How Far Across the River?: Chinese Policy Reform at the Millennium 9780804767095

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HOW FAR ACROSS THE RIVER?

Stanford Studies in International Economics and Development Stephen H. Haber and John H. Pencavel, editors

The process of international economic integration has both ardent advocates and energetic detractors. Over the last half-century, the dramatic expansion of international trade and capital flows has been linked with unprecedented economic advances. At the same time, many view these closer economic ties as a major complicating factor in macroeconomic management, as well as a leading cause of financial crises. Moreover, nations share unevenly in global prosperity. Despite some conspicuous successes, many countries remain mired in underdevelopment and want. While supporters of integration attribute these failures mainly to deficiencies in developing countries' own policies, its opponents often attribute the failures to the self-same factors that help make some countries rich. These live and vital issues are the focus of the Stanford Studies in International Economics and Development. This series, which will include single- and coauthored books as well as edited collections of scholarly papers, deals with a broad spectrum of policy issues that influence the economic performance of low-income countries, including those engaged in the transition from command to market economies. The series concerns itself with the policy reforms that are urgently needed to raise the living standards of the world's poor, to enhance global cooperation and security, and to foster broader participation in the benefits engendered by growth in the global economy.

HOW FAR ACROSS

THE RIVER? ••••

Chinese Policy Reform at the Millennium •••• Edited by

Nicholas C. Hope, Dennis Tao Yang, and Mu Yang Li •••• Stanford University Press Stanford, California 2003

Stantord University Press Stanford, California ,:[;) 2003 by the Board of Tmstees of the Leland Stanford Junior University. All rights reserved.

Library of Congress Cataloging-in-Publication Data How far across the river? : Chinese policy reform at the millennium I edited by Nicholas C. Hope, Dennis Tao Yang, and Mu y;,ng Li.

p. em. Includes bibliographical references and index. ISBN 0-8047-4766-0 (alk. paper) 1. China-Economic policy-1976-2000. 2. China-Economic policy-2000 -. 3. China-Economic conditions-1976-2000. 4. China-Economic conditions-2000- 5. China-Social conditions-1976-2000. 6. China-Social conditions-2000 -. I. Hope, Nicholas C. II. Yang, Dennis Tao. TIL Yang Li, Mu. HC427.92 330.951-dc21

.H675 2003 2003009659

Typeset by G&S Typesetters in 10/12 Bembo Original Printing 2003 Last figure below indicates year of this printing: 12 11 10 09 08 07 06 05 04 03 Special discounts for bulk quantities of Stanford University Press books are available to corporations, professional associations, and other organizations. For details and discount information, contact the special sales department of Stanford University Press. Tel: (650) 736-17S3, Fax: (650) 736-1784 Stanford Center for International Development (formerly the Center for Research on Economic Del!elopment and Policy Riform)

To the memory of Ken MacLeod, who had the vision

CONTENTS Figures IX Tables x1 Acknowledgments xv About the Contributors xvii Economic Policy Reform in China

1

Nicholas C. Hope, Dennis Tao Yang, and i"vfu Yang Li

PART 1: POLICY REFORM IN CHINA: WHAT IS NEEDED NEXT? 29 2

China's Transition to a Market Economy: How Far Across the River? 31 Yingyi Qian and ]in.stlian Wu

PART II: BUILDING MARKET -SUPPORTING INSTITUTIONS 65 3

When Will China's Financial System Meet China's Needs?

67

Nicholas R. Lardy

4

Thriving on a Tilted Playing Field: China's Nonstatc Enterprises in the Reform Era 97 Chong-En Bai, David D. Li, and Yijiang Wang

5

The More Law, the More ... ? Measuring Legal Reform in the People's Republic of China 122 William P. Alford PART III: TOWARD GREATER ECONOMIC INTEGRATION 151

6

Trade Policy, Structural Change, and Chim's Trade Growth

153

William 1\Jartin, Betina Dimaranan, Thomas W Hertel, and Elena Tanchovichina

7

Sizing Up Foreign Direct Investment in China and India Shang-jin Wei

178

vm

Contents

8

How Much Can Regional Integration Do to Unify China's Markets? 204 Barry Naughton

PART IV: SHARING RISING INCOMES 9

China's War on Poverty

233

235

Scott Rozelle, Linxiu Zhang, and ]ikun Huang

10

Social Welfare in China in the Context of Three Transitions

273

Athar Hussain

11

Housing Reform in Urban China ]~[frey

313

S. Zax

PART V: SUSTAINING POLICY REFORM 12

351

Can China Grow and Safeguard Its Environment? The Case ofindustrial Pollution 353 David Wheeler, Hua Wang, and Susmita Dasgupta

13

The Political Economy of China's Rural-Urban Divide

389

Dennis Tao Yang and Cai Fang

14

What Will Make Chinese Agriculture More Productive?

417

Jikun Huang, Justin Y Lin, and S(ott Rozelle

15

Bending Without Breaking: The Adaptability of Chinese Political Institutions 450 Jean C. Oi PART VI: FURTHER RESEARCH

469

16 Agenda for Future Research 471 Nicholas C. Hope, Dennis Tao Yang, and Mu Yang Li Index

483

FIGURES

1.1 1.2 6.1 6.2 6.3 8.1 8.2 8.3 8.4 8.5 8.6 9.1 9.2

9.3

9.4 9.5 9.6 9.7

Transformation of the Sectoral Structure of the Chinese Economy 7 China in the World Economy 8 China's Share ofWorld Exports 155 The Share of Exports of Goods and Nonfactor Services in GDP 155 Changes in the Composition ofExports from China 156 Outflows and Exports, Twenty-Five Provinces 210 Inflows and imports, Twenty-Five Provinces 211 Total Provincial Outflows, 1987 and 1992 212 Total Provincial Inflows, 1987 and 1992 213 Energy and Transport Intensity of GDP 219 Infrastructure Investment: Major Trends 220 Investment-to-Wage Spending Ratio in Shaanxi, 1982-92 243 Poverty Alleviation Investment Per Capita and Proportion of Investment by Source in Forty-Three Sample Counties in Shaanxi, 1986-91 244 Poverty Alleviation Investment Per Capita and Proportion of Investment by Users in Forty-Three Sample Counties in Shaanxi, 1986-90 246 Total Provincial Poverty Investment in Sichuan, 1991-95 247 Provincial Investment of Total Poverty Funds, by Target Sector, in Sichuan, 1991-93 248 Total Provincial Poverty Investm.cnts in Industry, by Program in Sichuan, 1991-93 249 Total Provincial Investments in Agricultural Infrastructure, by Program in Sichuan, 1991-93 249

