The Hindu Business Line : The real forces behind China's rapid growth

In the previous edition of Macroscan, C. P. Chandrasekhar and Jayati Ghosh examined the pattern of economic growth in China over the past two decades and considered the macroeconomic policies associated with the growth trend and periodic deflation. In this edition they consider the possible factors behind the sustained growth and assess the degree of replicability by other developing countries.

CHINA is widely regarded as one of the "success stories" of globalisation, emerging into a giant economy of the 21st century.

The successes that have been identified are in terms of high and sustained rates of growth of aggregate and per capita national income; the absence of major financial crises that have characterised a number of other emerging markets; substantial reduction in income poverty.

These results, in turn, are viewed as the consequences of a combination of "prudent" yet extensive programme of global economic integration and domestic deregulation, as well as sound macroeconomic management.

This experience is then used to argue the case for globalisation and to indicate the potential benefits that other developing countries can reap, as long as they also follow "sensible" macroeconomic policies.

But there are very specific features of the Chinese experience which have allowed such rates of growth to be sustained, that are rarely mentioned in discussions. This is why Chinese economic growth warrants a closer look.

China recorded an annual trend rate of growth of real GDP of 9.8 per cent during the quarter century ending 2003. China's exceptional growth performance over the past three decades is most fundamentally a reflection of the high investment rates that have characterised the economy over this period.

As Chart 1 shows, capital formation as a share of GDP has been very high by international standards, varying between 32 per cent and 44 per cent of GDP. There has also been substantial volatility in this indicator, around an increasing trend.

The chart also indicates that rates of growth of GDP have been strongly associated with investment rates, which is only to be expected.

The cyclical pattern of aggregate income growth around a high trend rate therefore appears to a result of the pattern of investment growth over this period.

The question then becomes, what explains this pattern of volatile but generally high rates of investment?

It is evident that the stop-go cycles that characterise investment reflect the broader macroeconomic policy of adjusting domestic investment (and indeed consumption demand) to price changes. Macroeconomic policy generally — and therefore aggregate investment, which continued to be substantially influenced by government decisions given the nature of the economy — appears to have been strongly responsive to the inflation rate.

Chart 2 indicates the extent to which higher investment rates have caused high inflation in the subsequent period, thereby leading to cutbacks in investment.

However, as has been noted, these fluctuations occurred in a context of generally very high rates of investment (and therefore, of domestic saving, since foreign savings contributed relatively little to aggregate domestic investment and in recent years have only added to external reserves).

It is notable that despite volatility, the investment rate of the economy increased from 34.5 per cent of GDP for the three-year period at the start of the "economic reforms" (1979-81) to 39.8 per cent for the three-year period 2001-03. Most recent data indicate that the investment rate in China is around 45 per cent currently.

These imply rates of domestic saving which are exceptional not only by international standards, but more particularly for an economy at China's level of per capita GDP.

Such high rates of domestic saving in turn imply a suppression of domestic consumption which is only possible with high and/or growing income inequality, which allows a substantial proportion of incremental income to be saved.

We discuss the changes in inequality below; the point to be made here is that if this argument is accepted, then growing inequality is not simply an adverse fallout of the pattern of growth in China thus far, but an important factor behind such growth, enabling the sustained increase in investment rates which is the most obvious engine of economic expansion.

It may be argued that domestic savings has been less significant than foreign savings, and in particular FDI, in allowing for such high rates of investment.

This is particularly so because of the emergence of China as the second largest recipient (and the largest in the developing world) of FDI, which has increased from near zero in the early 1980s, to more than $50 billion in recent years on average. However, in fact China's dependence upon external capital for financing investment has been relatively low, especially when compared to other developing countries.

The ratio of foreign capital inflow to GDP rose to reach 8 per cent in 1994, and thereafter has hovered around 5 per cent. Furthermore, the large inflows of the past two years have not contributed to domestic investment, macro-economically speaking, since they have been associated with even higher domestic savings rates and the consequent build-up of foreign exchange reserves.

Therefore, the role of high investment — itself related to the overall development and macroeconomic stance of the government, which extends well beyond purely budgetary expenditures to its control over off-budget investments, and so on — has been critical in achieving the extraordinary growth of the past decades.

