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Lessons from Japan as China’s growth slows

After four disappointing years, Chinese economists have realised that slowing gross domestic product growth — from a post-crisis peak of 12.8 per cent in 2010 to about 7 per cent today — is mainly structural, rather than cyclical. In other words, China’s potential growth rate has settled onto a significantly lower plateau. While the country should be able to avoid a hard landing, it can expect annual growth to remain at 6 to 7 per cent over the next decade. But this may not necessarily be bad news.

Employees install an engine on a BYD Co. S6 sport-utility vehicle (SUV) at the company's assembly plant in the Pingshan district of Shenzhen, China, on Tuesday, Aug. 5, 2014. Net debt for BYD Co., the electric automaker partially owned by Warren Buffett’s Berkshire Hathaway Inc., or interest-bearing borrowings minus cash and equivalents, climbed 34 percent to a record 20.3 billion yuan ($3.3 billion) at the end of last year. Photographer: Brent Lewin/Bloomberg

Employees install an engine on a BYD Co. S6 sport-utility vehicle (SUV) at the company's assembly plant in the Pingshan district of Shenzhen, China, on Tuesday, Aug. 5, 2014. Net debt for BYD Co., the electric automaker partially owned by Warren Buffett’s Berkshire Hathaway Inc., or interest-bearing borrowings minus cash and equivalents, climbed 34 percent to a record 20.3 billion yuan ($3.3 billion) at the end of last year. Photographer: Brent Lewin/Bloomberg

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After four disappointing years, Chinese economists have realised that slowing gross domestic product growth — from a post-crisis peak of 12.8 per cent in 2010 to about 7 per cent today — is mainly structural, rather than cyclical. In other words, China’s potential growth rate has settled onto a significantly lower plateau. While the country should be able to avoid a hard landing, it can expect annual growth to remain at 6 to 7 per cent over the next decade. But this may not necessarily be bad news.

One might question why GDP in China, where per capita income recently surpassed US$7,000 (S$9,620), is set to grow so much more slowly than Japan’s did from 1956 to 1970, when the Japanese economy, with per capita income starting from about US$7,000, averaged annual growth of 9.7 per cent. The answer lies in potential growth.

Whereas, according to Japan’s central bank, labour productivity in the country grew by more than 10 per cent annually, on average, from 1960 to 1973, Chinese productivity has been declining steadily in recent years, from 11.8 per cent in 2001 to 2008, to 8.8 per cent in 2008 to 2012, and to 7.4 per cent in 2011 to 2012. Japan’s labour supply (measured in labour hours) was also growing during that period, by more than 3 per cent annually. By contrast, China’s working-age population has been shrinking since 2012, by more than three million annually, a trend that will, with a four-to-six-year lag, cause labour-supply growth to decline and even turn negative.

Given the difficulty of reversing these trends, it is difficult to imagine how China could maintain a growth rate anywhere close to 10 per cent for another decade, despite its low per-capita income. But there is more.

STAYING THE COURSE ON REFORM

As Japanese economist Ryuichiro Tachi has pointed out, Japan also benefited from a high savings rate and a low capital coefficient (the ratio of value of capital to value of output) of less than 1. Though a precise comparison is difficult, there is no doubt that China’s capital coefficient is much higher, implying a larger gap between the growth rate of capital intensity (the total amount of capital needed per dollar of revenue) and that of labour productivity.

At times, a high investment rate can offset a high capital coefficient’s negative impact on growth. But China’s investment rate is already too high, accounting for almost half of GDP. With capital intensity increasing significantly faster than labour productivity in China, the inefficiency of investment is clear. In this context, increased investment would only exacerbate the problem.

Making matters worse, China’s corporate debt is the highest in the world, both in absolute terms and relative to GDP. In this context, increasing investment would not only reduce capital efficiency further, but also heighten the risk implied by companies’ high leverage ratios.

With all major indicators suggesting a significant decline in China’s growth potential, China’s leaders must accept the reality of lower growth and adjust their priorities accordingly. Succumbing to the temptation of massive monetary and fiscal stimulus, such as that pursued in the wake of the global economic crisis, would not only fail to boost growth in a sustainable way, but also undermine growth and stability in the medium to long term. A better approach would focus on making economic growth more sustainable.

On this issue, Japan has some useful lessons to offer. In the 1970s, recognising the inevitability of a slowdown, it shelved its ambitious plan to remodel the Japanese archipelago. Policymakers shut down energy-intensive factories in the heavy chemical industry, promoted innovation and took steps to address air and water pollution. As a result, the quality of Japan’s economic growth improved considerably, even as its rate fell by nearly half in the decade after the oil shock in 1973.

The good news is that China’s leaders seem intent on adopting a similar approach, including avoidance of monetary and fiscal expansion, unless growth seems set to collapse. Indeed, at the recently concluded National People’s Congress, Prime Minister Li Keqiang affirmed the authorities’ 7 per cent target for GDP growth this year, while reiterating the importance of deepening reform and carrying out structural adjustments.

For China, accepting lower growth provides a crucial opportunity to support stable and sustainable development. If its leaders stay the course of reform and rebalancing, the entire global economy will be better off.

PROJECT SYNDICATE

ABOUT THE AUTHOR:

Yu Yongding, a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006.

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