China - Services sector development and competitivenes

THE WORLD BANK China: Services Sector Development and Competitiveness DECEMBER 15, 2000  World Bank Note December 15, 2000 China: Services Sector Development and Competitiveness Issue: The relative underdevelopment of consumer and producer services in China is a constraint on employment, growth, and competitiveness. Findings: (a) Despite major problems with the statistics, it is evident that the level of services is low in relation to (i) comparable countries, (ii) recent increases in domestic demand, and (iii) promoting economic efficiency and technical progress in the context of globalization. (b) Many services are unavailable, except at prohibitive cost, and there is limited choice. The quality of services is variable, with sharp regional disparities in social services, urban-rural divergence in services consumed by households, and in the quality of producer services available to different economic activities in the country. High cost services are a tax on consumers and producers, and impair the economic and technical efficiency of specific regions within the country as well as China's external competitiveness. (c) The underdevelopment of the services sector is due to an out-dated government policy regime. The protection of monopolies, price and other forms of intrusive regulation, and an inadequate framework for promoting the smaller and more-agile non-state enterprises that normally form the backbone of the services sector are the main constraints. In addition, low skills and limited access to world-class technologies act as a brake on the provision of services of the kinds demanded by consumers and producers. (d) Services development creates employment directly; while agriculture shed over 30 million workers, services created nearly 73 million jobs over the past decade, and have even greater potential. Equally important, better and more services are needed to expand the domestic market as an engine of growth, revive agricultural and industrial investment, facilitate industrial restructuring, accelerate human resource development, and compete in the global economy. (e) This note addresses producer services, specifically logistics, telecoms, business services, and e-commerce. The major thrust of policies in these sub-sectors should be directed at fundamentally reforming the role of the government. Specific and detailed proposals are made for each of the four areas. Quantitative analysis suggests that GDP would be 4 percentage points higher and private consumption 9 percentage points higher in 2010 with reforms, than under current policies. Next Steps: Local experts helped conduct the background work for this note. This collaboration showed that there is an urgent need to establish coordination mechanisms among agencies to improve the policy focus on services sector development. Some new work on services is underway in government agencies and through World Bank studies on post-WTO economic issues, but this should be expanded. In sub-sectors where the knowledge of issues and solutions is advanced (e.g., health care, social insurance), the relevant agencies urgently need to tap technical support to reformn policies and institutions. In some areas (e.g., the development of logistics), there is also a need for projects and advanced project management technologies.. * Questions on this note may be addressed to Ms. Li Li, External Affairs Officer, World Bank Office, Beij ing. Email: LLi2@worldbank.org  CHINA: SERVICES SECTOR DEVELOPMENT AND COMPETITIVENESS INTRODUCTION 1. This note is a collaborative effort between leading Chinese experts in government agencies and research and academic institutions and World Bank staff. The purpose of the note is to draw the Government's attention to the negative effects an underdeveloped services sector could have on medium-term growth and international competitiveness. The note recommends that the government adopt appropriate measures in the Tenth Five- Year Plan to stimulate growth in the services sector in step with the needs of a growing economy.' It presents some general recommendations based on earlier World Bank studies and recent work completed by domestic and foreign experts.2 Then, to illustrate the general points with specific recommendations, it focuses on a set of producer services that is judged to be critical at this stage of China's development-logistics, business services, e-commerce, and telecommunications. This note is neither exhaustive with respect to consumer and producer services in the Chinese economy, nor comprehensive with respect to all of the issues associated with the development of the four producer services described. It is intended to be a survey of some of the broad policy issues that need to be considered, and to point the direction to a more thorough and purposeful services sector development strategy. THE ISSUE 2. China has achieved a striking record of growth and poverty-reduction since the country launched economic reforms and opened the economy to external trade some twenty years ago. Consequently, it is on the way to becoming one of the world's largest market economies, if not the largest, some time in the 21st century. Despite this remarkable progress, today the Chinese economy faces unprecedented challenges, probably no less than twenty years ago. Domestically, there is the big challenge of an unfinished reform agenda that is far more difficult to resolve than the previous one. Internationally, there is an equally large challenge of harnessing the positive forces of globalization and technological revolution to benefit the Chinese economy, while minimizing their risks. Success or failure can best be measured in terms of China's ability to achieve sustainable growth over the medium- and long-term. This is because poverty alleviation and completing the reform agenda (which will displace a large part of the non-productive workforce in the State sector) requires sustained and high economic growth. 