McKinsey China Urban Institute Workshop
Columbia University, New York, USA, December 2013

Ladies and gentlemen, I am honored to have the opportunity to make these opening remarks for the session today.

I love this topic.  Mainly because for every solution you think you have come up with, other problems keep coming up.

I love it because it is such a dynamic part of economic evolution.

My exposure to the topic came about first in a major research undertaking that Jonathan Woetzel and I were intimately involved.

It resulted in the McKinsey Global Institute’s “China’s Urban Billion” report published in 2008.  I became fascinated by the topic and when I joined the World Bank Group, I put much energy toward ensuring that our client states took the issues surrounding urbanization seriously.

And I began scaling up activities within the World Bank to help clients innovate urban policies.

I felt that the issues countries face in urbanization needed to be at the forefront of the Development Institution’s poverty alleviation mission, …and not as an after thought.

If a good 70% of the world’s population is to live in urban centers by 2050, urbanization must translate to more equitable income distribution and wealth creation opportunities for all.

I am now a member of the WEF’s Council on Competitiveness where we are looking into issues influencing the Competitiveness of Cities, …yet another important facet cities need to take heed.

How does one prevent the vicious cycle of rapid decay that cities can easily fall into if they are just not competitive enough?

The topic today is specific to China. And, there is a need to expand our understanding of the challenges the country faces in continuing to rapidly urbanize.

According to the UNDP, China’s urban population is forecast to grow by an additional 310 million people to 70% of its total population by 2030 and generate 75 per cent of its Gross Domestic Product.

By that point, over one billion Chinese people will live in cities.

And let alone its future urbanization, we can also learn a thing or two about what China has already completed in the short span of about 30 years.

I mean learn from both her successes and failures.

We all know that the recently concluded Third Plenum addressed urbanization as one of the key elements for China’s future economic growth.

The Third Plenum, I believe, puts China’s urbanization at a crossroads.

The crossroad is not where it heads next, but how and in what shape.

This means the debate itself needs to go to the next level.  There is a competition and burgeoning of ideas in this space and …in my tenure at the World Bank I saw numerous organizations all trying to innovate around complex problems.  That is very good thing for all of us.

The Chinese government has also been unabashed about looking for answers.  We know that they are perhaps one of the most adept of countries to pilot initiatives and aggressively implement them.

As I recall, Chongqing, Tianjin, Suzhou and several others all piloted various aspects of urbanization.  We know that China is keen to learn from experiences of other countries—in what to do and what not to do.  All that is, again, good.

But I would contend that the debates of the last few years are done.   There’s no point talking any more about integrating the hukou population, or introducing property taxes, or making ‘green’ cities, or using land-use right exchanges to fund individual migration or local investment.

That’s all agreed, and whether or not to do those things – and even come up with the rough outlines of ‘how’ – were the easy questions.

There are much harder questions that need to be addressed.

To complement the critical agenda you have today that looks at physical infrastructure, healthcare, energy, or IT, all of which involve hard questions, I’d like to also flesh out the hard macroeconomic, political economy type of questions, because they will impact almost every facet of China’s future urbanization agenda.

And I do hope they would be beneficial to you to at least keep in mind.

In particular, I have four categories of these hard questions that could potentially influence China’s urbanization in major ways.  These are:

first, getting the credit issue in order;

second, addressing the jobs challenge for migrants,

third, asking what type of industrial structure to have in the face of a transforming global productive sector, and,

fourth, addressing the change in incentives required to fuel the next spurt in urbanization.

These categories also potentially cut across the spectrum of China’s political economy, its social fabric, and the competitiveness of its cities.

I will be quick with these for the simple reason that I do not have the answers for these questions.  All I’d like to do is to paint a broader picture to you by posing them.

Let me address the credit issue first. 

China has a mountain of debt among local governments stemming from the unprecedented infrastructure investments they made over the past 15 years or so.

Cities depended also on land sales to finance their urbanization, a resource that is now depleting as we speak and which the Chinese government has acknowledged as unsustainable.

Tier 1 cities don’t face the same issue because of the scale and political powers they have to garner sufficient capital for their requirements under today’s financing system.

