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China Credit Spotlight: The Great Game And An Inescapable Slowdown


Economic Research: Economic Outlook Emerging Markets Q1 2024: Challenging Global Conditions Will Constrain Growth


Economic Research: Economic Outlook U.S. Q1 2024: Cooling Off But Not Breaking


Economic Outlook Canada Q1 2024: Growth Is Set To Continue Slowing


U.K. Economic Outlook 2024: More Stagflation Ahead

China Credit Spotlight: The Great Game And An Inescapable Slowdown

China's growth slowdown will extend through 2030. Deteriorating demographics and declining productivity growth mean this is almost 100% guaranteed. Of course, there are two known unknowns:

  • How much will growth slow?
  • Will the slowdown be gradual or bumpy?

China's "New Normal," a concept formally unveiled in early 2014, explicitly recognizes that growth will slow. In response, policymakers have been trying to address these two known unknowns with a two-pronged strategy.

First, supply-side reform. The main idea is to foster a more innovative economy that relies less on the old drivers of growth and more on advanced manufacturing and technology-enabled services. This vision was set out clearly in the 2015 13th Five-Year Plan. [1] This strategy aims at lifting productivity and ensuring China can continue to grow relatively quickly, despite the structural forces slowing growth.

Second, reducing financial risks. The main focus has been to strengthen supervision and regulation, tighten budget constraints, and, in some cases, introduce a greater role for market forces. S&P Global Ratings interprets these efforts as aiming at smoothing the economy's descent and avoiding the turbulence associated with financial instability.

It is arguable how much progress China had made with this strategy before the Great Game--the tussle with the U.S. over trade, investment, and technology--began in early 2018. On supply-side reform, private firms have ignited growth in sectors such as e-commerce, fintech, and advanced manufacturing. At the same time, there are other signs, including an increasing state-owned enterprise footprint in the economy, that the balance has tilted toward the state and away from the market. China made progress in reducing financial risks but the costs to near-term growth were becoming painfully apparent at the end of 2018. Develeraging has paused more recently.

The "New Great Game" is a serious complicating factor. We define this game from an economic and financial perspective, as a strategic interaction in which both players adjust trade, investment, and technology policies in a unilateral and discretionary way to achieve their objectives. We would distinguish this from a multilateral rules-based relationship associated with high levels of trust and cooperation.

Our view is that a prolonged Great Game--the absence of a lasting deal on trade, investment, and technology--will make China's slowdown harder to manage. Other economies will also suffer costs but here we focus on China. Our reasoning is simple.

  • Opening up to foreign trade and investment and reforms unleashed technology-enabled productivity and fueled China's growth surges of the past four decades.
  • The Great Game and sluggish reform momentum may slow the pace at which China acquires, creates, and deploys technology across its economy.
  • In turn, this would slow productivity growth, which is the economy's only remaining rocket booster.

In short, we believe that the more local China becomes, the slower it will likely grow.

There are upside scenarios. China could surprise the world by both localizing and developing frontier technology rapidly. This is possible but we think unlikely. Based on our reading of the historical evidence, the pace of technological change for countries catching up to the frontier is usually faster when they are more open. We do not dispute China's capacity to reach the frontier, on its own, at some future date. We do think this will take longer if it mainly relies on self-reliant innovation.

A more plausible upside over a 10-year horizon is that China moves quicker on opening up and market-based reforms. That may not only defuse the Great Game but also sustain productivity growth. In this scenario, China would still slow but would continue to outperform global growth. Much will depend on the path China chooses.

China's Four Golden Decades

In the 25 years before China's opening up in 1978, growth was highly volatile and low on average for such a poor country at just 6%. Since then, China has enjoyed four golden decades in which it has grown faster than the rest of the world every year. It has avoided major economic and financial crises and the economy has expanded at an average rate of about 9%.

Opening up and reforms foreshadowed surges in growth

Many reasons lie behind China's spectacular performance over the last 40 years. Still, we think it is no coincidence that breakthrough reforms that opened China to the world and provided a larger role for markets in the economy preceded sustained surges in growth. Three inflexion points are noteworthy:

  • 1978: the start of opening up and market-based agricultural reform.
  • 1992: Deng Xiaoping's southern tour and the growth of special economic zones.
  • Late-1990s: State-owned enterprise (SOE) reform and financial sector clean-up in the run-up to World Trade Organization (WTO) entry in 2002.

China's growth rose, often for as long as a decade, following these breakthrough reforms (see chart 1). Another pattern is evident. These reforms, which required politically hard choices and, in the short term, often entailed painful economic costs, followed periods in which growth was faltering. This is a testament to China's ability to change course in the face of looming economic challenges.

Chart 1


China's extraordinary catch-up…

China was very poor before opening up and should have been growing rapidly. In 1978, official data show that per capita income was less than 2% of that in the United States. From a low base, China is following the footsteps of its most successful neighbors Japan and Korea, as we show in chart 2. This compares real incomes per capita, relative to the U.S., for all three economies at the start of their high growth periods. We have adjusted the scale to reflect progress; while a rise to 10% from about 1% may not seem much, in reality, it means China became more than 10x richer relative to the U.S. To repeat that success from 10% would mean getting to 100%. We have also included alternative data for income per capita from the well-known Penn World Tables (see sidebar: Alternative Histories Of Growth).

