Making Sense of China’s Growth Model

SHANGHAI – Although China’s economy has expanded at a staggering pace over the last three decades, its growth model is now widely agreed to be exhausted. Even China’s top leadership acknowledges the need for change – a belief that culminated in the far-reaching reform agenda presented two months ago at the Third Plenum of the Chinese Communist Party’s 18th Central Committee.

While not everyone agrees on exactly what the new growth model should look like, proposals do not differ drastically, given the prevailing consensus that the current model rests on an unsustainable foundation. On the demand side, many economists endorse a shift from investment-led to consumption-driven growth. Even more popular is the supply-side recommendation of a shift from extensive to intensive growth – that is, from a model based on capital accumulation to one propelled by gains in efficiency, measured by total factor productivity (TFP).

These recommendations are presumably influenced by Paul Krugman’s criticism in 1994 of Soviet-style extensive growth in East Asian economies (especially Singapore). At the time, disagreed, asserting that the East Asian model included far more efficient market-based investment allocation than the Soviet model did, and thus was unique; nonetheless, the criticism stuck.

It was not long before some Chinese economists began to categorize the growth pattern brought about three decades ago by Deng Xiaoping’s reforms as extensive – and thus problematic. A consensus has gradually emerged around this idea, with calls for a shift toward intensive, efficiency-driven growth intensifying since China’s GDP growth began to slow in 2011.

But empirical research reveals a fundamental problem with this argument: China’s TFP has grown at an average annual rate of nearly 4% since Deng’s reforms began. If the United States’ economy, with a TFP growth rate of only 1-2% annually, is considered efficiency-driven, why is China’s not? More important, if China’s TFP growth is expected to slow, as major drivers like the convergence effect wane, what does it mean to say that efficiency gains should propel China’s future growth?

Consider the facts. by Louis Kuijs, working with the World Bank, shows that, from 1978 to 1994, China’s GDP grew by an average of 9.9% annually, labor productivity increased by 6.4%, TFP rose by 3%, and the capital-labor ratio increased by 2.9%. In the period from 1994 to 2009, annual GDP growth averaged 9.6%, labor productivity increased by 8.6%, TFP increased by 2.7%, and the capital-labor ratio rose by 5.5%.

Similarly, that from 1978 to 2005, China’s GDP grew by 9.5%, while capital investment grew by 9.6%, contributing 44.7% to GDP. The share of tertiary graduates in the labor force rose to 2.7% by 2005, accounting for 16.2% of GDP growth. And TFP grew by 3.8%, adding 40.1% to GDP growth.