Morningstar Magazine - December 2017/January 2018 - 43

EXHIBIT 1

Why Has Growth Slowed?
China's economy has slowed markedly this decade.
But the extent of the slowdown is debatable.
Government statistics portray a gradual decline-
an apparent soft landing for what had been the
world's highest-flying economy. By contrast, most
independent estimates, such as those from
economist Harry X. Wu,3 suggest a bumpy descent
punctuated by periodic bursts of stimulus.

Few expect a return to high-single-digit growth
in the years to come, much less the double-digit
pace of the prior decade. But many believe
growth is unlikely to slow much further from the
prevailing rate (6.8% in the third quarter of 2017).
The International Monetary Fund envisions
China's GDP growth averaging 6.1% through 2022.
Most sell-side analysts expect something
similar, although a minority express a more bearish
view. We forecast average annual GDP growth
of slightly less than 4% through 2026.
In pondering the long-term trajectory of China's
economy, it's instructive to first consider the
underlying sources of the country's slowdown.
We start with a breakdown of GDP into its
constituent parts. At the most basic level, a
country's economic output is the product of three
inputs: capital, labor, and productivity. An economy
grows by accumulating capital (for example,
a new factory is built), adding labor (the factory
hires unemployed workers), and increasing
productivity (the factory adopts a new technology).
We can use this standard framework (specifically,
a Cobb-Douglas production function) to estimate
the contributions of capital, labor, and productivity
to China's GDP growth. To identify secular shifts
in China's growth pattern, we focus on average
annual growth rates for each of the past three
decades (1991-2000, 2001-10, and 2011-16) rather
than year-by-year estimates ( E X H I BI T 1 ).
Faltering productivity appears to explain much
of the economy's recent deceleration. We estimate
average productivity growth at 2.3% in the
current decade, down from 4.8% in the 2000s.

Why Growth Has Slowed Faltering
productivity is largely to blame for the
secular slowdown in China's growth.
Total Factor Productivity
Capital
Labor
0.6

0.3

5.0

5.5

Growth GDP
12.0%
0.2

8.0

5.2
4.9

4.0

4.8
2.3

1991-2000

2001-2010

0.0

2011-2016

Source: National Bureau of Statistics, Ministry of Human Resources,
CEIC, Morningstar.

Weaker productivity gains account for roughly
three fourths of the total decline in GDP growth
over this interval (2.4 percentage points of
the 2.9-percentage-point reduction in GDP growth).
And it's possible the narrative is a bit darker
than it might otherwise appear. That's because our
productivity growth estimates rely on official
GDP figures. To the extent government statistics
overstate China's GDP growth, they may
also understate the degree to which productivity
growth has fallen. Using unofficial GDP figures,
recent productivity growth has been meaningfully
lower, possibly negative.4
In contrast with the slowdown in productivity
growth, the contribution from capital accumulation
has remained elevated. Net additions to
China's capital stock have contributed 5.2% to GDP,
on average, in the current decade, down only
slightly from 5.5% in the 2000s.
The economy has become increasingly dependent
on capital accumulation as a source of growth.
Since 2010, net capital additions have accounted
for nearly 70% of GDP growth, up from roughly
half in the prior two decades.

This is a natural consequence of the government's
desire to prop up growth. Whereas Beijing
cannot easily boost productivity or the labor supply
in the near term, it has considerable influence
over the rate of capital accumulation.
The government's decision to keep capital
spending elevated despite a shrinking set
of high-return projects is a big reason productivity
growth has faltered. More importantly, because
each round of stimulus delivers yet another
blow to productivity, Beijing is likely to find it more
difficult to engineer the desired GDP growth rate.
While the contribution from labor supply growth
has slipped in the current decade, the decline
has played little direct role in slowing overall GDP
growth. As discussed in our first article,
changes in labor supply will continue to have
a larger impact on the composition of GDP
than on its size-shifting income to households
from corporations and lifting consumption at the
expense of savings and investment.
Why Has Productivity Growth Faltered?
Why is China finding productivity gains harder
to come by? Mainly because four conditions
that made rapid productivity growth possible in the
post-Mao era no longer exist.

The Imitator Must Become an Innovator
First, China is no longer a technologically
"backward" country that can generate easy
productivity gains by copying more sophisticated
foreigners. Arguably, no major country has
capitalized on the opportunity afforded
copycats as well as China. Rapid absorption of
foreign technology is evident in the growth of the
country's manufacturing sector. Since 1990,
Chinese manufacturing exports have grown at
a 15% compound annual rate and are now 50 times
larger in nominal U.S. dollar terms. By 2015, China
accounted for 19% of global manufacturing exports,
up from 5% in 2000 and 2% in 1990. China's
success as an imitator is attributable to four
factors: fortunate timing, an ideal location, strong
government support, and a vast domestic market.

3 Wu, H.X. 2014. "China's Growth and Productivity Performance Debate Revisited-Accounting for China's Sources of Growth with a New Data Set," The Conference Board, January.
4 Ibid.

global.morningstar.com/Morningstarmagazine

http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018