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Why Is China Growing So Fast?

Author(s):
International Monetary Fund. Research Dept.
Published Date:
January 1997
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Capital accumulation played a dominant role in China’s economic growth during the central planning era of 1952-78 (Perkins, 1988 and 1989; and Chow, 1993) because of the ability of the government to mobilize saving and undertake large-scale investments in physical and human capital to support its policy of rapid industrialization. Growth rates, while impressive, were substantially below those that have been witnessed in more recent years. Since market-oriented economic reforms were launched in 1978, China has achieved quite phenomenal rates of growth, with real GNP growing on average by nearly 10 percent a year. What are the principal sources of China’s postreform economic growth? In particular, what has been the role in China’s recent growth performance of the improvements in productive efficiency that typically are expected to accompany structural reforms? These are the main questions addressed in this paper.

It is useful first to consider some stylized facts to obtain an overview of the issue under consideration. Figure 1 depicts the behavior of the investment-output ratio, employment growth, and output growth in the 1952-94 period. Real national income expanded by an average of 7.2 percent annually in the past four decades. The average investment-output ratio was above 27 percent throughout the period, and in fact rose to over 40 percent toward the final years of the period. By contrast, employment growth was fairly steady, averaging 2.6 percent, although the educational attainment of the labor force, and thus its quality, increased significantly over this period.

This study examines the contributions of capital and labor inputs, and particularly productivity, to economic growth in China within the standard neoclassical growth framework. To undertake this exercise, a comprehensive data set based largely on official Chinese-language sources was constructed. This data set contains consistent time series on the relevant variables for a longer period than hitherto available. The results of the decomposition of growth highlight the relative importance of each factor in explaining the growth of output and thus provide important insights about the underlying causes of economic growth in China.

The central finding that emerges from this study is that, while physical investment continued to play a dominant role in China’s economic growth, its importance diminished over time, particularly during the reform period 1979-94. Since economic reforms were initiated, productivity growth has become the more significant force in driving the Chinese economy. Figure 2 shows the relative importance of capital, labor, and productivity in China’s economic growth before and after the reforms. Capital formation contributed over 65 percent of the output growth in the central planning era of 1952-78, while productivity growth contributed only 18 percent. However, a new pattern emerged following China’s economic reforms. In the 1979-94 period, productivity growth became substantially more important and accounted for about 42 percent of China’s aggregate growth.

Figure 1.Factor Supply and Output Growth

(In percent)

This study adds to a growing literature examining China’s recent growth experience, including McMillan, Whalley, and Zhu (1989), Li and others (1993), Woo (1995), Borensztein and Ostry (1996). and Sachs and Woo (1997). Since these studies are all motivated by a set of closely related issues concerning China’s growth, some of the differences between the findings here and the results obtained in these other studies will be briefly outlined. Comparisons of the results for China in the paper are also made with available estimates for industrialized countries, some Latin American countries, and four East Asian newly industrialized economies.

Figure 2.Sources of Economic Growth, 1952-94

Source: Authors’ estimates.

The remainder of this paper proceeds as follows. Section I briefly outlines the methodology used in this study. Section II describes how the data set was constructed. Section III presents the main findings of the analysis. Section IV extends the results in a number of directions and compares the findings for China with those obtained in other studies. The final section contains some concluding remarks.

I. Methodology

The methodology utilized in the analysis of this paper is the familiar one based on the notion of an aggregate production function for the economy. As is well-known from the large body of growth-accounting literature, this aggregate production function approach is an analytical simplification that makes it possible to summarize detailed information about the complex process of economic growth within a simple, unified framework.1

The neoclassical growth framework takes as its starting point an aggregate production function, F, which relates a national output measure to capital and labor inputs and time:

where Y is output. K and L are capital and labor inputs, and T is time. The specific form for the production function selected here is the translog production function:2

The translog production function represents constant returns to scale technology if and only if the parameters satisfy the following conditions:

The shares of primary inputs in output can be defined as

where Pk, Pl, and Qy are prices of capital, labor, and output, respectively. Assuming perfect competition, the necessary equilibrium conditions are given by equalities between each value share and the elasticity of output with respect to the corresponding input, as follows:

and

where µk and µl are the elasticities of output with respect to capital and labor, respectively. Moreover, under the assumption of constant returns to scale, the following condition holds:

That is, the value shares and the elasticities sum to unity. Finally, the rate of growth in total factor productivity (TFP). v„ is defined as the growth rate of output with respect to time, holding the capital and labor inputs constant:

A Divisia index for vt, called the translog index of total factor productivity, can be derived by first differencing the logarithm of the production function given in equation (2):

where vt-1, t is the rate of growth of TFP from year t -1 to t, and єk, and єl, are the averageticities of output with respect to capital input and labor input in year t-1 and in year t:

and

In the analysis, the directly observed factor shares vk, and vt, were used as approximate measures of these elasticities to estimate TFP growth, assuming that the restrictions underlying the methodology described above hold. The estimates of productivity growth for China may be biased in either direction if there are deviations from the assumptions imposed by the adopted methodology. However, since this methodology is widely used in studying sources of economic growth for members of the Organization for Economic Cooperation and Development, the newly industrialized economies of East Asia, and many developing countries with divergent income levels and economic structures, it is of interest, certainly as a first step, to apply the same analysis to the Chinese economy to obtain what could be viewed as “benchmark” estimates.

II. Data Construction

Decomposing China’s economic growth into its sources requires an enormous amount of detailed data for both prices and quantities of national output and inputs, and major efforts have been made in this paper to collect, compile, and reconstruct data. All original data were obtained from the State Statistical Bureau and various government ministries. Because of many unusual features of the Chinese statistical system, extra care was taken to evaluate the compatibility and consistency of each series from the Chinese national accounts data with the corresponding series defined by the System of National Accounts (SNA). Some of the major series used in this study are shown in Appendix Table A1.3

Measuring Aggregate Output

Chinese central planners emphasized “gross social output” (GSO) as the principal indicator of national output. Contrary to what the name might suggest, in China this indicator is limited to the so-called material production sectors, comprising agriculture, industry, construction, transportation, and commerce.4 Output from all other services, such as banking, education, health care, real estate, and social services, has been excluded from GSO. Moreover, GSO does not net out the value of intermediate inputs such as energy and material consumption, rendering it difficult to use in international comparisons of output.

