The China miracle is ending. That miracle consisted of very exceptionally strong growth of the economy. By 2010, GDP per capita, adjusted for inflation, was 17 times higher than it had been in 1980. Consider that if living standards doubled in a generation, that would be pretty cool. But a 17 times increase? That can be called a miracle.
China’s growth has slowed in recent years, partly due to maturity. Extremely poor countries have the potential to grow rapidly. As they approach the level of developed countries, growth is harder and thus slows. See, for example, China Is Too Mature For Rapid Economic Growth.
Maturity is not the only issue. We need to delve into the source of the growth to evaluate whether it can continue.
Michael Schuman writes in the Atlantic, “China’s economic ‘miracle’ wasn’t that miraculous. The country’s high-octane ascent over the past 40 years is, in reality, a triumph of basic economic principles: As the state gave way to the market, private enterprise and trade flourished, growth quickened, and incomes soared.”
The recent efforts by Xi Jinping to control the economy more tightly will diminish future growth, according to Schuman. And he’s right.
Prior to Deng Xiaoping’s economic reforms in the early 1980’s, most Chinese lived in poor, rural communities where job opportunities were limited to very inefficient agriculture. This inefficient, small-scale, unmechanized agriculture produced very little earnings. Poverty was the norm, not the exception.
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With Deng’s reforms, factories blossomed in the cities. Poor rural people moved to take jobs in cities. Incomes soared. Early success led to follow-on reforms that further grew the economy.
Economists plugged China’s progress into a basic model consisting of labor, capital and technology. Poor countries had low capital per worker, resulting in low productivity. The next wave of economic analyses of growth looked also at government performance, asking why poor countries had low capital per worker, and why the technology used in rich countries was not used in poor countries. For example, why would Chinese farmers not use tractors nearly 100 years after American farmers had started using them? If lack of capital was the problem, why did capital not flow into poor countries as it had flowed from Europe to the United States in the 1800s?
The quality of governance affects the ability of a country to fulfill its potential. Limits typically seen in communist countries are lack of incentives and feedback mechanisms to put capital and labor into the most productive uses. Among poor non-communist governments, “crony capitalism” and misguided regulation are common limits. The regulatory system funnels economic opportunities to friends and family of the ruling elite. And when corruption is not the problem, misguided regulations such as protective tariffs limit people’s ability to take advantage of opportunities.
As China’s communist system morphed into a more market-oriented system, economic performance improved. We economists speculated about when the country would hit the limit of its governance. But in recent years China’s governance has shifted in a very anti-growth direction. That’s not the primary intent of Xi Jinping, which seems to be increased control over all aspects of Chinese life. But the result of increased control by the president is worsening economic opportunities.
China’s communist party argues that it should have more control over management decisions of companies. Quashing Jack Ma’s IPO of the company Ant is an example.
The flow of lending to private companies in China collapsed after Xi took power, according to Nicholas Lardy of the Peterson Institute. Funds were, instead, channeled to state-owned enterprises. The state-owned companies place higher priority on serving political leaders than economic efficiency. And with lower economic efficiency, worker’s productivity is lower, limiting wage possibilities. The most productive opportunities are skipped in favor of the most politically favored opportunities.
Schuman concludes “By favoring the state sector, Xi is funneling valuable money and talent to notoriously bloated and inefficient government enterprises instead of far more nimble and creative private firms. The negative effect shows up in miserably poor productivity ….”
Xi’s power grab does not spell recession for the huge economy, but it does spell the end of rapid economic growth. American businesses will find Chinese sale opportunities growing much less rapidly than in past years. On the plus side for companies around the world, China will leave to other businesses great opportunities that it could have exploited.