Huang Yiping on China's Need for Bold Economic Reforms

"Why does a country as large as China only have the 'New Three'? … We should be seeing the emergence of the 'New Three Hundred', the 'New Three Thousand' or [even] the 'New Thirty Thousand'."

Today’s edition begins with an introduction by Tyler Cowen, professor of economics at George Mason University, director of the Mercatus Centre and host of the Marginal Revolution blog. I am forever grateful for his early belief in, and support of, this newsletter. — Thomas

Overall, I am modestly more optimistic about the Chinese economy than many of my economist peers.

I do see some major problems in the Chinese economy currently, starting with a hangover from a real estate bubble, deflationary pressures, and the exhaustion of low-hanging fruit from more and more infrastructure construction.

Many others worry about the aging of China. I do too, but Chinese retirement ages in the past have been exceptionally low. By raising them, as is now happening, China can extend the reach of its current labor force beyond what demographic variables alone might suggest.

It is on the human capital dimension that China really shines. The country has long been literate, but now is well-educated by global standards, including on the frontiers of many sciences. The exact status of Chinese science can be difficult to discern from a distance, given various mixes of plagiarism, bad incentives, fraud, and just sheer plain copying of foreign ideas. Yet progress has been more rapid than most observers would have predicted twenty-five years ago, and China is a major innovator in many areas, most recently electric vehicles. It is not crazy to think that China might end up with the world’s number one scientific work force.

The Chinese work ethic and interest in business have been legendary for some while, but now the economy is large enough to support such efforts on a larger scale than ever before. In general, the Chinese people come across to any visitor as energetic, pragmatic, and interested in making a mark on the world. Those are huge pluses which are simply not to be taken for granted.

It is difficult to estimate rigorously the value of human capital in a society. But many economists, if asked for a “seat-of-the-pants” estimate, might suggest that human capital is eighty or so percent of national wealth. It might be higher yet in China, given that so much national patrimony was destroyed during the Cultural Revolution.

If eighty percent of your economy is better than ever before, it is hard to be entirely pessimistic.

Of course, it remains an open question what Chinese politics will do with all this human capital. But the Chinese state and CCP themselves have high human capital.

So what I am expecting is, despite all the current problems, something very far from the worst possible outcomes.

Tyler Cowen

Key Points

1. China has entered a new stage of economic development, marked by the loss of its low-cost advantage, an increasingly hostile international environment and the challenges of an ageing population.

2. Innovation-driven growth is key to transforming China’s economic model and essential to understanding Beijing’s recent emphasis on developing “new productive forces” (新质生产力).

3. Fostering innovation requires continued openness to and engagement with the outside world—particularly the West. China must recognise that it will never be able to rely solely on itself.

4. China has every reason to be proud of its “New Three”—electric vehicles, lithium batteries and solar energy products—but given its size, it should be a leader in many more innovative sectors.

5. Government support should prioritise overcoming technological bottlenecks and driving innovation. Excessive focus on the “New Three” risks generating further overcapacity.

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6. Overcapacity has long been an issue in China, but as its economy has expanded and ideological rifts have deepened, its impact on other countries has been more pronounced, leading to increased tensions.

7. Moreover, the country’s large trade surpluses have become a significant source of international discontent and must be progressively rebalanced.

8. Boosting domestic consumption—whether through increased social security benefits or direct cash handouts—should be a top priority for Beijing. This is key to resolving China’s economic ills.

9. Beijing should consider launching a Chinese Marshall Plan for the Global South, aimed at driving the green transition in developing countries. This would have several benefits:

   1. Recognition from the international community.

   2. Absorption of China’s industrial overcapacity.

   3. Reduced dependence on US and European markets.

   4. A driver of economic growth.

   5. Internationalisation of the RMB.

The Author

Name: Huang Yiping (黄益平)
Date of birth: March 1964 (age: 60)
Position: Dean of the National School of Development, director of the Institute of Digital Finance and Boya distinguished professor, Peking University (PKU)
Other: Member of the Monetary Policy Committee, People's Bank of China (2024-now and 2015-2018); Independent director of Ant Group (2020–now); Member of the China Economists 50 Forum and China Finance 40 Forum
Previously: Managing director and chief economist for emerging Asia at Barclays (2011-2013); Managing director and chief Asia economist at Citigroup (2000-2009)
Research focus: Macroeconomic policy; International financial system; Rural economic development; Chinese and Asian economies
Education: BSc Zhejiang University of Agriculture (1984); MA Renmin University of China (1987); PhD Australian National University (1994)
Experience abroad: Senior Lecturer, Australian National University (1994-2000); Visiting Professor, Columbia Business School (1998-1999)
For a more detailed overview of Huang’s career and publications, see here and here

