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Institute of Global Economics and Finance
The Chinese University of Hong Kong
13/F, Cheng Yu Tung Building, 12 Chak Cheung Street, Shatin, Hong Kong
The Sources of Chinese Economic Growth Since 1978
by
Lawrence J. Lau
Working Paper No. 40
October 2015
2
Acknowledgements
The Institute of Global Economics and Finance is grateful to the following
individuals and organizations for their generous donations and sponsorship
(in alphabetical order):
Donors
Johnson Cha
BCT Financial Limited
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Hang Lung Properties Limited
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Henderson Land Development Co. Ltd.
Lau Chor Tak and Lau Chan So Har
Lau Chor Tak Foundation Limited
Lawrence J. Lau
Sun Hung Kai Properties Ltd.
The Bank of East Asia, Limited
The Hongkong and Shanghai Banking Corporation Limited
Programme Supporters
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Bank of China Limited - Phnom Penh Branch
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China Development Bank
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China Soft Capital
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HOPU Investment Management Co Ltd
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Industrial and Commercial Bank of China - Phnom Penh Branch
King Link Holding Limited
Sun Wah Group
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UnionPay International
3
The Sources of Chinese Economic Growth Since 1978
Lawrence J. Lau
1
July 2015
Abstract: China has made tremendous progress in its economic development since it
began its economic reform and opened to the World in 1978. It is currently the
fastest growing economy in the World—averaging 9.72% per annum over the past 36
years. What are the sources of this Chinese economic growth? Chinese economic
growth since 1978 may be attributed to the following sources: (1) The realization of
the surplus potential output from the initial economic slack that resulted from the
mandatory central planning prior to 1978 (12.65%); (2) The growth of tangible capital
(55.71%) and labor (9.67%) inputs; (3) Technical progress (growth of total factor
productivity (TFP)) (7.97%); and (4) The effect of economies of scale (13.99%). In
the context of China, an important way in which self-fulfilling expectations can be
created and changed is through the pronouncement of policy changes and actual
actions by a government with credibility. Episodes in which the government was
instrumental in changing both the direction and the magnitude of public expectations,
and thus enhancing the growth of aggregate demand, are identified and presented.
1
This is a paper presented at the Conference, “A Just Society: Honoring Joseph Stiglitz”, held at the
Columbia Business School, Columbia University, New York, 16-17 October 2015. Lawrence J. Lau is
the Ralph and Claire Landau Professor of Economics, The Institute of Global Economics and Finance,
The Chinese University of Hong Kong, and the Kwoh-Ting Li Professor in Economic Development,
Emeritus, Stanford University. He wishes to thank Michael Boskin, Ayesha Macpherson Lau, Joseph
Stiglitz, Yanyan Xiong and Wentong Zheng for their invaluable advice, comments and suggestions, but
retains sole responsibility for any remaining errors. All opinions expressed herein are the author’s own
and do not necessarily reflect the views of any of the organizations with which the author is affiliated
4
1. Introduction
China has made tremendous progress in its economic development since it
began its economic reform and opened to the World in 1978. It is currently the
fastest growing economy in the World—averaging 9.72% per annum over the past 36
years. It is historically unprecedented for an economy to grow at such a high rate
over such a long period of time. However, the Chinese economy has begun to slow
down, to an annual rate of growth of around 7%, in a process of transition to a “New
Normal”. Why has China been able to grow at such a high rate and for such a long
period of time? What are the sources of Chinese economic growth since 1978?
These are the questions explored in this paper.
It is interesting to compare the growth of Chinese and U.S. real GDP in both
aggregate and per capita terms (Charts 1 and 2). The red and blue lines represent the
levels of real GDP and real GDP per capita of China and the U.S. respectively. The
red and blue columns represent the annual rates of growth of China and the U.S.
respectively. Chart 1 shows that between 1978 and 2014, Chinese real GDP grew
from US369 billion to US$10.4 trillion (in 2014 prices), to become the second largest
economy in the World, after the U.S. Chinese economic growth began to take off
after China began its economic reform in 1978, and accelerated in 2001, when China
acceded to the World Trade Organisation (WTO). The rate of growth of Chinese real
GDP has been higher than that of the U.S. in every single year since 1978, sometimes
significantly so. By comparison, the U.S. GDP of approximately US$17.4 trillion
was approximately 1.7 times Chinese GDP in 2014.
