(Photo: Bloomberg)
(Photo: Bloomberg)

Opinion | The great growth story of China awaits a modern-age epilogue

With China in the midst of a profound change in its economic model, India needs to work out how to make the most of it

Most mental models about the Chinese economy are quite understandably based on the spectacular transformation of that country over the past four decades, from a miserably poor country to a powerhouse that could challenge American dominance of the global system. It is a record with no parallel in history.

The development model was something like this. China recorded high rates of economic growth, saved nearly half its national income, relentlessly focused on capital accumulation, powered an export engine to overcome a limited domestic market, welcomed foreign direct investment, plugged into global supply chains and kept its public finances more or less in order.

It also gamed the multilateral trading system to capture markets as well as absorb new technology that would raise productivity, which means that the grand American gamble in the 1990s to get China into the international economic system so that it would eventually become a liberal capitalist economy has failed. The ongoing trade war is a belated recognition that the gambit has not worked.

China was a free trader in theory, but mercantilist in practice. The journey was obviously not without bumps in the road—including episodes of inflation and financial fragility. The overall record is of staggering success, which even its worst critics cannot deny. However, there are now growing signs that the China of the immediate future will not resemble the China of the immediate past.

A new report by the International Monetary Fund (IMF) on the Chinese economy was released last week. It makes for interesting reading. Much of the analytical focus of the report is obviously on the current challenges faced by the second largest economy in the world. The view ahead is also important. Here are four big transitions that Indian policy makers should focus on.

First, it is well known that China is in the midst of a secular slowdown. The days of sustained double-digit growth are over. The IMF says that the Chinese economy will be expanding at 5.5% by 2024. A forthcoming working paper by M. Zhu, L. Zhang and D. Peng estimates that Chinese economic growth will slow to 4% by 2030. Some private sector economists say that China could end up growing at half that rate if the strategic squeeze being applied by the US right now is successful.

Second, the drivers of Chinese economic growth are rapidly changing. Domestic consumption is becoming more important in the growth mix while domestic investment is losing ground. The external trade story is likely to change dramatically, with China slipping into a minor current account deficit by 2024. In other words, the excess of domestic savings over domestic investment will disappear. China will continue to have a trade surplus in industrial goods, but that will be cancelled by a growing trade deficit in services.

Third, China is battling financial fragility. The effect of successive credit expansions to keep economic growth on target after the 2008 financial crisis is now showing. The IMF says that true fiscal deficit is now around 11% of gross domestic product, if off-balance-sheet borrowing for investment is taken into account. The credit splurge means that important parts of the Chinese economy are over-leveraged—the government, the corporate sector and households. There have also been episodes of large capital outflows from China, although these have moderated of late.

Fourth, there is already mounting evidence that Chinese manufacturing is moving up the global value chain. The widespread belief that China is still trapped in the lower end of the manufacturing value chain is not quite true. Hiau Looi Kee of the World Bank and Heiwai Tang of the University of Hong Kong have shown in their recent work based on enterprise data that China has expanded its domestic base in the intermediate input sectors, leading to an increase in domestic value addition in exports. The IMF notes that the share of hi-tech in China’s industrial value added was 43% in 2015, comparable to richer countries such as Belgium and Spain.

These are just four illustrative examples to show that China is in the midst of a profound change in its economic model. Such transformations are rarely smooth. The tiger economies of East Asia had to undergo gut wrenching pain during the 1997 Asian financial crisis before they could change direction. The difference is that they were minnows in the global economy compared to what China is today.

China has so far beaten back at least a decade of forecasts about its imminent collapse. So what it does over the next few years matters a lot. This is where the trade war with the US comes in. The US sees this as an opportunity to push back a country that is likely to emerge as its main geopolitical rival. The trade war is actually not about trade alone, but issues such as intellectual property protections, the foreign investment regime, dominance of newer technologies such as Artificial Intelligence, cyber security and much more.

It is an opening salvo in a deeper geostrategic battle. The question is: How does India take advantage?

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics