Microsoft Word EcRefChina Oct06. doc

IV. Concluding Remarks 
I have described China’s economic reforms since the late 1970s as a gradual 
transformation of the country’s economic system, expressed in terms of a nine 
dimensional vector (Figure 1 on page 8
)
. I have argued that China has much to gain from 
a continuation of the transformation in the form of further deregulations of product and 
factor markets, not least the markets for capital and credit. More efficiency-based prices 
on energy and raw material are also important from that point of view. Deregulations and 
equilibrating prices would also help reduce corruption, since politicians and public-sector 
administrators would then have less to “sell”, such as various types of permits, loans and 
subsidies. Deregulations, combined with less political interventions in publicly owned 
firms, would also contribute to further decentralization of production and investment 
decisions. 
The decentralization of China’s economic system would be further speeded up by a 
continuation of privatization and by improvements in the working conditions of private 
entrepreneurs. Broad experience from developed countries also indicates that private 
entrepreneurship is highly conducive to innovations; see, for instance, Baumol (2000). 
Moreover, a large-scale privatization banks would, most likely, reduce the bias in bank 
lending in favor of state enterprises. (In the case of large state banks, China has so far 
only sold minority posts.) China has also much to gain from giving up its resistance to 
private ownership of land which, most likely, is a serious obstacle to faster income growth 
in agriculture (at least during a period of transition). An important source of corruption 
would then also be removed by taking away the control of land allocations from local 
caders. 
Deregulation and privatization would also boost competition and increase the role of 
economic incentives in the production system. Although a continuation of a high degree 
of internationalization of the economic system is also favorable for competition, I have 
argued that it is not likely that such a large country as China will, in the long run, have a 
foreign-trade sector of the present size (i.e., about three times as large as in the United 
States and Japan).

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If the continued economic reforms follow such lines, it is likely that China’s growth path 
will be more “intensive” (less resource-demanding) than earlier – with more emphasis on 
human relative to physical capital, less use of raw materials and energy (per output unit), 
and a faster introduction of new technology, innovation and organization.
Why should such “fine tuning” of the economic system be important when China has 
already been exceptionally successful in generating fast economic growth? One answer is 
that a more intensive growth path would release resources for consumption of both 
ordinary consumer goods and human services (such as education and health care) – 
without reducing the GDP growth rate (much). There would also (or alternatively) be 
more resources available for cleaning up the highly polluted environment. Less capital-
intensive production would also counteract tendencies to gradually increasing 
unemployment. A complementary answer to the question (of the importance of “fine 
tuning” of the Chinese economic system) could be that a more intensive growth path will 
be more decisive in the future, when China is likely to be closer to the international 
technological frontier in a number of fields. Extensive growth (based on the mobilization 
rather than the effective use of resources) was probably less problematic in early stages of 
the transition period.
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To quote Edmund Phelps (2005): in an early stage of economic 
growth, “there are so much low-hanging fruit out there in the trees … that it doesn’t 
matter very much which fruit you pluck”. 
As pointed out by many observers, the Chinese authorities have been less concerned with 
social than with growth-oriented policies. Naturally, I refer to the neglect of policies 
designed to improve income security, reduce income inequalities, and provide human 
services to broad population groups. When considering ways of mitigating deficiencies in 
these fields, policies are confronted with a delicate balance between ambitions to further 
the social situation for “urban insiders”, on the one hand, and provide modest safety nets 
and human services for the population as a whole, on the other hand. In this essay, I have 
offered both ethical and efficiency arguments for shifting the balance in favor of the latter 
strategy.
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In a more general context, without specific reference to China, approximately this point has been 
made by, for instance, Nelson and Phelps (1966) and Acemoglu, Aghion and Zilibotti (2006). 

