Information about Asia and the Pacific Asia y el Pacífico
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8 Social Expenditure Assignments in China: Issues and Responses

Editor(s):
Ehtisham Ahmad, Vito Tanzi, and Qiang Gao
Published Date:
September 1995
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Information about Asia and the Pacific Asia y el Pacífico
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Author(s)
Zu-Liu Hu*

China has often been cited as an example of success in social development. Over the past four decades, it has achieved remarkable improvements in such important social indicators as life expectancy and adult literacy rate. A newborn Chinese infant in 1991, for example, has a life expectancy of 71 years, compared with 62 years for low-income countries as a whole. More than 95 percent of Chinese children under the age of one are immunized, with the immunization ratio among the highest in the world. By 1991, China had reduced the infant mortality rate to only 38 per 1,000 live births, the same level achieved by middle-income countries. An overwhelming majority of Chinese men and women today can read and write, compared with the still staggeringly high adult illiteracy rates in many low-income countries.

While there are many factors behind China’s better-than-average performance, clearly government activity in education and health has played a key role. China’s progress owes as much to good social services, including safe drinking water, improved sewage disposal, and other sanitation measures, as to broad immunization coverage and mass campaigns against parasitic diseases. It has much to do with the successful drive to reduce fertility as with the great efforts to provide basic education, nutrition, and preventive health care to the whole population. It reflects a long-term political commitment to social development. China’s experience illustrates the critical role of government, especially in low-income countries, in meeting the basic needs of the whole population and promoting social progress.

In spite of its impressive records in social sectors, China faces grave risks and challenges ahead because of three basic problems.

• China’s economy is in transition toward a market economy, and the rapid changes have severely strained the existing fiscal system with declining government revenues and rising demands for public resources. Confusion and uncertainty regarding redefining intergovernmental fiscal relations, in particular, may cause neglect and underfunding of social sectors and slow China’s progress in social development.

• The distribution of social expenditures has become more skewed, and inequality has emerged as a cause of concern. Fiscal reforms should address the issue of horizontal equity across regions and households.

• There are inefficiencies with existing public programs in financing and provision of education and health, and sectoral reforms are required.

While all these problems must be tackled urgently, the first one, allocating social expenditure responsibilities among various levels of government, seems to be the most pressing. The lack of clear and binding assignment of responsibility may diminish the role of government in education and health sectors, which are precisely the areas where government participation and intervention are indispensable. The restructuring of the intergovernmental fiscal system in China should help to improve rather than undermine the public delivery of essential social services, a goal that is consistent with the economic and social role of government in a decentralized market economy.

Theoretical Considerations and International Experience in Social Expenditure Assignment

Principles of Expenditure Assignment

There is no single rule that dictates social expenditure assignment. Some broad guiding principles ought to be observed, however, in specifying the appropriate role to be played by each level of government in education, health, and housing.1

The fundamental questions facing public finance, including social expenditure assignment, are what government does best and what the market does best. These questions are especially important for transitional economies like China’s. The government, whether at the central level or at the subnational level, should retire from direct production activities that are best undertaken by firms. Government intervention is justified, however, when “market failures” exist. Education and health services are vital to meet basic needs and improve the productivity of the population. Although, unlike national defense and law and social order, they are not “pure” public goods, education and health services, because of important externalities, cannot be efficiently provided by private markets alone. Government involvement is necessary to remedy market failures such as externalities, moral hazard, incomplete information, and imperfect competition that are commonly associated with social services, most notably, health care. The case for public delivery of housing, however, is much weaker. There are compelling reasons to believe that housing can be more efficiently provided by the private sector.

Another important consideration in social expenditure assignments is horizontal equity across regions and households. In a large, diverse country like China, wide variations in regional and local resource bases exist. Perfect local fiscal autonomy may lead to the underprovision of education and basic health care in poorer regions. Even within the same region, the income gaps among households are widening so rapidly that the access of the poor, especially the rural poor, to basic education and health care is in serious jeopardy. The design of intergovernmental fiscal relations should address the issue of horizontal equity in the distribution of social services. In many cases, intervention by higher level governments, through transfers and subsidies and allocation of grants, is needed.

