At 2:00 p.m., June. 5th, the Tsinghua PBCSF Global Finance Forum themed on South-South cooperation was held in Tsinghua University PBC School of Finance (Tsinghua PBCSF). Mr. Lin Yifu, joint founder and honorary dean of the National School of Development, Peking University (PKU), and dean of the PKU Institute of South-South Cooperation and Development, attended the forum and delivered a keynote speech. Also present were CaiEsheng, president of the Finance Center for South-South Cooperation (FCSSC), Liao Li, executive associate dean of Tsinghua PBCSF, Zhou Hao, associate dean of Tsinghua PBCSF, Cao Yuanzheng, chairman of Bank of ChinaInternational Holdings, Hu Wei, vice general manager of China CAMC Engineering Co., Ltd., Hu Zhong, director-general of the FCSSC and Wang Jingwei,assistant dean of Tsinghua PBCSF. The Forum was moderated by JuJiandong, visiting professor at Tsinghua PBCSF.

Below is the speech made by Mr. Lin.

Rise of Chinese Economy & South-South Cooperation

The rise of the Chinese economy and South-South cooperation. By the end of 1978 and before the great reform and opening up program was initiated, China remained an extremely poor country for a century or two. Statistics show that by 1978, 81% of the Chinese population lived in rural areas and 78% had to eke out a living on less than $1.25 a day, below the international poverty line. At that time, China’s per capita GDP was only $155, lower than the average level of the sub-Saharan Africa by over a third. Besides, China was a typical inward-oriented economy, as export and import took up only 4.7% and 4.8% of GDP respectively, which amounted to just 9.5% when combined. That means more than 90% of the Chinese economy was irrelevant to the world economy.

And like other indigent countries, the exports of China then were mainly products of the primary sector, such as ore and raw or processed agricultural products which combined accounted for 75% of China’s export. Hence, in a manner of speaking, it was just like the typical poor Southern countries today.

However, since 1978, the Chinese economy has seen wonders. From 1979 to 2005, China’s GDP climbed by an annual rate of 9.7% for 36 years in a row. And its export increased by 16.4% annually. By last year, China’s per capita GDP reached $7,960, becoming an upper middle-income country.

Thanks to such rapid growth, in the past 30 years or so, 680 million people have been lifted out of poverty. This, as it is, a great contribution to the global cause of poverty alleviation. But for the subtraction of over 600 million following China’s reform and opening up, the world’s poor population would, instead of diminishing, still be on the increase, even though so many international development organizations strived to help developing countries boost economic growth and reduce poverty.

I think it’s exactly under such a circumstance that I became the first Chief Economist of the World Bank from a developing country.

Besides contributions to poverty alleviation, with its large economic scale, China outstripped Japan, becoming the second largest economy in the world in 2009. And in 2010 it surpassed Germany as the largest exporter in world market. Then in 2013 it overtook America to become the country with the largest trade volume (including export and import) in the world.

Measured at purchasing power parity, the size of the Chinese economy was bigger than that of the US in 2014, which grantedChina the top slot among world economies. So in my speech today, I want to discuss with you several questions.

First: Why would the Chinese economy, poor and stagnant as it was for centuries, be able to achieve such miraculous development after 1978? How’s that possible?

Second: Why, before 1978, on the same land, the same Chinese population would have an economy that was in constant stasis like most developing countries, leaving people in poverty for a long time?

Of course, you’d say that this is because China’s reform and opening up started in 1978. But we all know that in the 80s and the 90s, such a policy was a common topic of all the developing countries. All the socialist states were on their course to reform and open up. And actually all the non-socialist states, no matter they are in Africa, Latin America or Southeast Asia, were doing the same in the eighties and the 90s. Nevertheless, the Chinese economy during this period was stable and continuously progressing, while those other developing countries, socialist or non-socialist, invariably saw economic breakdown, standstill or other various crises. Moreover, their average growth rate turned out lower than before their reforms started and the incidence of crises climbed. Why would they be so drastically different from China in achievement?

