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China and the Knowledge Economy:
Challenges and Opportunities
Douglas Zhihua Zeng 1
Shuilin Wang 2
Abstract
The rapid pace of economic growth in China has been unprecedented since the start of
economic reforms in late 1970s. It has delivered higher incomes and made the largest
single contribution to global poverty reduction. Measured by international poverty lines,
from 1978-2004, the absolute poor population in rural areas has dropped from 250
million to 26.1 million. Such gains are very impressive and have been driven largely by a
set of market-oriented institutional reforms, strong investment, and effective adoption and
application of various knowledge and technologies, especially foreign ones through trade
and foreign direct investment (FDI). While enjoying tremendous success, China also
faces many challenges that have to be addressed in order to sustain its long-term
development. These include weak institutions, low overall educational attainment, weak
indigenous innovation capacity, poor linkages between research and development (R&D)
and industries, etc. This paper is intended to provide an insightful analysis on some
strengths, weaknesses, opportunities, and Challenges of China’s knowledge economy in
the areas of economic incentives and institutional regime, human capital, innovation
system, and information infrastructure.
Key words: China, knowledge economy, competitiveness, innovation, institutions,
governance, education, strengths, weaknesses, opportunity, challenges.
World Bank Policy Research Working Paper 4223, May 2007
The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org.
Note: The authors are very grateful to Jean-Eric Aubert, the Team Leader of the Knowledge for
Development Program (K4D), for his valuable guidance and comments.
(^1) Knowledge for Development Program (K4D), World Bank Institute, World Bank. Email: Zzeng@worldbank.org. 2 Development Research Group (DEC), World Bank. Email: Swang2@worldbank.org.
WPS
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Table of Contents
- A. Strengths……………………………………………………………………….
- B. Weaknesses……………………………………………………………………
- C. Opportunities ………………………………………………………………....
- D. Threats…………………………………………………………………………
- E. Summary of China’s SWOT Analysis……………………………………......
China’s economic reform started in 1978 with the strong vision of developing a market
economy with Chinese characteristics, architected by then leader Deng Xiaoping. Putting
aside the communist ideology, the transformation started in the agricultural sector by
introducing the household responsibility system – which actually privatized the use rights
of lands previously controlled by communes. Built on the success of the agricultural
sector, the Chinese again invented the township and village enterprises (TVEs) –
enterprises owned and managed by local governments – to tap the rural surplus labor and
rising farmer incomes. The amazing success of the TVEs has left the traditional economy
theory a puzzle to solve.
In pursuing the transition towards a market economy, China has adopted a gradual
approach with great pragmatism. As at the outset of a reform, it is not possible to foresee,
let alone to resolve, all the potential problems that might emerge at later stages; change
has been conducted as a process of adaptive learning. Through such an approach, China
has successfully allowed regions and localities to experiment and then scale up the most
successful experiences at the national level. The agricultural reform, the TVE initiative as
well as the special economic zones later on were all tested as pilot(s) first and then scaled
up when proved successful. With the same principle, the reforms were gradually
expanded from the agricultural sector to industry and large parts of the service sector (see
table 1 for a chronology of China’s major reforms). This might be one of the major
reasons which could explain the contrasting results of the Russian and Chinese reforms.
Table 1. China’s Major Policy Reforms Year Policy Change 1978 “Open door” policy initiated, allowing foreign trade and investment to begin 1979 Decision to turn collective farms over to households; TVEs given stronger encouragement 1980 Special economic zones created 1984 Self-proprietorships encouraged, of less than 8 people 1986 Provisional bankruptcy law passed for SOEs 1987 Contract responsibility system introduced in SOEs 1988 Beginning or retrenchment of TVEs 1990 Stock exchange started in Shenzhen 1993 Decision to establish a “socialist market economic system” 1994 Company law first introduced 1995 Strategy of vitalizing the country through science & education initiated 1996 Full convertibility for current account transactions 1997 Plan to restructure many SOEs began 1999 Constitutional amendment passed recognizing private ownership 2001 China’s accession to WTO 2002 Endorsement of the role of the private sector 2003 Decision to “perfect” the market economic system 2004 Constitution amended to guarantee private property rights Source: Zeng’s compilation and OECD China Economic Survey 2005.
