Application of cost-benefit analysis in China : a case study of the Xiamen special economic zone

Abstract

Special economic zones were introduced as an important component of China's open-door policy. Although the impact of the growth of special economic zones is not large in the context of overall development, or even in the growth of exports, their performance has attracted considerable attention. It is also of interest to policy makers in China, who are seeking to evaluate existing and possible economic policies for industrialization in a reformed economic system. This study develops a cost-benefit analysis framework within which shadow prices can be consistently estimated, to undertake evaluations of public investment in China. A shadow price of capital is calculated for China as a whole. Because of the large size of the geographical economy, market segmentation and restricted geographic labour mobility, the estimation of the shadow price of skilled and unskilled labour is only applicable to the Xiamen zone. These shadow prices. are employed in a case study, to facilitate analysis of the economy of a region in the Xiamen special economic zone, the Huli export processing zone. Some recommendations are made on improvements in resource allocation which could enhance welfare gains from the special economic zone. The study of shadow prices suggests that the nature of the centrally planned economy and the pursuit of self reliance at all costs distorted the Chinese economy. The limits placed on the operation of market mechanisms have resulted in a great divergence of market prices from economic prices. The shadow prices of capital and labour indicate that the actual prices facing producers are highly distorted. The market price of capital is well below its true opportunity cost to the economy, while that of unskilled labour is well above its opportunity cost. Hence, the Huli zone has been the recipient of very large capital subsidies which have represented high costs to the Chinese economy. Real labour costs faced by zone producers and construction firms, on the other hand, are relatively high in relation to the opportunity cost of this labour. Given China's factor endowment, it needs to use labour intensive techniques for export. But in reality, there is a strong tendency to favour most recently developed technology. The Huli zone is therefore dominated by excessively capital and technology intensive techniques in the provision of infrastructural services and production. The case study shows that the Huli zone project is not viable economically unless the positive externalities, such as technology and managerial skill transfer have significant effects on the Chinese economy. To raise the welfare effects of the Huli zone, the design of the zone should be improved. Sensitivity analysis confirmed that the Huli zone should adopt more appropriate technology, reduce capital intensive inputs, markedly reduce domestic borrowing, eliminate government subsidies in the usage of public utilities and encourage the use of more local raw materials and capital goods inputs. This would lead to an appreciably higher economic rate of return to the Chinese economy.