China - Rural Industrial Technology (Spark) Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7484-CHA STAFF APPRAISAL REPORT CHINA RURAL INDUSTRIAL TECHNOLOGY (SPARK ) PROJECT OCTOBER 22, 1990 Industry and Energy Operations Pivision Country Department III Asia Regional Office This document has a restricted distribution and may be used by recpients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (August 1, 1990) Currency name = Renminbi (RMB) Currency unit = Yuan (Y) = 100 Fen US$1.00 = Y 3.72 (July 5, 1986 December 15, 1989) US$1.00 = Y 4.72 (since December 15, 1989) FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ABC - Agricultural Bank of China BOC - Bank of China BOF - Bureau of Finance BTVE - Bureau of Township and Village Enterprises CIB - China Investment Bank GDP - Gross Domestic Product GOC - Government of China ICBC - Industrial and Commercial Bank of China IHE - Institute of Higher Education ILO - International Labor Organization ISTIC - Institute of Scientific and Technical Information of China JEDIC - Jilin Province Economic Development Investment Corporatioa JGF - Japanese Grant Facility LCB - Local Competitive Bidding MIS - Management Information System MOF - Ministry of Finance NGO - Nongovernmental Organization PBC - People's Bank of China PCBC - People's Construction Bank of China PRC - People's Republic of China R&D - Research and Development S&T - Science and Technology SEdC - State Education Commission SOE - State Owned Enterprise SPC - State Planning Commission SPO - Spark Program Office SSTC - State Science and Technology Commission STC - Science and Technology Commission STS - Secondary Technical School SVS - Secondary Vocational/Agricultural School SWS - Skilled Worker School TOR - Terms of Reference TFP - Total Factor Productivity TVE - Township and Village Enterprise  FOR OFFICIAL USE ONLY ADMINISTRATIVE UNITS China is organized into some thirty provinces, autonomous regions and provincial-level municipalities. References in this report to provinces include provincial-level municipalities, such as Shanghai. The administrative level immediately below the province is generally referred to as the prefec- ture, although in Jiangsu its place is taken by 11 cities of prefectural status (also responsible for surrounding rural areas) and in Jilin the term region has been adopted. The functions performed by this intermediate level are often narrower than those of provinces or counties (though this is less true in Jiangsu). Below the prefecture come counties (with an average popu- lation, nationwide, of half a million people). In rural areas, the level below the county (and the lowest level of formal administration) is the town- ship. Smaller units, such as villages and below-village groups (the forme- production teams), are regarded as community rather than g-ernment entities. Central ministries generally have counterpart bureaus at lower levels. This document has a restricted 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.  - i - CHINA RURAL INDUSTRIAL TECHFOLOGY (SPARK) PROJECT Table of Contents Page No. I. BACKGROUND ......................... . 1 A. Introduction ......... .I...* 1 B. Industrial Technology: Policies and Instituti ons ........... 2 - Issues anu Policies ....... . .............. O. .* ......... 2 - Institutional Framework ............................ 5 C. Rural Industry .......................* , 6 II. THE SPARK PROGRAM .................... . ............ , 12 A. Objectives and Design . ................... , | 12 B. Organization and Implementation ....... .... ......... 15 - Organization ............. ................... .... is - Implement-ation .........I................................................ 16 C. Assessment......... . ......... .... . ... . 19 - Setting Program Goals .......... ........ .. ...... ...... 19 - Subproject Priorities, Review and Selec toon .............. 20 - Financing Terms a ndCitions .......n...............s 22 - Management Information Systems ............................ 23 - Diffusion ..................* 24 - Spark Training ...................... .... 24 - Technology Information . ..... . ... . 26 D. Project Rationale and Objectives ............................ 26 III. THE PROJECT.............. ... 27 A. Project Areas and Summary Description ....................... 27 B. Enterprise Modernization Component ...... . ........ 29 - Commercial Credit Subcomponent .......................... 29 - Precomnmercial Credit Subcomponent ............... 30 C. Spark Training Component m p o ne......... ... 31 D. Technology Information Componentm.................... 33 E. Institutional Development Componentm.....S.O...... .....V... 34 F. Impact on Envirenment, Women and Minoritieso................. 35 This report is based on the findings of an appraisal mission which visited China during June/July 1988, comprising Ms. B. Kafka, who led the appraisal and previous missions for the project, and Mr. A. J. Ody, who prepared this report (both Bank), with Ms. M. Hagen-Wood (Consultant), and supported by Mr. D. A. Mead (Legal Department). The report also reflects contributions made at preappraisal by Messrs. J. Chanmugan, M. H. Goldman, R. C. Ng and R. Venkateswaran (Bank) and Ms. L. Druben and Mr. R. Walt (Consultants), and subsequent assistance from Messrs. S.W. Leong, C.J. Maguire, P. Harrold and Ms. H. Chan (Bank). Following appraisal, various members of the preappraisal and appraisal teams held discussions with project entities on a number of occasions between July 1988 and August 1990 and on this basis updated the appraisal report.  - ii - Page No. IV. COSTS, FINANCING AND IMPLEMENTATION ............................ 36 A. Costs and Financing .. 36 - Summary of Costs .......................................... 36 - Financing Plan .. 38 - Disbursements .. 39 B. Implementation and Reporting .. 41 - Coordination .. 41 - Procurement .. 41 - Audits and Reporting .. 42 C. Financial Intermediation .. 42 - Intermediaries .. 42 - Final Lending Rates and Spreads .. 45 V. BENEFITS, JUSTIrLCATION AND RISKS .............................. 46 A. Benefits and Justification .. 46 B. Risks ....................................................... 47 VI. AGREEMENTS AND RECOMMENDATION .. 48 Tables in the Text 1.1 Ownership Structure of Chinese Industry, 1971-1988 ............. 7 4.1 Summary of Project Costs ....................................... 37 4.2 Financing Plan ................................................. 39 ANNEXES IN MAIN REPORT 1. Project Areas: Economic Structure, TVE Development, Science and Technology Infrastructure and Spark Program Strategies 2. Bank Group Strategy for Industry and Finance in China 3. Organization Charts: State Science and Technology Commission (SSTC) Jiangsu Science and Technology Commission Jilin Science and Technology Commission Shanghai Science and Technology Commission 4. Gross Value of Industrial Output by Subsector 5. National Spark Subproject Financing (1985-88) 6. Project Provinces: Historical Spark Subproject Approvals, Financing and Implementation 7. National Policy Statement for the Spark Program 8. Agreed Subproject Eligibility Criteria and Requirements 9. Risk Sharing Terms for Precommercial Loans 10. Summary of Project Costs (Non-credit Components) 11. Derivation of IBRD/IDA and JGF Financing 12. Estimated Disbursements 13. Jilin Province Economic Development Investment Corporation (JEDIC) 14. Monitorable Indicators of Project Implementation Map: IBRD 21063  - iii - SUPPLEMENTARY VOLUME FOR PROJECT IMPLEMENTATION 1/ SI. Spark Training Component Terms of Reference for Consultants Cost Estimates S2. Study of Spark Training Program Development Requirements Terms of Reference S3. Technology Information Component Overview of Cur.ent Activities Terms of Reference for Consultants Cost Estimates S4. Institutional Development Component Management Information System: Terms of Reference for System and for Consultants Training in Industrial Technology Evaluation: Terms of Reference Cost Estimates 55. Agricultural Bank of China (ABC) S6. China Investment Bank (CIB) 1/ Available in the Project File.  - iv - CHINA RURAL INDUSTRIAL TECHNOLOGY (SPARK) PROJECT Credit/Loan and Project Summary Borrower: The People's Republic of China. Beneficiariess Jiangsu and Jilln Provinces and Shanghai Municipality China Investment Bank (CIB) Agricultural Bank of China (ABC) Jilin Province Economic Development Investment Corporation (JEDIC). Credit Amounts SDR 45.1 million (US$64.3 million equivalent). Loan Amount: US$50.0 million equivalent. Terms of Credit: 35-year repayment, including 10 years of grace, on standard IDA terms. Terms of Loans Twenty years, including five years' grace, at the Bank's standard variable interest rate. Onlending Terms: The Government would relend US$114.3 million equivalent to Jiangsu and Jilin provinces and Shanghai municipality on tsrms and conditions acceptable to the Bank Group. The commercial credit subcomponent, which is equivalent to 902 of the above amount, would be onlent to the financial intermediaries for 15 years, including 5 years of grace. As regards the precommercial credit subcompo- nent (US$3.3 million equivalent) in Jiangsu, CIB and ABC, acting on an agency basis for the Province, would pass on funds to enterprises according to a risk-sharing formula. Satisfactory agreements have been reached on relending terms (including foreign exchange risk) to be applied to loan/credit proceeds.  Project The project would support GOC's ongoing Spark Program, Description: which seeks to upgrade standards of technology and man- agement in China's rapidly growing rural non-State enterprise sector, until recently largely ignored by support services and still suffering from inadequate access to technology, qualified staff and business- oriented information. In three representative areas, the project would support demonstration enterprise modernization subprojects in rural industries, upgrade the "Spark training program" for rural enterprise staff and help an existing technology information system reorient its focus to small enterprises. It would also strengthen the staffing and management of the Spark Program at national and lower levels. Benefits and Risks: Rural non-State enterprises are China's most dynamic sector, but standards of production technology and prod- uct quality are often low, reflecting their staffing constraints and technological isolation. The Spark Pro- gram, launched in 1985, is based on accurate diagnosis of sectoral problems, and has made an effective start in