Abstract: In this interview following the release of China’s 14th five-year plan on social and economic development, Liu Yuanchun talked about such issues as the major challenges faced by China’s social and economic development in the next five years, the coordination between monetary and fiscal policies, the role of innovation in national development and what China should do to achieve the “zero carbon” economy among others.
I. Five challenges facing China during the 14th five-year plan period
Q: What are the major challenges faced by China in its economic and social development during the 14th five-year plan period?
Liu: The first challenge is to overcome the so called “middle-income trap,” and to steadily transition into a high-income economy. There are still many things we could do regarding how to overcome the “middle-income trap” and maintain high-quality economic growth. This is the most important challenge faced by China during the 14th five-year plan period.
The second challenge is the rivalry between China and the US. It would be crucial for China to effectively deal with shocks related to this in the next five years. On this critical issue, it is, first and foremost, important to achieve substantial breakthroughs in innovation especially in key and core technology areas. Secondly, high-level opening-up will be needed to improve competitiveness.
The third challenge is that the reform of some key areas must be comprehensively and concretely implemented to stimulate the enthusiasm of micro entities at all levels. These are long-term issues.
The fourth challenge is that China will have to deal with social development that lags behind economic development as evidenced by severe inequality and underdevelopment in some fields relating to people’s livelihood as well as an insufficient safety net.
The fifth challenge is polarized income distribution. China must reduce the income gap between rural and urban areas and that among different regions, expand the middle-income population and stimulate the consumption potential.
Q: You have mentioned that the reform of some key areas must be concretely implemented. What are the toughest tasks that should no longer be delayed during the 14th five-year plan period?
Liu: Two core issues mentioned in the communique of the fifth plenary session of the 19th CPC Committee are an effective market and a trustworthy and responsible government, which have been repeatedly emphasized by Chinese President Xi Jinping.
In fact, the key to the reform of the socialist market economic system with Chinese characteristics is the reform of the government, that is, the positioning and the function of the government must be fundamentally changed by building a service-oriented, law-based and digitalized government, so as to further improve the business environment. The second core issue is the reform of the factor market which, in fact, has already been treated as one of the most important reforms in recent years, particularly evidenced by the issuance of the guideline on further improving the market-based allocation mechanism of production factors in April. This shows that while the reform of the product market in China has basically been completed, the reform of the factor market needs to be further propelled.
I think, these are the two core reforms.
II. Deepen the reform of the redistribution mechanism and boost domestic demand
Q: Boosting demand has become a strategic focus at the fifth plenary session of the 19th CPC Central Committee. You have also been stressing the necessity to implement relevant strategies. What are the reasons for expanding demand becoming a strategic focus? What should China do next in this regard?
Liu: Expanding domestic demand involves many issues and is a very important strategy put forward following the supply-side reform. Maintaining a dynamic balance between domestic demand and supply is not only key to domestic economic circulation but also to building a new development pattern.
Only through expanding domestic demand and unleashing consumer potential can China truly promote the development of its “super large market” to a new level and form new competitiveness by taking advantage of this market, further climb up the value chain, gain more negotiation power internationally, change the pattern of global competition, cultivate innovation and propel reform.
So how to effectively stimulate consumption and boost demand? This will require some basic reforms and adjustment to our system. Different from Keynes’ demand management, China’s c demand expansion strategy concerns addressing institutional and structural problems which can be summarized in two aspects.
First, unleashing consumer potential through the reform of the income distribution mechanism. Second, fostering new consumption areas and making up for the loss of high-end consumption through supply-side structural reform. Finally, develop new investment opportunities by deepening the ownership reform.
Q: Reform of the income distribution mechanism, particularly improving redistribution, is a very important policy focus for boosting domestic demand. What is your view on this?
Liu: The communique has envisioned that by 2035 China’s per capita GDP would reach that of a “mid-level advanced country.” For now, China is still far away from becoming a “mid-level advanced country,” as such strong momentum is needed to achieve this goal.
According to the communique, the population of the middle-income group should also be significantly increased. This will rely on the adjustment of the redistribution system which involves several aspects:
First, the reform of the primary distribution of national income is about changing the current proportions of personal income, corporate profit and tax revenue.
Currently, the proportion of wages of urban workers in GDP is less than 12% which is too low, while that of the total household income in GDP is less than 50%. Such a structure in which the level of household income is too low when compared with corporate profit and tax revenue is quite unproductive to unleashing the consumption potential. To change this pattern, reforms are needed in wage formation, profit distribution and taxation.
Second, reform of income redistribution.
First, China needs to reform its taxation system taking into consideration of different income groups. It is necessary to levy taxes on high income groups and capital gains, and increase transfer payments.
Second, it is necessary to improve the entire social welfare system to ensure that low-income groups can receive effective and adequate social security. There are two key issues in this regard. One is to further increase the coverage of the social welfare system, and the second is to comprehensively strengthen coordination and planning on the national level. In fact, due to regional and sectoral differences, redistribution sometimes becomes a source of inequity.
Under the redistribution system, it is necessary to reform policy tools in relation to taxation, especially the property tax. China needs to shift from the current turnover tax to property tax and income tax, and have more brackets the progressive income tax system.
It can be seen that the income distribution reform is a challenging project that will touch the vested interests. Generally speaking, if such reforms are carried out amid rapid economic growth, the impact or pressure it brings will be relatively moderate. Therefore, if China is to achieve the long-term goal set for 2035, it must conduct a comprehensive strategic design now.
III. Modern fiscal, taxation and financial system shall attach importance to the proper match between revenue and expenditure
Q: The plenary session proposed “Efforts should be made to stimulate the vitality of various market entities, improve macroeconomic governance, establish a modern fiscal, taxation and financial system, build a high-standard market system, and accelerate the transformation of government functions.” In your opinion, what are the characteristics of a modern fiscal, taxation and financial system? How to establish such a system?
Liu: First, the modern fiscal, taxation and financial system should address the proper match of revenue and expenditure. In particular, we should adjust and reform the tax base to adapt to future changes of expenditure needs of taxpayers and the expenditure structure, so that the fiscal, taxation and financial system can truly serve the supply-side structural reform and help boost demand.
Second, the system demands changes in the relationship between the central and local governments. For example, the fiscal power and expenditure responsibilities of local governments should be better matched, so as to increase motivation of grassroots governments under the centralized management system.
Third, fiscal policy should make good use of the fiscal and taxation system, and play its role as an "internal stabilizer" in counter-cyclical adjustments in the market. This demands transformation of fiscal departments from their traditional position to a service-oriented law-based government body so as to build a modern fiscal system.
Q: How to realize better coordination between monetary policy and fiscal policy during the 14th Five-year Plan period?
Liu: It is necessary to deepen reform of monetary policy and promote the market-oriented interest rate reform. Monetary policy during this period should become a more scientific and refined system.
However, it should also be noted that the challenges faced by monetary policy are also enormous, because during the "14th Five-year Plan" period, China faces considerable pressure, such as the excessively high debt ratio, and the risks of funds diverted out of the real economy.
The report of the Fifth Plenary Session of the 19th Central Committee pointed out that “emphasis on economic development should be laid on the real economy”, indicating that China needs to strengthen its efforts of improving financial services to serve the real economy. It also means that we need to make the monetary policy more clear and more penetrating in supporting the real economy, in particular we need to innovate the policy instruments.
Looking forward to the "14th Five-year Plan" period, there will be a great many large-scale projects to carry out. Therefore, it is rather important to better coordinate monetary policy and fiscal policy. We should still adhere to the project-oriented principle, and let fiscal policy play the lead role and monetary policy cooperate to ensure capital flows to where needed most and further enhance the adaptability of financial services in serving the real economy.
Q: You just mentioned that it is necessary to ensure fiscal funds flow to those fields where they are most needed. Recently, there have been a lot of discussions about establishing a normalized fast-reaching mechanism to improve the efficiency of use of fiscal funds. What is your view on establishing such a mechanism?
Liu: Sometimes we cannot rely too much on the administrative measures of fiscal policy and monetary policy to serve small, medium and micro enterprises.
From a fundamental point of view, first we need to further improve the market economy. In particular, we should focus on improving signal transmission, so that market entities can have a more accurate understanding of market signals.
Second, we need to rely on technology empowerment to direct funds to where needed. Technology development can help reduce information asymmetry in the capital matching process and solve a series of practical problems faced by small, medium and micro enterprises such as information disclosure and lack of collateral among many other problems. Technology empowerment is rather important.
Third, the innovation of financial and fiscal instruments also depends on the perfection of the market system, and innovations should be made in accordance with the changes in the risks of the entire market.
In fact, in recent years, China has made many successful innovations in making monetary and fiscal policies directly reach the real economy, including achieving rapid development in the field of inclusive finance. China now is leading the world in this regard.
Q: The plenary session mentioned "focusing economic development on the real economy." What do you think of the current risks of funds being diverted away from the real economy?
Liu: An important background behind this is that many countries experienced asset bubbles and industrial hollowing-out in the process of overcoming the middle-income trap and moving into high-income countries. These problems weakened the economic, technological and overall strength of these countries. This is a profound historical lesson.
