It is necessary to address carefully the future of the Chinese economy, but it is unreasonable to become too pessimistic.
Different from small economies, China has its own “wild goose queue effect mechanism” to buffer it from the pressure of new cost conditions. Therefore, it is almost impossible for the disruption of transition to occur between two growth stages and models. On the contrary, it is likely that China might retain continual high-speed growth for ten or twenty years into the future by such transitional means as the redistribution of capital between different regions.
Barry Naughton predicts the potential of China’s economic growth in the future with a very meaningful conceptual frame. Namely China’s economy will shift from the stage of hyper-growth to moderate growth. In particular, he emphasizes that the absence of the channels for steady transition between these two growth stages is the key to understanding the fact that China’s economy might already have started to slow down.
His speculation has been made through considering the experiences and lessons in the slowdown of growth in Japan, Korea and Taiwan. After the hyper-growth of 1955 to 1973, Japan suddenly faced a steep drop in its economic growth rate from 9.3 % before 1973 to around 4 %. This situation continued until the late 1980s. The appreciation of the Japanese yen caused by the oil crisis and the cancellation of the convertibility of the US dollar into gold was just a trigger for the “plunge” of the growth rate. The core problem of the Japanese economy lies in the track of the transition from the hyper-growth model to the moderate growth model. Japan failed to tackle this issue well and got derailed. According to Barry Naughton, there are good reasons for people to challenge how the Chinese economy realizes the transition from hyper-speed growth to moderate growth, based on the lessons of Japan, Korea and Taiwan.
Indeed, the plunge of the growth rate that occurred in Japan around 1973 is rather puzzling. But I am not at all surprised at the drops of the growth rate in Korea and Taiwan as proposed by Naughton because they seem more moderate and progressive in the reduction of speed. During the period from 1973 to 1990, Korea and Taiwan both retained growth rates above 7.5 %. From 1990 to 2010, the economic growth in Japan was only 0.63 %. But during the same period, Taiwan and Korea retained a growth rate of over 4 %. And more importantly, when people find that the economic growth has slowed down in Korea and Taiwan, the level of per capital income of these two economies has already approached Japan’s standard. In fact, when estimated according to purchasing power parity (PPP), it was during the period from 1995 to 2010 that the level of per capita GDP of the Asian Tigers approached Japan’s standard. So the situation that the slowdown of growth rate occurred to Korea and Taiwan after they had retained high-speed growth for 25 five years basically conforms to the principle of “convergence”.
But Japan was different. In 1973, its per capita GDP only reached about 60 % of the USA’s standard when estimated according to PPP. It was therefore unusual that it suddenly lost economic growth. The situation was similar to the steep drop of agricultural output during the period of the collectivization of agriculture from 1957 to 1962 in China. It can be speculated that the problem might be caused by the sudden change from high-speed growth to negative growth in total factor productivity (TFP). But the issue is that people are not completely clear about the reason as to why this could happen.
As a matter of fact, most people in China hope that the country’s economy might have a new growth model based on domestic consumption and diversified internal demand rather than the present hyper-growth model based on export and investment. In a certain sense, such a hope is correct because the conditions in demand and cost that support hyper-growth will change some day anyway. But Professor Naughton did not mention how high a growth rate has to be tobe termed moderate. The moderate growth model is just a sustainable growth model which relies more on sustainable demand conditions. The growth in such a model is based on large amounts of high quality labor and diversified domestic market demands.
Professor Naughton reminds us that, while it might be true that China is advancing toward this stage of moderate growth, the problem is that it is not certain whether its economy can realize the steady transformation from the first stage into the next stage as most people have expected when the changes in such conditions in demand and cost come too fast. Now, just like many people, more and more economists show strong doubt on whether China can retain faster economic growth (for example, 8 %) into the future. There are many economists who even believe that China has basically lost all its power to retain rowth. The collapse of China’s economy is inevitable if people do not implement political reform.
These pessimistic views do seem to match some structural problems that have been accumulating in China’s economy in recent years, as people can see. But I always believe that the structural problems in the economy are exaggerated in general. Professor Naughton quoted the data on trade surplus in 2007 when discussing the structural problems in China’s economy. In that year, China’s trade surplus approximated 10 % of its GDP, which was a typical abnormal value.
