Ladies and Gentlemen, we have lived through a remarkable 25 years. At the end of the 1970s, China emerged from the turmoil of the Cultural Revolution and embarked on the reforms initiated by Deng Xiaoping. As a result, more than a billion people, one-fifth of the population of this planet, have seen a sustained period of growth and poverty reduction that has been unique in human history. At the end of the 1980s, four hundred million people of Central Europe and the former Soviet Union set off also on a remarkable transition from a command economy to a market economy. There have been both achievements and trauma. But the changes are irreversible and many countries are now being welcomed into the European Union. More quietly in the early 1990s, India set off on the road to economic change and is now seeing growth and poverty reduction which few would have thought possible 20 years ago.

Remarkable too has been the overall improvement in living standards in the last few decades. In the past forty years, life expectancy in developing countries has increased from the mid-forties to the mid-sixties; it must have taken millennia to move from the mid-twenties to the mid-forties. In the developing world, the share of people who are illiterate has declined in the past thirty years from around one-half to around one-quarter, with particularly strong progress for girls and women. In the last 20 years, the absolute number of people living below one dollar a day has decreased by around 200 million people, the first sustained decrease since the early nineteenth century—or as far back as we can construct data. This decrease has occurred at a time when the population of the developing world rose by 1.5 billion.

Sadly, however, this progress has not been shared universally: all too many people have been left out of this story. While child mortality for children under the age of five is 7 deaths per 1,000 children per year in rich countries, the average in developing countries is 84 deaths per 1000, and in sub-Saharan Africa it is a shocking 162 deaths per 1000. Half of women over 15 in both South Asia and sub-Saharan Africa are illiterate. Over one billion people in low and middle-income countries lack access to safe water for drinking and personal hygiene.

Reaching those left behind presents many challenges, including overcoming disillusionment in many countries where growth has failed to take root despite undertaking difficult reforms. Average tariffs have been cut by half in developing countries over the last decade, inflation has been largely brought under control with average rates now in single figures. But many countries in Latin America and Sub-Saharan Africa have not seen the results in terms of growth and poverty reduction.

We also see the real possibility of a retreat into protectionism in rich countries. When the challenge should be to dismantle obstacles to developing-country trade, rich countries are subsidizing their agriculture with over $300 billion per year. This is six times the total amount of development assistance from OECD countries. These subsidies, along with protectionist anti-dumping actions and bureaucratic applications of safety and sanitation standards, block developing-country agricultural exports at enormous cost to farm incomes in poor countries. And rich country protection goes far beyond agriculture, with deeply damaging effects, especially in textiles. While preaching trade, the rich countries have erected obstacles precisely in those areas where poor countries have a comparative advantage.

While we should not be under any illusions about the magnitude of the challenge, I believe, however, that we now face a special opportunity. Building on the optimism and good intentions of a new millennium, an extraordinary international commitment to promoting development and fighting poverty has been created. This has been crystallized in the Millennium Development Goals (MDGs) adopted at the UN at the end of 1999. These goals represent specific targets for improvements in income poverty, health, education, the status of women and girls, the environment, and international development cooperation for the period from 1990 to 2015. In Doha in November last year the international community committed to a new round of WTO trade negotiations, and for the first time placed the interests of developing countries at the top of the agenda. In Monterrey this March, the international community reaffirmed its commitment to the MDGs. Developing countries committed to making improvements in governance, institutions, and policies, and rich countries committed to increasing aid, opening to trade, and supporting capacity building. The Johannesburg meetings this August looked further ahead to address the challenges of achieving sustainable development and protecting the environment. Taken together with past achievements, and what we have learned about development policy, these commitments put us in a uniquely strong position to take action to achieve the Millennium Development Goals. But with this comes a deep risk of failure that could cause lasting, and possibly irrevocable damage

My remarks this morning is about how to rise to this challenge. I will present a strategy for development based on what we have learned from development experience. The strategy is based on two pillars: creating a good investment climate for dynamic growth to take place, and empowering poor people to participate in the growth process. As this conference is about the investment climate in China, I am going to focus on that pillar and look at the experiences that other developing countries can take from China’s success so far as well as the challenges that lie ahead for China.

