China’s slowing productivity

  • China’s GDP expanded 6.9% in the first three months of 2017, the fastest rate since the third quarter of 2015
  • However, total factor productivity, which grew on average of 2.7% a year from 1998 to 2007, has grown almost zero % since. By contrast, the US productivity growth has fallen from 1% to 0.5% over the same period.
  • Total factor productivity is the extra output that the economy produces without additional labour or capital – it is what drives economic propserity.
  • Productivity growth was expected to slow after the initial industrialisation boom,  development of supply chains, and new technologies, but not to this extent.
  • This productivity drop can be attributed to China’s 4 trillion yuan stimulus program in 2008-  mainly directed at state-owned enterprises-  to help combat the effects of the GFC by propping up growth and avoiding mass unemployment.
  • While the increased government expenditure helped avoid an economic bust, the focus on SOE’s damaged the private sector.
  • Currently, SOE’s receive almost 30% of all loans but contribute less than a tenth of GDP, according to Gavekal Dragonomics, a Bejing economic consulting firm.
  • “The government’s repeated use of state-owned enterprises to stimulate short-term activity has weakened the private sector and lowered productivity growth,” Andrew Batson, research director at Dragonomics, wrote in a May report. As a result, China is “increasingly locked into a slower-growth future.”
  • While in most economies market competition helps drive productivity gains, China’s promotion of industrial policy has only intensified under President Xi Jinping. This is evident in the launch two years ago of Made in China 2025, a blueprint for a comprehensive industrial upgrade to complement the 13th Five-Year Plan. It aims to foster such fields as aerospace, robotics, and new energy vehicles through a combination of easy credit, subsidies, and tax breaks.
  • Further, under-performing firms, normally eradicated in a normal market economy, are driving under productivty through the government’s continued support of them to maintain employment i.e. corporate zombies.
  • China also offers tax breaks to companies that invest in research and development, while some local governments, including Guangdong’s, provide subsidies for each robot a company purchases. SOE’s are better positioned to take advantage of such provisions due to their ties to Communist party cadres: 75% of SOES spend money on R&D and 14% have robots, while private companies spend 42% on R&D and 6% on robots (according to survey of 1200 businesses by Wuhan University)
  • Over the past decade, the average monthly manufacturing wage has more than doubled, to 4,126 yuan, higher than in Mexico and Malaysia. Productivity is failing to keep pace with rising wages, putting great pressures on the profits of private firms.
  • The productivity gains before 2008 resulted from a series of market-opening reforms, including the shuttering of tens of thousands of SOES starting in the late 90’s, and the lowering of import tariffs and other barriers to competition – a condition for the country’s entry into the WTO in 2001.
  • Thus Xi Jinping can now replicate those market reforms by opening protected sectors of the economy, such as telecommunications and freight hauling, to competition and allow more zombie companies to die. This will allow greater resource allocation and improve efficiency.

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