Guest Contribution: “China’s Great Leap Backward”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared at Project Syndicate. The author thanks Sohaib Nasim for research assistance.

October 23, 2023Ten years ago this November, the 18th Central Committee of China’s Communist Party held its quinquennial Third Plenum.  The meeting decided on a set of reforms that were well-chosen to sustain the national growth rate.  But the reforms have not been implemented, contributing to a big slowdown in the economy.

  1. The decline in Chinese growth

As of ten years ago, 2013, a naive extrapolation of the differential in growth rates between China and the US suggested that the number two economy would overtake the number one economy by 2021 (when GDPs are compared using nominal exchange rates). Some even said the cross-over year would be 2019. This did not happen; the US economy remains far ahead.  Goldman Sachs and others now project that China’s GDP will not catch up with US GDP until 2035, if ever.  Even if the crossover occurs, it may be only temporary.  The Chinese economy is forecast to peak sometime in the middle of the century, after which the ongoing decline in the labor force will outweigh productivity growth.  This drastic revision of crossover forecasts is one indication of how sharply trend growth in the Middle Kingdom has been revised downward since 2013.

To be sure, China’s GDP has already passed US GDP if the two are measured in PPP terms (in 2017reported in 2020). But for many purposes, such as projecting military force or determining the size of quotas at the IMF, the comparison at current exchange rates is more important than the comparison at PPP rates.

It was probably inevitable ten years ago that the Chinese economy would slow down in the subsequent decade, relative to its preceding three decades of growth averaging 10 percent per annum, a globally unprecedented accomplishment.  Among the likely reasons to expect the  slow-down were technological catch-up, diminishing returns to capital, aging of the population, diminishing returns to rural-urban migration, a possible middle-income trap, and simple regression to the mean.  But the slowdown has been more severe than expected (even if one trusts the official numbers), or than it need be.

  1. The promises of 2013

The reforms that were announced by the Third Plenum in 2013, supposedly with a deadline of 2020, were sensible, whether judged from the standpoint of Chinese or foreign economists. The role of the state in the economy was to be reduced, and the market was to become the “decisive force in the allocation of resources.”  The importance of State-Owned Enterprises (SOEs) in the economy was to shrink, relative to the importance of private firms.  For example, private investors were to be given a rising equity share in SOEs and the SOEs were to return more profit to their owners as dividends.  The government was to simplify approval procedures, to state explicitly which industries would remain under state control, and to deregulate prices for energy and other inputs that firms buy from utilities (thus curtailing one form of SOE subsidies).

The financial system was to be liberalized, allowing more cross-border capital mobility. Rural residents were to be granted better land rights, hopefully allowing them the right to own and sell property, rather than facing confiscation by local officials, who sometimes expropriate land to build unneeded apartment towers.  The hukou system was to be reformed so as to allow urban newcomers access to the same health, education, and other public services as long-time residents.  The disastrous One Child policy was to be eliminated.  Emphasis in the economy was to shift from heavy investment and export components to household consumption.  The environment was to be cleaned up.

  1. Reforms retracted

A few of these reforms have been pursued during the intervening ten years. Some initial progress has been made on the environment.  The one-child policy was ended (though, for some reason, families are still limited to three children).

There has been a re-balancing toward domestic consumption, as opposed to over-dependence on export demand.  This shift is evidently what is implied by the slogan “dual circulation,” adopted in 2020.  The more fundamental driving force behind the reduced importance of international trade has been adventitious developments: Trump’s trade war, the Covid pandemic, over-extended international supply chains, and the general decline in relations with the United States and its allies.

But most of the reforms have not taken place; in fact, the reverse.  This helps explain the growth slow-down.

The role of the state in the economy has increased relative to the private sector. For example, the flow of loans to SOEs rose after 2013 while the share of loans going to private firms fell.   Productivity tends to be higher among private firms than among SOEs;  thus, the reality of greater emphasis on SOEs, rather than less, is one of the reasons why productivity growth has slowed since 2013.