We draw two comforting conclusions from this picture. First, China was much poorer when it began its high-growth period than either Japan or Korea. This gives China more headroom to keep growing relatively quickly. Second, China's progress is good but not unprecedented.

Chart 2


… means China is now comfortably middle income…

A simple way to express China's progress is by comparing income per capita in U.S. dollars at 2018 prices across countries. Table 1 shows how far China's income capita has come and how it compares with the average, or median economy.

Table 1

China's Rise Through The Income Ranks
Economy GDP size
Year Median Closest to China Median Closest to China China United States
1980 Angola Ethiopia 5,936 818 812 32,778
1990 Thailand Tanzania 7,422 1,708 1,705 41,344
2000 Serbia Angola 8,698 4,193 4,142 51,344
2010 Dominica Jordan 11,578 10,710 10,623 55,590
2018 Bosnia Azerbaijan 13,491 18,076 18,110 62,606
Note: GDP per capita in 2018 U.S. dollars measured using PPP exchange rates. Sources: World Bank, International Monetary Fund, and S&P Global Economics.

We take a broader perspective in chart 3 and show China's income per capita compared with a distribution of 194 economies each year since 1980. China's climb through the income distribution has been steady since 1978 and exceeded the median country less than a decade ago. The message is clear--China is now comfortably middle income but is still some way from being a rich country.

Chart 3


…but poorer provinces still have headroom

As China has become richer, the income gap across provinces has narrowed somewhat but remains stubbornly wide. Table 2 shows the average GDP per capita for the richest and poorest three provinces. We compare these provinces to countries with similar income levels and see a range from low-income to upper-middle income peers.

Table 2

More Than One Chinese Economy
Economy closest to China's: GDP size
Year Richest 3 provinces Poorest 3 provinces Rich peer country Poor peer country China's Richest 3 provinces China's Poorest 3 provinces
1980 Cape Verde Lesotho 800 508 794 510
1990 Nigeria Madagascar 2,037 1,078 2,048 1,068
2000 Paraguay India 6,400 2,026 6,327 2,028
2010 Uruguay Nigeria 16,623 5,126 16,716 5,201
2018 Greece Fiji 29,123 10,234 28,966 10,419
Note: GDP per capita in 2018 U.S. dollars measured using PPP exchange rates. Excludes Beijing, Shanghai, and Tianjin. Source: World Bank, International Monetary Fund, and S&P Global Economics.

Chart 4 shows that the three provinces with the highest income per capita earn about 3x as much as the bottom three, which is very close to the average multiple between the top and bottom three since the start of China's golden period. (We exclude the municipalities of Beijing, Shanghai, and Tianjin.) While this shows the extremes of the distribution, the general picture does not change much if we include all provinces.

Chart 4


One interpretation of Chart 4 is that China's economy resembles a fast locomotive pulling carriages. In other words, the richer coastal provinces that have most enjoyed the fruits of opening up drag their poorer peers behind them. Of course, the reality is more complex. When we think about long-term growth, the key question is whether, if the rich provinces slow down, can the poorer laggards ignite growth, close the gap, and prevent the overall economy from stalling. Can Gansu become more like Jiangsu?

Table 3

Previous Research Has Concluded China's GDP Growth Is Overstated
Reason Why This Could Overstate Growth Key papers (see references)
Service sector productivity Estimates of growth in this sector well above the historical experience in a broad range of countries. [2], [3]
Employment data breaks Large unexplained rises in employment in earlier periods may understate the historical level of GDP and overstate subsequent growth. [4]
Price indexes Possible downward bias to the change in price indexes which, when used to deflate nominal output, results in higher growth. [5]
Alternative data Broader range of data that are likely correlated with output (e.g., value-added tax receipts and satellite night light imagery) are consistent with lower growth. [6], [7]
Source: S&P Global Economics.

China's Productivity Booster Rocket Is Losing Power

We find it helpful to unpack China's growth from the supply side and we show the results in chart 5 (see Appendix for details). Here are our takeaways from this breakdown. First, the economy benefitted from a rising number of people of working age, the so-called "demographic dividend," in the 1970s and 1980s (the light blue bar). Second, these workers were steadily more educated and skilled, which added to the economy's potential (the yellow bar). Third, high investment rates and rapid accumulation of fixed capital has also lifted growth, especially in the last decade (the brown bar).

Our main conclusion, though, is that productivity--China's ability to get more out of the same amount of capital and labor--has been the booster rocket driving China's rapid growth over the past four decades (the pink bar.) The official data suggest that productivity lifted growth by more than 5 percentage points between the 1980s and the 2000s, making it the biggest contributor, by far, to China's stellar performance.

Chart 5


China's productivity booster rocket, while not flaming out, is now waning. Chart 6 shows an estimate of trend productivity growth based on official and alternative data (in this case the University of Groningen's Penn World Table 9.1 or PWT). [10] Official data point to a rise in trend productivity growth that happened earlier and was more powerful than suggested by the PWT. Still, both illustrate a surge and a pronounced slowdown that began just after the global financial crisis of 2008.

Chart 6


Productivity's substantial contribution to China's growth since 1980 suggests we must have a view of its future path if we are in the business of medium-term forecasts. There are good reasons to expect productivity growth to continue slowing and trade-tech tensions with the U.S. are likely to apply more downward pressure.

China's Inescapable Slowdown

After four Golden Decades, China now faces an inescapable slowdown through the next decade and beyond. This is due to four deep, structural factors.

