Going West: A Progress Report

by Catherine Gelb and Dennis Chen

For the last four years, the PRC government has been touting its Great Western Development Strategy (GWDS), an effort to improve the living standards of the 367 million Chinese, more than one-quarter of China’s population, who live far from prosperous coastal China. The strategy has included massive government funding of new infrastructure, efforts to improve the poor state of the region’s environment, encouragement of local industrial growth based on local resources, development of local high-tech capabilities, and efforts to attract foreign investors.

The admittedly long-term strategy has nevertheless had decidedly mixed results so far from the perspective of the foreign investor looking at the region as a potential investment destination. Infrastructure construction has been significant and in many cases has successfully modernized parts of the region, but transportation costs are still high and transport networks are still unreliable. The environmental awareness of officials, according to foreign investors based there, has improved, at least in major cities, but varies from district to district. Industries based on the region’s rich store of natural resources are growing, as are sectors such as autos, which have a long history in the west, but attention to foreign investors’ needs is uneven. Universities in major western cities, such as Xi’an, Shaanxi, and Chengdu, Sichuan, are established sources for engineering talent across China, but companies are still struggling to find and keep capable, bilingual staff. And although some high-profile, high-tech ventures were announced in 2003, foreign investment flows into western regions are still weak.

The western development story

Over the past two decades, China has gradually opened its economy to market-based commerce and foreign investment. Most of these efforts have focused on eastern China, particularly the coastal provinces. As a result, living standards of coastal residents have risen. But in China’s hinterland, poor infrastructure, a much larger rural population, and firmly entrenched government interests meant that the central government’s economic liberalization policies did not extend to the residents of China’s interior provinces. After many years during which the interior fell further and further behind, the PRC government realized that the imbalance in economic and social development posed a threat to the health of the overall economy and stability of the country and decided it was time to narrow the gap. The government’s solution was the GWDS, covering one province-level municipality and 11 provinces and autonomous regions: Chongqing, Gansu, Guangxi, Guizhou, Inner Mongolia, Ningxia, Qinghai, Shaanxi, Sichuan, Tibet, Xinjiang, and Yunnan.

The overarching goal of the GWDS is to eliminate poverty in the western provinces and significantly reduce the development disparity between the east and the west by the middle of this century. The Tenth Five-Year Plan (FYP, 2001-05) official goals are to

• Invest heavily in infrastructure, from water resources, transportation, and energy to telecom.
• Reverse or at least halt environmental deterioration and prevent pollution in the upper reaches of the Yangzi River and Three Gorges area, as well as along other rivers located in the western provinces.
• Improve the competitiveness of agricultural products, mineral resource projects, tourism, and high-tech industries.
• Raise education levels and improve the quality of human resources.
• Make significant improvements in the infrastructure of provincial capitals and urban facilities of smaller cities and towns.
• Establish a modern corporate system in large and medium-sized state-owned enterprises (SOEs) and significantly reduce the proportion of state capital in these SOEs.
• Significantly raise the western provinces’ proportion of national foreign investment and trade volumes.
• Supply rural residents with adequate food and clothing, ensure that the living standards of urban residents in the interior reach the “well off” (xiao kang) level, and prevent the east-west income gap from widening further.

Separately, the government is maintaining the numerous incentive policies instituted in 2000 to attract investment to the interior. The government apparently hopes that foreign investors will bring not only funds but also exposure to market-based behavior, exposure that might help government officials in the region appreciate the benefits of market-based, as opposed to government-promoted, economic growth.

First, the central government is increasing its budget for investment in key projects in the interior, disbursing more loans from state policy banks, and encouraging lending from international financial organizations and foreign governments for projects in western China. The government will also encourage PRC commercial banks to provide more loans (evaluated on their merits, the government is careful to note) for the construction of infrastructure projects like railways, trunk roads, and energy production and transmission.

