China’s Three Transformations for National Rejuvenation

The quarter century mark into the 21^st century is a propitious moment to take stock of the remarkable progress of the Chinese economy.

At the turn of the century, China was a USD 1.2 trillion economy (measured in current USD), barely 12 per cent of the size of the U.S. economy. Twenty-five years later, as the National Bureau of Statistics’ recent estimates of GDP denote, China’s USD 20 trillion economy is two-thirds the size of the U.S. economy. And there is still tremendous room for catch-up growth. Its more adverse demographics notwithstanding, there is ample pent-up growth awaiting release in the on-going transitions from state to market and from rural to urban. When a USD 35,000 per capita GDP spawns an overall USD 50 trillion economy at the half-century mark into the 21^st century, the Chinese economy will outrank the U.S. economy by size.

That China is poised to become the world’s largest economy during the second quarter of the 21^st century does not mean that it is inevitable. The policy emphasis on “high-standard opening-up” and the integration of “high-quality development” and “national security” suggests a calibrated yet decisive strategy to fortify China’s economic foundations while navigating a complex external environment. To understand the potential pathways implied by these strategic directions, we must look for three landmark transformations.

First, a successful transition hinges on transforming its peerless China’s manufacturing ecosystem from global production hub to indispensable innovation partner. The ambition to build a secure, controllable modern industrial system under high-standard openness would be greatly advanced by attracting global R&D functions, leveraging China’s world-class innovative ecosystems to complement its unparalleled manufacturing clusters. The global market leadership that Chinese enterprises have displayed in the commercialization of green technologies can be replicated in other key industrial chain technologies and products. These include industrial machine tools, medical equipment, integrated circuits, high-end instrumentation, industrial software, and advanced materials. Just as it has been an iron fact for the past 25 years that no major internationally competitive manufacturing firm could prosper in the global marketplace without a China onshoring strategy, so also it must become an unchallengeable proposition for the next 25 years that the onshoring of R&D functions in China is key to global success. This requires further rationalization of China’s market access restrictions and alignment of its industrial policy with high-standard international rules, enabling firms to sustain global competitiveness through deep integration into China’s innovation chain  

Second, rebalancing the economy towards a consumption-led model depends fundamentally on accelerating services sector liberalization to boost household income and demand.​

The share of China’s household consumption as a share of GDP remains a good 10 percentage points less than comparable upper middle-income economies. Eleven consecutive quarters of supply-demand imbalances-led deflation has also brought to the fore the difficulty of aggregate demand management in an economy as large and complex as China’s. A new development pattern with the domestic cycle as the main body and the domestic and international dual cycles promoting each other will not take hold until domestic demand is stronger and stable. For this to be the case, the labor share of national income must rise on the back of liberalization of the services sector, given that the vast majority of Chinese workers will continue to be employed in the services sector – rather than in capital-intensive advanced manufacturing – and low productivity growth therein will constrain wages, squeeze consumptive demand and impede rebalancing.

Progressive further opening of the financial services sector must be at the core of services sector liberalization. The wider presence of private institutional investors will increase the range of available savings instruments for households and check their tendency to crowd into property assets. Equally, their superior credit assessment ability will ensure a more liquid availability of funds for corporate borrowers while checking their tendency to herd into favored industrial sectors and foment involution-style excess capacity. Market discipline rather than administrative discipline as well as the unwinding of implicit guarantees must become the norm – even as the central government redirects capital towards key strategic emerging industries. 

Finally, achieving “common prosperity” requires a fiscally sustainable approach that stimulates opportunity while strengthening the social safety net, avoiding the pitfalls of either inadequate protection or welfare-driven imbalances.​

On the one hand, socio-economic precarity must not act as a bottleneck for consumption and growth. The central government should place an increased share of fiscal resources at the disposal of local governments as well as bear a greater share of social protection-related expenditure on its balance sheet. The former will enable local governments to plug their structural revenue deficits as well as transition away from the land-based model of finance which is no longer sustainable. Performance assessment of local government officials should be tied to criteria such as local income and employment growth and the provision of public services. The latter, meanwhile, will align expenditures with fiscal capacity, including taxes with the greatest redistributive impact such as the personal income tax and the capital gains tax, while reducing households’ propensity for excess savings.

On the other hand, entrepreneurialism and wealth creation, not egalitarianism or welfarism, must remain the engine of China’s pursuit of ‘common prosperity’. Transfer payments should not disincentivize work nor saddle government balance sheets excessively. It is instructive that the country is still reckoning with the ill-effects of the excess LGFV-sparked investment boom of the post-Global Financial Crisis era. It must not replicate a similar unraveling on the consumption side, fueled by unsustainable transfer payments-related expenditures.      

The international economic system stands at a moment of great flux, buffeted by the furies of protectionism, populism and economic nationalism unleashed by some of its largest constituents. The successful realization of the three landmark transformations by mid-century will ensure that China not only stands head-and-shoulders above its economic peers but that it can serve as a beacon of hope for the international system, underwriting its growth, prosperity and stability.