Author: Ross Garnaut, ANU and Melbourne University
What are the implications of the turning period for China’s continuing economic development, for China’s interaction with the global economy and for economic policy? Here I focus on four of the most important consequences, mention a consequence that is widely anticipated and feared, but which need not eventuate, and briefly discuss one way in which perceptions of China’s growth will be affected by its having entered the turning period.
As China enters deeply into the turning period (when unlimited supplies of labour become more difficult to mobilise for industrial development), there will be large and continuing increases in real wages and in the wage share of income. The powerful tendency since the 1980s towards increased inequality in income distribution is likely to be reversed. The rise in the wage share of income is likely to be reflected in an increase in the consumption share of expenditure. There will be a reduction in the national savings rate.
It is possible that the investment rate will in fact rise. Whether or not this is the case, it is likely that China’s savings rate will fall more than its investment rate. This will reduce the external surplus in trade and current payments. It will therefore ease current international pressures over payments imbalances and exchange rates. It would be wise for China to ensure that total domestic demand expands enough to ensure that this is the case.
The reduction in Chinese current external payments surpluses is therefore a second important consequence of moving through the turning period. This could ease tensions with other countries — especially the United States — which have identified Chinese surpluses as a principal cause of their own economic problems. Regrettably, a large fall in Chinese savings relative to investment would put upward pressure on global long-term interest rates and increase the requirement to reduce domestic expenditure on goods and services in the countries facing large challenges in the management of external and public debt, including the United States.
The third important consequence of China moving through and beyond the turning period is that the centre of China’s comparative advantage in international trade will shift rapidly from a fairly narrow range of labour-intensive products to a wider range of more capital-intensive and technologically sophisticated products. This will ease some dimensions of China’s trade problems with the rest of the world (perceptions of competitive pressure on other developing countries and heavily concentrated pressures for adjustment on particular sectors in industrialised countries) and complicate others (competitive pressures will be felt across a much wider range of industries in industrialised countries). The diversification of China’s comparative advantage will probably halt the decline in Chinese export prices that was associated with the heavy concentration of export expansion in a small number of products.
The fourth important consequence of entering the turning period involves a policy risk to economic stability and growth in the period ahead. Rising real wages and the pressure of strong increases in demand for non-traded goods and services will be inflationary unless accompanied by a combination of firm monetary policy and an appreciating renminbi. Nevertheless, the Chinese authorities might be tempted to maintain the fixed exchange rate against the US dollar to avoid adjustment pressures on export-oriented labour-intensive industries, which have played such an important part in Chinese economic growth since the mid 1980s.
To seek to maintain a fixed exchange rate against the US dollar through and beyond the turning period would only postpone and not avoid the structural adjustments that are a necessary accompaniment of the current stage of Chinese economic growth. Payments surpluses would eventually overwhelm the efforts to sterilise their monetary effects. The adjustments would occur through inflation.
It is likely that the authorities would respond to higher inflation by tightening fiscal and monetary policies. This would unnecessarily reduce the rate of economic growth below sustainable levels and postpone the increase in Chinese living standards that can come through and beyond the turning period. The inflation and the delays in inequality reductions could be destabilising to domestic political stability. The delays in reduction in the external payments surplus would certainly be destabilising for China’s productive interaction with the international economy and society.
There is one consequence of moving through and beyond the turning period that is often feared but which is unlikely to be important unless there are mistakes in economic policy, and one important implication for perceptions of the growth of the Chinese economy. There is no basis for the expectation that China’s rate of growth in output per worker must necessarily fall as it moves through and beyond the turning period. The rise in real wages as China moves through the turning period is likely to lead to an increase in the rate of total factor productivity growth. In the nature of things, this will be concentrated in industries producing relatively sophisticated and capital-intensive products, the competitiveness of which is less sensitive to increases in real wages. It is possible that the increase in Chinese domestic demand that is necessary to reduce external current payments surpluses will require an increase in the investment rate for a while. Together with the expected acceleration of productivity growth, this would support an increase in the growth rate in total output per worker, above the high rates of the early twenty-first century. That could surprise the world and also the Chinese authorities, but it may well be necessary to maintain internal and external balance in the period ahead.
How successful China is economically in this period of rapidly rising real wages will depend on the flexibility of the economy, its openness to foreign trade and investment and the world’s most productive ideas about managing enterprises, the quality of the human resources created by the rapid expansion of the education system in the past couple of decades and the quality of the regulatory systems applied to the more complex economy that is emerging. It is possible that the rate of growth in total output can be maintained at something like the average rates of the decades of reform, until the approach of the industrialised countries’ frontiers of productivity and living standards reduces the scope of rapid productivity growth through ‘catching up’ with the industrialised countries.
Whether or not China succeeds in maintaining such high aggregate rates of growth until it reaches the frontiers of the world economy, most observers will be surprised by how quickly China catches up now that it has entered the turning period. China’s real exchange rate will rise rapidly — whether that occurs through inflation, nominal exchange rate appreciation or a combination of the two. The value of China’s output when measured in the national accounts and converted into international currency at current exchange rates will converge towards the much higher ‘purchasing power’ estimates of GDP. People in China and abroad who focus on conventional measures of national output will find that China catches up with the world’s most productive economies in output per person — and with the United States in total output — much more quickly than they had been expecting from extrapolation of differentials in national growth rates.
Ross Garnaut is Vice-Chancellor’s Fellow and Professorial Fellow in Economics at the University of Melbourne. He is also Distinguished Professor of Economics at the Australian National University. This essay is an excerpt from Chapter 2 in ‘China: The Next 20 Years of Reform and Development,’ Ross Garnaut, Jane Golley and Ligang Song (eds). For Professor Garnaut’s background notes and recent papers see www.rossgarnaut.com.au.
Ross Garnaut’s full chapter from this year’s China Update, China: The Next Twenty Years of Reform and Development, can be downloaded from here.