China Development Compared to Japan, South Korea and Taiwan

The Economist magazine looks a tChina’s accumulated more capital per worker versus other fast-growing countries had at a similar stage of development.

But it also has many stages of development ahead of it. Its capital stock per worker is only about a quarter of South Korea’s, for example. As the economy grows, big problems tend to diminish in its rear-view mirror.

In 1998 up to 40% of China’s loans turned sour. Cleaning up the mess cost 5 trillion yuan, or 58% of China’s 1998 GDP.

But China’s growth makes molehills out of mountains: 5 trillion yuan now represents less than 9% of its GDP. New production quickly eclipses the old.

Indeed, of all the goods and services ever produced by the People’s Republic of China, over 30% were churned out in the four years since 2010.

The Brookings Institute has a more detailed paper that compares China with Japan, South Korea and Taiwan. (27 pages, Oct 2013) 


Summary of Brookings Institute – China’s Rebalancing: Lessons from East Asian Economic History 

China’s senior leaders have spoken for some time about the need to rebalance the economy away from such heavy reliance on exports and investment, towards consumption.

This paper examines the earlier development experiences of Japan, South Korea, and Taiwan in order to shed light on the questions of whether China really needs to rebalance towards consumption and how it might be accomplished.

The earlier developers had high investment rates peaking around 35% of GDP. Starting at about the level of per capita GDP that China has now, they all experienced a tapering off of investment.

In general they rebalanced towards external demand which was possible because they had trade deficits in their rapid growth phases, which could then shift to trade surpluses.

China differs from the earlier developers in several key dimensions. In recent years it has had 15-20 percentage points of GDP less in household consumption than the others; its investment rate has been noticeably higher; and it developed trade surpluses at an earlier stage of development.

The unique aspects of China’s development likely stem from key institutional features of its model: the hukou system limiting rural-urban migration, the large role of state enterprises in the economy, financial repression, and the system for evaluating and rewarding local government officials.

These factors together create a heavy bias in the Chinese system against household income and consumption, and in favor of investment and exports. Reform of these institutional features provides the best hope of smooth adjustment of China’s economy away from investment towards consumption.

China has been catching up over the past 30 years. The Penn Tables put China’s 2011 PPP GDP per person at $8,189, around 9 on the log scale. Japan reached that level of development in 1970; Taiwan in 1982; and South Korea in 1987.

In all three of these economies household consumption has consistently been the main source of demand. This may seem surprising given their reputations as economies with high investment and external surpluses.

In the early stages of development, household consumption was 60-70% of GDP for all three economies. By the time they reached China’s current level of development, the consumption share had declined to around 50% of GDP. In Taiwan’s case household consumption dropped to 42% in 1987.

As discussed below, this was a period in which investment remained high but Taiwan developed a large trade surplus. Between 1987 and 1994 Taiwan had a mini-rebalancing in which consumption rose back to 52% of GDP while the external surplus dropped. After that consumption rates for all three remained in the 50-60% of GDP range.

There are a number of important stylized facts from the historical experiences of Japan, South Korea, and Taiwan.

1. These economies had high productivity of capital at an early stage of development but the marginal productivity of capital naturally declined with accumulation.
2. Household consumption was always the main source of demand, representing 50-70% of GDP.
3. These were high investment economies with the investment rate peaking around 35% of GDP and then gradually declining.
4. As investment declined, there was little tendency for either household or government consumption to pick up the slack in demand
5. The rebalancing in these economies was towards external demand: they tended to have trade deficits during the rapid accumulation period, and then shifted to surpluses as investment slowed.

Over the past decade, China’s trade balance has been about six percentage points higher than its neighbors, at the same level of development.

In the ten years before Japan (1970), Taiwan (1982), and South Korea (1987) reached China’s current level of development, they averaged trade deficits in the national accounts of 3.5% of GDP.

For China’s most recent ten years it averaged surpluses of 3%. China’s experience so far has more similarity with Taiwan’s, which developed a surplus at an early stage, then saw it decline towards zero, and rebound to a high level around 10% of GDP in recent years.

It will be difficult for China to replicate that experience because China is so much bigger than Taiwan and because the global situation has changed. China’s two big markets, the U.S. and the E.U., are trying to increase savings and reduce trade deficits.

It is difficult to see how in this environment the world could easily absorb Chinese surpluses in the 10% of GDP range. Given that China still has a fairly large trade surplus, it is unlikely that additional demand can come from increasing that surplus.

Under the hukou system, each person is registered to a location, usually the place of their birth, and it is very difficult to formally change the registration.

If a child is born in a city to a woman with rural hukou, the child retains the mother’s rural registration. The public services to which one is entitled depend on hukou registration. It can affect matters such as the ability to buy a house or register a car.

Currently, 38% of the population has urban hukou while in fact 52% of the population actually lived in cities in 2012. That discrepancy shows that people in fact can move around, and in particular migrate from rural areas to urban areas.

Nevertheless, the hukou system affects the extent and the manner of migration.

Under this system it is difficult for a rural family to migrate; rather, what typically happens is that one or both parents migrate to cities for work while children, literally known as “left-behind children,” remain in the rural village with grandparents.

This pattern arises not only because of the hukou system, but also because of land tenure issues. A family that divides in the way described can maintain its rights over agricultural land, even if the grandparents have to rent out the land for actual farming.

If the whole family moved to the city, then rights over the land would be lost without compensation.

Even counting migrants, China’s urbanization rate is low compared to its Asian neighbors at similar levels of development. South Korea in 1987, for example, already was 68% urban. Taiwan had an urbanization rate of 66% in 1980 and 74% in 1989. Japan’s urban population was 76% of the total in 1980.

Aside from the small urban population, China also has one of the largest urban-rural income gaps in the world, at higher than 3:1.

Conclusion: A Rebalancing Agenda for China 

China’s leaders have already concluded that the economy needs to be rebalanced to some extent, away from over-reliance on investment and exports, towards consumption.

The analysis in the previous section, of the sources of China’s investment bias, naturally points to a reform agenda in which the key measures address changes to the hukou system, land tenure for farmers, state enterprises, the financial system, and the incentives for local government officials.

Reforms of the hukou system are already under underway. The question remains, how thorough the reforms will be. The easy reform would be to maintain tight control over residency in wealthy coastal cities while encouraging farmers to move to second- and third-tier cities primarily in the center of the country, where most of the remaining farmers currently reside.

The problem with this approach is that it is the coastal cities that have the high productivity and income. The biggest economic benefits would come from allowing more people to move to these locations.

They already have excellent infrastructure, which may need to be expanded somewhat to accommodate new entrants, but this would be a relatively inexpensive approach.

The alternative involves building up infrastructure in the second- and third-tier cities, a relatively investment-heavy approach. Having a large new target for investment may appeal to central officials who only want to see the growth model change very gradually.

The risk, however, is that such a directed approach to building new cities may not generate the desired efficiencies, so that China is stuck with the bill but not with the benefits. The pull factor for migrants is the attraction of better jobs in the cities.

The new cities in the center of the country may not in fact have enough jobs once their construction is finished

China development compared to Japan, South Korea and Taiwan


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