For social services, such as education and health, however, it is difficult a priori to give clear assignments to either the central or subnational government. The usual “benefits principle,” which ties benefits and costs of public services within geographical areas to promote accountability of the responsible government and the cost effectiveness of public spending, can offer some useful albeit limited guidance. The central government usually plays a large role in both education and health because of their externalities. In many countries, education and health are identified as “priorities” of public finance. Central government budgets often allocate a substantial share of total revenues to these “priority” sectors, supplemented with national education and health regulations, plans, and policies. There is scope, however, for decentralization of these social expenditures. Both theory and international experience suggest that much can be gained from an expansion in the responsibility of provincial, municipal, and county governments for these social services. Broadening the involvement of local governments can increase public accountability and responsiveness to local needs and preferences, and improve the quality of education and health care.

International Experience

A cross-country comparison of national and subnational government functions may shed light on the role of government in social sectors as well as on the allocation of social responsibilities between levels of government.

In most countries, ranging from industrial market economies to less-developed countries, government typically plays a very important role in education and health care. Government expenditures in both education and health care on average exceed 5 percent of GDP in industrial countries. Similarly government has had a leading role in education and health in developing countries. Schools are usually owned, administered, and financed by government in most developing countries, with the average percentage of students in public schools exceeding 83 percent at the primary level and 74 percent at the secondary level. Also, in most developing countries, the government accounts for a major share of total health expenditure, although, in contrast to the heavier spending on health in industrial countries, public expenditures on health care are usually less than half of those on education in developing countries.

The fact that government is actively involved in these sectors reflects in part the presence of externalities in these services and, probably more important, the public concern on income redistribution. Private market allocations may not only be inefficient because of the failure to internalize the large social benefits of individuals’ education and health status, but also may be inequitable as the poor may be denied access to basic health care and the opportunity for education—the most effective means for escape from poverty and for upward social mobility.

While it is clear that the government should play an important role in social sectors, it is less transparent how social responsibilities should be divided among various levels of government. Table 1 shows the pattern of social expenditure assignment in selected countries. It can be seen that responsibilities in education and health are often shared by at least two tiers of government. The central government in developing countries usually takes principal responsibility in both education and health. By contrast in industrial countries, the degree of decentralization varies across education and health sectors—the role of subnational governments tends to be larger in education, while higher level (central and state) governments usually take principal responsibility in health.

Table 1.Social Expenditure Assignment in Selected Countries
EducationHealth
Central

govt.
State

govt.
Local

govt.
Central

govt.
State

govt.
Local

govt.
Australia213213
Canada321312
Denmark2121
France1212
Germany312132
Luxembourg1212
Switzerland312123
United Kingdom211
United States321123
India2121
Indonesia1212
Israel1212
Thailand1212
Chile1212
Colombia123123
Kenya1212
Malawi1212
Tunisia112
Source: Leach (1970), Levin (1991), and Shah (1991)Note: 1 = principal responsibility; 2 = secondary responsibility; 3 = minor responsibility; — = marginal or no responsibility.
Source: Leach (1970), Levin (1991), and Shah (1991)Note: 1 = principal responsibility; 2 = secondary responsibility; 3 = minor responsibility; — = marginal or no responsibility.

Table 2 indicates how more finely classified functions are allocated between different tiers of subnational governments in selected countries.

Table 2.Allocation of Social Functions to Subnational Governments in Selected Countries
AustriaBelgiumDenmarkFranceGermanyIrelandItalyLuxembourgNetherlandsNorwaySwedenSwitzerlandTurkeyUnited Kingdom
Preschool educationR,LLLLLR,LL
Primary and secondary educationR,LR/LR/LLR,LR,LLLLLR,LL
Vocational and technical trainingRR,LR,LR/LLLR,LLR,LRL
Higher educationR,LRR,LRL
Adult educationLLLLR,LRLR,LR,LR,LL
HospitalsR,LR,LRL,DR,LR,P,LLR,LR,LRR,LR,L
Personal healthR,LLR,LLR,LR,P,LLLLRRR
Family welfare servicesR,LR,LLL,DR,LR,LLLLR,LLL
Welfare homesR,LLLLLR,LLLLLR,LR,LL
HousingR,LLLR,LLR,LLR,LLLLLL
Refuse collection and disposalLLLLLLLLLLLR/LLL
District heatingLLLLLLLLR/LL
Water supplyLLLLLLR,P,LLR,LLR/LR/LL
Source: Karran (1988).Note: R = state, regional government; D = departments in France; L = local government; P = provinces in Italy.
Source: Karran (1988).Note: R = state, regional government; D = departments in France; L = local government; P = provinces in Italy.

