Income distribution is in need of reform
(China Daily)
Updated: 2007-07-10 07:05

Policy tightening will probably be on the minds of many in the second half of the year.

After the key economic indicators were released early last month, people were not surprised to see that all but one economic figure was on high-speed growth. The trade surplus, the consumer price index, property prices in big and middle cities and industrial output were all climbing quickly by the end of May.

Many were alerted by the potential indication of the numbers. At a meeting of the State Council held on June 13, Premier Wen Jiabao and his colleagues pointed out that due attention must be paid to looming problems in the economy. Measures should be taken to step up macro control to prevent possible overheating of the economy. Both monetary and fiscal policies would be tightened to assist such an effort.

Of course, adjustments to the policy will bear some fruit in reducing inflation pressure, regulating industrial output and promoting imports to check the trade surplus. However, people expect too much from macro policies.

Under the current situation, macro controls bear a weakening effect on the economy. And the traditional way of economic adjustment may not be good medicine to cure a headache.

A tightened monetary policy will hardly check the excessive liquidity. The central bank has raised the requirement for deposit reserves several times in order to reduce liquidity in commercial banks.

Raising the requirement rate causes less of a shock to the economy than issuing central bank notes while having the same effect on liquidity control.

However, the central bank would have to pay commercial banks for the reserve fund. Commercial banks would probably be motivated to make such deposits to get interest. Thus, deposit reserves would no longer function as a policy tool for cutting down money supply from the bank.

The current excessive liquidity is not peculiar to China, other countries are also suffering from it. But in China's case, the cause is the imbalance of its international payment, especially the growing trade surplus in recent years.

Admittedly, the trade surplus is a result of the international industrial transfer, low labor costs and the changes in the exchange rate of the renminbi. But a more substantial reason for the trade surplus is the high saving that has gone far beyond the investment.

The runaway growth in investment is unlikely to be reined in with regular policy tools. In recent years, capital investment has been lucratively profitable. With a few exceptions, the sector has shown a 30 percent growth in net profit every year. Businesses have no reason to cut down investment with such encouraging rewards.

The fact that policy tools lose their efficiency originates from many elements, the key being a lopsided structure in income redistribution among different sectors of the nation.

In recent years, main part of the wealth newly created in economic activities has gone to the State revenue and business profits instead of the common people.

The government took 21.1 percent of the disposable income of the country in 2001 and 24.2 percent in 2006. Business income grew to 17.5 percent in 2006 from 15.1 percent in 2001 and residents' income dropped to 56.5 percent in 2006 from 63.8 percent in 2001.

When the government has more money, it will inevitably be motivated to make more investment through various channels. The increasing business income would also stimulate businesses to put more money into enlarging their factories.

In the last two centuries, most market economies have proven that unreasonable income distribution brings a production capability surplus.

China has also seen such a surplus. With the help of free trade, exports have diverted part of China's production capability into overseas markets, but the troubles caused by production capability surplus may surface sooner or later in China.

Such a scenario might be devastating to some industries or some regions. To guard against it, there must be reform to policies on income distribution. Once investment and consumption are on par, the economy can move forward with fewer obstacles.

The primary target in reforming income distribution is to eliminate factors retarding the free flow of productive elements, like capital and labor.

The authorities should facilitate rural residents to get equal opportunities in employment and education like their urban counterparts. When productive elements are free to flow according to market forces, the income difference between urban and rural populations, different parts of the country and different businesses would be reduced.

Another important step for the government to take is to collect taxes on the exploration of mineral resources, land, and use of other State assets.

Businesses, State-owned or private, should pay a license fee to the State to get their hands on State property and then pay taxes for their usage. State-owned enterprises should also give dividends to the government from their profits.

The money would flow from businesses to the government, and reduce the investment impulse of businesses and boost the State coffer as well. The government should also put more money into the public service and social security system.

The author is an economist with the State Information Center

(China Daily 07/10/2007 page10)