Conflict and Harmony: Development in the Yangtze River Delta [1 ed.] 9789814298803, 9789814298797

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Enrich Series on China’s Economic Issues Vol. 7

Conflict and Harmony: Development in the Yangtze River Delta The industrial upgrading of the Yangtze River Delta region is the key to the growth of this most critical area of China. Conflict and Harmony: Development in the Yangtze River Delta looks at the evolution of the relationships between local government and enterprises during this time of economic transition in the region. The book also considers issues of labor transfer, foreign direct investment-led growth, and the spillover effects of indigenous technology innovations in the Delta. • Detailed overview of the industrial structure of the Yangtze River Delta • Comprehensive examination of the convergence of economic development patterns and local government competition • In-depth analysis of the foreign investment-led growth model and distribution of income • Unique insights into the economic growth and new financial changes occurring in the Yangtze River Delta region

Conflict and Harmony: Development in the Yangtze River Delta

Revealing the Industrial Upgrading of China’s Yangtze River Delta

Authors

Zheng Jianghuai, Head of the Department of Industrial Economics, University of Nanjing. He also serves as Researcher of the Economic and Social Development Research Center of the Yangtze River Delta and Director of the Institute of Entrepreneurs at the University of Nanjing.

Liu Zhibiao Zheng Jianghuai

Liu Zhibiao, Dean of the School of Economics, University of Nanjing. He also serves as Executive Director of the Economic and Social Development Research Center of the Yangtze River Delta. He has published more than 200 academic papers in journals such as Economic Research Journal, Chinese Social Science, and Management Today.

Enrich Series on China’s Economic Issues

Vol. 7

Conflict and Harmony: Development in the Yangtze River Delta

Chinese Economic Studies

Liu Zhibiao Zheng Jianghuai

Enrich Series on China’s Economic Issues This series emphasizes the employment of modern economics methods to explore and research hot-spot issues and difficulties in the reform, opening-up and

economic development facing China today. It covers a wide variety of economic issues ranging from monetary policy, fiscal policy, regional economy to industrial and banking development.

Vol. 6

Research on the West Triangle Economic Zone: Development of the Anti-gradient Region

Vol. 7 Conflict and Harmony: Development in the Yangtze River Delta Vol. 8

The Strategy of Chinese Rural-Urban Coordinated Development to 2020 Part 1

Vol. 9

The Strategy of Chinese Rural-Urban Coordinated Development to 2020 Part 2

Singapore • Hong Kong • Beijing • Honolulu

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PO Box 30812, Honolulu, HI 96820, USA English edition © 2013 by Enrich Professional Publishing (S) Private Limited Chinese original edition © 2010 China Renmin University Press Translated by Wu Siying, Liu Ling, and Liu Hui Edited by Barbara Cao and Glenn Griffith

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ISBN (ebook)

978-981-4298-80-3 (pdf)

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Contents Preface to the Series

vii ix

Abbreviations

Chapter 1

Industrial Upgrade of the Yangtze River Delta

Chapter 2

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

29

Chapter 3

The Evolution of the Relationships between Local Government and Enterprises during Economic Transition

71

1

Chapter 4

The Convergence of Local Government Competition and Economic Development Pattern

103

Chapter 5

Local Government Competition amid the Integration of the Yangtze River Delta

123

Chapter 6

The Industrial Structure of the Yangtze River Delta

167

Chapter 7

Import for Export

193

Chapter 8

A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

221

Chapter 9

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

243

Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance of the Yangtze River Delta

267

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

289

Chapter 10

Chapter 11

Contents

Chapter 12

Land Utilization in the Economic Growth of the Yangtze River Delta

309

Chapter 13

Regional Economic Growth under the Transitional Financial System

337

Chapter 14

Financial Dependence of Economic Growth in the Yangtze River Delta and Comparison with Other Provinces

373

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

405

Chapter 16

Positive Analysis of Price Fluctuation and Household Consumption in the Yangtze River Delta

425

Chapter 17

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

445

Chapter 18

Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

465

Chapter 19

Research on the Integration of Cultural Markets in the Yangtze River Delta

491

Chapter 20

Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

507

Chapter 21

Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

525

Chapter 15

Notes

555

References

567

Index

613

vi

Preface to the Series The development of economic theory is closely associated with economic practice. With the transition of China to a Socialist market economic system, practice requires the development and prosperity of economics; at the same time, practice is creating the conditions for the development of economics. Market-oriented reform in China is unprecedented and no ready-made economic theory can be used for guidance. This is a major challenge for Chinese scholars. “By other’s faults, wise men correct their own.” With the translation and introduction of a large quantity of Western economic theories to China and the growth of many skills in modern economics attainment, brand-new tools and perspectives are available for the understanding and solving of the economic problems of China. Theory and practice are interactive. While using modern economic theory as reference, China, as an unparalleled “test field,” will certainly inject new vitality into the development of economic theory and become an important driving force for its development. Only in this way may economics based on research on Chinese economic problems be established. It is against this backdrop that Chinese economic issues are endowed with special significance. The fundamental purpose of planning for and publishing the Series on Economic Issues in China is to encourage economists’ spirit of innovation and exploration, further promoting the development and prosperity of economics research in China, and to establish a platform that is suitable for the growth of new ideas among economics works in China, providing a theoretical economic circle on China and explorers in real sectors a space for presentation of high-level research findings, thus enabling this series to be indispensable reading for readers at home and abroad to learn about the development of economics and the economy in China. The distinctness and urgency of economic issues in China will provide Chinese scholars with a broad space for development. Using economic issues in China as the breakthrough point, this series emphasizes the employment of modern economics methods to explore and research hot-spot issues and difficulties in the reform and opening-up and economic development of China. For the purpose of development of the Chinese economy and economics, on an academic basis, this series has employed a “double-blind review system” integrated with solicited manuscripts from experts so as to cultivate a number of Chinese academic pioneers with the spirit of rationality and exploration in the field of economics. China is an ideal country for economic research, where the diligent may make plentiful and substantial achievements.

vii

Abbreviations EU

European Union

FDI

Foreign Direct Investment

GVC Global Value Chain HOV

Heckscher-Ohlin-Vanek models

NTT

New Trade Theory

NVC

National Value Chain

ODM

Original Design Manufacturers

OEM

Original Equipment Manufacturing

R&D

Research and Development

SASAC State-Owned Assets Supervision and Administration Commission SMEs

Small- and Medium-Sized Enterprises

SOEs

State-Owned Enterprises

TVEs

Township and Village Enterprises

ix

1

Chapter

Industrial Upgrade of the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Thanks to the comparative advantage of low production cost and the excellent infrastructure of the Yangtze River Delta, the manufacturing sector of the region thrives in original equipment manufacturing (OEM) and processing trade, and the region has claimed its position in the global value chain (GVC), or in other words, in the hierarchy shaped by the global division of labor. The global value chain, or GVC, dominated and controlled by international big buyers from developed countries or multinationals, confined enterprises from the delta region to activities such as production, processing, and assembling characterized by labor intensity, low profits, and technological unsophistication. GVC has helped the region to progress to a new stage of industrialization. However, under the combined effects of an appreciating Renminbi, the surging costs of labor and raw materials, the crippled global real economy in the wake of the financial crisis, and a series of other factors, OEM, which for years has been the channel of export for the “Made in China” brand, is now being cornered by both internal and external challenges. For one thing, with the prices of end products falling and the production costs rising, the bulk of these OEM enterprises failed to buffer the pressure by transferring the pressure to the upstream of the value chain, i.e. they cannot transmit the pressure caused by rising production costs to international big buyers and outsourcers. As a result, the already slim profit margins of these enterprises went even slimmer or completely disappeared, leading to production suspension, or bankruptcy of enterprises in both the Yangtze River Delta and the Pearl River Delta. For another thing, the impact of the financial crisis in the U.S. rapidly rippled across the global real economy, causing a slump in both the demand and expectation of consumption in the developed world. This in turn led to a shrinking in China’s export market and took away many of the foreign orders the manufacturers along China’s coastline used to rely on. To make things worse, China’s constant trade surplus rekindled international trade protectionism. The export-oriented strategy relied heavily on OEM and, adopted both in the Yangtze River Delta and the Pearl River Delta, has finally seen an outbreak of its deep-seated problems. All these factors make us reconsider the possibility of harmonious and sustainable development for the Yangtze River Delta enterprises under the global labor division system of GVC, dominated and controlled by international big buyers from developed countries or multinationals. Furthermore, is it possible for these enterprises to go beyond just being “captured” and “exploited” in the current GVC labor division system, and to realize an upgrade? Given the weak growth, if not recession, in the developed world, is it possible for the manufacturing sector

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Industrial Upgrade of the Yangtze River Delta

in the region to cease its total reliance on foreign markets, and give equal focus to both foreign and domestic markets? As is widely expected, with a sustained but mild increase in China’s exports, it is also crucial that the country further expand its domestic demand, so as to steer the country’s economic progress safely and harmoniously into the next stage. Meanwhile, some scholars have made the following observation: Enterprises in undeveloped countries that had made their way into the GVC by OEM and clung to this position would usually find it difficult to climb upward along the value chain and upgrade themselves. On the contrary, those that had integrated themselves into the GVC but later turned to constructing a national value chain (NVC) that is grafted onto the GVC but also deeply rooted in these enterprises’ home countries saw a gradual industrial upgrade, and eventually developed their own international competitiveness. For supporting examples, we can refer to the initial stage of development of some international brands in the manufacturing industry of the four Asian tigers. Therefore, constructing a NVC that is joined to the GVC but has a certain degree of independence from the latter may well be a necessary step for enterprises in the undeveloped world to move upward along the value chain and eventually gain competitive strength over their rivals in the global arena. In view of this, we believe, at this time of great strategic change in the Yangtze River Delta, that it is necessary to stress the question of how to avoid being “captured” and ”exploited” in the GVC, and intensify the construction of a NVC network that is based on domestic demands. This chapter starts with a comparison of the different implications of GVC and NVC. It then goes on to analyze and compare the two important vehicles used to construct NVC specifically under China’s circumstances, which are the bilateral trading platform vehicle mode (specialized market) and the unilateral trading platform vehicle mode (leading enterprise network). By doing so, the chapter attempts to find out the possible ways for the Yangtze River Delta to construct the NVC and use it to upgrade its industry. Finally, the chapter makes a brief analysis on the possible problems Yangtze River Delta enterprises might face in the construction of the NVC.

A Comparison between the Industrial Upgrade Mechanisms of GVC and NVC The industrial upgrade mechanism and possible problems under GVC The second wave of globalization in the latter half of the 20th century was marked by the vertical division of specialized labor at the international level and, based

3

DEVELOPMENT IN THE YANGTZE RIVER DELTA

on this, the prevalence of outsourcing. The division of labor in international trade swiftly went beyond the traditional division carried out at the levels of industries or products, to the division of labor of the different processes of making one product among a set of countries. That is to say, the production process of a given product was broken down into different segments of the product’s value chain and was carried out in a set of countries or regions with different factor endowments, and therefore demonstrated different comparative strengths. The revival of international trade between the developed and undeveloped worlds during this period was, to a great extent, due to the prevalence of outsourcing. Such a form of international trade typically based on outsourcing and OEM not only facilitated the trade expansion of developed countries, but also, and more importantly, underpinned the industrialization and economic take-off of undeveloped countries. A 1997 World Bank report contends that enterprises of the undeveloped world that participated in the global export market by taking outsourced production and assembling processes from the GVC would very likely have the chance to obtain knowledge over product design, production, research and development (R&D), marketing, and management from developed countries, which would in turn facilitate the technological improvement of these enterprises, either directly or indirectly. More specifically, there are many ways in which such improvements could happen: (1) OEM enterprises in undeveloped countries may receive a great amount of technological support or technology transfer for free from the big buyers from developed countries, which would help them improve the production process (Evenson and Westphal, 1995). (2) Buyers or outsourcers from developed countries very often would gave their customers feedback, which typically includes customers’ requirements and suggestions on the products’ patterns, quality, design, functions to OEM enterprises, in order push them to follow this feedback. This, together with the fact that buyers would likely transfer various implicit forms of technologies and expertise to OEM enterprises, often improved the technological capacity of the said enterprises (World Bank, 1993). (3) Buyers or outsourcers from developed countries would often provide training and instruction for the engineers of OEM enterprises that they viewed as close partners. They might also send their own engineers to the assembly line of the OEM enterprises, providing instruction to the workers there. In many cases, big international buyers and outsourcers would invite engineers of the OEM enterprises to view their own R&D, design, and product quality improvement processes (Rhee, Ross, Larson, and Pursell, 1984; Hoekman, Maskus, and Saggi 2005). (4) In order to keep up with the diversity and changes of the global consumer market, and to meet the higher market entry standards of consumers in developed countries on the

4

Industrial Upgrade of the Yangtze River Delta

quality, types, safety and environmental requirements of products, big buyers and outsourcers from developed countries often need to transfer technology and key equipment to the OEM enterprises and give them patent authorization. This would help OEM enterprises to efficiently improve their production and product design capacity, namely, promote the development of OEM enterprises’ self-innovation capacity and facilitate their transition into original design manufacturers (ODM) (Feenstra and Hamilton 2006). Why do international big buyers spend such efforts to help OEM enterprises, which are external parameters for these big buyers and are only functioning in the GVC under the control of them? Why are they willing to pay such a high cost to establish and supervise the supply chain, instead of simply purchasing what they need in the market? There are mainly two reasons. First, it is the requirement of a product differentiation strategy. The more the buyer wants their product line to follow a differentiation strategy through design and brand building, the bigger the need for them to supervise whether their product specification is being precisely followed by their supplier or OEM enterprises. Second, it is a way to avoid default on the supplier’s or OEM enterprises’ part. In today’s market competition, non-price competition based on product quality, punctuality of delivery time and reliability is becoming increasingly important. This, together with other factors that are increasingly under the limelight, such as safety and some certain standards (labor standards for instance), constitute the overall performance of the supplier or OEM enterprises. In the increasingly fierce international competition, such factors may sometimes become the target for attack from the buyers’ competitors. For example, the high quality of the components of a product might become an important strength of the product, while violation of ethical standards during the manufacturing of the component might cause negative feelings towards the product in the market or society. However, there is ample evidence which shows that technology transfer and technology spillover based on OEM and outsourcing has a “discontinuous” and “segregating” nature, which may put the industrial progress of developing countries to a halt. When technology transfer and technology spillover based on OEM and outsourcing is beneficial for the developed country, or the outsourcer, the outsourcer would allow and encourage it to happen. In this case, the developing country, which is the home country of the OEM enterprise, would demonstrate a significant upgrade effect which is essentially a production technology upgrade and product upgrade. But when it is the opposite, the developed country or the outsourcer would “segregate” and “block” the said technology transfer and spillover. In this case, the OEM enterprise in the undeveloped country is deprived off an ascent along the GVC, which

5

DEVELOPMENT IN THE YANGTZE RIVER DELTA

often happens in the form of function upgrade and cross-sector upgrade. The outsourcer in fact puts a barrier in the OEM enterprise’s way of sustainable upgrade, thus confining the enterprise in the vicious cycle of “OEM–export– low profit–lacking brand awareness, point of sale terminal and self-innovation capacity–lacking the ability to move upward in the value chain.” At present, in the value chain that is characterized by “capturing” OEM enterprises, enterprises in the Yangtze River Delta have undergone the phase when they rapidly upgraded their production technique and products. These enterprises are now well over the stage of assembling imported components, and are focusing on improving their production capacity of complete end products. One of the most important goals of the next stage of industrial upgrade is to forge their own design capacity and to even establish their own brands. However, once they started reaching out for more high-end functions in the value chain – such as design, brand building, and marketing, i.e. trying to start a function upgrade – only a small proportion of them were able to reap modest success. The majority are still confined to the construction of production function, which forced them to rely on large-scale production, low cost, and low prices to win. An important reason for this is that the function upgrade of Chinese enterprises would, to a certain degree, replace the position of controller of the value chain, which is now held by outsourcers from developed countries or big buyers. The function upgrade of Chinese enterprises will create competition on the outsourcers or big buyers and generate a negative impact on their worldwide interests. As a result, the function upgrade of these Chinese enterprises is being resisted by both visible and invisible forces in the international market. Enterprises that tried to build their own brand might be warned of a “take-back” of orders, but only for a start. Some more unlucky ones among them might even be cornered by the outsourcers using their formidable financial power to crush these enterprises. However, moving out of the lower end of the value chain to the more profitable end is still a very realistic way for the manufacturing sector of the Yangtze River Delta to optimize its growth pattern.

The industrial upgrade mechanism and possible problems under NVC NVC develops based on the demands of the domestic market. Local enterprises are in control of the core segments of the value chain. They first acquire high-end competitiveness in the value chain such as their own brands, sales distribution channels, and self-innovation capacity, then enter the labor division system of the regional or international market. Unlike OEM enterprises

6

Industrial Upgrade of the Yangtze River Delta

and industrial sectors of undeveloped countries under GVC, enterprises or industrial sectors that mature under NVC have the potential to completely achieve a continuing upgrade including production technique upgrade, product upgrade, function upgrade, and cross-sector upgrade in the value chain. They may also demonstrate a sustainable international competitive strength (Schmitz 2004). The reasons that enterprises and industrial sectors of undeveloped countries under NVC demonstrate a full-fledged product chain upgrade ability and international competitiveness are as follows. (1) The capacity of the home market, especially the high-end market, is the most fundamental factor that determines whether local enterprises or the industrial sector can develop their own innovation ability. Either for the design and R&D of an enterprise’ product, or for the production and commercialization of this product, the most fundamental and effective incentive for innovation is the balance between the cost and return of innovation. Only when there is an increasing customer demand and a big enough base of customers who are willing and able to pay for innovative products, can the investment in advanced factors, such as innovative and R&D activities, eventually translate into the return of innovation and encourage innovative activities at the micro level of enterprises. (2) In a market where demands rapidly increase, the changes in the scale and structure of demands of the home market are a determinant of whether the upgrade of products and the industrial sector can eventually succeed. The more advanced the factors are in the product chain or value chain, the more reliant they are on the rapid growth of a market, as they need an increasing market space to realize the transfer of value and upgrade. Therefore, NVC, which relies on the home market rather than the foreign market, using the support for innovation provided by the changes of the scale and structure of home market demands, internally forges home enterprises’ or the home industrial sector ’s ability to develop advanced factors. This is called demand-based innovation. For developing countries, this has a far-reaching strategic implication. If developing countries can make full use of the changes of scale and structure of the demand of their rapidly expanding home market, and develop their own advanced factors, they will be on a level playing field with developed countries in terms of the competitiveness of their respective advanced factors. Furthermore, under economic globalization, for either a given industrial sector or the production chain of a given product, their various components have been broken down into segments and reorganized around the globe. Under such circumstances, even if developed countries have exclusive control over the technology of a certain core segment of the product value chain, as long as they have no control over the end

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

markets, they still cannot be sure whether they will benefit from their huge R&D investment in the upper part of the value chain, and, more importantly and implicitly, the control and dominance over allocation of profits. (3) Judging from the techniques used in the competition between developed and undeveloped countries in this aspect, developed countries are increasingly dependent on the construction of market entry barriers to protect their advantages. The competition has morphed, from a pricing competition, to today’s competition of the right to establish a standard market entry system. For one thing, relying on a home market entry system that is largely based on patents owned by home enterprises, developing countries can both strengthen the competitive strength coming from the advanced factors possessed by home enterprises, and establish a barrier for foreign competitors by charging for patent authorization, which would restrain imitators’ ability to catch up with patent owners and guarantee that their R&D costs are paid off. For another, the patent authorization system at home can serve as a bargaining chip in negotiation with other countries when home enterprises are seeking to circumvent other countries’ market entry barriers. The main problems for the upgrade of enterprises or industrial sectors in developing countries under NVC might be as follows: (1) Lacking the basic and key resources to upgrade. Enterprises of developing countries might find it hard to find a sustainable source for the capital that is needed for an upgrade (for example, the financial capacity to sustain long-term advertising) and human resources (for example, lacking sophisticated native R&D technicians or designers, and management level personal that are familiar with the marketplace). (2) The domestic market of a developing country might be opened to foreign competitors too early or to too great an extent, in which case, home enterprises will have to compete with very strong rivals and this will eventually lead to the crowding out effect. (3) Customers in undeveloped countries might have lower requirements for products than the international market, therefore putting less pressure for home enterprises to improve their products. In this case, policies that prevent the entry of foreign competitors may become a shield for ineffective home competitors, which would be contradictory to the original purpose to improve them. (4) Undeveloped countries may not have a market mechanism for enterprise restructuring, which in developed countries have cultivated international big names that could easily dwarf much smaller enterprises in undeveloped countries with their sheer scale and financial power. In this case, the home value chain would not have sufficient potential for extension and connection among segments. Moreover, enterprises in such value chains are often in an unstable state.

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Industrial Upgrade of the Yangtze River Delta

A comparison between the courses of industrial upgrade under GVC and NVC The differences between the courses of industrial upgrade in GVC and NVC are listed in Table 1.1. Under GVC, when the OEM enterprises in undeveloped countries try to improve self-innovation capacity, build a global brand, and establish an independent foreign sales network, they will be confronted with the positional block laid by multinationals which are in control of core technology patents and product standard system, and by international big buyers which are in control over the sale terminals of the global market. As a result, when moving from low value added segments of the value chain to the high value added segments, particularly when undergoing function upgrade or value chain position upgrade, enterprises in developing countries in GVC often face the blocking and control by international big buyers from developed countries (buyer motives) and multinationals (manufacturer motives), and are therefore confined in low value added activities like production and assembling, which are characterized by labor intensity, low profits, and low technological innovation. Therefore, under GVC, OEM enterprises in developing countries, due to the blocking and restraints of outsourcers, would find it difficult to accumulate advanced factors that are needed for sustainable economic development, such as innovation, brands, global sales channels, and high level personnel. Moreover, the fierce competition to grab high-pay and sophisticated technicians and the ensuing brain drain makes it more difficult for OEM enterprises to forge a domestic economic development cycle of highend positions–high income–high-end demands–compensating enterprises’ investment in innovation–high-end positions. To the contrary, under NVC, enterprises in developing countries can gradually develop their advanced factors through the learning curve effect and, more importantly, can forge the aforesaid domestic economic development cycle. Table 1.1

A comparison between the courses of industrial upgrade under GVC and NVC GVC

NVC

Upgrade pattern

Production technique upgrade; Product upgrade

Production technique upgrade; Product upgrade; Functional upgrade; Value chain upgrade

Brand building ability

Low

High

9

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) GVC

NVC

Ability to control sales terminals

No

Yes

Self-innovation capacity

Low

High

Market demands characteristics

No contact with end users and market; Stable demands

Direct contact with end users; Unstable demands

Controller in the value chain

No

Yes

Industrial relocation

Usually following foreign relocation cycle

Usually following domestic relocation cycle

Source: Compiled by the author.

China, though traditionally housing OEM enterprises, is now facing the rising cost of factors like labor and land price due to its rapid economic progress. As a result, outsourcers from developed countries now prefer to give their orders to other developing countries where labor and land are cheaper, instead of giving them to inland China (due to consideration for transportation cost and other transaction cost). This is unfavorable not only for the balanced development of China, but also for the sustainable development of all developing countries, as it forms a competition among developing countries in the low value added segments of the value chain. To the contrary, under NVC, due to favorable factors to enterprises in undeveloped countries such as cultural factors and their familiarity with the home market, they will normally succeed in the deployment and relocation of their domestic product chain. With the gradual increase of labor and land cost in relatively developed regions in the undeveloped countries, these enterprises can relocate labor intensive segments of the NVC to less developed regions, thereby narrowing the imbalance between developed and undeveloped regions.

The Strategic Significance of Constructing NVC At present, the manufacturing industry of China, especially those in its coastal areas, are captured by GVC, which is under the control of international buyers. Changes in orders from these big buyers not only have the fate of China’s manufacturing industry in their firm grip, but also act as an important factor that leads to some more far-reaching problems in China’s industrial development. The following problems in China’s industrial development can

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Industrial Upgrade of the Yangtze River Delta

all be attributed to this factor. First, as China’s manufacturing industry has thoroughly integrated with GVC, the country accordingly followed an external developmental pattern that relied on the import of manufacturing equipment and the export of manufactured products, which now leads to the disconnection among different segments of the domestic inter-industry cycle. As a result, the heavy industry of China, especially the R&D, production, and sales system of the industry (which used to provide equipment to the manufacturing industry), has shrunk. After the reform and opening-up, one characteristic of the surging manufacturing industry in coastal China is that the industry had to import equipment and some key intermediate products so as to meet the requirements on the end products stipulated in the orders of international big buyers. Such an export-oriented development relies on foreign buyers to digest products of the manufacturing industry and on foreign imports to purchase key equipment and intermediate products. For one thing, because the markets for the end products are in foreign countries, domestic enterprises have to abide by the technical standards required by big buyers, the product regulations set by foreign governments, and the demands of foreign consumers. Therefore, under the circumstances when China lags far behind developed countries in the production of manufacturing equipment and has no say in setting technical standards, its OEM enterprises are left with the only choice of importing technologies and manufacturing equipment from developed countries, so as to make sure their end products remain competitive in the global market. As a result, domestic manufacturing equipment producers who used to serve the needs of domestic manufacturers have now lost their market, while manufacturers continue to favor foreign-made equipment. This is in fact one of the most important reasons for the decline of northeast China, where heavy industry used to thrive. Unfortunately, this underlying cause of the region’s decline has for a long time been ignored by Chinese academia. For another thing, the heavy industry that now faces a withering market also has to face the disorder of its innovation investment and return, as demands for their products are falling, the time for their investment in R&D and the technology upgrade to be paid off by the market is now longer. Therefore, while China’s heavy industry enterprises are losing market opportunities, they are also losing the opportunity to catch up with foreign competitors technologically. Eventually, the inter-industry cycle of China has come to a stage of systematic disorder and imbalance. Second, as China’s manufacturing industry has thoroughly integrated with GVC, the country accordingly followed an external developmental pattern that relied on the import of manufacturing equipment and the export

11

DEVELOPMENT IN THE YANGTZE RIVER DELTA

of manufactured products, which caused a profound reorganization and adjustment in the industrial structure of China that eventually led to the contrasting economic landscapes of eastern, central, and western China. While the eastern coastline becomes both the most rapidly progressing region and a hub of low-end manufacturing, western and central China, whose laborintensive industry has been restrained along the eastern coastline, are reduced to be providers of raw materials and labor. The original spatial allocation of production forces in China was in line with the aforementioned inter-industry cycle. However, after manufacturing enterprises participated in the GVC, the inter-industry cycle was no longer in China and was controlled by international big buyers. Such an inter-industry cycle puts China in a passive position and deprived the country of its control over the cycle. Moreover, the cycle could no longer serve to extend and shape a balanced spatial development in China. Therefore, the growth in eastern China will only create demand for the raw materials, labor, and capital from central and western China. Moreover, as the manufacturing industry in the east participated in the GVC with the region’s good infrastructure and cheap labor, and has successfully become “the world’s manufacturing hub,” the east as a result puts the dual effect of absorbing production factors from the rest of China and, at the same time, crowding out the rest of China, where there are few relative strengths to compete with the east. This is an important contributor to the yawning gap between the eastern coastline and the rest of China, and is also an obstacle for China’s attempt to develop a multiple-layered modern industrial system. Third, as China’s manufacturing industry has thoroughly integrated with GVC, the country accordingly followed an external developmental pattern that relied on the import of manufacturing equipment and the export of manufactured products, which restrained the possibility for the country to develop its modern service industry. This may well be the most important reason that the growth pattern and the evolution of the industrial structure of the manufacturing industry have demonstrated a highly extensive pattern, which is characterized by high power consumption, technological unsophistication, and low value added. The externality of the growth pattern lies in the fact that the upper end of the value chain, the producer service industry and technology intensive industry are all in foreign countries. Ironically, the “smiling curve” of the GVC, with the lower segment in the middle left in China, and the two upper ends of manufacturing equipment production and the end market occupied by developed countries, is only making the latter smile. Through modern fictitious service industry such as R&D, design, finance, logistics, and marketing, multinationals have obtained control over the commercial activities

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Industrial Upgrade of the Yangtze River Delta

in developing countries such as production, manufacturing, and processing. The growth of the manufacturing industry in China’s coastal regions is mostly happening in segments of the value chain that typically consume resources and production factors. This growth pattern, which is characterized by production in plants and often manifests itself as increases in production capacity, has very low demands for the modern service industry. Moreover, fictitious activities in the upper end of the value chain are often carried out in the home countries of multinationals. Therefore, even if such activities are carried out more intensively and more sophisticatedly in foreign countries, the service industries of developing countries are seldom among the beneficiaries, instead, they might even be replaced by the stronger competitors from abroad. Therefore, only when developing countries in GVC strive to get rid of the control of international big buyers and develop their own manufacturing industry based on their domestic market can they provide for their knowledge-intensive service industry sufficient market demands. Furthermore, when their service industry becomes stronger, it is more likely for developing countries to move upward along the value chain and get rid of the low value added position. Fourth, as China’s manufacturing industry has thoroughly integrated with GVC, the country accordingly followed an external developmental pattern that relied on the import of manufacturing equipment and the export of manufactured products, which to some extent restrained China’s attempt to develop its modern industrial system. China’s attempt to develop its modern industrial system includes the following objectives: promoting the integration of informatization and industrialization, connecting service and manufacturing industry, promoting breakthroughs in key technologies, the scale of heavy industry, the brand building of traditional industries, progress of producer services of the high-tech industry as a whole, and forming a three-layered industrial structure that puts the high-tech industry at its fore, and makes advanced manufacturing and modern service industry as the main body and modern agriculture as its basis. Obviously, the external developmental pattern that coupled China’s industry with the GVC cannot help the country achieve this ambitious goal, because overall, neither producer service industry, nor high-tech manufacturing, nor even the brand building of traditional industries can be achieved when it is captured in the GVC. Another important factor that necessitates China’s refusal to be captured is that the Chinese modern industrial system should be a multiple-layered inter-supporting structure. If China has no NVC, the country will not have its own independent world renowned brands, and therefore will not be able to occupy the uppermost area of the modern industrial system. Under such circumstances, the central and western part of

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China will continue to be restrained by the coastal areas, which are kept in the bottom of the GVC. As a result, eastern China won’t be able to upgrade itself,

and the center and western regions of China won’t be able to take over the industries now located in the east.

In view of these considerations, if China is to make itself a mighty power of

manufacturing, it will have to pay much attention to the question of how to stop being captured in the GVC and rethink the strategic shift from integrating to GVC to constructing NVC. Reconstructing a NVC based on modern industrial system does not mean a resumption of the planned-economy-era strategy

of isolating China from the rest of the world, nor does it mean completely replacing export-oriented strategy with import substitution strategy. Instead,

China should utilize what has been achieved so far by integrating to the GVC,

and with this, reorganize the inter-industry cycle that Chinese enterprises rely on to survive and develop, reconstruct the administrative structure of NVC, and readjust the relationship among different industries scattered around

the country, so as to lay a good foundation for the upgrading of the Chinese manufacturing industry and the country’s sustainable economic growth.

Reconstructing NVC based on what has been achieved by integrating to the

GVC does not mean giving up existing market share in the international market. Rather, it means to give equal focus to both the domestic and foreign markets.

Focusing on brand building in the domestic market first and then advancing to the global market does not contradict much with what is required by keeping

the benefits of the current export oriented strategy. Doing so is different from

the case when a manufacturing enterprise simultaneously takes the orders of

international big buyers and competes with these buyers in the international market using its own brand, which would typically cause resentment and

a boycott by the big buyers. This is because giving equal focus to foreign

and domestic markets does not necessarily impede big buyers’ fundamental interests. Furthermore, the cost of implementing this strategy is relatively acceptable for small enterprises in China, and their familiarity of their home market and culture also makes the strategy more applicable.

Reconstructing NVC based on the current situation of integrating to the GVC

is a strategy that aims to generate changes from “Made in China” to “Created in China,” from an external player reliant on the foreign market to a central player

that controls the market, from OEM enterprises to outsourcers, from low-end to high-end, and from worker to boss. Clearly, this is a revolutionary reform that will affect the fate of China’s manufacturing industry.

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Industrial Upgrade of the Yangtze River Delta

The Vehicle Mode of NVC Construction and Upgrade for Yangtze River Enterprises The basic characteristics of the two vehicle modes Based on observation on the practice of Yangtze River Delta enterprises, we categorize them as two types as shown in Fig. 1.1. Fig.1.1

The two vehicle modes to construct NVC

Buyer

Buyer

Buyer

Specialized market

Manufacturer

Manufacturer

Consumer

Consumer

Leading enterprise

Manufacturer

Mode A: Bilateral trading platform vehicle Note:

Consumer

Supplier

Supplier

Supplier

Mode B: Unilateral market platform vehicle

The dotted line indicates non-market relationship, while the solid line indicates market relationship.

Mode A: The bilateral trading platform vehicle mode Considering the fact that the unit for production and global trade in the

Yangtze River Delta is not individual enterprises but mostly industrial clusters,

it is impossible for a discussion on the approaches of constructing NVC for

manufacturing enterprises in developing countries to overlook the analysis and research on the characteristics of industrial cluster as an important vehicle platform (Humphrey and Schmitz 2002).

It is clear that the rise and development of industrial clusters are to a

large extent attributed to the specialized market existing in the clusters (Lu

Lijun and Yang Haijun 2007). The specialized market has become one of the most important transaction platforms, which connects the producer supply system and the consumer demands system. It is also the most reliable and

crucial platform for Chinese enterprises to construct NVC. As a type of market transaction platform, its most prominent feature is that it demonstrates the

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

double market effect, i.e. it is simultaneously the market transaction platform for producers to sell goods and for buyers to buy goods. The specialized market, as a bilateral market transaction platform, with the reputation system and collective punishment mechanism that are embedded in a system similar to a segregated relationship-based social network, has effectively lowered the transaction cost for both sellers and buyer, restrained opportunist behaviors and moral hazards that could otherwise lead to a market for lemons, and combined in itself the three advantageous factors of economy of scale, economy of scope, and specialization (Bai Xiaohu 2004). If we look at participants in the system, we will find that the bilateral market transaction mode has connected domestic enterprises that have independent production capacity and the potential to build their own brands, and specialized independent sellers (wholesalers from home and abroad), but not direct consumers. Unlike OEM enterprise in the GVC, which can only participate in the market as the suppliers of international buyers and multinationals, the specialized market demonstrates the following advantages to be the vehicle mode of constructing NVC. First, the specialized market, as a sellers’ market, offers plenty of options for buyers. It meets the demands of both foreign buyers and domestic buyers, and both developed countries’ buyers and undeveloped countries’ buyers. Producers can switch between different buyers rather than limit their market to certain international buyers or multinationals. Second, in the specialized market, manufacturers or suppliers are not merely low-end products suppliers who have only manufacturing capacity, but highend suppliers who may already have their own brands and design and R&D capacity. This is because the specialized market can provide for enterprises a diversified market space for their upgrading in the product value chain.

Mode B: Unilateral market platform vehicle mode In reality, there are also plenty of examples for unilateral market transaction platform mode. The so-called unilateral market transaction platform refers to a mode of labor division network inside the product chain that has the following characteristics. Leading enterprise has its own brands, sales distribution channels, and capacity of innovation, R&D, and design. It occupies the peak of the pyramid-shaped product chain labor division network and has the control over other enterprises in the product chain network. The leading enterprise outsources production activities that are able to be standardized and broken down to modules and are not in the core or key areas of the product chain, to independent enterprises that cooperate with and are controlled by the leading

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Industrial Upgrade of the Yangtze River Delta

enterprise, so as to form a flexible and cooperatively effective product chain labor division network. Such a product chain cooperative network presided over by the leading enterprise is called unilateral market mode because in this labor division network, the leading enterprise should directly face consumers and have the competitive ability to directly convey to the consumers product information and features, through constructing its own brands and sales distribution channels. In addition, the leading enterprise should be able to make timely reactions to the changes in consumers’ tastes. However, the relationship between product component suppliers or OEM enterprises and the leading enterprise is not a simple market transaction relationship, but a transaction contract comprised of factor relationship-based transaction (or authoritarian-obedient relationship). The more diversified the outsourced product components are, the more relationship-based transaction nature will be observed. In this way, a multiple-layered and diversified product chain labor division cooperative system is formed, comprising enterprises both in close and loose cooperation with the leading enterprise. The closer the OEM enterprises are in relation to the leading enterprise, the bigger the chances are for them to have implicit exchanges of knowledge and technologies with the leading enterprise and the more likely they are to develop innovative R&D capacity. The unilateral market transaction platform mode under NVC requires that China’s home enterprises shoulder the responsibility of the leading enterprise, rather than letting multinationals or foreign-owned enterprises dominate the product chain labor division cooperative network. Only when Chinese manufacturing enterprises act as the leading enterprise in the network would NVC be able to possess self-own high-end upgrading capacity.

The construction and upgrading of NVC based on the bilateral transaction platform vehicle mode The specialized market, as the bilateral transaction platform that connects independent manufacturers and independent purchasers and wholesalers, is by its nature suitable and matching to the characteristics of the demands of China’s home market consumers. The imbalanced income distribution in China today has created immense low-end market demands, providing a market space based on home market for the specialized market’s bilateral transaction platform which mainly consists of low-end commodity and labor-intensive manufacturing. A large amount of Yangtze River Delta enterprises, thanks to the specialized market, have integrated into a geological industrial cluster, which then became a production network of worldwide competitiveness pivoting

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around the specialized market. After the regional brand effect of the specialized market expands worldwide, a large number of foreign purchasers swarmed into the specialized market, and meanwhile, foreign-owned enterprises also gradually integrated into the industrial clusters network based on the specialized market. The specialized market and the industrial clusters are thus inserted to the GVC and hence comes the problem of “locking in the low end of GVC.” However, in the bilateral transaction platform mode, the market of Yangtze River Delta enterprises is not totally reliant on foreign purchasers who have control over sales distribution channels abroad, as many of these enterprises occupy a decent market share in the home market. That is to say, Yangtze River Delta enterprises in the specialized market have the ability to switch between foreign and home market, rather than being locked down in the low end of GVC. With the continuous economic progress of China, its home market has seen the emergence of a large consumer base that has middle and high-end demands (the rise of the middle class), and has developed a diverse multiple-layered structure of demands, which offers to Yangtze River Delta enterprises that are attempting for NVC construction and transition from GVC to NVC, the space and opportunity for development that can be found nowhere else but China, an immense country with a sizzling economy. At present, the specialized market and industrial clusters feature a considerable influx of foreign-owned enterprises, a focus on the overseas market with the domestic market as a supplement, and a connection with GVC. The OEM orders from big buyers of developed countries have constrained the OEM enterprises in the Yangtze River Delta in an awkward situation where they typically make slim profits, have no self-owned brands and no innovation capacity, and are too reliant on foreign orders. This in turn encourages enterprises in the specialized market and industrial clusters to copy others and then make a profit out of it, which leads to the further absence of innovation and cut-throat competition among them. Moreover, specialized markets and industrial clusters which are completely embedded into the GVC and are dominated by international buyers have demonstrated an unsteady network structure of backward outsourcing. Core enterprises in such clusters which have direct contact with international buyers often construct a downstream multiplelayered outsourcing network, so that these core enterprises can transfer the pressure of lowering production cost brought by the “vertical squeezing effect” of international big buyers to downstream enterprises. Furthermore, backward outsourcing enables the flexibility of production scale, and strengthens the core enterprises’ reactive ability to supply and competitiveness brought by lower production costs. On the same layer of this downstream outsourcing network,

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enterprises compete with each other in cut-throat manners, i.e. they are in a perfectly competitive market. Therefore, these clusters demonstrate a perfectly competitive market and a vertical outsourcing market distance relationship among enterprises, rather than a close cooperative relationship. This severely challenges the upgrading ability of the specialized market and the industrial cluster to upgrade and develop sustainably. However, what makes the bilateral transaction mode special and a vehicle mode for the construction and upgrading of NVC is that it is a market transaction platform mechanism that can be embedded by governmental function. That is to say, government can make its influence on the transition of specialized market vehicle platform from GVC to NVC, and the construction and upgrading of NVC, so as to promote the upgrading and sustainable development of specialized market and industrial clusters. Government has the following tools at its disposal. The government can regulate the transaction, competition, and product quality standards, adjust market entry barrier standards, introduce and offer specialized innovation R&D public platform modules such as product design and product examination. This has provided an applicable unique method and approach for the construction and upgrading of NVC in China. More specifically, functional modules that the government can provide include the following: The government can strengthen the protection over intellectual property rights, so as to restrain the copycat, a form of cut-throat competition. The government can regulate the transaction and competition in the specialized market, so as to encourage innovative R&D and promote the emergence of leading enterprises. In the specialized market, which resembles a segregated social circle, the implementation cost of intellectual property rights protection is therefore relatively low, providing a very good platform for the government to introduce its intervention and guidance. By laying and enforcing entry barrier standards for brands, quality, environmental friendliness, safety and labor protection, the government can encourage or force enterprises to enhance product quality and quicken the upgrading and updating of products. The government can also promote a transition of the specialized market from a perfectly competitive market to a competitive monopolistic market. The government can introduce new high-tech, and highly-innovative enterprises or introduce high-end producer service enterprises specialized in product design, product examination, consulting, financing, logistics and other public innovation platform. Facilitated by these functional modules, there may gradually develop order in competition and innovation cooperative network (both vertical and horizontal innovation cooperation) in the specialized market and the industrial clusters. With these modules, the government will also be able

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to direct the product labor division chain and the value chain to extend towards the two ends of the “smiling curve” and encourage enterprises to enhance their self-innovation and product design capacity, build their own brands and sales distribution channels, promote their cooperation with specialized R&D institutes, institutionalize industry chamber and take other measures to forge the industry’s high-end competitive strength. Furthermore, the upgrading ability of the specialized market and industrial clusters also manifests itself as the extension of the product line, which in its later form, may include integrated products and complex products. A specialized market’s upgrading ability is also reflected by their ability to control, predict, and even create the demands of the domestic market and the ability to develop foreign markets. Only when we reach this point can we claim that the specialized market and industrial clusters in the Yangtze River Delta have acquired the capacity of high-end upgrading and sustainable development.

The construction and upgrading of NVC based on unilateral transaction platform vehicle The reason that the unilateral transaction platform vehicle mode can help the construction and upgrade of NVC is in the innovation and R&D capacity and the ability to adapt to the changing market of the leading enterprise of the product chain network. The leading enterprise’s own ability and its ability to cooperate with its OEM enterprises constitute the competitiveness of the NVC based on unilateral market platform mode. Unlike the bilateral transaction platform vehicle mode, government cannot actively intervene with the construction and upgrade of the NVC in this case. Instead, the market becomes the determinant here. For a leading network mode, there is pyramid-shaped labor division network that relates the leading enterprise and the smaller enterprises that it cooperates with. While the leading enterprise is in the peak of the network, dominating the rest, the smaller enterprises are providers of specialized manufacturing and related services. The relations among enterprises are mostly cooperative relationships of labor division between the upstream and the downstream. Enterprises on different layers of the network are, to a certain degree, reliant on each other. However, in the course of upgrading, the dominant leading enterprise plays the major role. The leading enterprise, which invests the most in key technology chain and therefore has core R&D capacity, is able to make use of its dominance in the labor division network to realize a sufficient compensation of its innovation investment and sunk cost. Also using its dominance in the network, the leading

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Industrial Upgrade of the Yangtze River Delta

enterprise can take the largest share of benefits from innovation. Moreover, by pressuring its OEM enterprises with a rating system and a mechanism to pick only the fittest, and by providing instructive design and production technology support, the leading enterprise can also require its suppliers to lower production costs, therefore taking over part of the profits of the multiple layers of OEM enterprises and giving the maximum support to the usually expensive innovation with money coming from sources identified in Schumpeter ’s theory. This provides a fundamental solution for the dilemma posed by the spillover effect in product innovation, which often reduces incentives of innovation. Furthermore, by outsourcing noncritical production activities to suppliers, the leading enterprise avoids the complexity which often comes as the accompaniment of increasing internal production scale in an enterprise and its negative effects on core innovation activities. This, therefore, allows the leading enterprise to concentrate all effective resources on catching external innovation opportunities, R&D, and commercialization of its technologies. In many cases, OEM enterprises participate in these innovation activities in very early stages, while the leading enterprise focuses only on setting standards and stipulating ways of connection between different modules. Furthermore, noncritical innovation activities can be allocated among OEM enterprises that separately carry out their respective tasks. All the leading enterprise has to do is set function specifications. Other innovation activities such as R&D, design, and manufacturing can be left in the hands of OEM suppliers. Such a cooperative system will not only significantly reduce the costs and time the leading enterprise would otherwise have to spend on innovation, but also make the labor division network presided over by the enterprise more flexible, effective, and adaptable to the rapid changes of the competitive environment. In a leading enterprise network, the leading enterprise, which as aforesaid, is in the dominant position of the value chain and technology chain, also presides over the design and maintenance of rules for both the competition and cooperation among enterprises in the network. It could be tempting to think that there is no hierarchical authoritarian governing mechanism on intellectual property rights in the leading enterprise network. However, looking more deeply into the network we will find that the existence of cooperative network and the anticipated profits of cooperation in the value chain and technology chain have created a flexible network governing mechanism protecting intellectual property rights based on a network of super market contract. Therefore, the intellectual property rights mechanism that originally offered insufficient external protection over such rights has morphed into a mechanism subordinate to the product chain enterprises network that

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demonstrates self-enforcing sharing and co-development of knowledge, under which, copycat behaviors are replaced by complementary cooperation in innovation. The innovation information released by the leading enterprise promotes the collective innovation activities in the multiple-layered OEM enterprises, and the overall profits from innovation are cashed through the brands and sales distribution channels of the leading enterprise and controlled by it as well, which gives it control over the allocation of the overall profits of innovation activities carried out in the whole network. By distributing the overall profits among the different innovation and production modules in the technology chain and value chain according to their contribution, the leading enterprise can effectively keep the balance between the spillover effect and the intellectual property rights mechanism. If the leading enterprise is capable of obtaining high-end outsourcing packages in the global value chain, and has the many smaller enterprises in its network listening to its allocation and indirect management, it will possibly be able to create within the product chain network an organizational structure where cooperation outweighs competition or where competition follows a certain order that will maximize the benefits for the network as a whole. Under such circumstances, the small enterprises which serve as cooperators in the labor division network will more or less undergo technology and product upgrade in their cooperation with the leading enterprise. Meanwhile, by utilizing its dominance in the NVC, and through simultaneously promoting domestic brand strategy and learning technologies from foreign markets, which are complementary to each other, the leading enterprise can make full use of the complementary nature of foreign and domestic markets. For one thing, it should actively utilize the “learning through exporting effect” and the “re-innovation after importing advanced technologies and equipments effect.” For another, it should use the technological capacity it obtained through exporting to foreign markets to strengthen its domestic competitive strength, and, based on this, further its domestic brand building and development of self-innovation capacity, and eventually achieve the upgrade of NVC. For the leading enterprise in the leading enterprise network, it can also obtain NVC upgrade capacity through a mechanism called adverse outsourcing. We will use the example of Chery Automobile to elaborate this mechanism. The carmaker has its own brand and sales distribution channels, and is the leading enterprise in the NVC of automobiles. It acquired the high-end design and R&D capacity in the automobile product chain through outsourcing design and R&D to a world renowned automobile R&D institute abroad, instead of taking the common approach of cooperating with multinationals in

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Industrial Upgrade of the Yangtze River Delta

production. More specifically, Chery sends its team to work together with the R&D institute throughout the whole R&D process. During the process, the team worked with the institute on the technological roadmap, R&D objectives, and conceptual design that are suitable for the Chinese market. By doing so, the company hoped to completely obtain the knowledge over R&D process and tools, experience and proprietary intellectual property right. Chery Automobile then extended the self-innovation pattern of engines that it learned from the R&D institute, to various key R&D areas, including complete vehicle, gear box, chassis, new energy, and hybrid car construction. This enabled Chery to swiftly graft international advanced technologies to its self-innovation activities, therefore improving its own R&D capacity and platform and the company quickly acquired a series of sophisticated technologies. There are two factors in the success of Chery that should not be overlooked: (1) The enterprise in developing countries, as the outsourcer in this case, must be the leading enterprise in the domestic NVC and must have its own brand and have control over domestic or even foreign sales distribution channels. (2) The R&D institute in developed countries, as the outsource contractor, must be in a competitive market structure, otherwise it will not have the basic motives to take the outsource package and the precondition to transfer R&D technologies. Concerning the first factor, we believe that a leading enterprise that has control over its domestic market and even certain foreign market share is in fact already a multinational. Therefore, we can say that forging a NVC based on domestic market and a leading enterprise among it, is in fact forging a Chinese multinational. They are simply two expressions for one thing.

Why Do Yangtze River Delta Manufacturing Enterprises Lack the Motives for Constructing NVC? The above analysis shows that the construction of NVC is one of the most important measures for Yangtze River Delta enterprises to cease their exportorientation in the GVC and realize sustainable upgrade and development. However, in reality, the following phenomenon can be observed: With China’s economic growth and the increase of domestic demands and changes of its spatial structure, many manufacturing enterprises in the region do not seem to be putting effort on the construction of NVC and the transition from GVC to NVC. They do not seem to value the domestic market, nor do they try to seize domestic market share and competitive strength by brand building. Instead, they would rather compete with each other as OEM manufacturers and

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participate in the GVC controlled by international big buyers or multinationals. Neither do they attach importance to the brand building in foreign markets, as their products are labeled with the big buyers’ or outsourcers’ brand and are distributed through the distribution channels of the outsourcers. These OEM enterprises have to compete with each other for the outsourcers’ orders by lower product prices. Therefore, a question must be asked. Why do the region’s manufacturers prefer GVC to constructing NVC based on domestic demands? Clearly, an in-depth analysis and interpretation of the question is crucial to our further understanding and solution of the problem.

Low-end demands in the domestic market Let’s begin with a comparison of data. According to a 2007 survey (Ding Ke 2008), in China’s beer market, the relatively low-end Yanjing Beer is sold at RMB1.89 and the relatively high-end Heineken at RMB8.9, making the latter four times more profitable than the former. In Japan’s beer market, the relatively low-end Kirin Pure Beer is sold at JPY105 and the relatively high-end YEBISU at JPY230, making the latter only 2.2 times more profitable than the former. The price difference of cigarette market in China is as big as 31.6 times (Zhonghua soft package RMB60 while Qianmen RMB1.9), while in Japan it is only 1.2 times (PARLIAMENT cigarette is JPY350 while Caster JPY290). Japan’s exports stayed steadily between 10%–14% among its GDP, while China’s export, which was mainly OEM export, rose from 5% in 1978 to 37% in 2006. After World War II, Japan’s home market demands structure is based primarily on its swelling middle class, which the country boasted to be 100 million, and this enabled Japan’s industry to rely on its home market consisting mainly of middle and high end demands and this led to the emergence of a series of world renowned brands, such as Toyota, Honda, Panasonic, Sony, Toshiba, and Hitachi. In contrast, China’s economic development fails to narrow the income gap among its population and regions. Quite the reverse, it further widens the gap between urban and rural areas and among different regions. Social demands have therefore developed into a dumbbell-shaped structure, creating immense low-end demands. This led to low social purchasing power and created the consumer preference for “low price, high quality” products and eventually for “low price, low quality” products. The high-quality products of enterprises are not popular among consumers because the scale of consumer market and social purchasing power is limited, therefore discouraging innovation by enterprises by not compensating for their innovation investment. Such market environment is incapable of developing leading enterprise in the key segments of NVC. More importantly, in an open economy,

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even the limited high-end demands in China are competed for by high-quality and high-performance branded products from foreign-owned enterprises and multinationals. Under such circumstances, home manufacturers would lose the space to develop into leading enterprises based on home market and the motives for constructing NVC. Adopting the low price competition export strategy therefore becomes the optimized and rational choice for them.

Institutional factors Through long-term field survey and observation, we believe there are two aspects of institutional factors that should be drawn under the limelight. First, with the absence of the social credibility system in China, many manufacturers selling products in the domestic market could face severe problems caused by the lack of a binding credibility system ranging from late payment or default in the chain debt among distributors to deliberate default. Compared to sales in the domestic market, with the guarantee of the irrevocable letter of credit and FOB, exporting to foreign markets has many advantages. Exporting to foreign buyers often means advanced payment, timely payment, equipment supply, the learning effect, big orders, and a steady market. Under such circumstances, even though the profit margin of exports to foreign market is lower than that of sales in the domestic market (due to the vertical exploitation of foreign dealers or outsourcers), with the better credibility system in the foreign market, many enterprises still turn to the foreign market. Second, without a proper intellectual property protection system and proper enforcement of such a system, once an enterprise makes large investment in R&D of a certain size and sells the product afterwards in the market and gains popularity, a large number of enterprises in the same industry will copy the product, either by soliciting technicians in the previous enterprises or by reverse engineering. After successfully copying the product, the copycats will sell it at a lower price to compete with the previous enterprise, therefore forcing the enterprise to turn to OEM export, so as to avoid being copied by enterprises in the same industry and being dragged into a cut-throat price war (Zhang Jie, Liu Zhibiao, and Zhang Shaojun 2008). In fact, the abovementioned aspects of institutional factors have become very important obstacles to China’s manufacturers’ construction of NVC and the nation’s transition from GVC to NVC.

The competitive behaviors of local government First, local government officials of various levels are very concerned about the achievements in their tenure, therefore paying much attention to the GDP growth of the region under their administration. The direct consequence of

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such undue focus on GDP growth is local protectionism, separation of regional market, and homogenization of industrial structures of different regions. The fact that local government officials count on GDP growth to polish their achievement, which will hopefully lead to their promotion, has a direct effect on the entry barrier of regional markets and the cost of integrating these markets. This has made it difficult for the different regions of China to combine into a unified home market, which severely hampers the developmental space for China’s manufacturers to construct NVC based on home market. Second, local government officials’ competition over GDP growth leads them to make various forms of implicit subsidy to foreign direct investment and domestic enterprises, which distorts the production factor investment cost differences and the investment-return ratio. More specifically, developed regions, in order to keep their advantages of economic scale, often offer tax rebates as a form of subsidy. Undeveloped regions, in order to catch up, offer their subsidy by consuming their environment and resources. For example, in local governments’ attempts to absorb foreign direct investment, they often offer “free land.” The cost of capital is also often artificially undervalued by preferential policies. Labor cost is undervalued due to the absence of labor protection and the social welfare system. The environmental cost of the production of enterprises is also undervalued due to local governments’ protectionist behaviors. Last but not least, Renminbi is also undervalued, together with the export tax rebate that has existed for many years, also increases the incentives for enterprises to export and are also making their products more competitive than they should have been in the international market. All these government actions greatly lower the cost of OEM export for China’s manufacturers, create incentives for them to participate in the GVC, and unfortunately, also reduce the incentives for them to construct NVC.

Conclusion and Implication The opportunities and challenges brought by GVC have been under extensive research by scholars from home and abroad. However, the upgrade of China’s manufacturing enterprises and the sustainable economic progress of the country as a whole brought by NVC has not attracted enough attention from the academy. Right now, as developed countries and emerging countries (regions) have control over the R&D capacity of core technologies and global sales distribution channels in the majority of traditional industries and emerging industries, Yangtze River Delta manufacturers mostly fell into the captive network of GVC

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and are structurally locked up. Enterprises in this region that participated in GVC, when attempting to move from the low value-added link to high valueadded link of the value chain (i.e., to develop self-innovation capacity, build their own brands, construct international market sales distribution channels, etc.), are under the attack and control of international big buyers (buyer-driven) or multinationals (producer-driven) from developed countries and a number of emerging countries. As a result, those enterprises are confined in the low-end part of the GVC, which is characterized by low value added and low profits, and may eventually be locked up in the cycle of OEM–low profits–lacking selfinnovation capacity. Therefore, the export-oriented strategy of enterprises in coastal China that rely heavily on OEM, are under extensive challenges. In view of the awkward situation of China’s manufacturing enterprises due to GVC, we made an observation underscoring the significance of constructing a home-market-based NVC on the sustainable economic development of China. Based on a comparison between the implications of GVC and NVC to China’s economic development, we made another comparison and analysis on the two important vehicle modes which can be used to construct NVC in China, i.e. bilateral transaction platform vehicle mode (specialized market) and unilateral transaction vehicle mode (leading enterprise mode). Through these, we try to find out the approach to construct NVC and rely on NVC to upgrade manufacturing industry, as well as the approach to a balanced development of both GVC and NVC in China. Furthermore, we made a brief analysis on the possible problems during the construction of NVC. There are many factors of different natures that affect the construction of NVC in the Yangtze River Delta. Some of these factors are rooted in economic development, and some are on policy and government actions. Moreover, the vehicle mode of NVC construction in China is going to change as the economic development of China evolves. In addition, China’s labor force, as its factor endowment will continue to exist for a considerable time, therefore developing processing trade, and promoting various forms of international outsourcing (service outsourcing for instance), should still be an important and practical policy that should be carried on. Therefore, the question of how to maintain balanced development between NVC and GVC still needs further study.

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2

Chapter

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction A great number of studies have been done by economists on the dual economic structures of urban and rural areas as well as those of agriculture and industry. In these studies, the course of economic development has been viewed as a process of the perennial transfer of labor from rural areas to urban areas, and from the agricultural sector to the industrial sector, until equilibrium is reached. However, from a geographical point of view, such flows of labor between sectors are bringing unharmonious factors to a country’s economy, as such flows may lead to the dual structure of developed and undeveloped regions. Although such a dual structure could have been explained by the “hub-andspoke” model, as the gap among regions in the levels of economic development has been constantly under expansion which demonstrates rigidity, it still seems better that we think of it as a dual structure. Under the regional dual economic structure, the task of economic development is to dismantle the “hub-and-spoke” structure and replace it with a new structure characterized by the coexistence of multiple centers. However, if we continue seeing it from the perspective of labor transfer, there seems to be no incentives that can explain the formation of multiple centers. This chapter, through a series of surveys on the development of southern and northern Suzhou Province in the past two decades, especially surveys specific industries that are more sensitive to labor and land cost and are therefore relocating from the south to the north of the province. It is found that the labor transfer typically observed during the formation of multiple centers is only a façade, while the underlying incentives of such transfer are the transfer of industrial capital and technologies. The reason for this is not difficult to understand. As the dual economic structure intensifies, the concentration of industries and labor continue until they reach a certain scale when there will be a decentralizing force driving the said two away from the center. Meanwhile, the less developed regions lacking industries in turn gain attraction with their cheaper labor and lands and start to absorb capital. The reverse flow of capital thus leads to a reverse flow of labor, providing the human resources base and along with it the expertise that the industrialization and urbanization of these regions require. Even under such circumstances, the gap between the developed and less developed regions might still widen due to the combined effect of the developed regions. But the less developed regions will still become centers that continue to absorb labor thanks to the influx of industrial capital. Such changes in the incentives will lead to the gradual weakening of the dual economic structure.

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

For both of the two dual economic structures, i.e. those between urban and rural areas and those between industrial and agricultural sectors, our observation shows that as economic progress proceeds, the income gap at first widened, but will later begin to narrow down. The chapter theorized the process of the development of the dual economic structure of Jiangsu Province, and conducted an empirical analysis based on the data of the province. Although the province ranks among the most developed provinces in China, it also demonstrates the biggest gap between its developed regions in its south and the less developed regions in the north. Moreover, the province also demonstrates a dual economic structure between its urban and rural areas, making it a very good target of the surveys this chapter needed in order to study the two dual structures between agricultural sectors and industrial sectors, as well as between different regions. The analysis of this chapter, which is about the dual economic development that is accompanied by industrial transfer and adjusted by spatial factors, is in fact a summary of the experience of Jiangsu Province. The chapter combines the industrial transfer mechanism with the urbanrural dual economy theory, and analyzes the change over labor transfer mechanism under the combined effect of dual economic structure between sectors and space, i.e. from outward transfer to inward transfer. When the township and village enterprises (TVEs) of developed regions thrived, less developed regions narrowed the gap between them and developed regions with the outward transfer of labor, whereby, the laborers could earn higher wages. For developed regions, inward transfer is still the major transfer mechanism, i.e. the development of township and village industry is mainly used to facilitate the transfer of labor from local agriculture to local industrial sector, therefore narrowing the gap between urban and rural areas inside the developed region. However, with the increasing influx of labor, industries in the developed region will undergo the decreasing returns to scale, especially the weaker enterprises. These enterprises, which are more sensitive to labor and land costs, would relocate themselves in less developed regions in order to survive. This provides the preconditions for the surplus labor of the less developed regions to move into the industrial sector in their own place. Therefore, in the double dual economic structures between sectors and regions, the changes in the dual structure between regions, which often occur in the form of transfer of industrial capital, lay the economic foundation for the inter-sector transfer of labor, i.e. dismantling the dual structure between sectors. The change from outward transfer to inward transfer, a change in the spatial pattern of labor transfer between sectors, is the main characteristic of the development of the dual structure in the coastal areas of China. Through an empirical study on the

31

DEVELOPMENT IN THE YANGTZE RIVER DELTA

factors affecting the dual economic structure based on the data of 13 prefecture cities in the Jiangsu Province during 1996 and 2006, this chapter concludes that the proportional increase of non-agricultural labor and the strengthening of FDI on the government’s part will facilitate the narrowing of the income gap between urban and rural areas. This chapter also concludes that the expansion of market scale can consolidate the income gap, that the income gap in southern Jiangsu Province and in coastal areas is significantly lower than that of the rest of the province, that the regional coordinative development policy is making little contribution to the narrowing of income gap between sectors, and that the mechanism that determines the size of the income gap varies dramatically from region to region. However, overall, among the three major factors of market, factor endowments and policy, forces that encourage the expansion of dual economic structure are still in dominant positions, which means that in Jiangsu Province, the polarizing effect is still dominating the economy.

Case Study: Jiangsu Province Expanding gaps between rural and urban areas, and between regions In the process of economic development, the gap between urban and rural areas, as well as that among different regions, is expanding, namely, the worsening dual economic structure is still common in China. In this aspect, even Jiangsu Province, the richest province in China and one that develops with an unheard-of rapidity, makes no exception. From the aspect of urban and rural development, the province is also experiencing an expanding gap between the two. In terms of its urban and rural areas, the gap in-between is also expanding. As shown in Fig. 2.1, the urban-rural gap in Jiangsu Province in the planned economy era was below the national average. In 1957, for instance, the national average was 3.22, against 2.79 in Jiangsu Province, which, however, was still higher than the figures in Zhejiang and Guangdong Provinces, which were, respectively, 2.16 and 1.4. The period between the economic reform of 1978 and 1990 was marked by a narrowing gap of the urban and rural income, thanks to the reform in China’s countryside. However, after this period, the gap began to enlarge. The income gap in Jiangsu Province basically evolved at the same pace as the national one, except for the fact that it is relatively narrow when compared to that of Zhejiang and Guangdong Provinces. In 1990, the urban-rural income gap in Jiangsu Province was 1.53, while those in Zhejiang and Guangdong Provinces were 1.61 and 2.05. After 1990, the income gap of Jiangsu Province continued to be lower than those of the two provinces. In 2006,

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

the respective urban-rural income gaps in Jiangsu, Zhejiang, and Guangdong Provinces were 2.42, 2.49, and 3.15, all below the national average of 3.28. Fig. 2.1

The urban-rural income gaps of Jiangsu, Zhejiang, and Guangdong provinces and the national average 3.50 3.25 3.00 2.75 2.50 2.25 2.00 1.75 1.50 1.25 1.00

1957

National average

1980

1990

Jiangsu

1998 Zhejiang

2002

2006 Guangdong

Before the reform and opening up, the income gap of Jiangsu Province stayed on a relatively high level, but after the reform, especially after 1990, the gap waned to a relatively low level. The underlying cause was the difference between the developmental pattern of Jiangsu Province and that of the rest of the country. In the 1980s and the first half of the 1990s, the TVEs in southern Jiangsu Province prospered and laid a good foundation for the local surplus agricultural labor to transfer to the industrial sector. The booming TVEs in the region gave the rural population a second chance to enhance their earnings after the systematic efficiency of the responsibility contract system, a product of the reform in the countryside, had been depleted. Zhejiang Province, whose economy consists of mainly private business, has also demonstrated such an income-allocation effect. However, for Guangdong, whose economy had long been established as an export-oriented one characterized by the concentration of industries in urban areas, its rural population didn’t benefit from its economic development, therefore leading to an enlarging gap after the reform and opening up. Like other provinces, the more striking difference has been observed among the incomes of different regions. Since 1996, the south, the center, and the north of the province started to demonstrate a trend of enlarging income

33

DEVELOPMENT IN THE YANGTZE RIVER DELTA

1

gaps as the province’s economy progresses. As shown in Fig. 2.2, the respective GDP per capita in the south, center, and north of the Jiangsu Province in 1996

were RMB15,535.66, RMB6,807.57, and RMB4,557.46, and in 2006, RMB47,512.31, RMB23,623.59, and RMB13,766.26. The respective growth rates of the three regions in these years were 12.10%, 13.43%, and 11.79%. However, the relatively high

growth rate of the central region was due to the rapid growth in 2006, which

reached an annual rate of 27.01%. In the same year, the south’s GDP reduced by 5.23%. Therefore, during 1996 and 2005, the south enjoyed the highest overall

growth rate, while the center’s rate ranked the second, and the north’s rate ranked the third. Fig. 2.2

The pattern of GDP growth of the three regions in Jiangsu Province (RMB) 60,000 50,000 40,000 30,000 20,000 10,000

Southern Jiangsu

Central Jiangsu

06

20

05

20

04

03

20

20

02

20

01

20

00

20

99

98

19

19

97

19

19

96

0 Northern Jiangsu

However, from 2004, the central part of the province started to accelerate in

a faster speed than the south, demonstrating a momentum that if maintained,

might help the center catch up with the south. Under such a growth pattern, the income gaps among regions at first seemed to be rising at an unstoppable rate, but in recent years they have taken a turn. According to Fig. 2.3, between 1996 and

1999, the gap between the GDP per capita of the south and the north enlarged only

by a small amount, with the value of the gap being less than 3.5. However, in the period starting from the following years till 2005, the value had been on a constant

increase, till it peaked at 4.51 in 2005, which then slumped to 3.45 in 2006. The gap

between the south and the center had been increasing before 2003, which climbed

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

from 2.28 in 1996 to 2.74 in 2003. After this, due to the accelerating growth of the center, this value started to drop. By 2006, it had dropped to 2.01. Before 2003, the gap between the center and the north had been a steady one, averaging at 1.48. But a continuous rise had brought the value to 1.71 in 2006, which was due to the relatively slow economic progress of the north during these years. Fig. 2.3

The ratio among the GDP per capita of the three regions in Jiangsu Province

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Southern/Northern Jiangsu Southern /Central Jiangsu Central/Northern Jiangsu Since the advent of the 1990s, the urban-rural gap and regional gap in Jiangsu Province have been enlarging, which contradicts with the concept of harmonious society that the central government has been advocating. In the following, we will analyze the changes over the ways in which market and the government facilitated the harmonious development of both rural and urban areas and among different regions. Furthermore, we will pay special attention to how the government utilized its policies and guidance to narrow the gap among regions.

Facilitating the convergence of economic development between urban and rural areas and among different regions According to the general process of economic progress, the flow of labor and capital are important factors in shaping the structure of profit allocation between

35

DEVELOPMENT IN THE YANGTZE RIVER DELTA

urban and rural areas, and among different regions. Regional and urban-rural wages difference often results in the flow of labor and therefore narrows the income gap among such regions and areas. Likewise, the difference in investmentreturn ratios results in the flow of capital, and therefore leads to the convergence of the ratios among such regions and areas. However, the first mover advantage urban areas and developed regions, as well as the returns to scale effect due to the industrial clusters in such regions and areas, may reduce the positive effect of the flow of labor and capital in narrowing the gaps among sectors and regions. The government uses its industrial policies to balance the flows of factors among sectors and regions so as to bring about a coordinated regional development. In Jiangsu Province, the flow of labor has always been a positive force in terms of narrowing the urban-rural income gap, which is to be shown in the next sections. Since the reform and opening up, the production force in agriculture has undergone a drastic increase due to the introduction of the family contract responsibility system, which led to a large amount of surplus labor in the sector. The surplus labor started to flow into urban areas in search of non-agricultural employment opportunities. Since then, with the continuous progress of both urban and rural industrial sector, and the further increase of agricultural productivity, rural surplus labor never stopped flowing into non-agricultural sectors either by inward transfer or outward transfer. Spatially, such a flow transferred labor from undeveloped regions to developed regions. Table 2.1 and 2.2 provide the patterns of changes in the inward transfer and outward transfer in the process of Jiangsu Province’s economic development. In terms of the labor transfer within the countryside, the proportion of non-agricultural labor has been constantly increasing, rising from 10.02% in 1978 to 40.78% in 1988, 52.09% in 2003, and finally, 58.14% in 2005. According to Table 2.2, the proportion of labor transfer bound for urban areas, i.e. outward transfer, was also on the rise, from 5.7% in 1995, to 28.4% in 2005. Obviously, inward transfer outgrew outward transfer by a large proportion. The underlying reason is that the abundant TVEs and the rural industry based on them in southern Jiangsu Province had become an important receiver of the inward transfer of the enormous surplus labor in the area. Table 2.1

Changes in rural labor from 1978 to 2005

Year

Rural labor force (10,000)

Agricultural labor force (10,000)

1978

2,256.69

2,030.67

1979

36

2,236.21

1,972.05

Nonagricultural labor force (10,000)

226.02

264.16

Proportion of agricultural labor (%) 89.98

88.19

Proportion of nonagricultural labor (%)

10.02

11.81

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

(Cont'd) Year

1980

1981

1982

1983

1984

1985

1988

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Rural labor force (10,000) 2,263.98

Agricultural labor force (10,000) 1,952.15

2,323.27

1,983.33

2,387.27

1,992.02

2,440.25

2,006.79

2,519.66

1,784.62

2,598.12

1,703.2

2,737.21

1,620.82

2,786.86

1,714.49

2,798.86

1,739.98

2,801.66

1,691.69

2,789.30

1,625.87

2,782.56

1,591.26

2,773.04

1,541.33

2,758.49

1,530.2

2,750.4

1,532.52

2,735.91

1,531.46

2,709.38

1,505.01

2,688.03

1,480.22

2,684.41

1,453.43

2,647.64

1,376.77

2,649.08

1,269.08

2,665.00

1,186.62

2,659.32

1,113.09

Nonagricultural labor force (10,000) 311.83

Proportion of agricultural labor (%) 86.23

339.94

85.37

433.46

82.24

395.25

735.04

894.92

1,116.28

1,072.37

1,058.88

1,109.97

1,163.43

1,191.30

1,231.71

1,228.29

1,217.88

1,204.45

1,204.37

1,207.81

1,230.98

1,270.87

1,380.00

1,478.38

1,546.23

83.44

Proportion of nonagricultural labor (%) 13.77

14.63 16.56

17.76

70.83

29.17

59.22

40.78

65.56

61.52

62.17

60.38

58.29

57.19

55.58

55.47

55.72

55.98

55.55

55.07

54.14

52.00

47.91

44.53

41.86

34.44

38.48

37.83

39.62

41.71

42.81

44.42

44.53

44.28

44.02

44.45

44.93

45.86

48.00

52.09

55.47

58.14

Source: Official website of the statistics bureau of Jiangsu Province.

Table 2.2 Year 1995

Outward labor transfer of Jiangsu Province from 1995 to 2005 Total rural labor force (10,000) 2,773.04

1996

2,758.49

1998

2,735.91

1997

1999

2,750.4

2,709.38

Outward labor transfer The proportion of outward population (10,000) labor transfer population (%) 158.06

195.85

206.28

262.65

335.96

5.7

7.1

7.5

9.6

12.4

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Year 2000

2001

2002

2003

2004

2005

Total rural labor force (10,000) 2,688.03

2,684.41

2,647.64

2,649.08

2,665.00

2,659.32

Outward labor transfer The proportion of outward population (10,000) labor transfer population (%) 465.03

491.25

17.3

18.3

556.83

21.03

699.20

26.2

629.00

754.50

23.7

28.4

Source: Official website of the statistics bureau of Jiangsu Province.

Underlying the labor transfer was the upgrade of industrial structure, namely, the development of non-agricultural sectors. The development of the export-oriented economy in the late 1990s spurred the progress of heavy industry and resulted in the concentration of labor in the industrial sector. According to Fig. 2.4, since the reform and opening up, the industrial structure of Jiangsu Province has been marked by its constant upgrade and the development of heavy industry. The proportion of the first industry saw a slight increase before 1984, but started to fall in the years that followed. On the contrary, the industrial sector has always been dominant, accounting for around 50% of the provincial economy ever since the reform and opening up. Service industry also saw a profound increase, accounting for 19.8% of the provincial economy in 1978 to 36.3% in 2006. Industry and the pattern of capital transfer determined by it steer the direction of labor transfer, especially under the circumstances when labor is employed by capital. Another great force driving labor transfer is inter-regional industrial transfer. The development of southern Jiangsu Province is the very result of industrial transfer by receiving industries transferred from developed countries and regions. Likewise, the recent rapid development of central and northern Jiangsu is also achieved by receiving foreign direct investment. Nevertheless, besides the transfer of labor and capital, government actions are also exerting a great influence. The development of TVEs is to a great extent due to the institutional innovations in the economic aspects by basic government units, which facilitated the transfer of a large amount of rural labor. In the initial phase of reform and opening up, rural labor transfer was largely carried out voluntarily. Later, as labor transfer demonstrated its positive effects on increasing the income of the population in undeveloped regions, the government started to facilitate the inter-sector and inter-regional rural

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

labor transfer. When TVEs were the main receivers of surplus rural labor, due to which they were often technologically unsophisticated and labor-intensive enterprises, no special training was needed for these rural laborers, and there was no information barrier for the transferred labor. Therefore, the government needn’t participate in such transfer in most cases. However, when TVEs started to morph into private-owned enterprises and embarked on the transition from labor-intensive enterprises to capital and technology-intensive enterprises, and when the rapid progress of the export-oriented economy of southern Jiangsu led to an increasing outward transfer of labor and information, and labor skills became important factors that hampered the transfer of labor. In this case, the government needed to, for one thing, offer information to laborers by strengthening communication among local governments, and for another, facilitate the employment of laborers by providing direct training for them, so as to promote inter-regional labor transfer. Since the tenth five-year plan period, the various levels of government in Jiangsu Province have taken outward labor transfer as the priority among other things related to social economic development and rural areas administration. They underlined efforts to increase such transfer as the most important approach to improve rural income. The province pledged to increase its yearly export of laborers by 500,000 people for eight years starting from 2003, making the yearly export total 700,000 people, so as to transfer its 5 million agricultural

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Changes of the proportions of the three industries of Jiangsu Province since the reform and opening up

1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Fig. 2.4

The primary industry

The tertiary industry

The secondary industry

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

surplus laborers into non-agricultural sectors. To this end, the provincial party committee and the provincial government carried out the following measures. First, a working team was set up to strengthen the coordination of rural labor outward transfer. And the government stressed the importance of such labor transfer for the whole province, especially for its northern part, where economic development was relatively backward. Second, the southern part of the province was coupled with the north so as to promote an orderly labor transfer from the latter to the former. Third, constructing a labor market which connected both the rural and urban areas. Fourth, strengthening investment in such transfer. The provincial government invested RMB20 million in 2003 and RMB40million in 2004 to provide training for millions of rural laborers. Fifth, improving the employment environment for transferred laborers. The implementation of these measures greatly promoted the labor transfer of the whole province. By the end of 2005, the total number of transferred laborers had reached 7.545 million, compared to 2.893 million by the end of the ninth five-year plan period. The yearly increase after 2003 reached 578.6 thousand laborers, or 10.2% yearly, making it the best year in this regard. Compared to labor transfer, the government played a bigger role in the balanced development among regions. Faced with an ever-enlarging regional gap in the province, the provincial party committee and the provincial government set up a coordinating team aimed at bolstering up northern Jiangsu as early as 2003. The team was headed by the then vice provincial governor, Liang Baohua, and convened a meeting every one or two years, the gist of which was jotted in a summary and used to provide guidelines for the initiatives to spur the region’s economic development. The 2007 Tasks for Provincial Government Bodies and Organizations to Support the Economic Development of Northern Jiangsu Province put forth in 2007 required almost all government bodies and stateowned commercial banks to provide support to the development of the region in the forms of policies, capital, technologies, and education. In the fiscal aspect, the provincial government used preferential policies to support industrial transfer inside the province and the construction of the value chain. For instance, the 2004 provincial fiscal budget reported that in the attempts to forge Jiangsu Province into a well-off and modernized province, the province was to offer preferential policies and an increased fiscal support to “the solution of the countryside-agriculture-peasant problem, the development of northern Jiangsu, and the impoverished population.” The following annual fiscal budgets all contained content related to supporting the development of northern Jiangsu and the industrial transfer from the south to the north. The provincial department of science and technology published Some Suggestions on Further Strengthening

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

Technological Work in Northern Jiangsu Province in early 2008 and, starting from the same year, integrated the then existing provincial Xinghuo subsidy fund, technology-based economic progress fund, agricultural development fund, and other related funds, and established the northern Jiangsu Province technologybased development fund, which is dedicated to supporting technological innovation projects in the region so as to spur leap-forward development there. On the macro level, the province’s every five-year plan stipulates in detail all aspects of the objectives of the province’s social and economic development. Stipulated by such plans, the planned industrial structural adjustment and developmental plan, as well as the technological development guidelines, all shape a very good environment with policies for the self-innovation and technological innovation of enterprises in the province. For example, under the guideline of The Eleventh Five-year Plan of Jiangsu Province, The Industrial Structural Adjustment and Development Plan in the Eleventh Five-year Plan of Jiangsu Province proposed the following objectives according to the insufficient energy resources, lands, and environmental factors of the province: increase the concentration of industries, improve self-innovation capacity, coordinated development capacity, energy efficiency, and related services of production. In view of the developmental stage of industries in Jiangsu Province, their environment of their development and these industries’ characteristics, the plan also proposed that the province should consolidate and further the advantages of production equipment manufacturing, IT industry, petrochemical industry, develop the four emerging industries of biotech, new medicine, new materials, and new energy, reenergize the four traditional industries of textile manufacturing, light manufacturing, metallurgy and construction materials and, finally, speed up the development of the producer service industry. In view of the unbalanced development between the south and the north of the province, the plan also made its guidelines over the reshaping of the industrial landscape and industrial transfer. The guidelines included constructing an industrial network consisting of four vertical and three horizontal lines. The four vertical lines are respectively along the riverbank, along the Shanghai-Ningbo railway, along the eastern Longhai line, and along the coastal industrial line. The three horizontal lines are the Su-Tong-Yan line, Xi-Chang-Tai line, and the Ning-Zheng-YangHuai line. The Technology Development of the Eleventh Five-year Plan of Jiangsu Province also made a detailed plan for the technological innovation system of the province, which consists of three aspects, namely, technological innovation and industrialization projects, major technological demonstration projects and major technological infrastructure construction projects. More specifically, the plan offered its guidelines in 15 aspects including IT industry, modern equipment

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

manufacturing, new materials, and their application, innovative medicine, new energy and energy saving, modern agriculture, and others. In terms of credit support, major commercial banks followed policy guidelines and provided sufficient support to the connection of northern and southern Jiangsu Province. For example, in October 30, 2006, the Jiangsu branch of the Agriculture Bank of China provided RMB1,200 million of credit support for enterprises from the south that are relocating to the north. Enterprises participating in this activity were mostly key clients of the branch. According to the contract signed that day, the branch was to offer these enterprises a set of preferential policies in financing them. In August 21, 2007, the China Development Bank provided the Susu Industrial Park with a RMB600 million loan with 10-year maturity, which would be used in infrastructure construction that would make it more convenient for the north-bound industrial transfer 2

from the south. In a word, government policies and actions are exerting a significant influence on the flow of factors among regions. Lands, taxes, and credit projects, which are typically under local government control, are very attractive factors in the spatial transfer of industries, especially industries that have a less resilient labor cost. The industrial upgrade of the north provides an opportunity for the south to get rid of industries that lag behind the overall development of the region. However, since the founding of the coordinating team of the development of northern Jiangsu Province, few immediate results in a more balanced development among regions have been achieved by their work. Nevertheless, since 2003, the gap between the center and the south has appeared to be narrowing. In 2007, the gap between the north and south finally started to narrow too. But still, whether the regional coordinated development policies will continue to work remains an uncertainty. Despite all these uncertainties in the future, the past experience of Jiangsu’s development provides us with a classic case where the two dual economic structures of both sectors and regions were tackled at the same time. Moreover, it can be viewed as a test for the capacity of the coordinated development pattern for both sectors and regions under government guidance.

Theoretical Background Classical theories There are plenty of studies on the dual economy in economic development. The classic dual economy model in the division of urban and rural labor was

42

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

proposed by Lewis (1954). Under this model, an economy consists of two components, namely, the highly effective industrial sector and the ineffective agricultural sector. The backward agricultural sector houses an immense supply of surplus labor, which is making zero marginal contribution to the sector. To the contrary, the productivity of urban industrial sector is relatively high, and the growth in production of the sector posts an immense demand for labor. Under such assumption, economic development can be seen as a process where the industrial sector absorbed a large amount of surplus labor from the agricultural sector to provide them with very low wages, so as to underpin its continuous growth. Before the entire surplus labor pool of agriculture is absorbed by the industrial sector, the agricultural sector will be free from any negative effect and the welfare state and economic level of the whole society will improve. However, the presumption about the rural surplus labor and the zero agricultural marginal productivity was criticized by Schurz (1964, 1967). Schurz holds that there is no surplus labor in agriculture. He believes that even in traditional agricultural society, the agricultural sector as a whole is still productive. The agricultural production and investment will bring about certain marginal productivity, rather than none. This productivity will also react positively to economic incentives. In other words, the agricultural sector is in a highly effective but unbalanced state. However, the dual economy model of Lewis gains tremendous popularity, as it seems to reflect the essence of developing economies, namely, the large-scale labor flows between urban and rural areas and between the industrial and agricultural sectors. Some other economists modified this model, making it more in line with the actual states of developing economies. For example, Todaro (1969) and Harris and Todaro (1970) took into consideration the actual state of developing economies and based the urban-rural labor flow on the comparison between the migrants’ expected income of the two regions. The model presumes that the rural labor market is perfectly competitive, the wages offered by urban formal sectors are above the market clearing level, and there exists the urban informal sector while only urban residents can land jobs in the formal sector. Under such presumption, the expected incomes of the urban and rural sectors determine the direction of labor flows. Moreover, under a balanced state, labor employed by the urban formal sector enjoys a better living standard than labor employed in the agricultural sector. Fei Jinghan and Ranis (1997) adopted a three-staged dual economy transition, and also took into consideration the effect of agricultural surplus labor on the expansionary speed of industrial sector and the speed of outward rural labor transfer, therefore demonstrating the inter-reactive process among different sectors during the process of dual economy transition. In the

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

first stage, the marginal productivity of part of the agricultural labor is zero, namely, there exists some absolute surplus labor. In this case, the least possible wage level provided by the industrial sector can absorb a continuous supply of labor, which will deal no harm to the agricultural sector. Soon after the absolute surplus agricultural labor has been completely absorbed, the dual economy morphs into the second stage. Due to the wage gap between the industrial and agricultural sectors, even agricultural labor whose marginal productivity is above zero will be absorbed by the industrial sector. This will lead to a decrease of agricultural output, which will in turn cause an increase in the prices of agricultural products and therefore a rising wage level in the agricultural sector. As soon as the wage levels of the two sectors meet, the dual economy will morph into the third stage. The dual economy in this stage is in fact a unitary economy, or in other words, the economy has unified its agricultural and industrial sector. More complex extension of the model includes the job hunting problem during population relocation (Carrington et al. 1996). For one thing, when migrating to urban areas, rural laborers will have to calculate the chances of being employed in cities, which are related to the laborers’ personal backgrounds (such as education, age, and gender). For another, laborers migrating later face a reduced cost of job hunting than those migrating earlier, therefore, the urban-rural labor flow depends on the net present value of the expected income of migrant laborers. This model takes into consideration the externality of earlier migrants to later migrants, which manifests itself by reducing the latter ’s cost of migration and job hunting, therefore resembling to a large extent the situation of labor flows in China.

Domestic studies The dual economy theory founded by Lewis has been given a lot of attention by Chinese scholars due to its excellent applicability on developing economies. Domestic scholars have made a series of innovation and expansion efforts based on this theory by combining the characteristics of China’s economy to the theory, which have produced a large amount of new theories and empirical literature. Based on the history of the industrialization of China’s villages (TVEs), Ma Xiaohe (2002) proposed an economic structure where there are two dual economies, with the first being the traditional urban-rural dual economy, and the second a dual economy inside rural areas (rural industries and rural agriculture). Before this, Chen Xiaobing (1999) held that there was another kind of double dual economies in China, which were the Lewis model and a

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

dual structure in the organizational level, where market economy and planned economy coexist. Therefore, the dual economy in China is not only on the economic level, but also on the institutional level. Zhang Guiwen (2001) on the other hand, made an analysis from the historical perspective on the formation of China’s dual economy. He proposed that, in the years close to the founding of Communist China, the preferential policies given to the heavy industry of China that aimed at helping the industry catch up with heavy industry in developed countries, would inevitably lead to a dual economic structure between urban and rural areas, where the latter was being exploited to serve the needs of the former. Such an institutional arrangement, and the dual economy as a result of it, explains the origin of China’s dual economy, while in the Lewis model, the dual economy between subsistence sector and capitalist sector is brought into shape by external causes. The dual economy under planned economy is entirely the result of policies. Therefore, the transition of such a dual economy also needs changes in policies concerning urban and rural areas, as well as industry and agriculture. This is in line with the fact that the transition in China’s dual economy started from the reform and opening up. However, the tendency in policy-making favoring urban areas and industry over rural areas and agriculture has not changed in many years. Therefore, forsaking the differential policies between China’s rural and urban areas and overhauling the institutional system of the urban-rural dual economy is the institutional guarantee for the transition of the country’s dual economic structure (Li Xue 2006). Considering these deeply-rooted institutional factors behind the dual economy, Shi Lichuang and Bai Xiaohu (2008) concluded the economic growth pattern under the double dual economies based on the experience of Hangzhou. The double dual economies refer to the dual economy between sectors and the dual institutional structure. They believed that the pattern of institutional transition with planned economy excluded (i.e., the industrialization of rural areas) is the main engine for the transition of the dual economy, whereby, the coordinated development between urban and rural areas will eventually be achieved. Similarly, Ding Zhaoqing (2004) proposed the concepts of “dual economy dominated by administration” and “dual economy dominated by the market.” The solution for any dual structure often lies in bringing about improving the level of industrialization and modernization in backward sectors, in which institutional arrangement controlled by the government is often the fundamental approach to transform dual structures of all kinds. However, due to the special stage of China’s current economic transition, the country’s dual economic structure often demonstrates a set of diversified

45

DEVELOPMENT IN THE YANGTZE RIVER DELTA

features. Apart from the traditional dual economic structure, there are also other forms of dual economies. Although the aforementioned research has distinguished the institutional dual economy from the traditional one, fundamentally, they are one structure, as the institutional dual structure can also be viewed as merely the cause for the economic dual structure. The socalled double dual economies are in fact two forms of one dual economic structure. This chapter proposes another dual economic structure, which is the dual economy among regions. Concerning the dual economy among regions, a large amount of studies have been done, but most of them are confined to the perspective of unbalanced regional development. Moreover, the unbalanced regional economic development is, to a large extent, attributable to the policymaking of the central government, which allowed eastern China to embrace development. However, to what degree can the perspective of unbalanced regional development be applied to the dual economy in the Yangtze River Delta, the whole of which belongs to the eastern coastal region, requires further study. Therefore, this chapter looks at the formation and transitional process of both the dual economy between sectors and that among regions based on the development of Jiangsu Province.

Theories and Quantitative Model on the Evolution of Dual Structure Expansion of classic dual economy theories The dual economic structure combining with spatial factors As can be seen in earlier sections, in the classic dual economic model, the spatial factor was assimilated into the sector factors. In other words, with the presumption that industrial sectors locate in urban areas and the agricultural sector locates in rural areas, the industrial-agricultural dual structure is equal to the urban-rural dual structure. However, such a division is abstract in a spatial sense, as neither urban area nor rural area is a specific spatial concept. The southern part and the northern part of Jiangsu Province are two distinctive regions, but both of them house a number of cities and villages. Therefore, in this chapter, we expand the classic dual economy theory, adding into it specific spatial factors, and therefore bring about double dual economic structures that consider both different sectors and regions. The description of these double dual economies is as follows. Presume

46

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

that there are two sectors, the advanced industrial sector and the backward agricultural sector, and there are two regions, the developed south and undeveloped north, with each of them housing both industrial (urban areas) and agricultural (rural areas) sectors. Obviously, the wages of the industrial sector are higher than the wages of the agricultural sector in the same region, and the wages of a given sector in the developed region are higher than the wages of the same sector in the undeveloped region. Labor flows between the two sectors and the two regions. Presume that historical government policies and geographical factors have resulted in the double dual economies, in a way that is similar to the process in which China’s historical system that differentiated urban and rural areas led to the segregation of urban and rural China, and the process in which geographical differences led to the gap between eastern and western China, as well as northern and southern Jiangsu Province. However, this is not the focus of the chapter. We use mathematical symbols to represent the factors in these double dual economic structures. The subscripts a and m represent agricultural and industrial sectors, respectively. The subscripts s and n are used to indicate developed region and undeveloped region. The letter w is used to indicate wage level. Therefore w sa, w na, w sm, and w nm represent, respectively, wage level of the agricultural sector in developed and undeveloped regions and the wage level of the industrial sector in developed and undeveloped regions. Moreover, the symbols of wsm > wsa, wnm > wna, wsa > wna, and wsm > wnm are also used. Under such double dual economic structures where wage difference exists both between sectors and regions, laborers will migrate in pursuit of higher wages. Moreover, in the settings of this model, labor flows will only occur due to institutional wage difference. Furthermore, the labor transfer under the double dual economic structures can be divided into two types: spatial transfer and inter-sector transfer. Spatial transfer can be further divided into local transfer (inward transfer) and outward transfer. In this chapter, local transfer is defined as the transfer of labor from the local agricultural sector to the local 3

industrial sector. Outward transfer can be divided into three types: transfer from local agricultural sector to agricultural sector of other regions; transfer from local agricultural sector to industrial sector in other regions; and transfer from the agricultural sector of a developed region to the industrial sector of an 4

undeveloped region. The chapter also presumes that cost will not occur in local transfer and inside-sector transfer; cost will occur, however, in cross-regional transfer and cross-sector transfer. More specifically, cross-regional transfer, local transfer, inter-sector transfer, and inside-sector transfer are, respectively, Ffc, Fhc, Fsc, and Fic, and Ffc > 0, Fsc > 0, Fhc = Fic = 0.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Taking into consideration the process of industrialization of villages in southern Jiangsu Province characterized by a large presence of TVEs, we can use Table 2.3 as a representation of the pattern of labor transfer from undeveloped regions to developed regions under the double dual economic structures. By the standards of whether a transfer is cross-region and cross-sector, we can categorize labor transfer into four types: local cross-sector transfer, local insidesector transfer, cross-regional and cross-sector transfer, and cross-sector local transfer. As an outlier, local and inside-sector transfer is, to a large extent, irrelevant to labor transfer. Therefore, it will be excluded from this chapter ’s study. Table 2.3

Pattern of labor transfer under the double dual economic structures Sector

Cross-sector transfer Cross-regional transfer Region

Local transfer Cross-regional transfer

Cross-sector transfer

Inside-sector transfer

Cross-regional and cross-sector transfer

Cross-regional but inside-sector transfer

—

Cross-sector local transfer

The formation and transition of the double dual structures The formation of double dual structures One major setback in the dual economy model of Lewis is the absence of causes that lead to the coexistence of an advanced manufacturing sector and a backward agricultural sector. In this theory, the dual economy came from his assumption of the higher institutional wages in the advanced manufacturing sector and the close-to-zero wages in the backward agricultural sector. The reallocation of labor due to the wage difference propels the unification of urban and rural areas. Todaro (1969) and Harris and Todaro (1979) built their model based on the differences in the expected income between rural and urban areas, as well as urban formal and informal sectors, and used the model to analyze the labor transfer between urban and rural areas. They categorized the wage difference between formal and informal sectors as external institutional factors, such as policies restricting the free flows between the sectors and the minimum wages set by labor unions. However, empirical studies excluding these factors show this is not the case (Funkhouser 1997). Marcouiller etc. (1997), and Yuki (2007) took into consideration the difference in workers’ skills between informal

48

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

and formal sectors, and used the perspective of labor cost to analyze the wage difference between sectors. Banerjee and Newman (1998) concluded that rural labor will not entirely transfer to urban areas based on the perspective of the availability of rural credit. Fei Jinghan and Ranis (1997) specifically analyzed the unifying tendency of urban and rural wage levels during the process of labor transfer. Bencivenga and Smith (1997) used a reverse selective model and concluded that even when labor will transfer, due to the fact that only laborers know their own level of productivity and the employers do not, the wages in the manufacturing sector will still be higher than the wages in the agricultural sector. For China, a country experiencing the transition from a planned economy to a market economy, such dual economic structure is, to a large extent, the result of government policies. In an isolated economy, the strategy for China’s heavy industry to catch up with developed countries internally predetermined that planning can effectively promote industrialization, which therefore leads to the many policies characterized by urban bias. During the transition, the isolated economy was opened, with coastal areas being given the advantages of easier access to the international market compared to the inland and they received many preferential policies, therefore this was the second-stage dual economic structure. A obvious characteristic of economic strategy dominated by the government is that policies and the economic rents coming from the policies will have a significant influence on the behaviors of industries and enterprises (Zheng Jianghuai etc. 2008; Zheng Jianghuai, and Gao Yanyan 2008), and that the government and its policies will become an important force impacting the evolution of the double dual economic structures. However, we cannot ignore the fact that non-governmental factors are also playing an important role in the formation of the double dual economic structure. An important factor that affects regional economic development is market demand. Therefore, the capacity of a region’s economic development is very dependent on its capacity to access the market. Moreover, the economic cluster effect as a result of the first mover advantage and the formation and extension of a region’s industrial landscape as a result of historical events further consolidate the dual economic structure, such as the manufacturing belt in northeastern U.S. (Krugman 1991). Furthermore, micro-level factors, such as information, credit, and labor cost also have their impacts on the formation of the dual economy. To conclude, policies, geography, and market are all among the most important factors in shaping dual economic structure in countries undergoing transition, but the first two factors seem to be of particular importance to these countries.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

The transition of double dual economic structures For any form of dual structure, there is a possibility that it is in a stable and balanced state. In other words, dual structure can either be the result of a process, which is eventually in a stable and balanced state, or an unstable and unbalanced transitional stage that will eventually morph into another state. For the former, as the dual structure is already in a stable and balanced state, triggering its transition will need external impact, such as policy shift or changes in market demands. For the latter, the current dual economic structure will either go further in its current direction, or return to a unitary structure, in which case, cross-regional development will withdraw. For transitional countries, their economies were certainly in a unitary state before the transition, and after transition, their market regulation will start to become an increasingly important tool of resources allocation. The transition from planned economy where government has complete control of the economy to market economy where the economy is dominated by the market is a transition from a balanced state to another. During such transition, the preferential policies from the government are usually the main factor that leads to economic divergence, and the geographical advantage of the coastal areas also strengthens the dual economic structure among regions. However, with the increasingly equal policies for different regions from the government and the increasingly free movement of factors, the dual economic structure may begin to withdraw. More specifically, factors that might lead to the withdrawal of the regional and urban-rural dual structure are as follows: Labor transfer mechanism: either in the classic dual economy theory or in the double dual economic structures introduced in this chapter, the intersector and cross-regional labor transfer is obviously the most important factor affecting the relationship among regions. In the classic urban-rural dual economic structure, the surplus labor and the wage difference among sectors lead to the continuous transfer of labor between rural and urban areas, and with it, a narrowing wage gap between urban and rural areas. Eventually, the dual structure will disappear. In the double dual economic structures, the labor transfer mechanism continues functioning. Urban-rural labor transfer narrows the wage gap between urban and rural areas. At the same time, cross-regional labor transfer narrows the income gap between regions. The micro mechanism in this model is that, only when the net return of migration is larger than the net return of not migrating, will labor transfer occur. Fig. 2.5 offers the determining factors of the spatial transfer of labor. Its horizontal axis represents the living costs before and after labor transfer, while the vertical axis represents the ratio

50

The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

between the incomes before and after labor transfer. Subscript n represents the native place of laborers and s represents places other than their native place. Therefore, it is easy to prove that, in column (1), i.e. when w s / w n < 1 and c n / c s < 1, laborers will choose local cross-sector transfer; in column (2) and (4), i.e. when w s / w n < 1 and c n / c s > 1, or when w s / w n > 1 and c n / c s < 1, it is uncertain which type of local transfer will take place, which will be determined by the comparison between the net returns before and after the transfer; in column (3), i.e. when w s / w n > 1 and c n / c s > 1, laborers will migrate to other places. However, the complexity of the question lies in that, in reality, laborers normally will be faced with the situation in (2) and (4). First, the differences in laborers’ skills and personal conditions lead to huge differences in the return and cost of their transfer. Second, due to the differences in the development of regions, the higher income of developed regions often comes with higher living costs. Therefore, there are very few cases when high income and low living costs can coexist. This makes the situation of (1) and (3) very rare in reality. Industrial capital transfer mechanism: apart from the familiar labor transfer mechanism, the capital transfer mechanism under the backdrop of industrial transfer can also trigger the transition of the dual structure between regions and sectors. Labor costs, traffic costs, land costs, competitive costs, changes in Fig. 2.5

The spatial choice of labor transfer under dual structure between sectors

wn ws Uncertainty (4)

Cross-regional transfer (3)

1 Local transfer (1)

0

Uncertainty (2)

1

cn cs

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

market, and many other factors may lead to the decline of a region’s industrial competitiveness, therefore triggering the spatial transfer of industries. Take industries in southern Jiangsu Province for example, their development pattern of integrating into the global value chain with unsophisticated production factors has determined their position in the lower end of the global value chain. However, faced with rising operating costs in the south, these industries, especially low value added industries, can no longer continue their development in the south with the low labor costs advantage. The province has to relocate low value added industries to its north or central or western China, and keep the high value added industries within itself, so as to replace the industrial growth pattern marked by heavy reliance on global value chain to a pattern based on the national value chain (Liu Zhibiao and Zhang Shaojun 2008). Such changes in the landscape of regional industrial development will certainly affect the balance of economic development among regions. Regional industrial transfer can improve the employment capacity of undeveloped regions by increasing local employment by transferred industries, which will serve as a supplement to the local employment as a result of the development of local TVEs. Moreover, the evolution of the industrial structure (i.e. the expansion of manufacturing and service sector, and the transformation of agricultural sector) also improves the inter-sector transfer of labor and increase local employment. Policy guidance mechanism: by adjusting land and tax policies, the government can offer a considerable space for local enterprises to adjust their costs, and by establishing “rents for policy,” local government can also effectively direct the transfer of enterprises and foster industrial clusters which will produce the combined effect (Zheng Jianghuai, etc. 2008). Due to the ever-enlarging gap between northern and southern Jiangsu Province since the reform and opening up, the provincial government has experimented on a series of institutional innovations to counter this trend. The provincial party committee and the provincial government published the 2007 Tasks for Provincial Government Bodies and Organizations to Support the Economic Development of Northern Jiangsu Province , which urged a series of government bodies and non-government organizations to bolster the 5

development of the north. Under the guidance of the provincial government, local governments offered preferential fiscal policies (fiscal transfer of payment) and land policies to enterprises relocated in undeveloped regions, and banks can also offer 6

preferential credit support for such enterprises and local governments. Putting all these factors together, the government provides a very powerful incentive for a large scale industrial transfer from the south to the north. And the north, thanks to such an industrial transfer, will see a change of direction of its labor transfer from cross-regional transfer to local transfer. In an attempt to reach a balance among

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

the development of different regions, the significance of government policies that readjust the location of industries lies in the fact that it will improve the government’s ability to absorb industries and capital from elsewhere, which will lead to the industrial transfer that may seem impossible under the sheer incentives provided by the market. However, even if labor transfer happens under double dual economic structure, even if the government makes a series of institutional innovations and direct industries to transfer to backward regions, there is still no guarantee that the gap between regions will narrow down. This is due to the first mover advantage of developed regions, and the advantage of economy of scale as a result of the first advantage. According to theories in the new economic geography (Krugman 1998 and 2007), as shown in Table 2.4, the internal production of an enterprise demonstrates the characteristic of increasing returns to scale, which, together with the transport costs, make the enterprise unwilling to relocate once it starts production in a certain place. Moreover, as market scale is often bigger in developed regions, such regions often have a more advanced labor market, which means a lower job hunting cost and a bigger chance to get a suitable job for laborers. A bigger market also leads to the trade-off of enterprises between the advantages of economy of scale and the disadvantages of market competition among more rivals. The more advanced the market is, the more willing the enterprise is to benefit from economy of scale at the cost of more competition. Moreover, with the increase of market capacity in a region, or the improvement of the capacity to access the market of the enterprises in the region, the productivity of these enterprises will increase and the region’s income level will rise (Overman, Rice, and Vernables 7

2008). Finally, the spill-over effect and externality are also important factors that discourage enterprises to relocate to less developed regions. Table 2.4

Factors affecting the distribution of economic activities

Centripetal force

Centrifugal force

Market scale effect (linkage effect)

Staying production factors

Intensive labor market

Land rents

External economy

External diseconomy

Source: Paul Krugman (2007), 24.

Even though some industries transfer to less developed regions due to concerns of costs, these enterprises are very likely technologically unsophisticated, labor intensive, low value added, and high power consuming industries. Therefore, when compared to technologically sophisticated, highly

53

DEVELOPMENT IN THE YANGTZE RIVER DELTA

innovative and high value added industries remaining in developed regions, we can hardly say such transfer can effectively dismantle the dual economic structure.

