China Business Summit 2006

Sustainable Growth through Innovation: China’s Creative Imperative Beijing, 10-11 September

INSIGHTS

WORLD ECONOMIC FORUM

China Business Summit 2006

Contents This publication is also available in electronic form on the World Economic Forum website at the following address: China Business Summit 2006 report: http://www.weforum.org/summitreports/china2006 (HTML)

The electronic version of this report allows access to a richer level of content from meeting, including the weblog, photographs and session summaries.

Preface

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Summary – Sustainable Growth through Innovation: China’s Creative Imperative

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Innovation

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Risk Management

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Sustainable Growth

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Globalization

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The Creative Imperative in China

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Acknowledgements

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The report is also available as a PDF: http://www.weforum.org/pdf/summitreports/china2006.pdf (PDF)

Other specific information on the China Business Summit 2006, Beijing, 10-11 September, can be found at the following links: Meeting News Photographs Programme Interviews Partners KnowledgeConcierge Weblog

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The views expressed in this publication do not necessarily reflect those of the World Economic Forum.

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REF: 121006 China Business Summit 2006

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Preface The China Business Summit 2006 was designed to generate insight and guide action to improve the alignment of China’s public policy, development and industry agendas. The frank and open discussions in Beijing laid bare the reality that China today is something of an anomaly in terms of modern economic history. It has accumulated now close to US$ 1 trillion in foreign currency reserves, while at the same time hundreds of millions of its citizens still live on less than US$ 500 a year. Or, as one pundit put it recently, China is “a developing country that has vast global impact.”* The report that follows examines this duality, particularly in the context of the newly endorsed 11th Five-Year Plan (2006-2010) which focuses on implementing “peoplecentred” and “scientific” development policies. Concepts, still not yet fully understood in terms of their long-term policy and economic impact, but much better appreciated in terms of their growing importance by those executives who engaged the senior officials participating in the Summit. China is now the world’s fourth largest economy – its per capita GDP is well over US$ 1,000 and it has surpassed the United States as the leading destination for foreign direct investment. These accomplishments, however, have led to the realization that this rapid economic success has also introduced new challenges requiring innovative government policies and creative business solutions if the country is to maintain its strong record of growth. During the week of the Summit, the Chinese government released its first measurement of the country’s “Green GDP” which subtracts the cost of natural resources and environmental degradation from total GDP. In 2004, the economic loss from environmental pollution amounted to 3.05% of GDP (US$ 64 billion). Thus, the China Business Summit 2006 was timely in bringing key stakeholders together to rethink and reshape the country’s growth and industry agendas in this changing development context. China’s first quarter GDP is already 10% greater than a year before and concerns are growing over excessive investment in specific industries and the need to tighten monetary policy. Although fears of excessive growth loom large, the new Five-Year Plan is focused squarely on reducing rural-urban income disparities and uplifting the living standards of the 800 million Chinese earning less than US$ 1,000 a year. Readers of this report will find that addressing both challenges requires shifting from investment and export driven economic growth to sustainable growth driven by technology innovation and domestic consumption. The modalities of achieving this appear to be at the centre of many more discussions in the future.

Lee Howell Director, Asia

* Martin Wolf, “Why Beijing should dip into China’s corporate piggy bank,” Financial Times, 4 October 2006

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Summary – Sustainable Growth through Innovation: China’s Creative Imperative “We have to switch from our previous industrial development mode, from consuming large amounts of natural resources to a development mode based on science and technology as well as innovation.” Zhang Xiaoqiang Vice-Chairman, National Development and Reform Commission, People's Republic of China

Tom Manning Chief Executive Officer, China Board Directors, Hong Kong SAR

Acquiring adequate energy for China’s development will continue to be the paramount challenge, one compounded by the urgent need to find cleaner and more efficient means of delivering it. China’s leaders must also solve the riddle of how to ensure that future development reverses growing disparities of income. Moreover, they must somehow unleash the nation’s innovative potential in a way that can arrest China’s growing trade deficit in intellectual property.

• Increase the protection of intellectual property rights of Chinese and foreign companies

Unleashing China’s creative impulse will require dramatic changes to the nation’s educational system, particularly its universities – the crucibles of China’s creative leadership. China will continue to need foreign cooperation and investment in order to make the transition. But Chinese companies must take the lead to innovate new products as well as their management processes. It will also need more dynamic capital markets that can channel the nation’s vast savings towards innovation and ensure that profit rewards those who dare to take risk.

• Address corruption at the local level • Promote the growing presence of Chinese multinational corporations in major industries and markets throughout the global economy The priorities emerged from a survey prior to the Summit that asked which issues would have the most impact on China’s development. The Summit began with the focus on how innovation has become the bedrock of the 11th Five-Year Plan. What became clear in those discussions was that China can no longer behave as merely the largest emerging economy, but must assert a role in global affairs proportionate to its size. “Whatever future China has,” said Ged Davis, Managing Director, World Economic Forum, “it will be a major shaper of the global system.”

“One major question is whether Chinese innovation will occur only in products, or more importantly will occur in business institutions – in processes, organization and management style. That locus of creativity could actually be more powerful than innovation in new products.”

Maurice Levy Chairman and Chief Executive Officer, Publicis Groupe, France; Co-Chair of the China Business Summit 2006

The economic model that has given China over two decades of remarkable growth is getting an overhaul. From now on, sustainable growth and development will depend on China’s ability to innovate. That was the message from the more than 500 senior government, business, media and academic leaders at the China Business Summit 2006. To accomplish this will require that policy-makers and businesses keep the following priorities at the forefront of their agenda:

• Improve environmental protection at the provincial and local levels

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“What will truly spur innovation within Chinese companies is the recognition of the real value of intellectual property rights.”

Innovation China needs innovation to produce less energyintensive economic growth and to reduce its dependency on foreign technology. • China’s companies have to innovate to fend off rival low-cost manufacturing centres and increasing foreign competition in Chinese markets. • China’s emphasis on R&D in cutting-edge industries presents new opportunities for foreign investors. • Universities need to work more closely with the private sector to develop curricula that produce graduates more suited to the workplace. • Innovative industries will not flourish without freer capital markets and a vigorous venture capital community. • China’s emphasis on protecting intellectual property rights is crucial to stimulating domestic innovation.

Risk Management "Whatever future China has, it will be a major shaper of the global system." Ged Davis Managing Director, World Economic Forum

China Business Summit 2006

As China expands, a growing number of risks threaten to impede its growth. • Foreign companies fear the risk of China’s economy overheating. • Growing global protectionism is an even greater risk to companies in China, imperilling the global supply chain and requiring greater regional focus. • China is particularly vulnerable to oil shocks. Securing stable energy supplies is therefore a priority in government policy. • Hedging against risks would require more developed Chinese capital markets. • Other risks are posed by political and geopolitical tensions.

China Business Summit 2006

Sustainable Growth The chief economic challenge is to shift from an exportled growth model to one driven by domestic consumption and innovation. • A key obstacle is the lack of social safety nets, which hinders the deployment of savings to more productive purposes and discourages entrepreneurship. • Reflecting the macroeconomic paradigm change that needs to take place, Chinese firms must transform themselves from focusing on market share to focusing on sustainable profits. • Achieving energy security with environmental responsibility and efficiency is top priority. • Addressing the absence of safety nets and the need for energy efficiency and environmental protection offers commercial opportunities that could drive new, sustainable growth.

Globalization Both rich and poor, China is a paradox. It is the fourth largest economy in the world but still has millions living below US$ 1,000 per capital GDP. • China’s population and economic size are giving it greater clout in the global community, with increasing influence in international organizations. • China is using this influence to exercise greater responsibility in issues where it has a major stake, such as the Korean Peninsula, energy security and the environment. • Chinese diplomacy has been largely economic, but its value-neutral foreign policy may not be sustainable, particularly with its major trading partners. • More and more Chinese enterprises are venturing abroad, reflecting China’s increasingly open economy and presenting new opportunities and challenges.

"Xu Guanhua Minister of Science and Technology of the People’s Republic of China

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Innovation

“We need to increase the development of our independently owned technologies.” Cheng Siwei Vice-Chairman, Standing Committee, National People’s Congress, People’s Republic of China

It should come as no surprise that intellectual property rights once again topped the agenda in discussions about China. What is remarkable is that, this year, it was China’s own officials and executives – not foreigners – who were banging the drum loudest for greater copyright enforcement and patent protection. For good reason: In its newest Five-Year Plan, the government has laid out an ambitious plan to reclaim China’s mantle as a world leader in science and technology. Staggering in scope, the plan seeks to redraw the economic landscape in a way that will promote innovation not only in China’s universities and companies, but in the very way policies are created and implemented. “Innovation is the soul of a nation’s advancement and the everlasting, driving power of national prosperity,” said Zeng Peiyan, Vice-Premier of the People’s Republic of China.

“We have to constantly conduct systematic innovation or else we will be eliminated by the competition.” Chen Tonghai Chairman, China Petroleum & Chemical Corporation (Sinopec), People’s Republic of China

are eroding China’s cost competitiveness, turning countries like Vietnam, Indonesia and even India into the new Chinas. China’s stress on “indigenous innovation” doesn’t mean it won’t welcome further foreign investment and technology. On the contrary, the business opportunities are manifold for companies that can help China move up the valueadded ladder. In addition to offering incentives for research into cleaner and more efficient energy use and renewable energy, China is promoting the development of less polluting industries. More broadly, the government aims to promote research and development in every field from aerospace and biotech to semiconductors and space shots – even missions to the moon.

