Challenges to China’s Growth:
Martin Wolf, Associate Editor & Chief
Economics Commentator, Financial
Times
Nottingham University
Nottingham
February 2010
Challenges to China’s Growth
“In the case of China, there is
a lack of balance, coordination and sustainability
in economic development.”
Wen Jiabao, Premier of the State
Council of the People’s Republic of
China, September 2010
2
Challenges to China’s growth
• Potential
• Model
• Challenges
• Policies
3
1. China’s potential
• The simplest measure of the growth potential of an
economy is its distance from the global productivity
frontier.
• This can be called its “catch-up potential”.
• Despite more than 30 years of very fast growth,
China is still far behind the frontier, with output per
head, at common international prices (or “purchasing
power parity), at a fifth of US levels.
4
1. China’s potential
PATTERNS OF CATCH-UP GROWTH
GDP PER HEAD RELATIVE TO US
(2009 EK $s)
100.0%
10.0%
19
50
19
53
19
56
19
59
19
62
19
65
19
68
19
71
19
74
19
77
19
80
19
83
19
86
19
89
19
92
19
95
19
98
20
01
20
04
20
07
1.0%
Japan
5
South Korea
China
India
Brazil
1. China’s potential
• China is still far behind the frontier, because it was
extremely poor when rapid growth began after the
shift to “reform and opening up”.
• GDP per head, at PPP, was only 3 per cent of US
levels in the later 1970s.
• Today it is about the same ratio to US levels as that
of Japan in 1950, before more than two decades of
very fast growth.
• So China may have up to another two decades of
very fast growth in front of it.
6
2. Model
• China is following what professor Michael Pettis of
Peking University’s Guanghua School of
Management calls a “souped-up” version of the
“Asian model” pioneered by Japan and South Korea.
• The characteristics of this production-oriented model
are: high investment, transfers from households to
industry (via low interest rates, suppressed wages
and a depressed exchange rate), rapid growth of
exports and high external surpluses.
• China is, in many ways, “Japan plus”: with a higher
investment rate, larger trade surpluses, lower
consumption and much more currency intervention.
7
2. Model: fast growth
CHINA’S REMARKABLE GROWTH RECORD
GDP GROWTH
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
19
85 986 987 988 989 990 991 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009 010
1
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
2
2
2
2
2
2
2
2
2
GDP growth
8
5-year moving average
2. Model: investment
INVESTMENT AS THE DRIVER OF DEMAND
COMPONENTS OF GDP GROWTH
25.0
20.0
15.0
10.0
5.0
0.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-5.0
Private consumption
9
Public consumption
Investment
GDP
2. Model: investment
HOW INVESTMENT SOARED
COMPOSITION OF CHINA'S FINAL DEMAND
(per cent)
60
50
40
30
20
10
0
-10
78
9
1
80
9
1
82
9
1
84
9
1
86
9
1
Net exports
10
88
9
1
90
9
1
GFCF
92
9
1
94
9
1
96
9
1
98
9
1
Private consumption
00
0
2
02
0
2
04
0
2
06
0
2
Public consumption
08
0
2
2. Model: financial repression
FINANCIAL REPRESSION
NOMINAL GDP AND INTEREST RATES
14
45
40
12
35
10
30
8
25
6
20
15
4
10
2
5
0
0
93 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009 010
9
1
1
1
1
1
1
1
2
2
2
2
2
2
2
2
2
2
2
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u
u
u
u
u
u
u
u
u
u
u
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u
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J
J
J
J
J
J
J
J
J
J
J
J
J
J
J
J
J
J
China: 1-Year Deposit Rate (%)
11
China: Lending Rate: 1-Year (%)
Nominal GDP (annual % change)
2. Model: exchange rate
THE MANAGED EXCHANGE RATE
VALUE OF THE RENMINBI
140
4.5
130
5
120
5.5
6
110
6.5
100
7
90
7.5
80
8
70
8.5
60
9
0
1
2
3
4
5
6
7
8
9
0
1
2
3
4
5
6
7
8
9
0
1
99 199 199 199 199 199 199 199 199 199 200 200 200 200 200 200 200 200 200 200 201 201
1
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
1/
/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0 1/0
1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
JP MORGAN TRADE WEIGHTED REAL
12
CHINESE RENMINBI TO US $
2. Model: exchange intervention
CHINA’S FOREIGN CURRENCY INTERVENTION
INCREASE IN RESERVES
(January 2000 - October 2010, $bns)
$3,000
$2,605
$2,500
$2,000
$1,500
$1,000
$776
$444
$500
$406
$274
$241
$237
$212
$173
$153
Taiwan
Brazil
India
Korea
Hong
Kong
Algeria
$0
China
13
Japan
Russia
Saudi
Arabia
2. Model: exchange intervention
CHINA’S FOREIGN CURRENCY INTERVENTION
INCREASE IN RESERVES
(FEBRUARY 2009 - OCTOBER 2010, $bn)
$900
$849
$800
$700
$600
$500
$400
$300
$200
$91
$100
$90
$90
$88
$86
$79
$57
$54
$30
$0
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2. Model: trade
CHINA’S OPEN ECONOMY
CHINA'S TRADE
(as a share of GDP)
40.0
35.0
30.0
25.0
20.0
15.0
10.0
5.0
0.0
-5.0
-10.0
82 983 984 985 986 987 988 989 990 991 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009 010
9
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2
Trade balance
15
Exports
Imports
2. Model: trade
CHINA’S OPEN ECONOMY
TRADE OVER GDP, 2008
(per cent)
120%
Source: World Bank, World Development Indicators
100%
18%
15%
80%
7%
60%
40%
19%
92%
14%
8%
73%
7%
59%
41%
20%
41%
7%
46%
32%
24%
0%
South Korea
Germany
China
UK
Merchandise
16
India
Services
Russia
Japan
US
3. Challenges
• So what might prevent China from sustaining the
high growth model for two or more decades?