Since China opened up to the outside world in the 1970s and embarked on market-oriented reforms, considerable effort has been made to bring the country’s statistical system, particularly its national product and income accounts, more into line with those typically adopted in developed market economies. The State Statistical Bureau has been compiling a new series for gross national product (GNP) since 1978, the beginning year of economic reforms. Unfortunately, however, estimates for the GNP series are not available for the period prior to 1978, thereby precluding comparisons with the prereform period.

However, an intermediate series called national income (NI), which lies somewhere between GSO and GNP. is available beginning in 1952 and ending in 1993.5 The Chinese NI series shares a common feature with GNP in that it is a value-added measure. Like the traditional GSO. but unlike GNP, the NI measure excludes the values of a variety of services. While the NI series is net of depreciation of fixed capital assets and other allowances for capital consumption, it is gross of indirect business taxes and business transfer payments. Therefore, the NI measure as reported by the Chinese authorities could be more appropriately dubbed a variant of net national product (NNP) originating in the five material production sectors of the economy. Since indirect taxes introduce a discrepancy between market prices and prices received by producers, all indirect taxes net of enterprise subsidies were deducted from the reported NI to derive the value of output at factor costs rather than at market prices. This derived series—adjusted NI—is chosen here as the preferred measure of aggregate output for the Chinese economy over the period 1952-94.

In the rest of this paper, the terms “output,” “value added,” and “national income” all essentially refer to the adjusted NI series. The average rates of growth in real output for various subperiods are given in Table 1. It is noteworthy that output growth in the reform period (1979-94) exceeded output growth in the central planning period (1953-78)6 by 3.5 percentage points. Also, for all periods the average growth rate of output per capita exceeded that of output per employee, owing to the faster expansion in employment relative to population growth.

Table 1.Real Output Growth in Selected Periods(Average annual percent change)
1953-941953-781979-94
Output7.25.89.3
Output per capita6.04.58.4
Output per employee5.03.87.0
Sources: Stale Statistical Bureau. People’s Republic of China, and various ministries; and authors’ estimates.
Sources: Stale Statistical Bureau. People’s Republic of China, and various ministries; and authors’ estimates.

Measuring Capital Input

The Chinese authorities regularly undertake fixed asset surveys for the state-owned sector, obtaining information on (1) the gross stock of fixed assets valued at the original acquisition prices of the respective assets: and (2) the stock of fixed assets valued at current prices in the survey years, net of depreciation. In comparing the net stock value series, as reported by the official asset surveys, with the capital stock estimated using cumulated investment flows and the official depreciation table for the state-owned sector, large discrepancies emerge. One possible explanation is that the state-owned enterprises (SOEs) and other state entities fail to use consistent price deflators for those asset surveys. Another possible reason is that official surveys suffer from serious reporting errors and omissions. In any event, such asset surveys are not conducted for urban collective and rural agricultural sectors, and thus do not cover the economy as a whole. Therefore, for the exercise in this paper, the capital stock values were constructed based on gross investment flow data from the Chinese national accounts.

Measuring capital inputs for China involves an important decision concerning the treatment of “circulating funds” in computing the capital stock.7 The literature usually includes accumulation of liquid assets as part of investment (Chow, 1993; and Li and others, 1993). The precise definition and coverage of circulating funds are difficult to grasp. The official statistics alternately refer to this series as “working capital” and, more recently, as “changes in inventory,” adding even more confusion. The term dates back to the central planning era when each SOE was allocated a certain amount of “quota circulating funds” for purchasing fuel, raw materials, intermediate inputs, etc., according to the plans drawn up by the line ministries and local governments for output, material, and credit allocations. The main function of circulating funds was thus to meet enterprises’ demand for working capital in the production process, and there was little role for “inventories” in a command economy characterized by chronic shortages and unsatisfied investment needs. However, economic reforms disrupted the working of the planning system, and the buildup of inventories became significant in China’s economy, as information on inventories was lumped together with the conventional series on circulating funds. A puzzle that arises is that the ratio of “circulating funds/inventories” to fixed investment is extraordinarily high—typically above 20 percent—for much of the period. While the SNA treats changes in inventories as investment, it is difficult to justify also including the accumulation of circulating funds, as they are used in China, as investment. This is just one of the areas where the Chinese statistical system fails to deliver reliable information. For all the above reasons, it is inappropriate to include circulating funds in the measurement of capital for China; only fixed investment data were used in this study in estimating the aggregate capital stock.

To estimate the capital stock for the aggregate economy, the standard perpetual inventory approach was used. This procedure involved four steps. First, investment data for the state-owned sector, urban collectives, rural collectives, the individual business sector, and other private businesses were collected and combined into a single consolidated investment series at current prices. Second, an investment price index was constructed to deflate the aggregate investment at current prices, thus generating aggregate investment at constant prices (with 1978 as the base year). While for much of the central planning period producer goods prices were fixed by the government, capital goods prices began displaying a rising and variable trend in the early 1980s, as the planning authorities gradually loosened their grip on prices, and producer price inflation became significant, particularly for building materials such as steel, cement, and glass. Specifically, the investment price index was based on the implicit deflator for accumulation estimated by Chow (1993) for the period prior to 1978, the price series for building materials between 1978 and 1990, and the price series for fixed assets thereafter. This index should mimic the path of asset inflation reasonably well.8 Third, an initial value of Y175 billion was set for the aggregate capital stock in 1952 (at 1952 prices), the estimate used by Chow (1993).9 Finally, official depreciation rates were used to construct net investment data. It should be acknowledged that Chinese planners have long used artificially low rates of depreciation, averaging 3.6 percent a year, as compared to depreciation rates of 13.3 percent (unweighted geometric averages) for a broad class of U.S. equipment assets (Hulten and Wykoff, 1981).