Second, countries around the world are adopting extremely eased monetary and fiscal policies, many of them slashing their interest rates to zero or negative. This could increasingly divert financial resources away from the real economy and incur huge risks, which is already observed in the United States, of particular note. China needs to be highly vigilant against this problem at a time of mounting debts, low interest rates and low growth.
Third, it should be noted that the development of the real economy, especially the high-tech sector, is at the core of China’s endeavor to improve its national strength. The Communique has proposed that China should “continue to take the real economy as the focus of its economic development”, which is a key principle of China’s financial and industrial development strategy which the country has stuck to over the recent years.
IV. Fully tap into the national innovation system and break through technological bottlenecks
Q: At the fifth Plenary Session, it was put forward that China should boost the innovation capacity of its corporate sector, inspire the creativity of its people, and improve the systems and institutions underpinning technological advances and breakthroughs. “Innovation” is also a key word that has been mentioned repeatedly in the Communique. What institutional barriers need to be removed to improve China’s national innovation system? In addition, we have noticed that many local governments and businesses have blindly followed the central government’s strategy and introduced massive high-tech programs regardless of their actual situations and needs. How to address this problem?
Liu: Innovation is most critical, but it faces the acutest shortage of resources. That’s why fueling innovation has become the first key strategic move listed in the 14th Five-Year Plan.
First, during the 14th Five-Year Plan period, it’s imperative that China breaks the bottlenecks in the development of key technologies. One of the reasons we failed to achieve breakthroughs in the past is the lack of a problem-oriented innovation process. Looking ahead, we should fully tap into our national innovation system to overcome major obstacles.
Second, China’s R&D investment in basic innovation isn’t anywhere near enough. The proportion of China’s input in basic innovation in total R&D is lower than that in the US by over 10 percentage points. Therefore, increased R&D investments based on the national innovation system will be important for groundbreaking basic innovation.
Third, innovation is a chain process, not a single separated link. Therefore targeted adjustments and reforms of systems and institutions are needed in multiple links along the process such as basic theory research, technological breakthrough, talent building and application of technology, One-size-fits-all reforms should be avoided.
In response to the call for innovation-driven development, many local governments and businesses have started building high-tech parks of all sorts. However, practical and tailored measures that are based on the foundations and levels of innovation in each region are needed to optimize the process. To this end, the central government could lead the strategic planning while taking the varied local situations into consideration.
V. Building a zero-carbon economy should be a strategic goal for China
Q: At the UN General Assembly in September, Chinese President Xi Jinping pledged that China would work to realize carbon neutrality by 2060, which has attracted worldwide attention. The Communique also stressed promoting green development and the harmonious co-existence of human beings and the nature as an important part of China’s development efforts in the 14th Five-Year Plan period. What actions do you think China should take to forge a zero-carbon, green economy? How can the financial system better support the country’s green development?
Liu: First, the building of a zero-carbon economy should be regarded as a strategic stronghold in our pursuit of green development and better life. In other words, the development of a green economy must be taken as a strategic goal.
Second, this is a long-term strategy. President Xi’s pledge is that China seeks to achieve carbon-neutrality by 2060, which indicates it’s not something that can happen overnight. Green development should be coordinated with other development measures, and should not be an isolated effort.
Third, a strategic shift in policy priority is needed to achieve the green development goal. Some short and med term policies and institutional arrangements need to be changed, and innovation in specific policy measures is also required.
VI. Transformation of global landscape will accelerate during the 14th Five-Year Plan period, and China needs to maintain strategic patience
Q: How do you understand the international environment facing China’s economic and financial development during the 14th Five-Year Plan? How should China get prepared?
Liu: To start with, we have observed profound changes in the balance of global powers, in particular the rise of Asia-Pacific, and a more important China at all fronts in this region.
The coming five years could witness these structural changes aggravating great power competition, altering the current asymmetry of power, and ushering greater uncertainty, instability and complexity. The Communique mentioned repeatedly the profound changes in the global balance of power and the increasingly complicated international environment.
So that brings me to my second point. In the post-pandemic era, with increased uncertainties and complexities in the international environment, deconstruction of the global governance system may accelerate, and the system cannot be possibly restored in a short time once demolished. Hence, global governance capacity is quickly diminishing. In the future, multilateralism could decline while regionalism will rise.
Against this backdrop, traditional challenges such as income inequality and geopolitics are deteriorating. As a result, populism and trade protectionism could continue their momentum.
In summary, in the next five years, transformation of the global landscape will accelerate amid global economic turbulence. At this critical juncture, China needs to remain calm, stick to its own goals and path, and actively pursue the dual-circulation strategy to underpin its economic development.
