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March 2, 2010

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Tax breaks and consumer subsidies herald big change in economic focus

CHINA'S success in turning itself from a developing country into the world's third-biggest economy in just three decades is often credited to its ability to adapt to changing times. Now, as government leaders, top legislators and their advisory bodies prepare for their annual meeting, another major retooling of the economy looks certain.

At issue when deputies of the National People's Congress and the members of Chinese People's Political Consultative Conference meet in Beijing this week is how to restructure the economy in the aftermath of a global financial crisis that struck at the heart of the nation's export-led growth.

"The disastrous economic meltdown last year has helped to enhance the determination of Chinese leaders to adjust the country's economic structure in a bid to improve the quality of China's development and make it sustainable," said Wang Tao, head of China Economic Research at UBS.

Some analysts said changes to economic policy may be the biggest since China embarked on market-oriented reforms and opening up to the outside world in 1978.

The global financial crisis has pushed China to the brink of becoming the world's second-biggest economy as Japan's growth falters. But at the same time, China's economy has lost its balance in at least three aspects, according to Morgan Stanley economist Wang Qing.

First, the nation's growth is too dependent on exports and investment from overseas. Secondly, household incomes have lagged behind the revenue surges enjoyed by both governments and corporations. And lastly, the role of manufacturing in the economic mix is disproportionately high.

The strategies to correct the wobbles point to stimulating domestic demand to increase consumption in China, raising incomes by reducing taxes on individuals and accelerating the development of the services industry.

The central government placed a high priority on consumer spending in the massive stimulus program unveiled in late 2008 and has already expanded subsidies.

This January, the subsidy to car owners was raised to a maximum of 18,000 yuan (US$2,635) from 6,000 yuan. This is for car owners who trade in old clunkers or heavily polluting vehicles for more fuel-efficient new models.

In December, the government announced that people who upgrade their mobile phones are eligible for discounts of up to 10 percent. That expanded the existing "old-for-new" program which started last September and offers subsidies for new refrigerators, television sets, washing machines, air conditioners and computers.

The stimulus policies appear to be working.

The Ministry of Commerce said sales of home appliances surged to more than 10 billion yuan in the last four months of 2009. At the same time, China's auto sales surpassed those of the United States, making it the biggest market in the world.

China is forecasting total vehicle sales of 15 million this year, up from 13.64 million units in 2009.

Many economists and advisers are urging the government to further raise the minimum wage (in Shanghai it is 960 yuan a month, the highest in China), and to lift the individual income tax threshold to put more money in people's pockets.

China raised the monthly income threshold for taxes to 1,600 yuan from 800 yuan in 2006 to alleviate the tax burden on the poor. The move exempted more than 20 million people from paying personal income taxes.

Economists are suggesting the threshold be raised to at least 2,000 yuan - some even suggest 5,000 yuan - to help release the huge pent-up potential of consumption among Chinese people.


But Gao Peiyong, deputy director at the Institute of Finance and Trade under the Chinese Academy of Social Sciences, said a better way to sustain consumption would be to spend more on health care, education and pensions to improve the social safety net.

Last year, consumption contributed 4.6 percentage points to China's annualized growth of 8.7 percent, while investment contributed 8 percentage points, and net exports dragged it down by 3.9 percentage points.

To alleviate over-reliance on manufacturing, which in turn depends on demand in foreign export markets, economists are recommending policies to boost the services industry.

"It is a long process and requires firm determination by governments at all levels because it sometimes comes at the cost of slower growth and employment," said Wang Depei, director of Forecast Think Tank.

Shanghai, a pioneer in China's economic reform, hasn't escaped the trials and tribulations of a changing world economic landscape. The city is trying to remodel itself into a global financial and shipping center, de-emphasizing its past reliance on manufacturing.

During the annual session of the Shanghai People's Congress in late January, some members voiced concern about the pressures encountered when they tried to shut down a handful of factories producing low-end products.

"It is related to the fiscal income of the local government and will affect the employment rate," said a member who was unwilling to be identified. "You have to find jobs for those being laid off after the factory is closed or moved out of the city. It is a big burden."

Lu Xiongwen, dean of the School of Management at Fudan University, said that's part of the pain of progress.

"If we want to become a global financial and shipping center, we should focus on that mission, and forget the irrelevant," Lu said.

That could be the same across China, where the services sector accounted for 42 percent of total GDP last year. Globally, the average is 60 percent, with developed countries such as the US and the United Kingdom up as high as 70 percent.

All eyes will be on the National People's Congress and the Chinese People's Political Consultative Conference this month as speculation mounts over what gears the nation will shift to keep the engine of growth running smoothly along some uncharted stretches of road.


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