Comment on “China's Recent Economic Performance and Future Prospects”

The questions Professor Perkins (2006) aimed at answering in his paper were how and why the rate of both human and physical capital in China grew so rapidly, and whether both capital and labor inputs were used with increasing efficiency. Based on his answers to these questions, Perkins went on to analyze what is likely to happen to the Chinese economy over the coming decade. The framework used for understanding China's growth performance is conventional growth accounting. Perkins reviewed the performance of the capital stock, employing labor and total factor productivity, respectively, starting with capital formation. China's rate of capital formation has been very high, which in turn is attributed to its high savings rate. In line with the life-cycle model, Perkins believes that the rising dependency ratio is likely to translate into a steadily falling savings rate in China, but that this fall in the savings rate should not be pronounced in the coming decade. In relation to the growth of employed labor, Perkins pointed out that, despite the fall in the rate of growth of China's total labor force, China's economic growth will not be constrained by labor supply in the next decade. China has been and will continue to be in a position to shift large amounts of labor from the countryside, without having much of an impact on the growth rate of agricultural output. The third element in growth accounting is total factor productivity. According to Perkins, total factor productivity after 1978 accounted for a quarter to a third of gross domestic product (GDP) growth in subsequent years. However, Perkins is not sure whether total factor productivity will continue to make a significant contribution to China's growth in the next decade. A key opinion held by Perkins is that the jump in productivity came first and lifted the rate of GDP growth; and, in turn, a higher rate of GDP growth made it possible to produce a much higher rate of growth of capital. From time to time, new bursts of productivity in particular sectors (first agriculture, then township and village enterprises, and finally foreign direct investment) helped sustain the high growth in both GDP and capital formation. Therefore, the issue is whether these periodic bursts in productivity are likely to continue. Here, we come to the thrust of Perkins’ analysis of China's growth prospect in the next decade: institution building. In Perkins’ words, “What then could keep China growing at something like the pace of the recent past? . . . The probable answer lies in how successfully China is able to complete its transition to a full market economy.” Perkins’ discussion of China's institution building focused on two general types of institutions: the financial system and the laws that govern economic activity; and more importantly, the legal or regulatory system that enforces those laws and settles economic disputes. He is much less sure whether China will be successful in this regard than when he is doing growth accounting. This is fair enough, although personally, I am much more optimistic. Broadly speaking, I am in agreement with Perkins in his growth accounting. There are only two points I wish to make. First, factors contributing to the rise in total factor productivity can and should be more carefully identified and empirically tested. For example, we wish to know to what extent the massive investment in infrastructures, steady inflows of foreign direct investment (FDI), and the high trade/GDP ratio have contributed to improvements in China's total factor productivity. Or, on the other hand, have these contributions offset factors that have dragged down China's total factor productivity; for example, low energy efficiency, a lack of investment in research and development, and income disparities. Through an analysis of these issues, we will have a clearer and more specific view of China's growth perspective in the next decade. Second, traditional growth accounting does not take structural balances into consideration. For example, in Perkins’ growth accounting, growth of the capital stock is constrained by the availability of savings. However, the relationship between aggregate investment (growth of capital stock) and aggregate savings can be disaggregated into the relationships between private investment and private savings, government investment and government savings, and foreign investment and foreign savings. Even if aggregate investment is equal to aggregate savings (domestic plus foreign), imbalances in individual sectors, which result in excessive accumulation of stock variables vis-à-vis corresponding flow variables, can still lead to the breakdown of the growth process. In China's context, there are at least three stock-flow relationships that should be examined: (i) the possible breakdown of the balance between private investment and household savings because of the excessive accumulation of household savings and enterprise debts; (ii) the possible breakdown of fiscal balance because of excessive government debt (including contingent liabilities) relative to revenues that the government can generate, even if private savings are available for the financing of government deficits; and (iii) the possible breakdown of external balance because of the excessive accumulation of foreign equity capital. In the short term, these stock-flow relationships will not pose any serious threats to China's growth prospects. However, in the long term, the trajectories of the M2/GDP ratio, the government debt/GDP ratio, the foreign capital stock/GDP ratio and so on are worth studying. I agree with Perkins that the more urgent challenge facing China is the establishment and improvement of key institutions of a market economy with Chinese characteristics. In fact, China has achieved more than most foreign observers have realized in this direction. As Perkins rightly pointed out, creation of an independent, competent, fair and efficient legal system “is not something that can happen within a few years. It took centuries in Europe and it will almost certainly take decades in China and in many other parts of Asia.” Based on China's track record, I believe that China will speed up institution building, establishing a solid foundation for sustained growth in the next decade.

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