Call it Philanthropy 0.2. Bill Gates is trying to take altruism out of the mansion garage and put it on a corporate footing. Thanks to a generous contribution by investment guru Warren Buffet in June, the Microsoft chairman is now overseeing a charitable foundation worth more than $60 billion. More important than its bankroll, however, is the global ambition: the Bill & Melinda Gates Foundation has dedicated itself to eradicating disease and poverty in developing countries using business strategies straight from Silicon Valley.

In fact, Gates and Buffet are at the vanguard of a new generation of U.S. business philanthropists supplanting the older-money foundations begun by Ford, Rockefeller, and Carnegie. True, private donations by the world's richest men are still dwarfed by the billions that move through official ODA channels every year. But it would be a mistake for the aid community to dismiss June's mega charity merger as media hype; governments listen to tycoons, and Gates says he wants to shape public policy.

So, how is philanthrocapitalism going to benefit the 'customers' -- the 1 billion people living in extreme poverty?

According to the Gates Foundation website, passion will be a big factor: "We take risks, make big bets, and move with urgency." Interestingly, many of the foundation's '15 guiding principles' would look at home in a corporate mission statement. The emphasis is on making the first move, innovation and focus. Not surprisingly, the role of science and technology gets heavy play, as does the need to show results.The software pioneer wants to shake up bureaucratic inertia in the aid community, relying on 'partnerships' rather than costly administration.

After six years in the donation game, the Gates Foundation says it has a results sheet that validates the entrepreneurial approach. It prioritizes two fields, health and education. In the international arena, the focus is on providing drugs to combat diseases in poor countries. The foundation is a major supporter of the Global Alliance for Vaccines and Immunization (GAVI), which has provided basic immunization to over 8 million children. It has also formed effective partnerships with pharmaceutical companies to develop drugs that the private sector would normally deem unprofitable. The windfall from canny technology bets is also being used in the fight against AIDS and for developing an inexpensive cure for Black-Fever.

By concentrating on easy to understand issues (enough cheap drugs = improved quality of life), the operating principles look feasible and the mission appears achievable. (Everyone remembers the WHO's big success in wiping out smallpox.)

But the MBA-school of international assistance also has some serious bugs in the program, many revealed by the foundation's own project reviews: GAVI was found to be too narrowly focused, and to have "not paid enough attention to developing country priorities." The five-year timeframe was also judged too optimistic. In other projects, too, the auditors identified cases where the foundation's haste and desire to go it alone has undermined good intentions.More worrying, the record is further marred by a "heavy handed" approach at times, and there is even a reminder note for program officers to visit local project sites. One conclusion, in particular, should be chastening: Drug development should not be viewed as an end in itself, but implemented as part of larger health system reform.

This self-criticism is commendable (the apparently rigorous project evaluations are one area other NGOs would do well to follow). The Gates say the lessons are being learned and a broader approach is being considered. But critics are right to ask why the poor have to wait while yet another charity start-up re-invents the wheel? The mines stepped on by the Gates Foundation have been signposted in the aid literature for years.

The answer can probably be found in a glaring omission in the '15 principles': No mention of recipient feedback, let alone project input. An extensive review of the humanitarian response to the Indian Ocean tsunami fingered "donor arrogance" as a recurring feature in its long list of NGO failures. More fundamentally, the Gates Foundation's methodology highlights a key flaw in the venture philanthropy approach: it chooses to ignore -- at times even deliberately circumvent -- local institutions and public policy. But the accepted evidence says otherwise: the best aid projects support initiatives that change the way the public sector does business. It's a lesson the Gates Foundation should have learned in its own backyard, where its independent crusade to break up large urban schools has earned some poor grades.

Does that mean charity foundations should be shut down? Not at all.Rockefeller's legacy helped create the modern research university, provided the seed money for antibiotics, and helped kick-start the 'green revolution' in agriculture. Obviously, these are achievements worth emulating and research will remain a valuable area for foundation support. As dispensers of funds to other charities, the foundations could also use their influence to encourage much-needed transparency and quality control in the humanitarian sector. Nevertheless, as the hard lessons from the tsunami response show us, international development aid is still a complicated process that might beat even the best and brightest minds from the business world.

The bottom line for the Gates Foundation is that it is saving lives and has made an impressive start raising AIDS awareness. But philanthropy is not a panacea for global development problems or humanitarian disaster management. At a time of NGO proliferation, what is needed is more donor accountability and performance, not more tycoon activism. If they really want to do good, venture philanthropists should remain a niche play.

Around the same time the recently-completed Three Gorges Dam began taming the Yangtze River, the World Bank was busy changing the course of an equally potent force -- it's own development philosophy. After a two-year review, the bank decided to re-focus on infrastructure projects. Lending for basic services -- roads, power, water, sanitation and telecommunications -- will be ramped up by around $1 billion a year. Stressing the need for public sector involvement, World Bank President Paul Wolfowitz says the only way for least developed countries to shake off poverty is to stop hauling buckets. (Africans lose 40 billion productive working hours each year to carrying water.)

The Asian Development Bank is passing out the hard hats too. It is telling countries in Asia that unless they team up to improve "physical connectivity," the region risks losing its competitive edge in trade. The Group of Eight (G8) nations, meanwhile, warn that a lack of access to modern energy services is fast putting the Millennium Development Goals out of reach. The latest meeting of G8 finance ministers concluded with a call for more aid to help poor countries overcome "energy poverty."

Governments, donors and academics -- a growing chorus, all chanting the infrastructure mantra.Is this a good thing? How will it affect the pledges by the multilateral development banks (MDB) to eradicate poverty? After all, the big lenders backed off PRC's mega-dam precisely because of the potential for negative environmental impact and social costs. Should we be urging developing countries to spend billions of dollars to sink pylons and lay cable just as sustainability and pro-poor growth gets traction with policymakers? Are we about to see a rash of concrete boondoggles blight the developing world while corrupt officials and contractors line their pockets? And the biggest question of all: Who is footing the bill for this?

Let's start with the 'new' thinking. It goes like this: building infrastructure is the most effective way of lifting people out of poverty. Why? Put simply, because roads, sea and air ports get people to jobs and goods to market. Electricity powers factories, schools and hospitals and keeps food, medicine and people cool. And water -- the clean, accessible, and affordable kind -- keeps people healthy and productive. Spend money on putting the necessary generators, antennas and pipes in place, and all the other poverty-fighting strategies, from microfinancing to village cyber cafes, will really start doing some good. If this sounds like a no-brainer, it has taken 20 years of research to prove it.

Unfortunately, while the economists were crunching numbers, the world took its eye off the infrastructure ball. It started when governments from South America to Africa were advised to bring their spending under control in the 1980s. Upgrading roads and refitting ports became secondary to balancing national budgets.Later, developing countries began trying to sell off utilities, following in the faddish privatisation footsteps of advanced economies. Some telecom networks thrived in private hands, but other services suffered (as it was in the developed countries too). In 2003, private sector investment in developing world infrastructure stood at $58 billion, half the peak level reached in 1997.

Even in Asia, home of mountain-moving macro-development, large projects were put on hold after the financial crisis of 1997.As a result of this neglect, the world's rapidly expanding and urbanizing populations are chronically short of basic services: 1.6 billion people do not have access to energy services, and 2.6 billion are deprived of water and sanitation services. By most estimates, African countries need to invest about 9 percent of their GDP -- roughly $40 billion per year -- in infrastructure if they want to meet the Millennium Development Goals. That's twice the sum they spent in the last 40 years.

