China: Urbanization and Hukou Reform

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China: Urbanization and Hukou Reform

They are likely to headline China’s new economic reforms. But they cannot be pursued in isolation.

Since taking office, Chinese Premier Li Keqiang has repeatedly emphasized the role further rapid urbanization will play in China's development strategy. Consequently, it is widely predicted that policies to spur urban growth will headline the major economic reform plan expected at November's crucial third plenary session of the 18th Central Committee.

However, Li has been keen to stress that future urbanization will be better planned and coordinated than before. Rather than focusing solely on the simple volume of new urban residents, Li wants urbanization to improve the quality of China's economic growth and the way the dividends are shared among the Chinese people.

As a key step in realizing these objectives Li has prioritized dismantling the "two-tier class system" that has emerged in China's cities, namely reform of the hukou household registration system. This will be crucial in both enabling existing migrants to fully participate in the economy and creating more attractive conditions to guarantee further waves of rural residents move to urban areas.

However, reforming the hukou will be easier said than done. It will force the government to address a number of other serious challenges, not least the precarious financial position of many provincial and municipal governments and the politically very sensitive issue of land reform.

Signs are these issues are currently the subject of fierce debate within the Communist Party. We will only know how far China's leaders are willing to go in pursuit of reform following November's crucial meeting.

Compelling Factors

Since the hukou was introduced it has been used by the Communist Party as a means of administering and organizing the Chinese population to support the Party's political, economic and social objectives. Broadly speaking there have been three phases in its operation.

During the first, from the 1950s to the late 1970s, the Communist Party had the dual goals of the collective transformation of agriculture and the development of Soviet-style heavy industry. Therefore, the Party used the hukou to balance the rural and urban populations. Movement was controlled by limiting access to work, food and services to people's registration location.

During the second period, from the late 1970s to the mid 2000s, the Party's priority was to exploit China's massive rural labor surplus to support rapid economic expansion. To this end, restrictions on movement and work were lifted but other rules, such as those stopping rural hukou holders accessing urban services, were kept in place. The result was the creation of a large, mobile and crucially low-cost workforce that became the backbone of China's manufacturing and export orientated economy.

During the third and current period, as China's economy has matured and started to move up the value chain, it is generally agreed, even tacitly by the Communist Party, that the hukou system has lost its useful purpose in supporting China's development. Instead there is growing consensus that the 260 million migrant workers who now exist actually present an obstacle to the new priority of rebalancing the economy to be more consumption centric. An analysis of migrants' income, savings and home ownership rate illustrates this problem.

Figures from the National Bureau of Statistics show that in 2012 the average monthly wage of a migrant worker was just 2290 yuan compared to 3897 yuan for permanent urban residents. Migrant workers also save a far higher percentage of their income than permanent residents due to the lack of a social safety net. Their savings rate is 50 percent of income compared to 30 percent for permanent urban households. In terms of home ownership the disparity is even greater. A 2011 survey showed that just 0.7 percent of migrants had purchased a home in their adopted cities. This compares with a permanent resident rate of typically between 60 and 80 percent.

Put simply, because migrants earn less and have less security they play a much smaller part in the economy than permanent urban residents who have better access to well paid jobs and social services. Therefore, without reform, the hukou system will lock out ever greater numbers from China's emerging middle class and make economic rebalancing an uphill battle.

However, the increasingly negative effect of the hukou is not only limited to the economic sphere. The part the system plays in widening inequality is also starting to weigh heavily on public sentiment.

Recent figures from the Pew Research Centre Global Attitudes Project show that worries about inequality are mushrooming. Data show 52 percent of the public now consider inequality to be a “very big problem," a jump of 11 points from 2008. Left unchecked, this growing dissatisfaction could precipitate serious social unrest as millions feel they are being left behind while a privileged elite surges ahead.

Therefore, there are compelling reasons for reform. However, the difficulty in transforming rationale into action lies in the fact that the hukou cannot be tackled in isolation. Instead the government must also address other highly sensitive issues that are related. It is for this reason that genuine and widespread reform has not come sooner.

The Complexities of Hukou Reform

Resolving who pays for reform is one of the key challenges. Since a major tax overhaul in 1994 local governments have been left with a substantial gap between the amount of tax revenue they receive and their spending liabilities. It is estimated that while local government is responsible for around four fifths of expenditure they only receive half of this from tax.

