IS CHINA’S rise inevitable? Well, as we’ve learned to our great chagrin over the past twelve months, there’s nothing inevitable about continued rapid economic expansion or the near-term success of any economic model, and past performance is most emphatically not a guarantee of future returns. And, as with any lower-income developing country, there are plenty of visible and unforeseen pitfalls that could hurt China’s growth prospects over the coming years and decades.
However, as author and newspaperman Damon Runyon famously remarked, “The race is not always to the swift nor the battle to the strong—but that’s the way to bet.” And when taking odds on the potential of today’s emerging markets to mature into wealthier and more powerful states, you had best be betting on China.
The mainland is already getting there faster than any major economy before it. And, the risks of an outright economic derailing over the next ten to twenty years are much lower than commonly believed.
IN A debate often dominated by conjecture and assertion it helps to focus on hard data, and at the macroeconomic level, here are the hardest numbers we have: in the three decades between 1978 and 2007 the official Chinese GDP grew at an average real pace of 9.9 percent. Of course, the quality of historical growth figures has generated an intense academic debate, and many researchers conclude that real growth has been overstated for a variety of reasons (such as under-measurement of inflation and other distortions in the traditional socialist statistical system); however, even the most skeptical analysts still come out with numbers of 9 percent year over year (y/y) or above for the postreform era.
How does an average growth rate of 9 or 9.9 percent compare with other major historical cases? As it turns out, whether we take the top or the bottom end of the range, China is a world-record holder. Over its peak thirty-year growth period Japan grew “only” at an average real rate of nearly 8 percent, and between 1960 and 1995 the high-growth Asian “tigers” expanded at paces of 7.8 percent in Hong Kong, 8.3 percent in South Korea, 8.4 percent in Singapore and 8.9 percent (the previous record) in Taiwan. This is not all; with the sharp slowdown in mainland birthrates since the 1970s, China’s outperformance in terms of per capita income growth is higher still.
The next set of figures concerns the sources of that growth. Remember from first-year economics that in the most basic formulation there are three ways for countries to grow: (i) by adding more labor, (ii) by adding more capital, and (iii) by combining capital and labor in better and more productive ways. The latter is so-called “total factor productivity” (TFP) growth, and is in many ways the best single measure of long-term economic success because it gauges the “quality” rather than just the quantity of growth.1 Here, as well, researchers have carried out detailed studies of China’s growth composition. Estimates of historical-factor-productivity growth tend to run from 2 percent y/y to 4 percent y/y, with the broad bulk centered around 3 percent. That is, as best we can measure, just under one-third of China’s growth is coming from rising productivity.
How does this compare with other parts of the world? Once again China posted a record performance. For much of the postwar era, the industrialized West saw annual TFP growth rates of up to 2 percent; the average for Japan and other high-growth Asian countries was around 2.5 percent—with no other region coming even close to these numbers. So productivity growth of 3 percent or thereabouts puts the mainland economy at the very high end of global experience.
And this brings us to our final set of hard numbers. In 1990, average Chinese national income in prevailing U.S.-dollar terms was $350 per head. By 2000, that figure had risen threefold to $1,000 per head, and, as of the end of 2008, per capita income had tripled again to $3,000. If China continues to grow at 8 percent y/y or above in real terms for the next two decades, then in present-dollar terms, per capita income could easily reach $8,500 by 2020 and $20,000 by 2030. This puts average mainland incomes above where Taiwan and Korea are now—i.e., solidly middle class and eligible for OECD membership—and also puts the total size of the Chinese economy above the combined level of the United States and the European Union today.
Let me summarize here for emphasis: in strict macroeconomic terms, so far China is unambiguously the most successful emerging economy of the postwar era. And at the current pace of development, China’s “rise” is not some hazy prospect shimmering on the distant horizon, but a concrete reality only twenty years down the road. Most important of all, as laid out above, the mainland doesn’t need to grow at a breakneck pace of 10 percent per year to attain developed-country status by 2030; 8 percent will do nicely, and even if trend growth drops to 6 percent or 7 percent, this simply pushes back the arrival date by a few years.
In other words, if you want to argue for China’s failure, it’s not enough to say that the economy will slow. Instead, you need a massive disturbance or outright crisis that derails growth for a long, long spell—and you need it fairly soon.
In today’s public debate there are plenty of potential hazards to point to, including bubbles bursting, global depression, social tensions, loss-making state enterprises, an inefficient socialist model and the lack of political freedom. And as I stated at the outset, there’s no guarantee whatsoever that one or more of these elements won’t suddenly overwhelm China’s growth prospects and drag the economy down. However, an objective look at risk factors shows that they are moderate, with little to suggest that the economy faces a looming crisis anytime soon. With apologies for the brevity imposed by space constraints, let me at least give a broad outline of the main arguments here.
FIRST UP is perhaps the most obvious and pressing concern, which is China’s fate in the current global recession. Export volume contracted outright in the fourth quarter of 2008, and the turnaround in local stock and property markets has sent domestic construction and industrial spending down sharply as well. With the prospect of much-slower growth and rising unemployment this year, it’s natural to wonder if this is the shock that could send the mainland over the edge.
However, by any measure China is one of the least export-exposed economies in the Asian region; only around 8 percent of the mainland workforce is employed in export industries, and light-export manufacturing, such as toys, textiles and electronics processing, accounts for a smaller share still of total Chinese investment spending. Even at the very peak of the recent trade expansion, net exports drove no more than one-sixth of overall GDP growth. This helps explain why China was able to keep right on growing during previous sharp export recessions, such as the global IT bust in 2001–02, and why it will take much more than falling exports to seriously impair medium-term-growth prospects today.
Turning to the domestic economy, China’s local stock market shot up nearly sixfold between 2005 and 2007 before suffering an equally dizzying fall in the past fifteen months, raising concerns of a Japan-style “postbubble malaise.” On the other hand, this is nothing new; for the past two decades Chinese stock prices have inflated wildly every five years or so followed by equally abrupt declines. The important fact is that even today equities account for a very small part of household and corporate balance sheets, that is to say, in real economic terms China’s stock market is still little more than a sideshow.
Housing and property markets are a different issue. As we have seen in the United States, property recessions can wreak significant havoc—but the key here is that China looks nothing like the United States. Consumer mortgage debt is tiny, average loan-to-value ratios are extremely low as well, nationwide home prices have actually declined relative to incomes for the past decade and absolute inventory levels haven’t budged since 2004. So while Chinese sales and construction volumes fell sharply last year and home prices are now contracting on a nationwide basis, there’s little in the data to suggest that the current property woes are anything more than a painful cyclical correction.
NEXT TO address in the debate over China’s rise is the persistent idea that since the country is nominally socialist, the economy must have muddled through so far due to the efforts of central planners who ignore free-market principles and allocate resources against all economic rationality—and just like the Soviet Union before it, China is threatened with a nasty shock if and when market forces finally prevail. A lighter version is that China is overdependent on the “extensive” growth model, i.e., planners are good at throwing capital and labor at a problem but bad at getting returns on investment; once the economy starts to run out of resources the entire system could falter.
According to the data, however, neither of these is a real concern. The single-best indicator of the quality of overall resource allocation in any economy is one already discussed—total-factor-productivity growth. For the Soviet Union, the figures were simply awful. On standard measures, the Soviet economy actually saw TFP levels fall by nearly 1 percent per year in the final two decades of its existence, the worst performance of any major region in the world and an accurate reflection of the hugely distorted nature of the economy.
Meanwhile, as we saw above, China not only had positive TFP growth for the last three decades, but one of the absolute-best productivity performances on record. This is mirrored in financial data such as industrial profitability, corporate returns on equity or returns on invested capital. Regardless of the measure you choose, China has seen consistent improvements over the past fifteen years, and, even in today’s global slump, margins and capital returns have remained near record-high levels.
Nor is there any indication that the “extensive” part of mainland growth is in danger anytime soon. Much has been made of the looming demographic downturn, but this almost completely misses the point; if we look at China’s historical growth pattern, only perhaps one-sixth came from labor expansion, with another third from factor productivity—and the rest was due to new capital creation. In other words, just as in China’s Asian neighbors, the real heavy lifting in trend growth was done by savings and investment.
How likely is it that China will run out of savings to invest, or profitable destinations for its capital? Rising productivity and respectable corporate returns tell us that the latter issue is not a concern, as China still has plenty of areas for profitable investment at home. And on the former front, remember that the mainland currently exports around 10 percent of its GDP in excess savings to the rest of the world, by far the highest level of any major economy.
ACCORDING TO current statistics, roughly 25 percent of Chinese GDP is generated by state-owned enterprises, or SOEs. To most readers this brings up a specific set of connotations: state enterprises generally do not run on market principles, depend on government for resource allocation and economic decision making, suck resources and subsidies from the “good” part of the economy, hide behind protectionist walls and often destroy value outright—causing outputs to be worth less than the cost of producing them. So even if the private sector is buoyant and profitable, having a “dead weight” of this magnitude risks pulling the rest of the economy down with it.
The trouble is that none of those characteristics really hold true in China. Industrial statistics show that mainland SOEs are more profitable on average than the private sector, and even when we adjust for sectoral differences there is almost no visible difference between state-owned and private profit performance. With the exception of recent short-lived fuel subsidies, the government does not hand cash to state companies; quite the opposite, SOEs pay far more in net taxes to the government than their private counterparts. And sectoral data suggest that overall productivity and margin growth have been a good bit faster in heavy-industrial state sectors than, say, in foreign-funded light-manufacturing export firms over the past fifteen years.
Many may ask how this is possible. The answer is that there’s not much “state” left in China’s state-owned enterprises. In most emerging markets you will find, say, one large, state-owned telecom company, one automaker, one airline and so on down the line—usually companies that are heavily protected and often loss making. By contrast, the mainland has dozens of major automakers and airlines, hundreds of steel companies, a good handful of major telcos, power producers and the rest. Most of these firms may be state owned, but they compete aggressively with one another; entry barriers are very low even by Asian standards, with many sectors highly open to private and foreign investment.
Moreover, only the very largest SOEs have any guarantee of existence at all, as they discovered in the late 1990s when then-Premier Zhu Rongji mercilessly shut down tens of thousands of state-run companies because they were neither profitable enough nor large enough to be worth saving, thereby putting more than 25 million state workers on the street. Major SOEs still enjoy preferred access to commercial-bank resources, but this access is fading rapidly as banks are under strong pressure to hone their focus on profits and cash flow. And the state now has almost no direct say in corporate investment and production decisions, having dismantled the (largely rubber-stamp) government-investment-approvals process a number of years back.
THEN THERE is the question of how China can grow without democracy. The idea that economic success puts the rising aspirations of the middle class on a collision course with China’s authoritarian regime is a cherished tenet, and the recent wave of rising social unrest is often touted as proof that a painful clash is imminent. However, while there’s little doubt that China will face growing political frictions and some painful choices over the next decades, there’s also little to suggest that the country faces a looming crisis.
In fact, when it comes to Asia, the better question may be: how can you grow with democracy? After all, every one of the region’s economic success stories over the past thirty years—Japan, South Korea, Taiwan, Hong Kong, Singapore, Malaysia—happened in what was effectively a one-party state, and some had governments as authoritarian as China’s. By contrast, countries with consistent or intermittent periods of democratic rule, such as the Philippines, India, Bangladesh, Pakistan and Thailand, came in toward the bottom of the growth list. Clearly the lack of contested elections was not a hindrance to growth in Asia; indeed, it was one of the best predictors of success.
