Growing beyond the

Low-Cost Advantage
HowtbePeople’sRepublicofCbina
canAvoidtbeMiddle-IncomeTrap
}uzhongZhuang
Paulvanuenbeig
YipingBuang
0ctobei2u12
}uzhongZhuang
Paulvanuenbeig
YipingBuang
Growing beyond the
Low-Cost Advantage
HowtbePeople’sRepublicof Cbina
canAvoidtbeMiddle-IncomeTrap
Ç2u12AsianBevelopmentBank
Alliightsieseiveu.Publisheuin2u12.
PiinteuinthePhilippines.
ISBN978-92-9u92-882-9(Piint),978-92-9u92-88S-6(PBF)
PublicationStockNo.RPT12Su2S
Cataloging-In-PublicationBata
Zhuang,}uzhong,Paulvanuenbeig,anuYipingBuang
uiowingbeyonuthelow-costauvantage:howthePeople’sRepublicofChinacanavoiuthemiuule-incometiap.
NanualuyongCity,Philippines:AsianBevelopmentBank,2u11.
1.People’sRepublicofChina 2.Niuule-incometiap S.Stiuctuialiefoim4.Inclusivegiowth
I.AsianBevelopmentBank.
Theviewsexpiesseuinthisbookaiethoseoftheauthoisanuuonotnecessaiilyieflecttheviewsanupoliciesofthe
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Contents
iii
Boxes, Figures, and Tables iv
Foreword vii
Preface viii
Acknowledgments ix
Abbreviations and Acronyms x
Symbols and Measures x
Executive Summary xi
1. Introduction 1
2. Key drivers of the PRC’s economic performance in recent decades 4
2.1. Naiket-oiienteuiefoim 4
2.2. Low-costauvantage 4
2.S. Theioleofthegoveinment 6
2.4. 0theisuccessfactois 6
3. The middle-income trap and policy lessons 9
S.1. Befiningthemiuule-incometiap 9
S.2. Bowtoavoiuthetiap:Policylessons 11
4. Sustaining the PRC’s long-term growth: Challenges and risks 15
4.1. Laigepiouuctivityanutechnologygaps 1S
4.2. Risingwages 21
4.S. Imbalancesinthesouicesofgiowth 2S
4.4. Risingincomeinequality S2
4.S. Natuialiesouiceanuenviionmentalconstiaints S6
4.6. Challengingexteinaleconomicenviionment 4S
5. How the PRC can avoid the middle-income trap: Policy options 47
S.1. Steppingupinnovationanuupgiauing 48
S.2. Beepeningstiuctuialiefoim S1
S.S. Expanuingseivicesanuscalingupuibanization S9
S.4. Reuucingincomeinequalitytomakegiowthmoieinclusive 6u
S.S. Piomotinggieengiowthtoconseiveiesouicesanupiotecttheenviionment 62
S.6. Naintainingmacioeconomicanufinancialstability 62
S.7. Stiengtheninginteinationalanuiegionaleconomiccoopeiation 6S
6. The long-term outlook of the PRC economy 65
Background Papers 68
References 69
|Contents
iv
Boxes, Figures, and Tables
BoxS.1 Bowtouesigninuustiialpolicy 1S
Box4.1 Calculatingpiouuctsophisticationinexpoitsanuimpoits 2u
BoxS.1 PeifoimanceofPRCfiimsbyowneiship S2
BoxS.2 PiioiitiesoffinancialsectoiiefoiminthePRC S4
BoxS.S RefoimingthePRC’speisonalincometaxsystem S7
Figuie1.1 AveiageannualuBPgiowth,selecteueconomies,198u–2u11 1
Figuie1.2 ContiibutionofthePRCtoglobalgiowth,2uu7–2u11 2
Figuie2.1 ShaieofglobalexpoitsanuFBI,selecteueconomies,198u–2u1u S
Figuie2.2 Inuexofhouilymanufactuiinglaboicompensationcosts,selecteueconomies,2u1u S
Figuie2.S Annualaveiageiealinteiestiates(lenuing),selecteueconomies,199u–2u1u 6
Figuie2.4 PRC:Infiastiuctuieuevelopment,198u–2u11 8
Figuie2.S Aveiageannualinflationiates,selecteueconomies,1987–2u11 8
FiguieS.1 Niuule-incometiap:SelecteuAsiananuLatinAmeiicaneconomies,196u–2u1u 9
FiguieS.2 Thepathtohighincome 11
Figuie4.1 Shaieofglobalhigh-techexpoits,top1ueconomies,2uu9 1S
Figuie4.2 ulobalcompetitivenessinuex,top4Seconomies,2u11–2u12 16
Figuie4.S PRC:Topfiveinuustiialsubsectois,199S–2u1u 17
Figuie4.4 Shaieofglobalmanufactuieuexpoits,top2ueconomies,2u1u 17
Figuie4.S Inuustiiallaboipiouuctivity,selecteueconomies,2uuu–2uu9 18
Figuie4.6 Aggiegatetotalfactoipiouuctivitygiowth,selecteueconomies,198u–2uu9 18
Figuie4.7 PRC:Shaieofpiocessingtiaueinhigh-techexpoits,199S–2uu8 19
Figuie4.8 Nanufactuieisineachcountiy’stop2ufiimslisteuinFoituneulobalSuu,2u1u 21
Figuie4.9 PRC:Realwageanulaboipiouuctivitygiowth,199S–2u1u 22
Figuie4.1u PRC:uiowthofiealminimumwagesincoastalpiovinces,2uuS–2u11 2S
Figuie ͶǤͳͳ Ratio of population ageu η͸ͷ to population ageu ͳͷȂ͸Ͷǡ selecteu economiesǡ ͳͻͷͲȂʹͲͷͲ ʹͷ
Figuie4.12 PRC:Woiking-agepopulation,ageu1S–64,198u–2uSu 2S
Figuie4.1S PRC:ShaieinuBP,uemanucomponents,199u–2u11 26
Figuie4.14 PRC:ContiibutiontouBPgiowth,uemanucomponents,198u–2u11 26
Figuie4.1S InvestmentshaieinuBP,selecteuAsianeconomies 27
Figuie4.16 PRC:Consumption,laboiincome,savingsanuinvestment,199Sanu2uu9 27
Figuie4.17 NetexpoitsshaieinuBP,selecteuAsianeconomies 29
Figuie4.18 uiowthslowuownuuiingtheiecentglobaleconomicciisis,
selecteuAsianeconomies,2uuS–2u11 29
Figuie4.19 SeivicesectoishaieinuBP,bycountiygiouping,2uuuanu2u1u Su
Contents|
v
Figuie4.2u Employmentinseivices,selecteueconomies,2u11 Su
Figuie4.21 PRC:Levelsoflaboipiouuctivitybysectoi,199u–2u1u S1
Figuie4.22 Incomeinequality,selecteueconomies,latestavailable S2
Figuie4.2S PRC:0ibananuiuialinequality,199u–2uu8 SS
Figuie4.24 Shaieofinequalityielateutoeuucationalattainment,selecteueconomies SS
Figuie4.2S Contiibutionofspatialinequality,selecteueconomies,late2uuus S4
Figuie4.26 PRC:Shaiesofinequalityaccounteufoibyuiban¡iuialincomegapsanu
intei-piovincialuispaiities,199u–2uu8 SS
Figuie4.27 PRC:Socialpiotectioncoveiagebyuibananumigiantwoikeis,2uu9 SS
Figuie4.28 Peicapitawateiiesouiceavailability,selecteueconomies,2u1u S6
Figuie4.29 PRC:Wastewateiuischaiges,1991–2u1u S7
Figuie4.Su PRC:Wateiuseefficiency,2uuu–2uu9 S7
Figuie4.S1 Inteinationalcompaiisonofwateiuseintensity,2uu9 S8
Figuie4.S2 PRC:Totalpiimaiyeneigyconsumption,198u–2u1u S9
Figuie4.SS Peicapitaeneigyconsumption,selecteueconomies,198u–2uu9 S9
Figuie4.S4 PRC:Piimaiyeneigyuemanupiojectionbyscenaiio 4u
Figuie4.SS AiipollutioniankingbyPN1u,selecteueconomies,2uu9 41
Figuie4.S6 uieenhousegasemissions,2uuS 42
Figuie4.S7 PRC:Eneigy-ielateuC0
2
emissionbyscenaiio,2uuS–2uSS 4S
Figuie4.S8 PRC:Compositionoftotalpiimaiyeneigyconsumptionin2uSSunueiIEAscenaiio 4S
Figuie4.S9 uiowthiatesanupiojectionsfoimajoiinuustiializeueconomies,2uuu–2u1S 4S
Figuie4.4u Top8taigeteconomiesfoiuisciiminatoiymeasuies,2uu8–2u1u 46
Figuie4.41 CNY–0Suollaiexchangeiateinuex,2uuu–2u12 46
FiguieS.1 Rankingineaseofuoingbusiness,selecteueconomies,2u11 49
FiguieS.2 R&Bexpenuituie,selecteueconomies,2uuuanu2uu8 Su
FiguieS.S CentialgoveinmentievenuesasashaieofuBP,selecteueconomies,2u11 S6
FiguieS.4 0ibanizationiateanupeicapitaincome,selecteueconomies,2u1u 61
FiguieS.S PublicuebtasshaieofuBP,selecteueconomies,2u1u 6S
Figuie6.1 Shaieofglobalgiossuomesticpiouuct,2uSu 67
FiguieB4.1-1 PRC:Expoitanuimpoitsophistication,1998–2uu9 2u
FiguieBS.1-1 Rateofietuinonassetsbyfiimowneiship,1998–2u1u S2
FiguieBS.S-1 Toppeisonalincometaxiateanupeisonalincometax,
selecteueconomies,2uu9oilatestavailable S7
FiguieBS.S-2 Toppeisonalincometaxiatethiesholu,selecteueconomies,latestavailable S8
Table1.1 PRC:Peicapitaincomeanuhumanuevelopmentinuicatois,198u–2u11 2
Table2.1 Savingsiate,selecteueconomies,2uu8–2uu9 7
TableS.1 Bigh-anumiuule-incomecountiygioups 1u
Table4.1 PRC:Shaieofuomesticvalueauueuinexpoitsbyfiimowneiship,2uu6 19
Table4.2 Patentgiants,2u1u 21
Table4.S PRC:Laboieainings,uibananuiuial,2uuuanu2uu9 2S
Table4.4 PRC:0ibananuiuiallaboifoiceanumigiation,millions,2uuS–2u2u 24
|Contents
vi
Table4.S Seivicesshaiesintotalvalueauueu,selecteueconomies,2u1u S1
Table4.6 PRC:Piojectionsofwateiuemanuin2uSu S8
Table4.7 PRC:Estimatesofinciementalinvestmentiequiieufoigieentiansition,selecteustuuies 44
TableS.1 Compaiativepeifoimanceonhumancapitalattainment,selecteueconomies,vaiiousyeais S1
Table6.1 PRC:uBPgiowthpiojections,2u1u–2uSu 66
Table6.2 PRC:PiojectionsofpeicapitauBP,poveity,miuule-classsize,anusectoishaies,
2u2uanu2uSu 66
Table6.S uBPgiowth,selecteuAsianeconomies,196u–2u1u 67
TableBS.S-1 Compositionofselecteufiscalievenuesouices,PRCanuselecteueconomies S7
Foreword
S
ome 2u yeais ago, we began iefeiiing to the iapiu uevelopment of a small gioup of economies as the
“Asianmiiacle.”Whattheseeconomieshauincommonweienotonlyveiyhighiatesofsustaineugiowth,
but unueipinning that giowth, iapiu incieases in laboi piouuctivity anu the impoit, auoption, use anu
uevelopmentoftechnologicallysophisticateupiocessesfoigeneiatinghigh-valuegoousanuseivices.These
economies—BongKong,China;}apan;theRepublicofKoiea;Singapoie;anuTaipei,China—moveutoglobal
stanuaiusanuuiusowhilemaintainingmacioeconomic,politicalanusocialstability,anugeneiatinguecent,
higheiwageemploymentfoitheiipeople.Incontiast,inLatinAmeiicatheexpeiiencesincethe197ushas
been veiy uiffeient. Nacioeconomic, fiscal anu financial imbalances, combineu with high inequality,
significantly constiaineu innovation, giowth, anu impiovements in social welfaie. Nany economies in that
iegionhaveiemaineuinthemiuule-incomestageofuevelopmentfoiuecauesanuhavebecomemiieuinwhat
isnowcommonlyknownas“themiuule-incometiap.”
The economic piogiess of the Chinese economy since the iefoim piocess began in the late 197us can
no uoubt also be labeleu a “miiacle.” Thiee uecaues of 1u% annual giowth is a miiacle by any uefinition.
We might also say, howevei, that it is a miiacle-in-piogiess. The People’s Republic of China (PRC) iemains
a miuule-income countiy, its piouuctivity gaps with auvanceu countiies iemain wiue, anu technological
capabilitiesaieevolving.Inauuition,thepatteinofuevelopmenthasgeneiateusignificantimbalances,along
with high inequality. Bow the PRC can continue its iobust giowth, iesolve these pioblems, anu avoiu the
miuule-income tiap of slowing technological piogiess, amiu iising wages, is the cential question that this
timelystuuyseekstoauuiess.
This iepoit is the iesult of close collaboiation between the Economics anu Reseaich Bepaitment of the
AsianBevelopmentBankanutheChinaCenteifoiEconomicReseaich(CCER)atPeking0niveisity.Biinging
the expeitise fiom the two oiganizations togethei, along with othei expeits at institutions in the PRC anu
globally, has geneiateu much inteiesting anu thought-piovoking analysis. It has iesulteu in this concise,
uistilleu synthesis iepoit of ieseaich, thinking anu iueas about the challenges facing the PRC anu policy
options it may consiuei. It is my hope that the issues iaiseu anu policy options pioposeu will stimulate
fuithei uebate anu piomote policy innovations that can assist the PRC in chaiting a couise foi fuithei
piogiessnowanuintheyeaisaheau.
ChangyongRhee
ChiefEconomist
AsianBevelopmentBank
vii
T
he Chinese economy is not easy to ueciphei, with its complex mix of maiket activity anu
goveinmentcontiol,uevelopeucoastalcitiesanubackwaiuinteiioiaieas,woiluclasstechnologyinsome
inuustiiesanuloweilevelpiouuctivityinmanyotheis.Thismixisnououbtuuetothefactthattheeconomy
continues to unueigo a iapiu tiansfoimation fiom tiauitional to mouein, fiom iuial to uiban, fiom plan to
maiket,anufiomuomestictoglobal.
As challenging as it is to unueistanu the cuiient economy, even moie challenging—anu inteiesting—is the
natuieoftheChinesegiowthpiocess.Intheieseaichfoithisiepoit,wesoughttounueistanuthebasisfoi
thepastsuccessofthePeople’sRepublicofChina(PRC)anuthenquestioneuwhetheithesamefactoiswill
continuetobethebasisfoisuccessintheyeaisanuuecauesaheau.PastsuccessinthePRChasbeenuuetoa
confluenceoffactois,incluuingalow-costauvantageespeciallyinlaboithathasfueleuexpoitsanuuomestic
as well as foieign investment. Bowevei, this cost auvantage is eiouing anu is likely to contiibute much less
tocompetitivenessinthefutuie.Insteau,tosustaingiowththioughanubeyonuthe(uppei)miuule-income
phase,thePRCwillneeutoielymoieonpiouuctivityimpiovementsthioughinnovationanuupgiauing.The
tiansition“fiomlowcosttohighvalue”isakeyimpeiativefoitheeconomy.
WhatmakesthistiansitionpaiticulailychallengingisthefactthatthePRC’siefoimpiocessisstillfaifiom
complete,anu,compounueubyiapiugiowthinthepastSuecaues,thishasgeneiateusignificanteconomic
imbalances, coupleu with iising inequality. These ueep issues aie becoming moie appaient anu coulu stifle
economic piogiess in the yeais aheau. The Chinese giowth machine has also cieateu piessuies on eneigy,
wateiiesouicesanutheenviionmentthatiequiieattention.
Wehaveattempteutoweavethesevaiiousfactois,tienusanuissuesintowhatwehopeisacompellinglook
atthePRCanuitspiospectsfoithefutuie.
}uzhongZhuang
BeputyChiefEconomist,EconomicsanuReseaichBepaitment,ABB
Paulvanuenbeig
SenioiEconomist,EconomicsanuReseaichBepaitment,ABB
YipingBuang
Piofessoi,ChinaCenteifoiEconomicReseaich,NationalSchoolofBevelopment,Peking0niveisity,PRC
viii
Preface
ix
Acknowledgments
T
hisiepoitispaitofastuuyonSustaininganuRebalancinguiowthinthePeople’sRepublicofChinafunueu
unueitheAsianBevelopmentBank’sTechnicalAssistance7S14foiEstablishingulobalReseaichAlliances.
Theiepoitwoulunothavebeenpossiblewithoutthecontiibutionsofaiangeofscholaisanuexpeits.Theauthois
wishtothankthemfoicontiibutingbackgiounustuuies,paiticipatinginwoikshops,anuoffeiingsuggestionson
vaiiousuiafts.
Betaileu backgiounu stuuies weie pioviueu by scholais at Peking 0niveisity, incluuing Xiaoyan Shiiley Lei,
Lixing Li, uuixia uuo, Yiping Buang, Feng Lu, Bo-Nou Wu, }ianguo Xu, Yang Yao, Niaojie Yu, Chuanchuan
Zhang,anuYaohuiZhao.ScholaisfiomtheChineseAcauemyofSocialSciences,FangCaianuNeiyanWang,
fiom the People’s Bank of China, Zhong Xu, anu fiom the Institute foi Fiscal Science Reseaich, }ia Kang
anu }unmin Liu, contiibuteu thematic papeis. Inteinational scholais who pioviueu stuuies on the Chinese
economy oi on countiies that have faceu similai challenges incluue: Loien Bianut, Noia Lustig, }aime Ros,
Ligang Song, anu Wing Thye Woo. ABB staff who contiibuteu stuuies incluue: }ingmin Buang, Yi }iang,
BonghyunPaik,SuphacholSuphachalasai,Paulvanuenbeig,uuanghuaWan,anu}uzhongZhuang.
We also wish to thank the expeits who paiticipateu in two woikshops in Beijing wheie iueas anu uiaft
papeis weie piesenteu anu uiscusseu. They incluue: Athai Bussain, Naiia Socoiio Bautista, Biswa Nath
Bhattachaiyay,YangBu,NichaelBan,BonBanna,BongBe,}ianwuBe,LipingBe,PaulBeytens,BayuanBu,
Nicholas Laiuy, }ong-Wha Lee, Shantong Li, Xin Li, Tun Lin, Ninquan Liu, Yolanua Feinanuez Lommen, Nai
Lu,NingLu,BonghyunPaik,BwightPeikins,YanShen,ByunSon,NinTang,uengXiao,PingYan,LinuaYueh,
FanZhai,BinZhang,LiqingZhang,LingZhu,anu}iZou.
Invaluable comments weie ieceiveu on uiafts fiom ABB’s East Asia Bepaitment anu we woulu like to
thank Klaus ueihaeussei, Bamiu Shaiif, Robeit Wihtol, anu Qian Ying foi theii suppoit anu coopeiation.
In paiticulai, we wish to thank Yolanua Feinanuez Lommen anu hei team in the Economics 0nit at ABB’s
Resiuent Nission in the PRC foi contiibutions thiough the unit’s ongoing economic analysis anu policy
woikanufoiieviewinguiafts.WeaiealsogiatefulfoiinsightfulcommentsfiomXianbinYaoofthePacific
Bepaitment, Lei Lei Song of the 0ffice of Regional Economic Integiation, anu }un Tian of the Regional anu
Sustainable Bevelopment Bepaitment on eailiei uiafts. Thanks also go to }esus Felipe anu Iiis Claus of
the Economics anu Reseaich Bepaitment foi theii contiibutions on expoit anu impoit sophistication in
Section 4 anu on tax iefoim in Section S, iespectively. Suppoit fiom Fan Zhai anu Wen }ianwu in moueling
stiuctuial change anu Bamaiis Yaicia foi caiiying out long-teim giowth piojections iepoiteu in Section 6
isalsogiatefullyacknowleugeu.TheiepoitwaseuiteubyuuySaceiuoti.Theuesign,layout,anutypesetting
weie caiiieu out by }oe Naik uanaban. Reseaich assistance at ABB heauquaiteis was pioviueu by Anneli
Lagman-Naitin,LilibethPoot,anuEmmanuelSanAnuies.
Finally,wewoululiketothank}ong-WhaLee,thefoimeiChiefEconomistofABB,foiinitiatingthisstuuy,anu
theInteinationalBepaitmentoftheNinistiyofFinanceofPRCanutheChinaCenteifoiEconomicReseaich
oftheNationalSchoolofBevelopmentatPeking0niveisityfoitheiisuppoitthioughoutthestuuy.
x
Abbreviations and Acronyms
ABB AsianBevelopmentBank
BA0 business-as-usual
E0 Euiopean0nion
FBI foieignuiiectinvestment
uBP giossuomesticpiouuct
uNI giossnationalincome
IEA InteinationalEneigyAgency
LaoPBR LaoPeople’sBemociaticRepublic
NSNE micio-,small-,anumeuium-sizeuenteipiise
NBS NationalBuieauofStatistics
0ECB 0iganisationfoiEconomicCo-opeiationanuBevelopment
PRC People’sRepublicofChina
PPN paitspeimillion
PPP puichasingpoweipaiity
R&B ieseaichanuuevelopment
S0E state-owneuenteipiise
TFP totalfactoipiouuctivity
0K 0niteuKinguom
0S 0niteuStates
Symbols and Measures
$ 0niteuStatesuollai
CNY Chineseyuan
utC0
2
gigatonofcaibonuioxiue
Ntoe milliontonsofoilequivalent
toe tonofoilequivalent
Chapteititle|
Key drivers of the PRC’s economic performance in recent decades
E
conomicperformanceintbePeople’sRepublicofCbina{PRC]basbeenspectacularovertbelast
3decades.uBPgiowthhasaveiageuabout1u%peiyeaianupeicapitaincomeincieaseubyafactoiof
1S.Rapiugiowthhasleutosignificantimpiovementinhumanwellbeinganuthequalityoflife.Fiomtheeaily
198ustolate2uuus,theinciuenceofpoveityat$1.2S-a-uayueclineufiom8S%toabout1S%,lifeexpectancy
at biith incieaseu fiom 67 to 7S yeais, anu chilu moitality unuei the age of S yeais ueclineu fiom 6S to
18ueathspei1,uuu.Economicexpansionhasalsoleutoashaipiiseinthecountiy’sinfluenceontheglobal
economy.ThePRCisnowthewoilu’slaigestexpoiteianutheseconulaigesteconomy.
Tbissuccesscanbeattributedtotbreeheydrivers—marhet-orientedreform,low-costadvantage,and
tbe role of government—along witb otber supporting factors. Naiket-oiienteu iefoim has unleasheu
poweiful economic incentives anu impioveu the efficiency of iesouice allocation anu utilization. The
libeializationoffoieigntiaueanuinvestmenthasgivenPRCfiimsaccesstotheglobalmaiket,exteinalcapital,
auvanceu technologies anu management know-how. The economy’s low-cost auvantage, uue laigely to a vast
pool of suiplus iuial laboi, has maue the manufactuiing sectoi globally competitive. The goveinment’s active
iole in uevelopment has helpeu auuiess pioblems often associateu with maiket failuie—such as infoimation
anu cooiuination exteinalities typical of stiuctuial tiansfoimation in ueveloping countiies. 0thei suppoiting
factoisincluuehighsavingsanuinvestment,majoiimpiovementsininfiastiuctuie,ayounganueuucateulaboi
foiceanutheassociateuuemogiaphicuiviuenu,anumacioeconomicanusocialstability.
Tbe PRC’s impressive acbievements, bowever, sbould not mahe one lose sigbt of tbe ma|or
cballenges it faces. With a pei capita gioss national income (uNI) of $4,9Su in 2u11, the PRC has just
passeuthethiesholuofuppei-miuule-incomestatusanuitstillhasalongwaytogobefoiebecomingahigh-
income countiy. But with iising wages anu population aging, giowth will have to be incieasingly uiiven by
piouuctivityimpiovementthioughinnovationanuinuustiialupgiauing—thePRCneeustomovefiomalow-
costtoahigh-valueeconomy.Noieovei,iapiugiowthhasexposeuseveialstiuctuialpioblems,inpaiticulai,
economic imbalances, iising inequality, iesouice constiaints, anu enviionmental uegiauation. To some
extenttheseaieoftenassociateuwithiapiustiuctuialtiansfoimation,butincompleteiefoimisalsoamajoi
contiibutingfactoi.Ifnotauuiesseu,thesepioblemscouluhinueiPRC’seffoitsinmovingtowaiuahigh-value
economyanuincieasetheiiskofgettingcaughtinwhatisincieasinglyknownasthe“miuule-incometiap.”
xi
Executive Summary
|ExecutiveSummaiy
Middle-income trap and lessons from international experience
Many countries experience a growtb slowdown after acbieving middle-income status. Some 18 countiies
globally have been “miuule income” foi the past Su yeais, incluuing 12 in Latin Ameiica anu thiee in Asia—
Nalaysia, the Philippines, anu Thailanu. At theii cuiient pace of giowth, many will iemain tiappeu foi yeais to
come. 0n the othei hanu, 14 economies have escapeu the tiap since 196S, incluuing five in Asia—Bong Kong,
China; }apan; the Republic of Koiea; Singapoie; anu Taipei,China. These Asian economies completeu the
tiansitionfiomlowtohighincomewithinSto4uecaues.
Avoiding tbe middle-income trap requires continuous industrial upgrading tbrougb innovation
and moving from a low-cost to a bigb-value economy. Low-income countiies possess a laige pool of
suipluslaboithatlimitswageincieaseswhenuibaninuustiialanuseivicesectoisexpanu.Fiimsemploy
low-level,establisheutechnologiesthataieeasilyimpoiteuanumasteieulocally,anucompeteonlowcost.
0ponieachingmiuuleincome,thepoolofsuipluslaboishiinksanu—asitappioachestheLewistuining
point—wages iise iapiuly. Countiies must upgiaue inuustiy anu seivices thiough innovation to impiove
laboi piouuctivity—moving fiom a low-cost to a high-value economy. If they fail to uo so, the economy
becomestiappeu:nolongeiabletocompetewithlow-incomecountiiesbutunabletocompetewithhigh-
incomecountiies.
Movingfromalow-costtoabigb-valueeconomyrequiresacriticalmassoffirmswitbstrongincentives
for innovation. It also requires tbe government to create a conducive environment. This enviionment
shoulu have the following key elements: (i) macioeconomic, political, anu social stability; (ii) auequate
public investment in infiastiuctuie anu human capital; (iii) a well-functioning maiket system that
pioviues piice signals, encouiages competition, piotects investois, anu piomotes tiaue; anu (iv) a well
uesigneuinuustiialpolicy.TheEastAsiamiiacleeconomiespossesseumostofthesechaiacteiisticsuuiing
theii take-off peiious. Conveisely, macioeconomic instability, uebt ciisis, high-income inequality, social
tension, anu political instability causeu many Latin Ameiican countiies to iemain caught in the miuule-
incometiap.
Sustaining the PRC’s long-term growth: Challenges and risks
ThePRCfacesthefollowingciiticalchallenges—which,ifnotauuiesseueffectively—couluhampeiitslong-
teimgiowthanuincieasetheiiskofgettingcaughtinthemiuule-incometiap.
Large tecbnology and productivity gaps witb advanced countries. Bespite significant auvances ovei
the past S uecaues, the PRC’s piouuctivity anu technology gaps with auvanceu countiies iemain laige. In
2uu9, its inuustiial laboi piouuctivity was about 1u% of the level of the 0niteu States. Although the PRC is
the woilu’s laigest high-tech expoitei, a veiy high piopoition of these piouucts aie piocesseu—with low
uomestic value auueu. While it is consiueieu the woilu’s factoiy, the PRC is laigely an assemblei with few
inteinationallyknownbianus.Innovationanuinuustiialupgiauingiequiieaciiticalmassofpiouuctiveanu
innovativeenteipiises.Bowevei,itspiivateenteipiises,althoughgiowingstiongly,iemainsmallinsizewith
limiteu innovation iesouices. In contiast, state-owneu enteipiises (S0Es) aie fai laigei with access to moie
innovativeiesouices—buttheyaielessefficientanuhaveweakeiincentivestoauvance.
xii
ExecutiveSummaiy|
Rising wages. The PRC’s low-cost auvantage is likely to eioue giauually in the coming yeais. Real wage
giowthintheinuustiialsectoinowexceeuslaboipiouuctivitygainsanutheieaielaboishoitagesincoastal
aieas in iecent yeais. Nany believe the PRC is appioaching the so-calleu “Lewis tuining point”, in which a
ueclineiniuialsuipluslaboileaustotighteninglaboimaiketsanuiisingwages—apiocessthatmayoccui
ovei a uecaue oi so. Laboi supply will also be affecteu by population aging anu an enu to the uemogiaphic
uiviuenu. Rising laboi costs mean the PRC’s giowth neeus to be uiiven incieasingly by piouuctivity
impiovementsthioughinnovationanuupgiauing—movingfiomalow-costtoahigh-valueeconomy.
Imbalances in tbe sources of growtb. 0n the uemanu siue, giowth has ielieu too much on investment
anunetexpoits,withpiivateconsumptionweak—in2uu9,thelatteicompiiseujustSS%ofgiossuomestic
piouuct(uBP).0nthesupplysiue,seivicesiemainunueiuevelopeuatabout4S%ofuBP—compaieuwith
an aveiage of 48% foi lowei-miuule-income countiies, 6u% foi uppei-miuule-income countiies, anu ovei
7u% foi high-income countiies. Imbalances aie often associateu with iapiu stiuctuial tiansfoimation.
But in the PRC, incomplete iefoim is also a majoi contiibuting factoi. 0vei-ieliance on net expoits makes
the economy vulneiable to exteinal fluctuations anu shocks, especially in the face of weak uemanu fiom
auvanceu maikets. 0vei-investment coulu leau to pooi asset quality, which in tuin coulu unueimine the
peifoimanceofbanksanuthestabilityofthefinancialsystem.
Risingincomeinequality.ThePRC’siapiugiowthhasbeenaccompanieubyiisingincomeinequality.The
uinicoefficientofpeicapitaconsumptionexpenuituieincieaseufiomaboutSuintheeaily198usto4S.4in
2uu8,whichisamongthehighestinAsia.Technicalpiogiess,globalizationanumaiket-oiienteuiefoimaie
amongthekeyuiiveisofPRC’siapiugiowth,buttheyhavealsohausignificantuistiibutionalconsequences,
incluuingaiisingskillspiemium,fallinglaboiincomeshaie,anugiowingspatialinequality.0nequalaccess
to oppoitunity—uue to weaknesses in goveinance—is also a majoi contiibuting factoi. Bigh inequality can
ietaiu giowth as low-income householus contiibute little to effective uemanu anu aie unable to invest in
theiihumancapitalthioughimpioveuhealthanueuucation.Beyonuuiiecteconomiceffects,inequalityhas
thepotentialtogeneiatesocialuniest,whichcanueiailthegiowthpiocess.
Resource constraints and environmental degradation. The PRC’s iapiu giowth has cieateu significant
piessuie on its natuial iesouices anu the enviionment. Rising uemanu anu pollution aie leauing to watei
shoitages, piojecteu to ieach 1u% of watei iequiiements by 2uSu if nothing is uone. Piimaiy eneigy
consumption coulu uouble in 2S yeais anu oil impoit uepenuence coulu ieach 8S%, making the PRC
vulneiabletoexteinalshocksifitcontinuesitscuiienteneigyusepattein.Thus,eneigysupplyanusecuiity
coulu also constiain the countiy’s futuie giowth. Fuitheimoie, the PRC’s coal-baseu eneigy system is
uamagingthelocalenviionmentanucontiibutingtoglobalwaiminganuclimatechange.
Acballengingexternaleconomicenvironment.Asthewoilu’sseconulaigesteconomy,thePRCexeitsan
incieasinglylaigeimpactonmanyofitskeytiauingpaitneisanuthewoilueconomyingeneial.Authoiities
neeu to consiuei these impacts when ueciuing on economic policy to help cieate a stable anu haimonious
exteinal economic enviionment. In paiticulai, the PRC will continue to face the following issues, among
otheis: (i) with the cuiient slow pace of global iecoveiy anu the ongoing euiozone uebt ciisis, exteinal
uemanu may be unable to contiibute to giowth as much as in the past; (ii) the PRC’s tiaue balance with its
tiauing paitneis will continue to geneiate tension; (iii) piessuie on the PRC to ieuuce its caibon uioxiue
emissionswillonlyintensify;anu(iv)callstouomoietopiotectintellectualpiopeityiightswillcontinue.
xiii
Policy options to avoid the middle-income trap
Toavoidtbemiddle-incometrap,tbePRCneedsadevelopmentstrategytbatallowsittogrowbeyond
low-cost advantage and move from a low-cost to a bigb-value economy. This stiategy shoulu incluue
the following agenua: (i) stepping up innovation anu inuustiial upgiauing by stiengthening enteipiise
incentives foi innovation, builuing an enviionment conuucive foi innovation, investing in human capital,
anu moving towaiu a knowleuge-baseu economy; (ii) ueepening stiuctuial iefoim, in paiticulai iefoims of
enteipiises,laboianulanumaikets,thefinancialsectoi,anuthefiscalsystem;(iii)uevelopingseivicesanu
scaling up uibanization; (iv) ieuucing income inequality to make giowth moie inclusive; (v) maintaining
macioeconomic anu financial stability; (vi) piomoting gieen giowth to conseive iesouices anu piotect the
enviionment;anu(vii)stiengtheninginteinationalanuiegionaleconomiccoopeiation.
Stepping up innovation and industrial upgrading. Selecteu policy measuies incluue (i) stiengthening
enteipiise incentives foi innovation thiough ueepening enteipiise iefoim anu piomoting maiket
competition; (ii) establishing¡impioving institutions neeueu foi a well-functioning maiket economy;
(iii) stiengthening the piotection of intellectual piopeity iights; (iv) stepping up public suppoit foi basic
science anu technology ieseaich; (v) incieasing public spenuing on euucation to naiiow the gaps with
auvanceu anu uppei-miuule-income countiies incluuing those in teitiaiy euucation; (vi) expanuing
vocational anu technical euucation to impiove the quality of the laboi foice; anu (vii) ueveloping anu
implementingasounustiategyfoimovingtowaiuaknowleuge-baseueconomy.
Deepeningstructuralreform.Thisiequiiesfuitheistepsiniefoimingenteipiises,laboianulanumaikets,
thefinancialsectoi,anuthefiscalsystem.
Ȉ Enterprise reform.Selecteupolicymeasuiesincluue(i)fuitheiuevelopingthepiivatesectoianuensuiing
piivate fiims anu S0Es compete on an equal basis; (ii) stiengthening coipoiate goveinance of S0Es,
incluuing moving towaiu a system wheie the aim’s length contiol by the goveinment is suppoiteu by
iobust auuiting, monitoiing, anu peifoimance evaluation; anu (iii) stiengthening maiket iegulation of
natuialmonopoliesincluuingsettingupspecialbouiestoiegulatepiicinganuseivicequality.
Ȉ Labor market reform.Selecteupolicymeasuiesincluue(i)iefoimingthehukuosystemtoieuucebaiiieis
tolaboimobilityespeciallyfiomiuialaieasanutheagiicultuiesectoitouibanaieasanunonagiicultuie
sectois;anu(ii)uevelopinganuexpanuingthecoveiageoflaboimaiketinstitutions,suchasemployment
piotection legislation, minimum wages, collective baigaining, anu unemployment insuiance, while
ensuiingapiopeibalancebetweenemploymentsecuiityanulaboimaiketflexibility.
Ȉ Financial sector reform. Selecteu policy measuies incluue (i) making the financial sectoi moie maiket-
baseu by allowing uemanu anu supply to play a gieatei iole in ueteimining inteiest iates, opening up
to piivate sectoi paiticipation, anu making state-owneu banks tiuly commeicial entities; (ii) enhancing
financial safety by stiengthening iegulation anu supeivision anu ueveloping an effective financial safety
net, incluuing mechanisms foi uebt iesolution anu ueposit insuiance; (iii) ueveloping capital maikets,
incluuing inteibank lenuing, coipoiate bonus, equities, contiactual savings, anu financial futuies anu
ueiivatives;(iv)bioaueningaccesstofinance,especiallyfoimicio-,small-anumeuium-sizeuenteipiises
anuiuialhouseholus;(v)makingtheexchangeiatemoieflexible;anu(vi)cieatingconuitionsfoigieatei
capitalaccountlibeialization.
|ExecutiveSummaiy
xiv
Ȉ Land market reform. Selecteu policy measuies incluue (i) ueveloping the iuial lanu maiket by
stiengthening anu claiifying the legal fiamewoik anu ueveloping maiket institutions anu seivices, such
as suiveyois anu valuation, biokeiage, lanu exchanges, anu mechanisms foi uispute iesolution; anu
(ii)makinglanuacquisitionfoiuibanusefaiieianumoietianspaient,topiotecttheinteiestsoftheiuial
populationwithoutconstiaininguibanuevelopment.
Ȉ Fiscal reform. Selecteu policy measuies incluue (i) shifting the composition of fiscal spenuing moie
towaiu pioviuing public goous anu seivices, piomoting social equity, anu auuiessing maiket failuies;
(ii)stiengtheningievenuemobilizationbybiingingoff-buugetfunusintothebuuget,incieasingpeisonal
income taxes as a shaie of uBP, completing the value-auueu tax iefoim, iefoiming piopeity taxes,
stiengthening asset management of S0Es anu incieasing uiviuenu payment, iaising public awaieness
of tax payment iesponsibility, anu stiengthening tax law anu enfoicement to ieuuce tax evasion;
(iii) iefoiming inteigoveinmental fiscal ielations by bettei aligning expenuituie iesponsibilities anu
ievenue souices at vaiious levels of goveinment, incieasing the fiscal tianspaiency anu accountability
of local goveinments, anu enhancing the effectiveness of fiscal tiansfeis to lagging iegions; anu
(iv) stiengthening fiscal management by establishing a compiehensive buuget system to covei the
goveinmentbuuget,thestate-owneuassetbuuget,thesocialsecuiitybuuget,anuoff-buugetfunus.
Expanding services and scaling up urbanization. Selecteu policy measuies to expanu seivices incluue
(i)ieuucingentiyiestiictionsinseivicesanupiomotingcompetitionfiomthepiivatesectoi;(ii)piomoting
the uevelopment of high-value seivices such as finance, tianspoit anu logistics, maiketing, management
consulting, computing anu infoimation technology, accounting anu legal seivices, anu ieseaich anu
uevelopment (R&B); anu (iii) eliminating policy biases against seivices. Selecteu policy measuies to scale
up uibanization incluue (i) iefoiming the hukuo system, in paiticulai uelinking social seivices anu welfaie
entitlementsfiomthehukuo;(ii)impiovingthelegalsystemgoveiningtheacquisitionofiuiallanufoiuiban
uevelopment—to ensuie both social equity anu economic efficiency; (iii) impioving city auministiation,
incluuing aligning expenuituie anu ievenue iesponsibilities of local goveinments at all levels; anu
(iv)piomotinggieenanuinclusiveuibanization.
Reducing income inequality. Selecteu policy measuies incluue (i) ieuucing uiban¡iuial income gaps by
cieating moie uiban jobs, giving migiant woikeis equal entitlements to social seivices anu welfaie, anu
incieasing iuial incomes thiough investing in iuial infiastiuctuie, public seivices, anu agiicultuie R&B;
(ii) ieuucing iegional income gaps by continuing to implement the gieat westein uevelopment stiategy,
piomoting inuustiial migiation fiom coastal to inlanu piovinces, anu impioving the effectiveness of fiscal
tiansfeis to lagging iegions; (iii) incieasing goveinment spenuing on anu ensuiing equal access to public
seivices, incluuing establishing an integiateu social secuiity system; (iv) incieasing peisonal income taxes
as a shaie of uBP by bioauening the tax base anu making the tax system moie piogiessive, incluuing
measuies such as loweiing the income thiesholu at which the top tax iate is applieu anu moving towaiu a
systeminwhichtaxesaiecollecteuonthebasisofconsoliuateuincomes;anu(v)stiengtheninggoveinance,
eliminatingsocialexclusion,anupieventingcoiiuption.
Promoting green growtb. Selecteu policy measuies incluue (i) ieuucing the iesouice intensity of
giowth thiough stiuctuial tiansfoimation, inuustiial upgiauing, anu the uevelopment of seivices;
(ii) impioving iesouice allocation efficiency anu ieuucing waste thiough sounu piicing systems—foi
eneigy anu watei iesouices in paiticulai—anu stiong incentive mechanisms, incluuing fiscal anu tax
ExecutiveSummaiy|
xv
Outlook of the PRC economy in 2030
Implementing tbis strategy would greatly increase tbe lihelibood of sustained growtb and reacbing
bigb-incomestatusbefore2030. ScenaiioanalysisshowsthePRChasthepotentialtogiow8%annually
fiom2u1uto2u2uanu6%fiom2u2uto2uSu—ifitauuiessesitschallengeseffectively.0nueithisscenaiio,
iealuBPpeicapitain2u1uconstantpiiceswouluieach$16,Suuin2uSu.Anu—likeseveialofitsEastAsia
neighbois—thePRCwoulucompletethetiansitionfiomalow-incometoahigh-incomecountiyinlessthan
Suyeais.Itwillbecomethewoilu’slaigesteconomybythemiu-2u2usatmaiketexchangeiates.
measuies; (iii) stiengthening goveinment iegulation anu enfoicement to contiol anu ieuuce pollution,
incluuing intiouucing emission taxes; (iv) intiouucing emission peimit tiauing to ieuuce the cost of
emission ieuuction; (v) piomoting innovation anu investing in ienewable anu clean eneigy souices; anu
(vi)incieasingpublicawaienessoftheimpoitanceofgieengiowthanuenviionmentalpiotectiontoinuuce
behavioialanucultuialchange.
Maintaining macroeconomic and financial stability. Selecteu policy measuies incluue (i) stiengthening
iegulation anu supeivision of financial institutions anu maikets; (ii) caiefully managing financial sectoi
iefoim, in paiticulai capital account libeialization; (iii) ensuiing fiscal sustainability anu stability; anu
(iv) stiengthening fiscal management of local goveinments by ensuiing ievenues aie aligneu with
expenuituie neeus, uiawing off-buuget funus into buugetaiy management, anu establishing an effective
iepoiting,monitoiing,anusuiveillancesystem.
Strengtbening international and regional economic cooperation. Selecteu policy measuies incluue
(i) taking into account the effects of uomestic economic policies beyonu its boiueis in uecision making;
(ii) actively paiticipating in the uioup of Twenty (u2u), Asia-Pacific Economic Coopeiation (APEC),
Association of Southeast Asian Nations Plus Thiee Countiies (ASEAN+S), anu othei multilateial, iegional,
anu bilateial economic coopeiation anu policy cooiuination foiums; (iii) fuithei incieasing ieliance on
uomestic consumption as well as uemanu fiom emeiging maikets—both within anu outsiue Asia—as
souices of giowth thiough ueepei stiuctuial iefoim anu closei South–South economic coopeiation; anu
(iv)playinganactiveioleincontiibutingtoglobalpublicgoous,suchasauuiessingclimatechange.
ThisuevelopmentstiategywilltiltthebalanceofthePRCeconomyfiomlow-costtohigh-valuepiouuction;
fiom ielying on the goveinment to ielying on maikets; fiom investment to consumption; fiom exteinal to
uomestic uemanu; fiom giowth foi its own sake to both giowth anu uistiibution; anu fiom uevelopment
to both uevelopment anu enviionmental piotection. It will suppoit the PRC’s economic tiansfoimation
towaiuasocietythatistechnologicallymoieauvanceu,stiuctuiallymoiebalanceu,sociallymoieinclusive,
anu enviionmentally moie sustainable. Innovation and industrial upgrading, structural reform, expansion of
services, and urbanization will be the key drivers of this transformation and growth.
|ExecutiveSummaiy
xvi
GDP = gross domestic product, PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed 19 July 2012).
0
2
4
6
8
10
12
PRC India Malaysia Republic of Korea Brazil
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1980–1990 1990–2000 2000–2011
1. Introduction
E
conomic giowth in the People’s Republic of
China(PRC)hasbeenspectaculaisinceiefoims
began in the late 197us. Buiing 198u–2u11, gioss
uomesticpiouuct(uBP)expanueuatanaveiageiate
ofabout1u%peiyeai(Figuie1.1).Peicapitaincome
incieaseu by a factoi of 1S in constant 2uuS
puichasing powei paiity (PPP) uollais (Table 1.1).
Fiom a veiy pooi anu agiicultuie-baseu economy
Su yeais ago, the PRC has ieacheu uppei miuule-
income status with a laige inuustiial base, anu is
nowoftencalleuthe“woikshopofthewoilu.”
Rapiu giowth anu stiuctuial tiansfoimation have
significantly ieuuceu poveity, impioveu human
wellbeing,anucieateuauecentstanuaiuofliving.
Figure 1.1 AverageannualCDPgrowtb,selectedeconomies,1980–2011
When the iefoims began, 84% of the population
liveu below the inteinationally accepteu poveity
line of $1.2S pei peison pei uay (Table 1.1). By
2uu8, that piopoition hau fallen to 1S%—an
incieuible achievement. Longevity incieaseu
fiom 67 yeais in 198u to 7S yeais in 2u1u, anu
chilu moitality unuei the age of S yeais ueclineu
fiom 6S to 18 ueaths pei 1,uuu uuiing the same
peiiou. These impiessive achievements have been
emulateu by veiy few ueveloping economies, anu,
in iecent yeais, have become the envy of both
emeiginganuauvanceucountiies.
Rapiu economic expansion has also leu to a shaip
iiseinthecountiy’simpoitanceglobally.ThePRCis
1
|uiowingbeyonutheLow-CostAuvantage
now the woilu’s laigest expoitei, the laigest holuei
offoieignieseives,anutheseconulaigesteconomy
aftei the 0niteu States (0S). What happens in the
PRC matteis gieatly to the iest of the woilu. The
Nillennium Bevelopment uoal (NBu) of ieuucing
global poveity by half will be achieveu by 2u1S
laigely because of the PRC. The woilu economy
iecoveieu quickly fiom the 2uu8 global financial
ciisis because the PRC, Inuia, anu othei emeiging
economiesmanageutosustainuemanuanugiowth
(Figuie 1.2). The cuiient centuiy can inueeu
become an “Asian centuiy” only if the PRC—along
with Inuia—continues to make iapiu economic
piogiess (ABB 2u11a). The PRC’s influence on
global economic policy anu goveinance is also
giowingiapiulyanuwillcontinuetouoso.
1.4
1.1 1.1
1.3 1.2
4.0
1.7
–1.7
3.9
2.6
–4
–2
0
2
4
6
2007 2008 2009 2010 2011
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p
o
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s