But if we crank up infrastructure spending, how do we ensure the poor don't miss out again? (Enron's ill-fated involvement in India's power sector provides lessons on what not to do -- sadly, there are many other examples.) The proponents of "neo-infrastructure" say they have left "growth first" and "trickle-down" orthodoxy behind them. In the words of the World Bank president, it is now about well-designed, sustainable projects that meet the needs of the poor.

Here's what the development community think needs to be done to ensure this happens:

'Smart' inclusive projects. The one-size-fits-all mentality needs to be demolished. Careful research and planning should identify the right approach for project scope, technology, funding and ownership -- a process that must involve the end users from the start. The watchwords are access and affordability. Large-scale infrastructure must be complemented by decentralized, efficient solutions that reach the poor and are really wanted by them.(There's no use in bulldozing their homes to make way for an interstate highway).

Public/private partnerships. Despite the wishful thinking, the truth is that governments will have to lead this endeavour, but private sector involvement is still crucial, not least as a source of know-how and financing.That will require removing regulatory obstacles and adopting financial tools that reduce currency devaluation and other risks. An open mind on subsidies is needed to strike the right balance between cost effectiveness and fair distribution.

Independent and honest regulatory bodies. Autonomous monitoring is essential to fight corruption, the great scourge of 'big ticket' projects which by their very nature tend to be monopolistic. Privatization, decentralization, and wider ownership will also help in this cause.

Environmental and social focus. No longer an afterthought, environmental and social impacts must be a key factor in project feasibility studies. The G8 statement stressed renewable, clean energy -- and the technology exists to put this in place.Initial funding will need to target inefficient plants, like PRC's coal-burning power stations.

Don't forget the farm. Rural infrastructure has had a low priority from governments and aid agencies. This is a mistake. Agriculture forms the core of the economy of most low-income countries. Even after years of rapid growth in East Asia and the Pacific, the sector still accounted for 46 percent of employment in 2000. Boosting facilities in rural areas -- roads in particular -- not only has a positive effect on food prices, farm incomes and employment, it also has indirect benefits for overall economic growth.

Regional links. As trade, investment and production becomes more integrated, it is vital that poorer countries can access regional markets to improve their growth prospects. Cross-border infrastructure, particularly transport and communication links, will become increasingly important in closing the wealth gap between regions.

The soft-side. In all of the above, there is always a soft underbelly of regulatory and support structures that need to be in artfully put in place to make the new mega projects commercially successful and self-sustaining.This is easier said than done as a number of advanced countries are still having trouble doing this -- to wit London's underground and Japan's highways.

These are challenging goals, requiring knowledge of what can work along with long-term political leadership. And that is where the MDBs can play a useful role. Although their share of the total $400 billion invested in developing country infrastructure every year is small (just two percent for the World Bank), their expertise and third-party guarantor status can be leveraged -- particularly in regional projects. International institutions need to learn to reach out far more effectively to policymakers within developing countries.

The bottom line: Unchain the earthmovers and hook up the grids. Without decent infrastructure -- the soft and hard kind -- poverty eradication is being held back.Decentralized, well-managed projects and services offering affordable transport, communication, trade, power and water could give people the tools they need to renovate slums, increase their GDP and make the land productive without stressing the environment.

For over two decades, globalization and open markets have been accepted as the main ingredients in the recipe for serious socioeconomic growth. Governments continue to pepper their documents and press releases with these mouth-watering terms, often tying them to the claim that foreign trade is the main course to continued economic expansion. As a result, trade agreements have become a major item on the menu of regional strategies targeting economic development. Asian governments have enthusiastically jumped on the chuck wagon, drafting new agreements with various partners and pulling old agreements off the shelf and renaming them to better reflect present-day terminology. But have we got it right?

Being outside of the WTO's multilateral Doha Development Agenda (or Doha Round), these free trade agreements (FTAs) and regional trade agreements (RTAs) so warmly welcomed are in reality bilateral and regional agreements; in other words, usually exclusionary or possibly protectionist in nature. Is this a reversal in policy for the purpose of short-term economic gain -- a stopgap measure until a better long-term multilateral strategy is proposed? Or, do administrations believe that the recent momentum of economic development created through regionalism-based activities can be transformed into an "open global market" in the future? The situation is one that requires caution in the process, as the bilateral-based agreements popping up throughout Asia could prove to have the opposite effect and significantly jeopardize the multilateral trading system.

Flight to regionalism

The Doha Round is floundering, despite attempts by major powers to revitalize it. The bargaining strength of the newly-formed G20 trade bloc (headed by the Group of 4 -- PRC, India, Brazil and South America) is finally strong enough to make a stand on agricultural opening. As a result, industrialized nations have chosen to pursue economic development though other means and delay the acceptance of reforms that might negatively affect their domestic markets, particularly vocal and cosseted farming interests.

Bilateral or regional trade agreements are not new for Asia: a preferential trade agreement was signed back in 1975. But Asian governments took a wait-and-see approach to the challenge thrown down by the mega-regional agreements signed up in North America and Europe. After much deliberation, they finally warmed to the idea and eventually got onboard, beginning with the signing of the Japan-Singapore EPA in November 2002. Today, the foreign trade policies of most Asian governments are based on the acceptance of a web of FTAs and RTAs, instead of multilateral solutions.

But the promotion of bilateral trade often leads to the inclusion of preferential treatment for the stronger more-developed country, complicated investment and trade decisions, and more often than not the exclusion of some neighboring countries. This could be seen as an extremely negative aspect from the viewpoint of the governments of developing countries with immature markets; these RTAs could even be contributing to the creation of new barriers between their products and the international marketplace.

No clear answer

Global trade has entered a new era, which no longer revolves just around the major industrialized countries. While the Doha Round places emphasis on fairer trade rules for developing and less developed countries (LDCs), a fascinating (but contrarian) report, "Winners and Losers: Impact of the Doha Round on Developing Countries" gives reason to believe that trade is neither the "cure all" for poverty nor for economic development. Of course, trade is a factor that has the potential to lead to economic growth -- if a country has the infrastructure, know-how and system in place to manage it. However, the WTO is missing a number of vital components required to promote equality among nations in terms of development.

The author of Winners and Losers, Sandra Polaski, posits some eye-opening observations using a global trade model created by the Trade, Equity, and Development Project at the Carnegie Endowment for International Peace. The model attempts to reflect real-life conditions in countries more accurately; for example, incorporating a country's actual rate of unemployment and expressing labor markets more precisely, such as the breakdown between agricultural and urban unskilled labor forces. Major findings show that: current trade scenarios will produce only meager gains for a global market, the solution to economic development for poor countries is not necessarily agriculture, and LDCs will likely lose rather than gain advantages from the agreements and will therefore require special assistance and other support measures if economic development is to be successful.

Where to from here?

Free, multilateral trade in an open global market is, of course, the best solution. The next best solution is for Asia to develop its own trade liberalization scheme. Calculations based on the creation of a hypothetical Asian free trade area that promotes open regionalism suggest that free trade would increase world income by $228 billion annually, with Asia's increase being $133 billion annually (approx. 1.1% of baseline GDP).

As for the chances of the Doha Round, a more specific agreement will probably be needed to attain the desired results. For DMCs, phase-in periods need to be longer so that peripheral mechanisms can be prepared and adjusted. In addition, measures for liberalizing sectors must be carefully thought out and synchronized with sector growth. For the agriculture sector in particular, aid is required for procuring resources not domestically available and special treatment is essential as farm labor needs to be (re)trained and productivity levels increased.

For LDCs, most important is that the agreement be expanded to include all of them in the future, and that industrialized and DMC rules blocking imports from LDCs be removed in order to allow these lesser countries to achieve economies of scale. It is also important to ensure that middle income developing countries and those with LDC status are treated equally. As economic development is promoted, governments tend to work together to achieve growth. To accomplish this, trade assistance programs are required and should be a part of all agreements. Multilateral development agencies such as the ADB and International Fund for Agricultural Development, could be among those to provide such financial aid and guidance.

In the meantime, however, the second-best solution of bilateral trade agreements are proliferating at an amazing speed (200 globally as of January 2006, and a WTO forecast for as many as 300 by the end of the year). The rate of growth in Asia parallels that of other regions, with nine new agreements notified to the WTO since the beginning of 2006. This "jump on the bandwagon" atmosphere may well entice other countries to negotiate similar agreements for the purpose of protecting their market share in various regions. Yet the end result could become more of an entanglement of interests that prohibit rather than promote progress.

Asia adopts regionalism "plus alpha"

Nevertheless, it is important for Asian countries to focus not only on creating FTAs/RTAs in their region, but to use them in such a way that emphasizes open regionalism and avoids hub-and-spoke configurations where countries with the stronger bargaining power tend to flex their muscles. Promisingly, governments in the region appear to be giving careful consideration to the situation before acting because many of the FTAs/RTAs being introduced in Asia, particularly in East Asia, are special in nature. Basically adopting the philosophy pioneered by the Asia-Pacific Economic Cooperation forum, member governments are concerned about the three pillars of "trade," "liberalization and facilitation of investment," and "economic and technological cooperation." They believe that this contributes not only to the success of partner countries, but also towards the economic development of neighboring nonmember countries as well.

Accordingly, these "plus a" issues are increasingly being worked into the agreements. While this type of approach has not been created in answer to the various problems seen in the Doha Round, a number of the difficulties pointed out by researchers (such as offering development aid, technological and educational support and other nonmember country considerations) are being usefully addressed by the "+a" agreements negotiated in East Asia.

East Asia model for the road ahead

Developing countries are key factors of influence as they work to expand their economies through trade, and the results of implementing FTAs/RTAs in East Asia appear to have been generally positive to date. Exports from Asia grew some tenfold in the 20 years to 2004, while that of world exports increased only fivefold; and as a share of world exports in the same period, the figure for Asia nearly doubled, reaching 21%. Intra-regional trade shot up as well, from 8% of world trade in 1990 to 13% in 2003, and intra-regional exports compared to total exports increased from 40% in 1990 to 51% in 2003. With such figures being reported, and the sharp increase in the number of FTAs/RTAs in other parts of the world, it is no wonder that other Asian countries are evincing a keener interest in being added to existing agreements and/or negotiating similar agreements of their own.

One agreement attracting attention from various countries is the Bangkok Round, newly renamed as the Asia-Pacific Trade Agreement. Original members include Bangladesh, PRC, India, Korea, Sri Lanka and Lao PDR. Other countries now discussing accession are Japan, New Zealand, Nepal, Myanmar, Iran; Hong Kong, PRC; the Philippines, Pakistan, Indonesia, Malaysia, Brunei, Georgia, Fiji and Mongolia. Other initiatives to keep an eye on are the ASEAN+3 and discussions between East Asian countries and India.

The bottom line is that the closer the Doha Round is scrutinized, the more it appears that revisions and special treatment measures for LDCs will have to be eventually included. This will no doubt cause further delays in completion and implementation of the round. In the meantime, current indications from FTAs/RTAs are that while industrialized countries and some developing countries can expect positive economic benefits overall, the vast majority of LDCs stand to gain little. East Asian countries, however, have neatly adapted the concept of the traditional FTAs/RTAs and inserted their "+a" philosophy from APEC. Whether or not this well-structured quasi-multilateral approach becomes a role model for sustainable economic growth in other parts of the world and how it can be squared with the evolving WTO regime remains to be seen.

India is committed to becoming an IT superpower by 2010. Forget 'workshop of the world' -- as far as many of India's policymakers are concerned, China can keep the title. Instead, South Asia's awakening giant is trumpeting a daring alternative: leapfrog the industrial revolution and build wealth on a service-based economy.

In place of assembly plants and smelters, India is busy promoting computer software, telecommunications, business processing (BPO), and financial services. Already, the Indian IT and BPO sector is estimated to be worth $22 billion. The NASSCOM-Mckinsey Report of 2005 predicts this figure will grow by 25 percent year, comprising 7.5 percent of GDP by the end of the decade.

Is this attempt to bypass manufacturing feasible? Can cellphones and binary code really turn a nation of subsistence farmers into a modern, wealthy society? Or is this a cyber pipe dream?

In the developed world, moving up the value-chain is seen as synonymous with growth. Innovation and R&D create jobs.

Finland is a classic case of a country marrying tertiary education and R&D to radically transform its economic fortunes. And the software industry has been a leading force in Ireland's economic emergence. But can services alone do the heavy lifting? That's harder to prove. Switzerland has moved nimbly to carve out its niche in financial services. New Zealand, though, has yet to prove that eco-tourism and movie production are growth engines with staying power.

For the developing world, the case for betting the farm on services is even more dubious. Efforts by Pacific islands to set up as financial hubs have had little traction. And, despite heavy investment, Malaysia's vision of becoming a biotechnology power by 2020 remains just that -- a vision.

Nothing can compare to India's high-tech adventure, though, in scale or ambition. For such a large country, the People's Republic of China is the most useful yardstick. Authorities in PRC have chosen the traditional path of wealth through manufacturing. And by most favoured measures, including GDP, foreign investment and infrastructure, China leads the race. Significantly, industry continues to account for close to 50% of China's GDP, nearly double the figure in India.

That doesn't faze the increasing number of pundits and foreign portfolio managers who are buying India's ox plough-to-services pitch. IT services, they argue, foster entrepreneurship, global connectivity and pull in foreign investment and venture capital.

Critics say services-led growth is a dangerous myth. India got lucky, they say, riding on the back of computer programmers in the US. Unless the country undertakes serious agricultural reform and builds a manufacturing base, growth will stall.

Arguments on both sides have merit. Few dispute that information and communication technology (ICT) has a role to play in unlocking the shackles of poverty. World Bank surveys of more than 20,000 firms in roughly 50 low and middle income countries showed firms in developing countries that used the Internet and related tools achieved faster sales and employment growth, as well as higher labor and productivity, than those that did not. Studies of Asia-Pacific economies found that investment in IT use on a national level is correlated to productivity gains and economic growth.

Used properly, ICT can boost efficiency, side-step bureaucracy and reduce corruption. The social benefits of poor countries getting online have been demonstrated not only in business, but also in education, health, and agriculture. The Asian Development Bank, World Bank and many others are speaking up for village Internet kiosks, distance learning, and cyber doctors.

Administering a digital tonic is one thing. Having services take over the show, though, is another story. As in China, only parts of India are prospering. While peninsular India, including states such as Karnataka, Maharashtra, Gujarat and Tamil Nadu, has grown rapidly, the hinterland states like Uttar Pradesh, Bihar, Madhya Pradesh and Rajasthan are lagging far behind. It's hard to see how pockets of fibre-optic opulence can overcome this disparity.

