Abstract: Agglomeration of economic activities is a common phenomenon across the world. Theoretical and empirical studies have shown that agglomeration promotes dynamic efficiency, which in turn is conducive to the long-term prosperity of a country’s economy. Compared with most countries, the spatial concentration of various industries in China is very low, and Chinese cities are relatively small and equal-sized. Thus, it is unnecessary to contain the agglomeration of economic activities in China. Widening regional gaps since pro-market reforms and opening-up in China should be ascribed to institutional barriers rather than agglomeration. Therefore, China should refrain from containing agglomeration and instead focus on integrating product and factor markets and improving education and health care in less developed areas.
Key words: agglomeration, growth, New Economic Geography, regional disparities
JEL: O18, R11, R58
1. Introduction
Agglomeration is an important reality of modern economic growth. On the temporal dimension, economic output grows continuously (P. Romer, 1986). On the spatial dimension, economic activities increasingly concentrate in fewer regions (P. Krugman, 1991a). Research by mainstream economists on the temporal dimension has long been carried out, but research on the spatial dimension did not begin until the early 1990’s. In fact, agglomeration is very common and can be observed from multiple levels.
At the global level, since the 1980s, the North American Free Trade Agreement (NAFTA), the 27 European Union (EU) member states and East Asia have accounted for more than 70 percent of total world output.1 At the national level, developed countries such as the United States and Japan have shown a clear tendency of agglomeration. Take Japan for instance. In 2001, the three urban economic circles that only accounted for 10.4 percent of Japan’s land area (Tokyo Rim, Nagoya Rim and Hanshin Rim) were home to 48.6 percent of Japan’s population, 66.2 percent of Japan’s GDP, and 68.9 percent of Japan’s industrial output (Liu Guiqing, 2006).
On the other hand, according to our calculation, as the world’s largest developing country China has also seen an increasing degree of agglomeration over the past 30 years since pro-market reforms and opening-up. Take the Herfindahl-Hirschman Index (HHI) of inter-provincial industrial output of mainland China for example; in 1978, the HHI for 31 provinces, municipalities and autonomous regions of mainland China (excluding Taiwan, Hong Kong and Macau) was 557.31. In 2009, this index increased to 729.44, up 30.89 percent.2 Jiangsu province, Zhejiang province and Shanghai municipality account for less than 3 percent of China’s land area; however, these three areas produced 22.14 percent of industrial output, contributed 40.87 percent to exports and 43.06 percent to imports, and created 21.29 percent of the GDP of mainland China. These facts show that agglomeration is a common phenomenon in world economic development. It is present not only at the global level but also at the regional level among major world economies.
However, since the pro-market reforms and opening-up of mainland China, agglomeration has been accompanied by a significant expansion of regional disparities. This experience started since the early 1990’s and has become a major cause of the increasing household income gaps in China (Chen Xiushan and Xu Ying, 2004; Guan Weihua, et al., 2006; Wan, G. et al., 2007; Wan Guanghua et al., 2005; Wang Xiaolu and Fan gang, 2004; Wei Houkai and Sun Chengping, 2004; Xu Zhaoyuan and Li Shantong, 2006; etc).3 Entering the 21st century, China’s central government launched a series of regional development strategies. Such strategies include settlement of the Western region (otherwise known as the “Go-west Campaign,” further discussed below), the rejuvenation of the old industrial base in northeastern China, and the development of Central China. Compared with the 1990s, these strategies slowed the expansion of regional disparities (Wei Houkai and Sun Chengping, 2004; Xu Zhaoyuan and Li Shantong, 2006). In addition, according to the research of Liu Shenglong et al. (2009), after 2004 China has witnessed some reduction in the regional disparities among its east, central, and western regions as measured by per capita GDP.
Discussions on China’s economic agglomeration and regional coordination should answer these questions first and foremost: is the economic agglomeration excessive? Is agglomeration in the coastal region the primary cause of increasing inter-regional per capita income gaps? Further, how much have the strategies of regional development such as the “Go-west Campaign” contributed to reshaping China’s regional economic geography? Lastly, is it possible to balance economic growth with regional coordination? To answer these questions, Section II reviews the status of agglomeration in China in light of international experience. Section III attempts to answer the question of whether China should control economic agglomeration in view of relevant literature on economic agglomeration, economic growth and regional balance. Section IV reviews the lessons that can be learned from the regional policies in various countries to serve as guidance and reference for China’s regional policy practice. Finally, Section V presents the fundamental conclusions of this paper.