And this has been permitted, indeed enabled, by the pattern of growth which has allowed incremental incomes to be concentrated in certain regions and among certain groups, thus enabling high savings rates to be continue and even increase over time.

The inequality within China has had mainly spatial dimensions, in terms of growing income and consumption inequality between rural and urban areas as well as across regions (between the more rapidly growing eastern region, and the central and western regions).

Within the east, the metropolises with province-level status, Shanghai, Beijing and Tianjin, have done very well and have contributed towards the high growth performance of the eastern region, especially in the 1990s when these cities were able to reap the full benefits of eased export restrictions and attract substantial FDI inflows.

The central provinces of Shanxi, Henan, Anhui, Hubei, Hunan and Jiangxi, the agricultural heartland of China, grew well in the 1979-84 phase when deregulation was undertaken in agriculture on a large scale, and the growth rate in per capita GDP at 7.7 per cent was higher than the national average growth rate.

Subsequently, the limits of agricultural growth were reached and per capita GDP growth fell to 4.9 per cent between 1984 and 1991, the lowest among all the regions.

Among the western regions, both the north (Inner Mongolia, Shaanxi, Ningxia, Gansu, Qinghai, Xinjiang and Tibet) and the south (Sichuan, Yunnan, Guizhou, and Guangxi) have shown lower growth rates compared to the national average between 1979-84 (7.1 and 5.4 per cent compared to 7.6 per cent).

This region suffers from lack of access to the mainland, especially to the coast. The north did better between 1984 and 1991 but over the 1990s, the entire west has again shown much lower growth rates compared to the average.

Within the western region, the south has always been much worse-off compared to the north except in the last period, suffering from a lack of mineral resources and mountainous land that offers very little arable land. In the 1990s, the differences became most pronounced between the west and the rest of China. It is not surprising therefore, that the coefficient of variation showing regional disparity in GDP per capita, which was already quite high, increased much more during the post-planning period to be as much as 0.68 over 1990-98. Similar differences are evident in terms of per capita consumption trends, which indicate increasing rural-urban and regional disparity.

The ratio of urban disposable income to rural net income increased from 1.86 in 1985 to 2.47 in 1997 to as much as 3.11 in 2002. There was a brief period (1995-97) during which these differences narrowed, but the divergence appears to have become sharper thereafter. Similarly, the ratio of urban-rural per capita consumption expenditure increased from 3.1 in 1997 to 3.7 in 2002, a much sharper rise than in the previous decade.

Overall indicators of inequality point to very sharp increases in economic differentiation in the recent period. Chart 3 indicates how the Gini coefficient (a basic indicator of inequality) has increased substantially for China as a whole from the mid-1980s onwards.

There is, therefore, clear evidence of an increase in China's already high rural-urban gap in consumption and income since the mid-1980s, when China started opening up to the outside world. This period of rising inequalities overlaps with China's attempts to introduce market reform and trade openness into its economy.

It also reflects the fact that over the 1990s GDP in agriculture grew much more slowly compared to the industry and services sectors. The latter two sectors predominate in urban areas, so their higher growth gives a natural advantage to urban income and consumption. But it was also this increasing inequality which made sustaining high domestic savings rates that much easier for the economy as a whole.

But the implicit dependence upon increasing inequality is not the only reason why other developing countries should be careful when trying to emulate the Chinese performance. There is a basic difference in economic structure between the Chinese economy and other capitalist developing economies. Even throughout the period being considered, the basic elements of a command economy have been much in evidence in China. Even after the quite sweeping economic reforms that have taken place since 1979, state control over macroeconomic balances remains substantial.

Furthermore, because of the significance of state-owned enterprises and town-village enterprises (TVEs) in total production, the ability to influence aggregate demand does not depend only upon fiscal policy in terms of purely budgetary measures, since many "off-budget" expenditures can be increased or reduced.

Further, monetary policy as is generally understood in capitalist economies has very little meaning in China where private financial activity is limited and state-owned banks still dominate overwhelmingly in the provision of credit. This means that for most of the period under discussion, macroeconomic policies in China were necessarily very different and had very dissimilar implications, from those in capitalist developing economies. It also makes the Chinese experience one which is only easily replicated by other countries.

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