electricity for industry, due to subsidies on coal for power generation, continues to encourage the establishment of electricity-intensive industry (Bugs 2005).

- Financing was channeled on favorable terms to investment in industry, particularly to large enterprises and/or SOEs. Under the traditional financial system, the interest rate has been low for those who have had access, which has promoted capital intensive development in industry. The People’s Bank of China (2004) estimates that small and medium-sized enterprises—which are significantly more prevalent in services than in industry—account for more than half of GDP but receive less than 10 percent of total bank loans. The government’s channeling of financing to investment in infrastructure has also traditionally benefited industry in particular.

- Development of the services sector was not sufficiently stimulated. Service sector development suffers from restrictions and regulation and a lingering bias against private ownership (World Bank (2003)).

- Labor movements were restricted due to the Hukou system (Whalley and Zhang (2004)), discriminating regulations against migrant workers, non-portable labor and social benefits, and land tenure policies. Migration has taken place to a large extent only in the form of “floating” population.

The overall result has been a subsidization of current production in industry, vis-à-vis current production in other sectors, future production, and environmental quality. The favoring of industry and investment does two things: in addition to the economic and social implications described above, the subsidization of input prices encourages a non-economic and not-sustainable use of energy and primary commodities, and degradation of the environment.

# **4. IMPLICATIONS FOR THE FUTURE: SUSTAINABILITY OF GROWTH AND NECESSARY POLICY ADJUSTMENTS**

In this section, we calibrate two scenarios to illustrate the future implications of the continuation of the current growth pattern and the pay-off of a change in growth strategy and associated policies. The scenario on current policies assumes an unchanged growth strategy with current trends continuing, and an alternative scenario assumes less emphasis on and subsidization of industry and investment. The projections are made extending the growth accounting and sectoral shift analysis discussed in sections 2 and 3. The assumptions underlying the two scenarios are summarized in Table 3.

As shown in Table 4, continued investment and industry-led growth in the scenario on current policies is almost certainly unsustainable. It would require the investment-to-GDP ratio reaching unprecedented high levels of 55 percent on average in 2014-24 in order to maintain GDP growth of 8 percent per year. In addition, the emphasis of continued investment in the industrial sector means that limited resources are devoted to development of the services industry. As a result, there would continue to be only moderate urban employment growth and a moderate labor flow out of agriculture, leaving a large share of people poor in agriculture. The productivity gap between agriculture and the rest of the economy would rise from an already high 6 times to over 8 times by 2024, further widening the rural-urban income divide. In 2024, 33 percent of total employment would still be employed in agriculture, a high share for a country with a per capita income of $20,000 at that time (in 1995 prices). Resource intensity and environmental problems would also likely continue to intensify.

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