China Business Summit 2006

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China Business Summit 2006

Sustainable Growth through Innovation:

China’s Creative Imperative

Beijing, 10-11 September

Preface 3

Summary – Sustainable Growth through Innovation: China’s Creative Imperative 4

Innovation 6

Risk Management 9

Sustainable Growth 12

Globalization 15

The Creative Imperative in China 18

Acknowledgements 20

1

Contents


The views expressed in this publication do notnecessarily reflect those of the World EconomicForum.

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© 2006 World Economic ForumAll rights reserved.No part of this publication may be reproduced or transmitted inany form or by any means, including photocopying and recording,or by any information storage and retrieval system.

REF: 121006

This publication is also available in electronic form on the World Economic Forumwebsite 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 contentfrom meeting, including the weblog, photographs and session summaries.

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, 10-11September, can be found at the following links:

Meeting News www.weforum.org/chinaPhotographs www.pbase.com/forumweb/china2006Programme www.weforum.org/china/programmeInterviews www.weforum.org/china/indepthPartners www.weforum.org/china/partnersKnowledgeConcierge www.weforum.org/china/kcWeblog www.forumblog.org

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Preface


The China Business Summit 2006 was designed to generate insight and guide action toimprove the alignment of China’s public policy, development and industry agendas. Thefrank and open discussions in Beijing laid bare the reality that China today is somethingof an anomaly in terms of modern economic history. It has accumulated now close toUS$ 1 trillion in foreign currency reserves, while at the same time hundreds of millions ofits 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 newlyendorsed 11th Five-Year Plan (2006-2010) which focuses on implementing “people-centred” and “scientific” development policies. Concepts, still not yet fully understood interms of their long-term policy and economic impact, but much better appreciated interms of their growing importance by those executives who engaged the senior officialsparticipating in the Summit.

China is now the world’s fourth largest economy – its per capita GDP is well over US$1,000 and it has surpassed the United States as the leading destination for foreign directinvestment. These accomplishments, however, have led to the realization that this rapideconomic success has also introduced new challenges requiring innovative governmentpolicies and creative business solutions if the country is to maintain its strong record ofgrowth. During the week of the Summit, the Chinese government released its firstmeasurement of the country’s “Green GDP” which subtracts the cost of naturalresources and environmental degradation from total GDP. In 2004, the economic lossfrom environmental pollution amounted to 3.05% of GDP (US$ 64 billion). Thus, theChina Business Summit 2006 was timely in bringing key stakeholders together to rethinkand reshape the country’s growth and industry agendas in this changing developmentcontext.

China’s first quarter GDP is already 10% greater than a year before and concerns aregrowing over excessive investment in specific industries and the need to tightenmonetary policy. Although fears of excessive growth loom large, the new Five-Year Planis focused squarely on reducing rural-urban income disparities and uplifting the livingstandards of the 800 million Chinese earning less than US$ 1,000 a year. Readers of thisreport will find that addressing both challenges requires shifting from investment andexport driven economic growth to sustainable growth driven by technology innovationand domestic consumption. The modalities of achieving this appear to be at the centreof many more discussions in the future.

Lee HowellDirector, Asia

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


Sustainable Growth

The chief economic challenge is to shift from an export-led growth model to one driven by domestic consumptionand innovation. • A key obstacle is the lack of social safety nets, which

hinders the deployment of savings to more productivepurposes and discourages entrepreneurship.

• Reflecting the macroeconomic paradigm change thatneeds to take place, Chinese firms must transformthemselves from focusing on market share to focusingon sustainable profits.

• Achieving energy security with environmentalresponsibility and efficiency is top priority.

• Addressing the absence of safety nets and the need forenergy efficiency and environmental protection offerscommercial opportunities that could drive new,sustainable growth.

Globalization

Both rich and poor, China is a paradox. It is the fourthlargest economy in the world but still has millions livingbelow US$ 1,000 per capital GDP.• China’s population and economic size are giving it

greater clout in the global community, with increasinginfluence in international organizations.

• China is using this influence to exercise greaterresponsibility in issues where it has a major stake, suchas the Korean Peninsula, energy security and theenvironment.

• Chinese diplomacy has been largely economic, but itsvalue-neutral foreign policy may not be sustainable,particularly with its major trading partners.

• More and more Chinese enterprises are venturingabroad, reflecting China’s increasingly open economyand presenting new opportunities and challenges.

Innovation

China needs innovation to produce less energy-intensive economic growth and to reduce itsdependency on foreign technology.• China’s companies have to innovate to fend off rival

low-cost manufacturing centres and increasingforeign competition in Chinese markets.

• China’s emphasis on R&D in cutting-edge industriespresents new opportunities for foreign investors.

• Universities need to work more closely with theprivate sector to develop curricula that producegraduates more suited to the workplace.

• Innovative industries will not flourish without freercapital markets and a vigorous venture capitalcommunity.

• China’s emphasis on protecting intellectual propertyrights is crucial to stimulating domestic innovation.

Risk Management

As China expands, a growing number of risks threatento 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 supplychain and requiring greater regional focus.

• China is particularly vulnerable to oil shocks.Securing stable energy supplies is therefore apriority in government policy.

• Hedging against risks would require moredeveloped Chinese capital markets.

• Other risks are posed by political and geopoliticaltensions.

“One major question iswhether Chinese innovationwill occur only in products,or more importantly willoccur in business institutions– in processes, organizationand management style.That locus of creativity couldactually be more powerfulthan innovation in newproducts.”

Tom ManningChief Executive Officer, ChinaBoard Directors, Hong KongSAR

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

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

• Improve environmental protection at the provincial andlocal levels

• Address corruption at the local level

• Promote the growing presence of Chinese multinationalcorporations in major industries and marketsthroughout the global economy

The priorities emerged from a survey prior to the Summitthat asked which issues would have the most impact onChina’s development. The Summit began with the focuson how innovation has become the bedrock of the 11thFive-Year Plan. What became clear in those discussionswas that China can no longer behave as merely thelargest emerging economy, but must assert a role inglobal affairs proportionate to its size. “Whatever futureChina has,” said Ged Davis, Managing Director, WorldEconomic Forum, “it will be a major shaper of the globalsystem.”

Acquiring adequate energy for China’s development willcontinue to be the paramount challenge, onecompounded by the urgent need to find cleaner and moreefficient means of delivering it. China’s leaders must alsosolve the riddle of how to ensure that future developmentreverses growing disparities of income. Moreover, theymust somehow unleash the nation’s innovative potential ina way that can arrest China’s growing trade deficit inintellectual property.

Unleashing China’s creative impulse will require dramaticchanges to the nation’s educational system, particularly itsuniversities – the crucibles of China’s creative leadership.China will continue to need foreign cooperation andinvestment in order to make the transition. But Chinesecompanies must take the lead to innovate new productsas well as their management processes. It will also needmore dynamic capital markets that can channel thenation’s vast savings towards innovation and ensure thatprofit rewards those who dare to take risk.

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


“What will truly spurinnovation within Chinesecompanies is the recognitionof the real value ofintellectual property rights.”

Maurice LevyChairman and Chief ExecutiveOfficer, Publicis Groupe, France;Co-Chair of the China BusinessSummit 2006

"Whatever future China has,it will be a major shaper ofthe global system."

Ged DavisManaging Director, WorldEconomic Forum

"Xu GuanhuaMinister of Science andTechnology of the People’sRepublic of China

“We have to switch fromour previous industrialdevelopment mode, fromconsuming large amounts ofnatural resources to adevelopment mode basedon science and technologyas well as innovation.”

Zhang XiaoqiangVice-Chairman, NationalDevelopment and ReformCommission, People's Republicof China

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7China Business Summit 2006

The good news for innovators is that the government isdetermined to beef up its intellectual property regime. “Letme put it this way,” said Xu Guanhua, Minister of Scienceand Technology of the People’s Republic of China,“without effective protection for intellectual property whatwe have said about indigenous innovation would benothing more than empty words.”

China has already made significant progress.Spending on R&D has risen above 1.2% of GDP fromless than 0.6% a decade ago (see Figure 1). China’saim is to push that figure up to 2.5% by 2020, vaultingit above where most OECD countries are today.

Spending won’t be enough, however. While some ofChina’s top universities have become nascent centresof innovation, most Chinese institutions still specializein churning out graduates who can ace exams butcannot think outside the box. Universities also need towork with companies to devise more practicalcurricula that will produce graduates who can gostraight to work. “We need to get away from trophydegrees and concentrate more on hands-oneducation if we are to encourage innovation in China,”said Nandani Lynton, Vice-President, Asia,Thunderbird, The Garvin School of InternationalManagement, People’s Republic of China.

Too much of the research at Chinese universities stayslocked in the lab. The government is trying to geteducational institutions to work with companies tomove discoveries more quickly into profitableapplications. Despite China’s massive foreignexchange reserves and vast public savings, however,venture financing remains scarce for researchers tryingto commercialize discoveries. With the largely state-owned banking sector unreceptive and the stockmarket still struggling (see Figure 2), financial expertssay venture finance will not take off until China’scapital markets are more mature.

