The pains of structural transformation

For more than a year, headlines worldwide have been pointing to a Chinese economic slowdown. But a closer look at regional dynamics within China tells a different story— one that is less about deceleration than changing gears.

According to China’s National Bureau of Statistics, the resourcerich province of Shanxi in North China has suffered an economic slowdown, but Southwest China’s Chongqing municipality and Guizhou province have experienced vibrant growth. North China’sHebei province and three other northeastern provinces are feeling the effects of recession, but the heavy-industry economies of Tianjin municipality, and North China’s Shandong province and East China’s Jiangsu province are booming.

After the 2008 financial crisis, when slower growth became the “newnormal” for many countries, China began accelerating its economic rebalancing by shifting the drivers of growth from manufacturing and exports toward goods and services for domestic consumption.

This transition has had farreaching implications for the future dynamics of China’s economy. Previously, the economic activities that are now flourishing weren’t categorized as manufacturing industries at all, but as “services”. But services do not exist in a vacuum. All businesses need manufactured products, transportation, information and communications technology (ICT), logistics, real estate, finance, insurance and more.

Thus, new demand for new services has virtuous-cycle effects in terms of capital investment in infrastructure and equipment. Contrary to the conventional wisdom, the growth of services in China to meet domestic demand does not mean the end of manufacturing and capital investment, much less of economic growth.

Service sectors stand to make up for much, if not all, of the growth lost to lower output in export-oriented manufacturing sectors. China’s transportation, ICT, finance, insurance, real estate, education and healthcare sectors have long had inappropriately low labor productivity, which means they have significant room to grow faster.

According to a paper by economists Jong-Wha Lee andWarwick J. McKibbin, service-sector productivity growth in Asia “benefits all sectors eventually, and contributes to the sustained and balanced growth of Asian economies”. Examining economic development trends in the Republic of Korea, the authors find that the average value added per worker in transportation, real estate and ICT is now higher than the average in manufacturing, and they point to similar dynamics in the United States, Japan and China.

This finding suggests that rapid development in China’s service economy could reverse the externally triggered dampening of growth since 2008. But, as the

Japanese and ROK transitions from export to domestic demanddriven growth demonstrate, structural transformation is a slow and painful process.

China is in the midst of that process, and it must be careful not to undermine existing sources of growth lest it fall into a structural trap where the cost of transition itself derails newgains. It is not a good sign that the high costs in many Chinese provinces have been weighing down overall growth.

This points to fundamental challenges ahead, notwithstanding the significant economic potential of Chinese consumers. For starters, economic development based on diversified domestic demand is more complicated than export-driven development, because these newsectors rely more heavily on sophisticated financial services, free and equitable market access, better educated workers, and higher investment in research and development.

As a result, the newbusinesses emerging from the shift to a new growth model are demanding far more from China’s current economic-governance system than it can bear. Further structural reforms would go a long way toward fixing this problem, but they will also require China’s leaders to make tough political decisions that won’t please everyone.

Another fundamental challenge is China’s slow rate of urbanization, which is still lagging, even after 25 years of export-led growth. Each of a thriving service economy’s major components— ICT, finance, insurance, transportation and real estate— needs the others to prosper, and cities are what bring them all together— a phenomenon of network externalities.

China’s cities will be a key ingredient of its long-term economic success. Urbanization should start accelerating today, and over the next 10-15 years, with the expansion of metropolitan areas geared toward the needs of services-led economic growth. If China can rise to that challenge, it will be well positioned to clear the remaining hurdles in its path toward highincome status. The author is a professor of economics and director of the China Center for Economic Studies at Fudan University. Project Syndicate

China recently said it would turn about 1,000 towns into dynamic environmental, cultural and economic hubs by 2020, which would create innumerable newjobs and give rise to newcommunities.

Since China has about 3,000 counties and 18,000 towns and is home to diverse regional cultures, the decision appears conservative, although turning a town into a heritage place is a time-consuming process.

Despite these facts, the decision is encouraging because it indicates China’s new urbanization policy, which in the past mainly focused on building cities of varying sizes. The move also indicates China’s determination to explore the richness of its diverse regional cultures by protecting as well as promoting its natural and historic treasures.

Assuming that at least $100 million a year will be needed for heritage protection, infrastructure construction, and providing entertainment and hospitality in one town, the scale of investment will be huge in these times of economic downturn.

And since this will be a newengine to drive economic growth, China has to exercise utmost caution. China must avoid the mistakes it has made in its urbanization process over the past two decades or more. For example, China should abandon the fast-paced development plan of the past decades because it didn’t aim at creating preserving heritage sites in cities.

In this context, China could learn from European countries’ experiences. Of course, that doesn’t mean simply copying European architectural styles, as many Chinese cities have done in the past.

China should strengthen legislation on heritage protection at the town level. Protection of historic buildings, bridges and heritages such as forests, rivers and lakes should be made mandatory. And the policy should apply not only to the 1,000 selected towns but also to the entire country.

China could also emulate the themebased planning of European countries. For instance, European countries have turned the towns in valleys along major rivers such as the Danube, Rhine, Seine and Loire into agricultural and industrial centers, as well as tourist destinations.

China is developing the region along the Yangtze River, the longest in the country, into an economic belt, so the towns along the Yangtze River and its tributaries could establish sisterly relations with European cities in the same way that more than 600 Chinese cities have already done. And the development of the towns in the river valleys can be one of the major areas of cooperation with European cities.

Of course, modern facilities such as museums, theaters, indoor and outdoor swimming pools, train and bus stations, and parking lots should be built. But preserving the heritage sites in the towns and following local architectural styles should also be part of the new urban development plan.

The plan should also aim to reduce the use of fossil fuels and, instead, encourage the use of bicycles and electric vehicles, including public transport vehicles. The outskirts of some of the selected towns could also be turned into agricultural parks, and the towns should strictly weigh the pros and cons of attracting industrial plants.

Moreover, the towns should pay special attention to building holiday resorts and nursing homes for the aged, because the demand for such facilities is on the rise across the country.

Perhaps some academic institutions could also be relocated to the newtowns to ease the pressure on big cities. Such a plan will also bring value-added benefits for the selected towns’ residents.

And we can only hope the newurbanization plan becomes an integral part of the major socio-economic transformation trend for China.

CAI MENG