Econometric model Based on the above theoretical analysis, on the empirical level, we will use the data on income and per capital GDP to make a simple analysis on the convergence and divergence of the income of Jiangsu Province. Then we will use the data on the prefecture city level to analyze the determining factors of the urban-rural dual economic structure. We categorize the variables that affect the urban-rural dual structure into three groups: market variables, policy variables, and endowment variables. At the same time, we refer to the characteristics of the convergence regression model in the theory of economic growth, and build the following model: lnINCGit = α0 + α1 MARKit + α2 POLI it + α3 ENDOit + vit (2–1) MARK, POLI and ENDO respectively represent the abovementioned variables. The variable measuring the dual structure, INCG is the ratio of urban and rural income. The greater the ratio, the greater the duality is. Dependent variables are in logarithmic form, so that we can obtain the relative effects of variables on rural and urban areas. By differentiating formula (2–1), we have the following: ∆INCGUrban INCGUrban

–

∆INCGRural INCGRural

= α1 ΔMARK + α2 ΔPOLI + α3 ΔENDO

(2–2)

If the coefficient is greater than zero, we can say that the one unit change of this coefficient will result in the increase of income difference in the speed of its coefficient. Otherwise, it will result in the decrease of the urban-rural income difference in the speed of its coefficient.

Explanation of Variables and Data Explanation of variables The variable of urban-rural dual structure is measured by the income difference, namely, the ratio of disposable personal income of urban residents to that of rural residents. The bigger the difference, the greater the duality is. Variables affecting the urban-rural dual structure are divided in the following three categories:

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

Market variables (MARK) Clearly, during the transition from planned economy to market economy, price gradually replaces administrative regulation as the most important lever for the adjustment of the economy. Under the market mechanism, labor and capital start to flow in pursuit of returns. The formation of a unified market can lead to the expansion of market scale and the improvement of division of labor, which will cause a spontaneous allocation effect on the income of laborers and capital owners. However, due to the scenario of increasing return to scale, the spontaneous evolution of market usually will lead to an expanding income gap and a strengthening dual structure. There are two kinds of market variables here. One kind of them reflects the scale of the market, which are as follows: (1) the scale of international market (MARK 1), which is defined as the ratio of the total volume of export and import to GDP; (2) the scale of domestic market (MARK 2), which is defined as the ratio of domestic consumption of retailed products to GDP; (3) the scale of floating population (GUEST ), which is defined as the ratio of floating population to resident population and is used to reflect the degree of activity in economic activities; (4) market transaction cost (COST ), which is defined as the length of roads owned by every 10,000 people, and reflects the transaction cost between different regions. This 8

variable affects the allocation of income by affecting the scale of market. Another kind of variable reflects the structure of the market, which is as follows: (1) the structure of labor distribution, including the ratio of non-agricultural employees to total employees (NONF ), and the ratio of rural employees to total employees (RURA ). Clearly, the rise in the number of non-agricultural employees will reduce the duality of the urban-rural dual structure. The two variables help us to examine whether the labor transfer from agricultural sector and from rural areas to nonagricultural sector will cause the dual structure to wane. (2) industrial structure variables, which include, the ratio of non-agricultural sector to GDP (NONFGDP ), the ratio of the second industry to GDP (2GDP ), and the ratio of the third industry to GDP (3GDP ). The effects of these three variables should be in line with the structure of labor distribution.

Policy variables (POLI) The industrial policy-making related to local government will clearly exert a great influence on the dual structure between urban and rural areas and among regions. Local governments, with variables like fiscal and credit policies, have a major influence on the cost and return of enterprises that seek to relocate. The “policy rents” therefore brought about (Zheng Jianghuai et al. 2008) are directing the flows

55

DEVELOPMENT IN THE YANGTZE RIVER DELTA

of industrial capital and labor. Besides, factors like medical service and the social welfare system can also prevent the further expansion of the urban-rural income gap. However, due to the absence of a rural social welfare system, the factor may not have an obvious effect. Therefore, we divide policy variables into two kinds: industrial policy and social welfare policy. Industrial policy variables are as follows: (1) the ratio of actual FDI to GDP (FDI ), which reflects the state of capital flows, which is to a large extent the result of government policy. Regions that receive relatively more FDI have a bigger capacity in transferring labor, which will help narrow the urban-rural income gap; (2) government power variable (POW ), which is the ratio of total tax income to GDP, reflecting the government’s capacity to develop its region’s economy. However, although the value of the variable is positively correlated to government power, hence its capacity of economic development, it also reflects the government’s power in taking wealth from the local economy. Therefore, the ultimate effect of the variable is still uncertain; (3) the ratio of infrastructure expenditure to total tax income (INFR ). The bigger the value of this variable, the lower the transaction cost is. However, the unbalanced investment in the infrastructure in urban areas and rural areas may reduce this effect; and (4) the provincial government’s policy to coordinate the development in different regions (REGI ). Judging from the samples and topic of this chapter, this variable is in the form of a dummy variable. In 2001, the provincial government founded the coordinating team of the economic development of northern Jiangsu, whose objective is to narrow the gap between the north and the south, therefore, before 2001, the variable’s value is 0, and after 2001, the value is 1.

Endowment variables (ENDO) Geographical factors have always made their impact on regional economic development. Study on this aspect has led to the emergence of the new economic landscape as defined by Paul Krugman. This chapter will study the impact on regional economy of two endowment factors: nature endowment, and human capital endowment factor. The former is related to whether the region is along the river bank (RIVE ) or along the coast (COAS ), and whether the region is in southern Jiangsu (SOUT ), which are all dummy variables, and population density (DENS ). The latter is the ratio of the population of professional technicians to resident population (PROF ).

Source of data

The data in the model comes from the Jiangsu Province Statistical Yearbook from 1997 to 2007, including data from 13 prefecture cities scattered among southern,

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

central, and northern Jiangsu spanning 11 years. There are in total 143 samples, and for some variables, we can obtain data covering only the period between 2000 and 9

2006. For the descriptive statistics of the data, please refer to Table 2.5. Table 2.5

The descriptive statistics of the related variables of the dual economic structure between sectors

Variables

Sample Mean size value

SD

Income gap (INCG )

143

1.964

0.28

1.295

2.69

Ratio of urban and rural income

International market scale (MARK 1)

143

0.33

0.468

0.011

3.006

Degree of reliance on foreign trade

Domestic market scale (MARK 2)

143

0.317

0.05

0.181

0.463

Ratio of retail consumption to GDP

Floating population 143 (GUEST )

16.455

11.48

3.267

50.556

Ratio of floating population to resident population

91

9.839

4.216

2.883

21.947

Length of highway owned by every 10,000 people

143

0.634

0.151

0.315

0.917

Non-agricultural employment’s proportion in total employment

Rural employment 143 (RURA )

0.732

0.124

0.373

0.973

rural employment’s proportion in total employment

Non-agricultural industries (NONFGDP )

143

0.818

0.14

0.409

0.984

Non-agricultural industries’ proportion in GDP

2nd INDUSTRY (2GDP )

143

0.471

0.116

0.052

0.666

2nd industry’s proportion in GDP

3rd INDUSTRY (3GDP )

143

0.347

0.048

0.214

0.48

3rd industry’s proportion in GDP

FDI

143

0.054

0.044

0.002

0.201

FDI’s proportion in GDP

Government power 143 (POW )

0.041

0.013

0.024

0.086

Tax income’s proportion in GDP

91

0.094

0.063

0.016

0.462

Infrastructure expenditure’s proportion in tax income

Transaction cost (TCOST ) Non-agricultural employment (NONF )

Infrastructure expenditure (INFR )

Minimum Maximum Explanation value value

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Variables

Sample Mean size value

SD

Minimum Maximum Explanation value value

Regional 143 coordinating policy (REGI )

0.545

0.5

0

1

Dummy variable

Social welfare expenditure (SOCI )

104

0.235

0.279

0.027

1.162

Social expenditure’s proportion in tax income

Hospital shared by every 10,000 people (MED 1)

143

1.4

1.003

0.266

4.008

—

Hospital bed shared by every 10,000 people (MED 3)

143

25.459

9.058

8.842

44.773

—

Along river bank (RIVE )

143

0.615

0.488

0

1

Dummy variable

Along coast (COAS )

143

0.231

0.423

0

1

Dummy variable

Southern Jiangsu (SOUT )

143

0.385

0.488

0

1

Dummy variable

Population density 143 (DENS )

0.073

0.016

0.045

0.122

10,000 people / Square kilometer

Professional technicians (PROF )

0.036

0.017

0.008

0.087

Professional technicians’ proportion in resident population

143

Empirical Analysis The convergence analysis on the urban-rural dual structure There is plenty of literature dedicated to the convergence of the economic growth among regions (for example, Wei Houkai 1997; Shen Kunrong and Ma Jun 2002; Lin Yifu 2002; Shen Kunrong and Tang Wenjian 2006). The main methods of convergence analysis are ß– convergence, conditional convergence, and σ– convergence. More sophisticated tools involve spatial econometric model (for example, Lin Guangpin 2005). Judging from the needs of this chapter, we will directly use the ratio of average urban income to average rural income, per capital GDP, urban residents’ disposable income and rural resident’s net income to

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

calculate the changes in the deviations from 1996 to 2006, as a measurement of the convergence of regional economic development in Jiangsu Province. Fig. 2.6 offers the pattern of changes in the ratio of the income of urban residents to the income of rural residents from 1996 to 2006. Overall, the urbanrural income gap was continuously expanding, from 1.75 in 1996 to 2.26 in 2006, while in 1998 and 2002 there was a slight narrowing. Although the average income gap in the 13 cities was expanding, the speed of such expansion was slowing. According to Fig. 2.7, the deviation of urban-rural income gap fell from 0.27 in 1996 to 0.19 in 1999, and increased to 0.22 in 2002, then fell back to 0.2 in 2004 but picked up to 0.23 in 2006. However, from the changes over the deviation of per capita GDP among cities and the deviation of urban income and rural income, we cannot identify convergence. Fig. 2.8 offers the pattern of change over the deviations of the GDP Fig. 2.6 2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 Fig. 2.7

The average ratio of the urban income to rural income among the 13 prefecture cities of Jiangsu

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 The deviation of the ratios of urban income to rural income among the 13 prefecture cities in Jiangsu Province

0.28 0.26 0.24 0.22 0.20 0.18 0.16

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

per capita among the 13 prefecture cities in Jiangsu. We can see from it that the gap among the GDP per capita of these cities was constantly enlarging, with the deviations increasing from 5,554.37 in 1996 to 19,867.06 in 2005, and decreasing to 17,014.7 in 2006. According to Fig. 2.9, the deviation of the income of urban residents was constantly increasing, rising from 1,034.06 in 1996 to 3,140.17 in 2006; the deviation of the income of rural residents dropped slightly from 947.2 in 1996 to 796.28 in 1999, but gradually increased to 1,693.4 in 2006. Fig. 2.8

The deviations of GDP per capita among the 13 prefecture cities in Jiangsu Province

22,500 20,000 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0

Fig. 2.9

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 The deviations of urban-rural income among the 13 prefecture cities in Jiangsu Province

3,500 3,000 2,500 2,000 1,500 1,000 500 0

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Disposable income of urban residents Disposable income of rural residents

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

According to the analysis in the previous paragraph, we can make our conclusions. Both in GDP per capita, and in the income of urban and rural residents, the changes in the urban-rural income among the 13 prefecture cities from 1999 to 2006 demonstrated a divergent characteristic, despite the slight convergence in the net income of rural residents before 1999. In the following, we will make an analysis on the factors contributing to such a divergence from the perspective of the dual structure between urban and rural areas and between sectors.

Analysis on the determining factors of the urban-rural dual economy Population regression According to the result of the Hausman test, we adopted the random utility 10

model. We will first show the regression results using the mixed data mentioned earlier, and then conduct separate regressions and report the results. According to Table 2.6, there are the following determining factors of the dual economic structure between sectors.` Table 2.6

Analysis on factors affecting convergence and divergence of the urban-rural dual economic structure ln INCG

Dependent variable

Independent variables

Mixed regression

Random effects

Robust Regression

Interactive effects (robust regression)

Interactive effects (random effects)

(1)

(2)

(3)

(4)

(5)

0.03 (1.35)

0.03 (1.35)

0.023 (1.01)

0.422 (3.24)***

0.372 (2.78)***

Domestic market scale (MARK 2)

0.912 (3.91)***

0.912 (3.91)***

0.779 (3.19)***

0.463 (1.61)

0.514 (1.74)*

Floating population (GUEST )

–0.001 (–0.52)

–0.001 (–0.52)

–0.001 (–0. 79)

–0.007 (–3.96)***

–0.006 (–3.06)***

Transaction cost (TCOST )

0.001 (0.75)

0.001 (0.75)

0.002 (0.99)

–0.003 (–1.70)*

–0.003 (–0.23)

Non-agricultural employment (NONF )

–0.26 (–2.47)**

–0.26 (–2.47)**

–0.238 (–2.16)**

–0.281 (–2.68)***

–0.381 (–3.54)***

International market scale (MARK 1)

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) ln INCG Dependent variable

Independent variables

Mixed regression

Random effects

Robust Regression

Interactive effects (robust regression)

Interactive effects (random effects)

(1)

(2)

(3)

(4)

(5)

Non-agricultural industries (NONFGDP)

2.609 (13.22)***

2.609 (13.22)***

2.527 (12.25)***

2.51 (12.83)***

2.678 (13.31)***

FDI

–0.575 (–2.55)**

–0.575 (–2.55)**

–0.534 (–2.27)**

–0.174 (–0.4)

–0.134 (–0.30)

Government power (POW)

2.141 (1.85)*

2.141 (1.85)*

2.264 (1.87)*

3.422 (2.85)***

3.216 (2.61)***

Infrastructure expenditure (INFR)

0.098 (0.97)

0.098 (0.97)

0.084 (0.81)

0.068 (0.72)

0.107 (1.10)

Regional coordinating policy (REGI)

–0.003 (–0.14)

–0.003 (–0.14)

0.002 (0.11)

0.008 (0.5)

–0.004 (–0.23)

Hospital beds shared by every 10,000 people (MED3)

–0.012 (–5.43)***

–0.012 (–5.43)***

–0.012 (–5.22)***

–0.009 (–4.64)***

–0.009 (–4.82)***

Along river bank (RIVE)

–0.185 (–7.72)***

–0.185 (–7.72)***

–0.179 (–7.16)***

–0.21 (–8.42)***

–0.199 (–7.77)***

Along coastline (COAS)

0.081 (4.79)***

0.081 (4.79)***

0.079 (4.46)***

0.027 (1.38)

0.044 (2.21)**

Southern Jiangsu (SOUT)

0.081 (4.79)***

0.081 (4.79)***

0.079 (4.46)***

0.027 (1.38)

t0.044 (2.21)**

Population density (DENS)

–0.167 (–0.34)

–0.167 (–0.34)

–0.201 (–0.39)

–1.697 (–2.92)***

–1.92 (–3.21)***

Professional technicians (PROF)

1.562 (1.58)

1.562 (1.58)

2.14 (2.08)**

1.025 (1.12)

0.571 (0.61)

SOUT * MARK1

—

—

—

–0.426 (–3.26)***

–0.378 (–2.81)***

SOUT * MARK2

—

—

—

–0.8 (–1.57)

–0.819 (–1.57)

SOUT * NONF

—

—

—

1.011 (3.94)***

1.094 (4.15)***

SOUT * FDI

—

—

—

–0.152 (–0.43)

–0.023 (–0.06)

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

(Cont'd) ln INCG Dependent variable

Independent variables

Mixed regression

Random effects

Robust Regression

Interactive effects (robust regression)

Interactive effects (random effects)

(1)

(2)

(3)

(4)

(5)

–1.309 (–8.88)***

–1.309 (–8.88)***

–1.235 (–8.02)***

–1.016 (–6.08)

–1.073 (–6.24)***

Ad-R

0.843

In the group: 0.657 Inter-group: 0.96 Overall: 0.871

—

—

In the group: 0.715 Inter-group: 0.984 Overall: 0.9052

F value

31.27

Wald chi2 (11) = 500.28

28.17

34.13

91

91

Constant term (CONS) 2

Sample size

91

91

Wald chi2 (20) = 668.30 91

Notes: 1. The value in the brackets are the t value, “*”, “**”, “***” respectively represent levels of significance of 10%, 5%, and 1%.

2. The results of the table are obtained from STATA10.0.

(1) From the perspective of market, different measurements of the expansion of market scale by different dimensions have very different impacts on the urban-rural income gap. Judging from the overall samples (regression [1] to [3]), the expansion of international market scale has a significant impact on income gap, while the domestic market enlarges the urban-rural income gap. The result of the robust regression (regression 3) shows that, a 1% increase in the domestic market scale will bring about a 0.78% decrease in the urbanrural income ratio. The degree of market activity and the transaction cost, which are respectively measured by floating population and traffic cost, have no significant influence on the income gap. When putting interactive terms of market scale and southern Jiangsu into the regression, the international market has a significant effect on income gap, while the domestic market has not. The expansion of the scale of the international market causes the decrease in the income gap of southern Jiangsu, but only by a small proportion. A 1% increase of the international market scale leads to a 0.004% decrease in the income gap

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(regression [4]). Both intensifying market activity and lowering transaction cost significantly reduce the income gap, but still by limited proportions.

(2) From the perspective of structural variables, a 1% increase in non-

agricultural employment will cause a 0.238% decrease in the income gap.

However, a 1% growth in the proportion of non-agricultural GDP will lead to

a 2.527% increase in the urban-rural income gap (regression [3]). In interactive effects regression, the non-agricultural sector demonstrates similar effects. This means that the expansion of the non-agricultural sector has two aspects of

effects. On one hand, it creates more work opportunities for rural population, therefore narrowing the income gap. On the other hand, it demonstrates the allocation effect. Due to institutional wage differences, the benefits of the sector ’s expansion are mainly reaped by non-agricultural population, this

therefore leads to an expanding urban-rural income gap. For southern Jiangsu, the increase of non-agricultural employment will further enlarge the urbanrural income gap.

(3) Government actions have a profound impact on the urban-rural

income gap. The FDI behaviors of the government and social welfare, which is measured by the number of hospital beds shared by every 10,000 people, are

positive factors for the narrowing of the urban-rural income gap (regression [1]

to [3]). A 1% increase in these two variables will respectively lead to a 0.5% and

0.012% decrease of the income gap. However, for southern Jiangsu, FDI cannot

reduce the urban-rural income gap, and social welfare has a reduced effect on the income gap. The increase in government power, which is measured by the ratio of tax income to GDP, significantly increases the urban-rural income gap

(all regressions). The reason is that tax income, and with it, the welfare effects are mainly directed to urban residents, which therefore enlarge the income gap.

A 1% increase of the proportion of government tax income will lead to a 2.26% increase in the income gap. The regional coordinating policies put forth by the provincial government since 2001 do not have a significant effect on the urbanrural income gap. (4)

Geographical factors also have significant effects on the urban-rural

income gap. All regressions show that the urban-rural income gap demonstrates

a regional convergence, with river bank regions and southern Jiangsu regions

demonstrating narrowing urban-rural income gaps, and coastal regions demonstrating enlarging income gaps. Population density will reduce the

income gap. Professional technicians have a positive effect on the income gap, but the effect is not robust.

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

Regional regression As the samples are geographically distinct from each other, we will conduct a further regression according to the different regions these samples respectively belong to. According to the previous mixed samples regression, we now divide the samples into three categories: southern, central, and northern Jiangsu Province. According to Table 2.7, the results are as follows: (1) For Northern Jiangsu, regression (1) in the mixed panel data regression Table 2.7 shows that the scales of international market and domestic market have significant effects on the urban-rural income gap, with the former enlarging the gap and the latter narrowing the gap. The bigger the proportion of rural employment, the narrower the income gap is. This is because in the less developed regions, the proportion of the rural population is usually high and the duality of the labor market is strong, therefore the reduction of rural employment will enlarge the income gap rather than narrow it. This is also applicable in the second industry, where the bigger the proportion of the second industry will lead to a bigger income gap. Using a fixed effect model does not change the negativity or positivity of regression coefficients, but changes their value and level of significance (regression [2]). Table 2.7

Region-specific determining of the urban-rural income gaps (1996–2006) Logarithm of urban-rural income (ln INCG )

Dependent variable Independent variables International market scale (MARK 1) Domestic market scale (MARK 2)

Northern Jiangsu

Central Jiangsu

(1)

(2)

(3)

0.714

0.975

(3.11)***

(5.48)***

–0.968

–1.175

(–1.98)*

(–3.43)***

0.586 (5.71)***

(4) 0.388 (6.85)***

Southern Jiangsu (5) —

668

—

(4.49)***

—

(4.52)*** 0.016 (5.73)***

Transaction cost (TCOST )

—

—

—

—

Rural population (RURA )

–1.125 (–3.64)***

–0.403 (–2.16)**

—

—

0.984

—

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Logarithm of urban-rural income (ln INCG ) Dependent variable Non-agricultural employment (NONF ) Secondary industry (2GDP )

Northern Jiangsu

Central Jiangsu

—

—

0.727 (2.53)**

— 0.18 (1.07)

0.267 (2.97)***

—

—

—

—

Southern Jiangsu — —

Tertiary industry (3GDP )

—

—

FDI

—

—

–0.955 (–2.57)**

–0.593 (–2.06)**

—

—

—

3.0 (2.42)**

5.196 (4.27)***

—

Government power (POW ) Social welfare expenditure (SOCI ) Number of hospitals shared by every ten thousand people (MED 1) Constant term (CONS )

–0.152 (–2.52)** — 1.612 (4.44)***

–0.206 (–6.13)*** —

–0.742 (–2.34)**

–0.07 (–3.17)***

—

—

–0.044 (–2.73)**

—

—

1.308 (6.18)***

0.147 (1.76)*

0.285 (5.55)***

0.905

0.782

0.513 (6.03)***

Ad-R 2

0.68

F value

17.82

32.82

37.54

29.76

24.6

40

40

24

33

35

Sample size

0.64a

0.676

Notes: 1. Only (2) is the result of the fixed effects model; 2

2

2. Superscript a , in the table it should be R , the R in the group should be 0.85 2 and the inter-group R should be 0.49;



3. The rest is the same as Table 2.6.

(2) For central Jiangsu, the mixed panel data regression shows that the expansion in both the international and domestic market will hamper the narrowing of the urban-rural income gap. Similar to northern Jiangsu, and contrary to population regression, an increase in non-agricultural employment will also lead to the expansion of the income gap. However, the FDI behaviors by governments have a significant effect on narrowing the income gap. The numbers of hospitals and hospital beds shared by every 10,000 people also

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

have significant effects on narrowing the income gap (regression (3) and [4]). However, the Hausman test failed again. We will therefore only report the regression results of the mixed panel data. (3) For southern Jiangsu, among the many variables, only domestic market scale, length of highway shared by every 10,000 people, and the scale of the third industry have major effects on the region’s urban-rural income gap. While the first two variables enlarge the gap, the last one narrows the gap (regression [5]). Similarly, due to the failure in the Hausman test, we will only report the regression result of mixed panel data. To conclude, comparing the population regression, the region-specific data regressions offer a mutually contrasting regression result. For market variables, in the population regression, both domestic and international markets enlarge the income gap. In the region-specific regression, the expansion of domestic market will narrow the urban-rural income gap in northern Jiangsu. For structural variables, unlike population regression, the region-specific regression didn’t show that non-agricultural employment will help narrow the income gap. To the contrary, in northern Jiangsu, the increase of agricultural employment will narrow the income gap. The result that the increase in the proportion of the second industry will enlarge the income gap is only true in the north. In other regions, the result is not significant. In the south, however, an increased proportion of the third industry will narrow the income gap. Medical care and social welfare are helping to narrow the income gap in the north and center, but such an effect is insignificant in the south. FDI’s effect of narrowing the gap and effect of the expansion of government power that enlarge the gap are only applicable in the center.

Conclusion The dual economic structure can either be a balanced state or an imbalanced state. It can be a result already or still in the middle a process. If it is in the middle of a process, it must be in an imbalanced state, under which, even the spontaneous regulation of the market may push it to a balanced state, either a unitary balance or a dual balance. If such a dual balance is a malignant balance, such as the dual economic structure where an immense gap exists in the development of different sectors or regions, which have hampered the healthy and sustainable development of the whole economy, such a balance should be broken down. However, breaking down such a balance and allowing it to morph into another kind of balance often need the intervention of external forces. This

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

external impact is often generated by the government, which is exactly the case in many developing countries. We adopted the dual economic structure in Jiangsu Province, and combined spatial factors with the traditional dual economic theory, based on which, we proposed a descriptive concept, double dual economic structure, and analyzed the determining factors of dual structure. In the traditional urbanrural dual structure, labor transfer is a core mechanism in narrowing the income gap between urban and rural areas, and thus that between regions. However, as influx of labor brings an abundant supply of labor to the urban areas, the boundaries of the urban areas undergo continuous expansion. Highly concentrated capital and labor often lead to diseconomy of scale, low technology, and the fall of the investment-return ratio of human capital and industrial capital, due to the rise in labor and land costs. These, together with the cheap labor and lands, as well as the attractive “rents of policy” in less developed regions, cause some industries to transfer from developed regions to undeveloped regions. Under the backdrop of industrial transfer, the development of undeveloped regions reshapes a urban-rural dual economic structure where labor continuously transfers from the agricultural sector of the undeveloped region to the industrial sector of the same region. This is the process now happening in northern Jiangsu, and through which local transfer is replacing outward transfer. The empirical study based on the 1996–2002 data of 13 prefecture cities scattered in the south, center, and north of Jiangsu shows that market development, labor transfer, upgrading of industrial structure, and government actions cannot have a unified effect on the urban-rural income gap in the region. Instead, such effects are deeply affected by regional factors. We found that the urban-rural income gaps of southern Jiangsu and the river bank regions demonstrate a narrowing tendency. But the same thing is not happening in the coastal regions. Overall, forces that enlarge the gap outweigh forces that narrow it. This is in line with the continuing expansion of the urban-rural income gap observed during the surveyed period. However, the samples for this survey on the urban-rural income gap demonstrate the characteristics of an interim stage of development. Therefore, we cannot draw the conclusion that such an income gap will continue to expand in the future. To the contrary, according to the theories introduced in this chapter, as the approach of labor transfer under industrial transfer continues to evolve, a new labor division structure among regions may appear, in which, developed regions will house technologyintensive industries, and undeveloped regions will house labor-intensive industries. However, this labor division structure is also not immune from

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The Evolution of Labor Transfer, Industrial Relocation, and Regional Dual Economy

changes. It will undergo further evolution that keeps it in line with the constant adjustment of the urban-rural and regional double dual economic structure. The urban-rural dual structure will constantly adjust itself between developed and undeveloped region, which will lead to the unification of both the dual structure between rural and urban areas, and that between developed and undeveloped regions. Eventually, the economy as a whole will become an advanced unitary economy. In such a unitary economy, the differences among regions will only reflect their different positions in the labor division network, rather than the differences between tradition and modernity, or that of backwardness and sophistication.

69

3

Chapter

The Evolution of the Relationships between Local Government and Enterprises during Economic Transition

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction China’s decentralization reform starting from the 1970s has given local governments relatively independent economic interests and administrative power. After obtaining control over local resources, local government was no longer the mere agent of central government, as they had become an economic actor that had an independent and distinctive interest orientation. Local governments, as independent stakeholders who are motivated by a strong desire for modernization and economic growth, are inevitably playing the leading role in propelling economic progress, namely, spurring economic growth in the local governments’ administrative areas is their first priority. Meanwhile, the continuous progress in the marketization-oriented institutional reform has led to the emergence of a set of diversified market entities and an increasingly open market, where competition is becoming increasingly perfect. These market conditions, on the other hand, require local governments to withdraw from the role of an economic actor, and become the provider of macro-regulation, social administration, public products, and judicial guarantee. Therefore, under the parallel objectives of promoting economic growth as a stakeholder, and constructing the institution of the market economy as an administrative entity, local governments are carefully balanced between entering the market and leaving the market. The performance of local economic development is, to a certain degree, dependent on local government’s ability to innovate during the institutional reform. We will look at the examples of the Yangtze River Delta region which has undergone the most intense economic growth in China. The Shanghai city and the provinces of Jiangsu and Zhejiang in the region, contrasting with each other in location, history, and culture, have chosen three very different paths to transform from planned economy to modern market economy and have reaped their respective success. Although the market is generally more effective than the government both in static efficiency and dynamic efficiency, the success of the Yangtze River Delta has showed that the process of marketization and government intervention do not contradict each other. In certain cases, the government can use many tools to improve the function of the market, while the power of the market can also improve the function of the government. Government and market functions, as two symmetrical systems in resource allocation, are complementary to each other in a variety of ways. This chapter will adopt the basic theoretical framework of new institutional economics and the perspective of historical evolution, so as to analyze

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The Evolution of the Relationships between Local Government and Enterprises during Economic Transition

and conclude the characteristics of the changing relationship between the governments and enterprises of the Yangtze River Delta during economic institutional transition. Our research maintains that, due to the immaturity of

China’s market, market transition should rely on government transition and

the cultivation of the market, in which, the transition of governments is crucial to economic transition. One major characteristic of economic transition is that

there is no predetermined institutional structure. All decision-making entities,

including the central government, local governments, enterprises, and other market entities should actively seek for a substitute institutional framework. As all these entities have incomplete information, and as they are acting as constantly

evolving internal variables, once a balance is reached between local governments and enterprises amid the conflicts and uncertainties of transition, they will

become the source of a sustained propelling power for regional economic growth and social development.

Literature Review and Research Framework From the 1990s, in view of the rise of the emerging world, Western economists

have extended the traditional political economics to government behavior during economic transition. Abundant results have been yielded in local government’s

effects on the industrial upgrade and economic development of their

administrative regions. There are some classic cases in this aspect. For example, Cammett (2007) compared the upgrade of the clothing industries of Morocco and Tunisia, and discussed the different functions and behaviors of the various forms of relationships between governments and enterprises. Purcell (1981) studied the

evolution of the alliance of the Mexican government and the sugar industry amid

economic and social conflicts. Bennett and Sharpe (1980) studied the Mexican

government’s role as banker and entrepreneur in the nation’s economic transition. China is the biggest transitional economy in the world, and is also the

economy that grows the fastest. The economic miracle of China has attracted an

increasing number of scholars, who based their research on the framework of the public choice theory, institutional economics, or new institutional economics, and have tried to study China’s successful transition and the motives of its economic growth from the perspective of local governmental behaviors.

Research concerning the functions of local governments and their transitional

mechanisms during economic transition can briefly be put into the following two categories.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Economic developmental functions of local governments: New political economics study Hayek (1945) and Leibout (1956), respectively, adopted the perspectives of the information advantages local governments enjoy and the cross-regional mobility of resources, proving that when compared to the central government, local governments have better efficiency and ability in terms of utilizing resources to provide public services. Based on the theories of market failure and non-market failure, Wolf (1987) made a comprehensive analysis on the differences of market and non-market, which are two symmetrical economic mechanisms, in terms of economic efficiency, efficiency in resources allocation, and social effects. He also argued for the righteousness of the participation in the economy of nonmarket mechanisms, such as the government. Also in the direction provided by these classical theories, a large amount of literature produced after the 1990s emphasized the positive effects of local governments in supplementing the functions of an immature market and market defects resulting from the absence of institution. Oi (1992) made an in-depth experience description of the evolution of local government behaviors since China’s fiscal reform, in which he emphasized the incentives provided by this reform for local governments to spur local economic growth. In addition, the privatization of agriculture made manufacturing the most likely choice for the local government to spur economic growth. He defined local government behaviors such as facilitating and coordinating with local enterprises to develop local economy as the corporatism of local government. Later on, in view of organizational characteristics of the various levels of the governments of China, Walder (1995) proposed a theory that local governments are industrial firms. Hong Yinxing and Cao Yong (1996) maintained that local governments serve to connect non-perfect planning and non-perfect market. Shen Kunrong (1998) believed that, during marketization reform, local governments make their contribution to the establishment of the market economy and economic growth by providing institutional innovations. The conclusions from empirical studies are consistent, with most of them maintaining that in China’s reform characterized by decentralizing fiscal power, local governments have become internal variables in the country’s economic growth whose effects on cultivating the market and market entities are positive. For example, Jin, Qian and Weingast (2005) conducted a relativity test on the time sequential data of a number of Chinese provinces spanning from the 1980s to 1990s, which showed that the budgetary income of provincial governments are significantly and positively correlated to non-state-owned economic

74

The Evolution of the Relationships between Local Government and Enterprises during Economic Transition

development, while budgetary expenditure is significantly and positively correlated to budgetary income, which leads to the conclusion that the incentive mechanism of budgetary revenue of provincial governments spurred market development.

Changes and effects of local government behaviors mechanism: Institutional economics study The miracle of China as a result of the country’s economic transition makes a sharp contrast to the decline of the Soviet Union and other eastern European countries also as a result of their economic transition. In view of this, many scholars further studied China’s economic transition, especially the changes and effects of local government behaviors mechanism, from the perspectives of institutional changes and institutional innovation. New institutional economics perceive government behaviors in a particular social, economic, and political context, and proposed the government competition theory (Breton 1996). He Mengbi (2001) held that government competition mainly exists in the form of institutional competition, including the appearance of informal restraints and solutions when conflicts arise in the vertical allocation of resources, which can also be seen as the institutional innovation and a learning process encouraged by government competition. He used this concept to analyze transitional economies like China and Russia and emphasized the perspective of evolution in analysis on local ownership reform, which often come together with tax reform. Feng Xingyuan (2001) and Zhou Xingan (2003) used the government competition theory to analyze China’s transitional economy, and held that there is an extensive institutional competition among China’s local governments, which try to enhance a region’s cost competitiveness through adjusting external and internal rules. Ever since then, government competition theory has been extensively used as an analytical logic to explain the success of China’s transition. From the perspective of vertical relations, Qian and Ronald (1998) added in the model of local government competition which is the result of fiscal decentralization, the prototype model of soft budgetary constraints and the mobility of production factors, and further revealed how competition hardens local government’s budgetary constraints and therefore facilitates the evolution of the relationship between local governments and local stateowned enterprises. Zhang Weiying and Li Shu (2003) extended this research to the privatization process of state-owned enterprises. The study of Liu Hanping and Liu Xitian (2003) emphasized how the process of local government

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competition as the discovery of knowledge and information in effect facilitates the establishment of a market economy. In contrast to the viewpoint that local government competition has a positive effect, some scholars proposed that, compared to market entities, local government demonstrates a more complex incentive structure, and that local government is not an independent property owner, but is a competitor on multiple levels. Therefore, in the mechanism of local government behavior, there is a competition between the element of the grabbing hand and the element of the helping hand (Shleiger and Vishny 1998). Similar to the zero-sum game model of Brennan and Buchanan (1980), Burstein and Rolnick (1995), many studies have shown that, as local government is put under pressure from both economic and political competition after the decentralization of fiscal power, local government will often protect local enterprises and industries, which therefore leads to separation of market and the convergence of local industry (Yong 2000; Yin Wenquan and Cai Wanru 2001; Zhou Li’an 2004) and an increase in the cost of cross-regional trade (Zhou Yean 2003). Some even believed that there is the danger of non-unification lurking in China’s marketization reform (Poncet 2001). Furthermore, Yang Ruilong (1998) and Huang Shaoan (1999) studied the evolution of the relationship of government and enterprises based on the perspective of the changing role of entities and the changing mechanism of such a relationship. Wang Jun (1999) used a combination of the changing content, entities, and mechanism as the basic analytical framework, and constituted a three-staged assumption that considers enterprises and governments separately. This research revealed the progressive nature of the relationship of China’s local government and enterprises and created a dynamic tradition in the study of this sort of issue. To conclude, existing theories and empirical studies have yielded the following conclusions: (1) Local government is the most important engine of China’s economic transition and growth. China is still in the initial stage of development, due to the absence of market, the insufficient power of entrepreneurs and private capital, and the backwardness of information and credit system, the intervention of local government is a helpful substitute for the market and entrepreneurs, which will facilitate the economic take-off of the country. (2) The institutional reform of fiscal decentralization reshaped the distribution of economic benefits among central and local governments, and eventually led to the changes in local governments’ behavior mechanism and orientation. Therefore, the incentive system should function earlier than the ownership system. (3) In line with China’s progressive reform, as the market

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economy system gradually matures, the behaviors and functions of local governments are also historically bounded. Existing literature perceives China’s modern economic development as the result of the government-led marketization reform, and often follows the research pattern of analyzing how the relationship between the central government and local governments affects local government behaviors, and then further analyzes how local government behaviors affect local enterprises and the market. Such an analytical pattern focuses on the mechanism and function of local governments as innovative entities in the economic transition, but overlooks the functions of enterprises and the public, which are also interestrelated parties in the transition. Moreover, in terms of the relationship between the effects on the economic transition of the ownership reform and the incentive system reform, and whether local government has a reliable theoretical support when choosing the approach of institutional reform, existing research provides very little response. Therefore, this chapter bases its study on the government competition theory of institutional economics and uses the example of the Yangtze River Delta (Shanghai, Zhejiang, and Jiangsu), so as to further analyze how local governments acted as the most important engine for institutional reform during the initial stage of economic transition. This chapter also describes how the relationship between local governments and enterprises constantly develops and evolves during the transition based on the perspective of governmententerprise interaction. By doing so, the chapter aims to find out the internal and external power that spurs the constant evolution of the relationship between local government and enterprises, and concludes with a look at the process and mechanism of such evolution.

Shanghai: Government-Led Self-Innovation Shanghai has always been the biggest and most important economic region in China. In the initial stage of the reform and opening up, Shanghai boasted a fullfledged planned economic system, and an all-encompassing variety of industries, which had both an immense volume and a relatively high efficiency. Such an example of a planned economy took only about two decades to transform into a world renowned example of a Socialist market economy. It was the first city to carry out industrial upgrade in China, its open market system thrived and its city functions underwent an all-rounded upgrade. The series of municipalgovernment-led innovation pivoting on state-owned enterprises reform were the underlying reasons of the city’s success.

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The difficulties in the initial stage of reform The institutional reform started in 1978 when the central government distributed its administrative power among local governments, following which, the central government also distributed its power to enterprises in an attempt to provide incentives for local governments and enterprises to improve production 1

efficiency. Until 1991, a series of reform policies had been implemented. The theory of planned market economy published shortly after this made an important theoretical breakthrough. The core objective of the reform was modified accordingly into: separate the responsibilities of government and enterprise, and allow enterprises to become independent and self-reliant commodity producers and marketers in the Socialist market economy. To meet the need of building a national economic system that allowed China to rely on itself, Shanghai shouldered the responsibility to provide capital accumulation and machinery for the industrialization of the country. It shifted its focus from light industry to heavy industry such as equipment, iron, construction materials, and chemical manufacturing, becoming one of the heavy industry bases in China characterized by a large proportion and high density of state-owned enterprises. In the early 1980s, thanks to its traditional economic advantages, the GDP growth rate of Shanghai was higher than the national average, and its economic level was also among the best of the country. However, not long after the reform and opening up, with the emergence of Guangdong, Zhejiang, Fujian, Jiangsu, and other coastal emerging industrial zones, the economic growth of Shanghai began to flag. Very soon, the economic growth rate, per capital national income, and its growth rate all fell to the bottom of the list of coastal regions. The fact that Shanghai has long been in a disadvantageous position in the centralized fiscal system was a direct cause of its economic difficulties in the earlier years of reform and opening up. For a long time, Shanghai has been a big contributor to the national fiscal revenue. Its yearly contribution made up one third of the national fiscal expenditure but got a very low investment from the central government in return. Even in the 1980s, in order to guarantee the stability of fiscal income, the revenue-tax reform in Shanghai was carried out later than many other regions, and the amount of revenue the city had to hand in long stayed at a high level. Shanghai has made an immense contribution to the country’s economic development, and was also inflicting the major cost of China’s progressive reform. Such a distribution system led to an insufficient accumulation of the city’s local finance, which put it in an unfavorable position in regional competition.

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The strategy and policy of the progressive reform was a deep-rooted cause of the economic difficulties Shanghai experienced after the reform and opening up. Due to the lack of experience in political and economic reform, and the uncertainty of a large-scale institutional reform, experimental and progressive reform became the only choice for the central government, which could be 2

seen in the spatial difference of the reform. In the earlier years of economic transition, due to the uncertainty of the reform, Shanghai, a major contributor of the central government’s tax revenue was not among the opened regions and therefore did not receive preferential policy. Dismantling the planned economic system does not necessarily lead to the success of the market economic system. The long-existing planned economic system had left a bad tradition in Shanghai which often hampered its marketization reform. The lack of market economic system was the main cause of Shanghai’s economic difficulties that lasted for a long time after the reform and opening up. Even in the end of the 1980s and the beginning of the 1990s, most of the enterprises in Shanghai still needed the approval of government officials, which sometimes meant scores of official seals, if they wanted to adjust the price of their products according to the situation of the market. For a long time, many enterprises did not even have a sales department, which was a typical legacy of the planned economy era. Failing to adjust their relationship with the market, after the centralized planning system was replaced by the market economic system, enterprises in Shanghai were mostly crippled by a shortage of raw materials and energy and rising costs. The immense industrial structure of Shanghai found it hard to make a swift adjustment to the market and had to face a falling business performance.

Three “promises” and three “reforms” forced Shanghai’s way out of difficulties In the face of economic difficulties, the Shanghai municipality proposed the policy of three promises and three reforms. The three promises included a promise to follow the Socialist direction; a promise to act according to the macro regulation of the central government; and a promise to maintain a sufficient fiscal contribution to the central government. The three reforms included selffunded reform, self-led reform, and pioneering reform. With the approval of the central government, in 1992, Shanghai formally started its comprehensive development and opening of its Pudong district. At the beginning of the 1990s, big and medium-sized state-owned enterprises were not the majority in Shanghai. But they owned a big proportion of assets in the city, demonstrated a

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high production volume and a high ratio of revenue to taxes, and were mostly in competitive industries. Therefore, it is impossible for the economic transition of Shanghai to circumvent reforms in the state-owned assets management system and reform in state-owned enterprises. If the reform in state-owned enterprises succeeded, the economic development of the whole city would be greatly boosted. Therefore, the municipal government put its focus on the reform of state-owned enterprises and assets, and opened a new chapter in the city’s economic revival, in which the city moved from domestic demands oriented to export oriented, from planned economy to market economy, and from tradition to modernity. In 1992, China made clear that the goal of its economic reform was to establish a Socialist market economy. In 1994, a separate tax distribution system between the central government and local governments was carried out. The institutional reform of China was moving clearly towards a market economy. Meanwhile, the Shanghai municipality put forth a series of reforms, showing its innovative capacity and boldness. The State-owned Assets Supervision and Administration Commission (SASAC) founded in 1993 was the first to start the reform in the state-owned assets management system, which yielded a new 3

system comprised of two managerial levels, three systems, and three layers. This provided an institutional solution for the problem caused by the absence of an “owner” of state-owned assets, established a system for the market operation of assets, ended the traditional management pattern of state-owned assets that divided the control over these assets to different parties, and made related reforms in the whole administrative body so as to safeguard the stable reform of the public sector. Based on these measures, in 1997 the Shanghai municipality again made the first proposal in China to establish modern corporate structure for stateowned enterprises, and set goals for the new reform, which were to stop these enterprises from incurring losses, encourage competition, and enhance their business performance. According to the principles of clarifying assets ownership and responsibility of these enterprises, separating government management from these enterprises and using scientific management, the following measures were proposed to improve the state of state-owned enterprises in Shanghai. To increase assets and reduce debt burden, measures were introduced to diversify owners of enterprises, invigorate remaining assets, exchange creditor ’s loans to shares of the indebted enterprises, encourage merger and acquisition and bankruptcy of the unfit, facilitate the development of existing enterprises and increase government subsidy. In order to improve the performance of state-owned enterprises, the municipality also urged these

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enterprises to strengthen their product development, accelerate product update frequency, enhance technological modification, increase momentum of further development, strengthen market development, expand space for development, enhance management, improve business performance, improve team building, and improve solidarity of employees. Five mechanisms were also introduced, including a survival of the fittest mechanism for these enterprises, a mechanism to retain and increase the value of state-owned assets, a mechanism allowing free labor flows in and out of these enterprises, a welfare mechanism covering the whole of society and a competitive mechanism for the employment of management level staff. These measures effectively reduced the level of indebtedness left from the planned economy years and reduced operating costs such as labor costs. After achieving the goal of turning losses to profits in major state-owned companies one year in advance of the schedule, these enterprises had mostly established a modern corporate system by the end of 2000. After 2000, the Shanghai municipality put the reform into a further strategic stage. Based on the strategic adjustment of state-owned economy, the municipality adopted a range of asset management models to optimize the allocation of state-owned assets. It facilitated the concentration of state-owned enterprises of all sorts in key industries, high-tech industries, and fundamental industries. At the same time, it also further pushed state-owned capital to retreat from general competitive areas, so as to attract more private capital to social construction. Through a series of reforms, while the state-owned assets of Shanghai continuously retreated from competitive, monopolistic, and public service sectors, state-owned enterprises still enjoyed a rapid growth and underwent an industrial upgrade. State-owned assets concentrated in key industries such as the third industry, information industry, financial service industry, logistics industry, car manufacturing, complete equipment manufacturing, and real estate. Another characteristic of the innovation of the Shanghai municipality is their active attitude in opening the capital market and its focus on developing an export-oriented economy that serves the need of the reform of state-owned enterprises (SOEs). Reinvigorating state-owned assets and alleviating the difficulties of SOEs needs a large amount of capital. But the private capital accumulation of Shanghai was insufficient and the government was also under heavy fiscal pressure. Therefore, faced with an insufficient fund, the municipality chose to intensify the development of export-oriented economy and attract foreign investment. So far, Shanghai still remains among the most attractive cities for foreign direct investment. Foreign invested projects and joint-ventures of foreign, private and state-owned capital keep springing

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out. Many enterprises in key industries such as car making, machinery, and electronic manufacturing made alliances with foreign companies and saw their competitiveness surge. A surge in foreign direct investment in Shanghai also energized foreign trade in Shanghai, which remained a powerful engine for Shanghai’s economic growth. Opening an economy is an institutional change that supplies a large amount of capital for transitioning enterprises within a very short time and guides such enterprises to industrial structural upgrade. But more importantly, it greatly facilitates the changes in the administrative patterns of local governments. During the process of using foreign direct investment and exporting to foreign countries, both the Shanghai municipality and local enterprises were constantly gaining knowledge on the corporate structure and trading rules of foreign market economies. In order to guarantee such economic activities continued to happen, the government had to learn from foreign countries in terms of how to build a competitive and fair environment for the further development of market economy and how to make adjustments in aspects such as the ownership system and income allocation system. Furthermore, with an increasingly open economy, market competition was also becoming increasingly fierce, which forced necessitated reforms in the tax system, financial system, investment, and financing system, foreign trade system, and price regulation system on the government’s part if it was to further improve the institutional environment for the export-oriented economy.

The government-enterprises relationship under economic globalization After entering the 21st century, as arranged by the central government, Shanghai embraced its new objective of becoming an international economic, financial, trading and logistics center and a Socialist modern international metropolis. This strategy puts Shanghai’s development in an international context, rather than just limiting it within the boundaries of the Yangtze River Delta or China. Therefore, requirements for the city’s economic development and infrastructure now rose to a higher level, and the challenges for the government for further institutional innovation, and the reexamination of its role in the city’s economy become even more formidable tasks. With an almost full-fledged market economic system, the first challenge for the municipality is to further implement the scientific outlook of scientific development and convince market entities to abandon their business model that pursues only short-term interests, so as to steer the growth pattern to

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intensive economy on the macro level. The scientific outlook of development is one that is characterized by technology-intensity, high profitability, low energy consumption, and environmental friendliness, and in line with China’s human resources endowment. Although such objectives are good for enterprises in the long run, the higher costs after product and technology upgrade, and the risks enterprises have to take for technological innovation in the short term, make the long-term and macro interests of the city and the short-term and micro interests of individual enterprise somehow contradictory to each other. Such a contradiction requires the government to exert its influence again during its gradual withdrawal from the economy. By doing so, the government may convey its innovative capacity into the innovative capacity of individual enterprises, so as to steer economic growth onto a healthy and balanced path. The ongoing globalization manifests itself in the form of the strategic relocation of the global resources of multinational companies from developed countries. The highly competitive international economic landscape makes it ever more important for the Shanghai municipality to realize an industrial upgrade of its regional economy. Given that it is already the hub of the regional headquarters of multinationals and an international financial center, Shanghai should be the first Chinese region to leave the lower end of the vertical labor division chain, improve the position of its modern service industry in the global value chain, and walk a new way of industrial innovation. In this sense, the Shanghai government needs to make a good balance between intervention in and withdrawal from the market. On one hand, it needs to exert its influence to supplement and overcome the disadvantages of the market system and the absence of some market functions due to the underdevelopment of market entities. On the other hand, it should be able to make timely withdrawal from the market so as to give free rein to market functions and encourage entrepreneurship. Furthermore, the city needs to meet the objectives related to its positioning as a metropolis such as improving web-based services and education and accelerating informatization. Last but not least, the process of economic globalization is the process when competition and uncertainty spread globally, under which, the international economic landscape is increasingly complex, dynamic, and diversified. Local governments must reshape themselves into a service-providing and responsible government that governs by law, enhance their decision-making and crisis management ability, and provide for enterprises a sound protective system and stable policy services. Furthermore, apart from withdrawing SOEs, especially those solely owned by the state, from monopolistic industries to competitive industries and encouraging private capital and enterprises to take part in the

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competition, local government also needs to create and maintain a free and fair environment, where SOEs, private enterprises, and foreign enterprises can compete with each other on the same ground. To conclude, changes in the socio-economic situation will constantly have new requirements for the functions of local government. And in different stages, the incentives for changes in government behaviors also vary. In the earlier years of the reform and opening up, the then economic hub, Shanghai, faced pressure for its falling economic significance and the lack of preferential policies from the central government. In the face of difficulties, the Shanghai municipality actively sought for, and succeeded in, institutional changes intended for the entities undergoing transition and interest-related entities affected by the transition. It connected the reform of SOEs and the wellbeing of the regional economy and embraced innovations. While maintaining a continuous growth in the public sector, it also completed the economic transition and marketization of its regional economy. With the gradual establishment of the modern corporate system and market economy, the economic globalization poses new challenges for the Shanghai municipality. To a certain degree, government work should be done as much as possible and as effectively as it can be done. Competition among factors such as natural resources, human resources, and institutional environment are happening in an increasing broad range. Resources will flow to where they are needed. Economic globalization is gradually becoming the main engine for a new round of institutional innovation of the Shanghai municipality. The government needs to continue its self-innovation like it did before and gradually replace the controlling administrative style with a more indirect administrative style. It should make full use of the existing diversified market entities structure and make the government-enterprises relationship a cooperative partnership, so as to make use of the abilities and resources of other entities to achieve the government’s own ends.

Jiangsu Province: A Development Pattern Based on Township and Village Enterprises Compared to the Shanghai pattern which relied on SOEs reform and economic opening, the economic take-off of Jiangsu relied on township and village enterprises (TVEs), especially the collective economy in Southern Jiangsu (Suzhou, Wuxi, and Changzhou). After the reform and opening up, its economic growth was among the fastest in China.

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The founding of TVEs in early years Southern Jiangsu is located in the Yangtze River economic belt. It not only boasts a sophisticated traditional agricultural industry, but is also a hub for modern national industries. In history, Southern Jiangsu was famous for its subsidiary industries, such as grassroots manufacturing, market network, crafts, and other commercial activities. Its location gave it some advantages in history, as it is close to Shanghai and Nanjing, two SOEs bases. Thanks to this, Southern Jiangsu is often the destination for skilled workers who were ousted from the two industrial bases for political reasons and engineers from the two bases employed to work in Southern Jiangsu on weekends and therefore had a very good basis for TVEs. T h e S o u t h e r n J i a n g s u p a t t e r n i s , i n e s s e n c e , a p ro c e s s o f v i l l a g e industrialization based on TVEs. As early as in the planned economy era, agricultural cooperatives-founded and people’s commune team-founded enterprises had thrived on the foundation of the region’s traditional subsidiary industries and handicrafts production. In the early 1970s, under the nationwide campaign of constructing infrastructure and mechanizing agriculture, village governments, led by those in Wuxi, started another campaign aimed at industrializing rural areas. Following the slogan of getting raw materials, producing and selling on-site, they used the lands, labor, technologies, and capital of their own villages, and started small processing industries, including equipment, chemicals, construction materials, and textile manufacturing. As the production of these enterprises was designed to meet the need of local agricultural production, they faced very low production costs and risks, and therefore thrived. The spirit of the village governments’ industrializing campaign was to improve the living standards of the rural population and to improve agricultural production. This did not contradict the planning of the central government. Therefore, the campaign soon gained support from the provincial government of Jiangsu. As these enterprises improved the productivity of villages and stabilized the rural economy, in 1979, the Ministry of Agriculture and Forestry drafted on behalf of the State Council The Regulations on Several Aspects of People’s Commune Team Enterprises , which gave formal approval to this initiative. Thanks to the support from the provincial government and the central government, these enterprises thrived and gradually became a unique form of economic participant and a dominant force in the rural economy, providing a certain level of accumulation of materials and capital for the later boom of TVEs.

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In the end of the 1970s and the beginning of the 1980s, people’s commune team enterprises had gone beyond the limit of subsidiary industries to become an independent rural industrial force under the commodity economy. In Wuxi, these enterprises had found four markets for their products, which included agriculture, major industries, urban and rural population and export. Processing trade also thrived in Wuxi. As their markets expanded, their product structure became very different from before. Agricultural equipment manufacturing was replaced by equipment manufacturing for major industries in urban areas. Construction materials manufacturing was replaced by light textile manufacturing, which served the needs of both the urban and rural populations. In 1984, TVEs became the formal name of these enterprises. By then, TVEs had undergone the first institutional transition, namely, they became collectively owned by the teams in the people’s communes, rather than by the state as before. From the perspective of ownership, the boundary of the concept “collective” here is relatively clear. Assets of TVEs were owned by the villages or townships whose administrative regions these enterprises were in. The township governments or the village communities exercised on the townships or villages’ behalf their right as the owners, including appointing the executives of these enterprises, concerning which, in some cases, government officials may became executives themselves. Therefore, the Southern Jiangsu pattern was in fact a process of rural industrialization in the form of collective ownership based on villages. It belonged to the small area that was left to market regulation from central planning. The prosperity of TVEs had promoted the division of labor in the Southern Jiangsu area, invigorated market competition, and had a positive effect on both the development of the market economy and diversifying market entities. The formation and development of Jiangsu TVEs followed a typical strong government pattern. TVEs came into being under the institution of people’s commune, which typically combined politics and the administration of the communes. TVEs were therefore the result of the bold and innovative experiments of the party leaders and administration of such communes. Therefore, TVEs were born as a combination of both political and commune administrative elements. Village administrations were the representatives of TVEs, which were the collective assets of the villages. They had the de facto ownership and managerial power of TVEs and would typically use their administrative power to intervene in the business activities of these enterprises. As a result, TVEs enjoyed a lower capital cost, managerial costs, and external transaction cost, which put them in a much more favorable position compared

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to pre-reform SOEs and the infant private business. The strong government pattern was an important reason for the success of TVEs under the parallel systems of market and planned economy. Local governments, in this case, were the engine for, and also the beneficiary of the reform. After the fiscal decentralization reform, which was characterized by the system where the central government gave fiscal autonomy to local government and demanded a certain amount of tax contribution, local governments became an interest-related party and began to have a competitive spirit. The entrepreneurship of local governments not only made a huge contribution to the economic growth of the countryside and the industrialization and growth of urban areas by making up for the functional defect of the market due to the imperfection of China’s then economic institution, but also rewarded local governments with benefits including extra-budgetary funds, bigger commodity consumption, better political performance and authority in their administrative regions. Local governments and TVEs therefore shared common interests.

The revival in the mid- to late-1990s In 1996, China passed The Law of Township and Village Enterprises , which defined the concept of TVEs and provided legal guidelines regulating their business activities. The passing of this law was an approval for the contribution TVEs had made to the development of the market economy, and a symbol that TVEs, as a form of collective economy, had become an important part of the Socialist market economic institution. By the latter 1990s, the Socialist market economy of openness and competitiveness gradually matured. Through measures such as adjusting operational system, structural reform, and asset restructuring, SOEs gradually got rid of their difficulties and saw a revival of their economic power. At the same time, burgeoning private companies started to emerge and foreign companies, thanks to encouraging policies, also started to open their Chinese branches. The institutional advantages TVEs used to have over other competitors from other sectors no longer existed. And their extensive developmental model put them in a chaotic state and confined their scale, which made them only a fragile force no longer having any competitive strength in the economy. On the top of their problems were their troubled managerial mechanism and operational mechanism. To tackle these problems, many institutional reforms were carried out, including the contract responsibility system, a new merit-based recruiting system for their executives, a contract-

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based recruiting system for employees replacing the lifetime employment system, merit-based wage system replacing the fixed wage system, manager contract system, internal audit system, etc., but yielded little result. As the macro economic situation grew increasingly unfavorable to TVEs, they were increasingly troubled by the immense losses, indebtedness and improper management. Finally, in 1997, a sweeping reform was carried out in the ownership of these then collectively owned enterprises. The reform was later 4

referred to as one of the three institutional breakthroughs in China during the period between 1992 and 1997. The core of the reform was to diversify investment providers, clarify the relationships between local governments and enterprises in relation to their assets and redefine the relationship between TVEs and their employees, so as to reinvent TVEs as cells or micro entities in the market economy. Promoted vigorously by local governments, the ownership reform swiftly gained momentum. In 1997 alone as many as 79% of TVEs in Jiangsu participated in the reform, and by 1999, the reform was almost completed. The rapidity and extensity of the reform later made people called it a shock therapy reform. Most of the small and medium-sized TVEs were privatized through auctions and transfers, while bigger TVEs were mostly restructured into joint ventures or limited corporations. The managers of the original TVEs mostly became the owners of the new companies. The primary reason for the success of TVEs of Southern Jiangsu is the existence of a proper incentive mechanism. By relating the wage levels of employees and executives with their contribution, local governments, TVE executives and employees were sufficiently encouraged to enhance the efficiency of the enterprises, even at the absence of private ownership. As has been concluded by some scholars, ownership is often the sufficient condition of effective allocation of resources, but may not be the necessary condition (Stiglitz 1998; Tian Guoqian 2001). However, as the marketization reform deepened, trying to accelerate economic growth only by making economic policy reforms rather than reform of the basic ownership regime led to an awkward situation (Kiefer and Shirley 2003). The managerial system of TVEs that combined politics and administration had a positive effect on TVEs by lowering the costs for them to enter the market. However, under a new market and institutional environment, such a system continued allowing local governments to impose their wills on many aspects of TVEs, such as their business operation and appointment of staff. This led to the disequilibrium among managerial power, responsibility, and business interests in TVEs, and restricted the effects of the said incentives system.

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It was tempting for one to think of the restructuring of Southern Jiangsu TVEs as a result of their debt crisis and that local governments pushed for such restructuring simply to get rid of them, because with the huge losses these enterprises incurred, it would be uneconomic for the government to own them. However, the restructuring was the result of a choice made jointly by the governments and TVEs. Because in the original institutional structure, both the government and TVEs were deprived of their ability to profit, a new institutional arrangement, or a change in the old institution was therefore an obvious choice. For one thing, with the deepening of marketization, resources provided by the governments for enterprises were becoming increasingly limited; for another, indebted operation and the extensive growth pattern were making the growth of TVEs increasingly unsustainable, pushing collective economy as a whole to the brink of collapse. Governments were also under heavy pressure from the TVE debt crisis. Protests frequently erupted due to the public debt of TVEs, posing serious disruption to government works. Under such circumstances, township and village governments, as the decision-makers and inventors of institutional innovation, started to advocate and promote restructuring of TVEs, becoming the primary engine for such reform. The continuing marketization and the success of restructured TVEs encouraged the other TVEs to follow suit, making them the second engine of the reform. Therefore the ownership reform gradually became a negotiation presided over by the local governments in which TVEs were transferred to their executives. This process proceeded rapidly as it was powered by the two main interestrelated parties of the reform. Despite unceasing disputes over the details of the reform, this reform covering both the operational system and ownership system of TVEs has undisputedly brought new opportunities for development to TVEs, as the separation of politics and management in these enterprises magnified the incentive for the executives of these enterprises to enhance the performance of TVEs.

The new Southern Jiangsu model under open economy With the continuous advancement of economic globalization, the Yangtze River Delta gradually became an international manufacturing base through the 1990s, with Shanghai being its center. With an advantageous location and a fine industrial base, the Southern Jiangsu area actively attracted international capital transfer through its industrial parks, and is gradually moving in a favorable

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situation. The former Southern Jiangsu model featuring rural industrialization has been replaced by a regional open development model characterized by relocation of industries in urban areas and industrial clusters. The updating of the development model of Jiangsu was marked by the overall completion of the restructuring of TVEs in Southern Jiangsu. While collective ownership and local governments were withdrawing from TVEs, innovations were made in various places in Southern Jiangsu, which led to the unique and vibrant economy at the township level. The TVEs in Jiangyin City adopted the joint-stock system, and based on this actively utilized the capital market and introduced a corporate management system, leading to a unique Jiangyin economy. The TVEs in Kunshan City made good use of the advantage of location adjacent to Shanghai. By constructing a good environment for foreign direct investment (FDI) and actively attracting FDI, the city created a path for itself characterized by economic openness. Changshu City encouraged restructured TVEs, mostly private enterprises now, to actively engage in merger and acquisition, which by now rewarded the city with a higher living standard and a thriving economy. Through continuing reforms, the resource allocation function of the market had been constantly expanding, and a diversifiedownership economy has come to a full-fledged state, with foreign, private, and joint-stock companies all claiming their relative share of the economy. The new Southern Jiangsu model is different from the old one both in a geographical and industrial structural sense. Geographically, the new model expands to cover five cities to the south of the Yangtze River, including Nanjing, Zhenjiang, Suzhou, Wuxi, and Changzhou. More importantly, there is also a significant change in terms of the industrial structure of the region under the new model, as the old one featuring labor intensive industries has now been replaced by one comprised of emerging industries like IT, precise instrument, mechatronics, bio-medicine, fine chemicals and new materials. Therefore, the new Southern Jiangsu model demonstrates a new industrialization process pivoting on technological innovation and knowledge-based economy. The process of industrialization is often coupled with the process of urbanization, as the process of modern economic development is often a process where urban areas increasingly become the dominant force in regional economy. Local governments in Southern Jiangsu mostly follow a developmental pattern that focuses on the construction of the urban circle, which leads to a regional economic landscape that pivots on major and medium-sized cities and uses small cities as the connection to the outskirt of the circle. In this new economic landscape, accompanying the concentration of capital and industries, concentrations are also happening in agricultural production, where smaller

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producers integrate into a big one, in industry, where industries concentrate in industrial parks and in rural labor flow, which concentrate in urban areas. The underlying meaning of the economic development of the Southern Jiangsu area is now the unification of urban and rural areas, which extends to regional development, instead of rural development as before. The new Southern Jiangsu model is the extension and result of development of the strong government tradition under an open economy. Under the new Southern Jiangsu model, the willingness of the local government to encourage local economic development is still on the rise. Although governments retreat from direct market activities and from their role in enterprises, their influence does not wane. What has been changed is the scope of their influence and the mechanism through which their influence is exerted. In the era of the open economy, regions that make the fullest use of the global flow of factors, namely, regions that do the best in attracting foreign capital and technologies, are in the best position to achieve industrial upgrade and to take their shares of interests from the global economic development. Encouraged by such thinking, almost all local governments prioritize attracting FDI and establishing development zones and industrial parks of various sorts, especially hi-tech industrial parks. In many cases, local governments use very direct approaches such as using administrative power, and cooperating with local government bodies and banks to offer an all-rounded preferential policy in the effort to attract possible market interest, investment, and projects. Regional economic competition often transforms into institutional competition among local governments, which, for one thing, leads to a waste of resources and overlapping construction among regions, and for another, a zero-sum game situation, making such a development pattern unsustainable. When the economic interests of local governments are in line with their political interests, local governments are bound to assume an entrepreneurial role that will try to develop and use the market. However, as local governments are separate administrative bodies, their respective interests contest with one another, which leads to institutional friction among regions, and in turn leads to a reduced efficiency in the overall allocation of resources. Moreover, at a time when the functions of market entities are becoming increasingly mighty and the flows of factors increasingly free, policies separating regions are harmful for both enterprises and the long-term welfare of these regions. Therefore, at the moment, further clarifying the relationship between governments and enterprises and changing the role of governments will provide an important guarantee for the success of turning institutional frictions to institutional integrative power, which will lead to a more balanced development throughout all these regions.

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After 2003, a series of reform measures under the guidance of The Decisions of the Central Committee on Further Completing the Socialist Market Economy , such as the system of administrative examination and approval and the administrative system for investment, have pointed out the direction for the change of government role in economy, which is that governments should provide services for market entities and create a good environment for investment. To effectively put these into practice, local governments need to liberate their thinking and make institutional innovations with a more open administrative style. Local governments also need to make full use of private capital, forge an interactive relationship between themselves and enterprises, as well as other market entities, so as to prepare enterprises and the society as a whole for the more complex global competition in the future.

Zhejiang Province: The Self-Innovation of the Private Sector and the Supplement from the Government The emergence and progress of private economy is an important phenomenon during China’s economic transition. Private economy is a concept contrasting to the concept of state-owned economy. It refers to collection of all ownerships other than state-owned, or, simply put, economy outside the state-managed system. The three decades since the reform and opening up have witnessed the birth and growth of the private economy. By now, the private sector has become an important part in propelling the sustainable growth of China’s economy and increasing the country’s competitiveness. Zhejiang Province is where the private sector grows the fastest, takes up the biggest proportion of the provincial economy, and is the strongest throughout China. The progress of the private sector facilitates the completion of market system and invigorates the market itself, leading to the emergence of many very competitive private enterprises ranked among the best of their respective industries. An analysis from the perspective of the evolution of institution on the internal relationship and mechanism of mutual influence between the local governments of Zhejiang and private enterprises will improve our understanding of the states of China’s private enterprises during the country’s transition.

The take-off of the private sector A saying that makes a perfect depiction of poor natural endowments of Zhejiang and its low per capita land ownership goes like “70% of hills, 10% of water,

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and 20% of fields.” The province’s historically weak industrial and agricultural foundation, the low capacity of capital accumulation of local governments and collective economy (agricultural cooperative team founded enterprises), and the insufficient investment from the state meant that both politically and economically, the province was in a disadvantageous position when compared to other coastal provinces at the early years of reform and opening up. Zhejiang’s handicraft was relatively developed compared to its agriculture and industry. It is a commercial tradition that dates back to the southern Song Dynasty which provided it with the basic parameters for the later boom of the 5

private sector. The burgeoning of family-based business marked the first phase of economic transition of the Zhejiang Province. By the levels of division of labor, such business can be put into three categories, farmer family-based business operating part-time, family workshop, and family factory. Part-time farmer family-based business was the primary form of family business, which mainly referred to the case when certain members use their surplus labor and capital to conduct simple industrial production in their spare time from agricultural production. This was very common in the early days of the reform and opening up, as it was a very good way for rural families to make full use of the surplus labor and time of their households. In some regions, income generated from such family business even became an important source of family income. Family workshop was a product of the evolution of the part-time farmer family business. In this form of family business, industrial production had become the primary work of households and family members were still the major work force of this business, albeit a few employed workers in some cases. Most of these family workshops produced handmade and labor-intensive products such as cloths and toys, and other low-capital-intensity products. Family factory is a relatively sophisticated form of rural industrialization. Production activities at this stage were carried out on a higher level of capital and technological intensity, the employment relationship between the factory and workers was more distinctive, and private loans and other commercial activities were active in this stage. An ensuing innovation in the business pattern of such factories, namely, the affiliation operation, pushed the family business into a new stage, which provided a sufficient market for the later surge of the private economy. The so-called affiliated business operation referred to the case when some family business, which did not have the corporate legal person status and couldn’t open a commercial account in the bank but still had to develop their supply chain and production, made themselves affiliated entities to some collective or stateowned enterprises and conduct production and other business activities under the name of the said bigger enterprises. Enterprises would provide for affiliated

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family businesses services such as providing invoices, establishing account,

paying state taxes and village taxes on behalf of the family businesses as well as allowing them to use the enterprises’ introduction letter, contract and bank account services. With these conveniences provided by the enterprises, family businesses independently conduct their business activities, and are liable for

their own losses and earnings. These affiliated family businesses paid a certain proportion of their turnover in return to the said services.

In the years of the planned economy, private enterprises were subject to

many restrictions as they were not part of the planned system. Even after the

reform and opening up in the early 1980s social environment, the commercial and taxation regimes and banks, in terms of credits provision, were still unfriendly to private enterprises, which therefore faced tremendous resistance

and difficulties. Private businessmen were allowed only to sell three stated kinds of agricultural and sideline products and other agricultural and sideline

products that were not provided by the planed system. Even consumers were suspicious of private business. Therefore, by affiliating themselves to stateowned or collective enterprises, private businesses could not only go beyond

the institutional difficulties they faced at the particular historical stage due to political restriction, they could also make market entry process of their products more economical.

The key period for the take-off of private business was in the later

1980s, when joint stock partnership started to take shape. With the further

development of family industry, these private enterprises faced shortages

in resources like capital, human resources, technologies, and land, therefore leading to the gradual formation of a joint stock partnership. At the time, the binding mechanism of such a partnership was one that was based on reputation,

and blood ties as partners might be relatives or neighbors in the same village.

Although the ownership structure and operation patterns varied among these

enterprises, only a very few of them were collectively owned by the whole staff.

Most of them demonstrated the basic features of family business, as most of them were funded by a few people from the same big family and gave no shares to staff.

The emergence of joint stock partnership enterprises not only enabled

Zhejiang private enterprises’ needs for capital, human resources, and

technologies, it also greatly facilitated the expansion and prosperity of such

enterprises, laying a good foundation for the later establishment of a modern corporate system.

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The role and functions of local governments in the take-off of the private sector The process of the emergence and development of Zhejiang private enterprises was very similar to the early spontaneous development of the market economy in Western countries. During the whole economic transition, due to the effects of the long-lasting traditional planned economic system and the absence of a full-fledged market economy, private capital and economy have been under a strong institutional restriction. Private capital and the private economy lacked the various conditions that were needed for further development, and they had very few political and economic resources at their disposal. Therefore, in view of the internality of the economic transition of Zhejiang, some scholars proposed that the spontaneous market entry and development were a spontaneous 6

regulation, during which government used a passive administrative style. Zhou Yean (2000) believed that the reform of China was a path constituted by two interwoven elements, i.e. the external regulation chosen by the government and the internal regulation chosen by social members. Although the former appears to be the dominant element, the latter actually serves as the de facto dominant element. The internal regulation, as part of the latter element, has brought about sustainable economic growth and energized the economy. However, if analyzed from another perspective, governments, especially local governments, are political organizations that have coercive power, with which, governments can choose to apply external regulations that facilitate the growth of the private sector, or external regulations that remove restrictions on such growth. Therefore, local governments were not only playing a passive role in the economic take-off of the private sector of Zhejiang (Zhou Jin and Zhou Wenjie 2003). Instead, they actively provided policy support and protection for the innovations of Zhejiang private enterprises, therefore demonstrating a significant market promoting effect (Shi Jinchuan 2004). This can be seen in the support and approval granted by local governments for the private economy in Zhejiang in the early days of reform and opening up. In Wenzhou, for example, on July 22, 1980, the Administrative Bureau of Industry and Commerce drafted The Report of the Overall Reorganization, Registration and Qualification Issuance for Privately or Individually Owned Business . The report approved the significance of private business, as they were often managed agilely, offering diversified services, and providing convenience for the public. The report also said such business not only played a supplementary role to the circulation of commodities and the living of the masses, but also improved employment. It pointed out some problems in

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the operation of some private businesses, modified the principles according to which private businesses registered and were granted license to operate, partly allowed the registration of private business run by couples and allowed specialized technicians to have one to two apprentices, etc. The revolutionary committee of Wenzhou circulated this report and expressed its approval to private business again in the attachment to the report, saying “Wenzhou city has always had the tradition of private business, which, if guided properly and allowed to develop in a proper direction, will certainly produce positive effects.” The report also asked related government bodies to free their thinking as it related to government works related to private business. In order to clarify the central government’s stance on private business in 1982, the Wenzhou municipal party committee made an extensive survey on rural households with specialized skills (referred to as specialized households) and those that had already achieved a certain degree of business success (referred to as key households), and convened a meeting with representatives of these two types of households in the city. In the meeting, 10 policies were specially designed to bolster up these households. Another meeting during December 12 to 19 in the same year included even more representatives of these two types of households citywide, and this had a significant impact on the city’s private business. High-ranking officials in the municipal party committee announced in the meeting that, both private business with or without a contract responsibility basis, and both specialized and key households, fell into the category of Socialist economy. As the various types of private business used their own hard-work to earn money according to the policy of the party, their creative labor would be encouraged and supported both by the party and the state, and there lawful rights to their business operation and properties would be 7

under legal protection. The meeting also announced the 10 policies made by the municipal party committee and government to spur the success of the two types of households. These policies by local governments served as an active approval to the role and position of private and individual business, providing policy protection for the take-off of the private sector. A series of detailed measures and the principle of “the investor and owner of a business should be its beneficiary” provided fundamental protection for the lawful rights of private business owners and encouraged private investment. Furthermore, local governments conducted a large amount of policy innovation in the key moment in the development of the private sector, effectively protecting the ownership of private business and facilitating their continuous growth. In 1987, the Wenzhou government announced the Wenzhou Affiliated Business Temporary Administrative Regulations, which

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provided legal guidelines for the organization pattern of affiliated enterprises, a new form of enterprises, providing policy basis by clarifying the rights and obligations of such enterprises and enterprises that they were affiliated to. All these policies and government behaviors undoubtedly had a significant promotion for the development of Wenzhou private enterprises. Moreover, in view of the emergence of the cooperative model of joint-stock enterprises, the local government of Wenzhou gave a definition to them as innovative cooperative economic organizations which are voluntarily and cooperatively founded by two or more individuals according to their agreement and using their respective capital, materials, technologies, or other resources, and which possess real estate assets where production or business operation can be carried out and have the capacity to assume sole civil responsibility. Furthermore, the government put forth a series of policies that offer protection for the ownership and stability of private enterprises and facilitate local economic growth. These policies included, The Interim Provision on Several Aspects of Village JointStock Enterprises, Circular on Several Aspects of Private Enterprises and JointStock Enterprises, Circular on Several Aspects of Policies Concerning the Standardization of Joint-Stock Enterprises , Regulations on the Promotion of Joint-Stock Enterprises , etc. Finally, with the deepening of the institutional reform, local governments implemented another series of policies to provide a fair environment for the market entry and competition of private enterprises, guaranteeing the sustainable development of the private sector. The first step was to allow nonstate-owned enterprises to participate in competition fairly. All business areas that were not legally forbidden entry, or areas open to foreign enterprises, were also open to non-state-owned enterprises. In terms of the conditions and procedures of investment authorization, financing services, taxation policies, land use, cross-border trade, and economic technological cooperation, non-stateowned enterprises were treated equally with other enterprises. Furthermore, support was given to private enterprises in taxation and financial policies. Governments of various levels actively implemented preferential taxation policies to promote R&D in private enterprises, and encouraged financial organizations to make financial innovation, so as to improve the financing environment for these enterprises. In the early days of reform and opening up, policies protecting the assets of private enterprises were missing and market conditions were immature, putting the private sector under various kinds of external pressure. Thanks to local governments’ appropriate and innovative adaptation and implementation of policies from the central government, these political restrictions imposed on

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private enterprises were defused. And thanks to this, the willingness of private enterprises to make innovation and further development were protected. The spontaneous innovation from the private sector and governmental supplementary effects together forged the opportunity for the economic take-off of the private sector of Zhejiang.

The development of the relationship between governments and enterprises under globalization As China’s economic institutional reform rumbled forward, the Socialist market economic regime was founded and the economic competition among various regions in China also intensified. Despite Zhejiang private enterprises’ advantages in both number and scale when compared to those of other regions, their first actor advantages gained through institutional innovation in the earlier days had been declining. In view of the new situation, the various levels of governments in Zhejiang actively modified their administrative patterns and engaged in a transition from acting as the manager to the service provider in the local economy. Local governments put forth a series of adjusted policies that were primarily aimed at improving the business environment for enterprises and lowering their operational costs. For example, the Zhejiang Province shifted its focus from improving the hard environment and offering preferential policies to improving the soft environment. Local governments and enterprises in the province witnessed the formation of a real interactive relationship between themselves, in which governments forged a good environment for enterprises and enterprises made an economic contribution to the local economy in return. The power of Zhejiang’s market economy therefore rapidly developed. Social private capital increasingly concentrated via the form of joint-stock enterprises, which as a result, have seen an increase in number. Based on this, the mixed ownership economy, which often exists in the form of joint-stock companies, also saw a rapid development. Among listed companies in Zhejiang, companies held by private enterprises make up a significant share. Zhejiang private enterprises’ flexible business operation mechanism and ability to keep pace with the market make them a rising force in the economy, which makes a significant contribution to the economic development on the provincial, even national, level. In recent years, the internationalization of Zhejiang private enterprises is gaining momentum. Apart from international trade, some established private enterprises have also made foreign investment, setting up factories and even R&D facilities abroad. By now, the commercial activities of Zhejiang private enterprises have extended to European, Middle Eastern, Southern American, and African markets,

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making these enterprises an important force in China’s strategy to promote economic globalization. Despite the rapidity of development, keeping this first actor advantage for Zhejiang private enterprises is still not an easy task. Overall, the scale of Zhejiang private enterprises is still small and the connections among them are weak. Therefore, despite the large number of individual business and private enterprises, their overall competitiveness is still low. Moreover, most of the private enterprises in Zhejiang are in technologically unsophisticated industries such as textile and fiber manufacturing, general machine manufacturing, electronics and equipment manufacturing, and metal manufacturing. Low cost competition and processing exports are very common strategies for these enterprises. This has led to the slowness in technological progress and the increase in productivity, making it difficult for these enterprises to have sustainable competitiveness. Most of the private enterprises went through the process of the primitive accumulation of capital to reach their current stage, with many of them still demonstrating the characteristics of family business. The characteristics of such an organizational pattern include their distinctive ownership structure, simplified organizational structure, lower management costs, and flexible decision-making, which play an important role in their low cost and rapid expansion. However, with further expansion in production scale and product line, improvement in technological sophistication and intensified market competition, traditional family businesses are often more vulnerable to the so-called “family complex,” internal friction, barriers to the enrollment of talents, management bottleneck, etc., which are the obstacles for these enterprises’ further development. Therefore, getting rid of the traditional family business management pattern, separating family from enterprise and enhancing scientific management are some innovations very difficult to make for these enterprises, but are also necessary if they are to accelerate their development and keep pace with the changing market. However, the economic globalization and the further opening up of China make the market competition for private enterprises even more complicated and fierce. Right now, rising costs of production factors such as land, power sources, electricity, and labor, China’s increasingly tough domestic economic policies, the rising RMB value, and these enterprises’ traditional strategy of low cost competition in both domestic and oversea markets have all posed severe challenges to the economy of Zhejiang. How to maintain the provincial economy of Zhejiang in a stable stage and tap local enterprises’ greater potential in further development in the face of such challenges and crises are a question to be answered by both the various levels of governments and enterprises in the province.

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Conclusion New institutional economics holds that only when the economic organization is effective can the economy as a whole grow. To understand China’s economic growth, we need to make an in-depth analysis on the function and role of local governments as the provider of institutional innovations from the perspective of the relationship between government and enterprises. The experience of the economic transition of the Yangtze River Delta provides us with the following conclusions. First of all, mandated institutional reforms such as the decentralization reform and the transition in the fiscal system have changed the objectives of local government behaviors, which served as the internal incentives for the change of relationship between local governments and enterprises. Political performance appraisal that determines the political future of government officials can be seen as the political interests of a region. Therefore, the regional political interests and the economic interests of the region together lead to the strong desire for local economic growth, making local governments and local enterprises two parties with common interests. In the early days of economic transition, local governments demonstrated entrepreneurship, which led to government behaviors that supplemented the incomplete market and planning 8

of the era. Second, from the perspective of the relationship between local government and enterprises, there are regional differences in the patterns of economic transition. Shanghai’s transition was one that was led by the government and was based primarily on SOE reform, the Southern Jiangsu pattern featured a combination between a tradition of strong government and collective economy, while by contrast the Zhejiang model was one that featured the self-innovation of the province’s private sector. The differences in the transition patterns of these regions were the result of the different economic traditions and the different factors endowment. The region-specific strategies and the innovative spirits of local governments then gradually steered these regions’ economies in the same direction. During economic transition, there is no universal or optimal model to follow. The most important thing in a reforming environment is to find out the most effective incentives. Furthermore, from the perspective of economic evolution, with the continuous maturing of market economy and the economic globalization, the transitional patterns of different regions gradually converge. The most fundamental meaning of market economic mechanism lies in competition, which is based on the right to choose and relocate in the process of factor

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allocation. The mechanism where resources flow to where they best fit has constituted the external restriction mechanism for government behaviors. The mechanism of economic competition is continuously modifying and adjusting the relationship between local governments and enterprises, forcing local governments to eventually give up their control over enterprises and transform from the controller of the economy to the administrator of the economy. Finally, from the perspective of the theoretical basis of economic transition, many studies have shown that a distinctive ownership structure is the sufficient condition for the effective allocation of resources, but not the necessary condition. Enterprises’ efficiency is not related to its ownership, 9

but to macroeconomic stability and the hard constraints on themselves. The privatization of some enterprises may improve market competitiveness, but is not sufficient evidence that privatization will improve the performance of enterprises. The experience of the Yangtze River Delta, however, shows that despite the fact that incentive mechanism, rather than private ownership, was the engine for economic growth in the initial period of economic transition, in the period when the market mechanism gradually matured, the converging growth patterns of the different regions in the delta have shown that the ownership relationship will eventually have its effects on the functions of the incentive mechanism. Therefore, there is no linear relationship between economic efficiency and ownership structure, but they are indeed related. For countries and regions undergoing transition, factors such as the relationship between their local governments and enterprises and the competition among local governments are much more important to these countries or regions than they are to developed and industrialized countries. The competition among local governments leads to economic changes, which in turn cause internal changes in the competition and the relationship between government and enterprises. Therefore, further study from the perspective of evolutionary economics is needed on a range of topics, such as how does government competition affect the learning process of related actors, how does this changed learning process further trigger changes in the relationships between governments and enterprises, and how does institutional and structural changes lead to changes in economic pattern.

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4

Chapter

The Convergence of Local Government Competition and Economic Development Pattern

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Introduction A s early as the middle 1980s, the southern Jiangsu province was referred to by Deng Xiaoping as the “black horse.” The region invented the southern Jiangsu model of marketization and industrialization by embracing rural industrialization and urbanization. This model is characterized by the use of collective capital to found enterprises, the village and township governments’ active part in the thriving of such enterprises, and the allowing of the population to get rich earlier than the rest but still having a focus on the enhancement of regional economic welfare (Hong Yinxing 2007). Wenzhou, however, followed a classical market-oriented pattern, which features a dependence on the market and the innovations of entrepreneurs. The Wenzhou model made full use of the flexibility of private capital and used such capital as the primary engine for the region’s economic development. These two models for regional economic development are widely believed to be the most successful models either in the Yangtze River Delta regions, or the whole country. In the 21st century, however, we find that these two originally distinctive developmental patterns started to converge. In southern Jiangsu, based on its existing levels of marketization and internationalization, the region has seen the emergence of an ownership structure mainly comprised of foreign, private, and joint-stock ownership, and a large number of large-scale enterprises that are founded based on mixed ownership, which is named the “new southern Jiangsu model” (Hong Yinxing 2007). In Wenzhou, the growth pattern that relied solely on private enterprises to propel economic growth has been abandoned. The region’s sole focus on exports has been replaced by a more diversified one that also takes into consideration the absorption of foreign investment, through which, foreign enterprises can promote economic growth in Wenzhou. Accompanying this, the region’s ownership structure also shifted from one that was dominated by private ownership to one comprised of foreign, private, and joint-stock ownership. Furthermore, the scales of enterprises in Wenzhou have also grown rapidly. These features together constitute the “new Wenzhou model.” For a long time, the academic circle had been comparing the two development patterns, and a large amount of literature had been devoted to find out which one of the two was better. These studies analyzed the two regions’ respective models and the formation processes of such models, so as to find out a universally applicable model for other regions. However, according to our analysis, the once very popular southern Jiangsu and Wenzhou models are both transitional regional development patterns which occurred against the backdrop

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of a bigger nationwide economic transition. In the economic integration of the Yangtze River Delta, these two models will continuously modify themselves and eventually converge. Then, why will the two representatives of two contrasting models, namely, the southern Jiangsu and Wenzhou models, converge? In the early 21st century, a German scholar, Herrmann Pillath, pointed out in a 2001 study which looked at the power of institutional transitions in China and Russia that local government competition will lead to the divergence of regional economic development patterns. However, we hold that the convergence of the southern Jiangsu and Wenzhou models is also due to local government competition. Therefore, this chapter attempts to give a plausible explanation for the convergence of growth patterns in the two regions under the analytical framework of local government competition. The structure of this chapter will be as follows. The second section will be devoted to related literature. The third section will establish a simple model based on the analysis of Bester and Güth (1998), so as to describe how the political contest of local government officials that is mainly judged by the GDP growth of their administrative regions affects government behaviors. This factor that is to be tested in our model is usually under the radar of performance appraisal carried out by high-ranking officials who oversee these local government officials. The fourth section focuses on an analysis from the perspective of GDP contest on the different measures taken by the local governments of southern Jiangsu and Wenzhou in different stages, which appeared in the form of various institutional and policy innovations and eventually led to the convergence of the two models. The fifth section is a brief conclusion.

Literature Review For a long time, due to the monopolistic position of the central government, government competition has been a long ignored factor. Later on, discussions over local government competition gradually received attention from the mainstream economic academic circle, which carried out their studies basically following two directions. The first direction was established by Teibout (1956) and Breton (1996) based on neoclassical economics, which emphasizes government competition in providing public services. Another direction was established by Herrmann Pillath (2001) based on evolutionary economics, which emphasizes the institutional competition among local governments. However,

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both of these two directions were established based on a set of presumptions that were based on having a democratic system in place. In these presumptions, governments are in the pursuit of the maximum public welfare rather than the maximum interests for themselves, the role of governments is to provide for the society public services including security, environmental protection, rules stipulating how the market should be functioning, an income allocation structure that is accepted by the society, a legal system that keeps the society functioning normally, and the necessary infrastructure, so as to please the maximum amount of voters and stay in office. As a result, most of the studies on government competition are related to democracy. However, government competition in China is a special case. The presumption that governments need to please their voters as much as they can is false, as the Communist party is the only ruling party in China. This is reflected in the following two aspects. First, China’s election is a top-down election that allows that party to elect itself. Such an election system, together with its centralized decision-making and representative system, deprive its citizens of the de facto right to vote. Secondly, the Hukou system long existed under the planned economy rendered the free flow of its citizens impossible and it therefore led to the absence of a system where resources such as human resources can flow to where they best fit. Therefore, under such a system, the government competition in China happens mostly in the form of the competition between the central government and local governments and the competition among local governments. These two types of competitions are referred to by Herrmann Pillath as the vertical and horizontal competition. The vertical competition is often broken down in studies to the exchanges between the central government and local governments in fiscal and political benefits. Such studies are sufficiently carried out in the study on the fiscal decentralization. The horizontal competition is mostly reflected in the competition among local governments to attract production factors needed for economic growth, which domestic scholars refer to as competition among brothers (Fan Gang, and Zhang Shuguang 1990; Feng Xingyuan 2001). North (1991, 1994) pointed out that the fundamental reason for the lack of growth in Africa is the absence of a political system that focuses on such growth. By the same token, he believes that the economic miracle of eastern Asia is, to a large extent, due to governments’ focus on economic growth, which leads to a government administration model that guarantees the rapid economic growth of the region. The longtime and prevailing success of this model should be attributed to local government competition. In fact, analyses on China’s local government competition are mostly done from the perspective of fiscal

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decentralization. Many studies have shown that fiscal decentralization reform was a key institutional arrangement that led to the economic miracle of the country. Such an institutional arrangement can provide local governments market-based economic incentives. And the competition among local governments will in turn facilitate and maintain the progress of marketization. This leads to the so-called fiscal federalism which focuses on the maintenance of marketization (Qian and Weingast 1997; Qian and Roland 1998; Lin and Liu 2000; Jin, Qian and Weingast 2005; Zhang Yan and Gong Liutang 2005). Apart from these economic incentives, the top-down centralized institutional system and the tendency of the central government to assess local government officials’ performance by local GDP growth have given absolute authority to the highranking officials in determining the political future of their subordinates and greatly intensified the competition among local governments (Zhou Li’an 2007). Due to the dual incentives from both political and economic aspects, local governments are very willing to promote local economic growth (Blanchard and Shleifer 2000). The competition among local governments comprises competition in the institutional aspect, such as taxation, subsidies, and rules for market competition; competition in the offering of platforms for human resources, technologies, patents, and technological innovations; competition in the offering of public products, such as infrastructure, public services and environmental protection; competition in how well local governments provide support and encouragement to local enterprises to develop, competition in the appeal to the central government for better preferential policies and treatment; and competition in local governments’ administrative efficiency (Shi Hongxiu 2007). Many scholars put their attention in the economic effects of local government competition. Teibout (1956) and Breton (1996) pointed to the negative effects of such competition, holding that competition may push governments to lower their taxes and expand public services, which will in turn lead to fiscal strain and deficit financing. Qian and other scholars (Qian and Weingast 1997; Qian and Roland 1998) made an objective observation on such phenomenon. He holds that, competition will discourage government to distort the allocation of resources. If local governments have to compete with each other to attract capital, they will have to invest more in infrastructure that will facilitate growth and engage in less ineffective activities such as helping enterprises at the brink of bankruptcy. However, under the pressure of competition, in order to attract foreign investment, local governments compete with each other to lower the operational costs of flowing factors, which may lead to insufficient tax revenue of local governments, which should have been used to sustain

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local governments’ provision of public products above an optimal level, thus leading to a situation where local government competition becomes ineffective. Zhou Li’an (2004) pointed out that, in local government officials’ competition to spur growth, they might be inclined to develop some strategic industries that have reverse comparative advantages, which will lead to repetitive construction, a waste of resources, market separation, and reverse specialization in some regions. Zhang Jun (2005) held that government competition will spur local investment in infrastructure and an improvement in the institutional environment so as to increase investment in the area. Although there may be excessive investment in an area due to the competition for growth, such competition also fundamentally reduces mistakes in decision-making as compared to centralized decision-making. Moreover, such competition speeds up the integration of China’s manufacturing and trade into the global labor division chain. Xu Xianxian et al. (2007) pointed out that, although facing different political incentives, in order to maximize their political interests local governments will make different choices between market separation and regional integration according to different parameters. When local government officials’ efforts demonstrated externality or positive spillover effects, officials will make the rational choice of regional integration, so as to internalize the positive spillover effects and achieve more speedy economic growth, which will bring them a better political future. When the opposite happens, i.e. when there are negative externalities or negative spillover effects, local government officials will make another rational choice of market separation, so as to externalize the negative spillover effects and protect regional economic growth from external negative influence and their political future which is dependent on economic growth. Pi Jiancai (2008) was in support of the abovementioned viewpoints. From the perspective of political future, he saw market integration as a process during which developed regions actively integrate with underdeveloped regions. He also held that, whether developed regions will actively integrate with underdeveloped regions depends on the costs and return of such integration. We attempt to use the analytical framework of local government competition to describe the evolution of regional economic growth pattern. Herrmann Pillath (2001) made an exploratory study based on this framework, but did not make it in-depth enough. In terms of the relationship between government competition and growth model, he emphasized that competition will lead to the differences among regions in growth pattern. Herrmann Pillath (2001) also pointed out that the regional property rights of local governments can be observed in many regions, which leads to competition among local governments for resources and

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interests whenever a transitional policy is carried out. Moreover, a nationwide transitional policy may generate different reactions in different regions, which will gradually lead to the different patterns for transition in different regions. Following this perspective, however, we come to a conclusion in contrast to Herrmann Pillath’s. We find that when the political future of local government officials is primarily dependent on local GDP growth, in order to win in the political contest, competition among local governments for resources is inevitable, which will in turn intensify local government competition. And such competition is the very cause for the convergence of economic development patterns among regions.

Model-Based Analysis Our theoretical framework comes from Bester and Güth (1998), who established a model to analyze the evolution of egotism and altruism. By simplifying their model, we make an analysis on the case when resources are scarce and local governments are driven by their preferences for grabbing resources and political promotion, local governments’ efforts in government competition will intensify due to the absence of budget constraints.

Basic assumptions First, presume that there are local governments A and B whose ultimate goals are to maximize GDP growth. Second, presume that GDP growth is totally dependent on the use of various resources, that the two regions are adjacent to each other, and that the total amount of resources in the area are limited, therefore when one of the two governments increases the consumption of the resources, the other will have less at its disposal. In order to maximize GDP growth, the two governments deploy their respective measures and efforts, which are defined as e A and e B. e A and e B are used to increase the intake of resources, which leads to competition for resources between A and B, including competition in attracting foreign investment and in infrastructure construction. Furthermore, the level of local governments’ devotion to promote GDP growth 1

is also closely related to the actual GDP growth. Third, local governments face only soft budget constraints. When there is a budget deficit, local governments can use measures like borrowing from banks to avoid bankruptcy. Therefore, there would be no constraints in fiscal expenditure. This means that there is no constraint on eA and eB, i.e. the levels of efforts.

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Fourth, officials in government A and B all have a strong desire for political promotion, and their supervising officials use local GDP growth as the sole criterion. Presume that there is no other criterion affecting local government officials’ political promotion. Therefore, local officials’ desires for promotion are desires to maximize local GDP growth.

Model Generally, local government competition is an oligopolistic competition. We therefore use the evolutionary game theory concerning oligopolistic competition in the theory of firm. The tendency of firms to pursue maximum profits in the theory of firm, in the case of government competition, transforms into government’s pursuit for maximum GDP growth. As governments A and B play games with each other in a symmetrical oligopolistic market, we can presume that it is a typical Cournot Model, namely, a model featuring differentiated products and a linear demand function. Therefore, we can roughly treat e A and eB, i.e. the levels of efforts made by governments, as firms’ decisions on the amounts of products to be produced. According to the presumption of linear demand function we define the two governments’ demand functions as m – e A + keB and m – eB + keA. We introduced two variables here, keB and keA, where, –1 < k < 0. This means that there exists a negative externality, namely, government B’s level of efforts, eB, has a negative effect on A’s consumption of resources. In other words, the harder government B works, it grabs more of A’s resources, which will lead to a slowdown in A’s growth. As the model is symmetrical, the opposite is also true. Therefore, government A’s total utility function (GDP growth function) can be expressed as below: UA (eA, eB) = eA × (m – eA + keB) (4–1) Symmetrically, the total utility function of B is: UB (eA, eB) = eB × (m – eB + keA)

(4–2)

1. The two governments jointly seek to maximize the total GDP growth of the two regions as a whole If there is no pressure from local government officials’ political promotion, the rational choice for both government A and B should to seek to maximize their utility as a whole, which can be expressed as follows: (eA, eB) ϵ argmax (UA + UB) e A, e B

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Namely, (eA, eB) ϵ argmax (meA – e2A + keAeB + meB– e2B + keAeB) e A, e B From first order condition, we get: ∂UA (eA, eB) = m – 2eA + 2keB=0 ∂eA ∂UB (eA, eB) ∂eB

= m – 2eB + 2keA=0

Which leads to eA = eB =

m (4–3) 2 (1 + k )

In this case, the utility functions of A and B are:

UA = UB =

m2 (4–4) 4 (1 + k )

2. The two governments seek to maximize their own GDP growth However, local government officials are often under pressure from political promotion, which is solely dependent on whether the government can maximize GDP growth. Therefore, normally, both A and B seek to maximize their respective effects, the conditions of which are as follows: e'A ϵ argmax UA (e'A, e'B), e'B ϵ argmax UB (e'A, e'B) e'A e'B

According to the first order condition, we have: ∂UA (e'A, e'B) = m – 2e'A + ke'B = 0 ∂e'A ∂UB (e'A, e'B) = m – 2e'B + ke'A = 0 ∂e'B Which leads to e'A = e'B =

m (4–5) 2 –k

In this case, the utility functions of A and B are respectively as follows:

U A (e 'A, e 'B) = U B (e 'A, e 'B) = (

m 2 ) (4–6) 2 –k

3. Government competition based on the political contest for promotion

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Zhou Li’an (2004) stated that local governments often find it difficult

to cooperate with each other, which is mainly due to the embedding of the

political promotion contest into the economic competition. Government officials on the same level - provincial, municipal, township, or village level – are all in some sort of contest for promotion, namely, political tournaments. In such

tournaments, only a fixed number of people will get promotion. Therefore,

the promotion of given officials lessens the chances of other officials being promoted. In this sense, the utility functions of both A and B are not separated, as the two functions are closely related to each other. Furthermore, this correlation coefficient is negative, which means that the promotion of officials

in government B due to local economic growth will reduce the effects of officials in government A. We presume that the correlation coefficient is λ, and λ < 0. Therefore,

2

U "A (e A, e B) = U A (e A, e B) + λU B (e A, e B) (4–7)

U "B (e A, e B) = U B (e A, e B) + λU A (e A, e B) (4–8) Officials in both government A and B, respectively, attempt to maximize

local economic growth, namely:

(e "A) ϵ argmax (U "A, U "B), (e "B) ϵ argmax (U "A, U "B) e "A e "B According to the first order condition, we have: ∂U"A (e"A ,e"B) ∂e "A

∂U"B (e"A ,e"B) ∂e "B

= m – 2e"A + ke"B + λke"B = 0 = m – 2e"B + ke"A + λke"A = 0

And therefore, we can prove that e"A = e"B = U"A = U"B =

m 2 – k – kλ m2 (1 – λ2)

(2 – k – kλ)2

(4–9) (4–10)

Simple analysis Calculating the differential coefficients of (4–3) and (4–5) against k , we will find,

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The Convergence of Local Government Competition and Economic Development Pattern

∂eA ∂k

∂e'A ∂k

= =

∂eB ∂k

∂e'B ∂k

= =

m

>0

2 (1– k)2 m

(2– k)2

>0

(4–11)

(4–12)

Therefore, we can get the following proposition. Proposition 1: As the externality of a government’s actions increases, namely, as a local government’s policies and actions pose increasing influence on the other local government’s consumption of resources, the former government inclines to raise the level of its efforts, which will further strengthen the intensity of local government competition. By comparing (4–3) and (4–5), (4–4) and (4–6), as –1 < k U 'A, U B > U 'B (4–14) Therefore, we come to the next proposition. Proposition 2: Local governments’ attempts to maximize local GDP growth, as compared to the alternative choice to maximize the collective GDP growth of both places, will lead to a more intense competition between the two governments. This intense competition will, to a certain degree, slow the economic growth of these places. Comparing (4–5) and (4–9), as λ < 0, and –1 < k < 0, kλ > 0. Therefore:

e "A > e 'A, e "B > e 'B (4–15) Therefore, we have the following proposition. Proposition 3: Under the pressure of political promotion, local government officials will increase their level of efforts, therefore further intensifying the competition. As λ < 0, –1 < k < 0 We transform the (4–9) into

e "A = e "B =

m (4–16) (2 + |k| – |k||λ|)

By calculating for the partial derivative of |λ|, we will have the following proposition: ∂e"A

∂|λ|

=

m|k|

(2 + |k | – |k ||λ|)2

>0

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Proposition 4: Under the pressure of the political promotion, the bigger the influence of local government officials’ promotion on officials in other local governments, the first will be more devoted to the promotion of local GDP growth. From the abovementioned four propositions we can see that, under the pressure of political tournament, due to the fact that it is far easier for higher ranking officials to assess the performance of local government officials by using the sole criterion of local GDO growth than for them to assess the real level of efforts of local government officials, the competition among local governments is much more fierce. This eventually leads to increased efforts from local governments, which in turn further intensifies the competition. This chapter will use this analytical framework to offer an explanation for the convergence of the developmental pattern of southern Jiangsu and Wenzhou.

The Convergence of the Southern Jiangsu Model and the Wenzhou Model: A Study Based on Local Government Competition As can be seen in the large amount of existing research on local government competition, most of the analyses were done under the framework of fiscal decentralization and political promotion. However, from the process of China’s fiscal decentralization reform we can find that, since the application of the new tax distribution system in 1994, the over-a-decade adjustments have by now drawn a very clear line between the central government and provincial governments in tax distribution, but still they failed to improve the chaotic situation in tax distribution among the various levels of governments below the provincial level, as a result of which, there are still many different tax systems being followed on these lower levels of governments. As the current economic situation in the Yangtze River Delta shows, local government competition exists mainly for municipal and township level governments. In southern Jiangsu, such competition exists in the Qunshan, Zhangjiagan, and Changshu regions of the Suzhou City and the Jinagyin region of the Wuxi City. In Zhejiang, it exists mainly in the Wenzhou city. Therefore, the local government competition in these regions cannot be explained directly with economic incentives, as there might not be a unified set of tax distribution policies in place for these regions to follow. Nevertheless, the new tax distribution system strengthened local governments’ autonomous administration of local issues, which in turn continued to deepen this fiscal reform. Accompanying the construction of the decentralized fiscal

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system, local governments’ authority over the allocation of resources was also growing, and the distinctive economic benefits of different regions were also strengthened. The formation and strengthening of the distinctive and special economic benefits of regions granted these regions a relatively independent contesters’ eligibility of the economic competition among regions, which was the foundation for the government competition for GDP growth. The competition in southern Jiangsu and Wenzhou which was based on GDP growth can also be attributed to the two places’ unique geographical locations. Both southern Jiangsu and Wenzhou are located in the Yangtze River Delta, a region known for its rapid growth. These regions’ GDP growth has been watched by attentive eyes from the central government, and even the whole country, and their GDP growth therefore becomes a more important factor in the assessment of local government officials’ performance as compared to other regions. Therefore, both places featured an intense focus on economic criteria, such as GDP. According to the definition of production function, in order to produce value, an economy needs to bring in production factors such as capital and human resources, and at the same time it needs to improve production sophistication by technological and institutional innovations, and obtain added value that is higher than the sum of production factors (Zhou Yean 2002). The competition among local governments lies in producing various kinds of policy measures to attract resources, or to at least prevent the outflow of local resources, and at the same time, improve productivity by appropriate institutional and technological innovations. In the 30 years after the reform and opening up, both southern Jiangsu and Wenzhou have completed their transition from the old models to the new ones. This allows the two places that originally had very different economic models to converge in this aspect. The two places have both developed and adopted a new economic model that allows the functions of government and market to complement each other under an open economy. The model also champions its private, joint stock, and foreign ownership economy. A large amount of literature is used to compare the two models in an attempt to find out the institutional cause of the formation of such models. This chapter holds that now the two models show a tendency to converge with each other and the engine for such a convergence is government competition.

