Making Sense of China’s Growth Model

While capital has been the largest contributor to China’s GDP, the economy’s TFP performance has been impressive – something that cannot be explained by an extensive growth pattern. Indeed, Japan’s rate of TFP growth never reached such high levels, even at the country’s economic peak. Even Hong Kong – the East Asian economy with the best TFP performance – registered only 2.4% average annual TFP growth from 1960 to 1990.

But annual TFP growth is not the only relevant figure. China’s TFP has contributed 35-40% to GDP growth, compared to an estimated 20-30% in East Asia’s four tigers (Hong Kong, Singapore, South Korea, and Taiwan). As for the Soviet Union, even in its best years, TFP accounted for only about 10% of GDP growth.

Though China’s TFP contribution to GDP growth is much greater than in the other so-called extensive economies, it remains well below levels in the intensive US economy, where the figure exceeds 80% – a divergence that some might use to justify their refusal to define China’s economy as efficiency-driven. But this argument ignores the fact that China has been experiencing double-digit annual GDP growth, owing largely to capital expansion, while America’s annual GDP growth has averaged only 2-3%.

If transforming China’s growth pattern were simply a matter of increasing TFP’s contribution to GDP to US levels, China’s annual GDP growth would have to drop to below 5% – three percentage points lower than its potential growth rate. Given 8% GDP growth, TFP would have to grow 6.4% annually. This is almost certainly impossible, owing to the gradual diminution of the major drivers – including market-oriented economic reforms, the convergence effect on per capita income, and the adoption of foreign technologies – of China’s extraordinary TFP growth over the last 30 years.

All of this raises a simple question: Do extensive- or intensive-growth models really exist? Perhaps there is only fast versus slow, or extraordinary versus ordinary.

According to this view, if a developing economy can realize extraordinary growth, it must be because it offers greater opportunities for capital expansion than a developed economy. After all, investment opportunity is inversely proportional to per capita capital stock. On this point, Krugman is right: such investment-fueled growth is achieved largely through perspiration, rather than inspiration. But so what?

The fact that some of Asia’s most dynamic economies – including China, Japan, and the four tigers (Hong Kong, Singapore, South Korea, and Taiwan) – have experienced investment-propelled growth and improvements in TFP simultaneously can be explained by the fact that TFP gains increase investment returns, accelerating capital expansion further. Though further analysis is needed to elucidate the long-term relationship between capital expansion and TFP, it is clear that the long-accepted theory that they cannot co-exist is seriously flawed.

In short, when it comes to Asian economies, the dichotomy of extensive and intensive growth is a red herring. A far more meaningful consideration is what drove these TFP gains; understanding that would enable China’s leaders to design a more effective plan for strengthening the economy’s long-term growth prospects.

Zhang Jun is Professor of Economics and Director of the China Center for Economic Studies at Fudan University, Shanghai.

Copyright: Project Syndicate, 2014.