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Rebalancing the Chinese economy
Yiping Huang interviewed by Tim Phillips
Yiping Huang
Rebalancing is what we need and what will be good for China and good for the rest of the world.
Tim Phillips
An unparalleled 40-year period of growth has transformed China, but it has also created structural problems in its economy that will take many years to resolve. My guest today sets out China’s plan to rebalance its growth. Welcome to VoxTalks Economics from the Centre for Economic Policy Research. I’m Tim Phillips. The fourth Paris Report from CEPR and Bruegel is called The New Global Imbalances. In a high debt and fragmented world, excess savings, rising surpluses and rising deficits pose a risk to stability and undermine the global trading system. In 2007, Premier Wen Jiabao said that China’s growth was unstable, uncoordinated and unbalanced. But China’s economy is now so large that fixing those problems is not an overnight process. Yiping Huang is Dean of the National School of Development at Peking University, and his chapter in the report analyzes the structural imbalances in China’s growth model and also the steps that the government is taking to create sustainable growth. Yiping, welcome. Hello.
Yiping Huang
Hello, Tim.
Tim Phillips
Your analysis is different to many of the analyses of China’s economy that I see, which tend to be focusing on what China can do to help other countries. You’re looking, if I’m correct, at how China can sustain its growth, how China can help itself.
Yiping Huang
Tim, I think this actually is the same story. It’s just from different angles, looking at the same issue. That is the rebalancing of the Chinese economy and the transition of the growth model to become more sustainable over the longer term. That’s why, for people outside of China, I guess they’re more concerned about the imbalances, especially the external account imbalances. For the Chinese, this is also an issue, but in the way that you need to balance the economy, for instance, We need to boost the domestic consumption. Therefore, you will be able to continue our growth. But at the end of the day, it’s the same story as I said. Rebalancing is what we need and what will be good for China and good for the rest of the world.
Tim Phillips
The model of growth that’s been working in China has been working for 40 years now, I think. Remind us how much China has changed in that time.
Yiping Huang
Well, a lot of things have changed in different dimensions. For instance, when China started, it was a centrally-planned economy. And today, I would say, by and large, most of the things are allocated by market mechanism. And you also see significant rise of the private sector. If you look at the industry, for instance, 40 years ago, we produced a very preliminary manufacturing products with low-value-added, labor-intensive stuff. But now we’re moving on to more high-tech and high-value-added stuff. So if it was a very small country economy 45 years ago, today it’s one of the largest country economies.
Tim Phillips
But however, these imbalances in the Chinese economy, I think they were acknowledged by the leadership in China as long ago as 2007. Has that created a desire to adjust the economy?
Yiping Huang
Actually, I think the starting point was even earlier than 2007. When then new premier came to office, the premier Wen Jiabao, in 2003, he immediately said that the growth model we had was not sustainable, and primarily because it was unbalanced. So, for instance, some of the indicators he looked at – over-reliance on investment and over-reliance on exports driving growth – rebalancing becomes necessary. If we look at what happened the last 20-plus years, lots of things changed, in fact. If you look at some of the indicators, for instance, the investment ratio was at its highest in 2011, 47%. In 2024, it was 41%. So significant adjustment. The consumption rate in 2010 was at its bottom, 50%. And now it’s about 57%. And finally, the one number that I think the rest of the world pays attention to was the current account surplus as a share of GDP. In 2007, immediately before the subprime crisis, it was 9.8%. And in 2004, it was 2.3%. Last year, it came up a bit to 3.7%. But if you look at the average from 2018 and onwards, The average was actually below 2% of GDP. So my point is a lot of adjustments have already taken place, but maybe that’s not enough, so we need to do more. The other point I think you’re hinting to that the big adjustments might be required compared to before. Even though our imbalance problems were greater, twenty, thirty years ago, but we were a small country economy so, whatever we exported to the international market, people didn’t really notice. But now, you’re a large country economy and when you export something, you tend to effect the equilibrium in the international market, and that’s why people are paying a lot more attention to today.
Intermission
This is the third podcast in our series of the contents of the Paris Report. Also, check out our conversation last week with Maurice Obstfeld on how previous episodes of Global Imbalances ended, and Gilles Moec’s explanation of why the US government has been so keen to promote investment in dollar stablecoins. And while you’re at it, don’t you [miss] Bruegel’s podcast, The Sound of Economics, to find an interview with two of the report editors, Beatrice Weder di Mauro, president of CEPR, and Jeromin Zettelmeyer, director of Bruegel, about the problem of global imbalances.
