Model and Characteristics of China’s Service Sector Reform during 1978-2016
Abstract: This paper intends to provide an in-depth and comprehensive analysis of China’s service sector reform during 1978-2016 and characterize the model of the service sector reform. Due to unique national conditions and development journey, China’s service sector reform was carried out in the context of China’s overall reform and opening-up program based on non-industrial motivations with a pragmatic approach to improve both people’s livelihood and efficiency and address practical problems facing China in various stages of its development, putting aside theoretical controversies. How to further improve the model of China’s service sector reform that came into shape in such a unique historical context and advance service sector reform is an important yet arduous task.
Keywords: service sector, reform history, model, uniqueness JEL classification code: L80, P21
DOI: 1 0.19602/j .chinaeconomist.2018.07.02
From 1978 to 2016, the nominal value added of China’s service sector increased from 86.05 billion yuan to 38.4221 trillion yuan, and its share in GDP went up from 23.4% to 51.6%. Service sector employment expanded from 48.9 million to 336 million, and its share in total employment rose from 12.2% to 43.5%. Since 2011, the service sector has ranked first among all industrial sectors in terms of job creation. Since 2013, the service sector has also ranked first in terms of output value. The rapid growth of China’s service sector prompted us to investigate its underlying forces. As is well known to all, reform or institutional transformation is the most important driver of China’s economic growth. This paper intends to tell two stories about China’s service sector based on an analysis of service sector reforms: first, the model; second, service sector reforms. Despite the uniqueness of China’s service sector reform, it is difficult to summarize the model given the service sector’s heterogeneity and fragmented reform initiatives and programs with no overarching theme. By taking stock of China’s service sector reforms, this paper intends to cast light on the features of the model for service sector reform and provide an assessment of the model.
1. Literature Review
Despite extensive studies on China’s reforms and the service sector’s rising status in China1, to our
surprise, very few studies have been carried out on the topic of China’s service sector reforms. Li & Xia (2009) believed that this omission is due to the following reasons. First, the service sector is defined using an exclusion method, i.e. the service sector is generally defined by economists to include what is not primary industry or secondary industry. Without a consistent and clear definition of the service sector, there is no commonality among various sectors in the economic sense, making it difficult to conduct an overall assessment of the service sector based on a general economic approach2. Moreover, China’s institutional change did not follow any consistent pattern. For a long time, the service sector had been widely considered by economists, industry practitioners and government officials as a non-productive sector supplementary to production industry as the sole growth driver. This view still has influence in China even today and is particularly evident in China’s industrial policies related to foreign capital. Third, service sector reforms are sporadic, specific and gradual compared with rapid institutional reforms in agricultural and industrial sectors. The patterns of such a gradual process may only be revealed over a long timeframe. These three reasons together may explain the limited research literature on service sector reform. Another important reason is that the theoretical framework of service-based economics is not yet fully established. For instance, Chinese and international textbooks on service-based economy are very limited3. An incomplete theoretical framework makes it difficult to carry out theoretical research on service sector reform.
Existing studies on service sector reform can be classified into two types:
The first type of studies deals with the performance or stage of service sector reform based on the journey of reform. Xu, Zhao & Yang (1993) considered that China’s institutional reform followed the sequence of primary, secondary and tertiary industries, i.e. reform started with agriculture and then expanded to industry, construction, commerce, and social and economic sectors. Institutional reforms are insufficient for many sectors of the tertiary industry, particularly transport, telecom, materials, culture, education, healthcare, science and technology and public and public welfare sectors. They also studied how the service sector supported economic development and was boosted by service consumption. These studies were of certain relevance back then. However, they did not reveal the driving forces behind reform. Li & Xia (2010) systematically reviewed the momentum and journey of China’s service sector development. They believed that the driving forces behind China’s service sector development were dynamic and evolved from employment pressures in the 1980s to fiscal pressures in the 1990s and internationalization pressures after 2000. In some follow-up studies, they further refined this view (Li, 2015). Based on the history of service sector reform, this paper intends to summarize the reform model and deepen previous studies.
The second type of studies unravels the reasons behind the underdevelopment of services. For instance, Ryan Rutkowsi, research fellow with the U.S. Peterson International Institute of Economics, believed that a key reason behind China’s insufficient service sector development lied in the pro-industry policy that had been followed over the years (2015) 4. SOE monopoly is also an important reason for the low level of service sector employment. Opening market access for the service sector is conducive to improving living standards and productivity. Zhong (2015) believed that in the process of service sector reform, not many people paid much attention to change in demand, nor was the principle of “putting people first” observed, and this restricted service price and service sector development. Hence, “putting people first” and satisfying people’s needs should be adopted as the objectives of service sector reform.
Xie & Huang (2015) believed that service sector regulation had inhibited productivity in manufacturing and that despite the necessity of regulation for some sensitive service sectors, unreasonable regulation exempted industry players from competition from potential foreign or domestic service providers and thus led to inefficiencies. Despite different trade policies, economic development levels and industry advantages of various countries, the conclusion that reform of service sector regulation is conducive to manufacturing productivity is of universal relevance.
