China’s Unproductive Production

Economic growth is the increase in the total production of goods and services within an economy (real GDP), and China¬†seems to know all about it. In 2013, it produced “$9.5 trillion worth of goods and services, nearly 3 times more than that of 2007”. But how significant is this growth?

Growth in output can occur in two forms: through an increase in the total inputs, and/or an increase in productivity. When studying economic growth, it is important to consider this; therefore, we use the Total Factor Productivity (TFP) to measure the efficiency with which labor and capital are being employed. If a nation is simply increasing its output by increasing the total number of labor and capital¬†it employs, it may not necessarily suggest economically efficient growth i.e the workers and machines are not being fully utilized. “As long as the amount by which labor and capital grow outpaces any fall in productivity, GDP will still increase.”

This type of growth cannot survive in the long run, especially in a world where factors of production are becoming more scare. For example, would countries during the mid-twentieth century really have cared about how efficiently they were using oil after major deposits had been discovered in the Middle East? Probably not, since they would be aiming to extract as much oil as possible versus efficiently employing the oil. However, today, firms are trying to utilize oil (and its products) more efficiently due to its increasing scarcity. Essentially, “in the long run, improving the productivity with which they (factors of production) are used is the magic ingredient for any economy, the only path to sustainable growth.” Moreover, this growth may not necessarily reflect an increase in living standards. If GDP grows at the same rate as employment, real wage rates (or income per capita) may not necessarily also grow.

Hence the concerns about China. A series of estimates published this year have all suggested that productivity is flagging. This may be even more detrimental to China’s future, as it could be signalling an end to it’s “catching up” rates of growth. “Catching up” is a phenomenon which allows countries like China to grow by 10% oer annum whilst the UK barely manages 1%. By transferring workers from low productivity sectors (eg. agriculture) to higher productivity manufacturing and service sectors, economic growth will substantially increase as the value of goods being produced per worker is greater. If a worker can produce $500 per year in output as a farmer, but $1000 working in a factory, then the act of transferring that worker from agriculture to industry will raise the growth of the economy tremendously. If China is entering a stage in its economic life where productivity cannot increase by transferring workers anymore, it could finally expose inefficiencies within the economy.

Take a look at the Economist’s article on China’s Unproductive Production. Ask yourself these questions:

Why is falling productivity harmful to China’s economy?

What limitations are there to measuring total factor productivity (TFP)?

How does the “catching up” phenomenon distort the TFP figures, if at all? What could this suggest will happen to China’s economy in the future?

What can China do to improve its productivity?