Why Is China Growing So Fast?
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Why Is China Growing So Fast?
Zuliu Hu
Mohsin S. Khan
©1997 International Monetary Fund
June 1997
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[Preface] [Why Is China Growing So Fast?] [Measuring Growth]
[A Surprising Find] [Why the Productivity Boom?] [A More In-Depth
Look][Conclusion] [Author Information]
Preface
The Economic Issues series aims to make available to a broad readership
of nonspecialists some of the economic research being produced in the
International Monetary Fund on topical issues. The raw material of the
series is drawn mainly from IMF Working Papers, technical papers
produced by Fund staff members and visiting scholars, as well as from
policy-related research papers. This material is refined for the
general readership by editing and partial redrafting.
The following paper draws on material originally contained in IMF
Working Paper 96/75, "Why Is China Growing So Fast?" by Zuliu Hu and
Mohsin S. Khan of the IMF's Research Department. Rozlyn Coleman
prepared the present version. Readers interested in the original
Working Paper may purchase a copy from IMF Publication Services
($7.00).
Why Is China Growing So Fast?
In 1978, after years of state control of all productive assets, the
government of China embarked on a major program of economic reform. In
an effort to awaken a dormant economic giant, it encouraged the
formation of rural enterprises and private businesses, liberalized
foreign trade and investment, relaxed state control over some prices,
and invested in industrial production and the education of its
workforce. By nearly all accounts, the strategy has worked
spectacularly.
While pre-1978 China had seen annual growth of 6 percent a year (with
some painful ups and downs along the way), post-1978 China saw average
real growth of more than 9 percent a year with fewer and less painful
ups and downs. In several peak years, the economy grew more than 13
percent. Per capita income has nearly quadrupled in the last 15 years,
and a few analysts are even predicting that the Chinese economy will be
larger than that of the United States in about 20 years. Such growth
compares very favorably to that of the "Asian tigers"--Hong Kong,
Korea, Singapore, and Taiwan Province of China--which, as a group, had
an average growth rate of 7-8 percent over the last 15 years.
Curious about why China has done so well, an IMF research team recently
examined the sources of that nation's growth and arrived at a
surprising conclusion. Although capital accumulation--the growth in the
country's stock of capital assets, such as new factories, manufacturing
machinery, and communications systems--was important, as were the
number of Chinese workers, a sharp, sustained increase in productivity
(that is, increased worker efficiency) was the driving force behind the
economic boom. During 1979-94 productivity gains accounted for more
than 42 percent of China's growth and by the early 1990s had overtaken
capital as the most significant source of that growth. This marks a
departure from the traditional view of development in which capital
investment takes the lead. This jump in productivity originated in the
economic reforms begun in 1978.
Measuring Growth
Economists studying China face thorny theoretical and empirical issues,
mostly deriving from the country's years of central planning and strict
government control of many industries, which tend to distort prices and
misallocate resources. In addition, since the Chinese national
accounting system differs from the systems used in most Western
nations, it is difficult to derive internationally comparable data on
the Chinese economy. Figures for Chinese economic growth consequently
vary depending on how an analyst decides to account for them.
Although economists have many ways of explaining--or modeling--economic
growth, a common approach is the neoclassical framework, which
describes how productive factors such as capital and labor combine to
generate output and which offers analytical simplicity and a
well-developed methodology. Although commonly applied to market
economies, the neoclassical model has also been used to analyze command
economies. It is an appropriate first step in looking at the Chinese
economy and yields useful "benchmark" estimates for future research.
The framework does, however, have some limitations in the Chinese
context.
Original data for the new IMF research came from material released from
the State Statistical Bureau of China and other government agencies.
Problematically, the component statistics used to compile the Chinese
gross national product (GNP) have been kept only since 1978; before
that, Chinese central planners worked under the concept of gross social
output (GSO), which excluded many segments of the economy counted under
GNP. Fortunately, China also compiled an intermediate output series
called national income, which lies somewhere between GNP and GSO and is
available from 1952 to 1993. After making appropriate adjustments to
the national income statistics, including adjusting for indirect
business taxes, these data can be used to analyze the sources of
Chinese economic growth.
A Surprising Find
Much previous research on economic development has suggested a
significant role for capital investment in economic growth, and a
sizable portion of China's recent growth is in fact attributable to
capital investment that has made the country more productive. In other
words, new machinery, better technology, and more investment in
infrastructure have helped to raise output. Yet, although the capital
stock grew by nearly 7 percent a year over 1979-94, the capital-output
ratio has hardly budged. In other words, despite a huge expenditure of
capital, production of goods and services per unit of capital remained
about the same. This pronounced lack of capital deepening suggests a
constrained role for capital. The labor input--an abundant resource in
China--also saw its relative weight in the economy decline. Thus, while
capital formation alone accounted for over 65 percent of pre-1978
growth, with labor adding another 17 percent, together they accounted
for only 58 percent of the post-1978 boom, a slide of almost 25
percentage points. Productivity increases made up the rest.
