Since 1979 China’s income per capita has increased by a factor of 37 from $272 to $10 099. This means that China has gone from a low-income country to a high-ranking middle-income country in 40 years, (a high-income country has a per capita income of $12 536 or more). In the first three decades of this huge growth, China grew at an average of 9-10% per annum and in only 3 years was this growth below 7%. This clearly shows the dramatic increase in China’s output that has taken place, which can be explained by a combination of five main factors: institutional development, reallocation of labour, accumulation of capital, technological advancements, and global integration. By understanding these factors, which are linked to key historical reforms, we can explore the challenges that China will face in continuing to grow its economy as it develops as a nation.
The most important determinant of growth is institutional development, a point which is supported by the historical growth of highly developed countries such as the UK and the USA during the 1700s and 1800s. Protecting “infant industries” with tariffs as described in Hamilton’s 1789 The Report on the Subjects of Manufactures, which was inspired by Robert Walpole’s policy, allows for the development of competitive industry and infrastructure to facilitate effective trade on a global scale to increase their income.
Aside from tariffs, another effective way of protecting your own “infant industries” is via SOEs or state-owned enterprises. The use of SOEs enabled China to develop past an agrarian economy under Deng Xiaoping (which Mao Zedong was unable to achieve – at the height of his collectivisation policy the economy shrunk by an estimated 27%). This was achieved with market-driven policies implemented in the farming sector. These ranged from the Household Responsibility System, which created residual claimant rights (i.e. farmers could retain a share of their profits) to Town and Village Enterprises which more efficiently organised farmers around informal property arrangements; both of which Lin (1992) attributes as the biggest drivers of growth in agricultural productivity. This meant that the industrial sector was comparatively under-developed and hence needed more protection from the state.
The idea that developing institutions aids economic growth is supported by the “Developmentalist tradition” in economics. This explains that governments can provide stability and bear some risk to enable a country to strengthen its own economy before competing in a free international market. This is achieved by developing the mechanisms to governance (such as law and order or the separation of bureaucracy and politics) and through state owned or state backed companies. Developmentalists believe that if an economy is able to develop from within, large gains can be quickly realised. For instance, between 1979-2004, 3.2 percentage points of the 7.3 percent growth of output per worker in China have been attributed to capital accumulation and 3.6 percentage points to total factor productivity (TFP), which is essentially increased efficiency. The increased output was only possible due to gradually introduced institutional reforms such as the Contract Responsibility System (which allowed workers to retain a portion of profits, i.e. wage reform), but more importantly the slow decline of SOEs in this time period. This is evidenced by a decline in the number of people employed by SOEs from 110 million to 64 million, despite an increase of around 80 million in urban employment. This had an enormous re-allocative effect on the productivity of labour and capital.
Progress after the decline of SOEs was only possible because of reforms in the 1990s and early 2000s, which increased links between Chinese and foreign enterprises. The establishment of: foreign Joint-Ventures (JV) with Technology Transfer Agreements, with special protective laws for FDI compared to getihus (non-state Chinese firms); and Wholly Foreign Owned Enterprises (WFOE) caused increased technological spill-overs, thereby increasing the productive potential in the long run and delivering immediate gains in efficiency. Additionally, WTO membership in 2001 resulted in: better integrated newly privatised SOEs, via standard, well developed, and predictable global integration ; increased foreign trade; and integrated China’s first stock exchanges (Shenzhen and Shanghai stock exchanges were established in 1990) into the global marketplace. These reforms meant that labour transitioning out of inefficient SOE’s ended up in sectors with established forms of corporate governance, thereby increasing productivity.
The fifth factor: technological advancements, is seen to improve productivity, in that JVs are the most productive enterprises per worker. This is because most JVs were initially set up with the condition of Technology Transfer Agreements (TTAs), that is the foreign partner would transfer technological know-how to the Chinese-foreign entity. This is supported by research which shows that technological spill-overs via TTAs could account for up to two-thirds of TFP growth between 1979 and 2004. Research also shows that TFP driven by innovation and technological progress alone, which was not derived from foreign entities, could account for up to 14 percent of GDP growth since 1979. This also fits in with the developmentalist tradition which states that “the actual raising of productivity requires deliberate investments in education, training and R&D”. This is also supported by work which notices that there are some industries with more “linkages” than others meaning that a change or improvement in one of these key industries would result in “more rigorous growth” in the whole economy.