Figures

x 9.8 9.9 9.10 9.11 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.8 12.9 12.10 12.11 12.12 12.13 12.14 12.15 12.16 12.17 12.18 12.19 13.1 13.2 13.3

Total Provincial Poverty Investments in Transportation Infrastructure, by Program in Sichuan, 1991-93 250 Total Provincial Poverty Investments in Other Sectors, by Program in Sichuan, 1991-93 250 Gross Per Capita Income in Sichuan's Poor and Nonpoor Counties, 1985-95 255 Net Per Capita Income in Sichuan's Poor and Nonpoor Counties, 1985-95 257 S0 2 Emissions and Atmospheric Concentration in Chinese Cities, 1991-93 354 Projected Deaths from Air Pollution, 1997-2020 355 Provincial Pollution Intensities 356 Provincial Pollution Levies 357 Provincial Differences in Citizen Environmental Compbints 359 COD Intensity Factors: Effect and Significance 360 S0 2 Intensity Factors: Effect and Significance 360 Output Share of Large Plants 361 S0 2-Intensive Sectors: Manufacturing Share 362 Trend in the Output Share of the Five Dirtiest Industrial Sectors, 1977-92 363 Trend in Net Imports from Pollution-Intensive Industries, 1987-94 363 Consumption-Production Ratio ofPolluting Products, 1987-92 364 Particulate Marginal Abatement Costs: Large Plants 366 Particulate Marginal Abatement Costs: Small Plants 366 COD Loads in Three Scenarios 374 Industrial S0 2 Loads in China 376 Lives Saved by S0 2 Regulation, 1997-2020 3 77 Total Deaths from Industrial Air Pollution, 1997-2020 378 Additional S02 Abatement in Zengzhou: Marginal Benefits and Costs 382 Ratio ofUrban to Rural Consumption and Income 396 Changes in Relative Agricultural Price and Relative SOE Wage Growth 402 Shares of Government Expenditures and Loans to Agriculture 407

TABLES

2.1 2.2 2.3 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9

Ownership Composition in Industrial Output 53 Ownership Composition in Retail Sales of Consumer Goods 53 State-Owned Industrial Enterprises by Size, 1993 55 Interest Outlays on Domestic Treasury Debt, 1993-98 76 Financial Sustainability in China, 1998-2008, Base Scenario 79 Fiscal Sustainability in China, 1998-2008, Revenue Enhancement 81 Fiscal Sustainability in China, 1998-2008, Commercial Bank Behavior 82 Fiscal Sustainability in China, 1998-2008, Revenue Enhancement and Commercial Bank Behavior 84 Working Capital Lending, 1991-99 87 Price Changes, 1994-98 88 Growth Rates of Industrial Output: State Sector versus Nons tate Sector 100 Development ofTVEs, 1980-95 101 Growth Rate ofTVEs Output and Employm.ent, 1981-95 102 Share of Nonagricultural Employment: State Sector versus Nonstate Sector 103 Share oflndustrial Output: State Sector versus Nonstate Sector 103 Share Contributed to Industrial Growth: State Sector versus Nonstate Sector 104 Types ofEntry Barriers by Firm Size 105 Share of Total Fixed Investment: State Sector versus Nonstate Sector 106 The Nonstate Sector's Share in Total Short-Term Loans from State Banks 107

Xll

4.10 4.11 4.12 4.13 6.1 6.2 6.3

6.4 6.5

6.6 6.7 6.8 6.9 7.1 7.2 7.3

7.4 7.5

7.6 7.7 7.8 7.9 7.10 7.11 8.1 8.2 8.3 8.4 9.1

9.2 9.3

9.4

Tables Sources of Private Firms' Initial Investment 107 How Private Firms Deal with Business Disputes 108 Most Important Social Problems Troubling the Operation of Private Firms 109 State versus Nonstate Sector: Government Budgetary Revenue 113 Share of Goods Sold at State-Fixed Prices, 1978-93 159 Contribution ofDifferent Firms to China's Trade, 1994 160 Products Covered by State Trading and Designated Trading 162 Share of Imports Protected by NTBs in 1996, Using 1992 Trade Weights 163 Changes in Average Tariff Rates in China, 1992-98 164 Final Tariff Bindings on Selected Agricultural Products 168 Cumulative Percentage Growth Rates, 1995-2005 170 Weighted Average Tariffs in China with and Without WTO Accession 172 Output, Exports, and Imports as a Share of the World Economy 173 Business Environment in Selected Countries, 1990s 179 Realized Foreign Direct Investment in China and India 181 Evolution ofLaws and Regulations in FDI in China and India 183 Sources of Foreign Direct Investment in China 188 Foreign Direct Investment Flow into China: Chinese versus Source Country Statistics 190 China as a Host for FDI Compared to Its Potential 194 Adding Public Policies and Public Institutions 195 Inflow ofFDI 197 Hong Kong Connection for FDI Stock 198 Hong Kong Connection for FDI Flow 199 Increment in FDl as a Result of Reducing Corruption and Red Tape 201 Domestic and Foreign Trade Ratios, 1992 209 Interprovincial Trade, 1987 and 1992 211 Characteristics of Goods in Interprovincial Trade 217 Provincial Priority Industries Selected for the Ninth Five-Year Plan 223 National Government's Investment in China's Poor Areas by Program, 1986-97 239 Estimates of the Number ofPoor in Rural China, 1984-98 251 Annual Growth Rates of Key Sectors in China's Rural Economy, 1970-95 252 Gross Per Capita Income (deflated) in Sichuan Counties, Grouped by Income Levels and Poverty Designation, 1985-95 254

Tables 9.5 9.6

9.7 9.8 10.1 10.2 10.3 10.4

10.5 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11 12.1 12.2 13.1 13.2 13.3 13.4 13.5 14.1 14.2 14.3