5
Chart 1: Chinese and U.S. Real GDPs and Their Rates of Growth since 1949 (2014 US$)
However, despite the rapid growth of the Chinese economy in the aggregate,
in terms of its real GDP per capita, China is still very much a developing economy.
Chart 2 shows that in 1978, the Chinese real GDP per capita was only US$383 (in
2014 prices), approximately 1.25% of the U.S. then real GDP per capita of
US$30,472. By 2014, the Chinese real GDP per capita had grown to US$7,604, still
less than one-seventh of the U.S. GDP per capita of US$54,575.
Chart 2: Chinese and U.S. Real GDPs per Capita and Their Rates of Growth since 1949
(2014 US$)
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Chinese and U.S. Real GDPs and Their Rates of Growth since 1949 (trillion 2014 US$)
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Rate of Growth of Chinese Real GDP (right scale)
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Chinese and U.S. Real GDP per Capita and Their Rates of Growth since 1949
(thousand, 2014 US$)
Rates of Growth of U.S. Real GDP per capita (right scale)
Rates of Growth of Chinese Real GDP per Capita (right scale)
U.S. Real GDP per Capita, in 2014 prices
Chinese Real GDP per capita, in 2014 prices
6
2. The Chinese Economic Fundamentals
What are the sources of this Chinese economic growth? Long-term
economic growth of a country depends on the rates of growth of its primary
inputs—tangible (or physical) capital and labor—and on technical progress (also
known as the growth of total factor productivity (TFP))—that is, the ability to
increase output without increasing inputs. The rate of growth of tangible or physical
capital depends on the rates of investment on structure, equipment and basic
infrastructure, which in turn depends on the availability of national savings. The rate
of technical progress depends on investment in intangible capital, which includes
human capital and Research and Development (R&D) capital.
Chinese economic growth since 1978 has been underpinned by a consistently
high domestic investment rate, enabled by a national saving rate of over 35% except
for a brief start-up period in the early 1950s (see Chart 3). The Chinese national
saving rate rose to around 40% in the early 1990s and at times approached or even
exceeded 50% in more recent years. The high Chinese saving rate means that the
Chinese economy can finance all of its domestic investment needs from its own
domestic savings alone, without having to depend on the more fickle foreign capital
inflows (including foreign direct investment, foreign portfolio investment, foreign aid,
or foreign loans). In particular, it does not need to borrow abroad and bear the
potential risks of a large, short-term and often interruptible
foreign-currency-denominated debt. Thus, the Chinese economy is always assured
of a high rate of growth of its tangible capital stock. It is therefore also more
immune from external disturbances than most other economies.
7
Chart 3: Chinese National Saving and Gross Domestic Investment as Percents of GDP
China, like Japan, Taiwan, and South Korea in their respective early stages of
economic development, has an unlimited supply of surplus labor—there is therefore
no shortage of and no upward pressure on the real wage rate of unskilled, entry-level
labor over an extended period of time. The distribution of Chinese GDP by
production-originating sectors in 2014 was approximately: Primary (agriculture),
9.2%; Secondary (manufacturing, mining and construction), 42.6%; and Tertiary
(services), 48.2% (see Chart 4). (Note that mining is normally included in the
primary sector in most other economies.)
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Chinese National Savings and Gross Domestic Investment as a Percent of GDP since 1952
Savings Rate
Investment Rate
8
Chart 4: The Distribution of Chinese GDP by Sector Since 1952
The distribution of employment by sector in 2014 was: Primary, 29.5%;
Secondary, 29.9%; and Tertiary, 40.6% (see Chart 5). The agricultural sector
employed 29.5% of the Chinese labor force but produced only 9.2% of the Chinese
GDP in 2014. Thus, labor can be productively transferred to the other two sectors
where labor productivities and wage rates are higher as long as complementary capital
and demand are available.
