China is striving to move away from heavy industry toward a more services-driven economy, and the country’s services sector now comprises more than 50 percent of GDP. But the bad news, according to a new Paulson Institute Policy Memorandum by Senior Fellow Andrew Batson, is that finance and real estate account for a large portion of these gains, making the ostensible shift to a services economy less sustainable. Batson, who is director of China research at the independent research firm Gavekal Dragonomics, weighs in on what needs to be done.
China is banking on a transition to a services-led economy to help escape the middle-income trap. Are you optimistic about that process?
The “trap”—maybe it is better to just say “problem”—that middle-income countries like China face is that it is increasingly hard to know what to do in order to sustain economic growth and become high-income countries. So I don’t think a transition to a services-led economy is by itself the solution to sustaining growth, since that transition could happen in many ways, not all of them good. The economy could become more services-led by default if manufacturing is persistently weak, for instance, and that would not mean sustained growth. And if you look in more detail at how the transition to services has happened so far in China, I think you do get a bit less optimistic, primarily because of the outsized role the financial sector has played recently.
In your paper, you express some doubts about the apparent rise of the services sector in China’s economy. Why?
I don’t doubt that the service sector has become a more important part of China’s economy over time. I just don’t think that saying the service sector is more than 50% of GDP demonstrates that positive structural change is happening in China’s economy, case closed. A lot of the recent increase in the service sector’s share of GDP is due to finance. And that is happening because the government has had years of loose monetary policy to try to stimulate growth, so it can’t be evidence that growth is becoming more sustainable. At the same time, you also have relatively slow gains in the household services that should be becoming more important now that China is at a higher income level. There are some positive service sector stories, such as the incredible boom in online commerce, but the overall picture is in fact quite mixed. That’s why I think a bigger push to deregulate service sectors is necessary.
Why do you think that targets for the private sector’s market share would be a good way to stimulate the services sector?
The Chinese government has said it is committed to allowing private firms more access to opportunities across the economy, including in service sectors. But there has also been a lot of discussion recently about how promised regulatory changes are not being well implemented at the local level. I think part of the problem is that the goals are too vague and so there is no accountability for failing to meet them. A quantitative target for an increase in the private sector’s market share is clear and unambiguous about what the end result should look like, which increases accountability. It also pushes lower level officials to figure out what specific changes they need to make to achieve the goal, rather than requiring central officials to micromanage every step in the process. There is some evidence that this kind of target has been effective in healthcare, and I think using targets to drive liberalization in other sectors would be a good way to jump-start the reform process.