Economic development ; Economic conditions - United States ; Economic conditions - China ; European Union

Xiaodong Zhu

English

Research Papers in Economics

FEDERAL RESERVE BANK OF ST. LOUIS REVIEW JULY/AUGUST 2009 343
Commentary
Xiaodong Zhu
on capital accumulation rather than TFP growth.
Because investment as a percentage of GDP has
exceeded 40 percent, the authors argue that further
increases in the investment rate, which would be
needed to maintain a growth rate of capital stock
similar to its recent average, is not sustainable and
therefore extensive growth cannot be sustained
in the long run. They suggest that a switch from
extensive to intensive growth is needed for China
to sustain its recent growth performance, thus the
emphasis on productivity increases.
The paper addresses an important question,
and growth accounting is the right place to start.
I am also sympathetic to the authors’ arguments,
especially their suggestion that TFP growth is
crucial for China’s growth performance in the long
run. However, a few puzzling facts about China’s
recent growth performance need to be accounted
for before we can judge the relative role of capital
accumulation and TFP in China’s recent growth
and make projections about its future growth.
First, given the high investment rates in recent
years, low returns to capital might be expected.
However, Bai, Hsieh, and Qian (2006) show that
this is not the case. They find that China’s returns
to capital have been around 20 percent in recent
years, which is not significantly lower than returns
to capital worldwide. If there has been no signifi-
cant TFP growth, how could China increase its
investment rate without lowering the returns to
capital?
Second, since 1978, when economic reform
started in China, TFP has grown substantially.
C
hina’s growth performance over the
past three decades has been remark-
able, if not unprecedented. A natural
question is whether China’s recent
pattern of growth is sustainable in the long run.
Zheng, Hu, and Bigsten (2009) use a standard
growth accounting framework to address this
question. They assume that the aggregate produc-
tion function is Cobb-Douglas: 
where At, Kt, and Lt are total factor productivity
(TFP), capital stock, and employment, respec-
tively, and α is the income share of labor. Accord  -
ing to their calculation using a labor share of 0.5,
the contribution of TFP growth to China’s gross
domestic product (GDP) growth has declined in
recent years. As they reported in their Table 1, the
average annual growth rates of GDP and TFP were
10.11 percent and 3.8 percent, respectively, for
1978-95 but 9.25 percent and 1.45 percent, respec-
tively, for 1995-2007.  In other words, the contri-
bution of TFP growth to GDP growth declined by
38 percent in the first period and 16 percent in
the second period. In contrast, the average growth
rate of the capital stock increased from 9.12 per-
cent in the first period to 12.81 percent in the
second period. So the contribution of physical
capital accumulation increased from 45 percent
in the first period to 69 percent in the second
period. Based on these calculations, the authors
suggest that in recent years China has pursued
an extensive growth strategy that relies heavily
Y A K L t t t t =
− 1 α α,
Xiaodong Zhu is a professor of economics at the University of Toronto and a special term professor at Tsinghua University in Beijing. 
Federal Reserve Bank of St. Louis Review, July/August 2009, 91(4), pp. 343-47.
© 2009, The Federal Reserve Bank of St. Louis. The views expressed in this article are those of the author(s) and do not necessarily reflect the
views of the Federal Reserve System, the Board of Governors, or the regional Federal Reserve Banks. Articles may be reprinted, reproduced,
published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts,
synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.According to a standard neoclassical growth
model, an increase in the TFP growth rate would
result in a sharp and immediate increase in the
investment rate followed by a gradual decline.
The actual investment rate in China, however,
behaves quite differently. Figure 1 shows that it
has increased gradually over time. Arguably, this
gradual increase in the investment rate may have
been due to a gradual increase in the growth rate
of TFP or the labor input. Figure 2 shows the
growth rates of TFP and employment in China
and neither has had an upward trend. Why, then,
didn’t the investment rate grow more rapidly?
The answers to these questions are important
for understanding the nature of China’s growth
performance and cannot be easily answered using
an aggregate growth accounting framework. I sug-
gest addressing these questions by looking at more
