Professional Documents
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China 2030
Building a Modern, Harmonious, and
Creative Society
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DOI: 10.1596/978-0-8213-9545-5
Foreword. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii
Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xv
Background to This Research. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xix
Executive Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxi
Abbreviations .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xxv
Part I Overview
China 2030: Building a Modern, Harmonious, and Creative Society . . . . . . . . 3
1 China’s Path: 1978–2030 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
7
Strengthening the Fiscal System and Aligning It with the Evolving
Role of Government. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
C H I N A 2 0 3 0 v
vi C H I N A 2030
Boxes
O.1 The middle-income trap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
O.2 Smart urbanization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
O.3 Reducing poverty. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
1.1 Significant potential remains for further productivity gains through factor
reallocation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
1.2 How fast will China need to grow to achieve high-income status by 2030?. . . . . . 82
1.3 Where are the largest remaining distortions in product and factor markets? . . . . . 87
1.4 Functional reviews: A tool for designing reforms for a more efficient
government . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
1.5 Indicative regulatory framework for subnational government debt. . . . . . . . . . . . . 99
1.6 China’s industrial concentration remains low in most sectors. . . . . . . . . . . . . . . . 106
1.7 Administrative monopoly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
1.8 Entry, exit, and “creative destruction” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
1.9 Improving the effectiveness of the state-ownership functions in the financial
sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
1.10 Establishment of a deposit insurance scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123
1.11 Historical perspective: China’s land-related policy reforms and emergence
of the legal framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
1.12 Legal and policy framework: International perspective. . . . . . . . . . . . . . . . . . . . . 131
1.13 Land markets: International perspective. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
1.14 Land institutions: International perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134
1.15 Rural-urban integration and “linking mechanisms”: Current and emerging
issues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
1.16 Land policies to promote rural-urban integration in Korea. . . . . . . . . . . . . . . . . . 138
1.17 Land valuation and taxation: International perspective . . . . . . . . . . . . . . . . . . . . 139
3.1 Examples of national green development strategies. . . . . . . . . . . . . . . . . . . . . . . . 219
3.2 Green development can help resolve the dilemma of global emission reductions. .220
3.3 Further sectoral benefits of green development. . . . . . . . . . . . . . . . . . . . . . . . . . . 224
3.4 Detailed analysis of two industries: Cement and iron and steel. . . . . . . . . . . . . . . 227
3.5 Robust growth projected for China’s environmental protection industries. . . . . . 228
3.6 The relationship between green development and employment. . . . . . . . . . . . . . . 229
3.7 China’s “Main Functional Area Development Plan”. . . . . . . . . . . . . . . . . . . . . . . 231
3.8 A “Big Push” model for green growth in poor areas: The case of Hunan. . . . . . . 232
viii C H I N A 2030
Figures
O.1 China’s impressive economic performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
O.2 Savings in China compared to other economies . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
BO.1.1 Few economies escape the middle-income trap. . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
O.3 China’s economic challenges. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
O.4 Urban land has expanded faster than urban population. . . . . . . . . . . . . . . . . . . . . 31
O.5 The quality of China’s tertiary education system is improving rapidly . . . . . . . . . . 37
O.6 Unequal spending on early childhood development across Chinese provinces . . . . 51
O.7 Pension coverage rate of the active labor force, various countries, mid-2000s . . . . 54
O.8 Local governments: Large expenditure responsibilities, inadequate revenues. . . . . 58
O.9 The renminbi is increasingly being used as the currency for cross-border
trade settlement. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
1.1 Cross-country comparison of government expenditures as a share of GDP . . . . . . 93
1.2 Cross-country comparison of tax rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
1.3 Cross-country comparison of government revenue. . . . . . . . . . . . . . . . . . . . . . . . . 96
1.4 SOEs have declined in relative importance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
1.5 The rate of return for nonstate firms exceeds that of SOEs. . . . . . . . . . . . . . . . . . 105
1.6 Ownership structure of the banking sector, 2005. . . . . . . . . . . . . . . . . . . . . . . . . 115
1.7 Financial system structure in comparison, 2009. . . . . . . . . . . . . . . . . . . . . . . . . . 116
1C.1 Select indicators of financial sector size/depth, 2009. . . . . . . . . . . . . . . . . . . . . . . 143
1C.2 Funds raised in the financial system (1993–2009). . . . . . . . . . . . . . . . . . . . . . . . . 145
2.1 China’s communication infrastructure and mobile networks, 2002–12. . . . . . . . 164
2.2 Shanghai R&D Public Service Platform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175
3.1 Emissions of CO2 from energy, annually and cumulatively. . . . . . . . . . . . . . . . . . 220
3.2 Decoupling economic growth from carbon emissions worldwide. . . . . . . . . . . . . 221
3.3 Index of innovation in climate change mitigation technologies (1990 = 1) . . . . . . 223
3.4 Energy intensity of GDP, 1990–2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224
3.5 No-regrets options for reducing CO2 emissions in China, 2030. . . . . . . . . . . . . . 225
3.6 Estimated energy savings and emissions reduction from installing 79 efficiency
technologies in heavy industry, 2005–20. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226
C O N T E N T S ix
5.11 China’s outward FDI is directed more toward mining, compared with
advanced countries’ FDI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 387
5.12 Carbon emissions will rise in the baseline scenario. . . . . . . . . . . . . . . . . . . . . . . . 403
5.13 Emissions per capita in developing countries are much lower than in
advanced countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 404
5.14 State-owned banks dominate China’s banking sector. . . . . . . . . . . . . . . . . . . . . . 406
5.15 China’s official finance increased sharply in the past decade. . . . . . . . . . . . . . . . . 408
Tables
O.1 China: Projected growth pattern assuming steady reforms and no major shock. . . . 9
1.1 China: Projected growth pattern assuming steady reforms and no major shock. . . 84
1.2 Size and composition of public expenditures, cross-country comparisons as a
share of GDP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
1.3 Subnational government finance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
1.4 Share of subprovincial governments in total government revenues and
spending. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .100
1C.1 Share of banking sector assets by type of bank. . . . . . . . . . . . . . . . . . . . . . . . . . . 144
1C.2 Size of financial sectors or markets as a share of GDP . . . . . . . . . . . . . . . . . . . . . 144
2.1 Sources of growth, 1978–2004. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
2.2 Sources of growth by industrial and services sectors, 1978–2004. . . . . . . . . . . . . 160
2A.1 Annual TFP growth rate: Major industries, 1999–2004. . . . . . . . . . . . . . . . . . . . 188
2A.2 Top USPTO patents by inventor resident in China, 2005–09. . . . . . . . . . . . . . . . 188
2A.3 WIPO Patent Cooperation Treaty, share of international patents by sector,
2007–09 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
2A.4 Sector composition of new entrants (legal unit) by established time,
Guangdong, Beijing, and Zhejiang, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190
2A.5 Number of patents in force in the high-tech industry, by industrial sector and
registration status, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
2A.6 Innovation inputs and outputs of industrial enterprises in China,
by enterprise size, 2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
2A.7 Innovation inputs and outputs of industrial enterprises in the high-tech
industry in China, by enterprise size, 2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192
2A.8 Foreign direct investment: capital utilized by industry, 2004–09. . . . . . . . . . . . . 193
2A.9 Patent family applications by value and country absolute volume. . . . . . . . . . . . . 193
2A.10 Regional and provincial productivity in China. . . . . . . . . . . . . . . . . . . . . . . . . . . 194
2A.11 Domestic patents granted in different provinces in China, 2009. . . . . . . . . . . . . . 194
2A.12 Innovation inputs and outputs of industrial enterprises in China, 2009. . . . . . . . 195
2A.13 Distribution of innovation inputs in China, by type of performer, 2009 . . . . . . . 195
2A.14 Distribution of innovation inputs and outputs in high-tech industry in China,
by type of performer, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 196
2A.15 Innovation inputs and outputs of industrial enterprises in high-tech industry
in China, 2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196
2A.16 Roles of various entities involved in Nation Innovation System. . . . . . . . . . . . . . . 197
3.1 Getting to a greener China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233
3.2 Direct savings and additional co-benefits of annual reductions in CO2
emissions, 2030. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236
xii C H I N A 2030
C
hina’s economic performance over World Bank would conduct research drawing
the past 30 years has been remark- on lessons from international experience as
able. It is a unique development well as China’s own successful development
success story, providing valuable lessons record, and prepare a strategic framework
for other countries seeking to emulate this for reforms that could assist China’s policy
success—lessons about the importance making as well as guide future China–World
of adapting to local initiative and inter- Bank relations. China’s state leaders wel-
regional competition; integrating with the comed and supported the proposal.
world; adjusting to new technologies; build- This report, China 2030: Building a
ing world-class infrastructure; and investing Modern, Harmonious, and Creative Soci-
heavily in its people. ety, represents the results of that work. The
In the next 15 to 20 years, China is well- research was organized jointly by China’s
positioned to join the ranks of the world’s Ministry of Finance (MOF), the Develop-
high-income countries. China’s policy mak- ment Research Center of the State Council
ers are already focused on how to change (DRC), and the World Bank. The report
the country’s growth strategy to respond to was written and produced by a joint team
the new challenges that will come, and avoid from DRC and the World Bank who worked
the “middle-income trap.” That is clearly together as equal partners. The team held
reflected in both the 11th and 12th Five Year numerous workshops, prepared several stud-
Plans, with their focus on quality of growth, ies and background papers, and forged com-
structural reforms to harness innovation and mon ideas as well as bonds of friendship and
economic efficiency, and social inclusion to mutual respect. A preliminary report was
overcome the rural-urban divide and the discussed at a high-level international con-
income equality gap. ference held on September 3, 2011, at which
The idea behind this study was developed many Chinese and international experts
in 2010, at the celebrations for the 30th provided helpful comments and guidance.
anniversary of the China–World Bank part- Building on these comments and additional
nership. To commemorate that milestone, work commissioned by the team, a confer-
former World Bank Group President Robert ence edition of China 2030 was launched at
Zoellick proposed to Chinese leaders to work a meeting in Beijing on February 27, 2012.
jointly on identifying and analyzing China’s Since that launch, there has been consider-
medium-term development challenges look- able interest in this joint study both within
ing forward to 2030. Together, China and the China and around the world. This final
C H I N A 2 0 3 0 xiii
xiv C H I N A 2030
version of China 2030 could further enrich First, rethinking the role of the state and the
discussions in China and elsewhere, espe- private sector to encourage increased com-
cially in middle-income countries that face petition in the economy. Second, encourag-
similar issues. ing innovation and adopting an open inno-
The report is based on the strong convic- vation system with links to global research
tion that China has the potential to become and development networks. Third, looking
a modern, harmonious, and creative society to green development as a significant new
by 2030. growth opportunity. Fourth, promoting
In order to reach that objective, however, equality of opportunity and social protec-
China must change its policy and institu- tion for all. Fifth, strengthening the fiscal
tional framework. China’s next phase of system and improving fiscal sustainability.
development will need to build on its con- Sixth, ensuring that China, as an interna-
siderable strengths—high savings, plentiful tional stakeholder, continues its integration
and increasingly skilled labor, and the poten- with global markets.
tial for further urbanization—and capital- Using the 12th Five Year Plan as a start-
ize on external opportunities that include ing point, and the six strategic directions as
continued globalization, the rapid growth a policy framework, this report lays out a
of other emerging economies, and promising time frame for and sequencing of reforms
new technologies. At the same time, China that can take China toward its vision for
will need to address a number of significant 2030. We hope that it can provide a practi-
challenges and risks, such as an aging soci- cal guide to help China’s policy makers suc-
ety, rising inequality, a large and growing cessfully navigate this next phase of China’s
environmental deficit, and stubborn external development journey. We also hope that it
imbalances. will mark the beginning of another period
The report proposes six strategic direc- of fruitful partnership between China and
tions for China’s new development strategy. the World Bank.
T
his research was organized jointly by and Vikram Nehru, and comprising Junkuo
China’s Ministry of Finance (MOF), Zhang, Yongzhi Hou, Guoqiang Long, Shiji
the Development Research Center Gao, Yongsheng Zhang, Sen Gong, Wen-
of the State Council (DRC), and the World kui Zhang, Pei-Lin Liu, and Changsheng
Bank. The report was prepared by a World Chen from DRC, and Ardo Hansson, Sha-
Bank and DRC joint team, led by DRC Vice hid Yusuf, Carter Brandon, Philip O’Keefe,
Minister Shijin Liu, World Bank Country and Hans Timmer from the World Bank.
Director for China and Mongolia Klaus The joint team is grateful to David Bul-
Rohland, and World Bank Chief Economist man, Aart Kraay, and Antonio Ollero for
for East Asia and the Pacific Region Vikram analytical support and background papers.
Nehru. Yukon Huang, advisor to the World Bank
President Robert B. Zoellick of the World team, as well as members of the Chinese
Bank, Minister Xuren Xie of MOF, and Advisory Board comprising Jinglian Wu,
Minsters Wei Li and He Liu of DRC pro- Bin Xia, Fei Feng, Wei Lv, and Yanfeng Ge
vided valuable guidance and strong sup- provided helpful advice and suggestions.
port throughout. A Chinese internal steer- The team benefited greatly from comments
ing committee comprising former Minister by peer reviewers Pieter Bottelier, Bert Hof-
of DRC Yutai Zhang, Vice Minister of the man, and Barry Naughton. The team is
Ministry of Finance (MOF) Yong Li, Vice also grateful for comments from Fang Cai,
Minister of DRC Shijin Liu, Director- Yuanzheng Cao, Yoon Je Cho, Evan Feigen-
General of DRC’s General Office Junkuo baum, Shuqing Guo, Motoshige Ito, David
Zhang, Director-General of the Interna- Lampton, Lawrence Lau, Jiange Li, Peilin Li,
tional Department of MOF Xiaosong Zheng, Dwight Perkins, Il SaKong, Pingping Wang,
and Deputy Director-General of the Inter- Yiming Wang, Fuzhan Xie, Shanda Xu,
national Department of MOF Shixin Chen, Lan Xue, Weimin Yang, Linda Yueh, and
and a World Bank internal steering commit- Yuyan Zhang. Most of those comments were
tee comprising Sri Mulyani Indrawati, Lars received at an international conference orga-
Thunell, Justin Yifu Lin, Otaviano Canuto, nized by MOF, DRC, and the World Bank in
Joachim von Amsberg, James Adams, and Beijing on September 3, 2011.
Klaus Rohland, guided this research. The five supporting reports were prepared
The overview report was prepared by a under the overall guidance of Shijin Liu,
joint team led by Shijin Liu, Klaus Rohland, Klaus Rohland, and Vikram Nehru.
C H I N A 2 0 3 0 xv
xvi C H I N A 2030
Supporting report 1 on structural reforms Wang, Chunfa Wang, Jun Wang, Lan Xue,
was prepared by a joint team led by Wenkui and Chunlin Zhang for their most help-
Zhang (DRC) and Ardo Hansson (World ful comments and suggestions. In addition,
Bank) and included Jianwu He, Louis Kuijs, Jingyue Huang and Bo Lv prepared some of
Ulrich Schmitt, Jun Wang, Anbo Xiang, the background company case studies.
and Min Zhao. Critical guidance, inputs, Supporting report 3 on green development
and advice were provided by Daofu Chen, was prepared by a joint team led by Yongsh-
Jianwu He, Shouying Liu, Hongri Ni, Jian- eng Zhang of DRC and Carter Brandon of
ing Wei, and Chenghui Zhang (all DRC), the World Bank and comprising Ede Ijjasz,
and by Robert Cull, Asli Demirguc-Kunt, Kirk Hamilton, and Chris Sall (World Bank)
Juan Feng, Yukon Huang, Guo Li, Haocong and Shouying Liu, Xiaowei Xuan, Yongwei
Ren, Tunc Uyanik, Xiaoli Wan, Ying Wang, Zhang, Xiaoming Wang, Jianwu He, and
and Luan Zhao (all World Bank). The report Jianjun Dai (DRC). This report also ben-
builds on new background papers or notes efited from background papers by Xiaodong
prepared by Ehtisham Ahmad (consultant, Wang, Noureddine Berrah (clean energy);
fiscal policy), David Bulman (consultant) Victor Vergara, Zhi Liu, Wanli Fang, Holly
and Aart Kraay (World Bank, economic Krambeck, A xel Baeumler, Meskerem
growth), Yoon Je Cho (consultant, financial Brhane, and Andrew Saltzberg (urban devel-
sector), Andrew Hilton and Paul Munro- opment); Lee Travers, Sudipto Sarkar, and
Faure (Food and Agriculture Organization, Paul Kriss (water); Sina Johannes (pollution
land), Hironori Kawauchi (World Bank, and waste); Luc Christiaensen (agriculture);
Japan), Chul Ju Kim (World Bank, Korea), Katrina Brandon (natural resource manage-
Ping Li (Landesa, land), and Wenkui Zhang ment); Urvashi Narain and Gordon Hughes
and Anbo Xiang (DRC, enterprise sector). (adapting to a changing climate); Kirk Ham-
The team benefited from useful discussions ilton and Maryla Maliszewska (simulating a
and comments from (in alphabetical order carbon price for China); and Chris Sall (Chi-
by surname) Carter Brandon, Loren Brandt, na’s future green export markets, and using
Nigel Chalk (IMF), Shixin Chen (MOF), urban quality of life indices to evaluate gov-
Klaus Deininger, Peiyong Gao (CASS), ernment performance). Additional comments
Sudarshan Gooptu, James Hanson (consul- and guidance from World Bank colleagues
tant), Ede Ijjasz-Vasquez, Kang Jia (Institute were provided by Andrew Steer, Ken Cho-
for Fiscal Sciences), Il Houng Lee, Lili Liu, mitz, and Michael Toman (peer reviewers),
Shangxi Liu, Xiaofan Liu, Millard Long, and Gailius Draugelis, Marianne Fay, Kath-
Philip O’Keefe, Thomas Rawski, Elaine ryn Funk, Marea Hatziolos, Dan Hoornweg,
Sun, Eric Thun, Rogier van den Brink, Vijay Jagannathan, Abed Khalil, Paul Kriss,
Dimitri Vittas, Yan Wang, Li Xu, Shanda Xiaokai Li, Magda Lovei, Gayane Minasyan,
Xu, Chunlin Zhang, and Zhuoyuan Zhang. John Roome, Stefanie Sieber, Xuemen Wang,
In preparing the report, the team was ably and Yanning Wang. Comments from DRC
supported by Jianqing Chen, Yan Wang, and other reviewers were provided by Zhi-
and Shanshan Ye. gang Chen, Fei Feng, Ross Garnaut, Stephen
Supporting report 2 on innovation was Howes, Carlo Jarger, Kejun Jiang, Nick John-
prepared by a joint team led by Shiji Gao stone, Frank Jotze, Hongri Ni, Jiahua Pan,
of DRC, and Shahid Yusuf of the World Ye Qi, Heling Shi, Fangfang Tang, Simon
Bank and comprising Zhiyan Sun, Jietang Upton, Jinzhao Wang, Yi Wang, Yiming
Tian, Xiaowei Xuan and Yongwei Zhang Wei, Ming Xu, Qian Ye, and Xinye Zheng.
from DRC, and Luan Zhao, Lopamudra Zijing Niu and Hua Zhu (World Bank), Jian-
Chakraborti, and Rory Birmingham from the peng Chen and Haiqin Wang (DRC) pro-
World Bank. We thank Hamid Alavi, Cong vided excellent support throughout.
Cao, Mark Dutz, Xin Fang, Zhijian Hu, Gary Supporting report 4 on social develop-
Jefferson, Yuan Ma, Jamil Salmi, Changlin ment was prepared by a joint team led by
A C K N O W L E D G M E N T S xvii
Sen Gong (DRC) and Philip O’Keefe (World (voluntary export restraints), Jin Fang (cross-
Bank) and comprising Dewen Wang (World border investment), Jianwu He (growth
Bank) and Liejun Wang (DRC). The team prospects), Gang Lv (foreign trade), Maryla
also included Jin Song (World Bank), and Maliszewska (forecasts for the global econ-
Changsheng Chen, Yang Su, and Dong Yu omy and the scenarios for the impact of cli-
(DRC). The Director-General of DRC’s mate change), Aaditya Mattoo (trade), Fran-
social development research department, cis Ng (trade), William Shaw (main author),
Yanfeng Ge, provided constructive com- Dominique van der Mensbrugghe (forecasts
ments for the report. It benefited from for the global economy and the scenarios for
background papers by Carl Mason and the impact of climate change), Lucio Vinhas
Quilin Chen (social spending modelling); de Souza (international banking regula-
Toomas Palu (primary health care); Sen tion), Hongqing Xu (foreign aid), and Lip-
Gong and Dong Yu (citizen participation); ing Zhang (opening of the financial sector
Liejun Wang and Sen Gong (doctor and and internationalization of RMB). Jin Fang
teacher pay), Scott Rozelle (human capi- helped coordinate the revision for this sup-
tal); Kin Bing Wu, Christine Boscardin, porting report. Yongsheng Zhang provided
and Peter Goldschmidt (education); Fang important suggestions on climate change
Cai, Yang Du, and Meiyan Wang (labor issues. We thank Jiyao Bi, Qisheng Lai,
market overview, and labor market insti- Hong Song, Youfu Xia, Xiangchen Zhang,
tutions); John Giles, Dewen Wang, and and Xiaoji Zhang for their helpful com-
Wei Cai (labor supply and retirement); ments and suggestions. Excellent data work
Dewen Wang and Philip O’Keefe (hukou); and other inputs were provided by Yueqing
Sen Gong and Liejun Wang (hukou) John Jia, Sergio Andres Kurlat, Jose Alejandro
Giles and Dewen Wang (social security); Quijada, and Sachin Shahria. The team also
and Laurie Joshua (aged care). The team benefited from excellent support provided
also benefited from comments from Tamar by Maria Hazel Macadangdang and Rosalie
Manuelyan-Atinc, Arup Banerji, Eduardo Marie Lourdes Singson.
Velez Bustillo, Fang Cai, Gong Chen, Ariel Pei-Lin Liu, Changsheng Chen, Wei Xu,
Fiszbein, Gerard La Forgia, Emmanuel Xian Zhuo, and Ting Shao thoroughly
Jimenez, John Langenbrunner, Peilin Li, reviewed and proofread the Chinese version
Xiaoyan Liang, Albert Park, Hainan Su, of the overview report and all supporting
Adam Wagstaff, Liping Xiao, Xiaoqing Yu, reports under the guidance of and with per-
Li Zhang, and Bingwen Zheng. The team sonal involvement of Shijin Liu.
is grateful to the Korea Development Insti- Coordination teams led by Yongzhi
tute and Japan-China Economic Association Hou, Shixin Chen, Elaine Sun, and Shiji
for making arrangements for DRC study Gao and comprising Chunquan Yin, Wei
tours in Korea and Japan, respectively, and Wang, Licheng Yao, Weijie Liu, Jiangnan
to local Development Research Centers of Qian, Yanning Wang, Yunzhong Liu, Zhi-
Chengdu and Nanjing, and the Hangzhou yan Sun, Xian Zhuo, Guangqin Luo, and
Government for joint field visits and meet- Li Li provided strong support for the suc-
ings. Finally, the team is grateful for assis- cessful completion of the study. Chunquan
tance in preparing the document from Limei Yin helped organize a series of important
Sun and Tao Su. meetings, while Yi Li, Lihui Liu, Hao Dong,
Supporting report 5 on China and Hui Han, and Li Zhu helped in communica-
the global economy was prepared by a tions, coordination, and other ad hoc tasks.
joint team led by Guoqiang Long of DRC Tianshu Chen of the World Bank served as
and Hans Timmer of the World Bank and interpreter at innumerable meetings, par-
comprising Dilek Aykut (service sector ticipated in the translation of the report,
FDI), Charles Blitzer (renminbi), Deborah and organized and coordinated the trans-
Brautigam (official finance), Allen Dennis lation work. The World Bank’s Elaine Sun,
xviii C H I N A 2030
Kathryn Funk, and Li Li managed coordi- Ministry of Human Resources and Social
nation and production of the English edi- Security, Ministry of Land and Resources,
tion. The team is grateful to Patricia Kata- Ministry of Environmental Protection, Min-
yama and Susan Graham of the World istry of Housing and Urban-Rural Develop-
Bank’s Office of the Publisher for the edit- ment, Ministry of Agriculture, Ministry of
ing and layout of the English edition. The Commerce, Ministry of Health, National
International Department of MOF, the Gen- Population and Family Planning Commis-
eral Office and International Department of sion, The People’s Bank of China, State-
DRC, and the World Bank provided support owned Assets Supervision and Administra-
in organizing numerous conferences, discus- tion Commission, State Administration of
sion meetings, small seminars, and inter- Taxation, National Bureau of Statistics,
national field study trips throughout this State Intellectual Property Office, China
research. Banking Regulatory Commission, National
This research also benefited enormously Council for Social Security Fund, National
from comments and suggestions from Chi- Energy Administration, State Administra-
nese ministries and local governments, tion of Foreign Experts Affairs, as well as
including Ministry of Foreign Affairs, governments of Beijing, Jilin, Heilongjiang,
National Development and Reform Com- Shanghai, Jiangsu, Anhui, Henan, Guang-
mission, Ministry of Education, Ministry of dong, Chongqing, Shaanxi, Gansu, and Xin-
Science and Technology, Ministry of Indus- jiang Uygur Autonomous Region. The joint
try and Information Technology, Ministry research team is grateful for all their com-
of Public Security, Ministry of Civil Affairs, ments and suggestions.
Background to This Research
T
his research was conducted by a joint high-level international seminar held at the
research team with experts from the Diaoyutai State Guesthouse, both renowned
World Bank and China, the first time domestic and international experts as well as
such research has been conducted in the his- leaders of China’s government departments
tory of cooperation between the two. The and high ranking executives of China’s enter-
research was organized by China’s Minis- prises commented on the draft and raised
try of Finance, the Development Research many critical and constructive ideas. The
Center of the State Council (DRC), and the team also asked for opinions and sugges-
World Bank. The research work and report tions of relevant central government depart-
writing was undertaken by a joint team from ments and local governments during differ-
the World Bank and the DRC. ent phases of the project. The team revised
The joint team formally launched the the report in line with these comments and
research at its first working-level seminar suggestions and held a series of special semi-
held at Fragrant Hills in Beijing on Novem- nars to address some prominent issues. The
ber 23–26, 2010. The seminar set the vision final report managed to reflect many of these
of the research as building a modern, har- diverse views, but without losing its focus
monious, and creative high-income society and realism.
in China by 2030. Five research groups were Needless to say, the research was challeng-
established to study the subjects of structural ing. This was the first time that joint research
reforms, innovation, green growth, social was conducted by experts from the World
development, as well as China and the world. Bank and China, who approached issues
Over the following year, Chinese and foreign from different vantage points, held beliefs
experts wrote background reports and jointly shaped by different experiences, and used
held a dozen seminars. The experts from the different ways of organization and coordina-
World Bank and the DRC also held working- tion. Moreover, China’s challenge over the
level seminars, conducted interviews and field next two decades will be nothing short of his-
research in relevant government agencies, cit- toric—taking 1.3 billion people from middle-
ies, rural areas, and enterprises in China, and to high-income status with the backdrop of
visited countries like Indonesia, Republic of an ongoing global financial crisis. While the
Korea, and the Philippines. After finishing research was more difficult than expected,
the first draft of the research report, the team it was always stimulating and occasionally
solicited opinions from many experts. At a fun. It was a good opportunity for sharing
C H I N A 2 0 3 0 xix
xx C H I N A 2030
knowledge and experience, conducting joint debate helped in converging viewpoints and
analysis, and learning from Chinese and developing a common understanding. Finally,
international experts of different persuasions. shared objectives and mutual respect between
The research was a relentless process of iden- the Chinese and World Bank experts, their
tifying and discussing problems, deepening professionalism, and their effective collabo-
understanding, and attempting to bring for- ration ensured that the research work went
ward creative ideas. Second, all members of smoothly. Hopefully, experience from this
the team approached the work with an open research will pave the way for more coop-
mind, and solicited opinions and sugges- erative undertakings between China and the
tions from experts inside and outside China World Bank in the future.
to push the discussions forward. Hours of
Executive Summary
B
y any standard, China’s economic per- fundamental shift in the country’s strategy.
formance over the last three decades After more than 30 years of rapid growth,
has been impressive. GDP growth aver- China has reached another turning point in
aged 10 percent a year, and over 500 million its development path when a second strategic,
people were lifted out of poverty. China is and no less fundamental, shift is called for.
now the world’s largest exporter and manu- The 12th Five Year Plan provides an excellent
facturer, and its second largest economy. start. This report combines its key elements
Even if growth moderates, China is likely to design a longer-term strategy that extends
to become a high-income economy and the to 2030. More important, it focuses on the
world’s largest economy before 2030, not- “how,” not just the “what.” Six important
withstanding the fact that its per capita messages emerge from the analysis:
income would still be a fraction of the aver-
age in advanced economies. First, implement structural reforms to
But two questions arise. Can China’s strengthen the foundations for a market-
growth rate still be among the highest in the based economy by redefining the role of gov-
world even if it slows from its current pace? ernment; reforming and restructuring state
And can it maintain this rapid growth with enterprises and banks; developing the private
little disruption to the world, the environ- sector; promoting competition; and deepen-
ment, and the fabric of its own society? ing reforms in the land, labor, and financial
This report answers both questions in the markets. As an economy approaches the
affirmative, without downplaying the risks. technology frontier and exhausts the poten-
By 2030, China has the potential to be a mod- tial for acquiring and applying technology
ern, harmonious, and creative high-income from abroad, the role of the government
society. But achieving this objective will not and its relationship to markets and the pri-
be easy. To seize its opportunities, meet its vate sector needs to change fundamentally.
many challenges, and realize its development While providing relatively fewer “tangi-
vision for 2030, China needs to implement a ble” public goods and services directly, the
new development strategy in its next phase government will need to provide more intan-
of development. The reforms that launched gible public goods and services like systems,
China on its current growth trajectory were rules, and policies, which increase produc-
inspired by Deng Xiaoping, who played an tion efficiency, promote competition, facili-
important role in building consensus for a tate specialization, enhance the efficiency
C H I N A 2 0 3 0 xxi
xxii C H I N A 2030
of resource allocation, protect the environ- will need to focus on increasing the techni-
ment, and reduce risks and uncertainties. cal and cognitive skills of university gradu-
In the enterprise sector, the focus will ates and building a few world-class research
need to be further reforms of state enterprises universities with strong links to industry; fos-
(including measures to recalibrate the role of tering “innovative cities” that bring together
public resources, introduce modern corpo- high-quality talent, knowledge networks,
rate governance practices, such as separating dynamic firms, and learning institutions, and
ownership from management, and implement allow them to interact without restriction;
gradual ownership diversification where nec- and increasing the availability of patient risk
essary), private sector development and fewer capital for private startup firms.
barriers to entry and exit, and increased com-
petition in all sectors, including in strategic Third, seize the opportunity to “go green”
and pillar industries. In the financial sector, through a mix of market incentives, regula-
it would require commercializing the banking tions, public investments, industrial policy,
system, gradually allowing interest rates to be and institutional development. Encouraging
set by market forces, deepening the capital green development and increased efficiency of
market, and developing the legal and supervi- resource use is expected to not only improve
sory infrastructure to ensure financial stabil- the level of well-being and sustain rapid
ity and build the credible foundations for the growth, but also address China’s manifold
internationalization of China’s financial sec- environmental challenges. The intention is
tor. In the labor market, China needs to accel- to encourage new investments in a range of
erate phased reforms of the hukou system to low-pollution, energy- and resource-efficient
ensure that by 2030, Chinese workers can industries that would lead to greener develop-
move in response to market signals. It also ment, spur investments in related upstream
needs to introduce measures to increase labor and downstream manufacturing and services,
force participation rates, rethink wage policy, and build international competitive advantage
and use social security instruments (pensions, in a global sunrise industry. These policies
health, and unemployment insurance) that are have the potential to succeed, given China
portable nationwide. Finally, rural land mar- many advantages—its large market size that
kets need to be overhauled to protect farmer will allow rapid scaling up of successful tech-
rights and increase efficiency of land use, and nologies to achieve economies of scale and
policies for acquisition of rural land for urban reduced unit costs; a high investment rate that
use must be thoroughly overhauled to prevent will permit rapid replacement of old, ineffi-
urban sprawl, reduce local government depen- cient, and environmentally damaging capital
dency on land-related revenues, and address a stock; its growing and dynamic private sector
frequent cause of complaint from farmers. that will respond to new signals from govern-
ment, provided it gets access to adequate lev-
Second, accelerate the pace of innovation els of finance; and a relatively well-developed
and create an open innovation system in research and development infrastructure that
which competitive pressures encourage Chi- can be harnessed to reach and then expand
nese firms to engage in product and pro- the “green” technology frontier.
cess innovation not only through their own
research and development but also by par- Fourth, expand opportunities and promote
ticipating in global research and development social security for all by facilitating equal
networks. China has already introduced a access to jobs, finance, quality social services,
range of initiatives in establishing a research and portable social security. These policies
and development infrastructure and is far will be critical in reversing rising inequality,
ahead of most other developing countries. Its helping households manage employment-,
priority going forward is to increase the qual- health-, and age-related risks, and increasing
ity of research and development, rather than labor mobility. China’s relatively high social
just quantity. To achieve this, policy makers and economic inequality (some dimensions
E X E C U T I V E S U M M A R Y xxiii
of which have been increasing) stems in large will be able to benefit from further special-
part from large rural-urban differences in ization, increased investment opportunities
access to jobs, key public services, and social and higher returns to capital, and a mutually
protection. Reversing this trend requires beneficial flow of ideas and knowledge. As a
three coordinated actions: delivering more key stakeholder in the global economy, China
and better quality public services to under- must remain proactive in resuscitating the
served rural areas and migrant populations stalled Doha multilateral trade negotiations,
from early childhood to tertiary education advocate “open regionalism” as a feature
institutions and from primary health care to of regional trading arrangements, and sup-
care for the aged; restructuring social secu- port a multilateral agreement on investment
rity systems to ensure secure social safety flows. Integrating the Chinese financial sector
nets; and mobilizing all segments of soci- with the global financial system, which will
ety—public and private, government and involve opening the capital account (among
social organizations—to share responsibili- other things), will need to be undertaken
ties in financing, delivering, and monitoring steadily and with considerable care, but it will
the delivery of social services. be a key step toward internationalizing the
renminbi as a global reserve currency. Finally,
Fifth, strengthen the fiscal system by mobi- China must play a central role in engag-
lizing additional revenues and ensuring local ing with its partners in multilateral settings
governments have adequate financing to to shape the global governance agenda and
meet heavy and rising expenditure respon- address pressing global economic issues such
sibilities. Many of the reforms proposed in as climate change, global financial stability,
this development strategy—enterprise and and a more effective international aid archi-
financial sector reforms, green development, tecture that serves the cause of development
equality of opportunity for all—have impli- in poor nations less fortunate than China.
cations for the level and allocation of public
expenditures. Over the next two decades, the ***
agenda for strengthening the fiscal system
will involve three key dimensions: mobiliz- These six priority reform areas lay out
ing additional fiscal resources to meet rising objectives for the short, medium, and long
budgetary demands; reallocating spending term, and policy makers need to sequence the
toward social and environmental objectives; reforms within and across these areas appro-
and ensuring that budgetary resources avail- priately to ensure smooth implementation
able at different levels of government (central, and to reach desired outcomes. A successful
provincial, prefectural, county, township, outcome will require strong leadership and
village) are commensurate with expenditure commitment, steady implementation with a
responsibilities. Without appropriate fiscal determined will, coordination across minis-
reforms, many of the other reform elements tries and agencies, and sensitive yet effective
of the new development strategy would be management of a consultation process that
difficult to move forward. will ensure public support and participation
in the design, implementation, and oversight
Sixth, seek mutually beneficial relations with of the reform process. And since the global
the world by becoming a proactive stake- economy is entering a dangerous phase
holder in the global economy, actively using and China itself will be transitioning from
multilateral institutions and frameworks, middle-income to high-income status, the
and shaping the global governance agenda. government will need to respond to a variety
China’s integration with the global economy of risks, shocks, and vulnerabilities as they
served it well over the past three decades. arise; in doing so, it must hold fast to the
By continuing to intensify its trade, invest- principle that policy responses to short-term
ment, and financial links with the global problems should uphold, not undermine,
economy over the next two decades, China long-term reform priorities.
Abbreviations
C H I N A 2 0 3 0 xxv
xxvi C H I N A 2030
IT Information technology
KBA Key biodiversity areas
KWh Kilowatt hour
LED Light-emitting diode
LFPR Labor force participation rate
M&A Mergers and acquisitions
MFN Most-favored nation
MIIT Ministry of Industry and Information Technology
MSME Micro, small, and medium enterprises
NBSC National Bureau of Statistics of China
NBFI Nonbank financial institutions
NDRC National Development and Reform Commission
NO2 Nitrous oxide
NPL Nonperforming loan
OECD Organisation of Economic Co-operation and Development
OPEC Organization of Petroleum Exporting Countries
PBC People’s Bank of China
PISA Programme for International Student Assessment
PM10 Small particulate matter
PPP Purchasing power parity
PSU Public service unit
R&D Research and development
ROE Return on equity
RMB Renminbi
SAMC State asset management company
SASAC State Owned Assets Supervision and Administration Commission
S&T Science and technology
SFI State financial institutions
SME Small and medium enterprise
SO2 Sulphur dioxide
SOE State-owned enterprise
TCE Tons of coal equivalent
tCO2 Tons of CO2
TFP Total factor productivity
TVET Technical and vocational education and training
UDIC Urban Development Investment Corporations
UN United Nations
UNEP United Nations Environment Programme
VAT Value added tax
WIPO World Intellectual Property Organization
WTO World Trade Organization
Part I
Overview
China 2030:
Building a Modern, Harmonious,
and Creative Society
China 2030:
Building a Modern, Harmonious,
and Creative Society
Introduction
From the early 1500s until the early 1800s, And can it maintain this rapid growth with
China’s economy was the world’s largest. little disruption to the world, the environ-
By 1820, it was one-fifth again as big as ment, and the fabric of its own society? We
Europe’s and accounted for a third of world answer “yes” to both, but only if China tran-
gross domestic product (GDP). But the next sitions from policies that served it so well in
two centuries were tumultuous for China. the past to ones that address the very differ-
The country experienced catastrophic ent challenges of a very different future.
decline between 1820 and 1950 and then, This overview, followed by five sup-
starting in 1978, meteoric rise (Maddison porting reports, identifies these challenges
2001). Today, China is once again among of tomorrow, points to key choices ahead,
the largest economies of the world, having and recommends not just “what” needs
overtaken Japan in 2010. Its economy is to be reformed, but “how” to undertake
now second only to that of the United States the reforms. The overview is divided into
(third, if the European Union [EU] is counted nine chapters. The first chapter examines
as one economy), and it is the world’s largest the characteristics of China’s development
manufacturer and exporter. The East Asian since 1978; considers future opportuni-
miracle may have lost some of its luster after ties, challenges, and risks; and describes a
the financial crisis of 1997–98, but China’s vision of China in the year 2030. The sec-
performance continues to impress. Even if ond chapter maps a new strategy that will
China grows a third as slowly in the future realize this vision, focusing on the key
compared with its past (6.6 percent a year on choices ahead for China to sustain rapid
average compared with 9.9 percent over the economic and social development and
past 30 years), it will become a high-income become a modern, harmonious, and cre-
country sometime before 2030 and outstrip ative high-income society before 2030.
the United States in economic size (its per Chapters 3–8 elaborate on each of the six
capita income, however, will still be a frac- pillars of the new strategy: consolidating
tion of that in advanced countries). If China China’s market foundations; enhancing
achieves this milestone, it will have avoided innovation; promoting green development;
the “middle-income trap” by traversing the ensuring equality of opportunity and social
seemingly impossible chasm between low- protection for all; strengthening public
income and high-income status within a gen- finances; and achieving mutually benefi-
eration and a half—a remarkable achieve- cial win-win relations between China and
ment for any country, let alone one the size the rest of the world. The ninth and final
of China. chapter addresses implementation chal-
But two questions arise. Can China’s lenges, including the sequencing of proposed
growth rate still be among the highest in the reforms and overcoming obstacles that are
world even if it slows from its current pace? likely to emerge.
C H I N A 2 0 3 0 3
4 CHINA 2030
Unique Factors behind China’s within the broader context of reform priori-
Economic Success ties. By introducing market-oriented reforms
in a gradual, experimental way and by pro-
Over the past three decades, China’s two his- viding incentives for local governments, the
toric transformations, from a rural, agricul- country was able to discover workable tran-
tural society to an urban, industrial one, and sitional institutions at each stage of develop-
from a command economy to a market-based ment. One key feature of these reforms was
one, have combined to yield spectacular their “dual-track” nature—supporting state-
results. Not only did economic growth soar, owned firms in old priority sectors while lib-
but the poverty rate fell from more than 65 eralizing and encouraging the development of
percent to less than 10 percent as some 500 private enterprises (Lin 2012). The economy
million people were lifted out of poverty, and was allowed to “grow out of the plan” until
all the Millennium Development Goals have the administered material planning system
been reached or are within reach. Although gradually withered. As a result of continuous
growth rates differed across China, growth and decentralized trial-by-error exploration,
was rapid everywhere. Indeed, if mainland institutional arrangements evolved as new
China’s 31 provinces were regarded as inde- and different challenges needed resolution.
pendent economies,1 they would be among Indeed, different localities often adopted
the 32 fastest-growing economies in the their own unique institutions tailored to their
world (figure O.1). Such rapid growth has specific situations.
been accompanied by many other achieve-
ments: for example, 2 of the world’s top 10 Balancing growth with social and macro-
banks are now Chinese;2 61 Chinese compa- economic stability. The difficult economic
nies are on the Global Fortune 500 list;3 and situation at the start of reforms in 1978
China is home to the world’s second-largest made economic growth an urgent priority.
highway network, the world’s 3 longest sea Early reform successes quickly transformed
bridges, and 6 of the world’s 10 largest con- this priority into a national objective that
tainer ports.4 The country has also made was effectively used to mobilize all quarters
large strides in health, education, science, of society—individuals and firms as well as
and technology, and is quickly closing the local governments—to focus their collective
gap on all these fronts with global leaders. efforts on economic development. The gov-
Many unique factors lie behind China’s ernment employed a mix of fiscal, adminis-
impressive growth record, including the trative, and employment policies to maintain
initial conditions of the economy in 1978 social stability during a period of rapid eco-
that made it particularly ripe for change. nomic and structural change. This was no
The spark came in the form of agricultural mean achievement, given the need to employ
reforms, including the household responsi- an additional 9 million new entrants into the
bility system that foreshadowed sustained labor force each year while also absorbing
reforms in this and other areas over the next workers affected by policy shifts (such as the
30 years. To summarize, key features of the 1998 reforms of state-owned enterprises, or
reforms included: SOEs), frictional unemployment, and occa-
sional external economic shocks.
Pragmatic and effective market-oriented Rapid growth and structural change also
reforms. China’s uniqueness among devel- presented macroeconomic challenges. The
oping countries is not what it did to achieve economy experienced occasional bouts of
success, but how it did it. China adapted a serious inflation, such as in the late 1980s and
strategy known as “crossing the river by feel- early 1990s. But macroeconomic stability was
ing stones,” which encouraged local govern- effectively restored through a combination of
ments to undertake bold pilot experiments traditional monetary and fiscal policies, as
O V E R V I E W 5
a. China’s rapid, broad-based growth . . . b. . . . has made it the second-largest economy in the world . . .
18 6,000
16
5,000
14
12 Chinese provinces (31) 4,000
1980–2010 (%)
10
8 3,000 Japan
other countries (182)
6
4 2,000
2
1,000 China
0
–2 0
Source: NBSC 2010; World Bank 2011b. 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: NBSC 2010; World Bank 2011b.
1,500
1.0
United States
0.8 China
1,000
0.6
China
0.4 500
0.2
0.0 0
1990 1995 2000 2005 2010 2015 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
well as administrative means when neces- and regional differences meant that local
sary. As a result, the authorities were broadly governments could experiment with and
successful in keeping inflation low through- champion specific reforms suited to their
out the period and protecting the rural and circumstances, while operating within the
urban poor from relative price increases in parameters established by central authori-
key necessities. ties. Officials were rewarded for deliver-
ing key reform goals: growth, foreign direct
Interregional competition. China built on investment (FDI), employment, and social
its strong local governments at various levels stability. The resulting competition between
by allowing them to compete in attract- local governments and regions was fierce—
ing investment, developing infrastructure, and became a strong driver of growth—far
and improving the local business environ- beyond the expectations of the authorities.
ment. Decentralization policies, including
fiscal reforms in 1994 (which significantly Domestic market integration. A key ele-
increased resource transfers from the cen- ment of the reforms was the dismantling of
tral government), gave subnational govern- regional barriers to the movement of goods,
ments the incentives and the resources to labor, and capital and the establishment of
aggressively pursue local development objec- a single national market. Major infrastruc-
tives. Increased factor mobility meant that ture investments connecting regions and
resources flowed to jurisdictions most sup- the interior to the coast helped. A large and
portive of growth. Finally, China’s vast size integrated domestic market allowed firms to
6 CHINA 2030
achieve scale economies, and the large varia- will be very different over the next 20 years
tion in income levels and consumption pat- compared with the past 30, not only because
terns across the country gave their products a China and other emerging markets have fun-
longer life cycle. damentally reshaped the global economy—
a trend that was accelerated by the recent
Steady integration with the global econ- global financial crisis—but also because
omy. With the establishment of special new global challenges and opportunities are
economic zones, Deng Xiaoping’s remarks emerging that will significantly affect the
during his famous South China tour, and future trajectory of the world’s economies.
accession into the World Trade Organiza-
tion (WTO) as milestones, China expanded
Global Megatrends
and deepened its economic integration with
the global economy. This policy reaped large The last three decades saw a supportive
dividends for China, bringing investments, global environment that undoubtedly assisted
advanced technologies, and managerial and accommodated China’s rapid growth.
expertise; opening the international market Key elements included relatively open trade,
for China’s goods and services; and giving a rising flows of foreign direct investment,
boost to China’s internal economic reforms. steady growth in the world’s major markets,
The proximity of Hong Kong SAR, China, sharply declining transport costs, increased
and Taiwan, China, helped, as did a large intraindustry trade, and the introduction
Chinese diaspora dispersed across the globe. and spread of information and communica-
tions technology. While extrapolating lin-
early from the past may be dangerous, some
Trends and Characteristics at of these trends are indeed likely to persist. 5
Home and Abroad in the There is widespread consensus, for example,
that in addition to China, other developing
Next Two Decades
countries, especially middle-income emerg-
China’s reforms, still ongoing, have facili- ing markets, will continue to outperform the
tated regional concentration of activities advanced economies as they have for the past
and captured agglomeration economies in decade. One reason is their continued poten-
coastal provinces, encouraged mobility of tial for technological catch-up. The other is
factors and goods across provinces and with continued slow growth in advanced econo-
the rest of the world, and established a high mies owing to deleveraging and the impact
savings- and investment-led growth process of high sovereign debt burdens. By 2030,
disciplined by the competitive pressures of developing countries are expected to contrib-
globalization. Most important, China has ute two-thirds of global growth (40 percent,
avoided economic setbacks: not only did excluding China) and half of global output
economic growth average nearly 10 percent (30 percent, excluding China), and will be the
over more than three decades, it fell measur- main destinations of world trade. The larger
ably below 8 percent only twice. During the emerging markets—China more so than oth-
recent global financial crisis, China’s contin- ers—will act as additional growth poles in a
ued rapid growth was a significant stabilizing multipolar world economy.
force that partly counterbalanced the impact Perhaps the most important global mega-
on global economic activity of the down- trend is the rise of China itself. No other coun-
turn and subsequent tepid recovery in the try is poised to have as much impact on the
advanced economies. global economy over the next two decades.
Will China be able to sustain this per- Even if China’s growth rate slows as pro-
formance over the next two decades? Much jected, it would still replace the United States
depends on how the global environment as the world’s largest economy by 2030, its
evolves and on the structural forces that share in world trade could be twice as high,
are already at work within China. But this it is likely to remain the world’s biggest emit-
much is certain: trends at home and abroad ter of carbon dioxide, and, notwithstanding
O V E R V I E W 7
shrinkage in its trade surplus, it is expected will be trade in services, now the fastest-
to remain the world’s largest creditor. Some growing component of global trade. Thanks
have argued that by 2030, China’s influence to new informational technologies, services
in the global economy could approach that previously considered nontradable (such as
of the United Kingdom in 1870 or the United health and education) will be routinely pro-
States in 1945 (Subramanian 2011). vided across national borders just as manu-
Continued rapid growth in emerging factures are now. In addition, the world is
markets will give rise to an unprecedented continuing to see further global relocation
expansion of the global middle class (by of industries (and, increasingly, tasks within
one estimate, from less than 1.8 billion peo- industries) in the incessant search for global
ple in 2009 to about 5 billion in 2030, of competitiveness.
whom nearly two-thirds will be in Asia). 6 The number of free trade arrangements in
That expansion will trigger an explosion in the world has multiplied manifold over the
demand for housing and consumer durables, past two decades; over the next two, trade
including automobiles. The pressure on integration will intensify and production net-
global supplies of energy, natural resources, works will expand further. Intra–East Asian
food, water, and the environment will ratchet trade could rival that of intra-European trade
up rapidly. Climate change effects could (as a share of GDP). Emerging markets will
exacerbate food and water shortages in some develop an increasing stake in an open global
areas. The price of raw materials will remain trading system. The resolution of climate
elevated and volatile. Higher prices for scarce change, international financial stability, inter-
natural resources highlight the need to intro- national migration, health pandemics, water
duce “green growth” strategies that could management, and other global challenges
potentially become a new source of growth. will require new approaches to transnational
Notwithstanding the potential for rapid and global governance arrangements.
growth in emerging markets, there are also The U.S. dollar will likely remain the
reasons to believe that growth in developing world’s major international reserve currency,
countries, including China, will slow. First, as especially given weaknesses in the Euro Area
populations age, the growth rate of the labor and Japan. But expansionary monetary poli-
force will slow, and in some countries (such cies in the advanced countries, including the
as China and the Russian Federation) will United States, will cause instability in the
even decline, leading to higher dependency international monetary system, and uncer-
ratios and lower savings and investment. Sec- tainty in key exchange rates will add to costs
ond, although emerging market economies of international monetary and trade transac-
will retain a comparative advantage in manu- tions. China’s growing weight in world trade,
facturing, rising unit labor costs will further the size of its economy, and its role as the
increase their relative share of services; over- world’s largest creditor will make the interna-
all growth would thus slow because produc- tionalization of China’s renminbi inevitable,
tivity growth in services is usually lower than but its acceptance as a major global reserve
in manufacturing. currency will depend on the pace and success
While protectionism may occasionally of financial sector reforms and the opening
rear its head, especially in advanced coun- of its external capital account (see chapter 8).
tries where the impact of the recent financial Technological breakthroughs, unpredict-
crisis has been particularly severe, the forces able as they may be, are more likely in some
of globalization will remain irresistible, and areas, such as clean water, energy storage,
further cross-border movements of goods, and biotechnologies, than in others. A break-
services, finance, people, and knowledge will through in clean coal technologies would give
endure and deepen. Production chains across China an obvious advantage, given its huge
borders will continue to flourish, and intrain- coal reserves. Renewable energy technologies
dustry and intrafirm trade will intensify. could also become more economically viable.
As global trade continues to grow at a The recent pattern has been for such techno-
more rapid rate than GDP, the new frontier logical breakthroughs to occur in advanced
8 CHINA 2030
countries, with their application in commer- These factors, together with “rebalanc-
cial and mass production usually transferred ing” policies to emphasize domestic growth
to developing countries. This pattern is likely sources, will contribute to a higher share of
to continue; adoption, adaptation, and mas- services and consumption in the economy
tery of existing technologies will remain an and a lower share of exports, savings, and
important growth driver in developing coun- investment. The challenge will be to support
tries. At the same time, however, as emerg- these growth and structural transitions while
ing markets develop their own technological avoiding sudden slowdowns and possible
capability, new and disruptive technologies crises.
will appear in the developing world and raise China’s external accounts are expected to
the chance of “leapfrogging” over advanced show a decline in the trade surplus—export
countries in a few areas. growth will slow as China’s global market
share rises and markets in advanced coun-
tries grow more slowly, while import growth
Major Trends within China
will be driven by continued expansion in
Just as growth is expected to slow in some domestic demand. At the same time, how-
emerging markets over the coming two ever, the external capital account will show a
decades, many signs point to a growth slow- rising deficit as Chinese savings flow abroad
down in China as well (Liu et al. 2011). in search of better returns and to counter
Indeed, we expect GDP growth to decline protectionist pressures abroad. This trend
gradually from an average near 8.5 percent will serve not only to keep in check further
in 2011–15 to around 5 percent in 2026–30 accumulation of external reserves but also
(see table O.1). One reason for the slowdown to facilitate the transformation of Chinese
is that much of the growth contribution from enterprises into global players.
shifting resources from agriculture to indus- China’s current pattern of development
try has already occurred. And going for- has also placed considerable stress on the
ward, the continued accumulation of capital, environment—land, air, and water—and
although sizable, will inevitably contribute has imposed increased pressure on the avail-
less to growth as the capital-labor ratio rises ability of natural resources. The challenge
(even though capital stock per worker, now an going forward will be to convert these pres-
estimated 8.7 percent of the U.S. level, under- sures into new sources of growth by adopt-
scores the need for further capital accumula- ing a green growth model that taps into new
tion). Moreover, China is poised to go through global markets in green technologies while at
wrenching demographic change: the old age the same time solving many of China’s own
dependency ratio will double in the next two pressing environmental concerns. If success-
decades, reaching the current level in Norway ful, the energy and commodity intensity of
and the Netherlands by 2030 (between 22 production is expected to decline signifi-
and 23 percent);7 and the size of China’s labor cantly by 2030 for three reasons: a smaller
force is projected to start shrinking as soon share of industry in GDP; a smaller share
as 2015. Yet workers will become more pro- of resource- and pollution-intensive firms
ductive as physical and human capital stock in the industrial sector; and better pricing
per worker continues to rise. Finally, total fac- of energy, commodities, and environmental
tor productivity (TFP) growth—a measure services (see chapter 5).
of improvements in economic efficiency and Income inequality in China, which
technological progress—has also declined, climbed continuously over the past two
in part because the economy has exhausted decades, is showing some tentative signs
gains from first-generation policy reforms and of beginning to flatten and possibly even
the absorption of imported technologies. As a decline. In the coming decades, three under-
result, the distance to the technological fron- lying structural factors could serve to con-
tier has shrunk, and second-generation policy firm this inflexion point. First, acceleration
reforms are likely to have a smaller impact on of growth in the middle and western regions
growth.8 will continue, so the income gap between
O V E R V I E W 9
TABLE O.1 China: Projected growth pattern assuming steady reforms and no major shock
Indicator 1995–2010 2011–15 2016–20 2021–25 2026–30
GDP growth (percent per year) 9.9 8.6 7.0 5.9 5.0
Labor growth 0.9 0.3 –0.2 –0.2 –0.4
Labor productivity growth 8.9 8.3 7.1 6.2 5.5
Structure of economy (end of period, %)
Investment/GDP ratio 49 42 38 36 34
Consumption/GDP ratio 47 56 60 63 66
Industry/GDP ratio 46.7 43.8 41.0 38.0 34.6
Services/GDP ratio 43.1 47.6 51.6 56.1 61.1
Share of employment in agriculture 36.7 30.0 23.7 18.2 12.5
Share of employment in services 34.6 42.0 47.6 52.9 59.0
Sources: NBSC and DRC.
the coast and the interior will narrow. Sec- At the same time, China’s existing com-
ond, migrant wages will continue to rise parative advantage in low unit labor costs
rapidly, reducing the income gap with urban will shrink gradually. Rapidly rising real
residents. The role of policy will be to sup- wages for unskilled workers in coastal prov-
port these structural forces by increasing inces are encouraging firms to relocate to
the equality of opportunity (see chapter 6). neighboring interior provinces where labor
Third, even though the urbanization rate is and land are more plentiful and relatively
expected to continue its rise, rural-urban cheap. Thanks to continuous improvements
migration will gradually slow over the period in connective infrastructure between the
as the structural shift from agriculture to interior and major cities and ports, the incre-
manufacturing eases, and the rural-urban mental transport costs from interior locations
wage gap narrows (the urban-rural income will be outweighed by the benefits of lower
ratio is expected to fall from 3.2 : 1 in 2010 input costs.
to 2.4 : 1 in 2030). T he rise in wages associated w ith
At the same time, rising educational stan- increased productivity will continue to spur
dards and brisk growth in tertiary educa- rapid expansion in the ranks of the middle
tion is rapidly increasing the numbers of class, which, in turn, will increase con-
skilled workers and helping China move up sumption of consumer durables and raise
the value chain, and this process is likely to the share of consumption in GDP. And, as
accelerate in coming decades. The grow- international experience shows, a growing
ing skill base will facilitate a further shift middle class will also act as a catalyst for
in production from labor-intensive to skill- improved governance, better delivery of
intensive activities and an increase in the public services, and the empowerment of
pace of innovation. Indeed, just as in the civil society.
1980s and 1990s when hundreds of millions And finally, China’s urbanization—a
of unskilled Chinese workers joined the driver of much of China’s increased global
global labor force as part of China’s “open- competitiveness—is poised to grow rapidly.
ing up” strategy, so too will tens of millions Over the coming two decades, the increase
of tertiary-educated Chinese workers join in the urban population will be the equiva-
the global workforce to significantly expand lent of more than one Tokyo or Buenos Aires
the global supply of skill-intensive products. each year as the share of urban residents in
Indeed, the number of college graduates the total population climbs from about one-
could swell by 200 million over the next two half to near two-thirds in 2030.10 This will
decades—more than the entire labor force of act as another powerful driver of growth,
the United States.9 although much will depend on how well
10 CHINA 2030
urban development policies are designed and competitive force in global markets in their
implemented. own right. This transition would present an
opportunity to improve quality, safety, and
environmental standards that would provide
Opportunities and Risks a competitive edge abroad and improve con-
sumer experience at home.
Going Forward
Growing recognition within China
These global and internal trends offer China that the current pattern of production and
many opportunities that could support rapid growth is unsustainable is giving rise to new
growth in the next two decades—and give approaches toward realigning government
rise to many risks that could threaten that priorities. A fresh emphasis on the qual-
growth. Any development strategy going for- ity—not just the pace—of growth provides a
ward would need to build on the opportuni- promising opportunity to encourage compe-
ties and manage the risks. tition between local governments on the basis
First consider the opportunities. Con- of a broad development index incorporating
tinued rapid economic development and a mix of social and environmental measures
decreases in inequality will swell the ranks that can be added to existing indicators of
of the middle class and accelerate domestic economic growth. Realignment of priorities
demand for income-elastic products, such would also be consistent with the expected
as consumer durables, leisure activities, and increase in demand from the rising number of
housing, as well as better health and educa- middle-class Chinese seeking improvements
tion services. This, together with the rapid in their quality of life.
growth of other emerging markets where At the same time, global and domestic
similar transformations are taking place trends are also likely to give rise to many
(albeit at a slower pace) will afford new risks that could slow economic growth and
opportunities to Chinese enterprises, enable disrupt China’s progress to become a high-
economies of scale in production and market- income, harmonious, and creative society.
ing, and provide fresh incentives to increase Managing the transition from a middle-
international competitiveness through inno- income to a high-income society will itself
vation and technological development. prove challenging, and a global environment
Increased specialization, intraindustry that will likely remain uncertain and vola-
trade, and the two-way flow of investment tile for the foreseeable future makes the task
will allow China to continue to exploit doubly daunting. The next five years will
opportunities to narrow the gap between its be particularly risky as the global economy
capabilities and the technological frontier enters a new and dangerous phase and works
through adoption, adaptation, and mastery its way through the aftereffects of the global
of existing technologies. The country’s high financial crisis and adjusts to the “new
savings rates will allow it to replenish its capi- normal.”
tal stock relatively quickly, and that will con- There is broad consensus that China’s
tinue to facilitate rapid technological catch- growth is likely to slow; annual average
up (figure O.2). And with improvements in its growth over the next 20 years is expected to
own research and development capabilities, be one-third less than annual average growth
China itself could become a global source for the past 30 years (6.6 percent versus 9.9
of product and process innovation as well as percent). While this will be enough to propel
occasional technological breakthroughs. China into high-income status by 2030, there
China’s growing technological prowess is no saying whether this slowdown will be
will lead to rapid change in its industrial smooth or not. Any sudden slowdown could
structure, which will create new areas of unmask inefficiencies and contingent liabili-
dynamic comparative advantage. Just as its ties in banks, enterprises, and different levels
construction industry has become a global of government—heretofore hidden under the
leader in construction projects internation- veil of rapid growth—and could precipitate
ally, so too will other industries become a a fiscal and financial crisis. The implications
O V E R V I E W 11
50 50
Gross domestic savings
(% of GDP)
30 30
20 20
10 10
0 0
–10 –5 0 +5 +10 +15 +20 +25 +30 0 10,000 20,000 30,000 40,000 50,000
Years since reforms GDP per capita, constant prices
China (year 0 = 1978) China (1974–2009) Thailand (1965–2009)
Former Soviet Union (year 0 = 1990) Korea, Rep. (1965–2009) Japan (1974–2009)
Eastern and Central Europe (developing) (year 0 = 1990) Malaysia (1965–2009) Hong Kong SAR, China
Singapore (1965–2009) (1965–2009)
for social stability would be hard to predict even stagnation. Over the past half century,
in such a scenario. many countries have entered middle-income
How government responds to a rapid status, but very few have made the additional
slowdown will depend on its causes. One leap to become high-income economies.
cause could be a macroeconomic shock, say, Rather, several faced sudden, sharp decel-
a sudden decline in real estate prices and a erations in growth and have been unsuccess-
sharp contraction in construction and invest- ful in addressing the root structural cause
ment, or a rapid growth slowdown in the of the slowdown. China does not have to
advanced economies leading to sharply lower endure this fate. Successful implementa-
global trade and growth. Such risks could be tion of the reform policies, contained in this
significant in the short term, and there is a report, aimed at finding new growth driv-
likelihood that China could face just such ers—increased efficiency in input use, higher
challenges over the course of the next two human capital investments, increased innova-
decades. Fortunately, unlike many other tion, and a shift to high-value services—will
countries, China’s fiscal and debt position help China avoid the middle-income trap and
allows it the space to respond with counter- maintain an expected average growth rate of
cyclical measures. But these short-term policy between 6 and 7 percent a year in the com-
responses should also be supportive of long- ing two decades, compared with an average
term structural reforms (such as those recom- of nearly 10 percent a year in the past three
mended in this report). decades.
Another cause of a growth slowdown— The risk of sharply lower growth rates is
arguably one of greater concern—could be exacerbated by China’s relatively high income
structural in nature, the so-called middle- and asset inequality, low consumption, and
income trap (box O.1). If, instead of respond- unequal access to quality public services (fig-
ing with policy reforms to address structural ure O.3). Notwithstanding massive internal
problems, the government applies macroeco- migration from farms to cities, barriers to
nomic measures to stimulate the economy, labor mobility (the household registration, or
then inflation and instability could result, hukou, system, the lack of portability of pen-
possibly undermining investor confidence sion plans, weak labor market institutions,
and ultimately leading to slower growth and and inadequate job market information) have
12 CHINA 2030
Growing up is hard to do. In the postwar era, many sectoral reallocation and technology catch-up are
countries have developed rapidly into middle-income eventually exhausted, while rising wages make labor-
status, but far fewer have gone on to high-income sta- intensive exports less competitive internationally.
tus. Rather, they have become stuck in the so-called If countries cannot increase productivity through
middle-income trap. a The factors and advantages innovation (rather than continuing to rely on foreign
that propelled high growth in these countries during technology), they find themselves trapped.b
their rapid development phases—low-cost labor and The concept of a middle-income trap has some
easy technology adoption—disappeared when they empirical backing. Latin America and the Middle
reached middle- and upper-middle-income levels, East provide compelling support for the trap hypoth-
forcing them to find new sources of growth. esis: in these two regions, most economies reached
Low-income countries can compete in interna- middle-income status as early as the 1960s and
tional markets by producing labor-intensive, low- 1970s and have remained there ever since (see figure
cost products using technologies developed abroad. BO.1.1a). Of 101 middle-income economies in 1960,
Large productivity gains occur through a reallo- only 13 became high income by 2008 (see figure
cation of labor and capital from low-productivity BO.1.1b)—Equatorial Guinea; Greece; Hong Kong
agriculture to high-productivity manufacturing. As SAR, China; Ireland; Israel; Japan; Mauritius; Por-
countries reach middle-income levels, the underem- tugal; Puerto Rico; Republic of Korea; Singapore;
ployed rural labor force dwindles and wages rise, Spain; and Taiwan, China.
eroding competitiveness. Productivity growth from
Ireland
Middle- Singapore Spain
35,000 Taiwan, China income to Japan
Mauritius high-income
5 Israel
30,000 Equatorial
2008 per capita income relative
Staying rich
to United States (log of %)
Guinea
25,000 4 Korea, Rep. Greece
20,000
3 China Puerto Rico
15,000 From low-
income to
middle-income
10,000 2 Middle-income
“trap”
5,000
1
0 Low-income
”trap” Becoming poor
50
55
60
65
70
80
85
90
95
00
05
08
75
0
19
19
19
19
19
19
19
19
19
19
20
20
20
trapped tens of millions of farm families in rising share of capital in national income.
low-paying, low-productivity work. These Furthermore, the quality gap in public ser-
barriers, combined with factor and resource vices available to rural and urban households
price policies that favor enterprise profits and has widened, and the “opportunity gap”
implicitly tax household incomes, have con- between urban and rural areas has grown.
tributed to the declining share of wages and Social tensions have ratcheted up in some
O V E R V I E W 13
100
40
80
30
60
20
40
20 10
0 0
4 5 6 7 8 9 10 11 12 4 5 6 7 8 9 10 11 12
Log real GDP per capita Log real GDP per capita
National averages, 2005–09 China, 1980–2009 National averages, 2005–09 China, 1980–2009
Source: World Bank 2011b; NBSC 2010; World Bank calculations. Source: World Bank 2011b; NBSC 2010; World Bank calculations.
c. Inequality in China has climbed rapidly . . . d. . . . and environmental costs have been high
70 10
65 degradation and depletion, 2008 (% of GNI)
9
Environmental and natural resource
60 8
55
7
Gini coefficient
50
6
45
5
40
35 4
30 3
25 2
20 1
4 5 6 7 8 9 10 11 12 0
Log real GDP per capita China India Brazil United Korea, Japan Germany
National averages, 2000–09 China, 1980–2009 States Rep.
Source: Milanovic 2005; World Bank calculations. Source: World Bank 2011b.
United States in 2010 (although, on a per external shocks. Ironically, these reserves
capita basis, the United States still consumes face the risk of large capital losses in the face
five times more energy than China, and of a weakened dollar. Efforts to export capi-
China has raced ahead in generating wind tal in the form of outward FDI, especially to
and solar energy). Similarly, rapid growth has secure raw material supplies, has met with
led to substantial natural resource depletion suspicion in some receiving countries, and
and serious environmental pollution. Uncor- unless appropriate steps are taken to address
rected, these trends could, in time, serve as a these problems, such risks and friction could
serious constraint on growth. grow.
Many of the policies that generated China’s relations with the rest of the world
China’s high savings and investment levels are affected by its rapid export growth,
also account for its external imbalance, as which has not been matched with equivalent
measured by its current and capital account increases in import volumes, and by bilateral
surpluses in the balance of payments. The trade surpluses with its key trading partners,
combination of these two surpluses has which have fueled protectionist pressures.
resulted in record foreign exchange reserves, Indeed, if China’s current export growth per-
most of which are invested in low-yield U.S. sists, its projected global market share could
securities, while China pays a substantially rise to 20 percent by 2030, almost double
higher interest or dividend rate for capital the peak of Japan’s global market share in
imports in the form of “hot money” and the mid-1980s when it faced fierce protec-
foreign direct investment. China’s current tionist sentiments from its trading partners.
account surpluses and reserve accumulation But China’s current trajectory, if continued,
are a relatively recent phenomenon, one that would cause unmanageable trade frictions
occurred only after the Asian financial crisis. with developed and developing countries well
They reflect not only the country’s growing before 2030. The anemic growth of high-
role as the center of a rapidly expanding and income countries as they continue to struggle
deepening East Asian production network with fiscal consolidation is expected only to
but also a policy objective to strengthen the magnify China’s expansion of its global mar-
country’s foreign exchange buffer against ket share.
O V E R V I E W 15
technological catch-up, and implementing the quality of human capital will require bet-
industrial policies when market and coor- ter education, health care, and social secu-
dination failures inhibit the development of rity. And it will demand a marked increase
internationally competitive industries consis- in equal employment opportunities and
tent with the country’s comparative advan- self-employment, as well as greater lateral
tage. The development strategies of East mobility of labor from rural to urban areas
Asia’s successful economies—Japan; Korea; and across towns, cities, provinces, and occu-
Hong Kong SAR, China; Singapore; and pations, and vertical mobility through the
Taiwan, China—have all broadly reflected social, economic, and political hierarchies.
these features. Another supportive role the govern-
But when a developing country reaches ment can play is encouraging greater par-
the technology frontier, the correct devel- ticipation in the development process. The
opment strategy ceases to be so straightfor- expanding middle class is increasingly vocal
ward. Direct government intervention may in its demand to participate in the discus-
actually retard growth, not help it. Instead, sion of public policy. This demand points to
the policy emphasis needs to shift even more a broader need to empower people to con-
toward private sector development, ensuring tribute to the country’s development efforts,
that markets are mature enough to allocate be creative, and improve standards of living
resources efficiently and that firms are strong through their own efforts. The government
and innovative enough to compete interna- should respond proactively to these needs and
tionally in technologically advanced sectors. grant rights to individuals, households, enter-
The role of the private sector is critical prises, communities, academia, and other
because innovation at the technology frontier nongovernmental organizations through
is quite different in nature from simply catch- clear rules that encourage broad participa-
ing up technologically. The process becomes tion. By doing so, the government can gradu-
essentially one of trial and error, with the ally transfer some of its previous functions
chances of success highly uncertain. Innova- to society at large, allow nongovernmental
tion is not something that can be achieved players to form networks in new and inter-
through government planning. Indeed, the esting ways, and create space for innovation
more enterprises are involved in the trial-and- and creativity. Moreover, empowering soci-
error process of innovation, the greater are ety, especially those who are disadvantaged,
the chances for technological breakthroughs, will help unleash new ideas and approaches
and the more likely that new discoveries will toward increasing equality of opportunity,
be translated into commercially viable prod- ensuring inclusive growth, and achieving a
ucts. As enterprises take a leading role, the balance between a caring and a competitive
government needs to adopt a more supportive society.
and facilitating role. Last, while the government reduces its role
One of the key supportive roles the gov- in markets, resource allocation, production,
ernment can play is enhancing the quality and distribution, it should step up its role in
of human capital. China’s rapid growth has financing public goods and services, protect-
been accompanied by a gradual decline in ing the environment, increasing equality of
its agricultural surplus labor and a steady opportunity, and ensuring an environment
rise in real wages in manufacturing, a trend conducive for private sector development.
that appears to have accelerated recently. Playing such an indirect and supportive role
Without concomitant increases in labor pro- is complicated but will have a wide impact,
ductivity, real wage increases could lead to a with greater leverage through the private
steady decline in international competitive- sector and social organizations. While pro-
ness. Increasing the quality of human capital viding fewer “tangible” goods and services
will not only increase labor productivity and directly, the government will need to provide
maintain China’s competitiveness; it will also more intangible public goods and services,
allow Chinese manufacturing and services like systems, rules, and policies, that increase
to move up the value chain. Improvement in production efficiency, promote competition,
18 CHINA 2030
facilitate specialization, enhance the effi- this role, the government will need to trans-
ciency of resource allocation, and reduce risks form itself into a lean, clean, transparent,
and uncertainties. It requires designing and and highly efficient modern government that
implementing incentive structures that lead operates under the rule of law. In redefining
to desired and sustainable outcomes. its role, the government will need to accel-
One key area, for example, is the financ- erate reforms in the state-owned sector and
ing of basic public services such as pensions, combine it with further development of the
medical care, education, and housing, where private sector. It will also need to advance
the government can invest more, drawing reforms in factor markets (capital, land, and
on resources it had previously devoted to labor) to help strengthen the foundations
infrastructure and manufacturing. Equally of a market economy and promote greater
important, the government should be less competition and innovation. At the same
concerned with whether the private or the time, society’s role will need to change sig-
public sector provides these public goods and nificantly, with the middle class becoming a
services—but instead focus on ensuring they major force in promoting harmonious devel-
are delivered efficiently and to the requisite opment through greater participation of the
quality. Encouraging the private provision people in the development process.
of public goods and services and forming
public-private partnerships where appropri-
Key Characteristics of the
ate will not only inject new skills and ideas
into public service delivery but also empower New Strategy
the private sector and encourage greater Before describing a proposed development
participation in the development process. strategy, it is worth highlighting five charac-
Another example is the environment, an area teristics that should lie at its core.
requiring strong action by the government. The first is improvement in the qual-
Not only will green development improve the ity of growth while continuing to increase
quality of life in China, it will contribute to incomes. Not only does China aspire to
global efforts at mitigating climate change. become a high-income society that enjoys
As the second-largest economy with the larg- sustained growth, it would like to see growth
est population in the world, China is bound measured in qualitative as well as quantita-
to shoulder increasing global responsibili- tive terms. Rising incomes need to be accom-
ties and play an important role in delivering panied by increased leisure, a better physical
global public goods. To do this, it will need environment, expanding arts and cultural
to align its national interests to global con- activities, and a greater sense of economic
cerns and build its capacity to participate and social security. Correspondingly, the
actively in global affairs and to design global incentive structure that drives central and
rules instead of merely accepting them. local government performance will also need
In sum, it is imperative that China adjusts to reflect this changed emphasis. China needs
its development strategy as it embarks on its to develop a new metric to measure prog-
next phase of economic growth. At its core, ress over the coming decades that balances
this adjustment requires changing the role of growth and income objectives with broader
government and its relations with the mar- welfare and sustainability goals.
ket, the private sector, and society at large. The second is to achieve balanced and
While the government needs to withdraw sustainable growth, consistent with mar-
from direct involvement in production, dis- ket forces. There is broad recognition in
tribution, and resource allocation, it will China—as reflected in the 11th and 12th
need to focus greater attention on design- Five Year Plans—that the country’s pattern
ing and implementing the policy and regu- of investment and growth has become largely
latory framework that empowers others to unsustainable. Spurred by high savings,
participate in economic decision making so cheap finance, and export-oriented policies,
that the desired outcome of rapid, inclusive, China’s impressive growth rate has been
and sustainable growth is achieved. To play capital intensive, industry led, and export
O V E R V I E W 19
dependent for several years. Compared with services. Most services have become trad-
rapidly growing manufacturing, the develop- able internationally, and China can benefit
ment of services has lagged (though the sta- from agglomeration economies and interna-
tistics may exaggerate the degree of lag). The tional specialization in services just as it has
shares of wages and consumption in national in manufacturing. For example, if China suc-
income have fallen steadily; the shares of ceeds in becoming a leading innovator in the
capital and investment have climbed. Rural- field of green development, then its expertise
urban inequality has expanded since the and knowledge on this subject will likely be
1990s. China is home to more than a million sought worldwide. Similarly, if China’s finan-
millionaires,11 while more than 170 million cial sector is strengthened to the point that
live on less than $2 a day.12 the capital account can be liberalized and the
Returning to balanced and sustainable renminbi become a key international reserve
growth will require a rise in the shares spent currency, then China could become a key
on services and consumption as per capita exporter of financial services.
income increases. This will be achieved, in The fourth is unleashing China’s full
part, by correcting factor price distortions human potential. Equality of opportu-
that implicitly tax labor and subsidize capi- nity will not only help unleash China’s full
tal. Correcting such distortions and allowing human potential, it will also support inclu-
market-driven structural change will not only sive growth and improve income distribution.
help achieve greater balance between manu- Increasing equality of opportunity should not
facturing and services but also in the distri- be restricted only to public services, such as
bution of income between capital and labor health or education; it should also include
and between rural and urban households. economic opportunities such as access to
The third is to strengthen innovation and jobs, finance, or official permits to start a
creativity. While development of services will business. One way to increase equality of
need to be a priority in the coming decades, opportunity in the enterprise and financial
manufacturing growth will continue to be an sectors will be to allow more competition in
important growth driver. After all, notwith- factor markets (labor, land, and capital) as
standing recent rapid increases in real wages, well as product markets. More competition,
China’s low-cost labor, especially in inte- of course, can come from abroad through
rior, less-developed provinces, will remain boosting exports and lowering import barri-
an advantage for many years to come. But ers, but it can also be encouraged by easing
rather than focus purely on growth, poli- the entry and exit of firms in the domestic
cies will need to encourage manufacturers market, giving small and medium enterprises
to move up the value chain and advance rap- (SMEs) greater access to finance and market
idly to the global technology frontier (and, opportunities, opening up public procure-
in some areas, push that technology frontier ment by making procedures transparent, and
forward). Services like research and devel- creating new opportunities for the private
opment (R&D), finance, logistics, training, provision of public services by separating
information services, and after-sale services financing from delivery. Smarter and more
will help. Achieving this will require further effective regulation can do more than just
integration with the global economy and help level the playing field between big enter-
increased specialization, as well as participa- prises and small ones. It can also help protect
tion in global R&D networks and marketing consumers, workers, and the environment;
arrangements. safeguard private and intellectual property
But it would be a mistake to believe that rights; ensure greater financial sector stabil-
innovation will be restricted to manufac- ity; and provide a solid foundation for corpo-
turing. If China is successful in nurturing a rate governance to guide enterprises.
culture of open innovation, then the services Equality of opportunity also means higher
sector could also be an important beneficiary, public participation in public policy formu-
and there is no reason why China should not lation, implementation, and oversight. As
become an important exporter of high-end economies grow in size and complexity, the
20 CHINA 2030
task of economic management becomes more values and moral standards should be reex-
complicated, and governments usually find amined and reinforced. From a social per-
that they alone do not, indeed should not, spective, not only will this contribute to
have all the answers. Governments, there- improving the quality of life, it will also
fore, tend to tap the knowledge and social provide a greater sense of community and
capital of individuals and nongovernment enhance social cohesion. From an economic
agencies, including universities, communities, perspective, it will reduce transaction costs
and think tanks. One of the hallmarks of and improve the quality of economic gov-
advanced economies is their public discussion ernance. Promoting social values and high
of public policies. Indeed, such discussions moral standards is not only the job of gov-
are already beginning in China, but there is ernment; it is also the duty of social orga-
a long way to go. Public consultations and nizations and, indeed, every citizen. Moral
policy debate ensure that all points of view awareness, not legal compulsion, should be
are considered before government reforms the hallmark of a high-income, harmonious
are introduced. These discussions not only society.
shrink the distance between the government
and the citizens and communities it serves,
Six Key Directions of the
but they also encourages stakeholders’ own-
ership of new policies, help render reform New Strategy
proposals intelligible to citizens and firms, Over the next two decades, China will face
and enhance the chances of success. many challenges in its quest to become a
The fifth (and last) values the role of the modern, harmonious, and creative high-
market, rule of law, social values, and high income society. These include transitioning
moral standards. As the government tran- government from being an active partici-
sitions away from direct intervention in pant in the economy to developing the legal,
enterprise and market activities and toward regulatory, and institutional framework sup-
creating a policy and regulatory environ- portive of a competitive market environment;
ment supportive of free and fair competition, implementing a “smart” urbanization strat-
it must also safeguard the rule of law. In a egy; encouraging innovation and industrial
similar vein, as the Chinese economy grows upgrading; reducing income inequality and
in complexity, not only must rules and regu- ensuring equal opportunity for all; modify-
lations evolve to reflect changing reality and ing its approach toward handling economic
emerging priorities, but they should be fairly relations with other countries; and playing
and effectively enforced. If the enforcement a more constructive role in a rapidly chang-
of standards varies from sector to sector, ing system of global governance. In reality,
region to region, entity to entity, and some- the list of challenges is much longer. While
times even person to person, then it will not some consensus has emerged with respect to
only discourage innovation and lead to ineffi- a few of those issues, controversies remain
cient economic outcomes, it will also contrib- and an intense debate is ongoing over key
ute to feelings of injustice. Where contract aspects. This report evaluates the major chal-
disputes arise, whether between private par- lenges China needs to tackle in the next two
ties or between private entities and the State, decades and identifies six new strategic direc-
the disputants should have access not only to tions that will form the core components of
legal recourse but also to a transparent and the new strategy.
effective judicial system that imparts justice The first new strategic direction is the
without fear or favor. appropriate role of the government, the state,
Similarly, social values and high moral and the private sector. The recent global
standards will be important. There is wide- financial crisis in the advanced economies
spread concern in China over many recent and, in stark contrast, China’s continued rapid
instances of “moral failures” that were growth despite the global slowdown, have
reported widely in the media. As China led some in China to conclude that China’s
becomes a high-income society, its social state dominance in key industrial and service
O V E R V I E W 21
sectors should continue (especially in the finan- strategy may yield short-term gains but will
cial sector).13 Others, however, counter that be ultimately self-defeating, while an open
China’s vision of itself in 2030 as an innova- innovation strategy promises more sustained
tive, high-income society will require markets long-term rewards.
and the private sector to play a bigger role in The third new strategic direction is that
resource allocation decisions. They consider China should “grow green.” Instead of
the dominance of the state in the economy as considering environmental protection and
potentially inhibiting China’s efforts to move climate change mitigation as burdens that
up the value chain. This report makes two hurt competitiveness and slow growth, this
points: first, that government should encour- report stresses that green development could
age increased competition in the economy, potentially become a significant new growth
including by increasing the ease of entry and opportunity. Much will depend on how
exit of firms as soon as possible; and sec- effectively government policies make firms
ond, that public resources should be used to internalize negative externalities and moti-
finance a wider range of public goods and vate firms to innovate and seek technological
services to support an increasingly complex breakthroughs. China does not want to rep-
and sophisticated economy. Reforms of state licate the experience of advanced countries
enterprises and banks would help align their that became rich first and cleaned up later.
corporate governance arrangements with the Instead, China intends to grow green by fol-
requirements of a modern market economy lowing a pattern of economic growth that
and permit competition with the private sec- boosts environmental protection and techno-
tor on a level playing field. This would create logical progress, a strategy that could become
the appropriate incentives and conditions for an example to other developing countries and
increased vigor and creativity in the economy perhaps even advanced economies.
in support of China’s successful transforma- The fourth new strategic direction is to
tion into a high-income society. promote equality of opportunity and social
The second new strategic direction is protection for all. China’s high inequality in
encouraging systemwide innovation and incomes and assets can, in part, be attrib-
adopting an “open” innovation system with uted to unequal access to quality public ser-
links to global R&D networks. Although vices, particularly those that help accumulate
China’s R&D investment as a share of GDP is human capital and increase public partici-
high by international standards for a country pation in the development process. Policies
at its per capita income level, much needs to should promote the equality of opportunity
be done to ensure that this investment yields to help all members of society, especially the
commercially viable innovations that will disadvantaged, who have the same rights as
help Chinese firms move up the value chain everyone else to access social and economic
and compete effectively in the same product services as well as employment opportuni-
space as advanced economies. Ensuring free ties. Promoting equality of opportunity will
and fair competition for all enterprises would largely entail increasing the quality of public
be the single most important policy to encour- services available to rural residents, migrants
age innovation, which is likely to be driven by in urban areas, and those in poor, interior
large private firms. Without competition, the provinces. While increasing the efficiency
effects of other policies aimed at encourag- of public service delivery can save public
ing innovation will unlikely have much effect. resources that can then be used to increase
At the same time, technology development the quality of public services, there will still
worldwide has become a collaborative exer- be a need to increase the allocation of pub-
cise in which countries benefit from special- lic resources toward this objective. Given
ization, just as they do in manufacturing or China’s sound fiscal situation, the temptation
services. China would therefore benefit from will be to design a public service and wel-
participation in global R&D networks just fare system that is comparable to advanced
as it benefited from participation in global economies. But China needs to ensure that
production networks. A “closed” technology spending on public services is increased
22 CHINA 2030
prudently and in line with available fiscal The sixth new strategic direction is to
space. China does not intend to fall victim develop mutually beneficial relations for
to the “high-income trap” whereby publicly the rest of the world. Notwithstanding tepid
financed social entitlements become fiscally growth in advanced countries likely for the
unsustainable. foreseeable future, China must continue
The fifth new strategic direction is to its integration with global markets even as
build a sustainable fiscal system that will it reorients the economy toward domestic
meet expected public finance challenges sources of growth. While further integra-
over the next two decades. Over the coming tion may bring its own risks, the benefits of
two decades, China’s fiscal system will face openness will be central to increasing effi-
three major challenges. The first will be to ciency, stimulating innovation, and promot-
make the fiscal system resilient to macroeco- ing international competitiveness. Opening
nomic shocks and a protracted growth slow- up served China well in the past, especially
down; the second will be to accommodate after its entry to the World Trade Organi-
new public expenditure demands linked to zation (WTO), and further integration will
the adoption of the new development strat- serve it well in the future, particularly for
egy; and the third will be to make the fiscal the development of the services sector. China
system transparent and responsive to policy also needs to engage with global governance
adjustments. Given the likelihood of a pro- institutions proactively as an international
tracted growth slowdown at some point in stakeholder to help shape the global policy
the next two decades, it is important that environment in a manner that is mutually
China’s fiscal system is able to adjust pub- beneficial for China and the world.
lic expenditures in line with an expected The six new strategic directions provide
rapid deceleration in revenue growth. It is an internally coherent policy framework and
also important for China to maintain ade- form the key pillars of the proposed develop-
quate fiscal space to deal with macroeco- ment strategy for the next two decades. Some
nomic shocks, some of which may originate may argue that they may not include some
abroad, given the continued uncertainties in important policy areas, but the pillars can be
the global economy. applied to explain virtually every significant
Moreover, the budget will need to development issue facing China. Box O.2,
accommodate expected increases in public which describes China’s urbanization chal-
expenditures linked to expansions in public lenge, provides a good example.
service delivery and the proposed green China’s senior leaders have recognized for
development program, while at the same time some time the urgent need to adjust the coun-
ensuring that fiscal sustainability is not try’s development strategy and transform
impaired. Finally, compared with other coun- the growth pattern. To some extent, China
tries, China’s fiscal system remains opaque, is already beginning to do this. A new pol-
intergovernmental fiscal relations have not icy direction for the next five years has been
been fully reformed and codified, and fiscal elaborated in China’s 12th Five Year Plan
risks and large contingent liabilities remain and other policy documents and includes
significant. Tackling these challenges will macroeconomic, social, and environmental
require a fiscal system that is flexible, trans- targets as well as pilot applications of the
parent, prudently managed, and responsive to “happiness” index to evaluate local govern-
emerging priorities. The efforts to strengthen ment performance. The plan is the first step
and reform the fiscal system will also need to in a longer-term shift in China’s development
be aligned with the broader objective of reori- strategy and is consistent with the reform
enting the role of government vis-à-vis the program described in this report.
private sector and with the longer-term needs Chapters 3–8 discuss the six new strategic
of a changing economy. directions in greater detail.
O V E R V I E W 23
Meeting China’s urban challenge presents an interest- adequate levels of public services—especially health,
ing example of how the policy priorities highlighted education, transport, water, and energy—in ways
in this report—economic policies, innovation, green and at prices that encourage efficient use. Finally, cit-
development, social policies, fiscal strengthening, ies that invest in effective risk reduction and disaster
and global integration—need to interact with one response capabilities often find these will be among
another to bring about desired change. the best public investments they make.
Over the long term, the health and vitality of Perhaps the most important recommendation for
China’s rapidly growing urban areas will not only be smart urbanization is the critical need to improve
central to continued rapid growth but will also hold the fiscal strength of municipalities (along with other
the key to greater equality and less resource-intensive local governments) and reduce the large disparities
growth. In 1978, less than a fifth of China’s popula- in resource availability between cities. Strengthen-
tion resided in cities; by 2009, urban residents made ing the resource base of cities will require improved
up close to half the population; and by 2030, the arrangements for tax sharing and transfer payments
share is expected to swell to near two-thirds. That with the central government as well as new tax
means about 13 million more urbanites each year, instruments, such as land and property taxes, that
or the equivalent of the total population of Tokyo or permit an elastic tax base. There are two reasons
Buenos Aires. Rapid as this may seem, China’s urban- why this is a priority. The first obvious one is that
ization level by 2030 will be broadly in line with city governments need adequate resources to meet
other countries with a similar per capita income. the needs of recurrent expenditure and investment,
Interestingly, China’s 20 fastest-growing cities are taking into account the future growth of population
located inland with per capita incomes that are and economic activities. Second, in the absence of
rapidly catching up with coastal cities. These cities such tax instruments, local governments will con-
can access the main metropolitan centers thanks tinue to use land sales as a key source of revenues.
to low-cost transport links and communications Besides increasing the pressure on arable land, this
facilities, while at the same time derive advantages practice also tends to continuously expand city
from the ease of face-to-face communication and size, contributes to urban sprawl, reduces popula-
social capital accumulation facilitated by spatial tion densities, and raises costs of transport and
compactness. infrastructure.
Most urban growth in the future will result from The second complementary policy would be
the expansion of existing cities through migration to restrain the geographic expansion of cities and
from rural areas. As recent research shows, cities are increase the population density of cities. Several
strong engines of growth. They permit economies of Chinese cities are already quite densely populated
scale and scope in production and distribution and by international standards, but for those that aren’t,
facilitate technology spillovers. Thanks to higher further increases in density will lower the cost of
population densities in cities, private and public public and infrastructural services, improve energy
investments are more cost-effective and yield higher and transport efficiency, and reduce the loss of arable
returns. And by bringing a critical mass of talent land. There remain large tracts in the core of major
together in compact space, cities often become cru- cities that are underused owing to ownership still
cibles for innovation. vested in state enterprises or local interest groups
But for urbanization to be supportive of rapid that prevent efficient urban development. Increased
and efficient growth, it should be “smart” as well population density can be consistent with growth in
as rapid. Smart urbanization involves delivering value added only if urban land and property markets
function smoothly. Of course, increased density has suggestions on how they can be improved. A third
its limits, but expanding city areas should be under- way is to support the participation of social and vol-
taken carefully and only when other alternatives to untary organizations in delivering services (including
combat congestion are exhausted. Adequate density health and education). Experimentation is already
needs to be accompanied by increased intra- and ongoing along these lines in many cities but needs
intercity connectivity. Intracity connectivity, critical to be encouraged and expanded, and substantial
to reducing the carbon footprint of cities and boost- changes need to be made in government practice and
ing city efficiency, requires providing viable options attitude. The government can then focus on being a
to private automobiles. Increasing connectivity regulator and coordinator. Identifying the services
between cities reduces economic distances, encour- that can be provided in this way should be the out-
ages growth of satellite cities, advances specializa- come of discussions and decisions at the local level,
tion, supports greater scale economies, and increases with guidance from the central government.
international competitiveness. The fifth recommendation is to advance the gov-
The third is the importance of strengthening ernment’s efforts to make cities knowledge centers
urban land use planning. Planning is important to and incubators for innovation. The government has
ensure an appropriate balance between green areas, already identified 20 pilot cities for those efforts. But
residential areas, factories, businesses, shopping what more can it do? One approach is to ensure that
areas, and recreational facilities such as parks and as many cities as possible provide the essentials for
playing fields. Urban areas that mix residential, rec- becoming knowledge centers—sound infrastructure,
reational, shopping, and business facilities tend to modern transport and telecommunication facilities,
develop more vibrant communities, have a smaller local universities and research centers, and a critical
ecological footprint, enjoy lower crime rates, and mass of skilled labor. Those that do not make the
generally improve the quality of life. At the same leap to becoming knowledge centers will still be bet-
time, planning has its limits and planners cannot ter positioned to attract manufacturing or service
anticipate the future perfectly. City designs therefore industries. Those fortunate enough to attract world-
need to evolve continuously to respond to the needs class firms or world-leading technology R&D centers
of citizens as lifestyles change. This requires constant beyond a particular threshold could receive local and
public and private investments, reinforcing the need central government support in the form of additional
for sound fiscal systems. It also demands a new role ancillary services, including research institutes, uni-
for government and emphasizes the importance of versities, and related and sponsored links to other
good governance. research organizations. Some urban centers have
The fourth is effective and good urban gover- already made this leap and are becoming recognized
nance, which goes beyond efficiency, integrity, and knowledge and innovation centers—opto-electronics
transparency, although these are very important. It for Wuhan, aviation for Chengdu, financial and engi-
includes responsiveness to citizen needs, and the abil- neering services for Shanghai, logistics and business
ity to use the energy and capabilities of private enter- services for Shenzhen, information technology (IT)
prises and civil society organizations. One way is to and software for Beijing—and should be supported
invite citizen participation in land use planning and in becoming centers of excellence. In others, such as
zoning, which not only harnesses public creativity Chongqing, efforts are ongoing. In identifying what
but also reminds officials to look beyond the interests to support, governments need to remind themselves
of individual sectors. Another way is through design- that innovation does not always mean high tech.
ing citizen report cards and other similar methods Experience has shown that firms in mature indus-
of surveying that regularly assess public satisfaction tries can also be transformed through innovation
with the level and quality of public services and seek and become globally competitive.
O V E R V I E W 25
Since 1978, China has made full use of its growth. China’s rapid growth, particularly
late-comer advantages in a globalized econ- since 2003, benefited from SOE restruc-
omy, experiencing rapid structural change, turing and expansion of the private sector.
becoming the world’s largest manufacturer Many small and medium-sized SOEs became
and exporter, and rapidly moving toward the privately owned. In line with these develop-
technology frontier in many industries. The ments, the new policy direction has been to
introduction of the market mechanism and diversify the ownership of state enterprises.
openness to trade provided strong incentives Indeed, many large state enterprises have
for efficient resource allocation and boosted been “corporatized” and some of the biggest
productivity growth. (including those directly monitored by the
But the forces supporting China’s con- central government) are now not only listed
tinued rapid progress are gradually fading. on stock exchanges but have also improved
The productivity benefits from structural their governance structure, managerial pro-
change are expected to decline. As China fessionalism, and profitability.
approaches the technology frontier, total
factor productivity growth from technology
adoption, adaptation, and dissemination will Key Issues
also almost certainly decline. At the same Relative to the private sector, SOEs consume
time, the government’s continued dominance a large proportion of capital, raw materials,
in key sectors of the economy, while earlier and intermediate inputs to produce relatively
an advantage, is in the future likely to act as small shares of gross output and value added.
a constraint on productivity improvements, A large share of state enterprise profits comes
innovation, and creativity. from a few state enterprises where profit-
At the same time, China’s transition to a ability is often related to limits on competi-
market economy is incomplete in many areas. tion and access to cheaper capital, land, and
A mix of market and nonmarket measures natural resources.14 Meanwhile, the financial
shapes incentives for producers and consum- performance of some state enterprises has
ers, and there remains a lack of clarity in been weak, in part because they have been
distinguishing the individual roles of govern- responsible for delivering public services or
ment, state enterprises, and the private sector. have been constrained by regulated prices. In
It is imperative, therefore, that China resolve fact, more than one in every four state enter-
these issues, accelerate structural reforms, prises makes a loss. A recent study also shows
and develop a market-based system with that between 1978 and 2007, total factor
sound foundations in which public resources productivity growth (a measure of efficiency
finance the delivery of key public goods improvements) in the state sector was a third
and services—while a vigorous private sec- that of the private sector,15 which has proved
tor plays the more important role of driving to be the more powerful engine of growth
growth. This challenge is bigger than it may and innovation.
appear because many other constraints to State enterprises have close connections
growth, including an anemic global economy with the Chinese government. State enter-
and a shrinking and aging labor force, also prises are more likely to enjoy preferential
need to be overcome. access to bank finance and other important
inputs, privileged access to business oppor-
Private Sector Development and tunities, and even protection against com-
petition (Li and others 2008). This discour-
State Enterprise Reforms ages new private sector entrants and reduces
Going forward, a vibrant corporate sector competition and innovation. Some state
will be critical for sustaining relatively fast enterprises operate outside their mandated
26 CHINA 2030
area (many invest in real estate and the seven strategic sectors where the state would
shadow banking system), because they can keep “absolute control”—defense, electricity
keep their earnings and invest them with generation and distribution, petroleum and
limited external control or oversight. A new petrochemicals, telecommunications, coal,
issue needing attention is the recent rapid civil aviation, and waterway transport.16
expansion of some state enterprises owned In these sectors, a handful of state firms
by subnational governments; their growth might compete with one another, but they
will likely further crowd out private sector are protected by barriers that discourage
activity, dampen competition, and conflict new entrants. The Chinese authorities have
with efforts to build sound foundations for a also designated “basic” or “pillar” indus-
market-based economy. tries—machinery, automobiles, electronics
The cost of reforming and restructuring and information technology, construction,
state enterprises will not be trivial. Reforms steel, base metals, and chemicals—where
in the late 1990s, in which many small state the state is expected to retain a “somewhat
enterprises were closed, incurred a cost strong influence” (Owen and Zheng 2007).
exceeding RMB 2 trillion—more than 20 Although formal barriers to entry may be
percent of GDP at the time—a measure of low in these industries, informal entry bar-
how difficult and costly such reforms can be. riers convey the clear policy message—com-
Potential costs of reforming and restructur- petition from private firms is not welcome.
ing state enterprises may have climbed signif- These barriers, together with less favorable
icantly because opaque accounting practices regulatory treatment tend to inhibit private
and lack of transparency mean that some sector growth and development, dampen
SOEs have accumulated large contingent innovation and creativity, and slow produc-
liabilities that will need to be revealed and tivity growth.
reduced over time.
Finally, the Chinese authorities have imple-
Key Reform Recommendations
mented a complex set of industrial policies
that are the responsibility of different agen- Reforms in the enterprise sector must begin
cies at different levels of government. In some with the recognition that government owner-
instances, these policies may have helped by ship is widespread and varied, covering most
overcoming coordination failures and pro- sectors and ranging from outright owner-
moting infant industries effectively, but in ship to controlling interest to minority share-
others, they did not yield the intended results. holder. The challenge, therefore, is twofold:
Some government departments are keen to How can public resources best be used; and
adopt industrial policies and view such poli- how can China best transition from its cur-
cies as a close substitute for planning; they rent approach to managing its portfolio
consequently often prefer large-scale invest- of state enterprises to an approach that is
ments by SOEs instead of achieving the same best suited for its long-term development
ends through incentives, market forces, and objectives?
private sector initiatives. Industrial policy ini- The response to the first challenge is
tiatives by different departments can some- straightforward. Public resources should be
times conflict and interact with one another, used solely or mainly for the provision of
making the overall policy framework compli- public goods and services, the production
cated and opaque and the results ambiguous or consumption of which result in unre-
and unpredictable. munerated positive externalities.17 These
Many studies suggest the potential for goods and services range from defense at
significant growth dividends from giving one end to infrastructure, social protec-
the private sector a greater role in compet- tion, and basic R&D at the other, and their
ing with state enterprises in key sectors. The scope could evolve as conditions change.
greatest benefit is likely to accrue in so-called The recent emphasis on public housing for
“strategic” sectors where competition has the poor is a good example of how govern-
been curtailed. In 2006, China identified ment resources can be used to address a
O V E R V I E W 27
pressing social need. Indeed, the scope of important that key principles are established
public goods and services can be quite broad, early. It is critical, for example, that the State-
and can even include reliable energy supplies Owned Assets Supervision and Administra-
and the widespread availability of commu- tion Commission (SASAC) confine itself to
nications and postal facilities. The share of policy making and oversight, leaving asset
public resources applied in a particular area management to the SAMCs. The SAMCs
will depend on the nature of the public good should have clear mandates, be indepen-
or service being supplied. In areas considered dently and professionally managed, and be
to be of high national priority, like defense, subject to publicly announced performance
government resources would be expected to benchmarks (depending on the nature of
provide the full or dominant share of finance. the enterprises in their portfolio). In addi-
But in most areas, a smaller share is usually tion, they will need to adhere to international
sufficient to achieve the government’s objec- standards for transparency, including on
tives. Most important, in many cases, private operations and results, value creation, profit-
sector firms will be fully capable of deliver- ability, and dividend payments.
ing public goods and services, even though More competition—domestic and inter-
the government may provide the bulk or national—will be key to improving the effi-
some part of the finance. The private deliv- ciency and innovation capability of Chinese
ery of public goods and services (with public enterprises. To increase competition in
financing) introduces the added dimension of domestic markets, further reforms will be
competition and helps lower production and needed to support private sector firms, such
distribution costs. as lowering barriers to firm entry and exit,
The response to the second question is breaking up state monopolies or oligopolies
less straightforward. First, the government in key industries (petroleum, chemicals, elec-
could securitize its implicit equity in state tricity distribution, and telecommunica-
enterprises as soon as possible (in listed state tions), promoting the growth of dynamic
enterprises, the value of the equity is already SMEs and increasing their access to finance,
known). This would pave the way for state stimulating much needed regional and local
enterprise reform by separating ownership specialization, and encouraging spontaneous
from management and introducing mod- state enterprise reforms through competi-
ern corporate governance practices, such as tion. China’s own past experience, together
appointment of senior management, public with that of other countries, shows that
disclosure of accounts in accordance with increased domestic competition can result in
international practice, and external audit- significant improvements in productivity.
ing. Second, the government could consider With these reforms, state enterprises can,
establishing several state asset management over time, withdraw gradually from contest-
companies (SAMCs) that would represent able markets. Starting in the late 1990s, for
the government as shareholder and would example, ownership diversification and mar-
professionally manage and trade these assets ket reforms stimulated entry and competi-
in financial markets where feasible. Each tion in most manufacturing subsectors. Even
SAMC could specialize in certain sectors. in some strategic or pillar industries, such as
They could then, on behalf of government, telecommunications, the breaking up and
gradually diversify the portfolio over time. corporatization of incumbent enterprises
The dividends of state enterprises would need created new competitive forces.18 Easing the
to be paid to the SAMCs who, in turn, would entry of private firms into these areas and
transfer them to the budget. Finally, a por- giving them access to adequate levels of
tion of state assets could be transferred to finance from state-owned banks will further
the national pension fund with the flow of promote efficiency and competitiveness.
returns being used to help meet future pen- And with an eye to redefining further the
sion obligations. role of government, policies should encour-
While the operational details of the pro- age the private provision of public services,
posed SAMCs can be elaborated later, it is and public procurement should be further
28 CHINA 2030
opened to competition by private firms. remains repressed and suffers from key struc-
Where natural monopolies exist (for exam- tural imbalances. The current system, char-
ple, in rail services), the monopolist enter- acterized by dominance of state-owned
prise should be subject to independent and banks, strong state intervention, and remain-
strict oversight to ensure that the lack of ing controls on interest rates, has been
competition does not lead to monopoly pric- remarkably successful in mobilizing savings
ing and the abuse of market power that could and allocating capital to strategic sectors dur-
harm downstream industries. Further efforts ing China’s economic take-off. Going for-
are also needed to level the playing field, ward, however, such benefits are increasingly
especially between smaller and larger firms, likely to be outweighed by many costs. The
and between state and nonstate firms—with first cost is the disintermediation of the non-
a special focus on laws and regulations, and state sector, especially micro, small, and
access to credit from state-owned banks. This medium enterprises that have significantly
will also require review and modernization less access to formal financial institutions
of China’s “industrial policies” to support than state enterprises and large firms. Sec-
the growth of firms in dynamic new sectors, ond, low lending rates have contributed to
improve resource allocation, and stimulate excessive investment and high capital inten-
innovation. sity. Third, the government’s important role
In addition, competitiveness and inno- in credit allocation at the central and provin-
vation will be encouraged by measures to cial levels is leading to the accumulation of
enhance international competition through contingent liabilities not easily quantified
further integration with the global economy owing to limitations on monitoring, data col-
(see chapter 8), and a reduction in behind- lection, and interagency data exchange. And
the-border barriers to trade. China’s acces- fourth, the financial system is growing more
sion to the World Trade Organization in complex—markets and institutions are
2001 triggered economy-wide improvements increasingly intertwined across borders, and
in efficiency and spurred technology acquisi- informal credit markets, conglomerate struc-
tion and adaptation. More recently, the phas- tures, and off-balance-sheet activities are on
ing out of incentives that had favored foreign the rise.
investors stimulated competition by leveling Not only do the above characteristics of,
the playing field with domestically owned and trends in, the financial system pose sig-
firms. nificant systemic risks, they will eventually
prevent China’s financial system from serving
an increasingly dynamic, sophisticated, inter-
Factor Market Reforms nationally integrated economy, driven, in
To complete the transition to a market econ- large part, by private sector firms. Banks,
omy and further strengthen its foundations, capital markets, and other financial interme-
China needs to also focus attention on factor diaries will need to raise and allocate capital
markets—capital, land, and labor—where efficiently; adopt modern corporate gover-
market reforms have tended to lag, and con- nance arrangements; provide access to micro,
sequently, the remaining distortions are par- small, and medium borrowers; assess and
ticularly large. Price, regulatory, and insti- manage risks using best-practice techniques;
tutional changes are essential to ensure that and provide a broader variety of financial
resources flow to economic activities that services to an increasingly diversified clien-
yield the highest returns. tele. At the same time, an increasing number
of Chinese enterprises will go global, placing
pressure on China’s domestic financial sys-
Capital
tem to adopt global standards to ensure
Despite impressive progress in reforming and seamless integration with foreign financial
deepening the financial sector in the past institutions and global capital markets. Ris-
three decades, China’s financial system ing income and accumulation of wealth
O V E R V I E W 29
within China will increase the demand for and using interest rates, rather than credit
new financial products and investment ceilings, to manage liquidity. Commercial
opportunities. And finally, in the event of banks would use commercial principles
financial crises emanating from inside or out- and creditworthiness analysis, rather than
side China, adequate systems (including ade- follow government signals, to guide lend-
quate capital buffers and clear accountabili- ing (an exception could be made for one
ties) will need to be in place for an orderly or more policy banks that would continue
and systematic resolution of bad debts and to finance government priority programs).
either the recapitalization or the closing of Such reforms may require a thorough over-
insolvent financial institutions. Instead of haul of governance structures in state-
persisting in pushing problems into the owned financial institutions, in which exist-
future, financial sector reforms in the next ing state ownership functions, agencies, and
two decades should be decisive, comprehen- practices are reviewed, using lessons from
sive, and well coordinated. examples of international best practice and
The aim of financial sector reforms should failures. In addition, efforts should be made
be to build a competitive, balanced, efficient, to further diversify the ownership structure
safe, and sound financial system that meets in state-owned banks and further reduce
the demands of the corporate, household, the shares held by the state.
and government sectors. A well-functioning Second, although its huge foreign reserves
financial system capable of sound risk man- give China a strong safety net against the
agement is essential to mobilize savings; possibility of a financial or currency crisis,
allocate capital efficiently to an increasingly it nevertheless must be prepared in case a
complex and sophisticated economy; and crisis occurs. To achieve this, the govern-
ensure access to finance for all sections of the ment needs to strengthen the independence,
economy including individuals, households, effectiveness, staffing, and funding of regu-
the poor, and businesses of all sizes. latory bodies, including supervisory agencies
To reach these objectives, financial sec- (at the central and provincial levels), and to
tor reform should follow an implementation give them greater enforcement and resolution
road map that is properly sequenced, and, powers. A high-level financial committee on
because the financial sector will remain vul- the basis of the existing framework could also
nerable to crises, be sustained as a priority be established, with the main objective of
through the next two decades. Much has monitoring and managing systemic risk and
been learned from China’s own experience maintaining financial stability. Limits need
as well as the successes and failures of other to be placed on emergency liquidity support
countries that have sought to reform their to solvent banks facing short-term liquidity
financial sectors. problems. Standing facilities should operate
The first priority should be to make inter- automatically to provide liquidity support to
est rates more flexible, and endeavor to move all domestically incorporated institutions,
to a point where interest rates, not quantity and clear guidelines should govern and limit
controls, clear the credit market. In addi- the use of fiscal resources. Stress testing
tion, greater exchange rate flexibility is should be continued and improved to take
needed to help cool inflation and take pres- account of emerging risks, and “financial
sure off reserve requirements, together with war games” should be conducted regularly
the deployment of a combination of mon- to fine-tune the institutional arrangements
etary and macroprudential measures to pur- for dealing with a financial crisis if and when
sue growth, inflation, and financial stability one occurs. The government should estab-
objectives. lish an efficient legal framework; insist on
In parallel, direct and indirect controls higher standards of disclosure, auditing, and
of financial institutions must give way to accounting; and streamline the court sys-
arm’s-length market-based arrangements. tem to deal with troubled banks and firms
This would mean an autonomous central in a timely fashion. A functioning deposit
bank adopting open market operations insurance scheme to underwrite risks faced
30 CHINA 2030
collective) and the price received when the FIGURE O.4 Urban land has expanded faster than urban population
land is auctioned has led to a sense of injustice
and been a factor in increasing rural unrest. Physical expansion of Chinese cities and population growth, 1995–2008
such markets will require improvements in In addition to revenues from land acqui-
land registration and documentation (and the sition, some local governments have also
latest land-mapping technologies make this become increasingly reliant on resources
cost-effective) as well as the establishment raised by land banks that use land as collat-
of credible and trusted dispute resolution eral, and, as recent events have shown, this
mechanisms. practice may lead to significant financial
Governance standards in rural collec- losses and transmit these risks to the broader
tives need improvement. One of the key banking system. The challenge lies in replac-
causes of land insecurity in rural areas is the ing these socially and financially costly forms
abuse of power by some village cadres at the of raising revenues with a more efficient and
expense of the members of the collective. sustainable revenue base. Over time, other
Land readjustment or sales are often under- revenue sources, including a property tax,
taken in collusion with commercial develop- may help make up the difference (see chap-
ers with little transparency or accountability. ter 7). A few countries, such as the United
Although the frequency of such events may States and Canada, raise 3–4 percent of their
have declined, one survey showed that every GDP from property taxes, while the aver-
village experienced at least one reallocation age among members of the Organisation for
during the period 1998–2008 (Wang, Tao, Economic Co-operation and Development
and Man 2010). Going forward, and espe- (OECD) is near 2 percent.22 China is already
cially in light of the policy supporting indefi- piloting property taxes in two cities but is
nite land use rights, the role of the collective finding that its introduction is usually dif-
will need to be reexamined, with a view to ficult for technical, institutional, and social
improving governance standards. reasons. This argues for its gradual introduc-
Policies governing acquisition of rural land tion and for modest expectations about its
for urban use need to be overhauled. Because contribution to revenues.
the state has used its untrammeled acquisition
authority to raise revenues, the urban land
Labor
area in China has grown much more rapidly
than the urban population. Two reforms are Just as land and capital need to be used
needed: First, local governments should be where they provide the highest returns, so
allowed to acquire rural land for urban areas too should labor be allowed to move to where
only if the urban development plans have the most productive and best-paying jobs
been vetted and approved by a higher level of are. But China’s hukou, or household regis-
government, and the approval process should tration, system and its locally administered
take into consideration regional land area insurance and pension systems make mobil-
priorities and urban land use efficiency. Sec- ity difficult. In addition, the labor force is
ond, the current practice of compensation— expected to start shrinking in a few years,
a frequent cause of complaints—needs to be and a declining labor force participation
reviewed. One approach would be to pay the rate among older workers is likely to make
going market price to the collective (with total this downtrend worse. Together, these two
pass-through to the farmer) but then impose constraints threaten to undermine China’s
a transparent capital gains tax. The current efforts at becoming an innovative and inter-
practice of expropriating the entire difference nationally competitive economy. To compete
between the agricultural value of the land against advanced economies in global mar-
and its urban market value is equivalent to a kets, China will need a more flexible and
100 percent capital gains tax; a lower figure dynamic workforce that can adjust quickly to
would be a reasonable compromise between changing market conditions. In the Republic
the need for more local government revenue of Korea, some 45 percent of the population
and some benefits for the farmer whose land migrated across provincial boundaries, con-
is acquired and way of life changed forever. tributing to extraordinarily rapid urbaniza-
Part of the capital gains tax revenue could be tion, concentration of economic activity, and
used for rural development within the county flexible reallocation of labor; 23 in China’s
where the land is located.21 case, 19.5 percent of the population migrated
O V E R V I E W 33
in 2010; nearly 85 percent of the migrants owing to fiscal constraints, have progressed
moved from rural to urban areas.24 least in large cities where rural migrants are
Over the coming decades, notwithstanding most concentrated. In contrast, migrants to
a decline in China’s overall labor force, hun- small and medium cities receive a modicum
dreds of millions will move in search of bet- of social services and social protection. Tak-
ter jobs, 25 and their absorption will require ing these factors into account, a systematic
labor markets that are flexible and institu- approach to propel hukou reform forward
tions that protect workers by providing some would include: (1) delinking the hukou from
employment predictability, social security, access to public services and using a residen-
and portable rights to affordable health care tial permit instead to determine eligibility to
and financial security in their old age. Gov- receive services; (2) encouraging pilot reform
ernment leadership will be crucial in helping programs at the local level; and (3) redefining
people obtain equal opportunities to access financing responsibilities between central and
jobs, education, and health care services, and local governments as an incentive for reform.
to manage rising risks stemming from further To increase the labor force participation
structural change, difficult global conditions, rate, especially among older workers, the
and increased competition. Developing a flex- government could increase the retirement age
ible and dynamic labor market will be central of men and women, which has the additional
to China’s future success as a high-income, benefit of reducing the burden on pension
open economy; whether that can be done will systems (see chapter 6). Many OECD and
depend critically on whether production and transition countries have tried this in recent
employment patterns adjust quickly to chang- years, with the annual increase in the retire-
ing demand conditions globally and domes- ment age ranging from six months a year in
tically. Phased reforms of the hukou system transition countries to one to three months
to ensure that, by 2030, Chinese workers a year in OECD countries. The government
can move to where the jobs are; measures to could also promote flexible working arrange-
increase labor force participation rates; and ments and strengthen mid-career training
reforms in labor taxation, hiring policy, and and life-long learning opportunities.
wage policy will all be essential to success. China should also reduce the level of
Hukou reform will be a top priority in social insurance contributions required for
the coming decades and needs to be com- employed workers. This implicit employment
pleted by 2030, but progress will likely be tax imposed on employers, amounting to
slow because it will depend on fiscal reforms. about 45 percent of the wage rate on average,
The hukou system no longer restricts move- is high by international standards. Because
ment of labor from rural to urban areas. 26 minimum contributions are set at a rate
But rural migrants without urban huk- applied to 60 percent of the average wage, the
ous are still denied access to social entitle- implicit tax rate is much higher for workers
ments—health care, education, and hous- earning low wages. Employers therefore avoid
ing—that urban residents receive. One of formalizing employment. Many employers
the key constraints to hukou reform is that and employees also “opt out” of social insur-
local governments have neither the resources ance schemes. The total number of contribut-
nor the incentives to extend public services ing urban workers in 2010 ranged from 237
to migrants and their families. So the speed million for health insurance and 236 million
of hukou reform will depend on the rapid- for pensions, compared with only 134 million
ity with which local governments strengthen for unemployment insurance and only 80 mil-
their fiscal systems (see chapter 7) and how lion for housing funds.27
financing responsibilities are shared between Finally, China’s public sector entities
central and local governments. The inability should be “equal opportunity employers,”
to provide migrants social entitlements on that is, their recruitment practices should be
par with urban residents not only increases transparent, based on merit, and impose no
inequality but also discourages mobility. restrictions on place of birth or possession of
Local hukou reforms have been ongoing but, an appropriate hukou.
