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Dr. Tao Wang: How can China sustain its economic development?
The UBS Chief China Economist elaborates on Making Sense of China's Economy in a new book. Here is an excerpt.
Tao Wang, Ph.D., is Chief China Economist at UBS Investment Bank in Hong Kong and formerly an economist at the IMF. She has been one of the most prominent voices on China’s economy for many years and recently published Making Sense of China's Economy at Routledge.
You may have heard about the book elsewhere, including in Brookings, The Wire China, and Bloomberg. Today, I’m privileged to share with you part of its last chapter, “Can China Sustain its Economic Development,” thanks to Dr. Wang and Routledge, the publisher.
The official description at Routledge
For years, China’s transformation from one of the world’s poorest nations was lauded as a triumph that lifted hundreds of millions of people out of poverty. There were always questions about data reliability and growth sustainability, but the general views on China have recently taken a decidedly sour turn. Concerns abound about state interference in the economy, an ageing population, and high debt level. Making Sense of China's Economy untangles China’s complex economic structure, evolving issues and curious contradictions, and explains some key features of this most puzzling of global economic powerhouses.
This book reveals how factors such as demographics, the initial stage of development in 1978, the transition away from full state ownership and central planning, the dual urban-rural society, and a decentralised governance structure have combined to shape the economy, its development and its reforms. It shows how the pragmatic and adaptive nature of China’s policymaking upends familiar perspectives and hinders simple cross-country comparisons. The book also explores crucial topics including the property market, debt accumulation and environmental challenges.
In this book, Tao Wang innovatively weaves the multiple strands of China’s economy into a holistic and organic tapestry that gives us unique insights from both a Chinese and an international perspective.
This book is critical reading for business leaders, investors, policymakers, students, and anyone else hoping to understand China’s economy and its future evolution and impact, written by a specialist who has studied the country from both inside and out.
Table of Contents
1. China’s economy ‒ the ever-changing puzzle
2. The evolving economic structure
3. The road to here – key reforms since 1978
4. The state versus the market
5. How does economic policy work in China?
6. Urbanisation and the urban-rural divide
7. Property market and local-government finance
8. The slow move towards a consumer economy
9. How serious is the debt problem?
10. The environment, public health, and the government management challenge
11. China and the world
12. Can China sustain its economic development? Appendix: Availability and reliability of China’s economic statistics
How can China sustain its economic development?
Economists and development specialists seem to agree that China needs to find alternative drivers of growth to those that spawned its earlier success (the mobilisation of high savings, cheap labour and cheap resources, and a reliance on export and property-led urbanisation). To this end, China’s policymakers have emphasised the expansion of domestic demand in various strategy formulations – the latest being ‘dual circulation’ centred on ‘internal circulation’. This shows a recognition of the worsening external environment.
To support domestic demand, especially consumption demand, the government’s policy plans include facilitating income growth (especially labour income growth), improving income distribution (a bigger middle class and better social protection) and adjusting the domestic supply structure to better satisfy domestic demand. To generate sustained employment and labour income growth, the government has emphasised the need to support SME development, also through more and cheaper credit, lower taxes and barriers to entry, and less red tape. Improving income distribution and expanding the middle class are the focus of the government’s increased drive to promote ‘common prosperity’, which includes more equal public service provision, the expansion of pension and healthcare insurance coverage, an intensification of anti-monopoly regulation and gradual adjustments to the tax system.
There is also consensus on the significance of moving up the value chain and climbing the technological ladder to secure China’s future development. Since 2018, there has been even more government emphasis on mastering core advanced technologies and becoming more self-reliant, as the US–China trade war has exposed the country’s vulnerability on the technological front. To this end, China needs to increase investment in education to improve its human capital, increase R&D spending to bring about technological progress and improve intellectual property rights protection to foster innovation. China’s government has targeted higher educational spending as a share of GDP for the past few Five-Year Plans, while R&D spending has climbed steadily. There have been greater efforts to improve intellectual property rights protection over the past few years, though most would agree that much more needs to be done.
In analysing why some upper-middle-income economies have failed to move up the value chain, some economists have pointed to the importance of manufacturing and policies that facilitate the ‘mastering’ of technology. On the former, China has developed its manufacturing capacity and capabilities in recent decades, which has helped to absorb the labour transfer from agriculture and increase overall productivity. While the share of manufacturing has declined since 2012 as services have become more important, the 14th Five-Year Plan targets a relatively stable manufacturing share while pushing for more upgrades.
On policies to facilitate the mastering of technology, China’s industrial policy is generally frowned upon by mainstream economists and heavily criticised by both liberal economists in China and western governments (Chapter 4). China’s own experience has shown that policies such as domestic content requirements, technology transfers in foreign joint ventures and a gradual introduction of competition may have helped the country increase its domestic ability to produce more sophisticated manufacturing products, in contrast to countries such as Thailand and Indonesia. The Made in China 2025 strategy was designed to help China master more advanced technologies, though it has vanished from official statements after strong objections and sanctions from the United States. In addition, there is domestic debate as to the efficacy of government subsidies in promoting innovation and technological progress. Scepticism aside, however, the government’s determination and plans to use various incentives to facilitate technological upgrades and innovation remain.