  • Demographics: China's labor force has peaked and has begun to shrink--steadily for now but more quickly over time.
  • Deleveraging: China will rely less on debt-financed capital accumulation to guard against financial stability risks.
  • Convergence: China is getting richer and there is less scope for technology transfer and catch-up, especially in richer locomotive provinces.
  • Rebalancing: Services will drive the economy more than manufacturing. Productivity growth is--always and everywhere--slower in services.
Demographic destiny means fewer workers

Chart 7 shows that China may have passed the Lewis Turning Point--the transition from a labor-surplus to a labor-shortage economy--just a few years ago. [11] This is not just due to demographics--it also depends on surplus agricultural labor--but declining fertility rates will be the main driver in the future. The United Nations estimates that the working-age population grew fastest in the 1980s at over 2.6% per year and projects that it will hardly grow at all in the 2010s before shrinking by 0.3% per year in the 2020s.

Chart 7


Rising labor force participation, that is more people of working age making themselves available for employment, is unlikely to offset this trend. Participation rates fell steadily by about 10 percentage points to 70% over the past three decades, based on different estimates. [12] Persistent factors, such as the 1990s' restructuring of state-owned enterprises (which eliminated many regular jobs) and more students attending tertiary education, are unlikely to reverse.

Deleveraging leaves limited space for capital accumulation

China can no longer rely on exceptionally high investment rates and rapid capital accumulation for growth. The reasons are well known. While investment, largely funded by credit, helped the economy grow since 2008, there is strong evidence that the marginal return on capital has fallen. Debt may also be increasingly used to buy existing assets rather than new productive capital. This has contributed to the debt problem.

One way to see this is a higher credit intensity of growth--the amount of non-financial sector credit associated with a RMB1 rise in GDP has risen from about 1x before 2008 to about 3x since then (we exclude central government borrowing from our measure of credit). Credit intensity will determine the steady-state debt-to-GDP ratio. If intensity averages 3x over a sustained period, then debt-to-GDP will settle at 300%.

S&P Global Ratings believes that deleveraging remains a policy objective for China. At an economy-wide level, the People's Bank of China (PBOC) has focused on "macro leverage," which it has defined as gross debt as a percentage of GDP for all sectors of the economy. [13] Last year, the PBOC discussed explicitly its expectation that macro leverage would stabilize in the future, which we interpret as an objective to achieve a steady (or even declining) debt-to-GDP ratio.

Putting this together, if the marginal return on capital remains lower than in the past, investment remains largely debt-funded and policymakers are targeting a stabilization in macro leverage, the space for further capital accumulation is limited.

Rebalancing means a larger role for services

Services are driving growth more than in the past, as they should while China becomes richer and consumers acquire a larger slice of the income pie (see chart 8). Rebalancing from manufacturing to services and investment to consumption (see chart 9) is healthy because it should reflect lower saving and investment. In turn, this would slow the rise in macro leverage and result in safer growth.

Chart 8


Chart 9


However, rebalancing also means slower growth. Evidence from China and across the world is clear that productivity growth in services is lower than in manufacturing. [14] As we show below, manufacturing in China has retained a 3-percentage-point labor productivity advantage over services since 2010. Even the emergence of the new service economy, powered by e-commerce and fintech, has been unable to close this gap.

Technology's Starring Role In Growth

We think the pace of the slowdown will depend largely on China's ability to acquire, create, and deploy technology. This is not just about the technology sector--structural reforms that create more space for the private sector and markets would facilitate a stronger push into tech and knowledge-intensive industries across the economy. For example, leveling the playing field between SOEs and private firms, including foreign firms, would help capital and labor flow toward more innovative parts of the economy. We think it is no coincidence that many of China's new economy tech champions are private firms.

Technology and manufacturing productivity growth outpace that in services

Our conviction that technology is so important comes from the data. We have estimated productivity across industries in China between 1980 and 2010. We define productivity growth here as "total factor productivity" or TFP for short. TFP is the change in real gross value added not accounted for by changes in labor and capital inputs. TFP usually represents better technology, knowledge, and efficiency (see Appendix for details).

These estimates use the China Industrial Productivity (CIP) Database meticulously constructed from input-output tables by the Research Institute of Economy, Trade, and Industry. [15] The input-output tables are consistent with official GDP data. Although somewhat dated, these data do illustrate long-term trends.

Chart 10 shows a dramatic productivity outperformance by manufacturing industries over service industries. The numbers are not even close--we estimate that between 1980 and 2010, productivity growth in information and communication equipment (ICT) manufacturing rose by a compound annual rate of above 10%. Other advanced manufacturing activities also experienced rising productivity, including transport equipment and machinery.

The service sector grew mostly by adding workers

Most service sectors saw productivity stagnate or worse even as, between the early 1990s and 2010, the service sector's contribution to growth roughly doubled to 50%. The answer to this apparent puzzle is that the service sector grew mainly by employing more workers. In the early 1990s, the service sector employed about 130 million people, a bit less than the manufacturing sector. By 2010, service sector employment had almost doubled to 260 million people, almost 50 million more than in manufacturing.

Chart 10


The labor-driven services story has been true over most of the last 40 years in China…

This growth story is evident when we consider less granular but more recent data. Chart 11 shows that across tech-related and knowledge-intensive industries (including pharmaceuticals) labor productivity growth has powered above the economy's average and been twice the level recorded in services. Labor productivity is a slightly different concept from the total factor productivity shown in Chart 10 because investment in new capital can raise output per employee.