34 CHINA 2030
Notwithstanding reforms in factor markets Even so, much will depend on complemen-
and development of the private sector, sus- tary domestic reforms and the global envi-
taining high growth poses a considerable ronment—merely investing another 1 percent
challenge. With population growth slow- of GDP in research and development will be
ing sharply and investment rates also set to insufficient. Many complementary ingredi-
decline, growth will be more dependent on ents in China’s innovation policy, including
gains in total factor productivity. During the private sector development and increased
past decade, TFP growth averaged 3 percent competition, reforms in factor markets, adop-
a year, which is high by international stan- tion of a green growth strategy, human capi-
dards and attributable in large part to rapid tal deepening, and the effective harnessing of
structural change; product and process tech- urban agglomeration economies to advance
nology spillovers from high levels of foreign ideas and technologies, are discussed in other
direct investment; the speed of technologi- chapters of this report. This chapter focuses
cal catch-up made possible by the buildup on policy reforms needed to develop a system
of physical, human, and financial capital; of incentives and institutions that could spe-
the progressive easing of infrastructure con- cifically support broad-based, economy-wide
straints; and the creation of a more competi- innovation.
tive and open economy.
The potential productivity benefits from
catching up in industry and services, from Innovation Advantages
measures to enhance competition in the As it begins its journey toward an innova-
domestic market, and from the accumula- tive economy, China possesses several advan-
tion of human and knowledge capital, are far tages. First, China’s spending on research
from exhausted. But there can be little doubt and development is on a steep upward trend.
that many segments of Chinese industry are Second, China’s manufacturing sector is
approaching the technology frontier, that large and possesses wide-ranging capabili-
intersectoral transfers of labor will dimin- ties. Third, having expanded its education
ish, and that the contribution of capital as system, China’s efforts to innovate are being
a growth driver will decline. Recognizing supported by a rising supply of science and
these facts, China is turning to innovation as engineering skills of improving quality.
a means of achieving rapid and sustainable Fourth, an elastic supply of patient capital is
growth while coping with looming challenges being mobilized to support innovative firms
associated with resource scarcities, climate and scale up the production capacity of new
change, and environmental degradation. entrants with good ideas. Fifth, China’s large
Is innovation the answer? Over the long and expanding market of urban middle-class
term, high levels of investment will remain consumers—expected to double in the next
a major driver of growth in China through decade—is attracting leading innovative
embodied technological change, but its multinationals, encouraging local innova-
importance is likely to decline while TFP tors, allowing domestic producers to attain
growth from innovation is expected to scale economies, and permitting formation
become increasingly significant. Were invest- of clusters and agglomerations. Sixth, a pro-
ment to fall to European levels of around 25 business, entrepreneurial culture in several
percent of GDP or less, growth would trend of China’s provinces, including Guangdong’s
toward 4–5 percent a year. But a more inno- Pearl River Delta, Zhejiang, and Fujian, is
vative China that continues to invest at least supportive of small firms and start-ups. Sev-
a third or more of its GDP has a high prob- enth, considerable potential is inherent in
ability of meeting its growth targets buoyed China’s relatively underdeveloped services
by above-average advances in TFP. sector. Eighth, and finally, not only is China
O V E R V I E W 35
urbanizing, some Chinese cities are realizing innovation efforts within a competitive mar-
that the productivity and growth of urban ket system.
economies will rest upon the quality of life The central government will need to take
and how effectively these cities can attract greater initiative in building countrywide
and retain global talent. research networks that mobilize national tal-
ent and reduce the isolation of firms in some
cities by including them in research consor-
Innovation Weaknesses tia that also involve advanced firms (includ-
China’s rising supply of skills and its large ing multinationals) from coastal cities. The
and advanced industrial base notwithstand- governments of Japan and the United States
ing, the reality is that government and state have successfully sponsored such consortia
enterprises conduct the bulk of research and in their countries; similar efforts in China
development—and part of this effort still could potentially develop more “global chal-
seems divorced from the real needs of the lengers.” These domestic networks can also
economy. True, China has seen a sharp rise link to global R&D networks in ways that
in scientific patents and published papers, leverage Chinese efforts with research activi-
but few have commercial relevance and even ties in other parts of the world. The natu-
fewer have translated into new products or ral inclination may be to protect domestic
exports (the honorable exception being tele- research efforts and innovative companies,
communications and consumer electronics). but that would prevent Chinese research-
Part of the problem may lie in weak incen- ers from interacting with external research
tives for indigenous, government-backed efforts, cut them off from new ideas, and
research institutes to work with commer- lower opportunities to adopt foreign technol-
cial users of new technologies. In addition, ogies. Links with global networks would also
research institutes may not be capturing help address constraints in domestic research
opportunities to leverage their capabilities capacity and overcome perceptions in foreign
by networking within the country and con- countries about China’s research and devel-
necting with global R&D networks. China opment program. Moreover, the trend in
has the potential to improve the institutional global R&D is rather similar to other kinds
arrangements needed to encourage broad- of economic activity, such as increased spe-
based innovation—such as ease of firm entry cialization, more intense exchange of ideas
and exit, increased competition, enforce- and know-how, and frequent exchange of
ment of laws protecting intellectual property research personnel. In such a model, China
rights, quality tertiary education, the avail- will be a participatory member in a global
ability of risk capital for small and medium research effort in which it is a consumer as
enterprises, evaluation of government R&D well as a producer of new ideas, new inven-
expenditures, and standard setting in gov- tions, and new ways of doing business.
ernment procurement. In the long run, the Many high-tech multinational corpora-
objective should be to develop a system tions have invested in R&D facilities in China
that stimulates broad-based creativity and (including in inland cities such as Xian and
innovation. Chengdu). Such investment should be further
encouraged because of its significant spill-
over effects, the reputational gains for those
Key Reform Recommendations Chinese cities that are fast becoming science
A better innovation policy in China will hubs, and the contribution this research can
begin with a redefinition of government’s role make to industrial upgrading. Closer collab-
in the national innovation system, shifting oration and partnerships with multinationals
away from targeted attempts at developing on the basis of mutual trust and recognition
specific new technologies and moving toward will contribute to the creation of a dynamic
institutional development and an enabling and open innovation system. In this con-
environment that supports economy-wide text, an efficient patenting system that re-
36 CHINA 2030
flects the experience of the U.S. and Euro- located in interior provinces, and permit ven-
pean systems (both of which are in the ture capital owners an exit option. Finally,
throes of reform) and effective protection of governments could help innovative SMEs by
intellectual property, especially in fields such establishing public technology platforms that
as biotechnology, nanotechnology, software, provide SMEs access to laboratory, metrol-
and multimedia, will expedite the growth of ogy, testing, and certification facilities.
China’s innovation capabilities. Then there is the direct role of govern-
China’s innovation policy needs to reflect ment in R&D. Central and provincial gov-
the lesson borne from international experi- ernments are seeking to enlarge spending
ence that most applied research and innova- on R&D and also raise the share of basic
tion is done within large private sector firms. research supported by universities and
Large private firms tend to make innovation a research institutes. Support of basic research
central plank of their competition strategies, is more likely to succeed through well-
respond to market demand and government targeted incentives, by committing a sufficient
incentives, and provide researchers with the volume of funding to a few high-caliber insti-
freedom to pursue interesting ideas and inter- tutions, and by sustaining that funding. One
act with other researchers both at home or example is the National Institutes of Health
abroad. A range of incentives—through fis- in the United States, which plays a central
cal, financial, and regulatory instruments— role in boosting innovations in life sciences
needs to be applied to encourage such firms to because it enjoys large and stable funding.
emphasize research, development, and inno- Another is the Defense Advanced Research
vation, and to give them a large enough mar- Project Agency, also in the United States.
ket to ramp up production of new products To maximize spillovers from government-
and achieve economies of scale. In addition sponsored research, findings would need to
to tax deductions for R&D spending, these be made widely available. Beyond that, it is
incentives could include temporary consumer up to firms to transform the research findings
subsidies for the purchase of new products into profitable products and services.
that have proven positive externalities (such But increasing R&D spending to the
as electric automobiles, for which China is government’s target of 2.2 percent of GDP,
already providing consumer subsidies). expanding basic research, and emphasizing
At the other end of the size spectrum, publishing and patenting is likely to have
SMEs should also be seen as an important only a small impact on productivity growth,
source of innovation, especially in sunrise unless the quality of this research and its
industries. 28 SMEs, after all, are the big commercial relevance and uptake are sub-
firms of the future, and every effort should stantially increased. Good research must be
be made to ensure they are not disadvantaged complemented by a stringent and disciplined
by regulations and are encouraged through process of refereeing and evaluating research
tax incentives. Innovative new entrants, espe- findings. The research community needs to
cially SMEs, face a perennial shortage of risk take the initiative here, although the govern-
capital. True, local governments and state- ment could provide the parameters.
owned enterprises are increasingly becoming China’s innovation objectives, increased
sources of venture capital and private equity effectiveness of its basic research, and
funds. Nevertheless, venture capital is scarce development of high-technology industries
for smaller private firms and SMEs trying to env isaged in the 12th Five Year Plan all
scale up. One partial solution is to increase depend on the availability of a vast range
lending by banks to small, hi-tech, private of technical skills for research, design, fab-
firms. The resulting creation of bank-led rication, production, information and com-
relational networks seems to work in other munication technology (ICT) support, and
countries, such as the United Kingdom and eventually marketing. By 2030, China is
the United States, and complements other expected to have up to 200 million college
sources of financing. Another approach is to graduates, more than the entire workforce
ensure that capital markets both allow SMEs of the United States. Moreover, the quality
access to funding, even though they may be of university training is improving rapidly:
O V E R V I E W 37
FIGURE O.5 The quality of China’s tertiary education system is improving rapidly
30
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in 2010, only five countries had more uni- qualifications, and do away with the rigid
versities than China in the top-ranked 500 boundaries that separate academic streams
universities of the world. China had 22 uni- from technical and vocational education and
versities in this list in 2010, compared with 9 training. To achieve the desired increase in
in 2003 (figure O.5). the volume and quality of skills and maxi-
Even so, the quality of tertiary educa- mize the returns from the limited supply of
tion more broadly is a matter of concern, quality instruction and teaching facilities,
and employers are experiencing a serious China will also have to rely more on inno-
shortage of skills. To address this shortfall, vations in ICT and pedagogical techniques
China needs to further accelerate governance involving the greater use of multimedia and
reform in universities, giving them greater flexible online training customized to the
autonomy while, at the same time, tighten- varying needs of students. The traditional
ing ethical standards in research. The best education approach of lecturing to large
universities must be allowed to mobilize classes may need to be rethought, with insti-
funding and appoint faculty that ensure high- tutions being encouraged to experiment and
quality, cross-disciplinary, postgraduate, and given the autonomy to do so. Universities
postdoctoral programs. They also need to can also take the lead in promoting public
develop innovative approaches to imparting lectures and exhibitions and in contributing
knowledge and analytical skills and set up to the teaching of science in local schools. In
well-staffed specialized research institutes. this context, opening the tertiary education
In this regard, China should encourage lead- sector to foreign investment and increasing
ing foreign universities to set up campuses in the participation of leading foreign univer-
China jointly with domestic universities and sities in China may help stimulate domestic
impart modern governance standards, teach- university reforms.
ing methods, and research management. There is also scope for encouraging inno-
In addition, both the private sector and vation through demand-side instruments
the government need to invest more in such as government procurement and stan-
improving the quality of human resources. dard setting. The key to success will lie in
Public-private initiatives can secure and genuine open competition. One way to begin
replenish the base of technical skills essen- would be to take EU or U.S. standards as
tial for innovative industries. The education a technical starting point while looking
system should emphasize competencies, not for ways to advance product performance;
38 CHINA 2030
another would be to involve industry leaders application of ICT in health care manage-
when setting standards. A third would be to ment, and institutional arrangements for
get industry associations to develop industry health care management and financing; and
standards based on consensus. • Green development—including the devel-
Technological capability is more likely to opment of more-economical renewable
advance in innovative cities. In the past three energy sources and new green technolo-
decades, coastal cities served as the incuba- gies, as well as the application of incentive
tors of technology development by attracting structures to change behaviors and encour-
large levels of foreign direct investment. But age green consumption.
industrial cities are not the same as innova-
tive cities. Innovative cities have depth and
quality of human capital (especially a high
Sequencing
share of science and technology workers) as The chapter on economic restructuring high-
well as mechanisms that support the genera- lighted the urgent importance of increasing
tion, debate, testing, and perfecting of new competition and lowering barriers to entry
ideas. Innovative cities have local knowledge and exit for increased efficiency and interna-
networks, institutions that support innova- tional competitiveness. These reforms are also
tion, an industrial base that employs scien- central in providing incentives for research
tific and technological talent, a few major and innovation activities. With more invest-
dynamic firms that invest heavily in R&D, ment in R&D, perhaps an equally important
and digital networks and online services. priority is to introduce an unbiased and inde-
Such cities thrive on the heterogeneity of pendent evaluation system for R&D spend-
knowledge workers drawn from all over the ing and current industrial policies supportive
country and the world. Moreover such cities of targeted technology development. Such
are closely integrated with other global cen- a system would give the government rigor-
ters of research and technology development. ous analysis to show what works and what
Finally, innovative cities are “sticky” because doesn’t, and where government financial sup-
their leading edge in design, assets, attributes, port needs to be reallocated.
and governance attracts global talent and Policies that will take longer to implement
does not let it go. Industrial cities can become include the institutional arrangements for
innovative cities—such as Tokyo, Stuttgart, innovation—university development, estab-
Munich, Seoul, Seattle, and Toulouse. But lishment of venture capital financial institu-
innovative cities do not have to be industrial, tions, and creation of nationally integrated
as Cambridge (U.K.), Helsinki, San Fran- R&D networks linked with global R&D
cisco, and Kyoto all show. networks. Many of the reforms will depend
International experience suggests that on other areas of the economy, notably fis-
innovative cities usually include one or more cal and financial sector reforms, but work on
leading research universities that compete these can nevertheless begin soon, recogniz-
and collaborate with each other. These uni- ing they will take time to bear fruit.
versities must interact with employers to mix As far as outcomes are concerned, once a
technical and soft skills as well as impart the sound institutional framework is in place and
latest industry know-how. Possible areas of as firms near the international technology
research include challenges associated with: frontier, a concerted effort will be needed to
strengthen basic research. The success of Chi-
• R apid urbanization—the development of na’s innovation policy will depend on how
energy-saving building materials, efficient effectively all branches of the research and
large-scale public transportation systems innovation network (research institutes, uni-
with low carbon emissions, and the infra- versities, central and local governments, state
structure needs of intelligent cities; and private enterprises) function together and
• H ealth care—including basic research how these efforts are leveraged internation-
in science and medicine, biomedicine, ally through global networks.
O V E R V I E W 39
Concerned that past and current economic percent. 30 And although air pollution levels
growth patterns are environmentally unsus- may be on a consistent downward trend, the
tainable and that the environmental base cost of illnesses from pollution has climbed
needed to sustain economic prosperity may as the population ages and urban populations
be irreversibly altered, the Chinese authori- and urban incomes grow.
ties proposed a new approach toward green Third, green development will help
development in the 12th Five Year Plan. The address a wide range of sector-specific
plan emphasizes continued rapid growth issues, such as energy security, urban liv-
together with ambitious targets for energy ability, agricultural output, and infrastruc-
efficiency, natural resource management, and ture constraints. The rapid growth of energy
environmental sustainability. This approach consumption has strained domestic supplies
is consistent with the concept of green devel- of electricity, raised coal prices, and made
opment used in this study, namely, a pattern China increasingly dependent on imported
of development that decouples growth from energy. With unchanged policies, China may
heavy dependence on resource use, carbon have to import 75 percent of its oil (making it
emissions, and environmental damage, and the world’s largest oil importer) and 50 per-
that promotes growth through the creation cent of its natural gas by 2030. The efficient
of new green product markets, technologies, use and better governance of land will help
investments, and changes in consumption reduce urban congestion and sprawl. Improv-
and conservation behavior.29 ing the quality of land and water will help
raise agricultural output. Better energy effi-
ciency will ease infrastructure constraints,
Why a Green Development
particularly for handling coal.
Strategy? Fourth, given rising and volatile commod-
China should give high priority to green ity prices, lowering the resource intensity of
development for many good reasons, both production will improve international com-
domestic and international. petitiveness and partially insulate domes-
First, new technological opportunities tic prices from fluctuations in international
make green development not just a realistic prices.
possibility but a potential driver of economic Fifth, while China’s green development
growth. If successful, green development will strategy is driven almost entirely by domestic
create new business opportunities, stimulate considerations, it will make a significant con-
innovations in technology, and potentially tribution to tackling global climate change.
make China globally competitive in sunrise China is now the largest energy user in the
industries. world and the largest emitter of carbon diox-
Second, quite apart from stimulating ide emissions, although its cumulative emis-
growth, green development would signifi- sions remain significantly below that of the
cantly improve the quality of China’s eco- United States (Baumert, Herzog, and Pershing
nomic growth. For example, less production 2005). Its annual per capita emissions have
and use of fossil fuels would greatly reduce already exceeded the world average and are
health losses from air and water pollution, still rising rapidly. Furthermore, China is one
water scarcity, and land subsidence. The of many countries that are likely to be most
costs of environmental degradation and seriously affected by climate change. Vigor-
resource depletion in China are estimated ous implementation of a green development
to approach 10 percent of GDP, of which air strategy will not only benefit China but also
pollution accounts for 6.5 percent, water pol- contribute toward global efforts to reduce
lution 2.1 percent, and soil degradation 1.1 emissions and mitigate climate change.
40 CHINA 2030
have) become more apparent. Instead, the high-level talent for innovative firms. New
government should consider market mech- entrants will stimulate competition and inno-
anisms such as taxes, fees, tradable per- vation; the production of electric vehicles, for
mits, tradable quotas, and eco-labeling. In example, should not rely solely on traditional
degraded ecosystems, rehabilitation is war- automobile manufacturers. Once such public
ranted, especially through expanded pay- policies spur private sector development in a
ments for ecological services in poor and eco- green sector, the focus could shift to the next
logically important rural areas (for example, vanguard sector. In this way, state invest-
upriver watersheds or downriver floodplains). ment can play a key role in spurring private
There is no better place to begin than by sector–driven technological innovation. State
ensuring that market prices of goods and ser- enterprises, on the other hand—especially if
vices reflect the true cost of production and they enjoy monopoly power, are subsidized
consumption to society. For example, the implicitly or explicitly, or are favored in any
price of oil, water, coal, and other natural way by discretionary government actions—
resources should include a tax to reflect the are more likely to hinder, rather than encour-
social and environmental costs incurred with age, green innovation.
their use. Complementary actions would In the early stages of developing green
involve removing direct and indirect subsi- industries, the government could “grow big-
dies, raising pollution taxes, and canceling ger fish by adding more water.” During the
export tax rebates for high-pollution, high- formative period of green firms, the authori-
emissions, and resource-intensive industries. ties could offer temporary tax relief, fiscal
(Indeed, export targets for these industries subsidies, preferential land allocation, and
should also be curtailed, if not abolished below-market financing. Once these firms
altogether.) Mining companies, state and are established, however, such preferential
nonstate, should pay royalties for the state- policies should be withdrawn. Any initial
owned mining resources they use. These loss in tax revenues will be more than made
measures, together with enforcement of the up by later increases. At the same time, if it
“polluter pays” principle, will help inter- becomes clear that international competitive-
nalize the pollution costs of enterprises and ness is unlikely to be achieved, this financial
reflect the true scarcity of the resources they support should be withdrawn.
use, as well as reflect their real competitive- Given the global push on climate miti-
ness in domestic and world markets. gation, the most effective way for China to
Such “no-regrets” policies not only establish itself as a global green technology
improve efficiency, they also support sustain- leader is by implementing stringent and effec-
able growth. But China’s green development tive policies to reduce greenhouse gas emis-
strategy has a loftier objective, which is to sions and to internalize the cost of carbon
make green industries a source of growth. emissions in the operating costs of enter-
To achieve this goal, industries that use green prises. Stringent emissions reduction poli-
technologies should be open to private and cies, achieved through such diverse market
foreign enterprises that compete on a level mechanisms as carbon trading, a carbon tax
playing field. Public investment should focus on fuels, technology standards, and regional
on public goods and services such as basic carbon partnerships, can act as a power-
research, appropriate infrastructure (for ful mobilizing force for innovation in green
example, smart grids), and a supportive envi- technologies. This, in turn, will help lower
ronment for private and foreign investment economic costs associated with improving
such as streamlined investment and copyright the quality of the environment and help drive
approval and rapid endorsement of new tech- overall growth.
nologies and products. The 12th Five Year Plan commits China
Because innovation is fundamental to to experiment with a carbon cap-and-trade
green growth, the government should fos- scheme to be rolled out gradually and on a
ter the conditions for creativity by permit- voluntary basis. As China embarks on its
ting new entrants as well as the import of own pilot emissions-trading schemes, it
O V E R V I E W 43
needs to evaluate policy choices between these standards could open up a huge market
price and quantitative instruments under the for green products and usher in a period of
guiding principles of efficiency and effective- robust growth in relevant industries.
ness. Beyond the more conceptual differ-
ences between these two approaches, China Public investment. While the bulk of new
can find valuable lessons in the experiences investment in green industries and technolo-
of many OECD countries, including exist- gies will be through enterprises, a sound
ing and proposed carbon-trading schemes in green development strategy will also require
Australia, Canada (Alberta), the European incremental public investments over and
Union, New Zealand, Switzerland, Tokyo, above the huge amount the government is
and the United States (both national and already doing. While China’s annual invest-
state-level schemes). ment in the treatment of industrial pollution
is roughly comparable to Europe’s, its total
Bet ter designed and enforced regula- expenditure on environmental protection
tions. Regulations are an important comple- activities is less than Europe’s by 0.3–1.1 per-
ment to market-based incentives to promote cent of GDP.31
green development, provided the authorities To improve environmental quality over
are able to monitor and enforce compliance the longer term, China’s government expen-
effectively. One important step will be the ditures related to the environment should be
establishment of strong environmental and at least half a percentage point of GDP higher
emissions technical standards that will shape than current levels. Incremental expenditures
behavior and create market incentives for should be focused not only on reducing pol-
green technologies. A key example is in the lution and solid waste but also on protecting
automobile industry, where standards can and restoring the health of China’s ecosys-
be set for fuel consumption. Another is in tems, water, and soil, and reducing potential
the appliance and lighting industry, where damage from flooding. Evidence from other
new standards for energy efficiency can countries indicates that such expenditures
have a direct and widespread impact, espe- have extremely high economic rates of return.
cially given the scale of urban construction. Therefore, a relatively modest incremental
A third involves setting national standards increase in environment-related expendi-
for climate-robust green buildings, urban tures would go a long way toward reducing
design, and transportation to avoid lock- the annual costs of environmental degrada-
ing in existing carbon footprints. Compli- tion and depletion (as noted, these costs are
ance with these standards can be increased approaching 10 percent of GDP).
through tougher inspections and buttressed One of the most important areas for
by market-based incentives (such as insur- increased public investment will also be
ance policies that require flood proofing or adaptation to climate change and, more
compliance with energy efficiency standards). broadly, the development of a climate risk
A fourth is the establishment of labels and management framework. Four of the ten
standards for green products, services, and Asian cities most vulnerable to rising sea
technologies so they are easily recognizable levels are in China. Careful planning and
and understood by consumers. And a fifth large public investments will be required to
is the implementation of recycling guidelines protect ports, infrastructure, and housing in
to reduce the need for new urban landfills these cities from extreme climate events. The
or incinerators by reducing the volume of government could invest more in public insti-
waste at the source. The government could tutions to analyze and disseminate weather-
also signal its seriousness about environmen- related and emergency response information,
tal goals by changing the way it conducts and it could also update and develop new
its own business. The most important and climate-robust technical standards for infra-
pervasive approach would be to introduce structure. Follow-on actions could include
green standards for the roughly RMB 1 tril- relocating transmission lines and distribu-
lion in government procurement each year; tion systems for power grids in coastal areas
44 CHINA 2030
exposed to natural hazards, and redesign- bold efforts are under way to deploy clean
ing storm water drainage systems in cities technologies, improve energy efficiency, and
so they can handle extreme weather events reduce greenhouse gas emissions. But green
projected for the next several decades. successes in some areas are not being scaled
The government also needs to prepare for up because most local officials remain under
climate-induced effects on agriculture and more traditional pressure to grow their econ-
to invest early in flood control, water man- omies and protect jobs.
agement, drought-resistant plant varieties One way to align national and local objec-
and agricultural methods, and research on tives is to introduce explicit performance
climate-induced effects on the economy. indicators for local governments that sup-
These investments would earn higher port green growth. China could consider
e conomic rates of return if they were using some of the measurable indicators sug-
complemented by measures to improve gested by the OECD (2010), along with other
water use efficiency (for example, through indicators that have been developed by local
consumption-based allocation and trading governments themselves. For example, some
of water rights) and expanded pollution reg- subnational governments—typically more
ulation that includes coverage of nonpoint affluent ones—have introduced quality-of-
sources of pollution. Finally, expanding cur- life indexes into performance appraisals for
rent programs that restore forest cover and public officials. Meaningful ratings depend
watersheds to meet the objective of restoring on publicly disclosed information, such as on
ecosystem health will have even broader the levels of air and water pollution and on
benefits. When investing in environmental the levels of environmental compliance across
improvements, it is important to use instru- industries. Fujian Province has included
ments that give value to environmental qual- ratings for environmental quality, energy
ity and then reflect these values in measures consumption, R&D, public safety, education,
used to monitor and rank the performance and rule of law in its performance evalua-
of local governments. tions. Guangdong Province recently started
To mobilize collective action on environ- using a “happiness index” as a supplemen-
mental protection and climate change, the tary measure of performance. A national poll
government needs to launch mass education in 2011 found an overwhelming 89 percent
campaigns to increase public awareness of of respondents in favor of including a happi-
these issues and the actions that individu- ness index as part of local government per-
als and households can take to contribute formance evaluations (Feng 2011).
toward the national effort. China can make Two other important ways to strengthen
emissions reduction and environmental pro- local institutions include, first, adjusting
tection a desirable lifestyle, thereby increas- the local tax structure away from land sales
ing market demand for green products. To and in favor of property and value-added
do so, it could mobilize nongovernmental taxes (see chapter 7). Among other benefits,
organizations, industry associations, and the greater use of property taxes would pro-
media. It can also change consumer behav- vide additional incentives for local govern-
ior by providing better information, through ments to increase land values by improving
energy efficiency labeling, for example. the local environment. Another step is to
strengthen interregional coordination to bet-
Local institutional strengthening and ter manage regional transportation, natural
reform. In the past, some of China’s most resources, and pollution control facilities.
successful reforms, such as the household Urban, transport, ecosystem, and environ-
responsibility system, originated as local mental problems are not confined to local
experiments that were later scaled up. The boundaries. Incentives are needed to encour-
same could be said for green development. age smart urban planning and risk man-
In a few cities such as Baoding and Rizhao, agement by local and regional governments
O V E R V I E W 45
China’s social development over the past in China and gradual ossification of social
three decades has been impressive. The coun- structures. In addition, many who escape
try has universalized compulsory primary poverty remain near poor, and a shock, such
education, expanded participation in higher as an illness, injury, or layoff, could easily
levels of education, sharply reduced the thrust them back into poverty (box O.3).
burden from infectious diseases, and dramat- Part of China’s income and consump-
ically increased health insurance coverage. tion inequality is the result of the “Kuznets
Labor has become more mobile, and a grow- effect”—which comes from structural change
ing number of rural migrants have moved to as labor moves from low-productivity agricul-
cities in search of employment. The “iron rice ture to higher-productivity manufacturing.
bowl” social protection system based on state But there are three other drivers of inequal-
enterprises has been transformed into a set ity, all related primarily to the inequality of
of social protection programs that are being opportunity in accessing social services and
expanded and consolidated. social entitlements:
Going forward, social policy will need to
focus on establishing a welfare system appro- • C hina’s decentralized fiscal system and
priate for China in 2030—one that promotes the mismatch at the local government level
human capital development, provides basic between resource availability and social
social welfare but avoids welfare dependency, spending responsibilities have led to large
and creates social conditions supportive of differences in government expenditures
growth and development. Its foundation per capita on social services—between
should be a basic level of security provided rural and urban areas within provinces,
to all, with a particular focus on the poor. and between coastal and interior prov-
Just as important, policies should promote inces. The inadequacy of fiscal resources at
equality of opportunity in education, health, subprovincial levels also makes many pub-
employment, and entrepreneurship to real- lic service units (PSUs) behave like private
ize everyone’s full potential and substantially sector profit-maximizing units and distorts
narrow disparities in income, living condi- incentives for service provision. Spending
tions, and wealth that will allow people to differentials have resulted in disparities in
enjoy a higher standard of living and share access. For example, progression rates of
the fruits of development. rural students to senior secondary school
remain far below those of their urban
counterparts, and relatively few of them are
Key Problems and Risks entering universities. Another example is
China’s social policy faces four broad prob- public subsidies on health care, which dif-
lems and risks. The first is relatively high fer by several multiples between urban and
inequality, some dimensions of which may rural residents. Just as important, spending
have even worsened in recent years. Inequality differentials have resulted in “inequality of
remains high in incomes, consumption, and quality” in education and health services
asset ownership, as well as in access to qual- and in the degree of financial protection
ity education, health, jobs, and social protec- offered by pension and health insurance
tion programs across and within regions and programs. Such disparities in turn lead to
especially between rural and urban areas. inequality in job opportunities, productiv-
Although regional inequality appears to have ity, and eventually incomes, as well as in
narrowed to some extent, other dimensions of risk management capacities.
inequality, such as housing wealth (account- • I nstitutional arrangements and policies
ing for some 60 percent of total household reinforce and, in some cases, accentuate
wealth), have increased. Rising inequalities inequalities; examples include the differ-
increase the risk of reduced vertical mobility ent rural and urban social entitlements
O V E R V I E W 47
Over the past three decades, more than 500 million for agricultural investments can improve the con-
Chinese have moved out of the ranks of the poor— ditions of poor rural residents and migrants, while
an achievement of historical significance. At the also improving opportunities in agriculture through
same time, China still has a large number of poor additional investments in rural infrastructure (nota-
people—204 million in 2005 when applying a $1.25 bly water, renewable energy, and roads).
a day poverty line (purchasing power parity) and Fourth, returns to labor can be raised by relaxing
household consumption as the measure (Ravallion disincentives to rural-urban migration and providing
and Chen 2008). Reaching those that still remain migrants affordable access to urban services through
below this international poverty line will prove dif- the phased reform of the hukou system. These steps
ficult. Many are in remote western provinces, and would not only raise household incomes of the poor
the rest are dispersed throughout the country. Many and reduce poverty and inequality, they would also
more are “near poor”—just above the poverty line boost household consumption, and at the same
and only one crisis away from falling back into pov- time allow firms more time to make the adjustment
erty. The challenge facing the country will therefore from labor-intensive to skill-intensive production.
increasingly be to reduce risks faced by the near- Complementary efforts could include improving the
poor and tackle transient poverty. The recommenda- education and skill base of potential migrants before
tions below are designed to meet this challenge. they migrate, providing assistance to migrants to
First and foremost is the need for continued rapid reduce job search and information costs, increas-
growth. Throughout the world, higher growth has ing connectivity between rural and urban areas,
meant greater likelihood that incomes and con- and improving the investment climate in the poorest
sumption rise above the poverty line for increasing western provinces where the bulk of poor potential
numbers of people. But poverty is not just about migrants reside.
income—it is also about access to affordable qual- Fifth, notwithstanding significant improvement
ity health care and education and the ability to in recent years, social protection instruments—
deal with risks. Indeed, China’s rising inequality is health, unemployment, and pension insurance—
largely the result of inequality of opportunity; one’s need to be strengthened to meet two objectives:
connections, place of birth, employer, and parental insuring the poor against a variety of risks with
circumstances still play a large role in gaining access adequate but sustainable financial protection; and
to critical social services. making full portability of entitlements a reality to
Second, it follows that identifying the poor promote occupational and geographical flexibility
and vulnerable through a metric broader than just for workers, giving them the freedom to seek better
income—one that includes access to public services and more productive jobs wherever they may be.
and ability to deal with uninsured risks—will help Finally, because local governments shoulder the
targeted poverty reduction programs and keep pov- bulk of the responsibility for implementing and
erty reduction at the top of the government’s devel- financing these programs, they cannot be expanded
opment agenda. China has developed a household- without fiscal reforms (identified in chapter 7).
based targeting system for providing direct assistance Bridging the gap between expenditure responsibili-
to the poor, but there seems to be scope to improve ties and revenue sources is one priority, and reducing
this program through a more explicit proxy-means regional disparities in fiscal performance is another.
targeting system based on easily observed household This in turn warrants strengthening the fiscal system
characteristics that are correlated with income. so it can shoulder these additional responsibilities.
Third, universal access to quality health care, sec-
ondary and higher education services, and finance
created by the hukou system, and the migration from rural areas to cities, from
fragmented institutional arrangements interior to coastal provinces, or even from
and delivery systems that limit portability city to city, because most migrants are
of entitlements and impede labor mobil- denied access to affordable health, edu-
ity. Thus, notwithstanding recent local cation, housing, and pension coverage to
hukou reforms, there remain obstacles to which urban residents have access by right.
48 CHINA 2030
• Other factors also contribute. For exam- and poses future challenges for social policy
ple, high taxes on labor—to pay for social formulation and the economy more broadly.
insurance—limit formal sector employ- With rising life expectancy and with total
ment opportunities, lower remuneration fertility at only around 1.5, the country
for workers, and bias investment toward is “growing old before growing rich.” As
capital-intensive technologies. In addition, the country ages, the labor force will peak
weak labor market institutions, in particu- around 2015 and then start to shrink (albeit
lar the wage determination system, do not gradually at first), and health and pension
provide an effective platform for balanc- costs will escalate. A smaller workforce,
ing the interests of workers, employers, combined with higher dependency rates, puts
and sustained competitiveness to ensure a premium on deepening human capital to
the growth of labor earnings in line with enhance labor productivity, places additional
increasing profits. The labor market is demands on education and training systems
segmented between and within localities, to increase relevant skills, and heightens the
often according to the hukou, income, and importance of ensuring that labor is allo-
social status of workers. As a result, work- cated efficiently. Moreover, the aging of the
ers without family or social connections population means that the disease profile has
are disadvantaged in accessing government changed sharply toward noncommunicable
or public enterprise jobs. The lack of porta- diseases—a trend that will only accelerate—
bility of social entitlements and differences requiring a shift in health care strategy from
in worker wage and entitlement terms curative to preventive care and better health
between the formal and informal sectors, education for children and adults. The fis-
and between the private and public sectors cal costs of health and pension programs
(state enterprises, PSUs, and government will need to be contained through greater
departments) exacerbate the segmentation. emphasis on primary care rather than hospi-
tals, structural reforms in pension systems,
A second challenge is inefficiencies in efficiency improvements in service delivery
social service delivery stemming from dis- driven by information and communications
torted incentives and market structures. technology (ICT), and better incentives for
Public organizations and agencies exercise health care providers.
a monopoly or quasi-monopoly in delivering And the fourth challenge is rising expec-
social services and face little competitive pres- tations, especially among second-generation
sure to improve efficiency or quality. Pressure migrants and a rapidly growing middle class,
from users of services is also limited because for higher wages, greater income security,
government incentive structures are not based better social services and greater equality in
on downward accountability. As noted, the access, and a voice in the design and deliv-
revenue and incentive structure in health ery of those social services. There is grow-
and, to some extent, education services ing dissatisfaction with service providers and
encourages public providers to maximize increasing expectations for more accountable,
revenues and to act as profit-maximizing affordable, and equitable social programs.
private sector entities. This results in some The expectations and interests of different
undesirable outcomes: for example, between groups may not be aligned, however, and may
a third and a half of admissions to hospitals even conflict with one another, raising con-
in China are estimated to be unnecessary; the cerns that unless these deep inequalities are
average number of days in hospital is double reduced, social unrest could grow.
the OECD average (World Bank 2010); and
school selection fees in urban areas drive a
further funding wedge between “key” schools
Proposed Reforms
and regular schools, excluding many deserv- Based on these problems and challenges,
ing students. social policy reform has three objectives.
The third challenge is rapid aging of the The first is to reverse rising inequalities in
population. China’s demographic transi- income, consumption, and access to public
tion will be among the most rapid ever seen services and ultimately to ensure that equal
O V E R V I E W 49
opportunities are available to all, irrespec- rely on competition with appropriate regula-
tive of whether someone is migrant or local, tion; and accountability to citizens for qual-
old or young, in the city or countryside, or ity services by increasing the role of civil soci-
from the coast or interior. The second is to ety organizations in monitoring and in some
help households better manage employment, cases giving them co-responsibility for man-
health, and age-related risks, and ensure a aging social services. Emerging local experi-
basic level of security. The third is to promote ence in China with citizen participation in
greater accountability of service providers, oversight and management of service delivery
public and private, to ensure that services are (for example, through school councils, elec-
made available in the right amount, at the tion of school principals, and medical dispute
right place, and of the right quality. mediation councils), and in providing feed-
To achieve equality of opportunity for back on service quality (for example, through
all by 2030, the policy focus will require web-based public feedback and citizen score
expanding opportunities to include all citi- cards) suggests that China can benefit from
zens so they can access quality, affordable more active citizen participation in service
health and education services and share in, as delivery as many other countries have.
well as contribute to, the country’s prosperity To achieve these objectives, China needs
through equal participation in the labor mar- to develop a vision, core values, and guiding
ket. To become a competitive high-income principles for social policy reforms. Policy
economy, China must deepen and broaden makers need to ask two questions: What level
its human capital base and put it to the most of social services and protection should the
productive use. state aim to finance, and how much of the
A more complex and dynamic economy burden should be shouldered by individu-
also brings greater risks for workers during als and households? And what should be the
and after their working lives, and reducing roles in service provision of government, the
these risks requires measures that enhance private sector, and communities? In China,
security in old age and help workers bet- the answer to the first question will depend
ter manage risks inherent in a more flexible on the amount of fiscal resources the gov-
labor market. The provision of such “flexi- ernment intends to devote for this purpose.
curity” requires making structural reforms Extending the current level of urban ser-
in pension and unemployment insurance vices and social protection to rural residents
systems so that workers have reasonable and and migrants—well over half the popula-
portable support in old age or when unem- tion—will itself impose a significant burden
ployed, while avoiding an ever-increasing on fiscal resources. Therefore, additional
burden on the working population; ensur- government-financed social services should
ing comprehensive coverage of pension be undertaken with considerable caution and
insurance, in particular for rural citizens, only if they do not strain the fiscal system (see
migrants, and informal sector workers in chapter 7). At the same time, international
urban areas; preparing for and gradually experience suggests that social spending
expanding long-term care for the aged and accounts for the bulk of incremental public
terminally ill; and strengthening labor mar- expenditure as countries get wealthier. China
ket institutions to enable wage bargaining will want to strike the appropriate balance
and dispute settlement mechanisms that bal- and avoid the current predicament that many
ance the interests of workers and employers. advanced countries face—a fiscal crisis that
Underpinning these reforms is the cross- has arisen, in part, from financially unsus-
cutting need to promote greater accountabil- tainable entitlement programs.
ity for results in social services and social pro-
tection programs. Accountability would need
Achieving Equality of Opportunity
to come through three channels: administra-
tive systems that monitor performance and Providing equal access to quality, afford-
encourage quality and equity in service deliv- able education and health care for all by
ery; market-based mechanisms that encour- 2030 requires action in several areas. In the
age the private delivery of public services and first place, the challenge will be to continue
50 CHINA 2030
fiscal and structural reforms that ensure the role for communities and the nongovernmen-
wider framework for equitable and sustain- tal sector, often with financial support from
able service delivery. But these will need to the state. The experience of OECD countries
be accompanied by sectoral reforms that pro- suggests a range of innovations in unbun-
mote opportunities to build human capital dling financing, provision, and regulation of
and allow people to be healthy and produc- social services that China could consider. At
tive across the life cycle. the same time, achieving plurality of social
Based on a vision of China’s future social service provision while ensuring quality will
policy, the government will need to put in require the state to assume a greater role in
place the appropriate fiscal measures— licensing, accreditation, oversight, and regu-
increased aggregate social public spending lation of providers.
commensurate with the level of development, Third, integration of ICT in social service
lower payroll taxes to increase labor intensity and social protection delivery systems should
in production and encourage formal sector be increased. This integration could include
employment, and stronger fiscal equalization electronic medical records, telemedicine, dis-
across local governments at the subprovincial tance learning, and high-functionality smart
level (see chapter 7). cards that allow individuals easy access to
In addition to fiscal measures, several their key medical data from anywhere. A
structural reforms in the social sectors can good ICT system will permit exchange of
improve the efficiency of service delivery and data and financial information across the
help achieve equality of quality. First, human country, dramatically reducing administra-
resource management should be reformed tive costs and costs to the population. But
for service providers, through effective moni- realizing such gains requires harmonization
toring of performance on key outcomes, of data standards and systems to end the cur-
strengthening the link between provider per- rent situation of major investments by local
formance and career progression, providing authorities in IT systems that are incompat-
incentives that discourage rent-seeking, and ible with one another.
ensuring that the best health providers and Fourth, intra- and intersectoral coordina-
teachers also provide services to underprivi- tion is needed for policy development and
leged urban and rural areas (for example, delivery of social services. As economies
through rotation policies for teachers and age and grow richer, effective social services
outreach programs for hospital doctors to increasingly require better cross-sectoral
periodically provide services to poor patients). coordination. For example, within health
Second, nonstate provision of social ser- services, coordination of care across levels
vices should be increased, and different of service is critical for managing noncom-
stakeholders (communities, commercial and municable diseases, and for education, the
nonprofit providers, and even households boundary between technical and vocational
themselves) given greater co-responsibility. education and training and academic streams
The state cannot and probably should not becomes more porous. Across sectors, new
“do it all” as it seeks to provide a wider and needs such as long-term care require inputs
deeper range of social services and social from social welfare, health, and other agen-
protection programs. Involving the nonstate cies, while labor policy for older workers
sector will open up new possibilities, from requires coordination of social security and
private hospitals and clinics, to private pre- training initiatives. Developing an adminis-
schools and universities, to involvement of trative system of cross-sectoral coordination
private insurers and third-party administra- requires the transformation of government
tors. In some fields, such diversification may functions and responsibilities.
also benefit from enhanced partnerships These structural reforms need to be
with international firms. New approaches to complemented by a range of sector-specific
financing will also be required. Greater plu- policies to promote equality of quality from
rality of service provision also offers a greater young children to the elderly.
O V E R V I E W 51
Education. A key priority in improving FIGURE O.6 Unequal spending on early childhood development
equality of quality will need to be an equal across Chinese provinces
start in life for all children, especially in the
14,000
areas of early childhood nutrition and educa-
tion for rural and poor children. These are 12,000
some of the highest return social investments
the current hospital-centric model to one promote administrative efficiency, and facili-
that manages care across levels of the system tate portability of entitlements. Greater pool-
with a revitalized primary health care system ing would also pave the way for greater inte-
playing the key role in care coordination. Pri- gration of schemes across rural and urban
mary health care, in turn, will need to have areas. In this process, health insurance agen-
stronger links to the broader health delivery cies could gradually ensure value and qual-
system to manage the epidemic of noncom- ity of health services, including through con-
municable diseases and to control the escala- tracts with public and private providers. More
tion of health service costs. Up to 85 percent broadly, the experience with the New Coop-
of patients with noncommunicable diseases erative Medical Scheme and urban residents’
need primary care because their conditions health insurance schemes points to the need
are best controlled with self-management. to consider over time an appropriate balance
This care can—and should—be provided and between financing from health insurance con-
managed by a strong primary health care sys- tributions and from the budget. Developments
tem that is well-coordinated with the broader in the rest of Asia point to an increasing role
health care system. Greater reliance on pri- for general revenues in financing health care,
mary health care will mean less demand for especially for the poor.
hospital-based care, which has been a key In parallel, provider payment reform must
factor behind the major cost escalation expe- be accelerated to increase the incentives for
rienced in the Chinese health system in recent all health providers to produce efficiency and
years. Unnecessary admissions and over- quality. A number of efforts have been made
treatment have made hospital costs in China to control costs in the health system, includ-
a significant outlier compared to a range of ing drug lists, zero markup policies, and con-
OECD countries. trols on the use of costly medical equipment
The necessary reorientation to primary and procedures. But without a more funda-
and preventive care in China will be diffi- mental shift away from the current provider
cult to achieve without further progress on payment systems, the basic provider incentive
hospital reform. Fundamentally, it will be structure will continue to drive inefficiencies
necessary to change the current incentives and inappropriate care. Changes in incentives
for public hospitals and doctors to behave will need to be complemented with a stronger
like private providers. The key reform will emphasis on professional ethics among pro-
be setting firm budget constraints on public viders and tools for greater accountability of
hospitals through a more active purchas- providers to patients.
ing role for health insurance agencies and Going beyond the health system, China’s
the use of information to monitor and pro- aging population will increasingly require
vide better incentives for improved provider aged and long-term care (ALTC), as the 4-2-1
performance. Evaluating the experience in extended family structure places greater care
improving hospital governance and manage- burdens on adult children. To date, the policy
ment will also be important. Given the diver- framework for ALTC is limited, and its mul-
sity in hospital organizational reforms across tisectoral nature has posed institutional chal-
China, it is necessary in the short run to have lenges to developing a coherent approach.
more rigorous evaluation of different models Nor are there enough appropriately trained
and the lessons from them. personnel to provide required services. Given
Reforms of the health delivery system will the early stage of development of ALTC in
be effective, however, only with a broader China, a first need is deciding on the appro-
reform of the incentive structure for health priate mixture of public and private financing
care providers, including health financing and and provision and the role of the public sector
provider payment arrangements in particu- for different population groups. These deci-
lar. An initial step will be to raise the pool- sions would benefit from extensive piloting
ing level of the health insurance system to and local experimentation. Another key issue
harmonize benefits across different schemes, will be the institutional and coordination
O V E R V I E W 53
arrangements for the ALTC sector, given system. Since the 1990s, China has put in
the number of public and private actors place a comprehensive package of social
involved. Once these questions are decided, a p rotection programs at a speed that is
framework for ALTC can be developed that unprecedented internationally. These include
involves mixed models of providers (state, pension programs for urban and rural resi-
nonstate, communities, and households) and dents; pension, unemployment, sickness,
ensures that basic standards of care are met. workplace injury, and maternity insurance
for urban sector workers; and a national
social assistance scheme that now covers
Achieving Flexicurity
more than 70 million people, among others.
An increasingly open economy with greater But there remains a big unfinished agenda to
labor market flexibility brings greater risks deepen the reforms already introduced.
for workers during and after their work- The first item on this agenda is the need
ing lives. To help them manage these risks to expand coverage of the pension system
requires flexicurity—labor market and social among rural residents, migrants, and other
security institutions that promote flexible urban informal sector workers. Until very
and efficient allocation of workers and also recently, China had pension coverage well
ensure they have decent working conditions below that expected of a country with its
and adequate social protection during and per capita income (figure O.7). Low cover-
after their working lives. age has been driven by the absence (until very
A first element of flexicurity is a set of recently) of a national rural pension program,
labor market policies and institutions that the very low participation rates of migrant
promote an internationally competitive workers in urban schemes, and the absence
workforce in which workers share in the ben- until mid-2011 of a pension scheme for urban
efits of growth and also enjoy some social informal sector workers (30–40 percent of
protection. This would first require eliminat- the urban labor force). Current policies com-
ing the remaining barriers to labor mobil- mit to comprehensive coverage of the pen-
ity—the most critical measure being phased sion system by 2020, and new schemes for
reform of the hukou system (see chapter 3). rural workers and urban residents represent a
To improve labor mobility, segmentation major step in this direction. To achieve com-
among social protection programs needs to prehensive coverage, the authorities could
be reduced to promote an integrated and consider a system with three pillars: a basic
seamless social security system. Social secu- benefit pillar that provides minimum poverty
rity entitlements should be portable within protection to the elderly through noncon-
and across provinces, and with central gov- tributory social pension benefits (this would
ernment involvement reducing interprovin- build on the general approach being taken in
cial disparities in social insurance protection. the new rural and urban residents’ pension
In parallel, labor market institutions will be schemes); a contributory pillar with a man-
needed to support wage determination that datory notional defined contribution scheme
is driven less by administrative direction for workers with wage incomes (modifying
and more by collective bargaining where the the current urban pension system) and a vol-
interests of workers and employers are bal- untary defined contribution pension savings
anced. Finally, by 2030, as people live longer scheme for urban and rural residents with
and healthier lives, the retirement age will nonwage incomes; and a supplementary sav-
need to rise gradually. Flexible work arrange- ings pillar for the urban and rural popula-
ments could make continued work more tion providing voluntary occupational and
attractive, and life-long learning opportuni- personal pensions that may supplement other
ties for workers would help reduce the deple- pension benefits.
tion of human capital with age. The second priority is the need to ensure
The second element of flexicurity is a the fiscal and financial sustainability of exist-
robust but sustainable social protection ing urban pension systems in order to ensure
54 CHINA 2030
FIGURE O.7 Pension coverage rate of the active labor force, pension contribution rates to enhance the
various countries, mid-2000s competitiveness of Chinese workers. Finally,
voluntary supplementary saving arrange-
120
ments will need to be expanded for those
100 workers wanting pension replacement rates
above the basic level.
The third priority is the reduction of frag-
% of labor force
80
mentation across different subsystems of
60 the pension system. The integration agenda
has both a spatial dimension and a cross-
40
program dimension. Across space, greater
China portability in the short run would be com-
20
plemented by pooling funds at higher levels
0 over time, first at the provincial level and
0 10,000 20,000 30,000 40,000 50,000 60,000 ultimately at the national level. Across pro-
Income per capita (PPP) grams, within the urban schemes, PSU and
civil servant schemes should be gradually
Source: Holzmann, Robalino, and Takayama 2009.
Note: PPP = purchasing power parity.
merged with the urban workers’ scheme in
line with emerging global practice. In addi-
a credible commitment to basic security in tion, national policy can build on the grow-
old age. Pension reform will need a robust ing provincial practice of merging rural and
financing strategy that ensures basic benefits urban residents’ schemes so that mobile
consistent with fiscal constraints. A key step workers have a more harmonized and ulti-
is phased increases in the retirement age in mately integrated system as they follow pro-
line with higher life expectancy, and gradu- ductive work opportunities.
ally harmonized retirement ages for men Finally, there is a broader need to build
and women. In addition, there is a need to a more coherent social protection system,
address the issue of inadequate returns on where the individual elements are aligned and
contributions in the current urban system, the system is more than the sum of its parts.
while controlling investment risks (for exam- The Chinese government has committed to
ple, through a notional defined contribution guaranteeing the poor a decent living with
approach). Pension reform will also require access to public services, including education,
a strategy for financing the legacy costs of health, and housing by 2020, and the social
the urban system. Pension liabilities for those protection system will play an important
under the previous pension regime—so-called role in this process by assuring a minimum
legacy costs—are estimated to range from 82 standard of welfare for the poor (State Coun-
to 130 percent of 2008 GDP, depending on cil 2011). In addition, the medium- to long-
assumptions. An appealing option for financ- term agenda in social protection will require
ing this obligation would be to gradually pay greater coherence across insurance, social
it down through incremental fiscal resources, assistance, and other welfare and antipoverty
while all the time ensuring that assets accu- programs to ensure not only that the poor are
mulating in pension funds are properly man- protected but also that the near-poor are not
aged and yield rates of return adequate to subject to “poverty traps,” where low-wage
meet future liabilities. This approach in turn earners are worse off than those receiving
would create space for future reduction in social assistance.
O V E R V I E W 55
Over the past two decades, China has fiscal space. Finally, although the share of
reformed its fiscal system significantly. A public expenditures on social and environ-
major overhaul in 1994 focused on enhanc- mental services has climbed in recent years,
ing revenue mobilization and revamping the large social and environmental agenda
national-provincial fiscal relations. A new over the next two decades will entail further
tax system with a value added tax at its core increases in public spending.
laid the foundations for a significant increase At the same time, it is important that
in the ratio of revenue to GDP. The reforms China preserve fiscal stability to protect
also launched important changes in China’s against future macroeconomic shocks. The
system of intergovernmental fiscal relations. demand for additional budgetary resources
Changes in tax assignments increased central to address social and environmental needs
government revenues, laying the foundation will arise at a time when China’s total public
for larger and more rules-based transfers to spending is already high relative to GDP, and
subnational governments to help tackle fis- the emergence of structural budget deficits
cal disparities. The combination of these could potentially erode available fiscal space
reforms put public finances on a solid foot- and pose a risk for future fiscal stability. So
ing, allowed China’s government spending to the challenge China faces is to contain the
grow to levels comparable with other econo- level of government expenditures as a share
mies with similar incomes, and paved the of GDP while at the same time changing the
way for increased social and environmental composition of those expenditures to address
expenditures. evolving strategic priorities. This will require
fiscal discipline as well as budgetary proce-
dures that allow reallocation of resources
Key Fiscal Challenges over time from lower- to higher-priority gov-
Now a key challenge is to further strengthen ernment programs. How China deals with
China’s fiscal system, improve fiscal sustain- two key factors—its decentralized fiscal sys-
ability, and align it with the evolving role tem, and its public finance management sys-
of government to support the delivery of a tem—will be central to achieving these objec-
large economic, social, and environmental tives. Consider each in turn.
agenda by 2030. For example, in the eco- China is among the most decentralized
nomic sphere, improvements in the efficiency countries in the world when it comes to gov-
and independence of the financial system ernment expenditures, but government rev-
will mean that some of its quasi-fiscal func- enues are highly centralized. Its subnational
tions will need to be transferred gradually governments account for around 80 percent
to the fiscal system. Additionally, as state of total budgetary expenditures and bear
enterprises are subjected to hard resource responsibility for the provision of vital public
constraints and better credit evaluation cri- services including basic health and education,
teria, their restructuring, closure, or owner- pensions, unemployment insurance, disabil-
ship diversification may require budgetary ity, housing, infrastructure maintenance, and
support. A strong fiscal system will also be minimum income support. But local govern-
central to China’s objectives to meet domes- ment revenues—available through the tax
tic and external economic shocks as and revenue-sharing mechanism and intergov-
when they arise—the 2009–10 fiscal stimu- ernmental fiscal transfers—are not commen-
lus package being an example of what can surate with local government expenditure
be achieved when an economy has adequate responsibilities. On average, these “revenues”
56 CHINA 2030
from the center finance 40–50 percent of the bulk of government expenditures, includ-
expenditure burden of local governments. ing center-provincial revenue sharing and
Moreover, provincial governments have con- resource transfers), the government-funded
siderable discretion in transferring resources budget (comprising off-budget revenues
to subprovincial governments, and it is at and expenditures), the state capital budget
the local level in poorer jurisdictions that the (financed by dividend payments from state
imbalance is most acute between available enterprises), and the social security fund
resources and responsibility for public service budget. The absence of a comprehensive bud-
delivery. get makes it difficult to assess or alter the
While intergovernmental transfers are aggregate allocation of government resources
common in most large countries, China is across priority sectors and programs. Min-
unusual in the discretionary power wielded istries have substantial latitude in allocat-
by provincial governments and the fiscal ing earmarked transfers to the provinces.
stress experienced at the lowest level of local Few budget details are made available, and
government responsible for service delivery. there is little oversight by higher authorities
In pursuit of rapid growth and motivated to or discussion about implicit intra- or cross-
“collect resources to do big projects,” subna- sectoral priorities. Moreover, little informa-
tional governments have identified innova- tion is available on whether governments
tive ways to raise resources locally. China’s spend money according to budgetary alloca-
subnational governments derive substan- tions (except at the broadest levels), whether
tial revenues from fees of various kinds, the government expenditures and programs lead
sale of land use rights, and taxes on real to the desired outputs, and whether the out-
estate transactions. Distorted incentives to puts lead to the expected outcomes. Internal
develop land can lead to corruption, forced audits focus on detecting malfeasance, not
land acquisition, inefficient use of land, and program performance. Additionally, the bud-
abuse of government power. Because local get cycle and the expenditure cycle are not
governments are prohibited from borrowing synchronized. Thus, even though the fiscal
directly from banks, they have established year starts at the beginning of the calendar
special purpose vehicles that are free to bor- year, the budget is not finalized until the end
row for infrastructure and urban construc- of the first quarter of the calendar year. This
tion, financed principally by local land sales delay forces government departments to start
and bank loans, often with land as collateral. program implementation before budgetary
Such activities have contributed to systemic authorization. While that may seem a small
risks in the financial sector (see chapter 3). procedural matter, it tends to reinforce the
Arguably, the availability of revenue and view that the budget itself is a formality with
borrowing outside the general budget has little operational significance for local gov-
fostered some degree of local government ernments and central ministries.
independence (especially because most trans-
fers from higher levels of government are for
earmarked expenditures). But not only have
Proposed Reforms
locally generated revenues led to distortions Over the next two decades, then, China’s
in land and financial markets, they may also challenge is to reform its fiscal system in the
have exacerbated inequalities. Some poor following four ways: first, to contain gov-
provinces, townships, and villages may not ernment expenditures as a share of GDP
be able to raise enough resources locally to but change their composition in line with
provide quality services, and poor house- China’s new challenges, with higher alloca-
holds cannot afford their high cost (see tions for social and environmental public
chapter 6). investment and recurrent expenditures; sec-
Finally, government financial manage- ond, to improve the efficiency of revenue
ment, fiscal transparency, and accountabil- mobilization, including through changes in
ity are key issues. China currently runs four the structure of revenues; third, to reform
budgets—the general budget (comprising the intergovernmental fiscal relations, including
O V E R V I E W 57
through better alignment between resource these incremental expenditures could be met
availability and expenditure responsibility at through efficiency improvements in current
different levels of government; and, fourth, expenditure programs and the rest through
to strengthen the management of government reallocation away from lower-priority invest-
finances and improve the efficiency of public ment budgets (such as infrastructure).
expenditures. Managing such a fundamental shift in
government expenditure composition by
2030 while containing its total share in GDP
Containing Growth of Government
will prove to be a major challenge. China’s
Expenditures While Altering Their
total government budget and off-budget
Composition
expenditures as a share of GDP are about
The composition of government spending the same as some other upper-middle- and
will need to evolve to reflect China’s chang- high-income countries. It would be inappro-
ing development challenges. Most notably, priate to push it higher. At no point should
the next 20 years will see a pressing need to China fall into the “high-income trap” by
further increase spending on health, social expanding entitlements to the point that they
protection, and environmental protection. become fiscally unsustainable in the long run.
These increases will be important to provide To prevent such an occurrence, a debt and
social security and a basic set of public ser- fiscal sustainability analysis that accounts for
vices and to build human capital and expand contingent liabilities and considers alternative
opportunity (see chapters 5 and 6). stress tests should be required as a condition
The amount of public spending relative to for the approval of each annual budget.
GDP for social and environmental protection
will depend on choices the authorities make
Improving the Efficiency of Revenue
in the current and upcoming five year plans.
Mobilization
While China’s reported spending on environ-
mental protection appears to be in line with Since the 1994 fiscal reforms and subsequent
OECD and upper-middle-income country improvements, China has been very success-
standards, the significant backlog and new ful in mobilizing revenues. But it has sig-
challenges in this area could well require a nificant untapped potential to increase the
further scaling up of such expenditures over efficiency of its tax structure. These are con-
the next two decades. In health, however, the centrated in six areas.
scaling up of China’s public expenditures will First, higher taxes on energy (carbon),
need to be significant. If high-income coun- water, natural resources, and pollution
tries are used as benchmarks, the share of will encourage resource conservation while
public spending on health in GDP can range improving environmental outcomes and gen-
from 4 percent (in Switzerland) to near 8 per- erating revenues (see chapter 5). 32 Second,
cent (in Iceland). China’s current spending is raising SOE dividend payments to the general
about 2.5 percent of GDP. budget (perhaps through the intermediary
Using these and other international bench- structure of state asset management compa-
marks as reference, China could potentially nies; see chapter 3) will spur more efficient
aim to increase public expenditures by 1–1.5 investment planning in SOEs while also gen-
percentage points of GDP for education, 2–3 erating significant budgetary resources. 33
percentage points for health care, and another Third, additional revenues can potentially be
3–4 percentage points to fully finance the mobilized from personal income taxes. These
basic pension pillar and to gradually meet the taxes make up only 1 percent of China’s
legacy costs of existing pension obligations. GDP, compared with an average of 5.85 per-
These add up to an incremental fiscal outlay cent in high-income countries.34
of around 7–8 percent of GDP, a reasonable Fourth, enhanced taxation of motor vehi-
estimate to bring China’s aggregate “social cles and parking (as a near-term option) and
expenditures” by 2030 to near the lower end congestion pricing (as a longer-term option)
of the range of high-income countries. Part of would lead to more efficient and livable cities
58 CHINA 2030
and better environmental outcomes. Fifth, FIGURE O.8 Local governments: Large
property taxes will encourage more effi- expenditure responsibilities, inadequate revenues
cient use of land while also reducing urban
90
sprawl and lowering local government depen-
80
dence on funds from land acquisition. While
70
promising, property taxes are unlikely to be-
60
come a major source of overall revenues for
50
Percent
some time; very few developing countries
raise more than 1 percent of GDP from this 40
China has benefited enormously from global- global effects of the Great Recession might
ization and by opening to the global econ- have been even worse than they were. In
omy. Open trade policies worldwide helped addition, China’s outward foreign investment
sustain global demand for Chinese products is playing an increasingly important develop-
just as opening its market has sustained Chi- ment role in developing countries.
nese demand for global products. China’s Going forward, this mutual dependence
openness to foreign capital helped improve between China and the world economy will
domestic economic efficiency by encourag- only increase. China’s large and growing mid-
ing competition within China and provid- dle class will become an even more important
ing access to cutting-edge technology. China source of global demand, the country’s indus-
imported foreign practices in a host of areas trial upgrading and expanding trade will
ranging from banking regulation to product lead to further specialization and increased
standards. And substantial inflows of foreign efficiency in world markets, and its increas-
direct investment helped drive productivity in ingly educated labor force will become a
domestic firms through competition, work- force for global innovation. It is now in the
force training, and demonstration of new world’s interest to see a growing and thriv-
technologies. ing China that will contribute a positive force
Other countries have similarly benefited in support of global economic recovery and
from China’s rise. The rapid growth of sustainable global growth. The world outside
China’s exports has been largely driven by its China will change dramatically too. In 2030
participation in the global production value the contribution of other developing coun-
chain; nearly half of its exports are process- tries to global growth will exceed 40 percent,
ing trade—imports that are further processed far more than the contribution of all (current)
and then exported—and multinational com- high-income economies together, which will
panies that have invested in China produce contribute roughly one-third. This shift will
more than half of its exports. Therefore, dramatically change China’s relations with its
China is part of a broader success story in trading partners and its comparative advan-
which enterprises from many countries and tage relative to other countries.
territories have benefited, directly or indi- With this backdrop of mutual depen-
rectly. Furthermore, China is now not only dence, China’s strategy toward the world
the world’s second-largest import market, it will need to be governed by a few key prin-
is also its fastest growing. Its strong demand ciples: open markets, fairness and equity,
for raw materials, advanced machinery, and mutually beneficial cooperation, global inclu-
consumer products has benefited developed siveness, and sustainable development. And
and developing countries alike. China should help shape global governance
At the same time, China’s relations with structures that will accommodate its own
the world have changed over the past decade. evolution while promoting global growth
It is now the world’s second-largest economy and providing opportunities for the develop-
and its largest exporter. Its foreign exchange ment of other countries. As with other large
reserves are the highest in the world, and economies, China’s long-term interest lies in
they provide a large amount of sovereign debt global free trade and a stable and efficient
financing for the United States and European international financial and monetary system.
countries. China’s economy is now so large China benefited enormously from entering
that its domestic policies have an impact on the WTO and is now an important stake-
the global economy. If China had not imple- holder in the existing global trading system.
mented such a strong fiscal stimulus pack- Similarly, it will want to see stable interna-
age in 2009 and grown as robustly as it did tional financial markets and a well-regulated
during the recent global financial crisis, the international monetary system supported
O V E R V I E W 61
by stable currencies and underpinned by space as advanced countries and other emerg-
sound monetary policies. And finally, ing markets. Reflecting these trends, the
to ensure sustainable global growth, it is number of disputes in the WTO involving
in China’s interest to work toward a global China has accelerated in recent years and
climate change agreement that is fair and currently stands at 107 (78 as third party, 21
effective. as respondent, and 8 as complainant). These
are expected to rise in the short term. The
Key Issues in China’s External share of developing-country antidumping
actions against China (as a share of their total
Economic Relations actions) increased from 19 percent in 2002 to
Notwithstanding slower growth in the 34 percent in 2009.37
advanced economies for the foreseeable With services rising as a share of GDP,
future, greater integration with the global productivity growth in services will become
economy will further increase China’s inter- increasingly important in maintaining over-
national competitiveness in a number of all rapid growth, and this growth can be
ways: through the specialization of Chinese boosted by further opening the services sec-
manufacturing firms in the international tor to global competition. Moreover, a more
value chain and greater economies of scale; efficient services sector will also advance the
increased specialization and productivity in competitiveness of manufacturing as China
services, where China would benefit from moves up the value chain. In stark contrast to
more international competition; continued the important position China holds in global
access to international technologies and trade is its virtual lack of presence in inter-
greater participation in the global R&D net- national financial markets. In the next two
work; and increased inward and outward decades, Chinese firms are likely to become
foreign direct investment that would build on regional and global companies, and they will
the comparative advantage between China need to invest and raise funds abroad. The
and its trading partners. international presence of Chinese commercial
The hard fact is that unless China moves banks and other financial institutions that
up the value chain, the future contribution have close relations with Chinese firms can
of exports to economic growth will decline help in this process.
for three reasons. First, China’s penetration Moreover, China’s emerging multination-
in key markets is already large, and further als will face new challenges as they seek to
expansion of China’s market share is lim- become global players. China’s outward
ited within the current export structure. flows of foreign direct investment have
Second, rising costs for unskilled labor are climbed rapidly over the past decade. Even
changing China’s international comparative as the stock of China’s foreign investment
advantage within the export sector and will remains a minuscule share of the global
require China to move up the value chain stock, efforts by Chinese companies to invest
to remain internationally competitive. And, in other countries have already faced market
third, reforms in input markets and natu- access restrictions in several countries, and
ral resource pricing designed to correct dis- these tensions are likely to rise. Such restric-
tortions will help increase the efficiency of tions are misguided, because Chinese multi-
resource allocation, but, if labor productivity nationals can play an important role in a host
does not increase to compensate for higher country’s development, by transferring tech-
production costs, international competitive- nology and by integrating business practices
ness will erode in traditional energy- and and organizational approaches.
resource-intensive industries. China faces other challenges in its exter-
As China moves up the value chain, it nal accounts. The combination of its current
will inevitably have to manage rising trade and capital account surpluses has resulted in
and investment tensions (in part, because of record foreign exchange reserves, exposing
China’s sheer size). Increasingly, China will China to notably increasing risks from any
compete internationally in the same product depreciation of the U.S. dollar or the euro
62 CHINA 2030
and to limits on its macroeconomic policy increased from about 70 in 1990 to almost
space to contain inflation and domestic 300 today; this poses a major challenge for
overheating. China’s future trade because Chinese export-
As its interactions with the global econ- ers are increasingly excluded from the same
omy continue to intensify, China will need to preferential access as other exporters to key
continue to protect its economic security and international markets.38 China should adopt
respond properly to risks that arise in other a strategy of emphasizing both multilateral
countries. The opening of the capital account and regional arrangements—abiding by and
as part of a possible initiative to internation- protecting existing multilateral agreements
alize the renminbi will, however, increase as well as pushing for further opening of
international capital movements and sud- global markets using multilateral channels. It
den changes in asset prices. China will also should also proactively push ahead with the
be more reliant on imported energy and raw negotiations for accession to the WTO gov-
materials, placing it at greater risk of supply ernment procurement agreement as part of
disruptions arising from sharp price move- its effort to improve procurement procedures,
ments in global commodity markets. And the enhance transparency, reduce costs, and
wide and increasingly deep application of the enhance quality in government purchases.
Internet and other information technologies At the same time, China needs to proactively
will increase risks regarding information and participate in regional trade agreements that
financial security. lower trade barriers at and behind borders
Finally, China is becoming an important and introduce trade facilitation arrange-
source of development assistance to other ments. Where possible, China should advo-
developing countries, but its conditions, pro- cate “open regionalism,” which requires that
cedures, and approaches differ noticeably tariff levels agreed among regional partners
from those of some international donors. be offered to other nonmember countries on
These differences did not matter when a most-favored-nation basis.39
China’s official development assistance was
still small, but it is beginning to matter now Further opening of the services sector to
and will be of increasing importance in com- international trade and investment. Not-
ing years. China’s processes—on tying aid, withstanding rapid opening up of China’s
transparency of terms and conditions, and services sector since its entry into the WTO,
application of environmental and other safe- its policies on services trade remain more
guards—will come under increasing scrutiny restrictive than policies in many developing
as its development aid program grows in size. countries and much more so than in high-
income countries.40 Further opening up the
services market will help introduce advanced
Recommendations for Achieving technology and managerial expertise, pro-
Mutually Beneficial Trade and mote reforms, increase competition, and
Investment Relations ultimately enhance the efficiency and com-
petitiveness of China’s services sector while,
Improving the external economic and trad- at the same time, providing China leverage
ing environment. Given its high trade-to- in international trade negotiations to further
GDP ratio relative to other large economies, open the services markets of trading partners.
the environment for international trade is
crucial for China’s future development, so Promoting outward FDI. By becoming
promoting an open global trading system global players, Chinese companies can cap-
should remain an important policy objective. ture higher value-added segments of the
In the absence of a successful Doha Round, global production chain and exploit econo-
a multitude of bilateral and multilateral mies of scale. It can also be an effective
free trade agreements have emerged around strategy in anticipation of increased scarcity
the world (most notably in East Asia), and of low-skilled labor within China. More-
the number of preferential agreements has over, increased outward FDI can limit the
O V E R V I E W 63
continued expansion of foreign exchange FIGURE O.9 The renminbi is increasingly being
reserves (in part to temper international used as the currency for cross-border trade
settlement
protectionist sentiment). To facilitate the
globalization of Chinese firms, the govern-
6
ment should further promote outward FDI 400
Import settlements (left axis)
and perhaps even liberalize outward flows Export settlements (left axis) 5
of portfolio capital. Bilateral investment Share of total trade
300 (right axis)
protection agreements could help create a 4
RMB (billions)
better investment environment for Chinese
Percent
3
enterprises investing abroad. Given doubts 200
about foreign investments made by Chinese 2
state-owned enterprises, the focus should be 100
on promoting outward FDI by private enter- 1
prises, thus enhancing their ability to oper-
ate internationally and, over time, to become 0 0
global companies. Q3–Q4 Q1 Q2 Q3 Q4
2009 2010
China should also consider supporting a
multilateral investment agreement that lib-
Source: People’s Bank of China.
eralizes FDI flows, provides basic guaran- Note: China’s total exports 2010: $1.75 trillion; China’s total imports
tees, and includes binding dispute resolution 2010: $1.52 trillion. Q = quarter; RMB = renminbi.
mechanisms. China’s contribution toward
the shaping of such a multilateral agreement
would be to ensure that the terms would is made flexible over time. The many prereq-
be appropriate for developing-country cir- uisites for an open capital account was the
cumstances. Achieving stronger protection main reason why many European countries
and easier access for all investors, including took nearly 20 years after the collapse of the
Chinese investors, would require granting Bretton Woods system to achieve full capital
reciprocal concessions to foreign investors account liberalization.41 In the case of China,
in China, implying a dismantling of most therefore, a relatively prudent approach,
restrictions on FDI inflows—something that stretching over many years, is recommended
would also be in China’s long-term interest. in transitioning safely to a more open and
efficient financial and exchange rate system.
Steadily pushing ahead with the interna-
tionalization of the renminbi. International-
izing China’s currency will bring important A Stakeholder That Plays
long-term benefits for China. The renminbi a Positive Role in Global
is already being used increasingly as the cur-
Governance
rency for cross-border settlement (figure O.9).
If a substantial portion of China’s assets and With its growing share in the world economy
trade were denominated in renminbi, then and its rising per capita income, China has
fluctuations in the dollar-renminbi exchange become an essential partner in the provision
rate would have few implications for domes- of global public goods. A growing number
tic stability. But internationalizing the ren- of global problems cannot be solved without
minbi requires opening the capital account, China’s active participation. China’s future
and that can be done only after China has in prosperity depends to a large extent on the
place a stable financial sector with improved capability of global collective action to make
corporate governance in banks and other available key global public goods. It is in the
financial institutions; well-functioning legal, common interests of the international com-
supervisory, regulatory, and crisis manage- munity (and China) for China to become a
ment frameworks; deep financial markets key proactive stakeholder in these global gov-
with credible indirect monetary controls to ernance arrangements. The fact that China
manage liquidity; and an exchange rate that is the second-largest economy in the world
64 CHINA 2030
and yet ninety-third in terms of per capita to put policies in place—such as international
income has created a huge gulf between the carbon trading—that are fair for developing
world’s expectations about China’s ability to countries and create win-win solutions for the
shoulder important roles and responsibilities world. Once carbon mitigation policies are
in global governance and China’s perceptions implemented globally, incentives increase to
of its own capabilities to do so. The process invent and implement new green technologies.
of China’s participation in global governance The resulting technological progress and eco-
will inevitably be gradual as the international nomic growth can potentially turn the reduc-
community and China make constant adjust- tion of emissions into an opportunity instead
ments to accommodate each other. of a burden.
As China’s strength in the global economy China should proactively push for the
rises, the international community will expect reform of the international financial system.
China to play a more proactive role as a key China’s role in discussions on reforming the
stakeholder in international governance rules international financial architecture should
for trade and capital flows. In multilateral be to ensure that the final outcome not only
negotiations, China could capitalize on its is consistent with China’s own plans to lib-
unique position of straddling the interests of eralize its foreign exchange system, financial
virtually the entire range of economies from sector, and capital account, but is also appro-
low to high income. Its responsibilities will priate for developing country conditions
correspondingly increase. China can also and suitable for strengthening the financial
wield enormous influence in shaping these systems and the reduction of financial risks
rules to ensure that they are supportive of in developing countries. For example, it is
Chinese development. In particular, China’s necessary to assess the appropriateness of
considerable impact on the global economy international prudential norms for China’s
means that it can take, and would benefit financial system and their implications for
from taking, a proactive stakeholder role in China’s interactions with global financial
the design of such multilateral agreements. markets. Another example is the need to con-
China should continue to proactively push sider the proposal of establishing a derivatives
forward global climate change negotiations. clearinghouse and the capital needs for such
China’s 12th Five Year Plan already includes institutions to ensure that they can reduce
declining intensity of carbon dioxide emis- systemic risks facing China’s financial system.
sions as a binding target. A fair and balanced China also needs to be an active stake-
global climate agreement could leverage these holder in shaping the international aid archi-
planned domestic actions by China, and make tecture. As China has become a more signifi-
them more effective, without placing China at cant source of concessional assistance, it can
a competitive disadvantage. China’s earnest better improve aid effectiveness, by further
efforts to reach this target and establish a enhancing the transparency of its foreign aid
market-based emissions reduction mechanism program, strengthening communication with
within the country will provide a solid basis OECD donors, and enhancing aid project
to help shape a global agreement and create management techniques.
crucial win-win solutions. Failure on the part Finally, China should increase its partici-
of major countries to reach agreement on pation, contribution, and predictability in
climate change and contain the climate cri- global governance in the international com-
sis will lead to serious consequences for the munity and play a role commensurate with
world economy and, in particular, develop- its capabilities. Over time it can better play
ing countries, including China, that are likely its role as an international stakeholder if it
to be the most severely affected by climate strives to learn from the experience of other
change. Such an agreement is also needed to major powers in global governance, train its
create a level playing field and to avoid car- representatives in international governance
bon tariffs, which can easily turn into pro- institutions to be world class, and enhance
tectionist measures. China’s proactive role in the mechanism for and efficiency of internal
the climate change negotiations is important coordination in international affairs.
O V E R V I E W 65
shortages, encourage efficiency, and lower reforms and change always meet opposi-
carbon emissions; and aggressively expand- tion. In China, this opposition is likely to
ing public transport options. take many forms, and the policy response
The next priority is for actions that will should be accordingly varied and flexible. In
form the basis of future reforms, offer incen- summary, we identify three kinds of possible
tives for innovation, and lay the foundations opposition.
for future sustainable growth. These include The most resistant group is likely to be
introducing fiscal transparency as well as vested interests—such as those enterprises
independent and rigorous evaluation of pub- that enjoy partial or full monopoly (or mon-
lic expenditures; mobilizing additional fiscal opsony) in key markets as well as firms,
revenues, including by rapidly ramping up groups, institutions, and individuals who
implementation of property taxation in urban obtain special privileges and benefits or
areas; recentralizing expenditure responsibil- enjoy preferential treatment from the current
ity for key social security programs, such as power structure and institutional setting.
the basic pension system and unemployment These groups gain from a special relationship
insurance, which will encourage labor mobil- with decision makers or reap economic rents
ity and integrate the labor market; phasing from distortions implicit in the current price,
out the hukou system; lowering entry and institutional, and administrative structures.
exit barriers for firms; and imposing a carbon Not only are these vested interests unlikely to
emissions quota, adopting tougher ecological surrender their privileged position easily, they
and environmental standards, and introduc- are likely to be very influential, powerful,
ing new building codes to meet energy effi- resourceful, and resolute in protecting their
ciency and safety standards. interests. Overcoming such opposition will
It is also important that the government require political courage, determination, clar-
make breakthroughs in core reforms to ity of purpose, and adroit leadership qualities
cement the foundations of a market economy at the highest level of the government.
and form the foundations for the rest of the A second group that may oppose the
reform program. The core of the program reform agenda are those who are likely to
comprises the fiscal, financial, and enterprise be hurt from reforms in the short term, even
reform components—key here are enterprise though they will gain in the long term. An
reforms (especially measures promoting com- example would be those affected by the
petition) and pricing reforms for natural proposal to reform the hukou system. In
resources, including energy and raw mate- the long run, this reform would clearly be
rials. Not only are these very closely tied to beneficial to China by helping to develop a
one another, they are building blocks upon more integrated and efficient labor market
which the innovation, environmental, and and also by lowering inequality in incomes
social components rest. These core reforms and access to social services, which would
are key to China’s efforts to consolidate the reduce social tensions. But urban hukou
foundations of a market economy. Their suc- holders, driven by concerns that their privi-
cess will determine the success of the other leged access to public services and social
elements needed to achieve sustainable and security may be threatened, may not be sup-
innovation-driven development. portive of these reforms. Similarly, work-
In the medium term, efforts should focus ers in loss-making enterprises, energy- and
on promoting innovation, green develop- pollution-intensive industries, and unregu-
ment, and participation in the reform and lated financial institutions may think the
support for global governance. reforms will hurt their economic interests.
If this were to happen, the government could
Overcoming Opposition to not only provide appropriate information
and guidance but also allocate such groups
Reform transitional assistance in the form of tem-
Finally, as China knows only too well, and porary income support and training in new
as is also the experience of other countries, skills. The government could also take steps
O V E R V I E W 67
to ensure that local governments do not incentives introduced to assist those who may
thwart or undermine the reforms by placing be hurt by structural reforms should be tem-
local interests above national interests. porary, and the conditions for their termina-
A third group is opinion makers who tion clearly established at the time of their
equate today’s problems as outcomes of ear- initiation.
lier reforms rather than of the distortions Finally, local governments and line min-
that remain. Some, for example, attribute the istries should be allowed to experiment
deterioration in the natural environment (air, with certain reforms within the framework
water, land) to the market mechanisms rather of national policy objectives, and success-
than to ineffective implementation of existing ful examples scaled up. China’s success in
laws, rules, and regulations, or inappropriate previous reforms has built on the strength,
price and incentive structures. Their impact flexibility, and adaptability of its institu-
on public opinion is usually significant and tions. Its future institutional evolution should
out of proportion to their small numbers. It continue to be firmly rooted within China’s
is important that such influential voices have own reality and experience. Interest groups
access to the thinking, analysis, and rationale that oppose change usually find it difficult
underlying the reform program. Government to argue against success—and successful
departments, think tanks, research institu- reforms at the local level tend to grow their
tions, and universities should be encouraged own champions who see benefits from the
to analyze reform issues and disseminate their new policies. Moreover, it is only through
results. Indeed, involving the participation of learning-by-doing that implementation prob-
civil society organizations not only will rally lems in reforms can be ironed out, so that
support for reforms but could improve the when scaled up, the potential for opposition
design of the reform program itself. is minimized.
Winning over opposition to reforms will
need to be a key part of the strategy and will
Managing Macroeconomic Risks
require a calibrated response depending upon
the reasons for the opposition. Strong lead- and Vulnerabilities
ership and commitment to the reforms will Macroeconomic and social stability is not
provide important signals, facilitate coordi- only key for innovation, investor confidence,
nation across ministries and agencies, and and sustainable growth, it is also a fertile
ensure that opposition to reforms is dealt environment in which reforms—short and
with sensitively and effectively. long term—can achieve desired outcomes.
As a practical matter, a high-powered Over the next 20 years, it is important that
reform commission needs to be established China’s record of stability be maintained
by—and with the full support of—the high- given the possibility of greater risks. These
est level of government. This commission risks include greater susceptibility to exter-
should be made responsible for the design nal economic shocks resulting from China’s
and implementation of the reform pro- tighter economic integration with the world;
gram. Only with such high-level support can weaknesses in government finances or in
reforms be implemented steadily and with a the financial and enterprise sectors, which
determined will. Commission members will might be revealed in a slowdown in China’s
need to undertake extensive and genuine con- economic growth as it is transitioning from
sultations and discussions with all stakehold- middle-income to high-income status; pos-
ers so that everyone respects and understands sible social unrest, which could erupt in the
the objectives of the reforms and the underly- face of perceived injustices; and greater dan-
ing rationale for policy changes and so that a ger from natural disasters (rise in sea levels,
proper balance is struck between the interests earthquakes, floods, droughts, tsunamis,
of various stakeholders. At the same time, pandemics), which are likely to be magnified
reforms should be designed so that they do by increasing urbanization.
not create new interest groups supportive of Usually, risks are idiosyncratic, that is,
distortive policies. Thus, fiscal or financial they occur randomly. But occasionally, they
68 CHINA 2030
can be covariant or systemic, when they that capital ratios are adequate, nonper-
occur together or have economy-wide effects. forming loans accounted for properly and
Economies can usually cope with idiosyn- kept within prudential limits, and currency
cratic risk, but covariant or systemic risks and asset-liability mismatches kept to a
are more difficult to manage. China is well minimum. Balance sheets of banks, systemi-
prepared to deal with idiosyncratic risks, but cally important state enterprises, and local
it must anticipate the possibility of systemic governments should be able to pass a vari-
risks and prepare appropriate responses. ety of periodic stress tests (such as interest
Thanks to its impressive capacity for rate variability, exchange rate fluctuations,
collective action, China has shown itself growth slowdowns, and capital flight).
to be particularly effective at dealing with International experience has shown how
macroeconomic shocks (including those quickly a small spark can ignite widespread
from abroad). The challenge to China is social unrest. According to surveys in China,
not whether it can respond well to crises the public’s trust in the judicial system and
but whether it can further lower the risk of public services is very low, and social frus-
future crises. Indeed, all risks—natural, eco- tration has been building. This situation
nomic, or social—are essentially contingent points to the critical importance of building
liabilities that can translate into actual lia- an impartial and effective legal and justice
bilities for either government or households. system and improving equality of opportu-
Most important, measures to reduce risk nity and accessibility to high-quality social
are not only possible, they are usually cost- services. An essential element of reforms in
effective. For example, adequate prudential these areas will be greater consultations and
safeguards that prevent reckless behavior participation of the public in decision making
in the financial and enterprise sectors can and oversight of service delivery (including by
help governments avoid costly expenses in the justice system), increased transparency in
the wake of a macroeconomic crisis; such the operations of these branches of govern-
safeguards can reduce the probability and ment, and greater accountability to stake-
the costs of a financial crisis. The benefits of holders and citizens.
such measures are often orders of magnitude If one thing has been learned from sys-
higher than their costs. temic crises, it is the importance of avoid-
Notwithstanding government efforts to ing overconfidence and remaining vigilant
ensure stability, the risk of macroeconomic against potential problems from social, eco-
shocks and instability cannot be completely nomic, and natural causes. Countries need
eliminated and will need to be dealt with to ensure that such vigilance is incorporated
in a way that promotes medium-term into the national risk management system.
reforms rather than sacrificing them. That can be done in five ways:
When shocks occur, the policy response First, risk management requirements
should depend on the cause. If growth should be embedded firmly in national regu-
slows because of a temporary slowdown in lations, policies, and public investments. In
demand, then countercyclical policies may addition, weaknesses in economic and finan-
be appropriate. But if the potential growth cial systems should be probed constantly to
rate decreases, then countercyclical policies identify where a crisis may arise and appro-
would be inappropriate, and instead, addi- priate preventive action taken. Regular risk
tional emphasis would need to be given to audits for critical parts of the financial infra-
structural reforms. structure and systemically important enter-
The government should also take pre- prises can reveal where structural or other
ventive action to reduce the size of “shock flaws may expose the broader economy to
amplifiers”—which tend to be high debt unnecessary risk.
(including high contingent debt) ratios in Second, because risk management tends
key parts of the economy such as banks, to cut across institutional jurisdictions, not
firms, households, and governments. Care- only is coordination needed across different
ful supervision of banks will need to ensure agencies and levels of government, so too is
O V E R V I E W 69
clarity on who is responsible and accountable depend on the wisdom, strength, and deter-
for what. mination of the Chinese leadership in press-
Third, the government can and should ing ahead with reforms in the six key areas
make information more easily accessible to highlighted in this report.
help individuals, households, and firms take
risk mitigation measures or preventive action.
Fourth, risk management institutions
Notes
need to be capable of quick and decisive 1. T he term “provinces” here includes munici-
action when crises occur, be receptive to all palities and autonomous regions that have the
ideas from all sources, and be able to build same status as provinces.
2. h ttp://www.bankersalmanac.com/addcon
partnerships for collective action, especially
/infobank/bank-rankings.aspx).
with communities that hold a stake in the
3. http://money.cnn.com/magazines/fortune
outcome. /global500/2011/.
Fifth, neither prevention nor mitigation 4. h t t p : / /a a p a . f i l e s . c m s - p lu s . c o m / P D F s
can completely eliminate risk, so insurance /WORLD%20PORT%20RANKINGS%20
is needed to soften the blow when macroeco- 2009.pdf.
nomic disasters unfold. One insurance policy 5. A lthough the reputation of forecasting is
is China’s already large external reserves. rightly in disrepute, even for the short term,
Another would be to keep adequate fiscal let alone the medium or long term, national
space by maintaining a prudent public debt development strategies do need to consider
burden. A third would be strong supervision future trends in the global environment, dif-
of the financial system. And a fourth would ficult as that may be. The authors recognize
that discontinuities and shocks, by their very
be a deposit insurance program that discour-
nature, are difficult to anticipate. Ideas, tech-
ages reckless lending and encourages prudent
nologies, events, and individual actions can
financial management, such as observance of sometimes snowball into powerful forces of
capital requirements. change—the so-called “butterfly effect” that
In managing social and macroeconomic occurs when initial conditions are such that a
risks, three principles need to be kept in small change triggers large consequences.
mind: the first is to guard against a retreat 6. E stimates of the scope of the middle class
from the market mechanism and a return vary depending on the definition. The esti-
to administrative measures; the second is to mate quoted here is from Kharas and Geertz
press ahead with long-term reforms, because (2010), who define the middle class as fall-
structural factors usually lie at the root of ing within the threshold levels of $10 a day
many of China’s periodic episodes of mac- to $100 a day per capita (measured in 2005
PPP terms).
roeconomic overheating; and the third is
7. The old age dependency ratio is defined as the
to ensure that risk mitigation strategies are ratio of the number of people aged 65 years
consistent with, and reinforce, the long-term and older to those aged between 15 and 64
strategy. years.
China’s road toward a modern, harmoni- 8. D uring 1994–2009, particularly high TFP
ous, creative, and high-income society will growth continued in part because of SOE
be filled with challenges; but the goal has restructuring, WTO accession, and very suc-
never been closer. The world’s economic cessful integration in the world economy of
landscape will change when China becomes China’s manufacturing industry and associ-
a high-income country. China’s rapid growth ated economies of scale. With a lower con-
and poverty reduction over the past three tribution expected from such forces, TFP
decades—achieved through domestic reforms growth (excluding the contribution of human
capital formation), is expected to fall by half
and opening up to the global economy—was
a percentage point to 2.5 percent a year in
nothing short of a miracle. The next two 2010–15 and ease thereafter to around 2 per-
decades could witness another miracle in cent in 2026–30. By way of comparison, in
which China’s economic, social, and cultural 1966–90, annual TFP growth in Hong Kong
contributions will not only benefit China’s SAR, China; the Republic of Korea; Singa-
own people but also contribute to global eco- pore; and Taiwan, China, averaged between
nomic prosperity and stability. Much will 1.7 and 2.3 percent. This average includes the
70 CHINA 2030
contribution of human capital accumulation, farmers with a plot located within a developed
which is separated out in our analysis. urban area equivalent to 40 percent of the
9. T he U.S. labor force numbers about 155 acquired land area. Such a program, however,
million. The calculation assumes that over may incur administrative delays and lead to
the next decade, China’s tertiary education very different outcomes for farmers affected
completion rate rises to the advanced country by the same land acquisition transaction.
average, where the advanced country average 22. OECD Stat Extracts: http://stats.oecd.org
is determined based on data from Barro and /index.aspx?DataSetCode=REV.
Lee (2010). 23. Based on data from Sam Ock Park (2009).
10. The population of Hong Kong SAR, China is 24. Sixth National Population Census, National
around 7 million. Bureau of Statistics of China (NBSC), Peo-
11. Based on the global wealth study prepared by ple’s Republic of China.
the Boston Consulting Group (2011). 25. The amount of “surplus labor” in rural areas,
12. E stimate for 2010 using 2005 purchasing and therefore the number of potential rural-
power parity prices based on staff calcula- urban migrants, is the subject of much study
tions in Povcalnet (http://web.worldbank and controversy; see Knight, Quheng, and Shi
.org /wbsite/external /extdec/extresearch (2010).
/extprograms/extpovres/extpovcalnet/). 26. There remain cases in very large cities where
13. T he term “state dominance” goes beyond this process remains incomplete, such as in
just state ownership and includes active state Beijing where applicants for government jobs
involvement in investment and other manage- and for many enterprises require a Beijing
ment decisions. hukou to be considered.
14. Unfortunately, the average profitability of the 27. MOHRSS (Ministry of Human Resources
rest of the SOEs cannot be calculated for lack and Social Security) data from end-2010.
of data. 28. Sunrise industries are the opposite of sun-
15. T FP growth in the state sector was 1.5 per- set industries—relatively “young” industries
cent a year, whereas the nonstate sector’s with future growth prospects, unlike sun-
TFP grew at a rate of 4.6 percent a year; see set industries that are mature and likely to
Brandt and Zhu (2010). decline in relative size.
16. F or example, in 2006, state enterprises 29. T he three key underlying concepts are that
accounted for the production of all petro- growth and resource use can be “decoupled,”
leum, natural gas, and ethylene; all basic tele- that the process of “going green” can itself be
coms services; about 55 percent of electricity a source of growth, and that green develop-
generation; and 82 percent of airline and air ment and economic growth could potentially
cargo traffic (see Owen and Zheng 2007). reinforce one another.
17. A pure “public good or service” is one whose 30. World Bank estimates using 2008 data. In
consumption by one individual does not addition, more than half of China’s water is
reduce its availability for consumption by polluted, over 300 million people use con-
others, and when no one can be effectively taminated water supplies, a third of China’s
excluded from using the good. The term, as waterways are below the government’s own
used in this report, applies to those goods safety standards, and about a fifth of China’s
and services that, when produced or con- farmland has been contaminated with heavy
sumed, result in positive externalities that metals (Ministry of Environmental Protec-
are not remunerated, and hence tend to be tion 2011).
underproduced. 31. For 2008, the last year for which data is
18. However, in some sectors such as telecoms, available.
the splitting up was along geographic lines, 32. S everal such taxes address negative exter-
still leaving a single dominant provider in any nalities. Unlike many other taxes, such taxes
given area. present few if any trade-offs when viewed in
19. Land Resources Statistical Yearbooks 2002–09, a more holistic way than through GDP alone,
published by the Ministry of Land Resources. because they make prices better reflect the
20. T he National Audit Office report is avail- true marginal cost of a particular activity,
able at http://www.audit.gov.cn/n1992130 including the damage to environment.
/n1992150/n1992500/2752208.html. 33. Zhang (2010) provides a detailed discussion
21. A n alternative approach could be the one on SOE dividend policy and international
adopted by Korea, which provides affected practices.
O V E R V I E W 71
34. Furthermore, the “revenue productivity” of Barro, R. J., and J. W. Lee. 2010. “A New Data
personal income taxes (PIT), measured as the Set of Educational Attainment in the World,
revenue collected as a share of GDP divided 1950–2010.” Working Paper 15902, National
by the weighted average PIT rate, is only 15 Bureau of Economic Research, Cambridge,
percent of global averages and 11 percent of MA.
high-income country averages. Baumert, Kevin A., Timothy Herzog, and Jona-
35. h t t p : / / w w w. a u d i t . g o v. c n / n 1 9 9 2 1 3 0 than Pershing. 2005. Navigating the Num-
/n1992150/n1992500/2752208.html. bers: Greenhouse Gas Data and International
36. Liu (2010) and Liu and Pradelli (forthcoming) Climate Policy, chapter 6. Washington, DC:
give a detailed discussion on the regulatory World Resources Institute.
framework of subnational government debt Bergsten, C. Fred. 1997. “Open Regional-
management. ism.” Working Paper 97-3, Petersen Institute
37. Antidumping is not the only mechanism used for International Economics, Washington,
to discriminate against China’s exports. Oth- DC. http://www.iie.com /publications/wp
ers include the Transitional Product-Specific /wp.cfm?ResearchID=152.
Safeguard Mechanism (a unique feature of Boston Consulting Group. 2011. “Shaping a New
China’s WTO accession that allows importers Tomorrow: How to Capitalize on the Momen-
to invoke safeguards against China through tum of Change.” Boston (June 21) http://
2014, with less evidentiary requirements www.bcg.com /media/ PressReleaseDetails
than under the normal safeguards regime), .aspx?id=tcm:12-77753.
the traditional safeguards regime, voluntary Bown, C. P. 2007. “China’s WTO Entry: Anti-
export restraints (particularly as a result of dumping, Safeguards, and Dispute Settle-
U.S. and EU investigations of China’s textile ment.” Working Paper 13349, National Bureau
and apparel exports, and despite the ban- of Economic Research, Cambridge, MA.
ning of voluntary export restraints under the Brandt, L., and Xiaodong Zhu. 2010. “Account-
WTO Agreement on Safeguards), and coun- ing for China’s Growth.” Working Paper
tervailing measures under antisubsidy poli- 395, Department of Economics, University of
cies (Bown 2007). Recourse to such instru- Toronto, Toronto (February).
ments will become more difficult when China Commission on Growth and Development. 2008.
attains market economy status in 2016. The Growth Report Strategies for Sustained
38. Only 6 percent of China’s exports enjoy pref- Growth and Inclusive Development. Wash-
erential access, well below the world average. ington, DC: World Bank.
39. “Open regionalism” ensures that “regional Eeckhout, Jan, and Boyan Jovanovic. 2007.
agreements will in practice be building blocks “Occupational Choice and Development.”
for further global liberalization rather than Working Paper 13686, National Bureau of
stumbling blocks that deter such progress” Economic Research, Cambridge, MA.
(Bergsten 1997). Feng, Shao. 2011. “Introducing a Public ‘Hap-
40. I nsurance remains closed in many respects, piness Index’ into Government Performance
majority foreign ownership is prohibited in Appraisals” (in Chinese). Decision Making
some sectors (such as telecommunications and Information 314: 58.
Gill, Indermit, Homi Kharas, and others. 2007.
and air transport), and provision of domestic
An East Asian Renaissance: Ideas for Eco-
legal services is restricted.
nomic Growth. Washington, DC: World Bank.
41. The end of the Bretton Woods system between
Heston, Alan, Robert Summers, and Bettina
1968 and 1973 was meant to eliminate the
Aten. 2011. Penn World Table Version 7.0.
need for capital controls, but European coun-
Center for International Comparisons of Pro-
tries did not achieve full capital account liber-
duction, Income and Prices at the University of
alization until the late 1980s and early 1990s,
Pennsylvania, Philadelphia (May).
and then only because liberalization was seen
Holzmann, Robert, David Robalino, Noriyuki
as a step toward monetary integration.
Takayama, eds. 2009. Closing the Coverage
Gap: The Role of Social Pensions and Other
Retirement Income Transfers. Washington
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O V E R V I E W 73
Supporting Reports
1
China: Structural Reforms for a
Modern, Harmonious,
Creative Society
77
78 CHINA 2030
and balanced. Specific challenges include protection, health care, environmental pub-
creating conditions for more employment lic investment, and recurrent expenditures,
generation and for improvements in “the dis- mostly by subnational governments. How-
tribution of primary income,” in the quality ever, such increases will need to be achieved
of and access to public services, in expanded while maintaining fiscal sustainability, avoid-
social security and other reductions in vul- ing levels of taxation that could harm growth,
nerability, and in efforts to create a less easing the fiscal pressures on subnational
resource-intensive form of growth. governments, and strengthening fiscal insti-
Indeed, the report shows how concerted tutions. Over the next two decades, then, the
reforms to address key remaining distor- challenge will be sixfold: changing the com-
tions can put China on a development path position and improving the efficiency of pub-
that delivers both relatively fast growth and lic expenditures in line with China’s evolving
improvements in key social, environmental, development objectives; improving the effi-
and external indicators. In contrast, such ciency of revenue mobilization; realigning
an outcome is inconceivable under broadly revenues with expenditure responsibilities by
unchanged policies. In fact, an attempt to sus- raising selected functions to higher levels of
tain the past growth model for an extended government and allowing some governments
period could lead to a forced change in course to charge local taxes; bringing on budget all
as China finally reaches some of the limits of subnational government borrowing and the
economic, social, environmental, or external associated spending, and putting them under
sustainability. Whether through a controlled strict controls; equalizing subprovincial trans-
change in policy or through a crisis, such a fers across lower levels of government; and
hasty shift would lead to sharply lower sav- improving the accountability and transpar-
ings and investment rates, putting China on ency of governments.
a slower growth path. This reality further
strengthens the case for proactive reforms. The enterprise sector. A vibrant corporate
Such fundamental policy reforms will need sector will be critical for sustaining relatively
to go hand in hand with increases in some fast growth. The central elements will be
categories of public spending. These needed further increases in competition, especially
increases have two implications. First, the fis- (but not only) between the state and nonstate
cal system needs to be strengthened to help (including private) enterprises in the “stra-
deliver the level and quality of public social, tegic” and “pillar” industries where compe-
environmental, and infrastructural services tition has been curtailed, and redefinition
deemed central to the vision of China 2030. of the function of state capital. To promote
Second, public resources will need to be the securitization and trading of state capi-
raised efficiently and allocated in a way that tal, state capital should be used solely for the
rapid growth is maintained even as China provision of public goods and services. This
approaches the technology frontier in a num- reform requires restructuring the state-owned
ber of sectors. This is a bigger challenge than enterprise (SOE) sector, dismantling monopo-
it may appear at first blush since many other lies and oligopolies in sectors where competi-
constraints to growth—including an anemic tion would yield superior results, introducing
global economy and a shrinking and aging oversight arrangements where monopolies
labor force—also need to be overcome. This are considered necessary to ensure that mar-
report argues they can be overcome through ket power is not abused and does not act as
reforms in China’s enterprise sector as well as a drag on the economy, and lowering entry
in its input markets—land, labor, and capital. and exit barriers for all enterprises. Improved
allocative efficiency will also require fur-
The fiscal system. The large social and envi- ther efforts to level the playing field, espe-
ronmental agenda over the next two decades cially between smaller and larger firms, and
will entail significant expansion of social between state-owned and nonstate firms, not
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 79
only in a legal sense, but also in the access to and effective regulation and supervision. In
key inputs. The portfolio of SOEs should be addition, there is a need to further liberal-
diversified, some state shares should be sold in ize interest rates; deepen the capital market;
the market over time, and modern corporate upgrade financial infrastructure and the
governance practices should be exercised in legal framework; strengthen the regulation
SOEs. Finally, this restructuring will require and supervision framework; build a financial
a review and modernization of the extensive safety net and develop crisis management and
“industrial policies” that the authorities have insolvency schemes; and recast the rights and
used to influence the structure within and responsibilities of government.
across sectors. These reforms are united by one com-
mon theme—“reforming government.” For
The allocation of factors of production. If much of the past three decades, and unlike in
anything, improving the efficiency in the use countries that belong to the Organisation for
of factors of production—land, labor, capi- Economic Co-operation and Development
tal—will be more challenging than reforming (OECD), government has maintained a direct
the enterprise sector. However, this sphere is role in allocating resources, with instruments
also the one in which many significant distor- such as industrial policy and state ownership
tions remain, suggesting much potential from leading to tight interconnections between
reforms to improve resource allocation. governments and enterprises. In contrast, in
In land, the principal challenges are to health, education, social security, and other
enhance security of rural land tenure and areas typically considered to require state
to ensure the equal treatment of rural and involvement because of market failures, Chi-
urban land tenure and property rights for na’s government had initially retreated. Tra-
social stability, particularly in rural areas; to ditional arrangements were abandoned, and
modernize the institution of the rural collec- government spending lagged behind. The
tive so that it remains relevant in the face of report identifies specific ways in which the
evolving shifts in law and policy; to address role of the government can be recalibrated,
the strict separation of rural and urban land generally toward a more limited direct role in
tenure systems, which currently drives the resource allocation, a more arm’s-length rela-
inefficiencies and inequities generated by the tionship between government and business,
process of converting rural land into urban and an enhanced role in delivering public
use, by reducing the role of state in the land goods and services and ensuring equality of
conversion process and by allowing for more opportunity. Reviewing the interrelationships
market-based allocation of land; to ensure between various tiers of government will play
the protection of priority farmland for food a key role in this recalibration.
security through comprehensive land use
planning; and to introduce taxation of land
and property to help ease the distortions and
Setting the Stage: China’s Past
social pressures created by subnational gov- Economic Performance, Key
ernments’ reliance on revenues from land Challenges, and Future Growth
transfer fees. Potential
The financial sector faces a few key reform
Rapid Past Growth and its Sources
challenges. First, there is a need to commer-
cialize and rationalize financial institutions China’s remarkable economic development
and markets to meet the diverse demands of over the past three decades has brought many
households, enterprises, and government sec- positive results. Growth averaged 10 percent
tors for financial services and products. To a year, far faster than in nearly any other
this end, financial institutions should be bet- country. This growth drove a parallel reduc-
ter governed and operate in a conducive pol- tion of the poverty rate from 65 percent to
icy environment under competitive pressure well below 10 percent (World Bank 2009a).
80 CHINA 2030
As a result, China has become the world’s economic, social, environmental, and exter-
second largest economy (accounting for 9.5 nal challenges that work against the govern-
percent of global GDP in 2010), its largest ment’s stated goal of building a “harmonious
exporter (with a global market share of over society.”1 Spurred by high savings, cheap
10 percent and rising) and manufacturer, and finance and other inputs, and export-oriented
an increasingly important engine of global policies, China’s growth has been investment-
growth. and industry-led. The priority accorded to
As elaborated in annex 1A, China’s fast industry stunted the development of services,
growth can be explained from various per- while the emphasis on physical investment
spectives. It was a type of growth char- led to lower investment in human capital. In
acteristic of a catch-up phase, where the turn, highly capital-intensive growth meant
combination of government-driven resource that China’s economy created few jobs per
mobilization and pragmatic and effective unit of urban GDP growth.2 With wages lag-
market-oriented reforms allowed the country ging behind productivity growth, the share of
to exploit the “advantages of backwardness.” wage income in GDP declined to 48 percent
Additional factors such as China’s large mar- by 2008, driving the share of consumption
ket size, a “demographic dividend,” the suc- in GDP to unprecedentedly low levels for a
cessful harnessing of globalization, and a major economy. These trends contributed to
large and disciplined workforce contributed high and widening income disparities. Social
to China’s boom in manufacturing. Market- imbalances were exacerbated by pronounced
oriented reforms unlocked a vast pool of unevenness in access to public services and
entrepreneurial talent, which further contrib- by tensions surrounding land acquisition.
uted to vigorous growth. On the environmental front, rapid growth,
While the market mechanism was con- a shift in production toward more energy-
tinuously expanded and now plays the lead intensive industries, and urbanization have
role in resource allocation, the government combined to make China the world’s larg-
has played a strong role during China’s eco- est energy user. Fast growth has also led to
nomic take-off. In general, the government substantial depletion of natural resources
has used its regulations and powers in ways and serious environmental pollution. Finally,
that favor the extensive input of capital and many of the policies that generated China’s
other factors to foster fast industrialization internal imbalances also contributed to its
and urbanization. The government’s focus on twin current and capital account surpluses.
expanding industrial investments has helped Together with China’s expanding global mar-
to promote reallocation of factors from low- ket share, they fueled protectionist pressures
productivity agriculture to higher-productiv- in key foreign markets.
ity manufacturing. Over time, however, the
government’s strong role, especially its influ-
Avoiding the “Middle-Income Trap”
ence on factor allocation, has contributed
while Addressing Key Imbalances
to ever more serious economic imbalances
and social disharmonies. Going forward, To become a modern, harmonious, and cre-
this strong role can also be detrimental to ative high-income society by 2030, China
improvements in technical efficiency, cre- will need to sustain relatively rapid growth
ative power, and entrepreneurship at a time while addressing the noted economic, social,
when China’s growth will depend more on environmental, and global imbalances. In
innovation. countries near China’s level of per capita
GDP, the first challenge is often termed that
of avoiding the “middle-income trap” (Gill
The Emergence of Imbalances
and Kharas 2007).
This rapid growth and the accompany- Two factors are set to contain China’s
ing structural change, while serving China growth rate going forward. The contribution
well in many respects, also introduced new from labor will decrease in line with lower,
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 81
and eventually (from around 2015) negative, reforms to further improve the efficiency of
expansion of the working-age population. China’s economy. Without new impulses
Similarly, if some income will be trans- to raise TFP, growth could slow rapidly,
ferred from enterprises to households either exposing China’s economy to heightened
because of a need to achieve social objectives risks. Within-firm improvements in techni-
or because of a tightening labor market, and cal efficiency can be generated by techno-
if growth must become more “intensive” to logical innovation, better organization and
meet environmental goals, the ratio of invest- management, exploitation of scale econo-
ment to GDP could gradually decline, albeit mies (including from consolidation of sup-
still remaining at very high levels. 3 In addi- ply chains), agglomeration economies linked
tion, somewhat lower investment rates will to successful urbanization, and productivity
reduce the scope for the transfer of tech- improvements spurred by enhanced competi-
nologies embedded in new equipment. In tion. Parallel improvements in allocative effi-
any case, as China moves from a technologi- ciency would come through the movement of
cal “catch-up phase” toward the frontier, a factors of production from lower- to higher-
smaller share of productivity improvements productivity uses (firms, sectors, locations).
will take such embedded form. Better resource allocation would sustain the
In this setting, the key to avoiding the pace, alter the pattern, and boost the qual-
middle-income trap is keeping TFP growth ity of growth. As elaborated in box 1.1, such
near its past high rates, through policies and efficiency gains have been an important part
BOX 1.1 Significant potential remains for further productivity gains through factor
reallocation
Several detailed studies of China’s past performance be the key driver of growth. They also find signifi-
support the conclusion that factor reallocation has cant misallocation of capital, with the less efficient
been a major contributor to its productivity growth. state sector absorbing over half of all fixed invest-
Hsieh and Klenow (2009) seek to measure the ment, while representing only 13 percent of employ-
degree to which resource misallocation has lowered ment. The authors calculate that if capital had been
aggregate total factor productivity (TFP) in China allocated efficiently across the state and nonstate
and India. They model how distortions that drive sectors, with more going to the latter, China could
wedges between the marginal products of capital have achieved the same growth without the observed
and labor across firms will lower aggregate TFP. increase in the rate of aggregate investment from
Using microdata, they find large gaps in marginal 21 percent of GDP in 1978 to 40 percent in 2007.
products of capital and labor across plants within Looking forward, reducing distortions in capital
narrowly defined industries in China compared with markets could help China maintain relatively rapid
the United States. By hypothetically reallocating growth while simultaneously reducing the imbal-
capital and labor to equalize marginal products to ances between consumption and investment.
the extent observed in the United States, they cal- Bai, Hsieh, and Qian (2006) also look at the dis-
culate potential manufacturing TFP gains of 50.5 persion of returns to capital across sectors, regions,
percent in China in 1998. By 2005, these potential and types of ownership. They find clear evidence
gains had been reduced to 30.5 percent, indicating of misallocation but also some evidence that it may
progress in improving resource allocation in the have lessened over time, thus contributing to China’s
intervening period as well as large remaining scope growth performance. Bulman and Kraay (2011) find
for further improvements. that factor reallocation has accounted for about 2.2
Brandt and Zhu (2010) seek to quantify the percentage points of growth over the period 1979–
sources of China’s past growth. The authors con- 2008, or more than one-half of the total growth in
sider three sectors: agriculture, the state part of non- TFP. This contribution appears to have been on a
agriculture, and the nonstate part of nonagriculture. declining trend.
They find the increase in TFP in the latter sector to
82 CHINA 2030
BOX 1.2 How fast will China need to grow to achieve high-income status by 2030?
Between 1989 and 2009, the World Bank thresh- exchange rate appreciation is 0.8 percent a year, and
old between upper-middle-income and high-income 4 percent average real GDP growth if real exchange
countries grew by an average of 3.5 percent a year rate appreciation is 3 percent a year.
(nominal U.S. dollars). Assuming that this threshold Alternative assumptions about each indicator
continues to grow at the same rate, the high-income are easy to apply in this simple framework. For
threshold in 2030 would be $24,079 per capita. To example, if the threshold were assumed to grow by
reach this level by 2030, China’s GDP per capita in around 4.5 percent a year instead of 3.5 percent,
dollars would have to grow at an average of 8.9 per- the required GDP growth rate would rise to 5–7.2
cent a year. Based on a projected population growth percent. Similarly, targeting a 2030 GDP per capita
of 0.4 percent a year, this would require average 10 percent above the formal high-income threshold
GDP growth of 9.3 percent a year, in dollar terms. would require a 0.5 percentage point higher average
Assuming 2.3 percent U.S. inflation, average annual growth rate.
real GDP would have to grow 6.2 percent if real
of China’s growth story to date. They are Japan, Republic of Korea, and Taiwan, China,
far from exhaustion, however, and can be over periods when their per capita GDP rela-
unlocked through further reforms. tive to that of the United States was similar to
China could formally reach high-income that of China today. In a recent multicountry
status with average GDP growth rates quite review of growth performance, Eichengreen,
a bit below those it achieved over the past Park, and Shin (2011) project China to grow
three decades. The threshold beyond which by 6.1 to 7.0 percent a year in the 2011–20
an economy is deemed to be high, middle, decade and by 5.0 to 6.2 percent a year over
or low income is naturally arbitrary. None- 2021–30. Finally, Lee and Hong (2010) fore-
theless, the World Bank employs such cast average growth over the period 2011–30
thresholds for classifying its client mem- of 5.5 percent under a “baseline” scenario
bers. Box 1.2 provides illustrative calcula- and 6.6 percent under a “reform” scenario.
tions of the growth rates needed to carry Our own projections (given later) imply aver-
China to the Bank’s high-income threshold age growth of 6.6 percent over the next 20
by 2030. Because global growth is mov- years under a reform scenario, also suggesting
ing this marker, while the relevant Chinese that such a target is within reach.
growth rate is the product of domestic GDP However, growth is no longer enough.
growth and the evolution of the yuan-dollar Simultaneously achieving a “harmonious
exchange rate, these calculations produce a society” along with high-income status will
range of estimates from 4 percent to 6.2 per- also require progress in making growth more
cent. Reaching a higher level above this very equitable, environmentally sustainable, and
minimal threshold would require faster aver- balanced. Specific challenges include creat-
age growth; the average per capita income ing conditions for more employment genera-
of high-income countries is more than three tion and for improvements in the distribution
times this threshold level. of “primary income,” in the quality of and
Prominent projections of China’s future access to public services, in expanded social
potential growth bracket this range of growth security and other means of reducing vulner-
rates, suggesting that high-income status by ability, and in efforts to create a less resource-
2030 is achievable. For example, Lin (2011) intensive form of growth.
argues that China could still grow at around China’s top leaders have long recog-
8 percent a year over the next 20 years, based nized this need. As a result, the need for a
on a comparison with the performance of new growth model has been the paramount
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 83
objective of all key government policy state- A reform scenario that assumes substan-
ments since the annual Central Economic tial policy reform along the lines sketched out
Work Conference of December 2004.4 The in the report is first developed and quantified.
following year, changing the growth pattern We then consider alternative, more qualita-
became an overarching thrust of the 11th tive scenarios where such reform is not forth-
Five Year Plan (5YP) 2006–10. In a major coming or is of lower quality.8
shift from previous plans, where growth was Under the modeled reform scenario, over-
the dominant objective, the 11th 5YP also all GDP growth would slow over time, but to
emphasized environmental and social objec- rates that still could ensure high-income sta-
tives. While some progress has been made, tus by 2030. All the main drivers of growth
the agenda is far from complete (World Bank evolve gradually. Although more employ-
2009c). These aims have now been main- ment-friendly labor market policies and more
tained and reinforced as central pillars of the labor-intensive production allow employment
12th 5YP. 5 The need for more fundamental to grow slightly faster than the working-age
structural change to achieve such objectives population, demographic factors still cause
has also long been stressed by many analysts employment to begin shrinking around 2015.
of China’s economy.6 With the beneficial impact of opening up the
economy and integration into the world econ-
omy expected to phase down, with China
Possible Scenarios to 2030
moving closer to the technological frontier,
This understanding is also supported by the and with declining potential to remove dis-
results of economic modeling, which deliver tortions, TFP growth edges down over time,
two strong messages. The first is a posi- although to a still high level by regional
tive one. Concerted reforms to address key standards. Finally, the contribution of capi-
remaining distortions can lead China to a tal accumulation to growth also declines but
development path that delivers both rela- remains sizable. Restructuring the economy
tively rapid growth and improvements in key takes time, while the need remains for high
structural, social, environmental, and exter- levels of manufacturing activity and for fur-
nal indicators. Second, and in contrast, such ther investment, notably in infrastructure
an outcome is inconceivable under broadly but also for industrial upgrading. The capi-
unchanged policies. Under such a scenario, tal stock per worker is now an estimated 8.7
while growth could still remain relatively percent of the U.S. level, underscoring the
high, key social, environmental, and external need for further capital accumulation. GDP
indicators would worsen significantly. growth would gradually decline from an
How might China’s economy evolve over average of 8.6 percent in 2011–15 to an aver-
the next 20 years under a scenario of substan- age 5 percent in 2026–30.
tial additional reform? Given the fundamen- Such a growth slowdown would be inde-
tals, how high could trend growth be? How pendent of policies to transform the economic
would the structure of the economy evolve? development pattern. Relative to an alter-
To examine the impact of different long-run native “on past trends” scenario described
strategies on the speed and quality of China’s below, this scenario features significantly
future growth (including on resource use, lower investment, hence a smaller contribu-
income inequality, and the external balance), tion from capital accumulation. However,
the Development Research Center (DRC) of this effect would be broadly offset by still
the State Council has updated its computable high TFP growth, driven by factors such as
general equilibrium model, which incorpo- more reallocation of labor (both across firms
rates the detailed structure of production, and from rural to urban areas), more finan-
demand, income distribution, and resource cial sector reforms, better corporate gov-
use in China to conduct illustrative alterna- ernance, fewer distortions and barriers to
tive long-term scenarios.7 services sector activities, more research and
84 CHINA 2030
TABLE 1.1 China: Projected growth pattern assuming steady reforms and no major shock
Percent
Indicator 1995–2010 2011–15 2016–20 2021–25 2026–30
development (R&D), and more development investment, the current account surplus
of human capital. gradually declines over time, as a share of
Over a 20-year horizon, this scenario also GDP, easing external imbalances.
sees significant changes in the structure of • The economy creates more urban jobs and,
the economy, supporting a reduction of eco- as a result, more rural-urban migration,
nomic, social, environmental, and external higher rural productivity and income,
imbalances (table 1.1). Key specific trends and less urban-rural inequality. More
include: urbanization stimulates the service indus-
try, including through spending patterns
• The importance of industry declines and of urban residents. The share of employ-
that of the service sector rises. The share ment in agriculture falls to 12.5 percent
of industry in GDP gradually declines by in 2030.9 This decline works to support
12 percentage points, from 47 percent in the growth of labor productivity in agri-
2010 to 35 percent in 2030, while that of culture, hence income growth in that sec-
the tertiary sector rises by a significant 18 tor. The decrease in the productivity gap
percentage points from 43 percent in 2010 between agriculture and the other sec-
to 61 percent in 2030. tors underlies lower urban-rural income
• The share of consumption in GDP rises inequality.
from 47 percent in 2010 to 66 percent in • The economy will be less commodity and
2030, reversing the past steady decline. energy intensive. That is because it has less
Reforms that encourage urban job cre- industry and, within industry, less heavy
ation and greater upward pressure on and dirty industry, in large part because of
wages boost the share of wages and house- better pricing of energy, commodities, and
hold income in GDP, increasing the role of environmental degradation.
household consumption. Government con-
sumption rises on the back of increasing Alternative scenarios are possible. Differ-
social spending and spending on opera- ences in global developments would naturally
tions and maintenance. affect China’s prospects. Because the result-
• Investment as a share of GDP declines ing possible range of domestic exogenous and
over time. This ratio trends down by 15 policy scenarios is vast, we discuss the key
percentage points to a more sustainable features of these alternatives in more qualita-
34 percent in 2030, well below both cur- tive terms.
rent levels and levels under any alternative One alternative domestic scenario would
“on past trends” scenario. Despite lower see much less progress with economic
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 85
restructuring. Under this “on past trends” to more reliance on markets and entrepre-
scenario, policy settings and trends would neurship, and from technology absorption
remain broadly unchanged. As a result, fac- to technology innovation, while simultane-
tors and resources would continue to be ously correcting economic imbalances and
channeled toward industry, with the share of social disharmonies. Doing so will require a
industry in GDP edging down only slightly sense of the policy areas that offer particular
between 2010 and 2030. The share of ser- promise for promoting rapid and harmonious
vices would still increase, but to a low level development and of the specific reforms that
compared with countries at a similar stage would be required. This report now turns to
of development. Already very high invest- examining such issues. It argues that these
ment and savings would increase further and reforms will need to focus on three broad
already very low consumption would decline areas that promise particularly significant
further. Overall, the current account surplus gains in efficiency or reductions in imbal-
would remain high despite increasing levels ances. First, the enterprise sector needs to be
of investment. Labor migration out of agri- further reformed to facilitate more efficient
culture and urbanization would continue, resource use and motivate innovation and
but at a slower pace. More modest urban entrepreneurship. Second, reforms of input
job creation would limit the increase in the markets—land, labor, and capital—need to
household income share, while the labor be advanced to rectify distortions in factor
productivity gap between agriculture and allocation.11 Third, the fiscal system needs to
the rest of the economy would remain high. be improved to help sustainably deliver the
Both factors would further accentuate urban- level and quality of public social and environ-
rural income disparity and overall inequality. mental services central to the vision of China
Finally, in this industry-led scenario, energy 2030. The remaining resources available for
and resource intensity would remain high, investment will need to be raised and allo-
and pollution and emissions would continue cated so that rapid growth is maintained even
to rise. as China approaches the technology frontier
In fact, continuing with the past pattern in a number of sectors.
would become increasingly difficult, if not These reforms are united by one com-
impossible. While this scenario can be mod- mon theme—“reforming government.” For
eled, a more likely outcome would be a future much of the past three decades, while the
forced change in course as China finally market mechanism has been demonstrating
reaches some of the limits of economic, its effective function in allocating resources
social, environmental, or external sustain- and spurring economic growth, the govern-
ability.10 Whether through a controlled ment has maintained a direct role in allocat-
change in policy or a crisis, such a hasty ing resources and deciding business affairs. It
shift would lead to sharply lower savings and does so by maintaining significant ownership
investment rates, putting China on a slower stakes in some important enterprises in “stra-
growth path than under the reform scenario. tegic” sectors and by deploying a range of
This possibility further strengthens the case industrial interventions to influence resource
for up-front reforms to get China on a new allocation. It also exercises complicated reg-
growth path. ulations and oversight to channel factors at
low cost into industrialization and urbaniza-
tion. In contrast, in health, education, social
Promoting Efficiency and Equity security, and other areas typically considered
through Structural Reform to require government involvement because
of market failures, China’s government had
Changing the Role of the State
initially retreated. Traditional arrangements
To achieve its vision for 2030, China needs were abandoned, and government spend-
to shift from factor input-driven to efficiency- ing lagged behind. Also many public entities
driven growth, from direct state intervention such as hospitals and schools had to “fend for
86 CHINA 2030
themselves,” becoming responsible for their role of government in input markets, in state
own revenue generation. ownership of companies, and in industrial
China’s strong track record under the and competition policies. At the same time,
existing policies, especially its relatively good in line with the aim to become a harmonious
performance during the recent global crisis, society, there is scope for more government
is no reason to avoid reforming government. involvement in health, education, and social
China’s past success was the combined result security. Reviewing the interrelationships
of market and government forces and actions. between various tiers of government will play
A strong government used direct interven- a key role in this recalibration.
tions to push forward industrialization and
urbanization, to overcome market failures,
From Catch-Up Growth to
and to facilitate factor accumulation while
Endogenous Growth
the market unleashed the power of the enter-
prise sector. As described by economists like Government reform will be crucial for help-
Gerschenkron (1962) and Rosenstein-Rodan ing China move from its previous catch-up
(1961), such policies to reap the “advantages growth approach to a more endogenous
of backwardness” are not unusual. However, development approach. So far, this shift
as China approaches the general technologi- has proven very challenging. While a 2003
cal frontier and finds it harder to sustain an plenum of the Communist Party of China
extensive form of growth, this previous (CPC) vowed to transform the government’s
advantage can become the disadvantage. function in economic management (espe-
Over time, specific incumbent enterprises can cially through reform of the administrative
solidify their privileged access to resources approval and investment systems), limited
and government support. In China, many progress has been made. Going forward,
such firms are larger state-owned enterprises, such progress in government reform will be
because SOEs are naturally connected to the promoted by reform of the fiscal system, the
government and often seen as strategically enterprise sector, and factor allocation.
important. This biased business environment
can jeopardize fair competition, efficiency The fiscal system. The large social and envi-
improvement, and innovation and thus be an ronmental agenda over the next two decades
obstacle for an economy trying to complete will entail significant expansion of social
its industrialization and join the club of high- protection, health care, public investment in
income countries. The economic imbalances the environment, and recurrent expenditures,
and social disharmonies will also become mostly by subnational governments. How-
more and more difficult to handle. ever, such increases will need to be achieved
The report identifies specific ways in which while maintaining fiscal sustainability, avoid-
the role of the government and its relation- ing levels of taxation that could harm growth,
ship with enterprises can be recalibrated to easing the fiscal pressures on subnational
achieve rapid sustained growth driven by effi- governments, and strengthening fiscal insti-
ciency and innovation. It calls generally for tutions. Over the next two decades, then, the
moving toward a more limited direct (more challenge will be sixfold: changing the com-
arm’s-length) role in resource allocation and position and improving the efficiency of pub-
an enhanced role in delivering public goods lic expenditures in line with China’s evolving
and services and ensuring equality of oppor- development objectives; improving the effi-
tunity. As economic development progresses, ciency of revenue mobilization; realigning
markets function increasingly well, and the revenues with expenditure responsibilities
economy becomes increasingly sophisticated, by recentralizing some selected functions
the benefit of direct government involvement and allowing some subnational governments
in allocating resources weakens. In this con- to charge local taxes; bringing all subna-
nection, it is useful for China to review the tional government borrowing and associated
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 87
spending on budget, subject to strict controls; efficiency will also require further efforts to
making subprovincial transfers more equal- level the playing field, especially between
izing across lower levels of government; and smaller and larger firms, and between state-
improving the accountability and transpar- owned and nonstate firms, not only in a legal
ency of governments. sense but also in the access to key inputs.
Finally, this will require a review and modern-
The enterprise sector. A vibrant corporate ization of the extensive “industrial policies”
sector will be critical for sustaining relatively that the authorities have used to influence the
fast growth. A central element will be further structure within and across sectors.
increases in competition, especially (but not
only) between the state and nonstate (includ- The allocation of factors of production. If
ing private) enterprises in the “strategic” and anything, improving the efficiency in the use
“pillar” industries where such competition of factors of production—land, labor, capi-
has been curtailed. The role of state capital, tal—will be more challenging than reform-
after being securitized and made tradable, ing the enterprise sector. However, as shown
should be calibrated to provide public goods. in box 1.3, this is also the sphere in which
That requires dismantling monopolies and many significant distortions remain, suggest-
oligopolies in sectors where competition ing much potential from reforms to improve
would yield superior results, introducing over- resource allocation.
sight arrangements where monopolies are con- In land, the principal challenges are to
sidered necessary to ensure that market power enhance rural land tenure security and ensure
is not abused and does not serve as a drag on the equal treatment of rural and urban land
the economy, and lowering entry and exit bar- tenure and property rights for social stabil-
riers for all enterprises. Improved allocative ity, particularly in rural areas; modernize the
BOX 1.3 Where are the largest remaining distortions in product and factor markets?
In a series of recent papers, Yiping Huang and col- the period 1980–2008 using the input-output panel
laborators (Huang 2010; Huang and Tao 2010; of 38 two-digit industrial sectors in China. They
Huang and Wang 2010) show that China’s specific find that, on average, factor allocative efficiency
reform approach has led to extensive liberalization plays a substantial role in industrial growth by
of product markets, with prices of more than 95 per- increasing productivity. Based on their analysis, the
cent of products being market determined, but with most urgent reforms are to continue the development
continued distortions in factor markets. The authors of factor markets (including by providing nonstate
focus on labor, capital, land, resources, and the envi- enterprises equal access to resources and develop-
ronment. They present crude estimates of the cost ing nonstate financial institutions) and to deepen the
of remaining distortions in each area, with particu- restructuring of state industry.
larly high measures for capital and labor. Such dis- Zhang and Tan (2007) examine and estimate
tortions acted like implicit subsidies and artificially the changing patterns of distortions during the
raised the profits of production, increased returns to reform process. They find that China’s product mar-
investment, and increased China’s external competi- kets have become more integrated after an initial
tiveness. While such asymmetric liberalization was a period of fragmentation in the early reform period.
fundamental cause of China’s extraordinary growth The large shift from farm to nonfarm employment
performance, it also contributed to the observed and relaxed constraints on migration also indicate
growing structural (including global) imbalances increased labor market integration. However, inter-
and risks. Future efforts should focus on comprehen- sectoral differences in marginal product of capital
sive market-oriented reform of factor markets. have grown during the reform period, suggesting
Similarly, Chen, Jefferson, and Zhang (2011) remaining distortions concentrated in financial and
investigate the impact of structural reform during land markets.
88 CHINA 2030
institution of the rural collective to remain rural and urban land influences the structure
relevant in the face of evolving shifts in law of government revenues and expenditures.
and policy; address the strict separation of Especially during crises, limits of the fiscal
rural and urban land tenure systems—which system have encouraged governments (includ-
currently drives the inefficiencies and ineq- ing subnational governments more recently)
uities generated by the process of convert- to employ the financial sector as a quasi-fiscal
ing rural land into urban use—by reducing tool to support state enterprises and pub-
the role of state in the land conversion pro- lic and social infrastructure. As a result, the
cess and by allowing for more market-based banking system has needed to be periodically
allocation of land; ensure the protection of recapitalized, with fiscal repercussions. Thus,
priority farmland for food security through making the fiscal system stronger is a critical
comprehensive land use planning; and intro- element of making the financial sector more
duce taxation of land and property to help competitive and commercial.
ease the distortions and social pressures cre- Such reforms must also be carefully
ated by subnational governments’ reliance on sequenced. While the following sections pro-
revenues from land transfer fees. vide specific suggestions on the sequencing
The financial sector faces several reform of reforms within a given area, there also are
challenges too. First, there is a need to com- some general lessons for sequencing across
mercialize and rationalize the financial broad areas of policy. First, in the most gen-
institutions and markets to meet the diverse eral terms, enterprise reforms should precede
demands of households, enterprises, and financial sector reforms. Otherwise, a liber-
government sectors for financial services alized financial sector channeling resources
and products. To this end, financial institu- to a still distorted enterprise sector could in
tions should be better governed and operate fact exacerbate distortions in resource allo-
in a conducive policy environment and under cation and raise risk levels. In contrast, once
competitive pressure and effective regulation major price and other distortions have been
and supervision. In addition, there is a need removed, once enterprises have begun to face
to further liberalize interest rates, deepen the a truly hardened budget constraint, and once
capital market, upgrade financial infrastruc- important sources of moral hazard have been
ture and the legal framework, strengthen the addressed, the financial sector will be much
regulation and supervision framework, build better placed to allocate capital in line with its
a financial safety net and develop crisis man- social rate of return. Of course, that does not
agement and insolvency schemes, and recast mean that all financial sector reforms should
the rights and responsibilities of government. be delayed. In fact, it places a premium on
Supporting Report 4 on social develop- early action to strengthen regulation and
ment addresses the issues of improving the supervision, enhance commercialization, and
flexibility and efficiency of labor markets in gradually lower floors on lending rates and
China, as many of the constraints and issues raise ceilings on deposit rates within a still
are interrelated with social protection and controlled setting.
insurance. In broad terms, fiscal reform should move
While discussed individually here, reforms in tandem with or even slightly in advance of
of the fiscal system, the enterprise sector, and enterprise sector reforms. Remaining tax dis-
factor allocation are highly interrelated. For tortions and incentives created by the system
example, incentives created by the fiscal sys- of intergovernmental finance are combining
tem influence the form of industrial policy, with other policies to distort China’s indus-
particularly the actions of local authorities. trial structure. Remaining weaknesses in the
The differential access to finance of various fiscal system have forced local governments
enterprises influences China’s industrial struc- to rely on off-budget borrowing, further dis-
ture. The ability of governments to capture torting resource allocation and raising risk
the rents created by China’s dual system of levels. Thus, a front-loading of fiscal reforms,
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 89
particularly in the spheres of revenues (espe- services. The reform also launched impor-
cially the channeling of SOE dividends to the tant changes in China’s system of intergov-
budget) and local borrowing could create ernmental fiscal relations. Changes in tax
conditions for more effective enterprise and assignments significantly strengthened the
financial reform. central government’s revenue base, laying the
The rest of this chapter examines four spe- foundation for greater and more rules-based
cific areas where policy reform will be crucial transfers to begin tackling fiscal disparities.
for achieving China’s 2030 vision. In each Further incremental reforms followed in a
of these areas, what is the vision for 2030? range of areas. Fiscal policies also played an
What progress has already been made, and active role in China’s industrialization. For
what are the key current challenges in getting instance, China successfully attracted foreign
on a critical path for achieving the vision? investment through preferential tax treat-
What more specific steps should be taken ment and other incentives provided by subna-
in the near-, medium- and longer term? The tional governments.
chapter highlights key points. By 2030, China will need a financially
strong and effective fiscal system capable of
meeting the economic, social, and environ-
Strengthening the Fiscal System mental needs of a complex and sophisticated
economy. In particular, as outlined below,
Fiscal System Reform in Line with the
the government will have to meet increasing
Evolving Role of the State
demands for public goods and services, an
Fiscal policy is a key determinant of efficiency expanded social safety net, and improvements
and equity and thus of China’s ability to in human capital. Despite China’s substan-
achieve its 2030 vision. By efficiently mobiliz- tial existing fiscal space and major untapped
ing and spending around 30 percent of GDP, sources of fiscal revenues, the scale of looming
government can increase the availability of expenditure pressures combined with the les-
crucial public goods and services, address key sons provided by the ongoing sovereign debt
externalities, and support increases in overall problems of several developed regions attest
efficiency. Tax policies have indirect incen- to the importance and difficulty of maintain-
tive effects on the savings, investment, and ing fiscal sustainability. Fiscal costs need to
consumption decisions of firms and house- be honestly estimated when initiating new
holds. Government also has a central role social programs, and containment of some
in reducing inequalities in opportunity and expenditures should be considered. In addi-
maintaining macroeconomic and financial tion, fiscal system reform will be a key instru-
stability. Well-designed fiscal reform can ment for recalibrating the role of the state and
help sustain rapid growth, address important strengthening governance and self-regulation
social gaps, and make the development path to meet China’s emerging challenges. Such
more environmentally friendly. reforms would focus on provision of public
Over the past two decades, China has goods and services, including regulatory insti-
greatly reformed its fiscal system. A major tutions, and on providing appropriate incen-
overhaul in 1994 focused on enhancing rev- tives for subnational governments to carry
enue mobilization and revamping national- out their functions in a financially sustainable
provincial fiscal relations. A new tax system and operationally self-disciplined manner.
with the value added tax (VAT) as its core Over the next two decades, successful reform
laid the foundations for a significant growth and institutional strengthening would funda-
in the revenue-to-GDP ratio. This increased mentally transform China’s fiscal system in
revenue allowed China’s public spending to five important dimensions:
grow to levels comparable with other econ-
omies with similar incomes, bringing sig- 1. The composition of spending would be
nificant improvements in public goods and different from what it is today, reflecting
90 CHINA 2030
TABLE 1.2 Size and composition of public expenditures, cross-country comparisons as a share of GDP
Percent of GDP
High income Middle income
comparable with that in OECD countries. for personal income taxes, and introducing a
This imbalance reflects the active role of fuel tax.
China’s government in economic activities, Improved revenue collection allowed
including subsidies to firms and infrastruc- spending to grow without compromising
ture spending. Part of infrastructure spending macroeconomic stability. Headline budget-
is financed by revenues from the sale of land ary revenues have increased from less than 10
use rights that are (correctly) excluded from percent of GDP in the mid-1990s to around
the aggregates noted above but now subject 20 percent of GDP today. The government
to budgetary oversight. However, a more also raises some 2 percent of GDP through
significant amount of investment is funded “government funds” other than land revenue
through borrowing by local Urban Devel- and about 4 percent of GDP through social
opment Investment Corporations (UDICs), protection contributions. In addition, subna-
whose activities are off budget by definition. tional governments raise significant revenues
Adding their expenditures would raise the from land assets and borrowing through
total public spending in 2008 to around 30 UDICs, which have mainly been used to sup-
percent of GDP.13 While an active govern- port land development and infrastructure
ment role in resource allocation is appropri- investment.14 The resulting modest fiscal
ate in the catch-up phase of development, this deficits and reported government debts also
role should shift toward the core business of allowed the government to effectively cush-
government—provision of public goods and ion the negative shock from the recent global
services—as China enters a more advanced financial crisis.
stage of development. The recentralization of revenues in 1994
On the revenue side, a series of reforms strengthened the central government’s capac-
have addressed many past distortions. These ity to redistribute in favor of poorer prov-
reforms include unifying the corporate inces. Net transfers from the center make
income tax (between domestic and foreign- up an increasing share of subnational gov-
funded enterprises), shifting from a produc- ernment resources (table 1.3). Among trans-
tion-based to a consumption-based VAT, fers, both general equalization grants and
lowering import tariffs, raising the threshold earmarked transfers (targeted at specific
92 CHINA 2030
Budgetary expenditures 578.6 100 1,313.5 100 4,924.8 100 6,104.4 100
Budetary revenues 374.7 64.8 780.3 59.4 2,865.0 58.2 3,260.3 53.4
Net transfer from center 211.9 36.6 541.1 41.2 2,204.4 44.8 2,856.4 46.8
Of which:
General transfer 15.9 2.7 121.5 9.3 874.6 17.8 1,131.7 18.5
Earmarked transfer 48.9 8.5 223.7 17.0 996.7 20.2 1,236.0 20.2
Sources: Ministry of Finance and staff calculations.
development priorities) have been growing Challenges and Policy Options for
in recent years, allowing a welcome phased Strengthening China’s Fiscal System
reduction of the “transitional systems trans-
fer.” Viewed at the provincial level, such The long-term vision and current starting
transfers have vastly reduced, if not removed, point elaborated above imply a clear direction
the correlation between government expendi- for fiscal reforms over the next two decades.
ture per capita and the level of local economic In most aspects, the broad direction is under-
development. The difference in expenditure stood by policy makers, and related programs
per capita across provinces can be largely have been included in the 12th 5YP. Within
explained by factors that affect the delivery each of the five noted dimensions, this sec-
cost, including average wage and population tion highlights more specific areas that offer
density. the greatest challenges as China seeks to get
Finally, the efficiency of public expen- on a path to achieving its vision. Drawing on
ditures has been improved through a range international benchmarking and experiences,
of measures to strengthen public financial it also suggests policy options and tools that
management. Most extrabudgetary charges could be applied in China.
have been abolished or brought on budget,
and plans are in place to bring the remainder Restructuring government expenditures. The
on budget. As in many countries, although composition of government spending needs
social security contributions and revenues to evolve to reflect China’s changing devel-
from sale of land use rights and other govern- opment challenges as it transitions to high-
ment assets flow to separate funds, they have income status. Most notably, providing social
all been subject to budget-type management, security and a basic set of public services,
and a more comprehensive view of public and building human capital and expanding
finances is emerging.15 Dividends from SOEs opportunity will require additional spend-
have begun to grow, have been brought into ing on health, social protection, and envi-
a separate capital operating budget, and are ronmental protection. As shown in table 1.2,
gradually becoming available to finance the China’s public spending on social protection
general budget. Single treasury accounts have and health as a share of GDP is significantly
been broadly established at the central and below average levels in OECD and upper-
provincial levels and are being rolled out at middle-income countries. The gap in educa-
lower government levels, laying the basis for tion spending is quite a bit smaller. While
enhanced monitoring and control of budget China’s reported spending on environmental
execution. Government accounting reform protection appears in line with OECD and
with improved classification of govern- upper-middle-income country norms, the sig-
ment activities made a strong foundation for nificant backlog and new challenges in this
improving transparency. Performance evalu- area could well require a further scaling up of
ation has been piloted in selected programs. such expenditures.
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 93
Source: Government Finance Statistics IMF 2007, 2009, and staff estimation.
aim to increase public expenditures by 2–3 this role has evolved significantly over the
percentage points of GDP for health care, past 30 years and should continue to do so.
1–1.5 percentage points for education, and Once this has been decided, practical adjust-
another 3 – 4 percentage points to fully ments to current spending patterns need to be
finance the basic pension pillar and to gradu- agreed and implemented, taking into account
ally meet the legacy costs of existing pension China’s specific organizational arrangements.
obligations. These add up to an incremental One way to begin this process is through the
fiscal outlay of around 7–8 percent of GDP— use of functional reviews (box 1.4).
which is a reasonable estimate to bring Chi-
na’s aggregate “social expenditures” by 2030 Further reform of taxes and other revenue
to near the lower end of the range of high- sources. To achieve its 2030 vision, China
income countries. Going forward, China will will need to adjust its revenue policies to gen-
also need to allocate more resources to oper- erate adequate on-budget revenues to cover
ating and maintaining its rapidly growing expenditures, cut efficiency-reducing distor-
stock of physical infrastructure assets. tions, and promote social and environmental
While infrastructure investment may need objectives. The main challenges and opportu-
to be scaled back in the longer term, these nities are focused in three main areas.
and other expenditure reallocations need not First, China has significant untapped
be linear. In the short to medium term, still potential to introduce or expand revenue
rapid urbanization and further integration sources that simultaneously promote all three
of the national market could demand more of the noted objectives. These are concen-
infrastructure investment. The further rise trated in four areas, two at the national level,
in household income would correspondingly and two at the subnational level. The most
increase the financial and economic return to significant near-term source of additional
infrastructure, justifying such investments. revenues is the collection of higher levels
Over the medium to long term, as the infra- of SOE dividends and their full channeling
structure stock is built, the marginal rate of to the budget. This adjustment could spur
return to infrastructure assets could begin to more efficient investment planning in SOEs
decline. By that time, public investment could while also generating significant resources.16
be more rapidly phased down toward levels For example, were SOEs to pay out half of
observed in higher-income countries, leaving their profits to the budget—a ratio prevail-
more resources for other activities. ing in developed countries—budgetary rev-
The structure of public investment also enues would grow. In the near to medium
needs to evolve to meet emerging needs. The term, higher taxes or prices on energy (car-
challenge is to choose projects that address bon), water, natural resources, and pollu-
current bottlenecks. As China develops, the tion would encourage their more efficient
bottlenecks are also changing. From a spatial use while improving environmental out-
perspective, no economy will develop equally, comes and generating major revenues.17 For
and cities are more likely to be the poles of example, Stern (2011) estimates that a tax
growth (World Bank 2009d). For China, Luo on coal at fairly modest carbon prices (for
(2005) finds that infrastructure investments example, $20 a metric ton of carbon dioxide)
in some inland regions such as Hubei and could yield revenues equivalent to 2–3 per-
Sichuan could reduce the regional develop- cent of GDP. In addition, enhanced taxation
ment gap without sacrificing much growth. of motor vehicle use and charges on parking
Therefore, from the perspective of enhancing (as a near-term option) and congestion (as a
growth, more public investment could be spa- longer-term option) would lead to more effi-
tially targeted to cities and selected regions. cient and livable cities and better environ-
In any case, the government needs to rede- mental outcomes. Experience with motor
fine its role and restructure its expenditures vehicle taxes, piloted in Shanghai, and with
in line with its development goals. In China, congestion charges, such as in Singapore and
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 95
BOX 1.4 Functional reviews: A tool for designing reforms for a more efficient
government
Functional reviews offer a flexible, problem-driven, resulted in a 50 percent downsizing of the public
and evidence-based framework that can help public sector. In Latvia, a 1999 functional review of the
sector organizations at various levels to identify key Ministry of Agriculture identified 161 separate func-
performance constraints, analyze the functions they tions, of which 9 were identified for privatization, 40
perform, assess their relevance, and draw recom- for rationalization, and 12 for transfer to other sec-
mendations for organizational and process changes tors. Implementation closely followed the proposed
to enable more effective delivery. These reviews typi- review.
cally evaluate existing expenditure programs along The literature on functional reviews points to key
two dimensions: efficiency and effectiveness. Each success factors. First, such exercises involve setting
review varies by objectives and scope. In some cases, general targets, but without specifying where they
the focus is at the policy and program level on effec- will be found. Second, aligning functional reviews
tiveness concerns; in other cases, the focus is at the with the budget process is essential to ensure that
organizational level on efficiency concerns or a com- recommendations are provided at the appropriate
bination thereof. point in the budget cycle. Third, one reason for suc-
Functional reviews have been applied in many cessful reviews in high-income countries was that
countries. In Canada, a 1994 program review estab- the legal mandates of the agencies and programs
lished a high-level special committee under the were flexible enough to allow relevant ministries to
prime minister. The committee set performance- amend their own structure and services. Fourth, it
based guidelines and managed the review process is often difficult for such exercises to succeed in the
that helped to generate substantial cuts (averaging absence of strong political leadership or of owner-
21.5 percent across departmental budgets). In New ship and buy-in on the part of line ministries and
Zealand, an expert-based, top-down review of the departments. Finally, a compelling need for such
state sector was undertaken without the participa- reviews, such as a looming fiscal crisis, can help gain
tion of line agencies. Restructuring in many sectors the consent of the public.
London, could offer useful guidance. Finally, FIGURE 1.2 Cross-country comparison of tax rates
as elaborated in greater detail in the subse-
quent discussion of land policy, expansion of
Value added tax rate, %
property taxes to residences would encour-
age more efficient use of land and also reduce 50
urban sprawl. While promising, it will take 40
time before property taxes become a major Tax
30
Corporate
source of overall revenues—very few devel- wedge, 20 income
oping countries raise more than 1 percent of as % of 10 tax rate, %
gross 0
GDP from this source (Bahl 2009). salary
Second, reform of labor taxes can promote
both greater efficiency and reduced imbal-
ances. Figure 1.2 gives a comparative picture
of the main tax rates on goods and services, Social contribution Highest marginal
corporate income, and labor income. The fig- rate, % income tax rate, %
ure shows that while China’s taxes on goods China Western Europe
and corporate income are not out of line East Asia and Pacific Latin America
with Western European and Latin American
averages, its marginal rates of labor taxation Source: Fiscal Reform and Economic Governance 2011.
96 CHINA 2030
FIGURE 1.3 Cross-country comparison of government revenue progressive (discouraging the formation of
human capital), while the various social con-
tributions are high and regressive, adding
Norway 34.6 9.1 14.9 further distortions and encouraging evasion
Denmark 47.8 1.9 6.1
at both ends of the income spectrum. As a
Sweden 35.2 12.6 7.5
Finland 30.8 12.0 9.8
combined effect of still low levels of cover-
France 26.7 18.0 4.9 age, a narrow base, and high levels of in-kind
Belgium 29.7 15.7 2.7 compensation and informal employment,
Austria 27.5 15.8 4.6 China also collects relatively little from social
Iceland 37.5 3.0 7.2 security contributions despite their high rates
Italy 29.8 13.3 3.3
Germany 23.8 16.4 3.5
(figure 1.3).
United Kingdom 29.5 8.3 3.7 A phased approach is advisable to reform
Canada 28.9 4.6 7.6 the labor taxation. In the near term, the con-
Greece 20.3 14.0 6.0 tribution rate for unemployment insurance
Switzerland 22.2 6.7 7.9 could safely be reduced by around 1 percent-
Australia 29.3 0.0 6.4
age point. In the medium term, the personal
United States 21.3 6.9 5.8
Japan 18.3 11.1 3.9 income tax could be consolidated to cover
Korea, Rep. 21.0 3.4 6.2 incomes from all sources (including capital
Singapore 13.1 0.0 6.6 gains), its base expanded by scaling back cur-
China 18.6 3.4 4.6 rently significant exemptions, and simplified
Russian Federation 27.0 6.0 14.5 with a lower marginal tax rate. If the first
% of GDP two effects were to dominate, and to be sup-
Total tax Social contributions Other revenue ported by an enhanced collection effort, such
a reform could possibly raise personal income
Sources: Government Finance Statistics IMF 2007, 2009, and staff estimations. tax revenues by around 1 percent of GDP in
the medium term and 2 percent of GDP or
more in the more distant future. In the lon-
ger term, China’s social protection contribu-
are far above global norms. Its top marginal tions could be reformed through reductions
rate for personal income tax (45 percent), in average rates combined with efforts to
total pension contribution rate (28 percent address the regressivity introduced through
of average salary of formal employment), high minimum contributions, complemented
and the overall labor tax wedge are high by by other reforms to mitigate unintended
any standard.18 These high rates work to effects on the finances of the respective social
reduce formal demand for labor and keep the funds. The latter could include separating out
wage share in GDP low, promoting inequal- the “legacy costs” of the pension system and
ity and discouraging consumption. Despite funding these from general revenues.
these high rates, major exemptions at lower Third, the taxation of land will need to
income levels mean that China mobilizes sur- shift away from transaction-related revenues
prisingly little from personal income taxes. toward a modern property tax. As elaborated
Data from the U.S. Agency for International in more detail later in this chapter, China’s
Development (Fiscal Reform and Economic subnational governments derive substantial
Governance 2011) indicates that China raises revenues from the sale of land use rights and
around 1 percent of GDP from personal taxes on real estate transactions. Because
income taxes, against an average of 5.85 per- prices and trading volumes in the property
cent in high-income countries.19 The personal market can be highly volatile, such revenues
income tax is also based on different rates for may not be reliable for financing essential
different types of income, introducing further public services and may put fiscal sustain-
distortions and inequities. At incomes beyond ability at risk. In addition, distorted incen-
the basic exemption, the tax becomes highly tives for officials in land development lead to
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 97
inefficient use of land, corruption, and abuse further growth of real revenues and favor-
of government power in land acquisition. able debt dynamics. China’s government
Since changes in land compensation practices commands a large portion of assets includ-
will in any case lower the net resources that ing SOE shares and land, which represent
subnational governments can derive from a source of potential revenues going for-
such sources, these governments will need to ward. Large national savings coupled with
find new revenues to fund their operations. investment-grade sovereign risk ratings imply
As detailed below, expanding property tax to a relatively low cost of borrowing. Given
cover residences offers such potential in the these factors, China could in principle sustain
longer term. somewhat higher annual fiscal deficits in the
Other important reforms on the revenue range of 3–4 percent of GDP.
side would include further changes in the At the same time, significant new pres-
VAT, enterprise income tax, and consump- sures will challenge China in maintaining
tion tax. These reforms could help rebal- fiscal stability. Citizens’ growing emphasis
ancing—making growth more domestically on social and environmental outcomes, rapid
driven and services driven. Changing the population aging, and further urbanization
excise tax on services to a value added tax will put upward pressure on public spend-
would not only lower the tax burden but ing. As noted, the combined effect of raising
also improve services’ competitiveness and social expenditures toward levels observed at
promote specialization. China’s current the lower end of the high-income spectrum
residence-based enterprise taxes deprive poor could alone add around 7–8 percent of GDP
provinces of significant revenues because to total spending. In the absence of reduc-
company headquarters are usually located tions in the share of other spending items in
in richer provinces. These taxes also have GDP, China’s total fiscal expenditure would
encouraged wasteful tax competition and reach around 40 percent of GDP. As shown
beggar-thy-neighbor policies among subna- by the current sovereign debt crises in some
tional governments. In the medium term, high-income countries, the revenue collec-
while the collection of the VAT, enterprise tion efforts required to finance such a level
income tax, and consumption tax could of spending could either be inconsistent with
remain residence based, the income could be rapid growth or (if patently infeasible) with
attributed to various locations, based on the macroeconomic stability. The conversion of
headcount of registered household, consump- currently quasi-fiscal liabilities (of UDICs,
tion, or value added (Xu 2006). for example) into explicit public debt could
add further fiscal pressure. At the same time,
Maintaining fiscal sustainability. Past fiscal slowing economic growth will cut the poten-
reforms and prudent macroeconomic policies tial growth rate of total fiscal revenues below
have left China with significant fiscal space. past levels, while the government faces pres-
Over the past decade, fiscal balances have sure to cut taxes to boost household dispos-
ranged from small surpluses to small deficits able income and facilitate restructuring.
(a 1.6 percent deficit of GDP in 2010). While Meeting the triple challenge of maintain-
off-budget borrowing by subnational authori- ing fiscal stability, sustaining rapid growth,
ties complicates the measurement of overall and addressing social and environmental
public debt, a conservative estimate of the imbalances will require choices in the face
debt of subnational governments based on a of difficult trade-offs. Even among high-
recent report by the National Audit Office income countries, different countries handle
would put overall public debt at around 44 such pressures in different ways, in line with
percent of GDP by the end of 2010.20 their specific circumstances and preferences.
Several factors will work to preserve or If China does not want to grow its size of
even enhance this fiscal space. China’s large government to average levels in high-income
growth potential creates the foundation for countries, part of the adjustment will need
98 CHINA 2030
to come from containment of some expen- thus supporting industrialization and urban-
ditures. In the near term, that could include ization. Debt financing will remain impor-
cuts to capital transfers and other enterprise tant for China’s urbanization drive, which
subsidies, streamlining government institu- demands continuing large investments in
tions and employment, and regulating “on- urban transit including subways, power,
the-job consumption” (san gong xiao fei in water, sewage, and the like. However, lim-
Chinese). Over time, as China’s front-loaded ited transparency and regulation has created
public investment program achieves its ini- potential risks to fiscal sustainability and the
tial aims, such investment could begin to quality of bank assets. Formally, borrow-
be scaled back. Given China’s fiscal space ing through UDICs should be for revenue-
and the existence of major untapped rev- generating purposes that can pay back the
enue sources, a large part can come from loan. In reality, a part of such borrowing
the scaling up of several taxes (noted above). appears to be for other purposes. Such quasi-
Such trade-offs will be eased by reforms to fiscal financing also obscures the true size
enhance the efficiency of government, includ- and composition of public spending and rev-
ing through the functional reviews described enues. The lack of a unified planning, execu-
above. tion, and monitoring of public spending can
China could construct a macrofiscal also lead to inefficient and suboptimal alloca-
framework (usually comprising medium-term tion of public funds.
budget plans and dynamic debt sustainability Allowing subnational governments to
analysis), linked to the five-year development access the financial market could have
plan, as a specific tool for promoting fiscal important benefits. Matching the economic
sustainability. Such a tool, employed at both life of assets that the debt is financing with
national and local levels, would help ensure the maturity of debt is sound public policy
the consistency of public spending with the because these infrastructure services can
country’s development strategy and resource and should be paid for by the beneficiaries
envelope. First, it would reveal the implica- of the financed services. Market access and
tions of current decisions on taxation and the operation of an active secondary market
spending on future budgetary and financing expose subnational governments to market
needs. Second, it can expose the fiscal risks disciplines and reporting requirements, help-
emanating from various sources such as ing to strengthen fiscal transparency, budget
contingent liabilities being called and global and financial management, and governance.
shocks hitting output growth. Third, it can A competitive subnational credit market
help evaluate the government’s capacity to with numerous buyers, sellers, and financial
meet current and future financial obligations. options, such as bonds that compete with
Were such analysis to show that debt limits loans, can help diversify financial markets
are likely to be breached over the projection and lower borrowing cost.
horizon, the government’s plans would need Moving forward, the central government
to be revised accordingly. needs to establish an institutional and regu-
Fiscal sustainability would also be pro- latory framework to reap the benefits while
moted by bringing subnational government mitigating the risks of subnational borrow-
borrowing on budget. Currently, while such ing. As demonstrated by over 200 years of
governments can formally borrow only with subnational infrastructure financing in the
State Council approval, they circumvent this United States, subnational debt financing is
limit by borrowing through UDICs and other viable under sound regulatory frameworks.
vehicles. Total subnational government debt The government’s recent inventory of all
has reached 26 percent of GDP according subnational government borrowings is an
to the National Audit Office. Such indirect important first step toward transparency
borrowing played a key role in financing in quantifying the liabilities of subnational
important infrastructure investments and governments and their entities and lays a
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 99
good foundation for further steps. Box 1.5, weaker localities could initially rely more
based on Liu (2010) and Liu and Pradelli heavily on transfers, with the central govern-
(2011), provides indicative elements of a ment establishing clear rules about when a
regulatory framework for subnational debt subnational government can graduate from
management. one status to another. Preconditions for
Direct borrowing by subnational govern- UDIC borrowing would include corporate
ments could be phased in, beginning with governance reform and clarity in its finan-
authorities with the greatest revenue capacity cial relationship with the subnational gov-
and most reformed fiscal systems. Financially ernment. Credit ratings and disclosure of
Core components of a subnational government debt system can be developed to include debt restructur-
regulatory framework are ex ante regulation and ing rules and a priority structure for settling claims.
an ex post insolvency system. In China, a complete
regulatory framework would also include strict reg- Regulating UDICs. As part of ex ante regulations,
ulation on borrowing by Urban Development Invest- UDIC long-term borrowing must be restricted to
ment Corporations (UDICs). public capital investments, ratios of operating reve-
nues to debt service must be established, and pledges
Ex ante regulation. The framework would spell out of assets as collateral must be regulated. Subnational
ex ante rules governing the purposes of subnational government guarantees of UDIC borrowing can play
government borrowing (such as long-term borrow- a useful role but would follow prescribed rules; for
ing for public capital investments only), types of debt example, total guarantees provided must be below a
allowed and disallowed (prohibiting exotic financial percentage of the subnational’s revenues, and no sin-
products, for example), and procedures for issuing gle UDIC borrower could have guarantees exceeding
debt. Fiscal targets can be established quickly by a certain percentage of total guarantees by a subna-
focusing on the debt service ratio, balanced operat- tional government. The U.S. regulation for subna-
ing budget, and guarantee limits, while developing tional special purpose vehicles can provide a useful
thresholds for fiscal sustainability assessment would reference.
take more time and effort. Fiscal transparency would To “ringfence” and reduce fiscal risks, China
be a precondition for subnational governments and could develop regulatory frameworks for UDICs to
UDICs to access capital markets. Credit assessment issue revenue bonds. In contrast to general obliga-
by reputable rating agencies can be required of all tion bonds, revenue bonds are secured by the rev-
subnational government and UDICS wishing to enue stream generated by the project that the debt is
access the capital markets. Only those governments to finance. Revenue bonds reinforce self-sustaining
that have adopted fiscal transparency and budgetary finance and allow the market to play a central role in
reforms would be allowed access the markets. enforcing debt limitation, pricing risks, and match-
ing the maturities of liabilities with the economic
Ex post insolvency system. International experi- life of assets. In the United States, revenue bonds
ences have demonstrated that unconditional bailouts account for about two-thirds of the US$3 trillion
of subnational governments and their entities lead subnational debt outstanding.
to moral hazard, encouraging irresponsible fiscal Developing revenue bonds can be supported by
behavior and reckless lending by creditors. In the complementary reforms, including corporate gov-
near term, China can develop two sets of monitor- ernance reform, regulatory frameworks for setting
ing indicators: one measuring fiscal deterioration tariffs, and standardized reporting, audit, and mar-
and another one for fiscal insolvency. The key is to ket disclosure requirements. Financial strength is
monitor, and intervene early, to prevent subnational assessed through a credit rating system that assesses
governments from deteriorating into insolvency. a borrower’s ability to pay debt. Hard budget con-
Over the longer term, a more systematic insolvency straints on special purpose vehicles are a must.
100 CHINA 2030
audited financial accounts (for UDICs) and where reforms have already been introduced
fiscal accounts (for subnational governments) have witnessed improved revenue capac-
are prerequisites for borrowing from the ity with increased transfer directly from
financial market. Those subnational govern- the province (circumventing the municipal
ments and UDICs that are allowed to borrow level—a tier between province and county)
should be subject to hard budget constraints, and enhanced monitoring of county finances
without recourse to central government sup- by provincial governments. Moving forward,
port. It is important for the central govern- a natural step would be to gradually expand
ment to send a credible “no-bailout” message this reform to the whole nation. While inter-
to the market, one documented in legislation national experience provides limited clues,
and demonstrated in action. China’s own pilot programs suggest it has
strengthened the fiscal capacity of county
Further reforming the intergovernmental governments, reduced the overall cost of gov-
relationship. Achieving a harmonious high- ernment, and improved the delivery of public
income society by 2030 will require further goods and services. Implementation of such
complex reforms of China’s system of local reforms should pay due attention to avoiding
finance and intergovernmental fiscal rela- gaps in, or shocks to, service delivery in the
tions. The key challenges for China’s fiscal transition period.
system in supporting this agenda remain Second, to enhance efficiency and equity
high fiscal inequality and a decentralization and to strengthen the national market inte-
of many functions that are usually financed gration, some expenditure responsibilities
or provided by higher levels of government in or their financing could be raised to higher
most high-income countries. Reforms in four levels of government. The economic literature
areas stand out: completing the move from prescribes that a function should be assigned
five to three levels of government; selectively to the level of government that best matches
raising some functions to higher levels of gov- benefits and costs of that function, whereas
ernment; introducing some more formal cen- the “subsidiarity principle” would lead to
tral government involvement in subprovincial assignment of a function to the lowest pos-
distribution; and introducing new sources of sible level (Dollar and Hofman 2006). These
subnational own revenues. considerations still leave much scope for
First, the ongoing move from five to three interpretation. In practice, there is consider-
(budgetary) levels of government should be able variety among countries in the assign-
completed. This is a key step toward stream- ment of functions. As table 1.4 shows, China
lining the size of government, improving is much more decentralized than high- and
the efficiency of government services, and middle-income countries on the spending
empowering county governments. Such side. In several cases, China’s assignment of
reforms in the fiscal management system are functions is out of line with theory and global
already being introduced in 27 provinces, good practice. In most countries, income-
covering more than 900 counties (Ministry maintenance responsibility (pensions, disabil-
of Finance 2010). Most county governments ity, and unemployment insurance) is the task
TABLE 1.4 Share of subprovincial governments in total government revenues and spending
Percent
Share provided by High-
subprovincial Developing income Transition
governments countries countries countries China
of the central government, for the good rea- ultra vires definition of subnational govern-
son that centralization can help pool the risks ments). But even if subnational government is
across regions and encourage labor mobility granted a wide range of autonomy (“general
and participation. In China, this also has competence”), the central government could
an equalization effect, because some coastal consider specifying at least those functions
provinces have relatively high employment- that it must perform.
to-retiree ratios thanks to many migrant A second option would be for the cen-
workers. tral government to get involved in the sub-
Third, China could consider introduc- provincial distribution of resources. For
ing more formal direct central government example, the center could, as a minimum,
involvement in subprovincial fiscal rela- establish expenditure needs for each level
tions. Because the tax-sharing arrangements of government and set limits on the dispari-
introduced in 1994 were not extended to the ties among subprovincial governments. Once
subprovincial level, the most serious fiscal dis- the assignment of expenditure responsibility
parities remain at that level, which accounts to subnational governments is decided, rev-
for nearly 60 percent of total public spending. enues would be assigned to ensure adequate
In 2007, provincial governments on average resources to perform these tasks. In this pro-
took about 25 percent of total subnational cess, the center could mandate some degree
revenue, municipal governments a further of uniformity in subprovincial revenue
one-third, and county governments, which assignment and transfer. One very ambitious
provide most services, took the remaining 41 option would require the provinces to trans-
percent. Subprovincial fiscal arrangements fer revenues to the county level in the same
remain at the discretion of provincial govern- way that transfers are allocated to the prov-
ments, leading to high variation across prov- inces. Alternatively, the center could require
inces. For example, the share of provincial the provincial governments to achieve cer-
governments in subnational revenues ranged tain prescribed targets, such as a minimum
from 37 percent in Gansu to only 9 percent level of education expenditure per student,
in Henan, while the county governments’ and revenue capacity equalization at some
share ranged from 30 percent in Helongjiang level.
to over 68 percent in Zhejiang.21 In general, There also is further scope beyond the
the higher-level government grabbed a higher property taxes already noted for subnational
fraction of fiscal revenue than its share of governments to tap new sources of “own”
expenditure responsibilities. As a result, the revenue. The high disparity in development
most serious vertical and horizontal imbal- warrants some flexibility in revenue assign-
ances are at the lower levels of government ment. China could consider first granting
(counties and below). new sources of own revenues to subnational
One option for addressing subprovincial governments in relatively developed cities.
disparities would be to set some limits on This step would free up fiscal resources for
the expenditure autonomy of subnational more transfers to poorer regions, and help
governments. Any such solutions would be bring a larger share of subnational financ-
guided by (and possibly limited by) a clear ing on budget. It might also help reorient the
understanding of the specific role of sub- enthusiasm of subnational governments from
national government in China. As in other growth and investments to a more balanced
unitary countries, while local authorities growth strategy that reduces rural-urban dis-
are in principle agents of the central govern- parities (discussed in more detail in the sec-
ment, they still enjoy a high degree of auton- tion on land policy). Finally, it could improve
omy. In many cases, the central government accountability, because citizens will hold
determines by law what types of activi- officials more accountable if local public ser-
ties subnational governments can engage vices are financed to a significant extent from
in through a positive list of functions (an locally imposed taxes.
102 CHINA 2030
A good local tax should meet several cri- transparency in fiscal and intergovernmental
teria. The subnational government should fiscal matters in law.
be able to set the rates itself, at least within Despite past improvements, China still
limits. The tax should be visible to local tax- faces considerable challenges in enforcing
payers, large enough to finance a chunk of accountability. The lack of accountability
local services, and not easily exported out- reduces what the intergovernmental fiscal
side the jurisdiction. In addition to the prop- system can achieve in terms of efficiency
erty taxes and motor vehicle and congestion and redistribution. Given the high degree
charges noted earlier, own revenues could of decentralization in China, a key issue is
also include a local personal income tax, pos- accountability of local authorities to the cen-
sibly as an add-on to the central government tral government. Specifically, with limited
personal income tax rate. However, because accountability for results, more equalization
the top national tax rate of 45 percent leaves of spending to poorer provinces could well
little space for such an addition, reform to lead to waste of resources rather than bet-
cut the top marginal rate may be crucial for ter service delivery for the poorer part of the
meaningful progress on granting subnational population. To enhance accountability of
governments more flexibility to raise own subnational governments, the central gov-
revenues. ernment could consider the following four
measures:
Institutional reform to enhance accountabil-
ity and transparency at all levels. Improved 1. Periodic evaluation of the fiscal implica-
information and greater fiscal transparency tions of expenditure assignments. Dispar-
at all levels of government would bring many ities among regions, the quality of basic
benefits. These include greater efficiency, infrastructure, priority areas for invest-
reduced corruption, and improved cred- ment, and the technical capacities of sub-
itworthiness. Past reforms of government national governments can all change over
accounting classifications, and the construc- time. The central government must have
tion of capital operating budgets and social flexibility to adjust to such changes. Such
fund budgets, have laid a good foundation evaluation will need to bring out the fis-
for improving government self-regulation. A cal implications (and necessary remedial
natural near-term step would be to further the policies) for the next 5 to 10 years if any
reforms to make information accessible to tax- restructuring takes place. This is a bigger
payers, research institutes, and universities. issue than just expenditure assignment.
More information in the public domain would The financing of this shift in responsibil-
allow better policy analysis and evaluation ity would likely include a reassignment of
and expand citizens’ scope for active partici- some revenue sources and reallocation of
pation in policy debate. That, in turn, would transfers as well.
ultimately lead to wider acceptance of policy 2. Development of a medium-term fiscal
choices and enhanced government credibility. framework and system for monitoring
Possible medium- and long-term measures the fiscal development of subnational
include better aligning of budget formulation governments. Local officials in China
and execution, moving the budget calendar have inherent biases favoring the alloca-
to better reflect the schedule of the National tion of resources to physical investments
People’s Congress, changing from cash to and “leaping forward.” These can lead to
accrual accounting, producing an inventory excessive (hidden) expansion of govern-
of government financial and physical assets, ment debt, and fiscal stress in the medium
and eventually constructing the government’s and long run. One way to mitigate such
balance sheet. The upcoming revision of the risks is to require subnational government
budget law is an opportunity to anchor more to develop a medium-term fiscal plan and
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 103
economic activity. While a large state role FIGURE 1.4 SOEs have declined in relative
may have had beneficial effects during the importance
recent crisis, China’s own experience over
a longer period supports its further scaling 80
back. As elaborated below, China’s nonstate 70
enterprise sector is much more productive, 60
profitable, and innovative than its SOE sec- 50
Percent
tor. Much of China’s impressive productivity 40
growth over the past decade was driven by 30
manufacturing, which had just been opened 20
to greater competition. To sustain rapid GDP 10
growth, China will need to extract more pro- 0
ductivity from its currently protected services 1998 2000 2002 2004 2006 2008 2010
and utilities sectors. One way to achieve this SOE share of total industrial enterprises
is through the same model that worked so SOE share of total industrial assets
well for manufacturing: expose firms to com- SOE share of total industrial employment
FIGURE 1.5 The rate of return for nonstate firms manufacturing sectors. In some “strategic”
exceeds that of SOEs or “pillar” sectors (airlines, telecoms, and
the like), some inter-SOE competition was
25
encouraged by the breaking up and corpo-
ratization of incumbent providers.25 China’s
20 opening to the outside world, especially its
accession to the World Trade Organiza-
15
tion (WTO) in 2001, enhanced competition
Percent
Sutherland and Ning (2008) compare the evolution tribution of electric power and heat. These indus-
of industrial concentration in China with that of tries accounted for only 14.4 percent of total sales
earlier periods in Japan and the Republic of Korea. across the 37 surveyed industries. Only 5 of the 37
While such international comparisons are hampered industries had eight-firm (C8) concentration ratios
by lack of strict comparability of data, they remain above 40 percent. By these definitions, only a small
instructive. The authors use data from Amsden and share of Chinese industry, found in traditional pil-
Singh (1994), which shows that in Japan the aver- lar industries, could be considered uncompetitive by
age (unweighted) three-firm (C3) concentration ratio these rather crude but often used metrics.
was 57.6 in 1937, 53.5 in 1950, and 44.1 in 1962. In The Organisation for Economic Co-operation
Korea, the all-industry average C3 ratio was 62.9 in and Development (OECD 2010) also finds that stan-
the 1980s. For China, the authors calculate a four- dard measures of concentration are relatively low and
firm (C4) average of only 23. Thus, Chinese industry declining in China. Using the Herfindahl-Hirschman
appears significantly less concentrated than Japan index, and grouping results by U.S. Department
and Korea in earlier periods. of Justice merger thresholds, OECD finds that the
Looking at individual sectors, Sutherland and number of industrial sectors at the four-digit level
Ning find only three industries in which the C4 deemed to be highly or moderately concentrated has
ratio exceeded 40 in 2006: extraction of petroleum decreased from 27 percent in 1998 to only 14 percent
and natural gas; processing of petroleum, coking, in 2007. This is low compared with other countries,
processing of nuclear fuel; and production and dis- including the United States.
Rates of entry and exit in China have been signifi- Several new studies suggest that dynamic economies
cant, but possibly different across market segments. with sustained high TFP growth tend to have rela-
Strong entry and exit is critical for competition. tively rapid turnover among large industrial enter-
Brandt, Van Biesbroeck, and Zhang (2009) find prises. For example, Fogel, Morck, and Yeung (2007)
that China has derived a large share of its total fac- study the impact of the stability of the top 10 firms
tor productivity growth from massive entry of new, in GDP and TFP growth in 44 countries. They find
productive firms and exit of inefficient incumbents. faster growth in countries where big business is less
Over their sample period, net entry contributed stable, that is, where “upstart firms undermin[e]
more than two-thirds of total productivity growth, stagnant behemoths.” This relationship is particu-
even more than its contribution in U.S. manufac- larly strong among higher-income countries. While
turing. However, this average could hide variation rapid growth in low-income countries can arise from
across firms of different sizes, sectors, and owner- improved factor reallocation, higher-income coun-
ship. Emerging evidence suggests that such creative tries also need “creative destruction” to push out
destruction is indeed strong among smaller firms. the frontier and develop a more dynamic industrial
Low turnover among larger companies could sector.
work to limit gains in productivity going forward.
different outcome from what otherwise purposes. For example, while the central
would have occurred. Such policies are most government may have aimed to consolidate a
critical in sectors with both state and private sector nationally, several provinces may have
ownership, but with a dominant role envis- sought to make it a “pillar” for their own
aged for SOEs. They have involved a range economy. With over 30 provincial and many
of actors across all levels of government more subprovincial authorities involved, the
applying a variety of instruments to achieve degree to which a particular sector is ulti-
multiple objectives across a large part of the mately favored or discouraged becomes hard
enterprise sector. to discern. Enterprises facing such compet-
Such interventions are implemented by ing pressures face a treacherous business
three broad classes of actors (see annex 1B environment.
for details). The first are high-level national As in any country, views on the over-
bodies. The second are central government all effectiveness of industrial policies vary
departments, including the National Devel- widely. As might be expected, the more
opment and Reform Commission (NDRC), positive evaluations tend to come from gov-
the Ministry of Industry and Information ernment institutions, 30 while more critical
Technology (MIIT), and others. The third are perspectives tend to come from academic
subnational governments and their depart- specialists. 31 There is more agreement on
ments. While such governments are expected positive achievements in some more specific
to help execute national policy, their exten- instances, for example regarding policies
sive responsibilities also give them the means directed toward the textiles sector in the
to influence industrial development, such as late 1990s. 32 Many also argue that excess
industrial planning, fiscal policy, access to capacity would have been even worse in the
land, and ownership of local SOEs. absence of efforts to restrain capacity expan-
The noted actors use at least five types of sion, for example in the steel industry over
instruments to pursue industrial interventions. the past decade.
These are policy statements;28 legislation; res- However, China’s industrial policy has
olutions (of government departments or min- been unsuccessful in at least two dimensions.
istries, which require the subordinated system First, actual developments have often dif-
to follow); written and oral instructions; and fered from those programmed by the authori-
“special inspection and reorganization.”29 ties. In some cases, targeted sectors failed
As elaborated in annex 1B, China’s indus- to emerge. For example, in 1982, the State
trial policies have had seven defining charac- Council set out to promote the Very Large
teristics. First, they have been scale oriented, Scale Integration (VLSI) industry. While
that is, they have focused on the develop- these efforts were supported with significant
ment of larger enterprises. As such, they have funds from the 7th to 10th 5YP periods, the
disfavored SMEs. Second, they have sought result was disappointing.33 In other cases, the
to control the expansion of sectors deemed sectors did emerge but on a slower timetable.
to have excess capacity. Third, they have For example, the auto industry was identified
aimed to concentrate sectors deemed to be as a “pillar industry” as early as the 7th 5YP
too fragmented. Fourth, policies to encour- period 1986–1990. Despite being nurtured,
age technological advancement, such as the industry made little progress during the
requirements to use specific (local) technolo- 1990s, probably because China had not yet
gies, have had industrial policy dimensions. reached a level of income that would sup-
Fifth, they have relied heavily on direct port rapid growth of auto ownership. The
administrative intervention to introduce sector took off only in the past decade after
(withdraw) resources from preferential (pro- incomes had risen and China had joined the
hibited) sectors. Sixth, they have often fea- WTO. 34 Finally, other industries flourished
tured multidivision joint action. Finally, and without being picked as winners, such as the
importantly, such policies have been pursued construction machinery cluster in Changsha,
at each level of government, often at cross Hunan Province.
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 109
Second, and most strikingly, despite con- at the “commanding heights” of indus-
certed efforts to increase concentration, and try. The resulting overabundant resource
despite much merger and acquisition activ- flows to (often less efficient) larger SOEs
ity, industries subjected to industrial policy helped keep these firms alive while hold-
have often fragmented further. Under the ing back SMEs. Furthermore, the scale
10th 5YP, the authorities tried to increase the orientation of policy can encourage Chi-
market share of the top 10 iron and steel pro- nese firms to expand simply as a means of
ducers from 50 percent in 2000 to 80 percent gaining policy support.
in 2005 (OECD 2006). In fact, this share 2. The frequent use of direct administrative
dropped to 34.6 percent in 2004 before rising intervention raises the level of uncer-
somewhat to 43 percent in 2009. Similarly, in tainty faced by unfavored firms, worsen-
1994, the central government published “the ing their investment climate. Industries
development policy for China’s auto indus- with long-term perspectives require a
try,” which aimed to nurture two or three predictable environment for innovation,
large auto companies during the remainder upgrading, and growth. Firms that fear
of the 20th century. In fact, the concentra- the unexpected imposition of direct regu-
tion ratio of the auto industry remained very lation, forced or “encouraged” merger,
low and tended to decline over the 1990s or even closure will be more reluctant to
(Hu 2008). While the central authorities can invest.
strongly influence the expansion of major 3. The tensions created by competing poli-
producers, other firms are also expanding. cies of agencies across and within various
One key reason for the ineffectiveness levels of government further complicate
of China’s industrial policies is the coun- doing business. Each actor can have
try’s five-layer government. In addition, the very different objectives, even within a
incentives faced by local officials exacerbate given level of government. The roles and
the fragmentation of strategically important responsibilities of each player are not
sectors. Large industrial firms are important clearly delimited, with overlap leading to
local employers and taxpayers. Because local confusion. The result is policies that pull
authorities are entitled to 25 percent of the firms in many different directions, with
VAT levied on products produced in their unclear net impact.
jurisdiction, they may protect existing firms
or compete vigorously to attract new ones. Compared with industrial policies, Chi-
Local officials become especially anxious na’s “industrial administrations” are more
about cross-provincial mergers that could cut heavily criticized. In particular, the use of
local jobs or transfer the tax base to another discretionary powers and the regulatory
jurisdiction. In some cases, these may be the approval system can lead to rent seeking and
same firms that central authorities are seek- corruption and worsen the business envi-
ing to close, for example because they use ronment. Industrial interventions provide a
inefficient technology or produce high levels basis for the close direct links between gov-
of pollution. Informational asymmetries and ernment and business. They have also been
pressure from local interests can exacerbate broad (affecting an unusually large share of
such tensions. the economy); often direct and intrusive; and
Finally, industrial policies affect enterprise applied by many players using many instru-
performance through three other channels: ments (Jiang and Li 2010; Shi and Wang
2011).
1. By discriminating between firms of dif-
ferent size and ownership, industrial
Enterprise Sector Reforms to Achieve
policies distort resource allocation. The
China’s 2030 Vision
“scale focus” of industrial policy works
to favor larger firms, implying a bias To generate the productivity gains and
toward SOEs that have the leading role enhanced innovation that can underpin
110 CHINA 2030
further rapid growth, and thus get China state ownership is deemed strong, the focus
on a critical path for achieving its vision by could shift to strengthening the governance
2030, China needs to: (boards and management) of such firms, and
to regulating them effectively (see below).
1. Improve technical and allocative effi- Such a review would be facilitated by a
ciency by restructuring the state sector and clear state ownership policy that addresses
further enhancing competition between both short- and long-term issues in the state
state-owned and private firms, especially sector. Given the explicit or implicit (from
by scaling back the state sector and tack- force of habit) role of ownership in China’s
ling “administrative monopolies.” current industrial policy, this policy could
2. Improve allocative efficiency by fur- include an elaboration of the envisaged role
ther leveling the playing field, especially for SOEs in the economy. Such a statement
between small and large firms, and could serve as a benchmark against which
implicitly between state and nonstate more specific policies would be measured. 35
firms. In 1999, a CPC plenum tried to define the
3. Meet new challenges and improve the function of state ownership, listing four areas
business environment by moving to more to be controlled by state firms: state safety,
limited, consistent, predictable, and mar- natural monopolies, public goods sectors,
ket friendly industrial interventions. and important enterprises in pillar and high-
tech sectors. However, this declaration was
All three spheres of policy relate primar- not a clear state ownership policy, nor has
ily to larger enterprises. While the agenda for it been well implemented. In 2006, SASAC
enterprise sector and business environment declared that the state should have “abso-
reforms in China is much broader, the com- lute control” in seven sectors and “somewhat
manding heights of the economy offer the strong influence” in nine others. Going for-
greatest potential for further efficiency gains, ward, the redefinition of China’s state own-
reduced imbalances, and limits on direct ership policy should emphasize that state
links between government and business. ownership should primarily focus on provi-
sion of public goods.
Restructuring the state sector and enhanc- China could also make efforts to further
ing competition between SOEs and non- downsize its state sector by a new round of
SOEs. To begin tackling “administrative SOE restructuring. In the late-1990s, some
monopolies,” the authorities could review the Chinese economists called for a “strate-
lists that give SOEs a privileged role in strate- gic restructuring of the state sector” (Wu,
gic and basic and pillar industries. In China, Zhang, and Liu 1998). The 15th Congress
these lists are very broad. They include sec- of the CPC decided to carry out this strat-
tors that are rather open in most high-income egy. However, its implementation seems to
countries, and where the rationale for state have been frozen in recent years after nota-
ownership is not obvious, especially because ble progress during 1998–2003. Accord-
the state could achieve its objectives through ing to recent research (Zhang 2010), state
regulation and law enforcement. If this review ownership is present in almost all competi-
does identify sectors or subsectors for removal tive sectors. For example, 20,296 SOEs—
from such lists, the authorities could next 17.8 percent of all SOEs—are involved in
identify and cancel the explicit or implicit bar- wholesale trade, retailing, and restaurants.
riers that unreasonably limit competition in The downsizing of the state sector in the
such sectors. A clear signal could be sent that late 1990s and early 2000s was in reaction
the evolution of such sectors will now indeed to serious financial distress. While ulti-
be on a level playing field. Such steps can be mately successful, it came at a high cost of
taken unilaterally without changes in the about RMB 2 trillion. 36 To limit such costs
Anti-Monopoly Law. Where the rationale for going forward, further front-loaded SOE
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 111
restructuring would ideally be more proac- private delivery of public goods and services
tive, rather than done in response to crisis, (with public financing) introduces the added
and be driven by the objectives of chang- dimension of competition and helps lower
ing to the growth model needed to move to production and distribution costs.
high-income status. Without further down- The response to the second question is less
sizing of the state sector, it will be hard to straightforward. First, the government could
create a fair competition environment for securitize its implicit equity in state enterprises
private firms and to limit the direct ties (in listed state enterprises, the value of the
between government and business. equity is already known) as soon as possible.
Government ownership of enterprises is Securitization would pave the way for state
widespread and varied, covering most sec- enterprise reform by separating ownership
tors and ranging from outright ownership to from management and introducing modern
controlling interest to minority shareholder. corporate governance practices—appoint-
The challenge for further SOE restructuring ment of senior management, public disclosure
is thus twofold: how can public resources be of accounts in accordance with international
best used; and how can China best transi- practice, external auditing, and so on. Sec-
tion from its current approach to managing ond, the government could consider estab-
its portfolio of state enterprises to one that lishing one or more state asset management
is best suited for its long-term development companies (SAMCs) that would represent the
objectives. government as shareholder and would pro-
The response to the first challenge is fessionally manage and trade these assets in
straightforward. Public resources should financial markets where feasible. Each SAMC
be used solely for the provision of public could specialize in certain sectors. They
goods and services—the production or con- could then, on behalf of government, gradu-
sumption of which result in unremunerated ally diversify the portfolio and scale back
positive externalities. These can range from state ownership over time. The dividends of
defense at one end of a continuum to infra- state enterprises would need to be paid to the
structure, social protection, and basic R&D SAMCs who, in turn, would transfer them to
at the other—and the scope could evolve as the budget. Finally, a portion of state assets
conditions change. The recent emphasis on could be transferred to the national pension
public housing for the poor is a good exam- fund with the flow of returns being used to
ple of how government resources can be used help meet future pension obligations.
to address a pressing social need. Indeed, the While the operational details of the pro-
scope of public goods and services is quite posed SAMCs can be elaborated later, it is
broad and can even include reliable energy important that key principles are established
supplies and the widespread availability of early. It is critical, for example, that SASAC
communications and postal facilities. The confine itself to policy making and oversight,
share of public resources applied in a par- leaving asset management to the SAMCs.
ticular area will depend on the nature of The SAMCs should have clear mandates, be
the public good or service being supplied. In independently and professionally managed,
areas considered to be of high national pri- and be subject to publicly announced perfor-
ority, such as defense, government resources mance benchmarks (depending on the nature
would be expected to provide the full or of the enterprises in their portfolio). In addi-
dominant share of finance. But in most areas, tion, they will need to adhere to international
a smaller share is usually sufficient to achieve standards for transparency, including on
the government’s objectives. Most impor- operations and results, value creation, profit-
tant, in many cases, private sector firms ability, and dividend payments.
are fully capable of delivering public goods In the medium term, the expanded scope
and services, even though the government for private participation could be comple-
may provide the bulk of the finance. The mented by the restructuring of remaining
112 CHINA 2030
SOEs. Building on China’s own past expe- laws grant exemptions or exceptions to par-
rience with corporatizing and restructuring ticular industries and certain types of eco-
SOEs, more such large enterprises, espe- nomic activities and transactions (UNCTAD
cially those parent companies supervised by 2002). Exemptions may be sectoral in nature,
the central and provincial SASACs, could such as a “natural monopoly,” or functional,
be restructured to mixed ownership enter- such as development of product standards or
prises and listed corporations. Furthermore, other practices where a single or few provid-
governments could reduce their ownership ers makes great sense. Some such exemptions
shares in those firms and build up modern might be necessary for furthering the objec-
governance featuring professional manage- tives of competition policy. Other exemptions
ment. One additional benefit of narrowing reflect pressures from special interest groups.
the scope of the SOE sector would be to In many cases, there is a clear need to revisit
strengthen SASAC’s capacity to supervise its such exemptions. The UNCTAD report offers
remaining SOEs. some general recommendations concern-
Also in the medium term, China could ing procedures and principles for granting
further spur competition by strengthen- exemptions. After applying such principles,
ing the Anti-Monopoly Law in two ways. the number, nature, and scope of exemptions
First, it could further rein in administra- will tend to be more limited and procedures
tive monopoly by making relevant clauses more accountable and transparent.
of the law clearer and more restrictive. Chi-
na’s new Anti-Monopoly Law, enacted in Further leveling the playing field. Greater
2008, devotes one chapter to administrative competition needs to go hand in hand with
monopolies and their impact on competition, fairer competition. This would enhance alloc-
broadly declaring them illegal. However, in ative efficiency by helping direct factors of pro-
its current version, the law lacks teeth. The duction toward their most productive uses. To
clauses are very simple and focused on the this end, firms of different size or ownership
cross-regional trade in goods. Moreover, the should compete on a more level playing field,
current law is not actionable, leaving enforce- not only in a strict legal sense, but also in the
ment as a voluntary matter for “higher terms on which they gain access to inputs.
authorities.” The relevant provisions are The most promising near-term reforms
explicitly subordinate to other laws and regu- to address this issue are outside the scope of
lations, almost guaranteeing that they will be competition policy and would directly tackle
overridden. Within government, application key distortions. These include the preferen-
and enforcement is spread out across several tial access to credit by larger firms or SOEs,
agencies. Such a cautious approach could including access resulting from moral h azard
well make sense at the beginning. Given the (see financial sector discussion below); the
importance of administrative monopolies, still low level of SOE dividend payments
a law that made no mention of them would (which can leave savings within firms to be
be incomplete. On the other hand, an overly deployed less effectively than in other pos-
ambitious approach (beyond the initial capac- sible uses); and the implicit advantages that
ity to enforce) could also erode authority of SOEs gain by their closeness to decision mak-
the law itself. For example, the Anti-Monop- ers (including through the ministerial status
oly Enforcement Agency would have to bring of CEOs of large firms. A review of indus-
cases against other parts of government at the trial policies (see below) to remove explicit or
same or higher rank. Clearly, enforcement of implicit biases in favor of firms of particular
these provisions of the law will require both scale or ownership would also address such
legal amendments and strong political will, concerns.
including high-level support to the enforce- In the medium term, fairer competition
ment authorities. could be promoted by developing and enact-
Second, the scope for exemptions from the ing a set of laws that would limit potentially
law could also be reviewed. All competition distortive discretionary actions, including in
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 113
the realm of industrial policy. By defining past 30 years, it may have at times played a
clear “rules of the game,” such laws would positive role in China’s objective of “catch-
be in the same spirit as the limits that the ing up.” However, China’s current system
WTO places on its members’ trade poli- of industrial interventions could become an
cies, or that the U.S. Constitution places on obstacle to achieving the innovation-driven
restricting interstate commerce. Such rules growth to which the country now aspires. In
could contain some of the most egregious distilling lessons of East Asian industrial pol-
attempts by central and subnational officials icy, Weiss (2005) notes that for higher-income
to pull in different directions using crude emerging economies, the agenda will be to
administrative means. One such law is the upgrade export structure and move up the
Anti-Monopoly Law, which has already value chain. For these economies, old-style
been discussed. If a strengthened law still left industrial policy of “second guessing” the
important gaps, it could be complemented market and creating winners will have less rel-
by additional legislation (possibly in the evance. Instead, these economies will require
form of a special law) to restrict currently a business climate that is more favorable to
widespread industrial interventions by cen- SMEs and new entrants, that encourages
tral or subnational governments. This law fair competition, that is more tolerant of low
should be actionable, with any governmen- sectoral concentration and excess capacity,
tal departments liable to be charged if they and that relies more on market mechanisms.
impose interventions restricted by the law. The type of innovation that China seeks to
In the longer term, to safeguard fair com- unleash can initially result in rash new entry,
petition in a single market, China could ferocious competition, fragmentation, and
consider enshrining limits on the financial excessive investment, developments that need
support that its governments can directly or not be unhealthy in industries that have yet
indirectly provide to firms. One recent exam- to mature.
ple is large capital injections into major state- Reform of industrial policy should start
owned airlines (Pan 2010). Such support, by from a clear elaboration of its role and pur-
allowing some firms to absorb losses that a pose. Which market failures, externalities,
purely commercial entity would not or could or other circumstances need to exist for such
not absorb, results in unfair competition. To policies to be applied? As Leipziger and oth-
counter such tendencies, China should pro- ers (1997) note, governments that follow a
vide its governments with clear rules of the “hunch” to support a particularly prestigious
game in dealing with inevitable pressures for industry without clear evidence of a market
aid of one form or another (Leipziger and failure, or that identify favored sectors based
others 1997). This could build on experience on noneconomic criteria, will impose a high
of the European Union (EU) in implement- fiscal cost and generally fail. Such principles
ing rules on “state aid.” While the EU and could be published to ensure transparency
China have many important differences, they concerning policy objectives and the moni-
face similar problem of regulating anticom- toring and evaluation of results.
petitive behavior either by member states (in Based on this clear elaboration, policies
the EU case) or by subnational authorities (in themselves would be more focused, imple-
China’s case). The EU experience emphasizes mented by fewer actors, simpler, and more
the necessity of a credible institutional frame- market friendly. As noted, China’s current
work to monitor industrial subsidy programs industrial interventions can be extensive,
and enforce mutually agreed rules for indus- inconsistent, unpredictable, and administra-
trial policy.37 tive. Greater focus means limiting their appli-
cation to a few sectors where the case for
Focusing and modernizing “industrial poli- such policies is strongest. That would avoid
cies.” China’s industrial policy needs to adapt spreading scarce technical and entrepreneur-
to changing circumstances. While such policy ial talent too thinly and crowding other estab-
did not always work as expected during the lished sectors with comparative advantage
114 CHINA 2030
out of input and factor markets (Westphal national priorities. To the extent that local
1990). The involvement of fewer actors (see industrial policy is motivated by the desire
below) would add coherence to policy. A for more revenues, different sharing rules for
more limited set of permissible interven- key taxes (especially the VAT) might reduce
tions, including the provision of any support incentives for fragmentation. Similarly, per-
through fiscal rather than banking channels, formance evaluation that goes well beyond
would promote greater transparency and indicators of local GDP growth could limit
reduce collateral distortions in other markets excessive desire to attract or preserve indus-
(Leipziger and others 1997). For example, tries in need of consolidation. All of this is a
pursuit of more general objectives, such as matter of degree, because competition among
consolidation of a sector, without prejudice subnational units has also had positive fea-
toward specific (incumbent) firms, would tures, and those features should be preserved.
avoid discrimination against potentially more Any deeper realignment of incentives would
innovative new firms. Support should be tem- require more fundamental changes to the
porary and subject to strict “sunset clauses.” relationship between levels of government in
The selection mechanism should lean toward China, which we do not consider here.
innovation ability instead of scale and owner- Finally, as a general issue cutting across
ship. Finally, policies should try to work with the themes discussed above, the assignment
the market, harnessing its power to achieve of functions related to ownership, policy,
desired aims, rather than against it. For and regulation across government agencies
example, using market forces to spur merg- needs to be rationalized. As a result of indi-
ers and acquisitions (by making more shares vidually sound but piecemeal reforms, China
tradable for example) would promote concen- now has a range of agencies with multiple
tration without prejudicing its outcome. and overlapping functions. For example, in
China’s unique size, complexity, and high addition to its core function of supervising
degree of decentralization should also affect state ownership in SOEs, SASAC also retains
the form of its industrial policies. Specific certain regulatory and policy-making roles.
approaches that may have worked well in Similarly, responsibility for enforcing the
smaller and more centralized economies such Anti-Monopoly Law is split between three
as Japan, Korea, and Singapore could be agencies with other broader responsibili-
problematic in China. With multiple layers ties—the State Administration for Industry
of government possessing significant de facto and Commerce (SAIC), the Ministry of Com-
autonomy, the central authorities could for- merce (MOFCOM), and the NDRC. For
mulate policy but find it very hard to monitor example, MOFCOM is charged with encour-
or enforce. Within a given level of govern- aging foreign direct investment. Some SOEs,
ment, numerous agencies with overlapping such as the tobacco enterprise, even retain
mandates can pull in different directions. responsibilities for sector policy while also
Local governments seeking to generate new seeking to earn a good return. This arrange-
jobs or tax revenues will have clear incen- ment compounds already severe fragmenta-
tives to protect existing enterprises or attract tion across levels of government and tensions
new ones by providing resources such as land between various stakeholders. Such fragmen-
at a steep discount, by helping navigate the tation can lead to a blunted focus, duplication
required permits and approvals, or by hinder- of efforts, conflicts of interest, and weakened
ing or blocking cross-border mergers. Such responsibility.
forces can exacerbate industrial fragmenta- Going forward, China could review cur-
tion, frustrating central government efforts rent functions and responsibilities, reallocat-
to consolidate. ing them so that one body would be the lead
Changes in tax-sharing rules and in (if not sole) agency in a given area. For exam-
performance evaluation of local officials ple, SASAC could focus entirely on the nar-
can help better align their incentives with row mandate of maintaining and increasing
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 115
the value of public assets. As in most high- banks were introduced by selling a portion
income countries, a single government body of shares to strategic investors and listing
would implement and enforce competition them on domestic and foreign exchanges.
policy. A third agency (such as the NDRC) Entry restrictions on financial institutions
could take sole charge of industrial policy. and controls on capital flows were somewhat
Enterprises would be charged with doing eased. Important regulatory reforms were
business. Focused bodies will individually undertaken by institutional restructuring
be more effective and work more coherently and introduction of global standards. Vari-
together. There has been some progress in ous measures were introduced to boost the
establishing separate sectoral regulatory bod- development of securities markets.
ies—this needs to continue. Despite the many reforms introduced so
The performance of China’s enterprise far, the Chinese financial system remains
sector can also be improved by other reforms repressed, unbalanced, costly to maintain,
beyond the realm of industrial policy. These and potentially unstable.
include issues on the general business climate,
remaining barriers to a deeply integrated • Repressed. Pervasive controls remain in
single national market, strengthening intel- key areas.38 The levels of state ownership in
lectual property rights, public procurement the banking sector (figure 1.6) and govern-
reform, contract enforcement, bankruptcy ment intervention in the financial system
regimes, and trade policy, improving access are much higher than in other countries at
to finance, and strengthening corporate a similar stage of economic development
governance. that later achieved high-income status.
Despite changes in the ownership structure
of commercial banks from the previous
Financial System Reforms system of exclusive state ownership to the
current system of joint-stock ownership,
China’s Financial System Developments
the government continues to dominate
to 2010
in the financial sector. Continued protec-
The Chinese financial system has served the tion and intervention in the business deci-
purpose of savings mobilization and capi- sions of financial institutions make them
tal allocation to strategic sectors during the
catch-up stage of economic development. It FIGURE 1.6 Ownership structure of the banking
was successfully transformed from a social- sector, 2005
ist fund allocation system to a system that
has proved effective for financing a rapid
expansion of investment and thereby eco- 100
convenient policy instruments, the use of far, China has not taken full advantage of
which prolongs the bureaucratic culture these complementarities. If the histories of
and distorted incentives that have pre- high-income countries are a reliable guide,
vented banks from full commercialization China’s future development likely hinges
and from allocation of financial resources on achieving a more balanced financial
to the most productive uses. system. Additional imbalance is found in
• Unbalanced. Despite recent efforts to pro- the capital market in which the share of
mote direct financing, bank credit still the fixed-income market is overwhelmed
accounts for close to 90 percent of funds by the equities market, and the share of
raised by the corporate sector. While it is corporate bonds market remains small.
not uncommon for financial systems to be • Costly to maintain. The financial system
weighted toward banks at China’s stage of is exposed to accumulated losses yet to be
development, international comparisons fully absorbed and new losses in the mak-
show that China’s is especially so (figure ing. Banks have been used as instruments
1.7 and annex 1C). Recent research indi- of the government’s macroeconomic and
cates that the optimal financial structure sectoral policy goals and have not always
becomes more market oriented as econo- been in a position to lend prudently. While
mies develop (Demirgüç-Kunt, Feyen, this approach may have helped achieve
and Levine 2011). This is consistent with policy goals, it has also exposed banks to
theoretical arguments that economic a greater risk of deteriorating loan portfo-
development increases the demand for lios, increasing the ultimate costs of such
the services provided by nonbank finan- public policies. Rounds of capital injec-
cial institutions (NBFIs) and the securities tions into state-owned commercial banks
markets relative to services provided by and disposal of nonperforming loans at
banks. The histories of developed coun- the end of the 1990s and before public
tries such as Britain, Germany, Japan, listing of their shares, not to mention the
and the United States also indicate major reported losses on lending to local govern-
complementarities in the functioning and ments incurred since 2008, 39 are indica-
development of banking systems and secu- tive of the magnitude of real and potential
rities markets (Allen and others 2010). So costs to the government budget.
• Potentially unstable. The financial system
is fragile and vulnerable to potential insta-
FIGURE 1.7 Financial system structure in comparison, 2009 bility for several reasons. Systemic risks
are embedded in the homogeneous behav-
ior and operations of financial institu-
100 tions, in part reflecting weak commercial
80
orientation; in the widespread financial
services integration and conglomeration
60 that has been going on for years without
Percent
created more than 10 years since its ini- future financial system should be free of
tiation. The mechanism for resolution of repression and strike a balance between the
troubled banks has not been institutional- banking and nonbanking financial institu-
ized and crisis management mechanisms tions and markets, especially the capital
are not well established. Lack of informa- market, with more diversified institutions
tion sharing and coordination among the and products reflecting the changing nature
fiscal, monetary, and financial regulatory of China’s economy. Financial institutions
authorities, and limited progress in build- should be commercialized and rationalized,
ing up a macroprudential framework through installation of effective corporate
against systemic risks, are also causes for governance, creation of a level playing field,
concern. establishment of effective oversight, and lia-
bility for bankruptcy regardless of ownership
Overall, financial sector reform and devel- structures. The financial system should have
opment have been out of step with the real better outreach to households, consumers,
economy. The current financial system, char- and micro, small, and medium enterprises
acterized by bank dominance and strong (MSMEs), and be able to provide long-term
state intervention, served to mobilize savings and risk capital to support the upgrading and
and allocate capital to strategic sectors during expansion of incumbent firms and the emer-
the economic take-off, but such benefits are gence and growth of new firms in high-tech
increasingly outweighed by the costs of the and emerging industries.
accompanying distortions and the resulting A well-functioning financial system is
buildup of imbalances and risks. China could essential in China’s drive to become a har-
conceivably sustain high economic growth monious and high-income society. First, as
for a while longer even without fundamental growth in the supply of labor and capital
reforms in the financial sector. However, in slows, China will have to rely more on pro-
such a case, distortions in resource allocation ductivity growth, which has to be supported
would be intensified, income and wealth dis- by the financial system through improved
tribution worsened, and internal and exter- allocation of capital. Second, the increasing
nal imbalance sustained. Eventually, these importance of TFP in supporting economic
distortions and imbalances would undermine growth requires innovation that cannot be
social stability, slow productivity growth, realized without support from the financial
and erode competitiveness. The potential system, especially a well-developed capital
debilitating effect of a future forced finan- market. Third, a well-functioning financial
cial liberalization, and lack of an integrated market could provide reliable monitoring and
approach and concerted actions on the part corporate governance, and facilitate timely
of the government, can only serve to exacer- industrial restructuring by permitting the
bate the negative consequences. Now is the entry and exit of firms through various paths
time for China to rethink its vision and strat- including mergers and acquisitions. Fourth,
egy in the financial system, to avoid a situa- the need to rebalance the Chinese economy
tion where delays in financial system reform will require an inclusive financial system that
and development disrupt or impose a drag on provides widespread access to diverse finan-
the real economy. cial services and products by households and
by micro and small enterprises. Fifth, finance
also contributes to preparing for old-age
China’s 2030 Vision for the
security and reducing poverty and inequality
Financial Sector
by improving opportunities for households to
China needs to build a more liberalized, bal- borrow and invest in assets whose value can
anced, efficient, safe, and sound financial grow in parallel with the economic advance-
system that meets the demands of corporate, ment of China. Finally, finance that is not
household, and government sectors. China’s managed well can be disruptive to economic
118 CHINA 2030
development, as shown in the recent financial institutions, either through direct holding of
crisis and China’s own experience. shares or through indirect influences, mainly
because it is heavily dependent on the use
of commercial bank credit for policy goals.
Key Reforms to Strengthen China’s
Full commercialization of financial institu-
Financial System
tions will not be possible unless this practice
Building a more efficient and robust financial is replaced by other mechanisms, including
system that can well serve China’s transition greater use of direct fiscal expenditures, gov-
toward a modern, harmonious, creative, and ernment credit programs that work through
high-income society will require a systematic the banking system, rationalization of the
approach to reform. For the system to embark policy banks, and reforms to intergovern-
on a virtuous cycle, it will be critical for the mental fiscal relations. The goal should be to
government to gradually reduce its influence first free the commercial banks from policy-
in the internal affairs of the financial insti- oriented functions to enable them to compete
tutions to focus on roles that belong to the with their peers from home and abroad, by
government, including regulation, supervi- subjecting them to market discipline and
sion, and infrastructure building, as well as effective regulation and supervision. Policy
creating and enforcing the right incentives loans and government-directed loans could
and mechanisms. be gradually phased out or transferred to
those few policy-based banks with clear
Full commercialization and rationalization mission and mandates that operate under
of the financial system. Macroeconomic strictly enforced performance monitoring
and financial policies and instruments need and evaluation.
to be better aligned to create incentives for A commercially oriented governance sys-
a lasting transformation to a more commer- tem should be introduced. While privatiza-
cially oriented and effective financial system. tion would be the best way to make state
Mechanisms, structures, and institutions must financial institutions (SFIs) more commer-
be created that provide financial intermedia- cially oriented, privatization of the big SFIs
tion without distorting incentives, exacerbat- would not be easy.40 Since the government
ing moral hazard, and creating contingent is likely to remain majority owner of the
liabilities for the government. To facilitate this commercial banks, state-ownership func-
process, the government should continue to tions need to be strengthened. To be effec-
reorient its roles and responsibilities, moving tive, state-ownership agencies need to act in
from direct controls to indirect measures. As ways similar to private owners. Otherwise,
an example, the central bank does not have the given the multiple objectives of the govern-
necessary independence to carry out its func- ment, SFIs will not become truly commer-
tions in monetary policy decisions. Monetary cialized. China may introduce a governance
policy has been conducted through frequent structure for banks after taking thorough
changes in reserve requirement ratios, window stock of the existing state-ownership func-
guidance, and even credit ceilings. To enable tions, agencies, and practices, and drawing
banks to better manage their assets and liabili- lessons from international best practice and
ties, the central bank could conduct monetary failures (box 1.9).
policy in more market-friendly ways, that is,
through open market operations. Further liberalizing interest rates. China has
It is important to move away from direct reached the stage where it needs to phase out
or indirect control of financial institutions remaining interest rate controls. Much prog-
and to develop alternatives to bank-based ress has been made in liberalizing interest
funding of government policy goals. The gov- rates, but the remaining controls have been
ernment at all levels has been closely involved blamed for many distortions in the finan-
in the commercial operations of financial cial sector.41 Such controls have played a key
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 119
China has yet to establish consolidated and effec- government needs to spell out the long-term and
tive state-ownership functions in the financial sec- overarching goals of the financial sector, explain
tor. While the government has stated its intention why it needs to own financial institutions, decide
to remain a dominant owner of key state financial which institutions should continue to be held and
institutions (SFIs) in the long run, there has never which should be let go, and determine what level of
been a clear elaboration of why direct ownership is ownership should be maintained over what period
necessary for achieving its objectives. Many orga- of time and how it should be done. The rights and
nizations are involved, each with responsibility for responsibilities of state-ownership agencies need to
only a small aspect of ownership. None has either be clarified in the law. An ownership policy should
the perspective or the authority to take a broad view be developed and published to inform the general
of the financial sector. Fragmentation leads to both public as to why the government intends to own
ambiguities over decision-making authority as well specific institutions and how its rights will be exer-
as mismatches between rights and responsibilities. cised and ownership responsibilities distributed and
Moreover, there is insufficient public information carried out. Transparency and accountability can
on how the state ownership in the financial sector be enhanced by implementing a performance-moni-
is organized, let alone about the objectives, man- toring system and developing aggregate reporting on
dates, division of rights and responsibilities, and the performance of portfolio SFIs. In the medium to
performance indicators. In this setting, a meaning- long run, a rational organizational format of func-
ful monitoring and evaluation framework is not tions should be considered. However, mere orga-
possible. nizational changes can fail to achieve the intended
Several reforms are needed to further improve results if they are not accompanied by fundamental
the effectiveness of state-ownership functions. The changes in incentives and institutions.
role in the overall strategy of catching up products could raise the risk of financial cri-
through strategic capital allocation to prior- sis. There will also be a need to avoid a signif-
ity sectors and in protection of the banking icant asymmetry in the pace of liberalization
system. However, as the economy matures, between banks and NBFIs, and between the
the remaining controls become a drag on direct market and indirect market. The moral
growth as artificially cheap capital contrib- hazard of financial institutions needs to be
utes to overinvestment and delays restructur- properly checked to prevent destabilizing
ing. The development of capital markets also interest rate competition. Effective regulation
has been hindered by distorted risk pricing. to prevent excessive competition for deposits
The guaranteed interest spread has prevented by bidding up interest rates and by making
the formation of a true risk culture, which is loans to risky borrowers at unduly high rates
key to commercial banking, capital market should be secured before liberalization of the
development, and access to finance. In addi- relevant bank interest rates.
tion, market-determined interest rates will
be crucial for an effective movement of mon- Deepening the capital market. Deepening
etary policy from direct quantitative control the capital market is conducive to a rebal-
to indirect control. ancing of the financial structure and to the
While the floor for lending rates is easier to catch-up strategy of innovation in science and
remove because it is no longer binding, liber- technology in which innovative, vibrant pri-
alization of deposit rates is a complex matter, vate firms could emerge and thrive. A coun-
requiring several key prerequisites that can- try’s financial structure influences the types
not be ignored. Too rapid disintermediation of industries that get financed, with equity
or too rapid inflow to short-term financial finance supporting more innovative industries
120 CHINA 2030
and debt finance through bond issuance and willing to take risk may purchase corporate
bank lending better suited to existing indus- bonds, mutual funds, and stocks. That would
tries. A key advantage of capital markets rela- facilitate the flow of funds to risky entrepre-
tive to banks stems from the evaluation of neurial ventures with potentially high return
business opportunities by multiple potential and long-term corporate investment with a
investors, whose diligence can help assess the long gestation period. The growth of asset
viability of new technologies. Venture capi- management businesses could also assist
tal and private equity industries will have to in providing greater financial security for
play a bigger role in financing technologically the elderly (through improved vehicles for
advanced industries. Institutional investors accumulating retirement savings) and, more
will also play an increasingly important role broadly, for securing social cohesion and sta-
in the development of China’s capital market. bility. Asset management requires less strong
Deepening capital markets will also help to regulation than banks, but it does require
increase the access to bank loans by house- transparency, strong investor protections,
holds and MSMEs as large and established market-determined interest rates, and mark-
firms rely increasingly on direct financing. to-market of assets. The government has to
A market-based financial system is more provide a solid legal basis to nurture this
dependent on the rule of law and market business. According to other countries’ expe-
infrastructure than a bank-based system. An riences, once the market infrastructure and
equitable, transparent, and efficient capital environment is provided, this business can
market is not achievable without a funda- grow quickly, taking a large part of house-
mental reorientation of the role of govern- hold and corporate savings.
ment. The authorities should gradually
reduce administrative controls where market Upgrading financial infrastructure and the
mechanisms could do better. As an example, legal framework. China’s financial infra-
China should move to a disclosure-based sys- structure needs to be further upgraded to
tem from the current merit-based approval facilitate the financial market in general
system for initial public offerings. The gov- and the capital market in particular. Finan-
ernment should focus on improving the legal cial infrastructure includes many elements,
framework, enforcement of laws and regu- such as credit information systems, rating
lations, upgrading financial infrastructure, services, accounting and auditing, payment
and imposing stringent rules on informa- and securities settlement systems, exchanges,
tion disclosure. Artificial segregation of the and over-the-counter markets. While many
market should be avoided. The current seg- key elements are formally already in place,
mentation of regulation in the fixed-income more needs to be done to ensure their effec-
market among the People’s Bank of China tive functioning. As an example, great
(PBC), China Securities Regulatory Com- strides have been made in the past few years
mission (CSRC), and NDRC raises concerns in C hina’s security interest filing system,
about regulatory inconsistency. Their respec- as demonstrated in the registry system for
tive roles should be clarified to ensure regu- accounts receivable and lease interest regis-
latory consistency among different market try. What remains to be done is in the reg-
segments. istration of inventory and equipment, which
Growth of the asset management busi- should be centralized and Internet-based. In
ness is essential to facilitate the deepening addition to the enhanced payments and secu-
of the securities market. China’s financial rities settlement system, efforts may include
system needs to provide a reasonable variety continuing to improve the coverage and qual-
of financial products with different risk and ity of consumer credit information reporting
return profiles to meet different risk prefer- as well as improving the independence and
ences of investors. Risk-averse individuals can professional ethics and standards of credit
choose bank deposits, while investors more rating agencies.
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 121
Adequate and accurate disclosure and securities, and insurance in the financial sec-
transparency supported by credible account- tor, the degree of financial conglomeration is
ing and auditing practices can go a long stunning. The existing regulatory and super-
way in supporting financial development by visory structure does not provide the neces-
minimizing informational frictions. China’s sary monitoring and surveillance to deal
legislative and regulatory framework on with the spillover of risks among financial
accounting and auditing has converged to institutions and industries—the coordination
international standards.42 However, reviews mechanism is perfunctory, and information
and anecdotal evidence point to noncom- sharing is sporadic. The authorities may be
pliance in the financial statements of some forced to decide whether to unify all finan-
listed companies and variations in the level cial regulators under one roof or to main-
of compliance with applicable auditing stan- tain the current regulatory architecture but
dards. More seriously, fraudulent activities strengthen their ability to deal with cross-
can cause reputational damages and loss of industry financial risks, probably through
investor confidence that is hard to restore. improved functional supervision.
More efforts are needed to further strengthen A well-defined and functioning macro-
the capacity of the regulators, as well as to prudential framework is critically important
improve the development of accounting and for China to prevent or mitigate disruptive
auditing professions. Strong and strict penal- idiosyncratic risks, including those that may
ties should be imposed on improper account- well emerge from the rapid growth of shadow
ing and auditing practices. banking activities. Currently, there is some
interagency coordination on broad financial
Strengthening the regulation and supervision sector issues, but a comprehensive macropru-
framework. The independence and effective- dential framework needs to be developed,
ness of regulatory and supervisory bodies with a clear institutional setup (including
can be enhanced. Achieving this is a chal- mandate, powers, distribution of responsi-
lenging task, especially because the govern- bilities, information-sharing arrangements,
ment role as both an owner and regulator of and the like). The PBC is deeply involved in
major financial institutions creates potential microprudential regulation and supervision,
conflicts of interest. Almost without excep- as evidenced by the differentiated approach
tion, the experiences of other countries in a to required reserve ratios and capital require-
similar situation bear out the failure of regu- ments43 and tight control of the interbank
latory oversight. The risk of failure becomes market participation and operations. But the
greater as financial liberalization progresses financial regulatory authorities are reluctant
and competition in the financial market deep- to retreat from areas pertaining to macro-
ens. China’s integration in the international prudence while not focusing fully on
financial system and the internationalization microprudential regulatory and supervisory
of the renminbi will put pressure on China work. While the concept of macroprudential
to improve its regulation and supervision. regulation is yet to be fully defined in China,
The government needs to seek institutional its importance for securing financial stability
reforms to secure the political independence is being emphasized globally.
of regulatory bodies to enable them to con- China could establish a high-level finan-
duct arm’s-length regulation and supervision, cial committee on the basis of the existing
regardless whether it would remain the owner framework, with the main objective of reduc-
of financial institutions. ing systemic risk and maintaining finan-
Institutional arrangements are needed to cial stability. Such a committee, if endowed
better align regulatory resources and struc- with strategic significance and charged with
ture to deal with increasing integration of forming an overall assessment of the finan-
the financial services industry. Despite laws cial system, would not only free the State
that insist upon segregation among banking, Council from its current heavy burdens, but
122 CHINA 2030
also enable sector supervisory authorities China should create an insolvency regime
to concentrate on improving the effective- for the financial sector that would allow for
ness of financial regulation and supervision. an orderly exit of weak or failing financial
It would also remove obstacles between the institutions. In China, the sense of being
central bank and various supervisory bod- “too big to fail” or “too connected to fail”
ies in coordination and information and is deeply rooted in the state ownership and
analyze and supervise all institutions, prod- control of financial institutions. Even small
ucts, instruments, markets, and transactions financial institutions that fail to pay off their
that might bring about systemic risks. The debt rarely go bankrupt.44 This situation cre-
role of this financial committee could also ates the potential for rampant moral hazard.
include development and establishment of Signaling in an early stage of liberalization
instruments, standards, and indexes for sys- that poorly managed banks and firms could
temic risk monitoring and identification, and go under would be necessary even if it entails
development of macroprudential instruments substantial short-run cost. Such a regime
(possibly using microprudential means as would include the designation of a resolu-
transmission channel). tion authority; the legal power to intervene
promptly in a nonviable financial institution;
Building a financial safety net and devel- resources to close, recapitalize, or sell such an
oping crisis management and insolvency institution; the capacity to manage the inter-
schemes. Financial liberalization will lead vened institution, including its assets; and
to a more efficient financial system but also an effective safety net. A well-functioning
will increase the risk of financial instability. insolvency regime would help contain moral
Most countries have faced big or small crises hazard and also protect fiscal soundness.
in the process of opening their financial sys- The authorities should establish an effec-
tems, often as a result of macroeconomic dis- tive exit mechanism in the legal framework
tortion and volatile changes in relative prices and streamline the court system to deal with
and asset values. While China’s huge foreign troubled banks and firms in a timely fashion.
reserves give it a strong buffer against a pos- It should allow for an orderly exit of weak
sible currency crisis, it cannot neglect the pos- or failing financial institutions and a clear
sibility of a domestic financial crisis. definition of the role of the government in
An early warning system would be help- providing fiscal support. The roles of the PBC
ful for effective oversight, early intervention, and regulatory agencies need to be reviewed.
and prevention of financial crisis. To identify For example, it is important to limit central
threats, the authorities need to continue to bank emergency liquidity support to solvent
deepen their financial stability analysis and banks facing short-term liquidity problems,
develop a full range of early warning indica- and to establish an out-of-court settlement
tors. This warning system can be composed system while streamlining the court system
of two parts. The first would be a set of mac- to resolve quickly failed financial institutions.
roeconomic and sectoral models, possibly A formal deposit insurance scheme is
encompassing the housing market, foreign needed to deal with potential bank runs
exchange market, banking sector, stock mar- on privately owned depository institutions
ket, and labor market, among other things. It and to protect the savings of small deposi-
could specify the range of daily, weekly, and tors (box 1.10). The preference to establish
monthly changes in indicators that would dic- a deposit insurance fund instead of a multi-
tate the severity of supervisory reaction. The function deposit insurance system requires
second part would be to define the institu- careful consideration. If such an institution
tions responsible for monitoring and report- becomes a fund only to pay for bank failures,
ing market developments and for making it will bear the loss from risks incurred by
decisions to address specific developments. banks with no ability to curtail those risks ex
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 123
A set of principles has emerged from cross-country however, deposit insurance schemes have tended to
evidence on the creation of an effective multifunction be publicly managed and to have noncompulsory
deposit insurance system. First, and most important, membership. Fourth, it must be made clear that
coverage should be limited so that large depositors, funds to cover bank losses will come principally from
subordinated debt holders, and correspondent banks the pool of surviving banks and that taxpayers will
are convinced that their funds are truly at risk. This be tapped only in truly catastrophic circumstances.
creates strong incentives for a relatively sophisticated Fifth, deposit insurance premiums should be actu-
set of depositors to monitor the activities of banks, arially fair for the risks taken by banks, although
while at the same time providing assurances of in practice they tend to be lower in many countries.
safety for depositors of smaller amounts of savings Sixth and finally, deposit insurers must play an active
who generally lack the ability to effectively monitor role in decisions about when and how to resolve a
banks. Second, membership in the deposit insur- troubled bank, to minimize the cost of resolution and
ance scheme should be compulsory, so that stronger protect the remainder of the deposit insurance fund.
institutions cannot select out of the pool when new Evidence shows that banks are less likely to become
funds are needed to cover losses by other banks. insolvent when the deposit insurer is responsible for
Third, joint public-private management of deposit intervening in failed banks and has the power to
insurance schemes has proved more effective than revoke a bank’s membership in the deposit insurance
either solely private or public management.45 In Asia, scheme (Beck and Laeven 2008).
ante. Experiences from other countries show not immune to external and internal shocks.
that deposit insurance institutions need to A framework for crisis preparedness should
have some means to curtail the moral hazard be put in place that consolidates the vari-
associated with bank risk taking, sometimes ous existing stand-alone arrangements and
involving a supervisory role, to better align blocks, includes financial projection model-
their compensation rights (that is, the pre- ing and contingency planning, and involves
mium paid by banks) and obligations (pay- all relevant agencies. Strategic design and
ments to insured depositors) in the event of capacity building are both key to the success-
bank bankruptcy. Otherwise, the advantages ful function of such a framework.
of deposit insurance, such as deterrence of
reckless risk taking by banks and improve- Recasting the rights and responsibilities of
ments in the stability of the banking system government. Most existing problems and
by decreasing the probability of bank runs, potential risks in China’s financial system
are lost. Second, it is important to provide a can be traced back to the functions of gov-
legal basis for deposit insurance institutions ernment. An important distinguishing feature
to carry out their duties. The proposed “Reg- of China’s financial system is the extensive
ulations on Deposit Insurance” try to solve involvement of the government in financial
problems through administrative regulations market activities. As mentioned, the govern-
rather than legislation. ment acts as owner and regulator of financial
An effective crisis management framework institutions and influences resource allocation
should be put in place. China has come out through direct and indirect controls. The gov-
of the financial crises of Asia in 1997 and ernment is also widely perceived as an implicit
the recent financial crisis of 2008 largely guarantor of financial institutions. Despite the
unscathed. But that should provide no reason perceived advantages of government involve-
for complacency, because the Chinese finan- ment and domination in the financial system,
cial institutions have been untested and are the negative impact on the financial sector has
124 CHINA 2030
become increasingly felt: the conflicting roles since the late 1990s. There are more than a
of government in ownership and regulatory dozen types of (quasi) financial institutions
functions have made it impossible for regu- under the administration of local govern-
lation and supervision to be truly effective; ments. However, supervisory functions for
continued patronage of financial institutions, these institutions are scattered across dif-
including through appointment of senior ferent departments. Lacking the means and
executives, has prolonged the bureaucratic capacity to ensure the safety and soundness
culture among banks; and the perception that of local financial institutions, provincial gov-
the government will guarantee losses of failed ernments can resort to heavy intervention
financial institutions has exacerbated moral in their governance and operations, either
hazard, just to mention a few examples. To through the provincial Rural Credit Coopera-
establish an effective financial system and tives Union (RCCU) or through the Financial
ensure financial stability, China needs to Affairs Office, or Jinrongban. In actuality,
reorient the rights and responsibilities of gov- the provincial governments have assumed an
ernment in the financial sector. ownership role in local financial institutions,
First, the government should put more at the expense of pursuing their regulatory
emphasis on creating an environment condu- functions.
cive to finance. The government could invest In this regard, there is a need to estab-
in financial infrastructure, allow the SFIs lish an effective provincial-level financial
to price their services and products without supervisory framework. Local governments
interference, promote entry, and impose dis- should focus on exercising their supervisory
cipline on failures. A combination of con- responsibilities, maintaining effective coor-
ducive financial policies, enabling financial dination with central government supervi-
infrastructure, a reasonable degree of compe- sory authorities, and gradually establishing
tition, and the threat of bankruptcy will go a regional supervisory capabilities, including
long way toward bringing down transactions establishing a supervisory framework, train-
costs and providing the right incentives for ing a professional supervision team, and
SFIs to step up efforts to provide convenient, strengthening the effectiveness of on-site
rapid, and reliable financial services. examination and off-site surveillance. Better
Second, the conflict of interest caused by provincial-level financial supervision will not
the multiple roles of government as owner, only alleviate the supervision burden of the
supervisor, and promoter should be resolved. central regulator but also fill the vacuum and
Such conflicts of interest make it difficult for ultimately reduce regional financial risks. To
the supervisory authorities to carry out their establish such an effective regional financial
roles in a neutral and just manner and thus supervisory framework, local governments
to take decisive actions in case of serious should gradually separate the responsibilities
offense. Besides, the regulatory authorities of ownership and supervision.
in China are deeply involved in the gover- Fourth, the government needs to define
nance and operations of financial institutions and effectively provide noncommercial finan-
through the power to appoint and remove cial services. A clear line between policy and
top-level managers. commercial activities would determine what
Third, the rights and responsibilities services and products should be provided
of local governments need to be aligned. by the government or by financial institu-
Although local governments bear the respon- tions owned by the government. In cases
sibility for the failure of local financial insti- where policy-related finance is justified, prin-
tutions, they do not have relevant supervisory ciples and policies should be clearly set and
mandates and capabilities. Consistent with supported by performance monitoring and
the overall trend toward decentralization, the evaluation. An exit strategy is also needed to
central government has increasingly granted avoid prolonged use of public resources and
authority to local governments, especially potential distortion of credit markets. All
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 125
this will allow commercial financial institu- assets of SOEs is also significantly lower
tions to focus on their commercial business, than that of other firms (see the previous
improving the effectiveness of capital usage section on enterprise and sector reform).
and avoiding both financial and fiscal loss. On the other hand, the average debt to
A good understanding of the commercially equity ratio of SOEs is substantially higher,
sustainable frontier is essential for further exceeding 230 percent (Liu and Zhao
reform in the policy banks and the promo- 2009). If the financial system is liberalized,
tion of inclusive finance to rural households many highly leveraged SOEs would face
and micro and small enterprises. difficulties in financing their investment or
debt at low cost, resulting in deteriorating
their financial situation and possibly lead-
Obstacles to Reform
ing to insolvency.
The main obstacles to reform and the diffi- • Political and bureaucratic resistance.
culties faced in the process of financial lib- Financial repression has created economic
eralization are those commonly found in a rent that has been distributed to favored
financial system that has been dominated borrowers and nurtured vested interests.
by state-owned banks or where the govern- Banks have enjoyed a comfortable busi-
ment has strongly intervened for a sustained ness environment provided by high entry
period. The concerns over these obstacles barriers, interest rate control, and excess
tend to delay the reforms even as reforms are demand for credit, which allows credit
needed to meet the changing internal and rationing. Officials’ power to control
external economic environment. banks and their credit allocation is one
source of their power over the economy
• Moral hazard of state-owned banks and and society. All these would work to
enterprises. In a situation where major mobilize resistance to financial reform
banks and firms are owned by the state, and build a tendency of system inertia or
moral hazard can be pervasive. Without regressing back to the old system.
hard budget constraints, firms may con-
tinue to engage in reckless investment and
Triggers for Change
borrowing that would lead to continued
high demand for credit despite increased Internal and external forces that build up as
interest rates. Banks that put higher pri- their economies grow and expand eventually
ority on gaining market share than on lead to financial liberalization and opening.
profit and prudential management would This is illustrated by evidence from other
drive interest rate competition. Weak countries such as Korea and Japan (annex
banks would have especially big incentives 1D). Such pressures from both domestic and
to offer higher deposit rates to mobilize external sources will also mount for the Chi-
funds and lend or invest them in high-risk nese authorities in the course of transition
borrowers or projects. That can lead to from middle-income to high-income status.
widespread distress borrowing and finan- The following forces could intensify pres-
cial instability. If the strong incentives for sures for change in domestic financial system
moral hazard are not properly checked, and drive the initiation of financial sector
interest liberalization, and financial liber- reform irrespective of the government’s inten-
alization more generally, may invite a high tions over the next one or two decades:
risk of financial instability.
• Financial weakness of some SOEs. Cur- • Integration in the global market. The Chi-
rently, SOEs pay much lower average nese financial system will have to become
interest rates for their debt than other more integrated with the international
borrowers such as private firms and coop- financial system. China’s rapid past eco-
eratives. The weighted average return on nomic growth results from, among other
126 CHINA 2030
things, the opening and integration of the become increasingly crucial in sustaining
Chinese economy into the global economy. growth.
