After four disappointing years, Chinese economists have realized that slowing GDP growth — from a post-crisis peak of 12.8 percent in 2010 to about 7 percent today — is mainly structural, rather than cyclical. In other words, China’s potential growth rate has settled onto a significantly lower plateau. While the country should be able to avoid a hard landing, it can expect annual growth to remain at 6-7 percent over the next decade. But this may not necessarily be bad news.
One might question why GDP in China, where per capita income recently surpassed $7,000, is set to grow so much more slowly than Japan’s did from 1956 to 1970, when the Japanese economy, with per capita income starting from about $7,000, averaged 9.7 percent annual growth. The answer lies in potential growth.
Whereas, according to Japan’s central bank, Japanese labor productivity grew by more than 10 percent annually, on average, from 1960 to 1973, Chinese productivity has been declining steadily in recent years, from 11.8 percent in 2001-2008 to 8.8 percent in 2008-2012, and to 7.4 percent in 2011-2012. Japan’s labor supply (measured in labor hours) was also growing during that period, by more than 3 percent annually. By contrast, China’s working-age population has been shrinking, by more than three million annually, since 2012 — a trend that will, with a 4-6-year lag, cause labor-supply growth to decline, and even turn negative.
Given the difficulty of reversing these trends, it is difficult to imagine how China could maintain a growth rate anywhere close to 10 percent for another decade, despite its low per capita income. But there is more.
As the Japanese economist Ryuichiro Tachi has pointed out, Japan also benefited from a high savings rate and a low capital coefficient (the ratio of capital to output) of less than 1. Though a precise comparison is difficult, there is no doubt that China’s capital coefficient is much higher, implying a larger gap between the growth rate of capital intensity (the total amount of capital needed per dollar of revenue) and that of labor productivity.
At times, a high investment rate can offset a high capital coefficient’s negative impact on growth. But China’s investment rate is already too high, accounting for almost half of GDP. With capital intensity increasing significantly faster than labor productivity in China, the inefficiency of investment is clear. In this context, increased investment would only exacerbate the problem.
Making matters worse, China’s corporate debt is already the highest in the world, both in absolute terms and relative to GDP. In this context, increasing investment would not only reduce capital efficiency further; it would also heighten the risk implied by companies’ high leverage ratios.
With all major indicators suggesting a significant decline in China’s growth potential, China’s leaders must accept the reality of lower growth and adjust their priorities accordingly. Succumbing to the temptation of massive monetary and fiscal stimulus, such as that pursued in the wake of the global economic crisis, would not only fail to boost growth in a sustainable way; it would actually undermine growth and stability in the medium to long term. A better approach would focus on making economic growth more sustainable.
On this issue, Japan has some useful lessons to offer. In the 1970s, recognizing the inevitability of a slowdown, Japan shelved its ambitious plan to “remodel” the Japanese archipelago. Policymakers shut down energy-intensive factories in the heavy chemical industry, promoted innovation, and took steps to address air and water pollution. As a result, the quality of Japan’s economic growth improved considerably, even as its rate fell by nearly half in the decade after the oil shock in 1973.
The good news is that China’s leaders seem intent on adopting a similar approach, including avoidance of monetary and fiscal expansion, unless growth seems set to collapse. Indeed, at the recently concluded National People’s Congress, Prime Minister Li Keqiang affirmed the authorities’ 7 percent target for GDP growth this year, while reiterating the importance of deepening reform and carrying out structural adjustments.
For China, accepting lower growth provides a crucial opportunity to support stable and sustainable development. If China’s leaders stay the course of reform and rebalancing, the entire global economy will be better off.
Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006. © Project Syndicate, 2015.