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China’s Rebalancing Act – Will It Work?

China is expected to unveil its latest five-year plan for the nation this week, as its two quasi-legislatures - the Chinese People’s Political Consultative Congress and the National People’s Congress - are expected to give their stamp of approval.

Security personel pass by the Tiananmen Gate in Beijing, China. The Chinese People's Political Consultative Conference began on March 3 in Beijing.
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Security personel pass by the Tiananmen Gate in Beijing, China. The Chinese People's Political Consultative Conference began on March 3 in Beijing.

A major focus of the plan is to rebalance the Chinese economy, by moving away from a growth model powered by exports and investments, to one driven by domestic spending.

But while the shift is crucial to rebalance global trade and keep China’s economy humming, it remains unclear if policy makers can pull it off.

Over the weekend, Chinese Premier Wen Jiabao said China will lower its annual gross domestic product target to 7 percent over the next five years. The figure's not far from the 7.5 percent target in the previous five-year plan; yet, the Chinese economy continued to grow at an average rate of 10 percent between 2006 and 2010, supported by exports and public projects. By 2009, China’s consumption-to-GDP ratio stood at just 35.6 percent, making it the country with the lowest share of consumption to national output among major economies, according to McKinsey.

According to Wang Jianmao, Professor of Economics at CEIBS, China's economic imbalance has become worse in the past five years due to an over-reliance on fixed investments and exports.

To encourage consumer spending, experts say Chinese leaders need to shift the billions spent on infrastructure to increasing household incomes, and to bridge the wealth gap between the richer coastal regions and that of the central and west.

“The most basic issues lie in the fiscal spending structure,” said Guotai Junan Securities' chief economist, Li Xunlei . “Most of the 8 trillion yuan investments went into building basic infrastructure. This should be shifted towards the low-income earners, like in the U.S. In comparison, The U.S. provides more in terms of food and housing subsidies for the poor.”

Another solution for leveling out income disparity, is to introduce a capital gains tax or change personal income tax structures. Li says minimal taxation levels should be raised from 2000 to 2500 yuan ($304 to $380). On Wednesday, China’s cabinet decided to raise the minimum threshold to as high as 3000 yuan. Li says personal income taxes only make up 6 percent of China’s total tax structure versus 30 percent in the U.S., hence the country has room to maneuver.

Apart from rebalancing issues, the five-year plan will include a raft of other initiatives, including increased government support for high-tech companies and other strategic industries, proposals to address environmental problems and more money for health care, pensions and other social welfare needs.

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