China is on everyone’s mind, particularly because of its economy and the increased interdependence between the rest of the world and China. After roaring growth since Deng Xiaoping initiated the policy of reform and opening up in 1978, China’s economy began slowing down to an annual rate of gross domestic product (GDP) growth target of between 6.5% and 7% in 2016. The longest period of vigorous and continuous economic growth with the exception of a hiccup in 1989 and 1990 seems to have come to an end in 2015 when China recorded an annual real GDP growth rate of 6.9% meeting its growth target of around 7% for the year.
The next 5 year plan, China’s thirteenth, from 2016-2020 has set as its objective China’s climb up the value chain. China wants to engage in what it calls “supply side restructuring” aimed at boosting economic growth to double the standard of living, as measured by per capita income, by 2020 and to eliminate poverty which is defined as living on an annual income of $354 or less a year.
“Supply side” is a term intended to distinguish the new policies from traditional demand side policies of easy money and a higher fiscal deficit to boost economic activity. Important among the supply side policies is the reduction of overcapacity in state-owned coal and steel industries which will displace about four million workers, or about 0.5% of China’s workforce, from their jobs. The government is setting up a special fund to assist those who remain unemployed after the restructuring. More restructuring of the bloated state-owned enterprise sector is needed where some firms are consolidated and some are allowed to fail which will create more unemployment, so the government is starting small to see how it works and to monitor the public’s response.
Investment in infrastructure will continue with the proposed building of 50 new airports and thousands of miles of roads and railroads as millions of people will be shifted from low-productivity agricultural areas to dozens of new cities. The proposed One Belt, One Road initiative to open up China to other countries in Central Asia and Asia and perhaps Europe with a network of ports, railroads, and highways linking China to these other parts of the Asian continent and the world could also provide an opportunity to export some of China’s excess industrial capacity.
While the gradual restructuring of the heavy industry-based ‘old China’ economy and continued investment in infrastructure and housing is meant to prevent a hard landing of the Chinese economy, the key policies are targeted to stimulate innovation through research and development including by lowering tax rates for high-technology firms. China’s value-added tax will also be extended to the service sector. Financial reforms will bring China closer to a market economy by eliminating limits on interest rates that banks can pay on deposits and charge on loans.
An important part of the reform process will be to deal with the outsize debts of the state-owned enterprises and the excess debts of local governments. China will be able to deal with these potential bad debts by transferring them to the central government in Beijing because government debt is very low – around 17% of GDP – at this time.
In the big picture, China’s productivity or output per worker will have to rise to achieve higher GDP growth in the new economic structure. Overtime, beyond the next five years, a large part of the GDP growth will be borne by consumption and low-end to high-end services as spending on infrastructure, housing, and industrial capacity bottoms out. Productivity will increase through automation especially as the working-age population declines through 2030. However, this increase in productivity will require upgrading the skills of the workforce to offset the need for large scale unemployment in the short to medium terms.
Productivity and innovation are the two key requirements for China to become a developed, high-income country by 2030. As more of the population becomes involved in the innovation sector and productivity rises through high-end manufacturing where China is no longer assembling parts but is designing and manufacturing from scratch aided by increased automation, the displacement of the workforce due to automation will be partly offset by the retiring workers because China’s working age population has peaked. In this context, a key reform is the establishment of a robust social safety net to assist the retiring and displaced workers.
Contrary to fears of a hard landing, execution of reforms, as China has done so far, and not short term monetary and fiscal policies, can relatively smoothly transition China into a high-income developed country by 2030.