SEVERAL KEY ELEMENTS FOR DEVELOPING NEW PRODUCTIVE FORCES
Huang Yiping (黄益平)
Published by PKU’s National School of Development on 13 August 2024
Based on a speech made in June 2024
Lightly edited machine translation
(Illustration by OpenAI’s DALL·E 3)

1. Introduction

China has entered a new stage of economic development. To help people understand the kind of changes this new phase will bring, I recommend the book China 2049. This is the result of a joint research project between Peking University's National School of Development and the Brookings Institution, a US think tank. The book focuses mainly on the period from now until 2049, that is, the time between the completion of our first centenary goal [in 2021, marking the centenary of the founding of the CCP in 1921], and the second [in 2049, marking the centenary of the founding of the People's Republic of China]. It discusses the changes in China's economic environment, conditions, challenges and strategy that are set to occur during this time.

2. China’s New Stage of Economic Development

How does one grasp the important changes of this new phase?

According to [this] joint research by Chinese and US think-tank experts, there are three major changes in China’s new phase of economic development that are particularly noteworthy:

1. Changes in cost advantages. China's cost levels have risen and [its] low-cost advantage no longer exists. Industries that hope to continue relying on low-cost advantages will find it increasingly difficult to develop. 

2. Changes in the international market. Over the past 40 years, China's economic development has largely relied on the globalisation of the world economy. [Chinese] exports and direct investment in China have played a significant role in driving economic growth, but both of these drivers are now facing increasing challenges.

3. Demographic changes. Population ageing presents [our country with] a major challenge. 

In addition to these three aspects, digital technologies and green development are also undergoing significant changes.

These important changes signify that China’s economic development has now entered a new stage. 

What changes are needed to maintain sustained growth? This is also the question that China 2049 seeks to answer. If the conclusions of the book were to be summarised in one sentence, it would be: [China’s] growth model will need to change. The set of practices that have supported China's growth over the past 40 years will be difficult to maintain.

To transform [its] growth model, [China] must rely more on innovation, its domestic market, digital technologies and policy changes. The core of this transformation is to shift from the previous expansive growth model based on low-cost advantages to innovation-driven growth.

Thus, innovation is becoming increasingly important. This viewpoint is closely related to the concept of new productive forces [新质生产力], as its core element is technological innovation.

3. Improving China’s Ability to Innovate

How to improve [China’s] capacity to innovate?

If innovation-driven development were to be represented by one simple indicator from the perspective of economics, it would be the improvement of total factor productivity (TFP). For economists, developing new productive forces requires a focus on TFP, and one important way to improve TFP is through innovation.

Over the past few decades, China's most competitive products internationally have been low-value-added, labour-intensive manufactured goods. However, in recent years, as [our] low-cost advantage has faded, so has our competitiveness. Many renowned economists around the world have paid close attention to this. For instance, former US Treasury Secretary Lawrence Summers once raised the following question: after the era of labour-intensive manufacturing and real estate-led growth has passed, will China be able to develop new industries to drive future economic growth?

There are also some sceptical voices across the world about China’s capacity to innovate. Michael E. Porter, a professor at Harvard Business School and a leading expert on the innovation capacity of countries, believes that a country’s ability to innovate is determined by two main factors: the first is investment in research and development (R&D), including the allocation of researchers and R&D funding. The second is the “return on investment” (ROI) from these R&D efforts.

Michael Porter listed several factors that affect innovation efficiency. Two of these are particularly relevant to the challenges China currently faces:

The first factor is national openness.

China is currently facing great changes not seen in a century [百年未有之大变局]. The international market and overall environment are already considerably different from what they used to be. In a complex international context, [marked by such policies] as the US's “small yard, high fence”, maintaining openness is crucial for innovation. Remaining set in [our] old ways [固步自封] would make it difficult [for us] to sustain high levels of innovation.

Here's a simple example: in the past, no one was particularly concerned about how many goods we exported; but now, as soon as we started to export some of the “New Threes” [i.e. lithium batteries, electric vehicles (EVs) and solar energy products], some countries reacted strongly [很敏感].