Figure 1: R&D Spending Increasing…and Shifting towards the Private Sector

After 20 years of stunning growth, China’s old resourceguzzling, pollution-spewing engine of an economy cannot run at the pace it has for much longer. Not only is China choking on the environmental problems created by inefficient use of coal and oil, but it faces growing risks to future growth. China is far too dependent on imported oil and other raw materials, too reliant on exports – particularly to the United States – and too accustomed to competing largely on price rather than quality.

Chen Yuan Governor, China Development Bank, People's Republic of China; Co-Chair of the China Business Summit 2006

Wang Jianzhou Chief Executive, China Mobile Communications Corporation, People’s Republic of China; CoChair of the China Business Summit 2006

China has already made significant progress. Spending on R&D has risen above 1.2% of GDP from less than 0.6% a decade ago (see Figure 1). China’s aim is to push that figure up to 2.5% by 2020, vaulting it above where most OECD countries are today. Spending won’t be enough, however. While some of China’s top universities have become nascent centres of innovation, most Chinese institutions still specialize in churning out graduates who can ace exams but cannot think outside the box. Universities also need to work with companies to devise more practical curricula that will produce graduates who can go straight to work. “We need to get away from trophy degrees and concentrate more on hands-on education if we are to encourage innovation in China,” said Nandani Lynton, Vice-President, Asia, Thunderbird, The Garvin School of International Management, People’s Republic of China. Too much of the research at Chinese universities stays locked in the lab. The government is trying to get educational institutions to work with companies to move discoveries more quickly into profitable applications. Despite China’s massive foreign exchange reserves and vast public savings, however, venture financing remains scarce for researchers trying to commercialize discoveries. With the largely stateowned banking sector unreceptive and the stock market still struggling (see Figure 2), financial experts say venture finance will not take off until China’s capital markets are more mature.

China’s entry into the World Trade Organization five years ago has made innovation an even more pressing imperative. As China opens up its markets, its companies and banks face greater competition from more advanced global players. At the same time, rising wages at home

“We hope to absorb technologies from abroad and adapt them into our own.”

“China has to move up the levels of development with innovation to the high end market and only in this way can we continue to develop.”

Figure 2: China Equity Markets Lagging

Source: Datastream

The good news for innovators is that the government is determined to beef up its intellectual property regime. “Let me put it this way,” said Xu Guanhua, Minister of Science and Technology of the People’s Republic of China, “without effective protection for intellectual property what we have said about indigenous innovation would be nothing more than empty words.”

Source: OECD Main Science and Technology Indicators 2006-1

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Risk Management China’s policy imperatives

Figure 3: Chinese Companies Raising More Equity Overseas

Source: Bloomberg, Datastream

The government is also adamant that companies will have to be at the forefront of China’s innovation drive (see Figure 3). Caught between a looming invasion by foreign imports, they must venture abroad into markets where consumers see them just as they saw the Japanese, Taiwanese and Koreans that came before them – cheap and inferior. Only by innovating in quality can they hope to win market share overseas.

“We are going to conduct another major round of innovation. We will be a society based on scientific development with innovation taking centre stage,” declared Zeng Peiyan, Vice-Premier of the People’s Republic of China, at the opening of the China Business Summit 2006. “China’s 11th Five-Year Plan outlines the national strategy to develop indigenous innovation. Our ability in indigenous innovation still lags behind, and some technologies rely on imports. For example, 80% of integrated chips in China are imported,” echoed Zhang Xiaoqiang, Vice-Chairman, National Development and Reform Commission, People’s Republic of China. Those in the business community welcomed China’s creative imperative. “We have to constantly conduct systematic innovation or else we will be eliminated by the competition,” said Chen Tonghai, Chairman, China Petroleum & Chemical Corporation (Sinopec), People’s Republic of China. “China is one of the fastest-growing economies in the world and one of the engines of the global economy. We have to bring the latest, cutting-edge technology to China. There’s no way out,” said Winfried Vahland, President and Chief Executive Officer, Volkswagen Group China, People’s Republic of China.

“Even an unfriendly external environment will not block China’s development.”

"We need to improve our legal system and also the corporate system as well as our cultural system."

Li Ruogu Chairman and President, ExportImport Bank of China, People's Republic of China

Tu Guangshao Vice-Chairman, China Securities Regulatory Commission, People's Republic of China

As solid as China’s growth has been (see Figure 1) and as steady as the government’s hand might seem, a growing list of risks could impede or alter China’s progress.

Figure 1: China’s Growth Still Outpacing World

Many risks lay beyond companies’ control. Political manoeuvring in anticipation of the 2007 meeting of the Central Committee of the Communist Party of China to elect the new Party leadership, for example, has distracted the bureaucracy, imposing delays and constraints on foreign investment. And there are utter wild cards, such as an avian flu pandemic or the possibility of an armed conflict on the Korean peninsula.

China’s Patent Office Busier

As they try to shift from manufacturing into services, however, companies also need to find innovative ways to run. “China may need technological innovation less than innovation in management, institutions and processes,” said Wang Jianzhou, Chief Executive, China Mobile Communications Corporation, People’s Republic of China; Co-Chair, China Business Summit 2006. Ultimately, however, the most difficult hurdle China may face in igniting its innovative spark is itself. Beyond deep pockets, governments have generally proven poor agents of creativity, tending instead to stifle it. China may also need to overcome its traditional fear of failure if it is to successfully reintroduce innovation to its cultural mix.

Chinese companies, on the other hand, are pondering the risks of greater foreign competition, how to offset it by expanding overseas. “The risk for many Chinese companies is integrating foreign companies into their portfolio, how to make it work,” said Edward C. Tse, Managing Director, Greater China, Booz Allen Hamilton, People’s Republic of China.

Source: World Intellectual Property Organization Source: IMF World Economic Outlook April 2006

…And Chinese Inventors Active in Overseas Patenting Foreign multinationals tend to focus on risks to China’s domestic economy. What is the likelihood of overinvestment and overcapacity caving in? How is deregulation changing the business landscape and will it increase or reduce corruption? Some even discuss the need to offset their China risk with a presence in Vietnam or Malaysia. Perhaps the biggest risk foreign firms are trying to fathom, however, is the risk of not being in China at all.

One of the greater risks, though, is raised in the World Economic Forum’s scenario report China and the World: Scenarios to 2025: an increasingly protectionist world that forces China and the rest of Asia to turn within for growth. The breakdown of the Doha Round appears to have increased the plausibility of this scenario, raising the risks to China and businesses in the country. “What this implies is that the global supply chain is going to be severely affected and that you’re going to, as a business, have to develop and depend upon regional supply chains,” said Jean-Pierre Lehmann, Professor of International Political Economy, IMD (International Institute for Management Development), Switzerland. As bilateral trade agreements multiply, the danger is that increasingly complex rules will raise transaction costs and complicate trade.

Source: World Intellectual Property Organization

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"Today we see a lot of risks in the private sector and the country in general is borne by the banking system, which takes on most of the corporate risk." John P. Drzik President, Mercer Oliver Wyman (MMC), USA

China’s vulnerability to imported oil supplies is also fostering a well publicized push overseas to secure oil-rich friends. Beijing’s diplomats and executives have become frequent visitors to Central Asia, Africa and South America. China has also assumed a more proactive role in settling diplomatic disputes in areas it depends on for oil, such as Iran. While those efforts may help mitigate the risk of an oil supply shock, for those in China the ability to offset risk would be greatly enhanced if its stock and bond markets were more developed. “Today we see a lot of risks in the private sector and the country in general is borne by the banking system, which takes on most of the corporate risk,” said John P. Drzik, President, Mercer Oliver Wyman (MMC), USA (see Figure 2). Insurers also want the freedom to invest in a wider range of assets to enable China’s savers to better hedge risks to the value of their nest eggs. “Rome was not built in a day,” cautioned Tu Guangshao, Vice-Chairman, China Securities Regulatory Commission, People’s Republic of China. Before China can further liberalize its capital markets, he said: “We need to improve our legal system and also the corporate system as well as our cultural system.”

These home improvements are vital, as David Dollar, Country Director, China and Mongolia, World Bank, Beijing warned: “To keep growing quickly, China needs to improve its institutions.” For example, a basic impediment to implementing much of China’s transformation plan is the lack of safety nets for unemployment, healthcare and retirement. Without them, the Chinese will continue to save at prodigious rates, instead of channelling funds to more productive purposes. The absence of social security also limits entrepreneurship and the willingness of investors to take risks. “Savings are high because there is insecurity,” said Pierre E. Cohade, President, Asia Pacific Region, Goodyear Tire Management Company (Shanghai), People’s Republic of China. The weak rule of law is another risk. Take intellectual property rights. Enforcement of IPR protection, while improving, remains patchy due to feeble commitment at the local level and the lack of a sufficiently independent legal system. This is not just a problem for foreign investors. In fact, about 90% of IPR infringements involve domestic firms. “The general issue is the extraordinary degree of decentralization in China,” Dollar explained.

Figure 2: Bank Loans Dominate Capital Structure in China

“It is not easy for companies from the West, who are often seen as ‘wolves’, to get a foothold in the Chinese market and generate a profit.” Liu Changle Chairman of the Board and CEO, Phoenix Satellite Television Co., Hong Kong SAR; Co-Chair of the China Business Summit 2006

Yet, the obstacles and risks that could block China’s economic transformation offer the very commercial opportunities that could drive new, sustainable growth. Japan and the US could supply China with the technology to enhance energy efficiency. The lack of social safety nets represents a “humongous opportunity not just for improving the quality of life in China but for unleashing all these savings,” said Cohade. He predicted that “empty nesters”, parents born during the years of the Cultural Revolution whose single child has already grown up and left home, would be “the engine of consumption” in coming years. “Understanding the empty nesters is going to be critical” for retailers and financial services providers.

