McKinsey Event
Dubai, 2009

Thank you for inviting me to your retreat. I am indeed very honored to be here.

I am with the McKinsey Global Institute, an independent think tank of McKinsey & Company, charged to undertake significant research on global themes of consequence and add to the public debate.

My talk today is about urbanization in China.   We embarked on this study about 2 years ago as it was evident to us that urbanization will affect not only millions of lives in China but will have global impact as well.

I will touch on three topics today: First, I will address where urbanization has been and where it is headed.  Suffice to say that MGI built and leveraged a very granular, bottom-up model and database in order to have the proper fact-base to support our findings.

Second, I will briefly talk about challenges that China will see as its urbanization unfolds, and third, I will try to capture for you a few selected opportunities that are likely to come from China’s urbanization.

The short of the story is that China’s urbanization will be BIG!!  In fact, it has grown no faster than other Asian economies’—but the sheer scale of it all is almost mind-boggling. Over the next 20 years, China will add an entire United States in terms of population—and then some.  China will have 200 cities with greater than 1 million in population. Contrast this with the fact that all of Europe today has only 35.  By 2025, there will be a billion people in China.  The opportunities as well as challenges that will visit upon China and for parties interested in China in a diverse array of sectors will be large.

Let’s take a look at the past.  The chart you see indicates that urbanization has been spectacular in the past.  There was spurt in urbanization over a relatively short time horizon that, frankly the world never saw before. Indeed , there was more than a doubling of the population within 15 years to 572 million people living in urban China.

I want to distract you a little though and tell you about a few interesting discoveries we made along the way. Over the past 24 months, we double checked and cleaned a massive amount of demographic and economic data. As I indicated, we wanted to get a bottom-up view of what was going on in China’s urbanization journey. To date all other studies on China has largely been top-down.  So, what did we find.

First, China has as many definitions as there are cities.  Of course, I exaggerate a little here.  But, there are multiple definitions of an urban area in China.  When we saw maps of what an urban area is we soon realized that most Chinese cities adopted a jurisdictional definition of urban.  In other words, a typical city would include all the areas under its political jurisdiction.  For example, Chongqing, a city in the south-middle of the country, claimed it had over 30 million people and therefore, is the largest city in the world. When we took a look at the map of this city, it was as large as the entire state of Maryland in the US.  It became obvious to us that we needed to force a unified definition of urbanization that looked at demographic density and economic linkages—somewhat like how Manhattan and the suburban area constitute New York City.  When we imposed this new definition, Chongqing was only about 8 million.

Second, we had to move away from the standard population count based on an internal passport system that China has maintained since the 1950s called the Hukou system. China had used this system in the past to control food distribution and rationing and of course, to restrict population movements.  Since 1980, however, after reform began, the rules were relaxed and millions of people moved from one area to another. However, they would still retain their original residency status, or Hukous.  So, of course, when cities reported their population via who was registered to live in a city rather than who actually lived in them, there are obvious errors and these errors got larger and larger. Today, by our estimates, most official data would either over-report or under-report population by as much 30 percent—sometimes differing from actual population by up to 60 percent even.  Shanghai, for example, does not have a mere 13 million people as many official counts have it. Our count is that it has 17 million.

Third, we discovered that there are an additional 195 areas that walk, talk and behaved like cities but were not designated as such.  What happened was that the central government stopped designation of new cities after 1996, because everyone was clamoring to be a city. For the simple reason that there were special privileges that they could get from the central government once designated as cities. For example, having a highway pass through the city. The central government found, however, that a number of areas were doctoring their data in order to qualify.  So, they abruptly stopped the designation process in 1996.  When we applied the same criteria in retrospect, we found that there were 195 areas that could qualify as cities.  We, therefore, included them in the landscape of urbanization.

Fourth, we also discovered that not all of what accounted for the massive increase in urban population in the past was due to migration.  We found out that a huge part of the population increase was due to cities expanding their administrative boundaries and therefore increasing their population.  We’ll come back to this in a while.

I show you now a map of Beijing that provides a clearer look at what we would consider as urban Beijing.  The dark shaded area is by population the densest part of Beijing while the lightly shaded area could be considered the suburban fringe of Beijing—and less dense. The unshaded area that Beijing would officially count into their population is largely rural. We decided not to count those areas.

We come back to what accounted for past population growth.  As you can see from this chart, migration accounted for only one-half of the total population growth from 1990 to 2005.  The rest came from city expansion.  While past migration involving 103 million people is by any measure a large phenomenon, it does not compare with what will happen over the next 20 years when migration will drive almost 70 percent of urban population growth from 2005 to 2025.  Think about it for a moment and you will note that this is startling!  The implication of such a huge migration is that cities in China will, on average, have about 40 to 50 percent of their population being migrants—a huge challenge considering that most migrants today are outside of the social safety net. They are not eligible for education, healthcare and retirement benefits.  The Chinese government knows that it needs to solve for this problem and solve for it quickly if it wants to avoid massive social problems, signs of which are already evident.

