Part I of Liu Shijin: search for growth potentials
Former Vice President of the State Council Development Research Centre emphasizes social welfare and TFP improvement amidst middle-income trap and earlier-than-expected population decline.
Liu Shijin is a Former Vice President (Vice Minister) of the Development Research Centre (DRC), a comprehensive policy research and consulting institution directly under the State Council, the central government of the People's Republic of China.
Liu delivered a speech at the Tsinghua University “预见中国 Vision China” High-Level Forum and the Tsinghua PBC School of Finance (PBCSF) China Economy Lecture Series on April 2. The transcript was released on June 13 via an official WeChat account of Tsinghua PBCSF.
Liu notes that China faces two major economic challenges: the middle-income trap and earlier-than-expected population decline. He also warns against rapid declines in sectors like real estate and highlights the unsustainable debt structure of some industries, likening it to a Ponzi scheme.
Still, comparing China's economic situation with Japan's in the 1990s, Liu assesses that China remains in a medium-speed growth stage with potential for continued growth over the next 5-10 years. However, this potential is achievable only if China focuses on improving labor productivity and total factor productivity (TFP).
"Assuming an average actual growth rate of 4.5%, along with an additional 5% from inflation and exchange rate appreciation, China will achieve an annual growth rate of 8% to 10% in current U.S. dollars. Only this level of growth is sufficient for China to reach the status of a moderately developed country by 2035," says Liu.
To achieve this goal, Liu emphasizes the importance of shifting investment from "physical capital" to "human capital", or, in other words, social security, healthcare, and education. He refutes the notion that social welfare is government subsidies, calling for increased support and investment in basic public services for rural migrant workers. These workers have long contributed to urban economies and paid taxes without receiving corresponding services, says Liu, now it is time to repay this debt.
—Yuxuan Jia
*This is the first part of Liu Shijin's speech. The second half will be published in the next post.*
稳增长促转型要加快深化结构性改革、挖掘新增长潜能
Accelerating Structural Reforms and Uncovering New Growth Potentials to Stabilize Growth and Promote Transformation
China's Medium- to Long-Term Economic Development: Three Steps and Two Major Challenges
I. Examining China's Modernization Growth Targets from an International Perspective
The 20th National Congress of the Communist Party of China (CPC) introduced an important concept: Chinese modernization. This includes a significant quantitative indicator that requires special attention: by 2035, the per capita GDP of China should reach a new milestone, achieving the level of a "moderately developed country." From an international perspective, this goal can be broken down into three stages:
Stage 1: Achieve a per capita income of $13,200, reaching high-income country status.
Stage 2: Achieve a per capita income of around $20,000, entering the ranks of developed countries.
Stage 3: Achieve a per capita income of $30,000 to $40,000, averaging $35,000, reaching the income level of moderately developed countries.
Despite rapid development in recent years and growing national pride, it is crucial to recognize that China is not yet a high-income country. In 2021, China's per capita GDP reached $12,500, very close to the World Bank's high-income country standard (about $200 short). However, this standard is dynamically adjusted, increasing by about 4% annually. In 2022 and 2023, China’s GDP growth slowed, and RMB depreciation further impacted the economy, resulting in a per capita GDP of approximately $12,700 by the end of 2023. This widened the gap to the new high-income threshold of $13,200.
To achieve a per capita income of $30,000 to $40,000 by 2035, per capita income must increase by 1.5 to 2 times during this period. The per capita income in current U.S. dollars depends on three variables: actual economic growth rate, the difference between nominal and actual growth rates (domestic inflation or GDP deflator), and exchange rate changes.
How can this doubling be achieved? From an actual growth rate perspective, China's actual GDP must grow by at least 4.7% annually in the coming years. China has always maintained a relatively stable inflation rate—around 2%.