Li (2007) studied the impact of institutional change on China’s service sector growth. Based on an econometric approach, his study analyzed the impact of institutional change on service sector growth and arrived at the conclusion that at least three percentage points of the increase in the share of service sector in GDP in the 1980s could be attributed to institutional change. Based on cross-national and crosssectional data, Wang et al. (2007) examined the relationship among government size, rule of law and the share of a country’s service sector. Based on empirical research, they discovered that the quality of contract maintenance system measured by a country’s rule of law is significantly positively correlated with the share of the service sector and government size is significantly negatively correlated with the share of the service sector. Among them, the rule of law has a greater impact on the share of the service sector in middle- and low-income countries. Further test shows that no statistically significant impact of private property protection system on the service sector could be found, while government spending and investment both have a negative impact on the share of the service sector. Chen (2004) concluded that the service sector has different requirements for the institutional environment compared with the manufacturing sector, while the manufacturing sector’s requirements for information authenticity and reverse choice are different from those of the service sector. This is why the manufacturing sector is able to develop rapidly in a rather weak institutional environment. The service sector has high requirements on the institutional environment. Empirical studies show that the level of press freedom and the rule of law (together with the predictability of contract enforceability) are positively correlated with the level of service sector development. Xu (2011) believed that China’s service sector stagnation is correlated with Renminbi depreciation. Service sector stagnation during 1992-1996 coincided with Renminbi depreciation during 1990-1994. Service sector stagnation during 2002-2008 coincided with Renminbi depreciation during 2001-2005.
Renminbi depreciation led to rapid growth in tradable sectors (primarily the manufacturing sector) and relative decline of the service sector. On the other hand, it also led to a sharp fall in the flow of resources to the service sector. Jiang & Li (2004) argued that in the 1980s, China’s service sector experienced a compensatory growth stage when growth momentum derived from undersupply (Li & Li, 2008). Hu (2015) maintained that institutional problems existed in China’s service sector development for the following reasons: (1) globalization trap, i.e. exclusion effect against the service sector; (2) marketization trap, i.e. serious internalization of the productive service sector, with administrative and institutional monopoly in certain sectors; (3) industrialization trap, i.e. low-price industrialization restrained demand for consumer services, a discriminatory industrial policy led to insufficient momentum for service sector development, and preference and policy guidance favoring industry caused a disconnect between industry and modern services; and 4) urbanization trap, i.e. service sector development was restrained by its prematurity at the low-end and immaturity at the high-end, while insufficient population density resulting from expanded urban space also restrained service sector development. The household registration (“hukou”) system created a tremendous drag on the service sector. Wang & Wang (2009) believed that transportation, warehousing and postal service have no causal relationship with China’s economic growth, whether in the short or long term, nor does economic growth contribute to China’s transportation, warehousing and postal service development. Therefore, demand-driven economic growth does not constitute any impetus for reform of the service sector. As mentioned in the Introduction written by Li Jiangfan for A Study on China’s Service Sector Development Strategies authored by Wei Zuolei5, China’s service sector underdevelopment can be attributed to the following three reasons. First, the service sector
is classified as a “non-productive sector” and thus subject to discrimination. Second, inappropriate de
6 velopment strategies. Third, policy mistake, i.e. the low-price strategy, discouraged service sector development.
In general, research literature on service sector reform is sporadic. Despite a great deal of attention to specific measures or policies, little attention has been paid to the general model of service sector reform and development. This paper intends to summarize the “China model” of service sector from the history of service sector reform.
2. Model of China’s Service Sector Reform: Basic Concepts and Characteristics
There is a great deal of research literature on China’s reform model. As far as this paper’s topic is concerned, we are more interested in the model and characteristics of service sector reform. Why separate service sector reform from overall reform? The reason lies in the uniqueness of China’s service sector reform. Judging by the results of existing studies, China’s service sector reform is different from industry and agriculture in terms of motivations, pathways, mechanisms and effects. Li (2015) noted that the motivations and pathways of China’s tertiary industry reforms are significantly different from those of agriculture and industry. Different from industrial reforms that aimed to achieve efficiency improvement, rapid growth and catch-up, institutional reforms for the tertiary industry were motivated by reality pressures rather than idealist calls. It is those differences in the motivations, rationale and measures of reform that made China’s service sector reform unique.
The model of China’s service sector reform is a set of pragmatic mechanisms and paths developed in the unique context of China’s reform and opening-up. Putting aside theoretical controversies, service sector reform was guided by non-industrial objectives, started from marginal areas to critical areas and evolved with the external environment.
2.1 Reform Motivations Driven by Non-Industrial Objectives
Different from industrial reform based on idealism7, service sector reform was guided by specific non-industrial objectives that may not have anything to do with the service sector per se. As far as industrial reform is concerned, both decentralization and mixed-ownership reforms intended to unlock the efficiency potentials of state- owned industrial enterprises and demonstrate the superiority of socialism. This is based on an ideal, i.e. productivity is maximized under the socialist system.
However, reform of the service sector deviated from this idealism and followed specific and realistic non-industrial objectives that had little to do with growth of the service sector as an industry. For instance, the first wave of service sector reform that started since 1978 was carried out to ease employment pressures (Li, 2015). At the beginning, the reform was not intended for the service sector (back then, the concept of a “service sector” was not yet introduced in China’s national economic system). Instead, marginal reform of ownership inadvertently contributed to growth of the service sector as an emerging force. This was not by historical coincidence and actually had its inevitability. With its short industry chains, the service sector does not compete with SOEs for raw materials, transport resources and funds, and marginal growth is a relatively easy path. In the 1990s, China faced serious fiscal pressure, which greatly abated thanks to market-based price reform and liberalization. For instance, market- based reform of the real estate sector not only saved the government tremendous housing subsidies in cities but also created new sources of revenue from land transfer. Market-based reforms of
healthcare and education also helped reduce government spending on these sectors.
