中國大陸預算赤字:演算、原因及影響
Budget Deficits in China:
Calculations, Causes, and Impacts

Huaping Luo
Robert T. Golembiewski

University of Georgia
Department of Political Science
Baldwin Hall
Athens, Georgia 30602
(706) 542-2057

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Abstract


This essay needs to acknowledge two deep debts. It sees itself in the perspective proposed by a leading report co-authored by the researcher to whom this appreciative book is dedicated (Verma and Sharma, 1985). There, every public functionpersonnel, finance and so onis seen intimately linked with its cultural and constitutional contexts in developmental cycles whose understanding will challenge the best that is in practitioners and researchers. Ideally, research can inform action; and action always help set the agenda for research, whether that elemental fact is recognized or suffers neglect. Generalizations typically are dangerous, but we cannot here go far wrong in assigning a high priority to public budgeting and financial administration. This was true in the United States of the 1970s and 1980s; it remains appropriate for the 1990s; and one can even now raise reasonable claims for the continuing salience for financial administration as we move beyond the year 2000 A.D.the Chinese year of the Dragon.

Cross-national studies on public budgeting and financial administration typically involve many challenges but, as a scholar points out, individual case studies and analyses constitute a key step in the right direction (Guess, 1992). This essay deals only with selected aspects of China’s financial administration that will inform later and full-blown comparative analysis. This essay does not hide its ambition, but it can now claim the label "comparative" only in the narrow sense of an early exploration of the synergy between the training, methods, and experiences of the two co-authors.

This essay also learns from Verma in another particular: comparative methods and research designs have a special power. Although developmental phases often will differ, good comparative research is relevant for many governmental units. In sum, such research can inform policy-makers about where their jurisdiction is, has been, or may be going.

Budget deficits are a main theme for disciplines like public administration, political science and economics (Wildavsky, 1988, pp. 205-209; Schick, 1990, pp. 70-74; Kettl, 1992; Savage, 1988, pp. 14-17; Eisner and Pieper, 1984). The People’s Republic of China provides a window through which students of comparative and development administration can have a glimpse at how one developing country deals with budget deficits. This essay has four emphases: it discusses the calculations of deficits in China, analyzes the causes of budget deficits, assesses the impacts of deficits, and predicts the future of deficits in China.



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Budget Deficits in China:


Calculations, Causes, and Impacts

1. Calculating Budget Deficits In China
Budget deficits are simply a fact of life for most of the countries in the world, and they are similarly understood. A budget deficit is simply the amount by which a government’s expenditures exceed receipts. There are no important differences in the way oriental and western scholars generally define budget deficits (Chen, et al, 1984, p. 123-35; Kettl, 1992, p. 16).

However, a general definition of deficits does not resolve the problem of how to estimate or calculate deficits (Courant and Gramlich, 1986, pp. 8-12). To illustrate, the calculation of deficits by the Chinese government uniquely dealt with debt revenues before 1994.(1) In the Chinese calculation, a budget deficit equaled expenditures minus the sum of debt disbursements and current revenues. In other words, in China, debt disbursements constituted revenues rather than a means of financing deficits. As a result, the officially published deficits were much smaller than the ones calculated by the method accepted by most countries. For instance, suppose that in a fiscal year the government’s expenditures were 500 billion yuan, debt revenues were 50 billion yuan, and non-debt revenues 400 billion yuan. For the Chinese government, the deficit was 50 billion yuan (500 billion - [400 billion + 50 billion]). But for most countries, the deficit would be 100 billion yuan (500 billion - 400 billion).(2)

Note another feature associated with this unique calculation. The official deficits were totally financed by "loans" or "overdrafts" from the central bank--the People’s Bank of China. In China, until today, the People’s Bank cannot refuse overdrafts by the Ministry of Finance because the government budget is approved by the top leaders. Of course, no one expected that such "loans" would be repaid by MOF to the People’s Bank, and in fact such "loans" have never been repaid. The official or "hard" deficits were simply financed by printing money. Consequently, the financing of deficits in China was different from that in America where financing deficits through direct loans from the Federal Reserve is was prohibited by law, although for the latter the Federal Reserve monetizes a very small share of the government deficit through open market operation (Kettl, 1992, p. 28; Courant and Gramlich, 1986, p. 20; Shahin, 1992, p. 74).