1 Examples of the kinds of economic activities that normally fall within the services category are: finance, accounting, auditing, legal services, insurance and real estate; education; tourism; health care; transport, storage and communications; trade (for example, importing, exporting, domestic wholesaling and retailing); business services (for example, advertising, marketing, sales, consultancy, information processing, research and development); restaurants and hotels; community and personal services (for example, entertainment), and government services. Broadly speaking, these activities produce either consumer or producer services, that is, output intended for final consumption or as intermediate inputs into production processes and goods. 2See Annex 2 for a list of background papers prepared to support the findings of this note, and related World Bank publications on specific services sub-sectors in China. 1  Measuring Services 3. The relative underdevelopment of China's services sector is a drag on more rapid increases in employment, medium- In all countries, statistical offices find it difficult term growth prospects and sustained to measure the share of services in national international competitiveness. In 1992, output. The problems with quantifying and cometitiveness.eInd1992, pricing outputs and inputs, tracking quality the Government gave unprecedented changes, and attributing to the service sector, policy attention to the development of the rather than to agricultural or industrial goods, the services sector, by issuing a strategy value of services inputs are believed to result in document.3 Subsequently, real services serious under-estimates of the contribution of sector output, as measured in China's services to national economies. In China, the problems are compounded by the transitional nattonal accounts, rose by 8.8 percent per nature of the national statistical system, which year, compared to 10 percent for the has only partially covered the distance from the economy as a whole. Employment older Soviet-based accounting methods to those increased by an average of 8.6 million per that are recommended in modern market year, at a time when industry created 2.9 economies. Annex I discusses the issues million jobs and agriculture shed 4.3 detail. million jobs. Even casual observation Thus, although the share of the services sector in suggests that the range and quality of total output is estimated to be about 33 percent, many services increased greatly, and this and employment in the sector is 190 million, the applies to both consumer and producer true numbers are likely to be larger. Nevertheless, even after reasonable adjustments, services. However, a comparson with China's services sector lags behind that of some of China's neighbors, or even with comparable countries in terms of its size. countries elsewhere at comparable levels of per capita income shows that the More important, however, are the high cost, services sector is relatively uncertain availability, and highly variable quality of services. Unfortunately, information on these underdeveloped. parameters is only available through case studies and micro-surveys. Nevertheless, the frequency 4. This note suggests that a with which they surface suggests that there is an fundamental reason for the under- development of China's services sector is economic: a highly restrictive policy regime for services delivery that does not allow it to respond effectively to the growing demand for services. Most services are tightly managed and controlled by the Government, therefore the providers are able to operate with great market power (for example, banking, insurance, telecommunications, passenger air transport, and railways). In other areas such as housing, health care, urban transport, and education, there is a strong emphasis on social welfare dimensions. This often results in high policy-induced barriers to entry and price regulation that seldom promote resource use efficiency, product innovation or improvements in quality, and often undermine desirable social welfare outcomes (for example, in the areas of credit, 3The document is titled: The Determination of the State Council and the Central Committee of the Chinese Communist Party to Promote the Development of Tertiary Industry, June 1992. Since the issue of policy documents related to the reforms of 1978, this was the first time that a sectoral development strategy document was issued by the Party. Aiming to achieve a services sector growth rate above that of agriculture and industry, it presented general objectives for promoting domestic and foreign investment in the sector, reforming state owned institutions involved in services output provision, financing the sector, and liberalizing prices for most services sector output. 