If you think China's economy is way out of whack, think again

In the past two or three years questions have increasingly been raised about the state of China's economy. Those doubts have been expressed at a time when growth has been relatively solid and inflation has been low. So what exactly is the problem that skeptics see in solid growth and slow inflation?

These skeptics, no matter where they are and what their political persuasion is, seem to agree that the Chinese economy is out of kilter. They point to the fact that domestic consumption is weak and that economic growth relies heavily on investment and exports. Resources and energy-intensive industries predominate, manufacturing is at the bottom of the value chain, there is uncompetitive innovative capacity, and tertiary industries lag far behind.

In fact, these structural "problems" have little bearing on people's livelihoods, unlike low GDP growth and high inflation. As long as there is solid growth and low inflation, the rest is academic. However, many economists are preoccupied with these structural ratios because they think growth based on such an economic structure is unbalanced, inefficient and unsustainable. They believe that what is missing in the economic equation is growth that is driven by consumption and innovation.

Let's assume for a moment that they are right. How you change the economic equation to introduce such elements will be a matter of opinion. For example, economists of the liberal persuasion who swear by small government and a big market may well say that the root cause of this out-of-balance economy is excessive government intervention or an excess of investment by the government or state-owned enterprises as a result of manipulated low capital costs and resource prices. Such people advocate market-oriented reforms. On the other hand, those who are skeptical of such reforms suggest the government should increase people's incomes and improve the social security system.

We believe the monopoly or advantageous position of state-owned banks and enterprises must be broken and that the government must deregulate some access to some industries and resource prices. We also hope people can see their incomes rise rapidly, more affordable housing and better social welfare, including medical treatment and education. However, what we advance is not aimed at tackling the alleged lack of structural balance in the economy but at increasing economic efficiency and equity.

In fact, such an imbalance does not exist, and quite a few economists, us included, are on record as refuting the existence of a long-term consumption deficiency in China.

First, the Chinese mainland's consumption rate is underestimated in statistics, and is in fact very close to that of the Four Asian Tigers - Hong Kong, Singapore, South Korea and Taiwan - at the same stage of their economic development.

Second, consumption does not drive economic growth; rather, relatively low consumption accelerates the accumulation of capital, which in turn favors sustainable economic growth.

Many people have confused mid- and long-term economic growth (the continuous increase of GDP) and short-term economic fluctuation (GDP changes in one year or over a shorter period), wrongly applying Keynesian theories that are applicable only to short-term fluctuations to explain mid- and long-term economic growth.

Short-term economic fluctuations are influenced by demand, while long-term economic growth relies on the expansion of total supply capacity. From the long-term perspective of supply rather than the short-term perspective of demand, it is investment rather than consumption that will continue to drive the economy.

Relatively low consumption is in line with much larger savings and investment, which is an important factor in China's rapid economic growth.

Of course, investment can always be more efficient, but when you look at China's investment rate and GDP growth together, it is clear that its investment has been far from inefficient.

Many fear that the result of high rates of investment will be excess capacity. It is normal to see excess capacity in many industries owing to a weak macro-economic situation, but jumping to the conclusion that long-term excessive capacity exists in many industries is unwarranted.

What's more, generally there is no lack of balance in China's industrial structure. What many want is the industrial structure of developed countries. But this can only be a long-term target rather than an ambition expected to be realized in a few years or a decade. If China does eventually become a developed country, what we today call structural problems, such as an under-developed tertiary industry, high-energy consumption, a lack of high value-added industries and weak innovation capacity, will disappear. However, the economic structure of developed countries is the result of economic development rather than the reason for it, and it takes steps to become a developed country. Even if China's economic capacity doubles every 10 years, it may still take the country decades to reach developed countries in terms of income per head.

In fact, as early as the Ninth Five-Year Plan (1996-2000), China spoke of a transition from a path of extensive economic growth to one of intensive economic growth. The 10th Five-Year Plan (2001-05) again pointed to restructuring and upgrading as the focus of economic development. The cast of the 12th Five-Year Plan (2011-15) was similar to that of the previous one, stressing that the economic development path should be transformed, and the economic structure upgraded.

So why have we not got what we expected? Many people blame a creaking old system and its defects, the stagnation of reform or mismanagement by the government. Yet the Chinese economy has grown at an incredible pace over the past 10 years to become the world's second largest. China has long since cast off the shackles of economic planning, and its economic structure is less a government choice than a natural result of economic developments.

Market rules do not bend to human will, and anyone attributing China's current economic structure to mistakes in the system or mistakes of policy is exaggerating the role of government.

Given that economic growth is a problem of supply rather than demand, policies aimed at promoting a sustainable economy must pay more attention to increasing the country's productive capacity and efficiency, or, to put it more mundanely, increasing labor productivity.

First, the country should increase the amount of capital stock per worker, and that calls for investment. China has a huge advantage here because the high amount of savings means there could be high investment. Yet an increase in investment will not necessarily produce effective supply unless investment efficiency is maintained and improved.

That means investment decisions must be dictated by the market. Apart from infrastructure investment, the government should have no hand in investment. The alternative is a sure-fire recipe for mistakes and inefficiency. So the government and state-owned sectors must gradually reduce their share in investment, and the current centralized investment control and approval system must be reformed.

The second way of improving productivity is to increase the level of human capital, which entails gradually upgrading education. One only needs to look at China's spending on public education, which as a percentage of GDP is below the world average, to appreciate this.

The third way of increasing productivity is to advance technologically. But technological advance does not mean independent innovation. As a developing country we must learn to emulate and absorb the advanced technology of advanced countries better and more quickly, instead of innovating ourselves. In fact, even though Chinese research is far behind that of developed countries, it exceeds our level of economic development.

China's research capacity and output rank higher than its per capita income. At this stage of development, blindly encouraging indigenous innovation can only result in government meddling in industrial upgrading and in rent-seeking enterprises, which can have consequences opposite those intended.

Because China's macro-economy is not out of balance structurally, relatively fast economic growth will continue. Though there is still too much government interference in the economy, China possesses what is essentially a market economy, with the bulk of the allocation of resources and decisions being reliant on the market.

Fueled by relatively high investment, it is feasible for China to envisage annual growth of 7 percent over the next 20 years. However, we are talking of a national average. Per capita GDP in some coastal cities has surpassed the standard of high-income countries set by the World Bank (about $12,500). So we should allow per capita GDP growth in these cities to fall to about 5 percent. If we do not, local governments are likely to build white elephants that take up investment, and even resort to doctoring statistical figures.

Zhu Tian is professor of economics at China Europe International Business School. Zhang Jun is director of the China Center for Economic Studies at Fudan University in Shanghai. The views do not necessarily reflect those of China Daily.

(China Daily 12/14/2012 page9)