China’s Economic Development in the New Era: Challenges and Paths

2.1 Challenges to Be Addressed in the Next Few Decades

2.2 A New Growth Model for the Future of China

China’s new growth story in the medium to long term should be: (1) Sustainable, which means offering the next generation opportunities at least as good as those available to the current generation; (2) Inclusive, addressing emerging challenges, promoting innovations and creating opportunities for all; (3) Low-carbon, which requires actions on climate change, targeting a net-zero-carbon economy within several decades; (4) Market-oriented, offering a fair and transparent investment climate for the private sector.

3.1 Factors Causing Old Approaches to Cease

The old era or approach to development is coming to an end for a number of reasons. Threats to natural, social and human capital are being reflected in: pressures on the environment; social strains, including inequality; changing technologies and the need for new skills; and the demographic challenges of an ageing population. China faces further associated challenges that come with the country’s elevation through middle-income and towards higher-income status. These include: rising wages, a shift to a service economy, changing world economic geography and interactions, and pressures on public finances.

The pressures on the environment are both local and global in origin. We know that strong global action is urgently needed to stop environmental degradation, and that China, because of the size of its economy and greenhouse gas emissions, must be a central player in climate action in particular. The world economy will double in size in the next two decades or so and within that China’s economy will more than double (Hawksworth et al., 2017). In the same period, global emissions will have to be cut by at least 25 percent if the world is to have a reasonable chance of meeting the Paris Agreement target of limiting temperature rise to well below 2°C (see Figure 1). World infrastructure will likely double in around 15 years, much of it associated with urban expansion and a large part of that in China (New Climate Economy, 2016). If this new additional world economy or infrastructure looks anything like the old, then cutting emissions absolutely by more than 25 percent will be impossible, hence the need for radical and urgent change. Change of this nature and scale requires decisive action and strong leadership but the new path can be a very attractive story, with strong, sustainable and inclusive growth.

Figure 1

China’s Carbon Dioxide Emissions (million tonnes) from Fuel Combustion, 1980–2016 Source: Authors using data from the International Energy Agency.

Inequality has been a pressing concern in China for some time: between urban and rural areas; regionally, including in areas with declining industries; and between individuals. In the early stages of reform some rise in inequality was inevitable; as Deng Xiao ping observed, some people get richer before others. But over the past two decades or so, inequality has become more troubling.

China’s wages have risen as its economy has advanced, strong investment has taken place and its workers have become more skilled. All this is part of China’s success but it also requires new strategies for the future. The era of China being the dominant world force in low-cost manufacturing is coming to a close, at least in low value-added manufacturing. Future technological change, with artificial intelligence and robotics in particular, is likely to transform investment, work, consumption and the functioning of cities.

China’s demography is changing strongly. Looking ahead, the ageing population is likely to build up pressures on public finances and health systems. Pressures on public finances will also arise in relation to cities and their ability to raise revenues to finance local infrastructure.

The world’s economic geography has changed and will continue to do so, as emerging market and developing countries have grown, and will grow, faster than richer ones. This implies that international trading patterns will change, with much more trade among emerging market and developing countries. This, in turn, requires stronger infrastructure linking those countries—which is the basic logic behind the Belt and Road Initiative.

The increasing strength of the emerging market and developing countries is sometimes met by negative reaction from some richer countries. Such reactions are short-sighted and damaging to the world economy as a whole, and it must be hoped that they are temporary. Nevertheless, they reinforce arguments for stronger links among emerging market and developing countries and for looking to stronger internal demand.

3.2 The Reformulation of Objectives

The above description of the recent phases of development, and of a changing world, points us towards our second question, concerning a re-examination of objectives in light of these experiences. The pressures on natural capital and social capital we have described imply that both fostering a better environment and managing inequality and social cohesion should appear strongly in societal objectives. A rapidly changing world, the potential dislocation arising from new technologies, and pressures from an ageing population all point to the importance of social security. And all of these lead us to the centrality of sustainability in objectives.

As we describe the way in which these concerns have arisen from experience and as we think about future changes, we recognise that we have made powerful arguments for looking beyond output or income as the overwhelming objective. The recognition that output is inadequate as the dominant objective is, of course, longstanding in China and elsewhere. However, the experience of the past few decades has led us to be much more multi-dimensional, explicit and analytical about the expression of objectives. Sometimes this has been summarised under the heading of “wellbeing”. Though useful, this term is insufficient by itself, partly because it focuses on outcomes rather than opportunities. For many, including, for example, Amartya Sen, both outcomes and opportunities should be of concern. Sen speaks of “capabilities” and the ability to pursue a life you have reason to value (Sen, 1999). Others have provided analyses in terms of “empowerment” (for example, Stern et al., 2005). The UN Sustainable Development Goals (SDGs) emerged from these kinds of discussions and do capture the key dimensions associated with the environment, inequalities and opportunities. The SDGs include the functioning of cities, infrastructure, the state of oceans, climate, forests, opportunities for rewarding employment and challenges of insecurity; they are a valuable framework for thinking about and setting societal objectives.

3.3 Strategies for the New Era

Answers to our third question on the key characteristics of strategies for the new era follow naturally from our discussions of the factors bringing the old era to an end. The strategy must embrace the challenges and opportunities of new technologies, changing economic geography and sustainability. And it must tackle the challenges of its public finances—China has strong spending needs associated with urbanization, infrastructure, education and health—and of social security and changing demography. In summary, selective investment and innovation in all forms of capital, human, physical, natural and social, should be the central objectives.

On technological and sectoral change, it is clear that China must now shift its balance towards more advanced technologies and the provision of knowledge-led services. This follows from rising wages, the rapid technological changes that are coming through, and demand patterns that are moving, as incomes rise, towards services. Shifting the balance in this way will involve strong investment in R&D and innovation, and in skills appropriate to this new era. It will also require management of declining industries and locations.

Wu (2000) examined the contribution of total factor productivity (TFP) to China’s economic growth and broke down the TFP growth into two components: technological progress and efficiency change. Wu suggested that China’s economic growth in the 1980s was mainly due to efficiency improvement and growth in inputs. However, technological progress has become an important factor propelling China’s economic growth since the 1990s. Chen and Golley (2014) estimated the changing patterns of “green” total factor productivity growth (GTFP), which incorporates carbon dioxide emissions as an undesirable output, and found that R&D intensity was the one factor that impacted in a highly significant and positive way, increasing both GTFP and TFP growth in China between 1980 and 2010.

The speed of technological change and a slowing in the overall growth rate imply that changing the composition of the economy can no longer occur simply through some sectors growing more rapidly than others: some sectors and places will decline in the coming years. Such transitions need to be well managed to ensure social cohesion and economic justice. There are many ways to achieve this, involving training, targeted finance, appropriate location of government activities (e.g. in areas affected by contracting industry), and provision of adequate social protection.

The changing pattern of activities within China—crudely speaking, “moving up the value chain”—will require changing the relationship between China and its trading partners. Income per capita and wages in the countries of the BRI are on average approximately half those of China. If trade and infrastructure links can be established, and technologies advanced and shared with these countries, then the countries of the BRI could play a powerful and positive role in the development of a new and changing international division of labour. This is analogous to the driver of change in China in the 1970s to 1990s being, in large measure, China advancing into the world economy through low-cost manufacturing and joint ventures. To some extent, China with its more advanced technologies will now play the role of an external partner to poorer countries.

Climate Action Tracker (2019) suggests that total greenhouse gas emissions have to reach net-zero by 2070 if the world is to have a reasonable chance of achieving the Paris Agreement targets. Carbon dioxide emissions have to reach net-zero earlier, around 2050, as suggested by the IPCC (2018). As we have already described, because of the size of China’s economy and emissions, China must also be close to zero-carbon for the world as a whole to meet this goal. Figure 1 shows that China’s carbon dioxide emissions appear to be plateauing, as a result of its past strong and impressive efforts towards efficiency and away from fossil fuels, and should start to decrease. China’s nationally determined contribution to the Paris Agreement involves peaking emissions by 2030. However, it is clear from the world aggregate requirements that if the Paris temperature targets are to be within reach, global emissions must fall by more than 25 percent in the next 20 years (UNEP, 2016). This cannot conceivably happen unless China’s emissions peak and start to fall strongly in the years from now.

The changes to investment required to achieve a strong fall in emissions, particularly changes to sustainable infrastructure investment, are discussed in more detail by our follow-up paper (Stern et al., 2020). If carried out well, the investments, innovations and reforms could yield a sustainable and inclusive growth path that could be very attractive. The public finances and demographic elements of the plan will be of great importance and we touch on these briefly in Section 4.

4.1 Innovation and Investment for the 14th Five-Year Plan

Many economists provide theoretical background that justifies intervention when there are clear market failures (Nelson, 1959; Arrow, 1962; Krugman, 1987; Romer, 1990; Grossman and Helpman, 1991). Because private enterprises cannot fully recoup their investment in R&D that is intended for public value, the private market lacks the incentive to invest in these areas, and there is little active role for public financing of innovation. As a result, it is important to identify the areas that policymakers should give particular attention.The key areas for investment and innovation in China will be: (1) New technologies that can give high-quality growth; (2) Modern service sectors, including health, education, transport, communications and IT, finance, and logistics; (3) The functioning of modern cities, including in their infrastructure and in relation to pollution, congestion and efficiency; (4) Food and land-use systems.

In the new era, overall resource productivity and efficiency will be crucial and there is real potential in the idea of the circular economy with its emphasis on design for reuse and recycling. Resource efficiency and productivity are not only powerful forces for growth but also crucial elements for the protection of natural and human capital.

Investment in the four key capitals—human, social, physical and natural-must move to centre stage in the 14th Five-Year Plan, as a natural evolution of the direction that China has taken in recent years. China has already begun to embrace an approach to growth and development that embodies a focus on the quality and quantity of these four types of capital, as it reflects on its experience and deepens its understanding of wellbeing. Recent years have also seen increasing emphasis on, and growing understanding of, the close connections between these different capitals.

4.2 Policy Measures for the 14th Five-Year Plan

Policy will need to be designed to further strengthen the role of the market in the allocation of resources. For markets to work well in guiding investment and innovation, governments must analyse and act on market failures. Key areas of potential intervention for the Chinese government, which would support innovation and strong and sustainable investment, include: (1) Greenhouse gas emissions and pollution; (2) Under-provision of R&D; (3) Capital market failures; (4) Network externalities in grids, public transport, broadband/ICT; (5) Information on opportunities, including technologies, in a changing world.

4.3 Lessons for BRI Countries and the World

One final point on overall strategy involves China’s lessons for the world. The reform period of the past four decades has brought remarkable success in raising incomes and reducing poverty. It is unique in human history. But it has also brought stresses and problems. If China had been able to look ahead more clearly to the problems of congested and polluted cities, it might have made policy and investments differently.

Many of the BRI countries are now where China was two decades ago in terms of income per capita. If in two decades’ time they have similar income per capita to China now, and if their economic structure of fossil fuel use looks like China’s now, the world would be headed for temperature increases well beyond 3°C and the catastrophic consequences that would involve. The 126 BRI countries (as of April 2019) ^[1] excluding China together accounted for 28 percent of global emissions in 2015. However, this share could grow to 66 percent by 2050 if BRI countries maintain growth trajectories while the rest of the world follows a 2^oC mitigation pathway (Ma et al., 2019).

Given China’s role in the BRI, it has a real and vital opportunity to help these countries move towards a much more sustainable, more efficient and greener form of development. China can share its experience and lessons, employ its technological and financial strengths, and help invest beyond its borders in the new models of growth and development, to the great benefit of all.

All this emphasises very strongly that the 14th Five-Year Plan and the BRI have to be understood together. Of course, China can and will shape the 14th Five-Year Plan directly but it does not determine the development strategies of these countries or other countries that may become part of the BRI in the future. Each country will shape and decide on its own strategy, but China can be a source of guidance and investment as well as a supportive partner. This is an interesting and important feature of the new era. China must work on its 14th Five-Year Plan and take its decisions with careful thought over how its BRI partners will be taking theirs, and what forms the partnerships will take.

5.1 Price, Regulation and Enterprise Reform

Rapid and efficient change towards growth that embodies high quality, high-tech, service-orientated sustainability will require clear price signals. If private sector investment and innovation are to be fostered within a strong and sound investment climate, then both price signals and regulation should take account of the potential market failures discussed earlier.

