Reforms to Boost Long-Term Growth in the People’s Republic of China

Economic growth in the People’s Republic of China (PRC) moderated in the past decade, even before the onset of the coronavirus disease (COVID-19) pandemic. Potential gross domestic product (GDP) growth in the PRC is expected to average 5.3% in 2020–2025, before gradually declining to 2.0% in 2036–2040. This brief recommends reforms to increase potential GDP growth. These include improving the allocation of capital and credit in the economy, increasing the quality of education, and introducing policy measures to mitigate the adverse impact of demographic aging on the labor force and to lift total factor productivity.


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Reforms to Boost Long-Term Growth in the People's Republic of China

Summary 概要
• Economic growth in the People's Republic of China (PRC) moderated in the past decade, even before the coronavirus disease (COVID-19) pandemic.A critical question is to which level of gross domestic product (GDP) growth the country will return after COVID-19 and what its longterm growth prospects are, given its rapidly aging society, the continued dependence of growth on investment, and a changed international environment.过去十年，中华人民共和国(中国)经济增长有所放缓，甚至早在新型冠状病毒疫情暴发前就出 现了趋缓迹象。鉴于中国社会快速老龄化、增长对投资持续依赖及国际环境发生改变等因素，一 个关键问题浮出水面：中国国内生产总值(GDP)增长在后疫情时代将恢复到何水平？其长期增 长前景又将如何？ • According to Asian Development Bank estimates, the PRC's potential GDP growth could average 5.3% in 2020-2025 before gradually declining to 2.0% in 2036-2040.Capital and total factor productivity (TFP) are the major contributors to future economic growth.Meanwhile, a shrinking working-age population will increasingly weigh on growth, while the contribution of human capital to growth is expected to be comparatively small.据亚洲开发银行估算，2020-2025年间，中国年均潜在GDP增速可达5.3%，随后将逐步降到2036-2040年间的2.0%。资本和全要素生产率是未来经济增长的主要推动力。但劳动年龄人口规模不断减少将使增长进一步承压，预计人力资本对增长的贡献则相对较小。 • This brief suggests a series of reforms to increase potential growth.To address the rapid demographic aging issue, mitigating the impact of a smaller labor force is key.Measures could include raising the retirement age, improving health care, raising female workforce participation rates, and increasing labor mobility by loosening residence permit restrictions.To boost human capital formation, improving the quantity and quality of education, especially in rural areas, is needed to narrow the urban-rural gap in education.Reform should include increasing years of schooling and supporting the children of migrant workers, as well as improving the skills and qualifications of the workforce.
• To improve capital and credit allocation, state-owned enterprise (SOE) reforms are needed.This requires clarifying the scope and function of SOEs, leveling the playing field for the private sector, separating social functions from SOEs, and improving SOE management.Moreover, credit allocation needs to be shifted in favor of the private sector, in particular micro and small businesses.

观察与建议
The implicit guarantees of SOEs need to be removed, while banks must strengthen their credit risk assessment capabilities and increase their operational efficiency.To accelerate structural change from industry to services, more policy support is needed for the service sector and for boosting household consumption.
• To facilitate trade openness, the PRC should continue to engage in and advance international trade and services agreements, and specialize in some industries while allowing room for imports in others.To increase the country's attractiveness to foreign direct investment (FDI) inflows, the negative list for FDI should be shortened and joint venture requirements reduced.Also, the country's research and development effectiveness should be improved to strengthen innovation capacity.为便利贸易开放，中国应持续参与和促成国际贸易服务协定，在深耕部分行业的同时为其他一些 行业预留进口空间。为增强中国对外商直接投资流入的吸引力，应缩减外商投资准入负面清单， 降低合资企业设立要求。同时，应提高国家研究与开发工作的有效性，加强创新能力。

I. INTRODUCTION
1.The People's Republic of China (PRC) had a long stretch of high growth from the end of the 1970s until 2010.In the 2010s, gross domestic product (GDP) growth declined while domestic debt increased sharply over the past decade.An important question is to which level of growth the country can return to after the coronavirus disease (COVID-19) pandemic and, more broadly, how fast the country can grow over the next 1-2 decades.Answers to these questions would be helpful for economic policy-making and social planning.
2. Potential growth is declining.Based on a Cobb-Douglas production function, with all input factors-labor, human capital, capital, and total factor productivity (TFP)-estimated separately, potential growth estimates show that the country's GDP growth will decline notably within this decade without major reforms. 1 Reforms are needed, in particular, to the country's capital and credit allocation, as are policy measures to address the shrinking labor force.Furthermore, TFP growth must be improved.