Chart 5: The Distribution of Chinese Employment by Sector Since 1952
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The Distribution of G DP by Sector
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The Distribution of Employment by Sector since 1952
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Tertiary Sector
9
The huge size of the domestic market with 1.37 billion consumers and their
pent-up demands for housing and transportation and other consumer goods and
services (e.g., education, health care, and more recently, elderly care) enables the
realization of significant economies of scale in production, based entirely on the
domestic demand in China. The huge domestic market also greatly enhances the
productivity of intangible capital (e.g., R&D capital and goodwill, including brand
building) by allowing the fixed costs of the R&D for a new product or process or
advertising and promotion in brand building to be more easily amortized and
recovered. In addition, the huge domestic market also enables significant
“learning-by-doing”, so that the unit costs of production decline with rising
cumulative output. This is yet another form of manifestation of economies of scale.
Another important implication of the huge size of the domestic economy is the
relatively low external dependence. Thus, while the rates of growth of Chinese
exports and imports fluctuate like any other economy (see Charts 6 and 7 for the
quarterly rates of growth of exports and imports respectively for selected Asian
economies), the quarterly rates of growth of the Chinese real GDP, represented by the
red line in Chart 8, can be clearly seen to be relatively much more stable than those of
other economies. It never turned negative whereas many of the other Asian
economies would experience absolute declines in their real GDPs. This is of course
also due in part to the fact that China does not have to depend on the inflow of foreign
savings for its investment.
10
Chart 6: Quarterly Rates of Growth of Exports of Goods: Selected Asian Economies
Chart 7: Quarterly Rates of Growth of Imports of Goods: Selected Asian Economies
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Annualized Percent per annum
Quarterly Rates of Growth of Exports of Goods: Selected East Asian Economies
China,P.R.:Hong Kong
India
Indonesia
Korea
Malaysia
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Singapore
Thailand
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China,P.R.:Hong Kong
India
Indonesia
Korea
Malaysia
Philippines
Singapore
Thailand
China,P.R.: Mainland
Japan
Taiwan Prov.of China
11
Chart 8: Quarterly Rates of Growth of Real GDP, Y-o-Y: Selected Asian Economies
Finally, China also had the additional “advantage” of having been a
centrally planned economy for more than a quarter of a century before it undertook its
economic reform and opened its economy to the World in 1978. A centrally planned
economy is well known to have inherent economic inefficiency, or equivalently,
economic slack, which implies that China had surplus potential output prior to its
economic reform, which could be realized under appropriate economic policies.
This prior economic inefficiency or surplus potential output thus also constituted an
additional source of Chinese economic growth since 1978.
3. The Monopsonistic Labor Market in China
Chart 3 above shows that China has an extraordinarily high national saving
rate. This rate would be considered high even by the standards of East Asian
economies
2
. Why is this the case, especially considering that the Chinese GDP per
capita is still significantly below those of other East Asian economies? One
explanation is that the Chinese Government was and still is the largest single
employer of non-agricultural workers in China and therefore has both the ability and
the incentive to keep wage rates low. Before the economic reform of 1978, the
Chinese Government was the sole employer for all workers in the urban areas of
2
Among East Asian economies, only Singapore has a comparably high national saving rate.
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Annualized Rates in Percent
Quarterly Rates of Growth of Real GDP, Year-over-Year: Selected East Asian Economies
China,P.R.:Hong Kong
India
Indonesia
Korea
Malaysia
Philippines
Singapore
Thailand
China,P.R.: Mainland
Japan
Taiwan Prov.of China
12
China and set their wage rates. As the sole employer, the Chinese Government
could exercise its monopsonistic power and pursued a low (and egalitarian) wage
policy, resulting in a low share of labor in GDP of less than 50% over the past several
decades.
The low- wage policy reflected three considerations: First, it was designed to
increase national savings through higher profits of the enterprises, most of which are
state-owned, so that the needed domestic investments could be readily financed.