2. China’s Economic Agglomeration: Excessive or Underdeveloped?
A common view holds that China’s economic agglomeration has already reached a high degree, and that the high degree of manufacturing agglomeration will cause a benign cycle in the economic development of the core region through the effect of forward and backward linkages. But due to various conditions, the diffusion effect of the core region on the other regions is restrained, causing regional disparities to expand. That leads to the question of whether China’s economic agglomeration is excessive or underdeveloped. To answer this question, it is necessary for us to make a detailed analysis of the status of China’s economic agglomeration. This will enable us to better explain the current stage and future trends of China’s economic agglomeration in light of international experience, and to provide reference for the central government for setting out regional policies.
Having calculated the HHI of gross regional product and gross industrial output value of 31 provinces, municipalities and autonomous regions of mainland China after 1978, we have identified an increasing tendency towards agglomeration of gross regional product and gross industrial output value in various provinces (Figure 1). The HHI of gross regional product by province increased from 471.10 in 1978 to 549.28 in 2009, up 16.60 percent. The HHI of gross provincial industrial output value increased from 557.31 in 1978 to 729.44 in 2009, up 30.89 percent. Statistics indicate that the tendency towards agglomeration of gross provincial industrial output value started to experience a minor decline after reaching its peak of 768.91 in 2004. After reaching the peak of 563.97 in 2006, the agglomeration of gross regional product by province also reduced slightly.
It should be clarified that the minor declines in both may traced to the regional development strategies adopted by the central government of China since 2000, such as the “Go-west Campaign,” the rejuvenation of the old industrial base of Northeastern China, and the “Rise of Central China,” rather than from market mechanisms. Take the “Go-west Campaign” for instance. Between 2000 and 2007 the central government made a cumulative amount of fiscal transfer payments to China’s Western region in the vicinity of 1.5 trillion yuan. More than 730 billion yuan worth of treasury bonds, budgetary construction funds and sectoral construction funds have been devoted to the development of the Western region (Liu Shenglong et al., 2009). It is clear that the implementation of these policies has exerted a great influence on the spatial distribution of China’s industries (the actual effect will be discussed below in more detail). Another important piece of information revealed by Figure 1 is that China’s economic agglomeration measured by the HHI of gross provincial industrial output is higher than that measured by gross regional product. This coincides with the fundamental idea behind the home market effect (HME), i.e., the region with a large market size attracts a more-than-proportionate share of manufacturing firms.
For specific industries, geographic or spatial concentration is used to describe the uneven spatial distribution of a single industry. Using China Industrial Economy Statistical Yearbooks, we calculated the spatial Gini coefficients of 18 major industries’ outputs in the 31 provinces, municipalities and autonomous regions between 1988 and 2006.4 Our research found that in a period of about 20 years (from 1988 to 2006), all 18 industries showed an increasing tendency of spatial concentration. There are three industries that are highly spatially concentrated (spatial Gini coefficient above 0.70), six industries that are relatively highly spatially concentrated (between 0.55 and 0.70); five industries that are relatively spatially dispersed (between 0.40 and 0.55), and one industry that is highly spatially dispersed (less than 0.40). Three industries experienced the transition from relatively spatially dispersed to relatively spatially concentrated (see Table 1). Further analysis reveals that most of the industries with high degrees of spatial concentration can be characterized as capital and technology intensive, with significant economies of scale, and with relatively high spatial mobility, which is in accordance with P. Krugman (1993) so-called second nature. Meanwhile, mining of ferrous metal ores, mining and washing of coal, and manufacture of tobacco, which are relatively spatially concentrated, rely on mining deposits, land, climate and such natural conditions, so their spatial concentration is high too, which corresponds with P. Krugman (1993) so-called first nature. On the contrary, production and supply of electric power and heat power mainly serve local needs, and transmitting them across long distances would be costly, which makes them have a high level of spatial dispersion.