Third: In terms of the other countries in the South, including those in Africa, Southeast Asia and Latin America, is it possible for them to replicate the economic wonder of the post-1979 China? Finally what benefits and opportunities on earth has the rise of China brought to other developing nations?

Those are the questions I want to discuss with you together.

First of all, let’s talk about why China can maintain a high growth rate for 36 years running after the reform and opening up in 1978. What are the underlying reasons? As we all know, economic development reflects the constant growth in per capita income which is fueled by increasing productivity. So how to raise productivity?Ithink the answer is obvious to you all. For one, when the current technology of an industry keeps upgrading and each worker inside the industry makes more products with higher quality and selling price, productivity rises.

For another, it’s to have constantly emerging industries with high value-added, which can thusreallocate human, capital and natural resources from low-value-added industries to those comparatively higher-value-added industries.

That’s to say economic development is realized through a chain reaction in which the technology and industry are constantly elevated to new levels. Well this is the very nature of economic development. Be it developed countries or developing countries, if it pursues long-term income growth, economic progress and improvement of life, it has to draw on this mechanism—the constant upgrading of technology and industry.

However, there is a big difference between developing and developed economies. Since the industrial revolution, the per capita income and per capita GDP of developed nations have led the world.This means that their productivity has been at the world top since the industrial revolution, that their technology remains the most advanced and that their industries maintain the highest value-added in the world.

In this context, if they want to continue to innovate, they need to invent on their own, and their industrial upgrading also entails independent invention. As is known to all, inventionrequires hefty investment and runs great risks. Numerical evidence suggests that the developed countries,relying on independent development of new technologies and new industries,achieved an annual growth of 3% during the 100 years or so from the end of the 19th century to present day.

As for a developing country, if it wants continual economic growth, the answer still boils down to technology innovation and industrial upgrading. Unfortunately, its current income remains low, which means its productivity, technology and the value-added its industry produces lag behind. We know that from the perspective of economic and management science, technology innovation means the application of better production techniques which are not necessarily newly invented. Some may have been useless in the past but prove superior to current ones and the use of them is exactly technology innovation. Given that developing countries lag behind developed countries in technology, chances are that they could borrow the mature technologies already invented by the developed countries.

So does it go with industrial upgrading. As long as the industries you put into production next time produce more value-added than your current industries, then this is exactly industrial upgrading. So even if the current industries of some developing countries fall far behind those world-leading industries of the developed countries, they just need to introduce the industries that, full-fledged and with a market, have been adopted and put into production by developed countries or higher-income countries. The introduction of those higher-value-added industries means precisely industrial upgrading.

That is to say, if a developing country knows how to use the gap in technology and industry between itself and those developed ones as the sources of its technological innovation and industrial upgrading, it could then enjoy much lower cost and risks compared with those developed countries. In that case, it would boast a way faster development rate, which is called Late-mover Advantage in economics. Supposing that an underdeveloped country knows how to take advantage of the above mentioned mechanism, it would have a much faster rate of technological innovation and industrial upgrading with lower risks, thus bringing itself a higher economic development rate, which can be predicted by experience.

Since the Second World War, 13 economies have already made full use of the gap between themselves and other developed countries and grasped the opportunity of Late-mover Advantage in order to accelerate their economic development. During that process, they have achieved economic growth of 7 percent or even higher, twice that of developed countries.

Since its reform and opening up, China has already made itself one of the 13 economies noted earlier with its 25 or more years of development. Thus, the answer to the first question is fairly simple. Why China has enjoyed so rapid economic development since its reform and opening-up? It is because that China knows how to boost its economic development with the gap in technology and industry between itself and those developed countries, and I believe it is shared achievement. Many of you may say that China has attained considerable economic growth in the past 30-plus years, but can you think of any new techniques that were invented by China? Or which particular industry? I can’t say there isn’t any, but I think it could take a long while for all of you present today to find one.

