The Future Made in China?

In the past forty years China has experienced extraordinary growth driven by an abundant supply of labour, exports and low wages. Will the authoritarian state will become the prevailing power in the years to come? I have decided to exclude issues caused by Covid-19 and instead focus on the underlying factors.

Since China began to modernise its economy in 1978, it has experienced an average of almost 10 percent annual GDP growth. However currently signs are showing that this economic growth is slowing down.

Firstly, total factor productivity (TFP) – a measure of economic efficiency and innovation – has experienced a significant cooldown in growth from c. 3.51 percent 10 years before the financial crisis to 1.55 percent from 2008-17.

There have been little gains in TFP growth from the reallocation of productive resources between firms or the exit of existing firms. Meaning that the poor performing firms are not exiting the industry in sufficient quantities to add to the overall TFP growth and the more productive firms are not receiving enough resources to increase output. This is shown by Figure 1 that represents the estimated growth of TFP based upon industrial manufacturing enterprise data in China, according to the NBS of China survey data.

Relating to the slowdown in TFP, Chinese labour productivity has also been decreasing. This is due to the lowered contribution of both the industry and services sectors. There has been a significant drop of c. 5.7 percent to a total 3.6 percent productivity growth in 2011-15 within the services industry. The reallocation of labour towards the services sector rather than the industry sector means that Chinese aggregate labour productivity growth has cooled. Also, with the labour targeted in the services sector rather than the industry sector there is a lack of technological innovation which ultimately reduces productivity.

This decrease in productivity may signify that China is not ready to progress into the next phase of economic development. What is needed for this change into an innovative economy is a reallocation strategy where capital is allocated to promote high-growth industries (e.g. biotech); and there must be more attention paid on education and skill improvement to increase future labour productivity growth.

Secondly, China faces a large total debt burden to the sum of over 300% of GDP in Q3 2019 (over $40 trillion), according to the IIF. To reduce this debt China must restructure their SOEs (state-owned enterprises are legal entities that operate commercially on behalf of the government), which causes a large burden on the national budget amounting to 8.4 trillion yuan as of February 2019, to manufacture high-valued goods.

Although, overall SOEs have performed well in recent years having grown from just 9 Chinese SOEs in the FG500 in 2000 to 82 in the FG500 in 2019. Nevertheless, state ownership makes SOEs less efficient than private businesses due to their inflexibility of acclimatising to new customer preferences.

A change that would make the SOEs much more flexible would be to introduce a “circuit breaker” in the administration as put by Professor Sung Won Sohn. This involves a board who would make decisions based on what is best for the company; and the board may be appointed by the government. By this appointment of a board there is no longer the decision-making by the Chinese government. Consequently, the board could actually start to utilise foreign capital which would increase competitiveness and produce goods higher up in the value chain.

Furthermore, with this ‘mixed ownership’ that Xiao Yaqing, chairman of the SASAC, alluded to in 2019 there is the additional benefit of knowledge on diverse running methods which would increase both efficiency and competitiveness because of this board and private capital. Ultimately, this would help to increase revenue and reduce the large total debt that China faces. 

Thirdly, an issue that China has tackled aggressively in the past years are the problems in the shadow banking system, specifically the peer-to-peer (P2P) lending schemes. P2P was a major concern within the fintech sector as lenders such as Ezubao defrauded $7.6 billion from 900,000 investors before it collapsed.

Scams such as these pose a threat to financial and social stability, incidentally leading to a crackdown on this unregulated segment. By Q4 2019 only 343 P2P firms remained which is down from 6,000 at the peak in 2015. Some provinces such as Hebei have shutdown P2P lending completely. Figure 2 shows the decline in the number of platforms and outstanding P2P loans in billions of yuan.

China has given the remaining P2P firms a two-year period to remove themselves from the industry. If lenders still want to operate then certain capital requirements must be met such as, if they wanted to work on a nationwide level, 1 billion yuan. These new demands are essentially turning the outstanding platforms into licensed microlending companies.

Demand for online lending will stay strong from small businesses and individuals so, those who seek credit must turn to other third-party payment platforms such as Ant Financial who need to pick up the slack from the P2P lenders. Otherwise it will be difficult for small businesses and consumers to gain credit from institutions such as traditional banks.

In conclusion, China has taken drastic measures to regulate the shadow banking sector but, a financial issue that could become difficult to control is the total debt burden it faces. SOE restructure and the Made in China 2025 plan could move China to manufacture goods higher up in the value chain thereby competing better against nations such as the US. However, China must address its productivity issue where the misallocation of human capital between industries has been a fundamental reason of the declining TFP. Moreover, one could argue that the trade war between China and the US is not a competition of trade, but instead the future will be a long-term war over who will lead the future in innovation. So, though it is not a secured period of dominance for China yet, there is a great possibility for it to be.