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After three decades of rapid growth, the Chinese economy has been slowing; at the same time, concerns about the sustainability of its growth model are mounting, calling for urgent rebalancing. This paper provides an assessment of how, and to what extent, the rebalancing process may impact China’s potential growth in the next fifteen years. After reviewing the main reasons behind China’s high growth and imbalances (and the role of factor price distortions), as well as its rising vulnerabilities (overinvestment, excessive credit growth, and a real estate bubble), we adopt a production function approach to derive potential growth. However we depart from the standard methodology in two important ways: first, we correct China’s capital stock for overinvestment by taking into account the credit cycle; second, we disentangle the effects of sectoral reallocations from within-sector productivity, allowing for a better assessment of the expected shift from manufacturing to services. Our results indicate that growth would be currently slightly higher than its potential, with a positive output gap, thus questioning the rationale for additional stimulus measures. Moreover, in our scenario potential growth would fall more quickly than currently expected by the Consensus, to around 5 percent by 2020.

The Long Landing Scenario: Rebalancing from Overinvestment and Excessive Credit Growth. Implications for Potential Growth in China