“China has to move up thelevels of development withinnovation to the high endmarket and only in thisway can we continue todevelop.”

Wang JianzhouChief Executive, China MobileCommunications Corporation,People’s Republic of China; Co-Chair of the China BusinessSummit 2006

“We hope to absorbtechnologies from abroadand adapt them into ourown.”

Chen YuanGovernor, China DevelopmentBank, People's Republic ofChina; Co-Chair of the ChinaBusiness Summit 2006

It should come as no surprise that intellectual propertyrights once again topped the agenda in discussions aboutChina. What is remarkable is that, this year, it was China’sown officials and executives – not foreigners – who werebanging the drum loudest for greater copyrightenforcement and patent protection.

For good reason: In its newest Five-Year Plan, thegovernment has laid out an ambitious plan to reclaimChina’s mantle as a world leader in science andtechnology. Staggering in scope, the plan seeks to redrawthe economic landscape in a way that will promoteinnovation 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 theeverlasting, driving power of national prosperity,” saidZeng Peiyan, Vice-Premier of the People’s Republic ofChina.

After 20 years of stunning growth, China’s old resource-guzzling, pollution-spewing engine of an economy cannotrun at the pace it has for much longer. Not only is Chinachoking on the environmental problems created byinefficient use of coal and oil, but it faces growing risks tofuture growth. China is far too dependent on imported oiland other raw materials, too reliant on exports –particularly to the United States – and too accustomed tocompeting largely on price rather than quality.

China’s entry into the World Trade Organization five yearsago has made innovation an even more pressingimperative. As China opens up its markets, its companiesand banks face greater competition from more advancedglobal players. At the same time, rising wages at home

are eroding China’s cost competitiveness, turningcountries like Vietnam, Indonesia and even India into thenew Chinas.

China’s stress on “indigenous innovation” doesn’t mean itwon’t welcome further foreign investment and technology.On the contrary, the business opportunities are manifoldfor companies that can help China move up the value-added ladder. In addition to offering incentives forresearch into cleaner and more efficient energy use andrenewable energy, China is promoting the development ofless polluting industries. More broadly, the governmentaims to promote research and development in every fieldfrom aerospace and biotech to semiconductors andspace shots – even missions to the moon.

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Innovation


“We have to constantlyconduct systematicinnovation or else we willbe eliminated by thecompetition.”

Chen TonghaiChairman, China Petroleum &Chemical Corporation (Sinopec),People’s Republic of China

“We need to increase thedevelopment of ourindependently ownedtechnologies.”

Cheng SiweiVice-Chairman, StandingCommittee, National People’sCongress, People’s Republic ofChina

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

Source: OECD Main Science and Technology Indicators 2006-1

Figure 2: China Equity Markets Lagging

Source: Datastream

The government is also adamant that companies will haveto be at the forefront of China’s innovation drive (seeFigure 3). Caught between a looming invasion by foreignimports, they must venture abroad into markets whereconsumers see them just as they saw the Japanese,Taiwanese and Koreans that came before them – cheapand inferior. Only by innovating in quality can they hope towin market share overseas.

As they try to shift from manufacturing into services,however, companies also need to find innovative ways torun. “China may need technological innovation less thaninnovation in management, institutions and processes,”said Wang Jianzhou, Chief Executive, China MobileCommunications Corporation, People’s Republic of China;Co-Chair, China Business Summit 2006.

Ultimately, however, the most difficult hurdle China mayface in igniting its innovative spark is itself. Beyond deeppockets, governments have generally proven poor agentsof creativity, tending instead to stifle it. China may alsoneed to overcome its traditional fear of failure if it is tosuccessfully reintroduce innovation to its cultural mix.

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Risk Management

China Business Summit 2006 China Business Summit 2006

Figure 3: Chinese Companies Raising MoreEquity Overseas

Source: Bloomberg, Datastream

China’s policy imperatives

“We are going to conduct another major round ofinnovation. We will be a society based on scientificdevelopment with innovation taking centre stage,”declared Zeng Peiyan, Vice-Premier of the People’sRepublic of China, at the opening of the China BusinessSummit 2006. “China’s 11th Five-Year Plan outlines thenational strategy to develop indigenous innovation. Ourability in indigenous innovation still lags behind, and sometechnologies rely on imports. For example, 80% ofintegrated chips in China are imported,” echoed ZhangXiaoqiang, Vice-Chairman, National Development andReform Commission, People’s Republic of China.