Environmental risk to sustainable Chinese growth China’s GDP is expected to quadruple by 2020, propelling aggregate energy use towards US levels and presenting challenges to overall environmental management. Pressure is rising on policy-makers and CEOs alike to improve energy efficiency and to take measures to mitigate widespread potential environmental damage to water supplies and air quality. There is an increasing recognition of environmental stress in Chinese cities, the fragility of several of China’s multiple ecosystems and the risks posed by environmental degradation to China’s long-term sustainable growth path. “The central government attaches great importance to building an environmentally friendly society,” said Zhang Xiaoqiang, Vice-Chairman, National Development and Reform Commission, People’s Republic of China. Zhang told participants that China aims to reduce energy consumption of per unit GDP by 20% and reduce total emissions by 10% over the next five years. This goal will be achieved through the reduction of pollution at source, implementation of new technologies and innovation. Market factors, such as adjustment to the price of oil, may also help this process. While Zhang said that China would continue to rely on coal as its major source of energy, the installation of clean coal technology and the increasing use of nuclear power – set to rise to 4% of overall energy production by 2020 – will help China to achieve its ambitious goals. Failure to act now to shore up the environmental foundations of China’s growth – locally, nationally and globally – risks human and political costs and future economic growth.

China’s Spending on the Environment Rising…

Source: Nicholas Lardy, Institute of International Economics

Source: State Environmental Protection Administration Reports on the Economy 20002004, China Statistical Yearbook, press accounts

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Sustainable Growth

“The domestic service sector will grow very fast, faster than the rest of the economy, but it will mainly cater to the local market. In general, we will not see large-scale service practice to the world.” David Li Daokui Mansfield Freeman Chair Professor of Economics, Tsinghua University, People's Republic of China

China’s chief economic challenge for the next decade is clear: how to shift from an export-led growth model to one driven by consumption and innovation, while maintaining social stability and avoiding a hard landing. When an economy as big as China’s – now the fourth largest in the world – is growing at a 10%-plus clip, that task is the macroeconomic equivalent of getting a charging elephant to turn the right corner without crashing or slipping. But make the turn the giant must. Heavy fixed asset investment has led to overcapacity in many industries, while China’s high savings rate of over 40% of GDP is unsustainable, particularly as the population ages. Meanwhile, in 2004, China has the largest energy imbalance in Asia (see Figure 1) and pollution was estimated to have resulted in economic losses equivalent to 3.05% of GDP. “We cannot continue with the traditional development approach and growth pattern,” concluded Zeng Peiyan, Vice-Premier of the People’s Republic of China, in a special address to open the China Business Summit 2006. “We have to transform our approach.”

Figure 1: China Has the Largest Energy Imbalance in Asia

“I don't see China becoming a service centre to the world anytime soon. To be at the same level of critical mass as India at a global level – it's probably about 7 to 10 years away.”

Pan Yue Vice-Minister of China's State Environmental Protection Administration

Sriram Venkataraman Senior Vice-President and Head of Asia Pacific, Infosys Technologies, Japan

The key to that transformation was obvious from the Summit theme: Sustainable Growth through Innovation: China’s Creative Imperative. Among the buzzwords of development, “sustainability”, “innovation” and “creativity” are practically regarded as off-the-shelf ingredients for a magic potion to combat the pressures of globalization. But China’s current Five-Year Plan offers a real recipe for action that can hardly be dismissed as glib: stimulate domestic demand, shift investment away from industries with too much capacity such as automobiles and steel, shore up the financial system so that it can better absorb the savings of Chinese, and mobilize more capital to productive investments. As for innovation, the plan commits China to increasing R&D spending from the current 1.2% of GDP to 2.4%, just above the OECD average. “Only by constructing new ways of development can China enhance overall growth,” said Summit CoChair Chen Yuan, Governor of the China Development Bank. But there are obstacles and risks. Perhaps the most talked about risk is that posed by increasingly volatile oil prices. Since becoming a net oil importer in 1993, China has emerged as the world’s second largest energy consumer, increasingly dependent on imported oil. China’s policy-makers are cognizant that China’s dependency on imported oil – and its wasteful use of it – is not only a drain on development, but that its growing demand for the increasingly scarce resource also raises the long-term probability of China getting into a conflict over oil, whether commercial or military.

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"Local governments want to focus on increasing GDP and, in doing so, favour vested local interests such as factories that may also be polluters."

For that reason, the government is trying to overhaul the economy to make China a greener, more energyefficient nation. China has been moving, for example, to gradually reduce subsidies on fuel in order to remove the incentive for waste and make consumers bear the true cost of oil. The government is investing in new technologies for oil and gas exploration and financing the development of renewable energy such as hydropower, biomass and wind power (see Figure 2). China is also trying to adopt cleaner ways to burn domestic coal and plans to build 40 nuclear power plants in the next 15 years. “In China, most of our experts and the public believe nuclear energy is relatively safe and clean. So the Chinese government believes we should still actively develop nuclear energy,” said Zhang Xiaoqiang, Vice-Chairman, National Development and Reform Commission, People’s Republic of China.

