47696 MID-TERM EVALUATION OF CHINA'S 11TH 5 YEAR PLAN Poverty Reduction and Economic Management Unit East Asia and Pacific Region World Bank CURRENCY EQUIVALENTS (As of December 18, 2008) Currency = Renminbi Currency Unit = Yuan (CNY) US$1.00 = RMB 6.845 FISCAL YEAR January 1- December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS 5YP - Five Year Plan BMI - Basic Medical Insurance BRICs - Brazil, Russia, India, China CHCs - Community Health Centers COD - Chemical Oxygen Demand CPI - Consumer Price Index EFA - Education for All IVDP - Integrated Village Development Program LICs - Low Income Countries MA - Medical Assistance M & E - Monitoring and Evaluation MDG - Millennium Development Goal MEP - Ministry of Environment Protection MICs - Middle Income Countries MOCA - Ministry of Civil Affairs MOF - Ministry of Finance MOLSS/ - Ministry of Labor and Social Security/Ministry of Human Resources (MOHRSS) and Social Security NCH - National Commission on Health NCMS - New Rural Cooperative Medical System NDRC - National Development and Reform Commission OECD - Organization for Economic Co-operation and Development PBOC - People's Bank of China PPI - Producer Price Index R & D - Research and Development SAT - State Administration of Taxation SO2 - Sulphur Dioxide URBMI - Urban Residents Basic Medical Insurance Vice President: James Adams Country Director: David Dollar Sector Director: Vikram Nehru Task Team Leader: Louis Kuijs Table of Contents Executive Summary........................................................................................................... i 1. Introduction............................................................................................................... 1 Situation and Developments Prior to the Start of the 11th 5YP........................................................ 1 The 11th 5YP.................................................................................................................................... 6 2. Stable Operation of the Macro Economy and Improve Living Standards........ 11 Situation and Developments pre the 11th 5YP............................................................................... 11 Key Objectives in the 11th 5YP on "Stable Macro Economy"....................................................... 12 Key Initiatives and Developments................................................................................................. 12 How Have Macro Policies Evolved during the 11th 5YP?............................................................. 16 Emerging Issues and Assessment .................................................................................................. 18 3. Optimizing and Upgrading of the Industrial Structure...................................... 21 Background and Key Objectives ................................................................................................... 21 Progress with the Tasks of the 11th 5YP........................................................................................ 23 Progress in Meeting the Overall Targets of the 11th 5YP .............................................................. 27 Soundness of the Industrial Structure -- How to Measure Progress over Time?.......................... 29 Concluding Remarks ..................................................................................................................... 34 4. Increasing Energy Efficiency................................................................................. 37 Background and Key Objectives ................................................................................................... 37 Main Initiatives.............................................................................................................................. 40 Key Results Achieved So far......................................................................................................... 45 Conclusions and Lessons............................................................................................................... 48 Recommendations ......................................................................................................................... 50 5. Coordinating Urban and Rural Development...................................................... 53 Background and Key Objectives ................................................................................................... 53 Measures Taken and Key Results.................................................................................................. 55 Emerging Themes and Recommendations..................................................................................... 69 6. Improving Basic Public Services ........................................................................... 75 A. Social Protection................................................................................................................... 75 Background and Key Objectives...................................................................................... 75 Overall Progress, Main Initiatives, and Key Results ....................................................... 77 Analysis of results, Conclusions, and Main Challenges Ahead....................................... 86 B. Health Services ..................................................................................................................... 90 Background and Key Objectives...................................................................................... 90 Main Initiatives and Overall Progress to Date ................................................................. 92 Factors Affecting the Achievement of the Objectives ................................................... 100 Conclusions and Lessons Learned................................................................................. 102 C. Education Development..................................................................................................... 105 Background and Key Objectives.................................................................................... 105 Implementation Status of Main Tasks ........................................................................... 106 Conclusions.................................................................................................................... 111 7. Building a Resource Efficient and Environmentally Friendly Society............ 115 Reducing Air, Water and Solid Waste Pollution ......................................................................... 115 Water Resources Efficiency and Safety....................................................................................... 123 Forestry and Eco-system Protection ............................................................................................ 126 Conclusions and Lessons............................................................................................................. 130 References...................................................................................................................... 135 Figures Figure 1 China's GDP Per Capita Growth Has Been Very Rapid.................................................................. i Figure 2 This Has Allowed China to Catch up with Other Countries ............................................................ i Figure 3 China's Capital-Intensive, Industry-led Economy in International Perspective 1/......................... iii Figure 4 Industry Still Outpaces Services ................................................................................................... vii Figure 5 Investment Still Outpaces Consumption....................................................................................... vii Figure 1.1 China's Growth Performance Is in a League of its Own.............................................................. 2 Figure 1.2 Human Development Also Progressed......................................................................................... 2 Figure 1.3 China's Capital-Intensive, Industry-led Economy in International Perspective 1/....................... 4 Figure 2.1 Potential Growth Broadly Keeps Pace with Actual Growth ...................................................... 13 Figure 2.2 Overall Growth Target Seems in Easy Reach............................................................................ 13 Figure 2.3 The Rise and Fall of Food Price Driven Inflation...................................................................... 15 Figure 2.4 Although a Price-Wage Spiral is is Unlikely, Wage Growth has Remained Robust ................ 15 Figure 3.1 Share of Value-Added of Hi-Tech Industries in GDP, Realized and Targeted, 1995-2010....... 24 Figure 3.2 Percentage Shares of the Tertiary Industry in GDP and Total Employment, Realized and Targeted, 2000-2010................................................................................................................... 28 Figure 3.3 R&D Expenditure As Percentage of GDP, Realized and Targeted, 1995-2010......................... 28 Figure 3.4 Labor Productivity in China's Industry, 1998-2006................................................................... 31 Figure 3.5 Capital Intensity in China's Industry 1/ ..................................................................................... 31 Figure 3.6 Return to Capital of Chinese Industrial Enterprises, 1998-2007................................................ 32 Figure 3.7 Return to Capital of Industrial SOEs and Non-SOEs (above cut-off scale), 1998-2007............ 32 Figure 3.8 Growth of Fixed Assets, Output and Employment of Chinese Industrial Enterprises, 1998-2006................................................................................................................................... 33 Figure 3.9 Growth of Fixed Assets, Output and Employment of Chinese Industrial SOEs (left) and Non- SOEs (right), 1998-2006............................................................................................................. 33 Figure 4.1 Oil Price and Domestic Gasoline Prices..................................................................................... 43 Figure 5.1 Grain Production Has Risen to Levels ....................................................................................... 66 Figure 5.2 Changes in Cereal Land Allocation............................................................................................ 66 Figure 5.3 Sub-Sector Share of Agriculture ................................................................................................ 66 Figure 5.4 Rural Income Per Capita Growth Accelerated Further Since 2005............................................ 67 Figure 5.5 Urban Income Per Capita Growth Was Consistently Higher, Widening the Gap...................... 67 Figure 5.6 Growth in Agricultural GDP, Agricultural Prices, and Agricultural Output.............................. 68 Figure 5.7 Growth of Agricultural Input and Output Prices........................................................................ 68 Figure 5.8 Urbanization............................................................................................................................... 68 Figure 5.9 The Rural-Urban Income Gap.................................................................................................... 68 Figure 6.1 Construction of National Total Health Expenditure................................................................. 102 Figure 6.2 Improvements in Life Expectancy and IMR Reduction in th Asia Pacific Region.................. 104 Figure 7.1 SO2 Emissions - 20 Most Polluted Cities ................................................................................ 116 Figure 7.2 Monitored COD Discharge in China........................................................................................ 117 Figure 7.3 SO2 Emission in China ............................................................................................................ 117 Figure 7.4 Comprehensive Utilization of Industrial Solid Waste in China ............................................... 117 Figure 7.5 Forest Coverage in China......................................................................................................... 127 Tables Table 1 China's Progress in Meeting the Quantitative Indicators under the 11th 5YP................................... vi Table 2 Indicators on the Macro Economy and Living Standards............................................................... vii Table 3 Social Indicators............................................................................................................................... x Table 4 Environmental Indicators ................................................................................................................ xi Table 1.1 China in 2005 According to the 11th 5YP Indicators..................................................................... 3 Table 1.2 China's 11th Five Year Plan........................................................................................................... 7 Table 1.3 China's Progress in Meeting the Quantitative Indicators under the 11th 5YP................................ 9 Table 2.1 Macroeconomic Developments (2000-2005) .............................................................................. 11 Table 2.2 Main Macroeconomic Indicators................................................................................................. 14 Table 2.3 Per Capita Household Incomes (growth, in percent)................................................................... 16 Table 3.1 Changes in the Shares of Tertiary Industry in GDP and Employment ........................................ 28 Table 3.2 China's R&D Expenditure by Source of Funding, 2003-2006.................................................... 29 Table 3.3 Labor Productivity in China's Industry, an International Comparison........................................ 30 Table 4.1 Provincial Energy Intensity Reduction Targets during the 11th 5YP Period ............................. 39 Table 4.2 Tax Rate Change for Selected Products (in percent)................................................................... 45 Table 4.3 Quarterly Energy Intensity Rate in 2006 and 2007 ..................................................................... 45 Table 4.4 Growth of Key Energy Intensive Products.................................................................................. 46 Table 4.5 Change in (Net) Export of Key Products..................................................................................... 46 Table 4.6 Closing Down of Inefficient Production Capacity ...................................................................... 47 Table 4.7 Primary Energy Consumption (Mtce) ......................................................................................... 48 Table 4.8 Efficiency Improvement of Key Products ................................................................................... 48 Table 4.9 Energy Intensity Reduction (EIR) of Key Industries in 2007...................................................... 48 Table 5.1 The 11th 5YP Target Indicators for the Balanced Rural-Urban Development............................. 54 Table 5.2 Budgeted Central Government Spending on Agriculture and Rural Areas................................. 55 Table 5.3 Government Programs Supporting Agricultural Production ....................................................... 56 Table 5.4 Central Government Spending on Agriculture............................................................................ 57 Table 5.5 Agricultural Subsidies ................................................................................................................. 57 Table 5.6 Programs Supporting Agricultural Modernization ...................................................................... 58 Table 5.7 Labor Mobility Programs Are Strengthened ............................................................................... 61 Table 5.8 Targeted Poverty Reduction Projects .......................................................................................... 61 Table 5.9 Central Government Funding for Poverty Reduction.................................................................. 62 Table 5.10 NDRC Investments in Rural Infrastructure ............................................................................... 64 Table 5.11 Achievements as of 2007 of the Major Relevant Target Indicators........................................... 65 Table 5.12 Budgeted Central Government Spending on Agriculture and Rural Areas............................... 69 Table 6.1 Social Protection - 11th 5YP Targets and Progress at Mid-Term................................................. 77 Table 6.2 Indicators for Urban and Rural Dibao, 2005-2007...................................................................... 82 Table 6.3 Major Indicators on Disease Control........................................................................................... 91 Table 6.4 Health Protection - Targets and Progress .................................................................................... 92 Table 6.5 Progress Indicators on NCMS..................................................................................................... 93 Table 6.6 Indicators on MA......................................................................................................................... 95 Table 6.7 Total Government Expenditure and Spending on Health............................................................ 99 Table 6.8 Central Government Health Spending(RMB billion)................................................................ 101 Table 6.9 No. of Documents and Programs Launched in 2006-2007........................................................ 106 Table 6.10 Key Indicators for Compulsory Education.............................................................................. 107 Table 6.11 Key Indicators of Vocational Education.................................................................................. 109 Table 6.12 Key Indicators of Higher Education........................................................................................ 110 Table 6.13 Inputs and Outputs................................................................................................................... 110 Table 7.1 The 11th 5YP Targets and Progress Related to Pollution Reduction ......................................... 120 Table 7.2 Target and Progress Regarding Industrial Solid Wastes (billion tons)...................................... 120 Table 7.3 Water Use Per Unit of Industrial Value-Added......................................................................... 123 Table 7.4 The 11th 5YP Targets and Progress Related to Water Resources .............................................. 125 Annexes Annex 1: Overview of Structure of the 11th 5YP....................................................................................... 132 Annex 2: Monitoring and Evaluation Framework..................................................................................... 137 Annex 3: Progress in Implementing the 11th 5YP: Summary Results for 45 Tasks of Chapter 10, 11 and 13 ...................................................................................................................................................... 138 Annex 4: "New Socialist Countryside"..................................................................................................... 154 Annex 5: NDRC Investments in Agriculture and Rural Development...................................................... 155 Annex 6: Labor Mobility Programs and Interventions.............................................................................. 158 Annex 7: China 11th Five-Year Program Key Policies and Regulations in Social Protection (2005-2008)159 Annex 8: Urban Pension System in China: Summary of Major Policy Changes ...................................... 161 Annex 9: China 11th 5YP: Key Policies on Health (2005-2008)............................................................... 