PRC Rest of the world
PRC = People’s Republic of China.
Sources: ADB staff estimates using data from IMF, World Economic Outlook April 2012; and ADB, Asian Development Outlook 2012.
Figure 1.2 ContributionoftbePRCtoglobalgrowtb,2007–2011
Table 1.1 PRC:Percapitaincomeandbumandevelopmentindicators,1980–2011
1980 1985 1990 1995 2000 2005 2011
Per capita GNI, current $ 220 280 330 530 930 1,740 4,930
Per capita GNI, current PPP $ 250 500 800 1,480 2,340 4,090 8,430
Per capita GDP, 2005 PPP $, % increase from 1980 .. 55 110 253 409 685 1,313
Poverty headcount ratio at $1.25 a day (PPP), % of population 84
a
69
b
60 54 36
c
16 13
e
Poverty headcount ratio at $2 a day (PPP), % of population 98
a
93
b
85 74 61
c
37 30
e
Life expectancy at birth, years 67 68 70 70 71 72 73
f
Under 5 mortality rate, per 1,000 65 54 48 43 33 25 18
f
Gross secondary enrollment, % 52 38 38 52 62 73
d
81
f
Gross tertiary enrollment, % 1 2 3 5 8 19 26
f
a
1981 data.
b
1984 data.
c
1999 data.
d
2006 data.
e
2008 data.
f
2010 data.
GDP = gross domestic product, GNI = gross national income, PPP = purchasing power parity, PRC = People’s Republic of China.
Note: Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to
the level of education shown.
Source: World Bank, World Development Indicators Online (accessed July 2012).
The PRC’s impiessive achievement, howevei, shoulu
notmakeonelosesightofthemajoichallengesitfaces.
Ȉ Fiist,uespitesignificantgains,PRC’stechnological
anu piouuctivity gaps with auvanceu economies
iemain laige. With a pei capita gioss national
income (uNI) of $4,9Su in 2u11, it still has a
long way to go befoie becoming a high-income
countiy.
Ȉ Seconu, the countiy’s iapiu giowth in iecent
uecaues has benefiteu gieatly fiom its low-cost
auvantage, especially in laboi. Bowevei, with
ueclining iuial suiplus laboi anu iising wages,
giowth will have to be incieasingly uiiven by
piouuctivity impiovement thiough innovation
2
anu inuustiial upgiauing—the PRC neeus to
move fiom a low-cost to a high-value economy
whichismuchmoiechallenging.
Ȉ Thiiu, iapiu giowth has exposeu seveial
stiuctuialpioblemsintheeconomy,inpaiticulai,
imbalances in the souices of giowth anu iising
income inequality. While to some extent these
aie often associateu with iapiu stiuctuial
tiansfoimation, incomplete iefoim is a majoi
contiibuting factoi. If not auuiesseu, these
pioblems coulu hinuei the PRC’s effoits in
movingtowaiuahigh-valueeconomy.
Ȉ Fouith, iapiu giowth has also cieateu enoimous
piessuies on iesouices, such as eneigy anu
watei,anutheenviionment.
Because of these challenges, a question obseiveis
anu commentatois often ask is: Bow long can the
countiy’sstionggiowthcontinue1Withthecuiient
weak global economy anu slowuown in the PRC
giowth,thisquestionhasonlygaineuinielevance.
Inteinational expeiiences show that, in many
countiies, giowth sloweu significantly aftei they
attaineu miuule-income status. They finu they
weie caught in what is incieasingly known as the
“miuule-income tiap.” 0n one hanu, they coulu
no longei compete with low-income countiies
because of iising wages. 0n the othei, they weie
unable to compete with high-income countiies
because they have not shifteu into highei-value
piouuction thiough innovation anu inuustiial
upgiauing. Nany Latin Ameiican countiies anu
seveial Southeast Asian economies aie often
consiueieu caught in the miuule-income tiap—
they became miuule-income countiies some
4u–Su yeais ago anu aie likely to languish theie
foi many yeais to come. While the PRC giauuateu
fiom low- to miuule-income status only in 1998,
policy makeis aie incieasingly conceineu with the
uangeiofgettingcaughtinthetiap.
Chaptei1: Intiouuction|
Thisiepoitaiguesthat,toavoiuthemiuule-income
tiap,thePRCneeustotackleitsemeigingchallenges
effectively.Boingsoiequiiesauevelopmentstiategy
containingthefollowingkeyagenua:
Ȉ Steppingupinnovationanuinuustiialupgiauing;
Ȉ Beepeningstiuctuialiefoims,inpaiticulaiiefoims
ofenteipiises,factoimaikets,anuthefiscalsystem;
Ȉ Expanuingseivicesanuscalingupuibanization;
Ȉ Naintaining macioeconomic anu financial
stability;
Ȉ Reuucing income inequality to make giowth
moieinclusive;
Ȉ Piomoting gieen giowth to conseive iesouices
anupiotecttheenviionment;anu
Ȉ Stiengthening inteinational anu iegional
economiccoopeiation.
Effective implementation of this stiategy woulu
enable the PRC to continue to giow at a iobust pace
anu giow beyonu its low-cost auvantage. It woulu
make the PRC technologically moie auvanceu,
stiuctuially moie balanceu, socially moie inclusive,
anu enviionmentally moie sustainable—theieby
gieatly incieasing the likelihoou of auvancing into
high-income status befoie 2uSu. The iepoit notes
that, encouiagingly, the PRC’s 12th Five-Yeai Plan
has intiouuceu many policy measuies that suppoit
theseagenua.
The iest of the iepoit is oiganizeu as follows.
Section 2 uiscusses the key uiiveis of the
PRC’s iapiu giowth ovei the past Su yeais;
Section S explains how a countiy enteis the
miuule-income tiap anu uiscusses policy lessons
leaineu fiom both countiies caught in the tiap
anu those that successfully avoiueu it; Section 4
examines the emeiging challenges the PRC
faces, which, if not auuiesseu effectively, pose
significant iisks to its long-teim giowth; Section S
uiscusses policy options to consiuei in sustaining
giowth anu avoiuing the miuule-income tiap; anu
finally, Section 6 examines the outlook of the PRC
economyupto2uSu.
S
T
he PRC’s iemaikable achievement in economic
tiansfoimation anu social uevelopment was
builtonthieekeyuiiveis:(i)maiket-oiienteuiefoim,
(ii) low-cost auvantage, anu (iii) the iole of the
goveinment.Thesehavebeensuppoiteubyaiange
ofotheifactoisthathelpeucieateaviituouscycleof
giowthanuuevelopment.
2.1. Market-oriented reform
The fiist anu most funuamental success factoi
was maiket-oiienteu iefoim since the late 197us.
The shift away fiom cential planning alloweu
maiket foices to ueteimine piices, enteipiises to
make piouuction uecisions baseu on uemanu anu
supply, anu piivate businesses to compete in the
maiketplace. These changes unleasheu poweiful
economic incentives anu significantly impioveu
theefficiencyofiesouiceallocationanuutilization.
At the same time, the goveinment manageu
the iefoim piocess in a giauual anu piagmatic
mannei.AsinthewoiusoffoimeiPRCleaueiBeng
Xiaoping,thegoveinmentsoughtto“ciosstheiivei
by feeling the stones.” By uoing so, the economy
iefoimeu while ensuiing stability. Foi example,
the PRC avoiueu the uestabilization biought on by
the iapiu anu wholesale piivatization that spaikeu
economicciisesinotheitiansitionaleconomies.
Akeyaspectofthisiefoimwasthelibeializationof
foieigntiaueanuinvestment(Figuie2.1).Incieaseu
tiaue openness—culminating in accession to the
Woilu Tiaue 0iganization in 2uu1—exposeu the
2. Key drivers of the PRC’s
economic performance
in recent decades
PRC fiims to inteinational competition anu alloweu
them to exploie this compaiative auvantage. It also
openeu uoois to vast global maikets, while offeiing
economies of scale anu access to neeueu capital
goous anu othei iesouices. In auuition, foieign
uiiect investment (FBI) playeu an impoitant iole in
suppoiting inuustiial expansion. It helpeu impiove
expoit competitiveness by pioviuing access to
auvanceu technologies, management skills, anu
exteinalcapital.FBI,intuin,wasattiacteubyalow-
cost piouuction base anu the countiy’s vast anu
expanuinguomesticmaiket.
2.2. Low-cost advantage
The seconu key uiivei of economic success was
the PRC’s low-cost auvantage—laigely the iesult
of a vast aimy of iuial suiplus laboi, typical of a
uualeconomy(Lewis19S4).Thisensuieuasteauy
supply of low-cost laboi foi the mouein, foimal
sectois in uiban anu inuustiial aieas. Laboi-
intensivemanufactuiinganuseivicesgiewiapiuly,
allowing fiims to ie-invest ietaineu eainings in
a classic pattein of uevelopment anu stiuctuial
tiansfoimation. Foi any low-income countiy, its
compaiative auvantage lies in piouucing goous
that iequiie low technology at low laboi costs. As
iecentlyas2u1u,houilycompensationiatesinthe
PRC iemaineu slightly below the Philippines, anu
consiueiablybelowthoseofmoieuevelopeuAsian
economies such as Taipei,China; the Republic of
Koiea; anu Singapoie, along with miuule-income
countiies in Latin Ameiica such as Nexico anu
Biazil(Figuie2.2).
4
To some extent, the PRC’s low-cost auvantage
also uevelopeu out of asymmetiic maiket
libeialization—wheie appioximately 9u% of
piouuct maiket piices weie fully libeializeu,
while piices in vaiious factoi maikets iemaineu
contiolleu by the goveinment to vaiying uegiees
(Buang 2u1u). Foi instance, low ueposit inteiest
iates combineu with high householu savings
offeieu banks a steauy flow of cheap funus. These
savings weie inteimeuiateu at low lenuing iates
to enteipiises, especially state-owneu enteipiises
(S0Es), enabling them to ieap highei piofits anu
thus inciease coipoiate savings foi investment.
Buiing 199u–2u1u, the PRC’s aveiage annual ieal
FDI = foreign direct investment, PRC = People's Republic of China.
Note: 1980 FDI for PRC refer to 1982. Exports consist of goods and services.
Source: World Bank, World Development Indicators Online (accessed January 2012).
0
2
4
6
8
10
12
14
FDI net
inflows
exports FDI net
inflows
exports FDI net
inflows
exports FDI net
inflows
exports FDI net
inflows
exports
PRC Brazil India Republic of Korea Malaysia
P
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1980 2010
Figure 2.1 SbareofglobalexportsandFDI,selectedeconomies,1980–2010
100
55
48
29
24
18
6 5
4
0
20
40
60
80
100
US Singapore Republic
of Korea
Brazil Taipei,China Mexico Philippines PRC India
PRC = People’s Republic of China, US = United States.
Note: The 2010 manufacturing labor compensation cost for the PRC is estimated from the 2008 figure obtained from the US Bureau of Labor
Statistics, adjusted by the average urban wage growth and average percentage appreciation of the Chinese currency against the US dollar
between 2008 and 2010. The figure for India refers to 2007.
Source: US Bureau of Labor Statistics at http://www.bls.gov/ilc/http://www.bls.gov/ilc/, China Statistical Yearbook at http://www.chinadataonline.org/,
and The People’s Bank of China at http://www.pbc.gov.cn/publish/english/1140/index.html (all accessed August 2012).
U
S

=

1
0
0
Figure 2.2 Indexofbourlymanufacturinglaborcompensationcosts,selectedeconomies,2010
lenuing iate was below 2.u%, among the lowest
of 1Su countiies with available uata anu well
below most high- anu miuule-income countiies
(Figuie2.S).
1
Fuitheimoie,goveinment-owneulanu
was often allocateu below maiket value to attiact
local investment. Eneigy piices weie contiolleu foi
an extenueu peiiou, although they have become
moie aligneu with inteinational piices in iecent
yeais(RosenanuBousei2uu7).
1
Notably, the combination of a high savings rate and low returns
to savers also characterized other East Asian economies during
high-growth periods (World Bank 1993).
Chaptei2: KeyuiiveisofthePRC’seconomicpeifoimanceiniecentuecaues|
S
|uiowingbeyonutheLow-CostAuvantage
2.3. The role of the government
The thiiu key uiivei is the iole of the goveinment.
The goveinment has continueu to play an impoitant
iole in allocating iesouices as iefoims weie caiiieu
out—in paiticulai key piouuction factois such as
capital,laboi,lanu,eneigy,anuiawmateiials.0none
hanu, this ieflects the PRC’s long list of uncompleteu
iefoims anu is among the unueilying causes of
the stiuctuial imbalances uiscusseu below. 0n the
othei, howevei, the goveinment’s pioactive iole in
economic uevelopment has helpeu auuiess some of
the pioblems often associateu with maiket failuie,
such as infoimation anu cooiuination exteinalities,
especially in the context of stiuctuial tiansfoimation
in ueveloping countiies (Bausmann anu Rouiik
2uuS, Lin 2u1u). This is paiticulaily tiue when
consiueiing that the PRC was emeiging fiom a long
peiiou of cential planning anu was in the piocess of
establishingeffectivemaiketinstitutions.
The PRC goveinment has been effective in mobilizing
iesouices neeueu foi investment in public goous anu
seivices,paiticulailyinfiastiuctuie,akeyconuitionfoi
iapiu giowth. In auuition, uecentialization pioviueu
local goveinments with stiong incentives to piomote
local tiaue anu investment—thiough making access
to cieuit anu lanu easiei, builuing infiastiuctuie, anu
PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Note: Real interest rate is the rate charged by banks on loans to prime customers adjusted for inflation as measured by the GDP deflator.
Source: World Bank, World Development Indicators Online (accessed July 2012).
1.8
4.1
5.3 5.7 5.8
6.6 7.1
47.4
3.0 3.4 3.5
4.5
8.7
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Middle-income countries High-income countries
Figure 2.3 Annualaveragerealinterestrates{lending],selectedeconomies,1990–2010
pioviuing an enviionment conuucive foi business
expansion anu entiepieneuiship (Buang 2u1u, Xu
2u1u, Yao 2u1u).
2
In shoit, the goveinment followeu
thepathofotheihighgiowthEastAsianeconomies—
it was committeu to uevelopment, hau a cleai vision,
possesseu auequate tools foi implementation, anu
useupiagmaticpoliciesanuinteiventions.
S
2.4. Other success factors
Beyonu these thiee key uiiveis, theie weie a iange
of othei factois—some ingiaineu in the PRC’s pie-
iefoim economic fibei—that also playeu a ciitical
ioleinsuppoitinggiowth:
Ȉ Bigh householu anu coipoiate savings
iates pioviueu the necessaiy funus foi
iapiu investment. Bigh levels of savings anu
investment uiove iapiu economic expansion in
otheihigh-giowthAsianeconomiesuuiingtheii
take-offpeiiousaswell.InthePRC,totalsavings
2
Some scholars characterize PRC local governments as “production-
oriented,” managing local economies like corporations (Huang
2010, Yao 2010). Local government units were in fact production-
oriented in the pre-reform period. The difference was—since the
late 1970s—combining government direction with market forces.
3
Many refer to the PRC development model as the “Beijing
Consensus,” one of the features being the combination of
market forces with government planning (see, for example, Li,
Brødsgaard, and Jacobsen 2009).
6
iose fiom below S6% of uBP in the eaily
198us to SS% by 2uu8, uespite the iepiesseu
inteiest iates foi saveis. In 2uu8, householus
anu the coipoiate sectoi contiibuteu almost
equally to savings—22% anu 2S%, iespectively
(Table 2.1). While many miuule-income
countiies woik to iaise savings anu investment
iates, the concein in the PRC is that the level of
investmentistoohigh.
Ȉ A young, euucateu woikfoice enableu the PRC
to benefit fiom a uemogiaphic uiviuenu. While
this is changing iapiuly as the population ages
(ABB2u11b),itwasabigboosttogiowthinthe
198us anu 199us. Euucation expanueu iapiuly,
pioviuinghumancapitalfoimoieauvanceu,non-
agiicultuial piouuction. Seconuaiy school gioss
eniollment iose steauily fiom below 4u% of the
agecohoitintheeailyyeaisofiefoimto81%by
2u1u (see Table 1.1). The expansion of teitiaiy
euucation has been even moie uiamatic—fiom
less than 1% of the age cohoit when iefoims
beganto26%in2u1u.
Ȉ Nassive expansion of quality infiastiuctuie
is anothei impoitant factoi. The goveinment
investeu heavily in tianspoit, eneigy,
telecommunications, anu uiban seivices. Nany
miuule-incomecountiieshaveseeninfiastiuctuie
gaps uevelop anu wiuen. Bowevei, with ample
fiscal space anu focuseu national anu local
goveinments, the PRC excelleu in infiastiuctuie
uevelopment. Fiom 198u to 2u1u, total highway
length moie than quauiupleu anu electiicity
consumption pei capita giew by a factoi of nine
(Figuie2.4).
Table 2.1 Savingsrate,selectedeconomies,2008–2009{¦ofCDP]
PRC India Republic of Korea Japan Mexico US Germany
Total domestic savings 53.2 33.7 16.7 3.6 12.4 –2.5 6.2
Household savings 22.9 23.5 2.0 1.4 7.3 4.7 7.4
Corporate savings 22.0 8.1 10.2 6.0 4.8 2.0 1.0
Government savings 8.4 2.1 4.5 –3.8 0.3 –9.2 –2.1
GDP = gross domestic product, PRC = People’s Republic of China, US = United States.
Note: Data for PRC and Japan are for 2008 while data for India, the Republic of Korea, Mexico, the US, and Germany are for 2009.
Sources: CEIC; NBS, China Statistical Yearbook (accessed May 2011); and ADB staff estimates using GDP and savings data from OECD.Stat
(accessed June 2011).
Chaptei2: KeyuiiveisofthePRC’seconomicpeifoimanceiniecentuecaues|
Ȉ Theie was a ieasonably compiehensive
inuustiial anu manufactuiing base when
economic iefoims began—the iesult of pie-
iefoim inuustiialization. Although it iequiieu
technicalmoueinizationanubetteimanagement,
inuustiy pioviueu a soliu base foi expansion
once iefoims weie launcheu. Inuustiy alieauy
accounteu foi ovei 4S% of uBP when iefoims
began, anu—aftei uiopping slightly uuiing the
fiist uecaue—has iemaineu between 4S% anu
Su%since.
Ȉ Piuuent macioeconomic management anu a
cautious appioach to financial iefoim pioviueu
a stable investment climate. Also, limiteu
capital account libeialization helpeu insulate
the countiy fiom global anu iegional financial
contagion uuiing ciises. The effects of the
1997¡98 Asian financial ciisis anu 2uu8¡u9
global financial ciisis on the PRC weie faiily
muteu—with the goveinment applying effective
counteicyclical measuies. Bespite peiiouic
spikes, inflation iemaineu moueiate uuiing
muchoftheiefoimpeiiou(Figuie2.S).ThePRC
avoiueu the hypeiinflation that ueiaileu giowth
in Latin Ameiica anu afflicteu seveial othei
emeigingmaikets.
The PRC’s success thus fai, howevei, shoulu not
let one lose sight of cuiient anu futuie challenges.
Bespite uecaues of iapiu giowth, Su% of the
populationstillliveubelowthe$2-a-uaypoveityline
in 2uu8 (see Table 1.1). Bespite significant gains, its
technological anu piouuctivity gaps with auvanceu
economies iemain wiue, anu pei capita income
woulu have to tiiple to ieach the Woilu Bank’s
7
|uiowingbeyonutheLow-CostAuvantage
high-income countiy thiesholu. With iising laboi
costs, giowth woulu have to be incieasingly uiiven
by piouuctivity impiovements thiough innovation
anu inuustiial upgiauing anu tiansition towaiu
high-value piouuction. Noieovei, iapiu giowth has
exposeu seveial stiuctuial pioblems. These incluue,
among otheis, imbalances in the souices of giowth,
PRC = People’s Republic of China
Sources: World Bank, World Development Indicators Online and NBS, China Statistical Yearbook (accessed July 2012).
0
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Electric power consumption Length of highways Telephone lines
Figure 2.4 PRC:Infrastructuredevelopment,1980–2011{1980=1]
PRC = People’s Republic of China, UK = United Kingdom.
Note: Data for UK cover 1989–2011.
Sources: World Bank, World Development Indicators Online (accessed July 2012) and Asian Development Bank, Statistical Database System
(accessed July 2012).
J
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Average inflation Coefficient of variation
Figure 2.5 Averageannualinflationrates,selectedeconomies,1987–2011
giowing income inequality, iesouice constiaints anu
enviionmental uegiauation, anu a moie challenging
exteinal economic enviionment. These pioblems,
if not auuiesseu effectively, coulu become binuing
constiains to the PRC’s long-teim giowth, anu
inciease the iisk of getting caught in the miuule-
incometiap.
8
3.1. Defining the middle-income trap
Nany countiies—aftei ieaching miuule-income
status—expeiience a significant moueiation in
economic giowth anu finu it uifficult to giauuate to
high-income status,
4
cuiiently uefineu as uNI pei
capita of $12,476 oi moie in 2u11 piices.
S
These
countiies may be caught in what is commonly
iefeiieutoasthe“miuule-incometiap”(FiguieS.1).
An analysis of giowth peifoimance shows that
4
For a recent account of cross-country experiences of growth
slowdowns, see Eichengreen, Park, and Shin (2011). Also see
ADB (2011c).
5
The latest income thresholds (GNI per capita) used by the World
Bank in classifying economies are in 2011 dollars, calculated
using the Atlas method. The thresholds are; low income, $1,025
or below; lower middle income, $1,026–$4,035; upper middle
income, $4,036–$12,475; and high income, $12,476 or above.
Felipe (2012a, 2012b) classifies countries into low-, middle-, and
high-income groups using 1990 purchasing power parity dollars.
3. The middle-income trap and
policy lessons
GNI = gross national income.
Source: World Bank, World Development Indicators Online (accessed July 2012).
0
5,000
10,000
15,000
20,000
25,000
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35,000
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$
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Brazil Costa Rica Republic of Korea Mexico Singapore
Figure 3.1 Middle-incometrap:SelectedAsianandLatinAmericaneconomies,19ó0–2010
28 out of 12S countiies globally have been at
miuule-income levels since 1987, the yeai countiy
income classifications weie fiist intiouuceu.
6
An
extiapolation of the classification thiesholus to
eailiei yeais inuicates that 18 of those countiies
weiemiuuleincomeaseailyas1962,meaningthat
they have been stuck at the miuule-income stage
foi at least Su yeais.
7
0n a iegional basis, 12 of the
18 aie in Latin Ameiica, thiee in Asia—Nalaysia,
the Philippines, anu Thailanu—with the iemaining
6
The 125 countries/territories, covered in the World Bank’s World
Development Indicators Online database, exclude OPEC members
and those with populations below 3 million in 2008.
7
The other 10 countries may have been middle income in 1962;
but reliable, comparable data on current GNI per capita (Atlas
method) are unavailable.
9
|uiowingbeyonutheLow-CostAuvantage
thiee in Afiica anu the Niuule East. 0nly a few of
these 18 appeai on theii way to becoming high
income in the yeais aheau—incluuing Biazil, Chile,
anu 0iuguay. Bowevei, most of the otheis will
iemainatthemiuule-incomestagefoiyeaistocome
(vanuenbeig,Poot,anuZhuang2u11).
The numbei of high-income countiies globally is
slightly laigei—S1, baseu on the same ciiteiia of
having a population above S million (Table S.1).
Among these, 14 moveu fiom miuule- to high-
income aftei 196S, suggesting it has been possible
in iecent uecaues to avoiu the peiils of miuule
income, stiuctuially tiansfoim an economy anu
giow above the high-income thiesholu. Nine of
thesecountiiesaieintheEuiopeanpeiipheiy,with
theiemainingfivefiomEastAsia.
The most iapiu tiansitions thiough the miuule-
income stage weie in Asia. }apan emeigeu fiom the
Table 3.1 Higb-andmiddle-incomecountrygroups
High income Middle income
Group 1 Group 2 Group 3
High income before/in 1965 High income after 1965 Middle income continuously during 1987–2009
n=17 n=14 n=28
Europe Europe Europe Latin America
Austria Croatia Belarus Argentina
Belgium Czech Republic Lithuania Bolivia
Denmark Hungary Romania Brazil
Finland Poland Russian Federation Chile
France Slovakia Colombia
Germany Asia Costa Rica
Italy Greece Malaysia Dominican Republic
Netherlands, The Ireland Philippines El Salvador
Norway Portugal Thailand Guatemala
Sweden Spain Mexico
Switzerland Africa/Near East Panama
United Kingdom Asia Jordan Paraguay
Hong Kong, China Lebanon Peru
North America/Oceania Japan Morocco Uruguay
Australia Republic of Korea South Africa
Canada Singapore Syria
New Zealand Taipei,China Tunisia
United States Turkey
Near East
Israel
Note: Includes only countries with a population of above 3 million; excludes members of the Organization of the Petroleum Exporting Countries.
Source: Vandenberg, Poot, and Zhuang (2011).
uevastation of Woilu Wai II to ieach high-income
status in 1968—a peiiou of just 2S yeais. The
RepublicofKoieamoveufiomlowtomiuuleincome
just befoie 1962 anu became high-income by 1994,
a peiiou of about S2 yeais. Bong Kong, China;
Singapoie; anu Taipei,China weie fiimly miuule-
incomein1962anubecamehigh-incomeeconomies
in the 197us anu 198us. Nost of these five
economies lackeu significant natuial iesouices, but
maueaiapiutiansitiontohigh-valuemanufactuiing
anuseivices,anugiewiapiulyanuconsistentlyovei
many yeais. Singapoie giew at an aveiage annual
iate of 11.9% in the 1u yeais up to its giauuation.
}apangiewby9.9%peiyeaiinthe7yeaispiioito
attaininghigh-incomestatus(vanuenbeig,Poot,anu
Zhuang2u11).
Althoughtheieisstillnowiuely-accepteuuefinition
of the miuule-income tiap, it is useful to link it to
the uual-economy mouel of Aithui Lewis (19S4).
1u
Accoiuing to this mouel, economic uevelopment
is about stiuctuial tiansfoimation that entails
shifting investment anu laboi fiom piimaiy
activities—notably faiming—into uiban-baseu
manufactuiing anu seivices ovei time. With a laige
supplyofunueiutilizeulaboi—“unlimiteu”inLewis’
woius—wages iemain low as uiban piouuction
expanus, anu business stays competitive at low
cost. This piouuctive stiuctuie employs low-level,
establisheu technologies easily impoiteu anu
masteieu locally. Simple machineiy anu piocesses
piouuce simple, low-cost goous. Expanuing the
uibaneconomy—withnouecieaseinfaimoutput—
allows total output to iise. As output iises fastei
than the population, pei capita income incieases.
An economy enteis the miuule-income stage
as piouuction expanus in such laboi-intensive
manufactuiing(anuseivices)(FiguieS.2).
The tiap uevelops when suiplus laboi is ieplaceu
by a tightening laboi maiket anu highei wages. To
boost output, the quality anu value of piouuction
Figure 3.2 Tbepatbtobigbincome
LOW INCOME
‡Significant agricultural
base
‡Simple manufacturing
(textiles, food
processing)
‡Low technologies
‡Labor intensive, low
skilled
LOWER MIDDLE
INCOME
‡Expansion of
manufacturing
‡Expanding FDI
presence
‡Low to medium
skilled
UPPER MIDDLE
INCOME
‡Adapting technologies
‡Development of local
firms
‡More complex FDI
‡Higher skills
HIGH INCOME
‡Technically advanced
domestic firms
‡High-value goods and
services
‡Developed market
‡Innovation in products
and processes
FDI = foreign direct investment.
Source: Authors.
ChapteiS: Themiuule-incometiapanupolicylessons|
must iise with business cateiing to highei-value
maiket segments anu giowth ielying moie on
piouuctivity impiovement thiough innovation anu
inuustiial upgiauing. If a countiy fails to uo so, it
willgetcaughtinthemiuule:ononehanuitcannot
compete against low-income countiies at low
wages; while on the othei it cannot compete with
high-income countiies on innovation anu highei-
valuepiouuction.Itistiappeubetweenthetwo.
3.2. How to avoid the trap: Policy lessons
Funuamental to avoiuing the miuule-income tiap
is a countiy’s ability to constantly innovate anu
upgiaue piouuction, iaise piouuctivity, anu climb
the value chain. This iequiies a ciitical mass of
fiims that aie uynamic anu with stiong incentives
to invest in anu uevelop new anu moie auvanceu
machineiy, piouuction piocesses, anu piouucts
thiough ieseaich anu uevelopment (R&B) anu
innovation. Expeiiences fiom a iange of countiies
ovei the past S uecaues suggest that suppoiting
11
|uiowingbeyonutheLow-CostAuvantage
innovation,upgiauing,anutiansitiontowaiuahigh-
valueeconomyalsoiequiiethegoveinmenttocieate
a conuucive enviionment with the following key
elements.
The fiist is macioeconomic, political, anu social
stability. Instability will uisiupt investment
uecisions,piouuctionplanning,anumaiketuemanu.
Asian countiies that giew iapiuly anu achieveu
high income cieateu such stability (Woilu Bank
199S), as uiu the 1S countiies that sustaineu high-
giowth ovei at least 2S yeais as iuentifieu by the
CommissiononuiowthanuBevelopment(2uu9).In
contiast, hypeiinflation, macioeconomic instability,
uebt ciises, high income inequality, anu political
instability uisiupteu the giowth peifoimance of
many Latin Ameiican countiies anu pieventeu
themfiommovingbeyonuthemiuule-incomestage
(Lustig anu Ros 2u11). Among the thiee Southeast
Asian economies that have been tiappeu since the
eaily 196us, the Philippines suffeieu fiom similai
pioblemsuuiingthepastSuecaues(ABB2uu8).
The seconu is auequate key public investments,
notably in infiastiuctuie anu human capital.
Fiims neeu efficient tianspoit systems to get
inputs to factoiies anu goous to maikets, a
ieliable powei supply foi piouuction, anu goou
telecommunications to inteiact. Without these,
fiims will finu it haiu to boost piouuctivity
anu compete globally. Countiies also iequiie a
skilleu laboi foice to opeiate machines, manage
piouuction, anu uesign bettei technologies. As an
economybecomesmoieuevelopeuanuseekshighei
value piouuction, these public investments become
moie ciitical anu neeu to be moie sophisticateu—
moie ieliable anu efficient infiastiuctuie anu
moie highly skilleu piofessionals, manageis anu
technical woikeis. East Asian countiies iampeu up
euucationanutiaininganuimpioveuinfiastiuctuie
significantlyintheiiiunuptohigh-incomestatus.
The thiiu is a well functioning maiket system to
allocateiesouices,oiganizepiouuctionanutiaue,anu
pioviuepiicesignalsanuincentivesfoipiouuceisanu
consumeis. Expeiiences have shown that a system of
fiims, pieuominately piivate, anu maiket competition
is most effective at oiganizing economic activity. This
oiganization incluues the necessaiy institutions to
ieassuie investois anu piomote ieliable anu efficient
tiansactions,notablytheiuleoflawanupiotectionof
physicalanuintellectualpiopeityiights.Fuitheimoie,
an efficient financial system is neeueu to lubiicate
the wheels of investment, piouuction, anu tiaue. As
with public investments, miuule-income countiies
climbing the value chain iequiie a moie uiveisifieu
anucomplexfinancialsystem—incluuingabioauening
of the souices of finance fiom financial institutions
to financial maikets—to manage iisk anu suppoit
investmentsininnovation.
The fouith is a focuseu inuustiial policy, although
this iemains contentious. Expeiiences of some
high-income countiies, in paiticulai the so-calleu
miiacle economies in East Asia, suggest that
inuustiial policy has an impoitant iole to play
in successfully tiansfoiming an economy anu
avoiuing the miuule-income tiap (Woilu Bank
199S; Amsuen 1989a, 1989b; Waue 199u). These
policies involve sectoi- anu inuustiy-specific
inteiventions to suppoit innovation anu upgiauing.
A bioau iange of inuustiial policy measuies have
been useu by vaiious countiies, centeiing on aieas
incluuing taigeting piioiity inuustiies, piovision
of subsiuizeu cieuit, tiaue policy, suppoit foi
R&B, state owneiship, anu infoimation shaiing.
These instiuments aie uesigneu to oveicome
maiket failuies—in paiticulai, infoimation
anu cooiuination exteinalities—inheient in
the uevelopment piocess anu paiticulaily
acute in innovation, upgiauing, anu stiuctuial
tiansfoimation (Bausmann anu Rouiik 2uuS,
Rouiik2uu4,Lin2u1u).
Bowevei, foi a long time, inuustiial policy was
uiscieuiteu, in pait uue to pooi uesign anu
implementation in many countiies, but also by
the Washington Consensus iueology unuei which
piivatization, libeialization, the fiee maiket
anu minimal state inteivention weie the noim.
Inuustiial policy has ieceiveu ieneweu attention
lately, paitly because policies baseu solely on fiee
12
maikets anu libeialization weie not effective in
achieving high giowth in many countiies in the
198us anu 199us, especially in Latin Ameiica. The
PRC’seconomicsuccessalsoshowsthatgoveinment
can play an impoitant iole, especially in uiging
stiuctuial tiansfoimation wheie the maiket
alone is not sufficient (Rouiik 2uu4, Lin 2u1u).
Fuithei, many believe that the excessive ieliance
on unfetteieu maikets helpeu cause the iecent
global financial ciisis (Stiglitz 2u1u). While the
ChapteiS: Themiuule-incometiapanupolicylessons|
Box 3.1 Howtodesignindustrialpolicy
Industrial policy has received renewed attention in recent years, and many economists and policy makers now believe
that it has an important role to play in addressing market failures, especially related to information and coordination
externalities that are particularly pervasive in the development or adoption of new technologies, new products, and
new markets. While the debate on industrial policy is likely to continue, the focus of the debate is now shifting from
whether or not it is needed, to how it should be designed and implemented.
Rodrik (2007) argues that industrial policy is not about subsidies, but about public–private collaboration to address
market failures—what are the missing public inputs the private sector needs to function effectively. What is needed is
a change in the framework for formulating industrial policy to “maximize its potential to contribute to economic growth
while minimizing the risks that it will generate waste and rent-seeking.” The emphasis should be on self-discovery of
the potential to enter into high technology and higher value industries and on assisting in addressing coordination
failures inherent in structural transformation.
Rodrik argues that the standard instruments of industry policy (credit and fiscal support, infrastructure provision,
among others) can be improved if they are deployed in a “more productive manner.” To do this, he proposes ten design
principles for industrial policy:
Ȉ incentives should be provided only to “new” activities;
Ȉ there should be clear benchmarks/criteria for success and failure;
Ȉ there must be a built-in sunset clause;
Ȉ public support must target activities, not sectors;
Ȉ activities that are subsidized must have clear potential of providing spillover and demonstration effects;
Ȉ the authority for carrying out industrial policy must be vested in agencies with demonstrated competence;
Ȉ implementing agencies must be monitored closely by a principal with a clear stake in the outcome and who
holds political authority at the highest level;
Ȉ the agencies carrying out promotions must maintain channels of communication with the private sector;
Ȉ the objective should not be to minimize chances that mistakes will occur—which would result in no self-
discovery at all—but to minimize the costs of the mistakes when they do occur; and
Ȉ promotion needs to be renewable, so the cycle of discovery continues.
While these provide broad principles to guide the implementation of industrial policy, the exact policy mix will differ
by circumstances and country. Any effective strategy is likely to be country-specific—there is no “one-size-fits-all”
solution.
Source: Rodrik (2004, 2007).
WashingtonConsensushasgiownoutoffashion,the
uebate on the meiits anu scope of inuustiial policy
continues.Bowevei,thefocusoftheuebateappeais
tohaveshifteufiomwhether or notinuustiialpolicy
shoulubeuseutohowitcanbebetteiuesigneuanu
implementeu(BoxS.1).
8
The above uiscussion highlights some of the bioau
policy lessons uiawn fiom countiy expeiiences.
Bowevei, in uesigning policies foi avoiuing the
8
Even developed countries such as the UK and the US are looking
to industrial policy as a way to revive and boost manufacturing
capacity (The Economist 2011).
1S
|uiowingbeyonutheLow-CostAuvantage
miuule-income tiap, it is impoitant to note that
countiies have uiffeient ciicumstances anu
confiont a unique set of challenges anu iisks.
Theiefoie, the neeueu policy options aie likely
to be countiy-specific. In the case of the PRC, its
laige piouuctivity anu technology gaps with the
auvanceu countiies anu iising wages mean that
the uangei of getting caught in the miuule-income
tiap is ieal. At the same time, incomplete iefoims,
which contiibute to low-cost auvantage, have
cieateu vaiious foims of economic imbalance,
leu to inefficiencies anu the misallocation of
iesouices,anucontiibuteutoiisinginequality.0ne
way oi anothei, these coulu potentially weaken
fiims’ incentives to innovate anu upgiaue, hinuei
the uevelopment of the countiy’s innovation
capabilities, affect economic anu social stability,
anu unueimine the sustainability of giowth, anu
thesehavetobeauuiesseuifthePRCistoavoiuthe
miuule-income tiap. In auuition, sustaining giowth
iequiies the PRC to effectively iesponu to iesouice
constiaints, enviionmental challenges, anu a moie
complexexteinaleconomicenviionment.

14
T
hePRCfacesanumbeiofchallenges,which,ifnot
auuiesseu effectively, coulu hinuei its long-teim
giowthanuincieaseitsiiskofgettingcaughtinthe
miuule-incometiap.
9
4.1. Large productivity and technology gaps
The PRC has piogiesseu fai in builuing
manufactuiing capability, auvancing technologies,
anu impioving piouuctivity ovei the past thiee
uecaues. It is the thiiu countiy to senu astionauts
into space on its own, aftei the 0S anu the Russian
Feueiation. It has piouuceu some of the woilu’s
fastest supeicomputeis (BBC News 2u1u); built
someofthewoilu’sfastesttiains;anuisthewoilu’s
9
The authors wish to acknowledge contributions to the analysis in this
section from Yi Jiang and Suphachol Suphachalasai on resource
and environmental constraints, Donghyun Park on population
aging, and Guanghua Wan on income inequality contribution.
4. Sustaining the PRC’s long-term
growth: Challenges and risks
PRC = People’s Republic of China, UK = United Kingdom, US = United States
Source: World Bank, World Development Indicators Online (accessed July 2012).
0
5
10
15
20
19.7
8.9
8.4
6.1 6.1 5.9
5.2
3.5 3.2 3.2
25
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Figure 4.1 Sbareofglobalbigb-tecbexports,top10economies,2009
laigest cai manufactuiei. In othei high-value
sectois, the PRC also ianks high globally. It is the
laigest high-tech expoitei in the woilu, accounteu
foi close to 2u% of the global total in 2uu9, aheau
of ueimany (8.9%), the 0S (8.4%), anu }apan
(6.1%) (Figuie 4.1). The Woilu Economic Foium’s
Global Competitiveness Index 2011–2012 iankeu the
PRC 26th out of 146 countiies, highei than seveial
auvanceueconomies(Figuie4.2).
Noie bioauly, theie has been gieatei technological
sophistication in the PRC’s manufactuieu piouucts
ovei the past 2 uecaues. As late as 199S, the PRC’s
laigest manufactuiing subsectoi by gioss output
was textiles—moie associateu with low-income
1S
|uiowingbeyonutheLow-CostAuvantage
countiies. 0thei majoi manufactuiing subsectois
at the time weie chemicals anu metals, the legacy
of pie-iefoim heavy inuustiial uevelopment. Foou
piocessing, which, like textiles, is geneially low value
anu low technology, was also piominent. By 2u1u,
textiles anu foou piocessing hau uioppeu out of the
top five, oveitaken by two highei-value subsectois—
electionic equipment anu electiical machineiy anu
equipment (Figuie 4.S). In 2u1u, about 17% of all
PRC’smanufactuieugoousweieexpoiteu,accounting
foi 14% of the woilu total (Figuie 4.4). In shoit, the
PRChastiulybecomethewoilu’sfactoiy.
The PRC’s piogiess in ueveloping technological
capabilities is also ieflecteu in the iapiu giowth of
its manufactuiing piouuctivity. Buiing 2uuu–2uu9,
inuustiial laboi piouuctivity giew in ieal teims
at 8.u% pei yeai, consiueiably highei than othei
ueveloping Asian countiies such as Inuonesia (2%),
Thailanu(2.S%),thePhilippines(2.6%),anuNalaysia
(2.9%) (Figuie 4.S). Stiong laboi piouuctivity
giowth has been uiiven by high levels of investment
in manufactuiing anu high total factoi piouuctivity
(TFP) giowth. Estimates of TFP giowth foi PRC
manufactuiingvaiygieatlyanuhavebeenthesubject
of gieat contioveisy (}effeison, Rawski, anu Zhang
2uu8).Bowevei,aiecentstuuyofmoiethanSuu,uuu
PRC manufactuiing fiims shows that, uuiing 1998–
2uu7, TFP giew by 8% each yeai on a value-auueu
basis (Bianut, van Biesebioeck, anu Zhang 2u11).
This fiim-level iesult is consistent with the estimates
of aggiegate TFP giowth foi the entiie PRC economy
geneiateu foi this iepoit (see Section 6). Buiing
2uuu–2uu9, the PRC’s aggiegate annual TFP giowth
ieacheu about 6%, compaieu with Nalaysia (1.7%),
the Republic of Koiea (1.8%), anu Thailanu (2.4%)
(Figuie4.6).
All these inuicatois suggest the PRC has significantly
incieaseu its technological sophistication ovei a
ielatively shoit span. These positive tienus shoulu
not leau to complacency, howevei. As aigueu below,
manufactuiing in the PRC continues to iely laigely
on laboi intensive technology anu competes globally
on its low-cost auvantage. The countiy still faces
the majoi challenge of naiiowing piouuctivity anu
technologicalgapswithauvanceueconomies.
PRC = People’s Republic of China, UK = United Kingdom, US = United
States.
Source: World Economic Forum, The Global Competitiveness Report
2011–2012.
5.74
5.63
5.61
5.47
5.43
5.41
5.41
5.40
5.40
5.39
5.36
5.33
5.26
5.24
5.20
5.18
5.17
5.14
5.14
5.11
5.08
5.07
5.03
5.02
4.93
4.90
4.89
4.78
4.77
4.75
4.70
4.64
4.62
4.62
4.58
4.54
4.54
4.52
4.52
4.47
4.46
4.44
4.43
4.41
4.40
0 1 2 3 4 5 6 7
Switzerland
Singapore
Sweden
Finland
US
Germany
The Netherlands
Denmark
Japan
UK
Hong Kong, China
Canada
Taipei,China
Qatar
Belgium
Norway
Saudi Arabia
France
Austria
Australia
Malaysia
Israel
Luxembourg
Republic of Korea
New Zealand
PRC
United Arab Emirates
Brunei Darussalam
Ireland
Iceland
Chile
Oman
Estonia
Kuwait
Puerto Rico
Spain
Bahrain
Czech Republic
Thailand
Tunisia
Poland
Barbados
Italy
Lithuania
Portugal
Figure 4.2 Clobalcompetitivenessindex,
top45economies,2011–2012
16
First, while “change” has been impressive, the
“level” of the PRC’s technological gap with advanced
economies remains large. An aggiegate inuicatoi of
the gap is the level of inuustiial laboi piouuctivity.
In 2uu9, the PRC’s inuustiial laboi piouuctivity
was only 1u.6% of the 0S (Figuie 4.6). Within
Asia, the PRC’s inuustiial laboi piouuctivity also
lags consiueiably behinu the iegion’s uevelopeu
countiies, incluuing the Republic of Koiea (S4% of
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
Note: Data are deflated using PRC GDP deflator 2000 base year.
Source: NBS, China Statistical Yearbook (accessed July 2012).
0
2
4
6
8
10
12
14
16
18
20
0
1
2
3
4
5
6
7
8
9
Textile
industry
Raw chemical
materials and
chemical
products
Ferrous metals,
smelting, and
pressing
Transport
equipment
Food
processing
Electrical
machinery and
equipment
Communication
equipment,
computers, and
other electronic
equipment
Electric power
and heat power,
production and
supply
G
r
o
w
t
h

r
a
t
e

(
%
)

S
h
a
r
e

(
%
)

1995 share 2010 share 1995–2010 annual growth rate
Figure 4.3 PRC:Topfiveindustrialsubsectors,1995–2010
PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Source: World Bank, World Development Indicators Online (accessed July 2012).
0 5 10 15
Poland
Malaysia
India
Thailand
Switzerland
Spain
Canada
Mexico
Singapore
UK
Belgium
Hong Kong, China
The Netherlands
Italy
France
Republic of Korea
Japan
US
Germany
PRC 14.1
9.9
8.1
6.5
4.0
3.9
3.5
3.1
2.9
2.9
2.7
2.5
2.2
1.8
1.8
1.6
1.4
1.3
1.3
1.2
Percent
Figure 4.4 Sbareofglobalmanufacturedexports,top20economies,2010
the 0S in 2uu8). It is also below the two Southeast
Asian countiies that aie sometimes consiueieu
caught in the miuule-income tiap—Thailanu
(1S%) anu Nalaysia (27%). The PRC level of
inuustiial laboi piouuctivity is similai to that of
the Philippines anu Inuonesia. It is below most
Latin Ameiican countiies, incluuing Biazil (18%),
Aigentina(22%),anuChile(S7%).
17
|uiowingbeyonutheLow-CostAuvantage
Second, although the PRC is now the world’s largest
high-tech exporter—notably of electrical and
electronic goods—its value added remains low.
A laige shaie of PRC’s manufactuiing expoits
involves “piocessing tiaue”, with impoiteu
components fiom high-income economies (such
as }apan; the Republic of Koiea; anu Taipei,China)
assembleu into final goous foi expoit—thus with
PRC = People’s Republic of China, TFP = total factor productivity.
Note: TFP growth rates are estimated using Cobb-Douglas production functions which link output with labor, capital, and TFP.
Source: ADB staff estimates.
–2
–1
0
1
2
3
4
5
6
7
3.2
–1.8
0.9
3.4
3.1
–0.5
1.6
2.1
1.5
6.3
1.0
1.6
1.8
2.4
6.3
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h
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1980–1990 1990–2000 2000–2009
A
n
n
u
a
l

T
F
P

g
r
o
w
t
h

(
%
)

Figure 4.6 Aggregatetotalfactorproductivitygrowtb,selectedeconomies,1980–2009
PRC = People's Republic of China, US = United States.
Note: Labor productivity = value added/employment. Data for the Republic of Korea refer to 2000–2008.
Sources: ADB staff estimates using data from World Development Indicators Online (accessed July 2012) and NBS, China Statistical Yearbook
(accessed August 2012).
–20
0
20
40
60
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100
–2
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4.3
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l
e
v
e
l
G
r
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(
%
)

Annual productivity growth, 2000–2009 Productivity level (market exchange rate) in 2009
Figure 4.5 Industriallaborproductivity,selectedeconomies,2000–2009
limiteu uomestic value auueu. Well-publicizeu
examples aie the Apple iPou, iPau, anu iPhone—
with estimates that only about $S of iPou’s $1Su
expoit value (S%), $8 of iPau’s $499
1u
woiluwiue
ietail piice (1.6%), anu $1u of iPhone’s $S49
11

woiluwiue ietail piice (1.8%) ueiive fiom the PRC
10
16-GB Wi-Fi iPad in 2010.
11
iPhone 4 in 2010.
18
assemblyinteimsoflaboicosts(Linuen,Kiaemei,
anu Beuiick 2uu7; Kiaemei, Linuen, anu Beuiick
2u11). In 2uu8, about 82% of the countiy’s high-
techexpoitsinvolveupiocessingtiaue(Figuie4.7).
0sing piouuct-level input-output uata, Koopman,
Wang, anu Wei (2uu8) examineu uomestic value-
auueu in expoits by fiim owneiship anu founu
that wholly-owneu foieign investeu enteipiises
(FIEs) tenu to geneiate ielatively low value auueu,
ielying on high-value impoiteu components as
pait of global supply chains. value auueu by FIEs
is just ovei a quaitei of the final value on aveiage,
wheieas these fiims account foi 4u% of the PRC’s
total expoits (Table 4.1). Anothei 18% came fiom
joint ventuies, with highei but still not veiy high
value auueu (4S%). By contiast, value auueu by
uomestic fiims iangeu fiom 7u% to 82%. The
PRC = People’s Republc of China.
Source: Xing (2010).
P
e
r
c
e
n
t
0
20
40
60
80
71
86
93
89
82
100
1993 1996 2003 2005 2008
Figure 4.7 PRC:Sbareofprocessingtradein
bigb-tecbexports,1993–2008
ielatively low value auueu in piocessing tiaue
also becomes appaient compaiing expoit piouuct
sophistication with component impoits. The PRC
impoit sophistication is much highei than its
expoit sophistication—although the uiffeience has
naiioweuiniecentyeais(Box4.1).
Third, the PRC holds few global brands in
manufacturing—despite being billed as the
“workshop of the world.” In 2u1u, theie weie
61 PRC fiims on the Foitune ulobal Suu list,
ianking thiiu aftei the 0S anu }apan (Foitune
2u11). Bowevei, an analysis of the top 2u fiims
in the list foi each countiy shows that only thiee
of the PRC’s top 2u weie manufactuieis. The
othei PRC fiims in the top 2u weie in iesouices,
constiuction, anu finance, with a piimaiily
uomestic maiket focus. The thiee manufactuiing
fiims (all automobile piouuceis) have combineu
annual ievenues equal to S% of PRC uBP in
that yeai, slightly below those of the 0S anu 0K
manufactuiing fiims in the top 2u (S% each) anu
well below those of the Republic of Koiea anu
}apan, with combineu ievenues of manufactuiing
fiims in the top 2u at 18% anu S2% of uBP,
iespectively(Figuie4.8).
Fourth, PRC patents in per capita terms are low,
although they have grown rapidly in recent years.
The PRC hau the thiiu highest numbei of new patent
iegistiations in the woilu in 2u1u, at 1SS,11u—
ianking only aftei }apan anu the 0S (Table 4.2).
0n a pei capita basis, howevei, the numbei of new
Table 4.1 PRC:Sbareofdomesticvalueaddedinexportsbyfirmownersbip,200ó
Share of total
domestic value added (%)
Share of processing
exports in total exports (%)
Share of exports by firm ownership
in total exports (%)
Wholly foreign owned 27.8 85.3 39.3
Joint venture firms 44.8 63.1 18.6
State-owned firms 70.0 27.1 19.8
Collectively-owned firms 70.9 24.7 4.3
Private firms 82.0 10.3 18.0
All firms 50.9 53.6 100.0
PRC = People’s Republic of China.
Note: Estimates for 2006 are preliminary as they use trade statistics in 2006.
Source: Koopman, Wang, and Wei (2008).
19
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
|uiowingbeyonutheLow-CostAuvantage
Box 4.1 Calculatingproductsopbisticationinexportsandimports
Figure B4.1-1 shows the level of export sophistication (EXPY) and import sophistication (IMPY) in the People’s Republic
of China (PRC) during 1998–2009. EXPY is constructed as a weighted average of the level of sophistication of the
products exported—a higher EXPY implies the country exports products more similar to those exported by advanced
countries. Analogously, IMPY is constructed as a weighted average of the level of sophistication of products imported.
Therefore, a higher IMPY implies the country imports products more similar to those exported by advanced countries.
The PRC’s IMPY is significantly higher than its EXPY. This means the import basket is more technologically sophisticated
than its export basket. However, the gap is narrowing. EXPY showed a 1.6% average annual growth rate during
1998–2009, while IMPY stagnated, indicating that PRC exports are becoming more sophisticated.
Figure B4.1-1 PRC:Exportandimportsopbistication,1998–2009
EXPY is calculated as the weighted average of the sophistication of the products (PRODY) a country exports:
where xval
ci
is the value of country c’s export of commodity i, and PRODY
c
is the weighted average of the GDP per capita
of the exporting countries:
PRODY
c
is measured in 2005 purchasing power parity (PPP) $. The average PRODYs are calculated for 5,111 products.
GDPPC
c
is country c’s per capita gross domestic product. Similarly, the sophistication level of the import basket (IMPY
c
)
of a country is calculated as the weighted average of the sophistication of the products (PRODY
i
) a country imports:
where mval
ci
is the value of country c’s import of commodity i.

