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Phelps: China doesn’t understand a dynamic economy

China doesn't understand the unpredictability of a dynamic economy, Edmund Phelps, winner of the 2006 Nobel prize for economics, told CNBC's Squawk Box.

Phelps said he sympathized with Chinese policymakers who have had to deal with rapid changes in the world's second-largest economy in recent years, having been accustomed to rapid expansion in the past two decades.

"An economy that's full of dynamism and people using their imagination and their creativity, such an economy is not predictable," said Phelps, who is currently the director of the Center on Capitalism and Society at Columbia University.

"Nobody knows exactly in what directions the economy is going to be moving and how fast it's going to be getting there. And this is something the Chinese are totally unfamiliar with," he said.

Concerns over China's slowing economic growth come as policy makers are trying to shift away from a focus on the industrial sector, much of which is state-owned, and toward a greater reliance on the service sector for growth.

That economic transition is showing up in the data. The economic growth rate slowed to a 25-year low of 6.9 percent in 2015, official data showed.

While secondary industry, or manufacturing, growth slowed to 6.0 percent in 2015 from 2014's 7.3 percent, tertiary industry, or the services sector, expanded by 8.3 percent last year, up from 2014's 7.8 percent.

Further hiccups may be ahead: China expects to lay off as many as 6 million state workers over the next few years to curb overcapacity in the industrial sector, Reuters reported earlier this month, citing sources.

That's likely to keep China watchers jittery.

"I feel very sympathetic for the leadership that it has to deal with all this nervousness and this dismay that the transition is going along slowly and with bumps in the road," Phelps said. "They want everything laid out for them and want to be told that it's certain it's going to happen and, of course, that's impossible."

But Phelps added that China's reforms are generally headed in the right direction.

"I don't want to put a stamp of approval on every single thing that they're trying to do, but I think generally they understand the big point, which is that there's tremendous overcapacity in the traditional industries," he said. "What investment there's going to be in the future is going to be in a different set of industries."

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—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1