Keyu Jin writes: Most economists have a reason to be worried about China’s economy – whether it be low consumption and large external surpluses, industrial overcapacity, environmental degradation, or government interventions like capital controls or financial repression. What many fail to recognize is that these are merely the symptoms of a single underlying problem: China’s skewed growth model.
That model is, to some extent, a policy-induced construct, the result of a deep-rooted bias toward construction and manufacturing as the leading drivers of economic development. Today, China’s proclivity for industrial production is manifested in large-scale manufacturing and infrastructure projects, encouraged by direct and indirect government subsidies. By boosting investment and generating tax revenue for local governments, this approach has a more immediate positive impact on GDP than efforts to develop the service sector.
The disparity between China’s GDP growth which has averaged nearly 10% annually over the last few decades, and its employment growth, which has amounted to just 1-2% annually. Clearly, industrialization and export expansion alone cannot absorb China’s massive labor force.
The problem is that rapid labor-productivity growth in the industrial sector – more than 10% per year over the last two decades – is reducing the need to hire more workers. The service sector, by contrast, experienced much slower labor-productivity growth (about 5% annually over the same period), meaning that it could be far more effective in generating employment growth. In the United States, about 80% of the total labor force was in the serevice sector in 2012.
Chinese households are missing out on the benefits of economic growth. In order to cap the rise in labor costs, wages were suppressed, growing by only 5% annually over the last 20 years, even as productivity grew at an annual rate of 8.5%. Meanwhile, financial repression lowered the cost of capital. In the last decade, the average real (inflation-adjusted) return on deposits has been near zero. With about 80% of Chinese household savings deposited in banks, this implicit tax on savings has had a major economic impact, reinforcing Chinese households’ tendency to save and thus undermining consumption growth and exacerbating global imbalances.
In this way, China’s distortionary policies have helped to perpetuate a dysfunctional growth model. Wage suppression, financial repression, and an undervalued exchange rate subsidize exports and production, at the expense of households, which are thus compelled to save, weakening domestic demand.
Breaking the cycle will not be easy, but there is no other way to address many of the most pressing problems confronting China’s economy. Indeed, the current growth model is also taking a heavy toll on the environment, with pollution threatening the population’s health, especially in urban areas.
Restructuring the economy is perhaps the most urgent – and most difficult – challenge facing China’s leaders today. Given that the current distortions are interlinked, they may need to be addressed simultaneously. China’s gradualist approach may no longer work.
