Tag Archives: economic development

The Cold War’s Role In Triggering China’s Economic Reforms

Deng Xiaoping took smart advantage of the Cold War between the U.S. and the Soviet Union encouraging the normalization of Beijing’s relations with Washington to open up U.S. technologies and trade to China’s emerging manufacturers. With America acting as handmaiden to China’s integration into the world economy and China having cheap labour, sitting at a crossroads of global trade, adapting the best of foreign development models to its own circumstances and maintaining a solid political commitment to economic reform, a unique combination of political and economic events converged that allowed China to develop as it has done over the past 30 years.

That, in summary, is the view of Andrey Denisov, Russia’s first deputy foreign affairs minster and the China hand among his country’s senior diplomats, given in an interview to Vestnik McKinsey, a Russian-language publication of the international management consultancy. (A shortened English version has been published in the McKinsey Quarterly.)

It is a conventional analysis with the exception of the Cold War point that Denisov says tends to be “overlooked” but for which he makes a compelling case that it was a critical catalyst. Denisov also provides the American or European reader with a necessarily different perspective on China’s development, and there are some telling if unstated comparisons with Russia’s own economic reforms after the collapse of the Soviet Union. (The Russian version is titled, The Chinese Path: Lessons for Russia.)

Denisov is similarly succinct about the challenges China faces in replacing imitation with innovation and in dealing with the environmental, farming, water and corruption problems that economic reform has brought. He also talks about Russia’s development of its own Far East and its future relations with Asia. Well worth the read.

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China, North Korea To Develop Joint Economic Zone

Pyongyang has agreed to develop a joint economic zone with Beijing, according to the North Korean state news agency, KCNA, quoting Japanese newspaper reports of the Presidium of the Supreme People’s Assembly’s decree promulgated on Monday. The zone will be set up the Hwanggumphyong and Wihwa Islands in the North Korean side of the Yalu River estuary, which forms the border between the two countries. Ground is expected to be broken on the project this week. The project was reportedly discussed during Kim Jong Il’s visit to China last month. It marks another small step to draw North Korea into China’s orbit and expose Pyongyang to the benefits of economic reform along its own lines.


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When China’s Demographic Dividend Becomes A Demographic Tax

Much of the follow-up attention given to the census results published this week has concentrated on the implications for China’s one-child policy. This Bystander is more struck by the long-term economic impact of the key demographic trends–low birth rates, a greying of the population and an unbalanced sex ratio (15% of young Chinese men won’t be able to find a partner among their fellow citizens in 20 years time).

These will, we believe, likely combine to make China a deficit country within two decades. Working population is a proxy for production, and when it grows faster than the total population (a proxy for consumption), as it has for the past three decades, the difference becomes exports. Some time over the next decade that trend will reverse and the reversal intensify over the subsequent three decades reaching its peak in 2050. The consequent demographic bias will work through to the trade account long before then.

For now, China’s demographic dividend has brought it more than just merchandise trade surpluses. Add on dramatically rising productivity from economic reform to the country’s working population growing much faster than its total population and the inevitable consequence has been a sharp improvement in per-capita income and living standards. The peak in the workforce forecast for sometime in the next decade will be accompanied by an explosive growth in the number of over-65s. China’s working population will begin to grow more slowly than its total population. The demographic dividend will become a demographic tax. As China is getting old really fast, it will become an increasingly heavy tax relatively quickly.

That will drive the transformation of the economy towards being more led by domestic demand. The supply of surplus labor available to low-cost export manufacturers will dry up. Manufacturers will move up the value chain, and a domestic market for products and services for the elderly will expand domestic demand, helping to run up domestic consumption and down domestic savings. The era of manufacturing in China predominantly for export comes to a close, replaced by an era of manufacturing and services provision in China for Chinese consumers.

How this all turns out in detail will depend on other factors, such as  changes in worker productivity, savings rates, institutional reform, whether monocultural China proves open enough to deal with future labor shortages through immigration, and, yes, what happens with the one-child policy. But today’s fast economic growth and huge export-driven current-account surpluses will by then be but a distant memory.

Footnote: Certainly the numbers can be used to argue the one-child policy policy should be scrapped. Wang Feng, Director of the Brookings-Tsinghua Center in Beijing, does just that in a commentary in Caixin.

