China And Sustainable Growth

Deng Xiaoping

Image via Wikipedia

In response to our recent post on China’s growth rate, one of our readers wrote and asked the following:

This may be a dumb question, but why is China’s high growth rate a bad thing? Shouldn’t the country be happy that its economy is growing rapidly while everyone else’s is slowing?

With countries around the world struggling to re-ignite meaningful growth in their economies, the reader raises an interesting question. Given the state of the global economy, isn’t any growth, however it is obtained, good for any economy, including China’s?

When I first came to China and talked about how we needed to reform our factories, for example, by describing what worked and what didn’t work in the United States, my Chinese counterparts would listen carefully, smile knowingly and then inevitably respond as follows:  “Yes, that may be true, Jack, but this is China, and China is different.”

I hated to hear that response, because in many cases, it seemed to me that it was merely given as an excuse not to change. Over the years, though, I have learned that that is not always the case. While circumstances in China are the same as those in other countries in many ways, they are also different in many other. That is why advice from Western economists about what China should and shouldn’t do may be well intentioned, but in many cases it is ill advised.

Despite its large size, China’s economy, quite simply, is in a much different stage of development than the more mature economies around the world. For most countries today, achieving growth is the central issue. For China’s leaders, it is how to grow in a sustainable way that does not place undue stress on other key factors such as inflation. China’s economic history provides some insights into why this is the case.

In 1978, China’s economy was in shambles. The Cultural Revolution had just ended, and the country’s Gross Domestic Product was a mere RMB 362 billion ($57.5 billion) at current prices. (At that time, the U.S. economy was more than six times larger at $358.3 billion.) While China’s economy grew by 7.6 percent and 11.7 percent in 1977 and 1978, respectively, following the restoration of order after the Cultural Revolution, industrial centers were hit by widespread earthquakes, including the worst ever at Tangshan in 1976, and agricultural output was hit by drought.

As Deng Xiaoping began to implement the “contract responsibility” system throughout the country, the output of China’s agricultural sector increased dramatically. This system was then applied to China’s industrial sector, primarily through the creation of the special economic zones.  Deng Xiaoping’s Southern Tour at the beginning of 1992 was a sign that the rest of China should follow suit. By the time I made my first trip to China in September of that year, China’s export economy was flourishing, and China was already one of the largest recipients of foreign direct investment. One of the first things that I noticed on my initial trips to China was the enormous investment that the country was making in developing its infrastructure — roads, bridges, highways and airports then, to be followed later by high speed trains.

When China began its economic reform program in 1978, the country’s domestic economy alone could not be counted upon to be the driving force for growth. Consumption levels were low; virtually all industrial enterprises were owned by the State; and there were no internal capital markets to support development. Therefore, to jump start the economy, the government had to rely on foreign direct investment and exports to bring capital and hard currency into the country, and as the economy developed, it had to use government spending to build infrastructure and further fuel growth.

Exports, foreign direct investment and government spending served a very useful purpose. They enabled the Chinese economy to grow for 30 years; they brought in capital, management and technology; and they created an unparalleled foundation for building a modern industrial economy. However, exports and foreign direct investment are dependent on the health of other economies, and the willingness and ability of companies in other countries to invest in China. While China has managed to make solid investments in infrastructure over the years, too much government spending in any country is problematic. It tends to lead to a misallocation of resources and waste.

For all of the above reasons, China’s leaders now want to wean the country’s economy away from too heavy a reliance on exports, government spending and foreign direct investment. Europe’s troubled economy and the slow recovery in the United States are only the latest catalysts for this change in thinking. Instead, China’s leaders want to encourage the development of its own domestic economy; they want to develop China’s capital markets; and they want Chinese companies to innovate. Only in this way can the continued growth of China’s economy be sustainable over the long run.

Moreover, growth that is too fast can create economic dislocations and the misallocation of resources. China’s industrialization is already having a harmful impact on the environment—industrialization that is too rapid only exacerbates this problem. Rapid growth can also lead to inflation, an issue that China’s leadership takes seriously given that the incomes of a large part of China’s population remain below $1,000 per year.

In the case of China, growth for growth’s sake is no longer the primary concern. Developing an economy where continued growth is sustainable over the long term is the objective today.

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