What are China’s next steps?
By Michael Spence
China has weathered the present financial crisis better than most countries, for a number of reasons. It reacted very quickly to the collapse of external demand with a domestic stimulus package of 9 percent of GDP in both 2008 and 2009. The stimulus package in China was heavily weighted toward investment, especially in infrastructure, which is something they know how to do. To some extent, the Chinese relied on past experience in the ’97–’98 currency crisis in Asia, a storm they weathered without depreciating the currency but instead with what was then a large domestic stimulus pro-gram. China also eased credit quickly, and used their massive reserves to stabilize the currency.
The result is a rapid transition to high growth, with projections for 2010 in the 9 percent and above range. On the other hand, as with other countries, the stimulus and other dimensions of the emergency response are not a permanent solution. There is a growing concern among knowledgeable Chinese policy makers and academics with regard to two things. One is a return to the old ways, meaning the strategies and policies of the past thirty years that focused on investment and labor-intensive exports, policies that worked well but have outlived their usefulness. The influence of those in government and in the labor-intensive sectors that are set to decline is still substantial. Their hand has been at least temporarily strengthened by the crisis.
The other is a deep concern about overconfidence in the economy’s resilience in the face of some daunting short- and medium-term challenges. Managing to bounce back in the worst global crisis in eighty years — and by far the largest in the history of the PRC — is impressive. But, then, the hallmarks of Chinese growth have been rapid learning, a long time horizon, a willingness to support and encourage constant change, and a pragmatic problem-solving approach to a long process. These will likely reassert themselves and displace any short-term tendency toward triumphalism. Nevertheless, the risk is there.
China is entering upon a complex set of transitions that will build the base for its path to advanced-country status in the next twenty-five years. After three decades of sustained high growth and a remarkably successful, rapid, and effective policy response to the crisis, confidence is justifiably high.
China faces several parallel and related rebalancing challenges that are crucial for its internal growth and development, as well as for its relations with the rest of the global economy. Among them are:
- The middle- income transition, entailing a major microeconomic restructuring of the economy
- A macroeconomic shift to a higher level of household income and consumption and a more rapid expansion of the middle class
- Reversing the pattern of rising income inequality
- Lowering the very high savings level relative to investment and thus reducing the current account surplus
- Reducing the energy and carbon intensity of future growth
- Assuming growing global responsibilities as its size and global economic impact become steadily larger
In this last respect China is unique. It has arrived at a point where it has systemically important global impacts, but at a much lower per capita income than any predecessor. The reason is that it is by far the largest country in terms of population to have sustained very high growth for thirty years. Global impact and responsibility have therefore been added to an already complex domestic growth-and-development agenda at a point where most countries can be excused for maintaining a largely domestic focus. It will require balancing the domestic and international policy priorities with very little historical experience to provide guidance. India should follow in about a decade in this respect.
With a rising per capita income, important urban segments of the Chinese economy are in or are entering the middle-income transition. It is a difficult transition, one where many countries have lost growth momentum and experienced a stalling-out of the structural transformation process. Labor-intensive exports sectors that have been a major contributor to growth are losing competitiveness and have to be allowed to decline or move inland and then eventually decline. They will be replaced by sectors that are more capital, human- capital, and knowledge intensive.
Services will grow. Higher-value-added sectors and functions upstream and downstream from the processing industries will need to grow. Global brands should start to appear, and government ownership of enterprises will continue to diminish to facilitate the shifting engagement of the private sector with the global economy. Public- sector investment will shift toward education and R&D. The market (global and domestic), not the government, will increasingly drive the transitions. Targeting of sectors will decline. The domestic market and a growing middle class will assume greater prominence in driving growth and guiding the structural evolution of the economy. Urbanization— an important supporting parallel process in development, modernization, and the middle- income transition— will accelerate with supporting public- sector investment.
Household disposable income is about 60 percent of national income and the household savings rate is close to 30 percent of disposable income. These numbers are, respectively, low and high as compared with other countries, both advanced and developing. To empower the domestic market to drive income growth, and to accelerate the growth of the middle class, these numbers need to shift. Household income needs to rise; and, as more ample provision of social security, insurance, and services is made, precautionary savings should fall. Both will support the middle-income transition by expanding the domestic market as a driver of growth. They will help sustain growth in the face of prospectively weaker global demand, as the stimulus expenditures are withdrawn. But, most important, rapid growth of the domestic market, especially the service sector, needs to largely replace the export sector as the employment engine driving the rural population’s entry to the modern economy. The export sector will move into higher-value-added sectors and will no longer serve this function as effectively.
The corporate sector has financed a large fraction of its growing investment out of retained earnings without having to raise capital from the household sector. The government continues to own in excess of 50 percent of the large state-owned-enterprise sector but does not use or need the income. The government is fully funded by tax revenue sources without resort to dividends from this ownership position. While there are a number of different ways to do it, the bottom line is that a portion of these two income streams (corporate and government) needs to be redirected to the household sector.
Reducing excess savings by increasing consumption while holding productive investment up will contribute to a reduction in the current account surplus and hence materially help with the restoration of global aggregate demand. China is not the only systemically important surplus country, but the elimination of its surplus could restore about a third of the missing global demand. Exchange-rate appreciation and rising incomes will help drive the needed transitions, but rapid expansion of domestic demand is needed to sustain growth.
High growth and urbanization have caused rapid rises in incomes in urban areas, with smaller increases in the rural areas. Rural residents suffer from inferior education and health care. A large group of migrant workers and families (on the order of 150 to 200 million people) are officially considered residents of rural areas, but in fact are marginal urban residents with constrained rights and access to services. Serious social tensions have arisen as a result. They are being addressed by expanded provision of rural services, by rapid urbanization with supporting investment in infrastructure and service provision, and by a regularization of the status of the migrants.
The government has put in place an aggressive set of plans and policies to accelerate the reduction of the energy and carbon intensity of the economy consistent with sustaining growth. Much of this is in fact growth. Some initiatives create growth opportunities: for example, alternative energy sectors like solar. Notwithstanding these programs, overall energy consumption and carbon output will inevitably rise in the short and medium term because of growth. This creates additional sources of tension with advanced countries in the context of the climate change discussions.
China has faced daunting challenges in the past and has generally outperformed the predictions of the skeptics. In this sense, the present is not all that different. But now, to these challenges has been added a set of global pressures, impacts, and responsibilities. These latter come in part from the sheer size of China’s population, but also from an occasionally hostile external environment that doesn’t like the form of government, doesn’t always place much value on the rising incomes and opportunities of a people who used to be very poor, and tends to see the game as zero-sum.
Meeting the challenge of the domestic restructuring to sustain growth, asserting the right to develop and not to be penalized purely for being large, while taking on increased responsibility for global balance, stability, and governance and representing the interests of less-powerful developing countries are major new mountains to climb. China’s success or failure will, in any event, have a significant impact on the rest of the world.
This is an excerpt from The Next Convergence: The Future of Economic Growth in a Multispeed World, which was published this week.