Tim Phillips
When China first reformed its economy, you called these reforms asymmetric liberalization. What does that mean?
Yiping Huang
For transition economies, there are generally two types of reform approach. For instance, the former Soviet Union adopted this shock therapy: ‘today, I privatize all the SOEs and tomorrow, I hope the private sector would work’. That was ideal, theoretically, but practically it was difficult. So the Chinese approach was more gradual. We had this so-called dual-track liberalization approach. We opened up for the private sector, foreign investor firms to operate, but at the same time, we maintained a state-owned company for some time. And I’m sure most people, when they hear me say this, their immediate response, well, that means inefficiency, right? SOEs are not very efficient. And if you maintain them, there will be lots of inefficient problems. I think the key feature of the Chinese reform is what we call pragmatism. We recognize there might be some inefficiency, but by doing this dual-track approach, you actually maintain some stability in the transition. Jobs, growth, product. So yes, we pay some costs in terms of inefficiency, but the transition will be much, much more smooth. And if you look at the overall result, if you look at the 45, 46 years of GDP growth, on average was close to 9% per annum. So a symmetric liberalization was a way of facilitating that approach. SOEs were not efficient, but we hoped that they could survive for some time longer for stability purposes than other purposes. then they needed to be effectively subsidized. However, the government did not have money to subsidize them. The way the government did it was liberalize completely the output market, but at the same time maintain some distortions in the factor market. So financial market is one good example. People put money into the bank and the bank lend money out. And I think for quite some time, the interest rate, both deposit and the lending rate, was depressed. Depressed in the way you reduce the funding cost. And if the banks lend that money to the SOEs and other companies, the SOEs increasingly receive some kind of subsidy. The natural result is that production cost was reduced artificially and investment cost. But that would affect the household income and so on. The onus of these factors, income will be reduced. So it naturally leads to very strong supply side, but relatively weak demand side. And in a way, I think that was one reason why we had that significant external accounting imbalance problems. Because if you produce lots of stuff and you can’t sell it at home, you export it. For a small country economy, that is doable. But when you become a large country economy, it becomes much more difficult. And this is primarily what we’re facing today.
Tim Phillips
The Chinese economy has also decentralized, with decision-making tied to GDP targets. How has that affected growth?
Yiping Huang
Decentralization of decision power from the center to local government was also a key feature of what I call the gradualism or the pragmatism, meaning liberalization. Well, the ultimate goal is to set up a free market system in China, right? But you can’t just liberalize everything without the infrastructure, the market infrastructure. So the first step was to hand down the decision powers from the centre to local governments. That immediately stimulates the economy because the local authorities, number one, they’re much more motivated to do better. And number two, they obviously know the local conditions better. And the regions actually compete with each other in getting better GDP growth results. So that was a big part of the growth story during the reform period. But at the same time, we probably should recognize, when the local governments were motivated to deliver faster GDP growth. And when you have some resources, It’s much easier to boost your investment and industrial activity than to boost the consumption activity. Again, that just strengthens the strong supply and the weak demand story. And this is still happening. My recommendation is that while decentralization worked for some time, maybe it’s time for us to move on. Because at the end of the day, the government set a very clear direction of reform, that is to let market mechanism play decisive roles in allocation of resources and factors. This is probably time to get over that period.
Tim Phillips
How successful have the efforts to boost consumption been? How does consumption now compare to what it would be here in the UK or in the US?
Yiping Huang
It’s much easier for the government to boost investment if you have some money at hand, like building a bridge or building an industrial park and so on. Our boosting consumption is much more difficult, but it’s improving. The bottom of consumption here of GDP was in 2010. At the time, it was below 50%, and now it’s below 60%. So at least around the 10 percentage point increase. In fact, consumption has been the key drive of Chinese growth. But you’re right, below 60% is still way below what should be ideal. If you look at the average ratio in UK and the US, they’re above 80%. I look at the average of the other countries around the world. They’re somewhere in the mid-70s. So it can and it should rise by another 10 to 15 percentage point. But I should also mention to you that raising the consumption share of GDP is a gradual process because at the end of the day, it involves two things. Number one is income and the number two is confidence. The households need to have more income to spend, and the number two, they need to have greater confidence to spend. If you look at what happened in Japan, for instance – which was also a very successful East Asian economy – the consumption share of GDP was at its lowest in 1970. And in 2010, it reached the average of the other countries, like around the mid-70s. It took Japan 40 years. I certainly hope it will be faster than Japan for China to raise the consumption here. But I’m sure you would agree, raising income for households, improving their confidence is a very tough job and it will take some time. But it’s happening. That’s the key point I want to highlight.
Tim Phillips
The most visible shock to China’s economy has been the collapse of the property market. How long has this been going on for? How deep is this problem?
Yiping Huang
The starting point of this current adjustment or correction of the property markets started around mid-2021. So it’s almost five years. Experts’ assessment of the movement or the future direction is mixed. Some are more pessimistic, but some more optimistic views say that we might be reaching the bottom. My view is that I think we need to look at China’s property market in different regions. ie, It’s not one market. In the major metropolitan cities, larger cities, we probably will reach the bottom relatively soon because the surplus excess capacity was more limited. Demand could recover much faster. The problems are much bigger in these, like the fourth, fifth, or sixth tier cities, very small areas, access capacity is already there, but people leaving from these regions. So I think adjustment will be much more difficult. I have to say the impact on the economy is quite significant. Just look at the headline number, the property sector overall at its peak. was contributing at least 30% of GDP growth. And now it’s a negative growth. That’s why how devastating it might become. So, for instance, it’s affecting the local government, their fiscal condition, because they used to rely on land sales and now it’s becoming very difficult. The household balance sheet was affected for obvious reasons. And some would also argue it might also actually affect the bank’s balance sheet because a lot of lending to SMEs, small or medium enterprises, are also relying on the corridors, the properties, land, and so on. So I think the impact is pretty widespread, but I hope, on the one hand, I think we might reach a turning point relatively soon. And the other point is no country or no economy in the world relies continuously, permanently on the property sector, expansion of the property sector. So what I think the government wants to do is to build a range of new industries. And hopefully these will gradually replace. the property sector as a driver of growth.
Tim Phillips
Are these effects on the economy that you’ve described, is this what is known in China as “involution”? Can you explain that term to me?
Yiping Huang
Actually, I think there are two different things. The property sector has been dragging down growth for the reasons I already explained. Involution is normally a term coined to describe the overcapacity problem in the new industries. So for instance, we have very successful green energy sectors, right? The batteries, the EVs, and so on. There, this industry as a whole has been successful, but the capacity increased quite dramatically and the pressure or the risk of overcapacity is quite significant. Involution, to a large extent, refers to some local government behavior in expanding their capacity through industrial subsidies, but they don’t necessarily significantly improve the quality or technology of the products. This is also related to the point we were discussing earlier on decentralization of the decision power was a very effective way of boosting growth. But I think these days are probably over because local governments boosting growth were probably more effective when the government were involved in building infrastructure and building industrial parks and so on, larger scale industrialization. Now we need to move into innovation-driven growth, and I think the government’s function would become probably more limited. because it means you need to look at the great risk that you’re taking, and that just is not the best thing that the government can do. The government can still provide a very good infrastructure, for instance, create lots of scientists, building digital infrastructure, and so on. But I think there should be a clear division of labor. The resolution of the involution problem, I think, involves, number one, make it clear what the budget [is] for the local government. You can’t borrow money and without paying the debt by yourself, because at the end of the day, somebody else will have to pay it for you. That’s not sustainable. The other thing was they were just expanding the industrial capacity without improving technology or efficiency quality of the product significantly, because industrial subsidy or industrial policy, in my view, is useful only when it was used to overcome market failure, but not to distort the market and certainly not to replace the market.
Tim Phillips
So, tell me about the 15th five-year plan, which I think takes us from 2026 to 2030. As you say, as some of the changes in the Chinese economy might mean that the government is less involved in the activities that produce growth, how important are the policies set out in a five-year plan?