This objective of the low-wage policy is similar to the “price scissors” policy of
maintaining a large gap between industrial and agricultural prices, practiced in the
former Soviet Union in the early Twentieth Century. Second, it helped to maximize
employment, and in particular, the absorption of surplus labor from the agricultural
sector into the industrial and service sectors. Third, it was compatible with the
ideological preference of the Chinese Communist Party for thrift and egalitarianism in
the distribution of income. Note that if the government is the sole employer, the
wage and individual income tax policies can be de facto integrated—no separate
individual income tax is necessary. In this context, a low-wage (and low or no tax)
policy has a similar economic effect as a high-wage and high-tax policy but is
politically easier to adopt, implement and sustain.
Even as recently as 2010, the share of Chinese public sector employment,
which includes the employees of central and local governments and their affiliated
units, state-owned enterprises (SOEs), and publicly financed educational and health
care institutions, was still over 50% of all urban employment (see Chart 9). The
government could therefore exercise a decisive influence on not only the wage rates
of the public-sector employees, but also the level of wage rates in the economy as a
whole. Today, a government job is still the preferred choice for many Chinese
workers because of the job and income security and the significant fringe benefits that
it offers.
13
Chart 9: The Share of Public Sector Employment in Total Non-Agricultural
Employment in China
This low-wage policy has had two major effects: first, it has kept the labor
share (and the household share) of GDP low; and secondly, it has created large profits
for state-owned (and other) enterprises. The disposable household income share of
GDP in China may be estimated at around 50% in 2014, much lower than the
corresponding share in a developed economy, where it would typically be around 60%,
and also lower than those of other developing economies with a comparable real GDP
per capita. The Chinese share of labor is likely to be lower than the share of
household disposable income, as the latter includes, in addition to wages and salaries,
also net proprietor’s income, net asset income and net transfers (which amounted to
43% of the total household disposable income), but excludes direct taxes and other
mandatory charges such as social security contributions. As Chinese households
have less disposable income to spend relative to Chinese GDP, China also has a lower
household consumption to GDP ratio than others. This ratio, as well as the total final
consumption (which is the sum of government consumption and household
consumption) to GDP ratio, have been declining over time (see Chart 10). As of
2014, the total final consumption ratio was just over 50% and the household
consumption ratio was approximately 38%, both significantly lower than most other
economies with a comparable real GDP per capita. The Chinese household saving
rate may be estimated at around 30% from survey data, comparable to those of
40
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The Share of Public-Sector Employment in Total Non-Agricultural Employment in China
14
ethnically Chinese households in Hong Kong and Taiwan. What all of this means is
that the high Chinese saving rate is not due to a particularly high household saving
rate but instead to high enterprise profits and reinvestment rates. Thus, Chinese
household consumption cannot be expected to be a major source of growth of Chinese
aggregate demand in the short or medium term as long as household disposable
income remains relatively low.
Chart 10: Total Chinese Final and Household Consumption as a Percent of Its GDP
The high Chinese national saving rate of between 40% and 50% should
therefore be attributed to the high propensity to save on the part of Chinese enterprises
out of their profits, especially since they distribute very little in terms of cash
dividends to their shareholders, which include the Chinese Government (the majority
shareholder of the SOEs) and the households. Household income and government
revenue can both be increased if the SOEs are required to distribute a greater
proportion of their profits as cash dividends to their shareholders, which may in turn
lead to higher household and government consumption.
4. The Sources of Chinese Economic Growth
The rates of growth of Chinese real output, real tangible capital stock and
labor (employment) over the past 36 years are presented in Table 1. It is clear that
30
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50
60
70
80
90
Percent
Year
Total Final Consumption and Household Consumption as a Percent of GDP
Total Final Consumption
Household Consumption
15
the tangible capital stock has grown much more rapidly than labor over the past 36
years.
