Industrialization, Innovation and Industrial Policy Lawrence J. Lau, Ph. D., D. Soc. Sc. (hon.) Kwoh-Ting Li Professor of Economic Development Department of Economics Stanford University Stanford, CA 94305-6072, U.S.A. China Development Forum, Beijing, China March 23, 2003 Phone: 1-650-723-3708; Fax: 1-650-723-7145 Email: LJLAU@STANFORD.EDU; WebPages: WWW.STANFORD.EDU/~LJLAU
Preview Industrialization is the only effective strategy for raising per capita income in a sustained way in a large economy such as China. Urbanization is the natural complement to industrialization. The growth of the output (value-added) of the industrial (nonagricultural) sector depends on: (1) Growth of tangible inputs physical capital (plant, equipment and physical infrastructure) and labor; and (2) Growth of intangible capital human capital, R&D capital, and other forms of intangible capital (advertising (brand names), goodwill, software, business methods, organization, corporate or enterprise culture). The implications for public policy. Is there a role for industrial policy? The role of foreign direct investment. Lawrence J. Lau, Stanford University 2
China s Economic Record: Real GDP per Capita and per Laborer 14,000 Real GDP per Capita and Real GDP per Laborer, 2000 prices 12,000 10,000 Yuan/Person, 2000 prices 8,000 6,000 4,000 2,000 0 Lawrence J. Lau, Stanford University 3 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year GDP per Capita GDP per Laborer
The Share of Agriculture in GDP and Employment 80% Share of Agriculture in GDP and Employment 70% 60% 50% Percent 40% 30% 20% 10% Share of Agriculture in GDP Share of Agriculture in Employment 0% 1979 1980 1981 1982 1983 1984 1985 Lawrence J. Lau, Stanford University 4 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year
Comparison of Values-Added per Laborer in Agriculture, Industry and Services 30,000 Value-Added per Laborer by Sector, 2000 prices 25,000 Value-Added in Agriculture per Laborer Value-Added in Industry per Laborer Yuan/Person, 2000 prices 20,000 15,000 10,000 Value-Added in Services per Laborer 5,000 0 Lawrence J. Lau, Stanford University 5 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Year
The Share of Agriculture in GDP and Employment versus Real GDP per Capita 80% Share of Agriculture in GDP and Employment vs. Real GDP per Capita 70% Share of Agriculture in GDP Share of Agriculture in Employment 60% 50% Percent 40% 30% 20% 10% 0% Lawrence J. Lau, Stanford University 6 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 Real GDP per Capita, Yuan, in 2000 Prices
Industrialization and Urbanization (1) The share of agriculture (primary sector) in GDP has declined from 43% in 1979 to less than 16% in 2001. Over the same period, the share of agriculture in employment has declined from almost 70% to 50% but appears to have stalled for the past few years. Given the large and increasing gap between the value-added per laborer in the agricultural and non-agricultural sectors, the transformation of the economy from agriculture to industry (and services) is inevitable in order that real GDP per capita can continue to rise. Historically, no large economy has successfully achieved a high level of real GDP per capita without a massive shift of the population and labor force out of agriculture. Industrialization and urbanization are complementary industrialization (or more broadly the growth of the non-agricultural sector) requires urbanization and urbanization facilitates industrialization. Lawrence J. Lau, Stanford University 7
Sectoral Composition of Output and GNP per Capita, Cross-Section of All Economies, 2000 90 Sectoral Composition of Output and GNP per capita, 2000 80 70 % Agriculture value added 2000 % Industry value added 2000 % Service value added 2000 % Manufacturing value added 2000 60 Percent 50 40 30 20 10 0 10 100 1,000 10,000 100,000 GNP per capita, 2000 US$ Lawrence J. Lau, Stanford University 8
Sectoral Composition of Labor Force and GNP per Capita, Cross-Section of All Economies Sectoral Composition of Labor Force and GNP per Capita, 2000 90 Agriculture Industry Services 80 70 60 Percent 50 40 30 20 10 0 Lawrence J. Lau, Stanford University 9 100 1,000 10,000 100,000 GNP per capita
Industrialization and Urbanization (2) The policy choice is: Should capital be brought to labor or should labor be brought to capital? Alternatively, should new cities be built where people currently live (in situ urbanization) or should people be encouraged to migrate to existing cities? Bringing capital to labor and building new cities where people currently live can help to redress the imbalance in the levels of development between the coastal and interior regions and minimize social disruption and costs. With the information and communication revolution, the costs of dispersion of people and resources are greatly reduced and the economies of agglomeration are also minimized. Building new cities and the associated communication, transportation and power infrastructure can generate a significant source of new domestic aggregate demand. Lawrence J. Lau, Stanford University 10
The Degree of Urbanization and GNP per Capita, Cross-Section of All Economies 100 Urbanization and GNP per Capita, 2000 90 Urban Population as Percent of Total (1995) 80 70 60 50 40 30 20 Non-Oil Producers 2000 Oil Producers 2000 10 0 10 100 1,000 10,000 100,000 GNP per Capita, 2000, US$ Lawrence J. Lau, Stanford University 11
