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Paulson Policy Memorandum

Achieving Comprehensive Reform in

Kam Wing Chan

December 2014 Paulson Policy Memorandum

About the Author

Kam Wing Chan

Kam Wing Chan is of Geography at the University of Washington. His main research program focuses on China’s , migration, , the household registration system, and related statistics. In recent years, he has served as a consultant for the Bank, United Nations, Asian Development Bank, and McKinsey & Company on a number of policy projects related to China’s cities and economy. He is the author of Cities with Invisible Walls: Reinterpreting in Post-1949 China, and some 60 journal articles and book chapters. His recent commentaries and interviews have appeared in , New York Times, Economist, , Morning Post, BBC, China Radio International, CBC Radio, Caixin, and other media. His webpage is http://faculty.washington.edu/kwchan/.

Cover Photo: /Jianan Yu Paulson Policy Memorandum

Introduction

he reform of China’s household At present, China’s urban population registration system—orhukou in includes 230 million of so-called TChinese—is a major issue for the “floating population”: residents of cities country’s future development. China who lack a local urban hukou. Among has less arable land than the United these, more than 10 million are college States, yet more than 200 million graduates, including junior college.2 Chinese still depend on for their livelihood and more than 800 The floating population is growing million citizens are registered with the rapidly. Indeed, while the urban floating government as having a rural hukou.1 population in 2000 was only 130 million, For China to further develop, it is this category increased by 100 million inevitable that it will need to pursue people in just 12 years. As illustrated systematic urbanization. in Figure 1 below, the And in doing so, the In effect, China’s migrants need gap between the de facto government will also to become full urban residents. urban population and the have to allow migrant urban hukou population— workers who have left rural areas for that is, the floating population—has cities to become genuine urban citizens. widened since the 1980s, a trend that is far from ideal. If this trend continues, Such a policy change will involve much it would not be a surprise if China’s more than simply altering a citizen’s floating population reaches as high as hukou category from rural to urban 300 million in ten years.3 And the fact in the registration record. Rather, it is, “second-class” of such means allowing migrant workers to magnitude will be a big threat to social gain in Chinese stability in China. cities, and thus to be covered by the urban system in The challenge for China’s policymakers, their place of work. In effect, China’s therefore, is to “reverse” the problem: migrants need to become full urban if, instead, only one-third of the floating residents. population of more than 300 million gains middle-class spending power, this Of course, such a major transformation will increase the middle-class consumer cannot be achieved overnight. Instead, group in China by 100 million, almost a workable plan that promotes half of the country’s current middle- incremental and comprehensive hukou class population of more than 200 reform, with some breakthroughs, million. Since China’s policymakers needs to be designed. are determined to increase the share

Achieving Comprehensive Hukou Reform in China 1 Paulson Policy Memorandum

of consumption in the economy, the the next six years, about 17 million power of a of spenders of people will be granted a local urban this magnitude cannot be ignored. hukou each year, among which the number from the floating population Since the natural urban population granted an urban hukou will see a growth rate in large cities,4 among substantial increase, reaching perhaps households with urban hukou 10 to 12 million annually. The Plan status, is currently very low (and envisages that by 2020 the floating has even been negative in some population as a percentage of China’s years),5 it is difficult to imagine how total population will decline by two China can achieve a substantial percentage points, from the current increase in the urban 17 percent down to 15 percent.6 population by relying solely on that part of the population that is At the end of July 2014, the State currently—and legally—registered Council released its “Opinions on with an urban hukou. So to promote Further Promoting the Reform of domestic demand as a growth driver, the hukou System” (hereafter “the China must principally rely on the Opinions”), which proposes an all- urbanization of rural migrant workers, out opening of hukou restrictions in thus expanding the country’s middle- towns and small cities, the opening class population. of hukou restrictions in an orderly fashion in medium-sized cities, How can such hukou reforms be reasonably determining conditions implemented? for hukou registration in large cities, and the strict control of population In March 2014, China’s central sizes in very large cities. Differentiated government released its “New policies for urban hukou registration National Urbanization Plan” (hereafter were also specified.7 “the Plan”), which proposes “granting approximately 100 million rural The Plan and the Opinions represent migrant workers and other long-term an important first step in hukou residents a local urban hukou” by reform, and exemplify the Chinese 2020 (see Figure 1). The priority group central government’s resolve to alter is migrant workers with stable work the current system. The Opinions in urban areas, but other groups are offer more clearly defined principles included: graduates of universities for how citizens who leave their and vocational and technical schools, permanent hukou residence to live workers from other cities, and local in a for half a year can gradually population with a rural, rather than attain rights to basic public services in urban, hukou. This means that over the city.

Achieving Comprehensive Hukou Reform in China 2 Paulson Policy Memorandum

Yet the Plan is merely a six-year This policy memorandum recommends program, and according to the rate of that hukou reform move more quickly change outlined in the Plan, completely and be opened more widely. The resolving the floating population issue— memo presents a plan that builds on that is, bringing down the floating the central government’s Plan and population percentage to zero—will Opinions. It proposes comprehensive probably require the work of another reform objectives, timetables, and three or four decades. concrete measures. Moreover, it attempts to take a longer term Another problem with the Opinions perspective, offering a vision of how is that it envisages little opening various aspects of reform might of hukou registration in very large fit together, and also how to give cities, and thus does not really meet members of the floating population the longstanding earnest desire of expectations and hope to plan for university graduates, professionals, a potential future. Such faster and and entrepreneurs who do not have deeper reforms will, in fact, be the local urban hukou to obtain one. beneficial for social stability.