Second, the central government is keeping a variety of tax breaks in place. Foreign-invested enterprises (FIEs) in sectors in which the government encourages foreign investment (according to the Catalogue Guiding Foreign Investment in Industry) benefit from a reduced income tax rate of 15 percent for the first three years after any existing tax break ends. With approval from the provincial government, enterprises in ethnic minority areas will be able to enjoy reduced income tax or be exempted altogether. New enterprises in the transportation, electricity, postal service, and radio and television sectors will be exempt from income tax for the first two years of operation and will pay only half of the normal income tax rate for the following three years. An enterprise in the western region that receives investment from an existing FIE will enjoy all preferential policies for FIEs as long as the foreign investment stake in the new company is at least 25 percent. The government also issued the Catalogue of Encouraged Industries for Foreign Investment in Middle and Western Regions of China, which lists encouraged industries in 20 interior provinces and cities. Any FIE in an industry described in the catalogue will be exempt from tariffs and value-added taxes for equipment imported for its own use, as long as the value of the imports remains below the FIE’s total investment amount.

Local governments and development zones also offer their own incentives; these vary from district to district and from project to project.

The strategy in numbers

According to China’s National Bureau of Statistics, from 1999 to 2002, the growth rates of GDP, per capita GDP, and fixed-asset investment in western China were slightly higher than the national rates, indicating that the western provinces are catching up in these areas, if slowly. Between 1999 and 2002, China’s GDP and per capita GDP increased by about 28 and 25 percent respectively, but the growth rates in the western regions are significantly higher than the national ones—about 31 and 30 percent, respectively. Only three western provinces (Gansu, Guangxi, and Yunnan) had growth rates of GDP and per capita GDP below the national growth rate—the rest exceeded the national rate. Of course, these figures must be taken with a grain of salt, as many economists have questioned the reliability of China’s provincial GDP figures.

Even if the GDP and per capita GDP figures accurately reflect the massive infrastructure development that occurred between 1999 and 2002 in western China, this momentum has not translated into a narrowing of the wealth gap between east and west. Urban per capita disposable income in the western region between 1999 and 2002 rose 26 percent, but this figure still lagged behind the national average urban income growth figure of 32 percent. (Rural incomes across the country grew only 12 percent during this period—one reason for the central government’s recent focus on rural areas.)

The foreign direct investment (FDI) figures reflect the difficulties facing central and western local leaders in trying to convince foreign investors to take a chance on China’s hinterland. Despite the incentives in place to lure foreign investment west, the share of China’s total utilized FDI that flowed to western China actually declined in 2002, to 3.8 percent from 4.6 percent in 1999. This downward momentum continued in 2003. According to recent statistics from China’s Ministry of Commerce (MOFCOM), the western regions used $1.72 billion in FDI in 2003, a decline of 14 percent year on year; total FDI used by western regions accounted for only 3 percent of total utilized FDI in China. Gansu, Ningxia, Qinghai, Tibet, and Xinjiang received the least FDI in China in 2003 (Tibet has attracted no FDI in the past several years).

In contrast, foreign investors poured funds into China’s coastal areas. In 2003, the five regions with the largest FDI inflows were Guangdong, Jiangsu, Shandong, Shanghai, and Zhejiang, all located along China’s eastern coast. The total FDI used by these five regions accounted for nearly two-thirds of total utilized FDI in China last year.

A region in flux

To be sure, Chongqing and the western provinces and autonomous regions have some comparative advantages over the coast: a ready supply of educated workers who can be less expensive for some positions and proximity to abundant natural resources and second-tier consumer markets. Companies that are able to take advantage of these features and hold the attention of local officials can probably make a project work in western China.

Indeed FDI, though still a small contributor to overall growth in western China, is increasingly visible in the major western cities, particularly in the high-tech and other industrial development zones. BP plc, Ford Motor Co., and foreign auto parts makers like Tenneco Automotive Inc. and Lear Corp. have set up in western China; Intel Corp. just announced a $375 million chip testing and packaging facility in Chengdu; and Infineon Technologies AG announced it was establishing an integrated circuit design center in Xi’an’s high-tech park. Liberty Mutual Insurance Group also just launched its operation in Chongqing to sell property and casualty insurance. Many of these and other large-scale or high-profile foreign investors that have set up in western China have received the special treatment that comes with being a major local employer. Such strategic investments may yet yield benefits for these companies beyond the goodwill they establish with leaders in Beijing by setting up in a less desirable location.

But the GWDS has so far failed to make progress in many of the areas of greatest importance to investors, both foreign and Chinese.

Transport infrastructure

Despite advances in transport infrastructure, investors in the west acknowledge that transportation still accounts for a larger share of operating costs in the interior than it does on the coast, and that transport links still tend to be unreliable. This may be less of a concern for manufacturers or service providers sourcing from, and selling in, local western markets, but higher-end goods like autos still must travel to the wealthier consumer markets on the coast. Transportation is also a problem for manufacturers who aim to export their products or who must source inputs from the coast or overseas.

Infrastructure improvements may accelerate in the medium term, though, as the Three Gorges Dam becomes fully operational, making inland shipping more efficient. New airports and eventually new air routes could benefit the western region as well.

A thornier issue is the development of efficient multimodal shipping options for inland-based companies. Multimodal transport requires cooperation among ministries and local governments that tend to resist such cooperation. It also requires consolidation of inefficient and protected industries like trucking, which has thousands of tiny fleets scattered around the country.

The environment

The central government’s push to clean up the PRC environment has been espoused by local officials in major western cities. But as in eastern cities, the tendency is to relocate polluting industries outside of the city center—and then forget about them. That is, enforcement of the government’s pollution laws runs headlong into local districts’ desire for the tax revenue and employment that large SOEs in steel, chemicals, and other polluting industries offer. A foreign company that sets up a world-class facility with state-of-the-art wastewater treatment facilities may find that its neighbors are politically protected, polluting SOEs.

Government capabilities

Government officials in the western regions are much less familiar with the workings of a market economy than are their coastal counterparts. The slow or even nonexistent change in the mindsets of many local officials toward foreign investors may be the GWDS’s most noticeable failure thus far.

A recent Asian Development Bank report, PRC: Attracting FDI to Western China notes, “Many local officials are not only not convinced of the benefits of FDI, but are outright suspicious of it and view FDI as a zero-sum game—if the investor is gaining something then China must be losing.”

The central government acknowledged the problem as far back as the 1980s, when it initiated a cadre-swap program in which some cadres from coastal areas were sent to help the interior areas for a couple of years, and officials in the western regions took jobs on the coast. The program has benefited some officials in western China, but the small scale of the program has limited its effect. How to train all the interior officials to be open-minded and forward-thinking is still a challenge for the GWDS.

Some foreign companies in western China praise the local officials with whom they deal as flexible and accommodating. Yet these companies tend to be the larger investors with the most tax revenue and employment prospects to offer local economies. Smaller foreign investors, or those without plans to expand their investment anytime soon, may suffer from the short-term focus of local government officials and their preoccupation with the largest taxpayers.

This short-sightedness has translated into a relatively weak set of investment incentives on offer for foreign investors in western China beyond the national incentives offered to all foreign investors. Land costs remain relatively high, for example, and the focus is mainly on tax breaks rather than on providing services that meet investors’ needs. Officials in some of western China’s high-tech development zones and investment promotion bureaus appear to be showing greater flexibility toward potential investors, though they are only just learning about the full range of services they must offer investors to win their business.

The central government’s plans to unify domestic and foreign corporate income tax treatment, moreover, could spell the end of the practice of offering special tax breaks to foreign investors. This makes the quality of government actions—from streamlining approval procedures to adopting policies that promote competition—all the more important.

Human resources

In western China, most colleges and universities are located in Sichuan and Shaanxi provinces, specifically in Chengdu and Xi’an. But many graduates seek jobs in Beijing, Shanghai, and other big coastal cities. At the same time, secondary education in the western regions has not yet adapted to meet the market’s demands for skilled workers. The result is that the qualified managers or technicians willing to work in western China are in high demand among foreign investors, and problems with retention can be just as intense as on the coast. Training demands are also significant both for high- and low-skilled workers. And human resource issues can take up much of a foreign investor’s time. Thus, though labor costs may be lower for some foreign firms in the interior, many others find few labor cost savings overall.

