The Chinese government has repeatedly insisted that the economy has moved into a “new normal,” with slower but sustainable growth. The Chinese stock market, after a more than 100% rally from last year to June this year, retreated by about 40% after its peak in mid-June. During the stock plunge in the past two months, the central government responded with “massive rescue measures”. In mid-August, the People’s Bank of China, or the central bank, unexpectedly depreciated the yuan by more than 3%.
China’s economy used to have little impact on the global economy. At present, however, nearly half of the global economic growth is being driven by the Chinese economy. Based on the standard of purchasing-power parity, China has already overtaken the United States to be the biggest economy in the world. In such circumstances, people could not help to ask these questions: Where is the Chinese economy heading for? How are the growth prospects of the Chinese economy?
To answer the questions, quantitative analysis and a better understanding about China’s national conditions are prerequisites. Furthermore, China’s future development strategy should also be taken into consideration. Without these criteria, a correct conclusion could not be reached, and the mistakes that most Western commentators have made in the past 30 years about China would be repeated again.
Data are needed for quantitative analysis. For people who are unfamiliar with the use of data, however, they would find it impossible to tell what data are questionable and what data are reliable. In China, we should be cautious about some data. For example, some unknown expenses are not included in the government’s fiscal budget; local governments, in submitting their gross domestic product, sometimes choose to exaggerate their data for a kind of showoff, but when taxation is involved, citizens or local governments will choose to under-report their incomes; and in foreign trade, in some extreme cases, some people would ship the same batch of cargo across the border and transport it back again, declaring the contents as exports and imports, in order to inflate the trade data.
These problems are fairly common in developing nations, but it is impossible to measure their impact. For instance, while import and export data are all being inflated, the trade surplus, which means the actual amount of foreign exchange reserves, could not be inflated. And, imports and exports do not have a direct bearing on GDP while trade surplus or deficit will have.
In fact, the biggest misconception about GDP is that many production activities are actually not included. In essence, GDP means the value of total social production, but many production activities, which are not subject to market transactions, are not recorded and computed into GDP. For example, cooking at home is a kind of production activity that produces value, but it could not be computed into GDP, on the other hand, expenses for eating out are included in the GDP figure.
Investment in children’s education
In China, one of the biggest investment activities is the investment in children’s education, but this, to some extent, is not recorded or computed into GDP. Therefore, the GDP figure is always underestimated. Robert Fogel, a Nobel-winning economist, believed that China’s GDP was undervalued, because the GDP figure failed to include the massive amount of family investment in education, and this kind of investment would naturally produce an important influence on the future economic growth.
It’s not the Chinese government that has been exaggerating the Chinese economy. When the World Bank said that China’s GDP was the biggest in the world last year, Premier Li Keqiang said the claim was nothing but flattery words about China. According to the World Factbook issued by the Central Intelligence Agency, China’s GDP was far too undervalued according to the exchange rate. When the economies of many countries across the world were on a downward trend, however, some people claimed that this was triggered off by a slowdown of the Chinese economy.
If there is reliable quantitative analysis, it will be the Country Report, which is issued by the International Monetary Fund every 12 months. In the more than 100-page-long China Report issued in August, the IMF included a big quantity of latest data and analysis, and explained its differences and similarities with China’s official views. We don’t have to agree with the analyses in the report, but they are of value for our reference. The IMF holds a cautiously optimistic view about the prospects of the Chinese economy, which is sharply different from those who tend to believe that the Chinese economy is on the verge of collapse. I did an estimate about China’s production function and analyzed China’s future economy based on the estimates. My main conclusions are not completely identical to that of the IMF, but basically similar.
The important reason for a slowdown in China’s economy is the changes in its development strategy. During the transitional period, the growth rate is highly probable to be low. What are the main features of China’s old development strategy? What are the changes in its new development strategy? Are there any problems with its execution and implementation of the new development strategy?
Adjustments to economic strategy
In the past 30 strong years of reform and opening-up, China relied on several factors to drive its economic growth. An important factor was the transfer of low-cost labor from the rural areas to cities. A huge number of rural laborers were sent to factories and immediately joined industrial production. These workers from the rural areas gradually accumulated production experience and improved their skills. With this factor, China fully tapped its advantage in the labor force, and it generated instant effect in driving the economic growth.
India, however, relied on high-end information technology to drive its economy. In this process, only a very small portion of Indians could join the industry of information technology, and it was slow process and took time for the strategy to bear fruit in terms of macro-economy. When labor costs began to rise in China, fresh migrant workers from the rural areas joined the force again. The ongoing massive urbanization process injects new impetus to drive economic growth. And in recent years, many factories in the coastal regions chose to relocate in the hinterland areas to tap the advantages of labor in those regions. Manufacturing industry not only needs a big quantity of laborers, but also calls for big investment. China no longer relied on foreign investment for growth, and instead, the extremely high savings rate, as high as 50% of the GDP, is now the main source of capital for investment and development. Low-cost labor, urbanization and high savings rate are the striking features of the China growth.
In the past few years, however, the strategy has been undergoing adjustments. The most noticeable change is with the secondary industry, the biggest part of the economy, that includes manufacturing and construction. The secondary industry, however, has been overtaken by the services industry. In 1980, the proportion of the manufacturing and construction industries in GDP was 47.9%, but in 2014, its share had already dropped to 42.6%.
