The Conundrum of Chinese Economic Growth

July 25, 2013

For more than three decades, China's gross domestic product (GDP) has grown by an average of more than 10 percent annually. But former premier Wen Jiabao rightly described this impressive growth performance as "unstable, unbalanced, uncoordinated and unsustainable," highlighting the many economic, social, and environmental costs and challenges that have accompanied it. Now China must choose between the export-based, investment-driven growth model of the past and a new, more viable economic order, say Andrew Sheng, president of the Fung Global Institute, and Xiao Geng, director of research at the Fung Global Institute.

Cheap credit and perverse incentives have led to massive but redundant investment, which, in turn, has contributed to excess capacity in manufacturing and infrastructure. This model is not only inefficient; channeling government resources to support investment also undermines China's social development.

  • China's leaders have decided to stop using GDP growth as the primary criterion for evaluating officials' performance.
  • Indeed, the 12th Five-Year Plan, which extends until 2015, aims to shift China's economy to a new, more sustainable growth model based on quality and innovation, and accepts that annual GDP growth will likely fall to 7 percent during the transition.

Indeed, China's economy has experienced a significant (and ongoing) growth slowdown in the wake of the global economic crisis that erupted five years ago. By 2012, human capital's contribution to China's GDP growth fell almost to zero, with fixed-capital accumulation accounting for roughly 60 percent of total growth. Large-scale, debt-funded capital investments have raised the country's credit/GDP ratio to nearly 200 percent, increasing the financial system's vulnerability.

In order to achieve more balanced and sustainable GDP growth, China's leaders must implement a set of deep, comprehensive and long-lasting institutional reforms aimed at boosting Total Factor Productivity. In particular, the reforms should be designed to facilitate China's transition from its traditional supply-based growth model, which assumes that building hard infrastructure leads automatically to demand growth.

In short, China must shift its focus from meeting GDP growth targets to creating an environment that fosters innovation and competition, thereby enabling market forces to set prices and allocate resources more effectively.

Source: Andrew Sheng and Xiao Geng, "China Grows Down," Project Syndicate, July 15, 2013.

 

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