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China Isn't Done Growing Yet

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Stein’s Law, named for former Council of Economic Advisers Chairman Herbert Stein, states that “If something cannot go on forever, it will stop.” That’s as true in economic growth as anywhere. Time and again we’ve seen a poor country grow fast as it industrializes, only to slow. This is predicted in every growth model. A poor country can move workers from the countryside to the city, mobilize savings to build up lots of capital, and cheaply mimic foreign technology. But eventually these processes run their course -- all the workers have left the farms, the return on capital investment drops and technology catches up to a level where a country can’t get ahead by copying. Growth then slows to the more sedate pace of the rich countries. 

China is in the middle of this process. The country’s economic growth rate slid from about 9 percent in 2011 to about 7 percent today. That was in line with predictions by economic historians, notably Barry Eichengreen, Donghyun Park and Kwanho Shin, who missed the date by only three years. 

But now China seems to be slowing even more and the economy, if not in out-and-out recession, is experiencing a sharp deceleration. The official growth rate is still about  7 percent, but China's data is often unreliable and private research firms put the true number at between 3.8 percent and 4.9 percent. Chinese officials are publicly expressing pessimism about the near future. 

The immediate reasons for this appear to be pretty typical -- the bursting of a land price bubble, combined with vast industrial overcapacity. The flight from real estate has probably given the Chinese stock market an unsustainable burst that will shortly reverse itself (and yes, for the record, I just did make an asset market prediction!). 

Does this mean that the heyday of Chinese hypergrowth is over? Lots of people are probably entertaining the idea at this point. Expect to see comparisons to the U.S. housing bubble and the Japanese real-estate bubble of the late 1980s. Also expect to hear crowing from those who think that China’s hybrid authoritarian system is fundamentally broken. 

But while a permanent Chinese slowdown is possible, it’s highly unlikely. The reason is that China still has so much room to grow. The country’s per capita gross domestic product, measured in purchasing power parity terms, is still only about $13,000. Japan, in contrast, stands at about $38,000 and South Korea at more than $35,000. For China to top out now would mean that a Chinese person, on average, never becomes more than about one-third as productive as a Japanese or Korean person. 

Again, possible, but unlikely. China has several big factors in its favor. For one thing, it's gigantic. A large, dense market gives rise to agglomeration effects, where companies want to locate near to consumers, and consumers -- who are also workers -- want to live near their employers. The snowball effect from this process means that China won’t be left as an economic backwater. 

Another factor in China’s favor is its openness to foreign technology. Part of this comes from stealing the technologies of companies in the developed world. Part of it comes from reverse engineering, and part of it comes from the natural spread of know-how through the Internet and through migration of employees between companies. But so far, China has proven both eager and very able to adopt the rich countries’ technological know-how for its own. 

Yes, eventually we can probably expected China’s authoritarian system to hold back its growth. The relative lack of clear property rights, the tradition of extensive government involvement in the economy and uncertainty over the political succession process will all conspire to stop China from reaching Japanese or South Korean levels of income. But even if China only reaches, say, 70 percent of South Korean levels, it still has a large amount of catch-up growth left to do. 

Economists Jingyi Jiang and Kei-Mu Yi of the Federal Reserve Bank of St. Louis explicitly model China’s future, using Japan and South Korea’s paths as examples. They find that if China reaches South Korean levels of income, it will grow robustly throughout the 2020s and then slow down. 

So expect China’s slowdown to be a stumble, not a fall. China will probably recover to something like its recent 7 percent growth rate in the latter part of this decade and much of the 2020s. The country has one big run left in it.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net