Noah Smith

China's economy has one more major growth run to go

STEIN'S Law, named for former Council of Economic Advisers chairman Herbert Stein, states that: "If something cannot go on forever, it will stop."

That is as true in economic growth as anywhere. Time and again we have seen a poor country grow fast as it industrialises, only to slow. This is predicted in every growth model. A poor country can move workers from the countryside to the city, mobilise savings to build up lots of capital, and cheaply mimic foreign technology. But eventually these processes run their course - all the workers have left the farms, the return on capital investment drops and technology catches up to a level where a country cannot get ahead by copying. Growth then slows to the more sedate pace of the rich countries.

China is in the middle of this process. The country's economic growth rate slid from about 9 per cent in 2011 to about 7 per cent today. That was in line with predictions by economic historians, notably Barry Eichengreen, Donghyun Park and Kwanho Shin, who missed the date by only three years.

But now China seems to be slowing even more and the economy, if not in out-and-out recession, is experiencing a sharp deceleration. The official growth rate is still about  7 per cent, but China's data is often unreliable and private research firms put the true number at between 3.8 per cent and 4.9 per cent.

Chinese officials are publicly expressing pessimism about the near future. The immediate reasons for this appear to be pretty typical - the bursting of a land price bubble, combined with vast industrial overcapacity. The flight from real estate has probably given the Chinese stock market an unsustainable burst that will shortly reverse itself (and yes, for the record, I just made an asset market prediction!).

Does this mean that the heyday of Chinese hypergrowth is over? Lots of people are probably entertaining the idea at this point. Expect to see comparisons to the US housing bubble and the Japanese real-estate bubble of the late 1980s. Also expect to hear crowing from those who think that China's hybrid authoritarian system is fundamentally broken.  But while a permanent Chinese slowdown is possible, it is highly unlikely.

The reason is that China still has so much room to grow. The country's per capita gross domestic product, measured in purchasing power parity terms, is still only about US$13,000 (S$17,516). Japan, in contrast, stands at about US$38,000 and South Korea, at more than US$35,000. For China to top out now would mean that a Chinese person, on average, never becomes more than about one-third as productive as a Japanese or Korean person. Again, possible, but unlikely.

China has several big factors in its favour. For one thing, it is gigantic. A large, dense market gives rise to agglomeration effects, where companies want to locate near to consumers, and consumers - who are also workers - want to live near their employers. The snowball effect from this process means that China will not be left as an economic backwater.

Another factor in China's favour is its openness to foreign technology. Part of this comes from appropriating the technologies of companies in the developed world. Part of it comes from reverse engineering, and part of it comes from the natural spread of know-how through the Internet and through migration of employees between companies. But so far, China has proven both eager and very able to adopt the rich countries' technological know-how for its own.

Yes, eventually we can probably expect China's authoritarian system to hold back its growth. The relative lack of clear property rights, the tradition of extensive government involvement in the economy and uncertainty over the political succession process will all conspire to stop China from reaching Japanese or South Korean levels of income. But even if China reaches only, say, 70 per cent of South Korean levels, it still has a large amount of catch-up growth left to do.

Economists Jingyi Jiang and Kei-Mu Yi of the Federal Reserve Bank of St Louis explicitly model China's future, using Japan and South Korea's paths as examples. They find that if China reaches South Korean levels of income, it will grow robustly throughout the 2020s and then slow down.

So expect China's slowdown to be a stumble, not a fall. China will probably recover to something like its recent 7 per cent growth rate in the latter part of this decade and much of the 2020s. The country has one big run left in it.

BLOOMBERG VIEW