Besides that, another critical variable is the exchange rate. According to data from the University of Pennsylvania, China's current per capita GDP based on purchasing power parity is approximately 15,000 international dollars, comparable to Japan in 1975 and Germany in 1971. [While the editor could not verify the source of these statistics, Justin Yifu Lin said in 2022, "On purchasing power parity, Germany’s per capita GDP reached 14,000 USD in 1971…Japan’s per capita GDP reached 14,000 USD in 1975."] Both countries experienced moderate economic growth and rapid exchange rate appreciation over the following 16 years, significantly increasing their per capita income in current U.S. dollars. Japan's per capita GDP even surpassed that of the U.S. in the 1990s, reaching 1.5 times the U.S. level. During this period, exchange rate contributions to income level increases were apparently more significant than actual growth contributions—Japan's GDP grew by 4.4% on average, with the exchange rate appreciating by 5.1%; Germany's GDP grew by 2.3% on average, with the exchange rate appreciating by 4.3%, indicating the greater contribution of the exchange rate.
Exchange rate changes are complex. Japan and Germany experienced significant appreciation under specific international conditions, which have changed considerably. However, for China, which is entering a similar growth stage, these experiences are worth studying and learning from. In the long term, the most critical variables remain labor productivity and total factor productivity (TFP). In recent years, China's central leadership has repeatedly emphasized high-quality development, which I believe has a specific economic meaning: improving TFP.
To achieve the 2035 growth target, two conditions are crucial and indispensable. First, China must strive for attainable actual growth rates as much as possible. Second, relying solely on actual growth ("hard growth") is insufficient; the focus must be on improving labor productivity and TFP, which will lead to reasonable exchange rate appreciation. Assuming an average actual growth rate of 4.5%, along with an additional 5% from inflation and exchange rate appreciation, China will achieve an annual growth rate of 8% to 10% in current U.S. dollars. Only this level of growth is sufficient for China to reach the status of a moderately developed country by 2035.
II. Two Aspects of International Experience Worth Noting for Achieving the 2035 Growth Target
1. Reaching the high-income stage from the middle-income stage, with a per capita income of around $10,000, is a particular, unstable phase.
Since World War II, over a hundred economies have entered industrialization, but only 13 have maintained a 7% growth rate for over 25 years. Among large economies, only Japan and South Korea successfully transitioned to high-income status. Many other countries, such as Argentina, Brazil, and Mexico in Latin America, as well as the Philippines and Malaysia in Asia, and more recently Russia, fell into the so-called "middle-income trap."
Their failure or rather lack of success can be attributed to factors like insufficient innovation capability, widening income distribution gaps, lagging human capital development, increasing resource and environmental pressures, and external shocks—all challenges China faces to varying degrees.
Over the past decade, China has managed a relatively stable transition from high to moderate growth without major upheavals or crises. However, it has not yet crossed the high-income country threshold. Five or ten years ago, this was not considered an issue; the middle-income trap seemed irrelevant to China. Now, this issue warrants consideration.
2. Impact of negative population growth on medium- to long-term economic growth
In 2022, China experienced negative population growth, earlier than the previously predicted 2028 to 2030 population turning point by research institutions. For the past decade, the number of working-age people (aged 15-59) in China has been decreasing by two to three million annually, and in recent years by four to five million. With negative population growth, the decline in the working-age population will further accelerate.
The decline in the working-age population impacts the supply side, while a total population decline directly affects overall demand. Both China's supply and demand are now beginning to feel the effects of these demographic shifts. International experience shows that countries like Japan, Italy, Greece, and Spain have all experienced negative population growth. This trend leads to a decrease in potential growth rates and worse, when actual growth rates sometimes fall below these already reduced potential rates.
Economic Transformation in the Crucial Stage of Momentum Shift: New Focus of Macroeconomic Policy and Structural Reforms Needed
I. Economic Growth Transitioning from High-Speed to Medium-Speed Momentum
The three-year pandemic has finally ended, and China's economy is on the path to recovery. In 2023, China's GDP grew by 5.2%, reaching a total of 126 trillion yuan [$17.67 trillion], aligning with the government's expected target. However, the average growth rate for 2023 and 2022 was only 4.1%, below the potential growth rate typically considered by the academic community, which is around 5%-5.5%.
The Government Work Report 2024 has set the economic growth target for 2024 at approximately 5%, figuratively described as "reachable if we stand on tiptoes and jump." I believe the Chinese government set this target to guide expectations, and I also advocate for setting a slightly higher growth rate. Any achievable margin for actual growth should be pursued with the best effort.
