Justin Yifu Lin: The Pressure, Potential and Pertinacity of the Chinese Economy
The senior economist says Beijing is NOT promoting the state sector at the expense of the private sector, and China's headwind "mainly stems from weak external demand".
Justin Yifu LIN is Dean of Institute of New Structural Economics, Dean of Institute of South-South Cooperation and Development and Professor and Honorary Dean of National School of Development at Peking University. He was the Senior Vice President and Chief Economist of the World Bank, 2008-2012. Prior to this, Mr. Lin served for 15 years as Founding Director and Professor of the China Centre for Economic Research (CCER) at Peking University. He is Councillor of the State Council and a member of the Standing Committee, Chinese People’s Political Consultation Conference (CPPCC) National Committee.
He gave the following speech on March 13, 2024, following the end of the annual sessions of the National People’s Congress and the National Committee of the CPPCC, known as the “Two Sessions” in China.
Not sidestepping the widely-circulating view that Beijing’s preference for bigger and stronger state-owned enterprises (SOEs) and suppression of private enterprises resulted in China’s growth slowdown, Lin confronted the criticism head-on, adding that some people with these views have made up their mind - “ (they) think the issue is largely unsolvable, as strengthening and enlarging SOEs is a state policy and as long as it remains the policy, efficiency will decrease.”
But Lin says the diagnosis is completely wrong: “The continuous decline in China's economy over the past decade is not caused by the prevalent notion that "the state advances, the private sector retreats" overseas. The causal relationship between economic slowdown and state-private sector dynamics is actually the opposite. It's vital to understand this, or there could be misconceptions about the government's policy direction, thinking it intentionally promotes state advancement at the expense of the private sector.”
I am very pleased to participate in this China Economic Observer forum on interpreting the Two Sessions. As Professor Yiping Huang introduced, this seminar is held amid a special year for the National School of Development (NSD), Peking University. This year marks the 30th anniversary of the establishment of NSD, initially known as the China Center for Economic Research (CCER). Since its inception, the school has been committed to promoting modern economic theories, conducting research on economic theories and policies, and providing policy advice as a think tank. The achievements of NSD over the past 30 years, recognized by all sectors of society, are mainly due to the collective efforts of all colleagues. Another important aspect of success is that we have been fortunate to be part of a great era. Founded by a group of young people with a deep love for their country at Peking University, NSD aims to contribute to the great rejuvenation of the Chinese nation.
As you all know, this year also marks the 75th anniversary of the founding of the People's Republic of China. In the beginning, China was one of the poorest and most backward countries in the world. However, since the reform and opening up in 1978, we have achieved unprecedented sustained economic growth in human economic history. From the end of 1978 to around 2023, over 45 years, our economy has grown at an average annual rate of 8.9%. No other country has experienced such high and sustained economic growth over such a long period. Compared to 1978, our economy has grown 47 times, a true miracle.
Given this momentum, China should be able to join the ranks of high-income countries soon, as the threshold for high-income countries is $13,845 USD, and China's GDP per capita is approaching $13,000 USD. I estimate that by 2025 or 2026 at the latest, China should be able to cross this threshold and become a high-income country, marking an important milestone in the great rejuvenation of the Chinese nation.
Of course, the miracle of economic growth since the reform and opening up is undeniable. However, as you may know, throughout this process, theories predicting China's economic collapse have emerged one after another, often suggesting that China's economy is on the brink of failure. Recently, the notion that China's economy is faltering, that it might collapse, and that it will never catch up with the United States has become particularly prevalent.
Today, focusing on the Two Sessions, I am here to discuss the potential and opportunities for China's economic development, as well as our determination and the challenges we face. But first, I'd like to take this opportunity to discuss why the reform and opening up that began in China in 1978 could achieve such miraculous economic growth. Then, I'll talk about why, during this miraculous growth, the theories of China's economic collapse have become so prevalent. After discussing this, I will share my personal views on the prospects for this year's development, which also reflects the content of interest at today's Two Sessions.
Why has China's economy achieved such rapid growth since the reform and opening up? The main reason, as you know, is the purpose and strategy of our reforms. At the beginning of the reform, China was the poorest country in the world, so impoverished that the economic condition did not even reach one-third of the average for African countries. At that time, as everyone knows, our economy was based on state ownership and a planned economy.
