China - Economic development in Jiangsu Province

Report No. 9354-CHA China Economic Development in Jiangsu Province June 25, 1991 Country Operations Division l China and Mongolia Department ,; .i Asia Region '! FOR OFFICIAL USE ONLY .Docment of theWorld Bank This document has at restricted dlistribution and may be used by recipients only in the performance of theifr offic'ial duties. Its contents may not otherwise be disclosed without World B3ank authorization.  CURRENCY EQUIVALENTS Currency Unit = Yuan (Y) Up to December 15, 1989: $1.00 = Y 3.72 Y 1.00 = $0.27 Up to November 29, 1990: $ 1.00 = Y 4.72 Y 1.00 $0.21 Effective November 30, 1990: $1.00 = Y 5.22 Y 1.00 = $0.19 FISCAL YEAR January - December WEIGHTS AND MEASURES km = kilometer ha = hectare kWh = kilowatt hour kg = kilogram unit of area = mu l ha 15 mu 1 mu - 0.067 ha ABBREVIATIONS AND ACRONYMS 7FYP = Seventh Five-Year Plan 8FYP - Eighth Five-Year Plan ABC = Agricultural Bank of China ADF Agriculture Development Fund BF = Budgetary Funds BOCOM = Bank of Communications BOF = Bureau of Finance BOT = Build, Operate and Transfer Back CAAC = Civic Aviation Administration of China CAM = Computer Assisted Manufacturing CATEC = County Agrotechnical Extension Center CNC = Computer Numerical Control COSCO = China Ocean Shipping Corporation CPC = Communist Party of China CDE = Centrally Planned Economy DER = Direct Export Right  EBF Extrabudgetary Funds FOR OMCIAL USE ONLY EEC n European Economic Community EIA Enviionmental Impact Assessment EPB = Environmental Protection Bureau FDI = Foreign Direct Investment FE Foreign Exchange FEAC Foreign Exchange Adjustment Center FI Foreign Investment FTDF Foreign Trade Development Fund FTC Foreign Trade Corporation GAC = General Administration of Customs GDP Gross Domestic Product GNP Gross National Product GOC = Government of China GVAO = Gross Value of Agricultural Output GVIAO - Gross Value of Industrial and Agricultural Output GVIO Gross Value of Industrial Output GVO Gross Value of Output IAIL = Integrated Agriculture and Intensification Loan IBRD = International Bank for Reconstruction and Development ICOR Incremental Capital Output Ratio JASS Jiangsu Academy of Social Science JEPB Jiangsu Environmental Protection Bureau JPCD = Jiangsu Provincial Communications Department JPPEC = Jiangsu Provincial Planning and Economic Commission Jv Joint Venture LDC = Less Developed Country MFA Multifiber Agreement MOC = Ministry of Communications MOF Ministry of Finance MOL = Ministry of Labor MOFERT = Ministry of Foreign Economic Relation and Trade NEPA = National Environmental Protection Agency NIC = Newly Industrialized Countries O&M = Operation and Maintenance PBC = People's Bank of China PNE = Production Network for Exports PRC = People's Republic of China PES = Production Responsibility System QR Quantitative Restriction R&D = Research and Development ROC = Rural Credit Cooperatives RPI = Retail Price Index RR = Retention Right SAEC = State Administration of Exchange Control SB = Specialized Bank SEZ = Special Economic Zone SOE = State-Owned Enterprise SMC = State Material Supply Corporation SPC = State Planning Commission SRC = System Reform Commission SSS = Secondary Specialized School STC = Science and Technology Commission SVS = Secondary Vocational School This document has a restrict i distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  SWS = Skilled Worker School TIC Township Industrial Corporation TPEC - Township Planning and Economic Commission TVCE = Township and Village Community Enterprise TVE Township and Village Enterprise UCMT = Urban Construction and Maintenance Tax VAT - Value Added Tax WRF = Wuxi Radio Factory ZSG = Zhong Shen Group  CHINA ECONOMIC DEVELOPMENT IN JIANGSU PROVINCE Preface This report is based on an economic mission which visited Jiangsu from September 9-26, 1990. Mission members included Christine Wallich (Mis- sion Leader); Fernando Montes-Negret (deputy, resporsible for TVEs); Anand Rajaram (Industry, Technology Policy and Foreign Direct Investment); Arvind Panagariya (Trade Policy); Caroline Jen (Education and Labor); Jose Veniard (Transport); Roy Bahl (Consultant, Budget and Fiscal Policies); Steven McGurk (Consultant, Agriculture Policy); and Chen Xingdong (RMC). A mission consist- ing of Messrs. Montes-Negret, Rajaram and Chen visited Jiangsu on June 13-14, 1991 to discuss a draft version of this report with the provincial authori- ties. The mission was hosted by the Jiangsu Provincial Planning and Economic Commission, represented by Messrs. Guo Shiliang, Deputy Director, and Jiang Renzhao. A counterpart team from JPPEC, consisting of Messrs. Wu Xingze, Yan Hao and Lu Hongwei accompanied the mission in the field. Mme. Tang Mei Hua (BOF) provided logistical support. The mission visited Nanjing and Wuxi in the sout of the province, together with their associated counties; and Huaiyin and selected counties in the less well-off northern part of the province (Shuyang county). Discussions took place with a range of government bureaus/departments responsible, inter alia, for the agriculture, industrial. material supply, fiscal, banking, foreign exchange and trade sectors, in addition to meetings with the Jiangsu Academy of Social Sciences (JASS); JPPEC (Planning Commission) and System Reform Commission (SRC).  CHINA ECONOMIC DEVELOPMENT IN JIANGSU PROVINCE Table of Contents Page No. EXECUTIVE SUMMARY . . . . . . . . iii I. JIANGSU PROVINCE: RESOURCE ENDOWMENTS, CONSTRAINTS, AND POLICY TOOLS . . . . . . . . . . . . . . . . . . . . . . . .1 A. Jiangsu's Economic and Social Structure . . . . . . . . 1 B. Jiangsu's Special Characteristics . . . . . . . . . . . 3 C. Policy Framework: National and Provincial Policies . . 10 D. Future Development Issues . . . . . . . . . . . . . . . 14 II. INDUSTRY, TRADE AND LABOR SKILLS IN JIANGSU . . . . . . . . 20 A. Features and Issues in Jiangsu's Industrial Economy . . 20 B. Jiangsu's International Trade: Past Growth and Future Plans . . . . . . . . . . . . . . . . 29 C. Foreign Direct Investment in Jiangsu . . . . . . . 37 D. Education and Training: Issues and Policy Recommendations 39 III. RURAL INDUSTRIALIZATION IN JIANGSU . . . . . . . . . . . . . 43 A. TVCE Sector Development and Recent Performance in Jiangsu 43 B. The Policy Framework: Issues and Recommendations . . . 49 C. Strengthening Jiangsu's TVCEs: Structural Issues and Recommendations .53 IV. ISSUES IN JIANGSU'S FISCAL POLICY .58 A. The Resource Envelope in Jiangsu . . . . . . . . . . . . 58 B. Problems and Issues in Jiangsu's Public Finances . . . . 62 C. Options for a Policy Agenda . . . . . . . . . . . . . . 66 V. AGRICULTURE DEVELOPMENT . . . . . . . . . . . . . . . . . 70 A. Agricultural Development in Jiangsu . . . . . . . . . . 70 B. Real Resource Constraints: Issues and Recommendations . 72 C. Policy-Induced Constraints: Issues and Recommendations 75 VI. THE TRANSPORT SECTOR IN JIANGU ISSUES AND PROBLEMS . . . . . 80 A. Transport Network in Jiangsu . . . . . . . . . . . . . . 80 B. Issues and Recommendations . . . . . . . . . . . . . . . 82 Kathleen Lynch gave excellent editorial assistance, while Adelma Trim and Meredith Dearborn provided invaluable word-processing support.  - ix Page No. TABLES IN TEXT 1.1 Jiangsu's Place in China's Economy (1989). . . . . . . 4 1.2 Comparison of Jiangsu and Other Coastal Provinces . . . 6 1.3 Policy Matrix for Jiangsu . . . . . . . . . . . . . . . 11 2.1 Jiangsu: Major Industries: Shares and Growth of GVIO . 21 2.2 Relative Industrial Structure in Jiangsu . . . . . . . . 22 2.3 The Regional Distribution of Foreign Direct Investment in China . . . . . . . . . . . . . . . . . . . . . . . . 37 3.1 TVCE Industrial Output Growth, 1986-89 . . . . . . . . . 47 3.2 Financial Performance of TVCE Sector, 1986-89 . . . . . 48 4.1 Fiscal Revenue Trends in Jiangsu . . . . . . . . . . . . 59 4.2 r.cvenue Buoyancy in Jiangsu . . . . . . . . . . . . . . 60 4.3 Revenue Sharing in Jiangsu . . . . . . . . . . . . . . . 60 4.4 Distribution of Expenditures in Jiangsu Province: 1987-89.. . . 61 6.1 Modal Shares in Jiangsu . . . . . . . . . . . . . . . . 81 BOXES IN TEXT 1.1 Aspects of Development in Korean and Taiwan, China . . . 19 2.1 Environmental Issues and Policies in Jiangsu . . . . . . 27 2.2 Enterprise Groups, Horizontal Cooperation, and Mergers . 28 3.1 Institutional Credit to TVCEs (1989/90) . . . . . . . . 52 4.1 Options for Reform of the Revenue-Sharing System . . . . 68 FIGURES IN TEXT 1.1 GDP Per Capita . . . . . . . . . . . . . . . . . . . . . 2 1.2 GDP Per Capita by Location, Jiangsu Province . . . . . . 3 1.3 GDP Growth Rate . . . . . . . . . . . . . . . . . . . . 8 1.4 Gross Value of Industrial and Agricultural Output . . . 9 CHARTS IN TEXT 3.1 Provincial TVE Bureau . . . . . . . . . . . . . . . . . 49 3.2 Township Investment Corporation . . . . . . . . . . . . 49 ANNEXES Annex 1: The State Council Circular on the Control of the Production Capacity of Certain Products . . . . . . . . 91 Annex 2: Sample Contract of Enterprise Responsibility System . . 95 Annex 3: The June 1990 State Council Regulation Governing TVCEs . 97 STATISTICAL APPENDIX ....................... . 99  CHINA ECONOMIC DEVELOPMENT IN JIANGSU PROVINCE Executive Summary i. Jiangsu is China's most industrialized province, while its agricul. tural sector is the most productive in the country. The industrial sector produces a relatively diverse range of products, with nonstate enterprises producing almost half of the gross industrial output. Jiangsu's proximity to Shanghai and its relatively well-developed transport infrastructure have enabled Jiangsu to forge important linkages with the rest of the country, sup- porting its industrialization, and offering the potential of greater outward orientation. ii. The Strategic Challenge. With this industrial base, Jiangsu is well placed for continued rapid development in the 1990s and beyond. None- theless, both policy and real resource constraints will have to be overcome for Jiangsu to double its current per capita income by the year 2000, as cur- rently targeted. Economic reform and the policy regime adopted by the central and provincial governments will determine Jiangsu's future growth artd struc- ture. To sustain the pace of growth and improvements in productivity, Jiangsu needs to push ahead with the full range of enterprise, price, and other related reforms to the extent permitted by central policy guidelines. iii. Jiangsu's development and growth will depend crucially on the levels of investment, especially in transport and infrastructure, as well as the efficient allocation of such investment. Investment in fixed assets as a share of GNP has generally been maintained at a high level in Jiangsu (as in China as a whole), with the exception of 1988/89 when it dropped from 33.3 percent to 26.4 percent in response to the stabilization policy of the central government. Nevertheless, there is some reason to be concerned about the long-term ability of various levels of government to finance required public investment programs. Budgetary revenue sources have not been buoyant, constraining public investment capacity, while, simultaneously, capital expen- ditures have been squeezed by the growth of social services and administration costs. Insufficient budgetary and investment allocatiuns to important sectors calls for fiscal reform, combined with attention to public-sector pricing issues and infrastructure-financing mechanisms. iv. In addition to these challenges, Jiangsu's future development will depend strongly on reforms to industrial policies; policies to foster TVEs; trade, direct investment, and technology-transfer; programs for labor educa- tion and absorption, and for agricultural development, described in turn below. Jiangsu will also need to overcome limits imposed by its enterprises' current technology and modes of organization. This will mean deepening enter- prise and organizational reform. Reforms to the system of industrial organi- zation (mergers and exit) would also hav- a major impact on efficiency and growth. v. Lastly, Jiangsu needs to give careful thought to the approach taken to emerging differences in the north-south development patterns, the balance  - ii - within the rural sector between TVCEs and agricultural activities, and the policies adopted in the enterprise sector, towards profitable and loss-making enterprises. Rapid growth in Jiangsu may be served best by permitting enter- prises, industries, and regions to develop by exploiting their comparative advantages in a policy environment when the government plays the role of a facilitator rather than a participant. This would require that the Jiangsu provincial and lower levels of government take full advantage of the powers delegated by the center to promote the development of markets, remove barriers to trade, encourage the autonomy and accountability of industrial and finan- cial entities, and, in general, redace its role in direct resource allocation. Summary of Recommendations vi. Industrial Policy. The various levels of government currently con- duct industrial policy by inteLrening in a wide range of sectors and J.ndus- tries through a host of discretionary policies. This raises the costs of economic management by requiring resources to be devoted to monitoring direct policy compliance (indirect policy induces the desired behavior without costly monitoring) and has obstructed achievement of a system whereby "the state will regulate the market and the enterprises will be g:ided by the market." vii. Policy reforms in Jiangsu should focus on reducing the interventions by the provincial and local governments and their industrial bureaus in enterprise-level decisions. The role of the government should be defined more narrowly, focusing administrative attention on a few priority areas. The Jiangsu Government has a natural role to play in developing the public infra- structure (transport, pcwer, education), removing barriers to trade and pro- moting market integration, and facilitating information flows within the prov- ince. Encouraging enterprise reforms that strengthen the financial and mana- gerial autonomy of enterprises would enable the government to focus on these priority areas. viii. Separate from the issue of excessive administrative interventions is the role of the government in defining "priority" industries, which is a major aspect of stated industrial policy in Jiangsu. At present, the priority industries are so broadly defined that any industry, unless explicitly forbid- den, can be justified as a priority activity. Real priorities are often only revealed by the system of key materials allocation but, with the gradual reduction of the scope of material allocation, this is a less effective tool for reinforcing stated priorities. This trend suggests that initiatives on industrial development are increasingly determined at local government level. Given this, Jiangsu can improve the quality of industrial investments in the province--addressing issues of appropriate choice of industry, scale, loca- tior., etc.--by strengthening the ability of the market to guide and discipline both enterprises and local governments. The province can assist in coordinat- ing investment decisions that straddle administrative boundaries. Promoting market competition both within the province and with other provinces will be a critical function in this respect. The provincial government also has to play a role in shaping technology policy, enforcing pollution control and in con- solidating industrial capacity. ix. Jiangsu's External Stance: Trade and External Policies. Both China and Jiangsu expanded their world trade during the 1980s, but many policies still interfere with Jiangsu's ability to pursue an outward-oriented develop-  - iii - ment strategy. National trade policies leave Jiangsu a heavily protected economy, pursuing import substitution and export promotion simultaneously. ALthough much of what needs to be done in the trade area falls under the cen- ter's authority, Jiangsu can carry out a number of reforms. x. Direc. export rights (DERs) for enterprises may be Jiangsu's most important means of promoting its own outward orientation. Currently, Jiangsu confers DERs very selectively under guidelines from the center, and enter- prises given DERs are allowed to export only t'4eir own products. Jiangsu should promote DERs broadly so that its firms, including large TVEs, can make direct contact with overseas markets and thus establish "reputation" and "name" recognition. xi. Second, because China's system of foreign exchange retention rights (RR) and input allocations are based on past export earnings, potential exporters are excluded at the outset. Within existing rules, however, Jiangsu does have some room to maneuver. The province can promote a freer market in foreign exchange through swap centers and can release its own planned foreign exchange into the markets for purchase by enterprises. Promoting provincial exports through FTCs on an agency basis is another initiative within the scope of Jiangsu's authority. Many firms seem to have forgone benefits of China's recent devaluations as FTCs maintained domestic procurement prices of export goods constant in Renminbi but raised domestic prices of imported inputs. This policy results in a strong anti-export bias that is inconsistent with Jiangsu's stated export promotion objective. xii. Finally, Jiangsu should develop a more rules-based export-promotion system wherever possible. Exports are currently promoted through a contract system, with specified export quotas and incentives negotiated enterprise.-by- enterprise. Enterprises subject to an export quota obtain a variety of incen- tives (entitlements to preferred prices for and access to raw materials; bank credit; power supply; foreign exchange) but these ad hoc benefits are not clearly known ex-ante. A rules-based system would be preferable to give every enterprise advance notice about all nondiscriminatory, standardized incen- tives. xiii. Technology and Foreign Direct Investment (FDI). Jiangsu has lagged in raising FDI under the open-door policy and should play a more active role in attracting technology and investors to thB province. Given Jiangsu's emphasis on expanding technology-intensive "pioneer industries," there is a greater need to develop a strategy to acquire foreign technology (for example, via direct investments; imports, licensing agreements, joint ventures, reverse engineering). Attention should also be given to exports as a way of importing technology (for example, via buyer-seller arrangements and compensation trade). xiv. Human Resources. Surplus labor is a major concern in Jiangsu, as well as elsewhere in China. While the incompleteness of the ongoing reform process poses difficulties on efficient labor absorption in urban areas, rural labor is outside the sphere of the administrative labor plan system. In Jiangsu, the counterpart of surpluses in the north are shortages and the shift of agricultural labor into the TVCE sector in the rapidly growing south. Some southern cities promote agricultural mechanization to free farm laborers for industry; others promote the contradictory strategy of capital-intensive  - iv - industrial development. Jiangsu must instead think globally about labor use and absorption strategies (including the expansion of tha service sector) and develop new managerial tools. These mechanisms should include: open, flexi- ble, and responsive province-wide labor markets; information systems at all levels to match job seekers and employers; and an agency for province-wide coordination and labor policy. xv. An educa.ion system with strong emphasis on general education sup- plemented by "demand-driven" technical/vocational programs is recommended. Under t.ae constraints of central guidelines and the general shortage of educa- tion funds, technical/vocational education should be more diverse, with greater effort dev ted to short-term training courses for primary and lower secondary school leavers, and use on-the-job training for improving worker skills. Finally, entrepreneurial, managerial, marketing, and accounting training should receive more emphasis to ena"le further development of both the TVCE and service sectors. xvi. Challenges for TVCEs. TVCEs are the mainstay of the economy and Jiangsu's local governments have actively promoted their development, but the future performance of TVCEs will depend on the ability to surmount a number of hurdles. TVCE growth may be endangered if local governments follow the path of arranging mergers between profitable TVCEs and failing enterprises. This approach drains retained funds and reduces incentives of profitable TVCEs. It would be preferable to allow loss-making enterprises to fail and encourage mergers and consolidation of profitable TVCEs to reach economies of scale. Jiangsu should also promote joint ventures among local governments so as to pool resources, i;crease the scale of operations, combat local protectionism and eliminate duplication. (The latter recommendations apply also to SOEs.) Closer ties between TVCEs and SOEs could foster specialization, if done in a way that guarantees TVCE flexibility and autonomy. xvii. Under the present local owniership form; TVCEs in Jiangsu will find it increasingly difficult to finance their next stage of development, which will involve investments in equipment and technology well beyond the capacity of a single local government (or group of TVCE workers). Larger TVCEs will need new financial instruments to support long-term investments and working capital. A worrisome signal is that, in certain respects, Jiangsu's TVCEs seem to be lagging behind other provinces (Shandong and Guangdong). xviii. Instances of fiscal predation by local authorities further constrain the supply of capital. If TVCEs in Jiangsu are to flourish, conflicts of interest inherent in the rola of local government as owners-cum-tax collec- tors, and as entrepreneurs-cum-regulators, must be addressed. Because locali- ties depend on TVCEs for revenue, they are ambivalent about collecting taxes, controlling pollution, and enforcing industrial safety standards. The fiscal and development functions of community governments may have to be separated, almost certainly as part of national fiscal reform.  xix. Financing Development in Jiangsu. The low buoyancy of budgetary revenue is the central problem in Jiangsu's fiscal system. While nominal GDP in Jiangsu has grown annually by an average of 17.6 percent over 1986-89, budgetary revenue has only increased by 8.5 percent. By contrast, extrabud- getary revenues of genural government (i.e., excluding retained earnings of SOEs) have increased by 18.7 percent per annum over the same period. However, this EBF revenue has accrued entirely to administrative agencies at lower levels of government, while the provincial government's share of revenue retained in the province has declined, from 16.7 percent in 1987 to 14.7 per- cent in 1989. Moreover, the use of "clawback" taxes on SOEs and TVCEs and the negotiated system of tax relief have resulted in a complicated tax system, straining tax administration capacity. xx. On the expenditure side, the share of resources devoted to public investment falls short of the amounts needed to improve infrastructure and upgrade industrial production capacity. Much of government expenditure is in the extrabudgetary accounts, which are not fully controlled by the Finance Bureau. Consequently, aggregate expenditures may not match governmental objectives. The provincial government's responsibility for fiscal planning is compromised by local implementation and an inability to monitor the compli- cated system. xxi. The province needs a fiscal plan to support its development plan, including projections and a strategy for raising and spending both government budgetary and extrabudgetary resources. Measures will have to be devised to rationalize extrabudgetary expenditures by the BOF and administrative units. Such a plan would include: (i) projections of budget gaps and needs; (ii) capital expenditures matched to resources to defray these expenditures; (iii) estimates of the operation and maintenance costs to support new capital expenditures; and (iv) a plan for fiscal redistribution among different areas in the province. xxii. While correcting the fundamental problems with the fiscal system must await central government initiative and guidance, some improvements can be carried out by the provincial government. Jiangsu sh_'ild begin to keep records on how contracting and tax relief affect the size of its tax base, prior to the renegotiation of enterprise contracts which begins in 1991. Another area is to strengthen the provincial tax administration, starting with the (three) major cities that generate half of all revenues. Computerization, unique taxpayer identification numbers, and a proper audit system would yield great revenue returns and would make the system more fair. xxiii. Agriculture. Jiangsu needs to encourage greater agricultural spe- cialization. Current requirements to produce grain in southern Jiangsu pre- vent exploitation of comparative advantage in agriculture, which would be served by producing specialty agricultural crops on high-yield lands in the south. Optimally, these regions should not be included in the Jiangsu grain plan. Rather, grain production should be encouraged in the north and other parts of the province that are better suited for these crops and less suited for other endeavors. Agricultural price reform should continue and, within central policy constraints, Jiangsu should cry to reduce staple crop procure- ment so as to release land for other uses, especially in the former leading grain areas.  - vi - xxiv. Jiangsu needs to take a number of actions on the following fronts: (i) changing investment priorities to rehabilitate and repair irrigation and drainage networks, particularly in northern Jiangsu; and (ii) reversing the declining trend in agricultural investment, and increasing allocations to research and extension; (iii) resuming the reform process lib3ralizing pric- ing, marketing, interprovincial distribution and foreign trade in grain and modern agricultural inputs, while phasing out consumer and fertilizer subsi- dies. xxv. Transport. Transport is vital to Jiangsu's industrial development, export growth, and improved north-south integration. To remove transport- related constraints to economic growth, investment must be expanded selec- tively. The intermodal balance must also be reworked, to build up road and air transport, and to favor waterways over ports. Cost-benefit analysis is recommended for all transport projects. A market-oriented (as distinct from administrative) approach to the allocation of traffic among modes is also recommended, with more decentralization and management independence for trans- port enterprises. Liberalizing the market and opening road transport to pri- vate operators would improve efficiency and encourage fleet modernization. xxvi. Jiangsu should increase its emphasis on road transport, improve the bulk cargo capacity of rail and waterway systems, encourage private operators in a liberalized market, upgrade and modernize existing facilities, and per- fect a multimodal transport system. Financing must be made an integral part of Jiangsu's investment plans for the transport sector. To reach the requi- site volume of investment, Jiangsu will have to increase local resource mobi- lization, seek additional central budgetary allocations, and, where possible, foreign financing. Transport development needs to be financed efficiently, especially through pricing policies that raise more revenues and also ration- alize demand. Many transport lines currently are not priced on a cost-basis but operate as if transport were only a public service. Road maintenance fees, and allocations of general tax revenues to transport would supplement self-generated revenues. Jiangsu should also seek to utilize its transport capacity more efficiently by lowering freight traffic intensity from its cur- rent high level. xxvii. Jiangsu has numerous natural advantages and endowments which have, in the past, enabled it to achieve substantial economic progress. The experi- ence of the last decade has shown that these natural advantages can be best exploited by allowing enterprises and farmers to respond to market-driven signals. Jiangsu's future development can thus be favorably influenced by the creation of an appropriate policy environment which continues to expand the role of markets while simultaneously redefining the role of government to focus scarce administrative capacity on a few priority areas. Many of the necessary policy reforms will require central government initiative and guid- ance but, as this report documents, many other improvements in the policy regime can be accomplished by the province.  