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Lessons other nations can learn from China

By David Dollar (China Daily)
Updated: 2008-11-20 07:49

When historians look back on this period of history, they will likely identify China's reform and opening to the global economy as the single most important event. China's reform has propelled the country from a poor, backward status to a rank as one of the largest and most important economies in the world.

China still has a long way to go to emerge as a fully developed economy, but its prospects remain bright even in the midst of this global economic turbulence.

On the 30th anniversary of the launching of economic reform, it is natural to ask what lessons China offers for other developing countries. Of course, China's experience cannot simply be transferred to other countries. Each country's situation is different. Still, countries can learn from each other, and right now there is more interest in China than in any other developing country.

There are many potential lessons from China's success, but I focus on three in particular.

The first lesson from China is not about what it did, but about how it went about reform. People sometimes characterize China's reform as "gradual," but I don't think that is accurate, given how much change has actually occurred in a relatively short period of time. "Pragmatic" is a better description. China really has followed the notion of "crossing the river by touching the stones."

In many areas of reform, new ideas were first tested on a pilot basis, and things that worked scaled up rapidly. The household responsibility system began as local experimentation and then became national policy. One of the best examples is the opening to trade and foreign investment first in four special zones. Good results led quickly to an expansion of the opening to coastal cities, and then to the Pearl River and Yangtze deltas, and finally the whole country.

Another good example of pragmatic reform is the power sector. In the early period China had serious power shortages. A State Council decree in 1985 allowed new sources of financing - foreign and domestic, state and private - and pricing of this "new power" at a high tariff that allowed a good return to the investment. At the same time, the price of the "old power" from existing plants was kept low.

Economists argue that this kind of dual pricing causes distortions, but in China's case it was a pragmatic compromise that allowed expansion of power generation without upsetting all the existing firms dependent on a low price of power. Within a relatively short time the "new power" expanded rapidly, while old power plants were gradually retired.

Today China has an excellent power supply, at a price that is economic, but high compared to the many developing countries that continue to subsidize power supply - with the result that their systems simply do not expand fast enough.

A second powerful lesson from China is the way in which the country has embraced globalization and shown that it can accelerate development.

Beginning in the mid-1980s, China has consistently been more open to imports and direct foreign investment than other developing countries at its per capita income. When China's import tariffs were still up in the 40 percent range around 1990, those of India, Pakistan, and many other large developing countries were in the 80-100 percent range.

As China has liberalized and joined the WTO, it has brought tariffs down below 10 percent - while many other developing countries keep theirs at 20 percent or above.

China has also been more open to direct foreign investment, and has become the largest recipient in the world. The direct investment brought new technology, management, training, and connection to global supply networks. It is one factor behind China's steady record of productivity growth in manufacturing.

China has pioneered a unique model of openness that is worth studying. It welcomed imports and direct investment, but resisted portfolio flows of capital - "hot money" that can flow in and out easily. Many other developing countries did the opposite - they borrowed on international capital markets while restricting direct investment by multinationals.

The Chinese path is better for technological development. It also looks particularly smart right now during this global financial crisis. Some countries that opened to capital flows are now in difficulty, having trouble refinancing their debts. China, on the other hand, is in good fiscal and financial condition. The international firms that made direct investments here are not taking money out during the crisis.

A third lesson from China is closely related to the second. Being open to imports and direct investment will not have much effect on the economy unless there is a good investment climate. It is striking that China has many cities - especially on the coast, but also some inland now - that have very good investment climates in terms of infrastructure, logistics, and regulation.

It is relatively easy to set up firms, move goods through ports and customs, get access to power and telecom. When we compare measures such as reliability of power supply, days to move goods through customs, and transportation times and costs, China's coastal cities compare well to cities in other developing countries.

How did these good investment climates develop? Partly it is a natural response to the powerful incentives coming from connection to the global market. But I also think that competition among cities has been a healthy thing in China. China has a very decentralized fiscal system. This has some disadvantages in that it can allow a high degree of inequality to develop. But it also has the advantage that it provides local government strong incentives to create a good investment climate. Cities that succeed attract investment and labor and grow extremely rapidly. Other cities are then inspired to learn from the leaders.

No other developing country can just copy what China did and get the same great results. But other countries can learn from China's experience. Most useful is the "pragmatic" approach to reform. Try out policies where possible on a smaller scale, and then scale up ones that work.

Take advantage of globalization. Trade liberalization creates a competitive market that is good for innovation and enables successful firms to export and grow to a scale that is not possible in a small, closed market. Use foreign capital, but more for its technology, management, and networks than for the money. Be careful of the "hot money" flows that have been so destabilizing in the developing world.

And create incentives for your cities to compete to provide the best service in terms of infrastructure, logistics, and regulatory environment. These are lessons that any country - developing or developed - would be wise to absorb and adapt.

David Dollar is the World Bank's country director for China and Mongolia

(China Daily 11/20/2008 page8)