Still, the broad story is the same--the service sector is growing because it is absorbing workers. Since 2010, service industries have added almost 100 million workers while manufacturing industries have shed 5 million workers.

Chart 11


…and across countries

Manufacturing and technology's special role in driving productivity and convergence to rich country income levels is a global story. We have quite strong evidence that the manufacturing sector drives a convergence of income levels across countries. Evidence of convergence in the broader economy, including the service sector, is much weaker especially if we do not take into account other economy-specific factors, such as the quality of institutions.

Recent research shows that the manufacturing sector is the most effective vehicle for catch-up. Harvard University's Dani Rodrik found strong evidence of convergence in output per worker across aggregate manufacturing industries. [16] He estimated a global convergence rate of almost 3%, which means that an industry which is half as productive as the most advanced firms should enjoy a convergence boost to its productivity growth of about 2 percentage points. This brings our story to the trade and technology tension with the U.S. and why it matters for China's long-term prospects.

The New Great Game Matters For Long-Run Growth

China's evolving relationship with the U.S. has many dimensions, but looking through an economics lens, technology, not trade, is at its heart (see S&P Global Ratings' report, "The Great Game: the U.S., China, and Technology," published May 2019). Within technology, we include knowledge-intensive industries such as health sciences. We say this for three reasons:

  • Issues: Economic stress points are most apparent in the tech- and knowledge-intensive sectors;
  • Policies: Measures taken by the U.S. will have the largest impact on the tech sector; and
  • Growth: Technology and knowledge acquisition is critical for China's medium-term growth path.
The Great Game will affect many players, not just China

Although we focus on China here, we should recognize that many players, not just China, would feel the economic pain of a prolonged Great Game. Other economies would suffer from China's slower demand but also reduced access to its burgeoning new economy, innovative eco-systems, and the diversity of ideas and opportunities that such a large country provides.

How the Great Game will evolve is uncertain and is a subject best left to political scientists. Nevertheless, the gap between the two sides appears to have widened over the past year and may not be easily closed. One or both parties may need to compromise on some of the "red lines" each has drawn since the start of 2018 to reach a deal that would re-open trade and investment flows.

Technology transfer to China may be affected

Our focus is on the economic implications for China. Until now, we have told a story that features technology as a lead character in driving China's four golden decades of growth. The world changes but we continue to see technology, through its impact on productivity, as the most important driver of China's growth over the next decade.

The Great Game matters because it could affect the rate of technology transfer to, and innovation in, China. The three main policies adopted by the U.S.--investment restrictions, export controls, and tariffs--all potentially affect China's access to technology. The first two affect China's access directly, and tariffs, more indirectly, by weakening incentives to locate supply chains in China.

We believe China's acquisition and development of technology would likely be faster in a world with lower trade, investment, and human capital barriers. Technological progress depends on new ideas, learning-by-doing, and exposure to global competition. The more local China becomes, the slower it will likely grow.

Foreign Direct Investment Is A Key Channel Of Tech Transfer

Foreign direct investment (FDI), especially when it leads to more activities by multinational corporations (MNCs), offers knowledge and technology transfer through many legitimate channels. Recruitment of foreign-trained employees by domestic firms, joint ventures, collaboration with local suppliers, and legitimate imitation all contribute to transfers. [17] Weak intellectual property (IP) protection may also spread technology but this may be a less powerful channel than it appears. Indeed, strong IP protections may boost the transfer of technology in the long term if they encourage MNCs to bring more technology into local production markets and share with local partners.

Evidence points to strong channels of technology-related productivity spillovers from MNCs in China. Many micro-level studies find strong productivity spillovers from MNCs to domestic firms, especially from companies headquartered in advanced economies.

These spillovers mainly benefitted other firms in the same province or region--there was less evidence that productivity spillovers stretched nationwide. This is consistent with the "locomotive" model of growth we suggested earlier, in which richer provinces stayed relatively rich. [18] Vertical effects are often stronger than horizontal effects--in other words, MNCs mostly affect the productivity of upstream domestic suppliers rather than domestic firms competing in the same industry. [19]

Both FDI inflows and outflows are important for China

Unlike many developing countries, China was never satisfied with the "passive recipient" FDI model. A few years ago, China appeared to update its strategy and began scouring the planet in search of technology it does not yet have but wants to acquire quickly. Chinese firms are now trying to acquire large or controlling stakes in foreign businesses that own valuable technology IP. Examples of notable successes in 2016, a peak year for FDI outflows, include: (i) the Midea Group Co.'s US$5 billion acquisition of 25.1% stake in the German industrial robotics maker Kuka AG and; (ii) Tianjin Tianhai's US$6 billion acquisition of technology distributor Ingram Micro Inc.

Acquisitions are recorded as FDI and a changed direction of net FDI flows hints at this strategic shift. Chinese FDI outflows to advanced economies more than doubled in 2016 to above US$30 billion. Manufacturing and technology investment saw the largest increases, suggesting currency-related capital outflows were less important than in 2015.

But China's FDI is now falling

Chart 12 shows that China's FDI flows to and from large advanced economies have plummeted over the past decade. The two waves of large FDI inflows that followed China's opening up in 1992 and 2002 are evident--a period when productivity and growth surged. Also evident is the persistent decline in flows over the past decade. Flows in both directions are now close to the lowest point, as a share of China's GDP, for almost three decades. This seems remarkable in a world of technological disruption.

