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China in the Global Economy

Address by
Liqun Jin
Vice President, Operations 1
Asian Development Bank

At the Senior Executive Seminar, Total S.A.
8 October 2007
Versailles, France

Introduction

Chief Executive Officer, Monsieur Christophe de Margerie, honored guests, ladies and gentlemen:

It is truly an honor and a pleasure for me to join you today. I want to first express my sincere thanks to Monsieur de Margerie for inviting me to address you on the topic of China in the Global Economy.

I also want to commend Total S.A on the company's various corporate social responsibility initiatives, and most particularly on its commitment to sustainable development and environmental protection. These are, as you know, issues of tremendous importance as China and indeed the entire Asia and Pacific region comes into its own on the international scene.

Obviously, today's China stands at the forefront of the international stage, politically and economically. Mutual understanding between China and the rest of the world, particularly the Western countries, is of great significance to global cooperation in many areas in the present-day world. The reform and opening up program adopted by China has paved the way for China to ascend to the level of international competitiveness in the world market in the space of about 25 years. At the outset, China looked outward to see what can be learnt from the outside world, and it looked inward to see what needed to be changed. China's reform program has always been staged on the highly raised platform set up by the opening up policy. The western countries warmly embraced China's opening up and reform, and its integration into the global economy as it shed, step-by-step, its planning economy. China's growth has created enormous opportunities for strengthened trade and investment opportunities for western countries. It is obviously a win-win situation. And this should be maintained through constructive dialogues between China and these developed countries.

As an IMF study indicated, in the last two decades, China's growth amounts to adding a country of the economic size of Portugal every year, creating as many new jobs each years as the total number of people employed in Australia, eradicating poverty in Ethiopia, Nigeria, Tanzania, and Zambia combined. In recent years, China has grown more than 10 percent annually while keeping inflation below 3 percent. It is the fourth largest economy in the world and the third largest trading nation.¹

China's growth is exerting significant impact on the rest of the world economy, and it is positive. That is why China's economic sustainability over the long term is important not just for the country itself, but also for the rest of Asia, and even the rest of the world, whose growth is increasingly linked to China. What will be the main growth engine of China in the next two or three decades? Will China follow into the trap of long recession after years of fast growth, as experienced by some of the developed countries in the past?

China's Challenges, Short-term and Long-term:

China has defied predictions. Some predicted China's political meltdown after the Berlin Wall collapsed. Some foretold that China's mighty economic tank would sink in the wake of the 1997 Asian financial crisis. Of course, this has not happened. China's adaptive and dynamic economic system has kept it resilient.

Nevertheless, China is faced with tough challenges, both short-term and long-term. Success in overcoming these challenges is of great significance to the political and economic stability of the country, with significant implications for the rest of the world.

With regard to the most urgent short-term issues, China needs to address potential overheating in the investment sector, particularly in real estate sector. Over the last three years, the Government has relied heavily on monetary policies, including increases in bank reserve requirements and increased in interest rates, to address this issue. Tightening control on approvals of new investment projects has been somewhat effective in reducing the growth of investment towards the end of 2006. However, the results seem to be mixed. This is because of the huge amount of liquidity poured into these sectors by commercial banks, which could make their lending decisions more or less on their own.

China has to continue to pursue reforms involving the financial sector, improving the banking, bond and equity markets and the SOEs, so that they will operate at an optimal level of efficiency.

China also has to do more to improve the rural economy, particularly in the hinterland provinces. Rural stability means stability for the entire country.

Recently, inflationary pressure has been mounting, mainly due to energy price surges and food price increases. The higher energy prices will adversely affect the growth whereas the food prices increases will erode low-income people's living standards.

Obviously, China's short-term and long-term challenges are to a great extent inextricably linked. Over the long-term, the fundamental challenge is to maintain growth in a balanced and environmental-friendly manner, and bring benefits to all segments of the population to achieve the Government's goal of a building a harmonious society. To continue on the path of progress, China will need to sustain a growth rate in the range of 8% to 9% a year for the next two decades to absorb the new entrants into the labor force. To do so, however, it will have to grapple with a long list of domestic challenges. Let me highlight just a few prioritized issues.

