Understanding China's Economy: The Turning Point and Transformational Path of a Big Country [1st ed. 2021] 9813363215, 9789813363212

Table of contents :
Contents
Part I China’s Miracle
1 Understanding the Stages of Economic Development
Demarcating Stages of Economic Development
The Malthusian Poverty Trap: The Long Dark Night Before the “Grand Divergence”
Driven by the Demographic Dividend: The Lewis Model
The Lewis Turning Point and the Middle Income Trap
Solow’s Neo-classical Growth: Innovation Changes the World
2 How Fast Has the Chinese Economy Grown?
Sustained, Rapid Growth: China’s Economic Miracle
The Achievements of China’s Economic Growth
China’s Economic Growth is Undeniable
How to Interpret the Judgment That China Is ‘No. 1’ for GDP
On Calculations of China’s Potential Growth Rate
Declining Actual and Potential Growth Rates
Stimulatory Policies Should Not Be Used to ‘Preserve Growth’
Raising the Potential Growth Rate Through Reforms
The Chinese Economic Miracle and the Logic of Its Continuation
3 Understanding China’s Development
The Riddle of China’s Development: A Noble Prize Grade Question
Researching the Chinese Economy with a Critical Mindset
Avoiding Biased Mindsets
Counterfactuals
Conventional Wisdom
For Want of a Nail
Stylised Facts About Economic Growth
Kuznet’s Facts on Modern Economic Growth
Palant-Prescott Development Facts
The Kaldor Facts
The New Kaldor Model
Decoding the Mystery of the ‘Deceleration’ of the Chinese Economy
Why is There a Middle Income Trap
Old Comparative Advantage Gone, New Comparative Advantage MIA
Changes to Sources of Growth
4 Escaping Misunderstandings About the Relationship Between Population and the Economy
A Large Population is No Barrier to Economic Growth
The Ageing of the Population is Inevitable
The Inevitable Disappearance of the Demographic Dividend
Labour Supply is a Finite Resource
Labour Shortages are Not an Excuse to Ignore Employment
Part II The Development Turning Point
5 The Lewis Turning Point for Large Countries
How to Understand the Lewis Turning Point
The Critical Point: From the Turning Point to Turning Interval
Controversy Over the Lewis Turning Point
How a ‘Large Country Economy’ Differs
Defining Large (and Small) Countries and Their Characteristics
China’s Large Country Economy
The Flying Geese Paradigm Can Restructure the National Layout
The Evolution and Key Aspects of the Flying Geese Paradigm
Why There Needs to Be a Chinese National Flying Geese Paradigm
Digression
6 The Demographic Transition and Labour Supply
China’s Semographic Transition
The Demographic Transition and the Development Stages of the Dual Economy
The Curse of Being ‘Old Before Rich’
The Grand Reversal: Labour Supply and Demand
Labour Shortages and Employment Difficulties
Reducing the ‘Old Before Rich’ Gap
7 The Challenges After the Lewis Turning Point
Two Difficulties: Should Wages Rise?
Delaying the Momentum of Rising Labour Costs
The Difficulties of Three Groups: The Latent Fragility of Labour
The State of the Agricultural Workforce
Changes to the Agricultural Workforce
The Demographic Characteristics of the Agricultural Workforce
Post Turning Point Rural Labour Transitions
References
8 China’s Second Demographic Dividend
Is the Chinese Turning Point Special?
The Second Demographic Dividend
Enormous Potential: Savings Rate and the Pension System
Raising Skill Sets and Maintaining Comparative Advantages
References
Part III Sidestepping the Trap
9 China’s Inevitable Speed Bump
Do Not Be Afraid of the Wolf
How to Set Rational Growth Speed Targets
Two L Shape Trajectories
The V Shaped Revival is Outdated
Short and Medium Term L Shape Growth Trajectories
A Longer Term L Shape Trajectory
Reference
10 Understanding the Middle Income Trap
What is the Middle-Income Trap
The Low Income Stage
The Middle Income Stage
The High Income Stage
The Tetralogy of the Middle Income Trap
How to Avoid the Middle Income Trap
Accurately Assessing the Economic Growth Stage
Unearthing an Institutional Dividend Through Reform
Developing Education and Training
11 Employment Issues: From the Aggregate to the Structural
Understanding the Labour Market
The Functions of the Natural Unemployment Rate
Strong Wage Growth as Bad as Weak Wage Growth
Employment Structure and Quality
12 The Income Distribution Kuznets Turning Point
We Need to Reacquaint Ourselves with Equality and Efficiency
The Income Distribution Turning Point: The Kuznets Turning Point
What Is the Cause for and Origin of Dispute
Income Distribution Policy Errors
Part IV Creating a New Miracle
13 Can China Create Another Economic Miracle?
Can the Chinese Economy Continue to Grow?
New Concepts Guide New Growth
The Fundamentals of an Improving Economy
Stimulating Microeconomic Vitality
Evaluating the New Pattern of Growth
How to Destroy the ‘Xiling Effect’
Opening the Right Policy Toolbox
Why Emphasise the ‘Three Increases’
Productivity Guided Industrial Restructuring
The Key Aspects of Industrial Upgrading
The Worrisome ‘Reverse Kuznets Effect’
Changing Approaches to the Upgrading of Industrial Structure
14 From the Demographic Dividend to the Reform Dividend
People Centred New Model Urbanisation
Pathway Outcomes
The New People Centred Focus
How to Really Implement People Centred Urbanisation
The Modernisation of Agricultural Production Methods
Challenges at the New Stage of Agriculture
On Traditional Concepts of Economies of Scale
Scale Constraints to Agricultural Modernisation
Land Regulations: The Reform Bridgehead
From the Demographic Dividend to the Human Capital Dividend
The Contribution and Formation of Human Capital
Education and Reforms
The Cost Benefit Reform Formula
15 From the Demographic Dividend to the Open Dividend
The Reversal of Globalisation
International Trade and Transnational Investment
The Depth and Breadth of Globalisation
The Populist Genes in Western Governments
Voting with Hands, and Voting with Feet
Popular Populism
China and Globalisation
Why Does China not Oppose Globalisation
Declarations at Davos
Notes
Addendum: Characteristics of Epidemic Shock and Response Policy

Citation preview

Fang Cai

Understanding China’s Economy The Turning Point and Transformational Path of a Big Country

Understanding China’s Economy

Fang Cai

Understanding China’s Economy The Turning Point and Transformational Path of a Big Country

Fang Cai Chinese Academy of Social Sciences Beijing, China

ISBN 978-981-33-6321-2 ISBN 978-981-33-6322-9 (eBook) https://doi.org/10.1007/978-981-33-6322-9 Jointly published with CITIC Press Corporation and through the agency of China National Publications Import & Export (Group) Co., Ltd. B&R Book Program The print edition is not for sale in China (Mainland). Customers from China (Mainland) please order the print book from: CITIC Press Corporation. © CITIC Press Corporation 2021 This work is subject to copyright. All rights are reserved by the Publishers, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publishers, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publishers nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publishers remain neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-01/04 Gateway East, Singapore 189721, Singapore

Contents

Part I 1

China’s Miracle

Understanding the Stages of Economic Development . . . . . . . . . . . . . Demarcating Stages of Economic Development . . . . . . . . . . . . . . . . . . . . . The Malthusian Poverty Trap: The Long Dark Night Before the “Grand Divergence” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Driven by the Demographic Dividend: The Lewis Model . . . . . . . . . . . . . The Lewis Turning Point and the Middle Income Trap . . . . . . . . . . . . . . . Solow’s Neo-classical Growth: Innovation Changes the World . . . . . . . .

3 3 7 11 16 24

2

How Fast Has the Chinese Economy Grown? . . . . . . . . . . . . . . . . . . . . Sustained, Rapid Growth: China’s Economic Miracle . . . . . . . . . . . . . . . . The Achievements of China’s Economic Growth . . . . . . . . . . . . . . . . . . . . China’s Economic Growth is Undeniable . . . . . . . . . . . . . . . . . . . . . . . . . . How to Interpret the Judgment That China Is ‘No. 1’ for GDP . . . . . . . . On Calculations of China’s Potential Growth Rate . . . . . . . . . . . . . . . . . . Declining Actual and Potential Growth Rates . . . . . . . . . . . . . . . . . . . . . . . Stimulatory Policies Should Not Be Used to ‘Preserve Growth’ . . . . . . . Raising the Potential Growth Rate Through Reforms . . . . . . . . . . . . . . . . The Chinese Economic Miracle and the Logic of Its Continuation . . . . .

27 27 27 28 32 34 34 35 37 38

3

Understanding China’s Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Riddle of China’s Development: A Noble Prize Grade Question . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Researching the Chinese Economy with a Critical Mindset . . . . . . . . . . . Avoiding Biased Mindsets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Counterfactuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Conventional Wisdom . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For Want of a Nail . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stylised Facts About Economic Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . Kuznet’s Facts on Modern Economic Growth . . . . . . . . . . . . . . . . . . . . . . Palant-Prescott Development Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Kaldor Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

45 45 51 53 54 55 57 58 59 60 60 v

vi

Contents

The New Kaldor Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Decoding the Mystery of the ‘Deceleration’ of the Chinese Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Why is There a Middle Income Trap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Old Comparative Advantage Gone, New Comparative Advantage MIA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes to Sources of Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Escaping Misunderstandings About the Relationship Between Population and the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A Large Population is No Barrier to Economic Growth . . . . . . . . . . . . . . The Ageing of the Population is Inevitable . . . . . . . . . . . . . . . . . . . . . . . . . The Inevitable Disappearance of the Demographic Dividend . . . . . . . . . . Labour Supply is a Finite Resource . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Labour Shortages are Not an Excuse to Ignore Employment . . . . . . . . . .

Part II

61 61 62 63 63 67 67 69 72 74 78

The Development Turning Point

5

The Lewis Turning Point for Large Countries . . . . . . . . . . . . . . . . . . . . How to Understand the Lewis Turning Point . . . . . . . . . . . . . . . . . . . . . . . The Critical Point: From the Turning Point to Turning Interval . . . . . . . . Controversy Over the Lewis Turning Point . . . . . . . . . . . . . . . . . . . . . . How a ‘Large Country Economy’ Differs . . . . . . . . . . . . . . . . . . . . . . . . . . Defining Large (and Small) Countries and Their Characteristics . . . . . . . China’s Large Country Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Flying Geese Paradigm Can Restructure the National Layout . . . . . The Evolution and Key Aspects of the Flying Geese Paradigm . . . . . . . . Why There Needs to Be a Chinese National Flying Geese Paradigm . . . Digression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

83 83 85 89 90 91 93 93 94 95 96

6

The Demographic Transition and Labour Supply . . . . . . . . . . . . . . . . China’s Semographic Transition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Demographic Transition and the Development Stages of the Dual Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Curse of Being ‘Old Before Rich’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Grand Reversal: Labour Supply and Demand . . . . . . . . . . . . . . . . . . . Labour Shortages and Employment Difficulties . . . . . . . . . . . . . . . . . . . . . Reducing the ‘Old Before Rich’ Gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

99 99 100 103 106 108 110

The Challenges After the Lewis Turning Point . . . . . . . . . . . . . . . . . . . Two Difficulties: Should Wages Rise? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delaying the Momentum of Rising Labour Costs . . . . . . . . . . . . . . . . . . . The Difficulties of Three Groups: The Latent Fragility of Labour . . . . . . The State of the Agricultural Workforce . . . . . . . . . . . . . . . . . . . . . . . . . . . Changes to the Agricultural Workforce . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Demographic Characteristics of the Agricultural Workforce . . . . . . Post Turning Point Rural Labour Transitions . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

113 113 116 118 123 123 124 127 131

7

Contents

8

China’s Second Demographic Dividend . . . . . . . . . . . . . . . . . . . . . . . . . Is the Chinese Turning Point Special? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Second Demographic Dividend . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Enormous Potential: Savings Rate and the Pension System . . . . . . . . . . . Raising Skill Sets and Maintaining Comparative Advantages . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

vii

133 133 136 140 142 146

Part III Sidestepping the Trap 9

China’s Inevitable Speed Bump . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Do Not Be Afraid of the Wolf . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How to Set Rational Growth Speed Targets . . . . . . . . . . . . . . . . . . . . . . . . Two L Shape Trajectories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The V Shaped Revival is Outdated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short and Medium Term L Shape Growth Trajectories . . . . . . . . . . . . . . . A Longer Term L Shape Trajectory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reference . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

149 149 153 155 155 160 162 165

10 Understanding the Middle Income Trap . . . . . . . . . . . . . . . . . . . . . . . . . What is the Middle-Income Trap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Low Income Stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Middle Income Stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The High Income Stage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Tetralogy of the Middle Income Trap . . . . . . . . . . . . . . . . . . . . . . . . . . How to Avoid the Middle Income Trap . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accurately Assessing the Economic Growth Stage . . . . . . . . . . . . . . . . . . Unearthing an Institutional Dividend Through Reform . . . . . . . . . . . . . . . Developing Education and Training . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

167 167 168 168 168 170 172 172 173 175

11 Employment Issues: From the Aggregate to the Structural . . . . . . . . Understanding the Labour Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Functions of the Natural Unemployment Rate . . . . . . . . . . . . . . . . . . Strong Wage Growth as Bad as Weak Wage Growth . . . . . . . . . . . . . . . . . Employment Structure and Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

181 181 185 186 191

12 The Income Distribution Kuznets Turning Point . . . . . . . . . . . . . . . . . We Need to Reacquaint Ourselves with Equality and Efficiency . . . . . . . The Income Distribution Turning Point: The Kuznets Turning Point . . . What Is the Cause for and Origin of Dispute . . . . . . . . . . . . . . . . . . . . . . . Income Distribution Policy Errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

195 195 197 201 203

Part IV Creating a New Miracle 13 Can China Create Another Economic Miracle? . . . . . . . . . . . . . . . . . . Can the Chinese Economy Continue to Grow? . . . . . . . . . . . . . . . . . . . . . . New Concepts Guide New Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Fundamentals of an Improving Economy . . . . . . . . . . . . . . . . . . . . . .

209 209 210 213

viii

Contents

Stimulating Microeconomic Vitality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Evaluating the New Pattern of Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How to Destroy the ‘Xiling Effect’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Opening the Right Policy Toolbox . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Why Emphasise the ‘Three Increases’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Productivity Guided Industrial Restructuring . . . . . . . . . . . . . . . . . . . . . . . The Key Aspects of Industrial Upgrading . . . . . . . . . . . . . . . . . . . . . . . . . . The Worrisome ‘Reverse Kuznets Effect’ . . . . . . . . . . . . . . . . . . . . . . . . . . Changing Approaches to the Upgrading of Industrial Structure . . . . . . . .

215 217 218 220 221 224 224 226 229

14 From the Demographic Dividend to the Reform Dividend . . . . . . . . . People Centred New Model Urbanisation . . . . . . . . . . . . . . . . . . . . . . . . . . Pathway Outcomes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The New People Centred Focus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . How to Really Implement People Centred Urbanisation . . . . . . . . . . . . . . The Modernisation of Agricultural Production Methods . . . . . . . . . . . . . . Challenges at the New Stage of Agriculture . . . . . . . . . . . . . . . . . . . . . . . . On Traditional Concepts of Economies of Scale . . . . . . . . . . . . . . . . . . . . Scale Constraints to Agricultural Modernisation . . . . . . . . . . . . . . . . . . . . Land Regulations: The Reform Bridgehead . . . . . . . . . . . . . . . . . . . . . . . . From the Demographic Dividend to the Human Capital Dividend . . . . . The Contribution and Formation of Human Capital . . . . . . . . . . . . . . . . . . Education and Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Cost Benefit Reform Formula . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

233 233 234 235 237 239 240 241 243 244 245 246 247 250

15 From the Demographic Dividend to the Open Dividend . . . . . . . . . . . The Reversal of Globalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . International Trade and Transnational Investment . . . . . . . . . . . . . . . . . . . The Depth and Breadth of Globalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . The Populist Genes in Western Governments . . . . . . . . . . . . . . . . . . . . . . . Voting with Hands, and Voting with Feet . . . . . . . . . . . . . . . . . . . . . . . . . . Popular Populism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . China and Globalisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Why Does China not Oppose Globalisation . . . . . . . . . . . . . . . . . . . . . . . . Declarations at Davos . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

253 253 254 256 259 260 262 262 263 265 268

Addendum: Characteristics of Epidemic Shock and Response Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 271

Part I

China’s Miracle

China’s Reform and Opening has now been underway for nearly four decades. The economy has soared and people’s livelihoods have greatly improved, and so it is known as the “Chinese Miracle”. The changes wrought by this miracle are unprecedented throughout the nation’s millennia of history, and are also vanishingly rare globally. This book aims to dissect the underlying logic to the Chinese Miracle via the perspectives of population and development theories, look at the Chinese economy from the perspective of long-term historical trends and global categorization and demonstrate the course charted by the Chinese ocean liner in deep waters via investigation and research. How should the China’s experience of economic development be demarcated? What kind of unique characteristics does the development of the Chinese economy display? How should we understand China’s economic development and what types of misunderstandings are we likely to have? Each chapter of this book offers detailed analysis and explanations to these questions.

Chapter 1

Understanding the Stages of Economic Development

I have written numerous articles and given many lectures on the subject of the stages of China’s economic development. I often compare my own experience to that of a Russian doll. When I tell such stories, the audience listens, but with doubt etched on their faces, and when responding to such doubt, I am constantly engaged on new research. Such research pertains to the entire process of the history of the Chinese and global economies, and incorporates the principles of economic growth from a range of national experiences. I turn these into a unified whole, and bring in research of my own into each aspect, and the end result has the likeness of a Russian doll. This large doll is in fact a grand framework. This chapter will conduct a general demarcation of the stages of economic growth and tell how China joined the race, and how it is placed at each specified development stage, and then delineate the propositions of the key theories at each development stage, and then analyse how these propositions apply to the Chinese experience.

Demarcating Stages of Economic Development The story of China’s economic growth cannot be avoided when discussing the stages of economic development. The Chinese experience is not purely a Chinese experience, for it is the only one that also deepens our understanding of development economics and theories of economic growth. From a global economic perspective, the nation has essentially skipped the overwhelming majority of the main stages of economic development, and is now slowly entering the final stage. The Chinese experience is vast in scope and, having comparatively quickly skipped many of the major stages, brims with observations and data. Furthermore, and critically, the Chinese experience has been a process of growth and decline, followed by renewed growth (see Fig. 1.1). A look at the longer term history of the Chinese economy shows that its GDP formerly comprised a major proportion of the world economy, peaking around 1820 © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_1

3

4

1 Understanding the Stages of Economic Development

Total GDP

GDP per capita

140

35

120

30

100

25

80

20

60

15

40

10

20

0

0

10 0 15 0 00 16 0 17 0 0 18 0 2 18 0 70 19 1 19 3 50 19 7 20 3 0 20 3 04 20 0 20 5 06 20 0 20 7 0 20 8 09 20 1 20 0 11

5

Year

GDP per capita as proportion of world GDP (%)

Total GDP as proportion of world GDP (%)

40

Fig. 1.1 China’s changing economic fortunes over the ages

with one third of total global GDP. A sustained decline followed, accompanied by a corresponding drop in GDP per capita, all the way down to its nadir. If you look at the x-axis of Fig. 1.1, you will see that to the left of where total GDP and GDP per capita fell to their lowest levels, early values are divided by millennia, and then centuries, and decades, and then on the right hand side, years. This shows that China’s global economic standing rapidly reversed following the implementation of the Reform and Opening. As such, I believe that the Chinese experience has much to contribute to theories of economic development. Let us first look at how to demarcate the stages of economic development. We could say that we have been studying both economics and growth theories for a very long stretch of time, but we have not been too concerned with the issue of their division in to stages, for we have been more involved with the so-called modern new classical growth theory. There have, of course, been innovations and revisions to the body of this theory, with /new growth theories/ for instance; but compared to when we learnt about development economics and the issues of growth at university, where we were exposed to all manner of different divisions of the stages of growth, but currently popular modern theories are ever more disinclined to conduct such demarcations. I believe that such demarcating still serves a purpose, for we are a component part of the history of economic growth, and if there are such a thing as stages, then there would be countries richer than us ahead of us, for China is a country with mid to high ranking income levels, whilst behind us would lie mid income countries, and then mid to low income countries, and then a multitude of impoverished countries. So if the entire course of humanity’s economic development may be demarcated into stages, then we will be able to co-ordinate ourselves; and following which, find out which stage we ourselves are at, what challenges there might be, and what kind of experiences we will face, and what lessons we might learn, and in so doing, such experiences and lessons can become much more targeted.

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Macroeconomics should consist of two aspects: the first aspect is short term and pertains to research into cyclical issues; and the other aspect should be called economic growth. However, the overwhelming majority of current macroeconomists do not actually discuss economic growth, and are in fact concerned with comparatively short term and specific aspects which pertain to the economic cycle, such as currency circulation volume, and recent changes to PMI, and changes to CPI (consumer price index), as well as changes to the unemployment rate, and have turned macroeconomics in to something that is not really that macro at all. If we consider economic growth over the very long term, we come into contact with concepts about stages, allowing the creation of a truly macroeconomic field of view, allowing the understanding of China’s recent issues from a perspective grounded in a long term focused framework. The economist Robert Lucas Jr. said that researching the rise and fall of a country’s economy over the long term can be mesmerising, and is something that is easy to become immersed in once one begins to consider such topics. And so, an observation and analysis of growth over the longer term will be of more utility in understanding our current issues. In the past, stages of economic growth have been divided into a wide variety of different ways. One fairly representative person is the economist and political theorist, Walt Whitman Rostow, who previously served as Special Assistant for National Security Affairs. His demarcation of economic stages has been extremely influential to a number of economists. Early on, he divided economic growth into five stages: the first was the traditional agricultural society, which featured low production, and was a classic impoverished society. The second stage was a development stage that featured the Pre-Conditions for Take Off. Whereby, poverty meant that everybody was eager to work towards development, and had prepared some of the necessary conditions for development. The third stage was the Take Off stage, the key to which being the reaching of the necessary degree of capital accumulation. The fourth stage was entry into the Drive to Maturity, and the fifth stage, the Age of Mass Consumption, where income and consumption levels have multiplied. When he later revised this theory, he added a Rising Living Standards stage, but most people now only remember his first five stages. The influence of these people during the 1950s was enormous, but by the 1960s there began to be misgivings about development economics, and it was being abandoned by the 1970s and 1980s. There are now virtually no courses on development economics on offer at American universities, and economists with whom we are so familiar, such as Lewis, are not even mentioned in the West. They believe that economic growth as delineated by the new classical model, and which emulates America and Europe, and so it is no longer demarcated into stages. There has, however, been a new development in recent years, exemplified by Masahiko Aoki. At the World Congress convened several years ago when he was the President of the International Economic Association, his President’s Report demarcated economic development into four stages based on the East Asian experience: the first stage was the M, or Malthus, Stage, which was primarily expressed by the equilibrium trap of poverty, whereby even if people were able to extract themselves from this trap for short stretches of time, a rise in income levels precipitated more children,

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1 Understanding the Stages of Economic Development

and a surfeit of numbers then diminished the original product, and income per capita fell once more. The second stage was that of government guided industrialisation. The key aspect of this stage are adjustments to economic structure, leading to the gradually reduction of the proportion comprised by agriculture, and the expansion of that of the secondary and tertiary industries. This stage is called the K Stage, or Kuznets transition. I once mentioned to Masahiko Aoki that this stage could also be called the Lewis Stage, because it primarily concerns the transition of labour from agriculture to nonagricultural sectors. Initially, he accepted this, and said that it could also be called an L stage. After he had carefully considered this matter, he continued to refer to it as the K Stage. The third stage is the H stage and is a stage of development which relies on human capital to raise productivity. If you could successfully pass this stage, then the fourth stage awaits, which is the population transition stage. This stage is essentially that of an ageing society, and features low fertility, and the cessation of the demographic dividend, and all new classical economies, growth can only result from increases in productivity and technological advancements and innovation. Masahiko Aoki primarily demarcates the East Asian model. Edward Prescott, Nobel laureate for Economics is a theoretical economist most inclined towards demarcating economic development theories in to stages. In an essay written with a colleague, he said, ‘In the past we have only admitted one type of new classical growth, called the Solow stage, in fact we cannot ignore that mankind existed for extremely long stretches of time in a Malthusian period of growth.’ Owing to which he set up a model which stated that mankind is divided into at least two stages of development: the first is called the Malthusian Stage, and the other the Solow stage. The former is an equilibrium of poverty, which if escaped, leads to the transition of economic growth, thereby entering the new classical stage, which adheres to the—the sole originator of economic growth being increases in total factor productivity—mentioned by Solow. Regarded as having opened a beachhead in traditional economic theory, mainstream economists eventually admitted that, apart from the Solow stage, there might also be other stages of development. Prescott also mentioned that there might be another stage between the Malthusian and Solow stages. He did not say what this stage might be called, he said that the main task of this stage is to eliminate institutional roadblocks that hinder the transition of excess labour from agriculture. Or to put it another way, this is a process of transitioning labour from the low efficiency agricultural sector, to non-agricultural sectors that enjoy higher levels of productivity. For us, this is an extremely natural stage, for this is the Lewis (L) stage, and features the development of so-called ‘dual economies’. However, Masahiko Aoki remained unwilling to rename his K stage as the L stage. Based on the work and observations that they have already undertaken, and the route that China has taken, as well as piles of documents on development economics, we have ascertained that economic development can be divided into four stages: Stage 1, the Malthusian poverty trap, or M type economic growth. Stage 2, Lewis’s ‘dual economy’ economic growth, or the L type of economic growth. Stage 3, the Lewis turning point, or T type. We have especially listed the Lewis turning point, for it has a

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special significance for China. Stage 4 is the Solow neo-classical economic growth, or S type. We have created a framework through these four stages of development, and we can observe how history has developed through this framework, and the route that China has taken, and which stage the country is at today, and what issues we will encounter at each stage. These issues concern a great many scholars; for the route that the Chinese economy will take over the coming years is a theoretical question pondered over by many economists. In the subsequent sections, we will look at these stages, and key issues to which they pertain.

The Malthusian Poverty Trap: The Long Dark Night Before the “Grand Divergence” Let us first discuss the Malthusian poverty trap. The Malthusian stage of development is the one which we should most not ignore, for mankind was in the Malthusian poverty trap for long durations of time. The theoretical economist, Charles Jones said, everybody usually acknowledges that we have been around for one million years, he compared those one million years with a 100 yard long American Football pitch, and assumed that humans had begun at one end of the pitch and walked to the other end. After 99 yards, and the passing of 990,000 years, and with just ten thousand years left, humanity’s most important industry—agriculture—appeared. A few steps later and we have reached the birth of Jesus Christ, and the apogee of the Roman Empire, at which point only seven inches remains before the end. A bit further on, another important node is the industrial revolution, which from our perspective happened a very long time ago, but by which point, less than one inch remains of the entirety of the human history football pitch. The industrial revolution is a key node that demarcates the Malthusian poverty trap from modern economies. It can be seen that humanity has been trapped in an impoverished Malthusian era for 99.99% of its existence. It was only by the time of the industrial revolution, around 1800, that the world began to experience real income per capita growth. Prior to this, the global GDP per capita was essentially around $100 dollars (per annum). After this point it began to rise rapidly, and now it is roughly several thousand dollars per capita. All countries did not exhibit increases at the same pace during this process. The United Kingdom was first, followed by the European mainland, and after that the process spread to Europe’s immigrant countries, such as those in North America, Australia, and New Zealand, before later expanding to Japan in the Far Asia. This means that after the industrial revolution, at the same time that income per capita began experiencing real growth, the world witnessed a great divergence, with the economies of some countries beginning to rapidly grow in the modern sense of the word, but the majority of countries were still backward, impoverished, and

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Fig. 1.2 The post industrial revolution ‘Grand Divergence’. Source Bradford DeLong (1998) Estimating World GDP, One Million B.C. - present

experienced slow growth or stagnation. This great divergence and global economic growth followed on from the industrial revolution (see Fig. 1.2). This means that the Malthusian stage is an extremely protracted, yet critical, historical process. In addition, we know that the modern world is blighted by Malthusian events: people say that the population explosion is a Malthusian trap; that natural disasters, and famine are the result of discordance between the human population and the natural environment, and is a Malthusian constraint. The pernicious impact of climate change is likewise linked to Malthus; whilst war and conflict are arguably also Malthusian constraints. This means that to a certain degree, Malthusian theory has a utility in the modern world. Malthusian theory is notorious amongst the Chinese, and that is actually the case globally too, everybody has repudiated him over the past two centuries, but he has become an economist who just can never be ignored. Someone once made an interesting comparison, which was that if you sought out the first edition of the most famous British classical economists in a London auction house during the 1990s, their prices at auction were: the father of modern economics, Adam Smith’s The Wealth of Nations, was £20,000, another great economist, Ricardo, The Principles of Political Economy and Taxation, was £6500, and Malthus’s An Essay on the Principle of Population was as high as £30,000. This reflects that Malthus’s influence is even greater than that of Adam Smith and David Ricardo. This is a specific stage, and when understanding this stage, people naturally wish to understand the reasons for the emergence of this ‘great divergence’. Why were all of the countries anywhere in the world, in a state of impoverishment prior to the industrial revolution. That is to say, that no matter whether people lived in Europe, Asia, the Americas, during the time of the Roman Empire or during Qin Dynasty China, or even earlier, or later, they lived the same impoverished lives. When you are researching economic history, and are unable to compare levels of economic

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development indices or levels of prosperity, you can use the average height of the population as a replacement index for income per capita levels. I will give an amusing example. I served as the chief editor of a magazine called Chinese Journal of Population Science for a long period of time. A German submitted a piece of research on the Terracotta Warriors, and whilst I was unable to completely understand its contents, but I found it extremely interesting nonetheless, and published it. He investigated the terracotta warriors, which were crafted to be the same size as real soldiers, real soldiers who would have been selected for being the youngest and possessing the best physiques. After composing his hypothesis, he calculated the average height of Qin Dynasty soldiers, and reached a conclusion. He discovered that the average height of Qin Dynasty soldiers was greater than that of soldiers of the American Civil War period, signifying that the United States of America was still in the Malthusian stage during its civil war, its living standards below that of Qin Dynasty China. Why is it that such different routes appeared during the industrial revolution? People discuss the key issue of the ‘great divergence’, to which the Chinese have given the name, ‘Needham’s Riddle’. Joseph Needham was an expert on Chinese technology and history, and mentioned relatively early on that China was historically extremely advanced. Not only was its economy highly developed, but its technology was in advance of other regions around the world, and the gap between China and the West only appeared during early modern times, when it became markedly backward. He said: ‘What we need to explain is, why was China, whose technology was world leading during the pre-modern era, so backward by the time of the industrial revolution.’ Many Chinese scholars discussed this topic by writing a great number of papers, where they expressed a range of opinions. Feel free to go read them yourself. A great many economists also pondered this issue. There is not enough space to discuss this in detail, so I will mention just two points. Current theories of economic growth are well known, and state that the core of economic growth is not just the accumulation of material capital, or land, but derives from ideas. In the past, this would have been translated into Chinese as sixiang, or ‘thoughts’, and is not terribly accurate. We should instead term it ‘creativity’, or ‘innovation’. We can at least see that there are two vital aspects deserving attention when explaining the presence or absence of economic growth: the first is the accumulation of material assets, the second is the accumulation of human capital. Creativity and innovation is wholly dependent on the accumulation of human capital, and it is only through capital accumulation that such creativity and innovation can be converted into material economic growth. However, these two things were in extremely short supply in any country during the Malthusian period. The nub of the issue is how these things should be nurtured and then accumulated, and so what needs to be considered is whether or not a given subject possesses the incentive mechanisms of material and human capital. The gap between China and the west is the result of these two things, and led to the creation of a grand divergence. First, China lacked the incentives to accumulate materials during certain stages of economic growth. Everybody worked the fields during the early stages of the Malthusian period. As per capita GDP was only $100, it was impossible for every

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single worker in the agricultural industry to accumulate material capital, so that period necessitated that either the state accumulated, or that it created local economic entities that possessed the incentive mechanisms for such accumulation. In Europe this led to the classic feudal system—where nobility or those who displayed exemplary military service were allocated a plot of land to construct a manor. This then became an independent economic entity, and was able to trade with outsiders, leading to economic growth, and owing to the contractual relationship that existed between the two, the overlord would not expropriate these possessions, for the latter had allocated land to the former, and the former could enjoy the proceeds. As there was no standing army at the time, so the lord of the manor was obligated to fight for his liege during times of war. Those members of the nobility who lacked finances could still don a suit of armour and ride a horse, and fight. This kind of contractual relationship that formed between the monarch, nobility and local economic entities endowed the region with the incentives and drive to develop its own economy and achieving, what was for a small-scale peasant economy, the impossible. China turned into a centralized empire at a relatively early date, the central government of this empire could not directly influence the economy except via grand projects such as the construction of the Great Wall or the weirs at Dujiangyan. In the overwhelming majority of circumstances, it did not participate in the establishment of an economy, and could merely dispatch officials to collect taxes and raise armies. The officials were only responsible to the emperor and the central government, and had no responsibility towards local economies, and would not elicit any direct advantage from that local economy. Land could be bought and sold, and there were other autonomies too. From the perspective of property rights however, all belonged to the emperor, and owing to which, China did not create independent, strongly incentivised local economic entities above a certain scale. This is how material asset accumulation mechanisms differ. With regards to the accumulation of human capital, a great many scholars, including Needham and Justin Yifu Lin have all said that the traditional Chinese Imperial Examination System was the factor which most obstructed the creation of human capital. However, most people’s research stops at this point, and they do not elucidate on why the Imperial Examination System arose in the first place. Institutions are born in response to a need, and it was thus for the Imperial Examination System. At that point the relationship between the imperial dynasty in the capital and regions was not that of the contractual relationships found in Western Europe, but that of the central government possessing absolute authority. Such authority demands constant renewal, and repeated confirmation, and constantly and directly expressed by each and every member of the elite. This means that when selecting the members of that elite: first, you need to sufficiently demonstrate the legality of the dynasty and the central government; second, you need to prove your loyalty. The rulers of that time discovered that of the works of the Hundred Schools of Thought, the doctrines of the Confucians had the most utility, and could serve as a set of foundational ethics that enabled the elite to express their loyalty to the dynasty, and having accepted this ideology, the works of the other schools of thought were abandoned in preference for a laser focus on Confucianism. This was then intensified via the Imperial

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Examination System, making it the solitary ideological bridge into the elite. This bridge consisted of the traditional eight-legged essay and disbarred the possibility of innovation. Chinese society also had its skilled artisans or scientific geniuses, for there is bound to be lots of creativity with such a large population base. However they were now only given a single route, and everybody crowded across that single wooden bridge, and technology, artisanship, and technical skills were not encouraged at the time. Although there were innovations and discoveries, they were unable to create the critical minimum effort, or an atmosphere of sufficient strength, to break out of the Malthusian trap. This is a key aspect of the Malthusian stage of development. The grand divergence needs explanation for its global scope, but for China, one only needs to answer ‘Needham’s Riddle’. For this is why China was unable to create an industrial revolution during the early modern period, was unable to become the birthplace of capitalism, and why it dropped to the back of the race.

Driven by the Demographic Dividend: The Lewis Model Let us return to the Lewis Model, a dual-sector model in developmental economics. W. Arthur Lewis published his important paper Economic Development with Unlimited Supplies of Labour in 1954, and was awarded the Nobel Prize for Economics in 1979. He has provided a tool that enables us to understand that the primary development process in very many developing countries is the siphoning off of surplus labour from agriculture, offering subsistence wages to absorb them into non-agricultural industries, right up to the point when that labour has been fully absorbed. This entire process is called the dual-sector model. Lewis himself did not clarify that the development of the dual economy is in fact two processes, which is evident upon observing two incidents: the first is the economic process itself, labour is constantly absorbed, and the industrial sector is in a process of constant expansion; the second is the process of population transfer. This process of population transfer can be described as follows, fertility rate or population growth gradually transitions from its Malthusian aspect (high fertility rate, high death rate, low population growth rate), to a status of population growth, reaching the development stage of modern populations, where people are beginning to have fewer children, and fertility rate is slowly falling. Changes to the working age population respond to changes in total population, for example there is a twenty year time lag between the working age population ratio and the population growth rate, and having experienced a process of moving from low to high and then back down again, finally resulting in an ageing population, and the working age population ratio fall in response. Owing to which, there are two inverted U-shaped curves, revealing why we have surplus labour (see Fig. 1.3), that there is a demographic dividend, that this demographic dividend will eventually disappear, that this surplus labour will finally be

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Natural Population Growth

Working Age Population Rate

Fertility Rate Minus Death Rate

Proportion of Working Age Population

Time Fig. 1.3 The two inverted U-curves of population transition. Source Jeffrey Williamson (1997), Growth, Distribution and Demography: Some Lessons from History

completely absorbed, that we are entering an ageing society, and that we will eventually head towards a process of neo-classical growth. This is why we should talk about the development process of the dual economy. The World Bank recommended the so-called ‘East Asian Miracle’ to the world at the start of the 1990s, which at the time were primarily represented by the The Four Asian Tigers. A large number of neo-classical economists, who did not know about the surplus labour phenomenon, and did not know about the demographic dividend, criticised the East Asian economies, saying that there was not any miracle in these countries, and that the good times could not last forever. The most representative of whom was the professor Paul Krugman, he saw several important econometrics papers, where much of the discussion of which revolved around Singapore’s data. He said that Singapore’s GDP growth was primarily production driven, with capital and labour investment, but no technological progress, and no total factor improvements in productivity. The former Soviet Union grew in exactly this manner before its economy finally collapsed, and so he said that the East Asian economies were merely paper tigers. For, although he is a proponent of Keynesian economics, the theories of development embedded in his bones are neoclassical in origin, and he does not know that East Asia has surplus labour, or that the region is experiencing a unique process of population transfer, and that it can at specific times benefit from a demographic dividend. Having not seriously researched the issue, he has only popularised other people’s research through his articles. The result being that everybody argues with him, and many people criticised his viewpoints, and because of this period, he gained a certain notoriety in Singapore. I heard about a story that Justin Yifu Lin had told. Krugman attended a conference in 2000, and Lee Kuan Yew, the founder of Singapore, was also present. Krugman was introduced to Lee Kuan Yew, as a Nobel Laureate of Economics, to which Lee responded, ‘I certainly know who he is,’ before continuing, ‘Professor Krugman, I

Driven by the Demographic Dividend: The Lewis Model

13

12 10 8 6 4 2

19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 09

0

Fig. 1.4 Contribution of the demographic dividend to growth during the Reform and Opening period

would like to ask you a question, you said that Singapore’s past economic growth was reliant on high savings and high investment, and that capital returns will eventually fall, and that the economic growth cannot persist, but this kind of high investment and high savings approach has persisted in Singapore for forty years, and our returns remain very high, even to this day. How would you explain this phenomenon?’ That is the end of the story, and I do not know Krugman’s answer. I think that he would have been lost for an explanation because he did not know about the demographic dividend. As we have undergone an extremely rapid process of population transition, each country in East Asia has surplus labour and a demographic dividend, and working age populations also grew rapidly for a while. In the past we measured the demographic dividend by setting the population dependency ratio as an individual variable, and then placing it within economic growth models to see how much it contributed. Later, I felt that this might not be the best method, and that we should view population factors having an impact on all of the economic growth variables. Figure 1.4 features Chinese data from the start of the Reform and Opening period until 2009, and when the growth rate of the entire economy approached 10%, and each total factor productivity and productivity ratio contributed. The greatest contribution was that of capital accumulation, comprising between 60 and 70%, Chinese economic growth primarily comprised of this. It did not look like a demographic dividend. In fact it was otherwise, for it was intimately related to population factors, for which we will give two reasons: the first is that if the working age population rapidly expands and comprises an ever greater proportion of the whole, then it will naturally pull down the population dependency ratio indicator, and so the population dependency ratio is in constant decline, as population only imposes a light burden, and our surplus production can accumulate for use as investment, thus ensuring the source of material capital; the second is that material capital desires constant investment, where it exerts a positive impact on economic growth, and also provides a rate of return, but

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neo-classical growth theory tells us that rates of return will fall if only reliant on the investment of material capital, because the the rule of decreasing marginal returns will kick in. However, the precondition for a progressive reduction in marginal returns is the existence of a shortage of labour, if the quantity of a factor does not change, and constantly increases the investment of another kind of factor, then returns will most certainly decrease. However, China, along with other East Asian countries, has an unlimited labour supply, however much capital you accumulate, I have a corresponding amount of labour for your needs. Over the past thirty years, vast quantities of China’s labour force has transitioned out from agriculture, ensuring an unlimited supply of labour, and it is owing to this that there has not yet been any sign of a progressive reduction in marginal returns. Researchers from Tsinghua University showed that China’s rate of capital returns had remained relatively high over many years, this was a result of population factors. Apart from this, human capital, labour, and the allocation of labour have been re-allocated from low productivity sectors (agriculture) to those of high productivity (not-agriculture), all of which is directly connected to population. China has been in a classic dual economy development stage for a long time, and Lewis theory has utility in analysing China. Many people have been deeply influenced by Neo-classical economic theory, and are also loathe to admit as much. There is a Chinese language periodical in the USA which specifically researches China’s economy, called zhongguo jingji pinglun, or The Chinese Economy Review, the chief editor of which is likely a neo-classical economist, and he did not agree with my pointing out that the Lewis turning point had already arrived, but he also felt that this was an important topic, and there was room for in depth discussion, and so he organised an article which gave space to each side of the divide. I was, naturally, the proponent, and he found someone to oppose, his own views then became even more opposed. The proponent said that China had already arrived at its Lewis turning point, whilst the opponent said that that was not yet the case. This chief editor believed that Lewis has absolutely no relevance to China, and Lewis theory had absolutely no ability to explain its situation. We know that when Lewis went to Stockholm to accept his Nobel prize for economics in 1979, someone else also received the prize, Justin Yifu Lin’s tutor, Theodore Schultz. They both won the same year, and both contributed hugely to the field. However, their opinions were diametrically opposed. Lewis believed that developing countries have a large volume of surplus labour, and that the marginal productivity of labour is either zero or a negative value. Shultz was resolute in his opposition, and stated that there was no such thing as surplus labour, and believed that the market forces held the price of surplus labour extremely low, before finally attaining an equilibrium. He considered the phenomenon of the marginal productivity of labour being either zero or a negative value as even more unlikely. They had completely different viewpoints, but each of their viewpoints had a logical foundation, both have been inspired, and they were both awarded the prize the same year. I will add a little gossip, around 1995, I suddenly received an invitation from an American professor, who said that he had a problem, which required my assistance. He had a study topic pertaining to the development of China’s agriculture, and was

Driven by the Demographic Dividend: The Lewis Model

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stuck on the issue of surplus labour. I took advantage of the situation, and over the course of a week helped him calculate the surplus labour, and I became one of the three authors of this study topic. When the topic was wrapping up, the sponsor invited some big name experts to come and debate, one of whom happened to be Justin Yifu Lin’s other tutor, Johannsen. This professor savagely critiqued this topic and especially criticised the section I had contributed on surplus labour, saying that there should not even be any surplus labour. He was an important economist of the Chicago school and could also could be considered one of Shultz’s students, he resolutely stood his ground, maintaining that there was hardly any surplus labour, and that the topic was flawed. At the time, we three writers were resolute in response and opposed such critiques, and made no further revisions, it was finally drew to a close, and from which a book published. Johannsen is actually an extremely good man, and also extremely good to Chinese students. After retirement, his two star pupils Justin Yifu Lin and Zhao Yaohui often invited him to visit China for research purposes. He heavily researched China’s rural areas. Finally Justin Yifu Lin and Zhao Yaohui compiled an extremely thick collection of theses, all of which researched the Chinese rural economy. I also read it thoroughly myself, and discovered that his papers frequently mentioned China’s excess rural labour, and fully acknowledged that China had surplus labour, and pointed out that agricultural productivity was much lower than that of other sectors. A great many neoclassical economists still probably have not appreciated this issue, and in not understanding this issue, are unable to understand the East Asian miracle, and cannot explain the Chinese miracle. Economists are the least likely group to reach a consensus. However, once there is empirical evidence of a certain hypothesis, then serious scholars who consider the pursuit of truth a duty, are always willing to abandon former prejudices and adopt new perspectives. Johannsen is one such great economist. In the year 2000, I was the chief editor of the first volume of the Green Book of Population and Labour, that volume was themed around the rural population and labour. After Johannsen read it, (it is more than likely that he asked one of his students to give him an overview), he sent me a letter in congratulations, and pointed out the vital importance of researching the Chinese rural population and labour. Evidently, he had relinquished his prior resolute opinion, and acknowledges that there is surplus labour in the Chinese countryside. Johannsen’s favourite pupil, Justin Yifu Lin is also such a scholar. What is amusing is that we started working together after he returned to China in the late 1980s. We had almost no topics on which we were in agreement during our joint collaboration, for I was extremely interested in the effect of surplus rural labour in understanding the Chinese countryside and Chinese economy, whilst he, being an outstanding graduate of Chicago University, and the brilliant disciple of Schultz and Johannsen, completely denied that surplus labour even existed. And so, we did not debate this issue for a long period of time, I researched my field, and he continued to overlook his. The most interesting thing is that, nowadays, where I can see the arrival of the Lewis turning point and surplus labour is set to virtually disappear, and Justin Yifu Lin is now ever more solemnly expounding on the issue of the surplus rural labour. We know that the dual economy stage of development is a process when labour is constantly transitioning out of agriculture and into other sectors, and the proportion

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1 Understanding the Stages of Economic Development Japan

Korea

China Official

China Estimated

80 70 60 Year 1972 50.5%

50

Year 2004 46.9%

40 30

Year 1960

30.2% Year 2004 27.8%

20 10 0

19 5 19 2 54 19 1956 5 19 8 6 19 0 1962 6 19 4 6 19 6 19 68 7 19 0 1972 19 74 1976 7 19 8 80 19 19 82 8 19 4 86 19 1988 9 19 0 1992 9 19 4 9 19 6 9 20 8 0 20 0 02 20 20 04 0 20 6 20 08 10

Proportion of agricultural work force(%)

90

Year

Fig. 1.5 Changes to the proportion of the agricultural workforce in China, Japan, and Korea

comprised by the agricultural workforce is constantly falling. Japan, Korea and China are the countries which most typify the experience of the dual economy stage of development, and where the proportion of the agricultural workforce has dropped precipitously (see Fig. 1.5). Japan reached the Lewis turning point in 1960, after which the proportion of the work force employed in agriculture constantly fell. Many people have criticised me, saying, ‘Considering that China’s surplus labour is still transitioning, why did you say that we have already reached the Lewis turning point?’ In fact, I never said that labour could not transition, but the Lewis turning point has arrived all the same. The significance of the Lewis turning point is that whilst surplus labour still exists, if wages do not rise then transitions cease. Korea reached the Lewis turning point in 1972, and labour continued to transition after this point. I believe that China reached the Lewis turning point in 2004. Agricultural labour previously transitioned rapidly, and it will also continue to do so in future.

The Lewis Turning Point and the Middle Income Trap The third stage of development or growth type has been specially tailored towards China’s characteristics: the Lewis turning point. This holds a special significance for China. I have previously mentioned that it is not that surplus labour vanishes once the Lewis turning point is reached, for if you read Lewis’s classic papers (there are only a few), you will find that upon reaching the first turning point, there is still surplus labour, rather that static subsistence wages, which could previously attract unlimited quantities of labour lose their power, and so wages must rise to stimulate a sustained labour supply. This results in the commonplace phenomenon of a shortage

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of labourers, and the arrival of the Lewis turning point is indicated when the wages of ordinary labourers exhibit sustained rises. We have added a population factor to the Lewis model based on China’s characteristics. If we say that in 2004 we saw a shortage of rural workers and difficulties in recruiting workers, then the process of a sustained rise in the wages of peasant workers is a symbolic phenomenon, behind which there is at least one driver, and that is a sustained reduction in the increase in the working age population. Then, by 2010, the 15–59 year old working age population embarked on an absolute decline. Our population dependency ratios feature the working age population as a denominator, and so the population dependency ratio began to rise. Previously we said that China’s economic growth was connected to its demographic dividend. As those economic growth factors have reversed, then the speed of economic growth naturally falls, and the demographic dividend can be said to have disappeared. When debating whether the Lewis turning point has arrived or not, a kind-hearted foreign scholar gave a suggestion, he said that as economic growth is a long process, and the unit of measure for a so called point is a year, then instead of discussing the Lewis turning point, we could discuss a Lewis turning interval, which would be a kind of juncture that lasted several years, and such a proposition might lead to more people being willing to take on board my viewpoints. I therefore wondered exactly how long such an interval might be. From 2004 until 2010, we suddenly discovered that there were two changes: the first was the dearth of workers, labour shortages, and rising wages that occurred in 2004; the second is the onset of an absolute reduction in the working age population. This six year period could be considered to be an interval (see Fig. 1.6). And so, I feel that China has already passed through such a

95 000 90 000 85 000 80 000 75 000 19 19 9 5 1996 1 99 7 1 9 98 2099 2000 20 0 1 2 00 2 2003 2 0 04 200 5 2 00 6 2007 2 0 08 20 09 2010 201 1 20 12 2013 2 014 2 01 5 1 20 6 1 20 7 2 0 18 2019 20

Working Age Population (ten thousand)

100 000

Year Fig. 1.6 China’s Lewis turning interval

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Lewis turning interval. China faced a process of slackening economic growth, and so people began to discuss the so-called middle-income trap. The middle income trap is signified by a country that has developed to a middle income stage, and especially those after the mid-high income stage, which then often stop growing, and then remain trapped in the middle income stage for decades, or maybe even centuries. The starting point for this trap is always when a rapidly growing economy suddenly falters. Owing to which, some people have researched at which point rapidly growing economies will suddenly exhibit similar sudden slow down phenomena. There is an outstanding scholar in the United States, Barry Eichengreen, who conducted research on a kind of special dollar standard, moreover he brought together data from a large number of countries, including those of early industrialisers, as well as East Asia and Latin America. The results showed that phenomena of declines in economic growth usually occurred when GDP per capita reached $17,000. The average growth rate for these countries for the seven years prior to this event was 6.8%, and then once GDP per capita hit $17,000, the seven year average growth rate fell to 3.3%, a drop of 3.5% points, or more than half of its prior growth rate. If we really want to say that there was a point where China’s growth fell, I believe that point was in 2010, for this was the year when the working age population peaked, and after which, reduced in absolute terms, heralding the disappearance of its demographic dividend. Accordingly, China’s potential growth rate also drastically fell. If we calculated according to the approach of the aforementioned research, then in 2010, China’s GDP per capita was $11,466, the gear shift has come somewhat earlier than this American’s data suggests, yet tallies perfectly with China’s characteristic of ‘growing old before it grows wealthy’, for the population has changed too quickly. The so-called phenomenon of deceleration appears in our calculations as a drop in the potential growth rate, which means that based on factors such as labour supply, capital investment level, and productivity improvements, we can then model exactly how healthy China’s capacity for growth is. We found that there is a definite decline after 2010 (see Fig. 1.7). Between 1995 and 2010, our average potential growth rate is 10.3%. Actual growth is more or less identical, and two tally for the majority of the years. After this point, and between the 12th Five-Year Plan it is only 7.6%, and by 13th Five-Year Plan it is only 6.2%. The primary causes of this are the disappearance of the democratic dividend and a substantial drop in surplus labour, resulting in the increase in growth to fall by this point. From a global perspective, 6% or 7% is normally the rate of economic growth prior to a speed drop, and so is not in itself bad news. This is just the point at which the growth of the dual economy comes to a conclusion, creating a special Lewis turning stage, and the key topic for this stage is how to avoid the middle-income trap, making it reminiscent of the grand divergence at the end of the Malthusian stage, or in other words, it is the same as Needham’s Riddle. China is yet to tumble into the middle income trap. Although growth speed is dropping and such a drop might precipitate entrance to such a situation. The most renowned of those to fall into the trap are many Latin American countries, as well

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Fig. 1.7 The point of deceleration of the Chinese economy

as countries including Malaysia in Asia. If we review the experiences of these countries, we find that the middle income trap has “a quartet”—four phases, which can occasionally co-exist. The first phase is that changes during the development stage result in a reduction in the speed of economic growth. Sometimes, everybody sees that this is a result of some specific condition, such as when the depreciation of the Mexican Peso precipitated a fall in the rate of economic growth, but any event is always going to be set off by some instigating condition, leading to a domino effect. Prior to this stage of development you will have some tools to stimulate economic growth, but once reaching a designated stage of development, the tools that you once used no longer work anymore, and you also cannot rustle up any new magic, and so economic growth loses steam. A reduction in the rate of economic growth is not necessarily a bad thing, but it is important to understand how to later sustain growth. If the reason for such a drop is unclear, and you are unaware that the democratic deficit has disappeared, and do not know that it is because the Lewis turning point has been reached, and you do not know that it is because the traditional methods to stimulate growth no longer work, and now need to rely more heavily on technological advances and reform, you will make policy errors, and turn a commonplace reduction in speed into a period of longterm economic stagnation. This is the second step of falling in to the middle income trap. After 1990, the Japanese demographic dividend disappeared, their situation was virtually identical to the Chinese situation in 2010. Japan however, did not realise that its demographic dividend had disappeared, and did not know that its potential supply capability had dropped. It instead thought that the reason was due to insufficient

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demand, and owing to which expended colossal amounts of energy to stimulate demand on a large scale, and engaged in industrial policies and regional policies. However this stimulation did not lead to improvements in total factor productivity, and so it has lost more than two decades during which it has experienced essentially zero growth. A drop in speed was transformed into total stagnation. Countries during periods of high rates of economic growth will experience the phenomenon of growing income disparities, and during this time you grow, I grow, you earn a lot, and my situation improves as well, and so income disparities are acceptable. However, if the economy stops growing, then the cake is no longer getting bigger, and becomes a cake of unvarying dimensions, and so the only method left is to re-distribute each slice of the cake. Can the cake be equally distributed? That is of course impossible. Whoever has the greatest powers of negotiation, whoever has the greatest influence on government policy, or whoever previously controlled the most resources, will be eligible for a large slice of the cake. The results of such redistribution result in drastic increases in income disparities, and social conflicts will become ever more pronounced. This is the third step of falling into the middle income trap. In this kind of situation, the leadership of some countries proposes income distribution optimisation, and an improvement in living standards for the common man, but as the size of the cake stays the same, they are unable to make good on their promises, and so the policies they enact become classic populist policies. At this point, those with stronger negotiating power and more influence on policy will stand up and oppose any kind of reform, leading to these countries falling into a vicious circle, and structural ossification. At this point, the fourth step is to take a country right into the middle income trap. The most stereotypical of the countries in Latin America is Argentina. In the 1930s, Argentina was wealthier than the United States, and historically its GDP per capita has exceeded $10,000, almost entering the ranks of the ranks of the high income countries, but after that point it stagnated and even began to reverse. China needs to consider how to avoid falling into the income trap. I will use the example of athletes to describe potential growth rate. Potential growth rate is athletic ability, which for an athlete means the limits and capabilities his own body possesses. Athletes can experience productivity changes, through his training team and modern exercise regime, all of which in aggregate serves as a steady indicator of his potential competition performance, and such performance is potential growth rate. When his performance no longer improves but stabilises at a certain level, or possibly even drops, it might be because his limits have come into play. For example, potential growth rate begins to drop between the ages of 18 and 28. If at this point we stand up and say, this is nothing to worry about, the reason for the drop is due to insufficient stimulation, and caused by insufficient demand, we just need to stimulate him via demand side factors. We could go online to praise an athlete, or heap scorn on another, or a government department could say that this is a political matter for his success is the nation’s success, or an advertiser could even provide him with material incentives. After all that, we would still not know the athlete’s potential growth rate and his supply side factors, for we have only attempted to stimulate him

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with demand side incentives, desiring that he can compete professionally based on his actual growth rate. Sometimes these methods might even elicit the desired result, but on the whole, it will inevitably lead to injury. The factors influencing economic growth are immeasurably more complicated than those of this example, for the result might be inflation or a bubble economy, or even the creation of ‘zombie enterprises’. Some people say that China’s new government has a new conceptual economic framework, the Likonomics proposed by the investment bank, Barclay’s. The first article of which is not to engage in large scale stimulation, this generalisation is accurate. Japan stimulated its economy when its democratic dividend and surplus labour had disappeared, and its traditional manufacturing industries faced no competition. On the surface, it did in fact look like the problem was demand side in origin, but the underlying factors meant that it just did not benefit from the same amount of labour that it previously enjoyed. If this period of economic stimulation led to the manufacture of more products, but nobody then bought those products, then more stimulation would be ineffective. What about stimulation via infrastructure construction? Demand for investment for infrastructure construction is derivative, and only where there is a corresponding increase in the real economy will there be a corresponding demand for the construction of infrastructure. When industrial growth has slowed, the potential growth rate has also fallen, and contrary to expectations, nobody is interested in investing in such infrastructure projects. When there is no investment stimulation, stimulating infrastructure construction will inevitably result in expanded fluidity. Money always wants to flow somewhere, and apart from flowing into the pockets of the corrupt, it will also flow away from the real economy towards virtual economies like the financial industry. Keynes advocated such economic stimulation. At that time, an economist who like him had a government position wrote to him saying, If you announce the launch of a grand £200 million plan, you will not receive a single order over a period of at least one year, for there is no demand in the economy. Once fluidity has left the system, it has a huge stimulating effect on the financial markets, and people will invest it in the virtual economy, and the result will be a bubble economy. This analysis was farsighted, for in Japan and China, once fluidity vanished, people bought shares, foreign assets and Van Gogh paintings, speculated on real estate, buying any kind of financial product that could generate wealth outside of the real economy, and in fact deviated from the original intent of the economic stimulation policy. This inevitably led to the onset of an economic bubble, which eventually burst. More than two decades of stagnation followed on from the bursting of Japan’s bubble. We need to clearly understand this situation, for the problem is supply side, and is a fall in the potential growth rate, and there is a solution to this problem. Let us return to the earlier story, the exchange between Krugman and Lee Kuan Yew. Lee Kuan Yew said that Singapore’s high savings rate had persisted for forty years, yet the return of investment was still so high, and asked Krugman why this might be. It was a very good question, yet because Krugman did not understand the demographic dividend, he was unable to give an answer. There was also something that Lee Kuan Yew himself did not completely understand, for he confused the rate of return on

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investments with the capital marginal returns. These two are occasionally in accord, and sometimes they vary. Let us look at Fig. 1.8, the x-axis is the middle of the development of the dualsector model, with labour transferring out of agriculture over long periods of time. Some is transferred into labour, and some into the accumulation of capital, right until just before the onset of the Lewis turning point. The capital marginal returns on the y-axis keeps level without dipping down. In addition, the rate of return on capital is also very high, and is always above the OA line. However when the Lewis turning point arrives, labour costs rise, and there is no longer an unlimited supply of labour, and the marginal returns on capital drops, leading to a fall in the rate of return on capital. One possibility is that if we ignore this, then this trend will decline in accordance with QB0 . We can see whether there is still any institutional potential, and we can created institutional dividends through reforms. China’s economic growth has slackened because there is insufficient labour. Labour is restricted by factors such as the hukou, or residence registration, system. If this restriction were to be abandoned, then the rate of decline in capital marginal returns would slow somewhat. To shift the rate of decline of capital marginal returns from QB0 to QB1 is very feasible, for this is exactly what Singapore achieved. Singapore adopted an open immigration policy after the Lewis turning point, and adopted an open Lewis dual economy development. Today, 40% of Singapore’s GDP is created by foreign workers, and it can forestall an overly rapid decline in the marginal rate of capital returns. Japan has an extremely strict immigration policy, and so there has been a labour shortage. China will be short of labour in future, but even if all of the people in all of the countries claiming to enjoy demographic dividends were added together, the number would still be insufficient for China’s need. Although we still have untapped potential, such as somewhat increasing the

Fig. 1.8 Decline in capital marginal returns and sustained return on capital

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mobility of peasant workers, but eventually China’s rate of capital marginal returns is destined to fall, and the demographic dividend will completely vanish. At this point we can raise whole factor productivity via technological and institutional innovation, and reclaim the part of the capital marginal returns that has diminished, and then the rate of capital marginal returns will not fall, and China can follow the QB2 curve. Singapore managed this, and is currently ranked as the 10th most innovative nation on the earth, whilst Japan is not even in the top twenty. These two processes are examples of reform induced institutional dividend. We conducted a simulation, the results of which showed that based on current trends and with no reform, China’s potential growth rate will continue to drop from its current level. It will of course not fall to the point of stagnation. However, we would like to ask: is there still any demographic dividend left untapped? Simulation 1: 2011–2020, the total size of China’s labour declines, but if the labour participation ratio can be raised, then more people will enter the labour market, and the labour supply will rise. If the labour participation ratio can rise by a comparatively objective 1% per annum, then the annual average potential growth rate can increase by 0.88%. Raising the labour participation ratio by increasing the retirement age is unfeasible because the education level of those aged around 60 is already extremely low, and enterprises do not need them. However, enterprises still currently need migrant workers. The residence registration system means that migrant workers do not receive retirement insurance and have no social security, they leave the labour market too early, and too often. So if the residence registration system can be reformed, raising the degree of migrant worker urbanisation, then their labour supply can increase, raising the labour participation ratio. Simulation 2: During this period, we wanted to raise the speed of total factor productivity by a single percentage point, which is likely to be rather difficult. This was only a simulation after all, and if it was indeed feasible, potential growth rate would increase by 0.99%, an almost one to one response, which tallies with the predictions of western neo-classical growth theory, even if there is no total factor productivity, then there is no increase in GDP growth, total factor productivity is directly supporting economic growth. Such a rise in total factor productivity is dependent on reform, and can only be achieved via reform. For instance, increasing the transfer of rural labour can continue to raise resource re-allocation efficiency, and corporate competitiveness can raise through survival of the fittest, and the re-distribution of resources between sectors and between enterprises can lead to efficiency gains, and there are also the gains which accrue from technological advance and innovation.

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Solow’s Neo-classical Growth: Innovation Changes the World The last stage is Solow’s neo-classical growth. The core of neo-classical growth is that when there are not any dividends or no surplus labour, then the law of diminishing marginal utility of capital comes into effect, because of which the only driver for economic growth comes from increases in total factor productivity. This is its keystone hypothesis. Rises in total factor productivity actually have two components: the first is technological progress. The wealthiest, healthiest countries are also ranked top most innovative globally, and that is where new technology is created and produced. However, this is only half of the utility of raising total factor productivity. The second, is the resource re-distribution potential of developed countries. We previously did not understand this aspect. Although developed countries do not possess large amounts of surplus labour to transfer to non-agricultural sectors from agriculture, but economists have discovered that there are productivity gaps between departments and between corporations. If your productivity rate is lower than mine, that means that your factors of production have not been effectively utilised, and so they should be given to me, and I will eliminate you. Owing to this, enterprises in developed countries are forever vying for factors of production, and the most efficient enterprises obtain higher investment and more factors of production, and owing to which they can survive and expand in scale. The calculations of some scholars show that this kind of survival of the fittest (creative destruction) contributes 30–50% of the increases in the United States’ total factor productivity. To us, the potential of this kind of resource redistribution efficiency is even greater, for there is a productivity gap between urban and rural areas, between departments, and also between enterprises. We need to restructure, this requires reforms, and such reforms will yield their own dividends. Economists are undecided as to the prospects of the growth of the Chinese economy. Krugman recently published a discourse which said that China had reached the Lewis turning point, and had run out of surplus labour, and faced a brick wall, and would very likely smash into this brick wall. He not only beats the drum of China’s collapse, he thinks that everybody is going to collapse. He is the high priest of collapse-ology. Speaking as an economist, I wish that more of those in this profession, including laureates of the Nobel Memorial Prize in Economic Sciences would acknowledge the conclusions I have drawn on the arrival of the Lewis turning point, but his extrapolation of its import is completely flawed. Historically, he has never been right, and we must take action to ensure that his theories are fully exposed for what they are once again. Gordon G. Chang is somebody else who beats the drum of China’s impending collapse, and he cites my opinions on changes to the population structure, and likewise comes to a pessimistic conclusion, and again, I am in disagreement with him. Some other economists are more optimistic, although there is no unconditional optimism. Everybody is very familiar with the American economist, Lawrence Summers, who has appeared in a number of films on the Wall Street financial crisis,

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he speaks very directly, and does not court the approval of the American public, but he is extremely optimistic about the prospects of the Chinese economy. He is in the habit of meditating, and asks himself this type of question: “how will the people of three hundred years’ time write about the history of today?”, he said that the people of that time would have already forgotten about the 9/11 terrorist attack, and might even have forgotten about the end of the Cold War, but they will definitely remember the rise of the Chinese economy and the impact of China’s rise on other nations. Why is that? He said that the rise of China, where living standards have increased by in excess of 100 times, is the only thing that could happen through the course of one individual life. Why does he say that? Einstein believed that compound interest was one of humanity’s greatest inventions, and could be considered to be the eighth wonder of the world. There is a famous rule of thumb in statistics, where the growth rate can be calculated without using a computer, it is called the rule of 72. It means that whether the subject is population or the economy, if the rate of growth is 1% per annum, then it will double in 72 years; if it can increase by 7.2% per annum, then it will double in a decade; if it can grow by 10% per annum, then it will double in 7.2 years. I calculated this, based on the predicted human life span at the beginning of the Reform and Opening, a Chinese person born then would witness a more than seventy fold increase in per capita GDP. This has never happened to any other country throughout the course history. Placing China’s economy against a longer historical scale with each development stage gives a Chinese person confidence, for we know what we need to do. Understanding the problems that we face today, understanding where we are from the perspective of economic history helps us find some meaningful topics and new avenues to research.

Chapter 2

How Fast Has the Chinese Economy Grown?

Chinese GDP has grown by an average of 9.9% per annum in the three decades or so since the launch of the Reform and Opening. Such rapid growth over such an extended period of time is, undoubtedly, nothing less than miraculous. Although the Chinese economy has previously been afflicted by rising unemployment and inflation, and is still beset by increasing income inequality, but the rapidity, health, and stability of its growth are beyond doubt. What is the internal logic that underpins the Chinese economic miracle? How should China’s potential growth rate be understood? And how much longer can China continue to grow?

Sustained, Rapid Growth: China’s Economic Miracle The Chinese economy’s sustained, high growth rates since the Reform and Opening is, globally, a rarity. There are many people, especially academics on the international stage who have long voiced doubts about this performance. This has given rise to a sizeable wave of debate, and rectifying such misunderstandings requires an in depth exploration of this topic.

The Achievements of China’s Economic Growth China enjoyed an average GDP growth rate of 9.8% between 1978 and 2013. It was exceptionally high some years, at around 15%, whist 1990 marked its nadir at 5%. Coastal provinces achieved growth rates surpassing 10%. Most years, the price index remained below 10%, although it did, on occasion, exceed this figure. This performance was not merely confined to the overall economy, per capita income growth was also miraculous. When controlling for inflation, GDP per capita growth during this period averaged as high as 8.8%. A statistical rule of thumb states that a © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_2

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7.2% annual growth rate doubles the total size of the economy in a decade, whilst a 10% annual growth rate doubles it in 7.2 years. As such, it is easy to imagine the impact of the sustained GDP growth rates delineated above had over more than three decades. It is instructive to compare the growth rates of other countries over similar time frames. The time required for GDP per capita to double for the United Kingdom was 58 years (1780–1838); the United States of America, 47 years (1839–1886); Japan, 34 years (1885–1919), and Korea, 11 years (1966–1977). China achieved this is a mere nine years (1978–1987), and then subsequently doubled again during the 1987–1996 nine-year period. It doubled twice over the eight and nine-year period of 1995–2004 respectively. And then doubled again in 2011, this time taking a mere seven years. During this period, the Chinese GDP per capita also rapidly doubled. No other country has been able to match this feat. Not only did the entire economy grow rapidly, but entire industries also grew and adjusted at extremely rapid speeds. This was especially true of secondary and tertiary industries. The impact of the theories of Adam Smith, William Petty, and John Bates Clark or that of the relative decline of agriculture that led to somewhat dissimilar growth rates across industries. Primary sector growth rates were comparatively slow, those of the secondary fast, and the standing of the tertiary rose higher and higher. The share of agricultural output value and proportion of unemployment fell in tandem with the level of economic development and rising GDP per capita. This is a venerable economic law. Almost all undeveloped societies experience a period of acclimatisation and a process of adjusting their economic structure as they develop.

China’s Economic Growth is Undeniable China’s economic growth has been the subject of doubt from both Chinese and overseas researchers. A great many of whom appeared in the West by as early as the turn of the millennium. The majority of which were self aggrandisers crying wolf, with only a minority of instances of serious research. First, by using variables such as passenger transport volume, whole society freight turnover volume, increases in employment, and resource consumption, as well as data such as taxation to infer other variables (such as GDP growth), the results were discovered to be inconsistent with economic growth, leading to doubt about the Chinese economy’s growth rate. This criticism is to a degree, longstanding, and is exemplified by Professor Thomas G. Rawski of the University of Pittsburgh who published an article in the December 2001 issue of Zhongguo Jingji Pinglun that discussed the issues of reliability of statistical data pertaining to China’s GDP for the years 1997–2000. Upon which, my colleagues and I conducted research specifically to respond to this viewpoint. To ensure that Rawski would be able to both find and understand our response we published in the English language paper China Daily.

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All in all, those indicators are indeed closely linked to GDP, but are not expressed via a simple linear relationship. Ignoring the intertwined and complicated relationships between economic variables, or when changing the empirical relationships of those periods means that such conclusions are fraught with risk. First, once the rate of growth has exceeded a certain level, those input factors increase at an even faster rate, and display a comparatively large growth elasticity. Conversely, when the growth rate falls from a high level, these input factors also exhibit marked drops, exceeding falls in GDP. Second, China’s industrial structure and development methods are shifting, and the relationship between the variables are exhibiting corresponding changes. If these changes are not noted, and as new phenomena is understood via past experience, then erroneous analysis will result. For instance, the main vehicle of growth of the traditional economy, industry and agriculture, is gradually contracting, and comprises a falling proportion of the whole, whilst the proportion comprised by the tertiary sector is steadily rising. This inevitably leads to changes in the economic growth model, such as to the nature of inputs like resource consumption. Second, Rawski shares a common problem with many other foreign academics, and many Chinese ones too, which is an inability to decode China’s employment data when researching the Chinese economy. This leads to the erroneous belief that China’s employment levels are not rising. The contradiction of economic growth not leading to job creation has led to it being a reason for querying China’s growth speed. Actually this is highly erroneous, to which the following examples should provide clarity. When conducting urban employment statistics by year, one parameter is workplace employment, this includes legal entities and industrial active units. Data based on this ‘basic unit statistical reporting system’ shows that in 2014 the total urban employment rate reached 182.78 million people. I discovered, over multiple conversations with a Russian professor, that in the overwhelming majority of instances, he and other foreign academics would treat this data as the total urban employment rate. However, the total workplace employment rate does not include private enterprise employment and self-employed industrial and commercial households. Once these two types of employment are added to the figures, then the urban employed population rises to 348.61 million people. In addition, urban workplaces employ large numbers of temporary workers and outsourced labour (large numbers of migrant workers and formally redundant re-employed personnel). These hires are often not recorded in their reports, and so are not included in the statistics. Therefore, investigations based on urban households and that of the International Labor Organisation’s recommended parameters results in an actual total urban employed population of as high as 393.1 million people. The difference between this figure and the total unit employment rate reveals the informal employment rate. This figure also potentially overlooks a large number of migrant workers in stable employment, for calculations show that apart from the current total urban employed population, there are a further 47.1 million migrant workers in urban areas not included in employment statistics. To put it another way, if we were to include all migrant workers in stable urban employment in the urban employment statistics, then the actual urban employment rate for 2014 reaches 440.2 million people. This quite evidently was not the kind of

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figure relied on by Professor Rawski when he arrived at his opinion of the growth of the Chinese unemployment rate. Third, actual economic growth fully accords with the potential growth rate. Our evaluation shows that between 1978 and 2010, the supply of essential factors of production and rises in total factor productivity supported an average potential growth rate of around 10%. Following which, it dropped to an average of 7.6% during the period of the 12th Five-Year Plan, and then dropped to an average of 6.2% during the 13th Five-Year Plan. So far, and despite annual fluctuations in the actual growth rate, the potential growth rate, on average, tallies with these figures. Based on the definition, the actual and potential growth rates are consistent, signifying no noteworthy inflation or cyclical unemployment. Deducting the calculated potential growth rate from the actual growth rate reveals the growth rate gap for each year (see Fig. 2.1), and on which pretext, we can review the historical fluctuations of China’s macroeconomy since the launch of the Reform and Opening. In Fig. 2.1, positive disparities are displayed where the actual growth rate exceeds the potential growth rate, whilst the reverse depicts a negative disparity. If the reader is willing to engage in a simple calculation, and find the unemployment and inflation rate data for the years corresponding to the stagnant macroeconomic periods (negative disparity), peak periods (positive disparity), and normal periods (normal disparity), then they can find that there is evident consistency between macroeconomic and labour market indicators and the actual GDP growth rate (as well as its disparity with the potential growth rate). The most classic cyclical periods, are in the four troughs of 1981, 1990, 1999, and 2009, and each corresponds to circumstances when employment was most severely challenged. This kind of congruent relationship between macroeconomic variables and the consistency of 8 6 Growth rate gap (%)

4 2 0 2 4 6 19 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2099 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 15

8 Year Fig. 2.1 The growth rate gap shows the fluctuations of China’s macroeconomy

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theoretical forecasts demonstrates that China’s economic growth data is in accord with reality. Fourth, Chinese residents display enormous spending power. This is the result of rapid increases in per capita incomes and the expansion of middle income groups. Disputing China’s rapid economic expansion leads to problems of explanation. We can review more than three decades of economic growth through the scale of China’s middle income groups. Regarding estimations of the size of middle income groups, ‘middle incomers’, or what is known overseas as the middle classes, has always been an issue of definition, with different definitions leading to widely divergent population sizes. Some academics have attempted to define middle income groups based on subjective perceptions of population, whilst greater numbers have defined this grouping via objective income of consumption levels. Some of the latter define based on concepts of relative income levels, whilst others consider absolute income levels. Different definitions should derive from different research frameworks and should possess differentiated academic aims, and could also, of course, correspond with different methods of calculating data. No matter which definition or calculation is employed, the long term high speed growth of per capita income, and also that of income disparities have decreased since 2009, such results accord with logic. The rapid expansion of China’s middle income groups corresponds with the enormous scale of its population, the absolute figures for such groups also, necessarily, attract attention and are obviously significant on both a national and global scale. Next, we will outline some related estimative figures. It is worth noting that estimates for the subjective definition of middle income groups are not suitable, for rapid growth leads to extremely high expectations for increases in income, whilst structural falls in speed and rising living costs result in discrepancies, and so subjective impressions tend to be much more pessimistic than reality. As an influential research based on relative income levels, the Institute of Sociology, Chinese Academy of Social Sciences adopts median resident income as its standard criterion. Those groups between 75 and 200% of this level are classed as middle income groups, and have been found to comprise 37.7% of the total population, or 514 million people. Of which the 75% to 125%, and 125% to 200% cohorts are respectively classified as being lower middle and upper middle income groups, and respectively comprise 18.9% and 18.5% of the population. Official data can also serve as proof for such relative income levels. The State Statistics Bureau urban and rural household sample survey divided urban and rural residents into five income bands. The data for which shows that once the impoverished group (20%) has been removed, the average daily income of all other groups clearly exceeds that of the US$2 purchasing power parity poverty line. If we also eliminate the high income group (20%), the average daily income is around $21 purchasing power parity (PPP) dollars. These three income groups comprise 60% of the population, and can be considered as being middle income groups, and include as many as 820 million people. If we calculate on absolute incomes, and utilise the comparatively widely used World Bank poverty line standard, we can take the population that resides above the poverty line as the middle income and above groups, then this group is enormous. Based on a purchasing power parity ratio calculation of

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1:3.5 for the US dollar and the renminbi, then daily income in excess of US$2 is the extent of the population lifted out of poverty, or can broadly be considered to be the middle income and above groups. We can also say that China still has around a 50 million strong impoverished populations in urban and rural areas. The impoverished population is only a fraction of the total population, meaning that 1.3 billion Chinese people can be classified in the middle income and above groups.

How to Interpret the Judgment That China Is ‘No. 1’ for GDP People often say that international observers view the convention defying Chinese economic miracle as an intractable riddle, with the result that this is not a pessimistic argument, but one that ‘praises with ill intent’. The World Bank asserted in a report released in April 2014 that the Chinese total GDP was predicted to, based on purchasing power parity, exceed that of the USA’s by the end of that year, becoming the largest economic entity in the world. Although China gave no clear official response to this judgement, it should, however, evidently pay close attention to, and thoroughly research the significance of, becoming the largest economy in the world. There are currently a multitude of problems pertaining to the calculation of purchasing power parity internationally, meaning that it cannot reliably be considered as proof. When the World Bank and International Monetary Fund are comparing the total size and income per capita of international economies, they not only utilise the Atlas Method to calculate total and per capita GDP, but also provide a series of nationally segregated purchasing power parity data. It is commonly believed that the price levels differ between different countries, and the exchange rate is unable to adequately reflect market equilibrium levels. So, some international organisations and academic institutions often calculate purchasing power parity via the actual purchasing power of each country’s currency for a given basket of goods, and from which, revise total and per capita GDP. When this kind of calculation is applied to China it, knowingly or not, often results in two errors: first, it underestimates the country’s actual price levels; second, it is loaded with an implicit assumption that China’s exchange rate is undervalued. This might result in a premature change to China’s status as a developing nation. In actual fact, China has never officially acknowledged purchasing power parity GDP data. Owing to which, and in line with its consistent principles, China has never officially responded to the World Bank’s prediction. Early judgements and research should be, however, conducted on the prediction that China’s economy will surpass that of America’s, it would serve as a useful policy backup. We should be able to see that China’s economy will overtake America’s based on China’s past actual growth rate and its forecast near future growth rate. It is just a matter of time. Having grown from the 10th largest economy in the world to the 6th during the 1990s, it successively overtook the economies of France, the

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UK, Germany, and Japan, ranking second behind America during the subsequent decade. Several years prior, the International Monetary Fund had already predicted that China’s total GDP would exceed that of America’s in 2017 based on purchasing power parity. It is commonly believed that China will surpass America before 2030 when the Atlas Method is used to calculate economic size, vaulting to become the largest economy in the world. China should research and prepare policy for this imminent and momentous remoulding of the world economic map. In actual fact, there are positive and negative aspects to the repeated exaggeration that China will surpass America. The positive being that the prediction that China’s economy will sustain its rapid growth is beneficial for increasing investor confidence both within China and overseas. China’s GDP growth rate began to decelerate from the time of the 12th Five-Year Plan as its demographic dividend disappeared, and its working age population transited from a state of sustained growth to one of absolute decline. Analysts from both China and overseas suffer from a kind of economic pessimism. Internationally, a full range of predictions from some observers, such as China is about to ‘hit the wall’, or will share the fate of Detroit and the American rust belt, or even that its bubble is about to burst, continue to persist. Even despite the current amelioration of some deep level issues that pertain to its mid and long term economic growth, they still serve as material for the chorus calling for China’s decline. Some analysts within China have been influenced by the phenomena of a decelerating growth rate, and have become beguiled by economic pessimism, and, as such, have offered inapposite policy suggestions. In this kind of climate, authoritative world economic development organisations publishing positive news about the Chinese economy helps dispel the negativity created by both analysts and investors, and wins confidence for China as its continues to drive its economic growth. However, the predictions of China’s economy overtaking America’s have been incessantly hyped, and will spur America on, causing it to further contain China’s political, economic and diplomatic freedom. This is detrimental to the maintenance of the external environment for China’s peaceful rise. For instance, in 2013 the Harvard scholar Graham Alison published an article stating that China and America are facing the so-called ‘Thucydides Trap’. More than two millennia ago, the Athenian general and historian Thucydides stated in his History of the Peloponnesian War that the prolonged war and its bitter aftermath originated in Athen’s rise, and Sparta’s reactive fear. Alison gave numerous other historical examples demonstrating the existence of the Thucydides Trap in the history of great power relationships. However, even if China’s total economic might approaches, and will eventually overtake that of America, its per capita GDP still lags far behind. Reducing its hard and soft power gap with America in the spheres of technology, military, and culture still needs protracted lengths of time and formidable energy. Owing to which, China should be humble, win more time and accelerate the pace of its reforms, and transition to a high income country. Taking advantage of this opportunity, China should intensify research on the tactics required for a great power with more responsibility in the fields of the global economy, politics and diplomacy. When a major global economic power, other countries will have higher expectations of the international responsibilities that China

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should assume. There are numerous countries of whom that wish to maliciously contain China’s peaceful rise, such as via the implementation of the World Trade Organisation’s agreements and accords that pertain to greenhouse gas emissions, and deny China’s status as a developing country. There are also other economic entities in newly emerging markets and numerous developing countries who have greater expectations owing to their sharply increasing reliance on the Chinese economy. China should thoroughly research these issues and formulate long term, overarching, strategic policies. One aspect of which is to employ the nation’s growing economic might, and accelerate the pace of its external ‘Go Out’ investment, increasing its prominence in the formulation of rules dictating international relations, thereby creating an external environment more amenable to economic development. The other aspect is working to maintain the nation’s status as a developing country for the long term, and create a deserved international role centred on principles that prioritise China and its internal development, and create a global economic layout favourable to developing nations catching up with and overtaking developed nations.

On Calculations of China’s Potential Growth Rate We should accurately pinpoint the characteristics of China’s current stage of economic development, and forestall policy errors that turn a decelerating economy into a stagnant one, and thereby avoid falling into the middle income trap. Although, based on past growth forecasts, China’s economy will catch up with and overtake America’s and join the ranks of GDP per capita high income nations, but from the perspective of labour supply, rate of capital returns and productivity rate trends, China’s GDP growth rate is predicted to drop yearly. The Chinese economy is already evidently engaged in a downward trend, and existing macroeconomic cyclical factors also reflect changes to its long term potential growth rate. Cyclical downward trends and long term growth deceleration have a number of causes, so we must be careful not to confuse the two in our minds. China must be especially cautious about adopting stimulatory policies when countering long term deceleration trends.

Declining Actual and Potential Growth Rates Both supply and demand side factors influence economic growth. Economic growth is constrained by supply side factors in the long term. These include labour, capital, and productivity, as well as total factor productivity. As the economy develops through different stages, the level of supply of factors of production and improvements to productivity methods all have staged characteristics, creating a given potential growth rate. China has enjoyed a wealth of supply factors, and enormous room for productivity growth over the three decades or so of its Reform and Opening, and also its demographic dividend. As such, potential and actual growth rates were very high.

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Our calculations show that the potential GDP growth rate, being the normal sustainable growth speed from the supply of factors of production and speed of productivity increases, averaged at 10.3% between 1995 and 2010, fell to an average of 7.6% during the period of the 12th Five-Year Plan, and then continued to drop to 6.2% during the 13th Five-Year Plan. It should be noted that a falling economic growth rate is the result of changes to supply side capabilities, and not a result of assaults on the demand side. China’s economic growth rate is currently trending downwards. It has, admittedly, been impacted by the demand factors of the European debt crisis and the feeble recovery of the main developed economies. This is, however, essentially an expression of a decline in its potential growth rate. Although impacted by exports, investment and consumer demand, cyclical factors dictate whether the actual economic growth speed is either above or below the potential growth rate. Ultimately, supply side factors determine the potential growth rate and create the fundamental constraints on future economic growth rate. Owing to which, China should accurately understand that economic growth can shift gears, and also accept a comparatively lower growth rate that better tallies with its potential growth rate. Accurate policy responses to which do not augment economic stimulation, but are reform driven changes that unleash economic growth potential. If we compare current actual and potential growth rates, and then that of demand and supply side factors, we can see that just as the 12th Five-Year Plan period’s 7–7.5% GDP growth rate was fine and should be accepted, then a 6.2–6.55% growth rate during the 13th Five-Year Plan period is also acceptable. In actual fact, this kind of growth speed tallies neatly with central government’s forecasts, and an appropriate low speed can be beneficial for accelerating the transition of the means of economic growth, and also assist its rebalancing.

Stimulatory Policies Should Not Be Used to ‘Preserve Growth’ There is a fatal error in understanding the issue of the potential growth rate. This pertains to supply and demand side factors in the mixed economy. People typically mistake falling potential growth rate induced growth decelerations as being the result of insufficient demand, and thereby advocate the adoption of expansionary measures to stimulate demand driven growth. For instance, Japan’s rising population dependency ratio in 1990 is symbolic, for its demographic dividend had formally evaporated and its potential growth rate plummeted. However, many economists and policy makers believed that the slowing of growth was indicative of insufficient demand, and supported the adoption of a loose monetary policy and stimulative financial policy over many years. A wide variety of Keynesian stimulatory measures were attempted, measures which ultimately proved to be counterproductive. The failure to control the true cause of the stagnation of the Japanese economy—the stagnation of total factor

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productivity, led to Japanese economy slipping into ‘two lost decades’, where GDP growth averaged less than 1% per annum. Policy tools that attempt to surpass the potential growth rate might specifically be visible in industrial support, regional development, and macroeconomic stimulatory policies. Such policies are constrained by the need to match the actual growth rate with the potential. Over use, with the aim that industrial and regional policies achieve a desired growth rate, or stimulate demand in an attempt to exceed the potential growth rate, will inevitably result in market distortion, and amplify uneven economic growth and uneven sustainable development. Such international examples and China’s current situation indicates that ‘growth at all costs’ policy measures leads to one never reaching one’s destination. First, distorted prices of factors of production. Driving large scale investment can signify the investment of underpriced capital, suppressing the relative pricing of capital factors, leading to an increase in the degree of capital accumulation that deviates from comparative advantage, and aggravates the phenomenon of diminishing capital returns. After Japan had lost its democratic dividend, it raised labour productivity by raising the capital to labour ratio, yet overlooked improvements in total factor productivity. After 1990, as labour productivity was increasing, the contribution rate of the capital to labour ratio reached as high as 94%, whilst the contribution rate of total factor productivity was −15%. This was the primary reason for the country’s economic stagnation. Second, wasted resources aggravate existing excess production. Investment behaviour outside of market forces can easily result in inefficient resource allocation, lowering investment efficiency and leading to excess production. Such as, in 2010, where relative to China’s industrial average level, some industries, such as sections of the textile industry and light industry were exposed to international competition. However, other industries, provided with industrial policy support, featured a rate of capacity utilisation lower than the overall Chinese industrial average of 82%. This included the steel industry, which had a rate of capacity utilisation of under 50%, whilst the nonferrous metals industry was somewhat stronger, at 70%. Third, the creation of counterproductive protection. The provision of a whole raft of preferential policies such as subsidies for poorly run enterprises, and industries that should exit the market, or even direct government intervention to forestall bankruptcy, are all conducted in the name of employment, GDP and taxes. However, this merely results in the protecting, and provision of a life-support, to backward, chronically inefficient enterprises. This ultimately harms competitive mechanisms and leads to the creation of ‘zombie corporations’. Once such enterprises comprise too high a proportion of the nation’s economy, its entire economic efficiency will be driven down.

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Raising the Potential Growth Rate Through Reforms The potential growth rate can change. There are, in fact, many windows of opportunity available for China. A goal of raising the potential growth rate is feasible via reforms. The next few reform related items should occupy an advantageous position. First, strong promotion of urbanisation. Driving the urbanisation of migrant workers, continuing to unearth latent labour supply, and raising labour participation rate and labour stability, are key measures in assisting a marked increase in the potential growth rate. Normally, once labour comprises a constraining factor on economy growth, raising the labour participation rate can lead to rises in the potential growth rate. For China over the next five to ten years, further driving the transition of rural labour to urban non-agricultural sectors and stabilising this labour supply is a special method available to China for raising the labour participation rate. This impacts reforms in spheres that include the household registration system and land system. Second, protect education’s priority development. Long term sustainable economic growth requires labour possesses higher and improving skillsets for innovation, and for the upgrading of the industrial structure. Raising the age limit on education requires a long term focus and is not something that can simply happen overnight. Once gross compulsory education attendance rates have reached 100%, then raising enrolment in pre-school and senior high school education is key to raising the education age limit of future workers. The development of higher education is critical in raising the nation’s innovative capabilities. This pertains to fundamental reforms of the education system and training methods. Third, raising total factor productivity. Once past the unlimited labour supply stage, the only sustainable source of economic growth comes from the reallocation of resources and technological progress derived sustained increases in total factor productivity. As resource reallocation efficiency within the tertiary sector is set to wane, future increases in total factor productivity will come from two sources. First, productivity gaps between industries mean that factors of production will flow towards those industries with higher productivity, leading to sustained resource reallocation efficiency gains. The coming decade is a crucial period for China as it transitions from being a mid to upper income country to that of a high income country. Compared to middle income countries that have per capita GDP of between US$6,000 and US$12,000, the latent potential promised by China’s agricultural labour force remains colossal. Academic calculations state that China’s agricultural labour comprised around 24% of the total up to 2009, whilst official statistics state that agricultural labour is still as high as 35%. This signifies that in the coming decade or two, and starting with the current agricultural labour force, China needs to reduce the size of this labour force by several million per annum, equal to a reduction of the proportion of the population engaged in agriculture of over 1% per annum. In this manner, it is possible to maintain sustained increases in resource reallocation efficiency, and from which support the sustainability of China’s economic growth.

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Second, there are also productivity gaps within industries and between enterprises, permitting the survival and growth of more efficient corporations, and eliminating those persistently and chronically inefficient corporations. This can raise industry productivity levels and also that of the entire economy. Research from the USA shows that creative destruction mechanisms such as entry, exit, survival or elimination of corporations within sectors contributed between 30 and 50% to total factor productivity. In addition, other research shows that China’s corporate productivity gaps within sectors are also enormous, and if reduced to the level of the USA could lead to total factor productivity gains of between 30 and 50%. The coincidental nature of these two figures implies that China has so far been unable to tap such sources of total factor productivity growth. Demolishing the industry barriers to entry and exit and eliminating structural obstacles to the flow of factors of production will permit competitive mechanisms to unleash the survival of the fittest. A deepening of reforms is undoubtedly required to achieve long term sustainable growth, but such reforms should not be valued for their material rewards, or anticipate that reforms from every spheres drive sufficient, instant economic growth. When faced with a declining potential growth rate: one aspect is that reforms need to be implemented to new heights and depths, and the systemic conditions for sustainable growth over the longer term need to be established. The other aspect necessitates being sufficiently mentally prepared for accepting comparatively low growth rates, and the shift in growth model from one orientated towards investment growth speed, to one focused on increases in high quality productivity.

The Chinese Economic Miracle and the Logic of Its Continuation The goal set for China’s economic reforms during the Fourteenth Party Congress was to establish a socialist market economic system. This means that the most prominent successes of the reforms should be expressed via the transformation from a planned economy to a market economic system, the ultimate test being how the Reform and Opening has stimulated economic and societal progress. When specifically appraising the successes of the reforms, we can generalise from several key components of the economic system. For instance, Assar Lindbeck investigated changes in nine aspects of the Chinese economic system: (1) the state of corporate ownership; (2) the state of asset ownership; (3) the state of decentralisation; (4) economic policy making; (5) corporate incentive methods; (7) the degree of competition faced by corporations; (8) the degree of competition faced by individuals; and (9) the degree of openness to foreign competition. Although these nine aspects covered the main aspects of the economic system, such an overview is, by nature, fairly superficial. Although Lindbeck also mentioned the interrelationships between, and within, these different aspects, he clearly did not investigate the gradated and logical relationships between each aspect.

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Justin Yifu Lin described the economic system as being four logically tightly interlinked segments. The first segment was the economic development strategy chosen by a nation. Roughly divided up, this means often being faced with a choice between a comparative advantage-defying strategy and a comparative advantage-following strategy. Regarding the choice of the development strategy, the second segment is the macroeconomic policy environment created for the implementation of the designated development strategy. When driving through a comparative advantagefollowing development strategy, the prices of products and factors of production all reflect their relative scarcity and supply and demand relationship. The corresponding macroeconomic policy environment for a comparative advantage-defying strategy was the distortion of the prices of products and factors of production, and often featured suppressed costs to curtail the development of heavy industry. The third segment was a suitable resource allocation mechanism. When relative prices have not been distorted, resource allocation is primarily conducted via market mechanisms, and if not, via collective planned mechanisms. The fourth segment is the microeconomic operating mechanisms formed for the aforementioned policy choices and systems. When promoting a comparative advantage-defying strategy, and thereby creating a macroeconomic policy environment that features distorted pricing, as well as the allocation of resources via collective planned mechanisms, microeconomic operating mechanisms are mainly expressed via a lack of corporate autonomy, soft budgetary constraints, and feature government protection and a lack of competition. Moreover, they are devoid of incentive mechanisms. On the contrary, a multitude of autonomous corporations that are constrained by hard budgets and economic incentives, and competing on the marketplace are required. When China created its economic system during the 1950s, the logical starting point was a development strategy that prioritised heavy industry. As this strategy led to contradictions between economic development goals and the structure of resource allocation, the development of heavy industry necessitated high concentrations of capital and large scale investment. This conflicted with a development stage typified by resource shortages, and owing to which, the macroeconomic policy environment focused on the artificial suppression of capital and the prices of other factors of production. The constraining of the prices of rare factors of production necessitated a highly centralised planning system to allocate resources, and the rejection of the utility of market mechanisms and pricing signals. Afterwards, to ensure that resources at production unit segments were invested and reinvested into the fields of heavy industry as the development strategy demanded, the nationalisation of the industrial sector and communalisation of agriculture was the logical next step. It was in this manner that post 1950s China formed a logically complete traditional economic system. This kind of economic system is replete with instances of low efficiency, including a dearth of technological and allocation efficiency at the microeconomic level. If reforms are first aimed at resolving issues pertaining to low resource allocation efficiency and malpractice in the planned economy, then this necessitates that the entire system be simultaneously transformed within a short time frame. However, when not based on market mechanisms, and when the economy is comparatively

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undeveloped, the result of such tactics for a country unable to accept a faltering economy is classic ‘shock therapy’, with eventual success hard to guarantee. Historically, China’s economic reforms began at the microeconomic level, and were driven by grassroots agricultural production units directly responsible for microeconomic incentives and efficiency. This included the reforms for the implementation of the agricultural family contract responsibility system and the decentralisation of power and profits to corporations, and consequently led to initial reforms that could follow a path that emphasised Chinese characteristics. It seemed that such reforms were in total opposition to the aforementioned economic system, but logically, accorded with the manner in which the reforms were implemented. Economists often link the effects of China’s economic reforms to discuss reform target models, such as the Washington Consensus and the Beijing Experience. They discuss reform methods, such as incremental and radical reforms; and discuss the relationship between the market and the state, such as the authoritarian and laissezfaire models of governance. It is interesting that when discussing the same Chinese experience, academics often come to conflicting or completely opposing conclusions. The reason for the creation of such conceptual ambiguity and the observation of conflicting phenomena is that in comparison with other countries, Chinese concepts of reform and their implementation have the following defining characteristics. China’s reforms have clearcut aims, end goals are defined, yet the means to achieve them are not. Numerous mixed measures are employed with a focus on practicalities. Even though there are such types of complex phenomena, they will be summarised and enumerated from several aspects, and are still able to reflect the essence of China’s economic reforms. For instance, the rural reforms and labour market reforms respectively exemplify the simultaneous implementation of gradual and radical reforms, or incremental and stock reforms. First is the gradual nature of the reforms. Targeted at the systematic malpractice of microeconomic segments, agricultural and corporate reforms directly attacked the issues of low efficiency and a dearth of incentives, and adopted individual reform methods such as the contracting system to rapidly increase production and drive economic growth. Whilst simultaneously demonstrating the effectiveness of reforms, and from which building society’s belief in the reforms, more vigorous microeconomic units began to search for more investment for factors of production from outside the planned economy. In so doing, they further improved allocation efficiency, thereby increasing operating profit and labour income. Owing to which, the reforms logically began to operate at the level of resource allocation, and gave birth to market mechanisms outside of the planned system. As the former constantly expanded, it regulated both the scale and scope of product distribution and the allocation of the factors of production. Along with the increase in the number of products and the scope of the factor market, prices increasingly became detached from planned control, and were instead determined by their relative scarcity and market determined supply and demand. Once prices had gradually rectified, the guided foundations for the heavy industry preferential development strategy were no longer stable, and

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economic growth and structural changes increasingly accorded with the direction dictated by comparative advantage. Next are the characteristics of incremental reforms. Reforms were initiated with the aim of resolving issues of incentives and microeconomic efficiency, but did not prematurely become involved with any adjustments to stock reforms, and therefore did not harm those groups with vested interests in the traditional system. Economists researching economic transition often pay close attention to reducing the impact of reforms on groups with vested interests, thereby minimising political costs incurred and risks posed by reform. In China, a sizeable proportion of such so-called vested interest groups were in fact ordinary citizens with comparatively low incomes. The stock adjustment of ‘smashing the iron rice bowl’ of employment in state owned enterprises might have impacted such groups of workers. They not only had relatively low incomes, but were comparatively old, and their low education levels and skillsets severely limited the extent to which they could participate in the labour market. The sudden unleashing of commodity price reforms probably harmed groups of citizens whose low wage payment systems dictated limited resilience. As such, adhering to the principles of incremental reforms, and protecting vested interest groups as appropriate (but not those cliques with both vested interests and privileges), is consistent with the aim that reforms raise the living standards of the general public. Then there are the principles of reform driven development. Many foreign observers and researchers noted that China’s gradual economic reforms began without an overarching blueprint. Initial measures adopted were aimed at resolving urgent problems and achieving direct results, and then evolved step by step. Although the Fourteenth Party Congress in 1992 established the goal of the socialist market economy, the characteristic ‘trial and error’ reforms remained. These were mainly expressed through multiple reform tasks, no clear timeframe, and the sequence of the reforms being not consciously determined. Moreover, the implementation of reforms exhibited geographic and temporal differences. Western economists are influenced by their preconceptions when they observe China. They are accustomed to comparing and evaluating the efficacy of China’s reforms via a set ‘a priori’ frame of references. However, one can often find that this frame of reference is neither one China’s reforms follow or one which China actively seeks. In fact, this delineates how the conceptual basis of China’s reforms differs from that of other nations. This means that the starting point of China’s reforms is not to achieve a certain target model, but to raise living standards of the general public and increase the strength of the nation. Starting from this position, we can gradually map out a route that suits China’s national conditions, and thereby achieve the transition from a planned economy to a market economy. The attainment of a market economy was not established as an independent goal, but was subservient to the goal of improving livelihoods and strengthening the nation. It is this difference between a conceptual basis for reforms and such a direct starting point that led to the guided principles and methods of China’s reforms never being held hostage to any kind of ‘a priori’ theoretical dogma. The reforms raised production, improved the living standards of the overwhelming majority of people, and increased the nation’s strength. The alpha and omega of these goals were clearcut,

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and China persevered. Under the guidance of these reform concepts, reforms, development and stability comprised an integral whole. Reforms were to develop, and were subservient to stability, and the successes of development were used to verify the viability of the reform path. Stability then created the conditions for the next round of reforms. Finally, there are the overall features of the impetus to the reforms. Despite the absence of a clearly defined overarching blueprint, each segment of the system needed to operate in unison and be mutually responsive with other segments, as the economic system is an interconnected whole. The spontaneity of the evolution of the reforms, meant that they were neither random or arbitrary, and can still be considered to be logically ordered. People often note that the reforms in some spheres lag behind those in others when typifying China’s process of institutional changes of its gradual and incremental reforms. For instance, the labour market transition and the reforms of the factors of production market that developed within it, are believed to be an area where reforms have been comparatively sluggish. However, if such an important component of the reform process lagged behind then the entire system would be out of kilter. In which case, why would the impacts of the reforms of the entire system still be so plentiful? Moreover, why have they expressed themselves via more than three decades of rapid economic growth, productivity rises and huge increases in the living standards of the general public? In actual fact, when we closely observe the logic and progression of China’s economic reforms, we can see that at the same time the entire system displayed gradual and incremental changes, with sequential characteristics. The stock changes of comparatively radical reforms are also interwoven. The manner in which the reforms were undertaken was dependent on the needs of an interconnected whole and on what society was able to bear. No matter whether looking at the effects in isolation, or by the stage in which they were enacted, reforms were enacted as a whole, and there were no areas that, in essence, either surged ahead or lagged behind. The implementation of China’s Reform and Opening over more than three decades have reaped historically unprecedented returns across economy and society. These successes are evident from the degree of globalisation of the Chinese economy, the development of the product market and the factors of production market, the transition in the role of government, the degree of coordination between economic development and social enterprise development, adjustments to economic structure, employment, reforms to social security and the income distribution system, as well as the development of related social enterprises. We should attempt to focus on the successes of the Reform and Opening and the development of the economy and society from these angles. Then, refine and analyse related experiences and lessons, and identify and propose new avenues for reform. Then, elaborate on the significance of the Chinese experience for other nations, and even propose that the successes of the Chinese experience could serve to enrich economic theory. The majority of academics all recognise that China’s three decades of rapid growth has been thanks to its demographic dividend. However, there are conditions to the

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employment of such a dividend, and this pertains especially to the systemic conditions. There are already a multitude of documents that clearly state that for developing countries to catch up with and overtake developed nations, it is crucial that they grow faster than the latter, for this leads to a conditional convergence. It is conditional in that, only by satisfying a series of material and institutional conditions can developing countries employ a range of potential factors to serve as sources of economic growth, and from which achieve faster economic growth. The fall in China’s population dependency ratio began in the mid-1960s, and it was only the advent of the Reform and Opening that created the conditions to employ that first demographic dividend. Based on this definition, no matter whether this means creating a second demographic dividend or tapping new sources of economic growth, the conditional requirements on the system are higher. The economic aspect involves reforms to corporate, financial, tax, investment and financing, as well as external economic systems. In the societal and living standards arena this involves reforms to the education, employment, household registration, and retirement safeguard systems, as well as the development of capital markets. This really is the successes of reforms to a whole series of tightly and logically interrelated spheres. The prior harnessing of the demographic divided created the institutional conditions and the institutional guarantees of sustainable future economic growth.

Chapter 3

Understanding China’s Development

This chapter expands on why economic development, and especially China’s economic development, requires research, through a discussion between an economic researcher and the normal reader. Starting with the goal of theoretical innovation, we discuss why we need critical mindsets, or other types of mindsets, to research economic development. We then enumerate a few key positive and counter examples from a methodological perspective, to serve as examples in the critical research on economic development. In addition, this brief introduction can serve as a starting point for overviews of several key stylised facts pertaining to economic development that were born of theoretical research and economic history. Finally this chapter discusses how to understand the problems that result from a falling economic growth rate and the drop in China’s growth rate.

The Riddle of China’s Development: A Noble Prize Grade Question There is no straightforward answer to the question of why we want to research China’s economic development. First, China’s economy undoubtedly deserves attention. Even for those not researching economic topics, anyone of Chinese heritage will find that, whatever their interests, their attention will eventually return to the Chinese economy. Furthermore, understanding the course of China’s economic development, its reforms, and history, and understanding what theoretical, or mental, frameworks to utilise when approaching the Chinese economy, is in itself a kind of training. There is no need to arrive at the correct conclusion whilst reading this chapter. It is more important to try some of the creative analytical exercises contained within. The reader might seem to have a professional grounding in the subject and be able to draw upon the resources of which when economic issues are discussed; and less like a taxi driver, who is only able to state his opinions to his passengers in direct and simple terms. So, since we are cultivating an economic mindset, and researching the © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_3

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issue of China’s economic development, there are several reasons to be interested in this topic even if, not being of Chinese ethnicity, you are not blessed with a natural interest. First, we must consider the nature of theory. Theory cannot be divorced from reality. A theory with no grounding in reality is meaningless, and like overly abstract art that can only be left to gather dust. What is the utility of theory? Theory is an abstract representation of reality. Sometimes people ask, as reality is real and can be directly observed, then why rely on abstract representations? First, it is impossible to describe reality in exhaustive detail, aspects need to be cut, or abstracted, this shrinks everything to a slightly smaller framework for our brains to process. This can be equated to how different map scales offer an overview of the entire world or just that of a specific region. Moreover, although people can directly observe reality, they cannot observe every single phenomenon. They might also be deceived by false appearances, and arrive at the wrong conclusion. Discussions of China’s economic growth have been both heated and topical in recent years. However, some special phenomena influenced the quality of the debate. The first has been that many of the ideas proposed by both sides did not originate in academic papers, but were instead aired in periodicals, the internet, conference speeches, and news interviews, and were typically not backed up by any proof. Second, the participants in some debates have been too indolent. They have not given any targeted responses to viewpoints with which they disagree, simply labelling them, ‘meaningless questions’. In science, meaningless or fake questions refer to a kind of judgement that does not accord with objective reality or match theoretical expectations. Owing to which, responding to such different opinions is undoubtedly the continuation of empirical research, the provision of more evidence, and as such we still require theories. Furthermore, economists place a higher value on the utility of theory to forecast future events. This means that, the stronger the predictive capabilities of a theory, the stronger that theory is. If we step back, we can see that the theory is a concept of a type of, or series of, stylised facts or experiences, moreover it is connected to specific epistemologies or methodologies. Theories allow us to look beneath the surface, or even behind false appearances, and understand the true nature of things, or changing trends, thereby freeing us of the shackles of traditional mindsets. Second, history and other people’s documents permits us to observe reality from a longitudinal perspective, however such documents might be inaccurate. Historical records might occasionally be objective, but in the overwhelming majority of cases they are subjective. An example of this is the Chinese tradition of evading taboo topics pertaining to those of high social standing, which can result in a degree of whitewashing of details pertaining to an important personage, for no wholly objective history exists. Even when historical records might plausibly be true, they might not be representative. So, we require abstract theories to help us correctly understand history. Documents might be flawed, but they can be ‘revisited’, and via the adoption of a reliable theoretical framework and mindset, possess value without contaminating results.

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Third, as the future cannot be observed, how can it be forecast? We require abstract theories to understand the past and the present, and from which basis, we can then peer into the future. It is only through the use of theoretical logic/ that an unseen yet imagined future might be accurate. By truly understanding the rules of historical development from antiquity until the present day, we can understand the future, and understand the whole via a knowledge of its parts. We can look down at the valleys of the future from the highlands of the present. This requires the adoption of an innovative mindset, especially that of critical thinking, and you will sometimes even need to think outside the box. The most important of which is a firm grasp of the abstract nature of theory. The best example of the insights enjoyed by economists is in the book that made Keynes’ reputation, The Economic Consequences of the Peace. In 1919 Keynes participated as a delegate of the British Treasury at the Paris peace conference where the terms of defeat were dictated to Germany in the aftermath of the Great War. When the politicians demanded that Germany pay reparations, Keynes perceived that the burden of overly punitive reparations might overwhelm the nation, and thereby sow the seeds of a future war. His suggestions were rejected by politicians. Afterwards, the destruction wrought by Hitler during the Second World War proved the accuracy of Keynes’ foresight. After the conclusion of the Second World War, the Marshall Plan, through which America implemented its reparations, undoubtedly contained Keynes’ fingerprints. An interesting subsequent event that gives further proof to Keynes’s foresight is the reports that German reparations for The First World War were only finally paid in 2011. Let us look again at the nature of the Chinese economic growth experience. When discussing this topic, we should first recognise that globally speaking, China started late, and was riddled with planned economy induced malpractice, and possessed all of the characteristics of a dual economy developing nation. The nation’s appearance rapidly altered during its three decades or so of reform and development, which is generally believed to have been a success. This is especially so with regards to the promotion of economic growth, and the refutation of traditional planned economy development strategies. It also did not follow neoclassicism, neoliberalism or the Washington consensus, and seemingly developed its own unique model. These are all reasons for researching China, but there are also others. Critically, the Chinese experience condenses the historical experience, and from which can be abstracted into economic theory. We previously stated that the core of theory is abstraction. What does abstract actually mean? Imagine, for example, that we desired a representation of everybody’s face, for every face is unique. When describing a group of people, for instance the students of the Graduate School of the Chinese Academy of Social Sciences, describing more than one thousand people is not feasible, and so, common features must be identified. This is why abstract representations are needed. Enrolment restrictions demand that students have an upper age limit, possess only two genders, and postgraduate studies may only commence following graduation from undergraduate studies. Using such generalisations, we can say such and such a person is an undergraduate student, whilst this other person is a postgraduate student. If we then add some extra parameters, we can say that

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this person is a student of the Graduate School of the Chinese Academy of Social Sciences. The Chinese experience is so appealing because it is, in of itself, an abstract representation. When researching the west’s historical development, its historical works or even some works of literature, we find that all are limited to a greater or lesser extent. For instance, when we read the books of the author Stefan Zweig, who recorded the changes of his time from his perspective as an individual observer. He could only record his own, personal, observations. The events described happened a very long time ago, yet if we added the preceding and subsequent events to this narrative we find that experiences that mirror China’s occurred in the west several centuries prior. This signifies that the western history of economic development was a gradual process that took place over extremely long timeframes. Or another example is Lewis’ dual economy theory, which states that many developing countries possess unlimited labour during the dual economy development stage. The last section of this stage features a turning point which was later described as being a turning period. It is often believed that this is a characteristic of developing countries. The question of whether these western nations have dual economy theory deserves research. When Lewis proposed the characteristics of his dual economy theory, he referred to the experiences of many European and American countries during the early stages of their economic development. Nobody, however, ever stated that western countries also have dual economy theory. I believe that once the development process of any country has been abstracted, features in common will outnumber those that are unique. Why does the theory focus on developing nations and why is it employed in such locales? It is because the development of the dual economy in European and American countries was both homogenous and gradual, with each special period unmarked by classic structural features. The evolution of the structure occurred over extremely long timeframes. The development history of developing countries, on the other hand, is characterised by their heterogeneity, and their development punctuated by clearly demarcated stages. Economists have always viewed the lack of a dual economy as a differentiator between developed and developing nations. I personally do not think that this is where the difference lies, for the early development of developed countries took place over such long timeframes that demarcation into stages is difficult. I will give a inapposite example. Imagine there are two species. The first are humans, with a natural lifespan of eighty years. This lifespan is demarcated into decade-long units, and changes are evident during each unit. The other species is an ape with a natural lifespan of three centuries. Humans are unable to distinguish an elderly ape from a young ape when they search for differentiating changes amongst them. This means that differences and characteristics can be seemingly reduced to nothing when they occur over the very long term. Another example is, have you ever wondered why life scientists always use white mice to conduct their experiments? It is because white mice have life cycles short enough to display biological responses in a timeframe acceptable to scientists. Or it is similar to drawing a line graph where one line features a great number of pronounced oscillations, whilst the line representing the

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long-term historical development of Western nations is so flat that no differences can be discerned. The Chinese experience is not only like that of other developing countries, where the early development history of developed countries is condensed. China’s development is even more condensed than that of the average developing nation. This means that the characteristics of every specific period—the characteristics of turning periods, and of every kind of stage can be even more clearly demarcated. The Chinese development experience has condensed over a century or even several centuries of experience of other nations into the space of a few decades. In this way, the Chinese experience is, in of itself, an abstraction; and researching such an abstraction aids the formulation of more refined abstractions. The import of this, as Milton Friedman said, is whomever can clearly explain China’s development and reforms would win the Nobel Prize for Economics. However, his words are problematic as there is no way to define whether or not something has been adequately explained. I believe his meaning was that China is a globally influential country, it is the most populous country in the world, and was both a victim of the planned economy and for not being sufficiently developed. Economists want to research the phenomenon of development, they also want to research phenomena of changing direction. If such matters can be clearly explained, then theoretically speaking, that is an innovation, and hence worthy of the Nobel Prize for Economics. We can also see why China’s economic development should be researched from the perspective of individual gain. When learning economics, no matter whether it is economic theory, or facts about economic development, it should be undoubtedly be undertaken like a public discipline. For one cannot merely engage in pure economic research, there should be a greater goal beyond this direct one. Reality dictates that the majority of readers are not themselves engaged in research, and no matter whether they’re reading a Ph.D. or masters, they do not, as people often imagine, engage in research to the exclusion of all else. That is of course how things should be, for if everybody were to enter this profession, then supply would greatly outstrip demand and wages would be suppressed, which would be a suboptimal outcome. I would like to emphasise, however, that learning economics and understanding economic development benefits everybody. First, civil servants may want to conduct some research and write a report. This role requires an understanding of the world and understanding the rules, trends, and future direction of China’s economic development to assist the analytical capabilities required for everyday work. In actual fact, even if the civil servant is fairly low ranking and not a decision maker, but only responsible for very narrowly defined tasks, they will also find themselves faced with a number of choices and decisions. Final decisions are made by leaders who are dependent on the information provided them by subordinates. There are not always reliable materials (such as central government documents), and there are also many options left out, and as long as it is in accord with the overall thrust, then decisions made at such a juncture are highly important. Such decisions help the nation, and are also undoubtedly beneficial to oneself. For, it is not

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terribly important whether a person is occasionally right or wrong, but in aggregate the more often you are right compared to others, the better you are performing. Moreover, in the corporate world, we need to be able to judge how China will develop in future. If you experience some stage like changes, then what is the significance of this changing policy? How could this be utilised as a business opportunity? Will it turn into an error to be avoided? Learning economics, and understanding the facts of economic development can be of huge utility here. My focus on the Lewis turning point is a good example. I am often talking about the arrival of the Lewis turning point and the disappearance of the demographic dividend. This has led to me being criticised by people from a range of walks of life. Whilst investment economists criticise me, they still pay close attention to what I say. Many of those who wrote articles in repudiation at the time now state that they have long believed that China has already reached such and such a turning point, because their priority is to convince their clients that their judgements are invariably correct. This also explains that they do believe that understanding the rules of the economic development directly impacts their investments and the future growth of their business. However, I believe that there are many among their ranks whose understanding is too direct and lacking in scope. If they researched this issue in more detail, their performance would improve. Furthermore, researching the rules of economic development and researching fundamental economic principles can be beneficial to individual finances. Let me give an example. The renowned collector Ma Weidu/ said that the reacquaintance of the world with China’s culture has led to China’s cultural artefacts, antiques, and works of art being valued increasingly high prices owing to their artistic worth. He is, himself, a successful practitioner and has been successful with his personal finances, but this theory is not necessarily accurate. In fact, whether or not cultural artefacts and works of art rise in value is not a result of their artistic value. If we consider the cultural artefacts of ancient Egypt, which frequently can be dated back to three or five thousand years before the present. Its portraits and sculptures reflect the highly advanced anatomical knowledge possessed by the Egyptians of antiquity. It is quite probable that their technological prowess exceeded that of the Chinese of the time. These artefacts, contrary to expectations, do not command high prices. This is because such artefacts and works of art all belong, ultimately, to the nation itself. There is nothing that can be considered a ‘world artefact’. From an economic perspective the saying ‘the more ethnic, the more global it is’ is a fallacy. If I introduce a tape of the /violin/ concerto, the Legend of Liang and Zhu, to foreign friends, they will make a show of listening to the piece, but they will not know what to make of it. Yet the first time I heard this piece of music, I found it truly inspiring, and it lingered in my mind and I rushed around asking people to identify the piece before finally learning it was the Legend of Liang and Zhu. The prices of both cultural artefacts and works of art are driven higher by investors from their own nation. The more developed a nation’s economy, the number of wealthy people and middle income groups increases rapidly, and when they search for something to buy, the nation’s cultural heritage will most definitely rise in price. This is not something overly impacted by foreign investors.

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Finally, I believe that an individual’s success, and this includes career success, spiritual accomplishments, and their satisfaction with their own lives, is dependent on how they think. Such mindsets can be strange in the extreme. How they view their friends, their chosen form of entertainment, their tastes, each impacts every single aspect of their life. The ability of economics to analyse matters, and its greater impact on analysing life, makes it, in my opinion, a very competent tool. It provides a more rational method of dissecting the world around us. Owing to which, no matter what you read at university, whether you are engaged in research or more focused on your own individual field, possessing a grasp of the rational economic mindset can be of assistance in choosing the right paths in life. In addition, the rational economic mindset can be used to understand the relationship between society and the individual. The more penetrating our understanding of society, the less we will be distracted by the petty worries of our everyday lives, and the more we can enjoy the finer things in life. When negative events do occur, such as a period of low income, they are easier to place in the context of the grand flow of history, and be viewed as an (individual) spot of bother on the road to (national) maturity. Then, all of a sudden, the issues just won’t seem like that big a deal.

Researching the Chinese Economy with a Critical Mindset The reasons stated above for researching China’s economic development were from an everyday perspective. From the perspective of pure methodology, China’s economic development experience possesses space for theoretical innovation and theoretical abstraction. With regards to specific research procedures, the researcher is undoubtedly concerned with China’s commercial and political aspects, and researching Chinese economic development admittedly has its own practical aims. However, such research also has goals which are in the common interest, and that is the cultivation of the correct mindset. So, this chapter can be understood as being ‘an alternative applicable analytical framework’. Actually it is not merely alternative, it is also critical in nature, and that mindset adopted to observe and analyse China’s economic development can be said to ‘possess applicability’. I will shortly talk about why a critical mindset is necessary, and how to develop one. We are exposed to an overwhelming number of explanatory theories when reading, any of which can assist in understanding a certain aspect of China. I will give an example to elucidate this point. When providing learning opportunities to ‘the Global South’, international organisations might invite Chinese people to tell Africans or South Americans the story of China, and introduce China’s development history. This is not a particularly hard task, and can be completed through the explanatory frameworks of any economist of certain renown, such as those of Wu Jinglian, or Justin Yifu Lin. Completing such a task in this manner is, however, somewhat lazy. People possess a natural mental inertia. Often when we say that people are ‘a little bit lazy’ or others are ‘quite diligent’, actually the greatest difference is that some people are unwilling to use their brains. We need to cultivate our own critical thinking skills,

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learn the theories of others, and find our own explanations. John Galbraith pointed out the concept of ‘conventional wisdom’, the core of which being that conventional wisdom possesses enormous social, national, and even global inertia. Everybody is, to a certain degree, the victims of conventional wisdom. As Keynes once said, no matter whether politicians admit it or not, they are all prisoners of the theories of long dead economists. No matter whether we are a theoretical producer or consumer, the perfect state is that we all possess our own individual creativity, and are able to describe reality, even if via the theories of others. However, if you do not know what other people have done, how would you know whether you are alternative or not? How would you judge whether your own theories are innovative? This means that the relationship between understanding other people’s theories and creating your own, demands a constant process of refining your own thoughts when learning. This is similar to the ancient Chinese wisdom of ‘learning without thought is labour lost, yet thought without learning is perilous’. Then, you should engage in a process of critical thinking and not simply blindly absorbing whatever sits before you. How can such critical thinking being developed, or how can you develop your own innovative patterns of thinking? One method is constant research, you will develop your own material and nurture your own method of thinking as your research deepens. Given enough time, determination wins through, and so this method is feasible. This route, however, is extremely difficult, and there is a risk of failure. Or to put it another way, the chance of success is only 5%. Why would I say that? Because normally, the reason for studying a Ph.D. is to research. If you want to do something specific, such as being a civil servant or engaging in business, then an ordinary degree is sufficient, or you could read an MBA (Master of Business Administration). Upon completing a Ph.D., the normal route is to either teach or research, and as someone once calculated, only 5% of holders of Ph.D.’s in economics became economists. These economists also differ in that only those who have achieved a certain degree of recognition and influence can be considered to be economists. However, in America, those engaged in economics research are considered economists. Only a very small proportion of that 5% creates groundbreaking work. Meaning, if you rely on your own research, and that research does not spark the higher level of creativity, then you have not reached your goal. So, when engaged in research, we must constantly review, summarise, find new routes, and analyse the veracity of our previous work, and then embark on the next round of research. We often discuss the development methods of the transformational economy. Research methods have also undergone transformation. Whilst being immersed in completing our projects, we also become the producers of traditional research methods, and are constantly investing mental, physical and emotional energy. While we are able to put food on the table this manner, low levels cycles are limited in how high they can rise, and grow increasingly distant from truly innovative theories.

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Avoiding Biased Mindsets Although Tolstoy said that ‘happy families all resemble one another, but each unhappy families is unhappy in its own way’, difficulties encountered research also often share commonalities. Or, to put it another way, some commonplace yet erroneous modes of thinking, always coincidentally drives us towards erroneous mindsets. Some typical problems with critical thinking derive from the framework that we use to scrutinise our own research. I have used such methods to approach some problem, and found them extremely deficient, lacking very many formed, comparatively systematic thinking frameworks found within methodology, and only include what the author themselves have come across in the course of their own reading. To help us create a critical thinking mindset, I have collated a few key logical points or misunderstandings. The Latin phrase post hoc ergo propter hoc, which means, after this, therefore because of this and can be simplified as post hoc. This essentially refers to an erroneous hypothesis of cause and effect. Such as, erroneous causality, coincidental relationships, or a relationship not based on causality. This kind of logical error differs somewhat from cum hoc ergo propter hoc, ‘after this’, logical fallacies which emphasise an erroneous relationship based on the sequence in which events occurred. Let’s take, for example, the relationship between the Spring Festival and postcards. As postcards are sent prior to Spring Festival, and so by following the temporal progression, an erroneous inference would be: the initial sending of postcards lead to the creation of Spring Festival. This kind of causality relationship are extremely easy errors to make when considering problems, especially those encountered during economics research. Such problems were likely somewhat less prevalent early on, such as during the early period of economics research (which at the time was known as political economics), and people did not know about calculations. Although some people have an accurate understanding of causality, that of others is more problematic. However, such an erroneous understanding is not commonplace. As economics continues to develop, and the role of econometrics becomes ever more prominent, then erroneous understandings of causality will become more frequent. It can be said that no matter whether in China or overseas, half of economists have an erroneous understanding of causality, and the most capable of our students learning statistics are the most likely to fall into the trap of cum hoc ergo propter hoc. Furthermore, there is a commonplace phenomenon amongst scholars—when reading documents, one first looks at the data. If it is discovered that China has such data, then look at the model estimate method, and the final conclusion. If it has already been done, then why do it yourself? Omit all of the preceding theoretical analysis and theoretical causality. American academic journals have a type of deleterious tendency, which is to encourage people to constantly change their data and statistical methods. This is misleading for young scholars, causing them to lose sight of their own goal. The Nobel prize for economics laureate, James Heckman has specifically criticised this behaviour. Those theoretical economists, who are only

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concerned with constructing theoretical models with no real world application, and for economists engaged in empirical research, who wish to use data to create some eye-catching statistical results, are violating the starting points/ needed for economics research. So, scholars should repeatedly remind themselves to avoid such tendencies. For causation objectively exists. However, if something that objectively exists cannot be observed, then observing causation from an objective starting point/ means that we will just see that the postcards arrived first, and then there was Spring festival. Owing to which, causation can only be seen via theories, and without theory, there can be no accurate perspective on causality. There are many classic examples of erroneous causalities in the history of economic theories. William Stanley Jevons made extremely important contributions to the development of modern economics, especially in the area of marginal analysis. He also cracked a very good joke. He explained the British economic cycle through changes to sunspots. He created a flawless model based on the econometrics of the time, which provided a seemingly rational explanation on the relationship between explanatory variables and explained variables. To prevent students falling such post hoc traps, good teachers should give this example when teaching econometrics.

Counterfactuals The counterfactual method is worthy of recommendation. Originating in psychology terminology, counterfactuals describe imagined events which tends to be antithetical to reality. People often deliberately consider how events would pan out if a precondition were to be altered. It can be understood as a change that is commonly believed to have happened in history triggers an entire chain of related events. However, as a logical starting point, if that change to the cause were not true, then assuming that there was no such change, then all subsequent conclusions might well be groundless. Considering problems requires considerable thought. Such as, if an event serves as the logical starting point, is it true or not. Any research cannot avoid returning to the logical starting point of that time. If China had not been a planned economy… of course this is just pure blue sky thinking… if a planned economy had not been consciously created, and was aimed at accelerated industrialisation, then how would we explain China’s economic development? If it were only because somebody told China to create a planned economy, then how would it impact explanations of China’s economic development? One often encounters past events during the course of research, and as such, it is necessary to analyse their logical foundations. There are some comparatively successful instances, where research aims to explain that some original conclusions might be invalid once a starting event has exhibited change. However, if we do not change the original starting event, and do not assume a different starting event, then such an event does not need to be inferred. It might also be unclear how subsequent research should be conducted. Then, what remains is the blind following of consensus, and the inability to meaningfully conclude the research. As such, the ability to conduct such hypothetical

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assumptions, and through which, reimagine history, might serve to develop one’s critical thinking. Robert Fogel won the Nobel Prize in economics in 1993 with Douglass Cecil North. Their research widely diverged from that of their contemporaries, and was moreover validated via an econometrical historical method. The first was the slave society in the USA. People commonly believe that slave societies were inefficient and inhumane. Fogel’s starting point for his research was, if slavery was highly inefficient, why was a hugely costly war needed to bring an end to it, and why was it not transformed via the economic system? Researching from this starting point, he found that slavery was efficient, and especially so in the southern states. By returning to first principles, he also found that the American Civil War resulted in enormous economic losses, which subsequently took decades to return to normal. Second, was to uncover the contribution of the main railroad linking the eastern and western parts of America to America’s economic growth. Over the long term, and in the research of American economic history, people currently believe that, as the large railroads linking east and west America, they drove the American economy westwards and contributed to America’s economic growth. Here, researching from first principles he found that the contribution of the construction of these railroads on the development of the American economy was negligible, and insufficient to explain its rapid growth. The methodology of Angus Maddison’s research (such as The World Economy: A Millennial Perspective), was built upon a counterfactual. He collated the historical data of the economies of a range of hypothetical countries. His methodology contained some basic assumptions to arrive at this data, and a special route required to return to the first principles, bringing the hypothetical into existence. A colleague and I wrote a paper on estimates of surplus labour, and asked ‘what would happen in the event of no more surplus labour’. Estimating surplus labour does not in itself necessitate a counterfactual. It is just a kind of non-traditional concept, but in following the logic of the question, it became a counterfactual method: if surplus labour is no longer in the region of 150 million or 200 million people, but is, in fact, insignificantly tiny, then a great many other commonly accepted conclusions might also be wrong. For example, the gap between urban and rural incomes might be exacerbated, and advances in agricultural technology might not be designed for use by labour, and instead be designed to save labour.

Conventional Wisdom I recommend everybody read The Affluent Society, written by John Kenneth Galbraith at the end of the 1950s. Galbraith was considered an outsider by mainstream economists for a fairly long period of time, he was criticised by multiple Nobel Prize for Economics laureates, and even upon being appointed president of the American Economic Association, many top-flight renowned economists declared that they would boycott the event, but in the end they all attended. Despite their unanimous criticism, they had to admit that he was enormously influential. They

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criticised him for not being a true economist, but they didn’t believe him to be insignificant. He served as a presidential advisor, in the Indian embassy, and as the president of the American Economic Association/. Although he was never awarded the Nobel Prize for Economics, but his influence, even today, exceeds that of any other American economist. The Affluent Society critiques conventional wisdom (or traditional concepts), a concept of which is detailed in its second chapter. If we say that a certain economist has invented a series of concepts, that can persist and become a common language used globally amongst intellectuals, then with his concepts of conventional wisdom and countervailing power, he stands alone. Galbraith believed that people might find the most commonplace concepts and ideas were already outdated if given consideration. When these concepts were created, they might have undergone a degree of abstraction, reflecting the relative truths and norms of a certain period. As time passes, they become conventional wisdom, yet are unable to explain modern phenomena. Galbraith was an advocate of Keynes. Keynes was the object of much criticism, especially in the United States. The greatest challenge he faced was the economic theories of classicism or neoclassicism, laissez-faire handed down by Adam Smith, and Marshall/. By the time of Keynes, these theories had become conventional wisdom. Galbraith also believed that just as Keynes had gained acceptance, then he himself could not avoid also becoming conventional wisdom. If the conventional wisdom is not struck down, is not doubted, then it will always be in the background, influencing people’s thoughts, possibly causing them to even constantly attempt to validate such conventional wisdom. The biggest problem with conventional wisdom, and the easiest way for us fall into this trap is a factor of our natural reverence for our forebears, the dead, the famous, and authority. If somebody were to propose a theory today, and if that person were to be the same generation as myself, a contemporary or even a classmate from university, then even if this theory was correct, I would say it were wrong, for I would naturally wish to challenge his authority. If this person was already high status, and had become an authoritative scholar, then I would not challenge his theory, but would accept that his opinion will become conventional wisdom. Galbraith mentioned in The Affluent Society that changing conventional wisdom is exceedingly difficult. Even after an awful lot of effort, and even if people believe that the new opinion is correct, but in the mere blink of an eye, they will return to the embrace of their conventional wisdom. If we take the Chinese population as an example, many people frequently say that the Chinese population is going to peak at 1.6 billion people. However, those researching population all know that the Chinese population is unlikely to even hit 1.5 billion, and even if family planning policies were to be adjusted, it still will not happen. 1.6 billion was the earliest forecast, however forecasts need to be constantly adjusted in line with real changes. For example, if one year the World Bank gave its earliest forecast that the Chinese GDP would grow by 8% per annum, and then if Chinese GDP growth exceeded 10% in the first quarter of that year, then the World Bank would need to recalibrate its forecast. In the same manner, China’s total fertility rate is constantly falling, and so the forecasts need adjusting. If it were to be adjusted for today, there is no way that it would state a figure of 1.6 billion people. This

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example shows that conventional wisdom is not merely about accepting whether or not new evidence can be absorbed, but that concepts dominate thoughts. If, when faced with an identically credentialed economist, and I query everything that can be queried, and you provide complete and error-free explanations, I will also believe it is correct, and so I can accept your proof, but the way in which I think will not change. Galbraith published a series of works, The Age of Uncertainty, which cast doubt on the liberalism trumpeted by Milton Friedman. Friedman was worried that people would change the concepts of liberalism, and so rushed out the publication of Free to Choose: A Personal Statement. Doubting conventional wisdom is necessary, especially at the moment, where academic disciplines are not robust, and so many so-called facts are erroneous. They might have been wrong from the very beginning, and even if some were originally right, we still unquestioningly accept them as fact.

For Want of a Nail Another procedure to help with critical thinking is to pay attention to logical details. We’ll start this section with a proverb: For want of a nail the shoe was lost; For want of a shoe the horse was lost; For want of a horse the rider was lost; For want of a rider the battle was lost; For want of a battle the kingdom was lost; And all for the want of a horseshoe nail.

It is said that during the Second World War this proverb was hung on the wall of the command headquarters of the British Army Logistics section, for it emphasised the critical nature of logistical supply to victory or defeat on the battlefield. The utility of this proverb for us is to emphasise that after making a bold assumption, one needs to carefully seek proof. The Chinese traditional so-called meticulous searching for proof means to seek extensively for proof, and work hard to discover materials used. During the process of analysing economics, the crux is not superficial elements, but actually theoretical logic. Data makes economic analysis more rigorous. Some people are naturally more rigorous brains, whilst others make more intuitive leaps, and so when data is not used to restrict the brain, people will worry about a lack of logic and highly accurate requirements at every single step. The conclusion of innovation and criticism does not indicate the existence of theoretical innovation, for a theory needs to undergo a rigorous deductive process and testing. A theoretical mansion, or even just a small theoretical room, is built brick by brick, tile by tile, one step at the time. Nothing can be built without the right materials, it is like lacking nails. There is also structure, for without structure it is not clear how it should be built, and once built it might not even be a mansion, or even a simple thatched hut, it might instead turn out to be a Trojan horse or a mere doghouse. Details are, therefore, the most vital component of the entire logical process, for, strictly speaking, without details, there can be no logic. Taking ourselves as example, the details of the proof of an entire piece of research are far from perfect. This requires a long period of cultivation, and nobody is able to hit true perfection. However, we

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aim to gradually raise our standards and strive towards this goal. Those who have reached a certain standard of research or renown often feel that they no longer need to engage in this process. It would be good if such researchers would not behave so, for the aim of engaging in an academic discipline is not merely to put food on the table. I have always believed that, if the point of being an academic is merely to feed yourself, to complete the task, to get your wages, and once famous you can take a topic for discussion and go and teach class, then I really think your life expectations are far too low. If engaging in academic discipline is the pursuit of perfection, then for there to be innovation, details require clarity. It doesn’t matter whether these details will be seen by anybody else, for they contain a kind of aesthetic beauty in of themselves. Theoretical and logical beauty invites a sense of joy during research. Furthermore, I believe that everybody is quite perceptive, and even if you are highly talented and can find fault in others work, you should never under estimate the power of ‘crowd-sourced’ judgements. To give an example, if you compare your highly detailed research with that of a perfunctory piece of research by a renowned economist, the general public will initially incline towards the words of the latter, but those highly experienced with economic reality will, even if they do not discover on the first couple of occasions, be more likely to notice differences the more time that passes, and will eventually find that your research is extremely well grounded. Even if the famous economist has a reputation that is seemingly set in stone, years or even decades can seemingly pass in the blink of an eye. Possessing a correct attitude towards research will yield its own satisfaction through your theories and, through which, you will be able to make a real contribution. This is why paying attention to the logical details is critical.

Stylised Facts About Economic Growth Once you wish to control your analysis through a correct mindset and possess an understanding of China’s economic development, you also need to become acquainted with some essential background details, especially those of some famous historical economic disputes. For instance, interpreting Needham’s riddle can be done via the use of classic papers that provide an overview of the actual characteristics of economic development. A great many research conclusions within economic literature that people are unwilling to arrive at themselves are known as economic theory or economic laws, and are called facts, or stylised facts. Although they might not be correct, but they may serve as the starting point for research or observation of an issue. We can utilise such ‘facts’ to conduct alternative research, or research how such facts themselves change, and to consider how to test these facts. If some of these ‘facts’ are discovered to be erroneous, then that may serve as an opposing viewpoint. Past research that is considered to be a stylised fact, indicates that ample research and analysis was formerly conducted and then summarised. This means that such summaries serve as a very good starting point. Frequently subjecting such past

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research to such a verification framework is an extremely fruitful research method. The aims of focusing on stylised facts are twofold. The first is that stylised facts can serve as a reference for the learner. For example, conducting statistical research with China’s data, and discovering the conclusion has already been reached by some stylised facts can boost your confidence in your own research abilities. The other aspect is, once you have become sufficiently experienced at research, you can test related statements, verifying whether these facts still have validity with reference to China, thereby raising your own understanding of the issue.

Kuznet’s Facts on Modern Economic Growth During the early stages of research, I relatively frequently read and quoted Simon Kuznets’ modern economic growth fact summaries. In recent years, discussing Lewis’ theories means that we understand that developing countries can exist within the dual economy development stage for long periods of time, and there can be a turning point (Lewis turning point) at specific development stages. However, what route will a country’s economy take once it has passed this turning point? Kuznets researched the transition from the traditional economy to the modern economy. During his Nobel prize acceptance speech, Kuznets described six characteristics to summarise modern economic growth. The first, that the per capita GDP and rapid population growth rate of developed countries was a large multiple of the observable growth rate of these countries and other countries in the world. Second, the growth rate of the productivity of each type of factor of production, and that of total factor productivity (TFP), reached historically unprecedented speeds. Third, rapid changes to the economic structure, including the transition from the agricultural to nonagricultural sectors, from industrial to service industries, changes in the scale of production units and related changes to corporate type, changes to professional status and changes in other areas all occurred faster. Fourth, rapid changes to economic structure correspondingly led to changes to social structure and states of awareness. Fifth, developed countries employ their increasing technological prowess, especially in the fields of telecommunications and logistics, creating a world that is vastly different to that of any past age (globalisation in modern parlance). Sixth, the spread of modern economic growth remains only partly effective. The economic successes in other areas of the world, which comprise the majority of the world’s population, are still far below that of the lowest possible level implied by the technological capabilities, leading to regional development gaps. China has already bridged the Lewis turning point, and based on existing concepts of modern economic growth transitions, it can consult these six points of reference. In addition, we can analyse the modern versions of these six rules, or analyse which of these six rules are essentially no longer applicable to the current situation. Japan might have been able to use these rules as a foundation for its decisions during its transition. However, they might no longer be able to serve as essential rules or characteristics. We will discuss Kuznet’s turning point in more detail in a later chapter.

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Palant-Prescott Development Facts The Palant-Prescott Development Facts were proposed by the two writers when summing up more than two decades of research. It emphasises the development fact of income distribution. Prescott was a former Nobel prize for economics laureate. These facts covered the following aspects. First, there are enormous wealth disparities between countries. Second, these wealth disparities now neither increase, nor reduce, and were essentially stable between the years 1960–1985. Third, wealth distribution flows upwards, meaning that the rich become richer, and the poor richer than before. This does not mean that the rich are getting richer and the poor poorer, and as such, there is no absolute poverty trap. Fourth, the existence of growth miracles means that there are also growth disasters. From a historical perspective, some countries experienced growth miracles upon entering the middle income stage, and headed towards high income levels of development, whilst other countries underwent growth disasters, and became mired in the middle income trap. This is their overview of income distribution, and pertains to whether the income gap is increasing or decreasing. In other words, it consists of their fundamental observations on economic convergence and divergence.

The Kaldor Facts Nicolas Kaldor was a contemporary of Keynes, and he made comparable contributions to the field. He is highly esteemed amongst economists, but is far less well known outside the profession. He composed six facts on economic development. First, labour productivity continuously rises. Second, capital per capita correspondingly grows over time. Third, the rate of return to capital are comparatively stable over the longer term. Fourth, the capital-output ratio is stable. Fifth, capital and labour as a proportion of national income is stable. Six, there are appreciable variations in the rate of growth of labour productivity and of total output among amongst similarly fast growing economies. It provides an overview of some of the basic phenomena of economic growth, including research of the national income account//, aggregate growth data, and hypotheses on the proportion of capital and labour required. It focuses on whether income distribution is expanding or contracting, and the exact nature of changes to the background capital returns and labour remuneration distribution ratios, whether growth gaps were increasing or decreasing, and the nature of the numerical concepts of the gaps. All of above are applicable to modern research. For instance, when discussing initial distribution, we need to know how relative rates of returns on capital and labour had changed over the preceding thirty years, and whether the share of capital was rising, or the share of labour falling. What I found interesting when reading Kaldor’s academic biography, was that many people complained while he was alive that his so-called Kaldor facts were definitely not facts. Perhaps we can

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target research on China’s development, and test Kaldor’s facts by trying to disprove them. We can also, of course repudiate them.

The New Kaldor Model The New Kaldor Model was proposed by Charles Jones and Paul Romer. I highly recommend the paper The New Kaldor Facts. New Kaldor Facts covers the following six aspects. First, increases in the extent of the market. Increased flows of goods, ideas, finance, and people—via globalization as well as urbanization—have increased the scale of the market for all workers and consumers. Second, accelerating growth. For thousands of years, growth in both population and per capita GDP has accelerated, rising from virtually zero to the relatively rapid rates observed in the last century. Third, variation in modern growth rates. The variation in the rate of growth of per capita GDP increases with the distance from the technology frontier. Fourth, large income and TFP differences. Differences in measured inputs explain less than half of the enormous cross country differences in per capita GDP. In other words, total factor productivity can explain more than 50% of such differences. Fifth, increases in human capital per worker. Human capital per worker is rising dramatically throughout the world. Sixth, long-run stability of relative wages. The rising quantity of human capital relative to unskilled labor has not been matched by a sustained decline in its relative price.

Decoding the Mystery of the ‘Deceleration’ of the Chinese Economy As mentioned in Chap. 1, the Lewis turning point has already occurred in China, and the demographic dividend has begun to disappear. China has begun to decelerate whilst still in the middle income stage. This naturally begs a rather pressing question: will China fall into the middle income trap? We should make use of data from a range of countries at different stages of development, and research at what point during an economy’s development does it begin to decelerate. One research paper believes that growth speed drops when a country’s per capita GDP hits US$7,000, whilst another believes that this happens at US$17,000. China’s per capita GDP falls between these two economic development speed deceleration periods based on purchasing power parity. Long term economic growth trends show that such a drop in growth speed is unavoidable. ‘Deceleration’ does not signify the falling into the middle income trap. The crux of the matter is in how much speed is lost. Speed drops from 11 to 9%, or 8%, to even 6% will not mean that China becomes ensnared in the middle income trap. However, if the growth rate falls to a very low figure, one which is unable to meet the people’s need for improved living standards and work prospects,

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then this signifies economic stagnation, and such an event might herald the arrival of the middle income trap.

