As China moves towards ‘common prosperity’, it must not take its eye off growth

If the shift in strategy is to succeed, Beijing must adjust tax policies, improve the social safety net, and ensure equal opportunities by reining in corporate excess
Achieving fast yet equitable growth demands a delicate balance between growth-oriented strategies and redistributive policies

Aidan Yao

Published: 2:30pm, 8 Sep, 2021

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As China embarks on a transition from a growth-first development model to one of balanced growth and equality, it is trying to ensure that wealth redistribution does not undermine the importance of wealth creation.

As a developing country, with per capita income less than one-fifth of the United States’, China cannot afford to abandon its growth objective and become a full welfare state. Finding an optimal balance between “ dual circulation”, which aims to grow the pie, and “ common prosperity”, which focuses on cutting the pie, is critical for China’s development.

In my last piece, I analysed how, beneath the seemingly uncoordinated regulatory crackdowns on multiple, unrelated sectors, a profound shift seems to be occurring in China’s long-term development strategy – from “allowing some people to get rich first”, an approach initiated by Deng Xiaoping, to “common prosperity for all” under President Xi Jinping.

While both strategies aim to remould China’s income and wealth distribution to create an olive-shaped society – from a pyramid shape – the first strategy does so by lifting people out of the bottom of the income pyramid, while “common prosperity” is designed to redistribute wealth from the top.

A public screen in Shanghai displays China’s GDP figures on August 18. China’s per capita income is less than a fifth of that in the US. Photo: Bloomberg

To achieve this ambitious objective, Beijing will probably need to focus on policy adjustments in three broad, but critical, areas.

First, it must redistribute income and wealth via tax and other incentives. While personal income and corporate tax rates are unlikely to change materially, a tax on wealth (such as inheritance and capital gain taxes) and assets (a property tax, for instance) could be introduced soon to tackle inequalities.

Big tech may soon see their tax privileges fade as Beijing tightens the criteria for tax breaks linked to innovation, and research and development spending.

Recent policy discussions also point to providing incentives for philanthropy as a way to redirect wealth from the super-rich.

Second, China must build a better social safety net by enhancing basic protection. China’s total public spending on social security, employment and health care only amounts to around 9 per cent of gross domestic product, according to the National Bureau of Statistics. This is significantly below that of the OECD average of 20 per cent.

Fiscal spending on social infrastructure has also trailed markedly behind investment in hard infrastructure in the past few decades as Beijing prioritised growth. But with the shift in priority, the former is now expected to grow faster, particularly when infrastructure investment runs into its own supply bottlenecks.

Roads are flanked by the Hongshui River in Jingsheng township of the Duan Yao Autonomous County in Guangxi, on September 1. Mountainous Duan has in recent years invested a lot to upgrade its roads. Spending on social infrastructure is now set to rise faster. Photo: Xinhua

Third, Beijing must enhance social fairness and equal opportunities by limiting excess profit for industries that produce public goods and supporting the advance of the underprivileged in society.

Common prosperity, from what I can see, is not about equalising income, which reduces incentives for workers and entrepreneurs but, rather, about equalising opportunities. In an ideal world, companies of all sizes and people of all backgrounds should be allowed to compete on a level playing field and have the same opportunities for success.

The reality is far from ideal, but government regulations (such as antitrust laws) and policies (including on strengthening the social safety net) can help narrow the competitiveness gap.

In that regard, investors might want to beware of future regulatory risks with industries that produce products of social importance which have been enjoying excess profit and attracting significant capital.

09:40

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The journey to common prosperity is not without risks. Achieving fast and equitable growth demands a delicate balance between growth-oriented policies and redistributive policies. A poor balance – leading to, for example, an overtightening of regulations – could stifle innovation and undermine business vitality and productivity growth.

Policy coordination is also key, as reshaping income distribution will require multifaceted reforms. With various departments and local governments eager to heed Beijing’s new strategic shift, there is a risk that too many regulations will be enacted too quickly. The lack of policy coherence is partly to blame for the violent market reaction recently.

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The last time badly coordinated policies wreaked havoc was in 2015-16 when mismanaged foreign exchange reforms coupled with a deleveraging campaign prompted billions of yuan of capital outflows from China. Beijing needs to be mindful of repeating the same mistake.

Finally, the lack of transparency in decision-making and poor communication have also exacerbated recent market volatility. This can undermine business and investor confidence, creating larger-than-necessary side effects or even sabotaging reforms themselves.

The bigger decline in recent months of Chinese stocks listed offshore – vis-à-vis those onshore – suggests that the erosion of confidence has been greater among foreign investors.

Without carefully managing their expectations, a misunderstanding of policy intentions could reduce the appetite of foreign (particularly US) investors for Chinese assets, curtailing Beijing’s effort on market liberalisation and fuelling financial decoupling between China and the US.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers