76299 China 2030 Building a Modern, Harmonious, and Creative Society The World Bank Development Research Center of the State Council, the People’s Republic of China China 2030 China 2030 Building a Modern, Harmonious, and Creative Society The World Bank Development Research Center of the State Council, the People’s Republic of China The World Bank © 2013 International Bank for Reconstruction and Development / The World Bank and the Development Research Center of the State Council, P. R. China 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 16 15 14 13 This work is a product of the staff of The World Bank and the Development Research Center of the State Council, P. R. China. Note that neither The World Bank nor the Development Research Center of the State Council, P. R. China necessarily own each component of the content included in the work. 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Contents 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 2  A New Development Strategy for 2030 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3  Structural Reforms for a Market-Based Economy with Sound Foundations. . . . . . 25 4  Increasing the Pace of Innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 5  Seizing the Opportunity of Green Development. . . . . . . . . . . . . . . . . . . . . . . . . . . . 39 6  Equal Opportunity and Basic Security for All. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 7  Strengthening the Fiscal System and Aligning It with the Evolving Role of Government. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 8  Achieving Mutually Beneficial Relations with the Rest of World. . . . . . . . . . . . . . . 60 9  Overcoming Obstacles to Implementing Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . 65 c h i n a 2 0 3 0 v vi  CHINA 2030 Part II  Supporting Reports 1 China: Structural Reforms for a Modern, Harmonius, Creative Society. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Setting the Stage: China’s Past Economic Performance, Key Challenges, and Future Growth Potential. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Promoting Efficiency and Equity through Structural Reform. . . . . . . . . . . . . . . . . . . . . . . . 85 Strengthening the Fiscal System. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 Enterprise Sector Reforms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 Financial System Reforms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 Land Policies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 Annex 1A Why Did China Grow So Fast? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 Annex 1B China’s Industrial Policies: Key Actors and Defining Characteristics. . . . . . . . 141 Annex 1C Unbalanced and Incomplete Financial System. . . . . . . . . . . . . . . . . . . . . . . . . 143 Annex 1D Experiences of Japan and the Republic of Korea in Financial Liberalization. . 145 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 2 China’s Growth through Technological Convergence and Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155 Purpose of the Chapter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158 Growth Drivers: Betting on TFP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158 Building Technological Capacity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162 The Road to Innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 Defining Policy Priorities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Emerging Priorities for Innovation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 181 Concluding Observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187 Annex 2A  Annex Tables. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 3  Seizing the Opportunity of Green Development in China . . . . . . . . . . . 217 Why Green Development?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 Green as a Source of Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 Green Improves the Quality of Growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Factors Favoring and Impeding Green Development in China . . . . . . . . . . . . . . . . . . . . . . 239 Addressing Concerns on Green Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247 The Road toward Green Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 249 Annex 3A  Sequencing Actions and Confirming Results. . . . . . . . . . . . . . . . . . . . . . . . . . 257 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265 4 Equality of Opportunity and Basic Security for All . . . . . . . . . . . . . . . . . . 271 Challenges for China’s Social Development. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274 Equality of Opportunity with Security: Goals and Principles. . . . . . . . . . . . . . . . . . . . . . . 280 Expanding Opportunities and Deepening Human Capital. . . . . . . . . . . . . . . . . . . . . . . . . 287 Developing a Flexible and Secure Labor Market. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 C O N T E N T S   vii Enhancing Security and Improving the Social Security System. . . . . . . . . . . . . . . . . . . . . . 336 Annex Table 4A  Illustrative Sequencing of Hukou and Supporting Reforms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 351 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354 5  Reaching “Win-Win” Solutions with the Rest of the World . . . . . . . . . . . 361 The World in 2030 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 367 China’s Integration in Global Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377 Global Public Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 402 Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414 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  CHINA 2030 3.9 The challenge of China’s water pollution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 3.10 China’s solar photovoltaic (PV) industry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241 3.11 International fossil fuel subsidies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244 3.12 A lack of competition has held up China’s shale gas exploration. . . . . . . . . . . . . . 246 3.13 Energy efficiency and consumer behavior. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 3.14 Low-carbon urban development in China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255 3A.1 Lessons from international experience on climate policy instruments. . . . . . . . . . 261 4.1 Health care coordination in OECD countries. . . . . . . . . . . . . . . . . . . . . . . . . . . . 309 4.2 Initiatives for public participation in social services . . . . . . . . . . . . . . . . . . . . . . . 314 4.3 Lessons from performance-related pay experience for public servants in OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326 4.4 Recent innovations in hukou reform. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 332 5.1 The Japanese experience with voluntary export restraints . . . . . . . . . . . . . . . . . . 382 5.2 FDI and competition in services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 391 5.3 Japan’s transition to a floating exchange rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . .394 5.4 Lessons of the European experiences with capital account liberalization. . . . . . . 399 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 B3.4.1 Comparisons of iron and steel energy intensity . . . . . . . . . . . . . . . . . . . . . . . . . . 227 3.7 Patent assignee origins for wind power technologies. . . . . . . . . . . . . . . . . . . . . . . 228 3.8 Projected annual Chinese exports of green products and services (2030). . . . . . . 229 3.9 Services, value added, as a share of GDP (2010). . . . . . . . . . . . . . . . . . . . . . . . . . 230 3.10 Environmental and natural resource degradation and depletion, 2008. . . . . . . . . 233 3.11 Urban air pollution trends in China, 2003–09 . . . . . . . . . . . . . . . . . . . . . . . . . . . 234 3.12  Average annual SO2 and NO2 concentrations observed for the 10 largest cities in Japan and China, 1970–2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234 B3.9.1 Wastewater emissions projections (COD), 2005–50. . . . . . . . . . . . . . . . . . . . . . . 235 3.13 Vulnerability to sea-level rise and storm surges by country, circa 2000 . . . . . . . . 238 3.14  Efficiency and CO2 emissions of coal-fired plants in China and United States. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 240 3.15a What emissions growth path should China’s cities take?. . . . . . . . . . . . . . . . . . . . 242 3.15b Which way will China’s transport sector efficiency evolve?. . . . . . . . . . . . . . . . . . 242 3.16  Household water and wastewater tariffs in China’s 10 largest cities compared with other major cities, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243 3.17 Direct CO2 emission intensities of various Chinese industries, 2007. . . . . . . . . . . 248 3A.1 Indicative sequencing of green development reforms. . . . . . . . . . . . . . . . . . . . . . . 257 3A.2 CO2 emissions per capita and per unit of GDP, 1990–2009. . . . . . . . . . . . . . . . . 259 3A.3 China’s annual CO2 emissions under three scenarios, 2010–30 . . . . . . . . . . . . . . 260 3A.4 Coal consumption trends for China under three scenarios, 2011–30. . . . . . . . . . 262 4.1 Per capita human capital: national, urban, and rural, 1985–2008 . . . . . . . . . . . . 274 4.2  The evolution of income inequality in China since the start of reforms, 1981–2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 4.3  Global trends in per capita GDP growth and Gini coefficients, 1980s–early 2000s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 4.4 Number and share of population age 60 and over, 1950–2050 . . . . . . . . . . . . . . 277 4.5  Total population and working age population, 1950–2050 . . . . . . . . . . . . . . . . . 277 4.6 Number of people with at least one noncommunicable disease, 2010–30. . . . . . . 278 4.7 Projected social spending as a share of GDP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 285 4.8  PISA score differences between students with at least one year of preschool education and students without . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288 4.9 Prevalence of anemia among children under age five. . . . . . . . . . . . . . . . . . . . . . . 289 4.10 International comparison of share of children attending nursery school or kindergarten . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290 4.11 Comparative shares of children attending one-year-only early childhood education programs, 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 4.12 Distribution of educational readiness test scores for four- and five- year-olds in China. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 4.13 Budgetary and total spending per student on early childhood education, by province, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 292 4.14 Comparison of public expenditure on education by level, 2008. . . . . . . . . . . . . . 294 4.16 Type of urban schools attended by various subgroups in five Chinese cities, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296 4.15 Spending per capita on education by province, 2000 and 2008 . . . . . . . . . . . . . . 296 4.17 Official promotion rates from junior high school to academic high school, urban and rural, 1990–2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 4.18 International comparison of annual tuition per student in public high schools, late 2000s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 298 x  CHINA 2030 4.19 Out-of-pocket and government health spending as share of total health spending, 1997–2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 4.20 Household health spending as a share of total household income, 2003 and 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 4.21 Comparison indicators on density of general practitioners. . . . . . . . . . . . . . . . . . 305 4.22 Pyramid of care model. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306 4.23 Roadmap for PHC modernization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 307 4.24 Urban labor force market participation rate among local workers, 1995–2009. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 317 4.25 Employment rates of older workers by age, gender, and residence, selected years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318 4.26 International comparison of employment rates by age and gender . . . . . . . . . . . . 319 4.27 Size and composition of informal employment in the urban labor market, various years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320 4.28 Labor supply by age for rural labor force and rural off-farm work, 2010. . . . . . . 321 4.29 Urban minimum wage adjustments, 1995–2009. . . . . . . . . . . . . . . . . . . . . . . . . . 324 4.30 Tax wedge on average formal sector worker, various countries, 2010. . . . . . . . . . 328 4.31 Index of hukou conversion restrictions by city against population and per capita GDP, late 2000s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331 4.32 Progressive acquisition of social entitlements for nonlocal workers: An illustrative case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 334 4.33 An indicative trajectory for residence permit expansion and hukou unification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 335 4.34 Pension coverage rate of active labor force, various countries, mid-2000s . . . . . . 337 4.35 Participation rates for pension programs among working-age adults in urban areas, by gender and residence status . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 337 4.36 Rural pension participation: total contributors and as share of rural employed. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 338 4.37 Pension benefits and replacement rates in urban China. . . . . . . . . . . . . . . . . . . . . 339 4.38 Potential design of long-term pension system . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343 4.39 Long-term care expenditures in OECD, 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . 346 5.1 Growth trends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370 5.2  Growing share of developing countries in global growth . . . . . . . . . . . . . . . . . . . 371 5.3  China’s future share in services and historical experiences of other countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372 5.4 Labor supply growth will vary greatly among countries. . . . . . . . . . . . . . . . . . . . 373 5.5 Capital output ratios will further rise, especially in emerging economies. . . . . . . 374 5.6 Land prices in China and India will rise sharply. . . . . . . . . . . . . . . . . . . . . . . . . . 375 5.7  China’s population will have more low-income people in 2030 than the United States does now . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 378 5.8  China’s share in industrial imports of the world’s 10 largest importers has increased. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379 5.9  China’s share in imports of 10 most-protected sectors in the 10 largest importers has increased. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380 5.10a China has a large trade surplus in industrial goods with the United States and the European Union. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380 5.10b China has a large trade surplus in industrial goods with major trading partners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 380 C O N T E N T S   xi 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  CHINA 2030 3.3  A comparison of total environmental protection expenditures, 2001–09. . . . . . . 237 3.4 China’s unique advantages and challenges in green development . . . . . . . . . . . . . 239 3.5 Comparisons of selected indicators for China and developed countries . . . . . . . . 240 3.6 Comparative national investment, savings, and consumption rates. . . . . . . . . . . . 241 3.7 Total exploitable renewable energy resources in China. . . . . . . . . . . . . . . . . . . . . 241 3.8 Key policy packages to achieve green development. . . . . . . . . . . . . . . . . . . . . . . . 249 3A.1 Comparison of specific indicators, China vs. high-income OECD . . . . . . . . . . . . 259 3A.2 Sector-specific recommendations for achieving green growth in China . . . . . . . . 262 4.1 Prevalence of overweight and obesity of students ages 7–18 in urban and rural China, 2005. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290 4.2 Hourly wages of migrant and local workers, and share of difference explained by observable characteristics, 2001–10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323 4.3 Share of migrant and local workers with income above minimum wage by gender, 2001–10. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324 4.4 Minimum wage approach and criteria, various economies, end-2000s. . . . . . . . . 327 4.5 Urban social insurance contribution rates in urban China . . . . . . . . . . . . . . . . . . 328 4.6 Share of workers with income below minimum SI contribution base (40–60 percent of average wage), 2001–10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329 5.1 Past and future growth trends. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 369 5.2 China’s trade with developing East Asia differs from that of Sub-Saharan Africa. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381 5.3 FDI outflows by emerging markets rose sharply in 2000–09 . . . . . . . . . . . . . . . . 386 5.4 China’s exchange rate was relatively stable during the East Asian crisis. . . . . . . . 393 Foreword 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  CHINA 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. Robert B. Zoellick LI Wei President, 2007–2012 President The World Bank Group Development Research Center of the State Council, P.R.C. Jim Yong Kim President The World Bank Group Acknowledgments 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  CHINA 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 ts  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  CHINA 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  CHINA 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  CHINA 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 5YP Five Year Plan ALTC Aged and long-term care APEC Asia Pacific Economic Corporation BITs Bilateral investment treaties BRICS Brazil, the Russian Federation, India, China, and South Africa CBRC China Bank Regulatory Commission CCS Carbon capture and sequestration CCT Conditional cash transfer CO2 Carbon dioxide CPC Communist Party of China CPCC Communist Party Central Committee CPI Consumer Price Index CSRC China Securities Regulatory Commission DRC Development Research Center of the State Council, P. R. China ECDE Early childhood development and education EFTA European Free Trade Association EU European Union FDI Foreign direct investment GATT General Agreement on Tariffs and Trade GDP Gross domestic product GEM Growth enterprises market GNI Gross national income GPT General purpose technologies HRS Household responsibility system ICOR Incremental capital-output ratios ICT Information and communication technology IMF International Monetary Fund c h i n a 2 0 3 0 xxv xxvi  CHINA 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 Chapter 1  China’s Path: 1978 to 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 Figure O.1  China’s impressive economic performance a. China’s rapid, broad-based growth . . . b. . . . has made it the second-largest economy in the world . . . 18 6,000 16 GDP (US$ billions, current prices) Annual average GDP growth, 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. c. . . . the world’s largest exporter . . . d. . . . and the world’s largest manufacturer 1.8 2,500 1.6 (US$ billions, current prices) 1.4 2,000 1.2 Manufacturing GDP United States US$ (trillions) 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 Source: NBSC 2010; World Bank 2011b. Source: UNSD 2010. 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 levels its strong local governments at various ­ 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 Figure O.2  Savings in China compared to other economies a. High savings will continue to be key to b. . . . which was high even by China’s rapid growth . . . East Asia’s high standards 60 60 50 50 Gross domestic savings Gross domestic savings 40 40 (% of GDP) (% 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) Source: World Bank 2011b. 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 BOX O.1 The middle-income trap 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 Figure BO.1.1  Few economies escape the middle-income trap b. a. Hong Kong SAR, China 40,000 6 Portugal GDP per capita, PPP (2005 constant prices) 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 75 80 85 90 95 00 05 08 0 19 19 19 19 20 19 19 19 19 19 19 20 20 Argentina Iran Jordan Malaysia Syrian Arab Republic 0 1 2 3 4 5 6 Brazil Japan Korea, Rep. Peru Thailand 1960 per capita income relative to United States (log of %) Source: Heston, Summers, and Aten 2011. Source: Maddison database. Note: PPP = purchasing power parity. The term “middle-income trap” was first defined in Gill, Kharas, and others (2007). “Middle-income economies” are defined in accordance with classifications by a.  income group as given in: http://data.worldbank.org/about/country-classifications. b. In today’s increasingly globalized world, escaping the middle-income trap may be even more difficult (Eeckhout and Jovanovic 2007). 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 Figure O.3  China’s economic challenges a. China is an outlier in consumption . . . b. . . . and investment 140 60 Gross capital formation (% of GDP) 120 50 Consumption (% of GDP) 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 coe cient 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. areas, resulting in a growing number of pub- individuals and nongovernment agencies, lic protests. Unresolved, these tensions could these demands can be transformed into a pose a threat to growth and stability in com- positive force supportive of improved gover- ing decades. nance and public policy formulation. Social risks are also expected to arise from Another risk relates to China’s growth another direction. If the experiences of other pattern, which has been particularly inten- countries is any guide, the rising ranks of sive in energy and natural resource use, con- the middle class and higher education levels tributing to a widening environmental deficit will inevitably increase the demand for bet- and exposing the economy to commodity ter social governance and greater opportuni- price shocks. While the energy intensity in ties for participation in public policy debate most individual industries has been declin- and implementation. Unmet, these demands ing steadily, rapid growth, growing urban- could raise social tensions; but if the gov- ization, and structural change within manu- ernment finds ways to improve consultation facturing have combined to make China the and tap the knowledge and social capital of world’s largest energy user, outstripping the 14 china 2030 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 Chapter 2  A New Development Strategy for 2030 China’ successful development strategy over in China that guides the analysis and recom- the past three decades has made it an upper- mendations in this report. middle-income economy today. But the A modern society is industrialized and opportunities and challenges in the next two urbanized and enjoys a quality of life that is decades will be unlike those it encountered in on par with developed countries. This soci- the past and will demand a new development ety would have modern values, a modern strategy. This strategy will need to build on economic and social structure, with access China’s opportunities, meet its challenges, to contemporary, state-of-the-art product manage its risks, and realize the country’s and process technologies, and would engage long-term objectives. But what are those and contribute as an equal with other nations objectives—and what kind of strategy does in the discourse of the modern world on all China need to achieve them? This chapter subjects. begins with a discussion of China’s vision of As a harmonious society, China sees three itself in 2030, identifies the core elements of a interrelated goals. First, its own policies need strategy that would help it realize that vision, to be inclusive and just, aimed at eliminating and examines the characteristics that such a most social and economic boundaries and strategy should have. at building a society in which everyone has a common stake in the country’s economic, social, legal, and political institutions. China The 2030 Vision: To Build a would like to see a society where people show Modern, Harmonious, and mutual respect, disputes are resolved justly Creative Society and peacefully through accepted norms, laws, regulations, and practices—and the institu- In a recent landmark study, the Commission tional structure is quick to adapt to society’s on Growth and Development (2008) identi- changing needs and aspirations. Second, fied five common features in countries that China sees itself living in balance with nature, sustained rapid growth and development for in which its ecological footprint—the use of extended periods: They exploited opportu- resources and creation of waste—are consis- nities in the world economy by maintain- tent with the biological capacity of its (and the ing open trade and investment policies; they world’s) land, water, and air resources given maintained macroeconomic stability; they existing technology. And third, China would enjoyed high savings and investment rates; like to see itself as an equal, constructive, and they allowed markets to allocate resources; accepted partner in the community of nations, and they were led by committed and cred- working peacefully and cooperatively toward ible governments. China belongs to this common goals, and engaging constructively select group and has demonstrated all five on global issues and in global institutions. of these features. The architect of China’s As a creative society, China sees itself reforms was Deng Xiaoping, who played an building its future prosperity on innovation in important role in building consensus for a which everyone’s creative potential is tapped. fundamental shift in the country’s strategy. Its success will lie in its ability to produce After more than 30 years of rapid growth, more value, not more products, enabling it to China has reached another turning point move up the value chain and compete glob- in its development path, one that calls for a ally in the same product space as advanced second strategic, and no less fundamental, countries. Creativity will manifest itself not shift. If managed well, China could become just in product and process technology, but a modern, harmonious, creative, and high- also in cultural and artistic pursuits. If suc- income society by 2030. Each element of cessful, China’s experience could potentially the phrase “modern, harmonious, creative, be a beacon for other middle-income devel- and high income” has specific significance oping countries to follow. 16 china 2030 As a high-income society, China’s aspira- acceptance of the renminbi as an interna- tion is to enjoy a per capita income on par tional reserve currency. The government’s with advanced economies; have a large mid- economic priority will shift to maintaining dle class that acts as a force for stability, good macroeconomic stability, creating an invest- governance, and economic progress; elimi- ment and regulatory environment conducive nate poverty as it is known today; and pro- for enterprise development, and financing mote social harmony by increasing equality public goods and services. China will be of opportunity and lowering inequality in all competing internationally in the same prod- its economic and social dimensions. uct space as the advanced economies; its uni- If China achieves its goal of becoming a versity graduates will have tripled in num- high-income society by 2030, it will be the ber; and its environment will be significantly world’s largest economy using market prices cleaner. Moreover, with a larger urban popu- (indeed, if GDP is measured by purchasing lation and more efficient transportation and power parity, it could well outstrip the United movement of labor between cities and the States later this decade). China’s incremental countryside, inequality between urban and size in the coming two decades will be equiv- rural areas will continue to decline. alent to 15 of today’s Republic of Korea’s. Even so, its annual per capita income will still be around $16,000, more than three times The Case for a New Strategy today’s level, close to today’s Slovak Republic Realizing China’s vision for 2030 will or Korea, and slightly more than a third of demand a new development strategy. The today’s United States. development strategy it pursued over the Another reality in 2030 that can be fore- past three decades was directed at meet- told with some accuracy will be China’s ing the challenges of a different era. Not demographic transition. Simply put, China only have the challenges changed, so have will grow old before it grows rich. Its low China’s capabilities. No strategy lasts for- fertility rate and consequent low population ever. Successful strategies must be flexible growth rate will mean a rising share of old and adjust in accordance with changing con- people in the economy. The old-age depen- ditions. Middle-income countries unable to dency ratio—defined as the ratio of those make such adjustments have stumbled into aged 65 and over to those between the ages the middle-income trap. China’s top deci- of 15 and 64—will double over the next sion makers recognize this and have made 20 years (UN 2010; UN 2009). By 2030, transforming the economic development pat- China’s dependency ratio will reach the tern the country’s most important economic level of Norway and the Netherlands today. policy priority. Just as important, China’s working-age Changing the development model is urgent population will decline after 2015. The because, as an economy approaches the tech- urban share of the population is expected to nology frontier and exhausts the potential rise from around 50 percent today to near for acquiring and applying technology from two-thirds by 2030, an average growth of abroad, the role of the government needs to 13 million people each year (NBSC 2011; change fundamentally. Initiating this change UN 2010). early helps smooth the transition from Compared with today, China’s economy in importing new technologies to innovating 2030 will be more complex, market driven, and creating new technologies. knowledge centered, and oriented toward Developing countries tend to benefit from services. Its trade and financial integration the latecomer’s advantage by following a with the global economy will make it more development path adopted by others. This interdependent with other economies and at path makes the role of government relatively the same time more vulnerable to external straightforward—providing roads, railways, shocks. It will have deeper and more stable energy, and other infrastructure to comple- financial markets, which can lay the founda- ment private investment, allowing open tion for an open capital account and broad trade and investment policies that encourage o v e r v i e w 17 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 Box O.2 Smart urbanization 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 (box continues next page) 24 china 2030 BOX O.2  (continued) 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 Chapter 3 Structural Reforms for a Market-Based Economy with Sound Foundations 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 port­ f olio 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 by small depositors should be established. Land Such arrangements will not only help ensure Over the next 20 years, land will be increas- financial stability but also provide the cred- ible foundations for the eventual integration ingly scarce, and its efficient use will become of China’s financial sector with the global critical for a range of China’s long-term financial system. objectives—food security, efficient and inno- Third, the capital market will need to vative cities, equality of opportunity, and be deepened and reformed to make avail- social stability. Better land policies will help able more equity and securitized financing, secure farmers’ rights over land use and pro- an important ingredient for more dynamic mote agricultural investments and productiv- and innovative industries. To achieve this, ity; ensure that land is used for the highest China could shift the way it handles initial productive purposes, whether in urban or pubic offerings from the current merit-based rural areas; help reduce rural-urban inequal- approval system to a disclosure-based system ity; and promote more efficient and sustain- and focus on improving the capital market’s able urban development. legal framework, enforcing laws and regula- Policies affecting land face three key chal- tions, upgrading the financial infrastructure, lenges. The first challenge is insufficient and imposing stringent rules on information security of rural land tenure. Despite a rela- disclosure. Adequate and accurate disclo- tively clear legal and policy framework, rural sure and transparency supported by credible households continue to possess weak land accounting and auditing practices can go a rights and often face expropriation risks. In long way in supporting financial development addition, serious difficulties remain in the by minimizing informational friction. China implementation of policies and laws, gover- could also promote the corporate bond mar- nance and accountability at the local level, ket, which would not only open up new documentation of land rights, and increasing channels of financing and further diversify citizens’ awareness of existing rights. financial markets but also create conditions The second challenge lies in the process conducive for further liberalization of inter- of converting rural land for urban use. Dur- est rates, the opening of the external capital ing 2003–08, the government requisitioned account, and internationalization of the ren- 1.4 million hectares of agricultural land for minbi. Financial infrastructure needs to be urban use, and another 450,000 hectares further upgraded to facilitate transactions in were reported to have been requisitioned the financial market in general and the capi- illegally.19 In China, the government has tal market in particular. unusually wide powers by international stan- Fourth, after the above institutional and dards to requisition agricultural land for governance structures are in place, the Chi- urban use. The exercise of this power has led nese authorities can also prepare and imple- to four consequences: the government has ment a plan that phases out the ceiling on reserved for itself the sole right to requisi- deposit rates and the floor supporting lending tion agricultural land for urban purposes; the rates; this step will facilitate the commercial- acquisition price of the land is its net pres- ization of banks and ensure stability in the ent agricultural value, not the (usually much financial sector. And as is actually well rec- higher) market price of land, which is its ognized and understood in China, this final opportunity cost; local governments, which stage of interest rate liberalization will have acquire land at the acquisition price and then to be properly sequenced—long-term mar- sell at the market price, have come to rely on ket instruments first, and short-term deposit land acquisition as a revenue earner to finance rates last. Careful monitoring of the progress the delivery of public services, especially of liberalization will be crucial to ensure that infrastructure; and the consequent rapid banks do not indulge in destabilizing compe- growth of urban boundaries has resulted in tition that erodes margins or in reckless lend- urban sprawl (figure O.4). The lack of trans- ing that harms the quality of the loan portfo- parency in land acquisition and the large dif- lio, and that any emerging risk of distress is ference between the price paid to affected dealt with swiftly. farmers (after a portion is held back by the o v e r v i e w 31 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 The third challenge is the use of land as 20 Shenzhen Annual % growth in built-up area of city a source of revenue for some local govern- ments and collateral for borrowing by special 15 purpose vehicles established to circumvent Nanjing restrictions on local government borrowing. Guangzhou Beijing Revenues from land acquisition now consti- 10 Chengdu Average tute a significant share of total government Shanghai Shantou Wuhan revenues and have become an indispensable 5 Shenyang Xi’an funding source that local governments use to Tianjin finance heavy expenditure requirements. In 0 addition, thousands of special purpose vehi- 0 2 4 6 8 10 12 14 16 18 20 cles have been established (by one measure Annual % growth in city population more than 5,000) that use local government land as collateral to raise funds from the Source: NBSC, various years; World Bank staff estimates. Note: The green line is the line of equality. The black line is the linear regression between banking system. The National Audit Office the two variables. The blue circles are China’s 11 largest cities. estimates that local-government-related debts exceeded RMB 10 trillion by the end of 2010, of which a significant share were deemed to be nonperforming.20 that the Communist Party’s 2008 Policy Meeting these three challenges will require Decision regarding this issue be enshrined in a mix of policy reforms and institutional law soon. The law will need to clarify who development that will take time to design and will be eligible for such rights; what the resid- implement but that is essential for the success ual role of the collective will be; the actual of the reform program as a whole. Without terms of the document that grants land user these reforms, agricultural investment could rights (a common title document used nation- suffer, rural-urban inequality could continue wide would be ideal); and the rights and to rise, urban sprawl could stymie environ- responsibilities of land users as well as sanc- mental and economic goals, and the effi- tions in case of violations. ciency of land use could decline. Effective implementation of land user The first priority is implementation of rights will require some degree of clarity measures that ensure the security of agri- about the land’s location and delineation. cultural land tenure, including rolling out Over the coming years, various land registra- the recent policy decision to grant indefinite tion pilots need to be scaled up. Lessons from land use rights to farmers, expanding land other countries indicate that placing land reg- registration and strengthening rural land istration and administration of the land regis- markets, and reforming and modernizing the try under a single agency is the most efficient, governance structure of rural collectives and because such an arrangement avoids overlap- dispute resolution mechanisms. A second pri- ping and competing jurisdictions. ority involves reforming land acquisition and Developing rural land markets will greatly compensation practices, including strategic assist in improving the efficiency of land use. land use planning at the municipal, regional, The transition to transparent and efficient and national levels. A third priority involves rental markets for user rights can potentially substituting property and other local taxes raise productivity by 60 percent (Jin and for land requisition as a revenue source as Deininger 2009) and facilitate labor mobil- well as allowing local governments to bor- ity and land consolidation. Such markets row from domestic capital markets subject to have developed rapidly since the 1990s, (they strict controls and regulations. now cover about 20 percent of cultivated In rural areas, the government could begin land), but the absence of enforceable con- by legally granting farmers indefinite user tracts continues to inhibit growth, and most rights to land they cultivate. It is important transactions remain informal. Expanding 32 china 2030 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 re­ adjustment 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 Chapter 4  Increasing the Pace of Innovation 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 lectual property, especially in fields such intel­ 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 Top 500 universities in the world, 2010a 45 40 35 Number of universities 30 25 20 15 10 5 0 Ze ina a2 a re en ep na ic y ,C l Au ina Sin one a ng y m Ch Can an ce Ne ust ly er ia Ch Sp p. Sw 20 n itz 03 iw Is d Be stria Fin um d Ne AR, azil nm d So Nor rk hA y de nd Sa Gr on i A ce ga sia Po re Po land C l Hu hi l e M ar y ec e o Slo ep. a Ko wed s Isl Tu lic ian I frica Fr 0 an rae ga S nd ut wa Ki n am rke in ad d i ni Cz Arg exic in a i lan lan De lan th ral A Ita In rab 01 Re a po do ub an ud ee d ma h R nti p ti Fe rela w Ch R h ve rtu ng i S Br la Ja lg ra a er a, ite Ger a ng Ta n, Ko Un Ira ss Ru ng Ho Source: Shanghai Jiao Tong University 2010. a. The United States, which has 154 top universities, is not shown. 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 Chapter 5 Seizing the Opportunity of Green Development 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 Green Development as a China’s Many Advantages Source of Growth in Moving toward Green There are also many reasons why green devel- Development opment can be a potential driver of growth. By some measures, China’s quality of growth The first is the greening of traditional sec- has shown improvement in the past two tors. A large number of existing conventional decades, although it has a long way to go. techniques and management models can For example, although its energy efficiency both reduce energy use and emissions and improved faster than that of any other coun- improve the level of corporate profitability. try, it is still one of the least efficient energy Although the greening of traditional sectors users in the world. The share of fossil fuels may seem less dramatic and revolutionary in China’s energy mix has fallen since 1990 than the development of cutting-edge new but is still much higher than that of advanced technologies, it is clear that with information countries. China’s expenditures on energy and financing, many energy-efficient invest- research have been the highest in the world ments are also cost-effective and yield high as a share of GDP, however, and these expen- economic returns. ditures appear to be having an impact. The Second, going green can drive growth efficiency of coal-fired plants has shown through the expansion of emerging green impressive progress, and China possesses the industries, including solar and wind energy, world’s largest capacity for renewable energy together with upstream and downstream generation. It is a world leader in small industries such as relevant equipment manu- hydroelectricity generation, has doubled its facturing and electric vehicle industries. More wind-driven turbine capacity every year since broadly, however, new markets and in­ centives, 2005, and has become the world’s largest supported by innovation and research, will manufacturer of solar panels. likely stimulate new low-carbon, reduced- Going forward, China can build on this resource, and environmentally friendly tech- progress and on its many strengths and nologies, goods, and exports. In addition, advantages. First, the Chinese leadership has increased public awareness will help shift reached consensus on green development, ­ consumer demand toward green products. and the government’s strong implementa- Third, services will also expand as a tion capability will play an important role complement to new green product markets in facilitating change. Second, China’s rela- and changes in consumer preferences. Not tively low urbanization rate and high level only will the rising share of services in GDP of investment as a share of GDP allows for help reduce the economy’s carbon intensity, a rapid turnover of the capital stock, permit- specialized services are likely to develop ting old technology to be replaced with new that specifically support green development. relatively quickly, thus avoiding the lock-in Examples are ecosystem services, carbon costs associated with old buildings and aging asset management services, carbon trading, infrastructure. Third, it can potentially use and contract energy management. its newcomer status in green industries and Fourth, by anticipating climate impacts technologies to leapfrog current capabilities on agriculture, low-lying coastal areas, and in the advanced countries. Fourth, the size areas vulnerable to extreme weather events, of its domestic market can support rapid green development will promote sustainable achievement of scale economies. Fifth, its growth and development, reduce climate- increasingly educated workforce will provide related risks, and improve investor and con- abundant skilled manpower; this, together sumer confidence. International experience with foreign partnerships and appropriate shows that preventive measures are usually policies and institutions, is likely to acceler- far more cost-effective than ex-post recon- ate the pace of innovation. And finally, its struction and rehabilitation. abundant wind, solar, biogas, and shale gas o v e r v i e w 41 resources give it many options to reduce its Recommended Reforms dependence on fossil fuels and improve its Economic activities are replete with external- energy security. ities and market failures that require govern- ment intervention through market and non- Obstacles to Green Development market policy instruments. To promote green While China has many advantages that development and control environmental deg- would help it implement a green development radation and carbon emissions, governments strategy, many obstacles and difficulties must intervene to allow economically and also need to be overcome. Most important environmentally efficient markets to fully among these is the price of energy, water, play their role. raw materials, and natural resources, which Applying this principle, the promotion of remain distorted to different degrees and do green development in China will involve five not reflect either the negative externalities distinct but coordinated policy levers: long- associated with their use or their true scar- term market incentives to encourage enter- city value. The result is high resource inten- prises and households to “go green”; better sity in production and associated wastage designed and enforced regulations requir- and pollution. A second and related obstacle ing changes in behavior in situations where is excessive dependence on administrative market incentives do not work; public invest- mechanisms to deal with environmental ments that deliver key environmental goods and natural resource management issues. In and services with high positive externali- the absence of market-based mechanisms, ties and that explicitly incorporate climate the government is forced to make decisions risk management; measures to strengthen that appear arbitrary and occasionally even local government institutions; and safety net heavy-handed. At the same time, other fis- schemes to mitigate any short-term negative cal and regulatory incentives for environ- employment effects of green development mental protection are either weak or weakly reforms. enforced; as a result, pollution and green- house gas emissions remain high. Long-term market incentives.  A key goal A green development strategy will also of using market incentives is to harness the face implementation and incentive con- creativity and entrepreneurial energy of straints within government, and may face China’s private sector and state enterprises opposition from workers and enterprises that to protect the environment and turn China’s benefit from the current pattern of growth, green industries into an important source of exports, and investment. The strategy will growth by making them world-class innova- require coordination across many govern- tors and competitors. Market incentives are ment ministries and agencies, many of whom also the best way to foster efficiency, which, may oppose it because it reduces their dis- in the case of green development, goes beyond cretionary power to make decisions. In addi- financial efficiency to include resource use tion, while a green development strategy will efficiency and the reduction of environmental be of considerable long-run benefit, it will in externalities. the short run conflict with other economic So far, China has mainly employed regu- objectives (for example, meeting employ- lations and edicts to enforce its environmen- ment and industrial targets for the five-year tal and emissions targets. Old power plants plan). Resolving these conflicting objectives have been retired and polluting factories will require job retraining, skill development, closed, with measurable benefits in improved and similar policies to smooth the adjustment en­vironmental quality. But as the scale and toward the new pattern of green develop- complexity of the Chinese economy and the ment, and will need clear and strong leader- environmental challenge grow, the disadvan- ship from the highest levels. tages of this approach will (indeed, already 42 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 across an entire region. Transjurisdictional Conclusion bodies, such as river basin commissions and Green development can drive growth and regional planning boards need to be given address past environmental deficits, but its more authority. success will take active government poli- Reduce negative impacts on specific sec- cies—applying market and nonmarket pol- tors or groups.  The introduction of reforms, icy instruments—together with competitive whether fiscal and financial incentives or and well-functioning markets for goods and nonmarket policy instruments (such as new services. Valuing natural assets and apply- standards and regulations), will inevitably ing a price to pollution will lie at the heart alter relative prices and change the profit- of China’s green growth strategy. Therefore, ability of different sectors. Pollution-intensive a key priority would be to price electric- sectors will see profitability reduced while ity, oil, gas, water, and other key natural green sectors will see profitability enhanced. resources not only to reflect scarcity value To handle objections of those likely to but also to incorporate the environmental be affected negatively, the government will costs associated with their use. Enterprises need to be ready with a range of policy mea- and households will need to respond to sures. First, compensation for carbon pricing price signals and regulatory standards and (whether through taxation or tradable per- restrictions. A cap on greenhouse gas emis- mits) could be made through fiscal transfers. sions together with an emissions trading If done in a fiscally neutral manner, carbon scheme—combined, perhaps, with a fuel revenues could replace other taxes that may tax to encourage emissions reduction in be more regressive. In addition, progressive transport (which is not amenable to inclu- “social” tariffs could be introduced where sion in carbon trading systems)—will be price increases in water, electricity, oil, and essential to ensure an optimal allocation of gas specifically do not affect low-income emissions rights. groups. As a result of these policies, returns to Second, if carbon trading is introduced, investments in green products and services the original allocation of permits, both by will increase, and “brown” industries will sector and across regions, can be done equita- be discouraged. More important, the expan- bly with the cost of low carbon transition in sion of green industries will contribute to mind. Less developed areas may not use their economies of scale in production and to full allocation and could potentially earn R&D. Competitiveness honed in the domes- revenues from the sale of the excess. High- tic market could accelerate the competi- emission enterprises that may be affected by tiveness of Chinese green firms in a rapidly carbon emission limits (especially industries growing international market. Net job cre- that are still subject to price controls or that ation is likely to be positive. In the long run, cannot pass on the cost of carbon emissions green development will derive from new to consumers) could receive free allocations product and process opportunities afforded at the beginning, moving to a partial and by innovation aimed at addressing envi- then full auction over time. ronmental concerns, more efficient use of Third, job retraining will be needed for resources through the removal of price dis- displaced workers, as will labor market poli- tortions that lead to environmentally harm- cies that permit workers to move jobs and ful practices, more rigorous appraisal of the locations at relatively low cost. Managing costs and benefits of alternative government this transition, and ensuring that the pace policies and public investments, and lower of change is well within the capacity of the economic costs associated with growing economy to absorb, will require careful pol- green now rather than growing now and icy planning and proactive implementation of greening later. social safeguards. 46 china 2030 Chapter 6  Equal Opportunity and Basic Security for All 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 Box O.3 Reducing poverty 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 Expenditure per student (RMB) in the next generation. The government 10,000 should prioritize nutritional supplements for children ages zero to three and for pregnant 8,000 or lactating women in all poor rural coun- 6,000 ties, especially in the central and western provinces, and for migrant children in urban 4,000 areas. The cost of such a program is not prohibitive—this intervention is in fact very 2,000 cost-effective in light of the high returns to health, cognitive development, and produc- 0 tivity. Over time, the focus of child nutrition 0 20,000 40,000 60,000 80,000 efforts would increasingly need to shift to GDP per capita stemming the incidence of childhood obesity, ECDE total ECDE budgetary which is already approaching Western levels in a number of China’s coastal cities. Source: World Bank staff estimates based on data from Chinese authorities. Note: ECDE = early childhood development and education. Similarly, early childhood education for three- to six-year-olds is another relatively low-cost, high-return public investment. In by 2020—comparable to Korea’s senior high the coming five to ten years, the program enrollment rate in 2000. Following the exam- should focus on children in poor rural coun- ple of the abolition of fees for compulsory ties, gradually expanding to rural areas in (primary and junior secondary) education, a central and western provinces, and migrant similar policy is needed for senior secondary children in urban areas (figure O.6). The schools in rural areas, together with a paral- financing can come through supply-side sub- lel initiative for poor and migrant children in sidies to providers and fee exemptions for tar- urban areas. This could be financed in part geted households. Another option could be by the incremental public funding that China the use of conditional cash transfers (CCTs) has already committed in its Education Law targeted to poor households. CCTs have (4 percent of GDP, around half a percentage proven to be effective in other developing point above current levels). countries, and pilots in China indicate that they have significant potential. Health.  Just as in education, much needs to Another priority will be extending afford- be done in health. Deepening health reform able access to secondary education. High fees is one of China’s biggest social challenges in are a key reason why a significant portion of the coming years. At the same time, Chinese rural children fails to enter senior second- and international experience demonstrates ary schools (fees are high because schools that health sector reform is one of the most are encouraged to use them to make up for complex and politically challenging reforms inadequate financing through local govern- that governments confront, a challenge exac- ment budgets). Yet, given the needs of the erbated in China by the rapid pace of popula- Chinese economy over the next two decades, tion aging and the explosion of noncommuni- and given the experience of countries that cable diseases, which, in 2009, accounted for have moved from middle to higher income, more than 80 percent of all deaths in China providing free senior secondary level educa- and 82 percent of the total disease burden. tion will be essential. China has set itself a 90 A critical challenge is reorienting China’s percent senior secondary enrollment target three-tier health delivery system away from 52 china 2030 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 Chapter 7 Strengthening the Fiscal System and Aligning It with the Evolving Role of Government 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 source (Bahl 2009). Sixth and finally, the gov- 30 ernment could capture important economic 20 rents by auctioning public resources such as 10 bandwidth user rights, franchises for public 0 1978 1990 1995 2000 2005 2008 utilities, and exploitation rights for natural Ratio of local government spending to resources. Not only will such measures raise total government spending government revenues, they would prevent Ratio of local government revenue to politically powerful interests from capturing total government revenue these economic rents for free. Source: NBSC, various years. Make Resource Availability Commensurate with Expenditure to be implemented in a manner consistent Responsibility at All Levels of with ongoing discussions regarding reforms Government in the number, structure, and hierarchy of Local governments are responsible for 80 subnational governments. In addition, it percent of government expenditure respon- may be appropriate to selectively raise some sibilities but receive only slightly more than expenditure responsibilities to higher levels 40 percent of tax revenues (in the form of of government or to pool their financing at transfers from the central government) (fig- these higher levels. Scope for such reforms ure O.8). The recentralization of revenues in lies largely, but not exclusively, in health and 1994 strengthened the central government’s pension spending (see chapter 6). Ultimately, capacity to redistribute in favor of poorer any such solutions will need to be guided by provinces. The most serious disparities in a clear understanding of the functions and resource availability, however, occur at the responsibilities of subnational governments subprovincial level, which was not included in China. in tax-sharing arrangements in 1994 and Subnational governments will be able which is responsible for more than 50 per- to increase their fiscal autonomy if they are cent of total public spending. Fiscal transfers given increased scope to raise their own rev- to subprovincial levels remain largely at the enues. The high disparity in development discretion of powerful provincial govern- across different countries, townships, and ments and are subject to negotiation, leading villages warrants some flexibility in revenue to high disparities across subprovincial local assignment. China could consider first grant- governments. ing new sources of “own” revenues—such One way to deal with the disparity in as property taxes and capital gains taxes on government resource availability across and agricultural land acquired for urban develop- within provinces would be to introduce ment (see chapter 3)—to subnational govern- rules governing resource transfers from the ments in relatively developed cities to replace provincial to the township and municipal- revenues from land acquisition. This step ity level. Increasing the autonomy and capa- would free up fiscal resources at the center bilities of local governments is a common for additional transfers to poorer regions trend in other countries, even in unitary and help bring a larger share of subnational states. But in China, such increases will have financing on budget. In addition, citizens are o v e r v i e w 59 likely to hold officials more accountable if of government in a manner consistent with local public services are financed to a signifi- reforms, also under way, to the structure cant extent from locally imposed taxes. of subnational governments. This step is Increasing the fiscal autonomy of local a key toward streamlining the size of gov- governments can be supplemented by allow- ernment, improving the efficiency of gov- ing them to prudently expand on-budget bor- ernment services, and empowering county rowing. In the past, local governments have governments. circumvented the rule against borrowing by Third, to discipline the budgetary process, •   establishing Urban Development Investment the budget and expenditure cycles need to Corporations and other special purpose vehi- be synchronized by either finalizing the cles that can borrow using land as collateral. budget two months before the start of the Total local government debt in 2010 reached fiscal year or moving the start of the fiscal as high as 26 percent of GDP, according year to April 1. to the National Audit Office. 35 Such indi- Fourth, independent agencies should be •   rect borrowing played a significant role in used to conduct rigorous performance eval- financing infrastructure investment and uations of government programs on a ran- thus supported rapid industrialization and dom basis. These evaluations will help pro- urbanization. But lack of transparency and vide feedback on the allocation of resources regulation has created potential risks to fiscal and identify programs that are delivering sustainability,36 and such quasi-fiscal financ- the right outcomes and those that are not. ing also obscures the true size and composi- Fifth, treasury management and budget •   tion of public spending and revenues. China accounts, together with cash management, has recently introduced a pilot program that could be strengthened to streamline dis- allows selected local governments to issue bursements, introduce fiduciary controls, bonds. There is a pressing need to revise the and prevent fraud and corruption. Budget Law and establish the institutions for Sixth, a strict tally could be kept of contin- •   bond issuance by local governments. Over gent liabilities accumulating in the banking time, subnational governments should be sector, state enterprises, and local govern- allowed to borrow from the domestic capital ments and conduct regular fiscal sustain- market on the strength of their own credit- ability analyses, accounting for these liabil- worthiness but subject to a prudential regula- ities under different stress scenarios. tory and institutional framework for subna- S eventh, all levels of government should •   tional debt. complete the process of bringing all pub- lic revenues and expenditures on budget in accordance with the latest Ministry of Improve Government Financial Finance regulations. Management E ighth, the central government should •   China could introduce a number of public change the criteria for performance evalu- finance management reforms to improve the ation of local officials from an emphasis efficiency and effectiveness of public finances, on growth to a focus on a “harmonious but here we just mention nine possibilities. society.” N inth, and perhaps most important, all •   First, it could bring all off-budget govern- •   levels of government should publish and ment revenues and expenditures on bud- make transparent all budgetary revenues get and prepare a comprehensive budget and expenditures from aggregate sectoral that combines the general budget, the allocations and outturns to project level government-funded budget, and the state allocations and outturns. In the experience capital operating budget, and includes cur- of other countries, this disclosure has been rent and capital expenditures together with one of the most powerful ways to improve transfers. expenditure efficiency and ensure that bud- Second, China could complete the ongoing •   getary resources are used in accordance move from five to three (budgetary) levels with budgetary priorities. 60 china 2030 Chapter 8 Achieving Mutually Beneficial Relations with the Rest of the World 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 Chapter 9 Overcoming Obstacles to Implementing Reforms So far, this report has described a proposed economic conditions, robust growth, and the medium-term reform program composed of largest stock of foreign exchange reserves in six new strategic directions to make China the world. Moreover, it has able and effective a modern, harmonious, creative, and high- central and local governments that have dem- income society. Reaching this goal is impor- onstrated strong capabilities for mobiliza- tant for China and for the world, but much tion, organization, management, and imple- will depend on the design and direction of the mentation and, as in the past, can make the reforms as well as on their implementation. important collective action decisions needed International experience shows that the to ensure successful outcomes. presence of a crisis may help a country reach internal consensus for action on reforms, but it also tends to make reform costs high and Sequencing Reforms outcomes uncertain. Crises narrow policy The six priority reform areas lay out objec- options, dictate the pace of reform imple- tives for the short, medium, and long term, mentation, and prevent adequate prepara- and policy makers need to sequence the tion. The advantage of appropriately timing reforms within and across these areas appro- and sequencing policy reforms is lost. In priately to ensure smooth implementation some cases, crises also set in motion events and to reach desired outcomes. that spin out of control and irreversibly shift Highest priority should be given to actions economies to a lower growth path. Con- that enjoy broad support, are likely to versely, initiating reforms proactively allows encounter little resistance, and are relatively adequate time for good policy design, appro- easy to implement. Examples include increas- priate sequencing, steady implementation, ing investment in human capital, encourag- and corrective actions when necessary. Yet ing public participation in the reform and proactive reforms tend to be opposed by development process, introducing a broad set vested interests, and reaching consensus is of indicators to assess economic, social, and difficult, requiring governments to be clear environmental progress and to measure the about objectives, communicating them well, performance of local governments. consulting widely, and working to overcome High priority should also be accorded to obstacles. actions that deliver “quick wins” and address In China’s current situation, the case for short-term risks. These actions include reform is urgent. The world economy is enter- increasing the flexibility of bank deposit and ing a dangerous phase in its recovery from lending rates and lowering high interest rate the global financial crisis, and the next five spreads; increasing SOE dividend payments years could prove to be particularly difficult. to the national budget; stopping forced con- At the same time, China’s economic, social, version of rural land for urban use, with any and environmental challenges are increas- conversions based on vetted urban plans, ing. China could postpone reforms and risk payment of market prices for acquired land, the possibility of an economic crisis in the and the introduction of a reasonable capital future—or it could implement reforms pro- gains tax; raising the retirement age for men actively. Clearly, the latter approach is pref- and women (which can be started soon but erable. Over the past three decades, proac- implemented gradually); removing fees for tive policy change has been key to China’s secondary education in rural areas; chang- economic success, and the calls for reforms ing local government growth targets from within the country have never been louder. In indexes based on GDP to those based on pushing for reforms proactively, China pos- “quality of growth”; raising energy, water, sesses the considerable advantage of good and carbon prices to reduce bottlenecks and 66 china 2030 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 T he term “provinces” here includes munici-   1.  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 A lthough the reputation of forecasting is   5.  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 The old age dependency ratio is defined as the   7.  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). Based on data from Sam Ock Park (2009). 23.  10. The population of Hong Kong SAR, China is Sixth National Population Census, National 24.  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). The amount of “surplus labor” in rural areas, 25.  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/). There remain cases in very large cities where 26.  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 MOHRSS (Ministry of Human Resources 27.  rest of the SOEs cannot be calculated for lack and Social Security) data from end-2010. of data. Sunrise industries are the opposite of sun- 28.  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 T he three key underlying concepts are that 29.  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 World Bank estimates using 2008 data. In 30.  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. For 2008, the last year for which data is 31.  18. However, in some sectors such as telecoms, available. the splitting up was along geographic lines, S everal such taxes address negative exter- 32.  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. Zhang (2010) provides a detailed discussion 33.  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. 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China Statistical Yearbook . ber) http://www.plc.pku.edu.cn/en _publica- Beijing: China Statistics Press. tions.aspx. o v e r v i e w 73 World Bank. 2010. “Fixing the Public Hospital .http://www.economist.com/economics/by System in China.” China Health Policy Notes, -invitation/guest-contributions/no_lewisian World Bank, Washington, DC. _turning_point_has_not_yet_arrived. World Bank. 2011a. Global Development Hori- Zhang, Wenkui. 2010. “The Direction and Task zons 2011. Washington, DC: World Bank. for China’s SOEs Reform in the 12th five-Year ———. 2011b. World Development Indicators. Plan Period.” (in Chinese). Research Report Washington, DC: World Bank (September). 203, Development Research Center, Beijing. Yao, Yang. 2010. “Is the Era of Cheap Chi- nese Labor Over?” Economist, July 16 Part II Supporting Reports 1 China: Structural Reforms for a Modern, Harmonious, Creative Society China’s remarkable economic growth over improve economic efficiency. Within-firm the past three decades has brought many improvements in technical efficiency can positive results and set the country on a path be generated by technological innovation, to become a high-income economy. But the better management, exploitation of scale pattern of growth has introduced new eco- economies, agglomeration economies linked nomic, social, environmental, and external to successful urbanization, and productivity challenges that could ultimately slow growth improvements spurred by enhanced compe- and work against the stated goal of building tition. Improvements in allocative efficiency a “harmonious society.” would come through the movement of factors To become a high-income economy by of production from lower to higher produc- 2030, China will need to sustain relatively tivity uses (firms, sectors, locations). Better rapid economic growth. However, three resource allocation would sustain the pace, factors look set to contain growth going alter the pattern, and boost the quality of forward. First, the contribution from labor growth. Such efficiency gains have been an will decrease in line with lower and eventu- important part of China’s growth story to ally negative expansion of the working-age date and are far from exhausted. To unleash population. Second, the need to achieve such efficiency gains, China needs to move more “intensive” and more balanced growth from a growth model appropriate for a period may require a gradual decline in the ratio of of “catch up” to one driven by efficiency and investment to gross domestic product (GDP), innovation. Building on modeling results, the albeit the ratio will remain at very high levels. report argues that sustained reforms could Third, the scope for gains in total factor pro- deliver growth rates that, while lower than ductivity (TFP) from rapid factor reallocation those of the past three decades, will still and the simple copying or transfer of technol- allow China to join the group of high-income ogy will taper off as China approaches the countries by 2030. later stages of industrialization. However, as long recognized by China’s In this setting, the key to sustaining rel- leaders, growth is no longer enough. Simul- atively fast growth will be keeping the rate taneously achieving a “harmonious society” of increase in TFP growth near its past high will also require progress in making growth rates, through policies and reforms to further more equitable, environmentally sustainable, 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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, C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 GDP growth (annual) 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   Share of industry in GDP 46.7 43.8 41.0 38.0 34.6 Share of services in GDP 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. 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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, C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 changes in the function of government as past improvements in institutional capacity. China attains higher income levels, places Within each of the five priority areas, the greater emphasis on social and environ- report explores policy options and tools that mental outcomes, and faces the need to could be useful for China to manage its new operate and maintain its rapidly growing challenges and contain emerging risks. stock of infrastructure. 2. Most remaining distortions in the rev- China’s Fiscal System: enue system would have been addressed Key Developments to 2010 with a view to improving efficiency and equity, and with several currently minor Government spending has supported the or nonexistent revenue sources (such as country’s development strategy and has carbon taxes, personal income taxes, and evolved in response to changing development SOE dividends) playing significant roles objectives. Expenditures heavily tilted toward in both mobilizing on-budget revenues physical investments supported rapid growth and addressing key distortions. in a “catch-up” phase during which the 3. While public spending may or may not removal of physical bottlenecks offered high play a larger role in the economy than it rates of return. While off-budget investment does today, the relative levels of spending by local governments obscures the size and and revenue would be in line with macro- composition of such investments, total pub- economic stability, balancing the tensions lic spending on infrastructure is estimated arising from pursuing the dual objectives to have reached over 10 percent of GDP (Liu of rapid growth and greater social and 2010), compared with 3–4 percent in many environmental sustainability. other developing countries. More recently, 4. Intergovernmental fiscal arrangements spending has begun to be shifted toward pro- would be better balanced, both vertically moting equity and more balanced growth, in (between levels of government) and hori- line with China’s development strategy out- zontally (across jurisdictions), especially lined in the 11th 5YP. To this end, the gov- at the subprovincial level. This would ernment has expanded its network of social promote the adequate provision of local protection, such as urban and rural minimum infrastructure, social protection, and income support, rural medical cooperative basic public services. schemes, medical assistance for the poor, and 5. A significant strengthening of budget sys- central transfers to expand rural education. tem institutions (including full consoli- It has also increased expenditures on rural dation of spending and revenues) would areas and agriculture, abolished agricultural have greatly enhanced accountability and taxes, significantly narrowed the fiscal dis- transparency, improved budget planning parities across provinces through transfers, and execution at all levels of government, and improved provision of public services. and thus improved the effectiveness of A large share of government spending government. has been devoted to “economic activities,” while gaps in core public services such as This report argues that such a transfor- health and social protection remain signifi- mation can be achieved through a continua- cant. According to the International Mon- tion and deepening of the fiscal reforms that etary Fund (IMF), total general government China has pursued over the past decades. spending reached 25.7 percent of GDP by Past and present policies have been broadly 2008.12 As table 1.2 shows, China’s public appropriate given the challenges of the spending on social protection and health as time, and much has already been accom- a share of GDP is well below that in OECD plished. However, more remains to be done and upper-middle-income country averages. to complete the reform agenda, to align with If such spending is excluded, the remaining evolving challenges, and to benefit from nonredistributive government spending is C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 91 TABLE 1.2  Size and composition of public expenditures, cross-country comparisons as a share of GDP Percent of GDP High income Middle income   Expenditure OECD Upper middle Lower middle China Total outlays 41.6 33.1 36.1 25.7 General public services 5.6 5.6 5.5 2.9 Defense 1.6 1.5 2.2 1.3 Public order and safety 1.6 2.0 2.6 1.3 Economic affairs 4.2 5.3 6.1 7.9 Environment protection 0.7 0.5 0.3 0.5 Housing and community amenities 0.8 1.2 3.0 1.9 Health 6.3 3.3 3.1 1.0 Recreation, culture, and religion 1.2 0.8 1.0 0.5 Education 5.4 3.9 5.4 3.7 Social protection 15.2 9.0 6.9 4.7 Memo: total outlays excluding health and social protection 20.1 20.8 26.2 20.0 Sources: Government Finance Statistics (IMF), World Development Indicators, and World Bank staff estimations. Note: Data are for 2007, except for China, where they are for 2008. China’s social protection includes outlays for both the pension fund and health insurance. The total public expenditure on health financed from the general budget was about 2.5 percent of GDP in 2008. 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 TABLE 1.3  Subnational government finance 1996 2001 2008 2009   Item yuan (billions) % yuan (billions) % yuan (billions) % yuan (billions) % 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. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 93 Figure 1.1  Cross-country comparison of government expenditures as a share of GDP a. Education b. Environment protection Iceland Japan Sweden United Kingdom Denmark France United States Italy United Kingdom Canada Canada Iceland France Belgium Belgium Norway Finland Switzerland Switzerland Norway Australia Austria Greece Australia Denmark Italy Germany Germany Austria Japan Sweden Greece Finland China China Russian Federation Russian Federation 0 2 4 6 8 0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 % of GDP % of GDP c. Health d. Social protection Iceland Denmark France France United States Sweden Austria Finland Canada Germany Denmark Austria United Kingdom Greece Japan Italy Norway Belgium Belgium Norway Italy United Kingdom Sweden Switzerland Finland Japan Australia Canada Germany Australia Greece Iceland Switzerland United States China China Russian Federation Russian Federation 0 2 4 6 8 0 5 10 15 20 25 % of GDP % of GDP Source: Government Finance Statistics IMF 2007, 2009, and staff estimation. There is no uniform high-income-country Iceland, and the share of social protection model for the size of such expenditures rela- ranges from 7 percent in the United States tive to GDP, especially for social and envi- to over 20 percent in Denmark and France. ronmental protection. High-income countries The overall cost depends greatly on the level tend to spend more on these items than of protection and the scheme design, which middle-income countries, but with much is ultimately a political decision of the coun- variability. Figure 1.1 benchmarks China’s try. Also, given the fiscal problems currently spending on these four items against a range faced by many advanced economies, their of high-income countries and the Russian current spending levels should not be com- Federation. For example, the share of pub- pared very mechanistically. lic spending on health in GDP ranges from Using these and other international bench- 4.1 percent in Switzerland to 7.9 percent in marks as reference, China could potentially 94 china 2030 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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. Source: World Bank 2009b. 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 Paci c 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 Box 1.5  Indicative regulatory framework for subnational government debt 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 holds for fiscal sustainability assessment would thres­ 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 Tax revenues   9.3 19.1 16.6 34.2 Government expenditure 13.8 32.4 26.1 59.3 Sources: Dollar and Hofman 2006; staff calculations. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 101 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 103 undertake the assessment of debt dynam- Enterprise Sector Reforms ics. Through this process, the fiscal impli- cations of any reform can be calibrated The Enterprise Sector and China’s Vision and public expenditure and revenue deci- for 2030 sions integrally articulated. A vibrant and increasingly efficient enterprise 3. Comprehensive evaluation of the perfor- sector is key for sustaining relatively rapid mance of local officials. Until recently, growth and enhancing the innovativeness evaluation criteria for local officials were and global competitiveness of China’s firms heavily focused on GDP growth. That over the next two decades. It would support growth is not hard to measure, and the growth by promoting further productivity accountability system has worked reason- gains and by keeping returns to capital at ably well. But the shift in focus to a “har- levels that sustain high investment demand. monious society” requires a greater focus Combined with a more favorable environ- on outcomes such as the health status of ment for small and medium enterprises the population, educational attainment, (SMEs), service sector firms, and labor inten- energy efficiency, and environmental sive firms, it would also promote China’s quality. As these mandates are spread objectives of moving to a more innovative among line ministries, it will inevitably and harmonious society. be harder for the central government to Successful reform and the resulting struc- know if the local government is doing a tural change would leave China with a very good job meeting these multiple objec- different enterprise sector by 2030. In nearly tives and to use that information in staff- all industries, a range of firms with diverse ing and financing decisions. size and ownership would compete vigor- 4. Cross regional and sectoral coordination. ously on a level playing field, facing similar China has quite a few revenue transfers: market-driven factor and input prices. Many some are allocated among regions, and sectors would have been greatly consolidated, others are earmarked for specific issues: primarily by market forces. Entry barriers for example, transfers for rural education. could remain in a few “natural monopoly” Each transfer program is administered sectors where dominant providers (whether separately and often allocated in an ad state owned or private) are subject to effec- hoc manner. It is important to ensure that tive regulation. Large firms, including a the different transfer programs combine diminished number of SOEs, would feature to provide solid foundations for regional modern corporate governance with profes- development, and to ensure equity across sional boards deciding key strategic mat- regions and consistency with the national ters. Having been made more competitive development strategy. by vigorous competition from home and abroad, Chinese firms would be increas- One bold option for enhancing subna- ingly successful in global markets. Within tional government accountability in public government, the functions of policy making, services would be to establish a budget com- regulation, and supervision would be better mittee under the direct oversight of the State separated, each led by a single agency with Council, and to centralize the performance strong capacity, clear mandates, and account- evaluation and monitoring of local agen- ability. Finally, “industrial policy” may still cies (including the noted four functions) in be implemented, but in a more focused, con- a single ministry. Such a practice is adopted sistent, predictable, and market-friendly way in many countries including Japan and Fin- than it is today. land, either as a separate ministry or as part Going forward, China will need to deter- of an existing ministry, such as the Ministry mine the relative role of the state in rela- of Finance. tion to the market and the private sector in 104 china 2030 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 petition through deregulation, international Source: National Bureau of Statistics (China), various years. trade, and private participation. In addi- tion, the relationships between government and enterprises need to be reformed to allow of technological innovations came from the firms with different ownership and sizes to nonstate sector.22 have equitable access to resources and busi- The 9th 5YP’s guiding principle of “grasp- ness opportunities. ing the big, letting go of the small” left China with a distinctive industrial structure. Most small and medium-size firms became pri- China’s Enterprise Sector: vately owned. Facing much domestic and Key Developments to 2010 external competition in an increasingly inte- Significant enterprise sector reforms have grated domestic market, they became very underpinned China’s successful past growth dynamic and productive and now dominate performance. In particular, bold reforms many sectors. 23 In parallel, the “command- under the 9th Five Year Plan 1995–2000 led ing heights” of the economy (most notably to a greatly expanded role for the private and the 120 or so large central enterprises in sec- other nonstate sector. Indeed, the state sec- tors such as electricity, petroleum, aviation, tor’s share in the total number of industrial and telecommunications) remained largely enterprises (with annual sales over RMB 5 state owned. Even here, much progress was million) fell from 39.2 percent in 1998 to 4.5 made. Many SOEs were corporatized, radi- percent in 2010. During this same period, the cally restructured (including the shedding of SOE share in total industrial assets fell from labor), and expected to operate at a profit. In 68.8 percent to 42.4 percent, while the SOE some sectors, intra-SOE competition was pro- share in employment was slashed from 60.5 moted, and the scope for private participation percent to 19.4 percent (figure 1.4). The SOE was expanded. Later, the 2003 establishment share in China’s exports fell from 57 percent of the State Owned Assets Supervision and in 1997 to 15 percent in 2010. As a result, the Administration Commission (SASAC) to exer- nonstate sector has become not only the main cise authority over large centrally run firms generator of output (an estimated 70 percent laid a foundation for future improvements in of GDP) and employment and the strongest governance and investment planning. engine of growth but also the most active sec- As a result, the profitability of China’s tor for innovation. According to one source, SOEs increased. Their reported average 65 percent of China’s patents and 75 percent return on equity (ROE) jumped from only C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 105 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 10 from abroad. Finally, the more recent phas- ing out of incentives that had favored foreign 5 investors enhanced competition by leveling the playing field with domestically owned 0 1998 2000 2002 2004 2006 2008 2010 firms. For this reason, and also because of China’s vast size, the overall industrial sector Return on equity is not very concentrated (box 1.6), suggest- For industrial enterprises For SOEs ing strong potential for competition between For non-SOEs individual firms. Competition remains curtailed in one key Source: National Bureau of Statistics (China), various years. dimension, however—between state-owned and nonstate parts of certain sectors— 2.2 percent in 1996 to 15.7 percent in 2007, especially in “strategic” industries and utili- before sliding back somewhat to 10.9 percent ties. Large SOEs dominate certain activities in 2009 (figure 1.5). not because they are competitive enough to However, the average profitability of SOEs keep the dominance but because the market remains well below that of nonstate (includ- competition is restricted and they are granted ing private) firms. In 2009, the average ROE oligopolistic status by the authorities (Lin of nonstate firms had declined somewhat but 2010). The weak and unfair competition still remained 9.9 percentage points above resulting from such “administrative monop- that of SOEs. In addition, a disproportion- oly” (box 1.7) has been deemed “the current ate share of SOE profits comes from a few problem facing private enterprise in China” monopolies that earn artificially high rates (Naughton 2011) and “the major source of of return because of limits on competition, monopolies in China’s economy” (Owen and while SOEs as a class have enjoyed access to Zheng 2007). The strong direct ties between cheaper capital, land, and natural resources.24 the government and incumbent SOEs, espe- As a result, the profitability of SOEs in cially large SOEs, limit equitable market less-state-dominated sectors is generally entry opportunities, hampering the efficient poorer, suggesting an even greater underlying use and equal allocation of resources and advantage for nonstate firms. The superior restraining entrepreneurship and innovation. performance of private and other nonstate The most problematic form of government firms is also confirmed by a wide range of intervention in competition and administra- other research, although the financial per- tive monopoly in China is official lists that formance of some SOEs has been weak in grant SOEs an exclusive or privileged role in part because they have been responsible for certain sectors. Two lists stand out. First, in delivering public services or have been con- 2006, China identified seven “strategic” sec- strained by regulated prices. tors in which the state would keep “absolute A significant expansion of competition control”—defense, electricity generation and contributed to productivity gains (World distribution, petroleum and petrochemicals, Bank 2009c). Privatization and market telecoms, coal, civil aviation, and water- reform generated vibrant competition in most way transport. 26 While a handful of state 106 china 2030 Box 1.6  China’s industrial concentration remains low in most sectors 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. technology, construction, steel, base metals, Box 1.7  Administrative monopoly and chemicals—the state has retained “some- what strong influence” (Owen and Zheng 2007). In such sectors, private participants “Administrative monopoly” refers to market power artificially created by government policies that restrict may face a range of entry barriers or other competition or compel anticompetitive conduct. It dif- constraints.27 Also, the clear signaling of the fers from a natural monopoly, where market power expected leading role of state enterprises may derives from structural factors such as economies of lead private firms to conclude that they would scale or scope. In China, the most important govern- not be allowed to grow “too big” and thus ment policies contributing to administrative monopoly may act as a powerful disincentive to expan- are explicit or implicit restrictions on (private and sion if not entry. As described in box 1.8, foreign) entry into (or expansion of capacity within) such barriers to entry and exit can reduce a still rather wide range of activities, particularly in potential growth of both GDP and TFP. services. They can also include government-mandated These lists are long by high-income coun- use of specific products or services, or discriminatory try standards and include many activities treatment of nonlocal firms or products by local gov- ernments (“regional blockades”). These policies can be where vigorous competition is feasible. Most exacerbated by government agencies requiring approv- countries rightly limit entry into bona fide als for a range of activities, at times in the absence of “natural monopoly” sectors. Until strong statutory authority. regulatory capacity has been established, there may also be a case for keeping such firms state owned. However, even in such firms might compete with one another in sectors, technological advances have made these sectors, they are protected from new large subsections potentially competitive, entry (Naughton 2007). Second, in desig- including much of the telecoms sector and a nated “basic or pillar” industries—includ- good part of electricity generation and distri- ing machinery, automobiles, information bution. Furthermore, in most high-income C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 107 Box 1.8  Entry, exit, and “creative destruction” 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. countries, vibrant competition and extensive to government-allocated resources such as private participation now exist even in sectors bank credit (see discussion of financial sector that China has deemed “strategic,” such as below). This greater predictability and cost coal mining and air transportation. Most, if advantage has allowed SOEs to undertake not all, of China’s current “basic and pillar” longer-term investment and maintain greater industries are inherently competitive, and slack in the form of inventories. In contrast, their counterparts in high-income countries less effective property rights protection and are not (or are no longer) subject to high lev- less access to government-allocated resources els of government ownership. Thus, adminis- has forced nonstate firms to take a shorter- trative barriers may be precluding significant term perspective and focus more on low-cost efficiency-enhancing competition in China. production and market-allocated resources. Policies that create an unlevel playing field or increase the uncertainty faced by busi- Industrial Interventions nesses further limit efficiency gains. As a result, state and nonstate firms coexist while Finally, since the late 1980s, the Chinese behaving differently in the face of very dif- authorities have implemented extensive inter- ferent incentives, leading to distortions in ventions, including industrial administrations resource allocation. While nonstate firms and industrial policies. Industrial admin- have driven China’s rapid economic growth, istrations include administrative approval less efficient SOEs remain in business. In a (shen pi) or reporting (bei an), administra- detailed examination of the relative perfor- tive inspection, mandatory closure of busi- mance of these two groups of firms (using ness, and other controls on firms that are China’s industrial census data), Li and Xia deemed to have inappropriate industrial (2008) seek to explain how firms with differ- activities. Industrial policies are more formal ent ownerships deploy resources and formu- than industrial administrations but they are late strategies to achieve their goals. While often connected. In broad terms, industrial nonstate firms outperform SOEs in labor interventions are designed to affect the allo- productivity, cost control, and profitability, cation of resources among economic activi- SOEs have had better and more stable access ties (across or within sectors) to achieve a 108 china 2030 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. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 ­ hazard 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 r­ egulatory 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 nomic growth during the past three decades. 80 The banking system has mobilized sufficient national savings to meet high investment 60 % owned demand by firms and local governments. Its 40 extensive branch network, perceived stability by depositors in state-owned banks, reason- 20 ably stable inflation, and high household sav- ings rate, among other things, have contrib- 0 China India Brazil Russian Korea, uted to this successful role. Federation Rep. The past decade has also witnessed impor- tant progress in reforming and restructuring Foreign Private Public the financial system. There has been prog- Source: World Bank Financial Regulation and Supervision database. ress in interest rate liberalization. Reforms in Note: The figure shows the share of banking sector assets held by the governance of state-owned commercial majority-foreign, private domestic, and state-owned banks. 116 china 2030 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 a strong regulatory framework to moni- 40 tor, measure, and mitigate risks across the 20 financial services industries; in the rapid growth of shadow banking activities that, 0 while providing useful channels to those China Russian Japan Korea, Brazil India United Federation Rep. States underserved segments of the economy, are largely out of the official oversight; Stock market cap Government bonds and in the large overhang of local govern- Nongovernment bonds Bank credit ment debts mentioned earlier. A major Sources: Bank for International Settlements, China Securities Regulatory Commission, IMF component of the financial safety net—the International Financial Statistics, World Development Indicators. deposit insurance scheme—has yet to be C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 117 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 119 Box 1.9  Improving the effectiveness of the state-ownership functions in the financial sector 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 ­China’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. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 123 Box 1.10  Establishment of a deposit insurance scheme 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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- (Box continues next page) 130 china 2030 BOX 1.11  (continued) 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 131 Box 1.12  Legal and policy framework: International perspective 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 133 Box 1.13  Land markets: International perspective One key pillar of economic development in high- land market. In addition to the different use s ­ ectors, 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 Box 1.14  Land institutions: International perspective 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. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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 Box 1.16  Land policies to promote rural-urban integration in Korea 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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. Box 1.17  Land valuation and taxation: International perspective 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. Annex 1A  Why Did China Grow So Fast? A wide range of factors contributed to Chi- institutions from the more advanced coun- na’s rapid growth. These can be viewed tries and thereby innovate and upgrade its from three different perspectives: “growth industry at low cost and risk (Lin 2010). accounting”; a review of exogenous fac- Lee and Hong (2010) find evidence that tors that favored growth; and a discussion such forces were at work. of the role of domestic policies and physical • A high initial level of distortions. The investments.47 Chinese economy of 1978 was heavily First, China’s grow th performance distorted by previous policies that played reflected strong contributions from labor and to the country’s comparative disadvan- capital accumulation as well as total factor tages. To achieve its aim of developing productivity (TFP) growth. Favorable demo- large, heavy, and advanced industries, the graphics, especially during the early reform ­ government was forced to protect such period, generated a large “dividend” in the activities through various distortions, form of a labor force that grew faster than including suppressed interest rates, low the overall population. Second, very high input prices, and an overvalued exchange and rising investment rates, supported by rate (Lin 2010). This left a sectoral and even higher and more rapidly rising savings spatial misallocation of resources, as well rates, allowed rapid capital accumulation. as a closed economy with limited links Over time, a gradual decline in the labor to the rest of the world. While negative contribution was broadly compensated by in their own right, such distortions also the effect of a rising investment rate. Third, create greater scope for increases in TFP by World Bank staff estimates, TFP growth through policies aimed at their removal. (including the contribution from improve- • A supportive external setting. The global ments in human capital and factor realloca- environment for much of this period tion) remained in the range of 3–4 percent (Vincelette and others 2011) and the a year, which is exceptionally high by world structural shift to more globalized forms standards.48 of industrial production (Yusuf and Second, China’s rapid growth was sup- Nabeshima 2010) both worked in China’s ported by three broad sets of exogenous fac- favor as it pursued a strategy of open- tors. These were: ing to the rest of the world. This process included China’s accession to the World • The potential “advantages of backward- Trade Organization (WTO) in 2001 and ness.” Under the “opening-up policy,” associated changes in tariffs and other China was able to borrow technology policies, as well as a gradual opening to and models for social and economic foreign investment. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 141 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 Annex 1B  China’s Industrial Policies: Key Actors and Defining Characteristics China’s industrial policy interventions are Commission (NDRC), the Ministry of Indus- currently implemented by three broad classes try and Information Technology (MIIT), and of actors: high-level national bodies, central others. For example, the “Guiding Catalogue government departments, and subnational of Industrial Structure Adjustment” and (provincial and local) governments and their “Catalogue of Industries for Guiding Foreign departments. In turn, they are influenced by Investment” periodically issued by the NDRC other stakeholders, such as industrial associa- are comprehensive policies, identifying indus- tions and firms themselves.49 tries to be “encouraged,” “restricted,” or The main high-level bodies include the “prohibited.” The NDRC also issues indus- State Council, the National People’s Con- trial policy guidance for specific sectors. For gress (NPC) and the Communist Party of its part, the MIIT has formulated “Opinions China (CPC). The State Council can issue on Promoting the Merger and Reorganiza- comprehensive multisector documents or pol- tion of Enterprises,” which was released by icy guidance for a single sector, with the aim the State Council in 2010. The role of sub- of promoting a particular structure across or national authorities and their departments is within industries. Laws enacted by the NPC discussed in the main report. can include elements of industrial policy with Currently, China’s industrial policies have significant impacts on certain industries. seven defining characteristics: Finally, “work reports” to various national congresses of the CPC have included impor- 1. They are scale-oriented, that is, they are tant strategic guidance (for example, on the focused on the development of larger selection of “pillar industries”), which has enterprises. For example, in 1993, the laid the ground for follow-up implementation central government announced a strate- measures. gic restructuring of state-owned enter- Several central government depart- prises, including through establishment ments release related policies in accordance of large-scale enterprise groups. In with their responsibilities. These include 1997, the 15th National Congress of the the National Development and Reform CPC issued the “Restructuring Major 142 china 2030 Enterprises and Relaxing Control over 4. Policies to encourage technological Smaller Ones” strategy to develop large- advancement have had industrial policy scale enterprise groups. Since 2000, “ful- dimensions. Such policies have included filling large enterprise group strategy requirements to use specific local technol- in key industries” became a central ele- ogies; for example, one large mobile tele- ment of China’s industrial policy. Specific communications operator was required instruments include formulating a scale- to use the indigenous TD-SCDMA 3G oriented industrial development plan and technology. Some such technologies have establishing examination and approval scale economies that preclude their use by conditions that limit entry while favoring smaller producers, thus tilting the playing large incumbents (Jiang and Li 2010). field toward larger firms. 2. They have sought to control the expan- 5. Industrial policies have relied heavily sion of sectors deemed to have excess on direct administrative intervention capacity. As early as the 1980s, when the to shift resources from prohibited to basic thrust of policies was the promo- preferred sectors. While market mecha- tion of industrial expansion, some sectors nisms also play a role, the authorities were already identified as having excess often use very direct means to “close capacity; these sectors included textiles, down, suspend operation, merge and automobiles, and home appliances. In shift” resources. These have included the 21st century, curbing the develop- market access controls, project examina- ment of industries with excess capacity tion and approval, land supply approval, has become a central pillar of China’s loan approval, industrial guidance industrial policy, especially in periods of catalogue, and compulsory elimination macroeconomic adjustment. Since 2007, of outdated production capacity. sectors targeted by the State Council as 6. They have often featured joint action by “controlled industries” included iron and many government divisions. For exam- steel, textiles, aluminum, coal chemicals, ple, the September 2009 “opinions on flat glass, caustic soda, cement, solar poly- inhibiting excess capacity and redundant silicon, shipbuilding, chemicals, solar, construction on some industries to guide and wind power. In such sectors, new the healthy development of industry” entry can be restricted, capacity expan- was jointly promulgated by 10 central sion projects might not be approved, com- ministries and commissions. It required panies can face prohibitions on financing joint action by departments for indus- through corporate debt and initial public trial management, quality management, offerings, and outdated production capac- investment management, environmental ity can be targeted for elimination. protection, land management, finance 3. They have aimed to concentrate sectors management, and local governments. deemed to be too fragmented. During 7. These policies have been pursued at each the 11th five-year-plan period, the gov- level of government, often at cross pur- ernment vigorously encouraged stron- poses. For example, while the central ger enterprises to acquire weaker firms government may aim to consolidate a sec- and took other measures to encourage tor nationally, each province may seek to concentration. Subsequently, documents make this sector a “pillar industry” for from the “restructuring and revitalization its own economy. With over 30 provinces plans of ten industries” have all noted the and many more subprovincial authorities need for “enhancing industrial concentra- involved, the degree to which a particular tion.” Some provincial governments have sector is ultimately favored or discour- in turn used such resolutions as a policy aged becomes hard to discern. foundation to promote a similar concen- tration of their own sectors. C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 143 Annex 1C  Unbalanced and Incomplete Financial System Although quantitative measures of financial and insurance companies have grown, they depth seem to indicate that for the most part are dwarfed by the banking system. The China’s financial system is on par or even banking system itself is unbalanced, with the ahead of its economic development, the finan- state-owned large commercial banks hold- cial system is still unbalanced and incomplete ing over half of banking sector assets (table (figure 1C.1). Although securities markets 1C.1). While that share has been declining, Figure 1C.1  Select indicators of financial sector size/depth, 2009 a. Bank credit to private sector b. Stock market capitalization 300 250 250 200 200 % of GDP % 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 c. Government bonds outstanding d. Nongovernment bonds outstanding 200 200 180 180 160 160 140 140 120 120 % of GDP % 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 e. Life insurance penetration, premiums f. Non-life insurance penetration, premiums 12 6 10 5 8 4 % of GDP % 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 Sources: WDI, IFS, BIS, AXCO. 144 china 2030 Table 1C.1  Share of banking sector assets by type of bank Percent  Institution 2003 2004 2005 2006 2007 2008 2009 2010 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. Table 1C.2  Size of financial sectors or markets as a share of GDP Percent Assets of Assets of Assets of Government Financial Corporate Stock   banking insurance securities bonds bonds bonds market institutions companies companies outstanding outstanding outstanding capitalization 1999 137.0 2.9 — 11.8 7.2 0.9 29.5 2000 138.5 3.4 — 13.1 7.4 0.9 48.5 2001 145.4 4.2 — 14.2 7.8 0.9 39.7 2002 169.8 5.3 — 14.8 8.2 0.5 31.9 2003 179.7 6.7 3.6 18.0 8.7 0.7 31.3 2004 175.0 7.5 2.1 22.4 9.1 0.8 23.2 2005 175.2 8.3 — 27.3 10.8 1.7 17.5 2006 204.0 9.1 — 28.9 12.1 2.6 41.3 2007 179.6 10.9 6.5 32.4 12.7 3.0 123.1 2008 204.3 10.6 3.8 31.3 13.4 4.1 38.6 2009 237.8 11.9 6.0 29.3 15.1 7.1 71.6 2010 241.6 12.7 4.9 28.1 15.0 8.6 66.7 Sources: China Bank Regulatory Commission, China Insurance Regulatory Commission, China Securities Regulatory Commission, Securities Association of China, Bank for International Settlements. Note: Government bonds outstanding include both Ministry of Finance securities and Central Bank bills or notes. 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). C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 145 Figure 1C.2  Funds raised in the financial system (1993–2009) 100 80 60 Percent 40 20 0 –20 1993 1995 1997 1999 2001 2003 2005 2007 2009 Equities Corporate bonds Financial bonds Treasury bonds Bank loans Source: China Securities and Futures Statistical Yearbook. Annex 1D  Experiences of Japan and the Republic of Korea in Financial Liberalization In both Japan and the Republic of Korea, financed by issuing larger volumes of govern- financial liberalization was initiated by inter- ment bonds. This led to the initiation of inter- nal and external pressures. But the authori- est rate liberalization on government bonds ties were reactive, rather than proactive, to and certificates of deposit as holders of those developments. Institutional and governance instruments required market-based interest, reforms in banks, firms, and regulatory bod- which also had to be applied to other interest ies were very slow or even absent, leaving rates to reduce the regulatory arbitrage. fertile soil for moral hazard while interest Second, the internationalization of Japa- rate deregulation and capital market opening nese firms’ operations required the domestic was in progress. In the process, regulatory financial system to support the expansion of arbitrage and risk were increasing. This ulti- their international business, by among other mately led to financial crisis, which had to be things hedging risk exposure and meeting dealt with at huge public cost. financing requirements in foreign currencies. In Japan, three main internal and external This spurred the relaxation of the foreign forces led to financial liberalization. First, as exchange system and increased entry by Japa- the period of high economic growth reached nese financial institutions into international an end in 1974, the corporate sector’s invest- financial centers by establishing branches ment demand slowed, and firms started to and subsidiaries. Once Japanese firms were accumulate surplus funds. The household able to issue debt abroad, and Japanese finan- sector had also accumulated substantial cial institutions could make investments in financial assets (deposits) by this time and foreign assets more freely, Japanese house- started to seek assets with higher returns holds’ savings started to find their way to than bank deposits. At the same time, gov- the purchase of (Euroyen) bonds issued (at ernment budget deficits, which had expanded uncontrolled interest rates) by Japanese com- as economic growth slowed, had to be panies through Japanese banks and insurance 146 china 2030 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e 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- ­ avings- tal is determined endogenously by the s 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 C h i n a : S t r u c t u r a l R e f o r m s f o r a M o d e r n , H a r m o n i o u s , C r e a t i v e S o c i e t y 149 and 11 percent of high-income-country and comprehensive or single-sector policy averages. documents. 20. This includes central government debt of 29. The latter policy is implemented by bodies RMB 6.75 trillion and subnational govern- such as the General Administration of Qual- ment debt of RMB 10.7 trillion. Of total ity Supervision, Inspection, and Quarantine; subnational government debt, 62.6 percent is the State Food and Drug Administration; explicit debt, 21.8 percent is contingent debt and the State Administration of Work Safety. (guarantees), and the subnational govern- Such inspections and reorganizations can ments have only limited rescue responsibility bring significant restructuring within sectors. for the remaining 15.6 percent. For example, in April 2011, many of China’s 21. The big three metropolises directly admin- dairies were shut down after having their istered by the central government (Beijing, licenses revoked. Shanghai, and Tianjin) have very small 30. See, for example, State Information Center county-level governments. (2007), Ou and Liu (2007) on the NDRC, 22. Jia Qinglin, “Remarks in the 3rd Conference and Yuan (2010). of Commending the Outstanding Builders 31. See, for example, Shi and Wang (2011), Jiang of Chinese Characteristic Socialism in the (2010), and Yang (2004). Private Sector,” People’s Daily, November 7, 32. At that time, the central government issued a 2009. policy aimed at eliminating outdated plants 23. “Bamboo Capitalism.” The Economist, and reducing some capacity in that indus- March 11, 2011. try. Measures included mandatory closure of 24. For example, Ferri and Liu (2009) find that outdated plants, subsidies for restructuring the cost of debt is significantly lower for and equipment replacement, and preferential SOEs, even after controlling for individual placement for fired workers. firm features. They estimate that had SOEs 33. Similar cases can be found at the provincial paid the same loan rates as otherwise equiva- and local level. For example, some local gov- lent private firms, the additional interest pay- ernments regarded the software industry as a ment would have wiped out their profit in local pillar industry and implemented prefer- 2004 and 2005, the two last years in their ential policies more than 10 years ago. How- sample. ever, the software industry remains weak in 25. However, in some sectors such as telecoms, many of these localities. the splitting up was along geographic lines, still leaving a single dominant provider in any 34. Some automotive firms favored by indus- given area. trial policy, such as Tianjin Xiali, Guang- 26. For example, in 2006, all of petroleum, zhou Peugeot, and Beijing Jeep have in fact natural gas, and ethylene production, SOEs declined, while nationally less favored firms controlled all basic telecoms services, about such as Geely, BYD, and Chery have grown. 55 percent of electricity generation, and 82 35. The government can use state ownership as percent of airline and air cargo traffic (Owen a policy tool to launch its industrial strategy, and Zheng 2007). especially as SOEs can become excellent plat- 27. Even if entry is allowed, and even beyond forms for accumulating resources in times of areas considered “strategic,” private firms economic prosperity. However, evidence sug- can face a range of other disadvantages. gests that a persistently large-size state sector Ferri and Liu (2009) document significant can be harmful to efficiency and equitable advantages in borrowing terms for SOEs. competition in the long-term. In an overview of prospects for private air- 36. DRC staff calculation. lines in China, Pan (2010) documents other 37. See Schneider (2010) for a detailed discus- regulatory and financial advantages of SOEs, sion of EU “state aid” rules in the Chinese including in securing bailouts through capi- context. tal injections and in access to bank financing; 38. Controls take the form of directed credit and and Tian (2007) documents entry barriers in aggregate credit ceilings, floors for loan inter- the automobile industry. est rates, and caps on deposit interest rates; 28. Examples include sections of work reports to business decisions of financial institutions are CPC congresses, policy guidance for 5YPs, also controlled. 150 china 2030 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. 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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 breaking up and corporatization or exit of in pedagogical techniques, with greater use incumbent, mainly state-owned enterprises of multimedia and flexible online training (SOEs) in the 1990s strengthened competitive customized to the varying needs of students. pressures. More recently, the phasing out of That, in turn, will raise the productivity of tax incentives that had favored foreign inves- the education sector overall and maximize tors stimulated competition by leveling the the benefits from the limited pool of talented playing field with domestically owned firms. instructors and the available physical facili- China’s accession to the World Trade Orga- ties. The effectiveness of traditional standard- nization (WTO) in 2001 increased competi- ized approaches to training such as lectures tion from imports, and the large volume of to large classes may need to be reconsidered, foreign direct investment (FDI) has led to a with institutions being encouraged to experi- further intensification of competitive pres- ment with supplementary modes of partici- sures. Sustaining this trend through insti- patory learning and given the autonomy to tutional reforms and measures to enhance do so. the supply of risk capital will be critical to China’s spending on R&D is on a steep the making of an innovative economy, because upward trend. This spending will increase it will stimulate the deepening of the private the production of ideas and prepare the sector, reduce barriers to firm entry and exit, ground for innovation. But because most promote the growth of dynamic small and applied research and innovation are done medium enterprises (SMEs), prod the SOEs to within firms and because the majority of raise their game (and pave the way for further scientists will be employed by businesses, reform), and result in national market integra- the commercialization of ideas will flourish tion as well as much needed regional or local and drive productivity only when firms make specialization of industry. innovation a central plank of their business The speed with which advanced technolo- strategies. How quickly firms take advantage gies diffuse and the capacity to innovate will of the knowledge capital being created by be keyed to the availability of a vast range R&D will be a function of market growth of technical and soft skills such as manage- and competition, the quality of the work- ment, research, design and production, the force, and fiscal and other incentives that effective harnessing of information technol- prioritize research-intensive activities. Agri- ogy (IT) and of marketing and customer cultural research will also continue to con- relationships. By 2030, China is expected tribute substantially to productivity gains, to have up to 200 million college graduates, price stability, and food security. more than the entire workforce of the United An adequate volume of much-needed basic States. Moreover, university-level education research, by virtue of its public good charac- is improving—China now has 11 universi- teristics, will depend upon government initia- ties in the top-ranked 200 universities of the tives and funding. Government agencies, key world.1 Even so, the quality of tertiary edu- universities and research institutions, and cation more broadly is a matter of concern, some large corporations will need to take and some employers are experiencing a seri- the lead, especially in high-risk, blue-skies ous shortage of the skills required to upgrade research, through well-targeted incentives, processes and the product mix. For China to by committing a sufficient (and sustained) become an innovative knowledge economy, volume of funding to high-caliber institu- increased investment in human capital will tions, and by means of prizes and awards. In be critical to build analytical and complex the United States, the National Institutes of reasoning capabilities, enhance scientific Health have played a central role in boosting literacy and the knowledge base of students, ­ innovations in life sciences, as have agencies encourage creativity, and instill communica- such as the Departments of Defense, Energy, tion and teamwork skills. Raising the quan- and Agriculture and the Defense Advanced tity and quality of skills demands innovation Research Projects Agency (DARPA). China’s Grow th through Technologic al Convergence and Innovation 157 Increased publishing of scientific papers significant long-run spillover effects, the and patenting is likely to have only a small reputational gains for Chinese cities (a few of impact on productivity growth—even if which are fast becoming science hubs), and China is able to raise R&D spending to 2.2 the contribution such research can make to percent of GDP by 2020—unless the qual- industrial upgrading. Closer collaboration ity of this research and its commercial rel- and partnerships with multinational corpo- evance and uptake is substantially increased. rations on the basis of mutual trust and rec- Good research must be complemented by a ognition will contribute to the making of a stringent and disciplined process of evalu- dynamic and open innovation system. In this ation and refereeing of research programs context, an efficient and discriminating pat- and findings, with the feedback incorporated enting system that learns from the experience in policies. The research community needs of the U.S. and European systems (both of to take the initiative here to uphold ethics which are in the throes of reform) and effec- and set high standards, with public agencies tive protection of intellectual property, espe- providing the ground rules. Universities can cially in technologically dynamic fields such reach out more actively than public research as biotechnology, nanotechnology, software, institutes to the business community to and multimedia, will expedite the growth of maximize the relevance of the research con- China’s innovation capabilities. ducted and to serve the cause of learning by Smart cities will be the locus of technolog- promoting public lectures and exhibitions, ical innovation and of nascent green growth and contributing to the teaching of science in in China as in other advanced countries— local schools. Beyond that, it is up to firms and urban development strategy intersects to transform research findings into profitable with strategies for technology development products and services. and growth. Innovative cities take the lead in The central government can help build building large pools of human capital (espe- countrywide research networks to mobi- cially in attracting many science and technol- lize national talent and create consortia ogy workers) and in embedding institutions composed of firms from inland and coastal that support the generating, debating, test- areas to raise the technological levels of all ing, and perfecting of new ideas. Innova- participants through cross-fertilization. Gov- tive cities serve as the axes of regional and ernments in Japan, the United States, and even international knowledge networks; Taiwan, China, have successfully sponsored they derive technological leverage from an similar consortia, and they can help China industrial base that employs scientific and develop more firms that are “global chal- technological talent; they are home to a few lengers.” The domestic research networks leading, research-oriented firms and provide should be incorporated into global research a business environment conducive to the networks so that Chinese companies can multiplication of SMEs; and they invest in also participate in research conducted in state-of-the-art digital networks and online other parts of the world. Such participation, services. Such cities thrive on the heteroge- and with it the creation of global research neity of knowledge workers drawn from all networks, will be promoted by measures over the country—and the world. Moreover, that improve internal organizational and such cities are closely integrated with other technological capacities and by policies that global centers of research and technology minimize protectionist tendencies in other development. Finally, innovative cities are countries. “sticky” because their knowledge environ- Many high-tech multinational corpo- ment, physical and cultural amenities, public rations have invested in R&D facilities in services, and quality of governance attract China (including in inland cities such as and retain global talent. Xian and Chengdu). Such investment should International experience suggests that be encouraged because of its potentially stickiness derives in large part from the 158 china 2030 presence of world-class research universi- Purpose of the Chapter ties that China is committed to creating. China will need to endow its premier insti- China is determined to become a global inno- tutions with a measure of autonomy from vative powerhouse by 2020. 2 Policy analy- government not only to succeed in stimu- sis has shown that productivity gains from lating urban innovation but also to ensure structural changes3 and technological catch- that they are disciplined by competition and up4 will be largely exhausted within a decade indicators of performance and remain effi- and that thereafter, growth rates in the 6–7 cient providers of services. These universi- percent range will be increasingly tied to ties must interact with employers to impart productivity gains stemming from innova- technical and soft skills as well as the latest tiveness in its several forms.5 The purpose of industry know-how. China’s front-ranked this chapter is twofold: The first is to exam- schools must mobilize the funding and staff ine the scope for productivity gains even as faculty positions needed to sustain cross- the technological gap between China and disciplinary postgraduate and postdoctoral the advanced countries narrows and to sug- programs, introduce innovative approaches gest how China could hasten the pace of to imparting knowledge and analytical technological catch-up by creating a more skills, and establish specialized, well-staffed competitive economic environment and a research institutes, some of international world-class innovation system. The second is standing. An important contribution uni- to sketch a menu of policies that could help to versities can make to innovation is to groom make innovation a major driver of growth in the entrepreneurs of tomorrow who can the new phase of development. The two are transform ideas into commercial products closely interrelated. Policies that promote and services. technological catch-up over the medium run With a yearly influx of more than 10 overlap with those that can enlarge innova- million people to its cities, China needs to tion capacity over the longer term. optimize the planning of urban develop- The chapter is divided into four parts. The ment, build energy-efficient mass public first underlines the increasing significance transportation systems, provide affordable of total factor productivity growth (TFP) as housing, and inculcate sustainable urban life a source of growth,6 describes China’s per- styles. Smart and green urbanization will formance since 1980, and examines sectoral stimulate both research on and the com- trends. The second reviews China’s prog- mercialization of green technologies. Energy ress in building technological capacity. The pricing reform and enforcement of national third assesses China’s strengths and some of environmental and energy efficiency stan- the constraints hindering the development dards will create pressures to upgrade tech- of innovation capabilities. And the fourth nologies, and urban development will be is devoted to the discussion of national and the main venue for introducing new con- subnational policies that would enable China struction materials and technologies for to realize its ambition of eventually becoming transport, heating, cooling, and many oth- an innovative nation on par with the United ers urban needs. Demand-side instruments States,7 Japan, Germany, and Korea, albeit such as government procurement and stan- one capable of sustaining a higher rate of dard setting can also spur innovation. The growth than these mature economies. key to success, however, will lie in genuine open competition supported by sound and Growth Drivers: Betting on TFP responsive policy making. China may need to develop a culture that Among the larger East Asian economies, only encourages more people to boldly pursue three were able to transition from the middle- new ideas and to push the frontiers of knowl- income to the high-income category during edge across a variety of fields. the second half of the 20th century.8 Japan China’s Grow th through Technologic al Convergence and Innovation 159 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 Table 2.1  Sources of growth, 1978–2004 Annual percentage rate of change Contribution of: 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. Table 2.2  Sources of growth by industrial and services sectors, 1978–2004 Annual percentage rate of change Contribution of: 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 Figure 2.1  China’s communication infrastructure and mobile networks, 2002–12 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). Furthermore, full-time equivalent R&D for example) is yielding promising results personnel tripled, from 750,000 to 2.3 mil- (Hassan 2005; Bai 2005; Preschitschek and lion person-years, and the total number of Bresser 2010; Italian Trade Commission personnel engaged in S&T activities reached 2009; Leydesdorff 2008). 4.97 million in 2008. Some 6 percent of Chi- However, as yet, China has relatively few na’s 1,700 institutions of higher education high-impact articles in any field (Simon and are elite Project 211 entities39 responsible for Cao 2009; Royal Society 2011), although training four-fifths of doctoral candidates, according to the social science citation index, hosting 96 percent of key labs, and contribut- China’s citation ranking rose from 19th place ing 70 percent of the funding for university in 1992–2001 to 13th in 1996–2005 to 10th research. A total of 218 national priority labs place in 1998–2008 (Hu 2011, 102). now cover all the major scientific fields.40 Mirroring the trend in publications, the Between 1996 and 2000, China’s global number of patents granted to Chinese enter- science citation index ranking as measured prises dramatically increased from 5,386 by publications increased from 14th to 2nd in 1995 to 76,379 in 2006.42 The number place (Adams, King, and Ma 2009). The of patent applications to WIPO increased output of publications soared from 20,000 from about 23,000 in 1996 to 290,000 in in 1998 to 112,000 in 2008, equal to 8.5 2008 (Hu 2011, 103).43 A continuing sharp percent of global output of scientific publica- increase through 2009 propelled China to tions. A study conducted by Britain’s Royal fifth place in WIPO’s rankings, but again Society found that between 2004 and 2008, quantity has not yet been matched by the China produced more than one-tenth of the quality of the patents.44 Incentives to patent published scientific articles while the United (including incentives offered by provincial States, produced one-fifth, putting China authorities) have produced a flood of minor in second place (ahead of the United King- design and utility patents that contribute dom).41 Chinese research publications lead little to advances in knowledge or commer- the field in materials science, physics, chem- cial innovation. 45 Most of the high- and mid- istry, and mathematics. Moreover, Chinese value patents are being registered by multi- research in nanoscience (which is likely to national corporations (Boeing and Sandner affect the development of advanced materials, 2011, table 9).46 Triadic patent filings (with China’s Grow th through Technologic al Convergence and Innovation 165 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 Assets GEM (Growth Enterprises Market) in Shen- zhen has provided innovative firms with an In its pursuit of innovation as a driver additional channel through which to access of growth, China starts out with seven financing and to give investors an exit route. advantages: A fourth advantage derives from China’s First, the scale and wide-ranging capa- successful penetration of the global market, bilities of China’s manufacturing sector are increasingly complemented by the expanding reaching the point where products can be market of domestic urban middle-class con- reverse engineered and new product lines sumers (Cheng 2010; Kharas 2009). A large brought into large-scale production within domestic market attracts multinational cor- months.71 This is being aided by the co-loca- porations and innovators, allows domestic tion of R&D and manufacturing in China’s producers to attain scale economies, and per- leading industrial centers, which are pro- mits the formation of clusters and agglomera- viding the foundations of a robust innova- tions that contribute to the competitiveness tion system. Advanced countries faced with of firms. It tests and winnows products and a hollowing of their industrial sectors are services and rewards winners. China’s mid- rediscovering this complementarity: once dle class is expected to double in the coming manufacturing capacity is severely eroded, decade and to double again in the next (Bhidé the skills and capabilities undergirding inno- 2008; Zhou 2008).76 Foreign firms first vation are also imperiled.72 flocked to China because it was an attrac- Second, having expanded its education tive platform for low-cost manufacturing. system, China’s efforts to innovate will be During the past decade, however, the widen- buoyed by the large supply of scientific and ing Chinese domestic market (and weakening engineering skills, which is adequate to meet demand in their home markets) has added the demand for high-level skills. This demand to the appeal of investment in China for is likely to remain strong, unlike the case in their existing product lines and for new Japan, for example.73 Moreover, the increas- offerings. ing attention to the quality of schooling at Fifth is the pro-business, entrepreneurial all levels, including the programs to develop culture (staunchly backed by local authori- world-class universities,74 will reinforce the ties) in the Pearl River Delta, Zhejiang, benefits from supply (Yusuf and Nabeshima Fujian, and elsewhere that is supportive of 2010). Shanghai’s top-ranked performance small firms and start-ups. Entrepreneurship in the 2009 Programme for International is not synonymous with innovativeness (De Student Assessment (PISA) tests provided Meyer and Garg 2005), but it can become a an inkling of what can be achieved through precursor as ideas and opportunities multiply. focused attention to raising quality of pri- State sector reforms initiated in 1996–97 led mary and secondary schools.75 Similar prog- to the exit, privatization, restructuring, and ress in the quality of tertiary-level graduates corporatization of thousands of state and col- nationwide would provide a quicker boost to lective enterprises and galvanized the private innovativeness and productivity (Hanushek sector. Since then, there is ample evidence of 2009; Pritchett and Viarengo 2010). entry and exit of private firms and of small The third asset is the elastic supply of and medium publicly owned firms under con- patient capital to support innovative firms, ditions of often intense competition, local which are currently in need of risk capital, and foreign.77 This is conducive to innova- and new entrants attempting to commer- tion—initially, most firms are focused on cost cialize promising ideas. Venture funds and innovation and customization for the domes- China’s private and state-owned banks are tic market, but that can change. Companies meeting some of the demand, especially in such as Huawei, ZTE, and Suntech can serve the coastal areas of the country, but a gap as role models for other domestic companies in funding remains. The creation of China’s seeking to become more innovative. 170 china 2030 The sixth advantage is the potential Speed Bumps inherent in China’s still underdeveloped and relatively unproductive services sector. The These several advantages are counterbalanced technology and productivity gaps in ser- by a number of challenges and constraints: vices are particularly large as are the oppor- First, China’s macroeconomic policies tunities for innovation. With the services need to encourage the growth of the domes- sector expanding robustly and set to over- tic market rather than continue to focus take industry during the next decade, the industrial attention mainly on exports.80 An low-hanging fruit with regard to growth, increase in domestic household consumption p roductivity gains, and employment is ­ (currently accounting for a little over one- increasingly tilting toward the services, trad- third of GDP) will have a positive impact on able and nontradable. Thus far, services such indigenous innovation meeting the needs and as education and health care are largely non- desires of Chinese buyers. tradable, but IT-related and other techno- Second, China’s SOEs control a huge logical and process-related advances could amount of physical assets as well as human lead to breakthroughs. Indigenous innova- talent and have yet to realize their full poten- tions in marketing,78 online sales, after-sale tial for innovation.81 Lack of competition or services, and IT services, to name just a few, effective corporate governance means that are already on the rise, with many new firms some SOEs are indifferently managed and entering the market. If the trend strengthens less receptive to strategies that give primacy and leads to the emergence of a few national to growth through innovation.82 Even when giants as is happening in the United States SOEs invest in R&D—which many are doing and Europe (with increasing activity among under pressure from the state—the effort multinational corporations), and if inno- tends to be unproductive and poorly inte- vation intensifies (assuming no easing of grated with the rest of their operations. Com- innovation pressures), productivity gains in pared with smaller enterprises, the SOEs are services could begin to equal or overshadow not as efficient at converting resources into those arising from manufacturing.79 patents and innovations (annex tables 2A.12 Seventh, and finally, not only is China and 2A.13 for the industrial sector, annex urbanizing but, relatively early in the game, tables 2A.14 and 2A.15 for high-tech indus- some Chinese cities are realizing that the tries only).83 Annual growth of total factor productivity and growth of urban econo- productivity in the state sector averaged 1.52 mies will rest on the quality of life and the percent compared with 4.56 percent in the resilience of cities. These factors are a func- nonstate sector. 84 Extracting high returns tion of urban design, the adequacy and effi- from R&D requires managerial ingenuity ciency of hard and soft infrastructures, the and experimentation with organizational testing and adoption of green technologies, structures; incentives; integration of research, environmental quality, affordable housing, production, and marketing activities; and a and the effectiveness with which cities—or long time horizon. Many small and medium entire metropolitan regions—are managed companies complain that some large compa- and decisions coordinated. An urban devel- nies, including large SOEs and multinational opment strategy, the objective of which is corporations, are abusing their market power to build efficient, green, and innovative cit- by favoring their own connected companies ies, will create enormous opportunities for and excluding other companies. Such favorit- innovation in urban planning, metro trans- ism inhibits innovation by other companies. portation systems, and green technologies. Third, China’s universities, particularly Successful innovation will be a function the leading ones, are adding capacity and of both national strategy and its elabora- giving greater attention to research and its tion and regional implementation (Howells commercialization, but the procedures for 2005). recruiting faculty with superior qualifications China’s Grow th through Technologic al Convergence and Innovation 171 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 Figure 2.2   Shanghai R&D Public Service Platform Shanghai R&D Public Service Platform Science and Equipment Testing Base Industry Testing Entrepreneuring Technology Literature Sharing Cooperation Service System Service System Service System System System Professional Technology Management Scienti c Figure Resources Security Technology Transfer Service Decision-making Sharing System System Service System System Support System Source: Shanghai Municipality Science and Technology Commission 2006. 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 utilization, management, and protection of government-sponsored research and con- intellectual property, but it may be the only tests to develop particular types of technolo- country to have criminalized violations of gies would be to make the findings of this intellectual property rights. As more and research widely available. In the 1950s and more Chinese firms file court cases charg- 1960s, the research on electronics financed ing violation of their rights by other Chinese by the U.S. government was shared gener- firms, the awareness of intellectual property ously with private companies, which enabled protection will be further raised and protec- many companies to come up to speed and tion rendered more effective.118 Furthermore, become innovators themselves. the Chinese government has recently relaxed Although an increase of one percentage some government procurement restrictions point of GDP in R&D will be one strand of on multinationals, which should encourage China’s growth strategy, the enabling char- these corporations to establish R&D centers acteristics of the domestic macroeconomic in China. The government could also encour- and business environments will be decisive if age home-grown multinationals to partici- China is to maximize the longer term returns pate in international R&D and integrate into from R&D spending. Comin (2004) esti- global innovative networks.119 mates that in the postwar period, R&D con- tributed between three-tenths and five-tenths of a percentage point to productivity growth 7.  Strengthen Basic Research to Sustain in the United States. That higher R&D need Continuous Support for Innovation have only a limited effect on growth is also Central and provincial governments in China apparent from the experience of Sweden, Fin- are seeking to enlarge the share of basic land, and Japan (Lane 2009; Ejermo, Kan- research in universities and research insti- der, and Henning 2011). tutes as well as to raise the profile of R&D in firms, thereby building research capacity 8.  Create a Stringent and Disciplined throughout the country. 120 They are more Process to Evaluate and Referee likely to succeed by committing a sufficient Research Programs and Findings volume of funding and ensuring the continu- ity of funding, with the help of an enabling This is a difficult but unavoidable activity. As macro policy environment, and through Lane (2009, 1274) observes, “The relation a systematic evaluation of programs. The between science and innovation is nonlinear U.S. government proactively supported agri- in nature, with complex outcomes that can cultural research starting in the mid-19th vary substantially by discipline and are sub- century and even through the 1930s, most ject to considerable time lags. . . . Innovation public research funding served to promote is nonlinear because the demand side and the agricultural productivity. More recently, the supply side of ideas are inextricably inter- National Institutes of Health have played the twined.” It is an activity requiring initiative central role in the boom in the life sciences in from the research community, particularly the United States because they were and are in strengthening research ethics,121 institut- a source of large and stable funding, much ing strict penalties against plagiarism, and of it for basic research done in the universi- strengthening the independence and qual- ties. This funding financed countless research ity of the refereeing process.122 However, programs, trained thousands of PhDs, sup- the government could provide some of the ported postdoctoral students, and created parameters and adopt a different approach the depth of expertise that has enabled the to high-risk research (as is the case in the United States to become the leader in the field United States with the National Institutes of of biotech. TEKES and SITRA in Finland Health Pioneer and New Innovator Awards, have also contributed along similar lines. and the Department of Energy ARPA-E One way to maximize the spillovers from program123), which promises to break new China’s Grow th through Technologic al Convergence and Innovation 179 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 Emerging Priorities for The inexorable march of noncommunica- ble diseases is heightening concerns; these are Innovation now responsible for 80 percent of all deaths As per capita incomes rise, China’s spending and 69 percent of the disease burden—higher on health care will increase in parallel. The than in the advanced countries—and they health care sector will become an impor- threaten to significantly erode China’s eco- tant sector for China’s economic growth nomic gains (World Bank 2011). David Cut- and social development. In addition, as hun- ler (2003) has estimated that high-income dreds of millions of people emigrate from countries can expect health care costs to rise rural areas, developing green, smart, and by 5.7 percent of GDP just on the basis of 182 china 2030 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 Annex 2A  Annex Tables Table 2A.1  Annual TFP growth rate: Major industries, 1999–2004 Percent China Japan Korea, Rep. Construction −1.74 0.18 −1.06 Food and kindred −0.29 1.20 1.91 Products Textile mill products 0.16 1.56 1.65 Apparel 0.80 1.00 2.65 Paper and allied 1.47 0.57 1.57 Products Chemicals 0.60 1.94 −0.97 Stone, clay, and glass 3.70 2.09 3.48 Products Primary metals −0.28 1.53 −2.85 Nonelectrical 2.71 1.78 1.65 Machinery Electrical machinery 2.83 5.18 11.05 Motor vehicles 2.78 1.13 1.39 Transportation 4.94 1.80 9.15 Source: Ito and others 2008. Table 2A.2  Top USPTO patents by inventor resident in China, 2005–09 Percent Share of Class Rank Class title total patents 439 1 Electrical connectors 10.3 361 2 Electricity: electrical systems and devices 6.8 370 3 Multiplex communications 3.4 382 4 Image analysis 3.2 424 5 Drug, bio-affecting, and body treating compositions (includes class 514) 2.8 707 6 Dp: database and file management or data structures (data processing) 2.5 455 7 Telecommunications 2.1 438 8 Semiconductor device manufacturing: process 1.9 375 10 Pulse or digital communications 1.7 532 14 Organic compounds (includes classes 532-570) 1.4 435 17 Microbiology 1.1 385 Chemistry: molecular biology and optical waveguides 0.8 356 Optics: measuring and testing 0.6 280 Land vehicles 0.5 99 Foods and beverages: apparatus 0.2 123 Internal-combustion engines 0.2 180 Motor vehicles 0.1 Source: United States Patent and Trademark Office. China’s Grow th through Technologic al Convergence and Innovation 189 Table 2A.3  WIPO Patent Cooperation Treaty, share of international patents by sector, 2007–09 Percent Worldwide China Share of patents   Sector of technology / field of technology Ratio Ratio held by China Total 100.00 100.00 3.15 I Electrical engineering 29.48 53.14 5.67 1 Electrical machinery, apparatus, energy 5.20 5.38 3.25 2 Audio-visual technology 3.16 2.46 2.45 3 Telecommunications 4.61 11.33 7.73 4 Digital communication 4.69 25.76 17.28 5 Basic communication processes 0.87 0.78 2.84 6 Computer technology 6.37 5.11 2.53 7 IT methods for management 1.27 0.70 1.72 8 Semiconductors 3.31 1.62 1.54 II Instruments 16.23 7.86 1.52 9 Optics 2.96 1.59 1.69 13 Medical technology 5.90 2.72 1.45 III Chemistry 29.61 18.49 1.97 15 Biotechnology 3.61 1.98 1.73 16 Pharmaceuticals 37.67 4.55 2.34 18 Food chemistry 1.11 0.72 2.04 19 Basic materials chemistry 3.42 1.68 1.54 20 Materials, metallurgy 2.00 1.37 2.16 21 Surface technology, coating 2.04 1.08 1.67 22 Micro-structural and nano-technology 0.25 0.04 0.45 23 Chemical engineering 2.76 2.08 2.38 24 Environmental technology 1.51 1.20 2.49 IV Mechanical engineering 18.31 12.93 2.22 32 Transport 3.46 2.21 2.01 Source: China State Intellectual Property Office. Note: Under the WIPO approach, one application may have several IPC classes and may belong to different technology fields. In this case, every technology field will be counted. As a result, the sum of the total number of all technology fields could be larger than the total number of applications in the year. 190 china 2030 Table 2A.4  Sector composition of new entrants (legal unit) by established time, Guangdong, Beijing, and Zhejiang, 2008 Percent Guangdong 1996–2000 2001–05 2006–08 Manufacturing 29.03 35.71 32.84 Processing of food from agricultural products 0.84 0.58 0.32 Manufacture of foods 0.86 0.59 0.34 Manufacture of beverage 0.29 0.24 0.15 Manufacture of tobacco 0.01 0.00 0.00 Manufacture of textile 1.24 1.72 1.19 Manufacture of textile wearing apparel, footwear and caps 1.68 2.54 2.80 Manufacture of leather, fur, feather and its products 0.86 1.24 1.60 Processing of timbers, manufacture of wood, bamboo, rattan, palm, straw 0.46 0.54 0.61 Manufacture of furniture 0.97 1.02 1.16 Manufacture of paper and paper products 1.15 1.47 1.26 Printing, reproduction of recording media 1.52 1.67 1.00 Manufacture of articles for culture, education, and sport activity 0.62 0.67 0.55 Processing of petroleum, coking, processing of nucleus fuel 0.07 0.07 0.04 Manufacture of chemical raw material and chemical products 1.58 1.63 1.07 Manufacture of medicines 0.16 0.17 0.09 Manufacture of chemical fiber 0.04 0.06 0.02 Manufacture of rubber 0.33 0.45 0.43 Manufacture of plastic 2.56 3.21 2.89 Manufacture of nonmetallic mineral products 1.77 1.77 1.31 Manufacture and processing of ferrous metals 0.11 0.19 0.14 Manufacture and processing of nonferrous metals 0.26 0.40 0.33 Manufacture of metal products 3.22 3.87 3.75 Manufacture of general purpose machinery 1.15 1.57 1.51 Manufacture of special purpose machinery 1.09 1.64 1.87 Manufacture of transport equipment 0.70 0.80 0.56 Manufacture of electrical machinery and equipment 2.34 3.08 3.10 Manufacture of communication, computer, other electronic equipment 1.77 2.73 2.96 Manufacture of measuring instrument, machinery for cultural and office work 0.40 0.46 0.49 Manufacture of artwork, other manufacture 0.87 1.14 1.05 Information transfer, computer services, and software 1.41 2.78 3.52 Telecommunications and other information transmission services 0.25 0.43 0.55 Computer services 0.45 1.16 1.57 Software 0.70 1.18 1.40 Finance 0.23 0.29 0.37 Banking 0.08 0.01 0.05 Securities 0.04 0.02 0.01 Insurances 0.05 0.18 0.18 Other financial activities 0.06 0.08 0.13 Tenancy and business services 9.04 9.01 9.93 Leasing 0.10 0.17 0.20 Business services 8.95 8.84 9.73 Scientific research, technical service, and geologic perambulation 1.98 2.87 3.16 Scientific research and experiment development 0.30 0.63 0.92 Technical service 1.35 1.78 1.75 Scientific exchange and disseminate service 0.32 0.45 0.48 Geologic perambulation 0.01 0.01 0.01 Education 3.97 2.42 1.56 Source: Economic Census Yearbook, Beijing, Guangdong, and Zhejiang 2008. Note: The table shows the share of newly entering firms in each category for the stated period. For example, 29.03 percent of the aggregate newly entering firms established in 1996–2000 in Guangdong province were manufacturing firms. New entrants are only those surviving in the survey year; firms that closed before the survey year were not counted. The data reflect the time a firm was established and do not reflect a possible move from one industrial sector to another. The new entry of S&T firms might thus be underestimated if a large proportion of them changed their industry affiliation from traditional sectors to high-tech sectors China’s Grow th through Technologic al Convergence and Innovation 191 Beijing Zhejiang 1996–2000 2001–05 2006–08 1996–2000 2001–05 2006–08 14.65 10.64 6.36 51.22 48.98 42.98 0.49 0.26 0.14 1.25 0.75 0.55 0.53 0.29 0.19 0.50 0.33 0.27 0.20 0.11 0.05 0.65 0.46 0.31 0.00 0.00 0.00 0.00 0.00 0.00 0.33 0.21 0.11 5.30 5.78 4.86 0.95 0.76 0.69 2.22 2.34 2.30 0.09 0.06 0.06 1.78 1.40 1.32 0.20 0.22 0.24 0.75 0.78 0.82 0.46 0.44 0.42 0.55 0.58 0.63 0.38 0.28 0.21 1.77 1.45 1.20 0.62 0.41 0.21 1.85 1.56 0.89 0.17 0.11 0.05 1.01 1.04 0.88 0.14 0.06 0.02 0.05 0.04 0.04 1.07 0.66 0.24 1.86 1.53 1.05 0.30 0.18 0.06 0.29 0.21 0.13 0.02 0.01 0.01 0.21 0.23 0.14 0.10 0.06 0.03 0.69 0.58 0.44 0.75 0.48 0.25 3.72 3.74 3.26 1.02 0.84 0.43 1.82 1.73 1.41 0.05 0.06 0.02 0.40 0.41 0.35 0.11 0.09 0.03 0.52 0.50 0.40 1.40 1.13 0.63 3.59 3.39 3.09 1.28 0.90 0.56 6.46 6.64 6.00 1.05 0.80 0.43 2.30 2.41 2.18 0.51 0.43 0.20 2.87 2.65 2.73 0.87 0.64 0.41 4.43 4.07 3.79 0.70 0.52 0.25 1.18 1.22 1.11 0.58 0.43 0.21 1.23 0.87 0.66 0.28 0.20 0.20 1.84 2.09 2.01 4.86 6.80 6.69 1.11 2.40 3.15 0.74 1.05 0.92 0.18 0.20 0.21 1.78 2.23 2.23 0.56 1.60 1.98 2.34 3.52 3.55 0.37 0.61 0.96 0.24 0.40 0.47 0.18 0.30 0.59 0.05 0.01 0.04 0.05 0.03 0.03 0.05 0.04 0.05 0.01 0.00 0.02 0.06 0.21 0.18 0.04 0.09 0.14 0.09 0.14 0.20 0.08 0.17 0.40 12.77 17.38 20.13 6.45 6.12 8.68 0.71 0.68 0.72 0.16 0.20 0.38 12.05 16.71 19.41 6.30 5.91 8.30 6.68 7.53 8.69 1.74 2.21 2.63 0.63 0.79 0.75 0.17 0.18 0.22 2.67 2.93 2.74 1.05 1.30 1.23 3.32 3.72 5.12 0.50 0.72 1.17 0.05 0.08 0.06 0.01 0.01 0.01 1.89 1.85 1.66 3.24 2.04 1.31 192 china 2030 Table 2A.5  Number of patents in force in the high-tech industry, by industrial sector and registration status, 2009 Large Medium Small enterprises Share (%) enterprises Share (%) enterprises Share (%) Total 22,975 55.81 8,855 21.51 9,340 22.69 Manufacture of medicines 1,460 24.26 2,451 40.73 2,106 35.00 Manufacture of chemical medicine 795 32.41 967 39.42 691 28.17 Manufacture of finished traditional Chinese herbal medicine 646 29.16 1,031 46.55 538 24.29 Manufacture of biological and biochemical chemical products 10 1.32 284 37.47 464 61.21 Manufacture of aircrafts and spacecrafts 368 59.16 197 31.67 57 9.16 Manufacture and repairing of airplanes 367 69.11 113 21.28 51 9.60 Manufacture of spacecrafts 1 1.52 59 89.39 6 9.09 Manufacture of electronic equipment and communication equipment 17,120 69.70 4,178 17.01 3,264 13.29 Manufacture of communication equipment 14,000 89.68 770 4.93 841 5.39 Manufacture of radar and its fittings 12 24.49 31 63.27 6 12.24 Manufacture of broadcasting and TV equipment 83 27.04 66 21.50 158 51.47 Manufacture of electronic appliances 2,084 43.98 1,523 32.14 1,131 23.87 Manufacture of electronic components 328 18.50 848 47.83 597 33.67 Manufacture of domestic TV set and radio receiver 553 41.02 612 45.40 183 13.58 Manufacture of other electronic equipment 60 8.15 328 44.57 348 47.28 Manufacture of computers and office equipment 3,525 70.28 667 13.30 824 16.43 Manufacture of entire computer 2,630 94.47 108 3.88 46 1.65 Manufacture of computer peripheral equipment 437 27.96 444 28.41 682 43.63 Manufacture of office equipment 1 1.25 41 51.25 38 47.50 Manufacture of medical equipment and measuring instrument 502 10.14 1,362 27.50 3,089 62.37 Manufacture of medical equipment and appliances 112 7.85 322 22.58 992 69.57 Manufacture of measuring instrument 390 11.06 1,040 29.49 2,097 59.46 Source: China Statistics Yearbook on High Technology Industry 2010. Table 2A.6  Innovation inputs and outputs of industrial enterprises in China, by enterprise size, 2009 Percent R&D spending R&D personnel Share of patents in force Share of patents Share with as share of core as share of per RMB 100 million of in force per Size of enterprise R&D activities business sales revenue total employment R&D expenditure 100 R&D personnel Total 8.47 0.74 2.19 29.18 6.18 Large and medium 30.48 1.03 3.19 23.58 5.37 Small 6.16 0.28 0.99 61.90 9.27 Source: China Statistical Yearbook on Science and Technology 2010. Table 2A.7  Innovation inputs and outputs of industrial enterprises in the high-tech industry in China, by enterprise size, 2009 Percent R&D spending Share of patents Share of Share of as share of R&D personnel in force per RMB patents in force enterprises with Share with core business as share of total 100 million of per 100 Size of enterprise R&D institutions R&D activities sales revenue employment R&D expenditure R&D personnel Total 17.52 25.53 1.63 4.96 42.51 8.67 Large-sized enterprises 53.61 61.68 1.71 6.06 43.67 10.81 Medium-sized enterprises 40.82 46.81 1.81 4.87 28.01 5.22 Small-sized enterprises 12.01 20.42 1.12 3.58 74.03 10.11 Source: China Statistical Yearbook on Science and Technology 2010. China’s Grow th through Technologic al Convergence and Innovation 193 Table 2A.8  Foreign direct investment: capital utilized by industry, 2004–09 Industry 2004 2007 2009 Total 100 100 100 Agricultural 1.84 1.11 1.52 Agricultural: farming 0.89 0.47 0.80 Mining 0.89 0.59 0.53 Manufacturing 70.95 48.93 49.72 Textile 3.88 2.21 1.48 Chemical material and product 4.38 3.46 4.24 Medical and pharmaceutical product 1.11 0.72 1.00 Universal machinery 3.58 2.58 3.17 Special purpose equipment 3.13 2.77 2.74 Communications, computer, and other electronic equipment 11.64 9.20 7.63 Electricity, gas, and water production and supply 1.87 1.28 2.25 Construction 1.27 0.52 0.74 Transport, storage and postal service 2.10 2.40 2.69 Information transmission, computer service and software 1.51 1.78 2.39 Wholesale and retail trade 1.22 3.20 5.73 Accommodation and catering trade 1.39 1.25 0.90 Banking and insurance 0.42 10.79 4.77 Real estate 9.81 20.46 17.86 Leasing and commercial service 4.66 4.81 6.46 Scientific research, polytechnic service, and geological 0.48 1.10 1.78 Water conservancy, environment, and public utility mgt 0.38 0.33 0.59 Residential and other service 0.26 0.87 1.69 Education 0.06 0.04 0.01 Health care, social security and welfare 0.14 0.01 0.05 Culture, sport, and recreation 0.74 0.54 0.34 Public management and social organization 0.00 0.00 0.00 Source: CEIC database. Table 2A.9  Patent family applications by value and country absolute volume High value Intermediate value Low value Year China Germany United States China Germany United States China Germany United States 1990 5 2,139 5,784 51 10,101 40,232 27,343 32,021 40,232 1991 5 1,781 4,747 37 10,445 39,887 33,158 35,216 39,887 1992 7 1,727 4,696 59 10,614 42,843 43,215 38,082 42,843 1993 4 1,868 4,314 47 11,014 48,298 44,879 40,573 48,298 1994 5 2,056 4,200 69 11,766 55,841 42,237 42,400 55,841 1995 3 2,107 3,888 64 12,073 62,261 41,296 43,300 62,261 1996 4 2,100 3,980 74 14,003 61,888 46,287 47,106 61,888 1997 8 1,851 3,977 97 15,218 68,525 48,099 49,319 68,525 1998 6 1,836 3,799 121 16,349 65,965 50,476 51,057 65,965 1999 5 1,543 3,743 160 17,167 66,363 59,659 52,417 66,363 2000 2 1,421 3,312 269 16,807 65,797 74,843 51,879 65,797 2001 10 980 2,564 333 16,143 62,624 87,826 49,961 62,624 2002 15 644 2,361 461 14,896 59,977 109,524 46,721 59,977 2003 13 556 2,027 759 15,603 50,830 133,444 47,140 50,830 2004 27 629 2,142 1,347 17,345 49,273 147,734 50,054 49,273 2005 25 606 1,722 2,528 18,321 50,098 187,067 47,245 50,098 Sum 141 23,843 57,254 6,476 227,867 890,706 1,177,087 724,491 890,706 Source: Boeing and Sandner 2011. 194 china 2030 Table 2A.10  Regional and provincial productivity in China RMB 10,000/person 2004 2005 2007 2009 Eastern Region 3.625 4.137 5.359 6.518 Beijing 6.771 7.482 8.416 9.683 Fujian 3.171 3.516 4.627 5.642 Guangdong 4.371 4.757 5.873 6.996 Guangxi 1.296 1.508 2.158 6.996 Hainan 2.180 2.368 2.949 2.711 Hebei 2.481 2.912 3.843 3.834 Jiangsu 4.034 4.721 6.139 4.420 Liaoning 3.419 4.048 5.322 7.596 Shandong 3.041 3.623 4.934 6.946 Shanghai 9.938 10.696 13.905 6.220 Tianjin 7.373 8.662 11.671 16.192 Zhejiang 3.767 4.196 5.195 14.828 Central Region 1.890 2.201 3.004 3.937 Anhui 1.378 1.543 2.047 2.727 Heilongjiang 2.926 3.390 4.256 5.089 Henan 1.531 1.870 2.601 3.275 Hubei 2.176 2.436 3.341 4.285 Hunan 1.567 1.780 2.454 3.342 Inner Mongolia 2.984 3.742 5.632 8.526 Jiangxi 1.695 1.925 2.505 3.411 Jilin 2.799 3.293 4.821 6.144 Shanxi 2.422 2.831 3.699 4.600 Western Region 1.436 1.625 2.199 2.939 Chongqing 1.594 1.784 2.304 3.476 Gansu 1.277 1.435 1.966 2.408 Guizhou 0.774 0.893 1.201 1.671 Ningxia 1.802 2.023 2.873 4.120 Qinghai 1.772 2.030 2.836 3.787 Shaanxi 1.685 1.952 2.844 4.256 Sichuan 1.417 1.604 2.198 2.862 Tibet 1.634 1.789 2.227 2.610 Xinjiang 2.967 3.407 4.399 5.158 Yunnan 1.283 1.411 1.823 2.260 Source: China Statistical Yearbook 2005–2010. Note: Productivity is calculated by dividing regional GDP by region’s labor force. Table 2A.11  Domestic patents granted in different provinces in China, 2009 Eastern Region Central Region Western Region Beijing 22,921 Anhui 8,594 Chongqing 7,501 Fujian 11,282 Heilongjiang 5,079 Gansu 1,274 Guangdong 83,621 Henan 11,425 Guizhou 2,084 Guangxi 2,702 Hubei 11,357 Ningxia 910 Hainan 630 Hunan 8,309 Qinghai 368 Hebei 6,839 1,494 Shaanxi 6,087 Jiangsu 87,286 Inner Mongolia 2,915 Sichuan 20,132 Liaoning 12,198 Jiangxi 3,275 Tibet 292 Shandong 34,513 Jilin 3,227 Xinjiang 1,866 Shanghai 34,913 Shanxi Yunnan 2,923 Tianjin 7,404 Zhejiang 79,945 Source: China Statistical Yearbook on Science and Technology 2010. China’s Grow th through Technologic al Convergence and Innovation 195 Table 2A.12  Innovation inputs and outputs of industrial enterprises in China, 2009 Percentage R&D spending Share of patents Share of Share of as share of R&D personnel in force per RMB patents in force enterprises with Share with core business as share of total 100 million of per 100 Enterprises R&D institutions R&D activities sales revenue employment R&D expenditure R&D personnel Total 5.91 8.47 0.74 2.19 29.18 6.18 State-owned enterprises 10.61 14.12 0.69 2.63 17.92 3.71   Large SOEs 56.56 50.86 0.85 3.48 14.10 3.27 Private enterprises 6.38 4.07 0.39 1.22 43.42 7.44 Enterprises with funds from Hong Kong SAR, China; Macao SAR, China; and Taiwan, China 10.41 7.71 0.76 1.76 28.81 5.62 Foreign-funded enterprises 8.22 11.62 0.69 2.18 26.17 6.32 Source: China Statistical Yearbook on Science and Technology 2010. Table 2A.13  Distribution of innovation inputs 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 (%) Total 429,378 100.0 1,914.27 100.0 405.20 100.0 11,8245 100.0 State-owned enterprises 8,860 2.06 174.77 9.13 36.16 8.92 6,478 5.48   Large-size SOEs 419 0.10 119.64 6.25 27.75 6.85 3,913 3.31 Private enterprises 253,366 59.01 356.35 18.62 61.09 15.08 26,528 22.43 Enterprises with funds from Hong Kong SAR, China; Macao SAR, China; and Taiwan, China 33,865 7.89 198.82 10.39 38.80 9.58 11,179 9.45 Foreign-funded enterprises 40,502 9.43 284.39 14.86 68.65 16.94 17,965 15.19 Source: China Statistical Yearbook on Science and Technology 2010. 196 china 2030 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 (%) Total 27,218 100.0 474.63 100.0 96.84 100.0 41,170 100.0 Domestic 17,922 65.85 297.83 62.75 60.69 62.67 29,254 71.06   State-owned enterprises 469 1.72 26.32 5.54 5.37 5.54 1,178 2.86 Enterprises with funds from Hong Kong SAR, China; Macao SAR, China; and Taiwan, China 3,809 13.99 70.39 14.83 13.37 13.81 4,713 11.45 Foreign-funded enterprises 5,487 20.16 106.41 22.42 22.79 23.53 7,203 17.50 Source: China Statistics Yearbook on High Technology Industry 2010. Table 2A.15  Innovation inputs and outputs of industrial enterprises in high-tech industry in China, 2009 Percent R&D spending Share of patents Share of Share of as share of R&D personnel in force per RMB patents in force enterprises with Share with core business as share of total 100 million of per 100 Enterprises R&D institutions R&D activities sales revenue employment R&D expenditure R&D personnel Total 17.52 25.53 1.63 4.96 42.51 8.67 Domestic 18.32 27.11 2.97 7.32 48.21 9.82   State-owned enterprises 27.93 41.36 3.81 8.70 21.95 4.48 Enterprises with funds from Hong Kong SAR, China; Macao SAR, China; and Taiwan, China 16.30 22.92 1.13 3.29 35.25 6.70 Foreign-funded enterprises 15.73 22.18 0.83 3.16 31.61 6.77 Source: China Statistics Yearbook on High Technology Industry 2010. China’s Grow th through Technologic al Convergence and Innovation 197 Table 2A.16  Roles of various entities involved in Nation Innovation System The actions that the Institutions and policies that could Entities in NIS Primary objectives Incentive mechanisms entities should and could take influence the behaviors of the entities 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 Notes products, markets, sources of materials, new production processes, and new organiza-   1. As ranked by the Times Higher Educa- tional forms. To these, one can add design tion Supplement 2011. The list includes and marketing and the list can go on. Dodg- universities in Hong Kong SA R , son and Gann (2010, 11), in their portrait China. http://www.topuniversities.com of Josiah Wedgewood, the renowned serial / world - u n iver sit y- ra n k i ng s /qs -world innovator, maintain that the enduring truth -university-rankings-2011. about innovation is that it “involves new    2. This projection is found in China’s Science combinations of ideas, knowledge, skills and Technology Medium-to-Long Term and resources. [Wedgewood] was a master Plan. For more discussion and analysis, see at combining the dramatic scientific, techno- Lu (2006); Xu (2006); Zhang, Liu, and Lu logical and artistic advances of his age with (2008); and Lu (2009). An earlier book rapidly changing consumer demand. The by Sigurdson and others (2005) visualizes way in which [Wedgewood] merged tech- China as an emerging “technological super- nological and market opportunities, art and power.” See also Hu (2011, 95), who believes manufacturing, creativity and commerce, is that by 2020, China will be an innovative perhaps, his most profound lesson for us.” country and the largest knowledge-based According to a recent survey by Hall (2011), society in the world. product innovation was unambiguously    3. These are the findings of the Development more productive than process innovation. In Research Center’s study on growth pros- services, marketing, customer relations, and pects. More than 320 million workers the clever use of IT can be decisive. continue to derive their livelihoods from    6. Jones and Romer (2009) explain the large agriculture, and this number will shrink differences in per capita GDP among coun- as agricultural productivity grows. Thus tries with reference to both factor inputs and the transfer of workers from agriculture to the residual. However, they note that “dif- more productive services will continue to ferences in income and TFP across countries yield a productivity bonus for some time. are large and highly correlated: poor coun- However, once this transfer is largely com- tries are poor not only because they have less pleted, the increasing absorption of workers physical and human capital per worker than in nontradable services that historically have rich countries, but also because they use registered very small or negative increases their inputs much less efficiently.” in productivity, could slow future gains in    7. Lester (2004, p. 5) observes that the real productivity. Two recent papers question wellsprings of creativity in the U.S. econ- whether China is close to this so-called omy are the “capacity to integrate across “Lewis turning point.” Knight, Deng, and organizational, intellectual and cultural Li (2011, 597) maintain that “there is a sub- boundaries, the capacity to experiment, and stantial supply of migrants still available in the habits of thought that allow us to make rural China. . . . Rural workers will have sense of radically ambiguous situations and better opportunities to migrate for employ- to move forward in the face of uncertainty.” ment and older workers will have a stron-    8. This count excludes Singapore and Hong ger incentive to move with their families as Kong SAR, China, which also achieved central and local governments respond to high-income status but, because of their the economic need for a more settled urban small size, can shed very limited light on workforce.” This view is echoed by Golley policies for China. and Meng (2011, 571): “There is an abun-    9. Japan differs from the other two because dance of rural workers who appeared to be it was already an industrial power before under-employed with earnings well below World War II capable of fielding weaponry their migrant counterparts.” comparable to that of the Western nations.    4. Comin, Hobijn, and Rovito (2006) ascribe For comparative purposes, however, the Jap- the bulk of productivity differentials among anese experience remains relevant. countries to lags in the assimilation of   10. The Toyota Motor Company was among technologies. the pacesetters that borrowed techniques    5. In its original form as proposed by Joseph and ideas pioneered in the United States and Schumpeter, innovation embraced new adapted them to Japanese conditions. The China’s Grow th through Technologic al Convergence and Innovation 199 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 manufacturing, for example, but also to that University Press (http://www.nri.org.uk of autos, is a reduction in the number of science.html). See also Subramanian (2011) /­ defects, which is a function of worker skills on why China is well placed to regain its ear- and familiarity with the production process lier preeminence. Subramanian computes a and of the plant’s physical and organiza- dominance index based on a country’s GDP, tional capital. trade, and status as a creditor. He is of the   26. According to Felipe, Abdon, and Kumar view, that as of 2010, China might already (2010), as early as the 1960s, China was have pulled ahead of the United States and exporting 105 commodities (with compara- could be well in the forefront by 2030. And tive advantage) from the 779 commodities in this dominance could very likely extend to their sample, many more than either Korea the technological domain. or Brazil. By 2006, the number had risen to   31. Walsh (2003). Zhang and Long (2011) pro- 269, well ahead of Japan (192). Of these, vide detailed analysis on investment by mul- 100 products were from the core of the tinational corporations in R&D activities in product space. China continues to export, China. with comparative advantage, 69 labor-   32. See Gao, Zhang, and Liu (2007) on the intensive products; its exports of machinery efforts of Dawning and HiSense to cap man- have risen from 1 in 1962 to 57; it has lost ufacturing capability with own innovation. comparative advantage in less sophisticated   33. The companies listed in the Forbes Global metal products and gained it in products 2000 generate $30 trillion in annual rev- with higher PRODY, which is the average enue, equal to one-half the global GDP. income of a country associated with that China still has only limited representation good. China has also forged ahead with in this group—with less than 5 percent of telecommunication and electronic products the revenue. The Chinese firms making and office equipment. As a consequence, the headway in the sphere of manufacturing are unweighted PRODY of China’s core exports Haier, Lenovo, BYD, Huawei, and ZTE. rose from $14,741 in 1962 to $16,307 in Lenovo’s experience with the acquisition of 1980 to $17,135 in 2006. IBM’s personal computer business and that   27. Data collected by Thomson Reuters shows of TCL with the takeover of Thomson’s TV that China’s patent rankings by subsector arm suggest that the acquisition of large for- are highest for chemical engineering, where eign firms with brand names can bolster the it is second after the United States. The fortunes of ambitious Chinese companies if rankings are fourth or lower for other major they can muster the managerial expertise subsectors (Zhou and Stembridge 2011). to harness and grow the reputational capi-   28. The data generated by the Nature Publish- tal of the acquired foreign assets and cope ing Group (2010) indicate that Chinese with the challenges posed by transnational researchers are increasing their contribution operations. On Lenovo’s circumstances, see to genetics, clinical medicine, and structural “Short of Soft Skills: Lenovo’s Bid to Become biology. a Global Brand Is Coming Unstuck,” Busi-   29. As of 2012, Huawei had emerged as the ness China, June 8, 2009. The acquisition world’s largest supplier of telecom equip- of Volvo, the Swedish carmaker, by Geely, ment (in 2011, its revenues amounted to the privately owned, Hangzhou-based Chi- $32 billion), although Ericsson remains the nese manufacturer, will be another impor- leading producer of network infrastructure tant test case of whether a Chinese firm equipment; see “Huawei: The Company can turn around an ailing foreign company That Spooked the World,” Economist, and effectively sustain and capitalize on its August 4, 2012, pp. 19–23. See also Nolan reputation. (2012), who compares the relative (global)   34. See Price and others (2011) on the success standing of Chinese and other leading multi- of China’s efforts to reduce the energy inten- national corporations. sity of the economy by 20 percent during the   30. This leadership has been convincingly docu- course of the 11th Five Year Plan. mented by the series of volumes on China’s   35. Gao and Jefferson (2007) note that countries Science and Technology launched by Joseph appear to experience an “S&T take-off” Needham and published by Cambridge when their spending on R&D doubles as a China’s Grow th through Technologic al Convergence and Innovation 201 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   60. See also http://www.sts.org.cn/sjkl/gjscy (2002). Keller (2001a, 2001b) substantiates /data2010/2010-2.htm. earlier work by Jaffe and by others.   61. Lenovo and Haier now have the makings of   70. See Markusen (1996) on factors contribut- global brands (Nolan 2012). ing to stickiness in slippery space. Gordon  62. A full listing of national programs and and Ikeda (2011) find that the most innova- policy initiatives from 1980 onward can be tive cities combine scale with “Jacobs den- found in Lu (2008) and Liu, F. and others sity,” which maximizes informal contacts (2011). An overview of China’s S&T system among city dwellers. can be found in Swissnex (2011).   71. This development, noted by Stevenson-Yang  63. http://archive.itif.org/index.php?id=226. and DeWoskin (2005), is unusual and affects  64. http://w w w.innovationfordevelopment the value of intellectual property, the return report.org /supplement/Supplement_ ICI on manufacturing, and the speed with which _profiles2010.pdf. manufactures are commodified.  65. http://ec.europa.eu/research/innovation-   72. This was the message of a major study con- union/pdf/iu-scoreboard-2010_en.pdf. ducted in the late 1980s by a group from   66. The Chinese government formally adapted MIT (Dertouzos, Lester, and Solow 1989). the “Strategy for Raising the Nation by It is echoed in “When Factories Vanish, Relying on Science, Technology, and Edu- So Can Innovators,” New York Times, cation (Kejiao Xin Guo Zhanlue) in 1995” February 12, 2011; emphasized by Andy and established the State Leading Group on Grove in “How America Can Create Jobs,” Science, Technology and Education in 1998, Bloomberg Business Week, July 1, 2010”; headed by then-premier Zhu Rongji. and reflected in a recent report to President Obama by the President’s Council of Advi-   67. See Huang, Zhang, and Zhu (2008) on the sors on Science and Technology on Ensur- footwear cluster of Wenzhou. Other clusters ing American Leadership in Advanced producing cigarette lighters and eyeglass Manufacturing. frames have also flourished, but as wages   73. “Education: The PhD Factory,” Nature 472 have risen, foreign demand weakened, and (April 2011), 2776–79. credit tightened in 2011, the Wenzhou-based   74. The reforms under way to make Shanghai’s clusters have come under considerable stress Jiao Tong University into a powerhouse with weaker firms having to exit. Less well comparable to MIT are described by Wang, known is the industry in Hebei and Shan- Wang, and Liu (2011). The making of high- dong. The so-called Gaoyang model—and caliber universities is explained in detail by its resilience through decades of turmoil—is Salmi (2010) and Altbach and Salmi (2011). described by Grove (2006). See also Kaiser (2010) on how MIT was   68. Meisenzahl and Mokyr (2011) observe that transformed into a world-class university the innovations responsible for the indus- with strong links to business. trial revolution in Britain were the work of a   75. Students from Shanghai topped the list with small band of inventors and a limited contin- a score of 575 in science and 600 in math- gent of skilled craftsmen who helped realize ematics, and although the scores from a the industrial potential of the innovations. single city are not representative, the results Lane (2009) observes that San Diego owes demonstrate the potential China can exploit 40,000 jobs in the life sciences and 12,800 through improved schooling on a nation- jobs in electronics to the research of just four wide scale. Among the measures introduced scientists at the University of California, San by Shanghai to raise the quality of educa- Diego. tion are merit pay for teachers demonstrat-   69. Adams, Clemmons, and Stephan (2006). ing results as measured by test scores, the Jaffe and Trajtenberg (1996) used patent designing of a new curriculum to prepare citations to map the diffusion of knowledge. students for tertiary-level training, its man- Others have observed that patents are only dating for all schools, and rigorous testing one of the avenues through which knowl- (“Chinese Lessons for the U.S,” Bloomberg edge diffuses from universities. Certain Business Week, April 14, 2011). informal means of communication are of   76. In purchasing parity power terms, private greater importance (Agrawal and Henderson consumption per head in China was only a 204 china 2030 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). formed by business enterprises is interpreted 102. See Mathews (2000) on the formation and 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. 208 china 2030 References 10-052, Harvard Business School, Boston, MA. Adams, James D., J. 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Given the unsustainability of cur- Since 1978, China has been developing at rent economic growth in both China and an average growth rate of nearly 10 percent the world, a new approach to development a year. Over just three decades, it has devel- is needed. The concept of green development oped in one giant leap from a poor country is such an approach. Green development can into the world’s second-largest economy become a potentially transformative process after the United States. Great changes have for the economy, for society, for the environ- taken place in the quality of people’s lives. ment, and for the role of government. It is an If this trend continues, then by 2030, China opportunity, an open door. will have attained high-income status in an Green development is a pattern of devel- unprecedented short period of time. Some opment that decouples growth from heavy consider China’s transformation as an eco- dependence on resource use, carbon emis- nomic miracle. But given the negative con- sions, and environmental damage, and that sequences of growth, it is, at best, an unfin- promotes growth through the creation of ished miracle. For various reasons, changes new green product markets, technologies, are needed in China’s growth model. investments, and changes in consumption First, China’s development has resulted and conservation behavior.1 Green develop- not only in past high emissions, resource ment is based on three key concepts: eco- consumption, and environmental destruc- nomic growth can be decoupled from rising tion, but also in external, social, and regional greenhouse gas emissions and environmental imbalances. If these imbalances are not cor- degradation; the process of “going green” rected soon, they have the potential to precip- can itself be a source of growth; and “going itate economic and social crises. Reforms are green” is part of a virtuous circle that is needed, and green development forms part mutually reinforcing with growth. Green of those necessary reforms. As income levels growth is the means by which green develop- increase, the Chinese people are demanding ment is achieved. improved welfare, a cleaner environment, 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 Box 3.1   Examples of national green development strategies 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 Figure 3.1  Emissions of CO2 from energy, annually and cumulatively 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) Tons CO2 (billions) 8 China 2009 300 United States OECD Europe 6 United States 200 4 OECD Europe China Russian Federation 100 Russian Federation 2 India Japan India Japan ep. Korea, R Canada Brazil Canada Brazil 0 0 Korea, Rep. 0 5 10 15 20 0 500 1,000 1,500 Tons CO2 per capita Tons CO2 per capita 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. climate change is an important opportunity Box 3.2  Green development can help resolve to speed up economic restructuring as well as the dilemma of global emission reductions the transformation of China’s mode of devel- opment and to hasten forth a new industrial revolution” (State Council 2011). The 12th Traditional analysis shows that the benefits of cli- Five Year Plan (5YP) contains many impor- mate change mitigation are global, while the costs are tant prerequisites for China’s efforts to “go local. This asymmetry leads to difficulties in global green,” including completing the transition coordination of emission reduction. However, this analysis fails to include the broader local benefits that to market through private sector develop- accrue to mitigation investments, such as greater eco- ment and factor market reforms, increasing nomic efficiency and competitiveness and local envi- the share of consumption, shifting toward ronmental co-benefits. As governments acknowledge less emissions-intensive service industries, these broader local benefits, the challenge of global increasing the pace of innovation, and devel- emission reduction can begin to change from being a oping human capital. It also supports increas- strictly zero-sum game to one with greater win-win ing research and development (R&D) expen- potential. diture to 2.5 percent of GDP by 2015, among the highest levels of any country. Source: DRC Project Team on “Fighting Climate Change.” Transitioning to green development is critical to China’s economic competitive- ness in the future world economy. The core New Opportunities Arise of global competition lies in technological While the transition toward green develop- innovation. The 12th 5YP has a strong focus ment will not be easy, it will open the door on seven strategic industries—environmental to new opportunities. China’s government protection and energy efficiency, new energy, has already clearly stated that “addressing next generation information technology, Seizing the Opportunity of Green Development in China 221 biotechnology, high-end manufacturing, although that decoupling is much more clean-energy vehicles, and high-tech materi- complete in OECD countries (figure 3.2). als—which are all leading sectors for future Overall, the data show that high growth is growth. They are mostly all “green tech- compatible with lower carbon emissions, nologies” with high-value-added and export and that China and the other BRICS have potential. Growth in these areas will make an opportunity to compete by going further China’s economic structure more competi- down this path. tive. Nevertheless, while technological break- Even though the transition to green devel- throughs are essential for green growth, the opment is a long-term process, the next 20 transition to green development is a much years are a crucial strategic period for China more profound process than technological to seize the opportunity, gain competitive change. The transition will span manufac- advantages, and show global leadership. It turing and services, construction and trans- could catch up with and even surpass the port, city development and management, and United States and Europe on green measures. energy production and consumption. This If China does not seize this opportunity, is why green development would be a sig- however, then its economy will lock into a nificant break from China’s past pattern of high-emissions structure, lose competitive- development, cutting across all economic and ness, and face much higher low-carbon tran- social sectors. sition costs in the future. Mounting global evidence shows that As China positions itself to take advantage economic growth and carbon emissions and of green development opportunities, its vision pollution have already begun to decouple. can be defined by these major indicators: According to the United Nations Environ- ment Programme (UNEP), the carbon inten- • “Green” will become an important source sity of the world economy has dropped 23 of economic growth. The share of green percent since 1992. Since 1990, economic products and green services in China’s growth has increased faster than carbon GDP will be among the highest in the emissions for both the developed countries world. and developing countries, as represented by • China will become a world leader in key the five BRICS countries (Brazil, the Russian green technologies and business models Federation, India, China, and South Africa), and will be an important destination for Figure 3.2  Decoupling economic growth from carbon emissions worldwide a. OECD countries b. BRICS countries 320 320 280 280 240 240 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 Source: OECD 2011. Note: BRICS = Brazil, Russian Federation, India, China, and South Africa. 222 china 2030 commercializing many globally important luxury—but green development goes far low-carbon technologies. beyond the trade-off between growth and • China will have made real gains in low- the environment. New evidence shows that carbon development. The correlation the two goals—growth and a clean environ- between growth and carbon emissions ment—not only may be realized simultane- will be significantly weakened, and carbon ously but may be mutually reinforcing. When emissions will have peaked. it comes to climate mitigation, new literature • China will have adopted some of the developed by researchers in the United States world’s most stringent and wide-reaching (Acemoglu and others 2012), in Europe (Jae- environmental standards, penetrating all ger and others 2011), and in China (Zhang sectors of the economy and society. and Shi 2011) suggests it is possible to sig- • Similarly, China will have established a nificantly reduce emissions without reducing resource-efficient society. Its resource effi- long-term growth.3 ciency through all phases of supply, con- sumption, and recycling will be among the How Green Contributes to Growth highest in the world. • China’s cities will have low-carbon and Green development is primarily market smart transportation systems and build- driven. The prerequisite for green develop- ings. They will be livable by international ment is a sound market economy in which standards. the governmental functions to correct envi- • The quality of air, water, and natural eco- ronmental market failures through combined systems will have improved dramatically. policies, regulations, and investments. One The recovery of the natural environment can say that past unsustainable growth rep- will significantly improve both public resents the failure of government to fulfill health and natural assets. this role. Once these government actions • Low-carbon living will become wide - are introduced, the market will respond to spread and will involve all aspects of reduce environmental and social costs. Fur- people’s lives, from housing, to transpor- thermore, high-polluting, high-emitting, and tation, to food, to other consumer items. resource-intensive products will become less • The risks posed by climate change will competitive as their external costs are inter- be addressed through proactive planning nalized. These changes in relative prices will across all key sectors, including water, help push resources into industries and ser- agriculture, urban, and health. vices more consistent with green development objectives. To be specific, “green” is a source How can China turn this vision into real- of growth in three major ways. ity? What opportunities does transition to Source 1: Green transformation of tradi- green growth bring to China? How does tional sectors. A large number of existing con- going green make China more competitive? ventional techniques and management models How does it become a source of growth? can not only reduce energy use and emissions How does it improve the quality of China’s but also improve the level of corporate profit- economic growth? What advantages does ability. Although the greening of traditional China enjoy, and what obstacles? This chap- sectors may seem less dramatic and revolu- ter aims to answer some of these questions. tionary than the development of cutting-edge new technologies, it is clear that with infor- mation and financing, many energy-efficient Green as a Source of Growth investments are also cost-effective and yield This chapter identifies the potential oppor- high economic returns. These efficiency gains tunities of how green could be a source of are growth enhancing. growth. In the past, a clean environment has Source 2: Expansion of emerging green too often been considered an unaffordable industries. Emerging green industries Seizing the Opportunity of Green Development in China 223 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- Patent applications (3-year moving average) 12 ported by innovation and research, will likely 11 stimulate new low-carbon, resource-light, 10 and environmentally friendly technologies, 9 goods, and exports. In addition, increased 8 7 public awareness will help shift consumer 6 demand toward green products. 5 Source 3: Expansion of the service sector. 4 Services will also expand as a complement 3 to new green product markets and changes 2 in consumer preferences. Not only will the 1 rising share of services in GDP help reduce 0 1975 1979 1983 1987 1991 1995 1999 2003 2007 the economy’s carbon intensity, specialized services are likely to develop that specifically Wind power Fuel cells support green development. Examples of Electric/hybrid cells Ocean energy Solar photovoltaic Lighting energy e ciency such services are ecosystem services, carbon Building energy e ciency All technology sectors asset management services, carbon trading, and contract energy management. Source: Haščič and others 2010. Of course, whether green becomes a Notes: The figure shows total worldwide patent applications in EPO PASTAT database by dominant source of growth will depend to a priority date; it includes only claimed priorities (those patents for which an application is filed at an office other than the original “priority” office). great extent on future technological improve- ments, which are uncertain. Still, with stable green development policies, the pace of tech- nological innovation and investment will source of growth” (OECD 2011). According no doubt quicken, thus increasing the pos- to Jaeger and others (2011), if Europe’s emis- sibility of technological breakthroughs. For sions reduction target is raised from 20 per- example, between 1975 and 1997, growth in cent to 30 percent by 2020, Europe’s annual the number of patents for wind power, bat- rate of economic growth may increase by up tery technologies, electric vehicles, marine to 0.6 percent, generating 6 million new jobs power, solar power, and other green tech- and boosting investment as a share of GDP nologies was relatively slow. After 1997, from 18 percent to 22 percent. Beyond these with increased global awareness of climate economywide benefits, additional sector- change, more stringent environmental poli- specific benefits may also accrue (box 3.3). cies, and increased investment in renewable capacity coinciding with the signing of the Source 1: Green Transformation of Kyoto Protocol, the number of patents for Traditional Sectors green technologies increased dramatically (figure 3.3). Despite the unprecedented progress China Although green development is still in an has made in reducing the energy intensity early stage and the speed of development in of its economy over the past three decades, the future is highly uncertain, the oppor- a large gap between China and the high- tunities it presents are increasingly recog- income countries remains (figure 3.4). The nized. For example, the OECD’s latest Green energy intensity of China’s GDP, measured Growth Strategy points out that “green in terms of primary energy consumed per growth has the potential to solve economic unit of output, was equal to 390 tons of coal and environment problems and become a new equivalent (tce) per $1 million of output in 224 china 2030 Box 3.3  Further sectoral benefits of green development 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. Sources: World Bank analysis; IEA 2011b. 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) 600 to growth. For example, according to esti- 500 mates by McKinsey & Company, installing light-emitting diodes (LEDs) for lighting in 400 buildings could generate RMB 184 billion 300 ($25 billion) in annual financial savings a 200 year by 2030 compared to business as usual (measured in 2009 dollars). Improving pas- 100 sive heating and cooling in buildings through 0 design modifications could provide another 1990 1995 2000 2005 2009 RMB 44 billion ($6 billion). Industry was the China Korea, Rep. United States largest sectoral user of energy, accounting for Japan Germany World about 72 percent of primary energy demand in 2008 (NBS 2010b), and many efficiency Source: IEA World Energy Statistics and Balances. Note: Energy intensity is the energy used per unit of GDP; PPP = purchasing power parity. gains can be found there. All together, the potential for direct savings through efficiency gains in China could be as high as RMB 480 2009. By comparison, the primary energy billion ($65 billion) a year by 2030, if the full intensity of Germany’s economy was 173 tce technical and economic potential of these so- per $1 million.4 called “no-regret” options can be realized.5 Whereas some new green technologies The direct benefits of these options are cost, many other technology and manage- to reduce the amount of fossil fuels burned ment changes that can help narrow the per unit of economic activity. However, they gap between China and the high-income often have co-benefits that add further value Seizing the Opportunity of Green Development in China 225 Figure 3.5  No-regrets options for reducing CO2 emissions in China, 2030 Tons (millions) of CO2 abated 0 500 1,000 1,500 2,000 0 Install structrural exteriors that Use farm waste as fuel –50 reduce heating and cooling needs for cement making for buildings Cost reduction (US$/tCO2) Improve engines for light-duty vehicles Substitute clinker for additives in cement making Install better controls for district heating in buildings –100 Reuse waste heat to remove moisture from coal used to produce coke in steel making Install variable speed pumps in HVAC and water supply systems for buildings –150 Use waste gas to generate electricity for steel making Use more e cient appliances Install LEDs in buildings –200 Added bene ts to society of avoided Direct nancial savings from illness from air pollution “no regrets” options 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 a. Energy savings b. CO2 emissions reductions 500 1,400 450 1,200 Tons of coal equivalent (millions) 400 Tons of coal equivalent (millions) 350 1,000 300 800 250 600 200 150 400 100 200 50 0 0 2005 2010 2015 2020 2005 2010 2015 2020 Pulp and paper Nonferrous metals Building materials Power generation Textiles Petrochemicals Iron and steel Source: Feng and others 2011. 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 ($25 billion) a year in The rapid progress of clean energy tech- investment, assuming 20 gigawatts installed nologies is illustrated by the dramatic rise in Seizing the Opportunity of Green Development in China 227 Box 3.4  Detailed analysis of two industries: Cement and iron and steel Driven by an unprecedented construction boom Chinese cement makers have made impressive over the past decade, China’s iron and steel and strides, reducing the energy intensity of production cement sectors accounted for nearly one-fourth of by 30 percent between 1998 and 2009. While now the country’s total energy consumption in 2009. As more efficient than the U.S. cement industry and on the construction boom is expected to last well into a par with Europe’s, China’s cement industry is still the 2020s, demand will continue to grow (Zhou and 30 percent above the energy efficiency level set by others 2011; Fridley and others 2011). By 2030, the the world’s best practice cement technologies. amount of coal consumed to make steel and cement China’s iron and steel industry has farther to go could reach 926 million tons a year, an increase to reach the efficiency levels of industry leaders (fig- of 276 million tons (42 percent) over 2008 (NBS ure B3.4.1). By deploying the best available technolo- 2010b; Zeng 2010; Zhou and others 2011). gies, it could save more than 100 million tons of coal a year (IEA 2010a). Figure B3.4.1  Comparisons of iron and steel energy intensity 300 Ton of coal equivalent per US$ (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. Sources: World Bank analysis; IEA 2011b. 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 Japan dated that sulfur dioxide (SO2) emissions be United Kingdom reduced 10 percent nationwide from 2005 Korea, Rep. levels. This target was bolstered by addi- Spain tional standards set by the National Devel- Canada opment and Reform Commission (NDRC) Sweden and the Ministry of Environmental Protec- tion (MEP) for emissions from heavy indus- France try. As a result, China’s flue gas desulfuriza- tion industry has grown dramatically since China 2006. Annual installations of sulfur dioxide BRIC countries Russian Federation scrubbers on coal-fired power plants have Brazil increased at an average rate of 34 percent, India even with spotty enforcement of the new standards (China Greentech Initiative 2011). 0 500 1,000 1,500 2,000 2,500 3,000 By 2009, the desulfurization industry and Patent applications other environmental protection industries, More than 5 years ago Past 5 years including water treatment and solid waste disposal, were valued at RMB 480 billion Source: Chatham House 2009, cited in Feng and others 2011. ($74 billion) (Lan 2011). With stricter stan- Note: BRIC = Brazil, Russian Federation, India, and China. dards introduced under the 12th Five Year Plan, the government hopes that the environ- over the past two decades have exceeded any mental protection industry can grow to RMB other country (figure 3.7). As China contin- 2 trillion by 2015 ($310 billion) (box 3.5). ues to absorb and innovate new green tech- Green emerging industries also create nologies—supported in part by government exports and jobs. By 2030, the projected investment and policies—these technologies exports of green technologies and services will become increasingly competitive and specifically related to renewable energy and contribute to the country’s growth in the clean energy (mainly electric) vehicles is pro- upcoming years. jected to rise to RMB 1.691 trillion–2.916 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–$395 billion, measured Figure 3.8  Projected annual Chinese exports of green products in 2009 dollars) in export sales (figure 3.8) and services (2030) and lead to 4.4 million–7.8 million new jobs. These export sales are on the order of 6–10 200 percent of total projected exports, or 2–3 175 percent of projected GDP. Of course, this 150 US$ 2009 (billions) large scale-up is driven by global demand and 125 depends on decisive action to address climate 100 change by the world’s governments. 75 As a driver of growth, green clearly cre- ates jobs. But green also implies some higher 50 costs, industrial restrictions, and layoffs 25 as well as government actions that lead to 0 Wind Solar Other Clean energy Green changes in prices and production patterns. turbines photovoltaic renewables vehicles services The positive impact on employment is greater the longer the time frame being considered Existing policies Ambitious policies and the wider the definition of green jobs being used. A recent study under the China Source: World Bank calculations. Note: The ranges given above compare two scenarios defined by the International Energy Council of International Co-operation on Agency (IEA). The “existing policies” scenario is one in which the G-20 countries follow Environment and Development (CCICED through with their commitment to reduce fossil fuel subsidies, countries fulfill their Cancun Decision pledges to reduce greenhouse gas emissions, and other existing CO2 mitigation 2011) estimates that government spending of policies are implemented (that is, the “New Policies” scenario in IEA 2010b). The higher RMB 5.8 trillion ($910 billion) on measures estimates correspond to the scenario in which countries take ambitious action to prevent atmospheric concentrations of CO2 from rising above 450 parts per million (that is, the “450” to save energy, protect the environment, and scenario in the IEA 2010b). replace polluting industries with high-tech firms would create 10.6 million jobs over the next 5 to 10 years. In contrast, eliminat- increased exports of certain green technolo- ing the dirtier sectors of the economy would gies. Although approximate, all of these esti- lead to the loss of 950,000 jobs. The previ- mates confirm the notion that the net trade- ous paragraph noted that 4.4–7.8 million offs favor green as a source of job creation new jobs may be created by 2030 through (box 3.6). Box 3.6  The relationship between green development and employment 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 Source 3: Expansion of the China, where farmers on marginal lands are Service Sector paid to maintain the ecosystem rather than to sell wood or other crops. The green transformation will impact the China’s traditional service sector is lagging service sector in two ways. First, it will give and has significant room to develop. In 2010, birth to new green service industries, such the share of services in total value added as ecosystem services, carbon asset manage- was 43 percent, a figure that is much lower ment services, carbon trading, and contract than the average for high-income countries energy management. Second, it will sup- (75 percent), and even lower than in most port the country’s intended economic rebal- middle-income countries (52–54 percent in ancing away from heavy manufacturing and 2010) (World Bank, World Development toward a larger service sector. Both trends Indicators) (figure 3.9). are important for reducing China’s carbon Several reasons explain the low share of footprint, as its efficiency in manufacturing services in China’s economy. First, the level of may soon approach or even surpass the levels government public service is very low, partic- of high-income countries. ularly in the less developed regions. Histori- The emerging green service sector is cally, the role of government has focused on already important. According to a trade asso- facilitating economic growth more than on ciation of energy conservation service provid- providing social services. Second, government ers in China, at the end of 2010, the total overregulation and in some cases monopoly value of China’s energy conservation service has restricted development of the service industry was RMB 80 billion ($12 billion). industry and has inhibited the flow of private The industry reduced power consumption capital into these sectors. This is particularly by 10.6 million tons of coal each year and true in finance, insurance, navigation, rail- reduced greenhouse gas emissions by 26.6 way, telecommunications, petroleum, power, million tons of CO2 . Another important education, medical services, entertainment, trend is that ecosystem management services sports, and the arts. Third, China’s export- are a growing industry in some poor areas of oriented development strategy has meant Figure 3.9  Services, value added, as a share of GDP (2010) 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 Agriculture Industry Services Source: World Bank World Development Indicators 2011. Note: Agriculture corresponds with ISIC (International Standard Industrial Classification) Rev. 3.1 divisions 1–5, covering forestry, fishing, livestock production, and the cultivation of crops; industry includes divisions 10–45, covering mining, manufacturing, construction, and utilities; services are defined as divisions 50–99, which cover wholesale, retail trade, transport, government, financing, professional services, education, health care, and real estate. Data for France and Japan are from 2009. Seizing the Opportunity of Green Development in China 231 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 Box 3.7  China’s “Main Functional Area Development Plan” 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 Figure 3.11  Urban air pollution trends in China, 2003–09 a. Trends in PM10 b. Total value of excess mortality and morbidity linked to PM10 exposure 140 800 urban population weighted Concentrations µg/m3, 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 Source: World Bank analysis based on China Environmental Statistical Yearbook. Figure 3.12  Average annual SO2 and NO2 concentrations observed for the 10 largest cities in Japan and China, 1970–2009 a. Average annual SO2 b. Average annual NO2 300 140 Chongqing 250 120 Beijing 100 200 Shanghai 80 µg/m3 µg/m3 150 Japan, national average Japan, national average 60 Beijing 100 Chongqing 40 50 Shanghai 20 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 7 8 8 8 9 0 0 7 8 8 9 9 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 Box 3.9  The challenge of China’s water pollution 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 Buildings Replacing old bulbs with LEDs 24,992 2,364 Appliances 9,007 978 Efficient variable speed water pumps 3,453 750 Water heating 2,085 489 District heating controls 1,439 1,125 Efficient buildingsa 6,116 8,967 Transport Light-duty vehicles, efficient combustion engines 5,018 950 Industry Combined-cycle power plants (steel) 5,630 745 Coal moisture control (steel) 2,085 827 Utilizing or destroying coal bed methane (mining) 751 0 Clinker substitution (cement) 229 2,669 Agriculture/forestry Fertilizer management 2,280 162 Cropland management and restoration 1,112 0 Methane utilization 834 0 Total 65,030 20,027 Sources: World Bank analysis, based on McKinsey & Company 2009; NBS 2008a, 2009a, 2009b; Ho and Jorgenson 2003; Cao, Ho, and Jorgenson 2009; Liu and Wang 2011; Matus and others 2011. Note: Figures are expressed in 2009 dollars. For this table, a sector-by-sector estimate was made of the local environmental co-benefits associated with energy efficiency investments. These co-benefits include the avoided costs of respiratory illnesses due to reduced air pollution, which is correlated with reduced burning of fossil fuels. For some industries, such as iron and steel and cement, most greenhouse gas emissions can be attributed to burning coal. For others, such as the transportation sector, the emissions come mainly from burning oil. Since certain fuels are “dirtier” than others, reductions in use have different impacts on local ground-level air pollution. A Chinese Academy of Sciences study calculated the fuel mix used by each industry type (Liu and Wang 2011) and estimated how many units of coal, oil, and natural gas were saved by reducing greenhouse gas emissions with the technology options in the McKinsey marginal abatement cost curve (McKinsey 2009). Damage estimates were taken from studies done by Harvard and Tsinghua University economists (Cao, Ho, and Jorgenson 2009; Ho and Jorgenson 2003) of the marginal cost of increasing people’s exposure to higher concentrations of pollutants. The sum of the benefits from reduced coal, oil, and natural gas combustion for each abatement option gives the total estimated value of avoided illness. a. Includes passive design, retrofit packages for commercial buildings, and other design improvements. Seizing the Opportunity of Green Development in China 237 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. Table 3.3  A comparison of total environmental protection expenditures, 2001–09 As a share of GDP 2001 2002 2003 2004 2005 2006 2007 2008 2009 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 Annual crop losses due to drought in the Urban population (millions) in low-lying coastal areas Northern China plain and northeast prov- inces are projected to rise (Nelson, Ye, and d’Croz forthcoming). While warming will Sources: World Bank 2008; McGranahan, Balk, and Anderson 2007. Note: Low-lying coastal areas are defined as “the contiguous area probably hurt rain-fed agriculture in parts of along the coast that is less than 10 meters above sea level.” Seizing the Opportunity of Green Development in China 239 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 A destination for global investments and R&D in green 7.  should these arise. For example, long-term technologies glacier melt on the Himalayan plateau will Challenges generate both enormous challenges and Distorted prices of resource commodities 1.  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. Sector coordination failures 5.  6. Weak monitoring and enforcement of environmental Factors Favoring and Impeding standards, especially at the local level Green Development in China In pursuing green development, China enjoys Five Year Plan, in which the State Council a number of unique advantages that other (2011) makes clear that “addressing climate countries do not have. At the same time, it change will accelerate economic restructur- also faces unique challenges (table 3.4). The ing and the reform of economic development, largest of these challenges is not a lack of driving forward the opportunities of the next financing but rather a lack of incentive struc- industrial revolution.” tures to promote green development. If China Beyond expressions of commitment, can overcome these challenges in the next the government has demonstrated numer- two decades, then it could position itself as a ous times that it can take decisive action on world leader in green development. issues of high political and economic prior- ity. Reforms undertaken over the past three decades have fundamentally redefined the Factors Favoring Green Development functioning of the Chinese state in allow- in China ing the market to play a greater role. Green First, government has the ability to mobilize development is consistent with further mar- action on high-priority issues. China’s top ket reforms that promote efficiency, while leaders have already reached a high level of increasingly correcting for market externali- consensus on the importance of green devel- ties that can be addressed only with a proac- opment. As President Hu Jintao remarked in tive government. a speech at the November 2011 Asian Pacific Second, there is advantage in being a rela- Economic Cooperation summit, China is tive latecomer. Because developed countries committed to “vigorously developing the industrialized following a high-carbon model, green economy.” This commitment is also their economies have to a great extent been evident in the Work Program to Control locked into a high-carbon path. On the other Greenhouse Gas Emissions during the 12th hand, China and other developing countries 240 china 2030 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) 1,060 ity to implement decisions quickly suggests Net thermal e ciency (%) 1,040 that opportunities can be exploited ahead of 35 1,020 competitors. 34 1,000 Fourth, abundant capital (including 980 human capital) is available to invest in green 33 960 sectors. China has traditionally enjoyed high 940 rates of savings and investment (table 3.6); 32 it attracts more direct foreign investment 920 than any other country; it has built up an 31 900 impressive research and development infra- structure; and it will have more than 200 08 09 10 00 01 02 03 04 05 06 07 20 20 20 20 20 20 20 20 20 20 20 million college graduates within the next 20 China CO2 emission intensity (right axis) China e ciency (left axis) years. Clearly, China possesses an abundant United States CO2 emission intensity (right axis) amount of capital for green development that United States e ciency (left axis) can be put to work, often with government support, to develop sunrise industries. The Source: Yuan and others 2011. country is able to quickly acquire, adapt, and Seizing the Opportunity of Green Development in China 241 Box 3.10  China’s solar photovoltaic (PV) industry 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. Source: Li and others 2011. Table 3.6  Comparative national investment, savings, and consumption rates Percent of GDP Saving rate Investment rate Consumption rate (%) (%) (%) Country 1970 2008 1960 2008 1960 2008 Average of developed countries 27 20 26 22 75 79 Average of Russian Federation and Eastern European countries 26 25 31 27 70 69 Average of South American countries 22 24 23 24 76 74 Average of Asian and African countries 23 34 19 29 61 47 China 27 54 36 44 61 47 Source: World Bank World Development Indicators 2010. 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 sector—for lower emissions coal technologies policy incentives change dramatically. An given the right policy support (Shi 2008). electricity-generation plant has a lifetime of Sixth, China has the potential to avoid 30–40 years; its carbon footprint is fixed the lock-in effects of higher levels of urban- at the time it is built. Only if China adopts ization. Although China’s current level of green development policies sooner rather urbanization is low (47.5 percent) compared than later will it capture the lock-in benefits with high-income countries, that will change. of efficient buildings, cities, transport sys- During the 12th Five Year Plan period (2011– tems, and industries that use low-carbon, 15), the country is expected to invest $300 environmentally friendly technologies and billion in basic infrastructure. According to standards (figure 3.15). UN estimates, by 2030, about 65 percent of Conversely, high-carbon investments China’s people will live in cities (UN Popula- today will render it exceptionally difficult and tion Division 2009). expensive to achieve future emissions targets. The policy and investment choices made If negative lock-in effects occur, China will today and over the next two decades will have to either retire assets early, well before have long-lasting implications for efficiency, the end of their service lives, or purchase lifestyle, the environment, and carbon emis- emissions reductions elsewhere in the mar- sions. For example, if cities lack adequate ket. The incremental cost of going low car- public transit facilities, commuters have no bon now, by designing low-energy-intensive alternative but to resort to private vehicles. urban and transport structures, for example, As vehicle density increases, so does conges- is much less than the future cost to retrofit tion, which, in turn, sharply increases pollu- high-carbon cities to a lower carbon track. tion, including emissions of CO2 . Similarly, High-carbon power plants may not even be commercial and residential building design amenable to retrofitting. The prudent strat- will largely lock in energy needs for the life egy is to introduce forward-looking low-car- of the building, even if future price and other bon incentives now that lay the foundation 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 Emissions from road transport 20 4 Saudi Arabia in 2009 (tCO2 /person ) Australia Canada 15 United States 3 Australia Japan Russian Federation Iran, Islamic Rep. France Korea, Rep. 10 2 South Spain Germany Italy Africa Germany South Africa Korea, Rep. France Mexico China Brazil 5 Mexico Argentina 1 Japan India India Turkey Chile Brazil China Russian Federation 0 0 10 20 30 40 50 60 70 80 90 100 0 10,000 20,000 30,000 40,000 Urban share of total population, 2009, % GDP per capita, 2009 (US$, PPP) High emissions path Low emissions path 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 will dramatically improve the competitiveness Box 3.11  International fossil fuel subsidies of solar power, wind power, and other forms of clean energy. Going further and including the social costs of pollution and illness asso- The International Energy Agency (IEA) estimates ciated with the burning of fossil fuels would that in 2010, fossil fuel consumption subsidies raise the price of fossil fuels even more. reached $409 billion. According to the IEA’s analy- Second, the country is overly reliant on sis, if subsidies can be gradually phased out by 2020, then global primary energy demand would decrease command and control measures for reduc- 3.9 percent and CO2 emissions from energy by 4.6 ing carbon emissions. Too much reliance percent by that year, compared with a baseline in on inflexible administrative measures has which subsidies are unchanged. At their 2009 sum- resulted in suboptimal allocation of resources mit in Pittsburgh, leaders of the Group of Twenty for reducing carbon emissions and uneven reached consensus on the need to gradually reduce compliance. The current provincial alloca- subsidies, while providing support to low-income tion of targets to reduce the energy intensity groups. “Inefficient fossil fuel subsidies encour- of economic output is an example. First, the age wasteful consumption, reducing our safety, targets are not allocated according to means obstructing investment in clean energies, and nega- or resources. During the 11th Five-Year Plan tively influencing measures to mitigate the dangers (2006–10), energy intensity targets for indi- of climate change,” the leaders said in a statement. vidual provinces were pegged to the national target of 20 percent. Although this method Source: IEA (2011b). seems to make sense, it has placed an overly heavy burden on the less-developed provinces that are currently experiencing a period of 2007 data, eliminating fossil fuel subsidies heavy industrialization. Second, although reduces China’s emissions by 6.21 billion tons targets for reducing energy or carbon inten- of CO2. Similarly, Zheng and others (2011a, sity are the result of a negotiated political 2011b) predict that if electricity prices are not process, they are rigid (neither flexible nor raised, then by 2020, China’s urban residents tradable). This rigidity has increased the costs will use 10 times the electricity they do today; of compliance and made it more difficult and if water prices are not increased, then by for individual provinces to save energy and 2020, the average urban household will use reduce emissions, leading to such phenom- a multiple of current consumption. These ena as cutting off power (that is, resorting research results suggest that raising electric- to “energy poverty”) in order to meet targets ity and water prices for urban residents may that are even lower than what could other- be an effective policy tool. In Beijing, for wise be achieved. example, it is estimated that raising electricity Third, incentives for environmental pro- prices by just RMB 0.02 ($0.003) a kilowatt tection are weak. Clear environmental regu- hour will slow the average annual increase in lations enforced by government are crucial household electricity consumption from 35.6 for improving the quality of the environment. percent to 23.9 percent. Slightly raising the However, China’s environmental regulations water tariff in Beijing from RMB 3.70 ($0.57) remain relatively weak, and enforcement has a cubic meter to RMB 4.00 ($0.62) is pro- been inconsistent. jected to reduce the average annual increase The problems associated with a lack of in water use from 14.7 percent to 5 percent. incentives for environmental protection are The use of tiered pricing could prevent undue evident in both pollution monitoring and burden on low-income households. compliance and natural resource manage- The distortion of factor prices in China is ment. Of course, there are some successes a serious problem, but not one that is unique as well, often market based. In agriculture, to China. It is a global problem (box 3.11). the lack of longer-term property rights in Eliminating perverse subsidies for fossil fuels land and water has created a disincentive Seizing the Opportunity of Green Development in China 245 to farmers to invest in longer-term sustain- have found it difficult to support long-term ability. Instead of increasing organic mat- public investments in projects that promote ter in their soil, for example, farmers find it environmental sustainability. In search of more economical to increase output in the revenue, many have grown excessively reli- short run by using more fertilizers and pes- ant on rents from land in peri-urban areas ticides. The same is true for China’s grass- that have been converted from farmland lands, many of which have been overgrazed and leased for development. As localities or encroached upon by expanding settle- have tried to attract outside investment and ments and are in decline.14 It was also true develop new industries to make up budget- for China’s forests, which, up until the late ary shortfalls, they have allowed projects that 1990s, experienced heavy cutting and were have damaged the environment and depleted shrinking. This situation was changed, how- natural resources. ever, largely through the introduction of eco- Finally, the lack of incentives for environ- compensation programs and reforms in for- mental protection is tied to the inadequacy est ownership. Between 2000 and 2009, the of the pollution control regulations that rely central government invested RMB 365 bil- on command and control directives, and to lion ($56 billion) on afforestation programs, the small scale of market-based pilot proj- providing cash payments and other incentives ects undertaken to date. For example, China for farmers who restored marginal lands in has attempted to establish local SO2 permit fragile watersheds, planted shelterbelts to trading schemes, modeled after the system in protect against sandstorms, and protected the United States. But these programs have natural forests. Reforms introduced in 2009 largely failed, because of overinvolvement by that extended the contract period for house- the government in trading that has weakened hold forest rights to 70 years and allowed the role of the market, led to the unfair allo- households to mortgage their rights strength- cation of permits, introduced problems in the ened the incentive for rural people to invest in design of trading mechanisms, and interfered sustaining forests. with monitoring of emissions. Similar to land, China’s water resources Fourth, a competitive market environ- management system lacks incentives to pro- ment for green industries is lacking. In real- mote efficiency at the scale required. As men- ity, China’s transition to green development tioned, the first obstacle to efficient water has two levels: the first is “greening” its cur- use is low tariffs. Other obstacles include the rent economic base, and the second is a more lagging water rights system reform and the fundamental shift toward emerging indus- inefficient use of market mechanisms. Some tries. Some Chinese green industries have examples are the extravagant use of water experienced rapid growth in recent years, for irrigation and the inefficient allocation of as exemplified by the rise of its clean energy water between different crops and regions. industries. Yet, its emerging industries still As a result, water for agriculture accounts lack a fair and open competitive market envi- for 65 percent of total water use, but only ronment in which to grow. 48 percent is actually used for crops (NBS The playing field for investment in emerg- 2010a; China Water Resources 2009). Only ing industries is still not level. In the case of 40 percent of industrial water was recycled the wind turbine and solar PV industries, for in China in 2003, compared with 75–85 per- example, private companies are mainly con- cent in developed countries (although indus- centrated in equipment manufacturing, while trial water recycling has been improving in SOEs continue to monopolize the electricity recent years). generation market (SERC 2011). State-owned China’s existing fiscal policies have dis- enterprises also dominate the development of couraged investment by local governments shale gas, which will continue to be noncom- in environmental protection. Because many petitive so long as the legal rights to shale gas local governments lack fiscal resources, they resources are not clearly defined (box 3.12). 246 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. Source: Zhang 2011. a. China has yet to make a systematic exploration and assessment of its shale gas resources, and there are large discrepancies between various estimates. PetroChina, for example, has calculated that there are 21 trillion–45 trillion cubic meters of recoverable resources, while the U.S. Energy Information Administration puts this number at around 36 trillion cubic meters (Zhang 2011) 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 services. As China introduces new market In terms of political costs, it is important incentives such as auctioning permits for car- to remember that the political economy of bon trading, strengthens a property tax, and policy reform is complex and difficult in all raises prices of undervalued resources, green countries, including China. Every subsidy development may actually increase tax rev- creates its own lobby, whether the subsidy enues and bolster the capacity of the govern- takes the form of preferential access to land ment to provide funding for social services. and credit or access to cheap energy and Moreover, improving the quality of the envi- resources. State-owned enterprises have polit- ronment will significantly reduce the need for ical power and lobbying capacity, and energy- spending on health care related to the burden intensive export industries will also lobby for of environment-related diseases. subsidies to maintain their competitiveness. Government will need to balance the broader social benefits of reforms with the losses of Figure 3.17  Direct CO2 emission intensities of various Chinese those adversely affected. Safety net policies industries, 2007 for those likely to be negatively affected may include income support, access to alterna- tive employment, retraining opportunities, Power and relocation assistance. Such policies will go a long way in mobilizing the political and Coal gas workplace-based support for the changes that Nonmetallic minerals are needed (ILO 2011; UNEP 2008). Second, different industries will face dif- Metallurgy ferent impacts. High-emission industries Transport include power generation, coal gas, metal- lurgy, nonmetallic mineral products, ship- Coal mining ping, coal mining, and oil refining. Three Petroleum processing industrial subsectors are the most energy- and coking Petroleum and intensive ones and will be most directly natural gas extraction affected by stringent carbon emissions poli- Chemical products cies (figure 3.17). More generally, raising the Manufacture of costs of energy, water, natural resources, metal products and pollution will more directly impact Mining, processing those industries that incur relatively more of metal ores Paper, culture, and those costs. Some firms may even be elimi- sport products nated, while others will survive and upgrade Agriculture their production processes, supply chains, and management techniques by investing in Machinery greater efficiency. Food products Third, different regions will face differ- ent impacts. Because less-affluent provinces Textiles tend to invest more in heavy manufactur- Social services ing and other lower value-added industries, they may be relatively more affected by green Institutions development policies. A number of China’s Other sectors poorer interior provinces are undergoing a period of heavy industrialization. If policies 0 100 200 300 400 500 600 700 800 900 1,000 are administratively allocated and relatively Tons CO2 per million RMB value added rigid, as has been the case in China in recent years, they will place a heavy burden on these Source: DRC, based on the 2007 input-output table in NBS (2008a). provinces. Conversely, relaxing price controls Seizing the Opportunity of Green Development in China 249 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 Provide strong market stimuli for transitioning to green 1.  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, Manage risks associated with climate change impacts 5.  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 supplementary sources of financing for local competitive grants to private research or governments and to create alternative job through public research, development, and opportunities. For all of the above measures, demonstration in sectors where public goods reforms in property rights and land mar- dominate. Complementary policies to “grow kets are fundamental to improving farmer bigger fish by adding more water” may also and business incentives to protect the local be applied, such as through limited tax relief, environment. enterprise bonds, and preferential financing to infant green industries. Subsidies should be phased out as each sector matures and Goal 2: Foster Green Sources of Growth the need for public support diminishes. To Beyond the provision of market stimuli for complement support for green sectors, the transitioning to green development is the government should also draw up a schedule need to more actively promote emerging to cancel export tax rebates and perhaps set green technologies and services. The national export quotas for the most polluting and goal, as articulated in the current five year most resource-intensive products. plan, is to turn China’s green industries into a Encourage green consumer habits and world-class example of innovation and com- increasing demand for green products. For petition. Further steps to be taken involve example, governments can advocate for green both focusing the role of the state and open- consumption; establish labels and standards ing up competition to the private sector. Pri- for green products and services so that they ority actions include: are easily recognizable by consumers; and Remove barriers to private capital to take steps to mobilize nongovernmental orga- stimulate private investment. Great poten- nizations, media, and other organizations to tial lies in investing in urban infrastructure promote green consumption (box 3.13). and services (such as water treatment, waste disposal, and contaminated site cleanup), Goal 3: Improve Regulation of but various barriers exist for private capital Environmental Quality and the entry, including information barriers. Once Management of Natural Resources financial access restrictions are released, and new sources of capital are created, through Although market incentives are fundamental such means as international climate policies, to achieving green development, regulations investment would grow. and other government actions are an impor- Reform state enterprises to eliminate tant complement in several critical areas. monopolies that limit new entrants to bet- The first need is to strengthen regulation ter promote innovation without excess state generally by improving the monitoring and market presence. (For additional information enforcement of existing regulations. In addi- on this subject, please see Supporting Report tion, other priority steps can to be taken to 2 “China’s Growth through Technological enhance the basic market incentives set out Convergence and Innovation.”) here. Increase governmental investment in criti- Strengthened standards. Standards are a cal infrastructure for green development. key regulatory area where improvements will Two examples are charging stations required shape behavior and create market incentives by the emerging electric car market and for green technologies. A key example is the improved electrical grids designed to absorb automobile industry where standards can large amounts of fluctuating power generated be set for fuel consumption. Another is the by solar PV and wind generators. Related to appliance and lighting industry where new expanding government investment is address- standards for energy efficiency can have a ing institutional and governance issues (see direct and widespread impact. A third is the goal 6, below). potential for national standards related to Offer targeted support for R&D, espe- climate-robust green buildings, urban design, cially in strategic industries, either through and transportation to prevent cities from 252 china 2030 Box 3.13  Energy efficiency and consumer behavior 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. Source: World Bank 2010. “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, Box 3.14  Low-carbon urban development in China 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. Source: World Bank 2012. 256 china 2030 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 Annex 3A  Sequencing Actions and Confirming Results The policy areas described in this chapter will new technologies, goods, and services; have a profound effect on China’s pattern of infrastructure and information support development. The demands on government to green domestic and export markets; to correct years of market failures and price and scaled-up public education for all ages distortions are enormous. This annex makes to help induce consumer and household some cross-sectoral observations about how behavior changes. The growth impacts to sequence these recommendations, mea- of new technologies—in output, employ- sure results, and confirm that the long-term ment, and exports—should be measurable targets for green development are being and significant by 2020. achieved. It was prepared by and represents • By 2030, important targets in lower- the views of the World Bank team. emissions growth, clean energy, air pol- lution, waste management, and efficient land markets can be met. In addition, risks Sequencing of Green Development associated with resource scarcity, climate Actions change, and irreversible biodiversity losses The concrete actions needed to achieve can be managed. However, sustained greener growth in China fall under the broad government intervention will be required headings: creating market incentives that in all of these areas, at both the national alter current behavior and foster technologi- and local levels, for the simple reason that cal innovation; using regulation, backed by most environmental gains require gov- enforcement, to complement these market ernment intervention to help internalize incentives; financing public investments in domains where public goods, such as better weather monitoring, will not be provided Figure 3A.1  Indicative sequencing of green development reforms by the private sector; and reforming and strengthening the local institutions that play Short-term Medium-term Long-term a key role in allocating resources and man- Today forecast forecast forecast aging environmental quality. While steps in (2012) (2015) (2020) (2030) all four of these areas can be taken now, the gains from green growth will follow a natu- Environment Increased ral sequence (figure 3A.1): • Legacy issues e ciency of • Pollution resource use damage • Pricing • Short-term gains will come from improved • Ecosystem reform economywide efficiencies, to be achieved loss • New • High energy standards Scaled-up use through efficient pricing (land, water, car- of green intensity • Better bon, and pollution), regulatory reform, monitoring technologies and public investment in critical green and • Market reform enforcement • SOE reform Resulting infrastructure. Early steps should also be • R&D and • Public Outcomes taken to tighten standards in areas that investment expanded • Economic will pave the way for technical develop- • Incentives private rebalancing investment • Transformed ments and behavioral change, such as • Innovation growth more efficient buildings, transport vehi- • Reduced cles, and household appliances. negative • Medium-term gains will accrue from inno- environmental externalities vation and changed behaviors, which will come in response to government reforms to SOEs; targeted R&D in support of Source: World Bank analysis. 258 china 2030 environmental externalities and govern- and agencies are working to establish an ment monitoring of compliance with optimal set of green development indicators. standards. Although this topic remains a work in prog- ress, the two most important areas for defin- Finally, while the 20-year time frame ing indicators are the quantity of growth and up to 2030 is sufficient time for some early the quality of growth. and important successes—such as in renew- For the quantity of growth, in addition to able energy, air pollution, and waste man- measuring economic output (GDP or GNI), agement—other challenges will certainly it is also important to measure changes in remain, such as ecosystem conservation, people’s well-being.16 Two indicators used water pollution, carbon emissions reduction, by the World Bank are adjusted net national and adapting to climate change. income (aNNI), a truer measure of income than GDP or GNI, and the adjusted net sav- ings (ANS).17 Measuring Progress Toward For the quality of growth, indicators are Green Development needed at the sector or even subsector level. Part of defining, pursuing, and achieving At this level, one challenge is to keep the list green growth is measuring progress. This of indicators to a manageable size. A highly point has been recognized both in OECD selective but informative set of indicators for work on green growth (OECD 2011) and the quality of growth includes: the World Bank’s new program to develop a green growth “knowledge platform” to guide • Energy productivity: increasing GDP per its activities in developing countries. For unit of energy used is greener because it is example, the OECD has identified four clus- a sign of increasing energy efficiency ters of appropriate indicators for monitoring • Share of fossil fuels: decreasing the share progress toward green growth: of fossil fuel in total energy used increases greenness, as does increasing the share of • Environmental and resource productiv- alternative and nuclear energy ity, to capture the need for efficient use • CO2 emissions intensities of total energy of natural capital and to capture aspects and of GDP of production that are rarely quanti- • CO2 emissions per capita fied in economic models and accounting frameworks. One of the important functions provided • Economic and environmental assets, to by green growth indicator systems is the reflect the risks to growth from a declining ability to benchmark performance against asset base and the need to maintain the international good practice examples. These asset base to sustain growth. benchmarked indicators are shown in table • Environmental quality of life, to capture 3A.1 and figure 3A.2, with these results: the direct impacts of the environment on people’s lives, through limited access • In terms of quantity of growth, the adjusted to water, for example, or the damaging income and saving indicators show China’s effects of air pollution. outstanding growth achievements. Over • Economic opportunities and policy the period 2000–09, the average growth responses, to help discern the effective- rate of real aNNI per capita in China was ness of policy in delivering green growth roughly ten times that in the OECD; and and identify where the effects are most net wealth creation in 2009 as a share of marked. GNI was seven times higher in China than in the OECD. Not all of the desired OECD indicators • The quality of growth indicators shows, are measurable today, and many countries however, where progress is needed. China’s Seizing the Opportunity of Green Development in China 259 Table 3A.1  Comparison of specific indicators, China vs. high-income OECD Indicator China OECD Year Measure 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 a. CO2 emissions per capita b. CO2 emissions per unit of GDP 20 2 Tons CO2 per $1,000 output (2005 PPP) 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 • A water productivity target of reaching decline in GDP growth rates in 2025–30. In best practice in OECD countries contrast, the scenario in which a CO2 price • CO2 emissions intensity falling by 60–65 of $10 a ton is gradually phased in over eight percent between 2010 and 2030 years beginning in 2023 produces substantial reductions and flattens the upward growth As is the case in OECD countries, green in China’s emissions, resulting in total CO2 growth indicators and future targets are a emissions of 9.2 billion tons (6.4 tons per work in progress in China, but an impor- capita) in 2030. And a CO2 price of $20 a ton tant step to be taken in implementing a green produces an even greater effect, with China’s growth strategy. absolute emissions peaking by 2020 and then dropping down to 8.4 billion tons (5.8 tons per capita) in 2030—a total level about 17 The Potential Impact of a Carbon Price percent higher than in 2010. Carbon pricing, whether achieved through Carbon revenues in China could be sig- trading or taxation, would influence such nificant in macroeconomic terms. By 2030, variables as the cost of emissions reduction fiscal revenues would amount to 1.4 percent and structural shifts in the economy. By of GDP under a carbon price of $10 a ton applying the base model used in this China (RMB 64) and to 2.7 percent of GDP under 2030 study, the World Bank team simulated a price of $20 a ton (RMB 129). If the car- the introduction of a carbon price in China, bon revenues were rebated to households, starting in 2015 and phased in over eight each household would receive between RMB years. 2,126 ($329) and RMB 2,097 ($634) a year Figure A3.3 shows the path of CO2 emis- by 2030, depending on the price and assum- sions in billions of tons for three scenarios. ing a household size of three. While govern- The “business as usual (BAU)” scenario fea- ment has considerable discretion on how tures continued strong growth in CO2 emis- such a lump sum could be distributed, a flat sions to 2030, from 7.2 billion tons (5.4 tons lump sum per capita would be progressive per capita) in 2010 to 10.9 billion tons (7.6 by definition, helping to offset any regressive tons per capita) in 2030. The key moderating tendencies of the carbon price itself. Further influence on emissions in this scenario is the notes on lessons learned from other countries on selecting and implementing climate policy instruments are given in box 3A.1. Although the simulated carbon price Figure 3A.3  China’s annual CO2 emissions under three scenarios, 2010–30 rates used in this analysis are too low to sig- nificantly affect the structure of the Chinese economy in 2030, they have a clear impact 12 on the amount of coal the country would Tons of CO2 emitted (billions) 11 consume (figure 3A.4). In the $10 price sce- 10 nario, China uses 492 million tons less coal 9 compared with business as usual in 2030 8 (a difference of 15 percent). Under the $20 7 price scenario, coal use drops by 770 million tons compared with business as usual (a dif- 6 ference of 23 percent). Both scenarios result 2011 2015 2020 2025 2030 in a peak in China’s coal use before 2020. Business as usual Carbon price of US$10/ton CO2 This decline is driven largely by a shift in the Carbon price of US$20/ton CO2 relative prices of different fuels for electric- ity generation. The market share of coal-fired Source: World Bank analysis. electricity in the power sector (in terms of the Seizing the Opportunity of Green Development in China 261 Box 3A.1  Lessons from international experience on climate policy instruments 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. Sources: World Bank 2010; Hood 2010; OECD 2008. 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. Table 3A.2  Sector-specific recommendations for achieving green growth in China 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 continued next page) 264 china 2030 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 Notes rates would catch up to “non-green growth” rates. Growth would be unaffected overall. If   1. To date, no standard definition of green devel- immediate action is taken, then the catch-up opment has emerged from the public and pol- period will be shorter. If action is delayed, the icy debate (Huberty, Gao, and Mandell 2011). costs of intervention will be greater, and the   2. See the other chapters and reports prepared as part of this China 2030 study, particularly the catch-up period will be longer. synthesis report.   4. Differences in energy intensity are attribut-   3. Acemoglu and others (2012) found that gov- able to such things as output mix and relative ernment interventions to redirect investments prices as well as to energy efficiency. Never- toward green technologies would have a short- theless, the opportunity for further declines in term cost but that long-term “green growth” China’s energy efficiency is clear. Seizing the Opportunity of Green Development in China 265   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 not improve the plight of informal work- building on the system of national accounts, 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. 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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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 273 productive population. By 2030, China both, depending on the categories of rights. would have an education system that pro- The higher levels of governments, in par- vides quality general education for all chil- ticular the central authorities, need to play a dren from preprimary to the end of senior more proactive role to encourage local efforts secondary schooling. The latter would be that promote social inclusion of migrant fee-free, and the former available affordably populations, financially and politically, to everyone, the most needy receiving sub- through a common policy framework. Labor sidies. Underpinning this education system mobility would be underpinned by a social would be an early child nutrition program security system where entitlements are fully and expansion of childhood obesity interven- portable across the country, and where pool- tions. Building the human capital base will ing of risk at higher levels reduces the cross- also require a post-general-education system regional disparities. And the burden of taxa- that provides a more flexible and demand- tion on labor would be gradually reduced. driven set of competencies. By 2030, the bar- In parallel, fair and representative collective riers between technical/vocational and aca- bargaining would drive the wage determina- demic educational streams would be reduced, tion system. Finally, by 2030, China would with more core skills for technical students, have extended the productive life of its urban more practical and applied higher education, workers through higher retirement ages, flex- and greater crossover between technical and ible work arrangements, and lifelong learning academic streams. The health system would opportunities. provide more uniform and deeper financial A basic but secure social protection sys- protection against health shocks for all. And tem that provides for a moderate level of the delivery system would be more account- security for all while respecting fiscal con- able for the quality and cost-effectiveness of straints. By 2030, China would have full services through provider payment and other coverage of sustainable pension and health reforms. The restructured health system insurance systems, with more reliable secu- would be less hospital oriented and be built rity from all schemes and greater integration around a high-quality primary care network of all subsystems. In addition, China would to meet more complex case management have a well-developed system of aged and needs of noncommunicable diseases. long-term care services that draws upon the Flexible and secure labor and entitlement human and financial resources of all stake- policies and institutions that not only pro- holders and provides a minimum level of mote an internationally competitive work- service for the poor. Finally, the safety net force but also ensure that workers share in for the poorest and most vulnerable would growth and maintain basic protections. have greater coherence between different Achieving the balance between the interests parts of the social protection system, provid- of workers and employers requires “flexicu- ing acceptable coverage of benefits for poor rity” in the labor market not only to pro- households without at the same time creating mote efficient allocation of workers to their “poverty traps” for the near poor. most productive use, but also to provide the While China’s social policies have achieved security to ensure decent pay and conditions some measure of success in the past 30 years, that reflect their productivity. The first step simply doing more of the same is unlikely to would eliminate the remaining barriers to be sufficient as the country faces new chal- labor mobility, in particular barriers that are lenges. The more complex challenges require related to inherited characteristics. Most crit- greater collective action across regions and ically, the hukou system would be phased out social groups in situations where interests no later than 2030 as an instrument of allo- diverge. They also require shifting emphasis cating social entitlements to the migrant pop- from quantity to quality of services, from ulation. Instead, entitlements would be linked input to outcomes of programs, and from to residential permits, stable employment, or government dominance to cogovernance 274 china 2030 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) governmental fiscal system). Overlaying these 60,000 challenges are ones of rapid demographic and 40,000 epidemiological transitions, changing social structures, sustained urbanization, and the 20,000 political economy of reform. Taken together, 0 the challenges strongly suggest that “business 1985 1990 1995 2000 2005 2008 as usual” in social policy will be insufficient Urban National Rural to address China’s needs in coming decades. Just as important, there are significant Source: China Center for Human Capital and Labor Market Research challenges of quality and efficiency in educa- 2010. tion and health services, as well as in social E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 275 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 Gini index of income inequality 45.3 organizations and agencies exercise a monop- oly or quasi-monopoly in delivering social 40 41.1 services and face little competitive pressure to improve efficiency or quality. And pressure from users of services is also limited because 30 of the lack of downward accountability. The revenue and incentive structure in health services, and to some extent education ser- 20 vices, encourages public providers to maxi- 1980 1985 1990 1995 2000 2005 mize revenues and act as profit-maximizing Without adjusments for (spatial) cost of entities. For example, it is estimated that living differences Adjusted for (spatial) cost of between one-third and one-half of admis- living differences sions to hospitals in China are unnecessary, and that the average number of days in hospi- Source: World Bank 2009. tal is double the OECD average (World Bank 2010a). School selection fees in urban areas drive a further funding wedge between “key” rapid sustained increase that China has wit- schools and regular schools. nessed since the mid-1980s, as can be seen in figure 4.3. Income inequality may have flat- tened in recent years—suggested, for exam- Inequality of Outcomes and Opportunity ple, by the rising relative wages of migrants The sustained rise in income inequality dur- and relative regional growth rates—but that ing the reform period is a major source of remains to be confirmed. concern. Income inequality was low in the Income inequalities are exacerbated by mid-1980s but—as reflected by the Gini coef- disparities in asset ownership, particularly ficient—rose rapidly to around 0.45 by the mid-2000s (figure 4.2). Subsequent analysis suggests that it may have climbed to 0.48– Figure 4.3  Global trends in per capita GDP growth and Gini 0.49 by 2007 (Li, Luo, and Sicular 2011). 2 coefficients, 1980s–early 2000s The disparities across the whole popula- tion are mirrored by large divides between BRA SAF the richest and poorest citizens, with mean 60 Gini coe cient of inequality income in the richest decile more than 16 CHL NGA MEX ARG times that for the poorest decile by 2003, and 50 PHL HKG more than 18 times greater by 2007 (World MYS CHN THA SGP GBR 40 Bank 2009; Li 2012). Rising inequality VNM USA IDN KOR reflects greater disparities between urban and 30 IND RUS rural areas and within rural and urban areas. POL FRA ESP JPN The sustained increase in income inequal- 20 ity places China at the high end of income 6.5 7.5 8.5 9.5 10.5 inequality among Asian countries, and Log, PPP per capita GDP (constant 2000 PPP$) inequality is high by OECD country stan- dards. While other countries have higher Source: World Bank (2009), except for China, which uses 2003 data. Start and finish years vary by country, but start years are in the early to mid-1980s and end years are in the late 1990s income inequality—notably in Latin Amer- and early 2000s. ica—few developing countries have seen the Note: PPP = purchasing power parity, 276 china 2030 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) E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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. ity restrictions in the hukou system. How- ever, the failure to address entitlement reform for migrants through incomplete reforms of “permanent” migrants. Deepening reform of hukou and the ongoing challenges of manag- the hukou system to reduce social stratifica- ing farmers who have lost their land to urban tion and equalize entitlements for local urban expansion has resulted in a fundamental seg- and migrant populations presents major mentation between the local and the nonlocal challenges, the resolution of which will have hukou populations. The social compact with a major bearing on the social and fiscal sus- migrants in urban areas remains for the most tainability of further urbanization. part different from that with local urban A final demographic challenge will be populations. Disparities in social entitlements sustaining a healthy and productive popula- that the original population of “floating” tion in the face of epidemiological transition migrants was willing to accept will become and the growing epidemic of noncommuni- harder to justify to second-generation, cable diseases. Chronic illnesses such as heart 278 china 2030 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 0 ment. The traditional links between citizens 50 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 285 Figure 4.7  Projected social spending as a share of GDP 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 noncommunicable diseases—and reori- Figure 4.8  PISA score differences between enting delivery systems away from overre- students with at least one year of preschool education and students without liance on hospital care through incentives to promote use of primary care. • Deepening reforms of financing and pur- chasing of health care services to promote Israel more equitable health services for all citi- Singapore Macao SAR, zens and ensure that the system provides China quality services in a more cost-effective France manner. Hong Kong SAR, • Increasing the role of the population in China United Kingdom oversight and some aspects of manage- ment of education and health services at Shanghai the grassroots level to promote citizen Brazil voice and accountability. OECD average United States An important cross-cutting theme in Finland implementing the above policy and institu- tional reforms is diversification of the roles of Korea, Rep. state and nonstate players to promote greater 0 20 40 60 80 100 120 plurality of social service provision. As noted, Test scores a key insight from international experience Observed di erences After accounting for is the potential for unbundling the financing socioeconomic background and provision nexus in social services, explor- ing diverse options including public financing Source: OECD 2010b. with private provision and public financing Note: Observed differences are differences in raw PISA test scores of students. Whole column = observed difference in raw scores. through demand-side interventions. If China is to realize its ambitious social service expan- sion and quality enhancement goals within its fiscal constraints, an expanded role for the Poor nutrition in childhood has immediate nonstate (for-profit and not-for-profit) and and serious impacts on children’s health and community sectors will be essential. educational performance, which can have last- ing deleterious effects. Anemia results in cog- nitive impairment, altered brain function, and Running from the Same Starting Point: physical impairment. Apart from direct and Early Childhood Development and immediate effects, poor child nutrition has Education been shown in developed and developing coun- Evidence from developed and develop- tries to have serious negative consequences ing economies alike finds that investing in for educational performance (Jukes, Drake, early childhood development and education and Bundy 2008). Negative consequences of (ECDE) yields high economic returns, is the poor childhood nutrition can also be seen in most cost-effective strategy to break inter- adult health, human capital, and productivity generational transmission of poverty, and during working life. In China, the Center for improves productivity and social cohesion.16 Disease Control and Prevention found that for An example can be seen in PISA (Programme every 1 percent of low height-for-age, physical for International Student Assessment) test productivity in adulthood is reduced by 1.4 scores for children attending at least one year percent (Chen and others 2010). of preschool, which are significantly higher across the developing and developed worlds Current status and challenges in ECDE.  The compared with those of students without two major challenges for early childhood such schooling (figure 4.8). development and education are poor nutrition E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 289 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 Figure 4.9  Prevalence of anemia among children under age five a. Among all rural children b. Among children in poor rural areas 50 50 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 Source: China Health and Nutrition Survey, various years. 290 china 2030 Table 4.1  Prevalence of overweight and obesity of students ages 7–18 in urban and rural China, 2005 percent Urban areas Rural areas Male Female Male Female   Age (years) Overweight Obesity Overweight Obesity Overweight Obesity Overweight Obesity  7–9 12.6 10.6 8.0 5.3 6.3 4.4 4.8 2.8 10–12 16.1 8.3 7.1 4.4 7.7 3.2 3.6 2.1 13–15 12.3 5.3 7.5 3.0 5.4 2.1 4.8 1.3 16–18 11.3 4.3 7.2 1.7 5.4 1.5 5.5 0.6 Average 13.1 7.1 7.4 3.6 6.2 2.8 4.7 1.7 Source: Ji 2007. 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, E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 a. Urban children b. Rural children 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 10 Beijing Starting in the short term, 23 increased (RMB, thousands) 8 emphasis should be placed on coordinated Beijing 6 action to combat childhood obesity. The lev- els and rates of increase in obesity in cities 4 Shanghai like Beijing, Tianjin, and Shanghai are pre- 2 cursors of those that all of China will experi- Guizhou Guangxi Hebei 0 ence over coming decades without action. But 0 10 20 30 40 50 60 70 80 90 just as with undernutrition, there are cost- GDP per capita (RMB, thousands) effective interventions that have been proven ECDE budget Budget ECDE extra budget Extra budget in China and globally to reduce obesity and improve child and subsequent adult health.24 Source: Ministry of Education 2010. To operationalize the enhanced policy Note: RMB = renminbi. commitment to address child nutrition—both undernutrition and problems of obese and seemingly modest, such fees can therefore be overweight children—consideration should a very high barrier to access for the poor. be given to rapid initiation of a national child and mother nutrition program. Designation Addressing the challenges of early child of institutional leadership from the national development.  Early child development is a to grassroots levels would be essential to pro- key investment in the productivity and good mote coordination. Child nutrition is an area health of the workers of tomorrow and can of interest for many public agencies in China, also be a strong equalizer. Because children including the Women’s Federation, Minis- under age six today will be the labor force dur- try of Health, CDC, State Council Working ing the period of China’s most rapid aging and Committee on Women and Children (chaired accelerating labor force decline, it is essential by the vice premier), National Population and to ensure that the human capital foundation is Family Planning Commission, Ministry of laid for all of them now. This section proposes Education, Ministry of Civil Affairs, and the measures to promote equality of opportunity Leading Group on Poverty Reduction. How- in early child nutrition and to expand early ever, significant hurdles remain in the areas child education, ensuring quality access for all. of institutional coordination, standardization Child nutrition in poor rural areas should of approaches, and quality assurance. Coor- be a high priority of government policy in dination could be handled at the national the near term. Within these areas, targeting level by the group led by the vice premier, but of specially vulnerable groups such as left- the agency that would take the lead at sub- behind children will be crucial, as will be national level would need to be clarified. Key closer monitoring of the nutritional status of elements of such a program could include: poor and migrant children in urban areas. China has huge potential to make a difference • Universal implementation of nutritional in a very affordable manner. Pilots by agen- supplementation for children under age cies such as China Development Research three and pregnant or lactating women in Foundation (CDRF), China’s Center for Dis- - all rural poor counties, and ideally in cen­ ease Control (CDC), and UNICEF demon- tral and western provinces, and for migrant strate that major improvements in nutrition children in urban areas. 25 The costs of and cognitive functioning can be made at low such a program are not prohibitive: even E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 293 at current low-volume production, the cost performance management indicators for of a nine-nutrient supplement for one year officials. Draft indicators that have been is around RMB 260 per child—very cost- proposed by the China CDC could be effective in light of high returns to health, reviewed as a basis for such indicators. It cognitive development, and productivity. will be important to keep such indicators • Inclusion of a parenting education pro- simple and to ensure that the monitoring gram. Family feeding, hygiene, and other system is capable of producing them with practices are major contributors to nutri- the required frequency. tional outcomes. International and Chi- nese evidence points to the benefits of For early child education, the major chal- parallel parenting education to ensure lenge lies in an effective expansion strategy both that the supplementation itself is for rural, migrant, and poor children. The regularly administered and that practices National Plan for Medium- and Long-Term negatively affecting nutrient intake and Education Reform and Development sets tar- absorption are reduced. Such programs gets to 2020 for expansion of early childhood have proved effective in many develop- education, such as almost universal cover- ing countries, including Brazil, Mexico, age of one-year kindergarten and enroll- and Vietnam (World Bank 2011a). In ing three-quarters of children in three-year China, the Ministry of Civil Affairs’ preprimary education programs. These are Social Welfare Department will be pilot- laudable goals, but do not answer questions ing community-based delivery of compre- of the appropriate (and fiscally feasible) role hensive child welfare service packages. of public financing in the expansion, and the • Identification of funding sources for pilot appropriate delivery models consistent with and rollout phases. The key question will the financing strategy and the capacities of be what combination of incremental fund- the state, communities, and the nonstate sec- ing and reallocation of existing resources tor in early childhood education provision. would be appropriate to support such To achieve China’s expansion targets, efforts. A potential source for the pilot a significantly higher commitment of pub- phase could be funds allocated by the State lic resources to early childhood education is Council Leading Group Office of Poverty needed, in line with practices in most OECD Alleviation and Development, which has countries (figure 4.14). While the OECD aver- indicated that reduction of child poverty age of public spending of 0.5 percent of GDP would be a higher priority in the 12th Plan on preschool programs may be ambitious period.26 in the short term, China does have signifi- • As part of the overall nutrition program, cant scope for major expansion from its cur- development of a national program rently very low public spending base. If China against childhood obesity. Pilot programs achieved the share of total public education in China suggest that a combination of spending that OECD countries have (that is, family-, school- and community-based 8 percent), that would suggest a sensible public interventions, including a focus on grand- spending target for early childhood education parents, can be very cost-effective. Direct of just over 0.3 percent of GDP by 2020. The interventions such as physical activity, current levels of public spending on this edu- health ­education, and dietary interven- cation represent a missed opportunity for an tions could be combined with collabora- investment that is highly productive and highly tions with local governments and industry equitable. China’s commitment to expand the to promote healthy school meals and con- overall educational budget, combined with the trol targeting of obesity-inducing foods at shrinking cohorts of young children, provide children. the possibility to change the situation. • Agreement on child nutrition outcome In the short term, incremental public indicators that could be included in spending on early childhood education should 294 china 2030 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 ­ parent-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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 s in st ed ed rie l in st go al nt en qu ore qu iche oy oy te e, ra s e e and Chengdu in equalizing financial and sid til til ca erag pl pl ig Po R Em em M Re Av other resources across districts and inte- Un 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 fragmented, making it difficult to provide Currently, TVET in China tends to be a consistent standards on which employers dead end, with no pathway to further aca- throughout the country can rely for a con- demic education for the large majority of stu- sistent picture of the skills and competen- dents. In contrast, the expanding practice in cies of TVET graduates. many high- and middle-income countries is to • Financing of TVET faces several chal- allow for TVET students to stream into fur- lenges, including the degree of decen- ther academic education. This can be seen in tralization and issues of vertical and reforms in Latin America and the Caribbean, horizontal equity, an uneven playing field the community college system in the United in the allocation of public funding between States, Nordic and apprenticeship countries public and private training providers, and such as Germany, and reforms over the past a strong emphasis on inputs and the sup- decade in Korea that allow technical students ply side of the system. to cross over into academic streams. Some • The system lacks a framework for licens- countries such as Norway and Austria have ing and accreditation of private training double qualifying pathways (Adams 2007). providers, which both limits the growth Given that the large majority of students in of the private sector and results in lack TVET are from rural, migrant, or otherwise of quality assurance and consumer pro- disadvantaged or “blue collar” backgrounds, tection for those undertaking private the structural segmentation of the TVET and training. academic streams also contributes to social • Systematic mechanisms for involving segmentation. employers in the development of train- Similarly, the Chinese TVET curriculum ing curricula are lacking. While there is does not place a strong emphasis on contin- often a healthy transactional interaction ued acquisition of general “core” and aca- between training schools and employ- demic skills. While that may be an appeal- ers (for example, through “preordering” ing short-term strategy in preparing workers graduates by employers), the channels for for immediate placement (as evidenced by involving employers in shaping course the preordering system between enterprises content remain largely ad hoc. and TVET colleges), it raises questions of how well prepared the TVET students will Apart from these institutional and policy be for the medium- to long-term labor mar- issues, the role and nature of TVET in China ket, since specific skill demands will continue needs to be considered. Overall, the shares of to shift. TVET reforms in OECD countries students in TVET versus academic streams since the 1990s increasingly recognize this varies considerably, from around one-quarter risk by blending vocational and academic in Japan in TVET to 80 percent in parts of curricula, with technical students receiv- central Europe, with an average of 50 percent ing more academic content while academic across OECD countries (about the same as stream students are taught greater practical China’s current share at the senior secondary application of their knowledge. Korea is a level). The bigger issue concerns the types of good example, with as much as 75 percent of competencies being acquired in TVET pro- curriculum being common between TVET grams and the extent to which they provide and academic streams in senior secondary options for students for further study as well schooling (Adams 2007). This approach is as labor market entry. The answers to these consistent with a wider trend of deferring the questions are crucial in assessing whether introduction of vocational subjects in OECD China’s TVET system is well prepared for education systems. These countries are also the faster pace of economic and labor mar- placing increased emphasis on general core ket change and the types of skills needed by skills such as communication, problem solv- workers over coming decades. ing, and teamwork. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 301 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 early management of noncommunicable • Health insurance agencies and the budget- disease and illness. There is also a strong ary authorities have a limited role in pro- hospital bias in Chinese health spend- moting cost effectiveness and quality of ing relative to OECD countries (hospitals services. To date, despite major increases accounted for around 53 percent of total in insurance financing of health services, public health spending in 2010, compared insurance agencies remain largely passive with only 6.3 percent spent on township financiers of services. As such, they do health clinics). 35 Second, the distorted not effectively hold providers accountable price schedule and fee-for-service provider for quality and cost-effectiveness. Simi- payment mechanisms have given health larly, budget subsidies are, to date, not care providers strong incentives to gener- used to contract for outputs and reward ate demand for profitable high-technology performance. services and drugs, rather than for basic • There are major challenges in building services, particularly for the poor. Third, the human resources for the emerging the capital funding model for public hos- system. A particular challenge is build- pitals—with strong reliance on bank lend- ing a primary care provider cohort of rea- ing and “project cooperation,” whereby sonable size and decent quality. In 2010, third-party capital investors take an effec- China had only 60,000 general practitio- tive role in hospital management and even ners, or around 3.5 percent of all licensed ownership—has reinforced incentives for physicians in the country—a very low profit maximization in public hospitals, ratio compared with OECD countries. led to unclear ownership and control of Notably, the OECD country with the public facilities at times, and contributed highest ratio of health costs to GDP (the to irregular practices (Liang 2007). United States) also has the lowest general • The three-tier delivery system operates in practitioner ratios (figure 4.21). The situ- a fragmented manner, resulting in poor ation in China is exacerbated by assign- coordination of care and case manage- ment of responsibility to local-level CDCs ment across the public delivery network. for essential public health services and in- Currently, there is very limited cross- service training at the township and vil- referral across the three tiers of health lage level without allocation of adequate facilities to ensure that health conditions resources to provide such training or are managed at the most appropriate and monitoring of provider practices. At the cost-effective level. Patients tend to go higher levels of the system, there is also directly to hospitals even for outpatient a significant shortage of qualified hospital care (around 53 percent of patients have managers. their first contact with the system at a • Trust in the health system and providers hospital), and there is no gatekeeping by is low, and social accountability remains lower levels. This “disintegrated” behav- limited. Currently, the hospital sector is ior is driven by provider incentives that considered to be one of the least-trusted promote profit maximization rather than public services by Chinese citizens (Wang appropriateness of care. This breakdown and Yang 2011). Part of the concern is the in the coordination of the three-tier sys- perception of the need to make informal tem means that China is not well prepared payments to providers to receive faster ser- for the more complex case management vice and better-quality doctors. 36 More needs that noncommunicable diseases generally, there are concerns of an “ero- demand. Pilots to build relations and har- sion of medical ethics” (Yip and others monize incentives between hospitals and 2010). While social accountability pilots lower-level providers are under way (in in health are growing, there is limited Shenzhen and Wuhan, for example), but accountability of providers and health these remain in their infancy. facilities to the population. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 305 Figure 4.21  Comparison indicators on density of general practitioners a. Per total physicians b. Per population % GPs per population (thousands) 60 2.0 % GPs per total physicians 50 1.5 40 30 1.0 20 0.5 10 0 0.0 Ca lia D e a da F ia re ce er . ite S s Ki in ite dom es a Ca lia D e a da F ia re ce er . ite S ds Un ing in d m Ch s a E s rk E s rk th ep th ep d e in in n n d pa d pa a a ite do at at Ko ran Ko ran la n la n t ra t ra to Ch to Ne a, R Ne a, R nm nm n n St St Un ng s s Au Au d K Un Un Source: OECD 2010a; World Bank 2011b. Note: Data for OECD countries are for 2007; data for China are for 2010. • 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 307 Figure 4.23  Roadmap for PHC modernization 100 All population covered by modernized PHC National legislation providers updated to re ect 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 First graduates lessons and closed down from retraining needed adjustments program Continuing education of policies enter practice system operational 40 PHC professionals Graduate and post- association graduate training launched programs manage the Training programs attrition of workforce launch New PHC nancing 20 modalities ready to PHC profession’s Stock taking of PMC prestige improved be applied nancing policies Special incentives Population trusts PHC Development of for population to practice guidelines enroll starts 0 0 2 4 6 8 10 12 14 16 18 20 Years from initiation of primary health care reform Post-graduate training program Retraining program Source: Palu 2011. 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 309 Box 4.1  Health care coordination in OECD countries 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 the co-responsibility direction of reforms, advances in information and communi- efforts to involve greater third-party and cations technology. In addition, hospital community involvement in the manage- design is increasingly flexible to allow hos- ment and oversight of hospitals could be pitals to expand or contract in response to accelerated in line with the growing num- shifting demand and to new technologies bers of pilots throughout China. and care practices. Such trends suggest the • A further reform, to be initiated in the need for a shift in the investment planning medium term, will be the introduction of model for China’s health system in the greater competition for public hospitals medium term to “right-size” the hospital from the nonstate sector. Government network. is looking to encourage greater entry of private providers, including international Health financing and payment reforms. health care investors who can bring global Health financing reforms would benefit from best practice in facility management and a dual-track approach that focuses on reduc- quality assurance. Private providers could ing disparities between schemes and between open their own facilities or enter under localities, while in the longer run further contract arrangements with public hospi- examining the role of social contributions tals. There is significant potential to con- and general revenues in health system financ- tract out management of public hospitals ing. Aiming for complete equality of coverage to nonprofit organizations, as several high- (services and financial protection) across all and medium-income countries, including schemes and all areas is probably not realis- Brazil, have done. To realize this goal, tic. However, it would be desirable to explore health financing and purchasing arrange- how increased funding at higher levels could ments will benefit from proactive inclusion help equalize a basic package of services that of nonstate providers. That in turn will localities could top up with local resources require development of a licensing and and that could be further supplemented by accreditation regime to ensure minimum expansion of private insurance arrangements. quality standards. In parallel, it is necessary to accelerate • A second area for attention in the medium provider payment reform to increase the to long term is the capital investment incentives for all health providers to improve strategy for hospitals and the appropri- efficiency and quality. A number of efforts ate future mix of health facilities to man- have been made to control costs in the health age the epidemic of chronic illness. While system, including drug lists and zero mark-up China has been trying to build up its hos- policies, controls on use of technology, and pital infrastructure in recent year, it is also the like. But without a more fundamental important to learn the lessons of OECD shift away from the current provider payment and transition countries that overbuilt systems, the basic incentive structure for pro- their hospital networks and struggled viders will continue to drive inefficiencies and subsequently to adjust the system as use inappropriate care. Payment reform needs to patterns shifted. In the European Union, be complemented with a stronger emphasis for example, as chronic illnesses came to on professional ethics among providers as dominate the disease profile, hospital beds well as tools for greater accountability of pro- fell from around 850 per 100,000 popula- viders to patients. tion in 1985 to around 530 in 2009, and The first step in the short term is to inte- average length of stay declined from 10.5 grate management of health insurance days to just over 6.5 in the same period.41 schemes within pooling areas. This agenda is As a result, the delivery model has shifted already being pursued in many areas and with from hospital-based care to community- central policy guidance toward integration based ambulatory centers and “teleportal” of social insurance schemes. An increasing clinics. This has been facilitated by rapid number of coastal areas (such as Dongguan) E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 311 are already merging the management of be addressed in part by offering voluntary the NCMS and urban residents’ insurance supplemental health insurance to those in the schemes and have even achieved integration urban worker scheme. of the NCMS with insurance schemes for To support such integration, the pooling urban residents and urban workers. However, level for health insurance should be raised the effort is constrained in some provinces by to at least the provincial level and a com- the split management of different schemes mon model of pooling defined to achieve across the health and human resources and more equalized health care coverage. social security departments. Provincial-level pooling has been the direc- Another short-term measure that should tion of China’s health policy for some time, be considered is to move from the current but progress remains limited. The first ques- model of individualized coverage in insurance tion is what model of pooling will be pur- schemes to household-based coverage. This sued. International experience suggests that approach makes sense from an insurance there is no single best model suited to all viewpoint, because it spreads risks across the country contexts (World Bank 2010d). Japan household members of different ages with has had a single “virtual” pooling fund since different intensity-of-care needs. But it also the early 1980s. Other countries such as the makes sense for supporting the core values of Netherlands use a risk equalization fund that social policy, which include building on fam- adjusts premium and payment rates. Others ily institutions. pool at the national level (Sweden and the In parallel, it is necessary to acceler- United Kingdom) or regional levels (Canada ate pilots on provider payment reform and and Kazakhstan). In a number of countries, evaluate their impacts on efficiency, quality, the process of moving to higher-level pool- and health outcomes. For all levels of care, ing took a decade or more, and a period of the priority is to move away from the cur- this length could be anticipated in China. rent fee-for-service model to alternatives. For Emerging experience in China suggests that higher-level care and hospitals, case-based some form of risk adjustment could be an payment is currently the main direction of intermediate approach, which could also help pilots. This approach helps to contain costs manage possible resistance from richer areas and is relatively simply to manage, but it may within each province. raise issues in quality of care. Case-based Based on the evaluation of pilots, another payment can also have unintended conse- key medium-term reform will be to roll out quences on spending on uncovered services. nationwide provider payment reforms that Other alternatives such as diagnostic-related fundamentally realign the incentives of groups avoid some of these problems but are providers and patients. Both China’s pilot also much more demanding of information, experience and the growing body of global management, and monitoring systems. practice—including that of middle-income For the medium term, integration of the countries—on provider payment reform can three health insurance schemes seems a sen- inform rollout of provider payment mecha- sible and achievable goal, initially within nisms, which are case-based or move toward prefectures and provinces. It would require diagnostic-related groups (World Bank gradual equalization of benefit packages 2010c). This is an essential achievement if and provider payment mechanisms across any of the other reforms and reorientation of insurance schemes, as well as a financing the health delivery system are to be achieved, mechanism to promote the equalization. A if uncontrollable cost escalation is to be key question is to what extent the coverage avoided, and if public trust in the health sys- package of the NCMS and urban residents tem is to be restored. is “scaled up” toward that of urban work- In addition to payment reform for hos- ers and, if so, over what time frame consis- pitals, continuing reforms of doctor salary tent with fiscal constraints. This issue could and compensation systems will be needed. 312 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 Box 4.2  Initiatives for public participation in social services 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. Source: Gong and Yu 2011. 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 315 participation in China can be considered allocations to fund the effective operation “state-mediated,” and there may be room in of relevant mechanisms. initiatives that are more directly the future for ­ • Information and education campaigns driven by citizens, as seen in many other parts among citizens, officials, and providers on of the world. There is also a major agenda for the benefits, challenges, and limitations of strengthening the capacity of citizens’ organi- citizen participation along with practical zations to play a more informed and effective guidance on how to initiate and institu- role. International experience also suggests tionalize mechanisms. These campaigns that unexplored possibilities for extending should include expansion of information- the areas of citizen participation upstream technology-based tools for informing citi- beyond service provision to involvement in zens and seeking their inputs. development of emerging policies for social • Investment of public resources in capac- services. Finally, it is important to define the ity building of citizen groups and organi- limits of citizen participation more clearly to zations to increase their effectiveness in avoid raising expectations that cannot be met. social service oversight and management. Looking ahead, some measures that can support this agenda in the short term include: Measures to be adopted over the medium to long term include: • Rigorous evaluation of experience in citizen participation in social services at • Use of provincial policies and guidelines the provincial and subprovincial levels. on citizen participation in social service This evaluation would include qualitative delivery and oversight as a condition of assessments of the policy, institutional, receiving central transfers in the education and financing frameworks for participa- and health sectors, with a similar require- tion; surveys of providers, service users, ment for subprovincial levels as a condi- officials, and other stakeholders; and tion for qualifying for provincial financing development of indicators on the extent of social services. of citizen participation and its impacts on • Inclusion of indicators on citizen partici- service quality, education and health out- pation in the monitoring and results sys- comes, client satisfaction, provider behav- tems of the education and health sectors ior and attitudes, and so on. and in the system for assessing the perfor- • Development of national policy guide- mance of local official. lines that draw on the lessons of the evalu- ations. The broad encouragement given Developing a Flexible and Secure by policies such as the National Educa- tion Development Plan will need to be Labor Market made more concrete. In the health sector, An innovative and internationally competi- the ongoing reforms would benefit from tive China will need a workforce that can more explicit incorporation of citizen par- adjust quickly to changing market condi- ticipation, which could include expansion tions and whose workers continue to share of subnational pilots in tools for citizen in growth and have secure labor protection. feedback on service quality such as citizen To promote this notion of “flexicurity,” the scorecards and web-based feedback and report proposes: complaints services (Brixi 2009). • In provinces where there is already expe- • Lowering barriers to labor mobility by rience, institutionalization of citizen par- ensuring the portability of pension and ticipation processes and institutions, for social security rights and phasing reforms example, through the adoption of pro- of the hukou system so that all residents vincial policies (such as in Shandong with have equal access to a common set of parent councils) and assured budgetary social entitlements by 2030. 316 china 2030 • 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 Participation rate (%) 75 security coverage and other urban social 70 entitlements such as free education and 65 social housing that historically have been 60 available only to local hukou workers. 55 50 Unleashing the Potential of Labor 1995 2000 2005 2009 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 a. Urban male b. Urban female 100 100 % working population to % 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) c. Rural male d. Rural female 100 100 % working population to % 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 Source: Giles, Wang, and Cai 2012. 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 319 Figure 4.26  International comparison of employment rates by age and gender a. China (2008 pilot) b. Indonesia 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 c. United States d . China (2009 pilot) 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 e. Korea, Rep. f . United Kingdom 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 Source: Giles, Wang, and Cai 2012. 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 321 Figure 4.28  Labor supply by age for rural labor force and rural off-farm work, 2010 a. Farm labor b. O -farm labor 10 6 5 O -farm labor (months) 8 Farm labor (months) 4 6 3 4 2 2 1 20 30 40 50 60 70 20 30 40 50 60 70 Age (years) Age (years) Source: Cai, Du, and Wang 2011a. could help to address labor supply challenges experimentation in OECD countries is include:50 flexible work arrangements for older work- ers. These arrangements include “job- • Gradually raising retirement ages in the sharing,” which splits a full-time position urban pension systems, removing the across more than one worker (as is com- mandatory retirement age, and ending mon in Germany, for example) and more disincentives for later retirement. These opportunities for part-time work. Such reforms are politically challenging but arrangements can facilitate greater labor seem unavoidable as society ages. Initi- force participation by women, which ating the reforms sooner can allow for a seems to be a particular challenge in more gradual increase in retirement ages, China. Some countries have used wage to at least 65 for both men and women. subsidies for older workers to support such Many OECD and transition countries measures, although this needs to be done have undertaken this reform in recent carefully to avoid distortions in the labor years, with the annual increase in the market. China would benefit from a close retirement age ranging from a more grad- assessment of international lessons and an ual pace of one to three months a year in expansion of pilots domestically. OECD countries to six months a year in • Enhancing mid-career skills training and many transition countries. If reform can upgrading. By the time workers reach their be started in the 12th Plan period, by 50s, employers may feel that investing in 2030, the retirement age for men could skills upgrading has low returns. OECD reach 65 with a fairly gradual increase experience suggests that skills upgrading of three months a year; for women, full at mid-career is attractive both to employ- equalization of retirement age with men ers in terms of returns on investment and would take longer or require larger annual to workers while they still have capacity increments in the retirement age. and incentives to learn. • Facilitating access to part-time jobs and • Strengthening the focus of employment flexible work arrangements for older services on placement of older work- workers. A key area of employment ers. A number of OECD countries have 322 china 2030 introduced specific employment service first provisions on collective contracts were in programs for older workers, piloting new the 1994 Labor Law, and a series of guide- approaches to promote effective job search. lines and regulations have been issued peri- These programs have been supported in odically since then. The number of workers some cases by special incentive payments covered by collective contracts increased from for private employment agencies for place- around 50 million in 1998 to 94 million in ment of older workers (OECD 2006). 2009. Most recently, the Employment Con- • These measures would also be beneficial tracts Law, effective from 2008, provides the for rural workers, but additional poli- legal framework. That was supplemented by cies could help facilitate their more active the 2010 regulations for the “Rainbow Proj- participation in off-farm labor. To the ect” of the Ministry of Human Resources and extent that there is greater relocation of Social Security, which urges complete cover- production away from coastal areas, more age of collective contracting in firms with opportunities should be available for rural trade unions by the end of 2012 (Cai, Du, workers closer to their homes. That may and Wang 2011b). Firm-level contracts are to increase their willingness to move into be supplemented by regional- and industry- off-farm work, but in many cases, rural level collective contracts. The expansion of and migrant workers will need significant collective contracts has been mirrored by the investments in training and skills upgrad- increase in members of local branches of the ing to be able to take advantage of such state trade union, rising from around 100 mil- opportunities. Substantial investments lion in 2000 to 226 million in 2009.52 have been made in recent years. Wage negotiations are guided in principle by wage guidelines issued by the local labor authorities.53 The local guidelines are based Building Modern Labor Market on annual surveys of local firms for different Institutions occupations in various industries and work International evidence suggests that labor within national criteria. Each profession has market institutions can have important a top, middle, and bottom wage level, and the impacts on the distribution of income. The national method is in principle meant to pro- effects of labor market institutions on macro- vide comparability across regions. The system economic performance, income distribution, is intended to provide an external reference employment, and other variables remain dis- point for employers in wage setting, and the puted. 51 Reviews of international evidence number of occupations and sectors covered agree on one consistent finding, however: the has gradually expanded since introduction. strength of labor market institutions in deter- In practice, collective bargaining is at mining wages has a significant impact on the an early stage of development and faces a distribution of income both within countries number of challenges in becoming a truly and across them (Freeman 2008). Given bargained process. While the mechanism of ­ China’s desire to reverse the rise in inequal- collective contracting is spreading in urban ity, the potential role of labor market institu- firms, the practice can be considered more tions is therefore of importance. This section one of “wage consultation” rather than bar- focuses on two key labor market institutions: gaining in the standard international sense wage setting and labor taxation, including (Shen and Benson 2008). Evidence shows broader wage determination and minimum that such consultation has reduced labor wages in the urban labor market. confrontations in multinational corporations that have such mechanisms, but it is also Wage determination.  Wage setting above the clear from the rising incidence of labor dis- minimum is a highly decentralized process in putes in China that much remains to be done. China that is evolving toward a mature and A key challenge in the process of developing uniform “system” of wage bargaining. The truly tripartite wage bargaining is the role of E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 323 Table 4.2  Hourly wages of migrant and local workers, and share of difference explained by observable characteristics, 2001–10  Indicator 2001 2005 2010 Migrant hourly wage as percent of local workers 35.0 46.7 78.0 Percent of difference explained by individual characteristics 74.7 62.3 63.7 Percent explained by individual and job characteristic 81.7 72.5 98.0 Source: Cai, Du, and Wang 2011b. 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 ??? 600 in urban areas have labor incomes above 400 the official minimum. Table 4.3 shows that almost all workers—whether migrant or 200 local, men or women—receive labor income above the city-level minimum wage. Overall, 0 the minimum wage is increasingly not a wage 1995 2000 2005 2010 that workers generally are paid (or earn) in Nominal Real urban areas, but it serves as a reference point significant in its relativities to overall wage Source: Cai, Du, and Wang 2011b. levels and to social benefits and thresholds. It therefore performs a benchmarking and administrative function, as well as an impor- tant political signaling function of the con- to be taken into account in setting minimum cerns of the authorities for low-wage work- wages include the local minimum living cost, ers. The question for coming years is whether urban consumer price index (CPI), social the minimum wage will evolve toward play- insurance contributions and other manda- ing a more direct role in the labor market, tory personal contributions, average wages, as discussed in the policy recommendations and the economic and employment situation section below. in the locality. Factors not mentioned include productivity, producer prices, and share of Improving approaches to wage determina- informal economy. City-level data on mini- tion: Looking ahead.  Wage determination mum wage elasticities show that minimum will play an increasingly important role in wages are most strongly associated with the coming years in balancing the interests of workers and sustained competitiveness. The key will be to strengthen the linkage between wage setting and productivity growth. Real Table 4.3  Share of migrant and local workers with income above minimum wage by gender, 2001–10 wages in urban China have enjoyed a period Percent in which they have risen rapidly but are still below productivity growth. As the rural Share of migrants Share of locals Indicator above minimum wage above minimum wage labor surplus is exhausted, productivity growth from labor transfer will decline over CULS2001  Male 92.3 95.5 time. However, worker expectations of sus-  Female 86.3 88.9 tained rapid wage growth will be entrenched,  Total 90.0 92.6 increasing the challenges of sustaining wage CULS2005 growth of recent years.  Male 88.3 91.2 Aside from minimum wage reforms, other  Female 76.4 83.5  Total 83.2 87.9 reforms will need to be deepened to achieve a CULS2010 more uniform and market-based approach to  Male 98.2 97.2 wage setting in the formal sector. While the  Female 97.1 97.3 overall direction of such reforms is common  Total 97.7 97.3 across the public service, SOE, and private Source: Cai, Du, and Wang 2011b, using data from China Urban Labor Surveys (CULS). formal sectors, the starting points differ. The E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 325 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. Sources: OECD 2005; Wang and Gong 2011. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 327 Table 4.4  Minimum wage approach and criteria, various economies, end-2000s   Economy Approach Key criteria for setting wage Australia Wage floor Productivity, business competitiveness, relative standards of living, workforce participation rate Korea, Rep. of Wage floor Cost of living, economic growth rate, average wage level, labor productivity, unemployment rate, consumer price index, and income distribution; there is no fixed weight for these factors, and the relevance of each is determined within the wage council debate and varies in time Taiwan, China Wage floor Conditions of national economic development, price index, national income and average individual income, labor productivity of different industries and employment situation; workers’ wages in different industries; survey and statistical figures on household income and expenditures United States Wage floor Manufacturing productivity, affordability to employers, cost of living, wage levels United Kingdom Wage floor Pay differentials, inflation, business costs, competitiveness, employment, economic conditions France Living wage Overall wages and income, CPI, economic conditions, needs of workers and families Hong Kong SAR, China Wage floor General economic conditions: latest economic performance and forecasts; labor market conditions: labor demand and supply, wage level and distribution, wage differentials and employment characteristics; competitiveness: productivity growth, labor costs, operating characteristics of enterprises, entrepreneurship, business sentiment and solvency, and relative economic freedom and competitiveness; standards of living: changes in employment earnings and inflation Source: Hong Kong SAR, China, Provisional Minimum Wage Commission, 2010 (http://www.mwc.org.hk). 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 Table 4.5  Urban social insurance contribution rates in urban China Type Employer Employee Pension insurance 20 percent of payroll 8 percent of monthly wage Unemployment insurance   2 percent of payroll 1 percent of monthly wage Medical insurance At least 6 percent of payroll 2 percent of monthly wage Work injury insurance 0.5–2 percent of payroll No contribution Maternity insurance 0.5–1 percent of payroll No contribution Total 29–31 percent of payroll 11 percent of monthly wage Source: Authors’ compilation based on policy directives and documents of the Ministry of Human Resources and Social Services and the provincial departments. 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. Labor taxation.  China is a high labor taxa- Spain tion country if all social insurance (SI) contri- Thailand butions are paid (table 4.5). The rates of social Vietnam contributions are high by any standard and OECD countries also exhibit considerable variation across and EU-15 within provinces (for example, within Guang- Australia dong alone, the employer contribution rate for pensions in 2010 ranged from 9 percent United States United in Dongguan to 22 percent in Zhanjiang). Kingdom Pension dominates, in part driven by the high Mexico costs of funding legacy pension costs (see the Japan next section). China By international standards, the “tax wedge” on workers in China is higher than 0 10 20 30 40 50 in most OECD countries and well above Percent East Asian regional comparators. Figure 4.30 shows the tax wedge on labor for a Source: OECD 2011c. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 329 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 contribution, which at 3 percent might be citizens, including education, housing, utili- reduced given the surpluses in Employ- ties subsidies, and social protection, and also ment Funds and the sustained low unem- affects the ease of accessing formal sector ployment rate in China. The use of such jobs. It is widely acknowledged that deepen- funds for training and other purposes ing hukou reform in China has the potential could be replaced by general revenues to provide substantial equity and efficiency financing, which would most likely induce benefits. At the same time, it is also agreed efficiencies that are not promoted cur- that hukou reform is a gradual and challeng- rently through the guaranteed revenue of ing process. the unemployment insurance contribution. Hukou reform can support China’s transi- • The compulsory savings contribution to tion to a high-income country in several ways. the Housing Provident Fund —when paid First, it can contribute to economic growth. in full—is very high and has question- Deepening reform of the hukou system could able benefits for many workers. The high increase the allocative efficiency of the labor share of workers and employers already market and promote productivity-enhancing opting out of the housing scheme points structural transformation and urban agglom- to low demand for the program, in large eration effects. World Bank estimates indi- part because of negative real returns and cate that moving 10 percent of the labor force the inadequacy of benefits. While hous- out of the agriculture sector could lead to a ing policy for workers needs to be looked 6.4 percent increase in GDP growth, with at, housing funds have proven to be an higher gains in western and central regions ineffective way of achieving the desired (World Bank 2005). Reform of social entitle- protection and may have helped inflate ments that are linked to hukou is key in deep- property markets by acting as a cheap ening the human capital base and promoting source of liquidity for local authorities. a healthier workforce. Second, hukou reform The primary source of resistance to such a can play a role in narrowing rural-urban and reform would thus likely be local authori- regional income gaps. Simulations show that ties rather than workers or employers. completing hukou reform can have a dra- matic equalization effect between rural and urban income.61 Third, well-designed hukou Promoting Hukou Reform and reform can promote inclusive and manage- Improving Labor Mobility able urbanization, which can help reduce the Hukou reform—current status and chal- inequalities in income and access to services lenges.  The hukou system is one of the key that create social tensions. sources of inequality of opportunity in China, Hukou reform has been an important part and the most distinctive feature of China’s of wider economic reforms in China (Wang, social policy.59 The mobility restriction func- O’Keefe, and Song 2012). The early stages tion of hukou has largely been eliminated in of hukou reform first encouraged the shift practice by reforms since the late 1980s.60 of agricultural labor off farm into township However, the lack of parallel entitlement and village enterprises, then increasingly into reform has meant that hukou continues to small and medium cities; eventually restric- have significant negative impacts on welfare tions were eased on movement into large cit- and equality of opportunity. Some compara- ies, feeding the massive expansion of migrant tive studies point out that the hukou system labor from the second half of the 1990s. results in much more limited access to social The 2000s saw increased policy emphasis entitlements than those for internal migrants on promoting rural welfare and deepening within EU countries, and than immigration rural-urban integration, but hukou reforms policies in Germany, Japan, and Mexico in major urban centers have for the most part (Solinger 1999; Roberts 1997). The hukou remained localized. At the national level, fur- system regulates many social entitlements of ther measures are being used to ease hukou E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 331 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 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 Box 4.4  Recent innovations in hukou reform 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. Source: Wang, O’Keefe, and Song 2012. 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 is also likely in such a framework—begin- exhausted. An illustrative graduation strat- ning with all rural residents of the prefec- egy is shown in figure 4.32. ture, then extending to all people with Under such a common national frame- hukou of that province, and ultimately work, the residence permit could be rolled opening up residence permits to those from out nationally sometime between 2015 and beyond the province. This pattern, already 2020. Once universally established, the visible in local reforms in places such as qualifying criteria and the pathway toward Chengdu, Chongqing, and Guangdong, pro- the same rights as the local hukou popula- vides a sequence for phased equalization of tion could be accelerated over time. In this entitlements. way, a residence permit could by 2030 have A third issue concerns the extent of rights the same social entitlements as those of local to be conferred once a migrant obtains a hukou populations and could be obtained registration permit, as well as the possible after a reasonably short period of residence in sequencing of such rights. Again, current a city with modest qualifying criteria. pilots may be informative on this issue. In A key challenge in making such a transition the initial phases, full social entitlements of effective would be agreement on the financ- local residents are unlikely to accrue imme- ing responsibilities for social services of those diately upon obtaining a residence permit. obtaining residence permits. This would be However, creating a pathway within the a complex negotiation between national and local permit system for gradual acquisition subnational authorities but should be guided of the same social entitlements as local resi- by a clearer understanding of migrant flows dents, and prioritizing rights such as chil- across space and of the externalities of labor dren’s education, would be important. The mobility. Fiscal burden sharing could be more pace and scope of rights given to residence weighted toward national financing in cases permit holders may also become a source where migrants come from beyond the juris- of competition among cities in trying to diction of the province, and it could involve a attract nonlocal workers as the aggregate role for the province in the case of intrapro- labor force shrinks and rural labor surplus is vincial migrants. Certain entitlements would have a significant degree of self-financing by the migrant household that would be built into the qualifying criteria, for example, with Figure 4.32  Progressive acquisition of social entitlements for social insurance contributions in the urban nonlocal workers: An illustrative case workers’ system. Figure 4.33 summarizes a possible Entitlements: Increasing overtime sequence of hukou reform that gradually • Minimum living expands the residence permit system to allowance/dibao Quali cation for participating in • Social housing diminish the relevance of hukou, ultimately • Free compulsory college entrance examination at Join in social leading to a simple population registry sys- • The right to be education within residence city elected • Being equally resident locality insurance and live in the area for a tem. It shows the progressive expansion (in • Public health care • The right to vote entitled to enter into the nearest Time of living and longer time terms of both coverage of population and • Rights of studying in the area employment school has reached certain number of years extent of entitlements) of the registration per- Temporary • Medical and pension help insurance participation Join local social insurance and live mit system among nonlocal populations over in the area for a short period of time time and the parallel reduction in full hukou Legal and decent accommodation conversion thresholds. It also notes key steps to reach the end goal of all local and nonlo- cal citizens merged into a single population Resident registry system with common entitlements Liberalizing permit quali cation based on city of residence rather than origi- Progressive extension of entitlements conditions: nal hukou status. More detailed measures at each stage of this process are discussed in Source: Wang and Gong 2011. annex table 4A. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 335 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 Principles for portability of entitlements facilitate portability. Realistically, it might across civil servant, public service unit, be achieved in a phased manner with a and urban worker schemes would also not gradually larger portion of provincial con- be straightforward but could be facilitated tributions pooled to the national levels greatly by gradual consolidation of urban over time as the information and adminis- schemes, starting with PSU and urban trative systems to manage information and worker schemes (see social security section funds flow are consolidated. for discussion). Once developed, imple- mentation of the guidelines could be initi- Enhancing Security and ated during the 13th Plan period and the Improving the Social Security system gradually consolidated. • To support the portability of both indi- System vidual accounts and social pooling enti- China has made remarkable progress in put- tlements, a clearing mechanism would ting in place the core elements of a market- be needed for transfer of individual pen- compatible social protection system since sion records and any necessary cross- the transition from the “iron rice bowl” of jurisdiction or cross-scheme financial set- work-unit-based social protection. Since tlement. This is a huge challenge and one the 1990s, it has introduced an array of that so far has proven difficult to achieve social protection programs at a speed that is even within provinces because of frag- unprecedented internationally. Among other mentation of information systems, lack of reforms, these include pension and health commonly agreed data standards, and lack insurance programs for urban and rural pop- of vision on the preferred models of data ulations; unemployment, sickness, workplace sharing. The first step would be agree- injury, and maternity insurance for urban ing on common standards for exchange formal sector workers; and a national social of pension records and financial settle- assistance scheme that now covers around ments. The jin bao program of MOHRSS 70 million people. This is a feat that took would be the logical vehicle for develop- decades in OECD countries, and one that ing consensus between the national and most middle-income countries have to date provincial authorities. However, design failed to achieve. and deployment of a nationally integrated The vision of social protection develop- clearing mechanism likely will not be ment for 2030 has the following components: achieved until around 2020, and bilateral exchanges between sending and destina- • All households participate in the pen - tion areas of mobile workers would con- sion and health insurance systems, and tinue to be the norm this decade. the systems are integrated among differ- • The more fundamental reform that would ent segments of population (rural, urban, facilitate portability of pension rights migrants) and across different segments is the achievement of national pooling (civil servants, public service unit employ- of social insurance contributions. This ees, and workers on the one hand, and is a long-held goal of national policy, residents and rural workers on the other). not only for pensions but also for health With rapid population aging, the pension insurance. Progress has been slower than system would also benefit from both para- hoped, however, with partial provincial metric and structural reforms to ensure pooling only recently achieved. Pooling of system sustainability and security at a health insurance contributions has tended basic level. to occur only lower down the system, at • China has a well-developed and decent the prefecture or county level. Higher- quality system of aged and long-term care level pooling of pension and eventually services that draws upon the human and health insurance contributions would financial resources of the government, be the single most effective measure to the nonstate sector, communities, and E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 337 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 Active members (% labor force) erage of benefits for poor households but 1.0 Australia also ensures that the near-poor are not Hungary Italy 0.8 disadvantaged and that “poverty traps” are not created. 0.6 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$) social challenges over coming decades. The Source: Paralles-Miralles, Romero, and Whitehouse 2012. China coverage rate is for 2008. unfinished agenda is large, in part a prod- uct of the rapid pace of reform to date, but one that the authorities have begun clearly to address. The first element of the agenda is Urban Labor Surveys (CULS) in 2005 and addressing historically low pension coverage 2010 gives a reasonable picture from a selec- among rural, migrant, and urban informal tion of large cities. As seen in figure 4.35, sector workers. The second is reducing frag- participation in the pension system among mentation across different subsystems of the migrant workers roughly doubled between pension and health insurance systems, both 2005 and 2010 but still covered only around to promote more seamless protection and to 25 percent of migrants, far lower than the 80 facilitate labor mobility. The third relates to percent participation among local workers. financial protection and ensuring sustainabil- ity of financial protection for those in exist- ing pension systems. Finally, in the longer term, structural reforms of the pension sys- Figure 4.35  Participation rates for pension programs among working-age adults in urban areas, by gender and residence status tem may be desirable to achieve the reform goals of the authorities. 100 Expanding pension coverage.  Until recently, China’s pension coverage was well below the 80 typical level for a country of its income level (figure 4.34). Low coverage has been driven 60 Percent by a few factors—the absence of a national rural pension program; the low participation 40 rates of migrant workers in urban schemes; and the absence until mid-2011 of a pension 20 scheme for urban residents, who make up 30–40 percent of the urban labor force. 0 Male Female Male Female Male Female Male Female Looking at the urban system, partici- Local Migrant Local Migrant pation rates in pension schemes of differ- 2005 2010 ent types of workers remain very different Employment-based Contribution to laid-o Residence-based between local and migrant workers despite Commercial Migrant Rural recent progress. Reliable nationwide sur- vey figures are not available, but the China Source: Giles, Park, and Wang forthcoming. 338 china 2030 Part of the expansion among migrants is in significant inroads in expanding coverage, schemes other than the core urban workers’ mainly because of the highly localized nature pension scheme, including participation in of schemes, fiscal constraints in many areas, rural schemes. Factors that positively affect lack of participation incentives for rural peo- the marginal probability that urban work- ple, and weak implementation (Wu 2009; Lv ers will participate in the pension scheme 2005). The introduction of the national pilot include level of education (an additional in 2009 brought an impressive increase in year of school increases the chances around participation. 4 percent and any postsecondary educa- In response to historical undercover- tion by 7 percent) and age (older workers age, China has moved rapidly since 2009 are more likely to participate). In contrast, to include groups formerly outside the for- controlling for other factors, migrants from mal pension system. Historically, the major other urban areas are 43 percent less likely groups with low coverage have been farm- to participate in the urban workers’ scheme ers, migrant workers, and the urban resi- than local hukou workers, and rural-to- dents outside the formal sector schemes. urban migrants are a further 26 percent less In late 2009, China started rolling out a likely to participate than urban-to-urban nationwide voluntary rural pension scheme migrants. While women are 5 percent less that combines a matched contribution to an likely to participate, this effect disappears individual account with a basic flat pension after controlling for the sector of employ- benefit after retirement. The schemes are ment, suggesting that it is occupational innovative efforts to encourage participation choice rather than gender per se that drives through public subsidies. The central govern- the gender gap in participation.64 ment plays an important role in financing Pension coverage in rural areas has his- the full basic benefit for central and western torically been very low (10–12 percent) but provinces and half the benefit for coastal has increased dramatically since the 2009 provinces. The broad design was replicated national rural pension pilot reform (figure in mid-2011 for urban residents, with both 4.36). Although China has experimented rural and urban resident schemes aiming for with rural pension reform since the 1980s, full geographic coverage by end-2013. Both it had failed, until the late 2000s, to make have a high public subsidy element, both dur- ing the accumulation phase through contri- bution matching and even more so through Figure 4.36  Rural pension participation: total contributors and the payment of a basic benefit after retire- as share of rural employed ment. Already the rural scheme has seen an increase of around 100 million contributors. 160 40 The Social Insurance Law of 2011 and labor legislation in 2008 also place stronger obliga- 140 35 tions on urban employers to include migrants Share of participants (%) 120 30 in urban workers’ schemes, and there are Contributors (millions) 100 25 indications of progress. 80 20 60 15 Financial protection and systemic risks to the urban system.  Besides coverage, another 40 10 key dimension of social security is the finan- 20 5 cial protection offered by schemes, an area of 0 0 concern for pensions. While benefit levels in 1994 1996 1998 2000 2002 2004 2006 2008 2010 2011 nominal terms have increased steadily in the Contributors Share urban schemes, wage replacement rates have fallen sharply in recent years (figure 4.37), Source: Ministry of Human Resources and Social Security. although from a high base by international E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 339 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- Annual pension bene ts (yuan) 20,000 100 mum, raising questions about the longer-run Replacement rates (%) financial protection from the scheme. These 15,000 80 concerns are in part attributable to various design and implementation features, in par- 10,000 60 ticular the negative real rates of return on individual account accumulations (most of 5,000 40 which are invested in bank deposits) and the prevalence of so-called “empty accounts” in 0 20 many jurisdictions, where individual account 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 deposits have been used in earlier periods to Enterprise retirees (left axis) PSU and civil servants (left axis) fund liabilities to current pensioners. The sys- Enterprise retirees (right axis) PSU and civil servants (right axis) tem also faces the challenge of managing the substantial “legacy costs” of promises to pre- Sources: National Bureau of Statistics 2010. vious generations of pensioners.65 A number of structural challenges in design and implementation of urban pension systems risk undermining the system and • Low returns on individual accounts , impose significant inequities and labor mar- which have meant that pension replace- ket distortions. They include: ment rates have been significantly less than anticipated when the system was devel- • Legacy costs of the earlier, more generous oped—a structural feature that cannot be urban workers’ system, which are financed removed so long as the bank deposit rate is largely through current pension contribu- mandated for individual account accumu- tions, sustaining high contribution rates lations. In effect, the already high pension and creating incentives for nonparticipa- contribution rate for urban workers is thus tion and inequities across generations of made even higher by a negative real rate of workers. Rough estimates of gross legacy return on these accumulations. costs range from 82 to 130 percent of • The multiplicity of urban pension schemes 2008 GDP, depending on assumptions.66 for workers, PSU employees, civil servants, • Design weaknesses that affect incentives and in some areas, residents and migrants. and undermine fiscal sustainability, such This creates “entitlement segmenta- as the low retirement age. Earlier studies tion” in the labor market and barriers to­ of the urban enterprise pension system cross-sectoral worker mobility, and it substantiate the threats to sustainability. also results in nontransparent disparities Long-term actuarial projections suggested in worker compensation across public a baseline financing gap (present value of and nonstate sectors. The multiplicity of projected yearly financial shortfalls) from schemes is inconsistent with international 2002 to 2075 of 95 percent of China’s trends toward consolidation of the pension GDP for 2001. The same projections sug- policy framework across different catego- gested that there would be marginal sys- ries of workers. temwide cash surpluses between 2009 and • Major spatial fragmentation of urban 2018, then deficits thereafter, despite the systems and lack of portability of rights, maturation of “young men” with lower as discussed in the previous section. Lack replacement rates.67 of risk pooling and interurban resource 340 china 2030 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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 frameworks and management. To move to rights, and the remainder could be a unified scheme for all formal workers, it financed by provinces and municipalities. will be necessary over time to integrate the • Raising the pooling level for the urban policy frameworks and managements of schemes to the national level. This the schemes for the three sets of workers. reform is a stated goal of national policy Integrating the PSU and urban workers’ and would be desirable on several fronts. schemes is a sensible first step; integration The two biggest challenges in achieving of civil servants’ schemes may require a integration of schemes and higher-level longer phase-in period. To avoid a sharp pooling will be agreeing on the rules for decline in income replacement rates for distribution of pooled contributions across both PSU and civil servants’ supplemen- space and putting in place the platform for tary occupational pension schemes may be exchange of beneficiary data and financial needed that could top up pension benefit information to support the portability of levels in the integrated urban formal sec- entitlements. One goal of pooled revenues tor schemes. should be to reduce gradually the spatial • Integrating the rural and urban residents’ disparities in pension benefits as well as schemes and their management. Given the disparities across population groups. Prog- close policy harmonization between the ress on data sharing would require accel- schemes, integration of schemes for rural erated progress on the current efforts of and urban residents should be somewhat MOHRSS to develop common standards more straightforward. In fact, a number of for data sharing nationally. Both are chal- cities, including Beijing, Shanghai, Zhong- lenging from a technical standpoint and in shan, and Chengdu, have already achieved the coordination of many players with dif- integration. The main practical challenge ferent interests. is ensuring that information and financial • Taking steps to ensure sustainable finan- transactions systems are sufficiently inte- cial protection of pensions. This reform grated across provinces and prefectures to would require measures both for ensur- allow for scheme integration to be effec- ing adequate rates of return during the tive across wide areas as well as within accumulation phase and for appropriate jurisdictions. indexation of pension benefits after retire- ment. For pensions after retirement, intro- The other main reforms in the medium ducing more systematic indexation would term would build on preparatory steps taken be desirable. Price indexation protects the earlier. These include: retiree against inflation but would most likely result in a decrease in pension ben- • Separating legacy-cost financing using efits after retirement relative to wages. An a clearly defined financing strategy out- alternative could be to mix prices with the side the pension system. Separating the increase in covered wages in the pension financing of legacy costs from the current system (Piggott and Sane 2009). During and future pension system would allow the accumulation phase, ensuring a bet- the authorities to reduce the contribution ter rate of return than produced by bank burden of the pension system on current deposits would be vital. A more balanced and future workers. This could also help investment approach for pension fund reduce possible resistance to a raising of balances could be adopted, or a notional the retirement age. The legacy costs could defined contribution (NDC) approach be financed by the government at different might be considered in the long term, with levels and could also be shared with work- returns linked to GDP growth rates. ers and retirees. The central government could establish a framework by which For the long term, it would be desirable it finances a minimum level of acquired to move to a system that distinguishes those E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 343 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 divide. Such a system would be consistent Voluntary with deepening rural-urban integration and Mandatory individual Contributory occupational hukou reform and would help address issues Pillar retirement retirement insurance of portability. It could also benefit from the insurance scheme lessons of OECD economies that have dis- tinct schemes for the self-employed. Basic Pillar Social pensions In terms of implementation, an integrated national data management system would be needed to underpin the nationally pooled and Source: Authors. integrated system. This is a daunting task, but ultimately necessary. The real question is what model of integrated data management is feasible, both technically and politically. It desired level of social pension, it could need not be a fully centralized database but also be subject to a pension test that could instead have distributed provincial sys- would take account of pension income tems with a data clearinghouse function at from other sources or some other form of the national level, or a cloud-based system. means testing (although a pensions test In addition to integration of pension has the attraction of administrative sim- schemes, consideration should be given to plicity). A key principle could be that the the structure and mix of pension benefits. To benefit would be set in a common way and balance financial protection, coverage expan- would provide minimum income support sion, and sustainability objectives, China higher than the dibao threshold. Social should probably in the longer term consider pensions of different forms are widespread moving the integrated schemes toward a in OECD countries as a method both for three-pillar design consisting of a basic ben- ensuring universal coverage of elderly ben- efit pillar, a contributory pillar, and a supple- efits and avoiding old-age poverty (Pala- mentary pillar (figure 4.38): cios and Sluchynskyy 2006; Holzmann, Robalino, and Takayama 2009). • The basic benefit pillar would provide • The contributory pillar would have a man- minimum elderly poverty protection datory defined-contribution scheme for through an integrated, noncontributory workers with wage incomes and a volun- “social pension.” This pillar would build tary defined-contribution pension savings on the basic benefit approach already scheme for the urban and rural population being taken in the rural and urban resi- with nonwage incomes (temporary work- dents’ pension schemes but would go a ers, the self-employed, and farmers). For step further in removing the link to even workers with wage incomes, a notional the low level of contributions required in approach to the contributory pillar could those schemes. The social pension—set be considered. Such an approach offers a at a modest level to ensure fiscal sustain- number of attractive features related to ability—could be financed from general labor market incentives and facilitation of revenues with a strong role for the cen- labor mobility, potential for reduction in tral government but some cost sharing contribution rates, and a lesser requirement with subnational levels. Depending on for retained savings in the pension system the extent of fiscal commitment and the to support benefit payments. Importantly, 344 china 2030 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 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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: • Piloting different models of aged care ser- Portugal 0.1 vices to gain deeper understanding of cost Czech Republic 0.2 and quality issues and to test d ­ ifferent Slovak Republic 0.2 mixes of public, nonstate, community- Hungary based, and household provision and 0.3 financing. Interesting experiments are Korea, Rep. 0.3 already taking place (in Hangzhou and Poland 0.4 Shanghai, for example) and these can Spain 0.8 be expanded and carefully assessed to inform national policy development. Australia 1.0 National policy can also draw lessons United States 1.0 from relevant international experience Slovenia 1.1 (OECD 2011a; World Bank 2010e). Austria 1.3 • Placing particular focus on the financing model for aged care services. With respect Germany 1.3 to financing, public resources are likely to Luxembourg 1.4 remain constrained for aged care in the New Zealand 1.4 short term. OECD approaches on public 1.5 financing of aged care vary considerably, OECD countries from models financed largely through gen- Canada 1.5 eral revenues (Scandinavia) to insurance- Japan 1.6 based approaches. For China, public France 1.7 financing is likely to continue to come from general revenues, but at much more modest Iceland 1.7 levels than the countries with more gener- Belgium 2.0 ous general-revenues-financed systems. In Denmark 2.0 providing public funding, policy makers Switzerland 2.1 may experiment in the short term with a mixture of supply-side subsidies to provid- Finland 2.2 ers and demand-side funding directly to Norway 2.2 households. An increasing number of Netherlands 3.5 OECD countries are providing demand- Sweden 3.6 side subsidies to households and giving households more choice in whether they 0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 provide care themselves or seek it from % GDP community-based or professional provid- Public LTC expenditure Private LTC expenditure ers (OECD 2011a). The role of family and informal care arrangements—including Source: OECD 2011a. community-based care—is critical in this regard, and it is vital that public invest- ments do not crowd out informal and ­ community-based care arrangements. At a values. It will require thinking about combi- minimum, public financing should not aim nations whereby the state both finances and to disadvantage those who choose to care provides services in some cases, finances but for their elderly family members in home outsources service provision in other cases, or community-based settings. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 347 • 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 Promoting a More Integrated Social on education fees, subsidized health insur- Security System ance, public housing, and subsidized utili- ties. As a result, they may be better off than The impressive pace of expansion and households just above the dibao threshold reforms of China’s social protection pro- that are not entitled to such noncash ben- grams over the past two decades has created efits but have only slightly higher incomes. the second-generation challenge of promoting This raises the risk that dibao households greater coherence in the system. Both within face high effective marginal tax rates individual programs such as pensions and upon graduation from the program (and social assistance as well as across programs, thus incentives to remain dependent on new issues of compatibility have arisen as welfare) and that the near-poor will feel the social protection system has expanded. unfairly treated. Cities such as Beijing are These issues need to be addressed to develop trying to address this issue by allowing a system that is a coherent whole, not simply some subsidies on selected basic services an accumulation of programs (World Bank for the near-poor, but such programs are 2012). Greater coherence will need to be not affordable for all localities. In OECD informed by a clear vision of the goals of the countries, the problem is often addressed social protection system and the underlying by tax credits or other preferred treatment social values those goals reflect. of nonpoor households with low incomes, Greater system coherence will require but such options will not be possible for balancing the desire for deepening security China while the large majority of house- and protection of the poor with appropriate holds remain outside the personal income incentives for people to work and increase tax net in the foreseeable future. participation in formal sector employment. • A second challenge will be developing a This is an agenda both within different parts more systematic approach to determina- of the social protection system and across tion of dibao eligibility thresholds and them. Some issues that the current system benefit levels. Currently, both the methods will need to navigate in the coming years to of determining dibao thresholds and the strike the appropriate balance between pro- benefit levels themselves vary enormously, tection and incentives include: reflecting the highly decentralized nature Deepening reforms of the social assistance of implementation. While some diversity system can help better achieve its poverty in threshold levels is appropriate, a more alleviation and promotional objectives. The consistent method for setting them would expansion of dibao in urban and rural areas be desirable. MOCA has made progress in to cover around 70 million beneficiaries has this direction, and assessment of emerg- been impressive over the past decade. Consol- ing experience can inform future policy idation of the program provides the opportu- development. nity to improve the program design and link- • A third direction is promoting greater ages further: synergies between social assistance pro- grams and the antipoverty interventions • One area for development is the relative in poor counties. Traditionally, areas- impact of the program on the poor and based antipoverty programs have oper- the “near poor.” While the dibao program ated in parallel to household-based social has performed well in excluding the non- welfare support. The government’s new poor, its design raises risks of “poverty rural poverty strategy points the way to traps” for households just above the dibao greater convergence of social assistance, eligibility threshold. Eligible households social services, and antipoverty programs have their incomes topped up to the dibao over time (such as prioritizing dibao and threshold and also receive noncash ben- near-poor households in training under efits including exemptions or reductions antipoverty programs).76 E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 349 • 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 Annex Table 4A Illustrative Sequencing of Hukou and Supporting Reforms  Phases Hukou reform policies Supporting reform policies 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 •   E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 351 Notes considerable diversity; see Esping-Andersen (1990) and Arts and Gelissen (2010). See Hol-   1. The measure of human capital used is the liday (2000) regarding East Asian models. Jorgenson-Fraumeni lifetime income-based 12. Core competencies include communication approach. skills, team work, and problem solving.   2. The 0.48 estimate uses data from China’s 13. See also chapter 1 for benchmarking of social National Bureau of Statistics and the 0.49 spending among OECD countries. estimate uses China Household Income Proj- 14. Barnett and Brooks 2010; Baldacci and oth- ect survey data. ers 2010. See Cai and others (2012) regarding   3. See World Bank (2010a) for a detailed exam- rural savings. ple of differential access to urban public edu- 15. The projections use national transfer accounts cation for migrant children. (NTA) modeling assuming constant real age-   4. See Cai and others (2012) for evidence on specific unit costs for social services and pen- emerging strains on family support in rural sions by age cohort over time and overlaying areas. Commentators have also pointed to China’s demographic trajectory for the base the longer-term prospect of an 8-4-2-1 family case. The “explicit targets” scenario over- structure. lays the base case with policy commitments   5. A useful symposium on the issue can be found already made by the authorities to expand in China Economic Review (2011). coverage of social programs (such as rural   6. The term social contract is not commonly and urban resident pensions; expanded senior used in China but is used in this report in the secondary and higher education) (Mason and sense of the relationship between the govern- Chen 2011). ment and its population as originated by Jean- 16. Early child development and education cov- Jacques Rousseau. ers children from conception to age six, and   7. Yongkang Zhao, “Strengthening and Improv- their parents, with a range of interventions ing Social Management and Promoting Social including nutritional and health care inter- Stability and Harmony,” People’s Daily, ventions for young children and mothers to October 25, 2006. See also resolutions of the ensure optimal physical and cognitive devel- 6th Plenary session of the 17th CPC Party opment; early education programs—institu- Congress. tion, community, and home-based—that aim   8. See report in China Daily, March 18, 2010, to improve school readiness skills, including on results of happiness survey of 70,000 Chi- language, numeracy, and psychosocial skills; nese residents. and parenting and caregiver education and   9. See CASS (2011), which reports on surveys counseling. High rates of return to invest- of nine large cities in 2009 and villages in 20 ments in ECDE can be seen in studies from provinces in 2010. the United States as well as developing coun- 10. See World Bank (2006) for an elaboration tries, including Colombia (ECDE attendees of the general framework for equity and 100 percent more likely to be enrolled in later development. grades), Turkey (20 percentage points higher 11. At one end of the spectrum, the governments school enrollment in teens), and Bangladesh of the social democratic welfare states of (58 percent better performance on standard- Scandinavia have a dominant role in provid- ized tests). ing highly equal access to high-quality social 17. There were, as of late 2011, 592 poor coun- services and social protection. In contrast, the ties in China, where around 20 percent of “liberal” welfare state model exemplified by the country’s population lives, although this the United States relies more on market-based number increased with the raising of the rural approaches and may have higher tolerance poverty line in December 2011. for differential access to and quality of social 18. According to the World Health Organization services and social protection. In between lie (WHO), stunting rates over 20 percent are the “conservative” welfare state models of considered medium level globally, and 40 per- other European countries, the “productivist” cent anemia prevalence is “severe.” welfare states of richer East Asian countries, 19. See WHO Global Database on Anemia, vari- and hybrid models in countries such as New ous years. Notably, the data show volatility in Zealand and Australia. Each model exhibits the anemia rate in the short period 2008–10 352 china 2030 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. E q u a l i t y o f o p p o r t u n i t y a n d B a s i c Se c u r i t y f o r A l l 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- ent cohort benefit frameworks: the different groups are described as “old man,” “middle References man,” and “new man,” depending on their Adams, Arvil V. 2007. “The Role of Youth Skills period of entry into the system (World Bank Development in the Transition to Work: A forthcoming). Global Review.” World Bank, Washington, 66. The net costs could be lower, as financing DC. for civil servant and PSU pensions already Almeida, Rita. 2009. “Does the Workforce in involves significant public subsidies (World East Asia Have the Right Skills: Evidence from Bank forthcoming). Firm-Level Surveys.” World Bank, Washing- 67. Sin (2005). 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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 more through globalization of Chinese predict. Nevertheless, strong signs suggest firms (and thus FDI outflows). Through that population aging and the shift to ser- investments abroad, globalizing Chinese vices will slow growth in China and many companies can not only enter new markets other parts of the world. Even if new sources and acquire new technologies, but they of productivity growth in services could be can take advantage of economies of scale unleashed, it would be prudent to anticipate and move production up the value chain. decelerating growth and to stress-test the Large global companies are a prerequi- sustainability of institutions in case of low site for the transition into a high-income growth. economy. Second, should China slow the pace of • In recent decades, China’s presence in global integration or rather step up its glo- global financial markets has been lim- balization in new areas? Some argue that the ited. In coming decades, China will have penetration of China in global manufacturing to become a more dominant player. In the has reached its limits. Further expansion of past, China protected itself from volatil- market shares is becoming increasingly dif- ity in international financial markets by ficult, while the slow recovery in high-income restricting capital account transactions, countries may magnify calls for protection- by pegging the renminbi to the dollar, and ist measures against Chinese exports. Con- by accumulating large foreign exchange sequently, future growth has to come more reserves. In the future, that strategy will from domestic demand. Moreover, with glo- become less effective, and stability should balization, China has become more exposed come from a more international and inde- to volatile global financial markets. China pendent role for China’s currency. cannot achieve its goal of becoming a high- • In recent decades, China has often income country by retreating from the world approached international policy debates economy, however. Indeed, China will have from a purely domestic perspective. In to integrate more into financial markets and future decades, it is in the interest of both markets for services to facilitate the global- China and the rest of the world that China ization of its firms, to strengthen the interna- adopt a more proactive approach and take tional use of its currency, and to increase effi- responsibility for proposing solutions to ciency in its delivery of services. As a result, global governance problems and for the China will likely become the main champion provision of global public goods. of globalization. Nevertheless, in some areas (the financial sector, in particular), a lengthy Such a successful transformation can transition period is required to reduce the ­ reate more win-win opportunities for China c risk of instability. and the world, but the next 20 years will pose Third, to what extent should China take new challenges and come with new uncer- responsibility for the provision of global pub- tainties. In thinking about the challenges that lic goods? Even if China reaches high-income China (and the world) will face over the next status, its per capita income will still be far two decades, it is useful to consider three behind those in more advanced economies, questions. The answers are not obvious, and and its domestic problems will remain daunt- the policy choices involved are difficult and ing. Still, it would be a mistake for China to in some cases risky. leave the initiative to more advanced econo- First, to what extent should China prepare mies. Global governance structures and pro- for significantly lower growth? Growth pros- cedures to provide global public goods should pects are obviously highly uncertain, not only be brought much more into line with the because of the short-run uncertainty linked need of fast-growing developing economies. to the global financial crisis but also because Not only is China’s participation critical in structural growth trends are contingent on providing global solutions for environmental innovations that are virtually impossible to problems and financial stress, but its active R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 363 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 ­China’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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 ­ China’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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 369 Table 5.1  Past and future growth trends Percent Low- and middle- High-income   Time period income countries China countries United States 1990–2000 3.3 10.4 2.7 3.4 2000–10 5.9 10.5 1.6 1.7 2010–20a 5.6–7.4 7.4–10.1 2.0–3.1 2.3–3.5 2020–30a 4.2–6.6 4.2–7.8 1.3–2.7 1.5–3.0 Average annual per capita GDP growth 1990–2000 1.6 9.3 2.0 2.3 2000–10 4.6 9.8 1.0 0.7 2010–20a 4.4–6.1 6.8–9.5 1.6–2.6 1.5–2.7 2020–30a 3.4–5.8 3.9–7.6 1.1–2.4 0.9–2.4 Source: World Bank calculations using Envisage Model. a. The lower and upper bounds reflect average growth rates in the low-growth and high-growth scenarios. 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 Figure 5.1  Growth trends 14 5-year moving average annual GDP growth 12 10 8 6 4 2 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 Source: World Bank calculations. 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 China Developing countries, not including China High-income countries Source: World Bank calculations. 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) 60 than in the low-growth scenario. The miti- 50 gated deceleration results from the smaller 2020 share of services in nominal GDP because 40 2010 the prices of services do not rise as quickly 1990 30 as in the low-growth scenario. Neverthe- 1970 20 less, in the high-growth scenario, the share 10 of services will still increase in China and other developing countries, very much in line 0 0 2.5 5 7.5 10 12.5 15 17.5 20 with experience in other countries that have GDP per capita, 2000 US$ (thousands) already achieved higher per capita income Brazil China Italy Korea, Rep. Portugal levels (figure 5.3). The additional technologi- cal progress in the services sector is the only Source: World Bank calculations. difference in assumptions between the two R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 373 Figure 5.4  Labor supply growth will vary greatly among countries Low-middle-income countries, not including BRIC countries Brazil Russian Federation India China EU-27 and EFTA United States Rest of high-income countries Japan –2 –1 0 1 2 Average annual percentage change 2010s 2020s Source: World Bank calculations. Note: BRIC = Brazil, Russian Federation, India, China; EFTA = European Free Trade Association. 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 Rest of Latin America and the Caribbean Brazil Sub-Saharan Africa Middle East and North Africa Rest of Europe and Central Asia Russian Federation Rest of South Asia India Rest of East Asia China EU-27 and EFTA United States Rest of high-income countries 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. capital-to-output ratios are surprisingly simi- in developing countries contributes to the lar across countries, even where capital-to- higher growth rates than in high-income labor ratios vastly differ. countries, but over time the scarcity of land On top of this mechanism, several emerg- makes this transformation more difficult and ing economies, with China as a prime exam- curbs macroeconomic growth. Densely pop- ple, are experiencing capital deepening (ris- ulated countries with high economic growth ing capital-output ratios) (figure 5.5). That should experience the highest increases in allows labor productivity to rise even faster. land and real estate prices. And indeed, the That capital deepening is expected to con- scenarios generate the sharpest increases in tinue, albeit at a slower pace, in China and land prices in India and China, with rela- India, where ample savings will allow more tively modest increases in Latin America, capital accumulation than is needed to keep Africa, and emerging Europe (figure 5.6). pace with output growth. By contrast, cap- Finally, internal migration from rural to ital-output ratios in the relatively young urban areas is an important driver of growth emerging markets in Latin America and in developing countries because it allows Sub-Saharan Africa will fall, while advanced workers to move to more productive jobs countries will experience only small changes where wages are higher. Like many other in capital-output ratios. drivers of growth, this one explains not only Another driver of growth is the availabil- why developing countries outperform high- ity of land, which can become a constraint income countries but also why growth is for agriculture and urban development. The expected to slow over time. The existence of rapid transformation of rural to urban land segmented labor markets with low-wage jobs R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 375 Figure 5.6  Land prices in China and India will rise sharply Rest of Latin America and the Caribbean Brazil Sub-Saharan Africa Middle East and North Africa Rest of Europe and Central Asia Russian Federation Rest of South Asia India Rest of East Asia China 0 1 2 3 4 5 6 7 Index of land prices in 2030 (2005 = 1) Low growth High growth Source: World Bank calculations. 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 Source: World Bank calculations, based on the low-growth scenario. 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. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 5 0 World EU-27 United Japan Korea, Rep. India Russian Mexico ASEAN-10 Brazil Canada States Federation 2001 2009 Source: UN COMTRADE database. 380 china 2030 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 25 % applied tari 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 tari 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 Source: UN COMTRADE database. Source: UN COMTRADE database. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 381 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 Box 5.1  The Japanese experience with voluntary export restraints 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 Source: Carbaugh and Wassink 1991. a. This is the share of existing products covered by export restraints. The share of potential exports (if the restraints did not exist) would be higher. 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 383 exporting countries, including China, go to significant, and there is considerable scope partners with whom the country has some for the preferential recognition of stan- sort of preferential agreement. This statistic dards, licensing, and qualification require- overstates the impact of agreements on trade ments. Strong exclusionary effects could also flows, however, because only 16 percent of arise from “deeper integration” along other trade actually takes place on preferential dimensions: preferential agreements increas- terms (WTO 2011).4 Nevertheless, preferen- ingly have provisions on investment protec- tial agreements are of particular concern for tion, intellectual property rights, government China, for two reasons. procurement, competition policy, and techni- First, China gains only limited benefits in cal barriers to trade. A discriminatory tariff the form of increased access through prefer- may matter less than the selective recogni- ential agreements. Only about 6 percent of tion of product safety standards or selective its exports enjoy preferential access—signifi- access to government procurement markets. cantly below the world average, and low com- The government should pursue a two- pared with other large traders, such as the track strategy to confront the potentially European Union (EU) (13 percent), United adverse impact of regional trade agreements. States (22 percent), India (26 percent), and On the one hand, on the basis of abiding Brazil (15 percent). Moreover, China’s non- by and protecting multilateral agreements, preferential exports are somewhat disadvan- China should make efforts to push for the taged compared with other major exporters. further opening of markets through multi- For most countries or trading blocs, includ- lateral organizations as a prime policy objec- ing the European Union, United States, India, tive. It should also proactively push ahead and Brazil, only about 4 percent of nonprefer- with the negotiations on its accession to the ential exports face MFN tariffs greater than WTO government procurement agreement as 10 percent, but the proportion for China is part of its effort to improve procurement pro- twice as high. cedures, enhance transparency, reduce costs, Second, in the future, preferential agree- and enhance quality in government pur- ments in services may have a more exclusion- chases. On the other hand, China should pro- ary impact. Today, preferential agreements actively participate in regional trade arrange- in services tend to cover more sectors and ments and, where possible, strongly advocate include greater legal commitments to open- “open regionalism,” which requires that tar- ness than under the General Agreement on iff levels agreed among regional partners be Trade in Services (Marchetti and Roy 2009). offered to other nonmember countries on an However, these commitments tend to be MFN basis. weaker than existing policies and thus have had little role in opening markets. 5 Even in Further liberalizing services trade and join­ the rare cases where preferential agreements ing the government procurement agreement have induced liberalization—for example, in could boost export opportunities. In the Costa Rica’s elimination of its telecommuni- context of joining the WTO, China com- cations monopoly—the new policies are at mitted to one of the most rapid programs least in principle applied on a nondiscrimina- of services market opening ever seen. Over tory basis. Thus, the cost of exclusion today 2001–08, many restrictions on banking, from a preferential agreement in services telecommunications, transport, retail, and a is not worse access but less secure access, range of business services were phased out. because these agreements involve not more Nevertheless, China’s services sector policies liberalization but wider and deeper bindings. remain more restrictive than those in many In the future, however, any deepening of developing countries and much more so than preferential agreements in services could cre- in the high-income countries, in all sectors ate significant discrimination against out- except transport.6 Easing remaining restric- siders because MFN levels of protection are tions could provide the reciprocity required 384 china 2030 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 According to a survey by China’s Develop- an important role in the country’s develop- ment Research Center, since the global finan- ment, by transferring technology obtained cial crisis, China’s attractiveness to transna- in foreign markets and by integrating busi- tionals has gone well beyond low costs. The ness practices and organizational approaches top 5 (of 17) reasons for investing in China observed in foreign countries into domestic were given as the domestic market, infra- operations. The government should strive structure, labor cost, access of FDI, and to strengthen legal protections for Chinese industrial clusters, in which the large market overseas investments, either through bilateral was the most important. investment treaties or a multilateral agree- Following this change in the strategy of ment on investment. Achieving stronger pro- transnationals, China needs to take several tection for Chinese investors would require steps to capitalize on the potential advan- granting reciprocal concessions to foreign tages. First, the Industrial Guidelines for FDI investors in China, implying a dismantling of should be adjusted to encourage investments most restrictions on FDI inflows and contin- in emerging industries and research and ued improvements in the autonomy of state development (R&D). Second, policy should enterprises. These policies also are in the be shifted from giving preferential incentives long-term interest of China’s development. to improving the investment climate: ensur- ing a level playing field between domestic FDI outflows are increasing.  FDI outflows and foreign investors, improving the quality have risen rapidly since inauguration of the and efficiency of public services, improving “Going Global” policies in the late 1990s, human resources, and strengthening the ser- from $1 billion in 2000 to $44 billion in vice sectors. Third, to make full use of FDI’s 2009. China’s total FDI outflows over the spillover effects, FDI’s R&D should be inte- period were greater than for any other emerg- grated into the domestic innovation system. ing markets except Russia and Hungary (table The government should encourage greater China’s 5.3). Since 2003, almost 55 percent of ­ cooperation and exchange between for- greenfield FDI and 27 percent of M&A eign companies and domestic institutes and transactions have been in the mining sector, companies related to the human resources, compared with 10 percent in M&A transac- information, and R&D sectors. Finally, the tions from advanced countries (figure 5.11).11 government needs to enhance international Investment projects in services and manufac- competitiveness of its service sectors by fur- tures tend to be smaller than in mining, and ther liberalizing FDI in services. these two sectors were more important over Even more important than these changes this period in terms of the number of deals. toward inward FDI, China can benefit from promoting outward FDI, because invest- ments abroad will play an important role in the transition to a high-income economy. Table 5.3  FDI outflows by emerging markets At first glance, it can be difficult to under- rose sharply in 2000–09 stand why a poor country like China should Total encourage its firms to invest overseas, and it FDI 2000 2000–09 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. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 387 Figure 5.11  China’s outward FDI is directed more toward mining, compared with advanced countries’ FDI a. China outbound green eld, 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% Mining Manufacturing Other primary Services 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 Box 5.2  FDI and competition in services 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 Box 5.3  Japan’s transition to a floating exchange rate 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 (Feyzioğ lu, 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 (Box continues next page) 400 china 2030 BOX 5.4  (continued) 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. Source: Bakker and Chapple 2002. 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 403 Figure 5.12  Carbon emissions will rise in the baseline scenario 150 100 50 Percentage change, 2010–30 0 –50 –100 n t e s pe ina ia ia sia ion dd As d Sa Afric nd a he in A zil be ca ld te ric un m pa Mi tral e an As Ind or a rib eri ro Un ries Su orth ast a hA ta Ch N le E ia a an rat co nco Br Af Ja W Eu st Ca m dS Ce rop de ut ran Ea i h- ite So Fe Eu of ha hig d t at of n an st of an f L of Re st ssi b- st o Re st Re Ru st Re Re Emissions/GDP GDP per capita Population Emissions Source: World Bank. 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 Emissions per capita (tons) 2010 2030 Source: World Bank. Note: EFTA = European Free Trade Association. 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. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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 China’s policies are in some respects ben­ Source: Originally from Brautigam (2009), as reported with modifications by the author in Christensen (2010). eficial to recipients. China’s provision of finance in different forms and with a differ- ent approach from the traditional donors can provide recipient countries with greater policy aid procedures are simple, allowing for quick autonomy; they have an alternative source of implementation because no policy conditions funding if traditional donors’ conditionality are attached. Most of the funds go to projects appears onerous or unproductive. China is that enhance infrastructure and living stan- willing to finance dams, power plants, sta- dards (roads, hospitals, clean water projects, diums, and other government buildings— personnel training programs, and the like), projects that traditional donors have largely fostering economic and social development in stopped financing. China finances projects in the recipient country. The provision of finance countries without regard to political or gover- has assisted China’s efforts to improve strategic nance concerns. China’s lack of conditionality relationships with other developing countries, reduces the burden on government officials, to foster trade and other business opportuni- as well as the delays and costs inherent in ties for Chinese firms, to improve access to demonstrating compliance with conditional- key commodities, and to boost awareness ity. All of this can increase the attractiveness and appreciation of China’s political and of Chinese finance for recipient governments. economic system. China’s aid institutions do require evaluation of social and environmental China needs to be vigilant about corruptive impacts and the efficacy of the aid programs. behavior in its aid programs. Preventing Perhaps not as specific and detailed as required corruptive behavior in China’s aid program by traditional donors, these evaluations can be and ensuring effectiveness of aid will become strengthened to ensure the quality and effec- increasingly important to maintain the real tiveness of China’s program and maximize diplomatic benefits that China has garnered developmental benefits for recipient countries. from its financial program. As China’s pro- gram increases, examples of mismanagement China does not impose formal conditions for and corruption may also rise. For example, receiving finance.  Unlike traditional donors, the China Eximbank’s system of relying on China does not systematically impose formal Chinese companies to generate projects for conditions concerning governance or eco- financing by concessional loans can increase nomic policy. Indeed, a central principle of the risk of illicit payments or kickbacks. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 409 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 independent evaluation) will be conducive more significant source of concessional assis- to enhancing the quality and reputation of tance, efforts to improve coordination with China’s aid programs. ­ other donors will become more important. The government could take several con- Coordination will require adjustments in the crete steps as its aid program develops during aid programs of both China and the tradi- the coming transition. First, transparency can tional donors. Extension of current initiatives, be improved. One possible way to enforce an such as the dialogue initiated with the British improvement in transparency would be to Department for International Development report the country’s official finance according and the collaborative workshop with the to DAC categories, as 20 non-DAC donors do Australian government on aid to the Pacific already (World Bank 2011) or according to Islands, and new initiatives would be useful alternative categories that are consistent with vehicles for learning and for considering pro- independent aid flows.47 Collecting this data posals for improved coordination between in a systematic way could also improve the China, traditional donors, and recipient government’s monitoring of its financing pro- countries. gram. Second, the government could intro- duce independent evaluations of projects or As its size and influence expand, China’s country programs. Such evaluations would official finance should take more factors into impose a useful discipline on officials respon- consideration.  The rapid growth of China’s sible for projects, and the lessons learned overseas finance implies that China will would ultimately improve program effective- increasingly be responsible for financial flows ness. At the same time, integrating research that are large relative to the size of some recip- on the impact of projects into project design ients’ economies. To ensure the continuing would force officials to be explicit about effectiveness of its economic cooperation, it the goals of projects and provide invaluable will be necessary to take into account broader information on project results. considerations than simply the quality of spe- The issue of conditionality in projects cific projects. The government will have to pay raises thornier issues. On the one hand, the attention to whether project allocation across lack of conditionality in Chinese projects the economy is sensible, whether the govern- means that they can be implemented more ment’s resources devoted to operations and rapidly, more cheaply, and with less of a maintenance are adequate, and whether the burden on government officials than proj- recipient is adequately coping with potential ects undertaken by traditional donors. On macroeconomic implications of large inflows the other hand, from the angle of traditional of finance (Christensen 2010). donors, the lack of conditions raises the risk of undesirable consequences. The challenge is to take side effects of aid projects into Notes account, while avoiding excessive interfer-   1. The actual share of services was 43 percent in ence in recipient government policies. Find- 2010. Because the model adopted 2004 as the ing the right strategy is not straightforward. baseline year and does not include some of the Many traditional donors still provide aid to more recent data revisions, there are differ- countries where governance has been sharply ences between simulation results of past data criticized (witness the rise in U.S. assis- and actual data.   2. Most of this section on trade is based on Mat- tance to Iraq and Afghanistan over the past too and Subramanian (forthcoming). decade). Nevertheless, many studies have   3. Antidumping is hardly the only mechanism shown that aid is more effective in an overall used to discriminate against China’s exports. environment of good governance. Others include the Transitional Product- Specific Safeguard Mechanism (a unique fea- Rising official finance may require greater ture of China’s WTO accession that allowed global coordination. As China becomes a importers to invoke safeguards against China R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 411 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. R e a c h i n g “ W i n - W i n ” s o l u t i o n s w i t h t h e R e s t o f t h e W Or l d 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). 