Speech at the China Development Forum, March 20, 2011, Beijing
By Sri Mulyani Indrawati, Managing Director, The World Bank
Honorable Ministers, Ladies and Gentlemen,
Thank you for inviting me to speak here today, to learn and to contribute to this prestigious Forum that has become a place for open and meaningful discussions between China and her friends all over the world. It is a privilege to be here.
Before I get into the substance of my remarks, I would like to express my deepest condolences to the people of Japan. The country is a close friend and important partner of the World Bank and we are ready to support its recovery and reconstruction.
We are humbled by the resilience and strength the Japanese people are showing in these difficult times. All too well, I understand the impact that such a tragedy can have on people, communities and the country. So while today I will talk about economic development and growth, recent events are a reminder that we need to place importance on the ability to plan for the risks, natural or otherwise, that we all face.
Over the weekend we have been discussing intensively about China’s macro economic development and the global economic outlook: issues that are ever more intertwined as are China’s and the World’s economy. We have heard about the short term prospects and challenges, the need to unwind state led economic stimulus and to reduce fiscal deficits, over time and in accordance with the state of the economies all around the world.
And we have discussed how to chart the right path to steer clear of the dangers of deflation and inflation, prolonged fiscal profligacy and premature frugality.
Today I would like briefly to discuss some aspects of the longer term structural challenges for China that also have been the subject of intensive debates in the National People’s Congress over the last two weeks. I will focus on what sometimes has been called the “Great Rebalancing” to sustain China’s growth and development.
You are, of course, aware of the main threads of the discussion: China, it is argued, needs to find a new balance between export led and domestically driven growth. China should shift its growth pattern from investment to consumption, from enterprises towards households. And China needs to address and overcome the divide between urban and rural development, between coastal provinces and the central and western regions.
And if this was not enough: in today’s world with worries about carbon emissions and climate change, growth and development needs to be rebased on green environmental strategies. A truly daunting agenda for a country that, in aggregate, may be the second largest economy of the world but still houses more than 100 millions of people below the poverty line and ranks around Number 90 in the world in terms of GDP per capita. As several of China’s senior leaders have noted, the need to change the pattern of growth has been ever increasing in recent years, accentuated, in part, by changes in the international environment.
What exactly is the issue with China’s growth pattern? Over the last 15 years China’s growth has been particularly investment-oriented, industry-led and export driven. At an estimated almost 49 percent of GDP in 2010, the investment to GDP ratio is higher in China than in any other major country and, with the secondary sector contributing 47 percent to GDP, the production structure is geared heavily to industry.
As an aside, it is interesting to see the unique challenge that China is trying to address. In most developing countries and emerging markets, the issues and objectives are quite different: how to increase investment? How to raise the share of industry in GDP? I know that other countries in Latin America and throughout the world enviously look to China’s growth rate and her pace of industrialization and tried to learn from her experience. It seems almost paradoxical: The issue discussed in many developing countries is whether progress has been made too little and too slow whereas the discussion in China is about too much and too fast!
Overall, China’s traditional pattern of growth has helped supply to grow alongside, or even outgrow, demand. As a consequence China grew rapidly without running into the problems of other emerging economies such as demand-led inflation and external current account deficits.
For quite some time, indeed already since the preparation of the 11th 5 Year Plan, policymakers realized that this pattern of growth while impressively successful has also contributed to imbalances. Changing the growth pattern—towards a relatively greater role for services and consumption, with less relative emphasis on industry and investment—became a key pillar of the development strategy and rightly so. During the 11th Five Year Plan period there has been good progress in some areas, for example in improving basic public services for social protection, education, health, and conditions in rural areas.
There have also been some advances towards attaining environmental objectives. But the sudden onslaught of the global financial crisis and the need for state intervention to stimulate economic activity has slowed down progress in restructuring the economy.
More needs to be done and is being contemplated by Chinese policymakers. According to the 12th Five-Year Plan, the major overall targets include “stable and relatively fast economic growth, major economic restructuring, raising people’s income relatively fast, and deepening reform and opening up.” Indeed, the success of China’s economic development in the past 3 decades demands adjustment to the institutions and policy making process to sustain this progress.
In terms of development strategy, this pronouncement translates into policies towards achieving three long term objectives: first, transforming the economic growth pattern; second, addressing the regional divide by emphasizing the development of inland regions; and, third, upgrading the industrial structure.
The first two of these are part of the overall rebalancing effort.
The third: “Upgrading the industrial structure” will ensure that productivity growth continues and China stays away from the “middle income trap”. China’s recent record of rapid growth of GDP and productivity, can be linked to successive bold efforts to reform and open up the economy, and to undertake needed public investments. Continued success will require new reforms and a business climate conducive to innovation and upgrading.
There is no question that China may need to implement a whole array of policy measures and institutional reform in order to achieve the goal of growth pattern transformation.
First, embark on forward looking reforms that help channeling resources to sectors, activities, and areas that need to expand in the new environment, while maintaining efficiency.
Measures to effectuate this include (i) improving access to finance for private sector, service oriented, and smaller firms and in rural areas; (ii) removing subsidization of inputs into industry such as land, capital, energy, and other resources, and exchange rate appreciation; and (iii) further scaling up the dividend payments by SOEs, to improve the allocation of capital. In addition, there is significant room to remove restrictions on service sector development and open up more service sectors to the private sector.
Second, introduce reforms both at policy and institutional level to help to boost permanent urbanization. Urban people consume more than rural people, and in particular spend more on services. Thus, more and permanent urbanization stimulates service sector development and labor intensive growth in urban areas. China has seen a lot of people moving to urban areas in the last 20 years. However, many migrants left their families behind and have not been able to take on an urban lifestyle.
In addition to removing obstacles to service sector development, other key policy areas include further liberalization of the household registration system, land reform, and reform of the inter-governmental fiscal system, to give municipalities the resources and incentives to provide basic public services (such as education and health) to migrants.
Indeed, in my World Bank responsibilities for Latin America and the Middle East/North Africa and previously in my tenure as Minister of Finance in Indonesia, I have learned and seen that sustainable economic development has to be built first and foremost on a strong fiscal foundation. Fiscal policies drive expenditure patterns, and tax policies provide for revenues. Good fiscal policy requires good and sound institutions to implement. Institutional reform should be designed and implemented on pace with the policy reform.
The right sequence and speed are key to the success of transformation. Done successfully, they establish the framework for the right balance between state and economy, public and private, and for correcting imbalances between the rich and poor income groups.
On the expenditure side, continuing to increase government spending on social protection, health, and education would both provide direct benefits and increase household disposable income and consumption.
On the revenue side, public finances can be used to increase household disposable incomes, for instance by lowering social security contributions in a financially sustainable way. The dividend policy for SOEs can be further expanded in coverage and level. Adjustments in fuel and water prices to reflect the true cost and increases in the resource tax are also moving into the right direction. Expanding the VAT system to the service sector would also help reduce distortions.
But reform of the overall system of fiscal intergovernmental relations is probably the most important element of the agenda. Expenditure responsibilities in China’s decentralized fiscal system generally do not match revenue capabilities well. Adequate local funding in poor regions would remove serious constraints on the delivery of social protection, education, health, and rural services.
In the absence of increased and reformed net transfers from rich to poor regions or other new revenue sources, large disparities between regions in spending per person on public services will unavoidably persist. Reforms can promote more permanent urbanization, especially by giving local governments stronger incentives to be “on board” with the rebalancing agenda. Pilot projects in several large cities may gradually be rolled out nation-wide to this effect.
As you know much of China’s public infrastructure is currently financed off budget by separate local government platforms. Shifting infrastructure finance on budget can make urban development and infrastructure expenditures more transparent and better integrated in the overall public finances.
This is an ambitious agenda: But can it be done? Yes.
Preliminary modeling work carried out a few years ago in cooperation between the Development Research Centre and the World Bank suggests that implementing a policy package along those lines would by and large transform the pattern of growth while keeping overall growth on track.
Over time we would see a higher share of consumption in GDP, a higher share of wages and household income in GDP; a rise in the share of services; a lower external surplus; higher rural incomes; less rural-urban inequality; and faster urbanization.
Because of the smaller relative role of industry, growth would be less intensive in energy and primary commodities, and produce less pollution.
The implications of China’s development in such a scenario for the rest of the world are benign. China would remain a manufacturing and export powerhouse, competing in an increasing array of sectors and products. This will continue exert downward pressure on prices of manufactured goods internationally, to the benefit of global consumers.
By itself this will tend to put upward pressure on China’s current account position with the rest of the world. However, with the successful transformation of the growth pattern and urbanization, domestic demand will play an increasingly important role, boosting imports of an increasingly wide array of goods and services.
Ladies and gentlemen,
For more than thirty years China has been growing relentlessly. By and large China has also managed balanced growth and social inclusion over these years. China has changed. And China’s rise is changing the world.
Thirty years ago China needed the world for its development. It needed external financing and knowledge. Today the World needs China’s prosperity to overcome the current financial crisis and sustain reductions in poverty.
China is reaching out. It has taken on issues of global importance such as climate change. It is working in the G-20 to establish a new basis for sustainable, environmentally friendly economic growth. It is increasingly active in support of partner countries in the developing world, such as in Africa.
China is uniquely positioned in this regard: It is an economic powerhouse, increasingly at par with the economies in the developed world. At the same time it is still a developing country with huge development needs ranking at 90th place in the GDP per capita league. China, one might argue, straddles the gap between developing and developed countries.
China’s role in the International Financial Institutions mirrors this development. Last year China became the third largest shareholder in the World Bank. It is actively engaged as a shareholder in the reform of the World Bank’s governance structure, contributes to the Bank’s concessional finance arm the International Development Association and it is ready to cooperate with the World Bank in direct support to developing countries. At the same time China and the World Bank are continuing their partnership of 30 years in cooperating in support of China’s domestic development through advice and well targeted interventions to pilot reforms and new initiatives.
But the emphasis of our cooperation has shifted from meeting financing needs to a knowledge partnership. I believe that such cooperation is beneficial to China and the World Bank: Indeed it may set an example for the World Bank’s future work with other fast growing middle income countries in Latin America, the Middle East/North Africa, East Asia and around the world.
Ladies and gentlemen,
China is shifting her growth pattern, gradually and carefully. For an economy with more than 1.3 billion people this is the right and responsible approach. Rebalancing will help China to sustain its development. And it will also be beneficial for the World Economy. We all have ample reason to support this direction. The World is a stakeholder in China’s future.
Thank you for inviting me to participate in this important event. I wish the Forum great success.