Those in the business community welcomed China’screative imperative. “We have to constantly conductsystematic innovation or else we will be eliminated by thecompetition,” said Chen Tonghai, Chairman, ChinaPetroleum & Chemical Corporation (Sinopec), People’sRepublic of China. “China is one of the fastest-growingeconomies in the world and one of the engines of theglobal economy. We have to bring the latest, cutting-edgetechnology to China. There’s no way out,” said WinfriedVahland, President and Chief Executive Officer,Volkswagen Group China, People’s Republic of China.

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

Foreign multinationals tend to focus on risks to China’sdomestic economy. What is the likelihood ofoverinvestment and overcapacity caving in? How isderegulation changing the business landscape and will itincrease or reduce corruption? Some even discuss theneed to offset their China risk with a presence in Vietnamor Malaysia. Perhaps the biggest risk foreign firms aretrying to fathom, however, is the risk of not being in Chinaat all.

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

Many risks lay beyond companies’ control. Politicalmanoeuvring in anticipation of the 2007 meeting of theCentral Committee of the Communist Party of China toelect the new Party leadership, for example, hasdistracted the bureaucracy, imposing delays andconstraints on foreign investment. And there are utter wildcards, such as an avian flu pandemic or the possibility ofan armed conflict on the Korean peninsula.

One of the greater risks, though, is raised in the WorldEconomic Forum’s scenario report China and the World:Scenarios to 2025: an increasingly protectionist world thatforces China and the rest of Asia to turn within for growth.The breakdown of the Doha Round appears to haveincreased the plausibility of this scenario, raising the risksto China and businesses in the country. “What this impliesis that the global supply chain is going to be severelyaffected and that you’re going to, as a business, have todevelop and depend upon regional supply chains,” saidJean-Pierre Lehmann, Professor of International PoliticalEconomy, IMD (International Institute for ManagementDevelopment), Switzerland. As bilateral trade agreementsmultiply, the danger is that increasingly complex rules willraise transaction costs and complicate trade.

"We need to improve ourlegal system and also thecorporate system as well asour cultural system."

Tu GuangshaoVice-Chairman, China SecuritiesRegulatory Commission,People's Republic of China

“Even an unfriendlyexternal environment willnot block China’sdevelopment.”

Li RuoguChairman and President, Export-Import Bank of China, People'sRepublic of China

Figure 1: China’s Growth Still Outpacing World

Source: IMF World Economic Outlook April 2006

China’s Patent Office Busier

Source: World Intellectual Property Organization

…And Chinese Inventors Active in OverseasPatenting

Source: World Intellectual Property Organization

10 11China Business Summit 2006 China Business Summit 2006

China’s vulnerability to imported oil supplies is alsofostering a well publicized push overseas to secure oil-richfriends. Beijing’s diplomats and executives have becomefrequent visitors to Central Asia, Africa and SouthAmerica. China has also assumed a more proactive role insettling diplomatic disputes in areas it depends on for oil,such as Iran.

While those efforts may help mitigate the risk of an oilsupply shock, for those in China the ability to offset riskwould be greatly enhanced if its stock and bond marketswere more developed. “Today we see a lot of risks in theprivate sector and the country in general is borne by thebanking system, which takes on most of the corporaterisk,” said John P. Drzik, President, Mercer Oliver Wyman(MMC), USA (see Figure 2). Insurers also want thefreedom to invest in a wider range of assets to enableChina’s savers to better hedge risks to the value of theirnest eggs. “Rome was not built in a day,” cautioned TuGuangshao, Vice-Chairman, China Securities RegulatoryCommission, People’s Republic of China. Before Chinacan further liberalize its capital markets, he said: “Weneed to improve our legal system and also the corporatesystem 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 toimprove its institutions.” For example, a basic impedimentto implementing much of China’s transformation plan isthe lack of safety nets for unemployment, healthcare andretirement. Without them, the Chinese will continue tosave at prodigious rates, instead of channelling funds tomore productive purposes. The absence of social securityalso limits entrepreneurship and the willingness ofinvestors to take risks. “Savings are high because there isinsecurity,” said Pierre E. Cohade, President, Asia PacificRegion, Goodyear Tire Management Company(Shanghai), People’s Republic of China.

The weak rule of law is another risk. Take intellectualproperty rights. Enforcement of IPR protection, whileimproving, remains patchy due to feeble commitment atthe local level and the lack of a sufficiently independentlegal system. This is not just a problem for foreigninvestors. In fact, about 90% of IPR infringements involvedomestic firms. “The general issue is the extraordinarydegree of decentralization in China,” Dollar explained.

“It is not easy for companiesfrom the West, who areoften seen as ‘wolves’, toget a foothold in the Chinesemarket and generate aprofit.”

