MNI INTERVIEW: China Needs To Cut Subsidies To Hit 3.5% Growth

China needs to reduce industrial subsidies if it is to boost productivity and achieve average annual growth of 3.5% over the next five years, likely the most it can manage given inefficiency of resource allocation and overcapacity in major sectors, a prominent economist told MNI in an interview.

The government aims to double GDP by 2035 from 2020 levels, which should require about 4.7% average annual growth, but research led by Harry X.Wu, professor of economics at Peking University’s National School of Development, indicates that the country has been growing at a lower rate than that for years.

Other previously fast-expanding East Asian economies, such as Japan, South Korea and Taiwan, slowed as they got richer, with higher output levels requiring more innovation than technological imitation, noted Wu, director of NSD’s Growth Lab.

China has also faced a steady decline in total factor productivity since 2008, he said in an interview, pointing to the distorting impact of CNY4 trillion in subsidies and government stimulus aimed at supporting investment and bailing out big state-owned companies in the wake of the Global Financial Crisis in 2008.

OVERCAPACITY

This has boosted supply to the detriment of demand, causing widespread overcapacity, with Wu’s research indicating that most sectors in China operate at about 75% capacity utilisation, compared with the 85-90% standard, and with auto manufacturing running at just 60%. (See MNI INTERVIEW2: China Green Transition To Boost Manufacturing)

“The situation is extremely dire – as far as I can see, the mismatch in resources allocation, primarily caused by government intervention, has not improved, or is even getting worse,” he said, calling for market-oriented reform to encourage competition and a reduction in state subsidies, together with greater legal protections for private property.

Meanwhile, official GDP data have overstated growth and smoothed out volatility, said Wu, who argues that National Bureau of Statistics calculations operate on the inaccurate assumption that changes in input prices are mirrored by output prices.

“This is a rather strong assumption that particularly exaggerates the growth of services, because their productivity usually rises slowly while their costs increase more rapidly compared to manufacturing,” he said. (See chart below from Harry X. Wu and research team)

Using a double-deflation approach closer to international standards, Wu’s team calculated that China’s economy grew by 3.2% in 2023, considerably below the official 5.2%, while annual growth between 2018-2023 was an annual 3.7% rather than 5%. GDP grew 7.7% a year between the beginning of China’s economic opening in 1978 and 2023, 1.3 percentage points slower than the official 9%, the calculations show.

LOW TFP

Total factor productivity declined by 0.2% a year between 2018-2023, after expanding by an annual 2.2% from 2001 to 2008 following China’s accession to the World Trade Organization.

“The efficiency of resource allocation has actually slowed after China joined the WTO, since the government strengthened subsidies to large state-owned companies with the earnings from the rapid expansion of the labour-intensive sectors,” Wu said.

An increase in manufacturing productive in recent years may be a positive side effect of the government’s reduced capacity to provide stimulus from borrowing, Wu said, adding that companies have had to rely on themselves by upgrading technology and management. (See chart below from Harry X. Wu and research team)