What's Behind the Rapid Growth?

Many economists and experts have voiced their opinions on the reasons for China’s rapid economic and social development. Satyabrata Rai Chowdhuri, former professor of international relations at Oxford University, is one of the eminent academics who recently looked into China’s growth rate, under the “neo-classical framework.” We share her views below.

PRIVATE ECONOMY BOOM: The private economy in Hengshui City, Hebei Province, has experienced good momentum since the city decided to take various measures to boost development of the private economy and local specialized industries

For years, investors and economists have been scratching their heads over China’s growth rate. As the nation has turned into the world’s workshop, questions about the reliability of its statistics have become important. The difference between a China expanding at 9 percent and a China growing at 4 percent is an astounding $65 billion in annual output.

China’s $1.3 trillion economy is the second largest in Asia and some say it was largely responsible for keeping the world from sliding into recession in 2001—if the numbers are reliable. Jonathan Anderson, a Hong Kong-based economist for Goldman, Sachs & Co., figures the annual growth rate is 9.6 percent. He is not wide off the mark. Offering fresh proof that the “cooling down” policy is not quite working, figures released by China’s National Bureau of Statistics reveal that the country grew an amazing 9.5 percent from a year earlier to 3.14 trillion yuan ($379 billion) in the first quarter as exports and investment surged.

A tremendous achievement indeed. But the question uppermost in the minds of many remains: How has China achieved this miracle? Economists studying China face thorny theoretical and empirical issues, mostly derived from the country’s years of central planning and strict government control of many industries, which tend to distort prices and misallocate resources. In addition, since the Chinese national accounting system differs from the systems used in most Western nations, it is difficult to derive internationally comparable data on the Chinese economy. Figures for Chinese economic growth consequently vary depending on how an analyst decides to account for them.

Although economists have many ways of explaining or modeling economic growth, a common approach is the neo-classical framework, which describes how productive factors such as capital and labor combine to generate output and which offers analytical simplicity and a well-developed methodology. Although commonly applied to market economies, the neo-classical model has also been used to analyze command economies. It is an appropriate first step in looking at the Chinese economy and yields useful “benchmark” estimates for future research. The framework does, however, have some limitations in the Chinese context.

Original data for a new International Monetary Fund (IMF) research came from the National Bureau of Statistics and other government agencies. Problematically, the component statistics used to compile the Chinese gross national product (GNP) have been kept only since 1978; before that, Chinese central planners worked under the concept of gross social output (GSO), which excluded many segments of the economy counted under GNP.

FINANCE CITY: By the end of 2004, there were 300 foreign and Chinese-foreign joint financial institutions in Shanghai, accounting for 10 percent of the banking industry’s market share in the city

Fortunately, China also compiled an intermediate output series called national income, which lies somewhere between GNP and GSO and is available from 1952 to 1993. After making appropriate adjustments to the national income statistics, including adjusting for indirect business taxes, these data can be used to analyze the sources of Chinese economic growth. Thus the measurement problem, while real, probably does not much alter the basic conclusion about substantial productivity gains after 1978.

Much previous research on economic development suggested a significant role for capital investment in economic growth, and a sizeable portion of China’s recent growth is in fact attributable to capital investment that has made the country more productive. In other words, new machinery, better technology, and more investment in infrastructure have helped to raise output. Yet, although the capital stock grew by nearly 7 percent a year over 1979 to 1994, the capital-output ratio has hardly budged. In other words, despite a huge expenditure of capital, production of goods and services per unit of capital remained about the same.

This pronounced lack of capital deepening suggests a constrained role for capital. The labor input—an abundant resource in China—also saw its relative weight in the economy decline. Thus, while capital formation alone accounted for over 65 percent of pre-1978 growth, with labor adding another 17 percent, together they accounted for only 58 percent of the post-1978 boom, a slide of almost 25 percentage points. Productivity increases made up the rest.

It turns out that it is higher productivity that has performed this newest economic miracle in Asia. Chinese productivity increased at an annual rate of 3.9 percent during 1979-94 compared with 1.1 percent during 1953-78. By the early 1990s, productivity’s share of output growth exceeded 50 percent, while the share contributed by capital formation fell below 33 percent. Such explosive growth in productivity is remarkable—the U.S. productivity growth rate averaged 0.4 percent during 1960-89—and enviable, since productivity-led growth is more likely to be sustained. Analysis of the pre- and post-1978 periods in China indicates that the market-oriented reforms undertaken by China were critical in creating this productivity boom.

How did this boom come about? The reforms raised economic efficiency by introducing profit incentives to rural collective enterprises (which are owned by local governments but are guided by market principles), family farms, small private businesses, and foreign investors and traders. They also freed many enterprises from constant intervention by state authorities. As a result, between 1978 and 1992, the output of state-owned enterprises declined from 56 percent of national output to 40 percent, the share of collective enterprises rose from 42 to 50 percent, and that of private businesses and joint ventures rose from 2 to10 percent. The profit incentives appear to have had a further positive effect in the private capital market as factory owners and small producers eager to increase profits (they could keep more of them) devoted more and more of their firms’ own revenues to improving business performance.

Although China occupies a unique niche in the world’s political economy—its vast populace and large size alone mark it as a powerful global presence—it is still possible to look at the Chinese experience and draw some general lessons for other developing countries. Most important, while capital investment is crucial to growth, it becomes more potent when accompanied by market-oriented reforms that introduce profit incentives to rural enterprises and small private businesses. That combination can unleash a productivity boom that will propel aggregate growth. For countries with large segments of the population unemployed or underemployed in agriculture, the Chinese example may be particularly instructive. By encouraging the growth of rural enterprises and not focusing exclusively on the urban industrial sector, China has successfully moved millions of workers off farms and into factories without creating an urban crisis.

Finally, China’s open-door policy has spurred foreign direct investment in the country, creating still more jobs and linking the Chinese economy with international markets. Despite significant obstacles relating to the measurement of economic variables in China, these findings hold up after various tests for robustness. As such, they offer an excellent jumping-off point for future research on the potential roles for productivity measures in other developing countries.