So, what will happen in the future?  As this chart indicates, we have broken down cities into categories—from the super large mega cities of greater than 10 million in population each to the smallest cities with populations of less than half a million.  What we found is that the largest populations will concentrate in mega and mid-sized cities.

Of course cities are not static. They grow or contract. Part of the phenomenon you see here is that there is a dynamic upgrading of cities as they grow from one size category to another. Also, new cities will keep appearing, but slower than before.

This next chart shows the same thing, but in terms of numbers of cities.  China will have 8 mega cities by 2025 from the two that they have now––Shanghai and Beijing.

However, of note is that GDP will come mainly from mega and mid–sized cities, the dark shaded bars.  Together they will account for 58 percent of total urban GDP, which in turn will account for about 90 percent of total countrywide GDP by the year 2025.  This has got massive implications in terms of where businesses choose to target their markets, from selling toothpaste to where they build logistical infrastructure to where they can take advantage of investment and construction build opportunities.

But, we found that looking at individual cities to be relatively uninteresting—not irrelevant, just uninteresting.  Let’s take a look at the next chart.

If you view China’s urban opportunities at the individual city level, I feel you will lose the flavor of the opportunities at stake.  When we dug into the data, we found that there is another way to look at China.  There are clusters of cities.  In particular, there are 11 clusters of cities, each of massive scale—each like an entire region or “country” of opportunity. When we peeled back the onion, we also saw that each of these clusters were becoming more and more economically linked, with economic ecologies that were becoming unitary. To give you a sense of proportions, each cluster today has about 20 to 60 million people. By 2025 each will on average have about 60 million each.  The Shanghai cluster alone would have about a 100 million plus in population and be surrounded by about 58 spoke cities.

Indeed, when we talked with several of our clients, we discovered that almost none of them were looking at these clusters.  They were still looking at opportunities within cities or at best, within provinces.  Many of these clusters cut across provinces. The old way of looking at China must necessarily be adjusted.  Strategies will have to be different.

As part of our effort to understand what possibilities are for the future, we decided to look at a few stretch scenarios.  From several visits to cities throughout China, we identified a series of pressure points and costs associated with urbanization. We then asked: “how will they evolve in the future?”

To help us look at these pressure points, we developed 4 alternative scenarios depicting contrasting directions for China’s future urbanization, size and pattern: from mega metropolises to scattered small cities. The reason why we opted for this scenario analysis vs. a simpler GDP sensitivity analysis is that there is indeed an active debate amongst Chinese policy makers– for example, should China favor smaller cities in the West or keep on helping the bigger cities in pulling China’s growth? We felt there was value in providing a fact base of “what-ifs”.  By studying different scenarios, we could derive social, environmental and economic implications for Chinese cities and the associated potential evolution of pressure points that China would face under each scenario.

The top two scenarios you see above are more concentrated forms of urbanization—denser urbanization, if you will.  We call one of them the Super Cities scenario, where super sized cities of 20m plus could develop in 8 cities; in this scenario, 4 cities accelerate rapidly then plateau at 30-40m people.  All other (smaller) cities slow down markedly, with lower population growth and GDP.  The second concentrated scenario is the Hub and Spoke scenario where growth agglomerates into 11 economic clusters of 30-90m people each; over time, the ‘spokes’ in the clusters take over as growth engines from the ‘hubs’; all non-hub and spoke cities experience sharply decelerated population growth.

The bottom two scenarios you see in the chart are what we call dispersed forms of urbanization—more scattered in form.  One of these is the Distributed Growth scenario where China could see several cities of greater that 4m people and very small cites with less than 0.5m in population.  Larger cities decelerate their GDP growth; mid-sized cities would grow 10% above trend, while cities in less developed regions will have an additional 50% boost to their GDP growth.  Finally, there is the very dispersed, Townization scenario, where there will be massive dispersal into small scale towns and cities; cities between 0.3m and 0.8m will experience accelerated GDP growth above trend and almost 300 rural counties will develop into cities under this scenario.  Well, so-what?

What you see, for lack of a better word is a traffic light chart that captures where the pressures will come from under various scenarios.  When we took a step back and looked at our overall findings, it was easy to see that the best outcomes would come from more concentrated scenarios. Indeed, it is imperative for China to move toward that direction.  We don’t mean explicitly Super Cities or Hub and Spoke.  The likelihood is that it would be somewhere in between. By doing so, China will gain, not only in terms of GDP but in many other areas.

China today is headed towards a more dispersed pattern.  We think this could spell trouble.  Moving towards concentrated scenarios will, for example, ameliorate pressures on talent, where bigger cities will be better placed to attract them, funding will be easier because larger cities have significantly larger GDPs to raise funds for urbanization, and there would be less depletion of land.  Energy use would be more efficient even though larger cities would consume more energy.

But concentrated urbanization would not come without a price.  Larger cities will face severe congestion. For example, Shanghai despite all its great efforts will slow down to a crawl by the year 2015.