The Chinese official deficits were often called "hard" ones because of their great impact on the economy. They were financed by printing money, which increases the supply of money undesirably, and exert inflationary pressure on the economy (People’s Daily, March 28, 1993). Unlike the U.S., where money supply is controlled by the independent Federal Reserve, Chinese money supply nominally is controlled by the People’s Bank, but which is very responsive to the commands of top party and government officials.

If judged from standard international practice, In China, "soft" deficits had also existed, although they were not reported by the government. Those deficits were "soft" because they were completely financed by the government’s domestic and foreign debts, and exert less inflationary pressure on the economy than "hard" deficits . "Soft" deficits approximately equaled the net of net debt revenues (new issuances minus repayments). This is not the place for details, but calculations suggest that the about 58 percent of the actual deficits (calculated by international standards) from 1979 to 1993 are "soft".

The unique Chinese official calculation of deficits further encouraged an always-tempting illusion--that the government can spend without discipline. On the maturity of government debts, and as debt repayments reach their peak, the government simply but has constantly increased the size of the new debt issuance. The illusion was a dangerous one, even if all stakeholders agreed to play that game.

The official calculation of deficits, although rather peculiar, had a major political advantage?it underestimated the size of deficits and hence overestimated the performance of the government. The Ministry of Finance (MOF) loved this definition because deficits were believed to be a negative indicator of MOF’s performance. In addition, because Chinese "hard" deficits had an inherent linkage with inflation, when (as often happens) inflationary pressures became a concern of the society, the government and elites leaders tended to prefer underestimated if illusory deficits over a real but larger one because no one wants to take the responsibility for inflation.

Note that, since the early 1980s, the government’s attitude toward budget deficits has changed from complete rejection to limited acceptance. Prior to 1980, China’s budgetary policy produced or even faked an annual balance between revenues and expenditures, plus a small surplus (Ge, 1982-83). This budgetary policy was required by China’s traditional command economy, in which the government controlled all economic activities. Microeconomically, the government specified what to produce and how much to produce by state-owned enterprises, which accounted for more than 80 percent of all goods and services. In this command economy, producer sovereignty reigned. Consumers had few choices in addition to purchasing whatever the state-owned enterprises produced: they could risk dilution of their funds by inflation, or go extralegal or illegal. Macroeconomically, the government tried to keep a balance, although illusory, between the quantity of money in circulation and the quantity of commodities in order to avoid a "hidden" inflation--commodity shortages. This was a losing game. The planned economy inevitably more or less resulted in shortages because price signals did not play an effective role in allocating resources. A planned economy failed because no government, even aided by modern computers, had the capacity to predict individual consumers’ demands and accordingly, to plan production. Budget deficits were believed to be a factor aggravating shortages. When prices were controlled, an unduly expanding supply of money would demonstrate itself by creating shortages of supplies and commodities. Of course, it is incorrect to attribute all shortages to budget deficits.(3)

In addition, the Chinese government tried to avoid deficits because they were believed to symbolize government inadequacy. Since the government had tried to maintain a picture of being omnipotent, it had claimed the ability to balance its budget. Budget deficits would erode the credibility of the government.

Consequently, the government tried to avoid deficits, or at least to camouflage them. Although deficits actually existed in ten of the thirty years from 1950 to 1979, all of them occurred as a result of overestimating revenues or underestimating expenditures due to uncontrollable factors such as natural disasters (Sheng and Chen, 1981). In other words, no even a single deficit was planned. Rather, expenditure controls were weak and/or arbitrary. In China, for example, supplemental appropriations needed no approvals from the legislature. Typically, when an agency faced an urgent unplanned demand, it could obtain extra appropriations if its request was approved by the main party and government leaders. If no revenues available could meet the agency’s demand, the Ministry of Finance would overdraw from the People’s Bank of China.

In the early 1980s, as noted, the Chinese government policy featured a limited acceptance of budget deficits, related to 1979’s unprecedently-large deficit--17.9 billion yuan, or 14 percent of expenditures. This resulted from several sources: a revenue decline caused by wage increases to state-owned enterprises’ staff and workers; an increase in capital outlays resulting from the government’s ambitious development programs; an increase in defense expense due to the Sino-Vietnam border conflict; and a one-time repayment to government employees of salaries postponed by the Cultural Revolution.(4) In FY 1979, while revenues decreased by 1.78 billion yuan, the wage bill, capital outlays and defense expenses increased by 6 billion yuan (Zhang, 1982, pp. 1-38). The 1979 deficit, due to its immensity, shook the government’s confidence in its ability to balance its budget in the short run, given the demands for government investment to fund long-term development. In 1980, the government planned a deficit for its budget for the first time (Wang, 1980). Ever since, all deficits have been planned rather than as a result of unexpected influences in the implementation process, except for those in 1981 and 1986 when planned balanced budgets ended with deficits. The correlation between budgeted and actual deficits seems both high and positive (See Figure 1).



This change in budgetary policy might be said to symbolize a shift in fiscal philosophy in China (Hsiao, 1987, p. 46) but, to a greater degree, it reflected tough trade-offs between political and economic alternatives. Although the accepting deficit budgets was hardly easy, they did have their economic and political advantages, given China’s context at that time. Economically, the government’s dominant role in economic development was inevitable, given the tiny non-public sector, and government capital spending had been major engine for China’s economic development. However, limited budget resources became a severe constraint on future development: it seemed impossible to further raise tax rates and profit contributions. Compared to slowing economic development, deficits were politically attractive. Rapid development is very helpful in building top leaders’ credibility. Because of a lack of personal stature like Mao Zedong’s, the Chinese leaders in the post-Mao period were eager to establish the trust of the people. People were tired of unfilled promises made by the government in the past. They strongly support those who can help reduce poverty. As a result, development became a top priority. Between reform and a balanced budget, the leaders chose economic reform. Hence, to post-Mao leaders, the political attractiveness of reform even with unbalanced budgets was larger than that of no reform with balanced budgets.

As noted above, the official estimates underestimated the size of deficits in China because debt disbursements were counted as revenues. In order to have a clear picture of China’s deficits, the official deficits need to be adjusted by a normal definition of deficits (see Table 1).(5) It needs to be pointed out that China’s deficits were modest even adjusted according to internationally accepted practice. Table 1 shows that the ratio of adjusted deficits/GDP and the ratio of adjusted deficits/expenditures were 2-3 percent and about 10 percent. Those two ratios were only about half of the average levels for developing countries (Shahin, 1992, pp. 29-31). However, although declining in the middle 1980s, thereafter increased in absolute size. The causes for the sharp increases in deficits are analyzed in the next section.






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2. Causes For Sustained Budget Deficits
The growth of budget deficits was linked to market-oriented reforms and to the way they were carried out, but some political considerations were involved. In the post-Mao period, especially during the late 1970s and early 1980s, competition continued between two political cliques: one favoring reform and development, and one insisting on maintaining the status quo (Short, 1982, pp. 227-251).

The reform faction’s chief asset was popular support because the people expected to live a better life through economic reform. It was very clear to those favoring reform that people were no longer satisfied with the planned economy because it led to serious commodity shortages. However, in the beginning, the reform lacked strong power base. The status quo faction was dominated by conservatives, who objected to reform either because they feared losing their vested interests, or because they had a deep commitment to Mao’s policies (Shirk, 1993, pp. 145-149).

To counteract the conservatives, the reform faction had to obtain support from local bureaucrats at the provincial level and below, as well as from ordinary people. Those in this group proposed to decentralize or delegate as well as to increase profits retained by state-own enterprises. Pro-reform leaders at the top won support from local bureaucrats because the latter gained power in the decentralization process. Besides its political advantage, decentralization was economically justified as improving efficiency in that the central government had never effectively controlled state-owned enterprises.(6)

Decentralization was implemented in two ways. Thus, the central government delegated to local governments discretion concerning planning, investing and budgeting. In addition, reforms increased profits retained by state-owned enterprises and gave them more management discretion. The state-owned enterprises (SOEs) accounted for more than 80 percent of total output in China and hence any improvement in their efficiency would trigger China’s economic growth. Delegating management discretion was the first step to revitalize SOEs via increasing their responsiveness to markets. This discretion focused on input procurement, production decision-making, pricing and marketing of products, as well as the use of retained profits.

Fiscal decentralization is another important dimension of decentralization. Under the new fiscal system--the fiscal contracting system, provinces were encouraged to develop their economies by keeping a large share of revenue increases, in sharp with the previous fiscal system. Under the pre-reform intergovernmental fiscal relationship, the budgets of all provinces had to be approved by the central government, which dictated a specific percentage of the revenues that each province could retain for each new fiscal year (FY). The percentages varied from province to province. Some poor provinces, whose own-source revenues were insufficient to cover their expenditures, received grants from the central government.(7) Although this system was designed to reduce fiscal disparity among provinces, it often proved counter-productive because it encouraged provinces to spend money rather than save or boost revenues. Under this system, the more you spent relative to your own-source revenues (excluding grants) in FYt-1, the higher the sharing ratio of retained revenues to total own-source revenues in FYt. Of course, provinces’ expenditures must be authorized, but the problem was that not all expenditures, once authorized, were justified. For example, even if some expenditures were no longer necessary due to unexpected changes after the budget was approved, provinces had no motivation to cut them.

