Improving city competitiveness through the investment climate: ranking 23 Chinese cities

Improving City Competitiveness through the Investment Climate: Ranking 23 Chinese Cities David Dollar Anqing Shi Shuilin Wang Lixin Colin Xu December , 2003 This report is based on an investment climate survey conducted in 2002 in five Chinese cities (Beijing, Chengdu, Guangzhou, Shanghai, and Tianjin), and a follow-up survey conducted in 2003 in 18 cities. We gratefully acknowledge financial support from the United Kingdom's Department for International Development (DFID), World Bank Research Committee and the Multi-donor Funded Knowledge for Change Program. A grant from DFID supported the collaboration of the Enterprise Survey rganization(ESO) in this survey and fellowships for two ESO staff, Mr. Yang Yumin and Ms. Li Hui, to visit Washington, DC, for analysis and preparation of an earlier report. We are especially grateful to Director Song Yuezhen, Deputy Director Wang Wenying, and Deputy Director Lei Pingjing. Director Lei has been the project manager for both surveys, and worked with World Bank staff in piloting and training. The paper has benefited from useful comments and help from Deepak Bhattasali, Milan Brahmbhatt, Philip Keefer, Axel Peuker, Andrew Stone, Kong-Yam Tan, and Albert Zeufack. This project is part of a larger effort in the World Bank Group to help countries assess their investment climates and to identify reforms that will lead to higher productivity, more efficient investment, and ultimately more job creation and growth.  Chapter 1. Investment Climate Matters During the last decade, major developing countries including China have begun to integrate much more with the global economy. The countries that are aggressively integrating have grown significantly faster than those that are not. In the 1990s, the more rapidly globalizing developing countries (measured in terms of increased trade participation) grew at 5.0 percent per year, while the rest of the developing world posted negative growth of 1.1 percent.1 Among the more aggressive globalizers were Brazil, China, Mexico, Philippines, Thailand, and India. That globalizing developing countries are doing well on average is good news. But these averages disguise considerable variation in performance within this group. China has done spectacularly well, and is the unchallenged leader of the pack. The country has doubled its ratio of trade to GDP over the past two decades (to 41 percent of GDP in 1999), and has had per capita GDP growth of nearly 8 percent on average during 1990-99. Malaysia was another winner: in spite of the temporary income compression due to the Asian crisis, it could still enjoy per capita GDP growth of 3.8 percent during the 1990s. Again, despite the crisis, Thailand's per capita GDP growth in the 1990s averaged 3.8 percent. However, the per capita GDP growth of another relatively aggressive globalizer, Brazil, has only been around 1 percent for 1990-99; and growth in the Philippines was only 0.4 percent. India, with per capita GDP growth of 3.3 percent during 1990-99 is in the middle of the pack (figure 1.1). The implication of these variations is striking. Such differences in growth rates sustained for one or two decades make a huge difference in living standards and the extent of poverty. While in 1990 China and India had comparable levels of GDP per capita (approximately $1,400 measured at purchasing power parity), in the following decade India's per capita income nearly doubled, but China's nearly tripled. Thus, today, China's per capita income is about 50 percent higher than that of India. Together with its faster growth, China has also had significantly faster poverty reduction (figure 1.2). 1During the same period, the rich countries grew at about 2 percent per capita. 2  Figure 1.1 Per capita GDP growth rates in globalizing developing countries (average 1990-99) 8 6 4 2 0 China Malaysia India Thailand Mexico Brazil Philippines Figure 1.2 Poverty reduction in India and China is closely related to the growth rate Percent per annum (1992-98) 10 9.9 8.4 8 6 5.4* 4.4 4 2 GDP per capita Poverty growth rate reduction 0 India China * India poverty reduction figure is for 1993-99 3  The purpose of our paper is to examine some of the reasons for such performance variations. Instead of focusing on country-level, we examine 23 cities in China. This has the advantage as these cities have the same legal and institutional frameworks, and the same macro environment. Therefore, it is less likely that we make wrong inference about true determinants of firm performances. Moreover, the large variations across Chinese regions and cities offer ample room to demonstrate the link between firm performance and the investment climate, which is a series of institutional factors and policies that determine firm performances. In the next section, we define in more detail what we mean by investment climate. Section 2 then briefly reviews some of the macro and micro evidences that show the importance of investment climate for sustained growth and poverty reduction. We also quickly go through a comparison of China versus other countries in the investment climate based on macro (i.e., country-level) observations. In general, China stands out favorably in areas such as macro and political stability, integration into the world market, and infrastructure. Abundance of cheap labor associated with rural-urban migration has been and continues to be a comparative advantage of China. Not everything is rosy, however. The financial sector is not operating efficiently--the vast majority of credit has been provided to state-owned enterprises, which often cannot service their debts, and small- and medium enterprises have to rely mainly on retained earning and personal wealth (or parent company financing) to finance their investment. Moreover, China also lags its more developed East Asian neighbors in terms of education level. While illuminating about the importance of the investment climate, the macro literature does not really provide much specific guidance about what aspects of the investment climate are important and what specific reforms are needed in particular countries. Moreover, the micro evidence in other countries cannot really tell us what are important for Chinese firms. As we shall see after finishing reading this paper, the investment climate determines firm performance in quite different fashions in countries with different institutions, endowment, and technology. For this reason, we go down to China-specific micro surveys in chapters 2 and 3. The source of information includes surveys conducted by the World Bank with the Enterprise Survey Organization of 4  China's National Statistical Bureau, comparable surveys conducted in other countries, and various cross-country databases. After describing the investment climate surveys in China in Chapter two, Chapter three compares the investment climate in the 23 cities, using the ESO-WB survey of 3900 firms. Chapter four then analyzes how the investment climate affects firm performance. We obtain several main findings. First, investment climate shows large variations across the 23 cities. We characterize the investment climate as having the following elements: infrastructure, domestic entry and exit barriers, skills and technology endowment, labor market flexibility, international integration, private sector participation, informal payments, tax burdens, court efficiency, and finance. We then use our firm surveys to compare each city in these elements, give a ranking for each element. Judging by the amount of gains a city expects from improving its investment climate (to the level of an ideal city), we then give a city an overall rank in the investment climate. The frontrunners (A+) are Hangzhou, Shanghai, Guangzhou and Shenzhen, all in the Yangze- river and Pearl-river Delta areas. The following cities also have excellent ICs (A): Chongqing, , Jiangmen, Changchun and Wenzhou. The A- cities are Tianjin, Dalian, Beijing and Zhengzhou. The B+ cities include Wuhan, Nanchang, Xian and Changsha. The B cities are Chengdu, Guiyang, Kunming and Nanning. The laggard group (B-) includes Ha'erbin, Lanzhou and Benxi.. Second, the growth potential from improving the investment climate could be quite large. For instance, we consider what gain an average city would get from reaching the level of investment climate indicators that we observe in a hypothetical city called Nice that would have the 10th best IC among 100 cities. We estimate that in this scenario firm productivity could be increased by about 45 percent and that the investment rate of the typical firm would increase from the 14 percent that we actually observe in the sample to about 17 percent. These specific point estimates inevitably have some uncertainty around them, but the general point is that firm productivity, investment, and growth are related to aspects of the investment climate and that addressing weaknesses identified in this analysis should lead to substantially better firm performance. Third, within the categories of investment climate we have found the most important elements are entry and exit barriers, skills and technology, foreign 5  participation, labor market flexibility, and finance. Private ownership and tax burdens are not as important as we used to think, but still significantly important. In contrast, infrastructure, court efficiency and informal payment do not appear to be a binding constraints at this stage, either because China has done particularly well (such as in the case of infrastructure, especially in the last five years or so), or perhaps because it is still too early for it to become important (in the case of court efficiency or informal payment). A. What do we mean by "investment climate"? The quantity and quality of investment flowing into China or any specific region depend upon the returns that investors expect and the uncertainties around those returns. These expectations can be usefully categorized as the following broad yet interrelated components: