Over the past four decades, China sustained remarkable average annual growth of 10 percent, while transforming from a rural agricultural society to an urban industrial one, and from a planned to a market-based economy. GDP per capita adjusted for inflation increased 24 times, average life expectancy rose by 10 years to 76.5 years in 2017, and more than 700 million people were lifted out of poverty, according to World Bank data.

Moreover, a significant proportion of this expansion was the result of increases in productivity. Productivity improvements within sectors as well as gains from the reallocation of resources between sectors—from agriculture to more productive modern industry and services—and between ownership groups—from inefficient state-owned enterprises (SOEs) to dynamic private firms—were especially important.

However, China has experienced a marked slowdown in growth in output per worker since the global financial crisis. In 2015–18, average GDP growth fell below 7 percent for the first time since 1991, to a large extent due to slowing growth in total factor productivity (TFP). Aggregate TFP growth slowed from 2.8 percent in the 10 years before the global financial crisis to 0.7 percent in 2009–18. In 2017, signs of improving labor productivity and TFP growth emerged but both remain significantly lower than their pre-crisis levels.

Although weaker productivity growth in China has coincided with—and likely been affected by—the recent decline in world productivity growth, the deceleration in China has been sharper. The main contribution of this paper is to examine the characteristics of the productivity growth slowdown using both macro- and micro-level data. We conclude that domestic factors and policy choices have contributed to the slowdown.

We update previous firm-level studies of manufacturing sector productivity and find that, while within-firm TFP growth has remained resilient, limited market entry and exit and lack of resource allocation to more productive firms have contributed to a slowdown in manufacturing TFP growth since 2008. The evidence points to considerable convergence in productivity between SOEs and private companies in manufacturing after market reforms were introduced in the 1990s, though SOEs remain less efficient than private firms in their use of capital. In addition, the relative profitability of manufacturing SOEs appears to have deteriorated as relative leverage rose after the global financial crisis. Overall, we find that the process of SOEs catching up to private sector efficiency has recently stalled.

Beyond the manufacturing sector, we use new capital stock estimates by sector to show that strong investment in infrastructure and housing has been associated with lower returns to capital. In response to the global financial crisis, China implemented a large fiscal stimulus which emphasized local government spending on infrastructure and housing. The allocation of a larger share of credit and investment to these sectors coincided with an increase in the sectorspecific capital-output ratios. It has also contributed to a rapid build-up in corporate debt and larger macroeconomic imbalances, raising the risk of slower growth.

Nevertheless, in Section 3 we argue that, from the perspective of international convergence, China’s growth potential remains significant. As per capita income and productivity are still far below those observed in advanced countries, there is significant room for catch-up growth through capital deepening (albeit crucially in the private sector), human capital accumulation, and improvements in TFP. The paper concludes with some policy recommendations to ensure that China realizes its potential for strong growth in light of recent external developments and domestic reforms.

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