Figure 1. Urban Population Growth Trends and Projections, 1980-2030

Sources: China Statistical Yearbooks; China Population Statistical Yearbooks; figures for 2013-2020 are from National New-Type Urbanization Plan; those after 2020 are the author’s.

Achieving Comprehensive Hukou Reform in China 3 Paulson Policy Memorandum

Costs and Dividends of Hukou Reform

n considering how hukou reform an astronomical figure that China is to be achieved, some believe obviously could not afford. Ithat the urbanization of migrant workers will involve costs that the But that arithmetic is flawed because public—or more precisely, the it simply multiplies 100,000 government—cannot bear. In fact, this by 230 million. The 100,000 yuan point of view is comprised of various in services for granting an urban misconceptions and blind spots. hukou to one member of the floating population would not be spent in In recent years, some relatively a year, but rather over a lifetime comprehensive estimates have (approximately 40 years). That is, concluded that the 100,000 yuan granting an urban will be distributed hukou to a typical over 40 years, which, based on a (including his or linear distribution, her dependents) amounts to an will incur lifetime average of 2,500 public expenditures yuan ($400) of approximately annually (in 2010 100,000 yuan constant prices).9 ($16,287) based on 2010 constant Photo: World Bank So if, on average, 20 prices.8 This includes the major million people are given urban hukou public benefits and services: each year, the total cost would be 50 compulsory , cooperative billion yuan (in 2010 constant prices) medical care, , per year, or 0.1 percent of China’s and other social security (such as current GDP. This ratio would increase subsistence allowance), as well as incrementally each year—by the costs for city management and social fifteenth year, the cost would amount housing. to 1.5 percent of GDP—but these are costs that China should be able to bear. Some media reports state that if the entire existing urban floating However, these costs represent only population of 230 million were the public expenditures, and thus do assigned urban hukou, the total cost not account for the public revenue would be 23 trillion yuan ($4 trillion), that would be generated by the

Achieving Comprehensive Hukou Reform in China 4 Paulson Policy Memorandum

floating population through taxes you-go system for and healthcare, and other channels of contribution. A the younger floating population’s healthy, well-designed public services contributions to welfare could help to plug system would be one financed by the urban public finance gap created by the taxes of the users. In the long run, aging of an urban hukou population. Under expenditures and revenue should this proposed reform plan, in the initial offset one another. stage, because mainly highly educated and higher-income groups are given hukou, The majority of the floating population is their contributions to urban public finances relatively young, thus the urban welfare should be even greater. In short, the public required by them in the short term would burden from more comprehensive hukou not be much, and would mainly consist of reform in the near term will not be as heavy some migrants requiring social housing, as many predict. especially after marriage. In the medium term, the main service required by these But there is more to the case for hukou migrants who have converted to holding reform than just the issue of public urban hukou would spending burdens. be public education In short, the public burden from more Although the “costs” of for their children. The comprehensive hukou reform in the near urbanization should, of largest expenditure, term will not be as heavy as many predict. course, be considered, social security, the enormous economic including pensions and healthcare, dividends of hukou reform are equally would primarily be a cost over the longer significant. term after 2030. So in the initial phase, urbanized members of the floating When a migrant worker works in the population would be net contributors, via city, the value of his or her output taxes and other contributions, to public generated will be far more than the finance rather than net beneficiaries. Put costs of public services. And the output differently, if only the first 15 years of will be far in excess of the costs of the hukou reform plan are considered, urbanization and workers’ . In expenditures for urbanization will not general, if China’s floating population be as high as some predict. Urbanized had local urban hukou, they would members of the floating population have the right to fully participate in will be net contributors—that is, the urban public affairs, and to enjoy what revenue they generate would exceed other urban residents do with regard expenditures.10 to choice of work, opportunity to play to their own strengths, and greater At present, the urban hukou population, security and fewer worries. These especially in very large cities, is aging would greatly improve productivity rapidly, and under China’s current pay-as- and boost domestic consumption

Achieving Comprehensive Hukou Reform in China 5 Paulson Policy Memorandum

and demand, setting into motion and social development. This is a virtuous “urbanization-economic different from certain urbanization growth” cycle. in some Latin American countries, where migrant workers enter the Meanwhile, a recent quantitative city but cannot find a job, resulting study by the Institute of Population in urban blight and other challenges. and Labor Economics11 notes that Looking at a longer time horizon, hukou reform will result in freer human beings have progressed movement of labor, an expansion on the path of urbanization for of the size of the labor market, more than 200 years. Of course more specialization of labor, and a there are problems, but overall, substantial increase in the total factor urbanization—the transformation of productivity of the urban economy. the rural population into an urban This study estimates that if 17 million population—has resulted in greater people are granted an urban hukou productivity, higher quality-of-life, each year, the resulting economic and a more promising future for net gains would be considerable. mankind.12 Between 2015 and 2020, the annual net economic gains would amount But over the past 60 years, China to approximately 1.6 to 2 percent of has been travelling down a GDP, equivalent to several times and somewhat different road, pursuing up to dozens of times the costs of an “incomplete” urbanization and urbanization over the same period. focusing too heavily on the short- term benefits of industrialization and There are also other indirect, hard- stressing the “costs” of urbanization, to-quantify benefits. For instance, while ignoring the interests of rural receiving an urban hukou will stabilize citizens as well as the long-term the expectations of residency of a interests of China’s people as a migrant. This will enable him or her whole.13 to gradually transfer the unused residential land and arable land in Presently, a major source of rural areas, in turn, greatly improving resistance to hukou reform is local the utilization efficiency of such land governments. Local governments, for production and residence. This is fixated on expanding business (since especially important for China, where enterprise taxes are a major source land is scarce. of local finances) and pursuing short- term boosts to GDP, view the welfare This is also the logic behind why of the floating population merely as proper urbanization will produce a a “cost” that should be written off as net profit and promote economic much as possible.