To put the growth of the population in some perspective, since the previous census in 2000, China’s population has grown by 74 million to 1.34 billion. The increase alone would be sufficient to rank as one of the 20 largest countries in the world by population, with about the same number of people as Turkey or Iran. Over the same decade India’s population increased by 181 million. And while we are making such comparisons, on present demographic trends, by 2050, silver China, the nation of Chinese over 65 years old, will constitute a larger nation than the U.S. today.


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One Country, Two Centuries

If India is said to be one country spanning three centuries then China may be one country spanning two. This passage in a new World Bank policy research working paper* caught this Bystander’s eye:

The PRC’s GDP per capita today is roughly equivalent to that of Britain in 1911. London at that time had a GDP per capita around 1.7 times the national average, whereas East Anglia had a GDP per capita two thirds of that average. In the PRC today, the comparable figures are 3.3 for Shanghai and one third for the lagging area of Guizhou. Shanghai has a GDP per capita ($16,044), roughly equivalent to the British average in 1988, while Guizhou has a level ($1,653) close to the British average in 1830.

The paper, by Qingqing Chen and colleagues, is a survey of surveys of China’s development from low- to middle-income economy over the past three decades. As such some of the data is a bit whiskery. The paper provides a succinct overview rather than breaks new ground, although it does suggest that barriers to inter-provincial trade (i.e. local protectionism) are falling more than some of the literature has held. Another passage that caught our eye:

Government efficiency and effectiveness are highest in the Southeastern cities (Fujian, Guangdong, Jiangsu, Shanghai, and Zhejiang), and are lowest in the lagging Southwest and Northwest. The firms in the coastal areas pay lower taxes and fees; have a much shorter customs clearance delay; spend less time dealing with bureaucracy; and spend less on entertainment and travel, which are good proxies of local corruption. The survey finds that foreign firms operating in the Southeast face considerably lower taxes and fees than elsewhere  while combined average export/import clearance in the Southeast stood at 7.3 days in contrast to the Northwest at 16.8. In the coastal areas, firms reportedly have better access to finance, more reliable protection of property rights, and more effective contract enforcement.

The substantive point of the paper is that China’s economy remains under-concentrated and under-urbanized so its rapid development phase has yet to run its full cycle with is consequent geographical disparities continuing. The corollary of that is that economic geography is not the same as the geography of social welfare. Dare we suggest the two need to be harmonized, or has that already been proposed?

* Market Integration in China, by Qingqing Chen, Chor-Ching Goh, Bo Sun and Lixin Colin Xu. World Bank Policy Research Working Paper 5630.

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Urban Sprawl

This Bystander had to retire to the peace and quiet of the country to pour over McKinsey’s recently published data dump on global urbanization, Urban World, Mapping the Economic Power of Cities. It is a trove of information and projections that brought out our inner wonk faster than you could say ‘megalopolis’.

Urban World ranges far beyond China, but even restricting ourselves to those parts germane to our immediate interest was mind-boggling. China is on track to become the first nation with an urban population of 1 billion people–sometime between 2025 and 2030, McKinsey reckons. One hundred new Chinese cities will enter the ranks of the world’s 600 largest economic conurbations by 2025. China will increase the number of its megacities–those with a population of at least 10 million–by 13 over the same period. And so it goes on and on.

The strains on land, energy, water and the environment will be immense; as will be the demands of providing adequate urban social services. Megacities or megaslums? More broadly, the shift in the world’s urban axis east and south will have tremendous implications for what we now call the developed world. We shall endeavor to return to these subjects in some detail, but meanwhile, on the grounds that a picture is worth a thousand words, and two twice as many, here is a graphical representation from McKinsey’s report that highlights the sheer scale of the urbanization China is undertaking and the wealth it will create.

First, population and per capita GDP for 2007:

Now, the projections for 2025:

That is quite some transformation. And remember urbanization is a policy priority.

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China’s Special Economic Zones Face Challenges, Need Transition

China’s special economic zones are facing a critical period of transition. As consequential as they have been to the country’s rapid growth over the three decades since Deng Xiaoping launched economic reform in 1978, they now face a number of challenges. These include:

  • moving up the global value chain;
  • questions over the sustainability of export-led growth;
  • environmental and resource constraints;
  • institutional changes;
  • lagging social development.

These are largely the challenges facing the broader economy, too. History suggests that it is the special economic zones that will first try to address these issues. As World Bank staff economist Douglas Zhihua Zeng writes in a new working research paper,

The SEZs have made crucial contributions to China’s success. Most of all, they— especially the first ones—successfully tested the market economy and new institutions and established role models for the rest of the country to follow.

