"Once we've passed the stage of industrialization characterized by high-speed growth, how do we continue to maintain the growth rate of total factor productivity (TFP)? This is the biggest uncertainty that China's economic and social development faces at present." In his keynote speech at the 22nd Guanghua New Year Forum, Professor Liu Qiao, Dean of Guanghua School of Management analyzed the five major trends of China's current economic development, stating that these five trends will largely determine the future demand of the Chinese economy, hence driving the changes in its industrial structure.

Below are the five trends addressed in his keynote speech:

Trend 1: Total factor productivity has become the most important driver of growth

In the past 40 years of reform and opening, China has been able to maintain a leading growth rate. An important reason for this is China's ability to maintain the high growth rate of total factor productivity through various methods. According to the theory put forward by American economist Robert Solow, growth in the past was mainly dependent on the demographic dividend, the massive input of labor and capital, as well as innovations in all aspects of the financial system. At the same time, as China was in the process of completing its industrialization process, it was able to maintain a high growth rate in total factor productivity. All in all, these favorable conditions culminated in China's high growth over the past 40 years.

As we can see, since 2010, total factor productivity has dropped to about 2% after we have more or less completed the industrialization process. Across the world, it has proven to be relatively easy for major economies to improve total factor productivity during industrialization. However, with the rise of the services and tertiary sectors in the post-industrialization period, raising TFP becomes more difficult. This is one big challenge that we are currently facing.

Based on our calculations, if China's total factor productivity (TFP) level were to reach 65% of that of the United States by 2035, its average annual TFP growth rate needs to exceed that of the United States by 1.95 percentage points, with a growth rate of 2.5% to 3% over the next 15 years. This is a tough challenge, which is also duly reflected in the 14th Five-Year Plan.

The most credible source of total factor productivity lies in a comprehensive reform from the supply and demand side, instead of simply adopting reactionary economic policies. After so many years of rapid growth, we still have four comparative advantages that will help improve total factor productivity.

First, the possibility of "re-industrialization". Currently, many of China's industries are undergoing digital transformations, which essentially signify another round of industrialization. This in itself will become the most credible source of growth in total factor productivity.

Next, the infrastructure needed for "re-industrialization", which we term as "new infrastructure", will also result in solid growth of total factor productivity.

Third, as a large manufacturing country, China's manufacturing industry now accounts for 27% to 28% of its GDP.As the manufacturing industry is expected to maintain its stable share of the economy in the next 5 to 10 years, its continuous development will also create room for the growth of total factor productivity.

The last point is the most credible. After all, we still possess vast dividends from the years of reform and opening. As the efficiency of resource allocation is relatively low at present, with further reforms and opening, there is a lot of room to improve total factor productivity. Hence, we might be able to see many positive changes in this area over the next 5 to 15 years.

Trend 2: China is moving upstream in the global value chain

China's participation in the global value chain is rather high, especially in its import and export of intermediate products. This indicates mutual dependence with the rest of the world, which is good news. On the other hand, we are still in the middle and lower rungs in terms of intermediate products or value chains, with a greater reliance on foreign suppliers.

According to McKinsey's calculation of China's dependence on imports in many key areas last year, our dependence on foreign supply and industrial chains is very high. This is not a good sign. As we embark on a new development pattern in the future, we need to strive for more secure supply chains.

A country's position in the upstream value chain is measured by the proportion of its domestic intermediate exports to its total exports (upstream index), less the proportion of foreign intermediate products included in domestic exports (downstream index). According to World Bank data, the average position of 40 major open economies in 2018 is 0.04. The position of the United States is 0.29, which obviously places it in the upper rungs. On the other hand, China is in the middle and lower rungs. Against the backdrop of increasing uncertainty in international circulations, it is extremely important for China to move up the value chain over the next 5 to 15 years.

