Boosting China's Regions

Estimated reading time: 4 minutes

China’s recent woes – decelerating growth, falling currency, plunging stock market – suggest that the world’s main growth engine is spluttering. For some, it’s all very reminiscent of Japan in the early-1990s: a boom followed by a prolonged bust against a less-than-helpful demographic backdrop. Not all financial upheavals, however, lead to a permanent plunge in economic growth. And not all economies are quite like China’s.

Habitually, China is treated as a single economy. In truth, however, it’s more like an empire. Politically, it’s a particularly singular empire: almost 92 per cent of the population are ethnically Han Chinese. Economically, however, there are vast differences across its more than 30 provinces, municipalities and autonomous regions.

Of all the regions with a population of at least 1 per cent of the total, the poorest – Guizhou – has an average income per capita only 25 per cent of the richest – Tianjin. That compares with equivalent figures of about 35 per cent in the eurozone, 42 per cent in the UK, 46 per cent in Japan and 57 per cent in the US. This unusually large divergence – at least when compared with single currency areas in the developed world – may hold the key to China’s longer-term economic development.

The divergence exists for a variety of reasons. Most obviously, the coastal areas can easily trade with the rest of the world while the inland provinces are not so blessed. On the policy front, however, two factors stand out.

First, the creation of special economic zones allowed some regions to connect with the rest of the world much more quickly than others: in economics, openness matters.

Second, the Hukou household registration system of residency permits has prevented the spoils of economic development spreading quickly from the urban rich to the rural poor, even when the rural poor offer migrant labour to the urban areas. Rural-registered workers don’t enjoy the social security, healthcare and education benefits that accrue to their urban equivalents, and they regularly suffer broader wage discrimination.

For those familiar with Germany’s Gastarbeiter system, which operated mostly in the 1960s and the early 1970s, this will come as no surprise. Facing a severe labour market shortage, Germany invited guest workers in from Turkey, Morocco, Tunisia, Italy, Spain and Greece, among others. Turkish workers dominated: by the beginning of the 1970s, more than one million Turks were living in Germany. Yet they were mostly offered only the most low-paid and unskilled jobs: thus, there was little benefit to the Turkish economy if and when they went home. The gap between German and Turkish living standards remained painfully large – from a Turkish perspective – throughout the Gastarbeiter period.

Rural-registered Chinese workers are modern-day Gastarbeiters. Yet they don’t have to be condemned to perpetual poverty. Beijing has already signalled it hopes to dismantle the Hukou system entirely by the early 2020s. And we know from other European experiences in the 1970s and beyond that eventually living standards can converge. Spanish and Portuguese citizens have seen their living standards slowly catch up with those in Germany: in 1960, per capita incomes in Spain were only 40 per cent of those in Germany. By 2010, they had risen to 81 per cent.* The gap narrowed in part thanks to the opening up of labour and capital markets across Western Europe: economic borders were slowly dismantled. A similar result might occur in China in the years ahead.

This would be a story of growth through convergence, a far cry from the divergent model seen for much of the last four decades. Arithmetically, it’s easy enough to show that, even if the hitherto-booming coastal regions were to see growth slowing dramatically – to between 3 and 5 per cent per year over the next 15 years – China would still be able to grow at about 6 per cent a year if (and it’s a big “if”) the poorer regions were able to enjoy sustained economic catch-up.

But how? The danger with China’s current economic challenges is that they lead to a more “protectionist” approach from the richer regions. The Hukou system would then be dismantled only very slowly, there would be no swift move to a single labour or capital market and the status quo would be preserved.

The alternative is to focus on developing trade routes to the west. Beijing’s emphasis on its “One Belt, One Road” initiative is hardly surprising. If a new Silk Road could be created to China’s west – either through the likes of Kazakhstan, Kyrgyzstan, Tajikistan, Uzbekistan and Russia or, for those of a more risk-loving disposition, Pakistan, Afghanistan, Iran, Iraq and Syria – then Chinese growth would likely rotate westwards, eventually linking with Europe, leading to further economic convergence within China itself.

That, however, will depend on Beijing’s international statecraft and the behaviour of states over which it has no control. Contrary to popular opinion, China has the potential to carry on expanding at a rate faster than most others regardless of recent financial upheavals. It will not, however, be easy.