Zeng’s paper is well worth reading. As well as Shenzhen (the first SEZ, started in 1980) and its six fellow SEZs, it looks at economic and technological development zones, free trade zones, export-processing zones, high-tech industrial development zones and, though Zeng, rightly, considers them a different economic animal, industrial clusters.  Zeng estimates that by 2007, the latest year for which he can get numbers, the total GDP of the major state-level zones accounted for 22% percent of national GDP, 46% of foreign direct investment and 10% of employment, mostly skilled jobs as they have been hotbeds of China’s new and high-technology firms, accounting for more than a third of the country’s R&D spending.

As the paper notes, the zones vary widely in their performance and speed of growth, but mostly they have all more or less succeeded. That is not always the case with economic development zones in developing economies. Zeng identifies several characteristics of China’s success with SEZs:

  • strong commitment from the top leadership, and high-level pragmatism, flexibility, and autonomy;
  • a gradualist approach toward reform;
  • proper role of government (active, pull-up strategy);
  • foreign direct investment, including from the Overseas Chinese diaspora;
  • public-private partnership approach
  • technology innovation, adaptation, and learning;
  • clear goals and vigorous benchmarking, monitoring, and competition.

Zeng also notes one other characteristic of the most successful SEZs, “the capacity…to identify its comparative advantages and bottlenecks accurately and implement the right strategy to remove problems as well as to build a conducive business environment.” What that means for the SEZs’ future, Zeng says, is that they will have to:

  • put more emphasis on producing for domestic markets and consumption;
  • move towards a more knowledge- and technology-based development model;
  • promote technology innovation and learning;
  • adopt stricter environmental and social standards.

The zones will attempt to do that by, in Deng Xiaoping’s phrase, “crossing the river by touching the stones”. There will be splashes along the way, but getting that right will have impact far beyond the zones themselves.

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Guangdong Pilots The Next Phase Of China’s Development

There is more to Guangdong than the export workshop to the world. Away from the prosperous Pearl River Delta along the coasts to east and west and particularly in the mountainous north of the province, poverty is deeper, income inequality greater, job opportunities fewer and social services more meager. In that sense it provides a microcosm of the development issues facing the country as a whole. Just as Guangdong was in the vanguard of the economic reforms and opening of the country over the past three decades, so it is being put forward as a pilot for the next stage of China’s development redressing growing inequalities.

For the past couple of years, and despite the trials of the global economic crisis that hit the Pearl River Delta’s manufacturers hard, Guangdong provincial authorities and the World Bank have been taking an unprecedented deep dive into Guangdong’s economic disparities. The result is a newly published study* which lays out a blueprint for tackling the issues of inequality that has become one of the top challenges of China’s development agenda.

The report is book length — more than 350 pages — and detailed, but worth the time of anyone who wants a glimpse at one way that China nationally could meet the aspirations of the Party over the next decade to transform the economic basis of the country into something more socially harmonious between rich and poor and urban and rural and focused on domestic consumption rather than export and infrastructure investment driven growth.

The approach suggested is three pronged: reduce absolute poverty through direct social assistance; reduce income inequality by promoting non-farm industry in rural areas; and contain the inequality of outcomes via taxation and public finance reform to ensure the equal provision of social services. The report makes specific policy recommendations concerning the relocation of industries and labor, vocational training, developing rural financial services, reforming the rural land system, improving basic education and medical services in rural areas, and, most intriguingly, pairing poor villages and households with agencies and enterprises in the richer parts of the province so each village and household will get a customized development plan. The aim is to equalize the provision of public services between urban and rural areas of Guangdong by 2020. Even more ambitious is to change fundamentally the situation of the province’s 3,400 poor villages and lift its 700,000 poor households out of poverty within three years.

Achieving those goals will be no easy matter, and particularly not by those deadlines. It is simply a huge undertaking, as the report acknowledges, although none the less necessary for that. Beyond the reordering and expansion of the provision of public services, it will require a reordering of the bureaucracy, whose officials have been judged and rewarded on their ability to promote local industry and infrastructure development, not the provision of public services, and of the public finances. China’s local government at all levels is a monumental supertanker to turn.

