China points to social welfare reforms needed for urbanization drive BEIJING/HONG KONG (Reuters) - Among the issues China's top leaders tackled this week as they hammered out their policy roadmap, some may determine whether children attending the likes of the Pengying school in Beijing fulfill their dreams. Thanks to China's system of internal passports, or hukou, parents in search of better jobs in the capital, or other urban areas, leave behind the public services they were entitled to as residents of their home villages - their pension, healthcare insurance and free public schooling. That means that if they want to educate their children they have to find an unlicensed school, such as Pengying, which charges an annual fee of 1,400 yuan ($228), most of a month's earnings for some migrant families. At the school, desks are rusty, smoggy air seeps in through broken windows and the acrid smell of broken plumbing fills the hallways. Students learn the basics despite such conditions, but importantly may not sit for the official exams required to attend local universities. "There is no choice," said Mrs. Wang, the mother of another of Pengying's students who declined to provide her given name. She brought her 8-year-old to Beijing from southwest Sichuan province, more than 1,000 kilometers (625 miles) away, and started a catering business. "There is no future either if you stay at home," she said. Easing the hukou system would undoubtedly make life easier for the more than 200 million people who have moved into China's cities from smaller towns and villages and the roughly 110 million more people China expects to move from the countryside into cities in the next seven years. Beijing wants this mass migration to be the backbone of an urbanization drive to combat rapidly rising factory wages and to help wean the economy from a dependence on manufactured exports by promoting urban consumer consumption. At the Communist Party's Central Committee's third plenary session, which ended on Tuesday, the country's leaders pointed to reforms that analysts have said could set in motion changes in how social services are paid for, ultimately leading to a nationwide social safety net seen as critical if the urbanization drive is to work. A report from the official Xinhua news agency on the closed-door meeting said the leaders promised a "more fair and sustainable social security system" and deeper reform of medical and health systems. It also agreed to "step up efforts to improve social welfare and deepen institutional reforms to realize social justice for all." The ideas are broad, so it is not clear exactly what China's leaders may have in mind. That will only emerge in coming months or possibly years. But analysts say unifying China's patchwork of social services would let citizens seek opportunities wherever they might find them and produce broader benefits for the economy. Portable healthcare, pensions and education could revive China's weakening productivity gains and reduce the propensity of China's citizens to save for a rainy day rather than spend. It could also quell growing discontent over widening income inequality and a disparity of opportunity, a source of great anxiety for a leadership that prizes social stability over almost all else. "If the central government pays for this, you can build up a national standard, so people can move," said Peng Wensheng, chief economist at China International Capital in Beijing. Mobility means a better use of skills, a more efficient use of skills. Shifting the financial burden of such social services to the national government would eliminate a mismatch between tax income and spending, whereby local governments collect just over half of national tax revenue but bear 80 percent of public spending costs. Doing that, economists say, would remove much of the rationale among local governments for a massive borrowing binge that has pushed local government debt to Detroit-like levels. Credit Suisse estimates local government debt could exceed 16 trillion yuan ($2.6 trillion), or as the IMF estimates, equivalent to roughly 30 percent of China's economic output. "Fiscal reform is bureaucratic," said Vincent Chan, head of equity research at Credit Suisse in Hong Kong. That's easier to bargain. Costs for provincial governments have risen dramatically as China's one-child policy accelerated the costs of an ageing society. Rapid urbanization meant costs for pensions, healthcare and other social services jumped as healthy wage-earners fled to more affluent provinces and the population of new citizens declined. As a result, most provincial governments saw demands on their spending surge. Beijing's solution has been to transfer a lump sum to help cover the costs, a massive annual transaction. For anything else, like investing in key infrastructure or projects designed to boost growth and the business tax revenue upon which they rely, local governments go around the law to either sell land or borrow. It is no secret the government aims to change this: Premier Li Keqiang stressed the need to tackle social safety nets and urbanization after taking office in March and the next month spoke on the dangers of local government debt. Although the central committee's pronouncements on fiscal reform were equally vague on Tuesday, they appeared to edge towards greater balance between the provinces and Beijing, talking of establishing a modern fiscal system that lets "both the central and local governments play active roles." Reforms in the 1990s ended free healthcare, although the government has managed to push medical insurance to 95 percent of the population in the past several years. Still, spending on healthcare has fallen only slightly, according to the World Bank, to 8.2 percent of household income from 8.7 percent. And roughly 99 percent of the insured cost of medical care is borne by local governments, according to Credit Suisse. Creating a national healthcare insurance system could turn China into one of the world's largest pharmaceutical buyers, economists say, helping drive costs down and increasing the quality of care. Province-level pensions are also chronically underfunded, as they have been collecting from workers (about 8 percent of their wages) and their employers (20 percent of employee wages) only since 1997. Worse, workers can only draw from the employer-funded part of their pensions if they work for 15 years in a single province. That not only discourages people from moving to take up better jobs elsewhere, it encourages workers to save on their own and worsens the pressure on public funding. "It limits the overall incentive to participate in pension systems," said Helen Qiao, an economist at Morgan Stanley in Hong Kong. Compared to those issues, funding China's nine years of compulsory primary-school education seems an easy task. Education is the single largest government expense in China, according to Credit Suisse, larger even than outlays on defense. Yet local governments shoulder roughly 95 percent of that cost. But those costs hide the expense to migrants who have to pay for their children to attend unlicensed schools like Pengying. Many cities have committed to finding spaces in schools for migrant children, but the problem remains so widespread that the Rural Education Action Program, a group of researchers from Stanford University, the Chinese Academy of Social Sciences and Northwest Socioeconomic Development Research Center, determined there were 230 migrant schools in Beijing alone educating roughly 70 percent of migrant children. The number of children being schooled outside the education system has sparked calls for the government to let them take university entrance exams outside their home base. "It's OK if they don't give us money, but they can at least treat us as equals," said Pengying's headmistress, who would only provide her surname, Zhao. These children are all children of China. Why should they be treated differently?