Yang Yuanqing Chairman of the Board of Lenovo Group, People’s Republic of China; Co-Chair of the China Business Summit 2006

Protection Administration. He called for an honest evaluation of the state of China’s environment and urged local governments to adopt sustainable practices. “Not all central government policies are fully implemented in the localities,” noted Zhang Xiaoqiang, Vice-Chairman of China’s National Development Reform Commission. “We need to improve the quality of our civil servants and the whole administrative mechanism has to deal in a balanced way with shortand long-term issues, all of which have to be coordinated on a national basis.”

Figure 2: Alternative Energy Expected to Rise with Demand…

At the same time, the government is trying to push industry into shape, phasing out inefficient factories and promoting cleaner, more efficient ones. It is imposing tighter emission standards on vehicles, clamping down on overloaded, gas-guzzling trucks, and even changing the way it evaluates local officials to rate them not just on economic growth but also on energy efficiency. Efforts to boost China’s energy efficiency, its economic expansion and environmental protection have been undermined by China’s decentralized political system. “Local governments want to focus on increasing GDP and, in doing so, favour vested local interests such as factories that may also be polluters,” said Pan Yue, Vice-Minister of China’s State Environmental

Source: IEA Energy Balances of OECD Countries and Non-OECD Countries 2003; World Bank World Development Report 2005; CIA World Factbook

China Business Summit 2006

“Internationalization is not an end in itself; it is a means to help you grow and develop.”

China Business Summit 2006

Source: US Energy Information Administration, China Daily, International Energy Outlook 2006

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Globalization The onus for action must also fall on enterprises. “Many companies in China have focused on the short term such as on increasing revenues from sales and marketing,” said Zhang Weiying, Vice-Dean, Guanghua School of Management, Peking University. Instead of focusing on racking up double-digit sales, enterprises have to put more effort and investment into R&D and generating sustainable profits, Zhang advised. Said Chen Tonghai, Chairman of China Petroleum & Chemical Corporation (Sinopec), which leads Chinese enterprises in annual patent applications: “In our industry, we not only have to look for new types of energy but to develop environmentally friendly products. We have to constantly conduct systematic innovation or else we will be eliminated by the competition.”

Figure 3: Chinese Economy Gradually Shifting towards Services…

Source: China Statistical Yearbook 2005

The maturation of China’s economy will surely speed up its transformation – naturally. The services sector already contributes almost 40% of GDP, Hellmut Schutte, Dean, Asia Campus, INSEAD, Singapore, remarked (see Figures 3 and 4). “As manufacturing productivity growth comes in, more people will be laid off with many of them starting their own little shop along the street,” he explained. “It’s pretty obvious that as China’s economy grows, consumption patterns will change, with very high growth in the leisure industries, healthcare and education.” The elephant is making the turn, but will it keep its balance?

Figure 4: …But Services Sector Still Has Room to Grow

Source: CIA World Factbook; 2005 estimates when available

"I can assure you that Japan's next administration will share the basic recognition that the rise of China is an opportunity for all of us rather than a threat against us." Yasuhisa Shiozaki Senior Vice-Minister for Foreign Affairs of Japan

In 30 years, China has transformed itself from a command economy inhospitable to overseas investors to an emerging free enterprise market that attracts the biggest share of global foreign direct investment. China is a key driver of globalization and one of its major beneficiaries. The world’s third biggest trader and the fourth largest economy, China combines geographic and demographic heft with purchasing power and manufacturing prowess. Even so, China is still a developing country. China’s per capita GDP is above that of the Philippines but below that of Thailand. In the World Economic Forum’s Global Competitiveness Report 2006-2007, China’s competitiveness ranking dropped from 48th to 54th. According to the World Bank, over the past two decades, China accounted for over 75% of the poverty reduction achieved in developing economies. Yet, today, more than 135 million people, mainly in China’s western and interior regions, scrape by on less than a dollar a day, without the benefits of clean water, adequate healthcare and education. That said, China has become a leading player in the international community, both through the roles it has sought such as its membership in the World Trade Organization (WTO) and those that have been thrust upon it. Beijing has emerged as a role model for developing economies, its non-judgmental foreign policy serving as a counterweight to western developed countries, particularly the United States.

