Structural Transformation in the Chinese Economy: From Manufacturing to Services

Zhang Bin, PhD, Senior Fellow, China Finance 40 Forum & Chinese Academy of Social Sciences, Beijing

A version of this article was originally published in the Business Standard as ‘The way forward for the Chinese economy’, 18 March 2017. This is part of a series by Chinese economists facilitated by the ICS.

As part of the cycle of economic development, all advanced economies have undergone industrialization and post-industrialization. Industrialization involved the manufacturing sector’s focus on increasing GDP, employment rate and consumption of manufactured products. For China, the post-industrialization phase implies economic activities will be concentrate in the service industry.

Based on measures of income level, the rate of growth of the manufacturing sector, employment rate and the consumption of manufactured products, China has passed the peak of industrialization. If global experience is a guide, the peak of industrialization happens when per capita GDP ranges between US$8,000 and US$10,000 (PPP based on 1990 value). After reaching the peak of US$10,000, the proportion of the industrial sector indicators continues to decline. By this yardstick, China has passed the peak of industrialization.

If one considers China’s per capita GDP figures these reached the US$8,030 mark in 2010, this was the point from where shifting from manufacturing sector to service industry had to occur. In 2016, per capita GDP (nominal) was around US$12,200. In 2006, nominal manufacturing growth rate reached its 30 years peak of 41.8% and it has decreased in subsequent years. The proportion of employment in manufacturing sector reached its peak of 30.3% in 2012 and started declining after that. According to available data, the consumption of manufactured products reached its peak in 2011 and has declined since.

Both, in terms of global experience and from a theoretical point of view unless there is a serious negative growth in income, these developments constitute a major inflection point for China. The demand for traditional labor-intensive or standard capital-intensive manufactured products has been steadily decreasing. This in turn has also dragged the economic growth rate down, both domestically and globally. This creates a need then for China to develop a ‘new engine’ of economic development.

A ‘new engine’ for China will need to cater to products and services matching the growth of income and changing patterns in demand. Demand for these products or services is growing faster than revenue growth, that is the demand elasticity is greater than 1, and spending on these products and services becomes the facilitator of economic development. From the perspective of the supply side, such products and services are also skill-intensive products and services.

A new engine of economic growth for China will require upgrading the manufacturing sector. Crossing the peak of industrialization, has also meant a drop in profits for most manufacturing sub-sectors in China. These pressures have also become the driving force for industrial upgrading in different ways. These include adopting technological innovation developing new products, horizontal and/or vertical integration of production to save per unit cost, improving labour and production efficiencies. Services within enterprises in the traditional industrial sector in China are now increasingly likely to hive off into independent specialized service providers.

So far, China has achieved significant progress in upgrading the manufacturing sector. In the field of high-end industrial products, the gap between advanced economies and China is noticeable but the ‘Made in China’ initiative is stepping up the pace and helping close this gap. In addition to brands, which produce products of daily use, there exist some well-known brands which are steadily increasing their competitiveness in both domestic and international market, such as Huawei, Hai’er, Guangdong-based Gree Electric Appliances, Xiaomi, digital and electrical equipment manufacturer Hisense, and automobile major Great Wall Motors, among others.

There are two distinct features of China’s evolving responses to economic transition. One involves creating an environment for industry upgradation and the other attempts to support an open and highly competitive market at home. China’s attempt is to showcase a unique economic model based on a position both as the world’s largest producer and consumer of manufactured products and of Chinese manufacturing enterprises having a broader market and the advantage of industrial clusters.

The new engine of Chinese growth will also be based on the development of technology-intensive and skilled human capital services. The contribution of such technology-intensive enterprises and skilled human capital to economic growth is not only an international experience but also fulfills China’s growth requisites. When one examines the average contribution of the service industry to GDP growth rate in last five years, a ratio greater than 1 indicates that the sector contributed significantly to China’s GDP growth rate.

As in the American case, not all technology-intensive services grow equally fast; the lower-skill/lower-tech service industries create the lag in the overall economic growth. Figures indicate that among the 14 major categories of services, 10 categories of services are growing at a faster clip than China’s GDP growth rate. The four sub-sectors of service industry with lower growth rates include transportation, warehousing, post and telecommunications services, hospitality and catering industry, residential and other services, public management and social organizations. However, these sub-sectors are already fairly well-developed in China.

Crucially, the fast growing areas include health, social security, social welfare, leasing and business services, finance, scientific research and technical services, geological prospecting, water conservation, environment and the management of public facilities. These are also the sub-sectors that require higher skilled human resources and are increasingly necessary for China.

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