The recent turmoil in the stock market and the ongoing growth slowdown does not lessen the importance of China’s economic growth as one of most remarkable episodes of economic history. The rise of China has received much less attention from macroeconomists than it deserves.1 Moreover, most academic studies of China’s success story start with the 1978 reforms. Mao’s era is either omitted or mentioned only in the context of the disaster of the Great Leap Forward and the turmoil of the Cultural Revolution.2 This is unfortunate, as the pre-1978 period was not only one of the largest economic policy experiments and development programmes in modern history, but also an important benchmark against which the success of post-1978 reforms should be measured.
In a new paper we provide a systematic analysis of both the pre-1978 and post-1978 periods in a unified framework (Cheremukhin et al. 2015). We develop a two-sector (agricultural and non-agricultural) neoclassical model with wedges, building on the analysis of the Great Depression by Cole and Ohanian (2004) and Chari et al. (2007) and on our previous work on Stalin’s industrialisation in Soviet Russia in Cheremukhin et al. (2013).
- What are the main growth facts for the Chinese economy during Mao’s era and during the reform period?
To answer this question, we construct a comprehensive dataset that allows the study of the entire 1953-2012 period and the application of the neoclassical model.
In 1952-1978, China’s real GDP per capita grew at a robust 4% average annual rate. However, the economy did not experience structural transformation. Even though Chinese agriculture was very inefficient, the fraction of the labour force in agriculture declined from 83% to only 75% - the value added produced in agriculture declined from 78% in 1953 to 30% in 1977.
In 1978-2012 annual growth in real GDP per capita increased to 8.4% on average. The structural transformation also sped up. The share of the labour force in agriculture fell to 33% in 2012, and the share of value added produced in agriculture fell to 5%.
- How do we determine the key quantitative factors behind growth and structural transformation?
We use the techniques of wedge accounting to answer this question. The first set of factors is the familiar total factor productivity in agriculture and non-agriculture. The second set is the wedges that measure misallocation of resources in the economy. The intratemporal labour wedge is the cost of intersectoral reallocation of labour. The intratemporal capital wedge is the cost of intersectoral reallocation of capital. The intertemporal capital wedge is the cost of reallocating capital across time. We further decompose the intersectoral labour wedge into three components – the consumption component (the difference between the relative prices and the marginal rate of substitution), the production component (the difference between the sectoral marginal products of labour and the ratio of sectoral wages), and the mobility component (the ratio of the sectoral wages). We similarly decompose the intersectoral capital wedge into its components. Our procedure is an accounting exercise – given total factor productivity and wedges, our model matches the data exactly.
- What are the key factors for growth and structural transformation during Mao’s period?
We measure the evolution of the wedges during Mao’s era and their contribution to the structural change and growth. We fix the wedges and total factor productivity at their initial values (1953) for the period of 1953-75 and simulate the economy. Compared to this counterfactual, Mao’s policies generated an additional 1.9 percentage points of annual GDP per worker growth and an additional 5.9 percentage points of the decline of the share of labour in agriculture. For GDP growth, the most important factors apart from demography were the growth of non-agricultural total factor productivity (contributing 1.9 percentage points) and the decrease in the consumption component of the labour wedge (contributing 1.6 percentage points). The rest of the wedges worsened and resulted in a 1.9 percentage point reduction in annual GDP growth. One surprising fact, at least relative to common wisdom, is a rather robust growth of non-agricultural total factor productivity (2.4% per year) in China even under Mao.
- How successful were the post-1978 reforms compared with the continuation of Mao’s policies?
