Embracing China’s “New Normal”: Why the Economy Is Still on Track

Hu Angang. Foreign Affairs. Volume 94, Issue 3. May/June 2015.

It is clear by now that China’s economy is set to slow in the years to come, although economists disagree about how much and for how long. Last year, the country’s GDP growth rate fell to 7.4 percent, the lowest in almost a quarter century, and many expect that figure to drop further in 2015. Plenty of countries struggle to grow at even this pace, but most don’t have to create hundreds of millions of jobs over the next decade, as China will. So understandably, some experts are skeptical about the country’s prospects. They argue that its production fueled growth model is no longer tenable and warn, as the economist Paul Krugman did in 2013, that the country is “about to hit its Great Wall.” According to this view, the question is not whether the Chinese economy will crash but when.

Such thinking is misguided. China is not nearing the edge of a cliff; it is entering a new stage of development. Chinese President Xi Jinping has called this next phase of growth the “new normal,” a term that Mohamed El-Erian, the former CEO of the global investment firm pimco, famously used to describe the West’s painful economic recovery following the 2008 financial crisis. But Xi used the phrase to describe something different: a crucial rebalancing, one in which the country diversifies its economy, embraces a more sustainable level of growth, and distributes the benefits more evenly. The new normal is in its early stages now, but if Beijing manages to sustain it, China’s citizens can count on continued growth and material improvements in their quality of life. The rest of the world, meanwhile, can expect China to become further integrated into the global economy. The Chinese century is not at the beginning of the end; it is at the end of the beginning.

Follower to Leader

Understanding China’s new normal requires some historical context. As a latecomer to the modern economy, China has followed what one could call a “catch-up growth” model, which involves rapid economic growth following years of lagging behind. From 1870 to 1913, for example, the U.S. economy followed precisely this path, growing at an average rate of four percent. Between 1928 and 1939, Russia’s GDP grew at an average rate of 4.6 percent. And from 1950 to 1973, Japan’s economy grew at an average rate of 9.3 percent. Yet none of those countries came close to matching China’s record from 1978 to 2011: an average GDP growth rate of nearly ten percent over 33 years.

This ascent has helped China’s economy approach, and perhaps even surpass, that of the United States. In terms of purchasing power parity, a measure economists use for cross-country comparisons, China’s GDP surpassed that of the United States in 2010 or 2014, depending on whether one relies on historical statistics from the Maddison Project or data from the World Bank’s International Comparison Program. Yet if one relies on the World Bank Atlas method, China’s economy won’t likely outgrow the United States’ until 2019. And China’s GDP still trails that of the United States if calculated using current U.S. dollars. But the best method for comparing the two economies objectively is power generation, since it is physical and quantifiable. It also closely tracks modernization; without electricity, after all, or at least without a lot of it, one can’t run factories or build skyscrapers, which is exactly what China has been doing. In 1900, China generated 0.01 percent of the power the United States did. That figure rose to 1.2 percent in 1950 and 34 percent in 2000, with China surpassing the United States in 2011. In this respect, China has caught up.

China’s rise has also brought massive benefits to the country’s population, although here there is obviously much more to be done. With a population more than four times as large as that of its closest economic competitor, China won’t likely match even half the United States’ GDP per capita until around 2030. To be sure, the country has made major strides in other areas. Its average life expectancy (around 76 years) is nearing the United States’ (around 79 years). Educational levels in the two countries are comparable. And measured by the Gini coefficient, economic inequality in China may now be lower than it is in the United States. Yet since 1979, most of the windfall from China’s rise has accrued mainly to those who live in urban or coastal areas. Realizing Beijing’s ultimate development goal-“common development and common prosperity”-will require not only more sustainable growth but also more evenly distributed gains.

Slower but Steadier

To a certain extent, China’s latest slowdown was inevitable. Three decades of breakneck growth have left China with an economy that is simply massive, making marginal increases in size all the more difficult. Even measured using current exchange rates, Chinese GDP exceeded $10 trillion in 2014, which means that growing by ten percent would amount to adding $1 trillion to the economy after one year, a sum greater than the entire GDP of Saudi Arabia, which is among the world’s largest economies. Growth on this scale was bound to become unsustainable at some point. It essentially requires an unlimited supply of energy and puts enormous stress on the environment. China already emits more carbon into the atmosphere than the United States and the EU combined, and its emissions are still increasing.

Given all this, China has little choice but to pare back. Although a seven percent growth rate is still high in comparison to most economies of the world, it will reduce China’s demand for basic inputs, whether coal or clean water, to more manageable levels. It will also allow China to finally address its contribution to global climate change, in part by making good on the U.S.-China Joint Announcement on Climate Change, a 2014 agreement that requires China to begin reducing its carbon emissions by no later than 2030. Thanks to slower growth and a host of new energy conservation policies, China will likely reach that target well ahead of time.