The Degrees of Industrialization and Urbanization in China 55 The Degrees of Industrialization and Urbanization 50 45 Degree of Urbanization Degree of Industrialization 40 Percent 35 30 25 20 15 Lawrence J. Lau, Stanford University 12 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year
The Complementarity of Urbanization and Industrialization 40 Urbanization vs. Industrialization 35 Degree of Urbanization, Percent 30 25 20 15 10 Lawrence J. Lau, Stanford University 13 30 35 40 45 50 55 Degree of Industrialization, Percent
The Complementarity of Urbanization and Industrialization (Including Services) 40 Urbanization vs. Industrialization (including Services) 35 Degree of Urbanization, Percent 30 25 20 15 Lawrence J. Lau, Stanford University 14 60 65 70 75 80 85 90 Degree of Industrialization (including Sevices), Percent
Industrialization and Urbanization (3) What types of cities are the best for China (and for the world)? A car in every garage is a nightmare scenario for China and the World. (Imagine 400 million automobiles on the road and a replacement demand of at least 40 million automobiles a year eventually!) China has become a net importer of oil in the mid-1990s and its import dependence is well on its way to exceeding 50% within a decade or two. Urban life in Los Angeles and San Jose, where an automobile is indispensable, is not the right model for Chinese cities; the right model is London, New York, Paris and Singapore. Urban sprawl and the traffic congestion that it generates are the natural outcomes of the growth of cities in the absence of adequate urban planning. Convenient, user-friendly urban mass transit is the only feasible substitute to the automobile, but it works effectively only in cities with high-density residential and non-residential neighborhoods. In order to achieve high densities, urban planning is essential. New cities can be planned from scratch, and the design and construction of mass transit (including the manufacture of the equipment and rolling stock) in mediumsized (say, between 1 and 2 million population) cities can become a growth industry in itself. Over the next decade or two, the number of such new cities is easily on the order of 50 to 100. Lawrence J. Lau, Stanford University 15
The Chinese Demand for Oil 250 Total Petroleum Consumption 230 210 190 (million metric tons) 170 150 130 110 90 Demand for Oil 70 50 Lawrence J. Lau, Stanford University 16 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Year
Energy Efficiency Energy efficiency, in terms of energy consumption per unit GDP, has improved significantly in the past decade. It is, however, still considerably higher than that of the United States, Japan, and other developed economies. In part, this reflects the sectoral composition of GDP; but in part, this also indicates considerable room for further improvements. The government can mandate energy efficiency standards, and can impose taxes on particular industries and/or products. For example, in addition to the promotion of urban mass transit, China can impose a tax on gasoline consumption that is similar in order of magnitude to that in the Western European countries, or a gas guzzler tax (license fee) that penalizes inefficient automobile engines, or both. Encouragement of the substitution of oil by other fuels, such as natural gas. Support for the development and commercialization of new technologies, such as fuel cells, or a hydrogen car. China has the potential of leap-frogging because it has a vast domestic market but no strong vested interest yet to protect, no existing investment that must be amortized. It is relatively low cost for China to switch to a hydrogen car but not so for the United States because of all the sunken investment in the stock of automobiles, in the invested structures and equipment of the automobile industry, and in the extensive gasolinebased fuel distribution system. (The potential for leap-frogging is real. For example, most Chinese people do not know what a VHS videotape recorder player is and never will. They go directly to the video compact disc (VCD) and then the DVD. In contrast, sales and rentals of VHS videotapes are still a substantial business in the United States.) Lawrence J. Lau, Stanford University 17
Primary Energy Consumption-GDP Ratio (China and the United States) 110,000 100,000 90,000 Primary Energy Consumption-GDP Ratio (China and the United States) United States (U.S. Energy Information Administration Data) China (U.S. Energy Information Administration Data) China (China Statistical Yearbook 2001) 80,000 BTU/1990 US$ 70,000 60,000 50,000 40,000 30,000 20,000 10,000 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Year Lawrence J. Lau, Stanford University 18
