China has been growing extremely rapidly for a long time, but an important shift in its growth pattern occurred at the time of the global financial crisis.
During the six years up to 2007 China’s GDP grew at an average rate of 11 percent, with investment equaling 41.5 percent of GDP. The current account surplus was rising in this period, reaching over 10 percent of GDP.
In the six years since the global crisis, the external surplus has fallen sharply into the range of two to three percent of GDP, but the shortfall in demand was made up almost completely by an increase in investment, which has reached more than 50 percent of GDP in recent years.
China’s growth has been impressive compared to the rest of the world, but lost in the admiration is the fact that the growth rate has slowed down to around seven percent down more than four percentage points from the pre-crisis period. Thus, in the recent period China has been using a lot more investment in order to grow significantly more slowly than in the past.
This pattern of growth manifests three problems. First, technological advance, as measured by Total Factor Productivity (TFP) growth, has slowed down. Second, and closely related, the marginal product of capital is dropping (it takes more and more investment to produce less and less growth).
The real world indicators of this falling capital productivity are empty apartment buildings, unused airports, and serious excess capacity in important manufacturing sectors. The third manifestation of China’s growth pattern is that consumption is very low, especially household consumption, which is at only one-third of GDP.
China’s response to this changing growth dynamic is partly external and partly internal. On the external side, it is no coincidence that this period of excess capacity at home is the moment at which China launched expensive new initiatives, such as the Asian Infrastructure Investment Bank (AIIB), the BRICS Bank, and the ‘One Belt, One Road’ initiative in order to strengthen infrastructure both on the westward land route from China through Central Asia and on the southerly maritime routes from China through Southeast Asia and on to South Asia, Africa, and Europe.
These initiatives are largely welcomed by China’s Asian neighbors and this essay’s next section will examine how they can contribute positively to Asian integration. However, the thinking in China that these initiatives can be a major solution to China’s excess capacity problems is largely misguided.
The contributions that these initiatives together make to China’s demand are likely to be too small to be macroeconomically meaningful.
The domestic response to China’s over-capacity problem is a set of reforms that emerged from the Third Party Plenum in November 2013. Together, these form a coherent set of measures that would rein in wasteful investment, increase innovation and productivity growth, and enhance consumption.
A further section of this essay reviews the key reform measures, as well as progress to date with regard to reform. Success in this area will enable China to continue to grow well for another decade or more.
China’s initiatives in Asia are seen in many quarters as a setback for the United States. The U.S. government contributed to this narrative through its efforts to discourage allies from joining the new AIIB.
In the end, major American allies, such as the United Kingdom, Australia, and South Korea, did join the Chinese initiative, and Japan is seriously considering becoming a member. However, this is likely to be a temporary diplomatic setback for the United States.
America’s own main economic initiative in the Asia-Pacific, namely the Trans-Pacific Partnership (TPP) now seems likely to be completed by the end of 2015.
Many Major Economies in Asia, such as Australia, Singapore, South Korea and Vietnam want to be part of both Chinese Initiatives (the AIIB and the ‘One Belt, One Road’) and the American effort to reduce trade barriers.