In terms of per capita income and overall level of development, China can be said to be roughly where countries such as Thailand were 15 years ago – shortly before the Asian financial crisis. These countries bounced back from the crisis, but growth levels are little more than half what they were before.
They have run up against a problem familiar to much of middle-income Latin America: how to sustain productivity growth, which needs ever-increasing levels of skill and industrial know-how. South Korea and Taiwan have managed it, but others have not.
Can China? It certainly starts with many advantages over Southeast Asia. First, Beijing’s huge net foreign asset position, a contrast to the pre-crisis Asian situation, should enable it to fund a continuing high level of investment in upgrading industry and infrastructure, whatever happens to global trade.
Second, China’s exports are and will remain primarily manufactured goods, whereas Southeast Asia has never escaped its reliance on cyclical commodity exports. Indeed, the post-crisis period has seen commodities rise as a percentage of exports as prices have risen, while progress has been slow in upgrading manufacturing capabilities.
Third, China can attract foreign investment into more sophisticated products because its domestic market is so large. In contrast, there are fewer opportunities for investment in export-based manufacturing in smaller economies.
Fourth, although the overall level of education in China may trail that of its Southeast Asian neighbors, there are centers of excellence that small countries cannot readily match. These can then feed talent through to locally owned industries, making it possible for them to develop their own technologies and brands while smaller countries mostly remain reliant on foreign technology.
South Korea managed to break free of this problem thanks to its high levels of education and policies aimed at nourishing locally owned industries and restricting foreign investment, but promoting exports.
For all China’s advantages, obstacles exist. The state sector, whether at central or provincial level, dominates industries in which the country should be most keenly climbing the value chain. There is always a risk that external pressures may impede managements or result in investment in low yielding projects.
China as yet lacks the large tier of small- to mid-sized firms – often family-owned – with niche technical skills that have been so important to the industrial success of Germany, Japan and Taiwan. These may emerge in time, but the bias in bank lending toward large, state-related companies means that entrepreneur-led and potentially high-growth industrial activities most in need of capital often go without.
Ongoing efforts to develop central and western China will also stimulate growth in value-added industries. Government spending has raised growth rates in these areas, but a big gap still needs to be bridged for political reasons. Returns on infrastructure investment required to maintain growth are falling and will continue to do so as urbanization rates decline – because there are fewer young people in rural areas to feed urban migration.
Manufacturing costs overall are likely to rise as the government imposes more effective restrictions on pollution. Whether it is reining in growth in coal use and promoting renewable energy or making industries pay for chemical clean-ups, the short-term cost of mitigating long-term problems will likely have an additional impact on rates of return on investments.
One would not want to take the comparison with the Soviet Union too far. But its growth rate in the 1950s was such that many predicted it would soon catch up with the US. What happened, however, was that there was excessive investment in heavy and defense industries and infrastructure with poor returns to capital. Consumer goods industries, meanwhile, lacked capital and competition.
In China’s case, domestic competition and the open door to foreign investment, technology and trade means that most of the Soviet mistakes will not be repeated. But excessive investment in low-yielding activities and grandiose projects could see China run into the productivity problems encountered by many other middle-income nations.
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