【原创】Theory, System and Policy Proposals on New Factor Supply ...
Theory, System and Policy Proposals on New Factor Supply for Higher-Stage Development in China
Yuan Fuhua (袁富华), Zhang Ping (张平), Chen Changbing (陈昌兵), Liu Xiahui (刘霞辉) and Wang Hongmiao (王宏淼)*
Research Group of China Economic Growth Frontier, Chinese Academy of Social Sciences, Beijing, China
Abstract: By introducing the knowledge sector, this paper has structurally redefined the production function and on such a basis, analyzed the role of new factor supply in China’s economic transition and reached the following conclusions: 1) The supply of new production factors represented by knowledge sector has become the dominant force that decides whether China can overcome the barrier of structural deceleration, and achieve sustained growth and stride into a higher stage of development; 2) In the context of rising urban household income and upgrading demand, the knowledge sector has emerged, encompassing science and technology, culture, health and sports that contribute to enhanced “human capital in the broad sense”, and the production and consumption process of the knowledge sector is also the process of human capital improvement and endogenous innovation; 3) Aside from its endogeneity, the knowledge sector creates spillover effects that will revitalize traditional industries and services, remove the barriers between consumption and production, and promote structural transition and economic upgrade for innovation-driven growth; 4) In the context of flagging growth driven by material capital, great importance should be attached to the contribution of consumption to human capital in the broad sense and promote the interactive upgrade of consumption and production structures, which are the key to overcoming the bottlenecks of development.
Keywords: consumption structure, human capital in the broad sense, knowledge sector, integrated production and consumption
JEL Classification: O34
Based on the observation of the growth journey of advanced and late-moving economies, we have redefined the production function by introducing knowledge sector and thus created the new factor supply theory for China’s future innovation-driven growth. Research indicates that in the context of economic deceleration, the supply of new production factors represented by the knowledge sector has become the key driver for China to overcome the “middle income trap” and stride into the stage of high-income growth. Aside from its endogeneity, the knowledge sector creates spillover effects that will revitalize traditional industries, remove the barriers between consumption and production, and promote structural transition and economic upgrade. Production and consumption of the knowledge sector contribute to enhanced human capital and endogenous innovation. Giving China’s flagging momentum of material capital growth, rising urban household income and upgrading demand, the key for China’s economy to move to a higher level is to expedite the reform of public sectors in such areas as the government, scientific and technological research, education, culture, health and sports in order to unleash the great potentials in the knowledge sector and transition towards growth driven by the accumulation of “human capital in the broad sense”, innovation and knowledge consumption.
1. Deceleration and Breakthrough of Long-Term Growth Process: Necessity for Introducing the Knowledge Sector
From the analysis of “structural deceleration” in factor accounting to the “regression towards the mean” argument in international comparison, as well as total factor productivity (TFP) and institutional interpretation, numerous studies have verified the fact that China’s economy is entering into a stage where previous high-growth rates are falling and all suggest that the pitfall may be avoided by introducing new growth factors.
1.1 Reality of China’s “Structural Economic Deceleration” in Factor Accounting
Based on a growth accounting framework, the Research Group of China’s Economic Growth Frontier evaluated the “structural deceleration” of China’s growth process in a series of papers between 2012 and 2014 and conducted continuous follow-up study on China’s economic growth on such a basis. According to the latest calculation result of the Research Group, the challenge of China’s “structural deceleration” remains serious:
(1) China’s labor factor supply will experience a turning point in the 13th Five-Year Plan period (2016-2020), and with the increase of urbanization rate, growth of capital factor supply will reduce to a single-digit level.
(2) Inefficient change of industrial structure becomes a prominent issue. With the modernization of industrial structure (value-added of modern sectors such as industry and services accounts for about 93% of GDP at comparable price), the structural allocation efficiency of labor migration from the rural sector to modern sectors declines; meanwhile, given that the tertiary sector is less productive than secondary industry, the inefficient allocation of capital and labor in the process of service sector expansion is inhibiting the overall improvement of productivity.
(3) Contribution of TFP to economic growth fell from the peak of around 30% to the current level of 17%. Technology became a less potent driver of economic growth partially due to delayed institutional reform and partially due to diminishing “learning-by-doing” effect.