Achieving Comprehensive Hukou Reform in China 6 Paulson Policy Memorandum

But the current hukou system (as allows local governments to legally well as the broader urban-rural dual expropriate the land from farmers structure) has produced a large cheaply and in turn to siphon off large army of “second-class citizens.” They amounts of land revenue. Further, have provided cheap labor that is and as noted above, another source crucial to China’s continued growth of resistance to hukou reform comes of production and GDP. However, from some who have overestimated this approach has also generated the fiscal costs of urbanization. These a large “debt” in terms of social sources of resistance to hukou reform welfare. Moreover, the current system can be mitigated and managed.

Achieving Comprehensive Hukou Reform in China 7 Paulson Policy Memorandum

Next Steps in Hukou Reform

hina’s current hukou system not population within their own country only divides people into different would no longer exist. Cclasses, causing social inequality, but is also completely incompatible Such reforms would be carried out with the that China is in two steps. The first step focuses establishing, as the system hinders the on granting local hukou to non-local free movement of labor and severely university graduates, professional and reduces economic efficiency. technical personnel, and business managers. Then, in the second step, In setting up a market economy, China local hukou would be granted to other also needs to simultaneously protect groups, mainly migrant laborers, in a social equality. Eventually, China gradual and orderly manner so that should aim to be a country where the eventually all members of the floating population can move freely, with place population have urban hukou. of residence and hukou registration determined by individual choices. Such an approach is similar to China’s current policy, but the pace of opening As an essential component of the would be much faster. More important workforce, members of the floating than just speed is the comprehensive population cannot be nature of the forever adrift. This In setting up a market economy, China proposed approach: memo sets a concrete also needs to simultaneously protect all cities and towns but realistic timetable social equality. should undertake to complete hukou to open hukou reform within 15 years: By 2030, the registration. And this is especially the hukou issue could be resolved for all case for large cities, which should take members of the floating population. on a greater role in the reform plan. By 2031, hukou registration would be completely open, so that China Hukou Reform Targets, Sequence, and would be in the same situation as Specific Measures the vast majority of other countries in the world—that is, people would How might the government achieve this? be able to move and settle down freely throughout the country, and Rough projections show the floating the absurd phenomenon of Chinese population will reach about 300 million people who are legally considered by 2030. Granting urban to 300 to be members of an “outside” million people over 15 years amounts

Achieving Comprehensive Hukou Reform in China 8 Paulson Policy Memorandum

to covering approximately 20 million important source of , major people annually, or about twice the rate contributors to economic productivity and in the government’s current proposal. growth, and thus should be prioritized. In the , many state (and Opening hukou registration in this way city) governments and companies would enable the government to tackle recognize that developing a high-value the easier cases first and difficult cases local economy requires a large number later. For example, in the first phase of of university graduates. Retaining local reform (2016-2020), urban hukou could graduates, attracting university graduates be granted to more straightforward from other states with work opportunities, cases, such as university (including and recruiting some qualified foreigners junior college) graduates, technicians who have graduated from US universities, (including skilled workers), and business are all important and relatively common managers (as well as spouses and American policies. Indeed, young children living with university graduates them). By focusing University graduates are an important also represent a major on these groups, source of human capital, major source of the American the objective would contributors to economic productivity and middle class. be to resolve the growth, and thus should be prioritized. hukou issue for 100 But in China, due to million people in a class of the floating hukou problems, the majority of the population who can readily contribute more than 10 million non-local university to economic growth in cities. graduates—such as those referred to in Chinese as being part of an “” Some large cities in China already have (yizu) in very large cities—often struggle experience with granting hukou to at the fringes of urban society. It is university graduates and professionals. difficult, for example, for them to set So implementation could simply be up a family and live a stable life in cities, accelerated without much difficulty. which in turn greatly dampens their Meanwhile, during this initial phase, morale and restricts such graduates from planning for the next phase (2021-2030) assuming productive roles within urban would continue. In the second phase, communities. Specifically, due to the efforts would be focused on resolving long period of “ant tribe” status before the hukou issue for other migrant an urban hukou can be acquired, they groups. Such a sequence of action cannot truly join the consumer class. should be in line with China’s financial situation and public expectations. It is quite obvious that granting young university graduates an urban hukou Why begin with university graduates? would be mutually beneficial for all Simply put, university graduates are an parties in China. Because university