For expatriates, a western China position can be a significant hardship, particularly because of the lack of support services, such as international schools and expatriate-friendly healthcare facilities. This is starting to change, however, in the bigger western provincial capitals.

Slow and steady?

The GWDS is neither the first nor the last of the PRC government’s efforts to direct economic and commercial development. Past efforts—even the government’s first foray into “opening” China to commerce in 1980, the Shenzhen Special Economic Zone—have met with similarly lukewarm initial responses from investors until commercial circumstances made the investment location a compelling one or until the government sweetened the incentive pot to make the new location more attractive.

The interior may yet, over the long term, come to benefit from the coast’s success. For one thing, production costs on the coast are starting to rise, driving many manufacturers out of the major cities. Progress in infrastructure development, too, should improve transport and communication links, power sources, and other key support networks. And consumer markets in second-tier cities around China are becoming more appealing—and more accessible—to foreign companies as World Trade Organization commitments are phased in. In the short term, the income gap may remain wide, however. And the development of “softer” skills among the employment pool and bureaucracy may take time. The key may well be sustained government financial support for concrete efforts to improve the interior’s investment environment.

But the Chinese government is saddled with many other, arguably more urgent priorities—reforming the financial sector and shoring up the nation’s frail social safety net are among the most pressing—and it is unclear whether the government’s commitment to western development will remain firm as reform of these and other weak sections of the economy intensifies (though an early 2004 plan to train farmers for off-farm jobs is encouraging).

Meanwhile, in late 2003, the Chinese government launched yet another regional development effort, this one to “Revive the Northeast,” China’s rust belt, which is suffering from severe unemployment and rising social discontent. Government efforts to lure foreign investors to this troubled region may come at the expense of western China, especially because of the essential role of government funding in these projects and campaigns. The government’s exhortations to investors to “Go West,” then, if not backed by more substantial incentives and measurable improvement in the commercial environment, will not be enough to jumpstart western China’s market for foreign goods and services.

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Western High-Tech Zones

One example of the central government’s effort to develop the west—the establishment of high-tech development zones in major cities—points out how far western officials have come, but also how much farther they must travel to catch up to their counterparts on the coast. The high-tech zones in Xi’an, Shaanxi, and Chengdu, Sichuan, for example, have both recently won major investments from foreign semiconductor manufacturers, but much of the foreign investment participation in these zones is in technology that is far from cutting-edge. The size of most investments has been relatively modest. And the number of foreign-invested enterprises (FIEs) within the zones remains far smaller than the number of Chinese entities.

The Yangling State Demonstration Zone of Agricultural High-Tech Industries

Yangling lies in the middle of the Guanzhong Plain in Shaanxi, 82 km from the provincial capital of Xi’an. The high-tech zone was established in 1997 in part to take advantage of the high concentration of academic resources in the area, including several agricultural universities and research institutes, which together employ about 5,000 research staff.

Yangling’s “mission,” according to zone officials, is to put agriculture-related scientific and technological resources to industrial use and to advance sustainable development of arid and semi-arid areas to help restructure the local agricultural sector and raise farmers’ incomes. The overarching goal appears to be to create a self-sustaining local agricultural economy in western China.

The zone may well be more interested in this mission than in fashioning itself as an ideal location for foreign agriculture-related investment. Though officials are extremely helpful, and the zone offers the increasingly ubiquitous “one-stop shop” for investors, the large growth in output that the zone has achieved has been accomplished with little foreign involvement. Examples of foreign participation in the zone include Israeli technology at one Chinese-run firm that manufactures specialized sprinkler systems and imported American seedlings cultivated by one zone enterprise that works to aid reforestation efforts across China.

Yangling is busy experimenting with new ideas and business models. One of these, called “Company + Experts + Farmers,” has been used successfully by some local companies. Under this model, a company engaged in the raising of livestock hires experts to provide advice on scientific methods and also lends baby livestock to interested farmers to raise at the farmers’ own barns. The farmers must follow the experts’ instructions on how to raise the livestock. Once the livestock mature, the company takes them back and pays the farmers for “babysitting.” This model seems to keep everyone happy, as the company can cut its overhead costs because it does not need to pay for any animal maintenance, the farmers don’t need to worry about whether they can afford to buy their own stock and whether they can sell the adult livestock later for a good price, and the experts are paid for their expertise.