So, the first answer is rather simple, that is, the Late-mover Advantage

Then if the Late-mover Advantage is the root cause for China’s fast economic development since its reform and opening-up began in late 1970s, the whole thing would again be a riddle. Since the Late-mover Advantage refers to the gap in technologies and industries between underdeveloped countries and developed ones, which can be dated back to the Industrial Revolution, way earlier than the year of 1978, why China didn’t make good use of it to speed up its economic development until its reform and opening up? And why China was as sluggish, underdeveloped and destitute as other southern countries before its reform and opening-up?

As far as I can see, the primary reason is that China gave up its opportunity to use the Late-mover Advantage in the past. As we all know that before the year of 1949 when the country was still plagued by all kinds of unrest, pursuing economic development was impossible. And after the founding of the Republic of China at the year of 1949, the New China planned to win itself an equal international status with other developed countries as soon as possible, and Chairman Mao announced loudly on the Tiananmen Square on 1st, October,1949 that “ Chinese people have stood up”. Then what is the prerequisite for Chinese people to stand up? The answer should be that China’s GDP is as high as those developed countries and that China has as strong national defense capabilities as those countries. So, how can we turn China into a country whose per capita income is as high as developed countries? And is there any necessity for China to have as high per capita labor productivity as those developed countries? If so, how to improve its productivity? We then thought that once China has the same labor productivity level and income level as those developed countries, it has to adopt the same techniques used by them as well.

And to have as strong national defense capabilities as those developed countries, we must possess the same abilities to produce aircrafts, cannons, and aircraft carriers as they do. And what particular industry produces aircrafts, cannons and aircraft carriers in Western countries? The answer is the heavy industry featured with intensive technology, large scale and considerable capital input.

Therefore, in 1952, 3 years after PRC, when the society became stable and economy grew, China introduced a so-called development strategy of “catching up with the United Kingdom within 10 years, and the United States within 15 years”, which showed our eagerness to develop our economy and to promote the same industries and techniques as those developed countries. I believe the strategy was well-intended. But since the industries and technologies mentioned were the most advanced ones in developed countries, which also formed the foundation of their national defense security, it was unrealistic for them to transfer their industries to China without preconditions. So, the New China had to develop those technologies and industries themselves, which means that it had to give up the alleged Late-mover Advantage.

And it was actually more than giving up the Late-mover Advantage. As an extremely destitute country in lack of resources back in 1950s, China had no advantage in developing heavy industries that are characterized by large capital input and scale. Those were the comparative advantages of developed countries. So, to pursue development in such a situation where China had no comparative advantages, it was doomed to face the problem that the enterprises in those heavy industries had no survival abilities themselves. It was because that in a country short of capitals, the cost of capitals must be high. And as the most important part of capital-intensive industries, the cost of capitals actually decided the enterprise cost. Under that circumstance, the cost of Chinese enterprises was necessarily higher than that of developed countries. As a consequence, they couldn’t survive in an open and competitive market.

Although the situation was extremely unfavorable to China, it still had to develop those heavy industries. And to achieve that end, government investment was an indispensable part. And even if China could finally develop the heavy industries, its operational cost would still remain higher than those of developed countries. Thus, the government had to continue to provide those industries with large subsidies, which could distort all the market prices including prices of capitals and raw materials.

And such distortion would inevitably lead to the natural reconfiguration, which would then result in inefficiency. And as China then gave up the existing Late-mover Advantage and developed industries that were dominated by those developed countries, its economic development was unavoidably sluggish and slow.

It was not until China’s reform and opening-up by the end of 1978 did it begin to use its labor advantages to promote labor-intensive industries that are in line with China’s comparative advantages and thereby winning itself competitive strength. And China’s comparative advantages have assured its products great competitiveness in both domestic and international markets, as well as a large market share and high profitability.