addressing them. However, its institutional basis is weak, and many specific subcomponents currently operate below potential. Bank Group involvement will assist in the transfer of evaluation, financing, training and information management techniques new to the program. Subproject review and supervision procedures will address risks involved in the adoption of new technology and marketing of new products. Risks associated with implementation of technical assistance will be minimized through contractual provisions for coordination. While the recent austerity program has included measures by the Central Government to tighten credit controls and other forms of regulation of non-State industries, China's leadership recognizes that the vitality of the rural industrial sector remains essential to meeting overall targets for growth and employment. Spark goals of improving efficiency, product quality and environmental standards thus continue to enjoy strong support at both national and lower levels.  - vi - Estimated Costs: Local Foreign Total ------------(US$ million)----------- Enterprise Modernization Commercial credit 144.5 53.5 198.0 Precommercial credit 4.9 1.8 6.7 Subtotal 149.4 55.3 204.7 Spark Training, Technology Information and Institutional Development Civil works 3.7 0.5 4.2 Equipment/furniture 4.0 3.9 7.9 Technical assistance/training 0.8 1.7 2.5 Program support 1.1 - 1.1 Subtotal 9.6 6.0 15.7 Total Base Costs 159.0 61.4 220.4 Physical and price contingencies 1.0 0.7 1.7 Total Project Cost 160.0 62.1 222.1 Financing Plan Local Foreign Total -----(US$ million)----------- IBRD/IDA 53.9 60.4 114.3 Central Government 1.0 - 1.0 Provincial Governments 8.3 - 8.3 Financial Intermediaries 35.4 - 35.4 Enterprises 61.4 - 61.4 JGF - 1.7 1.7 Total 160.0 62.1 222.1 Estimated Disbursements FY91 FY92 FY93 FY94 FY95 FY96 -S-------------(us$ million)----------------- Annual 6.0 6.1 31.4 32.4 22.8 15.6 Cumulative 6.0 12.1 43.5 75.9 98.7 114.3  - 1 - CHINA RURAL INDUSTRIAL TECHNOLOGY (SPARK) PROJECT I. BACKGROUND A. Introduction 1.1 The Government of the People's Republic of China (GOC) has requested a credit of SDR 45.1 million (US$64.3 million equivalent) and a loan of US$50.0 million equivalent for a Rural Industrial Technology Project to sup- port GOC's Spark Program. The Spark Program was launched by the State Science and Technology Commission (SSTC) in 1985, and is implemented throughout China under the leadership of SSTC and counterpart local Science and Technology Com- missions (STCs). It seeks to harness the resources of China's technology sec- tor to help upgrade technical and managerial standards in the rapidly growing rural non-State industrial sector (and, more selectively, in agriculture), through support for: demonstration subprojects to introduce modern technol- ogy; training of rural enterprise staff in technical and managerial fielt3. ("Spark training"); and provision of improved information services to busi- nesses. Spark takes its name from the adage that 'one small spark can start a prairie fire", a reference to the anticipated catalytic effect of the program on rural enterprise development. 1.2 The project will be implemented in three areas which offer contrasts in economic structure and rural enterprise development: Jiangsu and Jilin provinces and Chongming county in Shanghai municipality (see Annex 1 and map). It will support credit for commercial scale technology upgrading subprojects sponsored by rural industrial enterprises (and an experimental "precommercial" subcomponent in Jiangsu), and components to strengthen Spark training and the business information system. It will also support institutional development of implementing agencies in the project areas and at national level. 1.3 The project would be the first Bank Group-supported operation in China specifically oriented to rural non-State industry. The Bank Group's overall strategy in the industrial and financial sectors in China, together with lending to date, is summarized in Annex 2. Past industrial lending has focused largely on the State enterprise sector, though the industrial compo- nent of the Gansu Provincial Development Project (Ln. 2812-CHA/Cr. 1793-CHA) assists predominantly rural small industries, while agro-industrial operations are among the subprojects that have been supported by three Rural Credit Projects implemented or under implementation by the Agricultural Bank of China (Cr. 1462-CHA; Cr. 1642-CHA and Cr. 1871-CHA). Board papers for a Fourth Rural Credit Project were distributed to the Executive Directors on Octo- ber 11, 1990. A collaborative research program on rural industry has resulted in a recently published book 1/ and a summary Bank report (7267-CHA). 1/ China's Rural Industry: Structure, Development and Reform, W.A. Byrd and Lin Qingsong, eds. (1990).  - 2 - 1.4 This report is structured into six chapters. The balance of Chapter 1 provides background on the framework for industrial technology development in China and on the rural industrial sector. Chapter 2 discusses the objec- tives and implementation to date of the Spark Program and provides an assess- ment of its strengths and weaknesses. A detailed description of the project is provided in Chapter 3: project costs, financing and implementation arrange- ments are discussed in Chapter 4. Chapter 5 discusses the project's benefiLs and risks, and Chapter 6 concludes with a summary of agreements reached. Sub- stantial supplemental information is provided in a series of annexes in the main report as well as in the supplementary volume. B. Industrial Technology: Policies and Institutions Issues and Policies 1.5 Symptoms. Industry and science and technology (S&T) are two of the "four modernizations" to which China's leadership is committed. This reflects both a sense of the contribution technological change has made to growth internationally and an awareness that China itself long failed to take advan- tage of technology's economic potential. A good indicetor of the impact of new k owledge (including both embodied and disembodied techniques as well as managerial and organizational changes) is the growth of total factor produc- tivity (TFP). This measures how far output expands faster than the supply of factors of production (labor and capital stock, appropriately weighted). Increased TFP typically contributed as much to post-war economic expansion in developed countries as factor growth; many such economies sustained TFP growth of 2-32 per annum over extended periods, and some developing countries have at times seen TFP grow at 4% or above. Calculation of TFP in China involves methodological difficulties in valuing output and capital stock. However, several serious studies suggest that, after a burst of dynamism through about 1957, the PRC's industrial TFP entered twenty years of little discernible aggregate improvemenc. 1.6 The picture of technological stagnation through the iate seventies was consistent with observed production techniques in many industries. Fre- quently the technology embodied in the capital stock had not changed in decades. Not only were scrapping rates low, in addition, one Chinese econo- mist remarked, some capital goods industries had become 'reproducers of antiques", continuing to produce to outmoded designs (in some cases, those acquired from .he Soviet Union in the 1950s, which in turn often embodied Western technology from the 1930s). Product design and specifications also exhibited little innovation. Serious observers recognized that China, with an abundant labor force and capital scarcity, should not uncritically mimic tech- niques from advanced economies. But this difference did not explain why Chinese industry frequently wasted scarce energy or raw materials, why prod- ucts and components were of unsatisfactory or inconsistent quality, or why expensive equipment was often seriously underutilized by international stan- dards. Nor could it account for the limited diffusion of improvements suc- cessfully adopted by more dynamic enterprises. 1.7 Diagnosis. While poor performance from the late 1950s to the early 1970s could in part be attributed to internal disruption and international  political and economic isolation, current reforms are based upon an analysis that also blames deeper systemic factors: (a) organizational and incentive constraints to enterprises' adoption of new technology; (b) organizational and incentive constraints to generation of new know- ledge through Research and Development (R&D); and (c) barriers to information flows. 1.8 Deep-seated obstacles to innovation followed from the traditional incentive structure for (mostly State-owned) industrial enterprises. Central planning treated the firm as a production unit, not a significant decision- maker, and government allocation rather than markets guided production and resource use. Firms were judged largely against physical production targets, with only secondary attention to cost containment, economic use of raw materi- als or basic minimum product quality. Prices were essentially fixed, with no premium for higher quality standards, and often had little rational basis. They were in any case of limited relevance to enterprises, as profits were appropriated by the State (and losses made good through subsidies). For most items, producers bore little responsibility for marketing, which was handled by separate agencies. In addition, with pervasive shortages, almost anything produced could be sold. Finally, within the enterprise, little if any rela- tionship existed between performance (beyond basic physical quotas) and mana- gers' or workers' remuneration. 1.9 The PRC's initial adoption of the Soviet model for research placed scientific resources mostly in centralized, free-standing academies and insti- tutes. Funding came largely from central budgets, and appropriation proce- dures frequently failed to reflect effectiveness or relevance. As knowledge was regarded as a free good, there were inadequate mechanisms to reward insti- tutes for diffusing information to enterprises. Incentives for individual researchers also did little to stimulate work on pressing practical problems. Technical excellence was further blunted by the disruption of the educational system during the Cultural Revolution period. Scientific expertise in many areas fell behind the outside world, and many technical achievements that were made failed to be adequately applied. One Chinese source estimated that only 1CZ of China's R&D achievements were utilized, as against a comparable figure of 50-60% cited for Western Europe. 1.10 Flows of technological information were hampered by the underdevelop- ment of print and electronic media and the limited mobility of technical per- sonnel, either geographically or between employers. Institutional arrange- ments emphasized vertJcal communication between the enterprise and its con- trolling sectoral ministry, while inhibiting horizontal communication between enterprises (or ministries). Emphasis on self-sufficiency rather than spe- cialization (e.g. enterprises each forming their own, often drastically under- utilized, machine shops) in part originated from this vertical organization, though it was also an adaptation to the "shortage economy" in which reliance on suppliers was risky. There was thus little development of "intermediaries" such as consulting firms, specialized project design and implementation groups or component suppliers, which in other economies perform informal technology  - 4 - transfer. International transfer of knowledge was obstructed by a bureaucra- tic "air lock" distancing Chinese firms from potential foreign purchasers of products or suppliers of technology. 1.11 Reforms. Since the late 1970s, changes have been introduced which attempt systematically to remove the constraints to industrial technology moderniization discussed above. The pace of change has varied, and moves in the direction of decentralization have recently been subject to the overriding pressure to re-establish macroeconomic stability, which led to the Govern- ment's imposition of an austerity program involving some increase in adminis- trative controls. Nevertheless, reforms in the productive sectors have sought over time to transform the enterprise into a meaningful decision-making unit and to replace centralized physical planning by markets. The number of commo- dities covered by mandatory planning has been progressively reduced. A pro- portion of State-owned Enterprise (SOE) output is now sold through market channels, while over 952 of the rapidly growing output of non-State enter- prises (para. 1.22) falls entirely outside the Plan. Firms are increasingly involved in product marketing, domestically and internationally. Many prices have been entirely decontrolled, while others vary within bands which allow for the influence of supply and demand as well as product quality, though sig- nificant distortions remain in relative prices (and between controlled and market prices). SOEs now retain at least part of their profits, and there has been some attempt (though with limited results) to replace negotiated profit remittance by explicit profit taxes. Efforts have been made to eliminate the "soft budget constraint" with subsidies provided to loss-making enterprises (e.g. througn bankruptcy laws), though here, too, progress is slow. Various approaches have been taken to increase SOE managers' responsibility for results; workers' bonuses are also beginning to be tied to profitability. China's leaders recognize that industrial reforms are incomplete and have therefore supplemented them by specific incentives for innovation, including temporary tax rebates on products embodying new technology (para 2.5). 1.12 Reform of S&T policy gained momentum with the March 1985 issue of a key Central Committee document, emphasizing R&D's primary function of serving the economy and establishing new policy directives. Priorities for R&D are now set in a more explicit manner, with consultation across a broad range of informed opinion leading to publication of sectoral objectives. Research is increasingly organized on a "project" basis, whereby goals are set in advance and implementation is often open to tendering by alternative institutions. Mechanisms for independent review of research results have also been put in place. While basic, theoretical research will continue to be funded from budgetary sources, a freeze will apply for several years. To suppcrt growth in applied research, institutes are being encouraged to seek contract funding from enterprises, and annual targets set to increase the share of their bud- gets covered by this source (and phase out grants). This epitomizes a funda- mental change in the view of technical knowledge from a free good to a produc- tive commodity that may, in certain circumstances, be traded in markets. In 1985, to encourage development of a technology market, the PRC passed its first patent law, and a functioning patent system is now under development. Researchers are being given more opportunity to benefit from their work: awards and prizes have been revived, salaries and promotions are to be related  - 5 - to performance, and official sanction has been extended to part-time consulting by researchers. 1.13 Measures have also been initiated to reduce barriers to information flows. A wider range of technical and professional publications now circu- lates, and professional associations, once suspect, are actively promoted. Official statements call for 'encouragement' of skilled labor mobility, though there are still many obstacles. Decentralization of industrial decision- making is reducing the vertical emphasis of communications, and GOC encourages experiments with new forms of horizontal association. A consulting industry is emerging, and so is specialized industrial subcontracting and component supply, helped in part by flexible entry of non-State firms. Finally, prog- ress can be seen in breaking the air lock of communication with the outside world, with Chinese enterprises increasingly authorized to deal directly with foreign buyers and suppliers. Institutional Framework 1.14 Research in China is organized within five 'sectors': (i) the Aca- demy sector (e.g., the Chinese Academy of Sciences); (ii) Institutes of Higher Education (IHE), until recently inactive in research by Western standards; (iii) sectoral ministries, which as the traditional sponsors of SOEs became a major presence in industrial research; (iv) the defense sector; and (v) the now expanding local sector, under provincial and subprovincial governments. Available data on R&D, though much improved, still provide only partial cover- age: annual surveys launched by SSTC in 1985 do not capture R&D within IHEs or enterprises; they also exclude military research. 1.15 The 1988 survey recorded 7,773 R&D institutions, employing 1.082 million people, of whom about 405,000 were university graduates and 218,000 had completed secondary technical school or equivalent; total operational expenditures were Y 14.45 billion (US$3.9 billion). Agencies under the State Council (i.e. primarily sectoral ministries) accounted for about 66? of R&D expenditures (and 58Z of higher level staff), while local government insti- tutes were responsible for 34? of expenditures (and 331 of the scientists and engineers). The average local government institute was much smaller than that under central ministry control (in 1986, 16 university graduates or equivalent per institute, with a budget of Y 0.5 million, versus about 190, and Y 6.5 million, respectively). Industry accounted for expenditures of Y 7.5 billion (US$2.0 billion), or more than one-half of the total expenditure on research, in 1,904 institutes employing 504,000 people (of which 185,000 university graduates or equivalent and 95,000 at secondary technical level). 1.16 In 1958, in an attempt to create a high-level agency capable of over- seeing S&T, GOC established the State Science and Technology Commission (SSTC). Counterpart Science and Technology Commissions (STCs) were formed at provincial level. While SSTC was assigned responsibility for preparing over- all S&T plans, it was never feasible fully to centralize budgetary control for R&D. The separation between the S&T plans (under SSTC) and the economic plans (prepared by the State Planning Commission, SPC) was blamed by some leaders for diluting the economic relevance of R&D: in the early 1980s better inte- gration was sought through formation of a joint SSTC-SPC planning bureau.  1.17 More recently, GOC has acknowledged the limitations of central con- trol over research, and SSTC's role has been progressively transformed tc one of policy formulation. The Commission's influence is now reflected less in budgetary authority than, for example, through participation in the Science and Technology Leading Group, which provides interagency coordination and policy guidance. SSTC has formed an S&T policy "think tank", the National Research Center for Science and Technology for Development, and has recently published two S&T policy "white papers". 1.18 SSTC comprises some 30 departments and affiliates, with about 1,000 staff at central level (Annex 3). The SSTC/STC system retains responsibili- ties for S&T personnel matters (including certifying staff qualifications), assessment of research achievements, and international and domestic informa- tion exchange. SSTC has also launched development programs in priority areas, including initiatives in high technology (computing, remote sensing, biotech- nology and the new "Torch" program to support small high technology firms) and in the rural application of S&T (formation of the National Center for Rural Technology Development and initiation of Spark). C. Rural Industry 1.19 Definition and Growth. Although ownership rights to industrial enterprises and their legal status are not so clearly defined in China as in many other countries, three broad classifications are generally used: (a) State-owned Enterprises (SOEs), defined as enterprises under "ownership by the whole people"; (b) "collective" enterprises; and (c) individual or private enterprises. SOEs are usually located in urban areas, and their output is included in urban industry statistics. They have traditionally been subject to a high degree of government control, exercised by sectoral ministries at either the national or provincial level. Historically, they depended on financing provided by the state budget for all investment, and inputs and outputs were allocated by the materials allocation plan. SOEs were often characterized as being "factories" rather than enterprises. Reforms have been gradually changing this, and, in particular, over 90% of the SOEs now operate under the contract responsibility system. 