How China can promote common prosperity and still keep economic growth going

Tax reforms and better social benefits will bring down savings, boost consumption, and so lessen reliance on credit-driven investment and cut banking risks
Investor fears of a return to a more planned economy should be assuaged – removing the policy uncertainty that common prosperity has raised should be a first priority

Bert Hofman

Published: 4:30pm, 13 Oct, 2022

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In President Xi Jinping’s expected third term, his new development philosophy is likely to play a central role, with its constituent parts – including dual circulation, ecological civilisation and common prosperity – becoming cornerstones of China’s socio-economic policies.

Since the recent economic slowdown, common prosperity goals seemed to have been put on hold, but in recent months, they have re-emerged. One sign is that Xi’s 2020 speech on the new development philosophy was published this August in the Communist Party’s Qiushi journal.

Last month, Han Baojiang, professor and director of the economics department at the Central Party School, said common prosperity would be a central policy feature after the 20th party congress.

In August, a People’s Daily article by Chinese Academy of Social Sciences vice-president Gao Peiyong also suggested common prosperity would be central in Xi’s economic programme.

A key question is what this implies for China’s economy. Handled well, common prosperity can be a powerful tool for rebalancing the economy towards more equal, consumption-driven growth. Handled badly, it can harm growth and stifle innovation and entrepreneurship.

Common prosperity is first and foremost a political objective, much like Deng Xiaoping’s vision of a “ moderately prosperous society”, officially achieved last year. But Deng’s “some may get rich first” philosophy, which fuelled China’s extraordinary growth, has also resulted in rising income and wealth inequalities that have become a major political issue.

Xi outlined six areas in achieving common prosperity: (1) identifying a more balanced, coordinated and inclusive development path; (2) expanding the middle-income group; (3) facilitating equal access to basic public services; (4) intensifying the regulation and adjustment of excessive income; (5) promoting common prosperity in people’s spiritual life; and (6) promoting common prosperity in rural areas.

Of these, the regulation of excessive income has drawn the most attention. The regulatory clampdown on internet companies was increasingly presented as part of the common prosperity campaign. The wide-ranging campaign addressed issues such as monopolistic behaviour in e-commerce, risks in online finance, private tutoring, influencers’ high income and video game content.

Government documents and Xi have alluded to a traffic-light system for investment to contain the “excessive expansion of capital”. Such policies should ensure that capital works for the greater good in society, but have also raised fears of a return to a more planned economy. This has not helped China’s investment climate, already under duress from Covid-19 policies, a faltering real-estate sector and geopolitical tensions.

How can China promote common prosperity and keep growth going? Where China stands out is its limited redistribution though the government budget.

Redistribution is by and large the route European countries have taken, and to some extent the United States and Japan. Strikingly, these countries have Gini coefficients similar to or higher than China’s. After redistribution though taxes and transfers, most have Gini coefficients of disposable income well below that of China.

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Remarkably, China’s income tax revenue is modest. Though the highest income tax rate is 45 per cent, comparable to that of countries in the Organisation for Economic Cooperation and Development, China’s tax only yields a modest 1.2 per cent of its gross domestic product, compared to 8.4 per cent in the average OECD member.

Most of China’s tax revenues come from value-added taxes, consumption (luxury) taxes and social security contributions. Value-added taxes are a greater burden for the less well-off because they spend a greater proportion of their income on consumption. In China, social security contributions demand a minimum contribution from low-income earners and has a high income cap, which also makes them regressive.

Meanwhile, social security and welfare spending remains modest. While urban workers received on average a pension of 3,500 yuan (US$490) per month in 2020, the rural equivalent is 160 yuan. This is about equal to the national average for social welfare payment or dibao.

Furthermore, coverage of unemployment insurance is largely limited to urban hukou – residency rights – holders, and migrant workers have to rely on savings or welfare in their place of origin.

China’s consumption drive hinges on better social welfare, rural incomes

Thus, China is still far removed from the “welfarism” that the leadership fears could undermine growth. Tax reforms and more generous benefits could therefore contribute to common prosperity.

China’s spending on health and education has rapidly increased in the past two decades. However, since this expenditure comes under local governments, spending per capita differs widely across the country, even after central government subsidies to poor regions is accounted for. Equalising public services across the country, as envisioned for common prosperity, will require more, and more efficient, spending.

Spending more on pensions, welfare and social services has the added benefit of increasing consumption as a share of GDP. With better government provision, the need to save will go down and households can reduce their record-breaking savings rate of about a third of disposable income on average.

This will allow China to rely less on credit-driven investment, reducing risks in the banking system. Financing part of the spending increase using higher dividends from state enterprises would further reduce savings and such investments, in particular investment in infrastructure, which China has in abundance.

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Within a lower investment envelope, more should go to non-state enterprises, which yield higher returns and have been the drivers of innovation and productivity.

Taken as such, common prosperity could be a major contributor to a more balanced and stable growth. Removing the policy uncertainty that common prosperity has raised is a first priority, and the government can use the third plenum of the 20th Central Committee next year as a launching pad for the policy it takes to create true common prosperity.

Bert Hofman is director of the East Asian Institute and Professor in Practice at the Lee Kuan Yew School of Public Police, National University of Singapore