Hukou Reform in China

The Hukou Reform in China

8th August 2022

At the core of China’s society is the Hukou. It may soon be history.

Among the most important aspects of Chinese society, one critical feature that makes China such a unique country is the Hukou system, or best described as the local household registration system. It impacts the life of all Chinese citizens, rich or poor, from cradle to grave, in a profound way. It is also the subject of ongoing reforms that will change the life of future generations.

On 12th July 2022, China’s “New-Type Urbanization Implementation Plan” under the 14th Five Year Plan was made public. Under this rather technocratic headline lies a profound change to the Hukou system that opens a new era for 1.4 billion people. In a nutshell it is the launch of a trial implementation of a more flexible Hukou system that is no longer based on where someone was born but where that person commonly lives. It is a major initiative in the field of Hukou reform, aimed at further facilitating the free flow of labour. The goal is to boost the long-term economic growth of China while addressing social issues.

A quick review of Hukou in the historical context

The Hukou system is a core social-economic institution in China that divides all citizens into two categories, each one with its specific rules: one for urban residents and one for rural residents. At birth, everyone is given either a rural Hukou or an urban Hukou issued by the city where the person is born.

The Hukou system was gradually implemented between 1950 and 1954, but only came into law in January 1958. The purpose was to allocate resources and duties within the context of the central planning economy put in place by Mao Zedong.

Even though Chinese people live today in a market economy where Adam Smith’s “Invisible Hand” is largely in charge, it has not always been the case. It is important to remember that the Chinese economy in the 1950s and all the way until Deng Xiaoping’s Southern Tour of 1992 was crippled by ideological and political motives. There was no Invisible Hand. The Soviet system of command economy was adapted to China, together with the implementation of five-year plans that are still in force today. At the core of the Chinese system, and still in place today as well, is the Hukou.

Since industrialisation was the single most important target for China in the 1950s and 1960s, the government wanted urban residents to work exclusively in the industrial sector. Urban residents were not supposed to worry about food and other living necessities. Those were considered distractions that decrease workers’ productivity. The government decided that the burden of farming should be borne exclusively by rural residents. Urban residents in China were compensated by “free foods” (accessible through food coupons, also called “commercial grains” in Chinese) which were literally taxes paid in kind by rural residents to urban residents.

If one was born as a rural citizen, was it possible to amend one’s status to become an urban citizen?

That’s where the specificities of the Hukou system kicked in. In theory it was possible to transit from a rural Hukou to an urban Hukou and free oneself from the agricultural taxes and lifelong farming work. In practice, this hell-to-heaven transition was extremely difficult to achieve for ordinary rural residents as there were not enough jobs available in the cities. One typical path to achieve this transition was through education.

Exceptionally talented adolescents who could get access to any secondary vocational school, higher vocational college or university would be almost certain to obtain a job in a State-Owned Enterprise (or SOE), which would come alongside an urban Hukou. However, there were very few headcounts in vocational schools and universities as a percentage of the total population back in those days. Obtaining a secondary-education degree in China was very difficult all the way through the 1990s.

Admittedly the central planning economy and the Hukou system helped establish social order and contributed to the rapid industrialisation of urban areas in China, though it was at the expense of the entire rural population.

Hukou became incompatible with China’s transition into a market economy

Hukou and the underlying “dual track resource-duty allocation” mechanism remained pretty much intact during the first twenty years of China’s economic reforms while China was opening to the rest of the world. The need to reform the Hukou system suddenly became more acute when China became a member of the World Trade Organisation in December 2001 and quickly became “the world’s factory”, thanks to the epic-scale number of migrant workers. Millions of lowly paid migrant workers who were basically farmers with rural Hukou and no manufacturing experience flooded into the thousands of factories that had just been built in the outskirts of cities, allowing the prices of Chinese goods to remain low and fiercely competitive in export markets.

To this day, migrant workers cannot obtain an urban Hukou in the cities where they work and live. As a result, they have no access to local public services. They are not entitled to buy property, obtain a bank mortgage, have medical insurance, social insurance, unemployment insurance, their children are not entitled to public education, and they cannot apply for a passport. A migrant worker must be in the place where his Hukou was first delivered to be able to go to a public hospital, to withdraw his pension upon retirement and to send his children to a public school. Migrant workers are therefore falling under a “semi-urbanisation” status which has caused huge problems of split families, left-behind children, and social inequality.

Such “semi-urbanisation” status is not unique to migrant workers.

Many university graduates who grow up in the countryside and manage to attend university in tier-1 and tier-2 cities, and who want to remain in these cities to find a job, find themselves in the same dilemma. They earn their Bachelor’s degrees or Master’s degrees, but that is not enough to obtain a Hukou in Beijing, Shanghai, Shenzhen, or Guangzhou. If they chose to stay in tier-1 cities, they need to obtain an official job first and wait for seven years at minimum in Beijing/Shanghai, or for five years in Shenzhen/Guangzhou before applying for a tier-1 urban Hukou. It typically takes another one year at least to process the application. It is only after the applicant receives a physical tier-1 Hukou booklet that he or she could start thinking about buying a home and raise a child.

The waiting time is shorter in lower tier cities – three years in a tier-2 city and two years in a tier-3 city and below. Tier-2 and tier-3 cities are much more welcoming to young people, but salaries in those cities are not at all comparable to those in tier-1 cities.

