At your service: China's new economic chapter

China’s economy looks to have made a historic transformation, with the services sector finally snaring the single largest slice of GDP. Now it can no longer be seen as a single entity.

China consumption shopping economy

The year 2013 may well mark an historic step in China’s economic development. For the first time, according to just-released official statistics, China’s services sector accounted for the single biggest share of GDP.

In a year which saw China’s official GDP increase 7.7 per cent over 2012, services accounted for 46 per cent of GDP compared with 44 per cent for manufacturing and 10 per cent for agriculture. If sustained, this would mark the point at which China’s economy began to enter a more mature stage of economic development.

This rebalancing of China’s economy will be welcomed by the leadership, which has set down growth of services as a major policy objective. A raft of reforms to promote growth of the services sector was set out in the Third Party Plenum decision late last year. 

As has happened before in the course of China’s thirty-five years of economic reform and opening, policy settings are being aligned with the direction of market-driven economic change. When the two are aligned, as we saw with the ‘Western Development Strategy’ in the early years of the Hu Jintao administration, this can be a powerful force for change.

The growth of services as a share of GDP began to take off in 2006 as the rapid increase in per capita incomes from the early 2000s gathered greater momentum. In fact, it should be of no surprise that services have now become the biggest sector. The growth of the share of services in GDP is the normal course of economic development as incomes rise.

In 2012, China had six provinces, all of which except Inner Mongolia (which is an outlier because of its small population and extensive coal mining) are on China’s eastern seaboard.  These provinces (Tianjin, Beijing, Shanghai, Jiangsu, and Zhejiang) had nominal US dollar per capita incomes above $10,000 and purchasing power parity per capita incomes above $15,000. Together these provinces have over 200 million people. In PPP terms, these provinces would rank with Portugal, Lithuania, Poland and Mexico. Except Lithuania, these are all OECD member countries.

China’s economy can no longer – if indeed it ever could – be discussed as a single entity. It is rather like an inverted pyramid composed of at least three broad layers.The top section in terms of income are the advanced eastern seaboard provinces and major cities like Dalian, Qingdao, Ningbo, Fuzhou, Shenzhen and Guangzhou, all with developed-country levels of per capita income.

The next level comprises provinces with developing country levels of per capita income, including coastal areas such as Guangdong, Fujian and Shandong and central inland, such as Hebei, Shaanxi, Shanxi and Hubei. The rest make up lower levels of per capita income that cover the income ranges for less developed countries.

Rebalancing the economy towards services and away from investment-led growth to consumption is occurring as the different provinces move through different levels of economic development. In its latest survey of business conditions in Shanghai, the Amercian Chamber of Commerce describes the emergence of a consumption/services-based economy “as the new normal”.

Reflecting this adjustment to the sources of growth, in 2013 growth in investment in fixed assets fell below 20 per cent (19.6 per cent growth in 2013 compared with 2012) for the first time in over a decade.

But this was only for the more developed provinces and cities. For much of the rest of China, the investment-led growth model of the past still has a lot of relevance and therefore a long way to run. Growth rates in these provinces are still generally well above the national average. The government’s policies to promote urbanisation with the objective of moving another 300 million people into cities will continue to require massive investment in urban infrastructure and housing.

Urbanisation and the relatively high rates of investment that will accompany it in the poorer areas of China will ensure that notwithstanding the growth in services, China’s economic growth will still require a lot of resources and energy for many years to come.

Services are notoriously difficult to measure. Much is not captured, especially in the informal sector of the economy, and so China’s services sector may well for some time have accounted for the biggest share of total GDP. It is, however, now captured in the official statistics formally marking the beginning of an important to chapter in China’s economic transformation. Overall, this should contribute to more sustainable growth, even if at lower rates than during the credit-fuelled investment binges of the past decade.

Geoff Raby is a Professorial Fellow at Monash University, a NED at Fortescue Metals Group and Chairman and CEO Geoff Raby Associates Ltd, a Beijing-based advisory firm.

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