A.1.2. Open-door policy
Since the open-door policy was introduced in the early 1980s, the Chinese economy
gradually opened to foreign trade and investment. This process encompassed allowing
enterprises to participate in foreign trade, replacing trade procurement targets by market
based trade policy instruments such as tariffs, quotas and duty exemption schemes,
gradually reducing trade barriers, and finally, increasingly using market mechanisms.
Meanwhile, China set up various economic development zones and techno parks (from a
few to a big mass) to attract FDIs and new and high technologies. China’s entry into the
WTO in late 2001 further facilitated its openness and transition towards a market-based
economy. Today, China is well integrated into the global market (trade as a share of GDP
A.1.4. High saving and investment rates
Consistent with its culture of strong propensity for saving, China’s domestic saving rate
remains high (around 35-45% from 1978-2003). Such a high rate of saving was able to
withstand remarkable institutional changes, and meet strong investment needs incurred
from rapid economic expansion. A marked increase in household savings offset the
ending of artificially high state-owned enterprise profits and consequently lowered
savings in the combined accounts of the government and SOEs. 9 In the future, with the
decrease of total fertility and an increase of per capita income, the saving might continue
to be strong.
A.1.5. An emerging private sector
China’s private sector started to develop in mid-1980s, but it has emerged as a major
driving force in the economy. Output by privately controlled companies now accounts for
almost 60% of GDP (table 2), and dominates many industries, making them increasingly
market-oriented. The growth of the private sector has been facilitated by an increasingly
tolerant policy environment, and widespread structural reforms.
Table 2. Share of GDP by Firm Ownership (1998-2003)
Private Sector 50.4 51.5 52.8 55.5 57.4 59. Public Sector 49.6 48.5 47.2 44.5 42.6 40. State-controlled 36.9 37.1 37.3 35.7 34.6 33. Collectively controlled 12.7 11.3 10.0 8.8 8.0 7. Total 100.0 100.0 100.0 100.0 100.0 100. Source: National Bureau of Statistics and OECD estimates.
A.2. Education and Skills
A well-educated population is the key enabler of the knowledge economy. China’s
massive relatively educated labor force is the backbone of its strong economic
performance.
A.2.1. A relatively skillful human capital base
(^9) OECD Economic Surveys: China, OECD, 2005.
With a series of educational reforms starting from 1979, mainly focusing on improving
access, governance, financing and curriculum, China has made great progresses in
building a relatively well educated population. From 1978-2003, the adult literacy level
increased from 64% to 89% 10 ; from 1982-2000, the average number of years of education
for the population aged 15 and above increased from 5.33 to 7.85, and for the total labor
force, it increased from 5.81 to 7.99 (for the secondary industry where manufacturing is
the bulk, it increased from 8.05 to 9.44).^11 In addition, from 1990-2004, China’s primary
enrollment ratio (net) increased from 93.9% to 98.9%, junior secondary (gross) increased
from 66.7% to 94.1%, and tertiary (gross) rose from 3.4% to 19%^12.
A.2.2. Rapidly emerging private higher education
To address the huge demand for higher education, which the public system alone could
not fulfill, the private provision for tertiary education has been growing very rapidly
(table 3), especially in more remunerative disciplines such as business, commerce, and
ICT. Since most of them are more market-driven, more flexible, and better suited to
business needs, they will have great potential to grow and become the driving force for
better quality higher education. Although they still face many institutional constraints and
only account for 10% of total enrollment, given China’s huge household savings
(estimated at RMB 60 trillion) and long tradition of putting a high premium on good
education, private education will play an increasingly important role.
Table 3. Growth of Tertiary Education in China (1997-2002)
Growth of Private Tertiary Schools 0 13.3 94.1 30 97.7 54. Growth of Total Tertiary Schools -1.2 0.2 4.8 -2.8 17.7 14 Growth of Private Tertiary Enrollments 33.2 38.5 80.8 70 105.4 126. Growth of Total Tertiary Enrollments 5.1 7.4 21.3 34.5 29.3 25. Source: Chen, Guoliang, Shanghai Academy of Educational Sciences. Presentation at the WB/KRIVET Workshop on “Revamping Lifelong Learning System”, Seoul, June 2003.