An example would be a strong carbon price, and thus it is important to make sure the new carbon markets work well. This could include possible consideration of carbon price floors and carbon taxes. But carbon prices do not by themselves redesign cities, reduce congestion or promote compactness. Nor do they by themselves ensure that products, systems and buildings are designed in a way that the components can be re-used or recycled. These key features will require direct public action for the design and reform of cities, including regulation and standards. Further, reform is also likely required for state-owned enterprises so that they are not sites of inefficiency or kept alive artificially when their activities or methods of work are obsolete. China will be dependent on creativity and entrepreneurship in the new era and a clear, sound, transparent and supportive investment climate is crucial.

5.2 Financing Investment in the Four Forms of Capital

Investment in all four forms of capital will require a combination of private and public finances. The nature and combination of these finances will be a vital part of systemic reform and will range from bank loans, angel investments and crowd-funding for small enterprises, to capital markets for major private sector firms to raise debt and equity finance, and to large-scale finance, including development banks, for large-scale infrastructure projects. Sustainability and green finance can be an important part of the story. So too will be major mortgage, insurance and pension institutions as Chinese individuals and households buy houses and plan for old age.

Transparency, sound banking standards and regulation of individual institutions and the system as a whole will be of increasing importance in the financial sector. As the sophistication of the economy and financial system grows, the danger of financial crises increases. Crises cannot be wholly avoided but their probability, intensity and impact can be reduced by sound investment decisions, coherent policy and strong institutions. Investment, and especially overinvestment, in unproductive infrastructure carries severe risks to economic and financial stability. This can be alleviated by careful assessment of infrastructure costs, their financing structure and the actual benefits they generate. Sound, sustainable investment criteria can be strengthened and their use mandated. Their widespread application could help avoid the problem of “building more” instead of “building right”. Wise regulation is of great importance, for both avoiding the problems of excessive risk-taking and of the potential distortions and risk of directed credit.

5.3 Public Finances and the Functioning of Cities

Public finances can also be a source of instability and crisis. China has managed the national public finances responsibly over the years but serious problems could emerge, and arguably have emerged, at lower levels, particularly in cities. Cities will be the focus of most of the investments, particularly infrastructure investments, of the new era. They are home to the majority of the population and account for the big majority of output, pollution and greenhouse gas emissions and their relative importance will grow. How cities are managed in physical, human, social, environmental and financial terms will therefore be critical to China’s future.

For cities to create a stable investment climate and to carry through the infrastructure and other investments necessary to function in a clean, efficient and sustainable way, their public finances must be managed well. To do this they will need strong revenue streams from local taxation and payments for services. Local taxation can take a number of forms, including taxation of land and property, pollution or carbon taxes, local additions to income tax and so on. It is important that these taxation powers are clear and well-executed, and are not contradictory or confusing relative to taxation by national authorities. Transparency and efficiency of local taxation, as well as expenditures, will be crucial to the delivery of the next stages of China’s development.

It is also important that the design, taxation and infrastructure of cities foster compactness. At present, China’s cities are sprawling, creating severe problems of congestion, pollution and waste (NCE, 2018).

5.4 Internal Governance

The functioning of cities constitutes a major part of the investment climate but good governance, particularly in relation to investment, goes beyond cities. Private investment is at the heart of the growth model of the new era and it is very sensitive to the quality of governance, as well as the quality of infrastructure services. The quality of governance has a profound influence on how easy it is to get things done and the confidence of the investor in the returns to investment.

We identify three elements of the quality of governance in relation to investment: the soundness of policies, the predictability of policies, and the functioning and behaviour of institutions. We have already discussed above the meaning of sound policy in the new era, particularly as regards getting markets to give better signals, by overcoming market failures. Predictability reduces government-induced policy risk. Such risk is a major deterrent to investment round the world. We do, of course, learn over time about new possibilities, new evidence appears, experience teaches lessons, thus policy cannot be set in stone. But if investor uncertainty is to be managed, the criteria for policy change must be understood and, as far as possible, be set out in advance. Government policy should be “predictably flexible”.

Another source of both cost and uncertainty in China lies in the functioning and behaviours of institutions. Sometimes institutions and officials can be bureaucratically heavy or obstructive; sometimes they are corrupt. The more licences and permissions that are required, the greater the likelihood that these problems or obstacles can arise. In creating a good investment climate, it is important that bad or unnecessary intervention is reduced. That does not mean, of course, abandoning regulation and standards, for example on pollution or safety. The argument here is that government should focus on the important and make the application of the regulation and standards as user-friendly as possible.