(4) As the “Lewis turning point” approaches, factor distribution begins to tilt in favor of workers, with the output elasticity of labor rising to the level of 0.5, which further strengthens the tendency of deceleration.
(5) With rising household income, material commodities and general services such as basic clothing, food, housing and travel represent a declining share of consumption. On the other hand, a growing share of consumption is represented by items that contribute to education and quality of life, including science and technology, education, culture, sports, health and miscellaneous items. These facts can be summarized into the following statement: the income elasticity of consumption is generally smaller than 1% for the “general technology sectors” with traditional manufacturing and service characteristics and the share of such sectors in consumer spending diminishes; relatively speaking, the elasticity of consumer demand for producer services of the “knowledge sector” arising from improving quality of population is generally greater than 1% and the share of “knowledge sector” in consumer spending increases, triggering the transition of the economy from industrialized material production to a knowledge-based economy.
1.2 International Experience Comparison of Economic Deceleration
Extensive literature emerged in recent years over the topic of international experience comparison of economic deceleration (“regression towards the mean”) and a host of interesting propositions have been made (Eichengreen et al., 2013; Im & Rosenblatt, 2013; Cai Fang, 2013; Pritchett & Summers, 2014):
(1) Definition of deceleration point: a deceleration point is defined by the slowdown from rapid growth to decelerated growth over a span of seven years by at least two percentage points.
(2) Distance to frontier and convergence time: distance of late-moving countries to advanced economies determines the “time” it takes for economic growth to regress towards the mean.
(3) Interactivity principle for the catch-up of major countries and regression towards the mean: given that the catch-up of major countries will cause global rebalancing, the data of small nations in their economic rise cannot be directly used for comparison and the principle of interactivity should be followed.
(4) Hypothesis of stagnation in particular stages of growth: stagnation is inevitable when economic growth reaches a certain stage, i.e., such theories as “poverty trap”, “middle income trap”, as well as the “high income trap” that led to long-term stagnation of developed countries. Given their different selection of sample points and divergent conclusions, the conclusions of forecast will be uncertain if these empirical comparisons are applied in the analysis of China.
1.3 Theoretical Explorations of TFP and Institutional Change
Due to the endogeneity contained in “Kaldor’s facts”, economic growth tendency is embodied in the “regression towards the mean” model. As a matter of fact, the same is true for the calculation of growth accounting framework. Any capital and labor invested is subject to diminishing marginal return and gradually converge on a track of equilibrium. Hence, economic development will encounter the so-called “stagnation” in any stage. Under such a dilemma, only TFP is assumed to be endogenous, i.e., the current state of equilibrium may only be disrupted through technology revolution and innovation, otherwise every stage of development will be threatened by deceleration, and continuous innovation is the fundamental way to overcome various traps. Nevertheless, TFP is a black box and how to create new growth facts that overcome growth constraints and how to realize statistical, theoretical and policy possibilities have become the most important areas of research. Academic explorations on this topic are characterized by many directions, including the following:
(1) New facts such as the “Kaldor’s facts” are created to explore the “new factors”, i.e., factors that can lead to increasing return to scale such as knowledge, education, information, creativity, institutions and extent of market. Whether these factors can offset diminishing return of traditional factors to scale is the key to overcoming growth deceleration.
(2) Technology innovation pathways are mostly based on the endogenous growth framework of human capital and Schumpeter technological innovation process, putting premium on the effect of horizontal and vertical technology innovation.
(3) Resource mismatch and institutional improvement: attempting to introduce institutional factors to mitigate resource mismatch by identifying the pathways for institutional improvement to promote the contribution of technology progress;
(4) Statistical progress: new statistical systems associated with knowledge production have also kept pace. In 2008, the World Bank launched the new edition of SNA system for GDP accounting, introducing the most important concepts of “statutory ownership rights” and “economic owners”. Under this system, products of intellectual property rights are listed into GDP, including R&D, evaluation on mineral exploration, computer software and database, literature and original art works, others, et cetera. By moving cultural products from consumption items into supply items, the integrated process of knowledge consumption and production is brought into play. It also marks a breakthrough in the criteria for evaluating the economic transition. “Employee stock option” correlates option account with labor compensation system to convert the return to assets into the return to human capital, highlighting the importance of human factor. Of course, the reform of statistical system is a complicated process. What is clear is that the key of reform is to redefine knowledge production.