162 Annex 10: Key Educational Indicators in 2006.......................................................................................... 166 Annex 11: Key Policies and Regulations in China Related to Resources and Environment Objectives in China's 11th Five Year Program ............................................................................................... 167 Acknowledgements This mid term review was prepared at the request of the Development Planning Department of China's National Development and Reform Commission (NDRC). A summary report based on the draft executive summary was presented to NDRC in early July 2008 and a draft full report in early October 2008. The task manager is Louis Kuijs. The evaluations were done by the following World Bank staff members: Louis Kuijs (Chapters 1 and 2), Chunlin Zhang (chapter 3); Jianping Zhao (chapter 4); Sari Söderström and Luc Christiaensen (chapter 5), Xiaoqing Yu and Minna Hahn Tong (chapter 6A), Shuo Zhang and Shiyong Wang (chapter 6B), Liping Xiao (chapter 6C), and Andres Liebenthal and Xin Ren (chapter 7). Wanda Tseng provided much appreciated guidance and feedback on the overall evaluation approach and individual chapters and also co-authored the Executive Summary with the task manager. Andres Liebenthal also gave valued guidance to the overall evaluation approach. Skillful research assistance was provided by Chenjie Liu and Gao Xu. Jianqing Chen provided crucial assistance and formatted and compiled the report. Li Ouyang provided crucial assistance throughout the project. Several consultants provided welcome inputs and background information for several of the chapters, including Jianlong Yang, Research Fellow at the Development Research Center of the State Council (Chapter 3) and Professor Lin Wanlong of China Agricultural University (Chapter 5), who also commented on the main text. For Chapter 6, helpful information gathering was done by Rong Mo, Shaomin Cui, and Qinyi Yu on social protection, Dai Tao on health and Ping Zhu on education. Valuable comments and advice were provided at different stages by many collegues and other people. Special thanks go out to Deepak Bhattasali, Vivek Arora, and Shantong Li, who were peer reviewers of the concept note, and Pieter Bottelier, Nicholas Hope, and Shahid Yusuf, who were peer reviewers of the main report. Messrs. Bottelier and Hope also gave much appreciated comments on the Executive Summary. DG Xu Lin of the NDRC is thanked for valuable insight and guidance. Ardo Hansson gave much appreciated comments. Vikram Nehru, Sector Director and Acting Chief Economist, East Asia and Pacific Region, and David Dollar, Country Director for China, provided overall guidance. i Executive Summary Situation Prior to 11th 5YP When the 11th 5 Year Plan (5YP) was formulated in 2003-05, China had enjoyed an extended period of rapid economic growth, poverty reduction, and increasing integration with the global economy. Since the onset of economic reforms and opening up three decades ago, China's economic growth had been in a league of its own, surpassing that of low income countries (LICs), middle income countries (MICs), and other BRICs (Brazil, Russia, and India) (Figures 1 and 2). GDP growth had averaged about 10 percent per year, with reduced volatility and generally low inflation from the mid-1990s. Poverty had fallen sharply on all definitions; on the cost-of-basic needs benchmark, poverty had declined from 65 percent of the population in 1981 to about 7 percent in 2005, lifting hundreds of millions out of poverty at an unprecedented rate. China had also integrated swiftly into the global economy via trade and foreign direct investment, culminating in China's accession to the WTO in 2000. Reforms also increased the market orientation of China's economy. The role of the private sector and market mechanisms expanded steadily, while direct government control over economic activity diminished. Product and factor markets gradually became more integrated. One exception was the financial sector, where reforms lagged and all major banks remained state-owned, dominating the financial system. But even here progress was marked. The government had recapitalized the major state banks, invited strategic partners, raised funding in capital markets, improved the supervisory and regulatory framework, and aimed at reforming internal management and controls. And, in parallel, capital markets were expanded and deepened. Finally, fiscal revenues, which had been pressured during the early years of reforms, had recovered since the mid-1990s. Figure 1 China's GDP Per Capita Growth Has Figure 2 This Has Allowed China to Catch up Been Very Rapid with Other Countries 30 Growth China 4,000 GDP per (% yoy) China 25 Lower income countries 3,500 capita 2000 US$ Lower income countries 20 Middle income countries 3,000 Middle income countries 2,500 15 2,000 10 1,500 5 1,000 0 500 -5 0 1980 1984 1988 1992 1996 2000 2004 1980 1984 1988 1992 1996 2000 2004 Source: World Development Indicators, WB Source: World Development Indicators, WB ii Despite ­ or perhaps as a result of -- these achievements, the attention of policy makers focused increasingly on growing economic and social imbalances that emerged as a result of China's rapid growth. These imbalances included: · Heavy reliance on investment and exports for economic growth, at the expense of domestic demand, especially consumption. This was reflected in a large and growing external current account surplus that reached 7 percent of GDP in 2005. · Domination of industry, especially heavy industry, over the services sector (services make up 40 percent of GDP in China, compared with an average 54 percent in middle income countries and 70 percent in high income countries). · Rapid increases in the demand for energy and other resources. China's primary energy consumption grew by 62 percent during 2000-05 largely because of its capital-intensive, industry-led growth. China's energy intensity also climbed, reversing a trend decline since the start of market reforms. By 2005, it was 43 percent higher than in India and 73 percent higher than in the U.S., based on PPP GDP. Excessive withdrawal of water from surface and underground resources caused acute water scarcity in the northern plains. · Widening disparities in regional development and incomes, between urban and rural areas and coastal and inland provinces. · Pronounced unevenness in access to basic public services between urban and rural areas. Social protection remained inadequate, especially for vulnerable groups including large numbers of rural-urban migrants. Access to education was uneven between urban and rural areas; the health system was poorly developed in rural areas, and there was a general lack of access to affordable health care. · A mixed record in the improvement of environmental quality. While air quality had improved in many cities, and water quality had improved in the south, overall emissions of key pollutants had increased, as has the production of solid waste. China is now home to 13 of the world's 20 most polluted cities. Land use patterns created tensions among the conflicting demands of urbanization, farmers' income, and environmental protection. In no small part, these imbalances were an outcome of China's capital-intensive, industry-led pattern of growth (Figure 3). China's growth had been capital intensive, with the investment to GDP ratio rising to almost 43 percent in 2005 and--using growth accounting--capital accumulation accounted for over 60 percent of GDP growth during 1993-2005. From a sectoral perspective, China's growth was driven especially by industry, which during 2003-2005 accounted for over 60 percent of all GDP growth. The burgeoning profits of industrial firms, together with cheap credits from state banks, were invested in additional capacity. Industrial growth was associated particularly with iii increases in labor productivity, less so with employment growth, reflecting in part labor shedding by SOEs Moreover, with industry taking the lead, service sector development lagged (the share of services in GDP was 40 percent in 2005, compared to an average of 54 percent in middle income countries and 70 percent in high income countries). As a result, urban employment growth, while robust, was not as high as it could have been, given China's rapid overall growth. Figure 3 China's Capital-Intensive, Industry-led Economy in International Perspective 1/ 45 Investment over GDP ratio 40 (percent) South Korea China (2005) (1990) 35 India (2005) Malaysia (1990) Japan (1990) Japan (1980) 30 South Malaysia (1980) Korea 25 Japan Thailand Malaysia 20 US Indonesia 15 Malaysia (1970) Malaysia (1960) Share of industry in value added (percent) 10 10 20 30 40 50 60 Sources: World Development Indicators, NBS (for China), and staff estimates. 