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medium and long term development and transformation of the chinese economy an international perspective a synthesis report march 2011 prepared by edwin lim ian porter paul romer and michael spence sponsored by beijing cairncross economic research foundation

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contents foreword i preface v synthesis report chapter 1 introduction international growth experience 1 history of economic growth 1 middle-income transition 3 implications for china s medium term development 5 outline of this report 7 chapter 2 changing the growth model 10 a new pattern of growth 10 industrial and technological upgrading 12 investment system 13 financial sector development 16 chapter 3 urban and regional development 21 reducing urban-rural income disparities 21 changing the size and structure of cities 23 promoting efficient cities 26 reforming urban financing and management 28 reducing regional disparities as part of the middle-income transition 29 chapter 4 strengthening domestic consumption and the middle class 33 policies to strengthen domestic consumption 33 the middle class 37 the significance of the middle class 38 the middle class and sustaining economic growth international experience 38 estimating the size of china s middle class 41 chapter 5 employment education and the labor market 43 employment growth sectoral structure and adjustment 44 education and skills development 46 labor market institutions and regulations 50 chapter 6 strengthening the pension system 55 lessons from economic theory and international experience 55 options for further reform of china s pension system 60 overall management of china s pension system 64 concluding remarks 67 chapter 7 social policy 69 tackling income inequality 69 common principles of reform 70 education 72 health 74

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the dibao program 75 population policy 76 overall planning and governance of social policy 76 chapter 8 china s role in the global economy 80 the aftermath of the financial crisis 80 the realignment of the world economy 81 rebalancing global demand 85 rebalancing china 85 promoting global trade and investment 87 shifting to a low-carbon economy 89 global governance 92 chapter 9 system reform 95 enhancing the effectiveness and accountability of the government 95 changes in the scope and functioning of the soes 100 reform of the fiscal system 102 concluding remarks 106 background papers papers are available at www.cairncrossfund.org 1 k.y amoako africa s expectation of china in the global economy 2 a b atkinson issues in the reform of social policy in china 3 judith banister david bloom larry rosenberg population aging and economic growth in china 4 nicholas barr peter diamond pension reform in china issues options and recommendations 5 nicholas barr howard glennerster social policy a central element in china s development 6 cai fang richard freeman adrian wood china s employment policies in international perspective 7 andrew crockett china s role in the world economy looking forward to the 12th five-year plan 8 barry eichengreen what kind of economic and financial leadership does the world expect of china lessons from two historical episodes 9 mohamed el-erian ramin toloui what does the world expect from china and what should china provide 10 shenggen fan ravi kanbur xiaobo zhang china s regional disparities experience and policy 11 j vernon henderson urbanization in china policy issues and options 12 homi kharas china s transition to a high income economy escaping the middle income trap 13 santiago levy some remarks on social policy from latin america 14 li and fung research centre a business perspective on decentralization of production and manufacturing for the domestic market in china 15 li shi social policy reform in china

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16 jean pisani-ferry china and the world economy an european perspective 17 paul romer notes on optimizing china s new pattern of growth 18 andrew sheng china s approach to networked globalization ­ an institutional response 19 christine wong public sector reforms toward building the harmonious society in china 20 yves zenou housing policies in china issues and options

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foreword this study was conducted in 2009-2010 by an international team headed by michael spence nobel laureate and edwin lim the first chief representative of the world bank in china undertaken at the request of the office of central leading group on financial and economic affairs zhong cai ban and the national development and reform commission ndrc of the people s republic of china the purpose of the study was to provide some thoughts and suggestions on china s medium and long term development and the 12th five year plan 2011-2015 from an international perspective the international team comprised prominent economists and experts from universities businesses and public institutions from around the world members of the team were k.y amoako former executive secretary of the un economic commission for africa a b atkinson research professor oxford university judith banister director of global demographics at the conference board usa nicholas barr professor of public economics london school of economics david bloom professor of economics and demography harvard university cai fang director of the institute of population and labor economics cass andrew crockett president of j.p morgan chase international former general manager of the bank for international settlements peter diamond nobel laureate in 2010 institute professor of economics mit barry eichengreen professor of economics and political science university of california berkeley mohamed el-erian ceo of pimco shenggen fan director-general international food policy research institute richard freeman professor of economics harvard university howard glennerster professor emeritus of social policy london school of economics i