In spite of the diversity in the political structures (federal versus unitary) and in the size and population, it seems that among these countries there exists a substantial degree of uniformity about which functions are assigned to local governments (municipality and county). Preschool primary, and secondary education are basically a “local government” service, and vocational and technical training and adult education are provided by both regional (state or province) and local governments, while higher education is usually the responsibility of the regional or central government. It appears that hospitals and personal health services are also the joint responsibility of multitiers of government. Clearly, services such as housing, water supply, and refuse collection and disposal are primarily the functions of local governments.

International expenditure data also display interesting patterns in public spending on education and health care by different levels of government.2 Although social expenditures may entirely fall on a particular level of government in some countries (Tunisia and the former Yugoslavia, for example), it is far more common that these expenditures are shared by several levels of government, with some level playing a major role. It appears that there exists considerable variation in the shares of social spending administered by different levels of government across countries. For example, local governments accounted for more than 70 percent of total public expenditures in education in the United States, with the rest being split between the federal government (4 percent) and the state governments (25 percent). In France, the central government administered 75 percent of total government expenditures in education, and local governments spent the other 25 percent. In Germany, however, it is the state governments that administered most of the public expenditures in education (74 percent), followed by local governments (25 percent), while federal government spending contributed only 1 percent.

Likewise, the allocation of public spending on health between levels of government exhibits diversity across countries. Higher-level governments tend to play a larger role in health expenditures than in education. In most countries, central government-administered shares account for more than half of total public spending on health. State governments usually play a secondary role, while, with only a few exceptions, local government expenditures on health are relatively unimportant.

Although the ratios of central government or subnational government expenditures to the total government social expenditures are suggestive of the respective role of each level of government in social sectors, the data cannot provide accurate measures of the true degree of fiscal decentralization because they hide important distinctions between financing, administration, and regulation or control. For instance, the central government may administer only a small portion of total public education expenditures, but it may actually play a large role in financing education by giving grants to provincial and local governments, and it may have substantial control of the education sector because of its power as regulator.

The special role of intergovernmental grants in a multilevel fiscal system is worth mentioning, in particular. There is substantial intergovernmental grant financing of education in Australia, Canada, Switzerland, the United States, and Zimbabwe, but quite little in France, Germany, Luxembourg, and the United Kingdom. Intergovernmental grants cover some 20 percent of total government health expenditures in Canada, Luxembourg, and the United States, but very little elsewhere.3

One of the messages from international experience seems to be that an appropriate expenditure assignment should not only be broadly consistent with the economic principles in terms of efficiency criteria but should also fit into the particular social and political structure and institutional framework in a country.

Issues with Current Social Expenditure Assignments

In China, the state traditionally played a central role in the social sectors just as in most economic sectors. Since economic reforms were initiated in 1978, the Chinese economy has become increasingly market oriented. The central government has retreated from its role as a direct producer of goods and services in a formerly command economy and surrendered much of the economic decision-making power to lower-level governments and enterprises. The fiscal system has been considerably decentralized and responsibilities for some public services have been transferred to provincial and local governments.

Since 1978, the share of subnational government (provincial and lower-level governments) expenditures in total government expenditures has been rising steadily, reaching 60 percent by 1988 (Table 3), indicating a trend of fiscal decentralization in China. There have been no major shifts in social expenditures between the central government and subnational governments, however. The share of subnational government expenditures in the category of CESH (culture, education, science, and health) has been remarkably stable—staying in the neighborhood of 88 percent—considering the many drastic changes in revenue assignment that have taken place over the period. Social expenditures have been a small portion of total central government expenditures, accounting for less than 5 percent of the 1992 central budget (Table 4). They have gradually become the single most important expenditure responsibility for subnational governments, however, accounting for 30 percent of the total subnational government expenditures in 1992. Despite China’s efforts to increase budgetary spending on education over the past decade, total government expenditures for CESH still amounted to less than 4 percent of GDP in 1992 (Table 5), an abnormally low ratio by international standards. This ratio, however, understates China’s true level of public expenditures in social sectors because a bulk of social services is provided by state-owned enterprises. Much of the recent growth in budgetary CESH expenditures has come from subnational governments.

