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Full recovery needs more private investment
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She Xuebin is the kind of entrepreneur China needs. His Nature Flooring Company has been pioneering "green branding", trying to build a reputation as a wood flooring company that cares about environmental sustainability. The company has expanded because of exports and domestic sales. But since the onset of the global economic crisis its exports have dropped to zero, and She now must focus exclusively on the domestic market to maintain the firm's healthy growth.

He was one of the entrepreneurs I met when I was in Guangdong this week. Nature Flooring's struggles are symptomatic of the larger transformation one can see on the ground in China, as well as in the national statistics. China's first-quarter numbers can be read both as good news and bad news. The GDP increased 6.1 percent over the previous year, which may be a strong performance in the global context but is the lowest rate for China in many years. Consumption and government spending on infrastructure (up about one-third year-on-year) led the growth. But private sector investment has been decelerating, and is not likely to grow this year.

China has a track record of reinventing itself and turning crises into opportunities. What are those opportunities this time around? In my view, one such opportunity for China's recovery is private investment, the main source of jobs in recent years and critical for sustained recovery.

What can China do to bring back private investment? First, it is important that the fiscal stimulus provides private firms opportunities through a competitive process. Quite a few provinces and cities have promulgated regulations that require funds from the fiscal stimulus packages to go to local firms, usually State-owned enterprises (SOEs). This kind of local protectionism is not in China's interest. Since growth now is going to be based primarily on the domestic market, it is important to have a large, competitive domestic platform.

Let me be clear that in the first instance, I am not talking about international trade protectionism. I am talking about opening up government procurement in each location to all firms registered in China. This will create a lot of opportunities for China's private sector.

Externally, China may want to consider signing the Government Procurement Arrangement (GPA) in WTO, which is an optional protocol. This would open up China's government procurement to international competition, and in return Chinese firms would be able to bid on government contracts in the other economies that have signed the protocol, such as the US and the European Union.

A second area of reform is the financial sector. Here we have to give Chinese banks credit that they have not lost vast sums of money speculating on complicated financial instruments, as banks in the developed countries did. But it is also the case that banking practices here are very traditional, mostly lending to large, established firms based on collateral.

Talking about China having more consumption-driven growth in the future is the same as saying that service sectors will grow faster than industry. Service sectors are less capital intensive than industry - this has the benefit of generating more jobs for every 1 percent of growth. But their expansion requires a different kind of banking service, based more on cash flow and less on tangible assets and collateral.

China has been gradually opening up its banking sector to private Chinese and international banks. In 2007, however, only 26 small privately owned banks were granted license. This is a good time to accelerate that process because it would create jobs and provide important services that help other sectors grow.

Let me be clear that opening financial services is not the same as opening the capital account. China has a well-respected policy of gradually opening the capital account. The issue now is enabling faster opening of banking services - both to domestic private and international banks - which would help the recovery of private investment.

A third potential area for reform is logistics and distribution. Talking to firms and local officials in Guangdong, I came away with the impression that it is much easier for coastal firms in China to sell in the global market than in the local market. China's exports-oriented logistics (ports, Customs, handling) are excellent. It's much harder for a Guangdong firm to arrange to sell inland. Physical infrastructure is good, but there are no national logistics firms that facilitate shipments.

China spends about twice as much GDP on logistics as the US, a country comparable in size, but more needs to be done to facilitate the internal market. Again, opening up the market to domestic and international private logistics firms would immediately create investment opportunities and provide important services to other sectors.

Since the beginning of reform, China has responded to external shocks with faster reform. This is a model the World Bank encourages other countries to emulate. China is now facing its biggest external shock in 30 years. We are impressed with the rapid fiscal and monetary stimulus that has stabilized the economy and set the stage for a new, sustainable phase of growth.

But there are important reforms that can accelerate the transition to a new growth model. In the old growth model China created an excellent investment climate particularly for manufacturing firms. That sector of course remains important. But we encourage China to look for opportunities to create an excellent investment climate for service industries such as finance and logistics. That should support the growth of successful local firms, like the one owned and run by She, accelerate the return of private investment for new initiatives and lead to sustained dynamism and growth.

The author is managing director of World Bank.

(China Daily June 10, 2009)

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