China Research

China’s economy remains in many respects a peculiar conundrum. Obvious domestic and global ambitions both politically and economically are unfortunately not supported by transparency. For this reason, there is no way for foreign and Chinese economists to predict how China can make its dual economy to change successfully in the future. All we know is the fact that China – sooner or later – will have to meet substantial challenges that cannot be hidden forever despite probable and sizeable progress in certain technological areas which will develop even stronger in the foreseeable future.

The character of China’s dual economy

A dual economy is characterized by the existence of two strongly different parts in the economy, consisting of a promising and a lagging one. Criteria in this respect can be tech and innovation standards, productivity, wage levels, international competitiveness, etc. Important insights about the phenomenon of a dual economy in developing countries were launched already in 1954 by the future Nobel Prize winner from 1979, Arthur Lewis (see https://www.un.org/en/chronicle/article/w-arthur-lewis-pioneer-development-economics).

The research of Arthur Lewis remains interesting these days despite the fact that his modeling seems to be very theoretical and not completely applicable in reality. Thus, most experts do not share all his assumptions and conclusions. But we can learn a lot from Lewis about the general phenomenon of a dual economy also when we look at an emerging country like China.

Lewis refers in his analysis of a dual economy to the existence of two different kinds of economic sectors, i.e. lagging agriculture and promising manufacturing. The first one with low productivity and weak innovation and the second one with promising innovation, productivity and international competitiveness.  

Similarities with China are definitely in place. Also China has a clearly lagging sector with insufficient productivity and competitiveness (the traditional economy) and at the same time a productive sector with an innovative development of internationally competitive products (the modern economy).

Thus, we come to the big question whether the shift from the traditional economy to the modern economy can be too complicated for creating new Chinese GDP-growth potential with sufficient new jobs.

Will China be able to overcome its current dual economy?

The theory of a dual economy still can be applied generally to many emerging countries when considering the general phenomenon of a lagging and a future-oriented/promising economic sector. On the one side, the lagging sector in China is represented by the big number of unprofitable and subsidized state-owned companies and, on the other side, the promising sector by high-tech development and production. The Lewis model is interesting also in a Chinese context  since it reflects a model of structural change which describes the development from a traditional economy to a modern one. This is exactly the theoretical ambition of Chinese political leaders.

But when joining the conclusions of Lewis in a realistic and applied way, one has to raise the question to what extent the transformation of the less skilled labor force to the advanced high-tech sector will succeed sufficiently in order to increase China’s overall productivity plus income levels and, consequently, total GDP growth on trend. And if this should become the case, one has to raise serious doubts whether Chinese cities – where most of modern production is located – will be able to accommodate increasing numbers of migrant workers from the lagging areas. Or could it be the case that excess labor-force capacity already largely can be found in major urban areas?

The official Chinese sectoral model – can it succeed?

In practice, China obviously does not use the Lewis model. At least I have not found any official hint in such a direction. Instead, Chinese leaders try to stick to what officially is called “the dual circulation model”, aiming at creating a more independent economy. President Xi has been defining this approach as a strategy towards “internal circulation”, meaning increasing reliance on domestic development and production and a kind of decreasing dependence on imports of overseas technology and markets while maintaining global competitiveness and trading (“external circulation).

In other words: No one can claim that the Chinese plan and act without long-term strategic ambitions. The question is rather whether the Chinese version of a dual strategy has a chance to succeed. I have my doubts though it theoretically should not be impossible.

However, the number of economic imbalances seems to be too comprehensive. Major remaining problems are, for example, demography, the real estate sector, public and private indebtedness, bad loans, state control in areas like innovation, education and SoE:s, insufficient institutional conditions when it comes to the financial system and transparency and – at least for quite some time in the future – shortcomings in employment / consumer confidence and possibly continuous protectionist threats.

Finally – not to forget: Psychological support by the Chinese people will be badly needed as well. This will be necessary to manage the important challenge to achieve the strived contribution of private consumption to stronger domestic growth.

But will psychology be treated as an important policy parameter?

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University