The planned economy enabled China to establish a complete heavy industry system. This allowed us to detonate nuclear bombs in the 1960s and launch satellites in the 1970s, strengthening our national defense and enabling us to independently pursue our policies. However, the efficiency of state-owned enterprises (SOEs) was very low at that time, resulting in low income per capita. Everyone knows that our pursuit of national rejuvenation has always been twofold: we wish for a strong country and prosperous people. However, at that time, people were very poor. Thus, in late 1978, we could say that among all socialist countries, and essentially all developing countries, China was the first to transition from a government-led heavy industry prioritization or the so-called import substitution strategy to a market economy.
Why have we been able to achieve stable and rapid economic development after the transition? Over the past 45 years, not only has our development been rapid, but we are also the only country that has not experienced a systemic financial crisis. I believe that this is because our reform was based on the 解放思想 liberation of thought, 实事求是 seeking truth from facts, and adopting a gradual dual-track approach, which is to say, as a Chinese saying goes, 老人老办法,新人新办法 "new ways for new situations, old ways for old situations." At the beginning of the reform, there were many large-scale, capital-intensive, heavy, and SOEs with low efficiency. From the perspective of new structural economics, which I have advocated over the years, they were in consistent with comparative advantage and could not compete in an open market. Despite their inefficiency and lack of competitiveness, we adopted the approach of "old ways for old situations," continuing to provide them with necessary state protection and subsidies to ensure their survival and maintain the stability of our economy.
At the same time, we adopted a "new ways for new situations" approach for certain industries that were previously suppressed but now align with our comparative advantages. This approach involves allowing township enterprises, private enterprises, and foreign enterprises to enter the industries that match China’s comparative advantages. Moreover, the government also actively facilitates and guides their development.
For example, China’s infrastructure was poor at the time, and it was impossible to establish comprehensive infrastructure nationwide simultaneously. However, to develop labor-intensive industries, good infrastructure was essential. Thus, China established Special Economic Zones, Export Processing Zones, and Industrial Parks, where China built up infrastructure. Despite government intervention and distortions in the economy to protect SOEs, China implemented one-stop services in these zones, creating favorable hard environment (infrastructure and life service facilities) and soft environment (social background) within these zones.
While we were keen on entering the international market with our products, domestic enterprises had limited international contacts. To enter the global market, we sought inward investment. Foreign investors not only brought in capital and technology but also helped build China’s presence in the international market. Such strategies quickly allowed industries in which China has a comparative advantage to develop. Moreover, during this development process, China leveraged the latecomer advantages from the gap with developed countries. This means that in terms of technological innovation and industrial upgrading, the costs and risks we face are lower compared to those encountered by developed countries in their innovation efforts. Therefore, with the "new ways for new situations" approach, China achieved rapid development, which not only created jobs but also accumulated capital and foreign exchange. This allowed the Chinese economy to gradually shift from labor-intensive to more capital- and technology-intensive industries. Consequently, this industrial upgrading led to rapid development and, due to the quick accumulation of capital, gradually shifted China’s comparative advantage from traditional labor-intensive industries to more capital-intensive industries.
In the early days of the reform and opening up of capital-intensive industries, many SOEs were inconsistent with China’s comparative disadvantages. With capital accumulation, these enterprises have turned to align with our comparative advantages. So the need for state protection and subsidies diminish, allowing China to remove these government interventions and let the market play a greater role in resource allocation.
Why does the "China Collapse Theory" emerge one after another?
This has been China’s path to reform, enabling China to achieve stable and rapid development. However, why do theories predicting China's economic collapse frequently emerge? During the economic development process, cyclical fluctuations are inevitable, and investment can sometimes surge in new industries aligning with comparative advantages, leading to overcapacity. When overcapacity occurs, these enterprises' performance deteriorates, reducing their investment capacity and willingness, and subsequently slowing economic development.
This pattern was evident. An example was after Deng Xiaoping's southern tour when private and foreign enterprises, as well as rural collectives, rushed to invest in popular industries such as the home appliance industry, including televisions, refrigerators, and washing machines. Suddenly, investments led to hundreds of production lines and the establishment of hundreds of enterprises, resulting in overcapacity. Under such circumstances, of course, the economy needed to adjust, leading to slower economic growth. Sometimes, there were some external shocks. For example, the 1998 Asian financial crisis and the 2008 global financial crisis. After our reform and opening up, the industries that developed for export were in line with our comparative advantages, and their markets included domestic and international ones. China grew to be the world's largest trading nation and top exporter. However, when the global economy declines, China’s export industries would face significant impacts, slowing down economic growth.