• Answers lie in:
– Productivity;
– Investment;
– Finance;
– Resources;
– External demand; and
– Geo-politics.
17
3. Challenges: productivity
• First challenge – raising productivity:
– Further increases in the investment rate seem implausible.
– That will make economic growth relatively more dependent
on rising productivity.
– There is some evidence that the rate of growth of whole
economy productivity is slowing.
– The lowering of the rate at which labour is transferred from
rural activities to the modern sector will lower productivity
growth.
– So raising productivity growth will become ever more
important.
18
3. Challenges: productivity
INVESTMENT AS DRIVER OF SUPPLY
SOURCES OF CHINA'S GROWTH
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
2000
2001
2002
2003
2004
2005
2006
2007
2008
Total Factor Productivity Growth (ln difference, percent)
Contribution of non-ICT Capital Services Growth in GDP Growth (percent)
Contribution of ICT Capital Services Growth in GDP Growth (percent)
Contribution of Labor Quality Index to GDP Growth
Growth
19
3. Challenges: investment
• Second challenge – managing investment:
– China’s economic growth has been pushed by an
extraordinary savings and investment effort.
– Astonishingly, the country has emerged as both the largest
investor, relative to gross domestic product, in the world and
the largest exporter of capital, in absolute terms.
– While a source of very rapid growth, this growth pattern also
creates significant vulnerabilities.
20
3. Challenges: investment
– Assume the incremental capital output ratio is near to 4.
– Then a decline in the growth rate from 10 per cent to 5 per
cent would reduce China’s warranted investment rate by 20
per cent of GDP.
– If abrupt, that decline would generate a collapse in demand.
– This does not seem to be imminent. But such a sharp
adjustment is likely in the next 20 years.
– When this happens, China must either shrink savings
dramatically or increase its current account surplus
enormously, if it is to balance its economy.
– Otherwise, it would risk prolonged Japan-style recession.
21
3. Challenges: finance
• Third challenge – containing finance:
– China’s growth has been driven by rising ratios of credit and
money to GDP and heavy taxation of savers.
– As the marginal returns on capital fall and bubbles become
frequent, large banking sector losses become plausible.
– Higher interest rates, to support household incomes and
improve efficiency in the use of capital, would further
squeeze the margins of the banking sector.
– A move to open up the capital account, perhaps to support
the internationalisation of the renminbi, would make the
financial sector vulnerable to a severe crisis.
22
23
M2 (% of GDP)
Quasi money (% of GDP)
Oct-2010
May-
Dec-2009
Jul-2009
Feb-2009
Sep-2008
Apr-2008
Nov-2007
Jun-2007
Jan-2007
Aug-2006
Mar-2006
Oct-2005
May-
Dec-2004
Jul-2004
Feb-2004
Sep-2003
Apr-2003
Nov-2002
Jun-2002
Jan-2002
Aug-2001
Mar-2001
Oct-2000
May-
Dec-1999
3. Challenges: finance
MONETISATION OF CHINA
MONETISATION OF THE CHINESE ECONOMY
(12-month moving aveage, per cent of GDP)
180.0
160.0
140.0
120.0
100.0
80.0
60.0
3. Challenges: resources
• Fifth challenge – managing resources:
– China’s size means that, at any given level of development,
it needs vastly more resources than other countries, except
India.
– This means that it shifts the terms of trade against itself, as it
grows.
– It also means that it has to secure vast quantities of
resources.
– If, for example, China were to have as many vehicles per
head as Japan, its fleet would increase fifty-fold and world
consumption of oil would almost have to double.
