Thursday, November 27, 2014

Long Live China’s Boom

BEIJING – After three decades of 9.8% average annual GDP growth, China’s economic expansion has been slowing for 13 consecutive quarters – the first such extended period of deceleration since the “reform and opening up” policy was launched in 1979. Real GDP grew at an annual rate of only 7.5% in the second quarter of this year (equal to the target actually set by the Chinese government at the beginning of this year). Many indicators point to further economic deceleration, and there is a growing bearishness among investors about the outlook for China. Will China crash?

In fact, many other rapidly growing emerging economies have suffered – and worse than China – from the drop in global demand resulting from ongoing retrenchment in high-income economies since the 2008 financial crisis. For example, GDP growth in Brazil has slowed sharply, from 7.5% in 2010 to 2.7% in 2011 and to just 0.9% in 2012, while India’s growth rate slowed from 10.5% to 3.2% over the same period.

Moreover, many high-income newly industrialized economies (NIEs) with few structural problems were not spared the effects of the 2008 crisis. South Korea’s GDP growth slowed from 6.3% in 2010 to 3.7% in 2011 and to 2% in 2012; Taiwan’s fell from 10.7% to 1.3% over this period; and Singapore’s plummeted from 14.8% to 1.3%.

Given this, China’s economic slowdown since the first quarter of 2010 has apparently been caused mainly by external and cyclical factors. Facing an external shock, the Chinese government should and can maintain a 7.5% growth rate by taking counter-cyclical and proactive fiscal-policy measures, while maintaining a prudent monetary policy. After all, China has high private and public savings, foreign reserves exceeding $3.3 trillion, and great potential for industrial upgrading and infrastructure improvement.

Indeed, China can maintain an 8% annual GDP growth rate for many years to come, because modern economic growth is a process of continuous technological innovation and industrial upgrading. Of course, this is true for developed and developing countries alike. But developed countries differ from developing countries in an important way. Since the Industrial Revolution, developed countries have always been on the global frontier of technologies and industries, which has required them to invest in costly and risky indigenous research and development.

By contrast, technologies and existing industries in developing countries are in general well within the global frontier. As a result, they benefit from the “latecomer’s advantage”: technological innovation and industrial upgrading can be achieved by imitation, import, and/or integration of existing technologies and industries, all of which implies much lower R&D costs.

In theory, any developing country that can harness its latecomer’s advantage to achieve technological and industrial upgrading can grow faster than developed countries. How much faster is an empirical question. According to the Growth Commission led by Nobel laureate Michael Spence, 13 economies took full advantage of their latecomer status after World War II and achieved annual GDP growth rates of 7% or higher – at least twice as high as developed countries’ growth rates – for 25 years or longer.

China became one of the 13 economies after 1979. Because the country’s latecomer status explains its 33 years of rapid economic growth, the key to understanding its potential for further rapid growth in the future lies in estimating how large those advantages still are.

Per capita GDP, which reflects a country’s average labor productivity and its overall technological and industrial achievement, is a useful proxy to estimate latecomer’s advantage. That is, the per capita GDP gap between China and developed countries essentially reflects the gap between them in terms of overall technological and industrial achievement.

According to the most up-to-date estimate by the late economic historian Angus Maddison, China’s per capita GDP in 2008 was $6,725 in 1990 dollars, which was 21% of per capita GDP in the United States. That is roughly the same gap that existed between the US and Japan in 1951, Singapore in 1967, Taiwan in 1975, and South Korea in 1977 – four economies that are also among the 13 successful economies studied by the Growth Commission. Harnessing their latecomer’s advantage, Japan’s average annual growth rate soared to 9.2% over the subsequent 20 years, compared to 8.6% in Singapore, 8.3% in Taiwan, and 7.6% in South Korea.

If the latecomer’s advantage implied by the income gap between the four NIEs and the US enabled the NIEs to realize average annual GDP growth rates of 7.6%-9.2% for 20 years, China’s annual growth potential should be a similar 8% for the 2008-2028 period. To realize its potential growth as a latecomer, China needs, above all, to deepen its market-oriented reforms, address various structural problems, and develop its economy according to its comparative advantages.