Rebalancing the economy.

China's adoption of its export-oriented policy since the 1980s has turned the export sector into a powerful engine of economic development. Capital flows into the country under the strong incentives of tax policies and other preferential treatment have converted the coastal provinces into the world's plant of manufactured goods and a critical node in the global supply chain. In recent years, China's strong export performance has earned immense foreign exchange reserves, but has also fuelled protectionism in a number of its trading partners. The export-led growth strategy, supported by lost-cost labor, incentives of various forms, and domestic savings and local entrepreneurship has been the right path for the past two decades, but a series of new policies and strategies will be needed to keep economic balance between the export sector and the domestic sector, and thus will be less vulnerable to external shocks of the magnitude of the 1997 Asian financial crisis.

Theoretically, economic rebalancing is not an issue, as the Government has already decided to convert the growth pattern into one that de-emphasizes exports in favor of domestic consumption. The approach to rebalancing the economy by shifting away from excessive dependence on investment and export-led growth, and towards stimulating domestic consumption, is a sensible course of action, endorsed by the 11th 5-Year Program.

In reality, it is not so easy to break away from a successful model which has served the country so well over the decades. To change the growth equation will require economic restructuring. Export-oriented sectors cannot be remodeled overnight to serve the domestic consumers. Large amount of products designed for overseas markets and rolled off the assembly lines in quick succession would go nowhere if not bound for the market they are meant for. And to convert industry-led growth to services-led growth goes beyond shutting down the plants to turn them into hotels or restaurants. Nevertheless, a range of measures could be taken to help stimulate private spending. Raising minimum wages, improving social welfare, reducing income taxes, increasing public spending, particularly in education and health, and improving the living standard of the rural people, etc. are expected to contribute to domestic consumption.

China's growth over the last two decades has been driven mainly by capital formation and exports. This is the role model for many developing countries. However, as China's economy further grows, sticking to the same strategy will cause increasing problems in the future. China's competitiveness in labor cost will be quickly overtaken by the other developing countries in Asia and the other regions, and tax and other incentives offered to foreign investors by China early in the opening up stage is not hard for other countries to follow.

It is important for China to formulate appropriate policies for economic restructuring for balanced growth. However, rebalancing the economy depends on market forces rather than administrative measures. One important factor is to further financial sector reform, so as to guide the capital flows to competitive sectors and high-return projects that will help sustain growth of China's economy over the long term. More efficient utilization of capital means more competitive economy, particularly in the high value-added sector. The financial sector in China continues to provide readily financial resources to state-owned enterprises, or SOEs, not due to the administrative instructions as in the past, but due to perceived risks of lending to private firms and different implications of a default by private firms. Lending to the private sector should be facilitated on the basis of rational credit risk analysis rather than perceptions. Any bias for public ownership should be eliminated. Given the fact that the manufacturing sector is largely dominated by the private sector, providing resources to the private sector on a neutral, market basis will further enhance the private sector's efficiency and induce more investment in R & D, which is so critical for China's ascent on the curve of higher value-added production.

Bringing economic benefits to all.

To achieve such an economic rebalancing calls for critical nurturing of the domestic market. In this connection, macroeconomic policies and proper social policies should address the issue of how to ensure shared benefit and prosperity for the people in general. It is important to narrow the gap between rich and poor, between coastal areas and hinterland areas. While economic and social development performance in China has been impressive and poverty has come down, large segments of the population continue to be disadvantaged when it comes to economic opportunities and quality social services. More than 10% of China's population still live on a dollar a day or less. And over the past 20 years, substantial disparities in regional living standards have emerged. Per capita GDP in the hinterland region, for example, is about two thirds of the national average and only one third of that in the coastal region.

There is an important trade-off to address: high-tech growth versus job creation. Job creation is key to bringing the benefits of economic growth to the people in general, particularly the low-income group. China needs to keep its employment momentum to absorb the large numbers of rural people migrating to urban areas, either permanently or seasonally. Paradoxically, China should intensify its efforts to move up the value chain through more capital-intensive processes to be more competitive on the higher-end industrial products in the global market. Employment elasticity with regard to China's growth is pretty low, with one percent employment growth generating about 10 percent GDP growth. In most countries, the ratio is about 2-3 percent of employment growth to 3-4 percent growth.