(^10) World Bank SIMA database. (^11) Chinese Census 1982, 2000. (^12) China Education Statistic Yearbook 2000, 2004.
China boosts one of the world’s largest forces of scientists and engineers. Table 5 shows
that in absolute term, China’s number of researchers in R&D (almost 811,000) is second
only to the U.S., and the S&T journal articles only after the U.S., Japan, and Germany. Its
S&E enrollment ratio as a share of tertiary students is one of the highest in the world.
Such a critical mass forms a solid human foundation for its S&T and innovation
activities.
Table 5. A comparison of S&T talents (2003-04) China India USA Japan Germany Russia Science & Engineering Enrolment Ratio (% of tertiary students)
43 20 19 20 29 50
Researchers in R&D 810,525 117,528 1,943,000 646,547 267,000 487, Researchers in R&D / Mil. Pop. 633.0 119.7 4525.8 5084.9 3222.2 3414. Total Expenditure for R&D as % of GDP
1.23 0.85 2.67 3.11 2.64 1.
Scientific and Technical Journal Articles
20,978 11,076 200,870 57,420 43,623 15,
Scientific and Technical Journal Articles / Mil. Pop.
16.5 10.7 704.0 451.6 529.8 109.
Source: WBI KAM database.
A.3.3. Strong business participation in R&D
Enterprises are now becoming big players in both financing and conducting R&D
activities in China (tables 6 and 7). In 2003, the business sector accounted for 62.4% of
total R&D funding. However, it should be noted that public enterprises undertake most of
the R&D in the business sector - roughly 50% of all R&D in China. This means that the
amount being done by non-public enterprises is just about 10% of the total R&D effort,
and it appears that a large share of this is being done by multinational companies
(MNCs), not by domestic Chinese firms. The total R&D input in 2004 by state-owned
enterprises, supervised by the Central State Assets Supervision and Administration
Commission (SASAC), came to 76.8 billion yuan, accounting for 1.5% of firms’ annual
sales revenues.^14 As for the overall business sector, its share in total R&D spending is
much higher than India (table 7). Although this is mostly concentrated in big firms and
spin-offs from former public institutes, in general, it is an important trend which shows
the business sector’s enhanced capacities and increased demand for technologies as well
as stronger linkage between R&D and the market. Meanwhile, China needs more efforts
to encourage the R&D activities of the domestic non-public firms.
Table 6: Distribution of funding on R&D (1996 – 2003) Year 1996 1997 1998 1999 2000 2001 2002 2003 R&D institutions
Enterprises 43.3 46.1 44.8 49.6 60.0 60.4 61.2 62. Universities 11.8 11.3 10.4 9.3 8.6 9.8 10.1 10. Others 2.1 2.0 2.2 2.6 2.6 2.1 1.4 1. Source: MOST, 2004.
Table 7. R&D spending breakdown (%) Business GRI University China (2001) 60.4 27.7 9. India (1998-99, roughly) 22 75.5 2. Source: World Bank internal database and country statistics.
A.3.4 Rapid increase of S&T output
China’s patenting has increased dramatically over the last decade in terms of both patent
applications and patents granted. The number of applications filed (for all three types of
patents) increased from 41,773 in 1995 to 130,133 in 2004; and patents granted totaled
49,360 in 2004 (Figure 1 and Table 8). China’s international patents applications also
increased very rapidly. According to WIPO recent report Annual PCT Statistical
indicators report (annual statistics 1978 -2004), China fared very well. In 2004 it filed
1,705 invention applications, an increase of 32% compared with the previous year and
ranked 14 th^ in international application percentage (1.4%). Among developing countries
(^14) The Central State Assets Supervision and Administration Commission (SASAC), “Firms’ Input in R&D Activities”, Aug, 2005,
2003 56769 48549 105318 11404 25750 37154
2004 65786 64347 130133 18241 31119 49360 Source: SIPO and WIPO, 2003, 2004 and 2005
Table 9: Patent applications filed by and granted to Chinese residents in the United States Patent and Trademark Office (FY 2001 - FY 2005)
2001 2002 2003 2004 2005
Patent applications filed 695 966 1230 1132 2043
Patents granted 239 347 442 551 583
Source : USPTO, 2005
Meanwhile, China has improved from 15th^ in the world in terms of scientific publications
listed in SCI, EI and ISTP in 1990 to the fifth in 2003. Table 10 shows China’s
publications catalogued in refereed international journals since 1998.
Table 10: Publications catalogued in refereed scientific journals (SCI, EI and ISTP)
Year 1998 1999 2000 2001 2002 2003
of S&T papers catalogued 35,003 46,188 49,678 64,526 77,395 93,
Source: China national S&T output indicators; http://www.sts.org.cn
A.3.5. Well-established state key labs and techno parks
Though they are not prevalent, China has built some national key laboratories in the
fields of physics, chemistry, biotech, pharmaceuticals, optics, space, etc., and some are
world-class, such as those located in the Chinese Academy of Sciences, Beijing
University, Tsinghua University, and Shanghai Jiaotong University, and so on. In
addition, China has several leading technology parks which serve as important
technology and innovation hubs for the country, such as the Zhongguancun high-tech
park (Beijing, with 500 R&D centers), Shanghai Pudong technology park, Shenzhen
Technology Park, and Suzhou Techno Park, etc.
A.4. Information Infrastructure
A.4.1. Rapid improvement of ICT access
China’s ICT expenditure as % of GDP is 5.3% in 2004. Although its overall ICT
penetration is still low compared with more advanced countries, it has been growing
rapidly (table 11). From 2000-04, mobile subscribers per 1,000 people increased almost
4-fold, internet users per 1,000 people increased by 4 times, and personal computers per
1,000 people increased 2.5 times. By 2004, China’s mobile phone and PC penetrations
were higher than the average of either the lower middle income group or the EAP region.
The internet penetration is slightly lower than the EAP region average but higher than the
lower middle income group. The growth of the absolute numbers is even more
impressive. By 2005, China became the largest mobile phone market in the world and its
total number of internet users had surpassed 100 million (figure 2).
Table 11. China’s ICT Penetration
China Lower middle income group
East Asia & Pacific region 2000 2004 2004 2004 Telephone mainlines (per 1,000 people) 115 241 192 194 Mobile subscribers (per 1,000 people) 68 258 255 248 Population covered by mobile telephony (%) .. 73 76 73 Internet users (per 1,000 people) 18 73 70 75 Personal computers (per 1,000 people) 16 40 38 37 Source: World Bank: ICT at a glance – China, 2005.
Despite the strengths it possesses and significant achievements it has made over the last
quarter of the century in the different pillars of knowledge economy, China still has many
weaknesses to overcome, especially in the institutional and governance aspects, and its
unfinished agenda remains large.
B.1. Incentive and Institutional Regime
B.1.1. Weak institutions, governance and IPR protection
In China, the legislative body has been a relatively weak player in the government
function and largely controlled by the party. Beyond the contents of law, the more
substantial problem is the enforcement of laws. A relatively complete set of laws and
regulations covering economy and IPRs are in place, but enforcement is still inadequate.
Weakness here may hold back the degree of innovation and product development of both
foreign and local companies. Chinese entrepreneurs feel that expansion across provincial
borders is made difficult by the lack of objectivity of local judiciaries when it comes to
trying cases involving the infringement of trade secrets, IPRs, and contract enforcement
more generally.
Meanwhile, the weak monitoring system and the prevalence of personal relations –
“Guanxi” – in governance tend to create some bureaucratic inefficiency and rent-seeking
activities. Based on the recent WBI governance indicators, in certain areas, China’s
scores are actually retreating (figure 4).
Figure 4. China Governance (2000 vs. 2004)
Source: Kaufmann D., A. Kraay, and M. Mastruzzi 2005: Governance Matters IV: Governance Indicators for 1996-2004.