Table 1: The Rates of Growth of Real Output, Capital Stock and Labor
Chinese economic growth since 1978 could have come from several sources:
(1) The realization of the surplus potential output from the initial economic slack that
resulted from mandatory central planning; (2) The growth of tangible capital and
labor inputs (and the growth of the intangible inputs such as human capital and R&D
capital
3
); (3) Technical progress (growth of total factor productivity (TFP)); and (4)
The effect of economies of scale.
Lau and Zheng (2015), by comparing the economic performance of the
Province of Anhui and the Municipality of Shanghai before and after the introduction
of economic reform, found that the pre-existing slack in the Chinese economy before
it undertook its economic reform and opened to the World in 1978 could be estimated
to be 50% of the actual output in 1978. Based on the assumption that the Chinese
real GDP in 1978 was 50% higher than it actually was, the implied average annual
rate of growth of the Chinese economy between 1978 and 2014 would have been
8.49% instead of 9.72%. Thus, the reduction of the economic slack that existed
before 1978 would account for approximately 1.23 percentage points of the economic
growth over the past 36 years, or approximately 12.5 percent of the post-1978
economic growth. The remaining economic growth of 8.49% per annum can be
attributed to the growth of the primary inputs, technical progress or growth of TFP,
and economies of scale.
The degree of economies of scale cannot be estimated in a straightforward way.
In fact it is under-identified with time-series aggregate data from only a single
country--the effects of economies of scale are confounded with the effects of technical
3
In this paper, the contributions of the growth of human capital and R&D capital to Chinese economic
growth are not estimated separately but subsumed in the contribution of technical progress or growth of
TFP.
Rate of Growth of Real Output (1978-2014) 9.72%
Rates of Growth of Inputs (1978-2013)
Tangible or Physical Capital 10.83%
Labor 1.88%
16
progress. However, a meta-production function approach, first introduced by Lau
and Yotopoulos (1989) and extended by Boskin and Lau (1992), based on the
transcendental logarithmic production function introduced by Christensen, Jorgenson
and Lau (1973), can be used to identify and separate the effects of economies of scale
and technical progress under fairly general and testable assumptions. Boskin, Guo
and Lau (2015) have recently estimated the degrees of returns to scale for the
Group-of-Seven (G-7) Countries using the meta-production function approach.
They found the degree of local returns to scale of the U.S. to be 1.20 in 1960 and 1.11
in 2007. The average degree of returns to scale for the U.S. over this period would
be 1.155, almost the same as the 1.15 estimated by Denison (1974)
4
but somewhat
larger than the assumption of 1.10 used by Denison (1961)
5
. Assuming that this
estimate of the returns to scale also applies to the Chinese economy on average, it
would mean that over a 36-year period, from 1978 to 2014, the average rate of growth
would have been 8.36% if there were only constant returns to scale, instead of the
actual 9.72%. This difference would have accounted for 36.1% of the Chinese real
GDP in 2014. It also means that out of the rate of growth of 9.72%, economies of
scale account for 1.36 percentage points, or 13.99 percent of the measured economic
growth over this period.
As pointed out in Section 3, the actual share of labor in GDP in China is low
relative to other economies. It may be estimated to be around 50%
6
. However, it is
believed that the production elasticity of labor is probably higher than the labor share,
somewhere between 0.55 and 0.6, as labor has been systematically underpaid due to
the low-wage policy maintained by the Chinese Government. Since there exist
increasing returns to scale, capital, as the residual claimant, cannot in general be paid
its marginal product; but because labor is actually underpaid, capital can be either
underpaid or overpaid relative to its marginal product. With returns to scale assumed
to be 1.155, and the production elasticity of labor estimated as between 0.55 and 0.6,
4
See Denison (1974), p. 75.
5
See Denison (1961), p. 175.
6
One possible estimate of the share of household disposable income in Chinese GDP is 43% in 2014,
based on officially published data. However, the labor share can differ from the above because of net
proprietor’s income, net household asset income and direct taxes and transfers. The data on the
household consumption share of GDP, which are probably less prone to errors, indicate a share of around
38% in 2014 (see Chart 10). However, a household consumption share of 38% does not seem to be
consistent with a household income share of 43%, which would imply an exceptionally low household
saving rate out of disposable income. A more reasonable estimate of the household disposable income
share or labor share in GDP in 2014 is probably around 50% or even a little higher.