24
3. Challenges: resources
IMPORTS OF THE “WORKSHOP OF THE WORLD”
SHARES IN WORLD MERCHANDISE IMPORTS 2008
(per cent)
30.0%
27.8%
Source: World Bank, World Development Indicators
25.0%
22.6%
20.0%
17.0%
15.0%
13.3%
13.3%
13.1%
10.0%
10.0%
7.6%
6.4%
5.0%
6.2%
7.2%
5.0%
0.0%
Agricultural
Raw materials
Ores and
metals
Manufactures
China
25
Food
US
Fuels
Total
3. Challenges: resources
IMPORTS OF THE “WORKSHOP OF THE WORLD”
CHINA'S SHARE IN WORLD COMMODITY IMPORTS
(2009 estimates)
60.0%
55.0%
48.0%
50.0%
40.0%
30.0%
30.0%
25.0%
20.0%
20.0%
20.0%
8.0%
10.0%
0.0%
Iron ore
26
Soybean
Cotton
Copper
Nickel
Palm Oil
Oil
3. Challenges: resources
COMMODITY BOOM
Source: IMF WEO, October 2010
COMMODITY PRICES
600
500
400
300
200
100
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Fuel and Non-Fuel
Non-Fuel ncludes Food and Beverages and Industrial Inputs
Industrial Inputs Price Index includes Agricultural Raw Materials and Metals
Commodity Fuel includes Crude oil (petroleum), Natural Gas, and Coal
27
3. Challenges: resources
ENERGY INTENSITY OF THE CHINESE ECONOMY
ENERGY EFFICIENCY OF THE ECONOMY
(2005 GDP, at PPP $s, per kg of oil equivalent)
Source: World Bank, World Development Indicators
12
10
9.9
7.9
8
7.4
5.5
6
4.9
4
3.4
2
0
UK
28
Japan
Brazil
US
India
China
3. Challenges: world demand
• Sixth challenge – managing external demand:
– China is already the world’s largest exporter and has the
world’s largest current account surplus.
– It also has had unsustainably rapid growth of exports.
– Natural forces will tend to drive the economy into current
account deficit, since export growth will be constrained by
the growth of world trade, while import growth will be linked
to the growth of the domestic economy.
– This shift needs to be welcomed, since it will defuse tension
and enhance the level of welfare at home.
29
3. Challenges: world demand
EXPORTS OF THE “WORKSHOP OF THE WORLD”
SHARES IN WORLD MERCHANDISE EXPORTS,
2008
Source: World Bank
(per cent)
14.0%
12.0%
10.0%
11.5%
11.4%
9.3%
8.9%
8.1%
8.1%
8.2%
8.0%
5.6%
6.0%
4.4%
4.0%
3.8%
1.8%
2.0%
0.0%
0.0%
Manufactures
Ores and metals
Food
China
30
Fuels
US
Agricultural Raw
materials
Total
3. Challenges: world demand
CHINA’S SOARING TRADE
GROWTH OF VOLUME OF MERCHANDISE EXPORTS
AND IMPORTS, 2000-08
30%
Source: World Bank, World Development
25%
20%
15%
10%
5%
0%
China
Russia
South Korea
India
Export
31
Brazil
Import
US
Japan
UK
3. Challenges: world demand
CHINA RISES TO THE TOP OF THE SURPLUS LIST
CURRENT ACCOUNT BALANCES ($bn)
$500.0
$400.0
$300.0
$200.0
$100.0
$0.0
-$100.0
2000
2001
2002
2003
2004
2005
China
32
2006
Germany
2007
Japan
2008
2009
2010
2011
2012
3. Challenges: geopolitics
• Seventh challenge – a premature superpower
– China is a developing country and is also likely to remain a
relatively poor country for decades, in terms of incomes per
head.
– But, by virtue of its size, it has a gigantic impact. Indeed, it is
on its way to becoming a superpower.
– As a result, it is one of the few countries – arguably one of
two or three (if the European Union is viewed as one) – that
must take account of the impact of its actions on the world
economy.
– China cannot just “import order”. It must “export order”, too.
33
3. Challenges: geopolitics
CHINA’S LEAP TO THE TOP
GDP OF THE TEN BIGGEST ECONOMIES
(ranked in 2015, at PPP)
$70,000
Source: IMF WEO
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
20
15
$0
United States
34
China
India
Japan
Germany
Russia
Brazil
United Kingdom
France
4. Policies
• China has the potential to develop rapidly for another two
decades, or more. But if it is to succeed it will have to:
– Shift towards growth driven by domestic consumption.
– Manage a decline in the investment rate.
– Accelerate innovation.
– Rebalance the economy away from growth of exports.
– Further reduce the current account surplus.
– Sustain an open world economy.
– Increase resource efficiency.
– Secure resources at manageable prices.
– Help maintain a peaceful world.
35
4. Policies
• As the economy becomes bigger and more complex
and its impact on the world grows, all this will
become much harder.
• The premier has correctly defined the challenges.
• We all wait to see how the next generation rises to
meet them.
36