Governance, Investment Climate, and Harmonious Society: Competitiveness Enhancements for 120 Cities in China

Governance, Investment Climate, and Harmonious Society:  Competitiveness Enhancements for 120 Cities in China

A survey of 120 cities (and 12,400 firms) in China shows that city-level investment climate varies widely.  Business law and regulation are basically the same throughout China.  Hence, differences mainly reflect local government efforts (or lack of efforts) to operate efficiently.  For instance,

• Taxes and fees average 3.1 percent of sales revenue at the top 10^th percentile of cities, versus 6.9 percent at the bottom 10^th percentile. 
• Firm interactions with major bureaucracies average 36 days/year at the top 10^th percentile of cities and 87 days/year at the bottom 10^th percentile.
• Firm expenditures on entertainment and travel, which can be a vehicle for corruption, average 0.7 percent of revenues at the top 10^th percentile of cities and 1.9 percent of revenues at the bottom 10^th percentile.
• Combined time for customs clearance of exports and imports averages 5.4 days at the top 10^th percentile and 20.4 days at the bottom 10^th percentile.

University-educated workers account for 28.5 percent or more of workforces in the top 10^th percentile and 10.8 percent or less in the bottom 10^th percentile of cities.

While comparability with earlier surveys is extremely limited, it does appear that losses due to power/transport problems have increased since 2001/2002, especially in southern China; that informal payments by firms, relative to sales, may have declined; and that taxes/fees relative to sales have increased in many cities.

The survey also finds significant (or noteworthy) differences in the importance of state-owned enterprises (SOEs) in local industry; labor over-staffing; firm access to bank loans; confidence in protection of property and contract rights; and adequacy of local power and transport.  The prevalence of different types of industry or ownership in a particular locale seems to have some effect on tax/fee burdens, bureaucratic behavior, overstaffing, and other measures of government effectiveness.

In general, the investment climate of China's regions can be ranked from best to worst as follows:

1. Southeast (Jiangsu, Shanghai, Zhejiang, Fujian, and Guangdong;
2. Bohai (Shandong, Beijing, Tianjin, and Hebei);
3. Central (Anhui, Henan, Hubei, Hunan, and Jiangxi);
4. Northeast (Heilongjiang, Jilin, Liaoning);
5. Southwest (Yunnan, Guizhou, Guangxi, Sichuan, Chongqing, and Hainan); and
6. Northwest (Shanxi, Shaanxi, Neimenggu, Ningxia, Qinghai, Gansu, and Xinjiang).

Six cities offer outstanding performance in overall investment climate (both for domestic firms and for foreign firms), in government effectiveness (toward both domestic firms and foreign firms), and in progress toward achieving a "harmonious society."  These "golden cities" are Hangzhou, Qingdao, Shaoxing, Suzhou, Xiamen, and Yantai.

Cities in the bottom quintile of "government effectiveness" could expect near-term gains off 25-35 percentage points in firm productivity and 15-25 percentage points in foreign ownership by improving local government efficiency, labor flexibility, and financing to those of the leading cities in Shandong, Guangdong, Zhejiang, and Jiangsu. 

Significant gains in firm productivity and/or foreign investment could result from the following reforms:

• Further simplification of licensing and other procedures to start a business;
• Greater transparency and simplification of approvals for urban land use;
• Elimination of tax preferences, for instance, for foreign investors;
• Elimination of many city-specific administrative fees and adoption of objective measures for remaining fees;
• Adoption of best-practice customs clearance procedures at inland customs posts;
• More consistent labor practices, by tightening enforcement where necessary to improve worker protections and loosening labor rules where possible to enhance labor flexibility;
• Completing the ownership transformation of small/medium state-owned enterprises (SOEs) that are viable; liquidating non-viable SOEs; and improving governance at large SOEs;
• Encouraging foreign investment in local banks, e.g., city commercial banks;
• Providing additional legal/regulatory protection for lenders; encouraging more widespread credit reporting; and making it easier for small and medium enterprises (SMEs) to use assets other than real estate as collateral; and
• Encouraging wider use, by local banks, of international best-practices in SME lending.

In addition, the survey finds a correlation between local government efforts to achieve a good investment climate and local progress toward achieving a harmonious society.  For cities in the bottom quintile of investment climate, improvements in education/technical training, healthcare, and environmental quality to the levels of the leading Southeast and Bohai cities could lead to a 25 percentage point gain in firm productivity and a 10 percentage point gain in foreign ownership.  This would require sustained spending on education, health, and environmental protection/remediation.

The survey finds that about one-third of observed differences in firm productivity, and one-fifth of differences in the extent of foreign ownership, are associated with differences in "city characteristics" – such as population size, GDP and GDP growth rate, and transport costs.  Government reforms and/or medium-term investments can bring about improvements in important city characteristics:

• Firms in more-populated cities tend to be more productive, due perhaps to greater competition and agglomeration benefits.  This offers support for continued migration, especially to Southeast cities where water scarcity is less an issue.[1]  To absorb migrants without worsening urban poverty and unemployment, destination cities will have to invest in infrastructure, housing, and public services, while creating an investment climate that stimulates private sector investment and business development.
• Through both physical improvements and local income gains, continued investment in urban infrastructure and services could make lagging cities more appealing to investors, especially foreign investors.  Investment in urban infrastructure has been shown to support growth and to counteract urban unemployment and poverty.  State-of-the-art information technology is necessary for cities seeking to cultivate high-tech industry.  Greater reliance on private providers of public services offers opportunities for increasing competition, counteracting urban poverty, and enhancing local quality of life.
• Transport costs for moving goods to/from seaports is a key consideration, especially for foreign investors.  Survey data indicate that a 50 percent reduction in overland transport costs could raise foreign ownership by perhaps 5 percentage points in such deep-interior cities as Lanzhou and Wulumuqi.  Key measures to reduce transport costs include major improvements in China Rail’s governance and management, including full or partial privatization; development of real nationwide trucking companies; more regular air cargo service for interior cities; and regulatory reforms to encourage domestic and international integrated logistical service providers to expand into interior regions.

Lastly, to encourage local governments to pursue sustained improvements in government effectiveness, urban development, and progress toward a harmonious society, it would make sense to repeat this survey regularly (e.g., bi-annually) in order to track progress or deterioration over time.

 Press release  
 Full text (705kb pdf)
 Other Related Reports: 

• Improving City Competitiveness through the Investment Climate: Ranking 23 Chinese Cities (749kb pdf) 
• Improving the Investment Climate in China (276kb pdf)