The Chinese Economy

The rise of industrialized China and her resurgence as an economic powerhouse is a transformative event in the history of the world economy. However, there now appears to be an emergent consensus that the Chinese economy is facing a turning point, that is to say, another transition after the thirty years of successful transition to the market economy from the command economy. The nature of this new transition may be understood within a new conceptual and analytical framework that unifies development economics and demography in a long-term perspective (for example, Hansen and Prescott 2002; Galor 2011; Aoki 2012). After a rather long transition out of the Malthusian state (1911-the late 1940s) and then the phase of government-mediated initial industrialization (the early 1950s-the late 1970s), the era of high growth ensued, driven by favorable demographic factors such as demographic dividend (Bloom and Williamson 1998) and massive domestic migration of labor from the rural agricultural sector to the industrial sector.

China’s economic rise has been one of the world’s most significant events at the turn of this century. The economists of my generation witnessed of the economic ups and downs during the first thirty years of the People’s Republic of China. We are also active participants in the subsequent three decades of reforms. In this speech, I will explain the role of economics in China’s economic development based on my observation and experience.

East and Southeast Asia, with nearly a third of the world’s population, has over the past half-century become the most rapidly growing region in the world. With the exception of the Philippines and Myanmar, all of the economies in the region have experienced at least one decade — and often several decades — of per capita GDP growth rates of 5 per cent a year and more. No other major part of the developing world has experienced anything comparable — whether it is South Asia (despite the recent high growth of India) or Sub-Saharan Africa, or most of Latin America. China’s high growth of the past three plus decades is extraordinary in the broader developing country context but is not unique in the East Asian context. Other economies, notably the Republic of Korea (1963–97) and Taiwan (1961–97), have grown somewhat longer at rates of 5 per cent per capita or more a year. Korea and Taiwan did not grow as rapidly as China during their high growth period, but Japan grew just as rapidly in the 1950s and 1960s although only for two not three plus decades (Table 2.1 and Figure 2.1). China’s experience is unique, however, in one respect in that it grew at a very fast 9 per cent rate for a long period starting from a lower per capita income than the other fast developers (Figure 2.2).

After thirty years of reform and opening up, a socialist market economy framework has taken hold in China. Two characteristics feature prominently- first, resource allocations are market-driven. Prices are determined in a market system, with the exception of selective infrastructure services. China has shifted from a planned economy in which output quotas were state-directed to a market economy guided by masterplans formulated on a five-year basis. The market is free to decide how much is to be produced and consumed. As China is an open economy and its currency is convertible under the current account, the international market plays a key role in resource allocation. The second characteristic is institutional guarantees that underpin the stability of the macro economy. China practices a revenue-neutral tax regime and maintains effective tax collection and management. Fiscal revenue is witnessing strong and steady growth and fiscal conditions remain sound. China’s central bank and regulatory authorities are working with efficiency and competency. These institutional strengths empower China to rise above a situation of either inflation or deflation. Admittedly, there are many other factors at work, but these two are the most fundamental in that they facilitate market-driven resource allocation and help deliver macroeconomic stability, thus maximizing the well-being of the people.

Since the start of gradualist economic reform and opening up in the late 1970s and through its relentless efforts to join and operate within the World Trade Organization in 2001, China has been deepening its participation in economic globalization and engagement in the market-based allocation of resources. The reform and opening up so far has achieved considerable success, as it has fulfilled its original policy design — leading to significant improvements in its economic growth and people’s income level. As it replaced Japan as the world’s second-largest economy in 2010, its per capita GDP has hit $4,300 — according to World Bank estimates — and it has become a middle-income economy.

Until China began its post-Mao economic reforms, the country did not have a genuine labor market. State-owned enterprises were the only source of demand for labor. Administrative agencies assigned workers to firms, so individual choice played no part in the determination of labor supply. Then China began the process of transitioning from a state-run economy to a more market-driven one. The early reforms focused on agriculture and product markets but slowly the government freed firms to make labor demand decisions and freed workers to choose their own places of work, creating a genuine labor market. How did this emergent labor market respond to shifts in the supply and demand for labor as China’s urban economy grew rapidly?

China’s future population structure can be projected with reasonable confidence. In recent decades, China has had a ‘demographic window of opportunity’, in which a large and growing proportion of the population have been of working age. This process is now stalling and will soon reverse.

China’s human capital — the health and education of the population — has played an important and under-appreciated role in China’s rapid economic development. Moreover, with the driving force of China’s economy transitioning toward human-capital-based endogenous growth in the 21st century, investments in human capital may be even more crucial for China’s future development. This paper focuses on China’s achievements in raising population health and education, and their interaction with demographic transition since the 1950s. The first section describes recent research on the determinants of China’s unprecedented increase in life expectancy in the Mao era, the foundation of China’s demographic, epidemiological and human capital transitions over the past half-century. The second section discusses human capital development during the reform era, including research on the returns to education in China, the educational gradient in health, and the social challenges presented by widening disparities in human capital.

The Chinese household saving rate has been high and continually rising in recent years. The household saving rate rose by about ten percentage points from 1995 to 2008 and reached 28 per cent in 2008. This increase is higher than that observed in most other countries, including East Asian nations (Prasad 2009). This phenomenon, referred to as the Chinese saving puzzle, has been the subject of considerable international attention. Literature has provided many different explanations for the high saving rate in China. One of the most popular is related to the lack of a generous safety net in the country (Chamon and Prasad 2010; Meng 2003). In particular, people reduce consumption due to the income or expenditure risks associated with retirement, medical expenses and/or children’s education. The uncertainty about future status elicits more savings than the level that can smooth consumption in the case of no uncertainty. This is defined as the precautionary saving motive.

The conventional wisdom before the financial crisis that started in 2007 suggested a link between financial openness and economic growth. Papers by Bekaert, Harvey and Lundblad (2005), Bekaert, Harvey, Lundblad and Siegel (2007) and Quinn and Toyoda (2008) have shown that financial liberalization promotes economic growth. Bekaert, Harvey and Lundblad (2011) provides additional evidence that financial openness improves the growth of factor productivity. They attribute these liberalization effects to the role of financial openness in stock market and banking sector development, and to changes in the quality of institutions.

Concerns over energy security and domestic air quality have led the Chinese government to reduce the country’s overwhelming dependence on fossil fuels and to shift to a more energy- and resource-efficient development trajectory. Considering the international climate negotiations, this goal now has added emphasis on carbon intensity. The 11th Five-year Plan (FYP) set explicit targets for energy efficiency and pollutant emissions and this has led to a number of ambitious implementing measures. The government recently also set a carbon intensity target for 2020: reducing it by 40–45 per cent compared with the 2005 carbon emissions:GDP ratio. Despite the current global economic slowdown, and partly due to the strong fiscal stimulus in 2009, the growth of the Chinese economy and its resource demands are so swift that they are overwhelming many of these efforts, most notably in emissions of carbon dioxide (CO₂), the leading greenhouse gas (GHG).

The most salient feature of China’s economic development in the past three decades is the remarkably high and sustained level of economic growth: China’s real GDP growth rate was on average 9.6 per cent during the period 1978–2010. Even when the world economy was hit by the global financial crisis in 2007–08, the Chinese economy, which initially suffered a big drop in the growth (from 12 per cent in 2007 to 8 per cent in 2008), quickly recovered its normal strength, recording 8.7 per cent in 2009 and 10.4 per cent in 2010. The other important feature of the Chinese economy is the positive role played by local governments at the different levels (Oi 1992; Montinola et al. 1995; Walder 1995; Qian and Weingast 1997; Che and Qian 1998; Blanchard and Shleifer 2001; Li and Zhou 2005; Xu 2011). While bureaucrats tend to grab private business in many developing and transition countries, Chinese local officials have served as a helping hand to their local economies by building infrastructure, encouraging local business entrepreneurship and attracting foreign investment (Frye and Shleifer 1997; Easterly 2005).

Rapid economic growth in the past thirty years has transformed China into the second-largest economy in the world. This achievement is spectacular from the perspective of post-war history. The influence of China’s thirty-year economic growth and its contribution to long-term global economic growth, owing to China’s huge population, seem comparable with that of the USA in the late 19th century. However, this comparison could be misleading without considering the fact that at this time the USA had better institutions than most other countries and was a leading country during the second industrial revolution. Thus, not only did the USA surpass Great Britain to become the largest economy in the world, but it also became the richest in terms of per capita GDP. In comparison, the current GDP per capita of China only accounts for one-eleventh (by the market exchange rate) or one-sixth (by purchasing power) of the USA, ranking it 94th in the world after Thailand (IMF 2011). As China is a relatively poor country that has just entered the low- to medium-income category, with severe institutional problems and overall relatively backward technologies compared with advanced countries, the questions of how far China can reach and whether its growth is sustainable are most challenging to address.