1/ 2001, unless otherwise indicated. This capital-intensive, industry-led pattern of growth was a key driver of the imbalances outlined above. First, the capital-intensive, industry-led growth had been particularly intensive in energy, natural resources, and environmental degradation, thus accentuating the associated imbalances noted above. While energy and natural resource intensity was declining in several sectors, the relatively rapid growth of industry increased the weight in GDP of the most energy and resource intensive sectors. Second, capital-intensive growth created fewer jobs than a services-led growth pattern, limiting the absorption of surplus agricultural labor and contributing to the rising rural-urban income inequality and rural poverty noted above. Third, capital-intensive growth resulted in a declining share of wage income in GDP--a key driver of the declining share of consumption in GDP, the rising share of investment, and a ballooning external current account surplus. iv Government policies helped accentuate China's capital-intensive, industry- and export-led growth pattern. Thus, while serving the economy well in several regards, policies indirectly accentuated the imbalances noted above. Policies encouraged saving and investment, with government spending geared to investment in physical infrastructure more than health and education, and biased to richer, coastal areas. Industrialization was promoted via easy access to cheap credit for large industrial firms, as well as by under-pricing key inputs, including capitalenergy, natural resources, land, and the environment. The reluctance to move to greater exchange rate flexibility and allow the exchange rate to appreciate further stimulated exports and industry. The priority accorded to industry meant that services lagged. The hukou system restricted rural-urban migration and limited access to urban public services for migrants, further accentuating capital intensity, but at the same time dampening the rate of urbanization and avoiding the formation of urban slums. The 11th 5YP: A Turning Point in China's Development Strategy The 11th 5YP reorients policies to correct these imbalances. In a major shift from previous plans which had quantitative growth as the dominant objective, the 11th 5YP gives priority to rebalancing the economic structure as well as to environmental and social objectives. It recognizes that economic, environmental, and social objectives are intertwined. The guiding principles and policy orientation seek to rebalance China's growth pattern, with domestic demand, especially consumption, as the main driver, and services as the leading sector. This, in turn, is expected to better balance economic growth with resource conservation, energy efficiency, and environmental protection. Moreover, rebalancing the pattern of growth is expected to help mitigate the urban-rural divide, promote more balanced regional development, and improve basic public services, especially social protection, health, and education. To meet these objectives, the 5YP sets out 15 main tasks and strategic priorities, which in turn are supported by 22 quantitative benchmarks, of which 8 are obligatory and 14 are anticipative. A three-tier monitoring and evaluation framework was developed with a large number of quantitative indicators, although this does not seem to be operational yet. The overarching goal is to deliver a more people-centered growth and development that is more sustainable and equitable, thereby creating a more "harmonious society." Implementation of the 11th 5YP: Progress to Date This mid-term review has been undertaken to assess progress in the implementation of the 11th 5YP during its first two years and a half, draw preliminary lessons, and make recommendations for policy adjustments. The review examines the following strategic objectives: ensuring the stable operation of the macro economy and improving living standards; optimizing and upgrading of industrial structure; increasing energy efficiency; coordinating urban and rural development; improving basic public services; and enhancing sustainable development. During the implementation of the 11th 5YP, China has been buffeted by various exogenous shocks. Domestically, natural disasters--the severe storms last winter and the v recent massive earthquake in Sichuan--took a heavy toll. Externally, global demand has slowed owing to the slump in the U.S. housing market and the related credit crisis and increased risk aversion. International oil, food, and other commodity prices have soared. These developments pose new challenges. But they also reinforce the appropriateness of the policy priorities of the 11th 5YP to increase the economy's resilience and ensure sustainable growth. The 11th 5YP overall provides useful guidance to policy makers. The objectives and tasks set out in the 5YP are consistent with China's development challenges and government priorities Moreover, the quantitative indicators generally accord well with the overall guiding principles, orientations, and objectives, suggesting that these have been successfully put into operation. Many policies, programs, and regulations have been put in place recently to achieve the plan's objectives. These include high-level political directions, broad strategies, specific administrative and policy measures, as well as the establishment of new institutions, regulations, and standards. On the whole, these measures were comprehensive and relevant to the objectives. Progress toward achieving the major objectives of the 11th 5YP has varied (Table 1). · Economic growth has far exceeded expectations. · Considerable progress has been made toward the 5YP's most important social objectives: improving basic public services in social protection, education, health, and conditions in rural areas (even though income disparities between rural and urban areas continue to widen). · Progress on the environmental objectives has been mixed: insufficient progress has been made in reducing energy intensity, but improvements were seen in reducing air and water pollution, treating industrial solid waste, increasing the efficiency of water use, and expanding forest coverage. Broadly speaking, the progress achieved so far can be attributed to several key factors. These include a high level of political commitment, generally adequate administrative capacity to roll out new initiatives rapidly, strong public support for the objectives, an adjusted accountability system that links implementation to performance assessment of local officials, and increased central funding. The policy measures introduced were comprehensive and relevant to the objectives. However, little progress has been made in rebalancing the overall pattern of growth, which has in turn limited progress on other key objectives. There has been little rebalancing away from industry and investment towards services and consumption. This, in turn, has made it difficult to meet the objectives on energy efficiency, the environment, and reducing the external imbalance. The lack of decisive rebalancing has also made further widening of urban-rural income inequality almost unavoidable, despite strong vi government efforts. Going forward, rebalancing would help meet these objectives and solidify the social gains that have been achieved. The policy agenda for rebalancing is broad ranging, involving macroeconomic policy adjustments and structural reforms, as discussed below. Table 1 China's Progress in Meeting the Quantitative Indicators under the 11th 5YP 2005 2007 2010 Type of Category Indicator actual actual target Target 1/ Economic GDP (RMB trillion) 18.4 25.0 26.1 A growth GDP per capita (RMB) 14,103 18,885 19,270 A Share of services in GDP (%) 39.9 40.1 43.3 A Economic Share of services in total employment (%) 31.4 33.2 35.3 A Structure Ratio of R&D expenditures to GDP (%) 1.2 1.4 2.0 A Urbanization Rate (%) 43.0 44.9 47.0 A Total Population (100 mln) 13.1 13.2 13.6 O Reduction of energy use per unit of GDP (%) 0 4.6 2/ 20.0 3/ O Reduction of water use per unit of industrial VA (%) 0 ... 30.0 3/ O Population, Efficiency coefficient of irrigation water 0.45 0.46 4/ 0.50 A resources, Compreh. utiliz. rate of industrial solid waste (%) 56.1 61.2 60.0 A and Total cultivated land (mln ha.) 122.1 121.7 4/ 120.0 O environment Reduction of total major pollutants emission (%) COD na 2.1 2/ 10.0 3/ O SO2 na 3.2 2/ 10.0 3/ O Forest Coverage (%) 18.2 ... 20.0 O Average number of years of schooling (yr) 8.5 ... 9.0 A Public Population covered by basic urban pension (100 mln) 1.7 2.0 2.2 O Services Coverage new rural coop. health system (%) 75.7 85.7 80.0 O and New urban employment in five years (mln) 45 A Quality Rural labor force transferred in five years (mln) 45 A of Registered urban unemployment rate (%) 4.2 5.0 A Life Per capita disp. income urban households (RMB) 10,493 13,790 13,390 A Per capita net income rural households (RMB) 3,255 4,140 4,150 A Sources: China's authorities, NBS, and staff estimates. 1/ A = Anticipated; O = Obligatory 2/ accumulated reduction in 2006-07 3/ Targeted accumulated reduction in 2005-10 4/ 2007 data not yet available. This is the 2006 data. Looking more specifically at the major objectives of the 11th 5YP: Stable Operation of Macroeconomy and Improved Living Standards China has broadly succeeded in combining rapid growth with low inflation. During 2005-07, GDP growth accelerated to nearly 12 percent annually and per capita income growth rose rapidly in urban and rural areas even as the gap between rural and urban incomes widened (Table 2). But little progress was made in rebalancing the underlying drivers of growth, which on the sectoral side continued to be industry, and on the demand side, investment and exports (Figures 4 and 5). The labor-intensive services sector continued to lag behind industry, but with overall economic growth so strong, urban job creation remained robust. Preliminary data indicate strong poverty reduction in the first 2 vii years of the 11th 5YP period. China is affected by the global financial turmoil and slowdown, with growth in end-2008 and early 2009 expected to be particularly weak. However, the medium-term growth outlook remains good and the 11th 5YP's objectives for overall and per capita income growth will likely be achieved. Table 2 Indicators on the Macro Economy and Living Standards 2005 2006 2007 2008 WB 1/ Real GDP (production side) 10.4 11.6 11.9 9.4 Consumer prices (period average) 1.8 1.5 4.8 6.5 Fiscal balance (% GDP) -1.2 -0.5 0.7 -0.4 Current account balance (% GDP) 7.1 9.5 11.3 9.3 Real urban p.c. income (%) 9.6 10.4 12.2 ... Real rural p.c. income (%) 6.2 7.4 9.5 ... Source: NBS, SAFE, Ministry of Finance. 