One approach to tackling the trade-off is to improve the enabling environment for investment in the relatively low-income provinces and in the autonomous regions in the western part of the country.

According to an ADB business climate survey, 39% of foreign companies operating in China would not consider expanding their operations into the interior provinces, mainly because of a lack of markets and poor infrastructure. The situation is similar in many provinces of the central region, limiting economic opportunities and access to important services.

Therefore, development of roads, railways, power, telecommunications and water supply in western China will help pave the way for the hinterland's economic development and thus bring the benefit to the people in those areas. There is still great potential for job creation in the hinterland areas which, if fully tapped, will ease the pressure of labor migration to the coastal areas.

And while China has shown impressive progress toward eliminating illiteracy and universalizing a compulsory 9-year education, net enrollment rates in one-third of the provinces remain considerably below the national average, and access to affordable and high-quality tertiary education remains a major challenge. Needless to say, improving education and health in hinterland areas is very important in this respect.

Developing the western region and improving the living standard of the low-income provinces and people will greatly contribute to an increase in domestic consumption, and help shift from the over-dependence on exports to a more balanced economy. And a better balance between the export sector and domestic sector will make China's economy less vulnerable to external shocks.

Institutional buildup.

China has made remarkable progress in institutional buildup over the last decades. However, much remains to be done.

Some of China's trading partners deny China its status of a market economy. However, China is more market-oriented than many of the recognized market economies in today's world. Nevertheless, China has yet to strengthen some of the key institutional foundations necessary for a full-fledged market economy. There are two important dimensions to the institutional framework. One is the efficiency of the administration; a country with good institutions will be able to formulate and implement well-advised and well-designed economic and social policies. The other is the developing and maintaining of an enabling environment for the private sector to thrive and generate jobs.

A further requirement is regulatory reform for a market economy and the development of a legal system with a competent, efficient, independent and powerful judiciary. The latter may take at least a generation to develop. However, progress has been made in improving the legal framework for private sector development. In 1997, only one third of all urban jobs were in the private sector, but by 2006, that proportion had risen to three quarters of all urban jobs. Additional developments earlier this year, such as the adoption of a new property rights law that protects private property and a corporate income tax law that levels the playing field for domestic firms,² are signs of further progress.

As you may be aware, the Government has been taking tough measures to crack down on corruption and punish corrupt officials - measures unparalleled in other countries in the developing world. Good governance and anti-corruption can only be achieved under a sound institutional and legal framework.

Energy Security, and Environment challenges.

There has been much international media coverage about the environment cost of China's fast growth. Recently, international concern over the climate change has inevitably led to pressure on China, India and other major developing countries on the fast track of industrialization. China seems to be the first to bear the brunt. While the figures about China's energy consumption as percentage of the East Asia's total or China's carbon dioxide emissions relative to the US or other countries may reflect a trend, this kind of reporting often overlooks some special issues faced by the country.

It should be noted that the demographic features of China, India and other major developing countries imply increasingly strong demand for energy in the years to come. And given the existing technology, much of the demand will have to be met by fossil fuel. In per capita terms, however, these countries still rank very low in emission levels. Another factor is the economic structure. In OECD countries in the post-industrialization stage, the energy elasticity of growth is not comparable to that of the developing countries, which produce manufactured goods, particularly energy-intensive goods, bound for the OECD countries to be consumed. Unless there is a major breakthrough in developing new sources of clean, renewable energy which can sufficiently meet the needs of the global economy, emissions will pass on to the developing countries in the lower-income level as they take over from China, India and other emerging market economies with energy-intensive and polluting manufacturing production. Thus, the problem will repeat itself. The fundamental solution is not to point fingers, but rather for developed countries to engage those emerging market economies and transfer technologies to them to reduce emissions. This will be a more productive and constructive approach.