Enterprise and zone performance

• The zone is home to 600 enterprises with total registered capital of ¥3.5 billion ($423 million). Of these, 15 are FIEs.
• Nineteen enterprises in the zone had registered capital of more than ¥50 million ($6.04 million) each in 2002; 18 enterprises had annual revenue of more than ¥10 million ($1.21 million).
• The zone’s output has increased by around 20 percent on average per year, from ¥309 million ($37.4 million) in 1997 to ¥805 million ($73.6 million) in 2002. By the end of 2002, zone exports reached $15 million.

Selected preferential policies

Yangling offers the national-level incentives for high-tech zones as well as a number of others, including

• An enterprise development fund, which will be used to subsidize FIEs in the zone for any income tax that exceeds 10 percent of their revenue after their first profitable year.
• A 20 percent business tax refund until 2005 for tourism and information consulting enterprises in the zone that have paid more than ¥500,000 ($60,386) in business tax a year.
• Exemption from business tax for company or individual income obtained from technology transfer, technology development, or services.
• Exemption from land-use tax for land used for agriculture, forestry, stockbreeding, and fishing.

Contact information

Ms. Tang Limei
Officer, Foreign Affairs Office
Yangling Agriculture Demonstration Zone
Tel: 86-29-8703-3981
Fax: 86-29-8703-6061
E-mail: [email protected]
Website: www.ylagri.gov.cn

Xi’an High-Tech Industry Development Zone

Xi’an High-Tech Industry Development Zone (XHIDZ) was founded in May 1988 and was approved by the State Council in March 1991 as a national-level zone. XHIDZ is located in the southern suburb of Xi’an, home to numerous academic and research institutions. The zone, which has plans to double in size, is divided into sub-zones focusing on aviation science and technology, telecom, software, and startups by returned overseas Chinese, among others.

XHIDZ officials are keenly aware that they have tough competition for foreign investment. During a recent visit, they were open about the fact that Intel Corp. had chosen the Chengdu High-Tech Zone for its facility in western China. But they were proud of the Infineon Technologies AG project they had won and asserted that it was a better project, because it was bringing more sophisticated technology into China.

Some Chinese-run enterprises in the zone that have received foreign investment include Kaimi Co., Ltd., an environmentally friendly detergent manufacturer that also produces shower gels and other cosmetic soap products and that has started to export to Japan and South Korea (also the source of some of Kaimi’s initial investment). And Xi’an Kong Hong Information Technology Ltd., an electronics enterprise that produces piezoelectric ionizers for air purification and piezoelectric ceramic transformers for use in consumer electronics, reports that it has received investment from the International Finance Corp. and the Carlyle Group. The patented technology Kong Hong uses was developed at Qinghua University in Beijing.

Zone performance

• By the end of 2002, the zone had invested ¥14.75 billion ($1.78 billion) in infrastructure.
• In 2002, revenue rose by a quarter, to ¥48.1 billion ($5.8 billion) and GDP reached ¥11.9 billion ($242 million), a 22.2 percent growth rate.
• The zone was home to 4,991 enterprises in 2002, of which 541 were foreign-invested.
• The top five foreign investment sources were Hong Kong (35 percent), the United States (24 percent), Taiwan (9 percent), the United Kingdom (9 percent), and Japan (6 percent).
• Leading foreign investors include Honeywell, NEC Corp., Fujitsu, Toyota Motor Corp., Dakin, Brother Industries, Ltd., Royal Philips Electronics NV, Robert Bosch GmbH, and Shangri-La Hotels and Resorts.
• Infineon Technologies announced in 2003 that it would set up an integrated circuit design center in the zone.

Selected preferential policies

In addition to central-government policies common to all high-tech zones, XHIDZ offers a number of other incentives, including

• An intellectual property rights fund to support patent, trademark, and copyright registration both domestically and abroad.
• A one-time award of ¥500,000 ($60,386) for the establishment of a research and development center in the zone by one of the 500 largest enterprises in the world or top 10 enterprises global industry leaders.
• For investors in certain industries and at certain funding levels, preferential land prices. (Investors that commit more than $100 million to the zone can obtain land for free.)
• Loan facilitation for small and medium-sized enterprises.