I. JIANGSU PROVINCE: RESOURCE ENDOWMENTS, CONSTRAINTS, AND POLICY TOOLS A. Jiangsu's Economic and Social Structure 1.1 Economic Structure. Jiangsu is the country's most industrialized province, with an industrial output value (GVIO) in 1990 of Y 276.5 billion, about 12 percent of China's total GVIO and 82.6 percent of Jiangsu's total industrial and agricultural output value (GVIAO). More than half of Jiangsu's GVIO is generated by "light industry" (55.6 percent in 1988-90), mainly in the light chemicals, textiles, and electronics subsectors. In contrast to most other parts of China, Jiangsu's industrial TVEs produce a substantial share of provincial GVIO (44.5 percent in 1989), twice the national average. Real GVIO increased more than fourfold in 1980-89 (17.1 percent per annum, see Appendix Table 1.1). Significantly, the contribution of state-owned enterprises (SOEs) to Jiangsu's GVIO (35 percent) is well below the national average of 57 per- cent and about half of the 69.3 percent share of SOEs in neighboring Shanghai.l/ The importance of TVEs in Jiangsu signifies the relatively large role of market-oriented enterprises in this province. 1.2 Jiangsu's agricultural sector, favored by mild weather, rich soil, and abundant water resources, generates 26.4 percent of provincial gross out- put. Jiangsu has the highest yields in China in grain, cotton, and peanuts, and farming is diversified into cash crops, livestock raising, and aquatic products. Jiangsu is the second largest grain producer after Sichuan and ranks fourth in meat and cotton production. Jiangsu's agriculture grew at 7-8 percent in 1978-84, after the responsibility system was introduced. Since 1985, growth has leveled off to 4 percent (Appendix Table 1.2), following difficulties in increasing yields, marketing, pricing, and input shortages. 1.3 Jiangsu's external orientation is more recent than that of other provinces such as Guangdong, but the province is well positioned thanks to its coastal location and high level of industrialization. During the 1980s, for- eign trade grew rapidly--in real terms at an impressive annual rate of 15 per- cent until the mid-1980s, when growth tapered to 10 percent. Exports in rela- tion to provincial income rose from 5 percent to 10 percent. However, while Jiangsu produced 12 percent of China's GVIO, it only generated 4.7 percent of China's exports in 1989. Measuring export orientation as the ratio of national export share to national GVIO ahare, Jiangsu (.39) is less outwardly oriented than Guangdong (3.6) or Fujian (2.9). Close to 50 percent of Jiangsu's exports consist of textiles and garments; light chemicals and agri- culture also have significant share. Imports hitherto have been used to ease supply bottlenecks for production and consist mainly of raw materials, machin- ery, electronic equipment, and technology. Raw materials for the chemical industry have been the largest single import item. 1.4 Jiangsu has tried to create a healthy climate for foreign direct investment (FDI). However, FDI in Jiangsu, as of 1987, remains a small share 1/ Figures cited in this chapter may sometimes differ from figures cited in Chapter II. This is explained by the use of two different statistical sources: tha China Statistical Yearbook and the Jiangsu Statistical Yearbook and definitional differences therein.  -2- --1.6 percent--of China's total, compared with Guangdong (57.2 percent), Shanghai (6.7 percent), or Fujian (5.5 percent) (Table 2.3). Its composition and economic contribution have been somewhat disappointing. At end-1988, of Jiangsu's 442 approved investments (valued at $890 million), 421 (92 percent) pledged less than $10 million; and only two more than $100 milliorn. About one-third (121) were export oriented, and only 20 of them were "technically advanced,' as reflected in the sectoral orientation of FDI which ranked light industry first. (Electronics. instruments, and textile ranked second, third, and fourth, respectively.) 1.5 Product and Income Indicators. Jiangsu's GDP per capita was Y 1,880, 32.4 percent above the national average in 1989 (see Figure 1.1), about twice as high as in China's poorest provinces, Gansu and Guizhou. Within the richer coastal belt, Jiangsu's per capita income is about one-third of neighboring Shanghai's, China's richest province. Intraprovincial income differentials are significant, and the income gap between Jiangsu's northern and southern regions has widened since reforms began (see Figure 1.2). In 1978, southern Jiangsu's per capita income was 2.2 times that of the north; in 1989, it was 2.7 times that of the north (see Appendix Table 1.3). The higher income levels in the south have been driven both by a thriving industrial sector and agricultural prosperity. Industrialization in Jiangsu, by and large, is also associated with higher agricultural labor prodactivity; the richer industrial south is also agriculturally more prod_ctive. This pattern suggests a risk of further widening of north-south difrerentials. Figure 1.1: GDP PER CAPITA (unit: yuan in current prices) ao . 'ao 1@7s :971 180 98 19 98 1983 iWO '91 196 Igo? tWO19  -3- Figure 1.2: GDP PER CAPITA B: LOCATION, JIANGSU PROVINCE (unit: yuan) 3.000 1,500 . ., .... , - .. , ._.._. ,.. .S,T,-Ilo 500 1982 19831984 198S '9 1987 low8 iO 1.6 Populatjon, Education, and Employment. Jiangsu had a population of 67.6 million in 1990; its population density--higher in the south than the north--of 660 inhabitants per square kilometer, was 5.6 times the national average. Though a populous province, Jiangsu is well endowed with human capi- tal and skills: a comparatively high proportion of the population has received upper secondary, vocational, or technical education. For example, scientific and technical personnel have douoled since 1978 (to rate fifth in the nation) and the enrollment at higher education institutions in Jiangsu is the highest in China. Its labor force participation rate--80 percent of its roughly 35 million labor force--is also one of China's highest. Rural labor makes up almost 75 percent of the labor force, and over 40 percent engage in nonagri- cultural activities, the highest percentage in the natior. Of the remaining 25 percent, or 8.9 million, urban labor force, less than 0.3 million were employed in the private sector, the rest were "staff and workers" in state, collective, or joint ownership units (Appendix Table 1.1). Labor shortages in the south have appeared in recent years, with every indication that they will become more severe as the province's economy continues to develop. B. Jiangsu's Special Characteristics 1.7 Table 1.1 provides a comprehensive picture of Jiangsu's place in China's economy along a number of different dimensions. The following fea- tures of Jiangsu are noteworthy.  -4- T'Iobl 1.. JIANOSU'S PLACE IN CHINA'S ECONOIY (1O89) S Sharo in I Share in Ranking in the notion the nation the nation Tc.p anking provinceo 1978 1989 1989 1989 General Economic Indicators GCP (Y 113.2 billion) 6.9 8.2 1 Jiangsu, Guangdong, Shandong National income (Y 96.9 billion) 6.9 8.6 1 Jiangsu, Shandong. Guangdong GVIAO (Y 303.0 billion) 7 9 10.6 1 Jiangsu, Shandong, Ouangdone GDP per capita (Y 1,694) - - 6 Shanghai, Beijing. Tianjin, Liaoning Infraetructuro and Eneray Electricity generatior 4.9 6.3 4 Inland waterway (23,653 km) - - 1 Road network (24.609 km) - 24 Sichuan, Hunan. Yunan, Guangdong, Hubei Industry YVI0 (Y 250.7 bIllion) 8.0 11.4 1 Jiangau, Shandong, Guangdong Production of Industrial Commodities (quarterly) Cement (15.1 million tone) 6.9 7.2 3 Ouvngdong, Shandong, Jiangsu Caustic soda (0.3 million tons) 8.4 9.9 2 Shandong. Jiangsu, Shanghai Chemical fiber (0.3 million tone) 7.4 22.5 1 Jiangsu, Shanghai, Liaoning Cotton yarn (o 7 million tons) 11.9 14.3 1 Jiangsu, Shandong, Hubei Cotton cloth (0 7 million tone) 12.8 14.9 1 Jiongeu, Shandong, Shanghai Chemical fertilizor (1.4 million tons) 8.5 7.9 3 Sichuan, Shandong, Jiang"u Pesticide (0.04 million tons) 9.2 20.5 1 Jiangau, Hunan, Zhejiang Sulfuric acid (1.2 million tons) 13.6 10.1 1 Jiangsu, Sichuan, Guangdong Coal (24.5 million tons) 2.8 2.3 13 Shanwi, Henan, Hailongjiang, Sichuan. Shandong Steal (1.7 million tons) 1.7 1.9 IS Liaoning, Shanghai. Hubei, Beijing, Heboi Rolled steel (1.9 million tons) 2.7 3.9 7 Liaoning, Hubei. Shanghai. Sichuan, Beijing Production of Consumer Durablen TV (S.3 million) 7.1 19.2 2 Guangdong, Jiangsu, Shanghai Automobile (38,234) 10.1 6.6 6 Hubei, Beijing, Jilin, Limoning, Tianjin Bicycle (4.3 million) 3.6 11.8 3 Shanghai, Tianjin, Jiangsu Radio (6 8 million) - 37.0 1 Jiangsu. Guangdong. Shanghai Sewing machine (1.0 million) 4.1 10.3 3 Shanghai, Guangdong, Jiangsu Reorigr-ator (0.6 million) - 9.5 2 Electric fan (8.6 million) _ 17.2 2 Camera (358,316) - 14.6 2 Agriculture OVAO (Y 52.2 billion) 7.6 8.0 4 Guangdong, Shandong, Sichuan Cultivated land (68.4 million mu) - 4.8 7 Heilonm;iang, Henan, Shandong Grain (32.6 million tons) 7.9 8.0 2 Sichusn, Jiingau, Henan Oilseed (1.0 million tons) 7.2 7.7 5 Shandong, Sichijan, Honan, Anhui Cotton (0.5 million tons) 21.9 12.8 4 Shandong, Hebei, Henan (a) By most macroeconomic measures, Jiangsu is among China's top two or three provinces. It is top ranked in terms of the share of the nation's GVIAO and GVIO, and is second ranked in terms of provincial GDP and national income. (b) The picture of Jiangsu as a relatively well developed industrial economy is supported by the number of product lines in which it is ranked among the top three provinces. It is the top ranked producer of cotton yarn, cotton cloth, pesticides, sulfuric acid, chemical fiber, TVs and radios; second ranked in producing many consumer durables (electric fans, refrigerators, cameras); and third ranked in production of cement, chemical fertilizer, bicycles, sewing machines, etc. Only Liaoning and Shandong use more energy than  Jiangsu but, unlike these provinces, Jiangsu is among the most effi- cient in energy and electricity use per unit of output.2/ (c) As the fourth ranked province in terms of GVAO, Jiangsu's agricul- ture remains a significant source of both its own, and China's, economic strength. (d) Jiangsu's industrial sector is characterized by the relative impor- tance of small, nonstate (TVCE) enterprises engaged in light indus- try processing activites (see Chapter II). 1.8 Table 1.2 attempts a comparison between Jiangsu and its coastal neighbors to the north and the south; Shandong and Zhejiang, where industrial growth has also been rapid in the last decade, in order to pinpoint the basis for Jiangsu's growth performance. Jiangsu is similar to Zhejiang in most respects (per capita income, share of agriculture in national income, rate of taxation of TVCEs), it shares some features with Shandong (share of light industcy in GVIO), and falls in between on some quantitative measures (share of SOEs and collectives in GVIO). Jiangsu differs from both its coastal neighbors in being slightly more industrialized and somewhat less export- oriented. The significant difference between Jiangsu and its neighbors is that the rural industrial sector is a much more important part of Jiangsu's economy than in either of its neighboring provinces 3/ (see Table 1.2). 1.9 Another important factor in Jiangsu's development is the role of its skilled labor force and the initial endowment of human capital. As indicated by Table 1.2, Jiangsu has a relatively large share of the nations scientific and technical labor force (5.47 percent), a high rate of growth in that stock, and the highest level of enrollment in higher education institutions. Jiangsu's superior human capital endowment is only partially indicated by these quantitative measures. The qualitative significance of the educational variable (the quality of Jiangsu's educational institutions, for example) and the presence of entrepreneurial and managerial skills (which cannot be easily measured) is perhaps even more important in explaining Jiangsu's performance. 1.10 The historical and geographical connection of Jiangsu to Shanghai and the proximity of most southern Jiangsu cities to Shanghai has also con- tributed to development in Jiangsu. Historically, Shanghai was China's finan- cial and industrial center and its window on the western world.4/ Even today Shanghai remains China's richest and most advanced area. Good waterway and rail connections link Shanghai and Jiangsu. Shanghai provides southern Jiangsu with a conduit to managerial and technological expertise and access to 2/ Energy consumption in Jiangsu in 1989 was 23.9 thousand SCEs per billion yuan of GVIO whereas the corresponding figures for Shandong and Liaoning were 37 and 60.7 thousand SCEs, respectively. 3/ Recent growth of the TVCE sector in Shandong has been much faster than in Jiangsu, however, as is indicated by Table 1.2. 4/ Shanghai's importance is indicated by the early (1927) classification of Shanghai as provincial level municipality under the central government.  - 6 - Table 1.2: COMPARISON OF JIANGSU AND OTHER COASTAL PROVINCES Jiangsu Zhejiang Shandong Per capita income (1989 current prices) 1,879 1,876 1,472 Population (millions, 1989) 65.36 42.08 81.6 GDP (billion yuan, 1989) 122.85 78.96 120.1 Sectoral Shares Agriculture 30.6 30.8 38.5 Industry 51.5 48.7 45.8 Other 18.0 20.5 15.7 GVIO by Ownership SOE 35.0 22.5 46.0 Collective 59.4 63.5 48.9 Other 5.6 14.0 5.1 Light-Heavy Industry (Z) Light industry GVIO 53 64 52 Heavy industry GVIO 47 35 48 Exports as Z of GDP 7.4 8.9 9.6 Share of China's scientists and technicians 5.5 2.8 5.5 Rural TVCE Characteristics Growth of rural industrial output, 1986-89 (Z) 122.1 116.1 248.3 TVCE tax rate, 1986-90 (Z) 74.9 77.9 40.5 Sales income of TVCEs (billion yuan) 89.4 49.5 61.8 Original value of fixed assets (billion yuan) 29.9 16.0 24.0 Sources: China Statistical Yearbook, 1989, 1990; and 'China: Rural Enter- prises, Rural Industry, 1986-90,n by Anthony Ody, World Bank draft paper, 1991. the outside world.5/ The practice of subcontracting between Shanghai and enterprises in cities like Wuxi and Suzhou directly .-ontributes to Jiangsu's development. These factors are central to an explanation of southern Jiangsu's growth performance,6/ especiallv in its success in carving out a niche for itself in several technologically advanced industries: petrochemi- cals, electronics, and telecommunication. The strong growth in southern Jiangsu compared to northern Jiangsu (which is separated by the Yangtze and the Huai rivers) is another reflection of this 'Shanghai ccnnection." 5/ Close to one-third of China's cargo is handled at Shanghai seaport. 6/ Shanghai's contribution to southern Jiangsu's annual GVIO growth rate in the eighties is statistically significant with R2 value as high as 0.9.  - 7 - 1.11 GDP Growth. In the decade ended in 1989, Jiangsu's real GDP grew much faster (40 percent) than the nation (Figure 1.1).7/ The difference was particularly marked in 1981, when Jiangsu grew almost twice as fast as the country as a whole (9.6 percent versus 4.9 percent), and in 1985 when Jiangsu grew almost 60 percent above the already very high national rate (20.7 percent versus 13.1 percent for China). This exceptional performance was repeated but for 1980, 1984 and 1989, which were also periods of relative contraction throughout China. During these slowdowns, GDP growth averaged about 6 percent less in Jiangsu than in China as a whole. The difference seems to have become more marked over time, with Jiangsu's growth rate lagging only 0.3 percentage points behind the national rate in 1980 and by one percentage point in 1984. In 1989, for the first time, Jiangsu did substantially worse than the nation (1.4 percent versus 3.9 percent). 1.12 Cyclical Growth Pattern. Jiangsu's GDP growth rate largely follows the general cyclical pattern of the nation but its growth cycles have become more pronounced since 1984 (Figure 1.3). Growth spurts have been more peaked, and the decline more acute. Three factors explain this cyclical growth phe- nomenon: Jiangsu's orientation toward the domestic market, the relative sen- sitivity of Jiangsu's industries, particularly TVCEs, to the use of adminis- trative measures to control demand in China, and the importance of the machin- ery sector in Jiangsu. 1.13 First, Jiangsu's economy is relatively strongly linked to the national rather than the world economy, in spite of its coastal location. In 1989, Jiangsu exported about $2.4 billion or 7.4 percent of its GDP,8/ a lower share than Shandong (9.6 percent) and Zhejiang (8.9 percent) and far less than Guangdong (23.5 percent). Jiangsu started its "opening to the out- side world' relatively late and is still oriented towards the more profitable domestic market. As a result, when the domestic market turned down in 1989, Jiangsu's nominal GNP grew by only 8.5 percent whereas Guangdong (19.4 per- cent) and Fujian (17.7 percent) grew more rapidly. 1.14 Second, the 'retrenchment program" had a disproportionately negative impact on Jiangsu's economy in 1989 because the heavy reliance on administra- tive controls to reduce China's excess aggregate demand, especially through large cuts in bank credit, discriminated against the TVCEs, which constitute a more market-oriented segment of Jiangsu's economy. Jiangsu has a relatively high share of industrial township and village enterprises (TVEs) which gener- ate 45.3 percent of Jiangsu's GVIO compared with 19.6 percent at the national level. This relatively high concentration in the TVE form of ownership com- bined with the differential treatment accorded to TVEs during the retrenchment program in terms of discriminatory access to credit, made Jiangsu's TVEs, and therefore its industrial growth, very procyclical. 7/ In the early reform period, from 1978-82, Jiangsu grew 9.2 percent, com- pared to 6.6 percent for the nation as a whole. Growth accelerated in 1983, averaging 13.8 percent in the 1983-88 period, compared to 10 per- cent for China overall (Appendix Table 1.2). 8/ This ratio tends to overestimates Jiangsu's "openness" due to the large underestimation of its GDP.  -8- Figure 1.3: GDP GROWTH RATE (unit: in percentages) 25- 15 s~~~~~~~~~~~~s. 1979 1980 t 981 1982 1983 1984 1985 1986 1987 198 198W 1.15 Third, capital goods industries are subject to especially wide swings in the course of an economic cycle because, in a downturn, er'erprises cancel or put off orders for machinery while, in an upturn, investment plans may be speeded up. The large (11.6 percent) share of the machinery sector in Jiangsu thus has a sizable "multiplier-accelerator" effect on the economy, making GVIO more sensitive to aggregate demand shocks. 1.16 Ownership Structure. Rural reforms and the household responsibility system began formally throughout China in the early 1980s. Jiangsu already had a strong, pre-existing foundation of collective ownership, especially in the south, and had started the process of devolution of responsibilities to local governments. The development of rural industries (later TVEs) began in the 1970s and came into full flower with the rural reforms of 1979 and the introduction of market economy modes of organization. Jiangsu also emphasized early the role of the cities in the development of townships and rural areas, eliminating independent prefectures in 1984, and placing rural townships and counties under the leadership of municipalities. The parallel development of household- and collective-based rural agriculture as well as rural industry in this double-track system was unique to Jiangsu. The combination of individual and collective organizations has enabled Jiangsu to develop a broader cross- section of its economy than would have been possible had, for example, only household-based activities in agriculture and collective-based activity in industry been emphasized, as happened elsewhere in China. In Jiangsu's unus- ual ownership structure, rural community-owned industry generated 44.5 percent  -9- Figure 1.4: GROSS VALUE OF INDUSTRIAL AND AGRICULTURAL OUTPUT (unit: billion yuan in 1980 constant prices) GVUO-/* 100~~~~~~~~~~~~~~~~~~* OVAO 0 44 M e O 1971 1979 1910 1911 *91 1Q13 1Q1 1989 t9OM :97 1Q88 lOIS of Jiangsu's industrial growth in 1989 and contributed one-third to one-fourth of Jiangsu's total exports. 1.17 The "Wuxi (or Southern Jiangsu) model," an innovative and peculiar system of property rights evolved, particularly in southern Jiangsu. Under this model, a highly communally oriented and integrated economy developed in which the township governments exercise strict control over production, investment decisions, and important managerial decisions in all nonfarm opera- tions. After the introduction of the production responsibility system (PRS), community governments continued to own and control town and village enter- prises. In turn, town and village community enterprises (TVCEs) became major sources of revenue for local governments, through both taxation and profit remittances, part of which is used to subsidize agriculture, support social programs, and finance administrative functions of local governments. 1.18 North and South Imbalances. Jiangsu is characterized by dualism in urbanization, industrialization, and incomes between north and south, roughly divided by an arc drawn between Nantong and Yanzhou. Southern Jiangsu, once an important agricultural base of China, has become much more of an industrial region as a result of an industrial growth rate above 22 percent per annum since 1984. The south is more strongly linked to Shanghai and the coast than to the north. By contrast, northern Jiangsu remains agricultural and less well integrated with the coast or even the south largely due to poor transport infrastructure (see Chapter VI). Its GVAO has grown more rapidly than that of southern Jiangsu (Appendix Table 1.4) and now contributes close to half of  - 10 - provincial grain production (Appendix Table 1.5), and 60 percent of cotton production (Appendix Table 1.6). These differences in industrialization are reflected in the significant per capita income differentials (see para. 1.6) between south and north. 1.19 North-South income different'als are also reflected in the labor and educational attainments of the two areas. The north has a surplus of unskilled labor with only basic education, while education and technical sl-ills are quite high in the south. Infrastructural facilities are superior in the south which is also more urbanized. C. Policy Framework: National and Provincial Policies 1.20 As a province of a large nation, Jiangsu has both significant advan- tages as well as important limitations on its ability to formulate development strategy. Clearly any efficient strategy will involve both central government actions which improve the allocation of resources within the national economy as well as actions by the province which contribute to better utilization of Jiangsu's development potential. In the discussion of this report, responsi- bilities and actions required by the two levels of government have to be dis- tinguished and the need for coordination of policies and reforms identified where this is appropriate. 1.21 The policy matrix (Table 1.3) indicates that important areas of macroeconomic management fall under central control as would be expected. Trade policy is substantially determined by the center, as is interest rate policy. However, while the structure of nominal tax rates is centrally defined, the actual control over fiscal policy in China is limited by the revenue-sharing arrangement between the provinces and the center. The matrix also reveals the predominance of direct control instruments (credit ceilings, investment ceilings, materials allocation, grain crop targets, etc.) both in the list of central policy tools as well as in the provincial policy instru- ment list. 1.22 The identification of central and provincial policy instruments still leaves an important issue unaddressed--the need for economic reforms and the extent of initiative that can legitimately be exercised by the province. Previous Bank reports have provided suggestions on reforms which are important for China to continue its rapid economic progress--macroeconomic management (including tax and financial sector reform), price reform, enterprise reform (including ownership reform), reforms to the trade regime, and social sector reforms (including housing and social security issues). Without dwelling at length on the details, it may be useful to recount the role of the center in initiating many of these reforms.9/ 1.23 Reforms that will strengthen the center's ability to use indirect policy inst7uments for macroeconomic management include actions in the area of 9, The nature of such reforms has been discussed in earlier World Bank reports on the topic. See China: Macroeconomic Stability and Industrial Growth Under Decentralized Socialism, World Bank, 1989, China, Industrial Policies for an Economy in Transition, World Bank, 1990, China: Between Plan and Market, World Bank, 1990.  - 11 - Table 1J.! POLICY MATRIX FOR JIANO2SU INSTRUETS CONTROLLED BY THE CEBTER CONTROLLED BY .JIANOSU IIEMT E LICY CENTRAL PROVIWNIAL MUNICIPAL PRICES Prices of pll key Manripulatioii of auided Control ovor prices of Iuau of proce 0u.in dqreceC:,ntd inuence over consume tion I ems such as ,tr c.. ~~~~~~meat, eggs, et,c. TRADE POLICY fchang rate Tariffs Cpn very FE retention rt' t quta, Ftr,tSno ion rteee on via export quotes (see o elow) quo6 rnd above quota exports Export licensinq rf category 1 *nd ;! items FOREIT2 -Fravr?wcork of incentivee Exqn uiqn tefsI t FINIVr'i f4Tor loreigin invl met Fn eno a"..0.4" a o .erdtg Tngoncen ivm for aexport foi it h htech rI fo ot anwvtech.pgvn MoNETARY Interest rates TAX POLICY Nominal tax rates (See under direct policy below) TRANSPORT Ri "woy tariffs Water transport tarijf ret:: POLICY Fue taxes Truqk trgnsport triff r te nar #ra ntennce tee E IRONMiTAL D, insion levies ire sit Pro'vjnce has contracts with Municipal byreaus wrltg env. WLICY yjNEPA. evy cyatespis locol governments on envir- contracts with enterprieso currently under review. onmientol targets ranking them on performance INSTT5a CY CENTRAL PROVINCIAL miilCIPAL I"DU5TRIAL/ 0e,iignatign of nritio2al Provinciel priorities ltocaltpriori tiers for INVE5T POLICY priority infugriTes for for investrent inv.tsent and production investment meve opment Direct invqstment i key Direct investment in large sectors andi ergo ui8E enterprises in raetructure Approval process for Approva! of local investment Inv?:tment plan for investments over ceiling over ceiling municipalty CREDIT POLICY Cr:3it t ; and directed Credit 9locati9n w/jn Crefi, :Iloc:i-n j credit to key enterPrl-eo provincinl crer,it coiling mu cip cr t M i MATERIAL SUPPLY Key materials allocation Mmterial allocation Material allocation CONTRACTING Revenue sharing with Fiscal contract Bureau contracts with TAXES provinces (tax contracts) w/ towns, counties enterprises Contrecp- w/ st t3-owned Contrcts */ provincial Contracp x/ =uniqjpaI enterprises inc uding tax, entjrpr see including tax, ontIrar inclu ing tax, profit * export targets Pro fit I export targsto profit, iexport targets Tax conces3ions to Tax vonve ion. to Tnx concessions state cane enterprises provinci enterprisea to loca entarprimes Tpx concrsOons for high tech investment TRANSPORT POLICY Direct invpstment in ;nje%tment in transport transport infrastructure infrastructure TRADE POLICY Export guotMSwith Set Elport quotas for local S9t Export contrmct quotas provincial T govt. proventerpriesa with lce enterprises Oranting Direct Trading C9n rant dIret reding right right */irn gruTtie n. FOh_tR Approval process for RDI Imrleeentinu central Local tax and fee INVE&rT Ogudeli nes concessions iDefiningaIpproval limits Defining lppr9vpl limits for provinces for wunicipalities T LiiCY FrreAwork of technology Irrloawnting central Eermk ingureverue for PuLIClY p guird e ines tcrn IC a pg rea ing VAT xrpirfo to standa rd p roducts EDUCATION Defining objectives Iipplementip direntivei POLICY Finaco and training of Finapce and training of tooe era teachera ACRICULTU.RAL Cotton and sugar prices Additional price incentives Retail price clilings POLICY for cotton production and subsidiee lor Provincial grain and crop Cotton area targets within ma-t/egge, tc targets province Quota, ricsg for grain Negotiated prices or aboye Negotiated price. or aboye and ci seeds qu tagrocIrement ot grains qu3t roc,cremntof grotn ONd oiiseeda end see 8 Pricing nd.alocation of Priying ond allocatiton Priling and allocation gh ons ys;s ertt izer o t ! an, y zee oflo- n ,ly? i ertrlizp r rt oca factories otnign quality fertii zer Budgettry sybeidies Lor ?udgottry sybvidies lor ExtrabydYatay funds of .gri u tur, aQgt t gr eu tura inyuts to agri cu ture inanco departments cover agriC .SOt osest cover agroind. 0ses Investment in maJ9r irrig. Mediym irrigation, non-SOE Small irrigation projects, and grain processing enter- agroindustry investment depots, an agroindustry primes and depots. Land gonver9ion tax and a mdnintrative controle on land use SLrSIDIES Syb:idioS to covgr losses Subsidig1o0 pcover lo0ees Food syb d tofotet oenterpriseo of provincial ntorprimos to EXTRAbOlDCETARY Feeo and charges col lctd Loc tednd OPERATIOiNS Oy ad in dePartmnts Extu M .. IUMN ry r1bf3;:tC*0ry''?ucnt6d'& locations~~~~~~~~~~~_  - 12 - center-province fiscal relations and reforms to the system of enterprise taxa- tion. (The latter will necessarily involve modifications to the contract responsibility system.) Financial sector reforms must redefine the role of the PBC such that it focuses on monetary management, setting of the base dis- count rate, and supertrision and regulation of commercial banks which are allowed to function in an autonomous capacity. The center's role in planning has been substantially redefined in the last decade and has become more focused on investment in a few priority activities and a reduced volume of material allocation via the plan. This trend needs to be continued. Any change in the trade regime involves central government action. All the above constitute areas of reform that involve central initiative and that are com- pletely outside the domain of provincial authorities. A number of other issues require substantial guidance and coordination between state and provin- cial governments. These include enterpriEe reform and price reform. 1.24 Areas such Rs social security and housing allow provinces to experi- ment with alternatives under the current strategy of reform but the interrela- tionship between these and other reforms (for example, enterprise and price reforms) limit the scope of provincial experimentation. Thus, most economic reforms must either originate or be substantially guided by the center, with the province having some limited scope for action in specific areas such as housing and social security. Nevertheless, the continued pursuit of economic reform by the center has a critical bearing on the development prospects and strategies of individual provinces such as Jiangsu. The need for national price reform is perhaps the most pressing issue in terms of its impact on regional and provincial development prospects. 1.25 The decentralization of economic decision making during the 1980s has increased the scope for provincial and local governments to influence industrial investment, with central government direct investments limited to key raw material and infrastructural sectors and the largest state enterprises (about 200 nationwide). While the center retains some control over provincial investment (through aggregate investment ceilings, a list of "negative indus- tries," a requirement that all projects above a certain ceiling have SPC approval, and review of projects needing central funding or material supply), about 58 percent of total investment in China is now estimated to be outside central control (that is, under the control of provinces and smaller adminis- trative units).10/ Some of these controls have been tightened since July 1990, when a more extensive list of activities subject to central approval was issued in an effort to "adjust the industrial structure and to increase macro- economic efficiency" (see Annex 1). While these recent changes have checked the overall process of decentralization, the last decade of economic reform has nevertheless witnessed a significant overall reduction in the center's use of administrative instruments. However, this has not been matched by a corre- sponding development of alternative indirect instruments for controlling and influencing industrial development. For example, the use of market prices to 10/ Industrial Policies for an Economy in Transition, CHA-8312, World Bank, June 1990.  - 13 - deal with national shortages of key raw materials and interprovincial trade in such materials remains to be adequately adopted.ll/ 1.26 The policy matrix indicates that Jiangsu relies heavily on direct intervention to achieve its policy objectives. Relatively greater latitude is available to Jiangsu in the area of direct tools such as investment approvals. The central government's role here is increasingly limited to key sectors and large infrastructure projects, with provincial government now approving some 60 percent of investments. The role of local governments is also substantial in formulating the credit and investment plans. Correspondingly, the function of credit allocation within the overall provincial quota remains large within the province. 1.27 In spite of the latitude Jiangsu may have in implementing direct controls, these instruments remain flawed. For example, in an environment where prices are distorted, direct credit allocation can lead to a misalloca- tion of resources, including financing nonviable enterprises and unsalable inventories. The achievement of fast rates of provincial growth and Jiangsu's future modernization hinges increasingly on its ability to devise new finan- cial and institutional arrangements to revitalize its most productive indus- tries and companies. Delays in this area could frustrate Jiangsu's plans to integrate its economy more closely with the international market. 1.28 Similarly, enterprise contracts have only limited incentive effects, as they work like direct instruments with case-by-case negotiation of taxes, profits and exports, while also weakening the central government's development of indirect policy tools. Illustrating the axiom that direct, ad hoc, con- trols tend to proliferate, the system has been extended to foreign ventures which now receive tax concessions, preferential allocation of power, water and other inputs and access to infrastructural facilities--each a major element of the central guideline to local governments to increase foreign investment. 1.29 In sum, the policy matrix illustrates the continued heavy reliance on a system of direct controls generally, but particularly within the prov- ince. The limited reliance on market-determined prices reduces the efficiency of information flows and decision-making in Jiangsu and increases the costs of economic management. The negotiated system creates an approach that is non- transparent, arbitrary, and complex. It gives no clear signals for efficient resource allocation, and it increases the burden of administration and enforcement. 1.30 The Scope for Provincial Policies. Jiangsu could improve the policy environment by replacing direct controls with indirect instruments wherever possible, although this will require, for the most part, central government initiative. The province can take some measures to increase policy transpar- ency and to ensure that local government interventions support rather than 11/ Jiangsu's interests often conflict with raw material producing provinces that are unwilling to supply the amounts required, preferring to set up processing industries within their own provinces. This autarkic tendency is encouraged by the centrally guided price structure which allows pro- fits to be captured by final goods producers but not by raw material pro- ducers.  - 14 - distort the effects of the center's indirect policies. Within the realm of what Jiangsu can effect, enterprise reforms, removing taxes from the enter- prise contracts, allowing credit to be determined by autonomous financial institutions, increasing materials allocation via the market, subjecting all enterprises to a hard budget constraint are a high priority. Reforms in the system of industrial organization are essential to improve enterprise effi- ciency, and policies toward enterprise consolidation, industrial entries and 'exitsn (failures) all need to be addressed. Restructuring should be under- taken with extreme caution given the present context of distorted relative prices. Jiangsu could pioneer administrative reforms directed at reducing the number of industrial bureaus and strengthening horizontal cooperation. The province should enhance its role as facilitator of economic development, while strengthening its statistical, research, and policymaking capabilities. 1.31 Trying to overcome the shortage of raw materials, Jiangsu has been experimenting with various forms of 'horizontal cooperation' with other inte- rior, resource-abundant, provinces. Jiangsu has established "raw material production bases' in Gansu and Guangxi, supplying funds and technology, in exchange for raw materials. These work to a limited degree, but the fundamen- tal problem of materials shortages remains. Some of these scarcities are artificial and reflect price distortions and protectionist trade policies. The removal of intraprovincial barriers offers the best potential for increas- ing industrial efficiency, achieving optimal plant sizes and location, and enhancing Jiangsu's specialization to reflect local comparative advantages. D. Future De%'elopment Issues 1.32 Jiangsu's development and ,-owth path will depend crucially in the future on its reforms (discussed abo-.'), its investment rate, and its approach to addressing emerging differences In north-south development patterns; the balance, within the rural sector bet.eer. TVEs and agriculture; and the poli- cies adopted, within the enterprise sector, to the conflicting interests of profitable and loss-making enterprise; Each of these reflect different aspects of a strategic choice facing J. angsu, of whether to pursue a strategy of "balanced' or 'unbalanced' growth. Each of these are discussed below, and their implications for future growth assessed. 1.33 The Invesament Plan and Vision Information on Jiangsu's public investment program is limited. While the stabilization program necessitated a decline In real investment in 1989, it is likely that investment will recover rapidly. However, public investment may continue to be constrained by the slow growth of revenue. Improving the efficiency of investment is thus even more crucial. The greater efficiency generated by the urban reforms since 1984 has already been reflected in Jiangsu's past high growth rates. Growth has been 50 percent higher in the post reform period (14 percent from 1984-88 compared to 9.5 percent) than in the 1979-83 period. This has taken place with a less-than-proportionate increase in investment resources, suggesting a  - 15 - major improvement in investment efficiency due to reforms.12/ In fact, the investment rate also increased over this period, so that Jiangsu benefited from both an increase in the investment rate and from greater efficiency of investment. Higher investment per se is estimated to have increased Jiangsu's growth by about 2.5 percentage points in the 1984-88 period, while increased investment efficiency has added 1.9 percentage points. Assuming continued efficiency gains can be achieved through reforms, Jiangsu should be able to exceed the 8FYP GDP growth target of 6 percent per annum with a higher level of consumption resources available for tne population at large. By contrast, a return to the less-efficient, prereform structures would call for a larger share of investment resources than in the recent past to generate this level of growth. 1.34 Jiangsu's 8FYP outline has the objective of achieving annual rates of real growth of GNP, NI, GVIAO, GVIO and GVAO of 6 percent, 5 percent, 7.5 percent, 8 percent and 3 percent, respectively. The plan intends to increase the share of investment in agriculture and irrigation as well as transport, energy and communications, while reducing the share of investment in processing industries. Major projects in transport include three class I highways, a national railway through northern Jiangsu in collaboration with the Ministry of Railways, and a road bridge across the Yangtze at Jiangyin. In general, these investments are consistent with the view expressed in this report that government should focus on infrastructure projects in bottleneck areas. The plan should provide not only a list of growth targets and proj- ects, but a policy framework and a reform agenda in which investment and pro- duction will take place to achieve desired macro targets and distributional goals consistent with this vision, while addressing key infrastructural con- straints. The weakness of the provincial plan is its lack of emphasis on employment issues. Since many of the plan projects are capital-intensive, their potential for labor absorption is limited. An estimated 3.4 million workers are expected to join the urban labor force during the 8FYP, so this may have the effect of swelling urbaui unemployment. While the tertiary sector is expected to absorb over one millio:' of these workers, there do not appear to be any policies to spur the growth of the service sector to a targeted 25 percent share of GDP by 1995. 1.35 Intraprovincial and Sectoral Issues. Provincial policies should focus on increasing the links and exploiting the mutual benefits resulting from the existing or potential north-south complementarities. Improving the north-south transport linkages will promote integration of the two economies. In addition, Jiangsu has emphasized need for balanced sectoral growth in its industrial policies, with balance, not specialization, sought at the sectoral level. The attempt is to match primary sector growth with the growth of pro- cessing sectors, an approach which minimizes the role of trade. In rural areas balance means requiring TVEs (the high performers) to support the agri- cultural sector. Continued reliance on the more productive (TVE) sector to 12/ An estimate of the changes in Jiangsu's overall investment requirements in relation to its growth achievements (ICOR) in the pre and post reform periods show a significant shift in the efficiency of investment. Over the period 1980-84 it took Y 1.89 of investment to produce Y 1 of GNP. Following the reforms it took 16 percent less investment--Y 1.64 to produce Y 1 of GNP. (These figures include productive investment only.)  - 16 - support the weaker--whipping the fast ox--will erode not only Jiangsu's TVE potential, but support the development of a sector not in keeping with Jiangsu's comparative advantage. Specialized and interjurisdictional trade mechanisms need to be developed. 1.36 Profitable/Unprofitable Enterprises Balance. In the industrial sec- tor, balance is sought by developing mechanisms that allow nonviable firms to be subsidized on a continuing basis or to be "revitalized" through mergers with successful enterprises. Since no clear-cut exit of enterprises is allowed by local governments, merging or absorbing nonviable enterprises with profitable ones is the only available option; but is a strategy which only results in internalizing the enterprise losses and worsening the already large misallocation of resources. The economic efficiency of enterprises has been declining recently, (including that of TVEs) and about one-third of SOEs are operating at a loss, increasing the pressure on scarce fiscal resources. Exit mechanisms need to be developed and the pursuit of enterprise reforms enhanced, while devising mechanisms to minimize the resulting social costs (for example, retraining the labor force, establishing a social safety net, etc.). 1.37 How will Jiangsu lok by the end of the 20th century? If market- oriented reforms recover the momentum they had in the 1980s in support of non- inflationary output growth of 7-8 percent per annum, it is not unreasonable to expect current per capita income (Y 1,627) and provincial GDP to roughly dou- ble over the decade. More significantly, Jiangsu's productive structure by the end of the century would look more like that of the area's new industrial- izing countries (NICs) in the mid-1980s, than to the agriculturally-based economy of the early 19709. An extrapolation of Jiangsu's longer-term trends indicate that: (i) the share of the agricultural sector would continue its secular decline, reducing in half the sector's present share in provincial GDP (from about 30 percent to less than 15 percent by the year 2000); (ii) given the already high share (52 percent) of industry in GDP, changes in its compo- sition rather than total share are the most likely development; and (iii) the service sector's share, however, can be expected to rise appreciably to con- stitute 30-35 percent of GDP by the end of the century.13/ These changes will not necessarily materialize unless the central government and the provin- cial authorities adopt a policy regime conducive to a better allocation of resources, increase the integration of Jiangsu with the international economy and promote a fuller exploitation of Jiangsu's comparative advantages in China's expanding domestic market. 1.38 Estimates of the relative contributions of the labor force, the capital stock and the unidentified residual (attributed to "technical prog- 13/ In Taiwan (China), the percentage of labor engaged in primary industry has dropped from 56 percent in 1952 to 17 percent in 1986, while the share of labor employment in the secondary and tertiary industries increased from 17 percent to 42 percent and from 27 percent to 42 per- cent, respectively, during the same period.  - 17 - ress" or "productivity growth") for China,14/ indicate that during the pre- reform period only 12 percent of the annual 5 percent growth rate was due to increased productivity, whereas for the period 1976-85 productivity growth contributed 43 percent of the 8.8 percent annual real growth. The impressive rate of capital accumulation after 1985 was responsible for explaining as much as 40 percent of output growth, while labor's share has fluctuated around 20 percent. China's as well as Jiangsu's success during the 1990s increas- ingly hinges in raising productivity in its industrial sector, particularly in its TVCEs, for which at least three types of actions are called for: (i) faster progress in correcting distorted relative prices to enhance its information content, facilitating a decentralized and efficient allocation of investment, the functioning of markets and the dissemination of appropriate signals to address artificial scarcities (ex. cotton); (ii) an early adoption in Jiangsu of China-wide successful experiments in enterprise reform, particu- larly the joint-stock system, to enhance enterprise autonomy, competition and accountability, both for SOEs as well as TVCEs; and (iii) a rationalization of the tax system, including a clear demarcation of revenue sharing arrangements between the central government and the provinces, as well as a more equitable distribution of the tax burden among heavily taxed TVCEs and other types of enterprises in Jiangsu. 1.39 Jiangsu's Comparative Advantages. During the 1990s, Jiangsu will greatly benefit from a more conscious pursuit of its sectoral comparative advantages. In spite of Jiangsu's absolute advantage in grain production, reflected in high productivity and crop yields, the province does not have a comparative advantage in grains, and the national and provincial authorities should not only allow but actively encourage greater agricultural specializa- tion (ex. in high value added specialty products and agroindustry) and reloca- tion of production within the province and among provinces, moving away from autarkic regional production and trade policies. The main force driving Jiangsu's per capita income in the rural areas is and will continue to be of nonfarm activities, particularly in the TVCE sector. To the extent that TVCEs could recover some of their lost dynamism and profitability, it will acceler- ate the transition from lower-paid agricultural to more productive industrial jobs. 1.40 In the industrial sector, Jiangsu could exploit more fully its loca- tional advantages given by its proximity to Shanghai and the South China Sea. The priority given by the 8FYP to modernizing Shanghai's industrial base and the development of the Pudong area, will offer new opportunities for Jiangsu (ex. increasing industrial sub-contracting and specialization, and the provi- sion of new services by its relatively skilled labor force). It is not incon- sistent for Jiangsu to continue to develop its export base, while enlarging its role as entrepot and distribution center, and expanding its share in China's domestic market. For the later to be possible, Jiangsu will need to address the present bottlenecks in the transport sector (see Chapter VI), 14/ See D. H. Perkins, "Reforming China's Economic System," JEL, Vol. XXVI, pages 601-45, 1988; G.C.Chow, The Chinese Economy, Harper and Row, 1985; and G. Peebles, "China's Macroeconomy in the 1980s: The Impact of Reform on Structure and Performance," WP No.9015, National Center for Develop- ment Studies, The Australian National University.  - 18 - while the national authorities should dismantle the barriers to an integrated national market resulting from past policies of self-sufficiency at the regional level, reduced domestic competition and the suboptimal use of scarce skills and resources. 1.41 External Trade. Since Jiangsu's growth dynamic will continue to derive largely from China's domestic market, Jiangsu's development will differ from that of other economies in the area (see Box 1.1) which do not have access to potentially large domestic markets and whose growth was export-led. Taiwan (China)'s exports increased from about $117 million in 1952 to $67 bil- lion in 1990, raising the share of exports in GDP from 8 percent to well over 60 percent. Even with the rapid growth of exports planned by Jiangsu (12 per- cent per annum), the export-to-GDP ratio 15/ is likely to rise from. 7.5 percent in 1989 to less than 12 percent by the year 2000 unless exports grow much faster (at 20 percent per annum export growth, the export/GDP ratio would reach about 25 percent by the end of this decade). In spite of this relatively lower trade ratio, the dynamic effects and efficiency gains of Jiangsu's outward orientation should not be underestimated. An outwardly oriented strategy will allow Jiangsu to import needed advanced technology and expose Jiangsu's industries to more competition, encouraging greater effi- ciency and specialization, while reducing the cyclicality the economy now con- fronts. 151 Granting its overestimation resulting from the underestimation of the provincial GDP.  - 19 - Box 1.1: ASPECTS OF DEVELOPMENT IN KOREA AND TAIWAN (CHINA) Both Korea and Taiwan (China) achieved economic miracles In transforming resource poor, densely populated aress Into thrivin?, industrial economies. The period of economic takeoff" was 1965-81.1/ The single most mportant policy variable associated with their success was their export orientation early in their development effort. Taiwan (China) followed the conventional model of development via import substitu- tion until 1958 but switched to an export focus after tho domestic market had failed to create enough employment, A realistic exchange rate and emphasis on labor-intensive exports provided the bas asfor rapid and unprecedented growth of Income and exports: Taiwanese exports grew at an average rate of 27 percent in 1986-81, while Korean exports grew even faster at 36 percent per annum. Real CNP grew at average rates of 9.4 percent per annum in Taiwan (China) and at 8.7 percent per annum in Korea over the corresponding period. By 1981 and 1986, the export-GNP ratio had risen to 63.6 percent and 60.6 percent in Taiwan (China) (from a 17 percent in 1986), respectively. Even more remarkably, Kores had raised Its export share from 6.7 percent in 1965 to 48.7 percent in 1981. CONTRIBUTION OF EXPORTS TO GROWTH IN KOREA AND TAIWAN (CHINA) KOREA 1980-63 1963-66 1968-68 1968-70 1970-73 Export Expansion 4.8 14.2 12.4 16.1 36.9 Import Substitution -2.8 0.2 11.4 7.2 -4.0 TAIWAN (CHINA) 1966-61 1981-88 1966-71 1971-78 Export Expansion 22.6 35.0 46.9 67.7 Import Substitution 7.7 0.6 6.7 -2.4 Source: Korea: Policy Issues for Lon Term Devolocmont World Bank Country Study 1979, Table 1 3 and Taiwan Economy in Transition, by Kuo Shirley W., (Boulder, Colorado, Westview ress) 1983, Tble 7.8. Export success depends largely on an economy's rolative efficiency in producing the export items. Both Taiwan (China) and Korea's initial successes were in labor-intensive exports where their low wages gave them a comparatIve advantage. This strategy also contrib- uted to high rates of employment creation and beneficial income d7stribution effects. In Taiwan (China), the industries that provided the basis for thls expansion included textiles, basic metal products, chemicals and plastics, and food processing. Sub- sequent growth occurred in electronic components, machinery, precision optics, le ther, and clothing. In Korea the export industries Included textiles, apparel plywood and footwear and, after the late 1980s, shipbuilding, steol, electronics, chemicals, and synthetic fibers. Large investments in the heovy industry and chemicals in Korea after 1978 were partly justified as backward integration Into intermediate products for export industries. This stage is now viewed as having imposed large costs on Korea. Both economies have diversified export products and markets to spread out the risks of foreign trade. This is indicated by the relatively low commodity concentration (23 percent for Taiwan (China) and 26 percent for Korea in 1976) and geographical concentra- tion (41 percent in both countries in 1976) .2/ 1/ For a detailed comparison see "Models of Development A Comparative Study of Economic Growth in South Korea and Taiwan, Lawrence J Lau (ed.), ICS Press, 8 2/ Concentration ratios are derived by calculating the square root of the sum of the squared shares of different commodities/countries in Korea's (Taiwan, China's) trade.  - 20 - II. INDUSTRY, TRADE AND LABOR SKILLS IN JIANGSU 2.1 Sustained growth of industry and exports will provide the basis for increased income and employment opportunities in Jiangsu in the future, as they have done in the recent past. Policies which facilitate such growth are therefore of singular importance, along with policies which enable labor to respond flexibly to emerging regional labor requirements. This chapter dis- cusses, in turn, issues regarding industrial policy, trade promotion, foreign investment, and labor skills and training. A. Features and Issues in Jiangsu's Industrial Economy 2.2 Industrial Growth and Structure. Jiangsu is China's most industri- alized province, contributing almost 12 percent of China's GVIO in 1990. Industry has clearly been the engine of growth in Jiangsu, as illustrated by Figure 1.4. Total real GVIO increased fourfold in 1980-89, reaching Y 197 billion in 1989. Such rapid growth has raised per capita real GDP from Y 542 in 1980 to Y 1,285 in 1989, but it has also resulted in a widening of intra- provincial disparities, and increased competition for infrastructural capac- ity, particularly in energy and transport. 2.3 In 1989, six industries accounted for about 70 percent of Jiangsu's GVIO--textiles and garments; machine building; chemicals and related indus- tries; electronics and communications equipment; food processing; and con- struction materials (Table 2.1).1/ In several of these industries, Jiangsu produces the largest national shares of output. Most industries in Jiangsu have grown at double-digit real rates over the last five years. However, growth has varied substantially across subsectors, resulting in increased out- put shares for chemicals and synthetic fibers, and reduced shares for food processing, textiles, and construction.2/ 2.4 The distinguishing features of Jiangsu's industry compared to the national norm and to other industrialized provinces may be suwimarized as fol- lows: (i) processing industries dominate industrial output with 87 percent of GVIO while basic (raw material and mining) industries account for only 13 per- cent of output; (ii) almost 27 percent of Jiangsu's labor force is employed in industry, compared to the national average of 17.3 percent, and 51 percent of provincial income derives from industry, compared to 46 percent nation- 1/ Provincial authorities claim that, in their estimation, almost 85 percent of GVIO is due to these six industries. 2/ The impact of national contractionary policies in 1988/89, on growth per- formance, has differed across subsectors: export-oriented sectors such as textiles and garments were less affected, while more domestically ori- ented sectors (pharmaceuticals, machine building, electronics, and plas- tics) experienced dramatic declines in growth rates. Even booming indus- tries such as chemicals and synthetic fibers slowed their rate of growth in response to the contraction.  - 21 - Table 2.1: JIANGSU: MAJOR INDUSTRIES: SHARES AND GROWTH OF GVIO Share of 1989 GVIO Rate of Growth GVIO 1985-89 1988-89 Synthetic fibers 2.4 34.87 19.8 Chemicals 9.4 27.64 18.2 Pharmaceuticals 1.6 24.22 5.1 Plastics 2.7 20.28 -0.8 Textiles 20.3 17.52 13.4 Garments 2.3 17.64 16.7 Machine building 11.6 16.41 3.2 Electronics and telecommunications 5.5 22.23 4.5 Construction materials 5.8 14.99 4.3 Food processing 6.6 12.56 4.1 Subtotal 68.2 Total industry 100.0 18.27 9.0 Source: Appendix Table 2.4. ally;3/ (iii) state-owned enterprises are significantly less important in Jiangsu than elsewhere, accounting for only 35 percent of GVIO and 10.6 per- cent of enterprises, compared to 57 percent and 17 percent for China as a whole; (iv) small enterprises in Jiangsu account for a substantially larger share of GVIO (65 percent) than the national norm (50 percent) even though the proportion of 'small' firms is approximately equal; and (v) the composition of Jiangsu's output is tilted towards light industry (about 54 percent), whereas provinces such as Liaoning are much more oriented towards heavy industry (66 percent) (Table 2.2). 2.5 Jiangsu relies on external (mainly domestic) markets to supply its raw materials and to purchase its output. Over 70 percent of the iron ore used in Jiangsu, for example, was imported, including substantial amounts from Australia. The chemical industry imports over 50 percent of its raw materials from other provinces or abroad. The petrochemical industry simi- larly relies on crude oil from oil fields located outside the province. On the other end of the production process, an estimated 70 percent of Jiangsu's output is sold outside the province. One-third of machinery products, half of electrical appliances and 60 percent of electronics output (mainly components) is sold to other provinces. These features haSe an important bearing on its 3/ Including industrial TVEs below town level would raise industrial employ- ment share in Jiangsu to 35.4 percent.  - 22 - Table 2.2: RELATIVE INDUSTRIAL STRUCTURE IN JIANGSU Percent of GVIO Percent of Enterprises Jiangsu Chins Shandong Liaoning Jiangsu China Shandong Liaoning Light Industry 6a5. 49.a 61.7 a3.7 6a.4 64.4 64.7 43.4 Heavy Industry 46.6 60.7 48.8 66.3 46.5 46.6 46.3 56.6 Large Enterprises 17.6 80.7 24.7 47.6 0.6 0.8 0.7 1.3 Medium Enterprises 17.8 19.7 19.0 18.6 1.4 1.8 2.4 2.7 Small Enterprises 64.7 49.6 56.3 33.9 98.1 97.6 96.9 98. 0 State-Owned 34.7 66.8 4656 61.2 10.6 17.4 16.5 165. Collectives 69.4 36.2 48.9 29.6 88.7 81.8 84.2 83.7 Other 6.9 7.0 5.6 9.3 0.7 0.8 0.3 0.8 Source: China Statistical Yearbook, 1989. Tables T6.9, T6.14. Figures for share of large and small enterprises in GVIO are based on Table T6.14, which only includes enterprises at or above township level. All figures for number of enterprises are also based on T6.14. industrial structure and underline the importance of transport infrastructure in Jiangsu's development.4/ 2.6 Industrial Policy. Industrial policy in the United States is char- acterized by the virtual absence of government intervention in deciding on industrial priorities and investment. In other countries, such as Korea, the role of government is more evident and is widely regarded as having influenced the direction and rate of investment in different industries.5/ Most devel- oping countries employ both direct and indirect controls on industry--for example, licensing of capacity, subsidies to specific industries, tariff and quota protection against imports, favorable financing of exports, etc.--to achieve a variety of objectives; to ensure investment priorities, control monopolies, achieve regional balance, promote regional integration, expand exports, etc. 2.7 In general, international experience suggests that sound investment decisions are best made by those who have the most knowledge of the specific industry and who are guided by market price signals. The role of the govern- ment is then restricted to maintaining macroeconomic balance, ensuring the competitive functioning of markets, regulating monopolies, and creating the 4/ See Chapter VI for a discussion of the nature of the transport network as well as emerging bottlenecks in Jiangsu. 5/ In the period 1961-73, Korean government intervention featured comprehen- sive incentives for export-oriented activities (which overcame the effect of import protection) without a strong sectoral bias. Only after 1973 did Korea target heavy and chemical industries. Such targeting is gener- ally viewed to have imposed a large cost on Korea. See Korea: Managing the Industrial Transition, Vol. I, The Conduct of Industrial Policy, World Bank Country Study, 1987.  - 23 - conditions for efficient, decentralized decision-making in industry. While this provides a useful framework to strive towards, China and Jiangsu are still a considerable distance from that ideal. Moreover, as a province of a larger economy, Jiangsu is constrained in the degrees of freedom it has to reform industrial policy. 2.8 Policy Instruments and Issues. In China, and in Jiangsu, industrial policy is articulated through an extensive array of administrative controls. As indicated by the policy matrix in Chapter I, in addition to the administra- tive controls imposed by the center, Jiangsu sets its own controls, including municipal investment approval limits, credit allocations via the provincial mandatory plan and guidance plan, material supply, etc. Other administrative measures include investment approval processes, licensing restrictions, and the provision of 'information" on government policies. Economic measures include tax preferences, credit and foreign exchange allocations, labor dis- tribution and material supply policies, and price controls. Legislative mea- sures include various legal restrictions on industries such as rules governing enterprise formation, functioning, pollution control, and bankruptcy. Some of these are decided entirely by the province; others are provincially imple- mented, under varying degrees of central guidance. 2.9 The discretion available to Jiangsu and other provincial governments to influence industrial investment decisions at the provincial level derives mainly from the ability to approve investment up to limits defined by the cen- tral government.6/ While other restrictions on provincial investment deci- sions (for example, the center's 'negative' list of industries needing central approval, regardless of investment scale) impose some constraints, they still allow considerable room for the province and local governments to select and promote industries of their choice. At present, the provincial government attempts to intervene in a wide range of sectors and industries through a host of discretionary policies, but primarily via the enterprise contracting pro- cess.7/ This is problematic in a number of respects: (i) it hinders the development of indirect policy tools; (ii) it raises the costs of economic management by requiring resources to be devoted to monitoring direct policy compliance (indirect policy induces the desired behavior without costly moni- toring); (iii) it distorts industrial development; and (iv) it overburdens the enterprise contract with functions, diluting its fundamental purpose: effi- cient management of enterprises. In sum, it has obstructed achievement of a system whereby 'the state will regulate the market and the enterprises will be guided by the market." 6/ Provincial investment approval limits are Y 50 million (for transport, energy, and raw materials), Y 30 million (for other sectors), and $30 million (for foreign direct investment). Nanjing and Wuxi have the same approval limits. However, provinces can undertake many investments without central review by downsizing projects or stretching out projects over time. 7/ Enterprise contracts specify a large number of mutual obligations for both the enterprise and the industrial bureau. See Annex 2 for text of a sample contract.  - 24 - 2.10 Policy reforms in Jiangsu should focus on reducing the interventions by the provincial and local government and their industrial bureaus in enter- prise-level decisions. The role of the government should be defined more narrowly, focusing administrative attention on a few key areas. The Jiangsu Government has a natural role to play in developing the public infrastructure (transport, power, education), removing barriers to trade and promoting market integration, and facilitating information flows within the province. Encour- aging enterprise reforms that strengthen the financial and rnanagerial autonomy of enterprises would enable the government to focus on these priority areas. 2.11 Separate from the issue of excessive administrative interventions is the role of the government in defining "priority" industries, which is a major aspect of stated industrial policy in Jiangsu. At present, the priority industries are so broadly defined that any industry, unless explicitly forbid- den, can be justified as a priority activity.8/ Real priorities are often only revealed by the system of key materials allocation but, with the gradual reduction of the scope of material allocation, this is a less effective tool for reinforcing stated priorities. This trend suggests that initiatives on industrial development are increasingly determined at local government level. Given this, Jiangsu can improve the quality of industrial investments in the province--addressing issues of appropriate choice of industry, scale, loca- tion, etc.--by strengthening the ability of the market to guide and discipline both enterprises and local governments. The province can assist in coordinat- ing investment decisions that straddle administrative boundaries. Promoting market competition both within the province and with other provinces will be a critical function in this respect. The provincial government also has to play a role in shaping technology policy, enforcing pollution control and in con- solidating industrial capacity. 2.12 Trade, Transport, and Integration of Markets. The future develop- ment of Jiangsu will be significantly influenced by policies that integrate markets both within the province as well as with other provinces. Greater emphasis on development of the road transport network will allow for faster and more flexible movement of passengers and freight from Jiangsu's industrial sectors to markets within China while expansion of air transport and multimo- dal facilities will improve access to world markets for high value exports (see Chapter VI). Corresponding to these improvements is the need to break down barriers to trade within China. The removal of barriers to trade is an important action that will provide unambiguous benefits to all parties in the long term. As an economy dependent on trade, Jiangsu has a vested interest in achieving agreement with its neighboring provinces at first and then more widely to permit trade to occur without hindrance. Jiangsu could initiate a "free trade agreement" with its major trading partners in other provinces on an experimental basis to demonstrate how such a system might work. Policing 8/ The State Council defines priority sectors as including the following: agriculture and related activities, light and textile industries (which covers a very large set of industries), basic industries and facilities (all infrastructure and most intermediate goods), machinery and electron- ics, high technology (not sector specific), and foreign exchange earning acti-ities.  25 - such agreement to ensure compliance within tue province will then be Jiangsu's responsibility.9/ 2.13 Technology Policy. Under the 8FYP, Jiangsu intends to derive as much as 55 percent of agricultural growth and 40 percent of industrial growth from technological progress. By 1995, over 10 percent of provincial GNP and 5 percent of exports are expected to be from sectors using "new technology." Jiangsu's technology support policy includes four maiTh incentive devices: priority credit, income tax concessions, material supply, a-d flexibility in pricing of output. In addition, under central policy, technological invest- ments can apply for exemption from sales tax. Administrative measures are also employed in Jiangsu, including the earmarking of a percentage of sales revenue (1 percent to 10 percent) for technical development. Jiangsu's Sci- ence and Technology Commission (STC) sponsors collaborative research projects between research institutes and enterprises via zero interest loans to be repaid when profits are generated. However, while Jiangsu financially spon- sors R&D (10 percent), most financing comes from enterprise funds (60 percent) and borrowing from banks (30 percent). Jiangsu allocates about 10 percent of its contribution to basic science, 40 percent to applied research, and 50 per- cent to development research for small business. 2.14 In early 1991, Jiangsu unveiled a 17-sector technology strategy for the 8FYP that specifies, in considerable detail, the kinds of machinery and technology to be employed by different industries. It also goes so far as to target the composition of output by subsectors. For example, the proportion of synthetic to cotton fiber in total fiber production is targeted to be 35:65 by 1995. Such targeting is typical of a rigid, plan approach to technology and ignores the valuable role and natural advantage of markets in guiding such decisions. It also expands the interventionist role of the government and contradicts the assertion that enterprises will be allowed to make industrial production and investment decisions, guided by the market and a few industrial policy instruments. In addition, a rigid application of such technology stan- dards may have adverse consequences for competition by creating barriers to entry and forcing the exit of some efficient TVEs. 2.15 Issues that do require the attention of the provincial government relate to technology diffusion and acquisition of foreign technology. Diffu- sion of technology in Jiangsu could be improved by better information flows, greater labor mobility, and the removal of constraints on the marketability and reward for innovation. The creation of a provincial information agency that subscribes to technical and industrial journals and disseminates informa- tion will provide enterprise managers and engineers with the basis to make decisions on foreign and domestic technology. 2.16 Acquisition of relatively sophisticated technology (such as CNC machinery) will require Jiangsu to develop long-term strategic alliances, 9/ The World Bank has recommended that a State Industrial Policy Commission be established at the center to promote interprovincial trade and to arbitrate when conflicts emerge. See China: Industrial Policies for an Economy in Transition, 1990, World Bank. Also see China: Macroeconomic Stability and Industrial Growth under Decentralized Socialism, 1989, World Bank, particularly Chapter VIII.  - 26 - rather than one-time transactions, with leading foreign technology suppliers. Such alliances should include the foreign firm, domestic enterprises and local research institutes. For example, strategic alliances in the CNC industry (a Jiangsu "pioneer" industry) are :ncreasingly observed.10/ The coproduction arrangement between Nanjing Machine Tool Factory and vraub Company is a step in the right direction, but a broader-based alliance, incorporating Jiangsu's research institutes, would be more appropriate. Management groups such as Zhong Shan which have the technical capacity to absorb key technologies quickly and to learn from reverse engineering processes offer significant advantages in structuring long-term technology contracts with a major foreign entity on a broad range of technologies. Jiangsu should develop this mecha- nism of technology absorption. 2.17 Environmental Policy. Industrial policy in Jiangsu must more explicitly integrate environmental concerns into development plans (see Box 2.1). The existing system of adding environmental targets to a list of more conventional targets, such as profits and taxes, is inadequate. The pressure on enterprises to achieve tax and profit targets implies that when faced with a conflict, environmental targets are abandoned. Attaching greater weight to environmental objectives should be one modification to industrial policy that should be reflected in better enforcement. Jiangsu should support the produc- tion of pollution control equipment in which the chemical industry has some potential--this would enhance both industrial and environmental objectives. 2.18 Mergers, Enterprise Groups, and Subcontracting. Jiangsu's indus- trial structure, like China's, is characterized by inefficient scale, frag- mented markets, and policies that permit the continued operation of ineffi- cient or loss-making enterprises. Such a structure implies high costs, fails to take advantage of Jiangsu's comparative advantage, hampers technological development and innovation, and weakens Jiangsu's ability to compete in inter- national markets. In Jiangsu, industrial restructuring and improvement in industrial efficiency is sought largely through "horizontal cooperation" between enterprises, enterprise groups, and mergers. The cooperative rela- tionship is also intended to provide a channel for technological transfer from advanced enterprises to smaller, less knowledgeable firms within the coonera- tive group. In Wuxi, 34 such cooperative arrangements have been set up. The Wuxi Mayflower Electronics Group illustrates the successful operation of such a group (Box 2.2). To the extent that cooperation allows a firm to specialize in certain processes and to capture marketing and transaction cost economies, it can improve scale economy in participating enterprises. 2.19 The formation of "enterprise groups" such as the Zhong Shan Group is another instrument for internal restructuring to capture scale and scope econ- omies. The creation of such groups is particularly useful in industries that are earmarked for technical development because coordinating research priori- ties can yield substantial advantages. Size can be an asset in projecting reputation in international markets and in forming technical alliances with foreign corporations. 10/ For example, Fanuc, Ltd., of Japan, a leader in CNC machine tools, has formed a strategic alliance to produce computer integrated manufacturing devices with General Electric (U.S.) whose strengths are in software, programmable logic controls, and factory automation.  - 27 - Box 2.1: ENVIRONMENTAL ISSUES AND POLICIES IN JIANGSU Population growth, rapid urbanization and Industrialization have contributed to serious environmental degradation in Jiangsu. While some progress has been achieved, ade- quate environmental management remains a critical issue for Jiangsu's long-run sustainable development requiring, among other things, better Integration of economic objectives with environmental goals. Water pollution has been Identified as the top priority for Jiangsu's environ- mental management program, while air pollution Is also emerging as a serious concern. The importance of TVCE industries in Jiangsu poses special environmental problem since such industries, in some instances, use outmoded, polluting technology while their widely dis- persed location renders centralized waste treatment difficult and expensive. Despite growing environmental concerns, investment In pollution reduction has remained at 0.3 percent of ON? In Aiangsu, below the national average of 0.8 percent. Under the SFYP, Jiangsu proposes to raise this ratio to 0.6-1 percent with the objective of reduc- ing the pollution elasticity of GNP through improved waste management, energy conservation and industrial efficiency. While Jiangsu is considered one of the leading provinces In environmental management In China, its policies have been an eclectic assortment of command and control and incentive instruments. Contract ResponsibiliU System Since 1989, the province has employed an environ- mental CRS with respect to municipal governments who, In turn, have required enterprises to enter into contracts to reduce pollution. This contract system Is not a first best Instru- ment for cost-effective pollution reduction. However, some improvemonts to this system would include the following: (i) pollution control targets should focus on quality, in addition to the quan- tity, of the pollutant; (ii) the rewards/penalties for pollution reducing actions should be raised signif- icantly; and (III) the criteria for rewards should be refined to encourage cost-effective attainment of contract goals. Environmental Levy System. The current environmental standards are set In terms of pollution concentration levels, rather than the more effective mass discharge limits. Moreover, the present levy system has a number of deficiencies, Including: (i) levels of pollution levies too low to exert a deterrent effect; (tt) levies applied only to the high- est polluting constituent, ignoring other pollutants; (iII) the same levy charge is applied to all the pollutants even though higher treatment costs are required for toxic constitu- ents; (iv) levies do not cover solid and hazardous waste generation; (v) most of the levy funds are returned to the polluting enterprises for end-of-pipe treatment, however, a gener- ally more cost effective approach Is to build common treatment faciities for Industrial and domestic wastes or invest in waste minimization technology and/or to minimize waste; and (vi) varied levels of enforcement among the cities, while levy collection rate Is generally low at the county and lower levels. Pollution Monitorina nd Control. While environmental Impact assessment (EIA) is required to Fe an Integral part of project feasibility studies, Its Implementation has a number of shortcomings: (t) inadequate monitoring dta and funds; and (it) incomplete enforcement, mainly due to conflicts between environmental and economic objectives. Industrial Technologies. Industrial pollution control has thus far focused on 'end-of-pipe treatment" whic is generally not the most cost-effective approach. In partic- ular, more attention needs to oe focused on such least-cost approaches as waste minimiza- tion, recycle, recovery and reuse which would Improve both industrial efficiency and pollu- tion abatement. The problem of pollution in Jiangsu, as in China as a whole, Is closely related to the underpricing of natural resources, especially water and energy. Increasing sewer treaot- iient charges would allow mobilization of funds for treatment facilities. Deepening of eco- nomic reforms to the fiscal, price, and enterprise management systems are essential to enhance the incentive and ability of enterprises and municipalities to reduce pollution in a cost-effective manner.  - 28 - Box 2.2: ENTERPRISE GROUPS, HORIZONTAL COOPERATION, AND MERGERS Horizontal Cooperation. The Wuxi Mayflower Electronics Group consists of the Wuxi Radio Factory, as technological and production hub, in association with 85 other enterprises (including both state onterprises and TVEa). The group Is bound together by production sub- contracting and technology-sharing arrangements. The lead or hub enterprise, the Wuxi Radio oactory (WRF), produces video and communications equipment for domestic and international markets. Before this group was formed, space limitatlons prevented WRF oxpanding Its output in its existing location. The group arrangement has relaxed this constraint by allowing WRF to subcontract the production of plastic and rubber components to the smaller enterprises, while providing them with technological advice to improve quality. The cooperative arrange- ment has evidently allowed overall production to be Increased by 60 percent, which would have taken an estimated Y 40-60 million of investment without It. The Zhong Shan Group, a conglomerate that was part of China's military-industrial complex, has since its creation in 1986 been largely engaged In production for the civilian market. It is one of 10 such entities in China. Structurolly, ZSG Is a management group, composed of government officials, that controls selected central government enterprises in the electronics and telecommunications sectors primarily in Nanjing. Its holdings employ 78,000 people and include Nanjing Radio Factory (which produces Panda TV), Huadong Electron Tube Factory, Nanjing Telecommunications Works, and three research institutes. The group has a contract with the central government to dolivor an agreed amount of tax revenue and, In turn, the Board of ZSG writes contracts with the enterprises It manoges. ZSG can Issue bonds to the public (with PBC approval), and can borrow abroad atid conduct financial busi- ness with foreign financial entities. It has export and Import licenses, managed by its subsidiary the ZSG International Export Corporation, and can retoin 100 percent of Its for- eign exchange earnings. As proof of its special status via A via the central government, ZSG is paid in foreign currency for products doliverod to the government under quota con- tracts. Enterprise Merger. The Wuxi Electric Fan Factory is a highly profitable enter- prise that produces 12 and 18 inch table and floor model fans and which is diversifying into household items such as electric knife sharpeners. The enterprise has a substantial share of the domestic market (8 percent of national sales) and a fast growing export market which earned 88 million in export sales in 1990. Large profits have enabled the firm to increase capacity by 32 percent in 1990. In addition to this expansion, the factory recently acquired a lose-making entArprise by taking over Its debts (estimated at Y 1 million), thereby, obtaining the management rights to the sick firm. The managing director of the Wuxi fan factory indicated that this acquisition was not at the state's instruction but was sought by his firm. He attrlbuted the problems of the sick firm to 'inappropriate product structure.' Restructuring the acquired firm was already underway and Included the Installation of a new production line at the factory with plans for further capacity expan- sion. In Huayin county in northern Jiangsu, 66 enterprises were reported to have acquired 61 loss-making enterprises. The mergers Involved transferring 8,451 workers and totai assets of Y 29.8 million. Of the 81 loss-making firms, 20 were reported to have been roturned to profit-making status by the merger. 2.20 To revive ailing enterprises, especia'lly medium and large SOEs, Jiangsu also organizes mergers with well-managed enterprises. Such mergers and acquisitions should be based on efficiency grounds without distortions by fiscal or other incentives. Mergers where revival is unlikely weaken the healthy firms, magnifying the original problem. In particular, Jiangsu should ensure that the dynamnism and productivity of the TVEs is not hampered either by forced mergers wi:h SOEs or the creation of monopsonistic relationships with large SOEs. (See Chapter III for further caveats.) The guiding princi- ple in all state-guided attempts at industrial restructuring should be the promotion of competition between and among SOEs and TVCEs, on an even playing field.  - 29 _ B. Jiangsu's International Trade: Past Growth and Future Plans 2.21 In 1974, Jiangsu became the fifth province in China to be given the right to export directly. In 1978, Jiangsu was awarded the right to own for- eign exchange.l1/ During the first half of the 1980s, Jiangsu's exports in real terms grew at the impressive annual rate of 15.25 percent (compared to 11.3 percent in China as a whole) but, during the latter half, this growth slowed down to 10.57 percent (compared to 15.8 percent for China as a whole). The total value of exports at current prices grew from just $0.85 billion in 1980 to $2.95 billion in 1990. The ratio of provincial exports to income rose from less than 5 percent in 1980 to a peak of 10 percent in 1987 but fell to 8.8 percent in 1989.121 2.22 Composition and Direction of Trade: 1980-89. Together, textiles, silk, and garments traditionally account for the largest proportion of Jiangsu's exports: 52 percent in 1980, 55.30 percent in 1984, but 47 percent in 1989. The decline in the share of textiles has been especially sharp, from 32.8 percent in 1984 to 19.4 percent in 1989, corresponding to a nominal growth of textile exports of only 2.1.7 percent in 1985-89. This slowdown is largely due to the voluntary export restraints in the USA and EEC. The machinery sector, after stagnating in the early half of the 1980s, grew at the phenomenal rate of 39.7 percent in the last half of the decade, but from a very low base. The share of machinery exports in Jiangsu's total exports rose from 1.4 percent in 1978 to 13 percent in 1989. Until last year, when Japan became Jiangsu's largest importer, most of Jiangsu's exports had gone to Hong Kong and Macao. At the peak, in 1984, 28.3 percent of Jiangsu's total exports went to Hong Kong and Macao. In 1989, this share fell to 21.5 percent, Japan took 22.5 percent of the exports, and EEC, Jiangsu's third largest importer, took 15.2 percent. Exports to the United States and Canada in 1989 stood at 13.6 percent. 2.23 Consistent with its position in China's economy, Jiangsu has ambi- tious plans to expand exports during the 8FYP and 9FYP. The province intends to push the growth rate of exports to 10-12 percent during the 8FYP and 12-15 percent during the 9FYP. Foreign exchange earnings.are to reach $8-9 billion during the 8FYP and $15-16 billion during the 9FYP. 2.24 Jiangsu's export strategy is inevitably influenced by the national policy of encouraging the machinery and electronic goods industries. Thus, by 11/ For China-wide trade policy reforms, see China: Between Plan and Market (particularly Chapter V), World Bank Country Study, 1990. 12/ Export figures (referred to as "Self Managed Exports") as reported in Jiangsu Statistical Yearbook, do not include all of Jiangsu's exports as they exclude all exports handled by the center directly. At the national level, some 90 percent of China's exports are classified as self managed exports. Similarly, "Self Managed Imports" include only those goods imported by Jiangsu directly, using its own retained foreign exchange earnings. For China as a whole, over 70 percent of the goods coming into the country are handled centrally by national foreign trade corporations. (See Denny, David L., "Provincial Trade Patterns, " China Business Review, September-October 1987, p. 18 and p. 20.)  - 30 - the end of the 8FYP, Plan, exports of machinery and electronic goods are tar- geted to rise to 20-25 percent of the province's total exports. In Wuxi, for example, machirnery and electronic goods, which already account for 25 percent of exports, will be increased to 50 percent by the end of the 8FYP. Textiles will also be promoted with more emphasis on quality upgrading and less on expansion. The province also plans to expand foreign exchange earnings from trade in services. Earnings from tourism and labor exports are to expand by an avaerage of 10 percent during the 8FYP.13/ 2.25 These targets may or may not be feasible, depending on the rates of growth that can be maintained (see Appendix Table 2.11). Compared to the current low share of machinery and electronic goods (10 percent) in total exports, the 20-25 percent, five-year goal is rather ambitious, especially because exports by other sectors are also expected to rise during the plan. If the other provinces plan to expand their exports of machinery and elec- tronic goods at an equally rapid pace, Jiangsu's goal will be even more dif- ficult to attain. Furthermore, a simultaneous burst of exports from all provinces may pose a sufficiently serious terms-of-trade threat to warrant caution. There is insufficient information available on the plans of other provinces to reach a conclusion one way or the other, but Jiangsu authorities should pay close attention to them in this regard. 2.26 Another important objective is to develop substantially the export capacity of TVCEs. In Wuxi for example, by the end of the 8FYP, the authori- ties intend to reverse the current export pattern in which 70 percent of exports are generated by Wuxi city and 30 percent by its counties. Since most city exports are from SOEs and in the counties from TVCEs, increasing the counties' exports to 70 percent implies a substantial expansion of the TVCE sector. 2.27 Jiangsu has come a long way toward achieving an outward orientation of the economy during 1980s. The province's exports expanded rapidly, which, in turn, helped accelerate the growth of per capita income in the province. To continue on this path, reforms in the international trade regime must con- tinue. Some reforms will have to be carried out at the national level, others at the local level. 2.28 Foreign Exchange Retention Rights. To encourage exports, China has put in place an elaborate system of foreign exchange retention rights. Reten- tion ratios are set by the central government and cannot be adjusted by prov- inces. They form the framework within which the export promotion strategy of Jiangsu and other provinces must be developed. Retained foreign exchange can be either used for imports, or sold (above the official price) in a Foreign Exchange Adjustment Center (FEAC). In effect, the system partially offsets the negative effect of the overvalued exchange rate and/or the low renminbi prices paid by Foreign Trade Corporations (FTCs) on exports. While recent changes have modified the FEER system (see paras. 2.45-2.49), the following paragraphs first describe the system in place before 1991. Under the previous system, rights to foreign exchange were shared among the central and local 13/ For more details, see "Jiangsu's Export-Oriented Economy," China's For- eign Trade, 1988, Vol. 11, pp. 10-11, by Zhang Xuwu, Vice-Governor of Jiangsu Province.  - 31 - governments, FTCs, and the enterprise responsible for exports. These rights differed by industry and region, as well as by whether exports were within or above the mandatory quota and whether the exporting enterprise belonged to a "production network for exports" (PNE). Generally speaking, except for cen- trally designated PNE enterprises, retention rights within a sector are uni- form across enterprises and ownership forms. Thus, collectives and TVCEs continue to have the same retention rights as state-owned enterprises, whether they export their goods through FTCs or directly. 2.29 In Jiangsu, the sharing was as follows. As in most other provinces, 2 percent went to FTCs to cover handling costs. For within quota exports, the remainder was shared 75:25 between the center and Jiangsu. Jiangsu's share was divided between enterprise (12.5 percent) and provincial government (12.5 percent--7.5 percent to the municipal and 5 percent to the provincial MOFERT). An exception to the 75:25 sharing rule appeared to be the center's designated enterprises in the PNEs, whose retention ratios were higher than those for other enterprises in the same sector. Machinery and electronic goods also got higher retentions and were another of the many exceptions to this rule, reflecting the center's policy of targeting these goods for fast export growth.14/ PNE enterprises in the machinery and electronic goods sector were allowed to retain l00 percent of the foreign exchange earned. 2.30 For above-quota exports, these shares were virtually reversed, with the ratio being 20:80 between the center and the province. The locally retained portion accrued largely to the FTC (55 percent), 12.5 percent to the enterprise, and 12.5 percent to the province (7.5 percent to the municipal and 5 percent to the provincial MOFERT). These "above-quota ratios" apply also to light industry, arts, crafts, and knitwear sectors where the center has applied 20:80 sharing to all exports to provide special incentives. Mandatory targets apply typically to SOEs, with collectives and TVCEs only rarely sub- ject to these targets. Nevertheless. it is important to note that the above- quota FERR provided no added export incentive to enterprises, revealing a basic flaw in its design (see para. 2.37). 2.31 Like other provinces, Jiangsu signs annual contracts with MOFERT specifying an export quota, i.e., the province's total foreign exchange earn- ings. While the Jiangsu-center quota is negotiated with the center and can be considered a central policy tool, Jiangsu determines the quotas for lower lev- els.15/ Wuxi, for example, has an annual export quota of $250 million and 141 For within quota exports of these goods, on!y 35 percent goes to the center; the remaining is shared, 30 percent (exporting FTC), 21 percent (enterprise), 7 percent (FTC) and 7 percent (provincial and municipal MOFERTs). Above-quota exports are treated the same as other industries. 15/ Mandatory/instructive (i.e., within quota) and indicative export targets must be met commodity-by-commodity as stated in the contract whereas mar- ket adjustable targets allow a change in the mix of goods. Instructive targets correspond to export quotas in the provincial and municipal con- tracts and to MOFERT's command plan for exports. "Indicative" and "mar- ket adjustable" targets seem to correspond to MOFERT's guidance plan and are therefore more amenable to provincial influence.  - 32 - a foreign exchange quota of $99.9 million, which it must give to Jiangsu.16/ By adjusting these quotas that Jiangsu can manipulate the for- eign exchange retained by localities and enterprises, and thereby, the effec- tive export incentive felt by them. The system works as follows: mandatory/ instructive, indicative, and market adjustable export quotas and targets are specified in "contracts.' Since foreign exchange earnings on within-quota (instructive) exports are shared 75:25 between center and Jiangsu, while above-quota exports are shared 80:20 (implying higher FTC retentions), negoti- ations of these quotas between Jiangsu and its enterprises is an important provincial tool for influencing both the regional and commodity composition of exports. By putting a low (and easily achievable) quota on a certain commod- ity, Jiangsu can increase the sector's effective (average) retentions from exports. Of course, this must be done while meeting the center's overall export and foreign exchange quotas, so latitude may be limited. 2.32 The long-term goal of the Chinese authorities is to move to a freely fluctuating exchange rate, but until that happens, the system of exchange retention rights will continue to play an important role. Therefore, ratio- nalization of this system makes sense. Jiangsu can do little, however, about the serious inefficiencies caused by its current shortcomings. Reforms of this system must come from the center and, as discussed below, recent develop- ments address some of the issues mentioned here. 2.33 To the extent that exporting enterprises benefit from retention rights, they compensate exporters and reduce the antiexport bias resulting from import licensing, an overvalued exchange rate, and a price structure that favors domestic sales. The structure of these "subsidies" is inefficient, however, due to variations in retention ratios across provinces and commodi- ties, within commodities, and even across provinces for the same commodity. 2.34 Moreover, when exchange rates differ in different FEACs, even iden- tical retention ratios translate into different subsidy rates in different regions. Thus, for any given commodity, provinces with higher retention ratios and a higher dollar price in the swap centers will have higher marginal costs of production (because of higher import costs) than other provinces (Jiangsu can effect swap center pricing by allowing full arbitrage). Produc- tion can be made more efficient by eliminating differences in retention rates for the same commodity and equalizing the marginal costs in different prov- inces. 2.35 For a given commodity, retention ratios also differ. The ratio is much lower for within-quota exports than for above-quota exports. Provinces that can negotiate low export quotas with the center can therefore allow high- cost enterprises to operate profitably. Provinces that end up with high quo- tas may have difficulty operating even low-cost enterprises profitably. Simi- larly, at the provincial level, municipalities (or enterprises) that can nego- 16/ The difference between the overall export quota and the foreign exchange quota consists of: (i) foreign exchange retentions from quota and above- quota foreign exchange earnings by Wuxi enterprises, FTCs, and the Wuxi municipality itself; (ii) trade with East European countries, which gen- erates exports, but presumably does not generate any foreign exchange; and (iii) transportation, handling, and insurance fees.  - 33 - tiate low quotas can allow high-cost enterprises to export profitably, but high-quota cities and enterprises cannot. At the enterprise level, units that are subject to the quota have a disadvantage over units that do not have a quota. As noted, Jiangsu can use this system to manipulate its enterprise incentives, but, overall, the system generates major distortions. 2.36 These considerations suggest that the center should set uniform retention rates across provinces, at least within a given sector. Whether or not variations across sectors are justifiable is a complex issue.17/ On grounds of transparency and admP'istrative simplicity, a strong case can be made for use of one or two retet. son rates. Under the current system, enter- prises sometimes do not even understand what their retention rights are. 2.37 A further issue concerns the sharing of provincially retained for- eign exchange. If the agency system (under which FTCs act as agents, doing business at foreign prices, converted into renminbi) is introduced aggres- sively for exports, China should adjust the sharing ratios so that almost all locally retained foreign exchange is given to exporting enterprises. The current centrally mandated practice of giving as much as 55 percent of the foreign exchange generated by above-quota exports to FTCs leaves relatively little foreign exchange for enterprises and, more significantly, provides no added incentive to export. The 55 percent retention is especially unreason- able when goods are exported by an enterprise with direct trading rights. Moreover, FTCs presumably use the foreign exchange less efficiently than enterprises. 2.38 Export Pricing Policies. Procurement prices for exports are set (in renminbi) within central guidelines by the relevant provincial city or county FTC to suit local conditions. Available evidence suggests that, on average, domestic sales prices are higher, sometimes much higher, than the prices FTCs pay to enterprises for exports. In the price hierarchies, enterprises export- ing directly to other provinces receive the highest price on domestic sales, the next highest on their own direct-export price abroad and the lowest price on exports through the FTC. In Jiangsu, export prices received by enterprises are some 10 percent below the corresponding domestic prices, a difference that inhibits exports and efficiency.18/ To offset enterprises' loss on exports, higher prices must be charged on domestic sales. In addition, in setting procurement prices, FTCs in Jiangsu (and elsewhere) subsidize high- cost exports at the expense of low-cost exports. Because under the contract responsibility system any losses on procurement and sales of high-cost exports must be offset by profits on low-cost exports, FTCs use their monopsony power to enforce export purchases from enterprises and sectors with low production costs. The implication is that low-cost goods are exported in below-optimal quantities while the opposite is true of high-cost exports. Considering 17/ If the central government's objective is to raise a certain amount of foreign exchange or to target certain industries for exports, the optimal structure of retention rates across commodities will not be uniform. Determining the optimal structure, however, requires the kind of informa- tion that is difficult to obtain for even advanced industrial countries. 18/ See JPPEC paper "Foreign Economic Relations and Trade of Jiangsu: 1983-88", September 1990.  - 34 - Jiangsu's ambitious export plans, the province needs to examine how best to eliminate the export disincentive implicit in this price and procurement structure. 2.39 Inefficiencies arising out of this export pricing system will be largely eliminated if the export procurement system is reformed along the lines suggested below. If the procurement system is nct reformed, however, reforms of export pricing policies will be beneficial. One simple change would go a long way toward promoting efficiency and improving welfare: nar- rowing the difference between domestic and exports prices for the same commod- ity. If the domestic price of a commodity is higher than the export price, the marginal benefit from domestic consumption is higher than that from exporting. The opposite is true when the domestic price is lower than the export price. Jiangsu should make export procurement prices competitive with domestic prices and phase out exporting items that can be sold only at a loss. 2.40 Reforming FTCs. The FTCs' monopsony power over enterprises, espe- cially for quota exports, is an area that deserves attention in this context. Even if enterprises are required to export a certain quantity of goods. there is no reason to require those exports to go through a particular FTC. Allow- ing enterprises to choose from among all FTCs exporting the same commodity at least within the province will heighten competition. For example, after the export quota has been determined, enterprises under Nanjing municipality should be allowed to export textiles through Jiangsu's provincial textile FTC or textile FTCs in other cities of the province. Jiangsu should encourage competition between FTCs within Jiangsu (cross-sectoral and regional) as well as between its own FTCs and FTCs in other provinces. To the extent that the non-Jiangsu provincial FTCs take business from Jiangsu's firms (or vice versa), a corresponding change in the retention system may be called for. 2.41 Direct Export and Import Rights. China encourages provinces to grant direct export and import rights for nonlicensed (Category 3) goods to qualified enterprises and enterprise groups that export Y 10 million or more annually through FTCs. The province must also be satisfied with the person- nel's qualifications in the area of direct trading. Within three years of receiving export rights, enterprise's direct exports must reach at least Y 3 million (revised recently from Y 5 million). Otherwise, the right to trade directly can be withdrawn. These enterprises have the same retention rights as other enterprises in the industry, i.e., they share foreign exchange with the FTCs even though they do not use their services. 2.42 Two types of enterprises have DERs in Jiangsu. One group receives its rights to trade directly from Jiangsu on criteria from the center. The 27 such enterprises and business groups in Jiangsu exported $80 million worth of goods (3.3 percent of provincial exports) in 1989. The other group includes center-designated enterprises such as Nanjing Radio Import-Export Corporation and Nanjing Automobile Import-Export Corporation. These corporations, all members of PNEs, can retain 100 percent of their foreign exchange. Although, DER-enterprises account for less than 5 percent of Jiangsu's total exports, they may become important instruments of foreign trade growth. 2.43 Jiangsu's expansion of direct export and import rights is strongly to be recommended. Though an extremely important policy development, these direct rights for firms are an underexploited instrument in two respects.  - 35 - First, the rights are being conferred very selectively. The failure to ful- fill export contracts by unreliable firms that manage to get direct trade rights may undermine the reputation of more reliable exporters, but the cur- rent approach seems too conservative. A more rapid expansion would enable more firms to establish direct contacts with their customers. Also recommen- ded is the expansion of the business scope of firms with DERs. Firms that have the right to trade directly can only export their own products and import raw materials for their own use. They should also be allo-qed to export other firms' products and import raw materials for them. Reputation-conscious firms will export only high-quality products for smaller firms, especially TVEs, that cannot afford their own marketing network. This arrangement could only enhance an exporting firm's reputation in world markets. At the same time, competition will force FTCs to scour foreign markets to get the highest export prices an(i lowest imports prices for their clients. Jiangsu should develop "direct trading firms" into a serious alternative to FTCs over the long term. 2.44 With less than 5 percent of Jiangsu's exports transacted under the "agency system," the system has made little headway in Jiangsu as in the rest of China. Thus, FTCs bring in almost all imports on a commission basis. This means that any domestic currency devaluation immediately raises the import price in Jiangsu, as for example in December 1989 and November 1990. The export price can, by contrast, be almost completely insulated from devalua- tion.19/ In reforming FTCs, an expansion of the agency system for exports is the most important recommendation. Jiangsu could make this policy change within central guidelines. The contract responsibility system now requires FTCs to show a profit only on overall export transactions, not on each commod- ity. This means that FTCs can engage in an economically inefficient, complex cross-subsidization of various activities. The cross-subsidization will be controlled automatically when the agency system is introduced for exports. 2.45 Recent Developments. At the beginning of 1991, the central govern- ment introduced important changes to China's foreign trade regime. The reforms cover two main aspects: (i) the adoption of a new formula for allo- cating export retention rights; and (ii) the extension of the self-responsi- bility system for profits and losses to FTCs, meaning that from 1991 on the budget will not absorb their losses, nor pay direct export subsidies. 2.46 From the previous system (see paras. 2.28-2.37) under which reten- tion rights varied across regions, the authorities moved to one in which uni- form retention rates are applied across regions for any given commodity cate- gory. In addition, as discussed below, the new system enhances the role of the exchange rate determined in the Foreign Exchange Adjustment Centers (FEACs). 