Jun 22, 2007

China's Plan to Quash Rural Instability

Stratfor on China's new economic development zones blueprint using which China hopes to quell a key cause of rising rural instability.

The National Development and Reform Commission (NDRC), China's top economic planner, on June 9 added Chongqing and Chengdu -- two cities in China's western province of Sichuan -- to its portfolio of pilot reform cities (PRC). The PRC blueprint is essentially a reincarnation of the "special economic zones" and "economic development zones" (EDZ) zoning approach. This time, it is being applied to separate clusters of cities, with each cluster testing a mixture of policy experiments dedicated to one central government objective. These clusters are strategically located to push manual labor-intensive industries inland and to cultivate new financial industries in China's more prosperous coastal cities that are ready to move away from manufacturing-intensive industries and toward more service-intensive development.

The Zoning Approach
China first used a "zoning approach" in the 1980s to cordon off specific cities for piloting new export-promoting policies along its coast. These cities were selected for a number of reasons, the most obvious being their proximity to exporting ports. This EDZ blueprint was so wildly successful that two decades later, the stark difference in living standards between EDZ cities and non-EDZ rural areas -- the urban-rural wealth gap -- has become one of the greatest threats to Chinese single-party rule.

As a result, the State Council started merging EDZs in 2003, leaving only one in each county or city suburb, before finally terminating all expansion plans in April 2007. The PRC concept was not introduced until 2006, when Tianjin's Binhai New Area was named as the first "zone for comprehensive policy experimentation" and used to pilot foreign exchange reform.

Pilot Reform Cities
Since then the Shanghai Pudong area and Shenzhen special economic zone have been added to the first PRC cluster dedicated to financial innovation reforms. Chongqing and Chengdu make up a separate second cluster dedicated to minimizing the urban-rural wealth gap. Though both clusters' overall experimental objectives might seem distinct, they are both pieces of a wider plan by Beijing to direct intra-regional migrant labor flows back inland in order to balance China's currently imbalanced regional development.

The three cities selected for financial innovation reform are in the more economically advanced coastal region -- Tianjin Binhai in the north, Shanghai Pudong in the east and Shenzhen in the south. For several years, Beijing has been trying to disperse the foreign direct investment (FDI) concentrated along this coastline into the lesser-developed central and western regions, but with little success. This is unsurprising, given that the majority of FDI in China is in manufactured exports; moving inland would simply increase the costs and logistical difficulties of transporting finished goods for foreign-owned operations.

The two cities selected for wealth-gap reform lie at the frontier edge of the relatively poorer and backward western regions, where 50 percent to 80 percent of the population live in rural areas. Chongqing and Chengdu's positions -- straddling the line between regions of excess manual labor supply and manual labor shortage -- are significant. In the last two years, manual labor wages have been rising in coastal cities because of region-specific shortages of manual labor. Meanwhile, manual laborers are abundant in the central and western regions, where jobs are in short supply for lack of foreign investors.

This regional imbalance can be resolved in two ways: move the jobs inland, or move the workers outward. Beijing has tried the former and does not desire the latter. China already has more than 150 million floating migrant workers it is struggling to pin down and does not want the west-to-east outflows to increase. To stem the outflow, Beijing is creating an intermediate pit stop on the western-eastern borderland to absorb the rural migrant workers before they flood into eastern coastal cities. Chongqing and Chengdu might also attract foreign investors one day, when it becomes apparent that manual labor shortages on the coast are not about to be alleviated with migrant workers fresh off the bus from the west.

Although the theory sounds good, there are many primary complications. Like all local government officials across China, those in the two wealth-gap reform PRCs will likely already have significant stakes in urban development projects and be loath to divert state resources away from these to more needy rural areas. Economic concessions also will be needed if foreign investors are to be attracted inland (with or without rising wages along the coast), but China is obliged under its World Trade Organization membership conditions to maintain a level regulatory/taxation playing field for all domestic and foreign investors. If coastal labor wages stop rising, or if financial reforms fail in the cluster of PRCs along the coast, then the cost pressures forcing foreign investors to look inland could disappear. The cost of moving Chinese coastal operations inland for foreign investors might be even higher than that of relocating to neighboring Asian countries such as Vietnam; this would cause an emigration, as opposed to internal relocation, of foreign investment-generated jobs. And finally, the crux of any successful government policy lies in its implementation, especially in the hierarchical maze of Chinese politics, so uniform central government direction across PRC clusters will be difficult. For example, Beijing does not hold the same degree of control or influence over Shenzhen as it does over Shanghai following the September 2006 crackdown.

Difficulties aside, being a PRC includes a certain domestic political elevation. Local governments gain prestige from having a direct channel of influence from Beijing over their regional rivals. Should Chongqing and Chengdu improve the lot of their rural populations, more and more western frontier cities will want to join in the PRC program to draw idle manual workers eastward from the rural areas and draw foreign investment-generated jobs westward from the coastal cities.

Should Beijing succeed at using this zoning approach to balance regional economic growth and close the urban-rural wealth gap, it will relieve one key source of unrest among China's 800-900 million rural or migrant workers. At the pilot level, results could well be attained in a matter of years, but it will take decades before any results are achieved at the national level. Nevertheless, for now, the domestic propaganda the PRC program generates could be enough to keep rural discontent under control, as Chinese President Hu Jintao consolidates internal party control ahead of the autumn Communist Party Congress.[Stratfor]

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