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Reforms are needed to boost potential growth.This Observations and Suggestions brief suggests reforms to enhance the country's long-term growth potential related to labor, human capital, capital, and TFP.Moreover, this brief provides a discussion of long-term challenges such as demographic aging, the urban-rural gap, improving the capital and credit allocation, and shifting the country's growth model from industry to services.

II. POTENTIAL GROWTH
4. Potential GDP growth is estimated to average 5.3% in 2020-2025 and then to moderate to 3.5% on average in 2026-2030, before declining to 2.7% in 2031-2035 and 2.0% in 2036-2040.5. Capital and TFP are major contributors to potential growth in the long run.The contribution of capital is forecast to gradually decline from 3.4 percentage points on average in 2020-2025 to 1.2 percentage points in 2036-2040.The contribution of TFP to growth is estimated to be smaller in the next 2 decades because of a smaller contribution from the sectoral labor shift and lower returns to research and development (R&D).Despite this, R&D expenditure is expected to be the main driver of TFP growth in 2020-2040.The shrinking of the working-age population will increasingly weigh on growth, while increases in human capital will moderately contribute to growth.

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Actual GDP growth will likely be below potential in the first half of the 2020s.COVID-19 has weighed on economic growth in recent years and continues to have some adverse impact on the economy in early 2023.In addition, an ailing property market dragged down GDP growth, especially in 2022.Reforms boosting potential GDP growth could help increase medium-term growth.

III. POLICY CHALLENGES AND REFORMS TO BOOST LONG-TERM GROWTH
7. Demographic aging is an issue that must be addressed.Demographics have turned to headwinds as the working-age population started to shrink and birth rates have declined.Without reforms, demographics will increasingly weigh on economic growth in the future.Reforms should focus on mitigating the impact of demographic aging on the labor force.The following policy measures are proposed: (i) Extend work life.Raising the legal retirement age is unpopular, but gradually increasing it is necessary given the rapid aging of society and rising life expectancy.Moreover, it is important that people remain longer in the workforce.To this end, reforms should focus on raising the labor participation of the workforce in its mid-50s.
(ii) Improve health conditions of the workforce.To cope with an aging workforce, reforms should focus on a safe and secure working environment, occupational health services, and occupational disease prevention.Efforts are needed to scale up screening, early diagnosis, and controlling chronic conditions, as well as detecting cognitive impairment and depression at the primary care level.
(iii) Raise female workforce participation.To address the declining female workforce participation rate, possible measures include strengthening equal employment opportunities; increasing maternity leave; and improving support for childcare, elderly care, and single mothers.
(iv) Increase labor mobility.To better allocate the shrinking workforce, measures could include further relaxing the household registration system (hukou), improving access to social services for labor migrants (including access to education for their children), and ensuring the portability of social security benefits so that people do not have substantial disadvantages when moving.
(v) Increase family support.Policy priorities and resources should be given to support families in order to increase the birth rate.
8. Improving the quantity and quality of education can raise human capital.Despite significant improvement in educational attainment levels over the past decades, there is still a gap between the PRC and advanced economies.Moreover, better education would also contribute to higher potential growth as it would raise the productivity of the workforce.Policy recommendations include: (i) Increase years of schooling and the quality of rural education.The disparity in years of schooling between rural and urban areas in the PRC is significant.Greater efforts are needed to increase upper secondary school attainment in rural areas to enable higher tertiary educational attainment.Also, the urban-rural gap-not only in quantity but also in the quality of education-puts a burden on human capital formation and requires attention by policymakers.More funding from the central government should be allocated to rural 9. State-owned enterprise reforms are needed.To avoid a loss in business dynamism in the economy, continuously loss-making SOEs would need to exit the market.Also, the scope and functions of remaining SOEs need to be clarified, and reforms must aim at improving SOEs' performance.When undertaking SOE reforms, redundant workers would need temporary financial support and help to find and be qualified for new jobs, which might require retraining.SOE reforms must take into account these four aspects: (i) Clarify SOEs' scope and function.The areas in which the government wants to retain SOEs should be small and well-specified.Competition should be strengthened by making market entry easier for private companies in the other areas, while monopolies should be kept to a minimum.
(ii) Level the playing field.While currently SOEs have a privileged access to capital and land, there should over time be a level playing field for the private sector to compete with SOEs, in particular in terms of access to land and credit.
(iii) Separate social functions from SOEs.Currently, SOEs also perform social functions such as stabilizing employment and providing social services that in other countries often fall into the category of basic public service.Social functions should be separated from SOEs to increase their competitiveness and better realize economies of scale and scope.
(iv) Improve SOE management.The return of assets in industry is below that of their private peers and about a quarter of industrial SOEs are loss-making.The management and supervision of SOEs must be strengthened to raise their efficiency.
10. Credit will need to be increasingly allocated to the private sector.Micro businesses and small enterprises would need easier access to bank credit.Banks would need to shift their lending preferences, which requires moving away from implicit guarantees for SOEs and their privileged access to credit.Also, the banking sector will need to develop further and improve its credit risk assessment capabilities to serve small enterprises better.Reforms to raise capital efficiency entail the following: (i) Strengthen equity and bond financing.The share of equity financing has stayed very low, while bond financing has only increased moderately over time.Equity financing and bond issuance should be encouraged as a way of corporate financing, especially for larger companies, while reining in of shadow bank financing should continue.