1/ World Bank Forecast, December 2008. In 2007 and much of 2008, headline inflation was high as a result of sharply rising international and domestic food prices. The impact of higher international oil prices on inflation was more muted due to price controls, even with an increase in fuel prices in June 2008. In mid 2008, headline inflation started to recede as food prices stopped rising, even as additional pressure remained from higher oil and commodity prices. The global slowdown led to a sudden reversal of oil and commodity prices. Looking ahead, inflation is likely to continue to decline and it may be very low in 2009. However, risks and uncertainties about future price developments are accentuated by the conduct of monetary and exchange rate policy, with monetary policy constrained by the limited flexibility in the exchange rate. Figure 4 Industry Still Outpaces Services Figure 5 Investment Still Outpaces Consumption (constant prices) (constant prices) 16 Grow th Construction 25 Grow th 14 (percent, (percent, Industry Tertiary Exports yoy) 20 yoy) 12 Consumption 10 15 8 Investment 6 10 4 Primary 5 2 0 0 2006 2007 2006 2007 Source: NBS, World Bank staff estimates Source: NBS, World Bank staff estimates A visible reflection of China's macroeconomic imbalances is the current account surplus, which climbed to over 11 percent of GDP in 2007, approaching 0.75 percent of global output. The trade surplus declined in the first 5 months of 2008 from its level a viii year ago because of a large deterioration in the terms of trade as raw material prices soared. In constant prices, though, net external trade continued to contribute to GDP growth even as the world economy slowed. The large external surplus reflects the lack of progress in rebalancing the overall pattern of growth. Exchange rate developments have been an important factor limiting this progress, although, as noted, many elements of the policy setting have played a role, including the pricing of inputs and capital for industry, fiscal policy, and financial sector policies. China's exchange rate has gradually appreciated. Since July 2005, the exchange rate of the RMB has been set with reference to a basket of currencies, and it has appreciated almost 21 percent against the U.S. dollar up to November 2008. The U.S. dollar, however, has depreciated against most of world's major currencies during this period, despite strengthening in recent months. As a result, on a trade-weighted basis, the RMB's appreciation has been more limited since July 2005, at 15 percent. At the same time, productivity growth in China's manufacturing industry has continued apace, implying a strengthening of the equilibrium exchange rate. Optimization and Upgrading of Industrial Structure There is mixed progress in meeting the overall objectives in the area of industrial structure. The targets on the share of total employment in the service sector and R&D are within reach. However, given recent trends, it seems unlikely that the target to raise the share of the service sector in GDP can be met. Instead, during the first three years of the 11th 5YP, industry continued to outpace the services industry. Within the industrial sector, energy-intensive heavy and chemical industries (such as steel and aluminum) gained further importance, even though they slowed considerably in late 2008. These developments have made achieving the objectives on energy efficiency and environmental quality more difficult to achieve. The industry-specific agenda to upgrade the industrial structure appears to be on track. While it is difficult to measure progress in this area, the tasks the Government set on industrial upgrading are being carried out: accelerating the development of high tech industries; revitalizing equipment manufacturing industries; and adjusting the structure and spatial layout of raw materials industries. Industrial upgrading has involved a strong role for government in resource allocation, in the form of investment licensing, access to land and financial resources, and various administrative measures. Whether carrying out the industrial agenda actually improves the economic and industrial structure is open to question. This is because it is difficult to assess whether setting and carrying out a detailed agenda for industrial structural changes yields optimality in an increasingly market-oriented economy. With the increased market orientation of China's economy, industrial upgrading is best pursued by measures that encourage innovation such as improved IPR, venture capital markets, better governance of SOEs, and greater access of private firms to capital markets. ix Overall quantitative indicators generally suggest continued improvements in the performance of the industrial sector. This is evident in the continued rapid growth in labor productivity and catch up with high income countries during the first two years of the 11th 5YP. The productivity improvements and upgrading boost China's international competitiveness. Judging from continued increases in China's global market share, this competitiveness position is strong. In addition, until the recent downturn measures of the return on capital have continued to improve for both SOEs and non-SOEs. However, SOEs continue to show considerably higher capital intensity (the amount of capital per worker), with lower rates of return on capital, employment creation and labor productivity growth than non-SOEs. Increasing Energy Efficiency China's energy intensity (the amount of energy per unit of output) has been reduced, but by much less than needed to achieve a 20 percent reduction by 2010. At the start of the 11th 5YP, energy intensity reversed an upward trend exhibited since 2002. However, the extent to which this can be sustained is questionable. This is because the reduction in energy intensity seems to be mainly at the sectoral rather than the macro level. At the sectoral level, higher energy efficiency has been achieved in specific products. However, capital-intensive and high energy using industries continue to grow more rapidly than other parts of the economy. That is because the overall pattern of growth and the policies underlying it, including the pricing of energy and other resources, remain broadly unchanged. Looking ahead, the efficiency gains from technical upgrading and closure of inefficient capacity will become harder to tap in the future. Without rebalancing the pattern of growth and the economic and industrial structure, it is unlikely that the 20 percent reduction target in energy intensity could be achieved. Raising energy prices would likely be most effective in promoting energy efficiency and contributes to rebalancing. It is equally important to put in place the policies and the institutional, regulatory, technical, and financial framework and capacity to sustain China's efforts to transform to more energy efficient economic growth. Coordinated Urban and Rural Development and Improving Basic Public Services The first two years of the 11th 5YP have witnessed substantial social progress. Government spending on rural issues is budgeted to increase from 1.6 percent of GDP in 2005 to 2.0 percent of GDP in 2008. Conditions in rural areas improved significantly. The targets relevant to balanced rural-urban development in the 11th 5YP, including the coverage of the new rural cooperative medical services, farmland retention, and per capita income of rural residents, will likely be met (Table 3). Four policy initiatives during the 11th 5YP have been instrumental in improving farmers' incomes and living conditions: (i) the abolishment of agricultural taxes and fees in 2005; (ii) introduction of free compulsory education in the countryside; (iii) the introduction of the rural cooperative medical insurance schemes; and (iv) the extension of the minimum living standard allowance. x Table 3 Social Indicators 2005 2007 2010 Percent target completed Basic urban old age insurance contributors (millions) 175 201 223 54 No. of beneficiaries rural dibao (millions) 8.3 34.5 ... ... No. of counties with NCMS (percent) 1/ 22 86 80 2/ > 100 No. of beneficiaries rural Medical Assistance(millions) 11.1 35.7 ... ... Source: MOLSS, Civil Affairs Yearbook, MOH, MOE. 1/ New Rural Cooperative Medical System (health insurance). 2/ The target was recently revised to 100 percent. Considerable progress has also been made to improve public services in the areas of social protection, education, and health. This is based on strong government effort and significant progress in rolling out various initiatives. While there are still important design issues in need of reform, achieving the targets for the social objectives laid out in the 11th 5YP is on track, or even ahead of schedule in some cases: · China is on track to meet the targets for expanding basic urban pensions, unemployment insurance, work injury insurance, maternity insurance, and rural dibao program (a poverty gap program for the poorest rural residents). Having achieved this impressive progress, attention can now focus on several design issues with the framework for social protection. · The targets for health protection and major disease prevention and control are also being realized ahead of schedule. All counties nationwide are expected to be covered by the new rural cooperative medical system by end 2008. Basic medical insurance for urban residents and employees is also expanding rapidly. A medical assistance system now covers all rural counties; good progress is also being made on introducing medical assistance in urban areas. Building on this rapid expansion of health protection, the government could usefully turn to some design issues. · In the priority areas of education, targets for expanding free compulsory education nationwide, as well as for scale and system development of vocational and higher education will be achieved ahead of schedule. At the same time, the challenge of how to distribute the benefits of rapid economic development more equitably remains. This is because while conditions are improving in rural areas, they are improving even faster in urban areas. Despite a massive increase in financial support in rural areas, with central government spending on agriculture and rural areas rising by 75 percent during 2005-07, the gaps in income and quality of life between the urban and rural areas continue to widen. Enhancing Sustainable Development Preliminary indications are that China has made progress toward a more resource efficient and environmentally sound economy. The unrelenting increase in air and xi water pollution discharges over the past decade appears to have been reversed during the past two years, indicating progress toward the target reduction of SO2 and COD emissions by 10 percent during the 11th 5YP, although meeting the target may be difficult (Table 4). The share of industrial solid waste that is treated has been raised. The efficiency of water use in irrigation and the industrial value added per unit of water consumed have increased, but the reduction in water intensity in industry by 30 percent remains a difficult goal. Forest coverage has steadily expanded, although the timetable for reaching the 20 percent target may have been set back somewhat by the recent severe winter. Nevertheless, immense environmental challenges remain. Air and water pollution in China still exceeds applicable standards in most areas. Freshwater withdrawals already exceed sustainable levels of both surface and underground resources, especially in North China. The forest cover remains far below the level needed to restore its environmental and ecological functions, even though a massive reforestation effort has been under way for nearly a decade. Prospects for continued progress in increasing resource efficiency, however, are clouded by the current economic structure, with concentration of industrial growth in resource intensive, high polluting industries. Table 4 Environmental Indicators 2005 2007 2010 Percent target completed COD emission (10000 ton) 1414 1384 1270 21 SO2 emission (10000 ton) 2549 2467 2295 32 Utilization of industrial solid waste (%) 56 61.2 1/ 60 > 100 Source: Statistical Yearbook 2007, Xinhua. 1/ Data for 2006. In sum, significant progress has been made toward many of the major objectives of the 11th 5YP, but important challenges remain. In particular, insufficient progress on macroeconomic rebalancing and changing the economic and industrial structure has limited progress on energy and water intensity, and environmental quality. Also, with little progress in rebalancing, less urban job creation has occurred than could have been under a more labor intensive pattern of growth--in particular, less formal urban employment and permanent migration--potentially undermining the social progress that has been achieved. Moreover, the limited strengthening of the exchange rate, combined with rapid productivity growth, especially in manufacturing, has-- combined with other elements of the policy setting that boost investment in industry-- contributed to the large and unsustainable external current account surplus. Accordingly, priority should be given to rebalancing which would help to meet the environmental objectives and solidify the social gains. The Policy Agenda Ahead Achieving a rebalanced economy requires reforms in a broad range of areas. These encompass macroeconomic and structural policies, fiscal policy and intergovernmental fiscal relations, government spending, monitoring and evaluation, xii administrative reforms, price reforms, and regulations and standards. The implementation experience thus far suggests the following areas for policy adjustments. A range of macroeconomic and structural polices will help to stimulate domestic consumption, reduce domestic saving, and stimulate expansion of the services sector. These include: · Continue to shift government spending from investment to social protection, health, and education. · Strengthen further the exchange rate to shift production from tradables to non- tradables and increase exchange rate flexibility to give more independence to monetary policy; this, in turn, would facilitate greater reliance on market based instruments, including interest rates, for macroeconomic management. · Further pursue financial market reforms to improve the efficiency in the allocation of capital, consistent with higher interest rates, thus keeping growth up with less investment and increasing the role of consumption. Such reform and more efficient allocation of capital should benefit the service sector and small and medium-sized enterprises. · Expand the dividend policy for SOEs and improve corporate governance to remove the over-investment bias, especially in large, industrial SOEs. Fiscal and tax policy can help to adjust the structure of production: · Eliminate the underpricing of industrial inputs--land, energy, water, natural resources, and the environment--through price increases, tax measures, and/or pollution charges. Accelerated energy price reform would allow prices to reflect the full cost of supply, including environmental and depletion costs. The recent adjustment in domestic oil prices is a step in the right direction. · Remove remaining distortions in the tax system that subsidizes manufacturing, including the VAT system as well as remaining preferential tax treatment of FDI. · Remove remaining restrictions on the development of a thriving services industry. Addressing, as planned, monopolies and oligopolies in several service sectors is important, as is removing other barriers and vigorously implementing WTO commitments. Introduce institutional reforms that give local officials stronger incentives and better tools to pursue rebalancing are also important. A key measure is to increase accountability, especially via the performance evaluation of local officials and enforcement of laws and regulations. Last year's measure to include land revenue in the local government budget, rather than as part of the extra-budgetary funds managed by xiii land bureaus, could improve the governance of these funds and reduce the incentive to pursue a land-intensive development pattern. China is in a strong fiscal position to support the rebalancing of the economy. Fiscal savings from higher energy and resource prices and environmental taxes could be used for expenditures in priority areas identified by the 11th 5YP, reductions in other taxes, or compensation to vulnerable groups affected by the price adjustments. Reform of the intergovernmental fiscal relations would allow poor regions to have the resources to carry out improvements in the social sectors. Inadequate local funding (and capacity) in poor regions is a serious constraint on further progress in many areas, including the delivery of rural services, social protection, education, health, and resource efficiency. Sub-national governments in China are responsible for a much larger share of spending than in most other countries. In the absence of significant net transfers from rich to poor regions or other revenue sources, large disparities in spending per person on public services are unavoidable. Moreover, income-poor but resource-rich provinces are currently not adequately compensated when their resources are extracted for national development. Reform of the intergovernmental fiscal system is required to fundamentally address the problem. Such reform would need to include higher net transfers via the center from rich regions to poor regions, notably through higher equalization grants, possibly combined with further changes in spending responsibilities between sub-national governments and the center. In addition, China should consider options for devolving more revenue sources that benefit poor regions. Higher resource taxes provide an opportunity to grant the poor provinces higher tax shares and make the poor provinces less dependent on fiscal transfers. Payments for environmental services (such as water, land conversion rights) could become revenue for the poor provinces as well. Increased government spending puts a premium on the efficiency of spending. The recent increase in spending and introduction of many new initiatives call for more systematic and rigorous monitoring and evaluation frameworks. This involves more research and analysis to develop better monitoring indicators, focusing on results and quality, drawing on international experience and benchmarks; and developing a robust information system to track progress. More can be done to nurture a culture of evidence- based evaluation and building capacity for it. There needs to be better linkage between results of evaluations and adjustments in policies, priorities, and financing. In addition, stronger accountability is required, and the recent move to expand the local officials' evaluation system to include objectives of the 11th 5YP should be helpful in this regard. Fragmentation of various programs, while probably unavoidable in a big country like China, calls for further efforts at consolidation and coordination. To close the rural-urban income gap, a dual approach is needed that fosters both a reallocation of labor from rural to urban areas and increases rural labor productivity on and off the farm. While restrictions on the migration of rural labor to urban areas can be further relaxed, this in itself cannot be done fast enough to effectively close the rural-urban income gap. Nor can urban-rural income transfers fully close the xiv gap. This suggests the need for increases in agricultural output and productivity which, in turn, requires more, but also more efficient public spending on rural public goods. More spending could be directed to agricultural science and technology; environmentally sustainable techniques for staple crop production (including more efficient water management); and agricultural diversification to high value products. Further efforts are also needed to create an enabling environment for agricultural modernization by deepening and speeding up land related reforms, including land acquisition and land tenure rights, and improving agricultural producers' access to financial services. Administrative tools need to be augmented by increased reliance on market incentives and regulatory means. So far, rapid progress has been achieved through administrative measures in the areas of energy efficiency and environmental pollution. However, this rate of progress may be difficult to sustain in the future without greater reliance on market incentives and the regulatory system, including the criteria used for performance evaluation of local government officials. There is increasing urgency in building a policy and institutional framework that uses market-based instruments to encourage rebalancing. Price reforms are called for, especially in the areas of energy and resources pricing and taxation, but China's grain price policies may also need to be adjusted to bring domestic prices closer to international ones. Regulatory measures could include environmental emission standards, consumer products labeling, and fuel and building efficiency standards. Vigorous enforcement of regulations and standards will, of course, be equally important. 