Can China be like Chattanooga? Shifting from industry to services

Financial markets and media reports have been focused lately on the slowing of China’s growth rate. That slowing has diverse causes and consequences, but—as I’ll discuss in this post—in at least one important respect it is both a healthy and a predictable development, resulting from a necessary change in China’s growth model.

Since the beginning of China’s growth miracle, a large part of the country’s development has been directed from the center. This “top-down” approach has focused on heavy industry, infrastructure (highways, bridges, airports), the movement of people from rural to urban areas, and the promotion of exports, particularly manufactures. The top-down model had its roots in Communist central planning, but in China it has been leavened with enough market liberalization and openness to international competition to foster significant gains in productivity and a rapid ascent up the technological ladder. To date, this strategy has been incredibly successful: In real terms, the Chinese economy is two-and-a-half times bigger today than a decade ago (IMF estimates, converted to constant dollars at PPP exchange rates). And, despite the recent slowdown, Chinese economic growth currently accounts for about a third of global economic growth, up from about a quarter ten years ago.

However, the top-down approach is reaching its limits. The share of output devoted to heavy manufacturing, construction, and exports is too large to be sustained, the pace of urbanization is slackening, and the easier opportunities to improve technologically in manufacturing and related sectors have been exploited. Moreover, with its emphasis on capital investment and exports rather than on goods and services aimed at domestic consumers, the Chinese economy has not been serving its citizenry as well as it could. Recognizing these limits, China’s leadership is working to make the transition to a more organic, “bottom-up” growth model, focused on the development of services industries—retail trade, health, education, finance, transportation—delivered in many cases through markets and by smaller business units. (Services currently make up about half of the Chinese economy, compared to about four-fifths of the economy of the United States, according to the World Bank.) For various reasons, including the fact that productivity in services generally does not grow as quickly as in manufacturing, this transition will involve economic growth that is slower (though still rapid). And, because of the increasing reliance on market forces and smaller business units, Chinese growth in the future will be more erratic and harder to control from the center.

The experience of U.S. “rust belt” cities provides a helpful analogy for China’s challenge, at least qualitatively. As in China, the economies of American cities like Chattanooga and Pittsburgh were built on heavy manufacturing, a model that eventually reached its limits. The analogy is not exact, of course: Unlike the case of China, the industrial hollowing out of U.S. rust-belt cities resulted in large part from increased foreign competition. In some respects, however, the constraints on industrial development faced by China and Chattanooga—notably, the increasing toll of heavy industry on the environment—were similar. (In 1969, the federal government identified Chattanooga as the country’s most polluted city.)

In any case, the rust-belt cities that succeeded in reviving their economies did so primarily by turning from manufacturing to services. In Chattanooga and other cities, public/private taskforces worked to revitalize downtowns, to develop tourist attractions and conference facilities, to clean up the environment, to improve transportation links and other critical infrastructure, and to attract businesses in “clean” sectors like medicine, technology, finance, and retail. Strengthening education was key, with benefits ranging from attracting and maintaining skilled workforces to seeding high-tech startups. Pittsburgh’s redevelopment in particular was greatly helped by the location there of several major universities, including Carnegie-Mellon and the University of Pittsburgh, which led efforts to build research facilities where old mills had once stood. Emblematic of Pittsburgh’s transformation is that the U.S. Steel building, the largest in downtown Pittsburgh, now bears a UPMC sign, for University of Pittsburgh Medical Center—the region’s largest employer.

How can China make a transition to a more services-oriented economy, analogous to that made by Chattanooga and Pittsburgh, as well as by other East Asian countries like Japan or Korea? Reducing the subsidies to and direct government support for exports and heavy industry, while continuing reforms to make it easier to start and sustain new private businesses, are critical steps. So, in some cases, are partnerships with foreign companies that bring essential expertise. A useful lesson from the experience of reviving U.S. cities is the importance of building and empowering a strong middle class: Middle-class households are the primary market for more-sophisticated services, from education to health care to retail to entertainment. For those cities, attracting middle-class consumers involved improving public infrastructure and education, adding amenities, reducing crime, and increasing job opportunities. In China, empowering the growing middle class will require measures such as strengthening the social safety net (which will give households the income security they need to be comfortable saving less and spending more) and reducing regulations and controls that restrict consumer choice. A strong Chinese middle class will stimulate the development of new services industries, allowing the “bottom-up” approach a chance to succeed.

China’s economy certainly has its share of short-term problems, including bad loans in the banking system, a shaky stock market, and excess capacity in heavy industries. How it navigates those risks will have important near-term implications both for China and for China’s trading partners. In the medium term, however, China’s biggest economic challenge is to make the transition from a top-down, heavy-industrial growth model to a bottom-up, services-focused one. In considering models for reinvention, China could do worse than to contemplate the experiences of Chattanooga and Pittsburgh.

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