The Agenda

Stephen Roach on China’s New Model

Stephen Roach writes on the Chinese government’s efforts to shift from a focus on promoting export-oriented growth to a new focus on increasing domestic consumption in its new Five Year Plan, a decision that will hopefully contribute to global rebalancing:

First, China will begin to wean itself from the manufacturing model that has underpinned export- and investment-led growth. While the manufacturing approach served China well for 30 years, its dependence on capital-intensive, labor-saving productivity enhancement makes it incapable of absorbing the country’s massive labor surplus.

Instead, under the new plan, China will adopt a more labor-intensive service model. It will, one hopes, provide a detailed blueprint for the development of large-scale transactions-intensive industries such as the wholesale and retail trade, domestic transport and supply-chain logistics, health care and leisure and hospitality.

[…]

The new plan’s second pro-consumption initiative will seek to boost wages. The main focus will be the lagging wages of rural workers, whose per capita incomes are currently only 30 percent of those in urban areas. Among the reforms will be tax policies aimed at boosting rural purchasing power, measures to broaden rural land ownership and technology-led pro-grams to raise agricultural productivity. But the greatest leverage will undoubtedly come from policies that foster ongoing and rapid migration from the countryside to the cities. Since 2000, annual rural-to-urban migration has been running consistently at 15-20 million people. For migration to continue at this pace, China will have to relax the long-entrenched strictures of its hukou, or household registration system, which limits labor-market flexibility by tethering workers and their benefits to their birthplace.

Roach is mostly optimistic about the outcome of this shift, though he offers a caveat:

It would also be a huge boost for China’s major trading partners — not just those in East Asia, but also growth-constrained European and U.S. economies. Indeed, the 12th Five-Year Plan is likely to spark the greatest consumption story in modern history. Today’s post-crisis world could hardly ask for more.But there is a catch: in shifting to a more consumption-led dynamic, China will reduce its surplus saving and have less left over to fund the ongoing saving deficits of countries like the U.S. The possibility of such an asymmetrical global rebalancing — with China taking the lead and the developed world dragging its feet — could be the key unintended consequence of China’s 12th Five-Year Plan.

I have a few thoughts. Last June, Barry Eichengreen described the weakness of the Chinese service sector:

 

In countries that have traditionally emphasized manufacturing, the underdeveloped service sector is dominated by small enterprises – mom and pop stores. These lack the scale to be efficient, the ability to exploit modern information technology, and the capacity to undertake research and development. In Korea, less than 10% of economy-wide R&D has been directed at the service sector in the last decade. This stands in sharp contrast to the US, where half of all R&D is associated with services. Enough said.

In both Korea and Japan, large firms’ entry into the service sector is impeded by restrictive regulation, for which small producers are an influential lobby. Regulation prevents wholesalers from branching downstream into retailing, and vice versa. Foreign firms that are carriers of innovative organizational knowledge and technology are barred from coming in. Accountants, architects, attorneys, and engineers all then jump on the bandwagon, using restrictive licensing requirements to limit supply, competition, and foreign entry.

One can well imagine Chinese shopkeepers, butchers, and health-care workers following this example. The results would be devastating. Where value added in Chinese manufacturing has been growing by 8% a year, service-sector productivity is unlikely to exceed 1% if China is unlucky or unwise enough to follow the example of Korea and Japan.

Employing workers in sectors where their productivity is stagnant would not be a recipe for social stability. China needs to avoid the pattern by which past neglect of the service sector creates a class of incumbents who use political means to maintain their position. Perhaps China will succeed in avoiding this fate. Here at least may be one not-so-grim advantage to not being a democracy.

That’s one way of looking at it. But I think Eichengreen is missing something. Rapid growth has been a political balm. If a transition to a more service-driven economy leads to slower but, as Roach argues, more jobs-intensive growth, new political pressures will build. If anything, a transition to a more balanced, consumption-led growth model strengthens the case for political reform. Indigenous entrepreneurship requires a level of mobility and social freedom that represents a threat to one-party rule, and managing the pressures associated with even more internal migration, the hunger for higher-quality public services and a responsive social safety net, etc., will raise the perceived costs associated with corruption.

I simply don’t believe that China can make this transition without becoming more democratic. Eichengreen’s take, that the CCP will be better equipped to handle political pressure from mom-and-pops, strikes me as myopic. One can imagine the CCP facing a Poujadist and a workers’ revolt at the same time. 

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.

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