Achieving Comprehensive Hukou Reform in China 9 Paulson Policy Memorandum

graduates are major tax contributors to chain in its industries, large numbers social welfare expenditure, the opening of educated, highly skilled personnel, of hukou registration to non-local as well as technical personnel with the university graduates so that they can ability to operate high-tech equipment, settle should result in tangible social are urgently needed. Employers need and economic benefits. Such measures these people and want to retain them. for the more educated should be These are workers who can earn higher implemented as quickly as possible. wages and also have the capacity to pay for urban social welfare through taxes However, until now, the requirements and other methods of contribution. for obtaining a hukou for non-local So urbanizing them is basically also a university graduates, such as in win-win situation for the employers and ’s residence point-based system employees. and Dongguan’s point-based hukou granting system, have been set too high. Conferring urban hukou to skilled And this has meant that the number of migrant workers will also send a strong people newly registered annually is very message to large numbers of migrant limited (only several hundred to several workers to learn to become skilled thousand). workers. Put simply, this will effectively incentivize workers who do not yet have Relative to the more than 100,000 hukou to invest in themselves so that non-local university graduates that live they can work towards obtaining an in each very large Chinese city, such urban hukou in the near future. In the measures are truly inadequate. Only long term, this will help raise the overall , in the last two years, has put technical proficiency of Chinese workers significant efforts behind hukou reform. and benefit China. Through a point-based hukou granting system, Shenzhen gave urban hukou to Specific measures in this category could more than 100,000 university graduates include the following: in 2012, and to a similarly sizeable number in 2013. First, the central government should clearly define the scope of the three The key to hukou reform is to gradually groups of the floating population lower the thresholds so that some specified above, so that local migrant workers can be granted urban implementation can be carried out hukou as quickly as possible. The logic accordingly. Then, each city should and rationale for granting hukou to develop a plan to grant hukou to these university graduates are basically also three groups over the next five years applicable to policies for skilled migrant based on census population data, workers. For China to move up the value supplemented by surveys and estimates.

Achieving Comprehensive Hukou Reform in China 10 Paulson Policy Memorandum

The plan would be broken into annual large cities of more than 3 or 4 million, plans for implementation. With regard and especially in very large cities of to method of operation, the point- more than 5 million. Therefore, these based hukou granting system currently very large cities should play a more used in certain cities can be extended.14 substantial role in offering hukou. In This method is relatively flexible since line with their proportion in the urban it allows qualifications for hukou to population, these very large cities be adjusted each year as needed. For should absorb more people and not example, those who have resided locally close the door on hukou registration. for many years can be given priority As a strategy to jump-start the over newcomers. hukou reform program, China may give precedence to opening hukou Under this scenario, beginning in registration in the second-tier of its 2021, hukou registration would large cities (see Table 1). basically be totally open for the three groups named above. These three Beginning in 2021, China could then groups are mostly concentrated in begin to turn to the hukou issue for the

Table 1. Population Growth Rates by City Size, 2000-2010

Weighted Mean (%) Median (%) Cities Based No. of Cities 10-Year Average 10-Year Annual on “Urban Growth Annual Growth Growth Population” in Rate Growth Rate Rate 2000* Rate First Tier** 4 51.8 4.3 55.0 4.5 3-6 Million 11 43.0 3.6 40.7 3.5 2-3 Million 10 38.2 3.3 37.4 3.2 1-2 Million 36 53.4 4.4 37.6 3.2 National 653 cities and 45.0 3.8 NA NA 19,410 towns *“Urban population” refers to the de facto population in the urban areas (as defined by National Bureau of Statistics) in the city districts of a city. Based on that definition, for example, the urban population of Shanghai was 13.46 million in 2000 and 20.22 million in 2010. For a detailed explanation of this definition and its usage, see Chan (2007). To maintain comparability, the population size of some cities in 2000 has been adjusted to reflect merges of cities between 2000 and 2010. For example, the population of in 2000 includes those of Shunde, Sanshui, and Nanhai. **refers to Shanghai, , and Shenzhen. Source: 2000 and 2010 Censuses.

Achieving Comprehensive Hukou Reform in China 11 Paulson Policy Memorandum

remaining 200 million migrant laborers for obtaining a hukou. Of course, after (and their family members). 2030, once hukou registration is open, this condition can be lowered to three By that time, due to the overall higher months. Specific methods of operation education level of the population, the will still need to be further designed and self-effort of migrant workers, as well refined over the next three or four years. as a smaller cohort of younger people as the population ages, the number of Opening Hukou Restrictions in Large, unskilled workers with low education Medium-Sized, and Small Cities levels will greatly decrease. With China’s growing economic strength in the next Presently, the specific hukou policy ten years, the government would be measures stipulated in the Opinions able to put more financial resources is to “open small cities and control big behind achieving greater social equity. cities”—that is, to lift immediately hukou restrictions in towns and small cities, lift In this way, favorable conditions can be hukou restrictions gradually in medium- created for resolving sized cities, and to the hukou issue for strictly control hukou The fact is, after more than 30 years, ordinary migrant China’s investments are still primarily registration conditions workers and providing skewed toward large cities, resulting in in large cities and welfare to low-income their faster development. very large cities. This workers. approach is informed by a longstanding In the point-based system for granting misreading that such policies represent hukou to ordinary migrant workers, a path of “urbanization with Chinese one year of stable employment could characteristics,” which will allow China to be taken as a basic condition. In the avoid the “urban diseases” of blight and beginning, due to the very large . numbers of ordinary migrants in this category, other conditions could be To the contrary, this strict policy follows added—such as the length of time of rather than breaks from the early 1980s residence in a given locality, education policy of “controlling the population level, and work experience—so as to of large cities” and the outdated pre- allow the issue to be resolved in an reform policy of controlling the growth orderly fashion. of large cities. Such a policy is not based on the actual pattern of population In later stages, these conditions could . be gradually loosened—for example, employment and residence for six The fact is, after more than 30 years, months could become the prerequisite China’s investments are still primarily