The Sources of Economic Growth Different types of measured inputs--tangible capital, labor, and intangible capital-- play different roles at different stages of economic growth. Tangible capital accumulation is the most important source of growth in the early stage of economic development, and in particular in the East Asian NIEs and China in the postwar period. Technical progress, the ability of producing greater output with the same inputs, which may be identified with economically significant innovation, has played only a minor role in the East Asian NIEs, in contrast to the situation in the developed economies. But simply accumulating tangible capital is not enough--it must also be efficiently allocated. Efficient tangible capital accumulation is the major accomplishment of the East Asian NIEs in the postwar period and of China since its economic reform began in 1979. Intangible capital accumulation, which is the primary cause of measured technical progress, becomes important only after a certain level of tangible capital per worker is achieved. However, there is also evidence of positive measured technical progress in the more recent period in South Korea, Singapore and Taiwan, reflecting their increased investment in intangible capital. The growth of tangible inputs, in particular tangible capital, will continue to be the most important source of economic growth in China as it catches up to the developed and newly industrialized economies in terms of tangible capital intensity (equivalently, the tangible capital per unit labor). Given the existing Chinese factor proportions a very low tangible capital per unit labor the marginal productivity of tangible capital will remain high for years and decades to come. There are, however, also opportunities for leap-frogging. Lawrence J. Lau, Stanford University 19
Real Output per Labor Hour (1980 US$) 20 15 China Indonesia Malaysia Singapore Thailand Non-Asian G5 Real Output per Labor Hour (1980 US$) Hong Kong S. Korea Philippines Taiwan Japan 1980 US$ per Labor Hour 10 5 0 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 Lawrence J. Lau, Stanford University 20
Tangible Capital Stock per Labor Hour (1980 US$): Selected Economies 60 Tangible Capital Stock per Labor Hour (1980 U.S.$) 1980 US$ per Labor Hour 50 40 30 20 China Indonesia Malaysia Singapore Thailand Non-Asian G5 Hong Kong S. Korea Philippines Taiwan Japan 10 0 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 Lawrence J. Lau, Stanford University 21 1983 1985 1987 1989 1991 1993 1995
Average Human Capital: Selected Economies Years per Working-Age Person 14 12 10 8 6 4 Average Human Capital (Years of Schooling per Working-Age Person) China Hong Kong Indonesia S. Korea Malaysia Philippines Singapore Taiwan Thailand Japan Non-Asian G5 2 0 1953 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 Lawrence J. Lau, Stanford University 22 1983 1985 1987 1989 1991 1993 1995
R&D Expenditures: China Billion Yuan 120 China's R&D Expenditure and Its Share of GDP % 1.2 100 R&D Expenditure R&D as a Percentage of GDP 1.0 80 0.8 60 0.6 40 0.4 20 0.2 0 1987 1988 1989 1990 Lawrence J. Lau, Stanford University Year23 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 0.0
R&D Expenditures as a Ratio of GDP: G-7 Countries, 3 East Asian NIES & China 3.5 3 Figure 8.1: R&D Expenditures as a Percentage of GDP: G-7 Countries, 3 East Asian NIEs and China U.S. Japan W. Germany U.K. France Singapore Canada Taiwan Italy China South Korea 2.5 Percent 2 1.5 1 0.5 0 Lawrence J. Lau, Stanford University 24 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Patents Granted in the United States: G-7 Countries and East Asian Developing Countries 100,000 Table 8.3: Patents Granted Annually in the United States: G7 Countries, 4 East Asian NIEs and China 10,000 1,000 100 10 1 Lawrence J. Lau, Stanford University 25 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Number of Patents U.S. Japan W. Germany U.K. France Italy Canada Hong Kong South Korea Singapore Taiwan China
Patents Granted in the United States and R&D Capital Stock 100,000 Figure 8.4: The Number of U.S. Patents Granted Annually vs. R&D Capital Stocks Number of Patents 10,000 1,000 100 US Japan West Germany UK France Canada Italy South Korea Singapore Taiwan 10 1 0.1 1 10 100 1000 R&D Capital Stock in Billions of 1980 Constant U.S. Dollars Lawrence J. Lau, Stanford University 26
The Implications for Public Policy: What Can and Should the Government Do? Maintenance of a stable macroeconomic climate and an open and competitive market environment with free entry and exit (use of anti-trust laws to prevent unfair competition and monopolistic practices). This includes the eliminations of barriers to the free flow of goods, services and factors (capital and labor) so as to create an integrated national market within China itself. Competition and a large domestic market both facilitate innovation. Investment in infrastructure (both tangible and intangible), especially in development-leading infrastructure (e.g., the development of the Great West). Promotion of investment in intangible capital (human capital and R&D), especially basic education and basic research; tax incentives for education and R&D, which are the long-run foundations for innovation. Investment in human capital at the basic education level is the proven most effective way of making the income distribution more equitable. Implementation of the rule of law enforcement of contracts and prosecution of fraud; insistence on transparency and good corporate governance and stringent auditing standards; protection of tangible and intangible property rights, including patents, copyrights, brand names and trade secrets. Creation and continued provision of a credible and viable social safety net, independently of enterprises, that enhances labor mobility and flexibility as well as social stability without diminishing the incentives to work. Commitment to and focus on Lawrence economic J. Lau, Stanford development University creating and reinforcing 27 self-fulfilling expectations.
