How Beijing Can Right Its Economic Course
South China Morning Post: "Open Questions," July 15, 2024
SCMP: You have paid close attention to the third plenums in China and know their significance to China’s economic future. There have been years of calls for “structural reforms” as China aims to advance into quality growth. Looking back, what do you think have been the hits and misses in terms of economic reform?
Initially, I was very excited about the significant number of reforms that came out of the Third Plenum of the 18th Central Committee in November of 2013. It was President Xi Jinping's first real major effort to formulate policies and reforms that we thought would lead to major structural shifts in the Chinese economy.
Now, nearly 11 years later, I would have to say that while the Chinese economy has progressed on many fronts, the implementation of those reforms has been quite disappointing.
I think the critique that was raised by former premier Wen Jiabao in March of 2007 – when he warned that the Chinese economy, while strong on the surface, “was unstable, unbalanced, uncoordinated and unsustainable” – has yet to be resolved. In particular, I think the failure of the third plenum of November 2013 was more on the structure of the demand side – the incredibly low level of household consumption as a share of GDP. That has not been addressed and that remains an enduring problem for China's structural reform imperatives.
What, then, do you think have been meaningful structural changes?
There has been considerable effort made to address structural issues in China since 2013. There is no question about that. China has continued to grow, although of course the growth rate is now considerably slower than the blistering 10 percent pace in the 31 years from 1980 to 2011.
But I think the biggest change in my view, over that period, has been the recognition that the focus needs to shift from the quantity to the quality of growth.
There comes a point, as I think President Xi indicated in a recent article in the party journal Qiushi, that when the expansion of quantity reaches a certain stage, that it is critically important to then focus on quality. That point is now at hand.
The quality of growth, I think is best addressed, as Xi has put it, through boosting total factor productivity (TFP). That is a big challenge for China because TFP has now been declining for about a decade. It is critically important that this downtrend be reversed in China and return to a phase of increasing TFP as was evident in the first decade of this century.
TFP growth was very strong, starting in 2000, coinciding with the aftermath of China's accession to the World Trade Organization.
Reading from the Penn World Table, from 2000 to 2010, China’s average TFP growth rate was 4.6 per cent. It was spectacular. And then from 2011 to 2019, a nine-year period, TFP declined by 1.4 per cent on average.
What are your expectations for the coming third plenum?
In looking at early indications of where the third plenum of 2024 is headed — drawing on recent articles in Qiushi and speeches of senior officials — the focus seems much more on the supply side than on the demand side.
I don't minimize the importance of focusing on the supply side, especially the high-quality development that President Xi continues to emphasize through “new productive forces”. He stresses that the emphasis is very much aimed at boosting total factor productivity, which is important. So I'm not critical of that.
But what is missing is an equal focus on the demand side, especially internal private consumption, where the share of GDP remains below 40 per cent. I think this is a serious challenge that was not taken up in the third plenum of 2013, and I hope it will be given much more focus at this year’s third plenum.
You refer to TFP a lot when discussing China’s economy, can you explain why that is a significant metric?
First of all, it's the broadest measure of improved efficiency in any economy – China, the United States, Europe, or Japan. It is the output that is produced in excess of the contributions made by increased employment and investment. It reflects innovation, technological change, the emergence of new industries, the power of entrepreneurial spirit — all of which combine to create economic output beyond that which can be accounted for just by increasing the factors of production: land, labour and capital. So, it's a very important and broad measure of what can be dubbed the magic of economic growth and development.
TFP is particularly important now for China because of the demographic pressures that have led to a contraction in the working age population that began in 2015 and is projected by most demographers to continue through the end of this century. That hs been an outgrowth of the population distortions traceable largely to the “one-child” family planning policy, which has now been disbanded. But it will take a long time for birth rates to start increasing again — assuming that does occur, which has not yet been the case — to turn China’s demographic situation around.
So, when an economy is experiencing a declining working age population, the only way that it can really boost or support strong economic growth is by increasing productivity. In today’s climate, TFP growth is absolutely critical for getting more out of the Chinese economy.
