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Relevant Discussions on the Downward Trend of China's Potential Economic Growth


By Fan Jianjun, General Office of DRC

Research Report, NO. 36 2014 (Total 4535)

Recently there have been some heated discussions on the downward trend performance of the Chinese economy, with some people worrying that the country may fall into the "middle income trap". One point of view is that when economically catching-up countries attain a per capita GDP of 11,000 international dollars, their economic growth will begin to slow down significantly and now China is in such a phase (its per capita GDP may have exceeded 10,000 international dollars in 2013), so its potential economic growth rate (PEGR) will decline markedly in the years to come. Another point of view is that China is in the midway of urbanization and its enormous urbanization potential and latecomer advantage will keep its economy growing at the rate of at least 8% for more than 20 years. Both of the above views seem justified since each of them is supported by sufficient grounds of argument. This paper tries to discuss this topic from a different perspective, i.e., from the perspective of the supply side of the aggregate balance equation, and make an analysis and judgment that is slightly different from the above two kinds of views.

I. PEGR of Late Movers Will All Experience a Course of Changes Similar to the "Inverted U Curve"

Seen from the supply side of the aggregate balance equation ( Relevant Discussions on the Downward Trend of China's Potential Economic Growth, where Relevant Discussions on the Downward Trend of China's Potential Economic Growth), the major factors determining a country's PEGR include physical capital growth rate (including the growth rate of land and mineral resources), human capital growth rate, labor force growth rate and total factor productivity (TFP) growth rate.

Although at a certain time the contribution of labor force to economic growth is not high, in the process of industrialization and urbanization of a country, cumulative changes in the labor force will produce a major influence on savings rate and thus on economic growth. With the flow of surplus rural labor into urban areas, labor force will account for a bigger proportion in primary distribution of income, while the proportion of production capital will be on the decline. Because ordinary workers (ordinary families) have a greater propensity to consume than capital owners (especially government-capital owners), the proportion of consumption in GDP will rise in the process of industrialization and urbanization and that of savings will fall. That is to say, savings rate will be declining. On the other hand, with the increase in physical capital stock, the proportion of physical capital depreciation in GDP will gradually rise, leading to a decrease in physical capital growth rate. In the long run, therefore, as industrialization and urbanization continue to move forward, the labor force growth will decline (less and less rural labor will flow to the city) and as a result, the speed of physical capital accumulation will fall as well.

For a catching-up economy, with the gradual loss of late movers' advantage and the decline in savings rate, its technological progress will slow down; in the meantime, with improvement of the market system and various other systems, there will be less and less space for enhancing the efficiency of "allocation" of production factors. Therefore, with the advancement of industrialization and urbanization, the TFP growth of catching-up economies will inevitably slow down.

Finally, with the increase of educated population, the elevation of their education level, the slowdown of urbanization and the decline in savings rate, the human capital growth rate of catching-up economies will fall year by year.

If the relevant research horizons are expanded to cover the entire process of catching-up countries from economic take-off to the realization of industrialization and urbanization, it could be found that all of their physical capital growth, human capital growth, labor force growth and TFP growth have experienced a course of changes similar to the "inverted U curve": from low to high in the first phase; and from high to low in the second phase. Based on the above analysis, it is concluded that the PEGR of all catching-up countries will objectively go through a course of changes from low to high and then from high to low.

II. An Explanation of "Middle-Income Trap"

Most catching-up economies experienced an obvious economic slowdown or even fell into the "middle-income trap” after per capita GDP exceeded 11,000 international dollars. There are two possible causes for this: First, as mentioned above, the PEGR of all catching-up countries has gone through a change from low to high and then from high to low in the process of industrialization and urbanization. A per capita GDP of 11,000 international dollars usually means the start of the second phase of industrialization and urbanization, and therefore, the PEGR will gradually decline. Second, when the threshold of 11,000 international dollars is reached, durable consumer goods such as housing, automobiles and home appliances will come into the purchase list of the family, which will lead to a "sudden" drop in net savings rate of the entire society (or in other words, a sudden rise in residents' consumption propensity) and therefore cause economic growth to slow down markedly. Because the original savings rate of most catching-up economies is not high enough (20%-25% in most cases), when there is a sudden drop, their net savings rate (savings rate after capital depreciation is deducted) will probably become negative, meaning a negative growth of capital stock. In such a circumstance, the economy will be very likely to fall into the "middle-income trap" if no measures are taken to improve human capital growth and TFP growth.

III. The Chinese Economy Could Achieve a Gentler Decline

Although all catching-up countries will go through a course of changes similar to an "inverted U curve" and will be faced with the risk of "middle-income trap", yet from the global perspective, different countries have different paths and time spans in terms of economic growth. Ideally, in the economic take-off stage, the economy should rise as fast as possible within a shortest possible time span; in the economic landing stage, the economy should decline as slowly as possible within a longest possible time span so as to avoid the "middle-income trap".

Without considering the labor factor since it is much less influential, the three main indicators determining a country's PEGR are physical capital, human capital and TFP growth rates. The trend of change of the three indicators is determined not only by the trend of change of savings rate, but also by the change in the proportion of physical capital investment, human capital investment, technology capital investment and institutional capital investment.

To make the "inverted U curve" of economic growth as close to the ideal state as possible, the government can and is able to exert an influence on the path of change of the above indicators by implementing appropriate policies. In the initial stage of industrialization and urbanization, the government may push up domestic savings rate, investment growth rate and economic growth rate by expanding public investment and reducing public consumption or even implementing a trade-deficit policy over a short period of time. In the later stage of industrialization, the government may retard the decline in savings rate and economic growth rate by reducing its spending on social security system. More importantly, the government may maximize PEGR at any time through policy guidance or direct involvement by adjusting and optimizing the allocation of savings resources among the aforesaid 4 investment areas (typically, the policy is to inject more savings resources into the areas of human capital investment, technology capital investment and institutional capital investment).

IV. An Analysis of the Reasons for the "Abnormal" Decline in China's Economic Growth in Recent Years

1. China's savings rate and physical capital accumulation rate did not decline significantly in recent years.

According to statistical data of the last few years, though China's savings rate has been on the decline since 2010, the fall is not significant. In 2010, after domestic savings rate rose to a historical high of 51.81%, it began to fall in a fluctuating manner. The figure had fallen to 50.53% by 2012, showing only a slight decline. During the same period, the proportions of depreciation and inventory remained basically stable. As a result, we have seen no obvious decline in China's savings rate and its capacity of physical capital accumulation. In spite of the above fact, the country's economic growth rate dipped sharply from the highest 14.2% in 2007 to a low of 7.7% in 2012, a fall of more than 45%, which is evidently "abnormal".

In other words, the industrialization and urbanization process of all catching-up countries will undergo a transition period from a relatively low-level steady growth to a relatively high-level steady growth, but in fact such a process itself is a non-steady growth process.

From the perspective of depreciation, although the proportion of depreciation in GDP has risen from 13.1% in 1990, 14.2% in 2000, 14.1% in 2005, 14.8% in 2007, 15.2% in 2010 and 15.6% in 2012, the magnitude of rise is not significant. Compared with changes in the proportion of capital depreciation, those of inventory are small. Except for 2007 and 2008 when, due to the effects of macro control and the financial crisis, the proportion of inventory in gross capital formation (6.3% in 2007 and 7.4% in 2008) was slightly higher than the normal level, this proportion was around 5% in other years.

The article was published in China Development Review, No. 2, 2014.

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