24 August 2016

Capturing China’s $5 trillion productivity opportunity



It won’t be easy, but shifting to a productivity-led economy from one focused on investment could add trillions of dollars to the country’s growth by 2030. 

After three decades of sizzling growth, China is now regarded by the World Bank as an upper-middle-income nation, and it’s on its way to being one of the world’s advanced economies. The investment-led growth model that underpinned this extraordinary progress has served China well. Yet some strains associated with that approach have become evident. 

In 2015, the country’s GDP growth dipped to a 25-year low, corporate debt soared, foreign reserves fell by $500 billion, and the stock market dropped by nearly 50 percent. A long tail of poorly performing companies pulls down the average, although top-performing Chinese companies often have returns comparable with those of top US companies in their industries. More than 80 percent of economic profit comes from financial services—a distorted economy. Speculation that China could be on track for a financial crisis has been on the rise. 

The nation faces an important choice: whether to continue with its old model and raise the risk of a hard landing for the economy, or to shift gears. A new McKinsey Global Institute report, China’s choice: Capturing the $5 trillion productivity opportunity, finds that a new approach centered on productivity could generate 36 trillion renminbi ($5.6 trillion) of additional GDP by 2030, compared with continuing the investment-led path. Household income could rise by 33 trillion renminbi ($5.1 trillion), as the exhibit shows. 

Exhibit 

 

Pursuing a new economic model 

China has the capacity to manage the decisive shift to a productivity-led model. Its government can pull fiscal and monetary levers, such as raising sovereign debt and securing additional financing on the basis of 123 trillion renminbi in state-owned assets. China has a vibrant private sector, earning three times the returns on assets of state-owned enterprises. There are now 116 million middle-class and affluent households (with annual disposable income of at least $21,000 per year), compared with just 2 million such households in 2000. And the country is ripe for a productivity revolution. Labor productivity is 15 to 30 percent of the average in countries that are part of the Organisation for Economic Co-operation and Development (OECD). 

A new productivity-led model would enable China to create more sustainable jobs, reinforcing the rise of the consuming middle class and accelerating progress toward being a full-fledged advanced economy. Such a shift will require China to steer investment away from overbuilt industries to businesses that have the potential to raise productivity and create new jobs. Weak competitors would need to be allowed to fail rather than drag down profitability in major sectors. Consumers would have more access to services and opportunities to participate in the economy. 


Revolutionizing China’s economy

Five ways improving productivity can help the country confront its economic challenges. 

Making this transition is an urgent imperative. The longer China continues to accumulate debt to support near-term goals for GDP growth, the greater the risks of a hard landing. We estimate that the nonperforming-loan ratio in 2015 was already at about 7 percent, well above the reported 1.7 percent. If no visible progress is made to curb lending to poorly performing companies, and if the performance of Chinese companies overall continues to deteriorate, we estimate that the nonperforming-loan ratio could rise to 15 percent. This would trigger a substantial impairment of banks’ capital and require replenishing equity by as much as 8.2 trillion renminbi ($1.3 trillion) in 2019. In other words, every year of delay could raise the potential cost by more than 2 trillion renminbi ($310 billion). Although such an escalation would not lead to a systemic banking crisis, a liquidity crunch among corporate borrowers and waning confidence of investors and consumers during the recovery phase would have a significant negative impact on growth. 

Our report identifies five major opportunities to raise productivity by 2030: 
unleashing more than 39 trillion renminbi ($6 trillion) in consumption by serving middle-class consumers better 
enabling new business processes through digitization 
moving up the value chain through innovation, especially in R&D-intensive sectors, where profits are only about one-third of those of global leaders 
improving business operations through lean techniques and higher energy efficiency, for instance, which could deliver a 15 to 30 percent productivity boost 
strengthening competitiveness by deepening global connections, potentially raising productivity by 10 to 15 percent 

Capturing these opportunities requires sweeping change to institutions. China needs to open up more sectors to competition, enable corporate restructuring, and further develop its capital markets. It needs to raise the skills of the labor force to fill its talent gap and to sustain labor mobility. The government will need to manage conflicts among many stakeholders, as well as shift governance and incentives that rewarded a single-minded focus on rising GDP, even as it modernizes its own processes. 

Exactly how can China’s economy become more productive? Go toTableau Public to examine how six industry archetypes contribute to the country’s growth by province. 
About the author(s) Jonathan Woetzel is a director of the McKinsey Global Institute, where Jeongmin Seong is a senior fellow; Yougang Chen is a partner in McKinsey’s Hong Kong office, where Kevin Sneader is a senior partner; Nicolas Leung is a senior partner in the Beijing office; and Jon Kowalski is a consultant in the Pittsburgh office.Article Actions 

Exploring China’s productivity

Go to Tableau Public to examine how six industry archetypes contribute to the country’s growth by province.


Understanding its challenges and

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