The slowdown of the Chinese economy is not a cyclical downturn. It is part of a deep and complicated transition the outcome of which will shape the future of China, and, with it the rest of the world.
The reality of China’s economic slowdown, stripped to the bare essentials, has to do with the diminishing effectiveness of several key contributors to the productivity growth that fueled the country’s spectacular economic expansion in the previous three decades. These include the rising quality and quantity of the labor force, the more efficient allocation of resources and investment capital, the rapid upgrading of technology, as well as sustained high export growth.
When economic reform started in the late 1970s, the vast majority of China’s labor force toiled in agriculture, using tools and methods not much different from many centuries back. Even though basic literacy and education was vigorously promoted under socialism, only 2% of young adults had any post-secondary education. In the subsequent three decades, hundreds of millions of farm workers moved from villages to factories and urban construction sites, trained to use modern equipment and machinery. By 2016, about two-thirds of the population is urban, and over 30% of young adults are university educated. Over the same time period, the One Child policy also produced a massive demographic dividend with a rising ratio of working age to total population, according to data from China’s National Bureau of Statistics. The net effect was a growing and increasingly productive labor force.
But the demographic dividend ended in 2012, when the ratio of working age to total population peaked, ironically caused by the very same One Child policy that produced the demographic dividend, amplified by the rising longevity of the population. The pace of improvement in the labor force’s education and skill level has also slowed. While the better skilled and more mobile labor force will continue to contribute to productivity growth, it is impossible to maintain the pace of the past.
A second major contributor to productivity was the transition from a top down system of resource allocation to a price-based market economy. This was crucially important in enabling the emergence and expansion of a private sector, which could be guided by changing price signals in seeking out new market and investment opportunities. In recent years, investment by the private sector grew to account for two-thirds of the total.