Chinese official development policies emphasized new capital investment projects, with the objective of expanding China’s overall scale and capacity of industrial production: meanwhile, the continual updating and replacement of the existing machinery, equipment, and infrastructure were neglected. It is commonplace for technologically obsolete machinery and equipment to remain in service in Chinese firms (World Bank, 1983). The official depreciation rates thus bear little relation to the true vintage price functions that characterize the relative efficiency profile of capital assets in China, but, in the absence of independent estimates of depreciation, the official low rate of depreciation had to be used. Low rates of depreciation could lead to overestimation of the capital stock growth and thus bias upward the contributions of capital inputs to economic growth while biasing downward the role of other factors. This caveat should be kept in mind when analyzing the results.

To summarize, the procedure for estimating the aggregate capital stock is based on the following formula:

where Kt, is the stock of capital in period t, lt, is the total real investment (in constant Chinese yuan) in period t, and ξt, is the rate of depreciation. The average growth rates of calculated capital stocks for the aggregate economy and for the nonagricultural sector are shown in Table 2. For comparison purposes, also shown arc the average growth rates of the official real capital stock (for the state-owned sector).

Table 2.Capital Formation and Labor Force Growth in Selected Periods(Average annual percent change, unless otherwise indicated)
1953-941953-781979-94
Real capital stock growth a
Aggregate economy6.86.27.7
Excluding residential capital6.36.06.8
Real capital stock growth b
Official estimates11.411.411.4
Investment-output ratio (in percent)27.122.334.0
Capital-output ratio (in percent)2.582.592.56
Employment2.62.52.7
Population1.82.01.4
Sources: Stale Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

In 1978 base prices.

Changes in the net value of fixed assets in the stale-owned sector.

Sources: Stale Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

In 1978 base prices.

Changes in the net value of fixed assets in the stale-owned sector.

Measuring Labor Input

The sources of the Chinese labor statistics are annual employment surveys and the infrequently conducted population censuses.10 These surveys and censuses produce fairly accurate estimates of total employment in terms of head counts, cross-classified by gender, age. industry, and forms of economic ownership. However, almost no official attempts have been made so far to measure the number of actual working hours. With the possible exception of the state-owned sector, where all employers tend to follow standard 48-hour weeks as mandated by the Chinese State Council,11 little information is available on the hours worked by the urban self-employed and the vast rural labor force. Thus, the labor input for the Chinese aggregate economy was simply assumed to be equal to the total number of employed persons. The average growth rates of the labor force (employment) for the aggregate economy and for its nonagricultural component are shown in Table 2.

Estimating Factor Shares

To calculate labor compensation, total wage payments in each industry for the state-owned sector and for the urban collective sector were first summed to obtain the total wage bill for China’s formal employment economy. To this figure was then added total labor insurance and welfare payments to obtain total labor compensation for all formal sector employees, that is, wage earners. For rural laborers, several surveys on rural household income and expenditure were used to obtain the scaled-up total labor income of peasants for the period 1990-94. The average ratio of peasant labor income to labor compensation for formally salaried urban employees was then used to derive the labor income of rural laborers for all other years. Considering the relatively rapid growth in rural income in recent years, this approach might overestimate rural labor income and thus the aggregate labor income share. However, in-kind income, such as subsidized housing in urban areas and self-consumed agricultural products in rural areas, might be important enough to offset any upward bias of the labor share estimate.

As can be seen from Table 3, the measured labor income, or factor, share of NI averaged 0.411 in the 1952-94 period for the aggregate economy. If agriculture is excluded, the estimated labor share becomes 0.399. The estimate for the labor share is consistent with the assigned value of 0.40 in Chow (1993). It also appears reasonable in comparison with the few available estimates of labor income shares for developing countries. The study by Li and others (1993). however, has produced somewhat higher estimates for the labor income share in China, with an average value of 0.484 for the period 1952-90. That study, however, included implicit housing subsidies (state-controlled rent) in labor compensation. Such implicit housing subsidies were not included here for labor compensation on the grounds that the imputed value of housing services is not counted symmetrically as part of the aggregate value added in Chinese official statistics.

Table 3.Estimated Factor Shares in Selected Periods a(In percent)
1952-94b1952-781979-94c
Aggregate economy0.4110.3860.453
Nonagricultural0.3990.4000.397
Li and others (1993)c0.4840.4620.536
Sources: State Statistical Bureau. People’s Republic of China, and various ministries; and authors’ estimates.

Labor income as a share of total value added (NI): period average. “The period for Li and others (1993) ends in 1990.

The period for Li and others (1993) ends in 1990

Estimates by Li and others (1993) include implicit housing subsidies (state-controlled rent) in labor compensation.

Sources: State Statistical Bureau. People’s Republic of China, and various ministries; and authors’ estimates.

Labor income as a share of total value added (NI): period average. “The period for Li and others (1993) ends in 1990.

The period for Li and others (1993) ends in 1990

Estimates by Li and others (1993) include implicit housing subsidies (state-controlled rent) in labor compensation.

III. Sources of Economic Growth in China

Aggregate Productivity Growth

As shown in Table 1. China’s real national income (the derived net output measure) grew by 7.2 percent a year on average over the four decades to 1994. At the same time, there was extraordinary input growth. With investment averaging 27 percent of national income, China’s real capital stock expanded by 6.8 percent a year for the period (Table 2). Surprisingly, the capital-output ratio remained roughly constant at about 2.6. The absence of pronounced “capital deepening” in the Chinese economy suggests that capital accumulation is only a part of the story behind China’s economic growth.

Output growth in China for 1953-94 and the various subperiods was decomposed along the lines indicated by equation (9) in Section I. From this decomposition, it is possible to obtain estimates of the rate of growth in TFP, that is, the growth of output with respect to time, holding capital and labor inputs constant. The results are shown in Table 4.