It turns out that it is higher productivity that has performed this
newest economic miracle in Asia. Chinese productivity increased at an
annual rate of 3.9 percent during 1979-94, compared with 1.1 percent
during 1953-78. By the early 1990s, productivity's share of output
growth exceeded 50 percent, while the share contributed by capital
formation fell below 33 percent. Such explosive growth in productivity
is remarkable--the U.S. productivity growth rate averaged 0.4 percent
during 1960-89--and enviable, since productivity-led growth is more
likely to be sustained. Analysis of the pre- and post-1978 periods
indicates that the market-oriented reforms undertaken by China were
critical in creating this productivity boom.
The reforms raised economic efficiency by introducing profit incentives
to rural collective enterprises (which are owned by local government
but are guided by market principles), family farms, small private
businesses, and foreign investors and traders. They also freed many
enterprises from constant intervention by state authorities. As a
result, between 1978 and 1992, the output of state-owned enterprises
declined from 56 percent of national output to 40 percent,while the
share of collective enterprises rose from 42 to 50 percent and that of
private businesses and joint ventures rose from 2 to 10 percent. The
profit incentives appear to have had a further positive effect in the
private capital market, as factory owners and small producers eager to
increase profits (they could keep more of them) devoted more and more
of their firms' own revenues to improving business performance.
China's recent productivity performance is remarkable. By comparison,
productivity growth for the Asian tigers hovered around 2 percent,
sometimes slightly more, for the 1966-91 period. China's rate of almost
4 percent simply puts it in a class by itself.
Why the Productivity Boom?
Exactly how did China's economic reforms work to boost productivity,
especially in an economy still burdened by extensive government
controls? In the important rural sector the story is particularly
interesting.
Prior to the 1978 reforms, nearly four in five Chinese worked in
agriculture; by 1994, only one in two did. Reforms expanded property
rights in the countryside and touched off a race to form small
nonagricultural businesses in rural areas. Decollectivization and
higher prices for agricultural products also led to more productive
(family) farms and more efficient use of labor. Together these forces
induced many workers to move out of agriculture. The resulting rapid
growth of village enterprises has drawn tens of millions of people from
traditional agriculture into higher-value-added manufacturing.
Further, the post-1978 reforms granted greater autonomy to enterprise
managers. They became more free to set their own production goals, sell
some products in the private market at competitive prices, grant
bonuses to good workers and fire bad ones, and retain some portion of
the firm's earnings for future investment. The reforms also gave
greater room for private ownership of production, and these privately
held businesses created jobs, developed much-wanted consumer products,
earned important hard currency through foreign trade, paid state taxes,
and gave the national economy a flexibility and resiliency that it did
not have before.
By welcoming foreign investment, China's open-door policy has added
power to the economic transformation. Cumulative foreign direct
investment, negligible before 1978, reached nearly US$100 billion in
1994; annual inflows increased from less than 1 percent of total fixed
investment in 1979 to 18 percent in 1994. This foreign money has built
factories, created jobs, linked China to international markets, and led
to important transfers of technology. These trends are especially
apparent in the more than one dozen open coastal areas where foreign
investors enjoy tax advantages. In addition, economic liberalization
has boosted exports--which rose 19 percent a year during 1981-94.
Strong export growth, in turn, appears to have fueled productivity
growth in domestic industries.
In one final area, price reform, the Chinese have proceeded cautiously,
granting a fair amount of autonomy to producers of consumer goods and
agricultural products but much less to other sectors. Several bouts of
inflation have buffeted the Chinese economy in the past two decades,
deterring the government from implementing full-scale price
liberalization. High rates of growth also raise inflationary worries.
Inflation may pose the single greatest threat to Chinese growth, though
thus far it has been largely contained.
A More In-Depth Look
As with any national economy, China has unique characteristics that the
researcher must properly account for.
First, many researchers cite the periodic political crises that seized
China before 1978 as a factor obscuring pre-1978 economic strength.
Because the political climate in China was so much in flux, these
commentators argue, the economic pictures before and after 1978 cannot
be compared with any accuracy. This proposition was evaluated by
dropping from the analysis the 1958-70 subperiod, which encompasses the
Great Leap Forward and the Cultural Revolution. The result is that
pre-1978 productivity increased only modestly as a result, from 1.1 to
1.6 percent.
