Fundamental Shift in China Development Needed, Says World Bank

Over the last three decades, China's GDP growth averaged 10% a year and more than 500 million people were lifted out of poverty. But if China wants to realize its goals for continued growth, it will need to pursue a "fundamental" shift in its development path, says a new report from the World Bank and the Development Resarch Center of China's State Council.

China should complete its transition to a market economy (through enterprise, land, labor, and financial sector reforms), strengthen its private sector, open its markets to greater competition and innovation, and ensure equality of opportunity to help achieve its goal of a new structure for economic growth, the report, "China 2030: Building a Modern, Harmonious, and Creative High-Income Society", recommends.

"China's leaders have recognized that the country's growth model, which has been so successful for the past 30 years, will need to be changed to accommodate new challenges," said World Bank Group President Robert B. Zoellick.

Even if China's growth slows to an average 6.6% a year, it will become a high-income country before 2030 and overtake the United States as the world's largest economy. The report notes that China is already the world's largest manufacturer and exporter. By 2030, the report states, China's share in world trade could be twice as high, it likely will "remain the world's biggest emitter of carbon dioxide, and, notwithstanding shrinkage in its trade surplus, it is expected to remain the world's largest creditor."

The need for change in China reflects a number of significant trends, the report notes. Much of the growth that China saw in the transition from agriculture to manufacturing has already occurred. The size of its labor force could start shrinking as soon as 2015. And China will "grow old before it grows rich," the report notes, with the ratio of those 65 and older compared to those age 15-64 doubling over the next 20 years.

The report lays out six strategic directions for China's future:

1. Complete the transition to a market economy.
"Central to the report's findings is the need for China to modernize its domestic financial base and move to a public financial system-- at all levels of government -- that's transparent and accountable, overseen by fewer but stronger institutions, to help fund a changing economic, environmental, and social agenda," Zoellick said.

"The reform agenda, with a stronger and more flexible financial sector, the promotion of innovation, and green growth as drivers of development, can lead to opportunities for creating new jobs and additional productivity within China as well as new opportunities for foreign firms."

The report makes the case for the government to redefine its role -- to focus more on systems, rules and laws -- to boost efficient production, promote competition and reduce risks. It recommends redefining the roles of state-owned enterprises and breaking up monopolies in certain industries, diversifying ownership, lowering entry barriers to private firms, and easing access to finance for small and medium enterprises.

Reforms should include commercializing the banking system, gradually removing interest rate controls, deepening the capital market and further developing independent and strong regulatory bodies to support the eventual integration of China's financial sector within the global financial system. A priority is to liberalize interest rates according to market principles.

2. Accelerate the pace of open innovation.
To accelerate the pace of innovation, the report advocates greater efforts to build countrywide research networks, steps to improve the quality of tertiary education and links with global networks, supported by a stronger rule of law and intellectual property rights enforcement. It says such an open innovation system would be a prerequisite to benefit fully from global innovation links.

3. Go "green" to transform environmental stresses into green growth as a driver for development.
For China to advance the "going green" development agenda, the report states, it will need to look at long term market incentives to encourage enterprises and households to go green. This should include more public investments, and the better design and enforcement of regulations to complement market incentives, such as taxes, fees, tradable permits and quotas, and eco-labeling. China can establish itself as a global green technology leader by implementing stringent and effective policies to reduce greenhouse gas emissions. Stringent emissions reduction policies, such as carbon trading or carbon taxes, could spur innovation in green technologies.

4. Expand opportunities and services such as health, education and access to jobs for all people.
To reverse rising inequality, the report says China will need to focus on a social protection system appropriate for China in 2030, with a special emphasis on the poor. It lays out the case for "flexicurity." This can include reforms in pension and unemployment systems so workers have reasonable support in their old age or when jobless. This can ensure comprehensive coverage of pension insurance, especially for rural people and migrant workers in cities. The report also warns that extending the current level of urban services and social protection to rural residents and migrants -- well over half the population -- will pose a significant fiscal burden and should be implemented prudently.

5. Modernize and strengthen its domestic fiscal system.To fund China's priorities in the decades ahead, and to deal with external shocks, the report calls for further fiscal system reforms. These should include improving the efficiency of raising revenue and changing fiscal relations between different levels of government as well as strengthening the efficiency of public spending. There is untapped potential for revenues through higher taxes on energy consumption, taking dividends from state-owned enterprises, and levying taxes on personal incomes, motor vehicles, and property.

The report proposes a sequencing of reforms, as well as quick wins and actions to address short term risks. Support for reforms will be stronger if the plans are based on full participation throughout all levels of society, the report points out. The biggest risk is that vested interests will try to thwart reforms.

6. Seek mutually beneficial relations with the world by connecting China's structural reforms to the changing international economy.
As a key stakeholder on the global economy, the report states, China should support free trade and back a multilateral agreement on investment. China's long-term interests lie in global free trade and a stable and efficient international financial and monetary system, the report notes, relying on multilateral frameworks to help shape the global governance agenda.

China's growing weight in world trade, the size of its economy and its role as the world's largest creditor will make the internationalization of China's renminbi inevitable, the report predicts. Acceptance of the RMB as a major global reserve currency will depend on the pace and success of financial sector reforms and opening of its external capital accounts.