After gaining profiting ability, China began to accumulate capital, which generated the need for it to upgrade its industries. And during that upgrading process, China, with its comparative advantages, turned its labor-intensive and simply manufacturing industries into capital and technology-intensive ones, which are all already mature industries, so China got to use its Late-mover Advantage. The transition of development strategies, I believe, is the biggest difference before and after the reform.

We can almost say that since the end of WWII, to develop the same industries as developed countries has already become a shared development strategy among all the developing countries. As all of us know that the world was divided into two separate groups since the Industrial Revolution:

The first group: those northern countries, colonial power.

The second group: those southern countries, colonized countries.

The First World War witnessed the stormrise of democracy, whose advocates got rid of the colonial rule and began to pursue the modernization of their own states after the Second World War. At that time it seemed that to achieve the modernization of their own states and catch up with those developed countries, they had to at first reach the same income level and have as strong national defense as those countries.

And that was why China introduced its strategy of “catching up with the United Kingdom within 10 years, and the United States within 15 years”. As a matter of fact, be they socialist countries or not, they all took similar measures to achieve modernization and economic prosperity after having found their states through revolution or gained independence from colonial rule. Some countries followed the strategy of heavy industries and some followed the strategy of import zone. And China’s development strategy was fairly clear, that is, to develop capital-intensive and advanced heavy industries. And the strategy of import zone means that as developing countries mainly exported agricultural and mineral products and imported industrial ones, they hoped to develop their own advanced industrial manufacturing industries, thus reducing their demand for imported products.

But this strategy was also against their comparative advantages and required governments to exert strong intervention in market and provide all kinds of subsidies for those industries, which would lead to all kinds of distortions. And with inefficient distribution of resource and many problems in incentive mechanism, they all gave up their chances to use the Late-mover Advantage and ended up like China.

Such development pattern brought very poor economic performance. Then in the 1980s when China began its reform and opening-up, other socialist countries also introduced the same policy. Countries in Latin America, Africa and Southeast Asia launched their economic transformation with the help of the International Monetary Fund.

But in the end it turned out that during the transition from the government intervention economy to the market economy in the 1980s and 1990s, the average economic growth rates of those countries were even lower than those when the government intervened the economic operation in the 1960s and 1970s while the risks occurred even more frequently. So, there comes the question: Why does China enjoy rapid and stable economic development and remain as the only country that has never been plagued by a systemic economic crisis while other countries in their economic transformation, be they socialist countries or not, have all suffered constant economic bust, stagnation and crisis that is even more frequently than the 1960s and 1970s. Why does China have better performance than other countries when the root of the problems to be solved is the same? From my perspective of view, it is because that China has adopted a different strategy for economic transition.

Then how did the former socialist countries or other developing countries make the transitions from planned economies to market economies when their transformation started in the 1970s and 1980s? At that time, a consensus was formed from the so-called new socialism that too much government intervention had caused poor allocation of resources and twisted incentive mechanisms, which strangled the countries’ economies.

And how could they boost their economies? The answer was that they needed a sound market system like that of the developed countries. It entailed so-called marketization, liberalization, privatization rather than government intervention.

They believed that a successful changeover to a market economy required to lift all the interference of the government. And if you kept some of the rules of planned economies instead of eliminating them all, it would be the worst situation, even worse than the previous planned economy. In this case, all those developing countries began their so-called structural adjustments in such a radical way under the leadership of their governments.

Theoretically, it seemed obvious that government interference with the allocation of resources or the incentive regime would do harm to the economy, so they needed to be cancelled once and for all. Nevertheless, this consensus had ignored the fact that government intervention was aimed to give support to the industries that were given priority and relevant companies would collapse without protective policies. Therefore, if you adopted such a radical measure, which was against the comparative advantages of the countries, what would be the consequences? The industries developed would collapse. 20%, 30% or even 40% of the countries’ workers were employed in those industries in cities and they would lose their jobs if protective interference were lifted. Such mass unemployment in cities would result in social and political instability. Faced with this situation, the government in power would have to offer new protective subsidies in secret unless it stepped aside. This is the first reason why we cannot lift the intervention all at one time.

Secondly, all the industries were so called advanced industries that related to national defense. Once the industries collapsed, there would be no national security for the countries. Russia, for instance, is still among the top 8 countries in the world. That is because it has a well-developed national defense industry with eight giant monopolies. In this case, we need to continue providing subsidies for such industries, considering the importance of national security.

Actually, when you decide to provide subsidies for a company, a private one can cost you more than a state-owned one. In a state-owned factory, its directors and managers are employed by the country. They can ask for subsidies, saying the factory will have to close without subsidies. After receiving the money, they cannot make it they own income. The worst situation will be that they take some into their pockets. In this case, they will be charged with corruption or even be sentenced to death once arrested.

However, once the company is privatized, it is impossible for the owner to provide subsidies for the country. Instead, the owner will ask for subsidies with an excuse that it cannot survive without protective interference. The more subsidies it receives, the more money its owner gets. It’s not hard to figure that out. In the 1980s and 1990s when we were still students in the international society, we had been told the truth. But we thought it was just a theoretical deduction and didn’t believe it. Now, it is proved by the reality that in Soviet Union and other developing countries in eastern Europe, you have to provide more subsidies if the state-owned companies are privatized given the influence of their collapse on employment or national security. That will do more harm to the economy. If the economy breaks down during transformation and more inefficient subsidies were added, the country will lurch from crisis to crisis.

Then why is China able to solve the same problems and keep the economy growing steadily at the same time? The answer is that the opening and reform of China is more flexible and practical. In the 1970s and 1980s, many state-owned enterprises started to make transitions. At that time, state-owned companies accounted for 75% of the industrial sector. But as we know, they cannot survive without subsidies. China chose to do it in the old way. It continued providing subsidies while trying to restrain corruption and the enterprises were still owned by the country.

In addition, China relaxed market access for industries that agreed with the comparative advantages of China, labor-intensive industries included. These industries were kept out side of the market until the reform and opening up started in 1979. As these industries were in line with China’s comparative advantages, they had to keep their production cost low. And if they wanted to be competitive in the international market, they had to cut their transaction cost, which depended on financial infrastructure and business environment. However, China suffered from bad infrastructure and business environment during that period. How should China tackle these problems? Just as Chairman Mao put it: we need to concentrate our limited resources to get big jobs done. China improved the condition of infrastructure with limited resources by setting up a special economic zone, an export processing zone and an industrial park. The overall business environment was not good enough, but one-stop services could be provided in the special economic zone, the export processing zone and the industrial park, which made up for the bad condition of China’s infrastructure then.

At first Chinese labor-intensive products were usually in low quality, thereby not appealing to foreign buyers. In order to have access to the international marketing channels, China drawsto the mainland foreign labor-intensive companies in Japan where the salary is increasingly high. They bring with them the technology, managing systems and the international marketing channels to China. And international buyers are getting more confident in them. In this way, China’s comparatively advantageous industries thence develop rapidly and the industrial upgrading follows soon after the capital accumulation.

As capital accumulates with the rapid development, China’s capital-constrained economy has become one with relatively abundant capital and relatively short of labor. Thence heavy industry also becomes in accordance with comparative advantage, making enterprises more competitive and thriving in the market.

In the past when the national defense had little comparative advantage, the government had to allot subsidies to ensure its running. Now as it has become in accordance with comparative advantage, subventions are still needed to advance the industry and promote the industrial transformation. I think it is because of this pragmatic dual system that China is able to develop both rapidly and steadily in the reform and opening up.

From the analysis above, the answer to whether other low-income countries that engage in South-South Cooperation still have the opportunity to achieve rapid development as China has made during the past 30 years is rather clear—yes. Adopting the right approach, they will see the way out.

Here is the right approach. First, countries must develop industries that are in accordance with the comparative advantage in each phase of economic development as that is how competitive advantage comes into existence. As for developing countries, they would first develop the traditional labor-intensive industries of which the techniques related are already mature and patentedso they can be acquired at a lower price and low risks. In this way, rapid development can be achieved.