Liu ChangleChairman of the Board andCEO, Phoenix Satellite TelevisionCo., Hong Kong SAR; Co-Chairof the China Business Summit2006

"Today we see a lot of risksin the private sector and thecountry in general is borneby the banking system,which takes on most of thecorporate risk."

John P. DrzikPresident, Mercer Oliver Wyman(MMC), USA

Yet, the obstacles and risks that could block China’seconomic transformation offer the very commercialopportunities that could drive new, sustainable growth.Japan and the US could supply China with the technologyto enhance energy efficiency. The lack of social safetynets represents a “humongous opportunity not just forimproving the quality of life in China but for unleashing allthese savings,” said Cohade. He predicted that “emptynesters”, parents born during the years of the CulturalRevolution whose single child has already grown up andleft home, would be “the engine of consumption” incoming years. “Understanding the empty nesters is goingto be critical” for retailers and financial services providers.

Figure 2: Bank Loans Dominate CapitalStructure in China

Source: Nicholas Lardy, Institute of International Economics

Environmental risk to sustainable Chinese growth

China’s GDP is expected to quadruple by 2020,propelling aggregate energy use towards US levels andpresenting challenges to overall environmentalmanagement. Pressure is rising on policy-makers andCEOs alike to improve energy efficiency and to takemeasures to mitigate widespread potentialenvironmental damage to water supplies and air quality.There is an increasing recognition of environmentalstress in Chinese cities, the fragility of several of China’smultiple ecosystems and the risks posed byenvironmental degradation to China’s long-termsustainable growth path. “The central governmentattaches great importance to building anenvironmentally friendly society,” said Zhang Xiaoqiang,Vice-Chairman, National Development and ReformCommission, People’s Republic of China. Zhang toldparticipants that China aims to reduce energyconsumption of per unit GDP by 20% and reduce totalemissions by 10% over the next five years. This goalwill be achieved through the reduction of pollution atsource, implementation of new technologies andinnovation. Market factors, such as adjustment to theprice of oil, may also help this process. While Zhangsaid that China would continue to rely on coal as itsmajor source of energy, the installation of clean coaltechnology 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. Failureto act now to shore up the environmental foundationsof China’s growth – locally, nationally and globally –risks human and political costs and future economicgrowth.

China’s Spending on the EnvironmentRising…

Source: State Environmental Protection Administration Reports on the Economy 2000-2004, China Statistical Yearbook, press accounts

For that reason, the government is trying to overhaulthe economy to make China a greener, more energy-efficient nation. China has been moving, for example,to gradually reduce subsidies on fuel in order toremove the incentive for waste and make consumersbear the true cost of oil. The government is investingin new technologies for oil and gas exploration andfinancing the development of renewable energy suchas hydropower, biomass and wind power (see Figure2). China is also trying to adopt cleaner ways to burndomestic coal and plans to build 40 nuclear powerplants in the next 15 years. “In China, most of ourexperts and the public believe nuclear energy isrelatively safe and clean. So the Chinese governmentbelieves we should still actively develop nuclearenergy,” said Zhang Xiaoqiang, Vice-Chairman,National Development and Reform Commission,People’s Republic of China.

At the same time, the government is trying to pushindustry into shape, phasing out inefficient factoriesand promoting cleaner, more efficient ones. It isimposing tighter emission standards on vehicles,clamping down on overloaded, gas-guzzling trucks,and even changing the way it evaluates local officialsto rate them not just on economic growth but also onenergy efficiency.

Efforts to boost China’s energy efficiency, its economicexpansion and environmental protection have beenundermined by China’s decentralized political system.“Local governments want to focus on increasing GDPand, in doing so, favour vested local interests such asfactories that may also be polluters,” said Pan Yue,Vice-Minister of China’s State Environmental

Protection Administration. He called for an honestevaluation of the state of China’s environment andurged local governments to adopt sustainablepractices. “Not all central government policies are fullyimplemented in the localities,” noted Zhang Xiaoqiang,Vice-Chairman of China’s National DevelopmentReform Commission. “We need to improve the qualityof our civil servants and the whole administrativemechanism has to deal in a balanced way with short-and long-term issues, all of which have to becoordinated on a national basis.”


China’s chief economic challenge for the next decade isclear: how to shift from an export-led growth model toone driven by consumption and innovation, whilemaintaining social stability and avoiding a hard landing.When an economy as big as China’s – now the fourthlargest in the world – is growing at a 10%-plus clip, thattask is the macroeconomic equivalent of getting acharging elephant to turn the right corner withoutcrashing or slipping. But make the turn the giant must.Heavy fixed asset investment has led to overcapacity inmany industries, while China’s high savings rate of over40% of GDP is unsustainable, particularly as thepopulation ages. Meanwhile, in 2004, China has thelargest energy imbalance in Asia (see Figure 1) andpollution was estimated to have resulted in economiclosses equivalent to 3.05% of GDP. “We cannot continuewith the traditional development approach and growthpattern,” concluded Zeng Peiyan, Vice-Premier of thePeople’s Republic of China, in a special address to openthe China Business Summit 2006. “We have to transformour approach.”