The dollar amount of FDI is a rough proxy for the cross-border flow of technology and ideas. Such transfers can happen in other ways, including human capital. The dollar amount also tells us little about the quality of technology embedded in the investment. Still, we think this is a helpful guide to the broad flow of ideas.

Chart 12


Both FDI inflows and outflows are weak

As China becomes larger and better at producing frontier technology, one might expect FDI inflows as a share of GDP to fall. Still, we have not seen any offsetting outflows, except for a brief period in 2016. We might expect China to scale up its overseas investment activity to acquire new intellectual property and create opportunities for its more dynamic companies to compete in global markets.

However, the Great Game, which has resulted in closer scrutiny of Chinese investments abroad, has made such acquisitions harder. This is true in Europe as well as the U.S. China's FDI outflows to major advanced economies was barely above US$5 billion for the four quarters through March 2019.

Shared Pain Of Separation In Revealed Comparative Advantage

If FDI points to potential decoupling of China and some advanced economies, revealed comparative advantage (RCA) suggests a painful divorce. RCA helps us understand how competitive a country is by comparing the share of a particular product in a country's exports to that product's share in global exports. When this ratio is above 1, then the country is exporting more than its "fair share," and is revealing a likely comparative advantage in that product's production.

RCA can also help assess the pain of separation. For China, the less competitive its producers are in key technologies needed to power productivity (reflected in low RCAs), the more a path of self-reliance will affect growth. For the rest of the world, the more competitive China is in certain products, the more that trade barriers such as tariffs and export controls will force a substitution to less efficient alternatives, which leads to an increase in costs for consumers.

Sticky RCA in technology and knowledge-intensive industries

The RCA in tech- and knowledge-intensive industries may be "sticky," raising the costs of moving supply chains due to three factors: [20]

  • Information and knowledge transfer is typically highly complex with respect to product and process specifications.
  • It is hard to codify information and knowledge simply so production can be easily shifted to different locations. This is because products are highly differentiated.
  • Actual and potential suppliers face substantial technical demands in relation to the requirements of the transaction.

China introduces one more reason for supply chain stickiness--scale. Given China's abundant physical and human capital resources, including burgeoning domestic innovation, foreign firms have been able to scale up complex technology eco-systems. Replicating this in smaller economies will be hard.

Across these dimensions, there is a big difference between a t-shirt (even a washing machine) and a US$1,000 smartphone. In short, moving high-productivity tech supply chains is more difficult and costly than for basic manufacturing.

Once a country has an RCA in tech, it may be hard to budge, but where does the RCA for technology products come from? In our view, two sources are worth noting.

  • Intellectual property (IP): The availability of the necessary IP to produce it. Analogous to the natural endowment of commodity exporters--either you have it or you do not.
  • Relative costs: The cost of producing the product given the IP is available compared to other trading partners. This includes the technical capacity of the local ecosystem.

There is a wrinkle. In most cases, including our data below, we rely on gross exports, not value-added exports. This means that the IP may have been added at an earlier stage of production but still shows up as an export. One way to address this issue is to focus as much as we can on upstream products such as parts and components that are less likely to have crossed multiple borders than finished products, which we do below.

China retains substantial RCA in many tech-related products

Chart 13 shows how China's RCA across tech-related products has evolved between 2008 and 2017. Each data point shows the RCA for one of 132 industrial machinery and electrical machinery and equipment products, for both years, respectively. These all have a Harmonized System four-digit code that begins with either 84 or 85. When the data point is above 1 (dotted line), China is revealing a comparative advantage. When the data point is above the 45-degree line, its comparative advantage has improved over the 2008-2017 period.

China has retained or improved its RCA for many tech-related products, indicating greater global penetration of China's advanced technology industries. Where it has lost RCA, it has done so from a position of strength--evident in the data points with an RCA above 2 for 2017.

We have highlighted China's top 10 technology imports (a potential proxy for tech dependence). For some products, China retains a substantial RCA, including finished phones (HS-8517) and printed circuits (HS-8534) although we should be mindful of the "gross export versus value added" problem for phones. For other products, notably those further upstream where we can isolate IP better, China has less of an edge but has improved. Examples include electronic integrated circuits (HS-8542) and electrical parts (HS-8538).

Chart 13


But it lags frontier tech producers in some key areas

If China becomes more self-reliant--as a choice or as a result of the Great Game--the challenge is to achieve significant breakthroughs in key upstream technologies. Here, RCA suggests progress is slow. Looking at the RCA for electronic integrated circuits (HS8542) for five economies since 2007, China has improved and is now marginally above 1 but still lags well behind frontier producers, including Korea and Taiwan (see chart 14).

Note that the RCA for the U.S. and Japan is understated given some production of its HS8542 chips designed using the IP of both economies, takes place in other jurisdictions. This is less true for Korea and Taiwan.

Chart 14


In turn, China's import basket reflects the RCA enjoyed by these frontier economies. Chart 15 shows China's top 10 imports of technology products covering HS two-digit codes 84 and 85 by origin. The value of China's imports in billions of U.S. dollars is given by the figure in each cell. Over time, China's technology import basket has become more concentrated in a smaller number of products. This is because domestic producers have learned to produce more of its own technology and foreign firms have upgraded their China-based production.

However, China remains dependent on key suppliers in some segments, especially semiconductors and printed circuits (HS codes 8534, 8541, and 8542) and phone components (HS 8517). Again, bilateral trade data may understate linkages with the U.S. because some large American semiconductor firms export to China from third countries, including Ireland and Singapore.

Decoupling and more self-reliance may be costly and not just for China

Our analysis of RCAs tells us two things. First, China has a strong competitive position across many technology products and is deeply embedded in global technology supply chains. Decoupling will be painful for all parties concerned and end-consumers will eventually pay more. Second, China is less competitive in key upstream technologies, which will mean its path to self-reliance and the tech frontier may be tough, given that current gaps appear large and persistent.

These results are consistent with our more granular assessment of China's tech-related export supply chains (see "A New Great Game--China, The U.S., And Technology," published May 15, 2019). We found that foreign headquartered firms accounted for more than half of the suppliers for 657 listed Chinese exporters going back three steps in the supply chains. Most of those foreign suppliers were from frontier economies and operated in the technology industry.

Table 4

China's Top Technology Imports By Harmonized System 2007 Four-Digit Code
Electric transformers, static converters (e.g. rectifiers) and inductors 8504
Telephone sets and telecommunications equipment. 8517
Sound storage media 8523
Parts of radios, telephones, and T.V.s 8529
Electronic printed circuits 8534
Electrical apparatus for < 1k volts 8536
Electrical boards 8537
Parts for electrical apparatus 8538
Diodes, transistors, similar semiconductor devices 8541
Electronic integrated circuits 8542
Source: United Nations, World Customs Organization, and S&P Global Economics.

China's potential to reach the tech frontier quickly is a wildcard

One wildcard is China's capacity to accelerate homegrown innovation and technology development. China's past record and scale, particularly in terms of potential human capital, provides an edge that is unrivaled with the possible exception of the U.S. and India. Made in China 2025 aims to achieve such an outcome and, given the size of this effort, it should not be discounted entirely as a scenario.

History suggests a purely indigenous and rapid surge to the tech frontier is unlikely, however. Much of the evidence from China over the last two decades, as we saw above, points to openness as a key driver of technological progress and productivity growth. The presence of MNCs in China's supply chains and exposure of Chinese firms to global markets--two facets of an open economy--lift the performance of domestic firms.

We do not dispute that China has the capacity, on its own, to reach the tech frontier in many areas at some point. Our point is that the historical evidence suggests that this may happen more quickly in an economy that remains highly globally integrated, which benefits from the free flow of ideas, knowledge, and technology and is exposed to a competitive global market.

Putting It All Together: How China Might Grow Through 2030

Let us recap our story at this point:

  • Opening up and market-focused reforms precede technology-driven growth surges in China. One notable feature of growth surge periods is rising FDI flows.
  • Opening up and reforms, on some measures but especially FDI, have slowed since 2008. Growth has also slowed, mainly due to a cooling in productivity growth.
  • The Great Game and China's possible push for self-reliance could slow future tech and knowledge transfer to China.
  • A more local China could mean weaker productivity and an even more pronounced growth slowdown over the next decade.
The Great Game is a long-run global supply shock

If our understanding is correct, China's strategy in the Great Game--in terms of opening up and market based-reforms--will have substantial implications for growth through 2030. Our view has always been that the Great Game's effects should be viewed more as a long-run supply shock that works through investment than a short-run demand shock that hits exports.

Three scenarios—the good, the not so bad, and the ugly

Given the uncertainties, long-term scenarios must be illustrative. Still, even if our flashlight is weak it is better than stumbling around by touch in the dark.

Our three scenarios are rooted in assumptions about China's chosen path--opening up versus self-reliance and the balance between markets versus the state--and how that intersects with the prospects for a lasting resolution to the Great Game. We describe our assumptions in table 5.

Table 5

Qualitative Assumptions For Three Illustrative Scenarios
Scenario Assumptions
China's Chosen Path The Great Game
Gradual and targeted reforms at similar pace to 2013-2018 period. Stalemate but no major escalation.
Opening up: Gradual and targeted opening up to foreign firms (in terms of trade and investment), focusing mainly in "old economy" sectors where domestic firms are likely to maintain a dominant market share. Less opening up in the service sector and high-tech industries prioritized by Made in China 2025. Tariffs: Remain largely as is with prolonged uncertainty about future changes.
Market-based reform: Gradual and targeted reforms increasing the role of the market, especially in some parts of the financial system. Slow progress on SOE reforms, including mixed ownership. U.S. investment restrictions: No change in current policies. Committee for Foreign Investment in the U.S. (CFIUS) approval rates unchanged from recent levels.
U.S. export controls: Some broadening in controls to sectors identified by the Export Administration Regulations of 2018.
Quicker and broader reforms. Gradually easing tension and a comprehensive deal in the medium term (2-4 years).
Opening up: Faster pace and broader scope of opening up, especially in the service sector. Some selected opening up of trade and investment for foreign firms in high-growth technology sectors. Tariffs: Gradual return to pre-trade war levels by 2025.
Market-based reform: Reduction of barriers to entry across a broad range of sectors, especially the service sector, and a focus on "competitive neutrality" with SOEs. Investment restrictions: Some easing for Chinese firms acquiring U.S. assets. CFIUS approval rates rise.
Export controls: More narrowly focused on sectors covered under previous legislation/ regulations.
Slowdown in reform. Escalating economic and financial tension and diminishing prospects of a lasting deal.
Opening up: Slowdown in the pace of opening up with little progress made in easing trade and investment access for foreign firms in the service sector and the high-growth new economy. Scaling up of efforts to achieve self-reliance. Tariffs: All bilateral trade subject to 25% tariffs. Discretionary use of non-tariff barriers by both sides.
Market-based reform: Industrial policies aligned with self-reliance emphasized at the expense of market forces. SOEs take a lead role, including new economy areas where their footprint has traditionally been smaller. Investment restrictions: Tightening of current policies with CFIUS approval rates declining to low levels.
Export controls: substantial broadening and higher frequency of resort to controls.
Source: S&P Global Economics.
Quantitative assumptions keep it simple

