Geographies in Depth

What are China's growth prospects?

A woman and her daughter touch a structural model of the earth's core at Nanjing Geological Museum in Nanjing, Jiangsu province April 22, 2011. Earth Day, which is celebrated on April 22 every year, marks an annual effort to raise public awareness about the environment and inspire actions to clean it up. The Chinese characters on the model read "outer core". REUTERS/Sean Yong

A woman and her daughter touch a structural model of the earth's core at Nanjing Geological Museum. Image: REUTERS/Sean Yong

Robert Barro
Professor of Economics, Harvard University
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China

China’s diminished growth prospects have figured prominently in recent commentaries about global economic conditions and world stock markets (e.g. Frankel 2016). The general view, with which I concur, is that China will grow in the future at a much slower rate than it has in recent decades. This growth slowdown will reduce international trade and has probably contributed already to the depression in oil prices (Blanchard 2016).

Predicting rates of economic growth is difficult, but the best evidence for China or any other country comes from long-term data on international experience. This evidence happens to have generated a pair of ‘2s’. First, in the long run, each country’s growth rate of real per capita GDP is about 2% per year. Second, a country’s per capita GDP tends to converge to its long-run path at around 2% per year (dubbed the ‘iron law of convergence’). Finally, the level of each country’s long-run path depends on its individual characteristics and policies. For example, there are positive effects from better rule of law (institutional quality), greater international openness, higher life expectancy, lower fertility, higher saving rates, and lower inflation.

When I apply this empirical framework to China (Barro 2016), I find that growth rates were well below model-implied values from 1960 until sometime in the 1980s. Specifically, the average per capita growth rate from 1960 to 1990 was 2.5% per year, whereas the model’s prediction was 4.9%. The main reason for the high predicted growth is that China was extremely poor in this period, and the usual convergence process predicts a response of high growth. The likely reason that actual growth was well below forecast is that China really was a Communist country until the 1980s, and the resulting poor incentives for economic activity (not captured within the model) led to low growth. Part of the disincentive for growth was Mao’s disastrous Cultural Revolution from the mid-1960s to the mid-1970s.

The Chinese growth results changed dramatically around 1990, with average per capita growth from 1990 to 2014 at an astounding 7.5% per year. This growth miracle compares with a model prediction for growth of 4.6% per year (from 1990 to 2010, the Chinese per capita growth rate seems to be the highest in the world aside from that in Equatorial Guinea). There are suspicions that China’s reported growth rates in recent decades have been boosted by manipulation of the national-accounts data. Although this possibility cannot be ruled out, most of the rapid development is real, not a product of creative accounting.

Using information available through 2014, the model’s forecast for China’s per capita growth for 2015-2020 is 3.5% per year. The predicted slowdown compared to earlier periods comes mainly from China having gotten a lot richer (leading through the convergence process to reduced growth). In contrast, China’s most recent official five-year plan projects per capita growth for 2015-2020 at 5-6% per year. Thus, the model says that China’s government is overly optimistic on growth by about 2% per year.

Of course, the model I’m using may be wrong, as it was underestimating Chinese growth from 1990 to 2014. But it is highly unlikely that China’s growth rate can exceed in the long run the results predicted by international experience within a convergence-type framework. In particular, it is not possible for the per capita growth rate to exceed 5% per year for very much longer.

China can be viewed as a convergence success story, in the sense that the strong economic growth over a sustained period led to a level of real per capita GDP that can be characterised as middle income. To put the Chinese accomplishment into international perspective, I calculated all the convergence success stories in the world based on reasonable criteria. Specifically, I looked first at countries that had at least doubled real per capita GDP since 1990. Within this group, I defined a middle-income success as having achieved a level of real per capita GDP in 2014 of at least $10,000. An upper-income success requires a level of at least $20,000 (the numbers are in 2011 US dollars and factor in international adjustments for changes in purchasing power).

With these criteria, the world’s middle-income convergence success stories comprise China, Costa Rica, Indonesia, Peru, Thailand, and Uruguay (Uruguay is a surprise, apparently boosted by dramatic migration of human capital out of Argentina.) The upper-income successes consist of Chile, Hong Kong, Ireland, Malaysia, Poland, Singapore, South Korea, and Taiwan.

A view that has gained recent popularity is the ‘middle-income trap’. According to this idea, the successful transition from low- to middle-income status is typically followed by barriers that impede a further transition to upper income. The data suggest that this trap is a myth. Moving from low- to middle-income status, as achieved recently by China, is difficult. Conditional on achieving middle-income status, the further transition to upper-income status is also difficult. However, there is no evidence that this second transition is harder than the first one.

As mentioned before, China’s growth rate of real per capita GDP has been remarkably high since around 1990, well above the rates predicted from international experience. Although I forecast that China’s per capita growth rate will decline soon from 7-8% per year to 3-4%, this lower growth rate is sufficient when sustained over two to three decades to transition from low- to middle-income status (which China has already accomplished) and then from middle- to high-income status (which China will probably achieve). Thus, although the likely future growth rates will be well below recent experience, they would actually be a great accomplishment.

Perhaps the biggest challenge is that the prospective per capita growth rates in China are well below the values of 5-6% per year implied by official forecasts. Thus, the future may bring political tensions in reconciling economic dreams with economic realities. Reducing the unrealistically optimistic growth expectations held inside and outside China’s government would reduce the risk of this tension and lower the temptation to achieve targets by manipulating the national-accounts data.

Editors’ note: This commentary is based on the paper “Economic Growth and Convergence, Applied Especially to China”, which was presented at a conference at ADBI in Tokyo on 25-26 November 2015.

References

Barro, R (2016), “Economic Growth and Convergence, Applied Especially to China”, BER Working Paper No. 21872.

Blanchard, O (2016), “The price of oil, China, and stock market herding”, VoxEU, 18 January.

Frankel, J (2016), “China’s slowdown and the Chinese stock market”, VoxEU, 27 January.

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Geographies in DepthEconomic Growth
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