5.5 Management of Radical Change and Dislocation

Major change inevitably involves some dislocation. Such issues arise more strongly now that China is an established producer in many sectors. Some of these sectors will contract in the future, such as coal-mining, steel and some of low-cost manufacturing. The impact might be particularly large in specific geographical locations. This type of change, if badly managed, can damage social cohesion and create lack of hope or a sense of injustice.

There are a number of actions that both central and local governments can take. Key elements include: training and retraining, support and finance for local entrepreneurship, moving mobile government activities to the affected localities, help for workers in relocating, and social safety nets. Local dialogue (i.e. involving stakeholders including citizens locally) can contribute strongly to the effective working of these policies.

Certainly, the changing nature of technologies and of the world economy will involve some future dislocations. We can be sure that financial shocks will occur round the world and probably in China too. Rich countries have managed these kinds of changes badly on the whole, and the political consequences have been very damaging. China can learn from their mistakes.

5.6 Global Governance

As the world’s largest economy (in purchasing power parity terms), China is already a major influence on the world stage (even though its per capita income is still considerably lower than many rich countries’). China not only acts on the world stage, inevitably, it also shapes that stage. What happens to world trade and investment, to the global commons and to the future of the international financial institutions is of vital importance for China and the world. On all these, the world as a whole, including China, will benefit greatly from a well-functioning, rules-based and equitable world order.

On trade and investment, the extraordinary growth and development of the past 70 years globally has demonstrated the great benefits of collaborative and open international systems. Since such systems began to be created in the late 1940s, global output per head has gone up by a factor of four and global life expectancy at birth has increased by around 30 years, from around 40 to 70 years. This has been a unique period for development in world history.

It is vital that these international systems are maintained and enhanced (see, for example, Stern, 2018) and China has a crucial role to play here. Moving from a world with one dominant power, the United States, to a bipolar world with the United States and China in tension or antagonism would be damaging. It is unsurprising, therefore, that we see public discussion of the Thucydides Trap ^[1] (see, for example, Allison, 2017). An open and international order with all countries participating will be much more productive than a system dominated by quarrelling between two major powers. An open, rules-based order would allow the world to tackle much more effectively the new problems of the 21st century while continuing to lift people out of poverty. Working on further opening of trade within the World Trade Organization and supporting the UN organisations are vital.

The challenges of the global commons, particularly climate change, are of great urgency, as we have argued. China played a leading role in creating the Paris Agreement, at COP21, in 2015. China has begun to stabilise its carbon emissions and has committed to peak its emissions around 2030 or earlier. At the 2019 UN Climate Action Summit, China’s Ministry of Ecology and Environment (MEE) released a review on the effect of policies addressing climate change and strengthened China’s position on reducing emissions (MEE, 2019). It will likely begin to reduce them under the 14th Five-Year Plan. China is now, inevitably, in the vanguard of action and international collaboration on climate change and this presents it with great opportunities, not only in terms of its own new model of growth and its technological advances but also in terms of global leadership.

Finally, the world’s international institutions—the United Nations, the International Monetary Fund, the World Bank, the regional development banks, the WTO and so on—will increasingly look to China for leadership. China’s role in the G20 will be crucial—it exemplified this through its Presidency in 2015 and the Hangzhou Summit. As the report of the G20 Eminent Persons Group argued, the IMF is in urgent need of more resources if future financial crises are to be better managed and their frequency is to be reduced (G20 Eminent Persons Group on Financial Governance, 2018). The multilateral development banks (MDBs) could be still more effective if they functioned better as a group. That would involve the creation of country platforms for better coordination of action in support of a country’s development programme. China, which is increasingly important as a supporter of development in other countries, could play an important role here. It would also involve countries and MDBs working together for the management of risk to get stronger multipliers for private investment. And it would involve bringing sustainable infrastructure to the core of all the work of the MDBs.

This brief discussion of systemic reforms has covered: policy and sustainable infrastructure to create an investment climate to foster private sector innovation and investment; strengthening the financial system for strong, productive and stable financing; better functioning cities, including their public finances; local governance and global governance. Together, these systemic reforms could generate the investments in physical, human, national and social capital which will drive forward China’s new era of high-quality, sustainable and inclusive growth and development.