As we go from qualitative scenarios to hard numbers, we avoid false precision by keeping it simple and transparent, focusing on the two variables that drive our growth projections: productivity growth and the capital-output ratio.

We project future productivity growth using China's current labor productivity gap with the frontier (we use the U.S.) and the historical convergence of growth to the frontier across 123 countries between 1950 and 2018 (see Appendix for details). We then adjust the unique "China effect" for the 2020-2030 period to reflect different assumptions about reforms and the trade-tech tension:

  • Baseline: China becomes more like the average (median) country in our sample but continues to outperform. Total factor productivity growth averages just under 2%, a little below the recent trend.
  • Upside: China retains the characteristics it has exhibited in the past and remains a strong outperformer. Total factor productivity growth averages 2.2%, about the same as the current trend.
  • Downside: China becomes a lower-than-median performer. Total factor productivity averages 1.4%, some way below the current trend.

Our main assumption for the capital-output ratio is credit intensity, or the steady-state debt-to-GDP ratio. We pin this at 3x, or 300% for total social financing including local government debt. Other factors we keep in line with historical averages include the dividend payout ratios of firms and the proportion of new debt used for investment.

In the baseline, our assumptions about debt and the return on investment mean that the capital-output ratio stabilizes like it did during the 2000s. In the upside scenario, capital can continue to grow relative to output, boosting growth. In the downside, capital grows more slowly than output.

We keep some variables unchanged from recent levels through 2030, including improvements to human capital (better education and training) and labor force participation. Of course, China can change some of these growth drivers with policy changes, including changes to the retirement age. We use the United Nations projections for the growth of the working age population.

Baseline growth through 2030 at about 4.6%

In our three scenarios--the not-so-bad, the good, and the ugly--we project average growth over the next decade of 4.6%, 5.4%, and 3.7% (see table 6). The compound effects of these growth rates are large. By 2030, China's economy, in our downside scenario, will be about 10% and 18% smaller in U.S. dollar terms than the baseline and upside scenarios, respectively (note that different productivity growth rates also imply slight changes in the path of the real exchange rate over time).

Watch credit intensity for economic cycle and financial stability signals

Growth rarely moves in a straight line and these scenarios do not touch on what this means for the economic cycle and financial stability and risks of more abrupt changes. This may depend largely on how policymakers and financial markets respond in each scenario. This is likely to show up in credit intensity.

Policymakers may recognize the structural trend in growth and try to keep actual growth close to underlying potential. This would mean refraining from excessive stimulus or tightening and a stable or even declining credit intensity ratio. This would be consistent with a smooth glide path. However, if policies push growth too far above underlying potential, credit intensity will rise and the risks of abrupt changes, which may include financial instability, will edge higher.

Table 6

Illustrative Scenarios For China's Growth Path Through 2030
Units 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Baseline (stalemate with the U.S. and gradual reforms)
Total factor productivity Percent change 2.2 2.1 2.1 2 1.9 1.9 1.8 1.7 1.6 1.6 1.5
GDP growth Percent change 6.2 5.8 5.5 5.2 4.9 4.6 4.1 3.8 3.5 3.3 3.2
GDP at market prices Bil. US$ (2018 prices) 15,648 16,600 17,557 18,513 19,462 20,397 21,282 22,137 22,955 23,758 24,557
GDP per capita US$ (2018 prices) 10,985 11,639 12,296 12,951 13,599 14,235 14,836 15,414 15,965 16,504 17,039
Upside (trade deal and faster reforms)
Total factor productivity Percent change 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2
Capital depth Percent change 2.3 2.1 1.8 1.6 1.4 1.2 1 0.7 0.5 0.3 0.3
GDP growth Percent change 6.2 6.1 5.9 5.8 5.6 5.4 5.1 5 4.8 4.6 4.6
GDP at market prices Bil. US$ (2018 prices) 15,648 16,646 17,680 18,751 19,856 20,994 22,133 23,298 24,486 25,695 26,963
GDP per capita US$ (2018 prices) 10,985 11,671 12,382 13,116 13,873 14,652 15,429 16,222 17,029 17,850 18,709
Downside (self-reliance and little reform)
Total factor productivity Percent change 2.2 2 1.9 1.7 1.5 1.4 1.2 1 0.8 0.7 0.5
Capital depth Percent change 2.3 2 1.7 1.4 1.1 0.9 0.6 0.3 0 -0.3 -0.3
GDP growth Percent change 6.2 5.7 5.2 4.7 4.2 3.7 3.1 2.6 2.1 1.6 1.3
GDP at market prices Bil. US$ (2018 prices) 15,648 16,586 17,492 18,352 19,156 19,893 20,522 21,060 21,498 21,830 22,096
GDP per capita US$ (2018 prices) 10,985 11,630 12,250 12,838 13,385 13,883 14,305 14,663 14,952 15,165 15,332

China's Policy Choices And The Great Game Will Define The Slowdown

China must live with some things as they are, including demographics, debt, and rebalancing. China has also become richer. These factors point to an inescapable slowdown over the next decade. This is natural and mostly healthy.