2.47 Under the new system, retention rights are initially allocated in the following way: (i) 20 percent of the foreign exchange retention rights resulting from the export of ordinary commodities shall be turned to the cen- tral government at the official exchange rate; (ii) local governments can keep retention rights equivalent to 10 percent of the export value; (iii) enter- 19/ To the extent retention rights can be sold in FEACs at a market-clearing price, exporters will experience a price increase, but retention rights of enterprises are limited.  - 36 - prises (exporters) can also keep retention rights equivalent to 10 percent of the export value; while, (iv) FTCs can initially keep retention rights for the remaining 60 percent of export value. 2.48 The initial allocation of retention rights is modified by a second round of transactions between the central government and the initial recipient of the export rights: the central government purchases 20 and 10 percentage points--equivalent of retention rights from FTCs and exporting enterprises, respectively, at the foreign exchange rate prevailing in the FEACs. As a result., the final allocation of retention rights among the different agents and levels of government is as follows: (i) central government: 50 percent of total retention rights (20 purchased at the official exchange rate and 30 at the FEAC exchange rate); (ii) local governments keep 10 percent of total retention rights; (iii) exporters are left without retention rights (0 per- cent); and, finally, (iv) FTCs keep 40 percent of total retention rights. 2.49 While, in principle, the new system--combined with a more integrated foreign exchange market at the national level 20/--is more transparent and corrects previous regional inequities, it is still rather complex. By leaving a larger share of export rights to the central government, it might lead, potentially, to a tighter control over the foreign exchange rate in the FEACs. Secondly, export enterprises continue to receive too small a share of the benefits of FEAC rate transactions, while FTCs receive too large an alloca- tion. 2.50 Finally, while the authorities have announced, at the national level, that FTCs will be strictly accountable for their profits and losses, the acid test will come when some of the loss-making FTCs will be forced to close. Given the diversity of local interests, locally-owned FTCs may be bailed out by the various levels of government eager to receive retention rights. However, it is too early to pass any judgment on this issue. 2.51 Conclusion. Jiangsu's exports are generally governed by the rules laid down by the center. Although, the province has few direct policy levers to influence trade flows, it does have indirect influence through implementa- tion. For example, the center sets mandatory targets or export quotas for only certain items or limited volumes. Jiangsu, however, can make contracts between FTCs and enterprises for binding indicative and market adjustable targets. Similarly, despite the national trade associations, Jiangsu's FTCs seem to exercise their monopsony power when setting export prices, often below the corresponding domestic prices. Within state guidelines, provinces can confer rights to trade directly upon enterprises and enterprise groups. To the extent possible, Jiangsu should aggressively pursue these reform of direct trade rights. The province could also speed up its implementation of the agency system. Finally, Jiangsu should use whatever freedom it has in setting prices to reduce the export and domestic prices differentials. 20/ Under the new regulations, enterprises and individuals can buy and sell export/import rights in the FEAC of their choice. Previously, such sales and purchases had to be made in designated FEACs, leading to a relatively wide dispersion of exchange rates in the various FEACs.  - 37 _ C. Foreign Direct Investment in Jiangsu 2.52 Unlike some other coastal provinces, Jiangsu was slow to attract foreign direct investment (FDI) under China's "open door" policy. This is reflected in low shares of national totals of number of joint ventures approved (4.2 percent), value of pledged capital (5.8 percent), and actual investment (1.6 percent), relative to Jiangsu's share of national GVIAO (10.6 percent). However, FDI in Jiangsu has grown sharply since 1986, reach- ing $46 million in 1987 and $103 million in 1988.21/ Most FDI projects in Jiangsu involve investments of less than $1 million and are concentrated in light industry, textiles, and clothing. The few large projects include investments in the pharmaceutical, chemical, and electronics subsectors and two hotel projects. Jiangsu's joint ventures contributed 2.1 percent of the province's exports in 1989, whereas for all China foreign-invested enterprises contributed about 13 percent of exports in 1989. 2.53 Jiangsu's objectives in encouraging FDI include its potential posi- tive effect on total investment, transfer of technology and managerial skills, product quality and foreign exchange. For the foreign investor, Jiangsu offers relatively low cost skilled labor, proximity to the Pacific Rim coun- tries and access to a large domestic Chinese market. Table 2.3: THE REGIONAL DISTRIBUTION OF FOREIGN DIRECT INVESTMENT IN CHINA (amount actually Invested, I billion, 1979-87) Province/ Share of Province/ Share of Municipality Amount Total (S) Municipality Amount Total (X) Guangdong 31.12 67.2 Guangxi 1.22 2.2 of which: Shenzhen (18.99) 34.9 Sheenxi 1.22 2.2 Guangzhou (4.82) (8.9). Jiangsu 0.89 1.6 Zhutai (4.82) (8.9) Zhejiang 0.68 1.2 Beijing 6.40 11.8 Shandong 0.68 1.0 Shanghai 8.66 6.7 Sichuan 0.48 0.8 Fujian 3.00 6.6 Tianjin 1.61 2.8 Others 2.84 4.3 Liaoning 1.46 2.7 --- --- of which: Dalian (0. 90) (1.7) Total 6.44 100 Source: Almanac for Foreign Economic Relations and Trade, 1988. 2.54 Under the guidelines of the State Council statement of October 1986, Jiangsu can promote FDI by utilizing instruments within its discretionary control.22/ Incentives used by Jiangsu include exemption from local income 21/ This growth must be seen itl the larger context where global FDI in dev- eloping countries has declined from 25 percent in 1987 to 13 percent in 1988. See China: Direct Foreign Investment, World Bank Mimeo, October 1990. 22/ Jiangsu province, and 11 municipalities controlled by the province such as Nanjing and Wuxi, can approve productive FDI supported by the state up to $30 million (increased from $5 million in 1988).  - 38 - tax and land use fee for specified periods, concessional tax treatment for a further period, priority allocation of water and electricity at plan prices, exemption from certain fees and subsidy payments to workers. The incentives are particularly favorable to FDI engaged in export production or which employ advanced technology. 2.55 The low, though growing, level of FDI in Jiangsu reflects the late start as well as the fact that tourism related FDI projects have not been emphasized by the province. By contrast, over 41 percent of total FDI in China between 1978-88 was in luxury hotels, taxi services, and tourist facili- ties. The recent increase in the volume of FDI in Jiangsu suggests that muni- cipal and county governments have improved approval procedures and success- fully attracted small investors from Taiwan (China) and Hong Kong. However, Jiangsu's lack of success in establishing higher value, technologically advanced FDI suggests that provincial FDI policies and procedures may need to be improved. Recommendations 2.56 In order to compete effectively against other countries and prov- inces for a limited supply of global FDI, Jiangsu has to sharpen its self- promotion to make foreign investors aware of its features. The provincial government has a natural role in facilitating the flow of information both about Jiangsu to potential investors and vice versa. Improving business sup- port services (market research, legal counselling, etc.) will enable investors to obtain more reliable feasibility studies.23/ Malaysia and Singapore have used central investment promotion agencies to contact potential invest- ors, provide information and shepherd projects through to completion. Jiangsu should consider a similar "one window" agency which facilitates information exchange and simplifies the process for FDIs. 'Cutting red tape' often does more than the incentives themselves to increase investment flows. In addi- tion, FDI enterprises should not be subject to arbitrary levies and taxes or to administrative interventions in their day-to-day operations. Such inter- ventions undermine the development of long-term investor confidence, in addi- tion to raising direct costs. While Jiangsu uses administered allocation of key inputs as an important tool for encouraging foreign investment, these pri- ority allocations are so widely employed that in many situations FDI enter- prises have trouble obtaining key inputs.24/ A long-term policy of replac- ing administered allocations with market-guided allocations will reduce this uncertainty and improve the investment climate. 2.57 Targeting High-Technology FDI. Jiangsu's development plans place heavy emphasis on acquisition of advanced technology, best done through direct foreign investment. Central to this policy should be the realization that output of such advanced technology projects will not be exportable for some 23/ Current practice has been characterized as producing "approvability' studies rather than a realistic economic analysis of project feasibility. 24/ The 1986 policy document underlines priority allocation of power, water, etc., for foreign invested enterprises. The recent Coca-Cola project in Nanjing was set up at a time when power was in short supply and involved a guarantee of supply.  - 39 - time.25/ Successful technology transfer requires care in selecting the right partner. An FDI promotion agency could expedite direct contacts between leading enterprises seeking foreign technology and suppliers of such technol- ogy to enable a suitable match. To persuade foreign investors to share new technologies, attractive domestic market access might be of'.ered. D. Education and Training: Issues and Policy Recommendations 2.58 Employment Structure. Industrial growth (including industrial TVEs) in Jiangsu has led to a major shift in employment from agriculture into non- agricultural activities. Employment in agriculture dropped 23 percentage points (from 70 percent to 47 percent) while industry's share rose by 11 per- centage points (from 18 percent to 29 percent) between 1978 and 1989.26/ Employment in the tertiary sector (public administration, personal and pro- ducer services, and retail trade) increased from 13 percent to 24 percent of total employment. These shifts parallel the experience of Korea and Taiwan (China).27/ With respect to ownership forms, the bulk of urban employment (60 percent in 1988) is in SOEs (compared with a national average of 75 per- cent), with 38 percent in collectives (collectives have a 25 percent employ- ment share at the national level) and 2 percent in the private sector. 2.59 Unlike other areas of China, and in spite of its high population density, the advanced and rapidly growing southern part of Jiangsu Province had marked labor shortages prior to the 1989 slump. The shortages were pri- marily in three categories: manual laborers to carry out unpleasant, tedious, and dangerous tasks; highly-skilled scientific and technical experts to engage in R&D and disseminate know-how; and entrepreneurs, to organize both factors of production into profitable businesses and the necessary marketing networks. Rural enterprises continued to have difficulties in attracting entrepreneurs, managers, and marketing experts. The labor shortages in many villages became acute, as vast numbers of able-bodied peasants left their contract lands to seek higher earnings in booming TVCEs. Drawn by opportunities to farm these discarded croplands and to work at TVCEs, low-wage migrant peasants came in droves from surrounding poorer rural areas, northern Jiangsu, and even across the provincial boundary. In the urban areas, enterprises recruited peasants as "outside plan workers" to cope with the shortage of unskilled labor. 2.60 As noted earlier, the growth of the urban labor force in the coming decade will require attention to sectors which can absorb the additional labor. The tertiary sector is relatively underdeveloped in Jiangsu and its targeted growth from 20 to 25 percent of GDP by 1995 is expected to provide employment for one third of the estimated 3.4 million growth in urban labor 25/ Jiangsu's objective of achieving 5 percent of total exports from 'new technology" industries may therefore be unrealistic. 26/ At the national level, agricultural employment decreased by 12 percentage points and industrial employment increased 4 percentage points in the period of 1978 to 1989. 27/ Where nonagricultural employment rose from 49 percent to 66 percent and from 63 percent to 78 percent of total employment between 1970 and 1980, respectively.  - 40 - force in Jiangsu during the 8FYP. However, policies to spur the rapid growth of the service sector have received relatively little attention. Eliminating barriers to entry for private enterprises, facilitating licensing processes and providing access to institutional credit (at market rates and not subsi- dized rates) will enable the growth of this sector and accompanying labor absorption. 2.61 While employment issues deserve the province's continued attention, this report focuses on the relatively narrow issue of labor skills and train- ing. The China-wide decentralization of financial and administrative respon- sibilities has favored labor training based on local economic requirements and support, and Jiangsu has made notable progress toward the establishment of an effective education system needed for economic development and the diffusion of new technologies. Extra resources may, however, be needed to mitigate the widening disparities between rich and poor localities in Jiangsu. A shortage of qualified teachers (Appendix Table 2.18) and slow implementation of the nine-year basic education will jeopardize worker adaptability to Jiangsu's proposed technological improvements during the 8FYP.28/ A policy of expanding the scope of general education while using on-the-job training to "retool" workers for changing skill requirements is advisable as Jiangsu's industries incorporate technical advances. Enrollment in technical/vocational schools should be responsive to industrial demand rather than be administra- tively determined. 2.62 Education Financing. Public funds for education are raised and allocated by local government. Some 66 percent of provincial recurrent expen- diture goes for primary and secondary schools, and 12.8 percent to higher education. A major problem in Jiangsu is the shortage of education funds. The decentralization of financial and administrative responsibilities was intended to permit human capital formation based on local requirements; how- ever, the reliance on local funds has also raised the concern of limited bud- getary resources. To address this, local governments raise additional local extrabudgetary revenue for education, levies such as a 2 percent education surcharge on a portion of TVCE profits and peasant net income, and a 2 percent surcharge on major indirect taxes.29/ For vocational and technical educa- tion, financial support comes primarily from the local government budget, while some enterprises make a substantial contribution for short-term train- ing. Provincial funds help to mitigate the widening disparities in the provi- sion of education services between rich and poor localities. The challenge is to identify the investments that would provide the highest social return. The most urgent needs identified by the Jiangsu Education Bureau are in three areas: enhancement of teacher qualifications, implementation of nine-year compulsory education, and improvement of technical and vocational education. 28/ Under the central guideline of gradual introduction of nine-year compul- sory education across China, Jiangsu province, in accordance with the financial capacity of different localities, legislated its target goal of implementing the nine-year compulsory system in developed areas by 1992, and expanding the system to areas with a medium level of development by 1995. 29/ This surcharge has been included as a budgetary item since August 1990.  - 41 - 2.63 Teacher Qualifications and Supply. Teacher qualification in Jiangsu is a major issue, as in the rest of China. The first priority of the teacher training program in Jiangsu is to supplement the inadequate education of unqualified teachers and to increase the number of teachers up to qualifica- tion standards.30/ Ensuring adequate teacher supply to the needed educa- tion levels and fields is also essential. The Jiangsu Education Bureau esti- mates that the existing and planned training will basically meet the demand of student enrollment at primary and upper secondary levels of education. The shortage of teachers will be at the lower secondary level. 2.64 General Education and Technical/Vocational Training. General educa- tion, which is a foundation for both technical/vocational programs and the adaptability of workers, should be specially emphasized as a principle in Jiangsu. The enrollment of technical/vocational schools should be determined by market demand rather than to aim at an arbitrarily determined enrollment target. It is also important for technical/vocational schools to maintain constant contact with all employers to best meet employment needs and to design programs that adapt to changes in demand. Decentralization of enroll- ment plan and curriculum design and internship assignment 31/ are essential to accomplish this approach. 2.65 However, the current enrollment in technical/vocational schools in Jiangsu complies with central guidelines and incurs loss of economies of scale in utilizing teachers and equipment (Appendix Table 2.19). Constrained by enrollment guidelines and limited local budgets, programs of technical/voca- tional education should be more diverse with greater effort devoted to short- term training courses for primary and lower secondary school leavers. Jiangsu's emphasis on short-term pre-service vocational training is a step in the right direction.321 For vocational programs at the upper secondary level, where there the rate of return is generally higher, policy should emphasize using centralized facilities. In this connection, establishment of larger,33/ enterprise linked, educational institutions in populated areas is recommended. 2.66 Entrepreneurial, managerial, marketing and accounting training should be emphasized. These scarce skills are needed to organize factors of production into profitable business. Apprenticeships in managerial work in more developed cities may be an effective strategy to compensate for the shortage of entrepreneurship in the backward areas. 30/ There is a systematic effort to convert unqualified (minban) teachers into qualified (gongban) status; however, this conversion has been tempo- rarily suspended in 1990. 31/ Internship assignments are integral components of all school-based and employer-based technical/vocational programs and a part of the pre-ser- vice vocational training of regular secondary school leavers in Jiangsu. 32/ Huaiyin City started the program in 1984; 80 percent of new labor now has pre-service training. 33/ The average school size was 699 for "STS," 314 for "SWS,"' and 417 for agriculture "SVS" in Jiangsu in 1989. In the United States, unit cost is reported at minimum for schools of 1,000 to 2,000 students.  - 42 - 2.67 On-the-Job Training. On-the-job training should be encouraged as it is a cheaper and more effective way to upgrade workers' skills.34/ Because technological advancement is emphasized in Jiangsu's 8FYP, on-the-job training also provides an opportunity to introduce up-to-date technologies into the work place. To facilitate this, Jiangsu should address the shortcomings in the present system, including the fact that it is difficult for enterprises to replace the absent trainee, the very high tuition costs paid to large enter- prises or "SWS,"35/ and the unwillingness, for fear of possible competi- tion, to transfer know-how by large enterprises. 2.68 TraininR and Skill Transfer in the Rural Areas. Primary school dropouts occur primarily in the rural areas because of the indirect cost of compulsory schooling to families. Children in backward northern rural areas participate in farm work and household chores at an early age. The school dropout rate (5 percent) is much higher than the provincial average (1.3 per- cent). In advanced areas, children engage in non-agricultural rural activi- ties to contribute to household income. Jiangsu has taken appropriate mea- sures to safeguard basic education through school holidays and changes in the school schedule during agricultural peak seasons and by prohibiting all enter- prises to employ child labor. 2.69 Formal training and skill upgrading has been emphasized in the cit- ies, but specialization has increased in agriculture as a result of the responsibility system. Agricultural technical/vocational training deserves more attention in the rural areas. Complementary short-term skill training, currently provided by the rural adult education centers at township level, is an appropriate institutional setting for fostering rural household economy. 2.70 One of the drawbacks of TVCE development is the existing pool of unskilled workers; only 2 percent have had specialized training. TVCEs rely on restricted import of high-quality urban labor, and limited inflows of retirees or returning migrants to bring technical, marketing, and other skills to rural areas. Skill acquisition by TVCE workers could also be attained by arrangements whereby large "parent" enterprises provide training for smaller enterprises that are related to them in their production process. The TVE Bureau might consider coordinating with the Labor Bureau to extend on-the-job training requirements to TVCEs. In the short run, TVCEs must continue to depend on limited flow of quality labor from cities to village, but in the long term, planning is needed to upgrade the quality of rural industrial work- ers through formal education and training programs. 2.71 Another means of diffusing technology and skills would be by encour- aging highly skilled labor and entrepreneurs to provide consulting and advis- ory services in rural areas. To do so, entrepreneurs must be paid at competi- tive rates with their potential earnings in more developed areas, and their transportation and moving costs should also be subsidized. 34/ As of 1990, 28.5 percent of 6.5 million workers in state and collective enterprises in Jiangsu have received on-the-job training. 35/ The tuition ranges from Y 100 to Y 300 per training session per worker in Huaiyin City.  - 43 - III. RUTRAL INDUSTRIALIZATION IN JIANGSU Introduction 3.1 The rapid growth of rural nonstate (collective and private) industry is the most remarkable aspect of Jiangsu's recent economic development. The reforms of 1978--decollectivization of agriculture, devolution of many deci- sions to local governments, etc.--enabled Jiangsu to evolve new forms of rural industrial organization. It should be recalled that rural industries were common in Jiangsu before 1978, driven by the pressure of population on limited agricultural resources,l/ as well as policy directives (the Great Leap For- ward in 1958 and the emphasis on agricultural mechanization in 1970). Never- theless, the post-1978 growth in township and village community enterprises (TVCEs) reflects both a qualitative as well as a quantitative shift in rural industrialization in Jiangsu.2/ The output of this sector grew at more than 32 percent per annum over 1978-87 and by 1990 its share of provincial GVIO was 45.3 percent, while Jiangsu's industrial TVEs generated almost 19 percent of national output of TVEs. The TVCE sector in Jiangsu is now the primary source of rural income and its growth has raised provincial per capita GDP to a level that is 33 percent over the national average. Furthermore, TVCEs accounted for more than a third of goods procured for export and for almost one-fourth of Jiangsu's tax revenues in 1990. A. TVCE Sector Development and Recent Performance in Jiangsu 3.2 The introduction of the production responsibility system in agricul- ture and increased procurement prices allowed Jiangsu, endowed with fertile agricultural land, to sharply increase agricultural incomes and savings, thereby creating the surplus for investment in rural industries. The growth of these industries was actively pron)oted by local governments and enabled by the availability of skilled workers (including some retired from SOEs) as well as good transport connections, especially between southbrn Jiangsu and Shanghai. 3.3 Ownership. TVCEs in southern Jiangsu have evolved with a number of distinctive characteristics less common in other provinces such as Guangdong, where a different, mostly private variety of TVEs has been extremely success- 1/ Arable land per member of China's rural population dropped from 2.39 mu to 1.85 mu in the twenty-five years between 1952 and 1977. In Wuxi, with an above average density, arable land per person declined proportionally even more from 2.52 mu to 1.27 mu over the same period. By the end of 1990, cultivable land per capita was only 1.01 mu for the province as a whole. See Du Haiyan, "Causes of Rapid Rural Industrial Development," in China's Rural Industry, op. cit. 2/ There are some ambiguities in the definition of the sector, but the broadest definition encompasses all nonagricultural activities in rural areas and small towns other than those on state farms. Enterprises owned by community governments, the prevailing form of ownership in Jiangsu, are referred to as TVCEs. See W. Byrd and Lin Qingsong, China's Rural Industry: Structure, Development, and Reform, Oxford Univ. Press, 1990.  - 44 - ful.3/ In the pattern of development followed in southern Jiangsu, known as the Wuxi or Southern Jiangsu model, the township government "grandfathers" TVCEs at the three administrative levels: township, village, and below- village.4/ The township government, either directly or through its township industrial corporation (TIC), exercises tight control over production, borrow- ing, investment, labor allocation, and other managerial decisions by enter- prises (particularly labor allocation, wage determination, and distribution of profits), while leaving their managers considerable day-to-day autonomy. The Jiangsu authorities have repeatedly stated that rural industry has been put on "five wheels"--since the addition of private household and production team firms--on an equal footing with the township, village, and county levels. In practice, however, the first two types of firms have been explicitly or impli- citly discouraged in southern Jiangsu and the supremacy of the TVCEs has been maintained over other forms of organization and ownership. The township gov- ernment has continued to provide direct political and economic support for the local TVCE development keeping higher levels of government at bay.5/ This ownership model also economized on transaction costs in an environment where communal governments control land, labor, basic raw materials, and financial resources. The communal form of pooling resources to finance new investments also minimized the risks assumed by individuals in an area where wider disper- sion of individual gain was poorly tolerated. These community links, while in many ways a source of strength and stability, imposed limits to enterprise size, and have virtually ruled out enterprise relocation or cross-community mergers.6/ 3.4 Industrial Specialization. Almost 90 percent of the Gross Value of Output (GVO) generated by Jiangsu's TVCEs comes from industrial activities, and industrial TVCEs employ 80 percent of the TVCE labor force, compared with a national average of 73 percent and 60 percent, respectively (Appendix Table 3.1). Far behind industrial TVCEs comes the construction sector, which gener- ated 7 percent of TVCE GVO and employed slightly more than 10 percent of TVCE workers in Jiangsu, compared to 10.8 percent and 16 percent, respectively, at the national level. 