Secondly, while industries with comparative advantage develop, the government also has an important role to play—to guide the economic development. A developing country often has bad infrastructure, environmental governance and business environment and should address all these problemsif blessed with infinite resources. However, the fact is the resources that a government can get its hand on are limited so is its management capability notwithstanding the international aids from agencies like World Bank. That is when Chairman Mao’s suggestion comes into play—to pool resources to get major tasks done; injuring all of a man's ten fingers is not as effective as chopping off one. That is very different fromthe theory of international development, which suggests if one is to improve the condition of infrastructure, one should do it at a nation-wide range at the same time; the same is true of the environmental governance. But the government’s executive-power is limited.

So, in fact, the distorted governance environment is the result of protecting those outdated industries without comparative advantage. In this case, as the practical suggestion goes, the government shouldallot the finite resources to the improvement of the infrastructures and environmental governance of special economic zones, industrial parks or export processing zones first—to equip them withone-stop services, for instance—thereby boosting the economy in spite of the nation’s general undesirable condition in environmental governance and infrastructure.

I think a case in point is China’s development experience. If you refer to the Doing Business Indicatorfrom the World Bank, even today, China is still ranked the lower part among the 180 countries in the world, which is by no means satisfying. If you refer to the transnational investment indicators from theWorld Bank, China’s performance is considered to be the worst. But how can China attract so much foreign capital and develop its economy at such a tremendous speed? The principal reason is to be practical and realistic. Since our capacity is limited, Iwill first concentrate on the establishment of special economic zones, industrial parks and export processing zones, equipping them with the first-class infrastructure and environmental governance. Even if the national circumstances are not favorable, we can still achieve success in no time. We can create jobs and can increase exports and creating more resources like snowballing, gradually improving other aspects and developing other regions.

In my opinion, provided other Southern countries can use this approach for reference, they can also immediately create new growth points, jobs and exports on the condition of underdeveloped infrastructure construction and poor national environmental governance. This is what we Chinese call “sparks of fire can start a prairie fire”.

When I was theChief Economist of the World Bank, Istarted to popularize this method.But you cannot convince others with pure theory. Hence I came to one of the most deprived inland countries in Africa and conducted my research inEthiopia, which means, according to China’s experience, establishing export processing zones, handling the issues within the zones and selecting the industries with comparative advantages. If your products want to go global but lack confidence in international buyers, the best way is to attract foreign business and investment, ushering in the enterprises already included in the global value chain.

What delighted me was that the former premier of Ethiopia discussed with me and understood the idea immediately as the former Chinese leaders and he was an actionist. I channeled the concept to him in March, 2011 and he came to China to invite investment in August for its leather processing industryand footwear industry with comparative advantages. Then in 2011, its shoes company employed 8,000 people, compared with the number of 19 million in China. As an extreme labor-intensive industry, its employees accounted for just 10% of Chinesecompanies. So what contributed to the disparity even if it had the comparative advantages? That was because its transaction cost was high and because it failed to build up confidence in the foreign buyers. By borrowing Chinese experience, they came to china for investment in August. A boss from Dongguan decided to invest in Ethiopia, after investigating with a delegationin October and finding its wage cost was much lower than in China.

During his visit in October, the boss decided on the spot to send over 8,000 employees to China for training program. In January, 2012, the factory began to work with two production lines in the industrial park and 600 workers and in March, the products were ready for exporting. It soon became the largest export company in Ethiopia in May. Besides, it was this enterprise that doubled the volume of leather export in Ethiopia and increased the workers to 2,000 from its original 600 workforce at the end of 2012. In the next year, the number of its employees mounted to 4,000, which was considered impossible in Africa due to its undesirable infrastructure, miserable environmental governance and its inland geographical features. It would not have evolved into a world manufacturing base if measured in the old standards.