China also faces policy choices that will determine how much the economy will slow. These choices will affect its ability to acquire, create, and deploy technology and lift productivity. At a broad level, China may have two big choices to make:

  • More opening up or greater self-reliance;
  • A substantially larger role for markets or a bigger role for the state in the economy.

This is not either or, of course, but the mix will be important. There is also no "right answer" but the result will be important for growth now and through the next decade.

China's choices may also have implications for the complicated geopolitical environment, especially the Great Game. We recognize that some issues stretch well beyond economics and finance. Nevertheless, a decisive move toward opening up to foreign trade and investment and a larger role for the market could ease tensions. This could pave the way for a comprehensive deal.

Our baseline for China assumes a broadly unchanged pace of structural reform from recent years. In terms of opening up and allowing markets to play a greater role, this suggests an approach that is targeted, gradual, but somewhat slower than we have seen in the 1980s and 1990s. We think this is consistent with a stalemate but no major sustained escalation in the Great Game. Finally, we think this means growth will average about 4.6% over the next decade.

If our baseline is right, whether the glide path lower is smooth or bumpy may depend on whether China tolerates its inescapable slowdown.




Related Research

[1] People's Republic of China, 2015, The 13th Five-Year Plan For Economic and Social Development of the People's Republic of China, Compilation and Translation Bureau,

Central Committee of the Communist Party of China.

[2] Maddison, Angus, 1998, "Chinese Economic Performance in the Long Run," Development Centre of the Organization for Economic Co-operation and Development, Paris.

[3] Maddison, Angus and Wu, Harry, 2008, "Measuring China's Economic Performance," World Economics, 9.

[4] Wu, Harry, 2014, "China's Growth and Productivity Performance Debate Revisited - Accounting for China's Sources of Growth with a New Data Set," Conference Board Economics Program Working Paper Series.

[5] Kerola, Eeva, 2018, "In Search of Fluctuations: Another Look at China's Incredibly Stable GDP Growth," Bank of Finland Institute for Economies in Transition Discussion Paper, 23.

[6] Chen, Wei, Xilu Chen, Chang-Tai Hsieh, Zheng (Michael) Song, 2019, "A Forensic Examination of China's National Accounts," Brookings Paper on Economic Activity.

[7] Henderson, J.V., A. Storeygard, and D. N. Weil, 2012, "Measuring Economic Growth from Outer Space," American Economic Review 102(2), 994–1028.

[8] Holtz, Carl, 2006, 2006, "China's Reform Period Economic Growth: How Reliable Are Angus Maddison's Estimates?" Review of Income and Wealth Series 52, Number 3.

[9] Clark, Hunter, Maxim Pinkovskiy, and Xavier Sala-i-Martin, 2017, "China's GDP Growth May be Understated," NBER Working Paper No. 23323.

[10] Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer, 2015, "The Next Generation of the Penn World Table," American Economic Review, 105(10), 3150-3182, available for download at

[11] Lewis, W. A., 1954, "Economic Development with Unlimited Supplies of Labour," The Manchester School, 22, pp. 139–92.

[12] World Bank estimates based on official data suggest the participation rate has fallen from 79% in 1990 to 69% in 2018. See also Shuaizhang Feng, Yingyao Hu, and Robert Moffitt, 2015, Long Run Trends in Unemployment and Labor Force Participation in China, NBER Working Paper 21460.

[13] People's Bank of China, 2018, "Monetary Policy Implementation Report for the Second Quarter of 2018."

[14] Sorbe, Stéphane, Peter Gal, and Valentine Millot, 2018, "Can Productivity Still Grow in Service-Based Economies?" Literature Overview and Preliminary Evidence from OECD Countries, OECD Economics Department Working Papers No. 1531

[15] Research Institute of Economy, Trade, and Industry, 2015, "China Industrial Productivity Database 3.0,"

[16] Rodrik, Dani, 2013, "Unconditional Convergence in Manufacturing," Quarterly Journal of Economics, pp. 165-204.

[17] Blomström, Magnus and Ari Kokko, 1998, Multinational Corporations and Spillovers, Journal of Economic Surveys, Vol. 12, pp. 247-277.

[18] Wei, Y, and X. Liu, Productivity Spillovers From R&D, Exports And FDI In China's Manufacturing Sector Journal of International Business Studies (2006) 37, 544–557.

[19] Du, Luosha, Ann Harrison, and Gary H. Jefferson, 2011, Testing for Horizontal and Vertical Foreign Investment Spillovers in China 1998–2007, Journal of Asian Economics.

[20] Gereffi, Gary, John Humphrey, and Timothy Sturgeon, 2005, The Governance of Global Value Chains, Review of International Political Economy, 12:1, 78-104.

[21] Klenow, P. J. and A. Rodriguez-Clare, 1997, The Neo-classical Revival in Growth Economics: Has It Gone Too Far? NBER Macroeconomics Annual, 12, pp. 73–103.

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