Calculation of the Gini coefficients above did not take into account the impact of the different sizes of enterprises in the same sector from different provinces. The size of enterprises in a certain sector varies greatly across provinces, and this indicator cannot objectively reflect the level of spatial concentration of this industry. Considering the impact of corporate size, G. Ellison and E.L.Glaeser (1997) created EG coefficient using coefficient that can measure the level of spatial concentration and offset the impact of corporate size.5 Spatial Gini coefficients clearly showed that the levels of spatial concentration for various sectors of China have been rising since 1978. Yet compared to developed countries, the level of spatial concentration in China’s industrial sectors remains relatively low (see Table 2).
Another indicator that can be used to evaluate the level of economic agglomeration is the size of cities. Economic models with the number of cities being endogenous all presume there exists an inverted U-shaped relationship between real per capita income and city size, i.e., when cities are relatively small, the benefits of agglomeration deriving from urban extension (such as products diversification) outweigh the costs of agglomeration (such as congestion), so that real per capita income increases with the expansion of cities; when cities become very large, the costs of agglomeration increase at a much faster pace than the benefits of agglomeration, which are ultimately dominated by the costs and will cause per capita income to reduce with rampant expansion of cities (D. Black and J.V. Henderson, 1999; G. Duranton and D. Puga, 2001; M. Fujita et al., 1999; R. Helsley and W. Strange, 1990; J.V. Henderson, 1974).
In terms of the size of cities, C.C.Au and J.V. Henderson (2006) analyzed the inverted U-shaped relationship between real per capita income and the size of cities using statistics between 1990 and 1997 from more than 200 Chinese urban areas. Their research found that among 205 sample cities, at least 51 percent of the cities are too small while large cities account for less than 6 percent. Their research further noted that under the effect of China’s mobility-restraining household registration system, or Hukou, most Chinese cities are below the level of optimal scale, causing net output per worker to lose about 30 percent on average. According to the research of Fujita et al. (2004), Chinese cities are not only smaller than optimal but are characterized by the equalization in urban size. Their research also indicated that the size of Shanghai’s population and its growth are lower compared with the top 10 largest cities in the world.
According to statistical research by J.V. Henderson and H.G. Wang (2007) on 2,684 cities in 142 countries with populations exceeding 100,000, out of 2,684 sample cities in 2000, 94 cities had populations exceeding 3 million and 324 cities had populations in the range of one to three million, and the ratio between the two is 0.072. From an international comparison of spatial Gini coefficients of these cities, they found that the spatial Gini coefficient of world total sample urban populations is 0.5619. Among the seven most populous countries - China, India, the United States, Indonesia, Brazil, Russia and Japan - Japan has the highest spatial Gini coefficient of 0.6579 and China’s spatial Gini coefficient is the lowest at 0.4234. Obviously, not only are Chinese cities generally smaller, but also they are characterized by equalization in city sizes where large cities are not very large and small cities not very small.
Recent international comparative studies show that the degree of China’s economic agglomeration is still at relatively low levels compared with developed countries. According to the World Bank (2009), between 2000 and 2005, low-income countries experienced an annual growth of urban population by 3 percent, middle-income countries 1.3 percent, and high-income countries 0.9 percent. Before per capita GDP reaches $10,000, there is a significant positive correlation between globalization and economic development, which is characterized by massive flows of rural populations to cities. When per capita GDP exceeds $10,000 and economic agglomeration index exceeds 0.6, urbanization slows down substantially. There are only a few exceptions in countries whose per capita GDP is above $25,000 and economic agglomeration index is above 0.7 (see Figure 2). Figure 2 shows that both China’s per capita GDP and agglomeration index are at low levels compared with other countries. Even compared with countries of similar developmental stage such as Brazil and India, China’s agglomeration index is still lower. This is an indication that the agglomeration of China’s economic activities is insufficient.
3. Should China Contain Economic Agglomeration?
Current theoretical researches show that agglomeration of economic activities is conducive to economic growth (P. Martin and G.I.P. Ottaviano, 2001; Fujita and Thisse, 2003). Using U.S. statistics, A. Ciccone and R.E. Hall (1996) conducted empirical tests on the relationship between agglomeration and growth through two different models. Their research identified a positive correlation between employment density and productivity: an increase of employment density by 100 percent will increase productivity by 6 percent. They also found that more than half of the per capita output difference between various states of the United States can be explained by the density of economic activities. Using Swedish statistics, P. Braunerhjelm and B. Borgman (2004) reached conclusions similar to those of A. Ciccone and R.E. Hall (1996). R. Braunerhjelm and Borgman (2006) examined the impact of different types of agglomeration on economic growth from more detailed perspectives. Their research divided agglomeration into mono-industrial agglomeration and poly-industrial agglomeration, with each corresponding to Marshall-Arrow-Romer externalities and Jacobian inter-industry externalities respectively. Braunerhjelm and B. Borgman (2006) found that, compared with Marshall-Arrow-Romer externalities, Jacobian inter-industry externalities have a stronger effect on growth.
Geographic factors also play an important part in explaining the provincial differences of economic growth in China. From the core-periphery perspective, L.G. Ying (2000) verified the spillover effect in China’s spatial economy. Subsequently, L.G. Ying (2003) conducted further research on the provincial economic growth of China between 1978 and 1998. He found that there existed a certain spatial correlation between China’s provincial GDP growth rates and the adjoining regions. Having neglected the spatial factor, previous research is likely to have inappropriate model specification. Estimate factor indicates that China’s economy is experiencing a process of spatial polarization. Wu Yuming and Xu Jianhua (2004) analyzed economic growth of mainland China’s 31 provincial regions using Moran’s I. Their result showed that the degree of intensity in international and domestic trade as well as foreign direct investment and such economic activities leads to spatial imbalances among the economic growth of the 31 provinces. Geological characteristics explain a great deal of the core-periphery structure of China’s provincial economic growth. It needs to be noted that for China, restrictions on the flow of production factors such as land and labor will cause distortions that will push up prices of factors such as land, restraining economic activities from moving to China’s eastern region.
According to Lu Ming (2011), between 1990 and 2006, the greater the distance from major ports like Hong Kong, Shanghai and Tianjin, the lower the efficiency of land use. In 2006, the efficiency of urban land use approximately 500 km away from major ports was lower by about 50 percent compared with those closer to major ports. Within a distance of 450 km from major ports, the expansion of urban construction areas promotes the efficiency of land use. However, for inland regions even further away, the expansion of urban construction areas has the effect of reducing average land use efficiency. The implication is that if cross-regional transactions of construction land quotas are permitted, land use efficiency will increase as construction land quotas are traded from China’s western region to eastern region. As a result, overall land use efficiency will increase in the interest of economic growth. Xu Zheng et al. (2010) further verified the -shaped non-linear relationship between geography and urban economic growth. According to their research, as the distance of cities to major ports reduces, the effect on urban economic growth first increases, then weakens, and then enhances once again. On the whole, the greater the distance to major ports, the lower the economic growth.
In terms of both China’s current level of economic agglomeration and its effect on economic growth, it is necessary for China to promote agglomeration rather than diffusion of economic activities. China’s efforts to contain economic agglomeration appear justified by the need to address regional disparities. But the question is: should we ascribe China’s increasing regional disparities to agglomeration? It needs to be noted that a major difference between China’s reality and the classic model of New Economic Geography is that many factors that are presumed to be freely mobile in the theoretical model still face serious mobility constraints in China, and the artificially created mobility barriers may become at least partially responsible for China’s increasing regional disparities. As empirical research indicates, the inter-regional migration and agglomeration of production factors in China are not the cause of regional gaps.
Wang Meiyan (2003) separated wage differences caused by the personal characteristics of rural migrants and urban local workers from those caused by salary determination. Having estimated the impact of labor discrimination on wage difference, she found that 76 percent of the labor wage difference can be explained by labor discrimination. Using firms and rural labor survey statistics of Zhejiang province, Yao Xianguo and Lai Puqing (2004) analyzed wage income differences between urban and rural migrant workers and found that the wage differences can be attributed to two factors: differences in human capital levels and employers, and the household registration (Hukou) discrimination against rural migrant workers. The former contributes about 70 percent of wage income difference of both types of workers, and hukou discrimination contributes about 30 percent.
