A dose of economic realism is just what China needs

Lee Jong-Wha believes Beijing will maintain moderate economic growth, as long as its leaders stick to reforms and adjust their expectations

PUBLISHED : Sunday, 27 September, 2015, 9:31am
UPDATED : Sunday, 27 September, 2015, 9:31am

Pundits love debating the Chinese economy's growth prospects, and nowadays the pessimists are gaining the upper hand. But are things as bad as prevailing wisdom seems to indicate? And if they are, how can they be improved?

China's situation is certainly serious. The economy grew by 7.3 per cent last year, the lowest rate since 1990, and it is unlikely to meet the official target of 7 per cent this year. Weak domestic activity and diminished external demand are taking their toll.

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China is also losing long-term growth momentum, as falling fertility rates and returns on investment weaken labour-force expansion and capital accumulation.

These challenges have led former US Treasury secretary Lawrence Summers and his Harvard colleague Lant Pritchett to argue that China's growth could slow to 2-4 per cent over the next two decades. But, given that China's growth pattern has so far been exceptional, this seems unlikely.

The first step must be to recognise that the government cannot rely on direct intervention

Similarly flawed is the view of Justin Lin, former World Bank chief economist. Lin argues that China can achieve 8 per cent annual growth for another two decades, owing to its enduring "latecomer advantage". But this fails to account for the fact that only economies with comparable structural characteristics, such as labour skills and institutional quality, converge to similar per capita income levels.

I take a more moderate view, predicting that China's average potential gross domestic product growth will fall to 5-6 per cent by 2030. Unlike Lin, I believe the inevitable slowdown is coming soon. But, unlike Summers, I do not believe it has to be dire. The key to this scenario is that China's leaders move the economy onto a more balanced growth path, based on realistic expectations. They cannot afford to mishandle unavoidable challenges.

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The first step must be to recognise that the government cannot rely on direct intervention. Instead, it must implement reforms that boost productivity and offset pressure on growth. China's leaders must improve labour-market flexibility and labour mobility; make land use, acquisition and compensation more efficient; and build a more market-based financial system. Similarly, policies to promote continuous technological innovation and industrial upgrading can increase productivity. Reform of China's state-owned enterprises would also boost productivity.

The final piece of the puzzle is realism - China should lower its growth target to about 6 per cent in the coming years. That way, it could pursue the reforms needed to move the economy onto a more sustainable growth path.

Lee Jong-Wha is professor of economics and director of the Asiatic Research Institute at Korea University. Copyright: Project Syndicate