understanding china’s growth

8/11/2019 Understanding Chinas Growth

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Journal of Economic PerspectivesVolume 26, Number 4Fall 2012Pages 103124

T he pace and scale of Chinas economic transformation have no historicalhe pace and scale of Chinas economic transformation have no historicalprecedent. In 1978, China was one of the poorest countries in the world.precedent. In 1978, China was one of the poorest countries in the world.The real per capita GDP in China was only one-fortieth of the U.S. levelThe real per capita GDP in China was only one-fortieth of the U.S. leveland one-tenth the Brazilian level. Since then, Chinas real per capita GDP hasand one-tenth the Brazilian level. Since then, Chinas real per capita GDP hasgrown at an average rate exceeding 8 percent per year. As a result, Chinas real pergrown at an average rate exceeding 8 percent per year. As a result, Chinas real percapita GDP is now almost one- fth the U.S. level and at the same level as Brazil.capita GDP is now almost one- fth the U.S. level and at the same level as Brazil.This rapid and sustained improvement in average living standard has occurred in aThis rapid and sustained improvement in average living standard has occurred in acountry with more than 20 percent of the worlds population so that China is nowcountry with more than 20 percent of the worlds population so that China is nowthe second-largest economy in the world.the second-largest economy in the world.

To set the stage in this paper, I will begin by discussing brie y Chinas historicalTo set the stage in this paper, I will begin by discussing brie y Chinas historicalgrowth performance: that is, how China went from the worlds leading economicgrowth performance: that is, how China went from the worlds leading economicpower about 900 years ago to a situation in which it essentially missed the Indus-power about 900 years ago to a situation in which it essentially missed the Indus-trial Revolution and had close-to-zero growth in per capita GDP from 1800 to 1950.trial Revolution and had close-to-zero growth in per capita GDP from 1800 to 1950.I then present growth accounting results for the period from 1952 to 1978 and theI then present growth accounting results for the period from 1952 to 1978 and theperiod since 1978, using as my starting point a standard growth accounting exerciseperiod since 1978, using as my starting point a standard growth accounting exercise

that decomposes the sources of growth into capital deepening, labor deepening,that decomposes the sources of growth into capital deepening, labor deepening,and productivity growth. For the period from 1952 to 1978, Chinas per capita GDPand productivity growth. For the period from 1952 to 1978, Chinas per capita GDPdid rise by about 3 percent per year, but all of the growth was due to forced increasesdid rise by about 3 percent per year, but all of the growth was due to forced increasesin government investment as well as a rise in education levels. Productivity actu-in government investment as well as a rise in education levels. Productivity actu-ally regressed during this period, as Chinas economy went through the enormousally regressed during this period, as Chinas economy went through the enormousdisruptions of the famine in the late 1950s and the Cultural Revolution startingdisruptions of the famine in the late 1950s and the Cultural Revolution startingin the late 1960s. But the main focus of this paper will be to examine the sourcesin the late 1960s. But the main focus of this paper will be to examine the sourcesof growth since 1978, the year when China started economic reform. Perhapsof growth since 1978, the year when China started economic reform. Perhaps

Understanding Chinas Growth: Past,Present, and Future

Xiaodong Zhu is Professor of Economics, University of Toronto, Toronto, Ontario, Canada.His email address is [email protected]://dx.doi.org/10.1257/jep.26.4.103. doi=10.1257/jep.26.4.103

Xiaodong Zhu


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104 Journal of Economic Perspectives

surprisingly, given Chinas well-documented sky-high rates of saving and investment,surprisingly, given Chinas well-documented sky-high rates of saving and investment,I will argue that Chinas rapid growth over the last three decades has been drivenI will argue that Chinas rapid growth over the last three decades has been drivenby productivity growth rather than by capital investment. The growth contributionsby productivity growth rather than by capital investment. The growth contributionsmade by human capital accumulation and an increase in labor participation aremade by human capital accumulation and an increase in labor participation arepositive but modest. I will also examine the contributions of sector-level productivitypositive but modest. I will also examine the contributions of sector-level productivitygrowth, and of resource reallocation across sectors and across rms within a sector,growth, and of resource reallocation across sectors and across rms within a sector,to aggregate productivity growth. Overall, gradual and persistent institutionalto aggregate productivity growth. Overall, gradual and persistent institutionalchange and policy reforms that have reduced distortions and improved economicchange and policy reforms that have reduced distortions and improved economicincentives are the main reasons for the productivity growth.incentives are the main reasons for the productivity growth.

Despite the rapid growth of the last three decades, Chinas productivity is stillDespite the rapid growth of the last three decades, Chinas productivity is stillonly 13 percent of the U.S. level, which suggests that China still has plenty of roomonly 13 percent of the U.S. level, which suggests that China still has plenty of roomfor productivity growth through further economic reforms. Even if China can repli-for productivity growth through further economic reforms. Even if China can repli-

cate its extraordinary growth performance for another two decades, its productivitycate its extraordinary growth performance for another two decades, its productivitywould still be only around 40 percent of the frontier productivity level. would still be only around 40 percent of the frontier productivity level.Before delving into the analysis, let me rst mention the three main data sourcesBefore delving into the analysis, let me rst mention the three main data sources

that I use for this paper. For examining Chinas historical performance, I use the datathat I use for this paper. For examining Chinas historical performance, I use the dataconstructed by Madison (2007); for comparing China with other countries, I use theconstructed by Madison (2007); for comparing China with other countries, I use thepurchasing power parity data from Penn World Table (PWT 7.0); and for detailedpurchasing power parity data from Penn World Table (PWT 7.0); and for detailedgrowth accounting exercises, I mainly use the data series my coauthor and I constructedgrowth accounting exercises, I mainly use the data series my coauthor and I constructedfor Brandt and Zhu (2010), in which we made adjustments to Chinas of cial statisticsfor Brandt and Zhu (2010), in which we made adjustments to Chinas of cial statisticsby using alternative de ators and information from household surveys.by using alternative de ators and information from household surveys.

Chinas Historical Economic Performance

China was a world economic and technological leader in the premodern era.China was a world economic and technological leader in the premodern era.Many historians think that Chinas premodern economic performance reached aMany historians think that Chinas premodern economic performance reached apeak in the Song Dynasty (circa 1200) when China is though to have had the mostpeak in the Song Dynasty (circa 1200) when China is though to have had the mostadvanced technologies (Needham and Ronan 1978), the highest iron output (Hartwelladvanced technologies (Needham and Ronan 1978), the highest iron output (Hartwell1962), the highest urbanization rate (Chao 1986), and the largest national economy1962), the highest urbanization rate (Chao 1986), and the largest national economy(Madison 2007) in the world. However, sometime between 1500 and 1800, China lost(Madison 2007) in the world. However, sometime between 1500 and 1800, China lostits leadership position to Western Europe. Figure 1 plots Angus Madisons estimatesits leadership position to Western Europe. Figure 1 plots Angus Madisons estimatesof per capita GDP for China and Western Europe. According to his estimates, Chinasof per capita GDP for China and Western Europe. According to his estimates, Chinasper capita GDP stagnated between 1500 and 1800 while Western Europes per capitaper capita GDP stagnated between 1500 and 1800 while Western Europes per capitaGDP increased steadily during the same period. These estimates suggest that, by theGDP increased steadily during the same period. These estimates suggest that, by theend of the fteenth century, China had already started to fall behind Western Europe,end of the fteenth century, China had already started to fall behind Western Europe,well well before the Industrial Revolution occurred in England. Some historians and econo-the Industrial Revolution occurred in England. Some historians and econo-mists attribute Chinas falling behind during this period to the more centralized andmists attribute Chinas falling behind during this period to the more centralized andinward-looking political systems of the Ming (1368 1644) and Qing (1644 1911)inward-looking political systems of the Ming (1368 1644) and Qing (1644 1911)dynasties that sti ed innovation and commercial activities in China.dynasties that sti ed innovation and commercial activities in China.

Not all economic historians agree with this explanation. Kenneth PomeranzNot all economic historians agree with this explanation. Kenneth Pomeranz

(2000) argues in(2000) argues in The Great Divergence that in the eighteenth century, living stan-that in the eighteenth century, living stan-dards and the degree of commercialization in Chinas Lower Yangzi region weredards and the degree of commercialization in Chinas Lower Yangzi region werecomparable to those in the richest parts of Europe and that China only startedcomparable to those in the richest parts of Europe and that China only started


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A Growth Accounting Decomposition for Modern China

After the establishment of the Peoples Republic in October 1949, China nally After the establishment of the Peoples Republic in October 1949, China nallystarted its industrialization process in the early 1950s. However, growth perfor-started its industrialization process in the early 1950s. However, growth perfor-mance before and after 1978 differs signi cantly. Prior to 1978, the average growthmance before and after 1978 differs signi cantly. Prior to 1978, the average growthrate of real per capita GDP was a modest 3 percent a year, not much different fromrate of real per capita GDP was a modest 3 percent a year, not much different fromthe growth rate in the United States though starting from a much lower base.the growth rate in the United States though starting from a much lower base.Since 1978, Chinas growth in per capita GDP has accelerated to a rate in excess ofSince 1978, Chinas growth in per capita GDP has accelerated to a rate in excess of8 percent per year, and Figure 2 shows (on a log scale) how Chinas per capita GDP8 percent per year, and Figure 2 shows (on a log scale) how Chinas per capita GDPhas begun to close the gap with U.S. per capita GDP.has begun to close the gap with U.S. per capita GDP.