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China Business Summit 2006

China Business Summit 2006

“China is engaged and building partnerships to send a message to the world that it will play by the rules of the game. Let the rules of the game be fair.” Kapil Sibal Minister of Science and Technology and Earth Sciences of India

The recent agreement to increase China’s voting power in the International Monetary Fund (IMF), albeit by only a small percentage, is an acknowledgement of its rising profile – and mounting responsibilities. Geopolitically, China’s participation in the six-party talks on North Korea’s nuclear programme has been pivotal. And as a permanent member of the UN Security Council, Beijing is playing a key behind-thescenes part in the selection of the next UN SecretaryGeneral, who is expected to be an Asian. “Anything that happens in China will have a global impact so we have to be globally responsible,” said Wang Jianmao, Professor of Economics and Associate Dean, China Europe International Business School (CEIBS). Chinese diplomacy, however, has largely been driven by pragmatic economic motives, particularly the need to meet its burgeoning energy, raw materials and components demands. China has been an enthusiastic driver of integration with South-East Asia and has also forged strong commercial links with resource-rich countries in Central Asia, Latin America, the Middle East and Africa, as well as Australia. Energy imports rose by 55% in the first four months of this year to US$ 21.3 billion.

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Figure 1: China-US Trade Balance Shifting

Source: World Trade Organization

China’s exports, especially to the US, have increased to all-time highs, pushing its trade surplus to monthly records – US$ 18.8 billion in August 2006 (see Figure 1). This has inundated China’s economy with cash, boosting its foreign exchange reserves to nearly US$ 1 trillion (see Figure 2).

China’s foreign policy, its economic ascendancy and its ambitious enterprises have at times put China at odds with the global establishment. Beijing has clashed with Washington over how to deal with the conflict in Darfur and Iran’s nuclear programme. The bid by a Chinese state firm to take over a US energy company alarmed many American politicians. China’s trade surplus has fuelled accusations and led to enormous pressure on Beijing to move to a more flexible currency regime faster than it is willing to allow. The frequency of such friction is likely to increase. For now, China has played the unassuming new kid on the block with benign intentions. At the same time, it basks in the acclaim of those who see its market as a glowing opportunity no sensible investor can resist. After all, China will be hosting the Olympic Games in 2008, what for the previous Asian hosts – South Korea and Japan – was something of a global coming-out party. “Our policy of reform and opening up to the world means we embrace globalization,” said Wu Jianmin, President of the China Foreign Affairs University. “The most important feature of China’s rise is to share the growth with the rest of the world.”

Rachid M. Rachid Minister of Trade and Industry of Egypt

China’s foreign investment strategy Asia is the biggest investment destination for China which channels 60% of its overseas direct investment into the region, according to Deutsche Bank. Latin America receives 16% of Chinese foreign investment. Africa, North America and Europe tie in third place with roughly 7%, while Oceania receives 4%.

Chinese Investment Mostly to Asia…

Figure 2: China’s Foreign Reserves Growing…and Diversifying

Chinese enterprises, particularly industrial groups, are now accompanying the country’s diplomats to far-flung countries from Venezuela to Sudan. While some companies, notably the state energy groups, have gone global for strategic reasons, many others are seeking to hone their competitiveness abroad. “The reason for going global is simple: to create new opportunities to make profits today and in the future,” said Wang Jianzhou, Chief Executive, China Mobile Communications Corporation. Added Yang Yuanqing, Chairman of the Board of Lenovo Group, which went global through its acquisition of IBM’s personal computing division: “Internationalization is not an end in itself; it is a means to help you grow and develop.”

Source: Deutsche Bank

Source: State Administration of Foreign Exchange, People’s Republic of China, PwC estimates of composition

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The part China plays in the WTO in the aftermath of the collapse of the Doha Round will be an immediate indicator of its willingness to shoulder new responsibilities. Beijing could be instrumental in reviving the talks. China’s trading partners, meanwhile, will be assessing how well Beijing implements its WTO commitments, including the opening of the banking sector at the end of this year. Lastly, China’s attempts to set its own industry and technology standards have raised concerns among some trading partners and investors.

“We are entering a new phase in the relationship between Asia and the Middle East, but we need to create the foundations for better understanding of each other to take it to another level.”

China Business Summit 2006

The US and Chinese economies have become deeply integrated. In 2005 bilateral trade reached US$ 216 billion, and through the first half of 2006 the figure rose 25% from last year, said Ma Zhengang, Director, China Institute of International Studies, People’s Republic of China. Furthermore, China is now the fourth largest market for US exports. But as China marks the fifth anniversary of WTO membership, market barriers and the trade deficit with the US could create further problems and misunderstandings between the two sides, warned John Frisbie, President, US-China Business Council, USA. “I am concerned about the rising voices of protectionism on both sides of the ocean,” Frisbie said. If SinoUS relations suffer, said Ma, “both sides will suffer.”

China Business Summit 2006

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The Creative Imperative in China

“Never has the world seen the simultaneous take-off of two such nations together. This is the time for China and India to think out of the box so they can achieve their stated goals.”

"Innovation is the soul of a nation’s advancement and the everlasting, driving power of national prosperity.” Zeng Peiyan Vice-Premier of the People's Republic of China

Baba N. Kalyani Chairman and Managing Director, Bharat Forge, India; Co-Chair of the China Business Summit 2006

The theme of the World Economic Forum’s China Business Summit 2006 – Sustainable Growth through Innovation: China’s Creative Imperative – clearly spelled out the priority for China as it aims to achieve a new level of economic development. The discussions in Beijing neatly continued the Forum’s pursuit of the “creative imperative” since the Annual Meeting 2006 in Davos and through regional summits in São Paulo, Sharm El Sheikh and Tokyo. The goal: to identify innovative approaches to key challenges. By capturing these ideas, the Forum hopes to stimulate further debate and brainstorming at upcoming regional meetings and in next year’s Annual Meeting.

Sustainable Growth

Globalization

China should focus less on incentives to attract investment and more on institutional renewal to create a better business environment. The skills shortage, for example, must be addressed through an overhaul of the education system to promote creativity and critical thinking over rote learning and exam-focused assessment.

The collapse of the Doha Round indicates a disconnect between the reform-reluctant developed world and the reform-eager developing world. Along with other Asian economies, China could be a catalyst for the revival of the multilateral trade talks, even as they forge their own regional arrangements.

The urgent need for China to become more energy efficient can be addressed by cutting-edge technology available in Japan and the US, thus creating an opportunity from a challenge. For this to happen, China’s intellectual property regime has to work for the logical technology transfer to occur. The need to create a social safety net system offers similar opportunities to providers of financial services.

Risk Management

A key challenge for China will be how well it continues to manage its integration into the global economy which requires balancing its inherent market muscle with the benefits of integration. A major policy question of whether Chinese enterprises should adopt accepted world industrial and technology standards or insist on setting their own remains to be answered.

A key to mitigating the many risks confronting China is the appropriate sequencing of reforms. To mobilize the enormous pool of savings to more productive uses and stimulate consumption to head off an economic slowdown will require significant progress in creating social safety nets that encourage personal and commercial risk taking. Banking reform and strong capital markets will have a similar domino effect in promoting innovation, enterprise and the reform of state firms. The transfer to China of much needed technology will also happen only if intellectual property rights enforcement is sufficient.

This is a selection of some of the insights from the China Business Summit 2006 in Beijing:

Innovation While fast growing, the service sector in China is focusing more on the domestic market than on global customers. Key areas with strong growth potential include pharmaceutical R&D, aviation engineering, and the provision of business process outsourcing and call centre services to the Japan market. China’s innovation drive should focus not just on the development of new products and services but also on the creation of new business models to fit the specific characteristics of the domestic market. Examples of such inventive strategies include the varying of marketing approaches according to a city or region’s tier level and using offbeat sales techniques or promotions to generate brand loyalty in a market where such affinities are minimal. caption

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China Business Summit 2006

China Business Summit 2006

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Acknowledgements The China Business Summit 2006 is held in cooperation with the China Enterprise Confederation (CEC) and with the special support of the National Development and Reform Commission (NDRC). The NDRC serves as the World Economic Forum’s counterpart in China. The World Economic Forum wishes to acknowledge the support of the following companies as Partners: Strategic Partners Accel Partners Accenture AMD Apax Partners Audi Bombardier Booz Allen Hamilton BT CA Credit Suisse Deloitte Deutsche Bank Ernst & Young Fluor HP HSBC Intel Lehman Brothers Manpower Marsh & McLennan Companies Nakheel NASDAQ NYSE Group PricewaterhouseCoopers Reuters UBS Volkswagen Zurich Financial Services

Regional Partner GeoPost Intercontinental Phoenix Satellite Television UPS

Summit Supporter Ogilvy Public Relations Worldwide

The World Economic Forum would also like to thank The Coca-Cola Company and Nestlé for their support.

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China Business Summit 2006

Contributors Peter Torreele is Managing Director of the World Economic Forum. Lee Howell is Director, Head of Asia, at the Forum. The China Business Summit 2006 was under his direct responsibility, with Li Zhang, Associate Director, China; Dezhi Ma, Global Leadership Fellow, China; Yu Liu, Global Leadership Fellow, China; and Nadine Bonard, Senior Specialist, Events.

Samantha Tonkin, Senior Media Manager at the World Economic Forum worked with Wayne Arnold and Alejandro Reyes to produce this report. The World Economic Forum would like to express its appreciation to the summary writers for their work at the Summit. Session summaries are available at www.weforum.org. Associate Principal, Editing: Nancy Tranchet Design and Layout: Kamal Kimaoui, Associate Principal, Production and Design Photographs: Doug Kanter Special thanks to PricewaterhouseCoopers for their help in preparing data and statistics underpinning this report.

The World Economic Forum is an independent international organization committed to improving the state of the world by engaging leaders in partnerships to shape global, regional and industry agendas. Incorporated as a foundation in 1971, and based in Geneva, Switzerland, the World Economic Forum is impartial and not-for-profit; it is tied to no political, partisan or national interests. (www.weforum.org)