China’s Growth Model: The Logic behind the Nation’s Economic Problems

By Wen He, PhD Candidate, Department of Decision Sciences and Management Economics, CUHK Business School

“China’s economy is entering a turning point,” according to Xiang Songzuo, Chief Economist at the Agricultural Bank of China and Professor at Renmin University of China, who gave a speech at CUHK’s 50th Anniversary Economic Forum. “China’s economy has grown in a high speed over the past 30 years. However, from 2012, the growth in many key indicators such as GDP, industrial production and fixed-asset investment has shown a slowdown,” he said.

Prof. Xiang described China’s economy as “seriously unbalanced.” He pointed out the imbalance in income distribution and said that Chinese farmers, who account for 70 percent of the population, still maintain a very low level of income. “In the process of urbanization and industrialization, farmers receive a very low portion of the revenue from land demolition. Although the land revenue has grown from 100 billion yuan to thousands of billion yuan, farmers have received less than 40 percent of the pie. In some places such as Liaoning, Zhejiang and Henan, the proportion was even lower, at 10 percent, 3 percent and 12 percent, respectively. This is a big problem.”

The imbalance in industrial structure was also highlighted. “The key to China’s industrial restructuring is to solve the over-capacity problem in the manufacturing sector and the development problem in the service sector,” Prof. Xiang said. “Over-capacity in many industries, such as steel, cement, electrolytic aluminum, coal, automobile and more, has led to severe operating conditions, characterized by high debt and low profitability.”

He cited a joke in the steel industry: The profit from selling one ton of steel can be used to buy just one popsicle! “In the first half of 2013, one tone of steel only generated a profit of 4.8 yuan,” he said.

Why has severe over-capacity occurred in these industries? Prof. Xiang explained: “These are all high-input and high-output industries, which are most useful for promoting GDP growth. For example, when a city builds an automobile factory, 1 million cars can be produced in a year. Suppose a car sells at 100,000 yuan, then the annual output value amounts to 100 billion yuan. This result is very helpful in boosting the “aura and black hat” (official posts) of the city’s mayor and party secretary.”

China’s Growth is a ‘Three-Dependency’ Mode

Prof. Xiang believes that the economic imbalances originate from China’s growth model, which involves the government, enterprises and banks. “What the government pursues are: GDP growth, political achievements and tax incomes. As for enterprises, they aim to become big, because the big ones will always be saved. And banks like lending to state-owned enterprises, believing that this would never lead to bad debts. This phenomenon fully exposes flaw of the growth model,” he said.

Prof. Xiang summarized the growth model as a “three-dependency” mode: “In the past 30 years, growth depended on investment; investment depended on loans; and loan depended on currency. Almost any economic problem can be explained from this three-dependency mode.”

He elaborated: “To achieve steady growth, steady investments have to be made. To get steady investments, projects have to be launched. To launch projects, loans have to be put out. To put out loans, monetary policies have to be loosened. Many domestic and foreign market analysts know this mode very well. In future reforms, this mode has to be adjusted.”

“The problem is that such a growth model is not sustainable,” Prof. Xiang commented.  “We are losing our traditional comparative advantages. The traditional advantages are low labor, resource and environmental costs.  But these advantages are quickly disappearing.”

Prof. Xiang said it is imperative for China to develop new comparative advantages. “This is what the top leadership is most concerned about,” he said. He also mentioned that President Xi Jinping, with other members of the CPC Central Committee, visited China’s Silicon Valley, Zhongguancun, to learn innovation on the National Day of 2013.

Stable Growth is Still a Pursuit in Macroeconomic Policy  

Going forward, how should the growth model be adjusted? Does China still need to focus on economic growth? Prof. Xiang said: “First of all, we must have a clear understanding of China’s macroeconomic policy. No matter how the policy is adjusted, what is being said, and what actions are taken, steady growth in China is still the basic starting point of its macroeconomic policy for quite a long time to come. Many scholars believe that we should abandon growth. This is obviously a misunderstanding. We are now looking for a balance. As Central Bank Governor Zhou Xiaochuan said, the most challenging place in China’s economy is to find a balancing point between steady growth and structural adjustment.”

Prof. Xiang explained: “China needs to adjust its economic structure, ensure people’s well-being and prevent risks, all of which are built on the premise that there cannot be a sharp decline in the growth rate.”

He added: “Premier Li Keqiang once gave an explanation, saying that we must keep a certain growth rate to ensure employment – that GDP growth should not be less than 7 percent to ensure that the unemployment rate is kept at below 5.5 percent, according to the supply and demand of labor. Premier Li also said that we are neither monetary easing nor monetary tightening. This is again about the balancing point.”

“Furthermore, we still have favorable conditions for steady growth,” Prof. Xiang said. “First, the process of China’s industrialization, urbanization and modernization was half way through as of last year. The urbanization rate has just reached 53 percent. China needs another 30 years of rapid growth to complete that process. There is no going back. Second, as the largest manufacturing country, China now has the world’s most integrated manufacturing system. Although no longer possessing low-cost advantages, we have advantages in our integrated supply chains.”

Adjusting the Growth Model

Prof. Xiang then revisited the three dependencies of the growth model and said: “We should continue with the first dependency—growth depends on investment. What causes troubles is the other two dependencies—on loans and currency. These should be adjusted promptly. Economic reforms, especially reforms in the financial sector, are set to solve these two dependency problems.”

He suggested several areas where reforms in the financial sector should take place: marketization of interest rates, development of small and medium financial institutions, and development of municipal bonds.

“We must rely on investments for urbanization. Some scholars hold the wrong view that investments and consumption have opposing effects. In fact, these two are not opposites. People want to consume tourism, education and health care, none of which is possible without investments. Our problem is not whether to invest. It is about the structure and method of investment—what to invest in and where the money comes from. This is a big problem we have to resolve,” he said.