slowdown in Chinese economic growth inevitable without internal reform

China’s economic momentum is slowing. Official figures released this week show GDP growth in the last quarter stood at an annual rate of “only” 4.9%. This compares to an annualized GDP growth of 7.9% for the previous quarter.

I say “just” because the last time the Australian economy grew so rapidly was – check notes – about 80 years ago. So China’s economic growth may have slowed, but it’s not slow.

A number of supply disruptions caused the decline. Industrial production such as the steel industry has been affected by power outages. Other sectors of Chinese industry, such as the automotive sector, have been affected by the global shortage of silicon chips. And there’s the debacle of Evergrande, China’s second-largest real estate developer, which could collapse without a government bailout and damaged the entire construction industry. It has been an almost biblical confluence.

Read more: 3 ways the collapse of Evergrande will hurt Australia’s economy

But even without such factors, the economy says that China’s growth rate must inevitably slow down.

Conditional convergence

Over the past 30 years, China’s annual GDP has grown from US $ 361 billion to US $ 14.7 trillion. That’s an increase of almost 41 times, or a rate of 13.2% per year. During the same period, the US economy grew from $ 5.96 trillion to $ 20.94 trillion, a growth rate of 4.3%.

While the United States can still claim to be the world’s largest economy on these numbers, a more nuanced metric such as “purchasing power parity” – which considers what each currency can buy rather than exchange rates officials – shows that China has already overtaken the United States because of these different growth rates.

The difference reflects one of the most important facts in economic growth theory – known as “conditional convergence”.

Until a few decades ago, most economists believed that nations’ per capita wealth would eventually converge, with poorer countries catching up with richer ones. As Harvard economics professor Robert Barro wrote in an influential 1991 study:

In neoclassical growth models […] a country’s per capita growth rate tends to be inversely proportional to its starting level of per capita income. In particular, if countries are similar in structural parameters of preferences and technology, then poor countries tend to grow faster than rich countries. Thus, there is a force that favors the convergence of per capita income levels between countries.

In other words, the theory was that countries’ GDP per capita should converge because in poorer countries the ‘marginal product’ of capital – the return on adding an extra dollar of capital – is very high. high, resulting in strong growth. As they get richer, the marginal return on capital decreases, which means that the rate of growth slows down.

China’s auto industry has been hit by the global shortage of computer chips.
Chinetopix / AP

It’s a good theory with one problem: real world data says something different.

When Barro (and others) examined the empirical evidence – analyzing the GDP rates of 98 countries from 1960 to 1985 – they found that there was convergence, but it was “conditional.”

From a given “starting” level of GDP per capita, countries with more education, longer life expectancy, lower fertility, lower public consumption, better rule of law and inflation weaker ones tended to grow faster than those with fewer of these attributes. From a given starting level of structural characteristics such as these, countries with low GDP per capita have tended to grow faster than wealthier ones.

But countries with different levels of GDP and different structural characteristics did not necessarily converge.

Education and rule of law

This provides a useful lens for thinking about the future of the Chinese economy.

Aside from the symbolic question of when China’s economy will be, by any measure, the largest in the world, the basic question is how quickly China’s per capita GDP will continue to grow.

This is relevant for countries like Australia which benefit from China’s demand for goods and services. The more China’s GDP per capita grows, the greater its demand not only for iron ore and coal, but also for wine, lobster, beef, education, and overseas vacations.

Read more: Asia’s energy hub is a warning to Australia: Hanging on to coal is bad for the economy

The lessons of economic growth tell us that for China to continue to grow rapidly, it will need to invest more in its human capital and ensure that there is a stable and predictable legal regime.

These look like challenges. The Chinese education system is not as sophisticated as the best in the world (like the United States or France). This is why so many parents send their children to universities abroad.

Can it develop a truly world-class university sector? Great academic institutions need to empower great minds to engage in free inquiry. Will the Chinese Communist Party ever get to free speech? Right now, under Xi Jinping, it’s going the other way.

Then there is the absence of the rule of law. A predictable legal regime means that serious corruption cannot be tolerated, and foreign capital must be confident that it will not be expropriated. How China handles the Evergrande crisis will be instructive in both respects.

Every challenge is an opportunity, as the saying goes. But the fear is that these issues – education and the rule of law – may be, in the words of Sir Humphrey Appleby, “unsolvable opportunities”.

About Sharon Joseph

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