The Next Driver of China's Economy

By Zhang Hong
Published: 2009-12-03

The following is the text of a speech delivered by Zhang Hong, Deputy Editor in Chief of EEO, at a conference organized by DAS, a think tank connected to the French Defense Ministry, in Paris on November 18, 2009.

The conference focused on the future prospects for China and Zhang Hong presented his ideas as part of a round table that discussed "The Emergence of a Chinese Development Model." Other speakers included Nicholas Lardy of the Peterson Institue for International Economics, Gang Zhang, a senior economist with the OECD and Fran?oise Lemoine, a senior economist with the CEPII.

Ladies and Gentlemen, good morning.

It is a pleasure to be able to join you here today to discuss the nature of China's economic growth.

China has just released its GDP figures for the third quarter. In the past three quarters, the country registered an economic growth rate of 7.7 percent year-on-year. Growth rates have gradually increased from the 6.1 percent registered in the first quarter, to 7.9 percent in the second quarter and now 8.9 percent growth in the third quarter.

Many international institutions are now revising upwards their growth forecasts for China and the Chinese government is also extremely confident that they will achieve the target of 8 percent GDP growth that they set for themselves earlier this year.

We can say that the atmosphere both at home and abroad is rather optimistic.

But I am an exception.

On previous occasions, I have noted that despite the difficult economic challenges posed by the global financial crisis, China will definitely achieve the all-important target of 8 percent GDP growth.

For a country like China, economic growth over eight percentage points is crucial to generating enough jobs to ensure social stability. And social stability is always the first priority of the Chinese government.

But a careful examination of China's existing economic growth pattern,  should lead to a dampening of our  optimism about the current economic situation.

Growth figures might be important for the careers of Chinese government officials, but they don't offer much in the way of real benefits for the lives of a large number of Chinese people.

I would like to divide the process of China's contemporary economic growth into three periods, namely the interval from 1978 to 1989, the second spans the years from 1992 to 2000 and finally a third period from 2000 to 2007.

These three periods are differentiated by the nature of the economic forces that drove economic growth in each and also by a gradual change in policy focus.

We can view China's economic growth path as a gradual loosening of the ruling communist party's control on the economy.

In this sense, I believe that policy change, or political and economic reform, is the most important driver of China's economic growth.

I. 1978-1989

China began its contemporary economic reforms in 1978, when the country's economy was at the edge of total collapse. At that time, China had just been through ten tumultuous years of the Cultural Revolution, nothing short of a civil war in which rural farmers were one of the social classes that suffered the most.

As the country forced the rural areas to supply the city residents with food and other raw materials, to ensure material supply in the cities, rural farmers were left with barely enough food to survive. Thus, reforms were motivated by rural residents and were initiated in the rural areas.

Farmers of a small village in central China signed a secret agreement in 1978 to divide the land that had previously belonged collectively to the local government. They were decided to hold on to any surplus grain that remained after they had delivered their fixed quota of output to the government.

This model was soon copied by neighboring villages and the central authorities gave their approval for a trial of the new system in 1980. The household contract responsibility system was popularized nationwide four years later, officially raising the curtain on rural reform. 
After that, rural areas became the driving force for China's economy. Many rural enterprises were established. Thanks to the government's favorable policies - including tax incentives and other measures - rural enterprises grew at over 30 percent from 1984-1988.

In the first period, the countryside was the focus of China's economy. By freeing up the productivity of farmers, China embraced its first round of rapid growth in contemporary history.

But in the cities, the state-owned enterprises (SOE) were still taking the lion share and city residents gained little benefit from the economic growth. Rapid inflation growth coupled with slow income growth fueled discontent among urban residents, and even sparked the political turmoil that shook the country in 1989.

During the period 1978-1989, rural residents were the biggest beneficiaries of economic reform, but the cities were still lagging behind.

II 1992-2000

In 1992, China's late leader Deng Xiaoping pushed forward a new round of reforms in the cities through a series of important speeches that were given during his tour of Southern China.

From this period on, the ruling party ceased engaging in internal political debates and realized that only economic growth, and more specifically, income growth could settle the wide-spread discontent that existed among city residents.