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See official development assistance (ODA) accountability aircraft, 165, 202n57 for education, 271 air pollution, 39, 232, 235 for financial system reforms, 119b All-China Federation of Trade Unions, 323 for fiscal system reforms, 90 allocative efficiency fiscal system reforms and, 102–3 defined, 77 for health services, 271, 304 enterprise sector and, 78, 87, 110 for social service providers, 49, 272 financial system reforms and, 79 accounting standards, 29 land policies and, 79, 87–89 Acemoglu, D., 264n3 middle-income trap and, 81 Acorn Computers, 207n135 productivity and, 87b active welfare society model, 272, 281 state role in, 85–86 Adams, James D., 203n69 structural reforms and, 79, 81b, 85–89 administrative monopolies, 106b, 110, 112 Altbach, Philip, 203n74 Advanced RISC Machines (ARM), 207n135 ALTC. See aged and long-term care Advanced Technology Program, 207n127 Aluminium Corporation of China (Chinalco), affordable housing, 111, 349 388 afforestation programs, 245 Amsden, Alice H., 106b aged and long-term care (ALTC), 52–53, anchoring bias, 252b 344–47, 346f, 354n70 anemia, 288–89, 289f, 351–52n19 aging population. See demographic transition angel investors, 175 agriculture antidumping, 71n37, 381, 410n3 climate change risks for, 44, 224b, 238, 402 Anti-Monopoly Law of 2008, 112, 113 economic growth and, 160 Apple, Inc., 165, 207n135 green development and, 224b Argentina labor market and, 17 education system in, 295 land policies and, 30, 135 FDI and competition in services in, 391b poverty reduction and, 47b food exports by, 384 productivity, 198n3 ARM (Advanced RISC Machines), 207n135 property rights and, 244–45 Asian financial crisis (1997), 123, 393, 401, research and development for, 254 413n35 tenant farming, 138b assisted living models, 347 water use by, 245, 265n10 auditing, 29, 31, 150n42 c h i n a 2 0 3 0 419 420  CHINA 2030 Australia biodiversity, 253 aged and long-term care in, 347 biogas, 40, 226 carbon-trading scheme in, 43, 261b biopharmaceuticals, 165, 182 national qualifications framework in, 302 biotechnology, 36, 226 national training authority in, 301 blue-skies research, 173 Austria booster rockets, 165 health care services in, 312 Bosworth, Barry, 159, 199n15 TVET in, 300 brain gain, 175, 205n98 automobile industry Brandt, Loren, 81b, 107b electric vehicles, 40, 42, 227 Branscomb, Lewis, 206n114 industrial policy favoring, 149n34 Brazil innovation in, 165 carbon emissions in, 221 Japan’s FDI in U.S. auto industry, 382b FDI and competition in services in, 391b as pillar industry, 108 food exports by, 384 regulatory framework for, 43 green development strategy of, 218 state-owned enterprises vs. private sector health care services in, 310 in, 26 national training authority in, 301 parenting education programs in, 293 Bahl, Roy, 139 preferential trade agreements with, 383 Bai, Chong-En, 81b preprimary education in, 289 balance of payments, 14. See also capital social spending in, 284 accounts Bretton Woods system, 71n41, 394b bandwidth user rights, 58 Breznitz, Dan, 199n13, 201n45 Bangladesh, early childhood development and broadband services, 163, 164f education in, 351n16 budget cycle, 56, 59 banks and banking. See also financial system building codes, 66, 186, 242, 247, 254 reforms Bulman, David, 81b, 150n48 contingent liabilities of, 59 business schools, 205–6n107 economic growth and, 4 butterfly effect, 69n5 FDI and competition in, 150n40, 391b BYD, 200n33 financial system reforms and, 143–44, 143f, 144t Cambridge (U.K.), as innovative city, 38, 184 liquidity management for, 29 Canada regulatory framework for, 367, 405–7 carbon-trading scheme in, 43, 261b reserve requirements, 150n43 functional reviews in, 95b as risk capital source, 169, 180 health insurance pooling in, 311 state-owned, 28, 397, 401 property taxes in, 32, 139 supervision of, 68 cancer, 278 trade restrictions for, 383 capacity building for innovation, 162–68, 192t Baoding, green development in, 255 cap-and-trade scheme, 42–43, 250 Basel guidelines, 367, 405, 406, 413n38 capital accounts base metals industry, 26 economic growth and, 160 basic benefit pillar, 343 European experiences with liberalization of, Beidou Navigation Satellite System, 202n58 399–400b Beijing exchange rate and, 366, 392–402 cluster networking in, 168 fiscal system reforms and, 392–93, 393t elderly care services in, 344, 345 global economic integration and, 366 electricity pricing in, 244 internationalization of renminbi and, 63 entrepreneurial culture in, 185, 190–91t surpluses in, 61–62 health care services in, 306 trends in, 14 obesity in, 292 capital gains tax, 32, 58, 65 Berger, Axel, 412n21 capital markets “big push” model for green growth, 232, 232b development strategy and, 18 bilateral investment treaties (BITs), 63, 389–90, innovation and, 180 412n21 structural reforms, 28–30 i n d e x   421 capital ratios, 68 China Health and Nutrition Survey, 352n20 capital-to-output ratios, 373–74, 374f China Household Nutrition Survey, 289 carbon emissions, 362–3, 366, 403–4, 403–4f. China Investment Corporation, 394 See also emission reductions China National Offshore Oil Corporation, 388 carbon markets China Securities Regulatory Commission global governance and, 64 (CSRC), 120 green development and, 42–43, 45, 186, China Urban Labor Surveys (CULS), 337 249, 253, 260–61, 260f, 261b Chinese Academy of Science and Technology for carbon tariffs, 64 Development, 166 carbon taxes, 57, 174, 250, 261 Chongqing case management systems, 309b cluster networking in, 168 CBRC (China Bank Regulatory Commission), hukou reforms in, 332b, 334 405–6, 413n37 multinational companies in, 184, 207n136 CCICED (China Council of International residence permit system in, 331 Co-operation on Environment and Christensen, Clayton M., 182 Development), 229 chronic illnesses, 277–78 CDRF (China Development Research Cisco, 206n114 Foundation), 292 citizen report cards, 24b, 313 Center for Disease Control and Prevention citizen voice, 283, 285–86, 313 (CDC, China), 288, 292 Claessens, Stijn, 412n25 Center of Chinese Agricultural Policy, 132 clean coal technologies, 7 central bank, 29, 118, 396 Clemmons, J. Roger, 203n69 Central Economic Work Conference (2004), 83 climate change CFL (compact fluorescent lighting), 252b global public goods and, 7, 402–5, 403–4f chaebols, 146–47 governance for, 64 Chang, Morris, 199n12 green development and, 39, 224b, 238–39, Changsha 238f, 253–54 elderly care services in, 344 innovation and, 185 transport infrastructure in, 184 international negotiations on, 367 chemicals industry, 26, 200n27 risk management for, 43–44 Chen, Qing-tai, 204n91 cluster networking, 167, 186, 203n67 Chen, Shiyi, 87b, 160, 199n17 coal-fired power plants, 40, 226, 240 Chengdu coal gasification, 226 citizen voice in, 313, 314b cognitive biases, 252b cluster networking in, 168, 205n104 collective bargaining, 322–23, 327 hukou reforms in, 334 collective governance, 132–33 innovation capacity building in, 184 Collins, Susan M., 159, 199n15 multinational companies in, 184 Colombia pension reform in, 340 early childhood development and education research networks in, 176 in, 351n16 residence permit system in, 331, 332b FDI and competition in services in, 391b Cheung, Yin-Wong, 411n11 social insurance subsidies in, 349 children Comin, Diego, 178, 198n4 nutrition for, 288–89, 289f, 290t, 292, 293 commercial banks, 29, 30 obesity in, 352n20 commercialization preprimary education for, 289–92, 290–92f of financial system, 118 Chile, TVET in, 301–2 of technologies, 171 China Bank Regulatory Commission (CBRC), Commission on Growth and Development, 15 405–6, 413n37 Committee on Foreign Investment (U.S.), China Council of International Co-operation on 204n88 Environment and Development (CCICED), commodity security, 39, 243–44, 384–85 229 community-based ambulatory centers, 310 China Development Research Foundation community-based elderly care services, 344, (CDRF), 292 345 China Eximbank, 408, 409 compact fluorescent lighting (CFL), 252b 422  CHINA 2030 competition counterfeiting, 396 development strategy and, 17, 19 countervailing measures, 411n3 enterprise sector reforms and, 105–6, creative destruction, 107b, 205n94 110–13 creative society, defined, 15 exchange rate and, 366 crisis management planning, 122–23 innovation and, 173–74 cross-border trade settlement, 63, 63f market-oriented reforms and, 27, 28 CSRC (China Securities Regulatory procurement policies and, 181 Commission), 120 sequencing of reforms and, 38 CULS (China Urban Labor Surveys), 337 in services sector, 391b currency swap arrangements, 400 shale gas exploration and, 246b Cutler, David, 181 in social services delivery, 49 state-owned enterprises and, 26 DAC (Development Assistance Committee), 409 comprehensive wealth accounting, 265n16 Dalian Machine Tool Group, 165, 202n51, 344 compulsory land requisition, 135–36 decentralization compulsory primary education, 46, 287. See also of fiscal system, 55 education industrial policies and, 114 compulsory savings contributions, 330 inequality and, 46 concessional assistance, 407 interregional competition and, 5 conditional cash transfers (CCTs), 51, 294 Declaration on Green Growth (OECD), 218 conditionality of aid, 408–9, 410 Defense Advanced Research Project Agency congestion pricing, 57, 94 (DARPA, U.S.), 36, 156 construction industry, 26, 227b demand-side policies, 180–81 consumer behavior Demirgüç-Kunt, Asli, 412n25 energy efficiency and, 252b demographic transition green development and, 44, 251 decelerating growth rates and, 363 consumer credit information reporting, 120 development strategy and, 16 consumer rights, 173 economic growth and, 80 contributory insurance model, 312, 343–44 equal opportunity and, 276–78, 277–78f Convention Against Corruption (2005), 409 labor markets and, 271, 373 coordination social policy reforms and, 48, 272, 274 for aged and long-term care, 52–53 trends in, 7, 8 of early childhood health and education, Deng, Qusheng, 198n3 292 Deng Xiaoping, 6, 15 for education, 286 Denmark of elder care, 344–45 capital account liberalization in, 399b of green development, 246, 255–56 health care services in, 312 of health care services, 286, 304 innovation in, 167 of innovation capacity building, 179 public expenditures on social protection in, of official development assistance, 410 93, 93f risk management and, 68–69 Department for International Development (UK), of social policy reforms, 279 410 in social services delivery, 50 Department of Energy ARPA-E program (U.S.), corporate bond market, 30 178 corporate governance, 103 dependency ratios, 7–8, 16, 48, 69n7, 276, 370 corporate income tax, 91, 95, 97 deposit insurance, 30, 122–23, 123b corporate sector. See enterprise sector deregulation, 127 corruption derivative instruments, 400b, 407 enterprise sector reforms and, 109 desulfurization industry, 228 fiscal system reforms and, 56, 59, 97, 102 developing countries land policies and, 130 carbon emissions and, 405 in official development assistance programs, economic growth rate in, 363 408–9 FDI in services sector in, 391b Costa Rica, preferential trade agreements in, 383 future trends for, 367–68 countercyclical fiscal measures, 11 international trade with, 375–76 i n d e x   423 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  CHINA 2030 energy security, 404–5 innovation in, 166 engineering. See science and engineering skills labor market in, 373 enterprise sector, 78–79, 103–15 labor migration in, 330 competitiveness in, 110–13 manufacturing imports from China, 379, efficiency and, 87 380 history of, 104–7, 104–5f, 106–7b preferential trade agreements with, 383 industrial policy interventions, 107–9, property taxes in, 139b 113–15 sovereign debt financed by China, 60 state-owned enterprises and, 110–12 trade disputes by, 71n37 entrepreneurship, 169 triadic patent filings and, 165 entry barriers, 38, 78, 103, 107b, 149n27 European Innovation Scoreboard, 166 environmental protection European Patent Office, 165 FDI and, 388 European Securities and Markets Authority, fiscal system reforms and, 92, 93f 413n39 green development and, 228, 233–36, 233t, European System for the Collection of Economic 233–34f, 235b Information on the Environment, 237 incentives for, 244 European Systemic Risk Board, 413n39 international trade and, 375–76 European Union Chamber of Commerce, 384 middle class expansion and, 7 exchange rate public financing of, 17, 57 capital account and, 366, 392–402 trends in, 8 dual exchange rate system, 392–93, 412n26 epidemiological transition, 277–78 external shock risks and, 14 equal opportunity, 46–54, 271–359 fiscal system reforms and, 29, 392–94, 393t challenges for, 46–48, 271–72, 274–80, 274f flexible, 379 demographic transition and, 276–78, internationalization of renminbi and, 63 277–78f Japan’s transition to floating rate, 394b development strategy and, 19, 21–22 market-based, 398 in education, 51, 51f, 295–302, 296–98f monetary policy and, 7 flexicurity and, 53–54, 54f export growth goals and principles of, 280–87 innovation and, 161 in health care, 46, 51–53, 302–12, 303f, manufacturing and, 199n23 305–7f trade relations and, 379–81, 380f, 381t human capital and, 287–315 extractive industries, 231 implementation strategy for, 283–84 extreme weather events, 238 poverty reduction and, 47b public financing of, 17 faculty recruitment, 170–71, 176, 204n85, reform proposals, 48–54, 272–74 205n98, 206n110 social structure changes and, 278–80 family-based elderly care services, 344 Equatorial Guinea, transition to high-income family binding, 340 country status by, 12b FARs (floor area ratios), 186 ethical standards in research, 37, 157, 171 FDI. See foreign direct investment European Banking Authority, 413n39 Federal Reserve (U.S.), 396 European Business School, 166 fee-for-service provider payment systems, 303, Europe and European Union. See also specific 304 countries Felipe, Jesus, 199n15, 200n26 aged and long-term care in, 347 Feng, F., 225 anticompetitive behavior in, 113 Ferri, Giovanni, 149n24, 149n27 capital account liberalization in, 399–400b fertility rate, 16, 48, 276, 317 carbon-trading scheme in, 43, 261b financial regulations, 64, 121–22, 400b, 405–7, deregulation and financial crises in, 398 406f deregulation in, 127 Financial Stability Board, 406, 413nn40–41 educational and skills qualifications financial system reforms, 55–59, 115–27, framework in, 302 392–402. See also banks and banking green development strategy of, 218 allocative efficiency and, 79 health care services in, 310 capital controls and, 392–93, 393t i n d e x   425 capital market deepening, 119–20 flood control, 44, 238 challenges for, 55–56, 125 floor area ratios (FARs), 186 change drivers for, 125–26 flue gas desulfurization industry, 228 commercialization and rationalization of Fogel, Kathy, 107b system, 118 food security, 7, 30, 384–85, 411n8 crisis management planning, 122–23 Forbes Global 2000, 200n33 deposit insurance and, 123b foreign aid. See official development assistance development strategy and, 19, 22 (ODA) exchange rate stability and, 392–94, 393t foreign direct investment (FDI) financial infrastructure and, 120–21 bilateral investment treaties and, 412n21 government financial management and, 59, global trends in, 6 123–25, 397–98 green development and, 240–41 history of, 115–17, 143–44, 143f, 144t, 145f inflows, 361–62, 365 insolvency schemes and, 122–23 innovative cities and, 38 interest rate liberalization, 118–19 interregional competition and, 5 legal framework for, 120–21 Japan’s investments in U.S. auto industry, local government resources and, 58–59, 58f 382b poverty reduction and, 47b legal framework for, 389 proposals for, 56–59 outflows. See outward FDI public expenditures and, 57, 397–98 restrictions on, 377–78 regulatory framework for, 64, 121–22, services sector and, 391b 400b, 405–7, 406f technology transfer and, 175 revenue mobilization, 57–58 trends in, 14 securitized financing, 30 in university system, 37 sequencing of, 88, 126–27, 398–401 foreign exchange reserves. See also exchange rate state-owned enterprises and, 119b capital markets and, 29 transparency in, 66 exchange rate management and, 394 financing health care, 52, 310–12 FDI and, 60, 61–62, 387–88 Finland risk management for, 69 capital account liberalization in, 399b Foshan, cluster networking in, 168 innovation in, 166, 167, 178, 179 fossil fuels performance evaluation of local officials in, in energy mix, 40 103 international subsidies for, 244b TVET in, 300 pricing of, 174 vocational training in, 177 Foxconn, 165, 207n136 fiscal stimulus package (2009–10), 55 France fiscal sustainability, 97–100 capital account liberalization in, 399b fiscal system reforms, 78, 89–103 public expenditures on social protection in, accountability and, 102–3 93, 93f challenges for, 92–103 Fraunhofer Institutes (Germany), 174 efficiency and, 86–87 free trade agreements, 7, 62 fiscal sustainability and, 97–100 fuel efficiency standards, 43 functional reviews, 95b Fujian Province government expenditure restructuring, entrepreneurial culture in, 34, 169 92–94, 93f green development performance indicators history of, 90–92, 91–92t in, 44 policy options for, 92–103 functional reviews, 95b regulatory framework and, 99b Fung, K. C., 411n11 state role in, 89–90 F. Zimmermann GmbH, 202n51 subnational governments and, 99b, 100–102, 100t Gann, David, 198n5 taxes and revenue sources, 94–97, 95–96f Gansu Province, preprimary education in, 291 transparency and, 102–3 Gao, Jian, 200n35 flexible work arrangements, 321 Gao, Xudong, 200n32 flexicurity, 49, 53–54, 54f, 273, 282, 315–36 Gaoyang model, 203n67 426  CHINA 2030 García-Herrero, Alicia, 411n11 Goldwind, 202n54, 202n56 GATS (General Agreement on Trade in Services), Golley, Jane, 198n3 383, 411n5 Gordon, Peter, 203n70 GATT (General Agreement on Tariffs and governance Trade), 384 corporate, 103 Geertz, G., 69n6 land policies and, 31, 32 GEM (Growth Enterprises Market), 169 state-owned enterprises and, 27 gender wage gap, 353n48 in tertiary education, 37 General Administration of Quality Supervision, urbanization and, 24b Inspection, and Quarantine, 149n29 government financial management, 59, General Agreement on Tariffs and Trade 397–98. See also fiscal system reforms; public (GATT), 384 expenditures General Agreement on Trade in Services (GATS), government-funded budget, 56 383, 411n5 GPTs (general purpose technologies), 184–85 general budget, 56, 57 Great Recession, 60 general purpose technologies (GPTs), 184–85 Greece, transition to high-income country status Germany by, 12b aged and long-term care in, 347 Greenberg, Daniel S., 207n121 capital account liberalization in, 399b green development, 39–45, 217–70 financial system in, 116 advantages for, 239–43, 239–41t, 240f, green development strategy in, 218, 219b, 241b, 242f 229b “big push” model for, 232b industrial extension services in, 174 carbon markets and, 260–61, 260f labor migration in, 330 challenges for, 41, 239t, 243–47, 243f recycling in, 253 climate change risks and, 238–39, 238f, science and technology power in, 166 253–54 TVET in, 300 compensation for negatively impacted vocational training in, 177 groups, 45, 253 Gerschenkron, A., 86 development strategy and, 21 Giles, John, 354n64 economic growth and, 232–39, 251 global economic integration, 361–417 emerging green industries, 226–29, 228b economic growth scenarios and, 363–64 emission reductions and, 220b, 220f, 225, financial system integration, 392–402 225–26f, 236, 236t growth drivers for, 370–75, 371–75f employment and, 229b integration with, 6–8, 377–402 environmental degradation reduction and, projections for, 367–77, 369t, 370–75f 233–36, 233t, 233–34f, 235b public goods and. See global public goods as growth driver, 40, 222–32, 223f trade patterns for, 375–76, 379–85, innovation and, 42, 158, 184–87 379–80f, 381t institutional framework and, 44–45, global financial crisis, 6, 65, 123, 406 254–56 global governance, 63–64 market incentives and, 41–43, 249–51 Global Independent Commission for Education measuring progress in, 258–60, 259f, 259t of Health Professionals, 352n39 need for, 39, 217–22 Global Innovation Index, 166 opportunities for, 220–22 global public goods public investment in, 43–44, 237, 237t climate change and, 402–5, 403–4f recommendations, 41–45, 249–56, 249t defined, 70n17 regulatory framework and, 43, 251–53 development strategy and, 18 research on, 38 economic integration and, 362–3, 402–10 sectoral considerations, 39, 40, 223–26, financial regulations, 405–7, 406f 224b, 227b, 261–64, 262–64t, 262f official development assistance, 64, 407–10, sequencing of reforms for, 257–64, 257f 408f in service sector, 40, 230–31, 230f policies for, 366–67 in underdeveloped regions, 231–32 public financing of, 17 urbanization and, 255b structural reforms and, 26 green technologies, 367 i n d e x   427 Grossman, Jerome H., 182 Henan Province Group of 20, 244b early childhood health and education in, growth. See economic growth; income growth 294 Guangdong Province preprimary education in, 291 cluster networking in, 167 Herfindahl-Hirschman index, 106b education in, 296 Hertel, T., 353n61 entrepreneurial culture in, 34, 190–91t heuristic decision making, 252b entry of new firms in, 162 Hidalgo, Cesar, 161 green development performance indicators high-density power batteries, 165 in, 44 high-income countries hukou reforms in, 332b, 334 economic growth trends in, 368 pension reform in, 340 land policies in, 131b, 133b residence permit system in, 331 TFP growth in, 160–61 TVET in, 301 high-income trap, 57 Gwynne, Peter, 202n52 high-speed trains, 165, 202n55, 232 High-Technology Research and Development Haier, 200n33, 203n61 program, 165 Hainan Development Bank, 150n44 Hobijn, Bart, 198n4 Hall, Bronwyn, 198n5 Hoekman, Bernard, 412n20 “happiness” index, 22, 44 Hofmarcher, Maria, 309b harmonious society, defined, 15 Hong, Kiseok, 82, 140 Hausmann, Ricardo, 161 Hong Kong SAR, China health care development strategy of, 17 delivery improvements for, 48 Leasehold System, 129b demographic shift and, 277–78 minimum wage in, 327 equal opportunity in, 46, 51–53, 302–12, offshore market for renminbi in, 397 303f, 305–7f transition to high-income country status by, financing and payment reforms, 310–12 12b fiscal system reforms and, 92, 93f hospitals green development and, 232 admissions rates to, 271–72, 303, 308 hukou system and, 276 governance and management of, 308 innovation in, 170, 181–82 Household Responsibility System (HRS), 128, in OECD countries, 309b 129b poverty reduction and, 47b housing public financing of, 18, 57 affordable, 111, 349 quality of, 182 hukou system and, 276 research on, 38 inequality in, 46, 276 subsidies for, 349 innovation and, 172 training of primary care physicians, 352n39 in innovative cities, 170 trust in, 279, 304 middle class expansion and, 7 urbanization and, 23b public financing of, 18, 27 health insurance Housing Provident Fund, 330 fiscal sustainability of, 273 HRS (Household Responsibility System), 128, pooling level for, 311–12 129b poverty reduction and, 47b Hsieh, Chiang-Tai, 81b reform proposals for, 282–83 HSR (Health Systems Reform of 2009), 305 social security policy and, 46 Hu, Angang, 166, 198n2 Health Systems Reform of 2009 (HSR), 305 Hu Jintao, 228b, 239 heart disease, 277–78 Huang, Yiping, 87b, 243 heavy metal contamination, 235 Huawei, 165, 169, 200n29, 200n33, 201n50, Hefei 204n88 cluster networking in, 168 Huizinga, Harry, 412n25 innovation capacity building in, 184 hukou reform Helmers, Christian, 201n45 agricultural vs. nonagricultural, 353n59 Helsinki, as innovative city, 38, 184 economic growth and, 11–12 428  CHINA 2030 hukou reform (continued) industrial concentration, 89, 106b flexicurity and, 273 Industrial Guidelines for FDI, 386 inequalities reinforced by, 47, 276 industrial parks, 184, 186 labor market and, 32–33, 53, 66, 330–36, industrial policy 331f, 332b, 334–35f, 350t development strategy and, 17 opposition to, 66 economic growth and, 160 poverty reduction and, 47b enterprise sector and, 107–9, 113–15 human capital extension services and, 174 citizen participation in social services, state-owned enterprises and, 26 312–15, 314b technological changes and, 10 development strategy and, 17, 19 industry associations, 38, 44 early childhood development and education, inequality, 46–47. See also equal opportunity 288–95, 288–92f, 290t, 294f inflation, 4–5, 29, 393, 394b, 396 educational quality and access, 295–302, informal payments, 304 296–98f informal sector employment health care and, 302–12, 303f, 305–7f green development and, 265n6 innovative cities and, 38 pension insurance and, 49 labor market and, 315–36, 317–21f, urbanization and, 318–19 323–24t, 324f, 327–29t, 328f information and communications technology public investment in, 156 (ICT) sequencing of reforms and, 65 development strategy and, 19 social security and, 336–49, 337–39f, 343f educational use of, 206n108 Hwang, Jason, 182 green development and, 226 hydroelectricity generation, 40, 241, 241t, 261 health care service delivery and, 48, 182, 308–9, 310 Iceland, public expenditures on health in, 93, 93f innovation and, 161, 170 ICT. See information and communications social services delivery and, 50 technology state-owned enterprises vs. private sector IEA (International Energy Agency), 244b, 261b in, 26 Ikeda, Sanford, 203n70 Information Technology and Innovation ILO (International Labour Organization), 339 Foundation (ITIF), 166 IMF. See International Monetary Fund infrastructure implementation of reforms, 65–73 climate change risks and, 254 macroeconomic risks and, 67–69 development strategy and, 16–17 opposition groups and, 66–67 domestic market integration and, 5–6 sequencing of reforms, 65–66 economic growth and, 4 social policy reforms, 283 FDI’s impact on, 391b income growth, 18, 29 for financial system, 30, 120–21 income inequality fiscal system reforms and, 91, 94 development strategy and, 19, 46, 275–76, green development and, 39, 224b, 251, 257 275f land policies and, 128 financial system reforms and, 117 public expenditures on, 98 land policies and, 132 special economic zones and, 167 structural reforms and, 80 urbanization and, 23b trends in, 8–9 Ingersoll International, 202n51 income taxes, 57, 71n34 initial public offerings, 30 India innovation, 34–38, 155–216. See also carbon emissions in, 221, 376 technological capacity FDI in, 411n5 advantages in, 169–70, 188–89t labor market in, 373 basic research and, 178 land prices in, 374 capacity building for, 162–68, 192t preferential trade agreements with, 383 capital markets and, 180 indigenous innovation, 163, 170 challenges for, 170–72 Indonesia, labor force participation rate in, 318 competitive market reforms, 173–74 industrial administrations, 109 demand-side policies and, 180–81 i n d e x   429 development strategy and, 19, 21 international financial regulations, 64 economic growth and, 159–62, 160t, 188t International Financial Reporting Standards, enterprise sector reforms and, 104 150n42 entry of firms by subsector, 162, 190–91t internationalization of renminbi, 63, 63f, evaluation standards for, 178–80 395–97, 401–2 FDI and, 386 International Labour Organization (ILO), 339 green development and, 40, 42, 158, International Monetary Fund (IMF), 90, 148n12, 184–87 284 in health care, 181–82 International Standards on Auditing, 150n42 indigenous, 163, 170 Internet as global public good, 402 national innovation systems, 174–75, 175f, interregional competition 197t development index as basis for, 10 open system for, 177–78 economic growth and, 5 policy priorities, 172–81 green development and, 44 reform recommendations, 35–38, 37f intracity connectivity, 24b research networks and, 175–76 Investment Climate Surveys, 299 sequencing of reforms, 38 investment treaties, 389–90. See also bilateral state-owned enterprises and, 26 investment treaties (BITs) tertiary education and, 176–77 Ireland TFP and, 158–62 national qualifications framework in, 302 urbanization and, 24b, 158, 167–68, TFP growth in, 161 182–84 transition to high-income country status by, vocational training and, 177 12b Innovation Capacity Index, 166 Israel innovative cities, 38, 157, 170, 182–84, 207n134 innovation funding in, 179 INSEAD, 166 transition to high-income country status by, in-service training for teachers, 297 12b insolvency schemes, 122–23 Italy institutional framework gender wage gap in, 353n48 for aged and long-term care, 52–53, 347 health care services in, 312 for citizen participation, 314b ITIF (Information Technology and Innovation for green development, 247 Foundation), 166 green development and, 44–45, 254–56 Ito, Keiko, 160 harmonious society goals and, 15 for health care, 306, 313 Jaeger, C. C., 223 inequalities and, 46–47 Jaffe, Adam B., 203n69 for innovation, 172, 205n97 Japan for innovative cities, 183 aged and long-term care in, 347 for labor market, 48, 53, 322–30, 323–24t, air pollution in, 235 324f, 326b, 327–29t, 328f carbon-trading scheme in, 43, 261b sequencing of reforms and, 38 decentralization in, 114 intellectual property deregulation in, 127 acquisition of, 162–63 development strategy of, 17, 155, innovation and, 177–78 198–99nn9–10 piracy and, 206n116 economic growth rates in, 82 protection of, 35–36, 163, 173 education system in, 295, 297 interest rates FDI outflows from, 387, 411n14 capital markets and, 28, 29 fertility rate in, 317 controls on, 398 financial system in, 116, 125, 145–47 financial system reforms and, 65, 118–19, floating exchange rate in, 394b 150n41 gender wage gap in, 353n48 intergovernmental transfers, 56, 58 green development strategy in, 218, 219b International Centre for the Settlement of health insurance pooling in, 311 Investment Disputes, 389 industrial concentration in, 106b International Energy Agency (IEA), 244b, 261b industrial extension services in, 174 430  CHINA 2030 Japan (continued) knowledge spillovers in, 391b innovation in, 167 labor force participation rate in, 318 labor market in, 373 labor migration in, 32 labor migration in, 330 land policies in, 70n21, 136, 138b manufacturing imports from China, 379 resource depletion in, 232 performance evaluation of local officials in, senior secondary education enrollment in, 103 51 research networks in, 35, 157, 175 TFP growth in, 161 resource depletion in, 232 transition to high-income country status by, science and technology power in, 166 12b, 159 transition to high-income country status by, triadic patent filings by, 165 12b, 158–59 TVET in, 300 triadic patent filings and, 165 Kraay, Aart, 81b, 150n48 TVET in, 300 KSL-Kuttler Automation Systems, 202n51 voluntary export restraints in, 382b Kuijs, Louis, 150n48, 160 Japan Patent Office, 165 Kumar, Utsav, 200n26 Jefferson, Gary H., 87b, 160, 199n17, 200n35 Kunming, citizen voice in, 313, 314b Jiangsu Province Kuznets effect, 46, 271, 274 residence permit system in, 331 Kyoto, as innovative city, 38, 184 TVET in, 301 Kyoto Protocol, 223 Jiao Tong University, 203n74 job creation, 229b, 265n6 labor force participation rate (LFPR), 317–20 job retraining, 45, 253, 321 Labor Law of 1994, 322, 323 job sharing, 321 labor market Jones, Charles I., 198n6 demographic transition and, 7, 8, 16, 271, Jorgenson-Fraumeni lifetime income-based 373 approach, 351n1 development strategy and, 18 equal opportunity in, 46 Kaiser, David, 203n74 flexicurity and, 315–36 Kaiser Permanente, 309b future trends in, 370, 377 Kazakhstan, health insurance pooling in, 311 green development and, 40, 229b Key Technologies R&D program, 165 hukou reform and, 330–36, 331f, 332b, Kharas, H., 69n6 334–35f, 350t Klenow, Peter, 81b institutional framework for, 48, 53, 322–30, Knight, John, 198n3 323–24t, 324f, 326b, 327–29t, 328f knowledge diffusion, 168, 203n69 job retraining and, 45, 253, 321 knowledge spillovers, 81, 391b. See also spillover mobility within, 11–12, 32–33, 66, 282 effects rural labor supply, 320, 321f, 377 knowledge workers, 38 skilled vs. unskilled labor, 370 The Republic of Korea social development and, 4, 53, 315–36 aged and long-term care in, 347 social stratification and, 278 agricultural employment in, 148n9 structural reforms, 32–33 decentralization in, 114 supply and structure of, 316, 317–20, deregulation in, 127 317–20f, 373 development strategy of, 17, 155 taxation and, 328–30, 328f economic growth rates in, 82 technical skill shortages in, 176 education system in, 295, 297 vocational training and, 177 exchange rate in, 393 wage determination and, 9, 61, 324–28, FDI outflows from, 387 326b, 327–29t fertility rate in, 317 labor migration, 85, 132 financial liberalization in, 145–47 Land Administration Law of 1988, 129–30b financial system reforms in, 125 land banks, 138, 140 gender wage gap in, 353n48 landfills, 252–53 green development strategy in, 218, 219b land policies, 127–40 industrial concentration in, 106b agricultural development constrained by, 374 i n d e x   431 allocative efficiency and, 79, 87–89 liquidity management, 29 citizen participation in land use planning, 24b List, John A., 199n25 collective governance, 132–33 Liu, Li-Gang, 149n24, 149n27 development strategy and, 18 Liu, Lili, 99 green development and, 185, 186, 224b Liu, Nian Cai, 203n74 land registration and, 132 Liu, Shijin, 110b, 180b, 218b legal framework for, 129–31b Liu, Xielin, 200n32 municipal finance reform and, 138–40 living wage approach, 327 pricing mechanisms and, 243–44, 257 local governments. See also interregional property rights and, 250 competition property taxes and, 96–97, 138–39, 139b contingent liabilities of, 59 rural land acquired for urban expansion, environmental protection investments by, 70n21, 133–37, 134–35b, 138b 245, 256 rural land market development, 132, 133b financial system reforms and, 124 sequencing of reforms for, 65 fiscal autonomy of, 59 structural reforms, 30–32, 31f fiscal system reforms and, 58–59, 58f, 98, tenure security in rural areas, 130–33 99b, 100–102, 100t urban development constrained by, 374 green development reforms and, 44–45 urban village problem and, 137 “happiness” index used by, 22 land registration, 132 inequality and, 46 Lane, Julia, 178, 203n68, 205n97 labor migration and, 33 Latin America land policies and, 30, 31, 138–40 deregulation and financial crises in, 398 performance evaluation of local officials, FDI and competition in services in, 391b 103, 114 land prices in, 374 performance measurements for, 65 middle-income trap in, 12b revenue mobilization and, 55–56 TVET in, 300 taxation by, 86–87, 101–2 Latvia, functional reviews in, 95b testing of reforms by, 67 Leading Group on Poverty Reduction, 292, 293 urbanization and, 23b Lee, Jong-Kun, 412n25 logistics, 19, 163, 232, 232b Lee, Jong-Wha, 82, 140 Long, Guoqiang, 200n31 legacy costs, 96, 329, 339, 341, 342 long-term care. See aged and long-term care legal framework (ALTC) for citizen participation, 314b Luo, Xubei, 94, 353n61 development strategy and, 20 for FDI outflows, 389 machinery industry, 26 for financial system, 29, 120–21 macroeconomic stability for intellectual property protection, 177 economic growth and, 4–5 internationalization of renminbi and, 63 fiscal system reforms and, 55 for land policies, 128, 129–31b implementation of reforms and, 67–69 for outward FDI, 389 macroprudential regulation, 122 public trust in, 68 “Main Functional Area Development Plan” Leipziger, Danny M., 113 (State Council), 231b lending rates. See interest rates Malaysia Lenovo, 163, 200n33, 203n61, 204n78 agricultural employment in, 148n9 Lester, Richard K., 198n7 exchange rate in, 393 Levitt, Steven D., 199n25 FDI outflows from, 387 LFPR (labor force participation rate), 317–20 manufacturing Li, H., 243–44 carbon emissions and, 404 Li, Shaomin, 107 development strategy and, 19, 159 Li, Shi, 198n3 economic growth and, 80 Li, Xibao, 201n45, 205n101 entry of new firms in, 162 life expectancy, 48, 276 exports of, 199n23, 379–80 Lin, Justin Yifu, 82 FDI and, 386–87 linking mechanisms, 135b green development and, 226 432  CHINA 2030 manufacturing (continued) Ministry of Industry and Information growth rates for, 80, 372 Technology (MIIT), 108, 141 innovation and, 34, 161, 165 mixed-use neighborhoods, 185 international trade and, 375 mobile networks, 163, 164f research and development facilities modern society, defined, 15 co-located with, 169 Mokyr, Joel, 203n68 specialization of, 61 monetary policy technological catch-up and, 159 exchange rates and, 7 trade surplus in, 379–81 financial system reforms and, 118 value chains for, 376 macroeconomic stability and, 4–5 wages and, 17 monopolies, 28, 66 market incentives moral hazard, 125 green development and, 41–43, 249–51 moral standards, 20 innovation and, 173–74 Morck, Randall, 107b market-oriented reforms, 25–33 motor vehicle taxes, 94–95 capital markets, 28–30 MSK Corp., 202n51 economic growth and, 4 multilateral free trade agreements, 62 equal opportunity and, 278–80 multimedia development, 36 factor markets, 28–33 multimodal transport, 163 labor markets, 32–33 multinational companies land policies, 30–32, 31f domestic market and, 169 private sector development, 25–28 exports by, 60 state-owned enterprises, 25–28 innovation capacity and, 171, 173, 177 Martin, Ben, 179 research and development facilities in China, maternity insurance, 53 35, 157, 162–63 Mathews, John A., 205n102 Munich, as innovative city, 38, 184 Mauritius, transition to high-income country municipal finance reform, 138–40. See also local status by, 12b governments Mayo Clinic, 309b municipal landfills, 252–53 McKinsey & Company, 224, 236, 265n5, 299 Murphree, Michael, 199n13, 201n45 McKinsey Global Institute, 168 Murrugarra, Edmundo, 353n50 Meisenzahl, Ralf R., 203n68 Meng, Xin, 198n3 Nanjing, citizen voice in, 313, 314b metal manufacturing, 162 nanotechnology, 36, 164, 165, 202n53 Mexico National Aging Commission, 344, 347 education system in, 295, 298 National Audit Office, 31 FDI and competition in services in, 391b National Development and Reform Commission labor migration in, 330 (NDRC) parenting education programs in, 293 aged care services, 344, 347 preprimary education in, 289 capital markets and, 120 social insurance subsidies in, 349 green development and, 228, 246 micronutrient supplementation, 292 industrial policy and, 108, 114, 141, microprudential regulation, 121–22 150n49 middle class innovation and, 179 domestic market demand and, 10 National Education Development Plan for growth of, 7, 9 2010–20, 314b innovation and, 34, 169 National Energy Administration, 246 policy debate participation by, 13, 17 National Health Services Survey, 303 social policy expectations of, 48 national innovation systems, 172, 174–75, 175f, middle-income trap, 11, 12b, 12f, 16, 80–83 197t migrant wages, 9, 353n54 National Institutes of Health (NIH, U.S.), 36, Millennium Development Goals, 4 156, 178 minimum wages, 323–24, 324f, 324t, 327t National Patent Development Strategy Ministry of Commerce (MOFCOM), 114 (2011–20), 201n43 i n d e x   433 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  CHINA 2030 outward FDI Perkins, Dwight H., 199n18 benefits of, 387–88 permit trading schemes, 245 global economic integration and, 365–66, personal income taxes, 57, 71n34, 96, 148n19 378 Philippines investment treaties and, 389–90 exchange rate in, 393 legal framework for, 389 national training authority in, 301 obstacles for, 388–89 photovoltaic (PV) industry, 165, 226, 227, 240, trade relations and, 62–63, 386–89, 386t, 241b. See also solar power 387f pillar industries trends in, 14, 61 competition in, 105, 106 over-the-counter (OTC) derivatives, 407 enterprise sector reforms and, 78, 87 overweight and obesity, 289, 290t, 292, 293, innovation in, 173 352n20 market-oriented reforms and, 27 Oxley, Howard, 309b productivity improvements in, 155–56 state-owned enterprises vs. private sector in, Pan, Jane, 149n27 26, 173–74 parenting education programs, 293 piracy, 206n116 Park, Albert, 354n64 plagiarism, 204n86 Park, Donghyun, 82 policy statements, 108 part-time employment, 321 “polluter pays” principle, 42 passive heating and cooling, 224 pollution taxes, 42 Patent Cooperation Treaty, 201n47 Popp, David, 205n95 patents population density, 23–24b, 172, 255b green development and, 227 portability of benefits, 47, 48, 341 system reforms for, 35–36, 177, 200n27, Porter, Michael E., 182 201nn42–43 Portugal, transition to high-income country trends in, 35, 157, 161–62, 164 status by, 12b PBC (People’s Bank of China), 120 poverty reduction Pearl River Delta economic growth and, 4, 79–80, 377 cluster networking in, 168 equal opportunity and, 47b entrepreneurial culture in, 34, 169 financial system reforms and, 117 peer review of publications, 171 social security and, 348 Peng, Changhui, 206n114 poverty traps, 54, 273 pensions Pradelli, Juan, 99 coverage expansion for, 53, 54f, 337–38, precision medicine, 182, 207n132 337–38f pre-entry national treatment, 389, 390 employer contributions to, 33 preferential trade agreements, 383 fiscal sustainability of, 53–54, 273 preprimary education, 289–92, 290–92f flexicurity and, 53, 287 preventive care, 52, 182, 308 hukou reform and, 32–33, 335–36 price indexation, 342 legacy costs for, 329 primary education, 46, 169. See also education pooling of contributions for, 341, 342 primary health care system, 52, 305–6, 306–7f, poverty reduction and, 47b 309b public financing of, 18, 57 private sector. See also enterprise sector; reform proposals for, 49, 282–83 public-private partnerships subsidies for, 349 aged and long-term care services by, 345 trust in, 279 development strategy and, 16–17, 20–21 urban pension system, 353n62 green development and, 42, 251 People’s Bank of China (PBC), 120 health care services by, 310 People’s Mediation Council on Medical Disputes, innovation and, 36, 173, 175 314b market-oriented reforms and, 4 performance-related pay (PRP) public goods and, 18 for health care services, 312 social service delivery by, 49, 50 for public sector, 323, 325–26, 326b structural reforms for, 25–28 i n d e x   435 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  CHINA 2030 revenue mobilization, 55, 57–58 Seattle reverse engineering, 162–63, 169 as innovative city, 38, 184 Rights Protection Law for the Elderly of 1996, quality of life in, 207n134 344 secondary education Rio+20 (UN Conference on Sustainable access to, 51, 65 Development, 2012), 218 costs of, 281 Rio Tinto, 388, 412n17 enrollment in, 46, 297–99 risk capital, 36, 169, 171 quality of, 169 river basin commissions, 45, 256 sectoral considerations. See also specific Rizhao, green development in, 255 industries and sectors Romer, Paul, 198n6 for green development, 39, 223–26, 224b, Rosenstein-Rodan, P. N., 86 227b, 261–64, 262–64t, 262f Rovito, Emilie, 198n4 social services delivery and, 50 Royal Institution of Chartered Surveyors (UK), securitized financing, 30 134b selective formalization, 329 Royal Society (UK), 164 senior secondary education. See secondary rule of law, 20. See also legal framework education Rural Credit Cooperatives Union (RCCU), 124 Seoul, as innovative city, 38, 184 rural labor supply, 12b, 70n25, 276–77, 316, sequencing of reforms 320, 321f development strategy and, 38, 65–66 Rural Land Contracting Law of 2002, 129b financial system, 88, 126–27, 398–401 rural land tenure, 30, 31 fiscal system, 398–401 rural-urban migration, 9, 23b, 32–33, 47b, 377 green development, 257–64, 257f Russian Federation land policies, 65 carbon emissions in, 221 SERC (State Electricity Regulatory Commission), labor market in, 373 246–47 national qualifications framework in, 302 services sector social spending in, 284 decelerating growth and, 361, 363 Rusticelli, Elena, 309b development strategy and, 19 entry of new firms in, 162 Saggi, Kamal, 412n20 FDI and, 386–87, 391b SAIC (State Administration for Industry and foreign direct investment in, 365 Commerce), 114 global trends in, 7, 363–64, 410n1 Salmi, Jamil, 203n74 green development in, 40, 223, 230–31, SAMCs (state asset management companies), 27, 230f 111 growth rates for, 80, 372 San Francisco, as innovative city, 38, 184 innovation and, 34, 161, 170 SASAC. See State Owned Assets Supervision and international trade and, 375 Administration Commission preferential trade agreements in, 383 satellites, 165, 202n58 productivity growth in, 61 savings rate trade relations and, 62, 383–84 aging population and, 7, 8 SEZs. See Special Economic Zones dependency ratios and, 370 SFIs. See state financial institutions fiscal system reforms and, 97 Shaanxi Province future trends in, 377 education costs in, 298 social policy reforms and, 284 preprimary education in, 291 technological catch-up and, 10 shadow banking, 116 school councils, 314b shale gas, 40–41, 226, 245, 246b school readiness standards, 291 Shanghai Schumpeter, Joseph, 198n5 cluster networking in, 168 science and engineering skills, 34, 169, 176, 299 educational quality in, 169, 203n75 Science and Technology Power index, 166 elderly care services in, 344 science citation index rating, 164 health care services in, 306 sea-level rise, 238, 238f, 402 hukou reforms in, 332b i n d e x   437 obesity in, 292 social security and, 336–49, 337–39f, 343f R&D public service platform in, 175, 175f social structure changes and, 278–80 residence permit system in, 331 Social Insurance Law of 2011, 338 Shenyang social science citation index, 164 cluster networking in, 168 social security. See also equal opportunity multinational companies in, 184 aged care services and, 344–47, 346f Shenzhen employer contributions to, 33 cluster networking in, 168 financial system reforms and, 117 residence permit system in, 331 fiscal system reforms and, 92, 93f, 148n15 Shin, Kwanho, 82 flexicurity and, 53–54, 54f shock amplifiers, 68 insurance contributions, 328–30, 328f Sigurdson, Jon, 198n2 integration of, 348–49 Singapore land policies and, 135b congestion pricing in, 94 pension coverage expansion, 337–38, decentralization in, 114 337–38f development strategy of, 17 pooling of contributions, 336 innovation in, 166 social development and, 336–49, 337–39f, transition to high-income country status by, 343f 12b urbanization and, 338–40, 339f Singh, Ajit, 106b social security fund budget, 56 Sinovel, 202n54 social unrest, 68 SIPO (State Intellectual Property Office), 201n45 SOEs. See state-owned enterprises SITRA (Finland), 178 software development, 36 Siu, Alan, 411n11 soil degradation, 39, 235, 265n14 small and medium enterprises (SMEs) solar power, 40, 223, 226–27, 240–41, 241b, development strategy and, 19 241t enterprise sector reforms and, 103 South Africa financial system reforms and, 117, 120 carbon emissions in, 221 innovation and, 36, 157, 174 national training authority in, 301 market-oriented reforms and, 25, 156 South-South official development assistance, 367 profitability of, 205n93 sovereign debt financing, 60 Small Business Innovation Research program, Spain 207n127 health care services in, 312 social development transition to high-income country status by, challenges for, 274–80, 274f 12b citizen participation in social services, Spark program, 165 312–15, 314b Special Economic Zones (SEZs), 6, 141, 167, demographic transition and, 276–78, 183, 385 277–78f special inspection and reorganization, 108 development strategy and, 21–22 specialization of manufacturing firms, 18, 61 early childhood development and education, special purpose vehicles, 31, 32, 56 288–95, 288–92f, 290t, 294f spillover effects, 35, 81, 157, 163, 178, 386, 391b economic growth and, 4–5 sprawl, 30, 172 educational quality and access, 295–302, STAR METRICS project, 207n128 296–98f State Administration for Industry and Commerce harmonious society goals and, 15 (SAIC), 114 health care and, 302–12, 303f, 305–7f State Administration of Work Safety, 149n29 inequalities in, 275–76, 275f state asset management companies (SAMCs), 27, interregional competition and, 5 111 labor market and, 315–36, 317–21f, state capital budget, 56 323–24t, 324f, 327–29t, 328f State Electricity Regulatory Commission (SERC), land policies and, 30 246–47 public financing of, 57 state financial institutions (SFIs), 118, 119b, 124, risks to, 13 125 438  CHINA 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 Tan, Kong-Yam, 87b enrollment trends in, 176 tariffs, 379, 380f, 382 faculty recruitment for, 170–71, 176, taxation. See also revenue mobilization 204n85, 205n98, 206n110 corporate income tax, 91, 95, 97 innovation and, 36–37, 37f, 169, 170–71, FDI and, 385 176–77 fiscal system reforms and, 78, 86–87, 89, quality of, 9, 37, 156, 176–77, 201n39 94–97, 95–96f research networks and, 176 green development incentives and, 42, 44, Texas Instruments, 199n12 256, 261, 261b textile and apparel industry, 71n37, 161 innovation capacity building and, 186 TFP. See total factor productivity labor market and, 48, 328–30, 328f Thailand land policies and, 31, 32, 138–39, 139b exchange rate in, 393 local governments and, 56 health care services in, 308 of motor vehicles, 94–95 THCs (township health centers), 306 personal income taxes, 96, 148n19 Thomson Reuters, 200n27 progressive, 96 Tian, Lihui, 149n27 property taxes, 101, 139 Tianjin special economic zones and, 167 cluster networking in, 168 urbanization and, 23b elderly care services in, 344 value-added tax (VAT), 44, 55, 89, 91, 97, obesity in, 292 109 Tokyo tax-sharing arrangements, 101, 114, 138 carbon-trading scheme in, 43, 261b tax wedge, 96, 328, 328f, 353n57 as innovative city, 38, 184 teacher recruitment, 297, 352n31 Top Runner Program (Japan), 219b technical and vocational education and training Torch program, 165 (TVET) total factor productivity (TFP) access to, 299–302 allocative efficiency and, 81b coordination of, 286 decelerating growth and, 77 enrollment in, 297 innovation and, 34, 158–62 financing of, 300 for state-owned enterprises, 25, 69n8, 170 innovation and, 177 trends in, 8 national training authority for, 301 Toulouse, as innovative city, 38, 184 quality of, 287 township health centers (THCs), 306 technical efficiency, 77, 81, 85–89, 110 Toyota Motor Company, 198n10 technical skills, 36–37, 156, 177 tradable permits, 42 technological capacity, 162–68 trade barriers, 377–78 international comparisons, 165–67 trade relations, 60–64, 361–417 planning for, 163–65, 164f commodity security and, 384–85 urbanization and, 167–68 development strategy and, 16–17 technology parks, 186 economic issues and, 61–62, 363–64 technology transfer, 163, 175 export growth and, 379–81, 380f, 381t Teisberg, E. O., 182 global economic integration and, 16, 370, TEKES (Finland), 178 379–85, 379–80f, 381t telecommunications industry governance for, 64 entry of new firms in, 162 internationalization of renminbi and, 63, FDI’s impact on, 391b 63f, 395–97, 401–2 green development and, 232, 232b outward FDI and, 62–63, 386–89, 386t, innovation and, 161, 165, 183 387f total factor productivity and, 160 protectionism and, 381–82 trade restrictions for, 383 recommendations, 62–63 tenant farming, 138b regional trade partnerships, 382–83 tenure security in rural areas, 130–33 services sector and, 62, 383–84 tertiary education trade surplus, 7, 8 business schools, 205–6n107 Trajtenberg, Manuel, 203n69 completion rates, 70n9, 156 transaction costs, 396 440  CHINA 2030 Transitional Product-Specific Safeguard carbon-trading scheme in, 43, 261b Mechanism, 71n37, 410–11n3 childhood obesity in, 352n20 transitional systems transfer, 92 coal-fired power plant efficiency in, 240 transparency deregulation in, 127 for enterprise sector reforms, 114 dollar as reserve currency, 7, 61–62 in financial system, 30, 66, 119b, 121 early childhood development and education in fiscal system reforms, 56, 59, 66, 90, 99b, in, 351n16 102–3 energy consumption by, 14, 252b in land policies, 30 environmental protection in, 237 for local government financial management, exchange rate and, 393 59 financial system in, 116 in official development assistance, 407, food exports by, 384 409–10 green development strategy of, 218, 229b state-owned enterprises and, 26 health care services in, 309b transport networks innovation in, 36, 156, 166, 167, 178, 179 green development and, 44, 232b, 255b Japan’s voluntary export restraints to, 382b innovative cities connected by, 183, 184 labor force participation rate in, 318 trade restrictions for, 383 land policies in, 133b urbanization and, 23–24b manufacturing imports from China, 379, 380 triadic patent filings, 164–65, 201n47 monetary policy in, 7, 395–96 Turkey national innovation system in, 174 early childhood development and education objections to Chinese acquisition of in, 351n16 companies, 204n88 social spending in, 284 permit trading schemes in, 245 TVET. See technical and vocational education preferential trade agreements with, 383 and training property taxes in, 32, 139, 139b public expenditures on social protection in, UDICs. See Urban Development Investment 93, 93f Corporations research networks in, 35, 157, 175 UILs (University Industry Linkages), 171 science and technology power in, 166 unemployment insurance, 47b, 53, 148n15, sovereign debt financed by China, 60 329–30 trade disputes by, 71n37 UNICEF, 292 triadic patent filings and, 165 Union Oil Company of California, 388 TVET in, 300 United Kingdom (UK) venture capital funding in, 180 aged and long-term care in, 347 United States Patent and Trademark Office capital account liberalization in, 399b (USPTO), 162, 165 congestion pricing in, 94–95 universities. See tertiary education financial system in, 116 University Industry Linkages (UILs), 171 health care services in, 308 Urban Development Investment Corporations health insurance pooling in, 311 (UDICs), 59, 91, 98, 99, 99b labor force participation rate in, 318 urbanization land policies in, 133–34b climate change risks and, 238 national qualifications framework in, 302 development strategy and, 22, 23–24b, national training authority in, 301 371–72 science and technology power in, 166 green development and, 255b venture capital funding in, 180 innovation and, 24b, 34–35, 158, 167–68, United Nations Conference on Sustainable 171–72, 182–87 Development (2012), 218 land use planning and, 185 United Nations Environment Programme research on, 38 (UNEP), 221 social security and, 277, 338–40, 339f United Nations Industrial Development trends in, 9 Organization, 167 urban sprawl, 30, 172 United States urban villages, 137 aged and long-term care in, 347 U.S. Agency of International Development, 96 i n d e x   441 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  CHINA 2030 Zhang, S. M., 353n61 Zheng, X. Y., 244 Zhang, Xiaobo, 87b Zhengzhou, innovation capacity building in, 184 Zhang, Xiaoji, 200n31 Zhongguancun IT cluster, 168 Zhang, Yifan, 107b Zhou, Yu, 171, 206n113 Zhejiang Zhu, Nong, 353n61 cluster networking in, 167 Zhu, Xiaodong, 81b entrepreneurial culture in, 34, 169, 190–91t Zhuang, Lihuan, 205n105 entry of new firms in, 162 zoning regulations, 186 residence permit system in, 331 ZTE, 165, 169, 200n33 ECO-AUDIT Environmental Benefits Statement The World Bank is committed to preserving Saved: endangered forests and natural resources. • 27 trees The Office of the Publisher has chosen to • 13 million BTU of print China 2030: Building a Modern, Har- total energy monious, and Creative Society on recycled • 2,346 pounds of CO2 paper with 30 percent post-consumer waste, equivalent of in accordance with the recommended stand- greenhouse gases ards for paper usage set by the Green Press • 12,724 gallons of Initiative, a nonprofit program supporting wastewater publishers in using fiber that is not sourced • 851 pounds of from en­ dangered forests. 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