China can sustain 5-7% GDP growth with structural reform

After three decades of extraordinary economic development, China is shifting to a slower and more sustainable growth path. Further reforms are now needed to ensure that future growth is resilient, inclusive and green, according to the OECD’s latest Economic Survey of China. The OECD forecasts that China’s GDP will grow by 7% this year and 6.9% in 2016.

“Following one of the most tremendous economic expansions in world history, China’s gradual transition towards a ‘new normal’ of slower, more sustainable growth is to be welcomed” OECD Secretary-General Angel Gurría said. “China knows how to grow at a blistering pace. The challenge now is to ensure that future growth occurs on a more durable and inclusive footing.”

The ongoing transition of the Chinese economy is multifaceted – from rural to urban, investment to consumption and manufacturing to services – and will require unwavering commitment to structural reforms.

* OECD position is China’s economy has managable downside risks
* Daniel Rosen, University of Columnbia and Center for Strategic and International Studies (CSIS), has analyzed that China’s services sector is underestimated because of flawed accounting

Shifting from Soviet style national accounting to UN style national accounting shows a bigger and more balanced economy

An assessment of China’s nominal GDP undertaken by my colleague Beibei Bao and Daniel Rosen, in partnership with CSIS, provides new insights into China’s economy that modify this picture. Our independent calculations suggest that services exceeded industrial activity as early as 2009. This means the services sector—which is, by any reckoning, the future of China’s growth—does not suffer from insurmountable structural constraints so much as accounting problems that left it undercounted until recently, and most likely still today.

As a planned economy, China used the national accounting system favored by the Soviet Union to count GDP. The “Material
Production System” (MPS) excludes most services from the definition of economic production. The MPS legacy saddled China with institutions ill equipped to capture service value when the country transitioned to the UN-endorsed System of National Accounts (SNA) in 1993. That institutional weakness, including staffing, inadequate legal and political mechanisms to assure integrity, and data quality concerns, still prevents China from fully measuring its service industries. Using real-economy metrics, comparator country data patterns, and adjustments based on the latest international GDP accounting standards, we recalculated the size of China’s GDP in 2008. Our revisions indicate the need for a 12.9 to 16.0 percent upward restatement of 2008 results, which means RMB 4 to 5 trillion in missing output—$600 to $700 billion at exchange rates prevailing then. The good news from our recount is that China’s economy was already more balanced between services and industry than commonly thought.

The 2013 GDP base was revised, but only by 3.4 percent. The adjustment would have needed to be two to four times that amount if all current national accounting shortcomings were addressed. The choice not to make the full revision last month, despite previous intentions to do so, raises questions about Beijing’s motives. Why would authorities prefer to report a smaller economy than modern accounting suggests? Will statisticians use the unreported adjustment to “fluff up” GDP growth results in the difficult years of economic adjustment to come, to hide the full extent of a necessary downturn? None of us can be sure.

The OECD highlights a number of reforms to address the economic and social challenges faced by China. In the near term, China must maintain sufficient momentum to reduce economic imbalances while avoiding overly abrupt adjustments that might trigger a crisis. Looking ahead, the services sector will benefit from opening up to private investment and reducing the market share of state-owned enterprises in commercially-oriented activities. Greater innovation activity is also necessary to reduce the gap between China and the most knowledge-based economies, and will be a key element in Chinese efforts to move from middle-income to higher-income status.

Specific OECD policy recommendations include:

Reforms for sustainable growth. All firms should compete on a level playing field with regard to finance, regulation, taxation and public procurement. China should continue to gradually liberalise deposit interest rates while enhancing financial stability. Furthermore, it should increase fiscal transparency and sustainability.

Urbanisation and services as drivers of growth. To realise potential productivity gains related to the shift of rural residents to cities, China should also extend public service provision and social security coverage to all migrant workers and make social security benefits portable across the country. The share of services in value added has now overtaken that of manufacturing and will rise further as China becomes richer and urbanisation proceeds. But China needs to scale down state-ownership in commercially-oriented service enterprises and open up more industries for private investment.

Nurturing the right skills. To meet the demand of a knowledge-based economy, China should establish an effective countrywide VET system, evaluate universities and university staff on the quality of academic output and bolster merit-based promotion and stronger intellectual property rights. China should boost public spending on education, including by increasing teacher compensation to improve education quality while also ensuring equal opportunities for disadvantaged children.

Agricultural reforms. All rural households should receive certificates detailing their land-use rights and well-designed exchange platforms for land operation rights should be established. There is substantial scope for improvements in access to finance in rural areas, education and training for farmers, the pricing of natural resources and rural infrastructure. Along with hukou reform, rural wellbeing will also benefit from expanded coverage of rural social welfare payments and better rural health services.