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    1. CommentedDavid Kelland

      The most important two words in this article are "In theory." There are about 200 countries in the world today, many of which remain mired in low growth or have experienced secular stagnation within the past century. The theory of converging productivity via technological catch-up does not explain those cases. Instead, the author focuses on Japan, Singapore, Taiwan, and the ASEA-4. In fairness, that may be the relevant group for comparison because both they and China used the export-driven growth model to achieve many years of high growth.
      The crucial difference, however, between those countries and China is size. For those countries, increasing exports to the West was like a person riding a horse (a mouse riding a horse, in some cases). China's situation is more like an elephant riding an elephant. It was relatively easy for Malaysia, with 25-some-odd million people, to grow based on semiconductor manufacturing. China cannot simply monopolize one industry to employ its working-age population of several hundred million people.
      The Chinese economy is already running on fumes with fixed-asset investment above 40% of GDP. There is simply no way that the government is investing those funds efficiently. Although China does have foreign reserves of $3.3tt, the local governments are going to have serious debt problems when land sales to developers come to a screeching halt.

    2. CommentedMarc Sargen

      While I believe that China can still benefit from the latecomer gap China differs from the 4 break away economies due to size. Like the four listed successes, China had based its growth on becoming an export dynamo but because of its size it is reaching the point where the world's economy can not consume its excess production. To maintain growth requires re-tooling its entire economy for domestic consumption which will cause creative destruction & slow growth as export production gets mothballed or re-tooled. No country has made the transition w/ some form of economic downturn if the have ever made the transition at all.

    3. Portrait of Pingfan Hong

      CommentedPingfan Hong

      China still has a great potential to catch up with developed countries, but the potential growth of an economy is not simply defined by its technology gap from the frontier. Demographic factors and natural resource constraints matter, and so does human capital.

      The fact that only several economies among more than 100 developing countries managed to narrow the gap with developed countries in the past 50 years is already an indication of the extreme difficulty to do so.

    4. CommentedStan Paul

      But with growth so slow in developed markets, can China exports grow like South Korea, Japan, and Taiwan's did during that 20 year period? I think the author's growth assumptions are a little high for that reason.

    5. CommentedJeff S

      It is hard to take seriously an article on the Chinese (or any) economy that does not even mention the word "debt" once.

    6. CommentedJoshua Ioji Konov

      It should be all about overall Chinese market development, which is the small and medium businesses and investors, which are the only one that can employ the majority, built the middle class & consumption, and establish the right transmissionability of any stmolus measures..., the export and import factors are secondary of the pointed..., Chinese social oriented policies have greatly helped the overall economy hold up against a deeper economic slam, but in a longar term these are the small and medium businesses and investors not the government that can carryon a long-term economic success.

    7. CommentedBei De Zhu

      Yes the prospect for growth remains strong. But the caveat is how the world has changed. UNLIKE the previous economic climate that allowed the prolonged growth of Japan and the tiger economies, today China lives with the cancerous growth of "financial engineering", where developed nations engage in massive reckless GAMBLING never before witnessed in human history. The derivatives casino is already $700 Trillion, and is expected to become the first human "enterprise" to exceed a Quadrillion dollars in size, by the time TPP (which takes out national defenses against the marauding of Western banksters, through removal of capital controls by member nations) comes into effect.

      Note that the gambling DOES NOT PRODUCE ANYTHING - it merely moves funds from one pocket to another (mostly to the pockets of Western banksters), and sucks the life blood from Main Street economies. Such blood sucking has dominated most developed economies (with the exception of perhaps Germany) since 2008.

      Watching what the reckless (50 to 1 leverage) gambling did to the mightiest of economies (e.g. the U.S.A., the biggest in human history), it is well warranted caution to worry about China joining the TPP (unless on China's own terms). Opening up China's financial markets WITHOUT protective measures would be having unprotected sex with a known AIDS carrier person. Beijing needs to beef up enforcement against financial frauds: mandatory jurisdiction in China (invalidate or even criminalize externalizing contracts the purport to externalize jurisdiction), shift the burden of proof to the perpetrators, impose treble damages on the nominal amts., PLUS mandatory jail terms - in order to ensure safety for the economy.