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j vernon henderson professor of economics and urban studies brown university and nber ravi kanbur international professor of applied economics and management cornell university homi kharas former chief economist east asia region world bank santiago levy vice president for sector and knowledge inter-america development bank former deputy minister of finance mexico li shi professor beijing normal university edwin lim first chief representative of the world bank in china founding ceo of china international capital corporation jean pisani-ferry director of the bruegel institute ian porter former director the world bank paul romer professor of economics stanford university andrew sheng chief advisor to the china banking regulatory commission former chairman of hong kong securities and futures commission michael spence nobel laureate professor in economics new york university professor emeritus of management stanford university christine wong senior research fellow oxford university adrian wood professor of international development oxford university yves zenou professor of economics stockholm university xiaobo zhang senior research fellow international food policy research institute li fung research center hong kong the study was guided by an advisory committee that included liu zhongli xiang huaicheng wu jinglian zhou xiaochuan lou jiwei guo shuqing li jiange liu he victor fung hong kong and teh kok-peng singapore ii

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in the course of study the international team maintained close contacts with the relevant departments of zhong cai ban and ndrc the international team met with vice minister liu he of zhong cai ban and secretary general yang weimin of ndrc on numerous occasions to exchange views that played an important role in the preparation and completion of the study invaluable support was received from deputy director general han wenxiu deputy director-general wang zhijun deputy director-general meng jian of zhong cai ban and deputy director-general tian jinchen and director zhang gengtian of the planning department ndrc in the execution of the study the ndrc also provided a grant for this study the study was mainly funded and supported by beijing cairncross economic research foundation professor zhao renwei president of the foundation participated fully in the study s preparation implementation and dissemination and also provided comprehensive advice comprehensive organizational logistical and coordination support was received from the foundation s programme director dr cyril lin and the secretary-general susan su financial and administrative support was also provided by the east asian institute eaiof the national university of singapore since 2004 the eai has supported a number of research studies on chinese policy issues directed by prof michael spence and mr edwin lim beginning with a study on social security reform and most recently a study on urbanization findings from these studies have contributed significantly to the present study within eai professor zheng yongnian director and lian wee li senior associate director in particular provided valuable support simon cox edited the earlier shorter version of the synthesis report as well as the current expanded version he brought both clarity and consistency to the various chapters of the report that were prepared by different authors the study benefited from discussions with leading chinese economists and officials who provided invaluable comments on the synthesis report they included bai chong-en ding ningning fu jun he di lai desheng long guoqiang lu feng ma xiaohe qian yingyi wang xiaolu wu xiaoling xu shanda yi gang yu yongding zhang weiying and zhang xiulan the people s bank of china the institute of population and labor economics cass china international capital corporation ltd cicc and the china development research foundation kindly organized discussions and seminars for the international and chinese experts in the course of the study the participants included chen jiagui chen yulu cui zhiyuan du yang gao shiji ge yanfeng ha jiming han jun he ping he yupeng jing tiankui li daokui li shantong li yang liu guo-en liu guohong lu mai lu xueyi lu ying shan jingjing shen bing si jinsong song li song xiaowu su ming tang min wang dewen wang jianlun wang yanzhong wang youqiang wang zhenyao xie duo you jun yu faming zeng xiangquan zhang li zhang xiulan zhang iii

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zhenzhong zhao dianguo zheng bingwen zheng gongcheng zheng yongnian zhu ling zhu min louis kuijs philip o keefe and yvonne sin the heads of the study s international team would like to express their deep gratitude to all those who contributed and provided support to the study the findings interpretations and conclusions expressed in each of the background papers are the responsibilities of the authors alone iv