The real fact is that, although China achieved strong exports over the past ten years, the proportion of its trade surplus only accounted for about 3 % of its GDP, which could not be called serious structural imbalance. Although the growth of domestic household consumption was slower than that of GDP, the gap between the growth rates kept narrowing over the past decade. Today, this gap is only around 1 %. In addition, when considering that 40 % of the rural population will flow into the city in the future, people can expect that the investment demand released by the urbanization process will remain very strong for at least in twenty years into the future.
I also believe that most people should be more careful when they criticize China’s investment efficiency. A calculation that Zhu Tian of the China Europe International Business School (CEIBS) and I have done gives us some confidence. Over the past twenty years, China’s average incremental capital-output ratio (ICOR), namely the result of the average rate of investment divided by the average growth rate, reached 4.06, which only showed slight rise in comparison with the average ICOR of 3.86 from 1981 to 1990. People should know that it is not easy to achieve this. In general, ICOR will also rise as the level of economic development improves and per capital income rises. We also find, after using data from the World Bank, that high-income countries as a group showed ICOR figures of 6.32 and 12.62, respectively over these two decades. Did they also have higher rises? In contrast, China’s investment efficiency did not exhibit a large change in general and showed even a lower absolute value. In fact, such a result is easier to understand because people will have no other way to explain how China has achieved an average annual growth rate over 10.5 % in the past 20 years. Therefore, my opinion is that it is necessary to address carefully the future of China’s economy though it is unreasonable to be pessimistic.
It is an undeniable fact that China’s economy showed hyper-growth (10.5 %) over the past two decades. Today, we find that, just as Professor Naughton has mentioned, dramatic changes are occurring to the conditions in cost and demand that originally supported hyper-growth, exactly because of economic hyper-growth. Such changes include the fact that the speed of transfer of rural surplus labor slows down significantly, that wages keep rising, that the constant popularization of education results in the continual decrease of the proportion of low-skilled labor, that the costs in industrial land use see large increases, that the renminbi appreciates continually, and that trade frictions become worse. We can easily see that it is the cost that these condition changes brought about by hyper-growth that has really changed. So we can also say that a new cost condition is taking shape.
As to demand condition, it seems that no apparent evidence can be found to prove that it will have unfavorable changes. In fact, the demand conditions to support high-speed growth in the future are not at all deteriorating. This is because the drastic decrease in the growth rate of export in China is only a temporary phenomenon during the global economic recovery. The worsening trade frictions with some European and American countries reflects the fact that China still has huge potential and competitive advantage in exports. As wage income rises and urbanization accelerates, the growth and upgrading of domestic consumption will only accelerate rather than slow down. The investment demand further released by urbanization and industrialization will last at least for 15–20 years.
Therefore, whether China’s economy can still retain high growth in the future mainly depends on how its growth model successfully adapts to new cost conditions. Just as what Professor Naughton has said, it depends on how China transforms from its original growth model into a new growth model. An obvious key point is how the new growth model can adapt to new cost conditions. Or, from another perspective, whether new cost conditions can successfully induce a new growth model is, of course, a key point.
But I am not as pessimistic as Professor Naughton on the issue of the transition between two growth models because I believe that China has more advantage than Japan with respect to sucha transformation. That Japan is too small in size is naturally the main reason that the country has met problems in the transformation and transition of the growth model and that have resulted in a large plunge in the growth rate. First, because of its small size, Japan’s domestic demand was limited, so the hyper-growth of its economy seriously relied on exports over a long period. Second, because of the small size of its economy, the change in cost conditions became very intense and naturally delivered a larger impact on economic growth.
The oil crisis in 1973 and the first major appreciation of the Japanese yen after the breaking of the peg of the US dollar with gold both contributed to the landslide in Japan’s export. And its narrow domestic market failed to allow its enterprises to find a good buffering space to respond to these changes in external conditions.
As another example, the research of Japanese economists finds that the Lewis turning point occurred in the 1960s when the Japanese economy was midway in its high-speed growth. Because there is no buffering space, the termination of the flow of labor between the city and the countryside and the rise of wages delivered a fast and particularly large impact. The rise in the cost of industrial land use also became fierce and hit investment heavily. The changes in these conditions forced Japanese enterprises to flee the country in order to survive, which later evolved into the “hollowing out” of the Japanese economy.
In addition, Japan’s domestic service industry was much too closed off under the high protection of the government, which also contributed to the difficulty in domestic economic transformation. This is another main reason whythe Japanese economy failed to respond well when confronted with the changes in cost conditions.
I want to remind Professor Naughton of the fact that China can transfer its growth impetus from the eastern regions to the inland provinces. These regions possess sufficient labor to retain high-speed economic growth. In effect, as China has so massive a size that the differences between regions and provinces are much larger than most economies, the changes in cost conditions can never hit the country as intensely as they did in Japan and their impact on economic growth will also be much milder.
China does have the opportunity to transfer gradually its economic engine into the inland provinces as a channel for model transition. This is because the country still has a considerable amount of low-skilled labor, even though its coastal regions are confronted with a shortage of unskilled labor. The reason that such labor cannot flow into the eastern regions as before is because the manufacturing enterprises in the eastern regions cannot bear the pressure of wage rises and they need to move out of the eastern regions themselves.
If a person has visited China’s inland provinces in recent years, he or she would have found that they put large amounts of investment into public infrastructure and worked hard to accept enterprise investments and factory immigration from eastern regions. Thus it is easy to understand that, because of this, most inland provinces experienced over 10 % GDP growth in recent years while the growth in eastern regions saw some drop. So, different from small economies, China has its own “wild goose queue mechanism” to ease the pressure from new cost conditions. Thus it is almost impossible for the disruption of transition to occur between the two growth stages and models. On the contrary, China might retain continual high-speed growth over ten or twenty years into the future through such a transitional approach as the redistribution of investment between different regions. Indeed, inland development might become a natural channel to realize the steady transition of the development model.
In 15–20 years time, China’s potential economic growth will not be low and it is very unlikely that the country will become trapped in low-speed growth (5 % or lower). China’s per capita capital stock is still about USD 19,000 (in 2005US$), lower than 15 % of that of the USA and equal to 23 % of that of South Korea. Even if it enters the stage of upper-middle income in general in ten years’ timer, there is still plenty space for of catching up between different regions. There are very large gaps in per capita capital stock and per capital income between eastern regions and central and western regions and between coastal regions and inland regions (see Figs.
1.1 and
1.2).
The processes in industrialization and urbanization show that investment demand is still strong in Chinafor the following reasons: First, the proportion of the population employed in agriculture and other sectors in the industry are still larger today so that there is still a huge space for the transfer of labor into manufacturing and service industries (see Fig.
1.3). If China lowers the proportion of employed population in the primary industry at an average rate of 1 % per year as over the past 30 , it still needs 20 years to redistribute the proportions of the employed population in different sectors so that they approach the averages in most of the high middle income countries. Second, China’s urbanization rate has just reached 51 %. It still has 20 % to work for to reach the average standard of high middle income countries in the future. This also needs 20 years.
People need to encourage diversification in the economic structure so as to realize the transformation of the growth model. China’s economy needs to adapt to new cost conditions. Such adaptation might last for some time as the upgrading of structure never finishes in an instant. The good signal that we have already observed is that the fast flowing of labor and capital has already started to occur between different regions. A large group of enterprises have migrated into inland regions from the Yangtze River Delta and the Pearl River Delta. The service industry exhibits a very good development trend in the eastern coastal regions. As I have noted above, it is crucial that China successfully realizes the diversification of its economic structure to adapt to new cost conditions. This means that structural transformation will continue to play its role in the track of high-speed growth in the economy in the future. It will not only support steady transition but also contribute to the growth of total factor productivity. Considering the conditions which are changing at present, particularly the rapid growth of high-quality labor and the transformation of economic structure, I believe that total factor productivity will play an important role in economic growth in the future.
The emergence of new cost conditions functions as the catalyst to economic adjustment and structural change. The transformation into a new growth model relies on the successful transfe...
