Will China be able to catch up with Greece?

The goal of China's leader Xi Jinping to achieve the level of an upper-middle-income country by 2035 seems unlikely. The country faces serious obstacles in the form of an aging population and declining returns from its investment-driven growth model. Additionally, there are other factors that could hinder growth, including increased state control over the economy, emerging credit issues in the real estate sector and other industries, as well as restrictions on access to crucial foreign technologies. Even assuming generous conditions for future growth, China is likely to only narrow the gap with high-income countries by a small margin in the coming years.

In his statements, Xi Jinping did not specifically indicate which group of developed countries he belongs to, but it can be assumed that he was referring to the group of "Developed Economies" defined by the International Monetary Fund. This group includes thirty-two economies, with per capita incomes in 2022 ranging from $36,900 per capita (Greece) to $127,600 per capita (Singapore) based on purchasing power parity. We define the "average level" as starting from the 25th percentile of this group, which corresponds to a per capita income of $49,300.

Currently, China is a middle-income country, with a per capita income of $21,400, which places it slightly above the 60th percentile of the global income distribution. China has a significant distance to cover to reach our income level. To achieve this, per capita income needs to grow 2.3 times, which corresponds to an average annual growth rate of 6.6 percent by 2035. To reach the current income level in Greece, the annual income growth rate would need to be 4.3 percent.

The analysis of history highlights the complexity of this task. Of the forty-three countries that reached China's income level by 2009, none were able to achieve the necessary growth rate to elevate China to the 25th percentile of developed countries in the following thirteen years. The median income growth rate for this group is 3.1 percent, and only five countries showed growth above 4 percent. For the twenty-four countries with incomes above $49,300, it took an average of thirty-two years to rise from China's current income level. Only two of them accomplished this in less than twenty years.

Optimists on the rise

Optimists in growth undoubtedly point to the strong growth trajectory of China since the start of reforms in the early 1980s. Per capita income grew by 6.5 percent from 2009 to 2022 and was even faster during the two previous thirteen-year periods (9.4 percent from 1996 to 2009 and 8.8 percent from 1983 to 1996). China was the leader in per capita income growth globally during all three periods.

China's past growth performance is indeed impressive. However, official data shows a slowdown in income growth since the mid-2000s. The authorities' goals are to change or at least halt this trend.

Moreover, these figures take China's official statistics at face value. There has long been skepticism regarding the accuracy of Chinese statistics, as we discussed in our previous work, and many analysts believe that growth is systematically overstated. Economist Harry Wu confirmed this viewpoint by proposing a number of adjustments to the official data. These adjustments formed the basis for alternative series published in leading international databases, such as the Penn World Table and the Total Economy Database of the Conference on Economic Issues. China's income growth remains exceptional even after these adjustments, ranking in the top ten of the global distribution in each of the last three thirteen-year periods. However, this data shows that growth has already slowed to "only" 4.4 percent from 2009 to 2022 - barely fast enough to lift China to the bottom of the list of developed economies by 2035 - and an even slower pace over the last five years.

Discussion about China's actual growth rate.

The discussion about China's real growth rate is still ongoing. Fortunately, we don't need to resolve it. As we will see, the analysis of the changing sources of growth in China indicates that it will fall below our estimates, even if the official data is accurate.

The standard neoclassical growth model provides a useful framework for assessing China's growth prospects. According to this model, economic growth comes from two main sources: increases in labor and capital investments and improvements in technology. Contributions to growth from labor and capital are equal to the increase in these investments, weighted by their share in production value. The contribution to growth from technology (referred to as "total factor productivity" or TFP) is calculated as the residual - the increase in output that cannot be explained by the growth of investments.

The neoclassical perspective highlights two fundamental limitations for China's future growth performance.

A high share of investment in GDP in China - over 40 percent since the mid-2000s - supports rapid capital accumulation in the country. Indeed, China's capital productivity is now one of the highest in the world in terms of purchasing power parity. However, capital accumulation is subject to diminishing returns: each increase contributes less to growth when capital is abundant than when it is scarce. Moreover, as capital grows relative to output, a larger share of new investments must be directed towards compensating for losses due to depreciation. The impact of diminishing returns is already becoming evident. According to our estimates, the increase in capital investment contributed an average of 3.4 percentage points to GDP growth from 2018 to 2022, compared to 4.3 percentage points from 2013 to 2017.

In our previous work, based on a neoclassical model, we concluded that the contribution from capital will continue to decline in the coming years, even under favorable assumptions. Updated forecasts based on new data confirm this conclusion, suggesting a contribution of 1.4-1.9 percentage points in the period up to 2035. At the same time, we expect that the decline in contributions from labor and capital will reduce income growth to below 4 percent without a compensating acceleration in TFP growth.

However, a sharp increase in TFP seems unlikely, as labor productivity in China is already very high, averaging 1.8 percent since 2009. Only five out of the forty-three countries that reached China's income level in the past experienced such high TFP growth in the following thirteen years. None of them managed to exceed this rate by more than a few tenths of a percentage point. In other words, China needs to achieve TFP growth that surpasses rapid historical precedents to meet its official income targets. Moreover, these estimates assume that the official growth figures are accurate. If Wu's lower growth rates are true, TFP growth has already dropped to around zero.

Structural obstacles to China's growth

In our view, the combination of long-term and new structural obstacles will make it difficult for China to maintain its past performance levels, let alone exceed them. Long-term obstacles have already been widely discussed in other studies, including our own work, and we will simply list them here. Alongside this, new obstacles have emerged. China's growth has long depended on activity in the real estate sector (with some estimates suggesting that real estate accounts for a quarter of economic activity). Chinese authorities have traditionally relied on credit regulation and oversight to smooth out GDP growth cycles in the sector. However, over the past two years, activity in the real estate sector has continued to decline, unresponsive to the authorities' efforts to support activity.

The current tensions in the real estate sector serve as an example of a broader issue with the transition from growth based on credit and investments. However, these problems have their own dynamics. The shift from investment-driven growth will require a significant redistribution of government spending from investments to consumption and transfers to households. At the same time, overall government deficits and debt are already very high. Any change in spending priorities will be associated with the politically complex issue of restructuring government debt.