Shanghai Model – China’s Investment-led Growth Model

India and China as large economies of Asia hold development lessons for each other. The growth models of these two economies are essentially different from each other.

Today, China is world’s second largest economy after United States. The seeds of China’s rapid economic growth since the 1990s were first planted back in 1978 when the Communist Party started to introduce capitalist market principles, initially in the agricultural sector. While, in 1980s, the country was powered by the bottom-up enterprises, especially in the rural areas; the economic expansion accelerated dramatically in the 1990s as a result of mass privatisations, and the opening up of the country to foreign investment.

Overseas firms rushed to build factories in China to take advantage of its low labour costs. In this rush, China had changed its development strategy by placing greater emphasis on big cities like Shanghai and Beijing. This was the so called Shanghai Model. The Shanghai Model is an extreme version of investment led growth model.

Implication of the Investment-led Growth Model
  • The So called Shanghai model was effective in building up production but not in ramping up the consumption base.
  • It is alleged that China has been successful in generating GDP growth, but far less successful in generating household income growth.
  • Almost half of China’s GDP comes from Investment, which has a huge multiplier effect on GDP. However, maintaining a high growth rate is not sustainable for an economy which is heavily relied on investment and subsequent manufacturing and export cycle.
  • Most of the experts agreed that the fast GDP growth in China powered by investment is a time bomb. In terms of household income and small asset base, China is poor, indeed poorer than India. The Consumption-to-GDP Ratio of China is lower than India. The Household savings rate in China is not as high as that of India.

The impact of this investment-led growth model was that China witnessed over-investing, which led to over-capacity that resulted in wastage of resources.

However, it does not mean that China has no savings at all. In fact, China has persistent Current Account Surplus and has generated excessive savings, but, despite their exceptionally high levels, savings have not been absorbed in domestic investment, and have to be exported.

Why Investment led growth is not sustainable?

One way to assess the impact of investment on growth is to examine whether investment adds value to the capital stock. If investment does not add value in terms of creating a future flow of goods and services (i.e., the value added concept of national accounts), then that part of investment will not contribute to the productive capital stock. It will initially be captured as excess capacity and then, once depreciation sets in, as wasted. Such investment will contribute to GDP growth only at the time it is implemented, reduce the marginal product of capital, and lead to deadweight loss.

 The Shift in China’s strategy

In recent times, China has decided to take a pause from the investment-export led growth and focus its attention on the consumption side. The Chinese government is trying to increase domestic consumption; however, they’re trying that within the existing level of the income rather than thinking of growing the income.

Some of the important measures being taken are summarized as below:

  • The government is emphasising on rebuilding the social safety nets and narrowing the income gaps between the rural and urban areas.
  • Eliminate the operational taxes on small businesses so that small businesses which provide employment to millions can thrive
  • Tax exemptions so that people see more disposable income to spend off.

Overall, the Chinese seems to be convinced that the Economic Growth should not be investment led growth, but consumption led growth; the latter being much more sustainable and least susceptible to external shocks. The experts say that as China moves into consumption led growth, there may be a slowdown of temporary nature, which may indeed help India.