Upgrading China’s Economy

From: English Edition of Qiushi Journal Updated: 2013-11-07 15:58
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In order to realize the upgrading of China’s economy, we must address the constraints that are hindering economic development in a new phase, promote technological innovation through institutional innovation, and draw on the power of innovation to promote China’s economic restructuring and the fundamental transformation of its growth model. Doing so will allow us to realize the balanced and sustainable development of China’s economy.

Figures published by the National Bureau of Statistics of China on July 27, 2013 indicated a slowdown in the profit growth of Chinese industrial enterprises. Companies in China are currently engaging in restructuring efforts in a bid to change their profit models. / Xinhua (Drawing by Zhu Huiqing)

I. Economic upgrading is essential for China’s modernization

China’s economy has been transformed by 35 consecutive years of rapid growth. In 2012, China’s GDP stood at 51.9 trillion yuan, approximately 24 times greater than the country’s GDP in the early years of the reform and opening up drive according to comparable prices. This equates to an annual growth rate of 9.8% on average. Converted according to the current exchange rate, China’s GDP reached nearly US$8 trillion in 2012, making China the second largest economy in the world. This also means that China’s economy accounts for around 10% of the global GDP. In addition, China’s GDP per capita in 2012 was 38,000 yuan, approximately 17 times greater than that of the early years of the reform and opening up drive according to comparable prices. This equates to an annual increase of 8.7% on average. According to the current exchange rate, China’s GDP per capita is US$5,800, exceeding the average level for middle-income countries, which presently stands at US$3,400. This indicates that China is now an upper-middle income country.

At present, China has established itself as an upper-middle income country. But will it be able to make the leap to a high-income country over the next ten years? In other words, will China be able to realize its goal of building a moderately prosperous society in all respects by the year 2020? Judging from quantitative economic data, China will be able to double its GDP (2010) by the year 2020 provided that it maintains an average growth rate of 7.2%. At that time, China’s GDP will reach 90 trillion yuan (calculated in constant prices), or nearly US$14 trillion, equaling the size of the US economy in the early 2000s. Provided that the natural population growth rate can be kept under the current level of less than 5‰, China’s GDP per capita will double in that time, reaching almost 70,000 yuan (calculated in constant prices). This is equal to almost US$12,000 at the current exchange rate, which is the threshold for classification as a high-income country at present.

A comparison made between China and industrialized countries according to qualitative economic data reveals that China has now entered the later stages in the process of industrialization. In China’s developed eastern regions, municipalities and provinces such as Shanghai, Beijing, Tianjin, Jiangsu, and Guangdong are now essentially industrialized, while provinces such as Zhejiang, Fujian, Shandong, and Liaoning are not far behind. If this momentum can be maintained, it will be possible for China to essentially achieve nationwide industrialization by the year 2020. At present, China is undergoing a phase of accelerated urbanization under the combined effects of agricultural modernization and industrialization. It is fully possible that China’s urbanization rate will increase from 51.3% at present to around 70% by the year 2020, reaching the average level of high-income countries. Moreover, modern service industries underpinned by IT will see rapid development owing to the increasing application of IT in economic development, and especially with the rapid integration of IT into agricultural modernization, urbanization, and China’s new approach to industrialization.

From the above, we can see that China is in a historic position to make the leap from an upper-middle income country to a high-income country. If we can seize on this historic opportunity and complete the building of a moderately prosperous society in all respects by the year 2020, we will put ourselves in a sound position to establish China as a strong and fully modernized socialist country and catch up with developed countries by the year 2050. However, to achieve this leap, we must accelerate our economic restructuring, speed up the transformation of our economic growth mode, break through constraints that are hindering us in a new phase of development, and enable ourselves to seize new opportunities for growth by updating our economy.

II. Transforming our growth model is the key to upgrading China’s economy

According to a wealth of experience, if China is to maintain balanced and sustainable growth during its transition from an upper-middle income country to a high-income country, it will need to transform its model of economic growth and make strategic adjustments to its economic structure, especially its overall supply structure.

1. Promoting industrial restructuring and accelerating the transformation and upgrading of the economy. Analysis of input-output figures over past years shows that the enhancement of China’s industrial structure has fallen behind the pace of its economic expansion. In particular, the share of modern service industries in the economy is unable to meet the requirements of economic development at the current stage. This has not only caused the employment elasticity of economic growth to drop, but has also inhibited the increase of productivity and consumption.

2. Enhancing the effect of industrial restructuring on economic growth in order to accelerate the flow and transfer of resources from low efficiency industrial sectors to sectors with comparatively high efficiency. Insufficient competition in China’s market, coupled in particular with the homogenization of industrial structures in different parts of the country, has caused large amounts of resources to become concentrated in low efficiency industrial sectors. While resources in these sectors expand outwards on a constant basis, high efficiency economic sectors and areas are suffering from a lack of input, and this has weakened the contribution of restructuring to economic growth. The prevalence of this inverted distribution phenomenon in China means that the difference in efficiency between different sectors of the economy is not being fully exploited. In other words, resources are unable to flow from low efficiency sectors to high efficiency sectors, but the efficiency gap between different industries has still widened.