The revelation of the aforementioned theoretical tenancies is that for China, groundbreaking practical and theoretical analysis must be made in the following three aspects:
(1) New factors supply must be brought into theoretical analysis. Large-scale industrialization will inevitably slow down under the laws of diminishing marginal return to output and consumer demand. Qualitative consumption of various material commodities is subject to a saturation point and the corresponding utility level ultimately has to reach its ceiling.
(2) Knowledge production sector should be introduced in the model system. This sector will drive China’s transition from traditional pattern of manufacturing based on general technologies to an innovation-driven model of manufacturing. Consumption of material commodities (including traditional service goods) holds sway in relatively low stages of economic development. With diminishing marginal return to the consumption of material commodities, the consumption of knowledge and culture becomes elevated into the primary demand.
(3) Institutional change must take place if the potentials of knowledge sector are to be fully unleashed. With the declining efficiency of resource allocation in the late stage of industrialization and traditional catch-up system greatly restraining innovation, there has been a serious mismatch of resources, i.e., a great deal of human capital has been locked up in the public sectors. Bottlenecks of growth may be overcome only by redesigning institutional arrangements and incentives.
1.4 China’s Breakthrough: Knowledge Sector as the New Driver of Growth
In light of the above analysis, no answer can be found from the existing production and consumption structure to overcome China’s structural deceleration. Future potentials can only be unleashed from the new growth driver of knowledge production sector.
As have been demonstrated in the experience of catch-up economies, the journey of growth is characterized by the two-step leap of production and consumption patterns. Each leap reshapes the attributes of growth model and the pattern of efficiency enhancement. In the first step, production pattern is transformed by economies of scale through the application of general technologies to escape “poverty trap”, while the second leap of production pattern features an efficiency model of “knowledge-technology creation” in order to overcome the middle income trap. The first leap of consumption pattern is the satisfaction of demand for basic material goods and services through the expansion of production by applying general technologies; while the second leap requires the satisfaction of demand for high-quality material goods and higher levels of services based on the accumulation of human capital in the broad sense and the fostering of consumption-driven growth.
In the second leap, manufacturing and consumption patterns become increasingly integrated as both of them put premium on knowledge process. Creation of new sectors is inspired by the medium- and high-end items emerging from consumption structure, as reflected in the consumption items of human capital in the broad sense influencing value creation and shaping an independent knowledge sector. The spillover effects of the independent knowledge sector give rise to the upgrade of general technologies and the phase-out of low-level elements of industry structure, which results in the overall optimization and upgrade of economic structure. Such a knowledge process directly corresponds to the “new Kaldor’s facts”: new elements including knowledge, education, information, creativity, institutions and the extent of market become strong drivers of increasing return to wage. In this circumstance, the nature of consumption is transformed, with a considerable part of consumer behavior evolving into an integrated process of human capital accumulation, knowledge creation, production and consumption.
As the chapter of service-based economy is ushered in, economic growth becomes increasingly driven by the sector of knowledge production rather than the sector of material production as was the case when rapid economic growth held sway. The sector of knowledge production coexists with the sector of traditional production structure and traditional service sector. The former creates value and brings about the optimization and upgrade of traditional sectors. In this manner, consumption structure is divided into two parts: some consumption takes place in the sectors of traditional goods and services related to people’s everyday life such as clothing, food, travel and accommodations; the other part of consumption directly participates in the process of knowledge creation and creates value, i.e., consumption of science and technology, culture, health and sports. We must create a new framework in developing our strategies to respond to structural deceleration caused by diminishing return to factors as the new chapter of urbanization and service-based economy is ushered in. Hence, considerations must be given to the choice of pathways through which knowledge process takes over material capital to serve as the dominant driver of growth.