Although India's overall per capita GDP has increased at 5% per annum, per capita agricultural GDP has actually declined -- that's significant considering 60% of population still work the land. Moreover, despite the fairly steady growth (6.5%) in recent years and dynamic performance of the private sector, employment growth has failed to keep pace.

India's tertiary achievements are impressive. But the services economy employs somewhere between one and two million people in a working population of 600 million. The government's latest response to unemployment has been to fund make-work schemes in the countryside. This is fiscally unsustainable and risks aggravating corruption. Only manufacturing can provide jobs for the hundreds of millions of low-skilled farmers who will leave the land in the years to come.

Fixated with services-based growth, the government has also failed to deal with other serious challenges facing India. Poor infrastructure, inflexible labor laws and discouraging investment climates (outside a few favoured sectors) are costing the country dear.

Infrastructure problems are already threatening to choke the IT baby in its cradle. Exasperated at traffic congestion and other problems, global engineering giant Siemens AG decided in January to freeze all expansion plans in Bangalore.

The good news is that for a country the size of India, it doesn't have to be a question of choosing. Manufacturing and services should be the twin engines of growth. In fact, even though China has opted to toil at the coalface, its services sector is growing faster than India's.

There is much that other countries can learn from India's experience. In fact, some expect that India's grassroots' business culture and more open political system might give it the edge over China in the long run. Nevertheless, boosting IT services is not a development strategy in itself.

The bottom line is technology leapfrogging has its place. Village Internet kiosks and cleaner factories offer big possibilities. But economic policy planners should keep their feet on the ground. If India wants to help the 300 million citizens living on less than $1 a day, it will still need a vibrant, labor-intensive manufacturing sector.

There is no clear theoretical process for determining the optimum level of foreign reserves. However, the current ratio of foreign reserves to monthly imports is approximately 16:1, and that of foreign reserves to short-term foreign debt is about 10:1; both higher than the widely accepted figures of three months and one year, respectively. Compared to other countries, the PRC ratios rank number one for foreign reserves to foreign debt and no.5 for foreign reserves to imports and foreign reserves to GDP. (Moreover, FDI is the source of nearly 50% of recent foreign reserves.)

The PRC is presently working to deregulate capital account transactions and encouraging Chinese enterprises to move operations overseas ("zou quchu" in Chinese). Under these circumstances, the rapid influx of foreign capital could end suddenly or even be reversed. Accordingly, as a means of preparing for sudden or unexpected capital outflow, particularly on the tail end of the Asian economic crisis, one can understand why the PRC and other Asian nations tend to accumulate foreign reserves beyond the presumed optimal level.

In terms of economic theory, the greatest concern is monetary implications. Under normal circumstances, as foreign reserves flow into a country the central bank releases an equal amount of local currency into the domestic economy. When there is a rapid influx of foreign capital, there is a risk of overheating the economy if too much money is injected into the market. Over the past few years, however, the People's Bank of China (PBOC) has used a "sterilization policy" to successfully manage the money supply. For the time being there is no foreseen need to worry about the influx of foreign reserves to the PRC, neither in terms of amount nor speed. However, PRC authorities need to carefully consider the following issues:

(i) The rapid accumulation of foreign reserves influences the macro I-S imbalance of the domestic economy external balance in particular. The government introduced a reform plan for the renminbi exchange rate system, but is trying to use foreign exchange rate intervention to mitigate large-scale exchange rate adjustments; the result has been a rapid influx of foreign capital.

(ii) A vicious cycle has been created; namely, the accumulation of foreign reserves gives rise to further anticipation of renminbi appreciation, which in turn triggers foreign exchange intervention and results in an influx of foreign capital.

(iii) The sterilization policy has certain cost implications. To date, the interest rate of PBOC bills has remained lower than that of US treasury bills, which is where a large part of the reserves are invested. However, depending on future developments related to domestic and foreign interest rates, this may not be able to be maintained.

(iv) The PRC has achieved strong economic growth of 9-10% in recent years, and this has required the money supply to grow at a relatively high rate. However, a modest economic growth rate of 6-7% is envisioned during the 11th five-year plan. In order to prevent the economy from overheating, the money supply must grow at a more moderate rate as well.

How to utilize the massive foreign reserves accumulated for the PRC economy. This is the most important issue of all, and is not simply a matter for the PRC as other countries face the same dilemma. However, in the present case of the PRC, the domestic economy doesn't appear to be enjoying any specific benefits from the influx of foreign reserves.

In the latter part of 2005, the government injected a total of $60 billion from foreign reserves into the state commercial banks to strengthen their capital base, possibly giving a sign that the PRC is considering capital appropriations. If this is the case, there needs to be a planned appropriations effort such as setting aside reserves to create funds for projects like addressing environmental problems, promoting energy conservation and enhancing technological innovation. In order to avoid risks and maximize returns, a review of the current composition of the foreign reserves portfolio -- roughly 60% US dollar bonds and treasury bills, 20-25% euro and 15-20% yen -- may also be required.

A recent report by the PRC National Ageing Working Committee points out a few PRC's unique features. First, the size of the aged population is huge. It is expected that the population aged over 60 will become 200 million and then 300 million in 2014 and 2026 respectively. It will hit a peak of 400 million in 2037 and will become stable afterwards (about 30 per cent of total population will be aged). Second, due to the reasons above, the speed of ageing in the PRC is much faster than other countries. The Report says that it took more than 45 years for other countries to increase the share of population aged over 65 from 7 per cent to 14 per cent, while in case of PRC, it is expected to take only 27 years. Third, some distortions in the ageing picture are apparent: male population is already much larger than female and its discrepancy is expected to widen. In addition, the ageing situation is different from the East coast to inland areas or between urban and rural areas. Currently ageing in urban and coastal areas is faster, but as immigration from inland to urban areas develops, ageing in rural areas is also expected to progress rapidly.

However, the most important characteristics we need to pay attention to would be that unlike many other countries, PRC turned into an aged society before it became a fully developed and matured society. In many other developed countries, including Japan and in Europe, economies first became matured, followed by ageing for various social and economic reasons. In other words, these economies could afford the costs of ageing, while the PRC economy does not necessarily have such strength yet. In addition there is a strong tradition and culture in the PRC that old people should be supported by their families and relatives and still no nationwide pension and social safety net are fully developed yet. This suggests just how difficult will be for the PRC authorities to deal with the ageing issue over the long run.

On the up side, we should note that in the short to medium run, thanks to abundant labor forces, ageing should not have any serious impact on the PRC economy. Rather, population experts point out that the PRC would enjoy a "demographic bonus (renkou hongli)" for next ten years thanks to the declining fertility rate. Currently population aged 15 to 65 and population under 15 years accounts for 70 per cent and 15 per cent of total population in the PRC respectively, which are much higher than other developed countries. Only the proportion of population aged under 15 is lower than many developing countries -- we should note in those countries, infant mortality rate is high. Furthermore, although theory generally indicates that household propensity to save would decline as ageing develops, in the PRC, that would not be the case and rather many households will try to save more to prepare for ageing taking account of the lack of a social safety net as well as their still very low income.

This can be seen as either good or bad, but at least it will contribute to sustaining investment-led economic growth for the time being. However, such a situation will not be sustainable in the long run. As the outlook for 2006-2020 by the PRC Development Research Center correctly points out, ageing is one of the major risk factors for sustainable development, in particular for the critical period of 2010-2020. Therefore, it will be essential for PRC to develop and upgrade its economy and to begin to prepare for the coming aged society during the 11th five-year plan period when PRC could still take advantage of its population bonus.

In 2005, the PRC's robust economy experienced strong growth of 9.9 percent following 9.5 percent growth in 2004. The average growth rate was 9.4 percent per annum since 1978. Despite rapid economic growth, there are several significant problems facing sustainable development, most notably the huge regional imbalance. To wit, in 2004 the per capita GDP of Western, Central and Northeast PRC only accounted for 44%, 38% and 73% of the Eastern PRC's GDP respectively. The average net income for PRC's rural residents amounted to 3,255 yuan ($407) in 2005. This is less than one third compared to the 10,493 yuan ($1,312) earned by urban residents.

The "Reversal U" type of economic growth and regional balance posits a developing country should focus a limited scope of attention for a finite period of time in order to achieve effective growth, thus allowing a regional imbalance to exist. The regional policy is the government's tool for this unbalanced development theory. Since the reform that started in 1978, an imbalanced approach was adopted to allow certain regions to grow faster than others. The PRC adopted a "two-phase" strategy for regional development: encouraging the coastal regions to develop first and then having these regions help to develop the lagging inland regions. As a result, cities in the eastern coastal regions took the lead, not only driving nationwide development, but also establishing themselves as major pillars supporting national economic growth.

Two decades later, this policy has tremendously impacted regional development in the PRC, and its invisible hand has increased its influence over regional economic development. As a result, factors tend to flow toward higher yielding regions. The regional gap is widening. The Chinese government is greatly concerned that growing income disparities and sharply diverging living conditions between flourishing coastal cities and trailing rural "hinterland" may trigger social and political unrest. Further regional imbalance may lead to unsustainable growth, especially from the perspective of enlarging domestic demands and social stability.

In 2003, the new central government started a new round of regional policy adjustment. The central government put forward the view of scientific development and "five balances." These precepts include balancing urban and rural development, development among regions, economic and social development, development of man and nature, domestic development and further opening to the outside world. To level out regional disparities, current work should be directed at helping the regions that are lagging behind. To support these regions, the central government has taken concrete steps, including the Revitalization of Northeast Strategy (2003), and the Central PRC's Emergency Strategy (2005) following the Western Development Strategy (2000). The mainland of China accordingly can be divided into four regions by policy.

There was criticism for this plan which was described by some as a spreading of power that defined no real importance among these four regions. Critics also stated if preferential terms were given to all regions, the likelihood for action would be curtailed. However, an in-depth analysis illustrates this model will provide balanced development. It is a harmonious way to enforce the four parts to have their due function. On one hand, the Eastern coastal region should continue to upgrade and to enlarge its economy, while on the other hand, the other regions should exert their comparative advantages. Hence, making maximum use of each region's initiative and promoting interaction between the Eastern, Central and Western regions will allow them to complement and help each other and ultimately to develop together.

Of course, this is a new exploration and poses complex difficulties for the government to truly balance the developed regions with lagging regions. The government must neither hinder the fast development of the Eastern coastal region to enhance the competitiveness of the nation, nor further enlarge regional disparities.

The policy structure for balanced regional development is very important. First, it should depend on the functional regional division. It is foundational work for defining the functional position and main issues of each region in order to make appropriate policies. There are at least four kinds of functional regions: optimizing development, emphasizing development, limited development and forbidden development. Second, given that the regional disparity of per capita GDP will continue to widen for some time, it is important that living conditions and the opportunity for development should be equal. The policy also should pay attention to the equality of human development and public services. Finally, the balancing mechanism should be established to encourage market-oriented reform. To avoid the market failure, government intervention is necessary, but not at the expense of the market forces in regional development. Thus for Western, Central, and Northeast PRC, to provide additional room for market mechanisms to play themselves out is more salient than central government intervention and incentives.

In the PRC, the overall picture of small market enterprise (SME) policy can be observed through the Act on the Promotion of SMEs. It came into effect in 2003 and remains the only statute related to SMEs. The Act includes such policy measures as financial support, support for start-up businesses, support for technological innovation and market expansion. The Act also states the government will provide various information and training services for SMEs. However, the overall Act appears to be both too brief and ambiguous with no provisions for specific measures to be taken. Thus, it seems the PRC is still lacking a comprehensive SME policy.

Looking at global approaches to SME policy, generally two courses of action can be identified. The first approach, which is typically reflected in the SME policy of the United States, is that SMEs are market participants and therefore it is important for policy makers to ensure a fair and competitive market environment in order to promote the development of SMEs. The role of policy-lending financial institutions is limited and SME financing is mainly supported by the government guarantee to commercial loans. Supporting the start-up business is the core of SME policy in the US. However, contrary to this principle, there are several individual cases where US authorities tend to protect its internationally uncompetitive industries and enterprises.

The second approach can be understood through Japan's experience with its SME policy following World War II through the 1970s. The various disadvantages of the SME compared to large enterprises in terms of technical skills, human resources and financing capability were taken into account, and the primary objective of SME policy was to protect them against market forces. Accordingly, SME policy in Japan had only been one of the "industrial policies" for many years. It was notably characterized by the "industrial restructuring programs" aimed to adjust lag-behind SMEs to the new industrial structure in the mid-1960s. Various "market-distorted" measures such as preferential tax treatments, favorable government subsidies and favorable loans by policy-lending financial institutions specializing on SME financing were also introduced. Primary policy agenda was not necessarily to support start-up businesses and venture capitals during those periods. However, following the 1980s, the government started to recognize SMEs as market participants and contributors to the national economy with diversified skills and innovations. SME policy has gradually shifted from a protectionist approach to a more market-oriented approach. Measures now include how to work out a fair and competitive market environment and how to support SME self-endeavors to enhance their competitiveness. In this context, support to start-up business for SMEs and ventures has strengthened from the mid-1990s.

The PRC's current SME policy could be characterized as a mixture of these two approaches. In other words, there does not seem to be a clear vision about what kind of role the government should play to promote SMEs. This may partly reflect the current transitional nature of PRC's "socialist market economy." However it is also impacted by the fact that unlike Japan during its initial period of promoting SMEs from 1950s through the 1970s; the world economy surrounding the PRC has become incomparably borderless. Even SMEs are subject to competition not only with domestic large SOEs but also among foreign enterprises and multinationals.

The most salient reason for PRC authorities to promote SMEs comes from the requirement for absorbing redundant labor forces, particularly those in rural areas. In this regard, PRC authorities are required first to identify a basic vision for the SME policy, and then proactively work out various specific measures. In the meantime, the PRC could take certain protectionist measures, and may learn from recent progress in developed financial markets, such as the credit-scoring model loan, relationship banking and the development of asset-based lending, all of which could address the financial difficulty the PRC's SMEs continue to face.

These contrarians go on to argue that a regional imbalance or two-tier structure instead provides a solid basis for maintaining PRC's high economic growth and strong international competitiveness of PRC industries. Rural poverty forces people to go to urban areas to look for jobs and make money, and after working in the cities for one or two years, they return to their country homes with money and contribute to increasing consumption in rural areas, which in turn supports urban industrial production. And so it is argued that this kind of positive cycle enables PRC to sustain its current high economic growth.