Reform driven by non-industrial objectives is superior to reform based on idealism since resistance against reform would be smaller if clear objectives are followed. Without setting clear industrial objectives, reform allowed greater room for industrial development. This is the fundamental reason why China’s service sector is the only sector whose share in GDP has kept increasing after reform and opening-up in 1978. The orientation of non-industrial objectives meant that reform could put aside ideological questions and embrace a pragmatic approach.
Reform would be misguided if too much emphasis is placed on non-industrial objectives. Even if a correct direction is followed, reform would still lead to nowhere if a wrong path is followed. For instance, China’s market-based real estate reform since the 1990s followed a market-based approach, which is without doubt correct. But instead of creating a healthy real estate sector, too much importance was attached to the real estate sector’s contribution to the State coffer. Thereafter, the absolute State monopoly over land and reliance on land revenues led to the real estate sector’s superficial prosperity at the expense of the real economy. Behind skyrocketing housing prices, financial risks are in the making and pose a threat to China’s economic health. For another example, China’s medical reform since the 1990s also more or less failed in the past decade since such reform was motivated by reducing healthcare fiscal spending rather than improving healthcare service. This approach transformed China’s previous medical system. In the pre-reform planned economy era, medical service was deemed a “non-productive” service that was not an economic activity at all but a public-interest undertaking. The State enforced strict planning and management over medical service and drug prices, which were kept very low. For medical service institutions, their revenues from healthcare services and drug sales could not even offset their operational costs. As a result, medical service institutions had to rely on huge subsidies from the government. The intention of medical reform was to introduce market-based mechanisms, which indeed greatly eased government fiscal pressures. But the lack of appropriate regulation and oversight, particularly the implicit approval of over-prescription and drug price markup by medical institutions, caused catastrophic consequences for the medical industry, an industry with serious information asymmetry.
Another problem with reform driven by non-industrial objectives is that reform will gradually lose momentum towards its more advanced stage. Reform initiatives taken in an earlier stage of reform based on non-industrial objectives will also create vested interests that ultimately will impede reform from deepening. When non-industrial objectives contradict with industrial development, reform will stagnate.
2.2 Transcend Theoretical Controversies
At the inception of China’s reform and opening-up, the economic system was considered as being complementary to the political system. Public ownership and a planned economy were considered to be the key elements of the socialist system. Therefore, an important question at the beginning of reform was how to overcome ideological barriers. As Thomas G. Raski(2013) pointed out, discussions on socialist economic reforms were generally ideological. For instance, even for rural institutional reform, which was considered top-down reform, it only transformed the mode of agricultural production without changing rural collective land ownership. In China’s reform process, grassroots efforts to push forward reform played an important role. But in reality, such grassroots efforts were supported, either explicitly or implicitly, by the government in many cases. In this sense, ideological change at top leadership was vital to China’s reform. For China’s service sector reform, however, theoretical arguments or the correction of classical theories did not dominate the agenda as was the case for industrial and agricultural reforms8. This is an interesting question. To some extent, service sector reform transcended ideology for the following reasons:
First, service sector reform was not at the center stage of China’s reform, particularly during the 1980s when great theoretical controversies existed. As many researchers noted, “China’s reforms from
1978 to the mid-1980s focused on the countryside” 9. Reforms of the countryside and urban industrial SOEs took center stage from the very beginning and drew a great deal of attention. However, service sector reform started from village fair trade and individual economy and did not create any significant shock to the administrative and ownership systems of the state sector of economy. As a result, service sector reform did not take center stage back then and received little attention and therefore did not meet any significant barrier against institutional reforms. On the other hand, these service sector reforms addressed practical problems facing people in their everyday life, making it possible for the reforms to be carried out despite ideological controversies.
Second, back then, the service sector did not touch upon sensitive issues under the planned economy. For industrial reform, the introduction of individual economy would inevitably affect raw material supply, fixed asset investment plan and supply-demand equilibrium. Without much fixed asset investment, the service sector does not involve questions like allocation of the means of production. Moreover, service sector products cannot be stored or provided remotely. Therefore, the service sector needed to develop in close proximity to consumers and would not compete with state-owned service enterprises for raw materials, consumers and markets. Back then, service sector reform and development also involved questions such as the legality of long-range transport of goods for sale - it used to be illegal for individuals and entities other than SOEs to transport goods for purposes of sale without a government permit. This question, however, was not contradictory with China’s basic economic system. At a State Council meeting on theoretical matters held in 1978, economist Xue Muqiao proposed to vindicate long-range transport of goods for sale as a means to invigorate the market. Before reform and openingup, the service sector had been in extreme undersupply (Li, 2015). Marginal increment in the service sector would not shake the planned economic system to its root. Rather, it would deliver conveniences to people’s everyday life. Back then, service sector reform followed a very clear path, i.e. without changing ownership systems and the inventory of the planned economy, personal interests were recognized to create new service sector increments and promote the reform of inventory through increments to avoid ideological issues surrounding inventory reform.
Third, service sector reform proceeded with easier tasks before addressing more difficult issues to avoid theoretical controversies. There are numerous services with great inter-sectoral differences. For instance, finance, railway, telecom, science and technology are of great significance to the economy, while education and healthcare involve government functions and impact people’s everyday life. Restaurants, retail and personal services require smaller investments with a limited impact on the economy. In the process of service sector reform, it makes sense for reforms to be carried out first for easier sectors like retail (then extended to wholesale), restaurants and household services to minimize resistance against reform, avoid ideological controversies and facilitate reform.
In a nutshell, China’s service sector reform avoided theoretical controversies since the beginning and enabled all forms of ownership related to reform pathways including the individual economy and private economy to flourish, thus exploring a unique path for China’s reform.