1.20 The collective and individual classifications raise several issues. First, most Chinese collectives are owned not by their workforce (like collec- tives in many other countries) but in effect by the community as a whole (e.g., township or village). Secondly, as collectives may be established at many different levels, the classification extends from city firms to rural "township and village enterprises" (TVEs), which are active both in industry (the focus of this report) and other sectors. More ambiguous are the county collectives (generally aggregated in urban collective statistics and hence impossible to quantify separately). These are usually located in county seats of government and sponsored by county governments, which typically offers some advantages in access to institutional support compared to TVEs. Thirdly, available statistics on rural industry show considerable variation in coverage (especially of below-village and indlvidual firms). In particular, though urban enterprise data differentiate between collective and individual firms, rural statistics have at times been amalgamated with collectives such essen- tially private operations as cooperatives, partnerships and individual firms. Even on the ground, the distinction between different ownership forms is often  far from clear. Nonetheless, the number of privately-owned enterprises in China was estimated at 12.4 million at the end of 1989. 1.21 In 1988, the industrial output value of the non-State sector (i.e., excluding the SOEs) made up 43.22 of the total. Of this, 17.4% was urban and 25.8% was from rural non-State enterprises. This represents a 150% increase in the share of rural industry in total industrial output during the decade of the 1980s, from only 10% in 1980, a major shift in ownership pattern. Detailed statistics are provided in Table 1.1 below. Table 1.1: OWNERSHIP STRUCTURE OF CHINESE INDUSTRY, 1971-88 (% of total industrial output value) 1971 1975 1978 1980 1981 1982 1983 1984 1986 1986 1987 1988 State 86.9 81.2 77.6 76.1 74.3 78.8 72.6 67.8 64.9 62.2 69.7 58.8 Urban collective 10.9 13.7 13.7 14.4 14.1 14.3 ;4.4 16.9 16,6 14.8 14.6 14.8 Urban Individual a/ - - - 0.0 0.0 0.1 0.1 0.2 0.3 0.2 0.4 0.4 Urban other - - - 0.6 0.8 0.7 0.8 1.1 1.2 1.6 2.0 2.7 Rural non-State Z.2 6.1 8.7 10.0 11.0 11.2 12.1 16.2 18.0 21.3 23.3 26.8 Of which: Township 1.6 2.6 4.8 6.4 6.9 6.0 6.3 7.7 8.1 9.3 9.3 10.1 Village { { { { { { { 6.0 6.8 7.5 8.4 9.4 {1.6 (2.6 (3.9 (4.6 (6.1 (6.2 (5.8 Below village { { { { { { { 1.6 3.1 4.6 5.8 8.3 Of which: Individual firms 1.6 2.6 3.3 4.0 g/ Includes partnerships. Source: China - Rural Industry: Overview, Issues and Prospects. Bank Report 7287-CHA (soe original report for detailed notes on methodology and primary soarces); Statistical Yearbook of China, 1989. 1.22 The rise in TVEs' proportionate contribution coincided with rapid growth in total industrial output (approximately 13.7% per annum in real terms over 1980-88). Though issues arise concerning TVE price deflators, Bank Group calculations suggest real annual growth for industrial TVEs of above 20% for the 1980s as a whole. Although capital requirements exclude them from such large-scale operations as petroleum processing, they have developed signifi- cant capacity in machine building, construction materials, textiles, food and timber processing and chemicals (especially plastic processing), and are increasingly important in electrical appliances and electronics. The output structure of TVEs is compared with that of industry as a whole in Annex 4. 1.23 With varied sources of statistics and various definitions, there are wide variations in estimates of the numbers of industrial TVEs and the employ- ment they generate. The best estimate puts the number of industrial TVEs at 1.36 million in 1988, of which about 240,000 were at the township level, 730,000 at the village level and another 390,000 at other levels. Some 225,000 of those were defined as "private enterprises.' Employment in indus- trial TVEs was estimated at 34 million in 1988, compared with a total of only  - 8 - 19 million in 1980. Estimates for the total number of nonagricultural workers in the rural sector vary enormously, but were in the region of 86 million at the end of 1988. The total number of rural enterprises--including very large numbers of individual enterprises involved in commerce and construction--was estimated at 18.9 million, compared with 6 million in 1984. In 1987, for the first time, the gross value of rural industrial output exceeded that of agri- cultural output. Further, it is estimated that TVEs generated US$10 billion in exports in 1989, almost 202 of the total, and one third of total manufac- tured exports. 1.24 Economic and Political Environment. In the 1970s, rural nonagricul- tural activity in China was still well below levels in other Asian countries, for a variety of policy and administrative reasons. With the launching of the economic reform programs in 1978, the policy framework for rural industry began to improve, and became very positive after 1984 with the launching of the industrial reform program. Rural industrialization began to be seen as critical both for the success of the urban industrial reforms, and also for the success of China's policy of limiting the growth in the city population. 