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preface it is my honor that mr edwin lim invited me to write a preface for this research report this research on china s medium and long term development strategy was initiated by the beijing cairncross economic research foundation at the invitation of the office of the central leading group on finance and economics and the national development and reform commission ndrc mr lim and nobel laureate professor michael spence were responsible for the overall study to this end they invited more than 20 eminent economists from different institutions around the world to participate each drafting a background paper in their areas of expertise the international team included prominent economists with diverse backgrounds and experiences including for example professor peter diamond the winner of the 2010 nobel prize in economics professor paul romer the father of the new growth theory and mr mohamed el-erian ceo of pimco one of the largest asset management companies in the world our objective on the chinese side in requesting this study was to have the opinions of the international experts on the formulation of china s 12th five year plan this study began in early 2009 and was completed just before the spring festival of 2010 in the intervening period the participating experts met with us many times to exchange views on the scope as well as the substance of the study i believe this research report is of a high quality it is compulsory reading for anyone interested in understanding china in the context of global structural changes and in understanding the key development trends in china because of the broad perspectives and deep knowledge of the top experts the report accurately analyzes the trends key areas and priorities in china s development and reform it is an important and valuable reference for policy making at the completion of the study in accordance with our suggestion professor spence professor paul romer mr ian porter former director of the world bank and mr lim summarized and integrated the key findings in a synthesis report entitled thoughts and suggestions for china s 12th five year plan from an international perspective when we received this report we discovered it was full of insights on china s development over the coming five years the report was soon distributed to every member of the team drafting the chinese government s proposal for the 12th five year plan this was a high level and large team led by premier wen jiabao and vice premier li keqiang more than 70 ministers experts and scholars participated in this important assignment without doubt the research report submitted by the team of international experts played an important role in the formulation of the proposal for the 12th five year plan v

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china s 12th five year plan presents the future chinese economic and social development strategy coming after the global financial crisis and at a time when china is beginning its evolution into a high income country it is an important strategy at a critical junction in history the strategy not only defines the direction for the building of a xiao kang society in china but will also greatly influence the global economic balance and the welfare of humankind it was a fortunate and rare opportunity for any one able to participate in the formulation of the 12th fyp given its significance these participants should also be thanked let me use this opportunity on behalf of the chinese agencies involved to express our sincere appreciation to the international team of experts headed by professor spence and mr lim i would also propose that china should establish a special award for those international experts who have made important contributions to china s reform and openness because of them china was able to acquire advanced development concepts and valuable stepping stones from distant mountains it is unprecedented in china for official government agencies to invite international experts without official affiliations to conduct a study of china s development strategy we now see that this is a unique method of cooperation that assures high quality and high efficiency i hope we can continue to cooperate in this way in the future liu he 2011 3 10 vi

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chapter 1 introduction international growth experience chapter 1 introduction international growth experience1 history of economic growth economic growth is a recent phenomenon in human history it began with the industrial revolution in britain at the end of the 18th century this progress spread to europe and north america in the 19th century accelerating as it traveled in the 20th century particularly in the second half it spread and accelerated again see figure 1 as its economy grows a society becomes more tightly organized more densely interwoven a growing economy is one in which energies are better directed resources better deployed techniques mastered then advanced it is not just about making money figure 1 evolution of global and per capita gdp in the last 2,000 years 1990 international ppp dollars blue per capita gdp yellow gdp levels right axis source commission on growth and development the growth report p 18 original data from maddison angus 2007 contours of the world economy 1-2030 ad oxford university press 1 in 2006 a group of the world s leading development practitioners including former prime ministers ministers planners and businessmen plus two nobel laureates in economics were brought together to form the commission on growth and development governor zhou xiaochuan of china was a commissioner and professor michael spence who is one of the authors of this report was the chairman this chapter is based on the growth report strategies for sustained growth and inclusive development issued in 2008 by the commission the report background papers and more information on the commission are available at www.growthcommission.org 1

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chapter 1 introduction international growth experience today s economists explain growth with the triple formula of technology capital and human capital but these are only the proximate causes of growth its deeper roots draw on advances in science finance trade education medicine public health and government to name but a few of the factors in play over the past two centuries what we now call the global economy has expanded in fits and starts interrupted by the slump of the 1930s it was rebuilt in the 1940s when the institutional foundations of today s world economy were laid globalization has since proceeded apace aided by legislation the lowering of tariffs and quotas and the relaxation of capital controls and innovation the declining cost of transport and communication this renaissance of globalization helps to explain the acceleration in world growth since the latter half of the 20th century as the world economy has opened and integrated technology and know-how have flowed more easily to developing countries latecomers can assimilate new techniques much more quickly than the pioneering economies can invent them that is why poorer countries can catch up with richer ones the lessons that countries import are not only technological both china and then india reformed their closed heavily regulated economies motivated in part by the force of international example reform and openness in china brought about not only dramatic changes in china but also the global economy this accelerating growth has created new challenges the first is a clear divergence in incomes within and between countries of the roughly 6 billion people on the planet about 65 percent live in high-income or high-growth economies up from less than a fifth 30 years ago the remaining 2 billion people live in countries with stagnating or even declining incomes the world population is projected to increase by 3 billion people by 2050 unfortunately 2 billion of this extra population will live in countries that are currently enjoying little or no growth thus if these trends persist the proportion of the world population living in low-growth environments might increase the second challenge is environmental the quickened growth of world gdp has put new pressure on the planet s ecology and climate this strain may ultimately threaten the growth environment of the last 200 years if an economy fails to grow man s efforts to better himself become a scramble for a bigger share of a fixed amount of resources ecological stress quickly becomes social and political since the end of the second world war many countries and regions have experienced at least brief periods of rapid growth but only thirteen have enjoyed sustained growth of 7 percent a year or more on average for 25 years or longer these are botswana brazil china hong kong china indonesia japan the republic of korea malaysia malta oman singapore taiwan china and thailand two other countries india and vietnam may be on their way to joining this group it is to be hoped other countries will emerge soon 2

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chapter 1 introduction international growth experience this collection of economic success stories includes a remarkably diverse group of countries and regions the familiar asian examples may dominate the list but every other region of the developing world africa latin america the middle east and emerging europe is also represented some of the countries are rich in natural resources botswana brazil indonesia malaysia oman thailand the remainder are not the sample includes one country with a population well over 1 billion china and another with a population well below 500,000 malta the 13 economies each then have their idiosyncrasies but it would be wrong to conclude that they defy generalization or that there is no point in learning about their growth paths because the lessons cannot be applied at home a close look at the 13 cases reveals five striking points of resemblance 1 they fully exploited the world economy 2 they maintained macroeconomic stability 3 they mustered high rates of saving and investment 4 they let markets allocate resources 5 they had committed credible and capable governments middle-income transition these stories all then share some common themes but it is intriguing how their experiences in sustaining growth after reaching middle income status and attempting to reach high income have differed six of the economies hong kong china japan korea malta singapore and taiwan china continued to grow all the way to high-income levels but several of the others lost some or all of their growth momentum long before catching the leading economies the failure to evolve from middle to high income is not an uncommon phenomenon in a large group of countries including many in latin america growth has slowed markedly at the middle-income level the reasons are complex if anything this second stage of growth from middle to high income is less understood and certainly less studied than the first stage no one can identify all the reasons why some economies lose momentum and others don t but there are common patterns across countries that are suggestive as a country evolves successfully from middle to high income its economy branches out into more skill-intensive industries the service sector grows the domestic economy with its increased size and wealth becomes a more important engine of growth the supply of labor in middle-income countries which once seemed infinitely elastic ceases to be so as surplus labor disappears the opportunity cost of employing a worker in one sector rather than another rises firms compete for 3

