Reform in Factor Markets in the 13th Five-Year Plan

Production factors, or factors for short, refer to the input for manufacturing products and providing services, including capital, labor, land, and resources. A complete market system includes not only the market of products or goods but also that of factors like capital, labor, land, and resource. China’s reform in the product market has been a smooth process since the reform and opening-up, and now well developed. However, the reform of factor markets lagged behind, and the regulation over factor price led to the distortion of China’s economy despite fueling the speedy growth of the latter. Therefore, market of factor prices reform is the focal and difficult point In the future reforms, centered by the realization of the marketing of fact prices. Chinese government laid great emphasis on such reforms at the Third Plenary Session of the 18th Central Committee of the CPC.¹

However, the disputed and promoted factor market reforms, including that of finance, household registration, and land, have left on us the impression that “an empty barrel makes the biggest sound”. There were many reasons for this. One of the important points was that those who implemented these reforms had poor knowledge of them, with neither any vision about the relations between the reform of factor market and that of goods market nor a general view for the analysis of the discrepancies seen and correlation between reforms of different factor markets. Only by intensifying the understanding about the reform of factor markets can we be tolerant of the negative reform bonus in a short time and anchoring force of policies before the reform bonus is realized in the long run, and thus to truly intensify the reform of factor markets. The following contents emphasize the three key questions. Why did the factor market reforms lag behind? Why do we need the factor market reforms? How shall we propel the factor market reforms?

I Reasons for Lag of Factor Market Reform and In-Place of Product Market Reform: Fulfilling Both Speedy Economic Growth and People’s Living Needs at Low Costs

Committee of the CPC in 1984 that China’s socialist economy is not equivalent to a planned economy but a commodity economy based on public ownership. The major problems of commodity economy and value laws broke away the bondage of the Left thought at the Third Plenary Session of the 12th Central Committee of the CPC, and fully started up the product market reform. The dual-track pricing system implanted in the 1980s, though playing the role of transit in the early time, led to the prominent problems of low efficiency in resource allocation and corruption in pursuit of seeking rent. In 1988, the central government proposed the initiative of “pass-crossing in pricing”. To cross passes is a vivid metaphor to define the merging of the dual-track pricing system in a short time to adjust economy to balance with balanced price. The central government quickly declared to suspend the pricing reform, for the prices were unexpectedly far more out of control, although it was known previously that the form would be difficult to pass. After the failure of crossing such a pass, the dual-track pricing system of product market was gradually merged after rectifications until the resumption of relevant reforms in 1992. It was proposed at the Third Plenary Session of the 14th Central Committee of the CPC in 1993 to establish socialist market economy system. In this regard, the product market reform centered by pricing reform is fundamentally completed with the following details: first, the prices of most products are not decided by the government anymore. In 1992, China released the right of pricing for about 90% products by the government. This rate is higher now. Second, the main market players of most products were diversified and thus developed the balanced prices that were competitive but not monopolistic.

Although the reform of product market and the merging of dual-track pricing system were completed, the reform of factor market was lagging behind, and so was the property pricing reform, which was more complicated. There is still the dual-track pricing system for the coexistence of planned and market economy. Possibly, there are multiple reasons for the lag of factor market reform and for the product market reform to be in place. For example, compared to product markets, the vested interest groups in the dual-track pricing system of factor markets are stronger, which makes the reforms extreme slower. Additionally, the “pass-crossing in pricing” might easily fail, and the loose control over factor pricing might have butterfly effects, which shall exert more impact on China’s economy and society. It will be risky to try such measure. Besides, the writer also believes that the essential reason for the reform of factor market and that of product market being out-of-sync is that such reform portfolio helps pursuing high-speed economic growth and fulfilling fundamental living needs of people at low costs. On the one hand, the reform of product markets bred the marketing product prices, which inspired the production enthusiasts of enterprises and increased the market supply of products. China thus turned from the seller’s market with coupon-based supply for severe shortage of commodity in the early period of reform, to the buyer’s market with affluent supply of goods in terms of volume and category. Upon key inspection by the Ministry of Commerce, it was found that of more than 600 kinds of goods, those with supply greater than demand were close to two-thirds and those with supply equal to demand were one-third.² On the other hand, the difficult operation of, and price control over, the factor market curbed the price of factors, thus reducing investment costs and greatly stimulating investment and exports, which developed the pivotal support for the high-speed economic growth.