This integration has so far been led by the • External pressure from the global econ-
trade and real sectors, and to a limited omy. Relative to the global economy,
extent by the financial sector. In transition China’s ascendance toward an advanced
to a high-income society, greater integra- high-income economy will be different
tion of the Chinese financial sector into from that of the ascendance of any other
global capital markets will be inevitable, country in the past. Asian countries that
as the business of Chinese firms becomes took off earlier, including even Japan,
increasingly globalized and a growing could take the global economy and inter-
number of foreign financial institutions national economic system as an exog-
penetrates the Chinese financial system. enous variable in the course of pursuing
• Possible increase of nonperforming loans their development strategy. In contrast,
(NPLs) and deterioration of banks’ bal- the global economy and global economic
ance sheets. Without reforms in current system will no longer be endogenous to
lending practices and governance struc- the development of the Chinese economy.
tures of state-owned commercial banks, In other words, the interplay between
the banks are likely to again accumulate China and the world will be a key factor
large NPLs if the economic growth rate affecting the nature and pace of China’s
slows and the performance of SOEs dete- ascendance to high-income status. In the
riorates. The periodic increase in NPLs process, there could be tremendous poten-
and repeated requirement to clean up tial for conflict and tension between China
bank balance sheets using taxpayer money and the world economy. China is likely to
could increase public discontent with the play a major role in writing the rules of
government’s heavy regulation and control international trade and finance. It would
over the banking system. be hard to imagine that such a country
• Demand by the general public. As income would maintain strong foreign exchange
levels rise, and as households accumulate and capital controls with frequent inter-
greater financial savings, Chinese citizens ventions in the exchange market.
will demand a wider variety of financial
savings options and asset investments.
Sequencing of Reforms
The demand for more equal and open
access to economic opportunities will also Keeping adequate pace and sequencing will
increase. Likewise, as China’s industrial be very important for the successful progress
structure and firms become more sophis- of financial liberalization and opening. Chi-
ticated and diverse, there will be a grow- na’s financial sector has served the rapid eco-
ing need for decentralized monitoring and nomic growth reasonably well over the past
governance of firms by market players. three decades, and in the process, it has been
International experience indicates that as reformed and restructured. However, in view
economies mature, financial services pro- of the current and expected future economic
vided through securities markets become circumstances, it should be further reformed
increasingly important for firms, particu- and restructured. China may not need to pur-
larly those in high-technology industries. sue the same structure (including the own-
• Pressure from the real economy. As noted, ership structure) and practices of financial
to keep GDP growth at relatively high market as are seen in most advanced econo-
levels, China will have to rely more on mies these days. But it is also true that the
total factor productivity growth through liberalization and opening process will not be
support for innovations and efficiency easy and could face many challenges includ-
improvements. More efficient capital allo- ing instability or temporary deterioration of
cation through the financial system will economic performance, especially if it is not
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 127
managed carefully. While managing finan- may be more able to resist external pres-
cial reforms is as much art as science, and sure, it would still need to accommodate
country-specific circumstances figure heavily, demands by the rest of the world to grow
certain broad principles for managing reform and prosper together. By liberalizing the
can be put forth, drawing on the experience domestic system earlier rather than later,
of other countries. and in a systematic rather than piecemeal
Reckless deregulation driven by the inter- fashion, China could achieve the benefits
ests of the regulated should be avoided, as of financial development without suffering
attested to by financial crises of many other undue instability.
countries, including the United States and • Financial market infrastructure should be
Europe. Liberalization should be comple- strengthened before liberalization. For the
mented by strengthened regulation and system to embark on a virtuous cycle, the
supervision. On the other hand, too much government will need to strengthen such
regulation will choke innovations and infrastructure as quickly as possible and
improvement in efficiency. Striking the gradually reduce its influence in the inter-
right balance is not easy but is an essential nal affairs of the financial institutions,
consideration. placing its focus on the roles that belong to
the government, including regulation and
• Financial reform is the result of a politi- supervision, securing credible accounting
cal economic process that can limit what and audit practices and transparency in
is feasible in the near term and slow prog- transactions, and creating and enforcing
ress. Certain market-based reforms can- the right incentives and mechanisms.
not be deepened without accompanying • Financial reform can progress successfully
measures. Premature reforms may also be only when accompanied by institutional
a source of financial instability. The histo- and organizational reforms. Liberalizing
ries of both Japan and Korea indicate that market rules without changing old insti-
partial deregulation of the financial sys- tutions can deepen distortions. Unless
tem led to regulatory arbitrage that ulti- the government’s organization changes,
mately proved destabilizing. Deregulation its modus operandi of intervention and
thus must be introduced across various involvement in the financial system may
sectors in the financial system in ways that not significantly change. This gives the
do not lead to major regulatory arbitrage. system strong inertia against real liberal-
Banks and NBFIs should be liberalized ization. Again, the Japanese and Korean
along parallel tracks, so that a severe dis- experiences are cases in point. In this
intermediation or rapid expansion in some respect, in China, the reform of gover-
sectors does not take place and become a nance and incentive structures for man-
cause for financial crisis later. agement and staff of state ownership
• The pace of domestic liberalization must functions and institutional reforms of the
be expedited when external opening of relevant government bodies are two high-
the financial system is envisaged. While priority agenda items.
mounting external pressures eventually
forced financial market opening in Japan
and Korea, it also led to a significant shift Land Policies
of domestic financing toward offshore
A Key Factor: Land
transactions or to severe financial instabili-
ties because of a lack of concomitant prog- Land constitutes a key factor in China’s quest
ress in domestic financial liberalization. In for more efficiency-driven economic growth
this regard, further interest rate liberaliza- and more balanced and equitable develop-
tion should be expedited according to the ment. Over the past three decades, land,
principles suggested above. While China together with investment, has fueled China’s
128 CHINA 2030
extraordinary levels of infrastructure devel- market for urban land use rights has been
opment, urban expansion, and industrial established and advanced since the mid-
growth and has contributed to maintaining 1980s, and robust regulations on land tak-
social stability. Through its important links ings and compensation are in place.
to the fiscal and monetary spheres, land However, previous reforms have left in
use has critically affected macroeconomic place a number of problematic policies,
stability. The state, especially local govern- institutional arrangements, and implemen-
ments, has been skillful in using land, a key tation practices. Additional significant chal-
economic resource, to carry out its industri- lenges related to land policy have emerged in
alization and urbanization strategies. Fol- the course of rural-to-urban migration and
lowing the commercialization of finance, urban expansion.
land has also become an important means To transit successfully to high-income
to strengthen the links between government status and to realize a harmonious society,
and business. Although China seemingly has China will need to make some fundamental
some of the most rigid regulations for land choices in land policy to overcome the con-
use, land is often used by local governments straints embedded in the current land tenure
to motivate investments, but often in a discre- systems and to address the challenges that
tionary and distortionate fashion and to the have emerged. Further reforms will have to
detriment of rural land rights holders. reduce the complexity and contradictions
In the future, a sound land policy, legal inherent in the current system of collective
framework, and enforcement mechanisms and state ownership and emerging private
will be prerequisites for continued develop- property rights to land and ultimately treat
ment and structural changes. More efficient the different types of land ownership and
land use will promote TFP and GDP growth, the associated private property rights equally
help maintain employment, and ensure Chi- within a clear legal, institutional, and policy
na’s domestic food production capacity. Well- framework. Such reforms will also have to set
functioning land markets will allow farms to China on a path toward a more market-based
grow into units that can raise rural incomes allocation of land resources across rural and
and promote efficient and livable cities. Chi- urban spaces, ultimately in the form of a
na’s land policy will remain critical for main- unified land market. In parallel, the institu-
taining social stability. In the context of rapid tions to support such a market will have to
urbanization and migration, rural land will be developed. Over this period, China will
continue to serve as a social safety net in hard need to reconsider the state’s unique monop-
times. And land, in one form or another, will oly power in the primary land market, which
remain an important source of public revenue gives it the sole right to convert land for
at local levels. urban use. China will need to allow the state
Over the past three decades, China has to be transformed into a market regulator,
made impressive progress in reforming and administrator, service provider, and enforcer
developing its land-related policy and legal of rules. It will also need to ensure the equita-
framework. From the introduction of the ble participation and sharing of benefits from
Household Responsibility System (HRS) in land management and transactions among its
1978 to the Property Law of 2007 and the citizens.
2008 CPC “Decision on Important Issues In the most general terms, in realizing its
Concerning Rural Reform and Develop- vision for 2030, China will have incorporated
ment,” a range of policy decisions and legal and adapted the critical benchmarks from
reforms has addressed the questions of secu- experiences in high-income countries to its
rity of tenure and access to land, particularly specific economic, institutional, and societal
agricultural land, and property. (See box 1.11 context. It will have in place a policy and legal
for a summary of key milestones in rural land framework that provides clarity on land own-
reform.) In urban areas, a well-functioning ership and property rights. It will have open
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 129
BOX 1.11 Historical perspective: China’s land-related policy reforms and emergence of
the legal framework
China’s land policy and legal framework is evolv- forms of compulsory farming implemented through
ing continuously in response to economic and social administrative order.
changes. Policy directions provide clear evidence of In 1988, the Land Administration Law, modeled
a consistent appreciation of tenure security. There is on the Hong Kong Leasehold System, legalized the
also a clear trend of embodying policies into laws granting of use rights to state-owned land to private
that is moving the country toward a comprehen- users and the transfer of such rights among them. In
sive legal framework for land. The main reform 1998, the law was revised to mandate that farmland
milestones over the past three decades included the be contracted to households for a term of 30 years.
following: In the case of urban land, the revised law provided
China’s Constitution provides that land in rural for marketable use rights of up to 70 years and cre-
and suburban areas, except for that stipulated as ated the legal foundation for an active urban land
state owned, is owned by rural collectives. The rights market. The law set out detailed procedures
Household Responsibility System (HRS) of 1978 governing the taking of farmland by the state but
introduced the contracting of collective farmland to did not provide for the meaningful participation by
individual households for private farming, initially farmers, through such means as prior notification,
for a 5-year lease period that was later extended participation in determining compensation, and
to 15 years (1984) and then to 30 years (1993). By appeal during the expropriation process.
1983, virtually all arable land had been allocated to The No. 18 Document of 2001 provided further
rural households. The HRS laid the foundation for policy direction by prohibiting the collectives from
strong agricultural and rural growth and for China’s taking back land rights and recontracting those
extraordinary performance in rural poverty reduc- rights to nonvillagers for value. In 2002, these poli-
tion in the following decade (Lin 1992; Ravallion cies were embodied in the Rural Land Contracting
and Chen 2004). Law. It clarifies the relationship between collec-
The Party’s No. 1 Document of 1984 laid down tive land ownership and farmers’ land use rights,
the foundation of China’s current rural land rights defines the contents of land use rights, and gov-
system. It clarified the separation of collective own- erns the transfer of individual farmland rights. It
ership from individual land use rights and stipulated provides that rural land contracting and operation
that collective land be contracted to households rights held by farmer households may be transferred
for a term of 15 years. It allowed for the voluntary (to other village households), leased (to nonvillage
transfer of individual land rights between farmers households), exchanged, assigned, or transacted by
but did not provide guidance on land readjustments other means in accordance with law. It also pro-
within the collective. The No. 11 Document of 1993 vides legal remedies for any violations. The Property
reinforced the HRS. It required that farmers’ farm- Law of 2007, the first comprehensive civil property
land rights be extended for a term of 30 years upon code in modern Chinese history, articulates that all
the expiration of the initial 15-year lease period. It types of property in China—state, collective, and
endorsed transfers of farmland rights for value with private—are entitled to the same level of legal pro-
prior consent from the collective and clarified the tection. Furthermore, it characterizes farmers’ rural
Central Government’s view that administrative read- land use rights as property rights rather than as the
justments in response to population changes would contractual rights defined by previous laws, and it
violate famers’ rights. The No. 16 Document of provides greater protection for small farmers’ land
1996 explicitly prohibited large readjustments and rights. It also reaffirms the provisions of the Rural
restricted small readjustments through the require- Land Contracting Law. Regardless of the type of
ment of approval by two-thirds of the villager assem- land transaction, transfers of use rights must adhere
bly or villager representatives and by township and to the principles of voluntariness and free negotia-
county government. The document prohibited all tion between transferor and transferee, compensa-
tion, freedom from compulsion, content and formal rights for all farmers remains challenging. A revi-
procedure, specification of contract terms, and a sion of the Land Administration Law was under way
requirement that the transferee possesses the capac- (as of 2011) and was expected to further strengthen
ity to farm the land. In 2008, the CPC’s “Decision tenure security, clarify the scope of state expropria-
on Important Issues Concerning Rural Reform and tions for public interest, determine compensation
Development” introduced a landmark change to approaches for land takings, and extend the protec-
rural tenure by extending the 30-year term of fam- tion of farmers’ rights to all types of land, including
ers’ use rights for an indefinite period. residential and collective construction land.
Land policy reform has been significant, but
ensuring secure, marketable, and long-term land
and integrated land markets that facilitate the 1.12 for an international perspective on land
accessibility and efficient allocation of land to policy.)
various economic activities. And it will oper- Despite a relatively clear legal and policy
ate institutions that are efficient, transparent, framework on rural land tenure, rural house-
and accountable and support the functioning holds continue to have weak rights over land
of land markets, and it will apply technologies and often face expropriation risks. The result-
and skills that support the efficient adminis- ing insecurity creates strong disincentives for
tration and governance of land resources. longer-term investments in agriculture and
This report outlines three land policy reduces land consolidation and rental activi-
themes or issues that will be particularly ties. For example, one survey found that
critical for achieving high-income status and farmers who have at least one land document
social stability, along with relevant reform are 76 percent more likely to have made mid-
needs and options. The three needed reforms to long-term investments than those who
involve tenure security in rural areas and had not been issued a document (Landesa
governance of collectives; land policy and 2011). Farmers with documents that com-
rural-urban integration; and land policy and plied strictly with the law invested even more.
municipal finance. Problematic aspects are found in persistent
limitations in the tenure rights themselves,
specifically with regard to the renewability
Tenure Security in Rural Areas and
and duration of existing farmland use rights
Collective Governance
and contracts that have not yet been embed-
On its path to high-income status, China ded in the law. Equally important, the defini-
needs to improve overall tenure security in tion, protection, and the treatment of rights
rural areas to create the right incentives for over rural residential and other collective
long-term investments and continued growth land remain incomplete and problematic.
in agriculture and for rural-to-urban migra- In addition, serious difficulties remain in
tion through effective implementation of its the implementation of policies and laws, in
policies of indefinite land use rights to farm- improving governance and accountability at
land and strengthening of the rights to other the local level, in the documentation of land
types of rural land; expanded land registra- rights, and in citizens’ low awareness of exist-
tion and strengthened rural land markets; ing rights. Taken together, these gaps create
and reform and modernization of the gover- the potential for abuse of power and corrup-
nance structure of rural collectives. (See box tion. Disputes over rural land have become
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 131
High-income economies are typically characterized texts of compensation for compulsory acquisition
by widespread ownership of and access to land and or expropriation, taxation, and accounting) and for
property. Land is one of the most critical produc- defining processes for change of use (through plan-
tion inputs and accounts for a large share of national ning, zoning, and land use regulations). As a result,
wealth in any given economy. Given the importance associated rights and responsibilities are generally
of land and property, high-income economies have considered secure and well defined, which facilitates
generally moved toward ensuring clarity of defini- economic activity. While uncertainties in tenure and
tion of rights and security of tenure of land and transactions can never be entirely eliminated, they
property. Legal definitions and secure tenure have can be made somewhat predictable and be offset by
maximized land utility and its potential contribu- risk management strategies, including insurances of
tion to economic growth, while minimizing negative various kinds.
impacts of state interference and lengthy, unproduc- High-income economies, reflecting in part the
tive disputes. Thus, for example, while the ultimate power of the vote and in part that of social groups
level of ownership might lie with the state, it has and consumers, typically have well-developed legis-
long been established that the state retains in effect lated social policies and codes. Legislative provisions
only minimal rights. define basic landlord and tenant arrangements in
Constitutional and legal frameworks define basic both housing and commercial sectors. Similarly, leg-
ownership and how this may be given effect with islated and regulated environmental policies defin-
regard to alienation, inheritance, divorce, mortgag- ing restrictions and responsibilities significantly
ing, and the like. Registration and cadastral admin- influence how land and property may be used and its
istrations record and thus further define these rights value. Increasingly, social and environmental safe-
and parcels, covering an increasingly wide range of guards are conforming to international standards
tenures and rights. Legal frameworks also define the and codes of practice, facilitated by international
bases for defining values (for example, in the con- forums, conventions, and agreements.
more frequent, for example, in cases where document in this regard. Near-term reform is
returning migrants want to resume farming expected to anchor the provision of indefinite
and are claiming back their leased-out land. household rights to farmland, as articulated
About one-quarter of villages across China in the policy, in the relevant laws. The reform
is estimated to have been subjected to land toward indefinite land use rights will need to
consolidation and leasing arrangements to clarify who will be eligible for such rights, for
commercial enterprises, a recent and not yet example through determining farmers’ land-
well-understood phenomenon. rights-related membership in a collective.
This complex set of problems needs to be In the near to medium term, supplemental
addressed in a carefully sequenced and inte- reforms will have to tackle the poor quality
grated set of reforms that strengthens tenure of current documentation on collective land
security in rural areas, likely involving the ownership and individual use rights. These
following elements: reforms could promote the introduction and
implementation of a land certificate and con-
Securing indefinite land use rights. Use tract system that not only specifies the prop-
rights to cultivated land need to be secured erty itself but includes core legal provisions
by expanding the renewability and duration and rights and responsibilities as well as sanc-
of existing 30-year land use contracts and tions in case of violations. Land contract and
certificates. The CPC 2008 Policy Decision, certificate documentation needs to be harmo-
with its stipulation of indefinite land use nized across the rural and urban spheres, for
rights to agricultural land, was a landmark example, by following the standard format
132 CHINA 2030
of China’s existing urban land use rights The functioning of markets for farmland
certificate. serves as an important benchmark of tenure
security. During the 1980s and mid-1990s,
Improving land registration. China and less than 5 percent of cultivated farmland
most other developing countries lack a reli- in China was being planted under rental
able complete national inventory of land par- tenancy (Li 1999; Brandt and others 2002).
cels. While the full establishment of a national Since the mid-1990s, rental markets for culti-
land inventory may not be feasible in the short vated land have developed in a more vibrant
or medium term, effective implementation of way. Although little systematic official infor-
land rights will require some degree of clarity mation is available, recent surveys provide
about the location and extent of the land to some evidence of the expansion of the rural
which the rights apply. More reliable, precise, land rental market. The share of cultivated
and accessible records concerning the location land being rented was only 7 percent in 2000
of individual land parcels and who has what but increased to 19 percent in 2008, accord-
rights to a given parcel will help strengthen the ing to a survey conducted by the Center of
trust and sense of security of contract owners, Chinese Agricultural Policy in 2008. More
help reduce land disputes, and facilitate the land is being rented out in coastal and south-
more efficient implementation of land-related ern China than in inland areas or northern
laws. China. A DRC survey in 2007 covering
The government has recognized the role of almost 3,000 villages found that 21 percent
land registration in promoting tenure secu- of cultivated farmland had entered the rental
rity, rural growth, and rural-urban migration market. In Anhui and Shandong, land turn-
and has already piloted various land informa- over ratios were 12.4 percent and 6.1 percent,
tion management systems and methodologies. respectively (World Bank 2010b). Most of the
In the near term, the registration of farmland current transfer activities are informal trans-
needs to be scaled up to realize its broader actions and, in the absence of enforceable
benefits. Significant start-up investments will contracts, have led to inefficient and narrow
be required to pursue the systematic and free market segmentations where sanctions can
initial registration of farmland. Ultimately, as be enforced informally.
international experiences show, land registra- The transition to efficient markets for
tion can be self-financing through fees for farmland rights over the coming decade will
secondary transactions. Lessons from other be complex and difficult. The development
countries indicate that administration of the of appropriate market institutions will need
land registry under a single agency could be to proceed in parallel with complementary
one favorable option, because it avoids over- reforms, including household registration
lapping jurisdictions and parallel systems and reform, promotion of labor mobility and
approaches. Over time, land registration and expansion and access to social security sys-
the issuance of standardized rights certifi- tems. In due course, tenure security to other
cates will gradually have to be extended to all types of collective land and their marketabil-
types of rural land. ity will have to be strengthened in similar
ways. (For an international perspective on
Developing rural land markets. The transi- land institutions, see box 1.14.) In the lon-
tion to transparent and efficient markets for ger term, rural land use rights holders need
farmland use rights will be important to pro- to be given access to the urban land market
mote productivity and GDP growth and to and become full participants in the sharing
address China’s rural-urban income gap. (For of benefits whenever rural land is being con-
an international perspective on land markets, verted to nonagricultural purposes.
see box 1.13.) Gains in productivity of land
use through land rental in a growing econ- Reforming the institution of the collec-
omy, such as China, can amount to 60 percent tive. The relatively low security of land ten-
(Jin and Deininger 2009). ure is part of a larger grassroots governance
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 133
One key pillar of economic development in high- land market. In addition to the different use sectors,
income countries is the existence of efficiently func- separate markets reflect the diversity of tradable
tioning land markets. All economic activity requires property rights, including freehold (or “full” owner-
access to land. Land markets facilitate accessibility, ship), strata title, fractional title, timeshare, lease-
which allows land to be used in the most economic hold, and other property-related rights such as
way, thus increasing economic activity and prosper- quotas, carbon rights, and transferable development
ity. Prerequisites for an efficient land market include rights.
clear land policies, an appropriate legal framework, Efficient land markets depend upon buyers, sell-
secure land rights, capable institutional and pro- ers, professional advisers and other intermediaries
fessional services, transparency and availability of having access to information. In developed coun-
information, and easy access for all. tries, public sector land administration systems
L and transac tions are of ten complicated, register transfers of ownership and transfer prices
because of the complexity of the property rights and make them available for public inspection.
being transferred, the amount of money involved, In addition, data on transactions is usually pub-
and the regulatory framework within which the lished through national statistics offices. With the
transactions take place. In the United States and the recent growth in e-governance, the trend is toward
United Kingdom, sales by private contract (that is, improved web-based access and electronic public
for a price agreed directly between seller and buyer) services in analyzing and disseminating data on
are by far the most common form. There is no single property transactions.
deficit. The unresolved opportunities for abuse members of the collective; it will also have
of power and rent seeking of village cadres at to clarify the relationship between collec-
the expense of the members of the collective, tive ownership of land and individual rights
for example in practices of land readjustment to land in view of the government’s push for
or commercial development, and the rela- a transition toward stronger and indefinite
tive absence of transparent and accountable individual property rights. Such reform will
governance structures at the rural collective not only require the strengthening of gov-
level, point to larger problems in the relation- ernance at the collective level but involve a
ship between the collective entity and individ- fundamental redefinition of the remaining
ual land use rights holders. Although recent functions and roles of the collective entity as
surveys point to a reduction in the frequency its responsibility for land management may
of such reallocations, every village surveyed no longer be relevant.
experienced at least one partial reallocation,
on average, during the period 1998–2008
Land Policy and Rural-Urban
(Wang, Tao, and Man 2010).
Integration
A key policy challenge in rural areas of
China in the coming two decades is how On its path to high-income status, China
to modernize the institution of the rural needs to introduce fair and transparent rural
collective to keep it relevant and consistent land acquisition policies and practices, cur-
with the evolving shifts in law and policy, tailing the role of the state in land requisition,
specifically the transition from the original and ensure more socially compatible rural-
land use rights contracted for a specified urban integration by allowing collectives and
term under collective administration toward land use rights holders to share the benefits
indefinite, inheritable, and transferable indi- from urbanization.
vidual property rights to land. Reform will The government promotes urbaniza-
need to clearly define the nature of collective tion and rural-urban integration as part of
ownership and unambiguously identify the C hina’s overall development strategy. But
134 CHINA 2030
To work efficiently, land markets must be supported tion purposes and the extensive use of private sector
by a wide range of institutions. In high-income econ- firms by the Ordnance Survey, the national mapping
omies, institutional development has progressed agency.
alongside economic development as a means of deal- Enforcement of laws and regulations is primarily
ing with the complexities of land administration, a state function. Each country has its own unique
management, and markets. The list of institutional and hierarchical court system. In many developed
stakeholders involved in well-developed land mar- countries, these institutions are supplemented by
kets is long, ranging from policy makers to bro- special courts and tribunals that deal with spe-
kers, mortgage lenders to lawyers, and valuers to cific areas such as land acquisition, taxation, and
registrars. accounting. For example, in England and Wales,
Government institutions provide the policies, the Lands Tribunal determines disputes about com-
laws, and regulations governing all aspects of land pensation payable to owners and occupiers of land
use. Their interaction is often complex, with func- affected by expropriation, while independent Valu-
tions divided between ministerial departments and ation Tribunals have jurisdiction over annual prop-
different levels of government. These functions erty tax appeals by taxpayers. In addition, many
include land-use planning and enforcement, the countries have developed dispute resolution systems
implementation of property taxation, management that take place outside of court. These are usually
of state-owned land, and land registration. In recent administered by recognized independent profes-
years, there has been a trend toward commercial- sional bodies, such as the Royal Institution of Char-
ization, with government institutions operating as tered Surveyors in the United Kingdom.
“agencies,” outsourcing service provision to the pri- Competent, reliable, and accessible professional
vate sector and entering public-private partnerships. services provide an essential link between buyers,
These innovations have been driven by the demand sellers, and government institutions active in land
to cut costs, improve accountability, increase accessi- markets. In addition to bankers and financial service
bility, and enhance capacity. Examples in the United providers, these include lawyers and conveyancers,
Kingdom include the Valuation Office Agency, brokers or estate agents, valuers, land surveyors and
which is responsible for valuing properties for taxa- structural surveyors, accountants, and others.
China’s land tenure system remains biased surpluses supported the initial stages of
toward urban development at a time when industrialization. But these features, which
the rural-urban income gap has widened to are highly unusual in comparison with
levels rarely observed in other countries. The those in high-income economies, are now
land tenure system also remains character- less advantageous to China’s development
ized by the strict separation and different and a major obstacle to a harmonious rural-
treatment of rural and urban land. Within urban integration. The widening rural-urban
this separation, the state’s exclusive power income gap, widespread land-related social
to acquire rural land and transfer it to urban conflicts caused by this separation, and other
users favors the currently uncontrolled and serious problems put this feature of the pres-
often inefficient pattern of urban develop- ent land tenure framework and policy into
ment. The resulting land acquisition practices question.
seriously disadvantage both the collective and The persistent duality of rural and urban
the rural land use rights holder in sharing in land systems needs to be managed and ulti-
the appreciating value of land entering the mately phased out. Various pilot efforts at
urban market. the local level throughout China have experi-
These practices were historically deter- mented with rural-urban integration efforts
mined and were justified in the early years with a view to developing a more comprehen-
of China’s development when agricultural sive policy reform framework in the future.
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 135
BOX 1.15 Rural-urban integration and “linking mechanisms”: Current and emerging issues
In contrast to farmland use rights, Chinese laws do (discount factors apply to account for differentials in
not extend the same level of protection to farmers’ land quality). This unit of reclaimed farmland cre-
residential land or other collective land, such as col- ates one unit of construction land quota that can be
lective construction land. In 1962, when China’s applied elsewhere in the jurisdiction. At this “some-
agriculture was still collectivized, residential land where else” place, usually the peri-urban areas where
was allocated to farm households to use “for a long the urban land market price is high, the government
time without change,” creating a de facto individual can convert one unit of farmland to nonagricultural
property right to residential land. The limited legal use and grant use rights to this new nonagricultural
protection of rural residential land is a major disad- land to developers.
vantage for farmers in the land conversion process. Through this mechanism, currently nontransfer-
The legal vacuum has allowed many opportuni- able rural residential land rights can be made mar-
ties for experimentation and policy pilots that can ketable. However, because the rights pertaining to
infringe on farmers rights and contradict and cir- residential farmland and collective construction
cumvent Chinese laws. land are so weak, local governments have targeted
Local governments throughout the country are these lands for expropriation and revenue genera-
pursuing a range of programs aimed at promoting tion, while developers have sought them for urban
urban-rural integration. These programs often tar- construction. While local governments often classify
get farmers’ rights to farmland and residential land such “exchange” of farmland rights as voluntary
through an approach of “exchanging farmland rights land rights transfers, it can in fact constitute illegal
for social security coverage and exchanging residen- appropriation of land rights.
tial land rights and houses for urban apartments.” More important, forcing farmers to give up their
Initially put forward in 2004, these so-called property rights to land in exchange for social secu-
linking mechanisms involve the reclamation of rural rity coverage also poses a moral dilemma because
(collective) construction land, including farmers’ res- urban residents are not required to make a similar
idential land for conversion to farmland. Every unit exchange. This practice also contradicts the inten-
of land, reclaimed corresponds to a reduction of one tion of the Property Rights Law (2007), which
unit of rural construction land, and to an increase requires that all type of property rights enjoy the
of one unit of farmland within a given jurisdiction same level of legal protection.
Many of the pilots have brought new chal- the scope of this power is unusually wide by
lenges to the surface and often have created international standards, and its use has been
their own problems (box 1.15). very extensive. During 2003–08, a total of
To promote a more harmonious integra- 1.4 million hectares of agricultural land, of
tion of rural and urban areas and citizens, which about 950,000 hectares were cultivated
two fundamental reforms need to be pur- land, are estimated to have been requisitioned
sued: the reform of China’s current rural land under current laws, while an additional
requisition policies and practices is a pressing 450,000 hectares are reported to have been
short- to medium-term issue; and integration requisitioned illegally during the same period.
of rural and urban land markets is required The impacts of compulsory land requisition
for more equitable benefit sharing in the lon- have not been isolated and relatively localized
ger term. as they might be in other countries. The pro-
cess of land requisition needs serious reform
Reforming land requisition and compensa- in three dimensions.
tion practices. Across the world, govern- First, Chinese law does not explicitly
ments have the power to acquire land on a limit the purposes for which the state can
compulsory basis in certain circumstances use its power of compulsory acquisition. In
and subject to certain conditions. In China, contrast, no high-income country allows its
136 CHINA 2030
government to use compulsory acquisition as In the near term, reforms of the requisition
the normal means of assembling land for pur- process need to introduce key provisions such
poses that are clearly commercial or indus- as advance notice, provide the opportunity
trial in nature. In the near term, to be more for consultation and participation during the
in line with international practices, tighter requisition process itself, and put in place
constraints on the use of state’s power for workable channels for appeal and dispute
land requisition will need to be clarified in resolution.
the legal framework and implemented along
the overarching principle that government’s Integrating land markets for equitable ben-
taking powers are extraordinary powers that efit sharing. China’s long-term land policy
should be limited to meet public needs that vision needs to consider more broadly how
are not well addressed through the opera- to rebalance the relationship between the
tion of the market. Such reform needs to go state’s monopoly in the primary land market
hand in hand with allowing the emergence and the collective and farmer participation in
of market mechanisms that span the urban- the conversion of agricultural land. Measures
rural divide. to decrease the urban-rural gap will have to
Second, current practices of compensation consider fairer benefit-sharing approaches
for requisitioned land need to be reviewed through, for example, gradually granting
because they are a frequent cause of com- access for collectives or rural land-use-rights
plaints about unfairness in the land requisi- holders to participate in the transfer of rural
tion process. These are based on agricultural land to the urban land market, while at the
output value but do not consider the value of same time reducing and ultimately phasing
the land in its eventual urban use. The stan- out the state’s monopolist power in the pri-
dard for compensation of cultivated land is a mary land market.
multiple (generally the duration of the land Experiences for successful rural-urban
use contract, that is, 30 years) of the annual transitions and integration process exist, for
agricultural output averaged over three years. example in Taiwan, China, and Korea. Both
This practice is problematic in a context economies were able to make farmers’ land
where the differential between urban and rights secure and free from administrative
rural incomes and livelihoods is so large, and intervention. That enabled farmers to invest
where this differential is reinforced by the in land, resulting in much increased land pro-
separation of rural and urban land markets. ductivity, and to benefit from investments
A rethinking of the compensation practices, in urban development. In both economies,
particularly where land is requisitioned for urbanization took place against a back-
commercial purposes, is needed. It is rec- ground of small farms with low per capita
ommended that the government consider landholdings. Both economies adopted a
international practices, where compensation farmer-friendly approach to the conversion of
is usually based on the market value for the farmland for nonagricultural use and intro-
best possible use. duced comprehensive measures that let farm-
Third, shortcomings in the land requisi- ers capture a share of the increased land value
tion process itself need to be addressed. While as a result of conversion.46 In both econo-
the laws set out the procedures for the taking mies, farmers who sold their land rights and
of agricultural land by the state and require found employment in the city were automati-
local government to make the resettlement cally covered under urban social benefits. In
plan public and to receive comments on it, China, land requisition and urban expansion
these steps often take place only after the req- have not only limited farmers’ proceeds from
uisition has been approved. In addition, there their land assets but also led to an erosion
is no explicit requirement that collectives or of rural land rights by excluding collectives
farmers be advised of the requisition ahead and farmers from the urban land market.
of time and be given an opportunity to react. A comprehensive reform program to better
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 137
safeguard rural land ownership and, even accounts for the “public good” element of
more importantly, individual land use rights land converted to urban uses. Alternatively,
for farmland and residential land, in the pro- the zone expropriation model practiced in
cess of urban-rural integration needs to be Taiwan, China, or Korea’s experiences with
put forward. rural urban integration may offer valuable
Across China, several reform pilots are lessons on how to rationalize urban and
currently under way, most prominently in industrial planning with fair participation
Chongqing and Chengdu. These pilots are and benefit sharing of the rural population in
experimenting with rural-urban integration the development process (box 1.16).
approaches and promote the registration and
definition of rural land ownership and prop- Addressing the urban village problem. The
erty rights, the development of policies and move toward a unified market for construc-
mechanisms for the transfer and marketing tion land needs to be carefully sequenced.
of rural construction land for urban develop- One option would be to begin in urban areas
ment, policies for the protection of farmland, where collective land ownership is still wide-
and labor mobility and social protection spread in the form of “urban villages”; col-
reforms, as well as other elements. While the lectively owned land is generally construction
lessons and experiences of these pilots are land that was not requisitioned by the state
to be collected and carefully evaluated over when it requisitioned land for city expansion.
the coming years, the broader reform direc- Because of the much higher compensation
tions for making the rural-urban integration cost for collective construction land than for
process more equitable could embody the agricultural land, collective construction land
following: remains scattered throughout many urban
areas in China. The persistence of urban vil-
Curtailing the state’s land requisition lages is one cause for inefficient city develop-
and opening the market for construction ment and urban sprawl. Allowing collectives
land. As noted, the state’s power and scope in urban areas to trade their collective con-
for compulsory acquisition needs to be struction land in the primary urban land
restricted to a more narrowly defined “pub- would likely lead to more efficient develop-
lic interest.” This restriction will need to go ment and to higher density land use in urban
hand in hand with the gradual introduction areas.
of a unified market for construction land.
In such a market, collectives and individual Strengthening checks and balances in
land-rights holders would participate on an urban development planning. The transi-
equal basis with the state in the conversion tion toward a unified urban land market
and trading of collective construction land in will require a strict and enforceable imple-
the primary land market without first con- mentation of urban and industrial land use
verting the land to state ownership. Over planning. While a relatively rigorous urban
the longer term and within a framework of planning process is in place, implementation
approved and enforceable urban development and enforcement of long-term master plans
and land use plans, collectives and individ- is weak. In addition, there is no system for
ual holders of land use rights could also be considering the long-term interests of urban
empowered to participate in the conversion residents or to hold decision makers respon-
of collective farmland to nonagricultural sible for the social and environmental conse-
purposes and be allowed to sell and buy land quences of urban development decisions. The
use rights across the rural-urban divide and weakness in checks and balances in the cur-
benefit from it. rent urban planning system may be overcome
The capital gain accruing to collectives or by opening the planning process for public
individual holders of land use rights could participation and scrutiny and transparency
be subjected to a tax to be set at a rate that through mass media.
138 CHINA 2030
Tenant farming predominated in the Republic of remaining in place. First, half of the total investment
Korea before World War II. After the war, a massive by the corporation must come from farmers or farm
land reform was conducted to distribute to former families and more than half of the executive board
tenants the land purchased from Korean landlords must be farmers.
or confiscated from the Japanese. As a result, more One of the important mechanisms adopted in
than 1.5 million farm households received land, and Korea’s urbanization process was its land readjust-
the farm ownership rate was raised from 13 percent ment program launched in 1966. Upon the des-
to 71 percent. ignation of the project site agreed by 80 percent
To avoid social disruption in the course of urban- of owners of affected land, about 40 percent of
ization, Korea took a series of legal and policy mea- the assembled land will be used by government to
sures to prevent large-scale farming. During most develop infrastructure and finance such develop-
of its period of urbanization, tenant farming was ment. The remaining 60 percent of the developed
prohibited. This ban was eased in 1986 when the land is then distributed to participating landown-
farming population dropped to less than 35 percent ers in proportion to their land contribution to the
of the total population. The average farm size rose project. These landowners may choose to sell their
from 0.9 hectares in 1970 to just over 1.3 hectares value-added land or use it for other commercial uses.
in 1995. Korea also prohibited corporate ownership More than half of built-up areas in Seoul and over
of farmland and corporate farming. This prohibi- 40 percent in Pusan were developed through such
tion was lifted only in 1990, with two restrictions land readjustment projects.
Land Policy and Municipal Finance the state’s power to expropriate rural land
Reform and its monopoly in the urban land market,
and the practice of evaluating local officials
On its path to high-income status, China by their contributions to high GDP growth
needs to address the distortions in its munici- focus on generating high GDP growth, has
pal governance and finance system and encouraged local governments to generate
reduce its excessive reliance on land-transfer- additional income from land transfer fees.
based revenue generation through the intro- Local governments have also become
duction of property taxes and reform of land increasingly reliant on mortgage loans, using
requisition practices. requisitioned land as collateral, through the
China’s land policy and municipal gover- vehicle of land banks. The practice of land
nance and finance systems are closely inter- banking by public entities created under
related, and both are shaping the country’s local governments has grown phenomenally
urban land use and form for generations to in recent years. Land banks can mortgage
come. Both the spectacular achievements as the land they hold to state banks and invest
well as the enormous challenges in the area of the loaned funds in urban development. The
urban planning and development grow out of aggressive requisitioning of rural land to gen-
the country’s decentralized governance struc- erate local revenue is risky and is contributing
ture and fiscal systems. to unsound forms of urban growth, unsus-
In 1994, China adopted a tax-sharing tainable local finance, and inefficient use of
system that provides separate tax collection land resources.
powers for the central and subnational gov-
ernments. This system has left many munici- Introducing market-value-based property
palities with a mismatch between local taxes. Income from land transfer fees has
revenue and responsibilities for public service become a significant source of local public rev-
provision. In this setting, the combination of enue, and real property in China is subject to
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 139
a range of minor fees, taxes, and charges, but rates at relatively low levels, the initial take
there are virtually no annual taxes on prop- from a property tax would probably fall well
erty. Over time, property taxes could provide below these averages. For this reason, local
a sustainable substitute as receipts from land governments will also have to reduce their
trading are reduced in parallel with a reform dependence on revenues from land use rights
of land requisition practices. Property taxes in a gradual fashion.
are often one of the few major good sources of Implementation of a property tax is a com-
revenues for local governments and could in plex task, and even in well-established sys-
principle allow the cancellation of a range of tems, significant reforms are often required.
difficult-to-collect “nuisance taxes” that can International experience provides guidance
be harmful to the local business climate. on the necessary preconditions for effec-
However, the property tax will take time tive implementation, such as the existence
to grow into a significant revenue source. of adequate technical expertise for property
Even in the long run, it is unlikely to fully assessments as well as the administration
replace income currently generated by sale of of appropriate land records (box 1.17). The
land use rights. Bahl (2009) notes that only a development of such institutional capacity
few countries like the United States and Can- could begin in the near term. Political under-
ada raise on the order of 3–4 percent of GDP standing and will are critical preconditions if
from such a tax, with the developed-country the substantial challenges of implementing a
average being 2.1 percent of GDP. Among highly visible and difficult-to-evade tax are to
developing countries, the average collection be overcome. The introduction of property
is only 0.6 percent of GDP, with only a few taxes should be coupled with a simplifica-
countries (such as Uruguay) raising as much tion of the overly complex current system of
as 1.0 percent. Because the introduction of a property-based fees and taxes to ensure that
property tax is institutionally complicated, these taxes fulfill their particular purpose
and because difficulties in establishing initial and do not have an adverse effect on the real
valuation would also argue for setting initial estate market.
Most modern land administration systems include a Most developed countries impose property
significant valuation and taxation function. Public taxes—usually transfer taxes, estate duties, and
sector valuations are required for a variety of pur- annual property taxes—based on actual sale prices
poses, including property taxation; purchase, dis- or assessed market values. Market value is generally
posal, and rental of state land; and assessment of fair considered to be a fair and equitable basis of taxa-
compensation where land is acquired through expro- tion. In the United States and Europe, taxes on land
priation. An efficient land market, including easy and property provide a cornerstone of municipal
access to reliable market data, provides the platform finance. They have the advantage of being widely
for transparent and accurate market-based valua- accepted by the taxpayer and are sustainable, pre-
tions. High-income economies have well-developed dictable, and tend to provide a hedge against infla-
public and private sector valuation professions using tion over time, thus ensuring revenue maintenance
internationally recognized methodologies and stan- in real terms. Over the past two decades, technol-
dards. Valuers increasingly benefit from advances in ogy developments have made electronic billing and
information-technology-based automated valuation payment a central feature in both local and central
models, which particularly lend themselves to the government financial management.
mass appraisals required in countrywide land tax
assessments.
140 CHINA 2030
Effectively regulating land banking. China are devoted to profit maximization and secur-
needs to review the extent to which land ing land-backed loans. There is no national
banking has moved away from what was law or national regulation on land banking,
arguably its original purpose, namely, to serve although the practice is referred to permis-
as a planning tool devoted to the timed and sively in some government documents. More
targeted release of surplus government land effective regulation is urgently needed because
in support of overall planning objectives. land banking practices may be of a sufficient
Today, land banking is too often an unde- scale across the country to have serious impli-
sired conduit for requisitioned lands that are cations for the economy generally, and for the
slated for disposal through auctions, which financial sector in particular.
Third, and most important, China was important contributors included improved
able to exploit these favorable conditions macroeconomic management, factors sup-
to generate rapid growth by implement- porting a high saving rate (the combined
ing a stream of pragmatic, market-oriented effect of rapid productivity gains, contained
reforms, and by deepening domestic market wage costs, and a managed exchange rate on
integration through improvements in infra- enterprise profitability, with buoyant revenue
structure and logistics. Landmark reforms growth and contained current spending on
include the introduction of the household government savings), and strong subnational
responsibility system in agriculture, the government-led interregional competition to
opening up of the tradables sector beginning attract investment. Improved policies and the
with the establishment of special economic sustained reallocation of factors to higher
zones, extensive price liberalization, deep productivity uses helped keep the marginal
reform of the fiscal system, restructuring product of capital high despite a high and
and privatization of state-owned enterprises, rising investment rate (Bai, Hsieh, and Qian
promotion of the private sector, and reforms 2006; Song, Storesletten, and Zilibotti 2009).
associated with W TO accession. Other
% of GDP
150
150 CHN
100 CHN
100
50 50
0 0
5 6 7 8 9 10 11 12 5 6 7 8 9 10 11 12
Log of GDP per capita Log of GDP per capita
% of GDP
100 100
80 80
60 60
40 40 CHN
20 CHN 20
0 0
6 7 8 9 10 11 12 6 7 8 9 10 11 12
Log of GDP per capita Log of GDP per capita
% of GDP
6 3
4 2
2 CHN 1
0 0 CHN
6 7 8 9 10 11 12 6 7 8 9 10 11 12
Log of GDP per capita Log of GDP per capita
Large state-owned banks 58.03 56.91 56.06 55.12 53.25 51.03 50.89 49.2
Policy banks 7.68 7.63 7.82 7.90 8.13 9.05 8.82 8.0
Joint-stock banks 10.70 11.54 11.92 12.38 13.78 14.12 14.96 15.6
City banks 5.29 5.40 5.44 5.90 6.35 6.62 7.21 8.2
Rural banks 0.14 0.18 0.81 1.15 1.16 1.49 2.37 2.9
Rural cooperatives 0.73 1.06 1.23 1.61 1.62 1.6
Urban credit cooperatives 0.53 0.57 0.54 0.42 0.25 0.13 0.03 0.0
Rural credit cooperatives 9.58 9.74 8.39 7.85 8.26 8.35 6.97 6.7
NBFIs 3.29 2.76 2.71 2.41 1.85 1.89 1.97 2.2
Postal savings banks 3.25 3.43 3.68 3.67 3.36 3.55 3.43 3.7
Foreign banks 1.50 1.84 1.91 2.11 2.38 2.16 1.71 1.8
Source: China Banking Regulatory Commission Annual Report 2009.
China’s Big Four remain among the 10 larg- growing somewhat in recent years though
est banks in the world. they still represent only 9 percent of the
There is also imbalance in the capital total. In some recent years, the share of funds
markets: stocks dominate while the corpo- raised through bank loans has been as low as
rate bond market remains underdeveloped. 50–60 percent, but those declines are mostly
Stock market capitalization represents 67 attributable to increasing shares of fundrais-
percent of GDP, roughly seven times the ing through government bonds and financial
size of corporate bonds outstanding (table bonds (a large proportion of which are policy
1C.2). Viewed through the lens of the share bank bonds), rather than increases in equities
of funds raised, corporate bonds have been or corporate bonds (figure 1C.2).
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 145
100
80
60
Percent
40
20
–20
1993 1995 1997 1999 2001 2003 2005 2007 2009
Equities Corporate bonds Financial bonds
Treasury bonds Bank loans
companies located abroad. This process built However, true progress in banking sector
up further pressure to liberalize the domes- liberalization was limited because the govern-
tic financial system to reduce the potential ment still wanted to use the banking sector as
for regulatory arbitrage and stem the flow of a tool for industrial policies and also because
domestic finance to the offshore market. highly leveraged large corporations needed
Third, as the Japanese economy and finan- cheap and stable finance from the banking
cial market expanded, there was growing system for their survival. By this time, the
interest by foreign banks and other foreign large corporate firms (chaebols) had emerged
financial institutions to penetrate the Japa- as a group with strong vested interests and
nese financial market; these firms lobbied substantial influence over government eco-
their governments to put pressure on Japa- nomic policies. The government instead
nese officials. The continuation of Japan’s introduced greater market forces in the finan-
large current account surplus dating from cial system by allowing the expansion of
the mid-1970s also increased foreign pres- nonbank financial institutions (NBFIs), by
sure, especially from the United States, for relaxing entry of privately owned (including
the opening of the Japanese service sectors foreign) institutions such as finance compa-
and capital markets, a pressure that was nies, merchant banking firms, and insurance
eventually accommodated. That put further companies, which were free from policy loan
pressure on the government to liberalize the programs but could offer savings accounts
domestic financial system; without liberaliza- similar to bank deposits. As in the Japanese
tion, the distortions and weaknesses in the case, this liberalization was also caused by
domestic system would have intensified. increasing external pressure, especially from
In Korea, the government’s control over the United States, as Korean financial mar-
the financial system was more direct and per- kets grew larger and as a substantial current
vasive than in Japan. As in China, all banks account surplus emerged in the second half
were owned by the state, and their lending of the 1980s. These developments reduced
activities were strongly controlled by the banks’ shares of total deposits and squeezed
government through explicit policy lending their profits by shifting deposits to NBFIs.
programs and implicit window guidance. This in turn pressured the government to
Interest rates were controlled and set substan- allow banks to expand into products offered
tially below the supposed market clearing by NBFIs such as trust accounts.
rate. Government intervention grew stronger The government started interest rate lib-
in the 1970s when the Korean government eralization in the late 1980s but made little
initiated a strong drive to develop its heavy progress until the early 1990s when it lib-
and chemical industries (HCI). This led to eralized interest rates on short-term money
substantial overcapacity in the HCI sector market instruments such as commercial
and a large amount of nonperforming loans paper and certificates of deposit (CDs),
in the banking sector, while light industries while maintaining control on bank inter-
and small and medium firms were starved for est rates. This accelerated the shift of funds
credit. This in turn caused the deterioration to finance companies, other NBFIs, and
of Korea’s export competitiveness, slowed the trust accounts of banks. The net effect
economic growth by the end of 1970s, and was a reduction of average maturities in the
culminated in the assassination of President liability side of corporate sector balance
Park. Partly as a response to this negative sheets, which increasingly had to rely on
experience with heavy financial repression, these short-term financing instruments. For-
and as part of its overall economic liberaliza- eign exchange controls were relaxed under
tion efforts, the Korean government began pressures from both domestic firms, whose
gradual liberalization of the banking system business had become more globalized, and
by privatizing banks and relaxing entry bar- foreign governments, which were pressured
riers for other kinds of financial institutions. by their financial institutions to penetrate
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 147
uncompetitive but expanding Korean finan- of financial institutions and poorly man-
cial markets. On the other hand, large chae- aged financial regulation, started to deflate
bols and banks had built the perception that in 1991. Japan completed its financial liber-
the government would not be able to let alization and a restructuring of regulatory
them fail for fear of the impact on overall framework and government organization by
economic performance. In fact, the Korean 1998, and financial restructuring by 2004.
government had protected the chaebols and In the course, it experienced a prolonged and
financial institutions (including small ones) deep financial crisis, which it has dealt with
from failures, and no significant chaebol through injection of public funds at a huge
or financial institution had gone bankrupt public cost.
before 1997. The combination of these pres-
sures led to two significant developments:
increased reliance on short-term corporate Notes
finance; and increased foreign debt, espe- 1. For a more extensive discussion of these
cially short-term debt by financial institu- imbalances, see the overview of this series.
tions. In the first half of the 1990s, increased 2. Indeed, industrial employment grew by just
foreign capital inflows and domestic sav- 2.3 percent a year during 1993–2007, com-
ings were channeled to large firms, which pared with annual value-added growth of
expanded their investment recklessly, due 11.7 percent.
3. Investment rates would be supported by fur-
in part to pervasive moral hazard that came
ther reforms that work to sustain high rates
with the perception of “too big to fail.” The of return to capital, by the large remaining
first factor caused a domestic financial crisis scope for capital deepening, and by the new
when overly leveraged large corporate firms investment demand generated by emerging
could not service their debt and were faced social and environmental challenges (Stern
with an economic recession starting 1996. 2011).
Together with the first, the second factor 4. http://english.peopledaily.com.cn/200412
caused a currency crisis when foreign capital /06/eng20041206_166239.html.
flowed out massively from Asian countries in 5. Under the 12th 5YP, these gained added rele-
1997, which intensified the domestic finan- vance through changes wrought by the global
cial and economic crisis. financial crisis. With subdued medium-term
prospects for the global economy—and thus
Korea completed full liberalization and
for exports—China will need to generate
opening of the financial system under its more growth from domestic demand if it is
post-crisis International Monetary Fund pro- to sustain relatively high rates of overall GDP
gram, and undertook massive financial and growth.
corporate restructuring, with huge injections 6. For example, see Kuijs and Wang (2006),
of public funds (equivalent to one-third of Blanchard and Giavazzi (2006), Lardy
GDP) to clean up the balance sheets of finan- (2007), and Aziz and Dunaway (2007).
cial institutions. In sum, government control 7. The DRC–CGE model (2012 edition) includes
over finance was an effective vehicle for rapid 34 production sectors; 2 representative
industrialization and economic growth in the households distinguished by area; and 4 pri-
early stage of Korea’s economic advancement, mary production factors: capital, agricultural
labor, productive workers, and professionals.
but it led to pervasive moral hazard in both
The 34 production sectors include 1 agricul-
the banking and corporate sectors, which led tural sector, 24 industrial sectors, and 9 ser-
to reckless investment by favored firms and vices sectors. For a detailed description of the
poor risk management of banks. In the end, model, see Li and others (2010) and He and
huge amounts of public funds were required Kuijs (2007). This study has updated the pre-
to remedy the problems. Similarly, Japan vious simulations by incorporating new eco-
experienced a domestic financial crisis as the nomic data and adjusting some parameters
asset bubble, which was built during the sec- in light of new empirical research. The main
ond half of the 1980s with the moral hazard drivers of growth are technological progress,
148 CHINA 2030
demographics, and capital accumulation. In increasingly being aligned with that of the
this model, technological progress is exoge- core budget.
nous and calibrated according to China’s his- 13. This rose to more than 35 percent of GDP in
torical data and international experience. In 2010.
addition, the growth rate of population and 14. According to the Ministry of Finance (2011),
labor is exogenous. The growth rate of capi- the gross revenue from the sale of state-
tal is determined endogenously by the s avings- owned land use rights rose to 2.9 trillion
investment relationship. In this model, the yuan in 2010, equivalent to 7.3 percent of
basic factors driving structural change are GDP. Because a substantial share of such rev-
the income demand elasticity of residents enues is paid out in the form of compensation
for different commodities (the Engel effect), to displaced residents, the net proceeds from
the structural change of intermediate input such sales are lower but still significant.
demand resulting from technological change, 15. In 2004, the Ministry of Finance released a
and factor composition change resulting from list of government funds, stipulating that no
different factor accumulation speeds. government agency was allowed to charge
8. These scenarios are not meant to be precise, fees beyond this list. In 2010, the State
detailed investigations of the future. Rather, Council began compiling a national bud-
they are somewhat stylistic, based on analy- get for social security funds on a trial basis.
sis of how key macroeconomic variables This budget initially included funds for five
have related to each other in the past and types of social security: basic old-age insur-
assumptions on how these relationships may ance, unemployment insurance for enterprise
evolve in the coming 20 years. Many of those employees, basic medical insurance, workers’
assumptions unavoidably have an arbitrary
compensation, and maternity insurance for
element.
urban workers. The eventual aim would be
9. Although this decline may seem fast, it is not
to bring other social security funds within
out of line with experiences in other South-
the control of the national budget. From
east Asian countries. Korea witnessed a faster
2011, the Provisional Rule on Government
decline, from 50 percent in 1973 to 10 per-
Funds Management includes a stipulation
cent in 2001. Malaysia decreased its agricul-
that all government funds revenues should
tural employment share from 37 percent in
be included in the fiscal budget and sub-
1980 to 18.4 percent in 2001.
ject to the scrutiny of the National Peoples’
10. Such limits could include declining margins
in the production of tradable goods, excess Congress.
capacity, asset bubbles, insufficient employ- 16. World Bank (2010a) provides a detailed dis-
ment generation, environmental degradation, cussion on SOE dividend policy and interna-
and trade protectionism. tional practices.
11. Chapter 2 looks at the other policies needed 17. Several such taxes address negative exter-
to advance the pace of innovation, a critical nalities. Unlike many other taxes, such taxes
ingredient for rapid growth by improving present few if any trade-offs when viewed in
China’s technological capability and moving a more holistic way than through GDP alone,
up the value chain. because they make prices better reflect the
12. This compares to headline budgetary gov- true marginal cost of a particular activity,
ernment size of 19.9 percent of GDP in 2008 including the damage to the environment.
(22.5 percent in 2010). The IMF’s Govern- 18. Data are from Fiscal Reform and Economic
ment Finance Statistics, a broader measure, Governance (2011), which takes into account
includes government activities funded by only personal income taxes and contributions
some government funds and the social pro- to pension funds. Including contributions to
tection fund. As in other countries, these health insurance and housing fund, China’s
funds are separate from the core central overall labor tax wedge is even higher.
budget. Nonetheless, they are subject to 19. Furthermore, the “revenue productivity” of
budget-type planning and management and personal income tax—measured as the rev-
are sometimes presented as part of a broader enue collected as a share of GDP divided by
definition of consolidated spending. The the weighted average personal income tax
budget preparation cycle for such funds is rate—is only 15 percent of global averages
CHINA: STRUC TUR AL REFORMS FOR A MODERN, HARMONIOUS, CREATIVE SOCIE T Y 149
39. According to media reports, the potential projects, especially those of a commercial
losses of banks lending to local government nature. Under such processes, a farmer land-
platforms may be on the order of 2 trillion owner may demand 40–50 percent of the
yuan. expropriated land as compensation in lieu of
40. Finding domestic strategic investors would cash and thus share partially but significantly
be difficult. Selling banks to foreign strategic in the gains from such development.
investors may not be politically acceptable, 47. For more discussion of factors behind past
and it might be difficult to find willing and performance, see Hofman and Wu (2009),
able buyers for a variety of reasons. Privati- Huang (2011), and Vincelette and others
zation by placement of government shares (2011).
with small individual investors would not 48. Kuijs (2010) finds TFP growth of 3–3.5 per-
be a good option either, because the govern- cent a year from 1978 to 2009, of which
ment would continue to be able to control the about 0.5 percent comes from enhanced
bank’s management and operation. human capital. Bulman and Kraay (2011)
41. Financial institutions continue to be subject find TFP growth of 3.0–4.1 percent a year
to a floor on lending rates and a ceiling on from 1979 to 2008, over one-half of which
deposit rates. The cap on deposit rates has they attribute to factor reallocation.
been circumvented to a certain extent by the 49. In the past, the NDRC (or its predecessor,
newly emerging credit-based wealth manage- the National Planning Commission) led the
ment products in the banking system, which design and implementation of industrial
further exacerbated the situation of shadow policies, while specialized departments took
banking, with potential negative implications charge of detailed work and local govern-
for financial stability. ments and other stakeholders participated in
42. The new Chinese Accounting Standards the process. With reform, most of the special-
have achieved material convergence with the ized economic departments have been abol-
International Financial Reporting Standards. ished, while other stakeholders have become
The Chinese Standards on Auditing are also more powerful.
largely comparable to the International Stan-
dards on Auditing.
43. The practice of differentiated reserve require-
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2
China’s Growth through
Technological Convergence
and Innovation
Income gaps among countries are largely technology frontier outward in areas of
explained by differences in productivity. acquired comparative advantage.
By raising the ratio of capital to labor and Both technology catch-up through tech-
rapidly assimilating technologies across a nological absorption and innovation at the
wide range of activities, China has increased technological frontiers will rest on several
factor productivity manifold since 1980 factors, including the success of policies
and entered the ranks of middle-income focused on effective competition; the compo-
countries. With the launch of the 12th Five sition of the business sector and its strategic
Year Plan, China has reaffirmed its goal of orientation; agile policy making and robust
becoming a moderately prosperous society regulation that minimize the risk of crises
by 2020. This chapter maintains that China (from asset bubbles, for example, that can
can become a high-income country by 2030 depress innovative activity) and that position
through a strategy combining high levels the economy to seize evolving opportunities;
of investment with rapid advances in tech- skill development; research and development
nology, comparable to the strategy used by (R&D); national and international network-
Japan from the 1960s through the 1970s and ing to promote innovation; and the nurturing
by the Republic of Korea from the 1980s of innovation especially in the areas of green
through the end of the century. During the technologies, health and medical services,
next decade, more of the gains in produc- and urbanization modes, and in major urban
tivity are likely to derive from technology centers.
absorption and adaptation supplemented by A competitive market environment is
incremental innovation, while high levels of the precondition for a steady improvement
investment will remain an important source in productivity. Starting in the late 1980s,
of growth in China through capital deep- for example, market-enhancing reforms
ening and embodied technological change. increased entry of foreign and private firms
By 2030, China expects to have pulled and stimulated competition in most of Chi-
abreast technologically of the most advanced na’s manufacturing subsectors. Even in some
countries and increasingly, its growth will “strategic” or “pillar” industries (for exam-
be paced by innovation that pushes the ple, airlines and telecommunications), the
155
156 CHINA 2030
did so in the 1960s,9 and Korea and Taiwan, all three economies because their industries
China, during the 1990s. Japan made the are at the cutting edge and growth must lean
transition by means of a high-investment, more heavily on productivity gains deriving
manufacturing-sector-led growth strategy in part from successful innovation.
that combined technological catch-up with This experience has a number of implica-
both incremental and disruptive innovations tions for China’s growth strategy. First is the
introduced by the private sector but enabled need to fully exploit the potential of techno-
by the government’s industrial and technol- logical catch-up in industry and services for
ogy policies. The pocket transistor radio, the at least the next decade. During this period,
Walkman, compact automobiles, and lean original innovation based on technologi-
manufacturing were some of the disruptive cal breakthroughs may not be as common
innovations introduced by Japanese firms that as innovations combining different existing
contributed to productivity gains and export technologies or the introduction of innovative
successes.10 Korea and Taiwan, China, also designs and special features customized for
relied on technological catch-up facilitated by specific markets.13 Second, innovation capa-
high levels of investment in manufacturing, bility takes years to accumulate, and system-
and both benefited from incremental inno- atically defining and implementing an inno-
vation as their industries matured. Research vation strategy would begin yielding sizable
and development facilitated technology dividends in the form of frontier expertise
absorption although the contribution to pro- and groundbreaking discoveries most likely
ductivity growth via breakthrough innova- in the 2020s and beyond, when China would
tion was quite limited through the late 1990s be more in need for a productivity boost
except in Japan, whose technological capabil- from this source.14 Third, the quality and
ities in the 1950s and earlier put it in a differ- efficiency of the innovation system deserves
ent league from the other two. Governments priority over indicators such as R&D spend-
actively engaged in deepening human capi- ing, patents, and published papers—after
tal, improving access to financing, and all, innovation should create wealth. And,
encouraging the borrowing and assimilation fourth, realizing productivity gains will be in
of technology and investment in productive the hands of the business sector, and it is the
assets. But it was leading manufacturers, dynamism of firms that will be the ultimate
assisted by clusters of smaller suppliers, that arbiter of growth-enhancing innovativeness.
spearheaded technology absorption and inno-
vation.11 Korea and Taiwan, China, gradu-
Accounting for China’s Growth
ated from the middle- to the high-income
group of economies largely on the basis of A decomposition of China’s growth rate is an
technological catch-up and the building of appropriate starting point. A meta-analysis
globally competitive electronics, transport, of 150 studies of total factor productivity
and chemical industries with strong export growth in China (Tian and Yu 2012) con-
performance. The two economies began cludes that since 1978, the annual contribu-
strengthening their innovation systems in the tion of TFP on average has been 2 percent-
1980s through public and private investment age points, with the eastern region registering
in research infrastructure, systematic bor- higher rates than the central and western
rowing from overseas through licensing and regions (see below). Other research provides
FDI (in the case of Taiwan, China), among detail on subperiods and sectors. For exam-
other channels. The acceleration of techno- ple, a study conducted by Bosworth and
logical progress during the 1990s and early Collins (2007) shows that physical capital
2000s enabled them to cross the threshold and TFP contributed 3.2 percentage points
and join the club of high-income economies.12 and 3.8 percentage points, respectively, to
The importance of innovation has contin- China’s GDP growth between 1978 and
ued to increase and is now paramount for 2004.15 From 1993 to 2004, their shares
160 CHINA 2030
Period Output Employment Output per worker Physical capital Land Education Factor productivity
Total
1978–2004 9.3 2.0 7.3 3.2 0.0 0.2 3.8
1993–2004 9.7 1.2 8.5 4.2 0.0 0.2 4.0
Source: Bosworth and Collins 2007.
Period Output Employment Output per worker Physical capital Education Factor productivity
Industry
1978–2004 10.0 3.1 7.0 2.2 0.2 4.4
1993–2004 11.0 1.2 9.8 3.2 0.2 6.2
Services
1978–2004 10.7 5.8 4.9 2.7 0.2 1.9
1993–2004 9.8 4.7 5.1 3.9 0.2 0.9
Source: Bosworth and Collins 2007.
were 4.2 percentage points and 4.0 percent- machinery and motor vehicles during 1999–
age points, respectively (table 2.1)16 with 2004 (ranging from 2.71 to 2.83 percent a
industry overshadowing other sectors. Capi- year). Glass and clay products and paper also
tal and TFP contributed 2.2 and 4.4 percent- registered large gains (see annex table 2A.1).
age points, respectively, of industrial growth According to more recent estimates by
during 1978–2004 and 3.2 and 6.2 percent- Kuijs (2010), TFP growth slowed to 2.7 per-
age points from 1993 to 2004 (table 2.2). cent between 1995 and 2009, and the share
Agricultural output grew steadily at an aver- of capital rose to 5.5 percent.17 Growth of
age annual rate of 4.5 percent between 1978 productivity in services also slowed from 1.9
and 2009, with TFP gains averaging 2 per- percent (1978–2004) to just 0.9 percent a
cent a year. The performance of agriculture year between 1993 and 2004 (Bosworth and
was aided by market incentives, ownership Collins 2007).
reform, land-saving technologies, and the With capital spending subject to decreas-
diversification of production from grains to ing returns (as is evident from the upward
higher-value items such as meat and vegeta- trend in incremental capital-output ratios,
bles. Chen, Jefferson, and Zhang (2011) show or ICORs),18 the scope for raising growth
that TFP rose even more rapidly in most man- through larger injections of capital is being
ufacturing activities during 1981–2008, with rapidly exhausted. Moreover, rebalancing of
electrical and nonelectrical machinery, office consumption spending will lead to a decline
equipment and telecommunications subsec- in the share of investment. At the same time,
tors, which have benefited most from tech- the structural transformation of the Chinese
nological change, in the forefront (Jorgenson, economy is entering a stage when productiv-
Ho, and Stiroh 2007). However, metal and ity gains from the intersectoral transfer of
nonmetal industries, plastics, rubber, petro- resources will continue to taper off (Chen,
chemicals, and paper achieved comparable Jefferson, and Zhang 2011). In most high-
gains. Ito and others (2008) reaffirmed these income countries, TFP growth averaged less
findings. Growth of TFP was strongest for than 2.0 percent a year between 1995 and
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 161
2009,19 the exceptions being Korea and Ire- chain vulnerabilities24 and transaction costs),
land, which had rates of 2.7 percent and 3.1 could increase the share of higher-tech items
percent respectively—although Ireland fell to produced domestically and steadily reduce
1.3 percent and Korea to 2.6 percent during the imported content of China’s manufac-
2005–09.20 tured exports, which has already declined
International experience offers three point- from 52.4 percent in 1997 to 50.6 percent
ers: First are the advantages of a continuing in 2006 (Koopman, Wang, and Wei 2009).
emphasis on those manufacturing industries This trend is likely to reverse past tendencies
that are likely to deliver the highest returns for imported inputs to increase initially as
from catching up so long as Chinese firms the skill intensity of production rises (Moran
are quick to pursue technological possibili- 2011b). Product space analysis pioneered by
ties and strive to maximize efficiency gains. Cesar Hidalgo, Ricardo Hausmann, and oth-
These include industries such as electrical ers (Hausmann and Klinger 2006) suggests
machinery, office and computing equipment, that the average sophistication of China’s
pharmaceuticals, aircraft, motor vehicles, and exports is comparable to that of Malaysia,
nonelectrical machinery, which have dem- Thailand, and the Philippines.
onstrated rapid improvements in technology Since 1985, China has broadened its pro-
because they are also the most R&D intensive duction base and, through massive invest-
(van Pottelsberghe de la Potterie 2008). ment, has enlarged production capacity and
Second, catching up and innovation in ser- accelerated learning by doing.25 As a conse-
vices, promoted by information and commu- quence, China now produces a wide assort-
nications technology (ICT), is likely to play a ment of products that can be technologically
more prominent role over the longer run as upgraded and from which Chinese manufac-
the share of services in GDP begins to over- turers can diversify into other related prod-
shadow industry. 21 Services growth would ucts. In product space terminology, more of
involve encouraging innovation by firms the products lie in the densely networked
engaged in banking, insurance, retailing, real core that multiplies options for industrial
estate, logistics, and data services as well as diversification and the scope for innovation.
health care and education, two important A closer inspection of the products in
and growing activities. China’s export basket with the highest den-
Third, lowering market barriers to the sities underscores China’s rapid industrial
entry, growth, and exit of firms will contrib- progress. In 1987, the top 10 commodi-
ute to economywide improvements in pro- ties were mainly low-tech items that offered
ductivity growth by intensifying competition minimal opportunities for diversification.
and with it the process of creative destruction By 2006, the product composition had
(McKinsey and Company 2010).22 altered radically, with many opening avenues
The trends in manufacturing are promis- for upgrading into more technologically
ing. Chinese manufacturers of transport and advanced products with better market pros-
telecommunications equipment, consumer pects. China’s industrial capabilities are thus
electronics, and textiles and garments are strengthening, as is its competiveness relative
aggressively engaging in backward and for- to higher-income countries. In recent years,
ward integration, moving from the assembly the increase in product complexity and the
and testing of standardized products to the share of products employing advanced tech-
design and manufacture of differentiated nologies is linked to investment by multina-
parts and components and of new products tionals in upscale manufacturing activities
that generate higher profit margins. 23 These (Koopman, Wang, and Wei 2008, 2009).
efforts, if they are aided by a consolida- These findings are similar to those of Felipe,
tion of global production networks (result- Abdon, and Kumar (2010).26
ing partly from the pull of agglomeration The trend in patenting during 2005–09
economies and partly from emerging supply indicates that the changing composition of
162 CHINA 2030
manufacturing is serving to upgrade domes- scientific services (annex table 2A.4). Urban
tic technology. The largest number of patents development and the continuing structural
received by residents of China who registered transformation of the economy are facilitat-
with the United States Patent and Trade- ing the entry of small firms, which in turn
mark Office (USPTO) was for electronic contributes to patenting and the introduction
and electrical devices, followed by commu- of new products. Small firms are, on average,
nications devices, software, pharmaceutical more efficient in using R&D resources—
compounds, and optical devices (annex table financial and human—to generate patents
2A.2). Similarly, the overwhelming majority (annex tables 2A.5, 2A.6, and 2A.7). Look-
of patents granted to residents of China by ing ahead, there is more room for growth of
the World Intellectual Property Organiza- services activities and for competition that
tion (WIPO) was also for electronic, electri- would raise efficiency.
cal, and telecommunication devices followed The data on new domestic firms entering
by chemical27 and biological products28 and manufacturing subsectors is consistent with
products in the mechanical engineering cat- FDI data, which show that the two subsec-
egory (annex table 2A.3). tors most favored by foreign investors are
Among manufactured products, elec- computers and other electronic equipment,
tronic, telecommunication, and optical followed by chemicals, universal machinery,
devices are likely to remain the technologi- and special purpose machinery. The share of
cally most dynamic products, the focus of computers and electronic equipment, while
innovation, and a continuing source of still high, has declined since 2004; the shares
increases in productivity in the world and in of the others have remained largely stable
China. Chinese companies such as Huawei (annex table 2A.8).
and ZTE are emerging as world leaders in International experience suggests that the
the telecommunications sector and role mod- contribution of small and medium compa-
els for others seeking to establish a signifi- nies to innovation is likely to increase. This
cant presence in the global market.29 desirable development can be facilitated by
measures to reduce entry barriers, including
transaction costs for SMEs, and to make it
Entry of Firms by Subsector
easier for them to access financing.
China’s emerging comparative advantage in
manufacturing subsectors is supported by
data on the entry of new firms. The subsec-
Building Technological Capacity
tors with high rates of new entry are metal Before the Industrial Revolution in Europe,
manufacturing, machinery, and electrical, China led the world in technology. 30 After
computing, and telecommunications equip- losing ground for more than 250 years, China
ment. Meanwhile, business, scientific, and now is sparing no effort to become a global
technical services are growing robustly as force in technology, and possibly even again
China urbanizes and consumption shifts the leader, by 2030. China began piecing
toward services. The statistics on firm entry together a strategy starting in the 1980s with
for Guangdong reaffirm the importance of an emphasis on manufacturing capabilities
garments and leather products as well as the and cost innovation in major product catego-
strength of industries producing metal prod- ries. The next step was to increase the acqui-
ucts, machinery, and computing equipment. sition of foreign intellectual property (IP)
Business services are also a growth sector in complemented by reverse engineering. Since
Guangdong. Machinery and transport equip- the late 1990s, China has attempted to maxi-
ment and plastics are the favored subsec- mize technology transfer through foreign
tors in Zhejiang. And in both Zhejiang and direct investment, in particular by encour-
Beijing, as well as in coastal provinces, the aging multinational corporations to conduct
conspicuous growth drivers are business and more of their R&D in China.31 The transfers
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 163
and spillovers that resulted have fallen short important, the national program also has 16
of expectations. Research analyzing Chinese specific subprograms—from core electronic
and international experience suggests—albeit components to moon exploration—aimed
with qualifications and exceptions—that mul- at achieving advances in core common-use
tinationals thus far have generated few techno- technologies and enhancing the capabilities
logical spillovers and those that have occurred of Chinese enterprises. During the 11th 5YP
are in high-tech sectors and have remained in period and through 2011, the central gov-
the vertical plane, that is, from end users to ernment’s outlay on science and technology
suppliers, rather than also spreading horizon- rose by 22 percent a year. By 2011, R&D
tally to other sectors (Moran 2011a, 2011b). accounted for 1.83 percent of GDP.
In low-tech sectors, the spillover effects might Innovation and technology development are
even be negative. Moreover, where multina- assigned a central role in the 12th 5YP (2011–
tionals fear that their intellectual property 15), with the highest priority given to:
might be compromised, they are reluctant to
introduce the latest technologies or to conduct • Developing strategic industries such as
frontier research aside from taking precau- energy-saving and environmental pro-
tions to minimize technology leakage (Moran tection, next-generation information
2011a, 2011b; Fu and Gong 2011; Tang and technology, biotechnology, high-end man-
Hussler 2011; Bai, Lu, and Tao 2010; Fu, ufacturing, new energy, new materials, and
Pietrobelli, and Soete 2011). In the light of clean energy vehicles. A number of mega-
this experience, China is redoubling its own projects with a focus on basic research
efforts at technological upgrading, indigenous are earmarked for a large injection of
innovation, 32 and takeover of foreign firms resources starting in 2011. Two that have
and their brands by China’s leading challeng- been singled out are in the life sciences—
ers, while supporting determined efforts by on drug discovery and on major infectious
Chinese firms to innovate, build their own diseases—reflecting the view that research
brand image, and expand their share of global on biopharmaceuticals and stem cells
markets. 33 This approach is exemplified by might lead to profitable innovations.
Lenovo (Tzeng 2011). • Promoting enterprise-led innovation.
• Strengthening supporting services.
• Raising expenditure on research and
Planning Technology Development
development to 2.2 percent of GDP.35
in China
• Increasing the rate of patenting to 3.3 pat-
The 11th Five Year Plan stated that China ents per 10,000 people.
would build competitive advantage based on
science, technology, and innovation, and this An increase in R&D is being comple-
objective remains prominent in the 12th plan. mented by investments in the physical infra-
In early 2006, the government announced its structure supporting technological upgrad-
National Program Outline for Medium and ing.36 Strengthening and more fully exploiting
Long Term Development of Science and Tech- the potential of multimodal transport is help-
nology (2006–2020). Its key pillars include ing to raise logistics efficiency. And massive
“indigenous innovation,” “a leap-forward in investments in renewable sources of power,
key areas,” “sustainable development,”34 and a smart grid, and rail transport are expected
“setting the stage for the future.” The strat- to reduce energy consumption.37 Mobile net-
egy seeks to encourage enterprise-led innova- works were serving 1.1 billion users by 2012,
tion; to strengthen intellectual property pro- an increase of 650 million over 2006. In
tection; to create a favorable environment for 2012, of the 564 million internet users, 530
innovation in science and technology (S&T); million had access to broadband services,
to attract S&T talents; and to improve the more than the total population of the United
management and coordination of S&T. More States38 (figure 2.1).
164 CHINA 2030
a. China mobile subscribers and penetration rate b. The growth of broadband subscribers and Internet users
1,200 90 600 45
80 40
1,000 500
70 35
Subscribers, millions
Subscribers, millions
800 60 400 30
50
Percent
Percent
25
600 300
40 20
400 30 200 15
20 10
200 100
10 5
0 0 0 0
2002 2004 2006 2008 2010 2012 2002 2004 2006 2008 2010 2012
Mobile subscribers (left axis) Broadband subscribers (left axis) Internet users (left axis)
Mobile penetration rate (right axis) Broadband penetration rate (right axis) Internet penetration rate (right axis)
Sources: Data for mobile subscribers: Ministry of Industry and Information Technology, P.R. China (http://www.miit.gov.cn/n11293472/n11293832/n11294132
/n12858447/index.html); data for broadband subscribers: Ministry of Industry and Information Technology, P.R. China (http://www.miit.gov.cn/n11293472/n11293832
/n11294132/n12858447/index.html); data for Internet users: China Internet Network Information Center (http://www.cnnic.net.cn).
the patent offices of the United States, the foreign-owned firms or joint ventures. For-
European Union, and Japan), a better mea- eign firms also account for more than 85 per-
sure of the worth of a patent, are increasing cent of high-tech exports since 1996 (Moran
but are still few in number. In 2009, China 2011b).60 Having no big marquee brands or
ranked 11th in the world, having filed 667 core technologies,61 China reaps only a small
triadic patents compared with 1,959 by portion of rents from high-tech exports,
Korea, 12,715 by the United States, and which accrue mainly to foreign designers and
13,332 by Japan.47 In 2010, the numbers of engineers. The most illustrative example is
patent applications filed by Chinese residents the case of Apple’s iPad and iPhone. All iPads
to the United States Patent and Trademark and iPhones on sale worldwide are assembled
Office, the European Patent Office, and the in China by the Taiwanese company Fox-
Japan Patent Office, stood at 6,978, 2,049, conn with homegrown Chinese companies
and 1,063, respectively, an increase over supplying not a single component. In the case
2008 of 19.6 percent, 35.7 percent, and 37.7 of iPhone, the only value captured in China
percent.48 is the wage earned by Chinese assembly
By official count, the number of sci- workers, which accounted for 1.6 percent of
ence- and technology-based private firms in the sales price; Apple’s profits accounting for
China increased from just 7,000 in 1986 to 58.8 percent (Kraemer, Linden, and Dedrick
150,000 in 2006,49 and as of 2007, the assets 2011).
of privately owned Chinese companies were
approaching those of the SOEs, not including
China Versus Other Economies
the 100 largest (OECD 2010). Now a small
number of Chinese firms, such as Huawei50 How does China’s performance to date com-
and ZTE in the ICT industry, Suntech Power pare with that of the leading economies? For
in solar technologies, and Dalian Machine one thing, China’s growth has been higher
Tool Group in engineering, have reached or over a longer period buoyed by above-average
are approaching the international techno- productivity gains. But the data on industrial
logical frontier and demonstrating a grow- value added and technological indicators sug-
ing ability to create technology. 51 Chinese gest that plenty of rungs are left to climb on
companies are also mastering the latest tech- the technology ladder. By pouring resources
nologies in areas such as auto assembly and into S&T development, China has moved
components, photovoltaic cells, biopharma- faster than most of its neighbors in laying
ceuticals,52 nanotechnology,53 stem cell ther- the foundations of a world-class innovation
apeutics (Gwynne 2010), high-density power system. The efficiency of the emerging inno-
batteries, 54 high-speed trains, 55 telecommu- vation system is questionable; however, the
nication equipment, wind turbines, 56 single- quality will need improving, and the urban
aisle passenger aircraft, 57 booster rockets, dimension has been relatively neglected (see
space satellites, 58 supercomputers, shipping next section).
containers, Internet services, electric power Starting in the 1980s, China began to
turbines, and many other products. 59 Many reform its science and technology system and
of the companies introducing innovative initiated four programs—Key Technologies
products are state owned. R&D (1982), Spark (1986), High-Technology
These achievements notwithstanding, Research and Development (“863”) (1986),
the reality is that much of China’s export- and Torch (1988)—aimed at making science
oriented manufacturing industry is still and technology serve economic growth and
engaged in processing and assembly opera- social development, and enhancing S&T
tions, export competitiveness is predomi- capacity to complement China’s investment
nantly based on low factor costs, and more in manufacturing capabilities.62 These and
than half of all exports are produced by other reforms and programs introduced
166 CHINA 2030
since, with the focus shifting to innova- five pillars: the institutional environment;
tion after 1990, are now producing results. human capital; training and social inclusion;
A number of multidimensional indexes that the regulatory and legal framework; and the
measure capabilities across countries show adoption and use of ICT. 64 Sweden received
that China is rapidly augmenting S&T skills, the highest ranking in 2010–11 followed by
building research infrastructure, and assimi- Switzerland and Singapore, Finland, and the
lating information and communications United States. This index puts China in 64th
technology. place even though the report recognizes its
According to a ranking of 40 countries vast potential and huge investment in tech-
produced by the Chinese Academy of Science nology. The report observes, however, that
and Technology for Development, China is China’s R&D base is still somewhat weak as
in 21st place in its innovative capacity, with are the regulatory and legal frameworks.
a point score of 58 compared with 100 for The European Innovation Scoreboard
the United States. The index was constructed compares China’s performance on several
from five major subindexes based on 31 indi- benchmarks with the EU-27. 65 The most
cators. The various subcomponents indicate recent report concludes that the European
that China’s performance has improved since Union (EU) countries are ahead of China on
2000 in knowledge creation (it is now in 33rd most of the indicators of education and inno-
place—a five-point improvement). Innovation vation capability. However, China is increas-
performance has risen sharply to ninth place. ing its lead in medium- and high-tech exports
But as the report observes, efficiency, inten- and drawing abreast of the EU in tertiary
sity, and quality of research in China still lags education, international publication, business
behind the frontrunners—the United States, R&D, and patenting, while the EU is extend-
Switzerland, Japan, and Korea—it is seeking ing its lead in public R&D expenditure and
to match. most-cited publications.
Another ranking of countries by innova- INSEAD’s Global Innovation Index pro-
tiveness comes from the Information Tech- vides a fifth measure of China’s capabili-
nology and Innovation Foundation (ITIF).63 ties. This index ranks 125 countries using
This index covers 40 countries and is based measures of innovation input (such as insti-
on measures of human capital, investment tutions, human capital, infrastructure, and
in R&D, and numbers of scientific articles, market and business sophistication) and
entrepreneurship, IT, economic policy, and output, both scientific and creative. China
economic performance—in other words, this was ranked 29th in 2011, the three top-
index casts its net broadly. Singapore leads ranked countries being Switzerland, Sweden,
the ITIF list with a score of 73, followed by and Singapore. Like the European Innova-
Sweden, with the United States in 6th place tion Scorecard, this index points to China’s
and China ranked 33rd. The ITIF also pre- improving performance—China’s position
pares a separate ranking of the change in actually declined from 37th place in 2009 to
country scores to determine the scale of inno- 43rd place in 2010 before reaching its current
vation effort and progress between 1999 and position.
2009. By this measure, China comes first, fol- A sixth index of “Science and Technology
lowed by Singapore and a number of north- power,” computed by Angang Hu, compares
ern European countries. Interestingly, the China with the four leading nations—Ger-
United States ranks dead last in this listing many, Japan, the United Kingdom, and the
because it is the country at the technological United States—on five capacities: publica-
frontier in most areas and because of its weak tions, patents, computer usage, Internet
performance on a number of counts. access, and R&D spending. Each of these is
The European Business School is the given equal weight, and Hu (2011, 110) finds
source of a third measure, known as the that China’s global share of S&T power rose
Innovation Capacity Index, which rests on from 0.82 percent in 1990 to nearly 4 percent
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 167
in 2000 and to 9.7 percent in 2007, putting fastest-growing industries have emerged in
it in third place behind the United States and a relatively small number of cities. China’s
Japan. “reform and opening” since 1979 com-
These six by no means exhaust the indexes menced with the establishment of four
of innovation capabilities. Several others S pecial Economic Zones privileged with
arrive at rankings for selected countries by incentives for export-oriented industrializa-
fusing measures of competitiveness, scien- tion, which were subsequently extended in
tific and technological knowledge, ICT, and 1984 to 14 coastal cities and to several new
human capital. Information on these rank- coastal economic zones. These urban cen-
ings and a synthetic index constructed by ters and regions triggered and have crucially
Archibugi and Coco, are helpfully summa- sustained China’s remarkable economic per-
rized by Archibugi, Denni, and Filippetti formance. They have served as the locus for
(2009). According to this consolidated set of integrated industrial clusters that share a
rankings, the first place is assigned to Swe- common labor pool, facilitate buyer-supplier
den, followed by the United States, Switzer- relationships, allow collaboration between
land, Finland, Japan, and Denmark. China firms to refine and develop technologies, and
is ranked 42nd. Its ranking by the selected encourage joint efforts to create marketing,
indexes range from 26th in the United information gathering, and training systems.
Nations Industrial Development Organiza- Where cluster networking is taking root, it is
tion index to 45th in the World Economic internalizing technological spillovers and, in
Forum index, with other rankings clustered the most successful cases, providing a virtu-
around 44th place. ous balance between competition and coop-
Technology development and innovation is eration. To foster clustering, cities are relying
a fairly recent focus of China’s development upon science parks, incubators, and exten-
strategy;66 hence there are very few Chinese sion services; encouraging local universities
firms that can be counted among the techno- to engage in research and to establish indus-
logical leaders in their respective subsectors trial linkages; inducing venture capitalists
and that are significant producers of intellec- to invest in SMEs in the area; and trying to
tual property. Although the research infra- attract a major anchor firm, local or foreign,
structure and numbers of researchers have that could trigger the in-migration of suppli-
expanded many times over, quality, expe- ers and imitators. Higher-level governments
rience, and the institutions that undergird have reinforced these initiatives with a vari-
innovation, remain weak. Leapfrogging into ety of tax and financial incentives and invest-
the ranks of the top five contenders in most of ment in infrastructure and urban services
the indexes will depend upon the efficiency of (Yusuf, Nabeshima, and Yamashita 2008).
China’s technology policies and the response Some industrial clusters, as in Zhejiang67
these policies elicit from the business sector, and Guangdong, materialized autonomously
academia, and the providers of supporting from long-established traditions of entrepre-
services. It will also crucially depend upon neurship and the strengths of local networks;
the creation of an innovation system that is others came together mostly as a result
alive to the global and open nature of innova- of initiatives taken by national and local
tive activities and their locus in a number of governments (He and Fallah 2011; Fleisher
cosmopolitan urban hotspots. and others 2010). In many instances, the
attempts to create cluster dynamics failed
even after a number of firms established
The Urban Dimension of Technology
production facilities at an urban location—
Development
these failures reflect the experience of cities
Science and technology activities and indus- world-wide. That notwithstanding, dense
trialization are primarily urban phenomena, urban-industrial agglomerations, some with
and in East Asia, the most dynamic and networked clusters of firms, have been vital
168 CHINA 2030
for the growth of productivity, for stimulat- (Fan, Kanbur, and Zhang 2009). Inland cit-
ing technological change, and for promoting ies are in a position to capitalize on favorable
further industrialization by opening opportu- wage and rental gradients and, with suitable
nities and crowding in capital and skills. investment, some could offer more affordable
Three major urban-industrial agglom- housing, recreational amenities, and public
erations—the Pearl River Delta region cen- services to attract knowledge workers and
tered on Shenzhen, Dongguan, and Fos- high-tech firms. According to a recent study
han; the Yangtze River region around the by McKinsey Global Institute (2011), China’s
Shanghai-Suzhou axis; and the Bohai region mid-sized cities with excellent growth pros-
in the vicinity of Beijing and Tianjin—have pects—such as Wuhan and Zhengzhou—
spawned multiple clusters producing every- would be contributing more to GDP growth
thing from toys, footwear, and garments to than the leading coastal megacities.
computers, electronic components, autos, and
software (McGee and others (2011). Further
industrial deepening in these three regions
The Road to Innovation
is continuing, and industrial agglomerations The imperative of building domestic innova-
also are expanding in a number of the inland tive capacity is entwined with the dynamics
cities, such as Chengdu, Chongqing, Xi’an, of knowledge diffusion and the large rents
Hefei, Wuhan, and Shenyang. Some clus- that can accrue to lead innovators and first
ters are evolving from industrial parks, such movers. Once a country is at the technologi-
as the Zhongguancun IT cluster (Beijing), cal frontier and cost advantages have largely
the Pudong pharmaceutical cluster (Shang- disappeared, producing and capitalizing on
hai), and the Wuhan opto-electronics cluster a steady stream of innovations provides a
(Hubei Province), but most clusters are still degree of insurance against economic stagna-
operating at the lower end of the industrial tion. A compelling finding that has emerged
value chain and lack horizontal integration from the analysis of patent data is that the
(Zeng 2010). intricacies of the research techniques under-
Despite the rapid pace of industrial lying new findings are transferred, often
agglomeration nationwide, significant through personal communication, among a
regional differentials remain between coastal small number of researchers, because they
and inland cities. Productivity (measured by are tacit and not ready to be codified.68 The
the GDP output per labor force) of the East circulation of new findings among firms in
region is almost twice that in the Middle a cluster and between universities, research
region and thrice that in the West region institutes, and firms proceeds slowly and can
(annex table 2A.10). Scientific and techno- take three years or more, depending on the
logical advances measured by patenting also nature of the technology, the type of firm,
are much higher in the coastal regions (annex and expenditures by firms on R&D.69 A sub-
table 2A.11). stantial body of research indicates that a few
Technological capabilities and innovation cities account for a high percentage of innova-
would certainly benefit from a greater partici- tions and that these cities share certain attri-
pation of major cities in the inland provinces, butes that make them “sticky” for knowledge
many of which have substantial manufactur- networks and clusters.70 The persistence of
ing capabilities, growing stocks of human this tendency despite great advances in com-
capital, and strong tertiary institutions. A munications presents a strong case for invest-
two-pronged approach that stimulates inno- ment in research to push the technological
vation in coastal urban areas and cultivates frontier and to grow innovations locally in
more specialized expertise in the leading sticky cities. The challenge for China is to
inland urban centers would increase the likeli- arrive at a national innovation strategy that is
hood of achieving growth objectives and also cost efficient, optimally decentralized, ratio-
serve to reduce income and productivity gaps nally sequenced, and urban-centric.
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 169
from domestic and international sources by governments and solely state-owned invest-
could be improved, and many university ment institutions accounted for less than
faculty members need more experience. 85 40 percent of the total amount raised by
Moreover, the quality of research is low, and China’s venture capital industry in 2010
there are worries that faculty members in the (Wang, Zhang, and Zhao 2011). However,
leading research universities are distracted more support to newly created companies is
from teaching by the financial rewards and still required. In the meantime, entrepreneurs
recognition they gain from consulting, pub- continue to lack the mentoring, professional
lishing, and patenting. Widespread concerns assistance, networking links, and market
have been raised about research ethics and insights that are invaluable for young firms.
the rigor of peer review of publications and Moreover, some venture capitalists complain
projects. 86 Heavy pressure on researchers that exit is hindered because it takes too long
to produce and to collectively raise China’s for companies with venture-capital backing
standing in the world is leading to dysfunc- to be listed on the GEM.
tional outcomes. The scarcity of talented Fifth, Chinese firms need to work closely
young researchers is also an issue confront- with multinational corporations to build
ing universities as they attempt to recruit innovation capabilities, and it is in the inter-
individuals with foreign PhDs or overseas ests of both parties to create a robust inno-
experience. The tendency to tenure full pro- vation infrastructure. But the multination-
fessors from overseas institutions encourages als may hesitate if they have to worry about
others to spend their most productive years intellectual property protection, exclusion
abroad.87 Furthermore, although universi- from government contracts, newly intro-
ties have embraced the “third mission” of duced indigenous standards, rising domestic
commercializing technology, the effects of content requirements, and pressure to trans-
university-industry links on technological fer technology to China in exchange for mar-
change have been minimal. Wu and Zhou ket access (Hout and Ghemawat 2010). Inno-
(2011, 2) maintain that “the key role of uni- vation policies need to establish greater trust
versities so far centers not so much on cut- between the government and foreign inves-
ting edge innovation but on adaptation and tors and stronger institutions that validate
redevelopment of existing foreign technology and operationalize the mutuality of interests.
and products. . . . The contribution of UILs Western European experience starting in the
[University Industry Linkages] as a part of 1960s suggests that, once such trust in insti-
university R&D income was largely stagnant tutions is established, technological transfer
in absolute amount and declined sharply as a and spillovers begin to rise and multination-
proportion of the total R&D income during als begin to localize their latest production
the 2000s. . . . The third mission of universi- techniques. The European experience differs
ties seems stalled.” This conclusion is consis- from that of developing economies. Given
tent with other observations, noted above, China’s size and long-term importance for
regarding the current state of innovation in multinationals, however, China can learn
China. from Europe and invest in the institutions,
Fourth, China’s venture capital industry business practices, and cultural mores that
is relatively inexperienced, as are other pro- undergird rapid technological diffusion. Chi-
viders of services to start-ups and growing nese initiatives in these areas will be most
high-tech firms. Moreover, even with the fruitful if they are matched by a greater
emergence of local private firms and the entry readiness to cooperate on the part of for-
of foreign firms, the venture capital industry eign companies in the pursuit of technology
remains dominated by government-funded development.88
or -controlled companies (Zhang, C. and Sixth, although the benefits of smart (and
others 2009). This situation is being cor- green) urbanization are becoming appar-
rected, and the amount of capital contributed ent to many, much urbanization in China
172 CHINA 2030
is proceeding inefficiently and untidily, and resources while generating few spillovers;
characterized by low-density sprawl, rib- in time, these shortcomings contributed to
bon development along new highways, real the collapse of the Soviet economy.
estate speculation, rising costs of housing The time for a hard look at innovation
(with low-income households increasingly strategy and policies is now.
disadvantaged), and neglect of long-term
urban financing needs. These tend to hin-
der productivity, making it harder for cities
Defining Policy Priorities
to support an ecosystem of small businesses China is embarked on a longer-term strategy
that are the lifeblood of urban economies aimed at achieving technological parity with
and a major source of innovation (Glaeser the advanced countries, and at deriving more
2011). Furthermore, the absence of longer- of its growth impetus from higher productiv-
term fiscal planning jeopardizes urban ity across the spectrum of activities and by
sustainability. capitalizing on the commercial benefits from
Seventh, the signature characteristic pushing the technology frontier in selected
of innovative economies is a learning and areas.90 Recent gains in technological capac-
research environment that encourages new ity suggest that China is approaching the
ideas and lateral thinking and that relies stage when it can transition to an innovation-
on market signals to guide the direction of and productivity-led growth path. How
innovation. In this model, the public sector quickly it makes the transition will depend
plays a facilitating role, seeding experimental on strengthening the institutions that pro-
research with a long-term payoff, providing vide incentives to entrepreneurs, scientists,
the legal and regulatory institutional scaffold- and engineers in companies, universities, and
ing, and establishing enforceable standards. research institutions to be more innovative.
China is some distance from this model of an Thus, priority should be placed on loosening
open, cosmopolitan, market-directed innova- institutional constraints.91
tion system. It may well be that the dirigiste This transformation is likely to occur in
approach adopted by the Chinese state could two stages that will require shifting the pol-
deliver the goods with respect to innovation, icy focus between the first stage and the next
as it appears to be doing with technological (this division of stages is only for the pur-
catch-up. China is putting fairly big bets on a poses of illustration). In the first stage (2011–
number of technologies even as an innovation 20), China will continue to benefit from
system is being pieced together, and without imported technologies, supplemented by
thoroughly evaluating the returns from R&D domestic incremental innovation, to increase
spending or the merits of recent policies to productivity, and to deliver rapid economic
spur innovation.89 The development of science growth. An emphasis on further reforming
and technology for the purposes of innovation SOEs, improving the quality of the work-
remains a planned activity on an expanding force, encouraging applied research in firms,
scale spanning multiple sectors with a lot at strengthening the research infrastructure,
stake and considerable uncertainty regarding and building market institutions to sustain
the future productivity gains. the tempo of competition and facilitate the
The experience of the former Soviet Union entry of SMEs may be appropriate. During
with its planned approach to technology this stage, China should achieve the trans-
development focused on the defense sector formation from the planned national innova-
argues for caution. The Soviet Union achieved tion system to a system that is open, global-
near parity with the United States in many ized, market oriented, and compatible with a
areas of weaponry, but because the defense market economy. The government needs to
industry and its research were isolated from increase investment in basic research, push
the rest of the economy, it soaked up talent through university reform, raise the skill
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 173
quality of its scientists and technologists, 3. Building national research consortia and
and launch large science and technology pro- networks
grams targeting some of the weak links in 4. Improving the productivity and quality
key industries. of tertiary education with the help of IT
In the second stage (2021–30), China and other innovations
will derive more of its growth impetus from 5. Strengthening technical and vocational
home-grown innovations that rely not only skills to fully exploit technical advances
on the generation of ideas through cutting- 6. Tightening integration of a more produc-
edge basic research—with risky blue-skies tive national innovation system with the
research supported by the state—but also global innovation system
on the harnessing of these ideas by dynamic 7. Sustaining an increase in R&D spend-
Chinese multinational firms with global ing to raise the productivity of a national
brand recognition, which are technology innovation system
leaders in their own particular areas, com- 8. Enabling policies and rigorous evalua-
mitted to achieving competitiveness through tion and refereeing of research programs
innovation, and able to engage in technologi- to raise the quality of outcomes and to
cal exchanges and partnerships with foreign maximize productivity benefits
firms on equal terms.92 In attaining such lead- 9. Increasing access to risk capital and men-
ership, Chinese companies will necessarily be toring of start-ups and SMEs by suppli-
harnessing worldwide innovation resources ers of venture financing
much like their foreign counterparts. 10. Using effective and disciplined gov-
As indicated earlier, policies for the first ernment procurement to stimulate
stage necessarily overlap with those for the innovation
second. The difference is in emphasis. Sev-
eral of the policies listed and discussed below
1. Deepen Reform to Develop a
are frontloaded because the building of the
Competitive Market
innovation ecosystem is concentrated in the
balance of the decade with the government A competitive market environment is a
playing a lead role. In the second stage, the necessary condition for steady improvement
burden of success will rest on the microstruc- in productivity. Creating this environment
ture of the business sector, which is why a entails the opening of product markets, sub-
competitive environment and investment jecting SOEs in the pillar industries to com-
promoting macrostability are of paramount petition from private firms, enforcing, fairly
importance. National technology and inno- and effectively, laws regulating competition,
vation policies will need to be complemented and protecting intellectual property as well
by urban policies that recognize the vital as consumer rights (Owen, Zheng, and Sun
role of cities in advancing ideas, extracting 2007; Oster 1999). It also extends to com-
the maximum mileage from existing general petition and ease of mobility in factor mar-
purpose technologies, and helping germinate kets. Starting in the late 1980s, for example,
new green technologies. The roles of the vari- market-oriented reforms stimulated entry
ous entities involved are further spelled out in and competition in most manufacturing
annex table 2A.16. subsectors. Even in some strategic, or pillar,
industries (for example, airlines and tele-
1. Increasing market competition aided communications), the breaking up and cor-
by greater national market integration, poratization of incumbent providers in the
which promotes specialization of pro- 1990s released additional competitive pres-
duction and research activities sures. More recently, the phasing out of tax
2. Making enterprises play a pivotal role in incentives, which had favored foreign inves-
the national innovation system tors, stimulated competition by leveling the
174 CHINA 2030
playing field with domestically owned firms. 2. Enterprises Have a Pivotal Role in the
China’s WTO accession in 2001 increased National Innovation System
competition from imports, and the large
volume of FDI has led to a further intensi- Innovation is essentially about creating
fication of competitive pressures. Sustaining more wealth by discovering and using newer
this trend through institutional reforms and methods. In all innovative economies, be
measures to enhance the supply of risk capi- it the United States, the long-time innova-
tal as well as the mobility of the workforce tion leader, or more recent entrants such as
will be critical to the making of an innova- Japan and Korea, companies have success-
tive economy. These steps will stimulate the fully created national innovation systems.
deepening of the private sector, promote the Most of the applied research and innovation
growth of dynamic SMEs,93 and induce the of consequence for the economy is done by
SOEs to raise their game (and pave the way firms; 96 in the United States, for example,
for further reform). Greater national market the vast majority of scientists are employed
integration would discourage local protec- by businesses and governments and not by
tionism and lead to coordinated R&D activi- institutions of higher learning. Innovation
ties at least by public entities—including uni- will flourish if firms in particular provide
versities—thus minimizing the duplication of researchers with the freedom to pursue inter-
suboptimally scaled research and the waste esting ideas in a stimulating work environ-
of resources it entails. It would mean intensi- ment (Shapin 2010).97 Mani (2010, 15–16)
fying the degree of competition and churning notes that, “due to various historical and
among firms,94 encouraging firms to compete structural reasons, the efficiency and inno-
on the basis of technology, and promoting vation capacity of the business sector is still
much needed regional or local industrial and insufficient, despite a large and rapid increase
research specialization. in scale and scope.” Mani uses a crude mea-
Competition and market integration is sure of firms’ ability to develop local tech-
inseparable from the efficient pricing of fos- nological capabilities as the ratio of intra-
sil fuels (with carbon taxes added to reflect mural R&D in business enterprises to the
externalities), electricity, and other nonre- cost incurred in technology purchases from
newable resources as well as the setting of abroad. Over 1991–2002, China’s average
national standards (including environmental propensity to adapt grew from less than unity
standards and standards encouraging energy to only about 1.5 in 2002.
efficiency) for products and the enforcement Government can support enterprises in
of these standards. This will also generate developing technological capabilities and
pressures to upgrade technologies, which producing innovative products by establish-
some western countries have done to good ing research and development platforms for
effect.95 Strengthening the industrial exten- the use of those companies. In China, there
sion system and providing smaller firms are a range R&D platforms and business ser-
with easier access to laboratory, metrology, vice providers such as engineering research
testing, and certification facilities would centers and productivity centers, but many
facilitate meeting these standards by smaller of them lack the market orientation and the
firms. The German Fraunhofer Institutes pro- close involvement of potential employers
vide a model for China to adapt. In Japan, in the design and teaching of curricula and
the TAMA association makes laboratory suffer from shortages of funding and expe-
facilities and testing equipment available to rienced trainers. It is important to make
its member firms, most of which are small or them more functional and more respon-
medium in size. The association also offers sive to the needs of the economy through a
assistance in obtaining product certification public-private partnership approach. And
and in creating web pages for purposes of there are some good examples of public plat-
advertising, among other services. forms that could be more widely replicated.
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 175
For example, Shanghai’s R&D public service improvements in management and the cor-
platform offers a wide range of business and porate culture, China may struggle to absorb
extension services that cover the innovation technology at the desired pace and thus to
development process from the sharing of sci- make the leap from catch-up to a regime of
entific information to technology testing and steady innovation.101
transfer services to support for entrepreneur-
ship and management (figure 2.2).
3. Build Nationwide Research and
The influx of FDI and the recent brain
Development Networks
gain is helping to enhance managerial experi-
ence as well as technical, research, and teach- The central government can take greater
ing skills, but a significant shortfall persists.98 initiative in building countrywide research
To move forward, both the private sector networks that mobilize national talent and
and the government need to invest more in reduce the relative isolation of inland cities
improving human resources, especially the by including firms from the inland cities in
management of state-owned and private research consortia tasked with disseminating
enterprises, in order to build and embed a the latest technologies and advancing tech-
culture supportive of innovation.99 Too many nology in areas where they have an existing
Chinese senior managers from companies or nascent comparative advantage.102 Such
with global ambitions lack formal manage- consortia have been sponsored by govern-
ment training, and most are deficient in Eng- ments in Japan and the United States, and
lish language skills. They tend to rely more they can help China develop more “global
on informal networks to gather information challengers” including from the inland
and on intuition and instincts in making deci- metropolitan regions. Successful regional
sions. As a consequence, firm-level research innovation systems are associated with uni-
and innovation strategies can be haphazard versities that conduct some of the upstream
and do not systematically engage the relevant research and generate ideas; a mix of smaller
departments of a firm,100 little effort is made firms that often take the lead in introduc-
to gather and analyze data to evaluate results ing new technologies with mentoring from
and to guide decisions, and interactions with venture capitalists and angel investors; and
foreign firms—including foreign travel—are larger firms with resources to perfect, scale
too often delegated to junior staff. Absent up, and market the commercial outcomes of
176 CHINA 2030
these technologies.103 Recognizing the cost techniques that favor lecturing over discus-
and complexity of research in frontier fields sion and greater classroom involvement
(especially green technologies), even the larg- of students; and university systems poorly
est firms are finding it desirable to specialize equipped to exercise quality control and
and to form partnerships with other firms or to weed out weaker candidates.107 In the
with universities when developing sophisti- meantime, employers complain of a serious
cated new products or technologies. Through shortage of highly skilled technicians, engi-
a pairing of inland firms with more advanced neers, and executives. This low-skill glut
firms from the coastal cities (including multi- and high-skill shortage poses a difficulty for
national corporations), the research potential the skill transfer needed for companies to
of the interior would be more fully exploited improve the quality of their output or move
and technological capabilities enhanced. In to a higher rung of the value chain.
addition to consortia, the technological and Because the demand for tertiary education
innovative capabilities of inland cities would is likely to keep rising and because quality
benefit if both domestic and foreign firms will remain a major issue, China’s universities
could be persuaded to locate some of their will have to consider some disruptive innova-
R&D centers in these cities, and not just tions of their own in order to provide cus-
production facilities. This process is already tomized education for a vastly larger body of
under way in Chengdu and Xian, for exam- students at an acceptable cost (Christensen,
ple,104 but its success will depend on regional Horn, and Johnson 2010; Zhong 2011). It
innovation policies actively pursued by local must be recognized, however, that there is no
governments, which must provide the incen- simple technological fix.108 Universities are
tives and build the institutions tailored to more likely to embrace change if they enjoy
local needs. Inland cities with a research a measure of autonomy for their own gov-
orientation would benefit from a focus on a ernance, modes of instruction, curriculum
few specific industries, and, depending on design, hiring, salaries, course offerings, and
what kind of activities achieve prominence, research orientation; are induced to compete
governments would have to act accordingly: and collaborate with universities through-
developing a research-based biotechnology out the country; and supplement traditional
cluster would require very different policies lecture-based training with new pedagogical
from an engineering or a food-processing or practices and online and IT tools (especially
a white goods cluster. now that great advances in video links have
advanced to a point where a virtual seminar
is becoming a reality).109 Universities will
4. Improve the Quality of Chinese
need to recruit faculty from among some of
Universities
China’s brightest graduates, many of whom
China’s universities are graduating millions will be inclined to pursue careers other than
of students each year to meet the needs of teaching.110 They will also need to tailor
the knowledge economy.105 An estimated 6.6 course offerings, instruction, and research to
million, including more than 50,000 with instill the desired mix of technical and soft
doctorates, entered the job market in 2011. skills (communication, team working, report
But the quality of the training is weak, and and business plan writing) as well as the
many graduates are having difficulty find- industry know-how in the greatest demand.
ing employment, although this is likely to be Perhaps the greatest challenge is how to
temporary.106 The low quality is explained encourage creativity and initiative, attri-
by four factors: the massive expansion of butes that are urgently needed as the country
enrollment, which has strained instructional strives for technological maturity.
capacity; the short duration of PhD train- By harnessing IT and tapping the exper-
ing (three years); the inexperience and weak tise and resources of leading firms, universi-
qualifications of instructors and pedagogical ties can improve teaching, motivate students
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 177
to stick with demanding courses, limit the Germany, Switzerland, and Finland, between
escalation of costs (which is crippling schools one-fourth and one-half of all secondary
in many advanced countries), and help equip school students take the vocational and tech-
universities with the infrastructure they need nical route to a career in industry rather than
to fulfill their missions. China’s front-ranked opting for general education. Striking a bet-
schools must also be able to mobilize the ter balance between the general and the tech-
funding and staff faculty positions to offer nical would seem to be warranted.
cross-disciplinary postgraduate and postdoc-
toral programs and set up specialized, well-
6. Develop an Open Innovation System
staffed research institutes.111 Universities can
provide the precursors to innovation through Investment in R&D facilities by multinational
basic research that leads to discoveries and corporations is on the rise and needs to be
novel findings. They can also incubate entre- further encouraged and facilitated because of
preneurs112 and skilled researchers, who are its potentially significant spillover effects that
the vehicles for transforming ideas into com- can enrich the knowledge and experience of
mercial products and services. Together, the the Chinese workforce, the potential gains in
government and universities can enhance the reputation for Chinese cities that will come to
dynamism and innovativeness of the private be seen as science hubs, and the contribution
business sector.113 such research can make to industrial upgrad-
ing. Closer collaboration and partnerships
with multinationals on the basis of mutual
5. Strengthen Vocational Training
trust and recognition of the interests of both
The development of high-tech industry envis- parties will contribute greatly to the creation
aged by the 12th 5YP depends upon an of a dynamic and open innovation system.114
increased supply and upgrading of technical The size and future growth of China’s mar-
skills through in-house training and voca- ket means that many multinationals will be
tional schools. Workers need to be trained shifting the primary focus of their operations
in a vast range of technical skills to staff fac- to China; as a consequence, technological
tories, engage in technically more demand- spillovers are very likely to increase. In this
ing tasks as innovation ratchets up the level context, an efficient patenting system that
of industrial complexity, render IT support, reflects the experience of the U.S. and Euro-
maintain and repair complex equipment, and pean systems (both of which are in the throes
provide myriad other inputs and services. of reform)115 and effective protection of intel-
Smaller firms and start-ups frequently have lectual property will expedite the growth of
difficulty finding such skills and can rarely China’s innovation capabilities (Smeets and
afford to provide much training in-house. de Vaal 2011). Gwynne (2010, p. 27) writes
Hence, public-private initiatives are required that “even companies that possess legitimate
to secure and replenish the base of technical Chinese patents have had problems defending
skills essential for a smart city; aside from their rights, because the scope for protection
minimizing both frictional and structural is much narrower. . . . And when it comes
unemployment, these initiatives can antici- to enforcement, only [recently] have there
pate market failures and promote desirable been any large damage awards for infringe-
forms of industrial activity. Labor market ment.”116 Legal developments in the form
institutions can be strengthened and made of specialized intellectual property courts is
nondiscriminatory by setting up multilevel changing the picture.117 It is also undeniable
professional advisory agencies and by increas- that China has made substantial progress in
ing the provision of vocational training to protecting intellectual property rights in fur-
meet the demand from expanding and new therance of its ambition to become an inno-
enterprises. In the most innovative and indus- vative country. Not only did China launch
trially dynamic European countries such as reforms in 2008 to support the creation,
178 CHINA 2030
ground. Such projects should be evaluated and others 2011). The weight of leadership
by their potential for transforming a subfield. and the engagement of the National Devel-
More broadly, the management and evalua- opment and Reform Commission and the
tion of R&D in China requires considerable Ministry of Finance would also increase
enlightened strategizing and management by the commitment of subnational govern-
public agencies. ments to the innovation agenda and lead
The development of innovation capacity to the strengthening of regional innova-
in China since the mid-1990s has involved tion systems.
multiple agencies, and numerous policies • Leadership and coordination must go
have been introduced. Looking ahead, with hand in hand with a concerted effort to
the focus on innovation sure to sharpen, the raise the technical and implementation
tempo of policy making can only increase, skills of the government bureaucracies
and the economic outcomes will depend sub- tasked with driving the innovation strat-
stantially on the quality and timeliness of egy. It almost goes without saying that
the policy interventions. If past experience the growth of innovation capabilities will
from other countries is a reliable guide, these demand considerable farsightedness, agil-
policies will be multiagency and multidis- ity, and innovativeness on the part of those
ciplinary, relying upon a mix of tax, fiscal, responsible for guiding and managing a
financial, and regulatory instruments. Good highly complex endeavor during a cru-
policies will depend upon: cial stage of gestation. The quality of the
bureaucracy matters everywhere; however,
• Strong leadership by the Communist Party given the large role played by the state in
Central Committee (CPCC)/State Coun- China, the importance attached to build-
cil, by strengthening the leading group ing innovation capacity in the shortest
on Science, Technology, and Education, possible time and the vast resources being
headed by the premier, which would have invested, the caliber of the bureaucracy
the requisite authority. takes on an added significance.
• Direct and consistent involvement of the • The experiences of the most innovative
National Development and Reform Com- countries—such as Finland, Israel, the
mission, Ministry of Finance, and Min- United States, and others—none of which
istry of Science and Technology, the key can boast an unimpeachable innova-
ministries involved with innovation poli- tion system124 —underscore the contribu-
cies, and effective coordination of their tion that a sound process of evaluating
roles. research-related spending can make to the
• Effective horizontal communication and design and conduct of innovation policies
coordination among other major minis- and to raising system productivity. Econo-
tries engaged in the making and imple- mists have generally tended to give high
mentation of S&T policies, such as the marks to R&D spending, claiming that it
Ministry of Education, the Ministry of generates exceedingly high rates of social
Commerce, the Ministry of Health, the and even private returns, usually higher
Ministry of Industry and Information than spending on fixed assets.125 But on
Technology, the Ministry of Agriculture, closer scrutiny, it appears that many of
and others. The leadership role of a CPCC these claims might be exaggerated. Ben
leading group would minimize past frag- Martin the editor of Research Policy
mentation of decision making among observes that not infrequently, “there is
agencies, each of which pursues a narrow some PR [public relations] rather than
policy agenda within its own particular rigorous research involved.”126 Measur-
silo, as well the conflict among roles and ing the inputs and outputs of research is
mandates, thereby achieving greater policy not a trivial exercise. The benefits from
coherence and effectiveness (Liu, Simon, research are uncertain and variable and
180 CHINA 2030
they accrue over a long period of time. still scarce. Moreover, the level of profession-
Moreover, the bulk of the returns take the alism and experience of venture capitalists
form of spillovers for which there are no and the degree of trust between providers of
good metrics. The problem is especially risk capital and borrowers is still fairly low;
severe with basic research. There are costs hence, further development of risk financ-
to research results and their assimilation, ing by venture capitalists and business angels
which can come to light much later and will be needed. Banks can serve as a partial
need to be factored in. For example, new substitute, but such lending is rarely their
medical technologies that extend the lives forte. Nonetheless, such lending on a limited
of elderly patients impose costs on society, scale by local banks to local firms and the
nuclear power has imposed cleanup and creation of bank-led relational networks is a
disposal costs, and many defense technol- mode of financing that seems to work in the
ogies have not been unmitigated blessings. United Kingdom and the United States and
Collecting data on inputs and outputs complements the resources of entrepreneurs,
from myriad and disparate sources and angel investors, and venture capitalists. Too
making the data consistent and readable is little bank financing in China goes to private
an additional and daunting task. Once the firms and especially the riskier high-tech ones
data are gathered, selecting an appropri- (Hanley, Liu, and Vaona 2011). That said,
ate methodology for analyzing them pre the dot-com bubble and other bubbles have
sents a further challenge.127 But all this is highlighted the waste arising from bouts of
unavoidable in view of the sums involved irrational exuberance fed by an excess of risk
and the need to obtain the greatest pos- capital. The enormous investment in specula-
sible productivity mileage from public tive real estate both in China (amounting to
spending on the innovation system. The 12 percent of GDP in 2010) and in countries
lesson from advanced countries is to start with sophisticated financial systems suggests
early by putting in place a system to rap- that capital is not necessarily the constraint;
idly evaluate research spending, to absorb more often it is investors who are rightly
the learning promptly into the policy- skeptical of technological offerings with
making process, and to be ready to make uncertain prospects. Facilitating the exit for
corrections or terminate programs that are venture capitalists is as important as raising
not producing results. China is at the stage venture capital for start-ups and innovative
where it can begin building the elements firms (Guo, Zhang, and Li 2000; Guo 2009).
of an evaluation process into its emerging So far, SMEs have only limited choices to
innovation system, learning from others raise capital by listing on stock exchanges,
and fully utilizing the latest available data which normally takes a long time.
gathering, storage, and analytic technolo-
gies that promise to make a difficult task
10. Make Better Use of Demand-Side
more manageable.128
Policies
Demand-side policy instruments such as gov-
9. Develop Multilayered Capital
ernment procurement and standard setting
Markets to Support Innovation and
for equipment and services, combined with
Start-ups
adequate efforts to guard against protection-
Rising demand for risk capital calls for an ist and rent-seeking activities that undermine
increase in supply. The Chinese government market competition and discourage high-tech
is active in promoting both public and private FDI, will stimulate the demand for innova-
venture capital, at least in the coastal cities. tion (Liu and Zhang 2008; Zhang 2007).