American trade negotiators have objected to an overactive role for the state in the Chinese economy (particularly the “Made in China 2025” campaign).  This is ironic, if the economists are right and the aborted market-minded reforms would have been good for Chinese growth.

  1. Macro stimulus missing in 2023

If China’s government has enlarged its role in microeconomic and structural policies since 2013, its inclination to follow activist macroeconomic policy has diminished.  During the first 13 years of the century, the authorities made good countercyclical use of monetary and fiscal policy.  The People’s Bank of China responded in a timely manner to overheating in 2007-08, by raising interest rates as well as tightening reserve requirements on banks and loan-to-value ratios on mortgages, successfully curtailing inflation. It did it again in 2010-11.  In between those two overheating episodes, monetary and macro-prudential policies were loosened in 2008-09 in response to the Global Financial Crisis.  At the same time, the government undertook a big old-fashioned Keynesian increase in spending.  As a result, China recovered rapidly from the recession.

In 2022-23 output has fallen even below the slowed path of potential output, in the aftermath of a burst housing bubble and the contractionary effects of the zero-Covid policy.   Yet, monetary and fiscal policy have not responded to the most recent recession with the usual counter-cyclical adroitness.  In other words, GDP is currently depressed both by the failure to enact the structural reforms and by the failure to follow countercyclical macroeconomics.

How can one explain the contrast between a new wariness toward fiscal stimulus, on the one hand, and a generally enhanced long run role for the national government structurally, on the other hand?  It can be partially reconciled by observing that much of the spending in 2008-2009 and other past expansions has come from local governments, which are not under the full control of the central government.  A further reconciliation is to note that a natural way to stimulate the economy would have been to implement transfers to raise the disposable income of households and thereby stimulate their consumption; but this would mean increasing the role of the private sector, which is not the government’s revealed preference.

Ultimately, there is a genuine tension between the roles of the market and the government.  Financial liberalization was halted in part as a reaction to financial instability such as the crash of a stock market bubble in June 2015.  And in part to impede the switch to net capital outflow and yen depreciation, which began in late 2014 and disrupted foreign exchange markets in August of 2015.

  1. Chinese politics

If the reversal of the 2013 reforms has slowed growth, why has President Xi Jinping chosen this path?   Deng Xiaoping, leader of China from 1978 to 1989, famously made “getting rich” the national priority, which it was to remain for 40 years.  The Third Plenum of 2013 did not constitute the ascendance of Xi Jinping thought, even though he had already taken office by then.  That ascendance came in 2017, as he consolidated his power.  Xi is said to emulate Mao Zedong more than Deng. It used to be said that the Chinese government was committed to delivering continued economic prosperity, as a means of retaining popular support for the repressive regime.  But, for Xi, it is the other way around: political control by the Chinese Communist Party takes precedence over the economy.

This month is not the 10th anniversary of a watershed shift in China toward greater emphasis on market reforms.  It is, rather, the 10th anniversary of their zenith.


This post written by Jeffrey Frankel.

48 thoughts on “Guest Contribution: “China’s Great Leap Backward”

  1. Erik Poole

    ” The disastrous One Child policy ” -J

    Really? Draconian yes but was it not an important part of the growth success and the major accomplishment of pulling millions of people out of poverty?

    1. Ivan

      At first it was a productive and sensible policy to slow down population growth. However, the current situation is one of a diminishing and rapidly aging population – that is not good for GDP growth (although it may be good for other things).

      1. Moses Herzog

        Much of that had to do with gender choices, not just the one child policy. You had many families murdering the first child (sometimes more) if it turned out to be female. Babies and fetuses in dumpsters or inside bags with rocks in river ways.  I say murder, because some of them were killed after being birthed. This was good for college age and adult women as it presented them with more choices. But the ratio of women to men also created a lot of angry college aged or 20’s–30’s men later on. Maybe about post 2010. But I would think certainly by post 2015.

    2. Max B

      Dont use GDP ro compare, it includes too much fake growth. Example, googl and meta produce… nothing, and likely negative productivity.

