The role of innovation and consumption in China's growth transformation

Former World Bank chief economist Justin Yifu Lin analyses the benefits of China potentially transforming itself into a high-income country by 2020 as well as the wider global implications
China Mobile booth at the CHITEC expo, Beijing

In October 2015, the Chinese Communist Party's Central Committee proposed that the country's Thirteenth Five-Year Plan should aim for medium-high economic growth, later defined by Premier Li Keqiang as a rate of more than 6.5% annually. This rate would allow China to double GDP. However, China should aim to achieve 7%. This is because the Eighteenth Party Congress's target was to double GDP and per capita income by 2020, compared to 2010 figures. The population growth rate, meanwhile, is 0.5%.

There are several ways to achieve the second goal. One is to maintain the growth rate at 6.5% with greater income redistribution to households. But this may hurt business profitability, potentially creating a vicious cycle whereby slower growth leads to more redistribution, weaker profits and so on. The result would be higher unemployment and potential financial market instability. Aiming for 7% growth, therefore, seems more apt.

At close to 7%, Chinese GDP per capita would most likely exceed $12,600, the threshold for a high-income economy, by 2020, so long as the renminbi appreciates about 10% from the current level. It would be the third major economy of the post-war era to transform itself from a low-income to a high-income economy, following in the footsteps of Taiwan and the Republic of Korea. It would represent a significant milestone.

Global benefits

It would also benefit the global economy. The developed countries have yet to recover fully from the 2008 financial and economic crisis; in the past few years, China has been the major driver of global growth. A slowdown in China could create new, unexpected challenges for the world economy. At 6.5% growth or higher, China would continue to contribute around 30% of growth annually, thus remaining the major driver of the global economy.

There is concern inside China and particularly outside the country about whether or not China can meet its new growth targets, especially as growth has fallen to 6.9% in the third quarter of 2015 versus an annual growth rate of 9.7% until 2010. Some believe China's economic growth rate might decline further from current 6.9% to 6%, 5% or even 4%, due to structural impediments.

As a student of the Chinese economy, I take issue with the notion that the current slowdown is fundamentally structural. That is not to say there are no structural issues to be resolved – China is still, after all, a developing economy in transition. Nonetheless, it should be noted that other emerging economies, such as Brazil, Russia and India, and other high-income, high-performing economies, including Singapore, Taiwan and the Republic of Korea, have registered lower growth than China since 2010.

justin-yifu-linJustin Yifu Lin

The most likely explanation for this common trend is external headwinds. Domestically, China is in better shape than external observers give it credit for. It is exports that have suffered. Annual export growth slowed in 2015 after averaging 16.3% during the past 30 years. This, however, is not unique to China. Rather, it is a problem shared by all economies whose growth rate depends largely on exports, and one that owes much to the slow recoveries in the US, Europe, and Japan.

Meanwhile, as the global economy has yet to fully recover, investment will obviously be affected. This, again, is an international problem and not unique to China. Finally, consumption in China is growing at a relatively stable pace of 8-9% annually, significantly higher than in other countries and regions. That is why China has been enjoying more than 7% economic growth in the past few years while other countries and regions have had much slower consumption growth rates – and thus much slower economic growth rates compared to China.

Domestic demand

In the future, it might be relatively harder for developed countries to achieve robust recovery as they find it difficult to implement structural reforms. So a significant pickup in exports to these countries appears unlikely. So during the next five years, Chinese growth will be driven mainly by domestic demand, underpinned by both consumption and investment. Many international experts emphasise the former, suggesting China's hitherto investment-driven growth model cannot be sustained. I do not accept this view. Consumption is surely an essential part of the story. But the premise for long-term, sustainable growth in consumption is an ongoing increase in revenue, which relies on continuous innovation in current industrial technologies and the emergence of increasingly high value-added industries.

Technological innovation, industrial upgrading and infrastructure improvement all rely on financing. Therefore, the premise for strong increases in consumption is investment. Smart and efficient investment will grow employment and income – and thus, consumption.

Do good investment opportunities still exist in China? Certainly, there is overcapacity in infrastructure-related industries such as, steel, cement, glass and aluminum. But these are medium to low-end industries. The opportunities for upgrading and investing in medium to high-end industries with high returns remain tremendous. Moreover, while China has invested heavily in infrastructure, connecting one city to another through highways, rail and ports, there is still a severe shortage of infrastructure within cities, including in underground transportation and pipelines. Investments in these areas would generate high economic returns.

With a current urbanisation rate of 54%, which is expected to exceed 80% as it develops into a high-income country, China still has a long way to go. Unlike in high-income countries such as the US, Europe and Japan, whose industries are at the technological frontier and as such are experiencing diminishing returns, opportunities for catchup growth are prevalent in China.

Proactive policies

China still has huge space for proactive fiscal policies. Government debt, both central and local, makes up less than 45% of GDP – one of the lowest rates in the world. In addition, private savings make up nearly 50% of GDP – one of the highest in the world. Government investment could be used to leverage private investment. Domestic savings and ample foreign exchange reserves set China apart from many other developing countries.

By matching investment opportunities and resources, China can retain high investment growth, in turn boosting employment, revenue and consumption. The dual targets of doubling GDP and per capita income during the next half-decade can be achieved. China should become a high income country by around 2020.

This is good news for people across the globe. High income countries currently account for 15% of the world's population, a figure that could double in the next five years as China continues to provide economic opportunities not just at home but abroad. As President Xi Jinping urged in Vietnam in November 2015: time to board China's express train of development.

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