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On China’s Strategic Move for

a New Stage of Development –

A Productivity Perspective

Harry X. Wu

IER, Hitotsubashi University

Prepared for the Third World KLEMS Conference

Tokyo, March 19-20, 2014

2

Agenda

1. China at the crossroads: Searching for a new stage

of development

2. Changes over the last three decades: What can we

learn from the restructuring of the economy?

3. Methodology and data

4. Sources of the unbridled growth: How much can be

attributable to productivity?

5. Institutional problems addressed by sector-level

TFP analysis

6. Ready for overcoming the “middle income trap”? –

China in the East Asia perspective

7. Concluding remarks: On key challenges to

“Liconomics”

World KLEMS 3, Tokyo

1. China at Crossroads

After more than three decades of unbridled economic

growth, China and its new leadership now face mounting

problems.

It is a key challenge: cleaning up the dirty air, polluted

water, and tainted food supplies, reducing corruption, and

improving income inequality, which are fueling

widespread discontent among the country’s burgeoning

middle class.

Although these problems are deeply rooted in institutional

deficiencies, they can also be addressed by industry-level

productivity analysis.

After all, the government’s high growth target is pursued

through government-owned or controlled industries,

which has created distorted incentives and misallocation

of resources.

World KLEMS 3, Tokyo3

1….

The largely government engineered growth has ensured

a high speed so far but it is not yet rigorously clear if it

has also improved efficiency and promoted productivity

growth.

We will start our exploration of efficiency problem with

some important observations based on some descriptive

statistics …

using the most recently completed industry level data for

the entire Chinese economy in 1980-2010 (please refer data

problems and construction in CIP papers on data in Wu 2014, Wu and

Ito 2014 and Wu, Yue and Zhang 2014).

The data construction follows the KLEMS methodology

that is theoretically based on Jorgenson and Griliches

(1967).


1. …industry grouping – why it

can be insightful? Despite a declining share of the state sector, the Chinese

government (at all levels) has maintained strong interventions in

resource allocation to maximize growth.

The intervention is made industry-specific through either

subsidization or administrative control or both depending on a

particular industry’s competitiveness and its distance from the

final demand

Starting from the downstream industries… Local governments

tend to provide subsidies (various cost-reducing measures) to

local manufacturers who directly face the international market

Such manufacturers produce finished and semi-finished

products. The subsidized is to more quickly reap the benefit of

China’s comparative advantage in labor-intensive industries.

Since the subsidies do not come with administrative intervention

in business decision, these industries should be more efficient

5

1. …grouping

There are various costs underpaid by downstream industries

(Huang & Tao, 2010), of which the cost of energy is one of the

most important inputs produced by upstream industries.

They are much further away from the end market and do not

conform to comparative advantage but deemed strategically

important by the central authorities.

These industries not only receive subsidies in the form of public

resources, but are also subject to administrative controls, hence

less efficient.

Now, we see a kind of “cross subsidization” in the production

chain…

The downstream industries are subsidized by cheaper energy and

some primary inputs produced by the upstream industries.

In turn, more revenues collected from “more competitive”

downstream industries are used to subsidize the upstream

industries that are now “proved” more important for the downstream

to generate revenues and create jobs


The Research Problem…

Upstream industries also include those providing infrastructures

and government services

Most of the energy industries and some of the major primary

input materials industries are state owned or controlled.

An examination of their productivity performance compared with

downstream industries will shed important light on the problem

of structural distortion and misallocation of resources.

The key to sustaining the “cross subsidization” game is both the

growth and the productivity of down-stream “SF&F” industries.

This follows that the inefficient upstream industries can be

tolerated before the down-stream industries are finally

established and become efficient enough without subsidies.

Appendix for the grouping


Appendix: Industry grouping (for

structural distortion analysis)


2 CLM Coal mining Energy 1 AGR Agriculture Agriculture

3 PTM Oil and gas extraction Energy

4 MEM Metal mining C&P 26 CON Construction Market 2

5 NMM Non-metallic minerals mining C&P 27 SAL Wholesale and Retail Trades Market 2

6 F&B Food and kindred products Finished 28 HOT Hotels and Restaurants Market 2

7 TBC Tobacco products ?? 29 T&S Transport and Storage Market 1

8 TEX Textile mill products C&P 30 P&T Post and Telecommunications Market 1

9 WEA Apparel and other textile products Finished 31 FIN Financial Intermediation Market 1

10 LEA Leather and leather products Finished 32 REA Real Estate Activities Market 2

11 W&F Saw mill products, furniture, fixtures ?? 33 BUS Business Services Market 2

12 P&P Paper products, printing & publishing C&P 34 ADM Public Administration and DefenseNon-market

13 PET Petroleum and coal products Energy 35 EDU Education Non-market

14 CHE Chemicals and allied products C&P 36 HEA Health and Social Security Non-market

15 R&P Rubber and plastics products Finished 37 SER Other Services ??

16 BUI Stone, clay, and glass products C&P

17 MET Primary & fabricated metal industries C&P

18 MEP Metal products (excl. rolling products) Semi-finished

19 MCH Industrial machinery and equipment Semi-finished

20 TRS Motor vehicles & other transp. Equip. Semi-finished

21 ELE Electric equipment Semi-finished

22 ICT Electronic and telecomminucation equi. Finished

23 INS Instruments and office equipment Semi-finished

24 OTH Miscellaneous manufacturing industries ??

25 UTL Power, steam, gas and tap water supply Energy

2. Changes in the last three

decades VA (% p.a.) – official

estimates, supper

fast, more than EA at

the same stage (8.5-

8.8%)

Hours (% p.a.) –

adjusted for a

structural break and

informal sector

employment

Net K (% p.a.) –

constructed

The growth is

apparently investment

driven

Only the export-

oriented semi-finished

& finished goods

group is different …World KLEMS 3, Tokyo9

2… by industry group


2… structural changes


Agriculture

declines

significantly,

though still

took one-third

of total

employment

In industry

only SF&F

increased

share in VA

and H, but not

in K – a more

labor intensive

change

All types of

services

gained more

shares

… led to

changes in

Y/L, K/L and

K/Y ratios

2. … more insightful observations:

capital deepening, labor productivity…


The Y/L growth of

the whole

economy has

been driven by

capital deepening,

pushing up the

K/Y ratio

Energy appears to

be the extreme

case – a very high

K/L and then K/Y,

but a stagnated

Y/L

However, non-

market services

followed energy to

rely on capital

deepening

SF&F is the only

group with a

declining K/Y

2….



The methodological framework exactly follows the growth

accounting methodology as developed by Dale Jorgenson and his

associates as explained in Jorgenson, Gollop and Fraumeni (1987)

and more recently in Jorgenson, Ho and Stiroh (2005), which is

also used as the general framework in EU/KLEMS (O’Mahony and

Timmer, 2009).

It is based on PPF where the gross output (not value added) of an

industry j is a function of capital, labour, intermediate inputs and

technology, indexed by time T, that is

Under the assumptions of competitive factor markets, full input

utilization, and constant returns to scale, the growth of output can

be expressed as the cost-share weighted growth of all inputs and

technological change:

),,,( TXLKfY jjjjj

Yjtjt

Xjtjt

Ljtjt

Kjtjt AXvLvKvY lnlnlnlnln

3. Methodology & data


3…

Where

and

The right-hand side of each equation indicates the proportion of output growth accounted for by growth in capital services, labour services, intermediate inputs, and technical change as measured by TFP, respectively.

Next, we have to consider the aggregation problem

That is why we introduce the Domar weights that take into account the productivity effect of the upper-stream on the down-stream industries (an accumulative effect)

jtYjt

jtKjtK

jtYP

KPv

jtYjt

jtLjtL

jtYP

LPv

jtYjt

jtXjtX

jtYP

XPv

1 Xjt

Ljt

Kjt vvv

3…Domar aggregation

Domar aggregation considers the link between aggregate and

industry-level measures, explored by Domar (1961) and further

elaborated by Hulten (1978).

For an industry-wide equivalent, we postulate the existence of

an industry-wide PPF that relates available primary factor inputs

to deliveries to the final demand.

Aggregate productivity change is defined as a shift of the

aggregate PPF over time, or the rate of change of A (i.e. TFP),

which can be measured as the difference between the rate of

change in total final demand (FD) and the rate of change in

primary factor inputs (Z=L*K) and imported intermediate inputs

(M):


dt

Md

FDP

MP

dt

Zd

FDP

ZP

dt

FDd

dt

Ad M

FD

MMM

FD

z lnlnlnln

3. The Domar aggregation…

Now recall our industry-level equation to measure the rate of change in

TFP

Following the aggregate productivity change as discussed above, the

industry-level productivity change can be aggregated as:

Finally, Domar’s aggregation formula:

A direct consequence of this integration is that weights do not sum to unity,

implying that productivity growth amounts to more/less than a weighted

average of industry-level productivity growth.

This reflects the fact that productivity gains in M do not only have an “own”

effect but in addition they lead to reduced or increased prices in the

downstream industries, and the effects cumulated.


dt

Md

QP

MP

dt

Md

QP

MP

dt

Zd

QP

ZP

dt

Qd

FDP

QP

dt

Ad jM

jj

jMMM

jjD

jj

jDMD

jj

jj

jz

jj

j

jj lnlnlnlnln

dt

Ad

FDP

QP

dt

Ad j

j

jj lnln

4. Sources of Chinese growth(All inputs are cost-weighted with costs are

controlled by national accounts)


Overall, TFP growth is 0.8% p.a. or 1.1% with Domar

The best period appears to be 1991-2001, followed by WTO entry 2001-07

The most inefficient period followed the global financial crisis with the

unprecedented fiscal injection, which worsened the structural problem

Total Economy

GO L input K input M input TFP TFP (Domar)

