What Should China Do About Slowing Economic Growth?

China’s economy is slowing from its blistering pace of recent years. Recent data shows that GDP grew by 7.4 percent in 2014, the slowest rate for 24 years.

Premier Li Keqiang told global leaders attending the World Economic Forum in Davos that this slowdown is no cause for concern, that there would be no hard landing, and that China is now focused on ensuring an “appropriate” pace of economic expansion.

His remarks point to an important truth about China’s growth in the years ahead. It is not the precise rate of growth that is the key issue, but what drives that growth. What’s important for China is changing its growth model from one that is investment-driven to one that is productivity-led.

An aging China

China, in common with many other countries, is aging. Over the past 50 years, rapid population growth meant expanding labor pools, boosting growth. But population growth is now slowing—with major implications for growth.

China’s labor force could shrink by one-fifth over the next 50 years. On current trends, China could have one dependent aged 65 or more for every two working-age citizens. Peak employment could occur as early as 2024, concludes a new McKinsey Global Institute (MGI) report Global growth: Can productivity save the day in an aging world?

Productivity imperative

This puts the onus even more heavily on raising productivity to drive GDP growth. China has already made huge strides to improve productivity, which has increased 14-fold over the past 50 years, and been responsible for three-quarters of China’s growth over that period.

But because of dramatic demographic change, even at those rapid rates of productivity growth, over the next 50 years China could grow at a 30 percent slower rate—an average of 5.3 percent a year compared with 7.6 percent over the past half century.

That would still be a significantly faster rate than in other major economies but there is plenty of scope for China to accelerate its productivity-growth rate and do even better.

The opportunity

About 80 percent of the productivity opportunity MGI has identified in emerging economies such as China comes from catching up with best practice in operations and business approaches; the rest can come from innovation, not just in the use of technologies but through imaginative ways of managing businesses and processes.

Let’s look at four key sectors:

1. Today, China’s huge automotive industry has 67 percent of the productivity of the average in developed economies. But if China were to move from its large number of small plants to a smaller number of large operations, productivity could rise by up to 50 percent
2. In agriculture, there is huge scope to boost productivity through mechanization, which is still relatively low in China with nine tractors per 1,000 hectares compared with 27 in the United States and 16 in India. Taking Zhejiang Province as an example, the evidence suggests that mechanization could reduce the labor needed to cultivate rice by more than 40 percent. This of course has an implication for migration which is one reason why government policy in this area has been cautious
3. China is transforming retail through e-commerce players like Alibaba. By 2020, online sales could be as high as $650 billion, equaling the size of today’s US, Japanese, UK, German, and French markets combined. Online retail has far higher productivity than the bricks-and-mortar variety. Currently, labor productivity in China’s online retail sector is two-thirds of the US level, a much narrower gap than the 75 to 80 percent gap in retailing overall. If China’s online retailers were to match the productivity of their counterparts in other countries, this could boost overall retail productivity by 14 percent. In physical retailing, moving to modern formats is the most powerful way to boost productivity. Here, too, China is making progress. The share of traditional grocery stores fell from 31 percent of grocery sales in 2000 to 15 percent in 2009, largely through regulation encouraging more consolidation in the sector.
4. The productivity imperative is particularly acute in health care because spending is growing so fast. China’s spending has almost tripled in five years and is projected to reach $1 trillion by 2020. Making health care more efficient is a potent source of productivity. Today, patients spend an average of 10 days in hospital, which is expensive. But there are ways to reduce hospital stays. Japan has cut the (still lengthy) time people spend in hospital by nearly a week since 2000. It did so by moving toward less invasive surgical procedures, and using digital technology to monitor patients at home.

Slower growth can be smarter growth and China can continue its march toward prosperity. Productivity and innovation need to be front and center of this journey.

* * *

I'm a Director in McKinsey's Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China's urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories