Growing pains

China's dramatic economic growth is now presenting a new challenge: urban policy.

China's dramatic economic growth is now presenting a new challenge: urban policy. Mass migration to cities is leading to the loss of arable land and urban sprawl; spiraling demand for energy and natural resources; and the rising challenge of providing social services like education and health care, particularly to migrants. It's time for policy makers to rethink their approaches to all these problems.

About 600 million Chinese already live in cities, but that represents only 45% of the population, compared to over 80% in the United States. That suggests Chinese cities are likely to grow considerably. New research by the McKinsey Global Institute projects China's cities will add another 350 million to their populations by 2025, of which 240 million will be migrants from the countryside.

This influx could push cities to their breaking point. By our estimates, demand for energy in urban areas will likely more than double; demand for water will increase by between 70% and 100%. Providing healthcare and education to new migrants will severely strain cities' ability to fund these critical services. Depending on the shape that urbanization takes—more concentrated, or more dispersed—arable land could be depleted by 7% to 20% nationwide.

Rather than addressing each problem on its own, it's time to think of all these problems as facets of a bigger underlying challenge: how to increase urban productivity to enable both economic growth and more livable cities. By urban productivity, we mean an agenda for both the public and private sectors that would improve the quality and efficiency of urbanization, while moving away from the current focus on maximizing GDP growth of China's cities at any cost.

This approach would require systematically tackling the factors that currently make Chinese cities so inefficient. Urban planners would focus on growing its cities up, not out. Using zoning laws to encourage the more efficient clustering of taller buildings, along with a beefed-up investment in transportation infrastructure, would create more livable city environments while containing land and resource pressures. Policy makers would also devote more attention to managing the demand for resources, rather than simply building supply infrastructure as needed. By introducing peak-hour electricity price premiums, deregulating gas prices, and mandating the use of more energy efficient technologies such as compact fluorescent lighting and light-emitting diodes in the construction of all new buildings, urban China could reduce its energy demand growth and potentially cut oil demand by more than four million barrels per day.

Improved urban productivity will also deliver real financial benefits, particularly to small- and medium-sized cities which are finding the funding of urbanization itself more challenging. Sourcing sufficient funds to provide for adequate infrastructure and to improve public services for migrant populations without raising taxes is a challenge that all urban planners already face. One step will be improving the productivity of the public services that cities deliver. For example, deploying capital investment in transit infrastructure more efficiently through better rail network planning and increasing non-fare revenue, or better managing the more than $100 billion spent annually by local governments on fixed asset expenditures.

Despite the expense and challenges, this kind of holistic strategy is the best—and perhaps the only—way forward. And the benefits could be considerable. Our research suggests that such policies could help reduce government spending in 2025 by more than 1.5 trillion yuan ($215 billion at today's exchange rate) per year, the equivalent of 2.5% of China's projected GDP that year.

A comprehensive "urban productivity" model is already working—in China, no less. Since 2006, the central city of Wuhan has launched a progressive, transparent performance-management system designed to promote sustainable economic development and raise public-sector productivity. Wuhan has implemented a broader set of performance measures for government entities that reward the reduction of energy consumption, or the design of more environmentally friendly economic development policies. Since these measures have been put into place, Wuhan has reduced energy consumption per unit of GDP by 4.5%, compared with the nationwide average of around 3%, and cut administrative red tape in half. At the same time, GDP growth has increased to 15.5%, from the average 13% growth of previous years.

Through policy direction and incentives, the central government can do much to influence how urbanization plays out in China. But while Beijing plays an important role in guiding the overall direction of urbanization at the national level, it is city leaders who make many of the key decisions that shape the path and pace of urbanization. For the long-term sustainability of China's new urban economy, it is vital that the broad swathe of China's cities—rather than a far-sighted few—adopt an urban productivity agenda. Getting the process right now will be far less costly than attempting to fix problems further down the road.

Jonathan Woetzel is a director in McKinsey's Shanghai office. Janamitra Devan is a senior fellow at the McKinsey Global Institute.

This article was originally published in the Wall Street Journal Asia, April 14, 2008.

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