The Development of China's Service Sector

Speech by Craig Allen, Senior Commercial Officer, U.S. Embassy Beijing

Posted on Feb 4, 2005

It is a great pleasure to share a few thoughts about the development of China’s service sector.

According to official Chinese statistics, the service sector in China is remarkably small – only approximately one-third of GDP. Moreover, the Chinese service sector is growing at 8.5 percent – slower than the economy as a whole.

In contrast, services account for approximately 80 percent of the U.S. economy and the sector is responsible for virtually all of America’s growth. A multi-decade transition towards a services based economy in the U.S. has fostered great advances in employment, technology, efficiency and new capital formation.

The relatively modest statistical stature of services in the Chinese economy is due to a number of factors. Perhaps most importantly, the construction industry in China is placed in the rather more prestigious “industrial” category and is not considered part of the service sector.

In addition to classifications, China, along with every other major economy suffers from statistical problems associated with counting service activity. Indeed, economists and statisticians from the United Sates and China are currently working on a joint study on how to better measure the economic contribution of the service industries.

But, it is probably true that services have historically been undervalued in China. In classical China, merchants and other service providers did not enjoy a high social status. In the post liberation era, it is reasonable to suggest that the social status of merchants and many other types of private sector service providers fell to even deeper lows. As recently as fifteen years ago, believe it or not, it was very difficult to find a private restaurant in Beijing.

Since the process of reform began in 1979, China’s service industries have made great strides and we can expect even greater growth in the near term as China fully implements its WTO General Agreement on Trade in Services commitments.

2005 could be seen as the start of a Golden Age for the Chinese service sector. This is because there are three great trends in China’s service sector today that should give us hope for a bright future in the years ahead. These three mega trends in China’s service industry are privatization, internationalization and deregulation.

The quality of growth in the domestic service sector will depend largely on China’s ability to effectively manage these trends - in view of its WTO commitments and referencing regulatory best practices developed in other parts of the world.

First, China has made tremendous progress on the privatization of the service sector. By any measure, this has been a spectacular success – as Ministries have spun-off service suppliers and a raging free market economy shapes the very dynamic contours of most service industries. Privatization is the key to market competition in any sector – forcing each supplier to offer products that are a bit better, a bit quicker or a bit cheaper.

Industries are thriving – to the extent they have been privatized. For example, government entities were just recently told to divest them selves of real estate interests – and this sector is of course booming. Some analysts suggest that up to 50 percent of global construction of residential housing will take place in China in the near term.

Growth is significantly slower in the industries where privatization has been only partial or significantly delayed – such a railroads and utilities. All railroads in China remain part of a Ministry and all railroad workers are public servants. Almost all utilities are State Owned Enterprises.

Is there perhaps a correlation between insufficient private sector investment in these sectors and the current shortage of power and transportation? Perhaps these would be fruitful areas for more rapid privatization.

The second trend in many service industries in China is internationalization. Indeed, there is no finer example of internationalization than this very conference and there is no finer proponent of internationalization in China than our hosts – CCPIT. Please allow me to take one second to salute CCPIT in its efforts to integrate China into the global economy and encourage foreign companies to contribute to China’s economic development.

The World Bank characterizes internationalization of the services – or trade in services – as: cross border supply, consumption abroad, commercial presence and movement of individuals. It is patently obvious that China has made great progress in each of these modes – in most industries. There can be no doubt that China is benefiting hugely from both expanded imports and exports of services.

But, there are some industries where trade in services is either one-way only or conspicuously absent, such as telecommunications services and construction, engineering and design. In each of these cases, it is unfortunate that domestic suppliers – often closely tied with the domestic regulator – are reluctant to welcome foreign participation in quickly expanding markets. As a result, we should expect these markets to grow slowly and service consumers to pay more for lower quality services.

The third trend in China’s service industry development is de-regulation or liberalization. Now, one could easily pity China’s poor regulators. It is difficult to regulate an economy that is growing at nearly 10 percent a year. As soon as the regulators think that they have the necessary data and understand the problem that they are trying to address, then, the problem has probably changed. This economy is extremely dynamic and thus hard to regulate.

Regulatory practice in China is indeed a complex subject and Chinese government entities, at every level, have a great many tools at their disposal. It was the ancient Chinese who invented bureaucracy and modern Chinese government workers are extremely capable. According to the State Council, in addition to normal laws, Chinese regulators have no less than 13 types of official regulatory documents to communicate their intentions. These include:

• Ming ling or orders;
• Jue ding or decisions;
• Gong gao or public announcement;
• Tong gao or public notice;
• Tong zhi or circular;
• Tong bao or notification;
• Yi an or bills;
• Bao gao or reports;
• Qing shi or requests;
• Pi fu or official replies;
• Yi jian or official comment;
• Han or official letters; and
• Hui yi ji yao or summary of meetings.

As a public official myself, I cannot help but admire this vast armory of regulatory documents. And these are just terms used by the State Council, they don’t include the types of laws or responses of the National People’s Congress, courts, procuratorate or local governments.

But, the unsuspecting businessperson can easily be caught unaware by sudden regulatory change. The proliferation of government tools increases regulatory risk and increases uncertainties and the cost to business. Of course, these regulatory procedures are not necessarily designed to disproportionately effect foreign businesses; indeed, there is no doubt that private domestic suppliers are the greatest victims of excessive regulatory zeal.

