The process of economic development in China has always been characterized by a remarkable regional heterogeneity due not only to specific amenities and local factors (such as geographical position, demographic structure, resources, and so on), but also to the development policies implemented by central and local authorities over time. The need to address regional imbalances has been clear to the Chinese élite since the late 1990s because for a long time differences in per capita income levels and in growth performances across provinces (as well as between urban and rural areas) represented one of the main determinants of the severe inequality that characterized the country. It was to acknowledge and tackle the problem that Prime Minister Wen Jiabao defined China’s development as unbalanced.
The focus of Chinese development policy has moved over time from the coastal areas towards the central and western regions and the strategy has been recently strengthened, although indirectly, by the Belt and Road Initiative (BRI). The decision of the authorities to expand and improve infrastructural endowments in the least connected areas has permitted absorption of part of overcapacity in the steel, coal and cement sectors and has also facilitated the urbanization process in the internal areas, lessening the excess of labor supply in rural areas. With a view to reducing individual and regional inequality, the authorities have also started developing effective redistributive measures to combat poverty, especially in rural areas.
Thepossibility of continuing this strategy of regional rebalancing in the future must be assessed in light of two fundamental drivers that had shaped China’s economic growth over the last 10 years: the supply of credit for investments and the pace of technological innovation.
Credit supply has expanded fast since the late 2000s and the overall level of debt in China rose from 160% of GDP to around 250% of GDP in just ten years. Thus credit was a key driver of the growth process, as exports and foreign direct investments had been the main engines of growth in previous decades. Such large credit availability was the result of a combination of political and economic factors. The central monetary and regulatory authorities have used all available levers to either promote or restrict the provision of credit (both by the banking system and the shadow banking system) so as to ensure that annual economic growth targets could be met while preventing the creation of financial bubbles and the outbreak of crises. This activity carried out at the central level was necessary due to the misalignment in the incentives given public officials and politicians at the local level. As keeping high rates of economic growth was progressively becoming more complicated for local authorities, they started to employ sophisticated financial instruments and methods (such as local government financing vehicles) to provide their territories with the resources necessary to finance the investments needed to achieve the desired income growth and to produce higher local tax revenues. Credit growth also expanded in order to meet the growing financial needs of the large companies operating in the public sector, whose investment plans were fundamental to ensuring the achievement of local and national annual growth targets. Credit abundance allowed the investment rate in China to remain above 40% of GDP, a value that is much higher than that recorded in other advanced and emerging countries. This implies not only that consumption has not yet become an important engine of growth in China, but also that the productivity and the profitability of new investments have fallen to levels that do not justify them and that do not fully guarantee the repayment of underlying loans. Credit efficiency (measured as the ratio between the change in credit and that in output) deteriorated over time, further increasing the extent of resource misallocation.Many regional banks are now in fragile financial condition and suffer from the expansion of their non-performing loans, from risky partnerships with non-bank financial institutions (necessary to transform loans into assets), and from the declining share of deposits in total liabilities. Hence, while political and administrative decisions have been a great boon for regional rebalancing, they also fed risks of financial instability and long-term structural problems.
Due to the growing misallocation of resources, it seems highly unlikely that returns from recent and future investments will equal those recorded in the past. This implies that it will become increasingly difficult for the authorities to preserve financial stability and, at the same time, boost economic growth and promote regional rebalancing via massive investments. Aware of the growing risks in the credit sector, moreover, Chinese regulators have already increased scrutiny and set more demanding rules to curb excessive lending and risky funding practices. The unintended consequence of these (appropriate) decisions is that private companies encounter greater difficulties in financing themselves than the enterprises connected to, owned, and controlled by the public sector, as the latter enjoy facilitated access to financial intermediaries. Hence, even assuming that the Chinese economy will continue to walk the narrow path of good (albeit lower) growth performance and ordered debt deleveraging, it is possible that the coastal regions, the most densely populated with private companies, might be harmed. Such a pattern of regional rebalancing would not be positive for China as a whole, as private companies are more dynamic and growth-enhancing in the long term. Indeed, the overall effect of a poor allocation of resources, whereby credit and investment get more concentrated in the public enterprises located in laggard regions, can reduce overall efficiency and increase the risk of instability. In the medium term, therefore, economic growth could be negatively affected in all of China’s regions. Short of making precise predictions about the future, these considerations aim to suggest that the discussion about the future of regional development in China cannot be separated from an analysis of how the credit sector will evolve, both at the local and at the national levels.
Against this complex backdrop, one needs to consider another important determinant of future economic growth in China, i.e., the progressive expansion of the advanced services and manufacturing sectors. Resources and efforts have been spent over the years to develop and to adopt avant-garde technologies, such as, for instance, artificial intelligence, quantum computing and the Internet of Things. The Chinese authorities aim at increasing the productivity and competitiveness of existing manufacturing businesses to compete with the United States for technological supremacy that is characterized by high rates of growth, and at improving the domestic allocation of resources by shifting away from declining-returns enterprises towards IT-producing companies. This process has already produced valuable results. According to the National Bureau of Statistics of the People’s Republic of China, the added value and physical capital investment in high-tech manufactures (at least for the companies above RMB 20 billion) increased by more than 10% last year. Although the benefits from this process will spill over and spread across the country, the development of such advanced activities will inevitably take place either in a few highly specialized areas (such as Shenzhen) or where more innovative and internationalized private companies are located. This new form of industrial agglomeration might prevent the rebalancing in the geography of jobs that has recently favoured the central and western regions. In the case of this type of growth engine, however, serious risks also exist. In particular, the Trump administration has made the United States change its attitude towards the evolution of advanced technologies in China from one of benign neglect to one of rivalry. Both fierce opposition by Western countries to this catching up process and the evolution of incompatible technical standards across the continents (as might be the case for the 5G markets) could curb the short-term impact of this potential source of growth in China.