In this context, fostering innovation capabilities requires a deep understanding of the importance of maintaining openness. After all, Western countries still control most of the world’s advanced knowledge and technology. If we refuse to engage with them just because they introduce certain restrictions, it could lead to bigger problems, potentially affecting or even hindering China's scientific and technological progress. Although we can certainly mobilise domestic resources to tackle major scientific challenges, objectively speaking, no country in today’s world can rely entirely on its own resources to solve every scientific problem, nor can any country claim to possess all cutting-edge technologies. Thus, openness is a crucial variable. At a time where geopolitical tensions are becoming increasingly prominent, fully recognising this is of utmost importance.

The second factor is the vitality of the private sector.

Everyone is well aware of the innovation capacity of private enterprises. How to boost and maintain the confidence of entrepreneurs, especially private entrepreneurs, is indeed a significant challenge at present.

In 2022, two scholars from the London School of Economics specifically compared and summarised the share of intellectual property rights held by Europe, Japan, the United States, and China in the field of cutting-edge technology. Their conclusion was that, in terms of quantity, China’s growth has been incredibly rapid, surpassing Japan and even the US in many areas. However, in terms of quality, China’s strength is not as impressive. Nevertheless, over the past decade or so, China’s capacity to catch up and surpass has been particularly evident, with a noticeable trend towards closing in on cutting-edge technology. The key question now is whether we can maintain this momentum. In this regard, we face considerable problems and challenges.

4. Overcapacity

One of the topics discussed by US Treasury Secretary Janet Yellen during her visit to [Peking University’s] National School of Development was overcapacity. She argued that China's excess capacity would disrupt the international trading order and affect American industries and the US job market. However, less than a year earlier, when US Commerce Secretary Gina Raimondo visited China, she mentioned that all the commentary she had seen in Western media about China's economy claimed that China's economy was failing. The contrast between Raimondo's and Yellen's statements is very interesting. 

In my view, neither of these perspectives is accurate. However, on the positive side, the change in attitude among US officials, [while] related to the personal perceptions and attitudes of different individuals, also shows indirectly that China has become competitive in certain areas. China's “New Three” [新三样] are not only making the Chinese people proud but also attracting global attention. This, at the very least, indicates that China has done some things right.

How to understand the new issue of overcapacity?

Overcapacity, in simple terms, refers to supply exceeding demand. From an academic perspective, it is indeed a complex concept. If we set aside exports and only focus on the domestic market, is there overcapacity in some sectors? I believe there certainly is. From a longer-term perspective, the possibility of macroeconomic imbalances and supply exceeding demand have always existed. Another scenario occurs when investment outpaces consumption—capital invested this year results in capacity next year, and if there isn’t sufficient demand, overcapacity will emerge. Thus, the issue of overcapacity has existed domestically for a long time; it is not a recent development.

So, how is today’s overcapacity different from the past? 

The main difference is that in the past, we exported excess goods to the international market without causing too much of a reaction. So, even though we had an overcapacity issue year after year, it could be absorbed through exports. Many entrepreneurs indeed thought this way—as long as the products could be sold and there was a market, it didn't count as overcapacity.

Why is the issue of overcapacity more complex today? There are two main reasons: 

The first is increasing geopolitical tensions. Some Western politicians believe that as long as there is a potential [emphasis added] impact, they will make an issue of China’s [over]capacity. This means that the international market environment China faces today is no longer as friendly as it once was. Furthermore, China has shifted from being a small economy to a large economy. The difference between a small and a large economy hinges primarily on whether changes in import or export volumes can affect the equilibrium of the international market. To put it in the words of a layperson, when a large economy sells something, prices drop; when it buys something, prices rise. This is a typical characteristic of a large economy. In the past, China's imports and exports did not have too much of an impact on the international market because the economy was relatively small. Now that China has developed into a large economy, exporting products in large quantities as we did before will indeed affect the balance of international markets. Some countries are deeply concerned about this, and I believe this issue deserves [our] attention.

This is precisely why China has consistently made every effort to reduce imbalances and achieve an overall macroeconomic balance. This is not only an important macroeconomic goal but also a direction we have been striving towards—though we may still have a [long] way to go.

The second reason is that, although it is a good thing that China has achieved the “New Three”, it also raises a question: why does a country as large as China have only the “New Three”? Since we have already entered the era of innovation, we should be seeing the emergence of the “New Three Hundred”, the “New Three Thousand” or [even] the “New Thirty Thousand”. Currently, everyone is rushing into these [new] three fields. This issue requires reflection.

