China’s $5 Trillion Opportunity

SHANGHAI – China is facing the difficult task of managing a soft economic landing, after decades of spectacular expansion. Naysayers abound, but never mind them. China has an advantage that other countries in today’s troubled global economy lack: a clear path forward. If China carries out a sustained, comprehensive effort to raise productivity, it can address its growth challenges, reduce the risks of financial crisis, and complete its transition to a consumption-driven, high-income economy with a large and affluent middle class. If it does, its annual GDP could be an estimated $5 trillion larger by 2030 than it is likely to be if policymakers continue to pursue investment-led growth.

And, in fact, China may have little choice. The traditional drivers of its economy – a vast pool of surplus labor and massive investments in infrastructure, housing, and industrial capacity – are becoming exhausted. The working-age population has peaked, urbanization is slowing, and the steel and cement industries are suffering from overcapacity. Returns on capital have declined, so China cannot rely on investment spending to generate sufficient growth.

Fortunately, however, China has substantial room for gains in labor productivity, which is only 10-30% of the level in advanced economies. When the McKinsey Global Institute analyzed more than 2,000 Chinese companies in industries ranging from coal and steel to auto manufacturing and retail, it found opportunities to raise productivity by 20-100% by 2030.

Consider China’s service sector. Though the sector has grown rapidly and now accounts for about 50% of GDP, low-value-added businesses still dominate. On average, service businesses in China are just 15-30% as productive as their counterparts in OECD countries. In addition to streamlining existing operations (for example, by introducing self-checkout systems in retail businesses), China has opportunities to complement its manufacturing sector with high-value-added business services in areas such as design, accounting, marketing, and logistics.