. Again, that's not just a China problem. With loose monetary policies around the world, you see the zombie companies becoming a phenomenon worldwide. A 5% potential growth for the coming Five-Year Plan seems quite okay. But as John said, it might further level off as China becomes richer, as China becomes high income. The implicit target in Xi Jinping’s growth of doubling GDP is really quite ambitious at 4.75%.

Stabilising debt levels

ED: Macroeconomic tools that are available to China to taper that and to counter global forces, what are the tools that are available to them? I noticed in the working papers, when they were referring to the deficient budget, China tends to refer to it on a year-to-year deficient to GDP rather than deficient to spending. What are the tools available to a country like China that is different from say, the US, or other countries in the region that we can expect them to be using?

BH: China has used its macroeconomic tools: fiscal policy, monetary policy, quite extensively last year. But also, there is one key constraint on the use of those tools and that is the debt to GDP ratio where that's not really quite high for a country of China's income levels. It's going to 300%. Last year, it was at a 24-percentage point, from 272% to 296%. That's becoming a little tricky and trying to realise that. Actually, the aim of monetary policy is to stabilise this. Monetary policy is constrained from that point of view and fiscal policy to some extent, because the overall government deficit is planned to go down as a share of GDP. Therefore, it contributes to the stabilisation of the debt levels. One thing that China has done very well, and really has as an additional point, is to not just have a broad monetary policy, but to target that monetary policy, i.e., the central bank opening up specific credit or discount windows where banks can come with particular kinds of loans to get a discount rate, like on small and medium enterprises (SMEs). It is on green finances on some of the government priorities, that if you want the green quantitative easing, and as SME quantitative easing, which is quite unique to China, can be quite powerful. 

Local governments in action 

ED: But at the same time, what's interesting is that the government has been quite determined in trying to demonstrate a kind of a balance between funding state-owned enterprises (SOEs) versus small enterprises and private enterprises. On top of that, lately, there's been a push towards engendering more foreign investments as part of the overall capital mix. These tend to be contradictory policies. On the one hand, it seems that the state wishes that the most important progress in technology are made by state-owned enterprises, but these are not. These are made by the private sector. Then even for foreign capital, it's actually directed at specific industries, as you said. Talk to us a little bit about these contradictions and how do you see these being managed? Or are these contradictions? 

JG: I'm not sure if it's a contradiction. I don't think the central government has a policy of particularly favoring one type of enterprise versus another. At least this is very true at the provincial and local level. In China, what's very unique is that the competition is not so much driven by the central government, but really by the regional, local and provincial governments. These governments really don't care if you’re SOE or you’re a foreign company, or a private company. They will all treat you very well. From that perspective, it's a mixed picture even though the central government, in a way, sort of refract President Xi's strong faith in the legion of SOEs. He has a very famous saying about this. But if you look at what's really happening in the market, I don't think there are very strong domestic policies in supporting these companies. Probably on the international stage. If you look at the companies that are really heavily involved in the Belt and Road (B&R) initiative, for example, I will say the vanguards of most of these companies are state-owned enterprises that are probably supported by various policies from the central government. But in domestic markets, it’s all over the place. Let me put it this way, the competition in China is mostly between municipal governments and it's fierce. They come up with all kinds of policies, funds in support of the companies that are creating jobs and tax revenues for their local jurisdiction. I don't think they have a strong preference of one company versus the other. All investments are welcome. There's no such thing as an SOE investment, private or foreign investment. Investment is investment. It does wonderful things. So welcome.

Revolutionising the financial landscape

ED: My experience in talking to banks is something like this, especially the banks with a national charter. Their loan books are all filled up by January every year. If they are given a target of 30%, year-on-year growth on loans, by the end of January, they've distributed almost all of their loans to state-owned enterprises. Then they start worrying about small businesses. In fact, we sometimes have conversations with banks saying, now that we have been directed by the government to go out and look out for small businesses, how do we even start the process? We don't have the risk management capability and the ticket size is too small for the kind of books that we have. This thing about access to credit for small businesses is still an issue in China. The state-owned banks are already well-configured with the state-owned enterprises. That transition to giving more access to small businesses is still a work in progress. It's still in its early days. 