Beijing’s shift toward the new normal has already begun, and so far, the results are impressive. Consider its 12th five-year plan, which was approved in 2011 and will run through 2015. Despite the plan’s unfolding in a time of declining growth, five of its goals have strengthened the economy and improved the lives of Chinese citizens. The first was a commitment to creating 45 million new jobs in urban areas. Beijing has already exceeded the target, creating over 50 million jobs in the country’s cities, a feat that stands in stark contrast to the unemployment crises in the United States and Europe during the same period. The second involved economic restructuring, calling for the expansion of the country’s service sector from 43 percent of GDP in 2010 to just over 48 percent in 2014; in this case, too, the government has already hit its target, diversifying the economy and boosting employment in the process. The third objective, an emphasis on scientific innovation, mandated an increase in state funding for research and development from 1.75 percent of GDP in 2010 to 2.20 percent in 2015. Again, Beijing has hit its mark, turning the country into the world’s secondlargest funder of research and development. (The investment is already paying dividends: in 2012, less than three decades after China passed its first patent law, nearly 50 percent more patent applications were filed in China than in the United States.) The fourth priority was social welfare, including an expansion of the health-care system, which now covers more than 95 percent of China’s total population. The last emphasized conservation. It called for improvements in eight environmental indicators, such as the share of nonfossil fuels that make up primary energy consumption and the amount of carbon dioxide emissions in proportion to GDP.

The plan’s growth targets, meanwhile, were relatively modest by China’s standards. The central government set a goal of seven percent GDP growth and aimed to double per capita GDP by 2020 compared with the 2010 level. These targets sent a clear signal, especially to state governments that look to Beijing for guidance: when it comes to growth, focus on quality, not quantity.

The average income in urban areas is still more than twice as large as that in rural regions, but the gap is set to decrease in the coming years-a development that will boost domestic consumption and drive continued GDP growth. Of course, China’s relative slowdown will also pose difficult challenges, particularly in the realm of job creation and food production, where growth rates will likely slow. But this is the cost of structural transformation, and it is a price well worth paying to carry the country forward.

Global Gains

The new normal won’t be limited to its effects on China itself: by rebalancing its domestic economy, the country will take on an even greater role abroad. China is already the world’s largest contributor to global growth, and if its economy continues expanding at a rate of around seven percent, the country will likely remain, in terms of purchasing power parity, the most important force driving global growth. From 2000 to 2013, China was responsible for nearly 23 percent of global growth (the United States contributed almost 12 percent). My own fore-casts suggest that this figure will increase to 25 percent before 2020, helping keep global growth rates above three percent.

In trade, too, China is already the world’s leader, and it will continue its upward trajectory. According to the International Monetary Fund’s Direction of Trade Statistics database, it is the largest source of trade for some 140 countries, and its trading activities accounted for some 13 percent of the world’s total growth from 2000 to 2012. But if Beijing wants to raise domestic consumption and reduce China’s dependence on exports, it will have to open China’s borders, by cutting tariffs, encouraging Chinese companies to expand internationally, establishing more free-trade zones, and increasing its trade in the service sector. And to attract more foreign investment, Beijing will have to deliver on basic reforms, such as capital account liberalization, which involves easing restrictions on money flows across the country’s borders, and the creation of a so-called negative list, a single document that indicates which sectors of the economy are not open to foreign investment, signaling that all the others are.

China is poised to make greater contributions in the realm of ideas as well. The country is now among the world’s largest generators of intellectual property; from 2000 to 2012, inventors in China were responsible for nearly 62 percent of the growth in the world’s patent applications (inventors in the United States contributed to around 25 percent). And as part of its new commitment to innovation, Beijing will likely adopt stricter intellectual property protections and encourage Chinese companies to apply for international patents and disseminate new technologies, especially to developing countries.

The more integrated China’s economy becomes, the more it will act as a global stabilizer, just as it did following the 2008 financial crisis. It was Beijing’s aggressive stimulus plan that arguably contributed the most to the global recovery after the crisis hit. By ensuring that China kept its growth rate at over nine percent, Beijing helped turn negative global growth positive. China will continue to serve this role moving forward, but it will also act through more formal channels, mainly international financial institutions, such as the World Bank and the International Monetary Fund, to reform the international financial order in ways that benefit developing countries.

As China increases its economic lead, it will inevitably be called on to assume greater global responsibilities. But in many ways, Beijing is already stepping up, knowing full well that the success of China’s next stage of development depends as much on the wider world as it does on China itself. China can’t thrive without a balanced, rules-based global order, and so the country will continue to advocate for the liberalization of trade, the end of protectionism everywhere, regional cooperation, and a system of global governance more representative of developing countries. The new normal, in this sense, is about building a China strong enough not only to hold its own but also to help others.