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If the transformation of China’s economic system followed such lines, the role of the 
government would become more “traditional” than today. By that I mean that the 
government would focus on policies to encouraging market-supporting institutions, 
improving the infrastructure, stimulating investment in human capital, contributing to a 
stable macroeconomic environment, mitigating major market failures, including those in 
insurance markets, taking actions against negative externalities of various types, and 
redistributing income in favor of poor geographical areas and population groups – rather 
than intervening in individual firms. 
It is, however, generally realized that major improvements in the social arrangements 
would require much more government financing (taxes and/or mandatory insurance fees). 
Although tax revenues could already be increased through more efficient tax collection, 
considerably increased policy ambitions in the social field certainly require higher tax 
rates
. It would also be important to reform the system of intergovernmental financial 
relations by transferring more funds from central to local governments, in particular in 
poor geographical areas.
In spite of the modest ambitions of social policies during the period of economic reforms, 
life expectancy and adult literacy are rather impressive in China as compared to other 
countries with about the same per capita GDP. Indeed, according to several cross country 
evaluations, China ranks higher in terms of such “social” (or “human”) variables than in 
terms of per capita GDP – in spite of the rather low priority given to social issues during 
the reform period.
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There are at least two ways of explaining this apparent paradox. One 
could be that the high life expectancy and the widespread adult literacy are to a 
considerable extent an “inheritance” from the pre-reform period, when widely distributed, 
although quite simple, health care and basic education were emphasized. As regards 
health, another explanation could be that China more than other countries with a similar 
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For instance, while China was ranked as country number 96 in terms of GDP per capita (measured on 
a PPP basis) in 2003, it was ranked as number 85 in terms of the HDI index (UNDP, 2005, p. 81). This 
index – the Human Development Index (HDI) is based on a number of broad economic and social 
indicators.
In another study, the China Center for Modernization Research
 
(2005) concludes that China is in about 
the same position in terms of “economic modernization” as the most modern countries today were 100 
years ago, while the lag is 80 years in terms of “social modernization”. While economic modernization 
is then measured by variables such as GDP per capita and the share of the population and the share of 
GDP produced in agriculture, human modernization is measured by health variables, such as average life 
expectancy, and basic education variables, such as adult literacy rates.

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GDP per capita for a long time (before as well as after the initiation of the economic 
reforms) has stressed widespread sanitation and nutrition for the entire population – 
factors that, on the margin, may have been more decisive for life expectancy than health 
care. Moreover, as hypothesized above, serious health effects of environmental 
disturbances may only occur after rather long time lags (several decades).
I have also emphasized a number of lessons from the experiences of social arrangements 
in today’s developed countries. The most important positive lesson is perhaps that it has 
turned out to be possible to create both
 
considerable income security (through mandatory 
social insurance) and high-quality human services for the entire population – apparently 
without drastic reductions in GDP growth. Since social spending and tax rates are still 
quite modest in China, not even considerably more ambitious social programs are likely 
to be very harmful to economic efficiency and economic growth. Indeed, up to a point, 
some social policies may even be conducive on these accounts. The most obvious 
examples are subsidies of investment in human capital via better education and health 
care, as well as infrastructure investment in poor areas with a potential for considerable 
productivity increases. Social insurance may also stimulate investment in human capital 
among poor citizens by removing liquidity constraints (Benabou, 1996; and Aghion et al., 
1999). It is often also believed that, up to a point, social insurance may contribute to 
social stability, which may also enhance economic efficiency and growth – indeed, 
Bismarck’s classic argument for mandatory social insurance among workers. These 
examples illustrate the point that it does not make sense to ask whether there is a trade-off 
between welfare-state arrangements, on one hand, and economic efficiency and growth, 
on the other hand, without first specifying the starting point and 
how
new social 
arrangements would actually be designed.
However, experiences in developed countries also show that it is important to make 
welfare-state arrangements reasonably robust to exogenous shocks – such as unfavorable 
changes in demography, productivity growth and unemployment. It us also important to 
avoid large “undesired” endogenous behavioral adjustments by individuals, for instance, 
as a result of tax distortions and moral hazard. I have discussed various ways of 
minimizing such risks. One is, of course, to keep the generosity of the benefits within 
“reasonable” limits. Another way would be to opt for “quasi-actuarial” social-insurance 
systems, hence tying benefits tightly to the individual’s own previously paid 

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contributions. Countries in early phases of building up welfare-state arrangements, 
including China, have particularly strong reasons to be aware of the risks of disincentive 
effects when entering the route towards more advanced welfare-state arrangements. By an 
appropriate design of future social arrangements, and their financing, China may be able 
to avoid serious trade-offs in the near future between social ambitions, on one hand, and 
efficiency/growth considerations, on the other hand.

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