Currently, China's economy is still in the transition period from high-speed growth to medium-speed growth, or "from high-speed growth to high-quality development." As early as 2008-2009, when I led a research team at the Development Research Centre of the State Council, we proposed that "China's economy will shift from high-speed to medium-speed growth." We cautiously estimated that growth would decline from 10% to 7%. Many regions had maintained a 10% growth rate for years, making it difficult for leading officials to accept this projected decrease. However, as time has shown, the situation has evolved accordingly.
For over a decade, although growth rates have slowed, the main drivers during past high growth periods such as infrastructure, real estate, and foreign trade exports still had lingering effects. When the economy was down, stimulating these areas still had some effect. However, this time, real estate continues to experience negative growth, infrastructure investment struggles to sustain, and exports, after three years of pandemic-induced exceptional performance, are also in decline. Thus, the challenge is that old methods to stabilize growth are no longer effective, and new methods are still under exploration with considerable uncertainty.
(1) Assessing the Current Stage of Economic Growth
Recently, there has been a popular view comparing the current state of China's economy to that of Japan in the early 1990s. I have always believed that Japan, as a large economy, offers valuable lessons for observing and analyzing China's economic trends. However, I find this comparison inaccurate for three reasons.
Japan entered a low-speed growth stage in the early 1990s, while China is currently still in a medium-speed growth stage of around 5%. Japan's medium-speed growth phase lasted about 20 years. China has been in this phase for 13 years, with 5-10 years of potential medium-speed growth remaining.
In the late 1980s to early 1990s, Japan's GDP per capita was among the leading developed countries and even surpassed the United States at one point. In contrast, China's per capita GDP of $13,000 still lags significantly behind the US's $80,000.
Japan's low-speed growth in the 1990s was mainly due to a decline in structural potential and a lack of new growth points. Japanese economist Richard Koo introduced the concept of a "balance sheet recession," which was widely discussed in China. A balance sheet recession is just a symptom; it reflects how the decline in economic potential and the slowdown in economic growth manifest within the balance sheet structure. The most critical underlying issue is the lack of new growth points. Without addressing this, even in the absence of balance sheet problems, sustaining investment and economic growth is challenging. China's next step is to tap into new growth potential by accurately understanding the new characteristics of its economic structure.
(2) Demand Side
From the demand side, major consumer goods, real estate, and infrastructure in China have all reached historical demand peaks and will gradually enter a deceleration phase. One particular issue on the demand side that needs attention is distinguishing between survival consumption and developmental consumption. Currently, survival consumption, primarily including food, clothing, and other basic daily necessities, is largely met. Growth in consumption is increasingly driven by developmental consumption, such as social security, healthcare, education, cultural and sports entertainment, financial services, transportation, and communications. In recent years, the consumption structure of Chinese people and government spending has also changed accordingly, with social security, healthcare, and education ranking high in 2022.
It is essential to distinguish between survival consumption and developmental consumption. Survival consumption is mainly individual-based, while developmental consumption often takes a collective or public service approach. For example, health insurance and social security use mutual aid methods, and school education involves collective learning, both closely tied to the government's level of basic public service equalization. Thus, expanding developmental consumption cannot rely solely on individual efforts; it requires government support in building systems, funding, and providing basic public services.
Recently, government efforts in equalizing basic public services have lagged, directly hindering the growth of developmental consumption. In cities like Beijing, the "three big mountains" (education, healthcare, housing) are significant issues for the middle-income class (white-collar workers). The most severely affected are nearly 300 million farmer-turned-workers and almost 200 million rural migrant workers in cities, who face substantial deficits in basic public services. Despite claims that China's 400 million middle-income group has the world's strongest consumption power, attracting many foreign investors and producers, it is crucial to note the declining marginal propensity to consume within this group. More importantly, there is a significant demand gap between the 900 million low- and middle-income individuals and the middle-income group. This gap is not only related to individual income but also to inconsistencies in the level of basic public service equalization.