Under the fiscal contracting system, the sharing ratio for a province’s own-source revenues was fixed for a three-to-five-year period. This longer period was designed to stabilize the fiscal expectations of provinces and, hence, to reduce opportunistic behavior by them. In any case, the sharing ratio varied widely from province to province. Shanghai, the largest industrial city in China, was required to transfer three-quarters of its own-source revenues to the central government. In contrast, about eighty percent of Tibet’s expenditures were funded by grants from the central government (Agarwala, 1992, p. 74).

The fiscal contracting system stimulated the development of local economies because it stabilized the expectations of local bureaucrats. Under the fiscal contract signed in 1979, for example, Guangdong province was required to transfer one billion yuan to the central government every year. Because it could keep 100 percent of marginal revenues beyond one billion yuan, it was motivated to develop revenue-producing industries, and in turn the increased revenues supported many development programs. As a result, Guangdong’s economy showed very rapid development for more than a decade.

However, the fiscal contracting system has reduced the growth of the central government’s revenues since it was implemented more than decade ago. In the post-Mao period, provinces’ interests and independence were strengthened and they gained opportunities to bargain with the central government. In the negotiations with provinces, the central government did not have as much leverage as in the pre-reform period. in fact, the central government often had to make concessions, with the major consequence that the growth rate of transferred revenues from provinces to the central government was low, as compared with both economic growth and inflation. According to the fiscal contracts for 1988-1990, the nominal growth rate of transferred revenues from provinces to the central government ranged from 3.5 percent to 9 percent while, in the same interval, GNP grew annually by 14 percent (Agarwala, 1992, p. 264). Because fiscal contracts were fixed for three to five years, the central government could not adjust the sharing percentages annually, as it did before. When the economy grew rapidly, the central government’s revenues did not increase at the same rate, and provinces got windfalls. As a result, the growth of local government’s revenues was larger than that of the central government’s revenues, and the ratio of the central government’s revenues to consolidated revenues went down over time (Wong, 1991). While local governments could always find items on which to spend, the central government had to fund its increasing expenditures even if its revenues grew slowly because it seemed to lag in transferring expenditure responsibilities to province governments. This inevitably led to an increase in national deficits.

Another negative impact of decentralization on balanced budgets was abuse of discretion, including the granting of tax reductions and exemptions by local governments. Although in China all taxes belong to the central government by law, provincial and county governments enjoy important discretion--e.g., in granting tax reductions and exemptions to enterprises under their jurisdictions. Decentralization reinforced provincial motivation to seek their own interests. In the post-Mao period, performance on local economic development and popular support become more important than rewards from Beijing.

In order to protect their own interests, rich provinces used both illegitimate and legitimate methods to reduce the tax liabilities of their enterprises. Those provinces with a high revenue-remitting percentage would reduce the tax liabilities or profit remittances of their own enterprises rather than transfer revenues to the central government (World Bank, 1990, p. 17), often excessively. In this way, revenues were kept in their own enterprises and later would be "voluntarily" donated for local expenditures. Ningbo, a city of Jiangsu Province but under fiscal contract with the central government, was required to remitted 72.1 percent of its own-source revenues (Agawarla, 1992, p. 74). For instance, if it reduced the tax liability of one of its enterprises by 100 yuan, the central government’s revenues would decrease by 72.1 yuan and Ningbo’s government revenues would be reduced by 27.9 yuan. After that, the Ningbo government could ask those enterprises granted tax reductions to contribute 40 yuan to those programs financed by Ningbo’s budget. In this game, the central government lost 72.1 yuan, but the Ningbo government and the hypothesized SOE "gained" that sum: 12.1 yuan to the Ningbo government, and 60 yuan to the SOE. Such abuses of tax reductions and exemptions contributed to the growth of central budget deficits (Liu, 1993).