The starting point of the government competition From the history and current situation of southern Jiangsu, the prosperity of its TVEs and the recent rapid GDP growth are both the result of government

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promotion. Government used its power to borrow from banks and founded TVEs, so as to transfer agricultural accumulation into industrial accumulation, and promote the industrialization of rural areas. Therefore, this was a “strong government-weak market” pattern. However, by the later 1990s, the pattern’s disadvantages due to its ambiguous distinction between the role of government and enterprises, which led to a weakening activeness of these TVEs, and repeated construction, slowed down the overall economic growth of the region. At the same time, thanks to the flexibility of private capital and a clear distinction in ownership, the Wenzhou model was very successful in the process of marketization. For a long time, many viewed Wenzhou government’s style as passive administration, as the city’s economy was almost entirely pushed forward by the private sector. However, a report provided by the policy study office of Zhejiang party committee pointed out that governments in more developed regions of Zhejiang were often deeply involved in the promotion of rural industrialization, and had close relationships with enterprises. Even in Wenzhou, a city where government intervention is least seen, there are still ubiquitous examples of government protection for local enterprises, such as officially granted tax immunity for enterprises, and unofficial immunity (government’s tacit acquiescence to tax evasion), acquiescence to infringements 3

of intellectual property rights, and protection for low quality products. These measures in fact constituted the efforts of Wenzhou government to provide institutional innovations, so as to render an environment that promotes local economic development, and puts the government in a favorable position in the GDP competition.

The 1st competition strategy of southern Jiangsu: Reform on TVEs When the economic growth of southern Jiangsu slowed down, local governments in this region started to realize their region was in an unfavorable position, which necessitated a reform, thus came the TVEs reform in the late 1990s. Starting from the mid-1990s, the southern Jiangsu region started many rounds of ownership structure reform on its TVEs. In the first round, collectively owned TVEs were transformed into collectively owned joint-stock enterprises or jointstock cooperative enterprises. However, the results yielded by this initial round of reforms were unsatisfactory. Therefore, a second round of reforms were carried out, in which, local government gave up their stocks in these former TVEs, and therefore gave up their control over these enterprises. By the turn of the 21st century, over 95% of southern Jiangsu enterprises had completed their reform. Through these reforms, TVEs became private enterprises, joint-stock enterprises

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The Convergence of Local Government Competition and Economic Development Pattern

or joint-stock cooperative enterprises. Thanks to this, the ownership structure of these enterprises was clarified, and these enterprises and the whole region’s entrepreneurship were energized. We will use the situation of Jiangyin City to elaborate the changes in the economic developmental pattern after the ownership structure reform and the region’s attempt to attract foreign investment. As shown in Fig. 4.1, in 1985, the majority of Jiangyin’s employed population worked in collective and state-owned enterprises. Before 1992, the number of people employed by collective enterprises was higher than that of SOEs, and at the same time, only a very little proportion of the urban population was employed by private and foreign enterprises, accounting for only 0.24% of the total. However, with the implementation of TVE reform, from 1992, the city’s collective enterprises employment dropped rapidly, while private and foreign enterprises employment continued to increase. By 2000, the total employment of private and foreign companies amounted to 30.33% of the urban employed population, while the employment of collective companies dropped to only 18.36%, as compared to 51.77% in 1985. Fig. 4.1

The ownership structure of enterprises employing the urban residents of Jiangyin from 1985 to 2000

The number of urban workers

60,000 50,000 40,000 30,000 20,000 10,000 0

19

85 986 987 988 989 990 991 992 993 994 995 996 997 998 999 000 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2

State-owned enterprises Collective enterprises Private and foreign enterprises

The 2nd competition strategy of southern Jiangsu: Promote processing trade and attract foreign investment Moreover, in this political tournament based on GDP growth, another important strategy adopted by the southern Jiangsu region was to attract foreign investment for local governments, which led to another competition

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

in infrastructure construction, as it is an important measure to improve investment environment. In this sense, the role of FDI in local government competition is similar to the voters in a decentralized administration model who use their “feet” to vote (Zhang Jun, Gao Yuan, Fu Yong, and Zhang Hong 2007). In the mid-1990s, the southern Jiangsu region used its geographic advantage of being near Shanghai by actively integrating with Shanghai and developing its export-oriented economy in a way that avoided competition with Shanghai. While developing processing trade, the region also, at a time when international industrial and capital transfer into the Yangtze River Delta was accelerating, took measures to attract FDI to form enterprises owned by both Chinese and foreign investors. Here, the Kunshan region serves as a very good example. As early as 1985, the Kunshan government used their own budget to form a development zone before receiving any authorization from the higher government, which became the first initiative in China to attract FDI. The region therefore embarked on a bumpy journey in which it circumvented various institutional barriers after it discovered the potential benefits in China’s economic system, and then sought for retrospective authorization from higherlevel government (Yang Ruilong 1998). Moreover, when the Pudong district in Shanghai was under development, the Kunshan region also seized the opportunity to attract FDI. As the Pudong district had a threshold of 20 million RMB for foreign investments, many smaller foreign investors ended up in the Kunshan region of Suzhou City, thanks to the efforts of local government officials. Therefore, FDI surged in Kunshan.

Foreign investment in actual use (USD100 million)

Fig. 4.2

118

14 12 10 8 6 4 2 0

The use of FDI in southern Jiangsu and Wenzhou from 1993 to 2006

19

93

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94

19

95

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96

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97

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98

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99

20

00

20

01

20

02

20

03

20

04

20

Jiangyin

Kunshan

Zhangjiagang

Wenzhou

05

20

06

The Convergence of Local Government Competition and Economic Development Pattern

Fig. 4.2 reflects the use of FDI in southern Jiangsu (represented by Jiangyin, Zhangjiagan, and Kunshan) and Wenzhou from 1993 to 2006. We find that, before 1996, the FDI use in southern Jiangsu was relatively stable and was on a low level. In this period, the region’s focus was on TVEs. However, by the late 1990s, due to the slow GDP growth, various levels of local governments in the region started to intensify their efforts in attracting FDI, marking the start of a fierce competition. The use of FDI increased rapidly in Jiangyin, Zhangjiagang, and Kunshan. Take Kunshan for example, in 1997, the amount of its FDI use was USD529 million. But by 2006, due to its government’s effective work, the figure rose to USD1,172 million. With the completion of the TVE reform and the success in attracting FDI, the new southern Jiangsu pattern has taken shape, which further facilitated the region’s economic growth. Fig. 4.3 reflects the GDP growth rates of southern Jiangsu and Wenzhou from 1991 to 2006. Despite the influence of the macroeconomic circle on local GDP growth, we can still draw some significant conclusions from it. Starting from 1993, the growth rate of southern Jiangsu started to fall, which hit the bottom in 1999. Despite the government’s efforts in ownership reform and attracting FDI, due to the lag effect, the province’s growth rate did not pick up until 2000. After 2000, with the increasing government efforts to attract FDI, the whole southern Jiangsu region embraced prosperity again, with a growth rate of around 20% in recent years, which is far above the national average. Fig. 4.3

The GDP growth rate of southern Jiangsu and Wenzhou from 1991 to 2006

GDP growth rate, %

60 48 36 24 12 0 19

91 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 1 2 2 1 2 1 2 1 2 1 2 1 2 1 1

Wuxi

Suzhou

Southern Suzhou

Wenzhou

Changzhou

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Changes in the competition strategies of Wenzhou: Speeding up FDI attraction In the 1980s, the private economy of Wenzhou existed in the form of fragmented household handicraft, etc. Later on, these household businesses became partnership enterprises, which mainly produced small merchandise, leading to the economic landscape of “small merchandises, big market.” Wenzhou is a very good example of endogenous development. Although Wenzhou is a coastal open city, its economic development pattern has always been driven by interregional openness. This can be seen in the tradition that Wenzhou individual merchants are scattered around the world, promoting the internationalization of Wenzhou enterprises by sending back orders and setting up stores and factories overseas. Therefore, the export-oriented economy of Wenzhou was spurred on in the early years by the increase of exports. As shown in Fig. 4.4, the total export volume maintained a 30% increase on a yearly basis. In 1993, the export volume of Wenzhou was USD136.8 million. In 2005, the figure rose to USD8,081 million. Fig. 4.4 % 140 120 100 80 60 40 20 0 –20 –40 –60

The export-oriented economy of Wenzhou from 1993 to 2005

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93

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Growth rate of export Growth rate of foreign investment in actual use

However, Wenzhou’s foreign trade dependence has been relatively low, staying around 6%. As can be seen in Fig. 4.4, from 1993 to 2002, the city’s use of FDI fluctuated greatly. This is due to the fact that the Wenzhou government did not give enough attention to FDI. Of course, there are also some objective causes for this. 2

The per capita agricultural land is 0.32 Mu (1 Mu = 666.67 m ), which is less than

30% of the same figure in southern Jiangsu. The scarcity of land deprives Wenzhou

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The Convergence of Local Government Competition and Economic Development Pattern

of the ability to attract FDI by selling land at a very cheap price, like southern Jiangsu did. This puts Wenzhou in a disadvantageous position in attracting FDI. Therefore, in 2002, Wenzhou’s use of FDI was only USD80 million, which was even less than one tenth of that of the Kunshan region. After entering the 21st century, problems in Wenzhou’s development gradually emerged. With problems such as the scarce production factors and brain drain, how to retain the city’s prosperity, upgrade its industries, and adapt to the market requirement for scale economy in enterprises, are all problems that the city faces. Moreover, after the success of southern Jiangsu in reforming TVEs and attracting FDI, the Wenzhou government also needs to change the city’s development pattern, so as to find a new growth point. Therefore, the Wenzhou government is also taking various measures to speed up their attraction of FDI. From Fig. 4.2 we can find that, from 1993 to 2002, Wenzhou’s use of FDI basically stayed on a level below USD10 million. However, from 2003, its use of FDI significantly increased. As shown in Fig. 4.4, Wenzhou’s use of FDI growth rate stayed at over 50%, and from Fig. 4.2, it is also clear that the absolute value of the city’s use of FDI was also increasing swiftly, which reached USD204 million in 2004. In 2005, the municipal party committee made it clear that in 2005 the growth rate should be 50%. This means that the longtime exporter of private capital will now strive to reinvent itself into an importer of capital, use FDI to upgrade its industries, speed up its economic structural adjustment, and strengthen its overall competitiveness in the arena of economic globalization. Following this, in the municipal people’s congress and the municipal people’s consultative conference, attracting FDI was enshrined in the government report as the government’s priority. Moreover, the top officials in the city’s party committee and government led a delegation to survey the Songjiang district of Shanghai and southern Jiangsu in an attempt to learn from their experience of using FDI. Thanks to the local government’s efforts, the city’s use of FDI growth rate stayed between 60% and 70%. Looking at this competition strategy, we find that, under the pressure of political promotion, both southern Jiangsu and Wenzhou governments adopted different institutional innovation and policy innovation to promote economic growth in the competition based on GDP growth, which eventually leads to the convergence of the development patterns of these two regions.

Conclusion This chapter tries to analyze the relationship between local government competition and economic development pattern. In the early 21st century,

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Pillath (2001) made an exploratory study on this. His primary viewpoint was that government competition will lead to the divergence of the economic development pattern. He holds that transitional policies from the central government will lead to competition for resources and benefits among local governments which will lead to the different political and economic responses in various regions. The differences in these regions’ feedback will in turn lead to the difference in the development patterns of these regions. However, our study that follows that perspective leads to a conclusion opposite to his. We find that, when the criterion of local government officials’ performance is mainly local GDP growth, in order to win in the political tournament, local governments will inevitably engage in the competition to grab resources. The existence of such a competition mechanism eventually leads to the convergence of regional growth pattern. Based on the basis laid by Bester and Güth (1998), we establish a model to analyze the case when resources are scarce and budget constraints are missing. Under the pressure of political tournament, local governments will compete with each other in grabbing resources and increase their levels of efforts, therefore continuously intensifying the competition. The cases of southern Jiangsu and Wenzhou exemplify the conclusion of this chapter. With the continuation of the competition of growth, governments of the two regions kept carrying out institutional and policy innovations. Southern Jiangsu first engaged in TVEs reform and then attracted FDI, and Wenzhou first focused on exports but later also switched to attracting FDI. This makes the convergence of their economic growth pattern of these two places an objective fact.

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5

Chapter

Local Government Competition amid the Integration of the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

The Yangtze River Delta boasts an unparalleled comprehensive economic strength in China. In 2007, its 16 cities, which accounted for only 1.1% of the land area of China, yielded a GDP of RMB4.667 2 trillion, equivalent to one fifth of China’s total GDP.1 After years of rapid growth, the region increasingly faces constraints set by its environment and natural resources, which have become the bottlenecks for the region’s future progress. Obviously, furthering economic integration among the cities of the region and deepening the cooperation by regional labor division will increase the region’s overall competitiveness and gear it up for changes in the economic environment inside and outside the region. It is due to these changes in economic environment that the region is now seeking to integrate regional economies and pushing for various forms of in-depth regional cooperation, so as to eradicate the market protection and separation of regional markets and promote the free flow of goods and factors within the Delta. The economic progress of the Delta Region will not only facilitate the coordinated development among different regions and between rural and urban areas of the Delta Region, but also, through the spillover effect, bring about development in nearby regions and the Yangtze river bank, which will eventually add up to promote China’s economy as a whole. The 16 city economies independent from each other must have their own independent economic interests under the current decentralized fiscal system. These cities and their respective governments acted in their own ways and formed their own economic systems, making cross-regional coordination difficult. The disorderly competition among local governments and regional protection are the very reasons that retard the free flow of economic resources and cross-regional economic cooperation. Economic separation in the allocation of resources appears in the process of integration of the delta region. This chapter focuses on the analysis on local government competition amid economic integration, and discusses the causes and consequences of government competition as well as how to avoid it. This chapter is divided into four sections. The first section is about the accelerating economic integration of the Yangtze River Delta. The second section makes an empirical analysis on the effects of the region’s fiscal competition on investment behaviors. The third section will discuss the transition of government function and the coordinated development of the region. The last section is the conclusion.

The Accelerating Economic Integration of the Yangtze River Delta The regional integration of the outskirt regions of Shanghai started a long time ago. As early as in the planned economy years, there was an organization

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Local Government Competition amid the Integration of the Yangtze River Delta

specialized in coordinating the relationships among governments of regions around Shanghai. Due to the planned economy system, the coordination of interregional economic relations was mostly done by administrative power. Since 1978, with the continuous establishment of the market economic system, the economic integration of the Delta Region has also been accelerating, which is increasingly pushed forward both by government administrative power and firms, unlike before, when administrative power was the only force. The regional economic integration of the Delta is very important to the overall economic development of China. As the region boasts the biggest economic aggregate in China, the complementary cooperation within the Delta Region will not only improve the quality of regional economic development and regional competitiveness, but also empower the development of other regions in China through stratified development.

The basic landscape of industrial labor division in the Yangtze River Delta Since the 1980s, the adjustment of global labor division has been accelerating, in which process developed countries gradually quickened the transfer of the lower end of the production chain to developing countries and focused only on the higher end of the chain. The Delta Region followed the overall strategy of China to reform and open up its economy, continuously improve the basic environment of regional economic development, actively attract and receive the production resources of advanced manufacturing overseas, and accelerate the adjustment of the region’s internal structure. After years of efforts, the Delta Region has now become the manufacturing base for China, and even for the world. While the region’s industries were upgrading, the development of the manufacturing industry brought about progress in the modern service industry, as the external activities of manufacturing firms energized the emerging service industry. More importantly, the intra-industry trade in the manufacturing industry also provided new opportunities and market space for modern logistics, finance, insurance, legal service, accounting service, research and development (R&D) service, engineering service. Overall, the industrial development of the Delta Region is integrating, and features one main body and two wings. Shanghai’s industries are gradually focusing on modern service industries such as finance and information, while Jiangsu and Zhejiang continue to emphasize manufacturing. As the leading force in the economic progress of the Delta Region, Shanghai has seen the rapid development of its service industry such as finance, trading, and logistics, thanks to the rapid development of the two supporting forces of

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Zhejiang and Jiangsu. In 2005, the third industry accounted for 50.6% of the total industrial output of Shanghai, which reached 51.9% in 2007. The growth rate of the third industry in Shanghai was 17.1% in 2007, exceeding for the first 2

time since 2001 the same figure of the second industry, 11.5%. At the same time, the development of Shanghai’s service industry also offered opportunities for the other 15 cities of the Delta Region. In 2007, cities in the region saw rapid increases in industrial output, fixed assets investment, fiscal income (refer to Table 5.1). Such a coordinated development of the region should, to a large degree, be attributed to the differentiated labor division and the economic integration among the cities in the region. The cooperation and labor division among cities in the Delta Region receives increasing attention from the central government. The Outline of Regional Development in the Yangtze River Delta mainly drafted by the National Development and Reform Commission provided a series of detailed arrangements for the region according to the different degrees of industrialization and environmental capacity of the cities within it, in which, 3

principles for land development are clearly differentiated among the cities. Obviously, in order to implement the Outline, cities in the Delta Region should accelerate regional integration. Only when there is a reasonable division of labor within the region can the region have a balanced socioeconomic development while also improving its environment. When the region’s economy gradually integrates, and its economic factors flow more freely, the Yangtze River Delta Region will be further energized.

Table 5.1

Some economic indicators of the 16 cities of the Yangtze River Delta (RMB) GDP and growth rate

City

Shanghai Nanjing Wuxi

Changzhou Suzhou

Nantong

Yangzhou

126

Hundred million

%

Proportion of added value of the third industry to GDP %

12,001.16

13.3

51.9

3,858.00

15.3

40.1

3,275.00 1,880.00 5,700.85 2,111.88

1,311.00

15.6 15.6 16.0 16.2 15.7

48.4 37.0 34.6 35.1 35.2

Local fiscal income and growth rate

Hundred million

Social fixed assets investment and growth rate

%

2,102.63

31.4

300.58

36.1

330.19 158.07 541.82 127.70 85.69

34.0 33.0 35.4 38.0 36.0

Hundred million

%

4,458.61

13.6

1,674.22

13.5

1,867.96 1,203.94 2,366.36 1,265.8

717.88

15.8 26.5 12.3 20.7 34.6

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) GDP and growth rate City

Zhenjiang Taizhou

Hangzhou Ningbo Jiaxing

Huzhou

Hundred million

%

1,213.00

15.5

36.4

4,103.89

14.6

1,202.20 3,433.08 1,585.18 895.94

Shaoxing

1,971.00

Taizhou

1,722.89

Zhoushan

%

Proportion of added value of the third industry to GDP

407.00

15.7 14.8 14.4 14.4 14.3 17.0 14.5

Local fiscal income and growth rate

Hundred million

Social fixed assets investment and growth rate

%

80.26

33.5

45.7

391.62

33.9

105.24

33.2 40.5 34.8

85.22

329.12 61.68

22.9

29.9

1,684.13

15.3

29.0

900.01

12.4

843.27

10.1

38.6

27.9 23.9

122.12

29.2

39.4

108.86

26.4

35.06

%

588.02

33.9 45.3

Hundred million

44.5

703.97

1,597.91 458.32 279.64 727.64

32.2 6.3

12.5 27.7 16.7

Source: Yangtze River Delta statistic topic http://www.statssh.gov.cn/2005shtj/csj/sjxx/712.htm.

The driving force of the economic integration of the Yangtze River Delta In the history of the regional economic development of the Yangtze River Delta, Shanghai, Zhejiang, and Jiangsu have always had a close relationship with each other. After the founding of China, exchanges and cooperation in their respective industrial development have never stopped. Under the planned economy, the economic exchanges of the region were mainly seen in the fact that Jiangsu and Zhejiang were the raw material suppliers of Shanghai’s textile industry. Because of this, at the time when cloth coupons were only allowed to circulate within each province of China, the Delta Region’s retail market for clothes was already a unified market. For example, the cloth coupons of 4

Zhejiang could be used in Shanghai. Such an economic cooperation within the Delta Region under the planned economy was the result of the complementary industrial structure arrangement. With the allocation of raw materials and products set by the State Development Planning Commission, the integration of the Yangtze River Delta was established. After the reform and opening up, in the process of economic transition, the planned economic relationship was broken down, and the economic relationship within the Delta Region experienced a process of competition to

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cooperation. The core of the decentralizing reform since 1978 was to bolster up the incentives for micro-economic entities to engage in economic development. On the institutional level, by giving more autonomy to local governments and firms, these micro-entities were encouraged to engage in economic development. However, at the same time, in the process where regions pursue their own economic benefits, competition also flared, such as the silk war and the tea war in the Yangtze River Delta in the 1980s and many other local market protectionist behaviors. Under such circumstances, the state council decided to establish the Shanghai economic zone in December 1982 in an attempt to defuse the worsening market separation of the region by government coordination. At first, the Shanghai economic zone included only the 10 cities of Shanghai, Suzhou, Wuxi, Changzhou, Nantong, Hangzhou, Jiaxing, Huzhou, Shaoxing, and Ningbo. And it later expanded to Shanghai, Zhejiang, and Jiangsu. By 1987, the economic zone covered five provinces in eastern China and Shanghai excluding Shandong, which sent its observers. As the standing body of the economic zone was only the planning office, the operation of the zone was mainly conducted by the provincial governors’ meeting, which had no administrative power to override provincial and municipal administration. As a result, in the five years of this zone’s 5

existence, the economic zone failed to establish an integrated market. With the accelerating economic development of the region and the upgrading of its industries, higher requirements were put on market space, which facilitated the integration of the region since the 1990s. The driving force of the integration in this phase was from both governments and firms. The administrative driving force mechanism mainly refers to the periodic meeting on the government level, which includes the Periodic Meeting of the Leaders of Shanghai and the Two Provinces, the Economic Cooperation and Development Meeting of Shanghai, Jiangsu, and Zhejiang, and the Economic 6

Coordination Meeting of Yangtze River Delta Cities. The first mechanism is one that allows government leaders of the three places to have periodic meetings on key strategic issues on regional development and put forth short-term requirements and key tasks. The latter two mechanisms are mainly devoted to implement the cooperation areas set by leaders of the three places and promote regional cooperation. There are mainly two chains through which firms promote economic integration. The first is to establish property rights connection, namely, the crossregional distribution of firms and the cross-regional acquisition of firms, which facilitates the free flow of production factors within the three places and this improves the efficiency of resources allocation. The second is the cooperation of

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the supplier chain, namely, cooperation among the upstream and downstream firms of the region in procurement, production, and sales grows closer. As the economic development of the Yangtze River Delta has a very important demonstration effect to the macro-economic development of China as a whole, the regional economic development of the region is an important link in the national economic development strategy, and the central government has been actively pushing for the economic integration of the region. The Regional Planning of the Yangtze River Delta drafted by the National Development and Reform Commission (NDRC) stresses the functional division among the cities in the region and accelerating regional integration and clarifies the direction of the spatial distribution of the three industries, providing guidelines for local governments so as to avoid convergence in industrial structures. State Council Guidance in Further Promoting Reform and Opening Up and Socioeconomic Development in the Yangtze River Delta , based on the overall situation of China’s reform and opening up and modernity construction, proposes that the three places of the Delta Region should increase cooperation with various bodies in the state council, strive to facilitate the Delta Region’s innovation advantages on the basis of past achievement, and reach out for new achievements. In its introduction of the main principles for development, the Guidance writes, the region should continue its integration, coordinate the infrastructure construction, create an integrated and open market, and facilitate the free flow and optimization of various production factors. Driven by the joint effect of the abovementioned factors, the economic integration of the Delta Region indeed accelerates, which effectively promotes the cooperation within the region in transportation, environmental protection, information, human resources, etc. The integration of the region in the regional market, industries and policies has greatly facilitated the rapid growth of the knowledge intensive service industry. Among this, the cross-regional flow and allocation of the financial resources of the three places greatly facilitated the innovation in financial organization, structure, products, and services, which greatly improves the ability and levels of the financial industry in the Delta Region as well as China.

Government competition amid cooperation The reason that the Delta Region has in recent years developed a strong desire for integration lies in a series of contradictions and conflicts in the regional economic development. The barriers set for the flow of products and production factors, especially the cutthroat competition in local governments’ attempt to

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attract FDI have distorted the mechanism with which the market can effectively allocate resources, leading to losses to the overall economic benefits of the Delta 7

Region as a whole. Although from the perspective of individual local government, their intervention in the flow of economic factors due to concerns in economic growth and fiscal benefits is partially rational, excessive government fiscal competition will distort the price mechanism and lead to the loss in efficiency of the overall economy. For the Yangtze River Delta, the question that needs to be addressed immediately is how to establish a benign competition mechanism that will solve the conflicts between administrative zone economy and economic zone economy amid regional integration, and forge an orderly competition and benign cooperation of the region’s economy so as to realize the more rapid and higher-quality growth of the region. The competition among cities of the Delta Region can also be seen in their industrial convergence. Data shows that in the 10th five year plan of the cities of the region, the top four pillar industries are electronics and information, automobiles, new materials, and bio-medicine, the convergence rate of which is 70%. Shanghai, Hangzhou, and Jiangsu all said they want to forge a local silicon 8

valley. Although under a market economy, the investment entities are mostly firms, the high degree of convergence in industrial structure is also a result of the various government policies encouraging investment in their respective administrative zones. For example, the Circular on the Implementation of the Development Planning of the Microelectronics Industry in Hangzhou (2004–2010), stresses the preferential policies for the microelectronics industry in Hangzhou according to the policies of the central government, provincial government, and municipal government. Notably, for huge economies like China, a decentralized fiscal system is an inevitable choice, which means that interregional economic competition will continue to exist. The key in the topic of such competition is how to draw on advantages and avoid disadvantages, and make the most out of the competition to improve economic efficiency, which is a topic that most economists should be concerned about. As the effect of fiscal competition on the operation of the economy is complex (see Table 5.2), and the driving forces for interregional competition are no more than economic competition and the competition in the performance of government officials, the economic relationship among cities of the Delta Region is interregional competition against the background of integration. Given that research on the patterns and approaches of integration are abundant, this chapter will adopt the perspective of the economic effects of regional competition and cooperation, include regional competition in the

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background of integration, and analyze the positive effects of the economic competition of the Yangtze River Delta, and the question of how to retain the innovative capacity of the various cities of the region during integration so as to develop the region’s economy on a higher level. Table 5.2

The main economic effects of fiscal competition9

Positive effect

Negative effect

• Lower tax, and simplify tax regulations

• Distort tax, erode tax basis, and hamper social welfare

• Improve the efficiency of the provision of public goods

• Increase tax collecting costs, and reduce government’s ability for macro regulation

• Limit government behaviors, and improve the sophistication of government • Lead to regional protection, and reduce the administration overall efficiency of national economy • Encourage local economic development, and promote economic growth

• Lead to repeated construction and excessive structural convergence

• Reduce government intervention in firms • Amplify regional margin, and trigger fiscal crisis in underdeveloped regions • Lead to an ineffective enforcement of regulation, and hamper the legal environment of the society

An Analysis on the Fiscal Competition and Investment Behaviors of the Yangtze River Delta The current labor division structure in the Delta Region has a higher requirement for regional economic coordination and cooperation. The accelerating integration of government and firms in the region fundamentally reflects the requirements set by the region’s economic development. However, as the region now boasts the most advanced manufacturing industry and service industry in China, interregional competition is very fierce. For multinationals planning to invest in China, the overall marketization system of a region’s economy is often more important. Industrial convergence, overlapping infrastructure construction, and cutthroat competition as a result of market separation will all hurt the region’s overall competitiveness. How to find the balance between competition and cooperation is a question urgently needing an answer.

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The decentralized fiscal system and government economic competition Under a decentralized system, local governments are independent economic entities, which will for sure try to maximize their own interests. Their objectives pivot towards socioeconomic progress, which, when economic resources are scarce, will certainly lead to economic competition among regions. In theory, fiscal competition is often defined as competition among governments that want to 10

obtain certain valuable resources or avoid certain fiscal expenditures. Although China is a centralized Socialist country, which supposedly should have a closer interregional political and economic relationship among its regions than federalist countries, China’s de facto fiscal federalism (Qian and Roland 1998) led to the various forms of interregional economic competition for economic benefits. Before the 1994 tax distribution system reform, China adopted various ways of fiscal contract systems, where local governments needed to continuously negotiate with the central government on the base number of tax contribution, making the fiscal system extreme, complicated, and prone to changes. More importantly, at the time, business income tax was distributed by the affiliation of firms, and turnover tax was collected by the local governments where firms were located, which closely linked the tax of firms and local government fiscal income. This greatly incentivized local governments to develop local firms, especially TVEs. With the objective to promote the growth of local firms, local governments often facilitate the regional protectionism as well. In a situation where capital and labor factors are not flowing completely freely, interregional protectionism often led to market separation, distorted resource allocation, inequality among regions, and even fiscal instability. With the resource of income for local governments changed by the 1994 tax reform, which also partially regulated the fiscal behaviors of local governments, and other factors such as the fundamentally changed supply demand relationship in the market, local governments’ protectionism mainly based on geographical barriers had lost the reason to exist. Against such a backdrop, traditional studies on protectionism and market separation were corrected to a large degree. The team studying the topic of “the construction of an integrated market of China” of the development study center of the state council finds in its research that the efforts by the central government and local governments to reduce regional protectionism had yielded some results, with the degree of protectionism being now lower than the situation both two and one decades ago. However, firms still find the legal and market environment in its native province better than other provinces, indicating that there is still protectionism in China (Research Group of the Construction of an Integrated Market of China 2004). Bai Chongen et al. use the Hoover localization

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coefficient of 32 industries of China in the study, and find that the degree of regional specialization improved a lot during 1985 and 1997, indicating that market separation has been easing recently (Bai Chongen, et al. 2004). However, the fiscal reliance of local governments on local economy has not yet fundamentally changed, and the great effect of local economic growth on local officials’ political future has not been reduced, making it unrealistic to eradicate protectionism and market 11

separation. As the intergovernmental fiscal competition can happen in many forms, its socioeconomic effects are also diversified. Therefore, in theory, there is no certain direction of the effects of fiscal competition. For example, some studies indicate that, when different regions compete for flowing capital, local governments will lower taxes to attract such capital, which will lead to a lower level of public goods provision than the optimal level (Oates 1972; Zodrow and Mieszkowski 1986). However, government competition in reality does not always follow the perfect competition presumption. When considering the uncooperative tax competition model, although tax competition will lead to a low tax for capital, such a low tax on capital will not necessarily lead to an under-optimal level of public goods provision when local governments have other distortive tax instruments (such as labor tax), but only the excessive tax on other goods and factors (Wilson 1991; Janeba and Peters 1999). Various evidence shows that, although there is seldom regional protectionism as manifested in the 1980s, fiscal competition in the form of preferential land policy, tax expenditure, and public welfare is still widely seen. At the same time, FDI is still the focus of local government officials, as it means a great deal in their contest for a better political future. Therefore, the following will be an empirical study on the fiscal competition and fixed assets investment of the Yangtze River Delta, so as to identify evidence of the effects of fiscal competition on economic performance.

An empirical study on fiscal competition and regional investment behaviors In reality, the investment of firms is affected by many factors. For a representative firm, it will choose an investment level that maximizes its profits. Under the optimized conditions, the favorite capital stock level of the firm will reduce as capital rent increases. In reality, the cost of investment for a firm is more than market interest rate. The differences of tax cost among regions will also change the firm’s investment cost. Therefore, recent studies often stress the use of user cost of capital in the measurement of the cost of capital.

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Presume that the firm processes one unit of capital in period t , and the market cost of capital is p k (t ). If the firm holds this capital, it will at least face the following three costs: interest income of giving it up r (t ) p k (t ); depreciation losses of capital δp k (t ); the loss from price lowering of capital goods — (t ). Therefore, the user cost of capital will be: – dp k (t ) / dt = – p k — (t ) (5–1) r k (t ) = r (t ) p k (t ) + δp k (t ) – p k As the investment and investment return of a firm will be given many preferential tax policies in many countries, such as the tax sparing of investment tax, the f part of the total investment spending of the firm can offset some part of the tax the firm should pay of that year. Presume that the income tax rate is τ , as the tax sparing of investment tax means that the unit cost of the firm will be covered by the government τfp k (t ), its actual cost is (1 – fτ ) p k (t ). Therefore the expression of the user cost of capital is: — p k (t ) ] (1 – fτ ) p k (t ) (5–2) r k (t ) = [r (t ) + δ – p k (t ) Although theoretically there are many models of investment behavior of firms, as the chapter will use the fixed asset investment total to test the effect of tax preference on the attraction of FDI in the three places of the Delta Region, this 12

chapter will only use the neoclassic investment model (Jorgenson 1963) as the theoretical basis of the test, therefore, the quantitative function is:

I t = α + βK t–1 + γy t + φC t + X t + εt (5–3) 13

In (5–3), t represents time, and K represents capital stock. Considering the momentum of investment of firms, and the variable’s endogenous nature can be seen in the fact that the investment of a certain year will accumulate upon the original capital stock, the regression adopts the capital stock that lags one phase. y represents GDP growth rate, C t represents the macro tax burden, X is the collection of factors affecting the user cost of capital and capital returns of different provinces other than the tax burden variable, which includes the average wages of employees, profit rate on capital (the after-tax profit rate of the sum of the fixed assets net value and the average yearly balance of the current assets of independently accounting industrial firms), and ε the regression residual. In the empirical analysis, in order to increase the robustness of the results, we also take into consideration the first order lag budgetary tax burden and the income tax burden (the proportion of income tax in operating surplus), so as to study the effects of the time factor and income tax burden on the scale of interregional investment. Table 5.3 shows the regression results.

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Local Government Competition amid the Integration of the Yangtze River Delta

Table 5.3

An analysis on the factors affecting the investment in the Yangtze River Delta from 1994 to 2003 Model 1 c

–2.32 (1.38)

Macro tax burden

Model 2

Model 3

Model 4

–1.71 (1.63)

b

–3.59 (1.72)

–0.47 (1.99)

–4.95a (1.65)

–4.84a (1.67)

–3.64b (1.75)

5.71 (4.10)

Lag capital stock

0.58a (0.10)

0.59a (0.11)

0.61a (0.10)

0.61a (0.09)

GDP growth rate

0.03b (0.02)

0.03c (0.02)

0.03c (0.02)

0.03b (0.01)

Average wages of employees

0.50a (0.16)

0.42b (0.19)

0.62a (0.21)

0.25 (0.24)

Capital profits rate

—

1.72 (2.42)

0.57 (2.33)

6.02b (3.03)

Income tax burden

—

—

–4.23b (1.72)

–5.48a (1.62)

Lag tax burden level

—

—

—

0.84

0.88

Regression constant

R2 The test value of X

Hausman value

0.84 2

145.6 1.04

143.2 1.81

168.4 1.29

–6.76b (2.74) 0.91 217.3 0.15

Notes: 1. Regression dependent variable is the total fixed assets investment of each province, and the regression independent variables of capital stock and average wages are log value. 2 2. R in the report is within subject value; inside the bracket is the standard deviation; superscript a indicates that the coefficient is 1% significant, superscripts b and c indicate 5% and 10% significance, respectively. 3. The table reports the result of a random effect model analysis, and the criterion of model selection is the Hausman test (Hausman 1978).

The analytical result shows that, in the Yangtze River Delta, total investment in fixed assets is negatively correlated with budgetary tax burden (although the macro tax burden regression coefficient is positive, it is not significant), which indicates that in provinces with higher macro tax burden, their fixed assets investment is lower, consistent with common views. In model 4 of Table 5.3, we can also see that the regression coefficient of macro tax burden level of the last period is –6.76, and significant above 5%, which is to say, in regions where the tax burden was high last year, the investment level will significantly fall this year. In model 3 and model 4, we also notice that tax collected by a region is also negatively correlated to fixed asset investment. The regression result of

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this chapter shows that the preferential tax policy in the Yangtze River Delta can indeed play a positive role in the attempt to attract FDI. Although the capital profits rate variable is only significant in model 4 among the three models in Table 5.3, its coefficients are all positive, showing that the higher a province’s capital return rate, the higher the fixed assets investment level the province will have. In all four models, GDP growth rate and capital stock level are both positively correlated to investment, which shows that the fixed assets investment level is positively affected by a region’s economic development level. The bigger the scale of economy a region has, the more investment it will have. This shows that, without external interruption, regional economic development will not converge right now. This shows that, in the process of constructing a harmonious society, the government should employ necessary fiscal measures to intervene in the economy, so as to change the basis of economic development in backward regions. Fixed asset investment and the average wages of employees are positively correlated in three out of four models, which show that, the higher the wage level is in a region, the more fixed asset investment it will have. This may mean that, currently in the Delta Region, the wage level not only indicates the labor cost, but also the degree of human capital concentration in different cities. The interregional competition for investment through offering preferential policies will distort the allocation of resources among regions, and the market separation that comes with it will inflict losses to efficiency. Although existing studies disagree with each other on the amount of losses inflicted by structural 14

distortion of resources allocation, there is no argument on whether structural distortion of resources allocation leads to losses in efficiency. After the tax reform, the central government gradually tightens control on the authority of local governments in issuing preferential tax policy, which to some degree alleviated the tax competition in the Delta Region, which was replaced with a new competition in which regions tried to become regional economic centers. Such competition will improve the economic status of the Delta Region, but the competition in the development of headquarters competition also has a big effect on the resources allocation in the region.

The development of the headquarters economy and interregional competition in the Yangtze River Delta In the process of industrial upgrading in the Delta Region, the demand for service industry is bound to increase. Many scholars believe that the industrial structure of the Delta Region is formed by one body and two wings. Shanghai,

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as the center of the region, functions as the center of capital, technology, products, information, and resources, and provides the manufacturing 15

industries in Jiangsu and Zhejiang with basic services. Jiangsu should focus on petrochemicals, machinery, electronics industry, and other knowledge intensive industries. Zhejiang should focus on textiles, clothing, printing, food, and other light industries (Hong Yinxing 2003). Traditionally it is believed that the development of the modern service industry will facilitate the dissolution of market separation, and encourage firms to distribute their production resources cross-regionally, therefore leading to an integrated market. We also notice that, while Shanghai tries to forge itself into the capital of the service industry in the Delta Region, the headquarters and sales centers of many manufacturing firms of Zhejiang and Jiangsu relocated to Shanghai. For example, in 2008, Shanghai approved the entry of 33 foreign firms to construct the headquarters economy, among which, there are 17 regional headquarters, 6 investment firms and 10 R&D centers. Since September 2002, Shanghai has approved the entry of 626 foreign firms of the headquarters economy, among which, there are 201 regional headquarters, 171 investment 16

firms, and 254 R&D centers. From the perspective of micro-economic efficiency, the relocation of headquarters of firms to Shanghai will definitely put these firms at a better position in aspects such as the talent pool, information, financing, international trade. They can therefore reduce production cost and improve performance. However, in the process of Shanghai becoming the biggest receiver of headquarters economy foreign firms in China, second only to Hong Kong, the competition of fiscal interests in the Yangtze River Delta also sticks out, as according to the new tax law, residents or firms that set up business entities that do not qualify as a legal person in China should gather, calculate, and pay 17

income tax. Obviously this new law is favoring the center where headquarters concentrate. Recently, giant firms such as Nokia, Nike, Adidas, and Mobil left Suzhou City. According to the estimation of the city’s National Tax Bureau, merely the reorganization of Nokia cost RMB400 millions in lost tax revenue to the Suzhou industrial park, among which added value tax loss was RMB120 million, and income tax RMB280 million. Although in terms of the income tax distribution of large SOEs and crossregional joint stock financial firms, there is the Distribution Method of Taxation of Cross-Regional Enterprises in place by the Ministry of Finance, the People’s Bank of China, and the State Administration of Taxation, there is no measure to regulate the distribution of the income tax of foreign and private manufacturing firms. The headquarters economy, under the current decentralized fiscal system, especially

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the gathering payment system of the new corporate income tax law, will inevitably lead to the redistribution of tax resources, therefore reenergizing local government competition. Recently, many cities in the Delta Region, including Shanghai, have put forth various preferential policies to encourage the entry of headquarters. From this we can see that, the headquarters economy has become one of the most important objectives in the economic competition among cities in the Delta Region. In order to coordinate the economic interests of the different cities of the region, facilitate the free flow of the production factors of the headquarters economy firms, improve the overall economic efficiency of the labor division of the region, and give equal focus on letting Shanghai play its role as the leading economic force in the region, and protecting the fiscal interests of the two manufacturing bases of Jiangsu and Zhejiang, requires the central government to make adjustment on the fiscal distribution system. Most importantly, the central government should immediately perfect and regulate the cross-regional distribution of financial power. For sure, if the two manufacturing bases of Jiangsu and Zhejiang can play their part in the industrial division to better the region’s economic development, the construction of an integrated market of the region will still accelerate. But if the short-term interests of the local government are not protected in cooperation, protectionism is bound to be rekindled. Therefore, the cooperation and competition of the Delta Region is in essence a dynamic sequential process, both the political and economic interests of the three places of the region should be taken into consideration in the process of market integration. In this sense, the industrial division of the Delta Region is not only a topic concerning developmental strategy, or, in other words, not only about the differentiated development of the three places, but also a topic concerning the adaptability of the policy of the central government.

Change of Government Role and the Coordinated Development of the Yangtze River Delta China is a big country, administrative and economic decentralization is an inevitable choice for the political system. Regional interests are impossible, and are also unnecessary to be avoided. In fact, the three decades of rapid economic development of the Delta Region were, in a sense, driven by the innovation motivation as a result of the economic competition among the three places in the region. Of course, the disorderly competition also consumed a large number of economic resources. Notably, the excessive development of land and the low-cost use of land have increasingly posed obstacles for the region’s future development. Interregional competition is impossible to be circumvented in the future

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development of the Delta Region. Rather, we should focus on balanced and sustainable development. While improving social welfare comprehensively together with economic development, we need to coordinate the interregional cooperation and competition and construct an integrated market where economic resources can flow freely. Judging from the current demands of the progress of regional integration of the Delta Region, the priority is to change the role of government, improve people’s livelihoods, and the economic performance of the Delta Region and China as a whole, and facilitate a balanced socioeconomic development of the Delta.

Changing the role of government and regulating the competition relationship among regions Under a decentralized system, local governments have more independent economic interests. Therefore, in the handling of the interregional economic relationship, the central government should allow local governments to pursue and maximize their regional interests on the condition that national interests are not compromised. The institutional basis for local government competition is for sure related to the appraisal system for local officials (Zhou Li’an 2004). Under an appraisal system that uses criteria such as economic growth and fiscal income, local officials will take local economic growth as the objective of their actions, which, naturally leads to interregional competition. Jia Rangchng, et al. (2007) analyzed the competition between two similar regions using a simple fiscal income game model, in which he presumes Cournot competition, and proves that market separation is the only Nash equilibrium in the local government game, namely, the optimal option for all local governments is to adopt protectionist policies. Furthermore, after taking into consideration the level of efforts by local officials, they find that only when all local governments are in pursuit of the optimal common social welfare of the region as a whole will they actively carry out economic projects which demonstrate externality, while when economic performance is the sole criterion assessing the performance of local officials, local governments will not actively engage in interregional cooperation, namely, the political promotion incentive will intensify the interregional economic competition. Because the constructions of market order and government competition order are complementary to, and reliant on, each other, only when the interaction between a benign market order and a regulated government competition is formed can we secure a long-term stable economic development. Right now, the central government is the only thing that can really affect or correct the distortive competition among local governments, and regulating interregional

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economic competition and reestablishing the legislation system and the law enforcement system is of vital importance (Feng Xingyuan 2002; Zhou Yean, et al. 2004). Most importantly, the maintenance of a domestic integrated market should be enshrined into the constitution. In the process of establishing the rules of competition that is in line with the construction of an integrated market, while having an accurate positioning of the function and role of local governments, China should put the management of interprovincial trade into the jurisdiction of the central government, and, through the rebuilding of related legislative and judiciary systems, construct a nationwide integrated market for products and economic factors. The key to the integration of the Yangtze River Delta is to make full use of the positive effects of interregional competition, reduce its negative effects, create a scientific incentive and constraint system on the institutional level to steer local government behaviors to the direction that will guarantee the free flow of factors, and construct the integrated market of the Delta Region and a level playing ground so as to maximize the region’s overall interests. Of course, with the deepening of cooperation among firms in the region, the cooperation of supply chains in different areas of the region is becoming a great force pushing for the integration of the regional market. Therefore, the building of such an integrated market should rely on the functions of such firms. This means that governments should adjust their roles, respect the choice made by firms, and provide a good institutional and policy environment for these firms so that they can facilitate the integration of the regional market. We believe that the following aspects are the most important among the efforts to change the role of governments. First, construct a political and economic environment that facilitates the interprovincial socioeconomic balanced development. A balanced political and economic environment can not only minimize the negative effects of intergovernmental fiscal competition, but can also help local governments have a stable policy expectation, avoiding the cutthroat competition as local governments all try to obtain policy advantage. Second, strengthen supervision over government decision-making and improve the provision efficiency of public goods. The main objective of regulating interregional fiscal competition is to create a long-term mechanism of orderly interprovincial competition, and to prevent the prisoner’s dilemma for local governments while they strive to promote local economic growth. In order to reduce the pressure on local finance from wasteful fiscal competition projects, we need to improve the supervision efficiency of the various levels of people’s congress, and establish channels through which regular people can participate

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in the decision-making process of such projects, namely, creating different aspects of constraining mechanism for government decision-making. Third, improve the appraisal system for government officials. Interregional fiscal competition is mainly motivated by local government officials, whose political reputations are often closely related to the economic growth of their jurisdictions. Therefore, fiscal competition is not only the competition for the space for regional socioeconomic development, but also the competition for the political reputation of officials. If we are to truly alleviate vicious fiscal competition, we should improve the selection system of government officials, establish a more comprehensive appraisal system for the performance of officials to disconnect government official performance with economic figure growth, weaken direct intervention of government in the economy, so as to release the strong appeal of officials for growth-based promotion and create officials’ reasonable long-term expectation, so as to make them focus more on the sustainable socioeconomic development. In the system where the tenure of officials is limited, the reputation system should still be used to create a longterm development objective for officials. Fourth, construct a multidimensional appraisal system for fiscal competition so as to regulate interprovincial fiscal competition. There are many forms of intergovernmental competition. Except for tax and subsidies, the degree of tax collection efforts, land leasing, and the degree of enforcement of environmental regulations are all forms of interregional competition. Therefore, the central government should put in place a tool combining political, economic, and legal elements that can effectively assess interprovincial competition. Moreover, during the enforcement of regulations, the central government should avoid policy inefficiency due to problems in commitment and information, so as to provide an institutional guarantee for the harmonious interprovincial socioeconomic development. For sure, at the same time, the central government should also optimize the current tax regime, appropriately reduce some tax burdens, strengthen the seriousness of tax law enforcement, clarify the functions of local government, and facilitate the change of role of local governments, which will also institutionally reduce vicious tax competition among regions.

The internal motivation mechanism for the integration of the Yangtze River Delta The essence of economic integration is the requirement for the free flow of production factors among regions, namely, breaking down administrative barriers, and constructing an integrated market for production factors and

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products. The internal motivation mechanism of the Delta Region mainly lies in firms and the market. The region should rely on spontaneous market forces to eradicate forces that separate the market, accelerate the integration of socioeconomic development, and improve the overall competitiveness of the whole region. Therefore, in the integration of the Yangtze River Delta, the most crucial topic is to improve the micro resources allocation efficiency. Foundations should be laid down in the following aspects to make adjustments in the basic economic system and economic relationship of the region. First, legal foundation. From experiences home and abroad, we can see that, the priority in the construction of an integrated market is rules. The efficiency of such integration is also decided by whether there is a complete institutional guarantee in place. Take the EU for example. Its integration has, in every stage, been respectively guaranteed by a set of laws, which also stipulated the schedule of top-down integration. The building of an integrated market should also be based on a set of common rules in the Delta Region. Many scholars propose learning from the EU integrated market, and make an internal institutional adjustment in the region, so as to put in place a set of rules and treaties that allow the cross-regional free flow of resources. Some other studies suggest that we should learn from the experience of the regional economic 18

autonomic zones in the U.S, and replace the single local government structure that uses only administration as the only standard with an intergovernmental coordination mechanism that uses multiple standards. However, we believe that in order to create a truly binding legal basis for the integration of the region, legislation on the highest level is still needed. The central government can consider the possibility of enshrining into the constitution the right of free flow, and should put the principle of securing a domestically integrated market into the constitution, and create an organization similar to the Supreme Court of the U.S. that guarantees the implementation of the institution of the integrated market. For sure, for China, which uses the civil law system, regulating all economic relationships through a top-down legislation channel is unrealistic. Moreover, the intergovernmental competition is very complicated, making it hard for a supervising body to eradicate all such competition, as it will only have incomplete information. This is especially true when taking into consideration the fact that many governments directly participate in the interregional competition, which will lead to a vacuum in institutional constraints under such an administrative system. Therefore, the key in reducing vicious interregional competition is to reduce government intervention in the economy, and create a diversified set of political incentives for officials, instead of only using the

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few criteria such as economic growth and fiscal income. This requires the participation of civic organizations in the construction of the legal basis for the integration of the Delta Region. Opportunity should also be provided for these organizations to participate in the enforcement of such laws, promoting interregional government cooperation in a bottom-up manner to realize the regional economic integration. Second, economic foundations. The overall guideline for the regional integration of the Yangtze River Delta should be constructing a regional economic community that has an open market, complementary industrial structures, an information resources sharing mechanism and a complete transportation system, so as to improve the competitiveness of the whole region. Relying solely on the external policy of the central government to promote regional integration will not be sufficient. We should also actively create the internal force pushing for integration, and incentivize micro economic entities to allocate resources cross-regionally by pushing forth enterprise ownership reform, so as to accelerate the integration of the Delta Region. In the early days of reform and opening up, the founding of the Shanghai Economic Zone and the horizontal economic connection and economic cooperation advocated by the central government were crucial to the progress in the industrial transfer and the industrial horizontal labor division and reducing regional protectionism in the Delta Region. At that time, the frequent technology transfer between the SOEs in Shanghai and the TVEs in Jiangsu and Zhejiang on the microeconomic level had greatly promoted the industrial regional transfer between Shanghai, Jiangsu, and Zhejiang, which, in turn, led to intraregional industrial horizontal labor division. The opening and development of the Pudong district of Shanghai in the early 1990s again greatly promoted the regional economic integration, as accompanying the entry of a large number of foreign firms, many of them gradually spilled over to Jiangsu and Zhejiang. In the latter half of the 1990s, the rapid development of the private economy of Zhejiang also provided an example for the ownership adjustment in Shanghai and Jiangsu. In the current decentralized fiscal system, the regional integration of the Delta Region faces many new problems, the most prominent among which is the problem posed by the tax resources flow accompanying the cross-regional flow of economic resources. In order to properly allocate financial power among regions and defuse the conflicts of the direct economic interests of local governments, we need to erase the differences in fiscal return, government service charges, land leasing fees, business registration, etc., among different areas of the Delta Region, so as to let a broader region benefit from an economy

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of scale, an economy of scope, and technology transfer. Different levels of local governments also need to regulate the allocation of fiscal interests in their jurisdictions, so as to form the fiscal basis for the free flow of economic resources. Third, social foundation. The integration of the Delta Region is the appeal of the region’s own economic development. The increasing flows of products and factors naturally pose an increasing demand for a more integrated development of the region. The main tasks of local governments are to follow the principles of industrial economic marketization, remove various kinds of constraints on the interregional free flow of resources, and, for one thing, create a social environment based on an integrated market in the Delta Region or even the whole of China and redirect local officials’ focus onto infrastructure construction, and for another thing, and more importantly, give the initiative of regional economic development to the firms and residents, so as to create the social basis for an integrated Delta Region. In the past, the mention of interregional competition always leads to the requirement for all local governments to consider China’s overall economic interests. However, in the decentralized fiscal system, we have to admit the inevitability of regional interests. Developing the regional economy is the basic job description of local governments. Pursuing maximum regional interests while following laws and regulations set by the central government is among the responsibilities of local governments. Therefore, the internal basis for the integration of the Delta Region is the proper division of responsibility, rights, and interests between local governments and the central government and the encouragement for local governments to establish an interregional coordination mechanism. From the experiences of regional economic competition and cooperation in the Delta Region, we can see that the appraisal system for the performance of local officials is crucial to the establishment of orderly regional economic competition. However, using the diversified set of criteria of the harmonious society, although theoretically attractive, is very difficult in practice. An appraisal that consists of too many criteria will easily produce mistakes, and will be hard to harness, which will render it difficult for supervisors to manage. From the perspective of effectively obtaining information in the appraisal of local government officials, it will be more effective to give the right to assess the performance of officials to firms and residents in their jurisdictions. In this sense, the integration of the Delta Region is also related to the democratic progress of the region.

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Conclusion Problem-ridden though it is, the integration of the Yangtze River Delta is advancing fast overall. The various areas of the region made a lot of efforts in regional cooperation and provided the rest of China with a series of innovative institutions that facilitate regional coordinated development, serving as an example for other regions . Of course, we have to admit that, the economic development pattern of the Delta Region is currently still one that is based on administrative zone economy, and that there are still many conflicts and difficulties in the process of regional integration. The core competitiveness of the Delta Region is the overall competitiveness of its industrial clusters, which together forms an important link in the global production chain. Therefore, integrating regional infrastructure, such as the transportation system, is a necessary option. Although, under the decentralized fiscal system, interregional competition will incentivize local governments to engage in local economic development and provide more agreeable public goods for local residents, at the same time, excessive fiscal competition will also lead to abnormal growth of investment, reduce the efficiency of the overall distribution of investment among regions, trigger macroeconomic turbulence, and hamper the sustainable economic development in the long run. Moreover, excessive fiscal competition among regions will put public goods provision on a low level. In this chapter, we do find that in the Yangtze River Delta, preferential tax policy has a positive effect on attracting FDI. But obviously, such competition will deal harm to the orderly competition relationship within the region. With cities in the region following one another to put forth preferential policies encouraging the entry of the headquarters, the interregional competition relationship will become even more complicated. How to coordinate the economic interests of the cities in the region, facilitate the cross-regional free flow of production factors, and improve the overall economic efficiency of the industrial division of the region, have become questions that demand immediate answers. This for sure needs adjustment from the central government on the fiscal distribution system. Most importantly, the central government should forge a more complete interregional financial power-sharing system and regulate the interregional financial power distribution system as soon as possible. The industrial division of the Delta Region is not only a topic concerning developmental strategy, or, in other words, not only about the differentiated development of the three places, but also a topic concerning the adaptability of

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the policy of the central government. The analysis of this chapter has shown that the cooperation and competition of the Delta Region is, in essence, a dynamic sequential process, both the political and economic interests of the three places of the region should be taken into consideration in the process of market integration. Unifying the fiscal behaviors of different regions is, of course, useful. But it would be very difficult to unify the tax rates of different regions, as there are many forms of intergovernmental fiscal competition, making it hard to design a cooperative agreement. Cooperation in one policy variable which will only lead to fiercer competition in many other policy variables (Cnossen 1996); when the tenures of the government officials who participate in the game are short, it is impossible to have tax cooperation among regions (Janeba 2000). The steady advancement of the cooperation within the Delta Region requires, starting from the current basis, a proper handling of the relationship between government promotion and market operation, further construction of a multilayered and extensive regional coordination mechanism, and a proper integration that will create an effective and flexible operation system, so as to bring about innovations and breakthroughs in the interregional coordination and interaction mechanism. The State Council Guidance in Further Promoting Reform and Opening Up and Socioeconomic Development in the Yangtze River Delta published in September 2008 provides an important opportunity to promote the integration of the Yangtze River Delta. Whether the three places of the region will be able to accelerate regional integration with this opportunity is, to a large extent, decided by whether local officials will change their mindsets, which is decided by whether the appraisal system of their performance that determines their political future will be modified partially with an increased democratic supervision on their performance. Also important is that, in order to promote a strategically coordinated socioeconomic development, we should strengthen transfer payments among the region which will facilitate the average distribution of public services, therefore creating an orderly competition during the region’s integration, continuously improving the region’s overall competitiveness and finally, making it into an economic zone that has international importance.

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Appendix National Data Table 5a.1 Central Bank’s previous adjustment of interest rate Adjusting time

Adjusting contents

Oct. 9, 2008

One-year benchmark interest rate down 0.27%

Sep. 16, 2008

One-year benchmark loan interest rate down 0.27%

Dec. 21, 2007

One-year benchmark interest rate down 0.27%; One-year benchmark loan interest rate up 0.18%;

Sep. 15, 2007

One-year benchmark interest rate up 0.27%; One-year benchmark loan interest rate up 0.27%;

Aug. 22, 2007

One-year benchmark interest rate up 0.27%; One-year benchmark loan interest rate up 0.27%;

Jul. 20, 2007

Benchmark interest rate for RMB of financial institutions up 0.27%

May 19, 2007

One-year benchmark interest rate up 0.27%; One-year benchmark loan interest rate up 0.18%;

Mar. 18, 2007

Benchmark interest rate for RMB of financial institutions up 0.27%

Aug. 19, 2006

Benchmark interest rate for RMB of financial institutions up 0.27%

Jul. 20, 2007

Benchmark interest rate for RMB of financial institutions up 0.27%, to 5.85%

Mar. 17, 2005

Housing loan interest rate was increased

Oct. 29, 2004

One-year Benchmark Loan Interest Rate Up 0.27%

Jul. 11, 1993

One-year benchmark interest rate up from 9.18% to 10.98%

May 15, 1993

Deposit interest rate of all classes rose by an average of 2.18%; The loan interest rate rose by an average of 0.82%

Table 5a.2 Market exchange rate of RMB appreciating against USD (1998–2005) Year

Changes of exchange rates

1998

Year-end RMB exchange rate at foreign exchange market is RMB8.278 7 / USD, slightly rising by 9 basic points.

1999

Year-end RMB exchange rate at foreign exchange market is RMB8.279 3 / USD, dropping slightly by 6 basic points.

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(Cont'd) Year

Changes of exchange rates

2000

Year-end RMB exchange rate at foreign exchange market is RMB8.279 3 / USD, slightly rising by 12 basic points.

2001

Annual exchange rate is RMB8.277 0 / USD, rising by 14 basic points than that of last year; Year-end RMB exchange rate is 8.276 6, remaining flat compared with that of last year.

2002

Volatility of annual exchange rate is 10 points, slightly eased by 24 points of last year. Year-end daily weighted average price of the dollar is 8.277 0, rising 4 points compared with the same period of the last year.

2003

Volatility of annual exchange rate is 11 points, dropping 3 points compared with that of the last year.

2004

Exchange rates against major currencies are of appreciation and depreciation. Year-end exchange rate against the dollar, euro, and yen are RMB8.276 5 / USD, RMB11.258 8 / Euro, and RMB8.057 3 / JPY100, rising 2 basic points, dropping 7.6% and 3.9%, respectively.

2005

Since July 21, reform of forming RMB exchange rate mechanism has been implemented and the floating exchange rate system based on market supply and demand, with reference to a basket of currencies-conditioning and of management, has started to be carried out. RMB exchange rate overall rose modestly, two-way floating was orderly, with flexibility was strengthening, basically remaining stable at a reasonable equilibrium level.

Table 5a.3

Exchange rate of RMB against USD (1998–2006)



Unit: RMB /USD100 1998

1999

2000

2001

2002

2003

2004

2005

2006

End of Jan. 827.89

827.78

827.93

827.71

827.67

827.68

827.69

827.65

806.68

End of Feb. 827.90

827.89

827.79

827.70

827.66

827.73

827.71

827.65

804.93

End of Mar. 827.91

828.00

827.86

827.76

827.70

827.72

827.71

827.65

803.50

End of Apr. 827.81

827.94

827.93

827.71

827.72

827.71

827.69

827.65

801.56

End of May 827.95

827.86

827.77

827.72

827.69

827.69

827.71

827.65

801.52

End of June 827.98

827.86

827.72

827.71

827.70

827.70

827.67

827.65

800.67

End of Jul. 827.99

827.73

827.93

827.69

827.68

827.73

827.67

822.90

799.10

End of Aug.

828.00

827.71

827.96

827.70

827.67

827.70

827.68

810.19

797.33

End of Sep. 827.80

827.75

827.86

827.68

827.70

827.71

827.67

809.22

793.68

End of Oct. 827.76

827.76

827.85

827.68

827.69

827.67

827.65

808.89

790.32

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(Cont'd) 1998

1999

2000

2001

2002

2003

2004

2005

2006

End of Nov. 827.82

827.89

827.74

827.69

827.71

827.69

827.65

808.40

786.52

End of Dec. 827.87

827.93

827.72

827.68

827.72

827.70

827.65

807.59

782.38

Annual Average

827.53

827.84

827.70

827.70

827.70

827.68

819.17

797.18

827.91

Table 5a.4 Window guidance of the central bank over the previous years Time

Content

1998

It canceled the limitation of state-owned commercial bank loan amount since the beginning of the year.

1999

It still issued loan directional plan to the state-owned commercial bank but for the amount totally in accordance with the report, and respected the wills of project loans of commercial bank.

2000

It transferred to liquidity withdrawal of commercial bank since the beginning of the year, with annual net cage base currency of RMB82.2 billion, carried out the Management Measures of Closed Loan , and released Notice about Insisting on Closed Loan Conditions and Controlling Loan Risk.

2001

It provided window guidance to the reduced increase problem of loans in wholly state-owned commercial banks.

2002

It convened a meeting of three bank presidents of wholly state-owned commercial banks, and raised specific requirements for the commercial banks to strengthen loan marketing.

2003

It organized commercial banks to analyze the loan trend of more increases; required the financial organizations to avoid the decrease of capital adequacy ratio; and prevented all types of risk of loans and liquidity by trying to control the total loans.

2004

It reminded the commercial banks not only to pay special attention and prevent excessively rapid growth of credit, but also to avoid “breaks,” taking reasonable grasp of loan progress and optimizing capital allocation.

2005

It guided the financial organizations to implement the principle of “treating differently, keeping pressure,” avoiding blind investment of partial industry.

2006

It restrained the loan expansion impulse of commercial banks, overhauled and standardized various bundled loans, strengthened the credit management of housing developing loan, and individual housing mortgage loan.

2007

It put forward “tight monetary policy” with raising the deposit reserve rate, introduced loan recognizing details of the second house and strengthened commercial housing loan management, requiring that the actual loan amount for this year shall not exceed the approved amount.

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Table 5a.5

Conditions of real estate loan over the years (1998–2007)

Time

Condition

1998

The People’s Bank of China issued Notice about Increasing Investment of Housing Credit, Supporting Housing Construction and Consumption.

1999

Provisional Regulations of Economically Affordable Housing Development Loan Management was issued, housing mortgage loan interest rate was down-regulated again in September and the individual housing loan period was extended from 20 years to 30 years.

2000

With rapid development, the housing credit increased 16.7-fold for three years.

2001

Such documents were issued as Notice about Regulating Relative Problems of Individual Housing Loan , Notice about Forbidding Issuing Personal Consumption Loan without Designated Usage , Notice about Regulating Housing Financial Business and Management Measures of Individual Housing Loan , establishing quarterly joint conference system of housing finance.

2002

Such documents were issued as Notice about Further Strengthening Credit Business Management of Real Estate, Management Measures of Individual Housing Loan, Several Opinions on Strengthening Macro-control of Real Estate Market and Promoting the Sound Development of Real Estate Market, Management Measures of Government Land Reserve Agency Loan, Notice from The People’s Bank of China on Strengthening Credit Business of Housing Accumulation Fund and Notice from the People’s Bank of China on Incorporating “Big Entrust” of Public Housing Loan into the Statistics of All subjects , Management Regulations on Housing Accumulation Fund was modified, and such meetings were convened at the national real estate finance forum, real estate financial joint conference.

2003

The document, Notice from the People’s Bank of China on Further Strengthening Credit Business Management of Real Estate , formulated restrictive measures for developers’ loans, construction working capital loans, personal loans for many houses, and upscale housing loans.

2004

The documents were issued as Notice on Establishing Two Systems of Controlling and Preventing Credit Risk and Administrative Guidance of Real Estate Loan Risk from Commercial Banks.

2005

Personal housing loan preferential interest rate was drawn back to the level of loans at the same period. Commercial Banks were guided to lift the downpayment ratio of individual housing loans in an appropriate way in the cities or regions with excessively rising prices.

2006

Benchmark interest rate of bank mortgage over five years was increased to 6.39%; six measures promoting the sound development of real estate were put forward; the document was introduced as Opinions on Adjusting Housing Supply Structure and Stabilizing Housing Prices.

2007

As for the people who had bought a house with a loan, and applied for purchasing the second or the above house, the down-payment ratio of loan could not be lower than 40%, with an interest rate no lower than 1.1 times that at the same period and same class. The regulation of “limited partnership enterprises” in the new Partnership Enterprise Law would extend the financing channel of real estate enterprises.

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Table 5a.6 Time

Agricultural loan conditions over the years (1998–2007)

Condition

1998

Notice on Increasing Credit Investment, Enhancing Credit Management and Promoting the Economic Development of Agriculture and Rural Economy was copied and distributed.

1999

The document, Guiding Opinions on Well-conducting Rural Credit Work , relaxed the loan conditions of rural credit cooperatives; The document, Notice on Timely Increasing the Refinancing Support for Rural Credit Cooperatives to Improve the Supporting-Agricultural Service , issued refinancing of rural credit cooperatives of 15 billion.

2000

The documents were issued as Guiding Opinions on Peasantry Joint Loan Management of Rural Credit Cooperatives and Opinions on Improving Rural Finance Service and Clamping down Folk Usury.

2001

Rural microcredit loans method of “once check, fractional distribution, balance control, and turnaround utility” was promoted.

2002

The refinancing limiting amount of rural credit cooperatives was increased by RMB26 billion. The document, The People’s Bank of China’s Management Measures for Rural Credit Cooperatives , was amended, which extended the refinancing using period by 3 years.

2003

With the currency policy facing heavy pressure, the state still decided to invest funds to support the reform of rural credit cooperatives in the pilot areas.

2004 2005 2006

2007

The document was issued as Opinions on Further Deepening the Rural Credit Cooperatives Reform Pilot Areas .

Rural microfinance organization pilot was explored and promoted actively and carefully. It increased the regional refinancing regulating strength of support agriculture, extended the using period, and performed relatively low deposit reserve rate to the rural credit cooperatives, steadily promoting the pilot of micro-financing companies. It exchanged special bill for the 220 rural credit cooperatives at county (city) level in 14 provinces (cities), such as Jiangsu, with RMB12.3 billion.

Table 5a.7 Loan conditions of medium-small enterprises over the years (1998–2007) Time

Condition

1998

The document was issued as Opinions on Further Improving the Financing Service of Medium-Small Enterprises ; the loan interest rate floating-upward rate was expanded, from 10% to 20%.

1999

The documents were issued as Guiding Opinions on Strengthening and Improving Finance Service of Small Enterprises, Closed Loan Management Measures, Guiding Opinions on Establishing Credit Mortgage System Pilot of Medium-Small Enterprises, Notice on Increasing Refinance of MediumSmall Financial Organizations Appropriately, and Notice on Such Problems as Expanding Appropriately the Loan Interest Rate for Medium-Small Enterprises .

2000

Notice on Relative Questions of Commercial Banks of Stock System Opening Entrusted Loan Business ; rediscount accrual for medium-small enterprises accounting for 79.3% of the total.

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(Cont'd) Time

Condition

2001

The documents were issued as Work Plan for Guarding Against and Dissolving the Risk of Medium-Small Financing Organizations by the end of 2002, Provisional Measures of Medium-Small Financing Mortgage Institutes Risk Management ; eight departments jointly convened the “forum for improving the finance service of medium-small enterprises.”

2002

An Instruction on the Further Support to Small and Medium-Sized Enterprises that Have Markets, Efficiency, and Credit was issued.

2003

The financing organization interest rate floating band was decided to be reexpanded since January 1, 2004.

2004

Commercial bank loan interest rate cap was let go with urban and rural credit cooperatives’ loan interest rate floating ceiling expanded to 2.3 times of the benchmark interest rate; a small and medium-sized enterprise board was launched in the Shenzhen stock exchange.

2005

The document was published as Guiding Opinions on Bank Opening the Business of Small Business Loan , with holding a forum of medium-sized enterprise loans in the city commercial banks and market positioning.

2006

The document was released as Businesses Guide of Small Enterprise Credit Extension Work in the Commercial Bank (for Trial Implementation) .

2007

Enterprise management consulting service center of China association of small and medium-sized enterprises summed up 10 big issues faced by the small and medium-sized enterprises; solicit effective solutions; and launched, in the five central cities, the activity of “2007 Round Visit of small and medium-sized enterprise.”

Table 5a.8

Management system of the interest rate over the years (1998–2007)

Time

Condition

1998

Small business lending rate fluctuation range increased from 10% to 20%, and loan interest rate fluctuation range of the rural credit cooperatives expanded from 40% to 50%, simplifying the exporters’ credit interest rate structure, and implementing the “joint conference system of foreign currency rates.”

1999

With promulgating the Management Regulation of RMB Rate , the interest rate system was reformed with the train of thought of “first foreign currency, then domestic currency; first loan, then deposit; first countryside, then city.” With letting go of interbank loan, discount market, bond repurchase, and bond market interest rates, policy financial debt and national debt realized the issuing of interest rates tender marketization issue. Loan interest rate upward range of the financial institutions under county level was increased to 30%; loan interest rate upward range of medium- to small-sized enterprises was expanded to 30%.

2000

Reform of foreign currency rates, namely, foreign currency loan interest rate is ensured by the financial institutions on their own, foreign currency deposit interest rate of the bank by small association for approval of the People’s Bank of China. Amount more than USD3 million was ensured by the negotiation between the commercial bank and the client.

2001

Small and medium-sized enterprises loan interest rate fluctuation range was expanded, rising from the current floating of 30% to 50%.

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(Cont'd) Time

Condition

2002

Market-oriented interest rate reform pilot: loan interest rate fluctuation range expanded from 50% to 100%, with the interest rates on deposits rising 50%.

2003

2004

2005 2006 2007

It let go of methods of calculating and settling interest for RMB, and domestic small deposit rates management of GBP and the CHF and CAD. As for the small deposit interest rate of USD, JPY, HKD, EUR, it carried out cap management practice. From October 29, commercial bank loan interest rates were let go, urban and rural credit cooperatives loan interest rate floating ceiling was expanded to 2.3 times of the benchmark interest rate, carrying out the down-floating system of RMB deposit rate. Report on Steady Promoting market-oriented reform of interest rate was issued to down-adjust the interest rates of excess reserve deposits of financial institutions as 0.99%. Shanghai: the interbank interest rates of Shanghai Bank began the trial run in October, contributing to further promotion of market-oriented reform of the interest rate.

The interest rate swap market has become China’s main market of derivatives.

Table 5a.9 Regulation of institutions over the years (1998–2007) 1998 1999

2000

2001

2002 2003

In 1998, Mass setting up institutions was stopped, with an insistence on zero growth principle for the branches of the four commercial banks.

The document, Notice on the People’s Bank Reorganizing the Urban Credit Cooperatives’ Work Plan Forwarded by the General Office of the State Council of China , raised the request of strengthening financial supervision on urban credit collectives; the wholly state-owned banks initiates work of “reforming system and removing branches.”

Year 2000 was set as a “regulatory year,” with dropping rates of four types of institutions of 22.6%. The documents were issued as Notice on Implementing Overall Check on Urban Credit Collectives’ Rectification and Further Promoting the Rectification, Supplementary Notice on Implementing Overall Check on Urban Credit Collectives’ Rectification , and Notice on Relative Matters of Submitting Consolidated Statements of Implementing Overall Check on Urban Credit Collectives’ Rectification .

26 documents were issued as Implementing Responsibility System of Measures of Rural Credit Collectives Supervision (for Trail Implementation), The People’s Bank of China’s Notice on Relative Issues as Strengthening the Supervision on Rural Credit Collectives, Guidance on the Preparation for Supporting Agriculture of the Current Rural Credit Cooperatives , and Notice on the People’s Bank of China Well-Conducting the Current Work on Rural Credit Cooperatives . The commercial bank was deregulated, changing the establishing branches of banks to a registration report system; four state-owned commercial Banks including the joint stock commercial Banks established overseas branch offices.

The documents were issued as Notice on Strengthening the Equity Management of City Commercial Banks, Provisional Regulations of Rural Commercial Bank Management , and Provisional Regulations of Rural Cooperative Banks Management .

153

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) 2004

2005 2006 2007

The documents were issued as Implementing Opinions on Rural Cooperative Financial Institutions Chronological On-Site Examination, Inspection Procedures of Rural Cooperative Financial Institutions Site and Risk Evaluation of Rural Cooperative Financial Institutions and Warning Index System . The documents were published as Urban Credit Cooperatives Regulation and Development Planning , and Notice on Further Promoting Urban Credit Collectives’ Rectification . The document was revised as Corporate Governance of State-owned Commercial Bank and Relevant Supervisory Guidelines . The initial results were given of adjusting and loosening rural banking financial institutions access policy pilot produced results, approving 23 new types of rural financial institutions in six pilot provinces (areas).

Table 5a.10 Industrial regulations over the years (1998–2007) 1998

The document was issued as Securities Regulators System Reform Plan , with implementing “first restructuring operation, the issuing after listed” in the stock issuance market, strictly linked to the issuing of new shares and matching audit.

1999

The documents were issued as Notice on the People’s Bank Reorganizing Trust and Investment Company Profile forwarded by the General Office of the State Council of China, Notice of the Ministry of Finance and the People’s Bank of China on Copying and Distributing The Regulation of the Trust and Investment Company Assets and Capital Verification of Assets Evaluation and Loss Writeoff, Management Regulations of the Trust and Investment Companies (draft), Provisional Measures of the Trust and Investment Companies Management, and Notice on the Trust and Investment Companies Setting Special Reserve .

2000

The document proceeded to conduct the restructuring and reform of the trust and investment companies as Notice on the People’s Bank Reorganizing Trust and Investment Company Profile forwarded by the General Office of the State Council of China .

2001

Restructure and reform of the trust and investment companies achieved staggered results, with eight trust and investment companies finishing the registration by the end of the year.

2002

The documents were promulgated as Management Measures of the Trust and Investment Companies, Interim Measures of the Capital Trust Business of the Trust and Investment Companies , and Notice of the People’s Bank of China on Capital Trust Business Relative Questions .

2003

The document was issued as Notice on Relative Problems for Speeding Up the Removing of Original Business of the Trust and Investment Companies .

2004

The document was issued as Interim Measures for Information Disclosure of the Trust and Investment Companies, Notice on Relative Problems of Trust and Investment Companies Assembling Funds , and Trust Business Information Disclosure, with the establishment of China Trustee Association.

154

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) 2005

12 securities companies with high risk and no hope of rectification or with new illegal behaviors were marked for disposal; the market exit of the 16 financial institutes with high risk which were taken charge of by the Peoples’ Bank of China made substantial achievements.

2006

With the establishment of Management Measures of Trust Company , Management Measures of Trust Companies Assembling Funds Trust Plans , the disposal of 21 securities companies and 16 financial institutes and 27 securities companies was finished.

2007

The implementation of Management Measures of Trust Company, Management Measures of Trust Companies Assembling Funds Trust Plans marked the beginning of the sixth rectification.

Table 5a.11 Financial market and tools (1998–2007) Time

Market and tool

1998

Market-oriented issue of policy-form bond was an essential breakthrough of the construction of the Chinese currency market.

1999

The entering of securities companies and fund management firms into the interbank market provided a link between capital market and currency market.

2000

Currency market gradually became the site of short-term regulation for the financial institutes, with a remarkable increase of trading volume for short-term varieties. Securities companies became the major force of enlivening inter-bank market.

2001

Interbank trading variety in bond market became more diversified, which increased the issue of the new variety of long-term bond, with the ministry of finance issuing the first long-term coupon-bearing bond with fixed interest rate of 15 years; the National Development Bank issued the first long-term couponbearing bond with fixed interest rate of 30 years and callable bond of 10 years.

2002

With the rapid development of interbank bond market, the market accessibility transferred from registered system into record system. The documents were issued as Management Measures of Commercial Bank Counter Book-entry National Debt Deal , and Notice of the Peoples’ Bank of China on Relative Issues of 39 Commercial Banks as China Industrial and Commercial Bank Starting Agency Business of Bond Settlement . With the substantive breakthrough of the openness of the stock market, such documents were issued as Management Measures of Securities Companies, Regulations for Establishment of Foreign Capital Participation Securities Companies, Regulations for Establishment of Foreign Capital Participation Fund Management Companies, Notice on Relative Issues of Transferring State-own Shares of Listed Companies and Legal Person Shared to the Foreign Investors, and Interim Measures of Administration of Qualified Overseas Institutional Investors’ Territory Securities Investment .

2003

Sponsor system was carried out in the listed securities issuance, with the publishing of 5 documents as Trail Measures for Securities Companies’ Business of Customer Assets Management , etc. The opening of capital market proceeded overly fast.

155

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Time

Market and tool

2004

The document was issued as Several Opinions on Promoting the Reform and Opening up of the Capital Market and Steady Development . Currency market pushed forward the buyout-repurchase, currency market fund, etc.; establishing interbank market maker system of bond market; improving bond issuance method of fluctuation interest rate; approving commercial banks to issue subprime bonds; allowing securities companies to issue short-term financing bonds in the interbank bond market. May 27, small and medium-sized enterprises board was promoted in the Shenzhen Securities Exchange.

2005 2006 2007

Such documents were issued as Management Measures of Short-term Financing Bond, Underwriting Rules of Short-term Financing Bond , and Information Disclosure Regulations of Short-term Financing Bond . Bank of China and Industrial and Commercial Bank of China were listed in A share market, and the reform of non-tradable shares had basically been accomplished.

Corporate bonds put forward mortgage bonds and small and medium-sized enterprises joint bonds; firm bonds were introduced through the lead of China Securities Regulatory Commission (CSRC) and obtained the approval of interbank market circulation.

Table 5a.12 Innovative products of major small and medium-sized enterprises Innovative product

Loan method

Preservation warehouse loans

Small and medium-sized enterprises are required by the bank to put the commodities into the designated warehouse as mortgage for loans.

Export tax refund pledge loan

Small and medium-sized enterprises are required by the bank to set the refundable tax with the approval of national tax department as the payment pledge.

Unlimited liability guarantee loans

Legal representatives of small medium-sized enterprises or major shareholders take the unlimited responsibilities of entrepreneur loans.

Movable property of the pledged collateral loans

The banks require the large medium-sized enterprises to provide guarantee for the loans of the linking small and medium-sized enterprises, while, the latter provides reverse guarantee with the specificity chattels.

Accounts receivable pledge loans

Small and medium-sized enterprises are required by the bank to set their accounts receivable of large and medium-sized enterprises as the pledge loans.

Maturity factoring

Banks purchase the short-term receivable claims of the small and medium-sized enterprises.

156

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) Innovative product

Loan method

Group lending agency business

Group lending is launched among enterprises.

Buyer paying interest bills loans

Forfaiting within importation Export foreign exchange instrument buyout

Sino-German cooperative finance credit planning for small and medium-sized enterprises

Business start-up loans Staff, natural person loans with company guarantee

After selling, small and medium-sized enterprises go to the banks to apply for discount with the buyers’ bank acceptance or commercial acceptance, then conduct discount procedures based on all approvals, with bill discount interest assumed by the buyers. Banks buyout the acceptance of foreign banks without recourse and provide financing service for the export enterprises. Banks issue usance letter of credit according to the requirements of domestic import small and medium-sized enterprises. After the bank acceptance for the foreign bills, the banks provide immediate payment without recourse for the import of small and mediumsized enterprises, which is divided as the buyer servicing buyout business and seller servicing buyout business. This is a relatively preferential loan from Germany’s government, used mainly for promoting the demand of Chinese small and medium-sized enterprises to long-term financing in fixed assets. Credit program is taken charge of by a specific bank in China. It is an unspecific loan issued by local reemployment fund or mortgaged in other ways.

The loan for the company is transferred as that for staff of natural persons, with mortgage of individual assets or guarantee of company, and the loan obtained is applied into the entrepreneur usage.

Data of Yangtze River Delta Area Table 5a.13 Numbers of financial organizations over the years (2000–2006) Year

Number of financial organizations

2001

Various types of financial organizations totaled 3200, with 69 foreign-funded ones operating in Shanghai.

2000

2002

Various types of financial organizations totaled 3,300.

Operating foreign-funded financial organizations totaled 54 with 6 branches in the same city and 22 foreign-funded banks in Shanghai were intended to be the major reporting banks in China.

157

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Year

Number of financial organizations

2003

Operating foreign-funded financial organizations totaled 54 with 62 banks and financial companies, 19 insurance institutes, 8 securities institutions, in which, 47 institutions acquired the qualifications to run RMB business, 24 were intended to be the major reporting banks of domestic business in China.

2004

Operating foreign-funded financial institutions reached up to 113, with 75 foreign-funded banks and financial companies including 15 branch banks in the same city, 23 insurance institutions, and 15 securities institutions. 2005 Newly added financial organizations total 73, with 11 banks, 50 financial ones, and 3 securities ones. By the year-end, there has been in total 527 financial organizations, with banks of 13, insurance type of 227, and securities type of 91. Operating foreign-funded financial institutions total 123, an increase of 14. Foreign-funded banks and financial companies amount to 84 (including branch banks in the same city) with an increase of 9 in the year. 29 foreign-funded banks in Shanghai were intended to the major reporting banks in China.

2006

Newly added all types of financial organizations amounted to 59, with banks of 2, securities types of 54. There are, in total, 563 financial organizations, with 109 banks, 109 insurance types, 90 securities, 36 legal institutions, 27 national operating centers as national clearing centers, credit card centers, and capital trading centers.

Table 5a.14 Financial service and tools of Shanghai over the years (1998–2006) Year

Financial service and tools

1998

Small and medium-sized enterprises service center was established in Shanghai Bank; regulation of loan note obtained further improvement.

1999

Consultant system of bank credit registration was built.

2000

Industrial and Commercial Bank of China set up bill selling department, with partial financial institutes in Jiangsu Province and Zhejiang Province incorporated into the regional bill exchange in Shanghai.

2002

Bank of Shanghai was encouraged to transform its system into a regional commercial bank, with promoting the comprehensive reform of rural credit collectives in Shanghai and preparing for organizing Shanghai Cooperative Bank; Shanghai witnessed the settlement of some commercial banks’ fund operation, business operation, and management center.

2003

Industrial and Commercial Bank of China set southern data center and software development center in Shanghai; HSBC set data DPC in Shanghai; 4 foreignfunded banks set general representative offices in Shanghai.

2005

Financial innovation was positively promoted, with such new products as CSI300 indexes, bond forward, corporate commercial paper underwriting; the first national provincial-level rural commercial bank — Shanghai Rural Commercial Bank was built; it was overall launched by the small and mediumsized enterprises customer marketing work in the Shanghai branch banks of Industrial and Commercial Bank of China, with the city branches remaining competitive advantages and suburban ones springing up.

158

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) Year

Financial service and tools

2006

Shanghai Branch of Bank of China officially launched the business of granting credit to small-sized enterprises, with promoting the three products aiming at small-sized enterprises of “easy finance,” “safeguard export interest,” and “credit garden” (a foreign exchange wealth management product); Shanghai Branch of Agricultural Bank of China introduced financial service for small-sized enterprises; Shanghai Branch of Communications Bank of China expanded the scale of small-sized enterprises business; Shanghai Branch of China Merchants Bank introduced “golden touch growing plan” for small and medium-sized enterprises, providing brand-new online bank overdraft products for them.

Table 5a.15 Number of various types of financial organizations in Jiangsu Province (2002–2007) Time

2002

2003

2004

2005

2006

2007

Total

13,235

13,002

12,338

9,662

9,093

9,012

69

69

69

69

69

69

Wholly State-owned Commercial Banks

5,973

5,714

5,306

5,124

4,692

4,635

Industrial and Commercial Bank of China

1,424

1,401

1,299

1,236

1,061

1,053

Agricultural Bank of China

2,099

1,994

1,896

1,832

1,618

1,587

989

970

971

965

940

927

1,461

1,349

1,140

1,091

1,073

1,068

94

97

97

91

94

94

1

1

1

1

1

1

People’s Bank of China

Bank of China Construction Bank of China Policy-based Bank China Development Bank Import and Export Bank

—

1

1

1

1

1

Bicultural Development Bank

93

95

95

89

92

92

Other Commercial Banks

591

597

597

607

609

615

Bank of Communications

373

368

354

353

350

347

CITIC Industrial Bank

82

78

75

75

74

70

China Everbright Bank

18

18

18

18

19

19

Huaxia Bank

27

27

31

32

32

33

159

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Time

2002

2003

2004

2005

2006

2007

Guangdong Development Bank

14

18

19

20

20

20

Shenzhen Development Bank

7

9

10

10

10

11

China Merchants Bank

22

24

26

28

32

40

Shanghai Pudong Development Bank

35

36

38

39

41

41

Industrial Bank

7

10

16

19

16

16

Minsheng Bank

6

9

10

13

14

17

Hang Seng bank Municipal Commercial Banks Country Cooperative Bank Countryside Commercial Bank

—

—

—

—

1

1

468

470

470

474

477

482

—

—

—

—

333

638

293

289

354

705

694

686

5

20

2

2

2

2

3,414

3,419

3,122

2,474

2,115

1,783

3

3

3

3

3

3

12

10

5

5

4

4

3

3

3

3

1

1

2,311

2,310

2,310

—

—

—

Urban Credit Cooperation Rural Credit Cooperation Finance Company Trust and Investment Companies Leasing Company Postal Savings and Remittance Bureau

Table 5a.16 Establishment and revocation of financial institutes in Jiangsu Province (1998–2001) Year

Financial institutes

1998

Nanjing Branch of People’s Bank of China was set up; commercial banks in Yancheng, Changzhou, Wuxi, and Zhenjiang opened in succession.

1999

Nanjing Branch of National Development Bank finished the task of transferring the credit and debt of ex-investment bank to China Everbright Bank, with extracting Nanjing Branch of China Everbright Bank with normal business.

2000

There have already been 73 urban credit collectives at county-level changed to rural credit collectives, with 1,658 rural credit collectives and 81 counties (cities) joint associations combining as 82 corporations.

160

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) Year

Financial institutes

2001

Provincial rural credit collectives were established, with 3 rural commercial banks being set up; 51 urban credit collectives were disposed, in which 22 were reorganized as 2 commercial banks, 19 were changed as rural credit collectives, 5 organized units were taken back, and 1 Communications Bank of China was purchased; Guidance was provided on the preparation and building of commercial banks in the two cities of Huaian and Lianyuangang Harbor; As for the Nanjing Branches of Communications Bank and CITIC Industrial Bank with abundant institutional network and administrative layers, they were urged to set and upgrade 29 branch banks based on removal and merger of the net point with small business amount, low level, and poor operation, promoting their transition to the second tier.

Table 5a.17 Financial tools of Jiangsu Province over the years Year

Financial tools

1998

Problems of some enterprises were solved with such methods as setting up a loan guarantee fund, open vehicle mortgage registry, especially the problems of loan guarantee and mortgage difficulty of small and medium-sized, individual, and private enterprises.

2004

Nanjing Branch of Communications Bank introduced Yinqitong, Yinbaotong, and POS transfer expenses reimbursement system of entrepreneur finance; Nanjing Branch of CITIC Industrial Bank introduced structured deposits of foreign currency, industrial, and commercial silver business, warehouse receipts pledge, confirming warehouse business; Nanjing Branch of Shanghai Pudong Development Bank introduced international factoring, offshore business; Nanjing Branch of Hauxia Bank introduced enterprise financial advisory, and proof of bank credit business.

2005

Jiangsu Branch of Industrial and Commercial Bank of China promoted credit products with high fluidity combining the entrepreneur features, aiming at the features of private enterprises, promoting suitable international trade finance, standard warehouse receipt pledge, liquidity pledge loan under ownership of movable property; regarding the export and import enterprises, timely promoted liquidity revolving loan, account overdraw loan, and import trade financing with export shipping document pledge.

2006

Provincial Agricultural Bank of China set up special measures for the credit management of small enterprises, especially on the method of loan guarantee, actively explore, besides the regular methods, such methods as the accounts receivable, warehouse receipt pledge loan and group guarantee among smallsized enterprises; meanwhile as for the loans for small-sized enterprises whose loan volume was within RMB8 million, they implemented the way of taking mortgage of real estate one owns for loans directly, without category and rating.

161

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Table 5a.18 Regulations and financial service of Jiangsu Province over the years Year

Regulations issued and financial service

1998

The documents were issued as Opinions on Financial Departments Further Supporting Economic Development, Several Policy-based Opinions on Departments Further Supporting the Development of Small and Mediumsized Enterprises, Opinions on Financial Departments Further Supporting the Development of Individual and Private Enterprises, Procedures of Joint Conference of Financial Credit is Right Management Presidents on Enterprises Reforming Systems Evading and Rejecting Financial Debts , and Specific Regulations on Stopping Account Opening, Credit, Settlement Business ; Nanjing Branch of CITIC Industrial Bank and Nanjing industry and commerce federation jointly launched and established “Social Club Bank-Enterprise with Sound Credit of Jiangsu Province,” further exploring the way of bank-enterprises cooperation and supporting private enterprises.

1999

Bank credit registration information system was built.

2000

Rural credit collectives’ system reform pilot was launched.

2001

Over 20 rural credit collectives and associations with various features such as “one-card pass” in Taizhou of Jiangsu Province attended exchange of experience; rural credit collectives were established in Jiangsu Province, with carrying out property system reform in accordance with joint stock principle to the rural credit collectives in Changshu, Jiangyin, and Zhangjiagang and building rural commercial banks in the experiment areas.

2002

Four urban commercial banks of Suzhou, Wuxi, Changzhou, and Nantong officially launched the business of national bank draft management. 34 supply and marketing cooperative credit cooperatives at the county level, branches of urban commercial banks launched bank acceptance operation.

2005

It launched the financial supporting system for small-sized enterprises (period one).

2006

Jiangsu Branch of Industrial and Commercial Bank of China launched the receipt business of “principal-agent discount,” innovatively carried out “transfer of custody”; innovated selling method to lift the comprehensive contribution of credit business for small-sized enterprises.

Table 5a.19 Financial institutes of Jiangsu Province over the years Year

Financial institutes

1998

The number of rural credit collectives with high risk all over the province dropped by 44.6% than that at the beginning of the year.

2000

Three joint stock commercial banks of Everbright, Minsheng, and Fujian Industry were built in Hangzhou city.

2002

Zhenjiang Branch of Construction Bank of China set up an operating center of small and medium-sized enterprises, with bank leader as chief customer manager for 50 important customers in the province, who meanwhile promised that it would provide newly-added loans of RMB50 billion for the small and medium-sized enterprises in Zhejiang province within 3 years.

2003

Zhejiang Banking Bureau opened.

162

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) Year

Financial institutes

2004

Zhejiang Commercial Bank finished renaming and reconstruction, with stock structure optimized.

2006

Hangzhou representative of Import and Export Bank upgraded as bank branch of Zhejiang province, with direct regulating of postal savings branch starting to pilot; Hangzhou branch of Hengfeng Bank opened with approval, Hangzhou branch of CITI Bank and Hengsheng Bank obtained the approval of construction; 3 urban credit collectives were restructured as urban commercial banks; Currently, there are 4 state-owned commercial banks, 3 policy-based banks, 12 joint stock commercial banks, 5 foreign-funded banks with unincorporated banking financial structure, and 107 ones with corporate banking financial structure.

Table 5a.20 Law and regulations issued in Zhejiang Province over the years Year

Law and regulation

1998

Opinions on Implementing, Preventing, and Dissolving Payment Risk of Financial Institutions; Risk Supervision Opinions on Provincial Rural Cooperative Financial Institutions

1999

Several Opinions on Further Improving Financial Service and Supporting Reform and Development of State-owned Enterprises; Notice on Preventing and Dissolving Payment Risk of Small and Medium-sized Financial Institutions; Opinions on the Implementation of Credit Guarantee Institutions for Small and Medium-sized Enterprises in Zhejiang Province.

2000

Notice on Further Supporting Rural Credit Collectives to Increase Investment on Agricultural Credit; Notice on Several Opinions of Land Assets Disposal and Applying for Land Use Certificate and All Warrants in the Restructuring of Rural Industrial Enterprises allowed some rural enterprises to take advantage of such effective assets as land to conduct mortgage finance; Notice on Problems of Real Estate Mortgage Registration decreased the financing costs of enterprises and facilitated the distribution of loans.

2002

8 urban commercial banks in Zhejiang province issued the declaration of Jointly Creating Private Enterprises-oriented Bank Brand , and declared that within 3 years, they would gradually develop into local commercial banks with investment subjects of private fund, service subjects of private enterprises.

2003

Credit Evaluation and Management Measures of Small and Medium-sized Enterprises in Hangzhou City

Table 5a.21 Fina6ncial tools and service of Zhejiang Province over the years Year

2000

Financial tools and service

Refinancing balance for small and medium-sized institutes amounted to RMB0.98 billion; enterprises with sound credit and quality were chosen to launch the discount of commercial acceptance and rediscount business pilot; to meet the settlement demand of small and medium-sized enterprises, commercial banks in Hangzhou established special correspondence with the financial institutions in the other provinces; to meet the demand of small and medium-sized enterprises, some joint stock commercial banks actively set up and provided international settlement business.

163

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Year

Financial tools and service

2002

It built the commercial acceptance rediscount pilot joint areas of Hangzhou, Ningbo, Shaoxing, and Huzhou. Zhejiang Branch of Industrial and Commercial Bank of China introduced such new loan varieties as accounts receivable mortgage pledge loan, warehouse receipt mortgage loan, and promoted trade financing new products of finance consultant business, financing business for clients and Forfaiting, export factoring; Zhejiang Branch of Agricultural Bank of China successfully launched new businesses of open-ended fund agent selling, over-the-counter trading of national debt, Yinzhengtong, factoring, Forfaiting, export credit insurance financing D/A documentary credit, valet foreign exchange risk management, etc.

2005

2006

With taking use of professional experience, Zhejiang branch of the People’s Bank of China introduced such new businesses as Forfaiting, international factoring, valet foreign exchange trading, future foreign exchange settlement, valet debt hedge, and so on.

Hangzhou Central Sub-branch of People’s Bank of China launched bank draft of Zhejiang province and dredged the provincial settlement channel of small and medium-sized financial institutions; Zhejiang Branch of Industrial and Commercial Bank of China promoted such new business as structured financing, restructure of debt, securitization of assets, and so on; Hangzhou Branch of CITIC Industrial Bank classified the customers as four categories in accordance with the risk and cooperative value, which stand for four categories of focus support, general support, observation type, and eliminated type. This classification was used as the adjustment basis to increase the number of dominant clients. Zhejiang Branch of Industrial and Commercial Bank carried out the customer rating system of small-sized enterprises and credit management system for small-sized enterprises.

Zhejiang Commercial Banks set up branches specializing in the business of small-sized enterprises, adjusted the small-sized enterprises credit department of head bank, with developing such products as “multiplier group guarantee,” “standing credit fragmentary repay,” “Property Tong of Zhejiang Commercial Banks,” “Trading Tong of Zhejiang Commercial Banks.”

Table 5a.22 Financial chronicle of events of Zhejiang Province over the years Year

Financial chronicle of events

1999

It took the lead to hold bank-enterprise forum; established a working group of preventing and resolving payment risk for small and medium-sized financial institutions led by the president of the bank; banks in Hangzhou signed the agreement of assistance of same business, with the organization of bank same business association; provincial government held a forum on preventing financial risk all over the province.

164

Local Government Competition amid the Integration of the Yangtze River Delta

(Cont'd) Year

Financial chronicle of events

2000

Hangzhou Center Sub-branch of People’s Bank of China deepened into Kentoku rural credit collectives and launched financial support agriculture research with the rural residents, forming the research report of Rural Credit Collectives Want to Be the Close Friend of Mass Peasants ; forums were held of small and mediumsized enterprises, guarantee institutions and governmental administrative departments at different levels; it took the lead to hold bank-enterprise forum which it facilitated cooperative agreements of over 60 programs totaling RMB2.5 billion; Hangzhou medium-counts conducted deep research on financial service for small and medium-sized enterprises.

2001

It held over 20 financing fairs of small and medium-sized enterprises, summarizing 8 loan methods suiting small and medium-sized enterprises, which were promoted in commercial banks of Hangzhou and spread to branches in the other provinces.

2002

Dai Xianglong, president of People’s Bank of China, inspected Wenzhou and put forward the setting of Wenzhou as the comprehensive pilot of deepening financial reform.

2003

It supported and guided the Hangzhou commercial banks to overall promote the management method for small-sized enterprise of “three packs and one hook,” strengthening the support for small and medium-sized enterprises; reported profile of rural credit collectives reform pilot implementation in Zhejiang province.

2004

Zhejiang Branch of Construction Bank of China reformed the examining and management system, reducing the approval process.

2005

Small-sized enterprises credit system reform represented by 4 state-owned commercial banks was launched in Zhejiang province.

2006

Financial institutions promoted the development of small and medium-sized enterprises by simplifying business approval, innovating service process, developing new products, and so on. Loans to small and medium-sized enterprises from financial institutions by the year-end totaled RMB1,099.5 billion, accounting for 53% of the total.

Source: China Finance Yearbook (1999–2007).

165

6

Chapter

The Industrial Structure of the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction The State Council recently passed The Guideline for the Further Promotion of the Reform and Opening Up and Socioeconomic Development of Yangtze River Delta . Strategically, the guideline is significant for the solution of the challenges the region faces in the new situation, such as improving the overall quality and international competitiveness of the region’s economy, and promoting the region’s scientific, harmonious, early and integrative development. In order to promote the reform and opening up and socioeconomic development of the region, the outlook of scientific development must be followed thoroughly. In order to accelerate the transition of the region’s growth pattern and the adjustment of its economic structure, when constructing an international advanced manufacturing industry, the region also needs to bring into place an industrial structure pivoting on modern service industry. Moreover, it needs to make leap-frog improvement in its regional overall competitiveness, innovation capacity, and sustainable developmental ability. It also needs to thoroughly deepen the reform and opening up, promote innovations at the institutional level, empower regional development, accelerate regional integration, and promote regional coordination and balanced development between rural and urban areas. However, theoretically, the process of regional economic integration potentially conflicts with the inter-regional similarity in industrial structures. But the questions are: Is there the isomorphism in the industrial structures within the Yangtze River Delta, what is the cause for it, and what is a proper level of isomorphism in industrial structure beneficial to regional integration and regional growth? The very objective of this chapter is to answer these questions. In its concept, industrial isomorphism refers to the state when the industrial structures within a region become highly similar to each other during the region’s structural transition. In reality, industrial isomorphism has always been the target of criticism, as we tend to relate it with overlapped construction. Also, because there is no unified objective under the modern price structure dominated by Shanghai, Zhejiang, and Jiangsu governments, and because the convergence of investment will lead to the convergence of industries, if the degree of industrial isomorphism in the region decreases, that would be the result of an increased willingness to cooperate of the three governments. A more practical question is that, is there a situation of serious industrial isomorphism in the Yangtze River Delta under the current price structure, and how to define it? Answers to these questions must be provided on the basis of large-scale

168

The Industrial Structure of the Yangtze River Delta

statistical analysis. Nevertheless, results of contemporary research have shown that the proportion of industrial isomorphism is falling in the Delta Region. If this finding is true, we are very interested to know whether this is the result of local government coordination or a change in the market positioning of enterprises. Does this change in market positioning reflect a more differentiated industrial division of labor and a higher degree of specialization within the Delta? What caused the isomorphism under the original market mechanism? Why does government coordination or market competition lead to harmony? This chapter tries to address these questions. This chapter finds that, since 2000, the industrial structure of the Yangtze River Delta has not undergone the isomorphic change as many believe. The main reason scholars are convinced that the Delta’s industrial structures are isomorphic is their overly loosened statistical standards, which exacerbated the degree of isomorphism in the region. In fact, the industrial structures of the two provinces and one municipality in the Delta Region are quite different and complementary to each other. This is also supported by this chapter ’s statistical results. This chapter also finds that the converging investment in this region is an important cause of its converging industrial structures. Isomorphism is related to the nature of investment. The investment from stateowned enterprises (SOEs) or state-held enterprises will increase the degree of isomorphism, while public investment aimed at building and improving industrial infrastructure, as well as investment from foreign and private companies will decrease the level of isomorphism. The convergence of these investments of different natures is the real cause of both the conflicts and harmony in the industrial structures of the Delta Region.