观察与建议
(ii) Strengthen lending to micro and small enterprises.Hit hard by the adverse impact of the COVID-19 pandemic, micro businesses and small companies need financing support.
The share of business loans to these companies should be increased.As micro and small enterprises are frequently privately owned, more credit would flow to the private sector.
(iii) Move to longer-term financing.A high share of short-term loans potentially leads to high transaction costs.Therefore, banks should concentrate on improving their ability to assess credit risks to enable them to provide long-term loans, while monitoring risks.
(iv) Improve banks' efficiency.Lowering household deposit rates will likely not be a solution for the falling net interest margins of banks but could spur another round of property investment.Improving banks' (operational) efficiency is a better option.
11. Growth should be increasingly driven by domestic consumption.With a declining share of industry and a rising share of services in the economy, growth should be driven less by investment and more by domestic consumption.Since the shift to services has lost dynamism in recent years, policies should increasingly focus on the service sector to facilitate structural change.Developing the domestic service sector would require boosting household demand.To this end, basic public services and social security need to be strengthened and income inequality addressed to reduce the need for precautionary savings.
12. Measures are needed to boost TFP productivity, which has declined over time.As TFP growth benefits from imports, FDI, and R&D, policies to increase trade openness, reduce restrictions on FDI, and improve the quality of R&D can help lift TFP.Specifically, the following reforms can be recommended: (i) New trade and investment agreements.The PRC's commitments in the context of new trade and investment agreements can help increase openness and could also facilitate domestic reforms.The PRC economy could specialize in a number of areas while sourcing globally in others-an approach practiced by most advanced economies.This approach leaves room for imports into the PRC.
(ii) Loosen restrictions on FDI to potentially increase FDI inflow by substantially revising and shortening the negative list for FDI.Also, joint venture requirements that potentially hold back investors should be reduced.
(iii) Improve R&D efficiency.One challenge for the PRC's R&D policy is the misallocation of funds.Also, the expenditure of R&D on basic research as a percentage of GDP has remained low in the PRC.Therefore, improving the allocation of R&D funds and investing more in basic research, especially on the enterprise level, are key to improving R&D efficiency.

推动中华人民共和国长期增长的改革
(iv) Strengthen intellectual property (IP) rights protection.It is key to improving companies' incentives to invest in basic research and innovation.IP protection standards need to be unified across the country by establishing an IP rights protection regime in line with international best practices.Besides helping raise the quality of patents, this would be a step toward increasing companies' incentives to pursue innovative ideas instead of only gradually improving existing products.

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For details see D. Peschel and W. Liu.2022.The Long-Term Growth Prospects of the People's Republic of China.ADB East Asia Working Paper Series, No. 54.Manila: Asian Development Bank.
Reforms to Boost Long-Term Growth in the People's Republic of China 推动中华人民共和国长期增长的改革 education and children of migrant workers should get more support from the government to get easier access to education in cities. (ii) Improve the quality and relevance of education and qualification of the workforce.The PRC has room to catch up with advanced economies in terms of quality of education.Measures include expanding early child development, improving the quality of tertiary education, strengthening technical and vocational education and training, and increasing on-the-job and lifelong training opportunities.