China’s economic success is largely owed to its tradition for products “Made in China” that have earned the country its reputation as the “workshop of the world.”

However, many studies attribute high-speed growth of the Chinese economy to its population dividend and low labor costs. But low labor costs imply low labor productivity, which is by no means conducive to economic growth.

It is therefore inaccurate to conclude that China’s remarkable economic development has resulted from its population dividend and low labor costs.

Advanced production mode

Population dividend and low labor costs are merely potential competitive edges, but translating these into practical advantages is what matters most.

China boasts giant, plentiful industrial clusters coupled with detailed, professional division networks. With industrial parks nationwide, China has brought its distinctive “metropolitan economy” into shape.

Metropolitan areas have fostered close vertical divisions of labor throughout the industrial chain, which has manifested strong competitiveness.

Numerous factors have contributed to the competitiveness of China’s manufacturing sector. China’s construction of supplier networks even outperforms some developed countries, according to The 2013 Global Manufacturing Competitiveness Index produced by professional service firm Deloitte Touche Tohmatsu and the US Council on Competitiveness.

Logic of extraordinary growth

China’s unrivaled colossal industrial clusters and sophisticated division networks have a lot to do with its land system. Land nationalization has enabled the government to establish so many infrastructure projects of a vast scale, including industrial parks and roads.

Nonetheless, this sort of development model is inherently deficient.

Firstly, it represents a model at risk of overexploitation of resources and overcapacity.

Secondly, whether this model is effective rests with conditions of technical exogenesis. The optimal institutional arrangement, to a large extent, is to maximize resource mobilization and invest in specified directions. Under such circumstances, a “strong government” is as good as a favorable institutional arrangement.

Generally, market-based transactions are technically expensive, so it is most economical to organize and professionalize labor division by relying on intermediate products amid industrial cluster transactions. Conversely, new technology will put large enterprises at an advantage.

China not only has a large population, but its society is dominated by young adults whose high savings yet low rate of consumption influence the Chinese economy.

Take the nation as a whole. A trade surplus occurs when savings outweighs investment. Had foreign demand absorbed huge capacity of China, the economy would have been caught in overcapacity and deflation. Moreover, it would have failed to sustain balanced growth while maintaining a high national employment rate.

It is therefore conditional to depend on nationalization of important production factors, such as land and large-scale infrastructure projects that attract foreign investment, to boost production capacity and ensure economic growth.

The first condition is the need for foreign absorption of domestic capacity. Over the last two to three decades, the information technology revolution and collapse of the Berlin Wall curbed a price hike of manufacturing goods.

Consequently, Western countries were emboldened to issue excess currency, bring deficit financing into full swing and spend more than they earn, thus effectively absorbing the overcapacity of China through impulsive investment and depressive consumption.

This “distortion” had positive effects in the past. The inflow of foreign capital empowered foreign technology and management and knowledge of production and market to result in real productivity for China’s enormous population.

China’s huge population contains an extensive surplus rural labor force. With low agricultural productivity and high industrial productivity, China is bound to improve its overall labor productivity if transferring its surplus agricultural labor force to the industrial sector.

In recent years, jobs growth has allowed hundreds of millions of Chinese peasants to achieve effective human resource accumulation.

In the past, premature external consumption could absorb huge capacity and there was a sizeable internal surplus labor force; nationalization of land, consumption depression, overinvestment, and twin surpluses were not obstacles to China’s rapid economic growth, but instead causes.

Restructuring and property reforms

However, things changed after the global financial crisis when China’s foreign trade could no longer maintain its regular high growth. This called for relevant restructuring and strengthening the role of consumption, in addition to export and investment, to drive economic development.

When foreign absorption weakened, the high investment, high savings and low consumption that once facilitated the Chinese economy posed major obstacles to its growth. This led China to focus on reining in investment impulses and overcoming consumption depression while making structural adjustments.

But this is only one side of the problem. The other side is that the Chinese economy has arrived at the “Lewis Turning Point.” Despite its population dividend, labor will no longer be in surplus in the upcoming decade.

That means potential benefits of the development model, which relies on distortion of factor input and deep government intervention, have diminished or even disappeared.

While this is happening, further adherence to the previous development pattern stands to in turn hinder economic growth.

In future, China must rely on three pillars – consumption, investment and exports – to fuel economic growth, especially driven by domestic consumption. This is what structural adjustment and property rights reform should focus on.

If structural adjustment is not fulfilled, there is no likelihood that the world economy will return to the fast lane.

Although countries around the world have carried out grand plans to demand stimulation to tackle the financial crisis, demand management can never rectify structural imbalance. It instead only stands to worsen it instead and prolong restructuring.

As such, the world economy is still undergoing deep change.

On the supply side, China produces necessities. Economic downturn and falling incomes will reduce consumption of luxury goods. Although consumption of necessities will be restrained, consumption of living goods will still underpin demand for Chinese products.

Sustaining medium and high growth is therefore out of question in the medium and short term.

China must undertake reforms to shift from high growth to social construction in maintaining social stability.

The competitiveness of any given country’s industry is greatly endogenous from industrial clusters. If industrial clusters, labor division and professionalization are deepened, costs will progressively fall.

The market is tolerant to some degree, so China must particularly treasure its hard-earned status as the “workshop of the world.”

Xie Zuoshi is the president of the School of Economics and International Trade at Zhejiang University of Finance and Economics. Zhang Yuanhao is from the Ronald Coase Center for the Study of the Economy at Zhejiang University.

　　 　　Translated by Chen Mirong

　　Revised by Tom Fearon