1 1. Introduction Situation and Developments Prior to the Start of the 11th 5YP When the 11th 5YP was formulated in 2003-05, China had experienced a long period of sustained, rapid economic growth and development. GDP growth averaged close to 10 percent per year between 1978 and 2005, with growth less volatile over time and inflation low since the mid-1990s. China's overall growth put it in a league of its own: growth in GDP per capita was significantly higher than the average for low income countries (LICs), middle income countries (MICs) and other BRICS (Figure 1.1). As a result, China was catching up fast with MICs: its GDP per capita had increased from 43 percent from that of the MICs in 1995 to 66 percent in 2005 (in prices of 2000). Living standards improved and poverty was reduced substantially. The share of the population in poverty had fallen sharply on all definitions. On cost of basic needs benchmark, poverty had declined from 65 percent in 1981 to around 7 percent in 2005, lifting hundreds of millions out of poverty. Unemployment pressure in urban areas mitigated earlier this decade after the worst of the labor shedding by SOEs came to an end and private sector activity surged. Structural reforms and opening up had continued apace and had brought China closer to a fully fledged market economy. China's economy was integrating swiftly into the world economy via very rapid expansion of external trade and foreign direct investment. Multinational companies set up manufacturing bases in China to supply domestic and international markets.1 The role of the private sector and market mechanisms increased steadily, while direct government control over economic activity diminished.2 Product and factor markets had become more integrated domestically, although there is room for further integration, particularly in services. Financial sector reform continued, but lagged behind the transformation of the real economy, with all major banks still state-owned and bank financing dominating the financial system. Nonetheless, in 2005 the government was recapitalizing the major state banks, invited strategic partners and was preparing to raise funding in capital markets; supervisory and regulatory controls as well as internal management and controls were improved, although there is further room for improvement to reach international best practice. In parallel, capital markets expanded and deepened. Finally, fiscal revenues, which had during the initial stage of the reform period been under pressure, had recovered since the mid-1990s. 1Ranging between 2 and 4 percent of GDP since the early 1990s, FDI has been important in China not so much as a much-needed source of financing of investment, but as a vehicle to access technology and managerial skills. 2The OECD reports that in 2003 the private sector share of value added was 52 percent, up from 28 percent in 1998 (OECD, 2005). 2 Figure 1.1 China's Growth Performance is in a Figure 1.2 Human Development Also Progressed League of its Own 1/ 4,000 GDP per 0.60 China 3,500 capita 2000 US$ Lower income countries 0.50 3,000 Middle income countries 0.40 2,500 2,000 0.30 Lower income countries 1,500 Middle income countries 0.20 1,000 China 0.10 500 Other BRICS 0 0.00 1980 1984 1988 1992 1996 2000 2004 1980 1989 1993 1997 2001 2005 Source: World Development Indicators, WB Source: UNDP, staff estimates. 1/ UN Human Development Index excluding GDP per capita. Despite ­ or perhaps as a result of ­ these achievements, the attention of policy makers focused increasingly on growing economic and social imbalances that emerged as a result of China's rapid growth. The midterm review of the 10th 5YP carried out by the NDRC identified 5 major imbalances.3 These were an "unhealthy" pattern of economic growth, which relies overly on investment and exports"; insufficient development of the tertiary industry; insufficient policy guidance and incentives for developing the western region; slow progress with urbanization; and an imbalance between economic and social development. More specifically, during 2003-2005, the government observed the following imbalances that it wanted to address. · Heavy reliance on investment and exports for economic growth, at the expense of domestic demand, especially consumption. This was reflected in a large and growing external current account surplus that reached 7 percent of GDP in 2005. · Domination of industry, especially heavy industry, over the services sector. Services make up 40 percent of GDP in China, compared with an average 54 percent in middle income countries and 70 percent in high income countries (Table 1.1). 3This mid-term review, China's first, was carried out by the National Development and Reform Commission (NDRC)'s Development Planning Department. It relied on available indicators and data to measure key economic and social trends, as well as on mid-term reviews that provinces and ministries were asked to produce and a survey among 100 experts and academics. The review looked at the implementation of the 10th 5YP in 9 areas: "macro-regulatory targets", industrial structure, development of the western region, urbanization, science, technology and education, the natural environment, reform of the economic system, opening up to the outside world, and people's lives. 3 · Rapid increases in the demand for energy and other resources. China's primary energy consumption grew by 62 percent during 2000-05 largely because of its capital-intensive, industry-led growth. China's energy intensity also climbed, reversing a trend decline since the start of market reforms. By 2005, it was 43 percent higher than in India and 73 percent higher than in the U.S., based on PPP GDP. Excessive withdrawal of water from surface and underground resources caused acute water scarcity in the northern plains. · Widening disparities in regional development and incomes, between urban and rural areas and coastal and inland provinces. · Pronounced unevenness in access to basic public services between urban and rural areas. Social protection remained inadequate, especially for vulnerable groups including large numbers of rural-urban migrants. Access to education was uneven between urban and rural areas; the health system was poorly developed in rural areas, and there was a general lack of access to affordable health care. · A mixed record in the improvement of environmental quality. While air quality had improved in many cities, and water quality had improved in the south, overall emissions of key pollutants had increased, as well as the production of solid waste. China is now home to 13 of the world's 20 most polluted cities. Land use patterns created tensions among the conflicting demands of urbanization, farmers' income, and environmental protection. Table 1.1 China in 2005 According to the 11th 5YP Indicators 1995 2000 2005 Cagetory Indicator actual actual China MIC 1/ HIC OECD 2/ Economic GDP per capita (US$ 3/) 658 949 1,451 2,181 26,051 growth Value added of service industry (% of GDP) 32.9 39.0 39.9 54.3 69.8 Economic Employment of service industry (% of total employment) 24.8 27.5 31.4 70.0 structure R&D expenditure (% of GDP) 0.6 1.0 1.3 2.0 Urbanization rate (%) 29.0 36.2 43.0 53.9 76.8 Energy consumption per unit of GDP (PPP) 4/ 200.5 100 Population, Water consumption per unit industral value added ... ... resources, Comprehensive utilization rate of industrial solid wastes (%) 45.9 56.1 and Total cultivated land (1 million ha.) 95.0 128.2 122.1 environment Total major pollutants emission volume ... ... Forest coverage (%) 16.6 16.6 18.2 33.8 33.4 Average years of schooling (year) 6.7 7.6 8.5 12.0 16.5 Public Population covered by basic pension in urban areas (100 million 0.9 1.0 1.7 Services Coverage of the new rural cooperative healthcare system (%) 75.7 and Newly increased urban employment in five years (10 million) 3.2 2.5 4.4 Quality Rural labor force transferred in five years (10 million) ... ... ... of Registered urban unemployment rate (%) 2.9 3.1 4.2 6.4 6.2 Life Per capita disposable income of urban households (RMB) 4,283 6,280 10,493 Per capita net income of rural households (RMB) 1,578 2,253 3,255 Sources: WDI, NBS, CEIC, and staff estimates. 1/ Middle income countries (average) 2/ High income countries, OECD countries (average) 3/ Constant 2000 US$ 4/ High income countries average = 100 4 In no small part, these imbalances had been an outcome of China's capital-intensive, industry-led pattern of growth (Figure1.3). China's growth had been capital intensive, with the investment to GDP ratio rising to almost 43 percent in 2005 and--using growth accounting--capital accumulation accounted for over 60 percent of GDP growth during 1993-2005. From a sectoral perspective, China's growth was driven especially by industry, which during 2003-2005 accounted for over 60 percent of all GDP growth. The burgeoning profits of industrial firms, together with cheap credits from state banks, were invested in additional capacity. Industrial growth was associated particularly with increases in labor productivity, less so with employment growth, reflecting in part labor shedding by SOEs. Moreover, with industry taking the lead, service sector development lagged (the share of services in GDP was 40 percent in 2005, compared to an average of 54 percent in middle income countries and 70 percent in high income countries). As a result, urban employment growth, while robust, was not as high as it could have been, given China's rapid overall growth. Figure 1.3 China's Capital-Intensive, Industry-led Economy in International Perspective 1/ 45 Investment over GDP ratio 40 (percent) South Korea China (2005) (1990) 35 India (2005) Malaysia (1990) Japan (1990) Japan (1980) 30 South Malaysia (1980) Korea 25 Japan Thailand Malaysia 20 US Indonesia 15 Malaysia (1970) Malaysia (1960) Share of industry in value added (percent) 10 10 20 30 40 50 60 Sources: World Development Indicators, NBS (for China), and staff estimates. 