Although some public risk capital is available Managing government procurement is a
inland, private venture capital for smaller relatively new domain of policy in China.
private firms, which are trying to scale up, is The first national guideline for government
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 181
procurement was issued in 1999, and the innovative cities will be an important driver
National People’s Congress adopted the law of China’s growth through innovation.
in 2002. Despite the relative newness of this
approach, the government’s determination
Innovation in Health Care
to support innovation through procurement
has been clear. However, procurement policy The salience of health care in the Chinese
can be a double-edged sword. The key to economy is certain to increase, and innova-
success lies in open competition. In China, tion will be an important mechanism for
some potential risks in this area need to be controlling costs while raising quality and
fully recognized and reflected in government expanding access to health care. Health care
policies. These include the risk of turning the in China confronts a “perfect storm,” with
government procurement instrument into steeply rising social and financial costs that
one that protects national and local products could become a huge burden on the nation in
from international and national competition a handful of decades. To quote from a Lancet
and the risk of the government becoming editorial:
a passive taker of what domestic suppliers
offer, rather than a demanding buyer of tech- The population demographics are uneven,
nologically sophisticated products (Zhang, exaggerated by rapid ageing, as a result
C. and others 2009). of the single child policy, and by the large
The demand for innovation could be number of highly mobile workers within
increased through government standard set- the country. The health infrastructure is
ting. Standard setting allows governments variable, with world leading medical cen-
and other entities to generate demand for ters in the populous east of the country,
advances in, for example, the performance, whereas more rural areas lack basic sani-
safety, energy efficiency, and environmental tation. Despite better control, infectious
impact of products. Measures that could be diseases still account for considerable
taken to generate more demand for innova- morbidity with an ever-present danger of
tion include focusing exclusively on prod- new outbreaks. Alongside communicable
uct improvement and resisting the tendency diseases are the increasing burdens caused
to use standard setting to protect or help by the diseases of affluence and changing
domestic or local industry; taking EU or U.S. lifestyles. Meanwhile the ability to deliver
standards as a technical starting point while care is compromised by an uneven distri-
looking for ways to advance product perfor- bution of human resources and the loss of
mance; involving industry leaders more in doctors to other professions. In addition
standard setting (but that needs to be done to the breadth of the challenges, the size
in a productive way); and changing the role of the task is enormous. A Chinese man
of government from sole standard setter to smokes one in every three cigarettes. 177
time-sensitive driver of industrial consensus million adults in China have hypertension
(Zhang, C. and others 2009). but few receive effective treatment”129
demographic and technological changes. The it raises are lucidly discussed by West and
increase could be greater in China given its Miller (2009).131
stage of development, rising incomes, chang- ICT can also help to contain costs by
ing lifestyles, and epidemiological profile. enabling a much more exact measurement of
Containing health care costs while providing total costs of care than is the case currently.
modern health care to the entire population Providers and insurers have had only a rough
promises to remain a long-term policy objec- idea of the costs of caring for a patient but
tive. And the experience of advanced coun- now are in a position to track the type and
tries points to the urgency of policy inter- amount of resources used over the course of a
vention, before institutions have had time medical treatment (Kaplan and Porter 2011).
to solidify and strong vested interests have Christensen, Grossman, and Hwang
become almost politically invincible, as is the (2009) highlight another aspect of innova-
case in the United States, Europe, and Japan, tions in the biopharmaceutical and diagnos-
and the system acquires an immense status tic fields with potentially disruptive and cost-
quo bias (Starr 2011). reducing effects. This is the rise of so-called
Clearly innovation is only a part of the precision medicine tailored to the unique
answer, and in fact some of the cost escala- genetic profile of each patient, which would
tion is directly attributable to advances in sharpen the accuracy of diagnosis and ensure
pharmaceuticals, diagnostic devices, medi- that each ailment is treated with the medica-
cal implants, and others.130 But technologi- tions calculated to have greatest effect and
cal improvements are also behind some of the fewest side effects.132 The cost savings
the advances in the quality of health care from this set of innovations could be large.
and increasing longevity (Lichtenberg 2008, To strike the best balance between the
2010, 2011). Among the innovations that quality of health care and costs, China will
are likely to play a major role in the future, have to strive for medical innovation that is
and that thus deserve the most prominence, tempered by effective regulation (which mini-
are advances in preventive medicine, which mizes red tape, optimizes incentives for pro-
reduce the risks from communicable diseases, viders, and fully harnesses ICT) and for com-
ameliorate the effects of chronic ailments, petition among providers on results so that
bring about positive changes in lifestyles, and more patients migrate to better providers.
ensure that the majority of the population Porter and Teisberg (2006) note that “good
has access to clean water and good sanita- quality is less costly because of more accu-
tion. Some of these advances will involve bio- rate diagnoses, fewer treatment errors, lower
pharmaceutical innovations, but many others complication rates, faster recovery, less inva-
also will play a role. Digital medicine is set to sive treatments, and the minimization of the
greatly expand its contribution by revolution- need for treatment. Competition on results to
izing billing, ordering, record keeping and improve patient value is an irresistible force
sharing, and medical administration. Digital for transforming the health care system with-
medicine is also transforming access to medi- out the need for top-down government inter-
cal information, communication between vention.” Greater competition in health care
doctors and patients, and the monitoring of would be very much in tune with the over-
patients by providers. Advances in distance all strategy to build a more competitive eco-
medicine have the potential to multiply medi- nomic system.
cal assets and are only beginning to be tapped
through new diagnostic and other devices as
Building Green, Smart, and Innovative
well as through the outsourcing of diagno-
Cities
sis. The potential of digital technology, how
it can be assimilated (and the advantages of Investment in technological capacity is more
early action), and the many ethical, proce- likely to result in a flourishing of innovation
dural, administrative, and financial hurdles in a competitive environment and in “open”
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 183
cities (Hu 2011). Learning from its experience of knowledge workers drawn from all over
with rapid industrialization in the 1980s, the country—and the world (Page 2007).
China initially sought to enlarge techno- Moreover, such cities are closely integrated
logical capacity in a small number of coastal with other global centers of research and
cities (notably Shenzhen, Guangzhou, and technology development, and their teach-
other cities in the Pearl River Delta as well as ing and research institutions must compete
Shanghai and Beijing) with the help of FDI, with the best for talent and to validate their
imported equipment embodying new tech- own ideas. For innovative cities, openness
niques, licensing, and reverse engineering. and connectivity are more important than
The decentralized urban-centered approach, scale. These contribute to the productivity
bolstered by suitable organizational and of research and the generation, as well as the
fiscal incentives and increased R&D, jump- validation, of ideas. However, urbanization
started technology assimilation from abroad economies arising from size and industrial
and created the framework for stimulating diversity can confer important benefits by
indigenous technology development. On the offering a mix of technologies and production
technological plane, these cities are perform- expertise out of which innovations can arise
ing the functions that the Special Economic and that provide the soil for new entrants
Zones provided in the 1980s. The proposed to take root.133 Connectivity through state-
intensification of R&D activities during of-the-art telecommunications and trans-
2011–20 and the increasing emphasis on port infrastructure—airports in particular
achieving technological parity with the West (Kasarda and Lindsay 2011)—is a source of
and on greening growth to improve quality virtual agglomeration for an intelligent city,
and minimize environmental costs offers an conferring the advantages of a large urban
opportunity to develop the innovation capac- center without the attendant disadvantages of
ity of coastal and some inland cities and, in congestion and pollution. In this respect, the
the process, to increase the productivity of smaller innovative cities of Europe and the
R&D expenditures. United States enjoy the advantages of livabil-
Innovative cities rely upon the quality of ity without sacrificing the productivity gains
human capital, on institutional mechanisms accruing from agglomeration.134
and basic research of a high order for gener- To exploit the innovation potential inher-
ating ideas, and on ways of debating, testing, ent in virtual agglomeration, innovative cit-
and perfecting these ideas and transforming ies need to actively network with other cen-
them into marketable products. The innova- ters throughout the region and the world
tive city achieves rapid and sustainable indus- and build areas of expertise. This calls for
trial growth by bringing together and fully embracing a culture of openness, and activ-
harnessing four forms of intelligence: the ism on the part of major local firms and uni-
human intelligence inherent in local knowl- versities to translate such a culture into com-
edge networks, of which research universities mercial and scientific linkages that span the
are a vital part; the collective intelligence of globe. For a city to be recognized as an inno-
institutions that support innovation through vation hotspot, however, one or a few local
a variety of channels; the production intel- firms must join the ranks of the world’s lead-
ligence of a diversified industrial base that ing companies in a technologically dynamic
is a source of urbanization economies; and field and account for a sizable share of the
the collective intelligence that can be derived global market.
from the effective use of digital networks, Last but not least, because innovative cities
online services, and face-to-face contacts in are at the leading edge of the knowledge econ-
a conducive urban environment (Komninos omy, their design, physical assets, attributes,
2008). and governance need to reflect their edge over
The leading global innovative hotspots are others. Industrial cities can become innova-
open to ideas and thrive on the heterogeneity tive cities, and a strong manufacturing base
184 CHINA 2030
can be an asset, as it is for Tokyo, Stuttgart, established industrial parks to provide space
Munich, Seoul, Seattle, and Toulouse. But and services for industry to grow. These plus
industry is not a necessary condition: Cam- a full suite of incentives satisfy most of the
bridge (U.K.), Helsinki, San Francisco, and preconditions for the emergence of innovative
Kyoto are not industrial cities, yet they are industrial clusters. What might be missing is
innovative cities that have acquired signifi- an industrial focus on specialization and on
cant production capabilities that are high- the quality of the environment.
tech or “I-tech” (Markusen and others 2004).
Cities become innovative when existing
Greening Urban Growth
industries or institutions act as a nucleus of
new activities and start a chain reaction. The Economic growth that is largely urban driven
process can be initiated by any of a number must be rendered climate friendly. Hence
of catalysts—decisive and visionary leader- the “greening” of urban growth is becom-
ship by leading stakeholders, the upgrading ing a priority worldwide, including in China.
and transformation of a local university, the Although the precise meaning of green
creation of a new research institution, the growth remains somewhat elusive, it points
arrival or growth of a major firm, a small to the possibility of achieving sustainable
cluster of dynamic start-ups, or some other urban development through a virtuous spiral
catalytic event that energizes a combina- of innovations. At the core of green growth is
tion of intellectual and productive activi- the assumption that the energy, capital, and
ties. There are virtually no instances in the emissions intensity of GDP can be contained
past two decades of innovative cities being or reduced as economies expand. The hope is
successfully made to order anywhere in the that if greening can be mainstreamed, much
world. The attempts to engineer science cities more can be achieved: a green growth strat-
such as in Tsukuba in Japan and Daejeon in egy should lead to development of and invest-
Korea as well as similar complexes in Europe ments in low-carbon technologies and infra-
have rarely lived up to expectations. structures that bring about a green industrial
The science and technology capacity of revolution, creating the jobs and raising
China’s coastal cites is well established and incomes without the negative externalities
is being steadily augmented through rising associated with the fossil fuel–based growth
investment in the research infrastructure; of the past two centuries; greening can thus
that of several inland cities is now being contain the trend change in the climate. An
developed through increasing attention to exploration of the possibilities is still at an
regional innovation policies. Cities such as early stage and hemmed in by the prevalence
Xian, Chengdu, Zhengzhou, and Hefei are of entrenched technologies, but even now it
attempting to raise the profile of their leading is obvious that if the revolution is to succeed,
universities, grooming local firms that could much will depend upon the initiatives taken
become industrial anchors for local clusters, by cities and the effectiveness with which
much like ARM and Cambridge Consultants they are implemented.
served as the anchors for the electronics clus- To realize the potential of green urban
ter in Cambridge, U.K.135 Several cities such growth, a conceptual framework can usefully
as Chengdu, Shenyang, and Chongqing136 provide the scaffolding for policies—national
have also been successful in persuading mul- and local. In this context, an intersection of
tinational corporations to set up production two concepts pertaining to general purpose
facilities, which augment manufacturing technologies (GPTs) and to agglomeration
capabilities and create the preconditions for economies can serve to identify and elaborate
a concentration of the value chain.137 More- actions to promote green growth.
over, leading inland cities such as Changsha Long cycles of growth-augmenting tech-
are investing in the transport infrastruc- nological change are associated with the
ture to improve connectivity, and all have emergence and diffusion of GPTs, which
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 185
have protracted and economywide effects. cities, inefficient services, and infrastructures
A GPT has three characteristics (Bresnahan and transport systems that cater to ever-
and Trajtenberg 1996): increasing automobility. Green urbanization
suggests a number of policy directions:
1. Pervasiveness: It should spread to most
sectors. • With respect to urban design, it would
2. Improvement: It needs to evolve and put a premium on the compactness of cit-
improve over time with users benefiting ies and mixed-use neighborhoods with
from steadily falling costs. due attention to and investment in public
3. Innovation spawning: The GPT should transport systems, green spaces, and rec-
promote invention and provide the foun- reational amenities to reduce energy inten-
dation for new products, processes, and sity as well as environmental pollution.
related organizational and institutional • It would seek to more fully realize the
changes. returns from urban real estate and sup-
porting infrastructures while remaining
Steam, electricity, the internal combustion mindful of urban congestion and with-
engine, and now IT, are the emblematic GPTs out compromising individual intraurban
(Jovanovic and Rousseau 2005). Each was mobility and the quality of urban life.
and is responsible for urban industrialization • To deliver on its growth potential, green
extending over several decades, requiring a urban agglomeration would need to be
massive volume of investment. The effects hospitable to the continued vitality of
were not limited to a single sector; instead, existing industrial activities (while pro-
these GPTs unleashed innovations that dif- viding incentives for the greening of these
fused through and energized the entire econ- activities) and to the emergence of new
omy. The innovations shifted the production industrial clusters producing tradables so
frontier; triggered sustained investment in as to generate net employment and a flow
new products, business models, and modes of exports.
of production; and served as the founda- • It would support the growth of urban
tions of long-term economic growth. Start- industries and services producing for the
ing in the 1970s, the benefits from IT began green economy: the adoption of energy
filtering through the global economy and and resource-conserving technologies
very likely will continue to stimulate innova- (such as smart grids, energy-efficient hous-
tion and productivity for another decade or ing and consumer products) backed by
two. However, the looming threat of climate standards, regulations, and pricing and
change from accumulating greenhouse gases procurement policies plus consumer edu-
largely released by urban centers (up to 80 cation campaigns that bring about a shift
percent of the total) and the increasing press in preferences; of technologies controlling
of energy and resource scarcities has created emissions and waste; and of techniques
a need for new energy and resource utiliza- promoting recycling and disposal to mini-
tion systems that, in conjunction with IT, will mize environmental impacts. To this end,
gradually green the entire urban economy, green urbanization must strive after a mix
with seismic network effects similar to those of entrepreneurship and specialized skills
that arose from coal’s displacement of wood to research, produce, transport, install,
as the primary source of energy. and service the technologies and products
A green growth strategy can potentially driving green cities. Thus the productiv-
reinforce the productivity gains from urban ity of green urbanization would be closely
agglomeration by introducing technological related to technological change guided
innovations and minimizing the productivity- by market and nonmarket signals, as
eroding effects of urban sprawl, land use well as the quality and skills of the urban
distortions, inattention to the design of workforce.
186 CHINA 2030
• Fully exploiting the sources of green instruments that support green urbaniza-
growth will be a function of creative tion and how might they be improved. These
urban and national bureaucracies commit- include:
ted to a green agenda and able to respond
quickly to new information, formulate • Public bureaucracies tasked with devis-
and implement policies, and achieve the ing, implementing, and monitoring green
necessary interdepartmental and inter- strategies
jurisdictional coordination, the lack of • Local taxes, fees, and other charges to
which all too often stifles change. More so manage energy and resource consump-
than in the past, bureaucracies will need tion as well as to raise revenues, including
to be prodded by a vigilant, informed, and some earmarked for green infrastructure
networked civil society to set targets, learn and development.
from best practice, and benchmark and • Use of local or national carbon markets to
produce results. manage energy consumption
• Zoning, land use, floor area ratios, real
While the possibilities inherent in green estate and other property taxes (to limit
technologies and green urbanization deserve urban sprawl), and urban design to arrest
serious attention, good policies are difficult to current trends; promote compact, green
identify and will emerge only after a number development; and begin transforming leg-
of questions have been empirically addressed: acy urban infrastructure
First, it is important to ascertain the • Subsidies, taxes, and other incentives in
practicality of the green growth concept for support of specialized training to enlarge
policy-making purposes and its compatibil- the pool of relevant skills, provide incen-
ity with other views of economic growth. tives for research, and encourage start-up
Moreover, given that the current share of activity in green industries
green industries (producing “environmental • Standards and codes for structures and
goods”) is small (accounting for about 1.5 equipment; eco-labeling; incentives to use
percent of total employment in high-income green energy; and education programs to
countries), what would it take for the green stimulate use of green technologies
economy to become a significant growth • Fiscal instruments and financing vehicles
driver within the next two decades? (public and private, foreign funded) to
Second, it is desirable to canvas interna- raise the capital for the substantial up-
tional experience with net job creation (are front spending needed to jump-start green
green jobs new jobs?), local industrialization, development; implement green urban proj-
and productivity gains at the city level, of ects, many with long payback periods; and
policies aimed at increasing energy efficiency maintain the momentum of green develop-
and conservation (smart meters); substituting ment over the long haul
renewable energy for fossil-based energy, and • Technology parks, seed capital, and tax
developing advanced energy storage devices exemptions to induce the formation of
for use with intermittent power-generating green industrial clusters.
sources; retrofitting existing residential and
commercial structures and power, water sup- Finally, it is important to take a measure
ply, transport, and sanitation systems with of green technologies likely to mature over
new equipment based on green technology; the next 15 years, most of which are already
and managing ownership and use of private known, and judge whether a new green gen-
cars (with the help of sensor technologies eral purpose technology comparable to the
and ICT). Internet and the internal combustion engine
Third, China needs to learn from domes- is emerging, one that will transform many
tic and international sources about the more areas of activity and result in long-term pro-
effective application of policy vehicles and ductivity gains of the magnitude associated
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 187
with the diffusion of ICT. Such a measure constructed in two stages during 2011–30.
would help clarify whether reasonably Government policy will provide most of the
tested and cost-effective low-carbon, green impetus in the first stage, but success will
technologies (in the construction industry, hinge on the quality of the workforce, the ini-
for example, and related to the development tiative and strategy of firms, the emergence
of smart transport systems) are already of supporting services, and the enabling
accumulated and waiting to be exploited or environment provided by cities. Human tal-
whether the technologies expected to have ent is the source of innovation: its flowering
the largest payoffs (such as lightweight elec- depends on the research infrastructure in
tric cars connected by a mobility Internet) firms and cities and the degree of global net-
are still at an early stage of development or working. The innovativeness of the business
as yet undiscovered. In other words, tomor- sector is a function of many factors, some of
row’s green electrons should not just be which, such as management, competition,
expensive versions of today’s brown elec- and strategy, are discussed here.
trons: greening should be part and parcel With respect to China’s emerging inno-
of a quantum leap in technology and pro- vative cities (coastal and inland), two points
ductivity. The question to be asked is: How need to be emphasized. First, state-owned
quickly could the most promising and rela- and state-controlled enterprises continue to
tively cost-effective technologies be scaled account for a significant share of produc-
up given financing availability, technological tion in key industries. Second, although the
expertise, industrial capacity, public readi- innovation systems created by the cities are
ness to adopt new technologies and life- encouraging new entrants, it is not apparent
styles and constraints posed by legacy infra- from the low rate of entry and exit that truly
structures, vested interests, and mainstream innovative firms, especially privately owned
technologies? SMEs, are being groomed or that struggling
firms are allowed to fail in sufficient num-
bers. Making SOEs more innovative will
Concluding Observations contribute significantly to China’s sustained
Technological progress and the flourishing of growth. The best bet is an innovation system
innovation in China will be the function of anchored to and drawing its energy from a
a competitive, globally networked ecosystem competitive national economy.
188 CHINA 2030
Share of
Class Rank Class title total patents
TABLE 2A.3 WIPO Patent Cooperation Treaty, share of international patents by sector, 2007–09
Percent
TABLE 2A.4 Sector composition of new entrants (legal unit) by established time, Guangdong,
Beijing, and Zhejiang, 2008
Percent
Guangdong
Beijing Zhejiang
TABLE 2A.5 Number of patents in force in the high-tech industry, by industrial sector and registration status, 2009
TABLE 2A.6 Innovation inputs and outputs of industrial enterprises in China, by enterprise size, 2009
Percent
TABLE 2A.7 Innovation inputs and outputs of industrial enterprises in the high-tech industry in China,
by enterprise size, 2009
Percent
TABLE 2A.9 Patent family applications by value and country absolute volume
Year China Germany United States China Germany United States China Germany United States
TABLE 2A.12 Innovation inputs and outputs of industrial enterprises in China, 2009
Percentage
Number of
Number of R&D personnel Expenditure on patents in force
enterprises (unit) Share (%) (thousands) Share (%) R&D (billions) Share (%) (piece) Share (%)
TABLE 2A.14 Distribution of innovation inputs and outputs in high-tech industry in China, by type of performer, 2009
Number of
Number of R&D personnel Expenditure on patents in force
enterprises (unit) Share (%) (thousands) Share (%) R&D (billions) Share (%) (piece) Share (%)
TABLE 2A.15 Innovation inputs and outputs of industrial enterprises in high-tech industry in China, 2009
Percent
Domestic Sustained Market competition Improve management; Purchase Promote effective competition;
enterprises profitability; as driving force of technology; Long-term R&D Protection of IPR; Enhance the supply
Long-term for innovation investment; Research networking; of human resources; Encourage
competitiveness (Schumpeter ian Recruit talents entrepreneurship Tax incentives
innovation) for R&D investment; Demands-side
incentives;
Foreign Sustained Market competition Purchase technology from the Promote a fully completive
funded profitability; as driving force parent company; Launch local R&D environment; Credible IPR protection;
enterprises Long-term for innovation activities; Hire local talents Enhance the supply of human
competitiveness (Schumpeter resources; Incentives for establishing
innovation) R&D facilities and investing in R&D
Universities Cultivate talents; Teaching evaluation; Reform education philosophy; Grant more autonomy to universities;
Frontier research Funds granted improve education methods; Recruit Reform the evaluation and appraisal
from the state; top-grade faculties; Encourage free system of university; Reform the grant
Peer pressure thinking and independent research award and evaluation system of major
R&D projects
R&D Applied and Funds granted Design effective internal incentive Reform grant award system for major
institutions basic research; from the state; mechanisms; Recruit first grade R&D projects; Increase funds for hiring
Cultivate talents Peer pressure scientists and engineers experts and postdoctoral fellows
Engineers and Wealth creation; Professional Self-motivated lifelong learning; Reform grant award system for major
scientists Seeking after truth discipline; Perseverance R&D projects; Encourage freedom in
Peer pressure research; Reform the appraisal and
compensation system
Industry Serve companies Trust of the firms; Promote the cooperation between Grant more autonomy to industry
associations Recognition by the firms; Improve communications associations
society between governments and industry;
Facilitate R&D alliances
Financial Profit maximization; High profits; market Professional investment team; Good Create good financial eco-system;
institutions Long-term competition; Comply risk management mechanisms Keep balance market competition and
competitiveness with the laws and regulation; Provide tax deduction for
regulations the capital invested in the high-tech
enterprises
Central Economic and Demand and needs Improve the infrastructure, especially Reform of the administrative
government social development; of the people; Global those related to ICT, to facilitate the management system; Create a rule-
National security competitive pressure transmission and flow of knowledge; of-law government; Responsive to the
Develop effective market; Strengthen people’s demand
the social security system; Increase
investment in education and
enhance the quality of education;
Improve national innovation
system; Sustained investment in
basic research; Promote R&D by
firms; Organize major R&D projects;
Create initial demands through the
first-buyer strategy of government
procurement
Local Sustainable regional Performance Improve infrastructure and Reform appraisal system for local
government economic and social appraisal by superior; institutions to create an enabling government officials; Promote
development Competition environment for business start-ups regional competition in a unified
between regions; and innovation; Promote R&D by national market; Responsive to the
Demand and needs firms; Promote the development of people’s demand
of local citizens local industrial clusters
Source: Authors.
198 CHINA 2030
story of how entrepreneurs and inventors and useless concept for policy making.” The
transformed the Japanese electronics indus- sources of growth in China are estimated
try is well told by Johnstone (1999). Japan’s by, among others, Wang and Yao (2003);
technology development and innovativeness Badunenko, Henderson, and Zelenyuk
is the subject of two excellent volumes writ- (2008); and Urel and Zebregs (2009), all of
ten by Odagiri and Goto (1996, 1997). whom find that capital played the leading
11. The keiretsu in Japan, and the chaebol in role. Time series analysis arrives at similar
Korea. results. Chen, Jefferson, and Zhang (2011)
12. Among the innovations introduced by survey the sources of growth literature on
Korean companies was the 256 MB DRAM China.
(by Samsung in 1998). The dedicated sili- 16. See also the estimates on sources of growth
con merchant foundry pioneered by Morris and China’s share of the world economy in
Chang at TSMC in 1987 was a fundamental OECD (2010b).
innovation, which built on the creation of 17. Chen, Jefferson, and Zhang (2011) ascribe
standardized circuit design rules and elec- the slowdown in TFP growth since 2001 to
tronic design automation to transform the industrial policies that have reduced alloca-
chip manufacturing industry. This innova- tive efficiency, factor market distortions that
tion greatly widened the options for chip divert financial resources to less produc-
designers, who had hitherto depended on tive uses, and the diminishing productivity
excess capacity at vertically integrated chip bonus from structural change.
manufacturers such as Texas Instruments 18. Yu (2009). Perkins (2011) estimates that
to produce their chips (Perry 2011). See China’s capital to output ratio rose from
Mathews and Cho (2000); Breznitz (2007); 3.79 in the 1990s to 4.25 in 2000–07 and to
Hsueh, Hsu, and Perkins (2001, specifi- 4.89 in 2008–09. With a ratio of investment
cally the annex by Ying-yi Tu); and Brown to GDP approaching 50 percent in 2011,
and Linden (2009) on the technological China is now investing far more than Japan
development of Korea and Taiwan, China. did at the height of its boom and deriving a
On fabless firms and production, see http:// roughly equivalent amount of growth.
microlab.berkeley.edu/text/seminars/slides 19. Even at its peak, TFP growth was generally
/RChen.pdf; http://cadlab.cs.ucla.edu/icsoc less than 3 percent for almost all countries.
/prote c ted- d i r/ IC - DF N _ A gend a _ Aug For example, even during its years of rapid
_ 20 07/Jeremy%20Wang-FSA%20I ndu growth, Finland averaged 2.8 percent a year.
-stry%20Update.pdf. 20. The estimates differ. Those given here are
13. Breznitz and Murphree (2011) argue that from the OECD. See Groupe BPCE (2010);
China does not need to master break- Fukao and others (2008); and OECD Sta-
throughs over the near term to achieve eco- tistics Portal, http://stats.oecd.org/Index
nomic success. Instead, it can be a successful .aspx?DatasetCode=MFP.
second-generation innovator since the spec- 21. Eichengreen (2012) observes that the annual
trum of innovation possibilities is so wide. growth of productivity in China’s services
On innovation and China’s sustainable sector barely exceeds 1 percent, compared
development, see Fang (2007) and Gao and with 8 percent in industry, and that the sec-
Liu (2007). tor conducts little R&D. He calls for a revo-
14. Translating promising discoveries into prof- lution in services for China to catch up with
itable innovations can take many years if not the United States.
decades. The high-strength synthetic fiber 22. Comin (2004).
Kevlar created by DuPont took 17 years to 23. As noted earlier, China’s exports of manu-
achieve commercial viability, and it is not an factures overlap with those of the United
exception. States, but wide differences in quality and
15. The estimates by Bosworth and Collins are technological sophistication remain.
among the higher ones. Total factor pro- 24. T he Fu kushi ma disaster has f u r ther
ductivity is one of the most widely used sensitized companies to supply chain
indicators of growth, but its worth for vulnerabilities.
policy-making purposes is uncertain. Felipe 25. An aspect of learning highlighted by Lev-
(2008), for instance, is outspokenly critical, itt, List, and Syverson (2011) and critical
claiming that “TFP a dubious, misleading to the profitability of electronic component
200 CHINA 2030
share of GDP and begins to approach 2 per- ability to filter the good from the innocuous
cent. China has doubled its spending since has declined—especially the filtering of busi-
the mid-1990s and on current trends will ness model, process, and software patents
exceed 2 percent by 2014. See “China Bets applications. Many if not most patents lie
Big on Small Grants and Large Facilities,” dormant, never leading to any commercial
Science, March 2011, p. 1251. According to outcomes.
one estimate, a 10 percent increase per cap- 43. The National Patent Development Strategy
ita in spending on R&D raises TFP by 1.6 (2011–20) envisages that patent applications
percent over the longer term (Bravo-Ortega of all kinds will increase from 1.2 million
and Marin 2011). in 2010 to 2 million in 2015 and that over-
36. China has some of the best-equipped labo- seas applications by Chinese residents will
ratories in the world with state-of-the-art double.
measuring and testing devices. Computing 44. See “China’s Patents Push 2010,” Nature
power has also risen in leaps and bounds. News, February 15, 2010. However, foreign
As of November 2010, China, with 41 of patent applications account for two-thirds of
the 500 fastest supercomputers in the world, all effective invention patents (Hu 2011).
was second only to the United States (IEEE 45. See “Patents, Yes; Ideas, Maybe. Innovation
2011). For a period of less than a year (2010– in China,” Economist, October 14, 2010;
11), China’s Tianhe -1A was the world’s fast- and Li (2012), which refer to the generous
est supercomputer, before being overtaken incentives that are offered to researchers and
by the Fujitsu K computer. This might soon companies and also to bureaucrats in patent
be eclipsed by IBM’s Mira computer. offices to approve patents, many of which
37. Installed electricity generating capacity rose are of the utility model kind. So-called junk
from 350 gigawatts in 2000 to over 900 patents are not substantively examined or
gigawatts in 2010 “China’s power genera- evaluated by China’s State Intellectual Prop-
tion capacity leaps above 900 million kilo- erty Office (SIPO)—the patent being granted
watts,” Xinhua News, September 20, 2010. with the minimum of scrutiny. Breznitz and
Temporary shortages of coal and rising Murphree (2011) observe that most innova-
prices constrained supply from coal-fired tion in China thus far is of an incremental
plants, while inadequate rainfall reduced the sort. Firms in the ICT sector account for
supply of power from hydro sources in 2011. the majority of the USPTO and many of the
38. From the Ministry of Industry and Informa- SIPO filings. These firms, according to Eber-
tion Technology’s “2010 Statistical Report hardt, Helmers, and Yu (2011), tend to be
on Telecommunications Industry.” young, large, R&D intensive, and outward
39. China is attempting to groom up to 100 uni- oriented.
versities (including the 75 under the Minis- 46. http://transatlantic.sais-jhu.edu/bin/k/u
try of Education) into top-flight, world-class /cornerstone_project_lundvall.pdf; http://
universities—through the 211 and the 985 www2.druid.dk/conferences/viewpaper
programs (buttressed by the 863 and 973 .php?id=502529&cf=47
programs). Currently about 40 are being 47. OEC D Factbook 2011, http://dx.doi.
targeted by the 985 program. org /10.1787/888932505906. The small
40. Worldwide spending on R&D amounted to number of triadic filings also reflects the
$1.1 trillion in 2007, with spending by Asian high costs. Some firms take the Patent
countries surpassing that of the European Cooperation Treaty route, which estab-
Union and approaching that of the United lishes a filing date and needs to be followed
States (National Science Board 2010). up with national filings, but permits some
41. “China Shoots Up Rankings as Science delay. See http://en.wikipedia.org /wiki
Power, Study Finds,” CNN, March 29, /Patent_Cooperation_Treaty.
2011. See also Gao and Guan (2009) on the 48. Data supplied by SIPO.
increasing rate of China’s S&T output rela- 49. Ministry of Science and Technology (2008).
tive to GDP growth. 50. In 2008, Huawei filed more international
42. Patenting is an unreliable indicator of inno- patents than any other company. It was also
vation, and as patent offices have expe- the leading filer of patents with SIPO dur-
rienced an increase in applications, their ing 1985–2006 with a 34 percent share. See
202 CHINA 2030
“Patents Yes, Ideas Maybe. Innovation in 55. About half of all worldwide investment in
China,” Economist, October 14, 2010; and high-speed rail is occurring in China, and
Eberhardt, Helmers and Yu (2011). In gen- China’s $300 billion investment in this
eral, firms in the electronics industries are industry to date has created state-of-the-
the most prolific patenters, in part because art production facilities. See “China’s Rail
a portfolio of patents serves as protection Exports Will Survive Wenzhou Crash,”
against patent infringement suits by oth- Oxford Analytica, August 24, 2011.
ers and as a basis for countersuits. Patents 56. Goldwind has co-developed a direct-drive
are also useful bargaining chips in highly wind turbine, which dispenses with the cost
contested industries and can be a source of and inefficiencies of a gearbox. See Zhao
revenue through licensing arrangements or (2011) on the development of photovoltaic
outright sale. cells in China, starting in the mid-1980s
51. Some of this technology is generated by the with two silicon-cell assembly lines.
firms themselves, while some is acquired 57. The first flight of the COMAC C919 is
through the takeover of foreign firms. For scheduled for 2014, with an in-service target
example, Dalian Machine Tools purchased of 2016. This might be optimistic in light of
two businesses from Ingersoll International delays experienced by the ARJ 21 project ini-
and bought a majority share in F. Zimmer- tiated in 2002, which is running five years
mann. Suntech Power acquired the Japanese behind schedule. Whether the C919 can pen-
MSK Corp and KSL-Kuttler Automation etrate the single-aisle airliner international
Systems in Germany (BCG, “The 2009 market in the face of competition from new
BCG 100 New Global Challengers,” Janu- entries from Boeing and Airbus and also
ary 2009). See also Zhang, C., and others Bombardier, Embraer, Sukhoi, and Irkut,
(2009). will depend on the aircraft’s performance,
52. Gwynne (2010) notes that Chinese contract COMAC’s marketing and support services,
research organizations (such as Shanghai and its ability to win a few big orders from
Genomics/GNI) are now offering services foreign carriers or leasing companies (Farn-
ranging from the development and produc- borough, “Is China Cracking?” Flight Inter-
tion of biological drugs using recombinant national, Special Report, July 3–9, 2012,
DNA technology, and research on edible pp. 86–88; and “A Dogfight for Duopoly,”
vaccines is on the rise. Overall, however, Financial Times, August 7, 2012, p. 7).
Chinese companies hold only a limited port- 58. By 2011, China had launched more than 100
folio of pharmaceutical patents and lag in satellites for purposes of surveillance, remote
this field. sensing, weather forecasting, telecommuni-
53. Measured by purchasing power parity, cations, and, most recently, navigation and
China is likely to have spent more on nano- positioning via the Beidou Navigation Satel-
technology research in 2011 than the United lite System. China’s Long March launchers
States—$2.25 billion vs. $2.18 billion—and are now among the world’s most reliable.
several recently established nanotech cen- “Chinese Academy Takes Space under
ters in China are engaging in cutting-edge its Wing,” Science 332, May 20, 2011,
research (Oxford Analytica 2011). On some p. 904; “Beijing Adds Fuel to Global Space
views regarding the future directions of nan- Race,” New York Times, global ed., Janu-
otechnology, see Manoharan (2008). ary 1, 2012, p. 3; Cliff, Ohlandt, and Young
54. See Adams, King, and Ma (2009) on China’s 2011). A space station is now in the works
R&D effort. Sinovel, Goldwind, and Dong- following the docking of two orbiters, Shen-
fang Electric were the top Chinese produc- zhou-8 and Tiangong-1. “China Unveils Its
ers of wind turbines in 2009, ranked third, Space Station,” Science 473, May 5, 2011,
fifth, and seventh in the world, respectively. p. 14; “China Forges Ahead in Space Race,”
China’s BYD (Build Your Dreams) is a Nature 479, November 17, 2011.
leader in high-density batteries. These and 59. This list now includes stealthy jet fighter
other firms (such as the Galanz Group, the planes. See http://www.aviationweek.com
HiSense Group, and SAIC) are among the /a w / g e n e r i c / s t o r y. j s p ? i d = n e w s /a w s t
New Challengers in BCG’s list of 100 top /2011/01/03/AW_01_03_2011_p18-279564
firms in 2009. .xml&channel=defense.
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 203
tenth of the average for OECD countries; credit from banks further encourages capital
however, about 50 million households had spending (OECD 2010b).
incomes that exceeded 30 percent of U.S. 85. Recruitment of Chinese and foreign fac-
households (OECD 2010a). ulty members from overseas to introduce
77. This has resulted in corner cutting and envi- higher-quality talent and greater diversity
ronmentally damaging practices (Midler is ongoing with the offer of generous incen-
2011). The weakening of global demand and tives; however, these efforts are producing
a tightening of monetary policy to contain limited results and encountering resistance
inflationary pressures has increased the pres- domestically. See the efforts by Shenzhen
sures on smaller firms. University, http://topics.scmp.com/news
78. This is where firms such as Lenovo have an /ch i n a-news -watch /a r t icle / Shen z hen-
advantage over foreign rivals such as Dell University-in-global-search-for-top-talent.
and HP and why foreign firms seeking to tap 86. Plagiarism is a serious issue and one com-
the Chinese market need to find reliable and mented on in leading foreign publications.
savvy Chinese partners. http://factsanddetails.com/china.php?item
79. See Jorgenson, Ho, and Samuels (2010) on id=1651&catid=13&subcatid=82; http://
the contribution of IT to productivity in ser- w w w.npr.org / 2011 / 08/ 03/138937 7 78
vices. Brynjolfsson and Saunders (2009) pro- /plagiarism-plague-hinders- chinas
vide additional evidence. -scientific-ambition; http://www.nytimes.
80. This is not to deny the innovation-stimulating com/2010/10/07/world/asia/07fraud.html.
effects of exports, which over the near term 87. “High-Priced Recruiting of Talent Abroad
are likely to be greater than those of the Raises Hackles” Science, February 18,
domestic market. However, now that China 2011, pp. 834–35.
is the world’s largest exporter (and the lead- 88. Some Chinese companies have encountered
ing manufacturer with 19.8 percent of global barriers when trying to acquire certain kinds
output in 2010 compared with 19.4 percent of foreign high-tech firms. The latest exam-
for the United States), a slowing of export ple is the opposition from the Committee
growth and the concomitant restructuring on Foreign Investment in the United States
of production and demand will increase the to the acquisition by Huawei of a small U.S.
salience of domestic consumption on growth tech company, 3Leaf (a server technology
and on innovation—possibly of a different firm), on the grounds of national security.
sort. 3Leaf produces virtualization architecture
81. See Hsueh (2011) on physical assets. Half that enables commodity servers to mimic
of the key national laboratories operating the capabilities of mainframe computers.
in companies certified during the 11th Five Huawei eventually dropped its takeover
Year Plan period are located in enterprises bid. See “Huawei Backs Away from 3Leaf
owned by the central government. Acquisitions,” Reuters, February 19, 2011,
82. The contribution of managerial competence http://www.reuters.com/article/2011/02/19
and dynamism to productivity and profit- /us-huawei-3leaf-idUSTRE71I38920110219.
ability is analyzed by Bloom, Sadun, and See also “Huawei: The Company that
Van Reenen (2009, 2010). Brandt and Zhu Spooked the World,” The Economist,
(2010) and Dollar and Wei (2007) discuss August 4, 2012, pp. 19–23, on factors con-
the inefficiency of SOEs relative to their tributing to the resistance faced by Huawei.
counterparts in other sectors. 89. See the suggestions in Lane and Bertuzzi
83. Although SOEs are less-efficient users (2011).
of R&D resources, they have a higher 90. A comprehensive treatment of innovation
ratio of invention patents to total patent policy can be found in World Bank (2010).
applications. 91. Wu (2002) and Chen (2011) elaborate on the
84. SOEs also tend to use four times as much primacy of good institutions for technologi-
capital per worker on average as firms in cal progress and innovation.
the private sector, owing to their practice 92. The off-shoring of R&D is set to continue
of reinvesting a portion of their profits to (Dehoff and Sehgal 2009). See Carlsson
expand production capacity—profits not (2006) on the internationalization of R&D
generally being paid out as dividends or and on the contribution of national institu-
transferred to the Treasury. Easier access to tions to the process of globalization.
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 205
93. Rising costs, tightening credit, and weak- and the trend in brain gain seems to be posi-
ening export demand have dampened the tive (Oxford Analytica 2009).
performance and reduced the profitability of 99. Some recent research on enterprise restruc-
China’s 2.5 million privately owned SMEs. turing in China can be found in Oi (2011).
The future contribution of this vital sector 100. This is a practice perfected by the leading
will depend on a moderation of these recent Japanese firms, which, along with attention
trends. to customer feedback, accounts for their effi-
94. The gains from churning and creative cient commercialization of innovations.
destruction are analyzed by Fogel, Morck, 101. Li (2011) finds that own R&D is critical for
and Yeung (2008); Liang, McLean, and the absorbing of technology—a point under-
Zhao (2011); and Bartelsman, Haltiwanger, scored by Cohen and Levinthal (1990)—and
and Scarpetta (2004). that SOEs find it easier to absorb domesti-
95. Popp (2010) shows how environmental reg- cally generated technology than foreign
ulation and standards have contributed to technology, which might be related to the
green innovation. degree of sophistication, ease of communi-
96. The share of R&D expenditures by firms cation, and proximity to the actual research
increased from 68 percent of the total in source. This finding strengthens the case
2005 to 74 percent in 2009. This led to for indigenous innovation alongside inter-
a decline in the share of expenditures by national collaboration and borrowing from
R&D institutions from 21 percent in 2005 abroad. The importance of a corporate cul-
to 16.5 percent in 2009. Hence, even though ture of innovation is empirically supported
an increase in the proportion of R&D per- by Jaruzelski, Loehr, and Holman (2011).
102. See Mathews (2000) on the formation and
formed by business enterprises is interpreted
working of consortia in Taiwan, China;
as a desirable characteristic of a country that
and Branstetter and Sakakibara (1998) and
wants to become more innovative (Mani
Dodgson and Sakakibara (2003) on the util-
2010), this trend in China is partly an out-
ity of consortia in Japan and elsewhere in
come of its policy of converting R&D insti-
Asia. OECD (2007, p. 2) comments on the
tutes into business enterprises.
“islands” of science in China and urges the
97. Lane (2009, 1274–75) remarks that “sci-
linking together of these islands; “the gates
ence investment needs to generate an ‘aha’
of thousands of science and technology
moment or an idea that has value. Trans-
parks [need to be] opened up through the
lating that ‘aha’ moment into an innova-
promotion of networks for sharing human
tion also requires a well functioning team and capital resources. A greater national and
or organization, a well functioning patent regional concordance would avoid waste-
system, a well developed firm ecosystem, ful research duplication such as by issuing
or appropriate university links to industry.” guidelines or creating an independent coor-
The experience of successful firms in China dinating agency.”
and elsewhere provides useful clues to how 103. On China’s regional innovation systems, see
the innovative teams within firms interact Research Group on Development and Strat-
with the policy and institutional framework egy of Science and Technology (2011) and
in which they operate. A number of Chinese Liu, X. and others (2010).
case studies are presented by Tan (2011). 104. Both house military research and production
Case studies of foreign firms can be found facilities. Chengdu is one of China’s four
in Herstatt and others (2006); and Boutellier space research centers and produces military
and others (2000). jet planes.
98. Active recruiting of overseas ethnic Chinese 105. Zhang and Zhuang (2011) find that tertiary
academics and researchers is leading to a education has a stronger impact on growth
brain gain for China and helping to improve than primary or secondary education.
the caliber of faculties and of research. 106. “China’s Army of Graduates Struggles for
However, less than 30 percent of those going Jobs,” New York Times, December 11, 2010.
abroad return, and very often the ones who 107. China’s numerous business schools, which
do are not the leading lights. Nevertheless, have made a great effort to imitate Western
the relative attractiveness and rewards to schools and attract academics from abroad,
working in China have increased steadily, still lag behind on a number of counts, and
206 CHINA 2030
managerial talent remains in short supply. a specific product by orchestrating them into
See “China’s Schools Must Make the Leap a remarkably flexible, agile and skilled col-
Forward,” Financial Times, Sept. 26 2011, laborative supply chain. They mix and match
and “Education: the PhD Factory,” Nature, the special technical skills of the partners,
April 2011, p. 277. creating a network enterprise.” Collaboration
108. For example, the initial enthusiasm with needs to be encouraged at several levels. Peng
cheap laptops for children in developing (2011) writes of the increasing necessity of
countries is being tempered by the realiza- collaboration among scientists and observes
tion that it is likely to produce results only that to catch up, China should be a more
if it is combined with teacher training, a active participant on bodies such as the Inter-
redesign of the curriculum, and an overhaul governmental Panel on Climate Change and
of weak school systems. The mixed results FLUXNET (the global network of microme-
from the use of ICT in schools are also teorological tower sites).
highlighted by Machin, McNally, and Silva 115. On the problems that the U.S. Patent Office
(2007), who observe that the teaching of sci- is attempting to resolve, see “U.S. Sets 21st
ence and English benefited more than the Century Goal: Building a Better Patent
teaching of mathematics. Office,” New York Times, February 20,
109. Linking university funding on a sliding scale 2011; and on the European system see van
to the quality of outcomes is one way to spur Pottelsberghe de la Potterie (2010).
innovation. The merits of online instruction 116. Suttmeier and Yao (2011, 19) observe,
should not be overstated. They can be mea- “Piracy and other forms of infringement
ger unless complemented by personalized remain extensive. Chinese culture still seems
interaction with lecturers and with other to have trouble valuing intangible assets.
students in a structured classroom setting. Elements of techno-nationalism in China’s
110. Persuading a significant percentage of the innovation policies . . . encourage suspicions
best graduates and PhDs to take up teach- that that the country’s IP transition may not
ing is key to achieving quality, but unless be one of harmonization. And it is difficult
teaching is seen as rewarding monetarily to see how an internationally harmonized IP
and otherwise, only a small minority can be system can exist where the concept of rights
persuaded. (McKinsey and Company 2010). is so weakly established.”
111. Some Chinese universities are increasing 117. The number of courts equipped to handle
their cross-disciplinary offerings by hir- commercial and financial litigation has also
ing foreign faculty members with the req- been increased to handle a sharp increase in
uisite experience; see Jane Qui, “Foreign the number of cases.
Researchers Begin to Make Their Mark,” 118. On rules, policy directives and statistics,
Science, July 8, 2011, p. 144. see State Intellectual Property Office, http://
112. Experienced venture capitalists are more www.sipo.gov.cn/.
likely to “bet on the jockey and not on the 119. Chinese officials and some company CEOs
horse” and to want to know how many complain that certain international treaties
PhDs a high tech start-up has on its payroll. that date back to the cold war era, such as
113. Wu and Zhou (2011) suggest that greater the Wassenaar Arrangement on Export
autonomy for universities, allocating more of Controls for Conventional Arms and Dual-
the research funding to the leading research Use Good and Technologies, deny Chinese
entities, and the leveraging of science parks companies the right to purchase some tech-
adjacent to research universities might yield nologies or high-end equipment. See Xue
attractive dividends. Yanping, “The Wassenaar Arrangement
114. Highly successful and innovative companies and EU’s embargo on high-tech export
such as Cisco eagerly pursue open innova- to China,” http://ies.cass.cn/Article/cbw
tion. In fact, according to Branscomb (2008, /ozkj/201101/3394.asp.
916), “Cisco’s most important innovation is 120. The desirability of raising the share of basic
its partnership with customers and competi- research (only 5.2 percent of R&D spending
tors, making it a true networked enterprise. in 2006 as against 10–20 percent in OECD
Li and Fung maximize the collective innova- countries) was noted by the OECD (2008).
tive capacity of dozens of partners needed for Since then, basic research has received
CHINA’S GROW TH THROUGH TECHNOLOGIC AL CONVERGENCE AND INNOVATION 207
higher priority. See Zhu and Gong (2008) 130. One explanation is that the incentives for
and Nature Publishing Index (2010, p. 5). innovation by providers are much too gen-
121. Greenberg (2007) points out that maintain- erous, particularly in the United States, and
ing an ethical balance becomes even more that the checks on cost escalation through
important when universities draw closer the excessive use of new technologies, some
to the business community and enter into of dubious efficacy, are too weak (Callahan
multistrand research relationships. Trou- 2009).
bling ethical issues have arisen in the United 131. There is a vast literature on e-medicine
States, for example, as a result of corporate and on distance medicine in the technical
sponsorship of medical and pharmaceutical journals.
research. 132. A profiling of patients would initially be
122. Refereeing all too often relies on the “old- based on the patient’s genome, although
boy network,” which predetermines the out- later it could be done through the transcrip-
come. Many referees drawn from scientific tome. This approach would enable the medi-
fields also struggle to cope with socioeco- cal establishment to anticipate and prevent
nomic effects of new technologies. diseases to which a patient might be suscep-
123. See Bonvillian and Van Atta (2011) on the tible in the future and to develop drugs for
application of the DARPA approach to inno- currently incurable diseases.
vation in the energy sector. 133. See, for instance, Henderson (2003, 2010);
124. See http:/www.evaluation.fi for a measured Carlino, Chatterjee, and Hunt (2007); and
assessment of the innovation system in Fin- Carlino and Hunt (2009).
land, widely viewed as having one of the 134. A city that is top ranked with respect to
high-tech and I-tech scores is Seattle, the
best-performing innovation architectures.
home of Boeing and also of Microsoft. The
125. See Wieser (2005) for a survey, and Lach,
composition of employment in Seattle by
Parizat, and Wasserteil (2008) for an evalua-
subsector favors activities notable for their
tion of returns from investment by the Israeli
technology intensity such as aircraft and
government in R&D.
measuring instruments, and for IT intensity
126. “What Science Is Really Worth,” Nature,
such as insurance, computer programming,
June 2010, p. 683.
and architectural services. Innovative cities
127. The difficulty faced by the United States in
are also likely to fulfill the criteria of livabil-
finding satisfactory answers for legislators
ity such as good environmental quality, pub-
as to the cost effectiveness of the Advanced lic services, recreational amenities, housing,
Technology Program and the Small Business and connectivity. Seattle, for example, is one
Innovation Research program highlights of the better run and most livable cities in
the difficulties governments face as they the United States with an attractive coastal
craft innovation policies that will deliver the location (Markusen and others 2004).
sought-after growth and welfare dividends. 135. ARM (Advanced RISC Machines) was
128. See the extensive and many faceted discus- established in 1990 as a joint venture
sions of evaluation methods in Shapira and between Acorn Computers, Apple Inc,
Kuhlman (2003). The STAR METRICS and VLSI Technologies. It is the leading
project is one example of a comprehensive producer of microprocessors for mobile
approach to evaluating the full economic, telecommunications.
scientific, and societal benefits of research. 136. Chongqing, in particular, has demonstrated
Massive data assembly and number crunch- great initiative in persuading HP and Fox-
ing on a scale not imaginable a few years ago conn to relocate their laptop assembly oper-
is now a reality and being widely harnessed ations and support operations—the lure
by industry to study all kinds of behaviors being cheaper labor and land, lower taxes
and processes. These technologies, along and strengthened logistics. See “HP, Fox-
with visualization techniques, could make it conn to Build Laptop Manufacturing Hub in
easier to chart innovation policy and to cope Chongqing,” China Daily, August 5, 2009.
with its many uncertainties (Elmer 2004; 137. However, most of the more than 600 R&D
Ayres 2007). centers established by multinationals are in
129. Lancet, October 25, 2008, p. 1437. the coastal cities, chiefly Shanghai and Beijing.
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3
Seizing the Opportunity
of Green Development
in China
217
218 CHINA 2030
and higher quality of life—without the recur- gains, starting from its position as one of the
ring risks of environment-related disasters. most energy-efficient countries in the world
Second, whether China can attain high- (box 3.1).
income status by 2030 is still uncertain. The current transition toward green devel-
According to projections by the State Coun- opment has deep historical roots. Developed
cil’s Development Research Center (DRC) countries, with 20 percent of global popula-
(Liu, S. and others 2011) and other research, 2 tion, developed during a period of high fos-
China’s economic growth will slow down in sil fuel and resource consumption. Now, the
the coming years, exposing yet more social remaining 80 percent of the world’s popula-
and political challenges. Therefore, China tion also seeks to rise economically. However,
needs to find new sources of growth, driven if the 80 percent modernizes in the same way
by innovation and supported by medium- as the developed countries did—especially
and high-value-added production. Green considering that by 2050 the global population
development is part of the policy approach will rise to over 9 billion people—the environ-
to overcoming future risks and finding new mental costs will become insurmountable for
robust sources of growth. all countries. Therefore, the traditional model
Third, apart from domestic conditions, of development is no longer feasible.
changes in the international arena have also The global climate crisis is one of the most
made it important for China to change its daunting of the crises precipitated by tradi-
model of development. Western countries are tional economic growth. China will be one
making the transition to a more competitive of the countries most affected by climate
form of green development. As a result, a change. Therefore, addressing climate change
new race toward green development is now is a pressing need for China, and a matter of
being played out in the global economy, with self-interest. There is a scientific consensus
significant benefits accruing to early movers. that to limit the rise in global average surface
In 2009, the Organisation for Economic Co- temperatures to 2˚C, global carbon emissions
operation and Development (OECD) issued must peak in 2020 or so, then decline dra-
a Declaration on Green Growth in which matically by 2 percent a year (UNEP 2011a).
its member countries set forth a comprehen- In short, there is simply not enough “carbon
sive green growth strategy. Under the Euro- space” to satisfy the emission needs of all
pean Union’s (EU) “Europe 2020” initiative, countries if they continue to grow in the tra-
innovation and green growth form the core ditional mode of development.
of a strategy to increase the competitiveness Because of rapid economic expansion,
of European countries. At “Rio+20,” the and despite strong measures taken since
United Nations Conference on Sustainable 2006, both China’s total annual and per
Development held in Rio de Janeiro in June capita emissions are increasing at a high rate.
2012, green growth was one of the main Although its per capita emissions were histor-
topics of discussion. In May 2011, Germany ically low, they are now above those of France
announced that it would strive to be the first and Spain, and China’s total emissions are the
industrial country to achieve a complete largest in the world (figure 3.1). During the
shift to clean energy. The United States has period 2006–10, China reduced the energy
issued a 10-year clean energy strategy; the intensity of its economy (a close measure to
Republic of Korea has already made green carbon intensity) by 20 percent, through strict
economic development a part of its national energy conservation and emission reduc-
strategy going forward; Brazil has aggres- tion measures, even as it maintained overall
sively merged its forward-looking policies for growth of its gross domestic product (GDP)
growth, climate change, and environmental of more than 10 percent a year. China’s cur-
management; and Japan is pushing for an rent commitment is to decrease its carbon
additional 30 percent in energy efficiency intensity (carbon dioxide, or CO2 , emissions
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 219
Germany’s new energy plan. In May 2011, Germany domestic product to 10 green growth strategies, each
determined to close all of its nuclear plants by 2022 containing quantitative objectives and well-defined
and to become the first industrial country to shift projects. Korea also aims to increase its global mar-
completely to clean energy by increasing investment ket share of green technology exports from 2 percent
and research and development for renewable energy in 2009 to 10 percent by 2020.
and energy efficiency. Currently, nuclear power pro-
Japan’s energy efficiency strategy. Japan’s energy
vides 22 percent of Germany’s electricity. To fill the
intensity decreased 26 percent between 1980 and
gap in its energy supply after it abandons nuclear,
Germany has proposed vigorous development of 2009, and it is one of the most energy-efficient coun-
wind, solar, and biomass and new standards for tries in the world. Nevertheless, in 2006, Japan
the thermal efficiency of buildings. It is also urging pledged to improve its energy efficiency by another
European and North African countries to create a 30 percent by 2030 relative to 2006. The plan’s
continentwide super smart grid (which would allow implementation strategy fosters energy conservation
the import of power from sun-rich North Africa and technologies and develops a benchmarking approach
wind power from the North Sea). to monitor energy conservation. In addition to pro-
Korea’s green growth plan. In response to the moting the most advanced technologies across the
global financial crisis of 2008, the Republic of energy sector, the plan also introduces integrated
Korea is a first mover in the implementation of green energy consumption standards for all buildings and
growth. Its move toward green growth combines targets net-zero-energy houses by 2020 (which are
three mutually reinforcing objectives: responding to to become the norm nationwide by 2030). Japan’s
the latest economic crisis through a green stimulus, Top Runner Program tests 21 types of appliances—
reducing its energy dependency, and rebalancing its ranging from vending machines and air condition-
economy toward green sectors in the long term. The ers to television sets—to determine the most efficient
financial crisis exposed Korea’s reliance on imported model and make that model’s level of efficiency the
energy as a major weakness in its growth model. new baseline. Then, manufacturers are required to
Korea imports 96 percent of its energy—account- achieve the new baseline within four to eight years.
ing for two-thirds of all imports. To rebalance this Japan’s newest innovation is the concept of “smart
situation by 2030, Korea aims to decrease its energy community,” a model city that maximizes the use of
intensity by 46 percent and to increase the share renewable energy and relies on smart grids to deal
of renewable energy in total primary energy from with its intermittent nature. Four large-scale pilot
2.4 percent in 2007 to 11 percent. Furthermore, projects were started in 2010.
the latest five-year plan allocates 2 percent of gross
per unit of GDP) by 40–45 percent by 2020 In sum, green development is being driven
from the level in 2005. Nonetheless, China’s by harsh economic realities, changing global
per capita GDP will have doubled by 2020, priorities, and growing technological possi-
implying that both total and per capita emis- bilities (box 3.2). Many of the forces operat-
sions will continue to rise. It is clear that how- ing in the rest of the world are also present
ever global carbon budgets may be allocated in China. Chinese leadership has already
through national actions and international shown its commitment to green, low-carbon
negotiations over the next 20 years, there development, even though it is at the early
will never be enough carbon emission space stages of a long journey. This study focuses
for China to copy the past industrialization on how to achieve green development, not on
model of developed countries (DRC 2009; whether it is an option.
DRC Project Team 2011).
220 CHINA 2030
a. Annual emissions of CO2 from energy b. Cumulative emissions of CO2 from energy
(2009 and 2030) (1900–2009 and 1900–2030)
12 500
2030
10
400
Tons CO2 (billions)
Sources: World Bank. Historic emissions and population data for 1950–2009 from Boden, Marland, and Andres 2010; World Bank World
Development Indicators; and UN Population Division (2011). Projections of emissions for China from 2010 to 2030 are from World Bank and
DRC. Projections for emissions from other countries are from U.S. EIA (2011) and WRI CAIT (2011); population projections from UN Population
Division (2011).
Note: Solid dots = 2009; open dots = 2030.
280 280
240 240
Index (1990 = 1)
Index (1990 = 1)
200 200
160 160
120 120
80 80
1990 1995 2000 2005 2008 1990 1995 2000 2005 2008
GDP volume Real national income CO2 emissions from production Greenhouse gas emissions
include solar and wind energy, together with FIGURE 3.3 Index of innovation in climate change mitigation
upstream and downstream industries such technologies (1990 = 1)
as relevant equipment manufacturing and
electric vehicle industries. More broadly, 13
however, new markets and incentives, sup-
In addition to the three broad reasons why green • Agricultural output will be enhanced by reducing
development contributes to growth, the implemen- the degradation of land and water.
tation of green development policies brings several • Infrastructure constraints, particularly for han-
further sectoral benefits that are growth inducing: dling coal, will be eased, and infrastructure invest-
ment requirements reduced.
• Rapid growth of energy consumption has strained • By anticipating climate impacts on agriculture,
China’s domestic supplies of electricity, raised coal low-lying coastal areas, and areas vulnerable to
prices, and made it increasingly dependent on extreme weather events, green development will
imported energy. With unchanged policies, China reduce climate-related risks and improve investor
may have to import 75 percent of its oil (making and consumer confidence.
it the world’s largest oil importer) and 50 percent
of its natural gas by 2030. Alternative energy sec- All of these measures will support growth
tor policies will dramatically reduce this import through reduced costs, improved certainty, and the
dependence. reduced need for risk management options.
• The efficient use and better governance of land
will help reduce urban congestion and sprawl.
FIGURE 3.4 Energy intensity of GDP, 1990–2009 countries already pay for themselves through
lower energy and input costs. Policies and
800
investments to improve efficiency, by increas-
ing returns for investments in green tech-
Ton of coal equivalent per unit (millions)
700
nologies and products, will immediately add
of GDP (constant 2005 PPP)
FIGURE 3.5 No-regrets options for reducing CO2 emissions in China, 2030
Sources: World Bank calculations, based on McKinsey & Company (2009); Ho and Jorgenson (2003); Cao, Ho, and Jorgenson (2009); NBS (2009b);
Liu and Wang (2011), and Matus and others (2011).
Note: HVAC = heating, ventilation, and air conditioning; LED = Light-emitting diode; CO2 = tons of carbon dioxide.
to the economy, such as improving local air in 2030, on top of the direct savings of RMB
quality and thus reducing the incidence of 480 ($65 billion) a year.
respiratory illness associated with air pollu- Feng and others (2011) estimate that
tion; reducing infrastructure constraints in several hundred mature energy-saving tech-
related sectors, such as transport and water; nologies are currently available to, but not
and reducing dependence on imports of fos- fully deployed by, China’s high-energy-
sil fuels. In other words, cost-effective energy consumption industries. The analysis shows
efficiency and renewable energy investments that if energy-intensive industrial sectors
offer triple-win (“win-win-win”) outcomes widely applied 79 of these major technolo-
by trimming production costs, mitigating gies by 2020, the accumulated energy savings
emissions of greenhouse gases, and improv- would be 456 million tce (with a correspond-
ing public health risks in various sectors. ing reduction in emissions of 1.2 billion tons
The potential for no-regrets measures to of carbon dioxide, or tCO2) (figure 3.6). If
contribute to both the quantity and quality all existing and emerging energy efficiency
of growth is illustrated in figure 3.5. This technologies available for energy-intensive
figure shows the emissions reduction poten- industrial sectors were applied by 2020, the
tial and leveled cost of certain energy effi- accumulated energy savings capacity would
ciency technologies in 2030, as estimated for be 650 million–750 million tce (with corre-
China by McKinsey, but adjusted to reflect sponding reductions in CO2 of 1.7 billion–1.9
the social value of these co-benefits. These billion tons). More detailed examples of the
health-related co-benefits are valued at RMB cement and iron and steel sectors are given
148 billion ($20 billion, 2009 values) a year in box 3.4.
226 CHINA 2030
FIGURE 3.6 Estimated energy savings and emissions reduction from installing 79 efficiency technologies
in heavy industry, 2005–20
350 1,000
300 800
250
600
200
150 400
100
200
50
0 0
2005 2010 2015 2020 2005 2010 2015 2020
Source 2: Expansion of Emerging Green a year. Furthermore, if the State Council tar-
Industries gets are met, the contribution of emerging
green industries to China’s GDP will be 15
Emerging industries are green if they emit percent by 2020.
low levels of pollution and greenhouse gases. Cost reductions and technological prog-
The most concrete example of emerging ress in renewable energy technologies in
green industries is clean energy, and some China have exceeded expectations, mostly
such as solar power, wind power, biomass, due to a massive scaling-up in the industry.
and hydropower have already been com- In renewable energy, the cost of both wind
mercialized on a large scale. China’s seven energy and solar photovoltaic (PV) equip-
targeted strategic industries, mentioned ment has decreased dramatically during
earlier, are environmental protection and the past five years (Feng and Wang 2011).
energy efficiency, new energy, next genera- The wholesale prices of coal-fired and wind
tion information technology, biotechnology, power are already very close (just under
high-end manufacturing, clean-energy vehi- RMB 0.50 or $0.08 per kilowatt hour). The
cles, and high-tech materials. Globally, busi- price of a solar PV module has decreased
ness opportunities in many of these sectors, from RMB 149 ($23) in 1980 to less than
including clean-energy vehicles and clean RMB 20 ($3) in 2010 (U.S. DOE 2010). Fol-
energy, are shifting toward the developing lowing this long-term trend, the existing gap
countries. between coal-fired and solar PV power will
China is now the world leader in renew- likely close by 2020. Similarly, the costs of
able energy investment, surpassing all other biomass, marine power, shale gas, coal gas-
countries (Pew 2010). The wind power ification, and other clean energies will con-
industry alone could account for more than tinue to decrease.
RMB 161 billion ($25 billion) a year in The rapid progress of clean energy tech-
investment, assuming 20 gigawatts installed nologies is illustrated by the dramatic rise in
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 227
BOX 3.4 Detailed analysis of two industries: Cement and iron and steel
Driven by an unprecedented construction boom Chinese cement makers have made impressive
over the past decade, China’s iron and steel and strides, reducing the energy intensity of production
cement sectors accounted for nearly one-fourth of by 30 percent between 1998 and 2009. While now
the country’s total energy consumption in 2009. As more efficient than the U.S. cement industry and on
the construction boom is expected to last well into a par with Europe’s, China’s cement industry is still
the 2020s, demand will continue to grow (Zhou and 30 percent above the energy efficiency level set by
others 2011; Fridley and others 2011). By 2030, the the world’s best practice cement technologies.
amount of coal consumed to make steel and cement China’s iron and steel industry has farther to go
could reach 926 million tons a year, an increase to reach the efficiency levels of industry leaders (fig-
of 276 million tons (42 percent) over 2008 (NBS ure B3.4.1). By deploying the best available technolo-
2010b; Zeng 2010; Zhou and others 2011). gies, it could save more than 100 million tons of coal
a year (IEA 2010a).
300
Ton of coal equivalent per US$ (millions)
250
200
output (2009 PPP)
150
100
50
0
2005 2006 2007 2008 2009 United States Germany Korea, Rep.
China 2006 2006 2006
Sources: World Bank, based on IEA World Energy Statistics and Balances, NBS 2009b and 2010b, and UNIDO INDSTAT.
Note: The figure compares tons of coal equivalent per $1 million of output in constant 2009 US$.
Combined, the iron and steel and cement indus- costs. Cost savings may be even greater depending
tries could achieve average net savings of RMB 73 on future energy prices. Energy-saving technologies
billion ($9.9 billion) a year between 2008 and 2030 also contribute to growth by reducing the burden of
by using a basket of technologies that are already pollution-caused illness to society by an estimated
available on the market. This estimate includes net RMB 8.9 billion ($1.2 billion) a year over the same
incremental capital, operating, and maintenance period.
the number of worldwide patent filings for innovation. The number of wind power pat-
wind power, solar PV, ocean energy, elec- ents granted to Chinese inventors, for exam-
tric or hybrid vehicles, and lighting energy- ple, has surged within the past five to seven
efficiency technologies. China occupies a years, and transfers of wind power technolo-
prominent place within this global trend of gies to China from the developed countries
228 CHINA 2030
FIGURE 3.7 Patent assignee origins for wind The growth of China’s nascent environ-
power technologies mental protection industry, in particular,
demonstrates the important role that the
state will play in promoting the growth of
United States
green sectors. Take the flue gas desulfuriza-
Germany tion industry, for example. Under the 11th
Denmark Five Year Plan, the central government man-
Top 10 OECD countries
BOX 3.5 Robust growth projected for China’s environmental protection industries
In a speech in November, 2011, at the APEC (Asia what was invested over the previous 5 years. Chi-
Pacific Economic Cooperation) Summit, President na’s energy conservation and environmental protec-
Hu Jintao announced, “Continued rapid growth tion industries are seen as major sectors for foreign
is projected for China’s environmental protection investment. A flourishing demand for ‘green’ prod-
industry during the 12th Five Year Plan (2011–15). ucts and services, combined with a favorable invest-
By 2015, the total value of the industry may exceed ment environment will provide a vast market and
RMB 2 trillion. Between 2011 and 2015, China’s tremendous opportunity for enterprises from around
central government plans to invest RMB 3.1 trillion the world. . . .”
in protecting the environment, more than double
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 229
trillion ($229 billion–$395 billion, measured FIGURE 3.8 Projected annual Chinese exports of green products
in 2009 dollars) in export sales (figure 3.8) and services (2030)
and lead to 4.4 million–7.8 million new jobs.
These export sales are on the order of 6–10 200
percent of total projected exports, or 2–3 175
percent of projected GDP. Of course, this
150
Empirical research done in other countries has con- the overall economy (Muro and others 2011). A
cluded that in the medium term, green growth will study in Germany found that implementing mea-
have a positive but small net effect on the number of sures to mitigate climate change led to more job
jobs in the global economy (UNEP 2011b; Marti- opportunities for college graduates (cited in Dupres-
nez-Fernandez and others, 2010; ILO 2009; Dupres- soir and others 2007). This finding is linked to the
soir and others 2007). Within this overall scenario, higher component of innovation found in newer
of course, some countries, such as China, will excel technologies than in more traditional ones.6 In con-
in creating green technology jobs. Furthermore, evi- trast, extractive industries, utilities, marine fisheries,
dence from developed countries also suggests that and some heavy manufacturing industries are likely
those jobs that are created in the transition to green to shed jobs over the upcoming decades, primarily
growth are often skilled and high paying. A recent as a result of gradually increasing energy prices,
nationwide study of green industries in the United depleted natural capital (such as overexploited fish-
States revealed that the median wage in these indus- eries and forests), more efficient technologies, and
tries is 13 percent higher than the median wage in the automation of production processes.
230 CHINA 2030
100
90
80 79 78
75 72
70 71
60
% of GDP
54 58
50 52 50
40 43
30
20
10
0
China High-income Upper- Lower- Low- France United Japan Germany Korea,
countries middle- middle- income States Rep.
income income countries
countries countries
that local government has been dependent the precedent of the eastern provinces by
on large-scale, capital-intensive industries for growing first and then cleaning up later. This
tax revenue, and there has been less support is especially true for those central and western
to the service industry. All of these forces are provinces with abundant mineral resources.
weakening, thus favoring the long-term devel- Although extractive industries may have led to
opment of China’s service industry. high GDP growth rates, the income levels of
China’s service sector growth over the people living in these regions has not grown
long term will depend on the pace of reform commensurately, and in some places, the natu-
of government restrictions, policies favoring ral environment has been severely degraded.
the knowledge industries, and consumption The interior provinces should avoid the
patterns of the rising middle class. The ris- conventional (and environmentally degrad-
ing share of services in GDP will help reduce ing) growth path of the east for several rea-
the economy’s carbon intensity. According to sons. First, the ecological environment of
estimates by the DRC, the energy intensity of the interior provinces is relatively fragile
output (value added) by secondary industries compared with the east, and the costs of
in 2009 was eight times higher than agricul- “clean up later” would be prohibitive. Sec-
ture and five times that of services. Every per- ond, China’s population is aging rapidly. As
centage point increase in the share of services the surplus agricultural labor force that filled
in GDP is associated with a decline in energy the factories of the east gradually shrinks, it
consumption of 1.4 percentage points.7 will become impossible to sustain the kind
of labor-intensive growth observed over
past decades. Third, as China introduces
Additional Opportunities for China’s
more stringent policies to conserve energy
Underdeveloped Regions
and reduce greenhouse gas emissions, the
The green development approach can help potential for growth from high-emissions,
reduce China’s interregional inequality by resource-intensive industries will be limited.
helping its relatively underdeveloped central The interior provinces have a strong com-
and western regions catch up. Although his- parative advantage in clean energy resources
torically the eastern provinces always led in (State Grid 2010). Fourth, with rapid expan-
economic development, since 2005, growth sion of cities onto increasingly scarce land,
rates in the central and western regions have the national government has imposed stricter
overtaken the east (Liu and He 2011). How- controls on the use of land for industry (box
ever, the interior provinces should not follow 3.7). Thus, China’s underdeveloped regions
To protect the environment and avoid “polluting the rights of different regions to development con-
first and cleaning up later,” China’s State Council tains elements of a planned economy. Controversial
launched the “Main Functional Area Development aspects aside, the plan represents stringent environ-
Plan” in 2010. This plan divides all of China’s land mental regulation and will prevent certain regions
area into four major types: relatively affluent, indus- from following the more traditional path to devel-
trial, urbanized areas where development should be opment. Without the plan, local governments would
“optimized” to solve existing environmental prob- likely be unable to implement such strict environ-
lems; key areas for future development; areas where mental policies. Thus, by limiting or prohibiting the
development should be limited; and areas where development of certain regions, the Main Functional
development is prohibited. These classifications are Area Development Plan will encourage these regions
somewhat controversial: for example, restricting to take a new path to green development.
Source: DRC.
232 CHINA 2030
BOX 3.8 A “Big Push” model for green growth in poor areas: The case of Hunan
Huaihua in Hunan Province is endeavoring to take ing a “big push” to utilize new market mechanisms
full advantage of improved transportation, telecom- and build green economies that include conference
munications, and logistics networks to pursue a new centers, medical services, and eco- and cultural tour-
strategy for economic growth. The previously under- ism. A more productive division of labor is evolving,
valued intangible resources of the Wuling Mountain with the local population benefiting as both farmers
Area, such as its beautiful natural environment and and service providers. The slogan of this experiment,
rich cultural heritage, will provide a new source of “Villages Making Life Better,” suggests that villages
income for local people and help promote local eco- will no longer represent poverty in China but will be
nomic growth. a symbol of a high-quality lifestyle. More important,
Through the coordinated efforts of government the models are duplicable elsewhere.
and private entrepreneurs, poor regions are mak-
Source: DRC.
have a direct interest in growing green while to better connect a poor county of Hunan
avoiding the cleanup costs being incurred by Province with the market economy (box 3.8).
the eastern provinces. Elsewhere in China, other examples of green
Because their economies are currently less development are appearing every day. Search-
developed, many ecological, environmen- ing out different forms of green development
tal, and cultural resources of these regions that are suited to local conditions has great
have been preserved. With high-speed rail, importance not only for China but for other
highways, improved logistics, the Internet, poor countries as well.
and other telecommunication technologies,
the relationship between urban locations Green Improves the Quality of
and economic development is changing. By
capitalizing on better connectivity, the hith-
Growth
erto undervalued environmental resources People’s welfare includes such concepts as
of China’s interior regions may provide eco- good health, quality of life, and a clean envi-
nomic benefits that enable them to grow in ronment, in addition to income. While some
a way that does not require sacrificing their of these welfare concepts are not quantified in
environment. traditional measures of GDP, they can, never-
Many underdeveloped regions of China are theless, be measured. Improving the “quality
now pushing to develop in new ways, in areas of growth” implies improving some or all of
such as high-value-added agriculture, eco- these welfare measures. Even though China’s
tourism, cultural tourism, training and con- current levels of environmental degradation
ference centers, health care centers, and the and resource pollution, measured as a share
arts. Some of these innovations require new of gross national income, are much higher
business models, such as franchise businesses than in high-income countries, China has
that draw on local labor. Important oppor- already made great strides in improving these
tunities exist for payments for ecosystem ser- welfare measures. This section addresses the
vices as well as for installations of renewable magnitude of the welfare gains that can be
energy. For example, farmers in some poor made through green development. It also
parts of China have already transitioned from indicates that some improvements in envi-
selling timber to marketing ecosystem services ronmental quality are necessary investments
to earn a living. Another example is the more that will benefit the quantity of growth in the
complicated “big push” that is being piloted medium and longer terms as well.
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 233
Improving the Quality of China’s FIGURE 3.10 Environmental and natural resource degradation and
Growth by Reducing Environmental depletion, 2008
Degradation
10
Green development will reduce China’s cur- 8
% of GNI
rent high costs of environmental degradation 6
and resource depletion, which is crucial for 4
its continued growth and well-being.8 Under 2
no scenario can China achieve the quality of 0
growth that is already articulated in its 12th China India Brazil United Korea, Japan Germany
States Rep.
Five Year Plan and longer-term social and
economic targets without dramatic improve- Sources: World Bank World Development Indicators 2011; World Bank 2007; Shi and Ma 2009.
ment in the use and sustainability of its natu- Note: Here, environmental degradation includes damages from CO2, small particulate
ral resource base. The experience of Japan matter (PM10), and water pollution. Damages from CO2 are estimated at $20 per ton of
carbon (the unit damage in 1995 U.S. dollars) times the number of tons of carbon emitted.
shows that stringent environmental poli- Damages from PM10 are calculated as the willingness to pay to reduce the risk of illness
cies do not interfere with economic growth. and death attributable to particulate emissions. Damages from water pollution for China
are from 2003 and are based on estimates of health damages, calculated by monetizing
In fact, they may even catalyze growth. premature mortality from diarrheal disease and cancer associated with water pollution
Intervention-style environmental policies play and morbidity from diarrheal disease associated with water pollution (following World
Bank 2007). Natural resource depletion is the sum of net forest depletion, energy depletion,
an important role in this (Kobayashi 2011). mineral depletion, and soil nutrient depletion. Net forest depletion is unit resource rents
Economic growth and improving the qual- times the excess of roundwood harvest over natural growth. Energy depletion is the ratio
of the value of the stock of energy resources to the remaining reserve lifetime (capped at
ity of the environment thus may be mutually 25 years). It includes coal, crude oil, and natural gas. Mineral depletion is the ratio of the
reinforcing. value of the stock of mineral resources to the remaining reserve lifetime (capped at 25
years). It covers tin, gold, lead, zinc, iron, copper, nickel, silver, bauxite, and phosphate. Soil
The overall environmental benefits from nutrient depletion data come from Shi and Ma 2009.
green development can be substantial. At
China’s current level of development, the TABLE 3.1 Getting to a greener China
environmental degradation and resource Percent of GNI
depletion in the country is valued at approxi-
mately 9 percent of gross national income Environment depletion and 2009 “Greener” value, Net
degradation value reachable by 2030 improvement
(GNI), more than 10 times higher than cor-
responding levels in Korea and Japan (figure Energy depletion 2.9 1.9 1.0
Mineral depletion 0.2 0.2 0.0
3.10).9 A successful path of green develop-
PM10 health damage 2.8 0.1 2.7
ment would cut this value, by 2030, to the Air pollution material damage 0.5 0.1 0.4
much lower level of 2.7 percent of GNI a year Water pollution health damage 0.5 0.1 0.4
(comparable to current levels in the United Soil nutrient depletion 1.0 0.1 0.9
States)—at an estimated additional cost of Carbon dioxide damage 1.1 0.2 0.9
Total depletion and degradation 9.0 2.7 6.3
0.5–1.0 percent of GNI a year beyond cur-
rent spending on environmental protection. Sources: http://data.worldbank.org; World Bank 2007; Shi and Ma 2009; World Bank analysis.
Note: PM10 = small particulate matter.
While some of the benefits of this level of
investment in the environment come in the
form of financially viable “win-win” invest- externalities are internalized as efficiently as
ments, others would take the form of eco- possible in consumption, production, and
nomically viable investments in public wel- investment decisions throughout the econ-
fare and ecological health. omy. Prices of natural resources and key fac-
China’s specific environmental improve- tors of production will need to reflect scar-
ments would come from reducing reliance on city value as well as environmental costs and
fossil fuels, and achieving the lower levels of benefits. Green development, such as reduced
air pollution, water pollution, and resource reliance on fossil fuels, will improve local
depletion associated with high-income coun- environmental outcomes—such as reduced
tries (table 3.1). The best way to achieve these air pollution, land degradation, and water
improvements is to ensure that environmental contamination.
234 CHINA 2030
The largest part of the projected improve- air pollution. But despite improvements
ment would be the economic benefits asso- in urban air quality, the urban population
ciated with improvements in human health has grown so much that the total health
and material damage from reduced air pol- costs associated with air pollution, and the
lution. China faces one of the world’s highest exposure of the population most at risk, the
current and projected burdens of environ- elderly, continue to rise (figure 3.11).
mental disease linked to urban air quality A strong commitment to dealing with con-
(Cohen and others 2004; World Bank 2007). centrations of particulate matter in cities will
Trends in urban air pollution are improving, pay large dividends in improving health and
but the impact on health is still extremely social welfare. As China continues to grow,
large—nearly 3 percent of GNI in 2009. it will be possible to reduce air pollution lev-
The government has responded strongly els dramatically—just as Japan did starting
in recent years to address the problem of in the mid-1960s (figure 3.12). That is when
120 700
reference year 2000
600
yuan (billions),
100
500
80
400
60
300
40 200
20 100
0 0
2003 2004 2005 2006 2007 2008 2009 2003 2004 2005 2006 2007 2008 2009
FIGURE 3.12 Average annual SO2 and NO2 concentrations observed for the 10 largest cities in Japan and
China, 1970–2009
100
200
Shanghai
80
µg/m3
µg/m3
0 0
19 5
68
19 1
74
19 7
19 0
19 3
86
19 9
92
19 5
98
20 1
20 4
07
70
73
19 6
79
19 2
19 5
88
19 1
94
20 7
00
20 3
20 6
09
6
7
8
8
0
0
8
8
0
0
19
19
19
19
19
20
19
19
19
19
19
19
20
Sources: NIES database; Japan Ministry of Environment (1989); Kawasaki Air Pollution Monitoring Center; NBS, China Environmental Statistical
Yearbook, various years; city statistical yearbooks for Beijing, Tianjin, Shenzhen, Chongqing, and Nanjing, various years.
Note: Includes 10 largest cities in Japan by population in 1970; 10 largest cities in mainland China by downtown population in 2009 (excluding
Dongguan City, Guangdong). NO2 = nitrous dioxide; SO2 = Sulfur dioxide; µg/m3 = micrograms per cubic meter of air.
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 235
Japan’s air quality and other environmental critical water shortages in the north and
concerns reached crisis levels, and when it too northeast, where freshwater resources are only
was an upper-middle-income country. If air 785 cubic meters per capita, about 200 cubic
quality in China were brought to the level of meters below the international standard for
Japan in 1980, these benefits would be valued “severe water stress.”11 With the urban popu-
at 3.1 percent of GNI. In addition, these air lation growing by nearly 300 million over the
pollution improvements would bring large co- next two decades, the stress on existing sup-
benefits associated with reduced use of fossil plies will only increase. Cleaning up China’s
fuels, such as reduced depletion of fossil fuel water supply is a clear priority (box 3.9).
resources, improved water quality, improved Land degradation presents a similar prob-
soil quality, and reduced CO2 emissions. lem of scarcity. Heavy use of agrochemicals,
Pollutants in water and soil also affect pub- combined with pollution from cities and
lic health both directly and through the food industry has degraded soil quality. Accord-
chain. About 40 percent of the water sampled ing to the Ministry of Environmental Protec-
from the major rivers in the north and north- tion and the Chinese Academy of Engineer-
east is at Grade V or V+, making it unsuitable ing, heavy metal contamination of farmland
for most uses, whether recreational, agricul- is a serious issue raising concerns that these
tural, or industrial.10 This exacerbates already pollutants can make their way into the food
China’s surface and groundwater supplies are low on FIGURE B3.9.1 Wastewater emissions projections
a per capita basis, but useful supplies are much lower (COD), 2005–50
yet because of pollution. Although seen most vividly 100
in pictures of an algae-choked Lake Tai, across water-
90
stressed North China, 40 percent of the rivers fall into
the two worst water quality categories (Grades V and 80
V+), meaning direct use would endanger health. Water 70
treatment is very expensive. The government has nec-
Tons (millions)
60
essary, but ambitious, targets to control pollution:
50
Ministry of 40
Environmental Protection Targets 30
20
• By 2020: 60 percent of China’s surface waters
10
meet the standards for Grades I–III (compared to
57 percent in 2009) 0
• By 2030: 70 percent of China’s surface waters meet 2005 2010 2020 2030 2050
the standards for Grades I–III High emissions Medium emissions Low emissions
• By 2050: 80 percent of China’s surface waters meet 2020 targets 2030 targets
the standards for Grades I–III. Source: MEP and CAE 2011.
Note: Chemical oxygen demand (COD) is an indirect measure of the
Based on global experience, success in improv- severity of water pollution
ing water quality will depend on a combination of
aggressive regulatory monitoring and enforcement
with a strong set of economic incentives. China’s to reduce those sources of pollution, the country will
interventions to date have focused on industrial and need to tackle the even more difficult problem of
municipal point-source pollution. While continuing nonpoint sources.
236 CHINA 2030
chain (MEP and CAE 2011; Yang 2011). The climate mitigation, and local environmental
presence of contaminated arable land may benefits. McKinsey estimated the potential
also restrict land availability for agriculture, cost savings of these no-regrets low-carbon
which is already severely limited because investments available in China to be on the
of pressures from urban, industrial, and order of $65 billion a year by 2030. However,
infrastructural development. Indeed, total the co-benefits of these investments associ-
agricultural land may drop below the amount ated with improved productivity of China’s
mandated by the government as “the red workforce, thanks to fewer cases of respira-
line” below which self-sufficiency in grain tory illnesses each year, puts additional eco-
production will be hard to maintain. nomic gains at around RMB 148 billion ($20
billion) a year (measured in 2009 US$). The
magnitude of various other potential “win-
Environmental Co-Benefits of
win” strategies to improving public health is
Green Development
highlighted in table 3.2. Of these examples,
As highlighted in the previous section, there more efficient buildings that require less coal
are investments and management improve- to be burned for electricity would generate
ments that are cost effective (assuming effi- the largest health-related co-benefits (as much
cient markets), emissions reducing, and pol- as $9 billion), followed by the use of additives
lution reducing. These “no-regrets” cases in place of clinker in cement production (as
contribute, therefore, to economic growth, much as $2.7 billion).
TABLE 3.2 Direct savings and additional co-benefits of annual reductions in CO2 emissions, 2030
($, millions per year)
Additional benefits
Direct savings from from avoided
Sector Cost-saving abatement option reduced costs air pollution
The Benefits of Investing in Over the longer term, to improve its envi-
Environmental Protection ronmental quality, China’s government expen-
ditures related to the environment should be at
What are the costs China will face as it deals least 0.5 percent of GDP above current levels.
with the challenge of reducing the degrada- Any increased environmental expenditure in
tion of its natural assets (measured as a share China would include increased spending both
of GNI) and makes targeted increases in on pollution abatement and on efforts to pro-
spending on environmental protection? It is tect and restore the health of its ecosystems.
clear that cleaning up China’s environment Although China is already spending RMB
requires resources; otherwise, it would have 83.7 billion ($13.0 billion) each year on tree
been done already. planting programs to combat soil loss, flood-
Current annual investment in the treat- ing, and desertification, the cost-effectiveness
ment of industrial pollution in China—about of these programs can be improved by setting
0.15–0.20 percent of GDP—is roughly com- targets based on ecosystem health rather than
parable with the amount spent in several on acres of forest planted. It can also direct
European countries each year. Considering more investment to relatively neglected areas,
how fast China’s economy has grown over such as the conservation and restoration of
the past decade, this spending reflects a great wetlands and coastal ecosystems.
effort to reduce pollution, especially point- Evidence from the United States and else-
source pollution from industry. where shows that such expenditures have
Overall, however, cleaning up industrial extremely high rates of return when mea-
pollution is a relatively small fraction of sured in economic terms (for example, the
total environmental protection expenditures benefit-cost ratio of the U.S. Clean Air Act
by government and business in high-income is projected to be 25:1 by 2015 and 31:1 by
European countries. When the full range of 2020) (U.S. EPA 2011). Increased environ-
environmental protection activities defined mental expenditure in China would have
in the European System for the Collection of similar high rates of return by increasing nat-
Economic Information on the Environment ural and human capital in the economy. By
(EC 2002) are included, high-income Euro- this account, a relatively modest incremental
pean countries spent about 0.3 percent to 1.1 increase in environment-related expenditures
percent of GDP more than China on envi- would go a long way toward securing the
ronmental protection overall, measured as a gain in social welfare of 6.3 percent of GNI
share of GDP in 2008 (table 3.3).12 shown in table 3.1.
China — — — — — — — 1.23 —
France — — — 2.07 — — 2.16 — —
Germany 1.73 1.70 1.69 1.70 1.51 1.62 1.53 — —
Hungary 1.68 1.76 1.85 2.00 2.14 1.95 1.59 1.52 —
Italy — — — — — — — — —
Poland — 1.75 1.78 1.74 1.79 2.04 2.06 2.38 2.42
Portugal — — — — — 1.12 1.25 — —
Spain 1.48 1.55 1.56 1.54 1.61 1.69 1.78 1.83 —
Sweden 1.19 1.19 1.18 1.16 1.26 1.20 — — —
EU-25 1.90 — — — — 1.82 — — —
Sources: World Bank calculations based on Eurostat 2010, Eurostat database, OECD 2008, NBS 2010a, MEP and NBS 2010, MOF 2009, SFA 2009,
Wang and others 2010, Chang and others 2010, and Wu and others 2007.
Note: — = no data.
238 CHINA 2030
Adapting to a Changing Climate by the country where there is more indigent pov-
Increasing Resilience to Risk erty, other areas may actually benefit from
night-time warming, longer growing sea-
A further benefit that green development sons, and increased water available to irriga-
would bring to the quality of China’s growth tion systems (Wang, J. X., and others 2008,
is increased resiliency to climate risks.13 Chi- 2010). Coping with the significant variabil-
na’s climate is already changing, and changes ity of future impacts will require geographic
are likely to accelerate in coming years. Even shifts in production and more flexible and
taking into account current scientific uncer- robust water management.
tainty about the extent and nature of future Urban populations and industry will also
climate change impacts, preparedness for a be more exposed to extreme weather events.
more variable, unpredictable, and extreme Much of the population lives in areas where
future climate will be a prerequisite for sus- sea-level rise, storm surges, flooding, and
tained economic growth. Adopting planning tropical cyclones are a concern (figure 3.13).
and investment approaches to better address Indeed, economic damages from typhoons,
risks and uncertainties is a reason for China floods, and other severe weather events are
to fully incorporate climate change in its eco- already high: losses from typhoons alone
nomic management. in China averaged RMB 8.4 billion ($1.3
Among the observed effects of climate billion) each year from 1994 to 2005 (Guy
change are average annual surface tempera- Carpenter 2006). As the concentration and
tures increased by 1.38˚C between 1951 and value of productive capital and valuable
2009 for the country as a whole and much
faster in the north and northeastern prov-
inces (NARCC 2011). The number of rainy FIGURE 3.13 Vulnerability to sea-level rise and
days has decreased for most regions, and storm surges by country, circa 2000
more precipitation has come from shorter,
more intense storms (Di and others 2007;
China
Zhai and others 2005). The area of cropland
India
exposed to drought has also increased for Japan
many regions. In the years to come, despite Indonesia
more rainfall projected for China as a whole, United States
many regions may actually suffer from more Bangladesh
Vietnam
droughts (Woetzel and others 2009). Agri-
Thailand
culture will be particularly hard hit, because Egypt, Arab Rep.
precipitation will come during the winters Netherlands
and less during the crucial spring and sum- Brazil
mer months. The area of cropland affected Philippines
Ukraine
by flooding each year has increased signifi-
Myanmar
cantly for parts of the Yangtze River basin. Nigeria
Although the projections are highly uncer- Italy
tain, flooding may continue to increase for Argentina
this region in the coming decades (NARCC Germany
Malaysia
2007; Ren and others 2008).
Mexico
The agricultural sector is likely to have
the greatest early climate change impacts. 0 10 20 30 40 50 60 70 80
infrastructure increase in these areas, so TABLE 3.4 China’s unique advantages and
will potential damages. This is particularly challenges in green development
worrisome for long-term capital assets, such Advantages
as power grids, water supply and wastewa-
1. Government ability to mobilize action on high-priority
ter treatment systems, and road and rail issues
networks. 2. The advantage of being a relative latecomer
Institutions, planning processes, and 3. Large domestic market in which to scale up green
policies that effectively manage future risk sectors
through green development will increase the 4. Abundant capital (including human capital) to invest in
green sectors
resilience of China’s economy. In turn, China 5. Natural endowment of resources for clean energy
will be able to mitigate, recover quickly from 6. Potential to still avoid lock-in effects of higher levels of
damage caused by adverse weather, and be urbanization
ready to seize new opportunities for growth 7. A destination for global investments and R&D in green
should these arise. For example, long-term technologies
glacier melt on the Himalayan plateau will Challenges
generate both enormous challenges and 1. Distorted prices of resource commodities
opportunities for water conservation and 2. Overreliance on administrative measures for reducing
storage technologies. Opportunities for both carbon emissions
domestic and international gain abound in 3. Weak incentives for environmental protection
4. Lack of a competitive market environment for green
other sectors as well, such as agriculture,
sectors
building design, and infrastructure design. 5. Sector coordination failures
6. Weak monitoring and enforcement of environmental
Factors Favoring and Impeding standards, especially at the local level
TABLE 3.5 Comparisons of selected indicators for China and low-carbon technologies that face countries
developed countries with less rapid growth and less rapid turn-
Indicator China United States Japan OECD
over of capital stock.
Nevertheless, capitalizing on this advan-
Per capita GDP (US$, 2011) 5,445 48,442 45,903 37,029
tage and leap-frogging certain technological
Automobiles per 1,000 47 802 589 564
people (2009) stages into the most efficient and greenest
Per capita gasoline use 45 1,134 332 470 options will require early strengthening of
for road transport incentives. This is clearly shown in how rap-
(kg. oil, 2009) idly China has overtaken the United States in
Urbanization rate (%, 2011) 51 82 91 80
the efficiency of its coal-fired power plants
Source: World Bank, World Development Indicators 2011. (figure 3.14). In the past 10 years, due to
large-scale installations of larger and more
efficient supercritical and ultra-supercritical
can meet additional demand by building new power plants have led to a qualitative leap
green productive capacity and infrastructure forward in the overall efficiency of China’s
without having to eliminate equal amounts of coal-fired plants; those plants overtook the
existing physical capital. China’s current level U.S. coal-fired plants in efficiency in 2005.
of economic development is only one-eighth Third, a large domestic market allows
to one-tenth the level of developed countries, China to scale up green sectors. China has
measured in terms of per capita energy use, a vast domestic market that provides excel-
car ownership, and other indicators (table lent conditions for the formation of industrial
3.5). Because China is still in a stage of rapid green sector supply chains, giving companies
development, the incremental costs of green in China an advantage over competitors in
development will be relatively low. China other countries in seizing “first-mover advan-
can avoid the higher costs of transitioning to tages.” The rapid expansion of both wind
power and solar photovoltaics (box 3.10), for
instance, has shown that China is capable of
FIGURE 3.14 Efficiency and CO2 emissions of coal-fired plants in achieving economies of scale with the sup-
China and United States port of its large and growing domestic mar-
ket. Large market size drives down produc-
tion costs through learning by doing as well
37 1,100
as by lowering unit costs. Scale combined
1,080
36 with high investment levels and the abil-
CO2 emission intensity (g/kWh)
01
02
03
04
05
06
07
08
09
20
20
20
20
20
20
20
20
20
20
20
China is already the lowest-cost producer of solar companies producing silicon panels, more than 60
panels in the world, thanks in no small part to the companies making solar-powered batteries, and
country’s large domestic market, which has allowed more than 330 companies producing components
the solar industry to rapidly specialize and estab- for solar technologies. Fourteen Chinese solar com-
lish an efficient division of labor. From equipment panies are already listed on foreign stock exchanges,
manufacturing to the production of accessories and and 15 are listed on domestic stock exchanges. The
auxiliary parts, the indigenization of the industry industry’s annual production value now exceeds
has been especially fast. As part of the supply chain $45 billion, imports and exports have topped $22
for solar PV, by 2011, China already had 20 –30 billion, and the industry employs around 300,000
companies producing crystal silicon, more than 60 people.
master new technologies. Combined with the resources are also very high—almost two
advantage of its large domestic market, Chi- times its power generation capacity 2005
na’s ability to attract foreign companies and (NDRC 2007). In addition, China’s current
investors seeking to commercialize their own dependence on and large endowment of coal
technologies brings additional know-how also provides an opportunity—in the form of
and spillover effects. strong demand for cleaner coal, and the con-
Fifth, China has an abundant natural tinuing dynamism of investment in the coal
endowment of resources for clean energy.
China’s natural endowments, such as wind,
solar, biogas, and shale gas, favor new energy TABLE 3.7 Total exploitable renewable energy resources in China
sources (table 3.7). The country’s theoretic Gigawatts
solar energy reserves are equivalent to 1,700
Potential capacity based on resources (GW)
billion tons of standard coal a year, and
two-thirds of the country receives more than Wind power (on shore) 2,560
Wind power (off shore) 190
2,200 hours of annual sunshine. Compared Hydropower 542
with other countries at the same latitude, Solar photovoltaic 2,200
China’s solar energy resource is at par with Total 5,772
that of the United States and is much larger Source: Gao and Fan 2010.
than that of Europe or Japan. China’s wind Note: Small-scale hydropower includes retrofits.
242 CHINA 2030
FIGURE 3.15a What emissions growth path FIGURE 3.15b Which way will China’s transport
should China’s cities take? sector efficiency evolve?
25 5
United States
tCO2 emitted per person, 2009
20 4 Saudi Arabia
in 2009 (tCO2 /person )
Australia
Canada
Source: World Bank analysis based on IEA (2011a) and UN Population Source: World Bank analysis based on IEA World Energy Statistics
Division (2009). and Balances, World Bank World Development Indicators.
Note: Bubble size corresponds with total annual CO2 emissions. Note: Bubble size corresponds with total annual CO2 emissions.
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 243
for even stronger low-carbon policies in the FIGURE 3.16 Household water and wastewater
future. The sheer speed and scale of China’s tariffs in China’s 10 largest cities compared with
other major cities, 2008
urbanization and infrastructure construction
lends urgency to this issue, as does the rapid
expansion of the private automobile fleet.
Seventh, China is becoming a major desti- Copenhagen
nation for global investments and R&D. All Berlin
Paris
of the above advantages, coupled with China’s
Singapore
manufacturing capabilities, make it an excel-
Melbourne
lent location for investments in many global
Los Angeles
green technologies. Regardless of whether
New York City
future technologies are invented in China,
Tokyo
they will likely be commercialized there. The
Saô Paulo
cases of wind, solar, and cleaner coal technol-
Toronto
ogies are illustrative: the transfer rate of clean Osaka
energy technologies from developed countries Jakarta
to China is higher than to any other country Seoul
or continent (OECD 2010). Since more than Hong Kong SAR, China 0.54
70 percent of China’s energy consumption Beijing
comes from coal, there is a broad market Chongqing
space in China for technologies to clean up Tianjin
coal production and use. China can attract Shenzhen
the world’s best green technologies. This will Guangzhou
not only promote China’s own green transfor- Shanghai
mation but will also accelerate the develop- Wuhan
ment of technical options available elsewhere. Dongguan
Hangzhou 0.27
Mumbai
Factors Impeding Green Development
0 1 2 3 4 5 6 7 8 9
China’s advantages that favor seizing US$ per cubic meter
green growth opportunities notwithstand-
ing, China also has to overcome a range of Source: Global Water Intelligence 2008.
obstacles.
First, prices of resource commodities are
distorted. Because of market distortions and
rigidities, the major factor markets of land, extremely low by developed-country stan-
labor, and capital have encouraged capital-, dards (figure 3.16). For China to focus invest-
land-, energy-, and pollution-intensive devel- ments and innovation in green industries and
opment. As a consequence, damages to the technologies, it must pursue deep-reaching
environment and public health associated policy and institutional reforms and estab-
with the use of resource-intensive produc- lish markets in which prices reflect scarcity as
tion technologies have not been included in well as social and environmental costs.
production costs of companies; nor does the According to research by Huang (2010)
supply and demand of these resources on the and others, undervaluing China’s labor,
market reflect their true scarcity. Inefficient capital, land, energy, and environment is
pricing mechanisms, such as for water and tantamount to offering subsidies to resource-
land, is part of the cause, as are institutional intensive industries. For example, in 2009,
weaknesses, such as the strong presence of subsidies embodied in artificially low energy
monopolistic state-owned enterprises (SOEs). prices were equal to about 0.7 percent of
For example, water tariffs in China are GDP. According to H. Li (2011), based on
244 CHINA 2030
BOX 3.12 A lack of competition has held up China’s shale gas exploration
China possesses abundant shale gas reserves with developing the resources but lack access rights. The
an estimated 25 trillion–35 trillion cubic meters of result of this situation has been to hold up techno-
recoverable resources, comparable to the 38 trillion logical innovation in the sector.
cubic meters of conventional natural gas on hand.a Extracting shale gas involves surveying, drilling,
The country’s richest shale gas reserves tend to over- fracking, microseismic monitoring, environmental
lap with areas in which state-owned oil companies monitoring, water treatment, and other advanced
have registered conventional oil and gas fields. Under technologies. Exploiting shale gas resources requires
current policies, these reserves can be explored only sustained, successive investments over a span of
by existing state-owned oil companies. Yet, these many years. For that reason, it is particularly suited
companies are mainly interested in conventional for exploration through coordinated investment by
oil and gas resources and have made very lim- a diverse number of investors. For a single company
ited investments in exploring shale gas resources. to develop a site from start to finish often puts great
Some resources are claimed by companies but not strain on the investor and leads to low levels of effi-
explored. In other cases, companies are interested in ciency and a lack of technological innovation.
The Chinese government expects that been a problem in China, and one that has
SOEs will continue to play a leading role in been hard to correct.
strategic emerging industries, which may Fifth, coordination between sectors is
lead to disappointment given that SOEs have lacking. Coordination failures between gov-
historically been unable to take on the role ernment and the private sector, as well as
of green innovators. Not only do they lack between different levels of government, have
the same incentives to innovate, they have stalled key green development projects. The
also been placed in an awkward position complexity of coordinating different areas
by the government, which expects them to of public policy and investment is appar-
meet short-term GDP growth targets while ent with green industries, because they tend
also engaging in the innovation of high-risk, to span multiple sectors and because their
cutting-edge technologies. SOE managers infancy and focus on infrastructure often
are usually unwilling to take on the risk of require some form of government support.
failure; they are much more willing to pur- Typically, since each agency working in a sec-
chase new technologies than invest in R&D tor considers only what is in its own interest
on their own. and within its own purview, different agen-
There is also a problem of regulation. cies may hold each other back. The same
Currently, wind power development projects pattern holds for the central government and
smaller than 50 megawatts are approved by local government. For example, in the area
local governments, while projects larger than of clean energy, investment in a single project
50 megawatts are approved by the National may involve the National Development and
Development and Reform Commission. With Reform Commission, the National Energy
their powers of approval, local governments Administration, the Ministry of Environ-
have spurred a “clean energy rush” that has mental Protection, and various local agen-
quickly led to overcapacity by small projects. cies. Generating electricity and connecting
This campaign-style investment has long to the grid will involve the State Electricity
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 247
Regulatory Commission (SERC) and the instruments are used to reduce market
state-owned power companies. Pricing sub- externalities.
sidies are equally complicated and cumber- In summary, these six barriers will have to
some to navigate. In the case of SOEs, top be overcome through appropriate policy and
management will be evaluated by a number institutional reforms that together provide
of different agencies. clear incentives for changes in technologies,
For these reasons, the development of investments, and behaviors. That the list of
clean energy has been held back. For wind barriers is long should not be surprising; if
power, according to SERC, coordination it were otherwise, green development would
problems exist in several areas. First is the already be a reality in China. In the absence
difficulty in connecting wind power to the of reforms, financing for green investments
grid. In drawing up plans to develop wind will not be forthcoming because the cost
power, local governments tend to consider may continue to be seen as too high and the
only the availability of resources in one par- investments too risky.
ticular area in deciding the scale and timing
of grid construction. Less thought is given to Addressing Concerns on Green
the long-term development of the wind power
market. Second, the development of power
Development
generation capacity and the electrical grid While ample opportunities exist to increase
is not well coordinated. For example, China the environment and natural resource effi-
had proposed to construct seven large wind- ciency of the Chinese economy, there will be
powered generating bases (with a capacity trade-offs, winners, and losers. Policy makers
of 10 gigawatts) but did not lay down plans need to recognize that relative price changes
for how that electricity would be transmit- arising from changes in taxes, subsidies, regu-
ted and distributed. Third, the development lations, and standards generate losers as well
of wind power is not well integrated with the as winners. This section describes the impacts
development of other types of power. The of these changes on the economy, industries,
potential benefits of interprovincial trading regions, and socioeconomic groups. The next
and power switching are very high, although section provides more details on the numer-
coordination has proven difficult. ous policy options that government has avail-
Sixth, monitoring and enforcement of able to dampen negative impacts on different
standards remain weak, especially at the groups.
local level. For example, green building First, economywide trade-offs can be bal-
design standards have been issued but are anced. Concerns are often raised that the
not strictly enforced, even though buildings economic, social, and even political costs of
account for about 30 percent of the coun- green development are unacceptably high.
try’s energy demand. Standards for air con- Those concerns are misplaced. Although pur-
ditioners and large-scale chillers are lax. In suing green development will require greater
the case of wind farms, standards are lax or public investment in certain areas, such as
lacking for low-voltage ride-through, and for environmental protection and basic infra-
operating frequency (inactive versus active structure, the core of green development is
power). Since market externalities exist, by really to introduce market-based incentives
definition, in weak or distorted markets, the that raise the efficiency and sustainability of
public market regulatory role based on stan- China’s economy while also improving social
dards is essential. Weak institutions will hin- well-being. By no means does China need
der progress in green growth unless adequate to undergo “shock therapy” to transition to
institutional strengthening is undertaken. green development.
There is no substitute for strong monitoring Green development is unlikely to divert
and enforcement, even when market-based public expenditures from important public
248 CHINA 2030
on energy so that the environmental costs of and reducing air and water pollution levels,
extracting fossil fuels may be passed onto the are typically progressive because the poor
more affluent regions that consume more of have traditionally suffered the most. Invest-
these fuels, and introducing flexible trading ments in improved ecosystem health, biodi-
mechanisms for emissions and energy inten- versity, and watershed management will be
sity targets, may soften the negative impacts sustainable with local people’s engagement
on the interior provinces. and employment through ecological protec-
As discussed, the less-developed regions tion, restoration, and related payments for
of China will benefit in the long term by ecological services.
avoiding the costs of being locked into a
high-carbon pathway. Once green develop-
ment policies are put in place, they will also The Road toward Green
be able to better capitalize on previously Development
undervalued resources, such as water, forests, Whether China can capture strategic green
grasslands, and renewable energy. Since these opportunities over the next two decades will
regions should no longer follow the prec- depend on whether it can implement reforms
edent set by the more affluent provinces in sufficient to remove the obstacles in its way.
growing first and cleaning up later, they will Wide-ranging policies are needed to provide
find new opportunities provided by green the necessary long-term incentives to the
development. private sector and to strengthen the public
Fourth, different socioeconomic groups sector’s regulation of lingering environmen-
will experience different effects. Since energy tal problems. Policies for green development
use is so pervasive in production and in the should focus on six main goals, listed in
household, reforms in energy and carbon table 3.8.
pricing will affect a broad range of consumer
prices, and the net effect may be regressive
for some households. In general, energy Goal 1: Provide Strong Market Stimuli
price increases will generally be progressive for Transitioning to Green Development
rather than regressive, since high-income The basic drivers of green development are
households use proportionately more energy market stimuli. The most pressing market
than poorer ones (Cao 2011). In contrast, reforms will kick-start the transformation of
some argue that poorer households are more traditional sectors, start reducing environ-
emissions intensive because of their heavy mental externalities, and mainstream long-
dependence on coal (Golley, Meagher, and term sustainability goals. The highest prior-
Ming 2008). In response, fiscal transfers to ity interventions are described here.
households, financed by revenues from eco- First, reform pricing mechanisms for coal,
taxes, resource fees, or emissions reductions electricity, gas, water, and other resource
auctions, could be transferred to consumers commodities to provide the basic market
to offset price increases without affecting conditions for green development. This is the
incentives to use energy more efficiently. Even
more important, carbon revenues might be
best considered in a revenue-neutral fashion, TABLE 3.8 Key policy packages to achieve green
in which the selection of revenue sources to development
be replaced would also have a distributional
1. Provide strong market stimuli for transitioning to green
element. The specific distributional impact of
development
a carbon emissions trading scheme can also 2. Foster green sources of growth
be adjusted by freely allocating permits in the 3. Improve environmental quality
initial stage (Zhang and Wu 2011). 4. Minimize the negative impacts of green development
Other aspects of green growth reforms, 5. Manage risks associated with climate change impacts
6. Strengthen local institutions
such as strengthening rural property rights
250 CHINA 2030
most urgent reform so that prices reflect not might initially cover about 1,000 high emit-
only the market scarcity, but also as much ters, or about one-third of the country’s
as possible the external hazards imposed on total emissions.15 The emissions of most
the environment and health in the process of other enterprises could be addressed through
mining, producing, and using these resource other emission reduction policy instruments.
commodities. At the same time, this reform Fourth, new assessment methods should be
requires removing and eliminating direct and established for emission reductions by prov-
indirect subsidies for the traditional energy ince. Provinces should be able to reduce their
and resource commodities and charging the actual carbon emissions, or achieve their
SOEs full market price for their resource reduction targets through cross-regional or
inputs (such as minerals, oil, natural gas, national trading.
shale gas, and coalbed methane). The approach described here puts a price
Second, continue to impose CO2 emission on carbon using diversified instruments
reduction targets and accelerate the estab- including a cap-and-trade market mecha-
lishment of market-based mechanisms to nism. Analysis shows that China will be
reduce emissions. The Chinese government able to limit its emissions significantly with-
has announced ambitious plans to reduce out reducing social welfare (see annex 3A
emissions of carbon dioxide and expand for details). Any carbon revenue collections
environmental protection, and the emission could be done in a revenue-neutral way. For
reduction and environmental protection example, recycling the revenue from emis-
objectives set for local governments are bind- sions auctions by offsetting labor taxes nor-
ing. For example, in 2020, the CO2 emissions mally paid by employers is one way to achieve
per unit of GDP are targeted to be 40–45 job creation goals through green growth. In
percent lower than they were in 2005. How- this way, governments tax “bads” such as
ever, these policy objectives rely too much CO2 emissions rather than “goods” such as
on administrative measures, and emission labor. Such a strategy has proven successful
reduction and environmental resources are in Germany, where revenues from a tax on
not optimized. The measures do not promote fossil fuels and electricity were channeled to
technological innovation to the extent pos- workers’ pension funds, thereby lowering the
sible. According to the DRC Project Team overall cost of labor and contributing to a net
(2011), the following short-term steps should increase in employment (cited in ILO 2011).
be considered. First, the current target for Third, strengthen other environment-
reducing the carbon intensity per unit of related markets and introduce market-based
GDP should be converted into a total emis- environmental incentives. Property rights for
sions reduction target to create the conditions water, land, and forests should be strength-
for introducing more flexible market mecha- ened, and market mechanisms for water,
nisms. Second, the emissions cap could then ecosystems, and land should be increas-
be distributed in accordance with advanced ingly introduced. These resource issues are
industrial emission standards, regional GDP complex, politically as well as socially, but
per capita, and other criteria, and a carbon urgent. Poorer regions, for example, might
budget account could be established for each bring new areas of land under cultivation
area. The carbon budgets set by the differ- and sell these quotas of farmland to the more
ent provinces can be balanced to ensure the developed regions to increase the efficiency of
achievement of nationwide targets. Third, land use. For water-scarce regions, conserva-
flexible and diverse mechanisms should be tion and quality improvements can be driven
established to achieve emission reduction tar- by the market. For degraded ecosystems,
gets, including emissions trading, a carbon expanded payments for ecological services in
tax on fuels, emission technology standards, poor and ecologically important rural areas
regional cooperation mechanisms for emis- (for example, upriver watersheds or down-
sion reduction, and administrative control river flood plains) are needed (Bennett 2009).
measures. Among them, emissions trading These programs have the potential to provide
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 251
Prices are typically very poor for signaling the car- ing under the general heading of “cognitive biases”
bon content of consumer products, even if a country (Diamond and Vartiainen 2007):
has adopted carbon pricing, since it is likely a very
• Status quo bias—the tendency to “continue doing
small share of a product’s price. As a result, guiding
what you are doing” instead of taking more prof-
consumers to choose low-carbon goods and services
itable actions
through other means than pricing will be a key fac-
• Anchoring—giving undue weight to one piece of
tor in determining the country’s future emissions
information over other available information
profile.
• Heuristic decision making—for example, using
In the United States, households use one-third of
“rules of thumb” to evaluate investments instead
total energy, and it is estimated that existing energy
of accurately accounting for expected costs and
efficiency measures, if they were widely taken up,
benefits
could save 30 percent of household energy use,
reducing overall energy use by 10 percent (World Given these and similar divergences from what
Bank 2010). While these measures would be money economists would consider rational behavior, tradi-
saving as well as energy saving, many households tional economic incentives such as taxes and subsi-
never invest in profitable energy efficiency measures. dies may only weakly influence consumer behavior.
Compact fluorescent lighting (CFL) provides one A broader policy mix for energy efficiency could
example: while the up-front cost of CFL bulbs is therefore include information programs (which can
higher than it is for incandescent bulbs, the life-cycle help to reduce anchoring effects and status quo bias)
cost is lower. In practice, the uptake of CFL bulbs by and quotas and technical standards (which can over-
consumers continues to be low in many countries. come the limitations of heuristic decision making).
While this low uptake may be due to credit con- Similarly, promoting social norms in favor of saving
straints, behavioral economics also offers a range energy and avoiding waste can help to change con-
of explanations for this household behavior, fall- sumer behavior at relatively low cost.
“locking in” their carbon footprints, espe- Information disclosure. Health damages
cially given the scale of urban construction. from air pollution in China’s cities are increas-
Compliance with standards can be increased ing as the urban population grows faster than
through tougher inspections and buttressed air quality improves. Investing in the moni-
by market-based incentives (such as insur- toring of the most damaging pollutant, PM 2.5
ance policies that require flood proofing or (fine particles in the air 2.5 micrometers or
compliance with energy efficiency standards). less in size), and then regulating it, is the first
And a fourth is to establish labels and stan- step to curbing this trend. Better public dis-
dards for green products, services, and tech- closure of air quality data is critical for both
nologies so they are easily recognizable and awareness and effective action, and, indeed,
understood by consumers. China began to take steps in this direc-
Government procurement. Government tion when the State Council added PM 2.5 to
can signal its seriousness about environmen- national air quality standards in March 2012.
tal goals by changing the way it conducts its In rural areas, an expanded network of water
own business. The most important and per- quality monitoring stations is needed to iden-
vasive approach would be to introduce green tify and reduce nonpoint sources of pollution
standards for the roughly RMB 1 trillion from agriculture, the next major challenge to
($155 billion) in government procurement improving China’s water quality.
each year, which can open up a huge mar- Waste minimization and recycling in cit-
ket for green products and usher in a robust ies. Recycling guidelines and targets can
period of private sector growth. reduce the need for new urban landfills or
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 253
incinerators. By some estimates, China may this shift may pose adjustment challenges.
need an additional 1,400 municipal land- Similarly, jobs in pollution-intensive indus-
fills over the next 20 years, creating siting tries will decline, while those in clean indus-
challenges and competition for scarce land tries will increase. Through a mix of prop-
resources. Waste separation and recycling erly designed policies, the adverse impacts of
could significantly reduce waste generation green development can be minimized.
and landfill. Germany and the Netherlands, First, for regions most affected by poli-
for example, send only 1 percent of their cies to reduce emissions, compensation for
waste to landfills and recycle 60 percent. carbon pricing (whether through taxation
Reducing waste will be especially critical as or tradable permits) could be made through
the size and population of Chinese cities con- fiscal transfers. If done in a fiscally neutral
tinue to grow and as land becomes scarcer. manner, other taxes that may be more regres-
Immediate measures to protect natural sive could be replaced by carbon revenues.
resources and biodiversity. The natural- In addition, where price increases in water,
resource-oriented market mechanisms men- electricity, oil, gas, and other markets specifi-
tioned above will take time to implement, cally affect low-income groups, progressive
and many of China’s ecosystem problems are “social” tariffs could be introduced.
urgent and irreversible. Therefore, comple- Second, if carbon trading is introduced,
mentary measures are required to invest in the initial allocation of permits, both by
ecosystem management programs, protected sector and across regions, can be done in
areas, and watershed conservation. (In some an equitable manner with the specific cost
cases, maintaining healthy ecosystems, such of the low-carbon transition in mind. Less-
as wetlands and coastal mangroves, can be the developed areas may have relatively fewer
most cost-effective way to manage weather- opportunities for emissions reductions and
related risks, such as storm surges and flood- may therefore receive more favorable emis-
ing.) In parallel, investments in water use effi- sions allocations so that their economies are
ciency and water quality monitoring stations not negatively affected. High-emission enter-
would complement market-based initiatives prises that may be most affected (especially
concerning water rights, just as investments industries still subject to price controls or
in agricultural R&D and extension services that cannot pass on the cost of carbon emis-
would complement reforms concerning agri- sions to consumers) could receive free alloca-
cultural land property rights. tions at the beginning, moving to a partial
and then full auction over time.
Third, for displaced workers, job retrain-
Goal 4: Minimize the Negative Impacts
ing as well as labor market policies that per-
on Vulnerable Groups
mit workers to move to new jobs and loca-
Overall, green development will bring enor- tions at relatively low cost will be needed.
mous benefits for China; however, as with Managing this transition, and ensuring that
previous reforms such as those leading up to the pace of change is well within the capacity
China’s accession to the World Trade Orga- of the economy to absorb, will require care-
nization, some sectors, regions, and groups ful policy planning and proactive implemen-
will inevitably bear higher costs than others. tation of social safeguards.
The introduction of reforms, whether fiscal
and financial incentives or nonmarket policy
Goal 5: Reduce Risks Associated with
instruments (such as new standards and reg-
Climate Impacts
ulations), will inevitably alter relative prices
and change the profitability of different sec- In parallel to reducing the social and eco-
tors. Pollution-intensive sectors will see prof- nomic costs of green development, China’s
itability reduced, while green sectors will see future strategy should also reduce environ-
profitability enhanced. Resources will need mental risks associated with the impacts of
to shift over time from one to the other, and climate change. China’s climate will not only
254 CHINA 2030
become warmer, it will become more vari- respond to disasters are critical, especially if
able, with both greater extremes and increas- the intensity and destructiveness of extreme
ing frequency of extreme weather events. weather events increases.
Policies to better understand and manage Offer insurance and other financial
risk—and recover from damages—are pro- instruments to transfer risk and assist with
growth by nature, because they reduce uncer- recovery. Such instruments include disaster
tainty and diversify risk. New planning tools and calamity funds, contingent lines of cred-
can help ensure that long-lived infrastructure its, insurance, microinsurance, reinsurance,
assets can withstand future climate change and risk pooling. Insurance schemes can be
impacts, and new financial tools, such as designed to encourage beneficiaries to avoid
insurance for disaster recovery, can help occupation of high-risk areas, comply with
spread risks arising from adverse weather. building standards, and implement flood-
The recommended steps include: and storm-proofing measures.
Improve information on weather-related Invest in agricultural R&D and extension
risks. Already, China has invested consider- services to help make the agricultural sec-
ably in its network of weather monitoring tor more resilient to the impacts of climate
stations, and it has set up emergency alert change. Well-funded research institutions
systems in coastal areas. The country can can help develop new seeds and management
continue to improve its understanding of techniques that require fewer agrochemi-
past, present, and future impacts of climate cal inputs and are better suited to changing
change by increasing the quantity, quality, climate patterns. More effective extension
and accessibility of weather data. It should services can help to diffuse these technolo-
also continue to invest more in public insti- gies and practices. In this effort, cooperation
tutions to research, analyze, and disseminate between the public and private sector will be
this information. critical.
Update and develop new climate-robust Mainstream risk management into devel-
technical standards for valuable infrastruc- opment planning. China has issued laws
ture and physical assets. For example, China for protecting cities against floods, the out-
should ensure that transmission lines and dis- break of disease, and other hazards; how-
tribution systems for power grids in coastal ever, the current approach to risk manage-
areas are designed to be resistant to increases ment is highly fragmented, especially at the
in sustained peak wind speeds. Storm-water local level. Planning for weather-related risks
drainage systems in cities should be designed should be better integrated into infrastruc-
to handle changes in peak daily and weekly ture and land use plans. Risk management
rainfall at least 30 to 40 years ahead. And audits should be incorporated into perfor-
ports should be assessed for exposure to at mance evaluations for local officials.
least 50–100 centimeters of sea-level rise.
Strengthen the enforcement of technical
Goal 6: Strengthen Local Institutions
standards and building codes. Not only do
building codes and other standards need to Smart urban planning, water supply man-
be climate robust, they should also be uni- agement, pollution control, and disaster risk
formly enforced. Compliance with standards reduction planning all require coordinated
can be increased through tougher inspections action at the lowest levels of government.
and the introduction of more market-based To achieve this, measures are needed to
incentives (such as insurance policies that strengthen local-level governance and insti-
require flood proofing or compliance with tutions and to provide clear incentives in the
energy efficiency standards). direction of green growth. New, sustainable
Enhance disaster response systems. sources of fiscal revenue and standards for
Emergency preparedness plans and coordi- evaluating the performance of local govern-
nated procedures for government agencies to ment agents are needed to provide the right
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 255
incentives for provinces, cities, counties, and have good demonstration effects and can be
townships to pursue green growth strategies. imitated elsewhere. Yet, local institutional
First, encourage different regions to innovation is often suppressed because local
explore different models. In the past, some officials are still under immense pressure to
of China’s most successful reforms, such as grow their economies and protect jobs, and
the household responsibility system, origi- officials from different localities or bureau-
nated as local experiments that were later cracies often lack the incentives to cooperate
scaled up. The same could be said for green in solving transjurisdictional environmental
development. Because green development problems. The current competition between
is still in its infancy, some places will play municipalities across China is healthy, but
a pioneering role. For example, in Baoding could benefit from following some basic prin-
and Rizhao, bold efforts are under way to ciples for low-carbon urban development
deploy clean technologies, improve energy (box 3.14).
efficiency, and reduce greenhouse gas emis- Second, improve coordination vertically,
sions. The success of a few regions will between the central state and provinces,
Cities account for about 70 percent of energy-related • Managing cities’ physical growth. Cities need to
carbon emissions worldwide. That share is expected intervene in the shape and direction of their physical
to increase to 76 percent by 2030, with most of the growth. Cities with higher densities emit less green-
increase coming from rapidly urbanizing countries house gases. Cities not only need to grow denser but
such as China and India. Chinese cities already also smarter, fostering compact communities, mul-
have relatively high levels of per capita greenhouse tiple use buildings, and public transport networks.
gas emissions. With hundreds of millions of people • Support of low-carbon lifestyles. With rising
expected to migrate to the cities in China over the income and higher individual purchasing power
next 20 years, implementing policies to reign in car- and consumption demands, a low-carbon lifestyle
bon emissions in urban areas will be a central feature will be a key determinant factor of future energy
of China’s emissions reduction strategy. Taking into demand in Chinese cities. Some tools have been
consideration the characteristics of Chinese cities, developed internationally to engage citizens in
the following elements are essential building blocks understanding their household carbon footprint
for successful low-carbon urban development: and taking action to reduce it. Similar partnerships
at the city and neighborhood level in China could
• Increasing energy efficiency and clean energy contribute to less carbon-intensive households.
sources. Cities should make a consistent and • Replacing energy-intensive manufacturing with
dedicated effort to reduce carbon emissions by low energy-intensive economic activities. Changes
sustaining demand-side energy efficiency mea- in the urban economic base, such as through
sures—particularly in industry, power, heating, expanded services, will reduce emissions. However,
and buildings. In addition, clean sources of energy such strategies need to be considered carefully.
supply can be developed within cities, with roof- For today’s industrial centers, simply relocating
top solar PV and solar water heating installations. higher-emission industries outside a city boundary
• Reducing transport sector emissions. To minimize to reduce the carbon footprint of that city would
emissions from the transportation sector, reduced make little (if any) difference on the national scale.
motorization will be required. Decisive action But rapidly growing small and medium cities may
should be taken to both adopt new technologies have the opportunity to leap-frog and bypass the
and provide high-quality public and nonmotor- polluting, high-carbon growth paths taken by the
ized transport. earlier generation of Chinese cities.
and horizontally, between different agencies Adjusting the tax structure by establish-
and across jurisdictional boundaries. Urban, ing stable local revenue sources (such as a
transport, and environmental problems are property tax, not land sales) is fundamental
not confined to the jurisdictional boundar- to more efficient land use. A property tax
ies of local governments. The design aspects, would also encourage localities to improve
costs, and benefits of land use planning, the quality of the environment so as to raise
transport networks, and water resources property values and thereby increase local
management are not confined to one juris- tax revenues. The introduction of explicit
diction. Also, competition between local performance indicators for local govern-
governments to attract business investment ments that support green growth is also
and create jobs can discourage coordinated key. Higher-level governments could reform
planning on issues such as protecting against the performance and promotion system to
floods or preventing urban sprawl. Incen- reward lower-level officials who place new
tives are needed to encourage smart urban and specific emphasis on measuring the qual-
planning and risk management by local and ity of growth and the sustainability in the use
regional government agencies. Transjurisdic- of natural assets. Indicators of “greenness”
tional bodies, such as river basin commis- and quality of growth should carry the same
sions and regional planning boards, should weight as GDP in performance reviews. To
be given more authority. Membership should make these indicators work, local targets
be expanded to include representatives from for ecosystem health will be needed, and
multiple line agencies, local governments, jurisdictional authority of various agencies
and major users of natural resources. responsible for meeting these targets need to
Third, provide greater environmental be clearly defined by law in anticipation of
protection incentives for local governments. possible bureaucratic gridlock.
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 257
aNNI % growth rate 5.5 0.6 2009 Growth of real per capita PPP $, 2000–09
ANS % of GNI 37.7 5.5 2009 Share of GNI
Energy productivity 3.77 6.73 2009 Constant 2005 PPP $ GDP per kg oil equiv.
Share of fossil fuels 92.6 82.9 2009 % of total primary energy use
Alternative and nuclear energy production 3.53 13.88 2009 % of total energy use
CO2 intensity of energy 3.44 2.54 2009 tCO2 per t oil equivalent
CO2 intensity of GDP 0.91 0.38 2009 kg CO2 per 2005 PPP $ GDP
CO2 emissions per capita 5.67 10.36 2009 tCO2 per capita
Sources: World Bank, based on World Bank World Development Indicators; BP (2011); and U.S. EIA database.
Note: aNNI = adjusted net national income; ANS = adjusted net savings; tCO2 = tons of carbon dioxide.
FIGURE 3A.2 CO2 emissions per capita and per unit of GDP, 1990–2009
15 1.5
Tons CO2 per capita
10 1
5 0.5
0 0
1990 1996 2002 2008 1990 1996 2002 2008
China United States Korea, Rep. Japan Germany World
Sources: World Bank, based on World Bank World Development Indicators; BP (2011); IEA, World Energy Statistics and Balances; and U.S. EIA,
International Energy Statistics.
energy productivity is half that of OECD renewable energy, the declining share of coal
countries; its fossil fuel share of energy in total energy use, the declining level of aver-
is 10 percent higher than in OECD age urban air pollution; and the increasing
countries; its share of renewable and value of water productivity. Chinese targets,
nuclear energy production is only one- based on international benchmarks, could
quarter that of OECD countries, and its include:
CO2 intensity of GDP is more than twice
that of OECD countries. (On a per capita • An OECD benchmark of energy produc-
basis, however, OECD countries emit 80 tivity that nearly doubles between 2010
percent more CO2 per capita as China.) and 2030
• The EU target of reaching a 20 percent
As China transforms its economy toward share in renewable energy by 2020 and 30
high-income status, both benchmarks and percent by 2030;
targets will be useful in measuring progress • The Japanese air quality level of 25 micro-
toward greening growth. For example, spe- grams per cubic meter (µg/m3) in annual
cific targets could be set, such as the share of average PM10 concentrations
260 CHINA 2030
The World Development Report 2010 on climate tion to a lower-carbon investment. It does, how-
change outlines the issues concerning instrument ever, lead to some windfall profits and also delays
choice for reducing carbon emissions. Permit sys- adjustments by firms. The European emissions
tems give certainty on emission reductions but trading scheme is phasing out the free allocation
uncertainty about price. Taxes are the opposite— of permits.
they give certainty on price, but uncertainty about • Start-up. Trading schemes have tended to overal-
emission reductions. Because price volatility is more locate in the initial phase, leading to a price col-
of an issue with permits than taxes, investment in lapse. Allowing permits to be banked can over-
R&D for new technologies (especially without gov- come the price problem but also carries forward
ernment support) may be depressed with permits. the surplus permits into the next phase. Other
Revenue generation is possible under both regimes, options include establishing a price floor with can-
although the administrative efficiency of the instru- cellation of any unsold permits or using a fixed
ments differs considerably. Taxes can be integrated price in the initial phase, which would aid in the
with fuel excise systems, requiring little additional collection of emissions and cost data to better
monitoring effort. Permit systems require new regu- guide subsequent phases.
latory institutions as well as monitoring and enforce- • Support to carbon-intensive sectors. Concerns
ment systems to ensure compliance. about potential competitive impacts on carbon-
T he I nternational Energy Agency recently intensive sectors will lead to lobbying for finan-
reviewed existing and proposed carbon trading cial support to these sectors. Any support should
schemes in Alberta, Australia, the European Union, be time limited, and communicated as such, to
New Zealand, Switzerland, Tokyo, and the United reduce fiscal costs and provide incentives for firms
States (both national and state-level schemes). Some to invest in less-polluting technologies.
of the key conclusions are:
In practice, many jurisdictions have opted for
• Targets. Ambitious long-run targets are needed hybrid schemes, using tradable permits for the big
if firms are to invest in lowering their carbon emitting sectors and taxes for smaller sectors char-
footprints. acterized by many actors, such as transport. Envi-
• Allocation. Countries tend to allocate permits ronmental taxes and levies are used in all OECD
free of charge or to rebate costs to sectors heavily countries, raising revenues totaling 2.0–2.5 percent
affected by taxes, since doing so eases the transi- of GDP.
portion of coal-fired power in total real out- RMB 290 a ton of CO2 ($43 in 2007 dol-
put by the sector) drops 6 percent and 11 per- lars) generates the same amount of economic
cent by 2030 in the $10 and $20 carbon price co-benefits associated with reduced air pol-
scenarios, respectively. This drop is made up lution, improved health, and increased crop
for mainly by an increase in output volume production. According to this analysis, the
for hydropower. co-benefits in China associated with reducing
These results actually underestimate carbon emissions and recycling carbon tax
the benefits of the simulated carbon price, revenues are substantial.
because they do not include the co-benefits
for human health and crops that come from
Sectoral Considerations
reducing fossil fuel use. One important study
(Aunan and others 2007) shows that the cost Fully pursued, green development will per-
to households of imposing a carbon tax of vade all sectors of the economy, ranging from
262 CHINA 2030
FIGURE 3A.4 Coal consumption trends for China industry and energy to the management of
under three scenarios, 2011–30 cities, water resources, agriculture, forestry,
and biodiversity resources. Background
papers prepared for this report include sector-
Tons of coal consumed (millions)
3,400
specific studies of the issues involved in achiev-
3,200
ing green development targets by 2030.18
3,000 Each sector-specific paper follows a simi-
2,800 lar structure; it first sets out a vision for
2,600 China 2030 consistent with its status as a
2,400 high-income country, and then analyzes the
2,200 issues surrounding the implementation of
2011 2015 2020 2025 2030 that vision. While each sector is very differ-
Business as usual ent in its challenges and targets, the recom-
Carbon price of US$10 per tCO2 mended actions fall into the various policy
Carbon price of US$20 per tCO2 packages introduced in this chapter. Table
3A.2 summarizes the key findings of these
Source: World Bank analysis.
seven sectoral background papers.
Today’s challenges Short-term targets and policies Medium-term targets and policies Long-term goals (by 2030)
Energy Seek cost-effective, market- Scale up and accelerate innovation Develop a sustainable, efficient, and
based solutions using existing competitive energy sector
technologies
Reduce energy sector subsidies and Scale up renewable energy in a A greener energy mix in which
introduce market pricing competitive market renewable energy meets 30 percent of
primary energy demand
Invest in improving performance and Cap fossil fuel consumption Carbon emissions peak and decline
reducing cost of existing renewable and deploy carbon capture and
energy technologies sequestration on a large scale
Amend energy legislation and create a Implement carbon cap and trade Chinese energy companies are world-
more effective regulatory body class businesses, operating in an open,
competitive market
Continue to focus on reducing energy A sound, fully functioning public
intensity and improving efficiency regulator separate from the government
focused on making policy
China is the global leader in clean
energy technologies and innovation
Water Use directives and market-based Deepen resource governance Achieve efficient, balanced, and
approaches to control water use by reforms; ensure clean water sustainable use of water resources
main sectors supplies and sanitation
Introduce consumption-based Expand water allocation right and fee All major water users are covered by
water allocation rights and fees for programs to other major basins and consumption-based allocation system
agriculture and industry industrial sectors
Launch national rural sanitation Ensure safe drinking water from the Safe drinking water for all urban
program tap for large cities and improved residents
sanitation for all rural people
Expand membership in a major river 60 percent of China’s surface waters 70 percent of China’s surface waters
basin commission to include a wider meet standards for Grades I–III meet standards for Grades I–III
range of water users
SEIZING THE OPPORTUNITY OF GREEN DEVELOPMENT IN CHINA 263
TABLE 3A.2 Sector-specific recommendations for achieving green growth in China Continued
Today’s challenges Short-term targets and policies Medium-term targets and policies Long-term goals (by 2030)
Double efficiency of water use and Expand river basin commission Water use efficiency reaches current
achieve 50 percent reuse rate in membership for all major rivers; new high-income country average
industry by 2015 financial mechanisms such as flood
insurance
Expand payment for ecosystem Water use efficiency doubles again
services
Cities Pilot new regulations, policies, Scale up coordinated policies for Create efficient, livable, and
and financing mechanisms to alter land use planning, urban finance, sustainable cities
current growth patterns and urban governance
Pilot new performance indicators for Roll out green growth performance
local officials indicators for local officials across the Urban in-fill and higher density without
country spatial expansion
Introduce new financing mechanisms Expand fiscal support tools Livability achieved through connectivity,
to support green growth and steer strategic development corridors, and
cities away from land sales efficient transport options
Pilot a flexible land conversion quota Create functioning urban and National integration of markets of
and reallocation mechanism peri-urban land markets in several goods, capital, and labor
municipalities
Change regulations and standards Coordinate all new development and Low-carbon status through overall
leading to inefficient land use mass transit plans with urban land use resource use efficiency, bench-marked
zoning regulations internationally
Roll out market-based mechanisms to
encourage efficient resource use
Ecosystems Identify and implement immediate Bring all major ecosystems Halt biodiversity loss and the
actions needed to restore under sound management and degradation of ecosystems
ecosystem health significantly reduce the costs of
ecosystem degradation
Introduce targets for all natural Ecosystem health targets for NRM fully Integrated ecosystem landscape-scale
resource management (NRM) sectors incorporated and given equal weight planning with full cost and valuation
based on measures of ecosystem as production targets data
health
New incentives introduced for All KBAs are well-managed Perverse environmental subsidies are
restoration of degraded ecosystems components of the national protected eliminated
and ecosystem services, providing area (PA) system
rural employment
Key biodiversity areas (KBAs) are Agrochemical and fertilizer use is Biodiversity loss is halted
designated and actions taken to begin halved
management of these areas
Agricultural production targets Remediation actions started for Land degradation is halted
reoriented and remediation measures farmland that is most contaminated
taken to restore agricultural system with heavy metals
health
Inspection capacity is doubled and Invasive species costs and illegal Health of major ecosystems is restored
penalties are increased for illegal product trade are both halved
import or sale of native or imported
wild products
Urgent actions needed to protect Efficient and effective national-level PA
forest health are identified and system is in place
implemented in remaining natural
forests
TABLE 3A.2 Sector-specific recommendations for achieving green growth in China Continued
Today’s challenges Short-term targets and policies Medium-term targets and policies Long-term goals (by 2030)
Agriculture Remove market distortions Create a competitive agricultural Develop modern, commercial
market focused on high-value smallholder agriculture
products
Reforms in support of rural land rental Land consolidation through improved Fully functioning land markets
markets rental markets and supporting
institutions
Limit growth of agricultural subsidies Expand extension services to better Measurable share of low-carbon
(even if WTO-compliant) manage climate change risks agriculture
Reform extension services Scale up pilot schemes for input- Complete coverage of low-water
saving technologies technologies in water-scarce areas
Reform producer cooperatives Strengthen producer cooperatives in
supply chain for high-value agricultural
products
Air pollution Invest in systems to control the Bring pollution to within safe limits Complete coverage and attainment
and waste most damaging forms of pollution for people and ecosystems of pollution targets
and waste
Agree on standards for PM2.5 Achieve Class I targets for PM2.5 in Achieve Class I targets for PM2.5 for all
major cities cities
Phase out inefficient waste disposal Pilot air quality management plans in Complete implementation of air quality
methods, pilot new methods major cities management plans
Pilot incentives for efficient waste All new landfills meet international High-tech monitoring of waste stream
utilization standards; incineration of municipal and utilization
waste reaches 10 percent
Scale up waste utilization initiatives
Adapting to Improved information and Mainstream climate risks into Develop an economy that is resilient
climate change understanding of climate risks development policies to climate change impacts and
uncertainties
Invest in weather information and Update and enforce building codes Fully functioning risk management and
warning systems recovery mechanisms
Make information on hazards Introduce financing frameworks for
accessible catastrophic risks
Identify cost-effective adaptation Expand social services and support
measures networks in vulnerable rural areas
5. These estimates of cost savings are drawn on China’s national accounts, it may be an
from detailed work done by McKinsey & underestimate of China’s expenditures.
Company (2009) on technologies for CO2 13. Given the country’s importance as a carbon
abatement in China. The McKinsey cost esti- emitter, green (low-carbon) development will
mates are often considered an upper bound reduce emissions, reduce the magnitude of cli-
on the annual cost savings to be achieved, mate change, and reduce the need for China
because, while they include potential techno- to adapt.
logical gains, they do not include all transac- 14. China’s Ministry of Agriculture (MOA 2007)
tion costs associated with implementing those estimates that 90 percent of the country’s
technological gains. grasslands are degraded, about one-third of
6. At the same time, not all jobs produced by them seriously so.
green investments are a priori “good jobs 15. These industries include power generation,
which offer adequate wages, safe working con-
iron and steel, nonferrous metals, chemicals,
ditions, job security, reasonable career pros-
petroleum, and building materials.
pects, and worker rights” (UNEP and others
16. The United Nation’s work on a system of envi-
2008, p. 4). The creation of new employment
ronmental and economic accounts (SEEA),
opportunities through green investments may
building on the system of national accounts,
not improve the plight of informal work-
ers in such industries as construction, waste is one such initiative to measure the change
removal, and recycling. The effect of green in social welfare as a measure of progress
growth on work conditions across industries toward green growth. The World Bank’s
is also as yet unclear. Green growth is not a work on comprehensive wealth accounting
substitute for effective social protection and (World Bank 2006, 2011) is a complementary
investments in human capital. initiative.
7. Of course, if reductions in China’s manufac- 17. Adjusted net national income accounts for
turing sector are offset by increased output in both the depreciation of produced capital
other countries, the rebalancing would have and the depletion of natural resources such
negligible effects on global emissions even as as forests, minerals, and fossil fuels. The
China’s emissions intensity would decrease. growth rate of real aNNI is proportional to
8. These costs are typically measured by valuing the change in social welfare, and so the sign of
a country’s environmental externalities, or the this growth rate indicates whether the econ-
external costs associated with resource deg- omy is on a sustainable path. Higher levels of
radation (including pollution-related health aNNI mean that a country is using its natural
damages, property damages, and global resources more efficiently. Adjusted net sav-
impacts) and resource depletion (soil erosion, ings is a measure of net wealth creation that
deforestation, fisheries loss, biodiversity loss, measures the depreciation of fixed capital, the
water pollution, and watershed degradation). depletion of natural capital, investments in
9. It is recognized that figure 3.10 compares human capital, and health damages from pol-
countries at different levels of development. lution. Positive savings represent an improve-
That said, the figure is intended to illustrate ment in social welfare, while negative savings
the level of potential improvement that China
indicate a decline, implying that an economy
may achieve as it rises to high-income status
is on an unsustainable path.
(for details, see table 3.1).
18. The seven sectoral background papers covered
10. Grade V is defined as water suitable only for
are Energy, Urbanization, Water Resources,
agricultural water supply and general land-
Pollution and Waste, Agriculture, Natural
scaping use, and Grade V+ is water unsuit-
able for any use (NBS 2011a; MEP 2012; and Resource Management, and Adapting to a
MEP and AQSIS 2002). Changing Climate. They are available on-line.
11. The national average of 1,812 cubic meters of
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270 CHINA 2030
China’s social development over the past change as labor moves from agriculture to
three decades has been impressive. The coun- manufacturing. But there are other drivers
try has universalized compulsory educa- of inequality, including China’s decentralized
tion, expanded participation in higher levels fiscal system and the mismatch at local lev-
of education, sharply reduced the burden els between resource availability and social
from infectious diseases, and dramatically spending responsibilities, which have led to
increased social security coverage. Labor large spatial disparities in public expendi-
has become more mobile, and the number of tures per capita on social services; institu-
rural migrants moving to cities has grown. tional arrangements and policies, such as the
The “iron rice bowl” social protection system hukou system, and fragmented social secu-
based on work units has been transformed rity arrangements, which reinforce and even
into programs that are being expanded and accentuate inequalities; high social insurance
consolidated. taxes and weak labor market institutions,
At the same time, China’s social develop- neither of which favor labor; and significant
ment faces four broad challenges to which segmentation in urban labor markets.
social and economic policies will need to The second challenge is inefficiencies in
respond. social service delivery resulting from dis-
torted incentives and market structures.
Public organizations face little competitive
Four Broad Challenges
pressure to improve efficiency or quality. And
The first challenge is high inequality, some pressure from users of services is also limited
dimensions of which may have worsened because of lack of downward accountability.
in recent years. Inequality remains high in The incentive structure in health services, and
incomes, consumption, and asset owner- to some extent education services, encour-
ship, as well as in access to quality education, ages public providers to act as profit-
health care, jobs, and social protection pro- maximizing private sector entities. As a
grams across and within regions and social result, it is estimated that between one-third
groups. Part of the higher inequality is the and one-half of hospital admissions in China
“Kuznets effect”—the result of structural are unnecessary, and the average length
271
272 CHINA 2030
of stay in hospital is double the average in accountability for results in social services
Organisation for Economic Co-operation and social protection programs. Greater
and Development (OECD) member coun- accountability would need to come through
tries. School selection fees drive a further three channels: administrative systems that
funding wedge between “key” schools and monitor performance and encourage quality
regular schools and exclude many. and equity; market-based mechanisms that
The third challenge is rapid aging of the encourage private delivery and rely on com-
population. China is “growing old before petition with appropriate regulation; and
growing rich.” As the country ages, the labor direct accountability to citizens by increasing
force is expected to peak around 2015, with the role of civil society organizations.
dependency ratios rising rapidly thereafter. To achieve these objectives, China needs
These trends put a premium on deepening to develop a vision, core values, and guid-
human capital to enhance labor productivity, ing principles for social policy development
place additional demands on education and and social harmony. The report argues that
training systems, and heighten the impor- China could benefit from its particular blend
tance of allocating labor efficiently. Aging of social and economic characteristics. China
has also transformed the disease profile could choose the “active welfare society”
toward noncommunicable diseases, requiring (also called “developmental welfare”) model.
a shift from curative to preventive care and Underpinning such a model would be the
better health education. need to develop consensus on a common set
And the fourth challenge is managing of underlying values. These include social
growing economic, social, and cultural diver- equity and justice for all; acceptance that
sity. Significant changes in social structures society should help meet basic needs of all,
and values have taken place since opening up, especially the poor and vulnerable; respect
driven by changes in economic and industrial and care for family members; maintenance of
structure, employment and income distribu- a strong work ethic and avoidance of welfare
tion, and new social stratification patterns. dependency; development of the professional
The needs, expectations, and values of vari- ethics of service providers; and the sharing of
ous groups are increasingly diverse, a situa- responsibilities among the state, communi-
tion that will present increased challenges in ties, families, social organizations, and the
managing constructively the tensions of unity private sector.
and diversity. In moving toward such a model, an over-
arching question will be what level of social
services and protection the state should aim
The Social Policy Response
to finance. International experience suggests
In response to these challenges, this report that social spending accounts for the bulk of
argues that in the coming decades China incremental public expenditure as countries
needs to pursue social policies that promote grow wealthier. At the same time, additional
equality of opportunity with security. Social government-financed social services and
policy will need to focus on human capital social protection should be undertaken with
development, basic social welfare without considerable caution and with a strong focus
welfare dependency, and growth and develop- on efficient public spending. In striking this
ment. Simply stated, all citizens should have balance, China will need to avoid the pre-
equality of opportunity in education, health, dicament that many advanced countries face
employment, and entrepreneurship; and secu- from unsustainable entitlement programs.
rity from deprivation through a moderate but The key elements of such a social policy
sustainable social protection system, together model—some of which are already emerging—
with care services for the aging population. are:
Underpinning these reforms is the Equitable and effective social services
cross-cutting need to promote greater that build human capital for a healthy and
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 273
arrangements for social services that are rural health system in the 1980s, China has
complex to achieve and monitor. In this pro- moved actively to rebuild the health deliv-
cess, public resources need to be used more ery network. It dramatically reduced the
efficiently, along with structural shifts in pol- burden of infectious disease and expanded
icies and delivery systems; the country must coverage of basic health insurance to almost
recognize that the state cannot “do it all.” all rural and growing numbers of urban
Implementing the necessary social policy citizens. China is also transitioning from an
reforms will need strong and sustained com- enterprise-based “iron rice bowl” to consoli-
mitment to manage vested interests within dation of a market-compatible labor market
the social sectors and beyond. Current pat- and social protection system at a rapid pace.
terns of service provision and outcomes While hukou reform still remains an unfin-
result in divergent interests that are likely to ished agenda, the strict constraints on popu-
generate resistance to reform among those lation mobility have been gradually relaxed
who benefit from the status quo. As in other to release the largest flow of internal migra-
countries, careful management of reforms tion ever seen.
will be required, as will attention to creat- Despite these successes, China faces new
ing the incentives to win the support of all social challenges and risks as it seeks to
stakeholders. build a harmonious high-income society,
perhaps the key one being the inequalities
that have emerged during the reform period.
Challenges for China’s Social The 11th and 12th Five Year Plans recog-
Development nize the emerging limitations of the current
Since opening up, China has made great growth model and place greater emphasis
strides in social development. Educational on addressing inequality and enhancing the
enrollments have increased rapidly, with basic security of the population. Part of the
large increases in high school attainment and rising income and consumption inequality is
above. The real per capita stock of human the “Kuznets effect”—the result of structural
capital has risen rapidly, especially since the change as labor moves from low-productivity
1990s (figure 4.1).1 Since the collapse of the and labor-intensive agriculture to higher-
productivity and capital-intensive manufac-
turing. Some inequalities are unintended
consequences of market reforms and past
FIGURE 4.1 Per capita human capital: national, failures to deal appropriately with the public
urban, and rural, 1985–2008
goods nature of investments in human devel-
opment. Others, however, are direct products
120,000 of policies that institutionalize inequality of
opportunity (such as the hukou system) or
100,000 that do not provide an effective framework
80,000 for addressing inequalities (such as the inter-
RMB (1985)
security programs. Problems of quality risk FIGURE 4.2 The evolution of income inequality
compromising development of human capi- in China since the start of reforms, 1981–2005
tal and a healthy and productive population.
The problems arise in part from distorted 50
incentives and market structures. Public
housing. Housing is estimated to account financial protection for migrant, rural, and
for around 60 percent of household wealth urban informal sector workers (such as in the
and for almost two-thirds of the inequality scale of protection under New Cooperative
of wealth among households (Li and Zhao Medical Scheme, or NCMS). As a result, sec-
2011; Zhao and Ding 2008). Nearly all rural ondary distribution is in a number of cases
and almost 90 percent of local hukou urban regressive, despite the efforts of recent years
households owned their housing by the mid- to expand coverage. While the authorities
2000s, but fewer than 10 percent of migrant recognize and are trying to address inequali-
households owned housing in their city of ties of opportunity, promoting greater equity
residence in 2007. In addition, while housing in coverage and quality of social services and
wealth increased rapidly for all homeowners social security is hampered by the highly
between 2002 and 2007, the 15–20 percent decentralized nature of financing.
annual rate of increase for urban households
was significantly higher than the 7 percent
Rapid Demographic Transition
annual increase of rural households. As a
result, per capita urban housing wealth went China’s demographic transition will be
from 4.5 times that of rural households in among the most rapid ever seen and is an
2002 to 7.2 times only five years later, a gap emerging source of economic and social vul-
significantly higher than the urban-rural nerability. China has experienced the kind
income gap (Sato, Sicular, and Yue 2012). of fertility transition over the past 40 years
Inequalities in incomes are mirrored and that typically took more than 100 years in
driven by major disparities in opportunities developed countries (Uhlenberg 2009). With
for quality social services and social pro- rising life expectancy and the sharp drop in
tection. With China’s success in expand- total fertility to only around 1.5, the country
ing access to social services and coverage of has “grown old before growing rich.” Look-
social protection, new challenges of equal- ing ahead, the share of people age 60 and
izing quality of services and depth of finan- over in the total population will accelerate in
cial protection have emerged. Inequalities of coming decades, from around 12 percent in
opportunity start early in life and continue 2010 to almost 25 percent by 2030 and to
into working life. The opportunities for more than 33 percent by 2050 (figure 4.4). By
developing human capital, staying healthy, 2030, China’s population share over age 60
and having a reliable safety net vary greatly is expected to be just under the OECD aver-
in China, depending on whether a person age. As a result, the old-age-dependency ratio
is rural or urban, lives in coastal or inland in China will increase at an almost unprec-
provinces, and is a migrant or a local resident edented rate over the coming decades, with
in urban areas. In some cases (such as pre- more than one in every three residents in
schooling), inequalities are ones of access; in rural areas and more than one of every five
others (such as general education), the chal- in urban areas being 60 or older by 2030.
lenge is to promote “equality of quality” and The emerging “4-2-1” extended family pat-
affordability. The hukou system reinforces tern of four grandparents, two parents, and
disparities by imposing high costs of educa- one child will put deepening strains on family
tion, health care, and housing on migrant support networks.4 Aging will also challenge
households. 3 Migrant workers are also less social programs, in particular pensions and
able to access lucrative employment opportu- health care.
nities in the public and state-owned enterprise The end of the demographic dividend
(SOE) sectors, and they face greater chal- and exhaustion of the rural labor surplus
lenges than local workers in accessing decent will shift labor market dynamics. A source
work even outside these sectors. Inequalities of growth in the reform era has been an
in basic services have been compounded by expanding labor force, rising from under
lack of social security coverage and shallow 600 million people of working age (15–64)
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 277
in 1980 to around 990 million in 2012. This FIGURE 4.4 Number and share of population age 60 and over,
trend will reverse starting around 2015. The 1950–2050
decline in the working-age population will
not really take hold until around 2030, when 500 35
it will drop sharply from just over 1 billion in 450
30
2026 to 850 million by 2050 (figure 4.5). The 400
aggregate decline in the labor force is exac-
Population (millions)
350 25
erbated by the rapid decline in rural surplus 300 20
Percent
labor, which has until recently provided an 250
unlimited source of cheap labor. Although 200 15
the precise timing remains disputed, most 150 10
researchers accept that China is at or nearing 100
the Lewis turning point of exhaustion of the 5
50
rural labor surplus, and the remaining rural 0 0
working-age population may be too old, sick, 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
or disinclined because of family obligations Population age 60 and over % of total population
to migrate to urban areas. 5 The combined
Source: For year through 2010, see China National Bureau of Statistics; for 2020 to 2050, see
impact of a declining labor force, exhaustion UN 2010.
of the rural labor surplus, and rapid aging
means that productivity growth per worker
will become critical as China seeks to move FIGURE 4.5 Total population and working age population,
up the value chain. At the same time, in the 1950–2050
short run, low-skilled workers could benefit
from the shift in supply and demand in the
1,600
labor market, which might provide negative 1,400
incentives to investments in human capital
Population (millions)
1,200
beyond junior high level. 1,000
A further demographic challenge will be 800
managing sustained urbanization. China’s 600
urban population grew from less than one- 400
200
fifth of the total population in 1980 to almost
0
half by 2010 and is expected to grow to
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
around two-thirds by 2030. This growth has
contributed to structural transformation and Total population Labor force
higher productivity and will continue to do
so, facilitated by easing of population mobil- Source: UN 2010.
FIGURE 4.6 Number of people with at least one industrial structure, ownership, employment
noncommunicable disease, 2010–30 and income distribution, and new social strat-
ification patterns. As for economic structure,
100
diverse ownership patterns and new sources
95 Women Men of competition have emerged, although the
90 state and collective sectors are still domi-
85 nant. Social stratification has emerged as a
80
major concern, with the expansion of new
Age (years)
75
70 economic and social entities driven by private
65 entrepreneurship. Employment opportuni-
60 ties have been created with the emergence of
55 new social strata such as technical and man-
50
agerial staff employed in private and joint
45
enterprises, and self- and flexible employ-
00
00
00
00
00
00
0
50
3,5
3,5
2,5
1,5
1,5
2,5
Population (thousands) through the work unit and even within fami-
2010 2020 2030 lies have weakened. The resulting diversifica-
tion of interests and demands of stakehold-
Source: World Bank 2011b. ers, together with changing social values
reflecting the changes in social structures,
requires greater efforts to manage conflicts of
disease, diabetes, and cancer are already the interests and rebuild consensus on core social
number one health threat. They account for values. In recent years, China has attempted
more than 80 percent of the 10.3 million to explore new institutional arrangements
deaths annually and contribute to 82 percent to build social consensus, but to date, these
of the total disease burden (WHO 2009). efforts have proven insufficient to cope with
Around half of the noncommunicable disease the challenges of profound social change.
burden is among those of working age, with China faces a range of new challenges as it
significant costs to the economy. Urbaniza- seeks to achieve the social and economic pol-
tion and aging will accelerate a rapid increase icy goals that the country has set itself. Some
in the prevalence of noncommunicable dis- of these challenges are discussed below.
ease over the coming decades (figure 4.6), The first challenge is navigating the diver-
implying a major increase in demand for both gent interests of different stakeholders in the
curative and preventive health care. It will current system. The current patterns of ser-
also require reorientation of the health deliv- vice provision and outcomes result in diver-
ery system in the face of more complex case gent interests that are likely to generate resis-
management needs. If not addressed, health tance to reform among those who benefit
care costs could escalate rapidly, and labor from the status quo. These divergent inter-
productivity could be compromised. Rapid ests take many forms. They may be between
aging will make the need for health system service providers and users; between state
reforms even more urgent. and nonstate service providers; among dif-
ferent categories of users within localities
and across space; between the elderly who
Changing Social Structures and the
expect good pensions and affordable health
Challenges of Response
care and younger people whose wages are
Besides demographic transition and urban- highly taxed; between richer regions that
ization, significant changes in social struc- benefit from decentralized financing arrange-
tures have taken place since China’s open- ments and those that would gain from greater
ing up, driven by changes in economic and equalization of public spending; or between
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 279
employers, unions, and workers. Perhaps the and to promote more efficient use of pub-
most striking divergence is in the status of lic resources. This coordination can help to
urban, migrant, and rural populations, where achieve as yet unrealized positive externali-
the social contract with the state is fundamen- ties in public policy.
tally different in a number of areas.6 A third challenge is the lack of consensus
In addition, sectoral reforms are likely on core social values and social trust. Con-
to encounter the same resistance that they cerns are frequently expressed that China’s
have faced in other countries. For example, cultural development has not fully matched
increases in the pensionable age and the its economic achievements, reflecting a
merger of different urban pension schemes degree of moral anomie, distorted values of
will not be welcomed by those approaching some segments of society, and lack of trust in
retirement or working in public sector units key social services.7 Trust in health care pro-
(PSUs) and the civil service. At the same time, viders is among the lowest of public services.
reorientation of the health delivery system More than two-fifths of people say they do
toward greater reliance on primary care and not trust public hospitals, and almost two-
reforms of provider payment systems are thirds report they are suspicious of the medi-
unlikely to be supported by specialist doctors cal industry, reflecting deep concerns about
and hospitals that have profited from cur- deterioration in professional ethics (Wang,
rent arrangements. More generally, efforts to J., and Yang 2011). Around one-third do not
strengthen the role of the nonstate sector and trust the educational system. The future of
citizen voice in oversight of social services the pension system is also a major concern
may run up against the desire for “business of urban residents (Ru, Lu, and Li 2011).
as usual.” The fact that a number of social Surveys of citizen satisfaction find an urban
sector reforms and implementation of central middle class in big cities that is least satis-
directives have to date not made the desired fied of all social groups, citing issues such as
progress (examples are higher-level pooling work stress, the costs of housing, and food
of social insurance funds; directives to pro- safety.8 Such “soft” indicators of insecurity
vide free general education to migrant chil- are confirmed by the high levels of precau-
dren; and reform of public hospitals) is indic- tionary savings among citizens. China has
ative of the combination of technical and recognized the urgency of rebuilding a moral
political economy challenges that will need to foundation to guide individual behavior and
be navigated in coming years. collective action, but it is at the initial stage
A second challenge is coordinating inter- in seeking mechanisms to build a deeper con-
ests across agencies and regions to overcome sensus around core social values.
fragmentation in policy design, financing, A fourth challenge is managing citizens’
and delivery systems. Policies in China are rising expectations as China becomes richer.
fragmented between agencies at each level The success of the Chinese economy and the
of government and across space between lev- pace of social sector reforms have created
els of government. As a result, policies are rising expectations that coverage and qual-
characterized by systems that are less than ity of services will continue to deepen at the
the sum of their parts and can lack systemic same pace as recent years. For migrant pop-
coherence. In some respects, the emphasis on ulations, the shift in expectations is likely
local experimentation and innovation has to be even sharper, because the children of
served the country well in the reform period. first-generation migrants have higher expec-
The limits of this approach are now revealing tations of urban hukou and associated enti-
themselves, however, and future progress will tlements.9 However, with the likelihood of
increasingly rely on cross-agency and cross- slowing growth in the medium term, China
spatial coordination of policy and delivery will inevitably face the dilemma seen in many
to achieve more robust and coherent systems OECD countries of setting a sustainable level
280 CHINA 2030
of entitlements. The pace of wage growth, policy challenges that are in many ways more
deepening financial protection from social complex than those China has already faced.
insurance, and rapid expansion of the edu- They require, for example, greater collec-
cation system and other social reforms will tive action across regions and across social
inevitably slow also, and these adjustments groups in situations where interests diverge.
will require careful expectations manage- They also require shifting emphasis—from
ment by the authorities. quantity to quality of services, from input to
outcome of programs, and from government-
dominated to cogovernance of providers and
Finding the Way Forward
users. These reforms are complex to achieve
Despite the potential obstacles to social devel- and monitor, and there are no easy answers
opment, China has solid potential to address from the experience of richer countries on a
the above challenges. First, there is clear single “right” approach. The one certainty is
political commitment to address inequality that “doing business as usual” will be insuffi-
of opportunity and to deepen security, and cient to achieve China’s socioeconomic devel-
many policy initiatives to extend coverage opment goals.
and quality of services. Second, robust and
sustained fiscal growth means that China Equality of Opportunity with
is likely to have the resources to realize its
policy goals, although improved efficiency
Security: Goals and Principles
in social spending will be required to trans- In response to the social and economic chal-
late increased resources into improved social lenges facing China over coming decades,
outcomes. Finally, a strong tradition of local this report argues that China needs to pur-
level experimentation provides ongoing les- sue social policies that promote equality of
sons in how to turn policy commitments into opportunity with security. Simply stated,
better and more equal social outcomes. all citizens should have equal opportunities
The issues of inequality of opportunity to access basic public services and contrib-
and outcomes and lack of security are rec- ute to the country’s prosperity, regardless
ognized by the Chinese authorities, but there of place of birth, gender, or other factors;
are significant challenges and trade-offs in citizens should also have basic security from
managing the demographic and social tran- deprivation, for reasons of social equity (or
sitions. Synergy is needed among macro- harmony), to prevent any irreversible loss of
economic, fiscal, labor market, and social human potential and to promote economic
policies as China seeks to promote a more freedom of the population.10 A combina-
equal, high-income, and harmonious soci- tion of policies can promote both sustained
ety. The rest of this chapter highlights the productivity growth and a reduction in
priority social sector reforms that will be inequality to help ensure the social cohesion
needed. Many reforms are already starting to and stability necessary to underpin growth.
be addressed by Chinese policy makers, but Chinese policy makers will confront difficult
others have not to date received the attention trade-offs as they seek to realize their social
they may deserve. For both types of policies, policy goals, and their choices will require
the key issue is “how”—how to prioritize greater clarity on the underlying principles
and sequence reforms, how to manage the of reforms. This section first outlines the
inevitable resistance from certain players, overarching goal and vision for social policy
and how to coordinate financing and actions reform in China by 2030, before discuss-
across different parts of China and for differ- ing the guiding principles in implementing
ent social groups to realize the public goods those reforms. It then elaborates on three key
benefits of social sector investments. cross-cutting issues that will be critical as
The transition toward a high-income har- social sector reforms evolve over the coming
monious society will create a new set of social decades. Detailed discussion of the reforms
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 281
and their prioritization and sequencing fol- state and the population as China moves
lows in the rest of this chapter. toward high-income status, and the respec-
tive roles of the state, communities, house-
holds, individuals, and the private sector
The Goal and Vision for Social
in achieving that goal. There is no “right”
Development and Policies for
social policy model that high-income coun-
China 2030
tries choose.11 In setting a model, China has
In light of China’s social and economic chal- the opportunity to benefit from its particu-
lenges, the overarching goal of social devel- lar blend of social and economic character-
opment between now and 2030 would be istics. One characterization of such a model
progressive achievement of equality of oppor- is the “active welfare society,” or “develop-
tunity with basic security for all. While nota- mental welfare model,” which draws on the
ble progress has been made in China’s social strengths of government, the nonstate sector
development in the past 30 years, simply (commercial and nonprofit), communities,
doing more of the same is unlikely to be suf- and households.. Such a model would pro-
ficient as the country faces new challenges. mote human capital development, provide
“Business as usual” will increasingly reveal basic social welfare but avoid welfare depen-
its limitations, as the Chinese authorities dency, and increase the synergy between eco-
have already recognized in the 12th Five Year nomic growth and social development.
Plan. The goal of equality of opportunity The goal of equality of opportunity with
with basic security is not only fundamen- basic security provides a vision for social sec-
tal to achieving greater equity in China, but tor policies and outcomes in 2030 that would
would also contribute to sustaining growth include:
by deepening the human capital base, ensur-
ing a healthy and productive workforce, pro- • Equitable and effective social services
moting a more efficient allocation of labor, that build human capital for a healthy
and reducing overly high precautionary sav- and productive population. Based on
ings as people grow more confident in the the experience of OECD and successful
public safety net. middle-income countries, by 2030 China
Underpinning the social development will have an education system that pro-
vision is the need to develop consensus on a vides an expanded cycle of quality basic
common set of underlying values. These val- education that is accessible to all, starting
ues include social equity and justice for all, in preschool and continuing to the end of
independent of place of birth or other char- senior secondary schooling. Senior sec-
acteristics; acceptance that society should ondary school would be fee-free, as it is
help meet basic needs for all, especially the in most high-income countries; preschool-
poor and vulnerable, in order to promote ing would be available affordably to all,
social cohesion; maintenance of a strong through subsidies for rural, migrant, and
work ethic that avoids welfare dependency; poor children as needed. An early child
respect and care for family members, in par- nutrition program would ensure that chil-
ticular the elderly and disabled; development dren have a sound cognitive base to maxi-
of the professional ethics of service providers, mize individual and societal returns to
both public and private; and the sharing of education; over time this program would
responsibilities among the state, communi- also address the health risks of rising
ties, families, social organizations, and the childhood obesity. Building the human
private sector. capital base for the higher-value-added
Looking toward 2030, two fundamen- China will also require a system that goes
tal issues for policy makers in formulating beyond basic education to provide a more
China’s vision of social policy are the type flexible and demand-driven set of com-
of social contract they envision between the petencies for young people. By 2030, the
282 CHINA 2030
barriers between technical/vocational and latest, the hukou system would be phased
academic educational streams would be out as an instrument for allocating social
reduced, by extending the period of devel- entitlements to the migrant population.
opment of core competencies for techni- Instead, entitlements would be linked to
cal students,12 building a more practical residential permits, stable employment,
and applied higher education curriculum or both, depending on the categories of
in universities, and allowing for crossover rights. The higher levels of governments,
between technical and academic streams in particular the central authorities, need
within an overall qualifications frame- to play a more proactive role to encourage
work. To have a healthy workforce and efforts at the local level to promote social
promote healthy aging, the health system inclusion of migrant populations finan-
would provide more uniform and deeper cially and politically, through a common
financial protection against health shocks policy framework. Labor mobility would
for its population, with general revenue be underpinned by a social security system
financing likely to play a bigger role in where entitlements are fully portable across
total health funding. And the delivery sys- the country, and where risk pooling at
tem would have providers who are more higher levels has reduced the cross-regional
accountable for the quality and cost- disparities in social insurance protection.
effectiveness of services through provider And over time, the burden of taxation on
payment and other reforms. The reformed labor relative to other factors of production
health system would be less hospital ori- would be reduced. In parallel, core labor
ented than is the current case, and it will market institutions would mature. Key
be built on a high-quality primary care among these would be a wage determina-
network that is able to meet the more com- tion system driven less by administrative
plex case management needs of noncom- direction and more by collective bargain-
municable diseases. Case management ing, where the interests of workers, employ-
would also involve greater coordination ers, and the state are fully represented.
of patient care across levels of the health Finally, China would need to make signifi-
system. Both health and education services cant progress by 2030 in providing for a
would have institutionalized mechanisms longer productive life from its urban work-
for citizen voice to promote accountability ers. Retirement ages would be raised signif-
and inclusiveness. icantly, flexible work arrangements would
• Flexible and secure labor and entitlement make continued work more attractive, and
policies and institutions that promote an life-long learning opportunities for workers
internationally competitive workforce would help to reduce the depletion of their
where workers continue to share in growth human capital as they age.
and have labor protection. Achieving the • A basic but secure social protection sys-
balance between the interests of workers tem that provides a moderate level of
and the need for competitiveness would security for all while respecting fiscal
require “flexicurity,” that is, a labor mar- constraints. By 2030, China would have
ket with the flexibility to promote efficient full coverage of pension and health insur-
allocation of workers to their most produc- ance systems, with integration of currently
tive use, but also the security needed to separate subsystems for rural, urban, and
ensure decent pay and working conditions migrant residents and for civil servants,
that reflect their contribution to productiv- PSU employees, workers, and residents.
ity. The first step in this process would be Differences in levels of benefits would
the elimination of the remaining barriers remain, but the achievement of national
to labor mobility with equity, in particular pooling for pensions and provincial- or
barriers that are related to inherited char- national-level pooling for health insur-
acteristics. Most critically, by 2030 at the ance would give policy makers more
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 283
leeway to equalize basic benefit levels should be consistent with fiscal constraints
across the country. In addition, general and promote a more efficient use of pub-
revenue financing would play an ongo- lic resources. The rapid growth in fis-
ing important role in both pensions and cal resources in recent years has diluted
health, through subsidies to rural and the emphasis on efficiency in use of pub-
urban informal populations, and tax- lic resources in the social sectors. With
based incentives to formal sector workers overall and revenue growth likely to slow
to participate in supplementary pension in the medium term, there will be an
schemes. In addition to pensions, China increased premium on efficient use of pub-
would by 2030 have a well-developed sys- lic resources.
tem of aged and long-term care services • Promoting co-responsibility and citizen
that draws upon the human and financial voice. As in many areas of economic pol-
resources of the government, the nonstate icy, social policy reforms should be guided
sector, communities, and households, and by the principle that the state cannot “do
that prioritizes a minimum level of service it all.” These reforms should seek to pro-
for the poor. Finally, the safety net for the mote deeper participation of stakeholders
poorest and most vulnerable would have such as communities, nongovernmental
greater coherence between different parts organizations, and the nonstate commer-
of the social protection system so that it cial sector. To achieve this goal, the state
ensures adequate and affordable minimum will need new and more differentiated
coverage of benefits for poor households roles not only as a provider and funder but
but without disadvantaging the near-poor also as a regulator and facilitator.
and creating “poverty traps.” • Supporting and cultivating prevailing cul-
tural values, social institutions, and prac-
tices. Effective and efficient social policies
The Implementing Strategy for
need to be designed with close attention to
Social Policy Reforms
prevailing cultural values and practices. In
To achieve the goal of equality of oppor- China, the role of the family is of particu-
tunity with basic security and the vision of lar importance but has not always been
outcomes for 2030 outlined above, key prin- taken into account in formulating public
ciples underlying social policy reforms should policies (examples are the absence of survi-
include: vor pensions; individualized health insur-
ance coverage; and hukou policy that splits
• Promoting macroeconomic and structural families and leaves children of migrants
reforms. Social policy reforms should be behind). Ensuring a mutually reinforcing
consistent with, and ideally promote, mac- interaction between public policy and pri-
roeconomic and structural reform goals. vate behavior is thus vital to achieve both
China is pursuing several key macro and social harmony and economic efficiency.
structural directions, including rebalanc- • Aligning policy reforms with implemen-
ing of the economy toward higher domes- tation capacity. The pace of social policy
tic consumption, reducing distortions in reform in China since the 1990s has been
factor markets, moving up the value chain breathtaking. But delivery systems have
in production, and integrating rural-urban often struggled to keep pace with policy
activities. Different social policy choices reform, and the gap between policy and
may promote or hinder achievement of implementation has been highly variable
these goals, and assessing their contribu- across the country. The substance and
tion to macro and structural reform goals sequencing of social policy reforms should
is vital. be consistent with implementation capac-
• Ensuring efficient and sustainable use of ity to avoid a mismatch between policy
public resources. Social sector reforms commitments and on-the-ground delivery.
284 CHINA 2030
This alignment will also promote policies China’s recent health expenditure trajectory
that are simpler to understand and less suggests that it will not be immune to such an
prone to abuse. effect. Even among middle-income countries,
• Combining bottom-up with top-down China’s social spending is significantly lower
reforms in a systematic way. Chinese than spending in other large countries such
social policy has benefited from local as Brazil, the Russian Federation, and Turkey.
piloting and innovation, both by govern- Moreover, China faces the double fiscal pres-
ment and the nonstate and community sure of its demographics and policy commit-
sectors. Local demonstrations have often ments to rapidly expand pension and health
been fertile testing grounds for subsequent insurance coverage and provide higher levels
national policies. At the same time, they of education.
have sometimes resulted in fragmented In assessing the appropriate level of
approaches and implementation mecha- future social sector spending, the impact of
nisms across regions that can make sub- increased government social spending on con-
sequent consolidation of policies and sumption is an important additional effect
delivery systems challenging (for example, to take into account. A contributory factor
incompatible information systems and to China’s high household saving rate is the
overly localized pooling of social insur- need to “save for a rainy day” because of the
ance). A more systematic linkage of historically high burden of private health and
bottom-up local pilots and national poli- education spending and the underdeveloped
cies can ensure that fragmentation is social protection system. Research sponsored
reduced and that national policies take by the International Monetary Fund finds
local variation into account. that every yuan of incremental public spend-
ing on health results in a 2 yuan increase in
the consumption of urban households, and
Key Cross-Cutting Issues in Social Policy
that an increase in social spending of 1 per-
Reform
cent of GDP spread evenly across health,
As China’s social reforms evolve, policy education, and pensions results in a 1.25 per-
makers will seek to address a range of cross- cent increase in household consumption as a
cutting themes and trade-offs. Four in partic- share of GDP, with the consumption impact
ular deserve elaboration in light of the above highest for incremental spending on pensions
guiding principles of reform: and health. These results are consistent with
observed behavior among rural households,
Financing and efficiency in social pro- where saving rates are significantly lower
grams social sectors, where existing pro- among those with social insurance. 14
grams, planned reforms, and demographic While social spending will increase, inter-
transition will drive significantly higher social national experience also suggests that the
spending over coming decades. The transition expansion of social sector spending requires a
from middle- to high-income status entails an close eye on fiscal constraints to avoid unsus-
almost universal increase in the size and share tainable commitments. Projections done
of public spending devoted to the social sec- for this report suggest that by 2030, pub-
tors, in particular social security programs lic spending on pensions as a share of GDP
and related services, especially for the elderly. could double and public spending on health
For example, public spending on pensions could increase by over 50 percent simply as a
alone accounted for over 10 percent of gross result of demographic trends (figure 4.7a).15
domestic product (GDP) on average in OECD If policy commitments to expansion of pen-
countries in 2008. Similarly, public spend- sion coverage to rural and urban informal
ing on health care is growing ever higher in workers, and to expansion of enrollments
OECD countries, averaging over 7 percent at higher levels of education are taken into
(and rising) in 2008 (OECD 2009, 2011b).13 account, the increases could be significantly
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 285
a. Base case demographic projections, 2009 policies b. Indicative spending with current policy targets in place
12 12
10 10
8 8
6 6
% of GDP
% of GDP
4 4
2 2
0 0
2010 2020 2030 2010 2020 2030
Education Health Pensions Education Health Pensions
Source: Mason and Chen (2011), using National Transfer Accounts for China.
Note: Expenditures based on age-specific spending with 2009 policies, demographic and GDP projections. For GDP assumptions, see chapter 1
of this report. Education does not include preschool education spending.
higher (figure 4.7b). While these projections monitoring and a more rigorous system of
are at best indicative, even the “base case” impact evaluation for public programs.
growth due to pure demographics suggests a
need for reductions in other elements of pub- Co-responsibility in service delivery and
lic spending and expansion of new revenues citizen voice. A second cross-cutting issue is
to accommodate social obligations as the how China can evolve toward a more diverse
population ages. They also confirm the criti- model of social service provision with new
cal role of ongoing reform of the urban pen- roles for the state and co-responsibility with
sion system. the nonstate sector and households. To date,
While social spending is certain to the public sector has been dominant as the
increase, ensuring that it achieves the desired main provider of social services, with a lim-
social and economic outcomes will require a ited role for nonstate provision and a circum-
range of efficiency-enhancing reforms. Cur- scribed role for citizen participation and voice.
rently, inefficiencies in delivery models in the Looking ahead, the state cannot and probably
social sectors dilute the impact of incremental should not do it all as it seeks to provide a
spending. The most notable inefficiencies are wider and deeper range of social services and
in the health sector, which relies too much on social protection programs. The experience of
hospital-based care at the expense of primary OECD countries suggests a range of innova-
and preventive care. Similarly in the area of tions in unbundling financing, provision, and
pensions, negative real interest rates on indi- regulation of social services that China could
vidual accounts contribute to falling financial explore and incorporate into national poli-
protection in old age, despite the continu- cies. Such approaches open up new roles for
ation of high pension contribution rates. In nonstate sector provision and public-private
these and other areas of social spending, partnerships in social sectors: from hospi-
simply putting more money into existing sys- tals and clinics to preschools and universi-
tems will have limited impact without con- ties. In some fields, such diversification may
tinued structural reforms. Achieving such also benefit from enhanced partnerships with
efficiencies will also require a further shift in international players, who can accelerate the
administrative systems to promote account- adoption of good international practices. Plu-
ability for results through better performance rality of service provision also offers a greater
286 CHINA 2030
role for communities and the nongovern- is likely to involve a stronger role over time
mental sector, two sectors that, according to for central financing in the redistribution of
pilot experience in China and international spending across China. It will also require
experience, have an important role to play, a stronger role for the center in setting
often with financial support from the state. national policy frameworks in areas such as
Achieving plurality of social service provision hukou reform and management information
while ensuring quality will require the state systems where collective action is needed.
to assume more complex roles in licensing, However, current intergovernmental fiscal
accreditation, and regulation of providers. arrangements and the incentives for local
Developing regulatory capacity in particular authorities make progress challenging. The
will be challenging, as historical challenges national authorities have already moved in
in achieving effective regulation in areas such this direction with central funding of rural
as pharmaceuticals, food safety, and pension education, pension subsidies for rural work-
and housing fund management demonstrate. ers and urban residents, and subsidies to
It will also require in some areas a willingness health insurance premiums. But financing
to “step back” from micro-intervention in remains highly decentralized by interna-
the operations of social services and to focus tional standards, and disparities in quality
instead on setting rules-based policy, regula- of social services and the level of financial
tory frameworks, and sets of incentives. protection from social insurance remain
A related direction that will underpin high. Directions for reforms of the intergov-
social policy is the need to promote greater ernment fiscal system are discussed in chap-
citizen participation and voice in social sec- ter 1 on economic restructuring.
tor programs. A fundamental element of
promoting accountability in social sectors is Strengthening institutional coordination.
moving to a more rule-based system where Stronger intra- and intersectoral coordi-
access to quality public services is based on nation in policy development and delivery
policy and progression in employment and of social services will be vital to improve
education is based on merit or need rather social outcomes. As economies grow richer
than connections or wealth. There is an and populations age, effective social ser-
important and largely unexplored role for vices increasingly require better coordina-
“bottom-up” accountability in promoting tion within and across sectors. For example,
such a vision, through an increased role for within health services, coordination of care
people in monitoring and managing social across levels of service is critical for manag-
services. Historically, citizen voice in the ing noncommunicable diseases, and for edu-
operation of social services has been limited, cation, the boundary between technical and
although localized innovations are spread- vocational education and academic streams
ing (Gong and Yu 2011). Increasing citizen becomes more porous. Across sectors, new
participation in basic service delivery will needs such as long-term care require inputs
require new ways of doing business for ser- from social welfare, health, and other agen-
vice providers and is also consistent with cies, while labor policy for older workers
greater sharing of responsibilities in service requires coordination of social security and
provision. training initiatives. Developing an adminis-
trative system of cross-sectoral coordination
Aligning the roles of levels of government requires the transformation of government
to promote equalization. A third cross-cut- functions and responsibilities.
ting challenge in reorienting social policy is There is increasing consensus on the goals
the need to reexamine the roles of the cen- and vision of social policy reform in China, but
tral and subnational authorities in promot- less clarity on how to reach them and how to
ing greater equalization of social services. navigate the obstacles that lie ahead. The fol-
Promoting greater equality of opportunity lowing sections of this chapter discuss in detail
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 287
the current situation and possible elements of citizens, migrants, and informal sector
reform around three proposed themes: workers in urban areas; expanded aged and
long-term care provision; and greater coher-
• Expanding opportunities for all. The ence across different elements of the social
report proposes action in four areas: protection system to avoid poverty traps.
expanding public investments in early
childhood nutrition and education, espe- The scope and depth of social policy
cially for rural and poor children; promot- reforms points to the need for prioritization
ing “equality of quality” in compulsory and close attention to sequencing of reforms
education among different areas and within and across policy spheres. A process
social groups and extending affordable for agreeing on the top priorities is required,
access to postcompulsory education by as are decisions on what is possible over the
universalizing free senior secondary edu- short, medium, and longer terms given fiscal
cation and reforming vocation and tech- constraints, implementation capacity, and
nical schooling and university education, political economy challenges. The following
including reducing the barriers between sections of this chapter suggest a possible
technical and academic streams; accelerat- sequencing of reforms that takes account of
ing reforms of health financing and pro- the constraints.
vider incentives and rebuilding China’s
primary care system as the basis of a sys- Expanding Opportunities and
tem of coordinated care across levels of
care to manage the epidemic of noncom-
Deepening Human Capital
municable diseases and to avoid uncon- All people need equal access to quality,
trolled cost escalation of health services; affordable education, and health services if
and enhancing citizen voice and participa- China is to build the human capital base to
tion in the delivery and oversight of social reach high-income status by 2030 and share
services, and enhancing the role of the prosperity in a socially sustainable manner.
nonstate sector as service providers. This section outlines policies to achieve this
• Developing a flexible but secure labor vision, proposing action in six areas:
market. To achieve this balance, the report
proposes lowering barriers to mobility by • Ensuring that all children get off to a good
ensuring the portability of pension and start in life by expanding public invest-
social security rights; phased reforms of ments in early child nutrition and educa-
the hukou system; ensuring that older tion, especially for rural and poor children.
urban workers do not exit the labor force • Narrowing the disparities in basic educa-
prematurely, through pension system tion quality across space and social groups
reforms, more flexible work arrangements, and extending free access to senior sec-
and expanded training opportunities; and ondary education in a phased manner that
building and reforming labor market insti- is consistent with fiscal possibilities.
tutions, in particular in the areas of labor • Deepening reforms of technical/vocational
taxation and wage determination policy and higher education to promote a work-
and practice. force with competencies that are relevant
• Enhancing security and helping people to the current labor market but also suf-
better manage risks. Helping them man- ficiently flexible to adapt to the rapidly
age these risks requires structural reforms changing needs of the future labor market.
of the pension system so that people have • Moving from an emphasis on treatment
adequate support in old age from a sustain- of disease to health promotion, which
able system, as well as deepening financial will require rebuilding China’s primary
protection from health insurance; expanded care system to manage its new disease
pension coverage, in particular for rural burden—particularly the epidemic of
288 CHINA 2030
among plenty for China’s rural children and for boys and 0.1 percent for girls. But the
low levels of preschool education that put prevalence rates of overweight and obesity
children behind before they even start. have increased rapidly since the mid-1990s,
While China has made significant prog- especially in big cities. By 2005, the obesity
ress on child nutrition outcomes, it continues prevalence rate among 7- to 18-year-olds in
to face a major unfinished agenda in poorer urban areas was 7.1 percent for males and
provinces and poor rural counties nation- 3.6 percent for females. For 7- to 9-year-olds,
ally, especially for very young children.17 however, the rates were significantly higher:
Both national figures and studies within 10.6 for males and 5.3 percent for females.
central and western provinces indicate that Average rates of overweight boys and girls
a substantial challenge remains in address- were twice as high (table 4.1). Both levels
ing early childhood nutrition. Data from the and rates of increases in childhood obesity
China Household Nutrition Survey over the also show regional variation, with rates in
past decade confirms overall progress but also coastal provinces increasing faster than rates
large remaining disparities. Stunting affected in central and western provinces from 1985
more than 20 percent of children under age to 2005.20
5 in poor rural counties in 2010, more than China’s coverage rates for early child-
twice the national average and almost six hood education are well below those of high-
times the national urban rate.18 Similarly, income countries and a number of major
anemia rates among very young children in middle-income countries as well, and they
poor rural areas remained stubbornly high in and vary widely between urban and rural
2005–10, especially for children 12 months or areas. In 2009, around 51 percent of Chinese
younger, with anemia rates above 40 percent children attended any school before begin-
in poor rural counties in 2009 (figure 4.9).19 ning primary school, a share well below that
Looking ahead, an emerging challenge in emerging economies such as Mexico and
in child nutrition is rising rates of obesity, a Brazil. The averages for early childhood edu-
problem that Chinese evidence suggests will cation coverage in China disguise wide dis-
worsen with rising wealth. In the 1980s, parities between rural and urban areas: while
overweight and obese children were not coverage in urban areas averaged around
a big issue, with obesity only 0.2 percent 80 percent nationally in 2009, it was only
40 40
30
30
Percent
Percent
20
20
10
10
0
0
2005 2008 2009 2010 2005 2008 2009 2010
Age in months
0–5 6–11 12–23 24–35 36–48 48–60 Total
TABLE 4.1 Prevalence of overweight and obesity of students ages 7–18 in urban and rural China, 2005
percent
around 30 percent in rural areas. The rural than their rural peers. In 2008, about 48 per-
average is well below the national average for cent of preprimary enrollment in rural areas
India, which had coverage of 40 percent in was in one-year-only classes, and the share
the late 2000s (figure 4.10). goes as high as 87 and 83 percent in Guizhou
Just as important, among those enrolled in and Ningxia, respectively (figure 4.11). In
preprimary school, the length of attendance contrast, one-year preprimary enrollment
in rural areas is well below that in cities and accounted for only 13 percent of total pre
towns. Urban children have a much earlier primary in urban areas and 25 percent in
start in the education system, and children county towns. In the general education sys-
in counties and towns have an earlier start tem, rural and migrant children—particu-
larly in poor areas and households—are thus
behind before they start. International evi-
FIGURE 4.10 International comparison of share of children dence shows that such early educational defi-
attending nursery school or kindergarten cits are very difficult to overcome in terms of
later school performance.
Major quality differentials in preprimary
Euro Areas
education between rural and urban areas are
Mexico reflected in indicators of educational inputs,
Korea, Rep. which in turn translate into large disparities
Denmark in school preparedness. In 2008, the aver-
age rural pupil-to-teacher ratio was twice the
Sweden
national average of 17 to 1, while the urban
Thailand
average was under 10 to 1. The situation in
Norway some of the poorer provinces is even more
Russian Federation striking, with ratios in Ningxia and Guizhou
United Kingdom
of 167 to 1 and 164 to 1, respectively, in
2008. The share of qualified preprimary
Brazil
teachers in rural areas was just over one-third
United States of that in urban areas (Rozelle 2011). Two
China studies using the same measure of school
India readiness found that with a common score
of 70 being needed to meet the basic school
0 20 40 60 80 100 120 preparedness standard, urban children had a
Percent mean value of 100, with only around 3 per-
cent of urban 4- and 5-year-olds being con-
Source: World Bank 2011a.
Note: Date are for 2007, except for China, which are for 2009.
sidered “unready” for school. In contrast,
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 291
the same methods in a study in villages in FIGURE 4.11 Comparative shares of children attending one-year-
Gansu, Shaanxi, and Henan provinces found only early childhood education programs, 2008
that even the mean score for rural children
(64) was below the minimal school readiness 100
standard (figure 4.12).
A fundamental problem in improving 80
equity of access and quality of preprimary 60
Percent
schooling is the very low level of public
financing. Financing of early childhood edu- 40
cation remains overwhelmingly private even 20
in most public facilities, with an estimated 70
0
percent paid out of pocket, compared with an
0 10 20 30 40 50 60 70 80
OECD average of only 20 percent.21
GDP per capita (thousands)
Although China has targeted continued
Urban Counties and towns Rural
expansion of early childhood education in
the 12th Five Year Plan, allocations within
Source: World Bank 2011a.
the public education budget have to date
been very low relative to student shares and
relative to OECD benchmarks. In 2008 in
China, preschool programs accounted for 9.3 provinces are less than one-tenth the level
percent of total enrollment in education, but of spending in cities such as Beijing and
for only 1.3 percent of total public expendi- Shanghai.
ture on education (0.01 percent of GDP)—far Lack of public financing means that rural
below the OECD average of 8 percent of total and poor households struggle to afford pre
public education spending, or 0.5 percent of primary education for their children. As an
GDP (OECD 2007). In addition, large and example, the study of preprimary education
growing gaps can be seen between richer and in Gansu, Henan, and Shaanxi found com-
poorer provinces, with the share of extrabud- bined tuition and school lunch fees of RMB
getary funds being significant and an incre- 800 a year in 2008, a considerable amount
mental source of inequality (figure 4.13). Per- compared to average per capita income of
student government expenditures for early just over RMB 1,000 for a rural family at the
childhood education in the lowest-spending 2007 poverty line (Rozelle 2011). Although
FIGURE 4.12 Distribution of educational readiness test scores for four- and five- year-olds in China
0.025 0.02
0.02 0.015
0.015 Mean value = 100 Mean value = 64
Density
Density
Critical 0.01
0.01 value = 70
0.005
0.005
0 0
0 50 100 150 200 0 50 100 150 200
Measure of school readiness Measure of school readiness
Sources: Data in panel a, Ou (2007). Data in panel b, Rozelle (2011) for Gansu, Henan, and Shaanxi provinces.
292 CHINA 2030
FIGURE 4.13 Budgetary and total spending per student on early cost and at low risk. For example, a China
childhood education, by province, 2009 CDC intervention of low-cost micronutrient
Renminbi supplementation in children under two years
old in Gansu improved full IQ by up to 4.5
12
points, with effects persistent in follow-up
studies to age six.22
Per student expenditure
FIGURE 4.14 Comparison of public expenditure on education by for the medium term. The recommendation
level, 2008 of this report is that public subsidies in the
coming 3–10 years focus initially on children
in poor rural counties, gradually expanding
China
to all rural areas in central and western prov-
Australia
inces and to migrant children in urban areas.
Korea, Rep.
A significant fiscal injection from the national
Japan
authorities would be required, which could
Switzerland
in principle be done with supply-side subsi-
New Zealand
dies to providers, demand-side subsidies or
Norway
fee exemptions for targeted households, or a
Brazil
combination.
Finland
A financing option that could be piloted
Holland
on a wider basis is conditional cash transfers
Portugal
(CCTs) targeted to poor children to encour-
United Kingdom
age participation in preschool programs. This
United States
scheme has proven to be effective in other
Austria
developing countries (Fiszbein and Schady
Czech Republic
2009), and pilots in China indicate that it has
Germany
significant potential. A pilot in Henan Prov-
Italy
ince, for example, found that kindergarten
Slovak Republic
attendance was 98 percent among poor rural
Sweden
children whose families received a RMB 200
Chile
stipend and had their fees covered, while only
Russian Federation
19 percent of the children in a control group
OECD average
with no assistance attended.27
19 European
Commission countries The second major direction of reform
Belgium could be innovating with new models of
Poland preschool delivery that involve greater co-
Spain responsibility of state, communities, and
France households. This approach can be effective in
Iceland terms of both impacts and costs, drawing on
Mexico good international experience and emerging
Hungary Chinese pilots.28 Expansion of ECDE services
Denmark could involve a range of models, guided by
Israel the notion of “welfare pluralism,” in which
0 1 2 3 4 5 6 7 8 public subsidies could go to support not only
formal preschools but also community and
% of GDP
parent provision (through carer allowances,
Preprimary Preprimary and secondary Tertiary
for example). Given the high cost of center-
based ECDE services, such as p arent-child
Source: World Bank 2011a.
classes and formal kindergartens, local gov-
ernments are unlikely to have sufficient rev-
enue to fund center-based preschool services
in rural areas for the three- to six-year age
prioritize rural, migrant, and poor children. group. The financial constraints of local gov-
Given China’s starting point and simultane- ernment limit supply, and parental inability
ous expansion in other parts of its education to pay dampens demand.
system, education for all three- to six-year- Chinese pilots and international experi-
olds that is fully state funded seems unlikely ence also offer many lessons for innovation in
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 295
models of formal center-based ECDE deliv- is to move toward free senior secondary edu-
ery. Even in formal settings, there is signifi- cation, with sufficient public resources to
cant potential for greater efficiency and inno- ensure access and quality for rural, poor, and
vation. Reducing the length of shifts could migrant young people. The third direction
accommodate more children in two shifts in would reform technical and vocational edu-
the same facilities, perhaps even taught by cation and training (TVET) and higher edu-
the same teachers. A review of international cation to promote a set of competencies that
literature found that most children had cog- will continue to be in demand from employ-
nitive gains by participating in center-based ers as the economy evolves. Many elements
preschool programs for 15–30 hours a week of the vision for China’s education system in
for at least 9 months of the year, and chil- 2030 are already visible in the National Plan
dren from lower-income families benefit even for Medium- and Long-Term Education and
more. Different models of formal provision Development, including promoting equality
are also possible and are already being tried of access at all levels of the system, enhanc-
in China; one example is the use of mobile ing educational quality, and promoting inno-
kindergartens in remote rural areas. Piloting, vation and greater diversity in the education
evaluating, and gradually expanding different system.
models of early childhood education suited to
local fiscal and other conditions would be an Promoting equality of quality in compul-
agenda for the 12th Plan period. sory education. Promoting greater equality
in compulsory education is a major priority
from both social and economic perspectives
Promoting Equality of Quality and
and for maximizing China’s human capital
Access across the Education Cycle
base. China has made great progress toward
A key driver of China’s sustained growth its goal of universal completion of primary
and economic transformation into a high- and junior secondary schooling. Nonetheless,
income country will be the development of a challenges remain in completion of the full
workforce with the competencies needed in a junior secondary cycle in poorer areas and for
more complex and dynamic economy. A key certain groups such as migrant children, with
distinction between countries that have suc- around 9 percent of students nationally still
cessfully made the middle- to high-income not completing the full compulsory cycle in
transition and those that have stalled is the 2009 and higher shares in poorer provinces.30
level, quality, and equity of investment in The key challenge in basic education is
human capital. At the same point in their “equality of quality” for children in dif-
development paths, Japan and the Republic ferent areas, social categories, and income
of Korea were sending almost all students groups. Disparities in quality of basic educa-
to high school. In contrast, countries that tion remain substantial, and in some dimen-
have stalled at middle-income status—such sions may have increased in recent years. Dif-
as Argentina, Iraq, Mexico, and the Arab ferences in per capita allocations of public
Republic of Egypt—are distinguished by spending across provinces (and often within
low levels of human capital relative to their provinces and prefectures) increased between
income levels.29 2000 and 2009, despite rising spending
To promote and accelerate the human across the board as well as significant central
capital transition, reform efforts are needed subsidies to rural education as a result of the
in three directions in compulsory education fee-free rural education reform (figure 4.15).
and at the postcompulsory education level. The equality of quality agenda is relevant
The first is to reduce the remaining dispari- to both rural and urban areas but in distinct
ties in quality across space and across dif- ways. In rural areas, significant challenges
ferent groups of children in their access to include the recruitment, compensation, and
quality compulsory education. The second retention of quality teachers and gaps in the
296 CHINA 2030
FIGURE 4.15 Spending per capita on education The increased importance of family connec-
by province, 2000 and 2008 tions and “selection fees” to get children into
elite urban public schools reinforces exist-
2,000
ing social disparities. Better-quality urban
1,800 schools benefit from increased revenues from
1,600 the school-selection fee, further setting them
1,400
apart from ordinary schools. Despite national
RMB per capita
1,200 2008
1,000 policies, significant challenges also remain in
800 ensuring free access to schooling for migrant
600
400 children in urban areas. In Guangdong Prov-
200 2000 ince, for example, 55 percent of migrant chil-
0
dren from within the province and 79 percent
1,500 15,000
of migrant children from outside the province
Provincial per capita GDP (RMB, log scale)
enrolled in private schools (compared with
only 13 percent of local urban residents) in
Source: China Statistical Yearbooks, in Brixi and others (2011).
2009 (World Bank 2010a).
Although the authorities have been trying
to address quality differentials in compul-
quality of educational infrastructure and sory education, fiscal and other constraints
learning inputs.31 Poor households also con- make the task challenging. The removal of
tinue to experience difficulties in shouldering fees in junior secondary school has been an
the non-fee costs of education (such as travel important reform in recent years and has
and learning materials), especially in the face had clear benefits in funding levels and the
of rising opportunity costs as real wages retention rates of poor students (Wang and
have risen. In urban areas, disparities are Yang 2008). The authorities have initiated
evident in the differential enrollment rates free tertiary education to encourage teachers
in higher quality “key” schools and regular to move to western areas and are promoting
schools among local, migrant, and poorer rotation of urban teachers, but the scale and
children and in indicators such as average consistency of approach varies.
class size and transition rates (figure 4.16). Addressing “equality of quality” in com-
pulsory education will require deepening
reforms on several fronts, including:
FIGURE 4.16 Type of urban schools attended by various subgroups
in five Chinese cities, 2005 • Further financing inputs from govern-
ments above the county and district levels
55 will be needed to avoid further widening
55
50 of disparities in educational quality across
45
45 provinces and within them. This is par-
40 39
37 36 38
35 ticularly the case for rural schools, where
Percent
30 26
28
27 aggregate funding shortfalls and dispari-
25 24 23 22
21 21 22 21 22 21 22
20 16 16
18
16
18 ties remain an issue in achieving quality.
15
15 11
14
This equalization is part of a wider inter-
10 8
5 governmental system reform agenda dis-
cussed in chapter 1 on structural reforms.
The experience of cities such as Dalian
ts
in st
ed
ed
rie l
in st
go al
nt
en
qu ore
qu iche
oy
oy
te e,
ra
s
e
til
til
ca erag
pl
pl
ig
Po
R
Em
em
M
Re
Av
Province City District Regular grating poor and migrant children pro-
vides models, but such equalization efforts
Source: Wang and Wu 2008. will eventually need to go beyond the
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 297
prefecture. The experiences of countries FIGURE 4.17 Official promotion rates from junior
such as Korea and Japan also offer insights high school to academic high school, urban and
rural, 1990–2006
into the potential for more proactive poli-
cies to promote equalization of access to
good quality schooling. 80
• A key focus will continue to be teach- 60
Percent
ers—teacher recruitment and career pro- 40
gression, allocation, compensation, and 20
incentive policies. A combination of mea- 0
sures is required, including institutional- 1990 1994 1998 2002 2006
izing a rotation mechanism to ensure that Total China Rural Urban
quality teachers spend time in disadvan-
taged schools;32 twinning arrangements Source: Rozelle 2011.
between stronger and weaker schools; Note: Rural promotion rate includes promotions only in rural areas.
strengthened in-service training; incen-
tives for hardship postings; and more
fundamental examination of teacher com- however, because many go to high school in
pensation. China is experimenting with a urban areas. Taking this into account gives
number of such measures, including intro- an estimated junior-to-senior secondary aca-
ducing a degree of performance pay for demic promotion rate of 20–30 percent for
teachers. rural children (Rozelle 2011). In contrast,
• In urban areas, a key question is how to urban rates rose rapidly during this period,
reinvigorate the concept of a neighbor- from around 40 percent to around 70 per-
hood school, a concept that has been cent. While a significant share of rural chil-
substantially undermined by the practice dren go on to senior secondary vocational
of selection fees and the growing impor- institutions, because of concerns about poor
tance of personal contacts in accessing the basic school training in TVET education,
best schools. The issue of how to integrate this section focuses on barriers to accessing
migrant children into a stronger neighbor- senior secondary academic schools (Wan
hood school system is one that will require 2007; Xinhuanet 2009).
policy reform as well as close focus on Several factors drive low rural progres-
their educational needs. The experiences sion to senior secondary academic schools:
of Japan and Korea suggest, however, that the entrance test, the high costs of second-
a strong neighborhood school system has ary education, the perceived low quality rela-
a significant equalizing impact does not tive to cost, and the rising opportunity costs.
appear to compromise overall quality, Many rural students simply fail the entrance
given these countries’ consistently strong exam to senior secondary academic school
results in international tests. (zhongkao), with evidence even from rich
provinces like Guangdong suggesting that
Achieving full senior secondary enroll- fewer than half of rural junior high gradu-
ment. While China has made great progress ates pass the exam (Chen and Liang 2008). In
in expanding access to postbasic education, addition, there is evidence that students pass
getting rural children into senior secondary the exam but choose not to enroll in senior
academic high schools remains a major chal- academic school for quality or opportunity
lenge. As shown in figure 4.17, the rate of cost reasons (He 2009; Li 2007).
graduation into the senior secondary aca- However, high cost and rising opportu-
demic stream among rural children remained nity costs appear to be the main drivers of
almost stagnant from 1990 to 2006, increas- low rural graduation into senior academic
ing from 7 percent to only 9 percent. Getting high schools. Figure 4.18 compares average
the full picture for rural children is difficult, tuition fees for senior secondary school (or
298 CHINA 2030
FIGURE 4.18 International comparison of general high school where relevant) in a range
annual tuition per student in public high schools, of countries relative to rural China (the lat-
late 2000s
ter based on evidence from rural Shaanxi as a
representative poorer province). Even relative
China 160
to countries at much lower levels of income,
Belgium 0
China is a major outlier. The situation is
United Kingdom 0
more pronounced when comparing the fees
France 0
as a share of household income: in Mexico,
Germany 0
three years’ worth of school fees amount to
Hungary 0
only around 4 percent of per capita income,
Ireland 0
while in the China example, fees for the
Poland 0
three-year cycle would cost 82 percent of net
Romania 0 per capita income of a rural household at the
Spain 0 time ( Rozelle 2011). The costs of room and
Sweden 0 board in senior high school may more than
Switzerland 0 double the tuition level. All of these are direct
Canada 0 costs and do not take into account the rising
United States 0 opportunity costs of being out of the labor
Australia 0 force because of substantial increases in the
New Zealand 0 real wages of unskilled workers in recent
Bangladesh 0.4 years.
Cambodia 0 The government is aiming to provide
India 0 financial aid to 20 percent of students in poor
Indonesia 50 rural areas, but the level of aid relative to full
Iran, Islamic Rep. 0 direct costs remains low (leaving aside oppor-
Lao PDR 0 tunity costs). The government’s efforts are
Malaysia 0 clearly a step in the right direction. However,
Philippines 0 survey-based estimates from Shaanxi Prov-
Thailand 0 ince in 2008 found that financial aid cov-
Turkey 0 ered only around 6 percent of the total direct
Vietnam 1.22 costs (tuition plus board) of senior secondary
Argentina 0 school (Rozelle 2011). The major policy ques-
Brazil 0 tions for the authorities are:
Chile 0
Dominican • Should compulsory education cycle be
0
Republic
Mexico 100 extended to the end of senior secondary
Nicaragua 0 level?
Peru 10 • If so, should senior secondary education
Uruguay 0 be free for all students, or should a tar-
Benin 0 geted approach to financial aid be taken,
Ethiopia 0 and what should be the coverage in terms
Kenya 0 of groups/shares of total students and the
Lesotho 13 degree of financial support provided?
Tanzania 13
Uganda 0 Given the needs of the Chinese economy
and the experience of countries that have
0 20 40 60 80 100 120 140 160 180
moved from middle- to higher-income status,
US$ per student per year extending free education to include the senior
secondary level seems inevitable in the com-
Source: Rozelle 2011. ing decade. For China to continue deepening
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 299
its human capital base, getting all students than 24 percent by 2009. Similarly, technical
to finish senior secondary school is a neces- and vocational training has expanded signifi-
sity in the coming decades. China has already cantly at the senior secondary level, supported
set a 90 percent senior secondary enrollment in part by major investments in student sti-
target (with half in the academic stream and pend schemes.
half in the vocational stream) by 2020 in In both the technical and academic
its National Plan Outline for Medium- and streams, however, quality and labor mar-
Long-Term Education Reform and Develop- ket relevance need to be strengthened to
ment. The 2020 quantitative target is compa- enable China to achieve sustained produc-
rable to Korea’s senior high enrollment rate tivity growth. The greater openness and
in 2000. However, the strategy on financ- rapid technological adoption of the Chinese
ing of senior secondary school remains to be economy has created a demand for higher-
developed, beyond the (appropriate) priority skilled workers with more diverse competen-
given to central and western provinces.33 cies, posing an ongoing challenge to China’s
Given the rising opportunity costs of education and training systems. Employer
senior high school, the government may need surveys identify significant skills gaps in
to consider a bolder financial commitment to both higher education and TVET graduates.
achieving its 2020 target and the adoption of For example, a 2005 McKinsey report con-
an even higher coverage target for 2030. Fol- cluded that only 10 percent of the engineer-
lowing the example of the rural fee abolition ing graduates had the appropriate attributes
in the past decade, a similar policy would for working in multinational corporations
be advisable for senior secondary schools in (Farrell and Grant 2005). The key shortcom-
rural areas; the government might also con- ings were in the “soft skills” such as practical
sider a parallel initiative for poor and migrant and language (English) communication skills,
children in urban areas. A substantial injec- innovative capacity, professional qualifica-
tion of public funds would be required, with tions, and entrepreneurial capacity. Similarly,
the bulk needing to be financed by the central skills shortages were identified as a serious
and provincial levels. This could be financed obstacle by more than 30 percent of Chinese
in part by the incremental public funding firms by Investment Climate Surveys, with a
China has already committed to in its Edu- further 30 percent identifying them as signifi-
cation Law, with a target of increasing the cant (Almeida 2009).
amount spent on education to 4 percent of The TVET system faces several challenges
GDP from around 3.5 percent. However, in enhancing quality and the labor market
if such an initiative is to be combined with prospects of students and their contribution
increased funding for preschool education for to productivity growth:
rural, migrant, and poor children, and if the
planned continued expansion of higher edu- • The TVET system is fragmented, with
cation is to be achieved, public spending will uncoordinated provision across a range of
most likely have to be increased beyond the 4 public sector agencies and a growing pri-
percent target. Fiscal constraints are likely to vate sector. The bulk of colleges are oper-
force prioritization of educational reforms by ated by the Ministry of Education (MOE)
the authorities, with a sequenced approach. or the Ministry of Human Resources and
Social Security (MOHRSS) and their local
Developing competencies for the 21st cen- branches, but many other line agencies
tury. China has made great progress in are also operating significant subsystems.
expanding access to postbasic education in Governance is also decentralized within
recent years. The share of postsecondary stu- each of the subsystems.
dents enrolled in higher education, including • Consistent with the diverse governance
higher vocational education, rose from only arrangements, the system of qualifica-
around 3 percent in the early 1980s to more tions and competency certification is also
300 CHINA 2030
To help China ensure a sustained stream governance of the TVET sector is the estab-
of appropriately skilled workers as it moves lishment of a national (or provincial) train-
up the value chain, curriculum reform in ing authority. Examples of national training
TVET education should balance the contin- authorities can be found in Australia, Brazil,
ued acquisition of general core skills with New Zealand, the Philippines, South Africa,
technical skills. This will require a signifi- and the United Kingdom. The models vary,
cant shift in the approach to TVET education but governments hold primary responsibility
as well as greater emphasis on the practical for policy development and take the lead in
application of knowledge in tertiary aca- promoting the orderly operation of training
demic education. Countries such as Finland markets through regulation and institutional
and Korea provide a rich body of experience development and in ensuring equitable access
from which to draw as China develops such to these markets. Rather than relying solely
incremental reforms, including reforms such on public provision, new models of competi-
as dual academic/technical qualifications and tion have emerged. Employers, worker orga-
for the possibility of transfer from the TVET nizations, and civil society are participating
system into academic streams with credit for in policy development as stakeholders and
prior learning. assuming larger roles in provision and financ-
The fundamental trade-off in T VET ing of training. Establishing an effective
reform is between immediate employability national training authority is not straight-
and adaptability of skills across the life cycle forward, but experimentation in advanced
to accommodate a rapidly changing econ- provinces in the medium term could build
omy. Global evidence indicates that, indeed, experience for wider institutional reform in
youth employment rates for those with TVET the long term.
education are higher than those with aca- The TVET system can benefit enormously
demic education at the initial point of transi- from an expanded role for nonstate sector
tion from education to work. That advantage provision to help meet demand, service niche
decreases with age, however, as the narrow skill sectors, and provide a healthy dose of
technical skills that initially helped in obtain- competition. To help encourage greater plu-
ing work become outdated and the absence rality in TVET delivery, nonstate provision of
of more general competencies for adapting training should be publicly financed within
and life-long learning become a constraint a solid regulatory framework to ensure that
(Hanushek, Woessmann, and Zhang 2011). private trainers meet quality standards. This
And the deterioration in TVET labor mar- could in principle be done both on the sup-
ket benefits was found to be faster in coun- ply side (by allowing for public financing of
tries experiencing more rapid technological accredited nonstate training institutions) and
change. The trade-off between short-term on the demand side (by using public funds
employability from TVET and China’s long- to provide vouchers to students who would
run desire for a labor force with high but freely choose among public and nonstate
flexible skill sets as it strives for high-income institutions). Local-level experiments with
status will become increasingly important in training vouchers in China (such as Meizhou
coming years. in Guangdong; Jiangsu Province) can provide
In addition to reorienting the content of lessons for potential demand-side interven-
TVET education, structural reforms are tions. Licensing and accreditation for non-
needed to make TVET more responsive state providers is a seriously underdeveloped
to employer demand and more account- area in China and would benefit from les-
able for quality. These include governance sons of experience in countries with well-
reforms to streamline and consolidate over- developed training markets. In Chile, for
all sectoral policy setting and oversight. One example, the Servicio Nacional de Capaci-
option for addressing the current fragmented tacion y Empleo (SENCE), a specialized
302 CHINA 2030
agency of the Ministry of Labor, maintains the system with primary care providers play-
no in-house capacity for provision of training ing the key role in care coordination.
and procures training services from public Transforming the health system will be
and private providers (Johanson and Adams challenging, but if greater equalization and a
2004; Cinterfor/ILO 2001). more responsive and accountable system can
In the long run, adoption of a common be achieved, international evidence points to
standard for assessing the competencies of significant health, equity, and productivity
all students would promote greater integra- dividends (Spence and Lewis 2009). China’s
tion across the education system. A national Health System Reform initiated in 2009 rec-
qualifications framework (NQF) could play ognizes many of these challenges. This sec-
an important role in this regard. Country- tion discusses three key elements of health
level frameworks linking existing qualifica- reforms: reorienting the delivery system to
tions of different levels and types of educa- put a greater emphasis on primary and pre-
tion in a coherent and consistent way based ventive care; reforming health financing and
on a common set of criteria have proven to incentive systems; and deepening reforms of
be valuable in a number of countries, includ- the hospital system.
ing Australia, Ireland, the Netherlands, Rus-
sia, and the United Kingdom. The European Current status and challenges in China’s
Union (EU) has also established a voluntary health system. In the past decade, China
European Qualifications Framework to pro- has sharply increased public expenditure on
mote mutual recognition of educational and health care and undertaken a range of reforms
skills qualifications.34 The potential benefits in financing and delivery of health services.
of such a system in China, with its diversity China has achieved expansion of its health
of institutional subsystems of education and insurance system at a speed that has few prec-
training (both geographically and across line edents globally. Health insurance coverage of
agencies within the training system) are sub- the rural population rose from only around
stantial. Given the challenges of coordination 20 percent in 2003 to around 95 percent by
and agreement on common standards and the end of the decade, and urban residents
implementation arrangements, implement- outside formal sector insurance schemes were
ing an NQF would be a long-term process. also brought within the umbrella of insur-
Nonetheless, it is a goal worth pursuing, ance. Coverage of services and reimbursement
because it can contribute to needed improve- rates have also been expanded gradually, and
ments in educational quality and labor mar- major investments have been made in health
ket relevance. infrastructure. The expansion of health insur-
ance has been complemented by ongoing
structural reforms, most recently through the
Achieving and Sustaining a Healthy and
2009 Health Systems Reform.
Productive Population
Despite increased spending, however, the
Deepening health reform will be one of health sector remains inefficient and frag-
China’s biggest social challenges in the com- mented, is misaligned with the burden of dis-
ing years. At the same time, Chinese and ease, and provides inadequate and unequal
international experience demonstrates that financial protection for the population. A key
health sector reform is one of the most com- aspect of the changing context is the domi-
plex and politically challenging reforms that nance of noncommunicable disease, which
governments confront. This challenge is exac- requires a different policy and delivery sys-
erbated in China by the explosion of noncom- tem mix. Following are the key issues and
municable diseases, and requires a fundamen- challenges for China’s health sector:
tal realignment of the health delivery system
away from the current hospital-centered model • Financial protection for households
toward one that manages care across levels of remains inadequate. Although the share
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 303
of out-of-pocket spending in total health FIGURE 4.19 Out-of-pocket and government health spending as
expenditure has fallen in recent years to share of total health spending, 1997–2010
just under half (figure 4.19), health costs as
a share of household income remain high.
1995
Despite the massive expansion of the New
Cooperative Medical Scheme and urban
residents’ schemes in the 2000s, house-
2000
hold health spending fell only marginally
from 8.7 to 8.2 percent of average house-
hold income between 2003 and 2008 and
2005
actually rose slightly in urban areas (figure
4.20). Partial financial protection is driven
by a combination of actual reimburse-
ment rates (40–50 percent in nearly all 2010
provinces in the NCMS); annual caps on 0 20 40 60 80 100
coverage that expose households to major Government expenditure on health Private expenditure on health as
financial risk from serious illnesses; and as a % of total health expenditure a % of total health expenditure
variable inclusion of services within insur-
ance packages. Just as important, there is Source: China Health Economics Institute, China Health Total Expenditures Statistics 2011.
growing evidence of provider overservic-
ing and health price inflation.
• Financing is highly fragmented and FIGURE 4.20 Household health spending as a
unequal, with risk pools fragmented share of total household income, 2003 and 2008
across insurance schemes and across
space. In most provinces, insurance plans 12
are struggling to raise the pooling level
% of household income
10
beyond the prefecture level. As a result,
8
coverage of services and the extent of
patient reimbursement remain variable 6
across space and across social groups, 4
depending on which insurance scheme 2
they are in. Funding sources are even more 0
varied for primary care and include ear- National Urban Rural
marked vertical program budgets, health 2003 2008
insurance, central and local budgets, and
user fees. Source: Ministry of Health, third and fourth National Health Surveys.
• Financing and payment arrangements
give weak incentives to health care provid-
ers to strive for efficiency and to deliver biased toward inpatient care, until recently
core primary care services. For all levels excluding outpatient care. The National
of care, the dominance of fee-for-service Health Services Survey shows that in
provider payment systems and emphasis 2008, 33 percent of patients received reim-
on self-financing of facilities has encour- bursement for outpatient care, compared
aged overservicing and lack of emphasis with 85 percent who received reimburse-
on efficiency. As a result, unnecessary ment for inpatient care. Outpatient cover-
hospital admissions account for 30–50 age within health insurance schemes has
percent of the total, and average hospi- expanded significantly since then, but
tal lengths of stay are double the OECD the process remains incomplete. Insur-
average. In addition, the insurance-based ance plans often do not cover preventive
financing model has for most people been services, which are particularly vital in
304 CHINA 2030
50
1.5
40
30 1.0
20
0.5
10
0 0.0
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th ep
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e
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in
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d pa
a
a
ite do
at
at
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la n
la n
t ra
t ra
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• The nonstate sector has the potential to might be considered to achieve this, some of
contribute more to realizing the govern- them extensions of existing reform initiatives.
ment’s objectives in the health sector. These include primary care reforms, deepen-
Although around 20 percent of hospitals ing hospital reforms already under way, and
are private, they accounted for only about addressing challenges in health financing and
5 percent of total inpatient and outpatient payment systems.
services in 2008. The situation is rein- The Chinese authorities have emphasized
forced by public insurance systems that primary health care reform in the ongoing
have so far provided an unlevel playing health systems reform, but such reform is a
field between public and private health generational change that is likely to encoun-
providers. ter significant obstacles. 38 A modernized
primary care system requires a set of com-
Reforms to promote a healthy and produc- prehensive measures phased in over 10–20
tive population. Many of the challenges of years, including new delivery models, a new
health reform are outlined in the 2009 Health generation of primary care health profession-
Systems Reform (HSR), but questions remain als, financial and nonfinancial incentives, and
on how much progress can be made in the a realistic transition plan (figure 4.22). The
absence of more fundamental realignment of different elements of primary care reform are
the incentives in the health system.37 The five linked, and it is critical to move on all the
areas of the HSR recognize the need to reori- major elements in tandem. In addition, pri-
ent care to greater reliance on primary and mary care reform cannot succeed in isolation
preventive services, contain costs, and reform from reforms of other levels of the health sys-
financing and hospitals, but an overarching tem. An effective primary care system must
concern is whether the reforms will be suf- be part of a broader model of “coordinated
ficient to achieve the fundamental shift away care” that ensures that patients are treated
from an inefficient and hospital-centered and that their condition is managed at the
model of care to one that is more suited to right level of the system to contain costs and
the demands of a disease profile dominated improve quality.
by noncommunicable disease and is built International evidence shows that a dis-
around a primary care system that helps coor- ease profile dominated by noncommunicable
dinate care across levels of the delivery sys- illness requires more complex case manage-
tem. This section discusses the reforms that ment and coordination of care, and primary
306 CHINA 2030
FIGURE 4.22 Pyramid of care model reform and include decisions about pro-
fessional competencies, organizational
forms for primary care providers, financ-
Level 1 ing mechanisms and sources, responsibili-
Primary care with support/supported ties between levels of government, and so
self-care (65–80%) of low-risk patients on. The HSR provides a starting point but
would benefit from a more comprehensive
Level 2 approach.
Care management for high-risk
• Experiment with new institutional
patients (15%)
arrangements for new primary care pro-
Level 3
viders, learning from Chinese pilots and
Case management international experience. The primary
for highly complex care system remains fragmented in institu-
patients (5%)
tional terms with a host of often uncoor-
dinated actors, including family planning
agencies, maternal child health programs,
township health centers (THC) for pri-
mary and secondary care, village doctors,
public health agencies, and others. In rural
settings, township health centers with
Source: Palu 2011.
links to village clinics are the natural unit
to be strengthened or restructured to pro-
vide integrated primary care. A key ques-
care level plays a critical role in the process. tion is to what extent THCs should retain
As shown in figure 4.22, a majority (65–80 an ambition to provide inpatient care. One
percent) of such patients need low-level care possibility could be to convert THCs into
because their conditions are reasonably con- ambulatory care centers, with family prac-
trolled with self-management. This care can titioners providing technical oversight of
and should be provided by a strong primary village doctors. The urban solution would
care system. About 5 percent of patients with be built around urban community care
noncommunicable disease require complex centers. Emerging experiences in Shanghai
case management delivered by specialized or and Beijing indicate that they are able to
hospital-based care. Between these groups fulfill primary care provision tasks when
are higher-risk patients who need less com- equipped with a new set of competencies
plex care management from specialists. Pri- and provided with professional support.
mary care plays the key role in managing Shanghai and Ningbo have also provided
care across these three groups. In addition, promising examples of a functional fam-
evidence from developing countries shows ily doctor model for the past several years.
that expenditure on primary care is more Integrated care centers that include pri-
pro-poor than expenditure on hospitals. mary care providers along with other pro-
The key steps of primary health care fessionals (ambulatory specialists, social
reform are based on Chinese and global expe- workers, geriatricians) should also be
rience and are summarized in figure 4.23. In piloted.
the short term, two broad steps should be
taken: In the medium to long term:
• As a starting point, reach for consen- • Equip a new generation of providers with
sus about the policy direction and key new skills, a process that will take a gen-
components of reform. This consensus eration to complete. To achieve this goal
would outline the key dimensions of by 2030, significant changes to medical
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 307
100
All population covered
by modernized PHC
National legislation providers
updated to reflect Financing model
80 the modernized operational
health system
Continuous stream structure and Gatekeeping in force
of new professionals features
enter practice Coordination of care
happening
60 Continuous
learning from Retraining programs
Percent
education are needed.39 OECD standards in this regard (World Bank 2005). An
imply that China will need about 600,000 important element of the in-service train-
general practitioners and perhaps twice ing strategy would be reform of the fund-
as many mid-level health professionals, ing mechanism and incentives for local
but only a small number of universities CDCs to provide essential public health
in China currently provide training com- services training at the grassroots level.
parable to the eight-year Western medical • Further reform the resource allocation
training. Transitional arrangements will model supporting primary care develop-
need to be put in place, balancing retrain- ment. International experience suggests
ing the existing stock of providers (tem- that resources could be allocated per
porary programs) and establishment of capita, risk adjusted for gender, age, and
new streams of training (permanent). The mortality, possibly also including socio-
experience of former socialist countries in economic parameters (poverty, remote-
Europe and Central Asia provides lessons ness). High- and middle-income countries
308 CHINA 2030
provide examples of models of vary- public hospitals and doctors to behave like
ing complexity: for example, the United private profit-maximizing providers (World
Kingdom has used complex need-based Bank 2010b; Yip and others 2010). More spe-
resource allocation formulas for its health cifically, short-term reforms could include:
service, while Thailand uses a simple non-
weighted per capita allocation method • The key reform to be initiated in the short
for its universal health insurance scheme. term is setting firm budget constraints
A key step, which China has been pilot- on public hospitals. A key factor will be
ing since 2005, is to separate incomes of exerting greater influence over hospi-
primary care providers from revenues to tals through more active roles for health
encourage cost-effective and quality pri- insurance agencies as purchasers of health
mary care (Yip and others 2010). services that promote quality and cost-
• Adopt financing methods that provide effectiveness. Historically, health insur-
appropriate performance incentives for ance agencies in China have had weak
primary care providers and encourage influence on service quality indicators
greater use of primary care. The emerg- and use of information to monitor and
ing best practice of financing primary care encourage better provider performance.
services globally is a mix of methods that Moving from simply “paying the bill” to
includes fixed practice allowance, variable active purchasing will be key to promoting
capitation, and special incentives that can a system that puts patient care and cost-
help maximize benefits while reducing effectiveness ahead of revenue maximiza-
costs to patients and the health system. tion of providers. China has a growing
Pilots are being designed in China along body of local experience with contracts
these lines. In the primary care provider that set wider quality standards and form
payment reform pilots in Shandong and a good basis for further strengthening this
Ningxia, the township health center is function over time. This reform is linked
treated financially as a vertically inte- to wider reforms in provider payment sys-
grated organization with village clinics. tems (see below on financing and payment
reforms). In addition, with only around
Over time, China can move to a system of 10 percent of hospital revenues currently
coordinated care across the three tiers of the coming from public budgetary subsidies
health delivery system. This will require not (and the rest from fees for medical services
only better-quality primary care providers and drugs), the influence of budgetary
but also strengthened coordination of care agencies on hospital and provider behavior
between primary and higher levels of the sys- is weak.
tem and alignment of the financial incentives • A second set of measures would evalu-
of providers and patients toward primary ate the experience in improving hospi-
care. This process can benefit from global tal governance and management. Given
lessons (box 4.1) and from China’s pilots on the diversity in hospital organizational
care coordination.40 Such reforms can be a reforms across China, it is necessary in
driver for wider reform of the health delivery the short run to have more rigorous evalu-
system if well structured. ation of different models and the lessons
from them. The national pilots in 16
Hospital reforms will need to be deep- urban areas from 2009 are a useful labo-
ened. Achieving the necessary reorientation ratory in this regard. In addition, there are
to primary and preventive care and to pro- improvements in adoption of new develop-
mote a model of coordinated care in China ments in information, communications,
will be difficult without further progress on and record-keeping technology used in
hospital reform. Fundamentally, it will be hospital and insurance management that
necessary to change the current incentives for can significantly improve efficiency of
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 309
Health care systems in OECD countries have evolved mation), organized provider networks, patient
significantly in recent decades and offer lessons in reminder systems, use of evidence-based guide-
what to anticipate given an aging population, eco- lines, financial incentives to providers, and the
nomic and medical progress, emergence of chronic use of family physicians that coordinate treatment
diseases, and public dissatisfaction with access to (Ofman, and others 2004). A similar approach,
and responsiveness of health care providers. The sometimes referred to as case management, consists
growing prevalence of chronic disease has been a of assessing, planning, managing, and monitoring
major driver of calls for coordinated care. of an individual’s social service, prevention, and
It is well established that people with chronic con- treatment needs. This is performed by a “case man-
ditions are high users of health services and absorb ager,” who in principle works with providers across
a higher share of costs (Machenbach 2005; Thorpe all levels to ensure cost-effective treatment. Other
and Howard 2006). Care models are emerging to less common models involve the delivery of a com-
address the needs of these people to reduce costs prehensive package of services to a defined popula-
for both patients and institutional payers, improve tion through integration of financing, professionals,
outcomes, and raise the quality of and satisfaction and facilities under a single organizational and
with care. Although models vary considerably, coun- managerial structure. Kaiser Permanente and the
tries are consciously reducing their hospital capacity Mayo Clinic in the United States are examples of
and moving toward a care model that places greater an integrated delivery system.
emphasis on primary care and coordination across The impact of coordinated care models sug-
care settings (OECD 2009; Hofmarcher, Oxley and gests potential for improving system performance,
Rusticelli 2007). Care coordination consists of a although evidence on some indicators is mixed. In
mix of measures that link professionals and organi- a review of the literature, Hofmarcher, Oxley, and
zations at all levels of the health system, emphasize Rusticelli (2007) found disease management pro-
patient-centered care integration, manage patient grams appear to improve quality and outcomes.
referral through the delivery system, and promote These programs may reduce hospitalizations, but
follow-up care as well as the continuity of long- their impact on cost containment appears incon-
term-service provision. The concept is often based clusive. Evidence from large integrated delivery sys-
on the strong role of primary care as the driver of tems suggests that these organizations are able to
coordination functions, including through gatekeep- follow care management processes (such as clinical
ing (Saltman, Rico, and Boerma 2006). pathways), reduce unnecessary hospitalizations and
Most coordination models target specific patient lengths of stay, and provide higher-quality care at
groups such as seniors or people with one or more lower costs than other types of delivery arrange-
chronic conditions. One approach is known as dis- ments (Weeks and others 2010; Tollen 2008).
ease management. Disease management programs Finally, effective primary care systems have reduced
can consist of a number of components, including unnecessary and costly hospitalizations in both
multidisciplinary teams, provider education, pro- high- and middle-income countries (OECD 2010a;
vider feedback, information technologies such as Macinko and others 2010; Bynum and other 2011;
electronic medical records (to share patient infor- Bitran, Escobar, and Gassibe 2010).
operations under any model of hospital consistent data standards and protocols
organization. Moving from paper-based across health facilities, to reduce the cur-
to electronic systems can facilitate adop- rent fragmentation of systems and pro-
tion of tools such as cost-accounting soft- mote coordinated care across levels. And
ware and electronic medical records. The the effectiveness of any organizational
key in expanding management informa- change will depend on a new generation
tion systems, however, will be the need for of hospital managers. Finally, following
310 CHINA 2030
Measures already being initiated to delink within OECD, a number of countries, such
the incomes of doctors from prescription vol- as Denmark, Italy, and Spain, moved from
umes are a welcome initial step in realigning contribution-based to tax-financed health
doctor incentives with efficiency and appro- systems in the 1970s and 1980s, while those
priateness of care. But a more fundamental that have retained a contributions-based
reconsideration of the incentives embedded approach have in a number of cases reduced
in physicians’ current salary structures will the rates of contributions and increased the
be needed over time, even with case-based share of general revenue financing (Austria
or other payment system reforms. Building and the Netherlands are examples) (World
consensus in this area will be unusually chal- Bank 2010d). These experiences and China’s
lenging. The diverse experiences of OECD own with the NCMS and urban residents’
countries in striking the balance between schemes suggest that the appropriate balance
fixed and performance-based pay, along with of social contributions and general revenues
the different incentives and outcomes that (and the role of higher-level and local author-
result, provide useful lessons for China in ities) in the longer-run financing of the health
this regard.42 system is worth reconsidering.
