book cover




with Charles Pigott, Senior Economist and
Team Leader
of Orgainzation for Economic Co-operation and Development (OECD) - China Study


Question 1:  Kogan Page has just published the fourth edition of your new book China in the World Economy, An OECD Economic and Statistical Survey.  You were part of the original team that worked on this large and very informative new release.  Can you explain to us a little what the Organization for Economic Co-operation and Development (OECD) is and why it is involved in this analysis of China and its economy and what your role as one of the authors was in this important study?

Answer:  The OECD is a multilateral institution comprising the more advanced industrial economies that was created in 1961  as a forum for discussion and analysis of a wide range of economic issues of common concern. The organisation has expanded considerably in recent years and now includes 30 member countries drawn from all the regions of the world. Its primary mission is to help governments to deal with the economic, social, and governance challenges of a globalised economy.

The OECD has relations of various forms with nearly 70 other countries and economies. A major focus of these efforts has been larger non-member countries, including China, whose importance in the world economy is growing, and whose governments increasingly look to OECD experiences and best practices in economic development and management for potential lessons and insights for their own policies. The OECD presently has a strong working relation with the Chinese government and its agencies in a wide range of areas, involving every OECD directorate.

My role as head of the non-member Asian desk in the OECD economics department was to lead the OECD study and to contribute, with other colleagues in the economics department, several of its chapters. The team that produced the study consisted of nearly 25 experts drawn from across the OECD Secretariat and including a number of experts from Chinese government agencies.  Our group in the economics department prepared the chapters on the banking system, the overview of the impact of WTO on China’s industries, part of the chapter on financial system development, and the chapter on macroeconomic policies, as well as chapters on the distribution system and central-local government fiscal relations. 

Question 2:  I’ve just returned from a week in China touring the Economic Development Areas (EDAs) in the coastal regions around the Middle and North Coast of China.  I was impressed by the large amount of building going on and relocation of factories.  Many of the Chinese I met in these coastal cities expressed their feeling that China could not be denied as the coming Economic Leader in Asia if not the world.  However, after reading your book I see that many problems still remain.  With respect to China, what is your overall impression “Is the cup half full as they say or half empty”?

Answer:  The basic message of the OECD study is that China has great potential but that realisation of that potential is not automatic and will require substantial further reforms to achieve it. For example, China’s government has set a long term goal of increasing per-capita GDP four-fold by the end of the first two decades of this century, which will require growth in real GDP at an average annual rate of about 7.2 percent through 2020. This is perfectly feasible – even in recent years China’s growth rate has been above that pace—particularly given China’s high saving rate and rapidly increasing foreign investment. However to continue to grow this rapidly, China will need to overcome very serious challenges, to improve the efficiency of the business sector, to absorb the large numbers of workers who will be leaving agriculture or displaced from state owned enterprises, and to increase the effectiveness of the financial system—to mention only some of the most important.  

Question 3:  In your teams very thorough book, you divide your teams work into two parts, part one contains Sector studies on such sectors as agriculture, industry, technology, banking, insurance, distribution and Foreign Direct Investment (FDI) and then on economy-wide issues, such as the role of regulatory reform, role of competition, environmental priorities, etc.  Why did the team choose this organization and are you happy with the final result and if so why?

Answer:  This division reflects the fact that China’s reforms are proceeding on two levels which are complimentary and need to be mutually reinforcing. In the first part of the study we examined the problems of the main individual sectors of the economy and the policies to deal with them, for example measures to promote adjustment in the agricultural sector and policies to improve the efficiency of state owned enterprises. However all of the chapters in the first part repeatedly highlight the crucial importance of economy wide policies-- to develop and improve the basic institutions and processes essential for a market economy -- to the success of policies toward individual sectors. For example, the chapter on technology challenges emphasises the need for better governance and management of enterprises and improvement of intellectual property rights protection as essential to raising China’s technological capabilities. Indeed, the interdependence among policies in different areas, and the consequent need to pursue reforms on a broad front in a carefully co-ordinated fashion, is a key message of the study. The division of the study into sector and economy-wide issues is intended to help underscore that interdependence. 