As rapid growth continues, China will continue to experience significant environmental challenges, since its economic boom is being driven largely by industrial development. Furthermore, as the living standards of the Chinese people improve, the demand for natural resources, including land and water, will get stronger. Over the next two or three decades, rapid growth, industrialization and urbanization will place even greater pressure on China's environment and natural resources.

Indeed, the Chinese Government has exerted great efforts in recent years to address environmental degradation. The efforts to reforest the barren mountains, to give the land back to lakes and pastures, for example, have already yielded tangible results in restoring the environment in many areas. And the national environmental standards for undertaking infrastructure projects or industrial project are very high by international standards. But the to-do list remains very long.

China is keenly aware of the risks of increasingly reliance on imported energy. Oil imports are expected to increase from 46% of primary oil demand in 2004 to 77% by 2030³. Although currently relatively self sufficient in natural gas, it is estimated that by 2030 China will import about one-third of its total natural gas supply. Given the high cost of constructing new power plants, a large part of solution to China's energy challenge will be to increase energy efficiency. It is much cheaper to 'generate' energy by funding energy efficiency projects than it is to generate energy by constructing power plants.

There have been some encouraging signs, with the energy intensity of China's economy consistently improving until very recently. Since opening up in 1978, China has been producing more with less, and has gradually shifted away from energy intensive industries to capitalize on the comparative advantage of low labor costs. By 2000, economic activity required two thirds less energy per unit of output than in 1978.⁴

However, this trend dramatically reversed in 2002. Interestingly, the reversal was not due to increasing consumption by China's rising consumer class, but to a fundamental shift towards high energy consuming industrial production in relatively few sectors, such as cement, glass, steel and aluminum production.

The Government is well aware of the need to get back on track and has established a target of improving the nation's energy efficiency by 20% during the 11th Five Year Plan ending in 2010. In support of this target, it is implementing a broad range of regulatory, fiscal and market-based responses. These include building efficiency standards, removal of perverse fiscal incentives, dismantling of small inefficient power plants, reforming tariffs, targeting high energy intensive industries, piloting SO2 trading schemes, and revising the Energy Conservation Law, to name a few. Recent data indicate that these responses may be gaining momentum.

In order to change the energy efficiency of the economy in a sustainable manner over the long term, improvements to the existing infrastructure capital stock will be required, as well as basic restructuring of the industrial base of the economy. Reforms will be needed in the most polluting and least efficient industrial sectors. New capital will need to move towards the more efficient and higher value-added manufacturing industries and the service sectors that generally require less energy but include higher knowledge and technology contents. It will be important to continue the move towards market oriented controls and to manage the export of energy intensive and highly polluting products.

ADB has been working with China since 1986 to support poverty reduction and economic development through a variety of avenues, including the move to a more energy efficient economy. We provide technical assistance and project financing for a range of clean energy and energy efficiency project, including demand side energy efficiency, hydropower, biomass power generation, coal mine methane power generation, geothermal, and rehabilitation of inefficient coal fired heating boilers.

In the medium term, China needs to expand its research and development capabilities to become the world leader in new technologies in energy supply and use, supported by strengthened intellectual property rights. China's Action Plan on IPR Protection 2006 was formulated last year to provide such support. Above all, strong leadership in policy matters will help China avoid following the beaten track of the industrialized countries, and allow its people to assume a similar quality of life with much lower energy use.

China in the Global Economy

Clearly, China's development challenges will not be resolved overnight. But the blueprint is there, in the Guidelines of the 11th Five-Year Plan. The Plan rests, as I have noted, on a commitment to build a harmonious society within China, and harmonious relations with the rest of the world. Within that context, the Government has outlined its domestic agenda of maintaining relatively high economic growth, accelerating rural development, narrowing the rural-urban income gap, adjusting the industrial structure, enhancing its service sectors, coordinating regional development, building a resource-conservation and environment-friendly society, improving innovation and deepening institutional reform. It is a comprehensive development agenda, and one that will help ensure China's continued contribution to global poverty reduction and global prosperity.