Table 3.Central and Subnational Shares per Expenditure Category(In percent)
197819881989199019911992 (Budget)
CentralLocalCentralLocalCentralLocalCentralLocalCentralLocalCentralLocal
Total46.8953.1139.1760.8336.3563.6539.7760.2339.4760.5344.2555.75
Capital construction55.7544.2576.7323.2773.9626.0474.6625.3473.5926.4178.7821.22
Working capital29.3170.6970.0030.0061.5438.4672.7327.2770.0030.0063.6436.36
Technological upgrading and research and development33.3366.6731.7968.2135.3764.6335.7164.2933.1566.8542.2257.78
Geological prospecting30.0070.00100.00100.00100.00100.00100.00
Industry, transport, and commerce55.5644.4433.3366.6728.8971.1129.7970.2128.8571.1530.3669.64
Agriculture2.6097.409.4390.578.5991.419.9190.099.0990.919.2390.77
Culture, education, science, and health11.5088.5012.5587.4511.5588.4511.6588.3511.1688.8411.4388.57
Social relief and welfare100.00100.00100.00100.001.4798.531.4998.51
Defense95.834.1799.080.9299.200.8099.310.6999.090.9199.190.81
Government administration8.1691.8416.3283.6815.7984.2117.3382.6716.8483.1617.1682.84
Government debt service100.00100.00100.00100.00100.00
Price subsidies11.3688.6410.1989.8110.5089.5013.4886.5215.1884.82
Other47.3052.7012.5087.5012.9487.0612.6387.3711.8888.1214.7385.27
Source: Ministry of Finance, China.Note: Percent of total government expenditures. The local expenditures include the earmarked transfers from the central government.
Source: Ministry of Finance, China.Note: Percent of total government expenditures. The local expenditures include the earmarked transfers from the central government.
Table 4.Shares of Expenditure Categories in Total Central and Subnational Expenditures(In percent)
197819881989199019911992 (Budget)
CentralLocalCentralLocalCentralLocalCentralLocalCentralLocalCentralLocal
Total100.00100.00100.00100.00100.00100.00100.00100.00100.00100.00100.00100.00
Capital construction48.3733.9045.098.8141.908.4239.488.8535.748.3631.986.84
Working capital3.266.950.660.180.720.260.580.140.470.130.380.17
Technological upgrading and research and development4.037.124.536.264.714.914.014.764.075.364.174.53
Geological prospecting1.152.373.022.992.622.542.30
Industry, transport, and commerce1.921.361.231.581.181.651.021.591.001.610.931.70
Agriculture0.3812.711.428.751.549.351.609.621.479.581.3210.27
Culture, education, science, and health2.5016.955.7525.825.7925.325.2426.265.2127.054.8329.69
Social relief and welfare3.222.492.532.650.072.920.052.87
Defense30.901.1920.380.1222.530.1020.980.1021.840.1320.190.13
Government administration0.777.633.6812.154.0712.404.1513.084.2813.763.7814.50
Government debt service7.266.5213.8416.4323.59
Price subsidies3.4017.073.4417.312.9116.403.3413.982.8012.41
Other6.726.613.5816.164.6217.733.5716.313.5417.123.6816.89
Source: Ministry of Finance, China.Note: Percent of total central or local expenditures. The local expenditures include the earmarked transfers from the central government.
Source: Ministry of Finance, China.Note: Percent of total central or local expenditures. The local expenditures include the earmarked transfers from the central government.
Table 5.Central and Subnational Expenditures as a Percentage of GNP
197819881989199019911992 (Budget)
CentralLocalCentralLocalCentralLocalCentralLocalCentralLocalCentralLocal
Total14.5216.447.5811.777.0012.267.8911.958.0412.339.1111.48
Capital construction7.025.573.421.042.931.033.111.062.871.032.910.78
Working capital0.471.140.050.020.050.030.050.020.040.020.030.02
Technological upgrading and research and development0.591.170.340.740.330.600.320.570.330.660.380.52
Geological prospecting0.170.390.230.210.210.200.21
Industry, transport, and commerce0.280.220.090.190.080.200.080.190.080.200.080.19
Agriculture0.062.090.111.030.111.150.131.150.121.180.121.18
Culture, education, science, and health0.362.790.443.040.413.100.413.140.423.340.443.41
Social relief and welfare0.530.290.310.320.010.360.33
Defense4.490.201.540.011.580.011.660.011.760.021.840.01
Government administration0.111.250.281.430.291.520.331.560.341.700.341.66
Government debt service0.550.461.091.322.15
Price subsidies0.262.010.242.120.231.960.271.720.251.42
Other0.981.090.271.900.322.170.281.950.282.110.331.94
Memorandum item
GNP

