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China's next top model

16 July 2013

Massive and fast-paced change is creating a new model of Chinese economic growth, write ROSS GARNAUT, CAI FANG and LIGANG SONG.

Once an economy has stepped onto the escalator of modern economic growth it never stays still.

So it is with China, which has been undergoing restless change at a dazzling pace since Communist Party decisions in 1978 committed the country to a path of market-oriented reform and integration into the international economy.

Now, the Chinese economy is undergoing another profound change in policy and structure; all necessary to increase the value of and to sustain growth into the future.

Change is being driven partly by economic pressures that are emerging naturally from successful economic development. These include labour scarcity and rapid increases in real wages, changing patterns of resource allocation, income distribution, environmental impact, and rates of economic growth, savings, investment and international capital flows.

The changes are so comprehensive and profound that they add up to a new model of Chinese economic growth. They also have major implications for China’s interaction with the international economy.

From about 2004, as China entered the turning period of economic development, the old growth model began to be challenged by increases in wages in excess of productivity. This development was reinforced when the work-age population began to decline in 2012.

The international economic environment also became less benign for the old growth model. While China’s huge current account surplus (over 10 per cent of GDP in 2007) had allowed other countries, especially the United States, to maintain growth while implementing other policies that would have brought it to an end, the great financial crisis of 2008 encouraged criticism of Chinese surpluses. Tepid growth in the old industrial countries after the financial crisis diminished opportunities for rapid expansion of exports, although continued growth in developing markets allowed some changes to China’s geographic focus in trade expansion.

Uninhibited investment expansion was also approaching social and political limits towards the end of the first decade of the 21st century.

The increase in income inequality between rural and urban residents, and between workers and owners of capital and privileged positions in government and economy, became the focus of increasing comment and tension. The mandatory purchase of peasants’ land for urban development, which was a feature of uninhibited investment expansion, was increasingly controversial.

International concern about China’s increasing contribution to the build-up of concentrations of greenhouse gases in the atmosphere came to a head at the Copenhagen meeting of the United Nations Framework Convention on Climate Change in December 2009. Increasing community concern about health and amenity impacts of domestic pollution reached a crescendo in early 2013.

Longstanding community concern over corruption within government was explicitly identified as a potential source of political instability by Party and State leaders in 2012 and early 2013, and the old model of economic development was recognised as being conducive to corrupt use of public office.
For all of these reasons, the need to move to a new model of economic development—to make the transition to an advanced modern economy—began to be discussed with increasing purposefulness amongst Chinese scholars and thoughtful officials from around the middle of the first decade of this century. It was not that uninhibited investment expansion was exhausted; it could continue to add to economic output at a rapid rate for a few more years. But, there would have to be transition to a modern economy at some time in the near future, and leaving it too late would increase the strains and costs of change.

So, China entered the third major transition of the reform era – the transition to an advanced or modern economy.

The transition to an advanced economy is characterised by the gradual fall in the share of GDP represented by industrial investment and urban infrastructure; heavy investment in education and upgrading of the quality of education; expansion of the consumption and the services shares of expenditure, reform and improvement of the legal and institutional bases for an advanced market economy; and rapid structural change to technologically sophisticated industry with a much larger proportionate place for services.

All of the standard sources of growth are affected by these changes. The labour contribution to growth is markedly lower, and the contribution of capital intensification moderately lower. The contribution of total productivity increases to growth can rise if the increasingly sophisticated economy is supported by the necessary institutional improvements. The outcome is likely to be average growth in output two or perhaps three percentage points below the average of the period of uninhibited investment expansion.

The necessary changes in economic institutions require restraint in the use of old-style fiscal and monetary expansion through public institutions to avoid downturns in economic growth. This implies acceptance of moderate cyclical slowdowns without large-scale Keynesian responses—although strong anti-recessionary responses, at some cost to desirable structural change, could be expected in response to a major downturn.

Much higher priority is assigned to domestic and international environmental amenity in the transition to an advanced economy: energy saving and reductions in the carbon intensity of production are major objectives of the 12th five-year plan (2011–2015).
While the desirability of reduced inequality has been prominent in official policy statements right through the reform period, reduced inequality is an objective that attracts strong policy action in the transition to a modern economy. Rising real wages have been making a strong contribution to reduction in inequality from about 2008.

We can see this reflected in the increasing and now large central government payments to rural education, health, transport, communications and an income safety net over recent years. Quantitative measures of inequality have begun to fall.

China’s adoption of a new model of economic growth is of immense importance to people in the People’s Republic and everywhere. Not only that, familiarity with the early features of this new model is of fundamental importance to China watchers across the globe.

This is an edited extract from the new book China: a new model for growth and development, edited by Ross Garnaut, Cai Fang and Ligang Song.

China: a new model for growth and development is available for free download from ANU E Press.

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