Using China’s national sample data in 2002, S. Démurger et al. (2009) found that the annual earnings of urban residents are 1.3 times that of long term mobile population from the countryside. Using China’s inter-regional input-output table and national rural migrant worker survey, Fan Jianyong and Yin Weichun (2009) made a detailed analysis of the actual degree of impact between the migration of un-skilled labor and inter-regional income levels. They found that the wage elasticity coefficient of market access in coastal regions is lower by 1.7 to 2.7 percentage points compared with non-coastal regions. This implies that improvement of market access in coastal regions has a weaker effect on wage increase compared with non-coastal regions. In other words, the migration of un-skilled labor to coastal regions caused by the agglomeration of economic activities there will not substantially expand inter-regional income disparities.
In terms of theoretical research, Zhu Xiwei (2004) found that the existence of the hukou system has made it costly for the industrial labor force to relocate from central and western regions to eastern region where it is more likely to benefit from higher technology efficiency. If there is a very low substitution between goods to be made by the potential industrial labor force from central and western regions and those made by local workers of the eastern region, relaxation of migration will not only increase the welfare of the potential migrant industrial labor force but also increase the welfare of local workers of the eastern region.
The reason is that, although the potential industrial labor force may be in competition with the local workers from the eastern region, if the two groups are employed for the production of differentiated goods, then increased diversity of goods reduces the consumer price index in the eastern region at a pace faster than the reduction of nominal wages, contributing to the improvement of welfare for local workers of the eastern region as well. H. Song et al. (2012) further verified these conclusions within the framework of endogenous migration framework.
4. Regional Policy: Reshaping China’s Economic Geography?
Domestically and internationally, there have been endless policies to support backward regions. Our concern is to what extent regional policy has reshaped economic geography and what China can learn from the research and practice of international regional development policies.
Balanced regional development has always troubled the EU. About one third of the EU budget is used to support regional policies. From 2000 to 2006, about ?13 billion were earmarked for this purpose. In addition, the member states also used large amounts of fiscal spending to narrow regional gaps (V. Dupont and P. Martin, 2006). However, policies to narrow regional gaps always achieved little regardless of whether it took place in Italy, Germany or the EU at large (S.Brakman et al., 2005). Extensive empirical research found that Europe is a complex system with a core-periphery structure. Compared to market-originated centripetal forces, the centrifugal forces brought about by regional policies always seem impotent. This situation explains why regional economic layout fails to transform as expected by policy makers.
In Europe, policymakers have noticed this fact and are gradually changing their policies. The policy shift from balancing regional development to overall efficiency can be seen from the two reports below: Pieken in de Delta (Ministerie van Economische Zaken, 2004) and Third Report on Economic and Social Cohesion (European Commission, 2004). On the whole, the policies for undeveloped regions to overtake more developed regions are being replaced by more flexible policies in which the market plays an increasingly important role (S. Brakman et al., 2005).
In Asia, Japan has been committed to balancing regional development since the 1960s. With increasingly limited environmental, transportation, and housing capacities in Tokyo, the Japanese government clearly expressed its intention to diffuse urban hubs to peripheral regions in its fourth capital rim planning of 1986. The fifth capital rim planning of 1999 called for the improvement of Tokyo’s scattered network structure (Zhang Liang and Lv Bin, 2009). These policies caused stagnation and reduction of Tokyo’s population, which coincided with the decline of Tokyo’s development pace and international status. Even the Japanese economic growth as a whole suffered to some extent (Chen Zhao and Lu Ming, 2009). Since 2000, Tokyo’s population began to increase after many years of stagnation and reduction with a return to the downtown area. Japan’s plan to diffuse the functions of its capital failed to achieve the expected policy effects. 6
In China, since pro-market reforms and opening-up, increasing regional gaps are not only an economic issue but also a social problem that gives rise to social instability. In 2000, the Chinese government announced multiple strategies to balance regional development, such as the Go-west Campaign, the rejuvenation of the old industrial base in the northeast, and the rise of central regions. Policy measures were issued to facilitate infrastructure construction, environmental protection, industrial restructuring and opening-up and reform in the central and western regions. Between 2000 and September 2009, China allocated a cumulative amount of 550.7 billion yuan and increased the share of subsidies to projects in western regions. Capital construction funds and treasury funds within the central government budget have been increasingly used for capital construction in the western region. It is not yet known whether these efforts to balance regional development will be able to reshape China’s regional economic geography and derive long-term economic growth in undeveloped regions.