The key to that transformation was obvious from theSummit theme: Sustainable Growth through Innovation:China’s Creative Imperative. Among the buzzwords ofdevelopment, “sustainability”, “innovation” and “creativity”are practically regarded as off-the-shelf ingredients for amagic potion to combat the pressures of globalization.But China’s current Five-Year Plan offers a real recipe foraction that can hardly be dismissed as glib: stimulatedomestic demand, shift investment away from industrieswith too much capacity such as automobiles and steel,shore up the financial system so that it can better absorbthe savings of Chinese, and mobilize more capital toproductive investments. As for innovation, the plancommits China to increasing R&D spending from thecurrent 1.2% of GDP to 2.4%, just above the OECDaverage. “Only by constructing new ways of developmentcan China enhance overall growth,” said Summit Co-Chair Chen Yuan, Governor of the China DevelopmentBank.

But there are obstacles and risks. Perhaps the mosttalked about risk is that posed by increasingly volatile oilprices. Since becoming a net oil importer in 1993, Chinahas emerged as the world’s second largest energyconsumer, increasingly dependent on imported oil.

China’s policy-makers are cognizant that China’sdependency on imported oil – and its wasteful use of it –is not only a drain on development, but that its growingdemand for the increasingly scarce resource also raisesthe long-term probability of China getting into a conflictover oil, whether commercial or military.

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Sustainable Growth


“I don't see China becominga service centre to the worldanytime soon. To be at thesame level of critical massas India at a global level –it's probably about 7 to 10years away.”

Sriram VenkataramanSenior Vice-President and Headof Asia Pacific, InfosysTechnologies, Japan

“The domestic service sectorwill grow very fast, fasterthan the rest of theeconomy, but it will mainlycater to the local market. Ingeneral, we will not seelarge-scale service practiceto the world.”

David Li DaokuiMansfield Freeman ChairProfessor of Economics,Tsinghua University, People'sRepublic of China

“Internationalization is notan end in itself; it is a meansto help you grow anddevelop.”

Yang YuanqingChairman of the Board ofLenovo Group, People’sRepublic of China; Co-Chair ofthe China Business Summit2006

"Local governments want tofocus on increasing GDPand, in doing so, favourvested local interests such asfactories that may also bepolluters."

Pan YueVice-Minister of China's StateEnvironmental ProtectionAdministration

Figure 1: China Has the Largest EnergyImbalance in Asia

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

Figure 2: Alternative Energy Expected toRise with Demand…

Source: US Energy Information Administration, China Daily, International Energy Outlook2006

In 30 years, China has transformed itself from acommand economy inhospitable to overseas investorsto an emerging free enterprise market that attracts thebiggest share of global foreign direct investment.China is a key driver of globalization and one of itsmajor beneficiaries. The world’s third biggest traderand the fourth largest economy, China combinesgeographic and demographic heft with purchasingpower and manufacturing prowess.

Even so, China is still a developing country. China’sper capita GDP is above that of the Philippines butbelow that of Thailand. In the World EconomicForum’s Global Competitiveness Report 2006-2007,China’s competitiveness ranking dropped from 48th to54th. According to the World Bank, over the past twodecades, China accounted for over 75% of thepoverty reduction achieved in developing economies.Yet, today, more than 135 million people, mainly inChina’s western and interior regions, scrape by onless than a dollar a day, without the benefits of cleanwater, adequate healthcare and education.

That said, China has become a leading player in theinternational community, both through the roles it hassought such as its membership in the World TradeOrganization (WTO) and those that have been thrustupon it. Beijing has emerged as a role model fordeveloping economies, its non-judgmental foreignpolicy serving as a counterweight to westerndeveloped countries, particularly the United States.

The recent agreement to increase China’s votingpower in the International Monetary Fund (IMF), albeitby only a small percentage, is an acknowledgement ofits rising profile – and mounting responsibilities.Geopolitically, China’s participation in the six-partytalks on North Korea’s nuclear programme has beenpivotal. And as a permanent member of the UNSecurity Council, Beijing is playing a key behind-the-scenes part in the selection of the next UN Secretary-General, who is expected to be an Asian. “Anythingthat happens in China will have a global impact so wehave to be globally responsible,” said Wang Jianmao,Professor of Economics and Associate Dean, ChinaEurope International Business School (CEIBS).

Chinese diplomacy, however, has largely been drivenby pragmatic economic motives, particularly the needto meet its burgeoning energy, raw materials andcomponents demands. China has been anenthusiastic driver of integration with South-East Asiaand has also forged strong commercial links withresource-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 ofthis year to US$ 21.3 billion.

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Globalization


The onus for action must also fall on enterprises. “Manycompanies in China have focused on the short term suchas on increasing revenues from sales and marketing,” saidZhang Weiying, Vice-Dean, Guanghua School ofManagement, Peking University. Instead of focusing onracking up double-digit sales, enterprises have to putmore effort and investment into R&D and generatingsustainable profits, Zhang advised. Said Chen Tonghai,Chairman of China Petroleum & Chemical Corporation(Sinopec), which leads Chinese enterprises in annualpatent applications: “In our industry, we not only have tolook for new types of energy but to developenvironmentally friendly products. We have to constantlyconduct systematic innovation or else we will beeliminated by the competition.”

The maturation of China’s economy will surely speed upits transformation – naturally. The services sector alreadycontributes almost 40% of GDP, Hellmut Schutte, Dean,Asia Campus, INSEAD, Singapore, remarked (see Figures3 and 4). “As manufacturing productivity growth comes in,more people will be laid off with many of them startingtheir own little shop along the street,” he explained. “It’spretty obvious that as China’s economy grows,consumption patterns will change, with very high growthin the leisure industries, healthcare and education.” Theelephant is making the turn, but will it keep its balance?


Figure 3: Chinese Economy GraduallyShifting towards Services…

Source: China Statistical Yearbook 2005

Figure 4: …But Services Sector Still HasRoom to Grow

Source: CIA World Factbook; 2005 estimates when available

“China is engaged andbuilding partnerships tosend a message to theworld that it will play by therules of the game. Let therules of the game be fair.”

Kapil SibalMinister of Science andTechnology and Earth Sciencesof India

"I can assure you thatJapan's next administrationwill share the basicrecognition that the rise ofChina is an opportunity forall of us rather than a threatagainst us."

Yasuhisa ShiozakiSenior Vice-Minister for ForeignAffairs of Japan

The part China plays in the WTO in the aftermath ofthe collapse of the Doha Round will be an immediateindicator of its willingness to shoulder newresponsibilities. Beijing could be instrumental inreviving the talks. China’s trading partners, meanwhile,will be assessing how well Beijing implements its WTOcommitments, including the opening of the bankingsector at the end of this year. Lastly, China’s attemptsto set its own industry and technology standards haveraised concerns among some trading partners andinvestors.


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

Chinese enterprises, particularly industrial groups, arenow accompanying the country’s diplomats to far-flungcountries from Venezuela to Sudan. While somecompanies, notably the state energy groups, have goneglobal for strategic reasons, many others are seeking tohone their competitiveness abroad. “The reason for goingglobal is simple: to create new opportunities to makeprofits today and in the future,” said Wang Jianzhou, ChiefExecutive, China Mobile Communications Corporation.Added Yang Yuanqing, Chairman of the Board of LenovoGroup, which went global through its acquisition of IBM’spersonal computing division: “Internationalization is not anend in itself; it is a means to help you grow and develop.”

China’s foreign policy, its economic ascendancy and itsambitious enterprises have at times put China at oddswith the global establishment. Beijing has clashed withWashington over how to deal with the conflict in Darfurand Iran’s nuclear programme. The bid by a Chinese statefirm to take over a US energy company alarmed manyAmerican politicians. China’s trade surplus has fuelledaccusations and led to enormous pressure on Beijing tomove to a more flexible currency regime faster than it iswilling to allow.

The frequency of such friction is likely to increase. Fornow, China has played the unassuming new kid on theblock with benign intentions. At the same time, it basks inthe acclaim of those who see its market as a glowingopportunity no sensible investor can resist. After all, Chinawill be hosting the Olympic Games in 2008, what for theprevious Asian hosts – South Korea and Japan – wassomething of a global coming-out party. “Our policy ofreform and opening up to the world means we embraceglobalization,” said Wu Jianmin, President of the ChinaForeign Affairs University. “The most important feature ofChina’s rise is to share the growth with the rest of theworld.”


“We are entering a newphase in the relationshipbetween Asia and theMiddle East, but we need tocreate the foundations forbetter understanding ofeach other to take it toanother level.”