Second, in the 1953-78 period Chinese central planners invested heavily
in the urban industrial sector and restricted migration from the
country into the cities. Could the abandonment of this policy after
1978 itself explain the strong performance of the economy? Did these
sectoral shifts drive growth, or did productivity? In the event,
although these sectoral shifts are important, they do not eliminate the
independent rise in productivity associated with the reforms.
Third, some commentators maintain that if the productivity growth was a
one-time shot of adrenaline to the body economic, it is certainly not
sustainable. In fact, productivity gains have been steady throughout
1979-94 and even increased during 1990-94. If the post-reform period is
broken into three distinct phases, each associated with a different set
of reforms, sizable productivity gains are evident in each subperiod.
This indicates that the Chinese were able to carry over initial
productivity gains to other parts of the economy.
Finally, one can scrutinize the analysis for measurement problems. In
particular, are the capital-stock data calculated properly and were
there any measurement errors relating to the input data? Regarding the
capital-stock measurement, since the Chinese national income statistics
exclude the value of residential housing and since outlays for new
housing rose during 1978-94, the investment figures should be adjusted
accordingly. When this is done, there is no change to the pre-1978
productivity growth estimate and a modest increase in the post-reform
productivity growth rate, which corroborates the general story. Could
an overvaluation of the initial capital stock have biased the findings?
More conservative estimates of the capital stock were used to
re-analyze the data, but there is no strong evidence to refute the
findings. Although the pre-1978 productivity gains become negative, the
post-reform productivity rate is unaffected.
Another more significant problem with capital-stock data is that
Chinese asset surveys do not produce capital stock estimates consistent
with the investment data in the national accounts. The difficulties of
bridging this statistical gap are considerable. The analytical findings
of this study were compared with those obtained by economists who had
computed the data somewhat differently. On the productivity side, the
studies differed in emphasis but not in essence: as a body, the
available evidence corroborates productivity improvements as a
significant source of post-1978 growth, even when divergent
capital-stock calculations are employed. The outside estimates of
productivity growth vary from about 2 percent to nearly 4 percent for
the 1979-94 period.
Regarding other input data, a study was made of the potential for a
differential bias that might overstate the post-reform growth relative
to the pre-reform period. This problem might arise because centrally
planned economies are prone to the overreporting of output and the
underestimating of prices. As it happens, although enterprise managers
have traditionally tended to overreport output in an effort to meet
production targets set by the government, the incentives to do so have
probably declined in the reform era as managers have faced less strict
state control. It is unlikely, therefore, that performance in the
post-1978 era has been overstated relative to earlier eras.
The underdeflating of nominal output could be a more serious source of
bias. The piecemeal character of price reform--with some sectors
liberalized and others not--means that selecting an appropriate
deflator for the post-1978 period is difficult. Yet, the central
planning period may also have seen an underdeflation of output, since
repressed inflation was probably widespread (as manifested in
shortages, black market trading, and long waits for certain goods).
Thus, the measurement problem, while real, probably does not much alter
the basic conclusion about substantial productivity gains after 1978.
Conclusion
Although China occupies a unique niche in the world's political
economy--its vast populace and large physical size alone mark it as a
powerful global presence--it is still possible to look at the Chinese
experience and draw some general lessons for other developing
countries. Most important, while capital investment is crucial to
growth, it becomes even more potent when accompanied by market-oriented
reforms that introduce profit incentives to rural enterprises and small
private businesses. That combination can unleash a productivity boom
that will propel aggregate growth. For countries with a large segment
of the population underemployed in agriculture, the Chinese example may
be particularly instructive. By encouraging the growth of rural
enterprises and not focusing exclusively on the urban industrial
sector, China has successfully moved millions of workers off farms and
into factories without creating an urban crisis. Finally, China's
open-door policy has spurred foreign direct investment in the country,
creating still more jobs and linking the Chinese economy with
international markets.
China's strong productivity growth, spurred by the 1978 market-oriented
reforms, is the leading cause of China's unprecedented economic
performance. Despite significant obstacles relating to the measurement
of economic variables in China, these findings hold up after various
tests for robustness. As such, they offer an excellent jumping-off
point for future research on the potential roles for productivity
measures in other developing countries.
Author Information
Zuliu Hu received his Ph.D. in economics from Harvard University. He
was an economist in the Research Department of the IMF when he wrote
the article on which this pamphlet is based. Mr. Hu is now Co-Director
of the National Center for Economic Research in Beijing.
Mohsin S. Khan is Director of the IMF Institute. He is a graduate of
Columbia University in New York and the London School of Economics.
.
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