3. Promoting the upgrading of product structures through technological restructuring. Owing to slow progress in the upgrading of the product mix, increases in investment are only able to bring out expanded production on the basis of product mixes developed under existing technological structures. This reduces the efficiency of investment and gives rise to surplus production capacity. In fact, structural excess capacity is an outstanding problem in China’s industrial production. In addition to excess capacity in the production of many industrial consumer goods, notable surpluses have also emerged in the production of industrial materials such as polysilicon, non-ferrous metals, crude steel, electrolytic aluminum, and alumina. What is worse, excess capacity is also beginning to be seen in certain strategically important emerging industries, such as the wind power industry. This situation has restricted the effective growth of investment.

4. Promptly improving the cost structure of factors of production. Profound changes have occurred to the way that factors of production such as labor, capital, and natural resources constrain economic development, with the cost of labor and natural resources becoming an increasingly strong constraint on economic development. In addition to a gradually diminishing demographic dividend, China’s labor costs have been rising faster than increases in labor productivity for a considerable period of time. Although China has entered the later stages of industrialization, its agricultural labor productivity and secondary industry labor productivity are less than 15% and 50% of levels seen in industrialized countries respectively. Therefore, we must improve the cost structure of factors of production in order to gain a new competitive edge.

III. Innovation is the driving force for the upgrading of China’s economy

The most direct driving force for the transformation of an economic growth model is the sustained increase in economic efficiency that results from innovation. Therefore, innovation is the key to upgrading China’s economy.

In the modern market economy, the accumulation of human capital underpins the capacity of a national economy to engage in technological innovation. This process of accumulation includes two aspects: spending on education and spending on health. As far as education development is concerned, increases in the average length of schooling in developed countries such as the UK and the US have been faster than the growth of the GDP in those countries ever since the nineteenth century, and the average length of schooling in latecomers such as Japan and South Korea has also grown faster than their GDP. Moreover, the average length of schooling has also increased at a faster rate than the GDP in emerging economies such as Russia and Brazil, with the exception of fluctuations at certain periods. However, in countries that failed to make the leap from a middle-income economy to a high-income economy, increases in the average length of schooling lagged behind the growth of the GDP in the majority of cases. In China’s case, the average length of schooling has been increasing at a lower rate than the country’s GDP since the mid-1980s. This is something that demands a high level of concern.

Fundamentally speaking, institutional innovation is more important than technological innovation. This is because institutional innovation is the source of the forces that promote technological innovation. Institutional factors have been primarily behind the structural problems that China has faced over the long term, such as a skewed industrial structure, the irrational distribution of national income, and an overly large development gap between urban and rural areas. In other words, insufficient market competition and the uncoordinated relationship between the government and market have caused a lack of incentive for innovation. Theoretically speaking, a market economy provides the incentive for innovation through its competition mechanisms, rewarding enterprises that innovate, and punishing those that do not. Therefore, in working to upgrade China’s economy and promote the enhancing of its industrial structure, while it is certainly important that we pay attention to the driving forces provided by technological innovation, it is even more important that we focus our attention on institutional innovation, and particularly on the refinement of market mechanisms. For this reason, institutional innovation with the aim of improving market mechanisms has become our major task in deepening reform.

At present, China has entered a period of opportunity for making the transition from an upper-middle income country to a high-income country. At the same time, it has also entered a challenging stage of institutional reform, with profound changes taking place with regard to both the tasks and the constraints that the country faces in reform. With regard to the main focus of China’s reforms, the core of reform has shifted from the reform of enterprises, which was the focus early on in the reform and opening up drive, to reforms in key areas, with the transformation of government functions being the core. With regard to the reform of enterprises, the focus has switched from the reform of state-owned enterprises to the establishment of a modern enterprise system that features diverse forms of ownership. With regard to market systems, the focus of market reform has shifted from the establishment of commodity markets, which was the focus in the early stages of reform, to the development of markets for the exchange of factors of production, with the establishment of markets for the fair exchange of factors of production between different sectors of the economy becoming the priority. In terms of the development of institutions, our focus has shifted from breaking away from the constraints of the traditional planned economy to making market competition fairer and more orderly. Also, in urban and rural reforms, we have gone from implementing separate reforms in urban and rural areas to promoting comprehensive reforms aimed at coordinating urban and rural development. Moreover, these reforms are becoming increasingly integrated into the reform of government functions and mechanisms.

In our effort to upgrade China’s economy, we are not only facing technological bottlenecks, but also the challenge of promoting institutional innovation. Therefore, bearing in mind the goals of building a moderately prosperous society in all respects and realizing socialist modernization, we must clearly identify the purpose of reform and where our reforms stand at present. Working on this basis, we should draw on reform to promote institutional innovation, use institutional innovation to support technological innovation, and rely on technological innovation to drive the upgrading of our economic structure, so as to achieve the fundamental transformation of our economic growth model.

(Originally appeared in Qiushi Journal, Chinese edition, No.9, 2013)

Author: Vice-President of Peking University

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