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

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.
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   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.