Question 4:  In your teams study, one of your conclusions is that “the important engines that have driven China’s growth in the past are losing their dynamism.”  Could you explain this conclusion and how the team feels China should address it?

Answer:  A distinctive characteristic of China’s traditional reform strategy has been the development of certain segments of the economy outside of the constraints of the central planning, in order to catalyse the growth and development of the economy as a whole. This process has been characterised by a well known China scholar, Barry Naughton, as ‘growing out of the plan’. A prime example is the development of township and village enterprises (TVEs), which became the single largest contributor to industry growth and employment in the late 1980s and early 1990s, and whose growth was spurred by the substantial advantages they had  vis a vis state owned enterprises. Another example is the progressive opening of the economy, in part through the granting of tax exemptions and other preferential terms, to foreign investment, which together with the TVEs developed China’s export sector. However as the economy has become more market oriented and as problems not adequately addressed by reforms have accumulated, the impetus to growth from this ‘separate development’ strategy has progressively waned. In particular, job creation by TVEs has virtually come to a halt since the mid-1990s, as their previous advantages have been eroded by SOE reforms and as limited technology, constraints on their scale, and high debt loads have become increasing problems.

In our view, future reforms need to move away from preferential policies for individual sectors toward leveling the playing field among businesses and focusing on economy wide policies to improve the overall economic environment.  

Question 5:  In the early years of Deng Xiaoping’s reforms the farm economy and later rural non-agricultural enterprises (RE’ or TVE’s as they are called) were important engines of Chinese economic growth.  How important are changes in how China deals with the rural economy to improving China’s economic performance going forward?

Answer:  At various points, the rural economy has provided an important boost to China’s real growth. It did so when agricultural prices were raised early in the reform era and later on with the development of TVEs. Now, however, the rural sector’s performance has deteriorated considerably and has become a serious drag on growth in the overall economy. Two basic challenges have to be met to revive the rural economy. First, there will need to be a reallocation of production within the agricultural sector, away from land and water intensive grains such as wheat and soybeans and toward more land intensive crops such as fruits and vegetables. Second, and most critically, jobs outside of agriculture will have to be found for those workers who are now employed, and for the millions more who will be leaving agriculture —as many as 70 million over the next decade according to an estimate cited in the study. This is likely to require major changes in traditional policies, in particular to make it easier and more productive for rural workers to move to cities to find work.

Question 6:  One of the strengths of your team’s new work is the large amount of tables and the use of graphics that assist in demonstrating the points your team is trying to make.  In fact, the book even includes a CD with extensive additional tables and data that is very useful to any business, investor or researcher.   On page 16, you use a five sided pentagon that explains the vicious cycle of poor enterprise performance (Figure 2:  The vicious cycle of poor enterprise performance).  Can you explain the graphic and how poor enterprise performance is reinforcing a vicious cycle that will hamper Chinese economic development if not resolved?

Answer:  China faces several major challenges that are made all the more difficult by the fact that they result from a number of separate problems that are mutually reinforcing. For example in the graphic, government interference in enterprise management weakens the incentives and the capabilities of the enterprise itself to make economically sound plans and decisions. This in turn leads to inefficient operations and poor performance, which in turn leads to low profits, increased borrowing, and consequently high debt. To get out of this vicious circle, enterprises need to restructure their operations, but their ability to do so is severely constrained by their low profits and high debt. This throws much of the burden on the government, which reinforces (or at least makes it harder to curtail) the government interference in enterprise management.

The difficulty of breaking through the vicious circle is made all the greater by other factors that sustain it, notably the interaction between the non-performing loans of banks and the poor performance of a large segment of their business customers that is illustrated in another graphic (Figure 4: The vicious circles of bank and enterprise problems) in the study.  

Question 7:  One of the further points made in your teams book is that “the evolution of the financial system has lagged that of the real economy”.  Can you explain this observation, what implications it has for China and how your team would recommend that China resolve this issue?

