Measuring China's economy: an inside glimpse of capital investment, deflation and, of all things, a strange agricultural productivity boom.China's growth follows the typical pattern of a developing country. The agriculture sector's share in GDP GDP (guanosine diphosphate): see guanine. declined to 16 percent from 27 percent between 1990 and 2000. The industrial sector's share has expanded with the economy. The agriculture sector is growing at half the speed at which the economy is expanding. Its share in the economy is still declining by 0.6 percentage points per annum Per annum Yearly. . By 2010, China's agricultural sector's share in the economy could dip below 10 percent. The next phase of structural shift is from industry to service. This process hasn't begun. The reason is that Chinese households have low wealth levels and tend to minimize consumption in favor of wealth accumulation. As restructuring improves and capital returns and makes wealth accumulation easier to achieve, consumption preference should increase. The service sector's share in the economy should rise significantly. Most of the expected reduction in the agricultural sector's share in GDP in this decade should go to the service sector. China is in an early stage of capital accumulation Most generally, the accumulation of capital refers simply to the gathering or amassment of objects of value; the increase in wealth; or the creation of wealth. Capital can be generally defined as assets invested for profit. and, therefore, is experiencing rapid labor productivity growth. As the technology embodied em·bod·y tr.v. em·bod·ied, em·bod·y·ing, em·bod·ies 1. To give a bodily form to; incarnate. 2. To represent in bodily or material form: in capital is much more productive than just one decade ago, China is experiencing faster labor productivity growth than perhaps any other country. China has about 735 million people or 58 percent of the population in the labor force. The official unemployment figure was 6.8 million in the urban sector. China doesn't recognize a rural unemployment rate. Since Chinese labor is so underutilized overall, the only meaningful figure is non-agricultural employment. This figure was 382 million in 2000 or 54 percent of the labor force, up from 43 percent in 1990. China created 107 million jobs in the 1990's. If the current trend continues, non-agricultural employment could rise to 62 percent of the total labor force by 2010. The labor market labor market A place where labor is exchanged for wages; an LM is defined by geography, education and technical expertise, occupation, licensure or certification requirements, and job experience would be in much better shape, but would still be far from a full employment situation. China's labor market should achieve full employment only between 2025 and 2030. China's non-agricultural economy experienced an 8.1 percent annual growth rate in labor productivity between 1990 and 2000. The agricultural sector experienced 4.8 percent expansion during the same period. The whole economy had a higher growth rate of 8.9 percent due to steady redistribution re·dis·tri·bu·tion n. 1. The act or process of redistributing. 2. An economic theory or policy that advocates reducing inequalities in the distribution of wealth. of labor from the low productivity rural sector to industry and service sectors. Because the output of a worker in industry and service is 4.6 times that of a worker in agriculture, every one percentage point of labor redistributed re·dis·trib·ute tr.v. re·dis·trib·ut·ed, re·dis·trib·ut·ing, re·dis·trib·utes To distribute again in a different way; reallocate. Adj. 1. from agriculture to industry/service improves labor productivity by 1.2 percentage points. Total factor productivity growth is the Holy Grail Holy Grail: see Grail, Holy. A very desired object or outcome that borders on a sacred quest. There are several Holy Grails in the computer business. of economic efficiency. It indicates how much more output an economy generates with the same amount of capital and labor. Rapid growth of labor productivity could be attributed to more investment, that is, more machines for each worker. This so-called capital deepening Capital deepening is a term used in economics to describe an economy where capital per worker is increasing. It is an increase in the capital intensity. Capital deepening is often measured by the capital stock per labour hour. process is the most important factor in labor productivity. The basic model for measuring total factor productivity is based on Robert Solow's neoclassical ne·o·clas·si·cism also Ne·o·clas·si·cism n. A revival of classical aesthetics and forms, especially: a. A revival in literature in the late 17th and 18th centuries, characterized by a regard for the classical ideals of reason, form, growth model. Total factor productivity is equal to total output growth rate minus capital growth rate times its share in GDP, and minus labor growth rate times its income share in GDP. The sum of labor and capital's share in income is one. This number should be known in economies with good income data. Labor growth data are usually well documented. However, data on capital stock are usually hard to come by. Academic studies of TFP TFP Total Factor Productivity TFP Tradition, Family and Property TFP Time for Prints TFP Transference-Focused Psychotherapy TFP Trade for Prints (modeling) TfP Training for Peace (South Africa) usually focus on estimating capital stock. China doesn't have good income data. Data on capital stock are scarcer. Instead, we carry out a sensitivity analysis to try to guesstimate guess·ti·mate n. Informal An estimate based on conjecture. [Blend of guess and estimate.] guess indirectly the growth rate for capital stock and its income share in GDP. Figure 4 shows the range of TFP rates in relation to a range of annual capital stock growth rates Growth Rates The compounded annualized rate of growth of a company's revenues, earnings, dividends, or other figures. Notes: Remember, historically high growth rates don't always mean a high rate of growth looking into the future. and the income share of this in the economy in the 1990's. Capital stock should have grown faster than output in China. One important indicator is that the investment to GDP ratio has been increasing. The industry/service output ratio grew by 10.7 percent between 1990 and 2000. Hence, we can be reasonably sure that capital stock in the modern sector grew by more than 10.7 percent on average. The upper limit in capital stock growth could be derived from financial asset growth, especially household bank deposits. Bank loans have been the dominant force in financing. Retained earnings Retained Earnings The percentage of net earnings not paid out in dividends, but retained by the company to be reinvested in its core business or to pay debt. It