[MUSIC] We have learned that productivity growth has been the most important source of economic growth in China during the reform period. But what causes productivity growth? Well, here economists have some difficulty. Because in many ways, understanding productivity growth is a black box. It's a black box because it's very difficult to measure technological change. We can observe the growth in inputs of capital and labor but to explain why output grows faster than inputs Is very hard. In fact, total factor productivity is really defined as part of the output that we can't explain, that can't be explained by the amount of inputs that are observed. We do know that in China, Total Factor Productivity growth has been quite high, about six and a half percent per year. But what are the factors that contribute to creating such a high rate of Total Factor Productivity growth. We also know that the non-state, non-agricultural sector has been the key driver of productivity growth In China. So what are the factors? Let's think about them. I think, certainly one of the more important factors is competition. We have to think about the incentives that firms have to really try to maximize profits and increase profits. And a big part of that is that they have to feel some competitive pressure from other firms. China, the one thing it has done from the very beginning, has really opened up markets and forced households and firms to really be competitive in an open market. And I think this has really contributed to the drive that individual households and firms have had to try to maximize profits and increase their productivity. Incentive reforms have also been important. Even if you face markets if you don't have an ability to keep the profits that you earn, then you still will be under-incentivize. And so the decentralization reforms in various sectors and for the government have all contributed to I think to making people more motivated to improve productivity. Globalization has played a key role in particular in enabling firms to transfer technologies from the rest of the world through a foreign direct investment by being able to import capital equipment or other more sophisticated inputs and to learn from them. And also to export to consumers in other countries that have a high Demand for high-quality products, which forces the firms to understand better how to improve the quality of their production. Globalization can also increase competition through imports, so that Chinese firms have to not only compete with other Chinese firms, but they have to compete with firms globally. Finally, innovation really lies at the heart of sustained productivity growth going into the future. And here we can think of innovation in different Product and services but also management processes or production processes that improved productivity. We can look at a couple of indicators that are often use to proxy for the investment and innovation and this are for example research in doubt expenditures and patenting activity by firms. What supports innovation is also very complicated, and we'll come back to this point in the conclusion of this presentation. So, if we turn to the two indicators that we have, first if we look at research and development, expenditures as a share of GDP, we can see that China has risen from a somewhat low level to almost the same level as the other advanced economies. So it's increased the share of the GDP that it's investing back into research and development steadily over time since the mid 1990s. If we look at patenting activity for inventions, China's progress is even more spectacular. In this domain China is actually gone from a position of considerably lagging Japan and United States to quickly surpassing them. So that now much more patenting activities occurs in China than in any other country in the world. Another important aspect of innovation is what is the purpose of the innovation activity, in terms of trying to save different types of costs. What I mean here is there is a hypothesis are called the induced innovation hypothesis which states that, the demand for technology is biased toward economizing on the relatively scarce production factors. So, for China, which was originally a labor-abundant country, it means that, initially, most innovation and investment was designed to try to save on land and capital. Meaning raise output per unit of land, raise output of unit of capital but not so much raise output per unit of labor because labor was very cheap. So that was the focus, it doesn't mean that output per unit of labor didn't increase somewhat. But not nearly as much as would be the case if the goal of innovation was to try to improve labor productivity. Now this has changed quite a bit in recent years. Because in recent years, wages have been increasing quite dramatically in China. So the cost of labor has gone up a lot. Whereas the cost of capital has actually declined a lot in relative terms. Because as a richer country, capital is more abundant. And this means that there is now a much greater demand for labor saving technology. And the types of technologies we are probably referring to are automation, replacing workers with robots. The future of manufacturing many people feel is going in this direction and all of this is now happening in China. We'll talk a bit more about that in the next module. What's important to realize in this respect is that labor-saving technology is the key to increasing labor productivity. And thus wages and as wages rise so do incomes and consumption per capita. So when a country reaches the point where it's really trying to raise labor productivity, the innovation's often actually much more directly improve the standard of living of the people. Now in conclusion, what have we learned about productivity growth? First, we have seen that economic reforms played a very important role in spurring productivity growth. Especially in the non-state sector by promoting competition, improving incentives and giving firms and households an incentive to innovate. In recent years, the indicators of innovation that we have suggest that China may be transitioning from a strategy of mainly trying to copy global technologies, to a strategy of trying to innovate themselves. And this of course will be the key to sustaining growth into the future in terms of how innovation occurs. It's a complicated problem but we do know that in China both the public sector, the government and the private sector have both played very important roles. The government by making key investments in research and development, basic research, a whole system of research institutes of various types and also by giving concrete incentives to firms to innovate by providing subsidies and other types of support. However, the real driving force of production relevance Invention and innovation are firms themselves. And in China, because China has been so competitive and successful in it's exports and in globalizing it's economy. Many firms in China are facing fierce competition and are making great efforts to innovate and remain profitable in a highly competitive environment. In the long run, China needs to create an effective innovation ecosystem. Now, what are all the ingredients to a successful innovation ecosystem? There are many institutional factors that are going to be more important for innovation. And that includes protecting intellectual property rights, having a very good legal system that protects property rights, and having a good well thought out kind of public-private balance in developing new inventions and applying those new inventions to applications that will increase actual economic output. Many countries want to create a new Silicon Valley People disagree on exactly what the formula is. There is evidence of a high level of innovation of activity in China. Shenzhen, the city near Hong Kong, has now become a center of innovation in China, and many firms we know are investing in research and development and inventions. But the extent to which China can sustain this success into the future is something we will have to observe going forward.