One thing is for sure though. No matter what scenario China pursues, pollution will be a major problem. The only difference will be the type of pollution. Concentrated scenarios will face severe peak pollution, but distributed urbanization will see significant water pollution.   However, our believe is that despite problems, large cities under concentrated urbanization will be able to tackle the problems more efficiently.

I show you next a few opportunities that are likely to arise from the future urbanization of China.  We looked at several of these including opportunities in energy, intra and inter city transportation, construction and building of residential and commercial infrastructure, roads and highways and water requirement as well as the impact different forms of urbanization could have on pollution.  We do not have time to go through all of them, but I focus on a few, in particular energy, public transportation and construction. I show you the ranges on what you can expect.

Energy demand will double under any scenario, but energy intensity would likely become much better (though still not sustainable), though still not anywhere at the level of today’s developed country standards.

To meet these energy needs, the magnitude of capacity needs will be large. The speed at which this is already taking place is very fast and indicate the seriousness with which the Chinese government is approaching the issue of meeting energy requirements.  Even as China continues to reduce energy utilization, a big opportunity for the provisioning of energy infrastructure remains due to the sheer demands from industry and its burgeoning urban populations.

Also to note is that energy will be a major pressure point as China charts its course into the future.  If not managed well, pollution can become debilitating.

As this next chart shows, mid sized cities will need more energy than any other category of cities. Indeed, this is a recurrent theme of our findings. Mid-sized and mega cities will end up demanding more of everything not only in absolute numbers but in per capita terms as well.

This finding is confirmed by our city visits and interviews where we saw several mid sized and larger cities focused on increasing the resources supply in order to guarantee the avoidance of shortages.  And, for, cities affected by water shortages, especially in the northern regions, there are ambitious plans to build massive water transfer systems.

Turning your attention to public transportation systems, the story even more intense.  Strategic urbanization decisions will indeed shape the future markets in China in the same way that the Eisenhower highway system shaped a generation of income and wealth generating opportunities in the US.

If we move towards denser cities, indicated by the 2025 high in this chart, mass transit will be the key opportunity to manage congestion and provide better service.

At the same time, demand management will need to be in place that would likely reduce the growth potential especially of auto manufacturers.

China will build up to 170 light rail systems and will pave up to 4 Hong Kong’s worth of roads (and, I mean pave every square inch of HK). The potentials, in a nutshell, are going to be huge.

In all of Europe today there are only 70 subway and rail systems. China could add between 85 and 171 in just twenty years.  While the super city scenario will see fewer qualified cities, each city’s requirement will be large—that is, larger cities will require larger system.  These will add between 150, 00 and 400,000 rail cars.

The amount of rail transport needed in the future will be unprecedented.

Interestingly, the central govt decides on which cities qualify by using two main dimensions:  population density and wealth (GDP). They’ve got 4 categories of cities that are classified according to diminishing GDP and population. Within each category either population alone or GDP alone or a combination of both, can dictate whether a city gets approved or not.

What is also happening is that public transportation has been treated as second priority vs. supply of energy or water, therefore there is also a backlog which will need to be “debottlenecked” in the next few years – when the situation will be even worse. The upshot is that the  government knows this and therefore is not wasting time to implement them.

There will be massive road construction  under any scenario. But most of this will be centered in small and mid-sized cities where there is still much to be built. The larger cities are already reaching steady state and increments there will be marginal compared to their smaller cousins.

In building and construction, what has taken place will not compare with what is about to take place. The building boom will continue under any scenario but will be strongest under a hub and spoke scenario where there will be continued population growth even as other scenarios decelerate. Much of the growth will be in high income, low density spoke cities which benefit from the hub cities they surround.

It is important to mention, however, that the building boom could be negatively affected by regulatory steps, e.g., recent stipulation that 70% of apartments need to be less than 90 sq. m. The Chinese government will most definitely intervene whenever there appear any indications of over exuberance.

To put things in proper dimensions for you, China will be adding about a Chicago’s worth of new building every year, where we define new buildings as being above 30 stories each.  Under the more optimistic scenarios, Hub and spoke and super cities, China could add between 3,000 to 5,000 new skyscrapers each year.

Residential construction is likely to concentrate in the mid-sized cities. Again, we observed this taking place in our city visits as well.

Demand for construction materials and machinery will buoy the global markets in these categories for quite some time to come. In fact, by 2015 completed residential floor space will amount to around 450 million square meters or about 40,000 football fields.

The story of urbanization is indeed the story of China over the next 20 years.  There are several silver linings in this progression however there are also significant challenges. How China (and for that matter India) shapes its urbanization will also dictate the constraints on several raw material suppliers around the world. It would be boom time for everyone, but it raises fundamental questions about the environment, pollution and the like.  More significantly, China has the opportunity to shape an urbanization that could be friendly to the rest of the world. Or it could shape an urbanization that could be disastrous for the rest of the world.