China Has Got To Grow Smarter
In May 2016, the G7 leaders declared that global growth is an urgent priority for the world economy. Yet, times have changed and the G7 are no longer the sole drivers for economic growth, but depend more and more on the markets of the emerging countries. Even more, the model of growth has changed as well from a GDP driven approach to a smart and innovation driven model. At the G20 meeting in Hangzhou, global growth is an issue to be addressed, and China in particular needs to adjust its system to lead the way to a smart growth model.
We talked to Rolf J. Langhammer about China facing the challenge of growth and protection of its own environment, public health and the population’s wellbeing. He is a Professor of Economics, former Vice President of the Kiel Institute for World Economy and expert on China’s economy. An opinion piece by the author on the same topic was first published on the Mercator Institute for China Studies’ blog “European Voices on China”.
GESblog: Prof. Langhammer, China is the host country of the G20 summit. What role does the country play for the success of the summit?
Prof. Langhammer: China’s role is very critical because the future of global growth depends to a large part on China. The decline of productivity is a global phenomenon, but it has reached the most acute stage in China. The Conference Board (TCB), a research group that measures drivers of economic growth, reports a substantial decline of annual labour productivity growth in China from 5.2 percent in 2014 to 3.3 percent in 2015, continuing a downward trend that started after 2006.
GESblog: So China is in trouble regarding the production sector in regard to labor and capital. Are there any other factors to be concerned about?
Prof. Langhammer: There are other factors in decline as well like public health, education and technological advances. Following TCB estimates, this so-called annual total factor productivity growth has declined at a stunning rate in China, from 4.4 percent between 1999 and 2006 to negative growth of -0.1 percent in 2014.
GESblog: Facing such a decline, what needs to be done by the Chinese government to turn around this development?
Prof. Langhammer: China must change its vision of a traditional GDP growth model to a “smart growth” model. They have to get away from demand and output maximization to a model of raising output and productivity through innovation and services while lowering resource use or at least keep it at the same level. This would also minimize negative side effects for the environment and public health, contribute to overall human wellbeing and lead to a more just distribution of income and wealth.
GESblog: What would it take to adjust such a big economy to make it fit for the future?
Prof. Langhammer: This is not an easy task because China has got to overcome four major impediments to smart growth. First, take a look at the environmental degradation. For decades, there has been pollution and a very inefficient and irresponsible use of natural resources. To fight these problems, China still prefers regulatory measures over monetary incentives such as carbon taxes and/or emission trading. The balance should shift from a regulatory top-down approach towards “pay as you use” principles and transparency of environmental choices.
Second, there is a social security net that needs to be reformed. China’s institutions have not kept up with the needs of a more productive workforce and wealthier population. The people need to be encouraged to a responsible consumption rather than excessive private savings. Furthermore, the income tax system must be fit for income redistribution. Plus, the public sector needs to shrink, but remaining employees have to be better qualified and better paid, reducing incentives to generate illegal income through corruption.
GESblog: That’s two impediments: Environment and an outdated institutional framework. What else hinders smart growth?
Prof. Langhammer: A third factor would be the distortions of the financial system, which often rewards the wrong actors. Debt-ridden state-owned enterprises have easier access to financing than privately owned small and medium sized enterprises. A more efficient system would reward (private) innovators, rather than (government-owned) rent-seekers. Stricter enforcement of insolvency laws is also necessary to force unprofitable businesses out of the market.
The last factor is something we talked about before on this blog. It’s about the middle-income trap, the fact that China needs to find ways to lift the income of its working class people. It must rely more on service production rather than on goods production, which requires more human capital formation below the middle-income group. This group has the largest untapped potential for smart growth, but it will take time and a large amount of financial resources to unlock this potential.
GESblog: You stated these four impediments and how they can be overcome. What keeps countries like China away from following these steps?
Prof. Langhammer: There is no fast and easy way to smart growth. Losers are powerful and means of compensating them are limited. This holds true for China as well as for the other G20 countries. This is why the leaders in Hangzhou will be tempted to equate smart growth with traditional GDP growth driven mainly by fiscal impulses, physical investment and cheap money. Launching a new global paradigm for future growth, which puts the population’s wellbeing at the center, will only be possible if China leads the way towards this overdue course correction.