The other huge challenge is the other side of that coin: striking the appropriate balance between the role of government and the role of the market. Policymakers can decree that capital and labor has to relocate to poor rural areas, but they can’t decree that the resulting businesses will be a success. Guangdong officials say they will follow a principle of “government guidance and market-led operation” and obey the fundamental rules of the market when it comes to increasing employment opportunities for rural residents. But that is easier said than implemented.

The need to address these development challenges is urgent.  As the report says:

Experience suggests that inequality, which tends to constrain domestic consumption, may ultimately hurt economic growth. As a result, GDP growth is forced to follow an unbalanced path, with an increasingly high reliance on investment and exports, until it becomes unsustainable.

The province and the World Bank have provided a play-book for what may be China’s most crucial pilot scheme in economic development. Now they have to execute it, we hope, successfully.

*Reducing Inequality for Shared Growth in China, Strategy and Policy Options for Guangdong Province, The World Bank. ISBN 978-0-8213-8484-8.

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China’s $10,000-12,000 Question

Whether political reform is an inevitable consequence of China’s economic reform has been a longstanding question. Ilian Mihov, an economics professor at INSEAD,  the Paris-based business school, flips the question on its head. He asks whether the country’s ability to develop its economy rapidly can continue without institutional reforms regarding the rule of law, governance and accountability.

In a recently published report of a session on China at an INSEAD symposium in Singapore last November, Mihov said China needs “deep structural reforms”. Command economies can only sustain fast growth with weak institutions for so long. The tipping point comes when per capita income reaches $10,000-12,000 a year, the point at which developing economies tend to stop developing without institutional change (see chart below)*.

“There is not a single country that has good quality institutions and is poor,” Mihov said in Singapore. “The gap between rich and poor is driven by poor productivity that is linked to poor quality institutions and poor business environment.”  As evidence he offers the contrasting experiences of Singapore and Venezuela. Even more dramatically, consider the economies of the old Soviet bloc, which collapsed as per capita incomes hit and then got stuck at the $12,000 a year level (adjusted for current prices).

China’s annual per capital income is $4,000. At current growth rates that gives it less than a decade before it starts bearing down in earnest on that tipping point or The Great Wall as Mihov inevitably dubs it.

What makes for the aforesaid poor quality institutions and a poor business environment includes political instability, government inefficiency and the prevalence of corruption. Those are factors within government’s control. There has been progress, albeit piecemeal, as with, for example, the current anti-corruption campaign and, as Dan Harris from China Law Blog points out, the improving quality of China’s civil, if not criminal courts. There are other reasons than planning for long-term economic development for those changes, but the $10,000-12,000 question is whether that progress continues at a sufficient pace to carry the country through the transformation to a new peak of development. Or will it be left stuck on the plateau of stagnation?

The growing economic and political clout of state-owned enterprises is another possible impediment to progress. Like Japan before it, China has grown fast by replicating and improving on what advanced economies have already done and producing and selling the results much more cheaply. Yet, as Japan found out, there comes a point where innovation has to replace imitation if growth is to be sustained.

China’s state-owned national champions and aspiring multinationals are ambitious, adaptive and fast learners (as were Japan’s). They are developing R&D and product development capabilities but they remain reliant on access to low-cost capital from the state, have rudimentary organizational and financial management skills by the standards of multinationals and have yet to acquire two of the most essential traits of a globalized multinational, managing diversity and allowing the intrapreneurship in which innovation can flourish (traits that few Japanese multinationals were able to acquire).

Beijing is throwing a wall of money and of engineers and scientists at making its national champions more innovative (dealing with diversity isn’t even on the radar). Yet in the process of building up the SOEs it is distorting markets and entrenching vested interests that increase the resistance to reform. It also crowds out small and medium sized companies where growth-generating innovation truly flourishes. Those need a particular business environment which is possible only with good institutions and a regulatory and governance regime that may not be to the taste of big business in the form of the SOEs, who see their (patriotic) role to be competing with other multinationals not fending off pesky upstarts at home.

That sets up a dilemma for the leadership. If the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and Mihov is right that the country’s rapid economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

*There is a 2009 research paper on the $10,000-12,000 barrier by Mihov and his colleague Antonio Fatas, The 4Is of Economic Growth, from which the chart above was abstracted. A summary focusing on China, Another Challenge To China’s Growth, was published in the Harvard Business Review of March 2009.


