Slide 1

Improving the Efficiency of China’s Growth Is Important for

the Whole World

David DollarWorld Bank Country Director, Beijing

China has been the most successful developing country over the past two decades,

growing rapidly and achieving the fastest poverty reduction in history. While there are

good reasons to think that China could continue to grow rapidly for two more decades,

the country also faces some serious challenges. China’s growth has been inefficient in

three ways. China’s growth uses up more capital than is necessary, which is wasteful for

China and also affects the whole world economy because of China’s growing weight in

the world. China’s recent growth has also involved use of natural resources – water,

energy, and clean air – at a rate that is not sustainable. Again, improving efficiency of

natural resources use is good for China and good for the global environment. Finally,

China’s rapid growth in the past decade has produced less employment, poverty

reduction, and social improvement than it could have. Increasing the social benefits from

China’s growth would improve the lives of its people and contribute to global goals such

as the Millenium Development Goals (MDGs).

Slide 2

China will emerge asthe largest trading nation by 2020

US

3800

OHI China

900370

1400

OD2003 2020

US OHI China OD

8750

2400

3100

6800

Exports in constant1997 US dollars, billions

If recent trends continue, China will emerge as the largest trading nation before 2020.

China’s emergence is part of a more general trend for world production and trade to come

increasingly from developing countries. The U.S. together with other high-income (OHI)

countries account now for about 75% of world trade. By 2020 the share of high-income

will decline to 50%. This scenario is not a naïve projection of recent growth rates, but

rather takes account of the differing elasticities China’s products and other trading

nations.

Slide 3

…and the largest economy GDP in 2000 and 2030

U.S.ChinaJapan India0

5

10

15

20

25

30

Trillions of constant PPP US dollars

2000 2030U.S.ChinaJapan India

Measured at purchasing power parity (PPP), China is already the second largest economy

in the world, and will emerge as the largest by 2030, even if its growth rate slows

somewhat to the 6% range.

Slide 4

China’s growth prospects and challenges

• Favorable demographics and investment climate… but, major inefficiencies in

• Financial system

• Natural resource use (water, energy)

• Social development and equity (governance, inter-governmental fiscal)

The prospects for China’s continued rapid growth are good. It has favorable

demographics with a rapidly growing labor force and a still-declining ratio of dependents

(children and the aged) to workers. Population is shifting from rural areas to urban areas

at a rate of nearly 20 million per year, which is a source of productivity growth on the

supply side and of demand for consumer durables on the demand side. Among

developing countries, China has developed a relatively good investment climate –

attracting foreign investors and its own private entrepreneurs.

While prospects remain favorable, there are some serious inefficiencies or challenges that

need to be addressed, notably in the financial system, natural resource use, and social

development. How China addresses these will determine the extent of its ultimate

success and have a large spillover effect on the rest of the world as well.

Slide 5

Investment climate bottlenecks

China Poland Brazil Pakistan Algeria Uganda Tanzania0

10

20

30

Costs

as a

shar

e of s

ales

Disputes with suppliers and creditorsRegulationBribesCrimeInfrastructure disruptions

Source: World Development Report 2005, Investment Climate Surveys

The World Bank has been working with developing countries to carry out standardized

surveys of firms that aim to measure firm performance and to capture objectively the

main problems in their investment climates: that is, the regulatory and infrastructure

environment for production. This is looking at economic governance at a micro level. To

get new investment to take advantage of export opportunities, locations need to create

good environments for firms to start up, connect to the global market, and expand. The

project has so far covered several dozen countries. Some of the firms covered in the

surveys are large foreign investors. But most of the firms are small and medium

domestic enterprises, which are really the backbone of growth and job creation.

The figure above summarizes the cost of key bottlenecks observed in surveys for seven

developing countries. This measure of economic governance shows that China has a very

good investment climate in terms of infrastructure services, low regulatory burden and

crime, and levels of corruption not out of line with other developing countries. It is

because it has a good investment climate that China continues to attract foreign

investment and to export so dynamically.

Slide 6

Growth rates 1990-2003

8.58.9

10.9

13.4

Householdconsumption

Governmentconsumption

Capitalformation

Export volume

While China has grown well since 1990, it is remarkable how much savings and

investment this has required. Since 1990 China’s investment has been growing more

rapidly than consumption – either household or government consumption. Much of this

capital formation has been aimed at external markets, and China’s export volume has

grown much faster than its GDP (so that trade to GDP keeps rising).

This pattern of growth raises a number of issues or problems. On the one hand, the need

for such a large amount of investment for China’s level of growth reflects the inefficiency

of the financial system and the preference of local governments for large amounts of

investment. A lot of bad investments are financed which ultimately produce little value.

This is wasteful for China in real terms, and also creates the financial sector problem of a

large volume of non-performing loans. This situation creates a systemic risk for China,

in which some kind of internal or external shock could set off a costly financial crisis.

It also seems clear that this pattern of growth cannot be sustained indefinitely.

