China’s Economic TransformationHeller‐Hurwicz China Panel

April 19, 2016

Kjetil StoreslettenUniversitetet i Oslo

China’s GDP pc as % of US GDP pc

China’s growth pattern is different

• Wages have grown, but less than productivity, 1992‐2007)

• Return to capital has remained high• Even though return to capital is high, China has had 25 years of large trade surpluses– Standard economic theory suggests that capitalshould be flowing in, not out of China

Why did growth accelerate after Mao?1980s: Economic reforms in agriculture• household responsibility system (decollectivization of ag.)• Experimentaton with free‐market industrial policy (SEZs)

1990s: Broad privatization in industry and urban sector• welcome foreign firms and entrepreneurs • 1992 Private enterprises allowed in manufacturing (Southern Tour)• 1998 State‐owned enterprises (SOE) corporatized, subsidies curbed

– «Grab the large, let go of the small» (1997, CPC Congress) – Reallocation: exit of less productive SOE, entry of more productive DPE– Hsieh & Klenow (QJE 2009), Song, Storesletten and Zilibotti (AER 2011)

• Industrial policy: Technology transfer through FDI and offshoring– Acemoglu, Gancia and Zilibotti (2015) Holmes, Mc Grattan and 

Prescott (2013)

Why growth acceleration? (cont.)• New values and career incentives within theChina’s Communist Party– (e.g., Kudamatsu, Jia, and Seim JEEA 2015)– Competition between local governments

• Improvement in the performance of survivingstate‐owned enterprises– Hsieh and Song (Brooking Papers, 2015)

• A large share of Chinese growth is explained by reallocation– rural to urban – within the manufacturing sector (privatization) 

The rise in private employment

Growing Like China: early transition (1998)

Growing Like China: mid transition (2005)

Growing Like China: late transition (2015)

Theoretical predictions

• Low wage growth during transition – wage is set in the «low productivity sector» – as private capital accumulates, entrepreneurs face elastic supply of labor (Lewis 1954; Ventura 1997) 

• Non‐decreasing return to investments – yet low returns on (non‐entrepreneurial) savings 

• Fast output growth• Accumulation of large foreign reserves

The Middle‐income Trap?

• High growth during 1992‐2011 (exceeding 10% annual)

• Slowdown since 2012. – Growth rate was 6.9% in 2015– New “growth target” of 13th Five‐Year plan: 6.5%– Also, a fall in TFP growth and rate of return on investments 

• Concern: many countries stagnate as they reach 30% of the technology frontier 

Policy response: more state capitalism, less liberalism

• Reform process has stalled– Stagnated privatization in service sector– Renewed emphasis on state‐owned enterprises– Employment growth of private firms has stopped since 2008 

– Boom in public investments

• No reform of judicial system• Main focus of government: curb corruption

China’s 2008‐2010 stimulus package

• November 2008: government announced plan to invest 4 trillion RMB (13% of GDP) in infrastructure and social welfare by 2010. 

• 38% spent on public infrastructure (railway, road, irrigation, and airport construction)

• 26% to reconstruction of Sichuan (earthquake)

China’s stimulus package

• Short‐run effects: – China maintained growth during Great Recession

– average growth rate 2008‐11 is 9.5% (!) 

– Reduction in trade surplus– Acceleration of wage growth– Improvement in infrastructure– Credit boom

Credit boom

• In a financially repressed economy, an increase in external financing can be good– More funds to financially constrained firms 

• But in the case of the 2008 Stimulus Package,– «Easy credit» did not flow to small private enterprises – Rather, it got channelled to local governments, construction, mining

– Reversal of transformation toward private‐basedeconomy

Current challenge: overcapacity

Reliance on investment‐led growth and strongstimulus has created «the three overcapacities»1. Overcapacity in capital‐intensive industry

– falling capacity utilization

2. Excess capacity in urban housing– rising vacancy rates

3. Rising debt for local government and state‐owned enterprises

China’s growth: turning to innovation?

• Emerging economies invest very small shares of their GDP in R&D– Argentina 0.7% South Africa 0.9% Russia 1.1% 

• China: 2%– same as EU average

• China is second largest investor in R&D (after US)

China’s growth: turning to innovation?

Human capital growth

• Tertiary enrolment rate: 27% (5% in 1995)• six million college graduates in 2010, 

… up from less than a million in 2001• Surge in # of students studying overseas • Chinese comprise 18.2% of all international students enrolled in OECD countries

• Median Shanghai student has PISA math scores equal to 90th percentile in USA

Conclusions

• Growth in China is set to slow down – Future growth requires commitment to continuation of reform process

• Risk: unrealistic “growth target” can induce even stronger reliance on investment‐led growth– many marginal, wasteful projects– a severe slowdown may come later 

• Signs that China is trying to switch to innovation‐driven growth – human capital accumulation, R&D