By Liu Shijin, Xu Wei & and Liu Peilin, DRC Task Force on Analysis of Medium-income Trap

Research Report No.144, 2011

Since reform and opening up, China's economy has maintained a rapid growth for over thirty years. How long could such a rapid growth momentum continue? When and to what degree will the potential economic growth take a downturn? These questions are not only a matter of concern at home and abroad, but they also form an important basis for the formulation of long- and medium-term development strategies and plans. This paper made estimations and forecasts on the time window of the downturn in China's potential economic growth rate with three distinct but mutually corroborating methods and in light of the historical experience and patterns of economic growth in various types of industrialized countries.

I. The Historical Experience of Economic Development in Successful Catch-up Economies and the Stylized Fact it Shows

Since the beginning of the 20th century, except for those countries with global cutting age of technology and at the frontiers of growth, such as the US and the UK, most of the other countries that succeeded in joining the high-income ranks have experienced a rapid growth period lasting for 20 years or more. The end of that period has been followed by a noticeable slowdown of growth and the turn into a growth platform of lower speed. Such a downturn in growth rate and the concomitant structural change have been typified by the post-World War Two development of Japan, South Korea, China's Taiwan and Germany and shown a set of important traits.

1. Economic growth typically begins to take a downturn when per capita GDP reaches about 11,000 international dollars, marking the transition from the rapid growth period to the moderate growth period, with a fall of 30-40%

Japan enjoyed a rapid growth during 27 years after World War Two, with an annual GDP growth rate of 9.4% from 1946 to 1973. In 1973, its per capita GDP was 11,434 international dollars (the benchmark year is 1990¹, the same hereinafter). After that, the growth rate took a downturn, followed by 18 years of moderate growth, with an annual GDP growth of 3.7% from 1974 to 1992. The rate dropped further to 1.1% from 1993 to 2008 (Figure 1). South Korea's annual GDP growth rate was 8% from 1946 to 1995 and took a downturn after 1995, when its per capita GDP reached 11,850 international dollars. From 1996 to 2008, its annual GDP growth rate fell to 4.6% (Figure 2). Taiwan's economy maintained a rapid growth for over thirty years, with an annual per capita GDP of 9,538 international dollars in 1989. From 1990 to 2000, its annual economic growth rate was 6.4%, down about 2.7% from the average rate in the previous three decades (Figure 3). West Germany's annual GDP growth rate was 7.9% from 1947 to 1969, but it took a downturn after 1969, when its per capita GDP was 10,440 international dollars. This was followed by a period of moderate/slow growth from 1970 to 1979, when the annual GDP growth rate fell to 3.1% (Figure 4).

2. The industrial structure undergoes a significant change before and after the downturn in the economic growth rate

During the rapid growth period before the downturn, the proportion of industrial output keeps rising and is maintained at a relatively high level. After the downturn, however, there is usually a decline in the proportion of industrial output and a rise in that of the service industry. The proportion of Japan's industrial added value in its GDP fell to 20% for a time just after the end of World War Two, but it rose rapidly after that and peaked at 46% in 1970; after that, it gradually fell to less than 30% in 2007 (Figure 5). The proportion of South Korea's industrial added value in its GDP was less than 15% at the end of World War Two, but it gradually increased after that and peaked at 42.6% in 1991; after that it took a downturn and fell to 37% by 2007 (Figure 6). The proportion of Taiwan's industrial added value in its GDP was less than 27% in 1961, but it rose to 47.1% by 1986; that was followed by a gradual decline in both the economic growth rate and the proportion of industry, which fell to 41.1% by 1991 (Figure 7). The proportion of former West Germany's industrial added value in GDP peaked at 53% in 1965, but gradually fell after that to 30.2% in 2008 (Figure 8).

3. Urbanization also slows down after the downturn in economic growth rate

Rapid economic growth is accompanied by fast urbanization, which slows down after the former takes a downturn. After World War Two, Japan's urbanization rate increased rapidly, rising from 27.8% in 1945 to 55.4% in 1973, with an annual growth of 0.98%. After 1973, urbanization slowed down, with an annual growth of 0.32% from 1973 to 2008, when urbanization rate was 66.5% (Figure 5). South Korea's urbanization rate increased from 20.9% in 1950 to 78.2% in 1995, with an annual growth of 1.30%. After 1995, urbanization slowed down, with an annual growth of 0.25% from 1995 to 2008, when urbanization rate was 81.5% (Figure 6). Germany's urbanization started from the high level of over 50% even before World War Two. From 1950 to 1969, former West Germany's urbanization rate rose from 52.9% to 72.2%, with an annual growth of 1.02%. The rate remained largely stable since then, being 73.6% in 2008 (Figure 8).

II. Estimating the Time Window of the Moderation of China's Potential Economic Growth Momentum

If China's economic growth follows a course similar to that of the aforementioned successful catch-up economies, its potential growth rate will also take a downturn sometime in the future. This paper made estimations on the time window of such downturn with three distinct yet mutually corroborating methods and in light of the historical experience and patterns of economic growth in various types of industrialized countries.

Method 1: Take China as a single entity and estimations are made with the general data of the national economy and in light of the empirical evidence about the common downturn in the growth rate of successful catch-up economies such as Japan, South Korea, and Taiwan. Converted into 1990 international dollar, China's per capita GDP was 7864 international dollars in 2010. Assuming that China could still maintain its rapid GDP growth in the previous 30 years, based on the UN's forecast of China's population growth, China's per capita GDP will reach 11,608 international dollars in 2016, roughly equivalent to the level at which a common downturn occurred in other successful catch-up economies' economic growth rate. After 2016, in light of the empirical evidence regarding such economies, if China's potential economic growth rate falls by 30% or so from the rapid growth period, its GDP growth rate will drop by about 3 percentage points. Thus the year 2016 is expected to witness the downturn of China's potential economic growth rate, which will occur at the per capita GDP level of about 11,608 international dollars. The annual GDP growth rate is expected to be 9.7% during the 12th Five-Year Plan period and fall to 6.5% during the 13th Five-Year Plan period (official statistics of China).

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