JG: You're absolutely right. This is an issue with respect to the size of the borrower as opposed to the nature of the borrower. This is a universal problem. Banks don't like to make loans to small companies. It's true everywhere. It's because of the cost structure, because of the risk factor. This is actually nothing new. Bert made a very good point about China's central government. The central bank has a meticulously-designed scheme of providing incentives for the banks to make specific laws for a specific type of company. This is a very cleverly concocted plan. Whether it has to be successful or not, or whether it creates a problem for the banks, from a risk factor, or whether it really helps small companies, that I'm not sure. I haven't seen any strong evidence that this is really working. This is a commercial bank problem. They just don't want to make loans to small companies. That's a fundamental statement.

BH: Let me add to this from a couple of observations. One, it is true that there is a disproportionate share of loans going to state enterprises versus private enterprises, if you look at the overall size of the economy. But to some extent, that is also because there's a differentiation in industries. State enterprises are more in heavy industries compared to private enterprises. You can sort of add more capital intensive, so there's some explanation there. Unfortunately, state enterprises, in general, have lower returns and there are some issues with that allocation. But second, the large state banks, the centrally-owned banks, the China Construction Bank, they take in disproportionate amount of the deposits. But then of the loans. it's less so. On net, they lend through the interbank market through hundreds of smaller banks that are dependent on the interbank market for their funding. Those banks have better channels to small and medium enterprise. But the third, and that's the big, outstanding question at the moment: China had solved the problem or not China? Ant Financial had solved the problem of access to small and medium enterprises, i.e., with the enormous database from transactions in ecommerce, suddenly they had expanded massively the access to finance of small and medium enterprises. What the regulatory changes on Ant Financial is going to mean for that access remains to be seen, because we don't know yet what that is and Ant Financial is going to be restructured. But this sort of new fintech was truly a revolution. I've seen it happen when I was living in Beijing, whereas 10 years ago, there was no small and medium enterprise that will get a loan despite all the promotions from the government. That changed with fintech. So once the dust settles, we will see how far this is being pulled back. 

ED: My concern is exactly Ant Financial. I heard that the Ant Financial chief executive just resigned a couple of days ago. Guo Shuqing made a speech in Hong Kong in January saying that same business, same rules. In other words, if Ant Financial behaves like a bank, we will impose the same capital requirements on Ant Financial. It's more like a process by which they are pulling back on some of these new players to be regulated in the same way as traditional banks and make them part of the system. The thing about the interbank lending market is that further downstream in that market, there are small financial institutions with credit problems and liquidity problems. For a country where the growth was at one time 12%, you do have liquidity risk downstream, which are some of the financial factors that we need to get a good picture of how that's evolving to get a sense of how credit is being disseminated and holding up the private sector, especially in the small business sector. Ant Financial and there’s WeBank, the innovators have extended credit to the small enterprises. It'll be interesting to see to what extent the intentions of these documents and the policies that come out in the next few years, coagulate to continue that process, which has already started the whole process of innovation and access to credit. Talk to us a little bit about the rural vitalisation. 

Maybe John would have a very good feel of what's going on in the rural sector and Bert as well because you've actually lived in in Beijing and you've seen for yourself that the infrastructure part of the rural development is very clear to be seen today. The human capital part, what needs to be done? As agriculture will comprise less of the GDP components, how is the rural community going to evolve in the next five to 10 years?

Transforming rural communities

JG: I think this is very much from President Xi Jinping’s very strong personal preference. He has a strong, inclusive agenda. Today's poorest, the least segment of the population that has benefited from China's economic boom is the rural population. The rural area has been neglected for a long time, mostly driven by people leaving the rural area. The younger generation, they don't go into the fields toiling in the soil anymore. They move to the city; they look for jobs. In today's China, the people who are toiling in the fields in the agricultural sector are people who are in their 50s and 40s. Young people don't even know how to do agriculture anymore. That’s a big problem. On top of this, China is trying to build the local infrastructures for rural communities to close the gap between the rural and urban communities. You go to China and you immediately see the big difference. That's what the government intends to do, to revitalise the rural communities, to invest in local communities, and at the same time, to beef up agriculture from a security perspective. I would expect that China is going to make some big investment in this area in both soft infrastructure as well as hard infrastructure. Those might be investment opportunities.