2. What Have We Learned from Development Experience?

I would like to start by emphasizing that my focus on the two pillars of investment climate and empowerment arises from development experience over the past 50 years. Development is about fundamental change in economic structures, the movement of resources out of agriculture to services and industry, about migration to cities and peri-urban areas, and about transformations in trade and technology. Changes to social life—in health and life expectancy, in education and literacy, in population size and structure, in gender relations, and in social relations—are at the heart of the story. The challenge to policy is to help release and guide these forces of change.

In characterizing what we have learned from development experience I will draw out six key lessons in a way that can help to inform effective development strategy. The first concerns the role of the state. The state is not a substitute for the market, but a critical complement. We have learned that markets need government and government needs markets; and that government action is crucial to the ability of the people to participate in economic opportunity. These lessons point to an active state which fosters an environment where contracts and markets can function, basic infrastructure works, and there is provision for adequate health, education and social protection.

The second lesson is that the most powerful force for the reduction of income poverty is economic growth. Countries that have reduced income poverty the most effectively are those that have grown the fastest, and poverty has expanded most in countries that have stagnated or fallen back economically. The third lesson is that, notwithstanding the importance of an active state, the most powerful and the central force for economic growth is the private sector. Within the private sector, small and medium-sized enterprises (SMEs) play a particularly important role in the employment opportunities for poor people

The fourth lesson is that trade has been a crucial engine of growth. Trade patterns have changed dramatically since the 1970s, when trade with developing countries was still dominated by commodity exports. China’s opening to the world, and the shift away from import substituting strategies in many countries, has led to a surge in labor-intensive manufactures, which now dominate aggregate trade flows for the more rapidly growing developing countries.

A fifth and highly important lesson is that development activities function much more effectively if poor people are empowered. We can define an individual as being empowered if she or he has the ability to shape the basic elements of her or his own life. This requires that people be educated and healthy, in other words they need what economists call human capital. But empowerment goes beyond human capital. It also means effective participation, which depends in turn on information, accountability, and the quality of local organizations. For example, we know that schools function better if the community is involved; that infrastructure, electricity, water, and the like work more effectively if consumers’ voices are heard, and we know that poor people are more effective in their economic lives if they have reliable title to their own property.

The sixth and final lesson is that reform programs forced from outside, with weak societal commitment, are likely to fail. Ownership of the development agenda by a country and society is a vital ingredient for its effective implementation.

What I take from these lessons of experience is that an effective strategy for development is based on two pillars.

The first pillar is the creation of a good investment climate—one that encourages firms, both small and large, to invest, create jobs, and increase productivity. The centrality of this emerges from the lessons above on the role of the private sector, of trade, and of growth for effective poverty reduction.

The second pillar is to empower and invest in poor people—by enabling their access to health, education, and social protection, and by fostering mechanisms for participating in the decisions that shape their lives. This emerges from the lessons based on social inclusion and ownership of reform.

3. Investment Climate in China

Let me elaborate in more detail about the first pillar, the investment climate. I define “investment climate” as the policy, institutional, and behavioral environment, both present and expected, that influences the perceived returns and risks associated with investment. We think here not only of the quantity of investment but also of the productivity of investment and economic activity. We think first of the investment climate for smaller, domestic firms. If it improves for them it will in all likelihood improve for larger and foreign firms as well.

The investment climate is a function of various elements that can be grouped under three broad headings: (i) macroeconomic, trade and economy-wide policies, (ii) infrastructure, and (iii) economic governance and institutions.

Unstable macroeconomic conditions—often resulting from unsustainable fiscal positions—undermine the confidence of firms in making investment decisions and engaging in production. Trade barriers and weak competition in domestic markets suppress incentives to innovation and entrepreneurship. This macro aspect of the investment climate has been well understood for some time. It happens to be an area in which China looks quite good and provides useful lessons for other countries. Macroeconomic and political stability in China has been strong, and this stable environment is certainly one factor that has encouraged both Chinese and foreigners to investment here. Trade policy is another area of strength for China. Much of the work of reducing tariff and non-tariff barriers to trade was done before China joined the WTO.

But the investment climate involves micro issues of infrastructure and governance as well, and these aspects have been less examined and less well understood than the macro factors. One of our recent initiatives at the World Bank is to help developing countries carry out large, systematic surveys of firms in order to better understand the problems of infrastructure and governance that stand in the way of more productive investment and job creation. Together with the Enterprise Survey Organization we have done an initial investment climate survey covering 1500 firms in the five cities of Beijing, Chengdu, Guangzhou, Shanghai, and Tianjin. These are important production centers in China; but they also represent only a small part of the country. We hope that one outcome of this meeting will be an agreement that these investment climate surveys are a useful tool that should extend to more locations in China. It is particularly important to understand how to stimulate investment and growth in small cities and interior locations.

This first investment climate survey provides interesting insights into some of China’s strengths, as well as useful guidance about challenges ahead. In the area of infrastructure, for example, the five Chinese cities covered compare quite favorably to many other locations in the developing world. Some concrete examples: firms in China report losing an average of 2% of sales to power outages, compared to 6% in our Pakistan survey. Many firms in the study are importing materials or machinery, and the typical Chinese firm got its most recent shipment through customs in 8 days, which is comparable to more developed countries such as Korea or Thailand. In India by contrast the figure was 11 days; in Pakistan, 18 days.

China does not look so good, on the other hand, in the “soft” infrastructure of financial services. One of the striking things in the China sample is that private firms – which have become the most dynamic part of this economy – are about 30% more productive than state-owned firms. That is, private firms produce about 30% more output with the same capital, labor, and materials. Yet these same private firms receive very little financing from the formal financial system, which remains focused on serving state enterprises. The problem is particularly acute for SMEs. The typical SME in China gets about 10% of its working capital financing from banks; in Korea or Thailand, the typical SME gets 40% of its financing from the banking system. These issues of improving financial services will be the focus one of the sessions in our conference.

Let me turn to the third important aspect of the investment climate, governance. Bureaucratic harassment, corruption, and organized crime are all profoundly damaging to the investment climate, imposing barriers to entry, adding to operating costs, and creating uncertainty once the firm is established. This applies to both large and small firms, but it is especially important for SMEs, with their weaker capacity to finance start-up costs to deal with regulation and to use “political contacts” and other means to resist harassment.

I recall vividly the experience, whilst at the EBRD in the 1990s, of speaking to a number of women running small businesses in St. Petersburg. They described the endless visitations from tax officials, safety inspectors, the fire service, officials examining the structure of price lists, sanitation engineers, police officers, and so on. Many of these came in more than one version—from city, region, and federation. It was extraordinary, and speaks volumes for their perseverance and courage, that they managed to start and stay in business. It is hardly surprising that small and medium-sized businesses have grown so slowly in Russia. The story could be retold in transition and developing countries across the world.

In our investment climate surveys we are trying to find some creative ways to get at these difficult issues. For example, we ask firms to estimate how much time they spend dealing with the government bureaucracy and how much they pay in informal payments to get things done. Here I want to highlight that there is quite a lot of variation across the Chinese cities. Much of regulation and inspection occurs at the local level, and local government plays a large role in creating a good or bad investment climate. Local officials appear to influence what firms and what goods get to enter their markets. China is a huge and rapidly growing country, so that there are large benefits to having an integrated, national market. It is in the national interest to ensure that local officials cannot close off their markets from Chinese good produced elsewhere in the country. And it is in the interest of each locale to ensure that it is well integrated into this growing national market.

Let me conclude by emphasizing that improving the investment climate is really about improving the connection between sowing and reaping. Understanding investment and productivity is in large measure understanding whether investors can work effectively and reap the benefits of their efforts or whether their investments will be frustrated by uncertainty, instability, and predation. The good news in China is that there are certainly some locations with quite good investment climates and these locations have been a key part of the country’s economic success. Other developing countries can learn from this success. But what is needed now in China is both a widening and a deepening of the investment climate. By widening, I mean an expansion of good local governance and good infrastructure to more locations, especially in the interior, so that labor-intensive manufacturing can develop in these places. At the same time, the best locations in China – Guangzhou and Shanghai – are seeing their wages rise, which is a good thing – but for them to remain competitive they need to move into more sophisticated, higher value added products. What I mean by deepening the investment climate is supporting the development of financial services and business services more generally. These are themselves high value added activities, and they are a critical support to more sophisticated manufacturing and service production in general.

I remain optimistic that China will rise to this challenge and pursue the next round of reforms needed to ensure the continuation of its successful growth and development. Thank you.

(china.org.cn December 5, 2002)