China's Economic Recovery Belies a Lingering Productivity Challenge

By Lingling Wei

A surge in state investments has helped lift the Chinese economy from the effects of Covid-19, but likely has worsened one of its deepest weaknesses: low productivity.

Beijing has pulled off a robust economic recovery since early last year, when authorities locked down much of the country to combat the coronavirus epidemic. But the rebound has been unbalanced. It relied heavily on government expenditures and state-sector investments, while private spending remained weak.

That is amplifying a trend of declining growth in productivity -- or output per worker and unit of capital -- in the world's second-largest economy, according to a new report by the International Monetary Fund. By the measure of average productivity across sectors, a gauge of overall economic efficiency, China's economy is only 30% as productive as the world's best-performing economies like the U.S., Japan or Germany, the report shows.

This poses a challenge to the leadership's goal of elevating China into the ranks of rich nations and lifting its living standards.

"China has done most of the traditional public investment it can. It's facing a shrinking labor force. So, where will lasting income growth come from?" said Helge Berger, the IMF's mission chief for China. "Productivity."

Since former leader Deng Xiaoping heralded an era of "reform and opening up" in the late 1970s, China's economy grew by double-digit percentages most years for decades. Factories and workers also produced more efficiently, thanks to a gradual introduction of market-oriented policies and technological advancement.

However, productivity growth has declined markedly in recent years as the state sector gets bigger, crowding out private firms that tend to be nimbler and more profitable.

"The pandemic has added to the many interconnected financial vulnerabilities already present before the crisis," the IMF report said, adding that the state's support is prolonging the economic life of nonviable and low-productivity state-owned companies.

The IMF estimates productivity at Chinese state firms at about 80% of private firms.

The productivity slowdown traced back to the 2008 global financial crisis, when the government initiated a massive stimulus program to prop up economic growth, and accelerated further under President Xi Jinping.

The IMF estimates that annual productivity growth averaged just 0.6% between 2012 and 2017, a sharp decline from an average of 3.5% in the previous five years. The downward trend likely has continued, according to the fund, as China's economic growth has weakened further.

State firms operate in all sectors of the Chinese economy, and they have seen their share of the economy grow. In 2018, total assets at those firms were valued at 194% of China's gross domestic product -- higher than in the early 2000s and "several orders of magnitude larger than in any other country," the IMF said, based on the latest data available.

These state firms can often obtain loans at low interest rates, while private companies usually have a hard time getting banks to lend to them -- despite the government's repeated pledges to make financing more available. Still, state firms remain less profitable than private ones, and a higher share of state companies lose money, according to the IMF.

To catch up to advanced economies like the U.S., the fund said, Beijing will have to carry out long-promised state-sector reforms, such as improving state companies' efficiency.

Mr. Xi had set out some ambitious goals to revamp the state sector soon after he came to power in 2012, including increasing its contributions to the country's social safety net. However, "Beijing remains far from realizing" these goals, according to a Jan. 12 report by the China Dashboard, a research project between consulting firm Rhodium Group and the Asia Society Policy Institute, a think tank. A case in point, notes the report: More than 70% of the dividends state firms pay were reinvested back into the firms, not used for social spending.

Most recently, the government has also stepped up efforts to assert control over private businesses, especially those in the technology sector, a move that analysts say could further damp productivity growth.

A major push on state-sector reform, the IMF projects, could more than double annual productivity growth in the next five years to about 1.4% from 0.6%. This 0.8 percentage-point productivity improvement then would lift overall GDP growth by the same scale as well -- for example, to 6.5% in 2022 from 5.7%, as estimated by the IMF.

Among the fund's recommendations: ensuring a level playing field between private and state-owned firms, phasing out implicit financing guarantees for state companies, allowing nonviable state firms to be restructured or exit the market, and improving corporate governance at the remaining state companies.

The IMF cautioned that it is important to implement the changes step-by-step. For instance, given that state-owned corporate borrowers have long enjoyed implicit guarantees from the government that their debts will be paid off in the event of default, China's banking and overall financial system would have to be strengthened first to make sure it is prepared for possible failures of state companies.

"We're not saying do this overnight," Mr. Berger says. "But we say, continue to work towards it, because that will help sustain income growth in the future."

Write to Lingling Wei at [e-mail]

Corrections & Amplifications

This article was corrected at 0232 GMT to reflect that The International Monetary Fund projects Chinese state-sector reform could improve Chinese productivity and lift overall GDP growth to 6.5% in 2022 from 5.7%. The original version of this article incorrectly said the IMF estimated the improved productivity would lift GDP to 6% in 2022 from 5.2%.

(END) Dow Jones Newswires

01-17-21 0714ET