From an entrepreneur's perspective, this situation can arise quite easily. Some industries need upgrading and, with rising costs, their traditional business model has become unsustainable, requiring them to search for new avenues. Some sectors were doing well, but recent regulatory policies have made their future seem uncertain. Thus, it is understandable that entrepreneurs [began to] look for new ways forward. In the end, many have converged on the “New Three” as they see major breakthroughs and policy support in these areas, leading to a rush towards [these three fields].

At the policy level, some reflection and improvement are needed. The state has provided industrial policy support to encourage the production of new energy products. Although strong policy backing for innovation is certainly not an issue, theoretically its focus should be on overcoming technological bottlenecks. As long as these bottlenecks are resolved, [I] believe [our] market and entrepreneurs have the ability to address other problems on their own. However, the current situation is such that many local governments are eager to support new energy products, and even poorly performing factories can always find local governments in China willing to accept and support them. This is a problem.

The focus of central and local government support for industrial development should be on overcoming technological bottlenecks, rather than simply backing the replication of production capacity using already existing technologies. Industrial policy is important, but the key is to support technological innovation, not the simple duplication of similar industries. 

5. Consumption vs Investment

Which is more important: consumption or investment?

If the issue of macroeconomic imbalances is not addressed, overcapacity will continue to exist. In the past, overcapacity occurred in labour-intensive manufacturing industries, such as clothing and toys. Later, it extended to some home appliance sectors, and then to many industries like steel, alumina and cement.

Overall, industries with overcapacity have been characterised by high investment and low consumption. This issue needs to be addressed.

For a long time, economic growth was driven by investment. Later, some scholars suggested shifting from investment-driven growth to consumption-driven growth. On this point, there is considerable disagreement among economists. Some believe the economy should transition to consumption-driven growth, while others maintain that investment remains the real driver of growth. 

Perhaps the question of whether growth is driven by investment or consumption is not as important as it seems. What matters most is maintaining a relatively balanced ratio between investment and consumption. If everyone only consumes without investing, sustained growth becomes difficult—this was actually the problem the US faced in the past. Similarly, if there is only investment without consumption, major problems will arise. Investments eventually lead to increased production capacity, but if the goods can’t be sold, the investments can’t be recouped. This could result in overcapacity and hinder continued growth.

Therefore, boosting consumption is a clear strategy. There is no need to spend too much time debating whether consumption or investment is more important; the key is to maintain a relatively reasonable balance between the two. In the past, imbalances could be corrected by relying on the international market, but this has become more difficult now that China has become a large economy. 

The importance of consumption is self-evident. After all, the ultimate goal of economic development is to improve the living standards of the people. Increasing consumer spending is necessary to absorb the products generated in the production process. If people don’t have money, it is impossible for them to keep on consuming. Therefore, seeking a reasonable balance between investment and consumption is something we must start striving for from now on.

At present, China's policies seem to be good at supporting investment and supply, but less so at supporting consumption. This year, some new policies have been introduced, such as trade-in programmes for consumer goods. These are good policies that have had a significant impact. However, trade-in programmes sometimes work well and sometimes not so well—if people are already cutting back on spending, the effect [of such policies] can be greatly reduced.

Additionally, the government's reluctance to distribute money directly to the people remains quite clear. This is not to suggest that the government should immediately distribute money on a large scale, but this [idea] does deserve further consideration. Many officials oppose the idea of handing out money, fearing it could encourage laziness and that people might not end up spending the money. They are also unsure about how to distribute this cash and how much should be allocated to different groups of people etc. But in reality, these are all technical issues that can be overcome. Even if some aspects at the micro level aren’t perfect, they wouldn’t pose a major problem. After all, the purpose of handing out money is both to improve people's lives and boost overall demand. With more orders, companies can expand production, hire more workers, and increase investment, which in turn could accelerate economic growth. 

Only when consumption rises can economic growth be sustained. If consumption remains sluggish and people’s living standards don’t improve significantly, where will the driving force for robust and lasting economic growth come from? Consumers, producers and investors might easily fall into a vicious cycle of negative expectations instead. 

Perhaps it is time to consider changing [our] policy approach [改变政策思路]—boldly and confidently supporting a boost to consumption. Increasing consumption also means increasing supply and is an important driver for the development of [China’s] new productive forces [新质生产力].

