China economy

Cities must rise if services are to power China’s new economy

Zhang Jun says rapid urbanisation is a key requirement for the service sector to meet long-term growth expectations, but tough decisions will be needed as the journey to structural reform can be slow and painful

PUBLISHED : Monday, 22 August, 2016, 5:31pm
UPDATED : Monday, 22 August, 2016, 7:23pm

For more than a year, headlines worldwide have been pointing to a Chinese economic slowdown. But a closer look at regional dynamics within China tells a different story – one that is less about deceleration than changing gears. According to the National Bureau of Statistics, resource-rich Shanxi (山西) province has suffered an economic slowdown, but Chongqing (重慶) and Guizhou (貴州) in the southwest have experienced vibrant growth. Hebei and three other northeastern provinces are feeling the effects of recession, but heavy-industry Tianjin (天津), Shandong (山東) and Jiangsu (江蘇) are booming.

After the 2008 financial crisis, China began to accelerate its economic rebalancing by shifting the drivers of growth from manufacturing and exports towards goods and services for domestic consumption. This transition has had far-reaching implications for the future dynamics of its economy.

With its previous export strategy, the government’s main priority was to integrate domestic manufacturing operations into global production chains. Now its aim is an economy that meets domestic consumers’ diverse demands, and the industries closely connected to those demands are the ones quickly expanding.

Growth in China’s services sector slows but new orders on the rise

Previously, the economic activities now flourishing were not categorised as manufacturing industries at all, but as “services”. But services do not exist in a vacuum. All businesses need manufactured products, transport, ICT, logistics, real estate, finance insurance and more. Thus, new demand for new services has virtuous-cycle effects in terms of capital investment in infrastructure and equipment. The growth of services in China to meet domestic demand does not mean the end of manufacturing and capital investment, much less of economic growth. Service sectors stand to make up for much, if not all, of the growth lost to lower output in export-oriented manufacturing.

According to a paper by economists Jong-Wha Lee and Warwick J. McKibbin, service sector productivity growth in Asia “benefits all sectors eventually, and contributes to the sustained and balanced growth of Asian economies”. In South Korea, the authors found that the average value added per worker in transport, real estate and ICT is now higher than in manufacturing, and they point to similar dynamics in the US, Japan and China.

This finding suggests that rapid development in China’s service economy could reverse the externally triggered dampening of growth. But structural transformation is a slow and painful process.

High costs in many Chinese provinces have been weighing down overall growth. This points to fundamental challenges

China must be careful not to undermine existing sources of growth lest it fall into a structural trap where the cost of transition itself derails new gains. It is not a good sign that the high costs in many Chinese provinces have been weighing down overall growth. This points to fundamental challenges ahead. For starters, economic development based on diversified domestic demand is more complicated than export-driven development, because these new sectors rely more heavily on sophisticated financial services, free and equitable market access, better educated workers, and higher investment in research and development.

As a result, the new businesses emerging from the shift to a new growth model are demanding far more from China’s economic governance system than it can bear. Further structural reforms would go a long way towards fixing this problem, but they will also require China’s leaders to make tough political decisions.

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Another fundamental challenge is China’s slow rate of urbanisation. Each of a thriving service economy’s major components needs the others to prosper, and cities are what bring them all together. China’s system of dividing urban and rural regions, along with poor urban planning, has led to fragmented and scattered metropolitan communities without diversified networks that would have helped boost productivity.

China’s cities will be a key ingredient of its long-term economic success. Urbanisation should start accelerating today, and be geared towards the needs of services-led economic growth. If China can rise to that challenge, it will be well positioned to clear the rest of the hurdles in its path towards high-income status.

Zhang Jun is professor of economics and director of the China Centre for Economic Studies at Fudan University. Copyright: Project Syndicate