Discussing paper

Transformation of China,Xiaodong Zhu

Ada Alipaj Applied Intermediate Macroeconomics

Understanding China’s Growth Model

Outline China’s historical growth performance

Deficiencies of China’s growth model and challenges

Institutional reform to transform the development mode

China’s rise and the importance in world economy

Critical thinking over China’s growth

Conclusions

China’s historical growth performance

China’s historical growth performanceChina’s growth: ‘52-’78 from increases in both physical and human capital rather than increases in productive efficiency.

China’s historical growth performanceAfter 1978, total factor productivity participated in growth.

1/(1 – α) and α is 0.5=>the growth contribution of total factor productivity growth is 2 × 3.16 = 6.32 percentage points, or 78 percent of the growth in GDP per capita.

Capital deepening was not the source of China’s growth.

Government-led Industrialization between 1952 and 1978

Heavy industries investment driven- model of growth after ’48

The resources for investment by limiting household consumption and setting low prices for agricultural goods so that forced savings and surpluses extracted from the agricultural sector could be used for investment in such industries.

Not sustainable and had grave welfare consequences.

The Great Leap Forward years (1958–1960) not only failed to raise the GDP growth rate, it also had such disruptive effects on agricultural production that a severe famine occurred when China was hit by adverse weather shocks in 1959.

Heavy taxes on farmers. the agricultural sector included more than 70 % of China’s labor force Emergency grain imports were frequently needed to meet food deficits.

Sectoral Shifts and Productivity Growth since 1978 A general policy of Gaige Kaifang or “reform and opening up.” ’76

The “state sector”(state-owned enterprises and shareholding companies)

the “non-state sector”(domestic private firms, foreign-invested firms)

Two reforms: -collective farminf system to householdresponsibility system.

-increase of agricultural goods

These=>incietives of farmers=>productivity growth=>China’s agricultural output increased by 47%. Workers reallocated in nonagricultural sector

Reforms that changed the history of growth Two reforms in ‘80s: -dual track system(state owned enterprises were given quotas, but also

allowed to buy and sell inputs&output in market prices) -townships enterprises(decision-making powers to lower-level governments

and provided them with fiscal incentives )

Between 1978 and 1988, the share of total employment in non-state enterprises increased from 15% to 39%

The expansion of employment in the non-state sector =>TFP growth averaging 5.87% a year

1988 –2007: From Reform without Losers to Inevitable Tradeoffs To impressive GrowthState-owned Non-state ownedAverage annual growth Average annual growth rate of tot prod 2.96% rate of tot prod 3.66%

Townships a failure: lack of technological innovation lack of competition lack of effectivity non performing loans trapped to government

China after joining WTO: -cut tariffs, -broadened trade rights, and -liberalized its regime for foreign direct investment

Number changes since reforms

Rise of China

The world’s second largest economy after the U.S. at market exchange rates since 2010.

The largest exporter after overtaking Germany in 2009.

The largest manufacturer followed by the U.S. in value added measured in current prices.

The second largest recipient of FDI after the U.S. with about $100 billion in 2010.

The world's largest holder of foreign-exchange reserves. (about USD 3 trillion till 2011Q1)

China's Share of World GDP (%)

Source: World Development Indicators

China's Share of World Exports of Goods and Services (%)

Source: World Development Indicators

Global impacts of China’s growth

Source: Arora and Vamvakidis (2010)

(cumulative effects of a 1 percentage point rise in China’s growth on growth in other countries, in percentage points)

China factor

China’s price

China’s market

China’s role in global governance

Potential growth will slow down

The study shows: In the past three decades, China’s potential growth rate is 9.5%, about 1.3 percentage point is the cost of environment, entering the new century, the contribution of environment is 2 percentage point to GDP growth.

Taking account of the demographic change (i.e., the reduction of

working age population) and low carbon constraint, the potential growth rate will be below 8% in the next decade.

Economic catching-up with distorted factor prices wastes resources and damages the environment. Over-dependence on investment and heavy chemical industries are

especially unsustainable with the depletion of natural resources.

Unbalanced growth momentum Demand side: rely heavily on investment and export, not private

consumption Supply side: rely heavily on secondary industry, not tertiary industry Factor input side: rely heavily on capital and labor, not TFP

A narrow-minded focus on growth without fair distribution leads to a mismatch between economic and welfare progress. Mid-income trap

Unbalanced growth Challenges China’s future development

Middle income transition

Government role Transformation of government role

Government should play down its role in promoting economic growth and gradually evolve into a service-oriented organ.

Adjust the evaluation system of local governments’ performance

Local governments' passionate involvement in economic activities is rooted in the evaluation system of civil servants. Only when more social indicators, such as the growth rate of residents' incomes, employment, social security and environmental indices, are made a decisive part of the evaluation system can local governments start seriously thinking of changing their roles.

Conclusions Transformation of growth model cannot just rely on government directives.

More importance should be attached to market mechanism such as price signals and tax incentives.

Only when the prices of energy resources are reasonable and taxes on resources and the environment are in place, can the ambitious energy saving and emission reduction goals be met.

Only when direct taxes are increased by a large margin, can local governments be prompted to build better local industrial structures rather than just blindly expanding the scale of industry.

Only when relations between central and local finances are properly managed can the over-dependence on land transfer and lopsided malformation of the real estate market be corrected.

THANKS