Why did Chinas growth performance differ so much before and after 1978? To Why did Chinas growth performance differ so much before and after 1978? Toanswer this question, I begin in this section by using the standard growth accountinganswer this question, I begin in this section by using the standard growth accountingmethod to take a look at the sources of Chinas growth in both periods, which showsmethod to take a look at the sources of Chinas growth in both periods, which showsthat capital accumulation was the main source of economic growth in the 19521978that capital accumulation was the main source of economic growth in the 19521978period while productivity growth has been the main source of growth since then.period while productivity growth has been the main source of growth since then.In the next two sections, I offer more details on these two periods, including whyIn the next two sections, I offer more details on these two periods, including whythe capital-investment-led growth of the 19521978 period was unsustainable andthe capital-investment-led growth of the 19521978 period was unsustainable andcame at such a high cost to the country, and what has been underlying the rapidcame at such a high cost to the country, and what has been underlying the rapidproductivity growth since 1978.productivity growth since 1978.

Let the relationship between production inputs (physical capital, humanLet the relationship between production inputs (physical capital, humancapital, and labor) and GDP be represented by a standard CobbDouglas produc-capital, and labor) and GDP be represented by a standard CobbDouglas produc-

tion function:tion function:Y= AK (h L )1 .

Figure 2 GDP per capita of China and US: 19522009

100

1,000

10,000

100,000

1 9 5 2

2 0 0 5 i n t e r n a t

i o n a l

d o

l l a r

( l o g a r

i t h m

i c s c a l e )

Pre-reform period Reform period

2 0 0 9 1 9 5 7

1 9 6 2 1 9 6 7

1 9 7 2 1 9 7 7

1 9 8 2 1 9 8 7

1 9 9 2 1 9 9 7

2 0 0 2 2 0 0 7

United States

China


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Understanding Chinas Growth: Past, Present, and Future 107

Here Y is GDP, K is physical capital stock, L is labor (number of workers), h is theaverage level of human capital, A is total factor productivity (TFP), and is the outputelasticity of physical capital, which is usually measured by capitals share of nationalincome. Hall and Jones (1999) show how to use this framework to calculate per capitaGDP, 1 while Kehoe and Prescott (2002) note that in this framework the growth rate ofper capita GDP can be decomposed as the sum of four terms:

Growth rate of per capita GDP= growth rate of labor participation rate

+ /(1 ) growth rate of the capital/output ratio

+ growth rate of average human capital

+ 1/(1 ) growth rate of total factor productivity.

Note that in this decomposition the contribution of total factor productivity growth is weighted by 1/(1 ), taking into account both the direct contribution of total factorproductivity and the indirect contribution through its impact on capital accumulation.

For Table 1, I will set the value ofFor Table 1, I will set the value of to 1to 1 // 2 (as in Brandt, Hsieh, and Zhu 2008)2 (as in Brandt, Hsieh, and Zhu 2008)to match Chinas average capital income share as reported in Chinas nationalto match Chinas average capital income share as reported in Chinas nationalaccounts. With this assumption in place, Table 1 presents a decomposition of Chinasaccounts. With this assumption in place, Table 1 presents a decomposition of Chinasper capita GDP growth into contributions from growth of the labor participationper capita GDP growth into contributions from growth of the labor participation

rate, the capital/output ratio, average human capital, and total factor productivity .rate, the capital/output ratio, average human capital, and total factor productivity .22 This decomposition reveals very different patterns of growth in the two periods.This decomposition reveals very different patterns of growth in the two periods.

In the pre-1978 period, growth was mainly coming from increases in both physicalIn the pre-1978 period, growth was mainly coming from increases in both physicaland human capital rather than increases in productive ef ciency. Total factorand human capital rather than increases in productive ef ciency. Total factorproductivity actually deteriorated during this period, declining by 1.07 percent perproductivity actually deteriorated during this period, declining by 1.07 percent peryear. Due to the increases in average schooling years, average human capital grew year. Due to the increases in average schooling years, average human capital grewat 1.55 percent a year, partially offseting the reduction in total factor productivity.at 1.55 percent a year, partially offseting the reduction in total factor productivity.

1 Speci cally, Hall and Jones (1999) show that in this CobbDouglas framework one can express the GDPper capita in the following way:

Y _ Pop = L _ Pop ( K _ Y )

_ 1 hA

1 _ 1 .In this formulation, Pop is the population. GDP per capita can thus be calculated as the product of fourterms: the labor participation rate, the capital/output ratio raised to the power of /(1 ), the averagelevel of human capital, and total factor productivity raised to the power of 1/(1 ) . The other variablesare de ned in the text.2 The data on GDP per capita, GDP per worker, and labor participation rate are taken from the Penn

World Table (PWT7.0). The Penn World Table contains two versions of data for China. I use version 1because it is more consistent with the series we constructed for Brandt and Zhu (2010) using Chinasnational accounts data, with adjustments made to de ators in a way that is similar to what Alwyn Young(2003) did for the data over a shorter period of time. The physical capital stock data are constructedusing the real investment data from the PWT7.0 and the perpetual inventory method with a depreciationrate of 0.06. The initial capital stock in 1952 was set to I 52/(0.06 + ln( I 57/ I 52)/5), where I t is the realinvestment in year t . The average level of human capital is constructed using the average schooling yearsreported in the Barro and Lee (2010) dataset and the method of Hall and Jones (1999).


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The labor participation rate increased slightly, growing at 0.11 percent a year. TheThe labor participation rate increased slightly, growing at 0.11 percent a year. Themost important source of growth was increases in the physical capital/output ratio,most important source of growth was increases in the physical capital/output ratio,which on average grew 3.45 percentage points a year and accounted for 116 percent which on average grew 3.45 percentage points a year and accounted for 116 percentof the per capita GDP growth.of the per capita GDP growth.

After 1978, capital accumulation and total factor productivity growth reversed After 1978, capital accumulation and total factor productivity growth reversedtheir roles. Between 1978 and 2007, the physical capital/output ratio remainedtheir roles. Between 1978 and 2007, the physical capital/output ratio remainedroughly constant and the average human capital growth rate was lower than theroughly constant and the average human capital growth rate was lower than thegrowth rate in the pre-1978 period. The two sources combined contributed togrowth rate in the pre-1978 period. The two sources combined contributed toaround 15 percent of the growth in per capita GDP. Demographic factors played aaround 15 percent of the growth in per capita GDP. Demographic factors played avery limited role. Partly due to the one child policy, the labor participation rate grew very limited role. Partly due to the one child policy, the labor participation rate grewat 0.57 percent a year during this period, faster than in the pre-1978 period. But theat 0.57 percent a year during this period, faster than in the pre-1978 period. But thecontribution of the increases in labor participation rate was still modest, accountingcontribution of the increases in labor participation rate was still modest, accountingfor only about 7 percent of the growth. In contrast, total factor productivity grewfor only about 7 percent of the growth. In contrast, total factor productivity grewrapidly at 3.16 percent a year. (Bosworth and Collins, 2008, in this journal, andrapidly at 3.16 percent a year. (Bosworth and Collins, 2008, in this journal, andPerkins and Rawski, 2008, report similar results in their growth accounting exer-Perkins and Rawski, 2008, report similar results in their growth accounting exer-cises.) Since the contribution of total factor productivity growth is weighted bycises.) Since the contribution of total factor productivity growth is weighted by1/(1 1/(1 ) and) and is 0.5, the growth contribution of total factor productivity growth isis 0.5, the growth contribution of total factor productivity growth is22 3.163.16 == 6.32 percentage points, or 78 percent of the growth in GDP per capita.6.32 percentage points, or 78 percent of the growth in GDP per capita.

The nding that aggregate productivity growth has been the most importantThe nding that aggregate productivity growth has been the most important

source of Chinas growth since 1978 may seem surprising because it runs in thesource of Chinas growth since 1978 may seem surprising because it runs in theface of a popular view that China has followed anface of a popular view that China has followed an investment-driven growth modelgrowth modelthat relied heavily on capital-deepening for growth over the last three decades (forthat relied heavily on capital-deepening for growth over the last three decades (for

Table 1Decomposing Chinas Growth: 19522007

Average annual growth rates (%)

Period GDP per capita

Labor particationrate

Capital/outputratio

Average humancapital TFP

19521978 2.97 0.11 3.45 1.55 1.0719782007 8.12 0.57 0.04 1.18 3.16

Contributions to per capita GDP growth

Period GDP per capita

Labor particationrate

Capital/outputratio

Average humancapital TFP

19521978 100 3.63 116.15 52.25 72.0319782007 100 7.05 0.51 14.55 77.89

Source: Authors calculations. The data on GDP per capita, GDP per worker, and labor participationrate are taken from the Penn World Table (PWT7.0). The average level of human capital isconstructed using the average schooling years reported in the Barro and Lee (2010) dataset. Seefootnote 2 for details.Notes:Table 1 presents a decomposition of Chinas per capita GDP growth into contributions fromgrowth of labor participation rate, capital/output ratio, average human capital, and total factorproductivity. TFP is total factor productivity. See text for details.


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Xiaodong Zhu 109

example, Wolf 2011). But, although the share of annual GDP that ows to real xedexample, Wolf 2011). But, although the share of annual GDP that ows to real xedcapital investment in China increased from 33 percent to 39 percent between 1978capital investment in China increased from 33 percent to 39 percent between 1978and 2007, Chinas capital-to-output ratio barely increased during this time. Chinasand 2007, Chinas capital-to-output ratio barely increased during this time. Chinascapital investment since 1978 has been keeping up with its rapid rate of outputcapital investment since 1978 has been keeping up with its rapid rate of outputgrowth but not leading it. Examining the data between 1978 and 1998, Younggrowth but not leading it. Examining the data between 1978 and 1998, Young(2003) also comes to the conclusion that capital deepening was(2003) also comes to the conclusion that capital deepening was not the source ofthe source ofChinas growth. As Solow (1956) taught us: persistent economic growth can onlyChinas growth. As Solow (1956) taught us: persistent economic growth can onlycome from growth in total factor productivity. More than three decades of rapidcome from growth in total factor productivity. More than three decades of rapideconomic growth in China would not have been possible without signi cant growtheconomic growth in China would not have been possible without signi cant growthin aggregate total factor productivity.in aggregate total factor productivity.

Government-led Industrialization between 1952 and 1978After the Peoples Republic of China was established in 1949, the Chinese Commu- After the Peoples Republic of China was established in 1949, the Chinese Commu-

nist Party government, like governments of many other countries at the time, thoughtnist Party government, like governments of many other countries at the time, thoughtthe most effective way to speed up the industrialization process was by increasingthe most effective way to speed up the industrialization process was by increasinginvestment in heavy industries such as steel, concrete, and heavy machinery. Chinasinvestment in heavy industries such as steel, concrete, and heavy machinery. Chinasgovernment mobilized the resources for investment by limiting household consump-government mobilized the resources for investment by limiting household consump-tion and setting low prices for agricultural goods so that forced savings and surplusestion and setting low prices for agricultural goods so that forced savings and surplusesextracted from the agricultural sector could be used for investment in such industries.extracted from the agricultural sector could be used for investment in such industries.

This strategy of extensive growth based so heavily on capital accumulation wasThis strategy of extensive growth based so heavily on capital accumulation was

not sustainable and had grave welfare consequences. The big push towards industri-not sustainable and had grave welfare consequences. The big push towards industri-alization during the Great Leap Forward years (19581960) not only failed to raisealization during the Great Leap Forward years (19581960) not only failed to raisethe GDP growth rate, it also had such disruptive effects on agricultural productionthe GDP growth rate, it also had such disruptive effects on agricultural productionthat a severe famine occurred when China was hit by adverse weather shocks inthat a severe famine occurred when China was hit by adverse weather shocks in1959 (Li and Yang 2005). The Great Leap Forward became the Great Leap Famine1959 (Li and Yang 2005). The Great Leap Forward became the Great Leap Famineof 1959 1961, when the of cial statistics admit to 15 million deaths and unof cialof 1959 1961, when the of cial statistics admit to 15 million deaths and unof cialestimates suggest double that number or more.estimates suggest double that number or more.

Despite these disastrous results, the Chinese government continued its unbal-Despite these disastrous results, the Chinese government continued its unbal-anced growth strategy with only minor adjustments after the famine. Unfavorableanced growth strategy with only minor adjustments after the famine. Unfavorableterms of trade were set on farm products, which effectively imposed heavy taxesterms of trade were set on farm products, which effectively imposed heavy taxeson farmers. Theon farmers. The hukou or household registration system was implemented to keepor household registration system was implemented to keepheavily taxed farmers from leaving rural areas. Furthermore, farmers were prohibitedheavily taxed farmers from leaving rural areas. Furthermore, farmers were prohibitedfrom engaging in any nonfarm activities. These policies initially helped to ensure thatfrom engaging in any nonfarm activities. These policies initially helped to ensure thatthe government could extract surpluses from the agricultural sector to support thethe government could extract surpluses from the agricultural sector to support thecapital accumulation in the industrial sector. However, they also created incentivecapital accumulation in the industrial sector. However, they also created incentiveproblems that signi cantly reduced the productivity of farmers. As a result, agricul-problems that signi cantly reduced the productivity of farmers. As a result, agricul-tural output grew slowly. In the late 1970s, the agricultural sector included more thantural output grew slowly. In the late 1970s, the agricultural sector included more than70 percent of Chinas labor force but was not even able to provide Chinas population70 percent of Chinas labor force but was not even able to provide Chinas populationwith 2,300 calories per capita per day (near the UN-established minimum). Emer- with 2,300 calories per capita per day (near the UN-established minimum). Emer-

gency grain imports were frequently needed to meet food de cits (Huang, Otsuka,gency grain imports were frequently needed to meet food de cits (Huang, Otsuka,and Rozelle 2008). Chinas nonagricultural sector was little better. It was dominatedand Rozelle 2008). Chinas nonagricultural sector was little better. It was dominatedby the state-owned enterprises in which resource allocation and production activitiesby the state-owned enterprises in which resource allocation and production activities


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were carried out according to government plan rather than market signals. Most of were carried out according to government plan rather than market signals. Most ofthe state-owned enterprises at that time were inef cient, over owing with redundantthe state-owned enterprises at that time were inef cient, over owing with redundantworkers, and often producing output for which there was no market demand. At the workers, and often producing output for which there was no market demand. At thesame time, there were very few rms in the light industries like home appliances,same time, there were very few rms in the light industries like home appliances,furniture, and clothing, and there were constant shortages of consumer products.furniture, and clothing, and there were constant shortages of consumer products.

Given this background, it may seem paradoxical that Chinas economyGiven this background, it may seem paradoxical that Chinas economymanaged an average per capita GDP growth rate of even 3 percent from 1952 tomanaged an average per capita GDP growth rate of even 3 percent from 1952 to1978. The main reason for such a gain, as earlier emphasized earlier in Table 1, was1978. The main reason for such a gain, as earlier emphasized earlier in Table 1, wasthe increases in physical and human capital, both of which were at very low levelsthe increases in physical and human capital, both of which were at very low levelsin 1952. The capital/output ratio rose by about 140 percent during this time, fromin 1952. The capital/output ratio rose by about 140 percent during this time, from0.91 in 1952 to 2.22 in 1978. In addition, average years of education rose from 0.740.91 in 1952 to 2.22 in 1978. In addition, average years of education rose from 0.74in 1952 to 3.75 in 1978. Even with the substantial decline in aggregate productivity,in 1952 to 3.75 in 1978. Even with the substantial decline in aggregate productivity,

these factors were suf cient to increase Chinas per capita GDP over this time.these factors were suf cient to increase Chinas per capita GDP over this time.In summary, the industrialization policies pursued by the Chinese governmentIn summary, the industrialization policies pursued by the Chinese governmentduring this period from 1952 to 1978 created adverse incentives and gross misal-during this period from 1952 to 1978 created adverse incentives and gross misal-location of resources that resulted in declining aggregate productivity, recurringlocation of resources that resulted in declining aggregate productivity, recurringfood crises, and relatively little improvement in living standards.food crises, and relatively little improvement in living standards.