2.3 Philosophy of Pragmatism
As can be seen from existing studies, most scholars considered that China’s reform itself indicates a shift in the philosophy of top leadership from moral ideals to pragmatic rationality. China’s reform
was not based on theoretical assumptions. Rather, it was a practical experiment and started from a few localities before rolling out to broader regions with twists and turns. For instance, China’s rural reform was the outcome of a top-down reform philosophy based on pragmatism (Xiao, 2004; Ronald H. Coase, Wang, 2013; Wu, 2010). In our view, the pragmatic approach of reform is manifested more evidently in the service sector.
China’s service sector reform followed no specific target model (since the scope of the service sector was not clearly defined at the inception of reform). In various stages of reform, the service sector was regarded as an outlet for easing various socioeconomic pressures. In other words, reform itself was seen as a means rather than an end, as opposed to the reform of industrial enterprises which was considered an end. As discussed previously, whether it was when China developed the service sector to ease employment pressures at the inception of reform or to ease fiscal pressures in the 1990s, the reform was all based on pragmatism.
The pragmatic approach to reform was also evident in the mid-1980s, when the Chinese leadership became aware that the service sector accounted for over 60% in GDP for advanced economies. This realization deeply influenced the Chinese leadership, whose agenda was still dominated by industrialization. As a result, the service sector was included into national economic accounting and identified as a key sector in China’s five-year plan (7th Five-Year Plan) with a target growth rate far above that for industry and agriculture. This implied that China intended to develop the service sector as a means to ease economic growth pressures. To achieve service sector growth, the service sector was separated from the government and broken into independent segments such as finance, telecom, technology and railway.
Since China’s entry into the WTO in 2001, China’s service sector started to face international competition. How to deal with pressures from internationalization became an important question that must be addressed in China’s service sector reform. Various forms of institutional restructuring to increase service sector competitiveness became a theme of service sector reform. After the 18th CPC National Congress in 2012, service sector reform started to shift its priority to improving people’s livelihood. During this period, the government introduced a host of policy documents related to public welfare services such as healthcare services, sports, and elderly care.
Different from industrial and agricultural reforms carried out to fulfill political idealism, service sector reform followed a pragmatic approach since the very beginning. Such pragmatism reduced the pressure of reform, while reform also tended to avoid difficult areas. However, such a pragmatic approach also created obstacles for future reforms, making it hard for reforms to deepen. This is why the implementation of service sector reforms has become so difficult today (Sun, 2014).
2.4 Based on people's Livelihood and Efficiency Orientation: Double Standard
According to a study by Angus Maddison (1998), China’s service sector was subject to severe restrictions during 1952-1978. As a result, total employment in retail businesses, restaurants and grocery stores decreased from 9.5 million to 6.1 million and employment in retail reduced from 5.5 million to 1.3 million despite a two-fold increase in national population. This meant that service sector supply could not keep up with growing demand.
In this context, policymaking started to follow a public welfare orientation. By the end of 1978, the State Administration of Industry and Commerce (SAIC) held a national village fair conference in Dazhu County of Sichuan Province to rehabilitate village fairs, which had been restricted in the pre-reform era. In March 1979, the national conference for directors of industry and commerce administrations was held to discuss issues including deregulation of farmers markets in cities and concluded that “farmers market in cities should, in principle, be deregulated”. In April, the State Council approved the SAIC’s Report on the National Conference for Directors of Industry and Commerce Administrations. Later, farmers markets were opened in various medium-sized and large cities. By the end of 1979, the annual
turnover of farmers markets in 208 cities in China reached 1.2 billion yuan with product categories increasing from fewer than 60 at the beginning of the year to over 100 by the end of the year. These farmers markets also offered peanuts, fish, shrimp and other products that were rare even for the Chinese New Year holiday. Allowing farmers markets to flourish greatly improved people’s living standards10. A public welfare orientation was an important feature in China’s reform, which was different from the former USSR and Eastern Europe that had adopted privatization and marketization as their reform objectives. As noted by Joseph Stiglitz11, unlike Russia, China never mixed the end (people’s welfare) with the means (privatization and trade liberalization). Through reform, the number of retail businesses, restaurants and service outlets per 10, 000 inhabitants (in towns and cities) increased from 13 to 64 during 1978-1983, and employment in these segments per 10, 000 inhabitants increased from 63 to 163. In 1984, the Ministry of Transport adopted a pragmatic and proactive opening-up policy to “allow all state-owned, collective and individual businesses to develop and all regions, sectors and entities to work together” with the purpose of extensively attracting non-public elements to highway and waterway transport services, which led to rapid development in these services.
Ever since its beginning, service sector reform followed a public welfare orientation, which was unlike the focus on efficiency improvement for industrial sectors. In industrial sectors, reform improved internal management and minimized “X- inefficiency” and increased overall industrial efficiency by devolving power, creating incentives and introducing competition12. This process might cause unemployment. Hence, the reform essentially did not follow a public-interest orientation. At the beginning of 1983, a leader of CPC Central Committee Secretariat called for expanding the rural household contract system to urban state-owned industrial and commercial sectors and implementing the enterprise contract system for all urban industrial and commercial enterprises. In a matter of just two or three months, the contract system was put into place for all state-owned enterprises in China. But it quickly led to chaos in the economic order and price hikes without improving people’s living standards.
