Don’t give up on China’s growth

After three decades of 9.8% average annual GDP growth, China’s economic expansion has been slowing for 13 consecutive quarters – the first such extended period of deceleration since the “reform and opening up” policy was launched in 1979. Real GDP grew at an annual rate of only 7.5% in the second quarter of this year (equal to the target actually set by the Chinese government at the beginning of this year). Many indicators point to further economic deceleration, and there is a growing bearishness among investors about the outlook for China. Will China crash?

In fact, many other rapidly growing emerging economies have suffered – and worse than China – from the drop in global demand resulting from ongoing retrenchment in high-income economies since the 2008 financial crisis. For example, GDP growth in Brazil has slowed sharply, from 7.5% in 2010 to 2.7% in 2011 and to just 0.9% in 2012, while India’s growth rate slowed from 10.5% to 3.2% over the same period.

Moreover, many high-income newly industrialized economies (NIEs) with few structural problems were not spared the effects of the 2008 crisis. South Korea’s GDP growth slowed from 6.3% in 2010 to 3.7% in 2011 and to 2% in 2012; Taiwan’s fell from 10.7% to 1.3% over this period; and Singapore’s plummeted from 14.8% to 1.3%.

Given this, China’s economic slowdown since the first quarter of 2010 has apparently been caused mainly by external and cyclical factors. Facing an external shock, the Chinese government should and can maintain a 7.5% growth rate by taking counter-cyclical and proactive fiscal-policy measures, while maintaining a prudent monetary policy. After all, China has high private and public savings, foreign reserves exceeding $3.3 trillion, and great potential for industrial upgrading and infrastructure improvement.

Indeed, China can maintain an 8% annual GDP growth rate for many years to come, because modern economic growth is a process of continuous technological innovation and industrial upgrading. Of course, this is true for developed and developing countries alike. But developed countries differ from developing countries in an important way. Since the Industrial Revolution, developed countries have always been on the global frontier of technologies and industries, which has required them to invest in costly and risky indigenous research and development.

By contrast, technologies and existing industries in developing countries are in general well within the global frontier. As a result, they benefit from the “latecomer’s advantage”: technological innovation and industrial upgrading can be achieved by imitation, import, and/or integration of existing technologies and industries, all of which implies much lower R&D costs.

In theory, any developing country that can harness its latecomer’s advantage to achieve technological and industrial upgrading can grow faster than developed countries. How much faster is an empirical question. According to the Growth Commission led by Nobel laureate Michael Spence, 13 economies took full advantage of their latecomer status after World War II and achieved annual GDP growth rates of 7% or higher – at least twice as high as developed countries’ growth rates – for 25 years or longer.

China became one of the 13 economies after 1979. Because the country’s latecomer status explains its 33 years of rapid economic growth, the key to understanding its potential for further rapid growth in the future lies in estimating how large those advantages still are.

Per capita GDP, which reflects a country’s average labor productivity and its overall technological and industrial achievement, is a useful proxy to estimate latecomer’s advantage. That is, the per capita GDP gap between China and developed countries essentially reflects the gap between them in terms of overall technological and industrial achievement.

According to the most up-to-date estimate by the late economic historian Angus Maddison, China’s per capita GDP in 2008 was $6,725 in 1990 dollars, which was 21% of per capita GDP in the United States. That is roughly the same gap that existed between the US and Japan in 1951, Singapore in 1967, Taiwan in 1975, and South Korea in 1977 – four economies that are also among the 13 successful economies studied by the Growth Commission. Harnessing their latecomer’s advantage, Japan’s average annual growth rate soared to 9.2% over the subsequent 20 years, compared to 8.6% in Singapore, 8.3% in Taiwan, and 7.6% in South Korea.

If the latecomer’s advantage implied by the income gap between the four NIEs and the US enabled the NIEs to realize average annual GDP growth rates of 7.6%-9.2% for 20 years, China’s annual growth potential should be a similar 8% for the 2008-2028 period. To realize its potential growth as a latecomer, China needs, above all, to deepen its market-oriented reforms, address various structural problems, and develop its economy according to its comparative advantages.

The opinions expressed here are those of the author, not necessarily those of the World Economic Forum. Published in collaboration with Project Syndicate.

Author: Justin Yifu Lin, a former chief economist and senior vice president at the World Bank.

Image: A building under construction is seen reflected on the facade of another building REUTERS/Stringer