In recent years, policies have repeatedly emphasized expanding domestic demand and consumption. The premise is to identify the bottlenecks and key challenges. There are two key points:
1. Development-oriented consumption relying on basic public services
2. The low- and middle-income groups, especially farmer-turned-workers
Some believe that equalizing basic public services for farmer-turned-workers is merely government "subsidizing." This is a misunderstanding. Farmer-turned-workers have long worked in cities and paid taxes, yet the government has failed to provide corresponding basic public services, essentially accumulating a debt. Now, it is simply paying back this debt.
In recent years, all annual sessions of the National People's Congress and the Chinese People's Political Consultative Conference have proposed various investment projects worth hundreds of billions, but no local government has announced plans to address the basic public service issues for farmer-turned-workers. From the perspective of expanding domestic demand, if a city already has ten subways, it is more beneficial to use that money to solve housing and public service issues for farmer-turned-workers rather than building two more subways. Governmen-subsidized housing would prompt farmer-turned-workers to decorate and buy furniture and bring their families to the city, driving significantly more consumption than additional subways.
Some argue that there is no money for basic public service equalization, but funds can be raised by shifting investment from physical capital to human capital. In 2024, the Chinese government plans to issue 1 trillion yuan in ultra-long special treasury bonds. The priority should be solving the basic public service problems for farmer-turned-workers. Stimulating consumption and revitalizing the economy is essential to resolving the debt problem.
(3) Important Changes in the Investment Landscape: Focusing on Service Industry Investment
Following the recent reduction in real estate volumes, the "three drivers of investment" (infrastructure, real estate, and manufacturing) have shifted, with real estate falling to fourth place and service industry investment rising to third. The decline in real estate investment aligns with economic principles, reflecting both the overall historical demand peak and structural demand peak in metropolitan and urban areas. Conversely, service industry investment has demonstrated resilience, even during the pandemic.
(4) Supply Side
From the supply side, traditional industries are entering a downward trajectory due to decelerating demand. Therefore, while stabilizing growth, it is essential to counterbalance, replace, and upgrade through the development of high-tech, high-value-added industries and new industries. The greatest challenge is ensuring a soft landing for the declining traditional industries, which is crucial for stabilizing growth.
Taking the widely discussed real estate sector as an example, research conducted ten years ago indicated that the historical demand plateau for real estate had emerged. However, real estate performed well over the past five to six years, particularly with rising housing prices. A closer look reveals this was due to structural factors—development in metropolitan circles and certain provincial city clusters. However, this structural trend has also turned in the past two to three years, so the slowdown in real estate growth is in line with expectations.
As a pillar industry, real estate affects over 50 related industries, making its rise and fall significantly impact the economy. When real estate booms, it drives the economy upward; when it declines, it exerts equally considerable pressure. Given this characteristic, it was foreseen years ago that real estate would eventually make a "landing." The issue is how it lands. The past approach was to use time to create space, meaning using regulatory means to achieve a soft landing. However, the actual situation shows a rapid and severe decline, with significant shocks. For a highly complex economy, effectively using policy tools during the transition and promptly correcting errors after problems arise are critical areas for careful study.
Another prominent issue on the supply side is the unstable expectations and lack of confidence among entrepreneurs, particularly in some innovation fields where momentum is waning and progress is slowing.
(5) Liability Side
Under the dual impact of supply and demand, the balance sheets of the government, enterprises, and individuals are shifting from a focus on growth to one on efficiency. However, this shift is passive and crisis-driven. The real estate sector is a typical example of a high-debt, high-turnover, and high-sales "three-high" model. This model relied on rapid growth in housing demand, which, once it declined, made the "three-high" approach unsustainable.
In addition to real estate, some industries remain heavily leveraged, with significant assets lacking cash flow, creating an appearance of solvency by "borrowing new to repay old." I term this situation as a Ponzi structure, which will eventually collapse. Therefore, balance sheet recession is a phenomenon that arises after encountering difficulties or crises. As economic growth transitions from high speed to moderate speed, the entire debt model undergoes a significant transformation. Japan's transition took about ten years. In some sense, China is still in the early stages of this transition, with more challenges yet to come.
*This is the first part of Liu Shijin's speech. The second half will be published in the next post.*