Literature Review Is it true that the degree of industrial isomorphism has fallen in the Yangtze River Delta? Earlier, when scholars calculated the similarity coefficients among the three industries of the Delta Region, they found that the region had a high degree of industrial isomorphism. However, we believe that this most talkedabout isomorphism only exists on the macro level of the three industries, while on the medium level of the manufacturing industry, such isomorphism does not exist. That is to say, the degree of manufacturing isomorphism is far lower than the degree of isomorphism in the three industries. Although there might be the same extent of isomorphism in manufacturing, its degree is not as serious. If we make our analysis on the product structures within the manufacturing industry,

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

the isomorphism of the region may be far less severe. Moreover, whether there is an isomorphic situation in the region’s manufactured goods, and with it, overlapped construction and cutthroat competition, are questions yet to be answered with careful and objective measurement and evaluation. In fact, the academic world seems to share the view that, despite its intensifying integration, the region still houses a very isomorphic manufacturing industry. In view of this, Fan Jianyong (2004), under the framework of neo-economic geography, believed that integration must lead to the spatial transfer of manufacturing and an increasing structural difference among regions. Using the example of the Yangtze River Delta, he proved this hypothesis through calculating the indicators of the levels of specialization and concentration of industries. The result of this research shows that the levels of intra-regional labor division of Shanghai and Zhejiang are much higher than that of Jiangsu. In only a few years, the region’s manufacturing industry underwent a tremendous spatial adjustment. For instance, Shanghai reduced the proportion of manufacturing in its economy by transferring its laborintensive industries outward and specializing in only a few industries such as capital- and technology-intensive industries, port-based industry, and urban information industry. Zhejiang keeps absorbing the labor-intensive industries transferred from Shanghai and Jiangsu at a steady pace, increasing the proportion of manufacturing in the province. Jiangsu absorbed and released a roughly similar amount of manufacturing enterprises, keeping the proportion of such enterprises basically unchanged. Although Fan Jianyong’s analysis proved that the integration of the Delta Region will bring about the spatial transfer of manufacturing and the strengthening of interregional structural differences, the study failed to reveal the internal motivation of such changes, conduct quantitative measurement on the isomorphism of the region, or analyze the mechanism under which specialized industrial parks came into being. Jin Xiangrong and Zhu Xiwei (2002) viewed the formation mechanism of specialized industrial parks as the conflicts between industrial special factors and overlapping factors. Bai Chongen (2004) studied the determinants and trends of changes of the level of regional concentration in China from a quantitative perspective. In the study, he discussed why some industries tend to concentrate in several areas, while some other industries scatter around the country. The author used the dynamic approach of calculating the logarithms of the data groups, and found that in industries in which the state-owned proportion is higher and where taxes are higher, local protection tended to be stronger and the degree of regional concentration was also lower. Bai Chongen’s subject was the whole of China, and he focused on the role of local

170

The Industrial Structure of the Yangtze River Delta

protectionism when considering the determinants of the degree of regional concentration. Although he also took into consideration factors like economy of scale and the cluster effect, his study did not cover the isomorphism of the Delta Region and its mechanism. The study of Xu Xianxiang and Li Xun (2005) used cities in the Delta Region as its samples, and conducted an empirical study based on their 1990–2002 data. It found that the founding and operation of the Yangtze River Delta City Coordination Committee had significantly weakened the obstacles to regional coordinated development caused by regional market separation. The study proved that market integration is beneficial to regional coordinated development, but its data and statistical analysis were brief, not even categorizing industries. The study of Hu Xiangtin and Zhang Lu (2005) aimed at studying the effects of local government protection to local industrial structure and inter-regional industrial convergence. The authors used the government variable in the two aspects of changing inter-regional trade costs and government direct investment, so as to discuss the role of government behaviors to regional industrial structure. The analysis of the model found that increases in trade cost will facilitate the industrial convergence among regions, while government direct investment causes an uncertain effect on industrial structure, as it will facilitate the differentiation of such structures among regions under certain conditions. The study used the whole country as its subject, and found that the trend of China’s regional industrial structure wasn’t convergence, but differentiation based on the comparative advantages of different regions. Moreover, after controlling for historical factors such as transportation, regional differences in resources and industrial structure, government variable had a significant effect on the differentiation of regional industrial structures. When governments establish trade barriers to increase the cost of trade, regional industrial structures will converge. Overall, government investment will facilitate the differentiation of regional industrial structures. In zerms of the study on industrial characteristics, spatial competition, and the geographical concentration of manufacturing, the study of Wang Yeqiang and Wei Houkai (2007) is the most inspiring. The study covered 31 provincial capitals of China. According to the determinants of China’s industrial concentration, the study established a spatial competition theoretical framework based on industrial characteristics analysis. Through the quantitative test of the 1995–2002 panel data of 28 manufacturing industries that were subdivided into over 10 subcategories, the study yielded some very significant conclusions. For example, the authors claimed that, first, traditional comparative advantages such as labor, are increasingly the main factors retarding China’s industrial

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

concentration; second, China’s manufacturing industries concentration is mainly empowered by some industries’ preference to technologies, market scale, and the linkage among different industries, and this concentration has demonstrated a relatively significant regional spillover effect and backward linkage effect; third, the effect of scale economy was not significant, as it restricts the spatial concentration of industries and the spread of industries. Besides, the study of Yu Liangchun and Fu Qiang (2008), which is based on provincial panel data and aimed at studying the relationship between regional administrative monopoly and regional industrial convergence, was also inspiring. These abovementioned studies are not specifically aimed at studying the conflicts and harmony of industrial isomorphism and investment convergence in the Yangtze River Delta, but their analytical approaches and perspectives are very inspiring to our study on the industrial isomorphism and its impact mechanism.

Argumentation Based on Presumptions As can be seen in the literature review, government actions, regional resources, transportation, industrial structure, and historical factors have a major influence on regional industrial structure convergence. This is especially true after the decentralization reform and tax reform, as, after these reforms, the power balance between the central government and local government changed. Compared to the time prior to the reform, fiscal and tax authority is more centralized, but investment and financial authority, and the managerial authority of enterprises, is more decentralized. This, on one hand, weakened local governments’ fiscal income, but, on the other hand, gave them more freedom in terms of decision-making concerning economic issues. The former leads to long-term fiscal imbalance, which provides the incentives for local governments to secure their taxes. Local enterprises, which are a big source of tax income for local governments, therefore receive a great deal of local government protection. There are various forms of local protection. If protection is provided by establishing trade barriers, it often leads to industrial convergence. If local governments are able to make full use of the Tiebout mechanism1 in their direct investment, which is a form of exercising their economic autonomy (i.e. using local fiscal output expenditure mainly to improve local infrastructure and the development and use of human resources), local governments’ policies will very likely facilitate the differentiation of local industrial structures. Therefore, in order to reduce the negative effects of local protectionism to industrial

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The Industrial Structure of the Yangtze River Delta

isomorphism, measures are needed to guarantee the fiscal income of local governments, reduce the incentives of local governments to protect the local economy, and further develop the Tiebout mechanism in their decision making. These measures will have significant effects in avoiding repeated construction and overriding the effects of industrial isomorphism. According to the basic theories of neo-economic geography, the degree of similarity among industrial structures is decided by two basic forces, the centripetal force and the centrifugal force. The centripetal force at the enterprises’ level refers to the technology-based economy of scale as a result of big-scale production or the learning pattern effect. The centripetal force at the industrial level refers to the forward and backward linkages related to the concentration in the labor market, as well as the external location advantages such as information spillover. Centrifugal force refers to forces retarding the process of concentration, which are produced by stagnant production forces such as lands and natural resources, and external diseconomic factors like crowdedness, environment quality, and crime. Amiti’s 1999 study found that industries concentrated in the same region tended to use intermediate products, which therefore supported the theories of new trade theory and neo-economic geography. Theoretically, there are two types of determinants of the degree of similarity among industrial structures and the degree of concentration, which are the first natural factor and second natural factor. The first natural factor refers to material and natural resources endowments, and the second refers to the economic distances among economic entities (Krugman 1993; Overman, Redding and Venables 2000). Models based on different theories have different stresses on different factors. For example, the comparative advantage theory — Heckscher-Ohlin-Vanek models (HOV) stresses the effects of the second factor. The New Trade Theory (NTT) stresses the joint effect of the two factors. This is due to the argument of the NTT that geographical concentration is dependent on the cost of transportation, which implies that industries will scatter among different regions when transportation cost is high. Although there is a certain linkage between enterprises in the upstream and downstream, the local market still plays a dominant role. Under such circumstances, all regions tend to construct a self-reliant industrial structure. Only when the transportation cost goes under a certain level, will the force driving industrial concentration be greater than the incentives for such a self-reliant structure, in which case, industrial concentration will persist until a center-outskirt pattern is formed. When the transportation cost goes down further, the lowered transportation cost of intermediate products will reduce the effect of the investment-return linkage among enterprises. In this case, the differences in the costs of production factors

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

among regions will dictate the degree of similarity in industrial structures among these regions. The homogeny of resources endowment in the Yangtze River Delta is the very foundation of the industrial isomorphism based on briefly categorized statistical analyses. It is also the principal force shaping the overall trend of the development of industrial clusters in a bigger scope. Many scholars mistakenly believe that the isomorphism of the manufacturing industries of the Delta Region based on roughly categorized statistical analyses, are the biggest obstacle to the region’s industrial integration. However, if we use a statistical analysis based on three-digit or four-digit subcategories, the conclusion that there is a situation of industrial isomorphism is clearly false. Moreover, under an open international production system, the spatial layout of the region’s industries is an ultimate reflection of the spatial flow of international capital. Currently, the subcategorized industrial structure in the Delta Region is mostly harmonious, as there is a major difference among the industrial structures of the different areas of the region in which no conflict is observed. First, the corporate organization structure of the region has long been diversified by the joint force of foreign and private enterprises, and the monopoly of SOEs has long collapsed. Therefore, competition among enterprises is sufficient. Second, enterprises have sufficient freedom in terms of organization, management, and their spatial industrial layout. Although there might be some administrative interruptions for enterprises relocated to places other than their birth place, such interruptions are fairly weak. The labor division within the region’s enterprises and its industrial labor division structure is mainly shaped by the principle that specialized labor division will bring about higher efficiency and therefore more profits. Within the region, under the effects of the Tiebout mechanism, the production spatial layouts of both native and foreign enterprises have already reflected the comparative advantages of the internal industrial labor division of the Delta Region’s cities. Therefore, there is a slim possibility of internal repeated construction and cutthroat competition, and the labor division network within the region’s cities will continue to strengthen (Liu Zhibiao and Wu Fuxiang 2006). Although industrial isomorphism will theoretically lead to excessive competition due to repetitive construction, thanks to the relatively fast pace of SOE reform in the region, the region’s modern corporate system is sophisticated. The same products of different enterprises have been differentiated in the competition, leading to the improvement of product quality and the prosperity of the market. Therefore, the region’s industrial isomorphism will not only lead to the evolution of industrial clusters and the immense conflicts of interests, but will also lead to a competition among enterprises in the same industries both participated in

174

The Industrial Structure of the Yangtze River Delta

by foreign and private capital. The region embraces continuous innovations in investment structures. After lifting the veil of industrial isomorphism, we can not only appreciate the development and prosperity of the region, but can also gain the insight of a differentiated competition participated in by capital of various sorts. Therefore, to study the region’s industrial isomorphism, it is necessary to go beyond the statistical façade, and analyze the undercurrents and competitive relationship of the various sorts of capital. Studying the industrial isomorphism of the region from the perspective of the sources and structure of investment, is not only the logical starting point of this study, but also the key to reveal the truth about whether the region is experiencing a industrial convergence or divergence. From the above analyses, we develop the following propositions and presumptions: Proposition 1: Convergence of investment is an important cause of the industrial isomorphism of the Yangtze River Delta. Industrial isomorphism is related to the nature of investment, which is the origin of the conflicts and harmony of the region’s industrial structure. Proposition 2: Investment from SOEs will increase the degree of industrial isomorphism, while investment for construction and reconstruction under the Tiebout mechanism will lower the said degree. Proposition 3: The lowering of the degree of industrial isomorphism is due to export enterprises’ actively chosen differentiated positioning in the international labor division network under an open economy. The more diversified the export products from enterprises represented by enterprises jointed owned by foreign and private capital, the less isomorphic the industrial structure will be. Proposition 4: The transportation cost and trade barrier in the spatial economics, and historical factors such as lagged variables and initial conditions might have their influence on the degree of divergence in a region’s industrial structure, but their effects are indirect and related to the length of the time lag.

Statistical Analysis Samples In terms of choosing which industries are to be the samples, as this chapter is devoted to the study of industrial isomorphism and factors that affect it, the products of the sample industries must be tradable across regions. Because industries such as agriculture, service, mining, electricity, steam, hot water, gas and tap water supply, are all very reliant on resources and the distribution

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

of population, we choose the manufacturing industry as the subject of our statistical analysis, as it is less reliant on resources. In terms of the span of time covered by this study, due to the fact that China’s decentralization reform in administrative power was carried out during 1980 and 1994, that the power balance between the central government and local governments had not actually altered until the tax reform in 1994, and that the accelerated economic integration of the Delta Region had not begun until the early 21st century, this study will only cover the timespan from 2001 to 2007, so as to keep the timespan consistent with the sample industries. Therefore, the samples of this study will be the 27 manufacturing sub-industries of the Delta Region.2

Variables and data Dissimilarity of industrial structure (Dstruct) The measurement of this variable refers to the standard of Krugman (1991): Y in,t Y Y nm, t = — im,t ; n , and m = 1, 2, 3; n ≠ m . n and m represent location, Y n,t Y m,t which, in this chapter, mean Jiangsu, Shanghai, and Zhejiang. t represents time,

and i represents industry. Y nm,t represents the overall situation of industrial isomorphism between n and m during time t . In the calculation, all data is from the overall output of manufacturing enterprises above the sub-industrial scale in various areas of the Delta Region from 2000 to 2007.

Dissimilarity of foreign trade exports (Dexport) The variable can be measured by the degree of dissimilarity in products respectively exported to target countries and regions such as the U.S., Europe, and Japan from different sub-industries in the Delta Region from 2000 to 2007. Considering the fact that processing trade is a main characteristic of the export of the Delta Region, that foreign and private enterprises are important participants of the regional economy, and that products from these foreign and private companies are the major source of dissimilarity in the region’s exports, the variable will be the difference between the average yearly balances of the current assets and fixed assets of foreign and private enterprises in the region.

Dissimilarity of state-owned industrial investment (Dgov) This variable refers to the degree of activeness of governments’ participation in the market competition. Although it is very difficult for us to find out the

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The Industrial Structure of the Yangtze River Delta

distribution of government investment in the various manufacturing industries, we can use the differences in the average yearly net value of the fixed assets of SOEs and companies held by SOEs, as investment from such enterprises is to a large extent the reflection of government will.

Dissimilarity of construction transformation (Dtiebout) This variable is used to reflect the degree of market competition intensity in the region’s manufacturing sub-industries under the current price structure. Although there is no available data directly reflecting the degree of dissimilarity in the inter-regional competition of these sub-industries, we can still use the degree of dissimilarity of the investment for renewal and reconstruction that are under the category of construction in the statistical yearbook of these regions instead. Such investment to a large degree reflects the Tiebout mechanism, which denotes the intensity of market competition.

Initial or lag variation This indicator is not limited to a specific variable. Instead, it will be the first order difference or second order difference of related variables according to the needs of calculation. It reflects the lag effect of investment. It should also be noted that, as these variables are all represented by the share-shift of the figures of different industries in different years, the calculation of these variables is similar to the calculation of industrial structural isomorphism. We use the share-shift method to respectively calculate the timepoint average value, first order difference, antd second order difference of these variables. All data used in the statistic and quantitative analyses is from the 2000–2007 Statistic Yearbook and Foreign Trade Yearbook of Jiangsu, Shanghai, and Zhejiang.

Statistical description First, we calculate the share-shift in the 27 manufacturing industries’ outputs in the Delta Region according to the shares of the 27 manufacturing industries’ outputs between 2000 and 2006 (see Appendix Table 6a.1–6a.3). Furthermore, Y in,t Y — im,t , we can obtain the timewith the function Y nm,t = average Y n,t Y m,t point levels and averages, and the averages of first order difference and second order difference of the degree of share-shift of the manufacturing sub-industries’ outputs in Zhejiang, Jiangsu, and Shanghai from 2000 to 2006 (Table 6.1).

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Table 6.1

The share-shift degrees of the 27 sub-industries’ output in the Yangtze River Delta Average at different time points and average difference

Level at fixed time point

Industry 2000

2001

2002

2003

2004

2005

2006

Time point

First order

Second order

Food processing

0.981

0.959

0.967

0.885

0.884

0.851

0.912

0.882

0.014

0.094

Food production

0.732

0.902

1.114

0.905

0.920

1.032

1.068

1.007

0.074

–0.075

Beverage production 0.908

0.777

0.748

0.871

0.339

0.365

0.399

0.368

0.030

0.008

Textile

1.199

1.272

1.327

1.394

1.478

1.460

1.504

1.480

0.013

0.062

Clothing

0.661

0.711

0.688

0.921

0.575

0.653

0.638

0.622

0.031

–0.092

Leather products

1.818

2.129

2.137

1.956

2.014

2.341

2.328

2.228

0.157

–0.339

Wood processing

0.450

0.189

0.021

0.333

0.760

0.901

0.914

0.858

0.077

–0.129

Furniture production 0.648

0.663

0.744

0.836

1.281

1.184

1.242

1.235

–0.020

0.154

Paper production

0.831

0.883

0.882

0.942

1.015

0.912

0.922

0.950

–0.047

0.113

Printing

0.854

0.906

0.836

0.828

0.810

0.916

0.953

0.893

0.071

–0.070

Education and sport

0.410

0.441

0.402

0.383

0.468

0.484

0.471

0.474

0.002

–0.029

Petroleum

0.490

0.909

1.160

1.219

1.134

1.041

1.015

1.063

–0.060

0.068

Chemical

0.681

0.663

0.694

0.756

0.636

0.648

0.566

0.617

–0.035

–0.094

Medicine production 0.437

0.399

0.294

0.358

0.203

0.440

0.443

0.362

0.120

–0.234

Chemical fiber

0.389

1.225

1.270

1.434

1.547

1.739

1.781

1.689

0.117

–0.149

Rubber

0.318

0.095

0.075

0.142

0.365

0.292

0.242

0.300

–0.061

0.024

Plastics

0.499

0.504

0.553

0.780

0.937

0.957

0.981

0.958

0.022

0.004

Non-metal minerals

0.602

0.457

0.450

0.406

0.413

0.247

0.266

0.309

–0.074

0.185

Ferrous metal

1.521

1.500

1.302

1.257

1.089

1.177

1.127

1.131

0.019

–0.137

Non-ferrous metal

0.460

0.584

0.553

0.657

0.727

0.722

0.661

0.703

–0.033

–0.056

Metal products

0.250

0.102

0.152

0.217

0.173

0.086

0.108

0.122

–0.033

0.109

General equipment

0.241

0.245

0.142

0.039

0.198

0.309

0.314

0.274

0.058

–0.104

Special equipment

0.356

0.315

0.220

0.288

0.182

0.152

0.159

0.164

–0.012

0.037

Transportation

1.252

1.306

1.387

1.455

1.298

0.818

0.991

1.035

–0.154

0.654

Electronics and machinery

0.290

0.274

0.402

0.523

0.404

0.337

0.249

0.330

–0.078

–0.023

Telecommunication equipment

0.969

1.057

1.055

1.194

1.290

1.333

1.191

1.271

–0.049

–0.186

Instruments

0.286

0.310

0.627

0.382

0.479

0.331

0.113

0.308

–0.183

–0.070

Sources: Jiangsu Statistic Yearbook , Shanghai Statistic Yearbook and Zhejiang Statistic Yearbook 2001–2007.

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As shown in Table 6.1, the share-shift degrees of the 27 manufacturing industries in the Delta Region are relatively high. The textile, leather products, chemical fiber, ferrous metal, transportation, telecommunications equipment, and some other industries demonstrated significant differences. If we combine the 27 sub-industries into a few bigger categories, we will have Table 6.2. The share-shift degrees of Table 6.2 are relatively even. It seems that after loosening the statistical standard, industrial isomorphism intensifies. Table 6.2

Average share-shift degrees of the industrial output of several categories of similar industries Average at different time points and average difference

Level at fixed time point

Industry 2000

2001

2002

2003

2004

2005

2006

Time point

Food and beverage

0.874

0.879

0.943

0.887

0.714

0.749

0.793

0.752

0.039

0.009

Textile and leather

1.226

1.371

1.384

1.424

1.356

1.485

1.490

1.443

0.067

–0.123

Wood and printing

0.639

0.616

0.577

0.664

0.867

0.879

0.900

0.882

0.017

0.008

0.499

0.799

0.855

0.942

0.880

0.967

0.951

0.933

0.036

–0.102

Rubber and 0.409 plastics

0.300

0.314

0.461

0.651

0.625

0.612

0.629

–0.020

0.014

Mining

0.708

0.661

0.614

0.634

0.601

0.558

0.541

0.566

–0.030

0.025

Equipment

0.566

0.585

0.639

0.647

0.642

0.547

0.503

0.564

–0.070

0.051

Petrol, chemicals and medicine

First order

Second order

Source: Based on the data of Table 6.1.

Fig. 6.1 is the trend lines of six industries that demonstrate relatively big share-shift degrees. Many of these industries are key industries under intense development. We can see from them that there is no so-called industrial isomorphism in the Delta Region. Instead, the region’s labor division is in fact deepening, despite the similarity of resource endowments in the different areas of the region. Most cities view industries such as electronics, automobiles, machinery, chemical, and medicine industry as the key industries in the future. If we look at it from the perspective of labor division, we will find that the industrial structures of different areas are very similar, if not identical. Therefore, competition among these areas is a natural consequence, which we believe is a normal phenomenon in a market economy.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

The above results illustrate Li Qingjuan’s conclusion (2006) that the only reason many studies in the past held that there was a serious situation of industrial isomorphism in the Yangtze River Delta, was the loose statistical standards adopted in these studies, which failed to reflect the true degree of industrial isomorphism in the region. If we further categorize the region’s industries, we will find more distinctive dissimilarities among these sub-divided industries. For example, according to our calculation (see Appendix Table 6a.1– 6a.3), in terms of the differences among the leading industries of the three major areas of the Delta Region, from 2000 to 2006, the top three industries of Jiangsu were telecommunications equipment, textiles, and chemical industry, which accounted for 35% of its total manufacturing industry; the top three industries in Shanghai were telecommunications equipment, transportation, and ferrous metal industry, accounting for around 30% of the total manufacturing industry; the top three industries in Zhejiang were textiles, electronics, and general equipment industry, accounting for 30% of the total manufacturing industry. As we can see, although the three areas had a similar choice of key industries, there are distinctive differences on the industrial structural level, demonstrating a certain degree of dissimilarity, and complementariness among the industrial structures of the three areas. Table 6.3 illustrates this conclusion. Fig. 6.1

The trend lines of the six manufacturing industries that have relatively big share-shift degrees in industrial outputs of the Yangtze River Delta 2.5

Share-shift degree

2.0 1.5 1.0 0.5 0

2000

2001

2002

2004

2005

2006

Textile industry

Leather product

Chemical fiber

Ferrous metal

Transportation

Telecommunications equipment

Sources: Based on the data in Table 6.1.

180

2003

The Industrial Structure of the Yangtze River Delta

Table 6.3

Order

The average proportion of the top eight sub-sectors of the manufacturing industry in the gross industrial output value in each area (2000–2006) Jiangsu (65.65%) Industry

%

Shanghai (70.19%) Industry

Zhejiang(57.55%)

%

Industry

% 14.41

1

Telecommunications 13.86 equipment

Telecommunications 18.67 equipment

Textile industry

2

Textile industry

10.96

Transportation

12.79

Electronics

9.03

3

Chemical

10.18

Ferrous metal

8.78

General equipment

7.26

4

Ferrous metal

7.41

General equipment

7.07

Chemical

6.01

5

Electronics

7.11

Electronics

6.89

Transportation

5.78

6

General equipment

6.85

Chemical

6.75

Clothing

5.61

7

Transportation

5.14

Petrol

5.01

Telecommunications equipment

5.15

8

Metal product

4.14

Metal product

4.23

Leather product

4.3

Sources: Calculated based on the data of Jiangsu Statistic Yearbook , Shanghai Statistic Yearbook, and Zhejiang Statistic Yearbook 2001–2007. Please refer to Appendix Table 6a.1–6a.3.

The above statistical results show a clear division of labor of the manufacturing industry in the Yangtze River Delta. But what is more important is what factors lead to such a division — whether the government or the market played the leading role. Table 6.4 displays the data about the foreign trade exports, SOEs, and construction transformation investment. Table 6.4

The averages of the share-shift degrees of the 27 manufacturing industries in Jiangsu, Shanghai, and Zhejiang Provinces Foreign trade exports

Industry

SOEs investment

Time First point order

Second order

Time point

Food processing

1.475 –0.020

0.168

2.302

Food production

1.252 –0.033

–0.075

Second order

Time point

First order

Second order

0.806

–0.622

1.443

–0.297

0.009

1.369

–0.180

1.884

0.401

0.215

–0.794

0.227

–0.046

2.718

–0.314

1.082

1.544

0.040

–0.017

Textiles

1.996 –0.093

0.212

0.846

–0.277

0.796

1.719

–0.091

0.174

Clothing

0.983

0.165

–0.246

1.040

0.052

0.875

1.351

–0.221

0.375

Leather products

1.935

0.268

–0.171

1.358

0.707

–1.485

2.415

–0.643

1.017

Wood processing

0.970 –0.124

0.282

3.131

–0.188

–0.263

1.037

0.005

1.240

Beverage production 2.658

First order

Construction transformation investment

181

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Foreign trade exports Industry

SOEs investment

Time First point order

Second order

Time point

Furniture production

1.364 –0.195

0.652

2.000

Paper production

1.909 –0.093

0.174

Printing

1.266 –0.274

First order

Construction transformation investment

Second order

Time point

First order

Second order

0.525

–0.867

1.972

–0.130

1.083

1.759

–0.173

–1.572

1.128

0.032

–0.350

0.954

2.819

0.034

–0.827

0.500

0.142

–0.123

Education and sport 0.996 –0.160

–0.038

1.893

–0.414

–0.028

1.550

–0.084

–0.284

Petroleum

1.189

0.242

–0.331

2.269

0.374

–0.624

0.863

–0.472

1.204

Chemical

1.153

0.008

–0.035

0.759

0.140

0.244

0.712

–0.552

0.480

Medicine production

1.017 –0.132

–0.134

0.971

0.376

–0.288

0.578

0.257

0.181

Chemical fiber

1.991 –0.198

0.364

2.147

–0.517

1.482

1.512

0.140

0.571

Rubber

0.893 –0.132

0.310

2.360

0.669

0.022

0.898

–0.209

1.385

Plastics

0.943 –0.060

0.077

1.428

–0.022

–1.928

1.029

–0.020

–0.313

Non-metal minerals 1.264 –0.199

0.213

0.724

–0.192

–0.307

1.265

–0.157

0.363

Ferrous metal

0.408

0.054

–0.192

1.256

–0.196

0.231

1.618

0.566

0.182

Non-ferrous metal

0.609

0.025

–0.448

1.475

0.036

1.170

0.953

–0.746

1.481

Metal products

0.284 –0.164

–0.126

2.010

–0.860

0.548

0.784

–0.509

0.436

General equipment

0.476 –0.222

0.322

0.599

–0.344

–0.136

0.585

–0.428

0.263

Special equipment

0.753 –0.110

0.236

1.209

0.002

0.146

0.584

–0.314

0.693

Transportation

0.318 –0.104

0.202

1.135

0.019

–0.586

0.934

0.115

–1.375

Electronics and machinery

0.137 –0.018

–0.203

1.876

0.546

0.188

0.749

–0.357

0.465

0.016

0.018

1.638

0.110

–0.571

1.442

–0.074

0.337

0.743 –0.282

–0.282

1.163

0.300

–0.673

0.951

0.134

–0.487

Telecommunications 1.383 equipment Instruments

Sources: Calculated based on the data of Jiangsu Statistic Yearbook , Shanghai Statistic Yearbook, and Zhejiang Statistic Yearbook 2001–2007.

Table 6.4 shows that, in the past few years, both the shares and the directions of changes of the share-shift degrees of the capital and investments of different sorts in the Delta Region showed significant dissimilarity. Such dissimilarity can be seen in its average level, first order difference, and second order difference. Table 6.5 shows the result of a combination of the industries in Table 6.4.

182

The Industrial Structure of the Yangtze River Delta

Table 6.6 shows the statistical depiction of the averages and differences of the share-shift degrees of the aforementioned variables seen in the above tables. Although the two tables show very intuitive results, we will still need further quantitative measures to examine the effects of different capital and investment behaviors on the industrial isomorphism of the Delta Region. Table 6.5

The averages of the share-shift degrees of the different capital and investments in similar industries Foreign trade exports

Industry

Time point

First order

Reconstruction transformation investment

SOEs investment

Second order

Time point

First order

Second order

Time point

First order

Second order

Food and beverage

1.795

0.058

0.016

2.130

0.104

0.781

1.129

–0.014

–0.267

Textiles and leather

1.638

0.113

–0.068

1.081

0.161

0.062

1.828

–0.318

0.522

Wood and printing

1.301

–0.169

0.405

2.320

–0.043

–0.711

1.237

–0.007

0.313

Chemicals, 1.338 petroleum, and medicine

–0.020

–0.034

1.537

0.093

0.204

0.916

–0.157

0.609

Rubber and plastics

0.918

–0.096

0.194

1.894

0.324

–0.953

0.964

–0.115

0.536

Mining

0.641

–0.071

–0.138

1.366

–0.303

0.411

1.155

–0.212

0.616

Equipment

0.634

–0.120

0.012

1.270

0.106

–0.272

0.874

–0.154

–0.017

Source: Calculated based on Table 6.4.

Table 6.6

The statistical depiction of the share-shift degrees of the variables of the 27 manufacturing industries in the Delta Region Industrial isomorphism

Average values

Foreign trade exports

SOEs investment

Second Time order point

Reconstruction transformation investment

Time First Second Time point order order point

First order

First Second Time First order order point order

Second order

0.801 –0.001 –0.01

1.124

–0.060

0.06

1.639

0.038 –0.08

1.130 –0.135

0.30

Standard 0.098 error

0.015 0.03

0.116

0.029

0.06

0.131

0.077

0.18

0.084

0.059

0.13

Variance

0.006 0.03

0.362

0.023

0.10

0.460

0.161

0.85

0.239

0.093

0.46

Minimum 0.122 –0.183 –0.34 value

0.137

–0.282 –0.50

0.599

Maximum 2.228 value

2.658

0.258

0.157 0.65

0.268

0.95

3.131

–0.086 –1.93 0.806

1.88

0.401 –0.746 –1.38 2.415

0.566

1.48

Sources: Calculated based on Table 6.1 and Table 6.4.

183

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Quantitative Study Model settings Based on the previous propositions and statistical analysis, we will build a quantitative mode of the influencing factors of the industrial isomorphism of the Yangtze River Delta. The mode will first include the data of static time point and that of the averages, and second consider the lag effect of different investments, it will introduce the first-order and second-order differences of each variable.

Dstruct = β0 + β1 Dexport + β2 Dgov + β3 Dtiebout + γi χi + μit In the mode, Dstruct, Dexport, Dgov , and Dtiebout represent, respectively, dissimilarity of industrial structure, dissimilarity of foreign trade exports, dissimilarity of state-owned industrial investment, and dissimilarity of construction transformation investment. χi is the controlled variable, and is the first-order or second-order difference of Dexport, Dgov , and Dtiebout . μi is the initial or lag variable.

Quantitative test Table 6.7 shows the results of the quantitative test of the degrees of industrial structural differences of the Yangtze River Delta. During the test, we choose the variables of seven years, i.e. from 2000 to 2006. Moreover, in order to avoid multicollinearity, and considering the specialness and data difference of the tobacco and petrol industries, we overlook the two industries, leaving 26 industries or 182 samples for our test. Table 6.7

Dependent variable Constan

Dexport Dtiebout

184

Quantitative test for the influence factors of the industrial isomorphism of the Yangtze River Delta Independent variable: Dstruct (1) 0.106

(2) 0.147

(3) 0.038

(4) 0.076

(5) 0.082

(6) 0.180

(7) 0.188

(8) 0.155

(0.91)

(1.00)

(0.30)

(0.61)

(0.70)

(1.19)

(1.28)

(1.04)

(2.88)

(2.89)

(2.64)

(2.58)

(3.10)

(2.92)

(3.06)

(3.19)

(3.98)

(3.92)

(4.12)

(4.02)

(4.16)

(3.87)

(3.97)

(4.08)

0.243*** 0.361***

0.252*** 0.358***

0.225*** 0.376***

0.228*** 0.263***

0.255***

0.369*** 0.376*** 0.355***

0.265*** 0.359***

0.278*** 0.371***

The Industrial Structure of the Yangtze River Delta

(Cont'd) Dependent variable

Dgov ΔDgov Δ2Dgov

R2 Adj. R

2

D-W value

F statistics

Independent variable: Dstruct (1)

(2)

(3)

(4)

(5)

—

–0.029

—

—

—

—

(–0.46)

—

—

— —

—

— —

—

—

—

(1.23)

—

0.161 —

—

—

0.083

(6) –0.050

(7) –0.062

(8) –0.052

—

(–0.75)

(–0.94)

(–0.79)

(–1.29)

(0.92)

—

(–1.18)

–0.261 0.327*

(0.66)

(1.74)

0.081 —

—

—

0.128*

–0.240 0.329*

(1.69)

(1.75)

0.358

0.360

0.371

0.362

0.388

0.367

0.381

0.393

0.341

0.334

0.346

0.336

0.354

0.333

0.347

0.351

2.170

2.124

2.188

20.927

2.143

13.877

2.245

14.550

2.205

13.995

2.188

11.564

2.167

10.598

11.249

9.327

Notes: 1. Data used is from 2001–2007 Jiangsu Statistic Yearbook, Shanghai Statistic Yearbook , Zhejiang Statistic Yearbook and Foreign Trade Yearbook . 2. ***, **, and * respectively represent the significance on the level of 1%, 5%, and 10%. 3. Inside the brackets are the values of t .

First, we treat the Dstruct as the dependent variable, and respectively introduce Dexport , Dgov , and Dtiebout as the sole independent variable. The regression result shows that Dexport and Ditebout make a better explanation for the Dstruct , while Dgov did not pass the test. Second, we introduced two independent variables from Dexport , Dtiebout , and Dgov into the model. And the result shows that, Dexport and Dtiebout both passed the test, while Dgov did not. Third, we introduced all three of Dexport , Dtiebout, and Dgov into the model, and find that the first two passed the test, while Dgov did not. Fourth, we introduce the first order difference and second order difference of all variables into the model, and find that the result of the quantitative test of the first and second order differences of other variables are not significant. Dgov stands out from the rest as its first and second order lags, when introduced into the model as the sole variable, did not pass the test. Fifth, we respectively introduce Dgov , its first and second order difference, Dexport , its first and second order difference, and Dtiebout , and its first and second order difference into the model. We find that the second order difference of Dgov passed the test on the condition that Dgov is introduced. Therefore, although Dgov has an insignificant effect on industrial isomorphism, its second order lag has a certain degree of effect on industrial isomorphism.

185

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Analysis on the results The above tests show that the industrial isomorphism of the Yangtze River Delta is mainly under the influences of three factors. The first factor is Dexport . The distribution of the region’s industry is to a large extent driven by the processing trade of foreign and private enterprises under an open economy. Foreign and private enterprises are not only important participants in the economic activities of the region. The export and import of their products are also important sources of dissimilarity in the exported products of the region. Therefore, Dexport becomes an important source of the region’s industrial isomorphism. The second factor is Dgov . Although this variable reflects government will in investment, it also denotes the degree of government participation in the market. However, the quantitative test shows that the stagnant time point level of Dgov has an insignificant effect on the region’s industrial isomorphism. Instead, its second order lag has a certain degree of effect on industrial isomorphism. The third factor is Dtiebout. The variable, to a large extent, reflects the Tiebout mechanism and the degree of market competition intensity of the manufacturing industries under the current price structure in the region. The variable can not only reflect the distribution of government expenditure in different industries, but also the degree to which the various economic entities, including private economy, agree with such distribution of government expenditure.

Conclusion This chapter uses 27 manufacturing industries as the samples, and conducts a statistical analysis on the share-shift degree of the industrial outputs of various manufacturing enterprises above a certain scale. The result shows that, since 2000, there has been no industrial isomorphism observed as commonly believed in the Yangtze River Delta. Instead, the industrial structures of the Zhejiang and Jiangsu provinces and Shanghai are dissimilar and complementary to each other. Such dissimilarity originated from the differentiated positions the three areas have actively chosen in the international labor division network under an open economy. This chapter also proposes the hypothesis that there is a certain level of relationship between investment convergence and industrial isomorphism, and also conducts a quantitative test on this aspect. The test result not only finds out the micro-level mechanism of the intensifying integration and declining industrial isomorphism of the region, but also provides us with reliable empirical evidence. This chapter holds that investment convergence is the

186

The Industrial Structure of the Yangtze River Delta

fundamental cause of industrial isomorphism in the Delta Region. Industrial isomorphism is related to the nature of investment, and this is the origin of the harmony and conflicts in the industrial structures of the region. Important findings of this chapter are: first, the increasing convergence in the distribution of SOEs’ investment in industry has a limited effect on industrial isomorphism, but its lag effect is much more significant. Second, infrastructure construction and reconstruction investment under the Tiebout mechanism, as well as the investment and export of foreign and private companies, will effectively reduce the degree of industrial isomorphism. The bigger the dissimilarity of the exported products from such companies, the lower the degree of the isomorphism. The implication of this chapter on policy making is that, in order to further implement the spirits of the State Council’s circular, the manufacturing industry of the Yangtze River Delta needs to further differentiate their positions. For instance, Shanghai can continue developing its telecommunications equipment and transportation industries; Jiangsu can continue developing its telecommunications equipment and textile industries; Zhejiang can continue developing its textile and electronics industries. For sure, the Delta Region still needs to continue the coordinated development of fundamental industries, joint development of emerging industries, and complementary development of pillar industries.

187

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Appendix Table 6a.1

Industrial output share of 27 manufacturing industries between 2000–2006 of Jiangsu province (%)

Industry

Average value of time point and difference

Static time-point level 2000

2001

2002

2003

2004

2005

2006

Food processing 3.72

3.64

3.55

2.89

2.62

2.32

2.20

Beverage manufacturing

1.33

1.31

1.25

1.00

0.85

0.77

0.73

Textile industry 12.65 Clothing, shoes, and hats

4.29

12.29

11.86

10.73 9.80

9.94

9.46

Wood processing

0.91

Food manufacturing

1.06

1.04

4.67

0.95

4.35

0.89

0.75

3.62

3.09

0.64

3.45

0.56

3.66

Time- First Second point order order 2.99

–0.25 –0.01

1.04

–0.10 –0.04

0.84

–0.08 –0.06

10.96 –0.53 –0.06 3.88

–0.10 –0.71

Leatherwear

1.30

1.31

1.31

1.48

1.26

0.81

0.76

1.18

–0.09 –0.01

Cabinet making

0.31

0.33

0.32

0.30

0.29

0.31

0.31

0.31

1.77

0.00 –0.03

–0.08 –0.06

Printing industry

0.56

0.46

0.47

0.45

0.40

0.36

0.33

0.43

–0.04

0.11

0.96

0.98

1.01

0.87

0.77

0.75

0.71

0.86

–0.04

0.00

Petroleum and coking

2.55

2.42

1.79

1.97

1.91

2.03

1.99

2.10

–0.09 –0.49

10.68

10.30

10.47

9.74

9.55

Medical manufacturing

1.62

1.66

1.84

1.80

1.59

1.53

1.35

1.63

–0.04

0.15

Chemical fiber Rubber products

2.97

0.88

2.64

2.56

2.59

2.62

2.58

2.58

2.65

–0.06

0.26

Plastic products

2.83

2.72

2.73

2.51

2.28

2.16

2.09

2.47

–0.12

0.13

Ferrous metal

4.73

5.25

5.77

7.25

9.08

9.96

9.83

7.41

0.85

0.00

Metal work

4.09

4.10

4.15

4.46

4.45

3.77

3.94

4.14

–0.03

0.04

Paper-making industry

Education and sports

Chemical products

Non-gold mineral

Non-ferrous metal

188

1.93

4.02

2.32

0.96

2.03

0.93

4.07

2.25

0.98

2.06

0.88

3.80

2.13

0.85

1.77

0.86

3.01

2.21

0.71

1.55

0.80

2.93

2.43

0.95

1.56

1.04

1.48

10.33 10.19

0.85

2.73

2.74

0.90

2.63

3.63

0.91

0.02 –0.02

10.18 –0.08

0.87

3.31

2.53

0.55

0.00 –0.10

–0.23 –0.32

0.22 –0.05

The Industrial Structure of the Yangtze River Delta

(Cont'd)

Industry

Average value of time point and difference

Static time-point level 2000

2001

2002

2003

2004

2005

2006

General equipment

7.09

7.14

7.31

6.92

6.74

6.35

6.41

Special equipment

3.69

3.71

3.48

3.12

2.87

2.83

Transportation Electric apparatus

5.20

7.26

5.25

5.77

5.73

4.90

4.61

Carriage 9.67 communication installation

9.74

Instrument and 1.36 apparatus

7.57

1.25

Time- First Second point order order 6.85

–0.11

2.90

3.23

–0.13 –0.24

4.55

5.14

–0.11

0.46

10.93 15.22 17.64 17.32 16.50

13.86

1.14

1.11

7.15

1.12

6.55

1.23

6.78

1.33

6.87

1.50

7.61

1.66

7.11

1.35

0.14

0.06 –0.73

0.05 –0.03

Sources: Calculated in accordance with Jiangsu Statistical Yearbook , Shanghai Statistical Yearbook , and Zhejiang Statistical Yearbook of 2001–2007.

Table 6a.2 Industrial output share of 27 manufacturing industries between 2000–2006 of Shanghai (%) Industry

Average value of time point and difference

Static time-point level 2000

2001

2002

2003

2004

2005

2006

Timepoint

Food processing 1.36

1.31

1.29

1.15

1.09

1.01

0.87

1.15

–0.08

–0.02

Food manufacturing

1.90

1.96

2.09

1.73

1.51

1.47

1.36

1.72

–0.09

–0.04

Beverage manufacturing

1.05

1.06

0.98

0.82

0.80

0.71

0.67

0.87

–0.06

–0.01

Textile industry

4.15

3.73

3.38

2.85

2.34

2.39

2.05

2.99

–0.35

0.02

Clothing Shoes and hats

3.91

3.75

3.76

2.84

2.53

2.39

2.32

3.07

–0.26

0.02

Leatherwear

0.94

0.84

0.91

0.91

0.78

0.74

0.68

0.83

–0.04

0.01

Wood processing 1.35

1.15

0.97

0.73

0.57

0.45

0.44

0.81

–0.15

0.04

Cabinet making

0.48

0.53

0.55

0.52

0.58

0.95

1.00

0.66

0.09

0.00

Paper-making industry

1.18

1.12

1.10

0.92

0.84

0.92

0.90

1.00

–0.05

0.01

Printing industry 1.13

1.18

1.13

0.95

0.85

0.88

0.80

0.99

–0.06

–0.03

Education and sports

1.40

1.40

1.09

1.07

1.02

0.87

1.17

–0.08

–0.04

1.36

First Second order order

189

DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd)

Industry

Average value of time point and difference

Static time-point level

Timepoint

First Second order order 0.33

–0.46

7.62

6.75

0.09

0.16

1.46

1.35

1.75

–0.13

–0.01

0.57

0.33

0.28

1.01

–0.59

0.59

2.10

2.40

2.28

2.42

–0.05

–0.04

2000

2001

2002

2003

2004

2005

2006

Petroleum and coking

3.27

5.26

5.01

5.31

5.39

5.58

5.26

Chemical products

7.09

6.87

6.81

5.83

5.98

7.06

Medical manufacturing

2.12

2.05

1.98

1.78

1.50

Chemical fiber

Rubber products

3.81

0.78

0.72

0.60

Plastic products

1.09

2.59

2.68

2.73

2.20

Non-gold mineral

2.30

0.87

2.60

0.92

2.48

0.95

2.29

0.95

2.25

0.97

2.40

0.89

2.24

5.01

0.95

2.37

–0.03

–0.01

0.03

–0.09

Ferrous metal

9.56

9.94

7.84

8.13

8.66

9.03

8.27

8.78

–0.21

–0.23

Metal work

5.02

4.50

4.67

3.67

3.90

3.99

3.83

4.23

–0.20

0.07

Special equipment

2.77

2.88

2.85

2.47

2.55

2.66

2.62

2.69

–0.03

–0.03

Non-ferrous metal General equipment

1.57

5.61

1.44

5.75

1.40

6.38

1.37

7.16

1.60

7.54

1.73

8.29

2.38

8.75

1.64

7.07

0.13

0.52

0.16

0.07

Transportation

12.44 13.06 14.94 16.12 12.74

9.39 10.84

12.79

–0.27

0.16

Carriage communication installation

12.81 14.47 15.29 19.69 22.87 23.15 22.42

18.67

1.60

–0.48

1.73

0.00

0.00

Electric apparatus

Instrument and apparatus

7.41

1.72

7.28

1.55

6.77

1.65

6.12

1.78

6.62

1.81

6.75

1.89

7.30

1.72

6.89

–0.02

0.14

Sources: Calculated in accordance with Jiangsu Statistical Yearbook , Shanghai Statistical Yearbook , and Zhejiang Statistical Yearbook of 2001–2007.

Table 6a.3 Industrial output share of 27 manufacturing industries between 2000–2006 of Zhejiang Province (%) Industry

2000 2001 2002 2003 2004 2005 2006

Food processing 2.91 Food 1.21 manufacturing

190

Average value of time point and difference

Static time-point level

2.61 1.06

2.35 0.99

2.17 0.95

2.13 0.84

1.96 0.81

1.74 0.74

Timepoint

2.27 0.94

First order

–0.19 –0.08

Second order 0.01 0.02

The Industrial Structure of the Yangtze River Delta

(Cont'd)

Industry Beverage manufacturing Textile industry Clothing, shoes, and hats Leatherwear Wood processing Cabinet making Paper-making industry Printing Industry Education and sports Petroleum and coking Chemical products Medical manufacturing Chemical fiber Rubber products Plastic products Non-gold mineral Ferrous metal Non-ferrous metal Metal work General equipment Special equipment Transportation Electric apparatus Carriage communication installation Instrument and apparatus

Average value of time point and difference

Static time-point level 2000 2001 2002 2003 2004 2005 2006 2.24

2.05

1.88

1.67

1.05

0.96

Timepoint

First order

Second order

0.93

1.54

–0.22

0.03

14.31 14.74 14.90 14.63 14.78 14.23 13.30 6.53 6.94 6.58 6.13 4.23 4.63 4.24

14.41 5.61

–0.17 –0.38

–0.27 –0.16

3.93 1.04 0.57 2.78

4.74 1.04 0.63 2.85

4.93 0.97 0.67 2.74

4.61 1.00 0.72 2.54

4.11 1.09 1.04 2.41

4.04 1.04 1.01 2.34

3.73 0.95 1.11 2.26

4.30 1.02 0.82 2.56

–0.03 –0.02 0.09 –0.09

–0.22 –0.02 0.01 –0.03

0.69 1.30

0.79 1.40

0.83 1.38

0.90 1.27

0.77 1.17

0.76 1.20

0.75 1.11

0.79 1.26

0.01 –0.03

–0.02 –0.04

4.13

3.17

2.71

2.62

3.01

3.40

3.21

3.18

–0.15

0.16

6.13

6.04

6.03

5.63

6.21

6.01

6.01

6.01

–0.02

0.02

2.49

2.47

2.36

2.32

1.79

2.05

1.86

2.19

–0.10

–0.04

2.79 1.16 3.87 3.55

2.66 0.94 3.86 3.44

2.65 0.94 4.04 3.32

3.12 0.96 4.07 3.32

4.37 1.14 4.21 3.34

4.67 1.12 4.42 3.07

4.75 1.07 4.31 2.89

3.57 1.05 4.11 3.28

0.33 –0.01 0.07 –0.11

0.04 0.03 –0.02 –0.01

2.00 2.24

1.86 2.40

1.79 2.27

2.17 2.55

3.17 3.36

3.02 3.64

3.08 4.65

2.44 3.01

0.18 0.40

0.04 0.17

4.27 6.44

4.36 6.76

4.65 6.79

4.23 7.09

3.94 8.15

4.07 7.89

4.21 7.66

4.25 7.26

–0.01 0.20

0.01 –0.11

2.94

3.02

3.28

3.06

2.48

2.44

2.54

2.82

–0.07

0.00

5.31 9.06

5.39 9.07

5.75 9.29

6.15 9.19

5.54 8.96

6.00 8.69

6.35 8.93

5.78 9.03

0.17 –0.02

0.06 0.05

4.67

4.52

4.90

5.42

5.44

5.06

6.06

5.15

0.23

0.23

1.43

1.22

1.00

1.48

1.24

1.47

1.55

1.34

0.02

0.06

Sources: Calculated in accordance with Jiangsu Statistical Yearbook , Shanghai Statistical Yearbook , and Zhejiang Statistical Yearbook of 2001–2007.

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7

Chapter

Import for Export

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Since the start of the reform and opening up era, China’s export volume has seen rapid growth. In 1980, the annual export volume was USD18.12 billion. By 2007, the number had grown to USD1.218 trillion, 67 times the figure in 1980. In the intervening 27 years, China kept a yearly growth rate of 16.9%, making it the fastest growing country in the world in terms of exports. China has become one of the biggest exporters in the world, accounting for 8% of the world’s total export volume, as compared to 0.89% in 1980. China now ranks the third biggest exporter in the world, behind Germany and the U.S. The rapidity of the growth makes it appropriate to call the growth an export miracle. But how was this miracle produced? This will be the chapter’s topic. The Yangtze River Delta is China’s manufacturing powerhouse and a main force in the country’s export industry. Export growth in the region is a factor that has led to this miracle. Therefore, in order to reveal the truth of this miracle, study on the growth in exports in the Delta Region is a necessary step. The export growth of the region is essentially the growth of the export-oriented enterprises in the region. On the micro level, the continuous emergence of such big export enterprises and their rapid growth is the foundation for the region’s export growth, which in turn contributes to the export growth of China as a whole. However, what force did these big export enterprises rely on to support the growth of themselves? The big exporters in the Delta Region are more often than not, big importers as well. More specifically, they are big importers of equipment. This phenomenon is common among many export enterprises. Yet why do they need to import such a large amount of equipment? This is because the region’s export-oriented enterprises need to improve their product quality to meet the requirements of the international market. More specifically, their product quality must meet the standards of foreign consumers and regulations set by foreign governments. As domestic equipment suppliers are basically incapable of producing sophisticated and qualified equipment, these export enterprises have to import this equipment in order to secure their exports. Therefore, the fact that big exporters in the Delta Region are often big importers is an inevitable result of these enterprises’ export orientation and the underdevelopment of the domestic equipment manufacturing industry. Of course, such exports can be seen as import-stimulating exports; when the domestic equipment manufacturing industry is still underdeveloped, China’s exporters import sophisticated foreign equipment to improve their product quality, production efficiency and production capacity, so as to increase their export volumes.

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Such import of equipment bolsters up China’s rapid export growth, but also brings some problems. Imported foreign equipment squeezed the market space of domestic equipment suppliers, putting the latter in an awkward position where they have to catch up with foreign competitors not only in technological sophistication but also in market share. Moreover, insufficient market share will weaken their ability to catch up technologically and, at the same time, their underdeveloped technology also weakens their ability to increase their market share, especially in the high-end market (Chen Aizhen and Liu Zhibiao, et al. 2008). This is the grim situation China’s export-oriented strategy has led to: although downstream export industries enjoy a rapid growth, most of them are reliant on foreign equipment import, leading to the shrinking market share of the domestic equipment manufacturing industry. This emerges as the conflicts between upstream equipment manufacturers and downstream exporters, namely, the conflicts between different industries. Moreover, China’s equipment manufacturing industry was mainly located in the midwest in the planned economy era, while the export-oriented industry thrives mostly along its eastern coast after the reform and opening up. The more rapid the export industry grows, the more the market for the midwestern equipment manufacturing industry will shrink. Therefore, the conflicts between the upstream industry and downstream industry have developed into the conflicts between the east and the midwest, namely, conflicts between different regions. This is the second topic of this chapter. This chapter will first use the case of the Jiangsu Sunshine Group to illustrate the pattern of importing equipment to secure exports, namely, the mechanism of import-stimulating export. The reasons we choose the Jiangsu Sunshine Group are as follows: first, the group is a typical example of homegrown enterprises in the Delta Region. Second, the enterprise is mainly in the textiles and clothing industry, which is a traditional advantage of China. These two features ensure that this case will explain China’s export miracle with the case’s factual evidence. In the second section, the chapter made a brief literature review. In the third section, the chapter will establish a monopolistic competition trade model, and focus on studying the impact of open trade on the export industry that uses domestically produced equipment in a monopolistically competitive market. In the fourth section, this model will be extended. First we will analyze the conditions in which the downstream exporters will choose imported equipment in domestic ones’ stead, and prove the mechanism of import-stimulating export. Second, we will use statistics to demonstrate one of this mechanism’s effects, namely, factual demonstrations that are the result of the squeezed market-space of the equipment manufacturers in the midwest. Third, we will analyze the long-term effect of equipment imports on the balance of the export industry. The last chapter will be the conclusion of our study.

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Case Background The Jiangsu Sunshine Group was founded in 1986 in Jiangyin, Jiangsu province. It holds the Jiangsu Sunshine Corporation Ltd. Through its two-decade development, the company has grown from a township enterprise into one of China’s top 500 groups spanning over a diversified set of businesses, including textiles, clothing, biomedicine, ecological forests, real estate, and metallurgy, with textiles and clothing being its flagship business. The group is a leading producer of China’s textiles industry, the world’s biggest spinning enterprise, and a powerhouse of high-end clothing production. Since the 1990s, the group started the expansion of its spinning and clothing business to the international market. The group is a typical export-oriented enterprise, and the biggest woolen cloth exporter in China. In 1992, the group’s yarn and woolen cloth was exported for the first time, which eventually amounted to an annual export volume of USD1.243 2 million that year. In 2001, its clothing also started to be exported. By 2005, its export volume reached USD237 million, marking a 48.8% annual growth rate. Right now, the group’s products are mainly supplied to the international market, with its exports accounting for 70% of its total production. In 2007, the income generated from the international market was RMB2.19 billion, three times the domestic figure. Its international market expanded to over 20 countries and regions, including the U.S. and Japan, where it has set up sales and design companies. Accompanying the rapid growth of its exports, the group is also continuously improving its product quality, so as to spur further development. Its woolen cloth products can be divided into 20 categories and have over 6,000 varieties, among which, 10 products are among the state’s key new products, three of them are in China’s “torch plan project” of technological innovation. The overall quality of its woolen cloth has come very close to, if not reached, the top quality worldwide. Some of its products have surpassed the same products made in Italy. Therefore, the group has already become the material supplier to many of the world’s top fashion brands. Moreover, with the premium quality of its woolen cloth, the group also enters the high-end business suit business in which it adopted the management and design of Italy and Japan and set up a joint venture with foreign companies to produce the Pompei brand of business suits which have met the world’s highest quality standards. With its supreme product quality, the group has successfully developed its own brands. Sunshine Woolen Cloth has been rated as a World Renowned Brand of China; the Sunshine brand was rated as the 2005–2006 Key Export

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Brand; in 2006, the group received the highest honor among exporters, the title of Export-product-inspection-free Enterprise. Its high-end clothing brands like Pompei, Venetai, and Gezelia have received certain degrees of recognition in the international market. As is shown from the information above, the Sunshine Group has made the following achievements along with the export growth. First, its product quality has been constantly improving. Second, its export volume has been increasing. Third, it gradually developed its own brands. It is representative of the many successful exporters in China which were typically founded with very little resources then grew gradually in size to expand from domestic markets to international markets and finally become leading exporters in their industries. 1

Such a path to success has a universal implication. Among these three aspects, the improvement of product quality serves as the foundation. Only on this foundation can export volume grow continuously. And the growing export volumes of the numerous export-oriented enterprises constitute the export 2

miracle on the macro level. Therefore, only with the support of the first two aspects can exporters successfully cultivate their own brands. But the question is what do export-oriented enterprises like the Sunshine Group rely on to improve their product quality and increase export? The Sunshine Group attributes its success to its import of advanced equipment, such as high-performance product lines and precise inspection instruments. Over 95% of the group’s equipment was imported, which is, in proportion, significantly higher than many other enterprises in the industry. By importing a large amount of advanced equipment, the group becomes the best-equipped producer domestically, if not internationally. There are two types of equipment among the group’s import, production equipment, and research and development (R&D), or inspection equipment. First, in its two-decade development, the group has undergone four major technological upgrades in which it imported the whole set of most cutting-edge equipment in the spinning, weaving, and dyeing processes from Italy, Germany, the U.S., and Japan. In terms of the group’s production of clothing, it imported the CAD, CAS, and CAM system from France, the automatic suspension system from the U.S., the 3D ironing line from Italy, sewing machines from PFAFF of Germany, and a lot of other suit-producing equipment from Japan and other countries. This advanced equipment enables the automation and meticulous production of the group, which leads to the premium quality of its woolen cloth and clothing. Second, in order to improve its innovative capacity, the group established an innovation system that was comprised of one workshop and three centers,

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

namely, the postdoctoral scientific research workshop, national technology center, national engineering and technology research center for new material of wool spinning and the Jiangsu wool spinning technology R&D center. The design and testing equipment in these affiliated R&D facilities were also imported, such as the computer design system, electrical color testing and dye kitchen system, and wool spun fabric particularity testing equipment imported from Germany. Advanced designing equipment can automate the routine tasks in the R&D process, and make it more convenient for R&D personnel to realize their ideas. Advanced inspection equipment can precisely inspect the quality of products during the R&D and production process, providing comprehensive and accurate quality information for R&D personnel. In a word, this imported R&D or inspection equipment makes innovation easier for the group and improves its innovation efficiency. This is the technological foundation for the group’s attempts and success in inventing new products and ensuring the premium quality of its products. The group uses imported equipment to ensure the fineness of the production process, which ensures the improvement of product quality. It also uses imported equipment to facilitate innovation and R&D, so as to upgrade its products frequently. The Sunshine Group is a typical example of using imports to facilitate exports. This case also shows that the foundation of such a pattern is the mechanism of import-stimulating export. Imported equipment plays an irreplaceable role in the group’s attempt to improve the quality of its export products. By importing foreign equipment to improve product quality and meet the higher-end demands of the international market, the group sees the continuous increase of its exports. This is the import-stimulating export mechanism. In fact, this mechanism is not a single case, as it is very common in China’s export industry. This phenomenon is also manifested from a regional perspective. Regions that have a large amount of exports often have a large amount of imports as well, as can be seen in Guangdong, Jiangsu, Shanghai, and other coastal regions.

Theoretical Background Facilitating exports with imports is the practical interpretation of China’s export-oriented strategy. Meanwhile, the idea of import-stimulating export is a brand new pattern. The proposition of these two concepts explains the formation of China’s export miracle. In terms of the first topic of this chapter, studies based on international trade theory have already yielded ample findings.

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Jun Du and Sourafel Grima’s empirical study (2007) found that, in non-stateowned labor intensive industries, easy access to bank loans was related to the more apparent export-orientation. This means that the development of the financial sector might be one of the sources of comparative advantages of China. Based on the factor endowment theory, F. Gerard Adams, etc. (2006) believed that China’s abundant labor supply and low wage level were important engines driving the country’s export growth. This viewpoint is widely recognized in the international academic community (Fu Chaoyang 2005; Fan Aijun 2002). Based on the new technology trade theory, Hongxin Zhao and Hongyu Li (1997) found that R&D had a significant positive effect on the export-orientation and export growth of China’s manufacturing enterprises. Moreover, the profitability, capital intensity, and relative size of these enterprises are also significantly and positively related to their export orientation and growth. Apart from the abovementioned factors revealed by studies based on international trade theories, many studies done at home and overseas also tried to find out other factors affecting China’s exports by looking at the economic reality of the country. Their findings are as follows. First, foreign direct investment will improve exports. This is mainly due to the technology spillover that improves the productivities of China’s export enterprises (Liu 2002; Hu, A.G.Z. et al. 2002; Jiang Xiaojuan, and Li Xin 2002) which in turn increase exports (Jiang Xiaojuan 2002; Cai Xiaoyong, and She Zipeng 2005; Long Yangping, and Zhou Wei 2005; Wang Zijun, and Feng Lei 2004). Second, the exchange rate is also affecting China’s exports (W. L. Chou 2000). Third, institutional factors like tax rebates, the ownership of enterprises, and the establishment of export processing zones also have effects on exports (Chi Chure Chao, et al. 2001; Chien Hsun Chen 2006; F.C. Perkins 1997; Victor F.S. Sit 1988). Fourth, liberalizing policies towards Chinese imports in other countries will also diversify the export products from China (Robert C. Feenstra, and Hian Looi Kee 2007). The more comprehensive study of Zhong Changbiao (2007) conducted an analysis on the determinants of China’s electronics exports. He found that foreign direct investment (FDI) from Hong Kong and Macao and economy of scale will positively affect the export of electronics, while the share of stateowned enterprises capital in the export industry is negatively related to the industry’s export. Capital intensity, and R&D and human resource costs are not important factors of China’s electronics exports. Furthermore, in subdivided electronics manufacturing industries where labor intensity is lower, FDI will have a more significant positive effect on exports. These research efforts revealed the factors that underpinned China’s export

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

miracle from different perspectives. However, these factors are mostly at the macro level, and there is no comprehensive explanation on the micro basis for export growth. Most importantly, this research neglected the imports of equipment, which is a universal phenomenon in China’s exports industry, which should have been put together with export growth to be studied. Of course, there are some domestic and foreign scholars who have paid attention to the causal relationship between exports and imports, such as Augustine C. Arize (2002), Bahmani Oskooee, M. (1994), Reng Yongju (2003), and Francisco F. Ribeiro Ramos (2000). But most of these studies analyzed the causal relationship between imports and exports based on a country’s import and export totals, and are mostly devoted to find out whether there was a balanced relationship between the two figures, so as to see whether the trade surplus or deficits will continue to exist and whether the country’s macroeconomic policies can ensure balanced imports and exports in the long run. Therefore, these studies didn’t actually reveal the micro basis that links exports and imports, or study specifically the mechanism whereby imports of equipment are used to facilitate exports. Notably, Giorgio Barba Navaretti, Marzio Galeotti, and Andrea Mattozzi (2004) studied the wool spinning industry in Eastern Europe and the southern Mediterranean region and found that, while exporting to the European Union (EU), the two regions also imported equipment from the EU, which greatly facilitated the two regions’ exports of textiles. The situation of the textiles industry in the two regions reflected the pattern where the import of equipment facilitated exports. This study can be seen as a direct support for the importstimulated export mechanism from international academia. However, the study focused more on empirical analysis and lacked theoretical analysis on the micro mechanism by which the import of textiles machinery facilitated the two regions’ exports. As shown above, theoretical analysis on the use of imports to facilitate exports, or on the import-stimulating export micro mechanism, is still rare in existing literature. Therefore, in terms of the first topic, this chapter will use a model to make a specific description on how the imports of foreign advanced equipment improve product quality and then scale up exports. In terms of the second topic, namely, the causal relations between the rapid growth of export industries and the shrinking of the equipment manufacturing industry under the pattern of using imports to facilitate exports, Chen Aizhen, Liu Zhibiao, et al. (2008), conducted an exploratory study. However, their study was focused on the nationwide predicament of the equipment manufacturing industry in China, and therefore didn’t elaborate on the conflicts between western

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and eastern China under the pattern of using imports to facilitate exports. Domestic political and academic circles also listed a series of reasons to blame for the nationwide predicament of equipment manufacturing, which ranged from the industry’s weak foundation to institutional rigidity, and from the lack of technology innovation to external environment, for which they also provided pointed solutions. However, studies that try to understand the double tasks of this industry to catch up both in technology and market share with its foreign competitors from the perspective of China’s export-oriented economy are still rare.

Basic Model Based on the logic in the case analysis of the Sunshine Group, this chapter establishes a monopolistic competition trade model that includes the product quality factor, so as to analyze the basis of using imports to facilitate exports, namely, the import-stimulating export mechanism. Monopolistic competition is a good description for the international market structure that most enterprises in China’s export industries are in. This is especially true in the international market of labor-intensive and low value added products, as many Chinese enterprises managed to enter the market only with the help of low production costs. This is also the case for many enterprises in other developing countries. These enterprises all engage in fierce market competition. But at the same time, due to the differences in the location of production and technological sophistication, there are certain dissimilarities among the products of these enterprises, giving each of these enterprises a degree of monopolistic power. These are all typical features of a monopolistic market. This basic model is an adaptation of the monopolistic competition trade model in the neo-trade theory. It takes into consideration the quality factor of exported products, and interprets the effect of open trade to monopolistic industries and the trade benefits it brings to these industries. There are four presumptions of this model. First, presume that the world is comprised of one developed country, D , and

m developing countries, U . These developing countries are identical. S Ui is the D domestic market scale of developing country i , and S is the market scale for end W product in the developed country. The world market scale for end product S is D mS Ui + S . Second, there are two industries in the world, which are the manufacturing of equipment M and the manufacturing of end product R . m 1 developing countries U all have a large number of manufacturers that produce the end products R . therefore, these enterprises created a monopolistic competition in these

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

developing countries. After trade is opened, the structure of the international market for end products is also monopolistic. The production process of end products needs equipment M . Third, consumers concern themselves not only with the number of R consumed, but also with the quality of R , which is q . According to Anderson and Enomoto (1987), this chapter will view the q of R as a by-product of R . When the number of R , or d , is given, the more the number of q is, the better the quality of R is. In order to make an accurate description of this relationship, this 1 chapter goes further to presume that q = td , in which, t > 0 and t < . t is an bS W externally given parameter, which denotes the product quality when the number of R is 1, and is decided by the quality of M . Fourth, both developing and developed countries can produce M . M D related 1 ) interval. The basic parameter t D and that of M U — t , are both in the (0, bS W model will only consider the case when the producers in developed countries use domestically produced equipment R . The difference between the case when they use M D and the case when they use M U will be discussed in the model extension section.

The equilibrium of end product industry in self-reliant developing countries This chapter will analyze a random developing country, U i ’s end product manufacturing industry. According to the second resumption, due to the fact that this industry is in a monopolistic competition, the equilibrium of the industry is determined by four factors, which are the equilibrium production capacity, equilibrium quality, pricing of the representative producers, and the equilibrium number of producers. To solve this problem, this chapter studies the demand conditions of the representative producers, and then the production and supply conditions. Finally, we use the maximum profit condition and the zero profit condition of monopolistic industry to obtain these four equilibrium variables. First, the demand side analysis of representative producers. Presume that in a self-reliant country, the market demands the country’s representative producers of end product are d i, which is defined as the following: 1 — d i = S Ui [ n – a (p i –— p ) + b (q i – q )]

(7–1)

I n t h e f o r m u l a , n i s t h e n u m b e r o f p ro d u c e r s i n t h e e n d p ro d u c t manufacturing industry. p i and q i respectively represent the pricing of products

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— and product quality of the representative producer, while — p and q represent 3 the average price and average quality of R . a and b are external parameters that are greater than zero in value. (7–1) shows that, for the representative producer of end product in developing countries, under the equilibrium in S Ui industry, its market demand is n ,4 according to the symmetrical presumption of monopolistic competition industry. Moreover, its market demand is affected by its pricing and quality. When product price p i is higher than the average — price — p , or its product quality q i is lower than the average quality q , its market Ui S demand will be lower than . Transforming (7–1) will lead to (7–2): n

pi = — p +

b (q i –— q) d 1 – iUi + an aS a

(7–2)

As the profits of the representative producer of this product is TR i = p i d i, combining it with the (7–2), we have the (7–3):

b (q i –— q) di 1 — ] di – Ui + TR i = [ p + an aS a

(7–3)

Based on the third presumption, q i = td i, by calculating the first derivative of (7–3) against d i, we have the marginal profits, MR i, as shown in (7–4):

MR i = p i +

di btd i – a aS Ui

(7–4)

Second, the production and supply analysis of the representative producer. In a self-reliant country, representative producer can only use domestic equipment, i.e. M U in their production. Fixed cost of buying such machinery is FMU. In order to simplify the analysis in this chapter, we view FMU as all the fixed costs incurred by the producer during the production process. Under market clearance conditions, the cost function (C i) of the producer is defined as follows, among which, both α and β are greater than zero in value.5 Ci = FMU + αdi + βqi (7–5) Using the third presumption, i.e. q i = td i, we transform (7–5) into (7–6): Ci = FMU + (α + βt) di (7–6) From (7–6) we can find that the marginal costs of the representative producer (MC i) are α + βt , while its average cost is as shown in (7–7):

AC i =

FMU + (α + βt ) (7–7) di

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Finally, using the maximum profits condition of monopolistic competition

producer MR i = MC i, we obtain (7–8). Because there is no barrier for entry and exit of monopolistic competitive industry, the profit will be zero under a longterm equilibrium, namely, the price set by representative producer (p i) is equal to its average costs (AC i), therefore we have (7–9):

pi +

di btd i – = α + βt (7–8) a aS Ui

pi =

FMU + (α + βt) (7–9) di

From (7–8) and (7–9), we can obtain the equilibrium production capacity d *i, and equilibrium price p *i , as shown in (7–10) and (7–11):

d *i =

FMU aS Ui

1 – btS Ui (7–10)

p *i = (α + βt ) +

FMU (1 – btS Ui)

aS Ui

(7–11)

S Ui As the equilibrium number of producers in the industry n * is d*i , with (1 – btS Ui) S Ui . The equilibrium quality of (7–10), we know that n = FMU a the representative producer q* i is t

FMU aS Ui

1 – btS

. We now have the four

equilibrium variables of the end product industry in a self-reliant country. What 1 1 in the third presumption, t < is should be noted is that, because t < bS W bS Ui definitely true. Therefore, the four variables are all meaningful.

The equilibrium of industry and trade benefits with open trade In this part of the discussion, international trade is considered, we will see what changes on the equilibrium of end product industry in development country (U i) will occur under the new situation, and based on these, we will analyze the benefits of free trade. After trade is opened, a direct impact on the end product industry of U i is that its market is bigger, as the market expands from the former domestic market S Ui to , mS Ui + S D namely, the international market scale of end products, S W. Following the same logic, we will calculate the new industrial equilibrium after trade is opened, as is shown in (7–12) to (7–15):

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d**i =

FMU aS W

1 – btS W

FMU (1 – btS W)

p**i = (α+βt ) +

n** =

q**i = t

(7–12)

aS W

(1 – btS W) S W FMU a

FMU aS W

1 – btS W

(7–13)

(7–14)

(7–15)

1 t < bS W in presumption three also ensures that the four functions are valid. As f (S )=

S

, we know that fʼ (S ) > 0; as S W > S D, if we compare the 1 – btS industrial equilibrium of the end product industry before and after opening of trade, we will find that, d ** i > d* i , p ** i < p i* , q ** i < q i*. Therefore, we have the proposition 1. Proposition 1: After trade is opened, d ** i and q ** i will rise, but p ** i will fall. The significance of the proposition lies in that it shows that, after considering the quality factor of traded products, open trade will still benefit consumers worldwide. Comparing this proposition with the neo-trade theory, we will find that they both agree that the increased market scale as a result of open trade will promote internal economy of scale, lower prices, and will increase consumers’ utility level. This is the first layer of trade benefits, which proves that the increased market scale as a result of open trade is beneficial to all participants. Furthermore, this proposition claims that after considering the quality factor of end products, the second layer of trade benefits can be seen in the improved quality of consumed products in the international market, which increases the level of satisfaction of consumers and improves the welfare of consumers in different countries. This can be seen as an extension of the neo-trade theory, which also proves the benefits brought by free trade to trade participants. Of course, with the inclusion of the quality factor of end products, the model in this chapter is different from that of the neo-trade theory, which is summed up in proposition 2. Proposition 2: Under the end product industrial equilibrium after trade is opened, n ** decreases in all developing countries, namely, the variety of domestic end products is reduced.6

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Under the end product industrial equilibrium, the number of producers in developing countries is the same as the number of end products. This is because in the neo-trade theory, it is often presumed that differentiated production does not inflict cost to producers, which leads to the presumption that under the industrial equilibrium of monopolistic competition, every producer will produce one product that is differentiated from those produced by others, therefore the equilibrium number of producers is the same as the number of differentiated products. This chapter follows the same presumption. However, after trade is opened, n ** is smaller than n *, which is contradictory to the neo-trade theory. The latter shows that open trade will increase the variety of a certain country’s end products thereby increasing the utility level of consumers who prefer diversity in products. This is seen as another benefit of open trade. Does this contradiction mean that the model in this chapter fails to demonstrate this third layer of trade benefits? The answer is no. Although the number of the differentiated end products produced by a certain developing country is lowered from n * to n **, consumers’ option should be mn **, instead of n * under open trade. When comparing mn ** with n *, we have the third proposition. Proposition 3: When the domestic market scale of this developing country S —U 1 – btmS —W + m , the S U i meets the condition of S U i < 1+btm mS —W + S —U number of differentiated products consumers can buy after trade is opened will increase, namely, mn ** will be greater than n **. S —U is (m – 1)S —U , namely, the sum of the market scales of developing countries other than the one mentioned. S —W is S W—S Ui, namely, the sum of the market scales of all countries except the one mentioned, which is also S —U + S D . Proposition 3 shows that when considering the quality factor of the end product, the condition on which the third layered trade benefits exist is that the market scale of developing country should be less than S —U 1 – btmS —W + m . Furthermore, this condition, in fact, means 1+btm mS —W + S —U that the domestic market of the developing country takes up a low share in the total world market, namely, there are many developing countries similar to it. Under such circumstances, open trade will reduce the number of d omestic end products, but end products from other developing countries are also available to domestic consumers, therefore offsetting the decrease in the number of domestic end products. When this condition is valid, the third layered trade benefits will continue to exist.7 In conclusion, after taking into consideration the quality factor of end products,

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the monopolistic competitive trade model still shows that free trade is beneficial to trade participants, namely, there exist trade benefits. However, in contrast to neotrade theory, this chapter extends the concept of trade benefits to include not only the fall of end product price, but also the improvement of product quality. At the same time, the model of this chapter shows that, despite a decreased variety of domestic end products in a single developing country, as long as there is a sufficient amount of developing countries, consumers will still be able to make their choice among an increased number of products, namely, the third layered trade benefit will still exist.

Extension of Model The basic model analysis presumes that during the production of end products in developing countries, producers use M U, domestically produced equipment. As shown in the case of the Sunshine Group, in the study on import-stimulating export, this presumption should be extended to allow the import of equipment M D from the developed country. It is generally believed that the quality of M D is better than M U, which can be seen in the fact that the marginal production cost of R when M D is used is low by γ units than the MCMU when M U is used, and the fact that the quality of R when M D is used, namely, qDM is higher than qUM when M U is used. Accordingly, t is upgraded into t D, therefore MCDM should be α + βt D – γ. We can further presume that β (t – t D) + γ > 0, which means that the marginal cost of R i net declines after using M D. Of course, the higher quality of equipment means a higher purchasing cost, namely, for R i, the fixed production cost FDM when using M D is higher than FUM when using M U. With the abovementioned presumptions, the model extension will be divided into short-term and long-term analysis. The short-term analysis will consider the case when only one export producer R i in a certain developing country U i, such as the Sunshine Group, uses M D to produce R , while the rest of the producers in the same country and other developing countries use M U. The long-term analysis will study the case when all producers in developing countries use M D, and how the industrial equilibrium will alter in this case, namely, a comparison between the new equilibrium and the old one when only M U is used, so as to elaborate the impact of M D on the industry’s long-term equilibrium.

Short-term analysis In this part, it is presumed that the exporters in the developing country can either choose to use M U or M D. We first need to obtain the short-term condition

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on which R i will choose to use M D, then analyze how does it use M D to facilitate exports and form the import-stimulating export. In the short-term analysis, although R i might choose to use M D, but the other producers in the end product industry will still use M U, therefore, t remains unchanged. At the same time, the industrial price will still be (α+βt ) +

FMU (1 – btS W)

aS W

, which is also the price

set by R i. The number of producers in the industry is still

(1 – btS W) S W

. FMU a In the short-term analysis, R i faces two options, to use M U or M D. Its choice will be made based on the comparison of profits when the two kinds of equipment are used. When using M U to reach the monopolistic competitive industrial equilibrium after trade is opened, the profit π1 is zero. When using M D, except for the case when production conditions change, its end product quality will improve and, therefore, it will have a bigger market demand. Although t is the same, it still will cause the decline of product quality of other producers, and the industry’s average product quality q will decrease. Meanwhile, the market share of other producers will decrease, namely, the amount of products they produced will reduce. After adjustment, the market ~ demand for R i’s products is d i , and the market demand of other producers is ~ ~ d i**n ** – d i d **n ** – d i , and the average quality of the industry is i t . As n** is n ** – 1 n ** – 1 normally a big number, we can presume n ** – 1 is greater than zero. According to (7–1), and with the above assumptions, we will find that d i meets the following function: ~ d **n ** – d i d i = d i** + bS W t Dd i – i t . From it, we can find d i as shown in n ** – 1 (7–16):

d i = d i**λ (7–16) In the equation λ = FDM

(n **– 1) – bS Wn **t . The current average (n ** – 1) – bS Wt D(n ** – 1) – bS Wt

+ (α+βt D – γ ) . Therefore, when using M D, R i’s profit π2 will be as di shown in (7–17):

cost of R i is

π2 =

208

γ+

FMU (1 – btS W)

aS W

–

FDM

di

di

(7–17)

Import for Export

The condition on which R i will choose M D instead of M U is π2 > π1, namely, π2 > 0. According to (7–12) we know that condition can be expressed in proposition 4.

FMU (1 – btS W)

aS W

Proposition 4: In the short run, when γ >

F DM

–

=

FMU

d i**

, therefore this

FMU

, the end product d i** di exporters R i in the developing country will ultimately choose M D instead of M U. Proposition 4 shows that, in the short run, a rational R i will not replace all its M U with M D, as there is a tradeoff between M D and M U. R i will choose the equipment that will help it increase its profits. Only when importing M D will increase its profits, will the rational R i replace M U with M D. In proposition 4, γ, F DM and FMU are externally decided parameters, which will have important effects on R i’s choice. We can use lemma 1 to give more details on this. Lemma 1: When other variables are fixed, the bigger γ, the smaller F DM and the bigger FMU is, R i is more likely to import M D. Lemma 1 has very clear economic implications. It shows that the decisionmaking of an exporter R i, such as the Sunshine Group, is dependent on the comparison between the marginal costs and fixed costs of using M U and M D. The greater γ is, namely, the greater the quality difference between M D and M U, the greater M D can lower marginal costs, and the greater it can improve the quality of end products.8 The greater production efficiency as a result of using M D will make R i inclined to use M D. When R i sees a smaller F DM or an increased FMU, namely, compared with M U, the fixed costs of M D are not much higher than those of M U, R i is more likely to choose M D. If we view the lowered marginal cost of M D as the marginal profits of this decision, and view the higher fixed cost as a result of M D as the marginal cost of this decision, what lemma 1 expresses is that the comparison between marginal cost and benefits decides which equipment R i is to choose. In the following, we will discuss the relationship between d i** and d i , which has the following implications. First, the validity of proposition 4 is related to the relationship between the two endogenous variables, d i** and d i . Therefore, discussion over this relationship will deepen our understanding of proposition

4. Second, and more importantly, d i** and d i represent not only the market demand R i faces before and after it uses M D, but also its production volume after using M D. According to the first presumption,

(m – 1) – S Ui + S D within its mS Ui + S D

total production volume will be exported. If we set this proportion as ω, R i will

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

remain and will not change before and after the use of M D, which respectively become ωd i** and ωd i. Therefore, the discussion over the relationship between

d i** and d i can be used to prove whether or not the short-term importstimulating export exists.

The relationship between d i** and d i is shown in (7–16). The analysis on the two concentrates on whether the coefficient λ is greater than d i**. If λ is greater

than 1, d i is greater than d i**, and import-stimulating export is in effect. If it is the opposite, than import-stimulating export does not exist. However, in the discussion of whether λ is greater than 1, namely, discussion over whether its numerator is greater than the denominator, we need to consider two situations, which is the case when the denominator is greater than zero and the opposite

case. Here we will only discuss the first case. 9 When this occurs, a new 1 t presumption of t D is needed, which is t D < .10 It is stricter than W – bS (n **– 1) 1 tD < as in proposition 3 and 4. bS W As can be seen in the abovementioned, t D is greater than t , and n **–1 is

greater than zero. Therefore, tbS W (n ** – 1) < t DbS W (n ** – 1) is valid. Transforming it we will have (n ** – 1) – tbS W n ** > (n ** – 1) – bS Wt D (n ** – 1) – tbS W. According to the new presumption that t D
1 is valid. Therefore, we know that ωd i is greater than ωd i** namely, importstimulating export exists, which can be expressed in proposition 5. Proposition 5: Presume that t D
, on which R i will choose to use M D instead of M U is the shortd i** di W

–

term condition on which import-stimulating export will exist. Therefore, when

R i, such as the Sunshine Group import advanced foreign equipment to improve its product quality, its export volume is bound to grow. 1 t Although proposition 5 shows that when 0 < t D < and – W bS (n **– 1)

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Import for Export

γ>–

F DM

–

FMU

D d i** , R i must choose M and it must increase its export, we still do di not know how much the exports will grow. If the export volume of exporters grows rapidly, it will be a foundation for the rapid growth on a macro level. The amount of export growth is related to λ. The bigger it is, the bigger the export growth amount will be. From the definition of λ we know that it is positively related to the quality of imported equipment t D. Lemma 2 shows the factors affecting the export growth amount of R i. 1 t Lemma 2: When proposition 5 is valid, the closer t D is to the – W bS (n ** – 1) greater λ is compared to 1, therefore the bigger the export growth amount of R i. Lemma 2 shows that the bigger t D, or quality of the imported equipment is in its defined range, the more advanced this equipment is, therefore the bigger the amount of export growth the downstream exporters in the developing country, or R i, will be. This shows that, under the background of importing to facilitate export, in order to increase its export volume, R i should import more advanced equipment. Therefore, this provided China’s exporters, such as the Sunshine Group, who continue importing advanced equipment, with theoretical support. After proving λ >1, we can put the conditions of proposition 4 into (7–16) F DM 1 and obtain γ > – FMU . When other variables stay unchanged, the d i** λ

bigger λ is compared to 1, the bigger the chance of the inequality is valid. As the value of λ is positively related to t D, we have lemma 3. Lemma 3: In the short run, if other variables are fixed, the closer t D is to 1 t , the more likely the end product exporter R i in the developing – W bS (n ** – 1) country will use imported equipment from developed countries instead of domestic equipment. Lemma 3 is closely related to lemma 1. It has a very clear economic implication. t D reflects another effect of M D, namely, its effect on improving end product quality. Its increase means that, compared to M Ui, M D is more advanced and can more effectively improve the quality of end products. This will lead to demands for the products made by the producer in the developing country, who will therefore become more likely to obtain positive profits. Therefore, R i tends to use M D. The propositions and lemmas in the short-term analysis show two aspects of questions. First, proposition 4 and lemma 1 and 3 focus on the conditions on which R i will choose to use M D instead of M U. The conclusion yielded

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

has an important implication for the equipment manufacturing industry of developing countries. The industry is in a disadvantageous position when competing for market share with foreign competitors, which can mainly be seen in the technological backwardness of its products when compared with foreign competitors. When using M Ui, the marginal cost is higher than the case when M D is used, and the end product quality is lower, which are both disadvantages of the equipment manufacturing industry of developing countries. However, its advantage lies in its lower price compared to the products of foreign competitors. Therefore, overall, the competition between the equipment manufacturing industry in developing countries and foreign competitors is mainly decided by the comparison among equipment prices, the marginal cost and product quality of downstream industries. The result of this competition is that domestic equipment manufacturers occupy the low-end market and produce cheap but low-quality products, while foreign competitors occupy the high-end market and produce expensive and high-quality products. This is indeed the situation of China’s equipment manufacturing market. Second, proposition 5 and lemma 2 focus on proving the existence of importstimulating export. The proposition and lemma have a more abundant economic significance. Although what export-oriented import proves is only the growth of export volume on the micro level, it in fact provides a new perspective for explaining China’s export miracle. Moreover, although this analysis is conducted on a short-term basis, with upgrade of equipment and the advance of technology, exporters will continue to import more advanced equipment, and such continued imports will further empower the export growth of these exporters.

The squeezed market of the equipment manufacturing industry in central and western China under the strategy of export-oriented imports Proposition 5 revealed the basis of China’s strategy of export-oriented import, namely,the existence of the import-stimulating export mechanism. But if seen from another angle, it might also reflect the conflicts between the development of the upstream domestic equipment manufacturing and the downstream end product manufacturing. Against the backdrop of import-stimulating export, the more downstream end product manufacturing industry export, the more disadvantageous the domestic upstream equipment manufacturing industry will be. This is because in order to increase exports, China’s export industry grows increasingly reliant on imported advanced equipment, therefore directly leading to the squeezing of the market space of domestic equipment manufacturing

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industry. In this sense, the increase in the export of the downstream might be seen as a warning for the upstream manufacturing industry. At the same time, as the staple of the equipment manufacturing industry was located in central and western China in the planned economy era, and the prosperity of export industry is largely limited to the eastern coast, the strategy of exportoriented imports will squeeze the market-space of the domestic equipment manufacturing industry in the midwest, therefore further expanding the economic gap between the east and the west. Not only can the equipment manufacturing industry in the west not share the growth of the export industry through the linkage between the upstream and downstream, the equipmentmaking industry also loses more market share as a result of export growth. This constitutes the conflicts between the economic development between western and eastern China, which is expanding the economic gap between the two regions. In order to describe the situation where the market of the equipment manufacturing industry in central and western China is being squeezed, the following section will use statistical data from 1999 to 2006 and make a comparison over the whole country.11 This part will, according to the Economic Statistic Yearbook of Industry of China, choose the outputs of related equipment manufacturing industries of each year according to the yearly prices and the average employed population index, and divide the first with the second number, so as to obtain the per capita output of related equipment manufacturing industries of different regions. And then we use PPI from the CCER database to adjust this per capita output so as to make it vertically comparable. According to traditional division, the east includes Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, and Hainan; central China includes Shangxi, Jilin, Heilongjiang, Anhui, Jiangxi, Henan, Hunan, Hubei; the west includes Sichuan, Chongqing, Guizhou, Yunnan, Shangxi, Gansu, Qinghai, Ningxia, Xinjiang, Tibet, inner Mongolia, and Guangxi. This part covers six major equipment manufacturing industries, which are equipment, meters, office supply manufacturing industry, telecommunications, IT and other electronics manufacturing industry, machinery manufacturing industry, transportation equipment manufacturing industry, special equipment manufacturing industry, and general equipment industry. The six industries are labeled from 1 to 6.12 Our calculation shows that the development of these six major equipment manufacturing industries demonstrates common features among six regions from 1999 to 2006. Therefore, this chapter will only make analysis on the industry 1, namely, the meter, equipment, and office supply manufacturing industry and for the remaining industries please refer to Appendix Fig. 7a.1–7a.5.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Fig. 7.1

Changes over the per capita output in the industry 1 of China from 1999 to 2006 (RMB)

600,000

National total

Eastern region

Central region

Western regions

400,000 200,000 0 600,000 400,000 200,000 0

1998

2000

2002

2004 2006 1998

2000

2002

2004

2006

Per capita output (Price index adjusted) Fit line Since 1999, the per capita output of China’s industry 1 has been constantly rising, which can be seen in the national curve and the respective curves of the three regions. This is sufficient evidence that the output capacity of this industry has been rising gradually. This is also the case for other equipment manufacturers. However, there is still a significant difference among the three regions. Combining the scatter plot and the fitted line plot, we will find that the per capita output of industry 1 in the west and central China is still much lower than that of the east. Although some provinces have in some years reached the eastern level, generally, their output is still lower than the east. The west is even lower than central China. Therefore, the development of industry 1 in the east, central China, and the west follows a descending order, which is also a common feature of other equipment manufacturing industries. The formation of such a common feature is a reflection of the awkward situation of the domestic equipment manufacturers in western and central China under the strategy of export-oriented imports. As has been said above, this strategy results in the current situation where the equipment manufacturers in western and central China have always lagged behind the pace of the whole

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country, not to mention the east. At the same time, the entry of foreign capital helps explain why the once underdeveloped equipment manufacturers in the east now embark on a course of rapid development.

Long-term analysis The short-term analysis shows the process in which an individual exporter, such as the Sunshine Group, improves their product quality through importing advanced foreign equipment, so as to increase exports and profits. These are all the first actor advantages of such exporters. However, in the long run, such profits will be offset as other exporters follow suit, until zero-profit equilibrium is reached again in the monopolistic competitive market of all these export enterprises. Despite zero profits, the long-term new equilibrium is different from the industrial equilibrium after trade is opened. Following the same logic, we can calculate the four variables of the longterm equilibrium, as shown in (7–18) to (7–21).

d i’ =

FMD aS W

1 – bt DS W

p i’ = (α+βt D – γ) + n’ =

q i’ = t D

(1 – bt DS W) S W FMD a

FMD aS W

1 – bt DS W

(7–18) FMD (1 – bt DS W) aS W

(7–19)

(7–20)

(7–21)

Comparing (7–18) and (7–12), (7–20) and (7–21), and (7–21) and (7–15), as t D is greater than t and F DM is greater than F UM, therefore d i’>d i**, q i’> q i**, n ’

FMD (1 – bt DS W)

FMU (1 – btS W)

, p i’ will be aS W aS W lower than p ** in the long-term equilibrium, this will increase consumers’ utility i level. —

Conclusion This chapter uses the case of the Sunshine Group to elaborate the formation of China’s export miracle. It is shown that, on the micro level of enterprise, the import of foreign advanced equipment has an irreplaceable role in increasing an enterprise’s export, from which we conclude the pattern of import-stimulating export. The chapter continues its study with a monopolistic competitive model containing the product quality factor. Based on this model, the chapter first analyzes the trade benefits brought about by open trade, secondly loosens the presumption that only domestic equipment can be used, and continues with the analysis on the choice of exporters in developing countries between domestic equipment and foreign equipment. The chapter goes on to demonstrate the inevitability of the formation of import-stimulating export once foreign equipment is imported. The long-term equilibrium analysis continues to prove the effects of equipment imports on the export industry.

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Import for Export

The study of this chapter provides a new perspective to explain the export miracle of China, and concludes a new pattern from the economic reality. Import-stimulating export helps us understand comprehensively the development process of China’s exports. It also links the development of China’s export-oriented industry with its equipment manufacturing industry, which has certain implications for the development of the latter under an open economy. At the same time, import-stimulating export, to some degree, explains the regional economic difference in China, and is helpful to studies on regional economy based on industrial perspective.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Appendix Regional Per Capita Output Variation of Industries 2–6 in China (1999–2006) Fig. 7a.1

Per capita output variation of industry 2 (RMB)

15,000

National total

Eastern region

Central region

Western regions

10,000 5,000 0 15,000 10,000 5,000 0

1998

2000

2002

2004 2006 1998

2000

2002

2004

2006

Per capita output (Price index adjusted) Fit line

Fig. 7a.2

Per capita output variation of industry 3 (RMB) National total

8,000 6,000

Eastern region

4,000 2,000 0

Central region

8,000 6,000

Western regions

4,000 2,000 0

1998

2000

2002

2004 2006 1998

2000

2002

Per capita output (Price index adjusted) Fit line

218

2004 2006

Import for Export

Fig. 7a.3

Per capita output variation of industry 4 (RMB) National total

Eastern region

Central region

Western regions

10,000 5,000 0 10,000 5,000 0

1998

2000

2002

2004

2006 1998

2000

2002

2004

2006

Per capita output (Price index adjusted) Fit line

Fig. 7a.4

Per capita output variation of industry 5 (RMB)

5,000

0 5,000

0

1998

2000

National total

Eastern region

Central region

Western regions

2002

2004

2006 1998

2000

2002

2004

2006

Per capita output (Price index adjusted) Fit line

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Fig. 7a.5

Per capita output variation of industry 6 (RMB) National total

6,000

Eastern region

4,000 2,000 0

Central region

6,000

Western regions

4,000 2,000 0

1998

2000

2002

2004

2006 1998

2000

Per capita output (Price index adjusted) Fit line

220

2002

2004

2006

8

Chapter

A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Multinationals own, research, and develop the staples of key technologies in the world. They are the main participants in the world’s research and development (R&D) and innovation activities. With the many diverse preferential policies and measures, developing countries hope to attract investment from more multinationals. For the receiving countries of such investment, especially for developing ones, one important objective in their attempts to attract foreign direct investment (FDI) is that, such investment, through market competition effect, the flow of work force, the demonstration effect, and the forward and backward linkage of multinationals, will improve the productivity of local firms and the whole country’s technological sophistication and promote the country’s industrialization (Lall 1985). Technology diffusion can occur in various ways, such as international trade, international technology support, and technology transfer. But for FDIreceiving countries that are also developing countries, FDI is undoubtedly the most attractive approach, as it gives the receiver countries technology transfer that cannot be obtained through other approaches (Caves 1999). Even when multinationals want to keep their technology within the firms, technology transfer is still likely to happen. Since 1978, China has started absorbing FDI. By the end of 2007, the country has received FDI amounting to USD707.78 billion, and housed 588314 foreign firms (The Ministry of Commerce, 2007). China has become one of the most popular destinations of FDI, and the influx of such investment has greatly facilitated the country’s development (Jiang Xiaojuan, 2002). Amid an accelerating influx of FDI into China, China’s pioneer of export-oriented economy, Jiangsu Province, has made immense achievement in terms of using FDI. From 1985 to 2007, its FDI use reached USD142.3 billion, with 2007 alone reaching USD21.8 billion, accounting for 30% of the country’s total FDI use that year. FDI in the manufacturing industry accounted for a significant portion of the total FDI which flowed into the province.1 With FDI influx accelerating, the cluster effect started to gain momentum, bringing more and more foreign firms to settle down in Jiangsu. Many industrial clusters are taking shape, such as the electronics industrial cluster in Wujiang mainly funded by Taiwanese capital, the electronics, machinery, chemical, and medical industrial clusters in Wuxi and the IT industrial clusters in Suzhou, Nanjing, etc. The multinational-driven industrial concentration in the Jiangsu economy (Fang Yong and Zhang Erzhen, 2007) has magnified the cumulative circular effect of regional industrial clusters, which greatly facilitated local economic development (Wu Dandan and Xie Jianguo, 2007). With the Chinese economy becoming increasingly

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A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

open, how to strengthen both the horizontal and vertical linkage between foreign firms and local firms, how to improve the productivity of Chinese firms, and how to promote local economic growth, are questions that need to be answered by Jiangsu Province as well as the various levels of governments in China in their use of FDI. A study on the horizontal and backward linkage within the industrial cluster, using the manufacturing industry in Jiangsu as the sample, therefore, has great significance for the broader study on how to increase the stickiness of the clusters of multinationals to their current locations and increase the efficiency and level of the use of FDI. This chapter uses the panel data of Jiangsu manufacturing industry from 2000 to 2006, and studies the horizontal and backward linkage of FDI to Chinese firms. The result shows that, through the two linkages, FDI significantly facilitated the improvement in the productivity of local firms, with the horizontal linkage effect being stronger than the other. The article tests the effects of return to scale and appropriate technology gap on FDI linkage, which shows that, the two have significant effects on FDI horizontal linkage but no effect on backward linkage. Further research shows that, FDI significantly improved the productivity of laborintensive local suppliers, improved to a certain degree the productivity of capitalintensive local suppliers, while its backward linkage effect on the productivity of capital- and technology-intensive industry is low, which we believe might be explained with the relatively low matching capacity of such firms. Therefore, there is still a big potential for the backward linkage between FDI and the Chinese firms in the cluster production chain.

Literature Review The backward linkage effect has long been the subject of academic discussion. According to the World Investment Report from the United Nations Conference on Trade and Development (UNCTAD) (2001), FDI linkage effect can be divided into intra-industry spillovers and inter-industry spillover, or vertical and horizontal spillovers. Vertical spillover happens mostly in demonstration by foreign firms for local firms, local firms’ imitation, labor flows, competition, etc. Horizontal spillovers mostly happen through the forward and backward linkages between FDI and local firms. Research on FDI linkage is conducted overseas, which dates back to the study of Caves (1974). Caves believed that foreign firms facilitate the improvement of the productivity of local firms by improving the latter’s allocation and technology efficiency, and accelerating technology transfer. But later studies yielded different results. In studies on developed countries, the industrial spillover

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

effects of FDI are usually positive, such as the studies of Jonathan, et al. (2007), and Keller and Yeaple (2003) on Britain and the U.S. But studies on developing countries yielded opposite results, such as the study on Morocco by Haddad and Harrison (1993), the study on Venezuela by Djankov and Hoekman (2000), the study on Bulgaria, Romania, and Poland by Konings (2001), and the study on China by Chen Taotao (2003), which all yielded results which suggested that the FDI horizontal linkage effect on the productivity of local firms is insignificant or negative. Haddad and Harrison (1993) found that, although the FDI linkage effect in all samples is negative, but when tested again when the samples are divided into different industries with various levels of technology intensity, the effect is significant in industries with lower technology intensity. This shows that, in these low technology intensity industries, the competition between local firms and foreign firms is more sufficient. Chen Taotao (2003) used the data of 84 of China’s four-digit-divided manufacturing industries, and conducted an empirical study on the endogenous mechanism of horizontal linkage of FDI to Chinese firms. The result shows that, although in the test using all samples there is no significant relationship between the productivity of Chinese firms and foreign firms, when divided into different categories by the level of technology margins between Chinese and foreign firms, the FDI linkage effect is significant in groups with a lower level of technology margin. This shows that when Chinese and foreign firms have a smaller technology margin, the competition between them tends to be more sufficient and effective, increasing the likelihood of FDI linkage. Some scholars believe that the reason FDI linkage wasn’t found in some of these studies is because such linkage might have happened inter-industrially instead of intra-industrially. Recently, academia is increasingly focusing on horizontal linkage, with more and more studies dedicated to the study of the horizontal linkage based on the production chain, especially backward linkage. Javorcik (2004) made an empirical study on FDI spillovers with the 1996–2000 panel data on the firm level of Lithuania. The result shows that FDI has a positive linkage effect on upstream foreign firms and local suppliers through backward linkage. Moreover, such spillover effect is most observed in joint-ventured firms owned by local capital and foreign capital rather than foreign firms. However, there is no evidence indicating horizontal or forward linkage, for which, Javorcik explained that, due to the competition with local firms, foreign firms are motivated to prevent technology leak and spillover. They often use measures like putting a very strict intellectual property protection in place, and offering a high wage for employees so as to make them stay. Whereas, as foreign firms will benefit from the improvement in the productivity of intermediate product suppliers, foreign firms seldom take measures

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to prevent technology transfer towards upstream industries. Therefore, backward linkage is the most likely approach of spillover. Blalock and Gertler (2001) studied the effects of downstream FDI on the productivity of upstream industries with the 1988–1996 panel data of the manufacturing industry in Indonesia. The result shows that backward technology transfer through the vertical supply chain is an important channel for FDI technology transfer. Their study explains the incentives for multinationals to transfer their technology, in which, they will try to minimize technology leaks to their competitors so as to reduce their threats. They will actively transfer technology to suppliers, so as to lower the price of, and better the quality of, their inputs. The interview held by Blalock and Gertler with multinational Japanese and American firms and local small firms in Indonesia also yielded results that support their quantitative test. Kugler ’s study (2005) on the 1974–1998 panel data of Columbian firms shows that knowledge transfer is more likely to happen horizontally than vertically and that the relationship between multinationals and upstream suppliers established by outsourcing is a very important channel of spillover. Recently, as FDI influx into China continues to grow, the horizontal and vertical linkage of FDI to local firms is receiving more and more attention. Liu and Lin (2004) used the 1994–2003 industrial panel data of China to study these two types of linkages. The result shows that the forward and backward linkage effects are positive, while the horizontal one is negative. Jiang Jin and Zhu Guilong (2007) used the 1999–2003 industrial panel data to study the effects of FDI on the productivity of Chinese firms. The result shows that FDI has significant horizontal and forward linkages, but a negative backward linkage. However, they didn’t give a plausible explanation for the negative backward linkage. Liu and Wei (2006) used firm level panel data to study the linkages between FDI and Chinese manufacturers. The result shows that, overall, the vertical and horizontal linkages between FDI and Chinese manufacturers improve the productivity of Chinese manufacturers. Moreover, the study also shows that the linkage effects on Chinese firms are related to the ownership and industry of these firms, as horizontal linkage is only beneficial to non-state-owned firms and the linkage with SOEs are having a negative influence on them. Zhong Changbiao (2006) used the 1999–2002 panel data of China’s electronics industry to study the spillover effect of FDI. The result shows that both vertical and horizontal linkages exist in the electronics industry, and that the former is stronger than the latter. Xu Helian, et al. (2007) used the 1999–2003 panel data of China to study the vertical and horizontal linkages of China’s FDI. The same result as the study of Zhong Biaochang was yielded.

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Although there is much valuable literature in terms of the spillover effect of FDI, they all share two shortcomings. First, most of these studies used macro data on the state level, which makes it likely for them to overlook the vertical and horizontal spillover effects in FDI cluster. The studies of Blomstrom and Kokko (1996) and James and Adam (1996) show that technology spillover is more likely to happen between industries or firms that are geographically near to each other. Second, existing literature seldom combines regional industrial clusters with the FDI backward linkage effect to study the FDI backward linkage within industrial clusters. Liang Qi (2004) believes that if the FDI in the industrial cluster is less related to the region’s economy, FDI will relocate the cluster in pursuit of higher profits. With the increasing influx of FDI in a certain region, the cost of concentrating to one region will increase till the centrifugal force prevails, leading to the dispersion or relocation of this cluster. As we can see, improving the interrelation between local industries and FDI, and using the backward linkage of FDI to increase the productivity of local firms are important approaches to retain FDI in a certain region. This chapter starts from this perspective, and studies whether a close backward and forward linkage has been established between foreign and local firms in the regional manufacturing cluster led by multinationals. This study has important significance to establishing the embeddedness of FDI, consolidating the centripetal force of regional industrial cluster and avoiding an enclave economy. This chapter first establishes the analytical framework of factors affecting the productivity of Chinese firms, and then uses the 2000–2006 panel data of the foreign and local firms in 15 manufacturing industries in Jiangsu for regression so as to study the horizontal and backward linkage effects of FDI on local firms in the manufacturing cluster led by multinationals and, finally, categorizes the backward linkage effects of FDI by the different nature of industries, so as to study the different backward linkage effects in different industries.

