Good Investment Climate Promotes Harmonious Society

December 19, 2006

David Dollar China Daily

Chinese cities with good investment climates not only attract more foreign investment, they also have achieved a more "harmonious society."  Cities with good climates for foreign investment tend to have better environmental outcomes such as clean air days per year and better social outcomes such as low infant mortality and low unemployment.  This is the main conclusion of a new World Bank study of investment climate in 120 Chinese cities. 

The World Bank, working together with the National Bureau of Statistics, surveyed 100 firms in each city (200 firms in four mega-cities).  In this sample of 12,400 manufacturing firms, majority state-owned firms only accounted for 8% of firms.  These state-owned firms tend to be large, however, so that they control one-third of the total assets.  This ratio varies a lot across China.  In the southeast coastal cities manufacturing is almost completely private sector.  In the northeast and center, on the other hand, manufacturing assets are still majority state owned.  This issue is important because in the same sector and same location, state-owned firms have a much lower return on assets than private firms: 7% compared to 20%.  Interestingly, the pre-tax rate of return for foreign firms and joint ventures is about the same as the return for the domestic private sector.  The difference in ownership structure is one reason why the coastal areas have grown faster. 

Objective measures of investment climate vary a lot among Chinese cities: this is a second major finding of the study.  The survey asks practical questions such as how long it takes to get goods through customs or how much time firm management spends dealing with government bureaucracy.  Many manufacturing firms both import some parts or materials and export some of their product.  Combined import plus export customs clearance is a very low three days in cities such as Jiangmen or Dongguan.  On average the time is 7-8 days in the southeast, compared to twice as long (15 days) in the northeast.  On time spent dealing with government bureaucracy, Hangzhou scores best – firms report spending only 8 days per year dealing with government bureaucracy.  Other cities that are relatively unbureaucratic are Qingdao, Huizhou, and Shantou.  At the other end of the spectrum, firms report spending 60 days per year dealing with bureaucracy in northeastern cities and nearly 80 days per year in the northwest. 

There is a clear regional pattern on investment climate, with the southeast best, followed by the Bohai area, the center, northeast, southwest, and northwest.  Within each region, however, there is also a lot of variation among cities.  The Bohai cities of Qingdao, Weihai, and Linyi are among the best in the country in terms of investment climate.  Dalian in the northeast is also one of the best. 

Good investment climate attracts foreign investment and domestic private investment, leading to faster growth and a higher standard of living.  This is the third major conclusion from the analysis.  In the best one-fifth of cities in terms of investment climate, foreign investment accounts for about one-third of manufacturing.  In the worst one-fifth of cities, it is about 5%.  Foreign investors are attracted to port cities and to big cities with large markets.  But after taking account of that, we find that foreign investors are also attracted to cities with efficient services such as rapid customs clearance, relatively low bureaucracy and red tape, and good infrastructure.  The cities that score best in these areas are the not the big flagship cities of China, but rather smaller cities that have to try harder to attract foreign investment.  Hence we find that some of the best locations for manufacturing production in China are cities such as Jiangmen, Suzhou, Hangzhou, Weihai, Qingdao, Linyi, Yantai, and Shaoxing, that are not as much in the limelight as the mega-cities of Beijing, Shanghai, and Tianjin. 

Cities benefit from good investment climate through more investment and growth.  Their populations also benefit through higher wages.  Manufacturing wages average 1600 RMB per month in the best one-fifth of investment climate cities, twice as much as the 800 RMB in the worst fifth of cities.  It is good for Chinese workers that wages are rising in the successful cities.  An important issue for China is, where will labor-intensive manufacturing move as wages rise in coastal cities?  Will labor-intensive industries shift inland, or move to other Asian countries with lower wages (Vietnam, Indonesia, Bangladesh, India)?  China still has a large amount of surplus labor in rural areas, especially in the center of the country.  It would be beneficial to China if more manufacturing shifted there.  However, our analysis suggests that this development is held back by poor investment climate in many of the central and western cities.  The local governments need to develop an investor-friendly attitude and good public services if they are to attract more manufacturing investment. 

A final conclusion from our study concerns the important issue of "harmonious society."  While China's overall growth has been very impressive, there is mounting concern in the country about some of the side effects, such as environmental degradation and social disparities.  Hence, for this 120-city survey we also collected information on environmental and social outcomes.  Somewhat surprisingly, good investment climate for the private sector is highly correlated with good environmental and social outcomes.  For example, the best fifth of cities in terms of investment climate have 90% clean air days per year, whereas in the worst fifth of cities less than 75% of days meet China's air quality standards.  On discharge of industrial waste, nearly 100% is properly treated in the good investment climate cities, compared to 80+% in the poor investment climate cities.  On the social side, infant mortality is twice as high (around 14 deaths per 1000) in the poor investment climate cities as in the good investment climate cities (7 per 1000). 

What this correlation means is that there is no contradiction between creating a good investment climate for private investment, and meeting important environmental and social objectives.  The same local governments that have created a good climate for investment have also done a better job with environmental and social management.  The higher income that comes with good investment climate also raises demand for environmental and social goods and provides fiscal revenue to address these important issues. 

Because of this correspondence between good investment climate and good environmental and social outcomes we are able to identify six "golden cities" that are both good places for firms to produce but also good places for people to live in terms of natural environment and social harmony: Hangzhou, Qingdao, Shaoxing, Suzhou, Xiamen, and Yantai.  Just below them are 13 other cities that have good investment climate and good environmental and social outcomes: Beijing, Dalian, Dongguan, Foshan, Fuzhou, Guangzhou, Jiangmen, Ningbo, Shanghai, Shenzhen, Tianjin, Weihai, and Zhuhai. 

A critical issue for China is that local government needs to improve investment climate in many central and northeast cities.  Without improvement in investment climate in these locations, it will be difficult for them to attract more investment and spur growth.  Much of the inequality in China results from the large gap that has developed between standards of living in coastal cities compared to interior cities.  There is also a large rural-urban gap, and part of the solution to that gap is that 150-200 million people need to move out of agriculture into urban employment.  They cannot all move to the coast.  Hence the smooth resolution of glaring disparity in China requires the growth of interior cities that raises living standards there and pulls large numbers of people out of rural employment and rural poverty.  Improving investment climate in the cities of lagging regions of China is hence one of the most important measures that can contribute to a more harmonious society.