In the second period, urban areas became the focus of policy. In the coastal regions, cities and enterprises were granted more freedom and flexibility and the government encouraged people to establish their own enterprises. The entrepreneurs from the rural enterprises started moving into the cities and formed a fast-rising private business class.

At the same time, foreign investments were being welcomed into the coastal areas, serving as another pillar for the country's economic growth.

As large-scale infrastructure construction projects and labor-intensive manufacturing enterprises began to appear in the coastal areas, they attracted underutilized labor from the rural areas. The process of urbanization began to gather pace.

In this second time period, the private economy emerged as the driving force of the country's economic growth. The inflow of the rural workforce provided much-needed cheap labor and this trend has flowed over into the third period.

However, during this period, foreign enterprises were able to gain considerable footholds in certain sectors whereas state-owned enterprises  lost some of their market share due to their low efficiency. 

III 2001-2007

Another milestone of China's economic growth was the country's accession into the World Trade Organization (WTO) in 2001. WTO status granted China access to broader global markets and also attracted more inward foreign investment.

During this period, China's international trade grew fourfold to over 2 trillion US dollar in 2007 and the country also became the most popular destination for the world's foreign investment.

This third period of growth led to  the longest boom in China's contemporary economic history and rapidly growing trade also contributed to a considerable increase in the country's foreign exchange reserves.

Undoubtedly, both private and foreign businesses witnessed rapid growth during this period, further enhancing their status as major contributors to the country's GDP growth.

The swift rise in fiscal income filled the state's financial coffers, making it possible for the government to support state-owned enterprises either by injecting more capital or by granting favorable policies.

The large amount of foreign reserves also made it possible for China to seek merger and acquisition opportunities in overseas markets.

From my observation, during these three rounds of economic growth, changes in the policy focus of the state has played the most significant role in driving the country's growth.

Government intervention should not be the decisive force in a country's economy.

Unfortunately, in China, it still takes the leading role.

Now, the question that confronts us is, what will the next driving force of China's economic growth be? 

Since early 2008, China's economy started to show signs of slowing down.

Many private enterprises actually started failing even before the impact of the global financial crisis and the shrinking overseas export market had begun to be felt.

One of the main reasons for this failure among private enterprises was the growing influence and market share of state-owned enterprises, and of course foreign corporations.

Supported by the financial subsidies from the state and favorable market policies, many state-owned enterprises function as monopolies in China. If we look at the top 100 companies in the country, over 80 percent of them are state-owned.

In the past year, the government launched a 4-trillion-yuan ($586 billion, EUR391 billion) stimulus plan, but most of the contracts for the state-financed projects have been obtained by SOEs with private businesses benefiting very little from the stimulus.

Economists believe that the ongoing process of urbanization will provide the driving force for China's economy growth. However, if the power of the SOEs continues to grow, their low efficiency will make China's urbanization process too expensive to afford, not only for China, but also for the whole world.

I mean here the consumption of raw material such as steel, cement, oil and others will exceed the affordability of the whole world.

The Chinese government has already shown that it is ready to shoulder some responsibility in facing the challenges posed by global climate change. The government is preparing to release more details about the commitments it will consider at the upcoming Copenhagen summit.*

If China follows the previous growth model, pollution and CO2 emissions will become a serious headache and China won't be able to play a responsible role in the world's fight against climate change.

Besides that, China also needs to address many critical problems in order to achieve an internal economic balance. These problems include the widening income gap between rural and urban residents, a slowing of real-income growth due to a rapid rise in the cost of living and also a slowing in the rate of growth of the domestic consumption.

I believe a growing private economy will help solve many of these problems.

It will make Chinese economic growth more stable, sustainable and also dynamic.

Therefore, it's very important for the government to realize the important role of private economies, and deliver more substantial help to this sector.

The government should help remove the market barriers and obstacles which have hindered growth of the private-sector economy and grant private businesses access to most domestic markets.

Only a growing private economy can form the solid foundation required for the next round of high-growth in China.

Thank you.

* This speech was given prior to the Chinese government announcement on specific carbon emission targets on November 26.

Links and Sources
Details of Conference (French)