The calculations are based on the Base pour l’Analyse du Commerce International (BACI) trade database, classified
under the Harmonized System 1996 and the gross domestic product per capita (measured in 2005 PPP $) from the
World Bank’s World Development Indicators Online database.
EXPY =
xval
™
c
PRODY
c
i ™
i
ci
xval
ci
PRODY =™
c
GDPPC
c
c
™
c ™
i
xval
ci
xval
ci
™
i
xval
ci
xval
ci
IMPY =
mval
™
c
PRODY
i
i ™
i
ci
mval
ci
PPP = purchasing power parity, PRC = People’s Republic of China.
Source: ADB staff estimates.
1998 1989 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
9,000
10,000
11,000
12,000
13,000
14,000
15,000
2
0
0
5

P
P
P

$
export sophistication import sophistication
2u
iegistiationsislow,at1u1peionemillionpopulation,
ianking 28th woiluwiue. Resiuents iegisteieu S9%
of PRC patents, much lowei than }apan, the Republic
of Koiea, anu the Russian Feueiation. The uistinction
between iesiuent anu noniesiuent iegistiations is
impoitant—asthelatteimaybelesslikelytoiesultin
commeicially viable piouucts being piouuceu within
thatcountiy.
4.2. Rising wages
Low-cost auvantage has playeu a ciitical iole
in uiiving the PRC’s iapiu giowth ovei the past
Su yeais. In the next 2 uecaues, howevei, its
impoitance will uiminish. Factoi piices—notably
laboi anu lanu—aie iising iapiuly anu will
unueimine the low-cost, high-investment stiategy
that woikeu veiy well uuiing the past S uecaues.
This will iequiie piouucing moie sophisticateu
PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Note: Switzerland (15) and the Republic of Korea (14) have fewer than 20 firms in Fortune Global 500.
Source: Fortune Global 500 Database.
-
10
20
30
40
50
60
0
1
2
3
4
5
6
7
8
9
10
PRC United
Kingdom
US France Japan Germany Switzerland Republic of
Korea
R
e
v
e
n
u
e

(
%

o
f

G
D
P
)

N
u
m
b
e
r

Revenue of manufacturing firms in the country's top 20 firms
Number of manufacturing firms in the country's top 20 firms
Figure 4.8 Manufacturersineacbcountry’stop20firmslistedinFortuneClobal500,2010
anu highei-value goous anu seivices to absoib the
auueucostsanuietaincompetitiveness.
Rising wages is the most seiious thieat to the
low-cost auvantage. Wages aie iising uue to
funuamental stiuctuial anu uemogiaphic factois
that will be uifficult to change. In the eaily yeais
of iefoim, the economy benefiteu fiom a laige
pool of suiplus laboi—estimateu at Su% of iuial
laboi in the 198us (Zhuang 1996). As inuustiy
expanueu,woikeismigiateutotakeupnewuiban
jobs. Because piouuctive woik was haiu to finu in
iuial aieas, uiban migiants eageily accepteu low
wages.Theseintuinalloweubusinessestoopeiate
at low cost, geneiating high piofits that coulu be
ieinvesteu into fuithei expansion. This stiuctuial
laboi ieallocation kept costs low, closely following
the concept of uevelopment thiough suiplus laboi
aseluciuateubyAithuiLewis(19S4).
Table 4.2 Patentgrants,2010
Top 6 countries Total
Percent share
by residents
Per 1 million
population
Rank in per 1 million
population
Japan 222,693 84 1,747 1
US 219,614 49 710 6
PRC 135,110 59 101 28
Republic of Korea 68,843 75 1,393 2
Russian Federation 30,322 71 214 15
Canada 19,120 10 560 8
PRC = People’s Republic of China, US = United States.
Sources: World Intellectual Property Organization (accessed August 2012) and World Bank, World Development Indicators Online
(accessed August 2012).
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
21
|uiowingbeyonutheLow-CostAuvantage
Theie aie inuications, howevei, that the PRC is
appioaching the so-calleu “Lewis tuining point”—
in which the laige supply of suiplus laboi shiinks
anu wages begin to iise (Cai 2u11, Ranis 2u12),
although this may be moie likely a phase extenuing
oveithenextuecaueoiso.Wageshaveiiseniapiuly
in iecent yeais, compaieu with the seconu half of
the 199us anu the eaily 2uuus (Figuie 4.9). 0vei
1996–2uuS, ieal inuustiial wages iose at a mouest
aveiageiateofS.S%peiyeai,aiatelessthanhalfof
laboi piouuctivity giowth (7.9% pei yeai). Between
2uu6anu2u1u,howevei,wagesgiewmuchhigheiat
7.7% pei yeai anu outstiippeu piouuctivity giowth
(which uippeu slightly to 6.4% pei yeai). The stoiy
in seivices is similai. Wages giew S.S% on aveiage
in the 1u yeais to 2uuS, consiueiably below aveiage
piouuctivity giowth (7.9% pei yeai). Wages then
iose1u.9%onaveiagepeiyeaioveithesubsequent
S yeais, wheieas piouuctivity incieaseu at a slightly
PRC = People’s Republic of China.
Note: Wage growth is based on total real wage bill per worker employed. Labor productivity growth is based on real value added per worker
employed. Wages and value added are deflated by the GDP deflator.
Sources: ADB staff estimates using wage and employment data from China Statistical Yearbook; GDP and GDP deflator from World Bank, World
Development Indicators Online (accessed September 2012).
–10
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10
15
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9
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6

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9

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2
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2
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a. Industry
b. Services
Wages Productivity
Wages Productivity
–5
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10
15
20
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5

1
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2
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2
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9

2
0
1
0

Figure 4.9 PRC:Realwageandlaborproductivitygrowtb,1995–2010
slowei pace (1u.1%). Inueeu, annual wage giowth
in seivices outstiippeu piouuctivity giowth foi the
fiisttimein2uu8anuhasiemaineuhigheisince.The
wageincieasesininuustiyanuseivicesaieapositive
sign foi income uistiibution anu consumption, but a
woiiyingonefoicompetitiveness.
ueneialwageincieaseshavebeenbolsteieubyiises
in official minimum wages—which aie set at the
piovincial level. Fast-giowing coastal piovinces, in
paiticulai, have iaiseu wages to attiact iemaining
countiysiue woikeis anu to keep those alieauy
migiateu. The ieal minimum wage in 12 coastal
piovinces giew on aveiage 8.8% annually in 2uuS–
2u11, with thiee piovinces—Fujian, Shanuong, anu
Liaoning—iaising the minimum wage moie than
1u% annually (Figuie 4.1u). Seveial coastal cities
began expeiiencing laboi shoitages as eaily as
2uuS.Thus,businessesthatweiecompetitivebaseu
22
on low-cost laboi aie moving factoiies inlanu in
seaichofwoikeiswillingtowoikatloweiwages.
The iapiu iise in uiban wages exaceibates eaining
uiffeientials between iuial faimeis anu uiban
woikeis, anu natuially piomotes iuial to uiban
migiation as people seek highei wages in the city.
0iban¡iuial eaining uiffeientials continue to be
massive—with uiban wages moie than thiee times
highei (Table 4.S). Buiing 2uuu–2uu9, nominal
eainings pei woikei tiipleu foi uiban ietail anu
wholesale tiaue, anu hotel anu cateiing, anu they
neaily tiipleu foi manufactuiing. 0vei the same
peiiou, agiicultuial eainings incieaseu by a moie
CPI = consumer price index, PRC = People’s Republic of China.
Note: Minimum wages are simple averages of low and high minimum wage range in the province. Real minimum wage is estimated using
provincial general CPI (2005 = 100).
Source: ADB staff estimates using minimum wage data from Ministry of Labor and Social Security; consumer price index data from NBS,
Provincial Statistical Yearbooks.
0
5
10
15
20
25
S
h
a
n
g
h
a
i

B
e
i
j
i
n
g

T
i
a
n
j
i
n

Z
h
e
j
i
a
n
g

G
u
a
n
g
d
o
n
g

H
e
b
e
i

J
i
a
n
g
s
u

S
h
a
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d
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g

F
u
j
i
a
n

L
i
a
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i
n
g

P
e
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c
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n
t
Annual growth rate 2005–2011 Annual growth rate 2010–2011
Figure 4.10 PRC:Crowtbofrealminimumwagesincoastalprovinces,2005–2011
Table 4.3 PRC:Laborearnings,urbanandrural,2000and2009{currentS]
2000 2009 Percent increase
Urban
Manufacturing 1,033 3,925 280
Construction 1,149 3,537 208
Retail and wholesale
trade, hotel and catering
895 3,660 309
Rural
Agriculture 424 1,056 149
PRC = People’s Republic of China.
Note: Rural per labor earnings calculated as per capita rural household net income adjusted by the dependence ratio. Figures converted into $
using official exchange rates.
Source: NBS, China Statistical Yearbook (accessed July 2011).
mouest factoi of 1.S, suggesting the uiban¡iuial
eainingsuiviuecontinueutowiuen.
Knight,Quheng,anuShi(2u11)estimatethatabout
169 million migiant woikeis weie woiking in
uiban aieas in 2u1u, with this expecteu to inciease
to 22S million by 2u1S, anu 292 million by 2u2u—
as migiants aie luieu by highei wages (Table 4.4).
Neanwhile, the numbei of uiban iesiuent woikeis
is expecteu to uecline fiom 1S1 million in 2u1u
to 147 million in 2u1S, anu 1S9 million in 2u2u.
Coiiesponuingly, total iuial laboi is expecteu to
uecline fiom 468 million in 2u1u to 4u9 million in
2u1S anu SS4 million in 2u2u. uiven these figuies,
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
2S
|uiowingbeyonutheLow-CostAuvantage
moie than 4S% of the laboi foice woulu iemain in
iuialaieasby2u2u,mostlyinagiicultuie.
Laboi maiket segmentation explains the
co-existence of iapiuly iising uiban wages against
the still laige pool of potential migiant iuial
woikeis. This can be attiibuteu to the hukuo
system unuei which uiban iesiuents enjoy social
welfaie entitlements that migiant woikeis lack.
12

These uiffeiential entitlements make migiation
costly,asmigiantwoikeismustpaytheseexpenses
fiom wages anu savings. This is likely one of
the causes of laboi shoitages in coastal cities in
iecent yeais. To continue to attiact iuial migiant
woikeis, fiims will have to pay highei wages
anu pioviue entitlements—auuing costs that can
only be absoibeu if piouuctivity incieases anu
outputisupgiaueu.
The supply of laboi in the PRC will also be affecteu
by iapiu population aging (Feinanuez-Lommen
2u1u, Paik 2u11). Since iefoims began, the PRC
benefiteu gieatly fiom the uemogiaphic uiviuenu
associateu with a iise in the shaie of the woiking-
age population to total population—an impoitant
suppoit foi economic giowth. Bowevei, uue to the
ueclining feitility iate anu iising life expectancy,
12
Social welfare entitlements that migrant workers lack include
unemployment insurance, pensions, maternal care, and health
insurance, among others.
Table 4.4 PRC:Urbanandrurallaborforceandmigration,millions,2005–2020
Urban labor
(1)
Rural migrants
working in urban
areas
(2)
Increase in
migrants

Rural labor
(3)
Decrease in
rural labor
Total Labor
force
(1+2+3)
2005 148 125 – 485 – 758
2010 151 169 44 468 –17 788
2015 147 225 56 409 –59 781
2020 139 292 67 334 –75 765
“–” means data not available, PRC = People’s Republic of China.
Note: “Rural labor” denotes rural workers working in the rural areas.
Source: Knight, Quheng, and Shi (2011), adapted.
the uemogiaphic uiviuenu is waning. Economically
inactive ietiiees account foi a high anu giowing
shaieofthetotalpopulation.Theiatioofthoseatoi
ovei age 6S ielative to the woiking age population
(ageu 1S–64) will inciease fiom 11% to 24%
ovei 2u1u–2uSu (Figuie 4.11). The woiking age
population is piojecteu to peak in 2u1S at slightly
below 1 billion anu begin shiinking afteiwaiu
(Figuie 4.12). The uemogiaphic uiviuenu coulu
become a uemogiaphic tax—wheie woikeis must
suppoit the elueily thiough highei taxes anu
contiibutionstosocialpiogiams(ABB2u11b).
Nany high-income countiies—such as }apan
anu many in Euiope—must also ueal with aging
populations. As living stanuaius anu health caie
impiove, people tenu to live longei. Also, feitility
iates tenu to uecline as incomes iise. Bowevei, PRC
has tiansitioneu at a much moie iapiu pace than
most countiies, in pait uue to the one-chilu policy
initiateuinthe197us.ThePRCnowfacestheunusual
piospect of giowing olu befoie it giows iich. This
has significant economic implications in ieuuceu
laboi supply, iising wages, anu giowing social
piotection neeus—most notably health caie anu
pensions,whichcanbecostlyfoithegoveinment,the
tax-payingpublic,anuonpeisonalsavings.
24
4.3. Imbalances in the sources of growth
The PRC’s iapiu economic giowth has been
accompanieu by incieasing imbalances in the
souices of giowth, especially since 2uuu. 0n the
uemanu siue, two imbalances have attiacteu
paiticulai attention: one between piivate
consumptionanuinvestmentanutheotheibetween
exteinal anu uomestic uemanu. 0n the supply
siue, imbalances exist between manufactuiing
anuseivices.
(a) Imbalance between private consumption
and investment
Piivate consumption as a shaie of uBP ueclineu
fiom about 47% in 199u to S4% in 2uu9, although
PRC = People’s Republic of China.
Source: United Nations, World Population Prospects: The 2010 Revision (accessed May 2011).
0
200
400
600
800
1,000
1,200
1
9
8
0

1
9
8
5

1
9
9
0

1
9
9
5

2
0
0
0

2
0
0
5

2
0
1
0

2
0
1
5

2
0
2
0

2
0
2
5

2
0
3
0

2
0
3
5

2
0
4
0

2
0
4
5

2
0
5
0

M
i
l
l
i
o
n
s

PRC = People’s Republic of China.
Source: United Nations, World Population Prospects: The 2010 Revision (accessed July 2011).
0
10
20
30
40
50
60
70
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
P
e
r
c
e
n
t

PRC Singapore Indonesia Republic of Korea
Malaysia Thailand Philippines Viet Nam
Figure 4.11 Ratio of population aged η͸ͷ to population aged ͳͷȂ͸Ͷǡ selected economiesǡ ͳͻͷͲȂʹͲͷͲ
Figure 4.12 PRC:Worhing-agepopulation,aged15–ó4,1980–2050
itincieaseutoS8%in2u11.Thishasbeenmiiioieu
by an inciease in the investment iate, fiom 26% of
uBP to 46% uuiing 199u–2uu9, befoie it ueclineu
to 44.4% in 2u11 (Figuie 4.1S). A uecomposition
analysis suggests that, uuiing 2uuu–2u1u, the
1u.S% aveiage annual uBP giowth consisteu
of 2.1 peicentage points contiibuteu by piivate
consumption, S.u peicentage points by fixeu
investment, 1.4 peicentage points by goveinment
consumption, anu 1.9 peicentage points by net
expoits (Figuie 4.14). Rapiuly inuustiializing
economies often have high investment iates—
but the PRC appeais to be exceptional. Bong
Kong, China; }apan; the Republic of Koiea; anu
Taipei,China all hau significantly lowei iates of
investment when they weie at the PRC’s cuiient
levelofuevelopment(Figuie4.1S).
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
2S
|uiowingbeyonutheLow-CostAuvantage
GDP = gross domestic product, PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed July 2012).
–10
0
10
20
30
40
50
P
e
r
c
e
n
t

o
f

G
D
P

Private consumption Government consumption
Investment Net exports
1
9
9
0
1
9
9
5
2
0
0
0
2
0
0
5
2
0
1
0
2
0
1
1
Figure 4.13 PRC:SbareinCDP,demandcomponents,1990–2011
GDP=gross domestic product, PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed July 2012).
4.5 4.4
2.1
3.0
0.4
2.6
3.4
0.9
1.1
2.5
1.2
6.4
–1.4
2.2
1.3 1.7
1.4
1.5
1.0
0.7
0.9
1.8 1.6
1.6
1.2
1.2
1.8
0.8
3.3
3.5
5.0
4.1
4.4
6.2
5.3
4.1
5.4
5.7
4.5
7.8
5.2
4.2
0.1
0.3
1.9
–0.3
3.3
0.5 0.6
4.5
4.6
4.3
2.7
–6.2
4.8
1.9
–9
–6
–3
0
3
6
9
12
15
1
9
8
0

1
9
9
0

1
9
9
0

2
0
0
0

2
0
0
0

2
0
1
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
5

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

2
0
1
1

P
e
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a
g
e

p
o
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t

Private consumption Government consumption Investment Net exports GDP growth
Figure 4.14 PRC:ContributiontoCDPgrowtb,demandcomponents,1980–2011
Bothaueclineinhouseholuincomeanuaninciease
in householu savings contiibuteu to the uecline
in piivate consumption—all as a shaie of uBP. The
shaie of householu income in uBP ueclineu fiom
64%in199StoS8%in2uu9,causeubyaueclinein
the shaie of laboi income in uBP, which, accoiuing
toBeianuQian(2uu9),fellby1upeicentagepoints
uuiing2uuu–2uu7(Figuie4.16).Toalaigepait,the
uecline in the shaie of laboi income was uue to the
PRC’s stiuctuial shift fiom agiicultuie (wheie laboi
income shaie is highei) to nonagiicultuie sectois
(wheie laboi income shaie is lowei).
1S
In 2u1u, an
estimateu 169 million migiants weie woiking in
uibanaieas,withmostofthemigiationtakingplace
inthepast1uyeais.By2u1S,thefiguieisexpecteu
toieach22Smillion(Knight,Quheng,anuShi2u11).
13
Part of the decline in the share of labor income was due to changes in
the national income accounting method introduced in 2003–2004
(see Bei and Qian 2009).
26
In auuition, the shaie of laboi income in inuustiial
value auueu has also ueclineu, paitly uue to the
shiinking state-owneu enteipiise (S0E) sectoi,
whichpayshigheiwagesthanpiivatefiims(Beianu
Qian2uu9).Theueclineintheshaieoflaboiincome
in uBP also ieflects the fact that a laige supply of
iuial migiant woikeis has constiaineu wage iate
giowthinuibanlaboimaikets.
A ueclining shaie of laboi income implies a iising
shaie of ietuins to capital in uBP. If capital is
owneu by householus, the impact of these changes
GDP = gross domestic product, PRC = People’s Republic of China, t = time.
Note: Investment data for the PRC and the Republic of Korea are from World Development Indicators Online, and for Japan; Hong Kong, China; and
Taipei,China from Penn World Tables. Time t represents the year an economy’s GDP per capita in 2005 purchasing power parity dollars reached
about $4,400 (2000 for the PRC; 1957 for Japan; 1962 for Hong Kong, China; 1976 for the Republic of Korea. Year t-10 is the 10 years prior
to year t and t+10 is the 10 years after year t.
Sources: World Bank, World Development Indicators Online and Heston et al. (2009), Penn World Tables 6.3 (all accessed June 2011).
10
15
20
25
30
35
40
45
50
t-10 t
Time
t+10
P
e
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c
e
n
t

PRC Japan Republic of Korea Hong Kong, China Taipei,China
Figure 4.15 InvestmentsbareinCDP,selectedAsianeconomies
GDP = gross domestic product, PRC = People’s Republic of China.
Note: Data on labor income as % of total value-added for more recent years are unavailable.
Sources: Bei and Qian 2009; CEIC; NBS, China Statistical Yearbook (accessed May 2011).
0
10
20
30
40
50
60
70
45
35
59
47
18
23
33
46
12
22
1995 2009 1995 2007 1995 2009 1995 2009 1995 2009
Household
consumption
(% of GDP)
Labor income
(% of total
value added)
Household
savings
(% of GDP)
Investment
(% of GDP)
Corporate
savings
(% of GDP)
P
e
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c
e
n
t

Figure 4.16 PRC:Consumption,laborincome,savingsandinvestment,1995and2009
on householu income anu hence consumption may
not be that significant—as uecieasing laboi income
woulu be compensateu by incieasing non-laboi
incomefoihouseholus.InthePRC,howevei,alaige
pait of piouuctive assets in nonagiicultuie sectois
is owneu by S0Es—Su% in the inuustiial sectoi in
2uu8.Anincieasingshaieofcapitalincomeimplies
a tiansfei of factoi income fiom householus to the
state in the foim of ietaineu S0E piofits, a laige
paitofwhichwaschanneleuintocoipoiatesavings
anu new investment. Buiing 199S–2uu9, the shaie
of coipoiate savings in uBP incieaseu fiom 12%
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
27
|uiowingbeyonutheLow-CostAuvantage
to 24% (Figuie 4.16). The PRC’s cuiient level of
coipoiate savings as a shaie of uBP is moie than
twicethatofInuia,thePhilippines,anuTaipei,China.
The PRC’s aggiegate householu savings stoou at
aiounu 18% of uBP in 199S, ueclineu to 1S% in
2uu1, but iose to 2S% in 2uu9. In 2uu9, the PRC
householu savings iate was at pai with that of
Inuia, but 1u times highei than the Republic of
Koiea anu moie than 4 times as high as the 0S
(seeTable2.1).Thelackofeffectivesocialpiotection
systemshasoftenbeenciteuasakeyuiiveifoihigh
householu savings. Noie iecent stuuies (Chamon
anu Piasau 2u1u; Chamon, Liu, anu Piasau 2u1u)
finu that motives of savings foi piecautionaiy
puiposes uue to iising income unceitainty
(a iesult of maiket-oiienteu iefoims) anu foi
housing puichases explain iising householu saving
iates of young auults, anu pension iefoims anu
iising own-pocket meuical expenuituies account
foi much of the iise in savings iates of householus
heaueu by oluei auults. All these motives aie
amplifieu by the lack of instiuments foi boiiowing
against futuie income anu limiteu oppoitunities foi
poitfoliouiveisification(ChamonanuPiasau2u1u).
0theifactois,tovaiyinguegiees,havealsocontiibuteu
to the PRC’s low levels of piivate consumption
anu high investment. Fiist, as uiscusseu eailiei,
the PRC ueposit inteiest iates weie contiolleu by
the goveinment anu iankeu lowest in ieal teims
among high- anu miuule-income countiies in the
last 2u yeais—a sign of financial iepiession. Low
uepositinteiestiatesimplyatiansfeiofincomefiom
net saveis (householus) to net boiioweis (S0Es).
Seconu,alaigenumbeiofS0Esaienowlisteuonthe
stock exchanges, anu they aie known foi paying little
uiviuenus (Business China 2u1u), which incieases
coipoiate savings anu to some extent coulu be
explaineu by coipoiate goveinance weakness. Thiiu,
S0Es,faceuwithlowcieuitcostsanuoftensuppoiteu
bylocalgoveinments,havestiongincentivestoinvest.
In sum, a combination of factois contiibuteu to the
low anu ueclining shaie of piivate consumption
in uBP anu the imbalances between piivate
consumption anu investment. To some extent,
these aie inheient in the stiuctuial tiansfoimation
anu economic tiansition piocesses that the PRC is
cuiiently unueigoing. In this iegaiu, iapiu giowth
in uiban wages in iecent yeais is a welcome
uevelopment—as it suggests the countiy is
appioaching a tuining point wheie the shaie of
householu income in uBP may soon ieveise iecent
tienus. Bowevei, to eliminate the imbalance anu
incieasepiivateconsumption,thePRCwillalsohave
to auuiess vaiious institutional weaknesses in social
piotection, piovision of public goous anu seivices,
financial sectoi uevelopment, anu factoi maiket
anu enteipiise iefoim. Supply-siue measuies, such
as seivice sectoi uevelopment, will also play an
impoitantioleinstimulatingpiivateconsumption.
Peisistentimbalancesbetweenpiivateconsumption
anu investment coulu unueimine giowth
sustainability. While high investment is geneially
gooufoiuevelopingcountiies,excessiveinvestment
can leau to oveicapacity, pooi asset quality,
incieaseu vulneiability of banking anu the financial
sectoi, anu economic inefficiency. This coulu, in
tuin,incieasetheiiskoffinancialciisesueveloping.
Buiing 2uuu–2uu9, inuustiial S0E aveiage annual
piofitability (iate of ietuin on assets) was 4.S%,
while that of inuustiial non-S0Es was 7.4%,
inuicating significant ioom foi S0Es to impiove
investmentefficiency.Weakhouseholuconsumption
is not conuucive to impioving quality of life—a
funuamental goal of uevelopment. It also incieases
thePRCeconomy’sielianceonexteinaluemanuanu
vulneiabilitytoexteinalshocks.
(b) Imbalance between domestic and
external demand
The imbalance between exteinal anu uomestic
uemanu is inuicateu by the PRC’s shaie of net
expoits in uBP, which incieaseu fiom 2.4% in
2uuu to 8.8% in 2uu7, befoie moueiating to
2.8% in 2u11 (Figuie 4.1S). A consequence of
this has been laige tiaue suipluses anu a iapiu—
often “contioveisial”—accumulation of foieign
ieseives—$S.18tiillionattheenuof2u11(People’s
28
Bank of China 2u12), the highest in the woilu.
Expoit-leu giowth has been ciitical to the “East
Asian Niiacle” (Woilu Bank 199S). Foi example,
the Republic of Koiea’s aveiage expoits¡uBP iatio
was SS.9% in 198us, Su.8% in 199us, anu 41.8%
in 2uuus. While these aie compaiable to the PRC
aveiage of S1.u% uuiing 2uuu–2u1u, the Republic
of Koiea’s net expoits weie not as significant when
it was at a similai uevelopment stage. Buiing the
1u yeais befoie anu aftei ieaching $4,uuu pei
capita—close to the cuiient PRC level—net expoits
intheRepublicofKoieaweieinfactnegativeuuiing
most of the peiiou (Figuie 4.17). In }apan, net
expoitsweieinsignificantasashaieofuBP.
P
e
r
c
e
n
t

–15
–10
–5
0
5
10
t–10
t
Time
t+10
PRC Japan Republic of Korea Hong Kong, China
GDP = gross domestic product, PRC = People’s Republic of China, t = time.
Note: Time t represents the year an economy’s GDP per capita in 2005 purchasing power parity dollars reached about $4,400
(2000 for PRC; 1957 for Japan; 1962 for Hong Kong, China; 1976 for the Republic of Korea. Year t-10 is the 10 years prior to year t and
t+10 is the 10 years after year t.
Sources: Heston, Summers, and Aten (2009), Penn World Tables 6.3; and World Bank, World Development Indicators Online (all accessed June 2011).
Figure 4.17 NetexportssbareinCDP,selectedAsianeconomies
PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed August 2012).
–4
–2
0
2
4
6
8
10
12
14
16
2005 2006 2007 2008 2009 2010 2011
P
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n
t

