Stoking the engines of China’s next growth wave

Asia Business Politics Uncategorized World

Authors: Ligang Song, ANU, Yixiao Zhou, ANU, and Luke Hurst, Asialink Business

The highly publicised meeting between US President Donald Trump and Chinese President Xi Jinping at the recent G20 Osaka summit signals a temporary truce in the trade war between the world’s two largest economies. While the return of China and the United States to the negotiating table may give international markets some breathing space, big questions about global growth remain.

A Chinese flag is seen near a construction site in Beijing's central business area, China, 17 January 2017. (Photo: REUTERS/Jason Lee)

A Chinese flag is seen near a construction site in Beijing's central business area, China, 17 January 2017. (Photo: REUTERS/Jason Lee)

Central to this is whether a rising China will continue to grow and transition into a high-income economy, or whether trade tensions — and other complex domestic headwinds — will derail this growth.

Over the past four decades, China has experienced three growth surges — the initial ‘reform and opening up’ from the late 1970s, taxation reform in the 1990s, and accession to the World Trade Organization in 2001. This incremental approach to reform transformed China into the largest contributor to global economic growth. Its economy averaged annual growth of more than 9 per cent from 1978 to 2018 with per capita income reaching US$9723 and total foreign trade reaching US$4.6 trillion in 2018.

China’s current growth is still robust but has slowed considerably since 2010. Buffeted by an ongoing drop in domestic productivity, an ageing population and a decline in domestic savings, China finds itself at an economic crossroads where tough choices are required to enable future growth.

There is still great scope for further reforms to unleash a new round of high-quality growth in China.

For China to achieve this transition to a high-income economy, it will be essential to stoke the fires of three growth engines. These are not newly-found sources of growth but are areas that have long been identified as critical, yet still have great room for reform and improvement.

The first growth engine will be fuelled by deep institutional reform to drive improvements in the business and regulatory environment and deepen integration with global markets.

In the latest World Bank Ease of Doing Business index, China ranked only 46 out of 190 — for comparison Hong Kong ranked 4th, Australia 18th, and Kosovo was 44th.

Deepening institutional reform will require China and its trading partners to uphold the multilateral trading system, while exploring how that system can be reformed to accommodate new trade and investment flows. This is both pressing and confronting given the current trend of ‘deglobalisation’, rising protectionism, and the global ‘rules based economic disorder’.

Although uncertainty around the future of globalisation is high, the temporary truce between the United States and China could provide a boost to growth prospects for both sides as well as the wider global economy.

To improve the business environment and encourage investment, the Chinese government has lowered value-added tax from 16 to 13 per cent. Even though the policy saw a fall in tax revenue in the first half of this year, it is expected that the policy will enhance growth from the second half of 2019. The impact of this significant change in fiscal policy can be further enhanced by possible cuts in official interest rates, following similar attempts by a number of economies including Australia, to boost economic growth.

The second engine of growth will be stoked by continuing to open the door to global innovation and foreign investment.

China’s goods, capital and labour markets have all been liberalised to varying degrees over the past four decades. But China needs to continue to lower barriers to market entry if it is to encourage global collaboration on research, innovation and business. There are a number of promising moves in this direction — for example, China’s new Foreign Investment Law adds the principle of ‘non-interference’ to the FDI approval process and increases financial penalties for those who infringe trademark rights. In financial services, caps on foreign ownership of local banks were removed and foreign insurance companies were allowed to establish businesses.

These policies are helping China to increase its attractiveness as a destination for FDI. But significant potential remains to grow the total share of FDI in China’s overall investment. This will become increasingly important as domestic savings fall and new FDI is required to sustain growth.

The third engine will be powered by China’s capacity to realise its human capital potential and contribute to the global talent pool. Significant education and skills gaps need to be addressed to alleviate poverty and quell rising income inequality.

The Chinese economy remains short on human capital compared with other developing and advanced economies. Only around 25 per cent of China’s entire workforce (aged 25–64 years) have obtained upper-secondary school education, compared to around 75 per cent of the workforce average in high-income OECD countries.

China’s continued investment in education and training will need to be a policy priority, with human capital underwriting innovation and knowledge-based growth. This is also an area where there is considerable scope to deepen collaboration with international partners such as Australia, where Chinese students already make up almost one third of Australia’s AU$35.2 billion (US$24.4 billion) international education export income.

Despite a challenging global and domestic backdrop, by pulling the right policy levers there is significant potential for China to unlock a new round of high-quality growth and continue its transition to a high-income economy. But further robust reform and ongoing integration into global markets will be required.

To draw on one of Xi Jinping’s more recent metaphors, China will need to ‘dare to chew the tough bones and navigate the rough waters’ as it stokes-up its growth engines in the challenging period ahead. To stoke the three growth engines requires great political courage — none present low-hanging fruits in reform and growth-enhancing policies.

Ligang Song is Professor and Director of China Economy Program at Crawford School of Public Policy, the Australian National University.

Yixiao Zhou is Senior Lecturer at Crawford School of Public Policy, the Australian National University.

Luke Hurst is the Director of Research and Information at Asialink Business.

This article is based on research published in the 2019 China Update to be launched by ANU’s China Economy Program on 12 July.