  2. pgl

    The role of the state in the economy has increased relative to the private sector. For example, the flow of loans to SOEs rose after 2013 while the share of loans going to private firms fell. Productivity tends to be higher among private firms than among SOEs; thus, the reality of greater emphasis on SOEs, rather than less, is one of the reasons why productivity growth has slowed since 2013.

    Interesting observations. Alas – this will likely be met with the usual worthless babble from ltr.

  3. Bruce Hall

    While China’s economy is large in absolute terms, there is another measure:

    China make great claims about moving hundreds of millions out of poverty, but the catch is that the poverty line set by the Chinese government is $2.25/day in 2011 prices and adjusted for purchasing power. “…the U.S. first adopted an official definition of poverty, classifying people as poor if their daily consumption was less than $21.70 in 2011 prices, four times what the World Bank today considers reasonable and about 10 times what China believes is adequate.”

    1. pgl

      Brucie boy discovers what everyone else knew – income per capita is the issue all economists since Adam Smith focuses on. Way to go Brucie boy – you made it to the 19th century.

  4. JohnH

    This piece is a good example of the mindset of a Western, mainstream economist. However, not everyone shares that mindset. Others have a different view of what “the economy” is all about–much more than fixating on and maximizing GDP.

    Reuters: “BEIJING, Sept 2, 2021- President Xi Jinping has called for China to achieve “common prosperity”, seeking to narrow a yawning wealth gap that threatens the country’s economic ascent and the legitimacy of Communist Party rule.

    “Common prosperity” as an idea is not new in China, but a sharp escalation in official rhetoric and a crackdown on excesses in industries including technology and private tuition has rattled investors in the world’s second-largest economy.

    Xi, poised to begin a third term in 2022, is turning towards inequality after concluding a campaign to eliminate absolute poverty, pledging to make “solid progress” towards common prosperity by 2035 and “basically achieve” the goal by 2050…

    Chinese leaders have pledged to use taxation and other income redistribution levers to expand the proportion of middle-income citizens, boost incomes of the poor, “rationally adjust excessive incomes”, and ban illegal incomes.”

    No wonder investors, their Congresscritter lackeys are rattled, and mainstream, Western economists are flummoxed by what China is trying to accomplish. It is incomprehensible, if not downright anathema to an economic elite that thrives on stagnant wages, increased financialization and rents, and rising wealth and power of the 1%, all of which is a feature, not a bug, of today’s Western capitalism.

    Looked at from the mindset of the Chinese, they probably consider t the past 50 years to be “the West’s Great Leap Backwards.”

    1. Ithaqua

      Congresspeople and Western economists are rattled and flummoxed by the idea that illegal incomes should be banned… which the adjective “illegal” would indicate they already are… uh huh. “Rationally adjust excessive incomes” is surely a frightening concept if you’re not one of the government officials deciding, on who knows what basis, what is “excessive.” I wonder if Xi’s family’s income, including the illegal bits, will be deemed excessive. And the concept of using taxation and income redistribution to boost the incomes of the poor! Unheard of in the West! Flummoxing and frightening indeed.

      One wonders whether the top 1% in the West is more powerful than the top 1% in China. I rather doubt those in the West have even a quarter of the power of the top echelons of China’s government, which, of course, is a feature, not a bug, of today’s Chinese communism.

      1. JohnH

        The article notes that the Chinese government thinks that China has too many unconscionably wealthy people…and intends to address the problem, which is a public policy goal diametrically opposed to anything I hear in the United States. Instead, the fixation is on GDP growth, which is a pretty good proxy for the growth in incomes of the top 10%.

        Where are the government officials in “the world’s greatest democracy” who overtly express an intention to address the problem of unconscionable wealth here? Well, to be fair, they can’t, because they have all been bought by wealthy people…a democracy of Big Money.

        From what I see, the commenters here and mainstream economists with few exceptions barely give inequality, stagnant wages, and rising rents a second thought, indicating a notable lack of interest in addressing the problem. Instead, they carp at a government that expresses the goal of “common prosperity,” a policy that threatens their beloved oligarchs.