Sectoral Shifts and Productivity Growth Since 1978

When the Cultural Revolution ended after the death of the Communist Party When the Cultural Revolution ended after the death of the Communist Party

chairman Mao Zedong in 1976, the Chinese government under the leadership ofchairman Mao Zedong in 1976, the Chinese government under the leadership ofDeng Xiaoping sought to increase its legitimacy by improving aggregate economicDeng Xiaoping sought to increase its legitimacy by improving aggregate economicperformance and raising living standards. In December 1978, the governmentperformance and raising living standards. In December 1978, the governmentdecided on a general policy ofdecided on a general policy of Gaige Kaifangor reform and opening up. Xu (2011)or reform and opening up. Xu (2011)reviews the institutional changes during the reform period in China. There was noreviews the institutional changes during the reform period in China. There was nogrand design of systematic reform policies; instead, economic reforms have takengrand design of systematic reform policies; instead, economic reforms have takenplace in a gradual, experimental, and decentralized fashion. How did the reformsplace in a gradual, experimental, and decentralized fashion. How did the reformsgenerate such impressive growth? Is the growth sustainable? As a starting point togenerate such impressive growth? Is the growth sustainable? As a starting point toanswering this question, in this section, I look at productivity growth in differentanswering this question, in this section, I look at productivity growth in differentsectors and the reallocation of labor across sectors. In the following two sections,sectors and the reallocation of labor across sectors. In the following two sections,I then discuss the key economic reforms and institutional changes that were behindI then discuss the key economic reforms and institutional changes that were behindthe sector-level productivity growth in agriculture and in the nonstate sector.the sector-level productivity growth in agriculture and in the nonstate sector.

Table 2 presents total factor productivity growth rates of the aggregateTable 2 presents total factor productivity growth rates of the aggregateeconomy, the agricultural sector, and the nonagricultural sector. Because of theeconomy, the agricultural sector, and the nonagricultural sector. Because of theimportance of the state sector in the Chinese economy, the nonagricultural sectorimportance of the state sector in the Chinese economy, the nonagricultural sectoris divided into the state and the nonstate sectors. The state sector includesis divided into the state and the nonstate sectors. The state sector includesboth state-owned enterprises and shareholding companies; and the nonstateboth state-owned enterprises and shareholding companies; and the nonstatesector includes domestic private rms, foreign-invested rms,sector includes domestic private rms, foreign-invested rms, 33 and collectiveand collective

3 In China, foreign-invested rm is a term used for any one of a number of legal entities with foreignstakeholders, including equity joint ventures, cooperative joint ventures, wholly-owned foreign enter-prises, and foreign-invested companies limited by shares.


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rms in the nonagricultural sector. We include the shareholding companies inrms in the nonagricultural sector. We include the shareholding companies inthe state sector because many of them are former state-owned enterprises thatthe state sector because many of them are former state-owned enterprises thatwere restructured into shareholding companies after the mid-1990s but are still were restructured into shareholding companies after the mid-1990s but are stillcontrolled by the state. They continue to receive favorable treatment by thecontrolled by the state. They continue to receive favorable treatment by thestate, have easy access to bank credit, and are concentrated in protected indus-state, have easy access to bank credit, and are concentrated in protected indus-tries such as energy and telecommunication. In contrast, the collective rms,tries such as energy and telecommunication. In contrast, the collective rms,including those that are controlled by lower-level governments, receive littleincluding those that are controlled by lower-level governments, receive littlesupport from the state and, like domestic private rms, have dif culties gettingsupport from the state and, like domestic private rms, have dif culties gettingbank credit and entering into protected industries. Thus, we include them in thebank credit and entering into protected industries. Thus, we include them in thenonstate sector.nonstate sector.

The growth rates are reported for the entire period of 19782007 and threeThe growth rates are reported for the entire period of 19782007 and three

subperiods. The productivity growth rates are calculated using Chinas of cialsubperiods. The productivity growth rates are calculated using Chinas of cialnational accounts data on nominal output and xed investment, the revised GDPnational accounts data on nominal output and xed investment, the revised GDPand xed investment de ators, the revised employment series that is consistent withand xed investment de ators, the revised employment series that is consistent with

Table 2 Employment Share, GDP Share, and Total Factor ProductivityGrowth by Sector

Average annual total factor productivity growth (%)

Nonagricultural sector

Period Agriculture Nonstate State Aggregate

1978 2007 4.01 3.91 1.68 3.611978 1988 2.79 5.87 0.36 3.831988 1998 5.10 2.17 0.27 2.451998 2007 4.13 3.67 5.50 4.68

Year Employment share (%)

1978 69 15 16 1002007 26 62 12 100

Year GDP share (%)

1978 28 27 45 1002007 10 70 20 100

Source:Brandt and Zhu (2010).Notes: Table 2 presents total factor productivity (TFP) growth rates of theaggregate economy, the agricultural sector, and the nonagricultural sector, with

the nonagricultural sector divided into state and the nonstate sectors. See textfor details on the categorization of rms and enterprises into sectors. Becausethe TFP growth rates reported in this table are based on Chinas nationalaccounts data that use domestic prices, they are different from the TFP growthrates reported in Table 1, which are calculated from the Penn World Table datathat use international prices.


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Chinas census data, and the schooling year data of Barro and Lee (2010). In BrandtChinas census data, and the schooling year data of Barro and Lee (2010). In Brandtand Zhu (2010), we offer details on the construction of the data series .and Zhu (2010), we offer details on the construction of the data series .44

Total factor productivity grew rapidly in both the agricultural and the nonstateTotal factor productivity grew rapidly in both the agricultural and the nonstatesectors. For the overall period from 1978 to 2007, the average annual growth ratessectors. For the overall period from 1978 to 2007, the average annual growth ratesof total factor productivity in these two sectors is 4.01 and 3.91 percent, respectively.of total factor productivity in these two sectors is 4.01 and 3.91 percent, respectively.In contrast, the average growth rate of total factor productivity in the state sector isIn contrast, the average growth rate of total factor productivity in the state sector isonly 1.68 percent per year. Prior to 1998, in particular, the state sector had very lowonly 1.68 percent per year. Prior to 1998, in particular, the state sector had very lowproductivity growth rates. After 1998, though, total factor productivity in the stateproductivity growth rates. After 1998, though, total factor productivity in the statesector grew rapidly, averaging 5.5 percent annually.sector grew rapidly, averaging 5.5 percent annually.

The similarity of productivity growth rates in agriculture and in the nonstateThe similarity of productivity growth rates in agriculture and in the nonstatesector are associated with very different movements of these two sectors employ-sector are associated with very different movements of these two sectors employ-ment shares. As reported in Table 2, agricultures share of total employmentment shares. As reported in Table 2, agricultures share of total employment

declined from 69 percent in 1978 to 26 percent in 2007. The high rate of produc-declined from 69 percent in 1978 to 26 percent in 2007. The high rate of produc-tivity growth in agriculture helped to push workers away from jobs in agriculture.tivity growth in agriculture helped to push workers away from jobs in agriculture.Conversely, the nonstate sectors share of employment increased from 15 percent inConversely, the nonstate sectors share of employment increased from 15 percent in1978 to 62 percent by 2007. The extraordinary increase in the number of workers1978 to 62 percent by 2007. The extraordinary increase in the number of workersin this sector was not suf cient to drive down their productivity. Instead, the growthin this sector was not suf cient to drive down their productivity. Instead, the growthof the nonstate secotor represents the productivity bene ts of a sectoral shift awayof the nonstate secotor represents the productivity bene ts of a sectoral shift awayfrom the agricultural sector to a sector of the economy that could absorb this laborfrom the agricultural sector to a sector of the economy that could absorb this laborand still generate rapid productivity growth.and still generate rapid productivity growth.

The state sectors share of total employment remained remarkably constant atThe state sectors share of total employment remained remarkably constant ataround 16 17 percent of the total labor force from 1978 until 1997. The restruc-around 16 17 percent of the total labor force from 1978 until 1997. The restruc-

turing of state enterprises circa 1998 led both to a rise in the rate of productivityturing of state enterprises circa 1998 led both to a rise in the rate of productivitygrowth for this sector and also to a decline in its share of Chinas labor to 12 percentgrowth for this sector and also to a decline in its share of Chinas labor to 12 percentin 2001a level where it has remained since.in 2001a level where it has remained since.

In the next section, Ill discuss the transformation in agriculture in more depth.In the next section, Ill discuss the transformation in agriculture in more depth.In the following section, Ill delve more deeply into productivity growth for theIn the following section, Ill delve more deeply into productivity growth for thenonstate and state producers in the nonagricultural sector.nonstate and state producers in the nonagricultural sector.

Productivity Growth in Agriculture and Structural Transformation

Since China had experienced recurring food crises before 1978, it is notSince China had experienced recurring food crises before 1978, it is notsurprising that its economic reform started in the agricultural sector. Theresurprising that its economic reform started in the agricultural sector. Therewere two important reforms. First, the government increased prices for agricul- were two important reforms. First, the government increased prices for agricul-tural goods. Second, the previous collective farming system was shifted to thetural goods. Second, the previous collective farming system was shifted to thehousehold-responsibility system. Under the new system, each farm household washousehold-responsibility system. Under the new system, each farm household wasassigned a xed quota of grains that the household had to sell to the government atassigned a xed quota of grains that the household had to sell to the government at

4 Because the national accounts use domestic prices rather than international prices, these growth ratesare not the same as the growth rates calculated from the Penn World Tables. However, the differencesare small. For the entire period of 19782007, the annual growth rates of GDP per worker and totalfactor productivity calculated using the Penn World Tables are 7.55 and 3.16 percent, respectively. Thecorresponding growth rates calculated using Chinas national accounts data are 7.58 and 3.61 percent.