An Empirical Study on the FDI Backward Linkage Effect in Industrial Cluster Model design and data selection In a Cobb Douglas production model, there is

Y = AK β1 Lα (8–1)

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A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

In which, Y is the output of local firms, K and L are, respectively, the capital

and labor input of local firms. β1 and α are, respectively, the output elasticity of capital and labor. A represents the endogenous factor of technical progress. Presume that the return to scale is constant, then α + β1 = 1. Therefore, if we take the logarithm of (8–1), we will have: ln (Y / L ) = β1 ln (K / L ) + ln A (8–2) Presume that total factor productivity A is determined by two factors: first, the technical progress factor of local firms, and second, the spillover effect of foreign firms on local firms. We further presume that,

A = f (S , TG , Horizontal _FDI , Backward_FDI ) = S β2 TG β3 Horizontal _FDI β4, Backward_FDI β5 eα (8–3) S represents firm scale, TG the technical margin between foreign and local firms, Horizontal_FDI horizontal spillover effect, Backward_FDI the backward linkage effect of FDI, and e α other factors affecting technical progress. Substituting (8–3) into (8–2) will produce the following equation: ln YL jt = α + β1 ln KL jt + β2 ln S jt + β3 ln TG jt + β4 ln Horizontal_FDI jt + β5 ln Backward_FDI jt + εjt (8–4) ε jt is the stochastic disturbance. In order to study the effect of technical differences and firm scale on the absorption capacity of local firms, we further estimate the following equation: ln YL jt = α + λ1 ln KL jt + λ2 ln Horizontal_FDI jt + λ3 ln Backward_FDI jt + λ4 ln Sjt × ln Horizontal_FDI jt + λ5 ln TG jt × ln Backward_FDI jt + εjt (8–5) In the above listed equations: YL jt represents the productivity of the local firms in Jiangsu of the industry j in the year t , which is expressed by total productivity. It is obtained by: Total productivity = Industrial added value / Yearly average total employees. In previous studies, total industrial output value or added value is often used in total productivity’s stead as a dependent variable. Such handling has a shortcoming, as it overlooks the effect of the redundant labor factor on productivity. As redundant labor is common in local firms, even if industrial added value is high, the firm’s productivity is still low. Therefore, using total industrial output value or industrial added value may

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overestimate the productivity of local firms, while using total productivity will avoid this problem. In order to offset the effect of the price factor, the year 2000 is used as the base period, based on which we adjust the industrial added values of different industries in other years according to producer price index (PPI). KL jt is the capital intensity of local firms in industry j in Jiangsu in year t , which is expressed by “The yearly average balance of fixed net value / Yearly average employees.” In order to reduce the effect of the price factor, with 2000 as the base period, we adjust the fixed net values of different sectors in other years according to the index of investments in fixed assets. S jt is the yearly average scale of firms in the industry j of Jiangsu province in the year t , which is expressed by “sales revenue/number of firms.” The adjustment of sales revenue is similar to that of industrial added value. TG jt is the relative technical level of local firms in industry of Jiangsu j in year t as compared to that of foreign firms, which is expressed by the ratio between the productivity of local and foreign firms, indicating the technical gap between local and foreign firms and the technical absorption capacity of the former. Horizontal_FDI jt is the horizontal spillover effect, reflecting the share of FDI in industry j in the year t , which is expressed by the ratio of foreign firms’ industrial added value to the total industrial added value (that of SOEs and non-stateowned firms above a certain scale). Backward_FDI jt is the FDI backward linkage effect. According to Blalock’s definition (2001), is the share of the output of industry j of Jiangsu in the year t purchased by foreign firms in the downstream industries (excluding industry j ) among the said output, namely, the weighted mean of the share of the output of industry j purchased by all downstream industries in the said output, with the weight being the share of FDI in different industries (Horizontal_FDI jt), which is expressed as:

a jk * Horizontal_FDI Backward_FDI jt = k ,∑ jt k ≠j In this equation, a jk is the share of output of the upstream industry j purchased by downstream industry k in the said output, namely, the value of goods or services provided by industry j during the production process of k .2 This parameter is obtained from the different rows of direct consumption coefficients in the input-output table (factors on the diagonal lines are ignored, as Horizontal_ FDI jt has taken into consideration such a horizontal effect). The a jk used in this chapter are taken from the direct consumption coefficient table within the input-output table of 40 industries of Jiangsu Province in 2000 and 42 industries of Jiangsu Province in 2002. The 2000–2001 a jk are taken from the

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A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

direct consumption coefficients in the 2000 input-output table, and the 2002–2006 a jk are taken from the direct consumption coefficients in the 2002 input-output table. As the sources of data are limited in this chapter, we presume that industrial structure will not change rapidly over time. Although a jk are fixed values over a period of time, the value of Horizontal_FDI jt is still morphing over time, therefore Backward_FDI jt also changes over time and in different industries. Such a handling of data is similar to Blalock (2001), Javorcik (2004), Liu and Lin (2004), and Jiang Jin and Zhu Guilong (2007). The rest of the data used in the chapter is obtained from the 2001–2007 Jiangsu Statistic Yearbook . Due to the absence of the industrial added value in 2004, we omit the figure. As this chapter’s main focus is to measure the horizontal linkage effect of FDI, data in the input-output table is very important. In order to make full use of these technical coefficients, this chapter reorganizes the manufacturing industries of the Jiangsu Statistic Yearbook following the statistic standards of the 2002 input-output table of 42 industries and the 2000 table of 40 industries, and puts them into 15 industries which have concentrated data. The tobacco processing industry is ignored as there is very little FDI in the industry. In this chapter, the data of foreign firms comes directly from the related economic data of Sino-joint venture, cooperative business, and exclusively foreign owned enterprises. And the data for local firms is obtained through deducting the data of foreign firms which comes directly from the related economic data of Sino-joint venture, cooperative business, and exclusively foreign-owned enterprises from the manufacturing firms above a certain scale in the same industry.

The basic model test of the FDI backward linkage effect We make a panel data model regression analysis on the 2000–2006 relative data of the 15 manufacturing industries of Jiangsu. The model allows the individual effect on the individual industries, and explains it with the differences in interceptions, namely, variable intercept model. The forms of the fixed effect variable intercept model and the random effect model are as follows. ln YL jt = c j + β1 ln KL jt + β2 ln S jt + β3 ln TG jt + β4 lnHorizontal_FDI jt + β5 lnBackward_FDI jt + εjt (8–6) ln YL jt = c + v j + β1 ln KL jt + β2 ln S jt + β3 ln TG jt + β4 lnHorizontal_FDI jt + β5 lnBackward_FDI jt + εjt (8–7)

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(8–6) is the fixed effect model, and interception c j is a certain unknown parameter for the different industries j . (8–7) is the random effect model, c is the constant within the interception, and v j is the stochastic variable within the interception, representing the random effects of different industries. The fixed effect model presumes that the unobserved individual effect is related to the independent variables, while the random effect model presumes that there is no such relationship. In terms of the selection between the two models, there is a rule of thumb that, when the observed value cannot be seen as a result randomly picked from a population, we will normally view the interception as a certain unknown parameter and use the fixed effect model, and when the opposite is true, the random effect model should be used. Moreover, there are some other more standard tests to help us choose between the two models. Greene (1997) introduces a test, which is called the Hausman test. The test makes up the statistic W : ^ –1 [b – ^ ] W = [b – β^ ]t ∑ β In the equation, b is the result of the least squares (LS) dummy variable model test, β^ is the generalized LS estimator when the model is presumed to be ^ is the covariance matrix obtained after estimation a random effect model, and ∑ of the LS dummy variable model or random effect model. The statistic follows a χ 2 distribution with a degree of freedom of k , which is the number of independent variables. The original hypothesis and the alternative hypothesis of the Hausman test are as follows.

H 0 : the unobserved individual effect is unrelated to the independent variable, and a random effect model should be used.

H 1 : the unobserved individual effect is unrelated to the independent variable, and a fixed effect model should be used. The standard is that, if the Hausman value is greater than the critical χ 2 value, the original hypothesis should be rejected, namely, the fixed effect model should be used, and if the Hausman value is smaller than the critical χ2 value, the original hypothesis should be accepted, namely, the random effect model should be used. In the actual test, we first make a random effect regression, and second the Hausman test. If the original hypothesis is rejected, we use a fixed effect model to make the estimation, or in the opposite case, use the random effect model to make the estimation. In the fixed effect interception model, if the random error term does not meet the hypothesis of equal variances or mutual independence, we will need to make an estimation using the generalized LS method. Individual cross section heteroscedasticity means that there is

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heteroscedasticity among the random errors of individual equations, but the covariance is zero among different individuals and different periods, namely,

E (εjt, εjt) = σ2j E (u js, u it) = 0 (i ≠ j , s ≠ t ) Considering that cross section heteroscedasticity will exist, we choose cross section weights, and make the generalized LS estimation for the model using Eviews 5.1. The regression result is shown in Table 8.1. Table 8.1

The analytical result of the backward linkage effect model in industrial clusters

Model

C

1

2

3

4

5

0.181 (0.853)

–1.422 (–6.624)

–1.450 (–6.782)

–0.936 (–2.812)

–1.000 (–3.118)

0.233*** 0.760*** (2.932) (8.574) 0.765*** — (10.746)

ln KL jt ln S jt

0.380*** (8.959)

ln TG jt ln Horizontal_FDI jt ln Backward_FDI jt

—

0.504*** 0.547** (11.700) (2.536) 0.095** (2.537)

0.145** (2.536)

0.760*** (8.669)

0.446*** (3.606)

0.448*** (3.635)

6 –0.863 (–4.623) 0.378*** (4.862)

—

—

—

—

—

—

—

—

0.565*** 0.647*** 0.661*** 0.668*** (8.683) (7.610) (7.978) (12.343) 0.126** (2.712)

0.132** (2.679)

0.132** (2.698)

0.133*** 0.170*** (6.813) (10.091)

ln S jt * ln Horizontal_FDI jt

—

—

—

0.206*** (6.144)

ln Sjt * ln Backward_FDI jt

—

—

—

0.024 (0.763)

0.145*** (3.714)

—

—

—

—

0.085*** (9.008)

—

—

—

—

—

0.112** (3.115)

ln TG jt * ln Backward_FDIjt

—

0.025 (0.520)

After adjustment: R 2

0.984

0.962

0.962

0.955

0.956

0.979

D .W .

1.602

1.569

1.571

2.069

2.031

1.749

Hausman value

13.206**

10.158*

9.829*

Valid samples

90

90

ln TG jt * ln Horizontal_

FDI jt

Note:

0.129*** (7.882)

90

20.006*** 22.662***

11.648**

90

90

90

Inside the brackets are the statistics of t . ***, **, and *, respectively, means 1%, 5%, and 10% significance.

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The regression result shows that: First, capital intensity is an important factor affecting productivity. The regression result shows that the capital intensity factor KL jt of six models all pass the significance test of 1%. In the six regression models, the maximum and minimum capital output elasticity is, respectively, 0.760 and 0.233, averaging at 0.50 and never exceeding 1, which shows that every 1% increase of per capita labor costs will bring less than 1% of productivity increase in local firms, which means that the manufacturing capital in Jiangsu is facing marginal diminishing returns for investment. This result is consistent with the estimations of Guo Qingwang and Jia Wangxue (2005), and Xie Jianguo (2006).3 The low capital output elasticity is largely due to the rapid growth of investment in recent years. 4 The excessive deepening of capital, and the diminishing marginal returns, bring down the investment efficiency year by year. Jiangsu’s higher per capita capital stock makes the s province’s growth rate of capital output elasticity even lower than the national average. Due to the lowering inputoutput ratio, retaining the previous growth rate needs more investment, which will further lower the investment efficiency. Therefore, currently in China, retaining economic growth solely with investment expansion is unsustainable. Second, Horizontal_FDI jt variation coefficient is positive, with an average elasticity of 0.6, which means that every 1% increase of FDI will bring up the per capita output of local firms by 0.6%; namely, FDI significantly facilitates the productivity of local firms. This result is in line with the analyses by Li (2001), Chen Taotao (2003), Xu Helian (2007), etc. Theoretically, FDI will have a spillover effect on local firms through demonstration, competition, and labor flows, thanks to which the productivity of local firms will improve. However, FDI will also compete with local firms in resources and labor market, bringing up the costs of crowdedness in FDI clusters. If the technical margin between local and foreign firms is too large, FDI might depress the development of local firms, namely, FDI might cause the market stealing effect as proposed by Aitken and Harrison (1999), Haddad and Harrison (1993), and Kokko, et al., (2002). In this case, local firms only benefit slightly from the FDI technology transfer, but lose their market to FDI. The positive effect of the FDI horizontal spillover shows that, in Jiangsu, where manufacturing FDI concentrates, the effect of FDI spillover is still bigger than the market stealing effect; therefore FDI is still playing a positive role there. Third, the variation coefficient of Backward_FDI jt is positive, and passes a significance test of 5%. This shows that, in the manufacturing clusters in Jiangsu, foreign firms have a certain degree of backward linkage effect on local suppliers, which, therefore, facilitates the growth of local productivity.

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Blomstrom and Kokko (1998) make a conclusive list of the channels of FDI backward spillover. First, foreign firms often offer technical support to local intermediate product suppliers to help them improve product quality, upgrade their production facilities, or help local suppliers by providing management training, reorganizing production course, supervising product quality, etc., so as to improve local suppliers’ productivity. Second, the higher requirements on product quality set by FDI encourage local suppliers to modify and upgrade their production management system and develop technology innovations. Third, the entry of FDI increases the demand for intermediate products, thanks to which, local suppliers will have scale economies return and improve their productivity. The regression result shows that the average elasticity of FDI vertical spillover is 0.13, which indicates that for every 1% increase in the weights of FDI in downstream industries, the upstream local firms will see a 0.13% improvement in their productivity. If compared, we can see that the average elasticity of manufacturing FDI spillover is far lower than that of horizontal spillover, which indicates that horizontal spillover is still the staple channel of manufacturing spillover in Jiangsu. Therefore, there is still a huge potential in the backward linkage for local firms. Fourth, the result of model 1 shows that the coefficient of technical margin TG jt is positive and this passes the significance test of 1%, indicating that the technology efficiency of local firms significantly affects their productivity. Model 2 and model 3 show that the narrowing of technology margin will intensify the horizontal spillover, but have no significant effect on FDI backward spillover. In terms of the effect of technology margins on the absorption ability of local firms, Haddad and Harrison (1993) believe that, in industries that are technologically underdeveloped, the competition between local and foreign firms will be fiercer, therefore leading to a more significant spillover effect. Kokko (1996) and Djankov and Hoekman (2000) hold that when the technology gap between foreign and local firms is narrow, local firms have the capacity to use and imitate the technologies adopted by foreign firms, therefore leading to the demonstration effect and a more significant FDI spillover effect. The result of this chapter ’s empirical study is in line with those of Kokko, Djankov, et al. As can be seen in model 2 and model 3, after controlling the effects of per capita capital stock, horizontal spillover and backward spillover, technological margin has a significant effect on horizontal spillover. The narrower the technological margin, the more significant the horizontal spillover is. For every 1% narrowing of the margin, there will be a 0.12% increase in vertical spillover. This result also shows that in Jiangsu, a province housing a great amount of FDI, the demonstration effect is a more effective way to facilitate increases in

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production output than the competition effect. One possible reason for this is that foreign firms and local firms in Jiangsu face different markets. With many of the province’s foreign firms being export-oriented, their products are not posing a significant threat to local makers of the same products. Therefore, FDI vertical spillovers which tend to improve local productivity, happen mostly through the demonstration effect rather than the competition effect. The reason that technological margin does not have a significant effect on backward linkage might be that both local firms with higher and lower technical levels increase their productivity through external matching. 5 Therefore, on the macro level, it seems that the level of technological sophistication does not affect the FDI spillover effect. Much literature discusses the effect of a proper technological margin on the absorption capacity of local firms. The earlier theoretical model intended for the study of technology spillovers (Findlay 1978) held that, as the cost for imitation is far lower than technological innovation, the bigger the technological margin is, the bigger the option set is for those who lag behind in technology to imitate, which leads to the belief that the bigger technological margin is a favorable condition for the spillover and spread of technology. Following research, Driiffield and Taylor (2000) found that the technology spillover is decided not only by the initial technological margin, but also by the absorption capacity of local firms, therefore making the relationship between spillover and technology margin a non-linear one. The study also found that there is a certain critical value. When the margin is lower than this value, local firms can take the most benefit from the technological imitation and absorption. Whereas when this value is exceeded, the spillover effect will reduce. The studies of Kokko (1996) and Flores et al. (2000) provide further evidence for this. Kokko’s empirical study (1996) on industrial firms in Uruguay shows that the spillover effect is the most significant for sample firms whose technological margins with foreign firms are on an intermediate level. The study of Flores et al. (2007) on the industrial panel data of Portugal shows that when the productivity of local firms is 50%–80% of foreign firms, the spillover effect is the most significant. In order to examine the effect of a proper technological margin on FDI spillover, in the empirical regression (Euqation 8–6), we use the cross term of the square of technological margin and FDI as an independent variable into the model and conduct the regression. If the proper margin has a significant effect on FDI spillover and there is an optimal value, the cross term should be negative and should pass the significance test. However, the result of the empirical test (Appendix Table 8a.1) shows that there is no effect of the proper technological margin in either vertical or horizontal spillover. The regression result still

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supports the conclusion of model 2 and model 3 — namely, the smaller the margin is, the more significant the spillover effect will be. In the terms of the optimal interval of technological margin for intra-industry spillover, this chapter holds that, as Jiangsu manufacturing FDI mostly spread their technologies through the demonstration effect and local labor flow effect, the smaller the margin is between foreign and local firms, the easier it is for local firms to adopt technologies of foreign firms, in which case, the spillover effect will be more significant. Fifth, the coefficient of variable S jt is as high as 0.765 and it has passed the significance test of 1%, which indicates that the scale economy is an important factor affecting the performance of local firms. Model 4, model 5, and model 6 show that after controlling per capita capital stock, horizontal spillover effect, and backward linkage effect, the scale economy effect has a significant effect on the horizontal spillover of FDI. The bigger the scale of local firms, the more significant the horizontal spillover effect will be. A 1% increase in the scale of local firms will lead to a 0.17% increase in horizontal spillover. This shows that under the current circumstances, apart from labor, capital, and technological sophistication, economy of scale is also an important aspect in enhancing the performance of local firms. Similar to model 2 and model 3, we find no significant effect of the scale of firms on backward linkage. After controlling the effects of related variables, we find no significant effect of a proper scale of local firms on the horizontal and backward spillover (see Appendix Table 8a.1).

A modified model test on FDI backward spillover in different industries In order to study the backward spillover effect of FDI on local firms of different industries, this chapter multiplies the backward FDI parameter with the dummy variables representing the degree of concentration of different factors, and divides the backward spillover effect of FDI by industries, so as to test the effect of FDI on local firms in different industries. The test model is as follows: ln Y jt = α + β1 ln K jt + ln β2 L jt + β3 ln S jt + β4 ln TG jt + β5 ln Horizontal_FDI jt + (β6 × g 1 + β7 × g 2 + β8 × g 3) ln Backward_FDI jt + αj + εjt

g is a dummy variable representing the industries with intensive factors.

When the industry is a labor intensive one, g 1 is 1, when it is an industry intensive with other factors, g 1 is 0. By the same token, g 2 and g 3 are defined respectively as capital intensive industry and technology intensive industry.

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Please refer to Appendix Table 8a.2 for categories of factors. We use Eviews 5.1 to conduct a Hausman test. In a 5% significance test, the original hypothesis is rejected, and a fixed effect model is used. As cross section heteroscedasticity will appear, we choose the cross-section weights, and conduct a LS method to the model, which yielded a regression result as shown in Table 8.2. Table 8.2 The test result of the modified model of the backward spillover effect in FDI industrial cluster Coefficient

T value

ln S jt

0.753 7***

10.376

ln TG jt

0.406 5***

8.799

ln Horizontal_FDI jt

0.521 2***

9.773

g 1 × ln Backward_FDI jt

0.162 3***

3.021

g 2 × ln Backward_FDI jt

0.089 6**

2.084

g 3 × ln Backward_FDI jt

0.010 0

0.146

After adjustment: R

0.984

—

1.676

—

Variable

0.224 0***

ln KL jt

2

D .W .

Hausman value

Note:

14.832**

2.801

—

*** indicates 1% significance and ** 5%. The regression result does not report intercept.

As we can see in the regression result, every 1% increase in FDI, through backward linkage effect, will increase the productivity of labor intensive local firms by 0.16% and will increase the productivity of capital intensive local firms by 0.09%, which both pass 5% significance test. However, no significant backward spillover effect of FDI has been observed for capital- and technologyintensive firms. FDI backward spillover effect for labor-intensive firms is relatively manifest. The reasons for this may be that the market competition of such industries is more sufficient, and local firms already have good industrial basis and learning ability. Furthermore, as the technological threshold of such industries are generally low, multinationals have lower requirements for the quality and technology of input from such suppliers, therefore making it easier for these industries to integrate into the labor division network of multinationals. Multinationals, in order to lower costs under pressure from the competition, tend to have their demands on intermediate products satisfied in the investment receiving region, so as to construct a low-cost, localized, and efficient matching

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network. As the suppliers of such multinationals, local firms are under a strong backward spillover effect. One possible reason that FDI backward spillover effect is less strong on capital intensive firms is that capital intensive firms in Jiangsu are at a better state, therefore FDI accounts for only a very small share in industries of this sort, making investment from multinationals in these industries less important.6 As a result, the FDI backward spillover effect is not entirely released. Another reason that FDI backward spillover effect is less strong on capital intensive firms is that capital-intensive firms in Jiangsu is that FDI purchase less intermediate products from capital-intensive firms than labor-intensive ones, therefore lessening the FDI backward spillover effect on the former. Different from the first two cases, FDI has an insignificant backward spillover effect on capital- and technology-intensive firms. Wu Dandan and Xie Jianguo (2007) found that FDI has a significant facilitating effect on the industrial concentration of capital- and technology-intensive industries. In southern Jiangsu, with the increase in FDI absorption, FDI industrial belts featuring IT and high-tech industries have taken shape. The IT cluster in Suzhou is a typical example. In such industrial clusters where FDI accounts for a high share, FDI has an insignificant backward spillover effect on local firms. The reasons for this are as follows. First, many studies (such as those of Chen, Chang, and Zhang, 1995; Lan and Young, 1996) point out that, FDI in China lacks corresponding technology transfer due to the lack of intellectual property protection in technologyintensive industries in China. So that FDI only transfers labor-intensive links in their production process to China, therefore limiting the spillover effect in capital and technology-intensive industries. Second, the investment motivation of FDI leads to a low degree of local procurement of capital and technology-intensive intermediate products. Blalock (2002) and Clare (1996) point out that the motivation of FDI’s entry into the host country has a great influence on the degree in which the branches of multinationals make local procurement. Branches of multinationals that are oriented to the host countries usually purchase more local products than those oriented towards export. Compared to the home country of multinationals, the requirements on quality and technology of products are generally lower in the domestic market of host countries. Therefore, branches of multinationals oriented to the markets of host countries are more likely to have local suppliers that meet their procurement demands, which leads to the backward spillover in industries of low technology intensity. In contrast, export-oriented branches are part of the global production network of multinationals. They are more reliant

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on the mother firms’ global procurement policy. Moreover, as they are oriented to the global market, these branches have a stricter requirement on cost and quality, which requires local suppliers to have large structural adjustment and productivity improvement. Local suppliers therefore often have a certain degree of matching limitation, which leads to the low degree of local procurement of capital- and technology-intensive intermediate products and this in turn limits the backward spillover effect. Third, a large amount of capital- and technology-intensive FDI is the vertical FDI of multinationals. These investments in China often lead to the overall relocation of the original product chains. The investment of one multinational will often bring about the investment of its original suppliers following it. Such industrial clusters based on FDI have created, along with its relocation, an almost complete supporting system. These clusters therefore have a weak connection with local firms and a low embeddedness. Usually, the more technologically sophisticated the branches are, the weaker their connections are with local firms, and the higher the possibility of an overall relocation of their original suppliers, therefore the less intense the backward spillover will be. Fourth, the technological level of local firms is relatively low, making it hard for them to match the production techniques of multinationals in technology and capital-intensive industries, which also lowers the degree of local procurement of multinationals. This is often seen in high tech industries; as in these industries, the technology gap between the host country and the multinationals is wider than other industries. For example, when Suzhou tries to attract high tech FDI, it is mainly confined to the role of providing assembling and processing, and most of the firms providing such services are mainly foreign firms. High tech branches of multinationals make very little local procurement, and when they do, most of the products purchased are low value consumables. When it comes to the main parts of their products, especially the core parts, multinationals mainly rely on import or other foreign firms. Therefore, such FDI is making little contribution to the improvement of the productivity and learning of local firms. Judging from the current situation, manufacturing FDI absorbed by China, especially technology-intensive FDI, is still in the processing trade stage. Multinationals from developed countries and regions will relocate some low-end production, processing, and assembly links to China due to China’s comparative advantages, which are mostly production processes that require intensive labor of high tech products, such as the assembling of electronics and machines. The products of these foreign firms assembled in Jiangsu are mainly to meet the orders from abroad. The entry of a large amount of such foreign firms in Jiangsu has made the province an export

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A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

and import base for processing trade. Local firms take the orders of processing and are confined in the labor intensive production of products of lower technology intensity. 7 Such a labor division pattern limits the FDI spillover effect in technology and capital intensive industries.

Conclusion This chapter uses Jiangsu as a sample to study the backward spillover of FDI to local firms in industrial clusters led by multinationals. The result shows that the intensity of backward spillover is lower than that of horizontal spillover, indicating that, horizontal spillover is still the main channel of FDI spillover in the manufacturing industries of Jiangsu. The study also studies the effects of the scale economy effect and technological margin on FDI spillover, the result of which shows that these two factors have significant effects on FDI horizontal spillover. The bigger the scale of local firms, and the smaller the technological margin between local firms and foreign firms, the more significant the horizontal spillover will be. However, empirical study shows that backward spillover is affected by these two factors. The chapter makes an industry-specific analysis on FDI backward spillover. The result shows that FDI backward spillover effect varies in industries with different intensive factors. FDI backward spillover effect is significant on local suppliers in labor-intensive and capital-intensive industries, whereas FDI backward spillover effect is insignificant on local suppliers in capital and technology-intensive industries. This shows that there is still no close forward and backward production relationship between foreign firms, and local firms are in capital and technology-intensive industries. Possible causes of this are listed as follows. Local firms are still underdeveloped and therefore cannot make a technological connection with foreign firms, especially large multinationals. The competition between these local firms and foreign firms which are the original suppliers of the multinationals and have now also relocated themselves following the multinationals, or other foreign firms, makes it harder for local firms to integrate into the global labor division network of multinationals. As for those local firms that have integrated into the network, they are mostly confined in the lower end of this global production chain. This limits the backward spillover effect of FDI in capital and technology-intensive industries. Therefore, right now, the priority for local firms is to improve their production level and matching ability and meet the requirements of multinationals in

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

technology and productivity — so as to gradually integrate themselves to the value chain which is dominated by multinationals — and become the beneficiary of the global division of labor. For the governments, there are several aspects they need to pay attention to in the future attempt to attract FDI. First, they need to pay attention to the quality of FDI, continue absorbing capital and technology-intensive FDI, facilitate the horizontal and vertical spillovers and promote the optimization and upgrading of local industrial clusters. Second, they should try to absorb FDI that has a long production chain. And instead of absorbing the whole production chain, they should try to absorb some certain links of the chain, especially high-end links, such as R&D. In this way, the cluster brought about by FDI will offer more chances for local firms to couple with foreign firms and facilitate backward spillovers. Finally, governments should provide guidance for the exchanges and cooperation between multinationals and multinationals, between multinationals and local firms and, among local firms, create a good competition and cooperation relationship among these firms and an environment that encourages innovation, and strengthens the local embeddedness of multinationals which will facilitate local economic growth.

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A Study on the Spillover through Backward Linkage to Domestic Firms from FDI

Appendix Table 8a.1

The test result of the effects of proper technological margin and proper firm scale

Model

7

8

9

C

–0.889*** –0.704*** –0.816*** –0.837*** –0.859*** –0.887*** (–4.293) (–2.877) (–4.190) (–4.558) (–4.598) (–3.206) 0.357*** 0.467*** (4.277) (5.428)

ln KL jt ln Horizontal_FDI jt

10

0.345*** (4.345)

11

12

0.352*** 0.382*** 0.345*** (4.374) (4.795) (3.224)

0.699*** 0.587*** 0.675*** 0.647*** 0.664*** 0.682*** (12.203) (9.819) (12.065) (10.959) (11.830) (9.536)

ln Backward_FDI jt

0.127*** 0.096*** (2.772) (2.860)

0.148*** (3.344)

0.194*** (3.642)

0.148*** 0.156*** (3.828) (3.205)

ln S jt * ln Horizontal_FDI jt

0.183*** 0.151*** (9.227) (5.917)

0.177*** (9.959)

0.171*** (8.129)

0.171*** 0.148*** (8.224) (4.759)

ln TG jt * ln Horizontal_FDI jt

0.065** (2.327)

0.086*** (4.476)

0.085*** 0.085*** (8.447) (8.756)

ln TG jt * ln Backward_FDI jt

0.063** (2.108)

—

—

—

(ln S jt)2 * ln Horizontal_FDI jt

—

—

—

0.017 (0.890)

—

—

—

(ln TG jt)2 * ln Horizontal_FDI jt

–0.016 (–0.716)

–0.019 (–1.188)

–0.030 (–1.074)

—

—

—

—

0.004 (0.173)

—

—

—

—

0.978

0.978

0.967

1.759

1.767

90

90

(ln S jt)2 * ln Backward_FDI jt

(ln TG jt)2 * ln Backward_FDI jt

Adjusted R 2

D .W .

1.674

Hausman value

10.752*

Valid samples

Note:

0.977

90

–0.0001 (–0.007)

0.978 1.722

11.687** 90

—

0.978 1.743

10.904* 90

—

0.087*** (5.047)

–0. 0001 (–0.069) —

— — –0.019 (–1.204)

14.035*** 12.671**

2.083

14.249*** 90

Inside the brackets are the statistic values of t . *** indicates a significance level of 1%, ** indicates 5%, * indicates 10%.

Table 8a.2

Categories of intensive factors

Industries

Factors

Industries

Factors

Food manufacturing

Labor intensive

Capital intensive

Textile

Labor intensive

Metal smelting and calendaring industry Metal products

Capital intensive

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Industries

Factors

Clothing, leather, feather Labor intensive manufacturing

Industries

Factors

General and special equipment manufacturing

Capital and technology intensive

Wood processing and furniture making

Capital intensive Transportation equipment manufacturing

Capital and technology intensive

Paper making, printing, office tools making

Capital intensive Electronics, machinery manufacturing

Capital and technology intensive

Petrol processing, coke making

Capital and technology intensive

Capital and technology intensive

Chemicals

Capital intensive Meters, office tools manufacturing

Capital and technology intensive

Nonmetallic mineral products

Capital intensive —

—

Telecommunication equipment, computers and other electronics manufacturing

Note: The categorization in the table is made referring to Xie Jianguo (2003).

242

9

Chapter

Foreign InvestmentLed Growth Model and Distribution of Income: A Case Study of Kunshan

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Since the 1980s, with the deepening of global economic integration, foreign direct investment (FDI) has become a powerful engine for promoting China’s economic growth. The influence of this foreign-led economic growth process on the domestic pattern of income distribution has naturally become one of the hot issues of scholarly study. It is generally believed that the early experiences of Latin American countries in this area caused China’s policy-makers’ great concern. As early as the 1960s, Latin America countries formed an export-oriented processing trade development mode with the aid of the power of global economic integration. In such a development mode, foreign investment had a very serious influence on the income distributions of host countries in Latin America, which was especially concentrated in two aspects. One aspect was the influence of FDI on the host countries’ income level and income gap, and the other was the issue of profit distribution and foreign investment countries and host countries. For the first issue, researchers focus on the influence of FDI inflows on inequality of wage paying, widening of the social wealth gap between the rich and the poor, and other issues in host countries. After entering the host countries, foreign-invested enterprises pay higher wages than domestic enterprises or local enterprises of the developing countries on the average, but such payments have a huge difference for skilled workers and unskilled workers, thus widening the gap of actual wages between workers in developing countries. For example, after respectively analyzing the data of U.S., Mexico, and Venezuela, Brian, Harrison, and Lipsey (1996), and Zadia and Lipsey (1999), found that when other conditions were the same, the level of wages paid by FDI enterprises was higher than those paid by domestic enterprises, which increased the Gini coefficient of per capita wage of those host countries. Lipsey and Sjoholm (2001) used the data of 14,000 enterprises in Indonesian manufacturing (including FDI enterprises and domestic enterprises) for their study. As a result, they found that FDI enterprises’ payments for blue-collar workers were 12% higher than those of domestic enterprises, and for white-collar workers, FDI enterprises paid a premium of 22% more than domestic enterprises. Nafziger (1997) and Salvatore (1998) held that FDI would exacerbate the state of income inequality because multinational corporations would exert pressure on the host country government and trade unions, cut welfare spending and lower wages by threatening not to invest in the country. Thus, the interests of a vast majority of the lower and middle classes were damaged.

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Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

Lin Hong (2005) conducted an analysis of panel data model with related data (data 390 records in total) of 30 provinces, municipalities and autonomous regions in mainland China (except Tibet) from 1991 to 2003. As a result, he found FDI’s spillover effect for the overall level of wages of skilled workers in mainland China. Such a finding is similar with that of foreign scholars. In other words, FDI significantly improved the level of wages of skilled workers relative to unskilled workers. He indicated that the main source of income for the majority of Chinese residents still was wage income of labor. Among them, wage income of urban residents accounted for about 70% of the total income, rural wage income also accounted for 30% of the total revenue, and other income forms were relatively less. Therefore, the income disparity discussed here can be approximately deemed an income disparity. In addition to the gap in the wage distributions, some scholars studied the influence of foreign investment on regional distribution of income. Fan Yanhui and Duan Junshan (2003) conducted an empirical analysis of the influence of FDI on Chinese residents’ income gap, showing FDI has a very significant correlation with Chinese residents’ income distribution. It affected the income gap between foreign investment sector and non-foreign investment sector, and that between the regions with active foreign investment and the regions with rare foreign investment mainly through the industrial chain, the spillover effect of foreign investment sector, capital attraction, and trade driving. Thus, it resulted in the widening of the income gap between regions, especially that between the eastern and western regions. From the above scholars’ studies on the issue of foreign investment and income distribution of host countries, foreign capital inflow is beneficial to improving local wage levels. However, at the same time, it also tends to drive down the lower and middle classes’ incomes, thus increasing the gap of income distribution between skilled workers and unskilled workers, that between foreign-funded enterprises and domestic-funded enterprises, and that between regions. The wages of foreign-invested enterprises (FIE) are generally higher than those of domestic and local enterprises, which is also one of the reasons

leading to the inflow of labor to the foreign sector. For the second issue, Prakash (1999) believed that economic globalization had made the status of cross-border global value chains increasingly more important in international cycles. And, at present, the international flow of factors mostly took place in such global value chains. As factor income needs to obey the law of scarcity degree, and the barriers of the cross-border move of labor factors exist, they accordingly have determined the following characteristics of interest distribution mechanism in the global value chain: enterprises from

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

developed countries obtain high value-added knowledge work income, while developing countries can only get income of the low-end labor-intensive industries. Through simple comparisons of knowledge labor force, research and development spending, industrial division of labor, and other aspects between developed countries, such as the U.S., and developing countries, such as China, Zhou Xueqin (2003) explained that developing countries were in a weak position in the distribution of the six factors of knowledge-based labor force, knowledge factor, information factor, financial factor, innovation capability factor, and core technology factor. As differences of factor endowments determined the size of countries in participating in the interests of the system of globalization, developing countries were in a disadvantage in the income distribution process of global growth. He indicated that factor structure was determined by the level of a country’s development and it cannot be easily changed in a short period of time. In the process from labor-intensive stage to capital-intensive stage, due to relatively easy capital flow, developing countries can change the situation of insufficient capital in a short period of time, but due to insufficient flow of labor factors, especially knowledge labor factors, it is difficult for their relationships of income distribution to have an essential change. As a pioneer of the growth model of foreign-led processing trade, the imbalance issue of Latin America in the distribution of profits was also very serious. At that time, the massive influx of foreign capital to the manufacturing sector of Latin American countries also continuously accumulated the pressure of profit repatriation, while promoting economic growth. In the beginning of their independence and development, foreign capital already formed a monopoly on the economies of Latin America; Latin American countries bore the pressure of the imbalance of profit distribution proportion and couldn’t obtain the primitive accumulation of capital necessary for their national economic development, resulting in excessive-reliance of their economic growth on foreign capital. Thus, economic stagnation resulted. By empirical analysis on the Latin American countries using foreign capital, Li Jianwei (2006) concluded that: the influence of technological progress, domestic investment, and new inflow of foreign capital on economic growth was positive, and the influence of profit repatriation and debt service on economic growth was negative. China’s southeast coastal region is a typical area of China’s foreign investment-led growth mode, and its path of development has some similarities with Latin American countries. In the economic development of this region, China also faces the same problems encountered by Latin American countries in the past. One problem is the influence of foreign investment on the residents’ income. Liu Qihong (2004) indicated that in such a growth mode, Suzhou’s

246

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

per capita GDP and per capita income of urban and rural residents were not proportional, and in a horizontal comparison with cities such as Shanghai,

Hangzhou, and Ningbo, compared with the surrounding cities, Suzhou residents’ income had a large contrast. He pointed out that Suzhou took the path of “adventive industrialization” and did not really “enrich people.” Chu

Dongtao and Fan Qinxian (2005) analyzed economic challenges caused by

Suzhou’s foreign investment-oriented economy. They held that in this region’s

economic growth, huge profits were obtained by foreign businessmen, or were remitted to their native countries (regions), and a vast majority of the masses

of lower and middle classes in the south of Jiangsu did not obtain much actual interest from the rapid economic growth.

Of course, the export-oriented path of China’s southeast coastal region

also has many differences with early Latin American countries. Relative to the

phenomenon of the low domestic savings rate in Latin American countries, in China’s foreign investment-led growth mode, domestic capital is relatively adequate. However, the proportion of converting savings into effective

investment is very low, in which the lagging development of private enterprises is a prominent performance. In addition, due to China’s fiscal decentralization

system and politician performance requirement of the governments at all levels; China also has many prominent features in attracting foreign investment. In

order to pursue political performance effects and immediate economic growth, the governments often do not balk at sacrificing local resources of sustainable development, but to some extent, they ignore the issue of income distribution.

Based on the above understandings, we hold that when studying the foreign

investment-led growth model and the distribution of incomes, one sees an

urgent need to add the content of case analysis from China’s regional economic

practice, so as to enrich the understanding of China’s development process

and development features. The FDI-based economic growth feature of China’s coastal region provides our study with rich materials. This chapter takes

Kunshan City, Jiangsu Province as an example to analyze the residents’ income growth and income distribution issue in the export-oriented economic growth

mode from the two aspects of phenomenon and intrinsic formation mechanism. Our question is: in the economic growth mode of Kunshan City, how does foreign investment promote economic growth, and why do residents’ incomes

lag behind the regional economic development so much? In the operation of national economy with foreign investment participation in the distribution, how does its distribution pattern form?

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Kunshan: Foreign Investment-Led Economic Growth Mode As a county seat in the south of Jiangsu province adjacent to Shanghai and Suzhou, by its unique location advantage, Kunshan grasped the historic opportunity of the development of Pudong and Shanghai, and the upgrading of Taiwan’s industries, in a timely manner, and put forward the “export driving” economic development strategy, attracting a large number of labor-intensive small and medium-sized projects. Especially in more than one decade after 1995, foreign investment in Kunshan gradually changed from the labor-intensive type to the capital-intensive type and technology-intensive type. Thus is formed the link of the labor-intensive force with Kunshan’s four pillar industries dominated by electronic information, precision machinery, fine chemicals, and highend consumer goods, which mainly involved instrument assembly, garment processing, and other production. Within a short period of more than a decade, by its processing and exportoriented economic growth mode, Kunshan made the regional GDP increase from RMB2.012 billion in 1990 to RMB93.201 billion in 2006, and industrial added value increased from RMB5.618 billion in 1995 to RMB60.506 billion in 2006. Kunshan’s export-oriented industrialization road has made it develop from a backward traditional agricultural country into the head of China’s top 100 counties. In rapid development of foreign-investment economy, the living standard of Kunshan citizens also has been greatly improved. However, behind the surface phenomenon of the growth of the economy and people’s income, the existing problems have also become increasingly obvious and impossible to be ignored. It can be seen from Fig. 9.1 that, since 1991, compared with the rapid growth of the region’s per capita GDP, the urban and rural residents’ income growth has been very limited. Since 1990, Kunshan’s per capita GDP has increased from RMB3,579 to RMB141,063 within a few years, with an increase of 38.41 times, while the urban residents’ per capita disposable income growth rate has only increased by less than 10 times and the rural per capita net income has only increased by 5.28 times. Relative to the growth rate of enterprises’ profits, especially the high profit growth rate of FIEs, the level of workers’ wages growth has been slow. In 2006, the growth rates of both profit and taxation of profit of FIEs (including Hong Kong-, Macau-, and Taiwan-funded enterprises and FIEs, the same below) in the whole city were more than 50%. However, the growth rate of its workers’ wages was only 8.6%, and the growth rate of the

248

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

average wage of workers in employment was only 13.4 %. The proportion of residents’ income in the total GDP has been increasingly falling, and the people cannot fully share the actual performances of economic growth.

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

(RMB) 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0

1992

Changes of urban and rural residents’ income and per capita GDP

1991

Fig. 9.1

Rural per capita net income Per capita regional GDP Urban residents’ disposable income Note: All the data are present value. Source: Kunshan City Statistical Yearbook (1991–2007).

In an overall view, Kunshan’s economic growth has two significant features as follows: First, Kunshan is in a typical foreign investment-led growth mode. Its basic feature is, by large-scale absorption of FDI, to achieve a package transfer of capital, professional knowledge, and technology, to change its former industrial structure, to use international competitive advantage of cheap local labor force to develop export trade based on export processing, and gradually realize industrialization. In the process of developing the export processing industry, technical resource is the shortest growth factor of Kansan’s economy. Speeding up the use of external technological resources by introducing FDI and exchanging for advanced technology with the market has been the key local strategic goal. After more than 10 years of practice, Kunshan’s growth mode of attracting foreign investment to develop export processing industry has been formed. Kunshan City’s foreign trade and export have made a huge contribution to driving the region’s GDP. In 2006, its imports and exports amounted to USD42.745 billion, of which exports amounted to USD24.366 billion, imports

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

amounted to USD18.379 billion, and dependence on foreign trade was as high as 362%. More than 90% of Kunshan City’s import and export trade is export processing trade, of which more than 90% of export processing trade was completed by FIEs. On the surface, Kunshan’s export-oriented economy is mainly driven by foreign trade. As FIEs take an absolute dominant position in international trade, its nature is foreign investment-led export processing economy, and using foreign capital is the nature and core of Kunshan’s exportoriented economy. Second, the development of Kunshan’s local private economy is insufficient and is largely dependent on foreign investment, and the residents mainly work for foreign businessmen. According to statistics, in 2006, the contribution of foreign investment to gross industrial output value reached 91%, while individual and private economies only accounted for 8%. However, regarding fiscal revenue, a high degree of imbalance was shown: in the same year, foreignrelated taxation’s contribution to fiscal revenue was 46.6%, while individual and private economies’ contribution reached 22%. The reason for this was largely attributed to preferential tax policies enjoyed by foreign investors, and other reasons. Due to dependence on the industry chain, a very large part of local private enterprises, especially private enterprises above the scale (except for a very small number of enterprises with their own brand names [e.g., Goodbaby Group Co., Ltd. in Lujia Town]), act as supporting workshops of FIEs and process parts and accessories for the supply of FIEs’ export or processing and re-export. And, there are also a part of them that act as OEM factories mainly undertaking OEM orders and engaging in export trade. This part of private enterprises is very similar to the local FIEs in nature. They develop processing trade with cheap labor force as the main competitive advantage, are equivalent to the domestic-funded workshop of FIEs, and have indirect foreign investment orientation. If employees of those dependent enterprises are accounted for by being included in FIEs, it can be found that foreign investment also takes a dominant position in local residents’ employment form. The local people largely act as workers of foreign investment, and residents’ income mainly comes from wage income.

The Growth Path Combining Technology Dependence and Low Wage Since the end of the 20th century, technical efficiency has gradually become the most important endogenous variable affecting economic growth. In the

250

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

simple model on export processing economic growth built by Chen (1990), the deciding factor of export-oriented economic growth is the gaps of wage level and technological level, i.e., assuming the function Y = (T – W ), where Y is the rate of economic growth , T represents technological level, and W represents wage level. This theory is based on the development theory of Joseph Alois Schumpeter (1990) on technological innovation as the decisive factor of longterm economic growth. In this theory, maintaining a high contribution rate of technology to economic growth is an important driving force for sustained economic growth. Fig. 9.2 shows the long-term trend of technological level and wage level. The S -shaped curve of technological level shows, at the beginning, that the technological growth rate increases progressively, and when economic development reaches a certain stage, the technology growth rate begins to decrease progressively. The wage level curve is also S -shaped. At the beginning, due to the existence of a large number in the surplus labor force, the wage growth rate decreases progressively, and at a later stage, as the labor force is in a relative shortage, the wage growth rate increases progressively. Fig. 9.2

Export-oriented economic development mode Technological level Wage level

Economic growth Sources:

1. Chen E.K.Y., 1990, Foreign Direct Investment in Asia (Tokyo: Asian Productivity Organization). 2. Chen E.K.Y., 1994, Transnational Corporations and Technology Transfer to Developing Countries (London and New York: Routledge), 393.

Fig. 9.2 shows that the bigger the gaps of technological level and wage level are, the bigger the growth rate is; their gaps also determine international competitiveness of a country’s export products, and the gaps of technological level and wage level are consistent with competitiveness. It is just due to the existence of T – W gaps that support the completion of early industrialization

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

in the process of economic development. In the export-oriented growth model, we assume that technology mainly comes from FDI, and technological level will depend on the size and quality of FDI. Because the low-cost advantage of the labor force is a prerequisite for introducing one of the important conditions of determining investment environment, keeping low cost of labor factor, and obtaining high technological contribution rate will be combined organically. The former becomes a constraining factor of the latter, and the interaction between them further plays a role in the economic growth of the exportoriented mode. As stated above, Kunshan Economy is a typical foreign investment-led growth mode. Similar to the development mode described by Chen, its feature at the early stage is, by large-scale absorption of FDI, to achieve a package transfer of capital, professional knowledge, and technology, so as to solve the factors in shortage in economic growth, namely, the supply of advanced technology, change the former resource allocation pattern of the region, and vigorously develop export trade. At the end of the 20th century, Kunshan economic development entered into the second stage of this development mode, i.e., the gaps of technological level and wage level were widened, and the economy grew rapidly. In this process, technology mainly comes from foreign direct investment. According to the model given earlier, we establish Kunshan City’s economic growth estimate function:

Y = C 0 + α (T – W ) + ε Where Y represents the rate of economic growth, expressed with the added value of annual regional GDP per capita; T represents technological level, expressed with labor productivity. We assume technologies entirely come from FDI, so T is expressed with labor productivity of FIEs; W represents wage level, expressed with the average wage of employees; ε is random disturbance item; to some extent, it represents the influence of other factors on economic growth. This chapter uses the data of the Kunshan region from 1990 to 2006 (calculated at the constant prices in 1990) to conduct the least squares regression, and the result is as follows:

Y = 0.182 851 (T – W ) – 1,779.538 t 6.483 18 – 2.277 619 2 R = 0.947 680 D .W . = 0.885 650 2 AR = 0.944 192

252

F = 271.695 3

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

The result shows that both the statistical value of explanatory variable t and the F statistical value of the model pass the test of significance, but D .W . is too small, and there is autocorrelation. Considering the influence of the economic hysteresis role, as well as to more clearly demonstrate the relationship of change between economic growth and “technology / wage” gaps, the model was re-set as:

Y t = A (T t – W t)α Y t–1β Where Y is absolute value of GDP per capita, t is time series, both sides of T and W take logarithm, set ln A = γ, plus random disturbance item, then get:

Y t = α ln (T t – W t) + β ln Y t–1 + γ + ε The result shows (see Table 9.1), concomitant probability P value of F test is 0, indicating that the regression equation is significant. Moreover, concomitant probability P values of t statistical values of all the estimated parameters are close to 0, coefficient is significant at the level of below 5%, while autocorrelation is also eliminated, R 2 value is close to 1, and degree of fitting is excellent. This model shows the correlation between Kunshan City’s economic growth and “technology / wage” level gaps in 17 years from 1990 to 2006 from the perspective of time series in a good manner. Among them, the rate of contribution of “technology / wage” level gaps to economic growth reaches 84.37%, while economic growth in a previous period also plays a very obvious lagging role to economic growth of the current period, the rate of contribution is 25.29% and the constant is 1.252 3. As technological level is expressed with labor productivity of FIEs, the local economic development model is fitted very well. It shows that foreign capital plays a vital role in introducing technological level and promoting economic growth. Table 9.1 Coefficient

OLS results of double logarithmic growth function Coefficient value

Standard deviation

t statistical value

P value

α

0.843 737

0.084 672

9.964 709

0

β

0.252 907

0.071 991

3.513 061

0.003 8

γ

–1.252 3

R2

AR 2

0.998 503

0.998 273

0.213 688

–5.860 4

0.000 1

F statistic

P value (F test)

DW value

4,335.239

0

1.863 3

Note: The results are given by the Eviews software package.

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Kunshan’s economic growth feature of combining technological dependence and low wage formed in the development in the past has its historical background and role mechanism. We might conduct a simple analysis on it. First, before the 1990s, Kunshan City had slow economic development, low technological level of the industrial enterprises, almost no technological innovation investment, low labor productivity, and a low wage rate. In the 1990s, under the conditions of economic globalization, its international industrial structure was adjusted greatly, which was mainly manifested in the adjustment of different production links in the industrial chain led by multinational corporations. On one hand, in order to bypass trade barriers, expand production scale and obtain cheap labor, multinational corporations of developed countries and regions implemented a transfer of labor division of industrial chain to higher profit margins. They used the way of FDI to gradually transfer the manufacturing link lack of comparative advantage to developing countries. On the other hand, Kunshan region had backward industry, stagnant technological progress, was lacking effective investment, and its industrial development was in urgent need of capital and technology input. By virtue of its excellent initial resource endowments (convenient port of trade, abundance of cheap labor, etc.) as well as a favorable investment policy (cheap land-use fees, preferential tax policies, etc.), Kunshan successfully absorbed large-scale foreign investments and technologies. By the introduction of foreign capital and advanced technology, productivity was greatly improved, and an exportoriented development mode with low labor factor cost as the competitive advantage was initially established, thus rapid development of the local economy was promoted. Second, Kunshan’s economic growth has appeared with continuous path dependence and needs to constantly introduce foreign investment and advanced technology to enhance the original growth pattern. Foreign investment in Kunshan region basically is limited to simple processing and assembly process, which remains in the end of manufacturing and belongs to a labor-intensive industry. However, almost all technical supports come from FIEs. Due to FIEs’ monopoly of advanced technology, it results in the slow progress of the local technology, backward independent innovation, and blocked industrial upgrading of the local manufacturing. From the perspective of foreign capital’s investment direction, at present, most of FIEs in Kunshan belong to labor-intensive manufacturing link of high-tech industries. They mainly engage in activities of processing imported intermediate products and then re-exporting. Their productions are essentially labor-intensive operations with low technological content, and their effect

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of association with high technology of FIEs is weak. The local international

competitiveness only shows as the low cost of labor factor, resulting in

continuous low technological content of local manufacturing activities. A vast majority of FIEs put science and technology research and development and core technology in their home country (region), e.g., in their clothing

factories, sample design, and core fabric production are provided by FIEs’ home countries. In the production process of electronics and precision instruments,

core technology, product design, software support, key parts, and components supporting, key equipment and molds and other important links are also

mostly controlled by multinational corporations, and the local factories are only responsible for simple processing and assembly. The manufacturing activities have been at the end of the value chain.

With the entry of foreign capital, more and more foreign capitals adopt

the wholly foreign-owned form in order to prevent spillover of technology and sharing of technology. Thus, it leads to the fact that it is hard for the local

enterprises to absorb and digest advanced foreign technology through joint ventures. In addition, although at present, a lot of multinational corporations have established their research and development (R&D) center, they only

put auxiliary research and development work in Kunshan through the

strategy of independent fund operations and division of labor of research and development, thus largely blocking the channels of technology diffusion of multinational corporations and the spillovers of advanced technology.

It is just because of the foreign party’s monopoly of core technologies that the

technology spillover effect is not obvious. The local area’s absorption of foreign technologies is very slow. There is no way for the local area to rapidly improve

its local production technology level through imitation, technology transfer, and the technology innovation mechanism. The industrial upgrading is blocked, and

manufacturing is always at the low end of the industrial chain. Therefore, from the perspective of the existing industrial structure and industrial chain level, to

maintain the momentum of economic growth, we must allow the constant entry of FDI and continuously introduce exogenous technology.

Through further analysis, it can be found that low labor cost is the most

important factor of attracting foreign investment, and is also an endogenous requirement of economic growth, so Kunshan’s economic growth must rely

on the low wage rate, and maintaining the low wage rate is the necessary

requirement of economic growth, in other words, while maintaining economic growth.

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Income Distribution Mechanism during the Process of Economic Growth In Kunshan’s economic growth, the pattern of income distribution has the following characteristics: First, the proportion of wage in value added declines, while the proportion of profit in value added rises. Because the main source of the local residents’ income comes from wages, we use the data from 1995 to 2006 to survey the income distribution situation from the perspectives of profit and wage, with industrial enterprises as a representative. Table 9.2 reflects the changes of the proportions of wages and profits in industrial added value from 1995 to 2006. It can be seen that the proportion of profit in industrial added value has been always higher than the proportion of wage, and this gap became bigger and bigger. The proportion of wage showed an obvious declining trend from 1995 to 2006, with an average annual decline of 0.43 percentage points and a total decline of 4.37 percentage points. The decline degree was up to 39.02%. Although the proportions of pre-tax profit and after-tax profit in value added had fluctuations, they generally showed a rising trend, and basically remained stable from 1995 to 1999. From 1999 to 2001, a sharp rise appeared, and the proportion of pre-tax profit and that of after-tax profit rose by 8.95 percentage points and 6.61 percentage points, respectively. Within the following two years, after some adjustments, the rising trend kept going. During this period, the average annual pre-tax profit and after-tax profit rose by 0.76 percentage points and 1.04 percentage points, respectively, and they rose by 8.34 percentage points and 11.46 percentage points in total. The rising degrees were up to 40.31% and 100%. Table 9.2

Situation of Kunshan City’s industrial added value segmentation from 1995 to 2006

Wage (RMB10,000, Pre-tax profit %) (RMB10,000, %) Value added Year (RMB10,000) Total Proportion Total Proportion amount amount

Total amount

Proportion

1995 513,648

57,524

11.20

106,264

20.69

58,874

11.46

1996 610,405

69,966

11.46

125,735

20.60

70,033

11.47

1997 694,704

78,380

11.28

138,006

19.87

75,517

10.87

1998 798,604

83,000

10.39

169,479

21.22

94,223

11.80

1999 921,242

87,916

9.54

220,444

23.93

113,051

12.27

2000 1,105,699

114,221

10.33

355,116

32.12

205,853

18.62

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After-tax profit (RMB10,000, %)

Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

(Cont'd) Wage (RMB10,000, Pre-tax profit %) (RMB10,000, %) Value added Year (RMB10,000) Total Proportion Total Proportion amount amount

After-tax profit (RMB10,000, %) Total amount

Proportion

2001 1,284,488

136,022

10.59

422,308

32.88

242,557

18.88

2002 1,910,358

177,483

9.29

501,121

26.23

334,699

17.52

2003 2,670,751

227,750

8.53

660,513

24.73

444,980

16.66

2004 3,686,422

278,174

7.55

972,092

26.37

710,129

19.26

2005 4,740,275

351,649

7.42

1,210,129

25.53

910,016

19.20

2006 6,050,571

413,471

6.83

1,756,191

29.03

1,386,685

2.92

Note: Calculated at present price. Source: Kunshan City Statistical Yearbook (1995–2006).

From Fig. 9.3, we can clearly see that the declining trend of wage proportion and the rising trend of profit proportion are equally obvious. It indicates that in the process of economic growth, the workers are always in an inferior position of income distribution, and this situation is increasingly serious. Second, the growth degree of per capita wage is much lower than that of profit, which is more serious in FIEs. From Fig. 9.4, we can see that whether the whole city’s industrial enterprises or foreign-funded industrial enterprises, their profit growth rates are generally higher than their wage growth rate, and the gap is very obvious. Within 12 years, the whole city’s per capita wage increased by 6.30 times, with an average annual increase of 0.57 times, and the gross profit

Wage

Pre-tax profit

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

35 30 25 20 15 10 5 0

Situation of Kunshan City’s industrial added value segmentation from 1995 to 2006

1995

Fig. 9.3

After-tax profit

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increased by 23.55 times, with an average annual increase of 2.14 times. The FIE’s per capita wage increased by 3.02 times, with an annual average increase of 0.27 times, and the gross after-tax profit increased by 41.02 times, with an average annual increase of 3.73 times. Fig. 9.4

A comparison of annual growth rates of per capita wage and profit in the industrial sector

1.2 1.0 0.8 0.6 0.4 0.2 0 –0.2

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Profit growth rate

FIE’s profit growth rate

Wage growth rate

FIE’s wage growth rate

Notes: 1. Calculated at present price. 2. The profits in the figure are after-sale profits Source: Kunshan City Statistical Yearbook (1995–2006).

It can be seen that there is a very big similarity between FIE’s profit growth and the profit growth trend of the city’s industrial enterprises. Regarding numerical value, FIE’s profit growth degree almost doubles the profit growth degree of the whole city’s industrial enterprises, while the growth degree of the enterprise employees’ wages is less than half of the level of the whole city’s industrial enterprises. It shows that in the FIEs, the gap between distributions of profit and of wages is more obvious, and there is a very great disparity of the powers of income distribution between capital and labor. Based on foreign capital’s extensive and in-depth participation in Kunshan City’s national economy, the gap between distributions of labor and capital appearing in FIEs has a close connection with the slow growth of the whole Kunshan City’s employee wages. As the workers from FIEs took up a large proportion in the whole city’s employment number, slow growth of their employees’ wages has largely buffered the whole city’s wage growth rate, and affects the rapid growth of the income of Kunshan City’s residents. The reasons for the formation of this pattern of distribution are mainly as follows:

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Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

Labor supply mechanism In the early 1990s, Kunshan was an agricultural county dominated by agriculture. The rural population made up a large proportion, the local farmers used the traditional methods to engage in agricultural production, their labor productivity was low, and their incomes were just basically enough for them to survive. But in urban areas, there were also a certain number of industrial sectors. Such sectors carried out production with modern methods, and their labor productivity and wages were higher than those of the agricultural sector. Due to the insufficient capital input of the traditional agricultural sector, slow technological progress together with very rich labor force, marginal productivity of labor was difficult to improve, and the farmers’ incomes always remained at a low level. In such a situation, industrial sector only needed to pay a wage slightly higher than the income level of rural survival, and can receive adequate labor supply. Kunshan implemented the policy of inviting business and attracting investment and vigorously developed urban industry. In the early period of attracting investment, FIEs are basically all labor-intensive clothing factories needing a lot of labor force. As FIEs brought a large capital investment, especially advanced technological level, the labor productivity of the industrial sector was greatly promoted. Meanwhile, as long as a factory provided a level of wages slightly higher than rural incomes, it could obtain sufficient labor force from rural areas. Therefore, the workers’ wage level was not determined by their labors’ contribution to output, but, rather, was determined by their incomes in the previous period, i.e., rural incomes. It was just because of the excessive abundance of labor force, workers’ wages were maintained at a very low level under the role of the law of supply. Although efficient capital brought by foreign investment improved labor productivity, the interests brought by the increase of marginal output of labor did not go to workers’ hands, they were obtained by the owners of capital instead, i.e., capital investors almost obtained all the marginal interests. In the late 1990s, the local rural labor flow had already been unable to meet the needs of local manufacturing, especially foreign-funded factories. With the massive influx of foreign capital, labor force supply began to get nervous, and the wage level had a rapid periodic growth. However, due to China’s labor force flow mechanism, the mechanism of labor force flow between regions provides a guarantee for low labor cost. A large number of migrant workers swarm into Kunshan from Western inland areas. They provide FIEs with inexhaustible labor force, solving the problem of insufficient labor force of the FIEs and becoming one of reasons why wages of the FIEs are not raised, or the rise degree is small

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

for a long time as well. It is just a mechanism of labor force supply, and workers’ wages are always driven down, making workers’ wages of FIEs unable to be effectively improved while also ensuring profit margins of FIEs.

The local manufacturing moving towards the low-end of industrial chain In the division of labor of the whole industrial chain of internationalized p rodu ct ion , as K unshan ’s indust ry is a t t h e en d of t he valu e chai n, manufacturing’s technological content is low, value added is low and Kunshan’s industry can only rely on cheap labor force to participate in the international division of labor, workers are in an inferior position in the distribution of profits. However, foreign party obtains high value added by virtue of its ownership of high-end core technologies and brands. From the whole city’s trade statistical data, a high trade surplus appeared every year, but considering trade surplus formed by foreign-invested enterprises’ export processing trade accounted for more than 90% of the whole city’s trade surplus, a great amount of income brought by such a trade surplus did not become the region’s national income, but was transferred to the home country of the capital through FIEs’ profit repatriation instead. The profits really flowing into the local region to be distributed only took up a very small part. Regarding the distribution of profits from the products of this type of production in the industrial chain, American’s Wall Street Journal reported that: “Wanda wireless mouse is one of Logitech’s best-selling products. Its selling price in the U.S. is USD40. At such a price, Logitech gets USD8, and the distributor and retailer get USD15. The other USD14 enters into the wallet of Wanda suppliers. The company responsible for marketing is in Fremont, California, where the total amount of 450 workers’ salaries are much higher than the sum of salaries of 4,000 Chinese workers in its Suzhou assembly plant. China can only get USD3 from each mouse, and workers’ wages, electricity, transportation, and other recurring expenditures are all included in this USD3.” 1 The situation of Kunshan’s foreign-funded processing industry and some export-oriented private processing enterprises is very similar to what is reported. It can be seen that the welfare brought by the growth of such an economic model to common people is less than the growth degree of the economy itself, and is much less than the growth of FIEs’ income in China. China is seriously plundered by FIEs. As can be seen from Fig. 9.3, profit distributions between employees and enterprise have a very big gap. The underlying causes are that the local

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Foreign Investment-Led Growth Model and Distribution of Income: A Case Study of Kunshan

manufacturing belongs to a labor-intensive industry, marginal output of labor is low, and profitability is low; because FIEs own advanced technology, can effectively increase labor productivity, and own brands and sales channels, and for other reasons, their products’ comprehensive value added is high and the yield rate of marginal output obtained by them is far higher than the workers. As the improvement of output will bring higher gains to FIEs, the result is that, in export processing FIEs, the phenomenon of working overtime is very serious. Especially in some small and medium-sized Sino-foreign joint ventures and Taiwan-funded and Hong Kong-funded enterprises set up in the towns and townships, the problem of working overtime is very prominent. More than half of the enterprises’ employees have no weekend. Some enterprises implement a 12-hour work system, and the number of days of working overtime at some enterprises are more than 3 days. When the task is tight, the employees work overtime for days and nights, and there is randomness in this pattern. However, workers’ wages and overtime pay have been at a very low level, and are severely driven down. According to the investigation, before 2004, overtime wages of some employers were calculated according to basic salary rates. Some laborers working overtime for one hour obtained overtime pay of RMB2–3. Obviously, such overtime pay did not meet the minimum overtime pay standard of RMB5.5 formulated by Kunshan’s labor authority. In recent years, although there have been some improvements, a lot of enterprises’ wage levels still correspond to the minimum wage standard. Even the basic wage of Foxconn Technology Group, a FIE with the biggest scale in the locality, was only RMB950 per month, and overtime pay was RMB8 per hour in 2008, slightly higher than the minimum standards formulated by the local government. In the employees’ wages by official statistics, overtime pay is included into the wage statistics. Therefore, if wages of FIEs’ workers are calculated by hour, we will find that their wage rate is at a lower level.

Policy deviation in the redistribution link (1) Minimum wage standard. In the process of social redistribution, as Kunshan’s export-oriented economic model deems inviting business and attracting investment as its strategic goal, in order to minimize the business cost of regional investment and improve the attractiveness of attracting investment, the government is often restricted by many factors and it has no way to fully reflect the principle of fairness when formulating its policies and systems. Labor force factor cost is one of the main conditions of attracting investment. In order to maintain the low-wage rate of the region, the government has formulated some

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

hidden policies to drive down wages, such as a minimum wage rate. Those polices often become the reference standard of the wages of those FIEs’ workers. (2) Tax and land preferential policies. In the early period of inviting business and attracting investment, the People’s Government of Kunshan City formulated the preferential tax policy of “three exemptions and two halvings,” land preferential policy, and other policies to attract foreign investment and motivate investment. According to statistics, in the period from 2000 to 2004, Kunshan’s incentive cost of attracting investment was RMB13.3 billion in total, of which the amount of tariff reduction and exemption was RMB6.1 billion, land preferential amount was RMB5.2 billion and income tax allowance was RMB1.6 billion. It can be seen that Kunshan City’s FIEs also keep a large part of profits in the redistribution link. (3) Social security system. Regarding the social welfare security system, the FIEs’ efforts to complete are often very limited. In 2006, the city’s insurance and welfare costs were RMB655.71 million, but those of FIEs were only RMB5.79 million, accounting for only 0.88% of the total amount of the whole city. Before 2007, the labor law stipulated that endowment insurance was mandatory, and an enterprise must cover it for its employees, but medical insurance is guidance, i.e., whether medical insurance is covered can be determined in accordance with an enterprise’s condition. Many FIEs only cover their employees’ endowment insurance and the rate of joining in medical insurance was not high. Moreover, these social security systems were only for the local urban residents. As employees with rural household registration and migrant farmers did not need to cover various types of social insurances, the actual wages paid by the enterprises were lower than those of urban residents. The FIEs preferred to hire farmers “who are both worker and farmer” and migrant workers. At the end of 2002, Kunshan City basically established a social security system framework with endowment, medical, unemployment, work injury, and maternity insurances and the lowest living guarantee for urban and rural residents as the main content. The coverage and enforcement degree of these measures are also very low in the FIEs. Especially for migrant labor forces, due to the absence of employment and the wage protection system of the labor market outside of the system, the interests enjoyed by the employees within the system are hard to spillover toward the migrant worker market, avoiding a relatively rapid growth of migrant workers’ actual incomes. The limitation of welfare enjoying reduces the actual incomes of workers and has a direct influence on the improvement of their living standards. These factors jointly play a role in Kunshan’s labor market. They not only inhibit the wage level of the local workers and migrant workers, but also average the wage level of rapid growth of employees within the system or in formal sectors, alleviating the trend of rapid rise of total regional wage level.

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Squeezed by FIEs, the development of private enterprises is insufficient Local private enterprises themselves have weak foundations and are squeezed by FIEs. They cannot compete with FIEs in terms of funding, policy, technology, and the market. Their low profits cannot support the local residents’ income growth. (1) Regarding capital: After its establishment, a FIE’s working capital basically comes from its own domestic bank loans. Due to advanced technology and management, steady profits and the small loan risk of FIEs compared with private enterprises, banks are also more willing to loan FIEs. In the case of limited funds crowding out local enterprises, private enterprises will dominate. The Yangtze River Delta Economic and Social Development Research Center of Nanjing University conducted an investigation on the sources of funds for FIEs in some places including Suzhou. The finding was that although capital of FIEs basically comes from abroad, about 60% of the working capitals of the FIEs almost entirely depended on loans from domestic banks. FIEs basically do not have a problem of cash flow. By contrast, private enterprises’ bank loans are obviously at an inferior position. Therefore, the crowding-out effect of foreign-funded export processing enterprises on local enterprises does exist. (2) Regarding policy: In order to attract foreign investment, the government gives FIEs leeway through preferential policies. As early as in the initial stage of attracting investment, the government implemented the preferential tax policy of “three exemptions and two halvings” and low land use fees policy, thus FIEs got greater profit margins. The people’s government of Kunshan City exchanged for the contribution to local GDP at the cost of fiscal revenue. The operating costs of enterprises invested by FDI are much lower than those of private enterprises. Their profitability is strong and they have obvious advantages. (3) Regarding technology: Due to backward initial productivity and the system, limited research and development investment and poor follow-up technological innovation capability, there is a very large gap between private enterprises and FIEs with advanced technical support from developed countries. Lagging labor productivity and low marginal output of factors result in the fact that the marginal yield rate cannot keep up with FIEs and the profit margins are small. (4) Regarding the market: Contrasted with local enterprises, due to more secured product quality and technology of FIEs and the close connection of enterprises of FDI and the international market, whether in the domestic market or in the international market, FIEs have more competitiveness than local enterprises, resulting in a higher and higher market share of FIEs’ products and hard expansion, or even reduction, of private enterprises’ market.

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Combining the above factors, the development of local private enterprises does get squeezed by FIEs. Their competitiveness is far less than FIEs, resulting in the fact that the best orders are received by FIEs, the best talents are lured away by FIEs, and the most profits are taken away by FIEs. Meanwhile, due to the relative inferior position of competition and small profit margins, local private enterprises are unable to pay higher wages, and cannot undertake the important task of improving the income of local residents. In fact, just as mentioned previously, due to their dependence on the path of the industrial chain, among local private enterprises, especially private enterprises above a designated size, a large part engage in part and component processing for supplying FIEs’ exports or processing and re-export. This form of private enterprises is highly dependent on the cost of labor factor cost. They not only cannot improve local people’s income levels, but also their wages are even lower than FIEs. They inhibit the growth of wages to a greater extent instead.

Conclusions and Suggestions Kunshan’s economic growth model is foreign investment-led and takes cheap labor as its competitive advantage. On this account, Kunshan develops an export processing industry. In the process of economic development, on one hand, the introduction of foreign capital injects an advanced technological level into the regional economy, improves the labor productivity of the industrial sector, and promotes industrial structure adjustment; on the other hand, in this development model, private economy is squeezed by FIEs, and residents mainly work for FIEs. Regional economic growth is mainly dependent on the introduction of exogenous technology, forming path dependence on FIEs. The most important factor attracting foreign investment is cheap labor force, so in this economic growth mode, economic growth must maintain a low labor factor cost to meet the need of economic growth and the continuous introduction of foreign investment, thus resulting in the phenomenon of wage rates and residents’ income seriously lagging behind economic growth. The gap between Kunshan residents’ wage growth and the economic growth rate has been continuously widened. The distribution of profits between FIEs and their employees has an obvious imbalance, which is especially obvious in FIEs. The emergence of such a situation has connections with defects in the labor supply mechanism, low-end trend of industry, inappropriate policy of re-distribution link, and other reasons. How to further promote the local development level through independent innovation, the development of the

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private economy, the adjustment of income distribution policy, and other measures is not just the level of growth, but also one of the main problems that Kunshan’s development is faced with. It is worth noting that in recent years, the trend of wage rise in the southeast coastal region is becoming increasingly obvious. Moreover, with competition in the international division of labor of Southeast Asian countries, such as India, Vietnam, and Malaysia, this development mode in China’s southeast coastal region will encounter a very big challenge, and the upgrading of local industries will also become more urgent and necessary. Therefore, the local governments need to re-examine this economic growth mode, to adjust their development strategies, and to ensure sustainable development and all-around development of the region. In this light, we offer the following proposals: (1) Continuing to improve the local investment attraction policy, and enhancing the regulation, control, and management capabilities on FIEs. The entry of low-end industries should be strictly controlled, the introduction of high-tech and high-tech spillover industries should be encouraged, the pace of industrial upgrading should be sped up, and the position of our employees’ participation in the distribution of profits should be fundamentally improved. From the perspectives of experiences of Latin American countries, liberalization and fluctuating and uncertain policies for FIEs were a policy condition resulting in serious dependence on FIEs. We cannot only look at the good side of foreign investment, such as making up for construction funds and stimulating economic growth. We must see and attach importance to some adverse effects of foreign investment on China’s regional economic development. Only combining a sound foreign policy and implementing right guidance and management on FIEs can make them more helpful to China’s economic development. Furthermore, the social security system in the redistribution process should be improved and perfected. The local people’s living standards should be ensured. The proportion of profit distribution between workers and FIEs should be balanced, and healthy development of the regional economy should be promoted. (2) The importance of profit repatriation of FIEs: With the increase of the scale of introducing foreign investment, the negative pressure of profit repatriation on economic growth will be gradually reflected and enhanced. China’s current issue of profit repatriation of FIEs is not as serious as Latin American countries, but similarly, China is faced with enormous pressure, especially in the process of distribution of profits and income distribution, this issue has been very prominent and is in urgent need to be solved. In addition, from the experience of Latin American countries, profit repatriation is an

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issue that cannot be avoided for the use of foreign investment to develop the economy. (3) Enhancing and improving the efficiency of domestic investment. China’s savings rate is relatively high, so the issue of lacking investment capital owing to too low a savings rate does not exist. However, the efficiency of converting domestic savings into domestic investment also affects domestic investment. China’s current issue lies in the uncoordinated link between the development of the financial system and the needs of economic development. The top priority task now is to improve the efficiency of the financial system, to improve the financing environment for domestic enterprises, and to ensure that savings can be efficiently converted into domestic investment, thus reducing the dependence on foreign investment. In addition, the effectiveness of domestic investment is in urgent need to be improved. Among them, one of the most prominent performances is that the development of local private enterprises is blocked. The improvement of residents’ income and the practice of independent innovation are closely linked with the development of regional private enterprises. Therefore, to gradually get independent from foreign investment and to realize the upgrading of the industrial chain, we must improve the efficiency of domestic investment as soon as possible and vigorously develop private enterprises.

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10

Chapter

Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance of the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction The report of the Chinese Communist Party’s Seventh Congress regarded the construction of an innovative country and the improvement of the independent innovation ability in China as the core of China’s national development strategy. It has been clarified in the “National long-term plan for science and technology development (2006–2020)” that the core of science and technology development in the coming decade is independent innovation and the construction of an innovative country. Shanghai and Jiangsu Province and Zhejiang Province of the Yangtze River Delta area are the most developed areas in China with complete industrial systems and solid foundations. These are the key venues for national scientific and educational resources and they are in the advance position for opening to the outside and conducting international economic and technological exchanges. The Yangtze River Delta shoulders the responsibility of industrial structure adjustment and it should be the pioneer in China’s independent innovation to play more important roles in national independent innovation strategy. The study of economic activity in the Yangtze River Delta and China’s hightechnology industrial development has always been a hot issue in the academic field. For example, Chen Liu (2007) conducted the empirical research on the Yangtze River Delta economic growth based on the combination of indigenous innovation ability and FDI Technology Spillover. Liu and Buck (2007) conducted empirical analysis of the influencing factors of the endogenous innovation ability and international technology spillover in China’s high-technology industry, such as FDI, export, and technology introduction. They found out that the key factor which affects China’s technology innovation is the combination of endogenous innovation ability and international technology spillover, which is technological absorptive capability. The research above all stressed the influence of endogenous innovation effort. The essence of Chen Liu’s endogenous innovation ability (2007) is the endogenous innovation effort of the endogenous innovation theory, which is the research and development (R&D) activity. In this chapter, we will expand the endogenous innovation effort, the R&D activity. We will focus on the expansion of the concept of geographic technological coincidence index, which was put forward by Jaffe (1989) in 1989. The concept reflects the consistency characteristics of regional technology and the research looked at the innovative performance of Yangtze River Delta industries from two aspects. This study has revealed the influence of the endogenous innovation effort and endogenous technology spillover on the innovation performance of high-technology industries in the Yangtze River

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Delta, which will contribute to the interaction and interdependence of the Shanghai, Jiangsu, and Zhejing regions and help them make full use of their advantages to promote the development of the high-technology industry. The second section of this chapter shows theories about the endogenous innovation effort and endogenous technology spillover; the third chapter introduces model construction and major variables; the fourth chapter analyzes the measuring results from the dimension of industry and region; the last section is about the conclusion and the problems to be discussed.

Literature Review Innovation is not a simple process from R&D activity to the birth of new knowledge and the application of new technology. It is a phenomenon making use of the feedback of many influencing factors where disjunction and even dead ends occur. Malecki, (1997) and Kleine and Rosenberg (1986) used to call this the Chain-like Model. Then, Rothwell (1992) came up with the idea that innovative degree depends on the interaction and learning ability of the innovative subjects. Lundvall (1992) further expounded that innovation is the innovative and interactive learning process composed of R&D departments and external cooperators, including upstream and downstream firms, knowledge creators, and science and technology service organizations. The Endogenous Growth Theory represented by Romer and the new economic geography theory represented by Krugman and the Countries (industry or area) innovation system theory represented by Nelson are the theoretical foundation of this chapter. The Endogenous Growth Theory represented by Romer (1990), and Grossman and Helpman (1991) holds that technology innovation and advances in technology are the internal dynamics and sources for economic growth. New ideas and new technologies come from the input of R&D activity and the effective use of stock knowledge. Based on the endogenous growth theory (and Potter’s Industry Cluster Theory and Nelson’s national innovation system theory), Furman and others have shown that national innovation ability has something to do with the input of R&D activity input (human resources and funds) and knowledge stock. They found out that national innovation ability (endogenous innovation ability) could contribute to the market share of hightechnology product exportation. The New Economic Geography theory represented by Krugman (1991) discussed the relationship between reward growth and industrial development from the perspective of economic cluster and knowledge spillover. Cluster

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economy could be classified into two types, namely Specialized Economies formed companies of the same industry or related industries and Diversified Economies formed by diversified economic activities. An academic view holds that the specialized industrial environment is good for knowledge spillover and innovation and its representative figure is MAR, short for Marshall Arrow Romer, while scholars represented by Jacobs (1969) maintain that the diversified environment is good for the formulation of new ideas and new technology. The National Innovation System represented by Nelson (1993) holds that innovation is a systematic process formed by interrelated innovative subjects and a corresponding mechanism and system, which gives rise to the industry innovation system theory (translated by Chen Jing) represented by Dodgson and Rothwell, and regional innovation system theory represented by Cooke (1998). Research on the interactive innovation representativeness among innovation subjects (companies, research and development organizations, universities, government and intermediary organs) are as follows: (1) the influence of university and other fundamental research on knowledge spillover and technological innovation. For example, Jaffe (1989) has evaluated the influence of university and other fundamental research on industrial innovation, especially its great influence on a high-technology field such as medicine. (2) The influence of government R&D on high-tech industries. Sternberg (1996) has taken the U.S., Germany, Great Britain, France, and Japan — the five industrialized countries — as the examples to demonstrate that government R&D activity positively correlates with regional high-tech industry employment. (3) As to the influence of corporate interaction on innovation, Von Hippel (1988) conducted research on the interactive innovation among suppliers, manufacturers, terminal customers, and upstream and downstream companies. The above research stressed endogeneity, collectivity, and interactivity of innovation, but with the development of information technology and economic globalization, international technology spillover has a great influence on a country’s technological innovation, especially on the high-tech industrial innovation of late-developing countries. The research perspective could be classified into three groups: one is the positive influence of international trade on technological spillover (Feder 1983, Grossman and Helpman 1991, Coe and Helpman 1995, Lai Mingyong 2003). Classical research, such as that done by Coe and Helpman (1995), analyzed the positive correlation between total factor productivity and domestic R&D fund stocks, R&D fund stocks of trading nations and foreign trade dependence of OECD countries from 1971 to 1990. As to great powers, the capital stock of domestic R&D activity is very important while small countries are greatly

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influenced by foreign R&D activity. For countries of high economic opening degree, the capital stock that benefits greatly from foreign R&D activity is of a high degree. Second, there is the impact of R&D activity on FDI and multinational companies (Blomstrom and Kokko 1998, Xu 2000, Buckley et al., 2002, Liu and Wang 2003, Sinani and Meyer 2004, Shen Kunrong and Geng Qiang 2001, Jiang Xiaojuan 2002). For example, Jiang Xiaojun (2002) maintained that FDI technology spillover effective pathway mainly includes technology diffusion effect, technology competition effect, and technology application effect. Of course, as to the technology spillover effect of FDI on the host country, the result of abundant empirical research conducted based on different data and models by domestic and foreign scholars showed that both positive and negative effects exist. As a whole, there are three viewpoints, namely inhibition theory, facilitation theory, and “double-edged sword” theory (Fan Aijun and Han Qing 2007). Third, there is the technology spillover effect on direct technology importation. Connolly (2000, 2003) has constructed a theory model to demonstrate that technology importation of developing countries from developed countries and the reinforcement of technology learning are good for the developing country’s technological improvement. The technology spillover effect of interaction between developed countries and developing countries is better than that among developed countries. Based on the above Endogenous Growth Theory, new economic geography theory and national innovation system theory, this chapter will measure the affection degree of technology industrial innovation performance in the Yangtze River Delta on the aspects of innovation endogenous effort — the R&D activity scale, and technology spillover within the industry-technology geographic consistency index. According to the endogenous growth theory, we will investigate the impact of R&D activity scale in the Yangtze River Delta on innovation performance; based on the new economic geographic theory and national innovation system theory, and by drawing lessons from Jaffe’s concept of technology and geography consistent index, we will pay special attention to the technology spillover effect of the high-tech industry of certain areas in the Yangtze River Delta. In addition, we will investigate the impact of new product exportation, which is an important channel for international technology spillover on innovation performance in the Yangtze River Delta. With the Panel data of high-tech innovation and output of Yangtze River Delta from 1997 to 2006, this chapter has conducted empirical research by combining the above four related theories and has found the following aspects:

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(1) from the perspective of industrial dimension, endogenous innovation effort is the main source and driving force for high-tech industry innovation in the Yangtze River Delta; the weak negative externality of endogenous technology spillover in specialized concentration environment has hampered the innovation to some degree, and the export learning effect is good for innovation performance improvement. (2) From the dimension of region, Shanghai, as the innovation pole, has a positive technology spillover effect on Jiangsu and Zhejiang. Zhejiang could benefit from the technology spillover from Shanghai and Jiangsu, but while Jiangsu is benefiting from Shanghai, it is under the negative influence of Zhejiang. The political meaning of this research on high-tech industry development in the Yangtze River Delta is as follows: industrial homogenization competition is not good for an innovative external environment. The endogenous innovative effort of the Yangtze River Delta should be strengthened. Considering the contribution elasticity of export learning effect on industrial innovation performance, export-oriented development strategy should be further implemented; Shanghai, as the innovation pole, should be made full use of to strengthen technology expansion. Innovation should be boosted through industry complementary and technology learning in the outlying area.

Metric Model The endogenous theory of Romer (1990) uses knowledge production function to show the internal relationship between the technology advance rate and economic growth:

. λ Atφ (10–1) A = δHA,t . The definition of A is technology advance growth rate and HAλ represents the human resource in the R&D activity; A tφ represents the available knowledge stock, which has made technology advance take place within the two departments. In Romer ’s model, λ = ф = 1, which means knowledge stock of special proportion will lead to output increase of the innovation department. With this hypothesis, innovation growth rate is the function of effort in the . R&D department, and A / A = δ H A reflects a sustainable increased rate. However, Jones (1995) holds that λ and ф might be less than one, which may make the long-term sustainable innovation impossible. What’s more, Furman and others (2002) have also put forward that when ф > 0, it means that R&D activity is standing on the shoulders of giants (the “standing on the shoulders”

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

effect); when ф < 0, it means that the current R&D activity is inefficient due to the previous eagerness for quick success and instant benefits (the fishing out effect). The discussion about the endogenous growth model has led to some research on parameter improvement. For example, when Furman and others were considering the factors affecting a nation’s innovation ability, they will bring factors such as innovation infrastructure, industrial cluster innovation environment, scientific research and industry department contacting quality into the endogenous growth model. With this consideration, this chapter holds that if it is based on endogenous growth theory alone, the interrelated and interdependent relationship among administrative areas of the Yangtze River Delta could not be fully reflected no matter if we regard the delta as a whole or three independent geographic areas when measuring innovation performance. To this end, we will add a key explanatory variable in this chapter to show the network relationship of hightech industrial innovation in the Yangtze River Delta. The model is as follows: n =3

RD kjt ) + γ ln (RD ijt) ln (Yijt) = αijt + βk ln (C ijt × k∑ =1

+ λ1 ln (AV jt) + λ2 EXP ijt + εijt (10–2)

In the model, Y ijt represents the variable derived from innovation; i represents for province; k represents for province (k ≠ i ); j represents for hightech industry and its segmentation; t represents for the year.1 Variables derived from innovation are often known as patents internationally, but Griliches (1990) thinks as an output variable, patent has shortcomings. Some patents do not have commercial value and patents often overestimate the real value of innovation. For the high-tech industry, some companies do not apply for patents since they can launch new products immediately or keep commercial technology to themselves. As a result, the omission phenomenon occurs. Drawing lessons from the methods of Acs (1992), Feldman and Florida (1994), and Liu and Buck (2007), new product sales volume was chosen as the variable derived from innovation, which has won market approval and achieved performance with actual effect. RD ijt, the first explanatory variable reflects the endogenous innovation effort of endogenous growth theory and the R&D fund was regarded as the index. The model of Furman (2002) surely has taken into consideration the human resource input of R&D. But when conducting research on China’s high-tech industry innovation performance, Liu and Buck (2007) ignored this variable. China’s science and technology system reform possibly affected the human resources of R&D, which caused the differences and measuring results before and after

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2000. After this chapter, we will figure out that Liu and Buck’s method is more suitable. n =3

The second explanatory variable is C ijt × ∑ RD kjt . In the model, C ijt is the k =1

technology geographic consistency index of the Yangtze River Delta, which is mainly referred to as the concept of technology geographic consistency index put forward by Jaffe (consistency index). The goal of applying consistency is to reveal the interactive and interdependent relationship in the Delta. For example, a computer manufacturing enterprise in Suzhou is close to similar companies in Shanghai and Hangzhou, so it is possible for it to get a positive technology spillover effect by learning and to get a negative technology spillover effect when imitated by others. The meaning of Jaffe’s consistency index (1989) is as follows: when the distribution of university and other research organizations and R&D industry and technology field (information technology) are close to each other, it is good for technological innovation and expansion. Otherwise, even the basic research ability of universities is excellent, without matched industrial R&D activity, it is to the disadvantage of technological innovation and expansion. The mathematical formula is as follows:

Ci =

∑U TP is is S

[∑ U is2 ]1/2 [ ∑ TP is2 ]1/2 (10–3) S S

C i is the consistency index of special geographical university and industry in the same technological area. The subscripts of i and s represent geographical

units and technological areas. U is represents the number of researchers of the lab in the s technological field of a certain university; ∑U is represents the total number of researchers of the university lab in the s technological field

in i geographical area. TP is represents the number of researchers in the s technological field of i industry. ∑TP is represents the total number of researchers in the industrial lab of s technological field in i geographical area. By referring to Jaffe’s consistency index method (1989), when calculating C ijt, there are two kinds of situations in this chapter: first, when calculating the consistency index of high-technology and its segmentations of the Yangtze River Delta, the total number of scientific and technological organizations and average researcher number, the interaction (cross-multiplication) of average scientific research funds in different provinces are used to calculate. Secondly, when calculating the consistency index of an administrative area and the other two areas in the Delta, the pair-wise interactions are calculated respectively. In a word, in the first situation, a number is used to reflect the overall interaction

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

of high-tech industry in the Yangtze River Delta, such as the consistency index of computer manufacturing industry in the whole delta. In the second situation, there are two interaction values in an administrative area. For example, the consistency index of the computer manufacturing industry in Jiangsu contains the consistency index of Jiangsu and Zhejiang and the consistency index of Jiangsu and Shanghai. After the calculation of C ijt , the consistency index, C ijt × k∑ RD kjt is used to represent the technology spillover effect of peripheral =1 provinces on this province. More examples will be given in terms of the two types of indexes. In the first situation, the technology spillover effect of Jiangsu’s computer manufacturing industry is determined by the multiplication of consistency index of the Delta and the sum of the R&D fund of Shanghai and Zhejiang in the computer manufacturing industry. In the second situation, Jiangsu computer manufacturing industry is influenced by the multiplication and consistency index of Jiangsu and Shanghai and the R&D fund of Shanghai computer manufacturing industry. What’s more, it is also affected by the multiplication of the consistency index of Jiangsu and Zhejiang and the R&D fund of Zhenjiang computer manufacturing industry. The two control variables are the industrial innovation opportunity window and learning by export effect. As to opportunity window, when an industry is facing a huge market opportunity, companies tend to exploit new markets or expand production scale and ignore technological innovation. Otherwise, when an industry has entered the mature period, due to the fierce competition in the market, companies have to increase research and development efforts. Opportunity window variable controls the innovation differences among industries. In this chapter, it is represented by AV jt, the added value of the whole industry in the country. Another control variable is learning by export effect. According to the viewpoints of Liu and Buck, product export, especially high-tech product export, is good for the understanding of the international market and a grasping of the international advanced technology and industrial innovation. Therefore, it is represented by EXP ijt, the new product export sales volume. In addition, εijt represents random disturbance quantity. All the data is from Statistical Yearbook of China’s High-tech Industry (1998–2007), Statistical Yearbook of China’s Science and Technology (1998–2007), Zhejiang Statistical Yearbook (1998–2007), Jiangsu Statistical Yearbook (1998– 2007), and Shanghai Statistical Yearbook (1998–2007). According to Statistical Yearbook of China’s High-tech Industry , the hightech industry includes five segmentations, namely, pharmaceutical industry, aviation spacecraft manufacturing industry, electronic and telecommunication equipment industry, electronic computer and office equipment manufacturing

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

industry, medical equipment and instruments manufacturing industry. Actually, the nuclear fuel processing industry and informational chemical product industry should also be listed, but the relevant data are not provided in the statistical yearbook. First, new product sales volume and the innovation output should be analyzed. Fig. 10.1 shows the changing condition of new product sales volume of high-tech industry of Zhejiang, Jiangsu, and Shanghai from 1997 to 2006. From the perspective of overall scale, the order is Shanghai, Jiangsu, and Zhejiang. As to growth rate, Zhejiang province, Jiangsu province, and Shanghai all show trends of a high growth rate. Fig. 10.1

The sales volume of new products in the high-tech industry of the two provinces and a city in the Yangtze River Delta

Unit: RMB1 billion (current price) 180 160 140 120 100 80 60 40 20 0

1997

1998

1999

Shanghai

2000

2001

2002 Jiangsu

2003

2004

2005

2006

Zhejiang

Fig. 10.2 shows the distribution condition (new product sales volume) of high-tech industry segmentation of the Delta in 2006. From the perspective of industrial internal structure, the industry segmentations vary from each other. Electronic and telecommunications equipment industry and electronic computer and office equipment manufacturing industry are of a relatively large scale in the three administrative areas. By comparison, the aviation spacecraft manufacturing industry is of a small scale and Zhejiang does not have the industry. The pharmaceutical industry and the medical equipment and instrument manufacturing industry are in the middle scale. From the perspective of administrative area comparison, the electronic and telecommunications equipment industry and electronic computer and office equipment manufacturing industry in Shanghai are outstanding; the medical equipment and instrument manufacturing industry is prominent in Zhejiang; and industry segmentations do not differ much from each other in Jiangsu.

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

Fig. 10.2

New product sales volume of high-tech industry segmentation of the Yangtze River Delta in 2006 Unit: RMB1 billion (current price) 100 90 80 70 60 50 40 30 20 10 0

Shanghai

Jiangsu

Zhejiang

Pharmaceutical industry Aviation spacecraft manufacturing industry Electronic and telecommunication equipment industry Electronic computer and office equipment manufacturing industry Medical equipment and instrument manufacturing industry Second, two explanatory variables will be investigated: the endogenous

innovation effort and the distribution of endogenous technology spillover.

Endogenous innovation effort is represented by R&D fund. Fig. 10.3 shows the

changing condition of R&D fund of the high-tech industry of the Yangtze River Delta from 1997 to 2006. As to the overall scale, the two provinces and Shanghai city all show high increase rate. Jiangsu grows the quickest and ranks the top.

Zhejiang is gradually growing close to Shanghai, which shows they have all paid great attention to endogenous innovation effort.

Endogenous technology spillover, another important explanatory index, could

also be represented by R&D fund. Fig. 10.4 shows the changing condition of

technology spillover of high-tech segmentation of Zhejiang, Jiangsu, and Shanghai from 1997 to 2006. The spillover effect of electronics and telecommunications

equipment is the biggest; the spillover effect of electronic computer and office equipment manufacturing industry, pharmaceutical industry, and medical

equipment and instruments manufacturing industry is relatively big; the spillover effect of the aviation spacecraft manufacturing industry is the smallest.

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Fig. 10.3

The R&D fund of high-tech industry in the Yangtze River Delta

Unit: RMB1 billion (current price) 6 5 4 3 2 1 0

Unit: RMB1 billion (current price, expressed by R&D budget)

Fig. 10.4

1997

1998

1999

Shanghai

2000

2001

2002

Jiangsu

2003

2004

2005

2006

Zhejiang

The technology spillover index of the high-tech industry of the Yangtze River Delta from 1997 to 2006

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Shanghai (Pharmaceutical industry) Jiangsu (Pharmaceutical industry) Zhejiang (Pharmaceutical industry) Shanghai (Aviation spacecraft manufacturing industry) Jiangsu (Aviation spacecraft manufacturing industry) Zhejiang (Aviation spacecraft manufacturing industry) Shanghai (Electronic and telecommunication equipment industry) Jiangsu (Electronic and telecommunication equipment industry) Zhejiang (Electronic and telecommunication equipment industry) Shanghai (Electronic computer and office equipment manufacturing industry)

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

The Metric Result The results can be divided into two kinds of regression analysis. First, data and method that have fixed effects on the industry (the high-tech industry and the segmentations in the Yangtze River Delta) are conducted via regression analysis. This analysis regards data as the panel data form of three dimensions (industry, province, time) and puts the similar industry into the same regression model. Second, regression analysis is conducted based on areas, which means that investing in the high-tech industry and the segmentations of the three administrative areas of the Yangtze River Delta. Two satiations are mainly taken into consideration when transforming intercept model fraction with panel data: fixed effect model and stochastic effect model. Both of them give due consideration to the difference among provinces and industries. Fixed effect model manifests the individual effect of different provinces and industries which can be explained by constant terms as different intercepts in regression results. Stochastic effect model regards the differences among provinces and industries as the compliance of certain stochastic distribution. Intercept term is often divided into constant term and stochastic variable, which is used to represent the influence of individual differences. Referring to Batisse’s research experience in using fixed effect regression model when conducting panel data regression, this chapter will take the fixed effect model as the standard.

Regression result of the industry Table 10.1 is the statistical description of 150 sample data of the high-tech industry of Zhejiang, Jiangsu, and Shanghai of the Yangtze River Delta from 1997 to 2006, and Table 10.2 is the correlation analysis. Table 10.1 The statistical description of high-tech sample data in Yangtze River Delta from 1997 to 2006 (logarithm value) Variable

Sample size

Mean value

Standard deviation

Minimum

Maximum

Innovation output (new product value) Y

150

11.452 93

3.587 095

0

15.983 91

Endogenous innovation effort

150

2.949 831

0

12.658 52

8.497 141

(R&D fund) X 1

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Variable

Sample size

Indigenous technology spillover

Mean value

150

(R&D fund) X 2

Opportunity window (industrial added value) X 3 Export by learning (new product export value) X 4

8.638 337

Standard deviation

Minimum

Maximum

3.021 662

0

12.600 36

150

14.245 24

3.934 580

0

17.263 69

150

10.641 54

3.858 529

0

16.991 45

Table 10.2 Correlation analysis of variables Y X1 X2 X3 X4

Y 1.000 0 0.934 5 0.880 9 0.906 3 0.913 2

X1 — 1.000 0 0.857 2 0.839 8 0.853 0

X2 — — 1.000 0 0.860 7 0.799 5

X3 — — — 1.000 0 0.799 6

X4 — — — — 1.000 0

Fixed effect model method is chosen for panel data of the above variables according to all samples and the five segmentations. In the regression result, the positive goodness-of-fit of the fixed effect is between 0.54 and 0.98 and the joint significant tests of statistics are all positive. As a whole, the model specification has a certain explanatory ability. As to specific results, please refer to Table 10.3, from which we may find out: Table 10.3 The regression results of high technology and its subdivided industries under the effect of endogenous innovation effort and indigenous technology spillover Variable

High technology industry (Total)

Pharmaceutical Aviation Electronic and industry spacecraft telecommunications manufacturing equipment industry industry

Electronic computer and office equipment manufacturing industry

Medical equipment and instrument manufacturing industry

Innovation output (new product value) Y

—

—

—

—

—

—

Endogenous innovation effort X 1

0.461 902 6*** (0.051 712 4)

0.473 610 8*** (0.097 046 6)

0.390 523 8** (0.142 022 2)

0.386 685 4*** (0.128 820 2)

0.385 980 9*** (0.107 419 2)

0.607 910 9*** (0.140 350 6)

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

(Cont'd) Variable

High technology industry (Total)

Indigenous technology spillover X 2

–0.096 743 8** (0.043 596 7)

–0.050 332 8* (0.026 352 6)

0.059 511 2* (0.037 943 7)

Control variables: Opportunity window X 3

–0.023 687 9* (0.018 656 6)

0.168 465* (0.132 316 2)

Export X 4

0.395 459 3*** (0.047 987 1)

Constant term R-sq Wald test Prob (F )

Pharmaceutical Aviation Electronic and industry spacecraft telecommunications manufacturing equipment industry industry

Electronic computer and office equipment manufacturing industry

Medical equipment and instrument manufacturing industry

–0.036 961 2* (0.027 172 2)

–0.313 193 7** (0.117 952 2)

–0.211 306 1* (0.096 811 6)

–0.095 572 3* (0.062 627 2)

— —

–0.252 235 7* (0.158 667 9)

–0.380 715 8 (0.151 220 3)

0.266 491 2*** (0.073 648 4)

0.192 401 9** (0.099 925 6)

0.323 871 3** (0.126 671 6)

0.705 982 1*** (0.152 450 9)

0.681 559 7*** (0.127 966 9)

4.492 93 (1.155 87)

2.388 3 (1.637 332)

4.303 37 (2.413 246)

6.032 278 (0.629 917 6)

7.605 048 (3.923 748)

6.498 39 (3.238 938)

0.895 4

0.941 7

0.975 3

0.825 2

0.742 3

0.541 1

F (2, 23) = 16.48

F (2, 23) = 24.17

F (2, 23) = 28.10

F (14, 131) = F (2, 23) = 13.68 F (2, 23) = 12.48 16.01 Prob > F = 0.000 0

Prob > F = 0.000 0

Prob > F = 0.000 0

Prob > F = 0.000 0

Prob > F = 0.000 0

Prob > F = 0.000 0

Sample size

150

30

30

30

30

30

Number of sample group

15

3

3

3

3

3

Notes: 1. ***, **, * indicate the significance at the level of 1%, 5%, and 10%, respectively. 2. Results in the parentheses are t statistics. 3. There is serious multicollinearity between X 1 and X 3 of the electronic and telecommunications equipment industry, therefore, X 3 is abandoned. In fact, X 1 and X 3 of the electronic and telecommunications equipment industry between 1997 and 2006 show a tendency of exponential synchronized growth.

All high-tech industry regression results have the following characteristics: first, innovation performance is strongly related to endogenous innovation effort. According to contribution elasticity, every increase of 10% of the endogenous effort (R&D fund expense) will lead to about a 4.6% increase of innovation performance, which is in line with Romer ’s endogenous growth theory. Second, indigenous technology spillover shows negative externality. The R&D fund expense of peripheral provinces grows by 10% which will lead to a 1% decrease of innovation performance. The result has supported the research that specialized industry manifests negative technology externality, which was

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

done by Glaeser (1992), Feldman and Audretsch (1998), and Batisse (2002). It is different from Hendersonet and other ’s viewpoint that high-technology industrial specialization is good for innovation. It shows that homogenization competition and mutual imitation in the Yangtze River Delta have hampered the innovation to some degree. High-tech industry segmentation regression result has the following characteristics: first, apart from the aerospace industry, the endogenous technology spillover effect of the other four industries should be negative, which further shows that industrial specialization often has negative externalities. The positive externality of the aerospace industry might result from the special monopoly of Jiangsu and Shanghai caused by the weak industrial base in Zhejiang. Second, the distinct negative externality of the computer industry and medical equipment manufacturing industry, and the big contribution elasticity of export by learning, might be caused by the fact that the two industries also manifest certain special monopolies in the Yangtze River Delta and mainly depend on outside contact. Comparatively speaking, the negative externalities of the electronic and telecommunications equipment industry and pharmaceutical industry are small and the coefficient elasticity of export by learning is small. The two industries are in the industry maturity period, which leads to mutual learning and imitation and is disadvantageous to innovation. In the other aspect, due to the market competition pressure, technological innovation should be conducted and, as a result, the negative externality of technology is small. At the same time, although the export scale of the two industries is big, the domestic sales scale is also big and the export by learning effect is not as obvious as the former. The two variables of opportunity window and export by learning have an opposite influence on high-tech industry innovation performance. Opportunity window is in correlation with innovation performance. The industry with the big opportunity window has a strong negative effect on innovation performance. When the industry is in the expansion phase, it is not economical to increase corporate research and development. Companies should gain profit through economies of scale and new markets (considering fragmented markets due to China’s different economic developing levels). Export by learning, the other control variable, is of distinct positive correlation. It means the export-oriented economy in the Yangtze River Delta can increase high-tech industry development by absorbing international technology spillover. As a whole, the two explanatory variables of endogenous innovation effort and indigenous technology spillover have compound impact on technological innovation of the Yangtze River Delta. From the perspective of the absolute elastic coefficient, every increase of 10% of the endogenous effort (R&D fund

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

expense) will lead to an about 4.6% increase of innovation performance; every increase of 10% of the sum of R&D fund expense in peripheral areas will lead to a 1% decrease of innovation performance. From the perspective of standardized elasticity coefficient, 2 the endogenous innovation effort and indigenous technology spillover are 0.379 8 and –0.081 5, respectively. It can be seen that although the homogenous competition and mutual imitation in the high-tech industry are not good for innovation in the Yangtze River Delta, endogenous innovation effort is still the main driving force for industrial innovation and it can guide industrial innovation and development.

Regression results based on regions

In the regional regression model, the focus is the technology spillover effect of peripheral areas on the local area. Therefore, we will calculate the consistency indexes among Zhejiang, Shanghai, and Jiangsu. To be specific, we will calculate the consistency index of Jiangsu and that of Shanghai and Zhejiang, the consistency index of Shanghai and that of Zhejiang and Jiangsu, and the consistency index of Zhejiang and that of Shanghai and Jiangsu. Different from the industry regression model where a variable is used to measure endogenous technology spillover effect, endogenous technology spillover effect of regional regression model includes two variables, such as Jiangsu contains the technology spillover effect of Shanghai and Zhejiang. Similarly, Zhejiang contains the technology spillover effect of Shanghai and Jiangsu. The consistency index calculating method is similar to that of the industrial model, but the pair-wise effect should be investigated separately instead of the compound effect among the three. To highlight the effect of peripheral area on the local area, the regional model will be in two stages: first, calculating the regression result without giving consideration to the technology spillover effect of peripheral area on the local area; second, calculating the regression result with due consideration to the technology spillover effect of peripheral area on the local area. The quantitative analysis of the first step is the baseline for the second step, which clearly shows the effect of endogenous technology spillover on innovation performance. Similar to the above, when applying the panel data, we should choose the fixed effect model method. Among the regression results (see Fig. 10.4), the goodness-of-fit correction of the fixed effect is between 0.62–0.99 (Zhejiang is better and Jiangsu is relatively worse). The joint significant tests of F statistics are significant. As a whole, the model construction has certain explanatory ability.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Fig. 10.4

The regression results of the high technology industry of Jiangsu, Shanghai, and Zhejiang under the effect of endogenous innovation effort and indigenous technology spillover

Variable Innovation output Y Endogenous innovation effort X 1

Jiangsu Regardless of technology spillover effect

0.535 743 4***

(0.153 678 1)

(0.160 222 5)

X3

—

Constant term C R-sq

(0.021 705 7) –0.134 070 3* (0.076 35)

–0.809 014 2**

–0.633 341 4**

(0.306 546 8)

(0.301 126)

0.736 956 5*** (0.166 284 3) 10.971 66 (2.647 702) 0.713 6

0.759 927*** (0.172 542 2)

Zhejiang

Regardless of Considering technology technology spillover effect spillover effect 0.414 029 7** (0.150 597 9)

0.045 034 2* —

Export X 5

Considering technology spillover effect

0.435 284 4***

Indigenous technology spillover X2

Control variables: Opportunity window X 4

Shanghai

0.443 693** (0.149 745 5)

Regardless of Considering technology technology spillover effect spillover effect 0.415 906 3*** (0.066 720 7)

–0.178 668 2* —

(0.070 841 5) 0.109 358 9*

—

(0.063 961)

0.283 303 3*** (0.045 231 8) 0.521 613 8**

0.295 034 3 (0.060 160 5) 0.465 169 5**

0.386 125*** (0.080 719 9) 0.104 873 1*

—

(0.062 678) 0.020 236 6*

—

(0.011 440 7)

–0.168 755

–0.362 649 1*

(0.066 992 1)

(0.144 19)

0.541 543 3***

(0.197 633)

(0.223 273 4)

8.422 811

1.458 491

2.809 249

5.159 412

6.307 363

(2.955 666)

(1.842 828)

(1.086 748)

(1.479 202)

(1.657 266)

0.620 8

0.844 9

Wald test

F (4, 42) = 7.20

F (4, 40) = 8.24

Prob (F )

Prob > F = 0.000 2

Prob > F = 0.000 1

Prob > F = 0.000 0

Sample size

50

50

Number of sample group

5

5

0.854 2

F (4, 42) = 12.77 F (4, 40) = 11.68

(0.118 302 2)

0.603 204 4***

0.982 0

(0.128 731 8)

0.981 3

F (3, 33) = 8.28

F (3, 31) = 8.58

Prob > F = 0.000 0

Prob > F = 0.000 4

Prob > F = 0.0003 5

50

50

40

40

5

5

4

4

Notes: 1. ***, **, * indicate the significance at the level of 1%, 5%, and 10%, respectively. 2. Results in the parentheses are t statistics. 3. For Jiangsu, X 2 and X 3 represent the consistency index with Shanghai and Zhejiang; For Shanghai, X 2 and X 3 represent the consistency index with Jiangsu and Zhejiang; For Zhejiang, X 2 and X 3 represent the consistency index with Shanghai and Jiangsu.

We can see from Fig. 10.4 that the endogenous effects are different among Zhejiang, Shanghai, and Jiangsu. Jiangsu can get positive technological externality from Shanghai but negative technological externality from Zhejiang.

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

Shanghai can get positive technological externality from Zhejiang but negative technological externality from Jiangsu. Zhejiang can get positive technological externality from both Shanghai and Jiangsu. The reasons are as follows: first, Shanghai manifests positive technological externality towards both Jiangsu and Zhejiang, which means Shanghai has relatively advanced technology and Jiangsu and Zhejiang with less advanced technology could get technology spillover by learning and imitation. Second, if the technological level of Jiangsu falls between that of Shanghai and Zhejiang (it is reasonable from the aspects of the scale of high-tech industry and the scale of innovation output), according to the above theory that industrial specialization is not good for innovation, the approximate competitive relationship caused by the cluster of similar technological level is to the disadvantage of innovation. It leads to Jiangsu’s negative externality towards Shanghai and Zhejiang’s negative externality toward Jiangsu. Third, Zhejiang has positive externality toward Shanghai, which results from Shanghai’s monopoly for there is a great technological gap between Shanghai and Zhejiang. Different from the approximate competitive relationship with Jiangsu, the improvement of Zhejiang’s technology is to the advantage of technological promotion and expansion in Shanghai. The endogenous innovation effort and indigenous technology spillover has different influence on innovation performance of Zhejiang, Jiangsu, and Shanghai, which has shown different political meanings. First, no matter whether taking endogenous externality effect into consideration, innovation performance and endogenous innovation effort are in a cause-and-effect relationship. Contribution elasticity shows that every 10% increase of endogenous innovation effort (R&D fund expense) will lead to a 4%-5% increase of innovation performance, which is in line with endogenous growth theory. Second, For Jiangsu and Shanghai, when considering endogenous technology spillover effect, the output elasticity of endogenous innovation effort (R&D fund expense) increases, which means the increase in research funding is good for industrial innovation. “As you sow, you shall reap.” Third, for Zhejiang, when giving consideration to indigenous technology spillover effect, the output elasticity of endogenous innovation effort (R&D fund expense) falls, which means Zhejiang could get more externality by technological learning and imitation since it is of low technological level. In other words, it could get some free ride. We can see that the political meanings of Shanghai, Zhejiang, and Jiangsu are different. Jiangsu and Shanghai should strengthen independent research and development and Zhejiang could actively make use of technological externality to foster technology absorbing ability. The two control variables of opportunity window and export by learning have great influence on innovation performance in high-tech industry. In

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Jiangsu and Zhejiang, opportunity window is in negative correlation with innovation performance, which means when there is huge market opportunity, companies do not need to develop new products; instead, they could get profits by relying on the new market or production scale. In Shanghai, the opportunity window is in positive correlation with innovation performance. It may be that Shanghai is an important innovation pole in China and market opportunities and potential have provided good industrial environment for new product research and development, which enables more monopolistic profit. Export by learning all shows positive externality, which means the exportoriented strategy in the Yangtze River Delta is good for absorbing international technology spillover. The effect is more obvious in Jiangsu and Shanghai where the manufacturing industry is of a larger scale than that in Shanghai. It also shows why the contribution elasticity of export by learning is high in Jiangsu.

Conclusion and Problems to be Studied With the panel data in high-tech industry and the five segmentations of Yangtze River Delta from 1997 to 2006, this chapter has conducted empirical study on the influencing factors on the high-tech industry innovation in Yangtze River Delta. Giving due consideration to international technological spillover, industrial innovation opportunity window, this chapter focused on the influencing degree of endogenous innovation effort and indigenous technology spillover from the dimension of industry and region. What we have found are: (1) from the perspective of industrial dimension, the high-tech industry in the Yangtze River Delta follows Romer ’s endogenous growth theory, and the endogenous innovation effort is the main driving force of industrial innovation and development. Indigenous technology spillover shows negative externality. Every increase of 10% of the sum of R&D fund expense in peripheral areas will lead to a 1% decrease of innovation performance. It shows that industrial specialization is not good for innovation and the conclusion supports the research of Glaeser (1992), Feldman and Audretsch (1998) and Batisse (2002). It means homogenization competition exists in the high-tech industry of the delta and excessive imitation is not good for original innovation. Considering the fact that endogenous effort is the decisive factor, the high-tech industry in Yangtze River Delta should spare no effort to strengthen R&D activity. Export by learning effect has strong contribution elasticity for industrial innovation performance, which shows the correctness and rationality of the export-oriented strategy of the Yangtze River Delta and shows the necessity to develop high-

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Endogenous Innovation Efforts, Indigenous Technology Spillover, and High Technology Industry Innovation Performance

tech industry by making use of international technology spillover. From the perspective of the opportunity window of industrial innovation, China, as a developing country, with its huge market environment in high-tech industry attracts companies to expand production scale or to exploit the market, but it has not forced companies to establish the innovation-oriented developing model. (2) From the perspective of regional dimension, no matter whether we give consideration to indigenous technology spillover effect, innovation performance and endogenous innovation effort are in causal relationship. Endogenous technology spillover effects vary in different provinces. Jiangsu could get positive technology externality from Shanghai but negative technology externality from Zhejiang. Shanghai could get positive technology externality from Zhejiang but negative technology externality from Jiangsu. Zhejiang could get positive technology externality from both Shanghai and Jiangsu. In a word, we rate the technological levels of Shanghai, Jiangsu, and Zhejiang as high, middle, and low areas (relatively speaking). Areas with low technological level will benefit from areas with high technology and vice versa. It may be that disorderly competition and imitation is to the disadvantages of innovators’ profits. When there is a gap in technological level, an area with high-technological level could benefit from an area with low-technological level. It may be that moderate expansion of technology is good for increasing innovators’ benefit. In addition, in the external environment, export by learning is good for innovation, but the opportunity window suppresses the innovation. The Yangtze River Delta is in this stage. There are two shortcomings in the research. First, it ignored the knowledge (technology) spillover effect of knowledge innovation subjects such as universities and independent research organizations on industrial (corporate) efforts. Jaffe’s consistency index measures the spillover effect of the university’s basic research. It is mainly because of the lack of segmentation data of the hightech industry of research organizations in the Yangtze River Delta, such as the key lab number, scientific research personnel number, and scientific research cost in specific technological fields. Second, only export by learning factor is taken into consideration in the international technology spillover channel. Research of multinational companies and research of FDI technology spillover effects are not involved. The research of multinational companies and data of FDI segmentation in the delta are lacking. As a whole, data is not the inherent shortcoming of this chapter. It is necessary for future research to include the knowledge spillover effect of the university’s basic research, research of multinational companies, and FDI technology spillover effect into the analysis framework of unity.

287

11

Chapter

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

The Yangtze River Delta has always been one of the transfer destinations for China’s surplus rural labor. But this manufacturing center which seems to have infinite rural surplus labor was threatened by the skilled worker shortage in 2006. By analyzing the industrial structure evolution and the real situation of human capital of rural labor transfer in the Delta, this chapter will explain this phenomenon. The essence of the skilled worker shortage is as follows: A company’s requirement for labor quality in industrial structure upgrading is in contradiction with the low human capital level of the labor provided. To ensure the smooth industrial structure upgrading in the Yangtze River Delta, positive measures must be taken to improve the human capital level of rural transfer labor.

The Proposal of the Question In recent years, plentiful international manufacturing capital has accumulated in the Yangtze River Delta, which has made electronics, computer and information technology, and communications and biomedicine in the manufacturing industry of the Yangtze River Delta develop by leaps and bounds. According to the data provided by the State Statistics Bureau, the industrial added value of the Delta reached RMB2.48 trillion in 2007 and its contribution rate to national industry added value is 24%. It has played a very important role in national manufacturing speed and structure upgrading. However, the development of the Delta is limited by various factors: the increasing cost of raw materials; the shortage of production materials, such as land; the skilled worker shortage; the tight energy transportation capacity; the diminished environmental bearing capacity; technological barriers in European and American markets; and other factors. The skilled worker shortage refers to the lack of available skilled workers in the labor force. This is a special form of the migrant worker shortage. The skilled worker shortage is the structural labor shortage, which means the labor quality provided is in contradiction with the labor quality required by the company. The contradictions are often caused by the fact that labor quality does not change correspondingly with the industrial upgrading. Then why does the skilled worker shortage occur in the Yangtze River Delta, China’s manufacturing base and labor inflow area? From 2004 on, many scholars conducted analysis and research on the problem of the migrant worker shortage and the skilled worker shortage in China. Yao Xianguo and Lai Jun (2005) conducted research from the perspective of labor supply. The research holds that the main reason for the migrant worker shortage is the constant rural labor transfer to industrial departments, and

290

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

the gradual decrease of rural cheap labor stock has led to the relative decrease of supply. Wang Guohui and Mu Huaizhong maintain that the increase in agriculture and other revenues has increased the opportunity cost for agricultural production for peasants and caused the decrease in migrant worker number. Cai Fang and Wang Meiyan (2005) conducted research from the perspective of labor demand. The research holds that the production model relying on lowcost and non-technological labor in the labor-intensive manufacturing industry of the east China coastal area is the main cause for the shortage of migrant workers. Li Shimei and Xu Zhiyong (2005) consider that the migrant worker shortage is aggravated because the technical reconstruction of some enterprises is backward and capital cannot successfully replace labor for production. There are also some achievements in terms of the pioneering study on skilled worker shortage in the academic field. For example, “The Study Report on Skilled Worker Shortage” published by labor and social security group in 2004 has analyzed the issue from the perspective of education investment theory. It holds that China’s universities have not cultivated enough skilled talents and the mismatch between labor quality and the market demand is the main reason for the skilled worker shortage. Qiu Guoqing (2006) conducted the research from the perspective of the cultivation of enterprise internal talents. He believes that the serious shortage of enterprises for staff skill training has caused the skilled worker shortage. Luo Yongtai (2005) thinks that the low social position and income of skilled workers inhibited the enthusiasm for people to participate in professional training, which gives rise to the short supply of skilled workers. Although the research efforts have their merits, most of them are from the perspective of labor and are conducted in terms of the national situation. However, we maintain that the skilled worker shortage is caused by both labor supply and demand. Searching for reasons from the aspect of labor demand is a way to resolve the contradiction. What’s more, the Yangtze River Delta is an area which is different from the overall situation of the whole nation. From the perspective of labor supply quantity, the labor shortage should not occur in the Yangtze River Delta. The shortage is relative to enterprise technological advances and industrial structure upgrading. Otherwise, it is hard to explain the fact that the migrant worker shortage and skilled worker shortage have never taken place from 1978 to 2004. Nowadays, the economy in the Yangtze River Delta has made great progress and the skilled worker shortage started. The essence of the skilled worker shortage is the mismatch between labor quality and labor market demand against the backdrop of technological and economic advances and industrial upgrading in the Yangtze River Delta. To prove that this viewpoint is correct, we

291

DEVELOPMENT IN THE YANGTZE RIVER DELTA

need to consider two things: first, the industrial structure and the internal structure of secondary and tertiary industry is being optimized and upgraded. Second, the labor quality provided to the secondary and tertiary industry in the Delta is in disaccord with the labor market demand. This chapter aims to clarify the correctness of the above viewpoints. The following part emphasizes the analysis of industrial structure evolution and the upgrading in the manufacturing and service industry of the Yangtze River Delta. It draws the conclusion that the industrial structure in the Yangtze River Delta based on the manufacturing industry is upgrading and, as a result, it requires higher quality labor. The final part analyzes the status quo of labor, especially the human capital level of transfer labor, from which we get the essence of the skilled worker shortage: it is the contradiction between enterprises’ requirements for labor quality and the low level human capital of the provided labor. To ensure the successful upgrading of the industrial structure of the Yangtze River Delta, active measures should be taken to improve the human capital level of rural transfer labor. In the end, the author puts forward political suggestions.

The Evolution of the Industrial Structure of the Yangtze River Delta The evolution of the three industrial structures and employment structure As a rule, industrial structure refers to the proportion of primary, secondary, and tertiary industry in the GDP. Sometimes, it often refers to the technological and capital composition within an industry. It is an important measure of the economic development degree of a country or an area. In developed countries, the production value of tertiary industry is bigger than that of the secondary industry and the production value of the secondary industry is bigger than that of the primary industry. Fig. 11.1 shows the evolution of the industrial structure in the Yangtze River Delta from 1990 to 2006 and the growth of the non-agricultural population. In 1990, the ratio of production values of the three industries in the Delta was 15.8 : 57.0 : 27.2. It can be seen that agricultural production accounted for a large proportion; the tertiary industry is not developed; the manufacturing industry occupies a large part 1

of the industry in Yangtze River Delta. Five years later, with the increase of nonagricultural population, the ratio of the three industry production values is 9.5 :

292

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

56.6 : 33.9. The primary industry has fallen by 6.3 percentage points and tertiary industry increased by 6.7 percentage points. From 1995 to 2006, the annual growth rate of the non-agricultural population was over 3% in Yangtze River Delta and the quickest growing period was from 2001 to 2006 when the growth rate reached 4.4%. In this period, the industrial ratio changed to 4.6 : 53 : 42.3 from 9.5 : 56.6 : 33.9. The proportion of the primary industry dropped obviously from 9.5% to 4.6%; the proportion of tertiary industry increased by nearly 10 percentage points from 33.9% to 42.3%; the proportion of the manufacturing industry has not changed in this period. By the end of 2006, although the industrial structure had not reached the ideal condition, the industrial structure had been optimized evidently: the primary industry had dropped steadily; tertiary industry grew steadily; under the condition that the proportion of secondary industry remains consistent, non-agricultural industry has grown steadily. It can be seen from Fig. 11.2 that the number of employees in the primary industry in the Yangtze River Delta fell from 2004 to 2006 while the number of employees in the secondary industry grew. As is known to all, if technological level remains in the economy, the output is determined by the input of production factors. Labor is an important production factor. Since non-agricultural industry accepted large labor transferred from the agricultural industry, it has reached non-agricultural output growth, capital accumulation increase, economy growth, and capital strength enhancement. In the long run, with the improvement of capital condition and technological production level, industrial structure will gradually be optimized, which is the case with the evolution of the industrial structure in the Yangtze River Delta. We will investigate the upgrading condition of manufacturing industry and service industry. Fig. 11.1

The ratio of industrial evolution and non-agricultural population increase in the Yangtze River Delta (%)

Year

The ratio of the three industries

1995

9.5 : 56.6 : 33.9

1990 2001 2004 2005 2006

15.8 : 57.0 : 27.2 6.4 : 51.5 : 42.1 5.7 : 52.7 : 41.6 5.2 : 52.9 : 41.9 4.6 : 53 : 42.3

Sources: The data of 1990 and 1995 is collected from the internet document based on the Yangtze River Delta Region and the Urban Development International Researcher Center of Zhejiang University. Data of other years is collected from Jiangsu Statistical Yearbook , Zhejiang Statistical Yearbook , and Shanghai Statistical Yearbook .

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Fig. 11.2

The composition of employee number of the three industries in Zhejiang, Shanghai, and Jiangsu of the Yangtze River Delta 2004 Jiangsu

Zhejiang

Shanghai

Yangtze River Delta

Primary industry

33.6

26.06

8.0

22.6

Secondary industry

34.2

43.61

38

38.6

Tertiary industry

32.2

30.33

54

38.8

2005 Jiangsu

Zhejiang

Shanghai

Yangtze River Delta

Primary industry

31.5

24.5

7.0

21

Secondary industry

34.3

45.07

37.3

38.9

Tertiary industry

34.2

30.43

55.7

40.1

2006 Jiangsu

Zhejiang

Shanghai

Yangtze River Delta

Primary industry

29.8

22.63

6.2

19.5

Secondary industry

34.8

45.78

37

39.2

Tertiary industry

35.4

31.59

56.8

41.3

Sources: The data above is collected from Jiangsu Statistical Yearbook , Zhejiang Statistical Yearbook , and Shanghai Statistical Yearbook .

The optimization and upgrading of the manufacturing industry of the Yangtze River Delta From Fig. 11.1, we can see that the proportion of manufacturing industry in the Yangtze River Delta has always occupied about 55% of the national economy from 1990 to 2006, which is more than the sum of the primary and secondary industry. From 2004 to 2006, the proportion tends to grow. We can see from Fig. 11.2 that the labor force in the secondary industry is also growing, which is similar to that in the tertiary industry. Therefore, no matter from the perspective

294

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

of production value contribution or from the perspective of the contribution of absorbing labor employment, the manufacturing industry in the Yangtze River Delta plays a very important role. Since the manufacturing industry upgrading reflects the process of industrial upgrading, people always investigate the industrial structure evolution by associating manufacturing industry upgrading with the different stages of industrial upgrading. The manufacturing industry 2

upgrading can be classified into three stages. The first stage: This is the stage where the manufacturing industry centered on light industry becomes heavy industry-centered in the stage of heavy industrialization. The index to reflect heavy industry level is the proportion of heavy industry production value in all manufacturing output. The second stage: In the process of heavy industrialization, manufacturing structure centered on raw material develops to be centered on the processing and assembling industry, which is the height of processing. The third stage: In the process of the height of processing in the manufacturing industry, more and more technologies are adopted in each department of the manufacturing industry. The wide application of high technology represented by technology-intensive industry makes the structure of the entire manufacturing industry show the characteristics of being technologyintensive We will investigate the manufacturing developing condition and the evolution of the manufacturing structure in the Yangtze River Delta in light of this theory.

The heavy industrialization of the manufacturing industry in the Yangtze River Delta The Yangtze River Delta has never been the heavy industrial base of China, but with the upgrading of the industrial economic development of the Delta, the manufacturing industry in the area shows the trend of heavy industrialization. It can be seen from Fig. 11.1 that the heavy and chemical industries’ proportion of the Delta has always been growing since 1998. In 2003, the heavy industry output value accounted for 60.79% of the overall industrial value of the whole area. Since 2004, the proportion of heavy industry in the Yangtze River Delta began to show a strong rising trend. By 2006, the proportion of heavy industry reached 67.5%. It can be estimated that with the sustainable development of the Delta, the industrial structure will surely be optimized and upgraded and the heavy industrialization degree will be further improved in the Yangtze River Delta.

295

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Fig. 11.1

The trend of the proportion of the heavy and chemical industries in the Yangtze River Delta from 1998 to 2006

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0

1998

1999

2000

2001

2002

2003

2004

2005

2006

Sources: The above data is collected from Jiangsu Statistical Yearbook , Zhejiang Statistical Yearbook , and Shanghai Statistical Yearbook (1998–2006).

Fig. 11.2

The trend of the proportion of the heavy and chemical industries of Zhejiang, Jiangsu, and Shanghai from 2000 to 2006

0.8 0.6 0.4 0.2 2000

2001 Jiangsu

2002

2003

2004 Zhejiang

2005

2006 Shanghai

Sources: T he above data is collected from Jiangsu Statistical Yearbook , Zhejiang Statistical Yearbook , and Shanghai Statistical Yearbook (2000–2006).

From Fig. 11.2, we can see the heavy and chemical industries condition in

Jiangsu, Zhejiang, and Shanghai from 2000 to 2006. In 2006, the heavy industry

output value of Jiangsu, Zhejiang, and Shanghai is RMB2,887.873 billion,

RMB1,637.295 billion, and RMB1,488.394 billion, which account for 48%, 27.2%, and 24.8% of the total value of the area, respectively. It can be seen that Jiangsu has the absolute advantage in heavy industry value. From the proportion of heavy

296

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

and chemical industries in each area, Shanghai has always had a leading position, followed by Jiangsu, then Zhejiang. In 2006, the heavy and chemical industries’ proportion of Shanghai was 75.8%, Jiangsu was 69.7%, and Zhejiang was 56.2%. Heavy industrialization is the manifestation of manufacturing upgrading in developing countries. The technological characteristics of heavy and chemical industries’ products are with high technical content, big income elasticity, and a high correlation effect. Therefore, heavy industrialization makes a high requirement for the human capital level of the labor. If the labor quality and skill could not keep up with the pace of industrial upgrading, the heavy industrialization progress will slow down or even come to a standstill.

Processing optimization of the manufacturing industry in the Yangtze River Delta Processing optimization refers to the process where the main part of the manufacturing industry structure transforms from raw materials to processing and assembling in industrial upgrading. As a rule, the higher the processing level, the bigger the added value. As a result, the high processing optimization process is also called the high added value process. The high processing optimization in the manufacturing industry means that product processing will deepen with industrial upgrading development. When the raw materials industry develops to a certain stage, its increasing speed will be surpassed by the processing and assembling industry. Although generally speaking, there is no fixed proportionality coefficient between raw materials industry and the processing and assembling industry, the increasing trend of processing and assembling industry reflects the industrial upgrading process from a side. With the deepening of processing degree of the manufacturing industry, the increase of manufacturing industry’s dependence on raw materials will gradually decline. The use of intermediate products constantly increases and the proportion of the added value in the final product will be continuously improved. As a result, the economic efficiency of the manufacturing industry will be increased and the industrial structure will be improved. We can see from the above that processing optimization development is related to getting rid of resource constraints and making national economic growth exceed the output increase of the mining and raw materials industry. Next we will adopt the ratio between the manufacturing industry and the raw materials industry to reflect processing optimization for processing industry which includes light processing industry with industrial products as the raw material and the heavy processing industry. The two have formed a complete input and output relationship with the raw materials industry (see Fig. 11.3).

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Table 11.3 The processing optimization coefficients of the Yangtze River Delta and the whole country from 1995 to 2006 Jiangsu

Zhejiang

Shanghai

1995

3.44

3.42

2.57

2003

4.23

5.17

4.05

2000

2006

4.18

4.38

3.80

7.56

4.55 4.58

Yangtze River Delta

The whole country

4.18

3.42

3.15 4.48

5.50

2.24

2.74

3.01

Sources: The above data is collected from China’s Statistical Yearbook , Jiangsu Statistical Yearbook , Zhejiang Statistical Yearbook , and Shanghai Statistical Yearbook of 1996, 2001, 2004, and 2007.

In 2006, the overall processing coefficient of the Yangtze River Delta was 5.50, which was above the national average of 3.01. It shows the advanced characteristic of the industrial structure in the Yangtze River Delta as the manufacturing base. From the perspective of each area of the region, the processing optimization degree of Zhejiang in the last 10 years is obviously higher than the other two areas. Since processing optimization is accompanied with the high added value process, as a result, it is not like the primary period of industrial upgrading when simple labor can ensure the production. On the contrary, in this stage, the characteristic of high added value makes a high requirement for labor quality. Only high-quality and skilled labor could engage in the high-added value production. As a result, once lacking such labor, the process will receive great negative impact.

The service industry upgrading in the Yangtze River Delta From Table 11.1 and Table 11.2, we can see that the output value and the proportion of absorbed employment of tertiary industry (service industry) of the Yangtze River Delta are around 40% in 2006 while the output value and absorbed employment in tertiary industry in developed countries are around 70%. It can be estimated that there is big development space for tertiary industry in the Yangtze River Delta. From the perspective of developing direction, the experiences of developed countries show that the modern service industry which regards producers as the core will take more proportion. According to the definition of Canadian scholars Grubel and Walker (1989), producer service refers to the intermediate input service for other commodity and service producers. It is also known as “intermediate input service.” Although lots of scholars take it as the definition and regard all the behaviors in accord with the definition in the tertiary industry as producer service industry,

298

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

due to different statistic methods of nations and the statistic system change, there has been no unified standard as to which industries in the tertiary industry sector belong to the producer industry. Therefore, this chapter chooses typical industries generally with no controversies as the producer industry, such as communications and transportation, storage and postal service, information transmission, computer services and software, financial industry, real estate industry, scientific research, technical service, geological prospecting industry, lease and business services to conduct analysis of the development of the producer service industry of the Yangtze River Delta. First, we review the development situation of the producer service industry of Zhejiang, Jiangsu, and Shanghai in recent years. From Table 11.4, we can see that the producer service industry in Shanghai developed very rapidly from 2001 to 2006 and its proportion in tertiary industry increased by 5.5 percentage points from 0.549 to 0.605. This shows that the development speed of the producer service industry is faster than that of the tertiary industry and this has made a greater contribution to the GDP. The research report of the Shanghai Economy Committee pointed out on November 15, 2007 that, according to the incomplete statistics of seven main corporate groups and 170 enterprises in four development zones in Shanghai from January to September, the business revenue of the producer service industry in Shanghai is RMB96.08 billion, which has increased by 38.9% and this is higher than the manufacturing industry. The business service operation revenue is RMB53 billion, which occupies half of the producer service. In the growing process of producer service, manufacturers try to become general contractors and achieve total integration. The service industry began to expand to the production field. The manufacturing industry and service industry blended and integrated with each other to become an important force to drive industrial structure upgrading in Shanghai. Table 11.4 The output values of the main producer service industry and the proportion in tertiary industry in Shanghai from 2001 to 2006 Unit: RMB100 million Year

2001

2002

2003

2004

2005

2006

Transportation, storage, and postal services

274.36

294.07

306.69

493.60

582.60

669.01

Information transmission, computer services, and software

159.24

194.10

228.47

303.84

359.21

421.31

Financial industry

619.99

584.67

624.74

612.45

675.12

825.20

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Unit: RMB100 million Year

2001

2002

2003

2004

2005

2006

Real estate trade

316.85

373.63

463.93

666.30

676.12

688.10

Scientific research, technical service, geological prospecting

64.01

70.56

74.32

171.81

212.91

234.12

Lease and business services

63.68

78.17

82.72

253.29

292.19

332.98

2,728.94

2,755.83

3,027.11

4,097.26

4,620.92

5,244.20

The tertiary industry The proportion of the above producer service to the tertiary industry

0.549

0.579

0.588

0.610

0.606

0.605

Source: All the above data is calculated from Shanghai Statistical Yearbook (2001–2006).

From Table 11.5, it can be seen that with the change of statistical caliber, the development situation of the producer service industry of Zhejiang could be discussed in two stages: during the period of 1995–2003, the ratio of producer service industry in tertiary industry in Zhejiang rose more than 4 percentage points from 0.438 to 0.480, which was a huge increase; during the period of 2004–2006, the growth rate was quicker than in the previous period and it increased by 2 percentage points within three years. Table 11.5

The output values of the main producer service industry and the proportion in tertiary industry in Zhejiang in 1995, 2001–2006

Unit: RMB100 million Year

1995

2000

2001

2002

2003

Transportation and storage

164.96

268.37

334.11

401.78

453.55

Postal and telecommunication services

39.63

159.93

169.57

200.22

247.33

139.69

209.25

243.94

323.26

416.97

56.05

116.90

146.31

186.83

238.5

6.91

16.28

21.95

27.73

35.27

86.48

220.20

277.35

330.41

396.49

1,130.52

2,188.71

2,593.25

3,130.00

3,726.00

Industry

Banking and insurance Real estate trade Scientific research and polytechnical services Social services The tertiary industry The proportion of the above producer service to the tertiary industry

300

0.438

0.453

0.460

0.470

0.480

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

(Cont'd) Unit: RMB100 million Year

2004

2005

2006

Transportation, storage, postal and telecommunications services

444.65

512.94

630.94

Information transmission, computer services and software

273.92

316.19

376.17

Banking

523.49

674.77

846.63

Real estate trade

Industry

587.83

695.82

807.52

Scientific research, technical service, geological prospecting

95.01

120.49

144.72

Lease and business services

197.44

227.58

272.92

4,584.22

5,378.87

6,307.85

The tertiary industry The proportion of the above producer service to the tertiary industry Note:

0.462

0.474

0.488

Since the statistical standard of the tertiary industry has been adjusted in 2004, the classification in the above table before and after 2004 is slightly different.

Source: Zhejiang Statistical Yearbook over the years.

As is the same case with Zhejiang, the development situation of the producer service industry of Zhejiang could also be discussed in two stages. From Table 11.6, it can be seen that from 1995 to 2004, the ratio of producer service industry in tertiary industry in Jiangsu rose from 0.514 to 0.539. The ratio reached to 0.544, which is the largest in 2000. During the period of 2005–2006, the ratio of the producer service industry, calculated based on the new statistical standard, also rose by 1.5%. In addition, Tang Danhua (2006) investigated the development situation of the modern service industry of Jiangsu from 1990 to 2004. From 1993 on, the ratio of producer service industry in the service industry of Jiangsu rose steadily from 57.07% to 65.89%.What’s more, the annual growth rate of the modern service industry in Jiangsu is about 3 percentage points higher than the Jiangsu GDP growth rate, which contributes the most to the GDP. In 2007, Jiangsu began to build a modern service industry agglomeration district and the focus is to develop the modern service industry, the core of which is the producer service industry. Jiangsu’s leaders’ goal is to provide a good environment for the cluster development of the producer service. Nowadays,

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

a group of agglomeration districts, including Kunshan Huaqiao International Business District, are playing more and more important roles in the industrial structure upgrading in Jiangsu.

Table 11.6 The output values of the main producer service industry and the proportion in tertiary industry in Jiangsu in 1995, 2001–2006 Unit: RMB100 million Industry

Year

Transportation, postal and telecommunications services

Banking and insurance

Real estate trade

Scientific research and polytechnical services

Social services

The tertiary industry

The proportion of the above producer service to the tertiary industry

1995

2000

2001

2002

2003

2004

253.52

557.37

644.87

717.76

821.48

973.82

270.50

430.68

450.64

487.57

537.77

632.88

143.61

351.92

393.75

456.56

549.50

669.40

47.50

90.49

106.64

126.71

148.18

180.08

102.98

1,591.64 0.514

265.25

308.83

3,115.67

3,522.02

0.544

0.541

353.52

3,972.63 0.539

424.97

4,567.37

466.31

5,426.65

0.543

0.539

Unit: RMB100 million Year

2005

2006

741.06

928.41

Information transmission, computer services and software

318.92

383.47

Banking

Real estate trade

562.42

Scientific research, technical service, geological prospecting

731.01

723.79

118.01

133.36

222.69

284.22

Industry

Transportation, storage, postal and telecommunications services

Lease and business services The tertiary industry

The proportion of the above producer service to the tertiary industry

Note:

6,489.14

0.415

914.78

7,849.23

0.430

Since the statistical standard of the tertiary industry has been adjusted in 2004, the classification in the above table before and after 2004 is slightly different. Source: Zhejiang Statistical Yearbook over the years.

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Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

In the process of industry structure upgrading, manufacturing industry upgrading and producer service industry development are two complementary aspects. The upgrading and development of the manufacturing industry provides a market for the producer service industry while the producer service industry provides an upgrading service for the manufacturing industry by offering the technology, knowledge, and human capital that the manufacturing industry needs. Promoting the structure regulation and optimization of the manufacturing industry from the point of developing the modern producer service industry is a new phase of the industrial structure political transformation under the condition of knowledge economy and globalization. As to the effect of the modern producer service industry on the manufacturing industry, we can refer to the discussion of Liu Zhibiao (2005, 2006). In a word, the modern service industry, with the producer service industry as the core, in the Yangtze River Delta is rapidly developing, which not only greatly influences the optimization and upgrading of the tertiary industry, but also accelerates the upgrade of the manufacturing industry by transforming and promoting traditional manufacturing industry with the intermediate skill and service provided to the manufacturing industry. It enables manufacturing industries of the Yangtze River Delta not only to be involved in simple international subcontracting work with low added value in the value chain, but also to develop towards research and development and brand operation with high added value in the value chain. On August 6, 2008, premier Wen Jiabao passed the “Guidance on Further Promoting Reform and Opening up and Economic and Social Development in Yangtze River Delta” when hosting the standing committee of the state council. The first work was to speed up the regulation of the industrial structure of the Yangtze River Delta and to try to establish the industrial structure with the modern service industry as the major part, which has made clear the development direction of the basic industry structure framework with the modern service industry as the main content in the Yangtze River Delta. Of course, both the producer service industry and the modern service industry need high-level human capital labor. Without the high-quality labor that is suitable for the modern service industry, the service industry will not develop.

The Restriction of Migrant Labor on Industrial Structure Upgrading in the Yangtze River Delta There are two typical modes in the theoretical research of the labor transfer model. The first one is the model put forward by Lewis, the British economist

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

in 1954; the other one is the model put forward by Harris and Todaro, the American economists. Lewis’s model is about the fact that there is lots of surplus labor in the rural sector which leads to the situation where the marginal productivity of the rural population is zero. He holds that only if the industrial sector provides real wages more than the minimum subsistence, could the rural sector provide infinite labor to the urban sector and not have any influence on the rural sector. The model of Harris and Todaro holds that in the background there is unemployment in the urban sector and the flow direction is determined by laborers’ comparisons between rural real wages and urban expected wages. Many scholars use the two models to analyze China’s labor transfer and have achieved meaningful results. For example, when studying China’s migrant labor transfer mechanism, Li Xiaochun (2005) pointed out the labor transfer mechanism of a “shift from farming to other trades within the rural area” from villages to towns possesses the characteristics of Lewis’s model; the labor transfer mechanism of “migrant worker trend” cross towns and towards other areas is in line with Harris and Torado’s model. The important conclusion is that China’s labor transfer mechanism has the dual nature. On the other hand, in the big environment of a Socialist market economy, as long as there is an economic gap among regions in our nation, Harris and Torado’s labor transfer mechanism in line with the migrant worker tide” will have its role to play. Attracted by the high expected wage of developed areas, labor will continually gather towards developed areas. The gap between the economically developed Yangtze River Delta and other areas, especially the rural areas in central and west China, could not be wiped out in a short time. Therefore, that Yangtze River Delta, as the main gathering place for rural labor transfer will not change in a very long time to come. Through the analysis of the second section of the chapter, we know that the industrial structure of the Yangtze River Delta is constantly optimizing–the manufacturing industry in developing toward heavy industrialization and process optimization. The modern service industry with the producer service industry as its core is growing strongly. However, whether the process can be carried out smoothly depends, to a large extent, on whether the knowledge and skill of the labor could adjust to the process. According to the competition theory, in the short term, under the condition that the technological level of manufacturing equipment remains the same, labor’s quality as the production factor and the skillful degree of mastering the production skill will directly influence the production efficiency and the industrial competitiveness. When the labor costs are the same, the higher the labor quality, the more competitive the industry, and vice versa. With manufacturing industry’s evolution towards being capital-

304

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

intensive and technology-intensive, and the service industry upgrading in the Yangtze River Delta, labor quality and skill face higher demands. In the real economy, how is the Yangtze River Delta’s demand for skilled workers and what is the situation of labor? Table 11.7 shows the proportion of demand and supply in the labor market of major cities (including the Yangtze River Delta cities such as Nanjing, Shanghai, Wuxi, Xuzhou, Changshu, Nantong, Yancheng, Hangzhou, Ningbo, Shaoxing, Wenzhou, and etc.) in 2005, 2006, and 2007. It can be seen that there is a skilled worker shortage of various kinds in many places in the Yangtze River Delta and the situation was not mitigated from 2005 to 2007. The requirement for senior technicians (professional qualification A level) and senior engineers (senior title) has grown higher. The demand ratio of senior technician (professional qualification A level) rose from 2.08 to 2.62 and the increase rate is the biggest. The demand ratio of senior engineers (senior title) rose from 2.06 to 2.2. There are two reasons for this situation: first, with China’s rapid economic development and the optimization evolution of the industrial structure, the demand for skilled labor grows; second, the cultivation speed of China’s skilled labor is slow, which leads to the mismatch between the supply and demand of skilled workers. Next we focus on the analysis of labor, especially the human capital of transfer labor in the Yangtze River Delta. Table 11.7 The demand ratio of skilled workers in the labor market of some major cities in 2005, 2006, and 2007 2005

2006

2007

Junior worker (Professional level E)

1.52

1.37

1.42

Intermediate worker (Professional level D)

1.57

1.55

1.5

Senior worker (Professional level C)

2.10

1.76

1.68

Technician (Professional level B)

1.85

1.96

2.32

Senior technician (Professional level A)

2.08

2.03

2.62

Technologist (primary title)

1.31

1.41

1.47

Engineer (intermediate title)

1.51

1.65

1.66

Senior engineer (senior title)

2.06

2.21

2.2

Note: Demand ratio = People demanded / People supplied Sources: The above data is collected from the reports published by China’s Ministry of Labor and Social Security in 2006, 2007, and 2008.

Since China’s rural labor transfer is mainly from the agricultural industry to the non-agricultural industry, we could get the human capital level of the labor in the Yangtze River Delta only by studying the education of rural household

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

labor and migrant rural labor. Table 11.8 and 11.9 are education statistics of rural household labor of the Yangtze River Delta compared to the whole nation in 2006 and the education statistics of migrant rural labor in 2006, respectively. From Table 11.8, we could see that, from the perspective of rural residents, the situation of Shanghai is the best and the situations of Jiangsu and Zhejiang are similar, but all the rural residents of the three places are mainly of junior middle school education. Table 11.8 Education statistics of rural household labor of Yangtze River Delta and the national total in 2006

Jiangsu Zhejiang Shanghai Yangtze River Delta National total

Illiteracy

Primary school

5.2 6.3 2.9 4.8 6.8

29.4 36.6 20.6 28.7 32.7

Junior middle school 50.2 44.8 60.8 51.9 49.5

Senior high College school graduate or above 13.4 1.8 11.0 1.4 12.3 3.4 12.2 2.4 9.8 1.2

Sources: T he above data are from The Major Data Communique of the Second Agricultural Census in Jiangsu , The Major Data Communique of the Second Agricultural Census in Zhejiang , and The Major Data Communique of the Second Agricultural Census in Shanghai .

Based on the average of Zhejiang, Jiangsu, and Shanghai, although the figure of the Yangtze River Delta is better than the national average, the rural household labor of the Yangtze River Delta is still of junior middle school education level (51.9%), which exceeds the sum of the proportions of other educational levels. From Table 11.9, we can see that the educational level of the migrant rural labor is higher than that of farming residents in the Yangtze River Delta in 2006. However, the major part of the migrant rural labor is of junior middle school education level in the Yangtze River Delta, which accounts for 62.2% of all the outbound personnel. We may say that the educational level of the outbound labor in the Yangtze River Delta is still low. Table 11.9 Education statistics of migrant rural labor in the Yangtze River Delta and the national total in 2006 Illiteracy

Primary school

Junior middle school

Jiangsu

0.9

15.2

70.6

11.6

1.7

Zhejiang

1.7

22.6

60.0

13.5

2.1

Shanghai

0.6

10.2

56.1

22.1

11.0

306

Senior high College school graduate or above

Industrial Structure Upgrading and the Skilled Worker Shortage in the Yangtze River Delta

(Cont'd) Illiteracy

Primary school

Junior middle school

Senior high College school graduate or above

Yangtze River Delta

1.1

16.0

62.2

15.7

4.9

National total

1.2

18.7

70.1

8.7

1.3

Sources: T he above data is from The Major Data Communique of the Second Agricultural Census in Jiangsu , The Major Data Communique of the Second Agricultural Census in Zhejiang , and The Major Data Communique of the Second Agricultural Census in Shanghai .

The educational levels of Shanghai, Zhejiang, and Jiangsu rank in the forefront of the whole nation. The situation in the Yangtze River Delta is as described but the educational levels of other areas are more worrying. Wei Chaoan, the vice minister of the Ministry of Agriculture, has pointed out at the Farmer Scientific Quality Forum that the average educational period of 0.49 billion members of rural labor population is only 7.3 years; laborers received vocational training which only accounts for 9.1%, and less than 5% of the laborers have received agricultural vocational education. Most of the labor forces are farmers. There is a large gap between the urban labor educational level and that of rural labor, which is the matrix for labor transfer. Very few migrant workers have received specialized vocational training. The rural labor, especially the migrant labor, has a low cultural quality and skill level. As a result, when enterprises are undergoing technological updating, the migrant workers are inevitably shut out of the door. The skilled worker shortage, the phenomenon mentioned at the beginning of the chapter, occurs. When the situation of the skilled worker shortage cannot be improved, the process of economic industrial upgrading will slow down or even come to a standstill. The skilled worker shortage is the negative force which hampers industrial upgrading and economic development. In a word, we must point out clearly that currently the Yangtze River Delta is not well prepared for industrial upgrading in terms of labor supply. The low human capital level is the fundamental reason for the birth and threat of the skilled worker shortage.

Political Suggestions This chapter suggests that enterprises should realize from the realities of the skilled worker shortage and the migrant worker shortage that the age of an

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

unlimited supply of low cost peasant workers has passed. The competitive advantage based on low-cost labor will become history. Enterprises, especially the manufacturing industry, should not be satisfied with simple and repeated processing. Instead, the inevitable trend for corporate development is to transform from the intermediate stage with low added value to research and development, marketing, and brand operation with high added value. As a matter of fact, developing towards this direction does not mean giving up the labor-intensive strategy. The labor quality and skill could be improved by training, which can make the skill of the labor force more professional. In doing so, the industrial structure upgrading could be promoted and the problem of employment could be solved. Enterprises will consider staff training which would bring them benefits in terms of their long-term development. As to the contradiction between industrial upgrading and the skilled worker shortage, we hold that government should do the guiding work towards enterprises and peasant-workers to alleviate the skilled worker shortage. For example, government could formulate policies of hard rules about corporate training tasks to identify enterprises’ training responsibility; let enterprises make plans for peasant-worker position training and carry it out; draw out worker educational training fees according to rules for this purpose. As to enterprises which do not comply with its duty, staff educational training fees can be drawn out according to national regulation for obligating position training organized by the government or industry. Peasants should be guided to form the awareness of “training before employment” to make good preparation for skills. The government should also provide help to peasants and enterprises from the aspects of work information, training, and learning. In the end, we hope peasant-workers would actively participate in the activities to receive training and improve labor skill. If it is possible, they should pay part of the training cost, which is good for the formation of the capital input training mechanism of “government and enterprises take the major role and peasants take the minor role.” They should shoulder part of the responsibility for their own happiness. Meanwhile, local governments and enterprises should pay attention to the peasant training work and make contributions to peasant training. We should make the best of the circumstances. The skilled worker shortage is not a disaster. It leads us to think at a deeper level of the economy and society and to explore methods to solve the problem. It is an opportunity to promote the economic industrial structure and social progress.

308

12

Chapter

Land Utilization in the Economic Growth of the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction With technological progress starting to become the major power pushing the global economy forward, the main emphasis of growth theory has also turned from the traditional one dominated by capital toward investment into endogenous growth based on technological progress — New Growth Theory. But as the basic vehicle to support economic activities, land is always one of the indispensable elements in economic activities no matter how the orientation of key factors changes. Land utilization in economic growth involves not only the growth accounting of land in the current economic growth mode, but also the sustainable effect of land supply to economic growth when considering the inherent property of land. During the 30 years since the reform and opening up, Shanghai, in the south of Jiangsu province, together with the north and northwest of Zhejiang province have achieved rapid economic growth with the sharp rise of industry and the service industry and they have been collectively come to be called the Yangtze River Delta over time. According to the standard of Statistical Yearbook of Yangtze River Delta , Pearl River Delta , Hong Kong and Macao Special Administrative Region from the National Bureau of Statistics of China, the Yangtze River Delta area refers to the one that consists of the two provinces of Jiangsu and Zhejiang along with the one city of Shanghai –– altogether 16 cities at the prefectural level. Besides Shanghai, the Delta not only includes such cites as Nanjing, Suzhou, Wuxi, Changzhou, Zhenjiang, Nantong, Yangzhou, and Taizhou in Jiangsu Province, but also such cites as Hangzhou, Ningbo, Jiaxing, Huzhou, Shaoxing, Zhoushan, and Taizhou in Zhejiang Province. The area of 109.6 thousand square kilometers, making up 1.1% of the total land area of China, is one of the areas with the most advanced economies of industry. The Yangtze River Delta area in 2004 accounted for 20% of the total GDP with PGDP being 3.4 times the national average. The realization of the process, from the perspective of modern economic growth theories, is the result of scale growth in the inputs of major factors of production such as capital, labor, and technology. But in the meantime, the input of all these factors, on a large scale, is based on the greater investment in new land. Nowadays, with realizing sustainable development of the economy being the top priority around the world, especially in developing countries, the restraint on the growth mode merely depending on the scale enlargement of factors will come into effect through the fixed efficiency of factors by the combination of the scarcity of land and the diminishing marginal returns.

310

Land Utilization in the Economic Growth of the Yangtze River Delta

Under such circumstances, it will be an important issue that, on the one hand, makes an objective and scientific analysis on the relationship between the land input in the Yangtze River Delta and economic growth as well as the contribution of land to economic progress; on the other hand, conducting research on balancing the law of diminishing marginal returns on the basis of the analysis. In the view of this issue, the questions mentioned above will be analyzed based on the current result of economic growth accounting in the Yangtze River Delta in this chapter.

Literature Review Western economists have studied the status and function of land in the economy for a long time, just as they have capital, labor, and other elements. From William Petty, Adam Smith, to David Ricardo, they all treat land and land utilization as important parts of economic research, and land tax theory is also an important symbol of Marxist economics. Till the early years of the 20th century, Alfred Marshall, representative of neo-classical scholars, also shared the view of production including land, labor, and capital, writing: “By Land is meant the material and the forces which Nature gives freely for man’s aid, in 1

land and water, in air and light and heat.” The Elements of Land Economics , coauthored by Richard T. Ely and Edward 2

W. Morehouse, was published in 1924. The publication of this book marked the formation of land economics in which properties and the functions of land are the main content areas in the study of economic activity. The book pointed out that land as natural resources, is one of the most basic of all the economic concepts. This kind of characteristic is reflected in both a static and dynamic process. In a static process, all economic activity occurs in certain land while in a dynamic process, the change in land supply and land utilization efficiency would affect the quality of economic growth. Besides, the book presented analysis on the properties of the land from the four perspectives: economic, legal, natural, and social. The economic analysis of land is mainly focused on the shortage and diminishing marginal return of land, and the relative price rigidity (the tardiness that adapts fluctuation of price) during the process. After entering the 20th century, the development model in developed countries gradually changed from one of highly developed industrialization and urbanization to a technology-oriented method. This development changed and enriched the growth factors. The early growth factors include mainly capital and labor factors, and the Harrod-Domar model, which formed in the

311

DEVELOPMENT IN THE YANGTZE RIVER DELTA

1930s, to explain an economy’s growth rate in terms of the level of saving and productivity of capital. However, during the mid-1950s to the late 1980s, the Cobb-Douglas (C-D) production function is often used as an analytical tool in neoclassical economic growth theory, from exogenous growth theory to endogenous growth theory. Those theories are pioneered and represented by Solow and Romer, and they take the generation mechanism of the technical elements as the core elements. The C-D production function will divide productivity growth into physical capital, technology, or human capital in order to study its contribution. The growth accounting system (started by Solow in 1957) allows technological progress into the production function equation, and can conversely infer the contribution of technological progress (TFP) by economic growth and the contribution of capital and labor. Subsequently, Denison (1967, 1993), Kendrick (1993), Krugman (1994), Maddison (1995), and Young (1995), Robertson (1998), J. Felipe and McCombie (2001) and many other people make contributions to further promote research in this area by analyzing the growth source of the United States or the rest of the world. The evolution of growth theory promotes the development of land economics. The land became one of the foundations of economic growth. Thus, economists have begun to use the growth theory model to study the property and contribution of land. According to available information, Donald Nicholas (Nicholes 1970) created the neoclassical growth model including elements of land. Nicholas set production function Q = F (K , N *, L *), in which

K is the capital, N is the labor, L is the land, and F K, N* L* > 0, F KK, N* N*, L* L* 0); τ is the effort level of employees, consisting of two parts, in which τ0 is the labor of employees necessary to obtain a job and Δτ is the extra labor the staff offered in order to obtain higher incomes (Δτ ≥ 0). In the above formula, along with the improvement of efforts, the enterprise’s production will raise, which is also influenced by technology and capital investment level, λ. Assumption 2: The profits of an enterprise come from income which is taken off costs. The costs include the wages paid to employees, cost of raw materials, machinery and equipment depreciation, and other necessary administrative expenses, and financial expenses. Let p be the product price, q is the sales volume, v is the unit variable cost of raw materials, etc., f is a total fixed cost offsetting wages and salaries, s is wages and salaries, r is the profit, and w is the profit before wages. Therefore, irrespective of the income tax, we can get the following equation:

w = r + s = (p – v ) q – f = (p – v) λ (τ0 + Δτ) – f (15–2) In this chapter, it is assumed that w > 0, that is, only considering the case when the business is making a profit. Assumption 3: In order to motivate employees to work harder, the companies paid staff the salaries s . Most of the research on the incentives at home and abroad is based on linear contracts. This chapter also draws on the idea of a linear contract and builds the following incentive contract the enterprise pays based on w , the profits before payment.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

s = α + β (p – v ) λ Δτ (15–3) α is a fixed income and has nothing to do with the growth of enterprise

earnings. It contains necessary expenses and the fixed wages paid by enterprises for their employees. As mentioned earlier, if the staff wants to get α, they must offer a basic effort τ 0, or they will be dismissed; β is the share of corporate

profits for employees, known as the incentive coefficient. After staff complete the basic output λτ0, their increased efforts will cause the growth of the output

(λ Δτ), which will in turn lead to the increase in profits of an enterprise. A unit corporate profits increase will bring about the increase of employees’ compensation β units.

Consumption 4: Hard work of the staff can increase enterprises’ production,

and thus make a profit increase. But, at the same time, employees have to

pay the corresponding costs, such as the income to maintain basic living, the sacrifice of the rest time to work overtime, and self-funded training. The level of working effort is τ, and the cost is c which is the function of τ:

1 c = 2 k (τ0 + Δτ)2 (15–4)

k is the cost coefficient of effort and k > 0. The bigger k is, the higher the cost

employees pay at the same effort level τ.

The cost function designed in this chapter shows that if staff raise the level

efforts, this will lead to larger cost. The higher the effort level is, the larger the cost needed to raise the effort. This assumption is also in line with market realities.

The utility function of employers and employees The above assumptions show the manufacturer’s expected utility function (Er ) is:

Er = (p – v ) λ [τ0 + (1 – β) Δτ] – f – α (15–5) The staff’s expected utility function (Ee ) is: 1 Ee = α + β (p – v ) λ Δτ – 2 k (τ0 + Δτ)2 (15–6) Thus, this chapter has established the game model between the employers

and employees. In this model, the manufacturer is the leader of the Stackelberg game, and has the advantage of taking initiatives in the entire game. According

to supply and demand conditions in the labor market and enterprise operating conditions, they can determine the level of α and β. Employees only can maximize their own utility by adjusting the level of their own efforts τ.

410

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

(P ): Max { (p – v ) λ [τ0 + (1 – β) Δτ] – f – α } α , β, τ

(15–7)

1 s. t . α + β (p – v) λ Δτ – 2 k (τ0 + Δτ)2 ≥ s 0 1 Δτ arg Max {α + β (p – v ) λ Δτ – 2 k (τ0 + Δτ)2} β [0,1)

p , v , f , k , λ, τ0 > 0 α, Δτ ≥ 0

s 0 is the local minimum living level, that is, if the employees’ minimum income is less than the local minimum living standard, they will give up their jobs.

Income Distribution Before New Labor Contract Law Prior to the implementation of the new Labor Contract Law , the interests of the employees in many places including the Yangtze River Delta cannot get effective protection for their interests. Here we use the linear contract design for reference to explain this issue. First of all, the fixed income (i.e., α in the linear contract) of the employees is obviously exploited by employers, who lack stable expectations and protections. Many employers avoid the obligations to the workers by not entering into a written employment contract. So it is difficult to confirm the existence of labor relations of the two sides. Lots of labor rights on the basis of labor relations cannot be guaranteed, including the right to attain wages, the right to join trade unions and to organize and participate in collective negotiations, the right to attain financial compensation when the contract is terminated, and the right of social insurance. Some employers take advantage of the low wage to violate the lawful rights of the employees, especially at the small and medium-sized enterprises (SMEs) which have the feature of seasonal production and operation. They recruit a large number of employees in the production season, and set up the provisions of a long trial period. Before the end of the probationary period, the labor contract of workers is terminated by some excuses. By taking advantage of the incomplete specification of the laws, the employers abuse the labor dispatch. Unequal pay for equal work universally exists in labor dispatch and the labor contract is terminated as the employer pleases. Besides, it is hard for workers to participate in the trade union and to participate in employer collective bargaining, and workers’ social security cannot be guaranteed.

411

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Of course, there are a large number of incidents of malicious arrears of wages by employers. To some extent, the above problems enable employers to reduce the expenditures on social security and fixed wages for employees, and also reduce the income and protection of employees. Second, the employees’ incentive income levels (i.e., the incentive coefficient β in the linear contract) is generally not high. Although the laws require full overtime payments by employers for overtime work by legal standard. But in many industries, especially construction, processing, catering industries which have seasonal production and labor-intensive structure, they usually require the employee to work overtime and tend to pay less or even not pay for the overtime work. And many companies arrange for their staff tasks which cannot be finished within the normal working hours, and thus force the employees to “voluntarily” work overtime to avoid giving their workers overtime pay. Moreover, before the implementation of the new law, in order to reduce the dismissal costs, many companies prefer to enter into short-term labor contracts with the workers rather than long-term labor contracts. According to the survey, in 2005, the labor contracts of many companies in the Yangtze River Delta region were short-term. 60% of the contracts were signed for less than 3 years; only 20% of the contracts were signed without a fixed term. Many labor contracts of employers show an obvious short-term trend, which largely affected the staff’s sense of stability in work and sense of belonging to the enterprise, and jeopardized their enthusiasm for offering long-term services for the enterprises. These problems are bound to reduce the incentive income level of employees, and affect staff motivation and effort, which will eventually have an impact on the level of output and the effectiveness of the enterprises. The analysis indicates that, prior to the implementation of the new Labor Contract Law , the interests of the employees have not been effectively protected. Ordinary employees often get fixed wages and it is difficult for them to get due protection. The β that measures the incentive income is very low. In this case, the general principal-agent relationship between the companies and staff can be expressed as the following planning model: (P ): Max { (p – v ) λ [τ0 + (1 – β) Δτ] – f – α } α , β, τ 1 s . t . α + β (p – v ) λ Δτ – 2 k (τ0 + Δτ)2 = s 0 β [0,1)

p , v , f , k , λ, τ0 > 0 α, Δτ ≥ 0

412

(15–8)

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

Obviously, the payment manufacturers pay to employees must be higher than or equal to the income of the local minimum wage level, otherwise employees will choose not to work. To solve the function, we get: Labor income:

Ee * = s 0

1 α* = s 0 + 2 k τ02 β* = 0

(15–9)

Δτ* = 0 Employers’ income:

1 Er * = [(p – v ) λτ0 – f ] – s 0 – 2 k τ02 (15–10) This result is consistent with the conclusions of our theoretical analysis. At this point, employers obtain most of the profit of the enterprise. Due to the different job costs caused by different job natures, the nominal wages of employees are different. But the actual wage the employee receives is the amount only sufficient to maintain the minimum standard of living s 0. Staff cannot share the enterprise benefits resulting from the profit growth which is totally held by the employers, and the staff’s incentive coefficient β is zero. At the same time, the interests of employees cannot be guaranteed at low-income level. As a result, the employees will reduce the level of effort to achieve their own utility maximization. Therefore, they will try to maintain a minimum level of effort, that is, only to obtain the minimum level of effort τ 0 which is able to get the lowest fixed-income s 0, and will not choose to work hard to increase output. At this point, in order to maximize their own interests, the manufacturers will use all possible means to force employees to improve the level of effort by improving τ 0. This conclusion can be confirmed from the constant exposure of the so-called “sweatshops” phenomenon in the Yangtze River Delta and Pearl River Delta region in recent years. Of course, this model has a basic assumption that staff supply is infinite. Therefore, the results of the model are closer to the income status of ordinary manual labor. For the senior management of the enterprise and core technical personnel, et al., because the market supply of those kinds of human resources is relatively small, their income will be higher. To a certain extent, they are able to share the growth of corporate profits. It is worth mentioning that there are a large proportion of migrant workers. Compared with the ordinary workers of the city, they cannot get city subsistence allowances even if they lose their jobs,

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which means that their s 0 = 0. So this part of the labor population will accept lower income levels of the same labor intensity in order to survive. They are the largest labor groups whose interests have been jeopardized.

The Impact of New Labor Contract Law on Labor Income Distribution The impact on employees’ income The formal implementation of the new Labor Contract Law in January 1, 2008, has greatly changed the relations of interest distribution between employers and employees. The law is also bound to influence the labor income distribution pattern. The protection for labor interests in the new Labor Contract Law mainly shows in the guarantee and increase of employees’ fixed-income (i.e., α), as well as in employee incentive income levels (ie, β).

The protection for employees’ fixed income (1) To ensure that both employers and employees enter into labor contracts according to law, and to guarantee to fully get the protection of the labor contract in the right of workers’ wages, the right to participate in trade unions, the right to participate in collective bargaining, the right of financial compensation when the contract is terminated, and the social security rights. As to the situation of the employers evading obligations by not entering into a written contract, the new law stipulates the penalty for the violation besides the emphasis that the employers shall conclude a written employment contract. Article 7 of the Labor Contract Law provides that: “Employers should establish labor relations with employees since the date of employment.” As to the situation that recruitment comes before labor contract in actual work practice, Labor Contract Law article 10 (2) provides that: “if the establishment of labor relations have not concluded a written labor contract, a written employment contract shall be concluded within one month from the date of employment.” Article 82 provides that “the employer, since the date of employment for more than one month but less than one year, has not concluded with the employee a written labor contract, the employer shall pay the laborer twice his wage every mouth.” Article 14 (3) provides that: “For more than one year from the date of employment, the employer is not concluding a written labor contract with the employee; it should be considered that the employer and the employee have

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The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

entered into a non-fixed term labor contract.” (2) More specific provisions are made for the trial period in the labor contract to adequately protect the interests of the workers during the probationary period. As to the problem in which the employers abuse the trial period against the interests of workers, the new law makes detailed provisions on the agreed terms of probationary periods in the labor contract, the length of the probationary periods, wage levels during the trial periods, labor contracts dissolution during the trial periods and other matters. Article 19 of the Labor Contract Law stipulates that “fixed labor contract and non-fixed term with a term of employment of more than three months can stipulate a probationary period. No probation period may be stipulated in a labor contract with a period to complete the prescribed work or a labor contract with a fixed period of less than three months.” Meanwhile, Article 19 (1) provides: “The length of the probationary period of a labor contract may [vary] according to the length of the labor contract; the term of labor contracts which are more than 3 months to less than one year, its probationary period may not last more than one month; labor contracts which are more than one year and less than three years, the trial period may not last more than two months; [in] labor contracts which [are] more than three years fixed-term and non-fixed term, [the] probationary period may not last more than six months.” In addition, the Labor Contract Law also stipulates that during the probationary period employers shall not depress the wages of workers, “the wages of the workers during the trial period shall not be less than the minimum wages of the same post or 80% of the labor contract wage, and shall not be less than the minimum wage rate in the place where the employer is located.” Finally, the new law also stressed that during the probationary period the employers are not free to terminate the labor contracts. (3) Clear specification is made on labor dispatch. For the first time, the new law made clear specifications for the establishment of labor dispatching units, the positions of the labor dispatch, the obligations of dispatching units, especially clearly defined for the current widespread downward pressure on dispatched workers’ wages, different remuneration of the same work, and other issues. The new law provided for this in article 63: “Dispatched workers have the right of equal pay for equal work with the laborers in the company. If the company has no other workers in the same position [the company] should determine the wages with reference to the same or similar jobs in the place where the employer is located.” So the reasonable income of the dispatched labor is legally protected from infringement. In addition, the new Labor Contract Law strictly restricts the cases when the employer may not stipulate with employee provisions the manner of

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

being liquidated by the employee, in order to eliminate the arbitrarily charged liquidated damages by employers. The above provisions in the new Labor Contract Law can greatly help the employees to obtain reasonable fixed salaries and the necessary protection for their livelihood.

The guarantee of employees’ incentive income levels (1) As to the cases that many workers are unpaid for overtime, or enterprises pay less for overtime work, the law offers the following provisions. Article 31 of the new Labor Contract Law provides that: “Employers shall strictly implement the work quota standards and may not compel workers to work overtime. Companies shall pay employees for overtime in accordance with relevant state regulations.” In other words, if the employees work harder, Δτ > 0, then, manufacturers must pay the appropriate remuneration, that is, β > 0. This provision makes the efforts of staff be directly linked to their income and is bound to significantly improve the employees’ incentive income levels. (2) The provision of non-fixed term contract. Prior to the implementation of the new law, short-term labor contracts were very common, which resulted in the lack of a sense of stability towards work and a lack of a sense of belonging. In response to this situation, the new Labor Contract Law stipulated relevant provisions to guide the employers and employees to conclude a long-term contract or to enter into a non-fixed contract, from the situations when a non-fixed term labor contract should be established (article 14 (2)), and the employers’ economic liability when the labor contract is rescinded or terminated (article 46), to the conditions of economic layoffs by employers (article 41). The introduction of non-fixed term contract can greatly improve the staff’s vocational stability and sense of belonging to the enterprise and greatly motivate employees to work harder for enterprises.

The impact on labor income distribution Based on the theoretical analysis of the impact of the implementation of the new Labor Contract Law , we accordingly make some adjustments on the constraints of the planning model of the principal-agent relationship between employers and employees, and get the following model (15–11). Among them, the s is the necessary protection for employees according to * the provisions of the new Labor Contract Law , and considering the present real situation, it is obvious that s > s 0. * (P ): Max { (p – v ) λ [τ0 + (1 – β) Δτ] – f – α } α , β, τ

416

(15–11)

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

s . t . α ≥ s*

1 α + β (p – v ) λ Δτ – 2 k (τ0 + Δτ)2 ≥s0 1 Δτ arg Max {α + β (p – v ) λ Δτ – 2 k (τ0 + Δτ)2 } β (0, 1)

p , v , f , k , λ, τ0 > 0 α, Δτ ≥ 0 Solving the model, when (p – v ) λ > τ0 k, we can get: τ0k 1 β** = 2 + 2(p – v ) λ τ (p – v ) λ – 0 2k 2 α** = s (15–12) *

Δτ** =

At this point, the effectiveness of labor is as follows: [(p – v ) λ – τ0k ]2 (15–13) 8k Employers’ income is as follows:

Ee ** = s * +

[(p – v ) λ – τ0k ]2 + (p – v ) λ τ0 – f – s * (15–14) 4k Through the solution to the model, we can further discuss the impact of the new Labor Contract Law on the utility levels of employers and employees. Of course, to have a solution, there is a prerequisite to be met, which requires enterprises being able to obtain a normal level of profit, that is, w > 0. Next, we will discuss the conclusions. Conclusion 1: After the implementation of the new Labor Contract Law , employees can get a fixed income to satisfy the necessary need for security in life. From the solution of the model, we can see that the fixed-income of staff α** = s , that is, the implementation of the new law can improve the employee’s * fixed-income levels. Prior to the implementation of the new law, employees’ fixed income can only meet the basic needs of li ving and address the lack of security income such as social insurance and medical insurance. After the implementation of the new law, the fixed income of employees is not only able to guarantee a minimum subsistence, but also to provide social security income, including social insurance and medical insurance. Conclusion 2: The employees will receive incentive income after the implementation of the new Labor Contract Law .

Er ** =

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Before the implementation of the new law, employees cannot share the benefits of corporate profit growth which is all obtained by employers. The commission rate β of staff is zero. After the implementation of the new law, employees will share the benefits of corporate profit growth. It can be seen through the expression of β** in the model solution since k , τ 0, and λ are all larger than 0. When enterprises are at the normal level of profitability, p – v > 0, so after the implementation of new law, β** > 1 / 2, that is, the employees will receive at least 1/2 of the income because of the corporate profit growth. In addition, the nature of the enterprises will further determine the final ratio of profit sharing. Corollary 2.1: The higher the initial effort level of employees is, the greater the share of profit is received by employees. In the expression of β**, the staff ’s initial effort level τ 0 is one of the important factors to determine the profit sharing proportion, of which τ 0 is the labor employees must pay to get the job. It is also very easy to understand that the higher the initial effort level of employees is, the greater cost of effort employees need to pay, and the higher cost the enterprises need pay to motivate employees to make further efforts. In this case, manufacturers must improve the employee profit sharing ratio to promote employees to make more efforts to further improve corporate profits. Corollary 2.2: The higher the cost of staff efforts, the greater the profit sharing ratio. In the expression of β** of the model solution, k is an important factor to determine the profit sharing proportion, and the greater k is, the higher the profit sharing ratio is. In this expression, k is the cost coefficient of staff effort. When the level of effort is the same, greater k means greater disutility of employees, namely, greater cost of staff effort is needed. It is easy to understand that for some special positions, such as senior and middle management, or employees in some special industries such as chemical metallurgical industries, the effort cost is higher than the other positions and industries, so the enterprises’ incentive levels should also be higher. Therefore, the employees of these positions or industries will receive a higher proportion of profit sharing after the implementation of the new law Corollary 2.3: the larger the gap of the costs when enterprises’ products’ prices change, the lower the proportion of employees’ profit sharing. In the expression of β**, p – v is the difference between the costs when enterprises’ products’ prices change. We believe that the difference is related to market power and management level of the enterprise. The stronger the market power (such as the monopoly in the industry), the more likely that the

418

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

enterprise can sell its products on the market at higher prices and to obtain raw materials and other production factors at a lower price. Similarly, when other conditions are the same, the product quality with higher levels of management will be more competitive, the price may be higher, and production costs will be more effectively reduced. These advantages were not related to the staff’s efforts. Therefore, the greater the difference of p – v means the lower the employees’ profit sharing ratio. Corollary 2.4: The higher the output coefficients, the lower the employees’ profit sharing proportion. In the expression of β**, λ is the output coefficient, and the greater λ is, the lower the proportion of employees’ profit sharing ratio in enterprise. In this expression, λ is related to the technical level of enterprises in the industry. Those enterprises with high technological levels have relatively lower profit sharing proportion for their employees. It is also very easy to understand that in these industries, the increase of profit level is largely related to the technological level of enterprises, and naturally low profit sharing for the employees. Conclusion 3: Employees will improve their own efforts after the new Labor Contract Law is implemented, Prior to the implementation, employees cannot share the benefits of corporate profit growth, but only can get the minimum living guarantee income. So employees only can maintain a minimum level of effort τ0 rather than choose to improve the level of efforts to increase output. After the implementation, because employees can obtain more fixed income and incentive income, the employees’ level of effort increases. As (p – v ) λ > τ0k and therefore Δτ** > 0, that is, employees will improve their levels of effort. Of course, the extent of the improvement of the level of effort is related to the characteristics of businesses and employees, which we will not discuss here. Conclusion 4: The utility staff received is higher than the level before the implementation of the new Labor Contract Law . In model Solution (15–13), we get the utility level of the employees after the implementation, and we can compare the staff level of utility before and after the new law. When we use the staff utility after the implementation minus staff utility before the implementation, we can get the equation (15–15). [(p – v ) λ – τ0k ]2 – s 0 (15–15) 8k It can be seen from equation (15–15), because k > 0, (p – v ) λ > τ 0k , so [(p – v ) λ – τ0k ]2 > 0. According to the preceding analysis, for the domestic 8k enterprises under the current circumstances, there must be s > s 0, and thus *

Ee ** – Ee * = s * +

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(15–15) must be a number greater than zero. After the implementation of the new law, the utility level of the staff is certainly higher than the level before the implementation. According to the analysis of this chapter, the implementation of the law indeed has a positive influence on the protection of labor rights and improvement of the workers’ income levels. Conclusion 5: After the implementation, enterprises’ income is not necessarily higher than the level before the implementation, which depends on the combined effect of several factors. After comparing staff utility level before and after the implementation, we are going to further compare the enterprises’ income levels before and after the implementation. We also use the enterprises’ income after the implementation minus the income before the implementation, and we can get (15–16). (p – v )2λ2 3k τ02 (p – v ) λτ0 Eu = Er ** – Er * = + + s – – s * (15–16) 4k 4 2 0 We can see from (15–16), the companies’ income changes depend on the interaction between a number of factors, and the incremental revenue is not necessarily a number greater than zero. For example, the higher the workers’ protection insurance expenditure prescribed by the government, the greater

the s *, and the lower the profit level the company can get. In order to study the impact of external environment changes on the profits of manufacturers, we will seek partial derivative of p , v and λ. The results show that when the ∂Eu ∂Eu ∂Eu equilibrium conditions (p – v ) λ > τ0k , < 0 hold, > 0, > 0 , and ∂p ∂λ ∂v that is, the enterprises which have certain advantages in product prices and technical input are still able to obtain the continued growth of earnings after the implementation. The rising raw material costs may squeeze the vendor ’s profit margins, and the level of profitability may be lower than that before the implementation.

Conclusions and Enlightenment to the Yangtze River Delta The main conclusions This chapter uses the game model to analyze the impact of the implementation of the new Labor Contract Law on the enterprises’ labor income distribution. We can get the following main conclusions.

420

The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

1. Under the realistic conditions of the relative abundance of labor supply, relevant laws and regulations must be made to protect the legitimate rights and interests of laborers. From the results of our Game analysis of labor income distribution before the implementation, we can see that without system constraints, manufacturers will occupy the vast majority of corporate profits, and employees can only get the utility to maintain a minimum standard of living. In particular, for the rural migrant workers who are without the minimum living guarantee, their income levels may be even lower. Moreover, in order to obtain higher profits, manufacturers use various means to force employees to improve work effort without giving them a higher income. Thus the interests of employees will be greatly damaged. From the results of the model analysis, under the realistic conditions of abundant labor supply, a balanced distribution of benefits between employers and employees by market-oriented means cannot be achieved. Therefore, we must establish the legal protection system to protect the basic interests of the employees. From this perspective, the formulation and implementation of the new Labor Contract Law is very necessary and timely. 2.The implementation of the new Labor Contract Law will effectively improve staff’s enthusiasm for work and enhance the level of output in the long run. From the results of the game analysis of labor income distribution after the implementation, we can see that with the principles of labor relations change, employees’ medical insurance, pension insurance, and other forms of insurance are better protected. And employees’ income level has also increased (Ee** > Ee*). In this case, Δτ > 0, means that employees are willing to work harder. This will undoubtedly lead to the increase in the level of output, and the gains will be allocated between the companies and employees, which will more closely link the interests between employers and employees. Thus, it will form a virtuous cycle to promote enterprises’ development. Of course, the effect of the new Labor Contract Law will be a long process, which is greatly related to law enforcement efforts. At present, the formal implementation of the new Labor Contract Law is still a relatively recent event, and the role of the law is not fully reflected. However, through the analysis of this chapter it can be seen that this trend is inevitable. 3. The implementation of the new Labor Contract Law is conducive to promoting technical innovation and industrial upgrading. Establishing a technological innovation system with enterprises as the main body, market as the guidance, featuring a combination of industry, college, and institute to form the basic institutional innovation framework is an important

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

strategy for China’s Eleventh Five-Year Plan. The Game analysis results of the labor income distribution after the implementation show that the output coefficients λ which is related to the level of technology of the industry the enterprise engaged in and capital investment of the enterprise has an important role in promoting the effectiveness of the employees and the employees’ level of effort and manufacturers’ income. Therefore, the stronger the technological innovation capability of the enterprise is, the more advantageous the position of the enterprise after the implementation. Compared with other enterprises, such an enterprise not only offers a large proportion of profit sharing for its employees, but also makes the employees have a greater usefulness. Thus, employees will work harder, and the companies’ income level will be higher than that prior to the implementation. Therefore, under the guidance of the above utility, companies will increase investment in technological innovation to enhance the technical content of the production process, which will help to improve the level of enterprises’ technological innovation.

Suggestions for the Yangtze River Delta The implementation of the new Labor Contract Law will have a profound impact on business growth and the future economic development of the Yangtze River Delta region. According to the research findings of this chapter, the enterprises and local governments of the Yangtze River Delta region should take effective measures to actively use the opportunity brought by the implementation of the new law to achieve regional industrial restructuring and the transformation of the economic growth mode. 1. To build a harmonious market environment Prior to the implementation of the new Labor Contract Law , the Yangtze River Delta region also had the widespread phenomenon of the exploitation of workers. In order to pursue the maximization of their profits, the enterprises act against the interests of employees without any method being legally binding. For example, Nike, who admitted to forcing workers to work overtime and not allowing workers to drink during working hours in 2005, and Nine Dragons Papers Ltd., listed in Hong Kong, were revealed to be seriously exploiting and harming the interests of employees in 2008. The aforementioned companies all opened factories in the Yangtze River Delta. Therefore, the enterprises in the Yangtze River Delta region should fully understand the significance and opportunities of the implementation of the new law, and overcome the short-term negative effects of the implementation, such as the increase of operating costs and lower profits of enterprises. It is necessary to

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The Impact of New Labor Contract Law on Labor Income Distribution in the Yangtze River Delta Region

make great efforts to establish the equal relationship legally and publicly between enterprises and workers in the form of contracts. Local governments should also timely promulgate the relevant laws to help build the concept of equality, the system of rules and credit mechanisms between enterprises and workers to promote a more equitable and harmonious market economy environment. 2. To change the model of human resource management and corporate governance to enhance output From the conclusions of this chapter, we can see that the implementation of the new Labor Contract Law will significantly enhance the employees’ basic subsistence levels and the level of incentive revenue, and will provide new opportunities for the development of the Yangtze River Delta region. Under this context, the Yangtze River Delta region enterprises should actively implement the new Labor Contract Law and provide staff with the basic protection and incentive income prescribed in the law. More importantly, the enterprises should timely adjust the old human resource management model according to the new law to ensure that enterprises can quickly adapt to the new requirements of the new law. Besides, the enterprises should adjust the old model of corporate governance in order to maximize the workers’ willingness to work hard, which is stimulated by the implementation, and take full advantage of the favorable opportunity to enhance the level of output and profitability. 3. To guide technological innovation to promote technological upgrading and regional industrial upgrading Though the Yangtze River Delta region is an important industrial base of China, the traditional labor-intensive industries still dominate in the regional industrial structure. And those industries are, to a large extent, the international Original Equipment Manufacturer (OEM) base. According to the findings of this chapter, the implementation will be more conducive to the survival and development of high-tech enterprises and industries. Yangtze River Delta region enterprises should actively use the opportunities brought by the implementation to increase investment in technology and R&D in the production process, improve the level of technological innovation in order to motivate employees to work harder to enhance the profit level of an enterprise. Meanwhile, the government of the Yangtze River Delta region should actively introduce corresponding measures to encourage the upgrading of technology and the technological innovation activities of enterprises, and promote regional industrial upgrading, and change its industrial structure from the traditional labor-intensive industries to high-tech industries. 4. To focus on the external environment and supporting policies for the implementation of the new law

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

The implementation of every law and regulation needs to be protected by the external environment and related policies and measures, in order to get a good result. Since the new Labor Contract Law was formally implemented, many companies in the Yangtze River Delta region are facing many adverse factors of the prices, costs, and other factors, and are even facing being closed down. Take Wenzhou for example. According to the reports, in early 2008, the traditional labor-intensive enterprises in Wenzhou such as clothing, shoes, electronics enterprises as well as light industry have suffered large-scale close down. It is said that nearly 20% of the Wenzhou SMEs have ended up bankrupt. Some people believe that the main reason for this result is the negative impact of the implementation of the new Labor Contract Law . We believe that the main reason leading to the above phenomenon is that the domestic macro environment has undergone major changes after the implementation of the new Labor Contract Law . In recent years, the combined effect of various factors such as sharp appreciation of RMB, inflation brought by rising prices of raw materials represented by energy and bulk stock, and tightening monetary policy, largely compressed the profit margins of many companies, especially export-oriented enterprises. Thus it made it so that many enterprises in the Yangtze River Delta region, especially the SMEs of weaker profitability, cannot obtain a normal profit and plunge into a loss. Although we get to the conclusion that the implementation of the new law will enhance the level of output in the long run, there will be a time lag between the cost input and the output. In the short term, the sharp fall of short-term corporate profits not only threatens the normal existence of the enterprise, but also directly affects the implementation effect of the new law. T h e re f o re , l o c a l g o v e r n m e n t s s h o u l d f o c u s o n t h e t i m i n g o f t h e implementation, and select the appropriate external environment to launch the corresponding policies, to ensure the effect of the implementation. We believe that with the gradual weakening of the current momentum of inflation, the weakening of domestic and international energy and commodity prices along with a gradual relaxation of domestic macro-control policy, the environment faced by the enterprises will be gradually improved. The positive role of the new law will be gradually revealed.

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16

Chapter

Positive Analysis of Price Fluctuation and Household Consumption in the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Since 2000, the real estate industry, corresponding to the economic development in the Yangtze River Delta, has advanced by leaps and bounds. The completed real estate investment of Zhejiang, Jiangsu, and Shanghai in the region has accounted for around one fourth of that of the whole nation. With the macro-control of real estate deepening since the second half of 2003, the effects of macro-control have gradually emerged. The investment growth of real estate development in the region between 2002 and 2004 was higher than the national average, while lower than the national average between 2005 and 2007. Meanwhile, the proportion of the completed real estate investment in the region has dropped from 28% in 2004 to 22% in 2007. Meanwhile, the price of real estate presented great fluctuations and rapid rise in the Yangtze River Delta. Between 2000 and 2006, the national average housing price increased by 8.1%, but in the central cities in the Yangtze River Delta of Shanghai, Hangzhou, and Nanjing it increased by 12.4%, 13.3%, and 8.2%, respectively. Among the 16 cities in the region, Taizhou got the maximum increase of 19.1%, and Nanjing got the minimum, close to the national average. It is the housing price that has always been a major concern of the society. Has the real estate price in the Yangtze River Delta already departed from the economic fundamentals? What is the influence of the fluctuation of housing price to household consumption? What effect does the development of real estate in the region have on the construction of a harmonious society in the area? All these are urgent problems to be studied. This chapter will discuss the above problems mainly from the perspective of the influence of housing price fluctuation on household consumption, and summarize the experience in the Yangtze River Delta on the basis of the theoretical model by empirical examination. The structural arrangement of this chapter is as follows: the characters of housing price, and resident’s income and consumption in the region will be described in the following section; then, on the premise of a series of assumptions, the theoretical model of housing price fluctuation’s influence on household consumption in the region will be deduced; quantitative inspection and positive analysis will be carried out before a brief conclusion is drawn at the end of this chapter.

Characteristics of Housing Prices and Residents’ Income and Consumption in the Yangtze River Delta Flourishing like the economy and society in the Yangtze River Delta has in recent years, the living standards and quality of life have been remarkably

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Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

improved, especially the significant advances in dwelling environments and the constant improvement of the housing security system. But the rapid growth of housing prices in the region not only has an effect on the income and consumption of people in different income groups, but it also increased the business costs in the area. In a word, the housing price, resident’s income, and consumption are characterized as follows. First, most cities in the Yangtze River Delta are above the national average in terms of the housing price and the rate of increase, but with visible intercity diversities. From the absolute value of housing price, there were 11 cities above the national average in 2006 (see Table 16.1). The housing prices of Shanghai, Hangzhou, and Ningbo were at high levels all the time while maintaining a wide gap with other cities. Cities as Nanjing, Suzhou, Wuxi, Changzhou, Shaoxing, Zhoushan, and Taizhou were at medium level. The two cities of Jiaxing and Huzhou were close to the national average, while Nantong, Yangzhou, Zhenjiang, and Taizhou were lower than the national average. For Shanghai, the high housing prices are due to the outstanding geographical location and economic development; for Hangzhou, it is because of its sound geographical location, city construction, and eco-environment; for Ningbo, it is directly related to the city’s rapid economic development in recent years. According to the study of Hao Qianjin and Chen Jie (2007), the major element which led to the housing price difference in the Yangtze River Delta region was the diversity in demand caused by the income gap. Table 16.1 Commercial house price comparison between the country and the Yangtze River Delta between 2000–2006 Unit: RMB / m2, % City

2006

Average annual rate of increase

2000

2001

2002

2003

2004

2005

The whole country

2,112

2,170

2,250

2,359

2,778

3,168

3,367

8.1

Shanghai

3,565

3,866

4,134

5,118

6,489

6,842

7,196

12.4

Nanjing

2,795

2,907

2,939

3,148

3,516

4,072

4,477

8.2

Wuxi

1,718

1,808

1,814

2,216

2,534

3,679

4,591

17.8

Changzhou

1,686

1,725

1,874

2,186

2,477

3,683

4,000

15.5

Suzhou

1,778

1,843

2,157

2,574

3,108

4,430

3,991

14.4

Nantong

1,389

1,533

1,630

1,829

2,119

2,579

2,587

10.9

Yangzhou

1,234

1,437

1,571

2,008

2,317

2,858

3,212

17.3

Zhenjiang

1,291

1,742

1,436

1,759

2,054

2,328

2,887

14.4

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Unit: RMB / m2, % City

2006

Average annual rate of increase

2000

2001

2002

2003

2004

2005

Hangzhou

2,939

2,845

3,527

3,939

4,704

5,619

6,218

13.3

Ningbo

1,949

2,040

2,612

2,865

3,782

5,028

5,438

18.7

Jiaxing

1,415

1,553

1,898

1,990

2,518

3,372

3,440

16.0

Huzhou

1,453

1,501

1,848

1,816

2,495

2,793

3,334

14.8

Shaoxing

1,578

1,712

1,884

2,530

2,098

3,735

4,383

18.6

Zhoushan

1,755

2,126

2,231

2,477

3,099

3,855

4,264

16.0

Taizhou

1,654

1,720

1,948

2,651

2,836

4,177

4,726

19.1

Sources: China Statistical Yearbook , Shanghai Statistical Yearbook , Jiangsu Statistical Yearbook , Yangtze River Delta , Pearl River Delta , Hong Kong and Macao Special Administrative Regions Yearbook over the years.

From the growth rate of housing prices, the 16 cities in the Yangtze River Delta maintained a growth trend in a similar way: 2000–2002 with stable growth, 2004–2006 with accelerating growth, 2004–2006 with slowdown progress with the annual growth rate in a remarkable distinction. The growth of housing prices in the other 15 cities, between 2000 and 2006, was all in the double-digits, but Nanjing had a lower growth of 8.2%. The annual average growth rate in Taizhou, which had the highest growth of housing prices, was 19.1%, more than twice that of Nanjing. The first three cities with the fastest rise were all in Zhejiang Province, the two cities with slowest growth rate were in Jiangsu Province, and the growth rate of Shanghai ranked the third from the bottom. Second, the ratio of housing price to income was lower or close to the national average, and the real estate price in the Yangtze River Delta generally fit in with the economic fundamentals. To judge whether the housing price is high or low one can neither only consider the absolute value of home prices, nor make conclusions directly on the growth of home prices. The housing price in a city should be compared with the residents’ income which not only embodies the economic development in the area, but also reflects the consuming ability of the residents. Therefore, the ratio of housing price to income can be used to measure the deviation degree of housing price to resident’s income. As for the calculating method of the ratio along with the issue of horizontal comparison, the greatest controversy lies in the housing area of a single set (Yang Wenwu 2003; Wu Hang, et al. 2007). Under

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Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

such circumstances, the ratio of housing price to income can be dealt with as follows: To divide the product of housing price and per capita housing area by disposable personal income. On account of the income variable being per capita value, the single housing area cannot be restricted. The index measures residents’ affordability of housing prices, setting income as the major reference variable. From Table 16.2, it can be seen that among the ratio of housing price to income of the 16 cities in the Yantze River Delta in 2006, Shanghai topped 10.2, and Hangzhou and Yangzhou were slightly higher than the national average. The other 13 cities were all lower than the national average, among which the five cities with a ratio below 6 were Zhenjiang, Nantong, Shaoxing, Jiaxing, and Huzhou. The ratio of Shanghai was comparatively high, and it is due to its unique economic status, as well as the huge demand of investment and consumption from both home and abroad. Hence, the housing prices in the Yangtze River Delta are reasonable from the perspective of the ratio of housing price and income. Table 16.2 Ratio of housing price to income in the Yangtze River Delta 16 cities between 2000 and 2006 Year

2000

2001

2002

2003

2004

2005

2006

National average

6.8

6.6

6.7

6.6

7.4

7.9

7.8

Shanghai

5.5

5.6

5.6

6.5

7.8

7.8

10.2

Nanjing

8.7

8.7

8.5

6.6

6.5

6.6

6.4

Wuxi

5.1

5.0

4.4

4.7

4.8

6.2

6.8

Changzhou

5.0

4.8

5.0

5.2

5.3

7.1

6.9

Suzhou

4.9

4.6

5.4

5.6

5.8

7.1

6.4

Nantong

4.5

4.8

5.0

4.8

5.0

6.1

5.4

Yangzhou

4.7

5.3

5.3

6.6

7.0

7.8

8.0

Zhenjiang

4.6

6.0

4.6

4.3

4.4

4.5

5.7

Taizhou

4.6

5.0

5.0

4.8

5.3

7.1

7.4

Hangzhou

6.0

5.3

6.3

6.6

7.7

8.2

7.9

Ningbo

3.5

3.5

4.3

4.3

5.7

7.5

7.3

Jianxing

3.0

2.9

3.5

3.3

4.1

5.4

5.1

Huzhou

3.3

3.1

3.4

3.1

4.4

4.7

5.0

Shaoxing

3.3

3.3

3.3

4.0

3.2

5.6

5.9

Zhoushan

3.9

4.2

4.3

4.4

5.4

6.5

6.4

Taizhou

3.7

3.4

3.5

4.2

4.2

6.3

6.6

City

Sources: China Statistical Yearbook , Shanghai Statistical Yearbook , Jiangsu Statistical Yearbook , Yangtze River Delta , Pearl River Delta , Hong Kong and Macao Special Administrative Regions Yearbook over the years.

429

DEVELOPMENT IN THE YANGTZE RIVER DELTA

As one of the most dynamic areas and one of the three economic growth

poles in China, the Yangtze River Delta will further promote the economic

development and people’s income with the transformation of the economic

development mode and the industrial upgrading and the further promotion of regional integration. As a result, the current housing price in the region is

determined by the strong affordability of residents and a sound economic base for support.

Third, the housing price grows at the same pace as consumption, and the

price of real estate in the Yangtze River Delta is generally in line with the consumption.

The housing prices of the cities in the Yangtze River Delta all increase at

the same pace with the consumption expenditures, and the rising housing prices show no obvious effect on the consumption power of residents. Besides

the amount of expenditure, the structure of housing price and consumption expenditure (the Engel Coefficient1) also exerts the character of relativity: The higher the housing price, the lower the Engel Coefficient. On the basis of the standard of the United Nations Food and Agriculture Organization, other

than the cities of Zhenjiang, Yangzhou, and Taizhou being at the well-off level,

people’s livelihoods in the other 13 cities of the Yangtze River Delta are all considered at rich levels.

For the benefit of explanation, we make a two-dimensional scatterplot of

the national average housing prices, the housing prices in the 16 cities, and the Engel Coefficient in 2006 (see Fig. 16.1). It can be divided into four areas with the national average value being the origin. As shown in Fig. 16.1, Area I are

higher than the national average both in housing price and Engel Coefficient;

Area II is higher than the national average in housing price, but lower than the national average in Engel Coefficient; Area III is lower than the national average both in housing price and Engel Coefficient; Area IV is lower than

the national average in housing price, but higher than the national average in

Engel Coefficient. Fig. 16.1 shows that most cities, except Wuxi and Ningbo, are located at Area II and IV, indicating that the higher living standard in the

city, the higher the housing price. Definitely, the feature relationship between housing price and Engel Coefficient is merely a static comparison. Empirical study and positive analysis are required for such issues as the dynamic

influence mechanism of housing price fluctuation on the Engel Coefficient

and whether the rising housing price exerts an influence on the residents’ consumption expenditure.

430

Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

Housing price (RMB / m2)

Fig. 16.1

Two-dimensional scatterplot of housing price and Engel Coefficient in 2006

8,000 7,000 6,000 5,000 4,000

II

Taizhou

Nanjing

0.34

Suzhou

Nantong

III

2,000 1,000 0.32

Changzhou

The nation

Huzhou

I

Shaoxing Jiaxing

Zhoushan

3,000

Shanghai

0.36

Wuxi

IV

0.38

Zhenjiang

0.40

Taizhou Yangzhou

0.42

0.44

Engel Coefficient

Theoretical Analysis of the Relationship between Housing Price Fluctuation and Consumption of Residents According to the consumption theory, income, consumption, and wealth comprise the primary variables of consumer utility function. The consumer, under certain budget constraints, comprehensively considers his current income, future income, assets value, together with the recent and long-term consumption expenditure, and gets the maximum utility by choosing different commodity combinations. Assuming that the commodity vector X faced by the consumer contains two categories: general consumer goods and housing, namely, X = X (x , h ). The form of consumer utility function is:

U (x , h ) = α1 ln x + α2 ln h 0 < αi < 1, X i > 0

(16–1)

X stands for consumption expenditure, h is the area of purchased house, α1 is

the elasticity of consumption utility of consumer goods, and α2 is the elasticity of housing utility. Utility function is quasi-concave. According to the analysis methods of Henderson and Ioannides (1983), along with Arrondel and Lefebvre (2001), we assume that: (1) The resident maximizes his own utility through wealth collocation in a two-period model. (2) After purchasing the housing assets in the first period, the consumer pays for the general consumer goods x and house by income y1 and financing L . (3) The consumer gets the loan L from

431

DEVELOPMENT IN THE YANGTZE RIVER DELTA

the bank at interest rate r ; housing price is P which will change into P (1 + θ) in the next period; Customer’s deposit is S . Due to the volatility of housing price, namely, the housing price’s growth rate θ is unstable, so the investment for real estate is included in the venture capital. The deposit S is security assets with stable benefits of interest rate r , irrespective of interest rate’s gap of saving and loan. Based on the above assumption, consumer utility is not merely related to the present consumption, but also influenced by long-term wealth. The consumer distributes his income and wealth in an inter-period way to maximize the utility function as follows: max U (x , h ) + βE [V (w)] x, h, S

(16–2)

s . t . y 1 + L = px + Ph + S (16–2–1) w = y 2 + S (1 + r ) + Ph (1 + θ) – L (1 + r ) (16–2–2) x > 0, h ≥ 0, 0 < β < 1

Herein, V(•) refers to the indirect utility function, E [V (w )] is the consumer’s expected indirect utility, the smaller the value of β which is the discount factor of long-term indirect utility, the more the customer values the present utility. The customer’s income in the first period includes y 1 and loan L , expenditure includes consumption expenditure px , house purchasing expenditure Ph and deposit S . The assets of the second period equal to the income in the second period, returns from the deposit of the last period and real estate value, and minus the amount of principal and interest of the loan. Set Lagrange function as:

Z = U (x , h ) + β E [V (w )] + λ (px + Ph + S – y 1 – L ) On the basis of optimum condition, we have

Z x = U 1 + λp = 0 Z h = U 2 + β E [Vʼ (•) P (1 + θ)] + λ P = 0 Zλ = px + Ph + S – y 1 – L =0

(16–2–3) (16–2–4) (16–2–5)

λ is Lagrangian multiplier. The corner solution can be excluded by assuming the family being of normal house purchasing and consumption behaviors. Applying (16–1) to (16–2–3) and (16–2–4) to get the formula as follows: α α1 = 2 + β E [Vʼ (•) (1 + θ)] (16–3) px Ph The formula shows that with rising housing prices (larger θ), the consumer will decrease the consumption expenditure of the present period x . In order to see more clearly the influence of the housing price fluctuation θ to consumer’s

432

Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

consumption expenditure of the present period x , we will derive the comparative static relationship between the selected variables and θ. Applying total differentiation to θ in the equations (16–2–3), (16–2–4) and (16–2–5) and we get the formula as below: 0 p

∂λ ∂θ

P

P U 11 U 12

P U 21 U 22 + P βE [Vʼʼ (•) (1 + θ)] 2

2

∂x ∂θ

=

∂h ∂θ

0 0

–βE {Vʼ (•) P [1 + (1 + θ)] Ph }

(16–2–6)

The first item of (16–2–6) on the left is the optimized Hessian matrix of (16–2), which can be defined as F . Setting F ij as the cofactor of F , according to Cramer’s Rule, we have:

∂x –|F 32| = –βE {Vʼ (•) P [1 + (1 + θ)] Ph } ∂θ |F | ∂h |F 33| = βE {Vʼ (•) P [1 + (1 + θ)] Ph } ∂θ |F | With |F | being the determinant of matrix F and |F ij|being the algebraic cofactor of F , it can be obtained by calculation that:

∂x = –βE {Vʼ (•) P [1 + (1 + θ)] Ph ] Pp } < 0 ∂θ ∂h = βE {Vʼ (•) P [1 + (1 + θ)] Ph ] p 2} > 0 ∂θ

(16–2–7) (16–2–8)

From the formula (16–2–7), we can get to know that when the customer pursuing the utility optimization makes the selection in the X (x , h ), he will reduce the consumption expenditure x of the present period with θ becoming larger under the condition of ceteris paribus. It seems interesting and it runs counter to the wealth effect. Because, according to the theory of consumer choice, the consumer expenditure x (p , w ) is of the wealth effect, namely, ∂x (p, w ) > 0 . While, the rising housing price studied herein does not ∂w

necessarily mean the increase of wealth because real estate is both investment

433

DEVELOPMENT IN THE YANGTZE RIVER DELTA

goods and consumer goods and whether wealth effect or crowding-out effect will be brought by the changes of its price is determined by marketing conditions. Herein we make several assumptions as follows: (1) The customer realizes that the value of housing assets will increase when purchasing a house happens at the present period (the first period in the model), so he enlarges the housing area when purchasing a house, crowding out the consumption expenditure of the present period. (2) In the model, the investment of real estate will only be reflected in the appreciation of the value of the real estate in the next period, regardless of the house’s rent, so the virtual appreciation will not boost the consumption expenditure of the current period. And further analysis of (16–2) to (16–2–2), we will get:

y1 + L – S 1 x α1 px = r α2 + (α1 + α2) r + (1 + r ) E [Vʼ (•) Ph θ] (16–3–1) The above equation shows that the consumption expenditure of the current period changes in the same direction with the income and loan of the current period, but in the opposite direction with interest rates, savings, and the housing price changes. The influence of housing price fluctuation on residents’ consumption includes two aspects: Quantity and structure. Engel Coefficient, as the structure variable of consumption, is frequently applied to measure the livelihood of people. Research on the effects of housing price fluctuation on Engel Coefficient helps to empirically analyze the impact of housing price fluctuation on people’s lives. Therefore, the empirical analysis below will not only inspect the influence of housing price fluctuation on consumption quantity of residents, but also pay close attention to the influence on consumption structure.

Empirical Test for the Yangtze River Delta2 Introduction of variables The empirical test will be provided for the theoretic model with the data of the 16 cities in the Yangtze River Delta. The selection of sample cities has the following merits: (1) With the market-oriented reform of real estate starting early and getting a higher degree of marketization in those cities, the basic assumptions of mainstream economic theories are closer to the economic reality, which is convenient for model application. (2) The cities are similar in economic development, urban structure, culture, lifestyle, etc. It helps not only to compare the cities in a horizontal way, but also to avoid the effect of serious

434

Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

heteroscedasticity on the effectiveness of regression. (3) Located in the coastal areas with advanced economies, the Yangtze River Delta takes the lead in China in terms of the development, and its development model plays a pilot and exemplary role all over the country. Therefore, analyzing the experience and current situation of it can provide experience to the other cities in China. The variables involved in the article include: (1) Resident’s income y . The disposable income of urban residents, which easily exerts an influence on the residents’ consumption, will be chosen as the index of measuring citizen’s income level. To eliminate the effects of housing price, we will deflate the index with CPI of 2000 as the base period. (2) Housing price fluctuation θ. On the basis of adaptive expectation theory, people’s expectation of the future is based on the historical experience. It is assumed herein that the consumer measures the housing price fluctuation of the next period with the price of the present period, namely, θt = (P t – P t – 1) / P t – 1. To eliminate the influence of price rises, the selling prices of commercial houses in cities are deflated with 2000 as the base year, examining the fluctuation of the actual prices of real estate. (3) Deposit interest rate r . we use the actual deposit interest rate which is obtained from a year-long deposit interest rate minus the CPI of the current year in the cities. (4) Residents’ consumption expenditure x . The actual residents’ consumption expenditure level can be worked out by deflating the nominal value of the cities with 2000 as the base year to adopt the consumption expenditure of urban residents in the cities. (5) Structure of consumption expenditure measured by Engel Coefficient. Engel Coefficient is applied in the calculation of the ratio of food expenditure to the consumption expenditure.

Econometric model According to the theoretic analysis in the previous section, the econometric model can be built as follows: ln x it = β0 + βit lny it + γit θit + kitrit + δ1itD1i + δ2itD2i + εit (16–4) In the formula, βit refers to the flexibility of income and consumption. γit and k it measure the relative variation of residents’ consumption expenditure caused by the housing price increases and the absolute variation of interest rates, respectively. Regional dummy variable as D , D1i = 1 when the sample cities are in Jiangsu Province, otherwise, D1i = 0; D2i = 1 when the sample cities are in the Zhejiang province, otherwise, D2i= 0. Housing increase and interest rate variables enter the equation directly, while consumption and income variables come into it in the logarithm form.

435

DEVELOPMENT IN THE YANGTZE RIVER DELTA

As for the relationship between the housing price and Engel Coefficient, the econometric equation can be designed as follows: ln En it = β0 + βit ln y it + γit θit + k it r it + δ1itD1it + δ2itD2it + εit (16–5) In the equation, En refers to the Engel Coefficient, β it is the elasticity of Engel Coefficient to income, γ it, k it measure the relative variation of Engel Coefficient caused by housing price increase and the absolute variation of interest rates, respectively. The setting of dummy variable is same to the formula (16–5). The sequence used, before the formal econometric analysis, has to undergo the stability test; otherwise, misusing the unstable sequence will lead to spurious regression with an unauthentic result. At first, the variables were conducted in an ADF test with the software Eviews6.0. Due to no zero in the tested sequence, the constant term should be included in the test. Then the Schwarz Principles were adapted to ensure the relevant lagging number required for eliminating sequence, with the testing result shown in Table 16.3. Table 16.3 Variable

ADF testing result of sequence Orders of difference

Lag order

ADF statistical Prob. value

Trend

77.656 2

0.000 0

ln y

1

0

54.215 4

0.008 4

0

0

87.534 7

0.000 0

Individual intercept

θ

r

1

0

49.351 9

0.025 7

En

0

0

54.910 8

0.007 1

ln x

Note:

1

0

Conclusion

Individual intercept

I (1)

Individual intercept

I (0)

Individual intercept

I (0)

Individual intercept

I (1)

I (1)

I (n ) indicate that sequence remains stable after undergoing difference of n -th order.

As is shown in Table 16.3, ln x , ln y , and r , being unstable sequences, remain stable after the first order differential at 5%, while θ and En are stable ones. With regard to the equations containing non-stationary sequences, it is the first step to get stable sequences via difference, then conducting regression or cointegration analysis. According to the principles of the co-integration test, the rules for co-integration of sequence with different orders are more complex than that with the same order. It is a necessary condition that at least two nonstationary sequences of the same order in the maximal order are required in the co-integration sequences to form co-integration relation by order deduction. The

436

Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

two non-stationary sequences explanatory variables of first-order integration in the equation (16–4) can decrease the non-stationary order by liner combination, so as to form the co-integration equation with the explained variable. The cointegration can be conducted in the formula (16–5), if the explained variables are not higher than the integration order of all the explanatory variables. In addition, Eviews6.0 provides the operating module for panel sequence to conduct co-integration test, adopting the method of Pedroni panel cointegration test based on the two-step method of Engel-Granger. In light of the relative analysis of Pedroni (2001), the original hypothesis for H0: No relation of co-integration, and the results of co-integration test for sequence of variable in equations (16–4) and (16–5) (see Table 16.4) declined the original hypothesis, showing that the relationship of the co-integration lies among the variable sequences in the equations, allowing the regression and analysis of a long-term equilibrium relationship among variables. Table 16.4

Result of co-integration test for sequence of variable in equations (16–4) and (16–5) Statistics in group (Weighted)

Statistics among groups

Panel rho-Stat. = 3.110 087 (0.003 2)

Group PP-Stat. = –6.958 957 (0.000 0)

Equation (4) Panel v-Stat. = –2.126 725 (0.041 6)

Panel PP-Stat. = –3.242 105 (0.002 1)

Panel ADF–Stat. = –5.486 868 (0.000 0) Equation (6) Panel v-Stat. = –1.744 075 (0.087 2)

Panel rho-Stat. = 2.484 475 ( 0.018 2)

Group rho-Stat. = 4.800 244 (0.000 1)

Group ADF-Stat. = –15.486 868 (0.000 0) —

Group rho-Stat. = 4.460 811 (0.000 0)

Group PP-Stat. = –9.716 570 (0.000 0)

Panel PP-Stat. = –4.475 817 ( 0.000 0) Group ADF-Stat. = –9.617 488 (0.000 0) Panel ADF-Stat. = –2.907 279 (0.005 8) Note:

—

The numbers within parentheses are adjoining probabilities of corresponding statistics.

Setting of model form and evaluation of coefficient Setting is required for model form before regression. There are three basic types for panel data model: constant coefficient models without individual effect, variable intercept model, and varying coefficient model. If there is individual effect, the test for choosing between Fixed Effect and Random Effect is to be carried out in a certain way. To avoid the deviation between estimated result and actual economy caused by specification error of model, covariance inspection based on F statistic is adopted to decide the model form; Hartmann test is applied to decide whether it is F. E. or R. E. According to Gao Tiemei (2006),

437

DEVELOPMENT IN THE YANGTZE RIVER DELTA

it can be obtained that the values of F 1 and F 2 by calculation, as well as their marginal values under corresponding confidence (Table 16.5). If the value of F 2 is not smaller than the corresponding marginal value under given confidence, F 1 will be retested, if it is, choose the constant coefficient model without individual effect; if F 1 is not smaller than the corresponding marginal value under given confidence, choose unrestricted model; otherwise, choose the variable intercept model with constant coefficient.

Table 16.5 Setting test for model form Equation

F Statistic

Equation (16–4) F 2 = 1.289 842

F 1 = 1.431 500

Equation (16–5) F 2 = 1.896 807

F 1 = 1.294 025

Note:

Degree of freedom

(α=0.1)

Marginal value (α=0.05)

(α=0.01)

F (60, 32)

1.54

1.74

2.21

F (45, 32)

1.57

1.79

2.30

F (60, 32)

1.54

1.74

2.21

F (45, 32)

1.57

1.79

2.30

α refers to the corresponding confidence.

As is shown in Table 16.5 that F 2 in equation (16–4) is smaller than the marginal value at 5%, thus we choose the constant coefficient model without

individual effect; F 2 in equation (16–5) is not smaller than 5%, so we retest F 1, and F 1 is smaller than 5%, then we choose the variable intercept model with constant coefficient. When conducting Hartmann test for the equation (16–5) with individual effect, the result cannot reject the null hypothesis, so equation (16–5) is decided as variable intercept model with random effect. The error correction model based on the two-step method of Engle Granger is used to run regression for equations (16–4) and (16–5) which are of a cointegration relationship. First, the co-integration regression is conducted in the equation (16–4) which is of long-term equilibrium relationship, and then the stationary of regression residual is tested. The result of ADF shows that residual sequences are stable, which further proves the equation (16–4) is a co-integration equation. The fact that the dummy variable is not significant indicates that there is no obvious regional difference among the two provinces and one city in the Yangtze River Delta region, presenting the inner consistency of consumption among the cities. After getting rid of the dummy variable and re-regression, we use the residual sequence to express error correction term in ECMit, making ^ ^ ^ kit ri εit = ECMit = ln x it – β0 – βit ln y it – ^ γitθit – ^

438

Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

Error correction model for equation (16–4) is established as follows: Δln x it = βʼ0 + βʼit Δln y it + γʼit Δθit + k ʼit Δr it + αit ECMi, t–1 + μ it (16–4–1) Equations (16–4) and (16–4–1) form the dynamic model reflecting the influence of income, housing price and interest rate to household consumption. Equation (16–4) reflects the long-term equilibrium relation, while (16–4–1) reflects that the short-term fluctuation of consumption is affected by both shortterm elements and the trend of deviation from equilibrium of consumption. As for the regression of equation (16–5), we still use ECM of the two-step method of Engle Granger, whose process is the same as that in the equation (16–4). To study the difference of the 16 cities, we list the individual effect coefficient of (16–5) in the Table 16.6, and reduce the logarithm (the 4th and 8th columns of Table 16,6) to present the deviation of individual Engel Coefficient on the cross-section of panel data from the overall average. As is shown in Table 16.6, the Engel Coefficient of Zhenjiang, with the other variables remaining the same, gets the maximal positive deviation from the general average; while that of Changzhou gets the maximal negative deviation; Shanghai, at the general average, gets almost no deviation. Detailed rank is stated in Table 16.6. Table 16.6 The estimated result of individual effect and deviation coefficient in equation (16–6) Rank

City

β*i

φ

Rank

City

β* i

φ

1

Zhenjiang

0.014 052

1.014 2

9

Shanghai

–3.4E-15

1.000 0

2

Taizhou

0.007 113

1.007 1

10

Wuxi

–0.000 36

0.999 6

3

Suzhou

0.006 578

1.006 6

11

Nanjing

–0.001 49

0.998 5

4

Hangzhou

0.005 626

1.005 6

12

Jiaxing

–0.001 68

0.998 3

5

Ningbo

0.005 471

1.005 5

13

Shaoxing

–0.006 47

0.993 5

6

Huzhou

0.003 31

1.003 3

14

Nantong

–0.007 83

0.992 2

7

Taizhou

0.002 003

1.002 0

15

Zhoushan

–0.008 26

0.991 8

8

Yangzhou

0.000 399

1.000 4

16

Changzhou

–0.018 47

0.981 7

Note:

φ refers to the deviation coefficient of individual effect to average effect. If the coefficient is 1, it means there is no deviation of the city from the average effect; bigger than 1 means positive deviation; smaller than 1 means negative deviation.

The other results of regression are shown as Table 16.7.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Table 16.7 Results of regression of equations Variable

C ln y

θ r Δln y

Equation (16–4)

lnx

1.203 547***

–0.003 412

(1.162 438)

(–2.131 419)

(12.225 63)

(–0.636 319)

0.898 534***

–0.195 563***

(14.964 51)

(–8.440 543)

–0.002 539

0.005 338

(–0.524 829)

(0.416 540)

0.001 198

–0.003 315***

(1.415 295)

(–2.654 209)

0.661 959***

–0.130 309***

ECM

D

2

AR (1) R

En

Equation (16–5) short-term

–0.006 807**

Δr

D

Equation (16–5)

0.309 190

Δθ

1

Equation (16–4–1)

(–7.808 378)

(–3.317 945)

–0.001 268

0.003 921**

(–0.253 661)

(2.108 299)

0.001 516***

–0.003 179***

(3.534 259)

(–5.325 442)

–0.424 258***

–0.614 001***

(–4.033 972)

(–9.636 177)

–0.081 797**

–0.002 573

–0.014 757

0.010 223***

(–2.045 238)

(–0.367 102)

(–1.059 721)

(3.932 084)

–0.067 043*

0.000 284

–0.019 852

0.011 025***

(–1.754 681)

(0.126 008)

(–1.471 410)

(3.154 360)

0.795 567***

0.179 646

(14.839 31)

(1.301 521)

0.982 034

0.850 896

0.508 399

0.648 931

Ad-R 2

0.980 557

0.824 803

0.534 249

0.620 076

F -statistic

665.034 9

32.609 85

7.330 124

22.489 35

Prob (F )

0.000 000

0.000 000

0.000 000

0.000 000

D. W.

2.039 431

2.089 042

1.998 506

1.629 513

2

Notes: 1. t within brackets refers to the test value;

2. ***, **, * refers to the corresponding regression coefficients being not zero significantly at 1%, 5% and 10% respectively.

Analysis of regression result As it shown in Table 16.7, the fitting degree of equations is fairly good, and statistics F and Durbin-Watson all pass the significance test. The analysis for the

result of Table 16.7 is performed as below.

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Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

The regression result of equations (16–4) and (16–4–1) show that rising income obviously promotes the urban consumption of the Yangtze River Delta. In the long run, every 1% increase in income will lead to an 89.9% increase in residents’ consumption expenditure, while only a 66.2% increase in the short run. The result backs up the permanent income hypothesis. The long-term regression coefficient of interest rate shows that the resident consumption is not sensitive to the interest rate, and the interest rate has no significant effect on the adjustment of consumption with the upward trend of prices. As the interest rate regression coefficient of equation (16–4–1) is significant, the positive sign indicates the short-term positive impact action of increasing interest rate on consumption. The regression coefficient of housing price fluctuation is insignificant from both the long-term trend and the perspective of short-term fluctuation. This states, as for the Yangtze River Delta, that people will not change their consumption expenditure for housing price fluctuation. But it still can be judged from the sign of the regression coefficient that people intend to compress consumption of the present period when they believe the housing price is rising in the next period. This finding supports the conclusion of theoretical model. Dummy variable passes the significance test in the tendency equation, but fails in the equation of short-term fluctuation. According to the signs of dummy variables, the rank from the high to low on the consumption of the two provinces and one city in the Yangtze River Delta is: Shanghai, Zhejiang, Jiangsu (without remarkable regional distinction in short-term fluctuation). The regression coefficient of ECM shows that the short-term fluctuation of consumption will be drawn back to the balanced state at –0.42 when deviating from the long-term tendency. The regression results of long-term tendency equation and short-term equation for equation (16–5) indicate that income has a remarkable effect on the consumption structure of residents both in long-term tendency or shortterm fluctuation. It does not require any explanation that the increase of income will reduce the Engel Coefficient distinctively. The effects of interest rate on the structure of consumption are outstanding both from long-term tendency and short-term fluctuation, and the sign of coefficient of interest rate shows that the increase of interest rate will lead to the deduction of Engel Coefficient. The effect of housing price fluctuation to the structure of consumption, from the long-term tendency, is not significant; but it is significant from the shortterm fluctuation equation. The fact that rising housing prices leads to the rising of Engel Coefficient indicates that the housing price fluctuation will have a

441

DEVELOPMENT IN THE YANGTZE RIVER DELTA

short-term impact on people’s livelihood, but from the long-term tendency the variation of housing piece has no effect on people’s lives. Regression coefficient of dummy variable fails to pass the significance test but succeeds in passing the test in short-term fluctuation equation, which means that there is no obvious regional distinction in the consumption structure of the long-term tendency in the cities of the Yangtze River Delta. The difference, nonetheless, may lie in the process of fluctuation. To measure the urban living standard with Engel Coefficient, the ranking of two provinces and one city in the region, from high to low, is Shanghai, Zhejiang, and Jiangsu. The regression coefficient of ECM is fairly significant. The value of the coefficient indicates that the consumption structure will be drawn back to the balanced state at –0.61 when deviating from the long-term tendency.

Conclusion This chapter, considering the direct utility brought by present consumption and the indirect one brought by the wealth of the next period, analyzes the influence of housing price fluctuation on consumption by a two-period model with certain constraints of income and wealth. On that basis, the panel data of the 16 cities in the Yangtze River Delta, from 2000 to 2006, is performed via an empirical test and its results show that the rising housing prices have no obvious effect on the consumption expenditure of residents. The housing prices in the region, though, have experienced a rapid rise, but this was accompanied by vigorous economic growth and the sustained improvement of residents’ income, so the rising housing price did not squeeze the residents’ consumption in an obvious way. By observing the influence of housing price influence on the structure of household consumption, it is found that the rising housing prices in the short-term will result in the increase of Engel Coefficient, with every increase of 1% in housing price leading to an increase of 0.0004 in Engel Coefficient. That is to say, rising housing prices, in the short run, will lower the living standards of residents in the Yangtze River Delta, but with low intensity. Actually, it is a short-term impact. In a word, rising housing prices do not have a significant influence on the living standards of residents. The development of the real estate industry in the Yangtze River Delta, which suits the economic and social development in the area, is one of the essential driving forces of economic and social development. By improving the housing conditions of residents, the development of the real estate industry in the Yangtze River Delta promotes the increase of social assets. Along with the

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Positive Analysis of Price F luctuation and Household Consumption in the Yangtze River Delta

increasing perfecting of the housing guarantee system and the development of the real estate industry in the region, it will exert a bigger role in the development of the harmonious society.

443

17

Chapter

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction With the further development of reform and opening up, a substantial reform was carried out in the housing system of China. The appearance of commercial homes, monetization, and the commercialization of housing distribution promoted the explosive development of the powerful real estate industry. The rapid development of the real estate industry, on the one hand, accelerated the release of people’s demand for housing. On the other hand, it made housing a hot issue in the society. Along with the fast urbanization, the soaring housing prices had already been divorced from the idea of affordability for the general public in some areas and this was accompanied by the problem of low residential satisfaction. As a complex concept, residential satisfaction can be represented by various technological indexes. But, whatever indixes they are, all can be reflected in the housing prices from the economic aspect. This feature is especially outstanding during the growth process of housing industry. This chapter tries to, based on the housing price-income ratio, prove the long-term equilibrium of revenue determining the housing prices, and express the deviation of housing prices from the long-term equilibrium with the index of price-income ratio, then theoretically calculate the rational range of the ratio to express the public residential satisfaction. On this basis, this research will conduct a comparative analysis of the housing price-revenue ratio of the major cities in the Yangtze River Delta to study the issue of urban residential satisfaction.

Housing Prices and Residential Satisfaction Housing demand of people is rich in content, and includes not only living space, but also housing amenity and safety, etc. Therefore, the evaluation of housing satisfaction is a full set of evaluation index system. The index system is fairly complicated with the method of multi-element analysis to evaluate people’s residential satisfaction. It is generally believed, from the technology level, that residential satisfaction includes three aspects: first, the inner quality of housing, such as living area, the structure of house type, lighting, and aeration, infrastructure of water, electricity, and gas, housing quality and story; second, residential environment, such as residential safety, greening, sanitation, property management and public utilities; third, surrounding environment, such as transportation, location, natural environment, and supporting facilities. The above statements, from the perspective of the consumer, elaborated various elements which affect the evaluation of residential satisfaction. Integrating the

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Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

above elements, the elements will be found to be expressed in the housing prices economically, which is especially outstanding during the growth period of the

housing industry. With reliable inner quality of housing, comfortable residential environment and sound surrounding environment, the housing prices will be

relatively higher. Whether the housing is good or not can be determined by the housing price. Therefore, the residential satisfaction can be regarded as the people’s affordability of houses. To put it simply, the affordability of housing equals to the

accepted housing price of people. The stronger the affordability, the higher the accepted price, the better the house, and the higher residential satisfaction will be. Generally speaking, for the residents with higher incomes, with higher accepted

housing prices, they can afford the high-grade housing which is beautifully

decorated and with a good environment, leading to the high satisfaction of residents. For the medium and low income people, they either cannot afford the

housing, or can only afford the houses with poor conditions causing low residential satisfaction.

The residential satisfaction was analyzed by an on-the-spot survey whose scope

was Nanjing city and its suburb. The samples were classified as the group of low-

income and the group of medium-income (the group of high-income were excluded in the survey for the considerable difficulty), which also took the reality of current

income distribution of urban citizens in China into consideration. The low-income group, mainly located in the Xiaguan district and suburban areas, was of the

occupations such as vendor, self-employed, and few unemployed. The medium-

income, mainly located in Longjiang and the Drum tower, were of such occupations as teacher and corporate executives. To reflect the reality in a better way and

facilitate the survey, we classified the samples according to the age. There was no remarkable difference in the ages of the low-income group, but as some were retirees in the older age group of the medium-income, we reduced the number of interviewees in an appropriate way. For data obtained see Table 17.1.

Table 17.1 A survey of residential satisfaction of the low- and mediumincome groups Age Lowincome group

Number Residential Satisfaction of Satisfactory Comparatively General Dissatisfactory people satisfactory satisfactory

Quite dissatisfactory

25–34

1,170

230

350

430

90

70

35–44

1,040

80

260

500

100

90

45–54

1,500

160

190

480

330

350

Above 54

1,120

140

150

320

110

400

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Age Mediumincome group

Number Residential Satisfaction of Satisfactory Comparatively General Dissatisfactory people satisfactory satisfactory

Quite dissatisfactory

25–34

300

80

140

80

0

0

35–44

600

60

260

200

80

0

45–54

100

10

60

10

20

0

Above 54

800

160

300

220

120

0

According to Table 17.1, for the low-income, the total number of people who

chose satisfactory and comparative satisfactory only accounted for 32.3% of the total; for the medium-income, it was 59.44%. Since most sources of revenue of the 25–34 age group were from their parents in the low-come group, we got rid of the data in this category. As a result, the total number of people who chose

satisfactory and comparative satisfactory account for 26.78% in the low-income

group. Besides, it should be noted that it is zero for “quite dissatisfactory” in the medium-income group. It is obvious that the residential satisfaction of the low-income is low, while, the medium-income, high.

Both theoretical analysis and actual survey indicate that the residential

satisfaction can be expressed with the residential affordability which can be affected by two elements: One is housing price, the other one is residents’

income. The higher the housing prices, the lower the affordability; the higher

the residents’ income, the higher the affordability will be. But how are the accepted housing prices for residents decided?

The residents’ income directly determines what they can afford, and this

reflects the economic basic conditions. If the housing prices are too low, people

will improve their housing conditions with rising income. As a result, the housing prices will rise with the increasing demand for houses. If the housing price is so high that it exceeds people’s affordability and fails to guarantee the

housing of the public, the housing prices will decrease no matter whether due to economic development or social stability.

Therefore, it is assumed that there is a long-term equilibrium relationship

between housing prices and income (verified later). The housing price embodied by the long-term equilibrium relationship and determined by income is the one which can be accepted, reflecting people’s residential satisfaction.

The verification of the long-term equilibrium relationship between income and housing prices is to be performed as below.

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Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

Empirical Analysis of the Relationship between Housing Price and Income Theoretically speaking, with the income of people rising, the requirement and standard for housing will be higher, which will lead to the rising housing prices. However, with houses being investment products, the housing prices may be divorced from the basic values, rising so rapidly that it will cause a bubble. As for the long-term issue, is there a stable equilibrium relationship between housing prices and income? Or does the precipitous rising of housing prices stand under such a circumstance? The issues can be analyzed with data. The first step is to select data. The income level of the public can be measured with the per capita disposable income of the national urban households. The housing prices can be measured with the average sales prices of the national commercial housing, being that the turnover of commercial housing divides the area of that in the same year. The sample interval is designated from year 1991 to 2007, with the data of 1991–2006 being from Chinese Statistical Yearbook , and 2007 from Wind database. To rule out the effects of inflation factors, we can use consumer price index (CPI) and retail price index (RPI) to adjust the income and housing prices, respectively, with the base period as 1991. The natural logarithms of the data are taken to eliminate heteroscedasticity. Y is used to express the actual per capita disposable income of urban residents after adjustment, ln Y referring to its natural logarithm; P is used to express the actual average sales prices of the national commercial housing after adjustment, ln P referring to its natural logarithm. The data obtained is shown in Table 17.2. Table 17.2 Year

Disposable income of urban residents and average sales prices of commercial housing between 1991–2007

Average sales prices of the commercial housing (RMB/m2)

Disposable income of urban residents (RMB)

CPI (1991 = 100)

RPI (1991 = 100)

Y

P

ln Y

ln P

1991

756.23

1,700.6

100

100

1,700.60

756.23

7.438 7

6.628 3

1992

996.40

2,026.6

108.6

105.4

1,866.11

945.35

7.531 6

6.851 6

1993

1,208.23

2,577.4

126.1

119.3

2,043.93

1,012.77

7.622 6

6.920 4

1994

1,194.05

3,496.2

157.6

145.2

2,218.40

822.35

7.704 5

6.712 2

1995

1,508.86

4,283

184.1

166.7

2,326.45

905.14

7.752 1

6.808 1

1996

1,604.56

4,838.9

200.3

176.9

2,415.83

907.04

7.789 8

6.810 2

1997

1,789.80

5,160.3

206.5

178.3

249 8.93

1,003.82

7.823 6

6.911 6

1998

1,853.56

5,425.1

205.3

173.6

2,642.52

1,067.72

7.879 5

6.973 3

1999

1,857.02

5,854

202.6

168.4

2,889.44

1,102.75

7.968 8

7.005 6

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

(Cont'd) Year

Average sales prices of the commercial housing (RMB/m2)

Disposable income of urban residents (RMB)

CPI (1991 = 100)

RPI (1991 = 100)

Y

P

ln Y

ln P

2000

1,948.43

6,279.98

204.2

165.9

3,075.41

1,174.46

8.031 2

7.068 6

2001

2,016.75

6,859.6

205.6

164.6

3,336.38

1,225.25

8.112 6

7.110 9

2002

2,091.72

7,702.8

203.6

162.4

3,783.30

1,288.00

8.238 4

7.160 8

2003

2,197.35

8,472.2

205.4

162.3

4,124.73

1,353.88

8.324 8

7.210 7

2004

2,548.61

9,421.6

212.2

166.8

4,439.96

1,527.94

8.398 4

7.331 7

2005

2,936.96

10,493

215.6

168.2

4,866.88

1,746.11

8.490 2

7.465 1

2006

3,119.25

11,759

218.8

169.8

5,374.31

1,837.01

8.589 4

7.515 9

2007

3,665.00

13,786

232.4

179.3

5,932.01

2,044.06

8.688 1

7.622 7

In the sequence diagram made according to the sequence data of ln Y and ln P , we can find that they are both of rising, namely non-stationary, sequences (see Fig. 17.1). Fig. 17.1

Sequence diagram of ln Y and ln P 8.8

InY

8.4 8.0 InP

7.6 7.2 6.8 6.4

1992 1994 1996 1998 2000 2002 2004 2006

Spurious regression will be caused with conducting OLS estimation to non-stationary data in a direct way. To analyze whether there is a long-term equilibrium relationship between ln Y and ln P , we can first check their stability, then conduct co-integration analysis on them to see whether they are of the same integration order. At first we can conduct unit root test with ADF to ensure the stability, then determine the maximal with SC criterion and ensure the sequence of differences with the same principle. The result is shown in Table 17.3.

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Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

Table 17.3

Stationary test of ln Y and ln P

Variable

ADF test value

ln Y

–0.253 093

ln P

–1.810 413

Marginal value (5%) –3.733 2

–3.759 743

Testing result

Non-stationary

Non-stationary

Dln Y

–3.014 594

–3.875 302

Non-stationary

D (Dln Y )

–3.646 719

–3.119 91

Stationary

Dln P

–3.496 612

D (Dln P )

–5.510 023

–3.875 302

–3.098 896

Non-stationary

Stationary

ln Y and ln P both are found to be second-order integration, so we can conduct a co-integration test for them. According to the two-step testing method of Engel Granger, the first step is to run OLS Regression for them, with the result shown in Table 17.4. Table 17.4

OLS estimation of ln Y and ln P

Variable

Ln Y C

R-squared

Adjusted R-squared

S. E. of regression

Sum squared resid Log likelihood

Durbin-Watson stat

Coefficient 0.732 959

1.184 908

0.933 165

0.928 709

0.076 869 0.088 633

20.558 02

1.364 494

Std. Error

0.050 647

0.406 751

Mean dependent var

S. D. dependent var

Akaike info criterion Schwarz criterion F-statistic

Prob (F-statistic)

t-Statistic

14.471 83

2.913 102

Prob.

0.000 0 0.010 7

7.065155

0.287 896

–2.183 296 –2.085 271

209.433 8

0.000 000

Then, we can have the equation: ln P = 1.184 908 + 0.732 959 InY (2.913 102) (14.471 83) 2

R = 0.933 165

D. W. = 1.364 494

The next step is to run a stationary test for residual e , with the result shown in Table 17.5. Therefore, the residual sequence e is included in the stationary sequence. The formula above is the co-integration equation of the two variables, presenting the long-term equilibrium relationship between them. In conclusion, from 1991 to 2007, the disposable income of urban residents is of a long-term equilibrium relationship with the average sales prices of the commercial housing. Coefficient 0.732 959 is the elasticity coefficient of the average sales prices of the commercial housing about the disposable income of urban residents, that is to say, every increase of 1 percentage point in per capita

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

income will lead to 0.732 959 percentage point increase in commercial housing prices. It indicates that the increase of per capita income has a significant effect on the housing prices. Table 17.5

Stationary test of residual e

Variable

ADF test value

e

–2.736 127

Marginal value (1%) –2.717 511

Marginal value (5%) –1.964 418

Marginal Value (10%) –1.605 603

After confirming the existence of the long-term equilibrium relationship between the income and housing prices, we can verify the cause-and-effect relationship between them. For the reason that Granger test result is sensitive to the changes in the duration of lag, we choose a number of different lag periods. Test results are shown in Table 17.6. Table 17.6

Granger causality test of ln Y and ln P

Duration of lag 1 2 3 4

Granger causality

Value of F

Value of P

Conclusion

ln Y →ln P

4.166 94

0.062 06

Accept

ln P →ln Y

6.548 93

0.023 78

Accept

ln Y→ln P

3.600 21

0.066 42

Accept

0.000 18

Accept

0.066 19

Accept

ln P →ln Y ln Y →ln P

ln P →ln Y

ln Y →ln P

ln P →ln Y

2.895 76

32.516 8

0.923 95 5.370 36 0.331 8

0.101 83 0.477 44 0.844 72

Reject Reject Reject

Testing result shows, at the confidence level of 10%, income ln Y are always the Granger reason of housing prices ln P during the lag period of 1 year to 4 years, namely, the increase of income leads to the rising housing prices. Only at the time of one year lag, rising housing prices was the cause of the increase of income. During the other lag periods, housing prices are ruled out as the reason of income increase, that is to say, rising housing prices, in the long run, is excluded of the reasons of income increase. To further explore the relationship between them, we first set up VAR model, and then run an impulse response and variance decomposition analysis. On the basis of SC criterion, we set lag period as 3 and get the VAR equation as below, with the value of Schwarz criterion as –8.604 045. The result obtained is shown in Table 17.7.

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Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

VAR estimation of ln Y and ln P

Table 17.7 ln P ln Y

ln P (–1)

ln P (–2)

–0.007 3

0.328 985

ln P (–3)

ln Y (–1)

ln Y (–2)

–0.052 4

–0.586 9

ln Y (–3)

C

R-squared 0.997 014

0.795 121

0.580 017

–0.971 4

[–0.071 44] [2.970 34]

[–0.478 20] [–1.572 17] [1.544 97]

[2.001 50]

[–2.506 53]

0.138 109

0.030 298

0.002 606

1.199 848

–0.505 6

0.226 551

–0.497 7

[1.328 63]

[0.269 90]

[0.023 47]

[3.170 99]

[–0.969 32] [0.771 32]

— 0.997 767

[–1.267 08]

—

Below runs the impulse response and variance decomposition analysis with the VAR model. Impulse response refers to the influence of a standard deviation shock of a certain endogenous variable to the current and future values of each endogenous variable. The impulse response obtained from the model mentioned above is shown in the Fig. 17.2. Fig. 17.2

0.025 0.020 0.015 0.010 0.005 0.000 –0.005 –0.010 –0.015

Analysis of impulse response Reponse of InP to Cholesky One S.D. Innovations

1

2

3

4

5

6

InY

7 InP

8

9 10

0.025 0.020 0.015 0.010 0.005 0.000 –0.005 –0.010

Reponse of InY to Cholesky One S.D. Innovations

1

2

3 InY

4

5

6

7

8

9 10

InP

Above Fig. 17.2 shows, after housing prices having a standard deviation

shock on itself, a positive response at first occurs rapidly before it quickly diminishes, at last generating a negative response. However, as for a standard

deviation impact from income, housing prices first generate a negative response in the short time, and then generate a strong positive response which maintains obvious positive direction.

Considering income, it at fist generates a weaker negative response which

tends to decline and maintains a slight degree of negative response. While, as

for a standard deviation shock from itself, income will generate a high negative

response which will weaken itself after the second period, but maintain a high

level in the long-term. It indicates that income has its own continuity, and income of the early period will have a continuous impact on that of the future

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

periods by a great degree. But the effect of housing prices on the income is relatively low. Next, we will analysis the contribution of each structure variable to the variation of the endogenous variable which resolves the unit increment of each endogenous variable into a percentage of self-cause and that of contribution of the other variables. The variance decomposition obtained from the analysis is shown in Fig. 17.3. Fig. 17.3

Analysis of variance Variance decomposition of InP

100 80

80

60

60

40

40

20

20

0

1

2

3 InY

4

5

6

7

8

9 10

InP

Variance decomposition of InY

100

0

1

2

3 InY

4

5

6

7

8

9 10

InP

Above Fig. 17.3 shows that the contribution of housing prices to self-prediction

error is slowly declining, reaching 20% after the 9th period; while the contribution of income to prediction error of housing prices is gradually rising, reaching 80% after the 9th period. The contribution of housing prices to income prediction error is low all the time, while the contribution of income to its own prediction error

is always higher than 90%, which is consistent to the result of Granger cause and effect analysis and impulse response.

To sum up the above analysis, it can be concluded that there exists, in the long

term, a remarkable positive correlation between income and housing prices. An increase in income has an obvious effect on the price rise, with a one-way cause-

and-effect relationship of increase in income leading to housing prices rising for a long period. Function of impulse response shows that a standard deviation shock of income will have a significant positive response in the long run. In addition, the

analysis of variance indicates the contribution of income to the prediction error of

housing prices in the long term, reaches over 85%, that is to say, rising of housing prices, from the long-term perspective, in a large percent of over 80%, can be put

454

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

down to the increase of income. It means that since reform and opening up, there have been such reasons as speculative investment causing the rise in housing prices, but to a great extent, the rise reflects the increase of people’s demand, showing the essential fact of the increase of people’s income. However, we will find different results with short-term analysis. From the function of impulse response, it can be noted that the impact of housing prices on income did not generate a strong positive response until the 4th period, at the time of 1–3 periods, even in a negative way. It shows that to a certain extent, the urban residents of China are very cautious over the housing consumption, and short-term increase in income will not directly lead to the growth of housing consumption. In the meantime, analysis of variance indicates that the contribution of income to the prediction errors of housing prices increases in a gradual way, namely, the contribution of short-term income to prediction errors of housing prices is small. Therefore, in the short-term, the increase of housing prices is not due to the increase of income, maybe for the reason that monopoly of market by the sellers causes undersupply or the overinvestment and speculating prevail. Analysis of variance shows, prediction error of housing prices, in the short-term, is obviously affected by the housing prices; while in the long-term, it is weakly affected by the housing prices. It states that maybe the short-term rise of housing prices will drive up the prices once more, but not in the long run. Analysis of impulse response shows that as for the impact of its own, housing prices rapidly generate a strong positive response which declines in a quick way to the negative response. Housing prices are stated to be easy to pull high with the impact of the prices of the previous period which will decrease the prices soon, even making it lower than that of the very beginning. It means that housing prices are easy to rise and decline in a fast way, causing housing prices being slumping, which is the produce and burst of the housing prices bubble. Therefore, we should avoid a too fast increase of housing prices in the short-term. As there is a long-term equilibrium relationship between housing prices and income, if housing prices in the short-term are too high, they will be adjusted in the long-term equilibrium, so as to cause drastic fluctuations in the housing prices.

Theoretical Definition of Housing Prices-IncomeRatio The long-term equilibrium relationship between housing prices and income is reflected in the accepted housing prices within the income level of the public, namely people’s residential satisfaction. Then, what kind of relationship should

455

DEVELOPMENT IN THE YANGTZE RIVER DELTA

be maintained between prices and income to avoid deviating far from the longterm equilibrium relationship? Due to the reason that the index of housing price-income ratio is capable of stating the deviation degree of housing prices from income, our task transfers to ensure the suitable range of the ratio. Relevant scholars believe that the ratio is reasonable between 3 and 6 times. However, some believes that it is normal between 4 and 8 times, considering the invisible income in China. According to the analytical research on the range of the housing price-income ratio at home and abroad, combined with the specific housing credit financial policy in China and the consumption habits of citizens, we can calculate the range of the reasonable ratio. Via the constant payment mortgage to calculate the affordability of the public, we have the formula as below:

V=

x x x + + ... + 1 +i (1 + i )2 (1 + i )n

In the above formula, V refers to mortgage loan, x is yearly repayment, i is annual interest rate of loans, and n is period of loans. To simplify the above formula, we have:

V=

x i

•

1–

1 (1 + i )n

First setting down-payment proportion as z , housing prices as H , so we have V = (1 – z ) H . Setting the annual family revenue as A , the proportion of the annual repayment in family income as w , so the formula above can be changed into: (1 – z )

H=

1 w •A 1– i (1 + i )n

And then

H w = A (1 – z) • i

1–

1 (1 + i )n

H is the housing price-income ratio. Then we will determine the parameter A values. According to the requirement, the down-payment of mortgage accounts for 30% of the housing prices, so z can be seen as 0.3. The proportion of the annual repayment in family income w , according to the regulations of banks, cannot exceed 50% of the income, with 15% as the lower limit by convention. Period of loans is set as 30 years. As for annual interest rate, we choose the loan

456

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

interest rate of over 5 years of commercial banks. With the reform of housing

system proceeding in full swing and the real estate of China entering the stage of commercialization market, we choose the legal loan interest rate over 5 years of financial institutions since 1998. Changes in the periods are shown in Table 17.8. Table 17.8

Loan interest rates of each period

Year

Loans over 5 years (%)

Year

Loans over 5 years (%)

Jul. 1, 1998

8.01

Aug. 19, 2006

6.84

Dec. 7, 1998

7.56

Mar. 18, 2007

7.11

Jun. 10, 1999

6.21

May 19, 2007

7.2

Feb. 21, 2002

5.76

Jul. 21, 2007

7.38

Oct. 29, 2004

6.12

Aug. 22, 2007

7.56

Apr. 28, 2006

6.39

Sep. 15, 2007

7.83

To reflect the overall situation, we choose the average value — interest rate

i being 7%. To reflect the current situation in a better way, we choose current interest rate of 7.83%. Then according to the proportion w of annual repayment in the family income and the different values of i , we can obtain the ratio of housing prices and income which is shown in the Table 17.9. Table 17.9

Ratio range of housing prices to income w

15%

50%

7%

2.66

8.87

7.83%

2.45

8.17

i

It can be observed that since the interest rate before 2007 was lower than that

after 2007, the households before 2007 paid less and the maximal value of the

house prices-income-ratio being bigger than that after 2007. Therefore, we can

regard [2.45, 8.17] as the reasonable range, presenting the residential satisfaction of the public. Within this range, housing prices are acceptable to households, showing the long-term equilibrium relationship between housing prices and income. The ratio before 2007 can be appropriately relaxed at the interest rate of 7%.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Analysis of Residential Satisfaction of the Main Cities in the Yangtze River Delta As one of the economic regions with the most advanced economy, most intense population, and richest livelihoods, the Yangtze River Delta has rapidly developed its real estate market. However, the current souring housing prices have already caused widespread anxiety, and it is commonly believed that the housing prices, being too high, have already exceeded the affordability of the people. Dissatisfied with the housing, people feel also disappointed with the housing conditions. But, is this a common phenomenon in the Yangtze River Delta or just exceptions in several cities? It is clear that its location, transportation, society, culture factors give rise to the economic convergence in the Yangtze River Delta, which makes the housing prices of the cities linked to each other and the trends of housing prices go in the same direction. Certainly, the immovability of land and housing causes the regional distinction of the real estate industry, and the performances of housing prices are different due to the diversity in city scale, development, and location of the cities. In the following section, we have calculated theoretically the reasonable range of residential satisfaction. Only if the housing prices-income-ratio is within the theoretical range, can we believe that the prices are still acceptable and that the public are generally satisfied with the housing. We will get a whole picture of the situation of the Yangtze River Delta through calculating the ratio in the 16 cities in recent years. In accordance with the definition of the People’s Bank of China headquarters, housing prices-income-ratio = average selling prices of commercial housing × average area (housing standard) / average disposable income of urban families. Commercial housing consists of commercial residential building, office occupancy and mercantile occupancy. But since the urban residents are more concerned about the commercial residential building, we will first define the relevant concepts of residential building and income before calculating the ratio. The average selling price of commercial housing is defined as the annual sales of commercial housing divided by its area sold of the same year. The average selling price of commercial residential buildings is defined as the annual sales of commercial residential buildings divided by its area sold of the same year. Generally speaking, the average prices of the commercial housing will be higher than that of the commercial residential buildings. Average area of a set of houses (housing standard) refers to the average area of households. Currently, the determination of the area of a set of houses is not

458

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

scientific enough, setting the standard as data of 70, 80, 90 and 100 square meters. To calculate the actual data of the cities in the Yangtze River Delta in a precise way, the average area of a set of houses can be replaced by the product of per capita residential construction area multiplied by the population per household. Annual disposable income of urban households can be seen as the product of per capita disposable income of the urban households multiplied by the population per household. Population per household can be presented as census register population divided by the total households. The direct data is provided directly in the statistical yearbooks. As for the average prices of commercial housing, register population, per capita disposable income of urban citizens, we can, based on the Statistical Yearbook of the Yangtze River Delta , Pearl River Delta, Hong Kong and Macao Special Administrative Regions , collect the data as the population, households, per capita disposable income of urban citizens, average selling prices of commercial housing of the cities, and calculate the population per household between 2003 and 2006. Average prices of commercial residential buildings are calculated according to the statistical yearbooks of the cities. For the limitation of the statistical resources, we only succeed in collecting the sales and area of residential buildings of 2005 and 2006. As for the data of 2007, we believe that population per household remains the same. The other data is from the 2007 Statistical Bulletin of National Economic and Social Development and the websites of Statistical Bureaus of cities such as per capita disposable income of urban areas, sales, and selling area of commercial housing, sales, and selling area of residential buildings, with data loss of some cities. Considering per capita residential construction area, we will use the data in the 2003–2007 Statistical Yearbooks and 2003–2007 Statistical Bulletin of National Economic and Social Development as the basis. In some years, the statistical data is the per capita residential usable floor area in some cities. According to the principle of no exaggeration, we set the per capita residential construction area as the product of per capita residential usable floor area multiplied by 1.3. As for the data loss, we estimate the average area per set of houses according to the urban per capita residential construction area of Zhejiang and Jiangsu provinces and the population per household in the Statistical Bulletin of Urban Housing Survey of 2003 and 2005, before revising the data with the average area of a set of houses (from the levels of 60 to 100 square meters). The results obtained are shown in the brackets. By calculation, we have the housing price-income ratio of the cities, and details are shown in Table 17.10.

459

460

6.6

4.8

Yangzhou

Taizhou

6.4

3.6

6.1

5.8

5.4

Jianxing

Huzhou

Shaoxing

Zhoushan

Taizhou

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

4.5

(6.3)

6.1

4.4

8.0

5.1

6.8

5.3

(6.5)

(5.6)

4.5

(5.4)

(5.1)

(5.9)

6.5

10.3

Commercial housing price-income ratio

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

Residential housing priceincome ratio

2004

6.8

7.1

7.0

5.6

6.6

6.9

8.2

8.3

7.6

6.1

4.8

7.4

6.2

8.3

6.6

10.2

Commercial housing price-income ratio

6.5

6.7

6.4

5.3

6.2

6.2

8.0

7.0

6.9

5.4

4.7

6.8

5.9

8.0

6.2

10.0

Residential housing price-income ratio

2005

8.1

7.0

7.7

6.7

6.2

8.9

9.1

7.8

7.0

6.7

5.1

7.2

6.9

(7.5)

7.5

10.0

Commercial housing price-income ratio

7.8

6.7

6.8

6.2

5.9

8.4

8.7

6.6

6.6

6.1

4.8

6.6

6.4

(7.2)

7.2

9.7

Residential housing price-income ratio

2006

7.7

7.6

7.8

6.6

5.8

8.7

9.8

6.8

6.7

6.5

6.5

6.2

7.5

8.7

8.4

11.4

Commercial housing price-income ratio

—

7.2

—

6.4

—

8.9

9.3

6.3

(6.5)

6.1

—

6.0

7.1

8.5

7.9

11.2

Residential housing priceincome ratio

2007

Notes: Per capita construction area is estimated calculating the data within the brackets. Blank column is for loss of statistical data. Data with black shadows are those exceeding the range of reasonable housing price-income ratio [2.45, 8.17].

4.5

Ningbo

6.8

4.8

Nantong

Zhejiang Hangzhou

5.2

4.7

Wuxi

(4.8)

5.6

Suzhou

Zhenjiang

6.5

Nanjing

Jiangsu

Changzhou

8.5

Residential housing priceincome ratio

2003

Commercial housing price-income ratio

Shanghai

Cities

Table 17.10 Housing price-income ratio of cities in the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

From the above table, we can observe clearly that there exist obvious layered structures corresponding to the city administrative grades and economic development in the housing price-income ratio in the cities of the Yangtze River Delta. Shanghai, as the direct-controlled municipality, possessing the maximal ratio; in the second place are the provincial capital, sub-provincial capital, and the cities with advanced economies, such as Suzhou in Jiangsu Province, Hangzhou and Ningbo in Zhejiang Province; prefecture-level cities rank the last. Considering the ratio of cities in Jiangsu Province in 2007, Nanjing and Suzhou rank the first, followed by Wuxi, with such cities being relatively low as Changzhou, Nantong, Yangzhou, Taizhou and Zhenjiang; While for that of Zhejiang Province, Hangzhou and Ningbo rank the first, followed by Taizhou, Zhoushan, and Shaoxing, with such cities being relative low as Huzhou and Jiaxing. In Jiangsu Province, Suzhou and Wuxi are close to Shanghai, and thus their economy, being greatly affected by Shanghai, develops in a fast way, which causes a high housing price-income ratio. However, the other cities are either far from Shanghai or of inconvenient transportation to Shanghai, leading to lower ratio. In Zhejiang Province, although having a short distance to Shanghai, Huzhou, and Jiaxing have a lower ratio, while Taizhou, Zhoushan, and Shaoxing, being relatively far from Shanghai, possess a higher ratio. It is in contrast to that of Jiangsu Province. One explanation is that the influence exerted by Shanghai on Zhejiang Province is not as direct as that on Jiangsu Province. Located inland, the cities in Jiangsu Province are under the strong affection exerted by Shanghai, which leads to the result that the economy of those cities closer to Shanghai or with convenient transportation to Shanghai develop faster, with higher housing price-income ratio; while, facing the sea, the cities in Zhejiang Province, such as Taizhou, Ningbo, Zhoushan, and Shaoxing, are not so dependent on Shanghai as the cities in Jiangsu Province, so that the economy in these cities does not rely on the relationship with Shanghai. Comparing the urban per capita disposable income (see Fig. 17.4), we can find the above phenomenon. In Jiangsu Province, the income of Nanjing, Suzhou, and Wuxi takes the lead; while in Zhejiang Province, that of Hangzhou, Ningbo, and Taizhou ranks first. Jiaxin, being closer to Shanghai, has lower income. In 2003, the housing price-income ratio of Shanghai reached 8.5, which has already exceeded the upper limit of people’s affordability. It has risen continuously in recent years, and the housing price-income ratio reached up to 11.4 and the residential building price-income ratio reached up to 11.2 in 2007. Thus, it is clear that the housing prices in Shanghai have already exceeded the

461

DEVELOPMENT IN THE YANGTZE RIVER DELTA

affordability of the residents. As for Jiangsu Province, the ratio between 2003 and 2005 was moderate, and it experienced a certain increment in 2006, but rose too fast in 2007. The housing prices in Nanjing and Suzhou exceeded the affordability of residents as well. From the perspective of residential building price-income ratio, Nanjing of 2007 is 7.9, which was near the upper limit of the ratio, while Suzhou reached up to 8.5. It indicates that the housing prices of the two cities rose too fast, thus lowering the residential satisfaction of the public. However, although some cities witnessed the increase of the housing priceincome ratio, the ratio is still acceptable with Wuxi ranking first as 7.1 in 2007. It should be noted that the commercial housing price-income ratio of Taizhou was high in 2005 and 2006, which was due to the inconsistency of statistical standard of per capita construction area and periods between Taizhou and the other cities. It can be an exception with a per capita construction area of 35 square meters in Taizhou. As for Zhejiang Province, the ratio was not too high in 2003 and 2004, but from 2005, the ratio started to rise. The ratio of Hangzhou, since 2005, has been running at the upper level all through, exceeding the reasonable range, and the commercial housing price-income ratio reached up to 9.3 in 2007, far exceeding the upper limit of 8.17. The housing price-income ratio of Ningbo had been reasonable before 2005, but rose fast in 2006 and reached up to 8.9 in 2007. Commercial housing price-income ratios of Shaoxing, Zhoushan, and Taizhou in 2003 and 2004 were still within the range of 4 to 6, but have exceeded 7 to 8 during the last two years. Rising in a moderate way, the housing price-income ratio of Jiaxing and Huzhou is still in the range between 6 and 7, without severe problems caused by housing prices. To reflect the situation more directly, the ratio of cities is shown in the Fig. 17.5. Fig. 17.4

Urban per capita disposable income (2007)

25,000 20,000 15,000 10,000

462

Taizhou

Zhoushan

Shaoxing

Huzhou

Jiaxing

Ningbo

Hangzhou

Taizhou

Yangzhou

Nantong

Zhenjiang

Changzhou

Wuxi

Suzhou

Nanjing

0

Shanghai

5,000

Analysis of Urban Residential Satisfaction Based on the Relationship between Housing Prices and Income

Fig. 17.5

Housing price-income ratio of each city in 2007

1.2 1.0 0.8 0.6 0.4

Taizhou

Zhoushan

Shaoxing

Huzhou

Jiaxing

Ningbo

Hangzhou

Taizhou

Yangzhou

Nantong

Zhenjiang

Changzhou

Wuxi

Suzhou

Nanjing

0

Shanghai

0.2

Commercial housing price-income ratio Residential building price-income ratio

Conclusion On the basis of the analysis above, the housing price growth and the housing price-income ratio of the cities in the Yangtze River Delta are diverse from each other; therefore, the residential satisfaction of the public is unequal. The housing prices of such hotspot cities rise too fast (Shanghai, Nanjing, Hangzhou) and this leads to the decrease of residential satisfaction; the ratios of some cities with stronger economic strength, though still under control, are near the upper limit, causing people’s dissatisfaction with the housing; the problem of high housing prices in such cities as Yangzhou and Jiaxing are not severe since the housing price-income ratios, though higher, are still within the reasonable range. Therefore, aiming at the problem of the decrease of residential satisfaction, the policies and measurements should vary among different cities. As for the cities with too high a ratio, we should restrain the house prices with regulatory measures; as for the cities with relative high ratios, the prices should be reduced appropriately; as for the cities with normal ratio, the prices can be determined freely by the market. Certainly, located in an integrated economic area, cities in the Yangtze River Delta interact with each other in terms of the development of real estate industry. The regulatory and control department of real estate should keep close eyes on the actual situation and take corresponding measures.

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

A phenomenon revealed in the analysis is that the cities with comparatively high income possess high housing price-income ratio. A phenomenon revealed by the analysis is that the housing price-income ratio will be higher in the cities with higher income. It indicates, on the one hand, that the increase of income is indeed capable of pushing the housing price forward; on the other hand, sharp growth of housing prices is inevitable in the process of economic development. Experience shows that with per capita income reaching up to 300 dollars, the real estate industry just starts; with USD600–800, it comes into the period of rapid development; with USD1,300, it comes into the stable growth period; with USD8,000, it comes into the balanced period. Therefore, we should view the development of the real estate industry in accordance with the specific development of cities. We find that the per capita GDP of the cities with the highest housing priceincome ratio has already exceeded USD8,000 in 2007, and the real industry in those cities is to be into the balanced period. Indeed, the real estate industry of those cities has experienced rapid growth, with overtopped housing priceincome ratios. The emphasis of regulation should be keeping a balance between the house price and income, thus to decrease the ratio and increase the residential satisfaction. The other cities may enter into the period of stable development. The real estate industry in those cities should transfer from rapid development into stable development. The regulation should be emphasized on keeping sound and stable development of real estate industry. While promoting the growth, the government should avoid the overheating of the housing prices, control the housing price-income ratio and prevent the worsening of housing problems so as to ensure the residential satisfaction of the public.

464

18

Chapter

Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction With the rapid development of China’s economy and the further deepening of market-oriented reform, issues of education, housing, healthcare, etc., being in the contradiction of old-new systems, have already been the hot topics which concern the whole of society. Since 1985, the medical health system has already experienced two rounds of reforms which were trying to employ the experience of the reform of state-run enterprises to solve the problems of governmental undersupply and operational inefficiency in the state hospital system via marketization and property rights reform. This way of reform not only achieved some success in the short-term, but also fostered the state hospital to transfer from the non-profit sector into a half-profit public institution. The overemphasized profit motive leads to a new doctor-patient conflict. In the meantime, the medical health and epidemic prevention network at the grassroots level, especially of the countryside, declined in a fast way, causing an outstanding supply-demand contradiction of grassroots medical service. With the intensification of the difficult access to and high cost of medical care, the call for new medical reform has been growing louder in recent years. What on earth could be the cause of the difficult access to the medical treatment and overly expensive medical service? First, from the perspective of demand, with the rapid development of economy and society of China, especially under the background of stepping into an aging society, the incidence of some chronic diseases has been rising, giving rise to more people’s demands for medical service. Second, from the perspective of supply, under the background of economic transition, the proportion of financial subsidies for the medical institutions of state hospitals is getting smaller and smaller. Especially after the reform of the tax sharing system, the function of central finance has devolved to the local bodies, so the difference of local financial resources directly determines the regional supplying capacity of medical service. The continuous improvement of modern medical technology, on the one hand, expands the range of medical services obtainable for the public. On the other hand, the improvement promotes the increase of categories and items of medical services which leads to the rising total cost. However, with the rise of salaries, administrative charges, and medical prices, the prices of most technical services are relatively low, and unable to compensate for the costs. Therefore, the medical institutions turn to the drug sales, medical instrument inspection, and developing new service projects to obtain the compensation. The “excessive” medical services boost the rising of total charges, which is the pain of reform for the urban laid-off workers and the people in the

466

Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

countryside who are not covered by medical insurance. In this chapter, we will conduct a case study of Suqian medical reform to discuss the above mentioned problems. The medical reform of Suqian, Jiangsu Province, started in the year 2000. Against this background, a complete reform of marketization and property rights has been carried out in the local state hospitals. While Suqian is not the only area implementing reform for the old medical mechanism, it is, instead, a typical representative in the magnificent reform of the medical mechanism in the Yangtze River Delta, and even China as a whole. Based on this case, the questions to be answered by this chapter are about how the reform of marketization and property rights started and where it is to go. Via the model, the chapter verified the necessity and validity of the marketoriented reform. But we still cannot get the conclusion that market-oriented reform inevitably leads to property reform. The conclusion of the model corroborated the situation of a variety of medical organizations co-existing and pursuing common development through mutual competition. During the process of the top-down and magnificent reform in Suqian, the problem of difficult access to medical services has been alleviated in an effective way. While the problem of the high expense of getting medical service is still expanding amidst twists and turns, the property reform and the market-oriented process is playing a complex role. The following section of the chapter is to introduce the background of Suqian medical reform, followed by a review of the relative documents about medical service. Then, a two-stage model including owner and manager is introduced to explain such questions about the necessity and effectiveness of marketization, together with the privatization generating power. The confirmation of the above model is carried out accordingly, which also concludes the experience of Suqian medical reform, before a conclusion of the whole chapter is made.

Background of the Suqian Medical Reform Located in the northern part of Jiangsu Province, Suqian is a prefecture-level city newly constructed with the approval of the State Council in July of 1996, administrating the three counties of Muyang, Siyang, and Sihong, two districts of Suyu and Sucheng (111 towns and 4 sub-district offices in total). With the total population of 5.26 million, the area covered by Suqian amounts to 8,555 square kilometers. The economy in the city is relatively underdeveloped. Muyang County, as one of the 19 old revolutionary base areas, composes the most backward economy in Jiangsu Province (see Table 18.1), with 8 provincial-level povertystricken counties out of the 28 counties.

467

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Table 18.1

Economic status of cities in Jiangsu Province (2000)

Unit: RMB100 million Cities

Financial revenue

Financial expenditure

GDP

Per capita GDP

145.1

84.97

775.59

27,128

Nanjing Wuxi

54.75

28.11

426.43

37,959

Xuzhou

31.12

15.30

288.10

18,408

Changzhou

32.07

16.69

196.97

22,441

Suzhou

58.03

31.23

335.42

30,470

Nantong

24.83

12.90

159.87

24,619

Lianyungang

10.48

8.05

103.31

16,641

Huaian

15.46

6.45

69.76

12,921

Yancheng

7.69

6.13

69.63

11,229

Yangzhou

11.55

8.79

137.25

25,999

Zhenjiang

14.57

9.06

144.75

23,404

Taizhou

14.23

10.62

112.56

18,850

Suqian

1.39

3.13

19.96

8,186

Note: The figures only include the downtown areas of each city. Source: Jiangsu Statistic Yearbook (2001).

The heath undertakings of Suqian before reform have accumulated underlying difficulties and conflicts, specifically manifested in the two aspects of undercapitalization and inefficiency (see Table 18.2 and Table 18.3). Table 18.2 Basic medical resources

Staff size

468

Basic status of medical service in Suqian (2000) Number of beds

Number of hospital beds per thousand people

Number of health workers per thousand people

Medical health assets (RMB100 million)

Total population of medical organization

5,406

1.07

1.68

5.88

10,665

Number of health workers

Number of managerial and other staff

Number of attending doctors and people with above technical titles

Proportion of health workers (%)

Proportion of managerial and other staff (% )

8,519

2,146

1,466

79.88

20.12

Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

(Cont'd) Hospital revenue (RMB10,000)

Outpatient and inpatient status

Total revenue

Outpatient revenue

Inpatient revenue

Medicine revenue

Other revenue

6,060.25

1,334.5

1,746.25

2,654.75

324.75

Proportion of each one

20.02%

28.81%

43.81%

5.36%

Number of outpatients

Number of consultation per 10,000 people

Average length of stay

Average charge per outpatient

Average day charge per bed (RMB)

895,635

1,769.47

11.88

90.09

177.18

Source: Suqian Statistical Yearbook (2001).

Table 18.3 Cities Nanjing

Wuxi

Xuzhou

Changzhou

Suzhou

Nantong

Lianyungang

Huaian

Yancheng

Yangzhou

Zhenjiang

Taizhou Suqian

Basic status of medical service of major cities in Jiangsu Province in 2000 Number of hospital /health center

Number of beds

191

16,568

78

8,884

42

29

32

28

34

17

17

20

24

17 11

7,003

4,805

5,471

4,824

2,894

Number of doctors 8,542

2,521

3,848

2,335

2,634

1,918

1,507

2,561

1,258

3,287

1,389

1,817

889

3,363

1,736

636

387

1,941

987

Note: The statistics only cover the downtown area of each city. Source: Jiangsu Statistical Yearbook (2001).

In 2000 when the reform had not yet started, with the disposable funds only amounting to RMB0.68 billion, Suqian shouldered the financial support of 110,000 personnel, in which 60,000 were teachers and 10,000 were medical workers, with the per capita fund of RMB6,200. Around 60% of the financial expenditure of the county and over 70% of that of the township was applied to the educational part, with the prevalent phenomenon of arrears of wages of teachers and civil servants. With the system of dividing revenue and

469

DEVELOPMENT IN THE YANGTZE RIVER DELTA

expenditure between the central and local governments, it had already been difficult for the local government to ensure its basic expenses, not to mention the necessary investment in the medical organization and public health. The fund of normal hospital operation cannot be guaranteed, failing the upgrading of the facilities. Most health centers are trapped in a vicious cycle of “inadequate investment–hard operation–poor service–harder operation,” the medical service of Suqian was on the verge of collapse. In the end of 1999, with total assets of medical service being RMB0.495 billion, Suqian had 8,459 medical technical workers, per capital health assets of RMB96.12, and technical staff number of 1.64 owned by per 1,000 people, ranking the last in Jiangsu Province and being in the middle or low level of the whole country. Of the existing health resources, RMB299 million is distributed in the level of city and county, accounting for 60.4%, with senior technical workers of 1,055, accounting for 31.31%; RMB196 million is distributed in the countryside, accounting for 39.6%, with 458 senior technical workers, accounting for 31.31%; assets for disease prevention and health protection amount to RMB45 million, taking up 9.09%, with 848 technical workers taking up 10%; assets of RMB450 million is distributed in the medical part, accounting for 90.91%, with 7,611 1

medical technical workers accounting for 90%. On the other hand, at the end of 1999, with governmental health assets accounting for 98.8% of the total, medical service is generally controlled by the government, with a lack of motivation of independent administration and selfdevelopment. Without a sense of competition, the medical technical workers paid no attention to responsibility. Overstaffed, the medical organization of the countryside areas comprised of non-technical workers made up 40% of the total. Unable to make decisions independently, the state-run medical service was insensitive to the market, for the mechanism, with the problem of high cost but low efficiency prevailed. By the end of 1999, the total assets of the 124 township hospitals amounted to RMB1,700.424 million, with gross liability of RMB830.167 million, a ratio of liability of 48.8%, and the utilization rate of beds of 20%. The salaries for workers of two of the three hospitals could not be paid in time and the hospitals found it difficult to survive.

Literature Review Relative literature about medical service can fall into two categories as literature covering endogenous or exogenous research. As for endogenous research, the essential issue of the doctor-patient

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Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

relationship is based on asymmetric information and incomplete contracts. Doctors have more adequate information than patients on the knowledge of disease and curing methods, therefore, compared with the demand side, suppliers occupy a dominant position in the medical market. Thus, moral risk, such as the doctor inducing demand for patients, recommending excessive services, offering additional testing, and producing more agents, will increase as well. Since the patients are lacking the capacity of directly evaluating and supervising the doctors’ behavior, therefore, the high quality medical resources will have to get some authoritative guarantee either through professional titles of physicians, director of physicians, etc., or depend on authority, such as medical professional qualification authentication, and other default rules to send a “signal” to consumers. On the other aspect, unknown behavior or the behaviors unable to be observed by the third person will not be stated in the contract more often than not. For example, the doctor who tries his best to cure the patient may not be capable of curing the patient at last, while sometimes the doctor did not do much, patients got self-healing by other unknown reasons (Kenneth J. Arrow 1963). Hence, to look out for their own interests, the patients will search for the best medical service that they can afford. The patients mostly choose the brand hospital, famous doctors, and high-tech facilities, which promotes the competition among doctors, technologies, and facilities. But in fact, it is not always necessary to apply the most advanced technology and facilities. The problem fostered by the appearance of the third party payment, that is to say, the medical service obtained is not paid by the patients directly, but by the third party. Patients’ excessive desire for medical care is oppressed by the third party. The patients are guided to the community hospitals first, other than the comprehensive hospital directly. With market and property rights structure being the essential fundamentals of efficient medical service, exogenous research directly originates from the development of property rights theories in recent years, whose largest contribution is providing the answer to Coase’s question (1960) — why do enterprises exist? — from the perspective of organizational rights. According to Sanford J. Grossman and Oliver D. Hart (1986) and Oliver Hart and John Moore (1990), the optimal ownership structure to maximize total surplus can be realized under sub-optimal conditions, via the configuration of assets ownership or residual control rights, which requires the arrangement of ownership to the important or indispensable side of investment. From the perspective of incomplete contract, Oliver Hart, Andrei Shleifer, Robert W. Vishny (1997) and Oliver Hart (2003) discussed the model differences of state-run, individualowned, and public-private partnership.

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Domestic research on medical reform involves four aspects: public health service system, medical service system, medical security system, and medicine supply security system. As for the marketization and property rights reform, scholars showed widespread approval to the former. From the entire fiscal conditions of China, in accordance with Xie Ziyuan, Ju Fanghui, and Zheng Changjuan (2005), it is unrealistic to rely on the government to provide medical service completely. They suggest that we can introduce the mechanism of third party payment to change the structure of the game in the medical service market, suppress the moral hazard of hospitals, purify the medical service market, and eliminate the opportunistic behaviors of the patients. According to the analysis of Wang Dingding (2005), the problems confronted by the reform of the Chinese medical mechanism are exactly the reflection of the tortuous supply-demand market of medical service. The problems are to be solved by the marketization of doctors’ income and the overall reform of the hospital microscopic mechanism, with the two being the premise of each other. Qin Hui (2006) believes that the failure of medical reform lies in the inability in solving the asymmetrical power and responsibility in public affairs of government; therefore, considering the stability and harmony of society, reform can be carried out in steps. The power should be restrained in the field suitable for marketization so as to avoid depriving the public’s interests, while the responsibility should not be shifted to the market in the field of public service. Based on the opinions of Feng Jin and Yu Yangyang (2008), the medical health mechanism of the planned economy already cannot adapt to the new demand mode and scale. The reform in the medical field requires adaptation to the economic reform, and there is no reason to attribute the problems of reform to the market-oriented reform. Heavy medical burden, limited function of medical security, lack of medical fairness, etc., are exactly the results of market distortion. Therefore, the key element of medical reform lies in establishing an appropriate incentive mechanism which can control the medical expenditure and assure the quality of medical service. The form of the incentive mechanism relies on the perfect social security system and competitive market of medical service. The article mentions that in the aspect of medical service supply, to form a competitive market of medical service of doctors or hospitals is helpful to establish a fair doctor-patient relationship, lower the medical costs, and improve the efficiency. The function of government lies in establishing and perfecting the system of social security. According to Gu Xin (2005), the biggest problem of “the marketization of diagnosis” and “anti-marketization of prescription” falls on simplifying the market-government relation into binary oppositions. Actually, in the

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normal market economy system, the country can participate in the marketing activities with multiple identities as insurer, purchaser, employer, sponsor, regulator, supervisor, and even moral persuader. Most of all, the countries with market economy intervene in the market mainly by participation instead of replacing the market. The development of market mechanism or the process of marketization is definitely not the process of a zero-sum game, but the one of perfecting the market mechanism. It, in the first place, means the perfecting of a whole set of the game. Marketization is definitely accompanied by the restructuring of the governmental functions (Gu Xin 2006). Nonetheless, as for the property rights reform, the views of scholars are widely divergent which leads to variant opinions on the medical reform model of Suqian, which is representative of the fundamental change of the property relationship of the state hospital. The opponents are represented by the medical health reform research group in the Chinese economic research center of Peking University, led by Li Ling. Through the research study of the medical health status of the downtown area of Muqian City, Muyang County, and the countryside area, they believed that medical reform of Suqian changed the state of the government directly running hospitals. By introducing social funds, Suqian also rapidly increased the medical resources, formed the competitive situation of the medical market and fostered the medical organization to introduce the managerial mechanism of enterprises, so as to motivate the medical staff, improve the quality of the medical service, expand the items of medical service, and decrease the registration fee and unit price of drug and test items. However, the most important target of medical reform: public health development and the problem of the high expense of getting medical service still remains to be solved. The reason lies in that the profit motive of hospitals, after reform, was not eliminated but strengthened; opening the market of medical services too quickly and blindly pursuing the expansion of total available resources resulted in unregulated competitive behaviors in quantity; due to the unbalanced information, various kinds of means can be used to increase the profits by the hospital, such as introducing experts, technology, and purchasing advanced medical equipment. The rise in supply leads to the overuse of medical services, inspection, surgery, and drugs which results in the rapid growth of medical costs. It not only wastes the medical resources, but also harms patients’ health, even life. Finally seeing a doctor becomes more expensive for the public. Therefore, in view of the present situation in China, we should reserve the state hospitals in a reasonable quantity, with the strict control of the total costs by the government. Meanwhile, we should improve the managerial mechanism of the

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government to the hospital and foster the formation of competition among the state hospitals. Meanwhile, we have to eliminate completely the profit motive of state hospitals, making the competition among them be that of cost control and quality improvement other than making more profits. Specific to the research study report of Li Ling’s research group, Zhou Qiren (2008) stated that the negative evaluation of Suqian medical reform in Li’s report was not based on liable and eligible verification. He pointed out that Suqian medical reform had not only strengthened the administrative duty and financial responsibility of government, but also implemented the public health service at the village level by the form of governmental payment and competition for the bidding of village doctors. This practice indicates that even though taking full responsibility for the public health, the government is not needed to settle the total costs. The specific supply of the public health service, practically, can be tested and chosen within the frame of the “government being in full charge [of the] public-private partnership.” Suqian changed the property rights relationship of state hospitals fundamentally. Selling the stock rights, the government resigned from the field of directly controlling, operating, and managing the hospitals and clinics, concentrating on the industry regulation, especially the supervision of market competitive order and quality of medical service, which is of great significance. In the field of non-public products, the hospitals and clinics can be run via the ways of private-owned mode, 2

price mechanism, or company system of profit or non-profit. However, Zou Zhizhuang (2006) believes that it is insufficient to deny the applicability of the fundamental law of demand and supply just for some particular problems such as asymmetric information. That is to say, demand rises for high income but declines for high prices; if private run supply is allowed, the amount of supply will be more than that of the state-run. Reform of Suqian indicates that privatization will bring the increase of supply, decrease of prices, and improvement of quality. Also by research study, the research group of “Study of the Suqian Medical Health System Reform” in the Institute of Public Administration of Peking University drew the conclusion counter to the one from the research group of medical health reform in the Economic Study Center of Peking University. In their opinion, medical health reform of Suqian is a positive attempt, whose experience and lessons are of great referential significance for the reform of the medical health system in the underdeveloped areas and even all around the country. First, the underdeveloped areas should initiate change under the financial pressure and the local government, especially the leaders, should be provided with this pioneering spirit. Second, the reform of the medical health

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system should proceed on the basis of overall marketization reform, as simple conduction of medical health system reform is hard to achieve great success; the sufficient theoretic preparation and successful pilots are particularly important for the effectiveness of reform. Third, it is very important, in the reform of the medical health system, that clear ownership, integrated planning, law-based promotion, and technological assurance, which are the essential links to avoid the loss of state assets and assure the success of reform. Fourth, the basic guarantee to solve the problems of the high costs of getting medical care is that the supply of health resources increased by market competition, the advancement of technology, and service ability, and the improvement of the hospital administrative mechanism. While the stimulation and restriction of talents is the key link to ensuring the sound development of the hospitals. Fifth, as public health and medical service are different in product attributes, government should set accurate positions for the two and the responsibilities of the government at all levels should be defined in a clear way. The construction of the mechanisms of securing civil health and supplying medical service requires, on the one hand, the labor division and cooperation between government and market, on the other hand, a sound legal environment and the full equipped mechanism of governmental administration. Sixth, the appearance of the medical organization with mixed ownership is helpful to perfecting the supply mechanism of public health and medical service, combining the role of government and market. Ownership of the hospital is not important, and what matters is to establish the standard of medical organizations and medical service, which is the basis for the government to conduct regulation (Wei Fengchun 2006). The research study group of Southern Window which was hosted by Yan Xiaoyang in 2007 further stated that with the clarification of property rights just being the means, the function of marketization was not to turn the public into the private, but to create a reasonable mechanism for pricing, searching for information, and reasonably ordering the market demands. It is undeniable that the market has its blindness, the enterprises will meet with rebuffs in the process of trying and exploring the market and probably face certain waste, if only following the market power. Indeed, market failure will bring extra costs and the guidance of the government is required for the blindness of the market. But it does not mean that the government has to solely take over the operation of hospitals. The state hospitals governed by the plan also have their own disadvantages. And the efficiency loss caused by government’s sole control is larger than the loss caused by the blindness of the market. It is to combine the advantages of the market and government by transferring the government-

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owned hospital into government-run hospital, society-owned hospital, and government-supported hospital, and from the service of government-supply to government-purchase. In their opinions, government’s various programming and coordination exactly is a slow link; compared with it, the market is a response system with a faster speed. It seems that Suqian has gradually found out a series of medical systems following the above logic. By the behavior of medical organizations taking a fast grasp of the information under the market mechanism, the government is capable of coordinating the allocation of resources, clarifying its responsibilities, and supervising the realization of such objectives as welfare with government taking the leading role, supplemented by market-oriented means to assure the efficiency. Zhou Qin and others (2008) studied and compared the three models of medical reform of “market-oriented reform” in Suqian, “management-operation separation” in Wuxi, and “drugstore trusteeship” in Nanjing. According to the 3

report, the essence of market-oriented medical reform is a historic advance. Its greatest contribution lies in that it increased medical resources supply effectively, greatly alleviated the problem of the difficulties in getting medical service, improved the medical service level through competition, and basically met the people’s demands for medical service. Some problems arising in the current reform cannot be attributed to the market-oriented reform totally. Instead, the causes can be excessive regulations on market excess, monopoly of state-hospitals, unfair competition. The history of over 50 years witnessed that it is impractical for the medial services to be wrapped completely by the government. Marketoriented reform is able to solve the difficulty in receiving medical service but not the problem of the high costs of the medical service. The basic guarantee of solving the latter is to restructure and lead the medical health system to transfer into the one with the reasonable and effective structure, from the demand aspect, which, however, is unable to be realized by hospital and doctors. Government, especially the medical administrative department, has to bear the responsibilities. We have to combine the visible hand of governmental administration and the invisible hand of the market so as to alleviate the difficulty in getting medical service.

4

Analysis of Theory and Model All the medical service suppliers, no matter in the developed countries or in the developing countries, are facing the pressure of reform whose orientation is to introduce competition and market mechanism (McPake, Kumaranayake, and Normand 2002). On the basis of the study of the experts from the World Bank, the

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reforms of state hospitals are carried out using the following three models: Autonomy: The state hospital is still a part of the public sector, but the control power over all of its daily affairs should be completely divorced from the bureaucratic system to the managers of the hospital; as for finance, with the government setting the global budget, hospitals can dispose the financial revenue and expenditure independently within the budget; with supervising power still grasped by the bureaucratic system, the accountability mechanism with certain performance indicators as the measurement should be established, sometimes with performance contracts being introduced. Corporation: Independent of the public sectors (or government), the state hospital becomes a corporate entity with the corporate government. As a principal sponsor, the government takes an important role in the hospital board of directors. Completely as a private entity, the hospital participates in the competition for medical services, no matter if profit-making or non-profit-making. The hospital has to be responsible for its own losses and gains, with the possibility of going bankrupt. Privatization: State hospitals are transferred into private entities, no matter if they are profit-making or non-profit-making. Removing direct control of hospitals, the government resigns from the structure of corporate management. State-owned assets are sold in various ways to the operators of private hospitals (Harding and Preker 2003, 23–78). Considering medical service delivery, it is a common feature of the world to strengthen the governmental supervision and market competition, which run parallel. In a word, it is a general trend of global medical reform (especially reform of medical service delivery) to go to managed marketization. Taking the countries in Eastern Europe as an example, although the proportion of economic resources obtained by the department of health is not low, there are a lot of health problems, being starved of policies to increase the health expenditure’s unit value of currency. It amazed us that the countries in poverty, such as Bulgaria, Slovakia, are even higher than the countries of Organization for Economic Co-operation and Development (OECD) in the numbers of doctors and beds. But meanwhile, the reception rooms of the hospitals are overcrowded. There are many people waiting in line for tests and diagnostic procedures (such as surgical operation), while much material equipment and human resources are far from being fully exploited. Therefore, the economic mechanism has a great effect on the development of medical health. The co-existence of shortage and surplus should push the reformers to make economic plans to improve efficiency, to distribute the resources in a better way, and to achieve balance between supply and demand.

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Hence, in accordance with the difference of property structures, the hospitals can fall into three categories: the first one is state hospital mode, in which, the hospital does not possess independent accounting, but totally relies on the means of budgets and final accounts. Personnel appointments and removals are completely decided by the orders from superior leaders. At the moment, the government alone takes charge of the public’s medical supply. As the owner of the hospital, the government can designate governmental employees or employ professional managers (group) to hold the post of administrators. The former being the typical model of the state hospital, but the latter is a state hospital with a management-operation separation model which is also one of the forms of public-private cooperation relationships. The second one is the model of the private hospital. That is to say, as a hospital is a self-governed legal entity, the private owner is an independent bearer of medical supply. For the time being, the role of owner is played by the natural person or legal entity which is capable of choosing the way of selfsupporting or employing professional managers (group) to take the position of manager. The third one is the model of public-private partnership, namely, not being restricted to a certain idea, medical health service resources are provided in multiple forms via private owners entering into a contract with the government. To illustrate, private-owned hospitals are built in or beside the state hospitals which outsourced to the former the services of non-clinical support, clinical support, special clinical support, etc.; or private owners finance, build, and run the state hospitals (sometimes via lease back); or the state hospitals are sold to the private owners to be used either as hospitals or for other purposes. In simple words, it is either public hospital outsourcing services or private franchise operation authorized by the government. But whichever form it is, private owners and the government both have to share the duty and risk within the contract. For the time being, as entities of natural persons and legal persons take stake in state hospitals, the managers are designated by the two sides. The people designated can be natural persons (legal entities) or professional managers (group) hired from outside. The latter two models above include the concept of privatization or partial privatization. And the concept of marketization is included in the practice that administrators’ work can be held or participated in by the non-governmental employees, natural person (group), or professional manager (group). In accordance with the three situations above, the owner can be the government G , the natural person, or legal entity P . The administrator can be

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the governmental employee E , the non-governmental employee, natural person (legal entity) or professional manager (group) M . We assume that G , P , E and M are all of risk-neutrality. In the period 0, we have given property structure λ. 0 ≤ λ ≤ 1 stands for the proportion of private property taking in the total. The contract concluded by the owner and administrator can make sure the rewards obtained by the latter

is P 0. We define the efforts for the improvement of “cost efficiency” (price) and “output efficiency” (quality) as e and i , respectively. In the period 1, it is up to the administrator to make decisions. Herein, e and i can be observed by both sides of the contract, but cannot be determined in the contract in advance. Due to the market competition, the earnings of non-governmental employee M and governmental employee E are different. M ’s efforts for “efficiency improvement” can obtain a direct premium in the competitive market. Therefore, B E (λ; i , e ) = P 0, B M (λ; i , e ) = P 0 + γ (i ) + c (e ), in which γ, c ≥ 0, γ' > 0, c ' > 0, γ” < 0, c ” < 0. The costs for governmental employee G and non-

governmental employee M is C E (λ; i , e) = C M (λ; i , e ) = i + e . In the period 2, set total earnings as B 0 + β (i ) – b (e ), in which, β, b ≥ 0, β' > 0, b ' > 0, β”< 0, b ” > 0. β, b , γ, c stand for the sensitiveness of owner’s earnings and administrator’s earnings for the efforts of “efficiency improvement” e and “output efficiency” i , respectively. Because e and i are uncertain in the contract, β, b , γ, c cannot be given as well. In fact, β, b , γ, c have close relationships with the exogenous variables of the contract. Net earnings after removing the administrator’s rewards will be distributed among all the people according to

the property proportion, namely, B G (λ; i , e ) = (1 – λ) [B 0 + β (i ) – b (e ) – P 0], B P (λ; i , e ; ω) = λ [B 0 + β (i ) – b (e ) – P 0], as shown with the time shaft in Table 18.1. Table 18.1

Timeline

Period 0

Period 1

Period 2

M and G conclude a contract to confirm the ownership structure λ

Managers choose i and e

Income distribution

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Furthermore, once the contract is being signed, G and M have to choose one of the above contracts to provide medical service, with no other alternatives. The differences between the above three contracts are discussed below. 1. If the hospital is state-run, namely, G is the owner. Situation one: Administrator is governmental employee E . Due to that the reward obtained by E is fixed salary, the enormous efforts he made cannot be acknowledged through the market. As a result, his optimum choice is slack working, so e = 0, i = 0. And the earnings of owner G is B G = B 0 – P 0 . The conclusion verifies the problem that medical system development, under the planned economy, is basically stagnant in the long run, for that the rational choice for the administrator is inaction. As for the administrator ’s omission in situation one, the government can improve the situation via two ways. The first one is by the way of performance appraisal, supervising the administrators in a direct way. The second one is by the way of introducing a competition mechanism, with the market as indirect incentives to the administrators. Because β, b ≥ 0, β' > 0, b ' > 0, at the margin (i.e., Making marginal efforts i > 0), the earnings of G is improved by competition and market. Situation two: Administrator is the non-governmental employee M . By derivation, we can get the optimum conditions of first order for M : r ' (i ) = 1,

c '(e ) = 1, so the earnings of G is B G = B 0 + β (i ) – b (e ) – P 0. For efforts being fully recognized by the market, M has the motivation for improving both the costs efficiency and output efficiency, in which, the efforts for improving output efficiency will benefit the owner G , while, the efforts for improving costs efficiency will damage G ’s earnings. From situation one, we can get an important conclusion that the state hospital, by nature, has a strong driving force for market-oriented reform. But at the same time, according to situation two, we can get to know that to free this kind of competition cannot optimize G , and M ’s trend of excessive compressing costs which may let the owner take the knock. The conclusion verifies, since the 1980s, the emergence of the market-oriented reform of state hospitals in many countries, and reflects the importance of governmental supervision in the model of “management-operation separation.” 2. If the hospital is private, P is the owner of it. Situation one: Administrator is non-governmental employee M . Being the same as the situation two in 1, we have M ’s optimum conditions at the first order r '(i ) = 1, c '(e ) = 1. For the time being, the earning of owner P is B G = B 0 + β (i ) – b (e ) – P 0.

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Situation two: P as the administrator, hospital is private-run, such as a private clinic. Then, we can get the optimum conditions at first order in two phrases β'(i ) + γ'(i ) = 1, c '(e ) – b '(e ) = 1. Because, β, b ≥0, β'> 0, b '> 0, β”0, γ, c ≥ 0, γ'>0, c ' > 0, γ”< 0, c ” < 0, compared with situation one, the owner P has a stronger motivation of efficiency improvement, with the efforts for expressing costs

decreasing. At the moment, the earnings of P is B P = B 0 + β (i ) – b (e ) + γ (i ) + c (e ) – i – e. But we cannot compare P ’s earnings in the situation one and situation two. So, the two above situations and situation two in 1 all co-exist in many countries. 3. Hospital is run with the model of public-private partnership, namely, it is commonly-owned by government G and private P . Situation one: Administrator is non-governmental employee M . Now being same to the situation two in 1 and situation one in 2, we have M ’s optimum

conditions at first order r '(i ) = 1, c '(e ) = 1. The earnings of P is B P = λ [B 0 + β (i ) – b (e ) – P 0], the earnings of G is B G = (1 – λ) [B 0 + β (i ) – b (e ) – P 0]. Situation two: P is the administrator. At the moment, we can get the optimum conditions at first order in two phrases λ β'(i ) + γ'(i ) = 1, c '(e ) – λ b ' (e ) = 1. Compared with the situations of private-run, P ’s motivation of efficiency improvement declines while the efforts for expressing costs increase. Now, P’

earnings is B P = λ [B 0 + β (i ) – b (e ) – P 0] + P 0 + γ (i ) + c (e ) – i – e ; the earnings of G is B P = (1 – λ) [B 0 + β (i ) – b (e ) – P 0]. Compared with situation one, P and G both have a strong motivation for complete property reform of the hospitals. Conclusion: Market-oriented reform is included in Pareto improvement. Within the state hospital mechanism, the government has a strong driving force for promoting marketization. Marketization does not necessarily lead to privatization. Once the privatization starts, government and private owners who participate in the process of privatization will have the motivation to promote the complete implementation of property reform. A defect of the above model is unable to reveal the way of promoting the marketization and privatization. We have to review the case of Suqian medical reform to discuss how the process is carried out.

Practice and Experience of Medical Reform in Suqian As an important constituent of market-oriented reform of Suqian, the theoretical preparation of medical reform is adequate, with initiative creation gaining

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substantial support from government of higher levels. Local governments reinterpreted the concepts of public health and medical service, and verified the different natures of the two. On that basis, the difference between government and market, the responsibilities, rights, and obligations of the governments in different levels were defined. Since 2000, to change the backwards medical service and accelerate the development of it, Suqian has promoted medical reform oriented in the property rights reform of the medical unit. Suqian at first conducted pilot reform in Muyang County, gradually expanding to the overall city in 2001. As for the design of reform, Suqian insisted on the method of combining government leadership and market mechanism, concentrating human resources, material resources, and financial resources to handle the tasks for governments in accordance with the law of development of healthcare undertakings. Regarding the reform of management system and property mechanism in the medical reform of Suqian, its main practices are: reforming management system, and separating cure and prevention in the countryside; replacing assets, and attracting social assets for medical health; concentrating governmental funds, and expanding public health service; leading reasonable flowing of medical health personnel. The specific measures include: 1. Changing the system of combing cure and prevention in the countryside, establishing the new pattern of “one town, two hospitals.” Township health center and town hospitals were built in the 111 towns. As a public health organization, the township health center was launched by the government, mainly taking charge of such functions as township public health management, primary health care, disease control and prevention, and health supervision, without engaging in the medical activities. Its staff and businesses are subordinate to the administrative departments at the county level, and the funds are included in the fiscal budget of the counties. Township hospitals as medical organizations carry out the way of “private-run and private-operated,” fitting into medical service management. 2. Encouraging private funds to be invested in the medical field, setting up the new mechanism of social medical. Suqian adopted various ways of auctioning and approved granting internal stocks, conducted reform oriented in the property rights system in the medical units of the three levels of city, county, and town, and changed the competitive medical units into the market bodies of stock system, individual-funds, partnership, mixed ownership, etc. 3. Strengthening the governmental supervision function of public health, and accelerating the construction of the public medical health security system. Implementing comprehensively “512 Project” plan, namely, constructing

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five centers at city level (Disease Control and Prevention Center, InfectiousDisease Control and Prevention Center, Public Health Curing Center, MaternalChild Health Center, Blood Collection and Supply Center) and corresponding networks of city, county, town and village, perfecting two systems of supervision (supervision systems of medical health and medicines) and one health security system (medical insurance scheme in urban areas and new country cooperative medical system in rural areas). 4. Implementing comprehensive law enforcement, reforming the health supervision system and inner operation mechanism to unify the enforcement of law by integrating the supervision functions, which originally belonged to such departments as medical care, epidemic prevention, and mother-child health in the health system. Currently, the two levels of city and county both have separated the functions of health enforcement from the disease control 5

department, and established sanitation supervision stations. The new medical health system in Suqian was mainly characterized with “four separations” and “four transitions.” The “Four separations” refers to “management-operation separation, medical-health separation, medicalprevention separation, medical-medicine separation.” First, separating the operators and managers in the medical subjects, the government no longer runs the hospitals directly, with the main responsibilities of supervising; second, at the time of separating the attributes of medical and public health, separating the products of the two, with the market supplying medical services and the government supplying public health services; third, separating the two organizations of medical and prevention, which are of different properties; fourth, separating the two industries of medical and medicine in interests. “Four changes” refer to the government being changed from subsidies supply-side into demand-side, designated medical service being changed into free choice, material subsidy being changed into currency subsidy, and implicit subsidy being changed into explicit subsidy. All around achievements are obtained in the radical top-down medical reform completely promoted by the governmental political wills, which are explained as follows. (1) Health resources totals expanded rapidly, with structural layout tending to be reasonable. By the end of 2003, health total assets of the whole city amounted to RMB1,291 million, an increase of 161% of RMB796 million (in which private funds amounting to RMB780 million) than that before the mechanism reform (1999) of RMB495 million. The number of medical organizations increased in jumps and leaps with a total of 636, 401 more than that before the mechanism reform. In the health assets of RMB1,291 million,

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private health assets took up RMB780 million, increasing to 60.4% from 1.2% of 1999, while governmental health assets amounted to RMB511 million, decreasing to 39.6% from 98.8% of 1999; assets of public health totaled RMB329 million, increasing to 25.5% from 9.09% of 1999, while assets of medical totaled RMB962 million, increasing to 74.5% from 90.91% of 1999. (2) S y s t e m re f o r m p ro m o t e d t h e i n n o v a t i o n o f m e c h a n i s m , a n d strengthened the driving force of unit development. By property reform of medical units, a brand-new mechanism was established, with the vitality of hospitals increasing and trained people rationally flowing. The number of nonhealth technological staff reduced to 1,253, decreasing to 14.3% from 40% in the proportion taking in the work force; the salary of medical staff rose year by year, the gross pay of restructuring the medical unit in 2002 totaled RMB14.675 million, an increase of 9.15% from that before reform. The numerous workers’ consciousness of competition, risk, and devotion rose remarkably, with obvious strengthening of working responsibility and sense of responsibility. Since hospital income increased and patient outflow decreased, the rural medical health units have already passed the survive crisis, on the way to benign development. (3) The public obtained benefits for the improvement of medical service attitude and the decrease of prices. As the continuous rapid growth of medical service price occurs around the world, Suqian has retained its original charges for five years, even with a slight decline. In accordance with the statistics, compared with 1999, per capita charges of outpatient in hospitals at city or county level in 2005 decreased to RMB69.2 from RMB75.49, falling by 8.3%, only taking 49.7% of the provincial average; as for that of township hospitals, it fell to RMB28.09 from RMB37.62, with a 25% decrease. As for the daily charges for hospital beds, it fell to RMB180.64 from RMB182.18, with a 0.1% decrease in the hospitals at city or county level; it fell to RMB52.58 from RMB62.24, with a 15.5% decrease in the township hospitals. Regarding the average medical charge of the discharged patients, it fell to RMB2,128.17 from RMB2,150.80, with a decrease of 1.0% in the hospitals at city or county level, only taking 40.8% of the provincial average; it fell to RMB479.65 from RMB554.36, with a decrease of 13.5% in the township hospitals. From the types of major diseases, every cesarean operation cost about RMB2,500, only taking 53% of the provincial average, even with the low price of RMB1,800; every cholecystectomy cost about RMB4,000, only taking 64% of the provincial average; every appendicitis operation cost about RMB1,700, only taking 70% of the provincial average, even 6

with the low price of RMB1,000. Medical prices of township hospitals (according to the definition of price from news reports) are one third lower than the

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Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

national average. Not only did the prices decrease and quantity increase, but also the quality of the medical services is lifted. The patients surveyed generally reflected that the service became better, the attitude of doctors was better and the time of waiting shortened. In addition, the pouring of foreign funds increased the number of hospitals as well, up to 400 (in which some were smallscaled) in 2004 from 130 of 1999; the medical assets of the whole city reached 7

up to RMB1.54 million, over triple that of 1999. Details of the changes of major economic health indicators of Suqian before and after medical reform are shown in Table 18.4 and Table 18.5. (4) With prevention and protection strengthened, the public health service was improved. By separation of medical treatment and preventive treatment and separation of medical treatment and public health, specialized public health organizations were set up in the levels of city, county, town and village, equipped with professional contingents. The public health assets increased from RMB45 million before mechanism reform to RMB329 million now. Business personnel have increased from 848 before mechanism reform to 1,163. With personnel expenditure included in the governmental fiscal budget, the development of public health takings has a basic guarantee. The assets of Disease Control and Prevention and Maternal-Children Health Organizations increased from RMB69.6 million at the end of 2003 to RMB16.61 million at the end of 1999, in which, the city level part increased from RMB6.7 million to RMB35.27 million, as for country-level part, from RMB9.91 million to RMB34.33 million. Table 18.4

Changes of major economic health indicators of Suqian in medical reform

Unit: RMB100 million Regional total output value

Regional fiscal revenue

Regional fiscal expenditure

Number of hospitals and health centers

2000

19.96

1.39

3.13

11

2002

24.56

3.05

4.42

7

2001

2003

21.3

28.53

2004

124.2

2006

172.26

2005

142.26

1.63

3.72

3.55

5.35

5.19

15.97

9.75

20.29

6.75

16.59

8

21

Number of beds in hospitals and health centers 636

387

800

282

562 750

110

1,700

371

3,100

331

Number of doctors

2,500

251 306 800

1,800

1,400

Source: Collated according to Jiangsu Statistical Yearbook data over the years.

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Table 18.5

Comparison between before reform and after reform

Basic medical resources

Number of beds Number of beds per thousand people 2002

5,406

2005

1.07

8,509

Rate of change Number of personnel

2002

1.96

Medical health assets (RMB100 million) 5.07

12.15

57.40%

51.68%

16.45%

139.64%

Number of health technological personnel

Number of managers and other high level staff

Total staff of health organizations

Number of attending doctors and those with above technical titles

2,146

10,295

Rate of change

1.68

1.62

8,519

2005

Number of health technological personnel per thousand people

10,665

1,555

20.85%

–27.54%

1,466

11,850

3,158

11.11%

115.42%

Source: Qin Zhou, Comparison Study of Medical Health System Reform Model of Jiangsu Province: Taking Suqian, Wuxi and Nanjing as the Examples (Economic System Reform Foundation of China [first draft]).

Fig. 18.2

Changes of health indicators in the downtown areas of major cities in Jiangsu Province in the same period: Number of hospitals and health centers 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0

2000

2001

2002

2003

2004

2005

2006

Nanjing

191

225

256

255

198

1,525

1,913

Suzhou

32

67

75

69

69

750

793

Lianyungang

34

35

43

43

43

479

492

Suqian

11

8

7

21

110

331

371

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Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

Fig. 18.3

Changes of health indicators in the downtown areas of major cities in Jiangsu Province in the same period: Number of beds in hospitals and health centers 30,000 25,000 20,000 15,000 10,000 5,000 0

2000

2001

2002

2003

2004

2005

2006

Nanjing

16,568

17,909

19,505

20,292

19,300

24,300

25,200

Suzhou

5,471

7,335

8,876

8,545

9,300

11,300

12,100

Lianyungang

2,894

2,851

3,905

3,287

3,300

4,200

4,500

636

562

800

750

1,700

2,500

3,100

Suqian

Fig. 18.4

Changes of health indicators in the downtown areas of major cities in Jiangsu Province in the same period: Number of doctors 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0

2000

2001

2002

2003

2004

2005

2006

Nanjing

8,542

9,157

9,426

9,802

8,400

13,400

14,200

Suzhou

2,634

3,832

3,638

3,823

3,600

5,600

6.100

Lianyungang

1,507

1,495

1,499

1,557

1,500

2,300

2,500

387

251

282

306

800

1,800

1,400

Suqian

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Statistics show that compared with the other cities (such as Nanjing and Suzhou) in the province, the medical health takings of Suqian basically achieved the assumption of “catch-up growth.” Especially in the aspects of the number of health institutes, beds, and number of professional personnel, the development of Suqian has far exceeded that of the other cities (see Fig. 18.2, Fig. 18.3 and Fig. 18.4). Specifically speaking, by reform, the problem of the difficulty of getting medical service in Suqian has been solved basically, while the problem of “overly expensive medical service” has developed in a tortuous way. Competition decreased the prices of normal medical service, but technology extension and growth of service quality promoted the application of new medical items, causing the price of newly-added medical services to rise. System reform of medical health in Suqian verified a certain necessity of market-oriented reform of the medical market, but the process of marketization transiting to property reform is the complete reflection of political wills.

Conclusion This chapter reviewed the reform process of China’s medical system in 30 years. Taking medical reform of Suqian as the background, this chapter discussed the necessity of market-oriented reform for state hospitals and the medical reform experience of Suqian promoted by strong political will. By model, this chapter verifies the necessity and effectiveness of market-oriented reform, but we still cannot obtain the conclusion that market-oriented reform inevitably leads to property reform. The conclusion from models verifies the current situation that various medical organizations coexist and compete with each other. In the ferocious top-down reform of Suqian, the problem of the difficulty of getting medical services has been alleviated effectively, with the strengthening of medical accessibility. However, the problem of “overly expensive medical service” is still developing in a tortuous way, in which the property reform and marketization played a complex role. According to the inclusion, the author believes that in the reform of state hospitals in various areas, due to the difference in initial medical level, governmental regulation for medical treatment and the public’s need for reform, we can fully make reference to the model of public-private partnership, and use multiply ways to restructure the private’s participating form in the supply of medical service resources, instead of rigidly adhering to a certain contract or cooperation form. The advantages of this way lie in being able to avoid the resistance caused by extreme system change, facilitating the development of

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Conflict and Harmony amid the Property Rights Reform and Marketization of the State Hospital

state hospital reform. We can also explore different ways to search the most suitable model for the local areas. We should firmly resist such a kind of behavior: when some key conditions for the private sector are not formed yet, some activities of privatization are carried out in advance. Any decision trying to organize privatization of the medical service industry will only lead to chaos. On the other hand, we should encourage the legal, ethical, and professional private hospitals. It should be noted that the efficiency of output is mainly reflected in two aspects: one is about the medical service supply, the other one is about the patients’ ability of purchasing service. The final output of medical service is not fully determined by the system, but by the reform of payment model. We overlooked the former in the analysis of this chapter, but focused on the supply of medical service. As for the demand of medical service, the payment model of China’s medical service has not been changed yet. However, this reform is essential, no matter for the state hospitals or private hospitals, because the output of medical service will be of high price but low quality without an effective or incentive compatible service system for payment. With the gradual deepening of reform, decision-making domain of the individual expands in the welfare affairs, while the responsibilities of the government relatively shrink. It does not include, for sure, the government’s responsibilities for the people who are in a tight corner or of inferior status. The trend of future reform will expand from supply to demand, which can be discussed further in the future.

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19

Chapter

Research on the Integration of Cultural Markets in the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction The cultural industry, in recent years, has been booming as an emerging, highvalue added industry of reproducibility around the country. It was confirmed in the 16th and 17th National Congress of the Communist Party of China (CPC) reports that China should highlight both the development of the cultural industry and the prosperity of the Socialist cultural market, and grasp the two tasks unremittingly as essential issues. The 17th National Congress of the CPC report especially and explicitly raised the issue that, on the one hand, to construct a harmonious culture, we should value the development of news, publishing, broadcasting, literature, and the arts, while on the other hand, this industry needs active encouragement and support and special attention to the coordinated development of culture in urban and rural areas. Relative to the boom of the cultural industry, the gap between the provincial markets is growing wider due to reasons such as the economic transition, system reform, etc. Sandra Poncet (2001) pointed out that during the implementation of the reform policy of China, a large group of regional markets isolated from each other have come into being, markets which are protected by various trade barriers, such as the system of issuing licenses and the regulation of “only [buying] local products.” In the meantime, there are as well certain factors causing market barriers in such market administration and administrative law-enforcement departments as the Industrial and Commercial Bureau. The selling of most domestic products (including the products from the factories set up or invested in by foreign companies in China), after China joined the WTO and opened the domestic market to imported products, are still being confronted with obstacles of trade barriers among the provinces. Poncet believed that “the international integration of provinces synchronizes with the inverse integration (separation) of the domestic market in China.” In 1997, the losses incurred by trade barriers to trans-provincial commodity circulation equaled to the commodities being taxed at 46% which, however, was 35% 10 years ago. Taxation as high as 46% is almost at the same level with that of trade among member countries of the European Union (EU), and is flat compared with that of America and Canada. From this perspective, there barely exists a nationwide market in China, with trade barriers as high as those between a large number of sovereign countries. The findings indicate that as the tax of importation decreases, the trade barriers of interprovinces, however, are increasing continuously, causing serious regional market segmentation. In the cultural market field, due to the immovability of some cultural

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products (such as tourist products), the integration of cultural markets becomes more difficult; in addition, the immovability greatly increases the difficulty of the evaluation of markets integration. Meanwhile, the convergence of cultural market in the Yangtze River Delta makes the general prices comparison of a certain category of products (such as the tourist attractions of the same level) lack scientific evidence. Considering the above, this chapter builds a comprehensive evaluation index system of cultural markets integration in the Yangtze River Delta, and adopts the Analytic Hierarchy Process and Delphi Methods to analyze the integration of cultural markets in the Yangtze River Delta in a scientific and objective way.

Comprehensive Evaluation Index System of Cultural Markets Integration Basis of theory Porta officially raised, in the National Diamond , the concept of industrial clusters and defined it as a group of enterprises and related legal institutions close in geography and of an interactive relationship, in the specific field, connect mutually based on the similarity and complementarity. He also believed that there exists a close relationship between the industrial clusters and the integration of regional markets. Just as in the Yangtze River Delta, the age-old traditional handicraft industry enables each city in the region to have developed its own featured folk handicrafts, which to a large extent, promote the integration of the local cultural handicrafts markets. Meanwhile, the Central Place Theory is another important theoretical basis for the study of markets integration. W. Christaller believed that there is always a low-grade central place around the high-grade central place as a development support, and the high-grade central place provides higher level commodity supply. However, for a region with a benign economic development, the cities within should form a complete system in terms of number, size, spatial structure, etc. The Yangtze River Delta is a place of a typical central place structure, forming a complete system with Shanghai, Nanjing, and Hangzhou as the apex cities.

Index system building Based on the meaning of cultural markets integration, principles of index system building (scientific, instructive, systematic, multi-layered, etc.), consultation and feedback of relevant experts and research objective of this chapter, we use the

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method of combining static and dynamic analyses and construct a three-layered comprehensive evaluation system including criterion, domain, and index layers.

By adopting the Delphi method and analytic hierarchy process (AHP), we

construct the following evaluation index system of cultural markets integration in the Yangtze River Delta (see Table 19.1). Table 19.1

Evaluation index system of cultural markets integration in the Yangtze River Delta

Criterion layer

Domain layer

Index layer

Cultural market basic index (Z 1)

Economic index (Y 1)

Per capita GDP (X 1) Rise of prices index (X 2) Gross retail sales of cultural industry consumption products (X 3) Proportion of cultural industry in GDP (X 4)

Environmental index (Y 2)

Convenience of transportation (network density) (X 5) Green coverage ratio (X 6) Air index (X 7)

Cultural market basic parameters (Y 3)

Annual total of tourists (X 8) Legal entity of cultural industry (X 9) Value-added of cultural industry (X 10) Turnover of cultural industry (X 11)

Cultural market segment index (Z 2)

Market homogenization index (Y 4)

Homogenization degree of tourist products (X 12) Homogenization degree of folk craftwork (X 13) Homogenization degree of entertainment performance (X 14)

Market prices index (Y 5)

Admission price index of tourist attractions (X 15) Admission price index of concert and entertainment performance (X 16) Prices index of folk craftwork (X 17)

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Research on the Integration of Cultural Markets in the Yangtze River Delta

(Cont'd) Criterion layer

Domain layer

Index layer

Cultural market segment index (Z 2)

Cultural market costs index (Y 6)

Transportation cost index of interval cultural market (X 18) Trade cost index of cultural market (X 19)

Cultural industry barrier index (Z 3)

Economic barrier index (Y 7) Mechanism barrier index (Y 8)

Market access requirements (X 20) Scale economy barrier (X 21) Taxation barrier (X 22) Administrative mechanism barrier (X 23) Trade mechanism barrier (X 24)

Other barrier index (Y 9)

Cultural characteristic barrier (X 25) Regulations and law barrier (X 26) Local regulations barrier (X 27)

Empirical Analysis of Integration of Cultural Markets Data standardization Due to the different unit size and dimension in the comprehensive evaluation index system, in order to make the inter-data comparable, the primary data needs to be standardized to eliminate the effects of dimension. Common handlings of standardization include combination, the standard deviation, maximum value, and range. The chapter adopts the standardization method of standard deviation whose formula is stated as below:

Z = (X i – X ) / S × 100

(19–1)

In which: Z refers to the value of standard deviation after standardization; X i refers to the i th index value; X refers to the arithmetic value of the i th index, S represents the sample standardization deviation.

Source of data and statistical treatment In view of the effectiveness of the research, the index system chooses 2006 as the year studied, and numeric data in the index system is shown in Table 19.2.

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Table 19.2 Basic data of cultural market in the Yangtze River Delta Index

Shanghai

Jiangsu

Zhejiang

National average

75,990

28,685

31,684

16,108

1.2

1.6

1.1

1.5

Gross retail sales of consumption products (RMB100 million)

3,360.41

6,623.18

5,325

2,387.8

Proportion of cultural industry in GDP (%)

7.5

2.3

3.3

2.45

1,063.2

929.14

1,366.8

600

Rate of greening (%)

37.3

42

60.5

28.15

Air index / Annually days of sound air index (day)

324

318

312.8

NA

Annual number of tourists (10,000 people)

9,684

19,935

16,149

4,343

Legal entity of cultural industry (unit)

30,031

26,588

31,325

10,325

Value-added of cultural industry (RMB100 million)

269.5

258.55

378

100.63

1,366.64

1,782.30

1,570.44

527.4

Per capita GDP (RMB) Growth of average price index (%)

Convenience of transportation / Number of dispatched passengers (100 million people per km)

Turnover of cultural industry (RMB100 million)

To present the integration degree of cultural markets in the Yangtze River Delta in a more objective way, 32 experts were invited to conduct expert decisions for the nonnumeric data in the index system in the research, with the entire index being given science assignment by expert consultation and feedback of three rounds. Dimensionless numerical of all the data after standardization method of standard deviation are shown in Table 19.3.

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Table 19.3

Evaluation index system and dimensionless numerical of the cultural markets integration in the Yangtze River Delta

Criterion layer

Domain layer

Index layer

Basic index of cultural market

Economic index Y 1 (57%)

Per capita GDP X 1 (37.5%)

66.7

Average price index of the recent 3 years X 2 (19.5%)

85.2

Gross retail sales of consumption products X 3 (27.5%)

86.6

Proportion of cultural industry in X 4 (15.5%)

72.7

Convenience degree of transportation (Density of road network) X 5 (45.3%)

84.1

Rate of greening X 6 (31.3%)

73.4

Air index X 7 (23.4%)

67.3

Annual number of tourists X 8 (20%)

84.3

Legal entity of cultural industry X 9 (20%)

79.7

Valued-added of cultural industry X 10 (22%)

83.1

Turnover of cultural industry X 11 (16%)

85.7

Homogeneous degree of tourist products X 12 (45.3%)

70.0

Homogeneous degree of folk craftwork X 13 (23.3%)

65.9

Homogeneous degree of entertainment performance market X 14 (31.4%)

57.7

Ticket price index of tourist attractions X 15 (37.3%)

62.7

Ticket price index of concert and entertainment performance X 16 (29.8%)

60.9

Price index of folk craftwork X 17 (32.9%)

56.3

Z1

(41.5%)

Environmental index Y 2 (17.5%)

Basic parameter of cultural market Y 3 (25.5%)

Segment index of cultural market Z2 (24.5%)

Homogeneity index of cultural market Y4 (37.5%)

Price index of cultural market Y5 (35%)

Dimensionless numerical

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(Cont'd) Criterion layer

Domain layer

Index layer

Segment index of cultural market Z2 (24.5%)

Costs index of cultural market

Transportation cost index of interval cultural market X 18 (57%)

57.7

Trade costs index of cultural market X 19 (43%)

58.6

Barrier index of economy Y 7 (40.3%)

Market access requirements X 20 (51%)

64.5

Scale economy barrier X 21 (49%)

64.8

Barrier index of mechanism Y 8 (37.3%)

Taxation barrier X 22 (28%)

62.2

Administrative mechanism barrier X 23 (37%)

30.7

Trade mechanism barrier X 24 (35%)

56.6

Cultural characteristic barrier X 25 (44%)

34.4

Regulations and law barrier X 26 (23%)

67.8

Local regulations barrier X 27 (33%)

41.2

Barrier index of cultural market Z3 (34%)

Y6 (27.5%)

Other barrier index

Y9 (22.4%)

Dimensionless numerical

(1) Index calculation of domain layer (taking economic index as an example): Economic index = X 1 × 66.7 + X 2 × 85.2 + X 3 × 86.6 + X 4 × 72.7 = 76.71

(2) Index calculation of criterion layer (taking basic index of cultural market as an example): Basic index of cultural market = Y 1 × 76.71 + Y 2 × 76.82 + Y 3 × 64.79 = 73.70

(3) Comprehensive index calculation of cultural markets integration in the

Yangtze River Delta: After the layer summarization of index layer, domain layer and criterion layer, top-down, we have: Comprehensive evaluation index of cultural markets integration in the Yangtze River Delta = Z 1 × 73.69 + Z 2 × 61.44 + Z 3 × 54.10 = 64.03

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Research on the Integration of Cultural Markets in the Yangtze River Delta

Regional comparison In consideration of the limitation of data, this chapter only calculates the cultural integration level of the European Union (EU) and America–Canada (see Table 19.4). Table 19.4

Comparative analysis of integration degree of the cultural markets in the three areas

Region EU

America–Canada

Yangtze River Delta area

Integration degree 84.25 79.20 63.91

Integration Evaluation of the Cultural Markets in the Yangtze River Delta It can be observed from Table 19.3 and Table 19.4 that on the one hand, the Yangtze River Delta area has some advantages in the basic indexes, such as convenient transportation, index of annual tourists, value-added of cultural industry, operating revenue of cultural industry, etc. The data indicates that the Yangtze River Delta area has strong industrial and national economic foundations, with cultural consumption capacity taking shape, that is to say, the cultural markets integration of the Yangtze River Delta area is of relatively superior basic conditions; on the other hand, the integration level of cultural markets in the Yangtze River Delta area is far behind that of EU and America– Canada. The reasons attributed to the gap lie in the segments and barriers of the cultural market, reflected as the following four aspects:

Market segment caused by the homogeneity of Jiangnan culture In the process of cultural markets integration, homogeneity will go against the market combination between different areas. The stronger the homogeneity is, the sharper the competition of market and the more serious the market segment will be. As for the customers, the homogeneous products will bring intense diminishing effect of marginal utility and decrease the customers’ preference for homogeneous products, causing intense competition and weak cooperation between products. Originated from the Jiangnan (area south of the Yangtze River) culture, the cultures among the Yangtze River Delta area are of strong homogeneity. It can be observed from Table 19.3 that the homogeneous

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degree of tourist products and folk craftwork and the ticket price index of tourist attractions are all very high with 70.0, 65.9, and 62.7, respectively. The homogeneity of culture leads to the obvious homogeneous trend of the cultural market in the area. Just for cultural tourism, on the one hand, obvious homogenization of tourism culture features is presented in the three cities around the Taihu lake of Changzhou, Wuxi, and Suzhou; on the other hand, the tourist attractions of culture themed with “watery town in the southern Yangtze River” include Zhouzhuang town, Tongli town, Luzhi town, Wu town, Mudu town, and so on. The tourist attractions of EU member countries are of their own merits. No matter it is the Zeus shrine sites in Greece, triumphal arch in Paris or Rome Colosseum in Italy, thay have significant distinctions, with high cross-elasticity in the regional markets. The tourist markets in each country are highly complementary, which leads to an united regional tourist market in EU. The homogeneity of the cultural tourism markets in the Yangtze River Delta area makes the cities isolated from each other, with a lack of cooperation and intense competition. The cultural market is lacking united and effective coordination, and this affects the integration of the cultural markets in the area.

Market segmentation brought by the transformation from planned economy to market-oriented economy China is standing in the period of economic reshuffling. On the one hand, with the new system being perfected, government still adopts the method of direct administrative intervention for some economic activities, requiring time for changing governmental functions; on the other hand, with the old system remaining, the change in people’s beliefs and consciousness is to be finished. It can be observed from Table 19.3 that the barrier indexes of taxation, trade system, and cultural features in the Yangtze River Delta area only reach up to 62.2, 56.6, and 34.4, respectively; however the barrier indexes of administrative system and local policies also just reach up to 30.7 and 41.2, respectively. This shows that the conflict between the two systems stimulates the local government and production operators, starting from self-interest, to take advantage of the loophole and opportunities to seek profits, which leads to a higher system barrier among regions. After the governmental organizations reform and functional transformation of the central government, the local governments have not kept at the same pace with it, without clarifying responsibilities. Besides, the opening time and degree of cultural markets vary from each other in different places. The local governments, in the transformation, expand their authority, filling the power vacuum brought by the withdrawal of the central

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Research on the Integration of Cultural Markets in the Yangtze River Delta

government, and to capture more guarantee for their own benefits. Meanwhile, the policies strengthening the responsibilities of local government not only expand the duty of local government, but also capture more excuses and opportunities to obtain self-interests. All these realistic factors, to some extent, enlarge the difficulty of realizing integration of the regional cultural markets.

Market segmentation caused by economic strength difference among regions The economic strength difference among areas is one of the essential reasons causing market segmentation. The gap of economic development will, in the aspects of education, market concept and innovation mechanism, influence the economic development of backward areas, causing index enlargement of the economic gap among areas. The gap of economic strength among areas, on the one hand, induced the scarce resources to flow from the underdeveloped areas to the developed ones; on the other hand, as for the cultural industry whose income demand is flexibility, the difference of economy will bring big income demand so as to trigger a survival crisis of the local enterprises. Therefore, with the imperfect system of regional cooperation, duty-power mechanism divided by benefit cost and system of law and policy, the governments of underdeveloped areas were forced to adopt the administrative compulsory measures violating the market discipline to protect the local interests. On the market of cultural industry, to hold down the newly developed industry, the governments put restrictions on the manufacturers outside the area with various administrative barriers such as monopoly system, market-access system, causing severe snags of markets integration. Taking Jiangsu Province as an example, it can be found that the segmentation of the market is caused by the obvious distinction of economy between the southern part and northern part of Jiangsu province which are two different cultural markets. There exist economic differences among the member countries of the EU. However, on the one hand, the difference among the member countries is not as big as that in the Yangtze River Delta, on the other hand, the EU emphasized the implementation of integration policy, which aimed to strengthen the development of underdeveloped areas, narrow the inter-region gap and promote cooperation among the member countries, increasing the overall competitiveness of the EU. European Regional Development Fund (ERDF) and European Social Fund (ESF), between 2000 and 2006, have invested EUR235 billion, accounting for 0.45% of EU’s GDP to foster the implementation of integration policy. Although there is no such organization as the EU between America and Canada, the gap

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

of economic strength is far less than that in EU and the Yangtze River Delta area, which created the economic foundation for the integration of the cultural markets as well.

Market segmentation caused by reform of fiscal and tax system As a significant reform of financial resources distribution system, the “fiscal decentralization” carried out in the 1980s broke the centralization model, expanded the fiscal power of local governments in a large way. The measures of reform finally impel the government to be an economic body which has not only a strong motive for pursuing economic interests, but also a disposing capacity. After the setting up of tax-contracting and local taxes, the financial condition is related to the local economic interests, so the local government will definitely pursue the maximization of local finance. To the local governments, with tax from enterprises the main source of taxation; whether the enterprises can pay more taxes is largely dependent on the management benefit of them. In this way, a common body in benefits inevitably takes shape, in quite a number of aspects, between the local government and the local enterprises, especially the local state-run enterprises. The common body in benefits makes the local government win control of the local cultural market, and there is a lack of cooperation among regions, which result in the non-effective unity of the market.

Policies and Suggestions 1. Establishing cross-region industry association As integration of cultural markets requires sound organization and coordination, the united trade organization becomes particularly important. On the one hand, to coordinate the interest relationship among local governments, the macro-control of the central government faces higher costs and difficulty in reaching the goals. While the cross-region organizations and groups directly contacting the local governments may be aware of the innovation intention from individuals and groups of enterprises, therefore, the institutional arrangement provided by the cooperation among the local government with the coordination of cross-region organizations is more capable of meeting the institutional demand; on the other hand, the expansion of local governmental power, especially that of the economic power, changed their status and roles in the structure of the government’s power, making them not only change from the simple dispatched and proxy institutions of the central government under

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Research on the Integration of Cultural Markets in the Yangtze River Delta

the centralized system to behavior subjects of relative dependence, but also of the power and motive among governments of pursuing the rapid growth of the local economy and responding to profit opportunities. But the documental coordinator among governments will influence the speed and quality of integration. Hence, taking the cross-region coordinated and united institutions of market as the guide and fostering the cooperation among governments should be the best choice of coordinating the contradiction among local governments and getting rid of the “prisoner’s dilemma game.” 2. Increasing complementarities of products and regional integration A forceful promoter in the integration of cultural markets is that the cultural market constitutes a cultural market alliance of both integration and regional features. In the integration of markets, we should pay more attention to the division of labor and collaboration among different regions in the region, establishing a scientific and reasonable mechanism of it. Main work includes: (1) Coordinately implementing the joint constructions of major infrastructure, joint exploitation of important strategic resources and joint protection and construction of the eco-environment; (2) Unified programming of the strategy of economic development and the structure of cultural industry which meet up with the long-term development of the area; (3) Assisting the cities and counties, from the perspective of professional division, to make the strategy and plan for the development of local cultural industry, organically linking the planning of local cultural industry and integration planning of overall cultural market. 3. Innovation-oriented investment and financing system We should break the barrier of ownership, get rid of some limitation of the non-public sector investing in the cultural industry, encourage and support various types of funds to step into the cultural industry, in order to form all kinds of interest relationships of cultural economy. We should increase the investment proportion to cultural industry, seek to establish funds of cultural industry, and encourage the funds of private and foreign flow into the cultural industry, forming a diverse investment and financial system of cultural industry which regards governmental funds as the lead, the enterprise investment as the basis, bank credits and private capital as subjects, and stock financing and overseas capital as complements, so as to compensate the huge gap of capital in the great-leap-forward development of cultural industry. As for the cultural programs of potential and innovation, we can offer cheap or subsidized loans. Besides, we should encourage the formation of organizations or investment companies of cultural industry in all levels and all kinds, to realize the marketization, socialization and subject diversification of investment of the cultural industry.

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4. Establishing and perfecting the statistical monitoring system of cultural market Currently, relevant statistical investigation remains on the level of the department statistics, causing the channel to obtain statistical resources being sluggish and making the resources obtained incomplete and not systematic, which does not fit in with the object of promoting the integration development of the regional cultural markets. Therefore, we have to enlarge the investment, start from the reality of the cultural market in the Yangtze River Delta area, establish the statistical monitoring system of cultural market and conduct analysis and research of the statistical accounting data timely and precisely to provide information support for the integration evaluation of the regional cultural markets. 5. Forming resources distribution center of cross-region cultural market A quantity of resources in the cultural market are immobile, so establishing a cross-region recourses distribution center will contribute to optimizing resource allocation. As abundant and non-renewable as the ecological recourses in the cultural market are, we should control the loss and regeneration of the cultural resources at a reasonable level by the united coordination and distribution of resources. Meanwhile, we should give full play to the advantages of advanced modern logistics industry in the Yangtze River Delta area to create 3 to 5 distribution allocation centers of cultural resources, which take the lead in the region and are of substantial influence all over the country, with the current logistics distribution centers and the intersections between expressways and railways as the cores and vertexes. We should play the features of local cultural market and the advantages of the distribution centers’ intensification and scale, starting from the distribution center of cultural products and resources, to explore the market beyond the region and enhance the development power of the regional cultural market community. 6. Creating public service platforms of regional cultural market As the 21st century is an era of comprehensive network coverage, the development and usage of network resources will remarkably accelerate the markets integration of the Yangtze River Delta area. We should take the overall development and utilization of information resources in the cultural market as the entry point, provide various kinds of service resources together with the departments and associations of cultural industry in Shanghai, Jiangsu Province, and Zhejiang Province, to establish a public information platform which regards four groups of governmental departments, cultural enterprises, market research organizations and cross-region associations as the main service subjects to realize the interaction among the regional subjects.

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Research on the Integration of Cultural Markets in the Yangtze River Delta

7. Positively setting up the special supporting funds To foster the integration of cultural markets in the Yangtze River Delta area, it is essential to provide special supporting funds for the cultural enterprises. With the background of markets integration, the special supporting funds for cultural markets integration should be raised by joint contribution from the fiscal revenue of the governments at all levels in the way of agreement. In addition, we should evaluate the cultural enterprises from the perspectives of economical scale, cross-region development and innovation, list the fund supporting objects, increase the number of supporting objects as much as possible, and adopt all kinds of ways to release the special funds, such as direct subsidies, interest-free or interest-cut loans. 8. Positively promoting the market combination of the professional groups in the regional cultural market Since China joined the WTO, the openness of its economy has grown higher and higher, which necessarily exerted a significant impact on the cultural industry of our country. To enhance the overall competition of the cultural enterprises, we should promote the combination of industries. In the industries of newspapers, news media, and broadcasting, which are divided by administrative zones, we should unite the economic entities of regions to face the outside world in a united organizational form, and enhance the competitiveness in such aspects as the purchasing of raw materials, promotion and sales of products, in order to give full play to the advantages of scope economy and scale economy, and promote the overall development of cultural industry during the communication and competition with the overseas cultural tycoons.

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20

Chapter

Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Introduction Located in the hinterland of the Yangtze River Delta area and covering a drainage area of 36,895 square kilometers, the Taihu Lake is the third largest fresh water lake in China, with a water surface area of 2,338 square kilometers. The water environment of Taihu basin sustains the livelihood and development of 45.33 million people. An unexpected crisis of drinking water came to Wuxi in Jiangsu Province on May 28, 2007, and the chief culprit was blue-green algal in Taihu Lake. As a “regular customer” intruding into Wuxi every year, the blue-green algal came earlier and more fiercely in 2007. The economic development in the Yangtze River Delta area is mainly characterized by the acceptance of foreign-funded processing trade of foreign direct investment (FDI). The Taihu Lake basin develops a manufacturing-based economy. The advanced manufacturing industry, though, provides benefits to the area in taxation, foreign exchange, employment, etc. The extensive economic growth accompanied by the high consumption of resources and high intensity drive also make the area pay a heavy price. Since the 1990s, Taihu Lake has suffered from frequent pollution, with an outburst in different degrees of blue-green algal almost every year. The long-term accumulation of organics and nutrients in Taihu Lake provides the conditions for the large-scale reproduction of blue-green algal. Once the conditions of weather and water temperature become ripe, the outburst of algal may occur anytime. However, there has never been the stench and blackening of water before 2007. The eco-catastrophe caused by the outburst of blue-green algal is attributed to not only the climate factors of warm air temperature, adequate sunshine, and low rainfall, but also the sewage resulting from the severe depletion of oxygen. Moreover, the major cause for the production of organics, nutrients, and sewage is the pollution by three industrial wastes (waste air, waste water, and waste residue). It is also a warning that if the blue-green algal pollution cannot be controlled completely, the economy of Taihu Lake will not be able to develop in a sustainable way. In recent years, the government and non-governmental organizations in the Taihu Lake basin have done a lot to eliminate blue-green algal pollution. Besides heightening the environmental awareness of the public, developing and introducing pollution control technologies has also been an essential part in combating algal. On April 2, 2008, it was discussed and passed in principle in the executive meeting of the State Council in the Overall Scheme

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

of Comprehensive Regulation of Taihu Lake Basin Water Environment , which was drawn up by the National Development and Reform Commission (NDRC) and relevant departments and local governments. The Scheme has already introduced the development and introduction of algal control technologies into working processes. At the same time, the Cyanbacteria case reminds the Yangtze River Delta area to review its own development model in various ways, with inspecting the effectiveness of financial policy being one of them since some economic policies not only played a role in the economic activities, but also played a big part in the algal case. It is mainly due to the fact that an economic policy related to industrial development will have an effect on industrial production which, however, will create pollution. This is the transmission mechanism of the causeand-effect relationship between economic policies and environmental pollution, which was somehow concealed and seldom noticed before. With the deepening of people’s recognition of this kind of problem, from now on, to balance the advantages and disadvantages of a policy, we should consider its function not only in economy, but also in environment, which will be an indispensable part in evaluating the policy or guideline. This chapter analyzes the relationship between financial policy and Taihu Lake pollution from an economic perspective. By analysis, we find that the natural environment of Taihu Lake will be influenced by the financial policy oriented in interest adjustment and the fluctuation of market prices.

Theoretic Study of Economic Policy and Pollution As for the algal pollution in Taihu Lake, we can inspect it from multiple dimensions. From the research works published so far, the ones analyzed from the perspective of geo-ecology, industrial development history, positive economics, and ecology are in the majority. The major reason for algal pollution in Taihu Lake lies in economic production, in other words, the implementation of economic policies and fluctuation of market prices will both have effects on the production departments, so as to spread to the environment. It is the internal mechanism of economic policy or market prices influencing environment, which makes it necessary to analyze economic policies’ effects on pollution in Taihu Lake from the perspective of theoretic economics. In fact, since the 1980s, there have been some research achievements analyzing economic policies’ effects on the environment in academia based on the theories. Just to name a few: Dean and

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Gangopadhyay (1997), with the condition that production of intermediate products will decrease the productivity of the other products, carried out an analysis of the effects of limiting the exportation of intermediate products on labor transfer, unemployment, and environment; Nancy L. Stokey (1998) analyzed economic activities’ influence on pollution by AK model (K for capital, 1

A for technology). He supposed the final products are produced with a series of known technologies whose difference lies in the cleanliness. He concluded that unlimited growth with natural resources was unsustainable, in addition, he provided corresponding remedial measures; Andre Grimand (1999), by 2

introducing the variable of pollution in the Schumpeterrian model , analyzed the correlation of the scattered economic equilibrium with the variable. He discussed the balance between environmental quality and economic growth, and carried out an analysis of the former ’s promoting channels to the latter. However, those research achievements are not based on the economy of Taihu Lake as they all lack pertinence and are thus unable to be directly applied to the pollution prevention of Taihu Lake’s economy. On the basis of the existing achievements, this chapter analyzes the relationship between financial policies and the pollution of Taihu Lake from the perspective of theoretic economics. By analysis, we found that the natural environment of Taihu Lake would be influenced by the financial policies of interest adjustment and the fluctuation of market prices. The financial policy, with the primary purpose of regulating the economy, however, was playing a role in the environment, and the effect touched on the effectiveness of the policies directly. Therefore, the analysis of this chapter focuses on the environmental effects of financial policies to discuss financial policies’ influences on the algal in Taihu Lake.

Building Models In accordance with the reality of the Taihu Lake area, this chapter divides the economy of Taihu Lake into three sectors: The first one is the same, in a general sense, as the industrial sector which takes advantage of the capital and technologies to produce importable products, accompanied with the discharging of pollution (hereinafter called “the industrial sector”); the second one is the pollution victim sector which invests capital to produce exportable products, without discharging pollution during the manufacturing process, instead, output will decrease with pollution during the manufacturing process (hereinafter called “the Taihu Lake sector”); the last one is the technological

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

knowledge research and development sector which makes use of the capital to create the technologies able to reduce pollution and boost output for the industrial sector, as a sector of intermediate products (hereinafter called “the technological sector”). The reason for setting up the technological sector and setting the output as the input factors of the industrial sector in this chapter lies in the fact that emphasis should be laid on the prevention and control to solve the problem of algal in Taihu Lake. It requires the support of technologies which come specifically from the sector of research and development. In the study of theoretical economics, people who set technologies as the input factor of production to conduct study include Lucas (1988) and Rebelo (1991). Such people as A. Lans Bobenberg and Sjak Smulders (1995) even carried out dynamic research on the pollution problem with technologies as the input factors. Suppose the production of the industrial sector satisfies the function as below:

Y 1 = F (K 1, Z ) (20–1) In which Y 1 for the output of industrial sector, K 1 for the capital stock of investment in industrial sector, Z for the technologies provided by the technological sector and applied in industrial sector; F as concave function, ∂F (K 1 , Z ) ∂ 2F (K 1 , Z ) , F KK = , we suppose: F K > 0, F Z > 0, F KK < 0, F ZZ < 0, F K = ∂K 1 ∂K 12 ∂F (K 1 , Z ) ∂ 2F (K 1 , Z ) FZ = , F ZZ = . ∂Z ∂Z 2 Suppose the production function of Taihu Lake sector as:

Y 2 = ф (N ) H (K 2) (20–2) In which Y 2 for the output of Taihu Lake sector, ф (N ) for the efficiency function, N for the natural environment level, K 2 for the capital stock of investment in industrial sector; H as concave function, we suppose: dH (K 2) d2H (K 2) dф(N ) H K > 0, H KK < 0, фN > 0, H K = , H KK = , фN = , 2 dK 2 dK 2 dN 0 < ф(N ) < limф (N ) = 1. N →N

As a function showing environmental quality, efficiency function ф (N ) is a factor of environmental effect on Taihu Lake sector. As Taihu Lake suffers from the algal pollution, environmental quality has a direct bearing on the severity of the pollution. The worse the environmental quality, the more severe the algal

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pollution will be and the more damage it will do to the production of the Taihu Lake sector. The environmental quality level gets the maximal value when (at the status of unexploited), so, limφ (N ) = 1. N →N

Suppose the technological sector satisfies the function as below:

Z = G (K 3) (20–3) Where Z for output of technological knowledge, K 3 for the capital stock of investment in the technological knowledge research and development sector; dG (K 3) G is a concave function which satisfies: G K > 0, G KK < 0, G K = , G KK = dK 3 d2G (K 3) dK 23

. In the economy, the relationship between pollution and industrial

sector and between pollution and technological sector can be expressed as below: Z β α1 D = Y 1 (20–4) In which D for the pollution emissions accompanied with industrial production, α and β for the flexibilities of pollution and technology, respectively, which should satisfy: α > 0, and β > 0. Due to that, environment quality gets

the maximal value at the un-exploited state (N ), which can be knocked off by pollution with the appearance of algal, the environment quality of Taihu Lake satisfies the formula below:

N = N – D

(20–5)

Within a perfectly competitive market, the profits maximization of the three sectors in the capital market satisfies the formula below:

P 1 F K = P 2 ф (N ) H K = P 3 G K = r (20–6) In which, r stands for the prices of capital price, P 1 stands for the products of the industrial sector, P 2 stands for the price of Taihu lake sector’s products, and P 3 stands for the price of the technological sector’s products. So far, model building has been finished. To inspect the government’s economic effects on capital subsidies of the sectors, we can express formula (20–6) as:

P 1 F K = (1 – s 1) r (20–7) P 2 ф (N ) H K = (1 – s 2) r (20–8) P 3 G K = (1 – s Z) r (20–9)

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

In the above formulas, s 1, s 2 and s Z stand for the capital subsidies of the government to the industrial sector, Taihu Lake sector, and technological sector, respectively.

Theoretical Analysis We conduct perfect differential to formulas (20–1) to (20–5), and (20–7) to (20–8),

and finish at the initial status of s 1 = s 2 = s Z = 0, then we have simultaneous equations as below:

FK

0

F ZG K

–l

0

0

ф(N)H K

0

0

–lфNH (K 2)

β α Y1 Z 1 α

–

β –α –1

1 GK α Y1

0

0

P 1F KK

0

P 1F KZG K

0

P 2ф(N)H KK

0

0

0

=

0 0 0 1– s 1 1– s 2 1– s Z

+

0 0 0 0 –r 0

1 –1 α

P 3G KK

dr +

0 0 0 –F K 0 0

ds 2 +

0 0 0 0 0 –r

dP 1 +

0

1

0

0

0

0

0

P 2фNH K

0

0

0

0 0 0 0 – ф(N)H K 0

ds z

Z

β –α

0

dP 2 +

0 0 0 0 0 –G K

dP 3 +

dK 1 dK 2 dK 3 dY 1 dY 2 dN

0 0 0 –r 0 0

ds 1

(20–10)

Suppose the determinant value of coefficient matrix on the left of formula

(20–10) as Δ, we have:

Δ = –P 1 P 2 P 3 F KK ф (N ) H KK G KK > 0

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Influence of interest fluctuation on economy Interest adjustment is a commonly used financial policy tool for economic regulation in China’s economic activities, and is also an essential means of pollution control in the Taihu Lake economy. Solving equations (20–10) of capital prices, we have: Generally speaking, the conductive process of interest rates decline leading to environment deterioration is: Interest rates decline – increase of industrial sector’s investment – output rise of industrial sector – environment deterioration. dK 1 dr

dK 2 dr

= –[(P 3G KK – P 1F KZG K)P 2ф(N )H KK ] ÷ ∆ < 0

=

β α1 – β – 1 1 α1 – 1 – β –P 1P 2фNH KG K F Z α Y 1 Z α F KK – α Y 1 Z α F KK 1 α1 – 1 – β – F K α Y 1 Z α F KZ – P 1 F KK P 3G KK – F K P 2фN H KP 3G KK Q Y ÷ ∆

dK 3 dr

dY 1 dr

dY 2 dr

= [–P 1F KK P 2ф (N )H KK ] ÷ ∆ < 0 = [ –F KP 2ф(N )H KK P 3G KK + P 1F K F KZ P 2ф(N )H KKG K – P 1F KK F Z P 2ф(N )H KKG K ] ÷ ∆ < 0 =

1 α1 – 1 – β (P 1F KZ G K – P 3G KK)F K P 2ф(N )фN α Y 1 Z α [ (H K)2 – H (K 2)H KK] – (P 1F KKф (N )H KP 3G KK x фN G K

dN dr

÷ ∆ +

[H (K 2) H KK – (H K) 2] P 1 F KK P 2 ф(N )

1 α1 – 1 – β β α1 – β – 1 FZ α Y1 Z α – α Y1 Z α

= F KP 2ф(N )H KKP 3G KKQ Y + P 1P 2ф(N )H KKG K β α1 – β – 1 1 α1 – 1 – β – α Y 1 Z α F KK – F K α Y 1 Z α F KZ

514

÷∆ 1 α1 – 1 – β F Z α Y 1 Z α F KK

÷∆

(20–11)

Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

However, in the model designed in this chapter, an interest rate decrease does not necessarily lead to the deterioration of the Taihu Lake area’s environment due to the fact that the Taihu Lake sector is protected by the technological sector in the economy of three sectors. Whether the decrease of interest rates is able to influence the environment in the model of three sectors is in relation to the comparison between the technological cost–output value ratio of industrial production and the technology flexibility of the industrial output. To verify this notion, we set out to analyze from formula (20–11). The dN though, are uncertain, we can deduce the sufficient condition of signs of,  dr dN

> 0 through the formula. We can make

dr

dN dr

> 0, as long as

β α1 – β – 1 1 α1 – 1 – β 1 α1 – 1 – β F Z α Y 1 Z α F KK – α Y 1 Z α F KK – F K α Y 1 Z α F KZ < 0

(20–12)

If the inequality (20–12) is to be established, the following inequality has to

be established:

β α1 – β – 1 1 α1 – 1 – β 1 α1 – 1 – β F Z α Y 1 Z α F KK – α Y 1 Z α F KK < F K α Y 1 Z α F KZ The right of the above inequality is not less than zero, so when the following

inequality (20–13) is established, so is formula (20–12). β α1 – β – 1 1 α1 – 1 – β F Z α Y 1 Z α F KK – α Y 1 Z α F KK ≤ 0 1 α

For F KK < 0, Y > 0, Z

1 α Y Z F KK , we have: 1 α

β α

(20–13)

> 0, we divide both sides of formula (20–13) by

β α

Y1 FZ – βZ ≥ 0

P3 And for F Z = P under equilibrium condition, we deduce the sufficient 1 dN > 0: condition of the establishment of dr Y1 P3 P1 ≥ βZ

When β ≥ 1, we have P 3Z ≥ βP 1Y 1. But as technologies of output are invested in the production of industrial sector as intermediate products, costs of

technologies cannot be bigger than the sales revenue of industrial products. The above inequality cannot be established.

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When 0 < β < 1, inequality P 3 Z ≥ β P1 Y 1 may be established, which indicates that the technological cost-output value ratio of industrial production is greater than or equal to the technology flexibility of the industrial output. At the dN > 0. moment, we have dr Being operable, the conclusion is of great significance to the actual economic life in the Taihu Lake area. From the above, we can obtain proposition 1. Proposition 1: An increase in interest rate leads to the capital decrease in the industrial sector and technological sector, and output decrease of Y P industrial sector. And under the condition of 3 ≥ β 1 (0 < β < 1) , the natural P1 Z environment of the Taihu Lake area is improved; A decrease in interest rate leads to the capital increase in the industrial sector and technological sector, and Y P output increase of industrial sector. And under the condition of 3 ≥ β 1 (0 < β P1 Z < 1), the natural environment of Taihu Lake deteriorates.

Analysis of the interest subsidies in each sector Different from the interest adjustment applied to the overall economy, we will next discuss the interest subsidies in each sector, which is another means of economic adjustment and pollution control. First of all, we analyze the economic effect of interest subsidy carried out in the industrial sector. dK 1 ds 1

dK 2 ds 1

dK 3 ds 1

dY 1 ds 1

dY 2 ds 1

dN

ds 1

516

rP 2ф(N )H KK P 3G KK >0 ∆

=

1 α1 – 1 – β rF KP 2фN H K P 3G KK α Y 1 Z α = ∆

0 ∆

1 α1 – 1 – β rF KP 2ф(N )фNH KK P 3G KK α Y 1 Z α [(H K)2 – H (K 2)H KK] ∆

1 α1 – 1 – β rF KP 2ф(N )H KK P 3G KK α Y 1 Z α ∆

0 ∆

=

=0

Analyze the interest subsidy carried out in the technological sector, we have: dK 1 ds Z

dK 2 ds Z

=

rP 1F KZ P 2ф(N )H KKG K >0 ∆

= rP 1 P 2фN H KG K

β α1 – β – α Y1 Z α

dK 3 ds Z

dY 1 ds Z

=

=

–1

1 α1 – 1 – β F Z α Y 1 Z α F KK

1 α1 – 1 – β F KK – F K α Y 1 Z α F KZ

÷∆

rP 1F KK P 2ф(N )H KK >0 ∆ –rP 1 P 2ф(N )H KK G K (F KF KZ – F ZF KK) ∆

>0

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

dY 2 ds Z

=

1 α1 – 1 – β rP 1F KP 2ф(N )фN G KQ Y α Y 1 Z α [(H K)2 –H (K 2)H KK]

÷∆+

rP 1F KKP 2ф(N )фN G K [(H K)2

1 α1 – 1 – β β α1 – β – 1 – H (K 2)H KK] F Z α Y 1 Z α – α Y 1 Z α dN

ds Z

= – rP 1P 2ф(N )H KKG K

1 α1 – 1 – β F Z α Y 1 Z α F KK

β α1 – β – 1 1 α1 – 1 – β – α Y 1 Z α F KK – F K α Y 1 Z α F KZ

When

÷∆

÷∆

Y P3 ≥ β 1 (0 < β < 1), namely, the technological cost–output value ratio P1 Z

of industrial production is greater than or equal to the technological flexibility dK 2 dN of the industrial output, we can get the result of ds < 0 and ds < 0. From the z z above, we can get proposition 2. Proposition 2: Imposing interest subsidy in the industrial sector makes the industrial sector increase investment and output, and the Taihu Lake sector decreases investment and output, resulting in environmental quality degradation. But it has no effect on the capital investment of the industrial sector. Imposing interest subsidy in the technological sector makes the industrial sector increase investment and output, the Taihu Lake sector decrease output, Y1 P (0 and the technological sector increase capital investment. And when 3 ≥ β P1 Z < β < 1), the Taihu Lake sector decreases capital investment, with the result of the degradation of environmental quality.

The influence of price fluctuation of industrial and technological products on economy and environment In the perfectly competitive market, the price is determined by the market. But the price fluctuation of products is generally relevant to the economic trends. In addition, the economy of Taihu Lake assumed in this chapter will have an effect on the pollution degree, so studying price fluctuation is an important part of analyzing algal pollution. Solving the equations (20–10) of industrial products’ prices, we have:

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

dK 1 dP 1

dK 2 dP 1

dK 3 dP 1

dY 1 dP 1

=

F KP 2ф(N )H KK P 3G KK >0 ∆

=

1 α1 – 1 – β (F K) 2P 2фNH K P 3G KK α Y 1 Z α ∆

0

dY 2

1 α1 – 1 – β (F K) 2P 2ф(N )фNP 3G KK α Y 1 Z α [(H K)2 – H (K 2)H KK] = 0 ∆

=0

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Solve the product prices of technological sector: dK 1 dP 3

dK 1 dP 3

=

P 1F KZP 2ф(N )H KK (G KK) 2 0 ∆

=

P 1P 2ф(N )H KK (G K) 2 (F KF KZ – F ZF KK)

=

∆

÷∆+

x [ (H K)2 – H (K 2) H KK ] β α1 – β – 1 – α Y1 Z α

dP 3

=–

P 1 F KK P 2ф(N )фN(G K)2 1 α1 – 1 – β FZ α Y1 Z α

÷∆

P 1P 2ф (N )H KK(G K)2

1 α1 – 1 F Z α Y1 Z

β α1 – β – 1 1 α1 – 1 – β – α Y 1 Z α F KK – F K α Y 1 Z α F KZ

When

>0

1 α1 – 1 – β P 1 F K F KZ P 2ф (N )фN(G K)2 α Y 1 Z α [ (H K)2

=

– H (K 2)H KK ]

dN

÷∆

–β

α

F KK ÷∆

Y P3 dK 2 dN ≥ β 1 (0 < β < 1), we have < 0, < 0. Above all, we can get P1 Z dP 3 dP 3

proposition 3 to proposition 5. Proposition 3: If the prices of industrial products rise or fall, the input and output of the industrial sector will increase or decrease, making the investment output of Taihu Lake sector rise or fall with environmental quality improving or deteriorating. No matter how the prices of the products from the sector change, they will have no effect on the capital input of the technological sector.

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

Proposition 4: If the product prices of the Taihu Lake sector rise or fall, the investment and output of the Taihu Lake sector will increase or decrease, but this has no effect on the investment of industrial and technological sectors, and the output of the industrial sector. No matter how the product prices of the sector change, these will have no effect on the environmental quality of the Taihu Lake area. Proposition 5: If the prices of technological products rise or fall, the investment and output of the industrial sector will rise or fall, making the Y P investment of the technological sector increase or decrease, and when 3 ≥ β 1 P1 Z (0 < β < 1), the Taihu Lake sector will decrease investment, and environmental quality will degrade.

Effect of financial policies on the welfare of the Taihu Lake economy Suppose U (•) is a social utility function of the domestic consumption, which

is a monotone continuous function, E (P 1, P 2, U ) is the minimal expenditure function under U (•), and M is the import volume of industrial products. In addition, we use 100t% to represent the rate of tax, so the relationship between

the domestic price P 1 and international price P * of industrial products is: P 1 = (1 + t ) P *. Balance of payment of the economy can be written as:

E (P 1, P 2, U ) = P 1 Y 1 + P 2 Y 2 + t P * M (20–14) ∂E (P , U ) M = E P – Y 1, in which, E P = . According to Hotelling model, E P = ∂P C is the demand for industrial products, and t P * M for tax revenue. After complete differential of the formula (20–14) at fixed price, we can get: E U d U = P 1 d Y 1 + P 2 d Y 2 + t P * d M (20–15) Without regard to tax, t = 0, divide both sides of the formula (20–15) by ds 2, we have:

EU

PP 1 r ф (N )фN H K G KKF KK dU dY 1 dY 2 = P1 + = ds 2 ds 2 ds 2 ∆

>0

We can also inspect the influence of price fluctuation on economic welfare.

Divide both sides of the formula (20–15) by dP 2, we have: dU dY 1 dY 2 EU = P1 + P2 dP 2 dP 2 dP 2

= P2

P 1F KK [ф (N )H K]2 P 3 G KK >0 ∆

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

The change of utility cannot be inspected with the other exogenous variables. Considering the above propositions, we can find that the rise of the prices of Taihu Lake sector products, though, has no effect on the environment, the investment of industrial and technological sectors, and the output of the industrial sector. But, it will increase the investment and output of Taihu Lake sector, the social utility of economy, and the economic welfare. Carrying out interest subsidy in the Taihu Lake sector will increase the investment and output of the Taihu Lake sector, leading to the rise of social utility and the welfare of the economy, but it has no effect on the economy of the other sectors and environment.

Conclusion This chapter conducted a discussion based on the reality of the Taihu Lake area, designed a model of three sectors which was used to carry out an analysis from the perspective of economics on the effects of financial policies and price fluctuation on pollution. The conclusion of this chapter provided a reference for the environmental protection of Taihu Lake from the financial policies. For example, when the interest rate is lowered or the product price rises in the industrial sector, the natural environment of Taihu Lake is more likely to be destroyed, so we should pay special attention to the algal pollution and reinforce the preventive regulations; while, when the interest rate grows or the product price of technological sector decreases, the natural environment of Taihu Lake will be improved to some extent. The major conclusions of this chapter can be summarized in Tables 20.1 and 20.2. As the economy of Taihu Lake is one part of the national economy, the economic policy orientation of Taihu Lake has to comply with the general orientation of the national economic policy. Therefore, discussing the relationship between financial policies and the Taihu Lake environment in this sense can serve as a reminder for the local government to determine the impacts of the central government’s financial policies. The author believes that to decide whether a financial policy is effective or not, we should inspect not only its role in the economy, but also its effect on the environment. Only if the policy brings a positive effect to the two sides will the policy be considered an effective policy for sustainable economic development. No matter on which side it has flaws, it will do harm to the economic construction of China, which should not be our option. In the areas which are similar to Taihu Lake and frequently attacked by pollution, the environmental effect of the economic policies is even more important than the economic effect, because the cost for pollution treatment is always higher than the economic effect of the policies.

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Blue-Green Algal Contamination of the Taihu Lake and Effectiveness of Financial Policy

Table 20.1 Effect Policies

Economic and environmental effect of implementing financial policies in the economy of the Taihu Lake area Industrial Taihu Lake Technological Industrial Taihu Lake sector capital sector capital sector capital sector sector output investment investment investment output

Environmental Social improvement welfare

↓ (↑ )

—

↓ (↑ )

↓ (↑ )

—

( )

—

Implementation of s1

↑

↓

––

↑

↓

↓

—

Implementation of s2

––

↑

––

––

↑

––

↑

Implementation of sZ

↑

↑

↑

↓

r ↑ (↓ )

—

Notes: “↑” represents rise, “↓” represents fall, “ ” represents that the environment is improved when

Y P3 ≥ β 1 (0 < β < 1), “ ” represents that the environment P1 Z

deteriorates when

Y P3 ≥ β 1 (0 < β < 1); “– –” means that the policy has no P1 Z

effect on the item; — means effect unknown.

Table 20.2 Effect

Economic and environmental effect of price fluctuation in the economy of the Taihu Lake area Technological Industrial sector capital sector output investment

Taihu Lake sector output

Environmental Social improvement welfare

Policies

Industrial Taihu Lake sector sector capital capital investment investment

P 1 ↑ (↓ )

↑ (↓)

↓ (↑ )

––

↑ (↓ )

↓ (↑ )

↓ (↑ )

—

P 2 ↑ (↓)

––

↑ (↓ )

––

––

↑ (↓ )

––

↑

P 3 ↑ (↓)

↓ (↑ )

↓(

↑ (↓)

↓ (↑ )

)

—

( )

—

Notes: Same as Table 20.1

523

21

Chapter

Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

DEVELOPMENT IN THE YANGTZE RIVER DELTA

Research Background The exploration of the rural endowment insurance system in China started in the mid- 1980s. In October 1986, the former Ministry of Civil Affairs and the relevant departments under the State Council held the “National Rural

Grassroots Social Security Work Forum” in the Shazhou county of Jiangsu

Province, and ensured the major tasks of social security work in different rural areas. After the forum, social endowment insurance was applied in some

economically developed areas, with the insurance premium being shared by

the individual and the collective. In January 1991, the State Council decided

to select a number of areas with suitable conditions to establish the trials of

the rural social endowment insurance system and printed and distributed the

County Rural Social Endowment Insurance Basic Profile (Trail Implementation) . This document defines the guiding ideology and basic principles of “starting from the rural reality of China, aiming at ensuring the basic livelihood of the aged; insisting on individual payment as the main source, and collective allowance as the complement; the government providing policy support; insisting on self-help as the priority, mutual aid as the complement; combining the social endowment insurance with the family endowment; insisting on the unification of the social endowment insurance system for all kinds of rural personnel as farmer, worker, businessman, etc.” Relevant works were carried out on a step-by-step basis based on the trials.

The development status of the national rural endowment insurance system With the experiment in the early 1990s and the stable development afterwards, by 1998 the rural social endowment insurance program had been launched

in 2,123 counties (cities, regions) in 28 provinces, autonomous regions and municipalities, and 65% of the villages (towns), with 80.25 million people

participating in the insurance program. With annual fund revenue of the rural

social endowment insurance program equaling RMB3.14 billion, the work

gained remarkable progress. But after that, the advance of the rural endowment insurance system was slow, even sluggish and backward. Such a commercial experiment of the rural endowment insurance system did not succeed, with

many areas failing to establish the system while the areas which established the system encountered a lot of problems.

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

The contribution ratio being irrational, the phenomenon of “the rich failing to protect the poor” became outstanding Basic Profile emphasized the self-insurance of the peasants by stipulating that individual payments cannot be lower than 50% of the sum insured but without specifying the regulations for the part of government and collectivity. However, without the government and collectivity taking parting in the capital rising, the insurance coverage of peasants cannot be guaranteed. The current model of endowment insurance is totally the model of accumulation, which causes an outstanding problem that most of the people participating in the insurance program are the ones getting a high salary. The old age care of these people can be guaranteed, even though they do not participate in the insurance program. However, the low-income peasants who are in dire need of endowment insurance cannot benefit from the insurance. In addition, the gap between the cadres and the masses in terms of collective subsidies is much too wide, which aggravates the unfairness in the rural areas.

Low level and small coverage of rural endowment insurance with a downward trend The rural endowment insurance regulates 10 standards of paying insurance premiums: starting from RMB2, with each standard having RMB2 more, till RMB20. Due to the rural underdeveloped economy, peasants’ weak awareness of insurance, and lack of confidence in the endowment insurance system, most of the peasants choose the standard of RMB2 per month when participating in the insurance program. The low level of insurance is quite inadequate for the security of future elder-care.

Administrative mechanism drawbacks and the difficulties of maintaining and increasing the value Because of the complexity of rural social endowment insurance work, its administrative mechanism has not been straightened out yet. Currently, the major work of national rural endowment insurance is taken charge of by the organizations at the county level or below which are responsible for charging, accounting, distribution and, for the time being, the operation management of the funds. In the administrative model lacking a supervision mechanism, the endowment insurance fund raised cannot be earmarked which causes the problem of embezzling endowment insurance funds and damaging the applicants’ interests. Besides, maintenance and appreciation of endowment

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

insurance funds is difficult to be guaranteed for the limitation of fund investment, low-level administrative level, and so on. The advance of urbanization helps to solve the problem of rural endowment insurance. With a large rural population and low-level development of the rural economy, the government has not enough financial ability to incorporate all the rural residents into the endowment insurance system, while the peasants without income security are the group in greatest need of endowment insurance. The urbanization of China, now, is presenting the below characteristics: first, the urbanization of China is accelerating, which in 1980 was only at the level of 19.8%, while in 2007, 43.7%; second, regional development is imbalanced, and there is a remarkable gap among regions, with a maximal level of over 70% in Shanghai, Beijing and Tianjin, while, less than 30% is in 11 other provinces. Urbanization and the regional economy generally are in a positive correlation or trend of growing at the same pace. Therefore, in the process of urbanization, local governments can invest more funds in the rural endowment insurance. Under the above background, it is quite urgent to deepen the research of rural endowment insurance system, especially the one of the financing model, and establish the system suiting Chinese rural areas as soon as possible.

Development characteristics of the rural endowment insurance system in the Yangtze River Delta area The rural insurance system of Shanghai now is implementing the Rural Social Endowment Insurance Measures issued on January 15, 1996. Aiming to benefit the cohesion and transformation of the urban basic endowment insurance, the Measures made a great adjustment for the County Rural Social Endowment Insurance Basic Profile issued by the primary Department of Civil Affairs, by referring to the basic elder-care methods of urban staff, payment of endowment insurance, and system framework. The adjustments mainly lie in: Canceling household registration limitation; changing the simple individual account into a model of integrating individual accounts and social pooling accounts, upgrading the payment standard, adjusting payment methods, and regulating minimum payment and subsidy proportions. The experiment of rural social endowment insurance was started in 1999 in Zhejiang Province whose insurance model basically maintained the basic scheme of the Department of Civil Affairs, merely with an advance in the security standard compared with the Basic Profile . In addition, the high insurance coverage of township enterprises had an immeasurable effect on the development of the rural social endowment insurance system of Zhejiang

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

Province. By the end of 2005, there have been 95% of the towns and 80% of the administrative villages carrying out the work. Some regions in Zhejiang Province, such as Jiaxing, Ningbo, Shaoxing and Hangzhou, have explored and perfected actively the currently-used system of rural social endowment insurance. The soaring rural economy of Jiangsu Province has promoted the prosperous development of its social elder-care undertakings. Taking the advanced township enterprises as the breakthrough points, three cities (Changshu, Jiangyin, and Zhangjiagang) south of Jiangsu have reformed the insurance system. Changshu is a county-level city of Jiangsu Province. In accordance with the current situation of rural elder-care, combined with the local economic reality, the government of Changshu defined the development target of the rural social endowment insurance system as: Integrating social relief with selfsecurity, integrating fairness with effectiveness, integrating social pooling accounts with individual accounts. The government sought the breakthrough of system reform in the method of pooling so as to establish the rural social endowment insurance system integrating social pooling with individual accounts and in-line with the urban pension insurance. Jiangyin strengthened the coerciveness of participating in insurance program for the township enterprises staff, and clarified the cohesive relationship in the rural endowment insurance system, urban pension insurance system, and subsistence security system. In a word, with the rapid economic development in the Yangtze River Delta area and rapid advance of urbanization, the demand for establishing the rural endowment insurance system in the area is far more urgent than that for other areas in China. Till now, the cities of comparative advanced economic development in the area, on the whole, have established the regional rural endowment insurance system. This chapter adopts the method of theoretical research and empirical analysis to study the model of rural endowment insurance. By summarizing the models of the rural endowment insurance in the area, this chapter concludes the experience and suggestion for the establishment of insurance in other parts of the country.

Literature Review In consideration of the importance of the rural endowment insurance system, a number of scholars have conducted research on the financing of insurance. As an essential ingredient of the whole social security system, rural endowment

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

insurance is a typical public product. Establishing the government-oriented endowment insurance system is the requirement of the public financial function, thus the insurance should be provided by the government (Wang Zhuwang 2006). From national right of social security, it is the basic right of the citizens, including peasants, granted by the Constitution to obtain the social security provided by the government. The government has not only the responsibility but also the obligation to provide social security and service for the citizens. From the perspective of historical contribution, since the founding of New China, the peasants have made enormous sacrifices and contributions for the construction of national industrialization and development of the social economy, so the government has the responsibility to make appropriate compensation for the losses of peasants’ interests, by including them into the social security system (Chen Shaohui 2004). Governmental responsibility defects in the rural endowment insurance system mainly lie in the absence of compulsory enforcement and fund payment. From the experience overseas, there are 162 countries and regions carrying out social endowment insurance systems, with rural areas included in 70 countries and regions. In fact, any country and region, as long as it has obtained a certain level of economic development, is able to establish suitable rural social insurance system (Liu Feng 2007). From the advanced countries’ development experience of rural endowment insurance, especially at the beginning of system development, the government played a dominant role in the legislation, enforcement, capital investment, supervision administration, and other tasks. Especially in the aspect of finance, the government granted substantial financial support for the rural endowment insurance system (Gong Xiaoxia 2006). The important role the government played in the fund pooling of rural social endowment insurance is mainly embodied in two aspects: First, to appropriate a certain portion of the budget revenue to maintain or fill the gap in social security spending; second, to incorporate the agricultural system into the social security system and provide the peasants with an equivalent social security to that of the urban citizens. In Germany, the fund of rural social insurance is from the insurance tax of the insured peasants and governmental subsidies, with the latter accounting for two-thirds of the total. In all the social security programs of Germany, rural endowment insurance is the only one providing the insurant with premium subsidies under certain conditions. As a another example, the agricultural population of France accounts for less than 10% of the total, but the endowment insurance system of peasants has become the second biggest branch of the various social security systems in the country. The agricultural social mutual aid

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

funds of France come from the financial support outside the system, with parts from the state financial support and the rest from the support of the other public insurance departments. It is the same as that of some other Western countries. Canadian government takes charge of half of the rural social endowment insurance fund, with central and local governments each sharing half of it. Japan adopts the method of annuity payments, with two-thirds provided by the annuity system and one-third assumed by the national treasury (Song Jieqiong 2006). From the composition, the public annuity system, peasantry annuity plan, and individual savings plan commonly constituted a three-column social endowment insurance system in the industrialization country. The government provided enormous financial support to the establishment of the rural endowment insurance system, fully displaying the fiscal redistribution function (Ding Shaoqun 2004). Social security theories and practices of each country show that the governments have to take certain financial responsibilities when establishing and promoting rural the social endowment insurance system to guarantee the rational investment of funds. The practice of China proves that without subsidies from the government, or collective efforts, rural social endowment insurance does not develop well, while well-developed insurance systems are mostly provided for with many subsidies (Zhuan Huilin 2006). Many scholars are of the opinion of establishing rural endowment insurances consistent with the local economic development. As for the coastal developed areas, owing to the high revenue of peasants, advanced collective economy, strong local financial strength, rapid development of social elder-care undertakings, high involvement of peasants, the local government is capable of taking charge of the major duty of financial subsidies; while, as for the areas, such as the west in China, with relatively underdeveloped economies and backward economic conditions, the central and provincial governments should shoulder the majority of costs while countylevel finance takes no part in the subsidies to ensure that the implementation of subsidy policies will not be influenced by the local financial difficulties (Zeng Qingfen 2005). Cheng Ji’e (2006) believes that as for the areas with an advanced collective economy, the individual payment is the principal part, collective allowance supplements a part, and the government contributes a proper portion; while as for the areas with an underdeveloped economy, individual payment remains the principal, the collective provides appropriate assistance, and the government subsidizes costs for low-income citizens. In consideration of the academic classification of the peasants of our country as pure peasants, peasant-workers, and landless farmers, many scholars also raised different fund pooling schemes and contribution ratios. Based on the

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

rural endowment insurance concept of limited financial responsibilities, Yang Cuiying and Mi Hong (2007) innovated the current institutional arrangement and model framework of endowment insurance and raised four models: “flexible account + incentive account” for peasant-workers; “individual account + basic pension + reserve” for landless peasants; “individual account + longevity venture fund” or “individual account + social pooling account” for pure peasants; “pension subsidy” which is transformed from the reward of “support at a designated age” for birth control households. The models above can be mutually converted through certain channels. Liu Haiyan (2006) believes that, as for the endowment insurance of pure peasants shared by individuals, collectivity, and finance, the premium-paid base can be the local peasants’ net income of last year, and the payment proportion totals 20%, with individual amounts of 8%, finance of city (county), district and township and collective economic organizations of 12%. But the endowment insurance of rural flexible employees should be individual-oriented — individual accounts for 15% — with the premium-paid base and payment proportion being the same as those of the pure peasants. Liu Xianghong (2007) raised the method of capital pooling aiming at the peasant-workers. As for the peasant-workers with steady jobs, fixed income and relatively fixed residence, we should carry out the system of “individual account + social pooling account” same as the urban staff. However, as for the flexible peasant-workers with unsteady jobs and low-income, we should carry out the system of only individual accounts without social pooling, in which individual payments take 5% of the total salary, enterprise payments take 10% (among them, 6% is devoted to the individual accounts, and 4% contributes to the establishment of specific adjustment funds system). As for the peasant-workers who are unemployed, we should carry out the savings system of individual account accumulation. Run Airu (2003) believed that according to the national conditions of China, the government cannot provide substantial financial subsidies for the rural endowment security. The rural economic development of China is imbalanced and the income gap among peasants is wide and unstable, so it is hard to make sure the unified cost standard and remuneration. It is a realistic choice to establish a rural social endowment insurance system of individual account reserve accumulation and defined contribution, which is based on the summarization of trial experience, that accords with the national conditions and rural reality of China, and which is in line with the orientation of international endowment insurance. There are also some scholars believing that we should implement the grade payment system where the employers are allowed to pay the social pooling endowment insurance with different proportions according to peasant-workers’

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

years of working. The longer the working years are, the higher the payment proportion will be, till the proportion equals to that of the urban staff (Zhao Xiaoshi, and Du Mingxia 2002). In the opinions of Song Binwen and Jin Wei (2004), the endowment insurance model for the landless peasants should be the complete accumulation system of individual account, via pooling model of being collectively shared by government, collectivity, and individuality. The part from the government cannot be lower than 30% of the total, which is drawn from the land transferring fees and which directly enters into the social pooling account for adjustment purpose; the part from collectivity cannot be lower than 40% of the total, and is drawn from the land compensation fees; the part from individuality can be offset by the land expropriation compensation, with the funds paid collectively and individually and which are included in the individual account. Considering the current economic development and financial bearing ability of China, it is impossible for the government to invest vigorously in the rural endowment insurance. Therefore, to widen the financing channels of the insurance system and properly assign the payment proportion of payment subjects are the key tasks to solving the problem of rural elder-care in China. Method one: By mirroring the experience of urban social endowment insurance, governments make various social insurance bases and flexible payment deadlines to encourage the improvement of individual payment standards. Method two: Encouraging enterprises to be involved in rural endowment insurance, governments can provide preferential policies for enterprises, and rural collectives sign the agreements with the enterprises and prepay insurance money for peasants. Meanwhile, the township finances spare a certain proportion of capital as insurance funds to compensate for the reduced collective subsidies of rural social insurance funds after the canceling of agricultural tax. Method three: The state should strengthen its support responsibilities to the rural endowment insurance system, intensify the transfer payment efforts of finance to rural areas and then draw a certain proportion of land compensation fees, land utility fees and agricultural industrialization turnover to the legal financial channels of the rural endowment insurance system. Governmental risk fund for grain enterprises should be transferred into the subsidies for peasants selling grain, concentrating the subsidies fund as rural social insurance fund. The poverty alleviation funds should be adjusted to be used for the rural endowment insurance fund (Chen Changmin 2005). Besides, we can raise a part of the funding by levying social endowment security tax and issuing the welfare lottery of social security all over the country. Some scholars believe that the source of rural endowment insurance funds

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

should be realized by having the government be responsible for the major share, and individuals for the small shares. The issued amount should not only take the peasant’s individual accounts into consideration, but also be weighted based on the national base according to the local cost of living index, price index and life expectancy of the people, and add a part of the social pooling account funds, in order to guarantee the basic subsistence of the elderly in different areas and conditions (Fang Yueluan, and Huang Furong 2005). In the opinions of Li Qiang and other scholars (2007), according to the current situation of such factors as the per capita net income of peasants, economic strength of the collectives and national financial resources in China, a relatively reasonable proportion of fund raising is peasants being responsible for 30%–40% of the costs, the government for 50%–60%, and collectives for 5%–10%. With the development of the economy, the proportion for the government can be increased in an appropriate way. There are also some scholars who believe that endowment insurance funding should come from insurers, national public finance, and local collective organizations. In accordance with the social and economic development levels, the basic principle of different contribution proportions is: Individuals are responsible for the major shares, collective responsibility for the medium shares, and the government for the small shares. The specific proportion of each area should be designed on the basis of the local situation, and it is advisable to set the fund pooling at prefecture-level cities. The endowment insurance funds paid by any subject are incorporated into the individual account of the insurant (Shang Changfeng 2006). Some other scholars believe that we should stick to the principle of an individual payment-oriented system, a collective assistancesupplemented system, and governmental policy support in fund raising. Due to the huge rural population in China and the substantial expenditure of endowment insurance funds, it is remarkably hard to be totally assumed only by the government or the collectives. Hence, it is a reflection of the principle of self-security that the rural social endowment insurance fund is mainly assumed by the peasants. The government should, on the one hand, mirror the Central Provident Fund of Singapore to pay attention to encourage the effectiveness of individual labor by equaling more fund accumulation to higher security; on the other hand, learn from the national insurance model of Germany and America to allow for the mutual supplementation of insurance mechanism function and integrate individual funds account with social pooling accounts (Pang Huiqi 2005). However, in Wang Bin’s opinion (2004), the fund-raising of the rural endowment insurance system should be solved by the idea of integrating

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

the four main bodies of land expropriation as government, collectivity, individuality, and market into one. Whatever the purposes of the land expropriation are, a part of the land income should be set aside as the social security fund source for the landless peasants. The fund is deposited in a specific account and administrated by a specialized agency. Zhang Ling and other scholars believe that a diversified fund-raising mechanism, oriented in individuals and the government, and supplemented by collective assistance and complemented with social donations, should be established. On the one hand, the government and the collective should shoulder larger portions of the fund-raising efforts to alleviate the burden of the individuals. Individual peasants are responsible for 40%–60%, the government for 30%–40%, and the collective for 10%–20%. Different areas could adjust measures to meet the local conditions according to their own economic development speed and collective economic strength. On the other hand, the fund-raising standard of rural social endowment insurance should mirror the practice of urban staff where premiums are based in accordance with a certain ratio of the peasants’ per capital net income of the last year, other than with fixed amounts.

Financing Model of Rural Endowment Insurance System The rural endowment insurance experimented since 1990s failed to achieve success, which is mainly due to the defections on system design, with the absence of government being one of the most vital defections. To improve fundamentally the current status of rural endowment insurance, the government should be urged to fill its absence and assume the responsibilities. During the establishment of rural endowment insurance system, the government firstly should shoulder the duty of investment. Only if the government indeed assumes the duty, with multiparty financing, the peasants can be attracted to participate in the insurance via multi-party financing, so as to provide guarantee for the success of the system. In addition, from the analysis of the cases, we can get the findings: As two successful models, model of Suzhou and model of Huoqiu have played an essential role in promoting rural endowment insurance, with the insurance coverage being widely increased. However, at the same time, it has to be noted that the level and layer of the social security are at a low level. Relative to the overall consumption expenditure of the peasants, the proportion of the insurance is so small that it cannot solve the elder-care issue of the peasants in a real sense. The first and foremost reason also lies in the

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

inadequate investment of local government in the rural endowment insurance. Therefore, it is necessary to study the factors affecting the local governments’ investment in rural endowment insurance. The financing scale or proportion of local governments in rural endowment insurance is affected by various factors, such as local governmental financial status, local economic development, peasants’ income, and so on. The theories of the School of Public Choice stand for that the government is made of the people, its code of conduct is made by the people, and the act of government is decided by the people. And those people inevitably bear the feature of economic man. Niskanen referred to the fact that the bureaucrats (top decisionmakers), the same as other people, were seeking for the maximal utilization. With a method of administrative utility function, he raised the idea that the variables in the function included salary, number of staff who worked for the bureaucrat and their wages, popularity, privilege, or position. Therefore, this chapter constructs the utility function of local government and tries to start from the utility maximization to consider the effects on the local governments’ investment of rural endowment insurance system construction of two factors. The first one is urbanization level. The less the rural population, the higher the urbanization level and the local governments’ per capita investment on rural endowment insurance will be. The second one is the power of the interest group of peasants. As rural endowment insurance system itself is a topbottom transfer system, if the peasants just remain in the position of system accepters, the system which affects directly the interest of them is a passive one for the peasants, and the execution results of interests protection are generally limited. If the peasants’ interest group has a say in the establishment of rural endowment insurance system and is able to exert pressure on the local governments, the local governments will more heavily consider the power of the group, so as enlarge the investment on rural endowment insurance.

Establishing a model In the opinion of the School of Public Choice, whether the government itself, its rule of conduct, or its behaviors, the factors are all related to the people who display the character of the economic man. Therefore, there is no reason to look upon the government as a machine and believe that the government always stands for and embodies the interests of the collective. Based on the administrative utility function of Niskanen, this chapter believes that the local governments can obtain utility in the investment on endowment insurance from two parts: One is from the investment on urban endowment insurance,

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

and the other is from the investment on rural endowment insurance. The local governments distribute the total budget of endowment insurance to the rural and urban endowment insurance to realize its utility maximization which means the faster the increase of power, the faster the position rises. The utility of local governments lies in not only the government’s investment distribution, but also the influence of rural and urban population and interest groups. In a specific model, this chapter at first supposes that the interest group has no effect on the decisions of local governments before letting it join in.

Assumption and model Suppose the local governments’ total investment on the endowment insurance is E which includes the investment on both the rural and urban endowment insurance, with m 1 for the investment on rural endowment insurance and m 2 for that on urban endowment insurance. Suppose n for the sum population of

rural and urban residents, n 1 for that of the rural residents, n 2 for that of the m1 urban residents, n for the government’s per capita expenditure for the rural 1 m2 endowment insurance, n for that of the urban endowment insurance. γ1, and 2

γ 2 > 0, stand for the voting rights of rural and urban residents, respectively. Without the participation of rural and urban interest groups, the rural and urban residents are not capable of exerting pressure on the local governments

without a say in the policy-making of local governments, so that γ1 and γ2, the voting rights of rural and urban residents, are small. On the contrary, when the interest groups participate in the process, they have a greater say in the ∂U policy-making process, so γ1 and γ2 become larger. 0 < β < 1 ensures > 0, (∂m 1) 2 ∂U and < 0, so does m 2. Both the increase of per capita investment on urban (∂m 12)

endowment insurance and that on rural endowment insurance can increase the local governments’ utility. However, since the budget for endowment insurance is limited, the local governments, with the given budget, distribute the investment proportion of rural and urban endowment insurance to maximize the utility. Utility function designed according to the above assumption:

U = γ1

m1 n1

β

+ γ1

m2 n2

β

Local governments’ budget constraint on endowment insurance is:

m1 + m2 ≤ E

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DEVELOPMENT IN THE YANGTZE RIVER DELTA

Utility maximization of local governments Lagrangian coefficient is constructed as:

L = γ1

m1 n1

β

+ γ2

m2 n2

β

+ λ (E – m 1 – m 2)

Attain first-order conditions: γ 1β

m1 n1

γ 2β

m2 n2

β–1

β–1

1 n 1 = λ (21–1) 1 n 2 = λ (21–2)

λ (E – m 1 – m 2) = 0

(21–3)

According to formulas (21–1) and (21–2), we have:

m1 n1 = m2 n2

γ1n 2 γ2n 1

1 1–β

(21–4)

Equation (21–4) is deformed as:

m1 n1 = n2 n1 m2 n2

1 1–β

γ1 γ2

1 1–β

(21–5)

1 As 1 – β is constant and larger than 1, the ratio between local governments’ per capita expenditures on rural and urban endowment insurance depends on γ1 γ1 n2 the values of n 1 and γ2 .When γ2 remains unchanged — n 2 stands for urban population, n 1 stands for rural population — the lower the urbanization, the smaller the ratio and the wider the gap of local governments’ per capita investment between rural and urban endowment insurance will be; the higher the urbanization, the bigger the ratio and the smaller the gap will be. Currently, the rural population of China is larger than the urban one resulting in a relatively low urbanization level. The ratio between urban population and rural γ1 n2 population, n 1 , is less than 1. Besides, γ2 , the voting right ratio between rural and urban residents, can be shown in some facts, such as the substantial gap between urban and rural education, the land-losing subsidies obtained by peasants being far less than the market value of land in the urbanization. It m1 n1 γ , the local governments’ is visible that 1 is a number less than 1. Hence, γ2 m2 n2

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per capita investment ratio between rural and urban endowment insurance, is smaller than 1. It is advisable from the above discussion that without the participation of interest groups, that is to say, when the voting right ratio between rural and urban residents is fixed and smaller than 1, under the restraint of the given endowment insurance and to realize the utility maximization, the local governments’ per capita investment ratio between rural and urban endowment insurance is up to the urbanization level. The lower the urbanization level, the smaller the ratio and the more unfair the urban-rural distribution of local governments’ investment on endowment insurance will be. The higher the urbanization level, the bigger the ratio and the more equal the urban-rural distribution of local governments’ investment on endowment insurance will be. It should be noted that due to the voting right ratio between rural and urban residents being smaller than 1, even with rural population being equal to the urban population, namely, approximating to 1, the local governments’ per capita investment ratio between rural and urban endowment insurance is still smaller than 1.

The effects of urbanization level Urbanization refers to a variation of life-style and social structure, that is to say, with the development of social productivity, the population generally transfers from countryside to cities, and agricultural population transforms into nonagricultural population or urban residents. As a result, the number of cities and towns is increasing continuously, the city scales are expanding, residents’ lifestyles and travel modes are improving, city infrastructure, city culture and citizens’ ways of thinking are all being perfected, etc. The most simple and commonly-used indicator measuring urbanization is “urbanization level” which refers to the percentage of urban population in a country or a region. Since the reform and opening up, the urbanization level of China has been increased rapidly. In 1979, the urbanization rate was 18.19%, which rose to 20.16% in 1981 and to 29.04% in 1995. By 2002, the urbanization rate had reached 37%. Communique on Main Data of 2005 National 1% Population Sample Survey showed that China’s urbanization rate was 42.99%. With the continuous improvement of national urbanization level, rural endowment insurance attracted more attention and investment of local governments. Such places as Zhejiang, Jiangsu, Shanghai, and Guangdong with higher urbanization levels increased the investment on rural endowment insurance, so as to guarantee the sound development prosperity of the

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insurance. However, for the overall urbanization levels being low, local governments still invest most of their budgets on the urban endowment insurance. The Statistical Communique Of Labor And Social Security over the recent years showed: In 2007, financial subsidies at all levels for basic endowment insurance funds amounted to RMB115.7 billion (including central finance); in 2006, financial subsidies at all levels for basic endowment insurance fund amounted to RMB97.1 billion, with central financial budget of RMB77.4 billion and local finance of RMB19.7 billion; in 2005, financial subsidies at all levels for basic endowment insurance funds amounted to RMB65.1 billion, with a central financial budget of RMB54.4 billion and local finance budget of RMB10.7 billion. But, few subsidies were for rural endowment insurance, and the data is inaccessible. Therefore, the local governments’ per capita investment ratio between rural and urban endowment insurance is still smaller than 1. In accordance with the current development of urbanization in our country, by 2010 the urbanization level of our country will reach up to 50%. According to the assumption model, due to the fact that the voting right ratio between rural and urban residents is smaller than 1, the local governments’ per capita investment ratio between rural and urban endowment insurance is still smaller than 1. In line with China’s current reality, the voting rights ratio should be so small that it is close to zero. If the situation is slightly varied other than substantially improved, even with the high urbanization level such as 70%, the ratio of local governments’ per capita investment between rural and urban endowment insurance will still be smaller than 1.

Involvement of interest group As a social organization made up of individuals with a common position, opinion, and interest, an interest group is also called a pressure group, and a lobby group in the West. In Western capitalistic countries, public policies, to a large extend, are the results of the mutual efforts of the interest groups, and group politics is popular. As one of the essential components of nonofficial political subjects, an interest group plays an important role in the public policy cycle. It is easy to be understood since the public policy process mainly can be seen as the distribution process of interest or value. To secure or enlarge the individual interest, the interest group has to participate in or influence the public policy process, with its duty of fulfilling interest aggregation function to secure or enlarge its members’ interest. In a country or society, there will be various kinds of interest groups who raise requirements and aspirations to the governments, hoping that their interests are being further taken into

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

consideration by governments’ policies. Therefore, the public policy process,

to a certain extent, can be seen as the process of interaction, struggle and compromise among interest groups.

The earliest formulation of interest group theories is form from Olson who

raised the well-known proposition of “group scale”: the smaller the interest group’s scale, the more active its members will be to exert influence on the governmental supervision (Lu Lei 2001). Stigler expanded the theoretical

perspective of the interest group influencing the governmental policies, and

emphasized industrial groups having more incentives to implementing political

influence than the scattered consumers. Regarding the endowment insurance issue, owing to the small population of urban areas and close economic

connections among each other (although not industrial groups), and part of the population being local governmental officials, they have more incentives

to exert influence on the endowment insurance policies of the government, and, to a certain degree, they have already formed the interest group. On the

contrary, the phenomenon of a “free ride” is likely to happen in the rural areas

of a large population. Due to loose economic connections among each other and

the absence of interest representatives with power (such as local government officials), rural residents, failing to form an interest group, can only accept the local government’s endowment insurance policy in a passive way. Owing to

the engagement of an interest group, the voting rights of urban residents rise

with the increase of γ2 in the model, while the rural residents, failing to from an interest group, have constant voting rights with a invariant γ1 in the model. Hence, according to equation (21–5), with the engagement of the interest group, the ratio of local governments’ per capita investment between rural and urban endowment insurance lessens.

With regard to the endowment insurance issue, if an interest group can be

formed among the rural residents, the game of tripartite correlations carried out

among the rural interest group, the urban interest group, and local governments can continuously perfect the voting rights rules and direct the voting rights rules to develop towards fairness, namely, voting rights are proportional to population:

γ1 = a n 1, γ2 = a n 2 (21–6)

γ1 stands for voting rights of rural residents, a is a constant larger than zero, n 2 refers to the rural population, γ2 refers to the voting rights of urban residents, and n 2 refers to the urban population. Substituting equation (21–6) into (21–5), we have:

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m1 n1 = 1 m2 (21–7) n2 The equation indicates that owing to the engagement of rural and urban interest groups, as well as the voting rights of the interest group being simply proportional to the population, the ratio of local governments’ per capita investment between rural and urban endowment insurance, no matter what status the urbanization level is, equals 1. The conclusion above originates from the assumption for equation (21–6), which means that the voting rights of the interest group are simply proportional to the population of it. As a broad hypothesis, it is hard to realize in real life. An election with freedom and fairness is close to this idea. In each election, every citizen, no matter government official or plumber, no matter rural or urban resident, is entitled to one vote, which will be close to the hypothesis of the equation (21–6). China, in the short-run, is unable to implement the election with freedom and fairness, but at least is able to get close to democracy. The word “democracy” contains abundant connotations and implications. Democracy is a lifestyle, a kind of regime, a governing method, a type of state, a status of spirit, and a legal proceeding. Democracy means individual freedom, individual respect, and equivalent opportunities. It also means elections with freedom and fairness, majority principles, and freedom of expression. With the continuous promotion of democracy, the ratio of voting rights between rural and urban residents has been rising and the ratio of local governments’ per capita investment between rural and urban endowment insurance has been moving towards 1.

Conclusion In accordance with the above research, the basic conclusions we achieved are stated below: The ratio of local governments’ per capita investment between rural and urban endowment insurance will grow with the development of urbanization level; the engagement of urban interest group will decrease the degree of growth; if an interest group can be formed among the rural residents, and in the game of tripartite correlations carried out among rural interest groups, urban interest groups, and local governments, the voting rights rules can be lead to develop in the direction of fairness (voting rights are in simple proportion to the population), the ratio of local governments’ per capita investment between rural and urban endowment insurance will increase

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

significantly under the condition of satisfying the utility maximization of local governments. Based on this conclusion, we believe that establishing sound and perfect rural endowment insurance is closely related to two factors as follows: 1. Urbanization. The higher the urbanization level, the larger the ratio of local governments’ per capita investment between rural and urban endowment insurance will be. The measures of speeding up urbanization process are stated below. “Burden reduction” means indeed reducing various kinds of charges and non-necessary credentials so as to lower the cost of peasants who seek employment in the cities; “service” means creating a sound environment for the peasants to seek employment in the cities; “leaving ground for retreat” means the government should not take back the peasants’ contracted land immediately after they seek employment in the cities in order to resolve their worries for no place to go back; more importantly, the household registration system should be reformed to break the dual households structure between urban and rural areas, establish a unified household registration system in urban and rural areas, relax the limitation of residence migration, and so on. 2. Power of peasants’ interest group. The government should enhance the democratic political construction and improve the efficiency of communicating between the people and the government. It is especially important to strengthen the rural democratic political construction, bring the villager election system into play, increase the population of peasants’ deputies to the national people’s congress and Chinese People’s Political Consultative Conference (CPPCC) members and establish the supervision mechanism of peasants to the representatives, avoiding “alienation” of representatives from the peasants. The peasants’ education level should be raised to make their thoughts and suggestions expressed in an effective way, so that the local governments can adjust the policy based on their opinions. Government should allow the peasants to develop appropriate scale management with various kinds of land contractual management rights, so as to hasten the production of a batch of interest groups standing for the peasants’ interest.

Cases Analysis With the acceleration of urbanization and aggravation of aging trend, the practice of rural social endowment insurance remarkably suffers from system bottlenecks in different degrees. However, the system innovation and reform with distinctive features in Jiangsu and Zhejiang has brought rich experience and new hope for the development of China’s rural social endowment insurance system.

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Rural endowment insurance system in Ningbo As an open coastal city located in the Yangtze River Delta area, Ningbo in Zhejiang Province actively explores the new-model rural endowment insurance system which suits its local reality, as the province takes the lead in realizing an overall well-to-do society and advance modernization. It brings abundant experiences together and creates hope for the rural endowment insurance system in China. The rural social endowment insurance system of Ningbo, before the implementation of the new system, was positioned at the endowment insurance of individual accounts accumulation model, with insurance funds mainly being paid by individuals and supplemented by the village collectivity. The government basically did not invest in the insurance. Therefore, there is no “guarantee” for payment. Government’s investment on rural social endowment insurance is in stark contract with the expenditure of urban social security, with a serious problem of insufficient investments of the government. While with regard to the collective investment, due to the existing imbalance of collective economic development among different villages, there are only a few village collectives with strong economic strength which can provide collective subsidies for the villagers. Therefore, the model of rural social endowment insurance is transferred into one of individual accumulation model, which loses the feature of mutual assistance that the social insurance system should have. With the accelerating of urbanization in Ningbo and the deepening of “changing village to residential community,” a great amount of peasants’ land has been expropriated. For that the urban endowment insurance system is relatively well-developed but the rural one is fragmentary, the connection between the two systems is one of difficulty, so is making the landless peasants all participate in the urban endowment insurance system. After the land expropriation, the labor settlement allowance for each peasant, in general, ranges from ten thousand to tens of thousands of RMB, plus the land-use compensation fees from villager collectives, only with totals from RMB20,000 to RMB30,000. The endowment insurance is fairly low, which is far from being able to replace the protection of land to peasants. The endowment insurance system for landless peasants is a closed security system of one-time payments without effective compensation of security funds, due to the fact that the funds can hardly realize self-balance through a virtuous cycle of descendants paying and the predecessors enjoying. With the passage of time, the funds will certainly be unable to make ends meet. To provide for the elderly among the landless peasants, in the winter of

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

2002, Ningbo city took the lead in introducing the old-age security measures for the landless peasants. The measures regulate that the administrative villages’ permanent residence villagers, whose land of over 60% are expropriated, are able to voluntarily participate in the social endowment insurance. Adopting the method of one-time payments and enjoying monthly benefits after achieving the age of retirement, the endowment insurance has a three-tier payment standard and insurance treatment. Since January 1, 2008, the endowment insurance treatment of landless peasants has been increased RMB20 per month per capita, that is to say, RMB420 / month for level one, RMB370 / month for level two and RMB320 / month for level three. Accordingly, insurance-participation payment standard of landless peasants will be adjusted as well. The fund paid is from three aspects (government, collectivity, and individuality) in which there is no hard-and-fast rule for collective payment. Governmental subsidies per capita range from RMB4,000 to RMB6,000. By the end of 2008, there have been 132 towns and streets, 2,127 villages implementing the endowment insurance system for landless peasants. The rate of coverage of landless villages amounted to 96.9%, with the accumulated insured of 538,600. After that, Ningbo extended the endowment insurance to the mass rural population. In 10, 2007, after repeated investigation and argumentation, Ningbo printed and distributed Advices on Establishing New Rural Old-Age Insurance System . The document raised the overall structure of system establishment, and required the establishment of a new endowment insurance system which suits the overall level of rural economic and social development to be basically finished before the end of 2008. The new rural endowment insurance fund is mainly made up from individual payments and appropriate subsidies from the government, with the encouragement for the various economic organizations such as village collectives to provide certain subsidies for the insurance participants. The regions should, in accordance with the principle of rights corresponding to duties and based on the actual income of local peasants, make sure the standard and method of payment is reasonable by thorough calculation, under the premise of ensuring the sustainable operation of the fund. The regions should increase the financial investment to form a stable fund pooling system of governmental subsidies, and spare a certain proportion of the total insurance payment of the previous year for the insurance fund. The proportion should be adjusted according to the actual payment condition. The method of capital subsidies is determined according to the local reality by the local government, and the subsidy fund can be arranged from the annual budget, realization and proceeds of state-owned assets, etc. The subsidy fund of the government is mainly shouldered by the local governments, and the specific

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proportion of the two-class finances — county (city) level and township (street) level — is verified by the local governments. By the end of 2008, the population participating in the new rural endowment insurance all over the city had reached 85,000, in which 82,000 people have received the pension monthly. In February, 2009, Ningbo realized overall coverage of new rural endowment insurance system, together with the previous endowment insurance for landless peasants, and urban workers’ endowment insurance system enjoyed by peasants who have transferred to the second and tertiary industries. All the above symbolizes that the peasants of Ningbo have parted from the traditional rural old-care methods, entering into the modern social security system.

Suzhou model Since the 1990s, in the process of industrialization and urbanization, Suzhou has acquired substantial achievement in economic development, meanwhile, landless peasants in quantity appeared, which is a side-effect of urbanization. To bring the urbanization of the population into synch with the non-agricultural process of the rural labor force, we have to establish a social security system integrated both in urban and rural areas. In accordance with the general train of thought of “landfor-security,” Suzhou takes the lead in reforming the traditional resettlement compensation measures, and adjusts the one-time resettlement compensation measures for expropriated land in the past into an annual compensation, establishing a land compensation mechanism and special account for compensation funds. The basic living allowance fund for the landless peasants should be established, incorporated into the management of special financial account, which is earmarked for ensuring the basic living of landless peasants. Meanwhile, the eligible landless peasants should be incorporated into the endowment insurance system for urban staff and minimum security system for urban residents. Under such a background, in accordance with the general train of thought of social security, the endowment insurance system covering rural and urban areas is established in Suzhou city, with various categories for different insured under an united social endowment insurance system: Incorporating the rural labor primarily engaging in agricultural production (including planting industry and breeding industry, etc.) into rural basic endowment insurance, to initially establish the rural basic endowment insurance system with pure peasants as the main participants; incorporating the rural enterprises and their employees into the endowment insurance of urban enterprises staff; allowing the old-age peasants (males over 60, females over 55) to be able to obtain a pension subsidy of RMB100–120 per month without any payment.

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Research on the Financing Model of Rural Endowment Insurance in the Yangtze River Delta

As for the choosing of endowment insurance models, we should carry out the model of combining social pooling and individual accounts, which is the same as the model of urban endowment insurance. It is regulated in Suzhou that 11% of the insurance paid is included in the individual accounts, the rest into pooling funds. At the same time, in accordance with the principle of separating public service from politics, we should enhance the construction of rural endowment insurance agencies which take charge of the calculation and collection of rural basic endowment insurance fees, management of individual accounts, distribution of retirement pensions, and providing specific operation works such as consulting services related to rural basic endowment insurance. The old rural insurance in Suzhou before 2003 adhered to the basic principle of “individual payment-oriented, collective payment-supplemented, and the state providing policy support” and carried out the individual account model of savings accumulation. In 2003, Suzhou implemented new rural insurance, and took the lead in introducing guidance of reforming and improving the rural endowment insurance system. Suzhou had been the first to implement public finance subsidizing directly via the rural endowment insurance system, with a new mechanism of co-financing of the individual, collective, and public finance mechanisms. The financing subsidy providing for peasants is up to 50%–60%, which reflects the fund-raising principle of current social insurance. As the feature of Suzhou’s rural insurance model, “individual payment + collective subsidies + government subsidies” is also the key mechanism of new rural endowment insurance, which specially emphasized the flexible subsidy proportions from the government and the collective, each county being able to determine the proportions by themselves according to their own economic bearing capacity. Such a fund-raising channel ensured the diversification of fund sources, thus being able to increase the motivation to participate in the insurance by peasants. It is the construction of a steady and rational rural insurance fund-raising mechanism in Suzhou that reduces the heavy burden of peasants and then increases the motivation of insuranceparticipating for the agricultural workers. By June 2007, the number of rural laborers who participated in the basic endowment insurance (including rural and urban basic endowment insurance), in Suzhou reached 1.8 million, with coverage of 92%; the number of the rural old-age residents of the city who enjoyed the monthly basic old-care treatment and social endowment subsidies amounted to 0.8 million, with coverage of 96%; the number of landless peasants who were incorporated into subsistence security was .091 million. The rural social endowment insurance undertakings have achieved preliminary staged achievements.

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Comparison of two models From the above practice of rural social endowment insurance, there are some common features of the two cities stated as below: First, they both provide subsidies for the pure peasants with explicit subsidy proportion. With regard to the fund-raising, they both not only regulate the explicit payment proportion, but also provide collective or financial subsidies for the participation of pure peasants who are not employed. Second, the payment standards are generally upgraded and the methods of payment are more flexible. Third, system innovation is beneficial to the connection of the insurance between rural and urban areas. No matter from the standard and method of payment or the change of account model, it is visible that the basic orientation of the rural social endowment insurance system in both cities is urban-rural integration. The model of Suzhou, in financing, established the mechanism of combining financial support, collective subsidies, and individual payments, which broke out of the primary model of an individual payment-oriented system. It is related to the high economic development level, advanced collective economy, and the higher level of urbanization level of Suzhou. The above factors play a decisive role in the adequate funding from finance and the collective to be invested on rural endowment insurance. With the prevailing adjustment of financial expenditure structure, Suzhou enlarged its strength of financial investment to facilitate the insurance-participation of pure peasants, with the finance of county-level and town-level both achieving 50%–60%. Therefore, peasants’ motivation for participation is remarkably increased, and the coverage of rural endowment insurance is expanded notably. In accordance with the principle of government taking organizational leadership, peasants voluntarily participating, Ningbo raised funds by the method of combining individual payments, collective subsidies, and government support, and established the new rural endowment insurance model featured by “low barrier, multilayer, wide coverage and connection to urban insurance” with the adjustment mechanism of savings accumulation and enjoying treatment as the core, which provided necessary fund support for the subsistence of rural old-age residents. Government plays a domain role in the new rural insurance system, which not only shoulders the traditional responsibility of financial guarantee treatment when social insurance funding is inadequate, but also provides appropriate payment subsidies for the rural residents who participate in new rural insurance. The payment subsidies implemented indeed provide benefits to the peasants, which facilitates the implementation and promotion of the new system.

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The government made a great contribution both of the two models, mainly due to their high economic development level and urbanization degree. Suzhou model and the endowment insurance system of Ningbo, though, are successful and play essential roles in promoting rural endowment insurance system with the increasing increase of insurance coverage, it should be noted that the security levels and standards of the two models are comparatively low. Relative to the overall consumption expenditure of the peasants, the insurance proportion is very small and unable to indeed solve the old-care problem of peasants most of the time. Taking the rural endowment insurance of Suzhou as an example, which is relatively low compared with urban endowment insurance: The rural financing contribution of salary base is 50% of that of the urban standard, but the rural pension treatment equals to only 25% of that of the urban citizens. Rural endowment insurance itself is a top-bottom institutional transition. As the peasants are at the status of acceptor, the peasants cannot benefit from the system directly relating to them, in which the investment of the government being not in place is an essential element. It is visible that since the system of tax distribution of 1994, the administrative power of the government is unsymmetrical to its financial power. The funding scale and proportion of local governments to rural endowment insurance are influenced by various factors and the local governments are not of adequate financial ability to support substantial rural endowment insurance investment. With the restraint of limited funds, local governments are more willing to provide endowment insurance subsidies to the urban residents, which is a result of the current status of peasants who do not have voice in many issues and are lacking interest group standing for their interests. If the peasants compose a representative standing for their interest, who advocates on their behalf at the time of formulating policies and systems, the government may increase the expenditure on rural endowment insurance, and the security level of peasants will be remarkably increased.

Experience for reference To fully implement the new rural basic endowment insurance system, the essential element is government attaching importance, the basis is economic development, and the guarantee is strengthening management. In the implementation of the system, such aspects as financial funding and institutional setting can be in place only when the government highly values the insurance system. The high financial subsidies of the two governments

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remarkably increased the motivation of participation of the peasants. With different economic foundations supporting different system models, the rural endowment insurance systems of Ningbo and Suzhou cities both took shape under the premise of rapid economic development and the acceleration of the urbanization process. The reform and innovation of the rural insurance system in the two cities both produced and developed on the basis of the administrative promotion and financial support of the government, with the sound guiding and encouraging function of the government’s fund. But the financial pressure of the models is comparatively large and obviously impropriate for the regions with an underdeveloped economy. Therefore, in the process of establishing rural endowment insurance, we should at first make system policy which is suited to the local reality. It is undeniable in the two specific practices that the two cities both included the landless peasants into the rural social endowment insurance system. With the development of the economy and the prevailing implementation of the rural endowment insurance system, it can be promoted all over the country. Solving the problem of finding a stable funding resource is the key factor for the construction and sustainable development of the rural endowment insurance system. With regard to the raising of funding, the endowment insurance fund should adopt diversified fund-raising channel methods in accordance with the principle of “deciding the payment based on the expenditure.” The payment can be decided according to the per capita net income of peasants of the previous year or a certain proportion of the average contribution of the salary base of the urban staff. The ceiling of individual payments should be set and is published by the administrative departments of labor security each year. The system of financial and collective subsidies should be established and the rural insurance funds should be raised by the method of combining “individual payments, financial and collective subsidies.” Stable and rational financing mechanism is capable of laying foundation for perfecting the rural endowment insurance system.

Enlightenment on the Rural Endowment Insurance Practice in the Yangtze River Delta Area First, we should accelerate economic development and urbanization. On the one hand, as economic development is the basic guarantee of the development of the rural endowment insurance system, the sound rural endowment insurance system is hard to take shape with low-level economic status. The economy in the Yangtze River Delta area is relatively developed which is the foundation for

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establishing the sound rural endowment insurance system. On the other hand, we should continuously speed up urbanization. With a relatively high urbanization level and a small population of peasants in the Yangtze River Delta area, subsidies of local finance to peasants draw attraction from peasants to participate in rural endowment insurance, which is the key to developing a rural endowment insurance system. Second, the government has to increase financial subsidies to effectively protect the interests of peasants. The subsidy for peasants in Ningbo reaches up to RMB5,000–RMB6,000 and the subsidy in Suzhou reaches up to 50%–60% of the insurance. Enough subsides are able to attract peasants to actively participate in the rural endowment insurance system, which is the guarantee of the high coverage of Ningbo and Suzhou. Western scholar Winkler, who studied the financial status of rural pension in the European Union (EU) member countries, believed that: “No rural social security organization can pay the pension of peasants and their relatives solely by the payment of peasants. They all have to rely on the governmental subsidies and raising funds from the other channels.” Peasants, relatively speaking, belong to the vulnerable group, who have no say in policy-making. The local governments usually do not protect the peasantry group’s interest, but damage their interest. To develop and perfect the rural endowment insurance system, local governments have to foster an awareness of respecting and protecting the interests of peasants, and effectively protecting the interest of peasants. Third, we should strengthen innovation of the system. Although rural social endowment insurance has been promoted in the rural areas of China for about 20 years, the system has not been established in most areas around the country. Many areas participating in the trial program have stopped partway through. Even in the promoting process of the system in such regions as Ningbo, Suzhou, they have to improve and increase the system continuously so as to make it survive, suiting the development of the times. The other areas have to redefine the Basic Profile of the Ministry of Civil Affairs and reform the system, to make it adaptable to the changes of rural areas. Such questions as how to solve the elder-care issue of “landless peasants” and “peasant-workers,” what the nature of the system is, and how to define the objectives are all the essential issues in the innovation of rural endowment insurance system in the new age. Fourth, we should cancel constraint of urban and rural household registration. Staffs (with issued labor contract) are allowed to participate in the urban basic endowment insurance system in Shanghai, Zhejiang, and Jiangsu. Being of rural household registration, they can make a choice between “urban insurance” and “rural insurance.”

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Fifth, the insurance level has to adapt to the local productivity growth. With the development of society and approach of aging times, government’s expenditure on pensions is increasing. The pension expenditure of EU member countries has become a heavy burden of the state, thus leading to the reform of the pension system. The practice of the EU reminds us that the development of the endowment insurance system has to adapt to the development of productivity. Development of rural endowment insurance in such regions as Suzhou and Ningbo is in a progressive way, with local governments’ subsidies and contribution standards for peasants increasing in a gradual way according to the local economic status. The other regions have to lay down the standards of subsidies and payments in accordance with the local financial status and peasants’ income levels, so as to guarantee the sustainable development of the rural endowment insurance system.

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Notes Chapter 2 1. The per capita GDP used here is not directly quoted from the statistical yearbook, but it is the result of the author’s own calculation. The calculation process is as follows. Per capita GDP = the total GDP of all prefecture cities in the region i / the total population of these cities in the region i. 2. Please refer to Xinhua Daily , August 22, 2007. 3. Normally, it is possible for labor flow to occur inside the same sector of the same region. But in the institutional wages difference system of this chapter, as the wages of agricultural sector in a region are the same, there is no incentive for labor flow within the sector. 4. When w nm > w sa , namely, the wages of the industrial sector in the undeveloped region surpasses the agricultural sector in the developed region, labor transfer may occur. But such a labor transfer will be ignored in this chapter to simplify the discussion. 5. Please refer to the official website of the Jiangsu provincial government: http://www.jiangsu.gov.cn/. 6. Examples are plentiful. The provincial government of Jiangsu founded a team to coordinate the development of the province’s northern part; the establishment of the river-bank industrial belt and ports along the sea coast is in part aimed at facilitating the development of central and northern Jiangsu Province; in October 2006, the Jiangsu branch of the Agriculture Bank of China signed contracts with 26 enterprises in southern Jiangsu Province that had plans to invest in the north, which, according to the contract, will all together receive RMB12 billion worth of credit support from the branch; in 2007, the China Development Bank provided a loan of RMB600 million with a ten-year maturity for the Sushu Industrial Park, which was to use the money in infrastructure construction. All this information can be found in the official website of the Jiangsu provincial government: http:// www.jiangsu.gov.cn/. There are also some entrepreneurs who invest in the north with government support, like the Changjianrunfa Group located in Zhangjiagan, which participated in the Shuyu industrial park in Shuqian (please refer to Xinhua Daily , June 23, 2005). 7. By conducting empirical study based on the data of Britain, these scholars found that the capacity of the economy of scale is affecting spatial income

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differences through productivity, while factors related to the types of jobs account for about one-third of such a difference. This means that, for enterprises in developed regions, the effects of the economy in scale outweigh the rising operating costs. 8. Because the total volume of foreign trade is calculated in U.S. dollars, but GDP is calculated in Renminbi, this chapter converts the two values with the exchange rate in the year these data were collected, so as to obtain the scale of the international market. Most of the indicators of this chapter are in the form of ratios. The advantage of using ratios is that we can ignore the effect of price difference, as it is very difficult to obtain the price index at the prefecture city level. The letters in the brackets are symbols of variables. 9. The reason why the span of data starts from 1996 is that Shuqian in the north was founded in July 1997. Because we use the data of 13 prefecture cities, including Shuqian, we can only start from 1997. The Shuqian data includes data from Shuyang County, Siyang County, Shuyu District, and Shucheng District. 10. The value of χ 2 obtained from the Haussmann is negative; therefore the original assumption cannot be rejected. The result of the random effects regression and that of the mixed effects regression are the same, but there is a slight difference in their levels of significance. Therefore, there is no difference between the regression results (1) and (2) from Fig. 2.6.

Chapter 3 1. Among those policies, the reform of the fiscal institution is one of the most important ones. In 1980, the fiscal institutional relationship between the central government and local governments started to follow a system that separately settled their respective accounts, rather than following a centralized plan as before. This new fiscal system basically followed the ownership of different enterprises, namely, distributing the revenue of central government-owned enterprises to the central government, and that of local government to local government, therefore drawing a distinct line between the boundaries of income and expenditure for both local and central governments. Such a separate fiscal system makes the boundaries of fiscal distribution of the central government and local governments clear, therefore accelerating the separation of local interests from the central government and the formation of local interest entities. In June 1983, a reform replacing the old system under which state-owned enterprises

556

Notes

2.

3.

4.

5.

handed in their revenue to the central government with a new system under which these enterprises paid a certain amount of taxes to the central government and kept the rest of their revenue. This settled the distribution relations between the state and enterprises in the form of law. For example, a special policy was given only to Guangdong and Fujian provinces during 1978 and 1983, where Shenzhen and Zhuhai special economic zones were also founded. Five years later, the opened zone was extended to 14 coastal cities, with Dalian at the opened zone’s northernmost point and Beihai at its southernmost point. In 1985, the coastal opened zone was further extended to cover the Yangtze River Delta, Pearl River Delta and Southern Fujian Delta. In 1987, the Hainan province was founded, which was given even more special policy than special economic zones. In 1988, the central government implemented the coastal strategy, which aimed to accelerate the development of the export-oriented economy of the coastal region and reshape the region into an open region with special economic zones, open cities and open areas. During 1988 and 1995, the central government made it clear that there should be a balanced development between western and eastern China. From 1995 till now, the strategic focus has shifted into inland China, including the western part of the country. In 1996, the strategy of the great development of the west was formally announced. The two managerial levels refers to the municipal SASAC and the district-level bodies that were authorized by the former to manage stateowned assets. The three systems refers to the management system, operational system, and supervisory system. The three levels refer to an asset-management structure comprised of the municipal SASAC, asset management companies authorized by the SASAC, and entity companies. The first one was the end of the use of food coupons, which marked the end of the planned economic era characterized by material shortages and the beginning of the market economic era characterized by material surplus. The second breakthrough refers to the opening of the stock market, which instantly caused a nationwide fever for it, as overnight success was made possible. The third breakthrough refers to the reform in TVEs. Family-based business typically featured the family’s or individual’s ownership of the production means. Such business operates with mainly the household members and a few workers and within the dwelling of the family, which is often a processing industry that uses locally produced raw materials. The low technological and capital requirement of such a business means that it is suitable for most families to operate.

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6. Du Runsheng, “An Interpretation of the Economic Pattern of Wenzhou,” http://www.tecn.cn/data/detail.php?id=3431.

7. Those policies included, allowing the two households to not contract with the government to use farmlands, allowing the two households,

either individually or collectively, to contract with the government to use hills, beach and sea surfaces that had not been developed or had

been developed but had not been used for any economic activities by the agricultural cooperatives, allowing the two households to employ three to

five apprentices or laborers after their application was granted, allowing

the meeting of the producers and sellers of products other than foods and woods after the state-planned procurement and allocation of such products, allowing private business and dealers to make long-range transportation

under the planning of the state and the unified regulation of industrial

and commercial administrative government bodies, and supporting the development of the two households by providing them with materials

such as seeds and animal feeds, capital, technological support, information services, and product marketing.

8. Hong Yinxing, “The New Development of Southern Jiangsu Model and the Transition of Local Governments,” Review of Economic Research 72 (2005).

9. Vi c k e r s , J o h n , Ya r ro w, a n d G e o rg e , “ E c o n o m i c s P e r s p e c t i v e s o n Privatization,” Journal of Economic Perspectives , Spring 91, Vol.5, Issue 2

(1991):111–132.

Chapter 4 1. In order to be promoted, officials will generally work hard to promote local economic growth, which is highly related to the level of efforts paid

by these officials. It is also worth mentioning that, presumably, there are

some officials who forge inflated figures instead of paying actual efforts to promote economic growth. However, reported figures are still hopefully

reliable to some extent, because if all reported figures are inflated, which

was the case in the 1950s, China’s economy as a whole would have imploded a long time ago (Zhang Jun 2005).

2. To simplify the research, we presume that the two correlation coefficients of the two governments are the same.

3. For more details, please refer to the 1999 key research topic of the Zhejiang province, Research on the Strategies to Achieve an Early Completion of

Modernization for Cities and Townships .

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Chapter 5 1. Please refer to the website of Jiangsu Statistic Bureau: http://www.jssb.gov. cn/jstj/fxxx/sxfx/200803/t20080306_99263.htm. By the definition of the region provided by the Guidance in Further Promoting Reform and Opening Up and Socioeconomic Development in the Yangtze River Delta published by the state council in September 7, 2008, the region includes Shanghai, Jiangsu, and Zhejiang. However, many of the references of this chapter use the term Yangtze River Delta to mean eight cities in Jiangsu, seven cities in Zhejiang and Shanghai. To avoid ambiguity, in the following, the term Yangtze River Delta should only mean the 16 cities if not otherwise specified. 2. Shanghai Statistic Bureau, The 2008 Shanghai Statistic Yearbook (Beijing: China Statistic Press, 2008). 3. The Outline stipulates that the strictest measures must be implemented to protect the farmland and nature reserve along the Shanghai-NingboHangzhou line, land for construction use should be prioritized along the Yangtze river and the Hangzhou bay, only an appropriate amount of construction land should be approved along the sea coast, the NingboHuzhou-Hangzhou line and other roadside developmental line, and land development should be restricted in areas around Taihu lake. 4. Chen Jianjun, “Three Waves of Economic Integration of the Yangtze River Delta,” China Economic History Study 3 (2005):114. 5. In June 1, 1988, the planning commission annulled the planning office in Shanghai. 6. By 2007, the Economic Coordination Meeting of 16 Cities in Yangtze River Delta had been convened eight times. By March 2008, the governments of Shanghai, Zhejiang and Jiangsu signed a contract with the people’s bank of China in Shanghai agreeing to push financial coordination of the three places and support regional integration. 7. Cities in the region, in order to attract FDI, often offer preferential policies to foreign investors in land price, tax, etc. For example, an industrial park of a city in the region sold one Mu of land that costs RMB220,000 to develop, to foreign investors at the price of RMB50,000, and even gave some investors for free. (Please refer to “The third wave of repeated industrial construction,” http://hsb.hsw.cn/gb/newsdzb/2003 06/20/ content_319038.htm) 8. Please refer to “The third wave of repeated industrial construction,” http:// hsb.hsw.cn/gb/newsdzb/2003 06/20/content_319038.htm.

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Notes

9. Fu Wenlin, “The current situation, economic effects and planning of interprovincial competition,” Statistic Study 11 (2005). 10. U.S. Advisory Commission on Intergovernmental Relations, 1991 “Interjurisdictional Tax and Policy Competition: Good or Bad for the Federal System?” quoted in Kenyon, D.A. “Theories of interjurisdictional competition”, New England Economic Review , (Mar / Apr 1997):14. 11. Even in capitalist countries where the economy has basically been privatized, interregional competition is impossible to completely avoid, as local officials still have to pay attention to the economic growth and employment of their jurisdictions under the public election system based on which they will be elected. Furthermore, lobbying interest groups will often affect government decision-making and convince local governments to give preferential policy to their jurisdictions. 12. In the neoclassic investment theory, investments in reality are often categorized into two groups, the net investment and replacement investment. Replacement investment is mainly used to replace depreciated capital, therefore it could be expressed as = δKt–1 , with representing the level of replacement investment at period t, δ representing depreciation, and K t–1 representing the capital stock level of the last period. Net investment will be affected by the state of the economy. According to neoclassic investment theory of Jorgenson et al., under equilibrium, the condition of investment decision-making in a firm should be that the expected marginal profits of investment are equal to the expected marginal cost of capital. Presume that there is no elasticity of substitution in the production techniques of the firm, then the favorite optimal level of capital stock of the , with K* t representing the favorite optimal level of firm will be capital stock of the firm, α being a parameter, Y t the output level of period t , C t the marginal user cost of capital in period t and σ the substitution rate of capital and production variable input. Considering that there is a time lag from investment to return, we will use a distributed lag function to represent the demand of economic sector for new investment, which, after a series of simple algebraic transformations, will become the quantitative test function of this chapter. 13. The province-specific capital stock data includes a sequence calculated on the basis of the report of Zhang Jun (2004). Other data is all from the China Statistic Yearbook. 14. Zhen Yusheng and Li Chonggao (2003) believe that the overall losses due to regional protection and market separation are on the rise after the reform and opening up. In 2000, such losses reached 20% of the total output.

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Notes

Liu Peilin believes that, although regional protection does inflict losses in efficiency, it never reached the degree mentioned in the study of Zhe Yusheng, et al. (2003). 15. However, in our previous research, we find that Shanghai, as the leading force in the region’s economic development, did not provide sufficient support for the manufacturing industry in Jiangsu and Zhejiang (Liu Zhibiao, et al. Service Driven Yangtze River Delta (Beijing: People’s University Press, 2008)). 16. Jiang Xinhe, “Shanghai approved the entry of 33 headquarters economy foreign firms,” Jiefang Daily (July 16, 2008). 17. For sure, before 2008 when corporate income tax was combined, there were also a large number of firms combining taxes. For example, in 2007, the Nanjing Local Tax Bureau surveyed 56 firms, among which 34 firms reported tax combination, 24 firms combined corporate income tax, and several firms combined individual income tax as well. 18. Chao Peilin, An Extensive Discussion on Institutions (Beijing: People’s Press, 2005).

Chapter 6 1. Tiebout mechanism means to vote by the foot, namely, by relying on themselves, enterprises, and households to obtain the needed public goods. 2. The tobacco industry is ruled out because specially designed local taxes are imposed on it, making the industry inappropriate for our study as it is heavily affected by administrative planning.

Chapter 7 1. For sure, not all exporters can eventually come up with their own brands, but at least the first two points are essential to the success of an exportoriented enterprise. 2. The definition of the export miracle on the macro level is limited to the continuous rapid export growth of China as a whole. However, even from a macro perspective, export growth cannot forgo factors such as extensive product quality improvement and the optimization of product portfolio. 3. It is generally believed that, due to the large number of producers of a same product in a monopolistic competition market, the average price and quality of R is unrelated to the pricing and quality of R produced by the representative producer. 4. At this time, p i = p , and q i = q .

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Notes

5. This in fact means that, with the improvement in production capacity and costs of end products, the overall production costs will increase proportionally. 6. Comparing is valid.

(1—btS W) S W FMU a

and

(1—btS Ui) S Ui FMU a

, if S W > S Ui > 0, n ** < n *

1 7. From a further discussion of proposition 3, we will find that when bt