How the China Development Bank Should Cope with Market and Government Failures

July 20, 2007

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All the speakers have just made excellent speeches with numerous examples. These examples have illustrated that the China Development Bank has chosen some good projects which have generated wealth. But now the follow-up question is “Why has the China Development Bank been able to choose these good projects?” What are the barriers and difficulties in selecting good projects? These come from two places: the market and the government. The market is very good in theory, as seen in the Citibank spokesman’s discussion of the role of competition in the current market, so where is the problem? The market has costs, and when the market isn’t well-developed, the transaction costs will be high. Therefore, we are at a serious loss if we focus only on the market because China’s financial industry isn’t fully developed. The Development Bank in this regard has played a significant role in selecting good projects when market failures occur.

On the other hand, difficulties also come from the government which has set up many obstacles. This is why there are many problems in previously state-owned enterprises, as well as many problems in the bureaucracy. A number of projects that were planned by the government or faced restrictions could not be carried out effectively. The China Development Bank in this respect has a very important role, a unique position in which it has innovatively solved the two problems of the market and government. The bank not only addresses the difficulties of the market, but also finds solutions for dealing with government constraints and failures. As a result, in all projects developed by the Development Bank, a situation emerges where the bank significantly reduces social costs, thereby greatly increasing benefits. We have found that in all these projects, the Development Bank didn’t simply concentrate on the simple financial variables such as the interest rate, but rather it focused mainly on social benefits and reducing social costs. That is the most successful advantage of Development Bank. China’s market is not well-developed, and the government’s planning, regulations, and the financial sector haven’t fully opened. Thus the bank plays a leading role in explore how to help both the market and the government play positive roles, and at the same time minimize their negative effects.

I think that in the case of China, this role is very important, because the situation in China is that savings are too high and there is a large surplus of capital which can’t be fully utilized. As a result, China exports its surplus capital to the United States. China actually has an economic system with a low stock of capital which cannot be fully used up. At the same time it has a large surplus of labor and not enough jobs in the rural areas. In this context, China needs a lot of investment, but the problem is that a considerable part of the China’s investments are not efficient—they are low-efficiency investments. The low efficiency of these investments is resulting in economic overheating. How can we solve this problem? We need macroeconomic controls which are able to lower the quantity of investments while at the same time increasing the number of efficient investments. How does efficient investment happen? The most important thing is financial industry. But China’s financial industry and its economic governance are far behind and need to develop.

The China Development Bank has actually played a pioneering role and set a model for us in the selection of efficient investments. I think that for China, the Development Bank is of great significance because there continues to be the simultaneous existence of labor and capital surplus. I think our conference is very important, especially since in the construction of public infrastructure, the Development Bank has played a significant role in theory and practice. A highlight of China’s economic growth is that our public infrastructure construction is developing better than that of India’s, Indonesia’s, and even better than any other developing country. Many foreign experts and scholars wonder how China’s public infrastructure construction has done so well, given that is has been guided mainly by the Development Bank, as well as some state-owned enterprises. We need to outline and explain this experience.

In addition, as I mentioned just now, many people think China has invested too much, especially in public infrastructure construction, compared with India and other countries. If China has invested too much, we don’t need to encourage investment, but rather to control it. China is actually lacking in investment with high efficiency and low risk. The Development Bank’s rapid business expansion speaks to the need for its services.

How can we encourage more investment with high efficiency? I think that in China this issue is the most important one to address, as it is also the primary challenge of our future. It has a very wide scope, as seen in the process of developing good projects, which involve not only the environment, resources, education problems, but also the problem of comprehensive regional reform. Especially in China’s current circumstances, the market is developing so fast that the government has often been unable to meet the demands of the market. For example, half of China’s export industries are controlled by foreign investment enterprises, which speaks to the fact that China’s exports are basically beyond the control of the government. The macroeconomic regulations mainly control the major basic infrastructure, which often involve imports. We have to solve China’s foreign trade imbalance, as the Citibank representative mentioned in the first section. In order to solve this issue, the most important step is to increase China’s imports. We have already done very well in exports, not only in foreign-invested enterprises, but also in China’s state-owned enterprises and private enterprises. But we have still encountered many restrictions in imports. The major difficulty is that imports are always associated with and necessary for large infrastructure projects, including social security, health care reform, education reform and so on. The great demand for all of these has faced many restrictions.

I think it is very worthwhile to outline the Development Bank’s experience in this regard. It is particularly important for us to be aware that although China has already had big successes in medium and long-term public infrastructure before, much data and many studies are pointing out that we still need more efficient investment in long-term public infrastructure construction, and the current success only reflects our past efforts. We need to act because long-term public infrastructure is complementary to private investment, so when private investment increases rapidly, public investment in infrastructure must keep pace. Looking at the figures, public infrastructure investment has developed faster than that of any other country. Even by China’s standards it’s very fast. But private investment, private enterprises and international enterprises are progressing even faster, so we should be aware that investment in this regard should continue to be strengthened. The successful experiences we discuss and the law we review today will be significant for our next stage of reform.

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