Restructuring the economy to maintain growth should improve people's living standards and narrow the wealth gap

China has been facing obstacles in various aspects of reform. If the 7 to 8 percent annual growth rate is not maintained, many social problems will come to the fore, the most challenging of which is unemployment. Only by "making the cake bigger" will economic restructuring be achieved and these problems solved. So the question is: How to restructure the economy to make the cake bigger?

The major economic restructuring needed is undoubtedly industrial upgrading. Today, China has become the world's factory, but the problem is that the value added to the product is too small compared to the gross export value of $1.8 trillion. "Made in China" products are still regarded as low-end, high-polluting and labor-intensive. With labor costs continually rising, the gap in production costs between China and the United States and Europe has been narrowing, while the cost advantage compared to the members of the Association of Southeast Asian Nations has vanished. That Chinese products can still occupy the global market is merely because of the limited production capacity of countries like Vietnam and the Philippines. As such, increasing the added value, ensuring product quality, enhancing enterprise productivity and gradually moving up the value chain is undoubtedly the only way to go.

The kind of economic restructuring that should be brushed aside is that relying on short-term consumption growth. Admittedly, a slow and gradual increase in domestic consumption, which reduces reliance on external consumption, is the correct approach in the long term. However, to truly boost domestic consumption, household incomes need to be raised and the social security system improved. Otherwise, boosting consumption is merely empty talk.

So how can China enhance enterprise productivity and push forward industrial upgrading? If China's economic growth in the past 30 years can be summarized as benefiting from external opening-up and internal reform, then China's economic reform now should go the opposite way, namely internal opening-up and external reform.

So what should be opened up internally?

First of all, open the city gate and abolish the household registration system. As a policy to cope with the price scissor for agricultural and industrial products, it was necessary to build a national economic system that focused on heavy industry during the era of planned economy. However, it has already become a hurdle hindering labor optimization and resulted in the distorted distribution of resources. Over the past 30 years, the line of defense in regard to the household registration system has been slightly torn down in small and medium-sized cities. However, control in Beijing, Shanghai, Guangzhou and many other provincial capitals remains strict. The reasons for this include shortsighted local protectionism and the slow progress of urbanization.

Second, remove restrictions and reduce domestic trade barriers. Many enterprises have been complaining about the fact that it is more difficult to trade domestically than internationally. One of the reasons for this is the international trade barriers are public and open, which means cost is controllable despite the distances, while the numerous forms of local protection and barriers are much more difficult to identify and avoid.

Third, break the "glass door" and lower the access threshold for various sectors. For many years, the central government has been introducing different measures to encourage private enterprises to enter the monopolized industries. But while the State Council announced a new guideline in 2010, local governments have been running their own policies instead. In many industries, including telecommunications, railways and municipal administration, there is a "glass door" that blocks private companies from entering. Support for private capital to enter the financial services sector was included in the new guideline, but even now, little is being done in the various financial reform pilots.

What should we reform externally?

First, give up the deep-rooted mercantilism that declares exports are good and imports are bad. In fact, as a result of the large, long-term trade surplus and the foreign trade settlement system, the country's $3.5 trillion in foreign reserves are doing more harm than good. With the recent third and fourth rounds of quantitative easing by the US, China's enormous dollar assets have been depreciating rapidly. It would be better to encourage high-tech imports from the US. This seems a good approach in view of US President Barack Obama's plan to double exports.

Second, as the European and US economies are not likely to revive quickly, their markets should not be the focus of China's exports. On the contrary, the targets for export enterprises should be other emerging industrial markets, led by the BRICS economies. Russia, which joined the World Trade Organization last year, is a huge potential market for China's products.

Third, China should seek to strengthen its relations with ASEAN and proactively push forward the establishment of the China-Japan-South Korea Free Trade Area. Considering the current geopolitical situation, the focus at first should be on a free trade agreement with South Korea.

Maintaining economic growth and restructuring the economy are only the means; the ends should be improving people's living standards and narrowing the income gap. Currently, the biggest challenge facing China is the widening income gap. Statistics suggest China's Gini Coefficient has reached 0.47. Apart from nurturing the middle class, wealth distribution from the rich to the poor is also important. Heavy taxes should be imposed on the ultra-rich, and China should consider inheritance tax.

The author is an associate professor at the China Center for Economic Research, Peking University.