Table 4.Aggregate Productivity Growth in Selected Periods(Average annual percent change)
1953 941953-781979-94
Output7.25.89.3
Capital stock6.86.27.7
Employment2.62.52.7
Total factor productivity (TFP)2.11.13.9
Sources: State Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.
Sources: State Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

As can be seen from Table 4, capital grew for the 1953-94 period as a whole at 6.8 percent, and labor grew at 2.6 percent. By comparison. TFP growth was 2.1 percent. However, productivity performance improved dramatically during the reform period. While the average TFP growth rate amounted to about 1.1 percent during 1953-78, it rose sharply to 3.9 percent during 1979-94 when China was implementing market-oriented economic reforms.12 It is interesting to note that Chow (1993) finds no technological progress prior to 1978 in the Chinese economy. The results presented here indicate that, although productivity performance differed sharply before and after 1978, it was positive in the prereform era. The opening up to foreign trade and investment, the gradual price decontrol, the rise of rural township and village enterprises (TVEs), and the expansion of new private businesses brought competitive forces into the Chinese economy and helped make the economy more efficient during the reform period.

Sources of Economic Growth

Table 5 shows the relative contributions of capital, labor, and productivity to aggregate output growth in 1953-94 and various subperiods. The percentage contributions of capital and labor are obtained by weighting the corresponding growth rates by their respective income shares. For the period 1953-94 as a whole, capital is clearly the most important source of growth in China. During the central planning period 1953-78. capital input alone accounted for 65 percent of the output growth. The relative importance of capital has diminished over time, however. For the reform period 1979-94. capital contributed less than half of the output growth: for the last five years of the sample period, capital accounted for only about 30 percent of the output growth. Labor is the least important source of growth. For the period 1953-94 as a whole, labor accounted for 15 percent of the output growth. Labor was responsible for 17 percent of the growth for the central planning period 1953-78. but its contribution dropped to less than 13 percent during the reform period.

While the Chinese economy experienced low productivity growth in the central planning era. productivity growth has clearly become a significant source of economic growth since the beginning of economic reforms. Productivity growth contributed 42 percent of the output growth in the reform period 1979-94, rivaling the percentage contribution of capital.

Table 5.Sources of Economic Growth(In percent)
Variables1953 941953-781979-94
Output growth7.25.89.3
Capital input growth6.86.27.7
Labor input growth2.62.52.7
Total factor productivity (TFP)2.11.13.9
Contribution of capital a55.665.245.6
Contribution of labor a14.916.812.8
Contribution of productivity growthb29.518.041.6
Sources: Slate Statistical Bureau. People’s Republic of China, and various ministries; and authors” estimates.

Ratio of input growth, weighted by the corresponding factor income share, to output growth.

Ratio of TFP growth to output growth.

Sources: Slate Statistical Bureau. People’s Republic of China, and various ministries; and authors” estimates.

Ratio of input growth, weighted by the corresponding factor income share, to output growth.

Ratio of TFP growth to output growth.

In sum. China’s rate of output growth increased by more than 3 percentage points in the reform period compared with the central planning period. Although growth rates in both capital and labor inputs rose significantly in 1979-94. the productivity growth differential appears to explain the bulk of the difference in output growth between prereform and reform periods.

Causes of Productivity Growth

A variety of market-oriented reforms and increased integration into the global economy are the most likely explanations for the rapid productivity growth observed in China in recent years. Specifically, several factors are directly related to productivity growth in the reform period.

First, there has been a significant reallocation of labor from agriculture to the industry and services sectors. Agricultural employment as a share of labor force fell from more than 70 percent in 1978 to 54 percent by 1994. The process of labor reallocation into activities with higher value added, such as manufacturing, has been an important source of aggregate productivity growth for the economy as a whole, as noted by Woo (1995). Boren-sztein and Ostry (1996), and Sachs and Woo (1997), all of whom attribute a large part of aggregate TFP growth to the effects of labor reallocation.

Second, as can be seen from Figure 3, output of the nonstate sector— broadly defined to include the urban collective sector, rural industry, agriculture, and private and foreign businesses—has risen dramatically over the past one-and-a-half decades. Even if agriculture, which had already been liberalized from the collective commune system by the early 1980s, is excluded, the share of the nonstate sector in China’s nonagricultural economy, which was once dominated by the state sector, rose from 25 percent of output in the late 1970s to 56 percent by 1994. A growing literature has explored the nature and operations of China’s nonstate enterprises, especially the rural TVEs. Several features that distinguish TVEs from SOEs are important in explaining why nonstate businesses may outperform SOEs. First, TVEs have strong profit incentives and sharply focus on their financial bottom lines, whereas SOEs often have a variety of nonfinancial objectives, including the provision of social services (Byrd and Gelb, 1990; and Hu 1994). Second, unlike their counterparts in the state sector, TVEs face hard budget constraints, with high bankruptcy rates, while loss-making SOEs can obtain budgetary and credit subsidies (Qian and Xu, 1993). Third, TVEs enjoy more operational autonomy and, in particular, are relatively free of interference from the central and local bureaucracy in their labor hiring and tiring and wage-setting practices, allowing for far greater labor market flexibility (Hu, 1994). The rapid growth in the rural TVEs played an especially important role by drawing tens of millions of workers from agriculture into the higher-value-added manufacturing industry. The expansion of the nonstate sector relative to the state sector clearly helped raise overall production efficiency in the Chinese economy. Jefferson and Rawski (1994) provide estimates for sectoral productivity growth in Chinese industry, classified by ownership. They find that productivity in China’s nonstate sector grew more than twice as fast as in the state sector between 1980 and 1992. During the subperiod 1984-88. for example, productivity grew by 3.0 percent in the state sector. 5.9 percent in the urban collective sector, and 6.6 percent in the township and village sector. The sectoral evidence underscores the role of the nonstate sector in the surge of China’s aggregate productivity in the reform period.

Figure 3.Foreign Direct Investment

(In percent)

Sources: Chinese authorities and authors’ estimates.

a The share of the nonstate sector output in total nonagricultural output.

b The share of the total foreign trade in national income.

c The share of foreign direct investment in total fixed investment.