        1. pgl

          “The article notes that the Chinese government thinks that China has too many unconscionably wealthy people…and intends to address the problem, which is a public policy goal diametrically opposed to anything I hear in the United States.”

          If you are telling us no one in the US wants to tax the rich more – you are the dumbest troll ever. Yea Mitch McConnell wants to tax the rich less but there are many people who disagree with him.

          Now you may hope Xi turns into some progressive hero but nothing indicates he is about to do anything about the inequality. Of course we know what your good buddy Putin is doing – taking everything from the Russian economy he can get his hands on to turn over to his billionaire buddies.

        2. pgl

          “he commenters here and mainstream economists with few exceptions barely give inequality, stagnant wages, and rising rents a second thought”

          That is a bald faced lie. Your dishonesty is childish, stupid, pointless, and just plain boring.

        3. Ithaqua

          What the Chinese government *says* – e.g., concerning Xinjiang – and what it *does* are not always the same. Also note in the OP the 2013 statements about diminishing the role of the SOEs in the economy, followed by an actual increase in the role of the SOEs.

          Oh, and here are some government officials in the world’s greatest democracy who want to raise taxes on the rich: Observe the intended use of the increased revenue: to help fund safety net programs! This is the very same income redistribution technique which, in your opinion, “flummoxes” Western economists and “rattles” members of Congress!

          If you only read Republican stuff, sure, I can understand your belief system, but otherwise… just no.

          1. pgl

            Nice job of rebutting the lies of little Jonny boy with the facts. But remember – little Jonny boy lives in a fact free world.

    2. pgl

      “not everyone shares that mindset.”

      Yea – there are trolls like JohnH whose ‘mindset’ is incessant chirping such as this worthless comment.

    3. Macroduck

      Same old Johnny song. Johnny, who has demonstrated an appealing lack of understanding of economics, pretends to lecture the rest of us. His shtick is consistently that conventional economics is wrong, while he’s right, but he has never provided convincing evidence for any of his claims. Just little soapbox episodes like this one.

      Johnny, the grown-ups are talking.

    4. Macroduck

      Looks like Johnny copy-pasted at least parts of this diatribe from someplace else – someplace outdated:

      “Xi, poised to begin a third term in 2022, is turning towards…”

      And this is the kid who pretends to know special “non-western” stuffabout economics. What a poser.

  5. JohnH

    “China will do utmost to contribute to Palestinian-Israeli reconciliation, state media says.”

    Heck, they already brokered a reconciliation between Iran and Saudi Arabia.

    The way things are going, China is fast becoming the indispensable nation…using diplomacy, not guns.

  6. Noneconomist

    Having led the crowd in cheers for the Taliban, JohnH now turns his attention to China. Pom poms again raised, he yells “yay China!” Before adding “let’s hear it for Xi, second best leader after Putin in the whole world.”

    1. pgl

      Note Jonny boy’s source:

      China will do its utmost when it comes to contributing to Palestinian-Israeli reconciliation, its foreign minister told his Israel counterpart in a phone call on Monday, according to Chinese state media.

      Yea – that’s an unbiased source. Xi! Xi! Xi! Two bits four bits six bits a Yuan!

    2. JohnH

      Stated like a true believer in profits over people and war over peaceful conflict resolution,,,standard Western official mindset.

      1. pgl

        Little Jonny boy cannot argue facts so he hurls stupid dishonest and childish insults. Hey troll – you have been doing this for many years and EVERYONE here knows that. Yea – you are not only stupid and dishonest. You are a laughing stock. We would ask you to grow up one day but your mommy tells us you are incapable of doing so.

      2. Macroduck

        What??? pgl, who is an enemy of corporate tax avoidance, is a champion of the rich? Only in Johnny’s lying little story. pgl just called out Russia’s uber-rich, and Johnny tried to distract us by pretending things are the other way around.

        Let’s remember, some of Johnny’s policy ideas serve the interests of the rich over the non-rich, high interest rates in particular.

