1

China’s Economic Growth Through 2025:

What We Know Today about China’s Economic Growth Tomorrow

Carsten A. HolzHong Kong University of Science & Technology

1 September 2009

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Official real GDP growth 1978-2008

0

2

4

6

8

10

12

14

16

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Annual real GDP grow th in %

est.

3

Literature

a. China as next superpower

b. China collapse/ pessimist view

c. Firm/industry-level growth studies

d. Economic growth in the past

e. Economic growth in the future

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Literature

a. China as next superpower

-> China is rising

-> may pose a threat to the U.S.

Geoffrey Murray (1998): The Next Superpower

Emma Broomfield (2003): literature review

Bill Geertz (2000): The China Threat (2000)

Timperlake/ William/ Triplett (2002): Red Dragon Rising: Communist China’s Military Threat to America

Business Week (2004): … the devastation Chinese competitors are inflicting on U.S. industries, from kitchenware and car tires to electronic circuit boards…

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b. China collapse/ pessimist view

(1) economic arguments

Lester Brown (1995): Who Will Feed ChinaNicholas Lardy (1998): China’s Unfinished Economic RevolutionGordon Chang (2000): Coming Collapse of China

(2) political arguments

Ross Terrill (2003): The New Chinese Empire and What It Means for the United States> a crash looms because the Leninist core of the regime is unchanged…<> illusory nature of the market in most of the Chinese economy <

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c. Firm/industry-level growth studies

Jefferson et al. (2000): TFP

Colin Carter and Scott Rozelle (2001): major force in world food markets?

Allen Douglas (2002): 4 industries, imminent emergence of Chinese world-class brands

Ming Zeng and Peter Williamson (2003, 2008): “The Hidden Dragons”

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d. Economic growth in the past

(1) Transition literature

Wing Thye Woo (1994, 1999)

Qian Yingyi (2000, 2003)

(2) Development view: Justin Lin et al. (2003): comparative-advantage following strategy

(3) Aggregate production function framework

Alwyn Young (2000)

Gregory Chow and Kui-Wai Li (2002)

Wang Yan and Yao Yudong (2003)

Wu Yanrui (2004)

Dwight Perkins and Thomas Rawski (2008)

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e. Economic growth in the future

World Bank (1997): closed-economy model

Gregory Chow and Kui-Wai Li (2002): aggreg. prod. fcn.

Gregory Chow (2002): aggregate production function

Paul Samuelson (2004):

positive labor productivity shock in China may lead to

a permanent loss in per capita income in the U.S.

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Outline

1. Extrapolating Past Economic Growth Into the Future

2. Development Theories and Asian Precedents

3. Growth Accounting

+ Human Capital Formation

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1.Extrapolating Past Economic Growth Into the Future

a.) GDP, 2006: China: USD 2.6 trillion (20.9 trillion RMB)

U.S.: USD 13.2 trillionBecause prices in China are ¼ of prices in the U.S., in purchasing power terms China’s GDP is 4 times larger, i.e., equivalent to USD 10 trillion.

b.) If past average growth rates of the U.S. and China continuein the future, when will China’s GDP exceed that of the U.S.?

Past average growth rates are those of 1978-2005. Base year for projections is 2005.

Price adjustment? Aggreg. Per capita GDP Exchange rate adjustment? GDP National Coast 5 prov. 1. U.S. price level = 3.86 * PRC price level 2011 2035 2024 2021 2. + 3% annual RMB appreciation 2009 2026 2019 2017 3. U.S. price level = 3 * PRC price level 2015 2040 2027 2023 4. + 3% annual RMB appreciation 2012 2029 2021 2019 5. No price adjustment 2033 2057 2041 2036 6. + 3% annual RMB appreciation 2024 2041 2031 2028

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2.Development Theories and Asian Precedents

a. Structural change: Shifting labor from low-productivity agriculture to higher productivity industry or services

0

10000

20000

30000

40000

50000

60000

1978 1982 1986 1990 1994 1998 2002 2006

Val

ue a

dded

per

labo

rer

(yua

n R

MB

) Primary sector

Secondary sector

Tertiary sector

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The more laborers shift out of agriculture in a given year, the higher is labor productivity (and GDP) growth in that year.

Each data point = 1 year. Jap. 1956-05, Korea 1971-05, Taiwan 1967-05, China 1979-05.

-4-3-2-10123456789

1011121314

-0.035 -0.030 -0.025 -0.020 -0.015 -0.010 -0.005 0.000 0.005 0.010

Annual absolute change in share of agriculture in employment

Gro

wth

rat

e of

rea

l GD

P p

er la

bore

r (in

%)

Japan

Korea

Taiw an

China

China

Japan

Korea

Taiw an

13

How many more laborers can China shift out of agriculture?

Share of agriculture in economy-wide employment

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005

Sha

re o

f agr

icul

ture

in e

mpl

oym

ent

Japan Korea

Taiw an China

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b. Catching up: the lower labor productivity relative to the U.S., the higher labor productivity growth

Japan 1960-2005, Korea 1971-2005, Taiwan 1967-2005, China 1979-2005.