2. Creation of New Supply Factor Theory: A New Growth Function Based on Two Sectors
In order to explain the development of the independent knowledge sector and consumption emerging as a dominant driver of economic growth in the transition of early-moving economies from industrialization to urbanization, a new production function must be created. In addition to the factors and technological attributes of traditional production function, this new production function should take into account the production structure or pattern in which factors evolve and should be closely related to consumption structure. Thus, it can be referred to as the structurally defined production function, whose characteristics and connotations are illustrated in Figure 1.
2.1 Explanations on a Few Key Concepts of the New Production Function
General technology sectors: sectors for the manufacturing of traditional material products and sector of traditional services, including sectors of primary industry, secondary industry and traditional services. These sectors are characterized by the diminishing consumption elasticity of material commodities (including traditional services) in the transition from industrialization to urbanization and are increasingly saturated demand.
Knowledge production sector: i.e., sectors of science and technology, education, culture, health and sports that keep expanding and ultimately become dominant growth drivers in the transition from industrialization to urbanization. Knowledge production sector is characterized by two basic features: first, the innovation activities of knowledge production sector itself are spilled over to the “general technology sectors” to enhance technology progress and facilitate the transition from the production of intermediate goods to the production of final goods, i.e., the Schumpeter process of technological progress; second, knowledge production sector directly satisfies the demand for knowledge consumption. With rising income, culture and quality experience represent a growing proportion of consumption and their income elasticity of consumption is greater than 1. Such consumption can be abstracted into “knowledge consumption”, i.e., consumption of knowledge quality contained in services and commodities rather than the commodities themselves. For instance, consumers purchase mobile phones for their service functions rather than the physical form of mobile phones. Based on such an understanding, among the 12 tier-1 categories of China’s service sector, geological exploration, water conservancy management, finance and insurance, health, sports and social welfare, education, culture, art, broadcasting and TV industry, as well as scientific research and integrated technological services can be classified as knowledge sectors.
Integration between knowledge consumption and production: the equilibrium constraint of knowledge production is the integration between knowledge production and consumption achieved through interactive production and sharing. Supported by the Internet as the medium that matches between knowledge production and consumption, the supply and consumption may not take place separately as is the case under the traditional pattern. It is more likely that production and consumption are achieved through sharing (exchange with one another).
Human capital in the broad sense C(H): according to the process of knowledge production, we have redefined the production factor of labor by abstracting consumers into two extreme categories based on different positions or consumption levels of consumers in the consumption structure: the first category of consumers exist as labor force (L) in the world of economic reproduction characterized by the basic needs of food, clothing, competitions and travel; the second category of consumers exist as consumers of human capital in the broad sense C(H) in the world of knowledge or cultural reproduction, such as education, culture, entertainment, sports and aesthetics. Obviously, in the real world, each and every consumer exists as a combination of labor force (L) and human capital in the broad sense C(H). Therefore, our reasonable abstraction is further hypothesized as follows: if the first category accounts for a major share in the consumption structure, the consumer belongs in the category of labor force (L) and exists as the factor input for general technology sector and connected with material capital (K) in the production process. Correspondingly, if the second category represents a major share in the consumption structure, the consumer will belong in the category of human capital in the broad sense C(H), living in the world of knowledge and culture that can also create value.
We define the four items of categories 6-12 from the international classification of consumption, i.e., 6. Health, 9. Culture and entertainment, 10. Education, 12. Miscellaneous items as human capital in the broad sense C(H) and the remaining items of consumption as labor force (L) or labor reproduction, i.e., 1. Food and beverage; 2. Alcohol, tobacco, narcotics; 3. Apparels and shoes; 4. Housing, water and electricity, fuel; 5. Furniture and housing maintenance; 7. Transport; 8. Communication; 11. Catering and hospitality.
2.2 Nature of Knowledge Production Sector and Its Role in the New Production Function
Knowledge production sector is a sector intended to effectively develop and utilize human capital in the broad sense C(H), which has replaced the general technology sector to become a new driver of growth for its endogeneity, spillover effect and dominance.
First, the value creation of knowledge sector is endogenous, i.e., the more human capital C(H) in the broad sense and the more interactivity among abstract individuals C(H), the greater momentum there will be for the expansion of knowledge sector. Different from the consumption nature of material commodities (including traditional services), the consumption of human capital C(H) in the broad sense is not just a matter of “getting consumed” but is embodied in the creation of knowledge, as the consumption of human capital C(H) is not an exclusive consumption of material goods but the “enhancement” of interactive “human-to-human” consumption (sharing rather than exclusion), where the knowledge of individuals is enhanced through exchange and communication with one another. The argument that consumption itself is production is made from this perspective.
In addition, the process of knowledge formation through the interaction of human capital C(H) in the broad sense is specifically reflected in the integration between knowledge production and consumption. With the rise of income, the proportion of consumption in the general technology sector will decline, as the share of spending on food diminishes as well. What increases is the share of consumption of human capital in the broad sense. Consumption of human capital in the broad sense is essentially a process of the supply of modern services and a more generalized understanding is the process of integration between knowledge production and consumption. For instance, when you write a book, your writing is defined as knowledge production; when I read your book, my reading is a process of consumption. Furthermore, by reading your book, my human capital increases and thus I am also inspired to write a book, which is then consumed by you, and so on and so forth. In the Internet era, therefore, the producers and consumers become increasingly integrated, blurring the division in the age of industrialization.
Moreover, the knowledge sector creates spillover and filtering effects on the general technology sector. Judging by the relationship between consumption and manufacturing, the consumption of material goods (including traditional services) from the general technology sectors tend to be saturated. Capital is subject to diminishing marginal efficiency, and the scale of production is inevitably constrained. Such are the characteristics of traditional capital-driven growth. When material capital (K) has to be continuously increased and consumption (C) is suppressed, structural growth imbalance will be induced (the more C is suppressed, the less likely it becomes for human capital in the broad sense C(H) to be generated and the more consumption pattern is trapped at a low level). While offsetting the negative shocks of diminishing efficiency of capital, the spillover effect of the knowledge sector typified by the injection of innovation not only improves the quality of capital but enhances the consumption and reproduction of labor (L), thus inducing more labor force (L) to be converted into human capital in the broad sense C(H). As a result, the structure of the general technology production sector becomes upgraded and optimized, while the knowledge sector develops greater potentials for value addition with the introduction of new human capital C(H). In this sense, the spillover effect of knowledge sector has the “filtering effect” and optimization function for production model. In upgrading the structure of general technology, knowledge process has filtered low-level production processes.
Lastly, the knowledge sector has a dominant effect in the innovation-driven growth. When such interactivity of human capital in the broad sense C(H) exists, the output of knowledge sector is no longer a simple aggregation of C(H) due to the existence of production in the process of consumption but is greater than the value addition of C(H). As consumption structure evolves and the pattern of consumption moves towards higher levels of knowledge and culture, the momentum for the expansion of knowledge sector expands and so does the potential of value addition. Similar to the “great push” that was necessary to overcome the “poverty trap” of traditional agricultural society and finally lead to economic growth driven by industrialization, knowledge sector as the most vibrant sector for mass consumption is also required under the economic growth in the era of urbanization to serve as a major driver of growth to overcome the middle-income trap and structural deceleration.
2.3 Application of New Supply Factor Theory in the Fact of International Growth: Explanations and Inspirations
From the perspective of dynamic evolution of the general technology sector and knowledge production sector in the new growth function, new explanations can be offered on the international industrial upgrade and the flying geese pattern of growth by regarding such a dynamic evolution as a knowledge process. In this manner, the following new inspirations can be drawn:
First, production model must be compatible with consumption demand, i.e., the optimization of production must be spearheaded by the upgrade of consumption structure. The knowledge sector compatible with sophisticated consumption structure is characterized by production that creates value. Hence, the emergence of such a knowledge sector is an important indication that the traditional capital-driven pattern of production is being shaken. Under the ideal conditions of evolution and succession, the pattern of consumption is characterized by the upgrade of consumption from labor-intensive products to durable consumer goods and then to knowledge- and technology-intensive products. The pattern of production must move in tandem with such evolving demands. The symmetry between consumption structure and production structure can be illustrated by the product portfolio points (a, b, c) in Figure 2.