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Sustaining growth: China’s need for a new growth model

David Dollar's picture

China’s big stimulus plan will help keep the economy growing at a healthy rate, though 2009 will be a rough year with probably the slowest growth in nearly 20 years. While China applies stimulus to deal with the immediate downturn, it would be good to be thinking ahead. China needs a new growth model, and it should evaluate its possible spending plans both in terms of immediate stimulus and in terms of contribution to this new growth model.

China needs a new growth model because after the global downturn comes to an end, exports will never again play the same role as they have in the past two decades. I would argue that the four basic principles that account for the Chinese miracle since 1978 remain valid, each of which needs some tweaking in the new environment.

  1. First, human capital. Pre-reform China did a good job of providing basic education and health to the rural population, so that the country began reform with extraordinarily good human capital for a low-wage country. China has lived off this asset for a long time. But better public support is crucial to ensure basic education for the whole population, including the rural poor. Schooling through at least nine years and preferably 12 is essential if China is to have the labor force it needs in the near future.

    A big increase in public spending on education would definitely be a great investment for the new growth model. It may be effective stimulus as well, as it puts money in the pockets of teachers, hires many of the recent college graduates, and convinces middle-class households that they do not need to save quite so much for education spending.
  2. Second, incentives for private investment. China launched its reform with the household responsibility system, which took a big step toward restoring private property in agriculture. Whenever growth has threatened to slow, China has taken another step to strengthen incentives for private investment. Private investment has been the backbone of China’s growth, and returns in private firms are far above those in state enterprises. The global slowdown and the hit to the export sector create a real risk of backsliding. The big stimulus package is needed, but it will go largely to and through big state-owned firms: the airlines, the railway, road construction companies, and the big commercial banks.

    The new growth model needs to think about how to bring more dynamism and competition to services, as earlier reforms did to agriculture and manufacturing.  Some specific measures to consider: strengthening intellectual property rights (essential for service industries in which trademarks and copyright are big); easing up on entry restrictions in sectors from film to finance; and selling more shares in the majority state-owned companies and making it easier for private firms to issue bonds and stocks.
  3. Third, openness. China has pioneered a unique model of openness: compared to other developing countries it is open to imports and direct investment in manufacturing. It has otherwise kept its capital account fairly closed, which looks particularly smart at this moment. In the face of this crisis I think it would be smart for China to open its markets further, particularly markets for services. Selling services such as banking, insurance, tourism, and logistics often requires a direct investment. China has not been as open to investment in services as it has to investment in manufacturing. By opening more to investment and trade in services it could stimulate more competition and technological advance, and get the same kind of performance in services that it has shown in manufacturing.


  4. Fourth, infrastructure. I have written before about China’s pragmatic approach to infrastructure. The use of roads, ports, telecom, and power is priced at levels that pay for the infrastructure, which has enabled the rapid expansion of these networks.  The stimulus package contains a lot of resources for infrastructure. The question will be, is it infrastructure for the old model or infrastructure for the new model? The new model will be less export dependent and less resource using. It will be more knowledge based, both the higher value activities of manufacturing plus the expansion of services. The new model requires nice, livable cities (investments in public transportation, inter-city rail, water and sanitation, renewable energy). It will not have as much need for roads, ports, and coal-fired power stations.

A lot of attention will be focused in the near future on the projections of how rapidly China can grow in 2009 in the midst of this global crisis. Is the stimulus package big enough? I think that question is less interesting than the question of whether China is using the stimulus to make a transition to a new, more sustainable growth model.

Comments

Submitted by Dimitri de Boer on
Excellent remarks. I see the current slowdown in exports as a chance for China to take a crash-course in the promotion of domestic consumption. If it can focus on investments that support sustainable growth, such as more and better education, clean power, cleaner cities, etc, it might allow China to transition to a more modern society really quickly. Dimitri de Boer, UNIDO ITPO - China

Submitted by Anonymous on
I agree in principle. But there are certainly some important questions to be answered before the Chinese government could be convinced to adopt the new model as described in the article. For example, one of the concerns for the Chinese government could be that once private companies are allowed to mobilize massive amount of money from the capital markets, they could migrate with the money to foregn countries ilegally, due to the fact that current supervision is inadequate. Regarding service sector, it often involves the mass public or a wide geographic area, or could have a significant influence on national defence operations. Regarding education, I am not so convinced that China needs more teachers, though it needs better teachers. So there is no big opportunity for China to increase employment through investing more in education (I do agree to investing more in education, though). Overall, I think it is important to find out why the Chinese government has not adopted these strategies the Bank has advocated for many years, and what additional real, legitimate concerns the government has, in addition to protection of interest groups as some has claimed. On the basis of this, the Bank should help the government address these concerns before asking it to adopt the new model.

Submitted by Ngan A.Lam on
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Submitted by Peter Bowie on
Hi David - I agree this is a unique opportunity for China to accelerate the planned move to an economy based more on domestic consumption, enhancing the environment, access to education, universal health care, and broader social services. I have had the pleasure of visiting rural communities in several provinces such as Ningxia, Xinjiang, Yunnan and have been consistently impressed by the spirit and ambition of the people I was fortunate to meet. China has massive underutilised human capital that can contribute to greater development and growth if given the opportunity. Hopefully the fiscal stimulus will have less of a focus on supporting marginal export related activities and more on developing and enhancing the opportunities for domestic-oriented growth

Totally agree. The young people you meet in the countryside will be the urban work force of the future, to a large extent. Providing really strong education is a good growth model for the future.

I should have been clearer that I think that strengthening China's financial institutions such as stock and bond markets comes before opening the capital account. I support China's gradual approach to liberalizing the easy inflow and outflow of money. On services trade, I recognize that some of these are sensitive areas. But China faces a fundamental decision about whether it will have more competition in film and media, logistics, telecom, banking, and airlines. Without competition in these sectors it will be hard to maintain the country's record of productivity growth. Finally, I agree that quality of education is more important than numbers of teachers, but many rural areas could use more teachers, especially at the secondary level. Another 4 million college grads will come on the job market next spring, into a very soft labor market. Hiring some of these to expand the scope of secondary education seems a good investment to me.

With respect to the importance of education quality versus education quantity, some work authored by Eric A. Hanushek on behalf of the World Bank considers in depth the role of education quality in promoting economic growth. His 2007 paper entitled, "The Role of Education Quality in Economic Growth" is particularly good.

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