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Xiaodong Zhu 113

of cial prices. However, any extra grain the household produced could be sold atof cial prices. However, any extra grain the household produced could be sold atmarket prices. The reforms were implemented gradually and completed in 1984.market prices. The reforms were implemented gradually and completed in 1984.Between 1978 and 1984, total factor productivity in the agricultural sector grewBetween 1978 and 1984, total factor productivity in the agricultural sector grew5.62 percent per year. Several studies argue that most of the productivity growth5.62 percent per year. Several studies argue that most of the productivity growthduring this period can be attributed to the price and institutional reforms thatduring this period can be attributed to the price and institutional reforms thatgenerated strong positive incentive effects on farmers efforts and input choicesgenerated strong positive incentive effects on farmers efforts and input choices(for example, McMillan, Walley, and Zhu 1989; Lin 1992).(for example, McMillan, Walley, and Zhu 1989; Lin 1992).

As a result of the productivity growth, Chinas agricultural output increased by As a result of the productivity growth, Chinas agricultural output increased by47 percent during this period. The increase in food availability alleviated Chinas47 percent during this period. The increase in food availability alleviated Chinassubsistence food constraint and started a structural transformation that reallocated asubsistence food constraint and started a structural transformation that reallocated alarge amount of labor from agriculture to industry. From 1978 to 1984, agricultureslarge amount of labor from agriculture to industry. From 1978 to 1984, agriculturesshare of total employment fell from 69 percent to 50 percent: that is, in just six years,share of total employment fell from 69 percent to 50 percent: that is, in just six years,

19 percent of Chinas labor forcemore than 49 million workersreallocated out19 percent of Chinas labor forcemore than 49 million workersreallocated outof the agricultural sector. Most of the 49 million reallocated workers did not moveof the agricultural sector. Most of the 49 million reallocated workers did not moveto urban centers. Instead, they went to work in the rural industrial enterprises setto urban centers. Instead, they went to work in the rural industrial enterprises setup by township and village-level governments that are called township and villageup by township and village-level governments that are called township and villageenterprises (TVEs).enterprises (TVEs).

For the rst few years, the price and institutional reforms increased agriculturalFor the rst few years, the price and institutional reforms increased agriculturaloutput mainly by improving incentives without much change in the production tech-output mainly by improving incentives without much change in the production tech-nologies being used. However, by about 1984 these static ef ciency gains, from workersnologies being used. However, by about 1984 these static ef ciency gains, from workersusing the same technology with a much more rewarding set of incentives, were largelyusing the same technology with a much more rewarding set of incentives, were largelyexhausted. Both agricultural productivity and structural transformation stagnated inexhausted. Both agricultural productivity and structural transformation stagnated in

the second half of the 1980s. Starting around 1990, markets for agricultural inputs andthe second half of the 1980s. Starting around 1990, markets for agricultural inputs andoutputs were gradually liberalized and government interventions were signi cantlyoutputs were gradually liberalized and government interventions were signi cantlyreduced. Huang, Otsuka, and Rozelle (2008) document extensive market liberaliza-reduced. Huang, Otsuka, and Rozelle (2008) document extensive market liberaliza-tion in Chinas agricultural sector and state: aside from restrictions on land ownership,tion in Chinas agricultural sector and state: aside from restrictions on land ownership,China today may have one of the least distorted domestic agricultural economies in theChina today may have one of the least distorted domestic agricultural economies in theWorld. As this market liberalization provided farmers with strong incentives to adopt World. As this market liberalization provided farmers with strong incentives to adoptnew technologies, the average annual growth rate of total factor productivity in agri-new technologies, the average annual growth rate of total factor productivity in agri-culture reached 5.10 percent between 1988 and 1998, and remained at 4.13 percentculture reached 5.10 percent between 1988 and 1998, and remained at 4.13 percentbetween 1998 and 2007. Most of agricultures growth in total factor productivity afterbetween 1998 and 2007. Most of agricultures growth in total factor productivity after1990 came from technological progress ( Jin, Ma, Huang, Hu, and Rozelle 2010).1990 came from technological progress ( Jin, Ma, Huang, Hu, and Rozelle 2010).Structural transformation also resumed after 1990. By 2007, agricultures share of totalStructural transformation also resumed after 1990. By 2007, agricultures share of totalemployment had been reduced from 46 percent in 1991 to 26 percent in 2007.employment had been reduced from 46 percent in 1991 to 26 percent in 2007.

How did productivity growth in agriculture contribute to the overall economicHow did productivity growth in agriculture contribute to the overall economicgrowth in China? Since T. W. Schultz (1953)s pioneering work, economists havegrowth in China? Since T. W. Schultz (1953)s pioneering work, economists havelong emphasized the role of agriculture in economic development .long emphasized the role of agriculture in economic development .55 The standardThe standardargument is that productivity growth in agriculture not only contributes to aggregateargument is that productivity growth in agriculture not only contributes to aggregateproductivity growth directly, but also indirectly through structural transformation.productivity growth directly, but also indirectly through structural transformation.When agricultural productivity increases, food demand can be met with a smaller When agricultural productivity increases, food demand can be met with a smaller

5 See, for example, Johnston and Mellor (1961), Jorgenson (1961), Schultz (1964), and Timmer (1988).See also Gollin, Parente, and Rogerson (2002), Restuccia, Yang, and Zhu (2008), and Yang and Zhu(2010) for some recent analyses.


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number of workers in the agricultural sector than before. As a result, some workersnumber of workers in the agricultural sector than before. As a result, some workerscan be reallocated to the nonagricultural sector. Because average labor productivity iscan be reallocated to the nonagricultural sector. Because average labor productivity isgenerally higher in the nonagricultural sector than in the agricultural sector, the real-generally higher in the nonagricultural sector than in the agricultural sector, the real-location of workers from agriculture contributes positively to aggregate productivitylocation of workers from agriculture contributes positively to aggregate productivitygrowth. Indeed, in 1978, the average labor productivity in Chinas nonagriculturalgrowth. Indeed, in 1978, the average labor productivity in Chinas nonagriculturalsector was six times as high as in the agricultural sector, and therefore one wouldsector was six times as high as in the agricultural sector, and therefore one wouldexpect a signi cant contribution from the labor reallocation. For this reason, Youngexpect a signi cant contribution from the labor reallocation. For this reason, Young(2003) suggests that the reforms in the agricultural sector may have been the most(2003) suggests that the reforms in the agricultural sector may have been the mostimportant source of Chinas growth during the rst two decades of economic reform.important source of Chinas growth during the rst two decades of economic reform.

In Brandt and Zhu (2010), my coauthor and I use a multisector model toIn Brandt and Zhu (2010), my coauthor and I use a multisector model toquantify this contribution during the period of 19782007. We nd that, out ofquantify this contribution during the period of 19782007. We nd that, out ofthe 43 percentage points of the reduction in agricultures share of employmentthe 43 percentage points of the reduction in agricultures share of employment

between 1978 and 2007, total factor productivity growth in agriculture accountsbetween 1978 and 2007, total factor productivity growth in agriculture accountsfor 39 percentage points or 91 percent of the total reduction. Taking both thefor 39 percentage points or 91 percent of the total reduction. Taking both thedirect and indirect effects into account, we nd that the contribution of total factordirect and indirect effects into account, we nd that the contribution of total factorproductivity growth in agriculture to aggregate productivity growth is 1.5 percentageproductivity growth in agriculture to aggregate productivity growth is 1.5 percentagepoints a year for the entire period of 1978 and 2007. However, we also nd that thepoints a year for the entire period of 1978 and 2007. However, we also nd that therole of agricultures productivity growth diminishes over time, from a contributionrole of agricultures productivity growth diminishes over time, from a contributionof 2.1 percentage points per year between 1978 and 1988, to a contribution of onlyof 2.1 percentage points per year between 1978 and 1988, to a contribution of only0.6 percentage points per year for the period between 1998 and 2007. There are0.6 percentage points per year for the period between 1998 and 2007. There aretwo reasons for the decline. First, as the economy grew, agricultures share of value-two reasons for the decline. First, as the economy grew, agricultures share of value-added decreased, and therefore its direct contribution also diminished. Second, theadded decreased, and therefore its direct contribution also diminished. Second, the

marginal contribution of reallocation is a decreasing function of the agriculturalmarginal contribution of reallocation is a decreasing function of the agriculturalproductivity level. After 20 years of productivity growth, the gain from reallocationproductivity level. After 20 years of productivity growth, the gain from reallocationnaturally declined in the later years. As agricultures share of employment and value-naturally declined in the later years. As agricultures share of employment and value-added continue to decline, the contribution of productivity growth in agriculture toadded continue to decline, the contribution of productivity growth in agriculture toaggregate productivity growth will be even smaller in the future.aggregate productivity growth will be even smaller in the future.