B.1.2. Weak financial system
A healthy financial system is the key to achieving higher productivity of investment and
more balanced growth in China. Though China has conducted major reforms in the
banking sector in recent years, some recent evidence shows that the financial sector is
still not functioning efficiently. One major weakness is that the financial market does not
provide enough investment channels for China’s huge savings, and capital has been
persistently funneled to loss-making state-owned enterprises, and the incremental capital
output ratio is high (table 12). On the other hand, private firms with generally higher
marginal productivity of capital have much difficulty getting access to external credits.
This reflects a lack of sound credit culture such as market-based lending and risk-based
pricing. Most state-owned lending institutions had limited incentives and ability to assess
1995 to less than 150,000 in 2005. Increasing competition and ongoing enterprise
restructuring efforts have led to a better capital structure and performance. About one-
fifth of state industrial companies now have rates of return above 10%. Nonetheless, state
enterprises in the industrial sector compare poorly with private companies in terms of
productivity, and there remains a large tail of enterprises that continue to waste
investment and drain financial resources from the economy. For example, over 35% of
state-owned enterprises are not earning a positive rate of return and one in six have
negative equity.^18
B.2. Education and Skills
B.2.1. Low overall educational attainment
China has made impressive strides in improving the educational attainment of its
population over the last two decades. By 2003, among population aged 6 and above,
51.4% had attained secondary education and 5.5% attained tertiary education.^19 From
1990-2004, the gross enrollment rate for junior secondary level increased from 67-94%;
senior secondary from 22-47%; and tertiary increased from 3.4-19% (table 13).
Table 13. Educational Enrollments and Literacy Rate
Primary (net, %) 93.0 96.3 99.1 98.
Junior Secondary (Gross, %) .. 66.7 88.6 94.
Senior Secondary (Gross, %) .. 21.9 38.2 46.
Tertiary (Gross, %) .. 3.4 12.5 19.
Adult Literacy Rate (population
aged 15 or above, %)
Note: * 1982 figure; ** 1999 figure. *** 2003 figure. Source: China Education Statistic Yearbook 2000, 2004; and MOE: China Education & Human Resource Report – Stride from a Country of Tremendous Population to a Country of Profound Human Resources , Higher Education Press, Beijing, 2003.
(^18) OECD Economic Surveys: China, OECD, 2005. (^19) MOE: China Educational Statistical Yearbook 2005, People’s Education Press, 2005.
However, the overall educational attainment of the population is still low compared to
OECD countries. In 2001, the average years of education of the total labor force was
7.99, and only 4.7% of them had education at the college level or above. In OECD
countries the corresponding figures were 11.67 and 24%. A comparison of the shares of
population that has attained upper secondary or above shows sharp contrast between the
OECD average and China (Figure 5a and Figure 5b). In the agriculture and
manufacturing sectors, only 0.4% and 6.7%, respectively, of the labor forces got college
or above education in 2004.^20
Figure 5a: OECD: percentage of the population that has attained upper secondary or tertiary education (2001)
(^69 60 )
(^24 ) 15 74
27
25-34 35-44 45-54 55-
Age group
%
Upper secondary Tertiary
Figure 5b: China: percentage of the population that has attained upper secondary or tertiary education (2001)
(^1622 9 )
(^6 4 3 ) 0
20
40
60
80
100
25-34 35-44 45-54 55- Age group
%
Upper secondary Tertiary
Note: 1. The upper secondary level includes the population that has attained at least upper secondary education.
- The tertiary level includes three categories of qualifications: tertiary-type A; tertiary-type B and advanced research programs at the doctorate level. Tertiary-type A programs are largely theoretically-based and designed to provide qualifications fro entry to advanced research programs and professions with high skill requirements. Tertiary-type B programs are classified at the same level of competencies as tertiary- type A programs but are more occupationally-oriented and lead to direct labor market access. Source: OECD, Education at a Glance 2003.
B.2.2. Low quality of tertiary education with inadequate relevance to market needs
In recent years, China’s higher education had experienced rapid expansion with the
enrollment ratio increased from 3.4% in 1990 to 19% in 2004, however, it seems
focusing more on quantity rather than quality. In many fields, the courses are still too
(^20) National Bureau of Statistics (NBS) and Ministry of Labor and Social Security (MOLSS) of China, China Labor Statistical Yearbook , China Statistics Press, Beijing, 2005.