Despite the discrepancy between different factor markets, the price regulation of all factors might stimulate overinvestment, as seen in the following paragraphs.

Firstly, for the capital market, interest rate regulation policies depressed loan rates and reduced capital costs. The economic growth theory and international experience show that the higher a country’s economic growth rate, the higher will be the actual loan rate. From 1980 to 2010, China’s actual GDP grow rate was 10%, while its actual loan rate was supposed to be approximately 7%. However, the actual loan rate under interest rate regulation was only 2%.³ In comparison, in the corresponding period, the actual loan rate in Germany exceeded 8% that of the USA, Canada or France reach 5% or so, and that of Japan or Britain doubled as much as that of China. The actual loan rate of each of these countries was far higher than their economic growth rate. The interest rate regulation greatly reduced the capital costs of enterprises, especially state-owned enterprises, and provided stimulation for enterprise investment (Figure 5.1).

Secondly, for the labor market, low salary policy and household regulation system greatly reduced labor prices. In the context of demographic dividend, China’s ample labor supply and deficiency in the negotiation system of labor markets led China to implement low salary policy for a long time.

Figure 5.1 Actual loan rate and economic growth rate of China and major countries from 1980 to 2010.

Data source: calculation of data by World Bank.

Under the influence of low salary policy, China has obvious advantages in terms of labor prices, which greatly cut down the labor costs of enterprise investment. Take the salary of manufacturing workers, for example - the salary of Chinese workers is far lower than that in the USA, Japan, and OECD countries and even remarkably lower than other East Asian countries, Brazil, and other emerging economies. In 2002, the average hourly wage of a Chinese manufacturing worker was only USD0.6, which was equivalent of 2.2% of the average hourly wage of an American manufacturing worker and of 6.7% of the national average wage level of East Asian countries, excluding Japan. Later, with the enhancement of market regulation and further expansion of economic scale, China’s labor costs increased. Despite this increase, China’s manufacturing hourly wage was only 5.7% of that in the United States of America and 7% of the national average level of OECD countries.⁴

Thirdly, for the land market, the government, by virtue of its monopoly position in the land market, provided a great deal of cheap land for industrial usage, which encouraged people interested in enterprise investment. The land market in China is highly distorted. On the one hand, through the system of land acquisition, bid invitation, auction, and listing with Chinese characteristics, the government pushed the commercial land price and residential land price to a high level to get substantial revenue out of selling land. In 2013, China’s total revenue of land remises amounted to RMB4.13 trillion, surpassing the previous high of RMB3.15 trillion in 2011; the land remise revenue was 32% of the national fiscal revenue and 60% of local government fiscal revenue. On the other hand, the price of industrial land remained extremely low due to the low cost of land acquisition, as well as the pressed-down land prices released in succession by local governments out of fierce competition between them to attract foreign business and investment. From 2000 to 2011, the price of industrial land increased from RMB451 per square meter to RMB807 per square meter, up 1.8 times; later, the price of industrial land fell to RMB670 per square meter in 2012 and RMB700 per square meter in 2013.⁵ During the same term, the price of commercial land and residential land increased by 4.5 and 6.7 times, respectively.⁶ These two aspects effectively stimulated the investment in real estate and industry, respectively.