Another source of sustained productivity growth is the more efficient allocation of productive resources. China’s market-oriented reforms in the 1980s and 1990s unleashed a period of rapid productivity gains. The government has, therefore, emphasised the need to deepen reform, especially factor market reforms. These involve labour market, land and capital market reforms (including the hukou and related benefit systems, which distort the labour market), rural land reform and measures to improve the urban land supply mechanism, and reforms to enable the better functioning of the capital market and more equal access to credit for the private sector. Reforming the SOEs is also a key part of improving resource allocation, though progress has focused mainly on imposing discipline on decision making and cost control.
China’s government is keen to get two other important aspects right that are not prominent in ‘middle-income trap’ literature: macroeconomic stability and social stability. When China’s senior policymakers and scholars looked to Latin America and some Asian economies for lessons to learn, one common thread they picked up was how much a financial crisis could set back a country’s income level. This could result from a sharp decline in GDP, asset losses in debt restructuring and/or significant currency depreciation. If the debt crises in Latin America seemed hard for China to relate to, given the region’s vastly different economic policies, the lessons from the Asian financial crisis may have been more salient, as these were economies that China sought to emulate in the early years. China has made ‘no systemic financial crisis’ the absolute bottom line of its macroeconomic policymaking – and this was only reinforced by the global financial crisis. Another lesson learned from Latin America, in particular, was the importance of social harmony and stability. Policymakers in China observed that income inequality contributed to populism and polarised politics, leading to irresponsible, unsustainable, wild policy swings and macro instability, entrenching deep social divides. They were alarmed by the sharp rise in inequality and public protests at the beginning of the 21st century in China and have since prioritised maintaining social stability and addressing social issues through policy change.
Specific policies on maintaining macroeconomic stability have included modest monetary stimulus in response to the Covid-19 pandemic, tighter regulations on shadow banking and measures to contain and reduce leverage in LGFVs, the excess-capacity and property sectors since 2015. Concerns about macro and financial stability were also behind the government’s flawed attempt to stabilise the stock market in 2015, and the re-tightening of capital controls and exchange-rate management following the 2015 RMB reform. Concerns about inequality and social stability have been key factors behind the government’s ‘common prosperity’ policies. Policies aimed at addressing environmental issues, food and drug safety problems, work safety issues, social media and internet regulations have also arisen from concerns surrounding social stability.
Controlling China’s debt problem will be important to macroeconomic stability and sustained long-term growth. Despite success in containing leverage in 2017–2018, debt risks increased after the Covid-pandemic and as the debt-to-GDP ratio increased sharply in 2020. Concerns about debt have been further heightened since the second half of 2021, when debt payment problems at China’s largest property developers led to worries about the financial system. As discussed in Chapter 7, China’s total property-exposed debt is substantial. Moreover, a severe property downturn would likely lead to a hard economic landing, sparking debt issues in property-related industrial sectors and for local-government finances. However, as discussed in Chapter 9, the government is likely to be pragmatic in its property and deleveraging policies and in dealing with any subsequent bad debt and liquidity issues.
Indeed, since end 2021, the government has started to ease credit and property policies to help stabilise the situation. Property policies saw a major turn-around in late 2022 when the government eased financing to property developers from all channels. Any debt restructuring will likely be gradual, and regulatory forbearance and the central bank’s liquidity provision will help banks repair their balance sheets and limit the credit squeeze that typically accompanies a debt crisis. Remember that a high saving rate, majority state ownership of banks and a closed capital account should help China manage the debt challenge in the coming years. This also means that controls on capital outflows are unlikely to be removed anytime soon and that interest rates are unlikely to move meaningfully higher, even with further interest-rate liberalisation. In other words, while China may face the problems of a debt overhang, such as low returns on investment, it can still maintain a relatively stable macroeconomic and financial environment.
The rapidly ageing population is another major challenge on China’s path to becoming a high-income country. This is something that most other economies that transitioned to high-income status did not have to face until they were much richer. China’s population is set to peak this decade, while its working-age population (15- to 59-year-olds) started to decline in 2011. On current trends, the working-age population is likely to decline by another 50 million or so between 2020 and 2030. Some experts are worried that China will get old before it gets rich. But will getting old prevent China from getting rich? China’s own experience of the 2010s showed real GDP growing by close to 7% a year even as the working-age population shrank by 40 million, helped by the continued labour transfer from rural areas. This decade, there are fewer rural people left to move to cities – agricultural employment was only 23.6% of total employment in 2020. What’s more, the ageing of the agricultural workforce may also prevent further migration to urban areas; the average age of migrant workers rose to 41.4 years in 2020.
One way to facilitate rural-urban migration is to further relax the hukou system to facilitate whole-family migration and to reduce the exit of older migrants from the labour force. Another way of mitigating the decline in the working-age population would be to extend China’s retirement age, which the government has said it will gradually do. If the current effective retirement age of less than 54 years can be extended by three years by 2030, another 40 million people can be added to the labour force. Thus, the ageing population should not be a major constraint on the quantity of labour supply in the coming decade.
China has changed its population policy to encourage more births, although the efficacy of this policy is unclear, particularly as most other East Asian economies have low birth rates as well. In any case, any impact of such a policy on the labour supply will take at least 15 years to materialise. Meanwhile, China must (and plans to, as reflected in the 14th Five-Year Plan) improve its human capital by increasing the average length of education of its labour force and expanding vocational training. Importantly, the government needs to address systematic inequality and improve the education of millions of rural children, as discussed in Chapter 6.
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