1.25 Several aspects of the economic environment proved beneficial to TVE growth. Earlier planned development of agriculture and industry, concentrated on grain and heavy industry respectively, allowed unsatisfied demand to develop for specialty foods, consumer articles, services, etc. This was fur- ther fueled by growth in disposable income resulting from agricultural and other reforms in the early 1980s. Market entry was made possible by the eas- ing of state control over distribution channels. China's rapid switch from inward-looking development to an open door policy created similar market opportunities for exports. On the input supply side, productivity gains in agriculture following decollectivization opened up a large new labor supply, while the relaxation of plan control of raw materials removed another bottle- neck. Agricultural diversification created numerous opportunities in food processing, beverages and textiles, including silk and cotton. Funds which had either been accumulated under the commune system, or which were generated by the sharp increase in agricultural incomes as a result of the reforms, provided the seed capital necessary for start-up. Decentralization of admin- istrative matters--such as approvals of new enterprises--and in the financial sector also fostered the development of the TVE sector. Despite this, the policy framework was still largely oriented to the needs of SOEs. The author- ity of local bank branches to extend credit to TVEs has in practice been closely tied to their success in mobilizing additional deposits. Periodic credit squeezes have tended to single out TVEs for relatively restrictive treatment, and the share of TVEs in total formal credit was only 72 in 1988 (TVEs have, however, had access to informal credit). While tax rates for TVEs have been set at very low levels--the formal rate being 20% compared with 30% for collectives and 55% for SOEs--TVEs, being so closely associated with their local governments, have sometimes had onerous ad hoc exactions imposed on  - 9 - them. And although TVEs have become significant exporters (para. 1.23), allo- cation of foreign exchange continues, as a whole, to favor SOEs.2/ 1.26 For much of 1989, the government's austerity program had a major impact on TVEs' growth and investment. The annual growth of TVE outpuc fell from the 30% rate of 1987-88 to 15.9% in 1989, and investment fell by some Y 10 billion, with only half the number of new ptojects launched as in the previous few years. There were widespread calls among senior leaders for retrenchment of the TVE sector, particularly those enterprises which consumed high levels of energy, created pollution, or "gained windfalls from unfair competition with SOEs." In December 1988, within the context of overall man- datory credit ceilings under the austerity program, it was announced that there would be zero net growth in nominal credit to TVEs in 1989, which meant an 18% real cut in their level of credit. While it appears that industrial TVEs have fared reasonably well--not least since local governments have sought to protect these enterprises from going bankrupt--it is estimated that about 3 million rural enterprises went out of business in 1989, sending some 8 million workers back to the land. (Notwithstanding the policy framework, a high death rate among TVEs would be a natural consequence of the high birth rate, a pat- tern common worldwide among small enterprises.) The stated policies of the three-year economic "improvement and rectification" program, as reconfirmed in November 1989, sought to strengthen tax regulation over the sector, and skew credit and materials allocation towards the SOEs, the "backbone" sector. 1.27 More recently, however, a distinct improvement in this environment has been seen. TVE growth picked up in the last two months of 1989, after severe contraction in September and October, and the first eight months of 1990 saw a 9X increase in rural industrial output. The Ministry of Agricul- ture has established targets for 1988-91 which provide for a 15% gruwth rate in rural industry; a growth rate of within 20% for TVEs; and annual fixet investment by TVEs of up to Y 20 billion, of which 50% should be financed by owners' funds. With these parameters, the TVE sector will continue to expand its share of total industrial output, and its contribution to employment gen- eration. It is certainly this latter factor which led to a moderation of the stance towards TVEs, since the austerity program caused temporary urban work- ers--particularly those in construction--to return to the rural areas. 1.28 Support Services. As in the case of the policy framework, industrial support services also reflect SOE dominance. As discussed in para. 1.15, State firms can draw on researc;L support from large, specialized institutes financed by sectoral ministries, while local research centers are typically smaller and more diversified. Similar discrimination prevails regarding information networks, established by several sectoral ministries to serve SOEs under their sponsorship. There has been little coordination between the 2/ In general, exporting enterprises share with the provincial government (usually equally) 25Z of the relevant earnings in the form of foreign exchange entitlements. The balance accrues to the center which allocates it e.g. to sectoral ministries (which in turn may pass it on to SOEs). Reforms have increased exporters' share in sele