is recorded under shareholders equity on the balance sheet. on average have probably only offset capital depreciation. While the export sector has been profitable, the state-owned enterprises have run up huge amounts of bad debt. They have probably offset each other. FDI FDI See: Foreign direct investment contributed to about 8.5 percent of total capital formation between 1990 and 2000, and wasn't the major force in capital increase. Hence, household deposit increase relative to existing capital should give us an upper limit for capital stock growth. Household deposits were rising about 42 percent faster than industry/service output between 1990 and 2000. If we use the same deflator Deflator A statistical factor used to convert current dollar purchasing power into inflation-adjusted purchasing power. Enables the comparison of prices while accounting for inflation in two different time periods. for this as for industry/service output, household deposits grew 15 percent in real terms in this period. Total household deposits are still less than 100 percent of GDP today and should be less than the capital stock in the industry/service sector. Hence, the capital stock in the modern sector couldn't have grown at a rate above 15 percent per annum. Capital's income share in the economy ranges from 25 percent in the United States United States, officially United States of America, republic (2005 est. pop. 295,734,000), 3,539,227 sq mi (9,166,598 sq km), North America. The United States is the world's third largest country in population and the fourth largest country in area. to probably 40 percent in Hong Kong Hong Kong (hŏng kŏng), Mandarin Xianggang, special administrative region of China, formerly a British crown colony (2005 est. pop. 6,899,000), land area 422 sq mi (1,092 sq km), adjacent to Guangdong prov. . China is probably somewhere between. I would put it at close to 40 percent. The TFP for the modern sector should be around 4 percent. Capital stock in the agricultural sector should also have grown faster than its output but must be below 10 percent, as capital allocation for the agricultural sector has been consistently below its share in GDP. The share of capital in the agricultural sector's income is probably less than half of that for the modern sector. These two factors lead us to believe that the TFP for China's agricultural sector has also been around 4 percent. It comes as a shock to find that productivity in the agricultural sector has been growing as fast as in the modern sector. A good explanation is that the technology for agriculture has been highly effective in generating high, value-added output. Greenhouse technology and new seeds have been instrumental in improving agricultural productivity Agricultural productivity is measured as the ratio of agricultural inputs to agricultural outputs. While individual products are usually measured by weight, their varying densities make measuring overall agricultural output difficult. . The declining cost of technology may have contributed to the high TFP rate. Since China is mainly a technology user rather than producer, the declining price of technology improves China's terms of trade Terms of trade The weighted average of a nation's export prices relative to its import prices. , and hence, its TFP. Another factor in China's productivity story is network economies of scale. China is a large country, and it is connected through construction of networks such as transportations, communication, energy and water supply. The externalities externalities side-effects, either harmful or beneficial, borne by those not directly involved in the production of a commodity. from such investments are potentially large. The first implication from this analysis is that China must grow much faster than 4 percent to have employment growth at all. The current implicit target of 7 percent for its GDP growth rate may not be sufficient. Indeed, the 8.9 percent labor productivity growth rate implies the potential GDP growth rate for China is 10 percent, as the labor force is growing at about one percent. The second implication is that deflation deflation: see inflation. deflation Contraction in the volume of available money or credit that results in a general decline in prices. A less extreme condition is known as disinflation. should not be a major problem. With 4 percent TFP, the economy should be able to handle quite a bit of deflation without distress. Indeed, we observe this in the export, telecom, IT, and property sectors. However, there is considerable stress in the state sector. The explanation could be that the state sector lags far behind the non-state sector in generating TFP. Hence, China should try to make the state sector as efficient as the rest. This could allow China to live with deflation without a detrimental effect on growth. The third implication is that the agricultural sector could be more profitable than the modern sector. Its productivity is rising at the same speed as the modern sector. Its labor force is shrinking, but output is expanding. The commercial potential of the agricultural sector should be huge. The fourth implication is that China's export prices could continue to decline as the benefit from TFP is passed on to consumers. Deflation in China should continue to translate into a decline in the relative price of tradable to non-tradable goods.
Figure 1
Changing Economic Structure (%)
Growth Share in GDP Share in GDP
1990-2000 Deflator 1990 2000
GDP 262 184
Primary 145 195 27.0 15.9
Secondary 357 165 41.6 50.9
Service 238 215 31.3 33.2
Source: China Statistical Yearbooks and Morgan Stanley Research
Figure 2
Labor Force Redistribution (million)
1990 2000 2001
Population 1,143 1,266 Est. 1,278
Labor Force 645 712 730
Employment 639 712
Primary 365 330
Industry/Service 275 382
Source: China Statistical Yearbooks
Figure 3
Labor Productivity (% change p.a.)
Output/ Output/ Deflator Avg. Labor
Worker Worker (%) Productivity
(Rmb) (Rmb) (% change
1990 2000 p.a.)
Total 2,902 12,566 184 8.9
Primary 1,377 4,309 195 4.8
Industry/Service 4,923 19,701 183 8.1
Source: Morgan Stanley Research
Figure 4
Annual TFP Sensitivity Analysis (%)
Industry/Service
K Growth 10 15 20
K Inc Share
25 6.8 5.6 4.3
40 5.8 3.8 1.8
50 5.2 2.7 0.2
Agriculture
K Growth 5 10 15
K Inc. Share
10 4.2 3.7 4.2
20 3.6 2.6 1.6
30 3.0 1.5 0.0
Source: Morgan Stanley Research
Andy Xie is Chief Economist The Chief Economist is a single position job class having primary responsibility for the development, coordination, and production of economic and financial analysis. It is distinguished from the other economist positions by the broader scope of responsibility encompassing the for Asia Pacific at Morgan Stanley  To comply with Wikipedia's , the introduction of this article needs a complete rewrite. .
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