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Why China’s economy needs some quality time

4 April 2011
by Brian Keeley

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China’s economy has been zooming along over the past few decades, regularly reaching and exceeding annual growth rates of 8%. Pretty stunning, and even more so when compared to the current performance of most developed economies.

Indeed, it’s fair to say that China is now the main – albeit, not the only – engine of the world economy. A comparison with ten years ago illustrates its growing role: Back then, on the eve of the slowdown in 2001, the world economy was growing by about 5%, to which China contributed just over a tenth; last year, in the wake of the Great Recession, the world economy was again growing by close to 5%, but this time China accounted for almost a third of global growth.   

Impressive, but there’s a risk of being led astray by all these numbers – as the old tailors used to say, “never mind the quality, feel the width”. True, China’s boom has been long and has brought hundreds of millions of people out of poverty. But some fear its nature – in other words, quality vs. quantity – may not be laying the foundations for long-term sustainable growth.

If they’re right, China risks joining the long and depressing list countries that got stuck in the “middle-income trap”: Of all the economies that were in the middle-income camp in the 1960s, almost three-quarters are still there, or have regressed to low-income status. Among China’s neighbours in Asia, Japan and Korea managed to make the leap; Malaysia  – so far – has not. 

Why not? In essence, the middle-income trap reflects fundamental structural issues in an economy. An economy can often go from low- to middle-income on the back of a plentiful supply of cheap labour – loads of low-paid and relatively uneducated workers assembling sneakers, TVs and cars, and so on. But to make the next leap, those workers need to start “adding value” – dreaming up fancy new products and moving to a greater focus on services, rather than just manufacturing.

China may be at the limits of this first stage. Some economists argue it has now reached the “Lewis turning point”  – the moment when industrial wages start to rise as the supply of plentiful and cheap labour from the countryside dries up. That won’t kill off China’s manufacturing strength overnight, but over the coming years it will become less of an advantage.

As part of its response, China will need to ensure urban jobs remain attractive to people in the countryside, reducing the impact of the hukou system and ensuring that rural migrants have “the right to appropriate health, education and other public services” as the OECD recently noted.

China will need to do more than that, though. Last month, it sent a strong signal of exactly what it plans to do when it released its latest Five-Year Plan. At a time when many developed economies are struggling to expand, it’s striking that the latest plan actually sets a lower target for China’s expansion than its predecessor: 7% vs. 7.5%. In part, that’s probably aimed at reducing the risk of rising inflation in an overheating economy.

“In China, slowing down economic growth is important,” as the IMF’s John Lipsky  was quoted as saying last month. If history is any guide, applying the brakes won’t be easy: Despite the 7.5% target in the last plan, China’s economy actually grew by closer to 11%, as The Economist notes.

But, as The Economist also points out, perhaps the real point of the revised target is to indicate “that the pattern of growth now matters as much as the speed”. That focus is reflected elsewhere in the plan: As Morgan Stanley’s Stephen Roach notes, the plan emphasises the need for China to develop its domestic markets – shifting “the focus away from a powerful export- and investment-led growth dynamic toward an approach aimed at drawing more support from China’s 1.3 billion consumers.”

There will also be additional resources for seven strategic and high-end industries, including next-generation information technology, clean energy sources and biotechnology, all aimed at helping China make the transition to the next phase of economic growth and promoting greener growth.

Will China succeed? We’ll know more in another five years.

Useful links

 China’s Emergence as a Market Economy: Achievements and Challenges – An OECD review of the 12th five-year plan 

OECD work on China

The OECD’s Chinese-language site – 网站 (中文)

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