Another factor contributing to the growth of budget deficits was the reform of state-owned enterprises (SOEs). In the pre-reform period, taxes and transferred profits from SOEs accounted for 85 percent of the consolidated government’s revenues (State Statistical Bureau [SSB], 1992, p. 191). However, SOEs operated inefficiently due to stifling management system. SOEs acted as a government agency in relationships with central or provincial or county governments. Besides paying taxes, SOEs transferred nearly all profits to the government. At the same time, almost all expenses ?including working capital and investment--were financed by government budgets. Moreover, SOEs would receive subsidies from governments for their operating losses. The lack of linkage between SOEs’ profit performance and the disposition of financial resources, although contributing to equal income distribution among workers, eroded the motivation of SOEs to seek efficiency. As a result, from the beginning of the reform, the government decided to strengthen the linkage between the amount of profits made by SOEs and their spending.

Since then, two major profit-contracting systems--the profit-retaining system (PRS) before 1986, and the contracting responsibility system (CRS) since 1987 ?have been carried out in SOEs. Under either system, if the actual profits made by an SOE are smaller than or equal to the target profits set by the government, the SOE retain profits up to 10 percent. If the actual profits were larger than the target profits, as much as 70 percent of the excess profits could be kept in the SOE. This put pressure on the negotiation of targets, but otherwise encouraged profit-seeking.

A higher marginal retaining percentage for increased profits over targets was an incentive for SOEs to improve efficiency. As China’s economic showed rapid growth due to the reform and flow-in of foreign investment, government revenues did not grew rapidly as expected due to low performance of SOEs and the weaknesses in the profit-sharing method. Furthermore, the more rapid the economic development, the lower the ratio of the government’s revenues/GNP, as SOEs had a higher marginal retaining percentage for surpluses over the target profits (World Bank, 1990, p. 16). Consequently, both PRS and CRS tended to lower the growth of government revenues.

The profit-contracting systems sparked controversies between the players in the decision-making process, based on their conflicting interests. In general, the systems were welcomed by managers and workers of state-owned enterprises. With increased profits retained by SOEs, managers could control more funds and workers received more bonuses and improved welfare. In contrast, the Ministry of Finance (MOF) officials emphasized the importance of a balanced budget, and therefore opposed the profit-contracting systems. In the opinion of MOF, the systems were often tilted in favor of SOEs at the expense of the government’s revenues. MOF advocated implementing a tax-for-profit system, under which each SOE would pay taxes rather than remit profits to the central or local governments, because taxes are not subject to negotiations. In contrast, other central industrial administration departments--e.g. Oil, Railroad Transportation, Chemical, and Nonferrous Metal Industries--advocated the profit-contracting system. Under the profit-contracting systems, these ministries could play a role in setting ratios or quotas of remitted profits for enterprises under their supervision, and could even receive contributed funds from them.

MOF officials could generate a strong argument. Although fiscal decentralization and the profit-contracting systems provided institutional incentives for rapid economic growth, the government’s revenues as a percentage of GNP declined from 34 in 1978 to 15.3 in 1993 (see Figure 2). Figure 2 shows that the consolidated government’s revenues grew more slowly than GNP from 1978 to 1993, with the former growing at 9.7 percent, and the latter at 15.3 percent (SSB, 1992, pp. 28-29).



As government revenues declined, budget deficits could have been moderated by reducing expenditures, but expenditure pressures were sustained. China’s reforms were carried out in an incremental style because they had no precedents to follow (World Bank, 1992, pp. 37-42). Incremental reforms were intended to reduce risks and social shocks, but they had disadvantages--primarily, the failure of the decision-makers to estimate in advance the fiscal impacts of reform programs and to integrate them into a comprehensive plan. More often than not, the government increased discretionary expenditures to compensate citizens for the increasing living costs arising from price adjustments and liberalizations, with the hope of mitigating popular discontent but with the reality of budget deficits. Main expenditure pressures have been from subsidies, education and technology expenses, as well as administrative spending (see Table 2). Expenditures as a whole increased a bit more rapidly than revenues, with the former growing at 10.1 percent and the latter 9.7 percent (SSB, pp. 191-192).



The differing increases in revenues and expenditures resulted from a particular reform style, contextual factors, and development strategy. Since reforms were initiated in 1979, for example, the government’s spending for subsidies has constituted a large share of total expenditures--from 9.3 in 1978 to 17 percent in 1993 (Figure 3). The subsidies included two categories: one for essential daily consumer goods, and the other for SOE operating losses.

Subsidizing consumers for essential goods was a strategic choice for gaining popular support for the reform. It had been very clear to Deng Xiaoping and his supporters that, even if a reform brought benefits to people in the long run, it would be doomed to fail if it were carried out at the cost of lowering the living standards of most people as cases-in-point, economic reforms in the East European socialist countries such as the former Yugoslavia were accompanied by inflation and increased living costs that led to social shocks. In order to reduce dissatisfaction with several redistributions arising from reform, essential consumer goods were subsidized. The subsidized consumer goods included food grains, edible oil, meat, vegetable, cotton, and household coal (Wulf, 1986).