Such an intriguing argument certainly makes a few compelling points. For instance, if we recall Japan's experience of when it achieved high economic growth in the 1960s and the boom came to an end in 1970s, we will find that the timing of when high economic growth was over generally coincides with the time when life in rural areas was greatly improved and regional imbalances almost disappeared. Nevertheless, we should recognize the following weaknesses with the contrarians' main contention.

The fact that rural people often feel happy and enjoy their lifestyle and the issue of regional imbalance or widening income disparity between rural and urban areas are obviously quite different matters. To be sure, when we visit developing countries or regions, we are from time to time surprised to see that rural residents often look very happy or even happier than people in developed countries living with many kinds of stress, and we may well reflect upon the meaning of development assistance or wonder if such assistance is really good for them. To do this kind of exercise and think about what is the best from the recipients' point of view is very important.

However, income gaps and regional imbalances, after all, should be properly assessed by various objective and quantitative indicators, such as real income, availability of goods and services, education, sanitation and mortality rates. From these indicators, definitely no one can deny there is a serious regional imbalance in the PRC. Perhaps one of the main reasons that rural people are satisfied with their current life is that they are separated from a lot of information and do not know much about the situations in urban areas. However, as television and the Internet penetrate rural areas, local people are gradually coming to know what is going on in other more affluent areas and will start to realize the discrepancy. Although there are no official announcements at all from PRC authorities, rumors and unconfirmed reports persist that quite a few riots happen occasionally in many rural areas. If that is indeed the case, what are the underlying causes? Are there reasons other than anger and complaints over poverty and the widening income gap?

In short, while it may be true to some extent that a two-tier structure supports the current high economic growth and international competitiveness of PRC, PRC cannot, or should not, overlook the issue of its widening income gap and regional imbalance by saying that rural people are generally satisfied with their life. High economic growth supported by regional imbalances and income gaps can never be sustainable in the long run.

For the last few years, the biggest tourism project in Hong Kong, China, was the construction of Disneyland on LantaoIsland, which is expected to attract more foreign tourists. However, the lure of foreign tourists has enormous uncertainties. For many developed countries, a Disneyland is already quite common and they have their own park or similar entertainments at home. (How many Japanese really want to go to HKC just to visit the latest Disneyland, while they have two of their own in Tokyo?) Foreign tourists from developed countries now want to experience something completely different from theme parks.

HKC may expect more tourists from the Mainland to visit Disneyland, but in the medium run, Mainland cities such as Shanghai and Beijing may become a competitor, in particular if the project in HKC shows signs of success. This casts doubt on the long-term sustainability of the project. (We may recall that a couple of years ago, already there was a heated argument about the possibility of constructing another Disneyland in Shanghai or Beijing.)

What is more important is that HKC authorities and people try to be responsive to the needs from foreign tourists and at the same time realize its own competitive advantage. HKC is geographically a small urban society with a fairly good public transportation system. Furthermore, unlike many people's preconception that HKC is just a crowded area without any natural environment, HKC actually enjoys affluent natural endowments.

For example, HKC has many small islands with surprisingly beautiful scenery. On each island, as well as in the new territory close to Shezhen, there are also mountains with marvelous trekking routes. In fact, one of the trekking courses is the so-called Macrohorse Trail covering 100 km which many foreign tourists come to walk every year; while it is interesting to see that only few HKC people show interest in this course. On the other hand, people in many countries are becoming more and more environment-sensitive and wish to live in harmony with natural environments, and to leave behind the congested urban areas and busy lifestyles.

The most drastic measure being considered by HKC would be to basically take out all cars and motorcycles from the town and try to make the whole of HKC an exclusive environment-friendly region ("eco-region") in the world by making best use of its unique geographical characteristics. If HKC tries to go in such a direction, traditional big infrastructure projects other than the construction of new metro and railway lines may lose some of its traditional ground. By doing so, HKC could survive to attract many tourists from all over the world and more importantly could show the rest of the world a future model of urban development.

It is interesting to note that unlike prevailing conventional wisdom, HKC authorities have been taking a somewhat interventionist policy in terms of financial regulation and public finance. HKC must have a certain advantage to take the initiative to create such community. However, the sad reality is that the majority of people of HKC are not really sensitive to the environment yet and furthermore environmental degradation has been steadily worsening, in particular due to the air pollution mainly coming from southern China region such as Shenzhen, Guangzhou and Dongguan. From this current stage to fully improving HKC's environment and thereby strengthening competitiveness of HKC's tourism industry, it will be indispensable to think about the future of the whole of the southern China area, including HKC. It is definitely a challenging but worthwhile task for HKC.

Until recently, the manufacturing, financial and tourism sectors used to be the three main engines driving the economy of Hong Kong, China (HKC). However, many of the manufacturing industries relocated to southern China in the 1990s looking for cheap labor and office rental costs: now almost no manufacturing industries are left in HKC. The financial sector of HKC does have some advantages still, but as the PRC authorities have been deregulating and opening financial markets on the Mainland after its entry into the WTO, more foreign financial institutions have started to expand their share of PRC and even try to shift some operations from HKC to Mainland cities.

For example, foreign banks expanded their branch network in the Mainland from 157 operational units in 2001 to 226 in 2005. In addition to this, foreign banks currently have 249 representative offices. They also actively participate in acquiring the equity of PRC financial institutions. Some foreign stakes hit the ceiling of 25 per cent and also a variety of foreign and PRC financial institutions became involved in equity participation. The scope of business of foreign banks on the Mainland has also been expanding. Now they are dealing not only with corporate banking for multinational enterprises but also with various services for PRC enterprises and individuals in renminbi. All these developments suggest that the relative advantage of HKC in the financial business is now waning vis-a-vis the Mainland. Although the HKC economy has shown a strong recovery for past few years after a long recession, these structural problems have not yet been properly addressed (see Bill Chou's recent Bottom Line article). That is why HKC authorities started to promote tourism for recent years as an alternative engine for growth.

For the full picture of the future of the tourism industry in HKC, we should consider both the supply and demand sides. On the supply side, the main weakness of HKC is that its history is relatively short and historical cites and monuments to attract traditional international tourists are quite few. In general, prices of goods and services are relatively high even in comparison with Japan. Of course, it naturally depends on which commodities and services, but many ordinary Japanese feel that price levels on average are at least 30-40 percent higher than back home. (We can imagine the 100 yen coin shop in Japan and 1 HKD coin shop in HKC. 1 HKD equals to about 140 yen, but the quality of commodities in HKC is not as good as those available in Japan.)

In the last few years, prices became a bit cheaper for tourists due to the decline of the US dollar to which the HK dollar pegs under the currency board system. However, in the medium run, if renminbi is further revalued and renminbi becomes fully convertible, HKC might exit from its currency board system. Then price levels in HKC will again become very expensive for many foreign tourists. What's more, the quality of services is not necessarily good enough (with some claiming that even the legendary Cantonese cuisine is beginning to lose its preeminence).

Meanwhile on the demand side, HKC's tourism industry has mostly relied for the past couple of years on a dramatic influx of tourists from the Mainland; while tourists from other regions remained stagnant. The main reason for this is that Chinese tourists have been allowed to make individual trips to HKC since 2003 under the CEPA. It is also notable that Chinese tourists spend a sizeable chunk of their holiday money purchasing commodities such as gold, precious metals and top brands. It is reported that average per capita spending of Chinese tourists in 2003 was more than 6,000HKD, while the spending of other tourists is between 4,000-5,000HKD. Is this likely to continue?