PRC India Malaysia
Singapore Thailand Republic of Korea
Figure 4.18 Crowtbslowdownduringtberecentglobaleconomiccrisis,
selectedAsianeconomies,2005–2011
0vei-ieliance on expoits as a souice of uemanu
incieasesvulneiabilitytoexteinaleconomicshocks,
as occuiieu in many emeiging Asian economies
uuiing the 2uu8–2uu9 global financial ciisis
(Figuie 4.18). Foi laige economies like the PRC,
peisistently laige tiaue suipluses also contiibute
to global imbalances anu can leau to piotectionism
by tiauing paitneis—which huit both. It has been
aigueu that the PRC’s laige tiaue suiplus is the
iesult of an expoit-oiienteu giowth mouel baseu
on low factoi piices, incentives to manufactuiing
anu heavy foieign investment (Yao anu Yu 2uu9,
Yao 2u11). Stiong expoit peifoimance has also
been suppoiteu by a competitive exchange iate,
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
29
|uiowingbeyonutheLow-CostAuvantage
while weak uomestic consumption, along with
the exchange iate, has tenueu to limit impoits.
Theiefoie,auuiessingthisimbalanceiequiiespolicy
actions in all these aieas. While low factoi piices
anu a competitive exchange iate make expoits
competitive,theyweakenincentivesoipiessuiesfoi
innovationanuupgiauinginuustiy.
(c) Imbalance between manufacturing
and services
0nthesupplysiue,theimbalanceismainlybetween
inuustiy (paiticulaily manufactuiing) anu seivices.
In2u1u,PRCseivicesasashaieofuBPwas4S.1%,
compaieu with Su% on aveiage foi low-income
countiies, S2% foi lowei-miuule-income countiies,
GDP = gross domestic product, PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed January 2012).
0
10
20
30
40
50
60
70
80
2000 2010
P
e
r
c
e
n
t

PRC Low income Lower middle income Upper middle income High income
PRC = People’s Republic of China.
Note: Data for PRC is for 2010.
Source: ADB, Key Indicators for Asia and the Pacific 2012.
34.6
47.4
49.5
58.2
70.3
76.7
79.6
86.7
0
10
20
30
40
50
60
70
80
90
100
PRC Thailand Indonesia Philippines Malaysia Republic of
Korea
Japan Australia
P
e
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t

o
f

t
o
t
a
l

e
m
p
l
o
y
m
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n
t
Figure 4.19 ServicesectorsbareinCDP,bycountrygrouping,2000and2010
Figure 4.20 Employmentinservices,selectedeconomies,2011
S6% foi uppei-miuule-income countiies, anu ovei
7S% foi high-income countiies (Figuie 4.19). The
seivice sectoi’s shaie of employment is even lowei,
at about SS% in 2u11, compaieu with Thailanu
(47%), Inuonesia (Su%), the Philippines (S8%),
Nalaysia(7u%),theRepublicofKoiea(77%),}apan
(8u%),anuAustialia(87%)(Figuie4.2u).
Noie uisaggiegateu uata show that, in 2uu9, as
a shaie of uBP, most of the PRC’s majoi seivices
subsectois unueipeifoimeu compaieu with
uevelopeu economies such as the 0S anu }apan,
anu miuule-income countiies such as Inuia, the
Philippines, anu Thailanu, with the exception
of tianspoit anu stoiage (Table 4.S). The least
uevelopeu subsectoi is communication, finance,
Su
anu business seivices. Foi instance, in 2uu9, this
subsectoi accounteu foi 9.4% of uBP in the PRC,
compaieu to the 2S.1% in the 0S, 17.2% in }apan,
16.1% in the Republic of Koiea, 14.6% in Nalaysia.
Anothei subsectoi with a veiy low shaie of uBP
in compaiison with othei countiies is public
auministiation, community, peisonal, anu othei
seivices. Seivice sectoi laboi piouuctivity is also
low. In 2u1u, foi example, annual value auueu
pei woikei foi seivices was only 68% of that foi
inuustiy(Figuie4.21).
The unueiuevelopment of PRC seivices ielative to
manufactuiing can be attiibuteu to seveial factois,
PRC = People’s Republic of China, US = United States.
Sources: ADB staff estimates using sector value-added data from World Bank, World Development Indicators Online and employment data from
NBS, China Statistical Yearbook (all accessed August 2012).
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
1990 2000 2005 2010

U
S

d
o
l
l
a
r

Agriculture Industry Services
Figure 4.21 PRC:Levelsoflaborproductivitybysector,1990–2010
Table 4.5 Servicessbaresintotalvalueadded,selectedeconomies,2010{¦]
Economy
Total
services
Wholesale
and retail
trade
Hotels and
restaurants
Transport
and
storage
Real
estate and
dwellings
Communication,
finance, and
business
services
Public
administration,
community,
personal, and
other services
US 80.2 11.6 3.8 2.8 12.2 25.1 24.8
Japan 72.6 12.3 – 4.5 13.0 17.2 25.7
Republic of Korea 58.5 8.6 2.3 4.2 7.2 16.1 20.1
Philippines 55.1 17.4 – 3.9 6.5 13.9 13.4
Thailand 43.0 13.1 4.7 4.1 1.4 7.7 12.0
Malaysia 46.0 11.9 2.3 3.3 4.1 14.6 9.7
India 54.7 15.1 1.4 6.4 6.1 11.0 14.5
PRC 43.4 8.5 2.1 4.9 7.3 9.4 11.2
PRC = People’s Republic of China, US = United States.
Note: “–” means data not available or combined with “other services.” Data for PRC and Japan refer to 2009.
Source: ADB staff estimates using data from CEIC (accessed April 2012).
many policy-ielateu (Xu 2u11). Fiist, many seivice
subsectois iemain subject to significant entiy
baiiieisoicloseutopiivatecompetition—incluuing
iail tianspoit, telecommunications, euucation,
health caie, anu financial seivices. Seconu, ceitain
aspectsofthePRC’smacioeconomicanutaxpolicies
aie not conuucive to seivices uevelopment. The
expoit-oiienteugiowthmouelfavoismanufactuiing
insteau of laigely non-tiauable seivices, anu
seiviceshaveuntiliecentlybeensubjecttobusiness
tax insteau of the less oneious value-auueu tax
useu foi manufactuiing (Ping et al. 2uu9, Xu 2u11).
Thiiu, seivices uevelop with the uiban economy
anu this has been hampeieu by the ielatively low
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
S1
|uiowingbeyonutheLow-CostAuvantage
level of uibanization. Finally, laige enteipiises tenu
to pioviue business seivices in-house because the
uevelopmentofaueepeioutsouicingcultuiehasyet
totakeioot.
The unueiuevelopment of seivices has significant
implications foi the stiuctuie of the PRC economy.
Fiist, seivices aie geneially laboi intensive, anu
theii unueiuevelopment means a laige numbei
of potential jobs have not been cieateu. This
has implications on wage iates, laboi incomes,
anu householu consumption—contiibuting to
imbalances on the uemanu siue. Seconu, many
seivicesaiecloselyielateutohumanwellbeinganu
the quality of life. 0nueiuevelopeu seivices such as
euucation anu health caie affects the quality of life.
Thiiu, business seivices help impiove inuustiial
piouuctivity, anu thus theii absence is a baiiiei to
impiovinginuustiialpiouuctivity.
4.4. Rising income inequality
Since the PRC embaikeu on economic iefoim,
income inequality has iisen significantly. The
countiy’s oveiall uini coefficient of pei capita
consumption expenuituie—a measuie of
inequality—incieaseu fiom about Su in the
Lao PDR = Lao People's Democratic Republic, PRC = People's Republic of China.
Note: Gini coefficients are based on consumption data except for Malaysia and Singapore (income-based). Latest available data for Indonesia (2011);
Bangladesh, India, the Republic of Korea, and Nepal (2010); Kazakhstan, the Kyrgyz Republic, the Philippines, Tajikistan, and Thailand (2009); Armenia,
Azerbaijan, Cambodia, Georgia, Lao PDR, PRC, and Viet Nam (2008), Afghanistan, Bhutan, Mongolia, and Pakistan (2007); Sri Lanka (2006); the Maldives
(2004), Uzbekistan (2003).
Source: PovcalNet (accessed March 2012), supplemented by ADB estimates from household survey data (India and PRC).
0
5
10
15
20
25
G
i
n
i

c
o
e
f
f
e
c
i
e
n
t
30
35
40
45
50
28.9 29.0
30.0
30.8 30.9
32.1
32.8
33.7
35.6
36.2
36.5 36.7 36.7
37.0 37.4 37.9
38.1 38.9
40.0 40.3
41.3
43.0
43.4
46.2
48.2
R
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n
k
a

G
e
o
r
g
i
a

P
h
i
l
i
p
p
i
n
e
s

P
R
C

M
a
l
a
y
s
i
a

S
i
n
g
a
p
o
r
e

Figure 4.22 Incomeinequality,selectedeconomies,latestavailable
eaily 198us to 4S.4 in 2uu8, among the highest
in Asia (Figuie 4.22). Bisaggiegateu uata show
that inequality incieaseu in both iuial anu uiban
sectois—iuial inequality incieaseu fiom Su.6 in
199u to S9.4 in 2uu8, while uiban inequality
incieaseufiom2S.6toSS.2uuiingthesamepeiiou
(Figuie4.2S).Bighanuiisinginequalitycanietaiu
giowth as low-income householus contiibute little
to effective uemanu anu aie unable to invest in
boosting human capital thiough impioveu health
anueuucation.Beyonutheuiiecteconomiceffects,
inequality has the potential to ignite social uniest,
whichcanueiailthegiowthpiocess.
It is not just the PRC that expeiienceu iising
inequality in Asia. Nany othei Asian countiies,
such as Inuia, Inuonesia, anu the Republic of Koiea,
have also seen uini coefficients iise in iecent yeais.
A iecent stuuy by ABB (2u12b) iuentifies seveial
funuamental uiiveis of iising inequality in Asia.
Technological piogiess, globalization, anu maiket-
oiienteu iefoim have leu to iapiu giowth anu
openeuenoimousnewoppoitunitiesfoieconomies
to piospei. But they have not benefiteu all people
equally. These uiiveis affect income uistiibution
thiough thiee channels—(i) iising skill piemiums¡
ietuins on euucation, (ii) ueclining contiibution
S2
of laboi to total income, anu (iii) incieasing
spatial inequality. Fuithei, the impact has been
compounueu by unequal access to oppoitunity
uue to vaiious goveinance weaknesses, maiket
impeifections,anupolicyuistoitions.
Buiing 199S–2uu7, the shaie of total inequality
that can be explaineu by uiffeiences in euucational
attainment incieaseu fiom 8.1% to 26.S% in the
PRC (Figuie 4.24). Kang anu Peng (2u1u) pioviue
eviuence fiom suivey uata that ietuins on highei
euucation (univeisities anu piofessional schools)
incieaseu, while ietuins on uppei- anu lowei-
miuule schooling uecieaseu fiom the 199us to
PRC = People’s Republic of China.
Note: Gini coefficients are based on per capita consumption expenditure.
Source: ADB, Asian Development Outlook 2012.
0
10
20
30
40
50
1990 1993 1996 1999 2002 2005 2008
G
i
n
i

c
o
e
f
f
i
c
i
e
n
t

Urban Rural
Figure 4.23 PRC:Urbanandruralinequality,1990–2008
PRC = People’s Republic of China.
Note: Estimates are based on per capita consumption expenditure in nominal terms, except for the PRC, which is based on income. The
decomposition is based on the generalized entropy measure GE (0).
Source: ADB, Asian Development Outlook 2012.
0
5
10
15
20
25
30
35
40
45
50
8
26
20
30 30
24
23
25
31
36
44
46
1
9
9
5

2
0
0
7

1
9
9
3

2
0
0
9

2
0
1
0

1
9
9
0

2
0
1
0

2
0
0
2

2
0
0
8

1
9
9
4

2
0
0
9

1
9
9
5

2
0
0
5

PRC India Indonesia Pakistan Philippines Thailand
S
h
a
r
e

o
f

b
e
t
w
e
e
n
-
g
r
o
u
p
i
n
e
q
u
a
l
i
t
y

(
%
)
Figure 4.24 Sbareofinequalityrelatedtoeducationalattainment,selectedeconomies
the 2uuus. Figuie 4.24 shows that, among the
Asian countiies listeuǡ about ʹͷΨΫ͵ͷΨ of total
inequalitycanbeexplaineubyintei-peisonoiintei-
householu uiffeiences in human capital anu skill
enuowments in the late 2uuus. The PRC uoes not
iankhighest,butitsincieaseoveitimehasbeenthe
most significant. Theie is a laige bouy of liteiatuie
on how globalization (especially tiaue integiation)
anu technological change can inciease wage
uiffeientials between skilleu anu unskilleu woikeis
(ABB 2u12b). Foi the PRC, the move towaiu
maiket-oiienteu wage ueteimination as a iesult of
enteipiiseiefoimisalsoamajoicontiibutingfactoi
toiisingskillpiemiums.
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
SS
|uiowingbeyonutheLow-CostAuvantage
A uecline in the shaie of laboi income in total
income—oi a iise in the shaie of capital income—
incieases inequality because capital incomes aie
in geneial less equally uistiibuteu. Figuie 4.16
showsthat,between199Sanu2uu7,laboiincome
as a shaie of total value auueu foi the entiie PRC
economy ueclineu fiom S9% to 47%. The shaie of
laboi income in manufactuiing value auueu also
fell uuiing the same peiiou, fiom 48% to 42%
(ABB 2u12b). This uecline in laboi income shaie
is not confineu to the PRC. In fact, many countiies
globally, both uevelopeu anu ueveloping, have
expeiienceu a uecline in the shaie of laboi income
iniecentyeais,paitlyattiibutabletotechnological
change (ABB 2u12b). Foi the PRC, howevei, two
othei factois have also playeu an impoitant iole.
0ne is the laige amount of iuial suiplus laboi—
associateu with the uual economy—that puts
uownwaiu piessuie on uiban wages uespite the
iapiu giowth of laboi piouuctivity. The othei is
wagesystemiefoimanuthemovetowaiumaiket-
oiienteuwageueteimination.
A moie impoitant contiibuting factoi to iising
inequality in the PRC is incieasing spatial
inequality. The impact of technological piogiess,
globalization, anu maiket-oiienteu iefoim aie
usually geogiaphically uneven, leauing to iising
PRC = People’s Republic of China.
Note: Spatial inequality covers both between-regions and between-urban/rural inequality. The estimation involves dividing all sample households
into groups classified by both region and urban/rural. For example, if a country has 20 provinces, the total groups will be 40 (20 for urban and
20 for rural). The between-group inequality is the combined spatial inequality.
Source: ADB staff estimates using household survey data.
0
10
20
30
40
50
60
Sri Lanka
(2009)
Philippines
(2009)
Pakistan
(2008)
Indonesia
(2009)
India
(2008)
Viet Nam
(2008)
PRC
(2007)
S
h
a
r
e

o
f

s
p
a
t
i
a
l

i
n
e
q
u
a
l
i
t
y

t
o

t
o
t
a
l

i
n
e
q
u
a
l
i
t
y

(
%
)

13
21
22
26
32
35
54
Figure 4.25 Contributionofspatialinequality,selectedeconomies,late2000s
spatial inequality. This is because new economic
oppoitunities, ieleaseu by these giowth uiiveis,
often appeai closei to existing tiaue ioutes—foi
example, coastal aieas—anu in aieas with bettei
public infiastiuctuie, mostly cities (Lewis 1976).
Economists have also highlighteu the iole of
agglomeiation benefits—wheie, as concentiation
uevelops fiom natuial oi othei auvantages
(such as those ielateu to policy), theie is a self-
peipetuating piocess of incieasing concentiation
(Kiugman2uu8).
Becomposition analysis shows that moie than
half of the PRC’s total inequality in 2uu8 can be
explaineu by spatial inequality—iuial¡uiban
income gaps anu intei-piovincial uispaiities
combineu. This was the highest among selecteu
Asian countiies (Figuie 4.2S). Buiing 199u–2u1u,
the iatio of pei capita uisposable income between
uiban anu iuial householus incieaseu fiom 2.2 to
S.2.
14
At the same time, the uini coefficient of
piovincial pei capita mean income incieaseu fiom
22.6 in 199u to 27.6 in 2uuS—befoie uiopping to
24.7 in 2uu8 anu 22.7 in 2u1u (ABB 2u12b). This
suggests the inciease in spatial inequality has been
uiiven laigely by wiuening uiban¡iuial income
gaps.Thisisconfiimeubyuecompositionanalysis—
Figuie 4.26 shows that the shaie of PRC total
14
See China Statistical Yearbook 2011.
S4
inequality ueiiveu fiom uiban¡iuial income gaps
incieaseufiom2u%in199utoS2%in2uu8,while
the shaie fiom intei-piovincial inequality iemaineu
moieoilessunchangeuatslightlyovei1u%.
Toalaigeextent,highanuiisinginequalityinthePRC
isalsouuetoincompleteiefoims,iemainingbaiiieis
to factoi mobility, anu weaknesses in goveinance—
leauing to unequal access to oppoitunity. Foi
example, the hukuo system—wheie uiban iesiuents
with hukuo anu iuial migiant woikeis without
PRC = People’s Republic of China.
Source: Taken from Cai (2011).
0
10
20
30
40
50
60
Maternity
insurance
Unemployment
insurance
Work injury
insurance
Basic
health care
Basic
pension
P
e
r
c
e
n
t

o
f

t
o
t
a
l

Urban workers Migrant workers
PRC = People’s Republic of China.
Note: Estimates are based on per capita income adjusted by cost of living between urban and rural areas and across provinces. For more details
on the adjustment, see Lin, et al. (2008). The decomposition is based on the generalized entropy measure GE (0).
Source: ADB staff estimates using PRC provincial grouped household income data sources from Provincial Statistics Yearbooks; Lin et al. (2008).
0
5
10
15
20
25
30
35
1990
P
e
r
c
e
n
t
1995 2000 2005 2008
Between urban–rural Betweeen province
Figure 4.26 PRC:SbaresofinequalityaccountedforbyurbanJruralincomegapsand
inter-provincialdisparities,1990–2008
Figure 4.27 PRC:Socialprotectioncoveragebyurbanandmigrantworhers,2009
hukuo have uiffeient social welfaie entitlements
such as access to euucation, health caie, social
piotection, anu housing, among otheis, continues as
a significant weuge in income levels between uiban
anu iuial aieas anu acioss piovinces (Figuie 4.27).
Some inuustiies enjoy monopolistic powei uue to
entiy baiiieis, leauing to monopolistic ients anu
incieasing intei-inuustiy wage uiffeientials (Chen,
Lu, anu Wan 2uu9). The laige goveinment iole
in iesouice allocation, extensive uiiect economic
inteivention,anuweaknessesingoveinancehasalso
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
SS
|uiowingbeyonutheLow-CostAuvantage
leftwiuescopefoiient-seekingbythosewithspecial
piivileges anu connections, making theii eainings
significantlyhigheithanotheis.
4.5. Natural resource and
environmental constraints
ThePRC’siapiueconomicgiowthplacesincieasing
piessuie on its natuial iesouices. Among many
constiaints, watei anu eneigy attiact the most
attention. Rapiu giowth also iaises concein
ovei enviionmental sustainability. Aii anu watei
pollution cieates health pioblems anu uamages
the quality of life, with C0
2
emissions contiibuting
to global climate change. These aie some of the
most seiious challenges the PRC faces in the
cominguecaues.
Water resource constraints
ThePRChasthewoilu’sfifthlaigestavailablewatei
iesouices—aftei Biazil, Russian Feueiation, the
0S, anu Canaua. Yet its pei capita watei availability
uuiing 2uuS–2uu7, at 2,12Sm
S
,

is only about one-
quaitei of the global aveiage (Figuie 4.28). The
extiemely uneven spieau of watei iesouices is
also a significant pioblem. Annual pei capita watei
availability in the noith is one-fouith of that in the
south—below the “watei scaicity” level of 1,uuum
S
peipeison

(WoiluBank2uu9).
The PRC’s watei iesouices anu availability aie being
affecteu by two majoi factois—the changing pattein
of iainfall—which may have been ielateu to climate
change (Paiiy et al. 2uu7)—anu watei pollution.
Between19S6–1979anu198u–2uuu,annualiainfall
in foui majoi iivei basins in Noithein PRC (Yellow,
Bai, Liao, anu Buai) fell by an aveiage 6%, ieuucing
suiface watei by 17% anu total watei iesouices
by 12% (}iang anu Buang 2u11). In Southein PRC,
by contiast, iivei basin watei iesouices incieaseu
slightlybetweenthesametwopeiious.
The effects of watei pollution—paiticulaily on
suiface watei—have been moie seiious. The
goveinment’s 2uu9 Repoit on Enviionmental
Statement (NEP 2u1u) inuicates that suiface
watei pollution iemains seveie nationwiue uespite
iecent effoits to contiol it. 0f the 4u8 sections
of 2uS iiveis monitoieu, only S7.S% aie safe foi
human consumption aftei tieatment (I–III classes),
24.S% aie safe foi inuustiial anu iiiigation use
only (classifieu Iv–v), anu 18.4% aie unsafe foi any
use (below class v).
1S
Watei quality in noithein
iivei basins is notably woise than the Yangtze anu
Zhuiiveis.
Inuustiial anu uomestic wastewatei, along with
feitilizei anu pesticiue iunoffs fiom agiicultuial,
animal,oiaquaticpiouuction,aiepiimaiysouicesof
watei pollution. With stiongei policy inteiventions
15
Based on PRC’s environmental quality standards for surface water
(GB 3838-2002).
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
India PRC World US Russian
Federation
Brazil Canada
W
a
t
e
r

r
e
s
o
u
r
c
e
s
p
e
r

c
a
p
i
t
a

(
m
3
)
m
3
= cubic meter, PRC = People’s Republic of China, US = United States.
Source: FAO, AQUASTAT database (accessed September 2012).
Figure 4.28 Percapitawaterresourceavailability,selectedeconomies,2010
S6
anu toughei iegulations, inuustiial wastewatei
uischaiges have been on a uowntienu since 2uuS.
The piopoition of tieateu inuustiial wastewatei
meeting uischaige stanuaius has also incieaseu—
above 9u% in iecent yeais (Figuie 4.29). Bowevei,
uomestic wastewatei uischaige anu “non-point
souice” watei pollution
16
fiom iuial aieas have
been giowing. Bomestic wastewatei uischaige has
suipasseu inuustiial wastewatei anu incieaseu
iapiuly—fiom26,127milliontonsin2uu4toSS,uuS
milliontonsin2uu8.
16
Non-point source water pollution results from diffuse sources,
including land runoff, precipitation, atmospheric deposition,
drainage, seepage, or hydrologic modification.
0
20
40
60
80
100
120
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
1991 2000 2005 2010
I
n
d
u
s
t
r
i
a
l

w
a
s
t
e
w
a
t
e
r

m
e
e
t
i
n
g

d
i
s
c
h
a
r
g
e

s
t
a
n
d
a
r
d
s

(
%
)
W
a
s
t
e
w
a
t
e
r

d
i
s
c
h
a
r
g
e

(
m
i
l
l
i
o
n

t
o
n
s
)
Domestic wastewater discharge Industrial wastewater discharge
Industrial wastewater meeting discharge standards
PRC = People’s Republic of China.
Source: NBS, China Statistical Yearbook (accessed September 2012).
CNY = Chinese yuan, GDP = gross domestic product, PRC = People’s Republic of China.
Note: GDP and industrial value added are in 2009 constant prices.
Source: NBS, China Statistical Yearbook (accessed September 2012).
0
50
100
150
200
250
300
350
400
450
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
C
u
b
i
c

m
e
t
e
r
s

p
e
r
C
N
Y
1
0
,
0
0
0
Water use per unit GDP Water use per unit industrial value-added
Figure 4.29 PRC:Wastewaterdiscbarges,1991–2010
Figure 4.30 PRC:Wateruseefficiency,2000–2009
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
The PRC’s total watei use amounteu to S97 billion
m
S
in 2uu9, with agiicultuie accounting foi 62.4%,
inuustiy 2S.4%, anu uomestic use 12.S%. Buiing
2uuu–2uu9, total watei use giew appioximately 1%
annually. At the same time, watei use efficiency has
been impioving. Watei use intensity fell S6% uuiing
2uuu–2uu9, fiom S96m
S
to 17Sm
S
pei CNY1u,uuu of
uBP (Figuie 4.Su). Inuustiial watei use intensity has
also impioveu. Watei use efficiency impiovement can
beattiibuteutoseveialfactois,incluuingthestiuctuial
shift fiom agiicultuie to inuustiy anu seivices,
S7
|uiowingbeyonutheLow-CostAuvantage
the use of moie efficient technologies, anu bettei
management.Reuuctioninpeicapitaiesiuentialwatei
use by uiban householus—fiom 22u liteis pei uay in
2uuuto177liteispeiuayin2uu9—alsoplayeuapait.
Bowevei, pei capita iesiuential use in uiban aieas
iemains well above that in iuial aieas—72 liteis pei
capita pei uay (NWR 2u1u). Bespite the encouiaging
impiovement, the PRC watei intensity iemains high
by inteinational stanuaius (Figuie 4.S1). The PRC
outpeifoims lowei-miuule-income countiies in
oveiall watei efficiency, but falls behinu in inuustiial
watei efficiency. Noieovei, the PRC’s watei intensity
is uouble oi tiiple that in uppei-miuule-income
countiies.Thus,theieislaigeioomfoiimpiovingthe
PRC’swateiuseefficiency.
GDP = gross domestic product, PRC = People’s Republic of China.
Source: World Bank, World Development Indicators Online (accessed February 2011).
0
100
200
300
400
500
600
High
income
Upper middle-
income
World PRC Lower middle-
income
Low
income
C
u
b
i
c

m
e
t
e
r
s

p
e
r

$
1
,
0
0
0

Water intensity per unit GDP Water intensity per unit industrial value added
Figure 4.31 Internationalcomparisonofwateruseintensity,2009
Table 4.6 PRC:Pro|ectionsofwaterdemandin2030
Studies
Demand
Supply capacity Demand-supply gap Agriculture Industry Domestic Total
Demand/supply in 2009, billion m
3
372.3 139 74.8 596.5 596.5 0
Annual growth in 2000–2009 (%) –0.2 2.2 3 0.9
McKinsey
Demand/supply, billion m
3
420 265 133 818 619 199
Annual growth (%) 0.6 3.1 2.8 1.5
NCPWR
Demand/supply, billion m
3
407.8 171.8 102.1 700 700 0
Annual growth (%) 0.4 1 1.5 0.8
Jiang and Huang (2011)
Demand/supply, billion m
3
408 220 139 767 700 67
Annual growth (%) 0.4 2.2 3 1.2
m
3
= cubic meter, NCPWR = National Comprehensive Plans for Water Resources.
Note: Total water demand also includes ecological demand of 18.3 billion m
3
.
Sources: Jiang and Huang (2011); McKinsey (2009a); MWR, National Comprehensive Plans for Water Resources.
the PRC’s National Compiehensive Plans foi Watei
Resouices—appioveu by the State Council in late
2u1u—aims to keep total watei consumption below
7uu billion m
S
(the supply capacity) by 2uSu anu
watei use in agiicultuie, inuustiy, anu uomestic
sectois below 4u7.8 billion m
S
, 171.8 billion m
S
,
anu 1u2.1 billion m
S
, iespectively (Table 4.6). These,
howevei, aie only taigets. An ABB stuuy (}iang anu
Buang 2u11) examines a business-as-usual (BA0)
scenaiio, assuming that inuustiial anu uomestic
wateiuemanuwillgiowatthesameiateasthepast
uecaue—2.2% pei yeai foi inuustiy anu S.u% foi
uomesticuse.Thisconsiueiscontinueuimpiovement
in piouuctive watei use efficiency, inuustiialization,
anu uibanization. Foi agiicultuial watei uemanu,
S8
the giowth iate (u.4%) in the NCPWR piojections is
useubaseuonhistoiicaltienusanutheconsiueiable
potential foi bettei iiiigation efficiency. 0nuei
this BA0 scenaiio, total watei uemanu in 2uSu is
piojecteu to inciease to 767 billion m
S
. Assuming
wateisupplycapacitywillgiowtoNCPWRpiojecteu
levels, the BA0 piojections show a sizable uemanu-
supplygap,at67billionm
S
—oi9%oftotaluemanu,
in 2uSu.
17
These iesults suggest that immeuiate
policy inteivention anu public action aie neeueu to
auuiess watei iesouice constiaints, especially to
ieuucewateipollution.
17
A McKinsey & Company (2009a) study indicates that by 2030
PRC’s annual water demand-supply gap could reach about 25%
of total demand.
0
500
1,000
M
t
o
e
1,500
2,000
2,500
1
9
8
0

1
9
8
5

1
9
9
0

1
9
9
1

1
9
9
2

1
9
9
3

1
9
9
4

1
9
9
5

1
9
9
6

1
9
9
7

1
9
9
8

1
9
9
9

2
0
0
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
5

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

Hydro, nuclear, wind Natural gas Crude oil Coal
Mtoe = million tons of oil equivalent, PRC = People’s Republic of China.
Source: NBS, China Statistical Yearbook 2011.
PRC = People’s Republic of China, toe = tons of oil equivalent, UK = United Kingdom, US = United States.
Source: US Energy Information Administration, International Energy Statistics 2010.
0
1
2
3
4
5
6
7
8
9
10
1
9
8
0

1
9
8
1

1
9
8
2

1
9
8
3

1
9
8
4

1
9
8
5

1
9
8
6

1
9
8
7

1
9
8
8

1
9
8
9

1
9
9
0

1
9
9
1

1
9
9
2

1
9
9
3

1
9
9
4

1
9
9
5

1
9
9
6

1
9
9
7

1
9
9
8

1
9
9
9

2
0
0
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
5

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

PRC
t
o
e

p
e
r

p
e
r
s
o
n
India Japan Republic of Korea UK US World
Figure 4.32 PRC:Totalprimaryenergyconsumption,1980–2010
Figure 4.33 Percapitaenergyconsumption,selectedeconomies,1980–2009
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
Energy constraints
In 2uu9, PRC’s total piimaiy eneigy consumption
was about 2.27 billion tons of oil equivalent (toe),
five times the 198u level, with coal accounting foi
7u%, ciuue oil 18%, natuial gas 4%, anu hyuio,
winu, anu nucleai 8% (Figuie 4.S2). Although the
total amount neaily matcheu the 0S—the woilu’s
top eneigy consumei in 2uu9 (IEA 2u11)—in pei
capita teims, PRC’s eneigy consumption iemains
below the woilu aveiage (Figuie 4.SS). Rapiu
giowth in eneigy consumption has occuiieu while
S9
|uiowingbeyonutheLow-CostAuvantage
eneigy intensity has ueclineu—fiom u.8S toe in
198utou.28toein2uu8,pei1,uuuuBPinconstant
2uuS PPP uollais. This is a significant achievement,
thanks to incieaseu efficiency anu the stiuctuial
shiftoftheeconomyfiominuustiytowaiuseivices.
Bespite this, eneigy intensity iemains above
auvanceucountiiesanuthewoiluaveiage.
With abunuant coal iesouices, the PRC has
maintaineuahighlevelofeneigyself-sufficiency.In
2uu8, ovei 9u% of its piimaiy eneigy consumption
was supplieu fiom uomestic piouuction, compaieu
with }apan (18%), 0S (7S%), Inuia (76%), anu
the aveiage foi membeis of the 0iganisation foi
Economic Co-opeiation anu Bevelopment (0ECB)
(71%).
18
The countiy holus ovei 1,uuu billion tons
of coal iesouices—its pioven iecoveiable ieseives
aie the thiiu-laigest globally, behinu the 0S anu
the Russian Feueiation (WEC 2u1u). In 2uuS,
the Ninistiy of Lanu anu Resouices estimateu
economicallyviablecoalieseivesat189billiontons
(NLR 2uuS, IEA 2uu9). In 2uu8, it piouuceu anu
18
IEA, World Energy Outlook 2010.
IEA = International Energy Agency, Mtoe = million tons of oil equivalent, PPM = parts per million, PRC = People’s Republic of China.
Source: IEA, World Energy Outlook 2010.
0
500
1,000
1,500
M
t
o
e
2,000
2,500
3,000
3,500
4,000
4,500
IEA 2008 IEA Current Policies 2035 IEA New Policies 2035 IEA 450 PPM 2035
Renewables Nuclear Oil and Gas Coal
Figure 4.34 PRC:Primaryenergydemandpro|ectionbyscenario
consumeu about S billion tons of coal (NBS, China
Statistical Yearbook 2010). At the same time, it has
incieasinglyielieuonoilanunatuialgasimpoitsin
iecentyeais.In2uu8,netoilimpoitstoppeuSu%of
totaloilconsumption.
The PRC neeus to continue its stiong giowth in
the coming uecaues to naiiow the income gap
with auvanceu economies. Its population, though
aging, will inciease until 2u26. With uibanization
acceleiating, cities aie expanuing iapiuly to
accommouate a laige numbei of migiants—
theiefoie, eneigy uemanu will continue to expanu.
Accoiuing to the Inteinational Eneigy Agency’s
WoiluEneigyNouelpiojections,unueiitsCuiient
Policies Scenaiio (IEA 2u1u),
19
the PRC’s total
piimaiy eneigy uemanu woulu uouble between
2uu8 anu 2uSS, incieasing fiom about 2,1uu Ntoe
to 4,21S Ntoe (Figuie 4.S4).
2u
Coal is expecteu
to iemain the majoi souice, supplying 61% by
2uSS, nucleai anu ienewables (hyuio, winu, solai,
biomass, anu geotheimal) aie to inciease, but
19
The IEA’s Current Policies Scenario takes into account
measures the PRC adopted by mid-2010 in pursuit of energy
and environmental policies. It does not assume policy change
beyond 2010.
20
This is similar to projections by the Energy Research Institute
of the China National Development and Reform Commission
(NDRC 2009) under its Energy Conservation Scenario, which
accounts for policies already introduced to conserve energy and
reduce pollution, but without specific measures to move toward
low carbon growth.
4u
iemain ielatively small at about 1S%, anu 26% is
tocomefiomoilanunatuialgas.
This huge jump in eneigy uemanu coulu stiess
the PRC’s eneigy system. Accoiuing to IEA (2uu7),
uepenuence on net oil impoits coulu iise to
8u% of total oil consumption by 2uSu, making
it vulneiable to global oil supply uisiuptions
anu piice shocks. The PRC’s coal ieseives aie
concentiateu in the noith anu noithwestein
piovinces, while uemanu centeis aie in
southeastein coastal aieas. Tianspoit bottlenecks
aie alieauy constiaining coal piouuction anu will
continue to limit futuie expansion. Inauequate
powei giiu capacity anu watei availability (foi
theimal powei plants anu coal washing) in the
noith limit the coal-by-wiie option.
21
Theiefoie,
even with laige coal ieseives, supply will be
incieasingly constiaineu anu face iising costs
unuei the cuiient eneigy consumption pattein.
21
Coal-by-wire refers to the transmission of energy in the form of
electric power generated from coal-fired power plants located near
the mines to the market through high-voltage transmission lines.
Lao PDR = Lao People’s Democratic Republic, PRC = People’s Republic of China, US = United States, UK = United Kingdom.
Note: Particulate matter concentrations refer to fine suspended particulates less than 10 microns in diameter (PM10) that are capable of penetrating
deep into the respiratory tract and cause significant health damage. Data for countries are urban-population weighted PM10 levels in residential areas
of cities with more than 100,000 residents. The estimates represent the average annual exposure level of the average urban resident to outdoor
particulate matter. The state of a country's technology and pollution controls is an important determinant of particulate matter concentrations.
Source: World Bank, World Development Indicators Online (accessed August 2012).
0 10 20 30 40
PM 10
50 60 70 80
Indonesia
PRC
Argentina
India
Chile
Thailand
Viet Nam
Lao PDR
Cambodia
Republic of Korea
Japan
Singapore
Brazil
Malaysia
US
Philippines
UK 12.7
17.1
18.0
18.6
19.5
23.2
24.9
32.5
37.0
44.6
50.4
52.6
53.3
57.1
60.0
60.2
68.1
Figure 4.35 AirpollutionranhingbyPM10,selectedeconomies,2009
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
Noie policy actions aie neeueu to fuithei impiove
eneigyefficiencyanuuevelopneweneigysouices.
Environmental constraints
The PRC’s cuiient eneigy consumption pattein,
especiallytheuominanceoffossilfuelsintheeneigy
mix, is causing seiious enviionmental pioblems.
Extiaction, piocessing, tianspoit, anu buining of
coal anu combustion of oil anu petioleum piouucts
emit aii pollution—such as sulphui uioxiue (S0
2
),
nitiogen oxiues (N0
X
), caibon monoxiue (C0), anu
paiticulate mattei. It is estimateu that 8S% of S0
2
anu6u%ofN0
X
emissionsinPRCcomefiombuining
coal(WanganuFeng2uuS).Thecountiywasiankeu
148 of 179 countiies in aii pollution measuieu
by PN1u
22
in 2uu9, with the level of aii pollution
much highei than uevelopeu countiies such as the
0K, the 0S, }apan, anu the Republic of Koiea, uppei-
miuule-income countiies such as Nalaysia, Biazil,
22
Fine suspended particulates less than 10 microns in diameter.
The alternative measure is PM2.5—fine suspended particulates
less than 2.5 microns in diameter.
41
|uiowingbeyonutheLow-CostAuvantage
anu Thailanu, anu low- oi lowei-miuule-income
countiies such as the Philippines, Cambouia, the
Lao PBR, anu viet Nam (Figuie 4.SS). Aii pollution
causesiespiiatoiyuiseases,leaustoaciuiain,causes
watei pollution, anu uamages agiicultuie. A iecent
stuuyestimatestheannualhealthanuenviionmental
cost of coal use foi the PRC is aiounu $2Su billion
(Nao, Sheng, anu Fang 2uu8). A stuuy by the Woilu
Bank anu PRC’s State Enviionmental Piotection
Auministiation (2uu7) puts the costs of pollution—
such as health caie anu laboi, anu lanu piouuctivity
losses—atS.8%ofuBPin2uuS.
Asiue fiom uamaging the local enviionment, coal
anu oil use ieleases caibon uioxiue (C0
2
)—a
gieenhouse gas—into the atmospheie, contiibuting
to global climate change. In 2uu9, the PRC emitteu
about6.9utC0
2

2S
fiomeneigyconsumption,mostly
fiom coal (IEA 2u1u). The PRC may be the woilu’s
laigest souice of C0
2
emissions, although in pei
capita teims, its emission level is low (Figuie 4.S6).
Climate change leaus to iising tempeiatuies anu
sea levels, incieases extieme weathei, affects watei
supply anu agiicultuie piouuction, causes coastal
uegiauation, uamages ecosystems, anu enuangeis
human health. Accoiuing to Stein (2uu7), if the
woilucontinuesBA0,climatechangecoulucostthe
23
Gt = gigaton = 10
9
metric tons.
CO2e = carbon dioxide equivalent, EU = European Union, PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Note: The countries in both charts are the top 12 globally in terms of total emissions. The PRC is ranked 84th and the US is 9th in the world in
terms of emissions per person. Figures are for 2005, latest available.
Source: World Resources Institute Database (accessed July 2011).
0 5 10 15 20 25
PRC
US
EU (27 countries)
Russia
India
Japan
Brazil
Germany
Canada
Mexico
UK
Indonesia
% of world total
0 5 10 15 20 25
US
Canada
Russia
Germany
UK
Japan
EU (27 countries)
Mexico
PRC
Brazil
Indonesia
India
Metric tons CO2e per person
Figure 4.36 Creenbousegasemissions,2005
woilu an equivalent of up to 2u% of uBP annually
by22uu.
uiven the potential uamage to the enviionment
of a coal-baseu eneigy stiuctuie, PRC authoiities
have iecently taken significant measuies to
impiove eneigy efficiency anu uevelop clean anu
ienewable eneigy souices. The goveinment aims
to ieuuce eneigy intensity by 17.S% anu caibon
intensity by 18% uuiing its 12th Five-Yeai Plan.
24

It has committeu to ieuucing the countiy’s C0
2

intensity between 4u% anu 4S% by 2u2u ielative
to 2uuS, anu to iaising the shaie of non-fossil fuels
in piimaiy eneigy consumption to aiounu 1S%
by 2u2u, unuei the Copenhagen Accoiu.
2S
Noie
iecently, at the Confeience of Paities 17 in South
Afiica, the PRC committeu to the unpieceuenteu
Buiban Platfoim—which will biing uevelopeu anu
ueveloping countiies togethei by 2u1S unuei a
common anu legally binuing global fiamewoik that
becomeseffectivein2u2u.
0nuei the IEA Cuiient Policies Scenaiio, the PRC’s
eneigy-ielateu C0
2
emission level is piojecteu to
ieach 12.6 utC0
2
in 2uSS, an inciease of 6.S utC0
2

fiom the 2uu8 level (Figuie 4.S7). IEA (2u1u) has
compaieu this with those unuei two alteinative,
24
National Development and Reform Commission, People’s
Republic of China (http://en.ndrc.gov.cn/).
25
United Nations Framework Convention on Climate Change (http://
unfccc.int).
42
gieenei giowth scenaiios—New Policies anu
4Su PPN—which incoipoiate policies specifically
taigeteu at moving towaiu a low caibon anu gieen
economy. These incluue eneigy efficiency measuies
in powei geneiation, inuustiy, tianspoit, builuings
anu appliances, incieaseu use of clean fuel anu
ienewable eneigy souices, a shift in economic
stiuctuie fiom inuustiy to seivices, anu auoption
of caibon captuie anu stoiage technology. The New
Policies Scenaiio assumes that the PRC ieuuces
C0
2
intensity by 4u% by 2u2u compaieu with
2uuS (the lowei enu of its taigeteu iange unuei
the Copenhagen Accoiu) anu continues this pace
beyonu 2u2u. The 4Su PPN Scenaiio
26
assumes
that the PRC ieuuces C0
2
intensity by 4S% by 2u2u
compaieu with 2uuS (the highei enu of the taigeteu
26
Globally, this scenario is consistent with global requirements to
stabilize atmospheric CO
2
concentration, thus curbing the rise in
global temperatures to relatively safe levels.
IEA = International Energy Agency, PPM = parts per million, PRC = People’s Republic of China.
Source: IEA, World Energy Outlook 2010.
0% 20% 40% 60% 80% 100%
IEA 2008
IEA Current Policies 2035
IEA New Policies 2035
IEA 450 PPM 2035
Coal Oil and Gas Nuclear Renewables
Figure 4.38 PRC:Compositionoftotalprimaryenergyconsumptionin2035underIEAscenario
0
2
4
6
8
10
12
14
2005
G
t
C
O
2
2010 2015 2020 2025 2030 2035
IEA Current Policies IEA New Policies IEA 450 PPM
CO2 = carbon dioxide, GtCO2 = gigatons of carbon dioxide, IEA = International Energy Agency, PPM = parts per million, PRC = People’s Republic of China.
Source: IEA, World Energy Outlook 2010.
Figure 4.37 PRC:Energy-relatedCU
2
emissionbyscenario,2005–2035
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
iangeunueitheCopenhagenAccoiu)anutakesmoie
aggiessive mitigation measuies than unuei the New
PoliciesScenaiio.0nueithesetwoscenaiios,eneigy-
ielateu C0
2
emissions woulu ieach 1u.1 utC0
2
anu
S.2utC0
2
,iespectively,in2uSS.
Piimaiy eneigy uemanu anu supply composition
will look veiy uiffeient in these low caibon,
gieenei scenaiios fiom the Cuiient Policies
Scenaiio anu the cuiient eneigy consumption
pattein (Figuie 4.S8). 0nuei the New Policies
Scenaiio,totalpiimaiyeneigyconsumptionwoulu
be S,7S6 Ntoe in 2uSS, with coal accounting foi
about SS%, nucleai anu ienewable eneigy 19%,
anuoilanugas28%.0nueithe4SuPPNScenaiio,
total piimaiy eneigy consumption woulu be S,1S1
4S
|uiowingbeyonutheLow-CostAuvantage
Ntoe in 2uSS, with coal accounting foi S8%,
nucleai anu ienewable eneigy S2%, anu oil anu
gasSu%.
uoinggieen,especiallyunueithe4SuPPNscenaiio,
cieates a significant financing challenge. Accoiuing
to IEA (2u1u), moving fiom its Cuiient Policies
Scenaiio to 4Su PPN scenaiio woulu cost the PRC
about $7u billion pei yeai by 2u2u (about 1.S% of
PRC’s 2u1u uBP) uue to inciemental investments
in low-caibon technologies anu eneigy efficiency,
incieasing to ovei $Suu billion pei yeai by 2uSS
(oi about S.6% of the PRC’s 2u1u uBP). 0thei
stuuies show similai ianges of estimates of
financingneeus(Table4.7).
Whilemovingtowaiugieeneigiowthinvolvescosts,
it also biings significant benefits. Fiist, accoiuing
to NcKinsey & Company (2uu9b), eneigy efficiency
impiovement measuies—often calleu “win–win”
options—woulugeneiatesignificanteneigysavings,
offsetting much of the cash outlay foi iequiieu
inciemental capital investments, especially in the
eailyyeais.Seconu,thePRCwillbenefitsignificantly
fiom gieen giowth in teims of avoiueu uamage
fiom climate change. Accoiuing to an ABB stuuy
on the economics of climate change in Noitheast
Asia (foithcoming), if the woilu continues as BA0,
climate change coulu ieuuce PRC’s uBP by 6.4%
Table 4.7 PRC:Estimatesofincrementalinvestmentrequiredforgreentransition,selectedstudies
IEA UNDP NDRC McKinsey & Company
Total CO
2
abatement
(from the reference scenario), GtCO
2
1.0 in 2020
7.4 in 2035
3.2 in 2020
5.1 in 2035
2.0 in 2020
3.7 in 2035
6.7 in 2030
Annual incremental investment,
constant $ billions
70 in 2020
310 in 2035
86 in 2020
269 in 2030
150 in 2010–2020
240 in 2020–2050
200–260 in 2010–2030
Annual incremental investment as a
share of PRC total GDP in 2010, %
1.3 in 2020
5.6 in 2035
1.6 in 2020
4.9 in 2030
2.7 in 2010–2020
4.4 in 2020–2050
3.5–6.6 in 2010–2030
CO
2
= carbon dioxide, GDP = gross domestic product, GtCO
2
= gigatons of carbon dioxide, IEA = International Energy Agency, NDRC = National
Development and Reform Commission, PRC = People’s Republic of China, UNDP = United Nations Development Programme, US = United States.
The reference scenario is similar to IEA’s Current Policies Scenario.
Sources: IEA, World Energy Outlook 2010; UNDP (2010), NDRC (2009), and McKinsey & Company (2009b).
each yeai by 21uu—close to the global aveiage,
compaieu with a no-climate change scenaiio.
27

Thiiu, gieen giowth will cieate bettei local aii
quality anu quality of life. Accoiuing to IEA (2u1u),
moving fiom the Cuiient Policies Scenaiio to 4Su
PPN scenaiio coulu ieuuce both S0
2
anu N0
X

emissions by SS% anu paiticulate mattei by 17%.
Life-yeais lost uue to exposuie to anthiopogenic
emissions of PN2.S woulu be ieuuceu 2S% by
2uSS. Fouith, gieen giowth contiibutes to eneigy
secuiityanusustainability.Last,butnotleast,gieen
giowthcieatesnewenginesofgiowthanubusiness
oppoitunities. The PRC is now among the woilu’s
leauei in winu anu solai photovoltaic installation,
anu theie is vast potential foi futuie giowth.
Fuitheimoie, the PRC coulu become the woilu’s
laigest maiket foi electiic vehicles in the coming
uecaues,benefitingitsautomobilemanufactuieis.
0vei the coming yeais, the PRC will continue
constiucting new powei plants, new inuustiial
plants, anu new commeicial anu iesiuential
builuings. Theiefoie, theie is a stiong case foi an
eaily gieen tiansition to avoiu inefficient futuie
lock-ins. This can allow a successful tiansfoimation
to a clean, eneigy secuie, anu efficient economy,
anu ultimately move the countiy onto a sustainable
giowth tiajectoiy. Nobilizing the sizable financing
iequiieu, howevei, poses a gieat challenge.
27
The PRC is vulnerable to many climate risks. Coastal provinces and
large cities face a rise in sea levels and storm surges, while inland
regions must cope with more variable climate change resulting
in too much or too little water for agriculture and households.
Rising temperatures will increase economic burdens, ranging
from health risks to higher demand for cooling energy.
44
Inteinational coopeiation baseu on common but
uiffeientiateuiesponsibilitiesisthekey.
4.6. Challenging external
economic environment
The PRC’s economic iise has piofounuly changeu
its economic ielations with the exteinal woilu,
especiallyitskeytiauingpaitneis.Befoieeconomic
iefoim, the PRC was a small, closeu economy
with little global exposuie. Touay, as a laige open
economy,itsimpactonotheicountiieswillcontinue
to inciease, not only within the iegion but on the
woilu’slaigesteconomiesaswell.Atthesametime,
thecenteiofeconomicpoweiintheglobaleconomy
is shifting. Combineu, this will make the PRC’s
exteinal economic enviionment moie anu moie
challenging with implications foi its economy anu
giowth piospects. The uiscussion below focuses on
exteinaluemanuanutiauefiiction.
External demand
Exteinal uemanu has been a majoi souice of
the PRC’s uBP giowth. Buiing 2uuu–2u1u, net
expoits contiibuteu 1.9 peicentage points to its
annual aveiage giowth of 1u.S% (see Figuie 4.1u),
as eviuenceu by laige cuiient account suipluses—
especially with the 0S anu the E0. In 2u1u, the
PRC accounteu foi S2% of the total 0S tiaue
–6
–4
–2
0
2
4
6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
P
e
r
c
e
n
t
Sources: IMF (2012a, 2012b), World Economic Outlook Database.
Euro area Japan United States
Figure 4.39 Crowtbratesandpro|ectionsforma|orindustrializedeconomies,2000–2015
Chaptei4: SustainingthePRC’slong-teimgiowth:Challengesanuiisks|
ueficit. Bowevei, as the global economic stiuctuie
evolves, the PRC may not be able to iely as much
on net expoits to uevelopeu maikets as a souice
of giowth as in the past. The slow pace of the
0S iecoveiy fiom the 2uu8–2uu9 global financial
ciisis anu the cuiient euiozone ciisis means
that expoit uemanu fiom uevelopeu maikets
will iemain weak in the foieseeable futuie
(Figuie4.S9).Tosustaingiowth,thePRCwillneeu
to iely moie on uomestic uemanu anu finu new
uemanu souices in emeiging maikets both within
anuoutsiueAsia.Inthelongeiteim,thistienuwill
likely be ieinfoiceu by a shifting of the centei of
giavity of the global economy fiom Noith to South
anufiomWesttoEast.
Trade friction
ThePRC’siisingshaieofexpoitsinwoilumaikets
have cieateu some fiiction with both uevelopeu
anu ueveloping countiies. The PRC anu most of its
tiauing paitneis aie membeis of the Woilu Tiaue
0iganization (WT0)—anu aie thus obligeu to
follow WT0 iules on equal tieatment, openness,
anupiouuctionanutiauesubsiuies.Butuisputes—
often ielateu to issues involving subsiuies, the
exchange tiaue, intellectual piopeity iights, anu
maiket access—anu ietaliatoiy measuies have
been giowing. Between 2uu8 anu 2u1u, the PRC
was the woilu’s top taiget foi uisciiminatoiy
4S
|uiowingbeyonutheLow-CostAuvantage
0
50
100
150
200
250
300
350
400
Japan Italy UK France Germany US EU27 PRC
N
u
m
b
e
r

No. of trading partners imposing discriminatory measures
No. of discriminatory measures imposed on the country target
EU27 = European Union, PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Source: Data from Evenett (2010).
CNY = Chinese yuan, US = United States.
Source: IMF (2005 and 2011), International Financial Statistics Yearbook; ADB staff estimates.
90
100
110
120
130
140
$
/
C
N
Y
,

2
0
0
5
=
1
0
0

Nominal exchange rate Real exchange rate
2
0
0
0

2
0
0
1

2
0
0
2

2
0
0
3

2
0
0
4

2
0
0
5

2
0
0
6

2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

2
0
1
1

J
u
l
y

2
0
1
2

Figure 4.40 Top8targeteconomiesfordiscriminatorymeasures,2008–2010
Figure 4.41 CNY–USdollarexcbangerateindex,2000–2012
tiaue,withSS7measuiesimposeuby79countiies
(Figuie 4.4u). The PRC’s laige cuiient account
suiplushasfiequentlybeenciteuasamajoisouice
of global payments imbalances. While the yuan
has appieciateu by close to 4u% against the 0S
uollai in ieal teims since }une 2uuS (Figuie 4.41),
it continues as a souice of tension with global
tiauing paitneis. Tiaue fiictions huit the PRC,
its tiauing paitneis, anu the global economy
in geneial. While some fiiction is unavoiuable,
the PRC anu its tiauing paitneis shoulu pievent
fiictionsfiomescalatingintotiauewais.
46
T
hePRCgiauuateufiomlowtomiuuleincomein
1998 anu has, until veiy iecently, continueu to
geneiateannualgiowthiatesclosetououbleuigits.
Bowevei, technology anu piouuctivity gaps with
auvanceu economies iemain laige. To attain high-
income status, the PRC neeus to continue to giow
stiongly anu to naiiow these gaps. The countiy’s
iapiu giowth in the past S uecaues has benefiteu
gieatly fiom its low-cost auvantage. But with iising
wages anu population aging, giowth neeus to be
incieasingly uiiven by piouuctivity impiovement
thiough innovation, upgiauing, anu tiansition fiom
low-costtohigh-valuepiouuction.Atthesametime,
incomplete iefoim, compounueu by iapiu giowth,
has cieateu vaiious foims of economic imbalances,
anucontiibuteutoiisinginequality.Ifnotauuiesseu,
thesecoulubecomebinuingconstiaintstosustaineu
giowth(ABB2u11e).
Baseu on this analysis, to avoiu the miuule-income
tiap, the PRC neeus a new uevelopment stiategy
that woulu allow it to giow beyonu the low-cost
auvantage anu help its tiansfoimation into a
high-value economy. This stiategy shoulu have
the following pillais: (i) stepping up innovation
anu upgiauing; (ii) ueepening stiuctuial iefoims,
in paiticulai iefoims of enteipiises, laboi anu
lanu maikets, the financial sectoi, anu the fiscal
system; (iii) ueveloping seivices anu scaling up
uibanization; (iv) maintaining macioeconomic
anu financial stability; (v) making giowth
inclusive; (vi) piomoting gieen economy; anu
(vii) stiengthening inteinational anu iegional
5. How the PRC can avoid the
middle-income trap:
Policy options
economic coopeiation. Each of these pillais is
ciiticalanufoimsanintegialpaitofthestiategy:
Ȉ Innovation anu upgiauing aie necessaiy foi
continueu piouuctivity giowth to naiiow
technological anu income gaps; they also enable
fiimstopayhigheiwages,whichintuininciease
householu income, consumption, anu help
ieuuceimbalances.
Ȉ Enteipiise iefoim is ciitical foi suppoiting
innovation anu upgiauing; factoi maiket iefoim
is essential to ieuuce anu eliminate baiiieis to
factoi mobility anu factoi piice uistoitions that
contiibute to imbalances anu income inequality;
while fiscal iefoim is neeueu to align the iole of
goveinmentwithinamaiketeconomy.
Ȉ The uevelopment of seivices pioviues a new
souiceofgiowth,ieuucessupplysiueimbalances
anu, togethei with uibanization, geneiates
gieatei uiban employment oppoitunities; this in
tuin pushes up wages, absoibs moie iuial laboi,
incieases householu income anu consumption,
anuieuucesincomeinequality.
Ȉ Finally, a stable macioeconomy, social inclusion,
a clean enviionment, anu haimonious exteinal
economic ielations aie essential foi sustaining
thePRC’slong-teimgiowth.
In sum, the PRC neeus a uevelopment stiategy
that tilts the balance fiom low-cost to high-value
47
|uiowingbeyonutheLow-CostAuvantage
piouuction; fiom ieliance on goveinment to the
use of maiket anu competition; fiom investment
to piivate consumption; fiom exteinal to uomestic
uemanu; fiom taigeting giowth alone to both
giowth anu uistiibution; anu fiom a uevelopment-
centiic appioach to one that matches uevelopment
with enviionmental piotection. The bioau policy
uiiections anu options foi each of these stiategic
piioiities aie uiscusseu below. Nany of the policy
uiiections anu options uiscusseu below aie alieauy
incluueu in the PRC’s 12th Five-Yeai Plan. Foi
these, the ciitical issue is how to ensuie effective
implementation(ABB2u11u).
5.1. Stepping up innovation and upgrading
While the PRC is now iefeiieu to as the “woikshop
of the woilu”—uue to the enoimous quantity of
goous piouuceu, it iemains the “assemblei” oi
“piocessoi” of the woilu. As the PRC’s wages giow
iapiuly, coupleu with population aging, its low-
cost auvantage will giauually eioue. To iemain
competitive, it neeus to move up the value chain.
This iequiies continuously upgiauing inuustiies
anu seivices thiough innovation. The PRC shoulu
seek to become the woilu’s “uesignei,” “innovatoi,”
anu “bianu piouucei.” To achieve these goals, the
followingpolicymeasuiescoulubeconsiueieu.
Strengthening enterprise incentives
for innovation
Enteipiises aie the uiiveis of innovation. The PRC
neeus to fuithei stiengthen incentives anu builu
the capacity of enteipiises to caiiy out inuigenous
innovation, while continuing to acquiie foieign
technologies. Biffeient types of enteipiises face
uiffeientchallenges,anuiequiieuiffeientsolutions.
Ȉ S0Es aie laige, have easiei access to cieuit, anu
possess moie iesouices iequiieu foi innovation.
Buttheyneeubetteiincentivesuuetocoipoiate
goveinance weaknesses anu because in many
cases they face limiteu competition. Foi these
enteipiises, the solution is to (i) expose them to
gieatei maiket competition; (ii) ieuuce uiiect
goveinment inteivention; (iii) put in place an
effective coipoiate goveinance system, anu
(iv) make them tiuly commeicial (see moie
uiscussionbelow).
Ȉ While piivate-owneu enteipiises have stiongei
incentivesthanS0Es,theyaieingeneialsmallei
in size
28
anu have gieatei uifficulty accessing
cieuit.
29
Piivatefiimsmustalsocompeteagainst
S0Es foi talenteu woikeis anu often lose out as
state fiims aie seen as pioviuing moie stable
employment.
Su
The policy piioiities foi these
enteipiises aie to (i) cieate an enviionment foi
them to compete with S0Es on an equal footing,
especiallyinmaiketaccess,finance,anutaxation;
(ii) encouiage anu suppoit them to stiengthen
coipoiate goveinance anu builu innovation
capacity; (iii) impiove iules foi meigeis anu
acquisitions (N&A) to facilitate enteipiise
iestiuctuiing anu expansion; anu (iv) piomote
public–piivatepaitneishipsininnovation.
Ȉ Foi foieign-investeu enteipiises, the main policy
focus shoulu be to allow equal tieatment
alongsiue uomestic fiims, piomote faii
competition, anu auuiess othei conceins such
asintellectualpiopeityiightspiotection.
Building a conducive environment for innovation
Because of maiket failuies such as infoimation anu
cooiuination exteinalities that uetei innovation,
the goveinment has an impoitant iole to play in
builuing an enviionment that suppoits innovation
28
In 2009, the average size of industrial SOEs was eight times larger
by number of employees, 11 times larger by gross output value,
and 29 times larger by total assets compared with domestic
private firms (NBS, China Statistical Yearbook 2010).
29
SOEs are preferred borrowers for the large state-owned banks that
dominate the financial landscape. For instance, private enterprise
surveys show that in mid-2007, of the total outstanding loans by
the five largest commercial banks, only 12% went to SMEs (http://
www.bankloan51.com/a/qiyedaikuan/2011/0320/152.html).
Private enterprises also pay higher interest rates than SOEs. The
average rate paid by private firms in 2001–2005 was 4.53%
compared with 2.55% for SOEs (Ferri and Liu 2010).
30
For example, a recent survey of university graduate career planning
in Tianjin shows 51% of respondents favored SOE employment,
against 20% who aspired to join large private companies (http://
henan.people.com.cn/news/2011/01/12/520535.html).
48
anu auuiesses maiket failuies. The following
piioiitiescoulubeconsiueieu:
Ȉ Further strengthening market mechanisms to
ensure fair competition, protect private property,
effectively enforce contracts and encourage
commercial trusts, and make the bankruptcy
system work better. Accoiuing to the Woilu
Bank’s latest Ease of Boing Business suivey,
the PRC iankeu 91, fai behinu the Republic of
Koiea (8), Thailanu (17), anu Nalaysia (18). The
PRC’s low scoie was mainly uue to conceins
ovei staiting a business, constiuction peimits,
investoipiotection,anupayingtaxes(FiguieS.1).
Ȉ Further stepping up public support for basic
science and technology research. Reseaich anu
uevelopment (R&B) as a peicentage of uBP
almosttiipleuinthePRCto1.S%inthe11yeais
to 2uu7, but iemains much lowei than the level
in most uevelopeu countiies, incluuing the
PRC = People’s Republic of China, UK = United Kingdom, US = United States.
Note: Chart shows selected countries from a total of 183 countries. A lower number means the regulatory environment is more conducive to
starting and operating a local firm. This index averages the country’s percentile rankings on 10 topics (starting a business, dealing with
construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing
contracts, and resolving insolvency), giving equal weight to each.
Source: The World Bank Doing Business website (accessed January 2012).
136
132
129
126
113
91
39
29
20
19
18
17
8
7
4
2
1
0 20 40 60 80 100 120 140
Philippines
India
Indonesia
Brazil
Argentina
PRC
Chile
France
Japan
Germany
Malaysia
Thailand
Republic of Korea
UK
US
Hong Kong, China
Singapore
Rank
Figure 5.1 Ranhingineaseofdoingbusiness,selectedeconomies,2011
Republic of Koiea anu }apan (Figuie S.2). The
PRC fell shoit of its own taiget of 2% set out
in the 11th Five-Yeai Plan, achieving a level of
1.8%onlybytheenuoftheplanpeiiou.Notably,
the 12th Five-Yeai Plan (2u11–2u1S) has set a
R&B expenuituie taiget at 2.2% of uBP (BBvA
Reseaich2u11).
Ȉ Gearing the use of industrial policy toward
supporting the development of new industries,
new products, and new technologies. The PRC
has useu a vaiiety of inuustiial policy tools
to suppoit innovation anu manufactuiing.
A iecent stuuy on the PRC finus that inuustiial
policy is effective in iaising TFP anu spuiiing
piouuct innovation, especially when sectois
exhibit a high uegiee of competition (Aghion
et al. 2u11). As the maiket becomes bettei
establisheu anu the piivate sectoi giows,
inuustiial policy shoulu shift towaiu suppoiting
uevelopment of new inuustiies, new piouucts,
49
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
|uiowingbeyonutheLow-CostAuvantage
anu new technologies—wheie maiket failuie
is paiticulaily pievalent.
S1
Risk financing
instiuments such as ventuie capital coulu be
uevelopeutosuppoitinnovation.
Ȉ Further strengthening intellectual property rights
protection.Intellectualpiopeityiightspiotection
in the PRC has impioveu in iecent yeais. But
compaieu with most high-income countiies anu
somemiuule-incomecountiies,ithasmuchioom
foi impiovement. The Global Competitiveness
Report 2011–2012oftheWoiluEconomicFoium
(2u11) iankeu the PRC’s intellectual piopeity
piotection at 4 on a scale of 1–7 with 1 veiy
weak anu 7 veiy stiong, which is 47th, below
most 0ECB countiies anu some miuule-income
countiies such as South Afiica (Su), Nalaysia
(S1),anuSiiLanka(44).
Investing in human capital and moving toward a
knowledge-based economy
Innovation anu inuustiial upgiauing neeu to be
suppoiteu by a laige pool of high quality human
capital. The PRC has maue significant piogiess in
humancapitaluevelopmentuuiingthelastSuyeais.
31
The 12th Five-Year Plan (2011–2015) targets seven strategic
emerging industries—clean energy, clean energy technology,
clean energy vehicles, next-generation information technology,
biotechnology, high-end equipment manufacturing, and new
materials.
R&D = research and development, PRC = People’s Republic of China, US = United States.
Note: Latest available data for Germany (2009) and India (2007).
Source: World Bank, World Development Indicators Online (accessed August 2012).
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Republic of
Korea
Japan US Germany Singapore PRC India
P
e
r
c
e
n
t