Reform was often a matter of one step forward, in sum, and then one backwards. In order to stimulate agricultural development, for example, the government raised the purchasing prices of agricultural goods several times after 1979. Since an overall wage increase without efficiency improvement would reduce the profits of SOEs and probably also would induce inflation, wage increases were delayed. Consequently, in order to prevent the living standards of most citizens from going down due to inflation, essential agricultural products had to be sold to urban dwellers at prices lower than the purchasing prices paid to farmers.

The losses caused by the price gap between purchasing prices and reselling prices were subsidized from the government budget. Although price subsidies protected the vested interests of most citizens, they induced a perverse phenomenon: the greater the agricultural production, the more the government’s spending on subsidies. If further reforms on marketing and pricing of agricultural goods are carried out, and if citizens accept upward-adjustments of the prices of consumer goods, price subsidies will tend to decline (see Figure 3).



The other kind of substantial subsidy compensated for SOE losses during the course of market-oriented reform and the bill is large. Overall, 45 percent of SOEs operate at losses (China News Digest, October 28-29, 1994). In order to avoid serious unemployment and social riots due to the possible bankruptcies of SOEs, the government paid large subsidies to loss-making SOEs. A top leader even said, if all loss-making enterprises were allowed to go bankrupt, the resulting 20 percent unemployed might well hit the streets in demonstrations, and the government would be paralyzed.(8) The net contributions to government revenues from SOEs’ profits decreased from 52.7 percent in 1978 to 5.0 percent in 1993 (see Table 3), a decrease due in part to the rapid expansion of the private economy. Recently, the government has made every effort ?including passing the Bankruptcy Law and the Enterprise Law ?to make SOEs responsible for their financial performance. These laws are designed to reduce government subsidies to SOEs, but their effects to date have been limited. Indeed, as Figure 3 shows, those subsidies have more or less stabilized at a high historic level.



Chinese leaders understood the positive relationship between increasing subsidies and deficits, but they preferred reform to a balanced budget. In 1985, when a price reform plan was discussed at a meeting at the top decision-making group, an MOF official argued that the country could not afford such an ambitious price reform program. Premier Zhao retorted fiercely, asking MOF not to use its budgetary problem to slow reform.(9)

Even if these subsidies to SOEs are unavoidable, they have serious consequence. Although increased government subsidies were not surprising given China’s institutional context and reform strategy, ironically, administrative spending as a percentage of the government’s total expenditures increased from 4 percent to 8.4 percent in 1992. While government has been reorienting from micromanagement to macromanagement, and as the tasks of government should have been reduced, the size of government employment also has increased by 8 percent from 1978 to 1990. This compares with the growth rate of 2.9 percent in the total social labor force (SSB, 1992, p. 80). Undoubtedly, this growth is counterproductive. It suggests that the government met difficulties in attempts at "streamlining". For example, government employees were reluctant about non-government employment because Chinese public bureaucrats enjoy high status, job security, and benefits such as public housing. Some top leaders also wanted to protect their pet ministries. For instance, two industrial departments--Machine Manufacture and Electronic--were merged in 1987, only to be separated in 1993, soon after Li Peng became Premier. Not incidently, Li Peng had worked in the Ministry of Electronic Industry.

The fast growth of spending for education and science as a percentage of expenditures ?from 7.3 percent in 1978 to 13.1 percent in 1992 ?was supported by Deng’s preference and China’s economic development strategy. Unlike Mao, Deng studied abroad in the 1920s and accepted the significance of knowledge and technology to economic development. He walked that walk, rather than merely talking it. Indeed, when Deng was rehabilitated as Vice Premier the second time in 1977, he chose to take charge of national educational and science affairs. Virtually all Chinese leaders believed that it was impossible for China’s economy to take off without major improvements in human capital. The economic objective is to make China a middle-income country in the next fifty to seventy years. Sustained economic growth based on quality human resources and technical progress are indispensable, if this objective is to be achieved. Hence, increases in government’s expenditures on education and science were inevitable strategic choices, and their short-run contribution to deficits intended to serve continued economic development.



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3. The Impacts Of Budget Deficits
In sum, the growth of deficits in China involved not only economic factors but also political dimensions. Politically, budget deficits supported the reform and hence strengthened the power of the pro-reform leaders. Realistically, few reform programs could have been implemented if China had stuck to the balanced-budget principle.