-3-2-10123456789

1011121314

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4

GDP per laborer (in USD) per U.S. GDP per laborer (in USD)

Gro

wth

rat

e of

rea

l GD

P p

er la

bore

r (in

%)

Japan

Korea

Taiw an

China

Japan

Taiw an

Korea

China

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c. Relative factor price equalization: the lower the price of labor relative to the price of capital,in comparison to the U.S., the higher employment growth (//structural change -> switch to higher labor productivity sectors)

Japan 1960-2004, Korea 1971-2004, Taiwan 1967-2004, China 1979-2003.

-5-4-3-2-10123456789

1011121314

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8

Relative w age rates, divided by relative investment prices (PWT)

Gro

wth

rat

e of

rea

l GD

P p

er la

bore

r (in

%)

Japan

Korea

Taiw an

China

Japan

Taiw an

Korea

China

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3. Growth Accounting (+ Human Capital Formation)

a. Production function estimation

b. Assume constant labor share

Labor share ≡ labor remuneration / GDP = constant

a ≡ w * L / GDP = constant

Real GDP growth = real wage growth + labor growth

c. Decompose income components of GDP

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Income shares in GDP

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002

Labor compensation Depreciation

Net taxes on production Operating surplus

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c. Decompose income components of GDP

(i) Definitional identity

GDP labor remuneration + depreciation

+ net taxes on production + operating surplus

price tax rate return on capital

output quantity

wage rate labor quantity

depreciation rate capital

ttttttttttt KsYPKLwYP

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(ii) Explaining economic growth in China 1978-2002

growth in real

net GDP 78-02 labor growth real capital growth

real wage growth depr. rate growth surplus r. gr.

labor share depr. share surplus share

814% 0.5981*495% + 0.5981*60% + 0.1370*16% + 0.2649*(-50%) + 0.4019*1185%

= 296% + 36% + 2% - 13% + 476% = 797%

-> so small that can ignore in future

Mean shares 1978-2002

)ˆ

()(ˆˆˆ)ˆ

(ˆt

ttttttttt

t

ttt P

KedsedLa

P

waY

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(iii) Estimate economic growth in China 2000-25

From 1978-02 estimations know that can use growth in net GDP as a proxy for growth in GDPcan drop two irrelevant items on the right-hand side to yield

Growth in net GDP =

labor share * growth in real wage rate +

labor share * growth in quantity of labor +

(depr. + surplus share) * growth rate of real capital

Already know future values Need

Use previous-year values

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Estimate economic growth in China 2000-25 --- based on cointegration equations 1978-02

“Dependent” variable All variables in levels All variables in natural logarithms A. Wage B. Capital A. Wage B. Capital Regression number I II III IV

Constant 4387.96 4144.38 6.2426 7.6163

C. Average years of schooling minus 5

0.7171 (12.8369)

0.2829 (3.1779)

D. Average years of schooling minus 5, squared

3126.44 (23.1977)

E. Share of laborers with primary school education

-1.3593 (-5.0228)

F. Share of laborers with upper middle school education

-39066.18 (-4.0676)

G. Share of laborers with college level education or above

152080.0 (18.8042)

H. Number of laborers -13973.42 (-2.5510)

Trend 238.63 (2.3934)

0.0946 (15.2316)

Lag length of the VEC 2 2 1 2 Trace, maximum eigenvalue test 1%, 5% 1%, 1% 1%, 1% 5%, 5% Normality (10% level) OK OK C 1%, E 10% OK Granger causality “Y: X (Z%)” None H:D(10) A: E(0.1)

C: E(5) B:I(1)

Variance decomposition

period 3 A: 97/ 1/ 2

F: 34/ 66/ 0 G: 1/ 78/ 21

B: 87/ 11/ 2 D: 19/ 77/ 5 H: 83/ 1/ 17

A: 82/ 3/ 15 C: 0/ 94/ 6

D: 0/ 61/ 38

B: 87/ 13 C: 8/ 92

Variance decomposition period 10

A: 66/ 12/ 22 F: 16/ 81/ 3

G: 19/ 60/ 21

B: 25/ 70/ 5 D: 23/ 72/ 5

H: 33/ 45/ 22

A: 65/ 4/ 31 C: 11/ 89/ 10 E: 13/ 60/ 27

B: 29/ 71 C: 6/ 94

Number of observations 23 22 24 22

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Growth Forecasts (average annual growth rates in %)

Individual variables - - -> GDP Wage

(I) Capital

(II) Wage (III)

Capital (IV)