Trend 3: The fundamental role of a strong domestic market and consumption

I will touch upon the third point briefly, as we have placed emphasis on domestic circulation as the main focus of the new development pattern drawn in the 14th Five-Year Plan. We did a statistical analysis of OECD countries. In high-income countries, per capita GDP is negatively correlated with the dependence on foreign trade. With the increase of per capita GDP, the proportion of imports and exports as part of GDP will naturally decrease. China follows such a general rule as well. Our exports accounted for 36% of GDP in 2006, dropped to 18% in 2019, and will further decline in the next 5 to 15 years. This means that in the future, Chinese manufacturing and production industries may serve the domestic market to a larger proportion. Hence, in view of the relatively low consumption rate in China, it is timely to consider ways to form a strong domestic market and to promote the fundamental role of consumption in its future economic and social development.

Looking forward to 2035, we believe that with a strong domestic market and domestic consumption playing its role in economic and social development, the household consumption rate will increase from the current 39% to nearly 60%, and the consumption of services out of total consumption will increase from the current 44% to 60%. Hence, the economic, social and industrial structure will all undergo profound changes.

Trend 4: Efficient markets, optimal allocation of resources and increasing investment returns

The fourth trend is related to optimizing the allocation of resources and improving the rate of return on investment capital. In the "Proposal", we have paid special attention to the key terms of "promising government" and "efficient markets". While there are many ways to interpret the concept of "efficient markets", I personally believe that the biggest focus in the future is to form a strong market pricing mechanism, so that prices can guide the effective allocation of resources and improve investment efficiency.

China is a country that possesses vast investment potential. After many years of high-speed investment, the current per capita capital stock is still only half of that of developed countries, indicating numerous investment opportunities in the future. At the same time, we can see that the urbanization process also brings investment opportunities. The Proposal mentions the key role of investment in economic growth—but how does it work? The prerequisite is effective allocation, where investments should be allocated to the most suitable place, city, industry or new field. At present, we face problems such as low investment efficiency, unreasonable investment layouts and resource mismatches. In our research, we also found that low investment efficiency will lead to a higher macro leverage ratio.

In addition, the process of urbanization still has a long way to go. According to an analysis of the 2010 census data, 88% of prefecture-level cities have not reached their ideal population size, indicating an economic deficiency. It is noteworthy that an ideal population size facilitates the rise of new industries and improvements in investment efficiency. In view of the above, we indeed require an efficient market, as well as a pricing mechanism to allocate resources to profit-generating sectors in the future.

As such, the supply-side reform in the financial sector is of great significance. This is the reason why China requires a REITs market and an effective stock market.

Trend 5: Increasing the proportion of residents' income and eliminating the urban-rural divide

The last trend is an ongoing change of a longer-term significance. In order to form a new development pattern with domestic circulation as the main driver, it is necessary to enhance consumption capacity and willingness. At present, there are two problems with income distribution. First, income distribution to residents is low, which we estimate to be only about 43.3%. This means that with a GDP of USD 10,000 a year, disposable income is only RMB 30,000. In contrast, this value is about 63% in the United States. Hence, we have yet to fully tap into potential consumption. The second problem is the extent of the unequal distribution, which is still relatively high.

In the future, we will have to consider ways to increase the share of residents' income distribution in domestic output and reduce the extent of income inequality. This concern is also duly reflected in the Proposal.

Another important problem is related to the migration of the agricultural population. Guanghua Thought Leadership Research Group conceptualized a possible long-term goal in 2035, where the proportion of the agricultural sector in the economy will only be about 3%, with a corresponding drop of its employed population to about 6%. This means that more than 20% of the employed population will be reallocated to high-end manufacturing or service industries in the next ten years. As they settle down, their inclination and ability to consume will serve as preconditions for us to form a new development pattern with domestic circulation as the main driver.

Let me give an additional example. According to calculations by Guanghua Thought Leadership, the urbanization rate in China is about 60% at present and will reach 75% or even 80% by 2035. With the increase of urbanization, hundreds of millions of people may seek to live in cities in the future. Where shall they go, and where will they live? To solve these problems, we will have to be innovative in our thinking and business models and carry out concrete reforms.

In the next 5 to 15 years, we will see the largest urban-rural interaction in history, with a mass reallocation of labor forces. Correspondingly, the construction of the financial service system and public service system will become an important driving force for China's future economic and social development. The above five trends will determine our future demand to a great extent, thus driving the changes in our industrial structure.