(in billions of yuan)
358.801,398.401,578.901,740.001,861.802,001.40
Source: Ministry of Finance, China.Note: The local expenditures include the earmarked transfers from the central government.
Source: Ministry of Finance, China.Note: The local expenditures include the earmarked transfers from the central government.

Although expenditure data suggest that, compared with many developing countries, subnational governments in China play a greater role in social sectors, particularly in administration and financing, the central government nevertheless has substantial power in regulation and in formulating national policies. In education, for example, the central government, through the State Education Commission, sets national standards for primary and secondary education and administers the national university entrance examination system. Provinces must also follow the central government mandate to achieve the goal of universalization of nine years of basic education. In addition, the central government affects the financing of education at the provincial levels through allocating earmarked grants. Indeed, tight central supervision and application of uniform standards nationwide in particular may help to explain the relatively high quality of primary and secondary education in China.

Further breakdown of subnational government expenditures at the provincial and local level (municipal and county) is difficult because of lack of data, but Hubei Province may provide a good example. Table 6 illustrates how expenditures are divided at different tiers of subnational governments in Hubei Province. Of the Y 8.2 billion expenditures in 1990, about 26 percent was spent at the provincial level, down from 30 percent in 1981. Capital construction expenditures largely remained at the provincial level, which still accounted for 85 percent. Social expenditures, however, were concentrated in local governments—the municipalities, counties, and townships, which together accounted for 77 percent of the total. Townships, at the lowest level of the government structure, play an especially important role in social sectors. About 30 percent of social expenditures in Hubei Province was spent at the township level in 1990.

Table 6.Hubei Province: Expenditure by Level of Government
In Millions of YuanAs a Percent of Total
TotalCapital

construction
Technological

upgrading
Education,

culture,

health
OtherTotalCapital

construction
Technological

upgrading
Education,

culture,

health
Other
1981
Total2,360286687371,269100.012.12.931.253.8
Province706286527629229.9100.076.510.323.0
Municipalities589718739525.00.010.325.431.1
Counties1,065947458245.113.264.545.9
1985
Total4,3594381821,1702,569100.010.04.226.858.9
Province1,5563918415592635.789.346.213.236.0
Municipalities1,211484332779327.811.023.627.930.9
Counties1,5935568885036.530.258.833.1
1990
Total8,2845563671,9875,374100.06.74.424.064.9
Province2,188472862491,38126.484.923.412.525.7
Municipalities2,506841405431,73930.315.138.127.332.4
Counties2,5061415891,77630.338.429.633.0
Townships1,08460547913.130.48.9
Source: Hubei Finance Bureau, Wuhan, China.Note: Figures may not add because of rounding. The fiscal system has recognized the township level since 1986. Figures include Wuhan City.
Source: Hubei Finance Bureau, Wuhan, China.Note: Figures may not add because of rounding. The fiscal system has recognized the township level since 1986. Figures include Wuhan City.

Examining the current fiscal system also reveals that subnational governments to a large degree depend on self-financing in funding social responsibilities and that the role of intergovernmental grants is relatively unimportant in determining social expenditures of subnational governments. In Hubei Province, for example, earmarked grants from the central government accounted for less than 2 percent of total social expenditures in 1990 (Table 7).