Labor Income decomposition

Assume labor share constant

I+II III+IV I III 2000-05 4.15 6.98 5.18 10.91 0.83 5.80 8.09 5.01 6.05 2005-10 8.18 6.37 6.29 10.85 0.71 7.84 8.83 8.95 7.05 2010-15 7.76 5.63 7.81 10.75 0.20 7.06 9.42 7.98 8.03 2015-20 6.36 5.40 11.79 10.71 -0.80 5.50 10.85 5.51 10.90 2020-25 4.63 4.14 14.22 10.54 -0.62 4.06 12.02 3.98 13.51

2000-25 6.20 5.70 9.01 10.75 0.06 6.05 9.83 6.27 9.07

Cumulative: 2000-25 350.04 299.69 763.49 1184.75 1.58 333.77 942.78 357.15 777.14

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20-2930-39

40-4950-60

60-6465+

No school/ lit. class

Primary school

Secondary school

Tertiary level

0

20

40

60

80

%

+ Human capital = quality of labor

Share of Education Level by Age Group, 2000 (in %)

Year 2000 Census

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Tertiary Level New Enrollment, China and U.S.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

1978 1982 1986 1990 1994 1998 2002 2006

milli

on

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

0.55

0.60m

illion

China: BA + Associate degree

U.S.: Freshmen (2- and 4-year programs)

China: MA + PhD --- right scale

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Tertiary Level Graduates, China and U.S.

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

3.2

3.6

4.0

4.4

4.8

1978 1982 1986 1990 1994 1998 2002 2006

milli

on

China: BA + Associate degree

U.S.: BA + Associate & Professional degree

China: MA + PhD

U.S.: MA + PhD

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Summary

1. In purchasing power terms, China will be as large as the U.S. by 2010. Per capita, it will take longer, except for the most developed provinces.

2. China fits standard development patterns, such as of structural change, and appears to be at a stage of development at which Japan/ Korea/ Taiwan were thirty years ago.

3. Economic growth is likely to continue at current rates through around 2015. For the years after 2015, the projections are more uncertain, with, in a lower-bound scenario, real growth falling to about 4% per year.

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Implications

1. Demography I: population size2.5 x EU, 4 x US, 10 x Japan or 1.5 x (EU+US+J)

Large population => large domestic market =>

Economies of scale = low cost

Competition = pressure to innovate

=> What does that mean for mass production in the West?

Where is the competitive edge of the West Vs. China?

China following East Asian development patterns

-> population size will make it the largest market in the world

=> Implications for firms worldwide?:

Design? Marketing? Production location?

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2. Demography II: pool of talent

If talent is randomly distributed among the world population, and if China’s education system is able to identify the brightest students,then China has a larger pool of talent to draw from than any other

country in the world.

Why not important earlier?How long will it take to make full use of this pool of talent?

=> Implications for future innovation capacities in comparison to the West?

Current comparative advantage: labor quantity. Current comparative disadvantage: scarcity of technology; capital?Always comparative disadvantage: scarcity of land.

=> Specialization worldwide?

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3. Growth I: China

Rising living standards

Coastal provinces approaching income level of middle-income countries

=> What does that mean for China?Poverty alleviation -> middle class -> democratization?

Consumption waves

Environmental pollution

=> What does that mean for the world?Market for Western goods

Energy / natural resources

Tourism

New world currency

Income?, Employment / job security

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4. Growth II: China -> World

China’s exports are moving up the product ladder.

=> The “China price” affects ever new product markets

Transmission of growth to other Asian countries

(2/3 of China’s imports originate in Asia).

=> China as growth locomotive for South East Asia

Leader-follower effect with India

The world five / ten / twenty years from now?

China produces and consumes:

manufacturing hub predominantly for the domestic market

Opportunities for foreign firms (sell domestically, not only abroad)

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5. New and different “superpower:”

large element of foreign-directedness

Extensive foreign ownership of assets in China

=> Who “controls” the Chinese economy?

Our pensions depend on China

More than half of China’s exports are from foreign-invested firms

=> Are we importing from China, or from ourselves?

Large degree of openness to foreign economic norms/ standards

=> Are we still dealing with a foreign country?

Integration into international markets and production chains

=> Support for free trade / economic policies of market economies

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cont.

What’s the meaning of being Chinese?

=>Most profs at HKUST look “Chinese,” but they are U.S. Americans.

Where are the loyalties? What is the meaning of nationality?

If “China” and the “West” become increasingly indistinguishable,

what are the political / civil rights / human rights implications?

Direct use of economic power by China’s leaders to pursue their goals worldwide:

Ex.: “CCP” Politburo running firms in the U.S. / Europe?

Ex.: use of forex reserves to buy support of individual countries / politicians

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Paper (with less on implications) is published as

“China’s Economic Growth 1978-2025: What We Know Today about China’s Economic Growth Tomorrow” in World

Development 36, no. 10 (Oct. 2008): 1665-91.

Appendices: http://ihome.ust.hk/~socholz

Labor calculations (1978-02 / projections through 2005) are in separate manuscript at http://ihome.ust.hk/~socholz.

Physical capital 1978-03: published in the

China Economic Review 17, no. 2 (2006): 142-85.