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China takes federalism way further than the US, and is paying the price for it

Shanghai at night.
Shanghai at night.
Eustaquio Santimano

The recent turmoil in the Chinese marketplace has shaken Western observers’ faith in the government’s ability to effectively manage the economy. While it’s too early to judge the fallout from this downturn, it is an important reminder that China faces many large challenges in creating economic and social policy that can keep up with the country’s rapidly changing growth picture. A stable stock market is one; so too are reducing inequality, building a stronger safety net, and improving the environment. The central government in Beijing calls the shots, but much of what actually happens — and why it’s happening — takes place in provinces, municipalities, and below. When the stock market disappears from the headlines, the structures underlying the country’s biggest challenges are crucial to understanding how well the Chinese government will be able to handle the road ahead.

These aren’t directly causing the stock market to fall, but they matter hugely down the line.

Spending is done at the provincial level or below. This makes it much harder to run a safety net or reduce inequality.

Although it is easy to view the Chinese government as a large, organized monolith, it is actually a complex and delicate system that balances between central, provincial, municipal, local, and individual interests. Since major fiscal reforms in 1994 (and then subsequently a few times after 2000), the central government has collected an outsize share of revenues, but subnational governments are responsible for implementing the vast majority of policies and providing services. According to Xiao Wang and Richard Herd, in 2009 provinces and other local government entities were responsible for 99 percent of health-care expenditures, 95 percent of the social safety net, and 94 percent of education expenditures. Yet local governments collect far less than that in revenues.

Chart showing the central revenue share equaling the provincial revenue shares, which only happened around 1993.

Xin Zhang, “The Quest for Welfare Spending Equalization: A Fiscal Federalism Perspective.”

As a result, there is always a tension between the federal and local governments and their respective goals. The central government wants to promulgate progressive policies, but doesn’t take responsibility for implementing these policies. After all, if anything goes wrong, they want to avoid the blame. On the other hand, local governments, with few funds but large responsibilities, want to bolster their own power by finding and controlling new sources of funding. For some years, this took the form of local governments imposing informal fees on their constituents; more recently it has meant taking farmers’ land and selling it off to developers. It often means not implementing the policies of the central government, which may or may not have been expecting the local government to defy it in the first place.

Chart showing provincial expenditures outpacing central government expenditures after Deng Xiaoping came to power.

Xin Zhang, “The Quest for Welfare Spending Equalization: A Fiscal Federalism Perspective.”

This lack of alignment between local and central governments makes the actions of the government as a whole seem confusing, inconsistent, and difficult to interpret. This inconsistency is one way to maximize power. As the China scholar Perry Link has argued in regards to Chinese censorship, vagueness breeds fear: The less clarity there is about what the government really intends, the more control it has. But this confusion also arises because the government — and the party — is large, hierarchical, and sprawling: If any organization with a handful of employees will have disagreements, imagine what a political party with more than 80 million members will look like. In large part, Chinese citizens and outside observers are confused by the government’s actions because the actions are, themselves, confused — different people at different levels of government deciding different things, with nobody really sure who believes what.

One result of this fiscal federalist structure is a huge variation between the amount of public services provided in different areas of the country. In the US, wealthier states like New York and New Jersey indirectly subsidize poorer states, because they contribute more in federal revenue than they receive in federal spending. In China, this dynamic also exists: Because the central government collects more revenues, it is able to redistribute from wealthier to poorer provinces. This has occurred in the last decade, and some efforts have been made to give more money to inland and poorer regions. However, the actual amount of revenue sharing is still fairly low. As Xin Zhang notes, "In practice, the central government has spent about 30 percent of its revenue to reimburse provincial governments using matching formulas, but the reimbursement formula has been biased toward the contributions rather than the needs of provincial governments."

The result of these disparities is a very different situation in different parts of the country. According to a 2014 paper by economists Chen Wang, Guanghua Wan, and Dan Yang, the wealthiest province spends more than eight times as much per capita for public purposes as the least wealthy province, and the wealthiest county spends 48 times as much per capita as the least wealthy county.

The rural-urban divide is still big, and matters a lot

Photo of older woman gleaning wheat in a field

A farm worker in Huaibei, Anhui province, on May 29, 2011.

ChinaFotoPress/Getty Images

Urban and rural China are worlds apart. Beijing, Shanghai, and other major cities are very developed. There are many highly educated people, modern amenities (sometimes), some of the most advanced transit systems in the world, and many people who would qualify as "middle class" in any country. Rural areas, on the other hand — with rapidly decreasing populations as working-age populations temporarily move to big cities and urbanizing populations to smaller ones — are still very poor. Many rural villages lack basic infrastructure like running water. Public transportation often consists of quasi-hitchhiking in a van generally headed in that direction (an interesting experience, I assure you). Most importantly, despite recent policy changes, there are few social services. As Qin Gao and her co-authors write, if urban and rural China were separate countries, "the size of the urban welfare state would be comparable to those of western industrialised countries, while the size of the rural welfare state would be among the world’s smallest and similar to those of the least developed countries." Even though most urban residents would likely consider social services in cities inadequate, they are far more comprehensive than in rural areas.

It is a common refrain among scholars of China that to understand China you need to understand the parts of China outside of Beijing, Shanghai, or Guangzhou. As numerous studies have shown, this inequality can be attributed to either regional disparities (mentioned above) or disparities between rural and urban areas. Growing inequality will become an increasingly important part of the Chinese social and economic picture, and understanding it requires seeing where rural and urban part ways.

The Chinese economic miracle is less miraculous to most Chinese people than we like to think

Pedestrians walk by the Burberry store in Shanghai

Pedestrians in Shanghai.

Kevin Lee/Getty Images

Nearly everything written about China in the past 10 years begins with a phrase like, "China’s economic development has been the greatest story of poverty alleviation of the modern era." This is absolutely true, and the reduction in poverty is mind-boggling — in comparison to nearby India, for example, China’s economic progress has been extraordinary. But the economic development has yet to help many Chinese people as much as they want or need it to.

True, most would prefer to not go back into grinding rural poverty. But the economic rise that has rocketed the wealthy and well-connected to new heights and pushed the poor up a little past the poverty line has brought with it many new stresses that seem just as, if not more, difficult to surmount. China may have pushed itself enough past poverty to send international aid programs searching for poorer, needier recipients, but its residents don’t feel economically secure.

Keeping up with the costs of modern life — education and health care, as well as housing, child care, transportation — on low wages and deposits that return negative real rates due to financial repression puts many in a perpetual state of economic insecurity. In a hypercompetitive environment, pressure is always high; fear of that one misstep, whether in your control or not, that will push you under is all around. This is particularly true for the generation born in the 1980s (八零后) who are caught between a variety of economic pressures in supporting new families. China is not a place brimming with optimism about economic growth; it is a place where struggling to stay afloat is the name of the game for most people, particularly outside of major metropolitan centers.

When I describe China to friends back home, I always say that China is best described as more. Many of the problems China faces are the same as those of the US, just more. Inequality is large in the US, but in China it’s much larger. Economic insecurity exists in the US, but in China it is far more widespread. Corruption is apparent in the US system, but in China it exists on a much greater scale. And the everyday pressures people face in the US are certainly big, but they seem to feel much more daunting in China. The Chinese government might be able to address many of these problems. But to do so, it will need to figure out not just how to right the markets but how to solve the larger challenges beneath.

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