Price mechanism lies at the core of the market economy. The economy's two major functions--effectively allocating scarce resources and forming compatible incentive mechanisms--are both realized through this mechanism. In the move to reform the economic system initiated in 1984, the Central Committee of the Communist Party of China (CPC) vowed to reform the planned price mechanism, which reflected neither costs nor the relationship between market supply and demand, saying that reform of the mechanism represented the crux of overall economic reform. For various reasons, however, this reform has not yet reached completion 30 years later.

The Decision of the CPC Central Committee on Some Major Issues Concerning Comprehensively Deepening Reform adopted at the Third Plenary Session of the 18th CPC Central Committee in November 2013 requires the improvement of the mechanism whereby prices are, for the most part, determined by the market. That is, any price that can be determined by the market must be left to the market, and prices which are determined by the government will be limited to important public utilities, public-welfare services and network-based natural monopolies while raising transparency and accepting social supervision.

The Central Government on October 15 passed a guideline on advancing price mechanism reform, stating that China will lift price controls over basically all goods and services in competitive sectors by 2017 and that by 2020, the country will have a sound pricing mechanism rationale in which the market plays a decisive role, with well-reasoned and transparent pricing regulations, and a well-enforced anti-monopoly law.

In my opinion, there are three salient themes in this guideline.

First, it makes a clear distinction between a macroeconomic problem and a microeconomic one.

The terms "microeconomy" and "macroeconomy" describe two different fields, but they used to be lumped together in China. For instance, when a macroeconomic problem of asset price inflation occurred, the government has not adopted countermeasures addressing the root cause from the macroeconomic perspective but rather attempted to curb price hikes through microeconomic measures such as limiting home purchases. This was naturally unable to solve the problem of soaring prices and only further intensified the problem by causing resource mismatch and reducing efficiency.

By distinguishing individual price problems in the microeconomy from the overall price level in the macroeconomy, the guideline leaves the former to the market and the latter to the government.

Second, it upholds the principle that any price that can be determined by the market must be left to the market and that the government shall not to carry out improper interventions.

Now most people have agreed that the prices of ordinary commodities must be determined by the market, but there are still disputes on whether or not the principle is applicable to the industries of natural monopolies, such as water supply, power and rail transportation. Those opposing price reform in such industries think there is no competition in industries of natural monopolies; therefore, the prices must be regulated by the government. As a result, reform in these industries is progressing slowly.

In fact, post World War II, the experience of market economies has suggested that even in these industries, most business activities do not belong to the industries of natural monopolies. Therefore, to implement the principle that any price that can be determined by the market must be left to the market, the government must lift price controls over the competitive business activities in these industries.

Take the power industry as an example. Among the four major business activities of generation, transmission, distribution and sales, power transmission and distribution are, by their nature, natural monopolies. As a result, price controls in power generation and sales of electricity can be lifted so that similar power prices will be determined by the market. Reforms in some countries have achieved success. In 2002, the State Council approved a scheme of power reform. However, no other progress in the reform was observed after the operations of power plants and power grids were separated.

The guideline reiterates that price controls over competitive activities in the water supply, oil, power and transportation industries must be lifted so that prices can truly be determined by the market. With this principle, price reform in these industries is likely to advance.

Third, the guideline puts forward clear and determined principles but requires prudent and sound implementation.

Prices involve the interests of all people. Particularly, price fluctuations that affect daily necessities will immediately have an effect on production and people's life, so the government must be prudent in carrying out price reform in these sectors. On the other hand, price reform requires the support of a relaxed economic environment to prevent wild price fluctuations during the reform. Price reform therefore needs the coordination of macroeconomic policies. When production and people's life are severely affected by price fluctuations, the government must be prepared to take action to remedy the problem.

The guideline urges caution in advancing the reform and includes some detailed remedy measures designed to ensure the success of the price reform.

This is an edited excerpt of an article written by Wu Jinglian, a renowned economist and a researcher with the Development Research Center of the State Council, and published in People's Daily 

Copyedited by Kylee McIntyre

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