Table 7.Hubei Province Budgetary Expenditures and Central Earmarked Grants, 1990(In millions of yuan)
Total

Expenditures
Central

Government

Earmarked Grants
Grants as

Percent of Total
Capital construction5566010.8
Technological upgrading367102.7
Agricultural support8318910.7
Education, science, health2,035371.8
Urban maintenance36651.4
Administration1,147595.1
Price subsidy1,61394758.7
Other1,36920314.8
Total8,2841,41017.0
Source: Hubei Finance Bureau, Wuhan, China.Note: The figures include Wuhan City.
Source: Hubei Finance Bureau, Wuhan, China.Note: The figures include Wuhan City.

Some of the features in China’s intergovernmental fiscal relations, especially the delegation and devolution of fiscal responsibilities for social sectors to lower-level governments, appear to be consistent with the general principles of expenditure assignment. Fiscal decentralization has given provinces and lower-level governments powerful incentives and increasing autonomy to manage local public finances and hence produced substantial efficiency gains. Since fiscal decentralization is somewhat poorly planned and implemented piecemeal, however, it has also created many problems. Specifically, the Chinese authorities ought to address a number of issues outlined below.

Define Expenditure Assignments

To date, China has failed to work out a law that clearly defines expenditure responsibilities for different levels of government. Existing expenditure assignments are murky, and often, motivated by political expediency, shift between levels of government in ad hoc ways. The central government may shift its own expenditure responsibilities to provincial governments in times of difficulty (price subsidies and state-owned enterprises subsidies, for example), and provincial governments may use their broader responsibilities to bargain for a larger share of revenue. Intergovernmental bargaining has weakened budgetary planning and control and contributed to the instability of China’s fiscal system. Without first reaching decisions on expenditure assignment, the Chinese authorities have found it difficult to reform tax assignment rules and revenue-sharing mechanisms between the central and provincial governments.

Expenditure assignments between the provincial government and lower-level authorities, such as municipal and county, are even more vague. Local governments are often forced to take the responsibility that should be undertaken by higher-level government, accentuating the mismatch between local revenue and local expenditure responsibility. The lack of specificity and the unpredictability built into the current system of expenditure assignments have given rise to budgetary uncertainty for the central government and made fiscal planning an impossible task for provincial and local authorities, hence adversely affecting the supply of public goods and services in both quantity and quality.

Relieve Social Burden of Enterprises

Historically, state-owned enterprises have been undertaking many social responsibilities such as day care, schools, hospitals, housing, sports, and theater, most of which would belong to the public sector in a market economy. With increasing competition from rural township enterprises, foreign joint ventures, and other private enterprises, state-owned enterprises—many of them incurring losses—have difficulty financing social services for their employees and the local community. An important task of both fiscal reform and restructuring state-owned enterprises is to relieve enterprises’ social burden through transferring their social expenditure responsibilities from the enterprise sector to the appropriate level of government.

Equalize Social Services Across Provinces

Horizontal inequity has increasingly become a problem in China as market-oriented economic reforms proceed. The current fiscal system has produced an inequitable distribution of social services across both regions and households. Poorer provinces tend to spend much larger shares of their fiscal revenues on primary and secondary education, but still have considerably lower per capita expenditures relative to the national average. In 1990, per capita expenditures on CESH in Beijing, Shanghai, Tianjin, and Tibet well exceeded Y 100, while those in poorer provinces, such as Anhui, Henan, Sichuan, and Guizhou, were less than Y 35 (Table 8).

