China's Economic Transformation

Year after year China's economic transformation is the top cover story. Frequently the commentary is polarized between breathless optimism and suspicious skepticism, which usually means the truth lies somewhere in between. This will be true of many views and statements in this article because of diversity in a huge country and because of rapid change. Indeed, where all can agree is that China's re-emergence as a world economic power after a hiatus of several hundred years is a dramatic accomplishment. Some of the Asian tigers have done better on export-led growth, but no economy of this size has reformed and opened so quickly.Consider some of the numbers:* Growth: For 25 years China has been the world's fastest growing economy; 9-10 percent annual growth means that the economy doubles in size every seven or eight years.* Size: Using a purchasing power parity measure, China is already the world's second largest economy after the United States. Measured by current exchange rates, its economy is the world's sixth largest after the United States, Germany, Japan, the United Kingdom and France, and will soon be the fourth largest.* Integration through foreign direct investment (FDI): In the past five years China has emerged as a global manufacturer and trader because of FDI inflows. In the past four years it has received the largest absolute inflows (although round-tripping through Hong Kong is a contributing factor).* Integration through trade: In 2005, the size of its total trade (imports plus exports) surpassed Japan's to make it the world's third largest trader.These numbers need to be put in perspective in at least three ways. First, even when China becomes the world's largest economy, its average citizen will still be relatively poor. It has been said that China will grow old before it becomes rich. Second, many of the superlatives apply to three city clusters, in the Pearl River Delta, around Shanghai, and around Beijing, where huge building programs and infrastructure projects have propelled more than 140 million people to first-world status. Third, we cannot talk about the future without understanding thousands of years of history. Going back just to the 1949 revolution, private property was abolished and today attitudes remain ambivalent towards property rights despite their importance as a key building block of a modern market economy. Even so, the past 30 years provide a remarkable record of successful economic policies. China's managers are doing many of the right things to create a transparent market economy, but major political constraints remain because of the communist party's determination to maintain its grip on political power and on the commanding heights of the economy.My purpose in this article is to assess China's transformation using a long-term economic growth framework and to explore the implications for the rest of us. I will do this by reviewing the main drivers of growth: inputs of capital, labour, land, and new technologies, as well as the role of key institutions, and then discuss some of the main implications for the world economy and for Canada in particular.PROSPECTS FOR SUSTAINED LONG-TERM GROWTHMainstream economists agree that sustained growth is determined by inputs and technology, but also by institutions. In particular, government's role should be to provide the necessary frameworks for an efficient market economy. It should improve the economy's ability to reallocate resources from failure to opportunity. It should contribute a strong human resource base, encourage flexible labour markets, and provide social safety nets. And it should provide an incentive framework, including a strong and resilient financial system, which supports and rewards innovation. I keep these benchmarks in mind in the following discussion.The role of capital and financial markets in long-term growthChina has the world's highest saving rate, at 43 percent of GDP, and an investment-to-GDP ratio of more than 45 percent. …

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