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China’s Economic Rebalancing Act

The Asian Development Bank’s latest update to its quarterly economic outlooks leaves China’s gross domestic product growth for the year unchanged at a forecast 9.6%. But it notes that the pace of growth has started to moderate and will continue to do so as the effects of the government’s fiscal and monetary stimulus wears off and recovery in China’s export markets in the developed world stays sluggish.

Despite exports being a net contributor to GDP in the second quarter this year for the first time since the onset of the global recession, the ADB is forecasting that China’s GDP growth in 2011 will slow by half a percentage point to 9.1% as those trends continue.

The ADB also reiterates the need to shift the economy from being driven by investment and exports to domestic demand.

Longer term, failure to decisively implement the agenda to rebalance the PRC economy risks jeopardizing the sustainability of growth. A greater emphasis on private consumption demand, as against the current investment-driven economic growth model, would promote longer-term growth and raise living standards. Growth in consumption has been limited by the declining share of household income in total income, while the shares of enterprises and the government have increased.

ADB economists believe that China won’t be able to sustain its current pace of growth over the long-term with its current development model under which a rising rate of investment is needed to maintain its target rate of economic growth. At some point investment will stop rising (even China will eventually run out of money) and growth will slow unless another source of demand replaces it. The ADB expects China’s average annual GDP growth over the two decades to 2030 to be 5.5%, compared to the annual average of 9.4% between 1981 and 2007, though it could average 6.6.% growth in 2010-2030 with greater rebalancing of its economy.

China’s growth since Deng Xiaoping opened the economy at the end of the 1970s has been a remarkably success, though its growth rates have been much the same as those of Japan and South Korea at similar stages of their economic development. China’s economy, however, is on a different scale to those of both its neighbors, which is what really makes the achievement so impressive. It is investment that has got it there, but won’t be able to keep it there alone. As even Prime Minister Wen Jiabao has said recently, “In the case of China, there is a lack of balance, co-ordination and sustainability in economic development.” How China finds its balance will shape the global economy over the next two decades.

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China Open For Business, But That Business Is Changing

There is a turning point in the development of emerging economies at which the supply of surplus rural labor available to low-cost export manufacturers dries up and real wages start to rise. At that point industrial production becomes more capital and IP intensive, exports move up the value chain and domestic demand becomes more important for the economy overall as the society urbanizes. Japan and South Korea passed through that turning point; now China, too, is reaching it. Another way of putting it is that the era of manufacturing in China for export is coming to a close, and the era of manufacturing in China for Chinese consumers is getting underway.

For foreign multinationals, it marks a sea change in the reasons for them to be operating in the country. Change can always be uncomfortable, both for those that see it and those that don’t. To this Bystander that explains some of the concerns being voiced by executives at foreign multinationals about what they see as growing barriers to market entry and unfair treatment, intended to give domestic companies an edge as the economy changes.

Most of this criticism has been made privately, as is the custom, but the heads of companies like General Electric, BASF and Siemens have stuck their heads above the parapets of if briefly. All three companies have been working cooperatively in China for at least two decades so may have a degree of seniority that allows them to express frankly the wider view, but the level of concern has been sufficient for Chen Deming, China’s Minister of Commerce, to defend China’s foreign investment environment in a signed piece in the Financial Times.

Foreign direct investment in China was up 19.6% in the first half of this year compared to the same period a year earlier, but last year’s number was low so don’t set too much store by that. National tax breaks and provincial incentives for multinationals to invest have been significantly reduced. Wages have risen and employment regulations become tougher. Furthermore, China is upgrading its own industries in areas such as high-end manufacturing and environmental goods and services. To do this, as Chen pointed out, “China wants to make better use of the knowledge and expertise of multinationals.” That sounds more take than give, to foreign ears.

At the same time export markets in Europe and the U.S. have cooled whereas China’s domestic market has continued to expand, even though consumption rates in China are still far below those in Europe and the U.S. That doubles the vexation for foreign multinationals. A potentially huge and increasingly important market is in sight for but it remains frustratingly out of reach.

Changing that will require policy decisions in Beijing to raise the consumption rate further and to allow the greater internationalization of the economy, which will mean making the currency convertible. Meeting both those challenges are part of the rite of passage of economic development. Smart multinationals will align themselves with helping Beijing push forward change on those two fronts.

Smart multinationals will also realize that they will eventually change in the light of all this and will become more Chinese as the proportion of their sales, employees and assets in China increases, just as Sony is no longer a Japanese multinational in anything but name.

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