Achieving Comprehensive Hukou Reform in China 12 Paulson Policy Memorandum

skewed toward large cities, resulting in present circumstances, the “urban their faster development. The majority of population” (chengzhen renkou) used the floating population has not followed by China’s National Bureau of Statistics the official policy and moved to small in each city administrative region can cities and towns. Instead, they moved generally represent the functional to large cities anyway in response to job urban population.16 Table 1 displays opportunities, even though the members the central tendencies (mean and of this floating population have not, as a median) of population growth rates for consequence of their choice, been able different groups of cities based on data to receive most of the social welfare and from China’s 2000 and 2010 censuses. services in large cities because they lack Because variations in the growth rates urban hukou. of small cities are considerable, the median is a better indicator than the In recent years, hukou registration mean to show the “average” trends of policies have already been loosened in the growth rates. many small and medium-sized cities, but such a loosening has not actually The data show that in the period 2000- attracted many migrant workers. And 2010, the median growth rates of the this is mainly because the capacity of urban population of China’s cities have small and medium-sized cities to absorb been correlated with city size. In other employment is limited. words, first-tier cities (China’s largest) grew the fastest. So there is no connection between hukou policies and the movement of This trend is likely to continue over the migrants. Moreover, under current next 20-30 years because agglomeration circumstances, where local finances in very large cities will continue to be depend primarily on land revenues, an important driving force in economic local governments lack the capacity to development. For this reason, the key develop small cities and towns, because to hukou reform is to open the door to the land in those areas does not sell for hukou registration in very large cities. a high price. It is well known that over the last two years, many newly built The rapid growth of China’s very large apartments in these second-tier and cities can be attributed not just to third-tier cities have remained vacant. policy factors but also to the fact that in China’s current phase of development, The population statistics of China’s agglomeration economies will favor the cities are complicated and confusing. very large cities. Agglomeration brings Many people misunderstand them many benefits and reduces business and make a number of errors.15 Based transaction costs, a point that has been on my many years of research, under widely accepted by economists.17

Achieving Comprehensive Hukou Reform in China 13 Paulson Policy Memorandum

In addition, many scholars studying focus on lowering unit cost through China’s urban economy believe that economies of scale. Small cities are the number of very large Chinese cities simply not a good choice for this. is too few, not too many.18 China’s expanding service industries also Ultimately, the agent for achieving benefit greatly from agglomeration agglomeration effects should be the economies in very large cities. These market, not the government—in other cities are the centers of words, companies and urban and rural because they are hubs of scientific and residents, rather than government technological development and finance. policies, should be the driver. That is, This is yet another reason why rational because officials do not possess all the urbanization and urban development relevant information, they do not know promotes economic development. which companies do better in large or small cities and thus Agglomeration in where they should very large cities has be located. Nor can been an important officials know if a driving force of certain migrant is Chinese economic “better” situated development over in a large or small the last 30 years. city for the simple And China’s urban reason that the development will specific conditions continue along of each individual this road in the Photo: World Bank/Freedom House are different. next 20 years. For example, further development of tertiary industries In the end, such decisions should be left will no doubt be tied to further to companies and workers themselves agglomeration in very large cities and based on market conditions, not a corresponding decline in some small determined by an across-the-board cities and towns. Land in China is scarce, policy to control the population of very so urban development will have to be of large cities and encourage migrant high density. workers to settle in small cities.

This compact urban development model Today, very large Chinese cities such is also more compatible with China’s as Beijing, Shanghai, and Guangzhou pursuit of low-carbon development. experience a host of urban problems, And to provide public services to large including serious and numbers of the low-income floating housing shortages. The main reason population, it is also necessary to for these problems is not because of

Achieving Comprehensive Hukou Reform in China 14 Paulson Policy Memorandum

their large populations but because congestion in these very large cities is of poor , ineffective the lack of consideration and provision use of space, inequitable distribution in urban planning and supply of social of housing (e.g., many people own services for migrants (such as housing, multiple units), unreasonable prices for transportation, and children’s education) public facilities,19 and other factors. over the last two to three decades. All along, the floating population has been There are also some who believe that treated as merely a temporary workforce. the populations of the very large cities have already exceeded their carrying But even if floaters are temporary capacity, and thus more hukou cannot workers, they are still human beings be granted there. In fact, the carrying who need to live their lives (even if capacity of cities should not be based on their needs are modest). When the the static capacity of natural resources floating population finally rises to such as water. A more account for one- important factor is the The central problem these cities face third of a city’s total carrying capacity of is not a lack of land or water per se, population (as is social infrastructure, but rather a huge debt in the supply of the case in Beijing, which is ultimately social services for the migrants. Shanghai, and a question about Guangzhou), or even financial resources: who provides them, more than one-third (as in Shenzhen) who uses them, and who pays for them. today, then long-term neglect naturally yields serious problems such as Consider, for example, that although overcrowding and congestion. Beijing’s land area is three times as large as Tokyo’s, Beijing’s population The central problem these cities face is only two-thirds that of Tokyo.20 is not a lack of land or water per se, Beijing’s GDP is one-tenth of Tokyo’s, but rather a huge debt in the supply of and yet Beijing’s urban problems are social services for the migrants. far more serious than those of Tokyo. This illustrates that natural resources It is essential, therefore, thathukou are not the most important factor reform be carried out in all cities, in determining the capacity of large irrespective of size, including very large cities. In fact, high-density urban cities such as Beijing, Shanghai, and development of very large cities Shenzhen. That is because very large enables greater economies in using cities are the places where the majority natural resources. of China’s floating population (including a large number of non-local university What turns out to be a more important graduates) is concentrated and where factor in explaining the serious work is most readily available.