1980-1991 8.5 0.6 2.1 5.2 0.5 1.1

1991-2001 11.0 0.1 2.3 7.3 1.2 2.2

2001-2007 15.9 0.5 2.9 11.5 1.0 1.1

2007-2010 12.7 0.7 3.4 8.8 -0.2 -1.9

1980-2010 11.2 0.4 2.5 7.5 0.8 1.1

4. TFP index for the total economy


The economy entered

a stage of steady

efficiency improvement

after mid 1990s

following the reform of

the state sectors

But TFP slowed down

following China’s WTO

entry while

consolidated large

SOEs resurged and

growth motivated local

government get more

involved in business

Now China is still in

the difficult aftermath

of the global crisis …

5. Sector level TFP growth and

institutional problems


5…


Remarks

The TFP growth of energy, C&P, infrastructure (services 1). As

well as agriculture are important. Their improvement in 1991-01

played a key role in the rise of Domar weighted TFP growth for

the entire industry…

…and their deterioration in 2001-07 and 2007-10 was behind the

drop of the Domar weighted TFP growth.

Most of energy and some of C&P industries , government

monopolized services cannot survive in a market situation

without the subsidies

Our conjectured “cross subsidization” is evident. No matter how

inefficient the (especially state-owned) upper-stream industries

is, they maintained a strong growth to ensure that the

downstream industries are “competitive”.

This is certainly unsustainable when the market situation is bad..


6. China in East Asia Perspective

We use per capita PPP GDP in 1990 prices to define the

same stage of development for East Asia economies

$2000-$8000

Like its EA neighbors, China spent almost the same time

to accomplish this stage

However, in terms of labor productivity China is still much

lower than EA (Chart)

This means that China has to be more productive

Where will the productivity come from? More investment

or structural reform to address the inefficiency problem?

EA experience has also showed that after this stage, the

growth will slowdown, see the case of Japan and South

Korea, which make the challenge to China even bigger


A comparison of TFP growth


PERFORMANCE OF TOTAL FACTOR PRODUCTIVITY: CHINA VIS-À-VIS EAST ASIAN ECONOMIES (Percent per annum)

TFP growth

(% p.a.)

Period Coverage of

the Economy

Source of

the Study

China 0.8 1992-2010 Industry This study1

0.9 1992-2010 Total economy This study1

Japan 5.1 1950-1973 Total economy Maddison (1995)

4.4 1950-1973 Total economy Wolff (1996)2

5.0 1960-1970 Total economy Bosworth, Collins and

Chen (1995)

South Korea 1.8 1970-1990 Total economy Kawai (1994)2

1.7 1966-1990 Total economy Young (1995)

3.0 1966-1990 Manufacturing Young (1995)


Chen (1995)2

Taiwan 4.5 1970-1990 Total economy Kawai (1994)2

2.6 1966-1990 Total economy Young (1995)


Chen (1995)2

China has to work much harder to achieve the

same level of per capita GDP (1990PPP) as its

east Asian counterparts

Annual growth rate of per Capita GDP:

China v Japan

ChinaPPP/GDP$2000-$8000

Japan PPP/GDP

$2000-$16000

China has to grow

faster than the rate of

Japan after PPP$8000

pc due to lower labor

productivity.

However, poor areas may have strong growth

potentials

Level of per capital PPP-GDP:

The richest five versus the poorest five

7. Concluding remarks –

implications for “Liconomics” Our results well justify one of the three pillars, the most

important one, structural reforms

The other two pillars are “no stimulus” and “deleverage”

However, there are signs that the government has gone

back to its old trick of boosting the economy.

Major banks (in services 1 group) have been required to

provide more landing to sustain the growth

China observers have been saying that there is no way

for Li to become the first premier to abandon the growth

target

The most politically correct argument is that China needs

growth, and a faster growth to avoid falling into the

“middle income trap”, at whatever the cost. This won’t

work. World KLEMS 3, Tokyo30

Main References Domar, Evsey (1961), “On the Measurement of Technological Change”, Economic

Journal 71

Hulten, Charles (1978), “Growth Accounting with Intermediate Inputs”, Review of

Economic Studies 45

Ito, Keiko and Harry X Wu (2013) “Construction of China’s Input-Output Table

Time Series for 1981-2010: A Supply-Use Table Approach”, presented at the 2nd

Asia KLEMS Conference, Bank of Korea, Seoul, August 22-23, 2013

Jorgenson, Dale W., Frank Gollop and Barbara Fraumeni (1987), Productivity and

U.S. Economic Growth, Harvard University Press, Cambridge, MA

Jorgenson, D.W., Ho, M.S. and Stiroh, K.J. (2005). Information Technology and

the American Growth Resurgence, Cambridge, MA: MIT Press

O’Mahony, Mary and Marcel P. Timmer (2009), Output, Input and Productivity

Measures at the Industry Level: The EU KLEMS Database, The Economic

Journal, 119 (June), F374–F403.

Wu, Harry X. (2008), Measuring capital input in Chinese industry and implications

for china’s industrial productivity performance, 1949-2005, presented at the World

Congress on National Accounts and Economic Performance Measures for

Nations, Washington D.C.

Wu, Harry X. and Ximing Yue (2012), Accounting for Labor Input in Chinese

Industry, 1949-2009, RIETI (Japan) Discussion Paper Series, 12-E-065


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