The “semi-urbanisation” status of well-educated young talents is often cited as a key reason for social issues such as the decreasing number of marriages and a fertility rate that keeps on dropping. To decide whether to remain in a tier-1 city or to leave because of Hukou considerations is a frequent question for younger generations.

The existence of Hukou quickly became an obstacle, impeding the free flow of labour and talent as China was transitioning more and more towards a market economy. China’s policymakers are well aware of these issues, but how to reform such an important social economic institution without causing too much chaos in a country with 1.4 billion people remains a challenge.

*Young couples need to go to the place where their Hukou is based for marriage registration

How the Hukou system evolved overtime

The first reform was to introduce in 2014 a new certificate that supplemented the Hukou booklet: a residence permit. This reform was called the National New-Type Urbanization Plan (2014-2020), and it was quickly followed by the State Council’s Interim Regulation on Residence Permits (November 2015). Residence permits were given to migrant workers and university graduates with a rural Hukou who managed to find a job in a city. This residence permit gave them access to most of the public services, but it did not give access to properties and mortgages, and it did not allow them to send their children to public schools. It was a way for the government to reduce the segregation that existed between local urban Hukou holders and outlanders with rural Hukou as to social benefits, without amending the physical paper-based Hukou system. However, it did not tackle the issues of aging population and low fertility rates in urban areas.

The second round of Hukou reform was in 2019 – The next steps are to abandon the physical Hukou booklets and paper-based residence permits altogether as local records are transitioning towards a nationwide integrated system with digital ID cards.

In early 2020, the State Council and the National Development and Reform Commission (NDRC) issued a series of documents calling for a relaxation of household registration restrictions in urban areas. It also declared the end to all Hukou-related restrictions in smaller cities (defined as having less than 3 million people) while lowering the restrictions attached to the granting of an urban Hukou in larger cities. The aim was to facilitate the free flow of talents and labour to improve the quality of urbanisation.

Starting in the second half of 2020, many tier-3 and smaller cities abandoned the need to prove that the applicant had contributed to the social insurance fund for at least two years prior to applying for an urban Hukou. In fact, before the second round of Hukou reform was officially launched, many tier-1 and tier-2 cities with over 5 million population already volunteered to ease their Hukou thresholds and removed their annual Hukou quota. Local governments had realised they needed to retain their workforce (especially young talents) to boost their local property market and sustain economic growth.

Local governments all came up with a grade point system to select and fast-track outstanding fresh university graduates for Hukou registration. The grade point system for fresh graduates varies from city to city, but in essence the higher the diploma of the student, the higher his/her initial score. The graduating student then needs to earn extra grade points to reach the threshold required to submit a local urban application (being employed and paying social insurance deposits each month will earn a fixed number of points).

Among the four tier-1 cities, Shenzhen and Guangzhou have always been the most accommodating to fresh university graduates. Bachelor’s degree holders from any university can obtain a Hukou issued by one of these two cities without any job offering and without having priorly contributed to social security. On the other hand, Shanghai is far more selective, as the “Shanghai Hukou upon graduation” fast track program (launched in 2018) was only open initially to Peking University and Tsinghua University bachelor’s degree graduates, while all other university graduates and postgraduates had to pass through the ordinary grade point system to earn a Shanghai Hukou. The “Shanghai Hukou upon graduation” fast track program recently became more inclusive: master degrees issued by Chinese “world-class” universities were added to the list in 2020 and fresh graduates from 15 universities located in Shanghai were added in July 2022. Comparatively, Beijing remains the most restrictive city when it comes to Hukou applications. We rarely hear of any relaxation of Beijing Hukou thresholds for young graduates.

But none of those top-down decrees or bottom-up fast-track programs were as groundbreaking as the announcement made on 12th July 2022 that introduced the “New-Type Urbanization Implementation Plan”. This latest reform officially specifies that China will implement, first on a trial basis, a Hukou attribution system based on where the applicant commonly lives, without any threshold or restriction, and without any reference to the place where he or she was born. This is nothing other than a revolution for the Chinese society. The only exception at this stage are large cities with more than 5 million population which were only asked to remove their use of quotas.

In other words, the country is one step closer to replacing altogether the Hukou system that differentiates between those who were born in cities and those who were born in the countryside by a simple and straightforward digital-enabled ID card.

It is hard to assess all the consequences of this latest Hukou reform. But we know it will impact the daily lives of millions. It will also change profoundly the supply-demand dynamic of public services, including hospitals and schools that will likely see considerably higher traffic and enrollments. It will also encourage family reunions and hopefully have a positive impact on the birth rate of China that keeps on reaching new lows. Arguably this last chapter of Hukou reform should have been implemented much sooner, but it is never too late.

*Oct 2017 – 31 year old bachelors degree holder and local property owner Ms. Wang, became the first to receive the Wuhan Hukou after new Wuhan local policy was implemented

The information contained herein is issued by JK Capital Management Limited. To the best of its knowledge and belief, JK Capital Management Limited considers the information contained herein is accurate as at the date of publication. However, no warranty is given on the accuracy, adequacy or completeness of the information. Neither JK Capital Management Limited, nor its affiliates, directors and employees assumes any liabilities (including any third party liability) in respect of any errors or omissions on this report. Under no circumstances should this information or any part of it be copied, reproduced or redistributed.

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The Hukou Reform in China

8th August 2022

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