In order to evaluate the contribution of the post-1978 reforms, we construct a counterfactual where Mao’s policies (specifically, the post-Great Leap Forward 1966-1975 rates of growth of sectoral total factor productivity and of wedges) continued in the post-1978 period. We find that reforms were very successful. Compared with the continuation of Mao’s policies, reforms generated an additional 4.2 percentage points of annual GDP growth and a 23.9 percentage point decrease in the share of labour force in agriculture. Without reforms, China’s GDP per capita would have been $2,536 rather than $10,274 (both numbers are in terms of 2012 PPP US dollars), and the share of labour force in agriculture would have been 57% rather than 33%. About three quarters of the higher growth is due to the increased growth of non-agricultural total factor productivity and a quarter is due to the faster reduction in the intersectoral wedges, in particular, the consumption component and the production component of the labour wedge.
- What policies may have explained the key factors of growth and structural change during the reform period?
First, we provide extensive historical evidence that two reforms may explain the changes in the key components of the intersectoral wedges post-1978 – price and housing reform (for the consumption component), and increase in competition (for the production component). Second, we further analyse the factors behind growth of non-agricultural total factor productivity by dividing this sector into state and non-state firms following Brandt et al. (2008). We confirm their finding that the growth of productivity in the non-state firms and reallocation of labour and capital from state-owned enterprises are responsible for the bulk of growth of non-agricultural total factor productivity.3
- What policies are not consistent with the key factors of growth during the reform period?
Our analysis also casts doubt on some common hypotheses of the ‘rise of China’. First, consider an argument that the growth of China is due to excessive investment or savings. In our framework, the simplest formalisation of this idea would imply a significant decrease in the intertemporal capital wedge (one can think of this as investment being implicitly or explicitly subsidised) or as a significant decrease in the non-consumption component of the intersectoral capital wedge (one can think of this as allocation of capital to non-agriculture being subsidised). However, we find that the quantitative contribution of these two wedges is minor. Second, we find that the direct effect of trade growth was limited. A caveat of course is that trade plays a minor role to the extent that it does not affect total factor productivity or other wedges, which it probably does. Third, consider an argument that the relaxation of hukou (household registration policies that restricts movement of people from villages to the cities) played an important role. The simplest formalisation would result in narrowing of the difference between agriculture and non-agriculture, and hence the decrease in our mobility component. We find that the mobility component of the intersectoral labour wedge increased, reflecting most likely the importance of human capital in the non-agricultural sector. Finally, we do not find any evidence that state capitalism is responsible for growth in China. We show that the growth rate of total factor productivity in the state non-agricultural sector was the same post-1978 as in Mao’s era. Rather, non-state total factor productivity growth, relocation of labour and capital from the state to the non-state sector, and the reduction of consumption and production distortions explain virtually all (that is, nearly 100%) of the growth and structural transformation in China. Any explanation that aims to account for the rise of China should therefore simultaneously appear in either of the key factors we find to be significant and not appear as factors we find to be insignificant.
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Cheremukhin, A, M Golosov, S Guriev, and A Tsyvinski (2015), “The Economy of People's Republic of China from 1953”, CEPR Discussion Paper No. 10764.
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1 Notable exceptions are a collection of papers in a landmark book edited by Brandt and Rawski (2008), quantitative analysis of China’s post-1978 structural transformation by Brandt et al. (2008), Brandt and Zhu (2010) and Dekle and Vandenbroucke (2010 and 2012), growth accounting by Young (2003) and Zhu (2012), the model of ‘growing like China’ with the focus on financial frictions by Song et al. (2011), a study of misallocation by Hsieh and Klenow (2010), analysis of factor wedges across space and sectors of Brandt et al. (2013) and Tombe and Zhu (2015), and a model of transformation of the state-owned firms by Hsieh and Song (2015). A body of work by Carsten Holz (2003, 2006, 2013a, b) is the most comprehensive attempt to construct high-quality data for economic analysis of China’s economy.
2 This is also consistent with the analysis of Song et al. (2011).
3 We are aware of only one strand of papers dedicated to model-based macroeconomic analysis of the 1953-1978 period by Chow (1985 and 1993), and Chow and Li (2002), whose work mainly focuses on data issues.