OECD recommends China focus on economic reforms

The OECD last week released its latest OECD Economic Survey of China. The report sees economic growth slowing slightly, but remaining above 6 % p.a. in 2017 and 2018 with the help of extensive stimulus measures. The survey's main emphasis, however, concerns China's need to tackle emerging problems to place the economy on a sustainable long-term growth trajectory.

Chinese fiscal policy has been very expansionary. In addition to increased budget spending, fiscal stimuli have been channelled through re-capitalized policy banks and allowing local governments' off-budget financing vehicles to restart borrowing. The OECD would like to see China adopt more prudent fiscal policy, given rising pressure for public spending as the population ages and the need to expand social safety nets. Improving and expanding coverage of pensions and health care services, as well as providing better education opportunities, would reduce the need for households to save. This, in turn, would boost consumption demand and facilitate structural change of the economy.

With the elimination of business tax, local governments have had to make up for lost revenues by resorting to extensive sales of land-use rights. The OECD notes that regional administrations could compensate for the loss with environmental taxes and more progressive personal income taxes, taxing other types of income such as rents, as well as the introduction of real estate and inheritance taxes. The tax changes would help to address income inequality and mitigate environmental problems.

Financial sector risks have increased with the rapid rise in housing prices, purchases of securities and real estate on credit, as well as the extremely high corporate indebtedness. Moreover, an increasing share of money invested in wealth management products offered by banks is simply reinvested into other wealth management products rather than corporate loans as earlier. Should shocks occur, there is a heightened risk of contagion. To avoid problems, the OECD suggests that China improve its financial sector regulation, increase supervision and restrict leveraged investment in asset markets. The OECD also recommends improving the financial literacy of households.

The OECD estimates that productivity growth has slowed in recent years, due mainly to poor investments made in the wake of the financial crisis. Improving production in the corporate sector remains critical. It should be easier to set up a new business and wind down non-viable zombie firms. One needed step is to update China's bankruptcy law. Competition could be improved further in some branches and pricing of for example energy rates could be revised so that end-user prices reflect actual production and transmission costs. Many problems would be ameliorated through improved corporate governance practices, including better internal and external supervision. For example, laws on whistle-blower protections need improvement. Management of state-owned enterprises should be professionalised and compensation more closely tied to performance.