Third. China’s open-door policy and “special economic zones” helped attract massive foreign direct investment. Foreign direct investment into China was negligible prior to 1979. By 1994. however, cumulative foreign direct investment had reached US$95.6 billion. Annual inflows increased from about 0.5 percent of total fixed investment in 1979 to 18 percent in 1994. Significant spillover in technology and managerial know-how was likely through the numerous joint ventures and wholly owned foreign enterprises that have sprung up along China’s coastal provinces in the last decade.

Finally, China emerged as an export powerhouse over the last decade. Total exports as a share of national income rose from less than 6 percent in 1978 to over 30 percent in 1994. Manufacturing exports, in particular, were expanding in U.S. dollar terms at a rate of 19 percent a year in the 1981-94 period. The ratio of trade to national output increased from a little over 10 percent in 1978 to over 60 percent by 1994. The evidence from a large number of cross-country studies suggests that export growth has a strong positive correlation with productivity growth in domestic industries. The competition in world markets apparently exerted strong pressure on Chinese industry to adopt the best manufacturing practices and improve efficiency.

International Comparisons

A recent study by Young (1995) documenting the East Asian growth experience has stirred a healed debate. Noting Young’s findings that East Asian economies had rather unspectacular TFP growth rates. Krugman (1994) dismisses the East Asian economic miracle as a myth and goes so far as to put Singapore and the former Soviet Union in the same category of economic inefficiency! As it is widely suggested that China is well on its way, following the examples of its East Asian neighbors, to achieving an economic miracle of a far bigger proportion (for example. Perkins, 1989), it is interesting to compare China’s growth experience with those of other countries.

Table 6 tabulates estimates from previous studies for the Group of Seven industrialized countries (Dougherty, 1991). several Latin American developing countries (Elias, 1992). and four newly industrialized East Asian economies (Young, 1995). While China’s TFP growth in the prereform period was lackluster in comparison with productivity in other economies, its TFP growth rate in the postreform years was notably higher than those experienced by other countries in the periods shown in the table. China’s high TFP growth indicates that it is rapidly catching up with international productivity levels, particularly those in the advanced industrialized countries.

IV. Further Explorations and Sensitivity Analysis

Although extremely useful, growth accounting is nevertheless a very delicate exercise. The question is whether the results reported in this paper constitute firm evidence that the Chinese economy has truly moved since the reforms onto a sustainable long-term path of high productivity growth. To check the robustness of the findings, the analysis was redone using alternative data and methodologies suggested by other studies.

Table 6.Productivity Performance in China and Selected Countries(Average annual percent change)
Total factor productivity (TFP)
CountryPeriodgrowth
G-7 industrial countriesa
Canada1960-890.5
France1960-891.5
Germany1960-89l.6
Italy1960-892.0
Japan1960-892.0
United Kingdom1960-891.3
United States1960-890.4
Latin Americab
Brazil1950-851.6
Chile1940-850.8
Mexico1940-851.2
Venezuela (manufacturing)1950-702.6
East Asiac
Hong Kong1966-912.3
Indonesia1979-960.9
Malaysia1979-962.0
Singapore1966-900.2
1979-962.5
Koread1966-901.7
Taiwan ovince of China’d1966-902.1
China1953-942.1
1953-781.1
1979-943.9
Sources: Authors’ estimates and references cited in the footnotes.

The estimates of TFP growth for earlier periods (1966-91) are from Young (1995) for Hong Kong, Singapore, Korea, and Taiwan Province of China; estimates for more recent period (1979-96) are taken from Sarel (1996).

Excluding agriculture.

Sources: Authors’ estimates and references cited in the footnotes.

The estimates of TFP growth for earlier periods (1966-91) are from Young (1995) for Hong Kong, Singapore, Korea, and Taiwan Province of China; estimates for more recent period (1979-96) are taken from Sarel (1996).

Excluding agriculture.

Impact of Political Disruptions

Comparisons of China’s efficiency and growth performance in the central planning and economic reform periods may be affected by the major political disruptions that occurred before the country’s opening up to the outside world in 1979. During the central planning period 1952-78, China experienced periodic political upheavals, highlighted by the 1966—69 Cultural Revolution. It is well-known that in those politically chaotic years China subordinated the national priorities of economic development to political objectives, and that the ideological struggles greatly disrupted economic activity. As noted by a number of studies, including Chow (1993) and Borensztein and Ostry (1996), it is important to separate out the influence of political disruptions on China’s growth performance. Borensztein and Ostry (1996) find that, once the political turbulence of prereform China is taken into consideration, the difference in the growth rates of GDP per worker between the prereform and postreform periods becomes less dramatic. Their results point to the possibility that, excluding political influences, the true improvement in China’s productivity growth in the reform period may be smaller than suggested by the unadjusted official data.

We also find that failure to take out the impact of political disruptions would lead to underestimation of output growth in prereform China. When the politically disruptive years from 1958 to 1970 were excluded, the growth rate in output per employee was 4.5 percent in the prereform period, rather than 3.8 percent, as estimated from the unadjusted data (Table 7). Nevertheless, the TFP growth rate in the prereform period, excluding the politically disruptive years, amounted to 1.6 percent, only marginally higher than the TFP growth for the entire prereform period, mainly because higher output growth in the politically stable years was also accompanied by higher investment growth. It thus seems that political events alone cannot completely explain the lower productive efficiency in China’s central planning period. Even after excluding the politically most disruptive years from 1958 to 1970, the difference in estimated TFP growth rates between the central planning and reform periods remains substantial.

Table 7.Impact of Political Disruptions on Efficiency and Growth(Average annual percent change)
1953-781953-78a
Output5.86.6
Output per capita4.54.7
Output per employee3.84.5
Real capital stock6.26.5
Employment2.52.2
Total factor productivity (TFP)1.11.6
Sources: State Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

Excluding the politically disruptive years from 1958 to 1970.

Sources: State Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

Excluding the politically disruptive years from 1958 to 1970.

Table 8.Efficiency and Growth in the Nonagricultural Economy(Average annual percent change)
1953-941953-78a1979-94
Output8.59.310.0
Capital input10.112.19.3
Labor input5.06.55.4
Total factor productivity (TFP)0.9-0.83.1
Sources: Slate Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

Excluding the politically disruptive years from 1958 to 1970.

Sources: Slate Statistical Bureau. People’s Republic of China, and various ministries: and authors’ estimates.

Excluding the politically disruptive years from 1958 to 1970.

Efficiency of China’s Nonagricultural Economy

In the 1952-78 period. Chinese central planners favored the urban industrial sector over agriculture, allocating the predominant share of national savings as capital investment to industry while forcing the rural population to stay in agriculture by strictly controlling migration to the cities. In the reform period 1979-94. Chinese industry continued to receive a dominant share of capital, hut the government also adopted a more flexible labor market policy that permitted rural surplus labor to move out of agriculture into rural industry or the urban services sector. At the same time, agriculture shrank from 40 percent of the national income in the early 1980s to about 25 percent by 1994.13

With the continuing reduction in the shares of agricultural output and agricultural labor force, and with more capital and labor resources drawn into the nonagricultural economy than ever before, an important question arises: How have such sectoral shifts in output and reallocation of labor affected the efficiency of China’s nonagricultural economy?

As can be seen from Table 4 and Table 8, growth in nonagricultural output outpaced output growth for the economy as a whole, but growth in inputs for the nonagricultural economy was considerably higher than growth in inputs for the aggregate economy. The capital stock expanded by 10 percent a year for the nonagricultural economy, compared with 6.8 percent for the aggregate economy, while growth in labor inputs averaged 5 percent in China’s nonagricultural economy, as opposed to 2.6 percent for the economy as a whole. Excluding agriculture. TFP growth turned out to be negative (minus 0.8 percent) in 1953-78 and 3.1 percent in 1979-94.14 While TFP growth for the nonagricultural economy was a little lower than the 3.9 percent tor the overall economy (including agriculture) in the 1979-94 period, the contrast in productivity performances of the nonagricultural economy between the central planning era and the reform period is remarkable.

Can China’s TFP Growth Be Sustained?

Looking at the reform period alone, the question arises, How sustainable is China’s productivity growth?15 If the dramatic productivity improvement in the 1979-94 period mainly reflected the onetime gains induced by the earlier reforms, such as the dismantling of collective agriculture (including the people’s communes) and the restoration of family farming in the rural areas, one might have observed a subsequent slowdown in aggregate productivity growth as the potential for efficiency gains was exhausted over time. In the first six years until 1984. Chinese reforms were concentrated in the rural sector and were largely successful. As shown by McMillan, Whalley, and Zhu (1989) and by Khan and Khan (1995). productivity growth in Chinese agriculture during this period was impressive, partly owing to increases in agricultural prices and—more important—to positive incentives to farmers induced by institutional changes. These changes included the introduction of the household responsibility system and the increased labor market flexibility that permitted rural surplus labor to move into industrial and urban tertiary sectors. As shown in Table 9. the estimated TFP growth for the aggregate economy over the initial period of reforms (1979-84) was 2.5 percent, a full percentage point higher than in the prereform period.

Beginning in 1984. China shifted its reform priorities to the urban, state-owned industrial sector. These reforms proved far more complex and challenging than the earlier rural reforms (Perkins, 1988: and Bell, Khor, and Kochhar, 1993). It was possible that the continued problems with the state industry would limit the scope for sustained further productivity gains in the Chinese economy. Nevertheless, mainly because of increased autonomy and strengthened working incentives associated with a number of reform measures, even the Chinese SOEs registered higher productivity growth (Groves and others, 1994). Indeed, as shown in Table 9, TFP for the aggregate economy grew by 2.7 percent between 1985 and 1989. In the last several years of the sample period (1990-94). TFP growth reached an astonishing 5.8 percent, and productivity changes for the first time overtook capital as the predominant source of China’s economic growth. Instead of slowing down (as one might have expected), productivity growth reached stunning new highs as China moved forward on the reform path, albeit at an uneven pace.

Table 9.Productivity Growth in the Reform Period(Average annual percent change)
Extension of reformAccelerated
Rural reformto urban, state-ownedreform
1979-84sector 1985 -891990-94
Output8.08.811.5
Capital input7.18.67.5
Labor input3.02.82.1
Total factor
productivity (TFP)2.52.75.8
Sources: State Statistical Bureau, People’s Republic of China, and various ministries; and authors’ estimates.
Sources: State Statistical Bureau, People’s Republic of China, and various ministries; and authors’ estimates.

Therefore, the evidence from this study points to a somewhat different conclusion from that reached by Sachs and Woo (1997). Even though the efficiency gains brought about by earlier agricultural reforms may have dissipated, the sharp growth in rural industry, the surge in foreign direct investment, the export boom, the further dismantling of the central planning system, and the increasing market orientation in the state-owned sector have combined to boost aggregate productivity growth in the 1985-94 period, and even more so during 1990-94.

Adjusting Capital Stock Growth

During the central planning period, much of the fixed investment was allocated to new machinery and equipment to increase the country’s industrial capacity, while infrastructure and residential investment was neglected. In the reform period, outlays in new housing by state and nonstate entities increased sharply, taking a larger share of gross fixed investment. Since the Chinese NI series excludes the imputed value of residential housing services, a corresponding adjustment for the capital stock was made by deducting residential investment from gross fixed investment. As can be seen from Table 10. such an adjustment has no impact on the TFP growth estimates for the central planning period 1953-78 but raises the estimated TFP growth for the 1979-94 reform period to 4.4 percent from 3.9 percent.

