Why China won’t keep growing fast forever

October 27th, 2014

The Upshot, The New York Times
October 26, 2014

There has been plenty of discussion lately about signs that China’s economy is slowing down, focused on details of a possible housing bubble and vast sums of bad loans that the country will have to reckon with. But put aside the challenges China faces this quarter, or next year, and there is one view that is overwhelming: China is a long-term economic juggernaut that will stand astride the global economy in another generation’s time.

I know this because, for years now, major magazines and editorials and books have told me about the Chinese Century, in which we are apparently now living. Leading foreign policy journals have devoted copious ink to exploring what China’s rise will mean for global economics and politics, often taking as a given that China will be the dominant power of the coming century. (“Can the Liberal System Survive?” Foreign Affairs asked in 2008.)

Official forecasts — from international agencies like the Organization for Economic Cooperation and Development and the World Bank, and from United States intelligence circles — envision China continuing to grow rapidly over the next couple of decades, its economy eventually becoming much larger than that of the United States. Robert W. Fogel, a Nobel laureate in economics, forecast in 2010 that in 2040, Chinese economic output would be $123 trillion, about seven times the current size of the American economy (and three times his forecast for the United States in 2040).

But what if it’s all hogwash?

Many of the most bullish forecasts of China’s economic future are based, more or less, on extrapolation. For more than three decades, its economic output per person has been rising at an extraordinary annual rate of 6 to 10 percent, climbing rapidly toward levels in the richest nations. If that continues for a couple of decades, the bullish forecasts will prove accurate.

But if you look at the long arc of economic history, such performance would be a remarkable aberration. That’s the argument that the Harvard economists Lant Pritchett and Lawrence H. Summers make in a new working paper. In short, past performance does not predict future results. What tends to happen, rather, is “reversion to the mean”: Countries having long periods of abnormal growth tend to revert to something around 2 percent growth, closer to the long-term global average.

“China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind,” with sustained super-rapid growth for more than 32 years, they write. “Why will growth slow? Mainly, because that is what rapid growth does.”

There are plenty of other China pessimists out there, who note everything from aging demographics to years of politically driven investment that may offer poor returns, to an economy trying to make the perilous transition away from investment spending and toward consumers. Just last week, a Conference Board report argued that China’s economy would slow as a credit and investment bubble deflated.

But part of what makes the argument from Mr. Pritchett and Mr. Summers interesting is that they don’t trouble themselves with those gory details of why growth may slow; they say just that the historical evidence suggests it is likely. Maybe concerns about debt levels and bad investments in China will prove justified. Or maybe not. Regardless, we should think that a change is more likely than not.

“China is a huge economy and a profoundly different economy than it was a generation ago,” Mr. Summers, the former Treasury secretary, said in an interview. “But it would be ahistoric to extrapolate and assume with any high degree of confidence that China will enjoy such extraordinary growth rates over the long term. Economists, strategic analysts, business planners and nervous neighbors should all recognize that a very wide spectrum of economic outcomes is possible over the next generation and that the most likely outcomes involve a very substantial slowing of growth.”

The paper’s authors put it in baseball terms. “If a hitter has a hot streak with a batting average up 50 points over the past 20 at-bats, then we would forecast a return to the average batting average over the next 20 at-bats,” they write. “If pressed to say why the batting average would be lower, one could speculate about why it currently is so high and predict those factors will diminish or predict future events will causally explain the lowering, but mainly, this is just what happens.”

The strongest arguments that they may be wrong, by contrast, focus on details of why China (as well as India, which they also analyze) has the potential to keep growing rapidly for many years to come.

I asked Jim O’Neill, the former Goldman Sachs strategist who coined the term “BRIC” for the large emerging economies of Brazil, Russia, India and China, to critique the Pritchett-Summers paper.

“In the case of China and India, the core driver of why a more positive path is likely to continue is the simple process of urbanization,” Mr. O’Neill wrote in an email. “If and when each get close to 70 percent urbanized, I’d have more sympathy with their findings, but this is a long way off.” (Just more than half of Chinese and a third of Indians live in cities. When people move from rural areas to cities, their economic output tends to rise sharply).

In other words, a China bull can look at the details of the country’s situation — the great potential of its people to keep increasing their productivity, a political system that has proved resilient through the challenges of the last few decades — and see plenty of reasons for optimism. The reversion-to-the-mean view says simply, “We don’t know what will go wrong, but history suggests that something will.”

If the pessimistic view is right, there are enormous implications for the global economy’s future. If China’s per capita G.D.P. kept growing from now until 2033 at the same rate as it has in recent decades, the country’s annual economic output would rise by $51.1 trillion over current levels in present-day dollars. By contrast, if growth reverts to the mean, the size of the Chinese economy will have increased only $11.2 trillion by 2033, or a difference of about $40 trillion. To put that in context, the current gross domestic product of the United States is about $17 trillion.

For decades, economists have been building models to try to understand the mysteries of what drives growth. Is economic destiny shaped by culture? By government institutions? By patterns of industrialization?

But those debates have been inconclusive. Consider some of the economic success stories of the last generation — China, India, Mexico, Poland, South Korea and Turkey, to name a few. All have different cultures, government institutions and economic development strategies.

Years of work on growth theory suggest that there is no secret recipe for a developing nation to achieve prosperity. As it turns out, a simplistic reversion-to-the-mean approach explains economic growth about as well as some more complex approaches to predicting which countries’ economies are poised to boom or shrink.

This work also offers a reminder: If you just extrapolate from the recent past to predict the economic future, you are likely to be wrong. Analysts predicted that the Soviet economy would soon surpass the American economy in the 1960s, that Japan’s would do the same in the 1980s and that the United States had achieved a new era of perpetual speedy growth in the late 1990s. None of these have come to pass.

In other words, when it comes to predicting nations’ fates over the long haul, we know a lot less than we like to admit.