Can China return to rapid growth in the post

By Zhu Tian

How will the economic pain inflicted by three years of COVID-19 affect China’s growth in the long run? And, what are the key engines to the country’s economic growth? In economics, there are two crucial concepts – long-term growth and short-term fluctuation.

While consumption will be a major driver for the country’s short-term recovery, the real engines for long-term economic growth are investment, education and technological progress. To create a favourable environment for these three driving forces, China should retain market-oriented and rule-based reforms and adopt counter-cyclical policies to ensure economic stability.

Understanding long-term growth and short-term fluctuations

In economics, “economic growth” is defined as a sustained rise in productivity and output of a country or region, and is often measured by the average growth rate of GDP per capita in the mid-to-long term. “Economic fluctuation” refers to changes in GDP growth rate (upward or downward) relative to the country or region’s long-term growth trend, which is also known as the business cycle.

Since long-term economic growth is, in essence, a matter of an increase in productivity and supply (rather than demand), the real engines for a country’s economic development in the long run are investment, education, and technological progress. By comparison, the more well-known three drivers of growth – consumption, investment, and export – are the demand-side factors that affect the short-term GDP growth rate in the context of a given level of productivity. This toolkit can be used to analyse short-term fluctuations (such as how the pandemic has affected economic growth during the past three years), but not mid-and-long-term economic growth.

The following statistics show how some countries and regions have performed in long-term economic growth. In 1979, the US GDP per capita was nearly $30,000 (USD) while China’s was only $300 (about 1% of the US level). Through 40 years of fast development, China’s GDP per capita grew at an average annual rate of 8.41%, compared to 1.66% in the US. The gap between the two countries has narrowed by half almost every decade, such that, 40 years on, China’s GDP per capita has reached about 16% of that of the US. This continuous rise of per capita income is evidence of economic growth, which is a long-term concept. By “long-term”, I mean a decade or several decades, rather than a century or millennium, for economic growth has only come into view in the last two hundred years or so.

It is not surprising that China has grown much faster than the US, Europe, or Japan. In part, this can be attributed to a catch-up effect due to China’s low starting point (as measured by GDP per capita). But it is hard to explain why China has grown faster than other developing countries – something which we can call “China’s growth puzzle.”

Three engines for China’s economic growth

To unravel the puzzle about China’s robust growth, we need to pinpoint the country’s competitive advantages over most other developing countries from the perspectives of investment, education, and technological progress.

First, China’s strong growth is bolstered by its heavy investment in fixed capital, whose share of the GDP is the highest in the world. South Korea, Singapore, and India also have fairly high figures in this regard, which has also spurred their growth. You cannot invest without money. But, where to get the money? The most vital source is domestic savings. According to the World Bank, China’s savings rate is the highest of all developing countries. It has taken up an average of 41.4% of China’s GDP over the past 40 years, higher than the share of fixed-asset investment in GDP (39.2%).

Second, China’s education excels not because of the better coverage of public education, but by the quality of basic education (primary and secondary education). An authoritative study has revealed that a key predictor of a developing country’s economic growth is the quality of its basic education. Developing countries that value the quality of basic education typically have a stronger capacity to learn and absorb what is useful from developed countries.

Lastly, strong economic growth must be fuelled by technological progress. The innovation capacity of a developing country should be measured primarily by its growth rate in innovation, rather than how its current level of technological capacity. From this perspective, China has had the fastest growth in innovation capacity in the past 30 years. There are two paths to innovation: invention – doing something no one has done before – and imitation – doing something you have not done before. How well a country can imitate is positively correlated with the quality of its basic education.

It is noteworthy that invention and imitation are not mutually exclusive, for imitating others can pave the way for coming up with something original on your own. China started out as an imitator, but as its technologies develop, the focus is shifting from imitation to original creation (as evidenced by the rising quantity and quality of its patents and academic papers). China is now a patent powerhouse with a fast-growing number of patent filings, and leads the world in the number of academic papers published in core international scientific journals.

On the whole, reform and opening up, globalisation, and political stability are conducive to and necessary for China’s robust growth, but they are not what makes China special. China boasts the highest investment rate in the world thanks to its high savings rate. It outperforms other developing countries in the quality of basic education, which enables it to quickly learn and imitate western technologies. That in turn drives China’s technological progress and builds the innovation capability of Chinese players. These are the real differentiators that set China apart from all other developing countries and contribute to its strong growth momentum.

Misunderstood role of investment

The main reason for the sharp downturn of China’s economy in recent years lies not in the country’s declining growth rate of potential productivity, but in its shrinking demand, especially in investment. This is a matter of economic fluctuation rather than long-term growth, so we should turn our eyes to consumption, investment, and export.

Amongst these demand-side factors, consumption and investment were hit hardest by the pandemic in the past three years, while export was the only one that remained resilient.

China’s economy had shown clear signs of slowing down even before the pandemic. Statistics from 2011 to 2019 also revealed a decline in the growth rate of consumption. However, China’s economy was not slowed down by the weakened momentum of consumption, since domestic consumption grew faster than China’s GDP in previous years. It was the economic slowdown that put a drag on consumption.

In times of economic slump, boosting consumption can help economic recovery; spurring investment and export can also help. Yet, long-run economic growth has to be powered by investment, education (including training), and technological progress. Consumption growth is not the cause, but the result of economic growth.

The primary contributor to China’s economic downturn was the tumbling growth rate of investment in fixed assets, which dropped from nearly 20% in 2013 to almost zero in 2018 – a plunge so fast that it was unlikely to be the result of any structural cause. Instead, it was the result of policies rolled out in recent years to address overcapacity and company debt.

Now, it is evident that China’s economic slowdown is not something inevitable. The blame should not be placed on structural reasons, shrinking demographic dividends, insufficient innovation capacity or unbalanced development. The crux of the matter is investment. China’s recent policies have created an unfavourable investment climate. Policymakers have tried to keep the investment rate down to boost consumption, but this will not translate into economic growth, for investment is not only a short-term demand, but also a major driving force for long-term growth.

There is still plenty of room for China to catch up with more developed countries, which means China’s economy can and should grow faster. If we keep to the path of reform and opening up that is market-oriented and rule-based, adopt counter-cyclical policies to ensure economic stability, and reduce misjudgement in policy-making, China’s economy will continue to grow at a fast rate and enjoy promising prospects.

Zhu Tian is a Professor of Economics , Associate Dean and the Director of the EMBA Programme at CEIBS. For more on his teaching and research interests, please visit his faculty profile here.