Is There a Role for Industrial Policy, Broadly Defined? It is in general difficult to pick winners and losers. It is also in general difficult to justify picking winners and losers, except in cases of (1) significant non-appropriable externalities (and indivisibilities), e.g., urban mass transit; basic research; (2) co-ordination failures (lack of credible commitment); and (3) incompleteness or imperfection of markets. The Government should, insofar as possible, not do anything that the non-state sector can do adequately. It should also try, over time, to move to a system of regulation by negative lists rather than positive lists. In other words, enterprises should be allowed to do anything that is not expressly forbidden or violates any current laws or regulations rather than just those things that are explicitly permitted. Allowing enterprises more freedom and flexibility can encourage greater experimentation and hence innovation. Direct and indirect support for education and for R&D Information and communication technology, biotechnology, nanotechnology. Investment in development-leading infrastructure, e.g., the New Silk Road. Facilitating the creation and expansion of demand e.g., the creation of a market for mortgage-backed bonds for the long-term financing of private, residential, owner-occupied housing; the accreditation, regulation and standardization of public services such as education and healthcare. Strengthening the capital markets and encouraging and facilitating long-term equity investments by the public. Lawrence J. Lau, Stanford University 28
The Role of Foreign Direct Investment (1) With a national savings rate of approximately 40%, a recurrent healthy current account surplus and ample reserves, it is not the money that China needs. Doing business in a foreign country is always more difficult. Foreign direct investors invest in China only because they believe they can add significant value based on their comparative advantage in technology, know-how, marketing (including established brand names) and business methods. They only come because they know they can bring something that China does not have and do something that Chinese enterprises on their own cannot do. Thus, foreign direct investment facilitates innovation in China. Foreign direct investors should be accorded national treatment, no more, no less. There should be a level playing field between foreign-invested enterprises and domestic enterprises (and between state-owned and non-state-owned enterprises), except possibly in industries critical to national security, such as defense industries and telecommunication or public transportation. Except in these industries, as long as a foreign direct investor is not given special privileges, including monopoly or quasi-monopoly franchises, that domestic enterprises do not have, and comply with all applicable Chinese laws (e.g., on environment, foreign exchange transactions, labor and taxation), it should be allowed to make its investment, up to 100% ownership, and conduct its business as it sees fit. As long as a foreign direct investor is prepared to invest (and risk) its own money, the Chinese Government should not worry excessively that the investment project of the foreign directly investor, according to the analysis of the Chinese Government, does not seem to yield an economic return. The Chinese Government has little or nothing to lose. Lawrence J. Lau, Stanford University 29
The Role of Foreign Direct Investment (2) After all, the tangible investment (the structures and equipment) will be located in China and most of the new employment generated will be taken up by Chinese workers. If the investment does not work out for any reason, chances are that another enterprise will be able to pick up the pieces for a fraction of its original cost and continue operating it in China. Competition, both domestic and foreign, should be encouraged. The Chinese domestic market is large enough to have multiple major players. Chinese consumers and Chinese workers will ultimately benefit from the competition among Chinese and foreign-invested enterprises through lower prices and higher wages and greater opportunities for learning. Foreign direct investors should be allowed to decide on their own whether they need Chinese joint venture partners or not. Requiring a joint venture as a prior condition may actually discourage foreign direct investors with the most advanced technologies. Technology transfer will occur through diffusion and spillover in any case. Foreign direct investment is long-term investment, and unlike foreign portfolio investment and bank loans, cannot be easily withdrawn in a time of crisis. Foreign direct investment brings mostly benefits, and little costs and risks to China. It is true that some inefficient Chinese enterprises may have to shut down because of the competition. But if they are not economically viable to start with, closure is only a matter of time, without or without the foreign direct investor. It is far better for Chinese workers to work at an enterprise that is viable in the long run, regardless of its ownership, than to hang on at an enterprise with a precarious and uncertain future. Both inward and outward foreign direct investment should be encouraged. Lawrence J. Lau, Stanford University 30