• Thu
  • Jul 10, 2014
  • Updated: 9:57pm
PUBLISHED : Friday, 07 February, 2014, 5:17am
UPDATED : Friday, 07 February, 2014, 12:54pm

To continue growing, China will have to work a lot smarter

Productivity is the growth driver that will determine whether the optimists or pessimists are right when it comes to China's outlook

As ever, there are two views about the outlook for the mainland's economy. As usual they could hardly be more different.

Everyone acknowledges that its economic growth has slowed, decelerating from double-digit rates as recently as 2010 to a relatively modest 7.7 per cent last year.

But the optimists believe that's about as low as the growth rate is likely to fall, and that the mainland will successfully maintain growth of around 7.5 per cent for the rest of this decade.

The pessimists, in contrast, argue that the slowdown has barely begun. They expect the annual growth rate to slump well below 5 per cent over the coming years.

Both camps recognise that China's economy needs to reform and rebalance, becoming a lot less dependent on credit-fuelled investment by local governments and state industries and a good deal more reliant on private service sector businesses.

Where they diverge is on how smoothly reform will proceed, and the impact rebalancing will have on growth.

The optimists believe that the planned opening of state-dominated areas of the economy to the private sector, coupled with financial liberalisation, will release a pent-up wave of productivity growth.

That boost, they say, should easily offset any short-term pain caused by the elimination of excess capacity in China's over-invested heavy industries.

The pessimists argue that just as the mainland's recent rapid expansion has been driven by increasing leverage, so the deleveraging process must lead to slower growth in the future. It's in the maths, they insist.

To get an idea who is closer to the truth, it helps to borrow an old analogy.

If you run a sausage factory, there are three ways you can increase your output of sausages. You can employ more staff to make them. You can invest in new sausage-making-machinery.

Or you can use the staff and machines that you already have more efficiently.

In short, you can add labour, or human capital. You can add physical capital. Or you can get smarter about how you work.

Measuring the first two inputs is simple. Measuring the third driver of growth is very difficult. Essentially it's what produces the growth you can't account for either by adding workers or boosting investment. Economists call it total factor productivity, or TFP.

In China, very little growth in recent years has been driven by adding labour. As the first chart shows, almost all has been propelled by capital and TFP growth, with the lion's share driven by investment in physical capital.

Ominously, the contribution of TFP growth has been declining, from an average of 4 percentage points between 2001 and 2008, to just 2.4 percentage points from 2009 to 2012, according to the International Monetary Fund. Meanwhile, the contribution from investment has grown.

If China is successfully to wean itself off excessive investment, the contribution of additional physical capital to economic growth will need to fall by between a third and half.

The IMF's researchers believe that some of this decline can be offset as reform and deregulation boost the contribution of TFP growth to overall growth to around 3.3 per cent a year.

That would imply growth of around 6 per cent a year over the next decade or so as China gets smarter, partially compensating for slower investment.

Not everyone agrees that TFP growth can pick up the slack, however. One projection by the Asian Development Bank sees TFP growth not accelerating, but slowing to just 1.7 per cent over the rest of this decade (see the second chart).

If the ADB's research is right, Chinese growth could indeed fall below 5 per cent a year by the end of this decade. It all depends on whether China can manage to work smarter or not.



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This article is now closed to comments

China's economy is a planned economy and not a free market economy therefore applying free market principles and expecting an economic correction to happen on its own is rather misplaced. The success of Chinese economy primarily had been one of control - be it low interest rates, cheap labour, land, cheap credit or keeping the currency artificially low .This successful economic model of control resulted in a huge trade surplus in its favour bringing huge economic prosperity to its people and lifting them out of poverty thus justifying people's faith and confidence in their govt. Then why would any incoming leader want to change this successful model?
Today the Chinese economy is passing through a similar phase as witnessed some 40 years ago and in both circumstances they were faced with the same questions - Political ideology v/s economic expediency. In the past if it didn't open its economy it would have triggered an economic collapse and with it the end of its ideology. Today it is faced with the same question but in a different context, Will economic liberalization end its political domination?
Everything in China is political.Today it is at a cusp where its has to balance its political interests with economic expediency as its old economic model has run its course.
How the political leadership balances its act will determine its future economic course not the Pessimists or the Optimists.
In Holland's view, both optimists and pessimists think that the government role in the economy will be reduced but with different outcomes. What is the justification for believing the government will compromise it's political objectives to improve the economy. Building up the state sector increases benefit to the party members and solidifies an important source of support for the government - state-sector workers. Private sector jobs do neither. Hu JinTao spent his 10 years in office building up the government, Xi JinPing has talked about a different course but so far has not taken any actions. It seems that the pessimists may be right but not for the stated in this column. China can have a growing economy or unchallenged dominance by the Communist Party, but increasingly it looks like it can't have both.
More blind addiction to the growth religion. Even 7% annual growth implies doubling the economy and consumption of resources in 10 years. Just where is China going to find twice the fresh water flow, twice the food, twice the crude oil supply ? Only the cornucopians know, and they have no specific answers beyond faith in human ingenuity.
Economic growth does imply a greater consumption of resources of course, but the increase is not necessarily proportional to the amount of growth. For example, the USA is probably 5 or 10 times richer than China per capita, but that does not mean they each use or consume 5 or 10 times the amount of food, land, televisions, cars etc etc. Much of the growth comes in the form of services (entertainment, leisure, financial products, meals out etc) which consume relatively fewer natural resources compared to the meeting of basic needs. So China could continue to grow without running out of resources, though obviously improving its TFP will ensure that any extra resources it does consume are best utilised.
To tub....
I hope there is an economic system (may be there is one already) that doesn’t depend on growth. More it is just a recycling or replacement of what is consumed. But then how would all the present crop of economists including JVDK and TH make a living? Sometimes it is what we have learned and knew that perpetuates us even to a dead end. Sorry to my two favorite columnists in SCMP that I am just reflecting and telling what I think.


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