17
the production elasticity of capital may be estimated as (1.155-0.55) or (1.155-0.6), or
between 0.555 and 0.605, as the capital and labor elasticities should sum to the degree
of returns to scale. Thus, the relative weights of capital and labor may be estimated
as 0.48 versus 0.52, or vice versa. Since they are almost equal, we shall use 0.5 as
the relative weights of capital and labor for the purpose of the growth-accounting
exercise.
The results of the growth-accounting exercise are presented in Table 2. We
note that the elimination of the pre-existing economic slack and economies of scale
account for respectively 1.23 and 1.36 percentage points, or a total of 2.59 percentage
points, of the Chinese economic growth of 9.72% between 1978 and 2014. If we
subtract 2.59% from 9.72%, we obtain 7.13%. This average annual rate of growth
has been achieved by quite a few other economies over a couple of decades in the past.
We also note that the growth of tangible capital accounts for more than half of the
growth in real output, whereas the growth of labor and technical progress each
account for less than 10 percent of the economic growth. If we take out the
contributions of the elimination of the prior economic slack and economies of scale,
the growth of tangible capital accounts for the bulk of the remaining economic growth,
5.42% out of 7.13%, or 76%. This is similar to the findings of Kim and Lau (1994)
on the sources of economic growth of the East Asian Newly Industrialized Economies
(NIEs). If a more conventional growth accounting exercise is done under the
assumption of constant returns to scale, the effects of the elimination of the
pre-existing economic slack and economies of scale would have been captured as part
of technical progress or the growth of TFP. If that is done, technical progress or
growth of TFP would have accounted for 34.61% of Chinese economic growth since
1978.
Table 2: The Sources of Chinese Economic Growth
Sources of Chinese Economic Growth, 1978-2014 Percentage Points Percent
Elimination of Pre-Existing Economic Slack 1.23 12.65
Growth of Tangible Capital 5.42 55.71
Growth of Labor 0.94 9.67
Technical Progress 0.78 7.97
Economies of Scale 1.36 13.99
Total 9.72 100.00
Monopsonistic Labor Market Case
18
5. The Role of Expectations
Expectations of the future are important determinants of the behavior of
enterprises and households, which in turn determines whether and how much they
invest and consume respectively. For a large economy such as China, the domestic
investment and consumption together determine the level of aggregate demand and
ultimately whether the economy grows or stagnates. There are many ways in which
expectations about the future may be formed. Expectations may be based on past
experience, such as “tomorrow will be the same as today,” but they may also not be
based solely on past experience, for example, they may be based on the views of
so-called opinion leaders. Expectations may also be affected by the occurrence of
some important event, such as the breakout of a war, the election of a new
government, the rise of an epidemic, or some specific government pronouncement or
action, which can credibly cause changes in the public expectations of the future.
Moreover, expectations can often, but not always, and certainly not consistently, be
self-fulfilling, if they are sufficiently strongly held by a sufficiently large number of
people.
One well-known manifestation of self-fulfilling expectations is in the asset
markets. If investors expect the price of an asset, for example, real estate or stock, to
go up, and act accordingly by buying real estate or stock, the price of real estate or
stock will indeed be driven up by the concerted buying, because the increase in
demand in real estate or stock is not and cannot be immediately met by an increase in
supply. Thus, the expectations of the investors can be self-fulfilling. There are
many such examples in which asset price bubbles are created around the World.
The run-up in the price of Chinese residential real estate between October
2012 and October 2013 was an example of self-fulfilling expectations. The more
recent Chinese stock price run-up between November 2014 and July 2015 may also
be considered as another such example. But self-fulfilling expectations do not
always have to be bullish. If all investors believe that the price of residential real
estate is likely to be stable, and act accordingly, that is, they do not try to out-bid one
another since they know they can always buy a similar property later, then the price of
residential real estate will indeed be quite stable. This was what occurred in
Singapore, where the government was believed by the public to adjust the rate of
release of new lots for residential construction upwards and downwards in the same
direction as the price of residential real estate, thus dampening the price changes.