Table 10.Sensitivity Analysis of Total Factor Productivity (TFP) Growth Estimates(Average annual percent change)
CentralEconomic
planning periodreform period
1953-781979-94
Alternative TFP growth estimates
Li and others (1993) a-0.82.5
Borensztein and Ostry (1996)-0.73.8
Sachs and Woo(l997)b1.7
Alternative measures of capital inputc
Excluding residential investment1.14.4
Reducing initial capital stockd-0.93.7
Assumed values of labor sharese
α = 0.30.73.2
α = 0.51.13.7
α = 0.61.84.6
Sources: Li and others (1993), Borensztein and Ostry (1996). and Sachs and Woo (1997): and authors’ estimates.

The economic reform period covered is 1979-90.

The economic reform period covered is 1978-93. Sachs and Woo (1997) also report TFP growth estimates of 3.3 percent and 0.8 percent for subperiods 1978-84 and 1985-93. respectively.

Using authors’ own estimates of output growth, input growth, and factor shares.

Setting initial capital stock at Y58.9 billion in 1952. which reduces the initial capital-output ratio from 2.5 to 1 in 1952.

Using authors’ own estimates of output and input growth.

Sources: Li and others (1993), Borensztein and Ostry (1996). and Sachs and Woo (1997): and authors’ estimates.

The economic reform period covered is 1979-90.

The economic reform period covered is 1978-93. Sachs and Woo (1997) also report TFP growth estimates of 3.3 percent and 0.8 percent for subperiods 1978-84 and 1985-93. respectively.

Using authors’ own estimates of output growth, input growth, and factor shares.

Setting initial capital stock at Y58.9 billion in 1952. which reduces the initial capital-output ratio from 2.5 to 1 in 1952.

Using authors’ own estimates of output and input growth.

TFP growth estimates can also be sensitive to the initial values of capital stock. To assess this possibility, the value of initial capital stock was set at Y58.9 billion (1952 prices).16 which reduces the starting capital-output ratio from 2.5 (derived from Chow’s (1993) estimate) to 1. This adjustment increased real capital stock growth rates, particularly in the earlier central planning period. As a result, estimated TFP growth turned negative (minus 0.9 percent) for 1953-78. but it was only slightly lower for the reform period 1979-94 (3.7 percent) than when Chow’s (1993) estimate of the initial capital stock was used.

Measurement Errors in Output and Input Data

The potential measurement errors in the official Chinese data warrant considerable caution in interpreting the results presented in this paper and elsewhere. Woo (1995) and Sachs and Woo (1997) assert that the Chinese official output data overstated output growth by as much as 0.5-1.0 percentage points in the postreform period. If correct, their output adjustment would reduce the TFP growth estimates in this paper by 0.5-1.0 percentage points, holding inputs and factor shares at the same levels.

According to these recent studies, the errors in the official output data stem mainly from two sources: overreporting of nominal industrial output and underdeflating of nominal industrial output by Chinese collective enterprises, especially TVEs. It is puzzling that China’s nonstate enterprises should in the reform period overreport their nominal output to the authorities. These enterprises have strong profit incentives and would like to avoid taxes if possible. One possibility is that overzealous local officials overstated the total output in their jurisdictions to justify their job performances to their superiors. However, such bureaucratic incentives are presumably far weaker in the post-reform era of decentralization and increased local autonomy than they were in the central planning period. In fact, plenty of evidence suggests that China’s informal sector expanded substantially since the economic reforms, which had a growth effect as well as a level effect on output. As such, it is doubtful that correcting a bias resulting from the overstating of output could reduce the sharp differences in China’s output growth before and after reforms.

The underdeflating of nominal output could be a more important source of bias. Recent work by Woo (1995), Borensztein and Ostry (1996). and Sachs and Woo (1997) attributes much of the upward bias in official output growth estimates to the improper deflating of industrial output, especially in the collective sector. However, they fail to make the symmetric adjustment to the official investment series, which could be similarly underdeflated as industrial prices determine to a large degree investment goods prices. Thus the net impact of the Sachs-Woo adjustment on the true TFP growth estimates is not clear. One should also bear in mind that official output statistics in the central planning period are not free of the “improper deflating” problem. Selecting an appropriate deflator for that period is a delicate matter because of the severe repressed inflation. The chronic shortages, queues, and excess demand for capital investment indicate that, in the absence of price control, open inflation would have been much higher. Thus, while underderflating the output series poses a serious problem for the estimated values of TFP growth, it does not change the basic conclusion that efficiency has improved substantially in the reform period.

Essentially, the biggest problem with the official statistics lies with the capital stock data. As noted in the discussion of data construction in Section II. the official asset surveys do not produce stock estimates consistent with the investment How data from the national accounts. The differences between the official estimate of the capital stock and the estimate obtained by applying the perpetual inventory method to the disaggregated investment flow data , with proper deflating, are substantial. Woo (1995), Borensztein and Ostry (1996), and Sachs and Woo (1997) all use a series of capital stock estimated earlier by Li and others (1993). As discussed in great detail in Hu (1996). this capital stock series, although representing a significant improvement over the official series, seriously overestimates China’s real capital stock growth in certain time periods.

Table 10 shows how TFP growth estimates vary if different measures of output, capital input, and factor shares are used. Li and others (1993) estimate TFP growth rates to be minus 0.8 percent for 1953-78, and 2.5 percent for 1979-90. Woo (1995) and Sachs and Woo (1997) estimate TFP for China’s aggregate economy to be 1.7 percent for 1978-93.17Borensztein and Ostry (1996) estimate TFP growth to be 3.8 percent for the reform period 1979-94. These estimates do not differ substantially from the TFP growth estimate of 3.9 percent for 1979-94 reported in this paper, considering their use of alternative output and input data. Li and others’ (1993) results imply a net increase of 3.3 percentage points in TFP growth, for instance, as compared to the 2.8 percentage point increase from the central planning to the reform period estimated here. Using alternative values for factor shares, as for example done by Borensztein and Ostry (1996), also does not change the results significantly (Table 10). In particular, the differential in TFP growth between the prereform and reform periods remains large, irrespective of the value chosen or the labor share (α). By and large, the available evidence from these studies confirms that productivity improvements are a significant source of economic growth in China during the reform period, and the basic conclusion remains unchanged when alternative measures of capital input and values of labor income share are used.