Growth outside Agriculture: A Tale of Two Sectors

Before economic reform started in 1978, resource allocation was centrallyBefore economic reform started in 1978, resource allocation was centrallydetermined by the governments plan rather than by the market. The state sectordetermined by the governments plan rather than by the market. The state sectordominated nonagricultural activity, accounting for 80 percent of the total urbandominated nonagricultural activity, accounting for 80 percent of the total urbanemployment and more than three-quarters of industrial output. The nonstate sectoremployment and more than three-quarters of industrial output. The nonstate sectorat that time mainly consisted of collective rms. Urban collectives were con nedat that time mainly consisted of collective rms. Urban collectives were con nedto producing a small number of consumer goods and providing neighborhoodto producing a small number of consumer goods and providing neighborhoodservices. Rural collectives were only allowed to manufacture producer goods for theservices. Rural collectives were only allowed to manufacture producer goods for theagricultural sector.agricultural sector.

1978 1988: Rise of the Nonstate Sector

In the early 1980s, encouraged by the success of the rural reforms, the ChineseIn the early 1980s, encouraged by the success of the rural reforms, the Chinesegovernment started two market reforms in the nonagricultural sector. First, agovernment started two market reforms in the nonagricultural sector. First, adual-track system was introduced. State-owned enterprises were still given quotasdual-track system was introduced. State-owned enterprises were still given quotas


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on both production inputs and output that transacted at of cial prices, but theyon both production inputs and output that transacted at of cial prices, but theywere also allowed to buy inputs and sell output beyond quotas at market prices. were also allowed to buy inputs and sell output beyond quotas at market prices.Moreover, the non-state-owned enterprises, including collectives (as we discussedMoreover, the non-state-owned enterprises, including collectives (as we discussedearlier), small-scale individual businesses, and foreign-invested rms in the specialearlier), small-scale individual businesses, and foreign-invested rms in the specialeconomic zones, were allowed to enter previously forbidden industries, buying andeconomic zones, were allowed to enter previously forbidden industries, buying andselling their inputs and outputs at market prices. Second, the central governmentselling their inputs and outputs at market prices. Second, the central governmentalso devolved economic decision-making powers to lower-level governments andalso devolved economic decision-making powers to lower-level governments andprovided them with scal incentives. Starting in 1980, a scal contracting systemprovided them with scal incentives. Starting in 1980, a scal contracting systemwas implemented that effectively made local governments the residual claimants was implemented that effectively made local governments the residual claimantsof the enterprises under their control (Qian 1999). As a result, provincial-, city-,of the enterprises under their control (Qian 1999). As a result, provincial-, city-,and county-level governments controlled most of the state-owned enterprises whileand county-level governments controlled most of the state-owned enterprises whilethe township- and village-level governments controlled the group of rural collectivethe township- and village-level governments controlled the group of rural collective

enterprises that became known as the township and village enterprises.enterprises that became known as the township and village enterprises.Under these reforms, the township and village enterprises based on the old ruralUnder these reforms, the township and village enterprises based on the old ruralcollectives ourished and led the way to an expansion of the nonstate sector, whilecollectives ourished and led the way to an expansion of the nonstate sector, whilethe state-owned enterprises did not. The number of township and village enterprisesthe state-owned enterprises did not. The number of township and village enterprisesincreased from 1,520,000 in 1978 to 18,880,000 in 1988 (National Bureau of Statisticsincreased from 1,520,000 in 1978 to 18,880,000 in 1988 (National Bureau of Statisticsof China 1999). The success of the agricultural reforms made available to these enter-of China 1999). The success of the agricultural reforms made available to these enter-prises a large number of local workers, and the dual-track system allowed them to gainprises a large number of local workers, and the dual-track system allowed them to gainaccess to capital and raw materials from the markets. Between 1978 and 1988, the shareaccess to capital and raw materials from the markets. Between 1978 and 1988, the shareof total employment in nonstate enterprises increased from 15 percent to 39 percent.of total employment in nonstate enterprises increased from 15 percent to 39 percent.The expansion of employment in the nonstate sector was also accompanied by totalThe expansion of employment in the nonstate sector was also accompanied by total

factor productivity growth averaging 5.87 percent a year during this period.factor productivity growth averaging 5.87 percent a year during this period.The reforms did less for state-owned enterprises. Local governments at countyThe reforms did less for state-owned enterprises. Local governments at county

level and above sought to improve the economic performance of the state-ownedlevel and above sought to improve the economic performance of the state-ownedenterprises under their control by implementing a managerial responsibilityenterprises under their control by implementing a managerial responsibilitysystem that linked managers and workers income to nancial outcomes of thesystem that linked managers and workers income to nancial outcomes of theenterprises. The reforms did have some positive effect on productivity. Using aenterprises. The reforms did have some positive effect on productivity. Using apanel data set of 272 industrial state-owned enterprises collected by the Chinesepanel data set of 272 industrial state-owned enterprises collected by the ChineseAcademy of Social Sciences, Li (1997) estimates that their total factor productivity Academy of Social Sciences, Li (1997) estimates that their total factor productivityon average grew at 4.68 percent per year between 1980 and 1989, and that most ofon average grew at 4.68 percent per year between 1980 and 1989, and that most ofthe productivity growth could be attributed to stronger incentives, increased marketthe productivity growth could be attributed to stronger incentives, increased marketcompetition, and better allocation of production inputs. Using the same data set,competition, and better allocation of production inputs. Using the same data set,Groves, Naughton, Hong, and McMillan (1994) also report positive incentive effectsGroves, Naughton, Hong, and McMillan (1994) also report positive incentive effectsof the managerial responsibility system on productivity.of the managerial responsibility system on productivity.

While enterprise reforms made industrial state-owned enterprises more ef - While enterprise reforms made industrial state-owned enterprises more ef -cient, their productivity growth was slower than that of the nonstate enterprisescient, their productivity growth was slower than that of the nonstate enterprisesand not fast enough to offset the rising real cost of material inputs. Using moreand not fast enough to offset the rising real cost of material inputs. Using moreaggregate data on industrial enterprises reported by Chinas National Statisticalaggregate data on industrial enterprises reported by Chinas National StatisticalBureau, Jefferson, Rawski, and Zheng (1996) estimate that between 1980 and 1988,Bureau, Jefferson, Rawski, and Zheng (1996) estimate that between 1980 and 1988,the average annual growth rate of total factor productivity was 2.96 percent forthe average annual growth rate of total factor productivity was 2.96 percent for

state-owned enterprises and 3.66 percent for the nonstate collective enterprises.state-owned enterprises and 3.66 percent for the nonstate collective enterprises.However, these estimated rates of productivity growth are based on a productionHowever, these estimated rates of productivity growth are based on a productionfunction that uses gross output rather than value-added. If the costs of real materialfunction that uses gross output rather than value-added. If the costs of real material


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inputs are rising, using gross output rather than value-added may be misleading .inputs are rising, using gross output rather than value-added may be misleading .66 In the pre-reform period, prices of material inputs were kept arti cially low, andIn the pre-reform period, prices of material inputs were kept arti cially low, andso during the reform period, market prices of material inputs rose signi cantlyso during the reform period, market prices of material inputs rose signi cantlyfaster than output prices. Using the information reported in Jefferson, Rawski, andfaster than output prices. Using the information reported in Jefferson, Rawski, andZheng, I calculated the growth of total factor productivity for the state and collectiveZheng, I calculated the growth of total factor productivity for the state and collectiveindustrial enterprises between 1980 and 1988 using value-added, rather than grossindustrial enterprises between 1980 and 1988 using value-added, rather than grossoutput. By this metric, the state-owned rms had annual productivity growth ofoutput. By this metric, the state-owned rms had annual productivity growth of1.33 percent, while the nonstate collective enterprises had a growth rate of positive1.33 percent, while the nonstate collective enterprises had a growth rate of positive3.11 percent per year. (There has been no comparable study for the speci c state3.11 percent per year. (There has been no comparable study for the speci c stateand nonstate enterprises in services because data for such a study are not available.)and nonstate enterprises in services because data for such a study are not available.)