Fourth, in terms of the resource market, the government brought down the cost of resource that was supposed to be borne by enterprises, and stimulated the expansion of investment of enterprises. For a long time, as the prices of water, electricity, natural gas, and other important resources inevitable for production of enterprises were controlled by the government, the resource costs that China’s enterprises shouldered were much lower than international regulations. Take the price of water, for example, where an investigation by Global Water Intelligence in 2011 showed that the average price of water in 25 main cities in China was USD0.46 per cubic meter, while the international average price of water was USD2.03 per cubic meter, 4.4 times as much as that in China.⁷ As for electricity prices, when production cost

Reform in Factor Markets 109 of power generation enterprises was on a constant rise, the price of electricity remained low. In 2007, the industrial electricity price in China was USD0.068 per kWh, equivalent to 72% of that of OECD countries, much lower than that of Japan, which was USD0.12 per kWh, and Britain, where the price was USD0.13 per kWh.⁸ In terms of natural gas prices, in 2007, the industrial natural gas price of China was USD281.9 per GCV,⁹ in OECD countries USD336.6 per GCV, France USD414.1 per GCV for 1.5 times as much as that of China, and ROK USD551.1 per GCV for twice as much as that of China.¹⁰

Fifth, in terms of the environmental market, Chinese local governments significantly attached more importance to economic growth than to ecological environment, which resulted in the enterprises polluting the environment at extremely low expense. A local government of one place, in order to quickly develop economy and prevail in competition with that of another place, could even acquiesce to the establishment and existence of high-pollution enterprises and even become the protector for enterprises responsible for high pollution. It made many laws and regulations related to environmental protection, which were passed by the Chinese government, practically perform no function. According to statistics, from 1998 to 2002, there were 387 major and extra serious environmental pollution accidents in China, but only 25 of them were investigated for legal responsibility. From 2003 to 2007, there were more than 90 major and dangerous environmental pollution accidents in China, but only 12 of them were investigated for legal responsibility.¹¹ Besides, different from the United States of America and other developed countries, China enforced the maximum amount of penalty against corporate environmental pollution and ecological damage behaviors¹² and considered the continuous illegal discharge of pollution to be a violation, which would punishable. Such provision greatly reduced the punishment that China’s environment-polluting enterprises would face.¹³

The factor price regulation supports high growth as it can not only stimulate enterprise investment but also increase the international competitiveness of the products and significantly promote export growth. The fundamental reason for China to be mentioned as a “world factory” is that the low cost of production has created the price advantage of export products. The low prices of labor, capital, major resource products, and other production factors have provided export enterprises advantage of low costs, where the low labor costs play a significant role. From 2004 to 2010, China’s unit output labor cost¹⁴ was only 8.4% that of Germany, 11.7% of Japan, and 15.8% of the United States of America. Compared with Mexico, the Philippines, and other competitors, China’s labor cost advantage was also remarkable. As for the processing trade mode of “putting both material purchasing and product selling at the oversea market”, labor costs determine the final costs. Thanks to low labor costs, China has been rapidly raising its share in the international markets by vigorously developing processing trade and has become the world’s largest exporter. Of its total exports, China’s processingtrade accounted for the increase from 5% in 1981 to 56.8% in 1996, and later around 50% for a long period. In and after 2006, such proportion was in declination, but remained as high as 42.1% in 2012.

Factor price regulation provided China’s high investment with strong stimulation, created prominent cost advantage for its exports, and therefore resulted in dual-wheel-driven growth mode of high investment and high exports, which was the backbone for the high growth of Chinese economy. This emphasizes that there was a linkage mechanism between Chinese exports and investment. The rapid increase of exports promoted the further expansion of investment scale, consume the large productivity in investment expansion, and maintain considerable investment income, which sustained the high investment development mode. Especially when China joined WTO in 2001, low- and medium-end manufacturing industries were gradually shifted from developed countries and regions to Chinese mainland that provided cheap production factors; meanwhile, the international competitiveness of cheap Chinese products grew stronger, which gradually developed into export-oriented economy. China economy therefore made remarkable achievements as follows: in terms of world GDP, China’s GDP accounted for an increase from 1.9% in 1980 to 11.3% in 2012. In 1978, China’s GDP ranked tenth in the world. It ranks second now, and possibly up to the first in 2014, calculated according to purchasing power parity, exceeding America. Therefore, objectively speaking, given that the product market reform satisfies people’s basic living needs, factor price regulation can support rapid economic growth. In accordance with the core idea of the Party’s ruling for the people, it will enhance the stability of political power, with undeniable historical and periodical significance.