By Zhu Tian

It’s easy to make an economic forecast, but very hard to get it right. Any country’s economy is prone to fluctuations that make the yearly or quarterly growth rates hard to predict, and China is no different. But, somewhat counterintuitively, long-term growth is easier to predict.

Economists often use the average growth rate of GDP per capita over a sustained period of time to measure long-term growth in the standard of living. When looking at the past 40 years or so, the US’ per capita GDP grew from about $30,000 to more than $60,000 measured in 2010 US dollars. China, however, started from a very low level of $300 or so to a level close to $10,000 now (again, measured in 2010 US dollars). This puts the US average growth rate over the past 40 years at just 1.7%, compared to 8.4% for China.

China has not just grown faster than the US, but also faster than almost all other countries over the past 40 years. Can China keep growing at a relatively faster rate than most countries? Is the new growth rate target of around 5% a year sustainable, or even likely? To make such a prediction, we must answer two key questions:

1)  What has driven China’s rapid long-term growth in per capita GDP over the past four decades? and,

2)  Why has China’s growth rate slowed down in recent years?

Looking for the differentiating factors

People have often attributed China’s rapid economic rise to diverse factors ranging from reform and opening-up, globalization, cheap labour, demographic dividends, industrial policy, and political stability. While significant, none of these things are unique to China. Instead, we must look at what truly differentiates China’s economy from that of other countries, especially other developing countries.

What determines long-term economic growth? Standard macroeconomics tells us that there are only three direct drivers of economic growth – investment (the accumulation of physical capital), education (the accumulation of human capital) and technological progress (the accumulation of technologies).

High Savings and Investment

A crucial strength of the Chinese economy is its high levels of savings and investment. While China has one of the highest savings rate in the world, it also has the world’s fastest growth rate in consumption. Consumption growth in China has been driven by income growth, even while savings levels remain high. In other words, consumption growth is the result, not the cause, of economic growth. Lower rates of consumption lead to higher rates of savings, enabling higher levels of investment and hence faster economic growth, which, in turn, leads to faster consumption growth.

Education: quality matters more than quantity

In terms of government investment in education, China remains distinctly average. However, what sets China apart is the high quality of basic education (i.e., primary and secondary education).

According to OECD sponsored PISA test results, almost all East Asian economies as well as most Western economies are at the top, while developing countries are mostly at the bottom. China is the exception: It is a developing economy that provides a relatively high quality of basic education. According to Stanford Professor Eric Hanushek and his coauthors, the quality of basic education as measured by comparable test scores is the most important predictor of a country’s long-term economic growth. It also explains a large part of the puzzle of why China routinely outperforms other developing countries. It may also help to explain how and why China’s innovation streams are moving beyond the ‘copycat tactics’ of past decades and towards true home-grown innovation.

To summarize, China’s rapid growth has been accelerated by a faster accumulation of physical capital (due to higher savings) and relatively higher quality of education – making its workforce more capable of absorbing existing Western technologies, and consequently spurring on greater innovation and technological catch-up.

How long is the economic slowdown likely to last?

If China still maintains the same comparative strengths that drove its high growth in past decades, why has this growth slowed? Remember, even before the pandemic, Chinese economic growth was already slowing. But why?

The only consistent area of decline leading up to the pandemic was China’s investment rate, which was 18% a year in 2013 but fell to almost 0% by 2017. Policy played a central role here, as the government wanted to guide China’s transition from an investment-driven growth model to a more consumption-driven model, using policies to curb investment in favour of boosting consumption. But as can be inferred from discussions above, there is no such thing as a consumption-driven growth model.

What about geopolitics, such as the US-China trade war? The data does not suggest that this is such an influential factor. China’s US trade levels declined in 2019, but then sharply rose in 2020, 2021 and 2022. China’s trade with Europe also sharply went up. China benefited hugely from its export sector in 2021 and 2022, demonstrating that even in an unprecedented global pandemic, it is hard for the world to decouple with China (and vice versa).

Ultimately, economic fluctuation may be inevitable and growth can be slowed down somewhat by geopolitics or policy mistakes. But, as long as China stays the course of market reform and opening up, it can still achieve a relatively high long-term growth rate, averaging about 5% a year in the next 10 years or so.

Zhu Tian is a Professor of Economics, Associate Dean and the Director of the EMBA Programme at CEIBS. For more on his teaching and research interests, please visit his faculty profile here.