Of course, “stimulating” consumption cannot just be about making empty promises to the public [开空头支票]. As part of a broader macroeconomic policy, the government should spend real money—whether by increasing social security benefits, enhancing welfare entitlements for urban residents or by directly handing out cash to the public. Only then can the [current] macroeconomic trends have a real chance of stopping their decline and beginning a recovery [止跌回升].

6. Policy Recommendations

Recommendations for the Future:

In the foreseeable future, completely eliminating macroeconomic imbalances is not very likely. Macroeconomic balance, then imbalance, followed by rebalancing is always a [lengthy] process. This may mean that trade surpluses and current account surpluses will persist for some time to come. For the past 40 years, China, like many East Asian countries, has had continuous surpluses, and this didn’t seem to pose much of a problem. 

However, China is now a large economy. Having such large surpluses at this stage could gradually become a problem. From the perspective of our trading partners, a trade surplus means China is always selling to them but not buying [enough] in return. Americans argue that China is “stealing US jobs”. Although such claims are biased, they nevertheless reflect the fact that a large economy with sustained surpluses will face greater difficulties and challenges.

Historically, China has learnt a lesson in this regard. Before the Opium Wars, China’s exports to Britain – mainly of tea, silk and porcelain – were flourishing. However, it imported very little. This led to large amounts of silver and gold flowing continuously into China, which made the British very unhappy. They then tried correcting their trade [deficit] by exporting opium to us, which eventually resulted in the Opium Wars. Similarly, in the 1980s and 1990s, Japan's strong exports led to dissatisfaction in the US, resulting ultimately in a serious trade conflict.

We currently have trade surpluses with more than 170 countries. In the long run, we need to take this issue seriously. Although it may be difficult to resolve these surpluses within a short period of time, China should engage in economic cooperation with its trading partners, such as making investments and developing opportunities for joint economic development. 

The development of China’s new productive forces is currently concentrated on the "New Three”, which is something to be proud of. However, [we] are also encountering significant difficulties [很大的困难]. What should we do?

In addition to providing active support to the growth of our domestic demand, three strategies can be considered when it comes to our international economic policy: first, be resolute in maintaining a multilateral and open international trade and investment system; second, encourage certain domestic companies to expand abroad and invest in foreign markets, thereby reducing the pressures [currently] facing Chinese exports; and third, cooperate with members of our Belt and Road Initiative and consider implementing a “Global South Green Development Plan”.

The idea of the “Global South Green Development Plan” is inspired by the Marshall Plan implemented by the United States after World War II, where the US invested heavily in supporting the reconstruction and revival of European countries, which ultimately benefited both sides. Currently, the main market for China's “New Three” is in Europe and the US. However these markets are facing increasing difficulties and uncertainties.

In this context, I recommend shifting more of our focus to the Global South—i.e. developing countries. New energy goods are of great value to developing countries, as they all face the task of green transition and are [therefore] in need of such goods. These countries lack the technology and capital to produce new energy products on their own. The “Global South Green Development Plan” can use commercial tools, policy instruments and even direct aid to support the green transition and economic development of these countries. This approach has multiple benefits: as a large [emphasis added] developing country, a long-term trade surplus is not beneficial to China's development; [but] in the short term, overseas markets are still needed to absorb [our] production capacity [消化产能].

In addition, I believe this approach can also achieve the following three objectives:

1. It could help some [of our] financial tools “go global” [帮助一些金融工具“走出去”] even before our capital account is fully liberalised. This could include using the digital renminbi to facilitate the internationalisation of our currency and having Chinese financial institutions become more active in developing corresponding cross-border financial services.

2. It could help developing countries drive their green transition, which is recognised universally as a morally commendable initiative. Although developed countries often talk about green development, few actually spend the money to help developing countries achieve this transition. If China could take this step, it would be [seen as] a globally significant effort. At the same time, it would also help us absorb some of our domestic overcapacity, ensuring that our “New Three” industries continue to lead the global industrial development [race].

3. It could become an important macroeconomic policy for [promoting] economic development. For example, when using fiscal and financial tools to increase demand, such demand could be both domestic and international, which would help stabilise our domestic economy. If this is done well, it would contribute greatly to China's long-standing mission of building a community with a shared future for mankind. In today’s climate of heightened geopolitical tensions, making more friends and finding more partners across the world is, in itself, a very meaningful endeavour [是一件非常有意义的事情].

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