What is the Future of the Chinese Economy? The U.S. Economy?

Art’s article, copied below, is based on the economist’s understanding of how economies grow, and eventually converge: As an already-developed economy, the U.S. continues to grow on trend.  China’s growth slows as it becomes more developed (productivity gains are harder to come by the more developed the economy is).  In this Issue in Depth we explore:

• How, in fact, do economies grow?  How has economic growth historically developed?
• What are the pre-requisites of growth? 
• What is the economic growth future of the U.S.?  Of China? 
• Does the rise of China means the decline of the U.S.?

As Robert Lucas insinuated, understanding the factors that underlie economic growth – and those that can stymie it – is the golden goose.  Policymakers would do well to keep these factors in mind so that discussions about Sino-American trade can center on the issues that matter, not on the ones that don’t.

Convergence of Growth Rates in the U.S. and China

By Art Blakemore

In this scenario, growth proceeds according to the convergence pattern observed throughout modern industrialization.  

In the case of the U.S., despite periodic ups and downs, it maintains an economic environment conducive to innovation, pushing the envelope of technological progress.  American policies remain relatively free-market oriented.  As such, the economy grows as it has for decades – relatively faster than other highly developed economies but considerably slower than emerging economies.

There are some reasons to question the United States’ commitment to the policies that have sustained it as a growth leader. Among the warning signs are: increased market intrusion, fiscal imprudence, and relatively poor educational performance at the primary and secondary levels.  Yet there are more compelling reasons to think that the U.S. will continue its trend growth. Among the reasons favoring prolonged prosperity are: a relatively flexible market, world-class higher education, strong investment and performance in research and development, strong enforcement of the rule of law, and high-quality regulatory practices. All in all, it’s reasonable to imagine a scenario in which the U.S.’ real per capita GDP growth – a good proxy for standards of living ­– continues to grow 2% annually on trend.

At the same time, a likely scenario for China is that it continues to grow rapidly within its catch-up phase of economic development, as it has for three decades. As workers continue to move from less-productive sectors, such as agricultural and state owned enterprises, into modernized manufacturing, the economy, measured by real per capita GDP growth, continues to grow at high rates (about 9% a year trend over the last decade).  The state retains a relatively heavy hand (though increasingly less so) with a primary focus on economic growth. 

As workers are increasingly reallocated into higher productivity sectors, wages rise in China. As a consequence, Chinese firms find it more difficult to compete with newly developing economies in the lowest-end, lowest-cost manufacturing sectors.  But at the same time, Chinese firms become more technologically capable (by following the leaders), and better able to compete in higher-end manufacturing and services.  As China moves into this second phase of economic transition, productivity gains are less easily attained, and growth slows.  

To compete as a developed economy China must further reform its institutions and open its markets.  Necessary reforms (many already announced by China’s State Council) include:

• Increasing openness to private enterprise (foreign and domestic)
• Freeing markets and reforming state-owned enterprises (SOEs)
• Improving education
• Rapidly – and dramatically – improving infrastructure
• Pricing reforms for resource products
• Fiscal and taxation reform
• Improving the efficiency of financial institutions and regulatory system
• Establishing a social safety net, and by so doing, generating more personal consumption
• Sustainable development of China's foreign trade including reform of currency controls

In the final stage of development, decades from now, China will be reliant on technological innovation at the frontier to the same degree as its developed partners.

China has managed to astound the world with its incredible 30-year growth miracle.  In place of traditional hútòngs we find stunning skyscrapers.  In place of rickshaws we find BMWs and Fords.  We should not underestimate the power of China’s state-planned economy to transform itself into the club of developed economies, even if that means China must let go the reins of central planning.

On the other hand, it is important to remember as we imagine the convergence of growth rates of U.S.-China that the growth of China does not require or even imply the decline of the U.S.  Developed economies that wish to prosper must innovate – technological innovation is the only way that developed economies continue to grow.   The U.S. has a choice. If America maintains its place on the frontier of technological innovation, the “catching up” of China does not mean any sort of decline of the U.S. 

In the end: China is richer.  The U.S. is richer.

This "imagination" of the future of US-China trade servers as our jumping-off point for Issues in Depth: What is the Future of China's Economy?  The U.S. Economy? Dive into the issue below – hear what the experts have to say, see relevant data charts and graphs, read our in-depth analysis, and see relevant news articles and commentary.   All of the expert commentaries, facts and figures, analysis, and commentary are commentable, so please share your thoughts!