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chapter 1 introduction international growth experience workers and wages increase these higher wages slow the growth of the labor-intensive sectors indeed the export industries that once drove growth decline and eventually disappear shortages of high-skilled labor emerge as a result policies shift toward promoting human capital and technology the policy maker s role must also change when a country is far behind the leading economies it is very clear what it has to do so policy makers can run things like an army but as an economy catches up with the leaders it becomes less obvious what it should make and where its future prosperity lies more must be left to the bets of private investors and the collective judgment of the market the first priority for policy makers is to anticipate this transition and the new demands it will make of them many governments have a planning unit which focuses attention on the future evolution of the economy and anticipates the public policies and outlays needed to support it korea for example changed its policies and public investments in the 1980s and 1990s to help the economy s evolution from labor-intensive manufacturing to a more knowledge and capital-intensive economy it opened the door to foreign-direct investment privatized the national steel company joined the oecd and watched labor-intensive manufacturing move to new destinations a government s second task not easy is to let go of some of its earlier policies even the successful ones to cite some specific examples special export zones heavily managed exchange rates and other forms of industrial policy can be pursued for too long the problems these policies address decline over time so they are not needed forever resisting such forces will delay the structural change of the economy it will divert investment away from new export industries and from industries that serve the domestic market latin america provides many examples of countries that failed to sustain growth beyond the middle income level all of the major economies in the region particularly argentina brazil chile colombia and mexico experienced periods of rapid growth but none enjoyed the prolonged robust expansion required to graduate once and for all as a high-income country their progress has instead been spasmodic vigorous growth punctuated by serious macroeconomic crises followed by strong recoveries and renewed growth what explains this unstable pattern the underlying cause may be the region s longstanding inequality and the failure of its social policies to tackle it to this day latin america s income distribution is one of the worst in the world even several decades of fitful growth have failed to overcome it because of its inequality latin america suffers from a profound lack of political consensus and because it lacks consensus it is prone to chronic political turmoil that instability weighs on long-term expectations undermines investment and makes it harder to build a solid 4

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chapter 1 introduction international growth experience institutional framework without those things it is impossible to sustain growth.2 implications for china s medium term development china s per capita income reached $4,280 in 2010 according to the imf or $7,520 in purchasing-power parity ppp i.e after adjusting for price differences between countries3 this places china among the middle-income countries of the world according to the world bank s classification these national averages however obscure the considerable diversity that exists within the country relatively poor provinces such as guizhou and gansu remain in the lower middle-income category while the most advanced areas such as the pearl river delta and the yangtze delta qualify as upper middle-income economies with urban areas approaching high income these regional disparities should not be forgotten nonetheless despite its lagging regions china can still legitimately aspire to become a high-income country in the foreseeable future and it should plan for the challenges that entails the government has set the worthy goal of becoming a xiao kang society by 2020 but that should not be the summit of china s ambitions or define the limit of its planners horizons policy makers should also look beyond that goal to the ultimate aim of becoming a high-income country that challenge has been recognized by chinese policy makers and economists for some time they often discuss the need for a transformation of the development pattern this usually comprises three elements first a transition from input-driven growth based on the accumulation of capital and labor to growth based on productivity gains second a shift in the mix of output from industry to services and third a change in the source of demand from foreign to domestic spending a second set of challenges relates to building a harmonious society and ensuring that china s development is putting people first these chinese priorities are entirely consistent with the lessons of international experience two characteristics of china however make its development challenges unique one is the disparity noted above between different regions of the country and between rural and urban areas these wide disparities must be taken into account when designing the new growth model and formulating the social programs required to achieve a harmonious society 2 see also box 2 in chapter 4 on the middle class in latin america a contribution from mario blejer former governor of the central bank of argentina and senior advisor in the imf 3 on february 28 2011 the state statistical bureau estimates china s gdp in 2010 as rmb 39,783 billion and the population at the end of 2010 as 1,341 million with the exchange rate of rmb 6.57 per us china s gdp per capita in 2010 comes to us 4,517 5

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