CHINA must tackle unsustainable weaknesses in its institutions and reduce the Government’s role, though its transition to a market economy is “well-advanced”, the Organisation for Economic Co-operation and Development (OECD) said.

About 59 per cent of the economy is in the private sector only decades after Deng Xiaoping introduced economic reforms, the OECD said. In its report, Governance in China, the OECD identified the state’s changing role as the main issue underpinning many of China’s problems.

These include corruption, increasing inequality, poor corporate governance, disregard for intellectual property rights and a deficient banking system. Although President Hu Jintao has prioritised the fight against corruption, the OECD said it was an endemic problem, making up 3 per cent to 5 per cent of the economy.

Corruption spans all levels of government, with kickbacks from government deals about 1.5 per cent of gross domestic product.

The report highlighted an unprecedented exodus of Chinese officials flooding out of the country in recent years, with about two-thirds of the fugitives former senior executives of state-owned companies.

In the first half of 2003 more than 8,300 officials fled China, with another 6,500 disappearing in China to evade prosecution on charges of corruption or embezzlement.

Calling the Government’s efforts to tackle corruption “laudable”, the OECD said that it posed a significant political challenge and was undermined by poor enforcement.

Calling for measures to tighten financial regulation, the OECD said an estimated $24 billion (£13 billion) of assets gained through illegal means is laundered annually.

The OECD proposed the introduction of competition law to prevent market abuse, harmonisation of the tax system across China, and greater flexibility to allow for migration within the country.

The 677-page report was produced in an effort to promote dialogue between the OECD and the Chinese Government.

It also identified the restructuring of state-owned companies, increasing demands for social welfare and bailing out of insolvent banks as potential risks for the Chinese Government’s finances.

Dr Lu Yiyi, a senior research fellow at the Royal Institute of International Affairs, said that the Government, anxious to avoid the Russian “electric shock” means of introducing market reforms, had adopted a step-by-step approach.

“The Chinese Government does recognise that the system can’t carry on like this indefinitely but it can’t afford to have the country descending into chaos,” Dr Lu said.

Since the turn of the century, China has become the growth star of the world economy. Last year the country received a record $54.9 billion in foreign investment.

About 80 per cent of the money was concentrated in eastern China, in areas such as Shanghai.

However, despite an average growth rate of 9 per cent over the past 20 years, which created dozens of billionaires, many Chinese still live in poverty, particularly in the rural areas of the country. This has lead to tensions between rural and urban populations. Activists have also blamed the widening wealth gap, environmental problems and corruption for unrest in some Chinese towns.