Economy: Why China Is Too Scared to Spend

This month marks the 30th anniversary of Deng Xiaoping's economic reforms in China. But rather than celebrating, officials are in a panic. The global economic crisis has rammed home the message that China's old export-driven development model won't work forever; last month exports were down for the first time since February 2002, and overall GDP growth has dropped from nearly 12 percent last year to a projected 8 percent in 2009. Economists and party leaders now agree: the only way to keep China humming is to boost domestic consumption. That means getting Chinese people spending. But there's a problem. China's social-security network is broken, badly, and nowhere are the problems worse than in health care. A serious illness can still wipe out a family's savings. As long as that's the case, ordinary citizens will keep sticking large chunks of their income under their mattresses. And while that lasts, consumer demand will lag.

It's not that China doesn't have the money. Just the opposite: Chinese householders currently sit on savings worth $3 trillion, thanks to a savings rate of more than 25 percent, or about 16 percent of GDP—which is higher than all OECD countries, according to the World Bank. In theory, that cash could help China out of its conundrum. "We have a large domestic market. Savings are high, economic reserves are high," Vice Commerce Minister Yi Xiaozhun told a nervous gathering of elite Chinese entrepreneurs on a recent weekend. The government has already tried to allay fears with a stimulus package worth $586 billion, which Beijing will use to counter the effects of factory closures. But it plans to do this largely through infrastructure spending. According to the cabinet-level National Development and Reform Commission (NDRC), some 45 percent of the package will go to projects such as new railways, ports and power stations. Meanwhile, only one percent of the total stimulus spending is pegged for health care, culture and education.

A growing pool of experts argue that that represents a missed opportunity and is unlikely to help China long-term. Huang Ming, a Cornell professor who teaches at Beijing's Cheung Kong Graduate School of Business, sums up a widely held view when he says, "It's in the interest of the government to develop the social safety net fast. It will stimulate consumption. [Chinese] save because they are frightened of getting sick." The costs of illness can be ruinous. A better health-care system would unleash domestic spending and thereby boost employment, especially in retail and services. It could even offset the social unrest Chinese leaders fear will come with slower growth. "If you have nationwide health care, people are less likely to go on the street," says Huang.

Yet tackling China's vast medical crisis is daunting. Even President Hu Jintao acknowledged in 2006 that "medical-service fairness is declining and medical fees are too high for most people to afford." He called for faster development of rural services, a network of city clinics, timely treatment and safe drugs at affordable prices.

But progress has been glacial, centered on pilot studies and exercises more visible to experts than the public. In October 2008, the NDRC issued a road map for reforms. But the document was vague and said little beyond confirming that health-care reform is "an urgent expectation of the majority of Chinese people."

That's putting it mildly. While the 30 years since Deng's reforms have brought scorching growth, in terms of health care China has moved backward. Hu Shanlian, a health economist who has been advising the Chinese government for 17 years, says there's been "great change since the 1960s," when there was "quite a good network for farmers to seek health care," including a broad system of "barefoot doctors" in village clinics as well as decent and affordable hospitals in towns. In the 1980s, this system collapsed when market reforms did away with the communes that funded such facilities. Something similar happened in cities, as state enterprises were privatized or laid off workers, cutting them off from the work-unit-based welfare net. In 1980 only one fifth of health-care costs were paid out of patients' own pockets, but by 2005 that had risen to more than half.

When the Mao-era system was dismantled, barefoot doctors disappeared and Chinese medicine became city- and hospital-based. Hospitals were permitted to charge for tests and drug prescriptions, and the more costly the procedure, the higher the revenue for both hospitals and doctors. The result has been "overprescription and overutilization of services," says Dr. Sarah Barber, who heads the World Health Organization's Health Policy and Systems team in Beijing.

With only a patchy network of primary-care clinics left, patients these days struggle to find the right doctor or diagnosis since they can rarely afford to visit many hospitals.

Hospitals charge fees way beyond the reach of ordinary Chinese. The problem is illustrated by the case of Liu Jiangtao, a 25-year-old party member who fell sick with leukemia in mid-2007. Liu currently lies in Beijing's No. 307 military hospital, where he's been trying to persuade TV and radio stations to help him raise the $58,000 he needs for a bone-marrow transplant. That sum is the equivalent of 40,000 times the annual income of his parents, who grow wheat and flax on the salty margins of the Yellow River. Liu was originally hospitalized in Shandong's Dongying City, but after eight months of ineffectual chemotherapy, his parents in May asked relatives for money to move him to Beijing. "Now most of my relatives don't want to communicate with us," says Liu. Meanwhile, delay in treatment has eroded his chances of survival.

Liu's plight points to another basic problem: the lack of adequate health insurance in China, a supreme irony for a country that's still officially communist (indeed, many capitalist countries in the West provide more comprehensive care for free). Liu has insurance, but it's China's most basic program, the Rural Cooperative Medical Scheme (RCMS). The RCMS was rolled out in the last four years. It costs participants as little as $3 a year and has been extended to 90 percent of China's farmers in record time. But the system is badly flawed. For one thing, it's a pay-first, claim-later setup, which doesn't do much good to patients like Liu who can't come up with huge fees in the first place. For another, most claimants get back only 20 to 30 percent of their costs. Many of China's poorest, sickest or least-educated citizens find the RCMS baffling and can't manage to jump through its procedural hoops.

Employer-based schemes have similar problems. Benefits aren't portable geographically so they don't help China's massive migrant population, and workers who lose their jobs can't take their contributions with them. Among city dwellers, health insurance coverage levels dropped from 45 percent of the long-term, settled population in 1998 to 39 percent in 2003. To tackle this, the government consolidated numerous employment-based deals into a single package better suited to job mobility. It then plugged a key gap for migrants with a new safety-net scheme that covers both urban and rural poor. Yet the overall health-insurance system remains so badly designed that simply adding money, as the government is doing, will solve little. Extra insurance funds simply tend to be soaked up by profit-hungry hospitals.

Still, the government is trying. Total government health spending increased from $143 billion in 2006 to an estimated $219 billion in 2007, according to Hu, the economist. And Hu and Barber say that the government is rolling out multiple new pilot schemes, experimenting with fixing drug prices, drawing up a national recommended drug-purchase list and passing price-label laws to prevent rip-offs. Village medics (of whom China has far too few) are to get guaranteed basic salaries in five poor provinces to stop them from relying on prescribing. Perhaps the most promising experiment is taking place in Chongqing, where rural and urban insurance pools are being combined to create portable, individual insurance, something China's lacked until now.

So far the government has avoided fanfare; it seems to want to avoid any big announcements and to build on the results if they turn out to be positive. That's good research practice, says Barber. "In health systems it's not one fix, so you look at your system and adjust; the key is to monitor what's happening," she says.

Yet this approach may not be politically decisive enough for these troubled times. "What China really needs is structural transformation," says Michael Shen Minggao, a former investment banker who is now chief economist with the highly regarded Caijing magazine. Without it, he argues, the Chinese economy may still manage to grow at 8 percent or more next year, but consumption won't budge. And that spells trouble long-term. Until Chinese start buying, their country's economic prospects over the next 30 years may fall far short of the world-beating growth they've enjoyed for the last 30.