Why is There a Middle Income Trap Let us bring together economic growth theories to elaborate on the significance of the middle income trap. In economics, ‘trap’ signifies an extremely stable situation. An extremely stable situation means that extremely small changes will eventually revert to the stable status quo. Poverty is a trap, but the Malthusian age concluded with the advent of the industrial revolution, whereafter escaping the poverty trap became comparatively simple. Escaping the middle income trap is, however, rather difficult. So far, only Japan and the four ‘Asian Tigers’ have been able to transition from middle income to high income economies. The countries of Latin America are still in the middle income stage. A great many Middle Eastern countries have not yet, despite being blessed with natural resources and very high per capita GDPs, joined the ranks of the developed countries. This means that explaining and researching the middle income trap is of the utmost significance. During the dual economy development stage, countries with low per capita GDPs are in the Take-off stage, and can be characterised by unlimited labour supply and a demographic dividend. Fully employing this sizeable comparative advantage of labour, and gaining a competitive advantage on the international market via globalisation, can drive rapid economic development. Likewise, developed countries possess the comparative advantages of being at the frontiers of technological innovation, possessing ample material capital, human capital and creativity. Owing to which, the economies of each nation can be depicted as a U-curve during the globalisation process: low income countries and advanced countries all profit greatly from globalisation, but those in the middle (middle income countries) reap much smaller dividends. The reason why middle income countries do not benefit quite so much from globalisation is the lack of evident comparative advantages. They cannot compare with low income countries in labour intensive industries, and cannot compete with advanced nations in hi-tech fields, and so they cannot be the primary beneficiaries of globalisation. China is already exhibiting heightened labour costs, and a fall in this comparative advantage. Additionally, China is growing ‘old before it is rich’. China is still uncompetitive in the fields of capital, technology, and education. If it still has not created any new ones when it has lost its original comparative advantages, then it could potentially reside at the bottom of the U-curve for a protracted length of time. The comparative advantage ‘vacuum’ will reduce how much it benefits from globalisation, and economic growth will slow, until it falls into a severe middle income trap.

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Old Comparative Advantage Gone, New Comparative Advantage MIA First, rising labour costs alter the comparative advantage equation. China is already exhibiting trends that it is losing its traditional comparative advantages. Owing to the rapidity at which worker salaries are rising, labour costs are growing substantially, and even outpacing the pace of productivity increases, leading to increased unit labour costs. The loss of this comparative advantage results in a substantial fall in the profitability of labour intensive industries. An item of research conducted by the Boston Consulting Group shows that there is only a 5% cost differential between Chinese and American products. If this pace continues to accelerate, then the disadvantageous effects of a drop in the speed of economic growth will become even more evident. Moreover, new comparative advantages do not arise automatically. Just as the original comparative advantages are disappearing, China’s standing in the fields of education, science and technology remains insufficient to serve as a new comparative advantage that would be discernible in economic growth figures. Although China’s investment in research and development and the proportion it comprises of GDP, and the number of patents and published scientific papers is catching up with developed nations, and already ranks in the top few globally by total quantity, but when assessed with quality indicators, such as patent usability, and academic papers citation rate, then China still lags far behind. For instance, China already publishes more total scientific research papers than the United Kingdom, ranking second world-wide. However, this is just the quantity published, and does not rank quality. Based on the relative quality index created from current research, and comparing the number of citations of the academic papers of a country with total papers published, whereby the higher the ratio, the higher the quality, and the lower the ratio, then the lower the quality. For instance, Country A publishes 10 academic papers, and if each of these ten papers are cited, then it receives a quality index score of 1, meaning that all of the papers of that country are high quality. If only one paper is cited, then it receives a quality index score of 0.1, meaning that all of the papers of that country are low quality. Based on the research of the Japanese scholar, Professor Hatakenaka (see Fig. 3.1), we can see that highest ranking on the relative quality index is Sweden, and then the United States, and then the United Kingdom. These are all technologically advanced countries. China rank fairly low down. This example shows that there is still a huge gap between China and technologically advanced countries.

Changes to Sources of Growth When the original comparative advantage has been lost, and there is no new comparative advantage in replacement, then economic growth with necessarily fall in response. Our decomposition is based on neo-classical growth theories, with elements

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Fig. 3.1 National comparison of the relative quality index

of the dual economy added. It analyses the reasons for the reduction in China’s economic growth speed from the perspective of its sources of growth. It shows that over the past three decades or so, capital investment has been a major contributor to China’s economic growth, possessing a contribution rate of 71% to the GDP growth rate. The contribution of labour has been 8%. The largest contribution of the unlimited labour supply has been in permitting unlimited investments of capital, and in addition, not causing a trend of diminishing capital returns. The contribution rate of human capital is 4%, whilst the remainder is comprised by Solow residual errors. We can combine elements of the dual economy, and further analyse the Solow residual errors, and display the demographic dividend via the dependency ratio. In a narrow sense, the contribution of the demographic dividend to China’s economic growth has been 7%, yet this does not include the demographic dividend in capital, labour, human capital and total factor productivity. Apart from this, we can analyse sources of economic growth from the perspective of optimal resource allocation. Labour transitioned from the low productivity agricultural sector to comparatively higher productivity non-agricultural sectors. This process has the effect of reallocating resources, and is the main source of total factor productivity during the transition stage of the dual economy. The results of the analysis show that: the contribution rate of capital is 76%; human capital, 5%; labour, 2%; total factor productivity, 17%; of which the sectoral reallocation of labour is 8%. Both the demographic dividend and resource reallocation have been drivers of China’s prior economic growth. However once the demographic dividend has disappeared, diminishing capital marginal returns and capital investment no longer serve

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as reliable drivers of economic growth. Remaining rural surplus labour will no longer migrate on the same scale as before. As such, the contribution of resource reallocation optimisations delivered by labour migration is set to substantially fall. Furthermore, as the previous two analyses showed, the contribution of the quantity of labour and human capital to the economic growth was fairly small. In view of this, if actual total factor productivity is unable to make noteworthy increases, then the rate of economic growth is destined to fall. This means that, in neo-classical growth theories, there is no GDP without total factor productivity, and without total factor productivity growth, there can be no GDP growth. Economic growth cannot be fully driven by total factor productivity for China’s current stage, but the contribution of other factors to its economic growth display evident declining trends. Based on its changing economic growth sources, China has already left the dual economy development stage, and has entered the neo-classical growth stage. China is about to face a historically unprecedented challenge. In the past, the state of its factors were sufficient to drive China’s economic growth, but these factors will no longer exist in the future, and so its growth speed will necessarily drop.

Chapter 4

Escaping Misunderstandings About the Relationship Between Population and the Economy

A Large Population is No Barrier to Economic Growth In early literature on demography and economics, the primary focus on the relationship between population and economic development was on the relationship between total population, or population growth rates, with economic growth rates. Discussions on demographic changes were purely limited to the fertility, birth, and death rates, and also total population. Starting from this perspective, the majority view was that a large population or fast demographic growth rates lead to constrained resources, environmental degradation, and a dearth of work, thereby hindering economic and societal maturation. Many of which presuppose such issues do not warrant further discussion. These viewpoints are generally considered to be of the Malthusian tradition, the veracity of which has never been proved throughout the entire course of economic history. Conversely, some academics believe that technology can benefit population growth. Such technological change and economic growth might provide answers to population growth induced resource shortages, meaning that population growth never need be a detrimental phenomenon. Moreover, population growth is beneficial to economic growth. However, such a perspective has failed to provide clearcut explanations on the vital nature of the relationship between population and economic growth. In short, research on this topic has long been inconclusive. During these discussions, people overlooked the relationship between economic growth and demographic structure, along with the most important outcome of demographic change—changes to the nature of demographic structure and labour supply. As the majority of developed countries and many newly emerging industrialising nations completed their own transitions, demographers began to observe the effects of an ageing population wrought by demographic transitions. Later, the economist Williamson observed changes to the working age population following these transitions, and the subsequent impact on sources of economic growth. The natural demographic growth rate ascended during the time lag between the fall in mortality rate and the fall in fertility rate. This inevitably led to a corresponding increase in the child dependency ratio. Following a further time lag, the working age population © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_4

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ratio rose as the baby boom generation matured into adults. Societal and economic development then led to a fall in the fertility rate, and population growth tended to slow. This was then followed by a gradual ageing of the population. In other words, when the natural demographic increase first rises and then falls it creates an inverted U curve. The working age population will exhibit a similar trajectory after a time lag of approximately one generation. This means that when the demographic age structure is in a stage most amenable to production, the ample labour supply and high savings ratio provides an additional source of economic growth. Accordingly, once past this stage, these productive characteristics are lost as the demographic age structure ages, and any noteworthy demographic dividend also disappears. Changes to the stage of demographic transition can be most generally reflected via the total fertility rate. Assuming no demographic transitions or technological advances, we can theoretically forecast the relationship between demographic transitions and economic growth. When the total fertility rate is high, the economic growth rate exists in a correspondingly low homeostasis. As the fertility rate falls, a productive demographic age structure will gradually emerge, and economic growth will accelerate, resulting in a demographic dividend. When the fertility rate falls to a lower level, then a rise in ageing will lead to economic growth rates gradually falling to their former low state, by which point there will be no further demographic transitions as we understand the term. However, technological progress is now at the frontiers of innovation. Correspondingly, when falls in the fertility rate then create a designated demographic transition stage of a demographic age structure geared towards production, then that leads to the so-called ‘demographic window of opportunity’. We can track the relationship between each country’s GDP growth rate and total fertility rate with the World Banks’ World Development Indicators database. Our theoretical forecasts do not depict a simple linear relationship between GDP growth rates and total fertility rates, but instead a fairly complex non-linear relationship depicting economic growth rates that first rise and then fall as the fertility rate drops. This means the relationship we actually see in our forecasts, which are based on theories of the relationship between GDP growth rates and total fertility rates, is an inverted U curve relationship between total fertility rates and GDP growth rates. Those countries with very high fertility rates have comparatively low GDP growth rates. As the total fertility rates fall, GDP growth rates rise. GDP growth rates attain their highest values when total fertility rate falls to a certain level, upon which they reach their own turning point, whereupon increases shift into decreases. Those countries with comparatively low total fertility rates also have comparatively low GDP growth rates. This simple empirical curve is entirely consistent with theoretical forecasts. The conclusion to which is, population size and growth rates do not necessarily exhibit an obvious correlation with economic growth rates, but demographic transitions and economic growth have a mutually interdependent catalytic relationship.

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The Ageing of the Population is Inevitable Economic and societal development are the primary drivers for demographic transitions worldwide. Birth control policies only have a supplementary, and moreover relatively secondary, intensifying effect. For instance, neither South Korea, Singapore, Thailand, nor Taiwan implemented compulsory family planning policies, yet they have followed trajectories similar to that of mainland China’s. They all peaked around the 1950s, and then declined to below replacement levels by the 1990s. The slow pace of India’s economic and societal development means that demographic transition has been comparatively sluggish, yet it too is on a similar path. China’s rapid economic growth began in the 1980s. Despite starting after the ‘Four Asian Tigers’, its growth miracle has spanned more than three decades since the onset of the reform and opening. This commencement of a new stage of demographic transition whilst still possessing a low GDP per capita, means it will be ‘old before it is rich’. In 2000, those aged 65 years and over comprised 6.8% of the Chinese population. This was comparable with the global average. By 2001, China’s per capital gross national income (GNI), calculated against the official exchange rate, was 17.3% of the global average. Measured by purchasing power parity, it was 56.3%. Although China’s strict family planning policies served as an accelerant, but ultimately, demographic transitions are the result of economic and societal development, and the gap created by being ‘old before rich’ (its ageing population converging with that of developed economies faster than the speed of convergence of its per capita incomes), are primarily the result of differentials between its level of economic development with that of developed nations. Whilst all developed countries are exposed to the stresses placed by ageing populations on economic growth and social security systems, how each country tackles ageing differs. In aggregate, however, these countries enjoy comparatively high levels of per capita GDP, and are home to world leading technological innovation. As such, primarily depending on productivity increases to drive economic growth has remained feasible, and has, to date, been sufficient to counter the risk posed by their ageing societies. Conversely, China’s response to the problems posed by its demographic transition, namely, a falling working age population, and rising levels of ageing, is critically dependent on sustaining a momentum of high speed growth. In other words, this process of demographic transition is irreversible, and the ageing trend is set to continue, despite adjustments to family planning policies. It has already created the old before rich gap. This gap should primarily be reduced via sustained economic growth, prior to its eventual elimination. Figure 4.1 is derived from United Nations data. If China’s future frame of reference is not as a developing country, but as a developed country, then its characteristic of being old before rich disappears. An important expression of demographic structural contradictions is the imbalance in the demographic sex ratio at birth. The sex ratio at birth is a comparison of the number of baby boys born for every hundred baby girls. A ratio of between 103 and 107 is, biologically speaking, comparatively normal. Looking at the sex ratio of the 0–4 age cohort, we can see that it was 110 in 1990, 120 in 2000, and had risen

70 Fig. 4.1 Reducing the ‘old before rich’ gap through growth. Source United Nations, Department of Economic and Social Affair, Population Division(2015), World Population Prospect: The 2015 Revision

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further to 123 by 2004. There are two controversial points pertaining to an imbalance of this nature. First, this phenomenon is not the result of family planning policies. Second, is whether this imbalance will eventually distort the future marriage market. Current sex ratio at birth forecasts suggest that there will be 40 million more males in the 25 to 35 age bracket than females in the 20 to 30 age bracket. The marriage age difference endemic to China’s culture means that these men will be unable to find a suitable partner. The labour market’s discrimination against women serves to favour baby boys at the family level, and is the fundamental cause of the imbalance of the sex ratio. In academic circles and the fields of policy research, people commonly believe that deficiencies in the social security system have led to the reliance of the elderly on boys, and a socioeconomic cause for the sex ratio at birth imbalance. A great many researchers suggest that a concerted public information campaign can change the tradition that sons are needed to support their parents in old age. Although such a change in perceptions is needed, it does not answer the problem of old age care. For, a change in the child to parent ratio multiplies the burden of old age care. Assuming that each couple is only capable of supporting one set of parents, and society is unaccustomed to old age care without sons, then whether it is the son or the daughter who cares for the elderly is random, resources for old age care are patently inadequate. And where customs dictate a model where sons provide old age care, then the actual allocation of old age care resources neatly accords with the principles of randomness. If the preference for the issues of sex ratio at birth and old age social security are related, then their causality relationship is not a matter of which side of the family the children should care for. It is actually, first, society’s old age care resources are inadequate, provide limited coverage, and lead to requirements on the number of children, which then becomes a requirement for sons. Second, women are disadvantaged on the labour market, meaning they are unable to provide sufficient support for old age care, thereby leading to a preference for boys. This means that where such a shortage of resources or capabilities creates an old age care crisis induced birth sex preference, merely changing the mindset of ‘a son is a support in old age’ will not solve the problem. As private sector freedoms to recruit and pursue maximised profits increased during the early stages of the development of the labour market, corporations placed a relatively low value on females in the labour supply, or were directly inclined to discriminate against them. When human capital and other individual characteristics are unable to fully explain salary differentials, then labour market discrimination will result. For instance, analysing investigations on the Chinese urban labour market reveals substantial differences in salary levels between employed male and female workers. Econometrical analysis conducted by Wang Meiyan shows that less than 5% of existing sex wages differentials are the result of differences in male and female education levels and other individual markers. The remaining more than 95% is a result of inexplicable factors, the major component of which being sex discrimination. Therefore, the solution to the problem of the rising sex ratio at birth is the radical improvement and standardisation of the labour market, as well as establishing a socialised old age social security system, and the elimination of labour

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market discrimination against females. Existing labour market discrimination exacerbates tendencies towards family investment in girls’ education being lower than that of boys. This means that, as higher levels of education become progressively more expensive, families will tend to economise on investment in girls education. Research shows that the gap between male and female enrolment gradually grows the higher the level of education. By the point of higher education, the gap can have doubled. Such situations become more probable with increasing numbers of impoverished families and the more constrained family budgets become. This means that focusing on, and intervening in, female education in poor families is an important step towards avoiding labour market sex discrimination.

The Inevitable Disappearance of the Demographic Dividend More than three decades of reform and opening resulted in China’s economy growing at historically unprecedented speeds. Many reforms only provided a one-off growth boost, such as that of the agricultural household contract responsibility system. Moreover, reforms need to make a tangible impact on specific sources of growth. Economists have, therefore, needed to uncover the source of the thirty odd years of high speed growth. Many people agree that the demographic transition which led to the formation of a demographic structure amenable to labour supply and high savings rates was an important source. This is what we call the demographic dividend. Our research shows that 27% of GDP per capita growth derives from the decline in the dependency ratio. This coefficient is calculated as the GDP per capita growth rate increases by 0.115% for each 1% drop in the dependency ratio. Thus, will the validity of this coefficient be affected if the dependency ratio stops falling and then begins to rise? Will this result in an inverse demographic dividend, whereby for each 1% increase in the dependency ratio, the GDP per capita growth rate will decline by 0.115%? Relatively early forecasts suggest that 2013 was the turning point of the demographic transition, after which, the dependency ratio rapidly rose. It was later shown that this turning point arrived early, in 2010. In short, the following question demands an answer: is the demographic dividend, which served as an additional source of growth for the Chinese economy, already exhausted? If so, what will be the source of future economic growth? Admittedly, losing the demographic dividend signifies a shift in sources of growth, but it does not signify that sustainable growth does not exist. If the first demographic dividend cannot be sustained, and there is no second demographic dividend to replace it, then the establishment of an optimised labour market that facilitates the building of a old age social security system, the strengthening of training, the deepening of education and of continued education, and harnesses the changing demographic structure, can further develop sources of economic growth. This type of demographic dividend (or the first demographic dividend) has only been half employed in several areas. There is still potential for further exploitation.

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We know that the demographic dividend is manifested in large scale transitions of labour from rural to urban areas, creating a wave of migrant workers, and correspondingly driving China’s urbanisation. As a manifestation of the demographic dividend, urbanisation is manifested in an ample supply of non-agricultural labour, expanding urbanised consumer demand and demand for the construction of urban infrastructure, as well as that of social security and savings contributions, and in the land development which accompanies urbanisation. In view that although China’s urbanisation has already grown at hyper-normal speeds, there are also atypical characteristics of urbanisation lagging behind industrialisation, and the urbanisation of land development. Such areas are sources of potential, and the remaining half of the demographic dividend is a rich seam waiting to be exploited. Urbanisation accelerated at an average of 3.2% over the past three decades or so, 2.9% over the past two decades, and 3.2% over the past decade. These kind of speeds are unsustainable over the long term. First, China is urbanising faster than the global average. The international experience shows that China’s rate of urbanisation should be between 0.8 and 1.6%, instead of the 2–3% rate of reality. Second, the rural working age population growth rate is falling daily, and has currently already stopped increasing. In actual fact, the migrant worker growth rate has already fallen. However, prior urbanisation has only been semi-urbanisation, as the permanent population is defined statistically as that resident for a period in excess of six months. Such as, in 2013, permanent population statistics placed the urbanisation rate as being 54%, however, based on statistics of the proportion of non-agricultural hukou, or registered residence, then the rate was only 36%, which is eighteen percentage points lower than the former figure. Urbanisation, by its standard permanent population definition, is also a key source of economic growth and societal development, for it achieves the employment structure transition of labour from agriculture to non-agricultural industries. Our fairly early calculations suggest that this kind of employment transition has had a 21% contribution rate to the speed of GDP growth during the reform and opening period. However, this only covers employment transitions and not changes to residential status. This kind of semi-urbanisation remains insufficient for expanding its contribution to consumer demand, demand for urban construction, raising labour force skillsets, as well as increasing the accumulation of social security funding. As such, there is a need to complete urbanisation. It is thus evident that urbanising migrant workers and their families will facilitate the unlocking of the other half of the demographic dividend. Or, simply put, even if the rate of urbanisation growth were zero, there is an eighteen percentage point gap between the 54% urbanised permanent population, and the 36% non-agricultural hukou residence registration urbanisation rate, meaning there is an enormous new source of growth waiting to be tapped. Moreover, whilst urbanisation cannot maintain speeds of 2% or 3%, it also cannot fall to zero. Advanced urbanisation, meaning the urbanisation of migrant workers, is just one example of the many options for tapping into that other half of the demographic dividend. There is also potential waiting to be harnessed in other areas:

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Eliminating labour mobility and the regulatory barriers hindering its utilisation to facilitate the employment of migrant workers. This reduces the misallocation of worker skills, and promotes employment amongst university graduates. The government has implemented a proactive employment policy, promoting the employment of problem groups. In addition, there is also the opportunity for a second demographic dividend. This would offer a smooth continuation with the preceding demographic dividend, and forestall the emergence of a vacuum amongst sources of economic growth.

Labour Supply is a Finite Resource The belief that China has a huge population base, vast quantities of labour, and a completely inexhaustible supply of surplus rural labour is a deeply entrenched traditional mindset. As such, any academic viewpoint or policy suggestion is highly unlikely to gain widespread acceptance if grounded in the belief that, even if in future, the surplus rural labour force will run out, thereby reaching the conclusion of the arrival of the Lewis turning point. Whether critical viewpoints targeting this author, or the understanding that state of the Chinese population and its labour force are set in stone, are both primarily the result of having been hoodwinked by statistics. The problems inherent in statistical figures are primarily covered by the following few areas. First, regarding the usage of agricultural labour data. Standard statistical systems are unable to fully reflect rapid changes to the realities of agricultural production, meaning that academics are either completely oblivious to the latest situation, or fall into the trap of ‘being ruled by data’, to the extent that basic econometrical analysis data can be extremely unreliable. An academic at the World Bank pointed out, ‘China’s reforms came so quickly, even statistical reforms could not catch up fast enough.’ For instance, the China Statistical Yearbook reveals that agricultural labour comprised as high as 35% of the nation’s workforce in 2012. Statistical approaches indicate that the agricultural employment figures for the agricultural survey were even higher. In actual fact, investigative documents into agricultural costs reveal the actual quantity of labour invested in agricultural production. It is substantially lower than the aforementioned figures. It is quite possible that the actual quantity might be much lower than statistics suggest if multiple factors of incremental trends of the agricultural working age population and the transitional status of agricultural labour, as well as the increasing mechanisation of agriculture are considered. This means that accumulated statistical data that depicts large quantities of surplus labour still available for transition, or econometrical analysis of which leads to the conclusion that marginal agricultural labour productivity remains very low. All of which are the result of overestimating the quantity of surplus labour still contained within the agricultural sector. This leads to the repudiation of the belief that the Lewis turning point has already arrived.

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A great many academics are unable to decode statistical data pertaining to the labour market and the urban and rural employment situation. Urban employment channels have tended to diversify as industrial structure and economic composition have gradually diversified. This was especially true after the assaults on the labour market in the late 1990s. They are no longer purely guided by the employment structures of nationalised or collective departments, and have instead given rise to large scale informal employment. Simultaneously, agricultural labour sought employment in non-agricultural sectors on a large scale, both in their home localities or other regions. Total numbers exceeded 260 million people, of whom 160 million sought employment in urban areas. Conventional statistics show that informal employment of urban residents and migrant worker employment, apart from via collection and analysis, indicates a total quantity of around 100 million people and a total urban employment rate of 30%, yet there are often no branch departments analysing such data. Apart from which, that related organisations have still not publicly released surveyed unemployment rate figures that more fully reflects the state of the actual labour market than the registered unemployment rate, results in many academics theorising without supporting data. This means that a great many researchers only rely on the formal employment data in the Statistical Yearbook, and give fairly arbitrary estimates when dissecting the status of the labour market. They then arrive at conclusions including zero employment growth or persistently high unemployment rates (such as Rowsky’s aforementioned opinions), leading many people to refuse to countenance the possibility of a ‘migrant worker famine’ until one is experienced on a nationwide scale. Third, regarding the trends of population growth and changes to the demographic structure. It is difficult for data tabulated by the Statistical Yearbook to provide a detailed overview, for it often does not feature the latest demographic forecasts. In actual fact, the data from previous censuses were all able to provide the latest demographic change trends. However, differences in opinion on key parameters, such as the total fertility rate, mean that there are no periodically published demographic forecast reports that are both authoritative and frequently updated, and moreover are officially approved. Readers are often even less informed of changing demographic trends. This means that many people still believe that China will only hit peak population, of supposedly 1.6 billion, at some point after 2040. With regards to the changing trends of the demographic age structure, the majority of people do not know that the increase in the working age population is already sharply declining, and that the population base for the prior unlimited labour supply is disappearing. As such, they are unwilling to believe that the demographic dividend is vanishing, and that the Lewis turning point has arrived. The Lewis turning point does not signify the end of the dual economy. Based on Lewis’ own research and as well as that subsequently conducted by others, I have called the point at which growth of labour demand exceeds supply, and where wages start to rise as the Lewis turning point. At this point, agricultural labour wages are still not determined by the marginal labour productivity, and there is still a divergence between the marginal productivity of labour in agriculture and modern

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sectors. Wages in the agricultural sector and modern economic sectors are already determined by marginal labour productivity. The arrival of the stage where marginal labour productivities in both sectors are equal is called the commercialisation point. This point truly signifies the conclusion of the dual economy. This means that much research that utilises the marginal productivity of agricultural labour and agricultural wages as criteria for differentiation, are insufficient1 to verify our own judgments. On the contrary, observing the sustained rise of the wages of ordinary workers signifies the arrival of the Lewis turning point. Although Lewis himself, as well as many other contemporaneous researchers, publicly asserted, or implied, that from a purely theoretical perspective—it did not matter whether the first turning point arrived, but its arrival had a much more critical import for policy. If the turning point is said to have arrived, then three important changes can be forecast and also better understood. First, changes to labour supply and demand necessarily drives accelerating wage growth. Second, the higher demand for the new generation of workers results in intense changes to the labour-capital relationship. Third, the disappearance of the demographic dividend leads to imminent changes in growth methods. First, the prominent appearance of the Lewis turning point in the labour market, is the rise in the wages of ordinary workers. Foxconn merely typifies the universal wage growth phenomenon that commenced a few years prior. This phenomenon has been a continuation of the trend of rising wages that has been underway since 2003. We have seen in the past few years that the wages of agricultural hands, migrant workers and several commonplace labour employment industries have risen sharply. This rise in wages accords with the rules of supply and demand, and can be borne by the market, and is also most welcome. The reason why I say this is that the current wage growth is accompanied by a simultaneous rise in labour productivity. It does not mean that it will lead to the loss of comparative advantages or competitiveness. To lose a swathe of those sweatshops that are only viable for their low labour costs and low profit margins is of no significance. Moreover, labour productivity rises outpaced wage growth for an extended period of time. This gave China some space, and permitted a certain period of somewhat faster wage growth. It is only in this manner that worker remuneration can comprise a higher proportion of the national income. As evidenced by Western and advanced Asian economies, rapid changes in labour relations is another important indicator of the arrival of the Lewis turning point. In tandem with the new labour supply and demand terrain, improving worker wages and compensation, as well as demands for better work conditions, and workers’ increasing assertion of their rights, clash with unwilling and slow moving corporations. This will necessarily result in partial conflicts between labour and management on isolated 1 The

total fertility rate was shown to be only 1.32 in the fifth census, conducted in 2000. This was even lower than the policy target fertility rate of 1.51, and resulted in the data being doubted by many people. Since which point, the exact total fertility rate figure has been continuously disputed. In general, government departments tend to believe it is still comparatively high, whilst the figures trusted by academics are somewhat lower. Despite all of this, the controversy is over the 1.6 to 1.8 range, a figure far below that of the 2.1 replacement rate.

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issues needing rebalancing. It is thus evident that the current conflicts between labour and management in China, such as strike action, is typical of the kind of changes that occur at this stage of development, and are, as such, inevitable. They should be considered a kind of ‘growing pain’, and should not be avoided. In fact, they must not be avoided. There are economists who suggest that, to avoid inviting trouble, such issues should not be resolved via the establishment of labour market regulations, such as collective wage negotiation systems. Such short sighted policy merely overlooks or suppresses conflict between the employed and the employer. The arrival of the Lewis turning point also portends painful challenges. Often, a change in the relationship between labour supply and demand in a society triggers or awakens conflicts between workers and management. One aspect is that the general public have higher income expectations. The other aspect is that such structural changes result in some people becoming economically and politically marginalised. For instance, each economic recession in the United States induces a wide number of changes and often results in employment failing to recover to its previous level. Once manufacturing industries relocated overseas, many formerly employed non-skilled workers were unable to find suitable work for many years. This has led to labour unions in developed countries frequently instigating manufacturing trade friction and the suppression of the rise in value of the renminbi. More generally speaking, the challenges and risks faced when transitioning from a middle income to a high income stage are in no way less formidable than those encountered during the low income to middle income transition. China is currently ranked as a middle income nation when measured by the World Bank criterion, GDP per capita. This stage is absolutely not a walk in the park, but faces even more rigorous challenges. Western nations, as well as Japan and Korea have become high income nations, yet many Latin American countries have stagnated in the middle income trap. An extremely important differentiator has been the ability to understand and manage such ‘growing pains’, of which employer-employee relations is but one. Simply put, Latin America failed because its populist policies overcommitted, giving the general public higher expectations. Institutional establishment did not keep pace, and since they could not, they also did not dare threaten vested interests. Honouring overelaborate commitments proved taxing, and income distribution actually worsened, leaving only high-handed policies, the end result frequently being social upheaval. Such policy ping-pong finally ran out of steam, resulting in a reversal in the region’s strong economic development. Those countries and regions that have been able to dodge the middle income trap have done so by establishing relatively optimised labour market regulations. This has not been painless, and has formed institutional frameworks for employment dispute resolution and antagonism. Although this kind of choice has costs, but there is no alternative. It is only via labour market regulations that workplace relations can be regulated and harmonised, and will not catalyse workplace disputes into corporate and worker dissatisfaction aimed at the government. There are those who worry that, when talks fail, collective wage negotiation systems result in strike action. Actually, strikes are unavoidable even without collective wage negotiation systems.

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On the contrary, they turn workplace conflicts into antagonistic relations between corporations, workers, and the government.

Labour Shortages are Not an Excuse to Ignore Employment Neither assertions that labour supply still outstrips demand over the long term nor that that labour will enter a state of protracted shortages, actually determines how much attention the government devotes to issues pertaining to employment, as well as formulating the required conditions for appropriate employment policy. The labour supply shortages in developed countries constrain economic growth, however the status of employment in macro-economic policy goals in the overwhelming majority of countries is much higher than in China. It is only by facing China’s labour market changes head on, and understanding the new characteristics of labour participation of different employment groups, can we effectively implement more extensive and proactive employment policies in accordance with the individual labour market requirements of each group. China has been simultaneously involved in the development of the dual economy and structural transformation throughout the entire reform and opening period. This has been expressed in the labour market via the coexistence of, and fluctuations in, and the frequency of three types of unemployment. Macroeconomics and labour economics neoclassical theory only focuses on cyclical employment that results from fluctuations in the economic cycle, and natural employment which is subject to the impact of labour market friction, as well as structural factors, such as technological advances and changes to industrial structure. In tandem with the transition towards a market economy, labour resources can be increasingly allocated via market mechanisms. China’s workers likewise face these two types of unemployment. Apart from which, as a dual economy is characterised by an unlimited labour supply, China still faces the threat of latent unemployment issues. This is evident from surplus agricultural labour and excess personnel in urban companies. Relatively early estimates on the degree of surplus urban and rural labour were in the region of 30–40%. These two processes fundamentally changed the structure of the Chinese labour market. First, regulatory barriers hindering labour market fluidity have been progressively eliminated, and agricultural labour has transitioned to the cities on a large scale. This has realised cross-China non-agricultural sector employment. There has also been a marked decrease in surplus labour within the agricultural sector, with more than half of the remaining labour being above 40 years of age. The financial crisis of 2008–2009 showed that the agricultural sector was no longer a reservoir of surplus labour, yet cities had gradually become addicted to this labour supply. Conversely, transitioned agricultural labour is no longer free to return home to work the fields. Moreover, the labour market has been maturing at an accelerating pace in line with adjustments to urban employment policies and the dismantling of highly secure corporate work posts. Simultaneously, the urban workforce is finally being

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Fig. 4.2 Changes to unemployment types with deepening reforms

reallocated via market mechanisms, which is also digesting the surplus employees in corporations. The aforementioned labour market reallocation is more or less differentiating those groups participating in the Chinese labour market based on the particular employment difficulties each faces. We can follow this point a little further with the help of Fig. 4.2. The original latent unemployment has evidently reduced, and no longer displays the characteristics of labour supply exceeding demand. However, surplus agricultural labour and surplus urban employees respectively possess new, yet somewhat dissimilar, characteristics. First, migrant workers have become a primary source of labour supply. They suffer from inadequate labour market protection. A majority have experienced cyclical unemployment when changes or fluctuations in the macroeconomic environment have been manifested as unemployment or labour shortages. Proactive employment policies need to reach this group. In addition, targeted at their regulatory needs, and via fair social security provision and the urbanisation of migrant workers, regulatory break up of the hukou residence registration system designed labour market and public services. Second, urban workers who have been attacked by reforms to the employment system and the labour market, although reallocation has led to transitions to their employment model (from a state of potential unemployment as surplus employees, and might even have become reemployed following being laid off or unemployment). A number of which, especially those personnel between 40 and 50 years of age with meagre skillsets are often plagued by structural or frictional natural unemployment. Proactive employment policies should focus more on improving this group’s employment prospects. The implementation of social protection policies are also needed to provide a better safety net. Third, in the wake of the expansion of enrolment, higher education graduates experience a disjoint between anticipated employment options and the needs of

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the labour market, owing to the specialisms of their studies. This has meant that this group faces the tricky problem of long term structural and frictional natural unemployment. Although the redundant surplus employees of urban corporations eventually found further work, albeit after a painful interlude, swollen numbers and mismatched skillsets mean that the issue of university graduate employment is set to be more protracted. Appropriate social protection and public employment services such as proactive training, and intermediaries can serve to shorten this painful process. Changes to the labour market do not signify that proactive employment policies have reached their natural conclusion. The government’s labour market policies still face major challenges. Changes to the structure of employment groups, as well as the analysis of the differing systemic requirements faced by each one, not only provides a powerful analytical tool for understanding labour market structure and the employment terrain, but is also of assistance in correctly demarcating the limits of the government and the market in promoting employment and the maturation of the labour market, and provides useful suggestions pertaining to the division of labour between different government departments. The Macroeconomic Regulation and Control Department is aimed at countering issues pertaining to cyclical unemployment, the Labour Department focuses on issues of frictional unemployment, and coordinates with the Education Department on issues of structural unemployment, whilst the Social Security Department and the civil government provide workers with more social protections. This means that a fear that society’s interest in employment is falling should not cause us to refuse to recognise the reality of the arrival of the Lewis turning point. We, of course, should not overlook the importance of employment because of its arrival, especially when faced with phenomena such as difficult recruitment, or ignore the existence of issues such as structural unemployment. In fact, if economic problems are inseparable from that of people’s livelihoods, and are often intertwined with political problems, then employment is the manner in which it is most typically expressed.

Part II

The Development Turning Point

This section discusses the issues and challenges faced by the Chinese economy after the arrival of the Lewis turning point. Generally speaking, China has already crossed the Lewis turning point, and its economy is set to enter a major sustainable development turning point. China’s three decades of sustained development has been reliant on a dual economy-induced demographic dividend. The absorption of labor by the market has exceeded labor supply, and rising wages have resulted, indicating the disappearance of the demographic dividend. The concept of the Lewis turning point has long been known. The defining feature of labor markets in this special period is the shortage of unskilled workers and the accelerated rise in the wages of ordinary workers. How to balance the conflict between the difficulties of finding employment with labor shortages, how to exploit a second demographic dividend, and how to inject a constant flow of vitality into the economy are the most pressing questions currently facing the Chinese economy.

Chapter 5

The Lewis Turning Point for Large Countries

This chapter discusses the challenges posed by China’s development, as well as the features particular to a large country, such as labour supply and demand relationships that are the result of regional disparities, and also the impact of which on economic growth. This writer views the Lewis turning point as an important concept in economic development, and also as symbolic of transitions between stages. Although a small number of overseas academics have analysed the Lewis turning point to varying degrees, but China exhibits a large number of divergent phenomena owing to its large nation status.

How to Understand the Lewis Turning Point Lewis adopted the two sector analytical method when analysing dual economy theory. The first was the capitalist sector, which accords with neoclassical economic growth theories, with labour compensation determined by the market, and trending towards the equal marginal productivity of labour. The other is the subsistence sector, which possesses high volumes of surplus labour to the extent that any input of additional labour leads to virtually no increase in production. This results in the almost total suppression of the marginal productivity of labour, producing zero, or even negative values. As Fig. 5.1 shows, the x-axis displays the quantity of agricultural labour, and the curve OPT represents the level of total output, and its property is diminishing marginal product. If we assume that the total quantity of agricultural labour is L, and is a surplus, when input of agricultural labour increases to L1, and labour continues to be added, then the marginal productivity of further additions to labour will be zero. This is because land and capital are limited, and so increases in labour beyond a certain point will bring no increase to output. Where the PT section in Fig. 5.1 becomes horizontal is the point at which the marginal output of labour equals zero, this section is the agricultural sector defined in Lewis’ dual economy structure. This © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_5

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Fig. 5.1 The Lewis turning point

means that farmers going far afield for work is the transition of agricultural labour, and is expressed via agricultural labour moving leftwards from L, and a fall in the level of input of labour in agriculture. During the first step, L falls to L1, prior to which point the marginal output of labour equals zero. After this point it is a positive value. The writer has defined this point (P) as the Lewis turning point. The second step is a transition from L1 to L3, and as it moves left of L, then the marginal output of agricultural labour no longer equals zero, but there is still room for transition, for at the L1 point the marginal productivity of non-agricultural sectors remains higher than the agricultural sector. This transition concludes at L3. At L3, the marginal productivity of the agricultural sector labour equals that of non-agricultural sector labour (the slope of the R point is identical to that of OT). This point heralds the conclusion of the dual economy structure, and also the conclusion of Lewis’ theory for analysing developing countries. Western economists believe that once marginal productivity of labour in two sectors is identical, then further analysis can follow neoclassical theory. Many academics believe that the R point is the Lewis turning point. The R point is an important turning point, because the main aim of economics is to govern for the benefit of the people, which is the situation expressed upon reaching the R point, but this writer has set the Lewis turning point at the P point. It is exciting to analyse this process, for the unlimited labour supply economy— right until the Lewis turning point and up until the disappearance of the structure of the dual economy, is an unprecedented process, which has not been deeply researched. The Lewis turning point I have defined (P point) is also very important. Prior to this, the marginal productivity of labour in the agricultural sector is zero. This signifies

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that income made by the agricultural sector is jointly shared, but the ratio of the average agricultural output to the number of farmers means that this is not marginal productivity, but average productivity. Moreover income will not rise when marginal productivity of labour is below average productivity. Furthermore, the existence of large quantities of surplus agricultural labour mean that even if transitioned to non-agricultural sectors, wage levels earned in these sectors will long remain static. However, after reaching the P point, if the non-agricultural sectors need to employ new migrant workers, then the wages of these workers will need to rise. This is significant because despite there being no fundamental change to the nation’s unlimited supply of labour, change has already arrived.

The Critical Point: From the Turning Point to Turning Interval In one of his songs, Bob Dylan asked, ‘how many roads must a man walk down before you call him a man?’ We could ask a similar question about a nation’s economic development: ‘how many crucial turning points must a country experience as it heads towards development, and maturity?’ We can summarise the economic development process with three turning points. First, the Lewis turning point. This is characterised by the end of an unlimited labour supply. This event does not signify the absence of surplus labour, but that of the onset of ordinary worker wage level rises. The Kuznets turning point. The Kuznets inverted U curve is an important hypothesis on the subject of income distribution in development economics. At its core it depicts that extremely low income levels mean very low income inequalities, for there is not much income to distribute, and only a relatively equitable distribution of income can ensure basic survival. Sustained economic development leads to higher income inequalities. This, however, does not persist indefinitely, once peaked, further economic development results in falling income inequality. This hypothesis has been subject to much research, the results of which indicate dispute over its veracity. Regardless of its validity, the consensus is that very many countries possess considerable income inequalities, moreover developed countries exhibit comparatively low income inequalities. This means that, regardless of the significance the inverted U curve holds for policy, this kind of objective fact, to a certain degree, exists. There is a close relationship between the Lewis and Kuznets turning points. The structure of factor endowment can reflect the key development stage features. A low development stage signifies relatively low capital per capita, and an abundance of ordinary workers, meaning that a relatively large proportion of the population are quite impoverished. As capital is a comparatively rare factor of production at this point, the return on capital is comparatively high. Moreover, capital allocation receives both societal and political protection. The comparative abundance of labour means that it has a fairly low rate of return. This means that those with capital enjoy

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higher returns, whilst the wages of ordinary workers are comparatively low. There is also a large population of the agricultural surplus workforce. Such situations are bound to result in unequal income distributions. The passing of the first Lewis turning point signifies that the unlimited supply of labour has gone, and wages rise as a result. It is worth noting that the focus of wage rises is not hi-tech workers, but ordinary and unskilled workers. There is always a shortage of hi-tech workers during this economic development process, and so wage levels rise at this stage when there is a shortage of ordinary workers. Simultaneously, expanding employment opportunities for ordinary workers increase low income family incomes. Logically, the Lewis turning point should facilitate the Kuznets turning point, and once past this turning point, income inequalities should fall. The stage from the first Lewis turning point to the Kuznets turning point necessitates adjustments to the labour market and economic structure, namely, the further development of, and the reduction of imperfections in, the labour market, and also the unearthing of potential labour supply. Improving government reallocation efficiency will also hasten the arrival of the Kuznets turning point; and allow people to strive towards realising income and social equality, and reach a consensus on employment, income, social security, and public services rights. The subsequent arrival of the Kuznets turning point signifies that income distribution has improved, that there are better incentive mechanisms, and that workers have better choices in a range of sectors. This development might lead to stages with more virtuous circles. As the economy develops and the second Lewis turning point gradually fulfilled, i.e. the ‘commercialisation point’, the third turning point. When the agricultural sector marginal labour productivity equals that of non-agricultural sectors, and there is no substantive income gap between urban and rural areas, the ‘commercialisation point’ arrives. This point heralds the disappearance of the dual economic structure, the conclusion of long term development tasks, and entry into the neoclassical growth process. There are a number of issues demanding attention during the transition from the Lewis turning point to the Kuznets turning point, and then to the commercialisation point. These include, no surplus labour in the agricultural sector results in opportunity costs in the continued extraction of labour from this sector. If this is handled incorrectly, it will lead to labour shortages within the agricultural sector, and furthermore, inflation. This has led to the Lewis turning point also being known as the ‘food shortage point’ in development economics. During this process, greater incentives to the agricultural economy are required, with increased agricultural operations scale and productivity, and the creation of a better institutional environment for labour transfers (Table 5.1). Lewis did not analyse demographic factors in much detail when he discussed the dual economy theory, and when forecasting future turning points in classic papers. Theories on demographic transitions were already appearing when Lewis published his most renowned papers. Moreover, when, in later papers, he also considered the fall in fertility rate when he forecast the Japanese Lewis turning point. Discussions on demographic factors in dual economy theory were still comparatively sparse.

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Table 5.1 Economic development turning points Name

Characteristics

Progression

Lewis turning point

Conclusion of unlimited labour supply, rise in ordinary worker wages

Development of the labour market, focus on income distribution

Kuznets turning point

The trend of worsening income distribution halted, income disparities begin to reduce

Societal consensus on income redistribution increases

Commercialisation point

Equal marginal productivity in agricultural and non-agricultural industries

Increased stimulation of the agricultural economy, raised agricultural production efficiency, improved policy environment for labour transitions

Development economics’ star had already begun to wane in the west, despite Lewis and Theodore Shultz winning the Nobel Prize in Economics in 1979, and mainstream research shifted towards western economic growth theories. Although economic growth theory research also touches upon demographic factors, but reliance on the western experience to explain economic growth processes, and the establishment of neoclassical hypotheses, means western economists have been unable to understand the special import of demographic factors to developing nations. Population is a constraining factor in western countries. Perpetual labour supply shortages, and diminishing marginal returns from constant capital investment results in diminishing capital returns, with the result that such economic growth theories are unable to explain many of the phenomena evident in emerging economies. For instance, they are unable to explain how Japan, Korea, Singapore, Taiwan, Hong Kong, Thailand, Malaysia, and the coastal regions of the Chinese mainland have been able to achieve long periods of rapid economic growth in the absence of an evident technological advantage, and also how these economies created the ‘East Asian Miracle’. In the 1990s, Krugman predicted that there was no East Asian miracle, for despite the rapid growth of the economies in the region, the sources of this growth still exhibited no productivity increases or technological advances, and were entirely reliant on the input of high volumes of labour, which was unsustainable. Western theories assume that labour is a fixed quantity, resulting in certain diminishing capital returns. Krugman did not consider the possibility that labour in East Asia might be unlimited to the extent that it would not constitute a constraining factor for comparatively long durations, and thereby would not drive a process of diminishing returns. As such, he naturally took exception to the ‘East Asian Miracle’, and this viewpoint has been a blemish on his otherwise illustrious career in economics. Demographic economists mention that this contains the issue of the demographic dividend, and empirical research shows that between a third to a half of the East Asian miracle is a result of demographic dividends. New world countries settled by Europeans such as North America, once exhibited economic growth speeds in excess

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of the European average. This excess can virtually be totally explained as being a result of a demographic dividend. These immigrants had all undergone a process of selection, and were on average high quality workers, moreover the dependent population was comparatively small. Combined with China’s situation, its long term experience of changing population structures was also the result of a demographic dividend. We can analyse demographic structure via changes to the dependancy ratio. The child dependancy ratio (ratio of the population aged 15 and under with that aged 16– 64) and the aged dependancy ratio (ratio of the population aged 65 and over with that aged 16–64). Figure 5.2 shows that the aged dependancy ratio has been in constant decline since the 1960s. This shows a larger working age population, with sufficient labour supply, a light demographic burden, persistently high savings ratios, and the total fixed capital formation to GDP ratio is very high. This has been the basis of China’s demographic dividend. We empirically researched this, and essentially found that the contribution of the decline in the dependancy ratio to the per capita GDP growth rate was 27%. Contemporary forecasts stated that the declining dependancy ratio trend would persist until 2013, after which the aged dependancy ratio would rise relatively rapidly. China has generally not been the beneficiary of a demographic dividend since 2013, and the population is ageing at an accelerating rate. Demographic changes can be seen as an echo. Historically, when Ma Yinchu proposed his ‘new population theory’, China’s fertility rate peaked and a baby boom followed. This led to a sudden and large influx of newborns into the normal population (newborns are known as the age 0 population). Two decades on this age 0 population entered the workforce. The ever tightening birth control policy and ever rising standards of living meant that such a high fertility rate did not persist. There was an echo two decades later as this group of people called out ‘I am here!’ to their former newborn selves. They had become the primary age 20 working population.

Fig. 5.2 Demographic transition induced changes to economic growth factors

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Another four or five decades passed, and they produced another echo as they grew into a large scale, aged population that comprised a high proportion of the whole. China’s population is currently ageing faster than anywhere else in the world. It will have the largest elderly population and the highest aged dependency ratio worldwide. This means that, although researching the demographic dividend enables us to formulate pertinent fertility policies, the future source of potential economic growth following the disappearance of the demographic dividend demands more attention. Despite China’s three decades or so of rapid economic growth, it is still not wealthy. Its mere US$6,000 GDP per capita ranks very low down, globally. Critically, China still needs one, two, or maybe three decades of growth before it will become wealthy. Such wealth is dependent on rapid economic growth. In which case, what will serve as the source of this growth? These are the questions that concern us. Might there be a connection between future growth potential, and the gradual disappearance of the demographic dividend and the arrival of the Lewis turning point? We need to dig deeper into the issue of the arrival of the Lewis turning point.

Controversy Over the Lewis Turning Point I believe that the reason for negativity on the arrival of the Lewis turning point from some quarters can essentially be attributed to three kinds of ideas. The first is Galbraiths’ ‘conventional wisdom’, which pertains to strongly entrenched beliefs about a given situation. For instance, several years prior our frequent discussion of the vast quantities of surplus labour in China’s large population, became a kind of fixed mindset. The second is the lack of practical experience work, or possessing an insufficient grasp of China’s statistics. A World Bank researcher wrote a paper titled When Economic Reform is Faster Than Statistical Reform, and analysed situations where economic reforms outpaced statistical reforms. He believed that China’s economic growth was so fast that statistical reforms were unable to keep pace, thereby posing difficulties in understanding China’s statistical data. The third is lopsided observations. For instance, some people have discovered through their research that some villages in western China still possess a large amount of surplus labour. Such local observations are the most inspirational, for there are some special localities in China. This country is, after all, a large country. Large countries differ in many ways from small countries, and this is the starting point for researching the features that are characteristic of large countries. Generally speaking, China’s Lewis turning point has already arrived. Lewis stated that the main determinant of the arrival of his turning point was that absorption of labour outstripped labour supply. Determining the supply and demand of labour can sometimes be tricky, and the issue of calculating surplus labour provokes the most controversy. We can analyse the relationship between labour supply and demand via changing trends in the workforce. When demand for labour exceeds supply, wages will naturally rise in response. Analysing the changing trends of the migrant worker

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63

2 000 1 750

49 42

1 500

35

1 250

28

1 000

21

0

0

20

20

19

19

01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12

250

00

7

99

750 500

98

14

Non-Agricultural monthly wages(RMB)

Agricultural daily wages(RMB)

2 500 2 250

56

Year Food

Pigs reared at scale

Cotton

Manufacture

Construction

Migrant workers

Fig. 5.3 Wage growth rate in related industries and groups

wage levels to explain surplus agricultural labour is the most persuasive. We have collated related statistical data in Fig. 5.3. After migrant worker wages had slowly risen over multiple years, substantial rises commenced in 2004. The actual annual wage growth rate was sustained at 11.5% between 2004 and 2012. Migrant workers temporarily struggled to find employment during the financial crisis of 2008–2009, but the economy bounced back relatively quickly, and demand for labour rose, and the wage growth momentum did not falter, this did not prevent the utility of rules of the Lewis turning point. Of especial interest is that China was already experiencing a ‘migrant worker drought’ when America’s unemployment rate rose to as high as 10%. This kind of analysis means that I continue to firmly believe that China’s Lewis turning point has already arrived.

How a ‘Large Country Economy’ Differs When researching China, it is crucial to understand China’s national circumstances. It is also extremely important to be able to describe them. People previously always spoke about China’s high population, its heavy burden, weak foundations, and large surplus labour, but these factors have all changed. The only static factor is that China is a large country, and even if India’s population surpasses China’s in several years time, China’s large country characteristic will remain. The explanatory framework provided by past economic growth theories was that late developers must repeat the experience of the countries that developed first. The viewpoints of Marxism, and the development economist Rostow, are similar. Even Rostow’s 5 + 1 development

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stages (believing that a country must go through 5 + 1 stages as it develops) illustrate that economic development possesses common rules, with each country adhering to a similar path of economic growth as it develops. Based on the same path and rules, then each country’s trajectory and outcomes should be identical. The facts, however, show that there are enormous differences between each country, and that economic growth rates in each country are not only not converging, but diverging, leading to a large diversity of development paths. The essential reason for such divergence is that the circumstances of each nation differ, and most importantly, each country’s economic scale differs. Differences between large and small countries are reflected in development conditions.

Defining Large (and Small) Countries and Their Characteristics Scale is generally the most important factor when defining large (or small) countries, but the national size as defined here also includes factors other than scale. The core features of small country economies is the homogeneity of their resource endowment and industrial structure, with there being similar levels of inter-regional development and resource endowment, comparatively similar industrial structures, without a division of labour. In general, everything is relatively similar. Large countries are typified by heterogenous regional economies, that feature differing resources, industrial structures, and development levels. This is how large and small countries differ. By this definition, China is a classic large country economy. As such, a unified nationwide factors market has not formed, inter-regional resource endowments are highly divergent, as well as the relative scarcity, prices, and the development levels of these factors. The old industrial bases in Dongbei (formerly Manchuria), traditionally value industrialised characteristics, coastal regions are characterised by overseas facing export industries, whilst many central provinces are primarily agricultural economies. Income levels are even more divergent, being several times, or several dozen times higher in Shanghai than Guizhou. It is interesting that official exchange rate calculations of total economic size rank China as being the second largest economy in the world, and Japan the third largest. However, based on the definition above, Japan definitely does not possess a large nation economy, for it has comparatively low inter-regional heterogeneity, and there is essentially no difference in the remuneration of the factors of production, and industrial structure is virtually identical. It needs to be stressed that the presence or lack thereof of inter-regional heterogeneity is the key factor differentiating ‘large’ and ‘small’ nations. This is not to say that scale is unimportant, for it is the combination of the scale and differentials that explain the characteristics of large nations, and are, hence, of key significance to China. Many people, including many Chinese and foreign economists, believe that the colossal total scale of China’s economy creates global imbalances. This does not

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refer to regional differences, but to the position held by the Chinese economy in the global economy. Obama repeatedly mentioned cooperative relationships when he visited China. Previously, American officials visiting China had focused most on ‘rebalancing’. I believe that ‘rebalancing’ is a trap designed by developed countries to block Chinese economic growth. The Chinese economy is characterised by being ‘strong before rich’, whilst the American economist Spence said that the Chinese economy was ‘big before rich’. China is probably the first middle income country to become an economic great power. The USA, Japan and Germany all became rich before joining the top ranks. This is to say that for China to realise economic growth, it should maintain a reasonable growth rate of around 10% for a period of time, and engage in the cheapest possible production, this leads to accumulation, which will naturally result in enormous trade surpluses, and the accumulation of vast foreign currency reserves, and the purchase of more American State treasury bonds, and consequently results in international cash flow imbalances. America has attributed these imbalances to China, but China’s development has been a rational process that has adhered to economic principles. China has a ‘dual economy structure’, with high quantities of surplus labour and low labour costs. Based on Ricardo’s theory of comparative advantage, participation in the international division of labour and the international market is the kind of development process that suits the laws of economic development proposed by the west. This means that China is not the origin of an imbalance, which reflects to a much greater degree, the imbalances of the American economy. However no matter which country caused the imbalance, China currently has regional imbalances. Regional differences create space, which can be used to create some special opportunities. China’s ‘late starter advantage’ has been the most crucial contributor to its growth over the course of the last three decades or so. The existence of differences have given the ‘late starter advantage’ a staggered effect, meaning that there are ‘late starter advantages’ in the international sphere, and also owing to divergences at the regional level, locally. From a perspective of economic development history, the fastest growth rate was at best only be between 1 and 2%. The USA’s peak growth rate was only around 3% when it overtook the UK and European nations, whilst Japan hit 9% at its fastest. The ‘Four Asian Tigers’ were even quicker, approaching 10%. China, even despite its size, sustained average growth rates of as high as 10% for more than thirty years, and China’s current ‘rising star’, Inner Mongolia, is sustaining growth rates of 20%. This means that the speed of economic growth has been accelerating throughout human history. More critically, this speed is a result of the ‘late starter advantage’. The later a country develops, the faster it will grow, for its development gaps with other regions and countries are indicative of gaps in technological, institutional, and managerial spheres, meaning that it can draw upon, or purchase existing advanced technology, and absorb or adopt the lessons of institutional advances. Foreign investment also means that a country does not have to rely entirely upon its own resources. China has made good use of all of these ‘late starter advantages’.

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Moreover, China being a large economy means that its inter-regional divergences exceed that of its divergences with other countries. Those Chinese regions that have developed comparatively slowly still have ample room to grow and can enjoy a dual ‘late starter advantage’. The first being international; the second interregional with China’s developed regions. This is a beneficial aspect of possessing a large country economy.

China’s Large Country Economy China’s large country economy is primarily manifested in four ways. First, regional and urban–rural resident income gaps. Research in this area shows that China has the largest urban–rural income gap in the world. This was formerly explained as being a result of institutional factors, such as labour market segregation and development strategy. We should also now consider that, being a large country, China will naturally have large gaps. Second, there are barriers to the mobility of factors of production between regions, and especially between urban and rural areas. Japan is a large economy, but the country itself is comparatively small. As such, convergence would occur rapidly in the absence of interregional barriers to factors of production, and so, Japan can be defined as being a small country economy. It is difficult for China to achieve convergence. Its large nation characteristics are more substantial, meaning that there are differences in interregional factor rate of returns. Third, levels of development between provinces, and the east, middle, and west of the country vary. These divergences greatly differ from region specific resource endowments, and pertain to staggered starting points that are the result of historical differences. Fourth, when the resource endowment structure and comparative advantages of developed regions alters, changes exhibited in comparatively backward regions are not evident or simply do not exist. This means that, some regions are already in a state of labour shortage, with migrant worker wages rising considerably; yet there might also be other regions that still have large quantities of surplus labour. This is inevitable in a large country at this stage of development.

The Flying Geese Paradigm Can Restructure the National Layout A crucial theory in the ‘late starter advantage’ is industrial transfer. When China still had a gap with the ‘Four Asian Tigers’ and Japan, it brought in vast quantities of technology, capital, management and institutions. More crucially, large numbers of labour intensive industries transferred from those countries and regions to China, providing an opportunity to employ its ‘late starter advantage’. This is the flying geese paradigm

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of development economics. The focus has been on industrial transfer between individual economies during prior discussions of this paradigm, such as the Japan—Four Asian Tigers—ASEAN nations—coastal China route. Following this logic, as China is already experiencing labour shortages, rising migrant worker wages, gradually rising factor costs, and falling labour intensive industry competitiveness, the next nation in the chain with a labour intensive product competitive advantage might be India, Vietnam or Mexico. A report by the American Boston Consulting Group states that China has already lost this competitive advantage and has been replaced by India and Vietnam. They did not, however, consider China’s large nation economic status, for this allows China to alter the country to country route of the flying geese paradigm, and instead fully internalise it to within its large country economy. Such a prediction is theoretically viable. China’s size means it has huge regional disparities, such as those between eastern and central China, which can fully and independently conduct several flying geese paradigm industrial transfer cycles, with each province, city, and autonomous region serving as a ‘national grade’ economy, thereby resulting in a continuous process of industrial transfer.

The Evolution and Key Aspects of the Flying Geese Paradigm The flying geese paradigm was first proposed by the Japanese economist Kaname Akamatsu. Its primary aim was to explain how Japan had overtaken the developed nations. It depicts that industry will transition between countries and regions as their differing comparative advantages evolve. Japan once experienced an import dependent development process. Once initiated, the Japanese found that imports were beneficial, and international trade provided answers to resource scarcity, allowing it to gradually develop its own industries. Japan embarked on ‘import substitution’ once it had achieved a large scale. Its own production was found to be more efficient. Then it began overseas exports, using exported labour intensive products in the stead of the export of raw materials. This led to the formulation of export friendly policies, whereupon it gradually entered Ricardo’s comparative advantage, and participated in the international division of labour. Labour intensive products then transferred from other countries to Japan. As its economy developed, its labour force later no longer constituted a comparative advantage, and so those industries transferred to other countries. Thereafter, it naturally evolved away from the flying geese paradigm. The American economist Vernon pointed out that flying geese industrial transfers are related to product life cycle characteristics, which can enrich the flying geese paradigm. Product life cycles are constantly changing. Industrial structure undergoes corresponding changes, and as such, industries can transfer between countries, implying their correlation with changes in the state of comparative advantage. Kojima explained that the field then expanded to the overseas foreign direct investment model

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(OFDI), linking industrial transfer with OFDI, and surplus capital can transfer as it follows industrial transfers, and this investment activity can follow a similar pattern as it flows between countries. Enormous differences in fields including the development stage, resource endowment and historical heritage between different countries are believed to possess a key interconnected, successive relationship of flying geese industrial development. Simply put, divergence creates the flying geese paradigm. China is a large country, and its regional disparities are those of a large country, meaning that the flying geese paradigm can fully operate within China.

Why There Needs to Be a Chinese National Flying Geese Paradigm There are several reasons why there should be a Chinese national flying geese paradigm. First, the arrival of the Lewis turning point heralds substantial rises in ordinary worker wage levels, raising workers income levels and changing the nation’s income distribution. Change, however, needs to proceed at a certain speed, exceeding this speed leaves insufficient time for adjustments, resulting in economic imbalances. As such, the wages of ordinary workers should rise, but steadily, smoothly and rationally. This is of especial import whilst China is yet to establish a unified labour market. Wage levels in eastern coastal regions have risen substantially, yet surplus labour still exists in the central and eastern regions. These regions can develop through industrial transfer. This will somewhat temper wage level rises in the eastern coastal regions, and employment in the central and eastern regions will correspondingly rise, leading to the much more equitable outcome of equal worker wage levels rises nationwide. Second, it can reduce the phenomenon of severe labour shortages, optimise the labour market, and unearth the institutional potential of labour supply. Labour shortages will always exist during this stage, but these occasionally do not accord with reality, and are not a nationwide phenomenon. Industrial transfer and the development of such a flying geese paradigm can thus avoid the emergence of excessive, and major labour shortages. Third, institutional preparations that buffer maladaptation to the Lewis turning point. Whilst the Lewis turning point is a positive trend, it signifies the need for people to facilitate the emergence of the turning point. Artificial rises to worker wage levels, will counter-intuitively hinder the turning point’s arrival when labour supply is unlimited. This means that we should more rationally utilise the appearance of the Lewis turning point to approximate better with general economic trends. More importantly, despite the rapid growth of China’s economy over more than three decades, the Chinese story is only half complete. For this high speed growth has been primarily centred on the coastal regions, and fairly large swathes of the country are not fully developed. Fully mobilising the resources of these regions will tap into growth potential, and support the long term future growth of the Chinese economy.

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When this process has ended, the Chinese miracle can be said to have concluded. China’s future economic growth depends on its central and western regions, and these regions are dependent on industrial transfer.

Digression When the flying geese paradigm was first published, some said that it was a colonialist theory. This requires a clear explanation. I will mention two aspects, the first, the abuse of economic theory, the second, the publicising of economic theories. There are two prominent examples of the abuse of economic theory. The first is the flying geese paradigm. This was originally the East Asian version of the theory of comparative advantage, but it has been abused. Akamatsu proposed this theory mainly to explain how Japan had overtaken developed countries. Later, during the 1930s, Japan invaded a number of countries in Asia and Akamatsu was dispatched to Singapore to gather data. Whilst in Singapore, Japan adopted his theory internally to validate its militarism and colonialism. This misuse had nothing to do with Akamatsu himself. The second was the abuse of Keynesian theories by Nazi Germany. These theories gradually crystallised during the 1930s, and included a series of issues such as state intervention theories and the specific usage of technology. Although Keynes possessed an enviable reputation by that point, being virtually deified, nobody accepted his opinions. The policies enacted by the German government of the time were essentially Keynesian in nature, yet their behaviour is not his responsibility. The original creator of a theory is unconnected from those who later disseminate it. The latter achieve renown via the use of pure theory. I will also give two examples to illustrate this point. The first is Akamatsu and Saburo Okita. Akamatsu was a serious scholar, who when researching the flying geese paradigm, analysed reams of data, and employed logical analysis, employing Hegelian dialectics during this analysis. This was a complicated and painstaking procedure. His published paper is likewise not an easy read. He published a corresponding paper in English in the 1960s, but it never attracted mainstream attention. It was only in the 1980s, when the Japanese Foreign Minister Saburo Okita employed the flying geese paradigm to explain the East Asian collaborative economic relationship did it finally attain popularity. The second is Young and Krugman. In the 1990s Young conducted a series of detailed investigations into the East Asian miracle, and arrived at the conclusion that the east Asian economy was mainly dependent on factors of production investment, that there was no technological progress, and as such there was no such miracle to speak of, and believed that such development was unsustainable. His paper, The Tyranny of Numbers, made virtually no impact at the time right until the mid-1990s when Krugman cribbed Young’s ideas for an article in the American magazine Foreign Affairs. From this point on, people began to doubt the East Asian miracle and the ‘Four Asian Tigers’. Unfortunately, Krugman had appropriated this opinion from

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Young. Theory can be abused, and can also be leached of all value. It needs to be emphasised that one must publicise one’s own research, and even then that might not be enough.

Chapter 6

The Demographic Transition and Labour Supply

Demographic growth trends and demographic transition stage changes lack consensus. There are also a diversity of opinions on the impact of the demographic dividend on the development of the dual economy. This chapter will attempt to show the concurrence between the demographic transition and the development of the dual economy from a theoretical perspective, for both share the same starting point and have related and similar stages, and have equivalent change processes. It will then employ empirical data, such as the results of demographic forecast, to expound and examine statements on the gradual disappearance of the demographic dividend and the arrival of the Lewis turning point. This chapter also points out that maintaining sustained, stable economic growth and joining the ranks of high income countries at the earliest opportunity, is the key, and only way, to reduce the ‘old before rich’ gap.

China’s Semographic Transition There is no consensus in theoretical and political research spheres. Opinions vary widely on research on whether the Chinese economic growth is in the process of losing its demographic dividend, as well as on judgements on whether the Lewis turning point has already arrived at China’s stage of economic development. Debate on these topics still flourishes. In a co-authored paper, this author adopted the dependency ratio as a proxy indicator, and calculated that the contribution of the demographic dividend to the Chinese GDP per capita growth rate between the years 1982– 2000 was 26.8%, and also pointed out that, as the dependency ratio shifted from falling to rising in around 2013, the demographic dividend, in its purest sense, trended towards oblivion. In other literature, the writer arrived at a judgement on the arrival of the Lewis turning point from new circumstances in areas that included changing demographic age structure trends, changes to labour market supply and demand relationships, the widespread ‘migrant worker famine’ phenomena, and also the rising wage levels of ordinary workers. This showed that the arrival of the Lewis turning © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_6

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point is of political significance for changes to economic growth modes, changes to income distribution, and the establishment of labour market systems, and also the cultivation of human capital. Knowledge of changes to demographic transition trends can help us accurately understand the nature of the labour market, and is more aimed at the foundations for the formulation of policy pertaining to tapping into sustainable potential for economic growth. The next section will explain that the demographic transition and the dual economy development process share a starting point, and that their stages of development share related, and similar characteristics. Their processes also largely correlate, and explain the period of the demographic dividend created by the demographic transition, and that it is a stage in the development of the dual economy. This means that, demonstrating the disappearance of the demographic dividend and proving the arrival of the Lewis turning point is, in fact, the same task.

The Demographic Transition and the Development Stages of the Dual Economy The dual economy development theory, the representative author of which being Lewis, is widely known. This theory demarcates a classic developing country into two sectors, the subsistence sector and the capitalist sector. The subsistence sector is beset by severe labour surpluses, relative to capital and land, meaning its marginal labour productivity is either zero or even a negative value. Surplus labour will gradually transition to seek employment in newly emerging industries as the capitalist sector expands, given that wage levels are not increasing in real terms, creating a process of dual economy development. This process will continue the point when growth in labour demand exceeds growth in labour supply, and the continued absorption of transitioned labour leads to rising wage levels. This heralds the arrival of the Lewis turning point. Although the status of dual economy theory has fluctuated over time, it has always occupied a core position in the theoretical models of development economics. Demographic transition theory had actually already been published in a mature form prior to that of Lewis’s original paper.1 It covers the industrialisation development period and divided population growth into three main stages: (1) high fertility rate, high mortality rate, and thus low population growth; (2) high fertility rate, low mortality rate, and thus high population growth; (3) low fertility rate, low mortality rates, and thus low population growth. Although we have no way of knowing whether Lewis was aware of this critical paper on demographic transitions in the field of demography, his own papers were filled with similar demographic hypotheses. When defining a key sector of the dual economic structure (namely agriculture), he 1 Thompson

first demarcated demographic transition into three stages in 1929, but as he did not explain a standard theory of a falling fertility rate, the title of the father of demographic transition theory was eventually bestowed on Frank Notestein.

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explained, ‘relative to capital and natural resources populations so numerous, to the extent that the marginal productivity of labour is so low as to be approaching zero’. As such, an unlimited supply of labour exists. This implicitly refers to the second stage of the demographic transition, whereby the fall in the outside born population mortality rate and the inertia of the high fertility rate, results in elevated levels of natural population growth. Surplus population and labour tend to accumulate in the agricultural sector as it is a more rudimentary production sector. The key to understanding the logical relationship between the demographic transition and the development stage of the dual economy, is to understand the mechanisms by which the demographic dividend emerges and is exploited. Early demography and economics literature on the relationship between population and economic development primarily focuses on total population and the relationship between economic and demographic growth rates, discussions on demographic transition to fertility rate, birth rates, mortality rates and total population. People, thus, ignored the relationship between economic growth and demographic structure in these discussions, as well as one of the most important outcomes of demographic transitions: demographic structure and the composition of the labour supply. Demographers have begun to observe the demographic ageing effects heralded by this transition as the majority of developed countries and many newly emerging economies and regions have completed their demographic transitions. Economists have observed changes to post demographic transition working age populations, as well as its impact on sources of economic growth. The natural population growth rate rises, and the dependent child population ratio also rises during the time lag between the fall in the mortality rate and the drop in the fertility rate. The working age population segment correspondingly rises after a further time lag, by which point the baby boom generation has reached maturity. Societal and economic development leads to a drop in the fertility rate, and the population growth rate likewise drops. This is then followed by the gradual ageing of the population. Or in other words, when the natural population growth rate comprises an inverted U curve, with an initial rise followed by a fall over a single generation long time-lag, the working age population will also exhibit a similar trajectory. Therefore, when the demographic age structure is most amenable to production, an abundant labour supply and high savings rates provide an additional source of economic growth. This is what is called the demographic dividend. Correspondingly, once the demographic transition has past this stage, the impact of an ageing demographic age structure means that the population is, generally speaking, no longer geared towards production. This can be said to signify the disappearance of the demographic dividend. As changes to the stages of the demographic transition can be most generally reflected by the total fertility rate, we can theoretically forecast the relationship between a demographic transition and economic development. When the total fertility rate is extremely high, the economic growth rate will correspondingly be very low yet steady, assuming the absence of demographic transition or technological progress. As the fertility rate falls, and with the gradual formation of a demographic age structure amenable to production, economic growth will accelerate, heralding the reaping

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of a demographic dividend. As the fertility rate falls to an even lower level, the rise in the ageing of the population leads to a gradual fall in economic growth rates to a very low equilibrium. There will be no further demographic transitions as we understand the term, but technological progress will be cutting edge. Correspondingly, when the fertility rate falls and creates a special demographic transition stage with a demographic age structure amenable to production, this creates a so-called ‘demographic window of opportunity’. It should be pointed out that there are a whole multitude of factors impacting economic growth besides those of a demographic nature. For instance, economists have successively found over one hundred explanatory variables of statistical significance when engaged in empirical research to defend neoclassical growth theory and decode the riddle of economic growth. Both low income countries, mired in the ‘poverty trap’, and high income countries, at the frontiers of technological innovation, can exhibit extremely low yet steady growth. One needs to be especially careful in avoiding explanations that revolve around demographic factors. In addition, we will, for the time being, sidestep the issue of the counter-effect of economic growth on the demographic transition,2 to focus on the relationship between the fertility rate and the economic growth rate. When doing the aforementioned hypothesis, and when starting from the theory of demographic dividend, we not only can create a hypothesis pertaining to the relationship between the aforementioned two items, but also engage in empirical validation. The World Bank World Development Indicators database shows that the annual GDP growth rate lies between –51 and 106%. We will avoid the complexities of the outliers for now, and focus on analysing observed values that better reflect ordinary trends, namely 0–10% GDP growth. Based on the relationship between theoretical GDP growth rates, total fertility rates as well as the quadratic components of fertility rates, Fig. 6.1 displays fitted values for GDP growth rates with a confidence interval of 95%. Figure 6.1 shows us that there is a kind of inverted U relationship between total fertility rate and GDP growth rates. Those countries with extremely high total fertility rates have fairly low GDP growth rates. GDP growth rates begin to rise as the total fertility rate falls; and then peak when the total fertility rate falls to a certain level, correspondingly reaching a turning point after a period of ascent which is then followed by a descent. As the total fertility rate falls further, the GDP growth rates for those countries with comparatively low total fertility rates also falls. This simple empirical curve is entirely consistent with the aforementioned theory. We will use the aforementioned database to further analyse such a nonlinear relationship between GDP growth rates and total fertility rates. In the regression we will set GDP growth rate as a dependent variable; and total fertility rates, and the quadratic components of total fertility rates as independent variables. It can be seen that the total fertility rate coefficient is clearly positive, whilst that of the total fertility 2 Du

Yang found in his article that the one child policy, and levels of GDP per capita and human capital had a substantial impact on the sharp decline of China’s fertility rate, and in addition was demarcated into the impacts of the three different variables.

The Demographic Transition and the Development Stages of the Dual Economy Fig. 6.1 The empirical relationship between the GDP growth rate and the total fertility rate

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rate quadratic components is negative. This further displays the inverted U-shaped empirical relationship, for the GDP growth rate follows the ascent and then descent of the total fertility rate. However, this statistical analysis does not attempt to replace a growth regression to explain the magnitude of the influence on economic growth, but merely focuses on the superficial relationship between the fertility rate and the growth rate. Once we have ascertained the relationship between the fertility rate and the economic growth rates from both a theoretical and internationally empirical perspective, we can more easily see the demographic transition process recognised by demographers, and the process by which the demographic dividend is obtained in demographic economics. We can also see the relationship with the Lewis turning point and its appearance in the economic development process. On this basis, we can begin with the results of the Chinese demographic transition, and analyse the emergence and forecast disappearance of the demographic dividend during the economic development process, and furthermore, determine the arrival of the Lewis turning point.

The Curse of Being ‘Old Before Rich’ The demographic transition entered its second stage after the establishment of the People’s Republic of China and following economic development and improving standards of living. Ignoring the abnormal fluctuations of the late 1950s to early 1960s, this transition was primarily expressed through a substantially reduced mortality rate and a sustained high fertility rate, causing natural population increase to rise excessively fast. Accordingly, the total fertility rate was often as high as six right up until before the 1970s. However, whilst many people imagine that the fall in the fertility rate was merely a result of birth control policies, this was not the case. Prior to the implementation of the strict birth control policy, the fertility rate

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had already fallen by 3.5 points, from 5.8 to 2.3. If we assume that the current total fertility rate is 1.6, then it fell by a total of 0.7 after 1980. This fact proves the academic consensus held by economists and demographers on the laws of demographic transition: progress through the three main demographic transition stages are the result of economic and societal development. On this basis, the shift from stage 2 to stage 3 of the demographic transition is when the working age population growth rate exceeds that of the dependent population, and comprises a gradually rising proportion of the total population. It also comprises a demographic dividend that can raise economic growth to a stable level. The dependency ratio is comprised of the dependent population (those aged under 14 and over 65) and the working age population (those aged between 15 and 64). Although China’s dependency ratio had begun to fall as early as the mid-1960s, this trend really got started in the mid-1970s. After which, the rapid growth of the total working age population, and the corresponding substantial rise in its proportion of the total population, led to a significant fall in the dependency ratio. Figure 6.2 is based on United Nation’s data. This demographic age structure was advantageous for conversion into a demographic dividend to drive rapid economic growth during the reform and opening period. This author has already covered in great detail, in a series of papers and books, explanations of the principles, description of the process, and empirical testing of China’s demographic dividend. This literature also contains the author’s judgements, empirical testing and proof on the arrival of the Lewis turning point. In this chapter, we will discuss three concepts and processes: the demographic transition, the demographic dividend, and the Lewis turning point. The aim is to explain the logical relationship between the three, and based on which, provide a consistent explanation for the multiple obstacles blocking China’s future economic growth. 160 000 140 000 120 000 100 000 80 000 60 000 40 000 20 000

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Figure 6.2 is based on the United Nations demographic forecasts for China, divided by age. It is based on the 2000 Fifth National Census, and a sample survey conducted on 1% of the population in 2005, as well as other data from subsequent surveys. It references key official parameters including estimates of the total fertility rate, and is based on the most recent revised results (2008) of the Central Plan. This chart is generally consistent with the forecasts produced by a number of Chinese organisations. This forecast shows that total population is forecast to peak in the year 2030, by which point the Chinese population will be 1.462 billion people. Prior to which, the 15–64 working age population will peak in 2015, with a total of 998 million people. Evidently, despite the forecast results of these two population peaks being freely available at public information platforms, but they are not only not widely known by the average reader, but there are even a great number of economists ignorant of this data. However, academics researching the prospects of China’s future economic growth clearly need to understand changing trends. This is especially true of those influential scholars who frequently air their opinions and are extremely influential with their audience. Further investigating the demographic forecasts delineated above, we can see that between 1970 and 2010, the working age population growth rate exceeded that of the total population, and after which, it reversed. This signifies that the demographic age structure is trending towards being less amenable to production. From a labour supply perspective, cities are hubs of concentrated development of the nonagricultural sector, and job growth during China’s rapid economic growth primarily occurred in urban areas; yet, the supply of the urban labour force is becoming increasingly dependent upon the transition of rural labour. Another of Hu Ying’s forecasts depicts that the number of new additions to the Chinese urban working age population will be smaller than the reduction in the rural working age population by 2015. This signifies that if rural workforce transition enticement, among other factors, remains static, then the quantity of migrant workers arriving in cities will not fill the gap created by the reduced production of the urban workforce. The reduction in the rural working age population has been approaching that of the increase in the urban working age population each year prior to the arrival at this point. These figures reaching parity is the point at which the working age population in China, as a whole, stops increasing. This is based on the parameter of the permanent population, and also considers factors pertaining to rural to urban labour mobility. The labour market has already began to respond. One aspect is expressed by the widespread nationwide ‘migrant worker famines’. Another aspect is expressed via the annual increase in migrant worker wage levels. Therefore, and by definition, these are the characteristics that mark the arrival of the Lewis turning point. In fact, the Chinese demographic transition is proceeding faster than people normally expect. This is especially true of the faster reduction in the size of China’s characteristic working age population, the 15–59 age cohort. Based on the data of the Sixth National Census, The China Development Research Foundation forecast changes to China’s demographic structure in its 2012 China Development Report. The report stated that, based on current trends, China’s working age population, the 15–59 year old cohort, began to reduce in 2010. Even though the ‘Only Child Two

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Child Policy’ was implemented in 2013 (whereby if either member of a couple were an only child, then that couple would be permitted a second child), this will be unable to effect a change to the trend of an absolute fall in the size of China’s working age population. This fundamental change will impact other trends, including savings rates, return on capital rates, and increases in total factor productivity.

The Grand Reversal: Labour Supply and Demand Combining factors pertaining to health and longevity with that of accumulated human capital (including education, training and ‘learning by doing’), the effective working age should extend, relative to increases in longevity. This would, if implemented, signify a postponement of the actual retirement age, an increase in the scale of the working population, and a lowering of the number of retired persons supported by the working age population. Figure 6.3 shows that an extension of the retirement age from 55 to 60 and 65 can result in a lowering of the aged dependency ratio. Taking the year 2030 as an example, extending the actual retirement age can reduce each 100 people of the elderly population supported by the aged 20 and over working age population from 74.5 people with a retirement age of 55; to 49.1 people with a retirement age of 60; or 30.4 people with a retirement age of 65. It is worth mentioning that the legal retirement age and the actual retirement age differ, in that when the legal retirement age is fixed, the status of the labour market might mean that the actual retirement age is vastly different. For instance, although the legal retirement age in the majority of situations is 60 for men and 55 for women; relatively strong pressures on employment, especially when impacted by the labour market, can conversely result in the actual retirement age often being much lower than the legally set retirement age. Therefore, it is the actual retirement 140 120 100 80 60 40 20

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age that can affect real change in the time spent working by the population, and their ability to support the elderly. As such, this is completely unrelated with the legal retirement age. If we simply change the legal retirement age when the labour market is unable to absorb this extra population, then this would deprive these people of the choice between employment and retirement, and exposes them to an extremely disadvantageous situation. Although many developed countries have increased the legal retirement age to the extent that it has become a common method for tackling ageing societies and pensionfund shortfalls; the Chinese situation clearly differs in two key areas, meaning that this cannot be considered as an option in the immediate future. First. Different groups of workers have differing post-retirement life expectancies. Life expectancy is a comprehensive indicator reflecting a population’s health. It is generally influenced by levels of economic and societal development. On an individual level, it is closely interlinked with divergent income levels, healthcare provision, and even educational attainment. This means that the life expectancies of different groups vary at the same retirement age. This impacts the duration that each groups is able to draw upon their pension. For instance, Weller’s research shows that even in America, a country which enjoys fairly high overall income levels and healthcare provision, the remaining life expectancy of the 67-year-old cohort in 1997, was 17.7 years for the entire group, yet the figure for females was as high as 19.2 years, whilst that of low income males as low as 11.3 years. Life expectancies in China are likely to be even more divergent. Comparing regional differences, in 2010, life expectancy was 80.3 years in Shanghai, but only 68.1 in Qinghai. Although China lacks age group segregated life expectancy data, but as income inequality is more pronounced in China than America, and given the extremely limited social security coverage, and that public services have, to a certain degree, regressed, then it is logical to infer that the remaining life expectancy of China’s retired population is even more divergent. Only a public policy designed around the concept of fairness will be feasible to implement. Moreover, using human capital as main criterion for assessing the differing general characteristics of the workforce. The the generation of workers currently facing retirement in China experienced much change. Historical factors mean that they possess a weak skillsets, meaning they would struggle to compete in a competitive labour market. For extending the retirement age to increase labour supply to be feasible, there needs to be no substantial difference between the education levels of the young and the old. If this is the case, then the latter’s wealth of work experience makes them competitive in the labour market. This sort of situation tends to be a truism in developed countries. For instance, of the American working age population, 20year-olds have received 12.6 years of education, lower than those aged 60, who have 13.7 years. In the Chinese working age population, currently, the older the age the lower the level of education. For instance, 20 year olds have nine years of education, whilst 60 year olds only have six, meaning that the Chinese 20-year-old has received 29% less education than the American, whilst the 60-year-old has received 56% less. Extending the retirement age in such a situation would expose elderly workers to highly disadvantageous competition. Western labour markets requires additional

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labour supplies, and so, extending the retirement age can better incentivise workers to work. A similar policy in China would however result in reducing the number of choices available to our workers, and might even subject a proportion of the more elderly workers to hardship: for they might lose their work and also be unable to draw upon a pension. Although the arrival of the Lewis turning point leads to the phenomena of constant labour shortages, there will be an evident reduction in the pressure on total employment, however the structural contradictions in labour supply and demand will conversely become more prominent. This indicates that the demand of the current labour market for elderly workers has not increased as a result of the arrival of the Lewis turning point. Calculations based on the data of the 2010 census show that the participation rate in non-agricultural sectors peaks for the 30–35-year-old cohort, at 86%, and after which drops rapidly. The 50–55-year-old cohort has a participation rate of 57%, whilst that of the 60–65-year-old cohort is only 13.8%. For those workers of advancing years, their falling labour participation rate evidently is a result of an inability to compete in the labour market, and is an expression of the ‘discouraged worker effect’. It seems that increasing the overall scale of the workforce and reducing the burden of care of the elderly population on society might not be possible with the cohort currently facing retirement. This might first require the right conditions, whereby the current young generation are gradually trained to be workers with stronger human capital, so they are not only able to adapt to the demands of changing industrial structures, but possess the skills to extend their working lives.

Labour Shortages and Employment Difficulties Exactly as forecast by the dual economy theory, the phenomenon of unskilled worker induced wage rises has been a constant since the arrival of the Lewis turning point in 2004, moreover the rate of increase in the working age population slowed in 2011, and then began increasingly pronounced negative growth. As labour supply has fallen, economic growth has maintained a strong demand for labour, and so it can be said that China faces an unprecedented loosening of the labour market. This analysis seems to be somewhat in conflict with the frequently heard saying of “such and such a year was the hardest year to find a job”. It is true that there are still employment difficulties in the labour market. However, such difficulties are not that of past labour supply greatly exceeding demand, but specifically pertain to structural unemployment difficulties faced by university graduates. For instance, there are as many as 6.99 million higher education graduates in 2013, an increase of 2.7% on 2012, creating an exception amidst the overall decline in labour supply. This issue is quite evidently structural in nature. In fact, the concept of the Lewis turning point itself, has long been visible. Unskilled worker shortages and the accelerating rise in ordinary worker wage levels have defined the labour markets during this special period.

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The job seekers ratio is a ratio of the number of work posts available to the number of people seeking employment, and estimated by market supply and demand data by a number of urban public employment service organisations, and released by the government. It depicts not only an evidently strong labour market, but also it is evident that low-level workers, meaning jobseekers with secondary or lower educational attainment, face more positive employment prospects than high-level workers, meaning graduate-level job seekers. Generally speaking, the situation is that as described by Okun’s law, for the health of the labour market is closely interlinked with that of the macroeconomy, in that rising (or falling) economic growth will lower (or raise) the unemployment rate. Strictly speaking, the changes to the growth rates discussed here, should refer to the actual GDP growth rate diverging from that of the potential growth rate, or the size of the growth gap; whilst the unemployment rates refers to the actual unemployment rate that diverges from the natural unemployment rate, or else to the cyclical unemployment rate. Simply put, China’s actual growth rate over the past few years has not been lower than its potential growth rate. There has, hence, been no cyclical unemployment, and the labour market has performed admirably. However, further analysis depicts what strong performance of the labour market might imply. The labour shortages experienced by China in 2004 heralded the arrival of the Lewis turning point. The potential growth rate could admittedly be sustained, within certain limits, by increasing the contribution of capital formation. However, by 2011, when the working age population had commenced its negative growth, the disappearance of an unlimited labour supply, and its attendant bonuses, inevitably led to diminishing capital returns. This was then succeeded by the notable drop in the potential growth rate, leading to the divergence of the actual growth rate from the potential. In actual fact, China’s actual growth rate has been faster than the potential growth rate in all other years since 2005, with the notable exceptions of 2008 and 2009, which were marked by the world financial crisis. The actual growth rate has been higher than the potential growth rate by an average 1.44 percentage points for these four years. That the economic growth rate has been above the potential growth rate has tended to result in extremely low actual surveyed unemployment rates, which might even have been lower than the national unemployment rate. Admittedly, as we lack the data for the surveyed urban unemployment rate, testing this point is not easy. However, there’s no harm in making a few rough calculations based on the data we have (Fig. 6.4). Estimates by the academics Du Yang and Lu Yang show that the natural urban unemployment rate (structural and frictional) is between 4.0% and 4.1%, while the registered urban unemployment rate has maintained a level of around 4.1%. As registered unemployment rates frequently do not include migrant worker data, purely observing the urban workers of that locality gives virtually no evidence of cyclical unemployment. However, if migrant workers already comprise one third of total urban employment, then once included within the statistics, the actual unemployment rate will differ.

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Existing research shows that the sustained low wages and high mobility of migrant workers has resulted in their unemployment rate being much lower than that of registered urban workers. For instance, based on the calculated unemployment rate of data from a sample survey of six major cities in 2010, the unemployment rate for registered urban workers was 4.72% while that of migrant workers only 0.73%. Furthermore, estimates show that, in 2011, migrant workers comprised 35.2%, and local urban workers 64.8%, of urban employment. Employing this weighting, the total surveyed urban unemployment rate, which includes both local workers and migrant workers, is 3.32%, and evidently lower than the natural unemployment rate.

Reducing the ‘Old Before Rich’ Gap China’s economy has stormed up the rankings, surpassing Japan in 2010 to become the second largest economy in the world, and low demographic growth rates mean that GDP per capita is rising at an accelerating pace. The Japanese Economic Research Centre conducted a long-term forecast on China’s economic scale and per capita incomes in 2007. This forecast, with purchasing power parity set at the value of the US dollar in 2000, by 2020 China’s total GDP will be $17.3 trillion, $25.2 trillion by 2030, and $30.4 trillion by 2040. The GDP per capita forecasts for these three years are respectively, $12,000, $18,000, and $22,000. The American economist Robert Fogel was even more optimistic, forecasting that China’s total GDP will be $123.7 trillion by 2040. On the assumption that population will total 1.46 billion people, this equals GDP per capita of as high as $85,000. It is worth pointing out that these two forecasts adopt different methodologies, and utilise widely divergent

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data sources, especially with regards to the usage of purchasing power parity, which does not accord with that employed by either the Chinese government or Chinese academics. In fact, the enormous gulfs between these two forecasts evidences their own limitations. However, these forecasts reflect the fact that since the second decade of the 21stcentury, China is accelerating its transition from a middle income country to a highincome country, from its status as the second largest economy in the world. If China can maintain the level of the past three decades or so, or maybe a somewhat lower level of economic and GDP per capita growth, then it will rapidly converge to the levels of wealth enjoyed by the developed nations. This means that these economists’ forecasts indicate the correct direction and that this growth is in accord with economic laws. As such, and as long as there is no change to demographic transition trends, the gap between the level of economic development and the ageing population will gradually reduce. Utilising United Nations data, we compared China’s demographic age structure with that of developing countries between the years 2000 and 2010. We found substantial evidence of China being ‘old before rich’. Then, when comparing China’s predicted demographic age structure for the years 2020–2030 with that of developed countries, we found that the ‘old before rich’ characteristic displayed a marked reduction. It can thus be seen that fully tapping into the potential of the current demographic dividend, creating a new demographic dividend, and gradually shifting towards new sources of economic growth, is the fundamental answer in countering an ageing population in the period after the Lewis turning point.

Chapter 7

The Challenges After the Lewis Turning Point

This chapter primarily focuses on structural employment issues in the Chinese economy that have arisen since the passing of the Lewis turning point, and how to counter these challenges. The influence of labour market supply and demand relationships should result in raised wage levels and improved income distribution, but the institutional barriers of current labour markets mean that raising wages incurs systemic costs. Once an economy has passed the Lewis turning point, agricultural marginal labour productivity is no longer zero. There is still potential for, and also necessary to, continue the transition of surplus labour, but the precondition is that agricultural labour productivity rates rise in tandem. During this stage, if labour transitions cannot be substituted by increases in the labour productivity rate such as via that provided by mechanisation, then a fall in agricultural production will result. How to respond to this stage and avoid the middle income trap is the crux of governance.

Two Difficulties: Should Wages Rise? As China traversed the Lewis turning point, it witnessed the emergence of labour shortages and the rapid increase in the wage levels of ordinary workers, as well as a corresponding fall in the rate of return of education, and also the new post1980s generation of migrant workers, who seemingly have no experience of a tough labour market, and also frequently lack the desire to continue studies after finishing middle school. Their frequent job switching means that they lose out on a great deal of opportunities for on-the-job training. For instance, studies in 2012 show that as many as 70% of migrant workers aged between 16 and 40 years old, have never received any on-the-job training. Even more foreboding is the fact that a great many teenagers from the countryside are so eager to go out and work that they fail to complete their compulsory education. For instance, data from key investigations by the National Audit Office covering 1155 © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_7

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schools in 52 counties allow us to make some general calculations. Middle school dropout rates increased by 1.6 times between 2006 and 2011. This means that it is worth exercising caution, for this golden age of the labour market will not last forever. For, migrant workers that lack the human capital to adapt to the technical demands of the future labour market will soon find themselves ensnared in structural unemployment. In 2011, migrant workers had received an average of 9.6 years of education. This level of human capital coincidentally has enabled them to adapt to labour intensive jobs in the secondary sector (base requirement of 9.1 years of education), as well as labour intensive jobs in the tertiary sector (base requirement of 9.6 years of education). However, Chinese economic growth is projected to slow in future, whilst the pace of industrial restructuring will accelerate. Based on the human capital requirements of present employment openings, capital intensive secondary sector posts require 10.4 years of education, whilst technologically intensive tertiary sector jobs require 13.3 years. Evidently, migrant workers education levels are no longer sufficient to permit them to transition to these new jobs (see Fig. 7.1). The government has adopted a more positive stance towards employment. It is targeting structural employment difficulties to alleviate labour market friction, and increase the degree of allocation of, and the supply and demand in, human resources, which is naturally its responsibility. However, labour market signals are also indispensable. This means that we actually need to maintain a certain level of natural unemployment, for this exposes those workers with human capital and labour that is mismatched with the market to pressure, thereby pointing the way for future workers. 15 13 11 9 7 5 3

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This, thereby, complies with the needs for constant industrial restructuring, and the receipt of as much normal and vocational education as possible, as well as a wide range of training. Given that the rising wage levels of ordinary workers is a factor of supply and demand, should we then calmly accept this situation? If rising wages is really the result of an unimpeded labour market, and rising wages facilitates improving income distribution, and can also increase consumer demand, then we should of course register our strong support. The issue is that there are currently still institutional barriers to the Chinese labour market, and as such there is an institutional cost to raising wage levels, and as a result they are, to a greater or lesser degree, distorted. In fact, when determining the utility function of whether 21st-century Chinese rural labour will transition, we not only include the Todaro forecast urban rural income gap, but moreover include an extremely extensive forecast urban rural welfare gap. This forecast welfare covers wages and other forms of remuneration, such as social security coverage, institutional labour market protection, as well as other basic public services such as guaranteed accommodation and compulsory education for children. When differential access to the basic public services of welfare systems is based on household residence registration status, and social security and compulsory education provision are unable to meet migrant worker needs, then the resultant gap will ultimately need to be compensated via wage rises. In addition, lacking both urban residence registration, hukou, and expectations of long-term residence, migrant workers in urban areas more often than not return back to their villages at a fairly young age. As such, their forecast lifetime work time is reduced, and their labour participation rate comparatively low. Studies by the National Bureau of Statistics show that in 2013 there were a total of 260 million migrant workers nationwide, of which as many as 100 million had not left their home areas, whilst the remaining 160 million had gone further afield to work, the majority of which arrive in cities of varying sizes. We can see the impact of the residence registration system on the stability of migrant worker employment from the differences in migrant worker age distribution and their home region and those further afield. Migrant workers employed in their home includes many who have returned from further afield, for 60.4% are aged 40 or above. Of those migrant workers who have travelled further afield to work, only 18.2% are aged 40 or above. This will undoubtedly have a certain impact on wage decisions. As rational actors, itinerant migrant workers who have had their lifetime working lives artificially shortened will inevitably seek to reflect this fact in their remaining wages. This means that, when migrant workers wish to make a decision to move, they are inclined towards a certain income level, which includes compensation for unrealisable work time. In actual fact, migrant workers are often very eager to work overtime, thereby earning overtime wages. This is related to their desire to compensate for their insufficient lifetime earnings. This produces pressure on rising wage levels. It is clear that, anticipated unstable urban employment and residence, as well as the lack of basic public services experienced by migrant workers, need to be at least partly compensated through the medium of wages by their employing companies. Or to look at it another way, if the government were to impartially provide migrant workers with

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equal access to related basic public services, the residential status means that migrant workers will expect to be able to fulfil their lifetime work time. This could lower the equilibrium point of rural labour migration to a comparatively low wage level, thereby alleviating wage growth speeds somewhat. This would provide many corporations time to adjust, and more generally, can avoid giving the industrial structure ‘shock therapy’ during this adjustment phase. This is to say that, the provision of basic public services can have the same impact as a rise in wage levels, and maintain the gravitational pull exerted by cities and nonagricultural sectors on labour transitioning from the countryside.

Delaying the Momentum of Rising Labour Costs Weak global economic growth has admittedly impacted China’s demand-side growth, but the primary cause of China’s slowdown is in fact supply-side. For, the demographic dividend has disappeared, and labour shortages have led to rising wages, and have caused the disappearance of the comparative advantage of the manufacturing industries. Here I will introduce a new concept of two calculable indicators to conduct such comparisons. The first is, we need to compare wage levels and labour productivity, and mark the ratio of the two as unit labour cost. If wage growth speed exceeds labour productivity, then this indicator will rise. The other is, the comparative advantage indicator displayed by labour intensive industry products, namely the ratio of the share of certain kinds of products exported by China with the share of that product in world trade. This indicator can reflect changes to comparative advantage. Labour shortages result in excessive rises in labour costs. This impairs China’s comparative advantage in manufacturing and by extension, its international competitiveness. For example, between 2003 and 2014, migrant worker real wages exhibited an average growth rate of 10.7% per annum. In addition, looking at average wages by industry, real wages of employed workers in the manufacturing, construction, and agricultural industries exhibited double digit average growth speeds. Data from The Conference Board shows that China’s overall annual labour productivity growth rate was 9.5% between 2007 and 2012, and fell to 7.3% in 2013, before dropping to 7% in 2014. This means that wages are rising faster than increases to the labour productivity rate. This is bound to weaken China’s comparative advantage and competitiveness in manufacturing. Our calculations on eleven kinds of labour intensive products that have a dominant position amongst China’s exports show that comparative advantage dropped by 22.7% between 2003 and 2013. The reasoning given by the Japanese media and academics for the substantial departure of the Japanese manufacturing industry from China to Japan, was the change in the unit labour costs between the two countries. Media reports stated that the Japanese unit labour costs were three times higher than in China in 1995 when calculated by the US dollar. However China overtook Japan in 2013, a trend which continued in 2014. Looking at the data shows that this reasoning is erroneous, for the unit labour costs of the Chinese manufacturing industry have quite evidently

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surpassed those of Japan. In 2013 the unit labour costs of China’s manufacturing industry were 29.7% of Germany’s, 36.7% of South Korea’s, and 38.7% of America’s, and were 39.5% of Japan’s in 2011. Even if we take changes to exchange rates into account, China’s unit labour costs are still lower than Japan’s, and exchange rates are set to change further in the future. This reasoning demands some attention. The first aspect is in determining the competitiveness of manufacturing (tradable goods) at the corporate, industrial, and national level requires consideration of both labour costs and labour productivity. The two combined comprise unit labour cost, which is a ratio of labour costs and labour productivity. The second is that China’s unit labour costs are rising very fast. They are rising faster, in fact, than that of other major manufacturing countries. One aspect is that labour costs are rapidly rising, the annual average growth rate of 8.5% between 2001 and 2005 rose to 14.8% between 2005 and 2013. The second aspect is that increases in labour productivity are being outpaced by wage growth, and having fallen from 13.9 to 9.2%. This trend is accelerating each year. This means that unit labour costs have risen from −4.9 to 5.2%, and so we can anticipate that it will exceed that of other countries. It is evident that the solution is to execute policy from both the numerator and the denominator, and then increase labour supply to reduce wage growth speed. However, sustained increases to labour productivity are more critical. From the perspective of the numerator, policy needs to consider methods of increasing labour supply. As the total amount of labour is decreasing, reforms to the residence registration system and raising the labour participation rate, are the most effective short-term methods to increased labour supply, and also tap in to latent potential. At present, a one percentage point increase in the labour participation rate can effectively increase labour by more than nine million people. This can offset the negative impact of the reduction of the working age population, and also offset wage growth momentum. We also need to ensure that labour costs do not rise too fast in other areas. For instance, the non-wage portion of labour costs also has the potential to inhibit rises. Social security expenses are an important component of labour costs, and impose a heavy burden on small and medium enterprises. This burden might be reduced by optimising social insurance systems and improving actuarial levels, whilst maintaining a constant level of protection for workers, and reduce corporate employment costs. In addition, we need to avoid the sub-optimal utilisation of a minimum wage system. Such a social policy serves to protect disadvantaged working groups, and in labour market environments that feature information mismatches. It is neither a redistributive tool, nor a wage setting tool, a function it is even less suited to serve. It also cannot be used to push up wage levels. From the perspective of the denominator, constant rises in labour productivity are the ultimate source for maintaining the advantages of unit labour costs, and also maintaining manufacturing competitiveness. The three factors on which rises in labour productivity depend are, human resources stock, raising the capital to labour ratio, and total factor productivity. The next factors impact rises in labour productivity, and deserve attention. The first is, from 2011 to 2020, new labour growth is reducing at a speed of 1% per annum, total human capital (total labour multiplied by education

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received per capita) is simultaneously falling at a similar speed, and is becoming a factor for the decline in the growth of total factor productivity. The second is overly rapid rises in the capital to labour ratio leads to diminishing capital returns. This is unsustainable and is of no assistance in lowering business costs. During Japan’s ‘lost two decades’, 94% of increases to labour productivity came from the capital to labour ratio, and 21% came from human capital. This resulted in a negative contribution to total factor productivity (−15%). This lesson is worth reflecting on. And so, increases in labour productivity are ultimately dependent on total factor productivity. At this stage of development, increases in total factor productivity are dependent on creative destruction. This requires advancing the development of a factor market, and deepening micro mechanism reforms, so companies can more proactively and more effectively respond to factor market pricing signals, eliminate industrial barriers to entry, and promote the freer flow of all factors of production, such as capital and labour, between regions, industries, and enterprises.

The Difficulties of Three Groups: The Latent Fragility of Labour There are markers that point to the onset of a new stage of economic development: China’s total working age population has entered a period of negative growth, the speed of the transition of rural surplus labour has abated, for total labour supply is reducing annually. The data shows that since 2011, the working age population, which is the population most suited to employment, has constantly been in a state of negative growth, falling by several million people per year. If we consider the rise in the labour participation rate (the proportion of the working age population possessing a desire to work), we can see that although the economically active population has increased over the past few years, this rate of increase is substantially slowing, and will subsequently turn into negative growth. As the economy still maintains medium to high growth speeds and labour demand remains vigorous, the long-term contradictions inherent in the nation’s employment will abate. However, economic theory and real-world experience shows that structural and frictional employment contradictions will exist in any macroeconomic situation. Undoubtedly, as the pace of technological advance accelerates, and accompanied by the deepening of reforms and restructuring, these employment contradictions not merely exist in China, but are becoming more prominent by the day. Just as the general public commonly believes, China’s employment problems are primarily concentrated amongst three groups: migrant workers seeking urban employment, personnel with difficulties finding employment in urban areas, and higher education graduates. Structural and frictional employment difficulties, and also natural unemployment problems from these three groups, became visible once China’s economy entered a new stage of development.

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Current official urban employment statistics primarily cover the employment of the urban residence registered population. The majority of migrant workers in the urban areas are not included in these statistics. If migrant workers were to be included, then in 2013 there would be a total of 450 million people employed in urban areas, of which 35% would be migrant workers who have been resident in that city for in excess of six months. Of the new increases to employed personnel in that year, 65% were migrant workers. This means that migrant workers already comprise the main body of urban employment, and in future this increase will be even larger. Moreover, inadequate migrant worker education levels prevents them from transitioning to new jobs in the future. Traditionally, the ‘back and forth’ labour migration model was a method of solving farmer unemployment. However, labour migration is increasingly unidirectional, meaning that this method will no longer produce the desired effect. In 2013, the new generation of migrant workers already comprised 46.6% of the total, 33% of which had lived in cities of varying sizes prior to the age of 16, and not in the countryside, and 38% attended primary school in urban areas. This is to say, a great many of these migrant workers have never had any experience working in the fields, and so will have no desire to return to the countryside. Furthermore, changing agricultural production methods increasingly depend on labour saving technological advances, meaning that agriculture can no longer serve as a ‘reservoir’ for surplus labour. It is evident that protecting migrant workers from the dangers of future unemployment fundamentally lies in raising their human capital. In view that if there had never been large-scale rural to urban labour flows, then urban labour would be much older than is the case. For instance, the Sixth National Census data shows that in 2010, of the urban resident 15–59 year old working age population, 35% of the 20 to 29-year-old cohort was comprised of people with external hukou, residence registration, and those with hukou for that locale comprised 21.6% of their population. For the 50–59 year old cohort, those with external hukou comprised 7.2%, whilst those with hukou for that locale comprised 19.3% (See Fig. 7.2). The relationship between age and education level informs us, of the workforce with an urban hukou, a fairly large proportion of groups patently possess insufficient levels of human capital. This is true of those of fairly advanced years and also those with fairly limited education levels. They will find adapting to the higher technical requirements of an upgraded industrial structure difficult. This group of workers are considered by the government to be urban personnel with poor employment prospects, and are a target group for assistance. This kind of urban worker demographic structure ensures that there will always be a fairly stable group that are often in a state of structural or frictional unemployment, and comprise a classic case of natural unemployment in the labour market. The length of time that a worker spends unemployed during structural reforms, such as restructuring and the cutting of overcapacity, is linked to his demographic indicators including his education level and age. Those with comparatively high levels of education and who are also relatively young, find it easy to learn new skills, and can quickly transition to a new role. Those groups with relatively low levels of education and, moreover are fairly old, can easily become a troubled group

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during such a transition. Those subject to frictional unemployment for excessively long durations, or are unable to find new employment owing to their human capital constraints, will transition into potentially intractable structural unemployment. This means that we should pay special attention to these groups whilst restructuring and implementing reforms. This means that affected groups need to be analysed in depth, so that they can be differentiated through policy. First, the proportion of migrant workers age 40 and above in urban employment has already increased from 38.3% in 2011 to 44.8% in 2015. These people are very likely to return home to the countryside upon encountering restructuring. Next, the proportion of workers aged 40 and above in the coal and steel industries is respectively 48.9% and 41.4%, and those with only a middle school level of education or below comprise 69.4% and 55.9% respectively. At a rough guess, overproduction cuts in these two industries affects a total of 1.8 million workers. These workers face career change, of which at least half will encounter employment difficulties for an indeterminate period of time, and might even transition into structural unemployment. When talking about the natural unemployment risks faced by urban workers, it is worth emphasising a characteristic of human capital of this groups. Education provision in China has improved substantially since the 1990s. This has raised the number of years in education of new workers extraordinarily quickly. This is manifested in the human capital China’s working age population, whereby, the higher the age the lower the level of education. As the age of urban labour is somewhat high, so the proportion comprised by groups with insufficient human capital is also fairly large. The extremely rapid evolution to industrial structure means that a large proportion

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of workers will be unable to meet the new labour market skill requirements, and will hence be highly likely to become structurally unemployed. The difficulties faced by university graduates in finding employment and the convergence of their wages with low end workers, is becoming a phenomenon that is increasingly attracting the interest of society. Moreover, it is becoming fuel for naysayers who denigrate education institutes for expanding enrolment. It should be stated that the changes that came in the wake of expanded university enrolment were both sudden and fundamental. People were unable to fully comprehend the implications of which, or adequately counter them. This fundamental change being that in an extremely short space of time, higher education became a mass-market phenomenon. After entering such a stage, a few special rules gradually emerged for university graduate employment, then public opinion and policy will be misled if these underlying rules are misunderstood. Research into labour economics shows that, the higher the level of education, especially that of graduate level and above, the longer the time required to match jobseekers with the job market. This means that, university graduates need to invest comparatively more time in finding, and transitioning into, work to find a relatively ideal job. And so, by solely relying on the employment rate of university graduates several months after graduation, as well as graduate starting salary to form an opinion, will result in a fail to arrive at the correct conclusion on the human capital advantages possessed by this group. In actual fact, after seeking work for an extended period of time, and then finding that first place of employment, workers with a comparatively high level of education will still be seeking work. Apart from this, their superior human capital will give them more opportunities for professional advancement, allowing them to eventually find an advantageous position in the labour market. Eventual labour market victors Using data from the Sixth National Census, the surveyed urban unemployment rate in 2010 was 4.8%. However, the unemployment rate for those under the age of 28 was higher than the average, of which, the age 22 cohort (the age of university graduation) had the highest unemployment rate (see Fig. 7.3). One aspect is the structural difficulties faced by university students in finding employment. A questionnaire survey conducted by the Peking University Education and Economics Research Institute that covered 30 higher education institutes in 21 provinces during June 2013, found that the initial employment rate of vocational school students was 79.7%, and that of graduate students was 67.4%, whilst that of Masters and Ph.D. students was 86.2%. The other aspect is, this reflects youth unemployment trends similar to that experienced by other countries. There are two reasons for the difficulties faced by university graduates in finding employment. The first being that whilst the structural difficulties faced by university graduates have regularity, but the assistance of labour market functions and employment policies is still necessary. The second is, that mismatches between courses and subjects, and also low quality teaching, have undoubtedly aggravated the structural

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Fig. 7.3 Surveyed urban unemployment rates by age

employment difficulties faced by university graduates, and have raised a large number of questions pertaining to the reform of higher education. However, this obviously is not a reason to reduce the speed at which higher education expands. There is an opinion currently fashionable in academic and political circles that states that as ordinary higher education graduates have problems finding employment, whilst vocational college graduates receive a more enthusiastic reception on the labour market, then enrolment should be reduced for ordinary universities, and the increased for vocational colleges and higher vocational educational institutes. There are two reasons for this kind of policy orientation. The first is that current graduates of vocational schools do not have problems finding employment. The second is that Germany’s vocational education is closely interlinked with its status as an elite manufacturing power, and this success proves its viability. Current evidence suggests that these two reasons are in fact not terribly viable. First, it is easy to be beguiled by simplified stereotypes when comparing the employment prospects for vocational college graduates with that of university graduates. Indeed, unskilled workers are welcomed on the market, and so when university graduates have difficulty finding employment, the ‘migrant worker famine’ phenomenon persists. In actual fact, there is no difference between parents’ hopes for their child’s employment prospects when they send their children to vocational colleges with those of a migrant worker. As such, very many vocational schools generally act as employment intermediaries or agents, whereby they either introduce students to a job at the earliest opportunity, or send them to work on internships within companies. Moreover, Germany’s success in vocational education does not necessarily indicated that its imitators will also succeed. For Germany possesses a highly developed manufacturing industry, which has been a technological leader in some arenas for

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extended periods of time. This means that demand for skills can be anticipated. Conversely, China’s manufacturing industry is currently experiencing rapid industrial upgrading, and the speed of these adjustments is set to accelerate. Just as the American professor Austan Goolsbee pointed out during the 2014 China Elite development summit, the professional work skills currently required by society simply did not exist three decades ago. This means that the goal of a good education system should not merely be to ensure that the student has learned some kind of specific skill by the age of 18 or 19, but to ensure that they become lifelong learners. As such, it would be more advantageous to adopt the American lifetime education model when at a development stage with such rapid changes to its industrial structure, rather than adopt the German vocational education model. In America, a person might choose to enter the labour market upon graduating from high school, or they might choose to go to a renowned university, or they can choose to enter a community college which offers more targeted employment training. Most importantly, a person possesses the opportunity to catch up on any level of education or retrain at any stage of their life. Each education type offers opportunities to bridge to others, meaning that one individual choice does not condemn an entire life. Evidently, this is a more flexible, and efficient education model and is of practical value to China and the challenges it will face in future.

The State of the Agricultural Workforce The National Bureau of Statistics reveals that China’s total agricultural workforce was 283 million people in size in 1978, and 258 million people in 2012, and during which period agricultural labour dropped from 70.5 to 33.6% of the total, a fall of an average of 2.2% per annum. The extent of the drop in this proportion has evidently accelerated since the reforms. For instance, in 1953, the proportion was 83.5%, meaning that it fell by only 13 percentage points in the 25 years to 1978.

Changes to the Agricultural Workforce However, when looking at the speed of economic growth and industrial structural change since the launch of the reform and opening period, we can see that the rate at which the agricultural workforce has fallen over the past thirty years or so has either been unsatisfactory, or there has been a tendency to underestimate the statistics. First, the more than thirty years of transition of the agricultural workforce since the reform and opening have been unprecedented, and a highly concentrated version of what came before. An important outcome of labour mobility and demographic migration is the urbanisation rate, which has risen from 17.9% in 1978 to 52.6% by 2012, and is rising by 3.2% or one percentage point per annum. Moreover, the international experience shows that there have been extremely rapid falls in the

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proportion comprised by the agricultural workforce in comparable countries. For instance, the rate at which the agricultural workforce fell in Japan and Korea, which experienced analogous dual economy economic growth and realised rapid rates of growth, was much faster than China over comparable periods of time. During the 34 years from 1953–1987, the proportion comprised by the agricultural workforce dropped by 4.5% per annum in Japan; and during the 34 years of 1963–1997, the proportion comprised by South Korea’s agricultural workforce fell by 5.1% per annum, which is more than twice as fast as China’s figures (2.2% per annum) for the 34 years from 1978–2012. Official statistics record that the agricultural workforce was 297 million people large in 2009, and at 37.6%, comprised a still large proportion of the national workforce. Such an overestimate is, to a large degree, the result of the inability of traditional statistical methods to accurately determine the time invested by the workforce in agriculture. This means that, if the time invested in agriculture can be accurately recorded, then we will have a more persuasive conclusion. Du Yang and Wang Meiyan conducted research based on village residence registration data. This surpassed the limitations of prior research which had only able to categorise agricultural employment by year. They divided the labour input of different economic activities of agricultural workforce into months, and arrived at the result of the workforce actually engaged in agricultural labour being 192 million people in size. Official statistics overestimated the size of the agricultural workforce by 105 million people, or approximately 54.7%. Based on this re-evaluation, the proportion comprised in urban and rural employment by the actual agricultural workforce is not 37.6%, but 24.3%.1 Starting with an actual agricultural workforce size of 192 million people, a figure only 64.6% of that recorded in the Statistical Yearbook, we can restructure a data series of the size and proportion of agricultural labour to calculate its current size and proportion, and moreover uncover some pertinent policy implications. Our calulated outcome was that the proportion comprised by the actual ‘agriculturally engaged workforce’ was at least ten percentage points lower than the figures released by the National Bureau of Statistics. This figure is highly convergent with estimates arrived at by Brandt and Zhu (2010) from other data sources.

The Demographic Characteristics of the Agricultural Workforce The huge increase in labour mobility since the reform and opening, as well as the relative tardiness of the residence registration system reforms, led to a severe disconnect between the actual distribution of labour in the urban and rural areas and residence, hukou, registration data. This means that, when we discuss rural labour, there are 1 Yang

and Meiyan (2011).

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actually two implications. The first is it refers to the rural labour as defined by residence registration meaning the labour who hold rural hukou, residence registrations, no matter whether they are employed in the countryside or in cities. The second is the definition of rural labour as per their place of permanent residence (in excess of six months). This means that no matter where their hukou, or residence registration is registered, their place of permanent residence for employment is in the countryside. An overlap exists between these two definitions of rural labour. The rural labour implied by the former is most typically divided into two groups, agricultural labour and migrant workers. The rural workforce implied by the latter, although it theoretically includes a population holding non-rural hukou, but is primarily comprised of the registered rural population. They are employed in the countryside, and include both agricultural labour and workers in rural non-agricultural industries. This means that this book, which is entirely focused on rural labour, is an observation of three groups: agricultural labour, locally employed migrant workers and migrant workers who have gone far afield for work, and, as such, can essentially cover the entire composition of the rural workforce. Based on the parameters of the definition the permanent population in the Sixth National Census, the rural aged 16 and above working age population numbers 512 million people, whilst the rural employed population number 394 million people. Of which, agricultural labour (those engaged in arable and pastoral farming, fishing, and fishing) number 294 million. Although there are issues of delimitation with regards to employment time, these several figures are highly likely to be overestimates. Moreover the working age population has no upper age limit. This means that, these parameters of population numbers differ from the data we previously analysed. However, we can still rely on the census data to explore a few key characteristics pertaining to rural labour. The rural working age, economically active, and employed populations, and also agricultural labour age structures are of particular interest. Prior research has already shown that, when based on the permanent population, large scale labour migration means that the rural population is ageing faster than the urban. When observing the working age population we can also see that this demographic group which serves as the basis of the workforce, also exhibits severe ageing trends. The Sixth National Census data shows, based on the definition of the permanent population, of the aged 16 and above working age population, the 16–20 year old cohort comprises 9.1% of the population; the 21–30 cohort, 17.4%; the 31–40 cohort, 18.4%; the 41–50 cohort, 20.4%; and the over 50 cohort, 34.7%. Using the same parameters for the urban working age population shows that: the 16–20 year old cohort comprises 10.2% of the population; the 21–30 cohort, 21.3%; the 31–40 cohort, 21.9%; the 41–50 cohort, 19.7%; and the over 50 cohort, 27%. Correspondingly, the age structures of the rural and urban economically active and employed populations reveals strikingly similar results. The agricultural labour age structure reveals an even higher ageing process, with the 16–20 year old cohort comprising 3.4% of the population; the 21–30 cohort, 16.7%; the 31–40 cohort, 19.3%; the 41–50 cohort, 26.4%; and the over 50 cohort, 34.6%. In other words, the over 40s comprise 62% of the agricultural workforce.

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50+ 41

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Fig. 7.4 Comparison of the age structures of migrant workers and the workforce

Comparing the age structure of the agricultural workforce with migrant workers (including local and those far afield) offers the greatest contrast. Combining the census data with the survey data monitoring migrant workers shows that in 2010, the agricultural workforce age 30 and under group comprised 20.0% of the total, whilst the aged 50 and over group comprised 34.6%. These two age groups for migrant workers are 42.4% and 12.9% respectively (see Fig. 7.4). Furthermore, 38.8% of the migrant workers displayed here are locally employed, and have not gone far afield. If compared with the younger migrant workers who have gone far afield for employment, the age contrast is much more striking. For instance, surveys by the National Bureau of Statistics shows that in 2011, 60.4% of migrant workers employed locally are aged 40 and above, whilst of those who have gone far afield, only 18.2% are aged 40 and above. We have already discussed the size of the agricultural workforce, and its proportion of the total workforce. Now we will add a few supplementary descriptions about the rural background environment. First, as younger people possess higher levels of education, age serves as an advantage for labour heading further afield, and so the degree of ageing in the remaining agricultural population is much greater than that of the rural non-agricultural workers and those migrant workers who have gone far afield. Second, arable and pastoral farming, fishing, forestry, and irrigation works comprise 74.8% of the total rural workforce. 79.7% of females are engaged in agriculture, which is somewhat higher than the male figure of 70.6%. Finally, as the statistical data is limited to the aged 16 and above working age population, the level of participation of those aged 15 and under in agriculture is an unknown. However, experience informs us that children do help their families in the fields, whilst those employed in non-agricultural industries are more of a rarity. In conclusion, people often term the demographic features of workers engaged in agricultural production as Unit ‘386199’. There is a certain logic to this.

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Post Turning Point Rural Labour Transitions We adopted the concept of the Lewis turning point to refer to the first turning point of dual economy development. Thus, the arrival of this turning point neither signifies the virtual exhausting of surplus agricultural labour, nor does it mean that the agricultural and non-agricultural sectors possess equal levels of marginal productivity. However, the emergence of these two phenomena (the arrival of the commercialisation point), begins to accelerate after the Lewis turning point. An accurate inference of the arrival of the Lewis turning point is highly significant to China’s economic development. The passing of the Lewis turning point signifies that agricultural marginal labour productivity is no longer zero, and there is still potential for continued transfers of surplus labour, and there is also a need for this. However, the precondition is that it rises in lockstep with agricultural labour productivity. During this stage, if continued transfers of labour cannot be supplemented by increases in labour productivity from, for example, mechanisation, then a fall in agricultural output will result. It is for this reason that the Lewis turning point has been called the ‘food shortage point’ in development economics, for it can engender conflicts in the supply of agricultural products, as well as food price driven inflation. Reviewing the entire process of agricultural economic reforms, shows that, no matter whether manifested via labour productivity, land productivity, or total factor productivity, China’s agricultural productivity rises have been a clear success. However, when comparing the performance of agricultural productivity at a specific historical timeframe with that of other countries; and when observing the arrival of the Lewis turning point in China; and comparing its agricultural labour productivity and land productivity with that of the levels of agricultural productivity of other countries or regions at similar stages of development; we can see that, with regards to productivity, China still lags far behind, and that there is much room for growth. For instance, the literature on past research informs us that Japan arrived at its Lewis turning point around 1960,2 whilst South Korea and Taiwan did so in the early 1970s. Mainland China reached this juncture in 2004, at a point when China’s land productivity lagged far behind that of several other East Asian economies. We find an even more pronounced gap if we compare China’s agricultural labour productivity with that of 1960s western countries. In actual fact, in tandem with the transition of the agricultural workforce, the labour saving mechanisation of China’s agriculture had clearly accelerated by 2004, when the Lewis turning point arrived. We can see from improving agricultural technology and changes to its operating methods that agricultural development was responsive to changes in the comparative scarcity of the factors of production, namely labour shortages. This is to say that in the early days of the reform and opening, and when there were still vast quantities of surplus labour contained within agriculture, the focus of technological advance was not on saving labour, but on saving land. This was expressed by the relatively slow uptake in small-scale agricultural tools and 2 Minami

(1968), Bai (1982).

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machinery. Starting from somewhat after this point and until quite recently, the transition of surplus labour accelerated and total numbers have reduced, and agricultural labour shortage issues have become gradually more prominent. Large-scale agricultural tools and machinery are also developing rapidly, and are characterised by a shift to labour saving technologies. However, the transition of agricultural labour and incomplete urbanisation has impeded the circulation of arable land, constraining agriculture. It has also impacted the advancement of agricultural mechanisation and labour productivity. Half-hearted urbanisation cannot actually engender modernised agricultural production methods established on a basis of price incentives and scaled operations. Migrant workers heading far afield do not dare to transfer rights to their contracted agricultural land, and, when they lack the expectation of stable, settled accommodation, are even less willing to relinquish their vacant housing land. Thus, the highly rigorous land management administration has created a fall in land productivity and also in the life utilisation rate. For instance, in 2012 there were a total of 263 million migrant workers, of which, 99.25 million were employed in non-agricultural industries in their hometown. Their employment type means that these workers were, undoubtedly, no longer working the land. However, very many of their number still supplemented incomes via agriculture, and so they maintained their contracted agricultural land and housing land. In the same year, migrant workers who went far afield (rural labour which has departed its hometown for in excess of six months) numbered 163 million people. Of whom, around 130 million people were classified as family members of families still resident in the countryside, who would have no time to engage in agricultural production. However other members of their family still live in the countryside, and would not relinquish their contracted agricultural land or housing land. In addition, there is also a 33.75 million large rural population of whole families who have migrated away from the countryside and completely abandoned their lives and agricultural work in the countryside. However, in the vast majority of cases, this group of people have not relinquished the usage rights of the contracted agricultural land and housing land awarded them. There are some people who have contracted others to work their contracted land, and they profit from the government grain subsidies. Thus it can be seen that whilst the number of active farmers is drastically falling, the total number of agricultural operating units, meaning the number of rural households that are either fully or partially engaged in, or are still in possession of their contracted agricultural land operation rights, is not substantially falling. This means that, the scale of agricultural operations cannot correspondingly increase as the proportion of people employed in agriculture falls, and hinders increases in agricultural labour productivity. The composition of China’s agricultural land is an outcome of the early 1980s household contract responsibility system, and is characterised by its fragmentation, scattered distribution, and small scale operations. If this land operations status is not overhauled as the total size of the workforce falls, then not only will it hinder the mechanisation of cultivation, but land will also continue to be wasted at both plot boundaries and field ridges. In addition, the relatively small plot size is a

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greater obstacle to producers who proactively respond to price incentives, and is not conducive to the specialisation and professionalisation of operations. Larger plots of land make a certain scale operations feasible. This can lead to the creation of long strips of field ridges, and fewer but more effective channels, and also less land allocated for accommodation. Leaving aside factors such as economies of scale, the amount of cultivatable land occupied by buildings, field ridges, and channels, is sufficient to explain its relatively low productivity. In actual fact, agricultural surplus labour still exists after the arrival of the Lewis turning point, and its transition to non-agricultural industries shouldn’t reduce in the slightest. For instance, the data we have collected shows that Japan reached its Lewis turning point in 1960, when agricultural labour comprised 30.2% of the whole. During the subsequent 20 years, the proportion comprised by agricultural labour continued to drop by nearly 20 percentage points, dropping one percentage point per year. South Korea arrived at its Lewis turning point in 1972, when agricultural labour comprised 50.5% of the whole. This proportion dropped by 36.4 percentage points over the subsequent two decades, or 1.8 percentage points per annum (see Fig. 7.5). China arrived at its Lewis turning point in 2004, official statistics record agricultural labour as being 46.9% of the total, whilst academics have calculated a figure of 28.6%. Even if China subsequently mimics Japan’s relatively slow speed, then in the 20 years from 2004, the proportion comprised by China’s agricultural labour will drop by one percentage point per annum. The parameters of official data suggests a proportion of 26.9% by 2024, whilst academic estimates suggest that those so employed will comprise a mere 7.8%. This means that the future transition of agricultural labourer should in no way be slower than its prior speeds. 90 80 70 60

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Fig. 7.5 Changes in the proportion of agricultural labour in China, Japan and South Korea

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A comparison related to China’s grand economic growth goals, also requires that China maintains its agricultural labour transition speed in future. China’s GDP per capita surpassed US$6,000 in 2012, entering the ranks of middle income countries. The coming decade or so will be a critical time as China transitions from an upper middle income country to the ranks of the high-income countries. During this period, compared to middle income countries with GDP per capita of between US$6,000 and US$12,000, Chinese agricultural labour still contains enormous potential for sustained transitions. In 2011, the average proportion of the population engaged in agricultural labour of several countries at this stage of development was 14.2%. This is seven percentage points lower than the estimates of Chinese academics, and twenty percentage points lower than the data listed in the statistical yearbook. This signifies that in the coming decade or two, if starting from current agricultural labour levels, the agricultural workforce needs to fall by several million people, or around one percentage point, per annum. In addition, China’s 15–59 year old working age population is evidently falling. Forecasts on the data from the Sixth National Census show that this age cohort will reduce by nearly 3 million people per annum between 2010 and 2020. This signifies that if machinery does not substitute labour on a large scale, labour shortages will continue to exacerbate. For instance, forecasts suggests that between 2007 and 2011, average employment elasticity in non-agricultural sectors was 0.27. Based on forecasts of the potential GDP growth rates prior to 2020, economic growth will continue to create 9 million jobs per annum. As new additions to the labour market cannot meet this demand, a wide range of methods to raise the labour participation rates, including that of transitioned agricultural labour, is the only solution. Accordingly, we believe that when China has fully attained its goal of an affluent society in 2020, then the proportion comprised by agricultural labour should have fallen to levels equivalent to that of countries with similar per capita incomes, or around 14%. Which, starting from 2012 (around 20%), means reductions of 0.75 percentage points per annum. Simultaneously to this, the urbanisation rate for 2012 was 52.6%, and is rising by 0.9 percentage points per annum, meaning it will have reached 60% by 2020 (see Fig. 7.6). It is worth pointing out that an appropriate reduction in the speed of urbanisation does not conflict with the need for labour transitions. For an acceleration of the residence registration system reforms can effect an increase in the labour participation rate via the urbanisation of migrant workers, at the same time as the rates of urbanisation fall based on the statistics of the permanent population.

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Fig. 7.6 Forecast urbanisation and labour distribution in 2020

References Bai M (1982) The turning point in the Korean economy. Dev Econ 2:117–140 Minami R (1968) The turning point in the Japanese economy. Q J Econ 82(3):380–402 Yang D, Wang M (2011) Recalculations and discussions on China’s total employment and employment structure. In: Cai F (ed) China’s population and labour issues No. 12—Challenges during the 12th five year plan: population, employment, and income distribution. Social Sciences Academic Press (China)

Chapter 8

China’s Second Demographic Dividend

This chapter explores whether the Chinese economy can create a reform induced demographic dividend whilst in the Lewis turning interval. The unique outcome of China’s demographic transition has been summarised as being ‘old before rich’. Its ageing society also means that, compared with other countries, China will face challenges that are greater in number, in scale, and in rarity. Such challenges can be subdivided into several areas for closer inspection, and include the premature disappearance of the demographic dividend, the difficulties in initiating a second demographic dividend, insufficient resources for old age care, and challenges pertaining to human capital.

Is the Chinese Turning Point Special? Let’s first look at the relationship between being ‘old before rich’ and the disappearance of the demographic dividend. We have already discussed this topic in a previous chapter, and we will go into more detail here. The dependency ratio can serve as a proxy variable for the demographic dividend. In actual fact, the ageing population can also be reflected in the dependency ratio. We have calculated the transformation of the Chinese population with United Nations demographic data, and compared it with that of Japan, South Korea, and India (see Fig. 8.1). This also allows us to show China’s characteristic of being ‘old before rich’ from a different angle. Let us first compare with the early developers, Japan and South Korea. Japan’s dependency ratio reached its trough in 1970, a situation that persisted for more than two decades, until the 1990s, when it began to rapidly rise. Comparatively speaking, not only did Japan’s demographic transition begin much earlier than China’s, but its level of economic development far exceeded that of China’s at the moment that its demographic dividend disappeared. It is worth paying attention to the fact that Japan is a typical example of the disappearance of the demographic dividend leading to the stagnation of economic growth. However, this stagnation occurred after it © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_8

133

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8 China’s Second Demographic Dividend

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Fig. 8.1 An international comparison of the demographic dependency ratio turning point

became one of the wealthiest countries in the world, and so has not suffered from China’s malaise of being ‘old before rich’. As a high income country, South Korea’s demographic dividend ratio began falling early on. It experienced a long descent, and a comparatively long time at the bottom of the curve, and is forecast to begin to rise rapidly at the same time as China (2015). Now I will aggregate these comparisons and discuss the relationship between the Lewis turning point period and the disappearance of the demographic dividend. During the first decade of the millennium, Ryoshin Minami, a renowned Japanese development economist was elated when I mentioned my opinion that China had arrived at the Lewis turning point. For, Lewis’ theories of economic development had fallen out of fashion when Japan arrived at a similar turning point. This meant that Minami was fighting against the tide, and researched Japan’s economic turning point alone. Upon seeing my research, he especially organised several lectures for me in Japan. Academics from countries and regions currently undergoing or have already undergone the Lewis turning point were invited to engage in comparative research. This also provided me with the opportunity to gain an understanding of the experiences of other East Asian economies. According to Minami’s reckoning, Japan entered the Lewis turning point around the beginning of the 1960s. If we take the onset of rises to the dependency ratio as being the turning point for the disappearance of the demographic dividend, then Japan reached this turning point around 1990. Roughly three decades separate these two transitionally significant periods. The research of the South Korean academic, Moo-ki Bai, shows that South Korea entered the Lewis turning point at the beginning of the 1970s, and the point at which the demographic dividend disappeared occurred around 2015, on the assumption that increases in the dependency ratio signify the

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onset of this more than four decade-long process. If we take 2004 as the point at which China arrived at its Lewis turning point, and 2015 as the year in which the dependency ratio increased, heralding the disappearance of the demographic dividend, then this entire process only took 11 years. Why is it that these two turning points happened so much closer together in China, compared with Japan and South Korea? It is generally believed that since China’s reform and opening, and especially since entry into the World Trade Organisation at the turn of the 21st-century, the speed of transition of agricultural surplus labour is comparable to 1960s Japan, and 1970s South Korea. Admittedly, these three countries successfully achieved the redistribution of labour whilst engaged on their own process of dual economy development, thereby completing the tasks of the K stage of the five stages of East Asian economic growth as determined by the now deceased Stanford University Professor Emeritus, Masahiko Aoki. These were, the Malthusian poverty trap stage, or M stage; the government directed economic growth stage, or G stage; the Kuznets’ structural change driven growth stage, or K stage; the human capital driven development H stage, and the later demographic dividend stage, or PD stage. However, China’s surplus labour transition process possesses huge differences compared to that of the other two countries, which can be understood from two angles. First, China’s industrialisation did not develop in tandem with the transition of surplus agricultural labour prior to the start of the reform and opening at the turn of the 1980s. Rural labour was bound to agriculture by the three fetters of the people’s communes, the state monopoly on purchase and marketing of agricultural produce, and the household registration system. This resulted in extremely low marginal agricultural productivity, and the formation of the typical characteristics of the unlimited supply of non-agricultural labour. It is evident that, if the late 1950s marked the start of China’s industrialisation, then the start of the 1980s marked the beginning of the agricultural labour transition period. The onset of this process lagged behind industrialisation by more than two decades. Moreover, during the entire reform and opening period, and since the start of the 1980s, the institutional barriers set in place to impede the transition of agricultural labour did not immediately disappear, but have been persistently eliminated over the course of lengthy, gradual, incremental reforms. Moreover, the entire swathe of institutional factors, of which the household registration system is core, still currently serve to impede labour mobility. It could be thought that the existence of these barriers has delayed the transition of agricultural labour by at least a decade. Simultaneously to this, China’s demographic transition is progressing faster than that of Japan, South Korea, and many other well-known East Asian economies. The data shows that the temporal relationship between Japan and South Korea’s two turning points is primarily determined via the speed of labour transition or by demand side factors. China has been more impacted by the speed of the demographic transition and supply side factors. Evidently, the particular nature of China’s turning point heralds much more difficult challenges. We can understand the features of the economic development stages brought about by China’s characteristic ‘old before rich’ by reviewing the proportion of agricultural labour during the Lewis turning point in Japan, South Korea and China.

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With the development stage of industrial structural changes being the main impetus of economic growth (the K stage), that agricultural labour comprises the entirety of the workforce is an important symbol of successful development. However, labour transitions are influenced by a range of different factors, and, in terms of general trends, how they develop differs from country to country. The historical experience shows that China’s unique range of institutional factors have impeded the transition of surplus agricultural labour, with the proportion comprised by agricultural labour on the Lewis turning point being evidently higher than Japan at a similar stage in development. For instance, this proportion in Japan in 1960 was 30%; and based on National Bureau of Statistics data, China’s was as high as 47% in 2004. If we refer to adjusted data, then it is still higher than the Japanese level, at 35%. Furthermore, as China’s demographic transition is proceeding more rapidly, and is forecast to complete the descent and ascent sections of its shift in the dependency ratio at the same time as South Korea. This means that its proportion of agricultural labour at the Lewis turning point is substantially lower than that of South Korea. We can also compare China with India, which is at a lower level of economic development. India’s dependency ratio began to fall at roughly the same time as other countries in Asia, and is falling comparatively slowly. This decline is forecast to reverse around the year 2040. India’s demographic dividend will therefore persist for a long period of time, around twenty-five years longer than China’s. This means that as China’s demographic dividend disappears, and its comparative advantage in labour intensive industries also vanishes, India has the potential to inherit this comparative advantage. There are also other examples, besides India. Vietnam, as well as many other developing countries around the world such as those labeled the ‘Next Eleven’ by Goldman Sachs, compete with China in related industries to a certain degree.

The Second Demographic Dividend If we adhere to prior definitions of the demographic dividend, namely, sustained increases in the working age population, and its constantly rising proportion, thereby guaranteeing an ample supply of labour and high savings rates, then the dependency ratio is forecast to stop falling and begin rising in 2015. This signifies the conclusion of the demographic dividend. However, research, such as that by the American demographic economists Ronald Lee and Andrew Mason, which shows that as demographic structures age, individual and family precautionary behaviour can engender the creation of a new savings impetus. This new source of savings can further engender profit from investments in Chinese and international financial markets. This has been called a ‘second demographic dividend’, and differs from the definition given above.1 However, if we only observe from the perspective of savings 1 Lee

and Mason (2006).

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drivers during the ageing period, which although may be unable to reach the level of driving economic growth, it may serve as a second demographic dividend on a par with the first. When analysing the causes of the ageing population, people often focus on the initial reduction in the child population, which then matures into a smaller working age population, and eventually results in all increases to the proportion of the population occurring in the elderly population. However they often overlook the impact of increases in lifespan that herald increased demographic life expectancies. Imagine that the demographic structure of the child, working age and elderly age cohorts were to remain static. Then, if the elderly were to enjoy longer lives, then as defined, the elderly would comprise an increased proportion of the population if adopting this indicator to observe the ageing of the population. A healthy elderly population with longer life expectancies possesses valuable human capital. Since they are, in effect, already a part of the labour force, and are equipped with a wealth of human capital, this means that the second demographic dividend possesses intrinsic value only when considered from the perspective of labour supply and the accumulation of human capital. In addition, a country with a colossal population that is still at a stage with a relatively low average educational level, its scale means it will still be home to large numbers of people with relatively high human capital. Where creativity and innovation have an equal probability to emerge, then this country will also harbour huge amounts of creativity and innovation, which will positively impact on the country’s economic development. Economists, economic historians, and economic growth theorists have all separately come up with a theoretical basis and empirical proof on this aspect. This means that, as the institutional conditions for unleashing this kind of creative energy are being constantly optimised, even if the demographic dividend, in the traditional sense, disappears, a second demographic dividend is possible. This conclusion is undoubtedly of special and practical significance to China. It is worth noting that there are conditions that apply to the utilisation of the demographic dividend, in particular, a whole series of institutional conditions are required. A wealth of past literature shows that the key for developing countries in catching up with and overtaking developed countries is that they grow faster than the latter, which results in convergence. Research on neoclassical growth theories shows that this is a conditional convergence, in that it only needs to satisfy a series of material and institutional conditions, whereby developing countries require a range of potential factors before this can turn into actual sources of economic growth, and then, from which achieve faster economic growth.2 The fall in the Chinese dependency ratio began in the mid-1960s, but it was not until the reform and opening that the conditions were created to employ that first demographic dividend. Based on the definition, the requirements for a second demographic dividend are even higher, and pertain to reforms in education, employment, and residence registration system and old age care systems, as well as the maturation of the capital markets.

2 Sala-i-Martin

(1996).

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In fact, the concept of a demographic dividend is ultimately an artificial construction created by economists, and not a perspective on economic growth that derives from demography. Moreover, from an economics perspective, it is also merely a partial angle. For instance, when economists attempt to treat the demographic dividend as an explanatory variable for economic growth (such as using the dependency ratio as a proxy), when, in actual fact, other variables including the input of capital, labour and the accumulation of human capital, as well as total factor productivity, all pertain to demographic factors. Or in other words, the first demographic dividend only played a kind of role which permitted a certain period of economic growth to rely on the input of factors of production to a relatively large degree. As for the second demographic dividend, apart from producing an effect beneficial to the expansion of the quantity of factors of production invested, similar to that of the first demographic dividend, such as maintaining the level of savings rates required for economic growth and labour supply, the most important factor concerns the harnessing of more sustainable sources of economic growth, namely, the realisation of improvements to total factor productivity following the demographic dividend development stage, via the accumulation of human capital, technological advances, and institutional reform. The timing of the first demographic dividend differed for different countries, for some developed earlier, whilst others developed later, and is not even possible to discern an evident demographic dividend in the early development of many developed countries. This means that, although China did benefit from the contribution of its demographic dividend to its economic growth, in actual fact this does not exist relative to other countries, the ageing population presages the arrival of a demographic deficit. China needs to avoid the appearance of a demographic dividend vacuum between the disappearance of its first demographic dividend and the arrival of the second demographic dividend. That China will be ‘old before rich’ engenders particular challenges in linking these two demographic dividends together. If China can extend the duration of the first demographic dividend whilst creating the conditions required for a second, then it can avoid the detrimental impact of an ageing population on economic growth, and maintain a sustainable growth rate. There has been a clear breakthrough in research on the relationship between demographic transitions and economic growth since the 1990s. Prior to this, research in this field had focused on observing the relationship between population scale, or population growth rates, with economic growth. The results of which were quite inconclusive, with evidence of the existence of both positive and negative relationships. However, when the focus of research shifted to observing the relationship between demographic age structures and economic growth, people discovered that the sustained growth of the working age population, and a constant increase in the proportion of such a production orientated demographic structure, could provide the economy with extra sources of growth, or a demographic dividend, via the provision of an ample supply of labour and increased savings rates. For instance, when the American economist, Williamson, was explaining the East Asian miracle created by Japan and the four Asian Tigers after the 1960s, as well as the portion of Western

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economic history where the New World economy exceeded that of the old, he discovered that an improved demographic age structure resulted in a drop in the dependency ratio, and can explain 25–100% of growth in excess of steady state growth.3 Simultaneously to this, the existence of a demographic dividend in some countries and regions prompted doubt amongst mainstream economists about the ‘East Asian Miracle’. They started from the premise of neoclassical growth theories and labour shortage induced diminishing marginal returns. This means that, no observable progress in the total factor productivity indicators means that any observed economic growth will be considered to be unsustainable. For instance, Alwyn Young and Liu Zunyi conducted a series of quantitative studies that explains why total factor productivity was not prominent during the high speed growth phase of the ‘Four Asian Tigers’, and that economic growth is primarily a result of factors of production. Paul Krugman cited these results in the Foreign Affairs magazine, and cast aspersions on the so-called ‘East Asian Miracle’, and concluded that such growth was unsustainable. However, in the development of economies with unlimited supplies of labour and prior to the total absorption of surplus labour, the existence of a demographic dividend means that diminishing capital returns might not arise. This means that, when other institutional environments receive protection and economic growth primarily derives from capital and labour inputs, then dual economy development is sustainable. The effectiveness of this type of growth, which differs from the criteria of neoclassical growth theories, has been verified by East Asia’s own rapid economic growth (such as the research respectively conducted by Williamson and Bhagwati during the 1990s). It can be seen that the observation and explanation of demographic dividends is of huge import amongst economic growth theories. The rapid growth rates realised during the reform and opening period were likewise influenced by demographic factors. Thus, during the reform period, a combination of population policies, economic growth and societal changes drove the demographic transition process. The demographic structure was characterised by a vast and rapidly rising working age population that comprised a large proportion of the whole. This constituted a favourable demographic structure and potential demographic dividend. This kind of potential demographic dividend was created with a prerequisite regulatory environment created by the reform and opening, that was sensitive to the market economy, via the dual economy development process and participation in economic globalisation. The research conducted by my colleagues and myself on economic growth during China’s reform and opening period shows that, each time China’s total dependancy ratio drops by a single percentage point, economic growth increases by 0.115 percentage points. Between 1982 and 2000, the fall in the total dependancy ratio drove the GDP per capita growth rate up by 2.3 percentage points, roughly contributing one quarter of GDP per capita growth during this period. Since the source of the demographic dividend is an advantageous age structure created during a specific stage of the demographic transition, this demographic age structure will naturally age through the stages of demographic transition. This means 3 Williamson

(1997).

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that a demographic structure that possesses an advantageous working age population will eventually shift into one dominated by an elderly population. In actual fact, the 15–64 year old working age population grew rapidly from the 1960s until the 1990s, when its growth slowed. This growth is forecast to halt on or around 2015. Simultaneously to this, the aged 65 and above population already comprised 7% of the total population in 2000, and is forecast to comprise 9.6% by 2015. Correspondingly, the dependency ratio also reached its turning point, with its descent shifting to ascent. There is no harm in exploring a second demographic dividend of a similar magnitude to the first, from the perspectives of labour supply and savings rates.

Enormous Potential: Savings Rate and the Pension System From the perspective of an individual human lifespan, a person first belongs to the child dependent population prior to attaining working age, and after which, and through employment, they become part of the productive population. As the years go by and after they withdraw from the labour market, they become part of the aged dependent population. Correspondingly, people are primarily employed and earning an income between the ages of 20–65. The lengthening of the time in education has led to the postponement of active working lives by four or five years, compared to the figures usually stated. In addition, no matter whether a person derives their income from work or not, they consume throughout their lives. This leads to the creation of the characteristics of the individual work income and consumption life cycle, even if a static level of consumption is maintained throughout a lifetime, and income from work starts to appear near the age of 20, and then rapidly rises to a stable yet highlevel between the ages of 25–45, before gradually declining, and then disappearing around the age of 65. As work income and consumption periods do not completely correspond, individuals, families, and even societies need to save, to smooth out the lumpy income earnings period, with a relatively consistent level of consumption over a lifetime. This means that, based on the definition of the first demographic dividend, the larger the scale of the working age population, the greater the proportion it comprises of the total population, the stronger its savings capabilities, meaning that when all else is equal, this results in the creation of a high savings rate. Continuing this train of thought, when the growth rate of the working age population falls or even enters into absolute decline, precipitating the arrival of a stage with heightened levels of ageing, then savings rate will fall. However, just as the academics Lee and Mason pointed out in their analysis, the desire to save, and also maintain, or increase the value of savings in the future is still feasible in an ageing society. Whether this is realised is dependent on corresponding institutional conditions, especially that of the nature of the old age pension system. This means that, the pay as you go old age pension system, which does not require the future supported population to rely on their own saved pension funds, does not stimulate the desire to save.

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Since China accepted the dual method basic pension social plan combined with individual accounts, the two accounts have long featured mixed administration. When large-scale historical debts exist, individual accounts have funded plan expenses, leading to empty account management. Despite expansions to the cash flow balance of the basic pension fund or individual account savings as more provinces have participated in the pilot scheme, the gradual drop in contribution rates and also the fact that a large number of provinces have never initiated this reform have severely restricted the total contributions scale. Zheng Bingwen’s research discovered that, in 2011 the individual accounts featured accumulated contributions of ¥270.3 billion RMB, which compared to the figure on the books of ¥2.09 trillion RMB, still features a shortage of ¥1.82 trillion RMB.4 Data from the National Bureau of Statistics shows that, the accumulated surplus of the basic pension fund had already reached ¥1.3 trillion RMB by 2011, and had reached the even higher ¥3.5 trillion RMB by 2015. However, this cannot be transferred to supplement the empty individual accounts, for the basic pension is not implemented nationwide. This surplus is highly concentrated in a small number provinces with labour inflows. In 2012, 55.9% of the pension fund was held by seven provinces, of which, Guangdong province held 16.2% of the total national pension fund. In actual fact, issue of pensions in many cities in the developed coastal regions is dependent on migrant worker contributions. The high mobility of migrant workers means that despite contributing to the pension pot, they are unable to withdraw from it. The pay-as-you-go system is designed on the basis of a large scale working age population that also comprises a high proportion of the total population, and also a low dependency ratio. Higher labour productivity would be needed to compensate for a change in these conditions, otherwise the system becomes unsustainable. It is generally thought that increased life expectancies and the drop in fertility rates will result in a change in the ratio of the supporting population with the dependent population. In such a situation, the pay-as-you-go system will inevitably be faced with the three following options. First, either raise taxes or the level of compulsory contributions. Second, lower pension payment amounts. Third, raise the age at which people are eligible to draw their pension. If savings in individual accounts could commence at the earliest possible date, then these problems can be resolved. Several years prior, a colleague and I conducted a simulation study, whereby if the pay-as-you-go pension system was comprehensively shifted to a individual account savings system, then by 2020, a considerable group of retirees will be able to fund their retirements without relying in whole, or in part, upon the pay-as-you-go system. Which would greatly reduce the burden of retirement on society. In addition, we also need to simultaneously establish a more universal pension program, to ensure that every single elderly person, no matter their employment status, enjoys coverage. This would mean that a thoroughly savings focused pension could comprise a driver and source for savings.

4 Bingwen

(2012).

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Raising Skill Sets and Maintaining Comparative Advantages Although when people discuss the concept of the demographic dividend they are referring to a demographic structure beneficial to production, and exerts a positive influence on two of the conditions for economic growth, savings rates and labour supply. However, labour supply itself contains factors pertaining to human capital. As previously described, during the ageing of the population, labour market mechanisms can still be employed to increase the scale of the working age, thereby ensuring an ample supply of labour. In addition, improved education provision means that changes to the demographic age structure will not necessarily negatively impact human capital accumulation. On the contrary, changes to the demographic structure will lead to the creation of some new conditions, and will be beneficial for the expansion and optimising of education provision. This can be viewed as a second demographic dividend, a human capital dividend, that brings a new source of economic growth. Changes to the age structure brought about by demographic transition are expressed via a downward trend in the proportion and scale of the population receiving elementary education (the child population aged between 5 and 14 years old). This downward trend corresponds to a staggered delay in changes to the working age population. The forecast change of the latter is first that of a rise, and then a stable peak, followed by a drop. The changing relationship between these two population age cohorts, will engender a reduction in the school age population supported by the working age population. The economic implication of this phenomenon is that constrained educational resources will alleviate somewhat as the demographic structure changes, allowing the nation, society, and families to devote more resources to the further expansion and deepening of education. When the ratio of the 5–14 year old cohort student population with the 15–59 year old cohort working age population (the student population support ratio) trends downwards, we can conditionally raise the student age to a 5–19 year old cohort, which is simultaneously declining with the 20–59 year old working age population ratio, thereby not encountering severe resource constraints. This is even more the case when the compulsory education penetration rate is extremely high, as is now the case. If the actual retirement age can be raised in future, then such resource constraints will ease further. China’s education levels have substantially risen during the 30 plus years of the reform and opening, and higher and vocational education have made great strides forward on the heels of the virtual universalisation of compulsory education. However, there is still a relatively large gap between China’s education standards and that of developed countries. There are still enormous regional disparities in the level of education provision, and also between urban and rural areas. For instance, the enrolment rates for under 18s in developed countries is essentially 100%, compared to which, China’s enrolment levels abruptly drop after the age of 12. Virtually the same trajectory can be seen when observing disparities in education levels between rural and urban areas. This aspect is undoubtedly a constraining factor on increases

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to labour productivity. The other aspect is the goal of labour productivity increases via the improving of the educational depth possesses enormous potential. The fundamental nature of the dual economy, the unlimited supply of labour, has changed. The demographic dividend, which China fully benefited from during the reform and opening period, has also gradually disappeared. This constrained labour supply has not just negatively impacted economic growth speed, but is also manifested via a lowering of the potential growth rate, a slowdown in the improvements to labour skillsets (human capital), a drop in the rate of capital returns, and a reduction in total factor productivity growth. In actual fact, increases in wage levels do not necessarily signify a drop in competitiveness and comparative advantage. These are impacted by unit labour costs, namely the ratio of wage levels to labour productivity. A direct impact is that GDP growth is, to a large extent, constrained by increases in the quantity of labour, and is in fact dependent on the speed of increases to labour productivity. Or, in other words, even if the quantity of labour stops increasing, if the rate of increase in labour productivity can offset the impact of labour shortages and rising costs, then the comparative advantage will persist, meaning that the economy can continue to maintain its forecast growth rate. There are three main sources for labour productivity rises. First, increases in the capital to labour ratio. The replacement of labour by capital, or by machinery, is inevitable as labour costs rise. However this kind of substitution is constrained by the laws of diminishing capital returns, and would not be a quick fix. If workers are unable to adapt to the requirements of the machinery operation, capital-labour substitution will prove counter-productive. Second, improvements to human capital. Increasing machine operator skillsets, and the proportion of engineers, is a prerequisite for a smaller proportion of workers operating a higher proportion of machinery and equipment. This means that, a lack of workers possessing higher capabilities, with higher creativity and fresher skill sets, will make it harder for capital labour substitution to achieve its anticipated outcomes. Third, an increase in total factor productivity. The introduction of new technologies, an increased focus on innovation and the optimisation of resource allocation, will lead to total factor productivity rises, and is the most fundamental, and sustainable, source of labour productivity. This requires reforms to create a competitive environment. When a colleague and I were analysing factors affecting China’s economic growth between 1978 and 2010, we found that the contribution rates for accumulated physical capital was 73.7%, and that of the quantity of labour, 7.1%, and the education level of workers (human capital) was 4.2%. The dependency ratio was 6.7%, and total factor productivity was 15%. These results show that, the contribution of human capital is far below that imagined. In fact, other research aimed at explaining the factors contributing to China’s economic growth produced similar results. There are two items which require further explanation. First, the education quality was not considered in the calculations, meaning that the contribution of education to economic growth has been underestimated. The latest research by economists such as Ma Niuli clearly states that once education quality is factored in, human capital can become a more complete, and sufficient explanatory variable. Statistical data shows that education has a substantial impact on promoting

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economic growth, which could be said to be even larger than that of the contribution of productivity rises. Second, human capital is becoming an increasingly important contributor to economic growth. Of the economic growth factors analysed above, the contribution of physical capital accumulation wanes daily with the ageing population induced falling savings rates and the fall in the marginal capital returns, and demographic transition trends necessitate that the contribution of the quantity of labour and the dependency ratio becomes a negative value. The only sources of growth that are sustainable and certain derive from human capital accumulation, and increases in total factor productivity. For instance, the Canadian academic John Whalley estimated that the human capital contribution rate should be much higher. The result he arrived at, via neoclassical growth accounting methodology, clearly depicted that between 1978 and 2008 human capital had a contribution rate of 11.7%, of the factors of physical capital stock, labour, and human capital stock weighted by years of education, and total factor productivity. When considering the different productivities of differing levels of education, he estimated an increased human capital contribution rate of 38%. John Whalley’s research, as well as that of other academics, also pointed out that human capital accumulation not only played a key role in China’s economic growth, but also has a counterbalancing effect on negative expressions of total factor productivity. One manifestation of the disappearance of the demographic dividend that has been ignored is the evident fall in the speed of improvements to capital. The extreme speed of China’s demographic transition and economic and societal development, and its improvements in human capital stock is mainly dependent upon the constant increases to the growth of new adult labour. During the reform and opening period, China experienced the universalisation of nine years of compulsory education and the expanded enrolment of higher education. New adult labour, with its higher number of years of education received, clearly improved the overall human capital of labour. However, as the quantity of new adult labour has entered negative growth, the speed of improvement of human capital has inevitably fallen. Adding up the numbers of students who dropped out of each level of education and those who did not choose to enroll in a higher level of education, reveals the so-called new adult labour. Demographic forecasts suggest that this demographic group entered negative growth in 2014, and if there is no evident change to the status of the development of education, based on current trends, the growth speed of the average number of years of education of new adult labour will start to fluctuate, and might even enter negative growth post 2019. Correspondingly, the total annual new human capital (quantity of new adult labour multiplied by the average number of years of education of this group) will exhibit a negative growth trend, and will rapidly contract in scale (see Fig. 8.2). China’s economy did not encounter labour shortages in 2004, thus there are two main reasons why growth slowed at the Lewis turning point. The first is that when labour shortages emerged, especially the negative growth of the 15 to 59 year old working age population post 2010, the higher labour participation rate meant that the

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economically active population scale maintained a certain level of growth. Demographic forecasts shows that the economically active population peaked in 2017, and thereupon entered negative growth. Moreover, productivity grew faster than wages for a period of time, but as the latter was making up for historically low levels, there was no evident increase in unit labour costs. However, there was an evident fall in productivity growth speed after the start of the second decade of the twenty-first century. The latest data from The Conference Board, an independent business membership and research association, shows that the average growth rate of China’s labour productivity was 9.5% between 2007 and 2012, and fell to 7.3% in 2012 and 2013, and then 7% by 2014. This new trend of labour productivity growth lagging behind wage level growth resulted in higher unit labour costs. Du Yang’s calculations show that, as the speed at which wages rises outpaced labour productivity growth, unit labour costs in China’s manufacturing industry assumed a rising trend from 2004 onwards, increasing by 40% between 2004 and 2012. Although I do not in the slightest believe that the deceleration of the Chinese economy is a result of demand side factors of the post financial crisis New Mediocre of the global economy, but the weak external demand for a certain period of time did in fact lend an additional urgency to the necessity of changing the development stage. Taking the changes to the comparative advantage of labour intensive industries as an example, although labour shortages and high wage costs lowered the comparative advantages and competitiveness of these kinds of industries, however, potential international competitors (such as developing countries with advantageous demographic age structures) would struggle to compete with Chinese worker skillsets at short notice, and would be unable to substitute the supply of ‘Made in China’ at sufficient scale, and so, the comparative advantages of China’s products will persist

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over certain timeframes, yet a growth slowdown could occur gradually. The financial crises and the resultant lacklustre recovery has greatly foreshortened this ‘grace period’, and the existence of such an accelerating deceleration have made the need for restructuring even more urgent.

References Bingwen Z (2012) The China pension development report 2012. Economy & Management Publishing House, Beijing, p 2 Lee R, Mason A (2006) What is the demographic dividend? Financ Dev 43(3) Sala-i-Martin XX (1996) The classical approach to convergence analysis. Econ J 106(July):1019– 1036 Williamson J (1997) Growth, distribution and demography: some lessons from history. NBER Working Paper, No. 6244

Part III

Sidestepping the Trap

This section discusses how China can avoid falling into the middle income trap. At present, China has already entered the upper middle income development stage. This means that it has already traversed the Lewis turning point, its demographic dividend is gradually disappearing, and its economy is continuing to slow. The World Bank, among others, points out that many countries are unable to sustain their economic growth rates after entering this development stage, meaning they fail to catch up with high-income countries, and instead plunge into the middle income trap. How should we view the deceleration of China’s economy? What is the middle income trap, and can it be avoided? Furthermore, this section focuses on how to handle the severe problems that result from income disparities that have been nurtured by China’s high-speed development.

Chapter 9

China’s Inevitable Speed Bump

That China is to hit a speed-bump does not seem such a positive thing. As such, this chapter will cover why China’s economic growth is slowing, and also why this is said to be an important juncture. Should we artificially stimulate economic growth or honestly, and stoically accept these new growth trends? In addition, what kind of policies should be adopted? These questions are not merely the focus of this chapter, but of interest to economists, policy makers and the general public. And so, from a policy perspective, China currently stands at a point in time where one small error could reap a whirlwind of repercussions. Simply parroting the opinions of others, or building castles in the sky, or even just taking things for granted will not help much; for the answer is likely to require a basis in scientific analysis.

Do Not Be Afraid of the Wolf The 18th National Congress of the CCP set the goal that by 2020, GDP should double from its 2010 level. The 17th National Congress set the goal of a tripling of China’s 2000 GDP by 2020. China surpassed its target for the previous decade. To focus on doubling GDP per capita with the time left demands a higher development speed, and that is the reason for the stipulation of a doubling of GDP. Starting from 2010, GDP growth was 9.2% in 2011, and 7.8% in 2012. An average of 7% per annum would thus be more than sufficient for a doubling. This is a lofty goal, but it does not necessitate a higher growth speed, and signifies that China has room for manoeuvre to speed up its transition of its economic growth methods. China has maintained growth of close to 10% for the past three decades or so, reaching 11.2% during the 11th Five-Year Plan, and so everybody feels that growth is slackening if growth speed drops below 10%, or even 8%. All we have heard about since growth fell to 7.7% in 2012 is how China’s economic growth is failing. There are always those in the international arena who decry China, and are constantly preaching about China’s imminent collapse. There are also many © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_9

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people within China who worry about this problem, and who cried ‘the wolf is here’ on many previous occasions, yet the wolf never actually came. It did however seem that the wolf had finally arrived in 2012, when economic growth dropped below 8%. From 2006 onwards, even including the financial crisis, GDP growth speed had never fallen to this level. It looked as if they were finally right and that the Chinese economy was indeed faltering, and all those ‘children’ who had been ‘calling wolf’ had a field day. However, it seems like, on the issues that previously used to cause so much concern, the arrival of the wolf was not much to be scared of, after all. The Chinese government has always maintained that economic growth speed could not fall below 8%, including during the financial crisis. The government had been concerned about meeting employment demand. Insufficient work would lead to a fall in incomes, and precipitate social problems. Nevertheless, when growth really did fall below 8% in 2012, the labour market was actually extremely tranquil: increases in new employment overfilled goals set at the start of the year, and the urban registered unemployment rate maintained a level of 4.1%, exhibiting no significant change on prior years. In addition we also saw that each province, city and autonomous region nationwide successively raised their lowest wage standards. Increases were, on average, substantial. Rising wages implies insufficient labour, and that employers find recruitment more difficult than job seekers do finding employment. As such, the health of the labour market was better than that previously assumed, for it did not fall apart when growth dropped below 8%. We can utilise public employment service organisation data on labour market recruitment and job seeking, taking the number of job openings as the numerator, and the number of job seekers as the denominator, to arrive at the job seekers to job openings ratio. Evidently, if the ratio is higher than 1, then job openings outnumber job seekers. If lower than 1, then many people will be unable to find employment. In fact, the job seekers to job openings ratio has been higher than 1 since economic growth slowed in 2012, meaning that job openings still outnumber job seekers. Of course, the structure is different, in that there are not so many graduate jobs on offer. Why were we so scared of the coming of the wolf, yet it gave no hint of its ferocity upon its arrival? China’s employment has not suffered attack. This does not mean that we were previously wrong, but that the current labour market has evolved. The fundamental reason being that if the actual growth rate is above the potential growth rate, then there will be no cyclical unemployment and thus, no assault on employment. The potential growth rate is the normal growth speed as determined by current factors of production (labour, capital, land) and rises in total factor productivity. The precondition to which is the assumption of the full utilisation of all factors of production. A situation such as where the actual growth rate is not below the potential growth rate means full employment, or even, difficult recruitment. The government work report from the ‘Two Conferences’ (the National People’s Conference and the National People’s Political Consultative Conference) held at the start of 2012, forecast a GDP growth rate of 7.5%, the actual growth rate was ultimately higher than this target, and higher than the potential growth rate of 7.2% we calculated during the period of the 12th year plan, as well as 2012s potential growth rate of 7.5%. Results such as these will clearly not endanger the labour market.

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Looking at longer term factors, people always say, with regards to economic growth, the faster the better. They never say, the slower the better. In fact, whilst fast growth is desirable, faster is not inevitably better. It is not the most developed countries whose economies grow the fastest, for fast growth speeds are indicative of catching up, whereby a backward country can only catch up with others if they grow at a comparatively faster clip. Figure 9.1 drawn up based on data provided by the World Bank. The leftmost bar denotes average global growth speed. The bars to the right of which, that of some representative developing countries, all of which have extremely fast growth rates, all between 6 and 8%. After which are the BRICs, Brazil, Russia, India, and China, all of whom have comparatively fast growth rates, some a little faster, and some a little slower. Further to the right are those developed nations with fairly healthy economies, such as Germany and the USA. Japan and Greece represent poorly performing developed nations, and have negative growth rates. Normal, healthy countries are certainly the most competitive, of these, I have selected Australia, Austria, and Canada. All of which have positive growth rates, yet slower than that of rapidly growing developing countries, which feature comparatively low levels of development, and might be lacking in capital, with large technological gaps; yet with the right conditions, investment will rise, and they can make use of the technological know-how of other countries, and catch up at a slightly faster clip. In actual fact, the more developed an economy is, the less able it is to grow at super-normal speeds. Why is it that when relatively backward economies can achieve much faster growth rates when catching up? Normally, institutions are an important explanatory factor of economic growth. These factors are irrelevant in the event of war, political corruption, or the adoption of a highly centralised planned economy. Or assuming all else being equal, where everybody has the same background, then a technological gap actually provides a ‘late starter advantage’. The existence of a demographic dividend is also very important. Robert Solow, the founder of so-called neoclassical growth theory, hypothesised that labour is finite, and the constant input of other factors, such

Fig. 9.1 High growth speeds are indicative of catching up

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as capital, will result in diminishing returns, constraining the speed of economic growth. Sources of economic growth derive from productivity increases and technological advances, namely, increases in total factor productivity. When total factor productivity exceeds that of other countries, faster economic growth will result. Krugman criticised the ‘Four Asian Tigers’ in the 1990s based on this hypothesis, believing that these economies only had production factors inputs, meaning that there were only labour and capital inputs, and no technological progress, and thus, no productivity rises, and that total factor productivity, in particular, performed poorly. This led to him forecasting that the growth evidenced in these economies was unsustainable, and like that of the Soviet Union, would ultimately stagnate. However, the shockwaves of the Southeast Asian financial crisis did not harm their long term economic performance, and the ‘Four Asian Tigers’, without exception, entered the ranks of high income nations and regions. The cause of Krugman’s inaccurate forecast was a fundamental flaw in neoclassical growth theory. For, it overlooks the possibility of a demographic dividend and a dual economy economic structure, whereby developing economies, and especially contemporary developing countries and regions, have a reservoir of labour that can constantly flow from low to high productivity sectors. This flow facilitates economic growth. It is clear that the existence of a demographic dividend determines the existence of an opportunity to catch up. China’s economic growth was, against the background of the reform and opening, achieved through this employment of its demographic dividend. Compared to his criticisms of the East Asian model of more than three decades prior, Krugman now understands the dual economy development period surplus labour transition process, and that it can postpone the emergence of diminishing capital returns, enabling China to realise more than three decades of rapid growth. However, he persisted in being part of the vanguard of those denigrating China. He declared, in an article published in the New York Times, that when China’s surplus labour will be exhausted by the time it arrives at its Lewis turning point, and in the absence of any rebalancing, meaning a substantial increase in consumption as a proportion of aggregate demand factors, but if it continues to rely on excessive investment, then severe diminishing capital returns will result. He coldly declared that the Chinese model is about to hit the wall, and moreover, said wall is not any ordinary wall, but China’s very own Great Wall. He also incredibly arbitrarily declared that China will ultimately fail to implement necessary policy adjustments, implying that this forecast future was inevitable.1

1 Krugman

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How to Set Rational Growth Speed Targets Annual GDP growth rates or average annual growth rates serve as forecast targets during the formulation of the annual development targets, and also Five Year Plans, for society and the national economy. Generally speaking, growth targets can be determined in the following three manners. First, empirical methods, namely decisions made based on past and recent circumstances, as well as forecast national and international economic trends. This method extrapolates existing trends, yet can be overly simplistic. Further extending or refining such a method leads to the second method, namely the usage of macroeconomic econometric models to model potential futures with past data, thereby arriving at judgements on growth rates for a given forecast year. These two methods primarily focus on short term demand constraints, and have the same underlying assumption that, with realistic constraining conditions, the faster the economic growth, the better, and as such, are focused on exceeding targets. Third, annual growth targets are determined and based on the estimated potential growth rate. The aim is to match the actual growth rate to the economy’s growth potential. As the potential growth rate is determined by production factors’ supply ability and the increase in the productivity rate over a set period of time, then setting forecast growth rate targets against the potential growth rate can lead to more balanced, coordinated, and sustainable growth rates. This does not encourage the compulsion to overshoot the target. Moreover, as the potential growth rate is relatively stable over set periods of time, it will change in lockstep with changes to development stage, and as such, such a calculation better reflects shifting supply side trends. For instance, indicating the Lewis turning point as well as the reduction of the working age population via labour shortages and rising wages; and an increasing demographic dependency ratio to point to the disappearance of the demographic dividend, can reflect the trending of the potential growth rate downwards. Prior to 2012, the formulation of China’s economic growth targets relied more on the first two methods. Growth targets were not that high, such as the 7.5% of the 11th Five Year Plan. This was to ‘allow for unforeseen circumstances’, and also to prevent inter-region competition. However, ultimately, faster growth was always considered more desirable. It should be mentioned this was logical for the time. For right until prior to the onset of the 12th Five Year Plan, China still possessed a stable and high potential growth rate, and so, fairly high actual growth rates were quite achievable. For instance, based on China’s estimated potential growth rate of 10.3% for the years 1995–2010, as the well-known Okun’s law shows, the portion of the actual growth rate lower than the potential growth rate corresponded to a certain degree of cyclical unemployment. This means that, when the potential growth rate was still fairly high, the central government policy of ‘maintaining 8% growth’ was necessary to prevent too much negative pressure on employment. The period of the 12th Five Year Plan marked the onset of the absolute annual reduction in the size of the 15–59 year old working age population, and also the gradual disappearance of the demographic dividend, causing a substantial drop in

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China’s potential growth rate. Calculations show that the potential growth rate during the period of the 12th Five Year Plan was an average of 7.6% per annum, before further dropping to 6.2% during the 12th Five Year Plan period. This means that, the actual growth rate matched with this rate is at the right level, and so there is no longer a need to maintain a growth rate of 8%, and furthermore, this will not lead to any consequent severe employment issues. In actual fact, the central government has not sought growth rates in excess of forecast targets in recent years, neither has it adopted any short term stimulatory measures. It has reduced direct over-interference in economic activities, alleviated the further exacerbation of over-production, and avoided the formation of economic bubbles, and, has created a macroeconomic environment amenable to reform. This means that the setting of forecast economic growth rate targets, when based on an accurate understanding, decisions and calculations of the potential growth rate is of critical importance. This practice should be continued, gradually standardised and rationalised. A misconception currently exists about the understanding, and actual calculations of the potential growth rate that requires clarification. The potential growth rate reflects an economy’s mid-term growth ability. It is supply side determined, and is unrelated with short term demand fluctuations. Labour supply, savings rates and total factor productivity are keys factors influencing the magnitude of the potential growth rate, and determine the growth range for healthy economic growth. Demand side factors, such as exports, investments and consumer consumption, only determine how an economy performs within this growth range, and have no impact on the location or size of the range itself. Or in other words, demand side factors can interfere with the actual growth rate, causing it to be higher or lower than the potential, creating a gap between the two, the so-called ‘output gap’, but exerts no influence over the potential growth rate. And so, with a set potential growth rate, a risk that insufficient demand results in economic growth falling below its potential necessitates the employment of macroeconomic policy measures to manage demand. Conversely, policies that stimulate exports, investment and consumption, with the aim of dragging the actual growth rate up above the potential growth rate, are both undesirable and extremely dangerous. After Japan lost its demographic dividend in 1990, the mainstream consensus amongst the government and the people was that the feeble economic growth was a result of insufficient demand. This led to the year after year implementation of stimulatory currency and fiscal policies. This focus on industrial and regional policies created a bubble economy, ‘zombie industries’ and ‘zombie banks’, the productivity rate faltered, leading to ‘two lost decades’ of growth. The so-called Abeconomics were unable to rectify this policy mistake. Its spearhead stimulatory demand policy worked for a while, but reforms aimed at changing the potential growth rate were not fit for purpose, and so ultimately failed to rescue the Japanese economy. Stimulating demand in an attempt to exceed the potential growth rate is undoubtedly undesirable, but supply side measures are feasible, and the absolutely only real choice. Many institutional barriers still exist prior to the completion of the reform tasks deployed during the Third Plenary Session of the 18th Central Committee of the CPC. These barriers constrain the employment of the labour supply potential (such

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as the residence registration system), improvements to investment efficiency (investment and financing systems) and increases in total factor productivity (preferential treatment of small and medium enterprises and the private economy). Demolishing these institutional barriers via reforms can rapidly raise the potential growth rate, and reap a reform dividend. Revising birth control policies can also raise the total fertility rate to around 1.8, the positive effects of which, a raising of the potential growth rate by between 10 and 15%, will be evident post 2030. A comprehensive consideration of the static calculations of potential growth rates, namely the 12th Five Year Plan 7.6% average, and the 13th Five Year Plan 6.2% average; and also that of dynamic forecasts of a gradual released reform dividend, leads us to believe that a forecast GDP growth rate target of 7.5% for the last two years of the 12th Five Year Plan is realistic. This will fall somewhat by the onset of the 13th Five Year Plan, to an average level of circa 7%. An accurate definition and more authoritative data is still required to further refine this calculation of the potential growth rate. On this basis, a determined forecast growth rate target should not serve as either a lower limit to be exceeded, nor an upper limit, with lower outcomes tolerated. This is to forestall the expectation of inflation in the event of overshooting the target, and the emergence of cyclical unemployment in the event of undershooting it.

Two L Shape Trajectories The V Shaped Revival is Outdated For a relatively long period of time prior to the Chinese economy’s entry into the new normal, each fall in economic growth was succeeded by a recovery, creating cycle after cycle of V-shaped growth trajectories. In actual fact, when factors obstructing growth were primarily demand side in origin, the adoption of aggregate demand stimulatory measures was often sufficient to return the actual growth rate to the level of the potential growth rate. This was the source of China’s past V-shaped recoveries. The entrance into the new normal signifies that the primary factors influencing economic growth are supply side in origin, and that the demographic dividend, formerly a key long term economic growth driver, had disappeared, and moreover would not return. In such an environment, relying on past methods to revive economic growth to its former level becomes difficult. First, the Chinese working age population is already exhibiting negative growth. For reasons of convenience, we often use the 15–59 year old population to represent an economy’s total potential workforce. This population in China peaked in 2010, and exhibited negative growth after this date. Data from the 2010 national census shows that, nationwide, the 15–59 year old population is 939.62 million people strong (70.14% of the total), and based on calculations from the data of the 2015 nationwide 1% population sample (a mini-census), the 15–59 year old population

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is 924.71 million people strong (67.33% of the total). This population has fallen by nearly three percentage points in five years. Apart from which, calculations based on sample survey data from past years by the National Bureau of Statistics also showed that, no matter whether the proportion, or the total scale of the total population, China’s working age population commenced an annual downward trend several years prior. Second, China’s economically active population has already entered a period of negative growth. If we say that the working age population merely reflects an economy’s potential labour force, then the economically active population more truly reflects an economy’s labour supply status. We know that, not all of the current working age population work. A proportion of whom are not considered workers in the sense of labour economics. For instance, some people possess absolutely no desire to work, are enrolled in full time studies, are full time housekeepers, or have retired early or have left the labour market. This means that those who comprise the effective supply of labour from the working age population are those who participate in the labour market. The economically active proportion of the working age population is known as the labour participation rate. Its structure is often the result of a kind of behavioural preference, and determines the supply of labour. If the labour participation rate stays roughly the same over a certain period of time, then the economically active population will fall as the working age population falls. To further verify labour supply’s downward trend, we have drawn up Fig. 9.2 from a range of calculations based on demographic data, as well as that released by the National Bureau of Statistics, and have arrived at a somewhat different conclusion. First, we set the working age population as the population aged 16 and above.

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This allows for positive influences on labour supply, such as delayed retirement. Furthermore, we have compared this with the National Bureau of Statistics’ data, and adopted an internationally accepted definition. Second, we have adjusted the working age population with the forecast labour participation rate, to determine the economically active population. Figure 9.2 shows that labour supply still exhibited a brief ascent after 2011, peaking in 2015, before subsequently following a downward trajectory. Simultaneously to this, we included the economically active population data from the National Bureau of Statistics in the chart, for purposes of comparison, although it is still not evident whether this data set has peaked or not. Third, China’s labour participation rate is currently falling. Recently, the Institute of Demography and Labour Economics of the Chinese Academy of Social Sciences launched the latest round of labour surveys in the six major cities of Shanghai, Guangzhou, Fuzhou, Wuhan, Luoyang, and Xi’an (CULS-4). A basic conclusion can be arrived at when comparing with the collated data of the previous three rounds of survey data. Every age cohort of China’s working age population has exhibited a downward trend in recent years. This diverges somewhat from our prior findings. In addition, an analysis of the data of the 1% population survey leads to a similar conclusion. This means that when the labour participation rate is no longer rising but has directly entered a gradual downward incline, that the scale of the economically active population has peaked should be absolutely beyond doubt. When the working age population and the labour participation rate are both in decline, then the reduction in labour supply has been magnified, and signifies that the decline in China’s actual labour supply is more severe than anticipated. From the start of the reform and opening to the turn of this century, the comparative advantages enjoyed by China’s manufacturing industries enabled them to grow rapidly, and their international competitiveness soared. During the thirty years or so since the start of this process, employment expanded via the market allocation of labour. The wage levels of ordinary workers exhibited no rises in real terms for extremely long durations, sustaining the competitive advantage of the manufactured goods. This also postponed the onset of diminishing capital returns. Nevertheless, labour shortages gradually become the new normal as the Lewis turning point is completed, and the wage levels of ordinary workers rise increasingly fast. Wage rises (especially that of ordinary workers) is admittedly a good thing, and beneficial to the raising of per capita incomes of low to mid income families, and is conducive to improving income distribution, and realising inclusive growth. Enterprises can also gradually reallocate the factors of production, adjust market structure and technological structures as labour costs change, and ameliorate the impact of rising wage costs via productivity rises. However, if wages rise too quickly, then productivity rises will clearly lag behind, to the point that supporting new wage rises becomes tricky. A substantial increase in corporate unit labour costs will result, this poses operational difficulties, and thus harms the entire economy, which then will harm the workers themselves. Labour productivity rises are the basis of wage growth. The current situation is that labour productivity is increasingly struggling to support the momentum universal

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rapid rises to wage levels. Related research shows that China’s current unit labour costs (the ratio of wages and labour productivity) are currently rapidly rising, and gradually approaching the levels of some developed countries. This has led to the gradual decline in the traditional comparative advantages enjoyed by manufacturing industries. As a rule, adding up the number of school drop outs at every kind of school, and every level of education, with the number of those who have not pursued further education upon graduation, is roughly approximate to the number of people who enter the labour market each year to search for employment, which we may call new labour. Increases in an economy’s human capital stock primarily derive from the new labour group possessing stronger human capital accumulation. Which for China, new labour, along with a fairly high stock of human capital plays a huge role in the raising of the human capital stock per capita for the whole of society. Since the reform and opening, hypernormal education development policies, such as nine years of compulsory education, and the expansion of higher education, have greatly advanced new labour human capital levels. This means that, the speed at which human capital improves as a whole will inevitably slacken as new labour shrinks in scale. One of our forecasts shows that since 2013, the total amount of new increases to human capital in China has begun to exhibit an annual decline. A fundamental premise of neoclassical growth theory is that the phenomenon of diminishing marginal capital returns will exist when labour supply is limited. When China’s age of an unlimited supply of labour has become history, then the law of diminishing marginal capital returns will come to the fore, and the rate of capital returns will correspondingly fall. This is the situation that China currently faces. In actual fact, China’s capital to labour ratio rapidly increased after it passed the Lewis turning point around 2004, and in its wake came an evident fall in the rate of capital returns. For instance, research by Bai Zhongen and Zhang Qiong shows that between 2003 and 2014, China’s rate of capital returns fell from 24.3 to 14.7%, an average decline of 5.7% per annum. Under normal circumstances, when labour transitions from low productivity sectors to high productivity sectors, the resultant optimisation of resource allocation engenders resource reallocation efficiency. Since China’s reform and opening, the most important aspect of increases to total factor productivity has been the contribution of this kind of resource reallocation efficiency, especially that derived from the transition of rural labour. As such, the trend of increasing total factor productivity has also slowed. As the scale of the 16–19 year old rural population (the main body of labour heading far afield for work) already peaked in 2014, resulting in a marked reduction in the increase in the quantity of rural labour heading far afield for work, which for instance, was only 0.4% in 2015. In other words, in the current setup, that rural labour that can be reallocated has already essentially been allocated, making further substantial total factor productivity improvements extremely difficult. Apart from which, if the regulatory constraints of the residence registration system on workers moving from the countryside to the city are not eliminated, as they will be ineligible to receive fair urban social security provision, migrant workers will ordinarily return to the countryside after the age of

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40, which might result in a situation where the number of new migrant workers is smaller than the population returning home, resulting in a reverse flow of labour from the city to the countryside. All of the above factors have caused supply side falls in China’s potential economic growth rate. By using these variable factors, we predicted the potential growth rates of the Chinese economy over different periods of time. The overall picture being: growth was around 10.3% from the mid-1990s to before 2010; and it averaged at 7.6% during the 12th Five Year Plan from 2016 to 2020. The potential growth rate will drop to an average of 6.2% in the absence of major economic stimulatory policy reforms. Based on the definition, we can calculate the economic growth rate gap by deducting the potential growth rate from the actual growth rate. A positive value means that the economy exceeded its growth potential, and is often manifested via an overheating economy or the creation of an economic bubble. A negative value means that the economy did not reach its growth potential, and room exists for demand side stimulation. We can see from Fig. 9.3 that there were years with fairly large negative growth rate gaps during the reform and opening period, which coincidentally, is a period where demand side assaults have led to a stagnant macroeconomy. Stimulatory aggregate demand measures during such periods can often enable the economy to return to its potential growth rate level. This results in the formation of a V shaped growth rate. If we believe that the potential growth rate has not fallen, but still holds its previous level, then when the actual growth rate falls, we can calculate that there is still a negative growth gap (see Fig. 9.3). As this is owing to an unrealistic hypothesis on the potential growth rate, then, we can call this basic calculation of the growth gap as the ‘fake growth gap’. This kind of understanding, people will expect to return the 7.0 5.6 4.2 2.8 1.4 0.0 1.4 2.8 4.2 5.6 19 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 19 95 1996 1997 1998 2099 20 00 2001 2002 2003 2004 2005 20 06 2007 2008 2009 20 10 20 11 2012 2013 2014 15

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economic growth rate to the potential growth rate via the utilisation of commonplace stimulatory macroeconomic policies, which will result in an accelerated rebound of the V shape. Nevertheless, it is regrettable that, stemming from the range of reasons stated in the prior analysis, China’s potential growth rate has also exhibited an evident fall, the average potential growth rate has already fallen to around 6.2% during the 13th Five Year Plan period. We can see from comparing this with the actual growth rate that there is currently no extant way to remedy the negative growth gap, and thus it is evident that we should not hold out hope for an accelerated rebound of the V shape trajectory.

Short and Medium Term L Shape Growth Trajectories Although we do not wish to produce the accelerated rebound of the V shape trajectory, but structural reforms that impact the supply side, can eliminate institutional factors that impede the supply of factors of production and their allocation. This creates a more gentle decline of the potential growth rate curve, and respectively creates short term, medium term, and long term L shape growth trajectories. In actual fact, in 2016, China’s economic growth had already comprised a minor accelerated V shape rebound. Departing from the annual decline in economic growth since 2012, a seasonal declining trend emerged from the fourth quarter of 2014 to the first quarter of 2016. Growth for each quarter of 2016 stayed within the forecast growth range, creating a growth rate of 6.7% for the entire year. Relative to the prior and persistent declining trend, the release of reform dividends meant that a portion of the growth rate that was the result of the expansion of aggregate demand can be said to have formed a short term, and stable L shape curve. With this inspiration and encouragement, we have conducted a further forecast on the premise of a reform induced dividend, whereby the Chinese economy will present a different, and more clarified L shape growth path over the medium term. Forecasts conducted with differing premises leads us to believe that a reasonable range of growth for the Chinese economy during the period of the 13th Five Year Plan is between 6.2 and 6.7%. There will be a trajectory of annual decline no matter what the upper or lower limits are (see Fig. 9.4). Containing the L shape trajectory within its upper and lower limits ensures that the national economy operates within an appropriate range, and that growth, in the aggregate, remains steady. Simply put, ensuring that economic growth does not fall below the lower limit guards against the emergence of cyclical unemployment, and is the basic precondition for maintaining living standards. Although China is yet to experience evident cyclical unemployment, but high vigilance is needed as the actual economy heads towards this lower limit. Ensuring that economic growth does not rise above the upper limit safeguards against the emergence of economic bubbles, and also that of systematic economic risks. As there is currently already no growth gap, surpassing the upper limit, might indicate the overstimulation of growth, and potentially leading to the entry of a high

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Fig. 9.4 The growth range for the 13th Five Year Plan period and the first L shape trajectory

degree of fluidity in the fake economy. It can be seen that, setting upper and lower limits to growth are necessary, both to safeguard people’s livelihoods and to guard against risk. It is possible that an L shape trajectory will emerge in the short and medium term as reforms progress within this range. As of 2016, the actual growth rate of the Chinese economy was right within the reasonable range described above, but it once was somewhat closer to the lower limit, and then began to stabilise, as depicted in Fig. 9.4 by the solid line between the upper and lower lines. If we forecast that, starting from 2017, there was a gradual release of a reform dividend, and this was reflected in economic growth, such growth would be lower than that of the prior growth rate, owing to the fall in the potential growth rate. However, such a decline would be more mild than the post 2012 situation. In addition, it maintained an average growth speed of around 6.5% for the four years after the period of the 13th Five Year Plan, and so Fig. 9.4 shows that this speed will cause the future actual growth to trend towards the upper limit of the growth range (as depicted by the fake growth line). In this way, the actual growth line can create an L shape medium term growth trajectory within the upper and lower limits. This speed can ensure that total GDP can double by 2020, based on 2010 values, and such growth is relatively high value, profitable, and sustainable.

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A Longer Term L Shape Trajectory If each of the supply side reforms are enthusiastically advanced, a reform dividend will be released far into the future, and the Chinese economy will shift to an L shape growth trajectory for a comparatively lengthy duration. Supply side structural reforms affect a wide array of areas, some of which are delineated in Table 9.1, the reforms in these areas not only reap specific individual reform dividends, but might positively impact, creating a ‘comprehensive reform dividend’. Next, we will briefly analyse the long term impact of supply side structural reforms on China’s economy, via each of the items listed in the table. Taking reforms to the residence registration system to promote a new model of urbanisation as an example, there are extremely clearcut supply side effects of promoting the urbanising of migrant workers via residence registration system reforms, such as, raising rural labourers participation in non-agricultural sectors will lead to a substantial increase in the supply of urban labour. For instance, there is currently an 80 million strong population of 20–39 year olds, and a 70 million population of 40–59 year olds of those migrant workers currently employed in cities. As they are ineligible for permanent urban residence, such migrant workers tend head back to the countryside after the age of 40. This is to say that as the reforms to the residence registration system remain incomplete, those migrant workers who have already transitioned to urban areas to work and live leave the urban labour market when they still have extremely high employment potential owing to their ineligibility to enjoy basic urban public services such as old age insurance, unemployment insurance, healthcare services, education for their children, housing, and the most basic lifestyle safeguards. Reforms to the residence registration system could provide migrant workers the opportunity to settle in cities, as well as an equality of access to essential public services, leading to a substantial increase in the urban labour supply. Table 9.1 Supply side reforms induced reform dividend Reform area

Supply side effect

Demand side effect

Residence registration system reforms

Raise labour participation rate

Expand consumer groups

Raise total factor productivity Three cuts, one reduction, and one improvement’

Raise total factor productivity

Bottoming of social policies

Raise rate of return of capital Education and training

Raise human capital

Prevention of intergenerational transmission of poverty

Adjustments to birth control policy

Raise total fertility rate and future labour supply

Advance the balanced development of the population

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Labour will continue to transit from low to high productivity sectors if regulatory barriers are eliminated. I have called this productivity raising restructuring process the Kuznets Process, this kind of labour mobility can raise productivity. Conversely, there are already increasingly fewer numbers of new labour migrating to cities than previously. If the residence registration system is not reformed, the population that returns back to the countryside upon reaching a certain age will outnumber those arriving. Although migrant workers that return home have not left the labour market, but this transition from high to low productivity sector employment creates a reverse Kuznets process, and negatively impacts economic growth. In addition, the residence registration system reforms also have a clear demand side effect, which is primarily manifested via expanded consumer groups in the increased new urban citizen population. In addition, the ‘three cuts, one reduction, and one improvement’ reform listed in Table 9.1 has lowered corporate regulatory trade and production costs, raised the impact of total factor productivity, and also returns on investment. Existing and future human capital accumulation can be strengthened by increasing the quantity and quality of education and training provision. Adjustments to birth control policies and the optimisation of its supporting policies is beneficial to improving the layout of future labour supply. In addition to the direct, and main supply side impacts of the reforms, they should also be powerful enough to herald a series of favourable demand side effects. During our most recent piece of research, we created a supposition based on the effect of the potential labour participation rate, human capital accumulation, and increases to total factor productivity created by reforms in spheres such as the residence registration system, education and training, and state owned enterprises. After which, we combined the possible improvement that adjusted birth control policies might provide to labour supply, and simulated different potential growth rate scenarios, otherwise known as reform dividend scenarios. Figure 9.5 shows the long term growth trends (2010–2050) of the Chinese economy in several different scenarios. The reference scenario in the graph is the no reform growth trend. Scenarios 1 to 3 depict a gradual strengthening of reform intensity. This is especially true of Scenario 3, where the impact of adjustments to the birth control policies are more evident, and postulate a future total fertility rate approaching 1.8. We should recognise that no matter what the scenario, the general potential growth rate trends all head downwards. During the mid-income to highincome stage transition process, an increasing requirement for innovation, among other factors, drives increases in total factor productivity. The kinetic energy for such new growth cannot match that derived from the demographic dividend, which is sufficient to drive hypernormal growth. This means that decline in growth speed possesses a certain inevitability. In addition, we should also optimistically note that across a range of different scenarios, the deeper the reform, the greater the resultant reform dividend, and the closer the trajectory of the changes to the future potential growth rate approximates an L shape. Based on the performance of the Chinese economy’s potential growth rate in different reform scenarios, we can determine at what point China will cross over

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from the middle income stage, and successfully avoid falling into the middle income trap. Scenario 3 provides us with a comparatively accurate forecast. In 2014, China’s GDP per capita was roughly $7,400, an upper-mid income level. Based on the projections of reform scenario 3, by 2022, China’s GDP per capita can reach around $12,600, which is effectively knocking on the door of the high income stage. Crossing the threshold of the high income stage does not, however, signify a giant leap to developed country status. For instance, some Latin American countries have historically entered the ranks of high income countries, but later fell back to being middle income. Up to now, they have not recrossed the threshold to being high income economies, and have been instead enmeshed in the so-called middle income trap. As shown by Scenario 3, when striving towards long term L-shape growth, China’s GDP per capita might reach around $19,000 by around 2030, thereby more surely avoiding the middle income trap. A little later, by around 2040, GDP per capita will have reached around $32,000, approaching the average levels of current high income countries ($37,000). By 2050, China’s high income status will have consolidated, with GDP per capita reaching around $52,000, advancing to the highest level of the high income countries. It should be pointed out that the forecast depicts fine prospects, and is based on the receipt of the reform dividend of Scenario 3, which requires the deepest, highest intensity, and most challenging reforms of any scenario. We will need to wait and conduct further observations to see quite how the intensity and impact of the reforms will play out in reality. After the demographic dividend has been practically exhausted, future L-shape growth is dependent on the sustained release of reform induced dividends. During the process of advancing reforms across a range of arenas, we should pay full attention to the co-ordination, integration and synchronism between each arena, and create complementary policies that ensure that the reform dividends are sustained to the greatest possible extent, and from which leave the middle income stage, and realise the Chinese dream of the great revival of the Chinese people.

Reference Krugman P (2013) Hitting China’s wall. The New York Times, July 18

Chapter 10

Understanding the Middle Income Trap

China’s economic development has been earth shattering since the start of the reform and opening. It currently has a GDP per capita of in excess of $6,000, and has already entered the upper middle income development stage. However, the Chinese economy has simultaneously entered a new stage of development, meaning that it has already passed the Lewis turning point, and its demographic dividend is gradually disappearing as its economic growth rate began to decline in 2012. Organisations, including the World Bank, have pointed out that many countries have been unable to sustain their rate of economic growth after entering upper middle income development stage, and have ultimately being unable join the ranks of the high-income countries, plummeting instead into the middle income trap. Hence, people from every sector of society are now highly interested in the permutations of the middle income trap from people. This chapter will expound on how China can avoid the middle-income trap from both a theoretical and empirical perspective.

What is the Middle-Income Trap First, with reference to economics literature, we should theoretically demarcate the history of human civilisation the economic development stages. Then, we should classify China’s past and future economic development into different stages. This will help us understand the past, present and future of the Chinese economy, and also analyse the serious challenges posed by each stage.

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The Low Income Stage The Malthusian viewpoint is that this stage features virtually exponential population growth, food also features natural exponential growth, the rapid population growth means that food per capita levels are maintained at the subsistence level. Constant Malthusian traps result in population reductions, constantly intensifying negative feedback cycles, and a persistently low income level economy. Humanity has, for the overwhelming majority of its existence, been snared within such Malthusian poverty traps.

The Middle Income Stage Upon escaping the Malthusian trap, many countries experience renewed economic growth. They enact institutional reforms, constantly raise their rate of capital accumulation, before finally achieving economic takeoff. Following which, they leave the low income stage and enter a period of dual economy development. There are two sectors within the economy during this period. The first is the traditional agricultural sector, which possesses vast quantities of surplus labour, and extremely low marginal labour productivity. The second is the non-agricultural sector. For rapid growth, this sector requires huge quantities of labour. As such societies feature inexhaustible surplus labour, this sector can attract large quantities of labour from the first sector via fixed systemic wages for extremely long durations of time. This period is known as the dual economy development stage, and the Lewis development stage. During this stage, per capita incomes rise from a low to mid-level. This process usually concludes when incomes have reached an upper-mid level. The constant development of the non-agricultural sector draws large quantities of surplus labour transition from the primary sector, resulting in demand for labour exceeding supply. Population growth also exhibits change during this period. The fall in the fertility rate causes the prior rapid growth rate to slow. This is followed by the working age population trending towards negative growth, resulting in labour shortages, and the onset of ordinary worker wage level growth. This phenomenon is also known as the Lewis turning point. Once past this point, a new stage beckons.

The High Income Stage Once an economy has gone through the Lewis turning point, it enters a new stage of demographic transition, and so the gradual disappearance of the demographic dividend and the prior sources supporting economic growth, labour growth, capital formation and labour transition induced resource reallocation efficiency will tend to gradually trend downwards. Following which, the economy ultimately enters the

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neoclassical growth stage. The characteristics of the economic growth stage are, a short supply of labour and diminishing capital returns. This means that purely relying on factor inputs such as labour and capital are no longer sufficient to maintain sustainable economic growth, and the development of the economy becomes fully reliant on technological advance and productivity increases, or economic stagnation will result. This stage is also known as the Solow stage. To summarise, the development of mankind can be split into the Malthusian stage, the Lewis development stage and the Solow stage. The Lewis turning point which China crossed in 2004, is symbolised by the emergence of the phenomena of labour shortages and the rise in wage levels of ordinary workers. This juncture is marked by the onset of negative growth of the working age population (an increase in the demographic dependency ratio). 2010 marked the onset of the disappearance of the demographic dividend. This means that China faces the problem of how to cross the new economic development stage. If this problem proves insurmountable, then it will fall into the middle income trap, which is a situation we most definitely should strive to avoid. The concept of the middle-income trap was first mentioned in the World Bank’s 2007 report An East Asian renaissance: ideas for economic growth. The literature quoted by this report stated that: ‘middle income countries grow comparatively slowly in comparison to relatively wealthy or poor countries.’ To a certain degree, this concept is equivalent with the previously extensively used Latin American Trap, which had served to describe the development woes faced by Latin America as well as several Asian economies upon entering the middle-income stage, and has often served as the reference point for assessing the prospects of the Chinese economy. The blueprints used by western economists are that of their homogeneous, developed countries that experienced integrated economic development. Their theoretical frameworks lack readily available tools for the analysis of the middle income trap. This means that a great many economists, such as Robert Barro and Amartya Sen do not acknowledge the existence of phenomenon of economic development depicted by this concept. In particular, they believe that this concept is unable to explain the prospects of the Chinese economy. There are also some Chinese academics who equate the concept or research object of the middle income trap with that of China itself falling into the middle income trap. They find this idea, emotionally, very hard to accept, and so are anxious to dismiss it as a ‘pseudo-proposition’. However, if there really is such a thing as a middle income stage in economic history, which features particular development challenges that are especially likely to be faced by those countries with upper-middle income levels, and moreover such a thing is statistically significant, then if China is to avoid such a fate, taking these experiences and lessons on board is undoubtedly worthwhile. Would it not be more beneficial to believe such a thing to be true? First, the word ‘trap’ has been extensively used in economics to describe a sort of highly stable situation, an equilibrium that cannot be unsettled by short term external forces. During specific economic development stages, if the factors that provide a one-off boost to income per capita are not sustainable, and also insufficient to fundamentally alter the nature of the traditional equilibrium, then they will be

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counteracted by other factors, dragging income per capita back down to its original level, and causing the incomes of this economy to fluctuate around this level. Once a research focus is on how middle income countries can escape such cyclical processes, then such an analytical framework can prove beneficial. Second, the middle income trap is a clearcut statistical phenomenon, its existence verified by multiple instances of research. For instance, Professor Hu Yongtai utilised the GDP per capita of a number of countries relative to that of the USA, classifying those higher than 55% as high income, those between 20 and 55% as middle income, and those lower than 20% as low income. In a comparison of 132 countries, 32 countries defined as middle income in 1960, and 24 in 2008. He discovered in observing the changing nature of this group that middle income countries possessed a greater than 50% chance of remaining middle income half a century later. Those countries which had left the middle income group were more likely to have slid down to the low income group, and relatively less likely to have ascended to the high income group. In addition, Swaminathan Aiyar’s arrived at a similar conclusion from his research that focused on more than a hundred countries, whereby the probability that nations in the middle income stage would experience protracted ‘growth stagnation’ was significantly higher than during either the low or high income stages.

The Tetralogy of the Middle Income Trap We first need to emphasise that the middle income stage is not, in of itself, the middle income trap. Every nation needs to move to the middle income stage from the low income stage prior to entry to the high income stage. The middle income stage is, thus, a normal economic development stage. Real life middle income stage examples allow us to glean some stylised facts that possess commonality from the wealth of economic histories of developing countries, especially that of Latin America, and also some countries in Southeast Asia, who have fluctuated within the middle income stage for protracted lengths of time, to explain how an ‘unlucky’ economy can fall into the middle income trap in four easy steps. Step 1, an economy begins to cool after having experienced a certain period of relatively fast growth. Eichengreen collated reams of historical statistical data from many countries, and, through quantitative studies, discovered that when an economy is at a particular period of the upper-mid income stage, its economic growth will exhibit a marked slowdown. Such a slowdown can, on average, be as high as 60%. The cause for such a slowdown varies from country to country, some occur naturally, others are induced in the wake of a given crisis. However, such slowdowns are regular phenomena, and do not signify that descent into the middle income trap is inevitable. When analysing the slowdown experience of some countries, the International Monetary Fund categorised the risks of a range of countries falling into the trap as institutional factors, inadequate transportation and communication facilities, and also regional integration and trade defects. However, these slowdowns

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are linked to changes in development stage, which ultimately is the result of changes to supply side linked factors. Second, misunderstandings of the causes of slowdowns leads to inapposite policy choices, turning a slowdown into stagnation. For instance, if the slowdown is a result of a fall in supply side potential output capabilities, yet government policies are focused on stimulating demand side, then not only will the desired policy outcome prove elusive, but a whole series of distortions and detrimental outcomes will result. Of which, the most severe distortion is, without doubt, the over-adoption of industrial policies, causing the prices of the factors of production to decouple from their comparative advantages, and in the most severe instance, such policies can induce economic bubbles, overproduction, outdated industries and overprotected enterprises. Once this takes hold, what was originally an ordinary slowdown can conversely shift into a long-term, extremely slow economic growth, or even stagnation. If an economy reaches this stage, then confinement in the middle income trap is virtually inevitable. Third, when faced with a whole series of societal issues wrought by economic stagnation, governments will adopt further quick-fixes in response, resulting in the distortion of entire economic and social systems. For instance, during a period of economic stagnation, where the cake is not going to increase in size, the desire to redistribute the cake becomes irresistible, leading to rent-seeking behaviours and a wave of corruption. As those groups with special privileges will always receive a larger share of the income, and that the Matthew effect is extant in income distribution, then a worsening of income inequality results, and further ignite societal conflicts. At this point, governments with straitened finances will tend to espouse unimplementable populist policies, whereby not only will the original crisis remain unresolved, but the stimulatory mechanisms for economic activity will also be damaged. A wealth of research demonstrates that South American countries have adopted populist economic policies in the face of economic stagnation, blindly promising or attempting redistribution. The lack of control on the primary causes of the stagnation itself mean they are ultimately unable to raise economic growth. The cake remains the same size as before, and interest groups, who hold considerable sway over government policy, control how income gets distributed, meaning that the groups that the policies purport to assist are left without succour, and income gaps do not shrink, but instead expand. Such outcomes are a classic expression of the middle income trap. Up to now, the Gini coefficient of Latin American countries remains the highest in the world. Fourth, the severe existing inequalities of resource and income distribution that accompany the stagnation of economic growth create vested interest groups, who will do all that they can to preserve an income distribution profitable to themselves. This means that institutions detrimental to the escaping the middle income trap are extremely tricky to overturn. Once such a situation exists, related economic and social policies will be captured by such groups. This not only leads to economic stagnation, but progress on reforms and institutional changes becomes much more arduous, thus impeding economic and societal development, and as such, these institutions ossify. Existing experience shows that the aforementioned four steps have a temporal progression, but are also able to coexist. The lesson is that avoiding falling into the

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middle income trap requires an accurate understanding of the causes of an economic slowdown, to prevent a natural deceleration becoming an intractable stagnation. In addition, issues such as income distribution inequalities and excessive income gaps need resolution, so that social cohesiveness is maintained. Furthermore, barriers to reform erected by vested interests need demolishing, and income distribution efficiency improved via institutional reform, so that innovation driven and sustainable economic growth can be realised.

How to Avoid the Middle Income Trap From the perspective of economics, the middle income trap is a extremely stable equilibrium state, that is difficult to escape once enmeshed. In order to avoid the middle income trap, we must maintain mid to high economic growth via reform and opening. We will now cover important and pertinent measures in more detail.

Accurately Assessing the Economic Growth Stage China displayed high economic growth speeds that averaged 9.9% between 1978 and 2011. However, starting from 2012 there was a marked slowing of growth. Growth fell to an annualised average of 7.7% in 2012 and 2013, and then fell further in 2014 and 2015 to 7.3% and 6.9% respectively. Chinese and overseas economists proffered a range of different viewpoints on this slowdown. For instance, Justin Lin Yifu believes the cause is the substantial contraction in net exports in the wake of the financial crisis, leading to insufficient demand. Summers asserts that prior abnormal high growth speeds will eventually ‘return to the mean’; whilst Barro believes that no country can diverge from the ‘iron law of convergence’ over the long term (a growth speed of 2% per annum). It is this convergence effect that makes deceleration inevitable. How the cause of this slowdown is interpreted is of critical importance, for it pertains to the accuracy and effectiveness of policies adopted, and determines whether the shift from slowdown to stagnation can be avoided. The most important way to understand the deceleration of the Chinese economy is to observe which changes linked to development stages occurred. Thus, China’s slowdown is mainly a result of a fall in the relative scarcity of factors of production. This initiated a whole series of changes to conditions detrimental to increases in total factor productivity. China’s rapid economic growth since the reform and opening, as well as its pre-2010 performance, was directly linked to its demographic dividend, the rapid increase in its working age population, and the substantial fall in its demographic dependancy ratio. For, the ‘unlimited supply of labour’ raised savings rates, and postponed diminishing capital returns, and maintained a very high supply of labour and human capital, and resultant labour transitions also created resource reallocation efficiency. The analysis indicates that nearly half of the contribution of

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China’s total factor productivity rises between 1982 and 2009 derived from labour transition induced resource reallocation efficiency. Just as China’s total GDP surpassed Japan’s, becoming the world’s second largest economy, and just as its GDP per capita crossed the upper middle income threshold in 2010, its total 15 to 59 year old working age population peaked. After which, it embarked upon negative growth, and the demographic dependancy ratio began its corresponding ascent. The traditional motors driving high speed growth weakened as the demographic dividend vanished, causing the potential GDP growth rate, determined by production factors supply and productivity rise potential, to fall. There were a multitude of factors that drove economic growth speed further downwards. First, was sustained labour shortages and the rapid increase in wages. According to estimates, between 2004 and 2013, unit labour costs in Chinese manufacturing rose by 59.7%, causing a constant erosion in its comparative advantage. The second was the phenomenon of substantial diminishing capital returns, and a fall in the rate of return on investment. The third was the peaking of the 16–19 year old population in 2014, which thereafter embarked upon negative growth, and the slowing of labour transitions, and the decline in total factor productivity rises. The fourth was multiple systemic barriers that raised corporate trading costs, and lowered resource reallocation efficiency. There were issues including excessive government control in market operations, bothersome examination and approval procedures, and excessive taxes and social security contribution rates, impeded investment and financing channels, local protection and market segregation, and distorted factor prices, and also the preferential treatment of enterprises. These raised business institutional trading costs, and also objectively obstructed on a microeconomic level. The fifth was the comparatively severe structural overproduction, which wasted resources and reduced the room for economic growth. Understanding that the deceleration of the Chinese economy is a growth rather than a cyclical phenomenon, that it is rooted in supply rather than demand helps us to accurately pinpoint and implement targeted policies. This enables us to focus our energies in the right areas, and drive systemic economic reforms to unearth growth potential and launch new impetuses for growth, guaranteeing medium to high speed economic growth over sufficiently long timeframes, thereby sidestepping the middle income trap.

Unearthing an Institutional Dividend Through Reform We first need to divine the origin of China’s future sources of growth. Economic growth derives from the following few areas: the accumulation of capital, the growth of labour, the increase of human capital, a fall in the dependancy ratio, technological progress and improvements to resource allocation. China’s past economic growth was mainly dependent on the accumulation of capital, growth of labour, and the fall in the dependancy ratio. After the turning point, the contribution of capital accumulation naturally fell, that of labour growth became zero, and that of the dependancy ratio

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first fell to zero, and then fell further to a negative value. China’s future economic growth must rely on improvements to human capital, technological progress and improvements to resource allocation. All of which are only accessible via reform. The potential growth rate will naturally constantly fall between 2011 and 2020. We do not wish demand driven methods be used to stimulate growth, artificially dragging the growth rate above the potential growth rate. We should, however, raise the potential growth rate as appropriate. Although the current labour supply exhibits negative growth, but labour supply can be increased via raising the labour participation rate. We have previously modelled that if the labour participation rate increases by a single percentage point each year between 2011 and 2020, then the potential growth rate can increase by 0.88% points per annum. This means that of the working age population, those aged twenty and under will view education more favourably, and will not be a part of the employment population. Western nations have universally adopted the measure of extending the age of retirement. In the long term, China can adopt these methods, for it will eventually reach such a point. However, its best educated age group is currently the 20 year old age group. The 59 year old group are approaching retirement but have education levels lower than that of primary school level. An enterprise will not employ members of this older group even if it is short of workers, so artificially extending the retirement age will only result in the unemployment of some groups. So, no matter whether from the perspective of increasing the labour supply, or from the sustainability of old age pensions, delaying the retirement age will be a gradual process of reform, and first requires the existence of required preconditions. There would be a substantial increase in the labour participation rate if migrant workers can become urbanites. This would have an instant impact. There are 160 million migrant workers contained within China’s 53% urbanisation rate. However they are unable to benefit from the same essential social security safeguards as city dwellers. China’s urbanisation is an incomplete process, for when the migrant worker group is included in the urbanisation rate, the calculation is 53%, but when excluded, and based on the proportion of the population holding non-agricultural residence permits, or hukou, then the rate is only 35%, which is an enormous gap. Issues such as the hukou mean that migrant workers enjoy no social security safeguards in cities, and have no access to essential public services, making it difficult for this group to comprise a stable source of supply. How else can total factor productivity be raised? So far, a large proportion of China’s increases in total factor productivity derive from the redistribution of resources, such as labour transitions from the low productivity primary sector to the secondary and tertiary sectors. Resource reallocation has had a contribution rate of approaching 50% to past increases in China’s total factor productivity. The reduction in the quantity of surplus rural labour has reduced this contribution. However within a sector, such as the secondary sector, there are still productivity gaps between industries, as well as between different companies within the same industry. The vast diversity of corporate productivity indicates that factor mobility is not unimpeded, and there is insufficient competition. Highly efficient companies have not replaced

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inefficient ones. This is, in itself, symptomatic of inefficiency. Thus, ample competition between enterprises should be permitted. Companies should be allowed to exit and enter the market, and the healthy should be permitted to ‘devour’ the unhealthy. China still has a huge technological gap with developed economies, this gap has yielded a ‘late starter advantage’. Currently, if we over-emphasise or twist the meaning of innovation, then China might surrender the ‘late-starter advantage’ that it should enjoy. China has always emphasised innovation, and stated that it must take the incoming third technological wave by the horns, but China ultimately missed it. Reforms did, conversely, offer outstanding growth. Although the third wave is characterised by its novelty, but it has not change the mechanisms for innovation, which should be realised via survival of the fittest and creative destruction. Innovation improves that which can be improved, and that which cannot leaves the competitive stage, resulting in the optimised allocation of resources. People cannot be subject to the creative destruction process. It is for this reason that we have social security systems; but for enterprise, innovation only comes via creative destruction.

Developing Education and Training An important part of avoiding falling into the middle income trap is to rely on the accumulation of human capital. Society universally criticises China’s higher education as having expanded too rapidly, and hopes that the speed of its growth could slacken. This is actually what the government is doing. In fact, this is not logical. The actual problem is not that there is too much education, but that education has been unable to transfer into entrepreneurial and employment skills. Conforming to new technologies and the resultant new economic models, the Chinese government has strongly advocated its ‘mass entrepreneurship and innovation’ strategy, creating a stage for the nation to engage with the new technological revolution, and providing higher requirements for the human capital of participants. Next, we will begin with human capital theory and implementation, and based on the characteristics of new technologies, new business modes, as well as new forms of employment, to describe the characteristics of the human capital needed for this strategy, as well as its impact on education. One of the aims of education is undoubtedly to train worker skills. Skill training is conducted via the elementary education of the cognitive ability, and also via vocational education and training, and so to a certain degree, the number of years of education received can serve as a proxy indicator for skills. New demands are placed on worker skillsets as the industrial structure is upgraded and optimised, signifying the heightened requirements on the education levels of the working age population. Currently, the labour market demand for unskilled labour is relatively high, resulting in a signal that discourages families and individuals from investing in education, thereby disincentivising human capital accumulation. This state of affairs not only constrains the skill growth of current talent, but also clearly reveals a danger to the future potential human capital.

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Survey data on the education levels of labour that has transitioned out of agriculture shows that migrant workers currently have an average of 9.6 years of education received. This amount means that they are suited to labour intensive posts in the secondary sector (requirement of 9.1 years of education), as well as labour intensive posts in the tertiary sector (requirement of 9.6 years of education). However, China’s future changing economic trends are a slowing economy, and accelerating industrial restructuring. Human capital requirements for current job openings show that the capital intensive roles in secondary sector have a requirement of 10.4 years of education, whilst the technologically intensive roles in tertiary sector have a requirement of 13.3 years of education. If future industrial trends are that of a substantial increase in the number of capital intensive and technologically intensive posts, then it is possible to forecast that migrant workers education levels will impede their transition to such new roles. From the perspective of the matching of university graduate human capital, an important factor for why they find seeking employment difficult is that the employment field for this group of workers is extremely narrow. The scholar Hu Ruiwen discovered when comparing the industry distributions of workers with a college education or above in China and the USA, that those in China were overly concentrated in finance, information, education and health and public administration. The proportion of graduates in these industries even exceeded that of the United States. The proportion of graduates directly employed in productive industries is conversely much lower in China than America. For instance, the proportion of graduates in agriculture is 0.6% in China, and as high as 24.6% in the USA; for manufacturing, China has 10.3%, and the USA 30.0%; in transportation, China has 10.8%, and the USA 27.1%; in commerce, trade, catering and tourism industries, China has 11%, and the USA 28.6%. This is not to say that we should encourage university graduates to enter these actual economic sectors, but that we can forecast the effect on output. Actually, the reason why the proportion of those with graduate level qualifications or above is low in these industries is that these industries are still at the very low end of the value chain, and have very little demand for graduates. Nevertheless, the more preparation that a country devotes to human capital, the more likely it will be able to overcome the ‘Solow Paradox’1 at the earliest possible date, and the earlier new technology will enjoy widespread adoption, driving a new round of economic growth. The inevitably higher human capital requirements of the industrial upgrading of these sectors is highly predictable. Whether China’s higher education will be able to meet this demand as it develops is dependent on the choices currently being made are made with foresight or not. 1 Economists

once observed that the development of information technology has not instantly brought corresponding increases in productivity. This paradox can in a broad sense be understood as there is not a spontaneous causality relationship between the development of new technology and the economic growth that should result, or that such a relationship exists but with a time lag. This means that the necessary conditions first need to be established prior to the said productivity increases coming into effect.

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Apart from skills, the more important aspect of education is to nurture a person’s cognitive ability. As an innovator or creative worker, people need to possess a kind of skill—adding value, savings, and refinements, via information garnered via thought processes, and from which understand the creation, capabilities, and structure of a given thing; in addition to a number of other laws. This means that, education is not merely the inculcation of knowledge, but also demands the cultivation of the powers of observation, memory, imagination and attention of those being educated, so that they are able to independently acquire new knowledge in future, and are adept at adapting it for the purposes of innovation and skillsets. Evidently, education methods aimed at inculcating knowledge and skills, as well as examination orientated goals, obstruct the training of cognitive abilities. In addition, this also explains that whilst vocational education needs to develop, but it cannot replace general education. Industrial structure is evolving extraordinarily rapidly in the knowledge economy age, and as a result, certain specialised skills are rapidly becoming outdated. The experience of very many developed countries shows that current popular jobs and skills will no longer exist in two to three decades time, meaning that they will also not be taught by vocational schools. However, workers with cognitive capabilities will be more adept at learning new skillsets, and will not be eliminated from the labour market. This means that even if current labour market signals disincentivise increased family investment, extending the number of years of education received by children will, from a long term growth perspective, allow those individuals and families with greater amounts of education, especially that of higher education, to succeed. For instance, although teenagers having difficulties finding employment and high rates of unemployment is a global phenomenon, but the circumstances across a range of countries shows that those workers in possession of graduate or above levels of education, not only experience low levels of unemployment, but over the longer term, their wages rise at a faster rate, making it easier for them to become part of the middle income group. In addition to this, education increasingly includes the training of non-cognitive abilities, the key is that this is begun during the early development of a child. Noncognitive abilities include emotional health, sociability, and interpersonal communication capabilities. If we crudely classify cognition as ‘IQ’, then non-cognitive abilities come under the scope of ‘EQ’. The Nobel Prize in Economics laureate, Professor James Heckman has focused on child early years education for a long period of time, and is focused on abilities such as healthy spirits, stamina, concentration, and self-confidence, which are considered to be key soft skills that assist children perform better at school, and help them, as adults, to succeed in society. Education needs to be developed in the three ways described above to comprehensively nurture human capital to a level that will realise ‘mass entrepreneurship, and mass innovation’ in the new normal of economic development. Thus, each educational rule and its economic significance needs to be understood. Heckman’s research, that has attained widespread consensus, shows that, of the three kinds of capabilities that education needs to cultivate, the technical training provided by vocational education and training gives the highest personal rate of return, a relatively low societal rate of return, as well as the relatively small market externalities. In comparison, the

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cognitive abilities that are trained through education at ordinary schools have raised societal rates of return, increased externalities, and relatively low personal rate of returns. This mainly depends on the non-cognitive abilities of children nurtured in early development and pre-school education, which has the highest societal rate of return, the most evident externalities, and relatively low personal rate of return. This means that economists ranking on societal rate of return gives an order that goes ‘pre-school education—compulsory education—higher education—vocation training’ (see Fig. 10.1). Without doubt, the priority order of government investment should also be so ordered. There has been a longstanding fallacy in the recognition of the human capital rate of return, which is to have used the personal rate of return for education as the profit indicator, and establishing the incentive mechanisms for education upon this basis. In actual fact, the societal rate of return of education is more fundamental, and possesses a greater sharing return. Moreover, owing to the nature of education’s externalities, labour market signals incline towards ignoring or even concealing this quality, and are often unable to transfer the signals of the societal rate of return to educational incentives. The latest research has already verified the erroneous nature of the understanding delineated above. James Heckman lobbied the American U.S. Treasury Department official Lawrence Summers as early as the early 1990s. He appealed for the government to guarantee educational opportunities to three to four

Fig. 10.1 The ranking of the societal rate of return of each education type. Source Pedro Carneiro & James Heckman, Human Capital Policy, IZADP No. 821, July 2003

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year old children of impoverished families, pointing out that this policy suggestion was not an unfocused charitable desire, but a specific, real investment. For, it could provide a very real payback via reduced social security payments, lowered crime rates and increased tax returns.

Chapter 11

Employment Issues: From the Aggregate to the Structural

This chapter attempts to decode the labour market. Against the background of the implementation of far reaching supply side structural reforms and an innovation driven strategy, the new employment terrain features alleviated aggregate inconsistencies, but also increasingly prominent structural issues. A preferential employment strategy that is intimately connected with stable growth, restructuring, the advancement of reforms, and that benefit living standards should be implemented. Such a strategy should create an advantageous employment environment, raise worker employability, and also avoid the middle income trap.

Understanding the Labour Market Developing countries with dual economy characteristics often face different employment issues in comparison with developed countries. The classic dual economy features large amounts of surplus labour in agriculture, as well as in other traditional industries, and employment issues are manifested as aggregate issues; the resolution for which in modern economic growth sectors rely on economic growth, job creation, and the raising of the worker labour participation rate. Economic growth is neoclassical in developed countries, and no long term surplus labour exists. This means that employment issues are primarily manifested via frictional and structural unemployment, as well as cyclical unemployment which is connected with the macroeconomic climate. The solution to the former lies in improving human capital via education and training, and also by measures to improve the functioning of the labour market, whilst the latter can be solved with macroeconomic policies targeted at adjusting the economic cycle. The belief that the main issues in developing countries are surplus labour or insufficient jobs does not remotely mean the absence of natural unemployment phenomena, such as that created by frictional, structural, and cyclical unemployment. For developing countries, natural and cyclical unemployment that is a result of ineffective © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_11

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labour market matching and macroeconomic fluctuations, is superimposed upon surplus labour problems. However, when China was a planned economy, natural and cyclical unemployment were not manifested as open unemployment. This merely exacerbated the lack of jobs, via surplus labour and superfluous personnel. China has been in the dual economy stage, as defined by Lewis, for the vast majority of the reform and opening period, which is characterised by an unlimited supply of labour. Official and academic estimates show that during the 1990s, as much as one third of agricultural labour was surplus; or for state owned and collective enterprises, superfluous. The restructuring of the economic system, which was underway at this time, recalibrated worker proactiveness, in enterprise and local government via improved incentive mechanisms, and promoted transitions and mobility of labour via expanding the labour market. As China increasingly opened its doors to the outside world, low cost labour was transitioned to comprise the competitive advantage in the production of labour intensive goods, providing the nation a competitive advantage in the international marketplace. This means that despite each level of the government viewing job shortages with trepidation; and the dismantling of indiscriminate egalitarianism, the iron rice bowl, and secure tenures, as perilous; and is sorrowful in the face of employment pressures when economic growth dips, to the point that a lingering fear persists even when economic growth has returned to normal; but the numerous labour transitions that resulted were precisely the very same demographic dividend that enabled China’s economy to boom. All of the government’s efforts to promote economic growth to resolve employment issues, and advance labour mobility via reforms, conversely drove economic growth, and ultimately improved living standards. It is clear the focus on aggregate employment issues and GDP growth was exactly the right government policy for the development stage of the time. Just as the Lewis model predicts, when the development of the dual economy reaches a certain point, labour supply growth is outstripped by the speed of growth in labour demand, leading to labour shortages and rising ordinary workers wage levels, marking the Lewis turning point. China can be judged as having reached its Lewis turning point in 2004 from a range of labour market phenomena, including supply and demand relationships, rising wages, and wage convergence. One aspect is the change in that essential feature of the dual economy, the unlimited labour supply. The arrival of the Lewis turning point ultimately signals a change to the stage of economic development. The other aspect is that as the Chinese economy enters a new stage of development, the nature and characteristics of the labour market and employment issues undergo fundamental change. This new situation requires far reaching adjustments to government employment policies. Keynes was the first to educate people about macroeconomics from the perspective of full employment. On this basis, the renowned Phillips curve depicts the mutually substitutional relationship between unemployment and inflation. The person who really established an empirical relationship between economic growth and employment was Arthur Melvin Okun, the chairman of the Council of Economic Advisers to the former United States president, Lyndon B. Johnson. Nevertheless, Okun’s Law, as understood by Chinese economists for a very long period of time, was actually an

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incomplete and simplified version, and will soon be understood it as ‘the inverse relationships between economic growth and unemployment.’ Strictly speaking, Okun’s Law relates to changes to the growth rate, and should refer to the degree to which the actual GDP growth rate has deviated from the potential growth rate, namely, the size of the growth gap, and the unemployment refers to degree by which the actual unemployment rate has deviated from the natural unemployment rate, namely, the cyclical unemployment rate. Or in other words, there will be no cyclical unemployment as long as the actual growth rate accords with the potential growth rate, even though natural unemployment, namely structural and frictional unemployment, will still persist. We will now look at several macroeconomic variables affected by Okun’s Law, especially how the economic growth gap and cyclical unemployment rate are currently manifested in China. First, as the actual growth rate was roughly equivalent to the potential growth rate in 2012 and 2013, despite the fall in economic growth, the absence of a macroeconomic growth gap meant that no cyclical unemployment emerged. The actual growth rate fell below the potential growth rate on multiple occasions during the reform and opening period, which, in the majority of instances, led to severe employment pressure. For instance, in 1989, the GDP growth rate was 4.1%, 2.7 percentage points lower than the potential growth rate (6.8%), resulting in a 25.9% increase in the surveyed unemployment rate. In 1999, GDP growth was 7.6%, 1.8 percentage points lower than the potential growth rate (9.4%), resulting in a 39.6% increase in the surveyed unemployment rate. As the growth gap was essentially zero during 2012–2013, there was no evident change to the unemployment rate. However, we must not forget the financial crisis of 2008–9. During these two years, the potential growth rate was 10.9% and 10.6% respectively, whilst the GDP growth rate was registered at 9.8% and 9.2%, respectively 1.3 and 1.4 percentage points lower than the potential. This resulted in increases in the registered unemployment rate of 5.0% and 2.4% respectively. However, the surveyed unemployment rate actually fell by 3.5% during these two years. It looks like the theoretical forecast does not quite correlate with the actual situation, and is not entirely consistent with past experience. However, after we have introduced the next macroeconomic variable, (unemployment status), this problem can be readily solved. Second, labour market indicators such as the unemployment rate show that China currently has the most vibrant labour market in its economic history. Available conventional statistics shows that the registered urban unemployment rate maintained a constant 4.1%, and the labour market job seekers ratio has always maintained a value in excess of 1, and presents a sustained rising trend. Premier Li Keqiang first revealed the Chinese surveyed urban unemployment rate in an article published in the UK’s Financial Times, which for the first half of 2013 was 5%. After this point, this indicator was frequently disclosed. This figure is consistent with our reckoning. Compare with Fig. 11.1, where we have separately provided the registered urban unemployment rate and the surveyed unemployment rate. However, further explanation is needed on the relationship between these two unemployment indicators and their relationship with the natural unemployment rate (cyclical unemployment) (Fig. 11.1).

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Fig. 11.1 Changes to the urban unemployment rate

Theoretically, the real unemployment rate is often reflected by the surveyed unemployment rate. The relatively stable portion not impacted by macroeconomic fluctuations is the natural unemployment rate. This is comprised of structural and frictional unemployment, whilst the remainder is the rate of cyclical unemployment, which changes in lockstep with fluctuations in the economic cycle. This means that, we can empirically segregate natural unemployment from cyclical unemployment. The research of my colleagues Du Yang and Lu Yang shows that China’s urban natural unemployment rate has, in recent years, been 4.0–4.1%. It is interesting that this figure is entirely consistent to the registered urban unemployment rate that has, for many years, been unvaryingly constant. As the registered unemployment rate only includes the unemployed with urban residence registration, migrant workers are not included. As such, it can be said that urban residents only incur natural unemployment, and the deleterious consequences of cyclical unemployment are wholly borne by migrant workers, in that, the manner in which migrant workers enter and exit the urban labour markets responds to changes in the macroeconomic cycle. This also explains how during the 2008–2009 financial crisis the surveyed unemployment rate was unaffected when the actual growth rate fell below the potential growth rate. For, migrant workers temporarily vacate the labour market upon losing their jobs, and as such, are not reflected within surveyed urban unemployment figures. This allows us to see that the currently quoted surveyed urban unemployment rate does not provide full coverage of the migrant worker group, and as such, cannot fully reflect the actual state of the urban labour market. Based on the urban labour survey data produced by the Chinese Academy of Social Sciences’ Demography and Labour Economics Institute Research Group, the surveyed unemployment rate in 2010 of urban residence registered workers was 4.7%, whilst that of the urban employed migrant workers was 0.75%. The urban residence registered personnel and migrant workers, weighted as 65% and 35% respectively, can provide a surveyed unemployment rate, that includes the urban residence registered population and the migrant worker population, of 3.3%. If this is then compared with the natural unemployment

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rate of 4.0–4.1%, then there is actually no extant cyclical unemployment. Such a situation corresponds well with the dovetailing of the actual and potential growth rates. We can see that the central government has understood the relationship between these macroeconomic variables. Prior experience has been that regardless of the level set for forecast GDP growth rate in either the Five Year Plans or Annual Plans, it has ultimately maintained a speed of no lower than 8%. This situation was true for the Asian Financial Crisis of the late 1990s, and also for the World Financial Crisis of 2008–2009. This is because the belief at the time was that a growth rate of lower than 8% would be unable to create enough job openings, and also be unable to meet the employment needs of new and unemployed workers. However, as the potential growth rate has fallen, so has the growth rate required to meet employment needs. The calculations of the Ministry of Human Resources and Social Security, even if conservative, also demonstrates that a growth rate of 7.2% is sufficient for the required employment growth, meaning that the central government can accept a GDP growth rate of between 7 and 8%.

The Functions of the Natural Unemployment Rate For understanding the macroeconomic situation, we should presently not be overly concerned about a drop in growth speed, and should be even less worried about adopting economic stimulatory measures. In actual fact, an actual growth rate that exceeds economic growth capabilities is not healthy growth, but will conversely harm the sustainability of future economic growth. This likewise is manifested in the labour market. As previously described, the current actual unemployment rate cannot be lower than the natural unemployment rate, and is roughly the same as the latter. Stimulating a faster growth rate leads to the actual unemployment rate falling below the natural unemployment rate. We should be aware that the natural unemployment rate, comprised, as it is, of structural and frictional elements, exists for a reason. There were economists who, not too long ago, believed that the natural unemployment rate was not intrinsically ‘natural’, and advocated its lowering via macroeconomic or labour market policies. America actually achieved this during the Clinton administration. However, this seemingly positive employment situation had less beneficial consequences, in that after the Financial Crisis, many of those in America, and many European countries, who had left school too early to enter the still thriving labour market, were met with blisteringly high levels of unemployment owing to inadequate human capital. The experiences of these countries shows that poor human capital combined with macroeconomic shocks can result in short term cyclical unemployment, which eventually might shift into longer term structural unemployment. For instance, in 2007, Spain, Greece, Portugal, Ireland, Italy, the UK, the USA, Germany and Japan had an average unemployment rate of 6.4%. The financial crisis caused

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this to substantially rise, and was still as high as 13.8% during post-crisis 2013, and this was primarily caused by persistently high youth unemployment. As a macroeconomic indicator, the natural unemployment rate reflects structural and frictional factors in the labour market detrimental to employment, and the signals it provides can be valuable. For instance, a mismatch between worker human capital and labour market demand often results in structural unemployment. This means that an appropriate level of natural unemployment can provide the information required for matching human capital with the labour market, stimulating human capital accumulation and guiding educational reforms. An overheating economy can lead to an overly vibrant labour market, causing this indicator to lose its utility, and result in the young being unwilling to continue their studies, and enter the labour market at too early a date, and also includes malpractice where the education has dislocated from labour market demand. Over the long term, this group of workers with insufficient human capital will inevitably encounter employment difficulties during the next macroeconomic cycle, thereby constituting a vulnerable group within the labour market. In this sense, there are structural problems currently manifest in the Chinese labour market, in that there are numerous employment opportunities for workers with relatively low education levels, whilst those more highly educated face much greater problems finding suitable employment. For example, reflecting the differing employment circumstances of job seekers ratio whilst simultaneously giving out positive and negative signals. One aspect is that university students struggle to match the skills they have gained from their education with that of the options on the labour market, indicating that educational reform is urgently required. Another aspect is the differing labour market demand for those with high and low levels of education, as well as the wage convergence between workers with differing skillset levels, which inevitably serves as a disincentive for education, causing young people to leave school to work, and is detrimental to the improving of China’s overall level of human capital accumulation. This is actually a kind of classic failure of the labour market, and the response and solution to such a market failure, is bound to require the intervention of public policy.

Strong Wage Growth as Bad as Weak Wage Growth Labour shortages have heightened in the wake of the arrival of the Lewis turning point in 2004, and also from the subsequent onset of the disappearance of the demographic dividend in 2010. This has resulted in the wages of unskilled workers rising at an accelerating pace. For instance, between 2003 and 2012, and simultaneously with the sustained increase in the numbers of migrant workers going far afield for work, actual migrant worker wage growth reached 12%. 2011 was even more noteworthy, with rises of 21.2%. Migrant worker wages increased by 11.8% in 2012, as the GDP growth rate fell to 7.7%. Between 2005 and 2015, the actual wage levels of migrant workers going far afield for work increased by an average of 10.7% per annum. These

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changes were the cause of the sustained rapid growth of urban and rural incomes, and also the annual reduction in the income gap. The substantial increase in the wages of ordinary workers led to an evident reduction of the resident income gap. Data from the National Bureau of Statistics shows that the Gini coefficient of Chinese resident incomes increased from 0.29 in 1985, to 0.42 in 1995, and then peaked at 0.49 in 2008 before falling to 0.46 in 2015. However, wage growth is ultimately constrained by the speed of labour productivity growth. For the prior decoupling of the two, that is, when wage growth lags somewhat behind and then catch up, wages then again rise too fast, and once wages have exceeded labour productivity limits, then such rapid wage growth will weaken the comparative advantage of China’s manufacturing, giving insufficient time for industrial restructuring, thereby resulting in an excessively fast economic slowdown. Whilst wage growth is, admittedly, a good thing, faster does not necessarily mean better. No matter at what point, or what development stage, a good rule of thumb is that wage growth speed should not exceed labour productivity growth speed. Theoretically, the utility of labour productivity rises is counteracted by labour shortages and pressure exerted on enterprise by the resultant increased costs. Labour productivity rises can be expressed as being the increase in output of each individual worker, and also as the reduction required in the quantity of labour to produce one unit of output. Even once the Chinese economy has traversed the turning point, and hit its labour supply bottleneck, economic growth speed can be maintained if labour productivity can rise sufficiently fast to remedy the fall in output that results from insufficient labour. Although China’s labour productivity is quite out of the ordinary, internationally speaking, but overly pronounced labour shortages have resulted in wage growth outstripping labour productivity growth. Direct observation of the growth speed between migrant worker wages and GDP shows that, annualised GDP was 10.5% between 2003 and 2012, already slower than wage growth. Between 2009 and 2012, migrant worker wages grew by an average of 17.4% per annum, whilst GDP growth was only 9.2%. Worker incomes comprise a proportion of the national income, and, in rising faster than economic growth, wage growth is already trending away from its labour productivity base. Economic growth methods are changing and industrial restructuring accelerating as the Chinese economy enters a new development stage. This means that if wage growth and labour productivity growth are synchronised, then slower than average productivity rises and those companies paying increasingly uncompetitive wages will be exposed to pressure, and will struggle to survive if unable to raise productivity. Simultaneously to this, those companies that enjoy strong productivity rises will benefit, meaning that the entire economic structure is upgraded via a survival of the fittest process. With regards to the whole, wage growth speed that exceeds productivity growth speed signifies that the competitive advantage of the manufacturing industry will erode extremely quickly. Lacking a sufficient grace period, many companies will either struggle to survive, or perish, and investment and corporations will migrate outwards at scale. The unwitting formation of such an industrial restructuring adjustment shock therapy is not conducive to smooth transitions.

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I once expressed anxiety about excessively rapid wage rises, and in particular if they exceeded productivity growth rates. Subsequent media reports on my viewpoints were followed by furious online criticism, for many naturally believed that wage growth speed was not keeping pace with their expectations. Admittedly, I can understand the intense desire to increase one’s income, moreover, such a desire, or expectation, is forgivable. However, there is a ‘compound paradox’ that needs to be avoided when looking to understand economic issues. That paradox is, the rational behaviour for each and every individual may not lead to the anticipated outcome when in the aggregate. If we imagine that an excessive wage burden overwhelms a group of companies, and compels another group of companies to adopt labour substitution tools, such as machines or robots, and overly rapid wage growth simultaneously comprises in a disincentive on education, then who would, seriously, be willing to countenance the eventual outcome of such a sequence of events on the labour market? The British Financial Times records the experience of an American factory owner. As he gestured at his own workshop, this entrepreneur said that these manufacturing processes were formerly all conducted in China, but robots have allowed us to bring it all back home, and be made in the USA again. This is consistent with the overall nature of the revival of the American economy. The other aspect is that China’s unskilled labour is in competition with robots. Traditionally, this means that labour is being substituted by capital, and no matter whether expressed via labour being replaced by mechanical equipment, or by an older generation of robots, the laws of the diminishing returns of capital means that such processes are often gradual, giving labour the breathing space to adapt by raising their skillsets. However, the new generation of robots combine material capital with human capital, and is a fusion of operative skills and cognitive ability, and inevitably will replace workers engaged in labour intensive tasks, and will gradually replace knowledge intensive workers, thereby upending the laws of diminishing capital returns. This is in particular because the rate at which the chipsets that power robots iterate far exceeds the rate at which workers can learn new skills. The proximity of this revolution, and speed of the subsequent labour substitution, will far exceed that of times past. China overtook Japan in 2014 to become the largest robotics market in the world. It possesses a flourishing and expanding import and production market. Media reports state that the Guangdong provincial government announced spending of ¥943 billion RMB over a three year period to advance a technological transformation that included ‘robots’. Let us work with this sum of money, and assume that the Pearl River Delta region factory line workers currently have an annual salary of ¥50,000, then the forecast government expenditure is enough to employ 18.86 million people, and even calculating by the largest post-Spring Festival worker shortfall of 600,000 people of recent years, then this is sufficient to meet multiple years of labour demand. This ambitious investment is undoubtedly founded against painful bottlenecks, and possesses the following more powerful drivers and longer term forecasts. First, the trouble caused by multiple years of difficult recruitment and rising labour costs. China’s earliest ‘labour famine’ occurred in the Pearl River Delta region in

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2004. After which labour shortages and rising wage costs were also most pronounced in this region’s overseas facing manufacturing industries. Second, the incentives for the rapid progress in robotics. Traditional robots were essentially still machines, however the new generation possess the capacity to learn, and are set to grow ever smarter. This means that the point at which robots will replace people will likely come sooner than anybody anticipates. With this background of blisteringly fast robotics development, the competition faced by China might no longer be that of countries with youthful demographies. One aspect is that the advancement of robotics could very likely substantially reduce the opportunity window of those areas with youthful demographic structures, such as India and Africa. More importantly, the worker education levels of these countries are very far behind that of China. Such enormous gaps will prove difficult to remedy in the short term. For instance, for the 35 year old age cohort, the Indian population has an average of 5.4 years of education. This is 38.7% lower than China’s 8.8 years. The development laws of education suggest that this gap will prove impossible to remedy in the immediate future. The real competition comes from those developed countries at the forefront of innovation and technology and possess clearcut human capital advantages. For, based on this forecast, the advancement, and lowering of the costs of robotics will serve to rapidly eliminate any country that currently benefits from unit labour cost advantages, and will reduce the differences between countries in this area. In other words, it is science, technological innovation and human capital which will determine the future layout of the manufacturing industry, and not the quantity of labour or wage levels. Likewise, China’s 35 year old age cohort has an average of 5.4 fewer years of education compared to that of America (14.2 years). And so, the challenges that China faces are ultimately unrelated to contesting employment with those developing countries with extremely low labour costs, but that of the race for human capital accumulation and robotics. Whether it can win this race is dependent on the speed at which its human capital rises. Industrial restructuring and the increasingly widespread adoption of machines and robots means that this generation of skill impoverished and unadaptable workers will be vulnerable to future employment shocks. This will constrain the Chinese economy’s innovation motor and the optimal upgrading of its industries. Thus, extending compulsory education to raise the number of years of education received by new generations of labour, and increasing the provision of in-work and reemployment training to raise the skillsets, and adaptability, of the current workforce for restructured employment, should comprise an important component and preferential field for a prioritised employment strategy. Going a step further, creating a lifelong training system to strengthen worker innovativeness and employment competitiveness can help China board the fast train to the new technological revolution, and also maintain sustainable growth. In addition, the latent threat posed by countries with young populations should also not be ignored. The high level Goldman Sachs economist, Terrence O’Neill, who conjured the acronym ‘BRICS’, also created other such acronyms for other countries. For instance, one group he viewed favourably was comprised of Mexico,

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Indonesia, Malaysia, and Turkey. He named these four newly growing economies ‘MINT’. These countries were blessed with the advantages of favourable demographic age structures, geographic advantages, and were endowed with resources, and high potential growth rates. O’Neill viewed the demographic dividends that these countries could enjoy two decades hence especially favourably. We used the United Nation’s demographic data to conduct a comparison on the demographic age structures of these countries with that of China. We did in fact find that the MINT countries, as a whole, exhibited relatively young demographic age structures, and were in the process of transitioning towards a rising working age population ratio as China’s working age population ratio fell and its ageing accelerated (see Fig. 11.2). Or in other words, as China’s demographic dividend disappears at an accelerating rate, causing its economic growth potential to fall, the potential demographic dividends of the MINTs, as well as many other similar countries, meant that they are set to become China’s strong competitors. 2015

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Employment Structure and Quality China’s main current problems in the employment sphere are neither cyclical issues nor pertain to total capacity. However, economic theory and real experience shows that structural and frictional employment issues exist in any macroeconomic situation. Without doubt, these kinds of issues will not merely exist as reform and restructuring progresses, but will become increasingly prominent. Some regions and industries will encounter employment shocks during the restructuring process, as overcapacity is cut and ‘zombie enterprises’ dealt with, whilst some personnel face structural and frictional employment difficulties. For instance, when faced with handling those industries with the most prominent overproduction, the staff of such companies tend to exhibit the structural problems of weak human capital, and poor adaptability to new job roles. The proportion of the current workforce aged 40 and over in the coal and steel industries, for example, is 48.9% and 41.4% respectively, and the proportion with only a middle school education and below is, respectively, 69.4% and 55.9%. This allows us to roughly determine that of the staff impacted by cutting overproduction in these two industries, at least half will encounter employment difficulties in either the short or long term, and might even fall into an extended period, or even longer, of structural unemployment. In addition, some of the poor peasant households in some impoverished rural areas, still face difficulties in transitioning into employment owing to a dearth of work skills, information pertaining to work availability, and also that pertaining to public employment assistance. Simultaneously with the increase in employment numbers, and an easing of total capacity issues, some employment groups are yet to experience improvements in quality. Looking at employment stability, although the nationwide corporate labour contract signing rate reached 90% in 2015, yet some flexible and irregular employment groups were not included within the data. For instance, migrant workers already comprised as much as 35% of urban employment in 2015, yet this group only had a labour contract signing rate of 39.7%. For basic social insurance coverage, migrant workers have a 26% coverage of work injury insurance, and 17.6% medical insurance coverage, 16.7% old age insurance, and 10.5% unemployment insurance, whilst maternity insurance is only 7.8%. All of these figures are lower than those groups with urban hukous, or residence registration. As the overwhelming majority of migrant workers employed in urban areas have not obtained the residence registration of that locale, they are unable to fully, and equally enjoy its public services provision, and the participation rate in basic social security is relatively low. Many migrant workers have a fairly strong desire to return home to the countryside after passing the age of 40, and if the number of returnees exceeds that of new arrivals, then this will lead to reverse urbanisation, further aggravating the danger of labour shortages, and slowing productivity growth, thereby weakening the potential GDP growth rate, which is detrimental to the maintenance of medium to high speed economic growth.

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Current irregular employment and the constant flowering of new business types presents a severe challenge to the safeguarding of worker rights. China’s regulatory labour market framework has made great progress in recent years, and now offers substantial increases in worker social security provision. However, many current regulatory provisions remain dependent on workplace employment. Coverage for current irregular employment groups is both difficult and also ill-suited to the demands of new sharing economy employment types. This is in fact a global problem. Those groups working in non-traditional locations, times and roles, suffer poorly targeted mechanisms with regards to employment stability safeguards, working conditions regulations, social security coverage, and labour dispute mediation, and might, at the same time as creating new jobs, fail to effect a substantial improvement in workplace quality. There is a need to persist on people centred development ideology and a preferential employment strategy infused with fresh ideas. The implementation of this strategy needs to progress in tandem with stable growth, restructuring, reform, and raised living standards. The market should be permitted to play a determining role in allocating human resources, and maintaining labour market flexibility. Government can likewise focus on increasing redistribution, strengthening labour market regulations, simultaneously creating employment opportunities and raising employment. First, giving proper consideration to unification of labour market flexibility and the completeness of social security mechanisms. The operation of labour market mechanisms is, fundamentally, the most efficient manner to allocate labour. Labour market signals incentivise workers to upgrade their human capital, and enterprises can optimally allocate resources, and society correspondingly promotes the establishment of labour market structure, whilst government promptly improves the level, and uniform provision, of basic public services. Currently, there are still some institutional factors impeding the full employment of labour market functions, for which the right reforms urgently need to be found in the key fields to accelerate the dismantling of such barriers. For instance, reforms to residence registration centred on the urbanisation of migrant workers is an absolute necessity for the development of the labour market, and would also be beneficial to the establishment of the uniform provision of public services, that can sufficiently increase labour supply, and improve resource reallocation efficiency, and rapidly provide a reform dividend, and in addition, raise the sustainability and the sharing of the proceeds of growth. Simultaneously to this, China needs to avoid being misled by the surface representations of problems and resultant erroneous public opinion, and, based on which, conduct inapposite policy adjustments. This includes the establishment of labour market regulations including labour legislation, and the establishment of robust collective wage negotiation regulations, and the provision of trade union protections and worker rights, which must all continue to progress onwards, without reversing course. This pertains to government policy such as revisions to Labour Contract Law, and should focus on the revision of some specific regulations to further increase labour market flexibility, but this law absolutely must not be repealed. For, its fundamental intent and content is aimed at the protection of worker rights, the raising of

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employment quality, the safeguarding such basic rights can neither be changed nor abandoned. Second, considering both the short term utilisation of labour and the long term nurturing of human capital. 2004 marked the first ‘migrant worker famine’, which combined with the subsequent labour shortages, symbolised that the Chinese economy had already passed the Lewis turning point, and could no longer be said to possess an unlimited supply of labour. In recent years, even when economic growth fell, many corporations still faced recruitment difficulties, and a dearth of workers. As employment opportunities increased, and wages of ordinary workers rose at an accelerating rate, many youths in the countryside lost the desire to continue with their studies, and rushed to join the labour market upon the completion of their compulsory education. This admittedly satisfied short term labour demand, but such a phenomenon also acts as a disincentive on education, and influences the accumulation of human capital. Third, considering both the advance of supply side structural reforms and the undermining of social policies. The new functions of economic growth during the new normal pertain to the upgrading of the industrial structure and the transition to productivity driven growth methods. This necessitates supply side structural reforms. Such a process inevitably leads to the end to industrial growth and intensive life and death corporate competition. The reallocation of the factors of production renders the redistribution of some personnel unavoidable. Nevertheless, the ‘creative destructive’ nature of innovation driven growth does not mean the adoption of an ‘every man for himself’ attitude towards workers. As people are the medium of labour, and differ from other factors of production, reallocation requires government provided policy assistance and societal support. More proactive current employment policies, including the prioritisation of stability and employment promotion, and the raising employment quality amongst economic and societal development, so that those who have suffered redundancy, or are changing careers, have access to public employment services; and in addition, the provision of basic social security for those personnel who temporarily struggle to find reemployment. During China’s economic growth transition to the innovation driven new normal: one aspect is the need for a more complete and more extensive public employment services system, that reduces, to the greatest possible extent, the time workers spend in structural and frictional unemployment, and makes best possible use of human resources. The other aspect is that basic social security needs to provide more extensive coverage, and be more inclusive, so that those migrant workers still lacking urban residence registration, those personnel with flexible employment, as well as workers engaged in new forms of employment are afforded equality of access to baseline social policies; thus ensuring that reform, openness, and development can benefit all workers.

Chapter 12

The Income Distribution Kuznets Turning Point

The focus of this chapter is discussions on how to improve income distribution policies. The theoretical issue of the relationship between equality and efficiency is often a point of contention, with the main focus being their relative order. A related policy issue is the resolution of the increasing income disparities, whereby, should focus first be devoted to the initial allocation, or to subsequent redistributions? Behind these disputes lies how to arrive at a judgment about the facts of China’s income distribution. Is the income gap still diverging, or has it already begun to reduce? It is only when there is an adequate consensus on these questions that we might be able to arrive at useful conclusions on extremely important topics, such as resolving the issue of income inequality.

We Need to Reacquaint Ourselves with Equality and Efficiency Strictly speaking, the emphasis of the Classical Chinese Confucian phrase, ‘do not worry about scarcity, but rather about uneven distribution’ in antiquity was not on ‘do not worry about scarcity’ but on ‘but rather about uneven distribution’, so there is no conflict inherent in these concepts when we speak of making the cake bigger or dividing it into slices. In actual fact, the histories of every nation all evidence that whilst making a big cake is not the sina qua non of slicing the cake, but it is undoubtedly a prerequisite. For instance, the economies of some Latin American countries, such as Brazil, performed well during the first decade of this century. Correspondingly, their Gini coefficient also clearly dropped. The growth of the USA’s economy has clearly slowed since the 1970s in comparison with before, which in combination with some deviations to policy orientation, the poverty rate has risen, and the income gap has also grown. America has become the nation with the highest income inequalities and highest Gini coefficient in the developed world. © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_12

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In contemporary China, people universally recognise that income distribution is closely linked to policy. As such, discussions on the relationship between equality and efficiency can be quite protracted. As time passes and the income distribution situation changes, all manner of opinions clash, often leading to intense disputes. Equality and efficiency have become a topic of discussion, which was first targeted at the issues of egalitarianism and lack of incentive mechanisms during the period of the planned economy. At that time, the ‘big rice bowl’ phenomenon was still widespread, meaning that the road to wealth was blocked both from a legal perspective, and in practice. To counter this situation, in the mid-1980s Deng Xiaoping proposed letting some people get rich first, with an end goal of shared prosperity. Then, the official formulation of ‘first efficiency, and then equality’ emerged (proposed during the 1993 CCP 14th Third Plenary Session). For a comparatively long period of time, this kind of formulation achieved consensus, and enjoyed widespread acceptance. It was targeted at the traditional systemic corruption that flourished with the egalitarian ‘big rice bowl’. Now efficiency was prioritised, and incentive mechanisms established, which served to ignite worker and entrepreneurial enthusiasm. As the market mechanisms for factors of production gradually became the fundamental method by which resources were allocated and income distributed, the income gaps between regions, the cities and the countryside, sectors, and between members of society widened, and people began to focus on the issue of equitable income distribution. This was especially true of some systemic factors that resulted in unfair income distribution, and the rich and poor polarised, with the result that many people proposed a stronger policy focus on equality. These beliefs were gradually reflected in official wordings on the relationship between equality and efficiency. For instance, in the report of the Sixteenth National Congress of the CCP, the new formulation was: ‘initial distribution is to focus on efficiency, redistribution is to focus on equality.’ This emphasised the role of government in adjusting income distribution, and its commitment to rectifying excessively inequitable distributions. The official formulation gradually clarified after the 17th National Congress, ‘initial distribution and redistribution both need to manage the relationship between efficiency and equality, redistribution requires a stronger focus on equality.’ It was commonplace to observe conversations between people where the speakers viewed efficiency and equality to be diametrically opposing concepts, as if the two were mutually exclusive choices. In actual fact, this theory originated in Arthur Okun’s 1975 work, Equality and Efficiency—The Big Tradeoff . However, the Chinese translation of the subtitle deviated somewhat from the original meaning, which could result in misunderstandings, the translation of multiple versions being closer to ‘choice’ rather than tradeoff. This belief that equality and efficiency possess an opposing and mutually exclusive relationship very easily engenders misunderstandings, and indecisive policy. It can even create tendencies towards extreme distribution policies, and is detrimental to co-ordinating the impact of initial distribution and redistribution policies, or might lead to populist policies in the stead of socially redistributive policies. This has even

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resulted in catastrophic outcomes in some countries, where the intent and actual outcome of a policy are polar opposites. Such an erroneous understanding of income distribution policies have engendered misdirection. Originally, initial distribution and redistribution respectively created somewhat dissimilar income gaps, necessitating that both issues be tackled in tandem. However, when efficiency and equality are viewed as being diametrically opposed, either there is an inclination to create a policy in the name of efficiency that purposefully overlooks equality, or one that purely emphasises redistribution, thereby ignoring the constant widening of the income gap during initial distribution, all of which influence the effective resolution of the problem of income distribution. Efficiency and equality are both desired growth goals. Ensuring efficiency is key to firing up the enthusiasm of the participants in economic growth, and its core built upon effective incentive mechanisms. Equality is the ultimate aim of economic development, and is the criterion by which efficiency is evaluated. There is no fundamental conflict between efficiency and equality, and the prerequisite for demanding efficiency is that the cake is increased in size, so that a material foundation may be established for equitable distribution, and that the fruits of economic growth may be shared. Efficiency can only be guaranteed to emerge, and find its own endpoint, by ensuring equal distribution. However, efficiency and equality both possess their own centres of gravity, and as such, there is no natural equilibrium between the two. Ensuring their joint and equal progress requires following the requirements of new development concepts, whereby focus on priorities and policy weighting varies by period, stage of development, and by the nature of key problems currently faced. In which case, what is the most prominent problem that China currently faces in the sphere of income distribution, where does the difficulty in reforming the income distribution system lie, and which breakthrough point should be adopted so that reforms can make tangible progress? Next, we will discuss these questions in depth by combining the general rules of income distribution with the particular challenges faced by China.

The Income Distribution Turning Point: The Kuznets Turning Point The Nobel Prize in Economics laureate, Kuznets, once made a famed observation, that the income gap expands in line with the level of economic growth, and then after reaching a turning point, reduces. This discovery has been called the ‘Kuznets Inverted U-Hypothesis’. To date, there is a range of empirical research that either validates or negates this observation, and so the relationship between economic development and income distribution summarised by Kuznets can at best be considered a hypothesis. We must admit that there are a multitude of differing factors influencing income distribution, and moreover differing ‘development stage’ policy orientations of a nation’s economic structure, and so the guiding factors can also vary. And so,

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even if there were a kind of changing trend similar to that observed by Kuznets, its expression would inevitably also be diverse and complex in nature. During the early development of the dual economy, an unlimited labour supply and scarcity of capital mean that real wages are static for long durations, and the return on capital is relatively high, and despite the proceeds of economic growth being initially shared to some extent, but a relatively high income gap often persists, or evidences an expanding trend. Then, after the passing of the Lewis turning point, characterised by labour shortages and rising wages, income rises of ordinary workers and low income families accelerate. When tallied with other conditions, this might herald the arrival of the income distribution Kuznets turning point. Japan’s passage through its dual economy development stage and the Lewis turning point provided empirical proof of the causality relationship between the two turning points. For instance, academics such as Ryoshin Minami discovered that during the dual economy development stage, Japan’s large scale agricultural labour surpluses were sufficient to explain the its rapid economic growth, and also that of the long term decline of labour as a share of the national economy. Japan reached the Lewis turning point around 1960, which coincidently fostered the arrival of the Kuznets turning point, which improved income distribution. Symbolised by persistent ‘migrant worker famines’, difficult recruitment and the rise in ordinary worker wages, China crossed the Lewis turning point in 2004. After which, not only were there year on year wage rises (such as migrant worker real wages which maintained 11% growth per annum over a decade), moreover, there was wage convergence between skilled and unskilled workers, migrant workers and urban local workers, and also between that of blue collar workers and highly educated workers. This convergence occurred in a changing labour market, and the trends inevitably effected a reduction in the urban–rural income gap and general income inequality. This was also how it actually played out. Data from the National Bureau of Statistics shows that between 1981 and 2009, the urban–rural resident income gap (the ratio of urban resident disposable income with that of rural resident net income) climbed from 2.04 to 2.67, before dropping to 2.40 in 2014. During the same period, the nationwide Gini coefficient rose from 0.31 to 0.49 before falling to 0.47. If these trends persist, this signifies that China’s Kuznets turning point will arrive on the tail of the Lewis turning point. Income distribution patterns also underwent a process corresponding to the changes in China’s development stage. In general, changes to the state of income distribution were primarily influenced by three factors, which respectively expanded and reduced the income gap. The intensity of the relative impact of each varied at different times, and overall, created the particular locus of changes to the income gap. As the labour market has gradually developed, the human capital differentials between individual and groups of workers have led to divergences in income levels, causing an expansion of the income gap. From a certain perspective, such an effect is beneficial to encouraging enthusiasm and the receiving of an education. The economic growth advanced by the reform and opening was not a process that simultaneously unfolded nationwide. Economic growth opportunities were also not evenly

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distributed across regions or populations. This means that some income levels will inevitably rise before others. Even when equality of opportunity exists, differences to family situations, age, sex and education levels, the speed at which workers are able to take advantage of opportunities to increase their incomes, or even become rich will also, inevitably vary. The topic that economists most enjoy discussing—the rate of return of education, which measures the income differentials that differing types of human capital create, and is often expressed as a percentage of the increase in income for each extra year of education. This kind of return on human capital includes the proportion received by workers (individual return), and that received by society (societal return). When wages are not set by the labour market, worker human capital will produce an extraneous value, but the majority of which is gained by society, and not by the individual. Worker compensation that does not incentivise will not encourage creative work, and will not comprise an incentive towards education. During the reform and opening process, as internal corporate incentive mechanisms and the labour market matured and optimised, human capital produced individual returns, and moreover, as time went by, the share comprised by individual returns of the total education returns (the sum of societal and individual returns) increased. For instance, Chinese academics, using microeconomic data, calculated that the individual return on education increased from 1.2% in 1989 to 2.2% in 1993, and then increased further to 3.8% by 2000, and then 8.9% by 2006. In actual fact, this is not to say that the rate of return on human capital is increasing each year, but that the individual component of the aggregate rate of return has been gradually increasing. Such a change undoubtedly is a result of the development of the labour market. Although the income gap between workers has expanded, but, generally speaking, it does incentivise participants. However, the increase in the individual rate of return on education also produces a negative expansionary effect on the income gap. Some academics have discovered that the rate of return of education for high income groups is much greater than that for low income groups, where systemic factors mean that the former gains what amounts to a natural advantage in educational opportunities. For instance, the unequal distribution of educational resources means that the quantity and quality of educational opportunities is much greater in cities than in towns or the countryside. High income groups possess more social connections and privileges, giving their children access to a higher quality of education. The income gap that this engenders is, morally speaking, unfair. It is also inefficient from an educational investment and development perspective, and will result in an intergenerational transmission of poverty. Second, as the scope of employment for urban and rural residents expanded, in particular that of the increase of non-agricultural employment opportunities for agricultural labour, the urban–rural income gap reduced, and also served to improve general income distribution. Although the earliest employment and development opportunities were often taken by those groups possessing superior human capital, but as employment opportunities increased, this was gradually extended to increasing numbers of workers.

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The whole of China was in the dual economy development stage throughout the entire reform and opening period, whereby large numbers of surplus labour transitioned from agriculture to non-agricultural sectors, and the labour participation rate persistently rose, allowing increasing numbers of ordinary families and worker groups to share in the proceeds of growth. The employment opportunities open to migrant workers offered better money than could be earned in the fields, which generally served to lower rural poverty levels, and even if this did not reduce the town and rural income gap, it did serve to restrain the creation of even greater urban–rural income disparities. The household contract responsibility system which formed the institutional basis of equal land distribution guarantees that labour mobility is the result of the free choice for higher incomes and a better standard of living. This means that, even if wage levels are static, the increase in the scale of labour mobility was sufficient to effect a substantial increase in peasant incomes. The impact of labour mobility on peasant incomes, as well as the effect on reducing the town-rural income gap, can be observed from the following three areas. First, the effect of labour mobility on poverty reduction. Apart from those families with insufficient labour or who suffer impeded employability, many impoverished families are poor due to a lack of work. Moreover, prior research shows that, nonagricultural employment opportunities in rural areas are often taken by those groups of people with prominent skills, or with the right family background, or influence. The majority of poor families have little opportunity to win such work. This means that, heading further afield for work is an opportunity to earn a higher income. Research shows that, the per capita net income of poor rural households can increase by 8.5–13% by taking on work further afield. Second, the contribution of wage and salary income to increasing rural household income. Based on the statistical approach of the National Bureau of Statistics, the net income of rural households can be divided into four parts, wage, household operations, property, and transfer income. The increase in employment opportunities further afield substantially increases a rural household’s wage income, and raises the proportion that this income comprises of the household’s total income, and becomes the main source of increasing rural household income. Official statistics shows that the proportion of rural household income comprised by wage income rose from 20.2% in 1990 to 42.5% in 2011, and during this year, the contribution rate of wage income to farmer net income possessed an increment of 50.3%. Current statistical systems have in fact overlooked a large portion of casual work incomes. As official statistical systems household surveys are divided in to separate urban and rural categories, this means that those rural families where the entire family has moved to a different area, and rural family members who are engaged in casual work away from home, are clearly eliminated from urban samples owing to difficulties in inclusion. Those who are away from home for extended durations are no longer included in the rural resident population, and are largely eliminated from rural households survey coverage. Thus, migrant worker incomes have been, to a substantial degree, underestimated. Partial surveys have found that as the household survey sampling and definitions used by official statistical systems are problematic,

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the disposable income of urban residents has been overestimated by 13.6%, and the net income of rural residents underestimated by 13.3%, and the urban–rural income gap overestimated by 31.2%. Labour transitions will ultimately eliminate the dual economic development stage’s characteristic unlimited labour supply, a signature turning point being the Lewis turning point. This turning point does not signify absolute labour shortages, but that if there is no real increase in wage levels, then labour shortages will result. This means that, after experiencing the Lewis turning point, the income rises of migrant workers and rural households will substantially accelerate, thereby correspondingly reducing the town and rural income gap. An important influence on the unequal income distribution nationwide is the urban–rural income gap, once this embarks upon a diminishing trend, then general income inequality will inevitably fall as a result. Third, incomplete reforms induced problems that emerged during the reform process or the development stage in question, led to expanding income inequalities or an inability to reduce extant inequalities. Resolving such problems necessitated reforms that strengthened the economic system and social policy. In order to raise the efficiency of natural resources and asset stock utilisation, a proportion of the state owned assets were privatised when the institutions were transitioning, with many mineral resources and usufructuary land rights transferred to individual or conglomerate use. The outcome being that all manner of resources and assets were divided up and distributed, transitioning from de jure state ownership but lacking de facto ownership, to ownership by individuals and conglomerates, and from which becoming individual income. Such resource and asset allocation can be bereft of oversight, with many nonstandard and opaque operations that are commonplace, illegal and contrary to regulations. This means that any resultant income is often grey market in nature, and the allocation of which conducted in extremely unequal ways, thereby comprising a key factor in the expanding income inequalities. Using Wang Xiaolv’s estimates, and if we add every kind of invisible or grey income to current income statistics, and recalculate the urban residential per capita disposable income, the result is 3.19 times that of the figures in the statistics. Furthermore, 80% of which is concentrated in the hands of the highest income decile.

What Is the Cause for and Origin of Dispute Whether China has arrived at the Kuznets turning point or not is an important judgment. However, this issue has not only been widely disputed in academic and policy research circles, but moreover there are actually several factors which mean we cannot offer a simple ‘yes’ or ‘no’ answer. We selected urban–rural income gaps and the national resident Gini coefficient from the official data of the National Bureau of Statistics, to describe the changing income distribution trends. Generally speaking, income gaps climbed upwards for a relatively long period of time. When the Chinese

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economy welcomed the Lewis turning point, and after the emergence of ordinary worker shortages and wage rises, the trend of expanding income inequalities was restrained, and even exhibited some signs of falling. Official statistics show that although China has a relatively large income gap by international standards, but this has begun to slacken in recent years, and the Gini coefficient is also trending downwards. Some researchers believe that the official residential income data is flawed. These include Wang Xiaolv who believes that the scale of invisible income overlooked during National Bureau of Statistics household surveys is staggering. Some people have arrived at higher or even supporting an expanding inequality indices via their own research, such as Gan Li’s team, which estimated that the Gini coefficient was as high as 0.61 in 2010. Such discoveries are often cited by those who beat the drum of the ‘China collapse theory’, such as the American academic David Shambaugh, who arrived at the conclusion that China had the highest Gini coefficient in the world. Whilst such research might be of value to both academia and policy formulation, but the amateur and blind citing and extrapolating of such research results often leads to erroneous conclusions. When I was in Wellington, the capital of New Zealand in 2014 to attend a symposium on China, I happened to hear David Shambaugh give this opinion, were my intuition was that the ignorant fear nothing. After he had finished speaking, a female New Zealand professor gave a fairly incisive criticism of his viewpoints. However, my reaction to this criticism was that it had only showed that there were different opinions towards the prospects of China’s future economic growth, and made no critical attack on his methodology. During the farewell party at the conclusion of the conference, the hosts allowed me to give a speech on behalf of overseas attending scholars. I took this opportunity to attempt to clarify understandings of the issue of China’s income distribution. Many academics, even Chinese academics and readers, have often suffered confusion on this issue. My refutation was roughly as follows. The Gini coefficient is calculated via the subdivision of corresponding inhabitants and incomes, and from which, composing an income distribution Lorentz curve that reflects the nature of the income distribution inequalities. However, when collecting the actual income data of sampled households, researchers and statistics bureaus in every country will encounter the same problem, and that is the income groups at both extremities, namely the richest and poorest, are the least representative, meaning that income gaps will be underestimated by varying amounts. It might be that be discarding these two groups, China’s figures might appear to be even more severe than that of developed countries, but this really is a universal phenomenon in the statistical surveys of every nation. Some researchers focus on the omitted two extremes, and arrive at abnormal income distribution figures, and calculate larger income distribution indices, thereby assisting us understand the causes of income gaps, which is of value. However, such research outcomes are unable to be compared with the Gini coefficients of other countries which also do not include outlying values. This means that, as judgment that claims that China possesses the highest Gini coefficient in the world, lacks both methodological validity and conclusive credibility.

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Income Distribution Policy Errors Income distribution leads to a series of outcomes to initial distribution and redistribution, of which, government aspirations and intent, policy direction and methods, all clearly influence income distribution outcomes. In fact, Kuznets himself did not believe that the arrival of his turning point was inevitable. The Nobel Laureate in Economics, Paul Krugman, reviewed the history of the USA’s alternating Democrat and Republican administrations, and found that differing viewpoints on income distribution led to different social policies, resulting in vastly divergent income distribution outcomes. He himself, along with other economists, pointed out that just as the American economy and social policy increasingly benefited the wealthy, it endowed the nation with the highest income disparities in the developed world. For instance Joseph Stiglitz, among others, pointed out that the wealthiest 1% of America’s population was in possession of close to one quarter of the nation’s income and 40% of its wealth. American government policy orientation is deleterious to improving income distribution regardless of whether its public policy sphere investment is aimed at assisting ordinary families obtain a larger slice of the cake, or a redistributive measure aimed at enlarging the middle classes. American politicians and changes to politician passed review government policy factors verifies that changes to American society over the past two to three decades, have benefitted the wealthy, and not the poor nor the middle classes. For instance, Geerlings, among others, utilised quantitative methods to conduct an analysis of 1779 items of policy that impacted incomes between the years 1981 and 2002, and found that the elite in the field of economics as well as the representative interest groups had an enormous impact on American government policy, whilst the impact of ordinary voters and popular groups on policy was virtually non-existent. If we say that the early phase of the reform and opening was targeted at the issues of the traditional system of the ‘big rice bowl’ and rejected the lack of incentive mechanisms in the non-public sector of the economy, China’s policies inclined towards ‘first efficiency, then equality’. Then, ever since the 16th National People’s Congress, government policy has increasingly focused on improving income distribution. It has stressed the regulating function of government on income distribution, and pledged to adjust overly large income gaps. After the 17th National People’s Congress, focus turned to reducing inequality between urban and rural areas, regions, the income of different income groups, and in the provision of public services. The central government implemented regional development policies and financial transfer payments, and strengthened labour employment legislation and its enforcement. This substantially expanded the intensity and coverage of social security, and advanced reforms to income distribution system. These efforts are directly related to the reduction of the income gap and public policy since 2009. All in all, China’s overall income gap is still relatively large. Solely relying on the labour market turning point will not engender a rapid fall, instead, a heightening of redistributive intensity is required. International experience shows that those nations

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with relatively small income gaps achieved an equitable income distribution via redistribution. For instance, looking at the 28 Organisation for Economic Co-operation and Development (OECD) countries with relatively small income gaps, and calculating an arithmetic mean from their pre-redistribution and post-redistribution Gini coefficients, we arrive at the values of 0.47 and 0.3. This is to say that redistribution in these countries lowered the Gini coefficient by an average of 1.7 percentage points. China’s tax system currently still prioritises indirect taxes, and personal income tax is clearly not progressive in nature. This means that further adjusting excessively high incomes via the tax system, tallies with international norms, and there is also huge adjustment potential, and is forecast to result in substantial falls in income disparities. The view that adopting new technologies, industrial upgrading and globalisation is deleterious to rises in the incomes of ordinary workers was first raised during the early stages of the industrial revolution. Similar empirical observations exist today. When explaining the expansion of the USA’s income gap, the majority of research cited used such observations and as evidence. For instance, Cowen believes that a great number of technological innovations in America benefitted from private access to public resources. Moreover, such innovations were generally not of a type that could be widely enjoyed by workers. Samuelson also found that the benefits of a globalisation that focused on trade and industrial transfers could not equally shared amongst participating countries and groups within countries. This was manifested with relatively poorly educated American workers becoming the victims of globalisation. Moreover, Spence announced that industrial outsourcing had harmed employment in the nation’s manufacturing industry, and harmed the American economy after he had investigated the structure of American employment growth. This phenomenon exists, but demands analysis within a unifying theoretical framework. First, promoting the overdevelopment of capital intensive industries when there is a scarcity of capital contravenes the principles of comparative advantage that must be abided during industrial restructuring, and inevitably, artificial increases in capital returns as a proportion of national income distribution will consequently create a Piketty style income distribution layout. Second, neither technological advances nor globalisation itself are not innately geared towards the sharing of the proceeds of growth. One aspect is, this is dependent on whether progress can raise worker productivity quickly enough. The other aspect is that this is dependent upon whether worker compensation can maintain synchrony with rises in worker productivity. People once observed the so-called Solow Paradox, whereby advances in communications technology had not heralded improvements to productivity. However, events later proved that, the development of the internet and mobile technologies happened to offer more opportunities for flexible employment, bestowing a sharing aspect that had not previously emerged in economic growth. China fully employed the advantages of its rich resource endowments prior to the arrival of the Lewis turning point. It rapidly developed its overseas facing labour intensive manufacturing industries, and employed its comparative and competitive advantages through its proactive participation in economic globalisation. Simultaneously to driving high speed economic growth, China realised a reduction of poverty

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and an expansion of employment in rural and urban areas. Its economy of this time featured an unlimited supply of labour, and wage growth was unable to keep up with increases in labour productivity, achieving an unequal growth, whereby only some of the proceeds of which were shared. The arrival of the Lewis turning point led to accelerating ordinary worker wage rises, and improved income distribution, and the degree of sharing increased substantially. However, some researchers have pointed out that, the trend of falling income inequalities in recent years is still insecure, thus, precautions are still required when facing new challenges, so that this falling income inequality momentum can be maintained. When faced with labour shortages and rising wages, corporations will often adopt a labour to capital substitution strategy. This is dependent on the relative scarcity of factors of production and changes to their relative price levels, and the outcome of which is that machines and robots replace workers. General trends show that such a process is inevitable, and is a necessary path for upgrading and optimising China’s economic structure. Nevertheless, we simultaneously need to avoid negative impacts, so as to ensure that this process is beneficial. This means that labour to capital substitution must have a handle on the two following key principles. First, to give the market the right signals, factor prices must reflect the relative scarcity of factors of production. Distorted factor prices can result from industrial policies with subsidy and assistance packages that interfere with, and artificially suppresses asset prices. They can also result, if tardy residence registration system reforms leads to migrant worker employment instability, thereby magnifying the labour shortage phenomenon and causing an artificial rise in the cost of labour. Such an event might raise the capital labour ratio at too early a date, thereby inducing an industrial structure beyond that required by the development stage, leading to a further deterioration in the nation’s competitive advantage and competitiveness. This might ultimately impact economic growth and employment. Workers skillsets need to surge upwards if they are to adapt to machines and robot substitution process. The rapidity of advance in the new generation of robotic and automation technologies means that physical capital and human capital, as well as operating skills and cognitive abilities need to simultaneously mesh with that of robots. This current speed of labour substitution might very well outstrip that of past timeframes. Future technological revolutions will not only be orientated towards saving labour, but will, in a certain sense, be directed towards saving human capital. This means that we are faced with a competition between a revolution in human capital and a robotics revolution. If worker human capital is unable to win this contest, then an overly high capital to labour ratio might result, resulting in diminishing capital returns, and automation might encroach on every sphere of worker employment. The end result of which being the postponement of improvements to reductions in income inequality. In addition, I will summarise the success and failures of some policies aimed at reducing regional disparities. For instance, in order to reduce the development gap between southern Italy (commonly known as the Mezzogiorno) with that of northern Italy, the central Italian government implemented a series of policies that excessively relied on redistribution. These included income transfers and wage equalisation,

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resulting in an over reliance of the backward regions on the developed region and also on central government, resulting in a capital flow towards rent seeking and other non-productive activities, and civilian investment conversely constrained. The eventual outcome was a failure to control the productivity gap between north and south. In comparison, when implementing policies aimed at reducing disparities between east and west, the German federal government focused more on encouraging investment by individuals, increasing labour market mobility, and forestalling rent seeking behaviour. It has, to a certain degree, avoided the fate of the Mezzogiorno trap. China’s redistributive policies has focused on the equal provision of basic public services between the city and the countryside, between regions and between groups, to raise the income of low income groups, and expand the scale of the middle income groups, and adjust that of the high income groups, and constrain illegal and monopolistic income. This has been the correct overall direction, and has achieved success in reducing income inequalities. However, to a certain degree, trends appeared as these policies were implemented, whereby the misuse or overuse of redistributive policy tools in the pursuit of short term income rises might detrimentally impact sustainable economic growth. For instance, some local governments mistook the minimum wage system for being the level for wage level interference, adjustments were too frequent and too large, and interfered with market wage setting mechanisms. Basic social services are poorly budgeted, and excessively high contribution rates constitute an unbearable burden on small, medium, and also micro, enterprises. Reforms to the residence registration system have not progressed as hoped, leading to inaccurate forecasts on migrant worker groups. This has harmed improvements to human capital and the stabilisation of labour supply, and has also artificially aggravated unskilled labour shortages and has also accelerated wage rises. All of these policy orientations impair corporate competitiveness to greater or lesser degrees, leading to the forfeiture of the comparative advantage of the manufacturing industry at too early a date, and thereby weakening the sustainability of China’s long term economic growth. This ultimately reduces employment opportunities, and conversely, harms ordinary workers via a reversal in falling income inequality trends, or even increasing income inequalities. To avoid such an eventuality, China should focus on allowing the market to allocate labour resources and set wage levels. Redistributive policies should focus on the equal provision of basic public services, ensuring equality of access to resources and employment, and should simultaneously focus on living standards and maintaining the sustainability of economic growth. In this way, income disparities can be reduced in accordance with the laws of development, and also for longer periods of time.

Part IV

Creating a New Miracle

The focus of this section is whether China can create another economic miracle, and if so, how. As the nation’s growth speed has slowed, whether or not its growth can continue has become a hot topic both within China and overseas. Whether China’s goal of becoming a powerful country can be realized, and whether the Chinese Dream can come true is entirely dependent on the economy’s sustained and healthy growth. This author believes that there is much hope that China can tap into a reform dividend, drive growth in total factor productivity, advance the level of urbanization, and continue its stable growth. China’s potential growth rate remains healthy and the potential labor force can be further opened up. Generally speaking, comprehensively deepening reforms to unleash a reform dividend can support the Chinese economy for the foreseeable future, and offer sustained, healthy, and stable development. China only needs to take advantage of the opportunities presented by the reforms, and the creation of another economic miracle will not be a dream.

Chapter 13

Can China Create Another Economic Miracle?

China’s sustained high speed growth and the rapid rise in its overall national strength means that the restoration of its former world leading position as a physical and spiritual civilisation, pithily expressed as the ‘Chinese Dream’, is increasingly becoming the dream of countless Chinese. China is the only civilisation in the history of mankind to have persisted from antiquity until today, and will become the only country to have experienced rise and fall, and then another grand revival. However, past performance does not guarantee future economic growth, increases in the general income level do not signify that development is, in of itself, naturally inclusive and sharing. The task of vaulting from a middle income stage to a high income stage is even more onerous than escaping the poverty trap. China has moved from a low income stage to a middle income stage in a relatively short period of time. Its current standing in the world is ultimately a result of the economic miracle created over the last near four decades. So, for the Chinese dream to be ultimately realised, requires another economic miracle to take the nation successfully from its middle income stage to a high income stage. Turning this wondrous dream into reality requires colossal effort.

Can the Chinese Economy Continue to Grow? After China has completed its first 100 years goal, of the comprehensive establishment of a middle-class society, in 2021, the next grand goal is to have achieved the grand revival of the Chinese people by 2049, which marks the centenary of the establishment of the People’s Republic of China. This ‘Chinese Dream’ uses the word ‘revival’, rather than ‘growth’ because historically, China has not always been behind the pack in the areas of scientific development and economic prowess, but was at the top of the pack for extremely long durations of time. Scholars of Western economic history have long discounted the notion of Eurocentrism, pointing out that the current world economic layout, whereby Europe and © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_13

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its former overseas dominions# are absolute leaders in the fields of science, economy, and per capita incomes. However, the world was not always thus. Academic research shows that, globally, wealth was primarily concentrated in the east around the year 1500, and China played a critical role in this concept of the ‘orient’. It was only after this point that Europe began its rise, and the ‘Great Divergence’ with the orient did not emerge until the latter half of the 18th-century. At roughly the same period, economies, science and technology, and living standards of China and the West began to distinctly diverge, and China gradually became an impoverished and feeble country. It was the reform and opening and the resultant economic miracle that really reshaped this historical structure. Currently, China has already become the second largest economy in the world, the largest trader of goods, and the second largest importer of goods, the second largest direct overseas investor and possesses the largest foreign currency reserves in the world. It has an enormous bond market commodities market, and a huge supply of consumer tourist groups. The sustained rapid growth of its economy has not only laid down the prerequisites for the achieving of its grand dream, but is also inevitably a major driver of world economic growth. In summary, China’s experience of reform, opening, and growth means that it has already refined entirely new development concepts. It has determined the aims of its reforms, and is currently burning with unprecedented vitality.

New Concepts Guide New Growth The focus of the Party Central Committee is on the whole, the fundamental, the orientation, and the long-term. It has established new concepts for China’s economic and societal development during the period of the 13th Five Year Plan, which is to achieve innovative, coordinated, green, open, and sharing development. These five main development concepts embody ‘people’ centred development, refine the experience and lessons of the development of China and other countries, and aggregate an advanced consensus pertaining to theoretical explorations. It is targeted at unbalanced, uncoordinated and unsustainable problems inherent in China’s development, and is a response to the ardent anticipation of the Chinese people for growth, and is the guarantor for the concept of the long-term sustainable development of China’s economy. The main problems faced at specific stages of development determine mainstream development concepts and the direction of attack. Development is often confined to the economic sphere at a relatively early development stage, and strongly emphasises increasing the total scale of the economy, meaning that economic growth overrides broader concepts of development and also the direction of travel for its implementation. As soon as such an inclination is formed during a specific development stage, it will result in a narrowing of development goals, a bias towards certain development models, and constrained development outcomes. During development stages that feature a scarcity of capital, a relative over-abundance of labour, and universally low

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incomes, GDP guided development assists in increasing the total economic scale, employment, and incomes. It is thus the prerequisite for increasing national strength and improving livelihoods. As the development stage, its conditions and environment changes, not only will long extant problems during the growth period gradually grow, becoming increasingly prominent by the day, but some formerly effective concepts and measures will also tend to become less effective as time goes by. The World Bank specialist who first proposed the problem of the middle income trap also discovered this fact, whereby policies which successfully lifted a country out of poverty and allowed it to enter the ranks of middle income countries, were unable to assist that country in successfully transitioning from middle income to high income. This means that development concepts need to keep pace with the times. The concepts of innovation, coordination, green, open, and sharing development, amply reflects the new governance concepts, new thoughts and strategies in place since the 18th National Congress. They provide a comprehensive response to issues in the areas of development goals, methods, routes, key focus, balance, and sharing, and specifically embody a unity in the orientation of goals and issues. Innovative development is focused on nurturing new drivers for economic growth under the new normal. The Chinese economy grew at an average high speed of 9.8% for the more than 30 years of the reform and opening period. This was primarily dependent on the supply-side factors of the low cost advantages manifest in labour and land, and the technological ‘late starter advantage’, as well as the colossal demandside factors from rising incomes, infrastructure construction, and the opening up to the outside world. As the stages of economic development underwent fundamental change, the traditional motors powering the high-speed growth experienced a corresponding decline. The international experience shows that the traditional sources of growth gradually disappear in many countries at similar stages of development. There is often a failure to nurture the required innovativeness, and thus, the sustained impetus for economic growth is lost, resulting in a decline into economic stagnation. This means that, if innovation is the primary driver of development, it creates a long-term sustainable impetus for economic growth, enabling the maintenance of medium to high growth speeds, and also facilitates the sidestepping of the middle income trap. Second, coordinating healthy development. China’s growth has long been afflicted by its unbalanced, uncoordinated, and unsustainable nature. These issues already obstruct the maintenance of medium to high growth rates and the realisation of a sharing and inclusive economy in the new normal. International experience and the reality in China shows that moving across the intermediary stage from an uppermiddle income to a high income nation can prove tricky. A wide range of societal conflicts and dangers often result from, and are aggravated by, a lack of coordination between regions, cities and the countryside, the economy and society, the material civilisation and the spiritual civilisation, and also between the construction of the economy and national defence. Some countries fall into the middle-income trap exactly because of these problems. This means that, promoting coordinated development implicitly necessitates sustainable and healthy growth.

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Third, green development focuses on the environmental sustainability of development, and values the people’s desire for good living standards. Green development concepts state that verdant mountains and azure waters are highly valuable. The people’s desire for outstanding environments and healthy ecologies is manifested in the development goal. Once resources have been exhausted, all environments and ecologies destroyed, they are either gone for good, or recovery comes at an extremely high cost. Of particular note, environmental destruction is harmful to our living environments and our physical health. It is a high price to pay. The pervasive presence of an affluent society means that the people feel blessed by development. This, undoubtedly, cannot come at the cost of the resource environment and the ecology. Open development focuses on the optimal employment of both the national and international markets, and achieves the symbiotic growth of the two. Previously, China’s economic development benefited from economic globalisation and free trade. Its economy is now deeply integrated with the world economy. Moreover, new political trends have emerged on the global stage that might reverse economic globalisation. China needs to constantly improve its engagement with the international market, its global allocation of production, and also better counter international trade friction. It also needs to work towards the creation of a much more open economy, and raise its power of discourse in institutions in areas including international trade. By participating in global economic governance, China should provide international public goods and establish extensive communities of shared interests, and proactively utilise, expand the scope of, and lead economic globalisation. Fifth, sharing development focuses on resolving societal fairness and justice issues. It is manifested in the intrinsic requirements and development goals of socialism with Chinese characteristics. China’s problems of uncoordinated development are expressed via income inequalities between urban and rural areas, regions, and between citizens, as well as inequalities of access to basic public services. The comprehensive establishment of an affluent society is essentially evident in the general prosperity of the people. The importance and difficulty of properly dividing the cake is just as difficult as making the cake bigger during the final five years of the victory stage. A people centred development concept ultimately rests upon the concepts and measures adopted in sharing development. This is specifically manifested as upholding the generalised system of preferences, maintaining fundamentals, the equalisation of disparities, and a sustainable development orientation. This should begin by focusing on resolving issue that are the most feasible, most direct, and arouse the most interest of the people, leading to a more comprehensive and equitable public services provision.

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The Fundamentals of an Improving Economy President Xi Jinping pointed out that the positive base underlying the long term development of the Chinese economy remained unchanged. Its fundamental characteristics of economic resilience, sufficient potential capacity, and large room for manoeuvre remain unchanged. Its strong foundations and conditions for sustained economic growth persist, and economic restructuring and optimisations continue. That first ‘remain unchanged’ judgment truly reveals that China’s economic development has entered the new normal, and that the macroeconomic background and fundamental layout of its long term economic trends demonstrates confidence in China’s economic growth as it heads towards the new normal. An accurate grasp of the fundamentals of development requires a focus beyond that of the short term, the superficial and the incomplete, and on leading trends and the macroeconomic layout. The reform and opening has been the driver of China’s development, and signifies that the understanding of the critical concern of ‘whether there has been any change in the fundamentals of China’s long term positive growth’ requires both a national and global perspective. This can comprehensively advance the reform and opening zeal, and realise medium to high speed growth and the confidence for a mid to high end targeted industrial structure. An international political and economic environment perspective reveals that the main themes of peace and development remain in place, and that there are now also many new factors beneficial to China’s economic development. Although the negative effects of the financial crisis, which harmed growth globally, still exist, but generally, the deep restructuring of the global economy is giving rise to a circuitous recovery. Although there are those who, with a western focus, conclude that the world economy has entered a ‘New Mediocre’, but developing countries are exhibiting positive growth trends, and are increasingly contributing to the overall growth of the world economy. This is beneficial to the recovery of world economic growth impetus and also the creation of a new round of globalisation. For instance, the global average growth rate was 2.5% in 2014. Of which, those countries labelled as high income countries by the World Bank exhibited an average growth rate of 1.7%; upper-middle income countries of 4.5%; lower-middle income countries, 5.8%; and those classified in the low income grouping achieved growth rates of 6.3%. China has been increasingly proactive, and has actively participated in the governance of the world economy, represented developing countries interests in international trade regulations, and has won more institutional power of discourse. It has been further opening to overseas markets, allowing it to fully employ the international political and economic environment in its quest for medium to high speed economic growth. Key areas including biosciences, information technology, new energy resources, and new materials, as well as their integration into the Internet and mobile communications, mean that the new technological revolution and industrial transformation is already on the launchpad. This offers China a fantastic opportunity to harness innovative development. One aspect is that China’s GDP per capita is already ranked in

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the upper half of upper-middle income countries, and is approaching the high income threshold. It is currently engaged in a transition towards innovation driven growth, which combined with its unique advantages of its colossal internal market and abundance of human capital, provides an incubation period to employ this technological revolution. The precautions China has taken provide a ‘pioneer advantage’, and it also has the unique opportunity to take speed up as others slow down. Another aspect is the relatively large gap that still exists between China and developed countries in the fields of science and technology, and especially with regards to innovation. This provides a ‘late starter advantage’. Scientific and economic histories shows that the closer to the start of a new round of scientific and technological breakthroughs, the more late starter nations are able to harness industrial opportunities, and also employ the impetus for growth from existing achievements. China thus benefits from a combined ‘pioneer advantage’ and ‘late starter advantage’. This will help it to more economically, more effectively, and more rapidly surpass others, thereby realising innovative development. China still has growth potential, for it has a medium to high speed potential growth rate, and also a relatively large reform dividend waiting to be exploited. One aspect is that China has already entered a higher income per capita stage. The other aspect is the exacerbation of its new state of being old before rich. Its demographic dividend is disappearing at an accelerating rate, and its traditional drivers of economic growth are falling by the wayside. Unearthing new drivers for growth is becoming ever more urgent. The shift in growth drivers also inevitably signifies a step change in growth speed, which is manifested via a drop in both potential and actual growth rates. However, China’s sturdy foundations and stock of human capital means that it can still enjoy a noticeably high economic growth speed, global speaking. This is possible regardless of its falling potential growth rate and the already evidenced drop in the actual growth rate. More importantly, the reform and opening offers a wealth of opportunities for the further raising of the potential growth rate. China also faces a number of institutional factors that hinder the potential to employ the supply of production factors and productivity rises. This means that reforms aimed at eliminating these institutional barriers can bring about a reform dividend, which will be directly reflected in a rise in the potential growth rate. Implementing the comprehensive reform strategy deployed during the Third Plenary Session of the 18th CPC Central Committee; and the development and reform and opening blueprint delineated for the 13th Five Year Plan during the Fifth Plenary Session of the 18th CPC Central Committee, will bring tangible reform and opening dividends. From the perspective of openness to the overseas market, major openness measures, including being a highly attractive trading partner, increased openness to overseas trade, and advancing the construction of the ‘Belt and Road Initiative’, as well as the proactive participation in the governance of the world economy are all beneficial for maintaining the economic globalisation structure, and also for the protecting of developmental benefits that accrue from win to win cooperation.

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Looking at national supply side reforms, increasing the urbanisation of the census registered population can instantly raise the potential growth rate by stabilising migrant worker employment in urban areas, raising the non-agricultural sector labour participation rate, and maintaining the labour transition induced resource reallocation efficiency effect. Comprehensively implementing a two-child per married couple policy would help the fertility rate return to replacement levels, thereby improving the demographic age structure for the next generation. It would increase labour supply and lower the demographic dependency ratio, and raise the future potential growth rate. Deepening the reforms of administrative management, state owned enterprises, finance and taxation, and the banking system, would assist the market better fulfil its resource distribution role, and also help the government govern, thereby raising total factor productivity. In addition, China’s demand side reforms show that the urbanisation of migrant workers, the comprehensive lifting of the impoverished rural population out of poverty, and reforms to the income distribution system will bring about a more inclusive development that shares the proceeds of growth. This will fully unleash consumer demand potential, balance the economic growth demand structure, and also promote the rebalancing and stability of the macroeconomy.

Stimulating Microeconomic Vitality Entrepreneurial and investor investment enthusiasm falls each economic downturn. The investment bank economist, Richard Koo, gives a popular explanation, whereby, after a crisis has passed and asset bubbles have popped, corporations tend to have relatively high debt ratios and are thus anxious to restore their balance sheets. This leads to a marked decline in loan demand. This was the ‘balance sheet recession’ proposed by Koo as the reason for the decline of Japan in the 1990s, as well as that of the USA in the late 1920s and early 1930s. The focus of corporations on restoring their balance sheets after an abrupt fall in asset prices is a cyclical microeconomic manifestation, and explains why corporations are unwilling to take loans despite a relaxation of monetary policy. This is a classic demand side explanation, which might be of value in interpreting the circumstances of other countries, and in particular, that of developed countries. For instance, the excessive debt accumulation by, and the subsequent deleveraging of Reinhart and Rogoff, whereby, Ben Bernanke emphasised that the wild spending of money in emerging markets had resulted in excessive savings. After Krugman borrowed Keynes’ explanation on the liquidity trap to analyse the New Mediocrity of developed economies, Lawrence Summers pithily said, ‘the cause of the problems faced by developed countries is demand side not supply side’. He coined the phrase ‘secular stagnation’, attributing the blame to excessively low real interest rates, resulting in ineffectual traditional monetary policy. However, this explanation is not applicable to China’s situation, as its deceleration is primarily supply side in origin.

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China’s economic slowdown has been caused by the disappearance of the demographic dividend, the reversal of factors including labour and human capital supply, rate of capital returns, and total factor productivity; which for corporations and investors, is specifically manifested in increased production costs and transaction costs. The former, such as a rise in labour costs, leads to rising unit labour costs, and a weakening of the manufacturing industry’s comparative advantage. The latter include issues faced by small, medium and private enterprises, such as difficulty obtaining loans, expensive loans, and also the excessively high burden of social security payments. This means that there has been a decline in the quantity of high returns investment opportunities. The uncertainty surrounding returns on projects and investment has also increased. This has led to insufficient trust and even a desire to watch and wait on future developments. This wait and see attitude is a global phenomenon. However, China can take advantage of this situation, for its problems differ from that of the global economy. Moreover, this is particularly applicable to new entrepreneurs, and small, medium and private enterprises. Admittedly, the age of high returns on investment and entrepreneurship has already past; but, there is still room for costs to fall, and profit can still be raised. This simply requires participants in the microeconomic fields to strive to catch the next two opportunity windows. First, China needs to take advantage of reform opportunity windows, and aim to board the fast train to supply side structural reforms, and then share in the reform dividend. Directly economically active participants, such as entrepreneurs, possess an intimate understanding of the industrial opportunities that each type of reform presents. These include, people centred urbanisation, with a focus on the opportunities for consumption afforded by migrant worker urbanisation; investment opportunities pertaining to state owned enterprise reforms and public private partnership (PPP) projects; industrial opportunities in the old age care industry and long term nursing systems from the ageing population, the opportunities in green development and countering climate change, as well as those in the development of the cultural and sports industries. Of especial note are reforms rolled out from central government, such as the ‘three cuts, one reduction, and one improvement’ which refers to ‘cut production capacity, cut stock, deleverage, reduce costs, and improve weak links’; and also the ‘streamlining and decentralisation’ that pertains to government functions, as well as other kinds of reforms. All of which engender opportunities for improving institutional efficiency by lowering production costs and transaction costs, and also raise the efficiency and fairness of resource allocation. In addition, I would like to emphasise that future entrepreneurial activity will clearly not constitute fresh expansion, but will focus on survival and growth via creative destruction. Second, China should take advantage of the opportunity window presented by the new technological revolution, so that the optimisation and upgrading of Chinese industry is combined with the new wave of world class technologies. For entrepreneurs, new opportunities are fleeting. They come unannounced, and silently depart. This means that we should not concern ourselves with questions such as whether a new technological revolution has arrived or not, or of when it will arrive. An example from the background of Malthusian theory may provide clarification.

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The industrial revolution, symbolised by technological change, was well under way when Malthus composed his extremely negative demographic theories on economic growth and the fate of mankind. To a certain degree, this was a phenomenon of natural law, in that technological revolutions are often only proclaimed after the event. Or, as Zhu Geliang said, those who live in the age, are completely oblivious to the events that surround them. New technology, represented by the Internet, the Internet of Things, and artificial intelligence, when compared to the major technological revolutions of the past, neither convey productivity advances, nor present towering barriers to entry, nor the problem of ‘I’m late to the party’. However, when compared to traditional technology such as the steam engine, these new technologies possess higher universality, and being the synthesis other technologies, have resulted in staggering declines in cost. For instance, ‘Moore’s Law’, or the Law of Accelerating Returns, whereby technological power was increasing exponentially, means that humanity currently rides the crest of the wave of accelerating change, the speed of which exceeds that of any other period throughout history. This is diametrically opposite to the characteristics of the Malthusian Age. For instance, many of China’s new entrepreneurial success stories all show that innovation is not about being high-end, but about the right mix of new technologies, new organisation methods, new business types and the current needs of producers and suppliers. In addition, manufacturers in places like Germany, Japan, and Sweden are all focused on melding the traditional techniques with new data, the Internet and the Internet of Things. Germany’s small and medium sized enterprises, the majority of which are family owned and have been in existence for over a century, continue to maintain their world leading position in the manufacturing industry through their ‘old techniques-new data’ model, and also under the framework of Industry 4.0.

Evaluating the New Pattern of Growth In the new normal of economic growth, it is clearly not possible to assess performance with the old standards when achieving medium to high speed economic growth via new development concepts. Instead, new standards must be found. President Xi Jinping set the requirement that economic development be fundamentally raised in the areas of quality, economic benefit, and competition. The 18th National Congress proposed the development transition keystones of raising quality and economic benefit. The Fifth Plenary Session of the 18th CPC Central Committee proposed that the guiding ideology of the 13th Five Year Plan development period should be centred on the raising of the quality of development and economic benefit. The Central Economic Working Conference further clarified this by stating that the requirements for development were that: investment is to have a return, products are to have a market, companies are to have profit, employees are to have income, government is to receive taxes, and the environment is to improve.

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This means that the criteria for appraising the new layout of economic growth is the quality of this growth. This is a divergence from the prior focus on GDP and its rate of increase. In particular, we should at least have a grasp of five points. First, there should be no exaggeration of economic growth, and such growth cannot come at the cost of the destruction of resources, the environment, the ecology, or labour conditions. Second, growth should be the result of increases in the potential growth rate, and not a result of stimulatory policies causing growth to exceed the potential growth rate. Third, growth should be a result of productivity increases from industrial restructuring. Fourth, growth should be a result of increases in total factor productivity, and not from the continuation of more traditional growth factors. Fifth, growth should be based on a new dynamic equilibrium between supply and demand.

How to Destroy the ‘Xiling Effect’ The Party’s 18th National Congress brought ecological civilisation into the general framework of the ‘Five-Sphere Integrated Plan’. This raised the establishment of an ecological civilisation and ecological construction to a new state of civilisation development goal, thereby completing a cognitive leap on ecological concepts. On the subject of resources, the environment, and the ecology, international development theory has shifted from ‘first pollute, and then manage’, to ‘pollute, and manage’, and then to the sustainable development concept of not making future generations pay the price for development today. This concept is still viewed as a development method, and not given the same value as development itself. President Xi Jinping believes that the ecological environment comprises an important aspect of the people’s yearning for better living standards. He announced the timely development goal of ‘the environment is livelihoods, a verdant mountain is, in of itself, beauty, blue skies are, in of themselves, wealth, and a green environment is worth its weight in gold’, and ‘a good ecological environment is the most equitable public good, and is the most universal source of happiness in life’. Guided by these new concepts, the quest for quality economic growth meant that the 13th Five Year Plan got off to a good start, and, based on these improved indicators, achieved a 6.7% GDP growth rate in 2016. However, substantial improvement to ecologies and environmental management does not happen overnight. During their daily lives, people found that once the indices such as the manufacturing industry PMI rebounded, environment indices such as PM2.5 would then worsen, as if an inverse relationship between growth and pollution were unavoidable. For instance, The Economist published a chart that depicted fluctuating concentrations of airborne small particulate matter (PM2.5). Such fluctuations appeared to be synchronised with fluctuations in industrial output. This reminded me of a story from many years ago. After the major earthquake in Wenchuan in 2008, I lead a team to the earthquake zone to conduct an investigation as a kind of intelligence disaster relief measure. A Sichuanese colleague, who was working with me on the investigation, mentioned an interesting phenomenon that he had observed. Chinese readers will be familiar with

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the famous lines of the poem by the Tang Dynasty poet, Dufu, ‘A window frames snowcapped Xiling, and boats from East Wu float outside the door’. The Xiling mountains are not visible from Chengdu with the naked eye, and for a very long time, the locals believed these lines to be mere poetic license. However, economic activity, factories and transportation all halted in the wake of the earthquake, and there was a noticeable reduction in airborne pollutants, and the people were surprised to discover that the Xiling mountains were in fact visible from the city. This story led me to call the substitutional relationship between the environment (and even accidents) and growth speed (which in economics is called a trade-off) the ‘Xiling Effect’. However, my intention was not to wholly recognise this kind of substitutional relationship, for this ‘Xiling Effect’ is not an absolute, set in stone, rule. Simply put, this rule shows that it is only via proactively abandoning GDP targets, and sacrificing speed that environmental quality can be preserved. Indeed, many academics, both from China and overseas have stated the same to China’s policy makers. Nevertheless, some are sharply opposed to this viewpoint. For instance, during a media event at the 2017 World Economic Forum, held in the small Swiss town of Davos, Justin Lin Yifu gave a speech on ‘smog economics’, where he criticised this kind of viewpoint, and emphasised that GDP and its growth speed was still needed. The logic of his argument was that a horizontal analysis of countries showed that environmental conditions were relatively good in those nations with either extremely low or very high income levels, whilst those of middle income countries were comparatively poor. Since we cannot return to a low income status, the only option is to accelerate development, and reach the high income stage where improving the environment becomes feasible. I listened to his speech in person, and when I later spoke, I expressed my approval for Justin Lin Yifu’s adherence to economic growth, but also euphemistically expressed that I did not thoroughly agree with his underlying logic, and was not willing to wait until entering the high income stage for the arrival of the turning point of the Kuznets environment curve. The overwhelming majority of academics believe that the kind of substitutional relationship between the environment and growth rate described by the ‘Xiling Effect’ is rooted in the background growth method. Or in other words, if growth methods remain unchanged, then this relationship will persist, and the cycle of environmental improvement and degradation will repeat, over and over again. In actual fact, some researchers have found that when economic indicators improved in the second half of 2016, there was a tendency for traditional economic growth factors to rebound, and a relative weakening of new growth factors. The resolution to this problem is not to not develop, but to maintain a reasonable range of growth on the foundations of transitioning growth methods. Changing economic development methods is key.

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Opening the Right Policy Toolbox In answer to the voices on the international stage denouncing China’s economy, Li Keqiang repeatedly said that there are still many reserves and additional tools in China’s policy toolbox. However, different people had different preconceptions about the kind of tools that might be contained within the toolbox. We should comprehensively review these potential tools, their nature, utility, and effect, and when they should be used, and also the cost and benefit of each individual tool. Bloomberg News reported that China has six tools at its disposal, which it called ‘a selection of a number of stimulatory policies’. First, lower interest rates. Some people believe that China’s annual loan interest rate and deposit rate are too high. Second, lowering the deposit-reserve ratio. Some people believe that China’s depositreserve ratio is the highest in the world, and a fall of ten percentage points, would release ¥13 trillion RMB of bank capital for use as loans. Third, direct loan. For instance, the central bank infuses capital into policy and development banks for earmarked construction. Fourth, allow renminbi to depreciate. Fifth, the central bank completes buy orders. Sixth, increase financial expenditure, such as investment in capital construction. All of these tools mentioned by Bloomberg News are stimulatory tools, and moreover are focused on stimulating overseas market demand and investment demand. One aspect is that we should meticulously analyse these policy tools, especially from a cost to benefit perspective. The other aspect is that we must pay more attention to supply side policies. International observers do not deny the sustainability of China’s economic growth, and anticipate that it will prove to be a major contributor to the world economy. However, there is often a lack of consideration, or even misunderstandings, about how the Chinese economy grows, and of its contribution to the world economy. For instance, some people place their hopes in China implementing more stimulatory policies so that they can hitch a ride on the back of China’s economic growth, or even seek to profit from trade and investment. There have even been some investment bank economists who have adopted short-term investment, or lazy policies. They have not improved client confidence in China’s future by explaining the fundamentals of its improving economic situation, but have exaggerated the pessimism about its economy, in the hope that the Chinese government will emerge with more stimulatory economic measures, and thereby ignite their clients’ investment enthusiasm. Superficially, the logic seems simple and direct enough: stimulating China’s economic growth through investment will inevitably create a certain level of demand for resources, raw materials and equipment imports, as well as that of foreign investment, thereby benefitting specific investors or companies. This might even lead to an overflow, providing a short term boost to other economies. Nevertheless, the underlying logic reveals that such thoughts and methods would be irresponsible, both to others and to China itself. First, even if stimulatory macroeconomic policy really proved effective in the short term, at best it would be short term investors, or opportunists who would profit, as well as some other countries that are heavily dependent on the Chinese economy.

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However, as this would result in a growth speed that would not be healthy for the Chinese economy, it would be unsustainable. The world economy needs sustainable development, and not a single shot analgesic or cardiac stimulant. Second, as the clearcut judgment already made by the central government states, the drop in growth speed faced by the Chinese economy, along with other challenges, is primarily supply side in origin, and not demand side. The disappearance of the demographic dividend, the fall in the rate of growth in the supply of labour and human capital, as well as that of total factor productivity, the fall in the rate of return on investment, have all contributed to a decline in the potential growth rate. Forecasts show that the potential growth rate was 6.2% during the 13th Five Year Plan, which is somewhat below the requirement of 6.5% for medium–high growth. Nevertheless, focusing on the demand side and relying on stimulatory policies, such as relaxing the money supply and expanding investment, will not improve the supply of factors of production or allocation efficiency. Remedying this growth rate gap in this manner would, conversely, aggravate excessive production, heighten business costs, debt leverage, and financial risks, and postpone the transition process of the structural reforms and methods of development. In short, actual growth rates that exceed the potential growth rate are not only unsustainable, but also dangerous. In which case, how can a gap between the forecast potential growth rate and the medium–high speed growth required of the actual growth rate be remedied? There is, in fact, a way, and it has a positive forecast outcome. We modelled reforms and their outcomes, and came to the following conclusion: implementing supply side structural reforms can raise the potential growth rate to a level of not less than 6.5%. These reforms focus on innovation, coordination, openness, green, and sharing. Furthermore, our simulation also showed that the stronger the intensity and precision of the reforms, the more that the potential growth rate follows an ‘L’ shape trajectory of change for the subsequent several decades. This not only provides supply side impetus for economic growth worldwide, but also provides a constant and equalising increase in China’s urban and rural income levels; and from the demand side, it contributes by returning the world economy to the right trajectory. This means that the policy tools in the supply side toolbox will primarily be used for supply side reforms, to realise increases in labour productivity, total factor productivity and the potential growth rate.

Why Emphasise the ‘Three Increases’ In 2016, the Central Economic Working Conference proposed the ‘three increases’: increase labour productivity, increase total factor productivity, and increase the potential growth rate. It also specified the basic requirements and specific route of the shift towards the impetus for new growth patterns. What are these ‘three increases’ aimed at, and what is the logical relationship between them?

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For a long period of time, every decline in economic growth was viewed as a downside cycle, upon which an adjustment to the orientation of macroeconomic policies, would ultimately halt the decline and then bring growth back to a normal level. Nevertheless, the current state of the economy differs from past experience. Economic growth has maintained a downward trend since it fell below 8% in 2012, and has accelerated towards a shift in gears, and a fall in the potential growth rate, and is the result of structural factors, not cyclical. Policy responses can only be targeted and provide the anticipated positive outcome if economic conditions are understood under the unifying framework of the new normal of economic development. The potential supply of factors of production and productivity rises determines an economy’s supply capabilities, and is expressed as the potential growth rate. When supply conditions are fixed, cyclical changes to demand determine whether the actual growth rate is lower than, higher than, or equivalent to the potential growth rate. Of which, the first situation is the cause for the prior three economic growth low points, and is often countered via stimulatory macroeconomic policies. The second situation is often manifested through inflation, an occurrence that has happened on several occasions in the past. The corresponding policy tools to counter this often consist of the implementation of tight macroeconomic policy. The entrance of economic growth into the new normal signifies that a declining growth rate is not the result of the actual growth rate dropping below the potential growth rate, but that the disappearance of the demographic dividend has actually resulted in a fall in the potential growth rate. The potential growth rate has fallen because of the decline or even disappearance of traditional growth drivers that are connected to the demographic dividend. This means that adapting to the new normal means accepting a lower rate of growth. In addition, leading the new normal signifies the expansion of new drivers of growth, as well as the maintaining of growth speed within a reasonable medium to high range. In the final analysis, rises to labour productivity are the fundamental answer to insufficient labour and human capital, and also drops in the rate of return on capital. Normally, the traditional drivers of growth include physical capital, the size of the workforce, and human capital that pertains to demographic changes, as well as other physical inputs. The new economic growth impetus is mainly manifested via labour productivity. The three main sources of increases to labour productivity are as follows. First, increases in the capital to labour ratio. Rising labour costs will inevitably lead to capital labour substitution or the replacement of people by machines. However, this kind of substitution cannot occur overnight, for it will be constrained by the law of diminishing capital returns. If worker skillsets are unable to adapt to the requirements of machine operation, then the losses from capital labour substitution outweigh the gains. We know that labour is becoming increasingly expensive in China, and a direct response by entrepreneurs is to use machines in the stead of labour. However, this behaviour faces restrictions, for machines require management and maintenance by higher qualified workers. Although labour is becoming extremely expensive, but can one person simultaneously tend to two machines? The skillsets are not there, so this is currently not feasible. This signifies that as the number of machines increases, the

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rate of return on invested capital will fall. Therefore, we cannot blindly rely on a rising capital to labour ratio to raise labour productivity. Second, improvements to human capital. Rising operator skillsets and an increase in the proportion of engineers is a prerequisite for fewer workers operating more machines. This means that if there is a dearth of workers with higher skillsets, or who are able to upgrade their skillsets, and possess higher levels of innovativeness, then the capital labour substitution process will not produce its intended effect. Can worker skillsets or human capital support rapid rises in labour productivity? Reality shows that this is not feasible. When economists create econometrical models, they often use years of education received as a proxy variable for human capital, and then look at its impact on economic growth in the model. Nevertheless, this indicator cannot simply be raised by the input of more effort. Experience shows that increasing education levels takes time. It is not something that can be achieved overnight. For instance, based on census data and a 1% population sample survey, despite the increase in compulsory education attendance and expanded higher education enrolment, the average number of years in education of the aged 16 and above population rose from merely 6.24 years to 7.56 years between 1990 and 2000, a total of 1.32 years. The figure for 2005 was 7.88 years, an increase of only 0.32 years over five years. Moreover, the gross enrolment rate of compulsory education was already relatively high, and higher education had entered the mass market. Further increasing the number of years spent in education by the total population will really take time. Third, increases to total factor productivity. Total factor productivity can be increased by the introduction of new technologies, the promotion of innovation and the improving of the allocation of resources. This is the most fundamental and sustainable source of labour productivity, and affects systemic reforms to the creation of a competitive environment. The route towards clearcut and sustainable labour productivity rises comes from increases in total factor productivity. Total factor productivity refers to conditions where the input level of all manner of factors of production is fixed, yet there is additional production efficiency. For instance, no matter whether discussing a company or a country, if the rate of increase of capital, labour, and other factors of production is each 5%, and if there have been rises in productivity, in ordinary circumstances, output or GDP growth rate should also be 5%. If output of GDP growth exceeds 5%, for instance 8%, then the extra three percentage points will be expressed, in a statistical sense, as being a ‘residual error’. From the perspective of economics, this is the contribution of total factor productivity to output or growth. There are often two ways to increase total factor productivity: the first is technological progress; and the second is via reconsolidating of the factors of production to raise allocation efficiency, and is primarily manifested outside of production factor inputs, and drives economic growth via intangible factors such as technological progress, systemic optimisations, and improvements to organisational management. On a microeconomic level, total factor productivity can rise when corporations, for instance, adopt new technologies, new techniques, expand into new markets, develop new products, improve management, or engage in systemic reforms that fire people’s enthusiasm. On a macroeconomic level, if, for instance, the outcome of

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labour transitions from the low productivity agricultural sector to higher productivity non-agricultural sectors will be an increase in total factor productivity. It could be said that the more advanced the stage of economic development, the more a country will need to rely on increases in total factor productivity to achieve economic growth. There is a wealth of economics literature that attests that the manifestation of total factor productivity can explain the contrast between sustainable economic growth and stagnation. This has also been shown to be the main reason why so many countries fall into the middle income trap. At the development stage in which China currently finds itself, the most crucial aspect to accurately recognise, grasp, adapt to and lead the new normal is to find new drivers for economic growth and realise innovative development. One aspect is that these new drivers need to come from total factor productivity. The other aspect is that total factor productivity is a key indicator for balancing innovative performance and the quality of growth.

Productivity Guided Industrial Restructuring Some researchers believe that as tertiary sector labour productivity is lower than the secondary sector, and as the development of the former is gradually overtaking the latter, and as such, is a factor contributing to the economic downturn. Setting aside the policy implications of this judgment for now, its factual accuracy is not purely a theoretical matter, and requires data analysis based empirical studies to arrive at a conclusion. This book believes that, generally speaking, China’s industrial restructuring will lead to productivity rises. In addition, accelerating reforms aimed at developing the production factor market is of assistance in industrial restructuring towards upgrading and optimisation, and can avoid a ‘reverse Kuznets effect’ on industrial structural development.

The Key Aspects of Industrial Upgrading Although economists have long summarised the laws of the evolution of industrial structure, as Clark discovered, the industry restructuring often evolves in the order of primary, secondary, and tertiary industry. However, the real revelation on the impetus and outcome of industrial evolution came from Kuznets. He pointed out the key to industrial structural upgrading, which was that resources moved from sectors with relatively low productivity to higher productivity sectors. We can consider this to be the ‘Kuznets’ evolution of industrial structure. Thus, if the evolution of industrial structure does in fact abide by the primary, secondary, tertiary order, the implicit assumption is that productivity too rises as the order progresses. This means that the aggregate resource allocation efficiency of a nation’s economy constantly rises, and is expressed via increases to total factor productivity.

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China’s industrial restructuring essentially followed the laws of productivity rises during the reform and opening period. Inter-industry resource allocation efficiency comprised an important component of total factor productivity. This contributed substantially to economic growth during this period. Let us look, for instance, at the productivity in the three main sectors as well as the added value produced by labour between the years 1978 and 2013. Agricultural labour productivity rose from an average of ¥400 per worker to ¥29,200 RMB, which is equivalent to a rise in non-agricultural productivity from 16.4 to 31.8%. This increase in productivity is admittedly influenced by technological progress, such as increased output, yet more important is the effect of the sustained fall in the proportion of the agricultural workforce. Based on new estimates on calibrated official data, the proportion of the agricultural workforce fell from 70.5 to 21.9% during the same period. However, industrial restructuring that progresses through the primary, secondary, and tertiary sectors, will not inevitably result in increases to productivity and resource allocation efficiency. In recent years, some observers have begun to notice that worker transitions from secondary to tertiary industries will conversely lead to falls in productivity. If this is true then it signifies the emergence of a ‘reverse Kuznets effect’ during the industrial restructuring process. Employment in the tertiary sector exceeded that of the secondary sector in 1994. The former’s share of GDP surpassed that of the latter for the first time in 2014, when they respectively comprised 46.1 and 43.9% of total GDP. This change has been universally viewed as a key industrial restructuring milestone. However, if such a change results in an actual productivity drop, then the policy focus, which has always placed increasing the proportion of the economy comprised by the tertiary sector as a goal of industrial restructuring, will require review. Looking at the overall picture, in 2013, the labour productivity of China’s secondary and tertiary industries was respectively ¥108,000 and ¥88,000 per worker, the latter is 18.5% lower than the former. It can be seen that, some people believe that increases in the share comprised by the tertiary sector will lower overall resource allocation efficiency, and might even exert a downward pull on economic growth, this is not without cause or reason. However, such worries admittedly have a precautionary function, and the statistical basis on which this conclusion is founded is insufficient. The key to finding the answer to this problem does not lie in whether the proportion of GDP comprised by the tertiary sector is rising or not, or that these two sectors exhibit a inverse correlation relationship, but in the nature of the relative changing trends of the two. We can employ a statistical indicator—comparative labour productivity (the ratio of the proportion of the output value comprised by each industry with the proportion of employment) to observe whether resource allocation between the secondary and tertiary sectors is appropriate. When only considering these two sectors, the comparative labour productivity of the secondary industry has been clearly higher than 1 for a long time, signifying that a comparatively small proportion of labour creates a comparatively large proportion of added value; whilst that of the tertiary sector has always been below 1, whereby a comparatively large proportion of labour creates a comparatively small proportion of added value, illustrating that inter-sector resource allocation has room for optimisation.

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However, during the past period, the comparative labour productivity of the secondary sector exhibited a downward trend back towards 1, whilst the comparative labour productivity of the tertiary sector exhibited an upward trend back towards 1. Such trends, especially that of the turning point of tertiary sector output value surpassing that of the secondary sector indicates a trend towards equitable resource allocation.

The Worrisome ‘Reverse Kuznets Effect’ However, a note of caution about the phenomenon of the industrial structure ‘reverse Kuznets effect’, for it is not completely without validity. In fact, a few clues have already arisen that are worthy of attention. As China’s economic growth entered the new normal, the rate of growth substantially slowed, and to maintain sustainable economic growth requires accelerating the adjustment and upgrading of the industrial structure, and the transition of economic growth from being input driven to productivity driven. In actual fact, the gradual transition of an economy from the dual economy to the neoclassical development stage signifies that economic growth will increasingly be dependent on increases to total factor productivity. From the microeconomic level, a wide array of efficiency boosting methods are available to corporations. These may include adopting new technology, entering new markets, and improving management practises. From the microeconomic level, increases in total factor productivity are ultimately attained via increases in resource allocation efficiency. This means that, adjustments to industrial structure must adhere to the principles of increasing productivity. The potential and actual existing ‘reverse Kuznets effect’ on industrial restructuring is expressed in at least two ways. First, as the residence registration system reforms remain incomplete, those migrant workers who have already moved to urban areas are unable to enjoy equal access to basic urban public services, and are in particular, unable to enjoy social security provision such as basic social old age insurance, unemployment insurance or the minimum subsistence wage. As such, they will often exit the urban labour market at a period when they are still highly employable. Typically, migrant workers head back to their villages after the age of 40. Although they are still employed upon return, but they have transitioned from a non-agricultural sector to work the fields, from employment in the urban economies of China’s wealthy coast, to employment in the agricultural economy of mid to west China, which inevitably entails a drop in productivity and resource allocation efficiency. So, if we say that the transition of labour from agriculture in the countryside to employment in urban non-agricultural sectors is a kind of resource reallocation that contributes greatly to economic growth, and drives the development of Kuznets’ industrial structures, then migrant workers returning to the countryside is the expression of a ‘reverse Kuznets effect’, which not only reduces labour supply but also

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lowers resource allocation efficiency, and is detrimental to maintaining sustainable economic growth. Einstein is said to have said,’if the facts don’t fit the theory, change the facts.’ Evidently Einstein is not advocating bookishness, or inciting you to distort facts. My understanding is that once a method to observe facts is found to be erroneous, an empirical conclusion can result, yet this is an insufficient basis on which to reject the theory. There have recently been two observations and resultant inferences on urbanisation and the transition of rural labour which have not been established on the foundations of correct theories and standard methodologies, and are, as such, prone to mislead policy formulation, and undoubtedly belong to the ‘change the facts’ set. The following two observations are interrelated: the first asserts that migrant workers are leaving cities never to return; the second rashly believes that farmers are unwilling to relinquish their rural status and adopt an urban identity. First, investigations of a statistical nature conducted in the service of rigorous research are completely different from the assumption loaded ‘investigations’ conducted for news reports or hobbyist commentators. Generally speaking, we can see from a series of events that have caught the attention of the general public, that the latter so called ‘investigations’ fundamentally do not adhere to any statistical methodology, and have an even poorer understanding of the concepts of ‘sampling’, and ‘stochastic models’, and are unable to accurately explain even superficial phenomena. In particular, when an investigator does not obtain objective indicators, or arrives at conclusions via data analysis, but simply inquires with the aim of verifying a certain assumption, then methodology has been thrown by the wayside. Second, people seem to have noticed the reverse flow of labour, which is actually a result of demographic change. As the population changes, the reduction in the quantity of rural new labour will mean that the growth rate of migrant workers heading far afield will inevitably slow. For instance, no matter whether we use the rural resident population, or the agricultural census registered population parameters, the size of the 16–19 year old demographic peaked in 2014, and has since fallen each subsequent year. Correspondingly, the growth rate of migrant workers who head far afield is inclining towards stagnation. Between 2005 and 2010, the number of migrant workers heading far afield increased by 4% per annum. This figure fell to 1.3% in 2014, and then further to 0.4% by 2015. Based on the National Bureau of Statistics definition of migrant workers in cities for work or business, between 2004 and 2014 migrant workers contributed about one quarter of the increase in the rate of urbanisation. This means that, as current urbanisation statistical trends indicate, the number of migrant workers going far afield is falling and their rate growth falling (or even stagnating). This will inevitably slow the rate of urbanisation. In other words, the new growth of rural transitioned labour has entered negative growth, and is unable to settle in cities. Retired migrant workers continue to return to the countryside for their twilight years. The net effect of this is reverse urbanisation and a ‘reverse Kuznets effect’. Second, the labour transition from the secondary to the tertiary sector is a progression of the Kuznets industrial structure, yet is nevertheless a trajectory deviation from this, and is dependent on the kind of secondary industry that labour transitioning from,

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and the kind of tertiary industry it transitions to. In actual fact, the tertiary sector covers a wide variety of industries, including traditional services closely connected to the daily lives of the people, and also the modern industry and its series of tightly integrated new technologies. Productivity between the two vastly differs. We can use data from the first and third economic censuses to investigate the structural changes of the tertiary industry between the years 2004 to 2013. If we divide the tertiary sector into two, the ‘traditional services’ (wholesale and retail, transportation, storage and post business, accommodation and catering, neighbourhood services, repair, and other service industries) and ‘modern services (water conservation, environmental and public facility management, information transmission, finance, real estate, rental and commercial services, scientific research and technological services, education, hygiene and social work, culture, sports and entertainment, public administration, social security and social organisation), then the former grew by 117.4% over this period, comprising 34.7% of the entirety of the tertiary sector in 2013, whilst the latter grew by 68.3%, comprising 65.3% of the entirety of the tertiary sector in 2013. Both of these service sector areas are developing in the same direction, but also possess differing causes and impetuses. Not only as economic development enters a higher stage of development, with living standards placing higher demands on the development of a wide range of service industries, and the driving force of economic growth under the new normal will increasingly rely on the faster growth of many of the modern service industry sectors. One aspect is that growth of the traditional service industries is clearly faster than that of the modern service industries, which undoubtedly drags productivity down. The other aspect is that, the modern service industries comprise a larger proportion of the tertiary sector, and as such, contribute more to its growth. When we are discussing industrial restructuring induced resource allocation, we do not mean that tertiary industries have an inverse relationship with manufacturing. In actual fact manufacturing upgrades can extend to both ends of the ‘smile curve’, stretching from manufacturing to productive service roles such as research, design, marketing, and after sales services, the latter also assists manufacturing to become more competitive. In this manner, upgrading manufacturing and the development of modern service industries can occur in lockstep. International comparisons show that the size of the tertiary sectors in many countries at different stages of development are higher than that of China’s. The underlying logic for which is their dissimilar, or even widely divergent, compositions. Generally speaking, the service industries of developed countries comprise a relatively large proportion of total GDP, and are often modern service industries that have developed upon highly industrialised foundations. For instance, the tertiary sector comprises as much as 70–80% of the economies of the manufacturing great powers of America, Germany, and Japan. In addition, the services industries of some countries that have long fluctuated around the middle income level comprise a fairly large proportion of their economy. Yet, this is often a result of a lack of comparative advantage, or even an outcome of the ‘deindustrialisation’ of their industrial structure, and is manifested by traditional

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service industries comprising the majority of the whole, and does not represent an apogee or optimised industrial structure, and conversely can be considered to be a structural abuse of economic growth.

Changing Approaches to the Upgrading of Industrial Structure The most important basis for really turning structural evolution into a productivity rise led industrial upgrading and optimisation process, is to allocate resources via the total employment of market mechanisms, and avoid the artificial restructurings that result from government over-reliance on policy. When faced with such urgent and important issues like industrial restructuring, governments are often anxious to find a policy tool that offers instant results. Apart from general advocacy, governments are traditionally inclined towards, and have formerly been believed to be, policies that ‘produce results’. These are mainly implemented along with a whole series of incentivising and disincentivising industrial policies, namely providing favoured industries with financial, tax, credit, and regulatory support, or restraining disfavoured industries. A wealth of global development experience shows that whilst the original intent of implementing industrial policies may be benign, and can achieve their desired outcome, but there is no shortage of examples of the overuse of such stimulatory measures, which distort the prices of factors of production, and become case studies of how a natural industrial structure can evolve into an artificially intervened structure. The result is often that twice the effort gives half the effect, or even that the policy backfires. Upon observing the problems inherent in implementing industrial policy, some researchers suggested that such kinds of policies and also government intervention in industrial structure should be abandoned, and the market be fully left to adjust the direction, rhythm and intensity of the industrial structure. This is tantamount to throwing the baby out with the bathwater. In actual fact, there is no conflict between employing the determining role that market mechanisms play in resource allocation, with that of governments engaging with the process of the upgrading of industrial structure. Moreover, governments have feasible and effective means to fulfil such duties. Currently, adhering to the principles of raising resource reallocation efficiency to upgrade and optimise industrial structure, prevents changes to the industrial structure resulting in a ‘reverse Kuznets effect’. Governments can drive deeper reforms in several key fields, especially those reforms beneficial to the development of the factor market. The key to developing the factor market is accurate pricing signals. As long as factor prices fully reflect the relative scarcity of resources, then the comparative advantages of the country, or even each region, are evident, and industrial restructuring will proceed in accordance with the laws of comparative advantage. If factors

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of production are fully mobile, then this will lead to the formation of an industrial structure with efficient resource allocation. First, accelerating labour transition and also the urban residence registration of those migrant workers who have already found urban employment, facilitating the stability of their employment in non-agricultural industries, thereby rendering reverse flows and the inefficient reallocation of resources unnecessary, demands pushing through reforms to the residence registration system. Second, changes to industrial structure aimed at raising resource allocation efficiency ultimately need to be sensitive to countless companies and investors who themselves are sensitive to changes in relative factor prices, and enter industries with comparative advantages, and leave those that have lost theirs. Financial services that are fully competitive and feature fair compensation can help business and investors make rational decisions based on their own judgment, and can avoid poor judgments on comparative advantage that are the result of preferential policies, and also that of the phenomenon of ‘blind swarming’ that can occur during industrial restructuring. This creates an urgent need to realise the equitable distribution, and efficient utilisation, of funds via deepening of the financial system, and investment and financing system reforms. China’s economics academia was the centre of a flurry of attention in 2016 when the nation’s two most influential economists, Justin Lin Yifu and Zhang Weiying held an open debate. In summary, Justin Lin Yifu advocated the formulation and implementation of industrial policy, and the employment of the role of the market in resource allocation, and also that of the government’s role, whilst Zhang Weiying persistently refuted the effectiveness and efficiency of industrial policy. The media ask me my opinion of this debate. In general, I believe that industrial policies are required. The core of such policies, however, is not to tell the market and its core factors which industry to develop, but in the concepts to be adhered to in guiding industrial development. The intent of which is therefore to emphasise the determining role played by the market, and also enable to the government to better play its own role. It is easy to over interfere when attempting to tell the market which industries to develop, thereby giving the issue to a completely unoptimised and imperfect market. This process also endangers innovativeness and sharing, thereby losing the original trajectory of the optimisation and upgrading of industrial structure. The former situation is like that of the erroneous Hoffman Rule heavy industry priority development strategy, the latter is similar to how the industrial revolution, and the computing and information technology and artificial intelligence revolutions did not engender the sharing of the proceeds of their growth for extended periods of time (which is how the USA developed). Next, I will discuss the relationship between manufacturing and other sectors. First, manufacturing and the service industry. Kuznets believed that the goal of industrial restructuring was productivity increases. If the latter deviates from the development of the former, then the rules mean that productivity might fall, leading to the ‘Kuznets process’. For instance, statistics show that labour productivity in the tertiary sector is 18% lower than in the secondary sector. This means that only

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productive services that serve upgrades to manufacturing is innovative, and is able to avoid this Kuznets process. Second, manufacturing and the financial industry. The financial industry contributed somewhat to GDP growth during 2015. This was not, however, the task assigned to this sector, as such contributions are unsustainable, and also come at too high a risk. The result of leaving the supply side and the real economy and adopting macroeconomic demand side stimulatory policies will not be better than that of the real economy, and will be like ‘pushing a rope’. An excessive loosening will result in currency outflows and circulation within the financial industry, and will encourage industry bubbles that are disconnected from comparative advantage and competitiveness. Third, manufacturing and IT and AI. The prior experiences of countries like the UK and the USA show that these kinds of new technologies do not naturally facilitate sharing the proceeds of growth. This is similar to the industrial revolution during the late 18th and early nineteenth centuries. At that time, the United Kingdom was an industrial centre experiencing frantic technological progress, yet the quality of life of people engaged in this sector was lower than the national average (average life expectancy fell by 15 years). It is only when the manufacturing industry or real economy is the object of services, and that such technologies can be people centred, will they not be disconnected from ordinary workers, or exclude those workers. Fourth, manufacturing and construction (infrastructure and real estate). Bubbles form easily in the real estate industry, and so it cannot provide major or stable contributions to GDP, and is not the focus of industrial restructuring. Infrastructure construction requires the demand for its existence from the real economy, and with the exception of remedying weaknesses, should not be developed in advance, otherwise not only will it not ensure growth, but will also result in damage to the real economy, and a drop in growth speed. Research by the Tsinghua University professor Bai Zhongen, showed that an excessively strong construction industry exacerbates labour shortages, and aggravates wage growth pressure. When the wage growth rate exceeds labour productivity, unit labour costs will rise too fast, thereby lowering the competitive advantage of the manufacturing industry. I thus conclude that the optimisation and upgrading of industrial structure, which includes the upgrading of the manufacturing industry (with a focus on productivity rises), also includes the development and increase in the proportion of those industries that service the real economy (ie. manufacturing). The goals of serving the real economy and productivity increases will adjust the industrial structure in accordance with the concept of an innovative development that shares the proceeds of growth.

Chapter 14

From the Demographic Dividend to the Reform Dividend

The key to creating another economic miracle on the back of sustained medium-high growth speeds is the deepening of supply side reforms. In the new normal of economic development, the aim of maintaining medium-high speed economic growth is not the simple achieving of some percentage point increase in the growth rate, but in the transformation of the drivers of growth. In this way, growth forecasts are met via productivity driven methods. The key to maintaining sustainable economic growth in China is to abandon the quest for inspiration from demand side policy measures, and also that of the analytical framework of the economic cycle, followed by the adoption of a supply side focus on factors driving the potential growth rate downwards. This starts from systemic barriers that impede the supply of factors of production, as well as increases in total factor productivity; and from which tap into new growth drivers via structural reforms, thereby raising the potential growth rate.

People Centred New Model Urbanisation The new people centred new model urbanisation strategy has been driving Chinese urbanisation since the 18th National Congress. This concept draws upon successful Chinese and overseas examples of urbanisation, and rethinks, from first principles, the issues encountered by such examples during their implementation. It possesses a strong theoretical grounding, caters to national circumstances, and responds to challenges anticipated to arise as economic development enters the new normal. It promotes a people centred new model urbanisation, and is an important component of the development concepts of innovation, coordination, green, open, and sharing.

© CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9_14

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Pathway Outcomes Experience from around the world shows that urbanisation is the result of economic and societal development, and the pathway to modernity. Urbanisation’s dual nature is thus revealed as being both the means and the outcome of development. Economies of scale and the cluster effect stimulate industrialisation and are conducive to the clustering of industry and populations. This drives the development of the service industry, urban infrastructure, and public services supply sectors, ultimately accelerating urbanisation. Conversely, the industrial clustering that accompanies increased urbanisation leads to the clustering of populations, talents, and creativity, and also facilitates the more efficient provision of public goods. This creates a platform amenable to enterprise and innovation, improves local living standards, and from which, raises the sustainable and sharing aspects of economic development. An international comparison on the relationship between gross national incomes (GNI) per capita and urbanisation rates (the urban population as a proportion of the whole) evidences clear causality between urbanisation and economic growth. Data from 2015 shows that the average urbanisation rate of low income countries, as designated by the World Bank (with a GNI per capita below US$1,035), was 31%; that of low income countries (US$1,035–US$4,086), 39%; that of uppermiddle income countries (US$4,086–US$12,616), 64%; and high income countries (above US$12,616) as high as 81%. It is clear that the laws of economic and societal development lead to increased urbanisation, it is a historical necessity. In addition, as the journey from low to higher levels of income is a result of economic growth, urbanisation is inevitably a long term historical process. However, the international experience shows that not only is urbanisation uneven and also highly divergent in every city in the world, but that the outcomes of urbanisation are not necessarily all positive. It can lead to the emergence of the universal sickness—‘city syndrome’, which was not only historically commonplace in the urbanisation of developed nations, but is now also widespread throughout the developing world. There are universally recognised negative consequences of urbanisation. These include, urban unemployment that is a result of industrialisation lagging behind urbanisation, the decline of agriculture and the countryside from the disproportionate outflow of factors of production, insufficient employment opportunities and public services provision induced urban poverty, as well as the anarchic urban crime that can flourish in such conditions. The urban slums that exist in many developing nations are a microcosm of the negative effects of urbanisation and are a crucible for the manifestation of, and provides an explanation for, so-called ‘city syndrome’. Quite evidently, urbanisation may ultimately harm the interests of the people in some locales and at certain points in time. Thus it is evident that a colossal gap may exist between urbanisation’s anticipated benefits, and the actual outcomes. This informs us that promoting healthy urbanisation, and requiring that people possess a deeper understanding of its laws, as well as that of its relationship with other areas of economic and societal development, realises

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an epistemological leap from ’the realm of necessity’ to the ’realm of freedom’. If we can understand and abide by urbanisation’s laws, then we can, crucially, advance an urbanisation that puts people first. Urbanisation is not an isolated event, but a process and outcome that occurs in tandem with economic and societal development. The urbanisation process that corresponds to specific stages of development is dependent on a series of economic and societal conditions. For instance, the degree of mechanisation and labour productivity in agriculture, the progress and method of industrialisation, urban infrastructure and public services provision, the degree of integration between the urban and rural factor markets, especially that of the labour market, and the type and nature of land regulations, as well as governmental urban governance competence. All of these factors determine the pace and health of urbanisation. Positive and negative experience from both China and overseas reveals that when urbanisation abides by the rules of development, it can facilitate the sharing of the proceeds of said development. On the other hand, if it does not, then it can be a deleterious influence. Promoting urbanisation requires abiding by some common rules, and is often constrained by factors particular to different countries and stages of development. It is only through a sensitivity to the period and location specific to each country, that urbanisation can healthily and robustly advance. For instance, if there is equal mobility of all production factors, including labour, whereby each individual enjoys full freedom of choice, then workers and their families will choose to migrate to areas which maximise their return on factors, and living conditions. This, thereby leads to the creation of an inclusive urbanisation. However a starting point which expropriates farmer’s factors of production, forcing them to leave their homes, will struggle to create an urbanisation that is both fair and equitable. Furthermore, urbanisation in those countries that exhibit constrained manufacturing growth and highly unequal farmland distribution will inevitably be manifested via the destitution of newly landless farmers. When such people arrive in urban areas, they will be exposed to high levels of unemployment and poverty, or maybe even engage in a life of crime.

The New People Centred Focus China’s urbanisation stagnated and was substantially lower than that of the global average during its planned economy phase. At 16% in 1960, it was not even half of the global average of 34%, and it only rose by two percentage points in the years to 1978. During the reform and opening period, China not only created a high speed economic growth miracle, but also had the fastest rate of urbanisation in the world. Reviewing how urbanisation accelerated between 1978 and 2015, we can see that China’s average was as high as 3.1%; the global average was 1.0%; the low income country average was 1.5%; that of lower middle income countries, 1.2%; upper middle income countries had a rate of 1.7%, whilst high income countries only managed 0.3%. China’s urbanisation reached 56% in 2015, above the global

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average of 54%, and its GDP per capita of US$7,800 equates with its status as an upper middle income country. China’s rapid urbanisation since the reform and opening is not only reflects its economic and societal growth miracle of this period, but has been an important driver of its rapid economic growth during this time. From a supply side perspective, by transferring surplus labour from the agricultural industry where it had accumulated over the medium and long term to non-agricultural urban sectors, the increased urbanisation over this period guaranteed the labour supply and human resources, maintained high growth speeds, high savings rates and high rates of return on capital, and furthermore increased resource allocation efficiency and total factor productivity. From a demand side perspective, urbanisation created more opportunities for investment in infrastructure, and simultaneously enabled a greater proportion of the rural population to share in the proceeds of growth, and the reform and opening, thereby increasing internal demand. However, the urbanisation during this period was an aspect of the extensive economy development style. As China’s economic development has entered the new normal, this kind of urbanisation model has revealed a number of issues that are concentrated around the urbanisation of land being faster than that of the population, and with the urbanisation of the permanent population being faster than that of the census-registered population. Statistics show that between 2004 and 2014, the rate of increase in the area occupied by the urban area was 5.1%, that of the urban permanent population being only 3.6%, and the urban (non-agricultural) censusregistered population being even lower, at an average of a mere 2.8% per annum. Such an increase in urbanisation is, admittedly, of utility to economic growth. However, when assessed against a people centred benchmark, it cannot be considered to be a complete urbanisation, for there is a marked drop in both its sharing and sustainability functions. One aspect is that 169 million migrant workers in urban areas still do not enjoy the same access to basic public services as urban residents in the spheres of social security and compulsory education for children. The other aspect is that as the young rural population that is suited to leave the countryside has exhibited negative growth, the pace of this kind of urbanisation has slackened. If stronger incentive mechanisms cannot be created, then urbanisation’s contribution to economic growth is set to wane. This new people centred urbanisation is an important aspect of the modern set of governance concepts, thinking, and strategies in place since the 18th National Congress. Following on from the spirit of President Xi Jinping’s key speeches, and the central government’s deployment strategy, we stress the importance of the word ’new’ in the core ’new model urbanisation strategy’, and offer the following brief overview. The first is the specific manner in which the concept of people centred development is manifested. President Xi Jinping pointed out that ’people centred development is not an abstract or profound concept, and is not mere empty words, or blue sky thinking, for it is manifested in each and every segment of economic and societal development.’ Urbanisation is one such important segment that affects the sustainable development of China’s economy and society. This means that, new model urbanisation emphasises an urbanisation with people at its heart, and focuses more on raising

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the degree of urbanisation of the census-registered population, on the equal provision of basic urban and rural public services, on a liveable environment and the passing down of history and culture, on increasing the sense of gain, and of well-being, felt by the general public. In a sentence, people centred new model urbanisation must be an urbanisation that shares the proceeds of progress with everybody. Second is the specific methods used to implement the new development concepts. Advancing new model urbanisation is a key starting point for transforming development concepts and economic development methods, and directly reflects whether the development concepts of innovation, co-ordination, green, open, and sharing have been correctly implemented. Effecting an economic development transformation requires placing the people at the heart of development, the guiding of economic development tasks by the greater logic of the new normal, and a focus on extant imbalances, disharmony, and the unsustainability of current development. It also requires the combined management of such tasks as the maintenance of medium to high economic growth speeds, adjustments to the industrial structure, and the transitioning of economic growth. To bring this about, new model urbanisation can develop its own functions based on its laws via the realising of the dynamic integration of goal orientation and problem orientation, and thereby simultaneously help to resolve the urgent development problems that China faces. Third is the specific fields of the supply side reforms. President Xi Jinping pointed out that the focus of supply side reforms is to resolve structural issues, and on stimulating the economy. Supply side quality and efficiency will be primarily increased by optimising factor allocation and adjusting the structure of production, thereby driving economic growth. People centred new model urbanisation can promote the urbanisation of migrant workers by further reforms to fields such as the residence registration system, and advancing the equal provision of basic public services. One aspect is to tap into the potential of traditional drivers of growth by improving the policy environment of the supply of factors of production. The other aspect is to raise total factor productivity by optimising resource allocation efficiency, garnering impetus for sustainable economic growth.

How to Really Implement People Centred Urbanisation The effectiveness of new model urbanisation is ultimately dependent on the implementation of its people centred approach. Specifically, this appraisal needs to assess whether urban and rural residents have become proactive participants and real beneficiaries. In this sense, new model urbanisation is another expression of the integration of the city and countryside, and is a way to effect the synchronised, and comprehensive entry of urban and rural residents into the affluent society. Focus should be directed to four areas when implementing this people centred new model urbanisation approach. First, concentrating on advancing the equal provision of basic public services in urban and rural areas. China’s basic public services provision has substantial

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improved since the 18th National Congress, with a marked increase in the equality of provision in urban and rural areas. This has been a result of the implementation of the 15th Five Year Plan. However, as a consequence of the prolonged existence of the dual economy social structure, there are still disparities in the provision of basic public services in urban and rural areas. This gap is, to a certain degree, even larger than that of the urban-rural income gap. This means that, a stronger focus on equality of urban and rural public services provision lies at the heart of people centred new model urbanisation. In other words, one aspect requires the continued preferential treatment of the countryside with regards to new public resources, thereby raising the level of basic public services provision enjoyed by rural residents. The other aspect is to encourage the integration of migrant workers and their families, who have relocated to cities via the equal provision of basic public services including social security, compulsory education, and low-income housing. Second, concentrating on increasing the urbanisation of the census-registered population. Urbanising migrant workers via reforms to the residence registration system is the most effective method and final expression of improved equality in the provision of public services. China’s current level of urbanisation of 56% is calculated by the permanent population. This includes migrant worker groups yet to acquire an urban hukou, or residence registration, and lack equality of access to basic public services. To ensure that the direction of travel of, and indicators for, the advancement of urbanisation really does feature a people centred approach, the Fifth Plenary Session of the 18th Central Committee proposed to accelerate the urbanisation of the census-registered population, so that the 36% of 2013 grows to 45% by 2020. This is effectively the setting of a hard urbanisation target. This means that new model urbanisation is a reform battleground, and success demands even greater political courage and wisdom. To make good headway in the residence registration system reforms, we should first be aware of the reform dividend, which will yield instant results that this reform can engender. It can raise the non-agricultural labour participation rate, stabilise the quantity of labour supply and simultaneously raise resource allocation efficiency and total factor productivity by allowing migrant workers to register for residence in the urban areas to which they have relocated and also, continue to drive the transition of agricultural labour. In addition to this understanding of the reform dividend, top level design needs strengthening, so that reform costs are fairly distributed between each level of government, and the explicit sharing of the reform dividend will mean that, when preconditions are compatible, reforms will be more enthusiastically rolled out. Third, concentrate on the synchronised progression of industrialisation, informationalisation, urbanisation, and the modernisation of agriculture. President Xi Jinping pointed out that, ‘if China is to be strong, agriculture also needs to be strong.’ The required precondition of ’agriculture needs to be strong’ is the establishment of modernised agricultural production methods at scale, and features efficient production, possesses competitive advantages, independent production capabilities, and services that depend on society. Currently, agriculture remains the ‘short leg’ of the ‘synchronised four modernisations’. For instance, the advancement of urbanisation, and labour transitions, requires a corresponding development in the scale

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of agricultural operations. Currently, Chinese agricultural plots are only an average of 0.6 to 0.7 hectares in size, only one third of the 2 hectare standard set by the World Bank for ’small plot size operators’. Such a small plot size is not beneficial to mechanisation and the input of modern technological factors, and constitutes a constraint on modernising agricultural production methods. This means that, the necessary conditions to drive a suitable scale of operations for land need to be created. Such an outcome would remedy agriculture’s shortcomings in the ’synchronised four modernisations’, allowing for a healthy urbanisation, and a real implementation of its people centred focus. Fourth, concentrate on increasing urban liveability, thereby raising the people’s sense of gain and sense of well-being. Urbanisation is a process that extends outwards and also one where its inner qualities are constantly improving and becoming more complex. At current, China’s urban development is beset by a ’city syndrome’ that manifests itself via inadequate and unequal provision of public services, as well as poorly optimised infrastructure, high traffic congestion, poor environmental quality, and poorly protected historical and cultural sites. In aggregate, these factors reflect the poor liveability of Chinese cities, and necessitate urgent action in raising urban governance standards, and the modernisation of urban management. The Chinese characteristic people centred new model urbanisation fundamentally guides its urban people centred management modernisation, and must be based on the reform of urban planning and its management systems, and concentrate on establishing cities with a development focus on the concepts of innovation, co-ordination, green, open and sharing.

The Modernisation of Agricultural Production Methods China’s agricultural industry took the road less traveled during the reform and opening period, respectively resolving food supply issues and also that of farmer incomes. It supported the rapid economic growth of the time, and, after China grew strong, was repaid in kind by industry and cities. There was a fundamental change in China’s resource endowment as its economy crossed the Lewis turning point. The substitution of agricultural labour by machinery became ever more commonplace, and the capital to labour ratio substantially increased. However, as the scale of land operations was still constrained by tiny plot sizes, diminishing capital returns reared their head in agriculture, constituting a barrier towards raising efficiency, and thereby market competitiveness. Subsidies and protection were ultimately unable to take the stead of the modernisation of production methods, and China’s agriculture faces severe and pressing challenges.

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Challenges at the New Stage of Agriculture Since the start of the reform and opening, China’s agricultural industry has generally been developing in the correct direction, and has resolved a series of key issues, including adequate food and clothing, increasing production, promoting the transition of surplus agricultural labour, and realising a fall in the share comprised by agriculture and a rise in migrant worker incomes. However, as different agricultural development stages feature differing goals and requirements, once a development stage undergoes change, even if it continues to follow the formerly effective route, it will often encounter many obstacles. For instance, a problem we encountered was, we paid an extortionate price in sparing no efforts to ’support’ ourselves, leading to straitened circumstances. This means that taking an alternate route should be the logical, and inevitable, condition of a development stage, and also be of the utmost urgency. China has now passed that dual economy stage, where the focus of agricultural development was on resolving food supply issues and farmer incomes. Agriculture now features increasingly modern factors of production, and capital investment growth outstrips growth in labour inputs. Correspondingly, labour productivity has also substantially increased. Survey data on national agricultural goods income enables us to observe this clear change in the investments in rice crops, maize, and wheat, together comprise 81% of the surface area of cultivated cereals, and also observe fluctuations in physical capital and labour inputs. The rise in the cost of actual materials and service fees of the three cereal crops of rice, maize and wheat has accelerated since 2004 whilst the number employed per unit area exhibits a significant declining trend. Between 2003 and 2013, the actual materials and service fees of these three cereals rose at rates of 1.9%, 3.2%, and 2.6% per annum respectively, whilst labour input quantity fell at speeds of 4.4%, 3.9%, and 5.0% per annum. Simultaneously to this, farmer incomes grew and the urban-rural income gap fell, and are also decreasingly dependent on agricultural profits. This has especially been the case since the large scale agricultural labour transitions and the arrival of the Lewis turning point, whereby income from wages and non-agricultural operations now constitute the majority of the income of rural households. For instance, in 2014, 63% of rural household ready money and disposable income did not derive from agricultural operations, and of the increase in income of that year, the contribution rate of non-agricultural income was as high as 75%. This state of affairs raises two issues pertaining to agricultural development that require in depth consideration. First, as the stage of economic development changes, prior sources of additional farmer income will gradually, and eventually dry up, and replacements for which will be harder to come by. Analysis of demographic data shows that since China’s 16–59 year old working age population commenced negative growth in 2011, no matter whether utilising the parameter of the permanent population, or that of the censusregistered population, the 16–19 year old population of potential migrant workers who travel far afield to find work entered negative growth in 2015, and the growth rate of migrant workers going far afield inevitably dropped. In actual fact, the annual

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growth rate of this grouping has already fallen from an average of 4% between the years 2005 and 2010, to 1.3% in 2014, and was only 0.4% in 2015. The import of this change is that growth of farmer wage income cannot continue to maintain its past rates of growth. Moreover, this rural household income composition shows that the successful resolution of farmer incomes will not inevitably resolve issues that include agricultural production methods or efficiency. One aspect is, the small proportion of agriculturally derived income signifies that there are insufficient incentives to work in agriculture, with higher non-agricultural sector profits leading to the transition of agricultural labour. As such, agricultural profits are unlikely to lead to the creation of stable agricultural production methods. The other aspect is that, inefficient and non-viable agricultural production methods are unable to guarantee reasonable agricultural profits, and are thereby unable to support higher farmer incomes. This kind of vicious cycle has ultimately impeded the modernisation of China’s agriculture, and also the finding of solutions to China’s trinity of issues, in agriculture, rural areas, and farmers. This means that, although we cannot safely say that China’s issues with food supply and farmer incomes have been completely resolved, but adapting to changes in China’s stages of economic development and its need to change its growth methods, mean that modernising its agricultural production is the main task China faces at its current agricultural development stage. This is also a task of the utmost urgency.

On Traditional Concepts of Economies of Scale In discussions on issues in the Chinese agricultural economy, theories based on Schultz’s opinions on agricultural economies of scale adopt a particular viewpoint which still exerts a detrimental influence on theoretical discussions and actual adjustments to Chinese’s agricultural policy to the present day. Schultz used the example of a tractor to serve as proof of the existence of economies of scale—the indivisibility of factors of production do not actually exist in agriculture, the so called ‘fake indivisibility’. He pointed out that differing specifications and models of tractor can be manufactured for differing plot sizes, and so can be enormous or tiny. Going a step further, he extended this inferred ‘fake indivisibility’ to other factors of production. For instance, he believes that the manner in which agricultural labour is allocated in their secondary occupations means that workers are ’divisible’. This mediocre theory on agricultural economies of scale was used to legitimise the Chinese agricultural household contract responsibility system reforms at the start of the 1980s. It did, however, provide a rather important and powerful theoretical basis for the stage of development of China’s agriculture at that time.

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However, things change with time, and after Chinese agriculture had resolved the issues of that developmental stage, of food supply and farmer incomes, excessively small scale operations would undoubtedly impede agriculture’s mechanisation. By observing some real life examples of agricultural operations, we can see how small scale agricultural operations have increased transaction costs, and thereby creating losses of economies of scale. Superficially, the commercial nature of agricultural machinery or cooperative services, means that farmers to not necessarily need to independently fund such purchases. The purchase of such socialised services from agricultural machinery service companies or agricultural machinery cooperations can continue to hold together the ‘fake indivisibility’ of agricultural machinery.1 However, when we combine the production and transaction costs incurred during agricultural operations, it is evident that agricultural operations scale already constitutes a very real barrier to raising agricultural productivity. First, one type of opinion pertaining to the ‘fake indivisibility’ of agricultural factors of production is that small scale farming households do not need to own their own agricultural machinery, but can purchase agricultural machinery services. However, small average plot size and dispersed plot distribution constrains the usage of large scale agricultural machinery. Although theoretically such issues of scale can be resolved by co-ordinating with neighbouring household contract rural households, but land contracts and operations managed by family scale units result in neighbouring households cultivating widely divergent crop types. As such, onerous difficulties exist when contracted farmers negotiate with their neighbours, inevitably raising agricultural machinery purchase transaction costs. Second, economies of scale also exist when purchasing the means of production and related services during the pre-production, production and post production phases. Utilising such economies of scale requires a certain level of skill and enthusiasm to negotiate on price, gather information, assess outcomes, and then pay the corresponding transaction costs. The small scale of operations and plot sizes unfortunately and inevitably raises transaction costs and lowers enthusiasm. For instance, farmers are often faced with a wide range of choice at the seed market, including the risk of being deceived by poor quality, or even fake goods. As such, it is hard to contemplate that they would wish to, or be able to invest the time, energy, and finances in making effective appraisals and choices in the absence of a sufficient scale of operations. Third, it is difficult for small scales operations to initiate effective mechanisms for technological change. Temporal and spatial factors mean that the relative scarcity of, or market demand for, factors of production invariably fluctuate. Large scale operations mean that such changes create informative signals via changes in the relative pricing of factors of production, or changes to production operating costs. This results in technological change being orientated towards saving scarce factors, or meeting market demand. 1 The

phenomenon of the substantial increase in purchases of specialist machinery services by Chinese farmers also coincidentally demonstrates that large size tractors and accompanying agricultural tools already constitute required agricultural production input factors.

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However very small operations scales makes it hard for producers to respond effectively to market signals. For instance, raising taxes can reduce the usage of pesticides, but will correspondingly also raise the costs of agricultural production. Large farms can utilise measures such as lighting installations to attract insects to, and destroy them in, a single location. The constraints of family size operations mean that consensus on whose home should be used to entice insects would be difficult, and as such, effectively obstructs the adoption of technology.

Scale Constraints to Agricultural Modernisation The household contract responsibility system reforms of the mid 1980s led to the creation of small plot sizes, with the distribution of plots held by each family being highly dispersed. The division of such parcels of land, and in addition, the excessive numbers of paths, field ridges, and channels, resulted in a fall in cultivation rates. Moreover, labour shortages engendered an intrinsic demand for larger individual plot sizes. The current residence registration system impeded farmers from changing their place of permanent residence, and also made effecting any meaningful increase in the scale of land operations difficult. The fallow fields or slipshod cultivation that resulted from the division of households and land and also from impediments to free circulation and clustering does not require further elaboration. Based on figures provided by Chen Xiwen, the circulation of land has been promoted in recent years by stimulatory policies such as the separation of land contract rights and operating rights. Of more than 1.3 billion mu of contracted land (equivalent to 88 million hectares), currently 29% has been circulated, equal to around 380 million mu (circa 25.3 million hectares), whilst 920 million mu has not, (circa 61.3 million hectares). Looking at households, roughly 170 million rural households have not circulated land, whilst the land of only 60 million rural households, or around 26%, has been partly or wholly circulated. In addition, based on a sample survey that covered different points in time, Gao Liangliang pointed out that the ratio of rural households cultivating their own contracted land with that of circulated land changed from 97:3 in 1996 to 81:19 by 2008. That rural households were cultivating a larger proportion of circulated land undoubtedly signifies that land is trending towards agglomerated plot sizes, and that scales of operations were expanding. Nevertheless, Chinese agricultural plot size and the resultant tiny scale of operations undoubtedly remains a truism today, by international standards. On a small scale, such situations impede the raising of agricultural productivity by rural households, but on a large scale, it presents an obstacle to the modernisation of Chinese agricultural methods. My colleagues and I arrived at a few conclusions on agriculture’s stage of development and the challenges it faces via a calculation of agricultural production functions. These are as follows. Right until 1984, prior to the impact of the reforms being noticeable, Chinese agriculture was at the food supply stabilisation stage, and exhibited classic dual economy characteristics, which were expressed by extremely low marginal labour productivity.

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Between 1978 and 1984, the marginal labour productivity of rice and wheat was, on average, negative, whilst that of maize was virtually zero. This accorded with Lewis’ hypothesis of ‘zero value labour’. Correspondingly, the relatively low development lacked modern production factors, but the marginal labour productivity of capital was fairly high, which again accords with theoretical forecasts. Second, taking 1978 to 1990 as the starting point, the decreasing trend of the marginal productivity of capital of cereal crops and the increasing trend of the marginal productivity of labour were both quite evident. This is especially true of the period 2007 to 2013, where the marginal productivity of capital of rice fell by 27%. During the same period the marginal productivity of capital of maize and wheat fell by 29% and 19% respectively. Correspondingly, the marginal productivity of labour of rice rose by 50 times over the same period, whilst that of maize and wheat rose by 7 and 55 times respectively. The scale of the increase of the marginal productivity of labour of these three cereals greatly exceeds the degree of the fall in their marginal productivity of capital. Third, we have observed that the marginal productivity of capital of Chinese agriculture exhibited a sustained downward trend after the arrival of the Lewis turning point. This shows that when there is a change in circumstance to the relative scarcity of factors of production and their relative prices, the small scale of agricultural operations comprises a constraining factor, and results in diminishing capital returns and a fall in the rate of return on capital. Schultz’s theory and its policy implications is that the key to refashioning traditional agriculture is to introduce modernised factors of production. However, such production factors ultimately require the smallest scale of operations if effective allocation is to be achieved. Without doubt, when incentive mechanisms and market signals are correct, farmers are highly motivated to modernise their production methods and are highly enterprising business agents when they can follow changes to the relative scarcity of factors of production and their relative prices, and are fully able to independently select the appropriate technological and factor input structures. Nevertheless, current land regulations and the residence registration system are still characterised by a multitude of systemic factors. These obstruct the expansion of land operations scale, and constitute a barrier to agricultural production methods modernising in lockstep with industrialisation, informationalisation, and urbanisation.

Land Regulations: The Reform Bridgehead This means that pertinent regulatory changes and policy adjustments can not only produce a reform dividend that raises the potential growth rate themselves, but also eliminate the regulatory restrictions for the next agricultural development stage. In other words, policy efforts aimed at constructing modernised agricultural production methods with Chinese characteristics is the logical aspect of supply side structural reforms.

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Marx once quoted Sir William Petty’s famous phrase, ‘Labour is the Father and active principle of Wealth, as lands are the Mother’. This phrase can be applied to China’s economic growth, and is a main variable of supply side production functions. It can also be applied to the development of the countryside, the indivisibility of the two, and their mutual advancement. Expanding economies of scale creates the conditions for labour transition. This means that, achieving scaled operations is one level of the meaning of ’mother of wealth’, for it is only through scale that there can be profitability, and agriculture can mature. The current land plot size per household is only 0.6–0.7 hectares, one third of the size of the World Bank’s definition of ‘small plot size operators’. This scale is a mere 0.4% of America’s, and even just half that of the famed small scale plot agriculturalists, Japan and India. Extending economies of scale, and eliminating worries about labour transitions requires the reform of land regulations, and is, by definition, the proper reason for structural reforms, and also the second level of the meaning of ’mother of wealth’. President Xi Jinping pointed out that land circulation and multiple forms of scaled operations is the necessary route for the development of a modern agricultural industry, and is also the fundamental direction of travel of rural reforms. On the basis of the division of village collective land property rights and rural family contracted management rights, rural family contracted management rights are divided into contracted rights and management rights. This means that there are three types of rights: property rights, contracted rights, and management rights. Combined with a related, major piece of regulatory innovation, this puts in place the pathway towards large scale operations with Chinese characteristics. Reforms to the land system are not only proposed from the ’mother of wealth’ perspective, so as to increase operations scale; but may also be understood from the ’father of wealth’ perspective. This is aimed at population transfers and labour transfers to urban areas, and necessitates the payment of a transfer cost, and also requires entrepreneurial funds, and even payments for self-protection. Where do the funds to pay for transfers come from? The Peruvian economist Hernando De Soto pointed out in his book The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, ‘the poor are not bereft of assets, they have land and homes, but they lack property rights, and also the eminent domain and jus disponendi beyond the usufructuary rights of their utilised assets’. The separation of the three contracted land rights is a kind of institutional breakthrough. This innovation should be encouraged further.

From the Demographic Dividend to the Human Capital Dividend For China to maintain sustainable economic growth, it needs to switch its drivers of growth via industrial restructuring and the changing of its economic growth patterns. This requires switching from drivers of capital, labour and land inputs, to being driven

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by innovation and increases in total factor productivity. It is true that of traditional development methods, worker skillsets are of critical importance, and human capital also makes a substantial contribution. Nevertheless, human capital is not only set to become an increasingly important source of growth in the new development methods, but also is a precondition for innovation and productivity increases. Economic growth ultimately depends on worker creativity. The precondition of this creativity, the source of innovation, and the safeguard to productivity in modern societies is increasingly the universalisation or deepening of education provision. Education plays a critical and irreplaceable role as China accelerates its economic restructuring, and changes its development modes and economic growth drivers. Moreover, education also increases social mobility, forestalls increases in the income gap and the intergenerational inheritance of poverty. This means that developing education is not only the precursor for maintaining the sustainability of economic growth, but is also the fulcrum for increasing the sharing of the proceeds of economic growth.

The Contribution and Formation of Human Capital Economists have discussed the formation of, and metric for, human capital for a long time. Up to now, indicators including the population enrolment rates, the proportion of the adult population with a specific educational background, and the average number of years in education of the adult population (or workers) have served as metrics for educational outcomes, and have proven to be the human capital proxy indicators that are most observable, easiest to collect, and provide the most comprehensive data. The implication of which: one aspect is that when economists conduct an analysis, they often utilise similar education indicators as proxy variables for human capital. Another aspect is that when improving human capital, policy formulators and implementors often start with improving education when implementing a human capital accumulation strategy. This means that after Chinese economic growth has entered the new normal, the human capital challenges faced, namely the new requirements for developing education, should likewise afford new opportunities. The accumulation of human capital is dependent on the investments of the individual, the family, society, and government. It also requires the right market signals to encourage investment in human capital. At China’s current stage of development there are a multitude of systemic barriers that inhibit the demand and supply of education. Reforms need to be deepened in related areas, especially that of reforms to the education system, the aim of which being to unleash the productive capabilities of human capital accumulation, and avoid toppling into the middle income trap. Here, we are primarily discussing the excavation of new sources of growth required as Chinese economic development enters the new normal, and reveals the serious challenges posed to the accumulation of human capital, as well as the new face of human capital in the new normal, and from which, propose policy suggestions for reforms and to improve education.

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Education and Reforms The economist Aoki Masahiko found in the East Asian economic growth experience that after it has undergone a government directed economic development stage, any country or region will inevitably enter a human capital driven stage of development, characterised by Kuznets style restructuring. The vicissitudes of the stage he described are exactly what we call the Lewis turning point. The role of human capital during the industrial restructuring process is of vital importance, and future human capital will serve as a key source of sustainable economic growth. We used econometrical models to calculate that developing education and training to raise the overall level of human capital could contribute an additional 0.1% points to China’s future potential growth rate. Such a contribution is hardly worth mentioning for an economy that can realise double digit growth, but is worthy of attention for China in its economic new normal. For it is currently striving to maintain medium high speed growth, and avoid dropping to mid speed, or even medium low speed, at too early a date. Moreover, this value merely refers to human capital. The aforementioned research showed that once the quality of education has improved, the impact of human capital on economic growth will substantially increase, becoming even more prominent than the contribution of productivity. Thus, it is clear that the urgent task China faces is how to substantially increase the quantity and quality of education provision so that it can maintain sustainable economic growth via the accumulation of human capital. The key to increasing the quantity of education is to increase the number of years of education held by the new generation of workers. Generally speaking, the difficulty of providing a constant and substantial increase in the number of years of education received evidently increases when compulsory education enrolment rates are very high, and this must be achieved via a substantial increase in the penetration of preschool, high school and higher education. The key to increasing education quality is in the education model adopted, the efficiency of said model, and in the particular knowledge and capabilities taught students. Educational reforms are required, for both quantity and quality. The development of greater ’quantities’ of education has run in to difficulties owing to a number of visible cognitive blocks and policy obstacles that have impeded the degree of penetration of preschool, high school and higher education. We can search for the answer to this problem from this starting point, and formulate responsive policy. One obstacle to this is that disparities in income levels and education provision between the city and the countryside, between regions, and between individuals are quite substantial. The burden of the absolute level and proportion of direct payments for post compulsory level education on families remains large, and are unbearably high for low income families. Moreover, the trend of rising migrant worker wages has led to a continuous rise in the opportunity cost of receiving an education. The outcome of a ‘cost-benefit analysis’ by a family on their children’s education is not beneficial to the universalisation of education. A solution for when either the labour market or the rate of return on education misfires, is to extend the number of years of compulsory education by

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three, by extending into both pre-school and high school. This thereby increases the government’s liabilities. However, the government will vacillate when faced with numerous monetary options for raising living standards, and will, in particular, raise the question of whether or not China has reached the stage of development where preschool and high school should be included within the remit of compulsory education provision. The majority of developed countries are, admittedly, yet to extend compulsory education to this degree. However, considering the characteristics of China’s economic development can help us understand the necessity of surpassing these countries in education provision. First, China’s growth differed from the neoclassical growth of developed countries, for it caught up with them whilst in a dual economy phase, and so could grow faster than they could. After it passed the Lewis turning point, its growth slowed substantially prior to embarking upon neoclassical growth (high income stage). To forestall the downward trajectory of its economic growth speed, and avoid descent into the middle income trap, China’s education must continue to develop as fast as it can. Second, China’s characteristic of being ‘old before rich’ is reflected in the labour market, and is manifested as a powerful disincentive on education. The only way to correct this market failure is for the government to intervene and increase the scale and proportion of public investment, thus enabling education to propel itself ahead of the competition. The next problem is the source of the financing of this increased government expenditure. Since 2012, the Chinese government’s public expenditure on education exceeded 4% of GDP. Internationally speaking, this is comparatively high. Such a further increase in this proportion is necessary as per capita incomes rise. However, a more feasible route is to reform investment mechanisms, and restructure investment, thereby increasing the profitability of investment and production. Currently, many people have observed that the distribution of government investment in education is uneven. Such disparities exist between urban and rural areas, between regions, and between every grade and every kind of education, and are often criticised from a perspective of fairness. Actually, Heckman’s research shows that such unequal resource allocation is inefficient. This means that one method is to prioritise education resources in rural areas, and impoverished areas and families. The other method is to redetermine the priority policy order based on the societal rate of return for ‘preschool education–compulsory education–higher education–vocational training’. This would be the rationale for the allocation of public education resources, and can reduce skill and income gaps, forestall the intergenerational inheritance of poverty, and can substantially increase resource utilisation rates, and resolve the issue of insufficient investment. If we view education as a productive process for the nurturing of human capital, then there are differing ways to raise education quality in accordance with the external characteristics of different types and stages of education. For the compulsory education stage, a more equitable distribution of resources can raise the production of human capital by eliminating insufficient resources induced bottlenecks, whilst resources reallocation can improve the effectiveness of all education provision.

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The compulsory education stage lays the foundation for lifelong learning, and is the key for children to receive the same start in life, no matter their location, or the income of their families. The government should lower the proportion of the burden of payments borne by families of the compulsory education stage as much as is feasibly possible, thereby consolidating and raising compulsory education completion rates. Including preschool education into the remit of compulsory education will mean that the children of rural and impoverished families do not fail at the starting line. This will have a huge impact on primary and middle school completion rates, thereby increasing the equality of opportunities for continued education. We should substantially increase high school enrolment and promote the penetration of higher education. The enrolment rates of these two symbiotically impact the other, high school enrolment heightens the potential for increased number of university candidates. More opportunities to study at university incentivises middle school students to enrol in high school. The proportion of current government budgetary expenditure is relatively low for the high school stage. The financial burden of the high school stage on rural families, particularly those in impoverished areas, is excessive. When combined with its opportunity cost, and also low university entrance rates, the outcome is that this education stage constitutes a bottleneck on the future development of education. This means that if the aim is to continue the rapid expansion of higher education, then the government should increase the provision of free education for the high school stage (even if not compulsory). Comparatively speaking, higher education should further encourage families’ investments and the opening of privately run schools. Just as there are products that are very competitive on the market and the guarantee of their quality ultimately rests on their competitiveness, increases in the quality of higher education are likewise dependent on competitiveness. The creation of a busy, yet fair competitive environment requires a whole series of reforms of the education sector. That western universities can cultivate talents able to adapt to the needs of the knowledge economy is the result of prolonged trial-and-error and painful reforms. For instance, after realising that their universities were uncompetitive in comparison with those of the United States, a great many European countries embarked upon university reforms. The primary goal of which was to increase competitiveness, increase autonomy, reduce supervision, and also listening more carefully to the suggestions of stakeholders. Chinese education sector reforms faced the same issues as other nations, and also possessed problems unique to its national situation. It analysed both the public and the private before providing targeted policy suggestions. The logic of the renowned ’doubt of Qian Xuewen’ of ’why can our universities not produce outstanding talents’ is not, in of itself, abstruse. Every single university president can list a whole plethora of phenomena, from course design, research structure, teaching quality, and also very many suggestions for reforms that have come from a range of fields, including the labour market. However, any positive aspiration and ideal design ultimately needs to be compatible with incentive mechanisms, and feel the reverse pressure mechanisms of competition if its implementation is to be successful.

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The heavy focus on administration in university management has been a defining institutional factor impeding the competitiveness of China’s universities. This includes the over reliance on financial input, and the division of universities in to various ranks, as well as the administrative level determined by both universities and their administrators. Such an orientation means that some universities suffer from an administrative monopoly, and rely on their administrative level and key school status to obtain sufficient funding and attract the most outstanding students, and simultaneously are free of the pressure of increasing teaching quality to attract students and the resources of society. In addition, those schools classified as being relatively low level tend to over commercialise in response to market demand, irrespective of their actual situation. As such they have lacked the zeal to raise teaching standards. It is clear that the expansion of the scale and increase in the quality of education respectively require education sector reforms that should be targeted by stage and field, and in particular by the relative importance of societal and private rate of returns. For those spheres of education with relatively high societal rates of return, the equitable allocation of public resources can ensure resource investment effectiveness, and assists increases in human capital quantity, and also in quality, which can serve as management in the public goods production sphere. Reforms can be used to correct market signals for those spheres of education with relatively high private rates of return. This can right incentive mechanisms, increase the proportion of market financing, improve competitive mechanisms and raise educational quality.

The Cost Benefit Reform Formula The long term sustainable development of the Chinese economy is ultimately dependent on the implementation of supply side reforms. These reforms need to be designed at the top level, and need to be able to incentivise all concerned parties. From the perspective of incentive mechanisms, the implementation of the reforms will be onerously formidable in the face of vested interests. Incentivising this group will not be easy. The Meeting of the Central Committee for the Deepening of Reforms pointed out that, reforms are a revolution, for systems and mechanisms are changed, and vested interests disturbed. Anything short of full throttle will fail. The vested interests and partial interests affected by the reforms are somewhat unique, for they are not mere private interests, but include vested and partial interests under the guise of public interests. Representatives of which, who provide explanations on the aims, progress and methods of reforms that are inconsistent with those provided by the central leadership often possess the courage of their convictions, as if they ‘selflessly have the interests of heaven and earth in their hearts’. This however interferes with the reforms, and is no different to more vigorously open opponents of reform. So, the breakthrough point remains that stated by the Party’s Third Plenary Session of the 18th Central Committee: the reforms are to be advanced with more political courage and wisdom, and planned systematically from a comprehensive perspective. From the perspective of economics, the significance of this top level design

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is based on how the format of the reforms has changed, in that the ‘low hanging fruit’ has already been plucked. The so-called ‘Pareto improvement’ refers to clear benefits awarded by the reforms to some societal groups that also impose no losses on any other grouping. Such opportunities abound during the early period of the reforms, and are simple to advance and manufacture breakthroughs. For instance, increased farmer enthusiasm for the household contract responsibility system led to an increased supply of agricultural products for urban residents, heralding an evident reform dividend. The progress of the reforms to now means that harming the interests of some groups is unavoidable, resulting in incompatible incentives, and a substantial rise in the difficulty of continued reform. When the aggregate returns of reforms exceeds the aggregate costs, progress can be realised via compensating injured groups, which is the so-called ‘Kaldor improvement’. The misunderstandings that international economists and observers have, and media reports contain about China can tend to mislead the general public. The thrust of these opinions are that there is a kind of substitutional relationship between the reform tasks and the speed of economic growth, whereby implementing reform necessitates sacrificing growth speed. Some areas of the media even claim that China’s reforms ‘restrict growth’. Such a tendency also exists amongst domestic public opinion, whereby reform costs are exaggerated, and benefits underestimated. For instance, when discussing reforms to the residence registration system, we can see many evaluations of the costs of advancing the ’urbanisation’ of migrant workers, but very rarely see anyone calculating the benefits of the reforms. However, such a viewpoint does not accord with reality, and similar commonly held opinions are deleterious to the creation of a consensus on the reforms, and reduce the room for manoeuvre for different types of reforms, and can also mislead investors. I will now reply to two rather contentious questions. The first is whether the cause of China’s deceleration is supply side or demand side in origin. The second is whether China’s current growth rate is above or below the potential growth rate. There is no harm in using first hand evidence and international experience to give several examples of dividends that the reforms might bring, and evidence that not only do China’s reforms not ‘constrain growth’, but also provide instantaneous and direct increases to economic growth speed. The story related earlier about Heckman canvassing Summers for government investment in education for the three to four year old children of impoverished families, was about a cost benefit ’Heckman equation’ on public policy reforms. Today, the impoverished families health and education project that is aimed at increasing the first one thousand days of a child’s life, has become a hot topic amongst both the American government and the general public, and has become a rising social policy star. The reason for such a warm reception to this economist’s suggestion was not merely because it was ‘politically good’, but more crucially, because it brought the entire society ‘net profit’. It is in sharp contrast to the education voucher policy advocated by Milton Friedman, a suggestion which was aimed at increasing competition between education providers, and allowed families to independently ‘purchase’ education services. Even after several decades, there were very few uptakers of these vouchers, and even fewer for whom this became a commonplace social practice. The

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reason for this is that the policy suggestions and its implementation did not allow people to clearly see any evident benefit from this project. Institution Change Theory points out that oftentimes only when the benefit of an institutional change exceeds that of the cost, meaning net profit is greater than zero, that such an institutional change will take effect. Of course, this theory refers to policy makers considering the political costs and benefits of implementing reforms, namely whether the political support (benefit) brought by the reforms exceeds that of the political opposition (costs). However, generally speaking, benefits exceeding costs, in the economic sense, is enough to convince policy makers to implement a certain policy. The effect of China’s reforms in related areas can be said to be extremely similar to this, for they are aimed at increasing resource allocation efficiency, improving income distribution, and also increasing the equal provision of basic public services. The reforms are also aimed at increasing social equality, and from which, harvest direct and indirect reform dividends. Specifically, if we know the causes for the present decline in China’s economic growth speed, we can forecast which reform areas could yield direct increases in the potential growth rate, as well as other indirect outcomes that would prove beneficial to economic growth. Possessing an accurate understanding of the benefits or reform dividends that reforms can provide is not only of crucial importance in forming and consolidating consensus around the reforms, but can also increase choice about reform methods and strategy, and strengthen the impetus for reform. Although reforms can yield a net benefit, but costs and benefits are not equally distributed amongst concerned parties. There are often two kinds of choices which may maximise the compatibility of reforms. The first is the so-called ‘Pareto Improvement’, where this kind of reform can progress with the precondition that it not harm any vested interests. The second is the so-called ‘Kaldor Improvement’, where although reforms might injure vested interests, but some of the comparatively large resultant net profit can be allocated to such groups as compensation. When faced with reforms, there are already only a very limited number of reforms that possess ’Pareto Improvement’ properties, but if we can adequately understand and harness the benefits of a given reform, then we can reduce opposition to it by carefully utilising the ‘Kaldor Improvement’.

Chapter 15

From the Demographic Dividend to the Open Dividend

The wave of globalisation that has swept through the world since the 1990s has exceeded all previous iterations in breadth and depth. From a national economic and societal policy perspective, many industrialised countries have been unable to keep up. This has resulted in fewer employment opportunities and stagnating incomes. The ‘losers’ in this process, the middle classes and low income groups, have been increasingly giving vent to their dissatisfaction. Ineffective policy measures, typified by America’s expansion of credit, have conversely led the creation and subsequent bursting of a real estate bubble, and the engendering of a global financial crisis. This crisis triggered Europe’s debt crisis and caused the global economy to flounder. As western politics turns towards populism, protectionism is flourishing and globalisation has fallen out of fashion. China took full advantage of the opportunities presented by the last round of globalisation when it was still in its dual economy development stage, and achieved high speed economic growth and the sharing of the proceeds of this growth. The size of China’s economy and its potential consumer power endows it with the advantage of holding the balance of power in the global economy. It should thus be proactive and drive through the next round of globalisation, and thereby simultaneously reap a far reaching openness dividend.

The Reversal of Globalisation China’s prior demographic dividend, meaning factors of production, especially that of labour, flowed from low productivity sectors to sectors with higher productivity, thereby improving overall productivity, and maintaining the nation’s high speed growth. That dividend has already gone, and China hopes that there will be newer factors that can accelerate this flow. The previous Chief Economist of the World Bank, Paul Romer, defined globalisation not as the flow of products, or the flow of

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labour; but the cross border flow of creativity. In actual fact, the flow of creativity is also manifested in the flow of other products and factors. Globalisation is intimately connected to China’s future economic growth. An understanding of this process allows us to grasp what opportunities China will have in future. Globalisation is currently experiencing a reversal. In this chapter we will explore why this is so, and also, what China can do about it.

International Trade and Transnational Investment The rate of growth of total world trade was always higher than GDP growth speed since the 1970s. For many years it grew at twice the rate of GDP. However, after the financial crisis hit, trade growth instantly fell and it has been lower than GDP growth rates from 2012 until the present day. Traditional globalisation indicators, namely trade volume, depict the waning of globalisation. There is also transnational direct investment, which can be expressed via the sum total of global capital flows as a proportion of GDP. These have also rapidly fallen from their peak in 2007. In recent years, global export and GDP data shows that world economic growth rates are already very low. However, trade growth rates are even lower. Globalisation is defined as the flow of trade and factors of production. As such, it looks like economic globalisation already exhibits the markers of stagnation. This situation has been caused by a multitude of factors, and economists and politicians offer a wide range of reasons. For instance, they might say that China has already joined the ranks of the upper-middle income countries, and is transitioning towards more inwardly focused economic growth. This is the explanation of foreign academics. Some explanations are the converse, whereby the weakness of the global economy and global trade have meant that China is compelled to focus on expanding its internal demand. There are also many other explanations, and all of the causes of the drop in growth speed in the global economy can, to a greater or lesser extent, be summarised as being the stagnation of globalisation. I would like to look at this issue from the perspective of the international political economy. A G20 summit was held in London in the wake of the 2008–2009 global financial crisis. During this summit, the leadership of all countries unanimously pledged to prevent the rise of trade protectionism, and to promote the recovery of the world economy together. However, following the conclusion of the summit, a great many countries then announced protectionist policies. Of which, the largest and most developed economies were those that proposed the greatest number of protectionist measures. These included the three economies of the USA, Germany, and the United Kingdom. After this 2009 summit, they announced several hundred policy measures that could be classified as protectionism. Our appraisal of this should be that this is indicative of the non-cooperative playing of games with the governance of globalisation. This is not the sole cause of the stagnation of globalisation, but it is a major one. If every country decides to build a moat around itself when their economy falters, then it looks like they are trying to

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protect their own economy, and the outcome is the faltering of the advance of the globalisation project, eventually forcing them to reap what they have sown. If we view protectionism as an economic policy, then what kind of political impact will broader policies related to economic policies have? We can see that economic policies are, along with national political structures, heading towards populism and nationalism, both of which inevitably lead to protectionism, and are anti-investment, anti-immigration, and are against the flow of factors of production, and also against the unification of regional economies, and also against globalisation. It was evident that Trump was an extreme populist during the American elections. He did not mince words, and claimed to be anti-immigration, anti-trade, antiagreements, and anti-multiculturalism. People, such as Hillary Clinton, who were originally part of the government, and had participated in some of these trade agreements, but, regardless of whether they had a change of heart, or they simply wanted votes, they also started to express opposition to the Trans-Pacific Partnership trade agreement. The eventual, and unexpected, election of Trump proved that there really was a large market of voters for anti-globalisation. Although European countries have far right governments, there are also governments on the left too. However the tendency towards extremist, populist policies are currently in the ascendancy in an unprecedented manner. The most prominent example is the result of the United Kingdom’s referendum to leave the European Union, which commentators declared to be nothing out of the ordinary, but that it would be very interesting to see who would be next. The emergence of such a trend can be said to herald new changes to the global political structure, and globalisation is destined to run into colossal political obstacles. I have called the current outcomes of global integration the current round of globalisation. The depth and breadth of this globalisation has been greater than at any point throughout history, and it is for exactly this reason that globalisation was fated to encounter setbacks. When did globalisation begin? Some sources attest that globalisation began before Christ, others believe that it started when Columbus discovered America in 1492, which heralded the global expansion and overseas colonies of Spain and Portugal. There are others who say 1968, when regions all over the world were engaged in the same alternative wave, such as anti-war, and anti-government. In 2016, the Nobel Prize in Literature was awarded to Bob Dylan who, it could be argued, represented a contemporary ideological wave during the 1960s with his political ballads. There are also those who said it began in the year 2000, when information communications technology infiltrated into every aspect of the economy and society, turning globalisation into an unstoppable force. You can block the flow of goods or people, but nobody can block the flow of information. The start of the 1990s should mark the start of this round of globalisation from a trade and investment perspective. Since that time, global export volume and transnational investment volume have essentially risen rectilinearly. One aspect is the China’s reform and opening to the late 1980s led to the proposing of rejoining GATT, and after which it engaged in comprehensive preparations for entry into the WTO, which then marked the start of its embrace of the global economy. The second is the dissolution of the Soviet Union, and the redrawing of the East European map, at the start

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of the 1990s. These countries then began their transitions from planned to market economies. The result was that both goods and factors of production flowed into the entire global economy, creating the upsurge of this round of globalisation. What exactly is globalisation? There are many formulations, which all seem fairly similar to a greater or lesser extent. The narrow definition refers to economic globalisation, such as how Stieglitz spoke about how economic globalisation was the increased flow of commercial goods, services, capital, and also even labour; a process that led to closer transnational economic interactions. There are also those who have given a broader definition of the term, which includes the international flows of creativity and knowledge, and the sharing of culture, as well as a global civil society and environmental movements. Anything that makes the world smaller can serve as an impetus for globalisation. The depth and breadth of this round of globalisation is historically unprecedented. We can see the scope and advancement of globalisation in both its narrow and broad definitions. It began with trade, and then foreign direct investment. This was followed by the start of the flows of factors of production and labour. Labour flows led to creativity flows, and then to cultural flows. This meant that no country ever encountered something that was culturally wholly foreign in its dealings with others. We can speak in more detail about its depth. First we can look at how globalisation can be further advanced, and how it can herald complexity and change for both societies and economies. The second is how such advancements can, theoretically, be manifested. I would like to introduce these two rather important theoretical outcomes.

The Depth and Breadth of Globalisation I call the first theoretical development ‘economic growth and international trade share the same origin’. The two have the same reasons, the same causes, and can be explained as being economic growth, or as being international trade. This was not how things were viewed when we spoke about the history of economic theory. Smith was the first to give a systematic treatise on the problem of economic development, so we will say that he was the creator of modern economics. Ricardo, who came later, proposed his theory of comparative advantage, which he used to explain the existence of international trade. Although some countries possess absolute advantages in some areas, but ultimately every country has its own comparative advantage. They use their own comparative advantages to produce goods which are then exchanged for goods in which they possess no advantage, thereby giving rise to international trade, meaning that every country benefits. This was the prior formulation. When people encounter conflict during any new stage of development, there are always those who return to the classics to find its origins. This is proven by the fact that the earliest vestiges of any theory can be found in Adam Smith’s Wealth of Nations. Smith believed that the division of labour was the source of economic growth, and was the basis for increases in economies of scale. He pointed out that

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international trade was just the inevitable outcome of the expansion of the division of labour, which when it reached a certain level, reached its final form of an international division of labour. This means that theories of economic growth and international trade both share the same source. Adam Smith’s dynamic analysis of economic growth already includes some new factors pertaining to modern economic growth. He does not merely concern himself with capital, labour, land, and the division of labour. He also covers some important factors noted in new growth theories and new trade theories. Such as the important factors revealed by the new growth and trade theories of many economists, such as Paul Romer, and Paul Krugman. Ricardo came up with the theory of comparative advantage, which was then further developed by Heckscher, Ohlin and Samuelson. The theory states that each country possesses different factor endowments, meaning that they produce different types of products. The products which result from the concentration of these differing factors can lead to each country having its own comparative advantage. Countries then can trade with each other, and both can profit from this trade. However, prior to this round of globalisation, which means prior to the 1990s, world trade was focused on and primarily conducted by, and between, developed western nations. The west did not trade with either the Soviet Union or Eastern Europe, and there was not much trade to speak of with developing nations. At that time, China had not begun its reforms, and Latin America was focused on domestic economic growth strategies. This meant that the west was essentially just trading with itself, and their factors of production endowments were also almost identical. They exchanged very similar products, with American manufacturing equipment being exported to the United Kingdom, and then it would import manufacturing equipment from the UK in return. This is called intra-industry trade by economists. Given that each country possessed virtually identical production factor endowments and were at equivalent stages of development, then where did such comparative advantages come from? Some theorists have already come up with an explanation. For instance, Krugman found that there can be differing comparative advantages even when producing the same good. This comparative advantage is not a result of factor differentials, but differences in returns to scale. The existence of increasing returns to scale destroys the hypothesis of perfect competition. He, at the very least, explained why developed countries trade with each other. After which came a multitude of endogenous growth theories, including those such as Paul Romer, who spoke of human capital, especially that of studying whilst working and endogenous technological advances being sources of economic growth; and also being sources of increasing returns, thereby constituting the sources of trade. This theory is, thus, very important, for it helps us understand some of globalisations features, and also helps us understand how it has advanced. We can conclude that for the second theoretical development, globalisation, just like economic growth, does not necessarily lead to equitable income distributions. In the past people believed that economic growth possessed a small trickle-down effect, whereby if economic growth primarily benefited a small number of investors, those investors would, in a number of ways, ‘trickle-down’ the proceeds of their wealth

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to other levels of society, either by consumption, the employment of others, or via other methods. However people discovered fairly early on that economic growth does not inevitably improve income distribution, for people are inclined to negate the so-called inverted U Kuznets curve. During this round of globalisation, people found that trade could benefit a small number of people, such as large transnational corporations, but such benefits would not necessarily percolate down to other levels of society. Neither the poor nor even the middle classes would be sure to benefit. This kind of problem has been both longstanding and intractable, with the result that some western politicians have adopted populist political stances, and have pledged to change the status quo, and have grasped the reins of governance. This theory discovered that eventually we very clearly saw that globalisation brings inequality. The principles of globalisation were formulated by developed countries, and they have benefitted more than developing countries. In 1999, I was visiting Washington University when one morning I heard that many people from many countries had come here to protest. They were mainly opposed to the World Trade Organisation discussions led by the developed countries. However, western politicians are not really terribly interested in whether globalisation benefits developing countries or not. Nevertheless, those living in developed countries later discovered that large scale investors and transnational corporations had seized the benefits of globalisation, whilst the citizenry, middle classes and low income earners received little benefit, or even incurred colossal losses. This has already been verified by facts. People have also attempted to incorporate this in theories, whereby trade is presumed to infer benefits on everyone, but such benefits might not necessarily be fairly distributed. Let us look at the outcomes of globalisation, and how these were reflected in the political sphere. Prior to this round of globalisation, Western nations primarily traded with each other. Their factors of production were roughly similar, with the differences mainly manifested in their economies of scale. If this segment in your industry has economies of scale and increasing returns, then others will purchase your goods. If another country enjoys economies of scale and increasing returns for the next segment and for a similar product, then you will buy its goods. When factors of production and returns are roughly equivalent, trade will not change the returns on factors of production. China began to embrace globalisation after 1990, and the former planned economies of the Soviet Union and middle and eastern Europe also joined in international trade. Ricardo had never been more relevant. The trade was that of capital rich countries exporting their superior products, and importing the labour intensive products of developing countries. This led to our age of international trade featured by colossal differentials in factors of production. Evidently, as developed nations already imported labour intensive products from other nations, their own workers dropped in value, and so this round of globalisation tended to lower the incomes of workers in high income nations. This kind of globalisation for developing or low income countries tended to lower their capital income. Previously, when there was no trade, and no international division of labour, poor meant that capital was scarce,

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and its price was high. The current format of trade, and with the arrival of direct investment, has meant that the availability of capital is relatively high, meaning that its returns have been suppressed. Thus, it is possible to imagine that workers in developed countries can easily become globalisation’s victims. We can divide a country’s produce and services into trade goods and non-trade goods, and thus, sectors can be divided into trade goods sectors and non-trade goods sectors. Growth in employment in the United States has virtually all occurred in the non-trade goods sectors, whilst that from trade goods sectors only comprises 0.62%, a thoroughly inconsequential figure. This is to say that those goods that can be traded are now produced by other newly emerging economies, such as China. This signifies that the labour of these sectors in America has suffered harm to its employment prospects. Employment in some sectors in the United States is still growing, but such sectors are non-trade good sectors, which either must be produced locally or are primarily applicable to products produced locally. This includes some high end products in the research and development sector, as well as the social security and government services industries. There are also some extremely low end service products which are unable to be trade goods, such as street-side shoe shiners, or McDonalds service personnel. This means that the labour market in America, and also in Europe, has polarised. Areas with relatively fast growth include not just high end service workers, such as scientists, but also very low end workers, whose jobs can effectively be done by those with a high school education, whilst those in the middle, which require a certain level of skill, such as those in the manufacturing industries, have substantially fallen. A polarised labour market inevitably leads to polarised income distributions. The main policies of these countries over the past few years have tended to favour the top 1%, and have been disadvantageous towards the remaining 99%, resulting in the polarisation of income distributions. There has also been a dearth of redistribution policies. This is especially the case with the United States. Its income security regulations are extremely unhealthy, when compared with that of other developed countries. If, in the past, people from developing countries traveled to Seattle to demonstrate, the USA could ignore them, and simply refuse to award them a visa in future, but those occupying Wall Street today are Americans. Such a popular anti-globalisation sentiment will inevitably impact the politics of these countries.

The Populist Genes in Western Governments If we say that the cries of developing countries are largely ineffectual in influencing the progress and direction of globalisation, then the masses of ‘losers’ within developed nations, who can register their grievances at the ballot box, will ultimately impact the political and policy orientation of that nation. However, the numerous nationalist flavoured economic policies that are then formulated in response, often reap a sour harvest, which stirs up its people into greater political opposition.

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Voting with Hands, and Voting with Feet A former Governor of the Reserve Bank of India, Raghuram Rajan, wrote a book in which he pointed out that the American government attempted to alleviate the deep anxieties of the middle classes and low income workers about their lack of sustained earnings growth. The government, after all, needs votes, and so will try to make the citizenry happy, and so they appealed to the American Dream. An important aspect of the American Dream is that each person should have a home. Under this banner, they created financial derivatives, and the government substantially increased its endorsements, which implied that credit was guaranteed, which then when combined with lax supervision, lead to subprime supported growth of the real estate bubble, and then its subsequent bursting. More generally speaking, any kind of asset bubble will eventually burst when it gets big enough. Once a bubble has burst, the people have no means to make a livelihood, and many families fall into severe misfortune, and then the angry masses will become a mob. Trump was eventually elected president. People have found many faults in his character, any of which would have heralded a swift end for any of former American presidential candidates, but he still commands the support of a comparatively large section of the populace, and ultimately, was elected. The reason for this is that American and European financial policies have reflected a kind of populism. Such populism is, conversely, deleterious to the interests of the people. Although there was an economic recovery in the wake of the financial crisis, but it was incredibly slow, and beset by uncertainty. The Managing Director of the International Monetary Fund summarised current world economic growth as being a ‘New Mediocre’. There was once a joke about economists, where President Truman complained that you always employ economists as consultants, can we not find several one handed economists? For he had found that economists often offer a one sided view of an argument, yet when governments then implement these recommendations, they then say offer another viewpoint, with the words ‘on the other hand …’. The west has come up against the same disputes as China. The first dispute is that you need ‘two hands’, the first is the invisible market, the other is the visible government. They still have not worked out how to balance these two, and so this controversy rages to the present day. The second dispute is the need for two legs, meaning supply and demand, having just one leg is not enough. There have been a plethora of explanations for the recent stagnation of the world economy. All in all, it is a demand side problem. However, when analysing demand side factors, there are western economists who then state that the problem is supply side, such as the long term lack of improvements to total factor productivity, and the inability of many new technologies to transform into drivers of economic growth, therefore the supply side is also problematic. That is why, both legs need to be able to transform into drivers of economic growth. Europe faced a debt crisis in the wake of the financial crisis. Unemployment remained stubbornly high, especially that of youth unemployment in Southern

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Europe, which reached rates as high as 50%. Added to the migrant crisis, and its attendant social problems, this was a calamity. Neither America nor Europe realised improved income distribution in the wake of the financial crisis. The wages of the average worker did not rise. The United States’ unemployment rate has now fallen to roughly pre-financial crisis levels, but owing to the constant decline in labour participation rates, there was indecision on whether to increase interest rates for a long period of time. When we talk about the workforce, there is first the concept of the working age population, which, for instance, might be 16–60 year olds, or 16–65 year olds. However not every member of this working age population can work. There are some who originally wished to work, but owing to school or childbearing commitments, or because of sickness, who are unable to work. With the exception of this sub-group, the proportion of the working age population who are either in work or who wish to work is known as the labour participation rate. A fall in the labour participation rate does not signify that a great many people wish to relax at home. In the United States, the majority of such people are the result of the ‘discouraged worker effect’. If we imagine I am a surveyor from the statistical department, and three years prior I knocked on the door of a household to inquire about a person’s employment status. The first would would be whether he has worked for more than an hour during the previous week. If he replies in the affirmative, then he is part of the employed population. If he replies in the negative, then I follow up with the question of whether he is actively seeking work, which he then replies with, he is actively seeking but has not found anything suitable. I then ask a further question, if I give him a job, would he be able to start immediately. If he replies in the affirmative, then he is unemployed. Three years later, I survey the same person and repeat the first question of whether he has worked for more than an hour in during the previous week. If he replies in the negative, I ask whether he is actively seeking work. If he then replies in the negative again, I do not ask any more questions, and on my return to the office I eliminate him from the labour market roster. He is not part of the unemployed population, but he is lowering the labour participation rate. If I continued with my questions and asked him why he was not seeking work, when three years prior he was actively seeking, he would say, ‘three years ago I actively sought work, but I have never been able to find anything, so what’s the point of looking?’ He has departed the labour market because he is discouraged, but this does not mean that he does not need to work. So a fall in the labour participation rate, if the result of the ‘discouraged worker effect’, signifies that the labour market is not as healthy as we supposed. This is a major problem faced by western nations in the ‘New Mediocre’. The populace wish to express their dissatisfaction when faced with problems. How do they express such dissatisfaction? Some economics literature summarises a few channels for such signals. Generally speaking there are three methods. The first is to vote for a parliamentary representative or president, or in a plebiscite for some determined event. This is how they can express their wishes, and also what western politicians care about most. Western politicians are not bothered about the Gini coefficient, but they are very interested in whether the Gini coefficient will impact the number of votes they might receive. The second is via a voice. Media is

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just such a voice, and can also be a channel for expression. Once such a voice reaches a certain intensity, it will impact votes. The third is to disengage, or to vote with your feet. When Al Gore and George W. Bush were running for president, an American president said, ‘if Bush is elected, I’m moving to Canada’. Before the dust had settled on the last election, some of those who supported Trump said, ‘if Hillary wins, I’m moving to Puerto Rico’. Such words from both sides is a form of disengagement. There are other types of disengagements, such as the United Kingdom leaving the European Union. After it has left, a dissatisfied Scotland might decide to leave the United Kingdom, which is also a kind of disengagement.

Popular Populism The current tendency towards anti-globalisation is combined with the age-old political tradition of populism. Populism is very complex. Its formulation differs from nation to nation, time to time, sphere to sphere, and from discipline to discipline. Generally speaking, populism initially focuses on the demotic and is anti-elitist. This means that populism is often a tool with which to curry favour with the populace. However the current usage of the word is a denigration of this concept, with both the left and the right slinging this slight at each other, back and forth. Populism has taken on the form of being adopted by politicians to make use of the entreaties of the common man, or as a political armour, to hawk their own particular political viewpoints. Such political viewpoints are not necessarily in the interests of the people. The challenges that globalisation faces today are that of western politicians wielding the personal grievances felt at globalisation by the middle classes and disadvantaged groups, to sell vote winning anti-globalisation ideas and related policies. They themselves might not really desire anti-globalisation, but they see this issue as a way into office. As of today, this is not just the United Kingdom’s referendum on leaving the European Union, or Trump’s ascension to the US presidency, or the resignation of the Italian prime minister, Matteo Renzi, which has heralded the political advance of nationalism and populism; new Black Swan events have undoubtedly accelerated this process throughout many European countries. We face a colossal challenge, that will inevitably herald globalisation’s nadir.

China and Globalisation It is generally believed that China launched its reform and opening with the convening of the Third Plenary Session of the 11th Central Committee at the end of 1978. There are two levels of meaning here. The first is that the reform and the opening occurred simultaneously. They were closely interlinked and progressed in tandem. The reforms

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were conditional on the opening, and the opening advanced as the reforms progressed. Thus, the development of the national economy was interwoven with its meshing with the global economy. Second, opening to the outside world contained independent and precise intent. The early period of this open door policy was experimental and regional in composition. It began with the establishment of special economic zones, open coastal cities and coastal provinces. By the 1990s, China was preparing for its entry into the WTO, and embarked upon its comprehensive embrace of economic globalisation. It is very evident that, whether from the successful experience of the special economic zones, or the high speed economic growth and the homogeneity of its deep opening to the outside world, China has been a clear beneficiary of this round of globalisation. This is something that we have never kept quiet about.

Why Does China not Oppose Globalisation Generally speaking, globalisation has been good for China. We could even go so far as to say that China has been the greatest beneficiary of this past round of globalisation. First, China embraced globalisation, which coincidentally arose during its dual economy stage of economic development. These two aspects complemented the other. This is to say that the simultaneous onset and advance of the reform and opening gave China the opportunity to participate in the globalisation of the international division of labour. Second, China was, luckily, in the unlimited labour supply development stage. Its abundance of labour endowed a corresponding comparative advantage in manufacturing, allowing it to gain the initiative against the competition. Third, China developed labour intensive industries, and they grew extremely rapidly. With a ready market and ready demand, employment accordingly rose in response. The expansion of urban and rural employment inevitably provided these workers with the opportunity to share in the proceeds of growth. China’s Gini coefficient once rose as high as 0.49. A Gini coefficient of 0.4 is usually considered to be a red flag, so how could China reach 0.49 without any major negative response? The answer is China’s high speed economic growth meant that the cake was constantly growing in size. Although the cake has not been very evenly cut, but its constant increase in size has meant that there is more cake for everybody to eat. This kind of sharing of the proceeds of growth has primarily occurred via the expansion of employment. In the past, there were many who criticised migrant worker policies, but at that time each rural household only had an average of 8 or 9 mu of land (circa 1.5 acres or 0.55 hectares), and the marginal returns of the land were zero, there was no real incremental income, and the labour was surplus. It might seem that a migrant worker who enters the city to earn several hundred yuan has not made much money, but all in all, it was an improvement. It can be said that China experienced a period of economic growth that was not terribly equitable in both its inclusiveness and in the sharing of the proceeds of growth. From a macroeconomic perspective, abundant labour, the presence of a market, and the ability to turn this into a demographic dividend, gave an ample labour supply

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and a plentiful supply of human capital. There were fairly high capital returns, as well as increases in resource reallocation efficiency and total factor productivity. As such, China enjoyed a comparatively high potential growth rate, and so its actual growth rate was also quite high. From the reform and opening until 2010, China’s potential growth rate was approximately 10%. Although economic growth did fluctuate, but generally, the actual growth rate was also 10%. China’s demographic structure changed after 2010, the population aged and the demographic dividend disappeared, but by this point the country had already benefitted from its dual economy development stage and its intense participation in the globalisation process. In addition, China’s high volume of exports supported a high volume of imports. Apart from needed products, advanced technologies were also imported, which supported the upgrading of the industrial structure. The result of which has been an increase of GDP per capita from US $150 in 1978 to the upper middle income level of US $8,000. I previously cited Spence’s research into changing employment trends from American globalisation. America’s employment growth has occurred in non-trade sectors, with employment in trade sectors remaining virtually stagnant. We can contrast the Chinese experience with that of the American as we talk about how employment in China expanded as it embraced globalisation. We will use the data from three economic surveys covering the years 2004, 2008, and 2013. We can see that between 2004 and 2013, urban employment generally rose rapidly, with average annual growth rates of 5.9%, reaching a total of 350 million people in employment in 2013. Furthermore, China’s employment growth rates in both its trade and non-trade sectors was relatively balanced, with the trade sector growing at an average of 6.9% per annum, and the non-trade sector at an average of 4.7% per annum. In comparison, America’s trade sector exhibited virtually no growth. We can set China at one end of the globe, and the USA at the other. China shared the proceeds of its economic growth via expanding its employment, and was a major beneficiary of globalisation. This round of globalisation has benefitted the whole nation. Many of the earlier chapters in this book have covered how the reform and opening created employment in urban and rural areas. In the final analysis, employment growth is linked to the growth of non-agricultural industries, and the growth of urban employment. China is a nation that is highly dependent on external trade, but purely observing this dependence does not fully reflect the degree to which China has embraced globalisation, and especially the degree to which it has shared the resultant dividends. Looking at how urban and rural citizens created employment is more important. This was primarily a result of the expansion of non-agricultural sector employment, and was a sharing of the benefits of globalisation. Therefore, as long as trade persists, then globalisation will be a net benefit, no matter how trade theories are revised, or what kind of new trading methods emerge. It is a game that everybody knows. Nobody is currently forcing anybody to trade with anybody else, and so everybody is benefiting from the trade. The problem lies in whether everybody can share in the proceeds of this trade, or who is doing the sharing. This is dependent on a whole range of economic and societal policies of every country, which is not something that globalisation itself can determine.

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At its particular stage of development, China was well matched with globalisation. Its abundance of labour and trade with nations blessed with capital meant that worker incomes rose, and globalisation benefitted workers in many fields. China has understood the importance of sharing the proceeds of growth, and so it has constantly improved its income distribution mechanisms. This has made China’s globalisation a success. The west is aware of this problem, but the power of vested interests has led them to adopt de-globalisation policies. Rethinking once elected might be a good idea.

Declarations at Davos On 17th January 2017, President Xi Jinping gave a keynote speech at the opening ceremony for the World Economic Forum in the Davos International Conference Centre titled Shoulder the Responsibility of Our Times Together, and Promote Global Growth. He pointed out that the world needed to adapt to and guide economic globalisation, and eliminate the negative aspects of economic globalisation. In this way, it would better benefit every single nation and ethnic group. In the face of all of the opportunities and challenges presented by economic globalisation, the correct choice is to fully employ all opportunities, and counter challenges via collaboration, and guide economic globalisation’. Internationally, this speech was highly praised, and opinion of the majority of observers was that China was already well prepared to assume leadership of globalisation. In any case, China has been the largest beneficiary of globalisation, as such a reversal would not be in our interests. What should China do in the face of the challenges of de-globalisation? First, it should uphold with the original intent of the reform and opening, and should not alter the general direction of travel. China is not wholly dependent on globalisation, so a setback is nothing to worry about, and China should maintain its strategic focus, maintain its patience when formulating economic policy, and whilst there might not be a groundbreaking impact in the short term, China should persevere with a historical sense of patience, and a sense of proportion. Even if other countries roll out any number of trade protectionist policies, our response need not necessarily be that of an eye for an eye, or a tooth for a tooth. China needs to create a better open environment to encourage investors and all those who trade with China to vote with their feet. From a certain perspective, China should provide a better policy environment if other countries are to erect trade walls, or other regulatory barriers. The ancients said, ‘make those close happy, and those distant come’. This is a good strategy for China with its potential cooperative partners. If China cannot change the general anti-globalisation trajectory, it can create a positive microenvironment. Second, the current pattern of globalisation also presents an opportunity to China. After all, it is the second largest economy, the largest export economy, and currently the most populous country on the planet. It is also the main foreign direct investor, and the main recipient of foreign direct investment. Such an economic scale means

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Table 15.1 Substitute globalisation options Western directed globalisation

‘Belt and road initiative’ promoted globalisation

International impact Industrialised nations formulate the No conditions attached to rules, loans and assistance come infrastructure investment, focused with conditions attached, on mutually beneficial outcomes developing countries unable to benefit equally from the process National impact

Transnational companies powerful negotiators, polarisation of labour market, increased income gap

Provides public goods that provide peoples with widespread benefits, creates opportunities for employment and increased revenue

that China has already reached a new stage of development in its participation in global governance, and can obtain more power of discourse and will possess more leadership authority. Developed countries set the rules for the last round of globalisation, and so it was not beneficial for developing countries. Although China profited, but it did so only by following rules set by others. The high point of the next round of globalisation will need to be created by China. This will require more power of discourse. Advocacy of the ‘Belt and Road Initiative’, the establishment of the Asian Infrastructure Investment Bank, and the inclusion of the renminbi into the International Monetary Fund Special Drawing Rights currency basket all demonstrate China’s power of discourse. Of course, the power of discourse referred to here is unrelated to that implied of Trump’s ‘America First’ slogan of shifting one’s own troubles onto others, but embodies that which derives from win–win cooperation. For instance, the ‘Belt and Road Initiative’ advocates concepts that differ somewhat from those of the prior round of globalisation, and as such, has been the recipient of increasingly positive feedback (see Table 15.1). America and other western countries are reconsidering their participation in, withdrawal from, or renegotiation of regional agreements. China and developing countries appeal for some opportunity to express themselves to a greater or lesser degree during such renegotiations. Renegotiations will engender a rebalancing of interests, or some policy changes favourable to the middle class and low income workers of western nations, which for China, is an opportunity. In the final analysis, an improvement in the incomes of these groups can increase China’s market potential. We need to take advantage of new opportunities. Third, the creation of a new globalisation tipping point. Such so-called tipping points refer to several specific historical instances where the world has shrunk through globalisation. McGillivray listed four tipping points that had led to the world becoming smaller in his book. The first was 1490 to 1500, which he called the Iberian Partitioned World, which led to the development of colonies, and launched the first wave of internationalism. The second was between 1880 and 1890, and called the British apogee, and featured colonisation by the United Kingdom. The third wave was between 1955 and 1965, which he called manmade satellites. The fourth was from

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1995 to 2005, which he called global supply chains. These four tipping points did in fact mark high points of globalisation. He forecast that the next globalisation tipping point would be hot globalisation, referring to global warming. He believes that all the countries in the world, and in particular large economies who are heavy emitters, will step forward and initiate a further round of globalisation aimed at managing the main aspects of global warming. There is a certain logic to this, and it will, at least be beneficial for further globalisation. We have seen the positivity around the Paris Agreement, which the Standing Committee of the National People’s Congress also ratified. On the day of its ratification, President Xi Jinping was in Hangzhou with the former American president, Obama, where they gave documents attesting to agreement to the Paris Agreement to the Secretary General of the United Nations. This Agreement has already entered effect. The new American president, Trump, ridiculously believes that the issue of climate change is a ‘plot’ hatched by the Chinese, and so will withdraw from this joint action. China still holds its banner of leadership high, for it takes its great power responsibilities seriously, and is urgently concerned with transforming its national modes of development. This means it will play an even more proactive role on the international stage. The proposal of the ‘Belt and Road Initiative’ reflects China’s view that both the foreign and the domestic are interlinked. It will make good use of its approach to both kinds of resources and both kinds of markets. Leadership of the manufacturing industry originally lay on the United Kingdom’s shoulders. This later transferred to the United States, and then to Japan, and then to the Four Asian Tigers. The round of manufacturing transition that occurred in East Asia was called the flying geese paradigm. One country adopted the role of the leading goose, until its comparative advantages disappeared, and then its role was given to other countries and regions, until eventually this mantle was assumed by China’s coastal regions. China’s labour costs are currently rising, and its manufacturing industry is losing its comparative advantage, but China is a large country, and as such, it is unique. This means that the flying geese paradigm can also, quite naturally, be applicable within China, before shifting to beyond its borders, thereby becoming an international version of the paradigm. This is entirely consistent with the nation’s designs for its Belt and Road Initiative. China can employ its extant advantages to remedy the shortcomings of other countries and regions, including capital, infrastructure construction and real economy production capacity, and even markets. The rules will no longer be set by western nations during the establishment of such mutually beneficial, and sharing concepts. This will herald changes to governance concepts and rules. The ‘Belt and Road Initiative’ is not merely the transfer of production capacity, but the specific means for unleashing another wave of globalisation. The west’s globalisation has not been well received. This is because it has promoted globalisation, but it has failed to administer and govern this process, and failed to effectively integrate globalisation governance policies. We should advance a type of globalisation that embodies new concepts of development, one of which being innovative development. During this new stage of development, the ‘new normal’ signifies that the prior engines for economic growth no longer exist, that economic

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growth can no longer depend on being driven by the input of factors of production, and will increasingly need to be driven by increases in total factor productivity. Increases in productivity will primarily come from competition and survival of the fittest, or what is otherwise known as creative destruction. We have advocated a people centred development concept. This means that uncompetitive production capacity, ‘zombie enterprises’, and even those outdated or inefficient job roles can be destroyed. The only things which may not be destroyed are the workers. For workers are a special type of factor of production, they are people. China’s social policies need to focus on this, and enable workers to keep up with the times, and become the victors of the next round of globalisation. We have previously modelled what level of growth speed China can sustain in future via supply side reforms, and what kind of impact such a growth speed can have. Generally speaking, and based on our assumptions, increases in total factor productivity, the labour participation rate, and the fertility rate, combined with some other measures can substantially effect an increase in the future potential growth rate, comprising a long term L shape economic growth trajectory. In actual fact, China’s reform and its opening have always been closely interlinked. We can only achieve our development goals via persisting with reforms and through a deeper and a more extensive opening to the outside world. China will certainly lead the coming economic globalisation, and will most definitely create a new dividend.

Notes Three years ago, several editors from CITIC Press Group spoke to me with the hope that I could turn some thoughts on the theories of the Chinese economy into an accessible book. So from that point on, the themes of ‘big country turning points and routes for transition’ began to ferment in my mind. I have spent a few years preparing the themes for this book, and then I collated and organised what I had, and at the same time, published some articles, gave a few lectures, and then wrote this book, and after several revisions, finalised the manuscript. The target readers of this book include university students reading economics, professionals researching issues pertaining to the Chinese economy, and also those investors and entrepreneurs who seek a deeper understanding of the direction of travel of the Chinese economy, as well as ordinary readers with an interest in China’s economic development. Although this book might lack detail in some areas, it is the fruit of intense research and the conscious attempt to dispense with professional terminology as much as possible. I hope that provide you, the reader, with something of value. I would like to thank the following people from the CITIC Press Group: the Press Acquisitions Editor, Yuan Kaichun; and the Commissioning Editor, Wang Jin Qiang for their meticulous proofreading and editing. I would also like to thank the State Council Development Research Center’s Zhu Min (director of the New Economy Research Room) and Executive Chief Editor of the New Economy

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Weekly for his enthusiastic assistance. He made a huge contribution to the planning, copy editing and publishing of this book, and could be said to be a dedicated and highly responsible specially invited planner. Finally, I take full responsibility for any errors that might still exist in the book. Cai May 2017, Beijing.

Addendum: Characteristics of Epidemic Shock and Response Policy

Economists often say: never waste an economic crisis. This means that different economic recessions and crises are brought about by different economic causes and bear different economic results. However, great or small, they always cause harm to the national economy and to people’s livelihoods—which no one wants to see. If we cannot take away valuable experiences from these painful experiences, the high price will have been paid in vain. Moreover, economists are happy to argue about whether the problem of this crisis is the same or different from the last. In fact, historical experience has repeatedly shown that each economic crisis has its own unique features. At the same time, each crisis has much in common with other crises. Countries, societies and individuals who have suffered from the crisis also each have their own misfortunes. Economic history is full of economic disasters caused by economic recessions, financial crises and epidemics. These events have long been discussed in economic theory and policy, and, to some extent, can be considered to be the incubators or catalysts of innovations in economic theory. From a global perspective, this novel coronavirus epidemic is far from over. Therefore, our current task is not to simply summarize or reflect on it. Rather, based on past experience, lessons and related theoretical discussions, our current task is to focus on points relevant and significant to the response of the epidemic shock. We can thus put forward relevant issues for consideration from several different angles, not only discussing commonalities in different shock events, but also discussing differences among the different shocks. 1. There is No Such Thing as Excessive Policy Response In the face of major shock factors, it is very important for macroeconomic policies to make timely response. According to historical experience, policy response is usually conservative in most cases, and often unable to keep up with the needs of reality, and is quite passive. Therefore, it seems that no policy response has the so-called problem of “overreaction”. Especially in the face of a highly volatile and unpredictable pandemic, policy response must be timely and in place. This is very important for eliminating dual market panic caused by the dual effects of uncertainty of event trends and uncertainty of policy orientation. © CITIC Press Corporation 2021 F. Cai, Understanding China’s Economy, https://doi.org/10.1007/978-981-33-6322-9

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In Keynes’s view, the decision-making of economic activities often comes from the impulse of the actors themselves, not always from the prediction of the expected value. Therefore, the weakness of human nature will cause economic and market instability. This is the so-called “animal spirit”1 . This kind of impulse inevitably shows the irrational characteristics in individual economic decision-making, which can be said to be both in logic and not in accordance with logic itself. We can also understand this characteristic of economic activities from another perspective, that is, the situation of economic activities being impacted by shocks can not only show the decrease of the expected value, but also the increase of the variance of the value2 . The decrease of the expected value is usually manifested by investors’ withdrawal and investment reduction, and then the decline of output, which is mainly the response to risk; the increase of variance is shown as the fluctuation of output and what is caused by uncertainty factors in the large-scale fluctuation of capital markets and commodities trade. Since investment activities are driven by animal spirits, there are naturally too-high valuation factors or bubbles in their normal states. When people encounter sudden changes in risks and uncertainties, people will interpret them according to their own information, generate narratives and react accordingly3 . At this time, even if we do not delve into whether the response is a rational market adjustment, an irrational psychological panic, an inappropriate response to distorted information, or a wrong interpretation of uncertain information, it will eventually bring unbearable chaos to the market and the economy. The difference between risk and uncertainty is that the former can be reflected by specific information, so that the market’s response to it can be predicted at least in theory; the essence of the latter lies in the inadequacy, inaccessibility and even distortion of information, so that the market’s response to it is unpredictable. The market’s response to the unpredictability of the novel coronavirus epidemic is most fully reflected in the four circuit breakers of the very short period of March 9, 12, 16 and 18, 2020, in the American stock market. This became the worst stock market crash since the "Black Monday" crash of October 19, 1987 (the circuit breaker mechanism was not yet established), and also since the crash of October 27, 1997, following the establishment of the circuit breaker mechanism. Therefore, the macroeconomic policy of the United States took a large-scale action, not only out of consideration of the election, and not because it knew that the interest rate reduction policy was not symptomatic—but a standard action to prevent panic and the large shocks caused by it. It should be said that in order to avoid panic and the impact on people’s livelihoods caused by a sharp decline of the real economy, it is still necessary to make a timely and strong response, even if it cannot be accurately symptomatic. 2. Selecting Macro Policy Tools According to the Characteristics of the Shock The economic shock caused by the new coronavirus epidemic is dual, that is, the shock to the real economy is caused successively or simultaneously from both sides of demand and supply, which is reflected in the financial market and the commodities market. Although market status is determined by the matching and interweaving of factors affecting demand and supply, generally speaking, under the condition of the

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market economy, short-term shock comes from the demand side, while supply side factors mainly affect long-term economic growth performance. As the source of countercyclical regulation theory and policy, macroeconomics, especially cyclical theory, was born to resolve demand-side impact. Accordingly, the various techniques in the macroeconomic policy toolbox are mainly designed for this purpose. Although the economic histories of various countries have witnessed supply side shocks, such as the oil shock of the 1970s and various natural disasters, generally speaking, economic policies have a lack of experience in dealing with supply side shocks, and they are often short of options. The shock of the novel coronavirus epidemic on China’s economy has been manifested from the beginning by the interweaving of demand side and supply side. In order to strictly implement measures of social distancing, city lockdowns and quarantines, consumption activities associated with personnel mobility and aggregation, such as accommodations, food and catering, tourism, entertainment, passenger transport and other consumption demands, have been fatally suppressed. The related production and operation fields have also stopped, respectively. As China is in the first wave of the outbreak, the supply side arrangement of shutdowns and ceasing production have led to delay or even interruption of supply to producers in many other countries. When the domestic epidemic situation improves and the gradual promotion of returning to work and production is expected to change the supply situation, not only will it be difficult to repair the broken supply chain, but also the production suspension and shrinkage of the manufacturing industry caused by the global pandemic will set a new round of demand-side shocks for Chinese producers. This kind of shock effect is cumulative, and the consequences will be very serious. Therefore, the implementation of the policy must be super strong. The policy choice should not only fully tap the inventory potential of the traditional toolbox, but also try to change the thinking and path, so as to make effort inside and outside the picture at the same time, with abundant imagination. 3. Not Everyone is Equal Before the Shock of the Epidemic Although the novel coronavirus harms life and health alike, the availability of access to immunization, treatment and rehabilitation opportunities, as well as the degree and tolerance of the economic shock of the epidemic, are different between rich and poor countries, and between groups with different income levels. Reviewing the history of pandemics and human resistance to them, Nobel laureate Angus Deaton pointed out that the technology for the prevention and treatment of epidemic infectious diseases is usually distributed from top to bottom according to social hierarchy. Therefore, for this economist who revealed the phenomenon of “deaths of despair” in the United States—in the face of the virus, not everyone is born equal4 . It is true that in modern society, universality and availability of medical technology have been greatly improved. Moreover, in the face of the novel coronavirus, both billionaires and political elites in developed countries, and the informal employees

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struggling on the poverty line in developing countries, have the same opportunities to be infected, and they will all pay the cost of health and life after infection. However, there are huge differences between countries and between social groups on whether there is a choice to avoid infection: what kind of treatment can be obtained after contracting the disease, whether the vaccine can act in time once it is available, and especially the nature and extent of the impact of the epidemic. No matter what the cause of an economic crisis is, the shock to people should not be evaluated by its magnitude, but instead by its nature. For example, a financial crisis may cause trillions of dollars in losses to the financial industry, and at the same time, it will affect the real economy and cause a large number of minimum wage workers to lose their jobs. As for individuals, the amount of loss suffered by bankers and workers is not the same. However, in the former case, what the banker loses is the money of the capital owner, and the investor is faced with the difference between more or less capital gains or with or without capital gains, while in the latter case, what the laborer loses is their basic livelihood. Therefore, during the outbreak of the novel coronavirus, low-income countries and low-income groups are more likely to bear the brunt of the disease, and their lives and health will be more threatened and more harmed due to insufficient medical welfare. Furthermore, when the epidemic came to a climax, economic activities were stopped due to measures such as lockdowns and quarantines, fragile countries lacked sufficient resources and finances to maintain the necessary testing and treatment, as well as to protect the basic lives of residents. Ordinary workers were also more likely to lose their jobs as well as sources of income, so that they would fall into difficulties while being exposed to health risks. When the economy begins to recover, just as economic growth does not produce the trickle effect of income distribution, the life of ordinary workers will not naturally return to the normal track with an overall economic recovery. 4. Fiscal Policy Takes Center Stage in Macroeconomic Regulations Monetary policy and fiscal policy need to work together, with fiscal policy playing a more important role because it is more targeted and it has a direct implementation mechanism. Originally, the division of labor and the coordination between the two macroeconomic policy toolkits was a long-standing topic in macroeconomics. In recent years, a new wave of discussion has been ushered in. The development of some research fields, and policy implementation suggestions, have also appeared in US presidential candidates’ policy platforms. In the debate over whether the cause of long-term economic stagnation comes from the supply side or the demand side, people unconsciously form a consensus. That is, monetary policy cannot bear the heavy responsibility of stimulating economic growth alone. Especially for developed countries that are in a state of long-term low or even negative interest rates, and implement quantitative easing policies, encountering economic shocks, monetary policy tools are in short supply, and the space for macroeconomic regulation and control is very limited. Therefore, people think that

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fiscal policy should be used more, but there is no consensus on the choice of policy tools. Facing the special impact of the novel coronavirus epidemic, for the time being people may set aside differences in view, and attempt to reach new policy consensus. In emergency situations such as war and disaster, the necessary expenditures for maintaining national security, the national economy and peoples’ livelihoods, such as subsidizing residents’ income, relieving micro-, small- and medium-sized enterprises, and paying basic social insurance, are not only the natural responsibilities of the government, but also unbearable for individual residents and the private economy. At the same time, in such a difficult time, the normal public revenue cannot meet the needs of large-scale additional expenditure, which needs to be solved by increasing the deficit ratio of general public finance or increasing government debt according to the characteristics of its own financial structure and the nature of expenditure5 . It can be seen that in the synergy of monetary policy and fiscal policy, fiscal policy is now in the leading position, and monetary policy focuses on the implementation of the former. Under the pandemic situation, forced shutdowns and ceasing production first brought about open unemployment and underemployment, and then residents’ incomes suffered losses or even were lost, which seriously threatened the basic livelihoods of low-income families. Even if conditions permit complete resumption of production, the interrupted supply chain will take time to repair. Moreover, the global pandemic may break the supply chain further. Therefore, it is far more important and symptomatic for large-scale fiscal expenditure to ensure ample payment of social insurance and social assistance than it is to ensure the sufficient liquidity of financial links. Even current and former central bankers acknowledge that monetary policy is relatively complementary to the impact of the epidemic. For example, in a co-written article, two former Federal Reserve chairs, Ben Bernanke and Janet Yellen, point out that the role of monetary policy at this time is to meet the following needs: first, the additional demand for liquidity under the conditions of home quarantine and ecommerce; second, under such special circumstances, lenders need additional confidence in lending; third, whether it is the economic recovery after a brief pandemic, or whether enterprises and families are in difficulties after a long-lasting pandemic, there is need for readily available credit6 . In addition, monetary policy also needs to undertake the monetary financing functions that they did not mention. It can be seen that fiscal policy is more directly targeted on the area of concern, and it is expected to help enterprises and families to recover effectively. Therefore, it is more targeted in dealing with the economic shock of the pandemic and should take center stage in macroeconomic regulations. Accordingly, monetary policy can be said to play a supporting role to some extent, focusing on helping the government raise funds and ensuring that the implementation of these relief and recovery policies will not be constrained by insufficient liquidity. 5. The Epidemiological Curve Determines the Path of Economic Recovery

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The characteristics and direction of the development of the novel coronavirus epidemic determine the time, mode, path and effects of economic recovery. Therefore, it is necessary to choose the appropriate timing of measures according to the development process and sequence of events, as well as the types and means of macroeconomic policies. In the early stage of the outbreak of the epidemic, the inverted V-shaped epidemiological curve was in the rising stage prior to the peak. In order to control the wide-range spread of the epidemic, the most important task was to implement strict prevention and control measures, including citywide lockdowns, quarantining, canceling gatherings, etc. It was inevitable that economic activities would be reduced or even stopped. After the epidemic reached its peak, the inverted V-shaped curve entered the downward phase. According to the premise that the spread of the epidemic could be controlled, economic recovery took a higher priority. Accordingly, macroeconomic policies and other policy instruments were also affected by this feature, so we needed to choose the right time to issue them in turn—otherwise we could not achieve the desired results. For example, policies aimed at stimulating residents’ consumption, especially encouraging compensatory consumption, cannot produce the expected effects during social quarantine; monetary policy aimed at maintaining necessary and sufficient liquidity may be needed at different stages, but it should be adapted to the main policy objectives at each point in time, rather than becoming an independent goal; macroeconomic policies that aim to restore and stimulate investment cannot be implemented while society is still under general quarantine and before economic activities begin to recover; as for the social support policies that ensure the basic lives of residents, they should run throughout the development of the epidemic and its economic impact in various forms. Epidemic prevention and control, and recovery of economic activities, are both hard requirements; we must deal with the trade-offs and dilemmas of the two in a scientific way. Although the mortality rate of the novel coronavirus is low, it is also this characteristic that allows it to spread quickly, and finally causes loss of life and health due to the large number of infected people. Therefore, it is inevitable to carry out strict prevention and control measures in the form of mobilization across society, and it is also a universal principle that China contribute to the world. At the same time, under the overall control of the epidemic situation, it is also a top priority to return to work and production as soon as possible. However, there is a trade-off and a dilemma between the two. From the experience of the Wuhan City lockdown and various national quarantine measures, the dual-transition mode of separating space from time and exchanging time for space has been successful. According to the stage characteristics of the epidemic development among regions, the focus of prevention and control and the task of returning to work and production should be distinguished. It is because of the prevention and control at all costs in the previous stage, that it is possible to accelerate the process of economic recovery in the later stage—on the premise of ensuring that the number of infected people does not rebound. In view of the fact that the rest of the world is still in the rising stage of the inverted V-shaped epidemiological curve of the novel coronavirus, countries including China

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may also experience a W-shaped trajectory in the process of economic recovery, and furthermore the human race is likely to have long-term contact with the novel coronavirus. Therefore, according to China’s successful experience in coping with the epidemic situation and the dilemma it has encountered, this dual-transition model to separate space and time can be further developed to an updated version of a time and space mutually progressing. This version of the model has the following key steps. First, if conditions are met, the sensitive population should be tested comprehensively as far as possible, so that the tested population can be divided into two groups, respectively: safety group and risk group. Second, in the case of ensuring that the two groups of people do not cross each other, the safety group will immediately enter the status of returning to work, and at the same time continue to quarantine the risk group and conduct continuous screening. Third, with the increasing coverage of testing and treatment, the proportion of the number of the safety group gradually increasing, the number of the risk group decreasing accordingly, and the dual-track system tending to transition to a safe single track. By adopting this transition method, the time differential between prevention and control quarantine and the return to work and production can be minimized. This pandemic and its shock to the global economy have many similarities with historical epidemics, economic recessions and crisis events. For example, the uncertainty of the epidemic itself and the inadequacy of information led to the market shock and the hesitation of economic recovery—which are familiar scenarios in economic history. At the same time, the incident also has many unique features. In addition to the evolution of the novel coronavirus itself and the particularity of the mode of transmission of the epidemic, the huge proportion and growth contribution of China’s economy to the world economy, the central position of China’s manufacturing industry in the global supply chain, the transformation of China’s economic growth mode, and the fact that while the world is at a higher stage of globalization the undercurrent of anti-globalization has been pushed to climax—all of these bring unprecedented challenge to China and the world’s response to this economic shock. In addition, this epidemic and economic shock event also exposed a series of problems that were ignored under normal conditions, such as the public health emergency response system, cooperation among countries under the condition of globalization, emergency material reserves, maintenance and repair of supply chains, etc.—which were all faced with severe challenges. Because of this, economists need to think more deeply, put forward countermeasures and suggestions to solve the various difficulties they are facing, and at the same time be able to foresee the future. Fang Cai April 2020 Notes 1. John Maynard Keynes, The General Theory of Employment, Interest and Money. Huaxia Press, 2004, p. 124. 2. When Krugman discusses uncertainty, he considers it a decrease in the expectation rather than an increase in variance. See, Paul Krugman, “Tariff Tantrums

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4. 5. 6.

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and Recession Risks: Why Trade War Scares the Market So Much,” The New York Times, Aug. 7, 2019. However, if we make a distinction between “risk” and “uncertainty”, Krugman’s expectation reduction refers to the consequence of increased risk, while the uncertainty caused by the difficulty of prediction and insufficient information is manifest more in the expansion of variance. It is worth noting that Robert Schiller foresaw the collapse of the Internet bubble in 2000, and the fall in housing prices in 2007. In addition, as according to the principle of narrative economics, he gave advance warning for the market shock caused by the novel coronavirus epidemic. See Robert J. Shiller, Narrative Economics. Bowles Foundation discussion paper, no. 2069, January 2017. Angus Deaton, “We May Not All Be Equal in the Eyes of Coronavirus”, Financial Times, 6 April 2020. Mario Draghi, “We Must Mobilise As If for War”, Financial Times, 27 March 2020. Ben Bernanke and Janet Yellen, “How the Fed Can Lesson Lasting Damage from the Pandemic”, Financial Times, 19 March 2020.