On July 25, the State Council released the Decision on Reform of Investment System. It not only marked the most significant step in economic reforms since the 16th National Congress of the Communist Party of China (CPC), but also was a turning point from a planned economy to a market economy.

Since enterprises were given the right of decision-making in setting prices on output and labor and selecting raw materials in the late 1970s, they have become mostly independent businesses.

However, three decades later, enterprises, state-owned, state-held or private, still have to follow government instructions and obtain the government's approval in their choice of investments.

Under such circumstances, the State Council's decision to relax administrative controls over investment has removed the last boundaries of the State over specific decision-making for enterprises and economic reforms have overcome the last obstacle of the planned economy.

According to economics theories, investment is a decision that reallocates resources. Under the planned economy, investment projects from various industries all over the country have to apply for licences from the central government. The central government chooses those they think proper in line with an overall plan for the national economy.

To realize high efficiency, such decision-making processes have several preconditions that can hardly be fulfilled in reality: the cost of information accumulation, investment plans and enforcement are close to zero; the different levels of local government have the same interest as enterprises; and all officials in charge of the investment selection are knowledgeable, honest and insightful.

These preconditions are proven to be false in practice.

As a result, the economy is obsessed by many problems resulting from such central-controlled investment systems.

The national economy is in a vicious cycle swinging between overheating and sluggishness.

Investment projects have to undergo a tedious process before they reach final authorities. The best chance to market products has disappeared before some projects get approval to start construction, which causes huge amounts of waste.

Under the market economy, the government does not interfere in the businesses' choice of investment projects, the amounts or the means of the investment.

The flow of capital is primarily decided by the businesses' estimation of costs and prices of the products, the expected profitability of the industry or the technology.

Before the State Council issued the decision, the enterprises could choose labor, technology and locations at their own will, but would have to obey the government as to their flow of capital. It only distorted the resource allocation by the market.

Some are worrying that if businesses are free to decide on investment projects, the market's function of resource allocation will be ruined by disorder and bring about duplicate projects.

In fact, investors have developed techniques to avoid blindness and shortsightedness in investment.

In developed countries, many institutes and human talents specialize in evaluating investment risks and possible revenues. Investors usually refer to the opinions of such experts before they make major investment decisions.

Such mechanisms help reduce blind investments by individual businesses and improve investment efficiency in society as a whole.

Investment evaluation was introduced to China in the 1980s. And the authorities in charge of investment licensing also require applicants to submit investment evaluation reports.

But such reports were often written to get administrative approval rather than to assess risks and revenues of projects.

Therefore, the introduction of such risk and revenue assessment techniques seldom serve the duel role to avoid economic tumbling and duplicate projects.

Another far-reaching significance of relaxing the State control over investment is that it could stimulate private investment.

Under the previous investment scheme, authorities would prefer granting green lights to government investment. Private investors have much higher thresholds in investment than the government.

Investments of government and state-owned businesses are mainly poured into infrastructure and capital-intensive fields, which fail to create abundant jobs despite speedy growth.

Without sound employment, the residents' income could not increase at the same pace with investment, hence consumption lags far behind investment.

So, the reform of investment system would definitely enhance the development of the private economy, create jobs, raise the average income and increase consumption.

At the same time, the reform should also set guidelines about the fields in which the government does and does not invest.

As a matter of fact, the government should invest more heavily in the sciences, education, health and urban facilities.

Some local governments even borrow from the banks to support their investments, which do not turn out any revenues and burden the banks.

The new investment system should put state-owned and state-held enterprises under close watch in investment decisions.

But the watchdog should be the subordinates or trusts of the State-owned Assets Supervision and Administration Commission. And such kinds of supervision should be long-term and macro instead of day-to-day interference.

The reform of State-owned banks should also be accelerated after the investment system is reformed. Since the State has loosened its control over private investors, the state-owned banks must be better regulated, otherwise the private investor will probably abuse bank credit and put bank loans at risk.

To sum up, the government should invest in non-profit projects which are badly needed by the public but that cannot attract private investors. Governmental investment should withdraw from fields where private investors want to enter and that do not involve national security.

Other departments of the government should focus on checking whether investors have abided by the relative rules and regulations in land use or environmental protection.

All other issues should be left to the investors' own decisions and be controlled by market prices, costs and revenue.

Much work has to be done to put the State Council's file into practice. Current rules and regulations should be adapted to the latest changes in the investment system and new ones should be drafted to fill in possible loopholes.

(China Daily August 9, 2004)