Table 8.Main Items of Expenditures per Capita by Provinces(In yuan)
Capital

Construction
Culture, Education,

Health
Welfare
1987199019781987199019871990
Total province14.9015.4110.431.2946.033.434.77
Beijing98.13109.2128.780.88147.889.5614.73
Tianjin62.5848.4224.383.63106.905.547.58
Hebei6.835.979.526.2240.303.855.68
Shanxi22.6714.5211.836.0352.504.826.17
Inner Mongolia26.1922.849.848.9467.185.376.52
Liaoning28.2521.5315.642.7165.214.956.88
Jilin15.6014.1416.045.6562.516.106.24
Heilongjian14.8115.9213.837.7052.503.834.63
Shanghai80.24104.4927.888.00128.425.045.39
Jiangsu9.318.428.528.5142.433.394.95
Zhejiang10.409.219.132.8951.083.085.13
Anhui5.966.038.320.4429.412.513.63
Fujian17.7426.4111.434.0554.493.425.10
Jiangxi9.428.749.225.6335.493.404.30
Shandong6.149.208.626.7340.373.885.58
Henan6.786.298.220.1827.512.902.87
Hubei12.1310.2210.126.6436.532.974.01
Hunan8.039.148.425.6835.772.684.16
Guangdong23.4731.4710.435.5555.662.893.66
Guangxi10.198.599.729.5141.452.312.70
Hainan52.4965.614.98
Sichuan9.139.277.822.2933.692.453.42
Guizhou11.3913.898.525.2234.273.033.82
Yunnan20.2624.288.334.1555.053.599.92
Tibet57.2166.22111.06124.7710.1016.22
Shaanxi11.8210.0711.430.8243.703.144.43
Gansu20.6017.1211.232.7546.653.644.12
Qinghai44.6332.5924.363.3280.365.146.47
Ningxia46.4431.0622.259.5473.624.144.47
Xinjiang35.8132.4418.255.6979.273.443.79
Mean25.2026.0042.4060.404.205.70
Standard deviation23.1026.1022.6030.101.803.00
Coeff. of variation0.921.000.530.500.440.52
Source: China Finance Statistics; China Statistical Yearbook (various issues).
Source: China Finance Statistics; China Statistical Yearbook (various issues).

The inequality between urban residents and rural peasants is especially striking. For the past decade, government spending per capita on health care has been five times higher for urban residents than for rural residents. Most of the budgetary subsidies on education and health care have gone to employees of the urban state-owned sector. Peasants, who account for 80 percent of population in China, are not covered by any medical insurance plans. The rural poor in some areas often lack access to even basic health services, and rural schools—especially those in poorer regions—are grossly underfunded.

As the resources in the revenue-sharing system stagnated, the central government allowed the redistributive element of the fiscal system to weaken, at times when diverging economic conditions would require more equalization among regions. Fiscal redistribution now takes place mainly through ad hoc, earmarked grants, often poorly targeted and too small to meet basic needs in the poorer regions.

Reduce Risk of Crowding Out Social Expenditures

Facing tight budget constraints and the competition for faster regional growth, local governments are often compelled to shift their spending priorities to industrial projects that can potentially generate fiscal revenue and enlarge local resource capacity. The current fiscal system gives disincentives for local governments to fund social sectors, where government participation is critical. More of the limited local financial resources are allocated to local industrial investment, development zones, and physical infrastructure, such as roads, power stations, communication systems, and so on, at the expense of education and health care, whose benefits accrue only slowly and cannot be reaped exclusively by the local economy. Fiscal decentralization may result in underfinancing of social sectors, particularly in the revenue-stricken poor regions.

Directions for Reforming Social Expenditure Assignment

The reform of intergovernmental fiscal relations should enhance the role of government in the provision of social services. Public finance should continue to set education and basic health care as top spending priorities so that China’s remarkable progress in human and social development can be sustained. China needs a healthy, well-educated, and skilled labor force to maintain its productivity growth and external competitiveness. Human capital investment is a key variable that determines long-run economic growth, as demonstrated by China’s own and its East Asian neighbors’ experience. Since government activity in education and health is crucial for human capital formation, it needs to be assessed as an essential part of the overall set of government responsibilities.

More specifically, the reform of social expenditure assignment in China should focus on the areas described below.

Decentralize Social Services. The decentralization of education and health systems now evolving in China should be improved and consolidated. First, responsibilities for financing, providing, and regulating social services can be separated and properly divided among different levels of government. Second, assignment of expenditure responsibilities for each level of government should be made more specific, more stable, and more transparent. It should be finalized in the form of laws and regulations that govern intergovernmental fiscal relations. The central government should retain substantial power in the regulation and supervision of education and health-care sectors, to ensure conformity with national goals and standards. Transferring administrative and spending responsibility for primary and secondary education and basic health care from the central government to provincial and lower-level governments, however, will likely lead to substantial efficiency gains.

