The country is going through premature deindustrialisation, say experts

Suparna Goswami Bhattacharya

August 3, 2016: Of late, China has been less in the news for its ‘slowdown’. Economic activity in the country has stabilised in recent months, mostly on the back of the property market rally and strong infrastructure investments.

But, there is another challenge before the economy — slowing growth in labour productivity. The country is moving away from manufacturing towards services, a phenomenon which is called deindustrialisation. Though most economies in the world go through this phase, in China’s case it has been ‘premature’.

Deindustrialisation is a process of social and economic change caused by the removal or reduction of industrial capacity or activity in a country or region, especially heavy industry or manufacturing industry. It implies that productivity growth through rural-urban labour migration has started to slow, clouding the medium/long-term growth prospects if this trend is entrenched.

Qu Hongbin, chief China economist, HSBC, says both economic theory and empirical evidence suggest that premature deindustrialisation in developing countries can be damaging. “It blocks the main channel of productivity growth, and therefore reduces the economy’s potential growth rate and its prospects of catching up with more advanced economies. Given that China’s GDP per capita is only 14% that of the US, we believe it is way too early to shift towards services-led growth,” says Hongbin.

Around 2008-09, the industrial sector was affected by weakening external demand, which forced China to follow a different path.

Glenn Maguire, chief economist, South Asia, ASEAN and Pacific, ANZ, says, “The model was to shift economic growth away from reliance on exports and investment towards domestic consumption. Aligned with this, the government aimed to accelerate the growth of China’s services industries whilst targeting a reduction in industries suffering from overcapacity or inefficiencies – largely heavy industry associated with infrastructure and industrial production.”

From 2013, the services sector replaced the industrial sector as the biggest contributor to

China’s economic growth. According to data by HSBC, in Q2 2016, the services sector accounted for 51.9% of overall real GDP growth in China, compared with 40.7% for the industrial sector.

The economy obviously saw the benefits of the move. To begin with, the fast expansion in the services sector helped prevent GDP growth from sliding too fast. Between 2012 and 2015, the services sector has maintained robust growth of around 8.1% y-o-y, while output growth in the industrial sector decelerated from 8.2% y-o-y to 6.0%. Therefore, across the same time period, overall GDP growth fell by less than 1ppt (from 7.7% y-o-y to 6.9%), despite the sharp decline in the industrial sector.

According to China economist Chang Liu who works independently, the services sector has been able to maintain employment levels. “Despite slower GDP growth due to the underperforming industrial sector, China maintained healthy growth in jobs at 13m per year, all thanks to the services industry which is more labour intensive than manufacturing,” says Liu.

Though in the short run such a move did prevent a hard landing for China, from a long-term perspective a premature shift to services-sector led growth implies a huge efficiency loss. Jing Li, economist, HSBC, says, “The biggest source of productivity growth comes from the transition of labour from the agricultural sector to non-farm sectors. Therefore, the sector distribution of those migrant workers determines whether the economy is growing in the most efficient manner.” To this extent, this reshuffling towards the service industry means that a less productive sector is replacing the manufacturing sector as the main absorber of rural migrant workers.

An HSBC report states that between 2012 and 2015, the total number of migrant workers in the manufacturing sector declined by nearly seven million, compared with an increase of five million in the three biggest services sectors — wholesale and retail, residential services, transportation and logistics. Based on 2015 statistics, each worker in the manufacturing sector generated RMB45,000 more output than their counterpart in the three biggest services sectors.

Additionally, manufacturing industry is always on tenterhooks since it has to constantly upgrade itself in order to stay competitive and relevant. This improves the overall health of an economy — something very essential for a growing country.

“China still enjoys a high savings rate of nearly 50% of GDP. It is crucial that China does not pursue rebalancing towards consumption and thus lose the window of opportunity to catch up with more advanced economies. To avoid the middle-income trap, China needs to make more efficient investments and continue on the industrialisation path – this will be a challenge,” concludes Hongbin.