We should bear in mind the following: first, the PRC's economic growth may become more moderate in the near future from current annual growth rate of more than 9 percent to around 7 percent. Second, wealthy Chinese may start to choose other destinations, such as Europe. Third, as consumer markets in the Mainland become more mature, Chinese tourists will not spend as much money in HKC as now.

So it seems from both demand and supply sides, we cannot be that optimistic about the future driving power of tourism in HKC. Perhaps the HKC authorities need to work out a clearer vision of how to develop the region by attracting more international tourists. Such an undertaking would be indispensable for the economy of HKC in the future, assuming that other industries become less competitive than ever. In the concluding half, we consider what HKC authorities should pursue to promote their tourism industry.

A closer look reveals true picture

But behind these rosy figures stubborn structural problems persist within this economy. The tax base is surprisingly narrow. Attempts to broaden it by introducing a goods and services tax have been unsuccessful. The government's revenue relies heavily on land sales and stamp duty that are too volatile, as evidenced during the period after the 1997 Asian financial crisis. The transition from an industrial to a services economy has left a large number of workers with lower academic qualifications unemployed. The jobless rate for those with lower secondary education is 8.1%, a 4% higher rate compared to those with tertiary and degree level education.

The former competitiveness of the economy has worn itself thin with high land prices and labor costs. Movement to high value-added industries and a knowledge-based economy is stagnating due to the educational level of the workforce in comparison with the competency standards of emerging economies in Taipei,China, the Republic of Korea, Singapore and even major cities on mainland PRC. The benefits of the economic boom are not shared by all socio-economic classes. The earnings of semi-skilled and unskilled workers continues to be modest and the median income remains below its 1997 peak. The Gini coefficient rose above 0.52, among the highest worldwide.

Eyes open, hands tied

The government is well aware of the problems, but efforts to solve them pose intractable challenges. For instance, holding down land prices, a policy vigorously pursued by former Chief Executive Tung Chee Hwa has proved disappointing. Introduction of a goods and services tax is not feasible because of the strong opposition from major political parties that are not in power and are therefore not held responsible for policy failure. The quality of the workforce can only be moderately improved in the short term, despite the expansion of tertiary education. And the idea of a minimum salary is welcomed neither by the government nor by its main supporter, business people.

Unlike other East Asian emerging economies where governments actively involve themselves in directing industrial development, HKC administrations have historically embraced a "positive non-interventionist economic policy". As this name implies, the government actively nourishes a sound business environment, infrastructure and rule of law system but removes itself from choosing particular industries to support.

Mr. Tung tried to reverse the non-interventionist approach and designated HKC to become a regional hub for IT, Chinese medicine and fashion in order to diversify the economy. The policy was ultimately unsuccessful. His limited expertise combined with the administration's minimal experience in industrial development partially account for the failure.

Erosion of industrial base

The government has taken some measures to tackle these problems. To encourage manufacturers to return some of their production lines back to HKC and create job opportunities for workers with lower educational attainments, the government has relaxed its policy on importing labor for the manufacturing industries. Caution is necessary when assessing this policy. Even if it can successfully attract several manufacturers to establish factories in HKC and absorb unemployed workers, this would contribute little to the overall upgrading of HKC's manufacturing industry.

The cost of living and doing business in HKC is so high that only upscale industries have any real chance at survival. Yet few of HKC's manufacturers currently work in the upper scale industries. Even the southern part of Guangdong province, a long-time production base for most HKC manufacturers, has lost its edge to the inner provinces, Viet Nam, and Cambodia where production costs are much lower. Whether many manufacturing industries will be attracted back to HKC remains questionable.

A review of the electricity policy is going on. The main focus of the review is to lower the permitted rates of return for the power companies to 7-11% percent for different types of assets, down from the current 13.5% on fixed assets and additional 1.5% on assets financed by shareholders' funds. This review comes under a broader-based review of competition policy and has real potential for bringing down price levels and production costs.

Talent barred by bureaucracy

The government has introduced a more lenient work policy towards talented people from mainland PRC. HKC previously maintained a fairly liberal work policy for English-speaking foreign workers but not towards compatriots from the PRC. The historical relationship with the United Kingdom and Commonwealth countries, PRC's relationship with the Western world and the possibility of PRC citizens overstaying in HKC may help to explain this phenomenon.

After the 1997 handover, the HKC government revised its work policy towards PRC workers in managerial and professional categories with the Admission Scheme for Mainland Talents and Professionals and the General Employment Policy. Through these two schemes, more professionals with PRC connections and/or technical competencies are expected to work and enhance HKC's role in providing financial services to the PRC.

But so far these two schemes have not succeeded in attracting much fresh talent from PRC. In the first three quarters of 2005, less than 20,000 applicants, or around 0.6% of HKC's workforce, were approved. The small number was apparently due to the scheme's strict requirements. Applicants must first have an appointment in HKC prior to submitting their application. Additionally, their families cannot accompany them. The government hopes to further relax its policy later this year.

PRC citizens who have achieved certain academic and professional qualifications are allowed to reside and look for jobs in HKC. PRC graduates from HKC's universities are also permitted to reside during a certain period of job searching. The policy changes can certainly attract more PRC professionals to HKC and sharpen the edge of existing industries. Whether it can create job opportunities and boost domestic consumption is a matter of concern.

Coasting on past success

All these measures can be characterized by a minimal role for government in directing industrial and workforce development. The HKC government prefers to stick with its past practice of not selecting particular industries for support. Most people in HKC believe that their earlier economic miracle was largely attributable to the government's mainly laissez-faire policies. The cronyism and corruption found in other Asian states which are more proactive in economic development are cited in support of this belief.

The bottom line is that HKC's government, supported by the belief of its people in laissez faire economics, continues reusing ideologies and practices established by its colonial predecessors to deal with current challenges, tying its growth to the past not the future.

At first glance it seems there are differing views prevailing and the issue has become complicated but actually the situation is rather simple. Heavyweight players in the PRC bureaucracy are the Ministry of Finance, State Tax Administration and Ministry of Commerce.

Ministry of Finance and State Tax Administration are certainly in favor of terminating this treatment primarily from the revenue consideration as well as taxation principle (in particular the principle of "fairness"), while the Ministry of Commerce strongly opposes it, saying that this treatment is essential to encourage FDI which has been the main engine for economic growth in the PRC.

The fundamental difference seems to be that while the Ministry of Commerce tries to use the tax regime as one of the important policy tools, which may contribute to achieving a certain policy goal, tax authorities rather want to approach the taxation regime purely from the point of what makes tax logic. (It is interesting to note that we can observe exactly the same situation in Japan.)

In the past it seems that government ministries under the State Council had been just mechanically carrying out policies that were decided by the Communist Party without having their own views and opinions about policy matters. Or at least they did not explicitly express their views and tried to avoid giving an impression to outside that there are conflicting views among ministries and Party on any specific policy agenda. However, looking through the case of preferential tax treatment, although it is just one of many policy issues facing the PRC now, it is interesting to observe that ministries now start quite openly and actively to express their own views on various occasions. How should we interpret such a change in the context of the PRC?