        1. pgl

          I guess that material I posted on how the IRS is finally going after Microsoft was too long for little Jonny boy to read.

  7. pgl

    Will Tom Emmer be the next Speaker of the House? He would not be my first choice but it seems Trumps hates this guy so he can’t be all that bad.

    1. Ivan

      He also can’t be elected – Trump immediately branded him a RHINO so he had to withdraw.

      We are getting closer to the point where GOP will see defectors refusing to vote or outright voting for Jeffries. If 10 GOP members vote “present” then Jeffries will get a majority of the votes that are cast. The house would get a speaker, but that speaker would have to get support from at least 5 GOP members for anything that he wanted to pass.

  8. Macroduck

    “The one-child policy was ended (though, for some reason, families are still limited to three children).”

    Wild guess…urbanites tend to want fewer children than farmers. Farmers are not part of the plan to take over the world or whatever, so farmers having more children than urbanites is contrary to the plan.

    1. pgl

      One has to wonder how the elderly in China are going to pay for their retirements. I have an idea – let Nikki Haley run China as she will tell them they get to retire when they are 80 years old.

  9. pgl

    A little off topic but I have been trying to tease out one of the narrow details from that Tax Notes paper on Microsoft’s battle with the IRS over transfer pricing which goes to how to estimate its cost of capital. The authors of that paper use the old fashion Capital Asset Pricing Model (CAPM) which Macroduck alluded to (alas in one of those unfortunate duels with our Village Moron JohnH). This model comes down to three keys things:

    Risk-free rate + Equity Risk Premium*Unlevered Beta

    Microsoft has a very low debt/equity ratio so when this author’s guru says equity beta is just over one take it to mean the unlevered beta coefficient is near one. And one of Aswath Damodaran’s measure gives us a reason to suggest that the equity risk premium = 5%.

    Now the risk-free rate is often measured by the 20-year government bond rate which is now around 5.25%. So one could readily argue that Microsoft’s cost of capital has risen to 10.25%.

    And yet its stock price is soaring. Now one might be dumb like Princeton Steve and Jonny boy to suggest basic finance is bunk and we have a Microsoft bubble. Of course the value of any asset depends on expected future cash flows. And do what Princeton Steve and JohnH never do – read the Microsoft 10-K filing. Yea – the AI revolution may be driving this stock boom. Unless of course the Chinese steal Microsoft’s technology!

    1. Macroduck

      Just a tiny point. The 20-year is way out of favor right now:

      Odds are, it won’t stay that way. It might be worth extrapolating a 20-year rate between 10 and 30, based on historic norms, to get a lower end of a range, with the market yield giving the high end

      1. pgl

        Check how Damodaran measures these things. The equity risk premium is measured as the difference between the return to equities and the return to 20-year government bonds. I know people do this differently but consistency is how one defines the risk free rate and the market premium is a must.

      2. pgl

        Interesting graph. I have heard of upward sloping yield curves and inverted yield curves but this is more like a roller coaster.

  10. Macroduck

    Maybe, just for a while, we should ignore the troll choir and look at Professor Frankel’s argument. If I understand correctly, the main point is that China had a good set of policies on paper, but abandoned them. If so, then as long as the environment hasn’t changed too much, pursuing policies which Chinese policy makers – not western, Chinese – thought were a good idea might improve China’s performance.

    That raises an interesting question – why did China abandon the policies that its leaders had adopted? I’m not asking “who?” We all know the answer to that one. Why?

    There are plenty of options which any of us could think up, and many of them make sense. This, however, is where I’m going to put my money, for now: Xi is no more an economist than Johnny is, so he may be vulnerable to the same sort of errors in thinking as Johnny. If you see economics as an arbitrary and sometimes contradictory set of made-up rules, it’s easy to allow your own priors (or interests) to dominate your thinking. If you understand economics, your choice are more constrained.

    I don’t imagine Xi’s predecessors relished the idea of surrendering control of the economy to private actors, any more than they relished allowing increased personal freedom in other spheres. But they realized the gains that relaxing state control would provide. The Party would have a smaller slice of the pie, but the pie would expand so fast that the Party would come out ahead.