Even as it grapples with these domestic challenges, China understands the importance of building strong relationships with its neighbors in the Asia and Pacific region. Its relationship with India, for example, has improved considerably in recent years. Bilateral trade between the two countries has grown three-fold during the past six years to reach $18.5 billion on 2005-2006. China is now India's second largest trading partner after the US and, if the trend continues, will become its largest in the near future. China is the largest exporter to India and India's second largest importer after the US.

With trade ties strengthening, the Governments of China and India have shown a keen interest in learning from each other's development experience, a process which ADB has been asked to facilitate. With India now following a similar course of putting massive resources into infrastructure and becoming more open to foreign direct investment, a strong, positive relationship between these two giant emerging economies could have enormous benefits for the region and the world.

This will particularly be so as the Asia and Pacific region deepens its efforts in regional cooperation and integration. Smaller economies within the region can benefit from deeper integration through better access to the neighboring economies and the global economy. This will require that they too pursue ongoing economic, institutional and governance reforms at the national level. As the smaller and less developed economies take the necessary steps to catch up, the larger economies will also benefit from finding new markets and building new links in the regional supply and production chains. China is also emerging as an important donor and contributor to other developing countries in and outside Asia. It aims to be a positive force in the global economy and the global community. An ADB study made an apt remark about China's economic relationship with its neighboring countries: China's competitiveness may make it harder for them to earn their lunch, but the same group of countries will be invited to dinner in China. Needless to say, the dinner is heavier than lunch.

Given their size and economic weight in Asia, as well as their strategic locations, both China and India are well positioned to increase their engagement with other regional economies. Both are crucially important to the growth of Central Asia and are participating in Central Asian regional initiatives. And the growth of both economies is inducing Asia's most developed regional body - the Association of Southeast Asian Nations, or ASEAN - to promote further integration among its members and with its neighbors.

China also understands the importance of building strong international relationships with both developing and developed countries, as evidenced by its active participation in such international bodies as the Shanghai Cooperation Organization, ASEAN+3, Asia-Pacific Economic Cooperation and the United Nations Security Council. China also has Observer status in the G-24 process, and holds a strategic dialogue with the US twice yearly to discuss important issues such as trade and currency. China has been playing a big role in the six-party talks on North Korea's nuclear program.

Certainly, there are growing pains in this process. But it is important to recognize China's efforts to resolve difficulties through cooperative, constructive dialogue. The response to recent concerns over food product quality is a case in point. It is encouraging that at their meeting in Zhongshan to discuss this issue, international diplomats from the European Commission and 14 countries agreed that food quality affects all countries and can best be addressed through better international cooperation.⁵ This will enhance China's efforts to introduce quality labeling, reassess the food safety supervision system, and other measures to tackle this important issue.

A similarly cooperative, constructive international dialogue is needed to address other issues, be it China's role as an emerging donor, the protection of intellectual property rights, or the global imbalance of payments. These may be sensitive issues, but as China continues to evolve and mature as a market economy with an increasingly important role in global growth and stability, I am confident such issues can be resolved to the benefit of all concerned.

There are some fallacies about the implication of China's continued growth and further industrialization for the rest of Asia, and the rest of the world as well. Some argue that China will dominate all kinds of manufacturing, including those at the mid- and high-levels of technology, and thus deprive the other developing countries of the chance to move into manufacturing. Some argue that China is likely to play such an important role that other Asian countries will eventually break its dependence on the final demand in the U.S. and European markets. The fact is that while China may take some market share from its Asian neighbors, it is also offering an increasingly bigger market share to the same group of countries. China will serve as an important market for goods from other developing countries, but will not render the market of OECD countries totally irrelevant.

Concluding Remarks

Ladies and gentlemen, I hope that in my talk today I have given you some food for thought - not only about China's energy challenges but about its larger development challenges, both domestic and international. These challenges - as well as the opportunities arising from China's growth - are intertwined and need to be managed by all players in a spirit of commitment and cooperation.

If such an approach is taken, we can envision a day when China has conquered poverty, restored balance to its environment, is meeting its demand for energy in cleaner and more efficient ways, continues to create new opportunities for its citizens, and is a fully recognized, fully contributing member of the global economy and the international community.

Thank you.