China’s Economic Growth Through 2025: What We Know Today about China’s Economic Growth Tomorrow Carsten A. Holz Hong Ko

1. China’s Economic Growth Through 2025: What We Know Today about China’s Economic Growth Tomorrow Carsten A. Holz Hong Kong University of Science & Technology 1 September 2009

2. Official real GDP growth 1978-2008

3. Literature a. China as next superpower b. China collapse/ pessimist view c. Firm/industry-level growth studies d. Economic growth in the past e. Economic growth in the future

4. Literature a. China as next superpower -> China is rising -> may pose a threat to the U.S. Geoffrey Murray (1998): The Next Superpower Emma Broomfield (2003): literature review Bill Geertz (2000): The China Threat (2000) Timperlake/ William/ Triplett (2002): Red Dragon Rising: Communist China’s Military Threat to America Business Week (2004): … the devastation Chinese competitors are inflicting on U.S. industries, from kitchenware and car tires to electronic circuit boards…

5. b. China collapse/ pessimist view (1) economic arguments Lester Brown (1995): Who Will Feed China Nicholas Lardy (1998): China’s Unfinished Economic Revolution Gordon Chang (2000): Coming Collapse of China (2) political arguments Ross Terrill (2003): The New Chinese Empire and What It Means for the United States > a crash looms because the Leninist core of the regime is unchanged…< > illusory nature of the market in most of the Chinese economy <

6. c. Firm/industry-level growth studies Jefferson et al. (2000): TFP Colin Carter and Scott Rozelle (2001): major force in world food markets? Allen Douglas (2002): 4 industries, imminent emergence of Chinese world-class brands Ming Zeng and Peter Williamson (2003, 2008): “The Hidden Dragons”

7. d. Economic growth in the past (1) Transition literature Wing Thye Woo (1994, 1999) Qian Yingyi (2000, 2003) (2) Development view: Justin Lin et al. (2003): comparative-advantage following strategy (3) Aggregate production function framework Alwyn Young (2000) Gregory Chow and Kui-Wai Li (2002) Wang Yan and Yao Yudong (2003) Wu Yanrui (2004) Dwight Perkins and Thomas Rawski (2008)

8. e. Economic growth in the future World Bank (1997): closed-economy model Gregory Chow and Kui-Wai Li (2002): aggreg. prod. fcn. Gregory Chow (2002): aggregate production function Paul Samuelson (2004): positive labor productivity shock in China may lead to a permanent loss in per capita income in the U.S.

9. Outline 1. Extrapolating Past Economic Growth Into the Future 2. Development Theories and Asian Precedents 3. Growth Accounting + Human Capital Formation

10. 1. Extrapolating Past Economic Growth Into the Future a.) GDP, 2006: China: USD 2.6 trillion (20.9 trillion RMB) U.S.: USD 13.2 trillion Because prices in China are ¼ of prices in the U.S., in purchasing power terms China’s GDP is 4 times larger, i.e., equivalent to USD 10 trillion. b.) If past average growth rates of the U.S. and China continue in the future, when will China’s GDP exceed that of the U.S.? Past average growth rates are those of 1978-2005. Base year for projections is 2005.

11. 2. Development Theories and Asian Precedents a. Structural change: Shifting labor from low-productivity agriculture to higher productivity industry or services

12. The more laborers shift out of agriculture in a given year, the higher is labor productivity (and GDP) growth in that year. Each data point = 1 year. Jap. 1956-05, Korea 1971-05, Taiwan 1967-05, China 1979-05.

13. How many more laborers can China shift out of agriculture? Share of agriculture in economy-wide employment

14. b. Catching up: the lower labor productivity relative to the U.S., the higher labor productivity growth Japan 1960-2005, Korea 1971-2005, Taiwan 1967-2005, China 1979-2005.

15. c. Relative factor price equalization: the lower the price of labor relative to the price of capital, in comparison to the U.S., the higher employment growth (//structural change -> switch to higher labor productivity sectors) Japan 1960-2004, Korea 1971-2004, Taiwan 1967-2004, China 1979-2003.

16. 3. Growth Accounting (+ Human Capital Formation) a. Production function estimation b. Assume constant labor share Labor share ≡ labor remuneration / GDP = constant a ≡ w * L / GDP = constant Real GDP growth = real wage growth + labor growth c. Decompose income components of GDP

17. Income shares in GDP

18. c. Decompose income components of GDP (i) Definitional identity GDP  labor remuneration + depreciation + net taxes on production + operating surplus price tax rate return on capital output quantity wage rate labor quantity depreciation rate capital

19. (ii) Explaining economic growth in China 1978-2002 growth in real net GDP 78-02 labor growthreal capital growth real wage growth depr. rate growth surplus r. gr. labor share depr. share surplus share 814% 0.5981*495% + 0.5981*60% + 0.1370*16% + 0.2649*(-50%) + 0.4019*1185% = 296% + 36% + 2% - 13% + 476% = 797% -> so small that can ignore in future Mean shares 1978-2002

20. (iii) Estimate economic growth in China 2000-25 From 1978-02 estimations know that can use growth in net GDP as a proxy for growth in GDP can drop two irrelevant items on the right-hand side to yield Growth in net GDP = labor share * growth in real wage rate + labor share * growth in quantity of labor + (depr. + surplus share) * growth rate of real capital Already know future valuesNeed Use previous-year values

21. Estimate economic growth in China 2000-25 --- based on cointegration equations 1978-02

23. + Human capital = quality of labor Share of Education Level by Age Group, 2000 (in %) Year 2000 Census

24. Tertiary Level New Enrollment, China and U.S.

25. Tertiary Level Graduates, China and U.S.

26. Summary 1. In purchasing power terms, China will be as large as the U.S. by 2010. Per capita, it will take longer, except for the most developed provinces. 2. China fits standard development patterns, such as of structural change, and appears to be at a stage of development at which Japan/ Korea/ Taiwan were thirty years ago. 3. Economic growth is likely to continue at current rates through around 2015. For the years after 2015, the projections are more uncertain, with, in a lower-bound scenario, real growth falling to about 4% per year.

27. Implications 1. Demography I: population size 2.5 x EU, 4 x US, 10 x Japan or 1.5 x (EU+US+J) Large population => large domestic market => Economies of scale = low cost Competition = pressure to innovate => What does that mean for mass production in the West? Where is the competitive edge of the West Vs. China? China following East Asian development patterns -> population size will make it the largest market in the world => Implications for firms worldwide?: Design? Marketing? Production location?

28. 2. Demography II: pool of talent If talent is randomly distributed among the world population, and if China’s education system is able to identify the brightest students, then China has a larger pool of talent to draw from than any other country in the world. Why not important earlier? How long will it take to make full use of this pool of talent? => Implications for future innovation capacities in comparison to the West? Current comparative advantage: labor quantity. Current comparative disadvantage: scarcity of technology; capital? Always comparative disadvantage: scarcity of land. => Specialization worldwide?

29. 3. Growth I: China Rising living standards Coastal provinces approaching income level of middle-income countries => What does that mean for China? Poverty alleviation -> middle class -> democratization? Consumption waves Environmental pollution => What does that mean for the world? Market for Western goods Energy / natural resources Tourism New world currency Income?, Employment / job security

30. 4. Growth II: China -> World China’s exports are moving up the product ladder. => The “China price” affects ever new product markets Transmission of growth to other Asian countries (2/3 of China’s imports originate in Asia). => China as growth locomotive for South East Asia Leader-follower effect with India The world five / ten / twenty years from now? China produces and consumes: manufacturing hub predominantly for the domestic market Opportunities for foreign firms (sell domestically, not only abroad)

31. 5. New and different “superpower:” large element of foreign-directedness Extensive foreign ownership of assets in China => Who “controls” the Chinese economy? Our pensions depend on China More than half of China’s exports are from foreign-invested firms => Are we importing from China, or from ourselves? Large degree of openness to foreign economic norms/ standards => Are we still dealing with a foreign country? Integration into international markets and production chains => Support for free trade / economic policies of market economies

32. cont. What’s the meaning of being Chinese? =>Most profs at HKUST look “Chinese,” but they are U.S. Americans. Where are the loyalties? What is the meaning of nationality? If “China” and the “West” become increasingly indistinguishable, what are the political / civil rights / human rights implications? Direct use of economic power by China’s leaders to pursue their goals worldwide: Ex.: “CCP” Politburo running firms in the U.S. / Europe? Ex.: use of forex reserves to buy support of individual countries / politicians

33. Paper (with less on implications) is published as “China’s Economic Growth 1978-2025: What We Know Today about China’s Economic Growth Tomorrow” in World Development 36, no. 10 (Oct. 2008): 1665-91. Appendices: http://ihome.ust.hk/~socholz Labor calculations (1978-02 / projections through 2005) are in separate manuscript at http://ihome.ust.hk/~socholz. Physical capital 1978-03: published in the China Economic Review 17, no. 2 (2006): 142-85.