Xlll

Net Per Capita Income (deflated) in Sichuan Counties, Grouped by Income Levels and Poverty Designation, 1985-95 256 Income Levels and Program Designation ofSichmn Province's Poorest Counties 257 Results from Growth Regressions on County-Level Per Capita Incomes 258 Ordinary Least Squares Regression Explaining Income Levels and Growth in Sichuan Province, 1990 -95 261 Population Profile, 1998 and 2020 27 5 Age Structure ofWorking-Age Adults, 1982 and 1998 278 Sectoral Distribution of Labor Force 281 Causes of Death in Urban and Rural China 297 Sources ofHealth Financing 302 Dwelling Unit Size in 1988 and 1995 318 Other Housing Characteristics in 1988 and 1995 319 Tenure Type in 1988 and 1995 319 Monthly Rents and Housing Subsidies in 1988 and 1995 320 Actual and Estimated Market Monthly Rents in 1995 321 Correlations Between Estimated Market Rents and Actual Rents in 1995 321 Housing Finance for Owner-Occupied Housing in 1995 322 Correlations Between Estimated Market VJlues and Estimated Market Rents in 1995 323 Estimates ofHousing Construction Costs 325 Estimates of Subsidized and M:1rket Housing Sale Prices 326 Comparisons Between Housing Costs or Prices and Average Incomes 327 Projected Annual Deaths from Industrial S0 2 Pollution 377 Industrial S02 Abatement in Five Cities 380 Per Capita Consumption of Rural and Urban Residents 1952-97 393 Total Per Capita Disposable Income and Its Components for Urban Residents 395 Real Per Capita Total Income f(Jr Rural and Urban Residents 396 The Ratio of Nonagricultural Income to Agricultural Income: An International Comparison 397 Regional Development Policies and Their Geographical Coverage 403 Annual Growth Rates of China's Economy, 1970 -98 419 Changes in the Structure of China's Economy, 1970-97 420 Annual Growth Rate of Agricultural Economy by Sector and Selected Agricultural Commodity, 1970-97 421

XJY

14.4

14.5 14.6 14.7 14.8 14.9 14.10 14.11

14.12 14.13 15,1

Tables Capital Flow (billion yuan in 1985 price) from Agricultural/Rural to Industry/Urban Through Fiscal, Financial (banking), and Grain Procurement Systems 423 Nominal and Effective Real Protection Rates of Grain, 1985-98 425 Rural Enterprise (RE) Development in China, 1980-97 428 Agricultural Labor Productivity in China, 1978-97 429 Agricultural Research and Extension Expenditures in China, 1985-96 432 Trends of Output, Input, and Total Productivity tor Rice, Wheat, Soybean, and Maize in China, 1979-95 433 Experiment Station Yields, Actual Yields, and the Yield Gap in Sample Provinces in China, 1980-95 436 Elasticities ofTFP with Respect to Technology, Extension, and Other Factors for Rice, Wheat, Soybean, and Maize for China, 1982-95 438 Projections of Grain Production, Demand, and Net Imports Under Various Scenarios, 2005-2020 441 Grain Self-Sufficiency Rates Under Various Scenarios, 1994-2020 443 Toward Political Change in China 452

ACKNOWLEDGMENTS

This volume emerged from the conference on Chinese policy reform that the Center for Research on Economic Development and Policy Reform (CREDPR) of Stanford University hosted at Stanford in November 1999. Beyond the authors of the chapters included in this volume, the chief intellectual debt we owe is to the other participants in the conference who, as formal discussants of papers, chairs of sessions, or general commentators, enlivened the proceedings and contributed through the vigor of the debate to the revisions of the original papers. We thank, in particular, Professor Gregory Chow of Princeton University, the late Professor D. Gale Johnson of the University of Chicago, and Professor Lawrence Lau of Stanford University for contributions before, during, and after the conference that assisted us greatly in our task. We are grateful as well to Vice Minister Li Jiangc of China's State Council Office for the Reform of the Economic System fn firms were prohibited. Foreign exchange use was tightly regulated, and firms desiring to import raw materials, in principle, had to earn foreign exchange directly (at a time when no open market existed). There was a tight export performance requirement with, sometimes, 100 percent of the firm's output to be exported. In each of these areas, restrictions have been relaxed over time. For example, by now the annual value of inflow to establish wholly owned foreign firms (U.S.$16.5 billion in 1998) has exceeded that of contractual joint ventures (U.S.$9.3 billion in 1998) and is close to that of the equity joint ventures (U.S.$18.8 billion in 1998; Ministry of Foreign Trade and Economic Cooperation, 1999). Table 7.3 shows the evolution of all the major laws and regulations promulgated by the Chinese and Indian central governments affecting FDI. Three things are worth noting. First, in terms of the starting date of the reform, China was a decade ahead oflndia. 3 Second, on several occasions over the past two decades, the Chinese government promulgated laws and regulations specifically designed to attract investment frorn overseas Chinese, particularly those in Hong Kong, Taiwan, and Macao. Third, China offers supernational treatment to foreign firms. For example, foreign firms typically receive an exemption of income tax for the first two profitable years followed by three additional years of 50 percent tax reduction. Such benefits arc vvithheld from domestic Chinese firms. ln Chinese statistics, two notions of FDI are used: the contractual anwunt and the realized value. The contractual amount is the arnount that investors plan to invest over a specified period at the time they apply for approval to invest. The actual or realized value is not bound by the contractual amount and is typically much smaller. Because the ability oflocal officials to attract foreign investment is otten used by their superiors as an indicator of performance, governrnent officials have an incentive to encourage foreign investors to overstate the (not legally binding) contractual amount. For this reason, all data on FDI in this chapter refer only to the realized values. Table 7.2 shows the realized flow of FDI into China and India every year from 1980 to 1999. Until very recently, for China the growth has been truly exponential: the total inward FDI flow was a mere $640 million in 1983. Tt grew to $3.19 billion in 1988, to $33.77 billion in 1994, and to more than $45 billion in 1997 and 1998. The inflow ofFDI did less well in 1999 and 2000 due to the East Asian crisis (and the slow adjustment of China's domestic economy). Every year since 1995, China received more foreign direct investment than any other country except the United States. Foreign direct investment may be in the form of joint ventures, contractual

TABLJ:

7.3

Evolution of Laws and Regulations on FDI i11 China and India China

1979 1986

1988 1'JTation. Moreover, these other types of integration present special challenges to the collection of data. Even in the most sophisticated economies, measuring cross-regional provision of services is difficult.1 Therefore, it is appropriate to limit the scope of this chapter to commodity market integration. Even in the discussion of commodity markets, some of the following discussion will be devoted to establishing what ought to be the most basic facts. In service markets and capital market integration, existing data do not even allow us to outline these basic facts with any confidence. The new data exploited in this chapter are the provincial input-output (I-0) tables compiled by most of China's provinces. Provincial I-0 tables have been put together at five-year intervals, so provincial I-0 tables should exist for 1982, 1987, 1992, 1997, and 2002 (an additional national table was published for 1995). The provincial tables are not published and are considered sensitive for commercial and national security reasons. However, my Chinese colleagues and I have obtained access to the final-demand columns of twenty-seven provinciallevel I-0 tables for 1992. Two of these provinces list only net outflows and are thus not useful for studying interprovincial trade. Ten provinces separate inflows and outflows into domestic and f()reign sectors. I have combined these data with provincial import and export data from the General Administration of Customs, for all provinces, which also serve as a check on the foreign trade data from the ten provinces presenting these data separately. Together, this information provides meaningful domestic and foreign trade data for twenty-five provinciallevel units f()f 1992. In addition, Zhou Zhenhua (1996) performs a similar exercise using data from the 1987 provincial I-0 tables. This provides a basis for examining trends between 1987 and 1992. Details of data sources and manipulation are provided in the appendix to this chapter, but a few notes on the compilation of these tables are in order. Compilation of the provincial input-output tables involves an enormous amount of data collection and data handling. Existing data from State Statistical Bureau or ministerial sources provide only about 70 percent of the data required to build up the tables; the remainder are collected directly by provincial statistical personnel. Compilers break industrial sectors down into main products, visit factories, and interview sales personnel. Often production and sales by township and village enterprises have to be separately estimated and added to the data routinely collected for state-sector and urban enterprises. On the basis of these

Regional Integration and China's Afarkets TABLE

209

8.1

Domestic and Foreign Trade Ratios, 1992 (percent of provincial GDP,

twenty~five

Total Outflows Domestic outflows Exports

70 49 20

Total Inflows Domestic inflows Imports

68

provinces)

(Adjusted)

53

(48)

15

(21)

newly collected data, input-output table compilers estimate flows of inputs and outputs by main product, collecting data on over one hundred products for the larger industrial sectors. Inputs are easier to collect since factories maintain relatively complete records on inputs, but outputs must also be allocated to intermediate and final uses and to within-province and outside-province destinations. The product-by-product estimates are then reaggregated into sectoral data in value terms, providing estimates of the value of products (Zhang and Li, 1985. pp. 79-98, esp. pp. 95-97 on interprovincial flows; Zhang Shouyi, 1992. For updated information, unfortunately not including a discussion of interprovincial flows, see National Accounts Division, 1997b.) The data collection phase takes over a year, and an additional nine months is required to compile them into the first draft of a provincial table. Table 8.1 summarizes the basic data. Interprovincial trade is large, both relative to GOP and relative to foreign trade. The picture of Chinese provinces as relatively autarkic units, separated from each other, though perhaps open to foreign trade, is clearly false. The column of adjusted figures for inflows in Table 8.1 reflects the fact that the provincial foreign trade data from Customs do not capture all flows: whereas 95 percent of exports are covered, only 74 percent of imports are captured. The omitted imports appear to consist of commodities imported by central government foreign trade corporations and distributed through national networks. If provincial statisticians recorded all those imports as domestic inflows, it would be appropriate to adjust inflows as shown, which would make them essentially identical to outflows. Domestic trade is about 2>-'2 times as important as foreign trade. It is also possible to examine the same data from the standpoint of individual provinces, which is done in Figures 8.1 and 8.2. In both figures, provinces are ranked from left to right by share of domestic inflows in GOP. By this standard, Jilin is the province most open to domestic trade, followed by Tianjin, Jiangsu, Shanghai, and Hebei. Yunnan and Fujian are the two provinces least open to domestic trade, although the result for Fujian is sensitive to the procedure used to combine the two data sources. 2 There are two provinces for which foreign trade is more important than domestic interprovincial trade. It \Vill come as no sur-

Toumd Greater Economic Inte,gration

210

FIGURE

8.1

Outflows and Exports, Twenty-Five Provinces 100 90 .....

"'Q"' 80

0

'";j

70

·;;

60

g

.A

"'\

0 "0

bfj

c

""

a..c·n ::>

"::I ::c" C)

bfj

bfj

::>

")< .E § ..r::bO -~ E ::>bO :rr ~ E ..::::VJ C)"' ~ o:l @ (j

:.J

TABLE

I

~

.... ,

@

..r:: v:

::> ::> ::> .§ ic3 ::c::> ;.:1a"'0 ..r::"1)' N

~

@I

j

::I c ..r::u ::> "5' Vl ~ ""'

8.2

lntCiprovincial Trade, 1987 and 1992 (percent of provincial GDP, twenty-three provinces) 19~7

Gross outflows Gross inflows 1992 values (1987 = 100) Nominal provincial GDP (twenty-three provinces) Nominal gross outflows (twenty-three provinces) Nominal gross inflows (twenty-three provinces) National export growth E = Swap rate E = Official posted rate National import growth E =Swap rate E = Official posted rate

52 53

1992

69 6S

229 305 296 250 319 216 276

points to 12 percent, but the domestic outflow ratio increases from 49 to 51 percent. Total outflows for these provinces equal 63 percent of GOP, and domestic outflows are more than four times as important as exports. Similar results hold on the import side. Is interprovincial trade growing rapidly? With existing data it is possible to make only a simple comparison between two benchmark years, 1987 and 1992. Table 8.2 shows the contrast between results that can be derived by assessing the data with identical methodologies for 1987 and 1992 for twenty-three provinces. The summary data for 1992 differ slightly from those given in Table 8.1

Toward Greater Economic integration

212

fiGURE

8.3

Total Provincial Outflows, J987 and 1992 160 ~

u

"8

140

"0

10.


80

[/]

...

I

I I

60 40 20

------------------

0 ()

5

10

15

50

I

,/

" " ,,.'" "

__________________ , --

20 25 30 35 40 45 Degree of Abatement (percent)

----r ,,

55

6ll

65

70

75

industry as a whole, whether the abatement is achieved by process change or by installation of end-of-pipe treatment. Solving the estimated S0 2 intensity equatiou "in reverse" for the effective levy rate (or, in equilibrium, the incremental cost of abatement), we obtain an expression for incremental abatement cost as a function of industrial S0 2 intensity. We have plotted this MAC schedule in Figure 12.1.9. The Optimum Air Pollution Levy in Zhengzhou Our results suggest that air pollution control in Zhengzhou should be far stricter. At the city's current atmospheric S0 2 concentration, abating a ton of so2 will save about 0.63 percent of a "statistical life," yielding a benefit of approximately $50. By contrast, we estimate the incremental cost of abating one ton at the current emissions level (represented by the zero point in Figure 12.19) to be approximately $1.70. Clearly, there is huge social "profit'' to be made by abating more pollution. As the graph shows, additional abatement remains socially profitable at the margin until about 73 percent of current emissions are eliminated. The levy that will induce this reduction is about $90 per ton, at the intersection of the marginal benefit and cost curves. This is our estimate of the optimum industrial air pollution levy for Zhengzhou, since a lower levy would leave socially profitable abatement opportunities unexploited and a higher levy would impose an abatement cost higher than the social gain from further pollution reduction. Implications for China According to our results, the current levy in Zhengzhou makes sense only if China's policymakers value the life of an average urban resident at approximately

Can China Grow and SafeRuard Its Environment? $270 ($1.70/0.00625). This figure seems tragically low when compared to the loss of a life, with the associated pain, suffering, and elimination of a lifetime's contribution to China's economic output. Even our suggested statistical life value of$8,000 is a very conservative number, which only takes account of economic output forgone. But to meet even this conservative standard, our result suggests

that the air pollution levy should be increased more than fijtyfold in Zhengzhou-and by implication in the rest of urban China. The optimum rate-$90 per tonis not exceptionally high by industrial economy standards (e.g., $130 per ton for tradable S0 2 permits in the United States in 1995, an emissions charge of $72 per ton in Poland in 1993 and $29 per ton in France in 1992). However, China is much poorer than any of these countries. The optimum levy for Zhengzhou (and by implication for the rest of urban China) is so high because current air pollution is so bad-arguably the worst in the world.

Revenue Implications The purpose of the levy is to reduce pollution, but it generates public revenue as well. IfZhengzhou's environmental regulators increased the air pollution levy to $90 per ton, the city's annual revenue from air pollution charges would be approximately $1.1 million ($90 per ton X 12,500 tons after the 73 percent reduction). For all of China's large cities, scaling up the Zhengzbou result for a charge of$90 per ton yields a revenue estimate of approximately $250 milliona substantial sum, but only a small fraction of the levy's value as a lifesaving policy tool.

Keys to the Future Our analysis suggests that well-designed policies can substantially improve China's urban environment and that the associated costs are well worth incurring. We can summarize the keys to effective policy in the following propositions: • Continued economic reform is necessary to preserJJe past enJJironmental g11ins. Our research has demonstrated the powerful impact of the reforms on the air and water pollution intensity of Chinese industry. Ref(nm-induced changes in sectoral composition, ownership, and scale of production have been sufficient to compensate for much of the increase in scale of output during the reform period. Our projections show that continuation of the reforms can have similar mitigating eftects in the coming decades. Rapid industrial growth without further changes in ownership and production scale would produce far greater pollution loads than those contemplated in this study. • Pollution levy reform would be a very cost-effective investment in public health. In this chapter, we focus on the consequences of strengthening the pollution levy system. Our results suggest that a much higher air pollution levy would save lives very cost-effectively in urban China. However, we would also recom-

Sustaining Policy Reform mend certain changes in the design of the levy system. Water pollution levies are assessed only on "above-standard" discharges, making emissions "free" for polluters until the standards are reached. The air pollution levy is assessed on the total volume of air pollutants, but it is not fully adjusted for individual pollutants according to relative risk. For both air and water ernissions, it would be sensible to consider adoption of a complete charge system that would be targeted on specific pollutants and assessed on all units of pollution. Research on the water pollution levy (Dasgupta, Huq, Wheeler, and Zhang, 1996) has demonstrated that a revised system could be considerably more cost-effective. • Enforcement should be targeted on low-cost sources. The cost analysis in this chapter shows why targeting is a good idea: large polluters are easier to monitor and have far lower unit abatement costs. The key to cost-effective reduction of industrial pollution in China's cities is targeted enforcement of higher abatement standards for large facilities. • Township and village industrial enterprises should be fully integrated into the regulatory system. Our results show that stronger regulation has produced signiticant reduction of industrial pollution in China. However, many TVIEs remain outside the current sphere of regulation. Pollution from TVIEs is a "dark star" on China's horizon: It is growing rapidly, hut information currently available is insufficient to judge the consequences. Inclusion of major TVIE pollution sources should be a priority for China's regulators during the coming decade. • Rapid del'elopmmt will promote stricter pollution control. In the long run, this may be the most important factor of all. Recent research has shown that the strength of regulation in China's provinces is heavily affected by their levels of social and economic development. Poor communities with low education levels are far less able to promote their environmental interests than their more highly developed counterparts. Ultinutely, China's environmental interests will be best served by rapid economic development, coupled with concerted efforts to inform and empower poorer communities. In this context, greater commitment to public environmental information should make a very valuable contribution.

Conclusions China's industrial growth in the era of reform is a remarkable success story, but it has been clouded by serious pollution damage. Hundreds of thousands of people are suffering premature death or serious respiratory illness from exposure to industrial air pollution. Many of China's waterways are seriously contaminated by industrial discharges, rendering them largely unfit for direct human use. However, China's own experience during the past decade shows that this damage can be substantially reduced at modest cost. Much potential damage has been

Can China Grow and Safeguard Its Environment? avoided already, through the impact of China's economic reform policies on industry and the specitlc effect of stricter regulation in some polluted areas. Together, these policies have lowered industry's pollution intensity sufficiently to reduce organic water pollution in many areas and to curb the growth of air pollution in the face of rapid industrial growth. Despite this encouraging progress, a conservative assessment of the benetlts and costs of further air pollution abatement suggests that much higher levels of particulate and S0 2 emissions control are warranted in China's polluted cities. For our analysis. we developed three scenarios that projected pollution damage under varying assumptions about future policies. Even if regulation is not tightened further, we tlnd that continued economic reform should have a powerful etiect on pollution intensity. Organic water pollution will stabilize in many areas and actually decline in some. Air pollution will continue growing in most areas, but at a much slower pace than industrial output. However, our projections also highlight the unnecessarily high cost of regulatory inaction. If economic reform is not supplemented by tighter regulation, most of China's waterways will remain heavily polluted and many thousands of people will die or suffer serious respiratory damage from air pollution. Continuing recent movement toward tighter regulation for water pollution will result in sharp improvements; adopting an economically feasible policy of much stricter regulation will restore the health of many waterways. In the case of air pollution, the stakes are even higher because regulatory enforcement has apparently weakened in many areas in recent years. Reversal of this trend will save many lives at extremely modest cost. Adoption of SEPA's recommendation for a tenfold increase in the air pollution levy would produce a major turnaround in most cities, and our results suggest that even SEPA's recommendation is very conservative. For a representative Chinese city, Zhengzhou, we tlnd that a tlftyfold increase in the levy appears warranted from an economic perspective. Finally, our rnicroeconomic analysis of abatement alternatives has highlighted the cost-effectiveness of a pollution control policy targeted on large sources of particulate and S0 2 emissions. Abatement of particulates from large non-SOE plants is so cheap that even an extremely conservative economic analysis aHirms the benetlts of very high abatement levels. Our analysis suggests that high social rates of return can be obtained from regulation that induces at least 70 percent abatement of so2 and even greater abatement of particulates from large urban industrial facilities. At present, lax regulation of such facilities is causing so much health damage that reform seems imperative. Inaction amounts to valuing a Chinese worker's life at less than U.S.:n;SOO, a tragically low tlgure by any standard. In this chapter, we have focused on China's industrial pollution problems. Our analysis suggests that stricter pollution regulation would yield a high social rate of return. We recognize, however, that other environmental problems may warrant high priority as well. Topics that might particularly benefit from detailed analytical work include natural resource degradation, a~;ricultural poilu-

Sustaining Policy

R~form

tion, and solid waste generation. As in the case of industrial pollution, fi.rture policy research will benefit substantially frorn China's impressive investment in environmental, social, and economic data.

Notes 1. It is important to note that this does not include many township and village industrial enterprises (TVIEs), which are often highly polluting and account for a major share of China's industrial production. 2. These estimates are based on the dose-response relation established for atmospheric S0 2 in Beijing and Shenyang by Xu et. al. (1994). This relation is combined with monitoring data on so2 concentrations to produce estimated individual probabilities of premature mortality by city. City-specific probabilities are multiplied by current poptllation estimates to produce estimated annual deaths. 3. Again, it is important to point out that TVIEs are not included in the analyses. 4. Detailed econometric results are presented in Dasgupta, Wang, and Wheeler (1997). 5. For a detailed presentation of the econometric work discussed in this chapter, see Dasgupta, Wang, and Wheeler (1997). 6. The results for smoke and dust intensity, the two components ofTSP intensity, are similar to those for S0 2 . 7. These sectors are identified by multivariate analysis, in which exceptionally "clean" or "dirty" sectors are those that depart significantly from average pollution intensities after accounting for the effects of the levy. scale, and ownership. 8. These results are representative of changes in China as a whole. See Wang and Wheeler (1996) for an analysis of changes in industrial water pollution across all of China's provinces. 9. Huq, Martin, and Wheeler (1993) have found that more open developing economies absorb clean technologies in metals and paper production much more rapid! y than their less open counterparts. 10. See Hettige et al. (1995) and Mani and Wlweler (1998) for detailed information on pollution intensities by sector. 11. It is less clear that overall loads from industry have fallen, because much production in rapidly grmving TVIEs is apparently not covered by the traditional regulatory system. The evidence for TVIEs is extremely scanty. and researcl1 on the environmental performance ofTVIEs is clearly a top priority for future work. 12. SEPA has recommended a tenfold increase in the air pollution levy rate, which would be in the same range as our 10 percent annual increase scenario. 13. We assume that grovvth rates of pollution loads for the five cities are the same as the projected rates for their provinces. For Beijing and Shanghai, this is a tautology. The assumption seems quite reasonable in the other cases, since the three cities are the primary industrial regions of their respective provinces. 14. As previously noted, the "pollution-intensive" sectors in this analysis are the sectors with large "dirty" or "clean" residual effects after size, ownership, and provincial pollution levies are accounted for. 15. Since the calculations were made, Chongqing has also achieved provincial status independent of Sichuan.

Can China Grow and Safe,~;uard Its Environment? 16. Note that 30 J.Lglm 3 is the tightest SOc standard in the world, maintained in Canada, Switzerland, and Poland. By contrast, the World Health Organization standard is 60, China's standard is 50, and the U.S. standard is 80. 17. This estimate implicitly assumes that the actual di,count rate in China is higher and that the increment is equal to the expected growth rate in real wages for a currently employed worker. 18. For comparison, it is not uncommon to see public policy decisions in the United States reflect "statistical life" values of several million dollars. 19. We should note that this MAC curve is an average that reflects the distribution of production between SOE and non-SOE plants in Beijing. As we have seen, the MAC schedule for non-SOE plants is always far lower than the SOE schedule. A targeted regulatory strategy could, of course, exploit this difference to capture the largest returns from stricter enforcement for the least-cost plants. 20. Zhengzhou's 1993 population was 1.8 million; its average industrial wage was 3,350 yuan per year.

References Afsah, Shakeb, Benoit Laplante, and David Wheeler. Comrollinx Industrial Pollution: A New Paradigm. Policy Research Department Working Paper, November 1996. Washington, D.C.: World Bank. Dasgupta, Susmita, Maiuul Huq, and David Wheeler. Bending the Rules: Determinants of Discretionary Pollution Control in China. Policy Research Department Working Paper, January 1997. Washington, D.C.: World Bank. Dasgupta, Susmita, Mainul Huq, David Wheeler, and C. H. Zhang. Water Pollution Abatement by Chinese Industry: Cost Estimates and Policy Implications. Policy Research Department Working Paper, August 1996. Washington, D.C.: World Hank. Dasgupta, Susmita, Hua Wang, and David Wheeler. Surviving Success: Policy Reform and the Future ofindustrial Pollution in China. Development Research Croup Working Paper, November 1997. Washington, D.C.: World Bank. Dasgupta, Susmita, and David Wheeler. Citizen Complaints as Environmental Indicators: Evidence }Yom China. Policy Research Department Working Paper, December 1996. Washington, D.C.: World Bank. Hartman, Raymond, Mainul Huq, and David Wheeler. W7Ly Paper 2\llills Clean Up: Survey Evidence frorn Four Asian Countries. Policy Research Department Working Paper, December 1997. Washington, D.C.: World Bank. Hettige, Mala, Mainul Huq, Sheoli Pargal, and David Wheeler. "Determinants of Pollution Abatement in Developing Countries: Evidence from South and Southeast Asia." World Development, December 1996, 24(12), 1891-1904. Hettige, Mala, Paul Martin, Manjula Singh, and David Wheeler. IPPS: The Industrial Pollution Projection System. Policy Research Department Working Paper, February 1995. Washington, D.C.: World Bank. Huq, Mainul, Paul Martin, and David Wheeler. "Process Change, Economic Policy, and Industrial Pollution: Cross-Country Evidence from the Wood Pulp and Steel Industries." Paper presented at the annual meetings of the American Economic Association, Anaheim, Calif, January 1993.

Sustaining Policy Reform Lucas, Robert. Environmental Regulation and the Location of Polluting Industry in China. Policy Research Department, 1996. Washington, D.C.: World Bank. Mimeographed. Mani, Muthukumara, and David Wheeler. "In Search of Pollution Havens;> Dirty Industry in the World Economy, 1960 -1995." Journal of Environment and Development, September 1998, 7(3), 215-47. Parga!, Sheoli, and David Wheeler. "Informal Regulation oflndustrial Pollution in Developing Countries: Evidence from Indonesia." Journal of Political Economy, December 1996,6, 1314-27. U.S. Environmental Protection Agency. Latest Findings on National Air Quality: 1999 Status and Trends. EPA Document No. EPA-454/ F-00-002, August 2000. Washington, D.C.: U.S. Environmental Protection Agency. Wang, Hua, and David Wheeler. Pricing Industrial Pollution in China: An Econometric Analysis of the Levy System. Policy Research Department Working Paper, September 1996. Washington, D.C.: World Bank. Xu, Xi ping, Jun Gao, Douglas W. Dockery, and Yude Chen. "Air Pollution and Daily Mortality in Residential Areas of Beijing, China." Archives of Environmental Health, July-Augnst 1994, 49(4), 216-22.

13 The Political Economy of China's Rural-Urban Divide

•••• Dennis Tao Yang and Cai Fang

Governments in most developing countries have adopted policies that discriminate against agriculture. Interventions take a variety of forms, including the pricing and distribution of agricultural commodities and inputs, and fiscal and credit policies that favor the industrial sector. Governments also use indirect instruments, such as trade regimes and exchange rate policies, that often amplifY the discriminatory impacts against the countryside. The results of a large body of research indicate that these interventions introduce distortions in the economic systems, cause large income transfers away from the rural sector, and ultimately lead to slower agricultural and overall economic growth. 1 Although urban bias is virtually universal in the process of economic development, there are primarily two competing analytical paradigms for explaining policy formation. One theory, associated primarily with the work of Michael Lipton (1977) and Robert Bates (1981), tinds answers in the political structure of those countries, arguing that agriculture is disfavored in development because urban groups are politically powerfuP The second theory emphasizes the development strategy of the modernizing elites who, as evidence shows, believe that industry is the cat:tlyst tor rapid growth and that taxing agriculture provides the much needed financial support for industrialization. 3 Despite the clarity of views at the conceptual level, empirical assessment of these two hypotheses is difficult because of an identification problem. The coexistence of political activities of urban groups and the belief of the modernizing elites in industrialization complicates the measurement of the two causes, making it hard to separate the individual effects of the causes on policy tormation. As a consequence, the explanatory power of the two hypotheses remains largely untested. This chapter has two main purposes. First, we document the extent of China's rural-urban inequality for periods both before and after the initiation of reforms, and we investigate the institutions and policies that have been responsible for the

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disparity. Second, through a case study on China, we assess the relevance of the two existing explanations for the formation of urban bias. China's experience is unique because the period under consideration spans two episodes of distinct economic and political circumstances. During the centrally planned period before 1978, China bad tight economic and political controls in a hierarchical system in which pressure groups and voter voices were largely absent, contrasting with norms found in many other developing countries. In the postreform era, China has corrected the heavy-industry-oriented development stratq,ry andrelaxed political controls, creating an environment that is responsive to the pressw-es of interest groups. These regime changes provide special opportunities for isolating the influence of industrial development strategy on policy formation in the first period and for examining the impact of political pressures on government behavior in the second. The findings from this social experiment will provide insights into the determinants of urban bias for China in particular as well as general implications for the political economy of policy formation. We shall first estimate the extent of China's urban bias by examining the differences in per capita income and consumption expenditures between the rural and urban sectors. Data indicate that during the centrally planned period, the gap was large but stable. Since the reforms, the inequality has exhibited a cyclical pattern of declines in the initial years followed by a period of increases and then by renewed declines. For the entire period, China's disparity has been larger than the disparity in most other countries. We then analyze policy measures and institutions that have been responsible for the high level of disparity as well as its changes over time. We find that some policy instruments are unique to China, including direct restrictions on labor mobility and large-scale income transfers to the state-owned enterprises (SOEs). The government has increasingly used direct transfers to protect the income of urban dwellers since the inception of economic reforms. Next, we investigate economic and political factors that have influenced the making of urban-biased policies. We find that the sharp sectoral divide in the planning episode was a result of industrial development strategy, but since thereforms, the politically powerful urban population has pressured the government for fast income growth through various transfer programs. The central government has continued an urban bias to preserve regime stability and political legitimacy. Our analysis indicates that while the urban coalition may pressure the state for favors, political activities are not a necessary condition for the existence of urban bias. The pursuit of industrial development strategy alone can result in a rural-urban divide. Finally, we discuss the feasibility of policy reforms. We suggest that improvements in factor markets are strategically important for bridging China's rural-urban gulf, which will enable China to tap its potential for sustained economic growth.