First, it is apparent that the tight control over the mass media by the Communist Party observed in the past has been gradually loosened. Now it seems the Party does not necessarily care about giving an impression to outside that there are conflicting views within the authorities. Second, we have seen that in general PRC bureaucracy has been gradually changing over time reflecting a shift of economic structure from a centrally-planned to a more market-oriented one. (The milestone in this regard was the transformation of the former State Planning Commission to a State Development and Reform Commission in the late 1990s.)

We might suppose that each ministry has become a more autonomous entity to pursue its own policy. Third, we should note that there is a close relationship between the Ministry of Commerce and the foreign-invested companies and the power of the Ministry of Commerce appears to be supported by the strong, influential power of foreign-invested companies. This means with the deepening of the open economy, pressure from outside inevitably tends to affect policy decision-making within the PRC as well. (Another example is certainly recent foreign pressure on the revaluation of renminbi.)

Fourth, although the fact that bureaucracy becomes flexible may be a good sign, ultimately proper policy coordination is essential and in this regard, the role of the Party and maybe some other administrative body like the State Development and Reform Commission becomes more important. From this, they are required to have clearer ideas and policies than ever about what economic structure PRC is going to pursue for the future.

PRC and India want to grow first and go green later -- is it a good idea?

The rivers and skies of industrial Japan used to be filthy as it worked its miracle in the 1960s. Now they have been cleaned up without apparent lasting damage to the environment or health of the people (minamata disease excepted). The same environmental bounce back was true for postwar London or rust-belt Pittsburgh.

As countries get richer they tend to prefer more cleanliness, which they can then afford to buy. Conversely it is said that poor people by necessity have to accept living with more risk and dirt (or actually living on top of it in the case of Manila's Smokey mountain community).

Fossil fuel based industrial development and economic growth go hand-in-hand with environmental degradation. In most every case since the soot-glazed Victorian era, the world's industrialized nations have all polluted their domestic waterways and skies before achieving the economic prosperity required to pay for the clean up. The debate comes down to this -- who will bear the costs? And if no one will bear the costs, what will happen now and in the future?

Green vs. brown pollution

It now appears that the People's Republic of China and India are no exception to this well-trodden, but grimy growth path. Both nations rely heavily on coal and oil to meet their growing energy demands and both are already paying an environmental price with an increase in pollution-related disease and deaths because of poor air-quality and toxic waterways.

But can policymakers in PRC and India count on taking advantage of the same delayed trade-off enjoyed by the first comers or have times changed with pollution becoming too dangerous to ecosystems or wide-reaching with irreversible cross-border implications? It depends on what type of environmental degradation you are worried about.

Most of the developed world (including wealthy carbon emitters such as the United States and Australia) say they are concerned with cutting down "green" pollution (cleaner water, air, more trees and less greenhouse gases). But in the developing world pollution mainly looks brown: poor sewage, piles of unmoved garbage and diesel grime sticking to the sides of buildings and also peoples' lungs.

Very often dynamic, but imperfect markets, such as India's and PRC's, end up overproducing pollution, which few people want to buy and so is literally dumped. It is also a truism that markets tend to be bad at recognizing externalities and so the big issue is how the costs of environmental degradation should be captured and reflected fairly in the price mechanism. That means the main area for disagreement among policymakers from the developed and developing worlds revolves around how much and what type of pollution we should be prepared to tolerate for how long for a given level of growth.

Cleaner, efficient by-products

Experts at the World Bank and OECD-IEA are advising PRC and India to consider a range of energy options, especially various types of clean coal technology. Greater efficiency would undoubtedly help too. PRC is currently very inefficient (often double other countries) in energy use as measured by the energy required to produce one unit of GDP.

The most meaningful incentive for serious action may be the looming impact of rising energy, food, water, and raw material demands in both countries. Already India's oil consumption has doubled since the early 1990s and PRC has gone from near self-sufficient oil production to being the world's second largest importer of oil in just ten years. Studies from the International Energy Agency (IEA) suggest that by 2020 the Asia Pacific region alone will have doubled its consumption of oil from 1997 to a staggering 5.6 billion tons.

Moreover, this growing resource demand has the potential to increase geopolitical instability as 2.5 billion Chinese and Indians compete for a share of world's natural resources.

In response to these pressures the latest 5-year plan from Beijing is beginning to stress the importance of fixing the environment by relying on (primarily homegrown) technological advancement. But the problem with this approach is that it is both slow and expensive, and in the meantime energy usage in the PRC is growing at well over 10% per annum.

Yet investing in clean-development technology now would certainly mitigate future costs associated with environmental-related health problems and with the cost of eventual clean-up measures; surely a win-win scenario for both countries, and for the world.

Promise of carbon trading

Greater energy efficiencies and cleaner technologies with lower emissions are part of the answer but will they be affordable for, and eventually deployed in, developing countries where they are most needed. Similarly, worldwide trading of carbon emissions is finally getting going and might be a help, especially if the partnership between Japan and the PRC can work effectively in this area.

But some experts argue that at best, carbon trading -- which addresses the issue of who ultimately pays -- will only be a small part of the answer. The Executive Director of the Australian Bureau of Agricultural & Resource Economics, Brian Fisher, commented recently on prospects for the use of carbon trading. In theory, he said, trading should be an effective and low-cost way to reduce emissions. "But it's just not practicable: we can't negotiate a complex instrument through the United Nations."

At the recent inaugural meeting of the Asia Pacific Partnership on Clean Development and Climate (APPCDC) six nations including the United States, Australia, Japan, China, Korea, and India made multi-million dollar pledges to voluntarily invest in sustainable energy generation and technology cooperation. While the partnership process brings these countries to the table to discuss green technology cooperation, so far it lacks the hard targets or incentives to pursue greenhouse pollution cuts. Critics argue that without targets, timetables, and market-driven incentives to encourage clean technology development and use, APPCDC will not be able to effect any meaningful change.

And still largely avoided is the vexed debate over the potential for nuclear energy to displace fossil fuels to generate electricity, both in the developed and developing worlds, especially as the promise of renewables has yet to materialize as commercially viable.

Local choices with global impact

Fortunately, PRC and India have voluntarily begun to announce targets for energy efficiency and renewable energy. What's more, both countries could even be poised to leapfrog industrialized countries in the development and use of green technologies. After the APPCDC meeting, WorldWatch President Christopher Flavin pointed out, "The encouraging sign is that if China and India were to choose...they could push the world in a new direction." He added, "the choices the two countries make will have a huge impact on the quality of life throughout the world."

A new report from the Worldwatch Institute, a Washington DC-based think tank, offers its "State of the World 2006" and focuses on the global resource and environmental impact of the economic rise of India and PRC. The report optimistically points out that the PRC already uses solar technology to heat water for 35 million buildings, and has growing investments in the use of wind farms, small wind turbines, hydro-generators, and biogas pits in rural areas. For its part India has pioneered the use of rainwater technology and now has the fourth largest wind power industry in the world.

The PRC is also exploring ways to create a more "circular economy" that brings together industries that will use (and pay for) each other's waste as raw materials. And the emerging carbon credit market looks like a promising way for India to finance economic development by reducing domestic carbon dioxide emissions and selling current credits. Nevertheless, the relentless increase in domestic energy demand and consumer consumption will make it very difficult for any environmental gains to stay apace.

The bottom line seems to be that with more demonstration and commercial scale projects being tried out in PRC and India, both countries may come over time to appreciate more keenly the economic merit in pursuing clean development now rather than later, in partnership with technology suppliers from the developed world.