During our transformation process, the adoption of a gradual dual-track reform often led to considerable government intervention and what could be called structural distortions in our economy, such as those involving SOEs. When making investments SOEs are often inefficient, and the proportion of SOEs remained significantly high in our economy. Although this proportion has gradually decreased, it is still notably large, compounded by various government interventions. In such a context, when China's economy experiences a downturn, it's not unusual for some to attribute the downturn to China's economic mismanagement and inherent structural issues.
An interesting comparison can be made between perceptions of the Chinese and American economies. When the U.S. economy slows, the blame is often placed on other countries. In the past, Japan was blamed, and now China is often the target. However, when China's economic growth slows, the international academic community generally attributes it to China's systemic, institutional, and structural problems. This view is not only prevalent abroad but also within China's academic circles though it is true that China faces issues arising from an incomplete reform process.
China indeed faces various issues stemming from inadequate incremental dual-track reforms, but often, economic downturns may be attributed to external or cyclical factors. However, both domestically and internationally, there tends to be a belief that these issues are caused by China's systemic problems. Additionally, due to difficulties in reforming or an unwillingness to change the system, there is widespread pessimism about China's economy, with some even predicting an imminent collapse.
After 2013, China's economic growth rate declined from around 9-10% to 6-5%. This is a fact, but there are many interpretations of this continuous decline both domestically and internationally.
Many believe this downturn is due to "the state advances, the private sector retreats." From the perspective of property rights theory, it's generally believed that state-owned enterprises (SOEs) are inefficient, while private enterprises are efficient. At the start of China's reform and opening up, nearly 100% of enterprises were state-owned. Now, SOEs account for only about 25-30%, with private enterprises rising from virtually none to 70-75%. There was a theory that China's rapid growth was due to efficiency improvements brought by property rights reforms, supported by numerous theoretical articles.
However, after 2003, the proportion of SOEs in the national economy and their share of bank loans have continuously increased, while the share of private enterprises in both respects has decreased. Many believe this decline in the private sector's share is due to policy suppression. Those holding this view think the issue is largely unsolvable, as strengthening and enlarging SOEs is a state policy and as long as it remains the policy, efficiency will decrease. That’s how the economic slowdown is attributed to these policies.
This viewpoint can lead to pessimism and a loss of confidence in future development.
The proportion of SOEs in the economy and their share in loans have indeed increased. However, the question arises: among "economic growth slowdown," "increasing SOE share," and "rising proportion of loans to SOEs," which is the cause and which is the effect? Is the increased share of SOEs leading to slower economic growth, or is the slowing growth leading to a higher SOE share? If this causal relationship is unclear, the policies adopted will differ, as will future predictions.
In my view, the rising share and loan proportion of SOEs are consequences of the economic slowdown, not the cause. The reduced investment and loan shares of private enterprises result from external shocks and the overall economic slowdown.
After the 2008 global financial crisis, developed countries have not fully recovered. The average economic growth rate of high-income OECD countries between 1980-2008 was 2.7%, with the US at 3%. However, after 2008, absent necessary structural reforms, these developed countries saw a significant decline in growth rates. The US, having the best recovery among them, only achieved an average annual growth of 1.8% between 2008-2022, with OECD countries at 1.5%.
Moreover, international trade among developed countries has not fully recovered. Before the 2008 crisis, global trade growth was more than twice the rate of world economic growth. After 2008, both global economic growth and trade growth slowed down significantly. As the world's largest trading nation, China's exports, mainly in sectors where it has a comparative advantage (largely operated by private enterprises), have suffered due to the slowdown in global trade. From 1978 to 2008, China's annual export growth was 18%. After the 2008 crisis, due to the slowdown in international trade and slow growth in developed countries leading to low import demand, China's export growth rate dropped to around 5%.
This situation has most significantly impacted the export sector, predominantly private enterprises. The sudden drop in export growth following the 2008 crisis led to overcapacity in private enterprises, with recovery in developed countries appearing distant and even declining further. Consequently, private enterprises had poor future expectations, leading to reluctance to invest, resulting in lower bank loans.
The sectors now facing overcapacity and poor operational conditions, leading to reduced investment, have affected employment. With employment impacted, income growth and consequently household consumption growth are affected, leading to an overall economic downturn.