Achieving Comprehensive Hukou Reform in China 15 Paulson Policy Memorandum

Ultimately, this means that very large second-tier cities enjoy the benefits cities can make greater contributions brought about by the agglomeration to hukou reform than is the case under economies of very large cities. And at current government plans. Considering, the same time, they have the ability however, that the current pressure of to accommodate and attract large supplying public services in first-tier cities numbers of people who are immediate are considerable—and since population targets for hukou reform. carrying capacity cannot be drastically expanded in the short term—launching For purposes of comparison: the urban hukou reform in very large cities that are population in the United States is not in the first tier could be a temporary about 250 million; the country has two measure to help generate momentum. “” (metropolitan areas with But this would broaden current efforts a population of at least 10 million).21 beyond only medium-sized and small ’s urban population is 110 cities, and thus be a way of breaking million but also has two megacities. ground on a more comprehensive The urban population in China is about reform of the hukou system. three times that of the United States, and can certainly accommodate six Such very large but second-tier cities to seven megacities. But at present, include , , , there are only four. Xi’an, , and Zhengzhou. These

Achieving Comprehensive Hukou Reform in China 16 Paulson Policy Memorandum

Other Supporting Measures

ukou reform is a large-scale, and coordinating national hukou highly complex project, which policies, integrating specific measures Hrequires coordination among across provincial lines, actively many different components and promoting reform and supervising agencies of government. implementation, and developing regulatory mechanisms in a timely Role of the Central Government fashion.

Since hukou reform requires a Hukou reform requires breaking comprehensive development through the limitations imposed by strategy, strong leadership and regional administrative boundaries overall coordination from the so that migrant workers from one central government are needed. For province can obtain hukou across instance, the further provincial lines when development of Since hukou reform requires a they move. A large set China’s economy will comprehensive development of the current issues depend on having a strategy, strong leadership and involved with granting single domestic labor overall coordination from the hukou to the floating market and consumer central government are needed. population is about market. And the general social welfare task of establishing the underlying (such as public housing, education, conditions for a unified, free domestic social security, and land). Another set market is clearly a responsibility of the is about the sharing of fiscal resources central government. And hukou reform and responsibilities between the is pivotal to this. central government and local governments. These two sets of issues Again for purposes of comparison, urgently need the leadership of the consider the United States. The central government. strength of the American economy has depended, for more than a Indeed, this challenge will only grow century, on the federal government’s as China continues to develop its efforts to combat local economic market economy with increased labor protectionism and create a domestic mobility. Hukou reform will inevitably market in the United States within need to take place across multiple which both labor and capital can flow localities, involving the complicated freely. Applying this logic to China, issue of sharing responsibilities and the central government would need authorities among different local to play a strong role in promoting governments.

Achieving Comprehensive Hukou Reform in China 17 Paulson Policy Memorandum

The central government should The other part of social services establish a hukou reform governing involves mostly local services, which body. This may be a sub-agency of the can be mainly financed through local National Development and Reform taxes on households, such as income, Commission (NDRC) and would have sales, and property taxes. These should the power and responsibility to be expanded in China to generate specifically focus on implementating more revenue, so that those receiving hukou reforms. services will also contribute to local revenue streams. For example, the Adjusting Local Tax Structure property tax pilot program currently being carried out in two cities, Local governments are a major source Shanghai and Chongqing, can be of resistance to hukou reform, quite expanded to many more. simply because the burden of paying for social services has primarily fallen Over the next twenty years, the on them. China’s local governments majority of China’s floating population depend principally on enterprise will become new members of the taxes, land sales, and debt finance urban workforce, consumers, and (often through unofficial local finance homebuyers, so they will also become vehicles). In short, local governments new sources of income, sales, and have not established a sustainable property tax revenue. The crux of municipal finance system that is local tax reform is to create a tax base commensurate with population growth that grows with population. This way, and a market economy.22 expenditures on social services and revenues can expand in parallel to Despite the rapid pace of China’s achieve fiscal at the local urban development, large numbers of level. migrants have been excluded from the urban social services system. To keep Reform of the Agricultural Land pace with granting hukou to migrants, Transfer System then, spending on local social services would need to be increased, which Further will requires matching revenues. definitely require an increase in urban land, and this, in turn, will primarily As examined above, some social be achieved by converting agricultural services involve general social welfare, land to non-agricultural use. such as compulsory education and retirement security. These would be After members of the rural population best financed through fiscal transfers at move to the urban areas, the or provincial level. agricultural land they leave behind

Achieving Comprehensive Hukou Reform in China 18 Paulson Policy Memorandum

should be transferred to increase This measure could be more easily utilization efficiency. But in today’s China, implemented in developed areas, where such transfers, and especially transfers the rural population can benefit from the into the market, present complicated protection of a better developed legal issues of how to distribute revenue from system and a greater general awareness land value appreciation and protect of their rights. But in less developed the interests of the rural population. rural areas, due to their inadequate Indeed, there are inherent defects in legal system, it would be hard to ensure China’s existing rural land property rights reasonable compensation for rural land arrangements, mainly the ambiguity of transfer. Once members of the rural collective ownership, which easily lends population lose their land, it can mean itself to abuse. forfeiting their livelihood, posing It was decided at serious financial risks the Third Plenum of to themselves and the 17th Congress society. of the In the next stage of in 2008 that China reform, then, China would gradually will need to turn to develop a unified the question of how rural-urban land fair compensation market. This Photo: World Bank and protection can was reaffirmed at the Third Plenum be provided after members of the rural of the 18th Congress of the Chinese population leave their land. This will be a Communist Party in 2013. The latter critical issue in rural land reform. Plenum further stipulated that collective construction land could enter the Establishing a Unified Urban and Rural market. Social Welfare System

But how should “collective land” be The basic problem of inequality of defined? There is widespread debate and social services and opportunity created discussion of this issue in China, but the by the hukou system lies in the urban- general consensus has been to reform the rural dual social structure set up in the current rural land expropriation system to 1950s. To solve this problem, China allow the rural population to put collective needs to reestablish a unified society construction land into the market. This such that every citizen would have equal should result in the same rights and prices and reasonable access to social goods, for urban and rural land, hence protecting including public education for children the interests of the rural population. in cities where their parents work.

