China Has a Productivity Opportunity: McKinsey

To prevent a hard landing, China needs to avoid overbuilt industries and direct investment to sectors that have the ability to raise productivity.
Katie Kuehner-HebertJune 23, 2016

If China shifts gears and embarks on a new approach centered on productivity, the country could generate 36 trillion renminbi ($5.6 trillion) of additional GDP by 2030, compared with continuing on the investment-led path. That’s according to the McKinsey Global Institute report, “China’s choice: Capturing the $5 trillion productivity opportunity,” released Thursday.

“The nation faces an important choice: whether to continue with its old model and raise the risk of a hard landing for the economy, or to shift gears,” the authors wrote.

The report ticked off a growing list of red flags for China: last year GDP growth dipped to a 25-year low, corporate debt soared, foreign reserves fell by $500 billion, and the stock market dropped by nearly 50%.

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In addition, more than 80% percent of economic profit in the country comes from financial services — “a distorted economy,” the authors wrote.

However, China could create more sustainable jobs, reinforce the rise of the consuming middle class, and accelerate progress toward being a full-fledged advanced economy if the country adopted a new productivity-led model, the authors wrote.

This would require steering investment away from overbuilt industries to businesses that have the potential to raise productivity and create new jobs. Weak competitors would need to be allowed to fail rather than drag down profitability in major sectors. Consumers would have more access to services and opportunities to participate in the economy.

“Making this transition is an urgent imperative,” the authors wrote. “The longer China continues to accumulate debt to support near-term goals for GDP growth, the greater the risks of a hard landing.”

While the authors themselves do not expect that a systemic banking crisis would occur if China did not switch gears, they wrote that following the current course would result in a spike in nonperforming loans at banks, which would then result in bank capital impairments.

The country would then have to replenishing banks’ capital by as much as 8.2 trillion renminbi ($1.3 trillion) in 2019. Every year of delay could raise the potential cost by more than 2 trillion renminbi ($310 billion), the authors said.