We learned that painfully in watching the three last decades of Japanese economic growth. Japan’s working age population peaked in the 1990s when its TFP growth was stagnating. The failure of Japan to offset its declining population by increased TFP was a critical structural impediment to economic growth. While China is not Japan, for many reasons, it is facing a similar Japanese-like challenge with a declining working age population and weak TFP. There is a certain urgency here to addressing that.
How does China’s TFP reflect the challenges faced by the Chinese economy?
What we've seen in recent years is a shift in the mix of industries in China, away from private sector companies back to state-owned enterprises. Historically, state-owned enterprises have much lower productivity growth than privately owned enterprises. If this trend of a shift to state-owned enterprises, which has been evident in the last several years, continues, then China risks shifting the structure of its economy to its low productivity growth sector. That would certainly complicate President Xi's objectives to boost overall TFP.
A second concern I have on Chinese TFP prospects is that the private sector, over the past three years, has been under increased regulatory scrutiny, especially the internet platform companies. Historically, these have been the highest productivity growth segments of the Chinese economy. So that clearly needs to be addressed if China is to put in place reforms that unleash or unshackle the animal spirits of high productivity growth from private enterprises.
All in all, I'm pleased that there is now sharpening focus on China’s TFP challenge. But, at the same time, it’s most urgent for Beijing to try to deliver the reforms that are aligned with meeting this challenge That is especially the case in the current climate of an ageing and shrinking working age population.
At the moment, land reform, power system reform, corporate governance, technological self-reliance, and tax reform are believed by many to be in the cards at the third plenum. How do you expect these issues to be addressed?
I think there's a likelihood that there will be a large number of reforms that touch on most, if not all the issues that you mentioned — and even far more than that. I think that's encouraging. But again, I have a pretty narrow focus on what I'm looking for in the third plenum reforms.
What I would like to see is a focus on two major objectives: One, boosting TFP for the reasons that I've already articulated, and secondly, boosting private household consumption. TFP without consumption is a recipe for continued unbalanced growth in China, which ultimately is not sustainable, and would be a worrisome outcome.
What I'm hopeful for would be a more balanced economy where the consumption share of Chinese GDP moves up to well above 45 per cent, on its way to 50 per cent. If that is accompanied by a resumption of strong TFP growth, then I think the structure of the Chinese economy will be in much better shape heading to all the important millennial targets of 2049 than is the case today.
China has been an investment-driven economy, especially when property and infrastructure construction were at their peak. By comparison, the US is a service-led economy. Now that China has attempted to transform itself, leaning more towards a service and consumer-driven economy, how can it fast-forward the progress?
The main impediment to consumer-led Chinese economic growth — something I have focused on through papers and presentations in Beijing for years — is the lack of a strong social safety net, especially for medical care and retirement.
The emphasis by Chinese authorities has been to boost the enrollment in medical and health plans. The medical plan, in particular, is still highly fragmented by city and by province. The benefits have been inadequate.
As a result, there is an excess of household saving that is a reflection of the fear of an uncertain future. Economists call that precautionary saving. The precaution comes for good reason because the benefits are inadequate, especially now as workers and heads of households are getting older and the reality of retirement and the related need for security is, for many, extremely close at hand.
I would add a third aspect of the safety net issue which needs to be addressed: the imperatives of hukou [household registration] reform. Currently, there are nearly 300 million migrant workers lacking in benefits in the cities that they're working in. That also, I think, builds a bias towards excess fear-driven precautionary saving by this very large segment of the Chinese workforce, I think hukou reforms should be an equally important aspect of the need to boost household consumption through structural reform.
What might be the consequence if China struggles to boost private household consumption to around 45 per cent like you suggest? Does it increase the likelihood that it gets stuck in the so-called “middle-income trap”?
I don't think we really know the answer.