1/ 2001, unless otherwise indicated. The capital intensive, industry-led growth pattern has served China well in many respects. The high saving and investment, combined with respectable rates of technological progress, have supported the rapid GDP growth on a sustainable basis by ensuring that potential GDP (the capacity to produce) has broadly grown alongside actual GDP. The massive expansion of industrial production has made China a manufacturing powerhouse. 5 However, the capital-intensive, industry-led pattern of growth was also a key driver of the imbalances outlined above. · First, the capital-intensive, industry-led growth had been particularly intensive in energy, natural resources, and environmental degradation, thus accentuating the associated imbalances noted above. · Second, the capital-intensive growth has created fewer urban jobs than a more labor intensive service-based pattern would, and has thereby increased urban- rural inequality. Industry creates fewer jobs than services: in 1993-2005, when industrial value added growth averaged over 11 percent per year, industrial employment rose by 1.6 percent per year. As a result, absorption of agricultural surplus labor was largely left to the service sector, and has been moderate since the mid 1990s. This limited the movement of people out of agriculture and the rural areas, where productivity and income are much lower. The resulting divergence in productivity between agriculture and the other parts of the economy is a key to understanding the increase in rural- urban income inequality and has accentuated rural poverty. · Third, under this pattern, production has tended to outstrip domestic demand. While the pattern of growth was investment heavy, industry-led, and business friendly, surplus labor in agriculture helped to keep wage growth below productivity gains. In terms of the distribution of income, the flipside of the increase in enterprise income and buoyant tax revenues is that wage income, and household income in general, has lagged overall income considerably (the share of wages in GDP declined by 11.5 percentage points between 1998 and 2005). The declining role of wages and household income is the key driver behind the declining share of consumption in GDP since the late 1990s. From the external perspective, a significant share of demand for China's products has come from abroad instead of from Chinese households and businesses. This has resulted in very large current account surpluses (around 12 percent of China's GDP in 2007 and approaching 1 percent of global output). Government policies helped accentuate China's capital-intensive, industry- and export- led growth pattern. Starting with a large amount of surplus labor, China's successful industrialization would by itself have guided the pattern of growth in the direction described above. However, China's policies have clearly accentuated this pattern. Thus, while serving the economy well in several regards, policies indirectly accentuated the imbalances noted above. The government has subsidized and favored industry and investment over the services sector and domestic consumption in several ways: (i) policies have encouraged saving and investment, with government spending especially geared to investment in physical infrastructure instead of current spending on health and education; (ii) investment in industry has been encouraged in other ways as well, including via easy access to credit for large, industrial firms and a policy not to require profitable SOEs to pay dividends to the state; (iii) industrialization has also been 6 promoted by underpricing key inputs, including energy, land, and the environment; (iv) the reluctance to move to greater exchange rate flexibility and allow the exchange rate to appreciate further stimulated exports and industry; (v) prioritization of industry has also meant that the service sector lagged; and (vi) the containment of migration into urban areas has further shaped the capital intensive nature of growth, even though the containment of urbanization helped avoiding urban slums. The 11th 5YP The 11th 5YP (2006-10) is a major shift from previous plans in terms of the objectives of economic policy. 4 Through the 1990s the 5YPs had overall economic growth and development as their dominant objective and emphasized industry and agriculture. Reflecting concerns about the "imbalances," the 11th 5YP saw a broadening of the set of economic and social policy objectives. The 5YP gives priority to rebalancing the economic structure as well as to environmental and social objectives. The guiding principles and policy orientation seek to rebalance China's growth pattern, with domestic demand, especially consumption, as the main driver, and services as the leading sector. This, in turn, is expected to better balance economic growth with resource conservation, energy efficiency, and environmental protection. Moreover, rebalancing the pattern of growth is expected to help mitigate the urban-rural divide, and promote more balanced regional development, while improving basic public services, especially social protection, health, and education.5 China's 5YPs provide broad direction to policymakers. They do not include many concrete policies. The 11th 5YP has an elaborate structure, with 6 guiding principles, 6 overall orientations, 9 major objectives, and 15 main tasks and strategic priorities. Annex 1 contains an overview of the 11th 5YP. Table 1.2 shows this overview in table format. The 11th 5YP identifies six guiding principles: maintain steady and rapid economic development, speed up the transformation of the economic growth pattern; improve the capability for independent innovation; promote coordinated development between urban and rural regions; build harmonious society, and deepen reform and opening up to the outside world (see Table 1.2 and Annex 1 for more detail). In accordance with these guiding principles, the 11th 5YP lays down six policy orientations: expand domestic demand, optimize industrial structure, save resources and protect environment, enhance the capability of independent innovation, deepen reform and opening up, and be people-centered (see Table 1.2 and Annex 1 for more detail). 4A change in name from Plan to Program reflects recognition of the different role the government is supposed to play in an increasingly market-oriented economy. See Chapter 3. 5The concept of "scientific development" was first proposed at the 3rd Plenary Session of the 16th Party Central Committee of the Communist Party of China in October 2003. It calls for "people-centered development that is comprehensive, coordinated, and sustainable, for the promotion of overall harmonious development of the economy, society, and human beings." 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esi ):9 y,tivi non-,e cul envi e,erh( quie aliretamn oni ons,i cal roni baryr ntem revitalot amet E 70)p( gni ect ent urgn zone,t oni ienrf-t vocat enlyelvi ): sponder col udi en zat en vat entm onitul nerim, ectrdi,sesirpre ngo' pol act onalgier ogil (p nat,yte ioritrpcige edsiy comni rural ng,inairtll calni euolr 16)p( coalhtiw (elyr echt on,i pet,rew butirstid derom,t andlaicrem uretl and develnre ;yr ncli( opm bani nvestid eatrt n,oi unctf e, ngerst,ntem calidem dependenni ronm saf s,noi deoi( ilduby erentffdi ure, esil estw( save,retaw ski ent consere an arm envi cei eratw( ntselat ependentdni( ntelatyti :)25 oni zati qual (p ntemn SO,mrofer entla 16p(yet hs,trbie oypl cutsial oni ntr devel ruct urnoiat save, morf{ caitilopdna andgn dance gy pr oni ndal,eratw( educatyr so EOS( ; ncianif urcturtstr soci em gan tic soci uctr ech lope ogy ndano pr,etkramlanoiatn( andes ratstd couts productrehgih( ghih( upg overg m uso ors dustni sector ndusti onopom esciv gyetarst ent ndagn omotrpot ectot nte andhtalehcil ucati novatni ent emst stem emst oni urcturst,lor const guirofs alicios reutulc ralutulcirga(e ure vat ande n,oi : rastnfi( ructtslairt ndusti orajm(yr pocir omc(yr ndusti m gh-thi ser popul opt( enerev es ed cal ompulc( openin orefr( ootr al onsit ngi conserhtiw,yr ectel, urcturstlair nsporart(yr ceiv eak dev zedimi on,itaxat ecollaru prla sy craomed ofgnidl urt sm comni ducate(st ndusi oalc( on;iatziatmrofni;yr ur ndusti ndustieciv br: ser pmo and ogi opm d ngeahc( nat ent synotia onaliatnretni;uto-og;I xpande(sd pub(ht enfedlan nniapleteplm ans gy act naliog eaar deiug( nagemam an sycimo emst FD dar oodf,ytefaskrow,re ssarg( new agri s' of vorafd expoezimitpo( condi opmentle ndusti servicefo serde onipt 29)p( re veled cod oni oni onserc(y easurmyci entmnor cer science, opm devel emtsys taxd etkramn rmahtsial ng anst healse' nte istlaci buieht so cultsial tioan sk ta in upgnidil oni gyer enere ent shoul de echnolt mro resources-savi nanceif of cer econc an syyra ofyti en odernmpo peasant ralur peasanepyt en hen zati deve nufam en saf aliretam ndustielixtet dance nat ng pol dyemerd envi souer devel ref socie conthtrib(krow astsid(yte soci thg anhsi echanimnoita ent entiro- zatniab consum hen ent an hen hen souer basi netom oderm qual ngviil peopl thg erat and mpoel ent and ordi oni scalif managem ove ove ove ove rengt hen Bu pm evD oniat chi guiyci onalgierlla ur diil economecl an openiniw safci Co Strategies Promot St trenS abltsE Ma 1. devel creaseni provemi newnairt mitpO zeimi 2. accel equi opt eancl wartsu adj ghtil ducero 3. pr enr pol esitciegral .4 unctfeplcini over pr undos Bu.5 enpeeD trenS ecyr ngterts emplmi ectto pr ngterts ngterts 6. andcifinteics ducate onitarstinim hum 7. ad prmi rmofer mrofer overpmi n-iw prmi 8. popul prmi prmi publ alcios 9. 10. ngterts 11. 12. emplmi s,d ge,a , ental on,i ,D&R cover on,i onmri xatat ,ht