The Political Rconomy of China's Rural-Urban Divide

39I

The Rural- Urban Gap The impact of discriminatory policies on the welfare of rural and urban dwellers can be assessed in several ways. One approach is to examine closely each of the specific policy interventions, quantifY various policy measures, and estimate their direct impact on income transfers across the groups of agents in the two sectors. The total effects of the policies can be aggregated from the individual programs. This is the primary approach taken by the series of World Bank studies that assessed the effects of agricultural pricing policies. More specifically, for instance, to examine the distributional consequences of a particular program, such as a price ceiling for an agricultural commodity, one could first estimate the demand and supply schedules for this commodity and then proceed to assess the welfare consequences to producer and consumer groups. If the program under consideration is related to an exportable or importable product, the difference in the domestic and the world market price would serve as a measure of the extent of the distortion. 4 Although these methods are appropriate tools for assessing agricultural pricing programs, it is difficult to apply them to China for several reasons. First, for a long period, China did not have well-functioning agricultural commodity markets, which rendered the estimation of demand and supply schedules virtually impossible. Second, many governmental interventions went beyond the standard measures in agricultural pricing so that the usual tools of welfare analysis are not directly applicable. Finally, because China's institutions and policies have changed dramatically over time, it would be difficult, if not impossible, to trace all the specific policies and to aggregate their effects. In what follows, we use an alternative approach that focuses on the outcomes of the discriminatory policies by examining the disparities in per capita consumption and incomes across urban and rural regions. This approach rests on a simple premise: despite the complexity in measures of intervention and complicated channels of policy effects, sector-biased policies would eventually lead to differences in consumption expenditures and incomes across the sectors, which are directly observable and easily measurable. Therefore, if the consumption and earnings for comparable labor differ greatly between urban and rural areas, that would indicate the severity of the effects of policies and institutions on sectoral segmentation. However, we should be cautious in making rural-urban comparisons in consumption and incomes. First, labor quality, including schooling, training, and experience, has to be adjusted when considering earnings in rural and urban areas. Second, the comparison should be made in real, not monetary, terms. Third, any differences in the cost of living between urban and rural areas should be taken into account. Furthermore, the comparison should also reflect differences in the provision of subsidized public services, such as health care and housing, across

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the sectors. At the empirical level, it is difficult to adjust for all these factors because usually some information is unavailable. Here we will first compare ruralurban per capita consumption expenditures. Then we will use information from the State Statistical Bureau (SSB) to examine intersectoral income differences and compare them with the trends in consumption expenditures. We will make attempts to adjust for the values of social welfare provision in urban regions and the differential inflation rates across rural and urban areas. Unfortunately, we were unable to adjust for differences in labor quality and the cost of living due to a lack of information. However, our analyses will cover an extended period so that if the intersectoral differences in the two sets of £tctors stayed stable over time, there would be only a time-invariant, fixed-effect bias. Consequently, our assessment on the changes in the rural-urban divide would not suffer from the two potential biases. Table 13.1 presents per capita consumption expenditures and their ratios for rural and urban residents between 1952 and 1997. The consumption figures are in nominal prices, taken from various volumes of the Statistical Yearbook of China (State Statistical Bureau, 1990 -98b) corresponding to the national average, separate statistics for rural and urban levels, and the ratio of expenditures for the two sectors. However, because the two regions can have varying consumer price indices over time, one should deflate sector-specific consumption levels by the corresponding price deflator. The real ratio column reports the consumption ratios in real terms since 1978, reflecting the fact that the SSB started collecting sector-specific price indices in that year. Therefore, the best series of consumption ratios that are available to us arc the nominal ratios for the period 1952-77, continued with the ratios in real terms for the period 1978-97. Given the fact that the government set and rarely changed the prices for a large bundle of commodities during the centrally planned period, consumer prices were stable before 1978. Therefore, the nominal consumption ratios for that period should not deviate much from the ratio in real terms." This series on n1ral-urban consumption ratios reveals long-term patterns of change. Inequality between rural and urban regions was high but stable during the centrally planned ret,rime. However, since the reforms, the level of disparity has exhibited marked cyclical changes: the declines in initial years were followed by a period of increases and then by recurring declines. Throughout the period, the per capita consumption in urban areas has been about two to three times higher than the level in rural areas. More specifically, the data suggest four distinct periods: (1) 1952-77, the centrally planned period, in which the consumption ratio fluctuated within a narrow range around 2.5, except for the two years during the Great Leap famine (1959-60), when the ratio reached 3.2; (2) 1978-85, the initial period of economic reforms, in which the ratio dropped from 2.9 to 1.9, its lowest point; (3) 1986-93, a period in which the ratio slowly climbed to 2.7, almost

TABLE

13.1

Per Capita Consumption of Rural and Urban Residents 1952-97 (nominal yuan per year) Rural to Urban Ratio

Consumption Year

1952 1953 1954 19.)5 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977

1978 1979 1980 1981 1982 1983 1984 1986 1987 1988 1989 1990 1991 1992 1993 1995 1996 1997

Natio1tal Average

Rural Residents

76 87 89 '14 99 102 105 96 1.02 114 117 116 120 125 132 136 132 134 140 142 147 155 155 158 161 165 175 197 227 249 267 289 329 451 513 643 700 803 896 1,070 1,331 2,311 2,677 2,936

69 70 76 78 79 8.l 65 68 82 88 89 95 100 106 110 106 108 114 116 116 123 123 124 125 124 132 152 173 194 212 234 266 353 393 480 518 571 621 718 855 1,479 1,756 1,930

6:2

Urb:m Residents

149 181 183 11\C: 197 205 195

206 214 225 226 222 234 237 244 251 250 255 260 267 295 306 313 324 340 360 383 406 468 487 500 531 599 850 997 1,288 1,404 1,686 1,925 2,356 3,027 5,044 5,620 6,048

Ratio (Nominal)

(Real)

2.4 2.6 2.6 2.5 2.5 2.6 2.4 3.2 3.2 2.8 2.6 2.5 2.5 2.4 2.3 2.3 2.4 2.4 2.3 2.3 2.6 2.5 2.6 2.6 2.7 2.9 2.9 2.7 2.7 2.5 2.4 2.3 2.3 2.4 2.5 2.7 2.7 3.0 3.1 3.3 3.5 3.4 3.2 3.1

2.9 2.6 2.5 2.3 2.1 2.0 2.0 2.0 2.0 2.1 2.2 2.4 2.5 2.5 2.7 2.6 2.4 2.3

Ratio

There are minor inconsistencies in the consumption values reported in differcnt volume