BOOK REVIEWS

Christine Wong (ed.): Financing Local Government in the PRC

This work, edited under Christine P. W. Wong’s direction, is the fruit of a collective research project carried out under the auspices of the Asian Bank of Development and co-financed by the Chinese Ministry of Finance. The importance that the Chinese attach to the subject can be measured by that simple fact—that a public body in China should fund research carried out by foreigners: it doesn’t happen every day. This book forms, in effect, the second part of a wider enquiry into the Chinese fiscal system; the first part, which came out in 1995 (1), analysed the evolution of the system since the present reforms began, from the perspective of the central government and its relations with the provincial governments. This second study extends the research into public financing at the local level (cities, counties, towns and villages), while comparing Chinese experience with that of other countries. To construct their analysis, the authors carried out an in-depth study of local finances in two provinces, Shandong and Guizhou; in four cities, Qingdao and Tai’an in Shandong province, and Guiyang and Anshun in Guizhou province; and in four counties, Qufu and Penglai in Shandong, and Zunyi and Puding in Guizhou. The authors also gathered quite a lot of data on the province of Hebei. All this, together with the statistics available at the national level, enabled them to draw a fairly reliable picture of the state of local finances.

In spite of the importance of the subject, local funding remained, until lately, very widely ignored by China studies. A few recently published works have tried to tackle this problem: works like that of Marc Blecher and Vivienne Shue (2), or the collective article by Christine Wong, Albert Park, Scott Rozelle and Changqing Ren (3), or again from a slightly different angle David Goodman’s research programme into the Chinese provinces. None of them, however, confronts this subject head on, nor in as much detail as the new study edited by Christine Wong, which will certainly mark a milestone in this field.

In the book, the authors disclose that, according to a study by the Asian Development Bank, China needs to invest nearly US$500 billion in the telecommunications and transport sectors alone, over the next decade, simply to meet the requirements of growth (p. 124). More than 300 big cities and 13,000 medium sized towns have been administratively created since 1983 to help cope with urban population growth, which is expected to reach nearly 750 million people by the year 2010. Now it appears that Chinese public services (such as health and education) and urban infrastructures are very largely financed at the local level: the authors estimate that up to 60% of the country’s public spending is allocated by local government officials, and that does not include so-called “extrabudgetary funds” and other income which is controlled almost exclusively by local governments and would increase this percentage.

The authors find, however, that the Chinese fiscal system is badly organised to meet this challenge: this is one of the book’s main conclusions. Economic reform has brought greater fiscal autonomy over revenues and expenditures to all levels of public administration; but as a consequence of this evolution the researchers found very serious disparities between different local authorities in their capacity to provide for the most elementary needs of the population. The authors offer international comparisons that show China as one of the countries where such disparities are the most flagrant. The authors offer examples drawn from education and health to illustrate these imbalances, but they also emphasise the gap between political decisions taken at central government level and their application on the ground. When it comes to education and health, the central government has taken a number of measures, as it usually does, in the form of quantitative targets, without providing the financing or management structures to achieve them. Spending on education in the poorest rural county of Guizhou province has not kept up with the growth of tax revenue. The share which education draws from overall public spending is in decline, falling from 13.6% in 1989 to 12.3% in 1993 (p. 224). In most cases, local authorities have had to resort to taxes of various types (most often without the permission of the central government) to finance education spending (p. 230). Generally speaking, the average tax revenue per Chinese county was 34 million yuan, but we are witnessing a huge disparity: 161 counties, the richest, had more than a 100 million yuan in income, while at the bottom of the scale we find some 2,000 counties which cannot manage to cover their needs by the taxes they raise. One finds the same variance at city level, though to a lesser degree.

From this point of view chapter 7, written by C. Wong and L. West on the question of equalising public expenditure on the basis of local authority needs, is certainly one of the most interesting. It offers the main elements of an explanation for these disparities, and gives us a glimpse of the government’s formidable undertaking as it grapples with fiscal policy. The main element of the authors’ explanation is, firstly, the misuse of transfers of tax revenue between administrative levels since 1978, and, secondly, their slow erosion. The authors have carried out several statistical analyses to measure the differences between revenue and expenditure, so as to assess how effective transfer procedures are between provinces, and between different levels of administration within a single province. The lessons drawn from their study in the field, and from different statistical relationships, show that equalisation of budgetary spending is in fact taking place, thanks to massive transfers of income between provinces, or in the interior of a single province. The province of Shandong, for example, spent only 59% of its available resources: it redistributed upwards (to the central government) and downwards 41% of its taxation revenue. In the same way, the taxes raised at town and village level are sometimes diverted upwards in large proportion to the districts. Also, generally speaking, it is quite normal to find overall that there is less dispersal of expenditure between the different provinces and levels of administration than of revenue. There are wide disparities between tax revenue in different areas, and only transfers can help towards equalising public spending. However, the authors have toned down this conclusion in two important respects: on the one hand they conclude that equalisation is less and less perceptible; or, put another way, that sums transferred between different levels of administration amount to a decreasing share of fiscal revenues, particularly since 1988 (p. 292). So these results confirm what we knew quite well at the national level, namely that a diminishing share of the taxes raised in the provinces is passed to the centre. If one looks at provinces in surplus, and at big cities with an autonomous budget (jihua danlie chengshi, of which there have been nine since 1993), the transferred share of their tax revenues was down from 31% in 1986 to 22% in 1993. On the other hand, among different methods of transfer the one based on fixed quotas, negotiated between the different levels of administration, seems the most effective, for it offers a response to the real needs of governments. Their share, however, in the overall amount of transferred revenue is falling. Even so, subsidies have an effect that is contrary to their initial aim: they do not lead to an equalisation of expenditure. Subsidies benefit the richest provinces or local areas. The explanation offered by the authors is based on the fact that subsidies help to guarantee price stability, which in turn benefits the more urbanised regions. So as the years go by, cash transfers are less and less capable of securing equal expenditure per capita. It is all the more true that subsidies are determined in a muddled and improvised way that does not allow the needs of different administrations to be met.

