Date posted: October 3, 2006

Is China's Double Digit Growth a Miracle?

China is booming. There is no doubt about it. With its double digit growth rates, China has become a magnet not only for architects but also for analysts, newspaper editors and other commentators seeking to explain the Chinese miracle. And because China is BIG, its people look different and speak a different language, it also inspires fear.

One of the best books I've read this year is James Kynge, "China Shakes the World. The Rise of a Hungry Nation". Kynge describes with great flair and detail the rapid emergence of China as an economic superpower. From 1998 to 2005 Kynge was the China Bureau Chief for the Financial Times. He witnessed the recent transformation of China first hand and was able to speak with numerous people across China, from CEO's who have gone from rags to riches to party officials, farmers who invested all of their savings in local oil wells, which were subsequently seized by the local government and a girl whose identity was stolen.

But is the sudden rise of China as an economic superpower really the miracle many people claim it to be? I believe it isn't. The main difference between the rise of China and previous supposedly economic miracles such as the rise of the "Asian Tigers", South-Korea, Taiwan, Singapore, a few years ago, is the speed of change.

I was educated (or indoctrinated with if you wish :) in neoclassical economics. Robert J. Barro's Macroeconomics was the textbook we used at university and the classic articles by the other two Roberts, Robert E. Lucas jr. and Robert Solow were required reading.

So what are the determinants of economic growth? First of all, in the neoclassical framework the lifting of trade barriers represents a one-off shift in the level of the "production function". It does not change economic growth as such. For economic growth to increase there has to be an increase in either labour or capital supply, labour productivity or technological progress.

In China there is and has been a huge flow of people from the country to the city. But urbanization is a global phenomenon. It is also happening in Africa and South-America. Yet China is experiencing double digit economic growth and many other countries aren't, so cheap labour in itself cannot be the full explanation. The same goes for labour productivity. People won't be more productive if you give them two computers. It is true that in factories across China people work very long hours, but you will find the same working conditions in other developing countries. So China is not special compared to other countries in this respect. China does have a technological advantage, but only over other developing countries such as Vietnam and Laos, to which China is now outsourcing labour. The only factor left and the real determinant of economic growth in China, is investment or capital.

In Chapter 11 of Macroeconomics Robert Barro discusses economic growth and provides growth rates of real GDP (Gross Domestic Product) of nine industrialized countries during the 50s, 60s and 70s. He concludes that "as the theory predicts, the countries that start with less capital per person experience faster growth rates of output per capita and also invest a larger fraction of their output" (p. 302). My wholly unscientific claim is that China is no exception.

What struck me most about Hong Kong and what also emerges from James Kynge's "China Shakes the World" is the fact that everyone from small business men to large corporations is investing whatever they earn. There may be various "institutional" factors at play here: the fact that it is or has been difficult for Chinese firms and individuals to invest abroad and the fact that there are few or fewer barriers to starting a business compared to other countries. With a needle and a thread you can sew on buttons. With the money you earn you can buy a sewing machine. Etc.

Another factor in China's growth is the existence of multiple and competing supply chains or business chains in areas such as the Pearl River Delta (Shenzhen, Guangzhou), Chongqing and Shanghai. Manufacturers can choose between competing suppliers and all half-products can be sourced in the same area. Shenzhen and Shanghai have the further advantage of having major container ports.

I'm taking a few shortcuts here and the topic deserves a deeper analysis, substantiated by comparative economic data, but to summarize, standard economic theory provides the tools to explain the rise of China as an economic superpower.

Further reading:

Robert E. Lucas, Jr. "A Million Mutinies. The Key to Economic Development". Excerpt from Lectures on Economic Growth by Robert E. Lucas Jr. Harvard University Press (2002).
Robert M. Solow, "Growth Theory and After". Lecture to the memory of Alfred Nobel, December 8, 1987.

Two classic but technical papers:

Robert E. Lucas jr. "On The Mechanics Of Economic Development", Journal of Monetary Economics 22 (1988) 3-42.
Robert Solow, "A Contribution to the Theory of Economic Growth", Quarterly Journal of Economics, Vol. 70, No. 1 (1956) 65-94.