Investment cannot just keep rising as a share of GDP and it will be increasingly difficult

for China to keep increasing its share of world trade at the same rate.

Slide 7

Financial sector reform

• Reform/privatization of state-owned commercial banks

• Reform of pension system

• Exchange rate?

In the medium term China will need to rely more on domestic consumption to drive

demand in its economy. Getting this adjustment requires an integrated series of reforms.

On the one hand, development of robust pension and health insurance systems would

stimulate household consumption since families would have to rely less on large built-up

savings. The financial system could also do a better job of financing consumer durables.

Finally, the government could put more expenditure into social areas such as health and

education – where recurrent costs are recorded as consumption. Institutional and policy

changes that lead to lower savings and investment would in turn affect China’s external

balance. Less saving and more consumption should lead to higher imports, reducing

China’s trade surplus. Appreciation of the exchange rate would also help stimulate

consumption and spur adjustment.

Slide 8

Distribution of water

• Water is not evenly distributed

• South = Water Abundant• North = Water Scarce• Distribution of population and

industry does not match distribution of water resoruces

Distribution of water in China’s river systems

Total quantity of water resourcesTotal runoff

The rate at which natural resources are being used up in China is unsustainable. First,

take water. China is a relatively water scarce country; its per capita availability of

renewable water resources is only about one-third of the world average. Furthermore, its

water is not distributed in the same way as population. Most of the water is in the south,

whereas more than 40% of the population lives in the north.

Slide 9

Renewable fresh water per capita

cubic meters728

2183

3380

3386

4513

9621

13,233

17,848Myanmar

U.S.

Thailand

China

North China

Japan

Vietnam

Indonesia

As a result, the large population in China’s northern half has only 728 cubic meters per

capita of water, compared to 3380 in Japan or Thailand, and much higher levels in water-

rich countries such as the U.S., Indonesia, or Myanmar.

Slide 10

Water quality

• 5 grade water classification system (G1 best)– 2000: G1-3 58%, G4 21.6 %,

G5 6.9%, G5+ 13.8%

•Most pollution occurs when water passes through large cities

Water quality in main river basins

Grade I - IIGrade III - IVGrade V

Not only are the natural sources of water scarce in China, but the resource has not been

well taken care of. As a result, there is serious pollution in all major river systems,

especially in the north.

Slide 11

Urban water prices

0.15

0.51

1.45

Dollars per cubic meter

China U.S. Germany

There are a variety of weaknesses in China’s water policy. One weakness is that the

price of water in urban areas is very low, so that waste is not penalized.

Slide 12

Water policies

• Grain policies and imports

• Water pricing

• Enforce water pollution regulations

Water prices are even lower in rural areas. While it is understandable that the

government wants to help the poor rural population, subsidizing the price of water is not

sustainable and in fact is more of a boon to consumers than to producers. More rational

water policies would encourage farmers to concentrate on rice and food crops, while

opening up more space for imports of grain used for animal feed. China could import

significant quantities of animal feed without in any sense becoming food insecure.

Urbanization is potentially a water saving development path, as urban uses of water in

production and consumption are generally lower than rural and agricultural uses.

However, proper urban pricing and enforcement of water pollution standards are

important if the potential of urbanization to be water-saving is to be realized.

Slide 13

Growth rate of petroleum imports1988 - 2003

1.8%

6.8%

31.1%

Japan U.S. China

Energy is another important factor in China’s development equation. While China is rich

in coal, it appears so far to be scarce in oil and natural gas, which are important fuels for

some aspects of industrialization and development. Over the past 15 years China oil

imports have been growing rapidly, and it has emerged as the second largest importer

behind the U.S. It is projected to emerge as the largest importer. Given the supply

situation in the world and the fact that much oil and gas come from politically unstable

countries, this is clearly a risk factor for the country’s future.

Slide 14

Energy efficiency

• Industrial processes use 20-100 percent more energy in China than in OECD countries

• Residential heating in China uses 50-100 percent more energy than in OECD countries

• Current Chinese auto emissions standards equal European standards in 1994

While it is inevitable that energy use will grow with China’s economy, much could be

done to increase the energy efficiency of China’s development. For specific industrial

processes, China uses more energy than OECD countries. Its residential space heating is

highly inefficient, using 50-100% more energy than is used in OECD countries with

comparable climates. Given the rapid pace of housing construction, enforcing strict

standards now would make a big difference for future energy demand. So too with auto

standards, which lag behind European standards by ten years. Energy use and auto-

related air pollution could be dramatically reduced by stricter emission standards.

Slide 15

ShanghaiChengdu

Guangzhou

Beijing

Tianjin

China

Lanzhou

Harbin

Changchun

Chongqing

Kunming

Zhengzhou

Nanchang

Wuhan

Jinan

Guiyang

Taiyuan

Shenyang

Zibo

Anshan

Pinxiang

Air pollution has become a serious problem in China. Of the 30 most air-polluted cities in

the world, 20 are in China. The air pollution results from the combination of (1) coal use

for power, industry, and home heating and (2) growing motorization.