The second source of disparities, the authors say, is the growth of “extrabudgetary funds” and other funds not included in the budget, which are at the discretion of local authorities. This phenomenon has been analysed over a long period in studies on China’s economy, especially studies on investment control and on the disorder created within industrial structures (absence of economies of scale, compartmentalisation of production at the provincial level). Here the authors have sought to analyse the consequences at the level of local government finances. While these non-budgetary revenues have without any doubt enabled local authorities to increase their spending capacity, not all authorities have the same ability to raise this kind of funding. Indeed, such revenues are directly linked to the scale of industrial activity (in essence they are taxes raised from businesses). Also the richer the town or village, the more local government is able to generate this type of income. However, this unbudgeted income escapes from the control of higher levels of administration and, by that very fact, from any redistribution policies that the central government may propose. Therefore, the least industrialised areas face a double disadvantage: their access to non-budgeted revenue is more restricted and, for reasons indicated above, their income transferred from other administrative levels is diminishing with time. The poor regions thus have a tendency, for their own survival, to impose very unpopular taxes; in the medium term this could have political costs for the Chinese authorities.

The great strength of this book is that it throws light on the fiscal mechanisms which help to create these budgetary spirals of imbalance in China. These phenomena actually perpetuate the problem. Before the reforms were launched in 1978 the imbalances were caused by deliberate choices of policy: they were linked to the planned economic system. Rural areas had to finance industrial development in urban areas, and were not supposed to require anything from those urban areas in terms of fiscal support. What’s more, in the cities, urbanisation and services were linked to the industrial enterprises which provided social security, housing, and sometimes education, and took care of industrialisation. In the context of a transitional economy, as in China, one can measure in this way the progress of fiscal reform.

The authors round off their book with a series of very apt recommendations. These include the necessity for the central government to lay down minimum national targets in education, health and urbanisation, which all local authorities must at the very least attain. The richest authorities would be free to exceed these minimums, but the poorest provinces should have access to transfers of taxation revenue that would allow them to meet the required standards. The authors assert the need to clarify responsibilities for expenditure, and to assign them more evenly, at different levels of the state administration. They also insist on thorough reform of transfer procedures of taxation revenue between poor authorities and richer ones. This obviously implies that unbudgeted funds and other sources of income that are still at local officials’ discretion should be embraced within the state budget, so as to include them in the system of revenue transfers. According to the authors, the reforms of 1994 amount to a first step towards relieving the structural imbalances of the Chinese fiscal system. The reforms, however, were limited to rationalising the relations between the central government and the provincial governments. The book suggests that the reforms have not yet reached down to the lower administrative levels of provincial governments.

In the end, there are few criticisms to be made of the book. One might occasionally deprecate some rather sterile descriptions of local authority structures, for income or spending, which the authors seek to compare. They themselves seem to acknowledge (p. 148) by their vocabulary that they do not know the details of certain expenditure items, or the causes of their evolution, which render the comparisons of little interest. One would also have liked to see a more thorough treatment of certain points. The link with the reform of state enterprises, for instance, is only superficially touched upon. Yet local governments and state enterprises maintain indivisible links when it comes to local financing of housing, education and, above all, social security. In fact, a complete overhaul of urban economic organisation, together with the reform of state enterprises, is at the heart of the debate. Enterprises must certainly withdraw from their involvement with welfare services, and hand over such management to local government, as the authors suggest in their recommendations (p. 318); but this withdrawal is far from being a straightforward or rapid process, as is demonstrated by the experience of China, as well as by that of other formerly socialist countries. The book’s introduction professes the wish to make comparisons with other countries’ experience, and one would have welcomed a little more detail on that subject. In the pursuance of this debate, the question of taxation inevitably leads us to that of social justice. How should the financing of the budget, and of social security, be shared out among different social categories? What form of control does the population have over the fiscal system, and over the big decisions to be made in fiscal policy? These are the points at issue. At no time does one find in the book any trace of this debate—neither in the analyses of the fiscal systems deficiencies, nor in the concluding recommendations for reform. Accordingly, one is bound to regret the failure to analyse the connection between public funding and democracy: like it or not, in industrialised as well as in developing countries, this connection represents one of the most important criteria of economic and social development.

In spite of this handful of criticisms, we have here a very rich book which covers practically every aspect of local funding in China. One can only hope that the recommendations for reforming the fiscal system will be heard by the Chinese authorities, who are at present undertaking a difficult policy change in the pursuit of economic reform.