China's economic transition

Report from Asia Society says China can no longer rely on the old sources of growth, a point even acknowledged by its leaders

The development model that propelled China’s growth over the past three decades is now “obsolete” and needs to be replaced with a new one. This transition is likely to be painful and considering that China accounts for 15.4% of global GDP, a slowdown in growth is likely to have far reaching consequences for the global economy. But while the era of growth consistently averaging consistently 9-10% may well be over, a new report from Asia Society, authored by Daniel Rosen, argues that the country’s growth potential has not been exhausted.

 

The report begins by emphasising that China can no longer rely on the old sources of growth, a point even acknowledged by its leaders. The demographic dividend that transformed China into the world’s manufacturing hub is now tapering off, as a consequence of the one child policy. With the labour force now poised to shrink, China can no longer rely on low cost labour intensive manufacturing to boost growth. Further, while capital formation powered investment growth in the past, existing investments are showing diminishing returns in sectors such as coal and iron and steel which are plagued with over capacity. Also, gains from the increase in Total Factor Productivity (TFP) are slowly fading as dividends accruing from the last round of reforms from the World Trade Organisation (WTO) implementation have dried up.

 

 

Rosen argues that greater dependence on rules and institutions that let markets work could translate to efficiency gains boosting growth. This implies steering resources into productive channels rather than letting leaders allocate funds to unproductive projects where returns are diminishing. Growth opportunities, he argues, exist in all sectors. In agriculture, modernization holds tremendous potential for the 100 million that are likely to remain in farming. In manufacturing, opportunities exist to move up the value chain, while in services, industries ranging from advertising to health care to engineering are full of potential. 

 

The report’s base line scenario projects a potential GDP growth of around 6% in 2020. Half of this is on account of continued investment in capital stock, but channeled into different assets than those currently invested in, while the other half is to accrue from greater productivity of human resources and capital. But as exploiting these opportunities are depend on regulatory reforms, movement on which has been slow, many are skeptical about how the future will unfold. Rosen however argues that contrary to expectations, the pace of these reforms could actually quicken. The crackdown on corruption, especially going after key figures, could be construed as a sign that drastic change is imminent. 

 

However, if reforms stall, then the report points out that productivity gains will be lost and there will be uncertainty about private investment which “could considerably lower growth to around 3% in a hard landing scenario or 1% at best in a crisis.” To put this in perspective, the difference between the size of the economy with or without reforms is roughly $2 trillion, larger than the size of the Indian economy currently.