19
However, the prices of assets cannot continue to go up forever. All asset
price bubbles are sustained by new investors with new buying power coming into the
market. At some point, the available potential new buying power will be exhausted
with the price levels significantly exceeding what can reasonably be supported by the
underlying economic fundamentals in steady state. When that happens, the asset
prices will begin to fall and fall precipitously. So ultimately, the rosy expectations
may fail to be fulfilled. And this will lead to a collective downward revision of the
expectations.
In the context of China, an important way in which self-fulfilling expectations
can be created and changed is through the signaling by the Chinese Government. A
government with credibility can use its pronouncement of policy changes and actual
actions as instruments for changing the macroeconomic expectations of the public
about the future of the economy. In fact, Keynesian counter-cyclical fiscal policies
often work because they have the ability to change expectations. In a country such
as China, expectations are often formed not only from directly experienced market
outcomes but also from the pronouncements and actions of its senior government
leaders. The government, because of the many potential instruments at its disposal,
is widely believed to have the power to turn around the economy, and is thus a
credible authority that can play the coordinating role. The following examples
drawn from the Chinese experience show how the Chinese Government was able to
change negative expectations credibly through its pronouncements and actions.
In 1989, in the aftermath of the June 4 incident, the Chinese economy became
quite depressed, in part because of foreign sanctions, but mostly because of generally
negative expectations about the future on the parts of enterprises and households. As
a result, enterprises did not invest and households did not consume. 1990 and 1991
were similarly slow years, despite an abundance of liquidity. The rates of growth of
real GDP in 1989 and 1990 were the lowest since economic reform began in 1978
(see Chart 11) and the rates of growth of fixed asset investment in 1989 and 1990
were negative--the only years with a negative rate of growth of fixed asset investment
since 1978 (see Chart 12), which showed how negative expectations were.
20
Chart 11: Annual Rates of Growth of Chinese Real GDP
Chart 12: Annual Rates of Growth of Chinese Fixed Assets Investment
Then in early 1992, Mr. DENG Xiaoping, the paramount Chinese leader at the
time, undertook his famous southern inspection tour. Everywhere he went, he urged
the people to seize the moment and grasp the opportunities. His words changed
expectations in the entire country almost overnight. Enterprises began investing and
households began consuming once again. As a result, the rest of 1992, as well as
1993 and 1994, were boom years with double-digit rates of economic growth (and
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21
relatively high rates of inflation) and high rates of growth of fixed asset investment
(see Charts 11, 12 and 13).
Chart 13: Quarterly Rates of Growth of Chinese Real GDP, Y-o-Y
In mid-1997, the East Asian Currency Crisis broke out, first in Thailand, and
then in South Korea until it engulfed almost all of the East Asian economies, with the
exception of Japan. Almost all of the East Asian currencies, with the exception of
the Hong Kong Dollar, which was (and still is) pegged to the U.S. Dollar, devalued
significantly. The quarterly rates of growth of exports and imports of all East Asian
economies fell precipitously (see Charts 6 and 7). Premier ZHU Rongji of the
People’s Republic of China decided to hold the Renminbi/US$ exchange rate steady
amidst the chaos of the East Asian currency crisis, and thus managed to maintain the
confidence of the domestic investors and consumers about China’s economic future,
keeping the Chinese economy growing (see Chart 14). In so doing, he also helped to
stabilize the exchange rates of the other East Asian currencies and facilitated the
recovery of the other East Asian economies. Had China also devalued at that time, it
would have led to another cycle of competitive devaluation among the East Asian
economies, with unimaginably negative economic and social consequences.
