Productivity-led growth could add additional $5 trillion to Chinese GDP

29 November 2016 5 min. read

The Chinese economy has boomed in recent decades on the back of considerable investment. A slowdown in the Chinese economy has however created considerable uncertainty domestically and globally about the future of the country’s growth rate, with some decrying pessimism and others suggesting that a move to a productivity-led focus, including increased consumer spending, digitalisation, and innovation, among others, could significantly boost disposable incomes, GDP and growth.

The Chinese economy has undergone a rapid growth spurt in recent decades, expanding, sometimes at double digits, to become the world’s second largest economy. The rapid growth, which brought hundreds of millions into increasing levels of prosperity, recently met with headwinds. The slowdown has resulted in a global fall in commodity prices, and added to the economic uncertainty felt by executives.

In a new report from McKinsey & Company, the consulting firm explores the recent development of the Chinese economy as well as the effect a transformation towards a productivity and innovation lead economic model may have on the long-term growth prospects of the country.

Growth-led models

Productivity-led growth

McKinsey’s analysis highlights that the Chinese economy has considerable scope and potential for productivity and consumption increases, with enough capital to realise many of the changes needed for companies to generate and meet demand, raise productivity, and create value. This model, dubbed the productivity-led growth model, has considerably better potential to raise longer-term prospects than the current investment-led model.

The article highlights that a shift towards a productivity-led economic model, has the potential to boost household income by an additional $5 trillion, pushing up CAGR between 2015 and 2030 from 2.8% to 5.4%. Total Chinese GDP would also see an additional $5 trillion in growth, growing at a compound 5% between 2015 and 2030, compared to 2.9% in an investment-led model. The productivity-led model would see consumption as a share of GDP increased from 34% in 2015 to 47% by 2030, while investment as a percentage of GDP falls from 49% to 38% in the same timeframe. To reach the productivity-led growth potential, the firm considered a number of areas in which growth can be fostered.

Chinese consumers after premium products

Consumption growth

Transformation to advanced economic status requires, according to the article, the stoking and meeting demand from China’s emerging middle class whose spending remains considerably below that of other advanced economic middle classes. The size of the group, given the size of the Chinese population, is considerable – with a recent McKinsey article highlighting that the group could drive around half of global consumption growth to 2030.

The firm suggests that particularly young middle class Chinese are interested in spending money over saving or paying down debt. In this class, the allure of spending money on products with a strong brand presence if they had more money is up from 41% in 2011 to 59% in 2015. The study finds that consumers today are more keen to pay for better quality and expensive goods in the categories of fast moving consumer goods, apparel and consumer electronics.

Digital channels growth

Digital consumption

The report also highlights that China is managing to generate considerable benefit from digitalisation. The country has around 700 million smartphone and internet users, creating a large base through which to leverage digital consumption, particularly for tier three and below cities, with many in the lower tier cities to begin the process of online shopping. China-based WeChat has seen significant growth in its platform’s ability to leverage in-app shopping channels, with around 31% of users this year accessing products through the platform from 15% in 2015.

R&D spending in China

Innovating the future

A previous report from the firm found that there is considerable scope for Chinese businesses to further carve out areas of innovative strength, providing the country as a whole to generate considerable advantages for both consumers, seeking innovations over imitations, as well as companies seeking to open up a global market for their innovative products.

The potential benefits of innovation have spurred investment into R&D, which jumped from $49 billion in 2007 to $163 billion in 2012. Spending again saw considerable increases between 2012 and 2015, up 12% annually to $228 billion. In the coming five years the firm suggests that innovation will see a further 12% annual increase in investment, jumping to a total of $404 billion by 2020.

Related: China CEOs remain confident as focus shifts toward innovation.