Yiping Huang
Well, the first point I would say is, yes, the government probably should involve less in some activities, but the government needed to do more in other areas. So, for instance, providing social protection, providing support to basic research and so on. So, it requires a transformation of the function of the government. The transition or the change of the growth model, I think, started at least from the beginning of the century. We mentioned about the government’s worry about the imbalance. That was the starting point. of thinking about the transition of the growth model. And if you look at what is happening today, during the five-year plan, the government gave a long list of the policy priorities. In my view, the 2D element or anchor For the change of the growth model, there are two things: number one is the development of the new quality productive force. Because the economy has moved into a new stage of development. These sectors that China used to do very well, like labor-intensive manufacturing products. These days were over because the costs are rising very quickly and we needed to do something higher tech, higher value-added, higher quality. This is especially given the new industrial revolution that is ongoing. And I think we need to move into the new industries. That’s on the supply side. On the demand side, we need to move from relying mainly on external demand, and hopefully in the future, we’ll rely mainly on domestic demand. And here, obviously, domestic demand includes both investment [and] consumption, At the end of the day, I think the fundamental question we have to ask is how to make the Chinese growth more sustainable in the longer term. And the way to do it is to smooth out the circulation between supply and demand, supply new industries. Demand consumption. And if this circulation becomes smooth and efficient, then it can carry the Chinese economy for much longer. That, in my view, is the key mission that’s the 15th five-year program trying to achieve.
Tim Phillips
To achieve this mission, do you have any policy recommendations that you would make?
Yiping Huang
Well, lots of changes, obviously, how to develop the new industries. If you look at the Chinese economic innovation in the past, you will find a couple of things. Number one, as I already mentioned, there needs to be a new division of labor between the market and the government. The government probably should continue to play an active role, but should probably refrain from directly allocating resources for economic activities and leave greater room for the market, and the private sector could play greater roles. And if you look at, for instance, innovation in China, the private sector contributes at least 7% of the new innovations, and that also implies that the private sector should become much more active in the future. That’s one thing we needed to do. There still needs to be some industrial policy, in my view, because there are marked failure problems. But when the government design and implement the industrial policy, they need to make sure that the behavior and the function are proper. And I just mentioned that a lot of local government behaviors were not particularly productive, and these need to be disciplined. Even for, I think, the government as a whole, we need to make sure that even if industrial subsidies are necessary, when there are market failure problems, we need to make sure there’s no prohibition of competition; there’s no picking the winners and so on. So these are a range of things that the government needs to do. But overall, I think just to promote what the government already said, a proper combination between an efficient market and a proactive government. On the consumption side, fundamentally, we need to put more money into the hands of the household. That means a lot of further liberalization of the factor markets, liberalization of resource allocation, and probably also to create a better financial market so that people can better manage their wealth. At the same time, I think the social protection and the social welfare system needs to be strengthened significantly, especially for people like migrant workers working in the cities and these are villagers and so on. And overall, we need to provide a better protection for the household. We want to make sure, number one, they have money to spend, and number two, they have confidence to spend.
Tim Phillips
These changes cannot happen overnight, but how urgent are they?
Yiping Huang
Well, I think these are pretty urgent, but I agree with you. I think some of these changes will be gradual. The problems we discussed, they’re not going away immediately. But at the same time, I think the lesson or the implication for China and the rest of the world is that we are in the same world and we are in the same international market. So it is important for China and its economic partners to work together and to benefit everybody. Some people are worried about China’s green energy capacity, if China is so productive, and what will happen to the same industry in other countries? My feeling is that, well, maybe domestically there is a pressure on excess capacity. But if you look around the world, there are lots of countries which also need to make the green energy transition. They don’t have the funding, they don’t have the technology, they don’t have the products. If China and these countries can work together, find a way for not only funding, but the implementation of the green energy transition, maybe it could be mutually beneficial. And these are the things I think we need to look at more carefully going forward, and probably more innovatively.
Tim Phillips
Yiping, it’s fascinating to get your point of view on this. Thank you very much for talking to me.
Yiping Huang
Thank you, Tim. It’s a pleasure.
Tim Phillips
We have been talking about Paris Report No. 4, titled The New Global Imbalances. It was edited by Hélène Rey, Beatrice Weder di Mauro, and Jeromin Zettelmeyer. The report is a free download at cepr.org.
Outro
VoxTalks Economics is a Talk Normal production. The Assistant Producer is Megan Beiber and our Editor is Andrei Zagarian.
