Chinese economy

The limits to China's planned urban revolution

March 18, 2014: 12:45 PM ET

China wants to increase its urban population by 91 million people in just seven years. It's an ambitious goal, but it's unclear if the nation is up to the task.

By Minxin Pei

Beijing skyline, 2012

Beijing skyline, 2012

FORTUNE -- For the last two decades, fixed-asset investment (infrastructure, real estate, and plants) and exports have powered China's massive economic growth. As these engines of expansion lose steam, though, the Chinese government has been searching for a new source of development.

It appears that Beijing has identified urbanization as its next economic savior. This week, the State Council (China's cabinet) released an ambitious blueprint called "The National New Urbanization Plan, 2014-2020." The plan aims to increase China's urban population, from 53% of its total populace today to 60% by 2020 (the average rate for a comparable middle-income country). This would require a net increase of 91 million urban dwellers in seven years (or 13 million per year).

More importantly, the government hopes to grant roughly 100 million rural migrants currently living in urban areas full residency rights, which will entitle them to government-provided social services, such as education for their children, health insurance, and retirement benefits. This will require a major overhaul of China's unique hukou (or household registration) system. And it's unclear if the nation is up to the task.

Instituted in the 1950s after the Communist take-over, the hukou system was designed to control rural migration. Under this system, China had two classes of citizens: urban and rural residents. Urban residents had full access to government services and their offspring would inherit the status of urban residents. Rural residents and their children, by contrast, were not allowed to live in urban areas or enjoy the services freely available to urban residents.

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The hukou has allowed the Chinese state to save enormous social expenditures that would have benefited the country's vast peasantry. But the system discriminates against the poor and disadvantaged.

After economic reform began in China, the hukou system became much less effective in controlling the physical mobility of rural residents. Seeking a better life for themselves and their children, perhaps as many as 300 million rural residents have moved into towns and cities since 1978 even though only 20% of them have obtained official permission to change their residency status.

Because of the hukou system, the actual rate of urbanization in China is only 36% (the nominal urbanization rate is 54%). Of the 700 million people living in urban areas, about 230 million are rural migrants who are, in terms of their citizenship rights and economic opportunities, not officially considered urban dwellers. Without legal urban residency rights, a rural migrant laborer has to pay tuition to educate his children at substandard schools. He cannot get health insurance coverage or retirement benefits provided by the government. He certainly has no means or incentive to buy an apartment (only 1% of migrants own housing).

The hukou system limits the social mobility of rural migrants and their children. It also suppresses economic consumption because migrants must use a significant portion of their income to pay for public services out of pocket.

Thankfully, China's leadership has identified hukou reform as a top priority. According to the recently released urbanization plan, rural migrants currently employed and living in towns and cities with populations under 3 million will have a shot at gaining full residency rights by 2020. The hukou will remain in force in cities with populations over 3 million for now. (China has 38 such cities, which include almost all provincial capitals and megacities like Beijing and Shanghai.)

The practical difficulty in giving 120 million rural migrants urban residency rights is funding. Chinese researchers estimate that the cost of giving a migrant full urban residency rights is about 100,000 yuan (about $16,400). However, this amount could be spread over many years. According to calculations done by Prof. Kam Wing Chan of University of Washington, settling 20 million migrants per year, as China's new plan envisions, entails an annual outlay of 50 billion yuan (or $8.2 billion) in additional social services (0.1% of GDP and 0.4% of public spending).

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Although China can evidently afford the additional outlays, it remains unclear which part of the Chinese state will foot the bill. The "National New Urbanization Plan" offers only vague guidelines -- financing for the reform is supposed to come from three sources: fiscal transfers from Beijing, local taxes, and issuance of local government bonds.

What worries observers most is the lack of incentives for local officials to adopt this reform. Rural migrants are politically powerless and socioeconomically disadvantaged.  Like all Chinese people, they have no votes. For the proposed reform to work, Beijing will have to give rural migrants sufficient political power to hold local governments accountable.

So, as with other announcements that promise reforms, Beijing's new urbanization drive deserves plaudits, but its success is entirely up in the air.

Minxin Pei is the Tom and Margot '72 Professor of Government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States

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