Reduce Disparity in Social Services. The new intergovernmental fiscal system should aim at reducing the wide disparity in social expenditures across regions and the coverage of social services for urban and rural families. The central government and provincial governments should explore various policy instruments to achieve horizontal equity in education and health care.

Improve Allocative Efficiency. The current allocation of public funds within social sectors is biased. It favors higher education and urban schools, and too much health spending goes to urban hospitals and curative health care. The new expenditure assignments should enable the responsible government to shift more resources to primary and secondary education, to increase subsidies to rural schools, and to refocus on basic preventive health care, especially in poor rural areas.

Mobilize Financial Resources. The education and health care sectors can improve efficiency and achieve cost recovery through user charges and other benefit-related fees for primary and secondary education in urban and rich regions, as well as most of the curative health-care services and higher education. Applying charges can provide incentives for efficiency in the delivery and consumption of social services, as well as increase revenue.

Expand Role of Private Sector. While the public sector will probably have to remain the dominant supplier of education and health care, China should encourage private provision of these services. Particularly in health care, the scope for private sector participation is large. The government should continue to expand basic health care with greater emphasis on access for the poor and take responsibility for health services that have a public-good character (e.g., clean air and water safety) or externalities (e.g., immunization programs), while allowing the private sector to play a larger role in providing curative care services. Most important, the provision of housing should cease to be a responsibility of the state-owned enterprises or government agencies. The authorities should push forward housing reform by encouraging private home ownership and development of housing market.

Policy Recommendations

The following policies are recommended.

  • The Chinese authorities should continue setting education and health care as top priorities of public finances, while the government should further withdraw from direct economic activities that should be left to the market. Housing, which can be efficiently produced and provided by the market, should no longer remain a responsibility of the public sector, except for some form of necessary intervention on equity grounds. At the same time, the government should assume responsibility for providing social services delivered previously by enterprises. Social functions of state-owned enterprises can be transferred to local governments—municipalities and counties—since local governments are in closer touch with local conditions and needs and can thus provide the right amount of services to residents in their jurisdictions at lower costs.
  • In the new intergovernmental fiscal system, the central government should have the primary responsibility for the legislation and supervision of education and health care, for formulating general policies and guidelines (universalization of basic education, vaccination for children, family planning, and so on), and for setting national education and health-care standards (e.g., curriculum design, central inspection, and national examinatibn), while provincial governments and lower-level governments should play the principal role in the administration and financing of basic public education and public health care.
  • The central government can continue undertaking responsibility for administering and financing national universities, and for supporting basic medical research programs vital to public health. It can share with provincial governments the responsibility for information and control of contagious diseases and for immunization. Provincial, and especially lower-level, governments such as municipalities and counties can be given primary responsibility for the financing and provision of primary and secondary education. Safe water supply, sanitation, sewage, and other local services concerning public health should be financed and provided primarily by local governments at municipal, county, or township level.
  • Increase diversification in China’s education and health sectors. In particular, expand the role of the private sector in education and health care services. Encourage the establishment of privately run schools and hospitals and foster competition between the private sector and public schools and public hospitals. Review and study alternatives for the development of national health insurance systems, including both public and private, market-related, decentralized approaches, and centrally or provincially funded and coordinated “universal health insurance systems.”
  • Improve the cost effectiveness of social services. This would be done by increasing the role of tuition and fees for public schools in rich regions and urban areas and applying user charges to curative care services, while preventive care, including prenatal care and immunization, would continue to be provided free of charge. Most social expenditures at the local government level should be financed out of “own revenues” to increase the accountability of local governments and encourage cost effectiveness of public services. To this end, revenue assignment should follow expenditure assignment so that local governments would have adequate resources to finance their social responsibilities.
  • Establish a sound system of intergovernmental transfers and grants. Intergovernmental grants are an important instrument to redress horizontal inequality in social expenditures. Both matching and equalization grants, allocated from central and provincial to lower levels of government, are likely to be needed to rationalize intergovernmental fiscal relations.
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*International Monetary Fund. Helpful comments from Ehtisham Ahmad, Ke-Young Chu, and Vito Tanzi are gratefully acknowledged.
1For a general discussion on expenditure assignment, see Chapter 6.
2Levin (1991). Data quoted refer to three-year averages for 1980. See also Chapter 6.

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