Threats to long term sustainable growth:
Since the historic causes of economic growth in China are interlinked via institutional development and global integration, careful management in the timing of these reforms is required to drive the productive potential of China’s inputs outward. This is seen in certain South American countries and Sub-Saharan Africa where countries prematurely adopted liberal economic policies, such as free trade, in accordance with World Bank SAPs or Structural Adjustment Plans. This resulted in per capita income in Sub-Saharan Africa declining at 0.7% per year between the 1980s and 90s in contrast to Sub-Saharan African growth in the 1960s and 70s of around 3% per annum. This show the drastic effects of opening up a country to global economic forces, a historical issue, which Abraham Lincoln commented on: “within 200 years, when America has gotton [sic] out of protection all that it can offer, it too will develop free trade”. China avoided this by the slow introduction of a less regulated and centralised economy and can be observed that in 80s and 90s in at least 7 years per annum GDP growth rates were above 10%. This shows the disastrous consequences of inappropriate economic policy, which means that such mismanagement is a serious threat to sustainable economic growth.
Aside from national economic policy, sustained growth via national R&D innovations is the key to sustainable growth. Hence, the lack of fruitful R&D is a serious threat to sustained development as it would result in China being stuck in the “middle income trap” whereby a country loses its competitive advantage in exports due to rising labour costs (which can be combated with increased efficiency through technological innovation via R&D). It remains to be seen whether Chinese investment in research will yield dividends, however there has been large in spending in this sector which the European Commission estimates to be about $280 billion in 2017, accounting for 2.12% of the country’s GDP and representing 20% of total world R&D expenditure. Some of this investment has been in robotic process automation, which has led China to have the most industrial robots in operation globally (an estimated 1 billion in 2020); this will surely increase sustained growth as yields are increased via continued improvements in efficiency.
Other factors which would result in the middle-income trap would be a lack of a developed internal market, created by middle class growth. A developed middle class means that the internal domestic dynamics of a demand economy can drive growth from within. Whilst China does have a growing middle class, as shown by the increased importance of services in the economy in the graph above; it is critical that development continues to lift people out of relative poverty or else there will not be enough demand for products which have already been inflated due to rising labour costs. In addition to middle class growth, whether or not a country can increase it exports has a significant effect on sustained economic growth. To this end, China’s Belt and Road initiative is intended to increase high value exports, by increasing regional connectivity (to China). Producing more high value goods is needed not only as an effective way to increase AD, but also as a counter-balance to the middle-income trap (as people are lifted from the poverty line, less low value goods can be produced as wages rise).
A final human-caused threat to sustainable growth in China is Sino-Indian relations. This is pertinent in and around Tibet on the Sino-Indian border which China views as critical. This is because eastern China, where almost all of China’s agriculture takes place, is supplied by rivers which originate on the Qinghai-Tibet Plateau, such as the Yangtze and Yellow rivers. If Tibet was controlled by India, China’s food security would drastically decrease and a hostile India could easily dam the rivers causing famine which would be catastrophic for Chinese economic development. Whilst this is a somewhat far fetched scenario, the ongoing boarder skirmishes show how delicate the balance of power is in the region meaning that China must manage its international policy carefully as it seeks to increase its security as a regional power. Its long borders are important for trade but also increase the threat of war which would not be conducive to economic growth and would only add to the debt which is currently at 300% of GDP.
Aside from direct human-caused threats to sustainable growth, there are also threats to sustained growth from the natural world. As already mentioned an increase in only 4ºC would result in the total crop failure of rice. In addition to this, if China continues to pursue a policy of “explosive growth”, increased negative externalities will degrade the natural wealth (stock of resources)- it is estimated that 40% of China’s water is undrinkable and one-sixth is so polluted it is unsuitable for use – and could lead to the destruction of the natural environment and a “brain drain”, whereby skilled workers emigrate because they no longer want to work in China.
It remains to be seen whether China will remain a middle income country or develop via continued structural reform and productivity based development. However, it is clear that the two most important factors in changing the productive potential of a country are economic reform and global integration. When done appropriately, these conditions enable the accumulation of capital and reallocation of labour which enable growth. To sustain growth produced by these gains, technological innovation must take place to ensure that a country does not become uncompetitive and remain in the middle income trap. By extension, other pitfalls to sustained economic development are those which either perpetuate the middle income trap such as a lack of growth in the middle class or lack of exports. In addition to this, events which decrease factor inputs – such as war, climate change, and brain-drain also reduce productive potential.