Rachid M. RachidMinister of Trade and Industry ofEgypt

Figure 1: China-US Trade Balance Shifting

Source: World Trade Organization

Figure 2: China’s Foreign ReservesGrowing…and Diversifying

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

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 andEurope tie in third place with roughly 7%, while Oceania receives 4%.

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

Chinese Investment Mostly to Asia…

Source: Deutsche Bank

Sustainable Growth

China should focus less on incentives to attractinvestment and more on institutional renewal to createa better business environment. The skills shortage, forexample, must be addressed through an overhaul ofthe education system to promote creativity and criticalthinking over rote learning and exam-focusedassessment.

The urgent need for China to become more energyefficient can be addressed by cutting-edge technologyavailable in Japan and the US, thus creating anopportunity from a challenge. For this to happen,China’s intellectual property regime has to work for thelogical technology transfer to occur. The need tocreate a social safety net system offers similaropportunities to providers of financial services.

Globalization

The collapse of the Doha Round indicates adisconnect between the reform-reluctant developedworld and the reform-eager developing world. Alongwith other Asian economies, China could be a catalystfor the revival of the multilateral trade talks, even asthey forge their own regional arrangements.

A key challenge for China will be how well it continuesto manage its integration into the global economywhich requires balancing its inherent market musclewith the benefits of integration. A major policyquestion of whether Chinese enterprises should adoptaccepted world industrial and technology standards orinsist on setting their own remains to be answered.


The theme of the World Economic Forum’s ChinaBusiness Summit 2006 – Sustainable Growth throughInnovation: China’s Creative Imperative – clearly spelledout the priority for China as it aims to achieve a new levelof economic development. The discussions in Beijingneatly continued the Forum’s pursuit of the “creativeimperative” since the Annual Meeting 2006 in Davos andthrough regional summits in São Paulo, Sharm El Sheikhand Tokyo. The goal: to identify innovative approaches tokey challenges. By capturing these ideas, the Forumhopes to stimulate further debate and brainstorming atupcoming regional meetings and in next year’s AnnualMeeting.

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

Innovation

While fast growing, the service sector in China is focusingmore on the domestic market than on global customers.Key areas with strong growth potential includepharmaceutical R&D, aviation engineering, and theprovision of business process outsourcing and call centreservices to the Japan market.

China’s innovation drive should focus not just on thedevelopment of new products and services but also onthe creation of new business models to fit the specificcharacteristics of the domestic market. Examples of suchinventive strategies include the varying of marketingapproaches according to a city or region’s tier level andusing offbeat sales techniques or promotions to generatebrand loyalty in a market where such affinities are minimal.

Risk Management

A key to mitigating the many risks confronting China is theappropriate sequencing of reforms. To mobilize theenormous pool of savings to more productive uses andstimulate consumption to head off an economicslowdown will require significant progress in creatingsocial safety nets that encourage personal andcommercial risk taking. Banking reform and strong capitalmarkets will have a similar domino effect in promotinginnovation, enterprise and the reform of state firms. Thetransfer to China of much needed technology will alsohappen only if intellectual property rights enforcement issufficient.

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The Creative Imperative in China


“Never has the world seenthe simultaneous take-off oftwo such nations together.This is the time for Chinaand India to think out of thebox so they can achievetheir stated goals.”

Baba N. KalyaniChairman and ManagingDirector, Bharat Forge, India;Co-Chair of the China BusinessSummit 2006

"Innovation is the soul of anation’s advancement andthe everlasting, drivingpower of nationalprosperity.”

Zeng PeiyanVice-Premier of the People'sRepublic of China

caption

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 NDRCserves 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 PartnersAccentureAMDApax PartnersAudiBombardierBooz Allen HamiltonBTCACredit SuisseDeloitteDeutsche BankErnst & YoungFluorHPHSBCIntelLehman BrothersManpowerMarsh & McLennan CompaniesNakheelNASDAQNYSE GroupPricewaterhouseCoopersReutersUBSVolkswagenZurich Financial Services

Regional Partner

GeoPost IntercontinentalPhoenix Satellite TelevisionUPS

Summit Supporter

Ogilvy Public Relations Worldwide

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

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Acknowledgements


Peter Torreele is Managing Director of the World Economic Forum. Lee Howell is Director, Head of Asia, at theForum. 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 AlejandroReyes to produce this report.

The World Economic Forum would like to express its appreciation to the summary writers for their work at theSummit. 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.

Contributors

The World Economic Forum is an independentinternational organization committed to improvingthe state of the world by engaging leaders inpartnerships to shape global, regional andindustry agendas.

Incorporated as a foundation in 1971, and basedin Geneva, Switzerland, the World EconomicForum is impartial and not-for-profit; it is tied tono political, partisan or national interests.(www.weforum.org)