o
f

G
D
P

2000 2008
Figure 5.2 R&Dexpenditure,selectedeconomies,2000and2008
Bowevei, theie aie still laige gaps compaieu with
auvanceu countiies anu some miuule-income
countiies. In 2u1u, the aveiage yeai of schooling of
thePRCauultpopulationwasestimateuat8.2,lowei
than Nalaysia (1u.1), }apan (11.6), anu the Republic
of Koiea (11.8) (Table S.1). The PRC’s teitiaiy gioss
eniolment iate was 24.S% in 2uu9, while S7.S% foi
Nalaysia, 46.2% foi Thailanu, S9% foi }apan, anu
1uu%foitheRepublicofKoiea.Relativetothesizeof
itslaboifoice,thenumbeiofscientistsanuengineeis
in the PRC is substantially below uevelopeu countiy
levels.In2uuS,foiexample,thePRChau14scientists
oiengineeisfoieveiy1u,uuupeople,compaieuwith
76intheRepublicofKoieaanu1u2in}apan.ThePRC
public spenuing on euucation was S.6% of uBP in
2uu9, also lowei than Nalaysia (S.8%), the Republic
ofKoiea(S.u%),anuthe0S(S.4%).
To iaise the level of human capital, the PRC coulu
consiuei seveial policy measuies: (i) fuithei
incieasingpublicspenuingoneuucationasashaieof
uBPtonaiiowthegapsinvaiiouskeyhumancapital
inuicatoiswithauvanceucountiiesanuotheimiuule-
income countiies; (ii) ieuucing the gaps in teitiaiy
euucation eniollment, at the same time expanuing
vocational anu technical euucation to impiove
the quality of the laboi foice anu ieuuce oi avoiu
skills mismatches; (iii) puisuing euucation iefoim
to impiove efficiency anu quality, anu intiouucing
univeisity teaching anu ieseaich peifoimance
evaluation systems to incentivize teacheis anu
Su
ieseaicheistoimpioveteachinganuieseaichquality;
(iv) stiengthening links anu inteiaction between
univeisities, ieseaich institutes, anu enteipiises
anu maikets to pioviue moie stuuents with both
maiketing anu innovation capacity, anu incieasing
the iate of maiketization of R&B; (v) encouiaging
piivate sectoi paiticipation in pioviuing euucation
anu fuithei stiengthening inteinational coopeiation
anu euucation exchange; anu (vi) incieasing
euucation spenuing in pooi aieas, anu expanuing
compulsoiyeuucationinlaggingiegions.
5.2. Deepening structural reform
Bespite significant piogiess ovei the last S uecaues,
the PRC’s tiansition towaiu a maiket economy
is fai fiom complete. Fiist, although the piivate
sectoi has giown iapiuly anu S0E peifoimance has
impioveu in iecent yeais, the agenua foi enteipiise
iefoim iemains long. In paiticulai, S0Es face limiteu
competition with many less efficient oi piofitable
than theii piivate counteipaits. At the same time,
piivateenteipiisesfacesignificantbaiiieistomaiket
entiy anu constiaints in accessing cieuit anu othei
piouuction factois. Continueu enteipiise iefoim
is ciitical if the PRC is to iely moie on efficiency
enhancementanutechnologicalinnovationasuiiveis
ofpiouuctivitygiowth.Seconu,whilepiouuctmaiket
iefoim is well auvanceu, factoi maiket iefoim has
Table 5.1 Comparativeperformanceonbumancapitalattainment,selectedeconomies,variousyears
Secondary
enrolment
(% gross)
Tertiary
enrolment
(% gross)
Public spending
on education
(% of GDP)
Average year
of total
schooling, 2010
No. of scientists
and engineers
(per 10,000 pop.)
Argentina 88.5 (2009) 71.2 (2009) 6.0 (2009) 9.3 –
Brazil 105.8 (2005) 25.6 (2005) 5.7 (2009) 7.5 –
Chile 87.9 (2009) 59.2 (2009) 4.5 (2009) 10.2 –
PRC 81.2 (2010) 25.9 (2010) 3.6 (2009) 8.2 14 (2005)
India 63.2 (2010) 17.9 (2010) 3.0 (2008) 5.1 –
Indonesia 77.2 (2010) 23.1 (2010) 3.0 (2010) 6.2 –
Japan 102. (2010) 59.7 (2010) 3.8 (2010) 11.6 102 (2004)
Republic of Korea 97.1 (2010) 103.1 (2010) 5.0 (2009) 11.8 76 (2005)
Malaysia 68.3 (2009) 40.2 (2009) 5.8 (2009) 10.1 –
Philippines 84.8 (2009) 28.9 (2008) 2.7 (2009) 9.0 –
Thailand 79.2 (2011) 47.7 (2011) 3.8 (2010) 7.5 –
US 96.0 (2010) 94.8 (2010) 5.4 (2009) 13.1 91 (2002)
“–” means data not available, GDP = gross domestic product, PRC = People’s Republic of China, US = United States.
Sources: World Bank, World Development Indicators Online; Barro-Lee Educational Attainment dataset; NBS, China Statistical Yearbook 2010
and NBS, China Statistical Yearbook on Science and Technology 2007 (all accessed January 2012).
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
laggeu behinu. Continueu ieliance on auministiative
inteivention has iestiicteu the mobility of laboi,
capital, anu othei piouuction factois anu uistoiteu
factoi piices. This leaus to inefficient iesouice
allocation anu utilization, contiibutes to stiuctuial
imbalancesanuiisingincomeinequality,anucieates
scope foi ient-seeking. Thiiu, the PRC will neeu
fuitheifiscaliefoimastheioleofgoveinmentshifts
towaiu pioviuing public goous anu seivices anu
auuiessing maiket failuies as opposeu to uiiect
inteivention. Beepening stiuctuial iefoim means
taking fuithei steps in iefoiming enteipiises,
factoi maikets (laboi, capital, anu lanu), anu the
fiscalsystem.
Enterprise reform
S0E iefoim in the PRC, especially since the late
199us, has laigely involveu piivatizing small- anu
meuium-sizeu enteipiises thiough selloffs oi
management buyouts. Laige S0Es have iemaineu
unuei sole state owneiship oi became publicly
listeu companies with the state contiolling the
majoiity owneiship. As a iesult, in teims of the
numbeiofenteipiises,theshaieofS0Esininuustiy
has ueclineu significantly—fiom S8% in 1999 to
about 4% in 2u1u.
S2
By othei measuies, howevei,
32
Refer to those with annual revenue from principal business over
CNY5 million.
S1
|uiowingbeyonutheLow-CostAuvantage
S0Es still contiol a laige pait of the economy. In
2u1u, S0Es piouuceu 27% of total gioss inuustiial
output, owneu 42% of total assets, anu employeu
19% of the inuustiial laboi foice. S0E peifoimance
has impioveu in iecent yeais. But they aie less
piofitable than piivate fiims anu uo not peifoim as
wellasnon-S0EsinteimsofTFPgiowth(BoxS.1).
The bioau uiiection of enteipiise iefoim
incluues the following. The fiist is to piomote
the uevelopment of the piivate sectoi by leveling
Box 5.1 PerformanceofPRCfirmsbyownersbip
Although the financial performance of state-owned enterprises (SOEs) has improved in recent years, as a whole they
are much less profitable than private and foreign firms (Figure B5.1-1). The gap narrowed in the mid-2000s, but
has widened again recently. In 2010, the industrial SOE average rate of return on assets was less than half that
of private firms, and three-fifths of that of foreign firms. Data from recent industrial enterprise surveys suggest that
SOE profitability was much lower than non-SOEs regardless of whether SOEs in public utilities—electricity, water,
and gas supply—were excluded or not (as they are subject to administrative pricing) (Xu 2011). Further, there is a
statistically significant positive correlation between SOE financial performance and sector dominance—those with larger
SOE dominance generally are more profitable, suggesting SOEs may profit from being monopolies. This correlation is
insignificant among non-SOEs.
Figure B5.1-1 PRC: Rate of return on assets by firm ownership, 1998–2010
Empirical studies show that SOEs do not perform as well as non-SOEs in terms of productivity growth either. SOEs
were 27% less productive than their private sector counterparts and their annual total factor productivity (TFP) growth
was 4.6 percentage points lower, according a study covering 336,768 PRC firms (Brandt, van Biesebroeck, and Zhang
2011). Chen et al. (2010) found that of 37 industrial subsectors, the five with the lowest TFP growth between 1981
and 2008 were dominated by SOEs. These include gas, water, petroleum, electricity, and the extraction of petroleum.
In four of the subsectors, TFP contracted over the period.
0
2
4
6
8
10
12
14
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
P
e
r
c
e
n
t

Private State-owned Foreign-funded
PRC = People’s Republic of China.
Source: NBS, China Statistical Yearbook.
the playing fielu so that it can compete equally
with S0Es. This iequiies ieuucing oi eliminating
entiybaiiieisinmanysectoisanuuisciimination
in aieas such as access to cieuit faceu by piivate
fiims. The seconu is to stiengthen S0E coipoiate
goveinance, incluuing moving towaiu a system
wheietheaim’slengthcontiolbythegoveinment
is suppoiteu by iobust auuiting, monitoiing
anu peifoimance evaluation. S0E executives
shoulu be ieciuiteu thiough the maiket on the
basis of inuiviuual meiit. Nany S0Es aie now
S2
listeu on stock exchanges. The PRC coulu fuithei
incieasethepiopoitionofS0Eshaieshelubythe
geneial public to make them tiuly publicly-listeu
companies. The thiiu is to stiengthen iegulations
foi natuial monopolies, such as public utilities, to
pievent them fiom extiacting monopolistic ients.
Special bouies can be set up to iegulate piice
settinganuseivicequality.
Labor market reform
Laboi maiket iefoim coulu focus on two specific
aieas. The fiist is to iefoim the hukuo system
with a view to integiating the laboi maiket by
ieuucing baiiieis to laboi mobility especially fiom
iuial aieas anu the agiicultuie sectoi to uiban
aieas anu nonagiicultuie sectois. This piincipally
involves gianting migiant woikeis equal access to
social seivices anu welfaie entitlements (health,
euucation, anu housing) cuiiently enjoyeu by
iegisteieu uiban iesiuents. In iecent yeais the PRC
has intiouuceu pilot piogiams in iefoiming the
hukuo system in some cities. This coulu pioviue
usefullessonsfoination-wiuehukuosystemiefoim.
The seconu key aiea is to fuithei impiove anu
expanu the coveiage of laboi maiket institutions—
such as employment piotection legislation,
minimum wages, collective baigaining, anu
unemployment insuiance—to bettei piotect the
basic iights of woikeis without imposing excessive
costs on businesses oi uisiupting job cieation. The
PRChasmoveutowaiua“flexicuiitymouel”oflaboi
maiket goveinance. This mouel combines flexibility
(easy hiie-anu-fiie laws that ieuuce ietienchment
buiuens on fiims) with secuiity (unemployment
benefits, active ietiaining, anu incentives to ietuin
towoik),aimeuatpiotectingthewoikei,notthejob
(vanueibeig 2uu8).
SS
uoing foiwaiu, the piioiities
aie to ensuie a piopei balance between flexibility
anusecuiityanutomakethemouelcoveitheentiie
laboifoice.
33
In a fast-changing globalized economy, few can expect to keep
the same job for life. See Vandenberg (2008) for a survey of a
“flexicurity” model for labor markets.
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
Financial sector reform
0vei the past S uecaues, the PRC has cieateu many
of the institutions neeueu foi a mouein financial
system. Bowevei, financial sectoi iefoim is wiuely
consiueieu to lag behinu iefoims in othei sectois.
The financial sectoi iemains uominateu by state-
owneu banks, with auministiative inteivention
in cieuit allocation anu contiolleu inteiest iates
uistoiting capital allocation, pioviuing low ietuins
to investois anu saveis, anu contiibuting to
excessive investment anu stiuctuial imbalances.
Ruial householus anu micio-, small- anu meuium-
sizeu enteipiises (NSNEs) aie unueiseiveu by
the financial system. Capital maikets (bonu anu
equity) iemain unueiuevelopeu anu aie inauequate
foi long-teim anu iisk financing. Fuithei, weak
coipoiate goveinance anu lax inteinal contiol anu
iisk management piactices expose the economy to
potentially significant financial iisk. If the PRC is to
iely moie on efficiency, impioveu piouuctivity, anu
innovation as souices of giowth, it is ciitical that it
ueepensfinancialsectoiiefoim.
Piioiities incluue (i) making the financial sectoi
anu financial inteimeuiation moie maiket-baseu—
this means allowing uemanu anu supply to play a
gieatei iole in ueteimining inteiest iates, opening
upthefinancialsectoitopiivatesectoipaiticipation,
anu making state-owneu banks tiuly commeicial
entities; (ii) enhancing financial safety by fuithei
stiengtheningiegulationanusupeivisionoffinancial
institutions anu establishing an effective financial
safetynet—incluuingmechanismsfoiuebtiesolution
anuuepositinsuiance;(iii)fuitheiuevelopingcapital
maikets, incluuing those foi inteibank lenuing,
coipoiate bonus, equities, contiactual savings, anu
financial futuies anu ueiivatives; (iv) bioauening
access to finance, especially by NSNEs anu the iuial
householus, anu piomoting financial inclusion;
(v) making the exchange iate moie flexible; anu
(vi) cieating conuitions foi gieatei capital account
libeialization(seeBoxS.2).
SS
|uiowingbeyonutheLow-CostAuvantage
Box 5.2 PrioritiesoffinancialsectorreformintbePRC
The priorities for deepening financial sector reform in the People’s Republic of China (PRC) include the following:
Making finance and financial intermediation more market-based. In the case of interest rates, while interbank
lending rates and bond yields are now largely determined by market demand and supply, commercial bank lending
and deposit rates remain controlled by government—despite recent measures that introduced some flexibility. Greater
flexibility in setting commercial bank interest rates could be introduced and—when specified conditions are met—
interest rates, especially deposit rates, could ultimately be determined by the market. For financial institution reform,
the broad direction is to make state-owned bank operations more commercially oriented by reducing administrative
interventions, while simultaneously improving corporate governance. Private sector participation in banking should be
supported, and a level playing field should be provided so private banks can compete with state-owned banks on an
equal footing.
Enhancing financial safety. Further strengthening the regulatory and supervisory environment for financial institutions
and establishing an effective financial safety net are among the needed reforms. The PRC has built a basic regulatory
framework for the financial sector—the central bank sets and implements monetary policies and manages foreign reserves,
while three regulatory bodies are responsible for regulating (i) deposit-taking financial institutions, asset management
companies, and trust and investment companies; (ii) capital markets; and (iii) the insurance sector, respectively. The
government could examine how the coordination among the four bodies can be further improved and institutionalized, as
there are strong links between subsectors. At the same time, more effort is needed to enhance internal control and risk
management systems of financial institutions, strengthen prudential monitoring, and further raise standards for disclosure,
financial reporting and auditing. An effective financial safety net should also include facilities to support financial institutions
that are solvent but face liquidity problems, mechanisms for debt resolution and workout, and deposit insurance schemes.
Developing capital markets. The PRC’s financial sector is dominated by banks. While stock market capitalization
is sizable, money market, bond market (especially corporate bonds), and the contractual savings industry are
underdeveloped. Underdeveloped capital markets contribute to the misallocation of resources as larger enterprises—
that otherwise might seek financing through capital markets—are relying more on banks, crowding out lending to
private enterprises, especially, micro-, small-, and medium-sized enterprises (MSMEs). It also constrains corporate
access to long-term as well as risk (for innovation) financing. Policy options include strengthening legal and regulatory
frameworks, prudential monitoring, and enforcement to ensure financial safety; improving the quality of companies
by strengthening disclosure and compliance, corporate governance, and encouraging merger and acquisition (M&A)
activities; developing and improving capital market infrastructure—such as trading and settlement systems and credit
rating agencies; increasing the range of financial products and services available, and promoting financial innovation
while ensuring financial safety; fostering market competition; and investing in human capital.
Broadening access to finance and promoting financial inclusion. Like most developing countries, MSMEs and rural
households in the PRC face severe constraints in accessing finance. This affects both growth and social inclusion. The
government has taken a range of initiatives in recent years to support MSMEs and rural financing, including encouraging
the establishment of special business units for MSME financing in financial institutions, supporting policies such as risk
compensation for MSME financing and various tax and regulatory concessions, establishing a range of credit guarantee
systems, and more recently, establishing SME boards on stock exchanges, policies to establish microcredit companies
to serve mainly rural areas, and piloting financial reform in Wenzhou of Zhejiang Province to improve access to finance
by MSMEs. While continuing efforts to promote financial inclusion and experimenting on new schemes, it is also critical
for the government to review and put in place the adequate legal and regulatory framework needed to ensure that
microfinance and microcredit institutions are well-governed and will not create systemic risks to the financial system
as a whole.
Making the exchange rate more flexible. In recent years, the PRC’s exchange rate has become more flexible, with
both the current account and trade account surpluses declining. The government adopted the managed float with
reference to a basket of currencies in July 2005, and more recently took steps to increase two-side exchange rate
movements, including increasing the daily trading band. The PRC should further increase exchange rate flexibility.
continued on next page
S4
Land reform
An efficient anu equitable lanu system is ciitical to
piomote agiicultuial investment anu piouuctivity,
foou secuiity, optimal allocation of scaice lanu
iesouices, ieuuction of uiban¡iuial income gaps,
maintaining social equity anu stability, piomoting
uibanization, anu the PRC’s long-teim giowth.
Authoiities neeu to tackle a numbei of issues to
make the lanu system moie efficient anu equitable,
especiallyiniuialaieas.
S4
0nepiioiityistoueveloptheiuiallanumaiketanu
make it woik bettei. The Law on Lanu Contiact in
RuialAieasgivesiuialhouseholusiightstosellanu
iesell lanu-usei iights. While the maiket has been
giowing,tiansactionvolumesiemainlow.Neasuies
to suppoit uevelopment of the iuial lanu maiket
incluue fuithei stiengthening anu claiifying the
legalfiamewoikanuuevelopingmaiketinstitutions
anu seivices, such as suiveyois anu valuation,
biokeiage, lanu exchanges, anu mechanisms foi
uisputeiesolution.
34
Land in the PRC is owned by either the state (in urban cities)
or collectives (in rural and suburban areas). In urban cities,
enterprises, households and individuals acquire land-user rights
through state allocation or the land market. In rural areas, a land
contract system—governed by the Law on Land Contract in Rural
Areas that came into effect in 2003—allocates user rights of farm
and residential lands owned by rural collectives (mostly villages) to
rural households, subject to several conditions covering restrictions
on converting agricultural land for other uses and contract durations
(30 years for agricultural land and 30–70 years for others).
Creating conditions for greater capital account liberalization. The PRC has taken a cautious approach to opening
up its capital account. Over the years, the government reduced restrictions covering cross-border capital flows,
especially for inward foreign direct investment (FDI). But it has maintained control over outward FDI, debt financing, real
estate investment, and portfolio investment. These have helped the PRC maintain financial stability and avoid financial
crises. The government is committed to further liberalizing its capital account given the significant benefits that can
accrue—lowering the costs of capital for corporations, increasing portfolio diversification for investors, and promoting
financial sector development that in turn boosts productivity in the real economy. Also, capital account convertibility is a
prerequisite for internationalizing the yuan. But these policies must also recognize the risks associated with liberalization
when the domestic financial system remains weak. The PRC should continue efforts to strengthen its domestic financial
system to create conditions for greater capital account liberalization.
Sources: ADB (2012c), World Bank and DRC (2012), Wu (2011).
Box 5.2 continued
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
Anothei piioiity is to make lanu acquisition
by local goveinments foi uiban use faiiei anu
tianspaient. The cuiient system gives the local
goveinment laige poweis to acquiie agiicultuial
lanu foi uiban uevelopment at piices fai below
maiket levels. While this has pioviueu a key souice
of local goveinment finance in iecent yeais (as the
goveinment can sell the lanu-usei iights at maiket
piices), it has also incieasingly become a souice
of social tension. The PRC neeus a faiiei anu moie
tianspaient system foi conveiting agiicultuial lanu
foi uiban use to piotect the inteiests of the iuial
populationononehanu,anunottoconstiainuiban
uevelopmentontheothei.
Fiscal reform
The PRC has unueigone significant fiscal iefoims
in iecent yeais, helping builu a soliu fiscal position.
Fuithei iefoims aie neeueu, howevei, in view of
the neeus foi aligning the fiscal system with the
evolving iole of goveinment, foi ensuiing fiscal
sustainability anu stability, anu foi impioving
fiscal efficiency anu equity. The PRC coulu consiuei
seveialiefoimmeasuiesinfiscalspenuing,ievenue
mobilization, cential¡local goveinment ielations,
anubuugetaiymanagement,amongotheis.
Composition of fiscal spending. As the PRC’s
tiansition towaiu a maiket economy ueepens,
theie will be a neeu foi shifting the focus of fiscal
spenuing moie towaiu pioviuing public goous
SS
|uiowingbeyonutheLow-CostAuvantage
anu seivices, piomoting social equity, anu
auuiessing maiket failuies. 0vei the next 1u–1S
yeais, the PRC shoulu giauually inciease fiscal
spenuing on euucation fiom a cuiient S.6% of
uBP anu health fiom a cuiient 1.4% of uBP
SS