This disparity has forced local officials to devise alternative ways of funding their spending obligations. Many cities have resorted to the socially destructive practice of illegal land seizures. However, with the amount of available land diminishing local governments have been piling up debt. When combined with the liabilities arising from the credit-fuelled infrastructure stimulus of 2008/9 local government finances are now in a parlous state.

Consequently local governments are deeply opposed to hukou reform. A 2012 project led by the National Reform and Development Commission, which interviewed city leaders across eight provinces, found nearly all said their administrations could not afford the extra spending to provide public services to hundreds of millions of migrants.

Therefore if hukou reform is to be central to China's new urbanization strategy China's leaders will have to agree how to resolve the funding issue. Will fiscal policy be reformed to give local governments a greater share of revenue? Will a cost-sharing model be developed between central and local government? Will local governments be given new means of raising revenues?

Without answers to these questions it is hard to see how substantive hukou reform can be delivered. Worryingly in recent days, with only weeks until the new urbanization strategy is expected, there are signs this issue is still far from being resolved. For instance Lou Jiwei, China's Finance Minister, is reported to be resisting calls for local governments to receive a higher share of tax revenues over concerns the funds would be used for vanity projects rather than public services.

Further, the financing of hukou reform is not the only area subject to fierce debate. Another is one of China's most politically sensitive issues – land reform.

Counterintuitive as it may seem a 2011 survey by the National Population and Family Planning Commission found that if offered an urban hukou only 26 percent of migrants would accept. This is because although a rural hukou has many disadvantages a key benefit it brings is that migrants retain their rural land use rights. Given the precarious nature of urban life migrants therefore often see this as a source of security even if they have no intention of returning to their villages.

The result is that urbanization will not fulfill its potential of maximizing consumption growth until migrants become more willing to forego their land use rights and become permanent urban residents. The fact that migrant workers' land often sits unproductive while they toil in the cities only adds to the economic disruption caused by the hukou.

The best solution to these problems is widely considered to be reform of rural land ownership. Currently rural land is owned collectively, although whether this means collectively by the rural residents or by rural residents and the government is unclear. If, however, rural residents were given the power to trade or mortgage their land use rights, and be fairly compensated for doing so, it would mean not only would they be more willing to swap their rural hukou but they would also start their urban lives with capital. This would allow them to escape the poverty trap that has traditionally greeted migrants.

Further advantages of allowing rural land to be freely traded are that it would become possible either to consolidate small plots into much more efficient large-scale farms or free up land for construction to further bolster urbanization.

However, how far China's leaders are willing to go with liberalization of China's rural land remains to be seen. Not only is collective ownership a totemic issue but there are real concerns about both cutting rural hukou holders' ties to the land and food security. Opponents argue one of the key reasons social stability was maintained following the laying off of approximately 23 million migrant workers during the global financial crisis was because they were able to return to their land. There are also fears that liberalizing the ownership of rural land would endanger China's self-sufficiency in domestically produced crops and thereby threaten China's security.

As with the issue of funding, however, it appears decisions about land reform are still being hotly debated. It has recently been reported that a pilot scheme to make non-farming rural land tradable for development, which had been expected in the upcoming economic reform plan, has been kicked into the long grass after opposition from elements within both central and local government. Central policymakers are reportedly worried the scheme could be abused and stoke further social unrest and local governments are opposed because the scheme would disrupt their monopoly on land.

Genuine Reform: Too Difficult?

While it is clear that the hukou system cannot be dismantled overnight, the increasing risk it presents to China's new economic priorities mean some sort of reform is inevitable.

However, genuine and substantive change will only come if hukou reform is pursued as part of a comprehensive and coherent urbanization strategy that addresses rather than ignores many of the related but highly contentious issues. It seems whether this will happen is currently the subject of fierce debate inside the Communist Party.

If agreement can be forged and hukou reform is tackled alongside much-needed changes to land and fiscal policy then it looks likely China's new urbanization strategy will play an important part in shifting the country to a more sustainable development path. If not, further urbanization will in all likelihood only exacerbate many of the already serious problems facing China.

John Marshall is a freelance writer focusing on China. Previously he worked at a management consultancy in Beijing advising multinational companies on their China investment strategies and in London for the U.K. government on trade policy.