disaggregated data. Figure 3 shows the returns-to-
capital and capital-to-labor ratios in the state and
non-state nonagricultural sectors, respectively,
and their significant differences. In the state sector,
the capital-to-labor ratio increased steadily before
1997 and dramatically afterward. Correspond  ingly,
returns to capital were roughly constant at 10
percent before 1997 and declined sharply after-
ward. Such behavior is consistent with what
Zheng, Hu, and Bigsten (2009) find at the aggre-
gate level. It suggests that, in the state sector, capi-
tal accumulation played a much more important
role than TFP growth in recent years. For the non-
state sector, however, the story is quite different.
The capital-to-labor ratio in this sector actually
declined in the early years, which coupled with
TFP growth resulted in a sharp increase in returns
to capital. In recent years, the non-state sector’s
capital-to-labor ratio increased, but the returns
to capital did not decline. This sector has main-
tained a relatively high rate of returns to capital
(around 60 percent) because of rapid TFP growth
(Figure 4).
So, the answer to the question of whether
China’s recent growth pattern is extensive or inten-
sive depends on which part of the Chinese econ-
omy is analyzed. If the focus is on the state sector,
then it clearly follows an extensive growth path.
Zhu
344 JULY/AUGUST 2009 FEDERAL RESERVE BANK OF ST. LOUIS REVIEW
0
5
10
15
20
25
30
35
40
45
50
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Figure 1
China’s Investment-to-GDP Ratio
SOURCE: Brandt and Zhu (2009).Zhu
FEDERAL RESERVE BANK OF ST. LOUIS REVIEW JULY/AUGUST 2009 345
TFP Growth Rates
–10
–5
0
5
10
15
Employment Growth Rates
0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Percent
Percent
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Figure 2
China’s TFP and Employment Growth Rates
SOURCE: Brandt and Zhu (2009).Zhu
346 JULY/AUGUST 2009 FEDERAL RESERVE BANK OF ST. LOUIS REVIEW
Returns to Capital
0
10
20
30
40
50
60
70
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Non-State
State
Capital-to-Labor Ratios
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
50,000
1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Non-State
State
Percent
Figure 3
China’s Returns to Capital and Capital-to-Labor Ratios
SOURCE: Brandt and Zhu (2009).The non-state sector, on the other hand, follows
an intensive growth path that relies much more
on TFP growth than capital accumulation. As
Zheng, Hu, and Bigsten argue in their paper, inten-
sive growth is more likely to be sustainable than
extensive growth. The sustainability of China’s
recent growth performance, then, will depend
on the relative importance of the two sectors.
Measured by the share of employment, the non-
state sector’s importance has increased over time.
According to Brandt and Zhu’s (2009) estimates,
the non-state sector’s share of nonagricultural
employment increased from 48 percent in 1978
to 87 percent in 2004. Measured by the share of
investment, however, the picture of the non-state
sector is not as rosy. 
Despite its lackluster TFP growth performance
and declining employment share, the state sector’s
share of investment has always stayed above 60
percent. Given the high TFP growth in the non-
state sector and the high investment rate in the
state sector, China can increase both the aggregate
efficiency of the economy and the GDP growth
rate without increasing the aggregate investment
rate, by shifting investment from the state sector
to the non-state sector.
REFERENCES
Bai, Chong-En; Hsieh, Chang-Tai and Qian, Yingyi.
“The Return to Capital in China.” Brookings Paper
on Economic Activity, 2006, Issue 2, pp. 61-88. 
Brandt, Loren and Zhu, Xiaodong. “Explaining
China’s Growth.” Working paper, University of
Toronto, 2009.
Zheng, Jinghai; Hu, Angang and Bigsten, Arne.
“Potential Output in a Rapidly Developing Economy:
A Comparison of China with the United States and
the European Union.” Federal Reserve Bank of St.
Louis Review, July/August 2009, 91(4), pp. 317-42.
Zhu
FEDERAL RESERVE BANK OF ST. LOUIS REVIEW JULY/AUGUST 2009 347
Non-State
State
0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Figure 4
China’s TFP
SOURCE: Brandt and Zhu (2009).348 JULY/AUGUST 2009 FEDERAL RESERVE BANK OF ST. LOUIS REVIEW

Explaining China’s Growth.” Working paper,

Commentary on Potential output in a rapidly developing economy: the case of China and a comparison with the United States and the European Union

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Commentary on Potential output in a rapidly developing economy: the case of China and a comparison with the United States and the European Union

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