    Xi doesn’t like sharing power with billionaires and journalists and academics any more than his predecessors did, and he doesn’t have the background – the inclination, perhaps – to understand what relaxing the dead hand could accomplish. They compromised because they wanted China to become great. Xi has reversed their compromise because he thinks he can mandate greatness.

    That’s my bet. If it’s near right, then China can switch to a healthier path, as soon as sound judgement replaces ignorance.

    1. pgl

      As an undergraduate taking both economics and Russian history, I decided to write my senior thesis on Lenin’s New Economic Policy which I argued showed some promise. But Lenin’s ideas were abandoned and we know how Russia’s economy suffered. Of course we might get a Know Nothing like Jonny boy arguing the Soviets cared about income equality, which of course is up there with his usual stupid rants.

    2. Ivan

      Autocrats quickly get surrounded by yes men. Those who dare speak up are removed and the rest are either true believers in the leader or survivors who know how to keep their heads low and survive. When Xi basically told young unemployed people to stop whining, it was clear he had no idea of how the economy works – or how to make young talented people want to stay in China. My guess is he will be more of the iron fisted old style “planned economy” leader than someone who understand what drives human beings. He is way too conservative to salvage or build the consumer class – the only thing that could bring China up to Western levels.

  11. David O'Rear

    China’s policies pre-Xi were Deng Xiaoping’s policies: Deng laid down the law on relaxing economic controls, established a collective leadership, opened the economy to the global marketplace, and did it all while constantly reminding everyone that it was a marathon and not a sprint.

    Jiang Zemin had to fight to establish his own credentials after Deng died (1997), and since he wasn’t going to be allowed to anoint his own successor (Deng chose Hu Jintao), Jiang decided to copy Deng’s decision to remain as head of the armed forces. Part of Jiang’s gaining control involved letting the army make a ton of money in business, which led to corruption getting out of control.

    Hu Jintao was hamstrung by Jiang from the start, and never really got his feet under him. He was a continuation of the Hu Yaobang / Zhao Ziyang liberalization, relaxation, and opening up slowly approach, but he didn’t have the chops to crack down on corruption.

    Xi Jinping capitalized on the remaining old guard (Qiao Shi, Wu Bangguo) being disgusted with corruption and carried on purging anyone and everyone who might challenge his grip on power. (Remember: Bo Xilai fell before Xi rose to the top jobs.) Jiang’s Shanghai Clique – which helped elevate Xi – wasn’t immune, Hu Jintao’s Communist Youth League gang was an easy target, and finally Xi had the political room to clean house in the PLA.

    Along the way, many of the best and brightest economic minds were sacrificed as being insufficiently toady. Their replacements knew that the sole economic policy was Whatever Xi Wants, Xi Gets, which is a poor way to handle a crisis like the pandemic, let alone the underground financial system.

    [cue childish insults]

    1. Moses Herzog

      Many of China’s leaders were, and probably still are, to a lesser degree than in years past, chosen in Beidaihe. The machinations and permutations of said decisions in Beidaihe, not even the “singularly genius” and B-grade poli sci analyst Mr. Rear could explain to us. Mr. Rear might have mentioned that piece of information if he wasn’t regurgitating what every major western newspaper has already told us in boilerplate prose 200 times over.

  12. Ivan

    More and more companies are getting smart with relation to producing advanced products in China:

    They are required to have local partners who will then rob them of all knowhow and intellectual property. Then those local “partners” get government help to set up their own shop and outcompete the foreigners who provided the training and knowledge that allowed them to succeed. This has always been a problem, but the Xi government has been particularly ruthless (stupid) with this approach and high tech companies are beginning to understand how little is in it for them. They literally are training, funding and setting up their own competitors. China is a great place for producing low tech low pay products for multinationals, not a place for anything sophisticated.

    1. Moses Herzog

      Somebody has been saying this exact thing, dozens of times, over a period of years, (about since 2009) both here and on Baselinescenario’s now defunct blog. I forgot his name now.

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