2  insurance or health care).4 It is especially important to note that, with very few exceptions, the gap between China and comparator countries is larger in the newer services or those requiring higher skills, than in traditional services. Equally important, the growing deficit on the services account of the balance of payments is a possible indication of bottlenecks in the provision of services from domestic sources.5 In addition to the policy regime, other factors that account for the slower growth of services are the low rate of urbanization, inadequate labor market skills and imperfect labor mobility within China. The development of Hong Kong SAR as a major provider of services to Mainland China firms (mostly non-competing or internationally benchmarked for quality) is another element that explains, in particular, the underdevelopment of producer services in China. TOWARD A SERVICES-DRIVEN GROWTH STRATEGY 5. The historical experience of developed and developing countries provides a firm basis for stating that, as aggregate incomes rise, they lead to an increase in the share of services in an economy. Consumer services expand as people move from the necessities (food, clothing and shelter) to better-quality necessities and an expanded array of goods and services. In general, individuals tend to have a higher income elasticity of demand for services than for goods.6 Producer services grow as they become more vital to the production of the kinds of new goods and consumer services demanded by society. Valuation issues aside, China's recent experience suggests that this trend is firmly underway. The strategic questions at this point are: Should the services sector be the growth-engine of the Chinese economy? Can it? How? 6. The potential contribution of the services sector to employment, medium term growth, and international competitiveness argues for a services-driven growth strategy for China. * Employment-In 1970, services employed 31 million people, compared to 35 million in industry (manufacturing, utilities and construction). By 1994 it had overtaken industry, and in 1999 nearly 190 million people were employed in the sector, compared to 162 million in industry. Clearly, as the share of agriculture shrinks in the economy, and the need for urban jobs escalates, both industry and services will have to shoulder the burden of job-creation. 4 While labor productivity (measured as real output per worker) is lower in services than in manufacturing, profitability and average wages (except in wholesale/retail trade and catering services) are higher. See below. 5The deficit on the non-factor services account rose from US$0.2 billion in 1992 to US$7.5 billion in 1999. The change in the factor services balance is even larger. starting from a surplus of US$0.3 billion in 1992 to a deficit of US$18 billion in 1999. However, caution is needed in interpreting this as an indicator of China's declining competitiveness in services, as many services are bundled in the value of merchandise exports. 6 It should be noted that both poverty and income inequality have profound effects on the bundle of goods and services consumed in a society. In China, decreasing, but still high, levels of poverty and increasing inequality may have generated opposite effects on the demand for services. 3  * Growth-However, industry in China is both more capital-using and less labor- intensive. Fixed capital investment per worker in manufacturing is higher than in most services activities, as is fixed capital investment for each new worker.7 The amount of employment generated per unit of gross output is also higher in services than in industry, more than three times as much, according to estimates derived from the 1997 Input-Output tables for China. More significant, however, is the fact that producer services, rather than manufacturing, are increasingly the drivers of growth and productivity. In an economy where the share of industry in GDP has already eroded, and the profitability of manufacturing is under severe pressure, adding services to products is one way of sustaining growth.8 Most important, the introduction of low-cost and high-quality producer services normally results in an economy-wide transformation of production, business organization, distribution and consumption patterns, rather than simply resulting in the accelerated development of one or more "leading sectors".9 * International Competitiveness-The concept of international competitiveness lies at the heart of achieving a sustained increase in China's standard of living.'0 It is a significantly broader idea than "external competitiveness", which can be maintained by exchange rates and subsidies, if necessary, to generate a rising share of world export markets and, although not in a sustained way, an increase in the domestic standard of living."' In a globalizing world, benchmarking to best practices is imperative. In this regard, it is useful to note that worldwide comparisons conducted by reputable organizations identify China's services sector weakness as a bottleneck to improved international competitiveness. 2 These findings are confirmed by a recent survey of private firms by the World Bank Group. Labor and management skills, technology, market information, and financial services emerged as the main constraints on growth.'3 7 Manufacturing, rather than industry as a whole, is the relevant comparator. Several sub-sectors within industry (e.g., energy) and services (e.g., transportation) involve massive infrastructure investment. 8 See Financial Times, "The Eclipse of Manufacturing", December 15, 1998 for a useful survey of such trends. Numerous examples are available from recent Chinese experience-the effect of improved cold storage and handling on seasonal fruit and vegetable availability; the success of Legend in a highly competitive domestic market for personal computers; etc. Many of these are documented in World Bank studies of specific services sub-sectors (see Annex 2). 9 See also Stephen S. Cohen, J. Bradford DeLong and John Zysman, Tools for Thought: What is New and Important About the "E-Economy", BRIE Working Paper #138, February 22, 2000 for a view on economic transformations, as distinct from leading sector development. '