Joint Government of Russia and World Bank Workshop Regional Development Strategies March 31, 2008

1. Joint Government of Russia and World Bank WorkshopRegional Development StrategiesMarch 31, 2008 Regional Development Strategies Lili Liu Lead Economist Economic Policy and Debt Department World Bank

2. Outlines • First present China’s regional development strategies and experience since 1980 • Context for the regional development strategy • Unbalanced growth strategy 1980 to late 1990s • Balanced growth strategy since late 1990s • Then briefly introduce Chilean experience in regional policy for extreme zones • Draw observations and thoughts from these experience

3. Map of China

4. Context for Regional Development Strategy • 1980-late 1990s • Maximizing national growth as a key objective. • Trade opening and FDI. • From plan to market. • Fiscal decentralization. • Urbanization. • From balanced development (1950-1980) to deliberate pursuit of an unbalanced growth strategy (1980-1995).

5. Unbalanced Regional Development Strategy1980-late 1990s • Coastal regions were viewed as having the most potential to gain from economic opening, due to proximity to key markets, skilled labor force, and relatively stronger economic base. • Major infrastructure investments such as national highway systems and airports. • Fiscal incentives related to corporate tax and tariff exemptions. • Reduced fiscal transfers to inland provinces and interregional fiscal transfers. • Central government transfers largely come from project financing which provinces have to match with local funds, which benefited more developed coastal regions.

6. Unbalanced Regional Development Strategy1980 - late1990s • Regional development strategy works through key municipalities that serve as regional hubs. • Fiscal decentralization gave provinces/large municipalities, starting with two coastal provinces, unprecedented fiscal autonomy and room for innovation and experimentation. Exploring the agglomeration of urban economies. • Rapid national growth is accompanied by widening regional disparities. Equally important and much less recognized, however, is that lagging regions also grew faster than the pre-reform period. • Gradual reform approach

7. Regional disparities in infrastructure development 1978 1999 > 5000 1000-3000 3000-5000 < 1000 Density of Road (km / 10000 km2 )

8. Economic centre & Periphery Periphery Economic centre

9. More balanced regional development Harmonious Society Era (since late 1990s) • Multi-prone regional development strategy, as challenges differ significantly across regions. • Coastal region: integration, supply chain linkages, agglomeration, and moving up value chain. • Western region: infrastructure, urbanization, development of non-state sector, etc. • Northeast: restructure the heavy industry and state oriented enterprise base. The region has the longest history of command and control. Heavy legacy of SOEs. • Central Region: launched last year and still being formulated, involving a broader agenda of social, environmental and economic development.

10. Coastal Region • With success come new challenges • More efficient, sustainable and equitable growth • Similar challenges as experienced by more developed economies: congestion, migration, employment opportunities, income inequality, social stratification, and social security, crime, etc. • Manufacturing is adjusting structure to move to high value added, need to coordinate policies. • Urban renewal and more rapid urbanization. • Dual structure: more advanced areas (such as CBD) vis-à-vis periphery areas. • Innovation, regional integration (e.g., Pearl river delta, Yangtze river basin and bohai bay) and global competitiveness

11. Rationale for “Go West” • Reducing regional inequality (e.g., per capita income was 2.5 times higher in the coastal region than the interior. The share of national FDI was 86% for the coastal region, 13% for the central region, and only 1% for the western region). • Stimulating domestic demand and consumption as a source for sustained growth. Low domestic consumption (and income level) in the western region. • Forging structural reform and the emergence of a dynamic private sector in the west would lead to a more efficient domestic internal market. • Rebalancing the national ecosystem, especially in controlling soil erosion and desertification. • Tapping the rich natural resources in the western region to contribute to national economic growth.

12. Go West: Priorities and Three Pillars • Vastness of the underdeveloped interior (12 provinces containing over 400 million population) • With fiscal resource constraint, the focus is on improving the investment climate to attract private investment to the western region and prioritizing the use of limited public funds. • Target key areas with relatively stronger economic base, high population densities – close to transportation routes and hubs or along the Eurasian corridor, the Yangtze, and the waterways in the south-west with outlets to the ocean. Rural to urban migrations are envisioned as a key way of reducing rural poverty, complemented by social safety nets and investing in education and health. • Three pillars: reliable infrastructure, favorable business environment, and a qualified and hard working labor force.