Answer:  Following the initial creation of the  major state owned banks (SOCB) early in the reform period, the further development of the financial system was given a lower priority than industrial development in China’s reforms through much of the first half of the 1990s. Partly as a result, China’s financial system has in important respects lagged behind the profound changes in the business sector over the past twenty years. A graphic illustration is the fact that more than 70 percent of bank loans go to SOEs, even though their contribution to overall output in the economy is much less than that of non-state enterprises, which have much more limited access to credit. The four major SOCBs continue to dominate the financial system and although no longer subject to explicit central planning requirements, their lending continues to be influenced by government mandates in certain areas.  As a result of these and other conditions, China’s financial system has some way to go before it can effectively support the extensive changes the business sector will need to undergo over the next ten years.

At least three challenges will need to be met to produce a fundamental improvement in the effectiveness of the financial system. First, the high level of non-performing loans and low capital of the major banks (and some other segments of the financial system) will need to be dealt with, since banks and other financial institutions need to be financially viable if they are to operate effectively on commercial principles. Second, the system needs to develop greater diversity, through a greater role for smaller banks and other financial institutions relative to that of the four major SOCBs, and through the further development of capital and other financial markets. And third, the governance and accountability of financial institutions needs to improve considerably, and this will require less government interference, improvement in management and internal control systems, improved supervisory oversight, and stronger market discipline.     

Question 8
:  Your new book is not just a “think-thank” study but in my opinion after having read and used the book also a book with real life applications to business people, consultants and business executives.  As an example of this, I note your table on page 145 titled Prospects for selected industries in light of China’s WTO accession (Table 4.3:  Prospects for selected industries in light of China's WTO accession) which shows how domestic demand, China’s exports, China’s import’s and FDI Inflow all will be affected by China’s entry into the WTO.  Can you explain a little who your intended audience was for this new book and a little about the table and what implications it may have for Western investors considering investments in China?

Answer:  We aimed our work at several audiences, both within and outside of China. Within  China, the large and growing community of government officials, policy-makers, experts, academics, and others concerned with formulating, implementing, and analysing economic policies was a key audience we have tried to reach. We benefited greatly from discussions with and support from many of these people. Outside of China, our major target audiences include officials and experts from OECD member countries, along with the wider community of scholars and practitioners in areas concerning China. While our study is not intended as a manual for potential investors, we think it provides background and insights on issues that will have an important bearing on the conditions and future developments that will be important for those doing business with China to be aware of.

Question 9
:  Countless stories in the press are appearing about China becoming the workshop to the world but one of your team’s conclusions is that Chinese businesses are not really investing enough in technology and that the government is investing insufficient amounts in education.  Could you explain these observations and how the team recommends the Chinese government respond to this?

Answer:  As a result of the large amounts of foreign direct investment it has received, China has become a major venue for the processing and assembly of products for export and its importance in this respect is likely to continue to grow. Large amounts of products that were produced and shipped directly from other Asian economies are now finished or assembled in China, using imported parts from those other economies. Nearly 40 percent of China’s imports now go to producing exports.

This is a favourable development for China, and for the region as a whole, but China needs to find ways to improve the spillovers to the domestic economy from its growing exports. In particular, local content is often low and technology transfer has been limited. To improve in these areas, reforms to improve quality of products from domestic suppliers, to bolster enforcement of contracts and protection of intellectual property so that foreign businesses are encouraged to form alliances with domestic companies, and other measures to improve the business climate are likely to be needed. 

Question 10:  The above question brings up another conclusion of the team, that there is a need for greater Chinese government revenue and expenditure at the local, provincial and national level if China is to adequately address the issues facing it.  How exactly does this fit into your team’s conclusions?

Answer:  Although total government revenues have been rising in recent years, China’s governments are still unable to adequately fund some key needs, such as education.

The problem is greatly compounded by the fact that revenues are raised inefficiently and badly distributed among various government levels. There are huge disparities in per-capita revenues between richer provinces on the coast and those in the central and western regions. Local governments typically lack the on-budget revenues needed to meet their obligations and this has led to growing reliance on ad-hoc fees and charges that are often illegal and often imposed on the poorest segments of the population. In effect, China’s government doesn’t have enough money to meet its obligations while at the same time much of the population is overtaxed. This is a classic symptom of a very inefficient system of public finances..

