The most effective way to develop China's vast hinterland is not a massive capital injection by the central government, but free market mechanisms that adjust the distribution of capital, labor and natural resources, Lou Jiwei, China's vice-minister of Finance, has said.

In a high-level symposium held earlier this week in Beijing, Lou emphasized the importance of government funds for basic education; public and social security; and infrastructure. But he doubted the efficacy of public spending for the purpose of bridging the wealth disparity between coastal areas and the poorer "wild, wild west".

Lou revealed that, of the 1.4 trillion yuan (US$168 billion) of last year's government spending, 770 billion was poured into the central and western regions. "But I wonder whether it has worked. The reason is we have not let the market play its role," said Lou.

Lou cited the example of an infrastructure project to build roads, water pipes and television connections to every village. The cost is prohibitive. "But if market forces are at work, farmers will migrate to places with higher income. As it is, the government would not be able to afford intelligent management of public services," said Lou.

Lou elucidated that it's an unstoppable force that human resources should flow from less developed regions to more developed ones. The good thing is that the underdeveloped areas will have more natural resources per capita as a consequence of population decrease. And people's income will rise accordingly. Capital should be encouraged to go to places with higher returns because that will help achieve high efficiency of resource distribution.

"Labor movement and the easing of private capital into certain areas will help balance our economy," said Lou. He believed that the residency system of developed regions should be reformed so that education and medical services for migrant workers can be improved. He also suggested that the planning of land use be eased for the east, be encouraged for agriculture in the central regions and accommodate a lower population in the west.

Hu Angang, an economist with Tsinghua University, asserted that China has two systems, one for urban areas and one for rural areas. And if you categorize China's 31 provinces or province-level cities or regions, you would find all four income levels: high, higher-middle, lower-middle, and low. On top of that, China has four societies: agriculture, manufacturing, service, and knowledge-based societies.

"What can China's government spending achieve ? And will things get worse in the next 10 years?" asked Professor Hu.

Vice-Minister Lou brushed aside the idea that government spending is omnipotent, adding that a market mechanism is needed. While acknowledging that local governments currently cannot set their own tax rates, Lou said they have plenty of non-tax means to generate revenue. He gave the example of the Beijing real estate market, where the 8,000-yuan price for a square meter includes over 2,000 yuan for all kinds of government fees. But he added that taxes for real estate and land are being considered, which will enrich the coffers of local governments.

Lou Jiwei maintained that the central government should not, and could not, continue with deficit spending indefinitely in the underdeveloped regions because that is not sustainable. This will lead to more taxes or more debt. And private investment will drop and interest rates will rise. Since this kind of financing cannot work for long, this kind of economy would not be able to carry on. "The whole idea of injecting money into less developed areas needs further study," mused Lou.

Lou mentioned Japan's Hokkaido and southern Italy as two examples that illustrate the failure of government initiatives in investment. But he disclosed that 85 per cent of this year's new tax revenues will go to China's western region, mainly in mandatory education, health care and infrastructure. This will improve the competitiveness of its human resources and push for more balance in income distribution, claimed Lou.

Bao Jigang, an eminent professor with Sun Yat-sen University, who has been evaluating government investment projects in the West's tourism industry, said: "It's hard to jump to a wholesale conclusion whether government investment is good or not. One has to assess it on a project-by-project basis."