Achieving Comprehensive Hukou Reform in China 19 Paulson Policy Memorandum

Currently, citizens of China’s large cities right to move anywhere in the country enjoy better public welfare and services. for work or business, or to be with And that is precisely why large-city their children. One would only need to hukou carry more value. Since very stay for three months (or six months) large cities have first-class education, to qualify for a local hukou. Under that healthcare, and other resources, as well condition, the freedom for individuals as very high college admission rates, it to change their place of residence in is no surprise that so many Chinese, no accordance with changes in family life matter where they are born, want to cycle or in employment would be greatly obtain hukou in these cities. expanded. Only in this way can China develop a productive economy that Rebalancing basic public services so that allocates human resources efficiently. comparable services exist more equally And China would also be a fairer society in different locations, including smaller characterized by relatively equitable cities, will change incentives to migrate. opportunity. Put differently: if the welfare, education, and healthcare services available in The Opinions has already outlined some small cities are also improved, some of the related and subsidiary measures migrants may be willing to move there for a comprehensive hukou reform. instead of going to the biggest cities. These include developing a nationwide, For instance, it is conceivable that some unified basic pension insurance system retirees may find it attractive to go to for both urban and rural residents; a small cities because of lower housing unified medical assistance system; the prices and better air quality, instead of protection of equal education rights crowding into China’s big cities. for migrant children; and a nationwide, unified hukou system for both urban and Under a unified rural-urban social rural areas. These are important first welfare system, people would have the steps, but they aren’t sufficient.

Achieving Comprehensive Hukou Reform in China 20 Paulson Policy Memorandum

Conclusion

his policy memorandum population) can be used as an provides a preliminary sketch indicator of overall progress toward T of the objectives, principles, comprehensive hukou reform. China’s and steps needed for comprehensive central government has already hukou reform. To be sure, many resolved to undertake comprehensive specific technical details must be hukou reform but the pace remains worked out. But through a gradual too slow. yet still comprehensive approach, the vicious trend of an increasing To summarize: This memo proposes gap between the urban resident a two-step hukou reform. The first population and the official urban step is to take a groundbreaking hukou population could be reversed. leap forward and commit to resolve the hukou issue China’s central Through a more comprehensive hukou within five years for government has well reform, the urban floating population the three groups recognized the hukou can be converted into a productive mentioned above problem. Yet it needs resource for China’s economic future. (most notably to have a roadmap university graduates), that gets the two populations to by opening the hukou door in China’s converge over, say, 15 years, thus very large cities, but especially its becoming a more unified and true second-tier ones. In the second step, urban population. after 2020, the government would move on to resolve the hukou issue for As in other countries, citizens other groups. anywhere in China should ultimately no longer be classified as “having To date, China has spent almost a hukou” or “not having a hukou,” two decades in talking about hukou but should be able to enjoy what reform, but little has been achieved. former Premier , in his There is no time to waste. If hukou 2013 report to China’s National reform is successful, both the urban People’s Congress, called “freedom of floating population and China as a movement and a satisfactory way of whole will benefit. Through a more life for all citizens.”23 comprehensive hukou reform, the urban floating population can be From 2016 to 2030, each year’s converted into a productive resource difference between the urban for China’s economic future—an resident population and the urban engine that powers the next round of hukou population (or the floating the country’s economic development.

Achieving Comprehensive Hukou Reform in China 21 Paulson Policy Memorandum

Affirmative movement toward the “economic miracle,” but also establish complete abolition of the class a fairer society and a modern nation. differences brought about by the That is critical if China is to realize hukou system will not only pay what President has termed dividends for China’s economy the “.” and help perpetuate the Chinese

Achieving Comprehensive Hukou Reform in China 22 Paulson Policy Memorandum

Endnotes

1 Chan, Kam Wing, 2012. “Crossing the 50 Percent Population Rubicon: Can China Urbanize to Prosperity?” Eurasian Geography and , Vo1.53, No.1, pp.63-86.

2 Estimates based on China’s Population Census in 2010.

3 Chan, Kam Wing, 2013. “An Investigation of the Path to Hukou Reform,” ed. Cai Fang, Reports on China’s Population and Labor, No. 14, pp. 111-125.

4 In this memo “large city” generally refers to a city with a population of more than one million, and includes “very large cities” (those with a population of more than five million). The State Council recently refered to a “very large city” as a city with an urban population of more than five million (State Council, “Opinions on Further Promoting the Reform of the Hukou System,” July 30, 2014).

5 Xie Lingli, Lu Gui, 2008. Population Development in Shanghai Toward an International Metropolis (in Chinese), Shanghai People’s Publishing House. Beijing – 60 Years, 1949-2009 (in Chinese), China Statistics Press, 2010, Table 5-4.