In short, the basic lesson is that productivity growth of the nonagriculturalIn short, the basic lesson is that productivity growth of the nonagriculturalsector during this period was mainly due to the rise of the nonstate sector. As Table 2sector during this period was mainly due to the rise of the nonstate sector. As Table 2

showed earlier for the 19781988 period, the state sector had an average annualshowed earlier for the 19781988 period, the state sector had an average annualgrowth rate of total factor productivity during this time of 0.36 percent, while thegrowth rate of total factor productivity during this time of 0.36 percent, while thenonstate sectors had annual productivity growth of 5.87 percent.nonstate sectors had annual productivity growth of 5.87 percent.

1988 1998: From Reform without Losers to Inevitable TradeoffsThe drastic difference in economic performances between the township andThe drastic difference in economic performances between the township and

village enterprises and the state-owned enterprises may seem implausible; after all, village enterprises and the state-owned enterprises may seem implausible; after all,both are enterprises under the control of local governments, albeit at different levels.both are enterprises under the control of local governments, albeit at different levels.One reason for the difference is that state-owned enterprises remained under theOne reason for the difference is that state-owned enterprises remained under theconstraints of government planning for a longer time, unable to sell their productsconstraints of government planning for a longer time, unable to sell their products

at market prices, although these restrictions diminished over time (Naughton 1995).at market prices, although these restrictions diminished over time (Naughton 1995).But the more important difference is the commitment made by the centralBut the more important difference is the commitment made by the central

government to support employment in the state sector. Remember that employmentgovernment to support employment in the state sector. Remember that employmentin the state-owned sector remained essentially constant at about 16 percent of thein the state-owned sector remained essentially constant at about 16 percent of theworkforce from 1978 up through 1997. This stability re ected the central govern- workforce from 1978 up through 1997. This stability re ected the central govern-ment strategy of letting the nonstate sector grow without downsizing the state sector.ment strategy of letting the nonstate sector grow without downsizing the state sector.The strategy had the political bene t of minimizing social instability and reducingThe strategy had the political bene t of minimizing social instability and reducingresistance to reform. Lau, Qian, and Roland (2000) call it reform without losers.resistance to reform. Lau, Qian, and Roland (2000) call it reform without losers.To avoid laying off workers or shutting down factories, the government usually askedTo avoid laying off workers or shutting down factories, the government usually askedthe state-owned banks to bail out loss-making state-owned enterprises. The possibilitythe state-owned banks to bail out loss-making state-owned enterprises. The possibilityof bailout created a soft budget constraint, to use a term common in the literatureof bailout created a soft budget constraint, to use a term common in the literatureon centrally planned economies, that further reduced the economic incentives ofon centrally planned economies, that further reduced the economic incentives ofthe state-owned enterprises (Kornai 1980; Qian and Roland 1998; Brandt and Zhuthe state-owned enterprises (Kornai 1980; Qian and Roland 1998; Brandt and Zhu2001). The lack of exit also eliminated market selection as an important mecha-2001). The lack of exit also eliminated market selection as an important mecha-nism for improving aggregate productivity in the state sector. In contrast, the centralnism for improving aggregate productivity in the state sector. In contrast, the centralgovernment had no commitment to support employment in the township and villagegovernment had no commitment to support employment in the township and villageenterprises. While the local governments that ran the township and village enter-enterprises. While the local governments that ran the township and village enter-prises did have political incentives to minimize unemployment and maintain socialprises did have political incentives to minimize unemployment and maintain socialstability in their communities, these local governments had only weak in uence onstability in their communities, these local governments had only weak in uence on

6 Speci cally, let s m be the share of material inputs in gross output, then ln( TFP value-added )= [ ln( TFP gross output ) s m ln(real material input cost)]/(1 s m ).


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Xiaodong Zhu 117

banks. For example, millions of township and village enterprises went bankrupt whenbanks. For example, millions of township and village enterprises went bankrupt whenthere was a general tightening of credit in 1989 (Qian and Xu 1993). Thus, townshipthere was a general tightening of credit in 1989 (Qian and Xu 1993). Thus, townshipand village enterprises faced a much tighter budget constraint and stronger marketand village enterprises faced a much tighter budget constraint and stronger marketdiscipline than did the state-owned enterprises.discipline than did the state-owned enterprises.

Unsurprisingly, at least to economists, a reform without losers strategy stillUnsurprisingly, at least to economists, a reform without losers strategy stillposes tradeoffs. In the absence of hard budget constraints and market discipline,poses tradeoffs. In the absence of hard budget constraints and market discipline,the state-owned enterprises continued to be outperformed by the nonstate sector.the state-owned enterprises continued to be outperformed by the nonstate sector.Between 1988 and 1998, the average annual growth rate of total factor productivityBetween 1988 and 1998, the average annual growth rate of total factor productivityin the state sector was only 0.27 percent, while the comparable growth rate of thein the state sector was only 0.27 percent, while the comparable growth rate of thenonstate sector was 2.17 percent (as shown earlier in Table 2). Faced with increasingnonstate sector was 2.17 percent (as shown earlier in Table 2). Faced with increasingcompetition from the more ef cient nonstate rms and without signi cant produc-competition from the more ef cient nonstate rms and without signi cant produc-tivity growth, the nancial condition of the state-owned rms deteriorated. Thetivity growth, the nancial condition of the state-owned rms deteriorated. The

resources needed to support the state-owned enterprises increased steadily betweenresources needed to support the state-owned enterprises increased steadily between1986 and 1993. Nonperforming loans in the state banking system increased rapidly,1986 and 1993. Nonperforming loans in the state banking system increased rapidly,and the creation of money to make these loans was leading to chronic high in ationand the creation of money to make these loans was leading to chronic high in ation(Brandt and Zhu 2000).(Brandt and Zhu 2000).

By 1994, it had become clear that the strategy of reform without losers couldBy 1994, it had become clear that the strategy of reform without losers couldno longer be sustained. In 1995, the Chinese government reduced its commitment tono longer be sustained. In 1995, the Chinese government reduced its commitment tostable employment in the state sector. Many small-scale state-owned enterprises werestable employment in the state sector. Many small-scale state-owned enterprises wereallowed to go bankrupt or be privatized through management buyouts. Betweenallowed to go bankrupt or be privatized through management buyouts. Between1995 and 2001, the state sectors share of total employment declined from 17 percent1995 and 2001, the state sectors share of total employment declined from 17 percentto 12 percent .to 12 percent .77 More diversi ed ownership forms were also introduced within theMore diversi ed ownership forms were also introduced within the

state sector. Some of the large-scale state-owned enterprises were converted intostate sector. Some of the large-scale state-owned enterprises were converted intoshareholding companies, with a majority of shares controlled by the state.shareholding companies, with a majority of shares controlled by the state.

19982007: Privatization and Trade LiberalizationThe 15th Congress of the Chinese Communist Party held in 1997 was a mile-The 15th Congress of the Chinese Communist Party held in 1997 was a mile-

stone in Chinas economic policies. The Congress formally sanctioned ownershipstone in Chinas economic policies. The Congress formally sanctioned ownershipreforms of the state-owned rms and also legalized the development of privatereforms of the state-owned rms and also legalized the development of privateenterprises. With the reduction of legal barriers, private enterprises grew rapidly.enterprises. With the reduction of legal barriers, private enterprises grew rapidly.Collective enterprises such as township and village enterprises lost their edge, someCollective enterprises such as township and village enterprises lost their edge, somewere closed and many of them were privatized, also in the form of management were closed and many of them were privatized, also in the form of managementbuyouts. As part of the lead-up to Chinas joining the World Trade Organization inbuyouts. As part of the lead-up to Chinas joining the World Trade Organization in2001, Chinas government also started to cut tariffs, broadened trade rights, and2001, Chinas government also started to cut tariffs, broadened trade rights, andliberalized its regime for foreign direct investment (Branstetter and Lardy 2008).liberalized its regime for foreign direct investment (Branstetter and Lardy 2008).Between 1998 and 2007, the share of total urban employment in domestic privateBetween 1998 and 2007, the share of total urban employment in domestic privateenterprises and foreign-invested enterprises increased from 8 to 24 percent. Theenterprises and foreign-invested enterprises increased from 8 to 24 percent. Theincrease in the manufacturing sector was even more pronounced. By 2007, domesticincrease in the manufacturing sector was even more pronounced. By 2007, domesticprivate enterprises alone accounted for 51 percent of total urban employment inprivate enterprises alone accounted for 51 percent of total urban employment inthe manufacturing sector (National Bureau of Statistics of China, 2008, tables 4 2,the manufacturing sector (National Bureau of Statistics of China, 2008, tables 4 2,

7 Chinas of cial employment statistics did not record a reduction in the employment of state-ownedenterprises until 1998. The state-owned sector actually started to downsize and lay off workers a few yearsearlier in 1995.


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4 6, 4 13). Song, Storesletten, and Ziliboti (2011) present a model that describes4 6, 4 13). Song, Storesletten, and Ziliboti (2011) present a model that describesthe transformation during this period.the transformation during this period.