to levels close to 0ECB aveiages.
S6
uoveinment
spenuing on public housing, social piotection, fiscal
tiansfeis to pooi householus anu lagging iegions,
enviionmental piotection, anu basic science anu
technology ieseaich shoulu likewise inciease while
maintaining fiscal sustainability. The goveinment
shoulu continue to invest in infiastiuctuie, but
also piomote piivate paiticipation anu public–
piivatepaitneiships.
Revenue mobilization. Refoims aie neeueu in
ievenue mobilization to ensuie auequate funuing
foi fiscal spenuing anu fiscal sustainability, impiove
the efficiency anu equity of ievenue collection,
35
The PRC’s current government (both central and local) expenditures
on education and health as a % of GDP refer to 2011 and were
calculated on the basis of data provided in the Statistical Report on
2011 National Economic and Social Development released by the
PRC National Statistical Bureau (http://www.stats.gov.cn); and the
2011 Final Report on Fiscal Revenues and Expenditures released
by the Ministry of Finance (http://yss.mof.gov.cn). However,
according to World Health Organization data, the PRC government
(both central and local) expenditure on health as a share of GDP
was 2.7% in 2010 (see http://apps.who.int/ghodata).
36
In the late 2000s, OECD average government expenditure on
education as a share of GDP was about 6%, and about 6.5% on
health (see http://www.oecd-ilibrary.org).
anu cieate incentives foi bettei piotection of the
enviionmentanumoieefficientiesouiceutilization.
Although the total size of the PRC’s goveinment
ievenues—incluuing both in- anu off-buuget—
is compaiable to many uppei-miuule-income
anu high-income countiies
37
, its total buugeteu
ievenues anu cential goveinment ievenues as a
shaieofuBP,at22%anu11%in2u11,iespectively,
weie not high by inteinational compaiison
(Figuie S.S).
38
uiven the PRC’s neeu foi gieatei
effoits in equalizing access to public goous anu
seivices, in ieuucing iegional inequality, anu in
meeting othei neeus such as auuiessing climate
change, piotecting enviionment, anu iesponuing
to futuie macioeconomic shocks, the size of its
buugetaiyievenuesmayhavetoincieaseoveitime.
Key iefoim measuies in ievenue mobilization
coulu incluue, among otheis: (i) biinging off-
37
According to the PRC’s Ministry of Finance data, the total size
was at 35.3% of GDP in 2011. This covers central and local
government budgetary revenues, revenues from state-owned
enterprises, social security contributions, and other government
revenues including those from land sales (http://www.mof.gov.cn).
38
The PRC’s budgeted government revenues (central and local
combined) as a share of GDP, currently at 22%, is low, especially
in comparison with OECD countries. In 2009, the average general
government revenues as a share of GDP for OECD countries was
41.4% including social security contributions, and about 31%
excluding social security contributions (see http://www.oecd
-ilibrary.org). The PRC’s revenues from social security contributions,
which are managed outside the government budget, were about
5% of GDP in 2011 (http://www.mohrss.gov.cn).
GDP = gross domestic product, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China.
Note: Data for Brazil and OECD refer to 2009.
Sources: MOF, Final Report on Government Revenues and Expenditures for the PRC; ADB, Key Indicators 2012 for other Asian countries; OECD
for OECD countries (http://www.oecd-ilibrary.org); and World Bank, World Development Indicators Online (accessed July 2012) for Brazil and
Chile. Central government revenues exclude grants and social security funds and contributions.
0
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10
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OECD
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Figure 5.3 CentralgovernmentrevenuesasasbareofCDP,selectedeconomies,2011
S6
Box 5.3 ReformingtbePRC’spersonalincometaxsystem
While the PRC’s personal income tax rates are comparable to many middle- and high-income countries, a narrow tax base
and weak enforcement have made personal income taxes an insignificant source of government revenue (Table B5.3-1).
Table B5.3-1 Composition of selected fiscal revenue sources,
PRC and selected economies (% of GDP)
PRC
(2011)
Malaysia
(2009)
Republic of Korea
(2010)
Japan
(2010)
OECD
(2010)
Corporate income taxes 3.6 8.1 3.5 2.8 2.9
Personal income taxes 1.3 2.2 3.6 5.2 8.7
Consumption taxes 10.4 3.9 8.5 5.1 11.0
GDP = gross domestic product, OECD = Organisation for Economic Co-operation and Development, PRC = People’s Republic of China.
Sources: ADB staff estimates for PRC using data from NBS, Statistical Report on 2011 Economic and Social Progress and MOF, Final
Report on Government Revenues and Expenditure. IMF, Government Finance Statistics (for Malaysia); OECD.Stat (accessed August 2012,
for the Republic of Korea, Japan, and OECD).
In 2011, PRC personal income taxes accounted for only 1.3% of gross domestic product (GDP), very low compared
with Japan’s 5.2%, Republic of Korea’s 3.6%, and the average 8.7% for members of the Organisation for Economic
Co-operation and Development (Table B5.3-1). This is despite the fact that the PRC has a relatively high top personal
marginal tax rate on wages and salaries (45%). Many Asian developing countries also have a much higher personal
income tax as a share of GDP—4.2% in Indonesia, 2.2% in Malaysia, 2.1% in Thailand and the Philippines, and 2%
in India. These figures suggest that there is much room for the PRC to better use personal income tax as a source of
government revenues (Figure B5.3-1).
continued on next page
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
buuget goveinment ievenues into the buuget;
(ii) iefoiming piopeity taxes that pioviue
souices of goveinment finance anu—at the same
time—help to contiol piopeity speculation;
(iii) incieasing peisonal income tax as a shaie
of uBP (Box S.S); (iv) making gieatei anu moie
effective use of gieen taxes to contiol pollution
emissions, conseive natuial iesouices—incluuing
eneigy anu watei—anu piomote gieen giowth
(see section S.4); (v) iefoiming the value-auueu
tax (vAT) system to expanu coveiage to the entiie
seivicesectoi;(vi)stiengtheningassetmanagement
S7
* = Unweighted average, GDP = gross domestic product, OECD = Organisation for Economic Co-operation and Development, PRC = People’s
Republic of China.
Note: Sorted from highest to lowest tax revenue as a percent of GDP.
Sources: IMF, Government Finance Statistics and International Finance Statistics; OECD.Stat; ECLAC, CEPALSTAT; KPMG, Individual Income
Tax and Social Security Rate Survey 2011; and NBS, China Statistical Yearbook 2011.
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Personal income tax Top personal income tax rate
Figure B5.3-1 Top personal income tax rate (%) and personal income tax (% of GDP),
selected economies, 2009 or latest available
|uiowingbeyonutheLow-CostAuvantage
Under the current system, 11 types of personal incomes are liable for tax—including wages and salaries; operating
incomes of privately owned businesses; incomes from contracted management or leasehold management for enterprises;
remuneration for labor services; income from royalties and franchises; interest, dividend, and bonus; rents and leasing
incomes; among others. Some of these categories are taxed progressively (wages and salaries), while others at a flat rate
(such as incomes of personal services, royalties, and rental and lease income). Income is not taxed on a consolidated
basis, so income earners receive multiple deductibles for incomes derived from different sources. High-income earners pay
lower rates than if taxed on the basis of consolidated incomes, making income taxes less progressive.
To even out personal income taxation, the PRC could move toward a system where taxes are calculated based on
consolidated incomes. Implementing such a system, however, requires putting in place a personal income reporting
system and associated legal framework, along with physical infrastructure. At the same time, the current tax structure
could be reviewed to identify areas where reforms are needed. One example is to lower the income threshold at
which the top tax rate applies. Compared with many other countries, the PRC’s income threshold for the top tax rate
is relatively high: about 22 times its per capita GDP in 2010, as opposed to 3–5 times for Japan, Republic of Korea,
Malaysia, and the OECD average (Figure B5.3-2).
Although taxation is not an effective means of redistributing income, and more effective redistributional policies may be
implemented with spending programs on social welfare and other social programs, taxes are important to raise financing
for government spending to achieve distributional objectives. Unfair tax systems can reduce people’s willingness to pay
taxes and thus the government’s ability to raise necessary funds. Notably, reforming the personal income tax system is a
policy priority of the 12th Five-Year Plan.
Box 5.3 continued
Figure B5.3-2 Top personal income tax rate threshold, selected economies, latest available
Lao PDR = Lao People's Democratic Republic, OECD = Organisation for Economic Co-operation and Development, PRC = People's
Republic of China.
Note: For OECD countries, data refer to 2008 or 2009; figure is simple average (excluding Turkey). For Asia, data are for 2012. It is
assumed that gross national income per capita of these countries in 2012 is growing at the average 2000–2010 rate.
Sources: ADB estimates using International Bureau of Fiscal Documentation Database (accessed January 2012): ADB (2011a); OECD Tax
Database.
0 10 20 30 40 50 60
Pakistan
Viet Nam
Lao PDR
Bangladesh
PRC
Thailand
Indonesia
India
Bhutan
Sri Lanka
Nepal
Singapore
Philippines
Japan
Republic of Korea
Cambodia
OECD
Malaysia
Hong Kong, China
Percent
S8
of S0Es anu incieasing theii uiviuenu payments to
the geneial goveinment buuget—which will also
help to impiove investment behavioi of S0Es; anu
(vii) iaising public awaieness of tax payments as a
citizens’ iesponsibility, anu stiengthening tax law
anulegalenfoicementtoieuucetaxevasion.
Intergovernmental fiscal relations. Among
otheis, two issues have attiacteu paiticulai
attention in iecent policy uiscussions on the PRC’s
inteigoveinmental fiscal ielations (Whiting 2uu7).
0ne is the mismatch between ievenues anu
expenuituie iesponsibilities at vaiious local
goveinment levels. It has been suggesteu that the
1994 iefoim shifteu a laige shaie of fiscal ievenues
fiom local goveinments to the cential goveinment,
but uiu not substantially ieassign expenuituie
iesponsibilitiesbacktothecentialgoveinment.Asa
iesult, local goveinments at all levels, incluuing the
county, lack auequate ievenues to finance the wiue
iange of public goous anu seivices manuateu. The
otheiisthatthefiscalgapleaustothegiowthofoff-
buuget funus (incluuing ievenues fiom lanu sales)
anuhiuuenlocalgoveinmentuebt.
ThePRCcouluconsiueiseveialmeasuiestoiefoim
inteigoveinmental fiscal ielations: (i) assignments
of expenuituie iesponsibilities anu ievenue
souices coulu be ievieweu anu bettei aligneu at
each level; (ii) off-buuget funus coulu be biought
into buugetaiy management to inciease fiscal
tianspaiency anu accountability anu ieuuce fiscal
iisk; (iii) the piopeity tax coulu be iefoimeu anu
useu to ieplace lanu sales ievenues as a souice of
local finance; anu (iv) iefoims aie also neeueu to
enhancetheeffectivenessoffiscaltiansfeisfiomthe
cential goveinment to lagging iegions in ieuucing
iegionaluispaiitiesthioughmeasuiessuchasbettei
peifoimanceevaluation.
Fiscal management. To ensuie fiscal sustainability
anustability,thePRCshoulualsofuitheistiengthen
fiscal management. Neasuies incluue establishing a
compiehensive buuget system to covei goveinment
buuget, state-owneu assets buuget, social secuiity
buuget, anu off-buuget funus; anu setting up an
effective monitoiing anu iepoiting system foi
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
public uebt, especially those of local goveinments
(ABB2u12a).
5.3. Expanding services and
scaling up urbanization
Expanding services
PRC seivices aie unueiuevelopeu compaieu with
its cuiient stage of uevelopment. This is uue to a
numbeioffactois—incluuing,amongotheis,limiteu
maiket opening in ceitain seivices subsectois,
the slow pace of uibanization, anu policy biases
that favoi manufactuiing (ABB 2uu9). Expanuing
seiviceswillbeakeypaitofthesolutiontoieuucing
imbalances in the souices of giowth. In the coming
uecaues, seivices will pioviue a key souice of
giowth anu job cieation. Piouuctive seivices will
help impiove piouuctivity in manufactuiing anu
suppoit inuustiial upgiauing, anu social seivices
willhelpimpiovethequalityoflife.
Policy options to piomote seivices incluue, among
otheis: (i) ieuucing oi fuithei ieuucing entiy
iestiictions in ceitain seivices subsectois such
as euucation, health caie, finance, tianspoit, anu
telecommunications—anu piomoting maiket
competition fiom the piivate sectoi in these
subsectois; (ii) piomoting the uevelopment of
high-value seivices, incluuing finance, banking
anu insuiance; tianspoit anu logistics; maiketing,
biokeiageanuauveitising;managementconsulting;
computing anu infoimation technology (IT);
accountinganulegalseivices;anuuesign,anuR&B;
among otheis; (iii) piomoting goou quality seivices
anu stiengthening maiket iegulation of seivices
fiims to piotect consumei inteiests, incluuing
establishing seivices quality coues anu stanuaius
anu ueuicateu iegulatoiy agencies (foi key public
seivices such as watei, electiicity, anu health caie,
foi example); (iv) ieuucing oi eliminating policy
biases in favoi of manufactuiing, incluuing making
the exchange iate moie flexible anu eliminating
uisciimination against seivices foi access to
cieuit anu in taxation; (v) encouiaging seivices
pioviueis to invest moie in seivices bianuing
anu, at the same time, stiengthening piotection of
S9
|uiowingbeyonutheLow-CostAuvantage
intellectual piopeity iights; (vi) investing moie in
seivicestiaininganuhumancapitaluevelopmentof
employees, incluuing intiouucing job skill giauing;
anu(vii)piomotinguibanizationanuseivicestiaue,
asnoteuelsewheie.
Scaling up urbanization
0ibanization helps impiove piouuctivity anu
efficiency in iesouices utilization, piomote
inuustiial upgiauing, expanu seivices, cieate
uiban jobs, anu inciease householu incomes anu
consumption. 0ibanization offeis agglomeiation
benefits. 0ibanization is also a key pait of the
solution to ieuucing oi eliminating economic
imbalances anu iuial¡uiban income gaps, anu is
an effective way to piomote balanceu uevelopment
of uiban anu iuial sectois. Bespite the iapiu pace
of uibanization in iecent yeais, the PRC’s iate of
uibanization, at S1% by the enu of 2u11, iemains
low, especially in compaiison with those of high-
income countiies anu many uppei-miuule-income
countiies (Figuie S.4). 0ibanization can be a majoi
uiiveiofPRCgiowthinthecominguecaues.
Some of the bioau policy issues in piomoting
uibanization in the PRC aie (i) iefoiming the
hukuo system, incluuing giauually uelinking social
welfaieentitlementswithhukuoinuibancitiesanu
iemoving othei iestiictions on uiban settlement by
iuial migiant woikeis; (ii) impioving the legal anu
auministiative system goveining the acquisition of
iuial lanu foi uiban uevelopment—to ensuie both
social equity anu economic efficiency; (iii) fuithei
iefoiming¡impioving city auministiation, incluuing
aligning expenuituie anu ievenue iesponsibilities
of local goveinments at all levels, shifting the
focus of local goveinments towaiu piovision of
public goous anu seivices, anu impioving the
efficiency of seivices ueliveiy; (iv) piomoting
seivices by ieuucing entiy iestiictions on the
piivate sectoi in ceitain subsectois, to both
cieate moie job oppoitunities anu ensuie bettei
quality of life; (v) piomoting gieen uibanization to
conseive iesouices anu piotect the enviionment;
(vi) ensuiing that uibanization is caiiieu out in an
oiueily mannei, pieventing anu eliminating uiban
poveity, anu exploiing anu ueveloping a low-cost
uiban housing system suiteu foi the PRC’s cuiient
ciicumstances; anu (vii) builuing capacity foi
uiban planning thiough euucation anu tiaining anu
continuingtoexploieuibanizationstiategiessuiteu
tothePRC.
5.4. Reducing income inequality to
make growth more inclusive
Ensuiingeveiycitizencanpaiticipateinanubenefit
fiom giowth, theieby ieuucing income inequality,
is at the heait of inclusive giowth (Zhuang anu
Ali 2u1u). It is also a key conuition foi the PRC to
sustain stiong giowth, avoiu the miuule-income
tiap, anu achieve a haimonious society. Rising
income inequality to some extent is pait of the
uevelopment piocess foi a uual economy. But
it is also uue to the PRC’s incomplete economic
tiansition anu the fact that theie aie significant
baiiieis to factoi mobility, institutional iigiuities,
goveinance weaknesses, anu maiket impeifections.
Policy options foi ieuucing inequality incluue,
amongotheis:
Reducing urban/rural income gaps
Reuucing uiban¡iuial income gaps iequiies fuithei
piomoting uibanization anu ueveloping seivices, to
cieate sufficient piouuctive jobs foi iuial migiant
woikeis. At the same time, iuial migiant woikeis
anu uiban iesiuent woikeis shoulu have equal
social welfaie entitlements. This iequiies giauually
iefoiming the hukuo system. 0ibanization neeus
to be accompanieu by moie iuial investment
(in infiastiuctuie anu public seivices, foi example)
anuinagiicultuie(suchasiiiigationanuR&B),anu
speeuingupcountiysiueuevelopment.
Reducing regional income gaps
To a laige extent, iegional inequality ieflects the
unbalanceu allocation of iesouices acioss iegions.
Thisispaitlythenatuieoftheuevelopmentpiocess,
anu paitly ielateu to baiiieis to factoi mobility
anu uevelopment policy biases in favoi of coastal
aieas ovei past uecaues. Reuucing iegional income
6u
inequality iequiies incieasing investment in
infiastiuctuieinpooianulaggingiegions,bieaking
uowniegionalmonopoliesanupiomotinguomestic
maiket integiation, incieasing fiscal tiansfeis to
low-incomeiegions,piomotinginuustiialmigiation
fiom coastal to inlanu piovinces, anu ieuucing
baiiieis to migiation fiom pooi to iich iegions.
Empiiical eviuence suggests that the PRC’s gieat
westein uevelopment stiategy has been effective
in ieuucing iegional inequality in iecent yeais
(see ABB 2u12b), anu this stiategy shoulu be
fuitheiimplementeu.
Increasing spending on and ensuring equal
access to public services
Public seivices—incluuing basic euucation, health
caie, social secuiity, anu othei social seivices—
iequiie fuithei iesouices. In basic euucation, the
PRC neeus to inciease goveinment spenuing on
compulsoiy euucation, euucation in iuial aieas anu
inpooianulaggingiegions,ensuietheauequacyof
the euucation buuget, equalize access to euucation
oppoitunities, anu—at the appiopiiate time—
inciease the numbei of yeais of compulsoiy
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
BRA = Brazil, CHI = Chile, GDP = gross domestic product, IND = India, INO = Indonesia, JPN = Japan, KOR = Republic of Korea, MAL = Malaysia,
PHI = Philippines, PPP = purchasing power parity, PRC = People’s Republic of China, RUS = Russian Federation, THA = Thailand, USA = United
States of America.
Note: PRC's urbanization rate is for 2011.
Sources: World Bank, World Development Indicators Online (accessed August 2012); United Nations, World Urbanization Prospect: The 2011
Revision; NBS, China Statistical Yearbook 2011.
BRA
CHI
INO
JPN
MAL
PHI
RUS
THA
y = 13.922 x –66.525
R
2 = 0.55891
0
10
20
30
40
50
60
70
80
90
100
5 6 7 8 9 10 11 12
U
r
b
a
n
i
z
a
t
i
o
n

r
a
t
e

(
%
)

Log of GDP per capita (in 2005 PPP$)
PRC
USA
KOR
IND
Figure 5.4 Urbanizationrateandpercapitaincome,selectedeconomies,2010
euucation to 12 yeais. In health caie, theie is neeu
foimoiegoveinmentspenuingtoieuucehouseholu
out-of-pocket meuical expenses, extenuing the
coveiage of public meuical insuiance, anu ensuiing
eveiy patient can get basic meuical caie. In social
secuiity,piioiitiesincluueestablishinganintegiateu
social secuiity system coveiing the entiie countiy
anu incieasing the poitability of social secuiity
accounts; incieasing the coveiage anu uepth of
socialsecuiity,especiallyiniuialaieas;encouiaging
the uevelopment of commeicial social secuiity anu
pension schemes as a supplement to the public
social secuiity system; anu incieasing goveinment
spenuing on low-cost housing anu ueveloping
an effective auministiative system foi housing
allocation;anuensuiingfiscalsustainabilityofsocial
secuiity(ABB2u1u).
Making the personal income tax system work
better and fairer
Although taxation is not an effective means
of ieuistiibuting income, anu moie effective
ieuistiibutional policies can be implementeu with
spenuing piogiams on social welfaie anu social
61
|uiowingbeyonutheLow-CostAuvantage
sectois, taxation is impoitant to iaise finance
foi goveinment expenuituies foi uistiibutional
objectives. 0nfaii tax systems can ieuuce people’s
willingness to pay anu hence the goveinment’s
ability to iaise necessaiy finance. uiven the PRC’s
low level of peisonal income taxes as a shaie of
uBP, theie is laige ioom foi the goveinment to
giauually inciease it thiough bioauening the tax
base anu making the tax system moie piogiessive
(BoxS.S).Thiscanbeachieveuusingmeasuiessuch
as loweiing the income thiesholus at which top tax
iatesaieapplieu,movingtowaiuasysteminwhich
taxes aie calculateu on the basis of consoliuateu
incomes, anu stiengthening tax collection anu
auministiationtoieuucetaxevasion.
Strengthening governance and ensuring social
equity and justice
A key pait of inclusive giowth is to stiengthen
goveinance to make the maiket woik moie
efficiently, fiims behave moie iesponsibly, anu
goveinment agencies seive citizens bettei. Policy
piioiities foi goou goveinance incluue piomoting
faii competition, piotecting the iights of woikeis
anu consumeis, eliminating social exclusion
anu uisciimination, pieventing coiiuption, anu
stiengtheningthelegalsystemanuiuleoflaw.
5.5. Promoting green growth to conserve
resources and protect the environment
The PRC is committeu to moving towaiu a gieen
anu low caibon uevelopment path. The 12th
Five-Yeai Plan highlights the incieasing iesouice
anu enviionmental constiaints, anu emphasizes
the impoitance of conseiving watei anu eneigy
iesouices, ieuucing emissions, impioving
incentivesanucontiolmechanisms,anupiomoting
iesouice-saving anu enviionmentally fiienuly
piouuctionanuconsumption.
Topieventiesouicesfiombecomingconstiaintson
giowth,thePRCcouluconsiueithefollowingpolicy
options: (i) fuithei ieuucing the iesouice intensity
of giowth thiough stiuctuial tiansfoimation,
inuustiial upgiauing, innovation, anu the
uevelopment of seivices; (ii) impioving iesouice
allocation efficiency anu utilization anu ieuucing
waste thiough bettei piicing systems, stiongei
incentive mechanisms incluuing fiscal anu tax
measuies, anu by iemoving baiiieis that block
auoptionofavailablenewanuefficienttechnologies
(anu ieuucing anu eliminating uistoitions);
(iii) stiengthening goveinment iegulation anu
enfoicement to contiol anu ieuuce pollution;
(iv) foi watei, incieasing investment in watei-
ielateu infiastiuctuie anu impioving oveiall watei
iesouice planning anu management; (v) foi eneigy,
incieasing investment in efficiency impiovement
technologies anu in clean anu ienewable eneigy
souices; anu (vi) encouiaging piivate investment in
iesouiceconseivationanuinvestmentpiotection.
A key pait of gieen giowth anu enviionmental
piotection is to ieuuce anu contiol pollution. The
goveinment has maue significant effoits, anu aims
to ieuuce eneigy intensity by 17.S% anu caibon
intensity by 18% uuiing its 12th Five-Yeai Plan. It
has voluntaiily committeu to ieuucing C0
2
intensity
by 4u% to 4S% by 2u2u (ielative to 2uuS), anu to
iaisingtheshaieofnon-fossilfuelsinpiimaiyeneigy
consumptiontoaiounu1S%by2u2u.Toachieveanu
exceeuthesetaigets,thePRCneeustopuisuefuithei
eneigy piice iefoim anu intiouuce emission taxes
to impiove eneigy efficiency anu ieuuce emissions
anu pollution; intiouuce emission peimit tiauing
to ieuuce the cost of emission ieuuction; piomote
innovation anu uevelop¡invest in ienewable anu
clean eneigy souices; inciease public awaieness
of the neeu foi gieen giowth anu enviionmental
piotection to inuuce behavioial anu cultuie change;
anu enhance inteinational anu iegional coopeiation
anuknowleuge-shaiingoncleaneneigyuevelopment.
5.6. Maintaining macroeconomic and
financial stability
Nacioeconomic anu financial stability is ciitical if
the PRC is to sustain giowth anu avoiu the miuule-
income tiap. To a laige extent, the PRC was able to
maintain macioeconomic anu financial stability
62
ChapteiS: BowthePRCcanavoiuthemiuule-incometiap;Policyoptions|
ovei the last Su yeais because of high levels of
auministiative contiol ovei macioeconomic
management anu the financial sectoi—anu
because authoiities have taken a veiy cautious
appioach to capital account libeialization. Fiom
anothei peispective, howevei, to vaiying uegiees
this contiol has also contiibuteu to the PRC’s
economic imbalances. Whethei fiom the viewpoint
of ueepening economic iefoim oi ieuucing
economic imbalances, the PRC will have to make
gieatei use of the maiket in macioeconomic
management anu in ueveloping its financial
system—incluuing letting inteiest iates bettei
ieflect uemanu anu supply, making the exchange
iate moie flexible, allowing banks anu financial
institutions to opeiate moie as commeicial entities,
anu biinging moie piivate paiticipation in the
financial sectoi, as noteu eailiei. Fuithei, if the
yuan is to become an inteinational cuiiency, the
capital account will neeu to giauually open. In the
piocess of fuithei iefoim, it is ciitical that the PRC
maintain macioeconomic anu financial stability
(seeSectionS.2).
0n the fiscal fiont, although cuiient levels of
public uebt anu fiscal ueficits as a shaie of uBP
aie not high compaieu with most uevelopeu
countiies anu many neighboiing Asian economies
(Figuie S.S), theie is neeu foi fuithei fiscal iefoim
anu stiengthening of fiscal management to ensuie
long-teim sustainability anu keep buuget iisks low.
This is especially tiue, given the giowing neeu to
finance infiastiuctuie, public seivices, anu social
piotection piogiams. An aging population will also
have significant fiscal implications. Among the fiscal
system iefoim measuies uiscusseu in Section S.2,
fiscal management of local goveinments iequiies
paiticulai attention. Piioiities incluue ensuiing local
goveinment ievenues aie aligneu with expenuituie
neeus; uiawing off-buuget funus into buugetaiy
management; establishing an effective iepoiting,
monitoiing, anu suiveillance system foi local
goveinmentfinance;anuincieasinglocalgoveinment
fiscaltianspaiencyanuaccountability.
5.7. Strengthening international and
regional economic cooperation
Naintaining a haimonious exteinal economic
enviionment is essential foi sustaining the PRC’s
long-teim giowth. This iequiies continueu woik
foiging inteinational anu iegional economic
coopeiation. Theie aie seveial key issues, among
otheis,toconsiuei:fiist,withitsgiowingimpoitance
GDP = gross domestic product, Lao PDR = Lao People’s Democratic Republic, PRC = People’s Republic of China.
Note: Central government debt for Indonesia; Republic of Korea; Japan; and Taipei,China; federal government debt for Malaysia; and national
government debt for the Philippines.
Sources: ADB, Asia Economic Monitor; CEIC (accessed February 2012).
0 20 40 60 80
Percent
100 120 140 160 180
Japan
Singapore
Lao PDR
Philippines
Malaysia
Viet Nam
Thailand
PRC
Taipei,China
Republic of Korea
Indonesia
Hong Kong, China 5
27
32
34
36
42
51
53
59
61
106
168
Figure 5.5 PublicdebtassbareofCDP,selectedeconomies,2010
6S
|uiowingbeyonutheLow-CostAuvantage
in the global economy, the PRC neeus to incieasingly
consiuei the effects its economic policies have
beyonu its boiueis. It neeus to continue effoits to
establish anu stiengthen mutual tiust with tiauing
anu economic coopeiation paitneis. Paiticipation in
the uioup of Twenty (u2u), Asia-Pacific Economic
Coopeiation(APEC),AssociationofSoutheastAsian
Nations Plus Thiee Countiies (ASEAN+S), anu
othei multilateial, iegional, anu bilateial economic
coopeiationanupolicycooiuinationfoiumspioviues
aneffectivemeanstoaiticulateitseconomicpolicies,
while at the same time influence global anu iegional
economic policy making anu goveinance; seconu,
with the changing global economic lanuscape, the
PRC shoulu fuithei inciease ieliance on uomestic
consumption as well as uemanu fiom emeiging
maikets—both within anu outsiue Asia—as
souices of giowth thiough ueepei stiuctuial iefoim
(see eailiei uiscussions), anu closei iegional anu
South–South economic coopeiation; thiiu, the
PRC also has a laige iole to play in contiibuting
to global public goous, such as auuiessing climate
change thiough inteinational coopeiation unuei
the piinciple of common but uiffeientiateu
iesponsibilities; anu fouith, while significantly
incieasing its uevelopment aiu to low-income
countiies in iecent yeais, the PRC coulu consiuei
establishing a ueuicateu goveinment agency to
enhance aiu effectiveness by stiengthening planning,
cooiuination,anumanagementofuevelopmentaiu—
asmuchaspossiblefollowinginteinationalpiactices
inpioviuingaiu.
64
T
his section examines the giowth potential of the
PRCeconomyoveithenext2uecaues,assuming
ittacklesthechallengesitfaceseffectively.Thegiowth
scenaiio in this iepoit is geneiateu using a Cobb-
Bouglaspiouuctionfunctionwithconstantietuinsto
scaleanulaboi,capitalanutotalfactoipiouuctivityas
inputs. Piojections of sectoi-specific stiuctuial
changes aie geneiateu fiom a iecuisive uynamic
computable geneial equilibiium mouel. Laboi
piojections aie baseu on changes in sectoi-specific
stiuctuieanuestimatesoftheemploymentelasticity
ofgiowth.Piojectionsofthesizeofthemiuuleclass
aieestimateuonthebasisofuBPgiowthanucuiient
incomeuistiibution.
In paiticulai, the giowth scenaiio is baseu on
the following assumptions: (i) the investment
iate will giauually uecline fiom 44% in 2u1u to
SS% by 2uSu; (ii) the laboi foice will peak in
2u16 at 789.S million anu uecline giauually to
7S6.S million by 2uSu—this is baseu on 0niteu
Nations (0N) piojections that the population
will peak in 2u26 at 1,S9S.6 million, ueclining to
1,S9S.1 million in 2uSu, anu that the laboi foice
paiticipation iate will uecline fiom the cuiient
79.7% to 76.7% in 2uSu;
S9
(iii) the speeu of
39
Total population and working-age population data are sourced
from UN (2009, 2010a).
6. The long-term outlook
of the PRC economy
conveigence is 1.8% each yeai;
4u
anu (iv) the
exchangeiatewillappieciateabout1.2%eachyeai
in ieal teims. uiven these foui assumptions, the
iesultsaieasfollows:
Ȉ Growth rates. The PRC economy has the potential
to giow an aveiage of 8% pei yeai uuiing 2u1u–
2u2u anu 6% uuiing 2u2u–2uSu, foi an aveiage
of 7% ovei 2u1u–2uSu (Table 6.1).
41
These iates
aie well below the 1u% annual giowth iecoiueu
uuiing199u–2u1u.Aslowuownisnoimal—when
a countiy’s pei capita income giows, the iole of
conveigence uiminishes, leauing to lowei TFP
giowth. In the PRC, slow uown in giowth ovei
the next 2u yeais will also come fiom expecteu
ueclines in the investment iate (given the neeu
foiiebalancingthesouicesofgiowth),anuuueto
piojecteuueclinesinthesizeofthelaboifoiceas
thewoiking-agepopulationuecieases.
Ȉ Factor contributions to growth.Thecontiibution
of total factoi piouuctivity giowth will uecline
fiom 6.2 peicentage points pei yeai uuiing
2uuu–2u1u to 4.6 peicentage points uuiing
2u1u–2uSu.Similaily,thecontiibutionofcapital
accumulation will uecline fiom S.6 peicentage
40
Estimated from historical data.
41
A number of studies have carried out growth projections for PRC
for the decades ahead. The latest is the World Bank and DRC
(2012) which projects that the PRC has the potential to grow at
8.6% in 2011–2015, 7% in 2016–2020, 5.9% in 2021–2025,
and 5% in 2026–2030. Lee and Hong (2010) project that if the
PRC continues its structural reform, it has the potential to grow at
7% in 2011–2020 and 6% in 2021–2030.
6S
|uiowingbeyonutheLow-CostAuvantage
Table 6.2 PRC:Pro|ectionsofpercapitaCDP,poverty,middle-classsize,andsectorsbares,2020and2030
2010 2020 2030
Per capita GDP at constant 2010 prices ($) 4,428 9,400 16,500
Per capita GDP at constant 2005 PPP $ 6,816 14,500 26,000
Per capita GDP at market exchange rates ($) 4,428 10,600 22,800
Poverty at $2-a-day (%), constant 2005 PPP $ 18 5 1
Poverty at $5-a-day (%), constant 2005 PPP $ 50 23 9
Size of the middle class (%)
(ranging from $5 per day up to the 90th percentile, constant 2005 PPP $)
40 67 81
Economic structure (%)
Investment 44 40 35
Consumption 50 60 65
Agriculture 10 8 5
Industry 47 45 41
Services 43 47 54
GDP = gross domestic product, PPP = purchasing power parity, PRC = People’s Republic of China.
Source: ADB staff estimates.
points to 2.6 peicentage points anu the
contiibution fiom employment will uecline
fiom u.6 peicentage points to –u.2 peicentage
points.
Ȉ Per capita income. Pei capita income in 2u1u
constant piices woulu inciease to $16,Suu by
2uSu (Table 6.2) anu, if applying the cuiient
Woilu Bank thiesholu, it woulu ieach high-
incomestatusby2u2S.Peicapitaincomewoulu
ieach $26,uuu in constant 2uuS PPP uollais anu
$22,8uuatmaiketexchangeiatesby2uSu.
Ȉ Sector shares/sources of growth. The iobust
pace of giowth will leau to significant stiuctuial
tiansfoimation. The shaie of inuustiy in uBP
will likely uecline fiom its cuiient 47% to 41%
in2uSu;seiviceswilliisefiom4S%toS4%;anu
agiicultuiewillueclinefuitheifiom1u%toS%.
0n the uemanu siue, the shaie of consumption
(bothpiivateanugoveinment)willincieasefiom
Table 6.1 PRC:CDPgrowtbpro|ections,2010–2030
2000–2010 2010–2020 2020–2030 2010–2030
GDP growth (%) 10.4 8.0 6.0 7.0
Sources of growth (percentage points)
TFP growth 6.2 5.0 4.2 4.6
Employment 0.6 0.1 –0.4 –0.2
Capital accumulation 3.6 2.9 2.2 2.6
GDP = gross domestic product, PRC = People’s Republic of China, TFP = total factor productivity.
Source: ADB staff estimates.
Su% to 6S%, with investment ueclining fiom
44%toSS%.
Ȉ Poverty and the middle class. Poveity in the PRC
willlikelybeeiauicateuby2uSugivena$2-a-uay
(constant 2uuS PPP$) poveity line. People living
on less than $S-a-uay (constant 2uuS PPP$) will
uecline fiom Su% in 2u1u to about 9% in 2uSu;
anu the miuule class, uefineu as living in the
iange fiom $S pei uay to the 9uth peicentile,
shouluincieasefiomabout4u%in2u1uto81%
in2uSu.
Ȉ The PRC in the global economy. The PRC woulu
become the woilu’s laigest economy measuieu
at constant 2uuS PPP uollais by 2u16—anu
at maiket exchange iates by 2u2S. In 2uSu, its
shaie of global uBP at maiket exchange iates
woulu be 22.2%, followeu by the 0S at 16.1%
anuInuiaat6.u%(Figuie6.1).Theshaieofthe
combineuE0woulube2S.4%.Atconstant2uuS
66
PPP uollais, the PRC shaie of global uBP woulu
ieach 2S.2% by 2uSu, followeu by the 0S at
1S.S%,anuInuiaat11.u%.
0nuei this scenaiio, the PRC woulu join its East
Asian neighbois in completing the tiansition fiom
low-incometohigh-incomestatuswithinSuyeais.
The five cuiient high-income Asian economies
completeu the tiansition to high-income status
at some point uuiing the peiiou fiom the late
196us to the miu-199us. As Table 6.S shows,
these economies maintaineu high iates of giowth
iight up to the time they giauuateu. }apan anu
BongKong,Chinagiewbyanaveiageofmoiethan
Chaptei6: Thelong-teimoutlookofthePRCeconomy|
Share of global GDP in constant 2005 PPP$, 2030 Share of global GDP in market exchange rate, 2030
ASEAN = Association of Southeast Asian Nations, GDP = gross domestic product, LAC = Latin America and the Caribbean, MENA = Middle East and North
Africa, PPP = purchasing power parity, PRC = People’s Republic of China, RoW = Rest of the world, SSA = Sub-Saharan Africa, US = United States.
Source: ADB staff estimates.
Asia, rest of: 8.6
ASEAN: 5.6
PRC: 23.2
India: 11.0
Europe: 18.6
LAC: 8.4
MENA: 5.3
RoW: 2.3
SSA: 3.7
US: 13.3
Asia, rest of: 8.9
ASEAN: 4.2
PRC: 22.2
India: 6.0
Europe: 23.4
LAC: 9.0
MENA: 4.4
RoW: 3.2
SSA: 2.6
US: 16.1
Figure 6.1 Sbareofglobalgrossdomesticproduct,2030
9% in the uecaue piioi to ieaching high-income
status, while Singapoie, Taipei,China anu the
RepublicofKoieagiewat8%oiabove.
The above giowth scenaiio anu long-teim outlook
foi the PRC economy aie fai fiom guaianteeu.
They hinge veiy much on whethei the PRC can
effectively implement neeueu stiuctuial iefoims,
successfully upgiaue its inuustiies anu move up
the value chain thiough innovation, uevelop a
knowleuge-baseu economy, anu auuiess the othei
challenges uiscusseu in this iepoit. While the ioau
islong,thepayoffisgieat.
Table 6.3 CDPgrowtb,selectedAsianeconomies,19ó0–2010{¦]
Japan
Hong Kong,
China Singapore Taipei,China
Republic of
Korea PRC
1961–1969 10.4 10.4 9.7 – 8.3 3.0
1970–1979 4.1 9.6 9.5 – 8.3 7.4
1980–1989 4.4 7.4 7.8 7.7 7.7 9.8
1990–1999 1.5 3.6 7.3 6.3 6.3 10.0
2000–2010 0.9 4.4 6.0 4.1 4.6 10.3
Year became HI 1968 1977 1975 1988 1994 –
Average growth rate
in 10 years before HI 9.8* 8.2 12.1 7.7** 8.5 –
in 5 years before HI 9.5 9.5 11.4 8.7 7.4 –
“–” means data not available, *over previous 7 years, **over previous 8 years, GDP = gross domestic product, HI = high income, PRC = People’s
Republic of China.
Note: All figures are average annual GDP growth. Republic of Korea dropped to upper-middle-income status during 1998–2000.
Sources: Author’s calculations from World Bank, World Development Indicators Online; and for Taipei,China; ADB, Statistical Database System
(all accessed August 2012).
67
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74
Growing beyond the Low-Cost Advantage
How the People’s Republic of China can Avoid the Middle-Income Trap
The economic success of the People’s Republic of China (PRC) over the last 3 decades has
brought with it new challenges. Rising wages and population aging mean that future
growth needs to rely more on productivity improvement through industrial upgrading and
innovation, and transition from “low cost to high value” is critical. What makes this transition
particularly challenging is the PRC’s incomplete reform, which, compounded by rapid growth,
has led to economic imbalances and contributed to rising inequality. Resource constraints and
environmental degradation could also hinder growth. This report analyzes the challenges the
PRC faces and examines policy options that could help its transformation from a low-cost to a
high-value economy, bypassing the “middle-income trap.”
About the Asian Development Bank
ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing
member countries reduce poverty and improve the quality of life of their people. Despite
the region’s many successes, it remains home to two-thirds of the world’s poor: 1.7 billion
people who live on less than $2 a day, with 828 million struggling on less than $1.25 a day.
ADB is committed to reducing poverty through inclusive economic growth, environmentally
sustainable growth, and regional integration.
Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main
instruments for helping its developing member countries are policy dialogue, loans, equity
investments, guarantees, grants, and technical assistance.
Asian Development Bank
6 ADB Avenue, Mandaluyong City
1550 Metro Manila, Philippines
www.adb.org
Printed in the Philippines
Printed on recycled paper

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