Will Super-High Chinese Growth Continue?

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While the Foreign Invested Enterprise sub-economy is still only 20 percent of China's total economy, it nonetheless accounts for over 40 percent of China's recent economic growth ... if FDI inflows level off (as appears to have happened in 2005), the sustainability of Chinese growth in the 7-10 percent range may be doubtful.

With an average annual increase in GDP over the last two decades of more than 9 percent, China's economic development has been nothing short of spectacular. But such astonishing growth inevitably inspires the perennial question: How long can China keep it up? In China's FDI and Non-FDI Economies and the Sustainability of Future High Chinese Growth (NBER Working Paper No. 12249), co-authors John Whalley and Xian Xin attempt to answer the question with data supplied by the National Bureau of Statistics of China. They consider, in particular, the roles of what they call two distinct sub-economies. One involves the mainly manufacturing-based Foreign Invested Enterprises (FIEs), which are often joint ventures between Chinese enterprises (usually state-owned) and overseas companies supplying Foreign Direct Investment (FDI), product designs, and international sales networks. The second sub-economy is the non-FIE portion of China's economy in manufacturing, agriculture, and services.

The two sub-economies are of course related, but quite different. FIEs employ only 24 million workers out of a total workforce of 752 million, and their labor productivity is around 9 times that of the workers in the non-FIE sub-economy. The FIEs account for over half of exports and 60 percent of imports. Industrial FIEs are responsible for over 30 percent of China's industrial output. Also, FIEs are concentrated in Southern and Eastern China, intensifying any inequality that results from rapid growth. The FIE sub-economy currently is growing at around 18 percent per year, while the non-FDI portion is growing at about 5-6 percent annually. This suggests that if FDI inflows level off (as appears to have happened in 2005), the sustainability of Chinese growth in the 7-10 percent range may be doubtful.

In dollar terms, annual FDI inflows to China were less than $2 billion in 1985, but had ballooned to $61 billion by 2004. Between 1985 and 1991, the annual growth rate of FDI inflows into China was 14 percent, and during those years annual FDI inflows remained less than $4.5 billion. But in 1992 the FDI inflows had jumped to $11 billion, and in the following year they leaped again to $28 billion, with growth rates of over 150 percent in both years. By 1997, China had FDI inflows of $49 billion.

In subsequent years world FDI inflows declined markedly, but China's FDI inflows continued to grow. Global FDI inflows bounced back to show 2 percent growth in 2004, while China showed an inward FDI growth rate of 13 percent. China's FDI inflows fall into two categories: horizontal FDI, which involves the transfer of production (mainly from North America and Western Europe) to service the Chinese internal market; and vertical FDI, which takes advantage of low-cost production in China for products to be exported and which is fueled mostly by China's Asian neighbors.

Whalley and Xin's analysis indicates that while the FIE sub-economy is still only 20 percent of China's total economy, it nonetheless accounts for over 40 percent of China's recent economic growth. This part of the Chinese economy thus has substantial implications for the sustainability of the country's future economic growth. However, whether rapid growth will continue depends on both continued growth in inward FDI and access to international export markets. While China's FDI inflow growth rate has averaged over 10 percent since 2002 (and China's association with the World Trade Organization), the authors' believe that the figures for 2005 are likely to show a leveling off, or even a slight decline, not least because FDIs have been moving to other low-wage countries.

China's WTO commitments imply both capital market liberalization (in banking) and further progress on commitments on rule-based WTO issues. Such changes will help to attract more FDI. Yet China's rapid export growth raises concerns about the continued absorptive capacities of the Organization for Economic Co-operation and Development. China's share of world exports is now around 6 percent and, with a 35 percent growth rate in exports, is doubling every three years. Continued FDI flows thus may also encounter problems here if they are export-oriented. China's large trade surplus with the EU and the United States also fuels protectionist pressures.

An additional concern, the researchers say, is whether regional disparities within China will continue along with inward FDI. About 84 percent of China's inward FDI occurs in nine coastal provinces, leaving the remaining 20 provinces with 12 percent of inward FDI and resulting in great disparities in income. If growing inequality constrains growth, continued FDI flows could worsen matters. It remains to be seen whether the non-FIE portion of the economy can generate higher growth to compensate for the slowing growth in the FIE sub-economy.

In sum, a leveling-off or falling of FDI, limits to FDI diversification from other non-OCED countries, and continued growth of exports all raise cautions for continued high growth in China. These negatives are counterbalanced to a degree by an ever-improving policy environment for FDI in China, but this in itself seems unlikely to support still more FDI growth into China. Whalley and Xin strongly suspect that more robust growth from the non-FIE sub-economy will be needed to compensate for further lagging growth performance from FIEs.

-- Matt Nesvisky