Under these circumstances, the government must undertake counter-cyclical investments to stabilize the economy. A clear example is the proactive fiscal policy of 2008, which involved significant infrastructure construction. Since the economies of developed countries have not fully recovered, infrastructure has continuously served as a counter-cyclical measure. In 2008, China's highways stretched 60,000 kilometers, reaching 90,000 kilometers by 2012 and expanding to 177,000 kilometers by 2022, all results of proactive fiscal policies. Similarly, high-speed railway coverage expanded from just over 1,000 kilometers in 2008 to over 45,000 kilometers, accounting for more than 70% of the world's total. Additionally, the rollout of 4G and 5G networks has largely been a response to the global economic slowdown, reduced exports, and suppressed private enterprise investment, with the government adopting proactive fiscal policies to stabilize growth.
These large-scale projects with externalities are typically undertaken by SOEs, hence their counter-cyclical increase in share. As SOEs embark on these projects, they naturally increase their bank loans, a response to the economic downturn and adverse effects on private enterprises aimed at stabilizing economic growth.
If the government does not invest in these infrastructure projects, the proportion of private enterprises might appear slightly higher, but life for them would be harder than it is now. The reason is that large infrastructure projects require materials like steel, cement, and flat glass, which are predominantly produced by the private sector, creating demand for private enterprises. Moreover, these proactive fiscal policies lead to investment that creates jobs, stabilizing employment and household income, which in turn increases household consumption. The daily necessities purchased by households are mostly produced by private enterprises. Therefore, although these proactive fiscal policies increase the share of state-owned enterprises and their bank loans, they also create demand and opportunities for private enterprises, benefiting their stability and development.
A lack of accurate understanding of the economic downturn in China and its causal relationships can lead to a pessimistic view. The current lack of confidence in China's economy and the considerable pessimism about China's future mainly stem from an incorrect perception of the current challenges, mistaking the effect for the cause.
2024 Economic Outlook for China
Looking from the perspective above, what will China's economy be like in 2024?
According to predictions by the International Monetary Fund, in 2024, the growth rate of the United States will be 2.1%, a decline from 2.5% in 2023; Japan's growth rate will be 0.9%, compared to 1.9% in 2023; and Eurozone countries will only see a growth of 0.9%, which is slightly better than 0.5% in 2023 but still 2 percentage points lower than their long-term growth rate of around 3%. Thus, this year, apart from the challenges brought by geopolitics, the export environment will not improve.
A poor export environment will most significantly affect sectors that align with comparative advantages, predominantly private enterprises, suppressing their investment intentions. Weak investment will dampen employment, and household income expectations will also be adversely affected, leading to relatively slower growth in both investment and consumption.
Under such external conditions, maintaining confidence in future development requires a reasonable growth rate, making government counter-investment indispensable. Also, restoring confidence in private enterprises is necessary. To restore their confidence, besides countering external downturn pressures, it's crucial to clarify the reasons behind the economic slowdown in China. As mentioned earlier, the continuous decline in China's economy over the past decade is not caused by the prevalent notion that "the state advances, the private sector retreats" overseas. The causal relationship between economic slowdown and state-private sector dynamics is actually the opposite. It's vital to understand this, or there could be misconceptions about the government's policy direction, thinking it intentionally promotes state advancement at the expense of the private sector. China's policy remains steadfast in "unwaveringly" supporting both the strengthening of state-owned enterprises and the development of private enterprises. The National Development and Reform Commission has even established a bureau specifically for the development of the private economy to implement our national policies supporting the further development of private enterprises, which helps restore their confidence.
Besides necessary proactive fiscal policies and flexible monetary policies, it's important to recognize China still has vast development potential. With advantages in a large population and talent pool, a large market size, and a complete industrial system, there's significant room for technological innovation in new economic sectors like the digital economy and artificial intelligence. Furthermore, with 85% of industries still being traditional, China has the advantage of being a latecomer, along with excellent telecommunications infrastructure and a solid foundation in the digital economy. These traditional industries not only have the potential for industrial upgrading but also for digital transformation, offering substantial opportunities for technological improvement and upgrading. Private enterprises can play a significant role in these areas, and the government needs to implement necessary reforms to motivate entrepreneurs and provide financial and fiscal support.
As long as there's a clear understanding that the current economic downturn's pressure mainly stems from weak external demand, appropriate buffering measures are taken, and necessary reforms are implemented to encourage entrepreneurs to engage in technological innovation and industrial upgrading,
I believe China can still maintain a growth rate of 5% or even higher. We should have this confidence and determination. Currently, China's economy accounts for nearly 19% of the global total, and a 5% growth rate can contribute 1 percentage point to global growth, accounting for about 30% of global growth. China will continue to be the country with the largest contribution to global economic growth and the one with the most opportunities.