In the longer run, a key question in health
financing is the appropriate balance between
The Role of Citizen Participation in
insurance contributions, general revenues,
Social Services
and out-of-pocket spending. In the past
decade, the balance of insurance contribu- In recent years, initial efforts have been
tions and general revenues has already shifted made to promote roles for citizens in service
in favor of the latter with the reliance on bud- delivery. Historically, citizen participation in
get subsidies to promote expansion of the the management and oversight of social ser-
NCMS and urban residents’ schemes. Out- vices has been weak in China. Lack of citi-
of-pocket spending has come down some- zen inclusion is reflected in attitudes surveys
what but is still well above the government’s indicating significant frustration with provid-
longer-term target of roughly 30 percent of ers of public services. As the challenges in
total health spending. The increase in general social services move from expanding cover-
revenues financing is a realistic acknowledg- age and quantity of services to ensuring that
ment of the challenges of covering rural and services are of adequate quality, initiatives
urban resident populations in a standard to increase the role of citizens in promoting
contributory insurance model and of the effective local services have expanded. How-
labor market risks of burdening workers with ever, efforts remain highly localized and for
overly high social contributions. If merger of the most part in their infancy.
the three schemes can be achieved, combining
the current demand-side budgetary subsidies Current status and challenges. Increased cit-
in insurance schemes and supply-side subsi- izen participation has several potential func-
dies to facilities into a basic scheme financed tions (Gong and Yu 2011). It can be a channel
largely from general revenues becomes a real for citizens to better understand the challenges
possibility in the longer term. Careful consid- and trade-offs that service providers face in
eration of the alternative budgetary revenue ensuring quality within budget constraints. It
sources to compensate for the removal or is one pillar of broader “social management”
reduction of health contributions from work- reforms in China that allow for some delega-
ers would be required. tion of functions by the higher levels to the
Rapid progress in this direction has been grassroots level. It can also help develop the
achieved recently within Asia (including in capacity of citizen groups to express their
India, the Philippines, Thailand, and Viet- grievances and provide an institutional basis
nam), with general revenues being the source for doing so. It can also build the capacity
of substantial coverage expansion. Similarly, of communities for a future role as service
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 313
providers in areas where community-based • While simple consultation may have value,
provision of social services has potential (such for citizen participation to have a real
as care of the aged and early child develop- impact, a clear policy and institutional
ment services); this in turn can help promote framework is needed so their participation
pluralism in service delivery in the longer run. is not ad hoc but is truly linked to formal
The roles of citizens in service delivery can decision-making structures and the incen-
take three forms progressively: consultation, tives of providers. Such a framework needs
presence and representation, and influence to spell out clearly the responsibilities and
(Goetz and Gaventa 2001). Consultation accountabilities of the citizens’ group, ser-
involves opening channels for dialogue and vice providers, and local officials. It should
information sharing. Presence and represen- also provide a clear financing base for the
tation involves institutionalizing access for sustained operation of such initiatives.
certain social groups in specific elements of • The specific interests of citizen groups
decision making. Influence is the final stage (such as parents of children in a school)
in which the representation of citizens trans- may at times run counter to some wider
lates into influence on policies and the way social policy objectives. For example,
services are run and organized. In general, parental pushes to tighten student entrance
China is at an early stage of developing these criteria to promote elite student selection
processes. may run counter to wider efforts to reduce
Emerging experience with different forms disparities between schools—and may
of citizen participation in social service deliv- be a particular problem with respect to
ery in China points to significant potential future inclusion of migrant children.
for increasing citizen voice. Recent experi- • Citizens may not at times have the infor-
ences in Kunming, Chengdu, and Nanjing in mation necessary to make informed deci-
the education and health sectors are summa- sions on matters involving questions of
rized in box 4.2. The positive features include technical judgment, and this lack can
the following: weaken their influence and bargaining
power. This challenge is likely to be par-
• Citizen satisfaction with services can be ticularly pronounced in the health sector,
improved, through feeling that their views where asymmetry of information between
are being taken into account and through providers and patients is significant. Infor-
the increased accountability of service pro- mation asymmetries can be addressed
viders to citizens. through appropriate involvement either
• The initiatives act as a localized and selec- of citizens who have such knowledge
tive experiment in representative expres- or experts who are able to provide such
sions of citizen voice. inputs to the decision-making process.
• Citizens learn about the operating envi- • There is not as yet good evaluation of the
ronment of local social services and are impacts on both processes and relevant
able to have a more informed dialogue outcomes (both qualitative such as client
with service providers on ways to improve satisfaction and “harder” indicators such
quality. as student performance, health facility
• In the case of medical mediation, the ini- quality indicators, or patient outcomes).
tiative has the potential to resolve griev-
ances in a more rapid and cost-effective Addressing the challenge of enhancing citi-
manner than formal dispute resolution zen participation in social services. National
channels. policies already set a clear direction for
increased participation of citizens in social
At the same time, the experiences reveal service delivery, but the key question is how
the challenges for effective citizen participa- to make their participation more effective
tion and the inherent trade-offs involved: in improving the quality of services and
314 CHINA 2030
Field work for this report reviewed the experience of vote. The councils have internal powers to vote and
several local initiatives on promoting citizen partici- recommend action to the school principal, although
pation in social service delivery. The cases reviewed final decision-making authority rests with the prin-
include: cipal. At the same time, important decisions of the
Kunming, the capital of Yunnan Province, fol- principal can be put to opinion polls and further
lowing a pilot, in 2008 introduced public election examination. While the anecdotal assessment of the
of primary and secondary school principals. More experience generally points to improved transparency,
than 2,000 schools now have elected principals for concerns have been raised about unclear account-
terms of three years. The elections involve voting by ability for the final decisions of the principal and the
students and parents, teachers, and experts. In addi- legal basis of the school council’s authority to recom-
tion, a process has been set up for regular public mend and review such decisions. Several other prov-
supervision of performance and for dismissal and inces have similar institutions from kindergarten to
by-elections. The candidates are subject to an inter- secondary levels. Some of them, including Shandong
view process by experts, faculty, and student and Province from 2009, and Chengdu city in the near
parent representatives. The second round of elec- future, have regulations that seek to clarify the scope
tions has recently been taking place. Candidates can of authority and underlying processes of the councils
come from anywhere in China, introducing wider to give them a firmer jurisdiction. The 2010 National
competition to the local education market. The Educational Development Plan for 2010–20 has also
former practice of lifetime tenure for the principal suggested establishment of such parent councils on a
has been removed as a result. Anecdotal assessment nationwide basis.
of the experience is positive among parents, stu- In Nanjing, a People’s Mediation Council on
dents, teachers, and local officials. As one principal Medical Disputes was established in 2008. The
expressed it, his attitude changed from “I was told to council has at least two full-time mediators in each
do” to “I wanted to do.” Teachers report more pro- district with designated budgetary allocations. They
active school management and an increase in teach- come mostly from retired health bureau or legal
ing quality. At the same time, there are concerns systems. In 2008–10, 1,700 disputes were handled,
that candidates can easily “buy” the small number with more than 90 percent successfully resolved.
of experts and influence votes with promises of ben- The number of disputes mediated doubled in 2010,
efits to other groups. In addition, the interview pan- including group medical disputes as well as indi-
els and voters do not include migrants for the most vidual claims. While the experience is judged gener-
part, so that the potential inclusiveness of schools in ally positively, the legal basis for the council is not
the future may be undermined. robust, and the difference in bargaining power and
In Nanjing, the capital of Jiangsu Province, school information between large hospitals on the one hand
councils, consisting of two-thirds parents or commu- and claimants on the other can be high. The lack
nity representatives and one-third school representa- of clear legal basis for follow-up and enforcement is
tives, have been established in primary and secondary likely to result in patients settling claims on terms
schools. Some schools allow parent representatives to that may not be to their best advantage.
user satisfaction and ensuring consistency above point to the importance of having a
with equity objectives. Chinese and interna- clear policy and legal framework for citizen
tional experiences point to several key chal- participation, and a robust institutional and
lenges in promoting citizen participation that financing framework for ensuring that citizen
moves from consultation to structures and participation is truly representative and does
processes that give real authority and influ- not place the costs of participation unduly
ence to citizens. The experiences reviewed on citizens themselves. To date, most citizen
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 315
• Increasing the labor supply from the exist- concerns about capital bias that may have
ing workforce. This will involve adopting contributed to rising inequality. The labor
a mix of measures to ensure that older share was consistently around 60 percent
urban workers—particularly women— of GDP from 1990 to 2004 before fall-
do not exit the labor force prematurely; ing sharply to under 40 percent by 2008.44
these measures including raising the retire- Although it has rebounded somewhat since
ment age. Higher rates of off-farm rural then, questions remain concerning whether
employment for those unlikely to migrate labor has been getting its “fair share” of
to urban areas should also be promoted. the fruits of growth since the mid-2000s or
• Building labor market institutions that whether the falling labor share was a short-
allow for a sustainable balancing of the run phenomenon produced by the transfer
interests of workers with the need to main- of labor to the more capital-intensive urban
tain competitiveness. In particular, China economy.
should explore options to reduce labor Looking ahead, China faces new labor
taxation and to develop a more mature market challenges as it seeks to move from
wage determination system. middle- to high-income status. These include:
A growing labor force has played an • The aggregate labor force will start to
important role in China’s economic per- shrink after about 2015, initially slowly
formance, but supply and wage dynamics but then faster beginning in the late 2020s,
are shifting. From just under 600 million in and is projected to be more than 15 per-
1980, the labor force is expected to peak at cent smaller than its peak by 2050.45 The
1 billion around 2015. The dramatic increase smaller labor force will support a growing
in labor mobility has reinforced the contribu- elderly population.
tion of labor to overall growth. The move- • China will no longer have the limitless
ment of rural labor has enhanced productiv- rural labor surplus that has shaped the
ity and fed the low-wage model of Chinese country’s comparative advantage for
growth. But the situation is changing. In the past 30 years. Indeed, a number of
the 1980s and 1990s, real wage growth for researchers claim that the Lewis turning
migrant workers was fairly flat, while labor point was reached as early as 2003. The
market returns to higher levels of education combination of shrinking or exhausted
were high and sustained (Cai, Wang, and unskilled surplus labor and the concomi-
Qu 2009). Since the mid-2000s, however, tant massive increase in workers with
a notable degree of wage convergence has senior secondary and higher education
taken place across skills levels and across will fundamentally shift the dynamics of
space within the country. While urban wage labor supply. This shift represents a huge
growth across all skill levels has been high in opportunity for demand to adjust and
recent years, that of low-skilled workers has move China up the value chain, but it also
been particularly so, roughly doubling in real carries risks.
terms from 2001 to 2010 (Giles and others • The rapid wage growth in recent years
forthcoming; Cai, Du, and Wang 2011a).43 among migrants and low-skilled workers
Despite that, productivity growth has to is accompanied both by rising expecta-
date outstripped wage growth, avoiding tions and by evidence of compression in
inflationary pressures from the labor mar- the productivity growth premium. While
ket (although there are signs of slower labor this wage growth has been a positive phe-
productivity growth in the second half of the nomenon, it raises the question of how to
2000s) (Cai, Wang, and Qu 2009). balance the continued need for upward
At the same time, the share of labor real wage adjustments with sustained com-
income in GDP fell during the 2000s, raising petitiveness as productivity growth eases
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 317
over the coming decades in the face of FIGURE 4.24 Urban labor force market
diminishing returns to capital investment. participation rate among local workers,
1995–2009
• As migrant workers shift from “float-
ing” to become a more permanent urban
population, they will increasingly expect 80
better nonwage benefits, including social
With China’s labor supply beginning to Source: Cai, Du, and Wang 2011a.
decline beginning about 2015, ensuring that
labor force participation among the current
stock of working-age adults is adequate and reasons might lead to relaxation of the pol-
that they are employed in the most produc- icy, but from a labor supply standpoint, this
tive ways will be essential. The discussion in report argues that China will still face signifi-
the last section on human capital emphasized cant challenges in coming decades.
that the quality of future workers will need
to improve for China to sustain robust pro- The supply and structure of the labor
ductivity growth in the face of a declining force. While urban labor markets have seen
labor force. However, there is also significant a vast influx of migrant labor, they have also
potential to increase labor supply among the witnessed substantial declines in labor par-
current stock of working-age adults (primar- ticipation rates among local urban workers.
ily older urban workers). There is also scope Figure 4.24 shows a steady fall in urban labor
to enhance the productivity of other groups: force participation rates (LFPR) among local
first, those who remain in rural areas, by workers from mid-1990s to 2009.46 While this
increasing their participation in off-farm decline appears to have stabilized at 62–64
employment; and second, urban informal percent, it is useful to understand the drivers.
sector workers, many of them migrants. This The overall decline in LFPR among local
section discusses these challenges and poten- urban workers masks different patterns
tial measures to address them. among younger and older workers. The mid-
Considerable debate swirls in China on to end-2000s saw slight increases in partici-
the need to relax the one-child policy to off- pation among younger urban workers but a
set the impacts of rapid aging. The policy has notable decline among those in their 50s. A
contributed to a fertility rate (1.54 according long-term phenomenon, the decline among
to the 2010 census) that is below what would older workers has continued since the main
be expected at China’s income level. How- wave of SOE restructuring and more than
ever, the experience of middle-income and offset the small increases in participation
East Asian countries and of parts of China among younger workers. Even more striking
raises questions as to whether eliminating the is how early urban women withdraw from
policy would have a significant impact on the the labor force, with only around 20 percent
fertility rate. The total fertility rates of coun- participation by the official retirement age of
tries such as Japan and Korea (both around 55.47 It is difficult to say to what extent the
1.3) and Vietnam (1.8) suggest that the long- decline in participation among older workers
run fertility increase may not be major even is a supply-side phenomenon or is driven by
if the policy were eliminated. Other social the combination of demand for younger and
318 CHINA 2030
FIGURE 4.25 Employment rates of older workers by age, gender, and residence, selected years
% working population to
80 80
total population
total population
60 60
40 40
20 20
0 0
45 55 65 75 45 55 65 75
Age (years) Age (years)
% working population to
80 80
total population
total population
60 60
40 40
20 20
0 0
45 55 65 75 45 55 65 75
Age (years) Age (years)
1991 1997 2000 2009
better-educated workers and the big influx of who appear unwilling to hire older workers,
cheap migrant workers in the same period; and lack of opportunities for skill upgrading
regardless, it is clearly a long-term feature of and “lifelong learning” among older workers.
urban labor markets. While LFPRs have also Gender analysis of urban wages suggests
fallen for older rural workers, they remain that one reason for early labor market with-
much higher until much later ages than for drawal by urban women may be the gender
their urban peers (figure 4.25). wage gap. Hourly wage differentials between
International comparisons reveal that urban men and women were consistently at
China’s local urban population has a sig- 22–25 percent between 2001 and 2010.48
nificantly shorter working life than their Decomposing the differential to take account
peers in other countries. Figure 4.26 shows of both individual and job characteristics
LFPRs for older workers in Korea, Indonesia, (sector and ownership type), the overwhelm-
the United Kingdom, and the United States. ing bulk of the wage gap cannot be explained
Women withdraw from the labor force earlier by observable characteristics, with the unex-
than men in all cases, but both urban men plained share of the difference ranging from
and women in the other four countries with- 76 to 90 percent over the period (Cai, Wang,
draw noticeably later than do those in China. and Du 2011b). Recent analysis also confirms
The findings are strongly suggestive of chal- that returns to work experience in the labor
lenges in the Chinese labor market and pol- market for women are notably lower than for
icy environment, which are likely to become men (China Center for Human Capital and
more acute as the population ages. The issues Labor Market Research 2011).
include early and mandatory retirement for A second issue in urban labor markets is
men and women, hiring policies of employers the share of informal work and the potential
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 319
100 100
% working population
% working population
to total population
to total population
80 80
60 60
40 40
20 20
0 0
45 50 55 60 65 70 75 80 85 90 45 50 55 60 65 70 75 80 85 90
Age (years) Age (years)
Urban male Urban female Rural male Rural female
100 100
% working population
% working population
to total population
to total population
80 80
60 60
40 40
20 20
0 0
45 50 55 60 65 70 75 80 85 90 45 50 55 60 65 70 75 80 85 90
Age (years) Age (years)
Male Female Urban male Urban female
Rural male Rural female
100 100
% working population
% working population
to total population
to total population
80 80
60 60
40 40
20 20
0 0
45 50 55 60 65 70 75 80 85 90 45 50 55 60 65 70 75 80 85 90
Age (years) Age (years)
Urban male Urban female Male Female
Rural male Rural female
to enhance productivity and worker protec- sector in urban employment has decreased,
tion through reforms that facilitate greater it still accounts for a large proportion of the
participation in the formal sector. Labor urban labor market (figure 4.27). Notably,
informality in urban China has undergone more than 60 percent of migrant workers in
major transitions in the past two decades. 2010 were in the informal sector, indicating a
Although the overall share of the informal remaining agenda for their incorporation into
320 CHINA 2030
FIGURE 4.27 Size and composition of informal employment in the are almost 47 years old on average, have
urban labor market, various years average educational attainment of only 7.3
years (less than a complete mandatory gen-
100 eral education), and 60 percent of them are
90 87.3 86.5 women (often with obligations to care for
80 children and aging parents). While there
70 may be some further movement from agri-
60.7
60
culture to urban areas, the observation by
Percent
50
40 37.5 one set of authors that “all the low hang-
30
30.2 30.6
25.8
29.7 ing fruit has been picked” seems accurate
20 13.4 (Park and others 2011). The argument is
10 supported by analysis from other national
0 surveys, which found in 2007 that over 80
2001 2005 2010
percent of rural laborers ages 16–30 were
Migrant workers Local workers All
in nonfarm activities, typically working as
migrant labor (Park and others 2011).
Source: Cai, Du, and Wang 2011b.
Analysis of rural work patterns also sug-
gests, however, the potential for increasing
the labor supply of existing workers and their
urban social security and labor regulation sys- participation in off-farm work. Analysis of
tems. Within the formal sector, migrant work- data on time and place worked (farm or off-
ers are heavily underrepresented in monopoly farm) among the rural population from the
sectors (usually SOE dominated) where wages 2005 minicensus indicates significant under-
are higher than they are in competitive sectors employment in rural areas, with average
and where there is evidence of “wage rents.” labor supply being under nine months even
In 2005, migrant workers accounted for only in the peak period of work life (figure 4.28).
3.1 percent of employment in monopoly sec- If one equates total months of rural work
tors, but for 40 percent in the overall urban to full-time equivalent workers (assuming a
labor force (Yue, Li, and Sicular 2011). 10-month work year), the total agricultural
working population shrinks about 22 per-
Rural labor supply. Another potential source cent, from the official estimate of 297 mil-
of future productivity growth is reallocation lion to 231 million. The analysis also shows
of rural labor from agriculture to off-farm low intensity of off-farm labor supply, with
activities. The decline of the Chinese labor participation in off-farm employment averag-
force has been the subject of much specu- ing only around four months and dropping
lation, in particular on whether the rural sharply after age 40.
labor surplus has already been or soon will
be exhausted.49 Under even the most opti- Addressing the challenges in labor sup-
mistic scenarios, it seems clear that the rural ply. Raising labor force participation among
labor surplus is declining and will certainly older urban workers, increasing formal sec-
be exhausted before 2030. At the same time, tor employment in urban areas, and pro-
the profile of the remaining rural labor force moting further participation in off-farm
suggests significant scope to increase produc- rural work can help dilute the impacts of a
tivity within rural areas through movement to shrinking labor force. One important point
off-farm activities in their localities. for policy makers is to avoid the “lump of
Moreover, the profile of the remaining labor” fallacy, which suggests that keeping
rural labor force indicates limited potential older workers in jobs reduces employment
for substantial urban migration. Those still opportunities for younger workers. Interna-
working in agriculture would not normally tional evidence consistently shows that is not
be in high demand in urban areas—they the case. Some reforms and initiatives that
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 321
FIGURE 4.28 Labor supply by age for rural labor force and rural off-farm work, 2010
4
6
3
4 2
2 1
20 30 40 50 60 70 20 30 40 50 60 70
Age (years) Age (years)
TABLE 4.2 Hourly wages of migrant and local workers, and share of difference explained by observable
characteristics, 2001–10
Indicator 2001 2005 2010
the All-China Federation of Trade Unions, observable individual and job characteristics.
which is still evolving toward a role as the Table 4.2 shows that the hourly wages of
representative of workers in wage discussions migrants relative to local hukou workers rose
(Bai 2011). A second issue is the role of wage from only 35 percent in 2001 to 78 percent
guidelines, which are based on surveys that in 2010.54 In addition, the proportion of the
often do not fully represent the local labor difference explained by observable character-
market, and in any event, play an unclear role istics rose from 82 percent in 2001 to 98 per-
in the discussions over wages at the firm level. cent in 2010. In contrast, evidence on wages
Public sector wages are determined sepa- in monopoly sectors—mainly dominated by
rately, and the mechanism for wage setting SOEs—indicates that in 2005, a high wage
is not systematic. On one hand, analysis sug- gap remained between SOE workers and
gests that more than half of the wage gap those in competitive sectors. Around half of
between monopoly (largely state-owned) that difference could not be explained by the
industries and competitive industries cannot characteristics of the workers in monopoly
be accounted for by observable characteris- and competitive sectors, such as gender, edu-
tics of workers (Yue, Li, and Sicular 2011). cation, age, and so on (Yue, Li, and Sicular
In contrast, in social services, the education 2011).
sector introduced in 2009 an element of so-
called performance-related pay (PRP), but Minimum wages. Minimum wages in China
these rules sought to address a complex set are a fairly recent phenomenon, and the
of issues related to the relative pay of rural system is still evolving, with as yet unclear
teachers, the pay of teachers generally relative significance in wage determination and mar-
to civil servants, and a desire to reduce incen- ket wages. The first minimum wage regula-
tives for informal payments (Wang and Gong tion was adopted only in 1993, with articles
2011). In the health sector, the fee-for-service also in the 1994 Labor Law. However, more
system that has historically dominated natu- detailed guidelines on minimum wage setting
rally produces an indirect form of pay based did not emerge until 2004 and 2007.55 Mini-
on performance (or at least on volume of ser- mum wages are set at a decentralized level,
vice), some of the negative effects of which most often at the municipal level, and should
were discussed earlier. be adjusted at least every two years (although
Wage outcomes in the urban labor market with no clear indexation mechanism). As
indicate that varied mechanisms are driv- shown in figure 4.29, real minimum wages
ing wage setting. In recent years, average across China have increased by almost two
wages of migrant and local workers appear and a half times since the mid-1990s, with a
to be converging rapidly, indicating that the rising share of cities making annual adjust-
labor market fundamentals of demand and ments (except in 2009, with the global finan-
supply are overcoming rigidities in wage- cial crisis).
setting mechanisms. The convergence can Standards for minimum wage setting focus
be seen in the falling differential in aver- on the relationship to cost of living and rela-
age hourly wages over the 2000s and in the tive wages rather than productivity. Accord-
degree of difference that can be explained by ing to the 2004 and 2007 regulations, factors
324 CHINA 2030
FIGURE 4.29 Urban minimum wage adjustments, level of average wages, followed by local
1995–2009 average consumption, while the urban CPI
has a significant but much smaller effect (Cai,
1,000
Du, and Wang 2011b).
While minimum wages have adjusted
800 sharply upward in recent years, the vast
majority of formal and informal workers
RMB(1995) per ???
pace of reform and factors to be considered systems of human resource management, pro-
thus also differ. Several directions should be fessional development, and promotions.
considered: A big question for China is the extent to
which it wishes to have performance-based
SOE sector reforms. For SOEs, the initial pay as an element—and if so, to what degree—
priority is to establish a robust system of in setting wages for workers in the education
benchmarking wages so that they are increas- and health sectors. Overall, there is a desire to
ingly determined by reference to relevant explore the possibilities of PRP in the social
comparators in the wider labor market rather sectors, but clarity on the objectives and
than simply by the amount of profits available potential modalities is lacking. The interna-
for distribution to workers. The current wage tional experience in recent years suggests that
premiums of SOEs are a reflection of underly- PRP is not suitable for all types of public sector
ing distortions in the operating environment workers. In considering the appropriateness
of the enterprises and are difficult to justify on of PRP, several questions must be addressed:
either efficiency or equity grounds. Although How closely is performance actually linked
strengthening and enforcing a rigorous to pay, and what other factors are driving
benchmarking system will be challenging for provider performance? How much are policy
SOEs in sectors where only the state sector is makers willing to shift the risk of low perfor-
active or in cases where a single employer is mance from the state to providers themselves?
a monopoly, the more generic types of func- Are there indicators of performance that are
tions (accountants, secretaries, drivers) could consistent with the overall policy objectives
be benchmarked against the outside market. of the sector and that have credibility among
It would also be useful to benchmark wages workers in the sector? If so, can those indica-
of local monopolies across regions to get a tors be measured in a reliable, consistent, and
broad sense of within-industry comparability transparent manner? What unintended con-
and identify outliers. sequences may result from an over-reliance
Enforcing wage discipline in the SOE sec- on certain performance indicators?56 Finally,
tor will be challenging, but it could yield sig- are there alternative approaches to providing
nificant benefits for the Chinese economy and incentives for better performance by providers
also result in a more equitable distribution of that may be more acceptable to the professions
wages across society. The specific nature of and less likely to induce unwanted behavior by
the benchmarking process would be a matter providers. An example might be structuring
for the Chinese authorities to consider fur- the promotions system within the education
ther, but the evidence strongly suggests that and health sectors to place a higher empha-
a transparent system of some form is needed. sis on performance and results rather than
Over the longer run, the direction of reform on seniority or other factors. More broadly,
would be to have SOEs conduct collective if PRP is implemented primarily to address
consultation and bargaining in the same way shortcomings in the wider system of gover-
as other firms under current labor legislation. nance and accountability in the education and
health sectors, there may be other instruments
PSU reforms. The issues in wage setting for for achieving the goals more effectively.
public service units are somewhat distinct, In considering whether PRP is appropri-
given the additional challenge of promoting ate, it is clear that pay based purely on perfor-
accountability of public sector workers while mance is not suitable for teachers and health
ensuring that they are compensated adequately. providers because of the perverse incentives
Because of the unsystematic nature of PSU that may result. If it is to be applied, a base
wage setting, it would be desirable in the short compensation with some degree of bonus
to medium term to develop a national strategy would be more appropriate. In addition, a
on reforming the process, including for social stronger system for determining promotions
services. That could be linked to broader and peer appraisal of performance is needed.
326 CHINA 2030
International experience also suggests that a Formal private sector. For the formal pri-
“one-size-fits-all” approach to PRP should vate sector, the challenge will be to develop
be avoided. The specific characteristics of the a mature system of collective bargaining. To
population being serviced should be taken into make progress in this direction, the role of the
account in assessing provider performance— union as an effective voice of workers in wage
for example, through adjustments to account negotiations will be expected to strengthen.
for remoteness or specific challenges of ser- Gradual reforms in collective bargaining can
vicing particular population groups such as be supported by efforts to make the labor
migrants or minorities. Box 4.3 summarizes market more competitive so that the relative
some lessons of experience of PRP in OECD bargaining strength of employers and work-
countries in the health and education sectors. ers reflects underlying supply and demand in
BOX 4.3 Lessons from performance-related pay experience for public servants in
OECD countries
Despite a growing history of experiences with • The countries with the strongest PRP empha-
performance-related pay for health and education sis are also those with the highest delegation of
workers in OECD countries, the desirability and human resource and budgetary management
outcomes of PRP remain contested, and the gap responsibilities.
between rhetoric and reality is often large. As of • In a number of cases, PRP systems have tended to
the mid-2000s, two-thirds of OECD countries had become more decentralized over time.
PRP for public sector workers or were introduc- • The criteria for assessing performance have
ing it (OECD 2005). The objectives underlying the become more diverse, with greater attention to
introduction of PRP vary and are often related to the outputs as well as competencies and social skills.
desire to promote wider organizational or manage- At the same time, PRP systems have become less
ment change, in addition to objectives related to the formalized and detailed, relying less on quantifi-
motivation or performance of individual workers. able indicators of performance.
The scope of PRP initiatives has also varied, with • Many countries have experienced implementa-
schemes often more focused on managerial public tion problems, for example, before introduction
sector workers and specific sectors. In addition, the of PRP in negotiations with unions and workers,
actual assessment of performance varies, with some during the deployment phase with management
systems having no or low individual assessment. who may not well understand the system and
While the share of PRP in total pay is not as great objectives, and in terms of the costs in money and
as may sometimes be claimed, salaries of civil ser- time for introducing PRP and the monitoring sys-
vants in most OECD countries consist of three com- tems that it requires.
ponents: base pay, pay based on the specific duties • International experience suggests that PRP itself
of the position, and a performance-related element. may be only one factor in motivating work-
The share of PRP has generally been fairly modest, ers, who emphasize other factors such as job
with PRP bonuses rarely more than 10 percent of the content and satisfaction, flexibility of working
base pay of civil servants, although closer to 20 per- arrangements, and promotion and other forms of
cent for management-level staff. Some overall trends recognition.
or features emerge from the review of OECD experi- • PRP should not be used in isolation but as a tool
ence, including: to promote wider organizational reform, and the
objectives and performance criteria should be set
• There has been some expansion in the use of with this in mind.
team or group performance as the benchmark for
assessment of PRP.
TABLE 4.4 Minimum wage approach and criteria, various economies, end-2000s
the labor market. This is starting to happen poverty function could actually harm low-
to some extent as the earlier labor surplus income workers by increasing unemployment
declines and workers now have a credible posi- or pushing them into the informal sector.
tion of exit to other firms if wage settlements China’s challenge over the coming decade
are inadequate. The bargaining process in will be to shift from its current “living wage”
the private sector can also benefit from better approach with respect to the minimum wage
information on productivity growth through to a “wage floor” approach, which is more
an improved system of labor statistics. common in OECD countries. Like the current
As a starting point, the basic function of approach, the wage-floor approach takes into
the minimum wage in the private sector will account several factors in determining the
need to be reoriented. That function is to minimum wage. Table 4.4 provides examples
ensure that workers are not exploited because of factors that are included in determining
of their limited bargaining power and that the minimum wage in some OECD coun-
they receive a wage that fairly reflects their tries as well as in Hong Kong SAR, China,
contribution to productivity growth. The and Taiwan, China. The major distinction is
minimum wage is not intended on its own to that some measures of productivity growth
pull families out of poverty; keeping families and competitiveness are the primary factors
out of poverty is the job of other policies, par- in setting the minimum wage. While price
ticularly social protection programs. Setting inflation and other factors remain important,
minimum wages too much according to their the key is adjusting minimum wages to reflect
328 CHINA 2030
productivity growth. China has elements single worker on average wage in urban
of this approach in its current policy, but China (including the housing contribution)
the relative balance between a needs-based compared with other countries. 57 China’s
approach and a productivity-based approach tax wedge of 45 percent is very high, espe-
is toward the former. cially considering that it is composed solely
Shifting toward a wage floor approach of social contributions (unlike most of the
will require an improved system of labor comparator countries the average worker in
market statistics to provide timely and reli- China does not pay personal income tax).
able measures of productivity to the authori- High average labor taxation leads low-
ties setting minimum wages. Currently, the income workers to avoid formal employment
Chinese statistical system does not produce or to “selective formalization” of employ-
such measures on a timely basis. Reforms of ment relations within the formal sector. The
labor market statistics will need to be deep-
ened, with regular surveys of representative
FIGURE 4.30 Tax wedge on average formal
samples of firms and workers. Greater efforts sector worker, various countries, 2010
will be needed to include small and medium-
size firms in the samples. Historically, firm
surveys have been based on information from Turkey
large and state-owned firms, probably result-
Chile
ing in an upward bias in wage data.
Korea, Rep.
tax wedge on labor dampens incentives for TABLE 4.6 Share of workers with income below minimum SI
formal sector participation for all workers, contribution base (40–60 percent of average wage), 2001–10
but an even more extreme impact can be seen
2001 2005 2010
when considering the marginal SI contribu-
tion rate of low-paid workers. This effect is Below 60% Shanghai 32.35 29.05 31.37
produced by the policy of setting the mini- Wuhan 36.95 37.44 37.96
mum SI contribution wage at 60 percent of Shenyang 28.10 33.84 31.41
Fuzhou 32.88 30.69 31.30
the average wage in each locality. Table 4.6
Xi’an 40.44 31.16 35.99
shows the distribution of urban workers in
a selection of large cities whose wage falls Below 50% Shanghai 28.56 22.89 25.12
below the 60 percent threshold. Around 33 Wuhan 11.53 28.89 29.07
percent of all workers fall below the mini- Shenyang 9.98 15.90 13.68
Fuzhou 19.85 20.74 21.53
mum contribution base threshold. For those Xi’an 20.72 17.64 18.05
at 50 percent of the average wage (13–29
Below 40% Shanghai 13.91 12.58 13.09
percent of all urban workers in these cities in
2010), the effective SI tax wedge if they are Wuhan 3.45 14.13 11.19
Shenyang 4.87 9.80 7.52
in the formal sector would be around 67 per- Fuzhou 11.66 13.12 12.51
cent. This is clearly an exorbitant burden of Xi’an 7.04 6.64 9.16
labor taxation and could be expected to be
Source: Cai, Du, and Wang 2011b.
a strong disincentive to formal sector partici-
pation at the lower end of the wage income
distribution.
Selective formalization can be seen in the without unduly harming the benefits that
varying levels of participation in different workers derive from their contributions.
types of “mandatory” SI in urban areas. In These areas include pensions, unemployment,
2010, the latest available year, the total num- and housing. An additional issue that could
ber of contributing urban workers ranges be addressed in such reforms is the high mar-
from 194 million for pensions, 178 million ginal contribution rate for low-paid workers,
for health insurance, only 134 million for which would be important to consider as
unemployment insurance, and under 80 mil- part of a wider strategy to incentivize formal
lion for housing funds.58 Whether driven by sector participation. More specifically:
employer or employee preferences, there is
clearly large-scale and tactical “opting out” • The pension contribution has potential
of social insurance schemes in response to for reduction, although it is a more com-
high tax rates. At the same time, most urban plex matter if worker benefits are to be
SI funds continue to generate significant protected. However, a win-win solution
surpluses. appears possible for workers and employ-
As part of its overall adjustment of the tax ers that could reduce contribution rates
structure, it would be desirable for China significantly while protecting the replace-
to lower the tax burden on labor over time. ment rates of pensions. This approach
The reform of labor taxation is only part of would involve financing the “legacy costs”
the broader tax restructuring discussed in of the current pension system from an
chapter 1 on economic restructuring. If new alternative source that could spread the
revenues such as property taxes can be intro- financing burden over a very long period,
duced, the potential to reduce taxes on labor and considering switching the urban work-
may increase. Any reduction would need to ers scheme to a Notional Defined Contri-
be gradual and carefully sequenced to avoid bution approach. The details are discussed
overvolatility in public revenues. in the next section.
Even within the current system, labor • A more marginal option for reducing
taxation could be reduced in some areas social contributions is the unemployment
330 CHINA 2030
eligibility for small and medium cities. At the hukou status itself. A number of large cit-
subnational level, different types of reforms ies and provinces such as Shanghai, Shen-
have been initiated: zhen, Zhejiang, Guangdong, Jiangsu,
Chongqing, and Chengdu have adopted
• Unified hukou registration. Between the residence permit system. The approach
2001 and 2009, 15 provinces had uni- differs across cities, with some offering
fied the registration function of hukou. easier access to permits but with more lim-
The absence of supporting entitlement ited rights; others (Shanghai, for example)
reforms, however, meant that in most offering a better package of entitlements
places, people have continued to enjoy but with stricter criteria to obtain the
different rights depending on the place residence permit; and still others (such
of their original hukou, so the reform has as Zhejiang) mixing the two approaches
been largely symbolic to date. In practice, for those with temporary residence per-
most medium and large cities have gradu- mits and those with permanent and fuller
ally lowered the criteria for migrants to entitlements.
change hukou identities and be granted
accompanying entitlements. As illustrated Local pilots in hukou reform point to
in figure 4.31, the threshold for “full” a number of challenges in achieving fuller
hukou conversion to a status with the full rural-urban integration if pursued only at the
entitlements of local residents has been subnational level. These challenges include:
higher in richer and larger cities. Box 4.4
describes some of the local innovations as • Local reforms have been least complete
well as the tendency in some provinces to in the large cities where rural migrants are
treat migrants from within the province most concentrated, at least for migrants
or prefecture differently from migrants from outside the municipal or provin-
from further afield. cial jurisdiction. At the same time, urban
• Establishment of a parallel residence per- hukou in small and medium cities entitles
mit system, which is intended to delink the migrant to less generous social services
access to basic services for migrants from and social protection, contributing to the
FIGURE 4.31 Index of hukou conversion restrictions by city against population and per capita GDP,
late 2000s
a. b.
3.5 3.5
3.0 3.0
Index of hukou threshold
2.5 2.5
2.0 2.0
1.5 1.5
1.0 1.0
0.5 0.5
0.0 0.0
4.0 4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 10.0 10.2 10.4 10.6 10.8 11.0 11.2 11.4 11.6 11.8 12.0
Log, population Log, GDP per capita
Source: Wu, Li, and Xiao (2010) for hukou index; China Statistical Yearbooks for population and GDP.
332 CHINA 2030
Local hukou reforms are diverse and offer lessons • Localized hukou conversion through exchange
for national efforts to deepen reform. They include: of rural and urban entitlements. Chongqing has
encouraged family migration with hukou conver-
• A score system for hukou conversion. In 2009, sion but only for those who are rural residents
Guangdong introduced a cumulative points sys- of Chongqing. Hukou transfer to urban districts
tem to manage hukou conversion. This system is requires that migrants work or do business in the
focused primarily on intra-Guangdong migrants, area for more than five years, purchase commer-
while the residence permit system regulates the cial property, or make significant investments or
entitlements of other migrants. Points are calcu- tax payments. Requirements are much lower for
lated based on education, vocational certificates hukou transfer in small cities and towns. The key
and professions, years of social insurance contri- feature is the so-called “exchanging three rural
bution, charitable activities such as blood dona- clothes for five urban clothes” policy: the “rural
tion and volunteer work, and government awards. clothes” being homestead land, farmland, and
In parallel, all migrants are encouraged to apply contracted forest land, while the “urban clothes”
for residence permits to receive additional public are pension, medical insurance, housing, employ-
services and welfare. The impact to date has, how- ment, and education. Those converting from
ever, been lower than expected. With a three-year rural to urban hukou can keep their farm, home-
target of 1.8 million conversions, only 100,000 stead, and forest for three years but must give it
hukou conversions were done in the first year. up thereafter if they wish to retain their urban
• Strict and fixed conversion criteria with rationing. hukou. Chongqing has, however, been easing the
Shanghai was the first city to introduce the resi- exchange requirements in recent years.
dence permit system open to all, but the qualifying • Hukou conversion of local residents without
conditions are among the strictest. The Shanghai exchange of rural rights. Chengdu introduced a
system prioritizes three categories: those with residence permit system with two types of permits:
college degrees or special talents and those who temporary and permanent. The residence permit
work, do business, or invest in Shanghai (and their and hukou conversion is only open to those who
families); those who have stable employment and are already residents of rural areas of Chengdu
housing; and those reunited with family members prefecture. Local migrants apply for temporary
with Shanghai hukou. Residence permit holders permits if they stay between one month and one
enjoy equal public services including children’s year and for a permanent permit if staying over
education, health and family planning services, a year. Local migrants will be issued residence
training, social insurance, and driver’s licenses. permits if they have contracted jobs, register a
They must make seven years of social insurance business, purchase housing, or are dependents of
contributions before applying for hukou. In addi- residence permit holders. Residence permit hold-
tion, Shanghai has a tight overall quota on hukou ers enjoy more public services and welfare than
conversions, and the number of conversions has to temporary residence holders and are eligible for
date been very low. hukou conversion.
limited success of the policy aimed at through entry barriers on skills, invest-
attracting migrants to smaller cities. ments, or income or through rationing
• Reforms in larger cities have generally by strict income, work, and residence
been oriented to better-skilled and richer requirements.
migrants, significantly limiting the labor • Uncertainties and potentially high oppor-
market impacts of the reforms and reduc- tunity costs with respect to rural land
ing their equity benefits. Migrants are holdings constrain demand by migrant
excluded in a variety of ways, for example, workers for urban hukou. In developed
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 333
areas, rural land values are high, and rural Reforming the hukou system. Hukou reform
hukou holders could lose the windfall needs a phased strategy implemented over
from land conversion if they change from an extended period, with the end goal being
agricultural to nonagricultural hukou. a simple population registration system,
• Lack of social entitlement reform in delinked from social entitlements. It needs
hukou policies is likely to result in inter- national-level planning in close coordination
generational losses and missed opportuni- with provincial authorities. The key issue is
ties for higher human capital acquisition not hukou reform per se, but rather the nec-
by migrant children. For example, while essary preconditions of entitlement and wel-
national policy calls for free education for fare reform that will reduce the importance
migrant children in urban areas, in prac- of hukou, turning it ultimately into a more
tice, the localities that fund the education typical population registration system such as
have failed to achieve the policy objective. exists in many other countries. These precon-
• Local urban residents have concerns ditions will require different types of collec-
about the potential effects on service qual- tive action—across agencies and across levels
ity in cities if their localities have to absorb of government—to ensure that reforms that
the costs of service provision for migrant are socially and economically optimal at the
populations. Sociological research finds aggregate level do not continue to be delayed.
that urban residents are concerned about They will also require consultation with the
migrant workers compromising the qual- public to explain the rationale and strategy
ity of services in cities and driving down for reform.
wages (Solinger 1999). Managing such The first step of the reform strategy could
perceptions may be as significant an ele- be to set a national framework for extension
ment in hukou reform as the technical and of the residence permit system, which would
policy issues. begin the process of delinking social entitle-
• Perhaps the key constraint to deeper ments of nonlocal residents from their hukou
hukou reform is financing public services status. While common levels of eligibility
and social welfare for migrants. Under a criteria (such as the number of prior years of
decentralized finance system, local gov- residence or of social insurance contributions)
ernments primarily finance core social could not be expected in the short to medium
services and social protection. They do term, having common indicators that urban
not have incentives to provide free or sub- jurisdictions could adapt to local conditions
sidized services for migrant families given (such as the period of prior local residence)
the limited public input and resources. would be important. The criteria could be
informed by the many local pilot programs
These challenges point to the key eco- and might avoid overly rigid rules by tak-
nomic problem of hukou reform: the ben- ing an approach like Guangdong’s scoring
efits of reform are national in scope, but the system. A second practical implementation
costs are overwhelmingly local because of the challenge would be establishing national
intergovernmental financing arrangements standards for information systems and data
for basic services. This is a classic externali- exchange of information on mobile popula-
ties issue, making collective action a major tions. While a fully centralized national data-
challenge. Cities capture only some of the base seems overly ambitious for the present,
benefits of financing entitlement reform, and a common platform would be essential to
the localized returns on investments remain underpin an effective reform.
unclear with a mobile migrant population. A second dimension of the reform is the
While their localized choices not to fund or spatial expansion of more liberal residence
to underfund basic services for migrants may permit and hukou conversion eligibility
therefore be rational, the resulting situation is standards. A gradual expansion of the spa-
suboptimal from a national perspective. tial scope of registration permit eligibility
334 CHINA 2030
Portability of pension rights. Lack of por- FIGURE 4.33 An indicative trajectory for residence permit
tability of pension rights has acted as an expansion and hukou unification
additional barrier to the mobility of workers,
both across space and across sectors within
urban areas. Until very recently, no national
guidelines existed for portability of accumu-
lated pension rights when moving to a differ-
ent city or when moving employment from Hukou Residence
thresholds permit
one subsystem of the urban pension system
to another.62 The level of pooling of contri-
butions has been highly localized, with only
recent efforts to pool partially to the provin- 1st Phase 2nd Phase 3rd Phase 4th Phase
cial level. As a result, workers face uncertainty • Pilot residence • Scale up RPS • Raise • Apply
permit system nationwide entitlements for residence
when moving across space, occupational sec- (RPS) • Liberalize RPS holders permit to all
tors, or both. This uncertainty is likely to act • Develop an RPS hukou system • Liberalize residents
as a barrier to greater labor mobility and effi- national within prefecture hukou system • Equal entitlements
cient job matching, undermining productivity framework • Unify RPS for within province for local
• Lower hukou interregional • Lower residents
growth. thresholds migrants thresholds for
Recent guidelines recognize the need for hukou conversion
portability reform and provide principles for
its realization within the urban workers pen- Source: Author compilation.
sion system.63 Effective from 2010, there are
principles for workers in the urban workers
pension system to transfer both their individ- rights within the urban workers’ pension
ual account accumulations and their accumu- scheme provide a good foundation for phased
lated social pooling rights to other jurisdic- expansion of portability across space, across
tions when they move jobs. This is a major schemes, and thus across different classes of
step in reducing the welfare costs of labor workers. In principle, as fuller integration
mobility. However, principles for portability of pension schemes is achieved, the need for
of pension rights across urban pension sub- portability should be lessened. Similarly, to
systems or between rural and urban systems the extent that national pooling of the social
have not yet been adopted. pool portion of contributions can be achieved
While the new guidelines are a welcome this decade, full portability within the urban
step, their effectiveness will require prog- workers’ scheme would be facilitated. Pool-
ress on implementation systems. Even within ing across schemes is a longer-term prospect.
provinces, significant practical barriers to Key steps to increasing portability of pen-
reliable and timely transfer of pension rights sions and thus reducing the welfare and
remain. Most prefecture information systems transactions costs of labor mobility for work-
are not compatible, so transfer of pension ers and administrators would include:
records from one to another is a cumber-
some process of physical movement of paper • Following the lead of the urban scheme,
records across cities. Moving to a system that similar guidelines could be put in place
can provide an effective clearing mechanism during the 12th Plan period for porta-
across cities and provinces is therefore an bility of entitlements across all pension
important but challenging agenda. schemes to facilitate spatial and sectoral
Portability of pension rights is a short- labor mobility. For the individual account
to medium-term priority that will in time portion of any schemes, the principles are
be made less pressing as greater merging of straightforward. The process of valuing
rural and urban schemes and higher-level and moving the implicit entitlements in the
pooling of contributions and pension records rural pension and urban residents schemes
take place. The guidelines on portability of is more complex but can be achieved.
336 CHINA 2030
households and that provides a minimum FIGURE 4.34 Pension coverage rate of active labor force, various
level of service even for the poor. countries, mid-2000s
• Greater coherence between different parts
of the social protection system provides 1.2
adequate and affordable minimum cov- R2 = 0.7962
0.4 Lebanon
Building an Inclusive and Sustainable Ecuador
0.2 China
Pension System Thailand
Uganda
0
With China’s demographics, developing a
0 10,000 20,000 30,000 40,000 50,000 60,000
sustainable pension system with wide cover-
age will be one of the country’s most pressing Income per capita (US$)
standards. The replacement rate in PSU and FIGURE 4.37 Pension benefits and replacement rates in urban
civil servants schemes remains relatively high China
at more than 60 percent, but the rate for regu-
lar workers has fallen toward the 40 percent 25,000 120
threshold recommended by the International
Labour Organization as an adequate mini-
transfers limit the insurance function of under age 45 will participate in the new
the urban pension system and increase schemes to a significant extent. Initial evi-
spatial disparities in financial protec- dence from surveys in Chengdu and Guang-
tion. While the recent portability regula- dong suggests that participation rates in the
tion for the urban system is a step in the new rural scheme among younger farmers
right direction, considerable deepening are indeed considerably lower than those
of the management information and pay- closer to retirement (Wang, Chen, and Gao
ment systems for transfer of information 2011; Wang, O’Keefe, and Thompson forth-
and funds will be needed to operationalize coming). “Family binding”—whereby the
the policy. More broadly, similar guide- parents of current workers can be covered in
lines do not yet exist for portability across the rural and urban residents’ systems if their
rural, urban workers, PSU, and urban resi- working children contribute—is one impor-
dents’ schemes. In addition, the stated goal tant incentive, but this is a transitional provi-
of provincial pooling remains incomplete, sion. In the medium term, the authorities may
with very partial pooling beyond the pre- need to consider stronger incentives for those
fecture level in most provinces. under 45 to contribute, such as higher ex ante
matching on individual account contribu-
Addressing the challenges in pension tions or some increase in the basic benefit for
reform. The Chinese authorities have set sen- those who contribute for more than the mini-
sible guiding principles for pension reform, mum period.
but the parametric and structural reforms For migrant workers, the incentive chal-
that will be needed will be challenging. In lenge in expanding pension participation
recent years, the government has articulated is somewhat different. While recent data
principles for a reformed pension system. The indicate notable improvement in the par-
principles call for an urban system that “has ticipation of migrants in the urban work-
broad coverage, protects at the basic level, is ers’ pension scheme, there is a three-way
multilayered, and sustainable,” while the prin- challenge of coverage expansion. First, the
ciples for the rural system are “broad cover- majority of migrant workers still remain
age, protects at the basic level, is flexible, and in the informal sector and ineligible for
sustainable.” Achieving expansion and inte- the urban residents’ scheme. Second, even
gration of the pension system while trying to those in the formal sector may be reluctant
ensure adequate and sustainable benefits for to participate because receipt of the pension
all workers presents complex challenges that benefit is so distant and because of uncer-
are likely to require structural and parametric tainty about their future location and ease
reforms. The key challenge is how to manage of portability. Third, employers of migrant
the trade-offs and strike balances between the workers may be reluctant to make pension
different objectives when they compete. Deep- contributions for migrant workers because
ening pension reform is a long-term agenda, of the added labor costs. For migrants who
with several stages. wish to return home, participation in their
The key challenge in the short term is local rural scheme would make sense, pend-
ensuring suitable incentives for coverage ing fuller integration of rural and urban
expansion of pensions to farmers, urban residents’ schemes. For migrants who intend
residents, and migrants. The use of public to stay, a potential mechanism to address
subsidies in the new rural and urban resi- the first two issues in part would be linking
dent schemes provides a significant incen- social insurance contributions for migrants
tive to participate. At the same time, the fact to registration permit and hukou reform by
that the subsidy is largely “back-loaded” to requiring a minimum period of contribu-
the retirement phase through the basic ben- tions for conversion.
efit—and that the vesting period is only 15 In addition to coverage expansion, there is
years—raises questions about whether those also a need to initiate reforms of the urban
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 341
formal sector schemes in the short run. These the key design question would be how
include: to integrate within the urban workers’
scheme while avoiding a dramatic down-
• Initiating an increase in the normal retire- ward adjustment in replacement rates.
ment age. Given the need to do this gradu- This would in turn require integrated pol-
ally, initiating the increase in pensionable icy development of PSU and civil service
age sooner rather than later seems advis- pension reform with broader compensa-
able. A caveat raised by some Chinese tion reforms.
scholars is that the current cohort of • Completing provincial-level pooling of
older workers has lower skills and may pension funds. Pooling contributions at
struggle to remain productive and employ- the provincial level will allow for greater
able. This is a reasonable concern, but a equalization of pensions within provinces
gradual increase in normal retirement age, and also strengthen the insurance func-
combined with availability of unemploy- tion. To date, pooling remains only partial
ment insurance and greater investments in most provinces, despite policy commit-
in mid-career training and lifelong learn- ments to achieving full pooling.
ing, should mitigate the potential negative • Putting in place the information systems
impacts on both older workers and overall to facilitate portability of pension rights
productivity. and pooling. Currently, the information
• Defining a strategy to deal with legacy systems for pensions are highly frag-
costs. A sensible sequence of steps could mented, typically at the prefecture level,
be, first, separating legacy costs from although efforts are under way to move
other pension costs; second, estimating toward common data standards within
the financial requirements necessary to provinces and within the new rural and
deliver on legacy costs (as part of wider urban resident schemes. In the short run,
actuarial modeling of the pension system it would be essential to set common data
financial position); and, third, agreeing on standards and data-sharing protocols
a financing strategy to meet legacy costs under the lead of MOHRSS and develop
over the long term, using channels outside a data management system strategy for
current pension revenues, such as govern- phased convergence. Social insurance
ment bonds and possibly resources from information systems would also need to
the National Social Security Fund (NSSF). be integrated within provinces to prepare
• Taking preparatory design steps to inte- the way for eventual sharing of beneficiary
grate the PSU, civil servant, and urban data and financial information across
workers’ pension frameworks. While five provinces.
provinces have been designated as PSU
pension reform locations, progress has The key medium-term challenge will be
been limited to date. Ultimately, the PSU promoting greater harmonization across
and civil servant subsystems should aim to schemes and making progress on integra-
be fully integrated with the urban work- tion of schemes for different groups. As cov-
ers’ scheme, and the first step in the short erage is expanded, reducing fragmentation
term is introducing contribution pay- of schemes across groups and across space
ments. 68 For some PSUs, this is already will come to the fore. Integration will be an
happening and needs to be widened. For important reform for creating a pension sys-
civil servants, this step is more challeng- tem that more fully reflects and facilitates
ing, but countries such as India where new the increased mobility of workers. It would
civil servants have been required to make involve several elements:
contributions provide useful examples of
how to manage such a transition to an • Completing integration of PSU, civil
integrated pension system. In both cases, servant, and urban workers’ schemes
342 CHINA 2030
with a formal employment relationship from FIGURE 4.38 Potential design of long-term
those without one such as self-employed and pension system
informal workers. This reform would require
unified pension systems for these two types
of workers across rural and urban areas, Supplementary Supplemental occupational
breaking down the historical locational Pillar and individual annuities
it would also allow for providing a positive 2011, and others often received benefits from
real rate of return to contributors without the dibao program. However, with urbaniza-
imposing undue risks on investments or as tion, the strains on children of the 4-2-1 fam-
many regulatory demands on government. ily model, and rapid aging, demand is rapidly
For those with nonwage incomes, continu- growing for a range of aged care services that
ing (and possibly increasing) government traditional arrangements and the very tar-
matching of contributions would provide geted public programs are not well equipped
strong incentives to participate in the vol- to handle.
untary contributory scheme. The scheme The policy framework for aged and long-
for those on nonwage incomes could be term care services has been developed but
fully funded, preferably with a rate of does not yet fully reflect the demographic,
return guaranteed by the central authori- policy, economic, and social changes of
ties to reduce the risk to contributors from recent years.70 China passed the Rights Pro-
empty accounts. A question to address in tection Law for the Elderly in 1996 to guide
such a dual scheme is the risk of encour- and regulate rights on social security, aged
aging informality through the subsidy to welfare and services, health, and education
nonwage income earners. One solution to for the elderly. In 2006, 10 line ministries,
this concern could be to provide incentives including the National Aging Commission,
for low-income formal sector workers as National Development and Reform Com-
well, as has been introduced, for example, mission (NDRC), and the Ministry of Civil
in Mexico and Colombia. Affairs (MOCA), jointly issued a policy
• The supplementary pillar for urban and document that defined the aged care service
rural residents would allow voluntary sector.71 Family-based and community-based
occupational and personal pensions that elderly care services were piloted in Beijing,
could supplement other pension benefits. Tianjing, Qingdao, Daliang, Xiamen, Shang-
For most people and employers, the sup- hai, and Changsha and were rolled out in
plemental pension could be an entirely more than 300 urban centers in 2009.72
voluntary arrangement used as part of The 12th Plan also gives much more explicit
the nonwage compensation package. It attention to the issue of aged care services.
would also be a vital part of a strategy to The multisectoral nature of aged and long-
integrate civil servants and PSU workers term care has posed institutional challenges
into the urban workers’ scheme without a to developing a coherent approach in China.
sharp fall in replacement rates. Numerous ministries, levels of government,
and nonstate actors are involved in aged and
long-term care, contributing to fragmentation
Aged Care Services: Aging with Dignity
in the overall approach. At the central gov-
Current status and challenges. Although ernment level, responsibility for policy cuts
pensions are a crucial element of old-age sup- across the NDRC, MOCA, MOHRSS, Min-
port, the rapidly aging population will also istry of Health (MOH), and China National
need a range of aged care and long-term care Commission on Aging. At the subnational
services, which are currently underdeveloped level, provinces, municipalities, counties, and
in China. Historically, aged care in China has townships have responsibilities for designing,
been primarily the responsibility of the fam- coordinating, and implementing aged and
ily, and that is still the dominant approach long-term care services, sometimes in collab-
culturally. At the same time, the state has oration with voluntary organizations.
provided for the poorest elderly people with- The lack of well-developed coordina-
out other forms of support, who are known tion mechanisms limits the overall effective-
in rural areas as wubao people and in urban ness of aged and long-term care initiatives,
areas as the “three no’s.”69 The wubao pro- and the effects are already visible. The lack
gram covered just over 5.5 million people in of coordination has hampered the ability to
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 345
adequately assess unit costs of different types increasingly strong interest in the high-end
of aged care services; assess the most appro- aged care industry in China.74
priate options for funding services; determine The challenges in design and implementa-
clear and transparent eligibility criteria for tion of aged and long-term care services are
services; identify appropriate splits between not unique to China. Many advanced and
purchasing and commissioning functions and emerging economies are further along the
the delivery of services; and establish systems aging curve and have already undertaken
for quality assurance of aged care services reforms to address the needs that China is
(Joshua 2011). now confronting. They offer many relevant
China also has a large deficit of appropri- lessons and also point to quite diverse mod-
ately trained personnel in aged and long-term els of financing, provision, and regulation,
care services. In particular, social work edu- which suggests that developing a model that
cation and practice are still in an embryonic is appropriate to China’s context and afford-
state across China. Currently, around 250 able will be challenging (Joshua 2011, vol. 2).
institutions provide social work training with
only 10,000 graduates a year, 60 percent of Addressing the challenges of aged care. Given
whom work in other professions upon gradu- the early stage of development of aged care
ation because of low pay and lack of career services in China, the fundamental question
opportunities.73 The scarcity of work set- for policy makers is what vision they have for
tings and places in which to train staff in the the system. The experiences of OECD and
application of social work skills makes it dif- transition countries show significant varia-
ficult to build a strong workforce for social tion in the ways aged care services are pro-
work, which could have implications for the vided, financed, and regulated, reflecting to
quantity and quality of aged care provision. a large extent differences in the underlying
Beyond social work, there are large short- social and cultural norms of different coun-
falls in most other areas related to aged-care tries. Major variations can be seen both in the
services, including professional carers and levels of spending on long-term care and in
gerontologists. the structure of public and private spending
Community-based long-term care services (figure 4.39). China will need to decide on an
have emerged in the context of the commer- appropriate model of aged care services that
cialization of state-owned enterprises but are reflects its broader social service vision, cul-
generally fragmented and weak. In 2007, 31.4 tural preferences, and fiscal possibilities. This
million enterprise retirees were under the sys- section therefore points to the priority issues
tem of “social management services.” These and options that Chinese policy makers will
services aim to serve various social and health need to consider over different time frames
needs of the elderly but are often fragmented. rather than offering firm recommendations.
In urban areas, community-based care ser- In the short term, the first need is to
vices have begun to emerge. For example, the develop the broad policy framework for aged
Beijing local government created a model, care services. In doing so, a central issue is
called “four nearby solutions,” that offers the mixture of public and private financ-
elderly people resources for studying, social ing and provision. Given the pace of aging
activities, and caregiving support, and oppor- in China and the scale of unmet need, aged
tunities to participate in community affairs. care services will clearly be an area where the
However, evaluations suggest that caregiving state cannot “do it all,” and co-responsibility
support functions in the community and at and plurality of provision—including the
home are often ill-defined, suffer from weak state, the nonstate commercial and nongov-
coordination across different agencies and ernmental sectors, communities, and house-
service providers, and have proven expen- holds—will be essential. A mix of cost shar-
sive to sustain (Cheng and Rosenberg 2009). ing and service provision is also likely to be
In addition, the private sector has shown consistent with Chinese cultural and family
346 CHINA 2030
FIGURE 4.39 Long-term care expenditures in and neither finances nor provides services in
OECD, 2008 yet other cases. More specifically:
• In addition, public resources are likely to formally trained personnel and the family
continue to be focused on the poor elderly and voluntary sector will be crucial.
in the short run. Again, practice in the
OECD varies between universal access In the medium to long term, the reforms
systems financed either from general rev- initiated in the 12th Plan period will need
enues or insurance contributions (in much to be deepened and new approaches are also
of Europe, Japan, and Korea), and means- likely to be needed as aging accelerates. Some
tested systems (in the United States, United of the key incremental reforms include:
Kingdom, and Australia). China may need
to consider a phased approach that focuses • Developing a regulatory framework for
on the poorest initially, with better-off aged care services that encourages the
households self-financing higher-quality entry of nonstate providers (community-
care. The challenge for the medium term based, commercial, and not-for-profit)
will be deciding on the appropriate role of but also ensures that basic standards of
public financing for the middle groups of care are met. The first step will involve
the population who are neither very poor better assessment of demand for different
nor have adequate resources to fully self- services and what households are willing
finance care. to provide themselves. Another impor-
• Another key issue will be the institutional tant element will be establishing a suitable
and coordination arrangements for the aged licensing and accreditation framework to
care services sector, given the number of ensure that providers meet basic standards
public and private actors involved. MOCA of care.
has developed approaches in the 12th Plan, • Experimenting with and potentially
but elaboration of policy will benefit from a expanding long-term care insurance to
high-level coordination mechanism involv- help finance the growing need for services.
ing other players such as NDRC, MOH, A number of OECD countries, including
MOHRSS, the National Commission on Germany, Korea, and Japan have intro-
Aging, and others. Similarly, coordination duced long-term care insurance as part of
mechanisms will increasingly be needed at their national social insurance programs
the subnational level to oversee, regulate, in recent years, and these models may pro-
and administer the aged care services sys- vide lessons for China. Given the existing
tem and subsystems. high burden of social insurance contribu-
• Accelerated efforts to develop human tions in China, the space for a dedicated
resource capacity for the aged care sec- long-term care payroll contribution is
tor are needed urgently. This has been likely to be available only as other contri-
recognized and efforts are expanding to bution rates in areas such as pensions and
train social workers and other profession- housing are reduced over time. Such pilots
als, including gerontologists, aged care should be complemented by a system of
nurses, and other needed personnel. In carers’ allowances for poor and possibly
2011, MOCA set a target of having 2 mil- middle-income households who choose to
lion qualified social workers by the end of care for dependent elderly members in the
2015 as part of coordinated efforts from home or with the support of community-
18 central agencies.75 However, a comple- based organizations.
mentary need will be addressing very low • Moving to integrated aged care and
social worker pay and lack of career devel- assisted living models that have a more
opment prospects, factors that lead many differentiated range of services across the
who train as social workers to leave the spectrum of needs and that draw on the
field. This is also an area where having a skills of service providers from a wider
clear strategy on the interaction between range of agencies.
348 CHINA 2030
• Over time, and in parallel with hukou revenues and social contributions may need
reform and further labor market integra- to be reconsidered in financing the social
tion, greater convergence of rural and insurance benefits of all workers, both formal
urban dibao programs would be expected, and informal.
with the gap between rural and urban Issues of coherence across social assistance
thresholds within prefectures and prov- and social insurance schemes will require
inces likely to narrow. closer attention in the medium term. One
example is the consistency of coverage and
Another challenge for social assistance treatment of elderly people across programs:
programs is the interaction between dibao with the expansion of basic pension ben-
and the host of national and local welfare efits to rural and urban informal retirees in
schemes for the poor, including wubao, tem- coming years, the interaction with measure-
porary assistance, and residual programs for ment of household income for dibao needs
tekun households. The draft Social Assis- to be examined closely. Currently, basic pen-
tance Law is a positive step in this direction sion income is ignored in the dibao eligibil-
in its effort to make dibao the “backbone” ity determination, but as the pension system
social assistance program. It will be impor- expands, it may be necessary to look more
tant to avoid the mistakes of many OECD closely at the rationale for such an approach.
countries that have seen a gradual prolif- Finally, given the dramatically increased
eration of social assistance and welfare pro- imputed value of housing for urban house-
grams that are often inconsistent in their holds in recent years, the interaction of
objectives and create inefficiencies in pro- government policy on affordable housing
gram administration. and social assistance programs will need to
In both the pension and health insurance be considered. The government has placed
systems, the use of public subsidies to encour- increased emphasis on affordable housing
age coverage expansion creates a future risk for lower-income households, in addition to
of disincentives for rural and urban informal public housing for the poor. While this is a
sector workers to move into the formal sec- welcome policy direction, it will also require
tor, where they face high social contribution more rigorous evaluation of the implicit value
rates. This may in the long run harm both the of social assistance packages that include free
economy (because of the lower productivity or subsidized public housing, and comparison
of informal sector employment) and work- of the value of the full dibao package with
ers themselves, who will continue to have subsidies on offer to non-dibao households.
worse working conditions. For the present, These issues are natural challenges to be
this risk seems worth taking in the interests expected in a social protection system that
of expanding coverage and promoting greater has expanded so rapidly and that has such
security for all workers, formal and informal. diversity across space. Advanced economies
In the medium term, however, it may be nec- continue to struggle with such issues in their
essary to look for ways to reduce the high more mature social protection systems. Con-
marginal tax rates that informal sector work- sidering such issues in future policy develop-
ers face when moving into formal employ- ment will be vital to ensuring that the dual
ment, caused by the combined effect of loss goals of protecting the poor and ensuring
of subsidy on their social insurance cover- fairness for all are appropriately balanced.
age and high social contribution rates. The The lessons—including the numerous fail-
experience of middle-income countries such ures—of OECD and middle-income coun-
as Mexico and Colombia, which offer contin- tries in balancing such considerations can
ued subsidies for low-income workers within be valuable, but the appropriate approach
formal social insurance systems, may provide for China is also very dependent on its spe-
lessons for managing such challenges. More cific social, cultural, economic, and political
fundamentally, the balance between general values.
350 CHINA 2030
First phase • Deepen and rigorously evaluate the local/ • Roll out rural-urban integration programs based
provincial hukou reforms to inform national on experiences learned from the national pilots
policy in Chengdu and Chongqing
• Develop a national framework and national • Implement specific plan for the equalization of
standards for residence permit system and basic public services and social welfare
indicators • Continue to increase the standards in rural areas
• Issue national guidelines and encourage to lower the gap to urban areas and harmonize
prefecture cities to promote local hukou reform key policies
based on the national framework and guidelines • Increase real pooling level of social security
• Pilot the national framework of residency permit system (pension at the provincial level,
system and prepare for scaling up unemployment insurance and health insurance
• Start to establish a shared information system at prefecture level) and issue social security card
and platform from population registration and nationwide
management
Second phase • Adopt the residence permit system nationwide • Continue to implement the equalization
and national guidelines for hukou conversion programs and pay more attention to lagging
indicators, standards areas
• Universalize open hukou access for rural • Complete rural-urban integration of key social
residents in all prefectures, and liberalize/ policies and programs (pension, health and
standardize access standards for all intra- health insurance, dibao programs)
provincial migrants • Establish full coverage of social security system
• Undertake costing and sensitivity analysis of net to provide basic social security, upgrade
costs of basic local-level service provision for pooling level of social security (pension and
migrants by type of city and volumes of migrants unemployment insurance at national level,
• Deploy and roll out population information health insurance at provincial level), and establish
system national standards for dibao and social welfare
programs
Third phase • Based on costing, agree fiscal sharing • Incorporate hukou reform financing into
arrangements for provision of basic public budgetary management system and social
services to migrants and implement national economic plan
net-settlement system to incentivize open hukou • Make budgets for public services and social
access by all cities through an incentive-based welfare based on the information of permanent
approach rather than an “ordering” approach residence population (>6 month)
• Further lower thresholds and requirements for • Arrange special budget and establish an
hukou conversion based on cost-sharing and adjustment fund to compensate the net cost in
financing by central and local governments receiving areas
Fourth phase • Apply residence permit to all residents to restrict • Establish a standardized budgetary approach
the function of the hukou system to population based on the information of permanent
registration residence population
• Open accesses to all migrants
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 351
in poor rural counties (particularly among Child Poverty Forum, reported in China
children 0–2 years of age) where anemia rates Daily, May 27, 2011.
rose 31–45 percent in a single year from 2008 27. Rozelle 2011. See also CDRF pilots on ECDE
to 2009, then dropped below 2008 levels by in Qinghai (http://www.cdrf.org.cn/en).
2010. This spike was presumably a conse- 28. See, for example, World Bank (2011b), which
quence of the global financial crisis. Given the summarizes a range of preschool innovations
long-term effects of nutritional deprivation, in Latin America. For details, see Vegas and
both the average levels and their fluctuation Santibañez (2010).
are real causes for concern. While the compar- 29. OECD (2007); Zhang and Zhang (2008)
ison of the very youngest in poorest counties regarding Asian countries; Miguez (2006)
in a crisis year with the cohort 6–60 months regarding Argentina; and Hanson (2010) re-
in other countries can be misleading, it is garding Mexico.
nonetheless instructive to note that the poor 30. National Plan for Medium- and Long-
county anemia rates for the very young in Term Education Reform and Develop-
2009 were equal to or above the most recently ment (2010–2020). http://www.moe.edu.cn
available rates for 6–60-month-old children /publicfiles/ business/ htmlfiles/moe/moe
in Afghanistan (37.9 percent prevalence in _177/201008/93785.html.
2004), Arab Republic of Egypt (29.9 percent 31. See Wu, Boscardin, and Goldschmidt (2011),
in 2000), Guatemala (38.1 percent in 2002), background paper for this report. See also
Namibia (40.5 percent), Tajikistan (37.7 per- National Inspectorate sample survey of teach-
cent in 2003), and Vietnam (34.1 percent in ers 2007, which found major challenges in
2000–01). retention of rural teachers—particularly key
20. Ji, Sun, and Chen 2004; Ji 2007; Ma and Wu teachers—and high incidence of substitute
2009. While obesity levels as measured by the teachers in western and central provinces
China Health and Nutrition Survey are nota- (http://www.moe.edu.cn/publicfiles/business
bly lower, rates still more than quadrupled /htmlfiles/moe/moe_914/201001/81660.html).
in the 1980s and 1990s (Li, Y., and others 32. Some researchers have suggested that shift-
2008). For comparison, in the mid-2000s, ing the employment status of teachers to that
the national rate of childhood obesity in the of civil servants would be one way to facili-
United States was around 11 percent (Deh- tate a teacher allocation and transfer system
ghan, Akhtar-Danesh, and Merchant 2005). that promotes greater equalization of quality
21. World Bank 2011a. The out-of-pocket spend- (Wang and Gong 2011).
ing estimate for China needs to be explored 33. The plan says, “More assistance shall be
further. It is based on estimates from informa- granted to senior middle school education in
tion on fees in public and private preprimary impoverished areas in central and western
schools and on education statistics on govern- regions.”
ment spending. 34. European Training Foundation, various publi-
22. Chen and others 2010. Results on develop- cations. See http://www. etf.europa.eu.
ment quotient (DQ) and IQ were all statisti- 35. C h i n a Nat ion a l He a lt h D evelopment
cally significant. Research Centre 2011.
23. For the purposes of this chapter, the short 36. Evidence from 2001 in China found that 74
term is the next two to three years, the percent of patients reported making informal
medium term from then until 2020, and the payments (Bloom, Han, and Li 2001).
long term from 2020 to 2030. 37. Opinions of the CPC Central Committee and
24. See Gao, Griffiths, and Chan (2008) for a the State Council on Deepening the Health
review of 20 studies on obesity interventions Care System Reform, 2009 (http://www.china.
in China that combine dietary intervention, org.cn/government/scio-press-conferences/
physical activity, and health education; 17 of 2009-04/09/content_17575378.htm).
the studies found significant improvements. 38. The background paper for this section is Palu
25. It could be the “yin yang bao” packages (2011).
already piloted in poor areas of China (Chen 39. The Global Independent Commission for
and others 2010). Education of Health Professionals provides
26. Speech of Deputy Chief of the Office of Pov- best-practice guidance on training of primary
erty Alleviation and Development at China care professionals.
EQUALITY OF OPPORTUNITY AND BASIC SECURITY FOR ALL 353
40. See Hofmarcher, Oxley, and Rusticelli (2007) 54. The total average monthly wages of migrant
for a summary of OECD experience on coor- workers are in fact higher than those of local
dinated care reforms, and Ma and Lu (2011) workers as migrant workers work more hours.
on Chinese pilots in cities such as Shenzhen 55. Regulations on Minimum Wages in Enter-
and Wuhan. prises (1993); Provisions on Minimum Wages
41. WHO Europe, European HFA Database, (2004); and MOLSS Notice on Further Devel-
2011 (http://www.euro.who.int/hfadb). oping the Minimum Wage System (2007).
42. See, for example, Ould-Kaci (2011) on the 56. The standard example in education is teach-
French medical salary system, which relies on ers “teaching to the test” when examination
a higher fixed salary component in total doc- results are a key indicator, perhaps neglecting
tor compensation, an approach similar to that the development of other skills in students.
of Japan. Another example is overservicing by health
43. Some commentators point to higher food and providers when “performance” is determined
rental shares of migrants and low-income according to the volume of services provided.
workers in consumption relative to the con- 57. The tax wedge is calculated as (total labor
sumer price index (CPI), both items that have cost – net take home pay)/total labor cost. So
risen faster than the overall CPI. for China, assume payroll = 100 RMB, then
44. Adjustments in statistical measures around total labor cost (100 + 42) = 142; net take
the time of the initial decline raise questions home pay (100 – 22) = 78, and tax wedge =
of how much it was a statistical artifact, but (142 – 78)/142 = 45.1 percent. For many coun-
there appears to be a consensus that a signifi- tries, one would also calculate the personal
cant fall in labor income share occurred. income tax levied after deduction of social
45. These trends appear to be accelerated in the insurance contributions; OECD also allows
light of the 2010 census results. for transfers from the state (for example,
46. LFPRs are not reported in official statistics in income tax credits). In China, neither of these
China and have to be constructed (Cai, Du, is included in the calculation for the average
and Wang 2011a). urban worker who falls below the personal
47. Analysis also finds that work intensity among income tax threshold.
older urban workers has not increased to off- 58. MOHRSS data from end-2010.
set the falling supply and, if anything, has 59. Hukou divides the population into rural (agri-
slightly declined over the same period (Cai cultural) and urban (nonagricultural) resi-
and others 2012). dents, as well as local and migrant residents,
48. This is comparable to the gender wage gap in largely according to the place of birth. The
OECD-26 countries of 16 percent in 2008. hukou status of parents is generally trans-
However, both Korea (at 38 percent) and ferred to children. The match is not exact, but
Japan (at 30 percent) were outliers, against the majority of rural people have agricultural
countries such as Italy, which had a less than 2 hukou.
percent gap (http://www.oecd.org). 60. However, this process remains incomplete
49. There are many contributions to the Lewis in very large cities, such as Beijing, where
turning point debate in China. See the sym- applicants for government jobs and in many
posium on the subject in China Economic enterprises require a Beijing hukou to be
Review (2011). considered.
50. OECD 2006. Murrugarra (2011) discusses 61. See Hertel, Zhai, and Wang (2002) and
policy responses in Latin America to similar Whalley and Zhang (2004), both of which
challenges. used CGE models to explore the impacts of
51. The effects of labor market institutions on removing all migration restrictions. See Zhu
indicators such as employment and unemploy- and Luo (2010) for a detailed study of Hubei
ment rates are the subject of debate. See Free- province on the positive distributional effects
man (2008) for a review of the literature. of labor mobility.
52. http://www.mohrss.gov.cn. 62. The urban pension system has separate sys-
53. A Notice on Establishing the Wage Guideline tems for civil servants, public service unit
System of Labor Market, Ministry of Labor and workers, and regular urban employees, each
Social Security, 1999 (http://w1.mohrss.gov.cn with different rules, replacement rates, and
/gb/ywzn/2006-02/15/content_106794.htm). the like (World Bank forthcoming).
354 CHINA 2030
63. State Council Interim Provisions on Portabil- 73. China Daily, November 11, 2011 (http://www
ity of Pension Benefits of the Urban Enterprise .chinadaily.com.cn /bizchina/2011-11/09
Pension System, December 2009. /content_14065471.htm).
64. See Giles, Park, and Wang (forthcoming) on 74. See, for example, the Retirement Communi-
determinants of participation across differ- ties World Asia Conferences (http://www
ent urban SI schemes, using CULSS 2005 . t e r r a p i n . c o m /c o n f e r e n c e / r e t i r e m e n t
and 2010 data. The paper also notes signifi- -communities-world-asia).
cant discrepancies in estimated participation 75. China Daily, November 11, 2011 (http://www
of migrants in the urban pension scheme .chinadaily.com.cn /bizchina/2011-11/09
and other social insurance schemes (medical, /content_14065471.htm).
unemployment, and work injury insurance) 76. Outline for Poverty Reduction and Devel-
between official sources and between official opment of China’s Rural Areas (2011–
and survey-based sources. 2020) (http://www.gov.cn/jrzg/2011-12/01
65. In China, several reforms of the pension sys- /content_2008462.htm).
tem since opening up have resulted in differ-
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5
Reaching “Win-Win” Solutions
with the Rest of the World
After an absence of two centuries, China has relation between China and the rest of the
returned to center stage of the global econ- world are required if China is to avoid the
omy. Domestic reforms and integration into “middle-income trap.” The next 20 years will
global markets have resulted in 30 years of radically differ from the previous 20 years as
unprecedented growth, making China the China moves toward a successful transition
world’s second-largest economy and premier to high-income status.
creditor. The integration of China into the
world economy has yielded huge benefits, • In recent decades, China’s growth has been
both for China and the rest of the world. In exceptionally high and driven by manu-
China, poverty has been reduced dramati- facturing sectors. In the coming decades,
cally and new employment opportunities however, growth will likely be lower and
have been created for hundreds of millions will depend more on the services sectors.
of people. Substantial flows of foreign direct In the past, the main concern was about
investment (FDI) into China have helped the impact of sustained high growth.
drive productivity in domestic firms with new The focus was on bottlenecks in the fast-
technologies, training on the job, and inten- growing export-oriented manufacturing
sified competition. China has imported for- sectors: limited availability of necessary
eign practices in a host of areas ranging from natural resources, adverse environmen-
banking regulation to product standards. For tal impacts, and slow-growing foreign
the rest of the world, manufactured products markets. Those problems will not disap-
have become more affordable, while the FDI pear, but in the future, an equally impor-
flows into China represented new investment tant concern could become the impact of
opportunities for foreign firms, and the effi- decelerating growth. What tensions and
ciency of global production networks has imbalances, especially in China’s financial
sharply risen. sector, will be revealed if growth slows?
This remarkable story is set to continue. • In recent decades, FDI inflows were instru-
China has the potential to reach high-income mental in China gaining access to global
status and to become the world’s largest markets and global technologies. In com-
economy within the next two decades. How- ing decades, further access to markets and
ever, wide-ranging transformations in the technologies will instead come more and
361
362 CHINA 2030
role in negotiations can ensure that the solu- main destinations for world trade. In both
tions adequately reflect the interests of China scenarios, domestic demand in other devel-
and other developing countries. oping countries will contribute more than
These questions and the policy issues they 40 percent to global growth in 2030. That
raise are explored through three main sec- is more than the contribution of all high-
tions that consider scenarios for the future of income countries together, where roughly
the global economy, China’s integration into one-third of global growth will originate.
global markets, and China’s participation China alone would contribute 20 percent (in
in addressing global public goods. Together, the low-growth scenario) to 28 percent (in
they outline a strategy for deepening China’s the high-growth scenario).
integration into the global economy over the Second, aging populations, declining
next two decades to upgrade production to investment rates, and a shift to services, with
more sophisticated manufactures, establish a relatively low-productivity growth all point to
world-class services sector, and contribute to a slowing of GDP growth in many countries,
the preservation of global public goods. including China. In the low-growth scenario,
growth in all developing countries combined
is expected to slow from 6.5 percent cur-
Scenarios of China’s Evolving Economy
rently to 4.5 percent in 2030. The slowdown
Following this introduction, the chapter pre in China will be even sharper, from 9 percent
sents scenarios for the evolution of the global currently to just below 4 percent in 2030,
economy and China’s role through 2030. To although on average China will remain one
capture some of the many uncertainties, both of the fastest-growing countries during the
a low-growth and a high-growth scenario next 20 years. High-income countries would
have been developed. Both scenarios include see their annual growth rates more than
anticipated structural changes, because halved, from 2.5 percent now to just above 1
C hina’s future role in the global economy percent in 2030. In the high-growth scenario,
cannot be explored by simple extrapolations with more innovations in the services sectors
of gross domestic product (GDP). The next worldwide, the slowdown is minimal. For
two decades are unlikely to bring a mere con- example, China’s growth remains for many
tinuation of current growth patterns. Indeed, years at current levels, dropping to 7 percent
comparative advantages will change, econo- only after 2025.
mies will move up the value chain, produc- Third, despite the slowing of over-
tion and trade patterns will shift, and rela- all growth, environmental pressures will
tive prices will adjust. Therefore, detailed, increase. That is clearly illustrated by the
model-based scenarios were developed for anticipated increase in greenhouse gas emis-
this study to capture the main changes that sions. Without additional policies, even in
are expected. The scenarios incorporate the low-growth scenario, emissions of the
key drivers of change during the next two four main gases that the model tracks are
decades, including technological catch-up, expected to more than double in China and
demographic transformations, and further India between now and 2030, while only
capital accumulation. minimal increases are anticipated in high-
Several striking features emerge in the income countries. This means that China and
scenarios. First of all, a further rise of other other emerging countries will increasingly
emerging economies as drivers of global hold the key to the solution for global envi-
growth should be expected, rather than ronmental problems.
mainly a further rise of China, which has Fourth, middle-income countries will
already established a dominant position. continue to dominate international trade in
More rapid growth than in advanced coun- manufactured products but will experience a
tries, combined with exchange rate appre- significant shift toward services domestically.
ciation, will make the emerging markets the Globally, the share of services in value added
364 CHINA 2030
would increase from 56 percent now to 65 been a critical driver of China’s remarkable
percent in 2030, while the share of manufac- success over the past three decades. Reduc-
turing would decline from 19.5 percent now tions in import barriers have boosted the
to 11 percent in 2030. As middle-income efficiency of domestic firms by strengthen-
countries shift to services and move up the ing competition and increasing access to
value chain in manufacturing, new opportu- imported inputs. These reductions have also
nities will be created for low-income coun- promoted China’s participation in compo-
tries to expand their low-skill labor-intensive nents trade and facilitated rapid expansion
production. into foreign markets through reciprocal
Fifth, even in the high-growth scenario, reductions in foreign import restrictions and
with large investment needs and a decline in eventual entry into the World Trade Organi-
the savings rate in China from 45 to 35 per- zation (WTO). Dismantling most barriers to
cent, capital will remain abundant in China. FDI inflows has increased access to foreign
Not only does that create opportunities for technology and business practices. The inte-
substantial investments in new markets, it gration of foreign standards into regulation
will also open up the opportunity for more and business practices has improved the qual-
productive investments abroad, a trend that ity of domestic production. Greater expo-
might well become one of the most distinctive sure to foreign ideas through the education
developments during the coming decades. abroad of Chinese students and increasing
A final character of the scenarios is that, communications through the Internet have
despite China’s dominant position in the enriched China’s, and the world’s, economy
global economy and the sharp rise in aver- and society.
age incomes, making China formally a high- Despite the obvious benefits of economic
income country, a large part of the popula- openness to China, pressures for slowing
tion will still be relatively poor. It will likely China’s economic integration with the rest
take significantly more than 20 years for of the world are still evident. These pressures
the whole population to reach high-income stem from concerns over China’s vulnerabil-
status. ity to foreign protectionism, China’s increas-
Many of the opportunities and solutions ing financial dependence on low-yield U.S.
to the challenges that emerge in this scenario government liabilities, and the disruption to
can be found in global markets. Countries, Chinese economic activity from the recent
developing and high-income alike, that global financial crisis and its aftermath, as
maintain an outward orientation will be the full implications of the expansionary
among the successful ones during the com- activities required to support demand are still
ing decades, while an inward-looking policy not clear.
will increasingly prove self-defeating. Three Despite these real concerns, China cannot
outward-looking policy areas are of special achieve its full potential and become a high-
interest for China: trade policies, policies that income country by turning its back on the
govern cross-border investments, and policies global economy. We argue that China needs
that will facilitate the internationalization of to continue its outward orientation but that
the renminbi. the focus of that orientation should change
during the coming decades. China (and the
world) will continue to benefit from main-
China’s Interaction with the
taining an open trading system and from
Global Economy
welcoming investment in its economy to
The chapter then reviews how policies in the improve competitiveness, but it will need an
areas of trade, FDI, exchange rates, and capi- open financial sector and policies that enable
tal controls will need to be modified in the an acceleration of investments in foreign mar-
light of China’s interactions with the global kets. It is in the interest of other countries,
economy. Increasing economic openness has both high- and low-income, to welcome these
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 365
investments. Only through openness will trading system and to China’s market access.
China be able to obtain the oil and metals China should emphasize both multilateral
required to support domestic industry and and regional arrangements. It will ben-
absorb the technology necessary to upgrade efit from abiding by and protecting existing
production to supply consumers with rising multilateral agreements as well as pushing
incomes and penetrate new foreign markets. for further opening of global markets using
That does not mean that the government multilateral channels. China should also pro-
should move rapidly to dismantle all its con- actively push ahead with the negotiations
trols on transactions with the global econ- for accession to the WTO government pro-
omy, which would be excessively risky. The curement agreement as part of its effort to
pace of change in each sector should take into improve procurement procedures, enhance
account the risks involved. China already transparency, reduce costs, and enhance
receives large FDI inflows and is generating quality in government purchases. At the same
increasing FDI outflows; most remaining lim- time, China needs to participate proactively
its on investment and approval requirements in regional trade agreements that lower trade
(except those to ensure compliance with barriers at and behind borders and that intro-
national laws and maintain national secu- duce trade facilitation arrangements. Where
rity) could be eliminated easily. China should possible, China should advocate “open
continue to pursue opportunities to increase regionalism,” which would require that tar-
its market access and maintain its relatively iff levels agreed among regional partners be
open trading system. By contrast, the transi- offered to other countries on a most-favored-
tion to an open financial system and a flexible nation (MFN) basis.
exchange rate will require time to ensure that In an integrated world, it is especially
China’s institutions are adequate to maintain important that countries press for disciplines
stability in the face of shocks from the inter- that limit the use of export restrictions at
national financial system. times of food scarcity. Although governments
China’s huge size, its presence in most understandably take steps to avoid sharp
markets, the threat of rising protectionism, increases in food prices, export restrictions
and limited regional agreements argue for should be discussed with consuming nations
continued support for a global trading system and the extent of the threat documented.
based on multilateral negotiations. While Without some provision for review, the
China will continue to have a comparative exceptions to WTO strictures against export
advantage in manufactures, it should focus restraints are open to abuse, resulting in an
on services in future trade negotiations. exacerbation of food shortages and sharper
Opening the services sector to foreign par- fluctuations in international prices. Trade
ticipants, if done in the context of a strong restrictions make it difficult for importers
regulatory framework to ensure competition, to rely on the international trading system
can improve the efficiency of the services in times of scarcity and thus reduce food
sector and thus improve efficiency in goods security.
production as well. In addition, despite the Outward flows of FDI from China have
rapid reduction in barriers to entry in ser- increased markedly over the past decade,
vices (from a high level of restrictions) under- despite attempts to restrict Chinese invest-
taken for WTO accession, China still has a ment in some markets. The government
relatively high level of protection in services. has supported outward investment through
Thus it has more concessions to offer in bilateral investment treaties that provide
future negotiations on trade in services than for national treatment of Chinese inves-
in most traded goods, where its tariffs are tors already established in the host country.
relatively low. Future efforts to protect overseas invest-
The division of the world into regional ment could shift toward gaining pre-entry
trading blocs is a challenge to the multilateral national treatment, essentially ensuring that
366 CHINA 2030
Chinese investors are allowed access to host- exchange rate. If a substantial portion of
country markets on the same basis as nation- China’s assets and trade were denominated in
als. Even this more liberal approach to invest- renminbi, then fluctuations in the exchange
ment guarantees will not overcome obstacles rate would not have major implications for
to investment based on national security domestic stability. Moreover, an open capital
concerns, which has been an argument account is needed to facilitate the interna-
used to block some highly publicized deals. tionalization of Chinese companies. Further
Such agreements, however, could support integration with global financial markets
less controversial investments in developing would also support the creation of a robust
countries where the legal system may not be and efficient domestic financial sector. With
reliable in protecting investors’ rights. And unrestricted capital movements, a floating
achieving pre-entry national treatment may exchange rate will be necessary to enable the
be necessary to maintain the competitiveness government to use monetary policy to control
of Chinese investors if such agreements pro- inflation. This strategy entails risk, however:
liferate in coming years. China should also opening the capital account before China has
consider supporting a multilateral agreement in place the regulatory framework required
on investment, provided the terms of such an to effectively supervise financial institutions
agreement can be shaped to be appropriate as well as the credibility and experience with
for developing country circumstances. indirect monetary controls required to limit
Sustaining access for overseas investment inflation could be destabilizing. Thus, a rela-
would require reciprocal concessions, includ- tively conservative approach, stretching over
ing the dismantling of many of the sectoral many years, is recommended in transitioning
controls on inflows of FDI. Such controls to a more open and efficient financial and
will in any event become less necessary, and exchange rate system.
less effective, as rapid growth continues to
increase the complexity of the economy and
Shaping Policy for Public Goods
as the financial system becomes more open to
external capital flows. Over the next few decades, China will have a
China’s tightly managed exchange rate major impact on, and will be greatly affected
and closed capital account have supported by, the supply of global public goods. The
rapid growth and helped limit financial insta- final section of the chapter reviews C hina’s
bility. Linking the renminbi to the dollar has role in global governance surrounding
avoided sharp changes in the renminbi value select public goods, such as climate change,
of foreign assets and trade flows that are financial stability, and official finance. In
largely denominated in dollars. And restrict- the medium term, the government will face
ing capital movements has protected China’s important choices in its policies toward
relatively undeveloped financial markets from global public goods. It can essentially leave
the volatility experienced by many of its East the determination of these global policies to
Asian neighbors. However, these policies a multilateral consensus, with specific inter-
have also led to sharp swings in China’s com- ventions to protect China’s interests, or it
petitiveness with third countries, necessitated can actively help to shape global agreements.
inefficient administrative controls to control Active involvement in international negotia-
inflation, resulted in a large buildup of low- tions would likely imply shouldering some of
return and risky reserves, and constrained the costs of preserving global public goods
financial sector development. by, for example, diverting resources toward
Going forward, as other parts of the world limiting environmental damages. Neverthe-
become more important and economic rela- less, China has much to gain from helping
tions diversify, greater use of the renminbi to shape international agreements on pub-
as an international currency would provide lic goods. The country’s huge size means
more economic stability than a managed that effective agreements are unlikely in its
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 367
absence, and in many areas China has a criti- transactions not overly impair the efficiency
cal interest in ensuring the preservation of benefits (and the profits of their financial
global public goods. In addition, having a say institutions) from sophisticated derivatives. In
in the design of agreements can minimize the contrast, Chinese banks lack the technology
costs for China and in some cases open up and banking relationships required to play
opportunities for gain. a major role in these markets, while China’s
Climate change is one of the most critical economy suffered from the extreme volatility
policies and the best example of why China generated by the failure to properly regulate
should not only participate in global negotia- them. Thus, it may be in China’s interest to
tions but proactively help shape new global promote a stricter regulation of derivatives
solutions. Absent changes in policy to reduce than is currently envisioned.
energy intensity, global carbon emissions China has recently transitioned from a
could rise by about 50 percent over the next receiver to a provider of foreign aid. China’s
20 years, with a quarter of this increase com- official finance has boosted the social and
ing from China alone. The resulting increase economic development of recipient coun-
in average temperatures could have disastrous tries and strengthened bilateral political and
implications for China and the global econ- economic ties. China’s current practice of
omy. Effective global policies to combat cli- tied aid, minimal project conditionality, and
mate change are not feasible without C hina’s competitive terms for export credits resemble
participation, both because limiting China’s those of advanced countries a few decades
emissions is critical and because other coun- ago. The South-South type official finance
tries are unlikely to participate in the absence provided by China is used to achieve mul-
of the largest source of carbon emissions. If tiple objectives, not only aiding the social
China fails to take steps to reduce carbon and economic development of recipient coun-
emissions while other countries do, China tries but also promoting its exports, secur-
would get an artificial comparative advan- ing future flows of natural resources, and
tage in energy-intensive production, making improving diplomatic relations. During the
the country even more dependent on uncer- coming decades, as the development objective
tain future energy supply and worsening its becomes a more independent one, aid effec-
already considerable environmental chal- tiveness should receive more emphasis. That
lenges. As chapter 3 shows, limits on car- will require transparency in reporting data
bon emissions would not necessarily reduce on aid flows and greater attention to envi-
China’s GDP because “green” technologies ronmental and governance standards. China
may become a new source of growth. Finally, could also improve global aid effectiveness by
it is important that China continue to push urging traditional donors to adopt China’s
actively for a global climate change treaty to more efficient approaches to infrastructure
ensure that emissions targets reflect develop- projects.
ing countries’ low levels of per capita emis-
sions and leave room for future growth.
The integration of international prudential
The World in 2030
norms into China’s banking regulations has Despite intermittent crises, developing econo-
helped the government improve the sound- mies have been strikingly successful during
ness of the banking system. Likewise, follow- the past two decades. Their GDP volume
ing the guidelines of Basel III should serve to increased, on average, by 4.6 percent a year.
improve regulatory standards and provide That was more than twice as fast as the 2.1
an anchor for continued reform. Heretofore, percent annual growth in high-income coun-
China has played little role in defining inter- tries. Prices in developing countries also rose
national standards, but that may need to twice as fast as those in the high-income
change. For example, advanced countries countries, raising their share in the global
may be concerned that controls on derivative GDP value from 16.7 percent in 1990 to 31.3
368 CHINA 2030
percent in 2010. This strong performance are easier to predict than short-term fluctua-
was achieved after broad-based domestic tions, but these trends are ambiguous too.
reforms in many countries and rapid integra- High-income countries are currently facing
tion into global markets, which pushed up structural problems that restrain competi-
potential growth from 3 percent during the tiveness; even in the case of adequate policy
early 1990s to 6.5 percent currently. Devel- responses, it is uncertain when growth will
oping countries’ share in world trade roughly strengthen and unemployment will return to
doubled, from 14.6 percent in 1990 to 30.3 normal levels. Fundamentals in most devel-
percent in 2010. Export volumes increased oping countries remain strong, but there
8.8 percent a year during the past two are limits to the current pattern of growth,
decades, compared with merely 2 percent if only because the share of services will
annually during the previous 20 years. That increase over time.
acceleration in exports coincided with a simi- To illustrate the long-term uncertainty, we
lar acceleration in import volumes, from 3.5 explore two scenarios. In the first scenario,
percent annual growth during the 1970s and technological progress within sectors will
1980s, to 9.5 percent annual growth during continue at the same pace, even though one
the past two decades. could argue that technological progress in
China’s success has been an important manufacturing could slow as several emerg-
part of the strong performance of develop- ing economies approach the slowly advanc-
ing countries, with its share in global GDP ing global technological frontier. Despite the
increasing from 1.5 percent in 1990 to 9.5 assumption of constant intrasectoral tech-
percent in 2010. But growth outside China nological progress, overall growth will slow
was strong. The share of other developing for two main reasons. First, aging popula-
countries in global GDP increased from 15 to tions (particularly in the Russian Federa-
22 percent over the same period. The pene- tion, China, and high-income countries) will
tration of developing countries in global mar- limit labor force growth and push down
kets has reduced the market shares of high- savings rates and, thus, investment. Second,
income countries but has not come at the cost since productivity growth is much higher in
of export growth in those countries, which manufacturing than in services, the shift to
averaged 5.2 percent a year between 1990 services will reduce overall growth. In emerg-
and 2010, exactly the same as during the pre- ing economies, the share of services will rise
vious 20 years. While competition increased because richer consumers will demand more
for high-income exporters, accelerating services and because the price of basic ser-
imports in developing countries also created vices will increase relative to manufactures.
new opportunities. High-income countries In the advanced countries, the aging popula-
also benefited from the increased supply of tion will demand more health and personal
affordable imports and from new investment services, and the relative price of those ser-
opportunities in the emerging economies. vices will also increase. Furthermore, many
Although the integration and catching up of new products in the global economy (coming
emerging economies has also caused new ten- from innovations in information and com-
sions, on balance the last two decades have munications technology and biotechnology)
shown many winners and few losers. have a large service component and require
The question now arises whether the pace higher levels of education, in turn increasing
of recent rapid growth can be sustained over demand for (education) services.
the next two decades and whether the world In the second scenario, we assume further
economy can continue to produce win-win domestic reforms and more rapid innova-
solutions. The uncertainty is obviously large, tions in the services sector that lead to higher
especially in the short run, as turmoil in productivity growth than in the past. The
financial markets has the potential to seri- higher productivity is supported by global-
ously disrupt global activity. Long-run trends ization of both production and consumption
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 369
of services, which boosts innovation, com- be difficult to maintain (figure 5.1). Espe-
petition, and economies of scale. As a result, cially after 2025, forces that curb growth
volume growth is higher than in the first sce- will become strong. Nevertheless, China
nario in both high-income and developing is expected to remain one of the fastest-
economies, but the relative price increase of growing economies in the world. Average
services is significantly smaller. annual growth is 5.7 percent in the low-
Average annual GDP growth during the growth scenario and 9 percent in the high-
next 20 years in developing countries ranges growth scenario, respectively 1 and 3 per-
from 4.9 percent in the low-growth scenario centage points higher than average growth
to 7 percent in the high-growth scenario in the other developing countries. Growth
(table 5.1). The actual growth during the in high-income countries will likely continue
past 10 years was 5.9 percent, exactly in the to be substantially lower than in develop-
middle of the two scenarios. So the two sce- ing countries. In both scenarios, develop-
narios seem to describe a range around a con- ing countries are growing more than twice
tinuation of the recent trend. However, that as fast. Average growth in the high-income
perception is not correct. The past decade countries ranges from 1.6 percent in the low-
includes the global financial crisis, which growth scenario to 2.9 percent in the high-
pushed average growth down, and trend growth scenario. And again, growth is likely
growth had been accelerating in the develop- to decelerate over time, to 1.1 percent or 2.5
ing world. In the two years before the crisis, percent in 2030 in the respective scenarios.
growth in the developing world exceeded 8 In both scenarios, developing countries
percent; in 2010, growth was 7.3 percent, will have established themselves in 2030 as
higher than the average growth in the high- the dominant force in the global economy.
growth scenario. That means that in both They will be responsible for two-thirds of
forward-looking scenarios, growth will come global growth, with only one-third origi-
down over time from its recent very strong nating in the current high-income countries
pace; in the low-growth scenario, it falls to (figure 5.2). A quarter of global growth will
3.5 percent in 2030 and in the high-growth come from China—slightly more in the high-
scenario to 6 percent in 2030. growth scenario, slightly less in the low-
The decline in growth is somewhat steeper growth scenario. That implies that develop-
in China than the average growth decline in ing countries other than China will have a
the rest of the world, because China’s excep- larger impact on global growth (contribut-
tionally high growth of the last decade will ing over 40 percent to global growth) than
370 CHINA 2030
14
5-year moving average annual GDP growth
12
10
0
1960–65 1966–71 1972–77 1978–83 1984–89 1990–95 1996–2001 2002–07 2008–13 2014–19 2020–25
China Developing countries, not including China High-income countries
all high-income countries together. That has the Armington assumption of differentiated
important consequences for China. Not only products. To analyze global environmental
will competitors to Chinese firms be predom- policies, a climate change module is incorpo-
inantly in other developing countries, but rated in the model.
increasingly, markets for Chinese products The main drivers of growth are tech-
will be there too. nological progress, demographics, capital
accumulation (including education, so-called
human capital accumulation), changes in the
Driving Forces of Future Long-Term
use of land, and domestic migration from
Growth of the Global Economy
low- to high-productivity sectors. All these
The expected deceleration of growth over drivers imply higher growth in developing
time and the associated structural changes countries than in high-income countries dur-
are suggested by mechanisms incorporated ing the next 20 years, but they also suggest
in an elaborate general equilibrium model. that growth will slow over time. As a result,
The model contains 14 countries or country overall growth tends to drop as economies
groupings and describes shifts over 21 sec- mature. The drivers can be summarized as
tors as a result of differentiated technologi- follows:
cal progress and different income elasticities.
The model also distinguishes between skilled • Technological progress is relatively high
and unskilled labor and a segmented labor in developing countries as these coun-
market, differentiating between rural and tries catch up to efficiency and skill levels
urban employment and describing endog- already achieved in high-income countries,
enous migration to cities. The allocation but the more they close the gap with the
of land between rural and urban areas can global technological frontier, the more dif-
have significant impacts on relative prices, ficult it will be to maintain the same pace
as does the availability of natural resources. of technological progress. Moreover, tech-
Savings depend on youth and elderly depen- nological progress is still high at a mac-
dency ratios and are positively correlated roeconomic level in developing countries
with growth. Together with capital flows, because the share of services is smaller
they determine capital accumulation. In than in high-income countries. However,
each sector, international trade is based on as a consequence, the future shift toward
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 371
FIGURE 5.2 Growing share of developing countries in global growth (five-year moving average)
a. Low case
120
Contribution to global GDP growth as share of total (%)
100
80
60
40
20
0
1960–65 1970–75 1980–85 1990–95 2000–05 2010–15 2020–25
b. High case
120
Contribution to global GDP growth as share of total (%)
100
80
60
40
20
0
1960–65 1969–74 1978–83 1987–92 1996–2001 2005–10 2014–19 2023–28
services will tend to lower technological but also to increase the capital-output
progress. ratio more than in high-income countries.
• Growth of population and of labor sup- However, as the capital intensity rises, fur-
ply is higher in developing countries than ther increases will be more and more dif-
in high-income countries, but over time, ficult to achieve.
those growth rates will decline. • Urbanization is an important part of the
• In many developing countries, savings growth advantage in developing countries.
rates are large enough to allow for rapid The capacity of urban areas to transition
growth in the stock of capital, making it labor and land from low-productivity sec-
possible not only to keep the capital stock tors to high-productivity sectors is a sig-
in line with the rapidly growing output nificant part of productivity increase at
372 CHINA 2030
a macroeconomic level. Segmented labor sectors. That in turn will increase the size of
and land markets keep the factor prices the services sectors in the developing econo-
relatively low in low-productivity sectors, mies. The result is lower macroeconomic
and the transition of factors implies a growth, because productivity growth in ser-
jump in value added. However, as with the vices is low. In addition, developments on the
other drivers of growth, this process has demand side mean that the share of services
inherent limitations. The potential gains is expected to rise. In developing countries,
decline as the share of low-productivity that will happen mainly because per capita
sectors drops. incomes grow quickly and the income elas-
ticity of the demand for services is high. In
In the low-growth scenario, historical high-income countries, it will happen mainly
trends in technological progress are extrapo- because aging will increase demand for
lated, which means that productivity growth health care and personal services.
remains higher in manufacturing sectors than The increasing importance of services
in services and agricultural sectors. That is will have far-reaching consequences beyond
especially true in developing countries, which the lowering of macroeconomic technologi-
benefit from catching up in manufacturing cal progress. Capital, including foreign capi-
sectors to the higher levels of efficiency in tal, will increasingly be drawn to the higher
more advanced countries. The latter coun- prices in services. This capital deepening in
tries continue to experience lower productiv- sectors with slow technological progress fur-
ity growth as they only gradually push the ther reduces macroeconomic volume growth.
technological frontier further out. The rise in the prices of domestic services will
The fast growth in manufacturing sec- also reduce the relative price of internation-
tors makes developing countries as a whole ally traded raw materials, including the rela-
grow faster than developed economies, but it tive price of energy. That reduces the energy
also carries the seeds for a future decelera- efficiency of services and makes the need for
tion of macroeconomic growth because the stringent environmental policies even more
relative prices of services will rise as a result urgent.
of differentiated productivity growth across The high-growth scenario assumes faster
growth of technological progress in the ser-
vices sectors, that is, additional progress over
FIGURE 5.3 China’s future share in services and historical and above the historical trend. All countries
experiences of other countries (high-growth scenario) benefit from the accelerating pace of global
innovations in services and from the fact that
a larger share of services becomes interna-
80
tionally tradable. As a result, macroeconomic
70 growth is faster and slows less over time
Value added in services (% GDP)
FIGURE 5.4 Labor supply growth will vary greatly among countries
Low-middle-income countries,
not including BRIC countries
Brazil
Russian Federation
India
China
United States
Japan
–2 –1 0 1 2
Average annual percentage change
2010s 2020s
scenarios. However, this difference endog- the pace of increase will be slower than in the
enously has consequences for other drivers of previous 20 years, when the average annual
growth. The higher macroeconomic growth rate of growth in world population was 1.3
results in more capital accumulation and also percent. In parts of the world, the change
slightly more internal migration from low- to in the labor force is even more dramatic as
high-productivity sectors. a result of aging. Toward 2030, the labor
Growth in labor supply is another key force in China, Russia, Japan, and Europe
driver of economic growth and does not dif- will be declining at an annual pace of 0.4 per-
fer between the two scenarios. As in the case cent or more. On the other hand, India and
of technological progress, the expected demo- many African countries will still experience
graphics during the coming decades point to high, albeit declining, growth rates of labor
faster growth in the developing world than in supply (figure 5.4). These developments will
the high-income countries, while over time obviously change the comparative advantages
growth should slow. among developing countries, with labor-
In 2030, world population is expected to intensive (especially low-skilled intensive)
have grown to 8.3 billion people, an increase production shifting to Africa and South Asia.
of 1.3 billion over the current 7 billion. All The trends triggered by technological
the additional population will be added in progress and demographics will be rein-
the developing world, which will grow from forced by capital accumulation. In the long
5.9 billion currently to 7.2 billion in 2030. run, capital tends to grow at the same rate
This is one of the driving forces behind the as overall output. Capital-to-output ratios
growing importance of the developing world. change only gradually, if at all, over time.
At the same time, demographic changes will If output increases, more savings are gener-
lead to slower growth worldwide, including ated that allow a corresponding increase in
in many developing countries. Despite the the capital stock. This phenomenon explains
20 percent increase in the world population the rapid capital accumulation in developing
during the next 20 years (0.9 percent a year), countries. The result of this process is that
374 CHINA 2030
FIGURE 5.5 Capital output ratios will further rise, especially in emerging economies
Brazil
Sub-Saharan Africa
Russian Federation
India
China
United States
Japan
0 1 2 3 4 5
Capital-output ratios
2010 2030
Source: World Bank calculations, derived from low-growth scenario; EFTA = European Free Trade Association.
FIGURE 5.6 Land prices in China and India will rise sharply
0 1 2 3 4 5 6 7
in rural areas provides developing countries a sectoral pattern of trade within the devel-
large growth potential. However, that poten- oping world is expected to shift radically.
tial will diminish over time as the rural popu- Rapidly growing middle-income countries,
lation shrinks. In the low-growth scenario, including China, will experience a declining
China’s internal migration in 2030 will be comparative advantage in low-skilled labor-
9 percent lower than it was in 2010. Other intensive products relative to other develop-
developing countries also are expected to ing countries. As these countries move up
experience substantial declines. Only in Sub- the value chain, new opportunities arise for
Saharan Africa does the migration potential lower-income countries, which will become
remain large, and internal migration is actu- increasingly competitive in labor-intensive
ally expected to increase by 50 percent over production.
the next 20 years. Developments in the high- Middle-income countries will continue to
growth scenario are even more pronounced. dominate trade in manufactured products,
Because of the higher productivity growth even if the share of services in total value
in cities, migration flows are larger than in added in their domestic economies is increas-
the low-growth scenario during the early ing sharply. Exports of high-income countries
years. As a result, however, the deceleration would, in both scenarios, shift more to ser-
also will be faster as the remaining pool of vices. As middle-income countries move up
rural workers declines faster. The migration the value chain in manufacturing, and as low-
flows in that scenario are expected to decline income countries export more (low-skilled)
by 12 percent in China, while in Africa the labor-intensive manufactured products, the
increase, from the higher levels achieved early comparative advantage of high-income coun-
on, is only 5 percent. tries will shift even more to internationally
tradable, cutting-edge services.
Trade patterns will also change once addi-
Changing Trade Patterns
tional environmental policies are put in place,
Emerging markets will likely become the an assumption not reflected in the baseline
main destinations for world trade, and the scenarios. The mounting environmental
376 CHINA 2030
pressures are clearly illustrated by the antici- productivity growth only if their service sec-
pated increase in greenhouse gas emissions. tors can benefit from increased global com-
Without policy changes to reduce energy petition. High-income countries can benefit
intensity, emissions of the four main gases from the new global opportunities in services
that the model tracks are expected to more only if they maintain an outward orienta-
than double under the low-growth scenario tion and keep their markets open for emerg-
in China and India between now and 2030. ing competitors that challenge their own
This increase contrasts with the high-income advanced companies. Low-income countries
countries, where emissions will not increase can step into labor-intensive manufacturing
much more over their already high levels. sectors that middle-income countries are exit-
In the event of a global agreement to reduce ing only if they participate in global markets.
emissions (see below for more discussion on In agricultural markets, the costs of food
these policies), overall trade would become policies that are based on self-reliance will
less energy intensive, and trade in energy- increase, as production costs will further
saving technologies would increase. If devel- d ifferentiate between areas with high and
oping countries do not pursue mitigating pol- low population density. Reliable international
icies, then they would be pushed toward an trade flows will be an essential ingredient of
artificial comparative advantage of energy- food security. And finally, cross-border envi-
intensive production, and their exports ronmental problems will require global solu-
would become more energy intensive. tions. Countries, developing and high-income
Despite the increased competition from alike, that maintain an outward orientation
low-income countries, and the slowing global will be among the successful ones during the
economy, plenty of opportunities will still coming decades, while inward-looking poli-
emerge for China to penetrate further in cies will increasingly prove self-defeating. In
existing markets and to explore new mar- short, many win-win solutions are possible,
kets. With the high growth in other emerg- but only if protectionist attitudes that aim to
ing economies, new fast-growing markets defend old positions and vested interests are
will open up. With higher schooling levels avoided.
and further accumulation of capital, Chi-
nese firms can move to higher value-added
The Transformation of China
segments of global markets. Globalization
of Chinese firms will also create new oppor- China has become a dominant global econ-
tunities, as these firms expand their invest- omy. In 2010, China outstripped Japan to
ments abroad, and acquire new technologies. become the world’s second-largest economy
And even environmental policies might create (while remaining less than 40 percent of the
new growth opportunities in global markets. U.S. economy), as measured in nominal GDP.
Bold, new environmental policies (that will Still, even this remarkable achievement does
price externalities in a consistent and predict- not fully reveal how important China has
able way) are likely to create win-win solu- become in terms of changes in the global
tions as they address domestic bottlenecks, economy. Between 2005 and 2010, China
make developing countries competitive in added $3.7 trillion to global nominal GDP;
new global growth markets, and contribute that amount represented almost a quarter of
to the solution of global environmental prob- global growth and was almost twice as large
lems such as climate change. as the $2 trillion added to global output by
With all the changes in the global econ- the United States. A similar picture emerges
omy that are anticipated, it is clear that even if the role of real appreciation of the
many of the opportunities and the solutions renminbi is excluded. This pattern continued
for many of the challenges will be found in in 2010, when China was by far the largest
global markets. Middle-income countries can contributor to global GDP growth; its econ-
move up the value chain and create enough omy added $638 billion to growth in global
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 377
nominal GDP, compared with $497 billion will place downward pressure on the return
added by the U.S. economy. to capital, which will shift China toward a
China is yet more important if one looks comparative advantage in capital-intensive
at the parts of the economy that are interna- sectors and create opportunities for substan-
tionally tradable. In 2010, the value of invest- tial investments in new markets. It also will
ment in China already exceeded the U.S. open up the opportunity for more productive
investment value by 50 percent, and between investments abroad, a trend that might well
2000 and 2010, China contributed half of become one of the most distinctive develop-
the growth in global investments. China also ments during the coming decades.
holds a dominant position in other interna- Finally, it is important to realize that
tionally tradable products. For example, in China will continue to struggle with signifi-
many metals markets, China is responsible cant levels of poverty. Even measured in pur-
for half of global demand. chasing power parity (PPP) terms, China’s
The low-case scenario envisions a slowing per capita income is only one-tenth of that in
of GDP growth in China and sharp changes in the richest countries in the world. More than
the composition of output over the next two 80 countries have higher per capita incomes
decades. The labor force in the modern sector than China, while the income distribution in
will fall as the population grows older and as China is more unequal than in many of the
migration from rural to urban areas declines. rich countries. Despite the sharp rise in aver-
The net rural-urban migration during the age incomes anticipated over the next 20
1990s was 125.5 million in China (Chan and years, which will make China a high-income
Hu 2003), which would indicate an annual country, a large part of the country’s popula-
outflow of about 4 percent. However, that tion will still be relatively poor. It will likely
migration rate likely has slowed significantly take significantly more than 20 years for the
in more recent years and is projected to be whole population to reach high-income sta-
around 1 percent (of a slowly declining rural tus. Unlike the current high-income countries,
population) in the coming years. in which virtually all inhabitants are part of
The decline in the labor force means that the highest deciles in the global income dis-
China will continue to lose its comparative tribution, China will still have, in 2030, key
advantage in labor-intensive production. characteristics of a developing country, with
Only 10 years ago, roughly 2 of every 10 a population much closer to a cross-cut of the
additional jobs in the world were created in world population (figure 5.7).
