Pacific Money

What Does ‘L-Shaped’ Growth Imply for China?

An unnamed official gives some hints about the official projection for China’s economy.

What Does ‘L-Shaped’ Growth Imply for China?
Credit: Shanghai via

Recently, in the People’s Daily an unidentified “authoritative figure” discussed China’s likely growth trend, referring to it as an “L-shaped trend.” Observers have assumed that the “authoritative figure” is a top official who cannot be named. The official emphasized that in the first quarter of the year, conditions have stabilized and reform has continued, but that reliance on credit has been excessive. While this article has been reported extensively in both the Chinese and Western media, there has been little discussion of what L-shaped growth is, and what is means for China.

L-shaped growth means that after the market or economy bottoms out, comprising the vertical part of the L, the economy then takes on a very slow recovery, comprising the horizontal part of the L. This would imply that the “New Normal” signifies even slower growth than expected, especially in a recovery after notable real estate and stock market asset price declines have taken place. A V-shaped growth curve would mean that after the economy reaches its lowest point, recovery takes hold and climbs rapidly. This is certainly not what is happening, as China struggles to spur growth in new sectors.

The official pointed to an L-shaped recovery due to weak demand and overcapacity in the economy. He stressed that structural reform is necessary to spur growth in the high-tech manufacturing and services sector, and pointed to “innovation, attention to quality and efficiency” as important components of development. China’s downward trajectory, or moving down the vertical portion of the L-shaped curve, was due to a loss of growth sources in first the manufacturing, then the fixed asset investment sectors. Growth based on low-skilled manufacturing is no longer possible, as the labor force is increasingly uninterested in low-wage, low-skilled jobs. Now that a higher percentage of the work force is educated and invested in working in a better environment, the only alternative is to improve the jobs available. Hence the promotion of high-tech manufacturing and higher-level service sector jobs are essential.

What is interesting is that China’s manufacturing growth was based on the opening up of its secondary sector, allowing for increased competition and trade with the outside world. Just as much potential lies in the tertiary, or services sector, but reforms have been instituted rather slowly, and many services sectors, such as health and education, remain largely in the hands of government institutions. If these sectors were to open as the manufacturing sector did, there is potential for a V-shaped recovery from the current economic slowdown.

It is important to note that the horizontal part of the “L” is the growth rate, rather than the level of economic activity. This means that while China’s growth is expected to level off, a consistent target of about 6-7 percent is still higher than that of most countries in the world. This rate of growth, though probably overstated, is extremely high, beating the potentially “strong performance” of the US this year of 2.5 percent and remaining neck in neck with India’s rapidly growing economy. China’s growth rate, if it leveled off at, say, 6 percent, will still help the nation grow out of middle-income status within the next twenty years.

To achieve the 6-7 percent target growth rate or beyond, officials must implement reforms in the service sector. Currently, the service sector is expanding, but many of the jobs being added are not high-skilled positions. Job creation is essential to bringing about production and consumption, and is the most important part of urbanization. As the unnamed “authoritative figure” claims, focusing on innovation and efficiency are paramount in ensuring economic growth and recovery, L-shaped or otherwise.