Jun 24, 2013 | 10:31 GMT

7 mins read

In China, Reform and the Risks of Urbanization

In China, Reform and the Risks of Urbanization
(PETER PARKS/AFP/Getty Images)

Chinese cities may be swelling, but the central government is seeking to continue driving urban growth while mitigating the risks and obstacles of urbanization. To reduce some of the deep social and economic imbalances between China's urban and rural regions and coastal and interior provinces, Beijing hopes to reorient its economy away from an overreliance on exports and state-dominated investment and toward greater domestic consumption. Promoting urban growth, especially among inland cities, is a core part this effort. 

In July, the government expects to release a plan outlining its approach to urbanization. To implement its strategies and support the growth of its cities, however, China must reform long-standing institutions such as the country's household registration system, known as hukou in Chinese, as well as structural issues fiscally constraining local governments. Ultimately, Beijing will struggle to balance between competing needs for reform and control.

Chinese media reported June 13 that the National Development and Reform Commission, China's top social and economic planning body, will release a national urbanization plan sometime in July. However, on May 13, the commission announced that it would have to delay what it called an important meeting on urbanization — originally set to take place in late May or June — due to a lack of consensus within the Chinese Communist Party over the type and extent of reforms necessary to meet the country's target urbanization rate of 60 percent by 2020.

Some degree of reform may indeed be necessary to boost economic activity in inland provinces, where the vast majority of new urban migration will occur, and to better prepare them to metabolize much of the $8.1 trillion the China Development Bank estimates will be needed to accommodate China's ballooning population of city dwellers over the next decade. But too much reform implemented too quickly could overburden China's increasingly constrained financial system, create massive upheaval in labor markets and lead to intolerable levels of unemployment, social dislocation and rural and urban social unrest.

The details of how the commission's plan will address these problems are still unclear, but the core issues have long been under discussion. The issues will dominate internal and public Party debates throughout the third quarter, and the leaders will officially decide how to proceed at the Third Party Plenum meeting in October.

The Need for Hukou Reform

A primary area in need of reform is the hukou system, which basically organizes all Chinese citizens around two core divisions: local vs. non-local hukou and agricultural and non-agricultural. Those who receive non-agricultural hukou, especially in major cities such as Shanghai and Beijing, are guaranteed access to a wide range of social services, including health care, public education and state-funded pensions. By comparison, those who receive agricultural or rural hukou receive few to none of these benefits. In recent decades, this dynamic has reinforced the formation of a massive underclass, especially in coastal Chinese cities, where some 250 million migrant laborers with non-local and often agricultural hukou are barred from receiving even the most basic social services.

General Migration Patterns in China

General Migration Patterns in China

Since 1978, hukou has served a crucial purpose in China's low-cost export-oriented economy by guaranteeing access to a large, artificially cheap labor force. Today, however, with the government attempting to boost domestic consumption and promote greater regional economic integration, hukou is fast becoming an economic, political and social liability.

Building a stronger domestic consumer class will require implementing widespread increases in wages, a process the government has accelerated rapidly in the past five years. Increasing consumption will also require stronger social services throughout the country and expanded access to those services. Each of these reforms would also help make the labor force more flexible and responsive to market needs. Moreover, bolstering the consumer class would require greater enforcement of workers' rights at the local levels, especially for legally disenfranchised migrant laborers. Increasing access to urban hukou, or at least to the social services typically afforded to those with urban registration, and improving the quality of social and educational services in the interior is key to each of these and thus fundamental to boosting inland urbanization.

Local Fiscal Reliance on Beijing

Reforming the fiscal relationship between Beijing and local governments will be key to managing the influxes of urban residents over the next decade and paying for the infrastructure expansions needed to absorb them. The hukou system, for example, can be relaxed only once central and local governments can afford the costs of expanded social services for new urban migrants. This concern is especially strong for many smaller and mid-sized inland cities, which lack the vibrant real estate markets of their wealthier counterparts on the coast, since land transfer fees from property construction are a primary source of revenues for local governments.

Since China's tax system was reformed in the mid-1990s, the vast majority (more than 70 percent in some cases) of tax revenues have been accrued by the central government, much of which has then been invested into national infrastructure development. In exchange, Beijing granted local governments control over land that could then be sold to real estate developers. This led to collusion between property developers eager to profit from exploding demand and local governments eager to fill their coffers. As a result, China has become filled with localities overly dependent on land sales.

Key Urban Development Zones in Inland China

Key Urban Development Zones in Inland China

Today, amid its push for urbanization, China is struggling to reverse such dependencies while still providing affordable housing to new residents, most of whom are being priced out of property markets. To fund urban development (of which social services are only a small part), local governments in the interior will need alternative and more stable sources of revenue. The Party has discussed transferring some control over tax collection and spending back to local governments and providing them with alternatives for raising revenue, including legalizing and expanding local government bonds.

Measures to alleviate local government dependence on land sales are also needed to maintain social stability in rural areas. Throughout the 2000s, local governments' dependence on land sales for revenue led to a sharp spike in expropriations of rural land for development — often illegally and without proper compensation for rural landholders. Land is often a sole source of income and insurance for rural residents. And as highlighted in the Wukan incident in January 2012, rural unrest over unlawful expropriations has become increasingly organized and politically potent. In a country where essentially every major episode of political upheaval has started in the rural hinterlands, this is not a trivial problem.

Risks of Reform

In 2011, Beijing launched a pilot project testing fiscal reforms in Shanghai and Chongqing, and it announced on June 20 that local government bond issuances would be allowed in cities in Shandong and Jiangsu provinces. But expanding the reforms from a small number of major municipalities and coastal provinces to the entire country will be painful at a time of worsening economic conditions, and poor implementation of fiscal reforms could backfire in many ways. Real estate markets could plummet before local governments have time to adopt new financial models, creating local debt crises and widespread unemployment. Alternatively, while allowing municipal bond markets to flourish would help reduce capital flows into property markets and alleviate some of the pressure caused by relaxed hukou restrictions and increased urban migration, it would also diminish central control over the economy.

Until recently, the central government has always maintained ultimate control over real estate markets through its ability to control the flow of credit to local governments via state-owned banks. If local governments can raise capital independent of the central government — say, through bonds — then central government influence would be weakened. In the event of a municipal bond boom or bust, Beijing would be put in the uncomfortable position of either bailing out local governments or facing widespread bankruptcies and unemployment.

Meanwhile, Beijing is also seeking to resolve several other issues related to the fiscal problems facing local government, including fragmentation in core industries such as steel and coal, plus the recent explosion of informal or shadow lending markets, which are poorly regulated and often opaque. These issues cannot be addressed in isolation, since they are both causes and outgrowths of each other. That they must be addressed in tandem would explain why the central government has been extremely careful in its approach to reform. But an overabundance of caution, when it prevents resolute action during times of economic hardship, can itself become a government's worst long-term enemy.

The National Development and Reform Commission's urbanization plan in July will outline careful, technocratic reforms designed to slowly move toward a liberalized, rationalized urban development process without causing too much disruption. For Beijing, this is not a technical problem. The central government is, in effect, attempting an impossible move toward a model of social and economic organization that is fundamentally incompatible with China's political structure — an economy and society that are at once free, mobile and market-driven and still immune to unemployment and firmly under the government's control.

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