In terms of regional industrial relocation, current research indicates that “large-scale industrial relocation did not take place” and “industrial relocation is not significant” (Chen Jianjun, 2002; Chen Jiwang, 2007; Chen Xiushan and Xu ying, 2008; Zhao Wei and Zhang Cui, 2009). For the sub-industries that are diffusing, Chen Xiushan and Xu Ying (2008) further concluded that between 1986 and 2005, the diffusion process made a very significant contribution to interregional industrial structure conflicts, i.e., the diffusion intensified conflicts of regional industrial structures.
In terms of per capita GDP, some research has contended that compared with the 1990s, the year 2004 was a watershed before which the increasing regional disparities of per capita GDP and consumption alleviated. After 2004, the tendency of increasing regional income disparities reversed (Liu Shenglong et al., 2009; Wei Houkai and Sun Chengping, 2004; Xu Zhaoyuan and Li Shantong, 2006). Because it might have been a coincidence for regional development gaps to be narrowed after implementation of strategies such as the “Go-west Campaign,” Liu Shenglong et al. (2009) undertook to verify the effect of the implementation of the grand campaign of developing western China.
Their research indicated that the implementation of this campaign increased the annual average economic growth rate in the western region since 2000 by about 1.15 percentage points. This turned China’s regional economy from divergence to convergence. However, the mechanism of economic growth in China’s western region is driven by investment in physical capital, especially infrastructure. No substantial improvement has been made in education, technology and soft environment. Whether short-term economic growth in western China can derive endogenous long-term growth still needs further observation. In fact, if we look at the history of the United States and Europe, we would see that, unlike Europe, despite high economic agglomeration, regional planning policy has never been an important issue in the United States thanks to high mobility of labor.
5. Conclusion
Economic agglomeration is a common phenomenon in the economic development of all countries. In light of international experience, China’s economic agglomeration is not high either in terms of industrial spatial concentration or the size of cities. It is therefore inefficient for China to contain economic agglomeration. If the Chinese government attempts to contain economic agglomeration by restricting factor flow, the result could run counter to the objective of convergence of regional income disparities. Both theoretical and empirical studies indicate that agglomeration is favorable to economic growth, which in turn increases the degree of agglomeration. Given that regional disparities (including per capita and aggregates disparities) are usually accompanied by economic agglomeration, an eternal conflict seems to exist between efficiency and equality. For countries or economies with serious regional economic disparities, regional policies often carry great expectations to reshape a country’s economic geography. Regretfully, these regional policies that pursue balanced regional development usually failed.
In Europe, policymakers are beginning to see that the force that drives economy to agglomerate in central regions is so strong that expensive policies to develop undeveloped regions achieve little effect. The “Go-west Campaign” of China alleviated the increasing tendency of regional disparities. But if the improvement is caused only by massive government spending or preferential policies, industrial relocation from eastern to western regions will not take place, unless long-term growth factors such as human capital in the western region are fundamentally improved. On the other hand, capital return and land use efficiency are higher in the eastern region than in the central and western regions, i.e., current market driven factor flow has the tendency to further agglomerate in the eastern region. Therefore, regional policies that attempt to diffuse economic activities to central and western regions may only achieve transient effect and possibly at tremendous cost.
In terms of China’s current economic geography and development stage, it is unnecessary, unwise and even impossible to contain economic agglomeration. The objectives pursued by regional policies shouldn’t be balance on an aggregate basis, but should instead stress balance on a per capita basis. International experience shows that under the condition of a labor force freely mobile across regions, per capita income gaps will not have the tendency of continuous expansion. The most urgent task for China is to realize cross-regional free flow of labor, i.e., to eliminate any institutional barriers that are unfavorable to labor mobility. In this sense, instead of making investment in physical capital, it is better for the central government to increase its spending on human capital including health care and education through regional policies that will balance development. Investment on people will increase human capital and labor mobility in western regions.
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