2.5 Synchrony and Mismatch between Reform and Opening-Up
China’s reform was carried out almost in tandem with opening-up. In 1978, the State Council held a meeting on theoretical matters starting July 6 attended by over 60 leaders of State Council departments to speed up foreign capital introduction and development. The meeting required “further liberating the mind, coming up with more approaches and taking bolder and faster steps” (Li, 2015). The meeting also adopted the idea of opening-up, i.e. make full use of China’s available resources to attract foreign capital, technology and equipment. On January 17, 1979, Comrade Deng Xiaoping said at a meeting with five senior business community representatives including Hu Juewen and Rong Yiren that “in pursuing development, we should open our minds to more approaches. We may utilize foreign capital and technology and welcome overseas Chinese and Chinese descendants to set up factories in China. We may attract foreign capital through compensation trade or joint operation. These activities should start with sectors with rapid capital turnover. 13” In 1979, the National People’s Congress formulated the Law on Chinese-Foreign Equity Joint Ventures as an initial step in expanding China’s opening-up.
At the policy level, China primarily opened the manufacturing sector to foreign investment, while the service sector remained less open. But tourism, real estate and restaurants were subject to fewer restrictions. By the end of 1987, the former State Planning Commission enacted the Interim Regulations on Guidance for the Attraction of Foreign Investment, which classified foreign investment projects into
four categories: encouraged, permitted, restricted and forbidden. This policy document also focused on the manufacturing sector.
As it turned out, over 1/3 of foreign investments in China during 1979-1990 went to the service sector. The reason is that hotels and tourism services attracted a great deal of foreign investment as China initially opened its door to foreign investors in the 1980s. During 1979-1990, FDI in real estate and social services accounted for 60.3% of total FDI in China’s tertiary sector14.
China enacted the Law on Chinese-Foreign Joint Cooperative Ventures in 1988 and the Law on Foreign-Funded Enterprises in 1990, and revised the Law on Chinese-Foreign Equity Joint Ventures. Thus, a complete legal framework for foreign investment came into shape. In the early and mid-1990s, foreign investment flowed into real estate in large volumes and accounted for a significant share - as much as 50% in some years. In the entire 1990s, real estate and social services accounted for 67% of FDI in the tertiary sector. In the process of service sector opening-up, there had been controversies regarding which sectors should be opened up to foreign capital. In July 1992, the State Council enacted the Approval on the Use of Foreign Capital in Commercial Retail Sector, which approved foreign retailers to establish Chinese-foreign joint cooperative and equity joint ventures in retail and importexport business. In June 1999, the State Council promulgated the Measures for the Pilot Program of Foreign-Funded Commercial Enterprises, which expanded the scope of pilot cities for Chinese-foreign joint cooperative and equity joint ventures to all provincial capitals, autonomous regions and cities under separate planning and allowed foreign-funded retail enterprises to engage in wholesale business. This policy led to a mass inflow of foreign-funded retail enterprises into China and sparked controversies among scholars in the early 21st century.
As can be seen from the above discussion, service sector opening-up and reform went hand in hand during 1979-1990 and focused on consumer services. Foreign capital also flowed into social services and tourism, thus benefiting from and reinforcing reform.
From 1990 to China’s WTO entry, no in-depth research was carried out in the field of service sector opening-up, which made little progress and fell behind reform. Quality in the use of foreign capital was also poor for the service sector. This indicates a mismatch between service sector opening-up and reform, with more headway made in opening-up. Foreign capital was entitled to policy preferences for taxation, foreign exchange and import-export. While these policies helped China attract foreign capital, they also put Chinese enterprises at a disadvantage in competing with foreign counterparts. After the WTO entry, China substantially opened up its service sector in accordance with WTO rules. However, China’s service sector reform stagnated and, in many cases, foreign capital was allowed access but private capital faced barriers. In this stage, service sector reform fell behind service sector opening-up.
Without considering the interactive effect between service sector opening-up and reform, many studies investigated how liberalization of trade in services contributed to the economy. Nicoletti (2001) believed that empirical studies of various countries suggested that regulatory reform of the service sector in OECD countries significantly improved economic performance and living standards and concluded that the deregulation of truck transport and liberalization of trade in services brought competitive pressures in the U.S. - such pressures induced productivity growth and increased allocation efficiency for companies previously subject to regulation. Hoekman et al. (1997) considered that policies to restrict competition in the service sector had exorbitant costs. Xu (2011) pointed out that China’s service sector underdevelopment was closely related to two interruptions, which might have resulted from growth in the home country’s net export and trade sector due to home currency depreciation that inhibited the development of the home country’s non-tradable sectors (the service sector). Most studies tended to
conclude that trade liberalization had a positive effect on service sector development. But we think otherwise. In our view, given the interplay between service sector opening-up and reform, the effects on service sector development are complicated, and reform and opening-up are equally important.
2.6 Theoretical Basis Needs to Further Deepen
China’s service sector developed rapidly, overtaking industry to become the biggest economic sector in 2013 and accounting for 51.6% in GDP by 2016. But theoretical research on service sector reform remains inadequate in many ways.
From the history of theoretical evolution, we may discover the basic clues of China’s service sector. From 1978 to the mid-1980s, the concept of the service sector (referred to as the tertiary sector at that time) was not even fully established. Hence, the service sector as a concept must be clarified in order to develop a theory on its reform. Back then, the question over “productive labor and non-productive labor” had to be answered to develop a clear theory of service-based economy. In classical Marxist works, service labor is treated as non-productive labor. This problem must be solved before service sector reform could be deepened. Back then, different views prevailed in academia regarding the scope of service labor. The next question is how to elevate practical experience into theoretical conclusions. In terms of guiding ideology, China’s reform is a process of transition from rationality and hypothesis to practical experiments. How to take stock of empirical facts about this process and develop a theoretical pattern based on these facts is also a challenge. Lastly, it is also essential to identify the theoretical basis and justifications of China’s service sector reform.
3. Uniqueness of the Model for China’s Service Sector Reform
The uniqueness of the model for China’s service sector reform is manifested in the following aspects. First, service sector reform is different from China’s industrial and agricultural reforms. Second, China’s service sector reform is different from reforms in other countries. Overall, China’s service sector reform is often regarded as an instrument for addressing practical problems and lacks clear motivations and targets. This is also an important feature of China’s service sector reform.
In comparison with agricultural and industrial reforms, China’s service sector reform is fundamentally different in its basic philosophies, motivations and initiatives (see Table 1).
Industrial reform started in 1978 with a priority to increase internal management efficiency of state-
owned industrial enterprises. Despite a multitude of reform initiatives, the theme was to adjust the allocation of rights, responsibilities and interests among the government, company insiders, executives and employees and devolve power to company insiders. Such devolution came in three forms: devolving power, increasing autonomy and implementing the contract system. After 1981, reform of devolution evolved into the economic responsibility system.
Rural reform also started with the devolution of power. The Third Plenum of the 11th CPC Central Committee adopted the Decisions on Accelerating Agricultural Development (Draft) in 1978, which clearly stipulated that “except as otherwise required by law, cooperatives and production teams cannot be forced to execute the commands of administrative authorities at any level; instead, they should be permitted to act according to local realities under the guidance of national planning in order to protect their autonomy and give play to their initiative”. The Decisions became an important policy justification for rural reforms that later swept across China. Despite the extensively recognized role of the household contract responsibility system, controversies still existed among researchers15.
In the service sector, reform initiatives were also introduced for SOEs. Pilot programs were carried out beginning in 1978 and 1979 to increase autonomy for commercial enterprises. But the effects of such reform were minimal. In the late stage, marginal players competed with existing economic entities, creating pressures for the reform of original elements in the state sector of economy. Under these pressures, China created a market-based economic system, encouraged various economic elements to compete freely with each other, and reformed the ownership system of the state sector of economy. This is how China’s service sector reform followed a unique path16.
Since service sector reform followed a pragmatic path, it took on features different from industrial reform (see Table 2). Since 1984, industrial enterprises started to seek breakthroughs in price and other matters. But contract and leasing operations prevailed in the mentality of SOE reform17. Real price reform was not carried out until 1988. But the big-bang reform that deviated from reality inevitably led to chaos in the price order.
Since 1984, achieving rapid development in the service sector became an important task of service sector reform. After the establishment of a statistical system for the service sector in 1985, the sector received great attention as an important sector in the economy. In 1984, the service sector as a share in GDP surpassed that of agriculture for the first time. As a result of these developments, growth of the
service sector as an industrial sector has been given unprecedented importance. When the 7th FiveYear Plan was formulated in 1983, the central government set a target to achieve service sector growth by over 11%, which was far above the growth targets set for production industry and agriculture. Why did the central government place so much expectation on service sector growth? The reason lied in the motivations and measures of service sector reform. In this stage, the central government followed a market-based approach in reforming the service sector to achieve the growth target. In some segments, government administration was separated from enterprise operation to establish the market entity status of service companies to spur their development. These included vital service segments such as finance, telecom, real estate, culture and science and technology. After 1985, the market-based approach became an important direction of service sector reform. Notably, an important aspect of market-based reform is to separate government administration from enterprise operation and establish market entities. This reform approach was evidently different from the change of operational mechanism for production industry.
By the 1990s, China’s service sector reform was carried out to ease fiscal pressures. This had both similarities and differences with industrial reform. In the 1990s, giving subsidies to loss-making industrial enterprises caused the government a great deal of fiscal pressures. Lessening the growing fiscal pressures was one of the objectives of the reform to create a modern enterprise system. However, service sector reform had greater potentials in reducing fiscal pressures facing the Chinese government at that time. Essentially, this reform followed two themes: first, providing market-based supply for services such as housing; second, relaxing price control to reduce government subsidies for services like healthcare. Such a reform approach led to a remarkable increase in the prices of the tertiary industry. In nature, price reform and market-based reform were all carried out to address fiscal pressures. This reflected distinctive utilitarianism in the model of China’s service sector reform.
With China’s WTO entry after the dawn of the 21st century, the lack of service sector competitiveness became increasingly evident. Among various factors, the service sector administrative system was responsible for causing this problem. In this context, service sector reform was carried out to enhance competitiveness in the first decade after the dawn of the 21st century. In this period, China’s service sector competitiveness swiftly increased as a result of market-based reform and introduction of competition mechanisms.
The 18th CPC National Congress adopted the goal of building a moderately prosperous society in all respects by 2020. To achieve this goal, China needs to compensate for its shortfalls in the development of education, healthcare, culture, and tourism, among others. These service segments should live up to their full potentials in supporting public welfare through institutional reforms. This is an important direction for service sector reform in this stage.
As can be seen from previous analysis, service sector reform served as a good instrument in China’s reform process to address major problems facing China in different periods of time. Despite this desirable effect in the early stage, this instrument presented barriers to reforms as reforms deepened. We must be aware of this pitfall.