13. Go West: Key Instruments • Developing infrastructure • Structural reforms, including reforming SOEs. • Human capital and R&D. For example, higher wage and compensation, waiving change in residence requirement. • FDI and trade: various measures to attract FDI to the interior region including income tax incentives and reducing entry barriers. • Give local government considerable autonomy in developing local growth strategy, consistent with the fiscal decentralization since the 1980s. • Examples of fiscal incentives: performance grants targeting poor regions such as reward counties and towns which raise more revenues (discretionary matching grants), and improve budgetary efficiency (for example downsize and streamline civil services).

14. Northeast Challenges • Three provinces with 107 million people • The longest history of planning, command and control • Large state-owned public enterprises with old technology, inward-looking, lack of competitiveness in global market • Large fiscal burdens due to existing public pension and other welfare commitments • Non-performing assets in financial sector due to its quasi-fiscal link to SOEs • Rust-belt type of “lagging region” • Losing domestic market share in industrial materials and capital goods due to competition from imports • Out-migration of skilled labor force to more dynamic coastal regions • Deteriorating urban infrastructure • Skill mix cannot fit new market demands and structure • Rising unemployment

15. Strategy for Northeast Revival • Key elements similar to the strategy of successful revival of rust-belt lagging regions, though more constraints due to the sheer size of SOEs • Restructuring SOEs with pension and social security reforms as pre-requisites • Openness and trade and integration with successful coastal regions and global economy • Develop dynamic comparative advantage • Competitive private sector essential • Skill reorientation to meet market demands • Success of Dalian

16. Chile: Regional Policy of Extreme Zones • Chile has long used regional policy instruments to integrate the lagging extreme south and the north into the national economy, to ensure territorial sovereignty, national integration, and effective administration of these regions. • Region I in the north is a coastal desert while Region XII in the extreme south is the glacial sub-Antarctic southern tip of the continent. • The accumulated package of special incentives (incentives for the Zonas Extremas): • Free trade zone incentives exempting enterprises from custom duties, value-added taxes and corporate income taxes, • Wage subsidies benefiting all private enterprises, • Investment tax credits, investment subsidies, and sales subsidies. • Intergovernmental transfers that favor the extreme zones, such as regional investment financing and support to current social expenditures, as well as higher salaries to civil servants to attract them to the lagging extreme zones.

17. Chile: Regional Policy of Extreme Zones • Policies viewed as successful, but fiscal costs are high. • Related to effective administration in Chile in general • Policies of special economic zones have mixed experience internationally, issue of governance and transparency • The ultimate aim of the regional policy is to help these lagging regions get onto a sustainable path so that subsidies are no longer needed, by turning subsidized physical and social infrastructure into agents that generate productive assets. • New direction of Chilean extreme zones policy: capitalizing the strength of the North region as a natural global gateway to the Pacific Rim, positioning itself as a Pacific portal and economic nucleus for the cross-border economies of Peru and Bolivia and even parts of Mercosur.

18. Observations from cross-country experience • Unbalanced and balanced growth strategy • China experience shows that a nation may pursue unbalanced growth strategy at certain point of time as part of its overall development strategy. • Chile experience shows that economic efficiency is not the only consideration by policymakers • EU experience shows the motivation of social cohesion and expanding markets • There is no one size-fit-all regional policy. • China’s multi-prone regional development strategies (coastal, west, central and northeast) shows that each region faces its own unique set of challenges (e.g., geographical remoteness; rust belt; well-endowed resources but require a new set of policy framework)

19. Observations from cross-country experience • However, successful regional development tends to align with market forces, economies of scale and agglomeration. • Openness, trade, efficient internal and external markets are central to sustained regional growth and development. • The Chilean experience shows that fiscal subsidies, special incentives and infrastructure can work but can be fiscally costly and would only work within a general environment of competitive economic structure, efficient and transparent governance structure. • The old regional policy tends to be top down centralized decision making. The emerging paradigm of regional policy focuses on developing local competitiveness, a transparent and efficient regulatory framework for private investment, and unleashing innovation by local agents of economic change.