Charting China's Path to Sustainable Economic Growth Amid Structural Challenges

The IMF paper highlights China’s economic slowdown due to aging demographics, declining productivity, and inefficiencies in its investment-heavy model. It proposes reforms to enhance productivity, shift toward consumption-driven growth, and support sustainable development while addressing structural imbalances.

Research authored by Dirk Muir, Natalija Novta, and Anne Oeking from the Asia and Pacific and Research Departments of the International Monetary Fund (IMF), delves into the economic challenges and opportunities facing China as it transitions from decades of rapid growth. After averaging an impressive 10% GDP growth rate during the 1990s and 2000s, China’s economic expansion has slowed significantly due to structural headwinds, including a rapidly aging population, declining productivity, and the diminishing returns of an investment-driven growth model. The paper predicts that without significant reforms, China's potential growth will decline to an average of 3.8% between 2025 and 2030 and further to 2.8% between 2031 and 2040. This deceleration reflects an overreliance on high domestic savings channeled into less productive sectors, rising levels of debt, and inefficient resource allocation, particularly in state-owned enterprises (SOEs).

Imbalances from High Savings and Inefficient Investments

China's growth story has been unique, powered by high savings rates, substantial investments, and structural shifts, including its entry into the World Trade Organization. However, this investment-heavy approach has increasingly financed unsustainable projects, such as excessive real estate development, which accounts for about 20% of GDP but offers diminishing returns. The paper highlights that high savings rates, driven by gaps in social protections and precautionary behaviors among households, have suppressed consumption as a share of GDP. While this savings surplus initially boosted domestic investments and GDP growth, it has also resulted in growing internal imbalances and slower productivity gains, particularly since the global financial crisis. The heavy presence of SOEs, which are less efficient than private enterprises, exacerbates these challenges by misallocating capital and slowing the broader productivity growth critical for economic sustainability.

Proposed Reforms to Enhance Productivity and Growth

The study employs both production function and general equilibrium modeling to forecast China’s potential growth and explore reform scenarios. The baseline scenario assumes no major structural reforms, projecting a continued decline in growth driven by a shrinking labor force, slowing productivity, and reduced efficiency in investment. However, the authors propose a reform agenda that could raise China’s potential growth rate to 4.3% on average between 2025 and 2040. This scenario outlines key measures, including improving SOE efficiency to narrow the productivity gap with private firms, reallocating resources from infrastructure and real estate to more productive sectors, and enhancing labor force participation by gradually raising the retirement age. Additionally, reforms to strengthen the social protection system would encourage greater household consumption, shifting China’s growth model toward a more balanced and sustainable trajectory.

Environmental Benefits of a Greener Growth Model

The paper also underscores the environmental implications of these reforms. By transitioning to a less investment-heavy and more consumption-driven growth model, China could significantly reduce the carbon intensity of its economy, supporting its climate goals. SOE reforms that emphasize innovation and renewable energy could further contribute to decarbonization, as SOEs currently account for about half of the country’s greenhouse gas emissions. Beyond environmental benefits, these reforms would also enhance economic resilience by reducing vulnerabilities associated with high debt levels and dependence on asset bubbles, particularly in the real estate sector.

Balancing Demographic Challenges with Economic Potential

One of the paper’s most critical contributions is its analysis of how reforms could simultaneously address China’s demographic challenges. With a rapidly aging population, the country faces a declining workforce, which threatens to constrain long-term growth. The proposed reforms include raising the retirement age and improving education and skill development to boost labor productivity. These measures would not only mitigate the adverse effects of an aging population but also enable a smoother transition to a high-income economy by ensuring that labor resources are better aligned with the needs of a more modern, service-oriented economy.

A Path to Sustainable and Inclusive Growth

While emphasizing the potential of these reforms, the authors acknowledge the risks of inaction. Without changes, China’s growth prospects could be further undermined by external factors such as geoeconomic fragmentation and reduced technological exchange due to rising global protectionism. These trends could compound the structural issues already challenging China’s economy, including low consumption levels and inefficiencies in capital allocation. Additionally, the risks associated with excessive reliance on credit growth and infrastructure investment would persist, making the economy more vulnerable to financial instability. The paper concludes that a reorientation of fiscal resources toward households, alongside productivity-enhancing structural reforms, could deliver a more inclusive and sustainable growth model for China. These changes would also help the country achieve its climate targets while ensuring economic resilience and long-term prosperity. By addressing the root causes of its economic slowdown slowing productivity, demographic challenges, and unsustainable investment patterns China has the potential to maintain robust growth rates and enhance overall welfare. However, the study also highlights the importance of continued research and refinement of these projections, particularly as China undergoes rapid structural transformation. Overall, the findings present a compelling case for comprehensive reforms as essential for China to achieve high-quality, balanced, and green growth in the coming decades.