Fortunately, the World Trade Organization’s General Agreement on Trade in Services (or GATS) offers a convenient framework to evaluate China’s regulatory progress in this area. China’s WTO accession agreement requires China to eliminate market access and national treatment limitations in a variety of service sectors – some to be phased out over several years. In some cases, these commitments require China to permit foreign ownership in sectors that were previously off limits or greatly restricted. China also committed to some basic regulatory disciplines in accordance with the GATS.

At the same time, China retains some freedom in the domestic regulatory process. How China uses this freedom will determine whether or not services will be able to contribute to economic growth, employment and better income distribution across this vast country.

Fortunately, there are a few key principles of good regulatory behavior that could be followed to realize the potential of the service sector. The degree to which Chinese regulators are able to implement these principles will play a great role in determining the economic health of the Chinese economy in the years ahead. These principles are: efficiency, effectiveness, transparency, clarity and equity.

Efficiency criteria would argue that China should adopt and maintain only regulations for which the costs on society are justified by the benefits to society, and that achieve objectives at the lowest cost possible.

Effectiveness criteria suggest that regulation should be designed to achieve a specific policy outcome – not favor one supplier or technology over another.

Transparency criteria demand that the regulation making process should be transparent and open to both the decision makers and those affected by the regulation.

Clarity criteria suggest that the regulatory process and requirements should be as understandable and accessible as practical.

Finally, equity criteria suggest that regulatory enforcement should be fair and treat those affected equally.

Viewed by these principles, China and many other countries, face a tremendous challenge in following good regulatory practice in the years ahead.

It is in both China and America’s economic interest for foreign trade diplomats to point out when China may have deviated substantially from these ideals and/or its WTO commitments in the service sectors. So, we will not be shy when American interests are disproportionately hurt by poor regulation – especially that which may compromise WTO obligations.

Let me please point out two policy areas, of special interest to the exhibition industry, where we feel policy improvements would be extremely beneficial.

First, China has not yet published the implementing regulations for its new distribution laws. This WTO commitment was scheduled for December 11, 2004. Thus, at present, foreign companies are not being allowed to apply for business licenses to distribute their products throughout China in the manner that was anticipated. We hope that these detailed implementing regulations will be published in the near future. This will encourage foreign firms to participate in Chinese exhibitions.

In a related matter, the further opening of distribution and logistics service industries represents a significant opportunity for China to remove costs and introduce novel technologies to maximize supply chain effectiveness. In general, logistics costs in China – as a percentage of total sales – are twice as high as the United States. Privatization, internationalization and deregulation will bring these costs down.

Second, an even bigger concern is intellectual property right protection. Under the WTO, China is committed to offering its trading partners effective intellectual property protection. While this issue is enormously complex, it is clear that one of the biggest inhibitors of the internationalization of the Chinese exhibition industry is the fear of intellectual property theft. Foreign companies are deeply worried about their trademarks, patents and copyrights and fear that they may risk all by exhibiting in China. China cannot become an international trade show hub without addressing IPR problems.

Recently, the Peoples’ Supreme Court of Chinese issued a judicial interpretation that should facilitate criminal convictions of IPR violations. But, it remains to be seen how the Police and Prosecutors will utilize these new regulations in specific cases.

Perhaps there is no bigger issue than IPR in the development China’s service industries. It is hard to see how private Chinese companies can successfully develop global brands if trademark protection is lacking at home. It is hard to see how global Chinese competitors can develop in the movie, publishing or software industry if they are under constant attack by pirates in their home market.

Clearly, it is in China’s own long-term economic interest to come to grips with this problem at the earliest possible opportunity.

From the perspective of the trade show industry, one important contribution to the central government’s crackdown on IPR violations would be vigorous prohibitions on the display of pirated products. Many show organizers have been very cooperative in this regard. But, more could be accomplished to ensure that Chinese exhibitions become known as “IPR violation-free” zones.

But, in general I am extremely bullish on the service trade and I expect that these problems will gradually be addressed over time. Already both China and China’s trading partners have made great progress and reaped huge benefits from liberalization of services. And, I have no doubts that my colleagues from other countries would agree with this upbeat assessment.

Internationalization, privatization and de-regulation of the service sector are mega trends in which all of the participating parties benefit and any adjustment costs are short term and marginal.

So, I very much hope that this conference is successful in its aim of encouraging cooperation between the Chinese trade show organizers and foreign companies.

If these general goals are met, I can see no reason why Beijing or Shanghai could not become one of the most important hubs of the global trade show industry. China has all of the ancillary features for a good trade show destination: dynamic markets, hospitality, culture, history and great people.

In fact, we within the U.S. Embassy feel so strongly about the potential for trade shows in China that we are making a commitment to be much more actively involved in key events in 2005, 2006 and beyond. Because China is one of the top markets for our businesses, we are planning for construction of American Pavilions at over 25 exhibitions this year. This is a long-term commitment, one where we want to work side-by-side with CCPIT, Chinese and American trade show organizers and other Embassy colleagues.

We have many good reasons to work together over the next few days to expand cooperation – a process that will promote mutual prosperity for the longer term.

I wish this trade show and conference every possible success.