V. Conclusions

The central finding of this paper is that, although capital accumulation was a dominant factor in China’s economic growth, productivity improvements have assumed an increasingly important role. Because of China’s high savings rates and abundance of labor, the significance of factor inputs in China’s economic growth is well understood; however, it is interesting to find that China has continued to achieve an impressive record of productivity growth in recent years.

The evidence is clear that China has reaped considerable gains from its market-oriented economic reforms in the past two decades. The TFP growth rate in the Chinese economy was fairly low for the period 1953-78 because the system of central planning stifled economic incentives, prevented competition, and distorted resource allocation. By contrast, China achieved spectacular productivity growth in the reform period, with the increase in TFP approaching 4 percent a year. Productivity growth contributed more than 40 percent of China’s aggregate economic growth during the reform period and rapidly replaced capital input as the predominant source of economic growth in China. In the absence of an identified surge in research and development efforts, the observed productivity gains can be mainly attributed to improved allocative efficiency under market-oriented reforms, such as the emergence of family farming and the rise of rural industry, as well as to China’s decade-long open-door policy, which brought about an expansion in foreign trade and foreign direct investment. While at this stage it is not possible to pinpoint the exact sources of productivity growth in China, there are good theoretical and empirical reasons to believe that the reform process that was initiated in 1978 has had, and apparently continues to have, an important effect on the rapid productivity growth observed over the past decade.

APPENDIX
Table A1.Selected Time Series of Output. Factor Supplies, and Factor Shares(In hundreds of millions of yuan, unless otherwise indicated)
NationalNationalNationalGross fixedCapitalTotal
incomeincomeincomeinvestmentstockLaboremployment
(current(1978deflator(current(1978income(10.000
Yearprices)prices)(1978=1)prices)prices)sharepersons)
19525896640.88725716590.3020729
19537097570.936810617060.3121364
19547488010.934312517710.3021832
19557888520.925212318360.3122328
19568829720.907520219850.3523018
195790810160.893916521040.4123771
1958111812390.902030023520.3726600
195912221 3410.911240226720.4326173
1960122013220.923043230640.4725880
19619969291.071616931790.5325590
19629248691.063311032800.5225910
196310009621.039615633640.4926640
1964116611211.040522034860.4427736
1965138713101.058437936070.3928670
1966159615341.040732937880.3629805
1967146714231.031225438980.4030814
1968141513291.064122039700.4231915
1969161715861.019131541600.3833225
1970192619550.984845644930.3334432
1971207720930.992351248560.3435620
1972213621530.992152652340.3735854
1973231823320.994256556220.3536652
1974234823580.995761760530.3637369
1975250325540.980172065890.3538168
1976242724860.976270471130.383S834
1977264426800.986574776430.3739377
1978301030101.000088042390.3740152
1979335032211,040294788500.3841024
1980368834281.0757102694890.4142361
1981394135951.096396199930.4143725
1982425838881.09491230106990.4145295
1983473642771.10731430115250.4046436
1984565248581.16341833126290.4048197
1985702055141.27302543139840.4049873
1986785959391.32333020153210.4351282
1987931365441.42323641168470.4252783
19881173872481.61144497185020.4154334
19891317675491.74544138194230.5455329
19901438479371.81224449204450.5656740
19911655785491.93695509217180.5358360
19922022398642.05027855233110.5159432
199324882113542.19151245825532o.5060220
1994333121341 12.483616370282970.5361470
Sources: State Statistical Bureau. People’s Republic of China. and various minislries.
Sources: State Statistical Bureau. People’s Republic of China. and various minislries.
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1See Solow (1957), Denison (1962), Jorgenson, Gallop, and Fraumeni (1987). and. more recently, Young (1995), among numerous others.
2See Christensen, Jorgenson, and Lau (1971 and 1973).
3The complete data set is available from the authors upon request. Various issues of China Statistical Yearbook, Statistical Yearbook of Chinese Industry. Statistical Yearbook of Chinese Agriculture. Population Statistical Yearbook, and Labor Statistics were used to compile the data.
4The agricultural sector broadly covers farming, forestry, fishery and animal husbandry: the transport sector also includes postal and telecommunications services.
5The NI figure for 1994 can be estimated from the reported (INP figure by adjusting for intermediate purchases, depreciation of fixed assets, and the values of all services except transport and post and telecommunications.
6With data for output levels beginning in 1952. data for output growth rales heuin in 1953.
7The term “circulating funds” is adopted from the official translation The original term in Chinese can also be interpreted as “liquid assets.”
8Prices of fixed asset investment were determined by taking the weighted average of prices of machinery and equipment, prices of construction and installation, and other prices.
9Chow’s (1993) estimate of initial capital stock value includes the value of land. The estimate implies a ratio of capital to output of 2.5 in 1978 prices.
10China conducted its lirsl population census in 1954; subsequently, censuses were conducted in 1970. 1982, and, most recently. 1990.
11In 1995. the official working hours for the state sector were first reduced to 44 hours a week and finally fixed at 40 hours a week.
12For a more-detailed description of the Chinese economic reforms, see Bell, Khor, and Kochhar (1993) and Perkins (1988 and 1989).
13In the 1950s, the Chinese economy was predominantly agricultural: the share of agricultural output in national income was 58 percent in 1952. Indeed, if the forced concentration of population in the rural areas is not taken into account, one could argue that China’s official development policies favoring industrialization over agriculture through much of the period were largely successful.
14Focusing on the nonagricultural economy is likely to produce more accurate TFP estimates because land is not included as a separate productive factor for the aggregate economy.
15The sustainability of productivity growth in China has recently been questioned by Woo (1995).
16Recall that Chow (1993) uses a value of Y175 billion (at 1952 prices).
17Their TFP growth estimates are 3.3 percent and 0.8 percent for subperiods 1978-84 and 1984-93, respectively.

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