ED: The number that I saw in the 2035 document is that in 2017, 37% of the workforce was in agriculture. In 2035, the document expects 6% of the bulk of the workforce to be in agriculture. That's a dramatic shift. I'm sure there's productivity involved as machinisation. But that fundamentally transforms the rural landscape and the way in which it grows. I'm just trying to imagine what that means in reality, 27% of workforce to 6% of workforce?

JG: That's a quite large number, actually. A 1% decrease represents a fairly large population reduction in a rural area. But that's happening, regardless of the government's plan. One thing that's taking place right now, in China's rural communities, is the consolidation of cultivation. In the old days, everybody does his own part of land and does his own cultivation, but now, you're seeing more and more people consolidate the land. They're not doing this anymore. It leads to someone who's doing this and using machinery to do this. That's actually a quite significant structural change that costs for less labour input, more capital input. It also calls for technology input. 

ED: Bert you have a view because you've seen several economies, not just China, and when a country makes that kind of transition, what does that mean? 

BH: The 27% is too high. Statistically, there are some questions, but China has already been heavily promoting agriculture by means of subsidies ever since the entry into the WTO, where agriculture prices went down, food security became an issue, and China has been subsidising the countryside quite a bit. It has made massive investments over the past 10 years, as part of the anti-poverty drive, massive investments in rural infrastructure, which has been absolutely dramatic. 

I literally went to the same village where I went first in 1992, where it took me almost three days to get there from Beijing. Now it took me six hours to get there. Just to give you an impression of how much that infrastructure has changed. But what has not happened, and I think President Xi is hoping for it, is to have new jobs move to the countryside. John said something before, the competition is between cities, it is between municipalities in China. They don't want to let go of a lot of infrastructure, so they continue to subsidise infrastructure, which in many countries would move far more to the rural areas. The second problematic area is indeed education and overall service provision. And I think they had a plan and tried to make a big difference so that it's better to live in the countryside. But nevertheless, the quality differences in education between, say rural Kuizhou and Shanghai are just tremendous. It's like an African country and a European country. Those big differences literally have an order of magnitude and it's very hard to overcome that, frankly. 

The one area where the rural areas have a comparative advantage is in aged care. China's population is aging. They do not necessarily want to stay in the cities, moving to the less expensive countryside. If there were communities that can absorb them, that would be a good growth area, but at the same time, I still see a movement of people from rural areas to urban areas. China's quite reluctant about that. Yes, they’re moving on the local system, but the land rights attached to hukou is still an issue. Let's say there's still some contradictions there. It's not yet clear cut where exactly the policy should be.

Impact of the rising middle class 

ED: Related to that is the whole discussion on income disparity over time. Then there were questions as to what measurement did they use? During the two meetings, I'm not sure which minister mentioned that China has technically eradicated poverty. Was that the United Nations (UN) or some of the other agencies, like the International Monetary Fund (IMF) measurement. But the real issue is the technical definition just continues to be an issue, especially if there's income disparity going forward. Do you see that China is the one country that might be able to ameliorate that, because in the liberal capital economies, that's not going away. They're becoming highly financialised in the disparities. Bert would you like to speak to us? 

BH: Yes, China has eradicated extreme poverty, its own poverty line, which is quite comparable as America, is a bit higher than the international poverty line that the World Bank uses. For the World Bank, China had already eliminated poverty by 2018. China now, according to its own poverty line, says extreme poverty is gone. That's a great achievement, no question about it. But if you look at countries that are at China's level of per capita income, i.e., $10,000, you would not count with a poverty line of $2.20 in 2011 prices, but more like $6 or $8. If you look at the $6 and the $8 line, you still have 300-400 million people in poverty in China. In other words, it's not that everybody is suddenly in middle class, not at all, there’s still a long way to go. 

Second, this rural urban disparity is really very high. It is about 1:3 in China and it has been a bit less in the ‘80s, and has been more in the ‘90s and the 2000s. Rural incomes are now growing more rapidly than urban incomes, but it's big. Second, it's not just income disparity, it’s wealth disparity that is very big, because most urban citizens, they have a big chunk of wealth in their apartment or in their second apartment or in their third apartment, if they've been smart. Rural citizens don't have that and they have very incomplete rights on their land, which is the asset that they could potentially trade, but they don't have the right to benefit from the capital increase on that. There's a big wealth disparity as well. In fact, it's very hard to get sort of back on board, even if you now move as a migrant to urban areas, because the big capital gains were between the end of the ‘90s and now. 

The apartments in Beijing are now really very, pricey. I wouldn't be able to afford it. In other cities as well, of course, where it’s a bit less so. But to remove those disparities is very hard. What is normally a big engine of equalisation is education. But again there, the quality of rural education lags far behind that of urban education. It's not altogether clear that there will be a rapid decrease in inequality between urban and rural areas, given the measures that are currently on the books.

ED: Good point. Just for the sake of completeness, let's get back to the question of domestic consumption. The 2035 goal for domestic consumption is 60%, whereas the 2019 matrix was more like 39% of GDP. From 39%-60%, that's almost doubled. What is domestic consumption comprised of? What is the profile, what is the scenario that we're looking at in order to see that come about? I noticed that during the pandemic, China increased the limits on duty free purchases, made Hainan a larger destination. In fact, Hainan is now the world's largest duty free destination. All the Europeans are lining up to be seen in Hainan. But domestic consumption is far more than that. Is that domestic production and domestic consumption? Or is that internalisation of imports? Give us a sense of what you think you see in these numbers?

JG: Are you sure it's only 39%? I thought it's more than that. 

BH: There’s also the income, but maybe there is a confusion. Total income, including government consumption, it's already 50%-53%. Maybe it is from 53%-60%. From 39%-60%, frankly, that would not be possible. But the assumption is 39% of GDP.

JG: In any case, we would expect that the household consumption will increase significantly. You ask this question, where are all these things coming from? I would say, two points. One is that the increased household consumption certainly will come from buying more expensive stuff, buying things of more high quality. That's definitely true. But it's going to be something more than that, for things that are now related to just products and goods. A lot of it come from the service side: high quality medical service, higher quality education service, more travel, traveling overseas, vacations, and also the cultural goods. In these areas, there's a large potential. In today's China, consumption at this point is more about better clothing, better food, all these things. But in the future, it's going to develop into something more than that. It's going to be more of a service component. The second thing is about imports. There's going to be a huge potential for imports. 

JG: Things really can sell on the Chinese market. I give you one example. Ecommerce has enabled imports of coffee from Rwanda. How would you imagine that this could be possible in the past? You’ve never heard about coffee from Rwanda but it's actually selling quite well in China. Alibaba has set up a regional collection center in Rwanda. The ecommerce centre in Rwanda is helping local farmers to package things, put on the right label, and these things are being sold on ecommerce platforms directly to Chinese consumers. In summary, service-oriented consumption is going to be a big part of imports. It’s going to be the next big point.

BH: I’m going to be throwing in some numbers. Yes, there is a middle class in China that is growing, that has been driving consumption. Because household consumption has been growing more rapidly than GDP, just not that much more rapidly than GDP. That's why it slowly creeped up over the last decade from 36% of GDP to now 39% of GDP. But if you really want to make a major impact on this, you can only do two things. One is to get a higher share of the pie of GDP to households, i.e., more rapid wage growth than GDP. Second, get the savings rate of households down overall. Despite all the encouragement of consumption, the Chinese still save a lot. Everybody saves in every income level and even at every age level, even though there is a more distinct pattern there. But the key among them is that the richest save, they save 50%-60% of their income. Whereas the lower income levels, they save 15%-20% of their income. A redistribution between the two would help. 

Challenging taxation and social security systems

BH: Second, social safety nets in China are still at a very low level. Yes, it's expanding. Pension now covers 95% of people, health insurance covers 95% of people, dibao has 70 million people, but at very low levels of income. You could imagine that government takes an active role in some redistribution through the budget, sponsoring the non-contributable rural pension system from say 130 to 140, to double that or triple that. You'd get definitely more consumption. But of course, that requires the sacrifice of others, i.e., somebody needs to pay the taxes for it. Second is to strengthen the overall social security, for instance, by devoting more dividends from state enterprises to the social security fund or giving the shares off state enterprises to the social security fund so that people say, my pension is actually assured, it's much stronger now than I thought of before, so I can consume a bit more. 