Slide 16

Gasoline retail price

0.410.50

1.00

China U.S. Japan

Dollars per liter

As with water, many energy prices are low in China. The retail price of gasoline is below

the U.S. level and far behind other OECD countries such as Japan, encouraging

inefficient motorization.

Slide 17

Energy policies

• Petroleum tax and pricing

• Urban planning and public transport

• Auto and construction standards

China’s cheap gas policy is an important factor encouraging the development of a car

culture. A significant petroleum tax could lead to more conservation and also provide a

source of funds for urban planning and for public transportation investments. Many of

the autos and buildings that China will have in five to ten years have not been built yet,

so strict energy-related standards will have a big effect if they are put in place soon (and

enforced).

Slide 18

Poverty decline has slowed since mid-1990s

0

10

20

30

40

50

60

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Headcount index

2000 calorie poverty line

Official poverty line

China should be praised for achieving the most rapid poverty reduction in history. But

most of this reduction was achieved in two waves – the first with the household

responsibility system in the 1978 to 1985 period and the second, related to labor-intensive

manufactures and exports and rural-urban migration, in the 1990 to 1996 period. The

chart above shows the poverty rate using both the official poverty line (solid line in the

picture) and a somewhat higher poverty line (dashed line) based on the real consumption

needed to have a daily diet with at least 2000 calories. Both lines show similar trends;

poverty reduction has slowed very markedly in the last few years, even though growth

has accelerated to extremely high levels.

Slide 19

… while inequality has risen sharply

Gini coefficient

10

15

20

25

30

35

40

45

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

National

Rural

Urban

China’s recent growth has not has much effect on poverty because it is not touching the

remaining poor – most of whom are cut off from the dynamic market economy for one

reason or another: they are in remote locations far from markets, and/or ethnic minorities

not well integrated into society and/or disabled. The sharp rise in both rural and urban

inequality in recent years is a reflection of this fact that recent growth is largely

bypassing the remaining poor.

Slide 20

Rate of decline of infant mortality

1990-2003(percent per annum)

1.82.2

2.6

3.63.9

China India Middle-income

High-income

Japan

China’s recent growth is also having surprisingly little effect on social indicators. Infant

mortality declined more slowly in China than in other middle-income countries and more

slowly than in India, despite the much slower increase in income in these comparators.

High-income countries in which infant mortality is already low have nevertheless

managed to continue high rates of decline. In this sense we can say that China’s growth

in the last 15 years has brought less social improvement than one would have expected.

Slide 21

Government health expendituresPercent of GDP

2%

2.9%

6.5% 6.6%

China Middle-income

Japan High-income

This result partly reflects the pattern of growth noted at the outset of this presentation. A

lot of resources have gone into investment, especially for export. Government spending

has grown less rapidly, and that is reflected in the low share of GDP that is accounted for

by public health expenditure – low relative to middle-income countries and far behind

what rich countries spend as a share of their income.

Slide 22

Social and equity policies

• Reform of land ownership and rights

• Inter-governmental fiscal system

• Facilitate rural-urban migration

Increasing the social benefits of China’s growth will require a number of measures. One

important issue concerns land rights over agricultural land. The ongoing process of

urbanization requires alienating some land out of agriculture to urban uses. At the

moment this is handled in an administrative way, with relatively little benefit accruing to

the farmers who are displaced. There are reasons why the country may not want the full

market value of the land to go to individual peasant families, but there is a lot of scope to

increase the compensation to rural families. This would ease their adjustment to urban

life and reduce inequalities. Also, newspaper reports suggest that the current, non-

transparent system is sometimes a source of abuse.

To be fair to local governments, currently they have few sources of revenue to finance

their infrastructure needs and social expenditure. There is a need for an overhaul of the

inter-governmental fiscal system, to ensure that every community can pay for basic

health and education and to devise sustainable funding sources for local infrastructure.

Adequate financing of local services and a more market-based system of land transfer

would greatly ease the inevitable process of rural-urban migration.

Slide 23

China’s Growth Prospectsand Challenges

• Favorable demographics and investment climate… but, major inefficiencies in

• Financial system

• Natural resource use (water, energy)

• Social development and equity (governance, inter-governmental fiscal)

In summary, the prospects for China’s continued rapid growth are good. It has favorable

demographics with a rapidly growing labor force and a still-declining ratio of dependents

(children and the aged) to workers. Population is shifting from rural areas to urban areas

at a rate of nearly 20 million per year, which is a source of productivity growth on the

supply side and of demand for consumer durables on the demand side. Among

developing countries, China has developed a relatively good investment climate –

attracting foreign investors and its own private entrepreneurs.

While prospects remain favorable, there are some serious inefficiencies or challenges that

need to be addressed, notably in the financial system, natural resource use, and social

development. How China addresses these will determine the extent of its ultimate

success and have a large spillover effect on the rest of the world as well.