This is because Asia’s economic winners may not have had democracy but they did have capitalism. All of the high-growth countries had a strong market orientation and a commitment to globalization; they generally also had strong governance institutions with some measure of social accountability. In effect, there was an unwritten contract with the populace that as long as governments delivered the goods in terms of growth, the citizenry would hold off on democratic aspirations until the economy reached a stable, middle-class income plateau.
Is China different, and could the political order fall apart well before incomes reach more developed levels? To make this claim, there are two possible lines of argument. The first is that the mainland simply isn’t as “capitalist” as the Asian tigers were, with less market orientation and more state distortions and problems. I’ve already disputed this idea for China itself, but I should also stress how well the mainland holds up in a comparative sense.
At one-quarter of GDP, China’s state-owned economy today is largely comparable in size to the historical role of Japan’s keiretsu and South Korea’s chaebol in their own economies, with the crucial difference that mainland SOEs are a good bit more exposed to market forces. Foreign direct investment plays a far bigger role in nearly every industrial sector in China than in Japan and South Korea even today, not to mention in the 1970s and 1980s. By any measure, China has much greater domestic competition within industries than its north-Asian neighbors, and large Japanese and South Korean firms arguably received more effective support and subsidization from their “main bank” relationships than mainland SOEs do from Chinese state banks today.
The second argument is that the Chinese state is more rigid and less responsive—and that a rising wave of social unrest is already threatening political stability. Even by the government’s own statistics there has been a marked increase in public or “mass” disturbances since the beginning of the decade, and reports of unruly demonstrations and violence are common in the foreign press.
But, there’s just one caveat. Very few of these disturbances involve higher-income urban residents, or for that matter urbanites at all; instead, the vast majority come from farmers and rural migrants. In other words, this is not the aspiring middle class “rising up” against authoritarian rule, but rather the poorest segments of the population chafing against their plight. And, as it turns out, their gripes are founded in economic issues, not political ones.
Let me explain what I mean. As China pursued enterprise reforms during the 1990s, one of the consequences was a collapse of budgetary finances; at the lowest point, general government revenue had dropped to less than 10 percent of GDP, more reminiscent of an African nation than a nominally socialist state. This left the authorities with barely enough funds to maintain civil-service employment, forcing sharp cutbacks in education, housing and medical services. And by far the worst affected were county and village governments, which were left to fend for themselves by exploiting their own base: levying taxes on farmers and expropriating land.
The other problem was rural incomes. Local farm prices were flat or falling from the mid-1990s through the early part of this decade, and Chinese farmers saw very little income growth at a time when their urban counterparts were gaining wealth at a record pace. With flat earnings, rising taxes and fees, village governments selling off farmland at minimal compensation and migrant wages stagnant as well, it’s little wonder the mainland saw growing rural disturbances.
But now look what has happened over the past half-decade. To begin with, budgetary revenue has rebounded steadily as a share of GDP, reaching 20 percent in 2007, and suddenly the center is flush with cash. This has meant rising transfers to local governments, increased spending on health and education, and the removal of all agricultural taxes in the last few years. Second, the authorities have undertaken significant changes in land-tenure policy, including better guarantees of a farmer’s claim to a specific piece of land, a more transparent sales and transfer regime, and more avenues for legal recourse. These leave less scope for local corruption and more gains to farmers from future land transactions.
Third, since 2004 there has been a large trend rise in domestic food prices, driven by rising urban consumption and the natural decrease in supply due to past land sales. And over the past three years real farm-income growth at last caught up with and even exceeded the urban pace of wage increases. Finally, rural migrant wages have also jumped over the same period as a result of tighter labor markets caused by fewer young, mobile workers.
The bottom line is that China has seen considerable structural and largely market-driven changes that are already fundamentally altering the rural income balance, and should go a long way toward addressing the economic problems leading to the recent unrest. This year and the next will be tough, to be sure, as weak export markets and, especially, falling construction demand take a toll on migrant employment—but as I argued above, these are cyclical issues that are unlikely to prevent a return to trend growth in the near future and over the long term.