6 “National New-type Urbanization Plan,” State Council. March 17, 2014. http://www.gov.cn/zhengce/ 2014-03/16/content_2640075.htm.

7 “Opinions on Further Promoting the Reform of the Hukou System,” State Council, July 30, 2014.

8 These estimates come from the following Chinese sources: Investigation Group of the Ministry of Construction, 2006, “New Demands on Cities as a Result of Migration,” Research Report on Chinese Migrant Workers, China Yanshi Press. Chinese Academy of Sciences, Sustainable Development Strategy Study Group, 2005, “China Sustainable Development Strategy Report,” Beijing: Science Press, 2005. Zhang Guosheng, “The Urbanization of Migrant Workers Based on Social Cost Considerations: Perspectives and Policy Choices for a Developing Country in Transition,” China Soft Science, 2009, no. 4. China Development Research Foundation, 2010, “China Development Report 2010: China’s New Urban Strategy of Promoting Human Development.” Development Research Center of the State Council, 2011, Urbanization of Migrant Workers, China Development Press.

9 This figure is very close to the annual per capita cost of urban public services (2,211 yuan) estimated by Qu Xiaobo and Cheng Jie using municipal fiscal data. Refer to: Qu Xiaobo and Cheng Jie, “Estimates of Cost of Hukou Reform,” Forum on Urbanization of Migrant Workers and Higher-Quality Urbanization, Beijing, Aug. 16, 2013. For detailed analysis refer to: Chan, Kam Wing, 2013. “An Investigation of the Path to Hukou Reform” (in Chinese), ed. Cai Fang, Report on China’s Population and Labor, No. 14, pp. 111-125. Assuming

Achieving Comprehensive Hukou Reform in China Paulson Policy Memorandum

an interest rate of 3%, the annual average will be 4,200 yuan. However, as a ratio of GDP, the ratio would be about the same when GDP grows at the same rate as the discount rate. Since GDP would likely grow faster than the discount rate, the ratio will likely decline over time.

10 The logic of the abovementioned analysis is similar to what is used in the U.S. Congressional Budget Office (CBO) analysis of revenues and expenditures that would result from legalizing undocumented immigrants. One can expect that, at least over the first two decades of granting hukou to the floating population would result in a net inflow of revenues to the public coffer, rather than a net outflow. See “CBO: Immigration Bill Would Profit U.S.,” The Seattle Times, June 16, 2013.

11 Du Yang, Cai Fang, Qu Xiaobo, Cheng Jie, 2014. “The Continuation of the Chinese Miracle: Harvesting Dividends from Reform of the Hukou System” (in Chinese), Economic Research, No. 8, pp. 4-13.

12 Edward Glaeser provides an insightful discussion on this topic; refer to: Triumph of the City, Penguin Books, 2011.

13 Chan, Kam Wing, “China Should Proceed Along Normal Path of Urbanization” (in Chinese), Caixin, 2010- 12-8, http://policy.caing.com/2010-12-08/100205422.html.

14 At present some cities employ a “residence certificate,” as a “preparatory” hukou for those who do not yet have a local hukou, and is functionally similar to a hukou. In view of simplifying the application procedures and complexity of the hukou system, this memo does not recommend using the “residence certificate”. This will save time and reduce opportunity for rent-seeking.

15 Chan, Kam Wing, 2010. “China’s Current Urban Population Statistical Issues and Their Impact on Economic Analysis” (in Chinese), ed. Cai Fang, Report on China’s Population and Labor, No. 11 – Labor Market Challenges in the Post-Financial Crisis Period, pp. 236-247.

16 Chan, Kam Wing, 2007. “Misconceptions and Complexities in the Study of China’s Cities: Definitions, Statistics, and Implications,” Eurasian Geography and Economics, 48(4), pp.383-412.

17 Wang Xiaolu, 2010. “Developing Large Cities is Imperative” (in Chinese), China Reform, No. 10, http:// www.caing.com/2011-01-07/100214829.html.

18 For example: Henderson, Vernon, 2009. “Urbanization in China: Policy Issues and Options,” Report for the China Economic Research and Advisory Program. Chan, Kam Wing, 2010. “Fundamentals of China’s Urbanization and Policy,” The China Review, Vol. 10, No.1, pp.63-94.

19 For example, a ride on Beijing’s subway only costs 2 yuan regardless of distance, which is tantamount to a free ride.

Achieving Comprehensive Hukou Reform in China Paulson Policy Memorandum

20 “Tokyo” refers to the Tokyo Metropolitan Area;”Beijing” refers to the entire adminstrative area of Beijing. See: , “Taking the Pulse of Beijing’s Urban Disease” (in Chinese), China Reform, 2014, No. 5, http://magazine.caixin.com/2014-04-28/100671369.html?p0. For an analysis of the populations of large cities worldwide, refer to: Forstall, Richard L., Richard P. Greene, and James B. Pick. 2009. “Which Are the Largest? Why Lists of Major Urban Areas Vary So Greatly,” Tijdschrift voor Economische en Sociale Geografie, Vol.100, No.3, pp. 277-297.

21 US Bureau of Census, 2014. Estimates of Resident Population, Metropolitan Statistical Areas, http:// www.census.gov/population/metro/data/.

22 Wong, Christine, 2012. “Improving China’s Municipal Finance,” Paulson Policy Memorandum, The Paulson Institute.

23 See Wen’s speech at http://www.chinanews.com/gn/2013/03-05/4615650.shtml.

Achieving Comprehensive Hukou Reform in China Paulson Policy Memorandum

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