But many of the tier 2 cities face them.   So, my question as you debate issues at today’s roundtable is as follows:

Given that it will take years to make all the pronouncements coming from the third plenum happen, how does China in the meanwhile create the necessary breathing space for its cities, given the mountains of debt and over-capacity they all have, …and do so without either igniting massive social unrest or sabotaging the transition to a new economic model? 

From another angle, what I ask here is how China can avoid a credit crisis derailing all these nice reforms before they even begin?

The answer to this lies in the domain of how China can realistically pace its reforms.

Otherwise, policy makers can easily run into the issue of putting the proverbial ‘cart before the horse’, as it were.

The second question I have deals with jobs and it is related to credit issue as well.

The issue of migrants and creating jobs for them is not well thought-out yet. I dealt with this at the Bank and it is a complex struggle and the solutions and policies proposed thus far have been somewhat simplistic. Just saying, “retrain the migrants” for those cities evolving to new economic platforms or “they’ll get jobs somewhere else” just doesn’t cut it.

And on top of this there is the financing puzzle I just talked about.

So, the question here is how do Chinese cities square the financing puzzle in a way that does not throw loads of migrants out of work, before they’ve even had a chance to become integrated? 

In other words, what jobs, and how do you create enough of them?  If the jobs don’t come, how does China phase in the changes? 

And if there is really no way to do it seamlessly, if the transition means some people have to accept loss, how does one deal with the politics, in a way that doesn’t overturn the spirit of reform?

Third, and this is related to the first and second questions as well, deals with changes in the global industrial structure.

There are massive changes taking place.  I foresee as other economists do, that the US is likely to see a re-emergence of its manufacturing sector as the advent of cheap oil and gas visits our shores, 3D manufacturing, the convergence of labor cost, etc.  This will impact China too.

At the same time all the old Marshallian externalities are being scrambled by innovations in supply chain management and knowledge sharing in large MNCs.

The Guangdong model is unsustainable.  The Chongqing model relied on massive Foxconn type factories – and those are dying, being automated as quickly as a spitfire and starved of skilled workers.

So if the large labor force, semi-skilled manufacturing disappears, what’s next?  

How are Chinese cities supposed to deal with the radical changes happening now in the global industrial structure?  And, by the way the argument that “services” could do it just doesn’t do it for me at least. 

What kind of services, what mix of traded vs. non-traded services, and services provided to whom? 

Fourth, and this is my final question, concerns incentives.

It’s fantastic that the Plenum said GDP wouldn’t dominate anymore.

But the entire performance appraisal system has been predicated on that unitary goal.

What happens now when mayor A has 5% GDP growth with better financial structures and mayor B has 3% GDP growth?

How do you know the first guy isn’t just cutting investment, and in three years the second mayor will turn out to have been better?  And that’s a simple trade-off.

What if Mayor A has a green city, and Mayor B has a migrant-friendly and fiscally sustainable city?  Who do you promote? 

How should China’s leaders really be tweaking the monitoring and evaluation of its officials?

By posing these questions, I don’t mean to be an instigator for, or cynic of China’s urbanization ambitions.

The point I am trying to make is that it takes an entire ecology functioning well to create a balanced and successful urban environment.

And you have effectively one chance at getting it right.

Just to add one more complication.  What is the quality of life equation that China wants to establish?

For example, the productivity of logistics and moving things around from pt. A to pt. B, as Jonathan mentioned in an interview, lags that in the US by two times.

In a sense, it costs twice as much.

How do you increase productivity, and raise the quality of life and ensure a sustainable environment—all at the same time.

In our work at the WEF’s Competitiveness Council, it is precisely because of the overlaps of nearly everything to quality of life …that we have tried to look at those issues in new ways.

Not as an important input factor for urbanization, but as a desired outcome as well.

In this regard, the country’s leadership has adopted the concept of an ecological Civilization.

Premier Li Keqiang stated in March 2013 that the new model of urbanization should be human-centered and should ensure the prosperity of the people.

That is a great start.

All of these questions I have posed need to be answered drawing on China’s real existing and institutional strengths, …the way its mayors talk to each other, …its dense networks of local research institutes, …its performance management system, and so on.

They give China the kind of momentum that few countries can boast.

An overarching question would thus be: what are the institutional tune-ups, and the granular institutional changes, needed so that China can actually deliver on this colossal task which is perhaps the most ambitious economic reform program in history?

Thanks for the invitation.