4. Analysis of the Model of Service Sector Reform 4.1 Remarkable Achievements
4.1.1 Reform unleashed rapid growth momentum for the service sector
According to the Statistical Communique of National Economic and Social Development 2016, China’s GDP totaled 74.41 trillion yuan in 2016, up 6.7% YoY. Specifically, the value-added of the primary industry came in at 6, 367.1 billion yuan, up 3.3% YoY; the value-added of the secondary industry reached 29, 623.6 billion yuan, up 6.1% YoY; and the value-added of the tertiary industry reached 38, 422.1 billion yuan, up 7.8% YoY. The value-added of the tertiary industry accounted for 51.6%, up 1.4 percentage points YoY, making 2016 a year with the highest share of the service sector in China’s history. By the whole-year average exchange rate, the values of the service sector exceeded 5.5 trillion US dollars, ranking second in the world. Compared with 1978, the share of China’s service sector increased by about 30 percentage points, or 0.75 percentage points on an annual average basis. Among primary, secondary and tertiary industries, the service sector is the only sector with a continuously growing share of output value. Following comparable price, the value-added of China’s service sector rose by about 40 times over the past 38 years, up over 10% on an annual average basis.
4.1.2 The service sector has become a major employer and social stabilizer
In 2014, China’s service sector employed 313.64 million people, accounting for 40.6% of total employment. The service sector continued to be the biggest employer in China. From a global perspective, the service sector accounted for 51% of total employment in the world in 2014, or 71% in advanced economies, 44% in middle-income countries, and 50% in medium-high income countries. Since 2013, China’s service sector has created over 10 million jobs for both new entrants in the workforce and transferred labor from agriculture and production industry. The service sector not only plays a key part in creating jobs but also serves as an indispensable social stabilizer as well.
4.1.3 Service sector gaining a growing share in the world total
By global comparison, the value-added of the global service sector stood at 54, 962.2 billion US dollars in 2014, while this figure came in at 4, 978.3 billion for China, or 9% of the world total. In the same period, China accounted for 13.3% of world GDP. In comparison, the share of China’s service sector was still smaller than the share of China’s GDP in the world total. In terms of long-term growth, China’s service sector has gained remarkable improvement in its international status. In 1978, China’s service sector accounted for less than 1% of the world total. By 2000, this figure rose to 2%. By 2014, it increased to 9%, up seven percentage points over a period of 40 years, or an increase of 0.5 percentage points on an annual average basis.
4.1.4 The service sector has become increasingly market-based and attractive to foreign capital
As China’s service sector becomes increasingly market-based after over three decades of reform, most services have achieved market- based pricing. Among market entities, private economy and individual economy have represented the majority of service market entities. With the banking and other financial services towards fully open, the service sector’s market access threshold has lowered, thus increasing the level of market-based operation for the service sector. In terms of foreign capital
inflow, China surpassed the United States in terms of actual use of FDI in 2014, becoming the largest FDI destination in the world. In addition to growth in FDI volume, we should also recognize a structural improvement. In 2011, China’s service sector overtook its secondary industry for the first time in terms of foreign capital utilization. In 2014, the actual use of foreign capital in the manufacturing sector amounted to 245.25 billion yuan (39.94 billion US dollars), down 12.3% YoY, accounting for 33.4% of national total. Actual use of foreign capital in the service sector amounted to 406.81 billion yuan (66.24 billion US dollars), up 12.5% YoY, accounting for 53.9% of the national total. China established 23, 778 non-financial foreign-funded enterprises, up 4.4% YoY, including 13, 925 non-financial foreign-funded enterprises, up 11.12%, accounting for 58.56%. In 2016, China’s actual utilization of foreign capital (FDI) totaled 813.22 billion yuan, up 4.1% YoY (excluding data of banking, securities and insurance services), and the service sector accounted for 60% of foreign capital utilization. This indicates that the pattern of China’s foreign capital attraction has shifted from manufacturing to the service sector. It is fair to say that China’s foreign capital utilization has entered an era of “service-based economy” in the real sense (Xia & Ni, 2016).
4.2 Continuously Improving the Model of Service Sector Reform
The model of China’s service sector reform is unique in the sense that the reform followed no specific target model and philosophy, and was instead used as an instrument to solve practical problems. As a result, despite the great achievements of China’s service sector reform, many problems have also been created and require continuous improvement.
4.2.1 Reform failed to deepen due to insufficient supporting policies
Since China’s reform in 1978, service sector reform was mainly carried out for marginal increment. Back then, service sector growth was motivated by the need to create jobs. In this context, the lack of service sector formalization resulted in poor competitiveness of services. From a policy perspective, the regulatory system failed to be promptly created due to the inadequacies of reform. As noted to the effect by Saich (2004), “on the eve of reform in 1978, the government controlled almost all service sector output. Back then, there were no independent fiscal and banking sectors, as they merely acted as government cashiers. Shifting towards fewer administrative interventions and reducing direct service supply and management would make governance more complicated and far from being easier. The Chinese government added new regulatory roles to its obsolete monopolistic function, making it far more complex than before”. While certain policies were issued to recognize the ownership system after the service sector grew marginally, how to regulate the service sector as a new type of productive force became a major question facing the government. However, the government did not promptly come up with any appropriate solution to create institutional systems for service sector development.
4.2.2 Absence of long-term strategies led to misguided service sector development
From a long-term perspective, service sector reform was more often used as an instrument to address practical problems without systematic arrangements. This led to the fragmentation of reform. For instance, the reform was not guided by the goal of creating a service sector system, and lacked a clear understanding of the role of various services in the economy. As a result, some critical services are underdeveloped, creating potential hazards to sustained economic development and security. Insufficient development of critical services also led to the “lawful” divulgence of national macroeconomic information. Regarding corporate financial services such as auditing and credit rating, PwC Zhong Tian, Deloitte Touche Tohmatsu, Ernst & Young Hua Ming and KPMG Huazhen more or less monopolize China’s high-end core auditing services. U.S. credit rating agencies control two thirds of China’s credit rating market. This has put China at a disadvantage in international competition, preventing Chinese firms from upgrading from low-end to high-end processes in the industrial chain. It has also created adverse impacts on the basic security of China’s critical industries. What is also absent in China’s national development strategies is an approach to coordinate the service sector with other industries and service sector reform with other reforms. For instance, China’s producer services are not fully linked with the manufacturing sector. While keeping innovative and high value-added manufacturing activities on their home soil, multinational firms relocated labor-intensive and repetitive processing, manufacturing and assembly activities to China. Some strategic resources related to production (especially soft strategic resources like branding, culture, technology and finance) failed to be developed domestically in China. Producer services failed to boost China’s manufacturing sector, and so did underdeveloped technology services. Take innovation for instance: China only ranked the 18th most innovative country in the world in 2015, which is incompatible with China’s economic prowess and international status. 4.2.3 Utilitarian goals caused deviations in service sector reform
In the 1990s, China reformed its service sector to establish market-based operations and price liberalization. But what was absent in the reform was a process to foster market entities. As a result of this omission, service companies essentially became affiliates to government departments. In response to market-based reforms in the 1990s and to ease their own fiscal pressures, many government and Party agencies created for-profit service businesses to increase revenues. As shown by research literature at that time, government and Party agencies were increasingly involved in market-based business activities in the 1990s, with numerous affiliated public institutions setting up for-profit companies. According to statistics, most of the mushrooming market intermediaries were affiliates to government agencies. Government-affiliated logistical departments, whose costs like rents were accounted for as government spending, competed unfairly with other market players. In the political environment at that time, various economic entities also allowed others to operate in their name in order to charge commissions.
In 1993, a string of rules was introduced to separate government agencies from for-profit businesses, but to little avail. In the first half of 1993, companies established by Party and government agencies accounted for 15% of all new companies. During 1992-1996, for-profit enterprises and institutions in China’s trade union system alone increased from 8, 952 to 63, 100, with annual business turnover amounting to 50.1 billion yuan. Businesses affiliated with government and Party agencies represented a form of parasitic economy. Another problem was tax evasion under the protection of public power. Allowing public institutions to generate revenues also gave rise to a wasteful operational mechanism: Authorities willfully created additional sources of revenues to boost their own coffers at the expense of disproportionate social costs. Encouraging government agencies and public institutions to generate revenues served as a buffer in the transition of the old system. It was also a byproduct in easing government fiscal pressures at that time.
In addition, many public-interest departments were allowed to engage in commercial operations under the slogan of market-based reform. Back then, this arrangement was also intended to reduce
resistance against reform, fiscal pressures or a redundant workforce. In fact, these public- interest institutions rarely assumed risks independently in market competition but enjoyed many industry privileges, including special permissions, independent pricing, risk transfer, and tax breaks. Instead of spurring economic efficiency, their vibrant development increased institutional frictions. 4.2.4 Misguided policy-making harmed competitiveness and helped monopoly
How to foster competitiveness is a big question. Under the pressures of international competition, China’s service sector reform must help create a group of powerful and competitive market players that flourish on China’s huge market potentials. But the degree of policy integration is insufficient when it comes to the fostering of market players. For instance, the development of producer services relies on an increase in the degree of roundabout production, i.e. the capitalization of production processes or production structure as argued by Friedrich Hayek18. In this sense, the share of the manufacturing sector’s demand for producer services is subject to the level of capital intensity in the manufacturing sector. Greater capital intensity of the manufacturing sector will lead to a greater share of demand for producer services. For instance, most of China’s capital-intensive manufacturing activities, not least high-end equipment manufacturing, have to rely on imports. In addition, extensive policy preferences all support the import of capital-intensive high-tech equipment. Tariff-free treatment for equipment and machinery import by processing trade companies also encouraged equipment import. This has also created barriers to the development of producer services on China’s home soil.
In fostering market entities, it is necessary to open up domestic competition and increase market vibrancy, rather than use administrative monopoly to artificially create a group of big but uncompetitive market entities (Xia & Liu, 2017). Service monopoly still exists in certain sectors in China, such as finance, railway and civil aviation. Creating market entry barriers under various excuses compromises service delivery and efficiency in these services. Despite reforms to remove administrative monopoly in some services, other implicit restrictions on competition still exist. Although state-owned testing institutions have been already decoupled from the government, for instance, private capital still accounts for a minimal share in this market. Moreover, government authorities artificially create market access thresholds in manufacturing services, resulting in poor accessibility to these services. Despite the opening of market access for environmental services, implicit thresholds still remain. Financing and leasing sectors are also subject to administrative licensing for market entry. 4.2.5 Setbacks in market-based reforms of public services, quasi-public services and public-interest services
Indeed, China’s service sector reform helped address urgent problems in various stages of its development. We should recognize that China’s service sector reform made tremendous contributions to solving China’s employment problems after 1978 and easing fiscal burdens after 1990. However, using service sector reform as an instrument to solve problems without having an overall picture easily trapped service sector reform into a long-term dilemma. For instance, China’s housing reform that started since the 1990s was intended to reduce the burden of housing subsidies to urban residents. However, extreme liberalization of the real estate market and absolute government monopoly of land encouraged government at all levels to use land revenues as a major source of revenue. Reliance on land revenues has become an inextricable problem for China today. The nature of this problem is not the commercialization of the real estate industry per se, but an artificially created shortage due to insufficient land supply under the government’s absolute monopoly. As for health reform, the government failed to create a healthcare system after market-based pilot reform programs in the 1990s. After the reform failed, the government blamed commercialization for such failure and attempted to do away with market-based mechanisms in the healthcare sector altogether. Going back to “government-run health