A lot has been written over the years about the middle-income trap. There are actually those who believe that it's blown out of proportion. The good news is that China has moved successfully through many of the thresholds associated with this middle-income barrier.
But I think the consensus among economists, both inside and outside China, is that ultimately a successful push through this middle-income barrier will require a shift from imported to indigenous innovation. If China fails at indigenous innovation – and there's little reason to presume that's going to be the case in light of China recent impressive progress in many aspects of indigenous innovation – that would be more problematic for getting ensnared in a middle-income trap than would be the failure to boost household consumption.
There is a notion that as long as China maintains GDP growth of around 5 per cent annually in the short term, and at least 4 per cent growth until 2035, it can overtake the US to be the world’s largest economy. Can it?
So many people, especially in China, always ask me that question – “when will China overtake the US?” First of all, with a population that is more than four times the size of the US, it is pretty astonishing that China has not already overtaken the US.
The real question for the Chinese people, I think, is convergence on a per capita basis. And that is not feasible for many decades, if at all. But in terms of nominal dollar-based GDP, it is perfectly possible and quite likely that that will occur at some point in the 2030s, whether it is the early part of the decade, or the latter part of the decade is dependent on some of the things we've already discussed, especially the TFP issue and the rebalancing towards internal private consumption.
It is also dependent on the currency. The renminbi has been weak and that has, together with a little bit of deflation as measured by the GDP deflator in the past couple of years, has caused many people, myself included, to push out the date of convergence from our earlier estimates.
What does it mean for China and the world if China’s growth continues to decelerate?
China had a period of spectacular growth from 1980 to 2011. And even after that, when the world was in the grips of the aftershocks of the global financial crisis, China's power as an engine of global growth was extraordinary. By my calculations, from 2010 to 2019 China accounted for 32 to 33 per cent of the cumulative growth in world GDP.
That was extraordinary, unprecedented contribution for any developing, emerging economy in any historical context.
But now, the rest of the world has healed, and China's growth has slowed. Unsurprisingly, the contribution has been reduced. So now China is contributing roughly 24 per cent of growth, which is still the strongest in the world, but not the 32 to 33 per cent that it had been contributing.
With China's share coming down, you have to ask yourself, who is filling the void?
The one economy that stands out where the global growth contribution is now sharply on the rise is India. India is still contributing less to global growth than China. But if the IMF forecast is to be believed, by the end of the 2020s India and China will almost be on a par in terms of their contributions to world GDP growth.
Does that mean that the power of the global economy is shifting from China to India? No, it doesn't — at least, not yet. It simply means that India is now emerging as a much stronger source of global growth. But it has got its own problems to address and tackle: India’s per capita GDP is well below that of China’s and while it has made big improvements in infrastructure, they lag dramatically behind the quality of Chinese infrastructure. India saves considerably less as a nation than China, and that leaves India with less ability to fund the investment that it needs to sustain growth in the years ahead.
So, it is not as if China has lost its role as the dominant source of global growth to an upstart Indian economy. But certainly, China is not delivering to the extent that it did during that 10-year period from 2010 to 2019.
In the past year or so, there have been increasing concerns about China's so-called overcapacity in the new energy sector. Do you share that view?
No, I do not. Unfortunately, I think that Western politicians have done a great disservice in focusing on overcapacity or excess capacity, largely because they have taken an economic concept and turned it into a political attack.
First of all, the accusation that any nation has excess capacity in green technologies at a time when the world is suffering horrific climate change is absurd. I mean, climate change itself is a visible sign that the world is deficient in the low-carbon capacity that it needs to address a serious greenhouse emissions problem.
There can be no excess capacity in low-carbon alternative energy products in a world afflicted with the existential climate change that we are experiencing.
I don't care who produces it, whether it's China or North Korea or Russia, we need as much green technology as possible to address this problem. Politicians who want to restrict a nation like China, which provides green technology at low cost and high quality in areas like electric vehicles and solar batteries, are drawing on a political agenda that makes no sense from the economics of comparative advantage.
Now there's one other aspect of this, hypocrisy. The excess capacity argument in the West, goes after China for unfairly subsidizing green technologies — either through direct government subsidies or via production from state-owned enterprises.
And yet, the US is basically doing the same thing. We have rediscovered industrial policy with our own American characteristics — namely, the Inflation Reduction Act, the tax credit that we've had in place for electric vehicles, the massive federal loan that Elon Musk received from the federal government to build or to support Tesla during its more difficult years, the Chips and Sciences Act. We are just as aggressive in subsidizing industries that we think are just as vital to our competitive future as China does.
As I said, there is a clear, unfortunate hypocrisy in this political campaign of going after excess capacity.
Is that why you called the recent US tariff increases on Chinese green technology goods a ‘blunder” in earlier public remarks?
It is a blunder for two reasons.
One, we're protecting our own industries, which have been slow to get started and are not cost-efficient compared to their counterparts in China — even after making adjustments for subsidies on both sides of the competitive spectrum. It is a blunder also because we are taxing green technology at a time when the world wants us to expand the supply of green technology to address an existential problem.
This could be a blunder of historic proportions for a variety of reasons, but those are the ones that I think are most important.
How has the ongoing US presidential election campaign weighed in on US-China trade and economic relations? And how is that going to shape the relations of the two powers in the longer term?
There is no question that China will be a lightning rod in the next few months in this election campaign, and anti-China policies are attractive, unfortunately, to Republicans and Democrats alike. There are very few issues that have bipartisan support in the US political debate like going after China.
The big question, I think, presuming we can make it through November without a serious problem, will be what happens to US policies, US-China tensions, post-November 2024. I remain very concerned. I think that we will not be able to find a workable resolution to this conflict unless we figure out a new way for the two countries to re-engage one another based on trust and collaboration.
As to your concerns about “a new forever war” on trade between China and the US, is that still avoidable?
That remains to be seen.
I was very critical of the Trump administration for starting the trade war, but I've been equally critical of the Biden administration for continuing the trade war and, if anything, escalating the actions against China through sanctions on technology, and now these new tariffs on alternative energy products.
For Joe Biden, who promised an end to America's forever wars when he withdrew troops from Afghanistan, it looks to me like he is risking that when it comes to the trade war with China. He's continuing to prosecute and escalate Trump's trade war with a strategy that is disappointingly similar to that embraced by his predecessor.
And who would you like to see become the next US president?
I'd rather not use this as a platform to make a political statement.
I would be very worried about the extreme positions that former president Trump has staked out thus far in this campaign season.
I do think that Trump’s talk of 60 per cent tariffs on China would have devastating consequences for both nations and for the global repercussion of disrupted supply chains that run through China. So that's certainly a very worrisome outcome should he be elected as the president again.
At the same time, Biden’s path to conflict resolution remains problematic, at best.
What is your immediate wish for China-US relations?
My immediate wish is for no further damage between now and the election. Make every effort to limit the fallout, especially in light of worrisome issues right now in the South China Sea, especially in the Philippines, and once again in the Taiwan Strait.
The drumbeat continues to get louder and louder in Washington, and I think if we can just avoid an eruption of further tensions and a degradation in the relationship between now and the election, we will then have an opportunity to hopefully take a deep breath to then, post-election, consider a better approach.
Last question: You said in one of your opinion pieces that you used to be a China optimist. How would you describe yourself now?
I would certainly not say that I am a China pessimist. I don't believe in “the China crash”, or “China disaster” scenarios. I don't believe that China is the next Japan, although I do worry about several Japanese characteristics — debt intensity, property bubbles, zombies, aging and TFP — that have eerie similarities.
I would concede that I'm far more guarded in my assessment of China than before. I have been more cautious, more worried, because of many of the concerns that we have discussed. I would like nothing more than to be able to resume my former optimistic stance on China. But to do that, China’s structural growth challenges must be addressed. Only then, would be I be open to changing my mind again.
NOTE: The original interview has been edited slightly for clarity of expression.