Growth through Innovation An Industrial Strategy for Shanghai By Shahid Yusuf Kaoru Nabeshima April 22nd, 2009
Source: Bosworth and Collins (2007); He and Kuijs (2007)
Physical capital is only one part of China’s growth story. Human capital increasingly abundant in the large urban centers such as Shanghai, is an equally important part and a fourth reason explaining China’s unusually brisk economic performance. Achieving universal literacy and a high level of primary enrollment was China’s objective from the 1950s. This equipped the Chinese workforce with the basic skills needed for the earlier stages of industrialization in the late 1970s and early 1980s.18 A redoubling of effort at raising levels of education after 1980 has paid handsome dividends. China has vastly expanded secondary and tertiary education and vocational training domestically and sent hundreds of thousands of its nationals for training abroad as well (see Table 2 .2).19 Shanghai is among the most successful cities in attracting some of these knowledge workers back. These efforts are expanding the supplies of skilled, technical and professional workers, who are needed to assimilate advanced technologies from overseas in manufacturing and services, to manage China’s increasingly more complex economy and to initiate home grown innovations in a variety of fields (Yusuf, Nabeshima and Perkins 2007). With technology absorption and innovation now viewed as the most potent sources of economic dynamism and of gains in productivity, the supply and quality of human capital might eventually overtake physical capital as the principal driver of growth via gains in TFP.20 As shown by Diego Comin, Hobijn and Rovito (2008), closing inter-country disparities in TFP is in large part a function of lags in the adoption of new technologies and the intensity of usage. Human and knowledge capital can reduce both.
Table 2.2: Gross Enrollment Rates in China, 1991, 2001, and 2006
Source: World Development Indicators
Fifth, the renewed priority given to education starting in the 1980s,21 was followed later in the decade by increasing attention to R&D with the launching of a number of programs such as the Spark and Torch Programs (see Table 2 .3 for a list of various national innovation programs and Sigurdson (2005)). This is building technological capacity and laying the groundwork for a culture of innovation, most notably in the leading industrial centers. The early emphasis given to R&D means that China is accumulating research capital faster, which expedites technology transfer and technology absorption.22, Gao and Jefferson (2007) introduce the notion of a science and technology take-off which refers to the scientific productivity of a country. They suggest that such a take-off which is likely to precede a surge in innovation, is associated with the doubling of research expenditures over a period of a decade or less. They show that the United States, several European countries and a few East Asian economies were able to achieve this and some are now demonstrating their innovation capabilities. By this yardstick, China and even more notably Shanghai, have achieved takeoffs. How rapidly this translates into a steady flow of innovations which are reflected in new products, exports, and GDP growth, still remains to be seen.
Table 2.3: Major National Programs in China
Source: Wu (2007); Sigurdson (2005); Rongping and Wan (2008).
From the early 1980s, China’s industrial capacity grew most rapidly in a few densely populated urban regions centered on cities such as Shanghai, Guangzhou, and Shenzhen which are gaining agglomeration economies (Yusuf 2007).23 This process accelerated between 1998 and 2005, although relative to more advanced countries, China is still low on the scale of industrial agglomeration (J. Lu and Tao 2009).24 Size and the agglomeration of activities translate into advantages of scale, of industrial diversity, of deep labor markets and a strong services economy. Together, these have led to productivity gains for firms and created an environment more conducive to technological advance, which is universally an urban phenomenon (Yusuf and others 2003).25 In other words, the five factors referred to above have been reinforced by agglomeration economies. Urbanization has thus interacted most fruitfully with other factors in promoting growth.
These six elements highlight the role of industrialization: an early start at building industrial capacity; FDI that initiated the growth of exports; the high level of investment in plant, equipment and infrastructure; rapid accumulation of human capital on a broad front; the attention given to R&D; and the geographically concentrated spiral of urbanization. Together they are responsible for the stimulating and sustaining China’s growth to date. Each contributing element depended upon a succession of policy initiatives that after experimentation and validation, defined and progressively elaborated China’s unique development strategy.26 In other words, policies that gave primacy to or accommodated these six elements were ultimately responsible for the huge economic strides taken by the country during the past three decades.
Starting in the 1980s, China’s industrial efforts were assisted by the global industrial product cycle,27 and by the strategies of MNCs and of major retailers in the United States. Rising costs of production in their home countries and the emerging capacity to manage dispersed operations with the help of IT, persuaded the MNCs to transfer the manufacture of mature standardized commodities whose production technologies had stabilized and become codified, to East Asia. The big retail chains in the United States found it expedient and cost effective to source from overseas (Bair 2009).28 As transport costs fell, the cost advantage enjoyed by East Asia producers grew (Hummels, Ishii and Yi 2001).29 Starting in the 1980s and at an accelerating rate in the second half of the 1990s, China was able to grasp the opportunities as they emerged by building production capacity and acquiring the manufacturing capability and scale demanded by foreign buyers. According to Hamilton and Gereffi (2008), it was the speed with which Chinese and other East Asian manufacturers adapted to the needs of contract manufacturing which explains why they were able to beat the competition. Furthermore, as China’s technological know-how improved, it diversified into medium and high tech products at a faster rate than other countries and established a commanding lead in markets for a wide range of manufactures. Table 2 .4 shows that China currently dominates the export market for various types of garments, toys, furniture, and leather goods.
This is the past. What of the future. China is now the world’s second largest exporter and the second largest manufacturer. Maintaining the recent trend rates of growth of the existing mix of products in the unfolding world environment will be difficult, perhaps impossible.30 Market saturation for some manufactured exports, rising domestic costs of production, natural resource scarcities and trade frictions31 are some of the factors arguing for a growth and export strategy which more fully harnesses technology assimilation from abroad, domestic innovation, productivity growth, industrial deepening, and the potential residing in business services still a relatively under-developed sector in China. The “low cost” model and industrial widening are still capable of delivering growth, but to a lesser degree. Thus, if gains in productivity, backward integration to increase value added, and innovation to generate new goods and services, better processes and better business models are the means of achieving sustainable growth, then strengthening technological and innovation capabilities promises the highest payoff.32 By building and tuning and coordinating technological capabilities and creating a functioning innovation system, the economy will be more productive, less resource and energy intensive and better able to generate goods and services enjoying wider profit margins.33
There are many empirical findings and lessons from more advanced countries which can help make China’s industrial economy more innovative. But among these, one stands out. Innovation whether in manufacturing or in services needs to be nourished in a few major urban centers which combine significant agglomeration economies with an intellectual culture which encourages innovation and an urban environment high on the scale. China’s technological capacity is already highly concentrated and very likely a relatively small number of cities will drive knowledge intensive growth. Shanghai can be the leader or tie with Beijing for first place.
Table 2.4: China's exports as a share of world exports, 2006
Source: Authors’ calculations
Although the past is one guide to future development, past patterns should not be seen as binding. In fact they could mislead. Hence, in this study, we will draw selectively and critically upon the relevant global and Chinese experience of mega cities, in proposing a high growth strategy for Shanghai.
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