3.5 Jiangsu's industrial TVCEs are relatively specialized by subsector. About three quarters of TVCEs' industrial output comes from four subsectors: machine building, textiles, chemicals and building materials (Appendix Table 3.2). Machine building is the most important industrial activity in southern 3/ While privately-owned TVEs have grown very rapidly in Guangdong, still about two-thirds of the sector's GVIO is produced by community-owned enterprises. 4/ See Luo Xiaopeng, "Ownership and Status Stratification," in China's Rural Industry, op. cit., pp. 134-171. 5/ A 1989 World Bank Report pointed that "the lack of "mothers-in-law" for TVEs outside the local community may be a major factor in their success." IBRD, China- Rural Industry: Overview, Issues and Prospects, Report No. 7267-CHA, March 1, 1989, p. 39. 6/ See A. Ody, 'China: Rural Enterprise, Rural Industry, 1986-90," World Bank, mimeo, January 4, 1991.  - 45 - and mid-Jiangsu, generating about one third of the GVIO. Next comes the tex- tile industry, responsible for more than one fourth of the GVIO in the south and one sixth in mid-Jiangsu. In northern Jiangsu's economy, building materi- als is the predominant industrial activity, mainly extracting yellow sand and brick and cement manufacturers (Appendix Table 3.3). 3.6 Geographical Concentration. TVCEs' GVIO is concentrated in southern Jiangsu, and about 62 percent of it is generated in three southern municipali- ties near Shanghai, with less than 21 percent of Jiangsu's population. Only 10 percent of the TVCEs' GVIO comes from the poorer, more agricultural, north- ern counties with almost 45 percent of Jiangsu's population. The higher degree of industrialization and concentration of TVCEs is closely correlated with a higher GDP and income per capita. GDP per capita in the southern part of the province is almost three times as high as in the four northern counties (Appendix Table 3.4). 3.7 Agriculture. TVCEs depended heavily on financial support from agri- culture and suLplus farm labor in the early phase of development. Since the mid-1980s, the role has been reversed and part of TVCE profits have been used to subsidize agricultural prices (especially in more industrially developed southern Jiangsu), to stimulate agricultural production by mechanization, and to finance rural infrastructure. Jiangsu's TVCEs currently pay a Y 120 to Y 180 head-tax per worker to promote agricultural modernization. 3.8 Exports. Jiangsu exported some $2.4 billion in 1989, 50 percent of it from the 3,800 TVCEs engaged in foreign trade. Most exports came from the largest TVCEs in southern Jiangsu (only 120 TVCEs had exports in excess of Y 10 million in 1989), where TVCEs generated up to 85 percent of the export revenues of some counties. The greater profitability of domestic sales over exports and the lack of direct export rights both inhibit export performance and must be addressed (see Chapter II). Increased competition in the domestic market (from other TVCEs, as well as SOEs) and saturation of some traditional product lines (textiles) is forcing these enterprises to increase their out- ward orientation. 3.9 Cyclical Growth. TVCEs tend to be vulnerable to economic cycles. During the 1980s, TVCEs experienced two full business-cycles. First, Jiangsu's TVCEs suffered a marked slowdown in 1981 and 1982, when real GVIO grew by 14 percent and 6.7 percent, respectively. Adjustment policies in the machine-building industry resulted in large cutbacks in state investment, which reduced direct orders for machinery and equipment and TVCES' subcon- tracting work with SOEs.7/ A restructured product mix emerged from the slowdown, and production moved away from heavy industrial machines into tex- tiles, light industrial machinery, and consumer durables. The second cycle is concluding now. After average real output growth of 35 percent a year in 1986-88, Jiangsu's TVCEs grew only 2.4 percent in 1989. During the second half of 1990, real growth had climbed to about 8 percent, recovering faster than SOEs (2 percent). For 1990 as a whole, TVCEs' GVIO grew by 14.3 percent, while SOEs' output only advanced by 7.6 percent. 7/ See Christine P.W. Wong, "The Development of Township and Village Enter- prises in Wuxi County," mimeo, January, 1987.  - 46 - 3.10 Number of TVCEs. Between 1987-89, the number of TVCEs in Jiangsu (above village level and excluding individual household enterprises) dropped by some 6,616 enterprises (Appendix Table 3.5). This decline started in Jiangsu in 1988, a year ahead of the decline at the national level, suggesting that Jiangsu's TVCEs were already experiencing difficulties before the 1989 austerity program. Of the 1,782 TVCEs shut down or merged in 1989, 1,104 were in light industry and 678 in heavy industry.8/ Four main reasons were behind the difficulties of industrial TVCEs: lack of financial resources; increasing market saturation; heavy taxation; and stronger competition from SOEs in a number of important industrial subsectors. Jiangsu was not unique, but the contraction of its TVCE sector in 1989 was more pronounced than at the national level, while they also seemed to have recovered faster in 1990 com- pared to the national average. Stricter enforcement of pollution standards and energy conservation measures may also explain this contraction. 3.11 Employment. Jiangsu's TVCEs on average are almost twice as large as the national mean, with almost 60 employees compared to less than thirty for the nation. Within Jiangsu, an average township-owned TVCE employed 108 work- ers in 1989; an average village-owned TVCE had 37 workers. TVCEs employed 6.9 million workers in 1989, 21 percent of the provincial labor force against a national figure of 9 percent. About 56 percent of these workers were employed in township entetprises, 44 percent by village-owned enterprises. Industrial TVCEs occupied about 86 percent of the TVCE labor force, followed far behind by TVCEs in the construction sector. The slowdown of the economy in 1989 caused TVCE employment in Jiangsu to fall by 6.3 percent in 1989 (Appendix Table 3.5), a fourth of the national job loss in the TVCE sector. Employment fell more in township-owned than village-owned TVCEs in 1989. 3.12 Financial Performance of TVCEs in Jiangsu. Despite the headstart advantage of Jiangsu's TVCE sector, its recent growth has tended to lag behind the growth rates of the TVCE sector in a number of other provinces, as well as the national average. Thus, in the 1986-89 period, industrial output of TVCEs in Jiangsu grew by 122 percent, below the national average of 147 percent and far below Shandong (248 percent) or Guangdong (195 percent) (see Table 3.1). 3.13 While TVCEs nationwide display a secular decline in indices of prof- itability, the TVCEs in Jiangsu (and Zhejiang) have reached dramatically low levels of net profitability. The decline of gross profit indicators in Jiangsu reflects, in part, increased competition in product markets, but may also be due to increased wage payments (as enterprises attempt to avoid profit taxes), as well as stricter enforcement of pollution controls. The decline, as well as the low level, of net profitability, on the other hand, seems to be largely explained by the high and rising level of taxation of TVCEs in Jiangsu. According to the classification system in China's statistical year- books, in 1986, the average effective tax rate on TVCEs in Jiangsu was 64 per- cent, almost 40 percent higher than the national average. According to the same source, in 1989, the Jiangsu average tax rate on TVCEs was 75 percent, 8/ Although it should be noted that there were about 1,000 new entrants in 1989.  - 47 - Table 3.1: TVCE INDUSTRIAL OUTPUT GROWTH, 1986-89 Percent growth, 1986-89 National 147.2 Jiangsu 122.1 Shandong 248.3 Guangdong (including Hainan) 194.8 Henan 165.6 Hebei 146.5 Zhejiang 116.1 Fujian 149.5 Source: China: Rural Enterprises, Rural Industry, 1986-90. 41 percent higher than the national average.9/ By contrast, provinces such as Shandong and Guangdong have average effective tax rates of approximately 40 percent, allowing the TVCE sector to expand at much higher rates than TVCEs in Jiangsu (see Table 3.2). These figures should be interpreted with a great deal of caution, since they might show not only income taxes paid (less than 18 percent of total taxes paid by TVCEs in 1989) and other taxes, fees and levies, but also profits transferred to local governments and TICs to be real- located among the various enterprises. One hypothesis would be that these figures capture 'gross transfers" (including taxes) to TICs, which would be reallocated to TVCEs in a "closed capital market,' presumably to their more profitable uses. If this hypothesis is true, the dispersion across provinces will be more an indication of the higher degree of intervention of the local authorities in Jiangsu compared, for example, with Guangdong. Nonetheless, to the extent that funds are siphoned away from TVCEs to other uses, the argument of low retention of after-tax profits at the enterprise level as a factor limiting investment and future growth continues to be valid. 3.14 Effective tax rates on TVCEs, as defined above, in Jiangsu are, on average, as much as 20 percentage points higher than on SOEs. 'While it is not possible to obtain a breakdown of the different taxes levied on TVCEs, it is apparent that enterprise income taxes constitute only a part of the total. Discriminatory treatment of TVCEs under the enterprise income tax in Jiangsu is one reason for the high effective tax rate. TVCEs, unlike SOEs, cannot deduct loan repayments in determining taxable profit so that the same nominal tax rate translates into a higher effective tax rate on TVCEs. The same effect is created by defining a lower profit threshold for TVCEs at which the top tax rate of 55 percent applies. In addition, TVCEs in Jiangsu are subject to ad hoc levies and forced transfers to agriculture which also tend to depress net profits. 9/ These figures were obtained from China: Statistical Yearbook, 1990 (see Table 9.57, p. 383), calculated as the ratio of total taxes over total taxes plus after-tax profits.  - 48 - Table 8.2: FINANCIAL PERFORMANCE OF TVCE SECTOR, 1986-89 Oror profit Net profit Reinvest- Average Gross profit Net profit as X *s X ment so X tax as X sales as X sales fixed assets fixed assets nst profit rate La National 1986 13.4 7.2 81.6 17.0 49.8 46.0 19S9 10.6 5.0 26.7 12.5 n.s. 65.2 Jiangsu 1988 10.0 8.6 80.8 10.8 67.7 84.4 1989 7.0 1.7 20.8 6.2 n.a. 74.9 Shandong 1986 16.8 10.0 84.9 22.9 60.1 84.6 1989 11.4 8.8 29.4 17.6 n.m. 40.6 Guangdong (tncl. Heinan) 1986 11.5 7.0 27.1 18.6 46.6 88.7 1989 9.7 6.5 22.8 18.0 n.m. 48.1 Zhej ing 1988 18.6 6.7 40.7 17.0 49.2 68.1 1989 8.7 1.9 26.9 6.9 n.m. 77.9 Fujian 1986 12.8 7.7 81.1 19.0 48.7 88.9 1989 11.8 6.8 80.0 16.8 n.m. 48.9 La Total/(total taxes + after-tax profits). Source: China: Rural Enterprise, Rural Industry, 1988-90. 3.15 While this picture of egregiously high taxation of the TVCE sector in Jiangsu appears to be well founded, the effect on fiscal revenue of the government has not been correspondingly positive (see Chapter IV). This sug- gests that taxation of this sector has either exceeded a level that would maximize fiscal revenue or revenue accruals are inadequately captured by con- ventional government accounts. For example, it is not clear if the head-tax per TVCE worker is recorded as fiscal revenue of the government. It is also not apparent if and to what extent extrabudgetary accounts have garnered this revenue. What is evident is that such high rates of taxation are not condu- cive to the continued growth and financial health of the TVCE sector. 3.16 Administrative Oversight of the TVCE Sector. The General Adminis- trative Bureau for TVCEs, which represents the interests of industrial TVCEs at the national level, is under the Ministry of Agriculture. At the provin- cial level, the TVCE Bureau is under the office of one of the Vice-Governors, at the same level as other line departments. Chart 3.1 shows the organization of Jiangsu's TVCE Bureau into five functional departments, and their services. In terms of budgetary flows, TVCE bureaus also collect distributed profits and managerial fees for the township industrial corporations (TIC). Below the provincial level, the Township Planning and Economic Commission (TPEC) and the TICs are the decision-making units, acting as holding companies with local officials as the board of directors, severely limiting factory manager auton- omy. Smaller or less advanced towns and villages do not have TPECs and deci- sions are taken by the Township Governments and the TICs. By contrast, in  - 49 - southern Jiangsu TICs can be more specialized, overseeing enterprises in par- ticular industrial subsectors. TICs (Chart 3.2) are organized into six departments, five of which oversee, tax, and provide services to TVCEs. Chart 3.1: PROVINCIAL TVE BU;EAt |PROV INQCIAL TVEEUtAU| Funet on Functiocn qraoNno ze *.Mng t~~ion -9naln - rga- - Tra,in meseting for cadres. A technology A output. administretion. exchange of - Supervise planning A - Economic rsnageg;aI training supervision. efficiency. evperience programs - Quality - Accounting. -Supervise at differ- control. management ent admin- - Develop pro- of TVEs istrat;ve duction for levels. eaport. Chart 3.2 TOWNS111P INVESTMBENT CORPORATION (TIC) |TOWNSiIP COERI 4 Deputy Managers] - 1 l l l En~~~~~~~,t.rprie Aeccount i ng rechn i ca 1 Mabnagement Personne Industria l1neral Depa rtment LepaDr trent Safety Office -C.ncti, !untion Funttio ucinFeit uein - Colleoct in- - port & export s Aeemss eisle a inl formeation from procedures a/the price: - Training (in- enforce preven- functions. enterpriaes, county. - Adminietra- house) siddie- tive measure. - Col lect man- - Examine need to tive effi- school gradu- - Industrial stan- agement fee. renovate equip- ciency. etes A accoun- darda & environ- ment. - staffing tents, mental protec- _ Planning role. - Services. Vocational tion. -Financial schools (paid indicators, by TVE). quality of manegement B. The Policy Framework: Issues and Recommendations 3.17 Jiangsu's TVCE sector appears to be at a crossroads, with major challenges ahead. The first challenge is to deal with emerging problems, while preserving the incentives, dynamism, and flexibility of TVCEs. Reforms are essential to enhance the sector's efficiency and competitiveness and to reduce the heavy burden of taxes and levies now imposed on the sector. Sec- ond, new financial mechanisms, instruments, and ownership forms must be intro- duced to finance the modernization at a new, more mature, and costly stage of TVCE development. Third, new organizational reforms in government oversight bodies are needed to enhance their ability to assist TVCEs with financial and managerial challenges. Last, new policy tools must be developed to goverc. the TVCE sector in an indirect way. This means interpreting and fleshing-out at the provincial and local level, recent State Council regulations, in order to accommodate the local characteristics of TVCEs (see Annex 3).10/ This 10/ See "Regulations Governing the Rural Collective-Owned Enterprises of the PRC,' issued by the State Council. Xinhua News Agency, June 10, 1990.  - 50 - local interpretation should forestall direct administrative recentralization through mandatory planning and guidance over the sector, as a substitute to correcting price and other administrative distortions. Deficiencies in the current credit system and its treatment of TVCEs should also be addressed. 3.18 Policy Tools and Framework. While it may not be possible for the TVCE sector to continue growing at the very fast rates of the 1980s, the bluntness of the policy tools applied during the recent retrenchment program-- significant cuts in public investment and a freeze in credit to the TVCE sec- tor--had a very negative impact on TVCEs' profitability, employment, and out- put growth. Implementation of the new central legal guidelines on TVCEs and the design of the local credit and fiscal measures discussed below is within Jiangsu's jurisdiction. In addition, Jiangsu could adopt measures to reduce the impact of the business cycle on TVCEs, to diversify its productive base and market orientation. 3.19 New Legal Framework. Jiangsu is to restructure its TVCE sector within the framework established by the State Council Regulations designed to strengthen the rudimentary legal and regulatory framework and the rights of TVCEs. The restructuring is to be achieved via "guidance' by means of three (overlapping) tools: economic, administrative, and legislative (Chapter II). While the provincial and municipal authorities will not bring the TVCEs for- mally into the production plan, they have started to use mandatory and guid- ance planning to restructure TVCEs in an effort to improve their efficiency by reducing their fragmentation and duplication of industrial activities, subop- timal plant scale and location patterns, wasteful use of energy and raw mate- rials and their negative environmental impact.ll/ This approach means a possible reduction in the limited enterprise autonomy and local government leeway in managing community-owned enterprises in Jiangsu, at the expense of dynamism, flexibility, local commitment, and resilience that characterized the sector high growth period in the 1980s. On the positive side, the local implementation of the new regulations potentially offers an important opportu- nity to deal with the TVCE sector's structural problems. 3.20 Until recently, TVCEs developed more or less spontaneously under the auspices of entrepreneurial local governments. However, the debate over the future role of the sector--in the economy and in Jiangsu--has turned to the issue of leadership over the process of rural industrialization. The State Council Regulations contain a number of positive measures to strengthen the legal and regulatory framework governing community-owned TVCEs, but they also raise the worrisome specter of tighter planning and 'guidance" over most aspects of TVCEs' activities by governn.ent bodies above townships and villages (see Annex 3). This could possibly move TVCEs closer to the planning process than to a more market and profit-oriented industrial subsector. The final impact of these regulations will depend on their provincial and local imple- mentation and (probably uneven) enforcement. 11/ Many of the criticisms made on TVCEs performance as regards efficiency in utilization of energy and raw materials are misplaced, and should more appropriately be directed against the lack of competitiveness and quality of some domestic suppliers of capital goods.  - 51 - 3.21 Inadequacies of the Credit Plan. Enterprise interviews in Jiangsu pointed to the difficulties TVCEs face in obtaining credit in general and bank loans in particular (Box 3.1). Most TVCE managers ranked the lack of funds as their biggest problem. Another major deficiency in credit operations was the lack of indirect instruments as exemplified in the denial of credit to TVCEs by administrative allocation of credit, especially during the retrenchment program. Indirect instruments would have allowed the more efficient and less risky firms to bid for additional resources at higher interest rates. 3.22 The system-wide lack of longer term financing in China's credit market, the absence of a developed capital market, and the fragmentation of TVCEs ownership among local governments make it difficult to match investment projects with financing or to pool enough funds to finance larger, more effi- cient projects. Major systemic changes in the credit policy framework and in the development of financial markets and products are needed if TVCEs are to flourish. 3.23 "Fiscal Predation" and Direct Financing of Community Services. TVCEs are often asked by local governments to directly finance public expen- ditures as part of current costs, with each TVCE worker paying a head-tax of Y 120 to Y 180 to promote modernization of agriculture. In addition, TVCEs often are forced to make ad hoc tax payments to local governments, directly or through TICs. Despite repeated central government bans on excessive milk- ing of funds from rural enterprise by local governments, the burden on the enterprises has grown increasingly heavy. In one case of "fiscal predation" in northern Jiangsu, 80 percent of enterprise profits were transferred to the local government. In the early reform years. rural enterprises benefited from a variety of tax exemptions; however, all of these exemptions have already expired. In the recent past rising tax rates and rapid TVCE growth, combined with relatively stagnant revenues from most other sources (resulting from the inflexibility of the revenue contracting system) has resulted in TVCE tax payments rising substantially faster (75 percent over 1986-89) than public revenues as a whole (43 percent over 1986-89). So, TVCEs in Jiangsu carry a disproportionate fiscal burden which is hampering their future development. 3.24 Because of the lack of buoyancy in other sources of fiscal revenue, local governments in Jiangsu have targeted TVCEs as "small treasuries" or "money trees" and have subjected them to various taxes and apportioned various costs. As a result, on the average, Jiangsu's TVCEs faced tax rates that are more than 20 points higher than the national average (53 percent) and more than 30 points above the levels of Shandong and Guangdong (see Table 3.2). This rate, the second highest in the nation (after Zhejiang), left TVCEs with less than 20 percent of pretax profits for expansion. While TVCEs theoreti- cally have under the new regulation the "right to reject the imposition of quotas and illegal fines," they must also provide "financial and material assistance and manpower in accordance with state laws and statutes." These elements reinforce concern about a scarcity of retained and reinvested resources to finance the new stage of TVCE development in Jiangsu, in the face of pressures to support public investment and current expenditures, welfare of local peasants, and upstream transfer of fiscal resources. This unsystematic and ad hoc treatment of TVCEs within the fiscal system is very harmful and needs to be remedied. The contract responsibility system needs reforms in two key aspects: (i) to contract profits after taxes; and (ii) to stipulate repayment of loans with after-tax income. This reform has been adopted for  - 52 - Box 3.1: INSTITUTIONAL CREDIT TO TVCEs (1989/90) Tho rapid increase ii rural bank savings after the 1970 reforms led to a rapid growth (particularly in the mid-1980s) In the supply of funds by local bank to the TVCE swc- tor, helping to fuel the 1986 and 1988 booms. As a result of the austerity measures intro- duced sinco 1988, the People's Bank of China (POC) instructed the specialized banks (S9), at tho national level, to freeze their loans to the TVE sector at their (year-end) 1988 lovol. Rural credit cooperatives (RCCs) were subject, for the first time, to global credit ceilings.l/ Only during the last quarter of 1989, when general credit policies became again expanaive, was the nominal level of bank lending to the TVE sector allowed to rise. The "credit crunch" was particularly severe during the second and third quarters of 1989 when total bank credit was growing at annual rates between 11 percent and 12 percent. In Jiangsu, under national guidelines, bank credit to the TVCE sector remained prac- tically unchanged in nominal terms, increasing by only Y 80 million, between 1988 and 1989 while RCCs increased their loans by less than Y 1.0 billion (16.3 percent), as shown in Appendix Table 3.6. According to Jiangsu's PBC Branch, In 1989 TVEs received loans from the S3s (mainly the Agricultural Bank of China, ABC) and the (RCCs) amounting to Y 11.06 bil- lion, of which 63 percent were granted by the RCCs, the main institutional source of funds for TVEs. Out of a total 1989 loan portfolio of Y 68.9 billion, the SBs lent less then 6 percent to TVEs (compared with almost 7 percent at the national level). In addition, almost 82 percent of Jiangsu RCCs' total loans were concentrated in the TVCE sector 4/ RCCs' high concentration of loans in the TVCE sector probably results from local pressures to channel funds to TYCEs as well as their exclusion in paot years from credit plan ceil- ings. In real terms. institutional credit to TVEs remained about constant in 1988. Bank credit to Jiangsu1s TVEs grew by 19.2 percent, while the national Retail Price Index (RPI) rose by 18.6 percent. However in 1989, real credit to TVEs fell markedly: credit rose 10.7 percent in nominal terms, while the RPI increased by 17.8 percent. TVEs were discrimi- nated in their access to institutional credit during 1989, which remained constant in nomi- nal terms, chilo total bank credit rose by 13 percent. RCCs' lending to TVEs grew 16.3 per- cent les8 than their total credit growth of 18.7 percent (Appendix Table 3.6). During the first half of 1990, bank credit rose rapidly In real terms, contributing to the fast recov- ery of the TVE sector. During the first semester of 1990 total credit to the TVCE sector rose by Y 1.7 billion. However, this has been mainly in the form of working capital loans. Practically no loans have been made for fixed assets, which will affect the TYE sector's future development. Jiangsu's banks face a large (though declining) negative gap between their sources and uses of funds, while the opposite occurs for RCCs (Appendix Table 8.6). For example, in 1989 bank credits exceeded bank deposits by more than Y 20 billion, while RCCs had a surplus of Y 4.2 billion. The banks' gap Is filled from transfers from three sources: (i) large credit allocations from the People's Bank (channeled mainly through ABC for grain procure- ment); (ii) allocation of funds by ABC's headquarters; and (i7i) to a lesser extent, inter- bank loans. Such dependence causes credit to behave in a highly procyclical way, even more so when contractionary policies are combined with stricter credit allocation to preferential sectors and SOEs. This "crowds-out more efficient and less risky TVEs, which would (if allowed) bid for additional resources at a higher interest rate. 1/ IBRD, Chins- Financial Sector Review: Financial Policies and Institutional Develop- ment, Report No. 8415-CHA, June 29, 1990. 2/ Notice that SB and RCC credits to TVCEs as reported by PBC amounted to Y 11.06 bil- lion in 1989, while "Bank Loans' to TVCEs in Table 3.6 (as shown in Jiangsu's 1990 Statistical Yearbook) reached Y 13.09 billion. The discrepancy results from differ- ences in institutional coverage (BOCOM is not included in PBC's figure) and possibly PBC's figures do not Include loans In foreign currency. TVCEs but not for SOEs, an additional element of discrimination. The fiscal treatment of TVCEs also should be made consistent so as to reduce its ad hoc and negotiated aspects.  - 53 - C. Strengthening Jiangsu's TVCEs: Structural Issues and Recommendations 3.25 Dealing with Structural Issues. Over the last decade, Jiangsu's economy has operated in a very procyclical way: it grows much faster than the rest of the country during expansions but contracts more during recessions. Something similar can be said of Jiangsu's TVCE sector. Such cyclical vulner- ability results, in part, from the high degree of sectoral specialization of TVCEs in a few industrial subsectors like capital goods, their higher depen- dence on an unstable and rapidly changing domestic market, and the close simi- larity of industrial structures across counties in southern Jiangsu. High dependence of TVCEs on bank credit for about 40 percent of their working capi- tal requirements and the procyclical role of bank credit, has served to amplify the phases of expansion and contraction. Higher dependence on the domestic market, compared to TVCEs in Guangdong and Shandong, also contributes to the vulnerability of Jiangsu's TVCEs. The policy environment for Jiangsu's TVCEs needs to be substantially strengthened if they are to live up to their potential contribution to industrial growth and exports. Among the areas needing attention are industrial structure, location patterns, organizational forms, the role of government, and financial structure. 3.26 Industrial Structure, Efficiency and Scale. While the small scale of Jiangsu's TVCEs is sometimes viewed as a source of inefficiency, this is best corrected by policies which continue to encourage competition. Increas- ing plant size is difficult in the presence of largely immobile productive factors (labor and capital) and distorted relative prices. In addition, the widespread use of the "Wuxi model" of community ownership makes it difficult in Jiangsu to increase enterprise sizes by cross-community mergers. The first characteristic rules out enterprise relocations, while the transfer of resources to larger enterprises (prosperous perhaps only because of arbitrary distortions) in the hopes of improving scale, may only compound the misalloca- tion of resources. 3.27 Groups. Strengthening subcontracting and other links between small and medium-sized enterprises has been a successful strategy in countries such as Japan (for example, auto parts sector) and northern Italy (for example, industrial districts) and would very likely be a good strategy to follow in Jiangsu. However, unless adequate safeguards are introduced, the regulatory environment in China and the weak legal system might put TVCEs at the mercy of SOEs or spread inefficiencies across enterprises if loss-making or less effi- cient enterprises are merged with successful TVCEs or SOEs. Moreover, the creation of "groups" and "conglomerates" for SOEs and TVCEs, has been promoted without clearly setting the objectives and types of integration desired in each case.12/ Alternatives include: on-site; off-site; backward integra- tion into basic materials with enterprises in other provinces; lateral inte- gration into components; forward integration into distribution. Jiangsu should not attempt these types of integrations by administrative means, but rather it should play the role of facilitator creating the incentives or cor- recting existing distortions while letting local governments and enterprises to select the most appropriate forms of integration. Through specialization in each stage of production from R&D to marketing, combined with a high degree 12/ See China: Enterprise Management Reform - Issues and Options, The World Bank, Report No. 7773-CHA, July, 1989.  - 54 _ of cooperation, small firms can reap economies of scale and scope that can match those of big firms. 3.28 Ownership Reform. The fragmentation of enterprise ownership and lack of mechanisms to overcome the 'cellular' character of the provincial economy, hampers TVCE development. Jiangsu must provide a 'framework" to facilitate cooperation among local governments to dev'lop forms of 'cross- ownership," or integration without reducing local inci.nttves and support for TVCEs. Joint-stock companies, one important option, wxald result in a cross- ownership arrangement that would also reduce local financial risks. Common ownership of successive stages of production would also be advisable when deepening asset specificity increases the number of specialized TVCEs in col- laboration. 3.29 While most TVCEs operate under the CRS, which intends to preserve the autonomy of enterprise managers regarding day-to-day production decisions and profit and tax obligations, in practice ad hoc interventions by TICs and local authorities are reported to be widespread in many provinces. In partic- ular, TICs and local governments exercise a great deal of discretion to extract revenue from enterprises. As a result, enterprises, in many cases, are left with inadequate retained earnings to finance continued development. 3.30 Clarification of property rights is an essential step to allow col- lectives to achieve significant organizational improvement. Defining the rights of owners/workers and investors regarding distribution of profits is essential to widen the access of TVCEs to equity capital while defining the functions, rewards and responsibilities of managers (as well as the control exercised by owners over managers) is necessary to ensure that assets are efficiently managed. Jiangsu should observe the experiments in this area of reform being carried out in Fuyang (Anhui province), Zoucun (in Shandong) and Wenzhou (in Zhejiang), with a view to encouraging the growth of shareholding enterprises. While "self-accumulations" will continue so be important, it will be unable to provide all the resources for the next phase of moderniza- tion. The lack of long-term bank financing will force TVCEs to access the emerging t.apital market. 3.31 Deepening Outward Orientation. Expanding international market share is a promising strategy for the future development of many of Jiangsu's TVCEs. TVCEs still have disadvantages vis a vis SOEs in terms of technology and equipment, economies of scale, and preferential access to skilled labor, credit, and subsidized raw materials. These factors make competition and expansion difficult for TVCEs. Consequently, TVCEs need to exploit better their comparative advantages (for example, cheaper labor costs, more autonomy and flexibility), open new "windows" and look more actively for opportunities in the international market (for example, SEZ, joint-ventures, faster acquisi- tion of new technology). In addition, export incentives for TVCEs should be corrected for distortions and Jiangsu could introduce new export promotion services for TVCEs and SOEs. Implementing these policies, by granting direct export rights, for example, will be crucial to deepening TVCE export potential (Chapter II). 3.32 Support and Community Arrangements: TVCE Bureaus and TICs. TICs theoretically act like "holding companies" in western enterprises but seem limited in their capacity to function as a "miniature capital market" for  - 55 - reallocating funds to high-yield uses or expanding finance for TVCEs. For the larger TVCEs (400-600 workers), these planning and decision-making bodies urgently need a "new mentality.' The quality and type of support services provided by TICs are inadequate; they seem more concerned about collecting administrative fees and overseeing the remittance of profits and taxes to the townships, than about providing TVCEs with technical and financial services. 3.33 The dual role of community governments also needs to be addressed, especially the pervasive "conflict of interest" between local government as owners and tax collectors (also as entrepreneurs and as regulators). Despite their high stake in the prosperity of TVCEs, they also depend heavily on TVCEs' revenue transfers to defray public expenses. This suggests the impor- tance of segregating the fiscal and the development roles of TICs and commu- nity governments, while maintaining their interest in supporting rural indus- trialization. TICs could become an institutional mechanism to pool funds for R&D, setting up joint training centers, promoting dialogue between producers and users of capital equipment and providing specialized export and legal services, giving to individual TVCEs access to facilities and expertise they could never afford on their own. This most constructive "high road" to devel- opment has proven successful in northern Italy's industrial parks, where com- petition, on the basis of innovation in design, quality and innovation, has proven successful, avoiding the self-defeating road of tax breaks and exemp- tion from regulations on employment, health, and safety standards. 3.34 Steps to Address TVCEs' Financial Weaknesses. The TVCE sector displays a number of financial weaknesses. It is highly dependent on bank credit by being "working-capital intensive," with a higher ratio of working capital to fixed assets (1.43 in 1987 and 1988, and 1.39 in 1989) than other sectors. TVCEs maintain large inventories of raw materials to ensure continu- ous operation, high inventories of finished goods or goods in process, and a generally low fixed-capital intensity. These features help to explain the vulnerability of TVCEs to swings in bank credit, retained profits, and rein- vested funds. To raise working capital outside of the banking system, well- established TVCEs in south Jiangsu should be allowed to issue commercial paper with the approval of PBC instead of issuing "receipts" to capture the savings of their own workers. Developing "associations of RCCs" as special financing vehicles for TVCEs should also be considered, as recommended in an earlier World Bank Report.13/ These features, together with the locally controlled ownership form, suggest that TVCEs will have a hard time financing their next stage of development. This stage differs from the previous one in the major investments that will be required to upgrade equipment and technology in already large TVCEs. Most likely these investments will exceed local govern- ment capacity. N?w longer-term financing vehicles and instruments will have to be found because current bank credit terms are inadequate. In addition, joint ventures among community governments should urgently be promoted to pool resources, reduce risks, and rationalize overlapping industrial structures. 3.35 Cross-Subsidies Between TVCEs. Profitable TVCEs are often asked to assume loans, to absorb loss-making TVCEs, or both. Jiangsu's authorities know that this financial burden results in a large misallocation of resources, 13/ See Financial Sector Policies and Institutional Development, The World Bank, 1990.  - 56 - slows down successful enterprises, and limits the resources that successful TVCEs can keep for modernization. Maintaining a 'balanced growth strategy" that leaves nobody behind violates the "self-accountability" principle and sends a negative signal to enterprise managers about government support. Loss-making enterprises should be allowed to fail, as, in fact, many have in the recent retrenchment (see para. 3.10). Setting clear and enforceable bank- ruptcy rules will assist the rational restructuring of industry. The govern- ment should enact measures to cushion the social costs by early reforms in social security,14/ labor retraining, and increased mobility of labor. Banks should be allowed to function as financially autonomous entities, responsible for assessing and bearing risk. 3.36 Other Issues: Human Resources, Pollution, Energy, and Raw Materials Consumption. Other pressing problems in the TVCE sector include a shortage of skilled workers in the south, especially technicians and managers, and a lack of entrepreneurs in the north. To address these problems, the authorities need to provide and refocus personnel training (Chapter II) and promote mobil- ity of entrepreneurs and skilled technicians. Greater use of competitive bid- ding for urban construction projects, together with informal easing of con- trols on internal migration, created in the past growing opportunities in the cities for both rural construction enterprises and individual construction workers. A return to such forms of competition would be especially important for high unemployment northern Jiangsu. This process was set back by 1989's austerity program, but it should be revived. 3.37 Industrial pollution resulting from the cumulative effects of TVCE concentration have overwhelmed both regulatory capabilities and the environ- ment's absorptive capacity. In addition, in southern Jiangsu, industrial safety standards are not enforced. This reflects, in part local government "conflict of interest." The authorities should consider enacting emission charges and other taxes to induce pollution abatement measures at the enter- prise level, and clustering and more effective industrial zoning in order to make technical solutions more affordable (Chapter II). Tougher safety stan- dards should be gradually phased in, because absorbing the costs of modern- ization will make enterprises less competitive. 3.38 At enterprise level, shop layouts are deficient and industrial machinery is obsolete, and energy and raw material intensive. Jiangsu should promote technical assistance from TICs and SOEs, or both, to TVCEs. Even gradual modernization will entail such huge investments that external help will be needed from foreign direct investments and long-term credits from multilateral agencies for the most advanced TVCEs (Chapter II).15/ 3.39 Finally, backup power at enterprise level is costly because the central government lacks revenue to finance infrastructure and because local enterprises, townships, and counties do not cooperate to assure larger power 14/ See China. ; orming Social Security in a Socialist Economy, Report No. 8074-CiiA, June 25, 1990. 15/ See China: Rural Industrial Technology (Spark) Project, Staff Appraisal Report, Report No. 7484-CHA, The World Bank, October 22, 1990.  - 57 _ pools.16/ To raze bureaucratic obstacles to interjurisdictional coopera- tion at the cour.ty, city, township, and village levels, "Regional Development Corporations" might be created to promote joint projects on pollution control and energy, for example, on an economic scale. 3.40 Promoting TVCEs in Backward Areas. The authorities should actively encourage new and existing individual and household TVEs, especially in north- ern Jiangsu. This encouragement could take several forms: (a) "seed" risk capital (but no subsidies) to finance new private TVCEs; (b) a long-term, comprehensive trainivg program in the north to raise the low level of techni- cal and managerial skills; (c) "job export" promotion from the south, espe- cially labor-intensive processes (using tax and credit incentives); (d) active encouragement of specialized agro-industrial and food-processing TVCEs in the north, instead of trying to "catch up" with, or duplicate, TVCEs in the south (as proposed by the Jiangsu's TVCE Bureau); and (e) promotion of rural service sectors in the fields of construction, transport, and commerce. Provincial policies should focus on increasing the links and exploiting the mutual bene- fits of north-south complementarities. Policies should not, however, "slow- down growth in the south," for example through heavy taxation of TVCEs, to subsidize the north, because the outcome might leave everybody worse-off. 3.41 Jiangsu is to be congratulated on being the first out of the start- ing blocks in promoting the TVCE sector and in achieving many notable suc- cesses. However, it is evident that this sector is slowing down as the early advantages of reform and endowments are gradually eroded. There can also be little doubt that the heavy load of taxes and levies on the TVCE sector in Jiangsu in recent years has the potential to significantly hinder investment and, consequently, the growth of this sector. The sector can be rejuvenated if appropriate policy actions are taken in a number of areas. First, the effective taxes on TVCEs and other transfers to TICs and local governments must be reduced to more reasonable levels to allow for the continued growth of the sector. Second, administrative intervention in the functioning of TVCEs should be minimized and market signals allowed to guide their development. Any attempts by local governments to protect TVCEs by limiting market competi- tion should be strongly discouraged. Greater flexibility in the institutions which govern labor flows will allow the TVCE sector to develop along appropri- ately labor-intensive lines, with desirable consequences for employment. Finally, Jiangsu should encourage the development of alternate organizational forms in this sector by clarifying property rights within the collective and by promoting experiments which allow the creation of joint stock companies and shareholding enterprises. 16/ See "Decentralization of China's Electricity Sector: Is Small Beauti- ful7," World Development, vol. 18, no. 14 (April 1990).  - 58 - IV. ISSUES IN JIANGSU FISCAL POLICY Introduction 4.1 The relaxation of fiscal constraints on the future development of the Jiangsu economy is high on the provincial policy agenda. To identify the proper solutions to the tax and expenditure problems of Jiangsu and its local governments, Jiangsu must initiate a detailed planning process. The analysis in this chapter is intended to give perspective to the policy process, not a blueprint for reform, in three areas: (i) an estimate of the 'resource enve- lope,' the revenues the government has available to provide necessary public services and to undertake investment in the provincial development plan; (ii) a summary statement of the fiscal problems which the province must resolve to realize its objectives; and (iii) a summary of the options that the province might want to evaluate should it put together a reform agenda.l/ 4.2 The Central Fiscal Framework. The national tax structure and the system of intergovernmental fiscal relations are inextricably linked in China. This understanding must inform any discussion of local tax and expenditure options in Jiangsu. The laws of taxation and the powers and responsibilities of the various levels of government are laid down in Beijing. Any changes in Jiangsu's local fiscal policy must thus take place within the context of cen- tral government tax reform. Because provincial and local governments are responsible for tax collection and administration, share in revenue collec- tions, and enjoy substantial latitude in awarding tax preferences to enter- prises, however, the central government's ability to use the tax system for its own objectives hinges on its ability to influence local implementation of central policy. Likewise, Jiangsu's ability to encourage revenue mobilization or expenditure redirection depends on the cooperation of its subprovincial governments. 4.3 The foundations for national fiscal reform' are being laid in China. Reform measures that would change the division of national and provincial revenues are being considered by the central government, including a variety of approaches to expand local government's revenue powers. Options appear to include: (i) an increased number of strictly local taxes ("local fixed reve- nues"), full separation of center and provincial tax powers and reassignment of major taxes between central and local governments in proportion to their expenditure needs; or (ii) a reform of the present system to include revenues of the locally retained tax shares to increase local tax effort, accompanied by a transfer system. The pros and cons of these are discussed in the context of Jiangsu, in Section C. A. The Resource Envelope in Jiangsu 4.4 Revenues. In 1990, the government sector including SOEs derived its revenue from budgetary resources (50 percent), extrabudgetary sources (45 percent), and central government grants (about 5 percent). Budgetary 1/ For detailed recommendations on tax policy and revenue mobilization at the provincial level, see China: Revenue Mobilization and Tax Policy, CHA-7445, June 1989, Chapter IV.  - 59 - revenues include the major taxes (enterprise tax, sales tax, customs duty), while extrabudgetary revenues consist largely of the retained profits and depreciation funds of the SOEs (65 percent), revenues raised by administrative departments, lirse agencies, etc. (32.5 percent), and revenue raised by local government (2.5 percent). 4.5 Table 4.1 describes the trend in revenue from both budgetary and extrabudgetary sources, as well as grants, over the period 1987-90. Budgetary revenue has declined slightly in importance, from a 51 percent share to a 50 percent share while, correspondingly, extrabudgetary revenue has increased in significance from 42 to 45 percent. Central granto have declined from 6.7 percent to 4.8 percent. Table 4.1: FISCAL REVENUE TRENDS IN JIANGSU, 1987-90 1987 1988 1989 1990 Y bin % Y bln X Y bin X Y bin % 1. Budgetary revenue 10.721! 61.1 11.80 60.8 12.64 49.6 18.62 60.2 2. Central grants 1.40 6.7 1.83 6.7 1.29 4.8 1.81 4.8 8. Extrabudgetary revenue 8.86 42.2 10.32 44.0 11.66 46.3 12.22 46.0 Of which: Local government 0.29 0.80 0.80 0.30 Undertakings, admins. agencies, institutes 2.44 8.02 3.44 8.97 SOEs 6.11 6.99 7.81 7.95 Total Revenue (1+2+3) 20.97 100.0 28.46 100.0 26.48 100.0 27.18 100.0 Revenue of "general govern- ment' (excluding SOEs) 14.86 16.46 17.87 19.18 /a Figures for 1987 do not Include revenue from the electric power construction fund which was Introduced In 1988. Revenue collected by this fund In 1988-90 was Y 0.26, Y 0.23 and Y 0.19 billion, respectively. Source: Based on Appendix Tables 4.1 and 4.C. 4.6 Table 4.2 describes the shares of the major components of revenue in relation to provincial GDP in Jiangsu over the period 1987-90. In general, we would expect revenues to keep pace with the growth of GDP in any fiscal system where revenues were buoyant. As Table 4.2 describes, however, revenue has not kept pace with GDP growth in Jiangsu. Most revenue sources have declined as a share of GDP although extrabudgetary revenues have declined the least. Excluding the revenues of the state-owned enterprises and focusing on the revenues (both budgetary, grant and extrabudgetary) of the general government sector, this period has seen a cecline in its command over real resources from 16.6 percent of GDP in 1987 to 14.6 percent in 1990.2/ This trend is impor- tant in understanding the fiscal situation and prospects in Jiangsu. 2/ The "general government sector" is defined to include provincial and lower level governments, administrative units, and line departments; it excludes the state-owned enterprises.  - 60 - Table 4.2: REVENUE IN RELATION TO PROVINCIAL GDP (Percent of GDP) 1987 1988 1989 1990 Budgetary revenue 12.00 10.42 10.29 10.35 Extrabudgetary revenue 9.91 9.12 9.41 9.29 Total revenue including central grants and revenue of SOEs 23.48 20.72 20.75 20.62 Revenue of general government excluding revenue of SOEs 16.64 14.54 14.39 14.57 Source: Jiangsu Bureau of Finance. 4.7 The second feature of Jiangsu's revenue system relates to the revenue-sharing system between the various levels of government. Table 4.3 provides the distribution of total revenue (both budgetary and extrabudgetary) across these government entities. Over the period 1987-89, the share of total revenue accruing to the center has declined from 29 percent to 25 percent. In part this is the effect of the "incremental revenue-sharing system" whereby the center receives a fixed share (59 percent) of a provincial budgetary reve- nue target that is determined by a 1987 base of Y 10.01 billion, adjusted upwards by 5 percent per year. So long as actual budgetary revenue collec- tions increase by more than 5 percent per year, this system will result in a declining share of revenue remittances to the center. Table 4.8: REVENUE SHARING IN JIANGSU (Billions of current yusn) 1987 X 1988 % 1989 X 1. Total revenue 20.97 100.0 28.46 100.0 26.48 100.0 a. Revenue remitted to the central 5.91 28.8 6.28 26.6 6.66 26.7 government b. Revenue retained within Jiangsu 14.61 71.2 17.22 78.4 19.87 74.8 Of which: I. Provincial government 2.41 (11.7) 2.86 (10.0) 2.40 (9.42) iI. Municipal and county govern- 8.86 (17.8) 4.86 (20.7) 6.28 (20.7) monts j0 ili. Administrative agencies, 2.44 (11.9) 8.02 (12.9) 3.44 (13. 6) institutes, etc. iv. SDEs 6.11 (29.8) 8.99 (29.8) 7.81 (30.6) / Revenue retsined by municipal and county government Is derived as a residual = l(b) - Il(b) (i) - Il(b) (i ii) - 1 (b) (Iv). Source: Based on Table 4.1 and Appendix Table 4.18. 4.8 While the share of revenue retained within the province has increased from 71 percent to 74 percent, Table 4.3 suggests that the provin-  - 61 cial government has not benefited from lower remittances to the center--the share of total revenue accruing to this level of government in fact declined from 11.7 percent in 1987 to 10 percent in 1988 and an estimated 9.4 percent in 1989. 4.9 Municipal and county governments have increased their share in total revenue from about 18 percent in 1987 to 20 percent in 1989. (Again, it should be noted that, since the extrabudgetary revenue of local governments stayed stagnant, these movements are due to budgetary revenue.) The long-term significance ef this increase is doubtful, however, since the revenue share of these lower levels of government in 1986 was as high as 24 percent. Adminis- trative agencies, undertakings and institutes have increased their share of total revenue from 11.9 percent to 13.5 percent (see Table 4.3), reflecting in part the increased use of "clawback" fees and levies under the extrabudgetary account. 4.10 Expenditures. The distribution of total budgetary and extrabudget- ary funds, including the ext-abudgetary expenditure of SOEs, is described in Table 4.4. The largest single item of budgetary expenditures is social ser- vices (mostly education). The next two largest are price subsidies and 'other" expenditures, including urban maintenance. The small (13 percent) share of budgetary expenditure devoted to capital activities is the most striking finding. When budgetary and extrabudgetary expenditures of the gen- eral government are taken together (col. 4), a similar pattern prevails; when SOEs' extrabudgetary expenditures are included, their higher investment rate raises the share of capital expenditures (col. 1-3). Table 4.4: DISTRIBTrION OF EXPENITU1ES IN JIANGSU PROVINCE: 1987-89 (billion yuan) ___ _ _ ~~~~~Xnc iud ig nQE S ___ tc yiI ud iw SO nD el;D. Yor,. bBD. Ei .TOAL 6U)UET.YOAL BUD. E.iW. YTAL GletaInVlExpendituro 1.02 2.60 8.62 1.17 2.47 3.64 1.24 S.55 4.79 1.24 0.47 1.71 Social Services 2.02 - 2.02 2.44 - 2.44 2.82 - 2.82 2.82 - 2.82 Price Subsidies 1.69 - 1.69 1.82 - 1.82 1.94 - 1.94 1.94 - 1.94 6t.ployeo Bonusee and Welfare - 1.37 1.87 - 1.62 1.62 - 2.08 2.08 - 0.12 0.12 Administration 0.47 0.05 0.62 0.89 0.12 0.71 0.71 0.07 0.78 0.71 0.07 0.78 Taxes and Contributiono - 0.54 0.54 - 0.5S 0.56 - 1.09 1.09 - 0.15 0.18 Other 1.60 8.36 4.98 2.12 4.26 6.40 2.51 4.82 6.63 2.51 2.66 8.38 TotIl Empenditurn 6_ L 42.2 2L2M 17.1 922