China’s Service Sector Is an Underutilized Driver of Economic Growth

IMF News, August 2, 2024

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We project growth will remain resilient at around 5 percent in 2024, despite the continued property sector adjustment.
Growth is expected to slow significantly in coming years, to around 3.3 percent in 2029, as diminishing productivity and an aging population constrain expansion.
The service sector’s share of value-added has increased in recent years to just over 50 percent, but remains well below the average of about 75 percent for advanced economies.
A comprehensive package of market-based structural reforms, enhancements to the social safety net, and pension reforms can raise GDP by close to 20 percent over the next 15 years relative to the baseline, or about 1 percentage point higher potential growth per year over the medium term.
This year’s increase in old-age benefits by 19 percent for rural and non-working urban residents is noted as a small but welcome step.

Reallocating resources to services has helped boost productivity over the past two decades and can continue to do so if supportive reforms are implemented.
Company-level data indicate that allocation of capital and labor across firms in services has become increasingly inefficient: highly productive firms have been too small on average, while less productive firms command too large a share of the market.
Service-sector firms have been highly innovative, but regulatory and market barriers have limited efficient scaling of the most productive firms.

Expanding the service sector can help create more jobs, particularly for young people who are disproportionately employed in service sectors like technology and education.
Since emissions are lower in services, expanding the sector would help China reach its climate goals more efficiently.

China has relied too much on investment as opposed to consumption.
The service sector remains subject to more onerous regulations compared with members of the Organisation for Economic Co-operation and Development, including restrictions on domestic and foreign entry and significant regulatory hurdles.
Local protectionism and regulatory barriers have prevented capital and labor from being efficiently allocated within services.

Prioritize reforms to improve allocation of capital and labor in services by:
- Easing regulatory requirements.
- Further reducing local protectionism.
- Allowing more businesses to enter and compete in services, including reduced trade and foreign entry restrictions.
Rebalance the economy to strengthen demand for services by:
- Improving social safety nets to reduce precautionary savings, especially among middle- and lower-income households.
- Making taxes more progressive.
- Increasing coverage and improving unemployment and medical benefits to boost consumption.
Combine demand-rebalancing policies with structural reforms that lower barriers to entry and ease regulatory restrictions to enable efficient allocation of capital and labor.

Source: Sonali Jain-Chandra, Siddharth Kothari and Natalija Novta, August 2, 2024.