Contact Information

Mr. Lu Dongguo
Director, Investment Promotion Bureau
Xi’an High-Tech Industry Development Zone
Tel: 86-29-8833-3797
Fax: 86-29-8833-3606
Website: www.xdz.com.cn

Chengdu High-Tech Industry Development Zone

The Chengdu High-tech Industry Development Zone (CHIDZ) was established in 1991, like its fellow zones, to take advantage of the local educational resources, in this case those of Sichuan’s capital. The zone received little support from the central government until the launch of the Great Western Development Strategy (GWDS)—yet the central government allowed all the national-level zones to offer the same incentives. The zone then had to distinguish itself from its rivals around western China.

Covering 67 km2, the southern two-thirds of the zone consists of an R&D and business area, while the western section (about 20 km2) is a manufacturing base, mainly for information technology (IT) and modern Chinese pharmaceutical industries. Most of the companies in CHIDZ are in the IT and biomedical sectors. The zone has an incubator with 289 enterprises and “startup parks” for returned overseas Chinese and PhD holders. By 2002, 313 Chinese returnees and doctorate holders had launched 100 startup companies in the two parks. The first state-level export-processing zone in western China was set up in CHIDZ in 2000.

When asked what challenges the zone enterprises faced, officials noted that transportation infrastructure—distance from major markets—was a competitive disadvantage. But they added that many companies in the zone benefit from its relatively transparent services. Once the companies grow, they want to branch out, but often find it hard to get used to the “conservative mentality” of officials outside the zone.

Interestingly, the zone officials tout the leanness of their management (like several of its counterparts, CHIDZ provides a “one-stop shop” investors) and show flexibility that is not considered common among western PRC government officials. But paradoxically, they exhibit a minimal understanding of the kind of outreach necessary to lure foreign companies west, even as they express interest in marketing themselves to foreign investors.

Zone performance

• CHIDZ had attracted 4,200 enterprises with more than $1.4 billion in investment from foreign investors by the end of 2002, including Motorola Inc., Sumitomo Corp., Mitsubishi Corp., Corning Inc., and Compagnie Financiere Alcatel.
• At the end of 2002, the zone had 480 FIEs. In 2002 alone, 51 FIEs signed contracts and 15 actually set up operations in the zone. In 2003, the zone won Intel Corp.’s coveted $375 million semiconductor packaging and assembly project, reportedly the largest foreign investment project in western China, over Xi’an, Shenzhen, and Shanghai.
• Before the GWDS, the zone took in $30 million in foreign direct investment (FDI) per year. In the years since then, the zone has taken in $60 million—by mid-2003, the zone had contracted $50 million in FDI.
• In 2002, the zone’s value-added industrial output reached ¥16.8 billion ($2.03 billion), up 25 percent, and total revenue was ¥47.2 billion ($5.7 billion), an increase of 27 percent. CHIDZ was tenth in total output in 2002 out of 53 national high-tech zones.
• CHIDZ is the first high-tech zone in western China to have passed ISO 14001 and UKAS certifications.

Preferential policies

• Commercial banks in the zone are encouraged to give priority consideration to enterprises in the zone when providing loans.
• In 2003, the zone waived its application fee.
• The zone will cover or subsidize land-use fees for foreign companies that invest above certain levels and in certain sectors.
• According to zone officials, in addition to the preferential policies posted on the website, other preferential treatment can be discussed on a project-by-project basis.

Contact information

Mr. Li Gang
Division Chief, Foreign Investment Promotion Bureau
Chengdu High-Tech Industry Development Zone
Tel: 86-28-8517-8684
Fax: 86-28-8517-6329
Web: www.cdht.gov.cn

— Dennis Chen and Catherine Gelb[/box]

[author]Catherine Gelb is editor of CBR and Dennis Chen is government affairs manager at the US-China Business Council in Beijing.[/author]