The services industry accounted only for 22.2% of GDP in 1980, but in 2014, its proportion had already risen to 48.2%, overtaking the secondary industry. This, however, could not be understood as a de-industrialization process. Still, it is undeniable that the services industry is becoming increasingly important in GDP. One characteristic of the services industry is that it is more labor-intensive than any other sector. For the output of the same unit GDP, the services sector will use 30% more laborers than other industries. Therefore, if the economy develops towards the services industry-focused direction, more job opportunities will be created to absorb rural laborers, even if the GDP growth rate slows down. To a country like China, a low unemployment rate is extremely important for social stability.
China’s economic transition also involves the interaction of other factors. The first factor is the gradual improvement in the technological level of products. If development is driven solely by the low-cost labor force, China will encounter fierce competition from countries such as Vietnam. Upgrading the technological level of products, however, calls for support from research and education, which often take time to bear fruit. The good news is that China’s expenses for scientific research have already exceeded 2% of the GDP. It is undeniable that this figure is somewhat inflated, because some expenses set for the sake of research turned out to be spent elsewhere. It is also a fact, however, that China is now the second-biggest country in terms of research papers published in the 68 top-end science magazines in the world. Scientific achievements involved in those papers published in these magazines could be easily recognized by the international academics, because any cheating or falsification would be readily exposed.
The second factor is the gradual modernization of the financial system. According to an IMF report, China plans to make the yuan a freely floating currency in two or three years. Recent exchange fluctuations have shown that the modernization of the financial system and exchange rate reforms are no easy job, although the changes are made in the right direction. The third factor is to gradually lower the savings rate and to stimulate consumption. And the fourth factor is to continue the crackdown on corruption and graft.
If China succeeds in the transition from a secondary industry-driven to a services industry-driven economy and with other supporting strategies, the Chinese economy will be able to witness a high-speed growth in a fairly long time. The timing and implementation of these strategies, however, are difficult and will test the policymakers’ wisdom. In developed economies, the services industry usually accounts for more than 70% of the GDP (in Hong Kong, as high as about 90%). In China, however, it is still at a level of less than 50%. Therefore, there is still great potential for development, and it will probably take more than 20 years to achieve the goal.
The following are a few suggestions for China.
First, it’s not the time to de-industrialize, and manufacturing industry still has to get priority for development, and it will be unwise if China gives up its hard-won advantages in manufacturing, which were fostered in the past decades. The development of services industry takes time, and in developing the services industry, manufacturing should not be sacrificed. If the yuan appreciates too fast, it will increase production costs and weaken the country’s competitiveness, therefore, China should not surrender to the pressure from the United States for yuan appreciation. In the past year, the yuan already appreciated more than 20% against the euro, Japanese yen, Canadian dollar and Australian dollar. It’s now the right time to consider its depreciation to a level lower than the equilibrium, and then let it float freely.
Second, China has no need to tackle the rising savings rate. A high savings rate may mean less consumption, but it is also helpful in accumulating funds and driving economic growth, and a high savings rate will eventually translate into high consumption in the future. A savings rate, which is able to maximize the present discounted value of one’s lifelong savings, is called the golden-rule savings rate, and the level of this savings rate is decided by how fast the productivity is developing and how efficient the accumulated fund is utilized. I also conducted an estimate about the highest savings rate that China could possibly tolerate, and concluded that the current 50% savings rate is fairly close to the golden-rule savings rate. Therefore, there is no need for the government to intervene.
Third, ethically and morally, the ongoing anti-corruption drive is a move in the right direction, and it will positively affect economic development in the long term. However, graft is actually a kind of lubricant needed for smooth market operations after the market was twisted under government intervention. Without such a lubricant, economic activities might become stagnant, and government officials would not have the courage to perform their duties or would be unwilling to do anything. Graft should be cracked down upon, but the anti-corruption drive should mainly target “big tigers” (high-ranking officials), and give the “flies” (low-ranking ones) a chance to repent and then be pardoned.
Slow and steady steps
The cconomy has its own law of development. Even if the direction is right, there’s no guarantee for success. The timing, dynamic and implementation methods all call for wisdom. In the 1990s, when Eastern European nations adopted “shock therapy” in an attempt to achieve the goal of a market economy in a once-and-for-all approach, the consequence was grave: It was beyond the bearable level for the people and the economy landed in deep trouble. Judging from the “massive rescue measures (for the stock market)”, it could be determined that China still follows the mentality of “brute force”. By “brute force” here, it could mean violent or forceful measures, but to be exact, it means “reckless moves.”
By applying reckless measures to solve problems, the results could be as bad as that of the “shock therapy,” and this could likely cause more troubles and trigger volatility in the financial markets. Reckless measures should be avoided, and smart moves should be applied. State-owned enterprises should exit from the competitive industries so that private enterprises could play their role, and private enterprises should be able to access to easier financing for their growth and market competition. Inefficient State enterprises should be liquidated. All these will lead to the creation of more job opportunities. The Labor Law stipulates that if an employee has worked for a company for 10 or more years, the company would not have the power to fire him or her. The law, which went into effect in early 2008, has actually become an excuse of enterprises to fire or lay off workers before they reach the 10-year level. It would be considered smart moves if private enterprises are given bigger room for development and if that clause of the Labor Law is annulled.
The direction of China’s economic development strategy is correct and reasonable. After more than 30 years of development, China has become one of the major economic powers in the world, but this does not necessarily mean that China knows well how to allocate its accumulated rich resources. China has all the strength it needs, but it lacks the skills of making or deploying the smart moves. During the transition of its economic modes, the government should always keep in mind: Haste makes waste. If China chooses to slow down a little bit, it would be easier for China to succeed and achieve the goals it has anticipated.
This article is translated from Hong Kong Economic Journal.