The combination of privatization and trade liberalization had strong effects onThe combination of privatization and trade liberalization had strong effects onproductivity growth in both the state and nonstate sectors. Between 1998 and 2007,productivity growth in both the state and nonstate sectors. Between 1998 and 2007,the average annual total factor productivity growth rates of the state and nonstatethe average annual total factor productivity growth rates of the state and nonstatesectors were 5.50 percent and 3.67 percent, respectively (as shown in Table 2).sectors were 5.50 percent and 3.67 percent, respectively (as shown in Table 2).After stagnating for much of the rst two decades of reform, the state sector nally After stagnating for much of the rst two decades of reform, the state sector nallyexperienced productivity growth in the last decade.experienced productivity growth in the last decade.

In the manufacturing sector, productivity growth during this period isIn the manufacturing sector, productivity growth during this period iseven higher. Using data of the China Annual Survey of Industries ,even higher. Using data of the China Annual Survey of Industries ,88 Brandt, VanBrandt, VanBiesebroeck, and Zhang (2012) estimate that, for the manufacturing sector, theBiesebroeck, and Zhang (2012) estimate that, for the manufacturing sector, thetotal factor productivity growth rate is 13.4 percent a year. Because even state-ownedtotal factor productivity growth rate is 13.4 percent a year. Because even state-owned

enterprises were allowed to go bankrupt and exit during this period, reallocationenterprises were allowed to go bankrupt and exit during this period, reallocationthrough the process of entry and exit contributed signi cantly to productivitythrough the process of entry and exit contributed signi cantly to productivitygrowth, accounting for 72 percent of the aggregate growth of total factor produc-growth, accounting for 72 percent of the aggregate growth of total factor produc-tivity in the manufacturing sector. Jefferson, Rawski, and Zhang (2008) report similartivity in the manufacturing sector. Jefferson, Rawski, and Zhang (2008) report similarresults. Using the same data, Hsieh and Klenow (2009) examine the contributionresults. Using the same data, Hsieh and Klenow (2009) examine the contributionof capital and labor reallocation among existing rms to the aggregate total factorof capital and labor reallocation among existing rms to the aggregate total factorproductivity growth in the manufacturing sector. They nd that between 1998 andproductivity growth in the manufacturing sector. They nd that between 1998 and2005, a more ef cient allocation within four-digit-level manufacturing industries2005, a more ef cient allocation within four-digit-level manufacturing industriescontributed 2 percentage points per year to aggregate total factor productivitycontributed 2 percentage points per year to aggregate total factor productivitygrowth in the manufacturing sector, with a signi cant portion of it coming fromgrowth in the manufacturing sector, with a signi cant portion of it coming from

the reallocation from state-owned to nonstate enterprises. In short, privatizationthe reallocation from state-owned to nonstate enterprises. In short, privatizationand trade liberalization reduced barriers to entry and exit, and increased competi-and trade liberalization reduced barriers to entry and exit, and increased competi-tion, which in turn led to rapid productivity growth in the manufacturing sector bytion, which in turn led to rapid productivity growth in the manufacturing sector byraising within- rm productivity and through reallocation along both the extensiveraising within- rm productivity and through reallocation along both the extensiveand intensive margins.and intensive margins.

However, Chinas nontradable sectorsprimarily construction and servicesHowever, Chinas nontradable sectorsprimarily construction and serviceshave faced much less international competition. There have also been signi canthave faced much less international competition. There have also been signi cantbarriers to entry of private and foreign-invested rms into service industries, andbarriers to entry of private and foreign-invested rms into service industries, andsigni cant barriers to exit of state-owned enterprises in services. In 2007, the statesigni cant barriers to exit of state-owned enterprises in services. In 2007, the statesector still accounted for 77 percent of total urban employment in services, insector still accounted for 77 percent of total urban employment in services, incontrast to 15 percent in manufacturing. It is perhaps not surprising, then, thatcontrast to 15 percent in manufacturing. It is perhaps not surprising, then, thatresearchers have found that productivity growth in the nontradable sector laggedresearchers have found that productivity growth in the nontradable sector laggedbehind growth in the tradable sector (for example, He, Zhang, Han, and Wu 2012).behind growth in the tradable sector (for example, He, Zhang, Han, and Wu 2012).

Sources of Aggregate Productivity Growth in China: A Summary From 1978 to 2007, Chinas annual growth rate of total factor productivity wasFrom 1978 to 2007, Chinas annual growth rate of total factor productivity was

3.61 percent per year. We can summarize the sources of aggregate productivity growth3.61 percent per year. We can summarize the sources of aggregate productivity growthin China during the reform period as follows. In the agricultural sector, productivityin China during the reform period as follows. In the agricultural sector, productivity

8 This rm-level survey has been conducted annually by Chinas National Bureau of Statistics. It coversall Chinese industrial rms (manufacturing, mining, and construction) with sales over 5 millionrenminbi yuan.


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growth contributed 1.5 percentage points a year to aggregate productivity growthgrowth contributed 1.5 percentage points a year to aggregate productivity growthover the 1978 2007 period, both directly and indirectly through structural transfor-over the 1978 2007 period, both directly and indirectly through structural transfor-mation. However, this source of growth diminished over time as agricultures sharemation. However, this source of growth diminished over time as agricultures shareof GDP diminished, and its contribution to Chinas future growth will be small. Inof GDP diminished, and its contribution to Chinas future growth will be small. Inthe nonstate sector, productivity growth contributed 2.27 percentage points per yearthe nonstate sector, productivity growth contributed 2.27 percentage points per yearto aggregate productivity growth over the 1978 2007 period .to aggregate productivity growth over the 1978 2007 period .99 This source of growthThis source of growthwill continue to drive Chinas future growth as the nonstate sectors share of total will continue to drive Chinas future growth as the nonstate sectors share of totalnonagricultural employment has risen from 48 percent in 1978 to 84 percent innonagricultural employment has risen from 48 percent in 1978 to 84 percent in2007 (more than 60 percent of total employment). Productivity stagnated in the2007 (more than 60 percent of total employment). Productivity stagnated in thestate sector until the late 1990s, and for the 1978 2007 period as a whole thisstate sector until the late 1990s, and for the 1978 2007 period as a whole thissector contributed essentially zero to aggregate growth in total factor productivity.sector contributed essentially zero to aggregate growth in total factor productivity.However, since 1998, the state sector also experienced rapid productivity growth asHowever, since 1998, the state sector also experienced rapid productivity growth as

a result of restructuring.a result of restructuring.The proximate sources of productivity growth have shifted over time. ForThe proximate sources of productivity growth have shifted over time. Forexample, productivity growth in agriculture under the dual-track system led the wayexample, productivity growth in agriculture under the dual-track system led the wayfrom 1978 up to about 1984; starting in the mid-1980s, the nonstate sector in thefrom 1978 up to about 1984; starting in the mid-1980s, the nonstate sector in theform of township and village enterprises under its own dual-track system led the wayform of township and village enterprises under its own dual-track system led the waythrough much of the 1980s and 1990s; and from the late 1990s and into the 2000s,through much of the 1980s and 1990s; and from the late 1990s and into the 2000s,the nonstate sector in the form of privately-owned rms and a restructured state-the nonstate sector in the form of privately-owned rms and a restructured state-owned sector led the way in an economic climate much friendlier to the privateowned sector led the way in an economic climate much friendlier to the privatesector and with lots of entry, exit, and competitive pressures. Whenever the effectsector and with lots of entry, exit, and competitive pressures. Whenever the effectof one set of reforms on productivity seemed to be exhausted, the Chinese govern-of one set of reforms on productivity seemed to be exhausted, the Chinese govern-

ment found a way to initiate new reforms that reignite growth.ment found a way to initiate new reforms that reignite growth.

The Future of Chinas Economic Growth

Experiences from other economies, especially the East Asian economies such asExperiences from other economies, especially the East Asian economies such asJapan, Korea, and Taiwan, suggest that periods of extremely rapid growth eventually Japan, Korea, and Taiwan, suggest that periods of extremely rapid growth eventuallyslow down and Chinas more than 8 percent a year per capita GDP growth rate will notslow down and Chinas more than 8 percent a year per capita GDP growth rate will notlast. Chinas per capita GDP is now around 20 percent of the U.S. level. Will Chinaslast. Chinas per capita GDP is now around 20 percent of the U.S. level. Will Chinasper capita GDP level out at 40 percent of the U.S. level, or 80 percent, or 120 percent?per capita GDP level out at 40 percent of the U.S. level, or 80 percent, or 120 percent?Of course, any answer to this question will contain a large dose of speculation. ButOf course, any answer to this question will contain a large dose of speculation. ButI will attempt to address this question by discussing what would be the key sourcesI will attempt to address this question by discussing what would be the key sourcesof Chinas growth in the future based on what we know about the sources of Chinas

understanding china’s growth

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