If the government is to adequately support China’s development, it needs to increase its on-budget revenues while reducing burdensome and inefficient off-budget charges. This will require tax reforms, to broaden tax bases and equalise treatment. It will also require  fundamental reform of central-local government fiscal relations to ensure that local governments have adequate resources to meet their spending obligations and to reduce inequalities among regions. 

Question 11:  Your team looked very deeply at the issue of corporate governance, the need for transparency, the role of corporate officers, need for outside Board of Directors, etc. in Chinese companies.  What were your team’s conclusions in this area and do you feel that there really is sufficient understanding for the need for change in China’s boardrooms and are you optimistic that much of this will occur in the short term?

Answer:  Despite strong backing from Chinese officials, reforms to institute modern corporate governance in China have had mixed, and in some respects disappointing, results for several reasons. First, there are some important differences between the way governance structures have been instituted in China and international best practices. For example, top managers of state owned enterprises continue to be appointed by political officials and/or local government officials. A second set of problems concerns the lack of clarity of about who actually is entitled to control the assets of state owned enterprises and to make key decisions about employment levels and certain other matters. Presently, management of state enterprises are not free, that is without government approval,  to lay off workers, close plants, or take other measures that may be essential to improve their performance. A third set of problems lie with the still limited market discipline that many enterprises face. Enterprises in competitive industries have strong incentives to improve their governance because it is important to operating effectively in the market. These incentives are much weaker for those SOEs  that are sheltered from competition and have favoured access to bank loans, the stock market, and other credit, and corporate governance reforms seem to have worked less well in these cases.   

China’s officials are aware of the present weaknesses in corporate governance and are seeking to address them. However, as other countries, including OECD members, have found, it is very difficult to get state owned companies to be as profit oriented and efficient as their counterparts in the private sector. The difficulties are probably even greater in China, given the long history of close relations between state owned enterprises and government agencies.

Question 12:  Chapter 13 of your book talks about the current tax system and priorities for reform.  For a practitioner, this is very useful as it gives a very good detailed outline of current tax policy as it affects a potential project and also gives your teams suggestions on how tax policy may change in the future.  Could you state briefly what the major issues affecting the tax system are at the current time and how you see China’s tax system changing to deal with these challenges?           

Answer:  There are three major issues concerning tax policy. First, as indicated earlier, there is a shortage of on- budget revenue, which is most easily allocated to the areas of greatest need, while there is way too much off-budget revenue and its collection and use is very inefficient and inequitable.  Second, there are serious weaknesses in the mechanisms and institutions for collecting taxes with the consequence that the government raises less on-budget revenue than it is owed. And third, there are distortions and unequal treatment in the tax system itself. For example, foreign controlled enterprises enjoy significant tax concessions, in the form of tax exemptions for the initial years of their establishment and exemptions from duties on imported inputs, not granted to domestic firms.

Some of these issues are now being addressed. In particular, there has been a major effort to improve collection that has resulted in a significant boost in revenues. Over time, authorities have said they will phase out the special tax advantages given to foreign businesses. Efforts are also likely to be made to broaden the tax base and to reduce the present reliance on the value-added and business (services) taxes, in part by increasing the importance of personal income taxes, which are now a relatively small share of the total.  


Copyright © 2005, Runckel & Associates

About the Interviewer:  

Christopher W. Runckel, a former senior US diplomat who served in many counties in Asia, is a graduate of the University of Oregon and Lewis and Clark Law School. He served as Deputy General Counsel of President Gerald Ford’s Presidential Clemency Board. Mr. Runckel is the principal and founder of Runckel & Associates, a Portland, Oregon based consulting company that assists businesses expand business opportunities in Asia. (

Until April of 1999, Mr. Runckel was Minister-Counselor of the US Embassy in Beijing, China. Mr. Runckel lived and worked in Thailand for over six years. He was the first permanently assigned U.S. diplomat to return to Vietnam after the Vietnam War. In 1997, he was awarded the U.S. Department of States highest award for service, the Distinguished Honor Award, for his contribution to improving U.S.-Vietnam relations. Mr. Runckel is one of only two non-Ambassadors to receive this award in the 200-year history of the U.S. diplomatic service.

Copyright, 2007 © Runckel & Associates
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