Nonetheless, conservative leaders often used budget deficits as a pretext to attack market-oriented reforms. Chen Yun, whose personal stature may not be lower than Deng’s, is a stubborn proponent of balanced budgets. He attributed the growth of deficits to the reforms advocated by Deng, and saw them as a symptom of a deteriorating economy. Deng replied: "Why be afraid of small deficits? The United States has had large-sized deficits, yet its economy is still expanding." In November, 1990, after the Tiananmen pro-democracy movement, conservative leaders--using budget deficits as evidence--tried to recentralize the fiscal system but failed due to strong resistance from local leaders.(10)

Despite the persistence of deficits, the political pressure has been strong enough to encourage certain flexibilities in economic reporting. In 1987, when many people complained about high inflation and attributed it to budget deficits, Premier Zhao ordered MOF to produce a phantom balance, a strategy often used in the American budgeting process (Mikesell, 1991, pp. 84-94). MOF delayed reporting until expenses actually incurred in 1986.(11)

Budget deficits may have positive economic impacts under some conditions (Heilbroner and Berstein, 1989, p. 132), and China’s deficits as a whole contributed to the development of bottle-necked sectors such as energy, transportation, and communications. These arenas are very important to China’s long-term economic growth, but they are underdeveloped, as compared with other industries. The government has been the main investor in these sectors over an extended period, due to several deficiencies. Basically, capital markets are underdeveloped, and large investments in infrastructure are hard to obtain. In addition, non-government entities pour their capital into arenas producing high profits in the short run, but have far less interest in low pay-back sectors, even if strategic. Although government investment has declined sharply, it concentrated on the bottle-necked sectors. If China balanced its budgets by cutting capital expenditures as it did in the past (Luo, 1988a, 1988b), the investment on energy, transportation and communications would bear the brunt, and their development would lag even more. Balancing budgets by cutting capital expenditures can be penny-wise and pound-foolish (Colm and Young, 1968).

Seen from another point of view, China’s deficits also have troubling impacts. Because most of China’s deficits (adjusted for debt revenues) are financed by "loans" or overdrafts from the central bank, the deficits directly contribute to inflation (see Table 4). From 1979 to 1993, the correlation coefficient between the size of deficits and the rise in the retail price index is 0.93. This correlation is not perfect, but neither is it very distant from 1.0.






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4. The Outlook For Budget Deficits In China
Will China’s deficits will continue into the foreseeable future? The answer is yes, probably. Let us review the positive as well as negative impacts of possible future developments on both the revenue and expenditure sides of the government’s budget. Positive developments include a higher growth rate of the government’s revenues and a decline in subsidies. Here, the early signs seem favorable. Beginning in 1994, a new intergovernmental fiscal relationship ?a division of taxing power ?came into effect (People’s Daily, Sept. 14, 1993). Under the new framework, the central government divides taxing power between itself and the provinces in order to strengthen its fiscal position. Provinces are deprived of the right to grant tax exemptions or reductions if the tax in question is administered by the central government. Moreover, a new tax system, through which the central government tries to control most important taxes--e.g. profit taxes and value-added taxes--was implemented in 1994 (Beijing Review, March 14-20, 1994). According to this tax system, SOEs will no longer remit profits to the central or local governments. Instead, they will pay a profit tax, whose rate is 33 percent. All enterprises in a few industries have to pay a value-added tax. A consumption tax also exists. In addition, spending on price subsidies might be further reduced. In 1993, many provinces liberalized the prices of daily necessities and the government made no commitment to pay for possible increases in future living costs (Beijing Review, August 1-22, 1993).

However, bad news concerning possible deficits also exists. Although the growth of the government’s revenues may speed up in the coming years, expenditure pressures will remain. As noted above, it will be impossible to reduce capital outlays appreciably without negative effects. A study of deficits showed that in the pre-reform period the government tended to balance its budget by cutting capital outlays in FYt, if the FYt-1 budget ended with a deficit (Luo, 1988b). However, this deficit-reduction strategy may result in more losses than gains over the long run. As analyzed above, investment in highly-desirable sectors such as energy, transportation, and communications would be reduced sharply if the budget were to be balanced. A lag in the development of these sectors will constrain China’s economic growth in the long run.