There's a whole range of policies that would lead to a bit more equality, that would lead to a bit of a higher share of households in the overall pie, and a better division between the state enterprises and the rest of the economy. There are a lot of things to do there. Difficult things. These are not easy, policy wise, but these would all feed into high consumption.

ED: In fact, I would expect taxation to come down so that there will be more disposable income. But it will be interesting to see how that works out. In terms of services, I need to pay insurance, which is very high. I figured that's because it's not broad based. If it was far more, broad based, the rates will come down. 

BH: But taxation is very low in China. Overall taxes as a share of GDP are now 18%. That's down from 22%, only 3-4 years ago. China has actually been reducing the taxation rate, the VAT and especially taxation on small and medium enterprises. It has been continuously keeping people out of the personal income tax, delivered policies, in part last year to stimulate the economy. But by now, 18% of GDP is really quite low. Because there are a lot of obligations that China also has taken on as a state. Taxation overall will come up, personal income tax will be a bigger part of that. Yes, as a foreigner, I'm sure you pay a lot of personal income, you’ll very easily hit the 45%. But the broad classes of the Chinese actually don't pay personal income tax, or recurring deposit (RD), except for the payroll taxes. The payroll taxes are quite high. Pension insurance in the formal system is really quite high. That's in part because there's very little returns on the investment that are being made. Again, a lot of areas of reforms to get to this modern socialist society in 2035. 

ED: To add to what you just said about taxation, there are objectives to be met for increased number of financial centres and tax havens in China. That's an interesting objective that they put into the program, which is increasing the special economic zones for different purposes. Final thoughts from both of you. You’ve given us a very good range of issues to drill down into and it's been a good conversation. Last thoughts Bert and then John.

BH: The next five years are going to be quite critical for China and to see how they move to this new development model, this dual circulation, how they get up research and development spending and become more innovative, contribute to more basic innovation. We haven't touched upon this at all yet. It's important for China for its long-term growth. I look forward to tracking that.

JG: I want to mention that this is sort of like a vision statement with written documents and it's very hard to go back and to compare what really happened to what this vision is saying. Overall, the real purpose is it determines where the central government's budget money is going to go towards. There will be quite significant funds allocated for achieving some of these targets. 

To be honest with you, the overall impact on where China's economy is going to go towards is going to be quite limited because the economy's going to have a huge inertia. It's going to run on its own, regardless what the government does. Overall, China's economic growth, the engine is still growing, it's moving at a very good direction. It's nice to see, as an ordinary citizen, that President Xi is also emphasising a lot of people-relevant aspects of the new economic growth theory as opposed to really just looking at the GDP figure. Income distribution and capital returns on labour, these concepts do matter a lot in the future.

ED: Thank you very much. I'll just add to that. When President Xi proposed that his leadership will continue for the foreseeable future, he didn't just engineer it so that there's continuity in government, but he also put in this 2035 document, which says, here's the agenda, these are the things we're going to be working on. It focuses everybody on that. One area that we didn't cover in our conversation is really the global implications and the global issues that China will be facing. In fact, top of mind right now is that the global cost of capital is the cheapest it's ever been, and that's denominated in dollars. China has effectively closed the economy in terms of the current account, convertibility pays a high price of capital domestically and it exports on that basis, too. The arbitrage of capital cost is something that I'm quite curious as to how that's going to work out over time. But somehow, China's managed over the years because of the trade engine, as trade decreases. And in these two documents, it has already started to recognise that trade will become less of a driver as it was in the first 20 years since joining WTO. We've got a good range of issues for us to bear our minds on in terms of what to look out for, as China puts in place the 14th Five-Year Plan and The Long-Range Objectives Through the Year 2035. 

ED: Thank you, both of you. I also noted that Bert had lived in China for about 12 years as the World Bank representative in Asia. You're very familiar with China. And it's good to be talking to both of you because you know China well. Thank you.