China. Over the next 5 years, China’s labor In the next section, we consider policies
supply will be declining and, if participation that would facilitate the shift to services,
rates do not change, employment will decline more capital-intensive production, and con-
in 2030 at a rate of 3 million jobs a year. tinued rapid productivity growth, focusing
That decline will be much larger if the cur- on outward-looking policies in trade, cross-
rent moderation of the still very high partici- border investment, and the internationaliza-
pation rate continues. tion of the renminbi.
Savings rates will fall 10 percentage
points, with a larger drop in investment rates. China’s Integration in Global
The share of services will rise from 38 per-
cent in 2010 to 67 percent by 2030, result-
Markets
ing in lower average productivity growth.1 China’s economic miracle is built on the
Despite the decline in investment rates, the adoption of market-oriented policies and
high initial level of investment (45 percent openness to the world economy. The progres-
of GDP) will mean that the capital stock sive reduction in trade barriers and the dis-
will continue to grow, by more than 7 per- mantling of many restrictions on FDI have
cent over 2010–30, or 1.5 percentage points generated great benefits in the form of access
more rapidly than output. Capital deepening to foreign technology, increased competition
378 CHINA 2030
FIGURE 5.7 China’s population will have more low-income people in 2030 than the United States does now
a. United States’ share of global income distribution, 2009 b. China’s share of global income distribution, 2030
100 100
90 90
80 80
70 70
% of total population
% of total population
60 60
50 50
40 40
30 30
20 20
10 10
0 0
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Deciles Deciles
in the domestic economy, and the growth of a eliminate absolute poverty, and to become
mammoth industrial sector built on exports. the world’s largest economic power. The
Despite this remarkable progress, pressures country cannot achieve these goals by look-
can be seen for a change in direction: either ing inward. Instead, China needs to embrace
a slowing of efforts toward global integra- further steps toward global integration to
tion or a measured withdrawal from interna- improve the competitiveness of its economy
tional economic interactions. The arguments and sustain increases in living standards.
for a retreat from integration are not trivial. Using its capital surplus to invest in foreign
China’s dependence on exports has increased markets, increasing exports of more sophis-
its vulnerability to foreign protectionist mea- ticated goods, encouraging domestic compe-
sures, and the threat of such measures is tition in services sectors, and deepening the
apparent in the political climate, for example, financial sector through the participation
in the United States. The huge export surplus of foreign financial institutions will enable
is reflected in an apparently never-ending China to avoid the “middle-income trap” and
accumulation of low-interest and potentially continue its development.
risky foreign assets. The financial crisis gen- We emphasize that these reforms are essen-
erated in the United States posed a severe tial to achieve broad-based development,
threat to stability. Although massive stimulus regardless of the particular specialization of
policies maintained growth, they also engen- production that China may adopt over the
dered a risky increase in bank lending and next two decades. For example, an efficient
local government debt that may yet have to financial system and world-class business ser-
be addressed. Looking at the risks of inter- vices generate broad economic benefits, but
national economic relations over the past few they are also necessary to support the produc-
years, it is not difficult to understand calls for tion and trade of sophisticated manufactured
a retreat from global integration. products. Thus, emphasizing services does not
We argue, however, that this view is short- mean the neglect of manufactures production
sighted. China has the opportunity by the but rather a choice for technological prog-
end of the next two decades to join the ranks ress and continued upgrading in all sectors
of high-income countries, to substantially through integration in the global economy.
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 379
This is a vision of how China should look long-term development is to seek to strengthen
in 2030. The transition to a more globally the world’s open trading system built on mul-
integrated economy and, in particular, the tilateralism. At the same time, China should
opening to capital flows transactions needs to advance its own agenda in future negotia-
be accomplished at a pace consistent with the tions, which could include reducing barriers
strengthening of Chinese institutions required to trade in services, seeking regional partners
to ensure stability. We do not recommend that to achieve deeper integration, strengthening
the government dismantle all of its controls on WTO disciplines to require “open regional-
economic activity in the interest of promoting ism,” and limiting the use of export restric-
efficiency. Instead, we would set a goal over tions at times of rising food prices.
the next two decades of transitioning to an
open financial system, a flexible exchange Rapid export growth has dramatically
rate, limited controls over FDI transactions, increased China’s share of global manufac
and a services sector that can compete with tures. China’s exports have risen by 17 per-
the world’s best. There are risks in this transi- cent a year (in dollar terms) over the past two
tion, but these policies promise to support a decades, transforming the country into the
prosperous society for the next generation. world’s largest exporter of goods and dra-
matically increasing the country’s presence in
global markets, particularly of manufactures.
Trade
China’s share of world manufactures trade
Those arguing for a retreat from global inte- doubled during the past decade, and China
gration point to the threat of protectionism now accounts for 35 percent of manufactur-
against China’s exports. 2 And, as China’s ing imports in Japan, 30 percent in the Euro-
exports further penetrate foreign markets, pean Union, and slightly over 25 percent in
increasing market shares in China’s traditional the United States (figure 5.8). China’s exports
products and competing in higher-value-added are particularly significant in markets with
segments, protectionism against imports from the highest tariff levels (figure 5.9), indicating
China may well increase. Already China faces that China is exporting to markets that are
higher-than-average protectionist barriers. politically sensitive and likely to be the source
But the policy response that is consistent with of trade frictions.
FIGURE 5.8 China’s share in industrial imports of the world’s 10 largest importers has increased
40
35
Import share from China (%)
30
25
20
15
10
0
World EU-27 United Japan Korea, Rep. India Russian Mexico ASEAN-10 Brazil Canada
States Federation
2001 2009
FIGURE 5.9 China’s share in imports of 10 most-protected sectors in the 10 largest importers has increased
40 30
35
25
China’s import share (%)
30
20
% applied tariff
25
20 15
15
10
10
5
5
0 0
Brazil Canada EU-27 India Japan Korea, Rep. Mexico Russian Turkey United States
Federation
Import share in 2001 Import share in 2009 Applied tariff rate in 2009
Source: UN COMTRADE database (trade data) and UNCTAD TRAINS database (tariff data).
Note: Sectors defined at the Harmonized Schedule (HS) 2-digit level of aggregation in 2009.
China has seen a substantial widening of respectively (figure 5.10a). China’s trade
its trade surplus in industrial goods with all surplus on manufactures with other large
of its major trading partners, with the excep- emerging-market countries has also increased
tion of the Republic of Korea and Japan. sharply (figure 5.10b).
For example, China’s manufacturing trade These bilateral surpluses are sometimes
surplus with both the United States and the seen as signs of imbalances and can trigger
European Union has increased more than protectionist responses. However, bilateral
three times to $200 billion and $250 billion, trade balances with individual countries
FIGURE 5.10a China has a large trade surplus in FIGURE 5.10b China has a large trade surplus in industrial goods
industrial goods with the United States and the with major trading partners
European Union
300 40
30
250
20
200 10
US$ (billions)
US$ (billions)
150 0
–10
100
–20
50
–30
0 –40
EU-27 United States Japan Korea, India Russian Mexico Canada ASEAN-10 Turkey
Rep. Federation
2001 2009
2001 2009
TABLE 5.2 China’s trade with developing China’s exports already have met increased
East Asia differs from that of Sub-Saharan Africa protectionist barriers. China was the target
Share of exports to China, %
of 15 percent of the antidumping actions ini-
1990 2010 tiated by the 10 economies that accounted
Developing East Asia for 79 percent of new antidumping investiga-
Final manufactures 33 33 tions during 1995–2001, while it accounted
Parts and components 10 47 for only 4 percent of these countries’ imports
Raw materials 35 16 (Bown 2007). Discriminatory practices
Sub-Saharan Africa
Final manufactures 7 5
increased after China’s WTO accession, as
Parts and components 8 0 the share of developing-country antidumping
Raw materials 67 88 actions against China (as a share of their total
Source: UN COMTRADE database.
actions) increased from 19 percent in 2002 to
Note: Export categories exclude some products. 34 percent in 2009. The corresponding fig-
ures for industrial countries were 11 and 27
percent, respectively.3
provide no information on overall balance The current threat from protectionism
of payments pressures and give at best an should not be overstated, because the share
incomplete picture of bilateral trade patterns. of China’s exports subject to quantitative
China is a major exporter of manufactures restrictions or WTO processes does not
and a major importer of natural resources, appear to be large. In 2009, for example,
so surpluses in manufactures trade may 2.6 percent of China’s exports to develop-
be (partly) balanced by deficits in natural ing countries and 1.6 percent of its exports
resources trade. The pattern of trade with to developed countries were subject to anti-
China also differs in part based on geograph- dumping (Bown 2010). Recourse to this
ical proximity and economic capabilities. instrument will become more difficult when
Close by and relatively industrialized East China attains market economy status in
Asia is becoming part of a manufacturing 2016. Moreover, the product-specific transi-
network with China, where these countries tional safeguards that were negotiated at the
export manufactured products to China, time of China’s WTO accession are sched-
some of them inputs to goods that are assem- uled to expire in 2013. But tensions over
bled in China and then shipped to advanced trade and disputes concerning exchange rate
countries. While the share of manufactures parities indicate the potential for increased
in developing East Asia’s exports to China protectionism in the future.
has remained at about a third since 1990,
the share of parts and components has risen Protectionism may rise as China’s exports
from about 10 percent in 1990 to almost half continue to expand and move into new mar
in 2010 (table 5.2). Over the same period, kets. China’s exports are expected to rise by
the share of manufactures in the exports to 6 percent a year from 2010 to 2030, a more
China of distant and less-industrialized Sub- moderate rate than in the past two decades
Saharan Africa fell slightly, while the share of but still representing some increase in pen-
raw materials rose from two-thirds to almost etration in the country’s traditional export
nine-tenths. markets. In addition, continued rapid growth
China’s trade surplus in manufactures in incomes will drive rising wage levels and
is likely to decline over time. Domestic exchange rate appreciation, somewhat reduc-
production should shift toward services to ing China’s competitive advantage in labor-
meet the growing demand from consumers intensive goods compared with lower-wage
with rising incomes. This shift will require economies. Thus, as outlined in the global
increased manufactured imports and will scenarios described above, Chinese firms will
draw resources away from industrial need to move into the production and export
production. of more capital- and knowledge-intensive
382 CHINA 2030
Episodes of agreements between the United States restraints by opening plants in the United States.
and Japan to restrain the latter’s exports occurred Japanese foreign direct investment into the U.S. auto
in textiles in the late 1930s and 1950s, in automo- sector increased from $200 million in 1980 (before
biles in the early 1980s, and in steel in the mid- the export restraints) to $850.8 million in 1986, and
1980s. While “voluntary” export restraints were by the early 1990s, Japanese brands accounted for
far from trivial (according to one study, they cov- some 30 percent of the U.S. auto market, up from 21
ered 32 percent of Japanese exports to the United percent in 1981. Japanese firms also exported from
States in 1984a), their economic impact on Japanese third countries not covered by the export restraint.
firms (although perhaps not on Japanese employ- Similarly, when the United States and major steel
ment) was limited. The automobile export restraint exporters (Japan and Europe) agreed on volun-
was on the number of cars, for example, not their tary export restraints, steel was exported from the
value, so firms sold higher-value (and more profit- restrained countries to the nonrestrained countries,
able) cars to the United States than before the export and then underwent some further fabrication and
restraints. Firms could also circumvent the export was later exported to the United States.a
goods and services. The need to absorb the partners, supporting multilateral trade
technology, business management practices, negotiations and open regionalism. China’s
and market knowledge required for this tran- response to the threat of rising protectionism
sition is an important reason why continued should be anchored in support for an open
openness is essential to China’s development. trading system based on multilateral agree-
China is so large, and the pace of its growth ments. It is important to remember that China
so rapid, that expanding into new markets remains an extremely open economy, particu-
is likely to elicit protectionist responses from larly given its large size (for example, in 2009,
both the high-income countries that tradition- China’s total trade in goods and services
ally have dominated these markets and from equaled 49 percent of GDP, compared with
other rapidly growing emerging economies 25 percent in the United States). Thus, con-
that wish to promote domestic production. All tinuing to pursue international agreements to
of these countries have a great deal invested in preserve and further open markets should be
an open international trade regime. Neverthe- a cornerstone of China’s trade policies going
less, China should be prepared for actions that forward.
are designed to limit competition, whether China faces relatively high tariff rates in
compliant with WTO rules or not. A useful many of its export markets. Therefore, in
historical parallel is the pressure that Japan further multilateral negotiations, the gov-
faced during the 1980s to limit exports to the ernment should push for proportionally
United States (box 5.1). This experience under- larger reductions in relatively higher tariff
lines the importance of supporting outward levels, rather than across-the-board tariff
foreign investment as a means of exploiting reductions.
market opportunities in the face of protection- Preferential agreements may ultimately
ism, apart from the obvious advantages for present a greater challenge to China’s mar-
Chinese firms if they internationalize. ket access than MFN tariff levels. The num-
ber of preferential agreements has increased
China should meet the protectionist threat from about 70 in 1990 to almost 300 today.
by seeking deeper integration with regional About half of the exports of the 30 largest
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 383
to open foreign markets as well as improve price spikes are still possible, owing to rising
efficiency in the Chinese economy. demand from increased incomes in develop-
International commitments could encour- ing counties, volatile fuel prices, and climate-
age both increased market access and change induced pressure on agricultural
improved domestic efficiency in government supplies. Multilateral disciplines could be
procurement, which represents well over 20 useful in limiting export restrictions that tend
percent of China’s economy. The European to exacerbate price hikes. During the global
Union Chamber of Commerce recently stud- financial crisis and its continuing aftermath,
ied foreign-invested enterprises competing 18 developing countries imposed some form
in China’s public procurement markets and of export restrictions (World Bank 2008).
found that the regulatory framework govern- Each country is trying to keep domestic sup-
ing this enormous and increasing amount of plies high on the grounds of food security.
economic activity is fragmented, inconsis- But, as more countries implement export con-
tent, and unevenly implemented. The WTO’s trols, global supplies contract, pushing prices
Trade Policy Review on China also found up further and impairing global food security.
that “China continues to face challenges in There are few restrictions on the use of
implementing a consistent and transparent export taxes in the WTO, and the disciplines
approach to procurement across all levels of on export restrictions are incomplete. Article
government” (WTO 2010). XI of the General Agreement on Tariffs and
China has applied for accession to the Trade (GATT) does prohibit quantitative
WTO’s government procurement agreement. restrictions on exports, but its paragraph
Establishing the transparent and reliable pro- 2(a) permits temporary restrictions to prevent
curement procedures necessary to gain access critical shortages of food or other goods.8 To
could enormously increase the efficiency of ensure continued access to critical foodstuffs,
government operations.7 Joining the agree- the government should consider pressing for a
ment would also open potentially huge mar- multilateral approach to dealing with tempo-
kets for Chinese firms. The total size of gov- rary shortages. This approach could involve a
ernment procurement markets of the current requirement that countries justify how export
and possible future accession candidates to restrictions would relieve critical domestic
the agreement is $2.3 trillion to $3.0 trillion shortages and include a provision for con-
annually, while the portion of these govern- sultations between importing and exporting
ment procurement markets that is likely to be countries at times of scarcity. While govern-
covered by the agreement is in the range of ments are unlikely to forgo trade restrictions
$380 billion to $970 billion annually (Ander- in the face of sharp increases in prices that
son and others 2011). endanger the welfare of their populations,
ensuring that such measures are undertaken
Improving commodity security. Multilat- only when essential would provide greater
eral negotiations may also be a useful forum assurance to importers that they can rely on
for improving China’s assured access to food the world trading system, rather than bilat-
imports. China is increasingly dependent on eral deals, to ensure food supply at times of
imported food. Already, China accounts for scarcity.
54 percent of world imports of soya beans, Similar considerations apply to China’s
and 98 percent of its imports come from just participation in global trade in raw materi-
three countries—the United States, Brazil, and als. Ensuring that the country has a reliable
Argentina. Considerable potential remains supply of raw materials will be an impor-
for increasing global food production (World tant element of China’s trade strategy over
Bank 2009), and prolonged food shortages are the next two decades. China is a significant
likely to be localized rather than affecting the producer of several metals that are critical to
global economy as a whole. However, short- production and has large reserves of oil. Nev-
term supply disruptions and demand-driven ertheless, the high commodity intensity of
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 385
production and rapid growth of China’s huge resulting from political instability or natural
economy has made the country a significant disasters) could be accommodated only by
presence in global trade in these commodi- changes in the share of global production that
ties. China accounts for a quarter or more is not subject to such contracts. That would
of world imports of most of the main met- prevent the right price signals in the con-
als and is a major energy consumer (Coxhead trolled parts of the markets and would intro-
and Jayasuriya 2010). For example, in 2009, duce tremendous volatility in the free part of
China produced half the world’s supply of the market. The resulting substantial differ-
coking coal but still accounted for 17 percent ences in prices with the more controlled parts
of global imports. China also produced 15 of the market would ultimately be arbitraged
percent of global iron ore but consumed more and could trigger smuggling or the breaking
than half of global production and accounted of contracts, thus imposing increased volatil-
for more than two-thirds of total imports ity on the market in general. Such a system
(Christie and others 2011). is not in China’s long-term interest, and the
Current efforts to secure the supply of government should help ensure that, glob-
commodities include restrictions on export ally, investment and consumption decisions
of selected minerals (such as coke, antimony, remain responsive to the right pricing signals.
bauxite, magnesium carbonate, molybdenum, Thus, while attempts to secure access make
silicon carbide, tin, and tungsten), limits on sense from an individual country perspective,
foreign exploration and mining, investment the world as a whole (and given its huge pres-
in commodity-producing activities abroad, ence in the market, China in particular) will
long-term contracts with suppliers, and loans benefit from maintaining an open trading
to energy-producing nations where minerals system for raw materials.
are used as collateral for eventual repayment.
The combination of the dramatic increase in
Foreign Direct Investment
China’s demand for raw materials and efforts
to secure foreign sources of supply has raised China has adopted FDI-friendly policies since
foreign alarms about the country’s efforts to 1980, beginning with permitting FDI in Spe-
monopolize access to minerals (for example, cial Economic Zones but steadily broadening
see Brightbill and others 2008) and calls for it to the rest of the nation. As a result, China
restrictions on Chinese minerals investments is now host to almost 700,000 partly foreign-
in some producing nations.9 These views are owned companies with accumulated foreign
gaining some public hearing, even though investment of $1.05 trillion. These compa-
Chinese firms’ investments in raw material nies account for 22 percent of tax revenue, 28
production differ little from efforts at vertical percent of industrial value added, 55 percent
integration by Western multinationals and of exports, 69 percent of the trade surplus,
China’s share of global mining mergers and and 50 percent of technology imports. For-
acquisitions (M&A) remains small.10 eign direct investment has enabled China to
Continued efforts by Chinese firms to gain integrate gradually into global manufacture
reliable access to raw materials seem rational networks, as well as contribute to exports,
from China’s perspective, and, to the extent employment, technology, and institutional
that these efforts lead to increased global reform.
supply, they can also benefit other countries. As China grows richer, its attractiveness to
However, a segmentation of the global mar- foreign investors changes. Transnational cor-
ket for commodities should be avoided. If porations no longer invest in China merely
major consuming nations have fixed, long- because of low labor costs but increasingly
term contracts that tie up a large share of because of its rapidly expanding domes-
global production, shocks to the system tic market, supporting industries, excellent
(for example, increased demand caused by infrastructure, and human resources (about
changes in technology or supply interruptions 7 million university graduates every year).
386 CHINA 2030
is easy for those arguing for a more inward- Russian Federation 3 215
looking development strategy to ignore the Hungary 1 160
implications for outward FDI. Indeed, open- China 1 159
India 1 75
ness to FDI inflows and domestic policy Korea, Rep. 5 84
reforms to ensure that technology spillovers Singapore 6 97
from foreign firms can disseminate quickly Brazil 2 60
to domestic firms remain an important ele- Malaysia 2 51
ment of China’s development strategy. How- Mexico 0 40
ever, Chinese multinationals also can play Source: IMF Balance of Payments database.
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 387
FIGURE 5.11 China’s outward FDI is directed more toward mining, compared with advanced countries’ FDI
a. China outbound greenfield, 2003–10 b. China outbound mergers and acquisitions, c. Advanced countries outbound mergers and
2003–10 acquisitions, 2003–10
55%
53% 64%
9%
0%
27%
27%
25% 3% 0%
17% 20%
Sources: For mergers and acquisitions data, World Bank staff estimates based on Thomson-Reuters SDC Platinum. For greenfield data, World Bank staff estimates based
on FDI markets.
China’s FDI outflows have increased at foreign exchange reserves is largely invested
about the same annual rate of growth as out- in low-return assets (such as U.S. Treasuries),
flows from Japan and Korea, to take regional and demand for foreign exchange by firms to
examples that have achieved rapid growth invest abroad represents some diversification
(beginning from the year that these countries’ of foreign assets, from the perspective of the
outflows exceeded $1 billion), but less than country as a whole.12
outflows from Malaysia. Given China’s huge More controversially, FDI can be used to
size, FDI outflows could quickly rise to high secure essential commodities for the domestic
levels. For example, by 2030, China’s per economy. The high energy and metals inten-
capita GDP will exceed $10,000. If China’s sity of production mean that the economy is
FDI outflows relative to GDP equaled the dependent on a stable, secure supply.13 There
level of Japan’s at a similar level of income are two reasons why China might be con-
(about 0.5 percent), then China’s outflows cerned about its future ability to secure com-
would almost double to $75 billion. modities. First, while these commodities do
trade in international markets, their supply is
Outward FDI can generate important bene heavily influenced by government decisions:
fits for Chinese firms and the country’s devel oil prices depend greatly on Organization
opment. Outward FDI can play an important of Petroleum Exporting Countries (OPEC)
role in exploiting global business opportuni- production, while several important metals
ties. China’s rapid increase in incomes means are located in a few, relatively unstable coun-
that firms may need to relocate to lower- tries, where the governments could poten-
wage locations to employ their expertise and tially affect supply, at least in the short term.
technology. Trade barriers may increase the China’s political influence and investments
profitability of locating production in host- in oil and metals could encourage supportive
country markets (see above). China’s multi- government policies in supplying countries.
nationals can become an important source Second, China accounts for a significant
of technology, brand names, distribution share of global consumption of some com-
networks, market contacts, and skilled work- modities (for example, in 2008, China’s con-
ers for domestic firms. China’s large stock of sumption of oil and net imports of oil equaled
388 CHINA 2030
almost 9 percent and 4.5 percent, respec- compared with total investment in most host
tively, of global oil consumption, according countries.
to the U.S. Energy Information Administra- Other issues are probably more impor-
tion). Concerns over continued increases in tant. Chinese firms’ lack of experience means
Chinese consumption coupled with increas- that they may lack the political networks and
ing investments in natural resources could knowledge of host-country culture necessary
lead other countries to try to safeguard their to avoid mistakes in public relations, brand-
own access to these resources. China’s share ing, and management. Chinese companies
of FDI in global natural resources has dou- have made mistakes that have engendered
bled over the past seven years but remains opposition. Many observers have expressed
below 15 percent. concern over the environmental impact of
Not that foreign investment is an unal- investments by Chinese firms. Governments
loyed benefit. The rapid increase in foreign or political interests who view China as a
investments by a relative newcomer to inter- long-term threat to other countries’ security
national investment can engender mistakes. interests may not welcome investment by
Witness the huge losses suffered by Japanese Chinese firms. The government’s support for
investors in U.S. real estate and other sec- outward investment, including subsidies for
tors in the 1980s.14 There is also some con- investments in natural resources, tax breaks,
cern that government influence over the large and low-interest financing from state-owned
state-owned enterprises (SOEs) may encour- banks (Luo, Xue, and Han 2010), has raised
age unprofitable, but politically important, resentment over competitive practices that
foreign takeovers and that limits on interest undermine domestic investors, although
rates reduce resources allocated to project some of these practices are hardly unique to
evaluation and increase incentives to lend to China.
public sector firms, thus reducing the effi- Perhaps most important, the prominent
ciency of FDI projects (Morck, Yeung, and role played by SOEs rather than private firms
Zhao 2008). may engender suspicion in host countries
about potential strategic behavior by Chinese
Chinese outward FDI has encountered investors. More than two-thirds of FDI out-
obstacles. China’s investment outflows have flows were from centrally controlled SOEs in
already stirred concern among some com- 2009, and a portion of the remainder came
mentators in host countries, and efforts by from firms partially owned or controlled by
Chinese firms to purchase foreign companies the state or by provincial or municipal gov-
and to operate in foreign countries have in ernments (Salidjanova 2011). The important
some cases met with political opposition. For role played by SOEs in China’s foreign invest-
example, the state-owned China National ment is not surprising—most of the large
Offshore Oil Corporation withdrew its bid for Chinese companies that have the resources
Union Oil Company of California (Unocal) in and expertise to invest abroad are owned by
the face of political opposition in the United the state. Only 2 of the 43 Chinese companies
States. And a 2008 deal to double Aluminium in the Fortune 500 list of the largest global
Corporation of China’s (Chinalco) stake in firms are privately owned.15 This legacy of
Rio Tinto, an Anglo-Australian iron ore pro- central planning notwithstanding, the gov-
ducer, was scrapped in the face of opposition ernment should ensure that private firms are
from Australian lawmakers (Xu 2009). The given the same opportunity to invest abroad
reasons for opposition to Chinese investments and should avoid burdensome approval pro-
are varied but do not (or, at least, should not) cesses that might inhibit such investment.
reflect fears of Chinese domination of the The main reason for encouraging outward
global economy. Despite its rapid growth, investment is to enable Chinese multination-
China’s outward FDI remains a small share als to absorb foreign technology and use it to
of total FDI flows and a minuscule amount improve domestic production. Since private
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 389
firms are typically more successful in adopt- to its foreign investors. Indeed, the failure to
ing new technology than government-owned participate in today’s proliferation of invest-
firms, it is important to ensure that private ment agreements could be taken as a symbol
firms participate in foreign investment. of government indifference.
Nevertheless, BITs cannot address many of
The government can help improve the legal the obstacles to China’s outward investment.
framework for outward investment. Given Even the U.S. BITs, which embody the most
the potential benefits of outward FDI and stringent investment protections, include an
the political obstacles and tensions that some exception for national security concerns (Cai
Chinese investments have engendered, the 2009), and such concerns were cited in the
government has an interest in demonstrating most prominent examples of barriers to Chi-
support for Chinese investors, to ensure that nese FDI. Thus, while useful, BITs cannot in
they are treated equally with other investors and of themselves resolve most of the barriers
and to provide adequate recourse in case of to investment described above.
disputes. This issue is set to intensify in com-
ing years, because Chinese outward invest- Should China enter into more liberal invest
ment will no doubt continue to expand as ment treaties? The most liberal investment
China becomes richer and its firms more treaties, as exemplified in treaties promoted
exposed to international competition. by the United States, include commitments to
Chinese policy has focused on interna- eliminate any existing discriminatory prac-
tional treaties to protect foreign investors. tices and to treat foreign investors equally
Since the early 1980s, China has signed with domestic investors in all respects, includ-
127 bilateral investment treaties (through ing giving foreigners the right to invest in the
May 2010) and 112 double taxation treaties country if they meet the criteria (if any) that
(through May 2009) (Davies 2010). Since are imposed on domestic investors (referred to
2000, China’s bilateral investment treaties as pre-entry national treatment).16
(BITs), mostly concluded with developing Securing pre-entry national treatment for
countries that are the main destinations for Chinese overseas investment could be ben-
Chinese FDI, have expanded protections eficial. In the absence of such protection,
for investors. These include commitments Chinese firms could be at a competitive dis-
by host countries to treat foreign investors, advantage in some markets. That is, Chinese
once established in the country, equally with firms could potentially be subject to time-
domestic investors, and to provide investors consuming processes that firms from coun-
with virtually unrestricted access to inter- tries with treaties guaranteeing pre-entry
national tribunals (such as the World Bank’s national treatment could avoid. Firms that
International Centre for the Settlement of are seeking a foreign purchaser may choose
Investment Disputes), when they believe that investors who are not subject to such delays.17
host-government policy violates these com- To the extent that BITs with strong investor
mitments (Berger 2008a). The latest Chinese protections proliferate over time, this con-
BITs do allow for the continuation of existing straint could become important.18
provisions that discriminate against existing A distinction should be made between BITs
foreign investors, subject to a “best effort” with developing countries that are not major
commitment to roll back such measures over sources of FDI flows and treaties with the
time. advanced countries. Explicit investment guar-
Bilateral investment treaties can provide antees and access to international tribunals
important support to overseas investors by are not so critical in the advanced countries,
cementing political relationships, offering where legal redress through relatively fair
some leverage to foreign investors where judicial procedures is available. By contrast,
political concerns are not paramount, and securing protection for Chinese investors in
demonstrating the government’s commitment the more uncertain policy environments in
390 CHINA 2030
developing countries may be more important Thus, if China decides to pursue a multilat-
in supporting outward FDI.19 eral approach to investor protections, it is
important that it play an active role in shap-
Bilateral investment treaties or a multi ing the agreement. Allowing the advanced
lateral agreement on investment? Assuming countries to negotiate such an agreement
that the government decides to strengthen the among themselves and then deciding whether
legal protection for Chinese outward FDI, it to accept it, is unlikely to serve Chinese inter-
then confronts the question of how to do so. ests. Instead, the Chinese government needs
One choice would be to enter into bilateral to act to help define the specific terms of
investment treaties that provide strong inves- such an agreement, to ensure that the level of
tor protections. Another would be to press for investment protection is suitable and that the
a multilateral agreement on investment that particular circumstances of developing coun-
includes most countries. tries are recognized.
A global agreement would have advan-
tages. The existence of multiple BITs can Guaranteeing national treatment to foreign
increase transactions costs for firms, which investors has important implications for
face different investment rules depending on domestic policy. Securing pre-entry national
the host country (although the importance treatment for Chinese investors would require
of these costs is disputed). 20 A multilateral providing the same protection for foreign
investment agreement could provide more investors in China. The large share of pro-
certainty to investor protections than a BIT, duction accounted for by state enterprises and
by increasing the costs to host countries of government subsidies for productive activities
violating the agreement. Thus, a multilat- complicates efforts to credibly ensure a level
eral agreement could play a more important playing field for domestic and foreign inves-
role in encouraging FDI than multiple BITs tors. Increasing state enterprises’ autonomy
(studies provide mixed evidence about the and phasing out subsidies that explicitly favor
extent to which stronger investment protec- domestic firms (as opposed to demand-side
tion secured through BITs encourages greater subsidies that do not discriminate between
foreign investment).21 By joining hands with foreign and locally owned firms) could pro-
other developing countries, China may be vide more credibility to policies guaranteeing
able to achieve a more development-friendly national treatment and thus help secure such
multilateral framework for investment than rights for Chinese investors in other markets.
it could through individual BIT negotia- Providing pre-entry national treatment
tions.22 A multilateral investment framework would also imply reducing restrictions on FDI
could also curb the power of multinational inflows. While China has progressively sim-
companies to implement restrictive business plified approval procedures for foreign invest-
practices such as transfer pricing to evade ment, local or central government review is
taxation, restrictions on the ability of subsid- still required for many investments.23 Invest-
iaries to trade with some domestic firms, and ment can be encouraged, restricted, or pro-
restrictions on the licensing of technology by hibited depending on the sector, the level
subsidiaries (Xiao 2010; Crystal 2009). of technology, and (formerly) the extent of
On the other hand, pursuing multiple BITs exports. Elimination of at least some of these
would provide China more leverage over spe- restrictions would significantly expand the
cific terms. Thus, for example, a BIT might sectors open to foreign investment.
specify the sectors in which national treat- It is difficult to argue that such dramatic
ment would be provided, while such sectoral changes in development policy should be
restrictions (apart from general provisions undertaken simply to achieve reciprocity for
such as national security or health and safety Chinese investments overseas. As it happens,
exceptions) would be more complicated to however, the domestic reforms that could
negotiate through a multilateral framework. help achieve stronger legal protection for
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 391
Chinese overseas investments are also likely the importance of which will rise as China
to further Chinese development. Increasing strives to become a high-income economy.
the autonomy of state enterprises and reduc- Encouraging FDI inflows can be particu-
ing the role of subsidies would be consis- larly useful in improving the efficiency of
tent with efforts to improve the efficiency of service sectors that are less affected by com-
SOEs.24 petition through trade (box 5.2). Also, as
Rationalizing the system of approvals and China becomes a richer and more globally
restrictions for inward FDI could reduce the integrated economy, the usefulness of gov-
costs confronting foreign investors, by pro- ernment review of foreign investment will
viding greater assurance that they would be decline. The economy will become much
able to invest without excessive delays and to more complicated, making it more difficult
operate without undue interference. In par- to control investments and to understand all
ticular, reducing restrictions on service sector of the ramifications of guiding investment
FDI would promote service sector efficiency, in the way practiced when the economy was
FDI can have a positive impact on the services sector Foreign direct investment can have a positive impact
and thus more broadly on the overall economy (sev- on infrastructure. A study covering 85 developing
eral studies show that FDI in services can improve countries from 1985 to 1999 found that telecommu-
productivity in manufacturing through vertical link- nications services improved after foreign entry (Fink,
ages—see, for example, Arnold and others 2007). Mattoo, and Rathindran 2002). In countries with
Many developing countries have limited FDI in ser- strong regulatory systems, FDI has led to improved
vices, in part because they lack an adequate regu- telecom services and contributed to higher economic
latory framework to oversee a more competitive growth (Norton 1992; Roller and Waverman 2001).
sector. But inefficient services sectors can be a severe FDI improved the reliability of electricity and tele-
constraint on development, so opening services to communications services provision in Latin America
FDI can be important to future growth as incomes (World Bank 2004). The positive impact of FDI in
rise and the resources available to regulate the sector infrastructure, however, requires a regulatory envi-
increase. ronment that encourages competition. In Argentina,
Foreign direct investment that results in increased Mexico, and Républica Bolivariana de Venezuela, tele-
competition can encourage lower prices and com enterprises were transformed from loss-making,
improvements in quality, expand the set of available subsidized entities into tax-paying firms, but part of
producer services, and improve the productivity of their profitability arose from monopoly positions and
domestic firms through knowledge spillovers. For captive regulators. In Argentina, the privatization of
example, cutting-edge retail practices (central ware- Entel did not result in lower service prices (UNCTAD
housing, appointment system, use of pallets) intro- 2004), and in Brazil, greater efficiency was accompa-
duced in Mexico by Walmart were quickly adopted nied by higher prices (Anuatti-Neto and others 2003).
by other retail chains (Javorick, Keller, and Tybout Both cross-country and case studies find that FDI
2006; McKinsey 2003). Similarly, with the opening can strengthen the banking sector. 25 Again, however,
of Korea’s retail market, competition from Walmart the regulatory environment is critical. Studies find
and Carrefour encouraged domestic firms to lower that foreign bank participation improved efficiency
prices and expand consumer choice, while enabling and competition in Colombia (Barajas, Steiner, and
them to absorb advanced technology that increased Salazar 2000) and Argentina (Cull and others 1999).
the productivity of distribution networks. While But studies of Mexico (Haber and Musacchio 2005;
smaller businesses were driven out of the market, the Schulz 2006) argue that high concentration in the
larger Korean retail stores flourished and bought out sector before and after foreign entry meant there
Walmart and Carrefour within 10 years. was no improvement in efficiency.
392 CHINA 2030
simpler. And, establishing an open capital eventually to full convertibility. These poli-
account (see below) will complicate the issues cies also would support the rebalancing of
involved in imposing restrictions on foreign growth toward greater domestic demand
investment (for example, by making it sim- and greater production of nontraded goods
pler to invest through local intermediaries). and services; this rebalancing is required for
Thus, with Chinese development, the use- China to become a high-income economy.
fulness of investment restrictions will decline, In the long run, when the economy becomes
while the potential benefits of stronger invest- even more integrated in the global economy,
ment protections in foreign markets will rise. the internationalization of the renminbi will
In short, China does have an interest in con- provide more stability than the current sys-
tinuing to ease restrictions on inward FDI tem of a managed exchange rate. The transi-
and to undertake commitments to strong tion to a more financially integrated economy
investor protection in international agree- involves risks, however. Careful attention
ments. A transition period is likely necessary must be paid to the timing and sequencing of
to ensure that government agencies have the policies and to the building of strong institu-
ability to regulate foreign investment effec- tions to manage the financial system.
tively without extensive approval procedures.
Also, in some sectors, domestic investors may Exchange rate stability and capital controls
need time to be able to compete with foreign have supported stability in China. China
investors who enjoy national treatment. Lim- has achieved remarkable growth by opening
ited exceptions to national treatment could be to the world economy. But at the same time, its
incorporated into investment agreements that global relationships have on occasion created
generally provide for an open regime toward significant challenges for domestic economic
FDI. It is important, however, that such stability. Most of China’s foreign investments
restrictions have sunset clauses to ensure that and a significant share of external trade trans-
eventually the protected sectors can enjoy the actions are perforce largely denominated in
benefits of increased investment. Overall, in dollars, so that changes in the dollar/renminbi
a decade or so, developmental interests likely exchange rate have enormous implications for
will be better served by the replacement of the profitability and balance sheets of domes-
the current regime for regulating inward FDI tic firms, and for the prices faced by consum-
with international agreements that will also ers. A stable (albeit not fixed) exchange rate
achieve strong protection for Chinese firms with the dollar has helped to limit domestic
investing abroad. economic instability.
China’s official exchange rate depreciated
sharply in 1994 with the unification of the
Deeper Integration into the Global
formerly dual exchange rate system.26 There-
Financial System
after, the government essentially fixed the
China’s tightly managed exchange rate and renminbi/dollar rate until July 2005 when the
extensive capital controls have been linchpins managed floating exchange rate regime was
of China’s economic policies. These policies adopted, after which the renminbi gradually
have helped support spectacular export-led appreciated. By October 2011, the real effec-
growth and supported financial stability. tive exchange rate had appreciated 66 percent
This policy mix has also played an important compared with that of January 1994, and
role in insulating the economy from global 31 percent compared with that of January
financial crises. Continued economic and 2005.27
financial stability requires the gradual adop- At the same time, the managed exchange
tion of an alternative policy mix, however, rate policy has required maintaining a closed
one involving greater exchange rate flexibil- capital account, so that the domestic mon-
ity, modernization of the financial system, etary policies could be more independent
and liberalization of capital controls leading and effective; with limited exchange rate
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 393
flexibility and an open capital account, the TABLE 5.4 China’s exchange rate was relatively
government would lose the ability to use stable during the East Asian crisis
Percentage change in exchange rate, 1997–98
monetary policy to influence domestic infla-
tion and economic activity. 28 This strategy Real Normal
exchange rate exchange rate
has enabled China to achieve rapid growth
and maintain a highly competitive exchange China –5.0 –0.1
rate to support exports. Korea, Rep. 32.0 47.3
Malaysia 25.3 39.5
Philippines 19.4 38.8
Nevertheless, the tightly managed exchange Thailand 19.0 31.9
rate is now posing more difficult challenges
Source: World Bank.
for macroeconomic policy. First, while tight
management of the renminbi’s exchange rate
does help stabilize the nominal value of a large (to the extent that capital controls are not
portion of China’s overseas investments and 100 percent effective) that will further boost
trade, it occasionally has engendered sharp domestic liquidity. Thus, the government has
swings in China’s competitive position with had to rely on administrative controls (such
third countries. 29 The most dramatic example as guidance to banks to reduce lending and
occurred when countries hit by the East Asian direct controls of prices) to restrain infla-
crisis in the late 1990s depreciated sharply tion. For example, the government was ini-
against the dollar, while the renminbi/dollar tially reluctant to raise interest rates to cope
exchange rate remained stable (table 5.4). The with the overheating economy in 2004, lead-
real exchange rate of Korea, Malaysia, the ing to a plunge in the real rate of interest to
Philippines, and Thailand fell by an average of corporate borrowers, which contributed to
24 percent, while China’s real exchange rate excess demand (Goldstein and Lardy 2006).
appreciated slightly. The collapse of demand Instead, the government imposed administra-
in the crisis-hit countries further reduced tive controls (which are inconsistent with the
China’s exports, with the U.S. dollar value of long-term goal of increasing the autonomy of
China’s merchandise export growth falling state enterprises) to reduce commitments to
from 20.9 percent in 1997 to 0.5 percent in large-scale projects (Gallagher 2005). While
1998. The stability of the renminbi has been these efforts were ultimately successful in
credited, however, as a significant factor in bringing inflation down, they introduced dis-
reestablishing regional growth and shorten- tortions that have hampered efficiency and
ing the effects of the crisis, while doing little undermined the credibility of government
damage to China’s medium-term growth. policy.
Second, the managed exchange rate policy Currently, very low interest rates in the
impairs the government’s ability to control United States and other advanced countries
inflation. Inflationary pressures are strong are contributing to another episode where
to the extent that in China, as in other rap- inflation is rising above government targets.
idly growing developing countries, the prices Thus, under the dollar-dominated interna-
of nontraded goods have a natural tendency tional monetary system, the tightly man-
to rise relative to traded goods (that is, for aged exchange rate has, to a considerable
the currency to appreciate in real terms). 30 degrees made China’s monetary policy hos-
If the prices of nontraded goods cannot rise tage to decisions by the U.S. Federal Reserve,
through an appreciation of the nominal the European Central Bank, and other cen-
exchange rate, then they will tend to rise tral banks in advanced economies. While
through inflation. It is difficult for the gov- exchange rate volatility can also be unde-
ernment to control inflation by increasing sirable, in current circumstances, less resis-
interest rates sufficiently in response to exces- tance to upward pressures on the exchange
sive demand growth, in part because rising rate (if accompanied by appropriate mon-
interest rates will attract some capital inflows etary and fiscal policies) would help dampen
394 CHINA 2030
Japan’s adoption of a floating exchange rate pro- existing rate, the Japanese government allowed the
vides useful lessons for China’s policies. Japan in yen to fluctuate (and appreciate) with only limited
the 1970s had several similarities with China today: intervention.
a fixed exchange rate (360 yen to the dollar from T he adoption of a f loating exchange rate
shortly after World War II until 1971), capital con- strengthened monetary autonomy and helped Japan
trols, limits on interest rates that helped finance cope with the significant economic turbulence of
industrial investments, an underdeveloped financial the 1970s. The floating exchange rate in the con-
system, a history of rapid growth propelled by rap- text of a steady decline in monetary growth led to
idly increasing exports, a large trade surplus, and a sharp fall in inflation (after the oil price shock),
tensions with trading partners over rapid market which averaged 4 percent in 1978–79 when inflation
penetration. Japan faced similar challenges in main- in the United States was about 10 percent. And the
taining stability with a fixed exchange rate, relying variability of both prices and output was consider-
on various administrative controls to contain infla- ably lower than under the fixed rate regime (Meltzer
tionary pressures. Rising inflation (which peaked 1986). Lower inflation was accompanied by aver-
at 7.7 percent in 1970) and complaints from trade age GDP growth of 4 percent from 1974 to 1982, a
partners over the low valuation of the yen increased comedown from pre-1970 growth rates but signifi-
pressures for a change in parity. Events came to a cantly higher than Japan’s advanced-country trad-
head with the breakdown of the Bretton Woods sys- ing partners (the period includes the severe global
tem, and after some initial attempts to support the recession).
inflationary pressures, similar to the experi- because any attempt to shift a large portion
ence of Japan during the 1970s (box 5.3). of reserves out of U.S. Treasuries could pre-
Third, maintaining the managed exchange cipitate a sharp depreciation of the dollar,
rate policy in the face of the booming trade thus severely reducing the real value of the
surplus has contributed to a huge buildup remaining stock of reserves, and could also
of foreign exchange reserves. Reserves rose be highly destabilizing to the global economy.
to almost $2.9 trillion in 2010 and were Fourth, while allowing greater flexibility
projected to reach almost $3.5 trillion by of the exchange rate may not immediately
the end of 2011, representing about 200 reduce the trade surplus by a substantial
percent of annual imports. The buildup of amount, over time, movement to an equi-
foreign reserves, largely held in U.S. gov- librium exchange rate will act to stimulate
ernment and agency paper, has saddled domestic absorption, reduce the current
China with assets that earn very low rates account surplus, and stimulate greater invest-
of return and, given the continued deteriora- ment in nontraded goods and services. Such
tion in the U.S. fiscal position and the Euro a readjustment would contribute to raising
Area debt crisis, have also become increas- standards of living in China, increasing mac-
ingly risky. Reportedly, the authorities are roeconomic stability; it would also contribute
making efforts to diversify reserve holdings to reducing global imbalances.
away from dollar-denominated assets toward
higher-yielding investments through various A different policy mix will be required to
sovereign wealth funds, including the China maintain stability as China’s development
Investment Corporation.31 China is also tak- continues. A tightly managed exchange rate
ing a lead in moving forward international regime with the rate deviating from equi-
discussions to encourage alternatives to the librium levels and a largely closed capital
dollar as a reserve currency. Such diversifica- account are unlikely to continue to contribute
tion is a slow process, however, particularly to stability over the medium term. The dollar
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 395
has been subject to considerable instability Increasing the use of the renminbi in interna
vis-à-vis other major currencies, which may tional transactions could support economic
become critical if it is no longer a reliable stability. Thus, continued development will
store of value owing to U.S. fiscal misman- require greater monetary independence,
agement. The renminbi’s close relationship to exchange rate flexibility, and a modern, more
the dollar, and the large amount of foreign open, financial system. Increased use of the
reserves dominated by the dollar, would thus renminbi in international transactions could
not be conducive to the future development make an important contribution if a signifi-
of China’s international economic activities. cant share of foreign assets were denominated
Also, over time, capital controls are likely in renminbi, and if Chinese firms that oper-
to become increasingly less effective, as the ate abroad could borrow in renminbi, then
sophistication of China’s financial system exchange rate fluctuations would have less
develops, as Chinese firms increase their over- impact on economic and financial stability.
seas operations, and as international financial From the perspective of individual firms, use
players become more adept at circumventing of the renminbi in external activities (such as
controls. To the extent that capital controls trade) would allow diversification in the sense
become more porous, an inflexible exchange of reducing exposure to risks specific to the
rate regime will make it increasingly difficult Chinese economy without increasing foreign
for the central bank to undertake an inde- exchange risk. From the perspective of the
pendent monetary policy, and the economy country, the danger of capital outflows during
would become increasingly vulnerable to the crises is smaller if the renminbi is recognized
global economic cycle. as an international currency.
Gradually liberalizing capital controls Achieving greater use of the renminbi in
would enhance China’s ability to achieve international transactions would have other,
high-income status. Capital controls inhibit perhaps less important, benefits. To the
the development of the financial sector, thus extent that nonresidents are willing to hold
reducing the scope of domestic investment by the currency, the government would enjoy
firms, limiting asset diversification opportu- seigniorage revenues.32 The government and
nities for Chinese households, restricting the firms could face lower interest rates on their
provision of sophisticated financial services debt if foreigners increased their demand for
required by complex modern economies, and renminbi-denominated assets. Chinese trav-
impairing the ability of the financial system eling abroad would be able to use renminbi to
to allocate resources to the most productive purchase domestic currencies with relatively
activities. In the past, the government’s domi- low transactions costs if currency traders had
nation of the financial system and the chan- access to well-established markets for trading
neling of resources to large industrial projects in the Chinese currency.
and exports have supported development by Having the rest of the world use one’s cur-
overcoming impediments to the coordination rency does have some downsides. If some
of economic activities, reaping economies of regional trading partners choose to peg their
scale, and increasing confidence. However, exchange rates to the renminbi, future Chi-
China’s future development will require a nese authorities could face some economic
more efficient services sector and more diver- and political challenges in pursuing purely
sified manufactured production to serve national objectives when conducting mon-
domestic demand. A market-based finan- etary and exchange policy. The increased
cial sector is essential to support these new demand for renminbi assets associated with
requirements as China’s economy becomes external use of the currency likely would
more complex and incomes continue to result in a more appreciated exchange rate
increase. The gradual removal of capital con- than otherwise, potentially reducing the
trols will be required to support an efficient attractiveness of China’s exports. Chinese
and well-regulated financial sector. monetary policy would become a greater
396 CHINA 2030
focus of attention if foreigners hold signifi- to the credibility of stabilization policies, the
cant renminbi assets (witness the consider- inability to understand how monetary policy
able reaction to the U.S. Federal Reserve’s decisions are made makes it difficult for mar-
quantitative easing, as opposed to little inter- ket participants to anticipate changes. An
est in similar policies followed by the Bank international ranking finds that the transpar-
of England), while foreigners’ demand for ency of China’s central bank improved sub-
renminbi could increase the instability of stantially in the early part of the last decade
money demand, potentially complicating but remained below that in most middle-
monetary policy. Counterfeiting of the ren- income countries (Dincer and Eichengreen
minbi could become an issue, as it has for the 2006). Thus, further moves to improve the
dollar. But these issues are manageable and independence of the central bank and to
would not greatly reduce the significant ben- increase the transparency of monetary policy
efits involved from the renminbi becoming an decision making would be essential to sup-
international currency. port greater international acceptance of the
renminbi.
What is required for the renminbi to become But perhaps the greatest challenge that
a more widely used international cur China faces in expanding the cross-border
rency? For a currency to be accepted in use of the renminbi is its underdeveloped
international transactions by other countries financial system. China lacks the diversified
and held as assets by foreigners, the country’s financial instruments and the secondary mar-
shares in international trade and financial kets that would enable investors to quickly
transactions have to be significant. Inflation and cheaply convert their renminbi assets into
and inflation expectations need to be low, so cash, even if capital controls were removed.
that the currency is a reliable store of value. Low efficiency, high transaction costs, and
Nonresidents should have confidence in the weak supervision and regulation are major
independence and competence of monetary limitations on financial sector development
authorities. Domestic capital markets need to (Wu, Pan, and Wang 2010). Administered
be deep and liquid (so that investors can buy interest rates and the lack of transparency in
and sell large volumes of securities without the regulation of banks and financial markets
greatly affecting the market price) and include inhibit market competition and the develop-
a broad range of financial instruments with ment of advanced financial products (Dobson
different risk-return characteristics. and Masson 2009). For example, interest rate
China currently meets only some of these controls allow the large SOEs to fund their
necessary conditions. The country is now activities with retained earnings and cheap
the second-largest trading economy. The sce- credit, which has meant little issuance of cor-
narios presented earlier indicate that China’s porate debt and asset-backed securities and
share of world trade is likely to increase by a relatively illiquid market. Financial market
two-thirds over the coming 20 years, and infrastructure is improving but remains chal-
its share of global output will nearly double, lenged: bankruptcy procedures are not widely
making China the world’s largest economy. understood, modern accounting standards
Officially recorded inflation is currently just are not applied uniformly, and issues often
above 5 percent, somewhat above the govern- lack transparency (Zhou 2005). Restrictions
ment’s target, as a result of expansionary pol- on the kinds of foreign institutions allowed
icies during the financial crisis. But inflation to acquire domestic securities, on the size of
was relatively low (about 2 percent, albeit investments, and on the pace of repatriation
somewhat unstable) over the past decade. (necessary to ensure that capital controls are
In most respects, however, the renminbi is not evaded) severely limit foreigners’ ability
not yet a suitable international reserve cur- to participate in the market.
rency. While the Chinese authorities’ concern Strengthening of financial regulation and
over inflationary pressures has contributed supervision is essential to ensure stability in
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 397
the context of a more liberalized financial market (Makin 2010), and some foreign
environment. Considerable progress has been participation in the banking system is under
made in strengthening the capital adequacy way, although foreign banks’ share of finan-
of the banking system, although the implica- cial assets remains below 2 percent, and their
tions of the recent sharp increase in lending activities are restricted.33 The government is
are as yet not fully clear. Improved coordina- developing an offshore market in renminbi
tion among the various institutions involved in Hong Kong SAR, China, including pro-
in financial regulation will be important. vision for renminbi balances to be held by
Further progress also will be necessary to foreigners, the development of instruments
ensure that state-owned banks operate on for hedging currency risk, and the issuance
market principles, rather than being respon- of renminbi-denominated government bonds
sive to political decisions. At the same time, (Huang 2010). The goal, according to Subac-
the regulation and supervision of nonbank chi (2010), is to develop an offshore market
financial institutions involved in these mar- while maintaining capital account restric-
kets will be essential, particularly because, tions, reminiscent of the development of the
in the absence of such improvements, restric- offshore Eurodollar market when the United
tions on the banking sector will be reflected States had controls on capital outflows dur-
in the transfer of funds to nonbanks. The reg- ing the 1960s and 1970s (He and McCauley
ulation of nonbank financial institutions is 2010). Some Chinese companies have issued
probably the most difficult challenge the gov- renminbi-denominated bonds in Hong Kong
ernment will face in establishing a market- SAR, China, but the size of the available
based financial system. It will be necessary to renminbi-denominated assets is still small,
encourage the growth of alternative instru- resulting in the bulk of the trade settlements
ments and sources of funds, while ensuring held in deposits in the Hong Kong SAR,
the soundness of all institutions that borrow China, clearing bank. Since October 2010,
short and lend long (and are thus potentially China has allowed three types of foreign
subject to sudden failure). Industrial coun- institutions, including foreign central banks
tries spectacularly failed to achieve adequate or monetary authorities—renminbi clearing
regulation of nonbank financial institutions banks in Hong Kong SAR and Macao SAR,
during the recent boom, with dismal results. China, and foreign banks participating in
cross-border renminbi trade settlements—to
The government is taking steps to increase invest in domestic Chinese interbank bond
financial integration with the rest of the markets using renminbi.
world. Government policies are increasing So far, these policies have played little role
the use of renminbi in trade and financial in encouraging a broader role for the cur-
transactions. On the trade side, settlement in rency. Overall, the renminbi remains little
renminbi is growing rapidly, accounting for used internationally, accounting for one side
around 7 percent of total trade in April 2011, of only 0.9 percent of foreign exchange trades
up from almost nothing at the beginning of (BIS 2010). An expanded offshore market
2010 (IMF 2011). The pattern of settlement in and expanded trade invoicing will encour-
renminbi, however, is very unbalanced, with age some greater international use of the ren-
almost 90 percent of the settlements on the minbi. However, even a flourishing offshore
import side. market is unlikely to encourage widespread
The government is also undertaking cau- adoption of renminbi-denominated assets
tious steps toward allowing foreigners to when the domestic capital markets remain
participate in capital account transactions small and illiquid.
denominated in renminbi. A few qualified
investors, including international devel- A program to deepen China’s financial inte
opment institutions in China, have been gration with the global financial system will
allowed to issue bonds in China’s domestic require careful planning. Deepening China’s
398 CHINA 2030
financial integration with the global financial controls in the context of a widespread expec-
system will require more aggressive measures tation of an appreciation of the exchange
to modernize and regulate its financial sys- rate would encourage huge capital inflows.
tem and to open it more to foreign competi- Establishing a market-based exchange rate,
tion, increased exchange rate flexibility, and while not eliminating the potential for insta-
gradual removal of capital controls. But these bility from capital inflows, would at least
policy changes, particularly the transition reduce one reason for it. Moreover, providing
to an open capital account and removal of for exchange rate flexibility would improve
domestic financial sector controls, entail sig- the authorities’ ability to control inflation-
nificant risks. Many countries in Latin Amer- ary pressures through monetary policy and
ica, Eastern Europe, and East Asia that have reduce the pace of the buildup of foreign
eliminated capital controls have suffered dra- reserves. At the same time, the government
matic financial crises accompanied by calami- should proceed with steps to increase the
tous declines in output and large increases independence of the central bank, improve
in poverty. These crises have typically been the transparency of monetary policy, and
driven by large financial sector weaknesses strengthen financial sector regulation.
and imbalances, coupled with failures to Even before the exchange rate reaches an
manage increases in aggregate demand from equilibrium level, parallel efforts should be
unrestrained capital inflows, real exchange undertaken to improve the methods for con-
rate appreciation (often reflected in real estate ducting monetary policy as well as financial
booms), and an eventual withdrawal of capital market regulation and supervision. As prog-
and a major collapse in asset prices. The Euro- ress is made on these fronts, the government
pean experience with financial sector and cap- can proceed with financial liberalization.
ital account liberalization was more positive, Deposit interest rates would be raised toward
and holds some lessons for China (box 5.4). market levels, perhaps in stages to gauge the
impact on bank balance sheets. Experience
To minimize stability risks, the reform agenda shows that the removal of deposit rates can
must be carefully timed and sequenced. China lead to excessive credit expansion, so it will
can limit the instability often experienced dur- be necessary to ensure that monetary condi-
ing financial sector liberalization and capital tions are sufficiently tight to maintain sta-
account opening through a gradual approach bility (Feyzioğlu, Porter, and Takáts 2009).
that involves careful attention to the appropri- Controls on lending rates can also be gradu-
ate sequencing of policy changes. A detailed ally removed. Although the reforms required
blueprint for financial and capital account lib- for successful financial liberalization take
eralization is impossible to lay out because some time, there is some urgency in implement-
flexibility will be required to take into account ing them. Financial innovation and stronger
economic developments and the degree of suc- banking regulation are encouraging greater
cess of various reforms. It is nonetheless useful flows to nonbank institutions, potentially
to provide an overview of the steps that will be challenging the government’s ability to con-
required, along with some information on their trol inflation through administrative means
order. In particular, there are several prerequi- (IMF 2011). Improving the regulation of non-
sites for an opening of the capital account. bank financial institutions while establishing
The most important first step is to reform market-based interest rates is necessary to
the renminbi exchange rate mechanism in enable the government to manage macroeco-
the direction of a more market-determined, nomic policy successfully and ensure finan-
flexible regime. That will indicate the extent cial stability.
to which the currency is misaligned. Indeed, To set the stage for further capital account
an important goal of China’s capital controls liberalization, the government could increase
has been resisting pressures to appreciate the current initiatives to encourage the use of
renminbi (Yu 2009). Dismantling capital the renminbi in settling current account
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 399
BOX 5.4 Lessons of the European experiences with capital account liberalization
Today’s Europe of open financial markets and unre- improving macroeconomic stability reduced the need
stricted capital flows took a long time to estab- for controls to respond to foreign exchange crises.
lish. Many western European countries imposed The European countries’ approach to financial
extensive restrictions on their financial sectors for sector liberalization and opening the capital account
three to four decades following World War II, and varied. Most countries employed a gradual approach
exchange controls were not fully abolished by the to liberalization. For example, France began a pro-
European Union until 1990 (Wyplosz 1999). Capi- cess of liberalization in 1983 (after aborted attempts
tal account restrictions were often used to dampen in the 1960s) that involved financial sector deregu-
pressures for exchange rate changes, by restraining lation and a shift to indirect means of monetary
capital outflows that could force a depreciation and control while capital account restrictions were still
(at other times) limiting capital inflows that would in place. Once the macroeconomic situation was
otherwise tend toward appreciation and a decline favorable and the financial sector was viewed as able
in competitiveness. In addition, several European to withstand foreign competition, capital controls
countries used capital account restrictions to sustain were gradually withdrawn. The sequence of mea-
financial sector policies that maintained low inter- sures to ease controls began with direct investment
est rates (primarily to reduce the costs of financ- flows within the European Economic Community,
ing government deficits) and directed credit toward then FDI from others countries along with travel
favored borrowers. With interest rates artificially allowances, then restrictions on foreign exchange
low, quantitative ceilings were used to control credit. operations, then restrictions on bank lending to non-
Thus, controls on capital outflows were necessary residents and administrative controls on import and
to prevent asset holders from placing their wealth at export settlements (initially imposed to avoid the use
the higher interest rates available abroad, and con- of current account transactions to circumvent capi-
trols on inflows were sometimes required to avoid tal controls), then controls on foreign borrowing and
exchange rate appreciation as borrowers sought to holding of foreign currency accounts by domestic
circumvent credit constraints. In short, some Euro- enterprises, and finally restrictions on bank lending
pean countries’ financial sector controls, monetary in French francs to nonresidents. The full process of
policies, and capital account restrictions, along liberalization took six years.
with the challenges faced in the potential disinter- Some countries adopted a much more rapid
mediation of the banking system and growing cir- approach to capital account liberalization. The
cumvention of controls, resemble China’s current United Kingdom abolished all capital account
experience. restrictions in 1979 in conjunction with floating
Financial repression and capital account controls the exchange rate, the removal of credit controls,
gradually became less popular, for several reasons. and a tightening of fiscal and monetary policies.
The effectiveness of controls declined as financial These measures, undertaken when the country had
markets became more sophisticated. The growth of a strong balance of payments position owing to
derivative products significantly reduced the costs the rise in the oil price, were largely successful in
of, and increased the potential for, circumventing improving macroeconomic stability and establish-
controls, while funds increasingly flowed out of the ing a more efficient financial sector, although there
tightly regulated banks to other financial institu- were some transitional costs from higher exchange
tions. Controls also became increasingly costly in rate volatility and an asset price bubble at the end
terms of administrative procedures, efforts at eva- of the 1980s.
sion that introduced competitive distortions among Denmark, Finland, Norway, and Sweden also
firms, and the diversion of commercial and financial rapidly implemented capital account liberalization
activities to other countries. The process of Euro- and a deregulation of financial markets during the
pean integration provided an impetus for more 1980s, with asset price booms leading to banking
stable macroeconomic policies to maintain the fixed crises in Norway, Finland, and Sweden (in the first
exchange rate with low-inflation Germany, and two countries, also driven by lower oil prices and the
collapse in trade with the Soviet Union). In contrast, Nevertheless, the applicability of the European
improvements in banking supervision allowed Den- experience for China is limited because of the sub-
mark to escape significant financial sector difficul- stantial difference in levels of development and
ties despite loan losses. changes in the international financial system. West-
The European experience has some useful les- ern European countries had a long history of estab-
sons for China. First, in China’s situation, reform lished financial sector institutions and prudential
must cover a broad agenda, including the removal frameworks, which China is now developing. Euro-
of credit controls and restrictions on interest rates, pean countries also had much more extensive stock
the reliance of monetary policy on interest rates and and bond markets that could absorb large capital
open-market operations rather than quantitative con- inflows without putting at risk depositors’ money,
trols, a move to a more market-determined exchange and thus potentially inducing rescues of insolvent
rate, and the gradual opening of the capital account. institutions and the attendant moral hazard that can
However, none of these reforms will function effec- spur excessive lending. A stronger and more diversi-
tively without the others. Second, steps to ease finan- fied financial sector in Europe likely contributed to
cial sector restrictions and open the capital account the relatively mild impact of financial sector liberal-
should be undertaken when the country is in a strong ization in most countries, as compared, for example,
balance of payments position. This perspective with the severe crises experienced in East Asia and
argues for China initiating this process soon, when the Southern Cone of Latin America. Thus, the risks
the country’s huge current account surplus could facing China in embarking on this process, and the
cushion downside risks involved in unanticipated need for caution and experimentation, are likely
capital outflows, which is likely a more serious prob- greater than in the Europe of the 1980s.
lem than unanticipated inflows. Third, it is critical to China also faces a much more complex and
achieve adequate supervision of the financial sector sophisticated global financial environment than
before opening the capital account. While defining Europe did. The availability of standardized deriv-
“adequate” in this context is difficult, the potential ative instruments and a multiplicity of offshore
for asset price booms followed by collapses is high centers that lack controls on external transactions
when the banks are unaccustomed to dealing with should make it easier to circumvent controls today
the increased potential for both profits and risks in than in the 1980s. While China’s control regime
a newly liberalized financial sector. Fourth, financial remains effective, the more sophisticated interna-
sector reform and capital account liberalization must tional financial environment implies some greater
be supported by a stable macroeconomic environ- difficulty in opening the capital account gradually,
ment. Thus, the recent rise in inflation needs to be because initial steps to free some transactions (by
addressed before, or in conjunction with, taking any removing all controls on FDI, for example) could be
steps toward liberalization. Finally, some European exploited to effect more extensive capital account
countries removed controls and then reinstituted transactions. This possibility implies the necessity
them when their exchange rates came under pressure. to maintain some vigilance, perhaps in the form of
The reversal in policies made it more difficult for requiring the reporting of transactions, during the
market participants to anticipate government policy process of capital account liberalization so that large
and reduced long-term investment. anomalies can be checked.
transactions; it could also expand bilateral 2011). A further early measure would be to
currency swap arrangements to more trade abolish approval processes for inward and
partners. But as these initiatives progress, outward FDI flows, which tend to be more
achieving a more balanced settlement pat- stable and long term than portfolio flows.
tern will be difficult while the exchange Given China’s large current account surplus
rate remains significantly undervalued (IMF and large and growing official reserves, it
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 401
would make sense to consider lifting con- hard budget constraints, that is, those that
trols on outflows before lifting controls on become insolvent would have to be allowed
inflows. Programs to allow residents greater to go bankrupt, so that creditors would not be
access to external financial markets could tempted to lend in the expectation that their
reduce upward pressures on the exchange rate loans enjoyed an implicit government guaran-
and lessen official reserve accumulation. The tee. Similarly, some constraints will need to be
range of qualified investments by foreigners placed on borrowing by local governments,
could then be increased and restrictions on either through greater administrative control
foreign investment in the stock market gradu- from the center or statutory limits on local
ally eliminated. Cross-country experience government deficits. Another problem worth
strongly suggests that restrictions on short- noting is the double mismatch between cur-
term capital inflows be removed last. rency and maturity of borrowing and lend-
ing—borrowing short in foreign currency
Establishing the renminbi as an interna while lending long in local currency. This
tional currency will take time. The reforms double mismatch has been a major cause for
outlined above are necessary, but not suf- heightened exchange rate risk and debt crises
ficient, to ensure that the renminbi becomes in many developing countries, most notably in
a major international currency. More time, the Asian financial crisis of 1997.
perhaps many years, will be required to The implications of these policies go
develop sufficiently deep capital markets and beyond ensuring financial stability in govern-
to establish the reputation for stability that is ment and government-owned institutions.
required for foreigners to hold large amounts To the extent that prices are allowed to clear
of a country’s currency. The pace of interna- markets, reliance on influence and contacts
tional acceptance will be determined in part should become less important than innova-
by international conditions. To the extent tion and efficiency for economic success.
that alternative reserve currencies, notably That would be beneficial to the economy but
the dollar and the euro, are subject to insta- may also imply that some formerly successful
bility and mismanagement, reliance on the firms are no longer profitable, underlying the
renminbi would increase more rapidly. One importance of social insurance for providing
informed estimate places the earliest year health care and pensions. A more market-
that the renminbi would become a global based exchange rate would mean less reliance
currency beyond 2025 (Wu, Pan, and Wang on exports and a rebalancing of the economy
2010); another model-based simulation pre- from manufacturing to services. All of these
dicts the currency could account for up to changes would be beneficial in their own
12 percent of international reserves by 2035 right, in addition to being consistent with a
(Lee 2010); and one market analyst sees the greater international role for the renminbi.
renminbi likely to become one of the world’s They do, however, imply dramatic changes in
major reserve currencies sometime after 2030 the way that business is transacted in China.
(Jaeger 2010). Finally, China should not ignore the inter-
national implications of increasing the use of
The policies required to establish the ren the renminbi. As Barry Eichengreen (2010)
minbi as an international currency will have has emphasized, the emergence of the ren-
important implications for China and the minbi as an international currency would
world. The implications for China’s develop- provide a useful diversification away from the
ment model will be profound. State-owned dollar, helping to limit financing of the sort
banks would have to be allowed to act like pri- of excessive current account deficits pursued
vate banks and not be subject to instructions by the United States before the 2008 finan-
from the government to increase lending for cial crisis, and thus reducing the likelihood
macroeconomic reasons (Eichengreen 2010). of a repetition. China’s efforts to establish the
State-owned enterprises would have to face renminbi as an international currency would
402 CHINA 2030
support global economic stability, which, Should China rely on a multilateral consen-
given China’s size and openness, is an essen- sus to determine global policies, with specific
tial ingredient of stability in China. interventions to protect China’s interests, or
should China actively help shape global agree-
ments? This question is particularly difficult
Global Public Goods for environmental agreements, where it might
China’s future prosperity depends to a large be argued that, because the advanced coun-
extent on the preservation of global pub- tries are principally responsible for damages
lic goods—a wide variety of issues that are to the environment, and are richer and thus
important for many countries where market better able to forgo income for future benefits,
forces cannot be relied upon to achieve effi- they should shoulder the costs involved.
cient outcomes. In such cases, coordinated While the moral argument concerning
government policies are necessary to ensure advanced countries’ responsibility has reso-
the efficient provision of global public goods. nance, it remains in China’s interest to play
For example, the market cannot be relied an active role in shaping agreements on global
upon to limit environmental damage, either public goods. China’s huge size imposes on
the country both a responsibility to contrib-
domestically or cross-border, so issues such
ute to safeguarding public goods (else oth-
as climate change and threats to the ozone
ers will refuse to cooperate as well) and the
layer can be resolved only through interna-
opportunity to shape global agreements so
tional coordination. Similarly, preservation
that they support China’s development.
of global resources such as ocean fisheries,
Here we consider a few examples of global
seabed minerals, and the Antarctic requires
issues that cannot be resolved efficiently by
coordinated interventions by governments.
relying on the market, and where China
The benefits of communications networks
should actively participate in international
increase with the number of users, so interna-
solutions, for its own and the world’s benefit.
tional agreements and domestic regulations
Some of these issues will be critical to China’s
that promote efficient Internet use, for exam- development in coming years, while others,
ple, are in everyone’s interest. International though important, will have less impact. Our
trade and financial transactions require a purpose is to provide examples of common
framework of rules to promote cooperation; problems where China plays an important
reductions in import barriers and steps to role, not to enumerate all of the challenges in
ensure global financial stability often require preserving global public goods over the next
international discussion. Efforts to reduce decades.
global poverty, thus enhancing global sta-
bility, will be more effective if all countries
with sufficient resources are encouraged to Climate Change
participate. Indeed, the term “global public The global economy faces an enormous chal-
goods” is, to an extent, misleading: much lenge in reducing carbon emissions to avoid
of the work involves establishing effective the worst effects of climate change. Absent
institutions that take into account the global changes in policies to reduce emission inten-
impact of the provision of goods and services. sity, the increase in average global tempera-
While all of these issues touch on domestic tures over the next several decades could be
policies, they all also involve international calamitous, with a rise in the sea level that
coordination; thus, this section also consid- would inundate vast regions where millions
ers aspects of domestic regulations that have of people live as well as the degradation of
a significant international impact. agricultural land that millions of poor depend
While China has certainly cooperated in on for their livelihood. China will be severely
efforts to sustain global public goods, the gov- affected, both directly in some regions and
ernment faces an important policy question. indirectly as the global economy deteriorates.
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 403
150
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Here we discuss how global emissions could per capita GDP growth compared with high-
evolve over the next 20 years, the role China income countries, although the relationship
might play in multilateral efforts to reduce between growth in developing countries and
emissions, and the implications of different global emissions is complex.
agreements for China’s economy. While developing countries will be respon-
sible for the bulk of new emissions, their
Emissions are set to increase. Global annual emissions per capita are much lower than in
emissions are expected to increase around high-income countries (figure 5.13). While
50 percent over the next 20 years, largely developing countries’ per capita emissions
because of growth in GDP per capita and, are expected to rise somewhat, they will not
to a lesser extent, population growth. Emis- approach the levels in high-income countries.
sions per unit of GDP are expected to decline However, emissions per unit of GDP are rela-
slightly (figure 5.12). tively high in developing countries, and China
More than four-fifths of the rise in emis- is among the countries with the highest emis-
sions over the next 20 years will come from sion intensity in the world. A key reason for
developing countries. The large share of the high emission intensity in the developing
developing countries in the global increase world is the low valuation of nontradable
reflects higher population growth and higher products in those countries, which makes
404 CHINA 2030
FIGURE 5.13 Emissions per capita in developing countries are much lower than in advanced countries
United States
Russian Federation
Rest of high-income countries
Middle East and North Africa
EU-27 and EFTA
Rest of Europe and Central Asia
Japan
China
World
Rest of Latin America and the Caribbean
Rest of East Asia
Brazil
India
Sub-Saharan Africa
Rest of South Asia
0 1 2 3 4 5 6
GDP relatively small. Especially in China, in emissions, even in a baseline scenario that
another reason is the small share of services assumes a significant shift toward the service
and the large share of manufacturing. As a sectors in China. Effective global policies
consequence of the high emission intensity, are not feasible without China’s participa-
GDP growth in the developing world leads tion, both because limiting China’s emissions
to more than proportional growth in global is critical and because other countries are
emissions, even as the emission intensity is unlikely to participate in the absence of the
expected to decline sharply along with the largest source of carbon emissions.
shift to services and the rise in the relative It is in China’s interest to reduce carbon
price of nontradable products. emissions significantly; otherwise, China
would create an artificial comparative advan-
It is in China’s interest to actively pro tage in energy-intensive production and be
mote global efforts to reduce carbon emis stuck with the current emission structure,
sions. China is the largest source of carbon making the country even more dependent on
emissions, accounting for 23 percent of global future energy supply. Over the long term, the
carbon dioxide (CO2) emissions (although supply of energy is one of the most binding
note that China’s large export sector means constraints on growth potential, so having
that a significant portion of the goods pro- a comparative advantage in energy-intensive
duced in generating these emissions are actu- production is not desirable. In addition,
ally consumed abroad). Moreover, during greater reliance on energy-intensive produc-
the next 20 years, China is expected to be tion would worsen China’s already consider-
responsible for one-quarter of the increase able environmental challenges.
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 405
Limits on carbon emissions would reduce levels and high future economic growth
China’s GDP in the short run. These limits potential. That growth potential has to be
would not necessarily reduce consumption, realized to meet pressing development needs.
however, because a large share of relatively Therefore, emission targets in a global cli-
energy-intensive production is devoted to mate change agreement should not be based
exports. Global limits on carbon emissions on existing emission levels, but on future
would increase the relative price of these needs.
exports, which would reduce the volume of
exports but also generate tax revenues for
International Financial Regulations
the government. The impact on consumption
would depend on the government’s allocation The global financial crisis highlighted the
of these tax revenues. More important, as importance of effective supervision of finan-
chapter 3 argues, a green strategy may well cial systems for global stability. International
become a new source of growth, increasing agreements can enable individual country
long-term growth potential. authorities to impose regulatory rules with-
out impairing the competitive position of
A fair and effective global climate agreement their banks relative to banks in other juris-
is important to China. China should actively dictions. International norms can also pro-
push for a fair, reasonable, and sustainable vide an anchor for domestic reforms. China
global climate regime based on common but has consistently supported international pru-
differentiated principles. Failure on the part dential norms for banking regulation and
of major countries to reach agreement on cli- has made considerable progress in integrat-
mate change and contain the climate crisis ing these norms into its domestic financial
will lead to serious consequences for the world system. Going forward, the government may
economy, in particular, developing countries, need to take a more proactive role in helping
including China, that are likely to be the to shape these norms. This discussion does
most severely affected by climate change. A not cover all, or necessarily even the most
fair global climate regime can be consistent important, areas where China relies on inter-
with China’s implementation of its domestic national coordination to preserve financial
commitment to reduce greenhouse gas emis- stability. For example, our focus on the long
sions. China’s 12th Five Year Plan already term means we do not consider the current
includes declining intensity of such emissions financial controversies concerning China’s
as a binding target. China’s earnest efforts to criticism of U.S. monetary policies and debt
reach this target and establish a market-based burden an important, albeit short-term, area
emissions reduction mechanism will not only for stability in China.
spur other major economies to adopt force- China has benefited from adopting inter-
ful measures for greenhouse gas reduction national regulatory norms for banks. China
but also facilitate transformation of the devel- accelerated its program to implement Basel
opment model, advances in technology, and standards in the late 1990s, as a guide for
economic growth within China, thereby turn- the recapitalization of state-owned banks in
ing emission reduction from a burden into an response to the large amount of nonperform-
opportunity. ing loans (NPLs). Adopting international
Global limits on carbon emissions have norms provided a useful benchmark and
to take into account the need for continued a means of enhancing the credibility of the
growth in developing countries. Developed government’s program. Authorities combined
countries, having reached an advanced phase elements of the implementation of Basel I
of industrialization, have high existing emis- (such as capital requirements) with elements
sions levels and low future economic growth from Basel II (supervisory review and dis-
potential. Developing countries, on the other closure procedures), in what officials of the
hand, have relatively low existing emission China Bank Regulatory Commission (CBRC)
406 CHINA 2030
FIGURE 5.14 State-owned banks dominate Moreover, the stimulus program adopted
China’s banking sector in response to the global financial crisis
Share of types of banks in total assets, 2009
involved a substantial expansion in credit
extended by the state-owned banks. The size
4.0% 1.5% and necessary speed of this process is likely to
7.0%
result in some rise in NPLs going forward.37
As happened with Basel I, the implementation
10.3%
54.7% of Basel III will provide an external standard
for Chinese regulators in the necessary future
cleanup and again will help to defuse poten-
tial domestic criticism of the process.38 The
Five Year Development Plan (covering 2011–
15) envisions the continued implementation
22.5%
of Basel regulatory norms, and the CBRC
announced in May 2011 the imposition of
increased capital adequacy ratios, with higher
State-owned Policy banks levels for “systemically important banks.”
commercial banks Foreign banks China also should take advantage of
Shareholding Postal savings banks
commercial banks City commercial banks informal bilateral relationships related to
international banking supervision to share
Source: UBS.
experiences and information. Membership
in the Financial Stability Board puts Chinese
authorities into direct and regular contacts
with other regulatory organizations, which
sometimes called “Basel 1.5.” As a result of also have an interest in formal and informal
this process and strong economic growth, exchanges of information with their Chinese
the banks’ NPLs dropped from a staggering counterparts.39
23 percent of GDP in 2000 (Allen and oth- China’s reliance on international pruden-
ers 2008) to below 2 percent in January 2010 tial norms in its domestic financial reform
(according to the CBRC).34 process does not mean that the country
Support for the use of international pru- should passively accept norms that are
dential norms also comes from the large, defined by the advanced countries. Although
state-owned banks, which hold over 50 per- developing countries have recently become
cent of total banking assets (figure 5.14). more involved in international financial dis-
These banks have an interest in adhering cussions,40 the agenda is still essentially set
to an internationally recognized regulatory by high-income countries.41 These interna-
framework to support their efforts at inter- tional norms should be reviewed both for
national expansion and to ensure that other their relevance to China’s financial system
domestic banks cannot compete by adopting and for their implications for China’s interac-
more lax prudential norms. tions with the global economy. The first issue
The government remains committed to does not present great difficulties, because
integrating the Basel prudential norms into the government has been successful in adapt-
its regulatory practices, despite the financial ing norms to domestic circumstances.42
crisis resulting from poor regulation and The second issue may require further
supervision in the U.S. banking system (Wal- study. International prudential norms have
ter 2010). 35 It is recognized that consider- changed in response to the vulnerabilities
able work remains in establishing an efficient exposed by the financial crisis. These changes
financial sector,36 and the implementation of reflect a difficult trade-off (from the perspec-
international norms is seen as a part of this tive of the advanced countries) between the
still unfinished reform process. desire for increased stability and the wish to
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 407
avoid unduly reducing the efficiency benefits countries since the 1950s, the size of its pro-
(and bank profits) generated from the use of gram and its importance for development in
sophisticated derivatives. China’s view of this the poorest countries is increasing rapidly.
trade-off may differ from those of authorities China’s program of financial assistance has
in advanced countries. China’s banks lack provided substantial benefits to developing
the technology and banking relationships countries, in some respects through mecha-
required to sell these products, while China’s nisms that are superior to the programs of
economy suffered from the extreme volatility Organisation for Economic Co-operation
generated by the failure to properly regulate and Development (OECD) countries. In the
them. Thus, it may be in China’s interest to future, China could improve the effective-
promote a stricter regulation of derivatives ness of its overseas development finance (and
than is currently envisioned. avoid the same mistakes that the advanced
For example, one difficult issue is the countries made in their aid programs) by
extent to which certain kinds of derivatives exchanging information about policies and
held by major financial institutions should procedures with the OECD. At the same time,
be moved to central clearinghouses and sub- the OECD countries should consider integrat-
ject to strict capital requirements. Establish- ing some aspects of China’s overseas financ-
ing a single clearinghouse that spans a broad ing policies, including flexible application of
range of over-the-counter (OTC) derivatives debt-sustainability guidelines and steps to
would be desirable to ensure adequate regu- improve the efficiency of infrastructure proj-
latory control. However, recent proposals ects, into their own programs. The govern-
that would reduce the capital threshold for a ment also should consider potential competi-
clearinghouse and exempt some OTC deriva- tive responses by the advanced countries to
tives from movement to clearinghouses would China’s growing export credit program.
encourage a proliferation of clearinghouses
and increase systemic risk (Singh 2011). China’s official aid statistics differ from
China profits little from such sophisticated OECD’s in classification. The recent publi-
derivatives, and the most recent five-year plan cation of an official paper on China’s foreign
envisions little progress in easing restrictions aid is a welcome step toward greater trans-
on such trades. It would, therefore, be logical parency (State Council 2011). However, the
for China to push for aggressive measures to statistics provided in the paper generally fol-
limit the risks from OTC derivatives. This is low the Chinese practice of providing cumu-
simply one illustration of the many technical lative totals of annual figures over many
issues where a developing-country perspec- years (China’s aid totaled RMB 256 billion
tive would likely take a more conservative by end-2009). Data on the government’s
view of the trade-off between efficiency and annual expenditures on external assistance
risk in today’s financial markets. (published in the China Statistical Yearbook)
In short, as China becomes more inte- show a sharp rise in concessional assistance,
grated into the global financial system, the from a total of about $700 million in 2001 to
implications for China of external instability almost $5 billion in 2009 (figure 5.15). How-
will rise. China should, thus, play an active ever, these figures cannot be directly com-
role in promoting more stable financial sector pared with those reported as ODA by other
regulation. major donors (see below), because of different
classification of aid statistics between China
and OECD countries. The difference is partly
Official Finance
related to the differing features of aid policies
One global issue where China is playing an and development experiences.
increasingly important role is official devel-
opment assistance (ODA). While China has Both China and recipients have benefited from
provided financial assistance to developing China’s program of official finance. China’s
408 CHINA 2030
FIGURE 5.15 China’s official finance increased sharply in the past China’s program is respect for the sovereignty
decade of recipient governments and the refusal to
become involved in their internal policies,
although the government has on occasion vig-
3,500
orously expressed concerns about corruption
3,000 and the possible diversion of its finance (Mold
2,500 and others 2010). Embezzlement in China’s
official loans is limited by paying Chinese
US$ (millions)
2,000
firms directly for building infrastructure.43
1,500 China provides very little direct budget sup-
1,000
port. China also has provided several rounds
of substantial debt relief since 2000, but with-
500 out linking debt relief to policy reforms. And
0 China’s loans to a few heavily indebted poor
2001 2003 2005 2007 2009 countries have raised concerns of a renewal of
debt problems.
Budgeted external assistance Eximbank commercial loans
Concerns have been raised about a lack of to improve the effectiveness of competitive
attention to operations and maintenance bidding in reducing costs. On average, only
costs in projects (Hanson 2009). Of course, about 13 percent of ODA in DAC countries
cases of corruption are sometimes found in was tied to purchases in donor countries (Per-
traditional donors’ programs. But China can roulaz, Fioroni, and Carbonnier 2010).44 In
impose more transparency as an important contrast, projects financed by concessional
measure to tackle corruption in its aid pro- loans from China Eximbank are required to
grams. It is encouraging that China has signed give priority to Chinese suppliers for equip-
and ratified the 2005 UN Convention Against ment, raw materials, technology, and services
Corruption, and recently followed through by procurement.45 Because of their competitive-
making corrupt practices by Chinese compa- ness, Chinese companies would likely still win
nies overseas illegal under Chinese law. The most, if not all, contracts even if they were not
challenge now will be effective enforcement formally tied.
(Brautigam 2011). As China’s financial programs increase in
size, the government will confront pressures
China can learn from the failures and suc to take on a similar perspective. Greater
cesses of traditional donors’ development openness in China will increase the impor-
assistance. In some respects, such as the tance of civil society and its ability to lobby
heavy reliance on tied aid and lack of condi- for policies that promote aid effectiveness.
tionality, China’s policies can logically be seen Higher levels of official finance will increase
as similar to the approaches by traditional the importance of coordinating with other
donors. Official finance programs, including countries. And China’s increased impact on
aid and export credits, were initially designed recipient countries will inevitably generate
to expand diplomatic influence and com- pressures to improve effectiveness.
mercial interests. Over time, however, some
policies were modified to focus on develop- The government should focus on improve
ment effectiveness and to adopt more coop- ments in transparency and standards over
erative approaches to the provision of official the medium to long term. China is still a
finance. This process, in part, responded to developing country, and its aid policy should
obvious aid failures and growing pressures be seen more as South-South cooperation than
from civil society. It also reflected the increas- as the unilateral aid provided by traditional
ingly important institutional role played by donors. Therefore, China’s classification and
the multilateral institutions, growing coop- data gathering of its official aid is also quite
eration among bilateral aid agencies, the real- different from those of the developed econo-
ization that competition among export credit mies. Naturally, China’s aid is now much
agencies was counterproductive (from the more integrated into its trade policies and its
standpoint of creditors), and more recently own development strategy. However, as China
the need to achieve fair burden sharing in transitions into a high-income economy, it is
debt relief to heavily indebted poor countries. logical that its aid policy becomes more inde-
Overall, global goals rose in importance com- pendent, with its own objectives and its own
pared with national and commercial goals. effectiveness measures.
These changes are only partial, and donors’ Already China has adopted higher tech-
financing programs still often serve narrow nical and environmental standards in its aid
interests, either that of the nation or specific programs and is paying more attention to the
firms. But the goals of promoting develop- people’s livelihood and natural environment
ment effectiveness and financial cooperation in recipient countries.46 However, increasing
have taken on more and more importance transparency and learning from the well-
over time. For example, most Development established practice and experience of official
Assistance Committee (DAC) countries have aid programs of the developed economies (for
considerably reduced tied aid requirements example, hiring professional institutions for
410 CHINA 2030
through 2014, with fewer evidentiary require- 9. See, for example, http://schumersenate
ments than under the normal safeguards .gov/Newsroom/record.cfm?id=331896&&
regime), the traditional safeguards regime, year=2011&.
voluntary export restraints (particularly as a 10. In 2010, only 6 percent of buyers in global
result of U.S. and EU investigations of China’s mining M&A deals were Chinese, and few
textile and apparel exports, and despite the Chinese buyers have secured controlling
banning of voluntary export restraints under stakes in global mining corporations (Price
the WTO Agreement on Safeguards), and WaterhouseCoopers 2011).
countervailing measures under antisubsidy 11. The data on M&A transactions may over-
policies (Bown 2007). state the share of services and thus under-
4. Over half of trade is already subject to zero state the share of mining and manufacturing.
MFN rates where there is no room for prefer- The M&A data are reported by the acquirer.
ences; and many products with high tariffs (in Because many acquiring firms are banks act-
agriculture, for example) are excluded from ing as intermediaries, the M&A data may
preferential agreements, so trade in those not accurately represent the business of the
goods still occurs at MFN rates. acquired firms. Fung, García-Herrero, and Siu
5. For example, India has committed to allowing (2009) find that proxies for natural resources
maximum foreign ownership of 25 percent in do not have a significant relationship with
basic telecommunications under the General the location of Chinese outward FDI flows.
Agreement on Trade in Services and 49 per- Cheung and Qian (2009) find that resource
cent in some of its preferential agreements, but seeking is an important motive, although
in practice it already allows 74 percent. China does not appear to invest in African
and oil-producing countries mainly to obtain
6. Restrictions of foreign firms in banking are
natural resources.
meant to ensure that they are not used to evade
12. The government also is beginning efforts
capital controls, insurance remains closed in
at diversifying foreign exchange reserves
many respects, majority foreign ownership is
through the China Investment Corporation.
prohibited in some sectors (such as telecom-
13. China’s per capita demand for steel rose from
munications and air transport), and provision
0.06 ton in 1990 to 0.37 ton in 2008, about
of domestic legal services is restricted.
2.5 percentage points more rapidly than the
7. To join the procurement agreement, countries
rise in per capita GDP (McKay, Sheng, and
must (for the transactions covered) eliminate
Song 2010). In 2010, China’s consumption of
discrimination against foreign suppliers, refined metals exceeded the total of all OECD
enhance ex ante transparency (advertising economies combined.
for bids for all procurements above a given 14. Japanese investment in U.S. real estate totaled
threshold) and ex post transparency (explain nearly $300 billion in the 1980s, and the
why suppliers were chosen), and establish pro- “value of many of these assets fell by as much
cedures to review complaints. as 50 percent in the early 1990s.” See Terry
8. This exception appears to have been inter- Pristin, “Commercial Real Estate; Echoes of
preted relatively broadly in justifying the the 80s: Japanese Return to the U.S. Market.”
application or threat of export barriers, in New York Times, January 26, 2005.
cases such as the U.S. proposal for an export 15. He and Lyles (2008) claim that fears of gov-
ban on soybeans in 1973. Article 12 of the ernment domination of SOEs are outdated
WTO Agreement on Agriculture requires after three decades of reform have improved
that developed-country members and net- the SOEs’ autonomy and responsiveness to
exporting developing-country members market forces.
introducing export restrictions under this 16. It is also necessary to define the assets to be
provision take into account the implications covered by the agreement, for example, to
for importing members’ food security, and decide whether short-term flows are also pro-
notify the Committee on Agriculture, prefer- tected, although a substantial transitional
ably in advance. However, notifications have period would be required until China can
rarely been issued; it appears that the most achieve an open capital account. Xiao (2010)
recent is from Hungary in 1997 (Gamberoni argues that China should press for a hybrid
and Newfarmer 2008). approach. Access to investment should be
412 CHINA 2030
based on a narrow definition (such as kind of notably the implications for employment, and
activity), while protection of existing invest- will need to be phased in over time.
ments should be determined by a broad asset 25. Claessens, Demirgüç-Kunt, and Huizinga
definition. (2000) use data from a sample of 80 countries
17. For example, one complaint concerning the to show that foreign entry reduces the profit-
process for approval of Chinese investment ability of domestic banks and enhances their
in Australia’s Rio Tinto was that the respon- efficiency. Claessens and Lee (2003) conclude
sible agency took three months longer than that the increased presence of foreign banks in
expected before ultimately approving it. low-income countries reduced financial inter-
18. The same issues are not as pressing for mediation costs and made the banking system
national treatment after entry, because MFN more efficient and robust.
provisions of Chinese BITs imply that Chinese 26. From 1988 to 1993, the government main-
firms would enjoy the same protections as tained a dual exchange rate system where
granted under other treaties. businesses involved in trade had access to
19. Even there, however, the importance of access the swap market with a market-determined
to tribunals is suspect. Investors are under- exchange rate, while most others had to
standably reluctant to appeal to interna- undertake transactions at the official, con-
tional tribunals against governments of host trolled rate. During the early 1990s, the rate
countries. For example, despite the inclusion in the swap market (which accounted for
of arbitration provisions, albeit with excep- about 80 percent of foreign exchange trans-
tions, in several Chinese BITs, no investor has actions by 1994) depreciated sharply, and the
brought a case against China to international official exchange rate became increasingly
arbitration (no doubt largely because of the overvalued. Thus, the official rate records a
fear that doing so would impair the investor’s large nominal depreciation with the unifica-
relationship with China) (Economist Intelli- tion of the exchange rate system (Huang and
gence Unit 2010). Wang 2004).
20. Hoekman and Saggi (2000) find that a mul- 27. BIS (Bank of International Settlements) effec-
tilateral framework would result in little tive exchange rate.
reduction in transactions costs for either gov- 28. China’s capital controls also serve other
ernments or investors compared with reliance purposes, including supporting interest rate
on BITs. controls and limiting the impact of capital
21. Some empirical studies find that BITs have movements on China’s relatively undeveloped
little impact on FDI flows (Nunnenkamp financial markets.
and Pant 2003). On the other hand, Berger 29. In 2005, the authorities announced that the
and others (2010) find that BITs with liberal renminbi would no longer be pegged to the
investment provisions guaranteeing market U.S. dollar but to a basket of currencies,
access for FDI are significantly and positively although the composition of that basket has
related to cross-border investment flows. not been announced. This shift may explain
22. For example, transparency provisions could why the real effective exchange rate has been
reflect weak administration in developing more stable than the exchange rate against the
countries, and technical assistance could be dollar (Frenkel 2009).
provided to help developing countries imple- 30. Increasing productivity in the production of
ment the agreement. traded goods will increase the demand for
23. The State Council has assigned most of its labor, thus increasing wages in both traded
authority for approving foreign investments and nontraded sectors. But because productiv-
to the Ministry of Commerce and local gov- ity growth is slower in the production of non-
ernments, although the council retains final traded goods, the rise in wages will require
authority for investments with significant an increase in the relative price of nontraded
macroeconomic or foreign policy implications goods.
(Berger 2008b). 31. The exact currency composition of China’s
24. The subject is beyond the scope of this paper, reserves is not known because China does
but such reforms of state enterprises will have not participate in the International Monetary
to take into account a host of concerns, most Fund’s COFER database.
REACHING “WIN-WIN” SOLUTIONS WITH THE REST OF THE WORLD 413
32. Because issuing additional cash is virtually of view, the new sectoral agencies created in
costless, the government earns a real return the postcrisis overhaul of the financial regu-
on monetary expansion, part of which would latory environment—the European Systemic
come from foreigners if the renminbi were to Risk Board, the European Banking Author-
circulate internationally as the dollar does ity, and the European Securities and Mar-
now. kets Authority—are institutionally mandated
33. Reuters, “Factbox: China’s Decade in the to engage in administrative agreements with
WTO,” November 29, 2011, http://news. third-country authorities in the pursuit of
ya hoo.com /fac tbox- ch i nas- decade -w to their respective mandates, and contacts with
-055550276.html. their Chinese counterparts to that effect have
34. The process of reducing NPLs of the four already started.
major state-owned banks involved the trans- 40. Developing countries are playing a more
fer of the loans to asset management com- important role in discussions of international
panies and subsequent sales to the public, in financial decisions through reliance on the
conjunction with capital injections into the Group of 20 as the main body for interna-
banks. tional economic coordination and through the
35. By contrast, the Asian crisis and the prolonged expansion of the Financial Stability Board.
Japanese stagnation eliminated the attrac- 41. Among other things, this agenda includes
tiveness of alternative regional models (for strengthened international governance; train-
instance, during the 1990s, Korea’s regulatory ing of supervisors for cross-border banks; the
framework was considered as a possible refer- expansion of the Financial Stability Board;
ence; this ended after 1997). better regulation of credit rating agencies
36. The Chinese banking system remains under- and private pools of capital (hedge funds);
developed in many areas. The scope of bank improvements in accounting standards; stan-
services is extremely limited in comparison dardization and increased resilience of credit
with more developed systems (for example, derivative markets; principles for employee
consumer credit remains a small share of total compensation; improved corporate gover-
credit), and the regulatory system is limited nance and prudential supervision (including
(for example, there is still no formal system- macro supervision); reducing evasion of stan-
wide deposit insurance scheme in China, and dards through off-shore financial centers; and
the government maintains ceilings and floors addressing the procyclical nature of capital
on interest rates). requirements.
37. The existing figures for the current level 42. As noted, authorities pursued a somewhat
of NPLs, at around 2 percent of GDP, are selective implementation of Basel prudential
widely considered to significantly understate norms during the past decade. And with the
the dimension of the problem (OECD 2010). onset of the financial crisis, CBRC statements
Nevertheless, the CBRC has already used its signaled an implicit rejection of Basel II’s
considerable “moral suasion” powers to force market-based and self-regulatory approaches
an increase in capital adequacy ratios, which to capital adequacy standards.
reached an estimated average of 9 percent in 43. See “The Chinese in Africa,” The Economist,
the 14 domestic listed banks by 2010. April 20, 2011.
38. Basel III is the successor of the ill-fated Basel 44. Note, however, that these figures exclude aid
II, but now with risk-adjusted capital, lever- related to technical cooperation and admin-
age, and liquidity standards of an (arguably) istrative assistance (which often are tied) and
simpler, more strict and transparent nature. thus probably underestimate tied aid levels.
39. An example of those more informal exchange Also, research shows that even when OECD
processes is provided by the regular dialogues aid is untied, donor country firms still win the
held by Directorate General for Internal vast majority of contracts (Nichol and Gor-
Market, the regulator of the financial mar- don 2011).
kets in the European Union, with its Chi- 45. China Eximbank website.
nese counterparts (see http://ec.europa.eu 46. It is important to distinguish between technical
/internal_market/ext-dimension/dialogues and environmental standards adopted in over-
/index_en.htm). From a more formal point seas business ventures by Chinese enterprises
414 CHINA 2030
and those adopted in official aid programs, Berger, Axel. 2008a. “China and the Global Gov-
which are normally higher than the former. ernance of Foreign Direct Investment: The
47. This would require presenting China’s aid Emerging Liberal Bilateral Investment Treaty
according to DAC definitions, which differ Approach.” Discussion Paper 10/2008, Ger-
somewhat from China’s. For example, China man Development Institute, Bonn.
does not count scholarships as aid, while ———. 2008b. “China’s New Bilateral Investment
DAC does; China includes military assis- Treaty Program: Substance, Rationale and
tance in its external assistance budget, but Implications for International Investment Law
DAC excludes military assistance from ODA; Making.” Paper prepared for the American
China does not count debt relief as aid, while Society of International Economic Law Inter-
DAC does include debt relief on nonconces- est Group 2008 conference in Washington,
sional loans; and China includes only the DC, November 14–15.
interest subsidy in concessional loans as aid, Berger, Axel, Matthias Busse, Peter Nunnen-
while DAC includes the face value as ODA kamp, and Martin Roy. 2010. “Do Trade and
while deducting repayments in subsequent Investment Agreements Lead to More FDI?
years (Brautigam 2010). Accounting for Key Provisions Inside the Black
Box.” Working Paper 1647, Kiel Institute for
the World Economy, Kiel, Germany.
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Index
Boxes, figures, notes, and tables are indicated by b, f, n, and t following the page number.
C H I N A 2 0 3 0 419
420 C H I N A 2030
developmental welfare model, 272, 281 middle-income trap and, 12b, 12f
Development Assistance Committee (DAC), 409 opportunities and risks for, 10–14, 11f, 13f
development quotient (DQ), 352n22 social stability and, 4–5
Development Research Center (DRC), 83, structural reforms and, 79–80, 82b, 140–41
198n3, 218, 386 trade relations and, 60–64, 363–64
development strategy, 15–24 economic integration. See global economic
key characteristics of, 18–20 integration
need for, 16–18 education
strategic directions for, 20–24 access to, 46, 51, 51f, 295–302, 296–98f
urbanization and, 23–24b fiscal system reforms and, 92, 93f
vision for, 15–16 hukou system and, 276
DeWoskin, Ken, 203n71 innovation and, 169, 170
diabetes, 278 policy debate participation and, 13
dibao system, 343, 348–49 poverty reduction and, 47b
digital medicine, 182 productivity of, 156
disaster response systems, 254 public financing of, 18
disease management programs, 309b quality of, 9, 287, 295–302, 296–98f
Dodgson, Mark, 198n5 rural teacher retention, 352n31
domestic market senior secondary enrollment, 297–99
economic growth and, 5–6 teacher allocation and transfer system,
green development and, 40, 240 352n32
innovation and, 169, 170 teacher recruitment, 297
middle class expansion and, 10 “teaching to the test,” 353n56
Dongfang Electric, 202n54 trust in, 279
Dongguan, cluster networking in, 168 urbanization and, 23b
double taxation treaties, 389 vocational education, 299–302
DQ (development quotient), 352n22 e-governance, 133b
DRC. See Development Research Center Eichengreen, Barry, 82, 199n21
drought risks, 238 electricity generation, 201n37, 244, 245,
dual exchange rate system, 392–93, 412n26 249
electric vehicle industry, 40, 42, 227
early childhood development and education, 51, electronic medical records, 309
288–95, 288–92f, 290t, 294f, 351n16 electronics industry, 26
early warning system, 122 emerging economies. See developing countries
East Asia and Pacific. See also specific countries emission reductions
deregulation and financial crises in, 398 decoupling economic growth and, 221,
industrial policy in, 113 221f
manufacturing network with China, 381 global trends in, 6–7, 367
Eberhardt, Markus, 201n45 green development and, 39, 220b, 220f,
eco-labeling, 42, 43, 186 225, 225–26f, 236, 236t, 250, 253
economic growth emissions-trading schemes, 42–43, 250
deceleration in, 361 employment. See also labor market
decoupling from carbon emissions, 221, green development and, 229b, 265n6
221f interregional competition and, 5
domestic market integration and, 5–6 job creation, 229b, 265n6
factors behind, 4–6 social development and, 4
future trends for, 6–10, 9t social stratification and, 278
global economy integration and, 6–8 Employment Contracts Law of 2008, 322
green development and, 40, 222–39, 223f, employment services, 321–22
251 energy efficiency, 185, 252b, 255b
history of, 4–14, 5f energy intensity, 264n4
innovation and, 159–62, 160t, 188t energy resources
interregional competition and, 5 economic growth and, 13–14
macroeconomic stability and, 4–5 taxation of, 57, 66
market-oriented reforms and, 4 urbanization and, 23b
424 C H I N A 2030
National Plan Outline for Medium- and NPLs. See nonperforming loans
Long-Term Education Reform and nuisance taxes, 139
Development, 299 nutrition, 288–89, 292, 293, 352n19
National Population and Family Planning
Commission, 292 obesity. See overweight and obesity
National Program Outline for Medium and Long ODA. See official development assistance
Term Development of Science and Technology OECD on monitoring green development, 258,
(2006–20), 163 260
national qualifications framework (NQF), 302 OECD countries
national social assistance scheme, 53 aged and long-term care in, 346, 347
National Social Security Fund (NSSF), 341 allocative efficiency in, 79
national training authority, 301 basic benefit pillar in, 343
national transfer accounts (NTA) modeling, carbon emissions in, 221, 221f
351n15 carbon-trading schemes in, 43
natural monopolies, 106, 112 early childhood health and education in,
natural resource management 293
economic growth and, 13–14 education systems in, 281
exploitation rights, 58 employment services in, 321–22
green development and, 41, 253 environmental taxes in, 261b
middle class expansion and, 7 gender wage gap in, 353n48
pricing reforms for, 66 green development strategy of, 218, 223
regulatory framework for, 251–53 health care services in, 304, 307, 309b,
taxes and, 57 310, 312
trends in, 8 hospital admissions in, 272, 304
Nature Publishing Group, 200n28 on industrial concentration, 106b
NBFIs. See nonbank financial institutions labor taxation in, 328, 328f
NDC (notional defined contribution) approach, official development assistance from, 64,
342 407
Needham, Joseph, 200n30 pension reforms in, 343
neighborhood school concept, 297 performance-related pay for public servants
Netherlands in, 326b
health care services in, 312 preprimary education in, 291
health insurance pooling in, 311 property taxes in, 32
national qualifications framework in, 302 public spending on health care in, 284
recycling in, 253 retirement age increases in, 33, 321
New Cooperative Medical Scheme (NCMS), 52, skills training initiatives in, 321
276, 303 social security in, 348, 349
New Zealand social services delivery in, 50, 279–80, 285
carbon-trading scheme in, 43, 261b TVET in, 300
functional reviews in, 95b official development assistance (ODA)
national training authority in, 301 from China, 367, 407–10, 408f
NIH. See National Institutes of Health concessional assistance, 407
Ning, Lutao, 106 conditionality of, 408–9, 410
Ningbo, health care services in, 306 coordination of, 410
nonbank financial institutions (NBFIs), 116, 119, corruption and, 408–9
146 global governance and, 64
nonperforming loans (NPLs), 68, 116, 126, 405, transparency in, 409–10
413n34 one-child policy, 317
“no-regrets” policies, 42, 224, 225f, 236 open regionalism, 62, 71n39, 365, 379, 383
Norway opportunity costs, 297–98
capital account liberalization in, 399b opportunity gap, 12
TVET in, 300 Organization of Petroleum Exporting Countries
notional defined contribution (NDC) approach, (OPEC), 387
342 Ould-Kaci, Karim, 353n42
434 C H I N A 2030
venture capital from, 38, 169, 171, 175, public transit, 242
180, 206n112 publishing of scientific papers, 157, 171
wage determination in, 327 Pudong pharmaceutical cluster, 168
procurement policies. See also public Puerto Rico, transition to high-income country
expenditures status by, 12b
green development and, 252 PV. See photovoltaic industry
innovation and, 180–81
productivity Qian, Xing Wang, 411n11
market-oriented reforms and, 155 Qian, Yingyi, 81b
middle-income trap and, 12b Qingdao, elderly care services in, 344
product space analysis, 161 quality-of-life indexes, 44, 170, 232
Programme for International Student Assessment
(PISA), 169, 288 “Rainbow Project,” 322
progressive taxes, 96 rationalization of financial system, 118
Project 211 entities, 164 RCCU (Rural Credit Cooperatives Union), 124
Property Law of 2007, 128, 129b, 135b recycling programs, 43, 185, 245, 252–53
property rights, 244–45, 250. See also land reforms. See implementation of reforms;
policies structural reforms
property taxes regional planning boards, 45, 256
fiscal system reforms and, 58, 66, 96–97, 101 regional trade partnerships, 7, 365, 382–83
green development and, 44, 186 regulatory arbitrage, 127
land policies and, 31, 32, 138–39, 139b regulatory framework
local governments and, 58 for aged and long-term care, 347
urbanization and, 23b, 186 for banking system, 367, 397
protectionism for FDI in services sector, 365, 391b
global economic integration and, 7, 379 for financial system reforms, 121–22, 396
trade relations and, 381–82 for fiscal system reforms, 99, 99b
vulnerability to, 364, 365 for green development, 43, 251–53, 257
provider payment reform, 52, 303, 308 international financial regulations, 405–7,
Provisional Rule on Government Funds 406f
Management, 148n15 internationalization of renminbi and, 63
PRP. See performance-related pay for local government financial management,
public expenditures 59
on early childhood development and risk management and, 68
education, 294, 294f for social service delivery, 286
efficiency of, 92 renewable energy, 7–8, 226
fiscal system reforms and, 57, 92–94, 93f, renminbi. See exchange rate; internationalization
397–98 of renminbi
on green development, 42, 43–44, 237, research and development (R&D)
237t, 251 development strategy and, 19
on health care, 284 FDI and, 386
on human capital, 156 global trends in, 35
on pensions, 284 for green development, 220, 251, 257
on research and development, 172 manufacturing co-located with, 169
risk management and, 68 offshoring of, 204n92
on social services, 50 public expenditures on, 34, 156
structural reforms and, 78 research networks, 21, 35, 157, 175–76
public goods. See global public goods research universities, 38, 158
public-private partnerships, 18, 37, 174–75, 177 reserve currency, 7, 394
public sector units (PSUs) residence permit system, 331, 333–34
pension reforms for, 46, 341–42 resource depletion, 80, 232, 232f, 265n17
retirement age changes and, 279 retail industry, 383
wage reforms for, 325 retirement age, 33, 54, 65, 279, 282, 317, 321,
public services quality gap, 12 341
436 C H I N A 2030
State Food and Drug Administration, 149n29 equal opportunity and, 278–80
State Intellectual Property Office (SIPO), 201n45 factor markets, 28–33
State Leading Group on Science, Technology, and financial system reforms, 115–27. See also
Education, 203n66 financial system reforms
State Owned Assets Supervision and fiscal system, 78, 89–103. See also fiscal
Administration Commission (SASAC), 27, system reforms
104, 110, 114 future growth scenarios, 83–85, 84t
state-owned enterprises (SOEs) imbalances in system, 80–83, 87b
autonomy of, 390 labor markets, 32–33
commodity pricing mechanisms and, 243 land policies, 30–32, 31f, 127–40
contingent liabilities of, 59 middle-income trap and, 80–83
dividend payments to general budget, 57, private sector development, 25–28
65, 92, 94 for social services, 50
enterprise sector reforms and, 78–79, state-owned enterprises, 25–28, 85–86
104–5, 110–12 technical efficiency and, 85–89
equal opportunity employment with, 33–34 Stuttgart, as innovative city, 38, 184
FDI outflows and, 388, 411n15 subnational governments. See local governments
financial system reforms and, 119b, 125, Subramanian, Arvind, 200n30
149n24 subsidiarity principle, 100
fiscal system and, 55 subsidies
green development and, 248, 251 for early childhood education, 51
innovation and, 170, 173–74 for electricity, 247
market-oriented reforms and, 4 for fossil fuels, 244b
productivity in, 170, 204nn82–84 for green development innovation, 42, 186
profitability of, 25, 104–5, 105f, 107 for health care, 46, 283
research by, 35 for pensions, 283
securitization of, 111 sunrise industries, 70n28
strategic sectors and, 70n16, 156, 245 sunset clauses, 114
structural reforms and, 25–28, 85–86 Suntech Power, 165, 169, 202n51
technology absorption by, 205n101 supercomputers, 165, 201n36
wage reforms for, 325 supplementary pillar, 344
status quo bias, 252b Sutherland, Dylan, 106
steel industry, 26 Suttmeier, Richard P., 206n116
stem cell therapeutics, 165 Sweden
Stephan, Paula E., 203n69 capital account liberalization in, 399b
Stern, Nicholas, 94 health insurance pooling in, 311
Stevenson-Yang, Anne, 203n71 innovation in, 166
stickiness of innovative cities, 157, 168 Switzerland
storm surges, 238, 238f carbon-trading scheme in, 43, 261b
strategic sectors innovation in, 166, 167
allocative efficiency and, 85 public expenditures on health in, 93, 93f
competition in, 105 vocational training in, 177
enterprise sector reforms and, 78, 87 system of environmental and economic accounts
green development and, 226, 251 (SEEA), 265n16
market-oriented reforms and, 27 Syverson, Chad, 199n25
productivity improvements in, 155–56
state-owned enterprises and, 26, 70n16, Taiwan, China
173–74 development strategy of, 17
structural reforms, 25–33, 77–154 economic growth rates in, 82
allocative efficiency and, 79, 81b, 85–89 land policies in, 136, 150n46
capital markets, 28–30 minimum wage in, 327
economic growth history and, 79–80, 82b, research networks in, 157
140–41 transition to high-income country status by,
enterprise sector, 78–79, 103–15. See also 12b, 159
enterprise sector TAMA association (Japan), 174
I N D E X 439
value-added tax (VAT), 44, 55, 89, 91, 97, 109 growth of, 202n54, 202n56
value chains innovation and, 165
development strategy and, 17, 364 WIPO. See World Intellectual Property
green development and, 240 Organization
international trade and, 7, 61, 375 Women’s Federation, 292
for manufacturing, 376 Working Committee on Women and Children,
outward FDI and, 62–63 292
Van Biesbroeck, Johan, 107b Work Program to Control Greenhouse Gas
Venezuela, (Républica Bolivariana de) FDI and Emissions, 239
competition in services in, 391b World Bank
venture capital, 38, 169, 171, 175, 180, on carbon pricing, 260
206n112 on comprehensive wealth accounting,
Very Large Scale Integration (VLSI) industry, 108 265n16
Vietnam green growth knowledge platform, 258
fertility rate in, 317 high-income status threshold, 82, 82b
parenting education programs in, 293 on labor mobility, 330
VLSI Technologies, 207n135 World Development Report 2010 (World Bank),
vocational education. See technical and 261b
vocational education and training (TVET) World Economic Forum, 167
voluntary export restraints, 71n37, 382b, 411n3 World Health Organization (WHO), 351n18
World Intellectual Property Organization
wage floor approach, 327, 328 (WIPO), 162, 164, 189t
wages World Trade Organization (WTO)
convergence in, 316 accession to, 6, 22, 28, 156
for green technology jobs, 229b disputes in, 61
labor market and, 324–28, 326b, 327–29t food export barriers and, 411n8
in manufacturing, 17 global economic integration and, 364
for migrants, 9 market competitiveness and, 105
Wang, Dewen, 354n64 protectionism and, 381
Wang, Qi, 203n74 Trade Policy Review on China, 384
Wang, Qing Hui, 203n74 Wu, Jing-lian, 110b, 150n47, 204n91
Wang, Z., 353n61 Wu, Weiping, 171, 206n113
Wassenaar Arrangement on Export Controls for wubao system, 344, 354n69
Conventional Arms and Dual-Use Goods and Wuhan
Technologies, 206n119 cluster networking in, 168
water pollution, 39, 70n30, 232, 235, 235b opto-electronics cluster in, 168
water supply Wuling Mountain Area, 232b
agricultural use and, 245, 265n10
climate change risks and, 239 Xia, Jun, 107
depletion of, 235, 265nn10–11 Xiamen, elderly care services in, 344
green development and, 41 Xi’an
middle class expansion and, 7 cluster networking in, 168
pricing mechanisms for, 243–44, 249, 257 innovation capacity building in, 184
property rights and, 250 research networks in, 176
taxation of, 57 Xiao, Jun, 411n16
urbanization and, 23b
Wedgewood, Josiah, 198n5 Yao, Xiangkui, 206n116
Weiss, John, 113 Yeung, Bernard, 107b
welfare pluralism, 294 Yu, Yongding, 199n18
Wenzhou, cluster networks in, 203n67 Yu, Zhihong, 201n45
Whalley, John, 353n61
WHO (World Health Organization), 351n18 Zhai, F., 353n61
wind energy Zhang, Chuanguo, 205n105
green development and, 40, 223, 226–27, Zhang, Jun, 87b, 160, 199n17
240–41, 241t, 246–47 Zhang, Ping, 200n32
442 C H I N A 2030