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Percent per annum
Quarterly Rates of Growth of Chinese Real GDP, Y-o-Y
GDPQ1
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22
Chart 14: Monthly Rates of Growth of Chinese Fixed Assets Investment, Y-o-Y
In 2000, the whole World was suffering from the burst of the internet bubble
in the U.S. and China was no exception (the negative expectations then were reflected
in the exceptionally low rates of growth of fixed asset investment). Then in
December 2001, China became a member of the WTO. The Chinese accession to
the WTO also changed expectations in a dramatic way, which also reflected the
expected expiration of the Multi-Fibre Agreement which governed global trade in
textiles in 2005. It had a significant effect on the rates of growth of both fixed asset
investment (see Chart 14) and real GDP (see Chart 15). In 2005, the Renminbi
began to be allowed to appreciate relative to the U.S. Dollar, which adversely affected
the growth of exports, and the rate of growth of fixed asset investment fell back to
more normal levels.
In 2008, in the immediate aftermath of the collapse of Lehman Brothers in the
U.S., all credit dried up in the U.S. as well as the other developed economies.
Overnight, importers in the U.S. and other developed economies could no longer
place their import orders to China and other trading partner countries because their
banks were not in a position to issue acceptable letters of credit. As a result, export
orders received by Chinese enterprises declined by approximately fifty percent (see
Charts 6 and 7). There was real panic in the air. Fortunately, barely six weeks later,
Chinese Premier WEN Jiabao unveiled the 4 trillion Yuan (approximately 6% of the
then Chinese GDP) economic stimulus program, which once again managed to
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Monthly Rates of Growth of Chinese Fixed Assets Investment, Year-over-Year
23
maintain the confidence of Chinese enterprises and households in their economy.
Actually, the economic stimulus program did not really take effect until at least a year
later, but the announcement of the program itself alone managed to restore positive
expectations among the Chinese public (see Charts 14, 15 and 16).
Chart 15: Quarterly Rates of Growth of Chinese Real GDP, Y-o-Y and Seasonally
Adjusted
Chart 16: Monthly Rates of Growth of Real Value-Added of Chinese Industry, Y-o-Y
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Quarterly Rates of Growth of Chinese Real GDP, Y-o-Y and Seasonally Adjusted
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%
Monthly Rates of Growth of Real Value-Added of the Industrial Sector, Year-over-Year
24
In all of these cases, the Chinese Government was able to turn around the very
negative domestic expectations about the future of the Chinese economy into positive
ones, and in so doing greatly reduced the uncertainty pertaining to the future and
increased general business as well as consumer confidence. These changes in turn
fueled investment booms that resulted in the subsequent economic growth.
However, with the bursting of the Chinese stock market bubble in July 2015
and the slight but unexpected devaluation of the Renminbi of approximately 4% in
August 2015, the confidence of the Chinese enterprises and households has been
somewhat shaken. At the same time, reacting to these developments in China, the
World markets have also panicked and doomsayers have been coming out in droves,
predicting the imminent collapse of the Chinese economy. Perhaps this is the time
for the Chinese Government to take more decisive and visible actions to increase
domestic aggregate demand so as to reduce uncertainty, shore up confidence and
change expectations of the Chinese public about the future.
6. Concluding Remarks
Chinese economic growth during the past 36 years can be attributed to the
growth of tangible inputs—tangible capital and labor, and in particular, tangible
capital—rather than the growth in intangible capital or technical progress, just as the
past economic growth of other East Asian economies at a similar stage of economic
development. The successful Chinese experience strongly reaffirms the fundamental
importance of having and maintaining a high investment rate, enabled by a high
national savings rate, and surplus labor. A low-wage policy was instrumental in a
high national saving rate and a rapid rate of absorption of surplus labor. In addition,
the size of the Chinese domestic economy is a favorable factor allowing the ready
realization of economies of scale and reducing vulnerability to external disturbances.
The prior economic slack, inherent in any previously centrally planned economy, has
also been a significant source of economic growth upon Chinese transition to a market
economy.
Expectations will continue to play an important role in the Chinese economy.
A strong Chinese central government with the unique power to mobilize domestic
aggregate demand can credibly change expectations from negative to positive at
critical junctures to keep the economy growing.
25
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