China's Productivity Problem

Abstract

China's Productivity Problem Loren Brandt (bio) Nicholas Lardy's The State Strikes Back: The End of Economic Reform in China? is an excellent sequel to his 2014 book Markets Over Mao: The Rise of Private Business in China. Combined, the two books offer a compelling narrative that is often advanced by academic economists working on China. In this review, I briefly summarize this larger narrative and highlight a few issues. Up through the global financial crisis beginning in 2008, China's rapid growth owed much to market-liberalizing reforms that freed up prices and resources, lowered entry barriers facing nonstate firms, opened up China to the rest of the world, and facilitated the reallocation of resources between agriculture and non-agriculture and the state and nonstate sectors. Estimates by my colleague Xiaodong Zhu show that during the first three decades of reform, rapid growth in total factor productivity (TFP) was the source of more than three-quarters of the 8.1% annual growth in GDP per capita.1 Especially important were productivity gains in the nonstate (largely private) sector, followed by those coming from the reallocation of labor and capital from the state to the nonstate sector where returns were higher. Even after three decades of reform, however, huge inefficiencies in resource allocation persisted. Per capita GDP on a purchasing power parity basis was also only 20% of that in advanced countries, and the level of productivity was probably even lower in international comparison. The implication is that China had a decade or two in which 8% growth was still in its future. In the wake of the global financial crisis, a halt—if not a reversal—in liberalizing reforms in most sectors led to a marked slowdown [End Page 170] in economic growth.2 Drawing heavily on estimates of profits, rates of return on assets, and leverage in the state and nonstate sectors to make his case, Lardy links the decline in growth to policy once again favoring the state sector. Although Zhu's estimates of productivity growth only extend to 2007, recent estimates by David Dollar (2017) and Chong-en Bai and Qiong Zhang (2017) that extend through 2015 suggest TFP growth after 2008 that is only a quarter to a half of prior levels.3 Harry Wu's recent estimates (2018) for a slightly shorter period suggest negative productivity growth after 2007.4 China's declining growth after the financial crisis appears to be a productivity problem. How has state policy contributed to this decline? Lardy goes through a long list of the ways in which the state has reasserted itself, but on the basis of his analysis, it is not possible to rank or quantify how important they are. Much more structure and formal modeling are required, but in terms of productivity, three margins are key. First, expansion of the state sector, in which productivity is lower, at the expense of the private sector would have resulted in lower productivity growth. Second, productivity growth in the state sector might have declined, thereby pulling down TFP growth in the aggregate. And third, productivity growth in the private sector may have fallen. Data presented in The State Strikes Back suggests that the problem is not the expanding weight of the state sector in GDP. On the production side, the share of state-owned firms continued to fall in industry, and has also likely declined in services. In the small but rapidly growing business services sector, for example, the share of the private sector rose significantly. On the expenditure side, a fall in the state's share of investment (see p. 19, Figure 1.1) [End Page 171] more than offset a slight rise in the percentage of GDP going to capital formation, implying that capital formation by the state as a share of GDP also fell. Productivity growth in the state sector may have fallen, however. I am less comfortable than Lardy in inferring changes in productivity on the basis of profitability estimates—the link is highly imperfect.5 But given that the state sector is the source of at most a third of GDP, the decline in productivity in the state sector required to explain the...