Another expenditure pressure on the government budget comes from pay increases to government employees. Since 1986, the pay level of staff and workers in the sectors of administration, education, science, health and culture has been lower than the average wage level. It seems impossible in these sectors for the government to delay pay increases very much longer. The government increased pay by a small scale to government employees in 1994, a strong pressure for continuing increases to guarantee the salary gap in a reasonable range between the government and non-government sectors . Finally, SOE losses will continue to be a heavy burden with nearly one-half of them reporting losses in recent months (China News Digest, October 28-29, 1994). In short, deficits may increase rather than decrease. Revealingly, early predictions fear that the budget deficit in 1994 will be more than double 1993’s deficit (World Journal, March 12, 1994).



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5. Summary
China’s deficits reflect serious conflicts in the course of market-oriented reform. The government had to retreat from overwhelming monopolization of resources, but its role in economic development was not assumed by other organizations. Due to decentralization in pursuit of market-oriented reforms, the government’s revenues as a percentage of GNP went down, at least in the short run. An inherent weakness in the intergovernmental fiscal relationship--the abuse of tax reductions and exemptions by provinces--exaggerated the decline of revenues. At the same time, the government faces difficulties in shifting expenditures, and spending on subsidies increased at a high rate. Here, there is a deep dilemma: reform has reduced the control of resources by the government, especially the central government, but sustaining development requires investment by government. Consequently, budget deficits became critical to the Chinese government. Political considerations are an important reason China abandoned the balanced budget principle and turned to budget deficits as a means of financing development. The political costs of deficit reductions will be prohibitive, and the probability of success seems small. People’s expectations about living standards have escalated, and this implies a sustained and stable development. Slow development based on a balanced budget might lack support from the people.

Can China recentralize its fiscal system? That probably is doomed to be an exercise with a high potential for civic unrest. Early reform empowered a particular interest group--local bureaucrats--and they would strongly oppose this attempt.

In sum, balanced budgets do not seem probable in China’s future. This dour prediction has to be discounted a bit, however. Recently, the government initiated a series of reform programs concentrating on adjusting intergovernmental relationships, and especially the tax system. Some of them are designed to increase the government’s revenues as a percentage of GNP, as well as to increase the central government’s revenues as a percentage of consolidated revenues. In addition, price reforms may reduce the government’s spending on subsidies.



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Notes:

The Minister of Finance reports a consolidated budget for all governments in China. Similarly, a province’s budget consists of the budget of the provincial government and the budgets of all county governments. This budget practice is common in centrally planned economies (Premchand, 1993). Return to your place in the document

Beginning with the FY 1994, the government will change the practice used since 1949: the government budget sees public debt as a means of financing deficits, but printing money is still an important source for funding deficits. Return to your place in the document

The famous economist Janos Kornai denied a linkage between budget deficits and shortage. See Kornai (1979, pp. 931-935). However, Kornai’s conclusion is valid only when deficits are financed by debts, or when financing deficits by loans from the central bank does not lead to a simple increase in supply of money. Neither of the two conditions is satisfied in China. Return to your place in the document

Mao deprived handreds of thousands of dissidents of their jobs from 1960s to 1970s. In 1979, Deng rehabilitated them and paid them owed salaires in the past years due to the deprivation of jobs. Return to your place in the document

In the Chinese context, adjusted deficit = (revenues + SOEs’ subsidies) + (expenditures + subsidies) + (debt disbursements - payments of principal and interest). See International Monetary Fund, (1986, pp. 91-92). Return to your place in the document

State-owned enterprises are administered by either the central or local governments. Return to your place in the document

The percentage for FYt is the ratio of authorized expenditures in FYt-1 (Et-1) to provinces’ own-source revenues in FYt-1 (Rt-1). If the ratio for a province were larger than one, it meant that the province received grants from the central government. If the ratio for a province were smaller than one, it indicated that the province remitted some of its own-source revenues to the central government. For developed provinces, Et-1 is smaller than Rt-1, the ratio of the retained revenues to the total own-source revenues is Et-1 / Rt-1. Suppose that a province’s own-source revenues are 1,000 million yuan and the authorized expenditures are 650 million yuan in FYt-1, and are 1,500 million yuan for FYt. The retaining ratio for that province for FYt would be 0.65, and retained revenues would be 975 million yuan (1,500 million x 0.65). The transferred revenues to the central government would be 525 million yuan (1,500 million x [1-0.65]). For poor provinces whose Et-1 was larger than Rt-1. The gap was filled by grants from the central government. Return to your place in the document

Confidential source. Return to your place in the document

Confidential source. Return to your place in the document

Confidential source. Return to your place in the document

Confidential source. Return to your place in the document



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