China’s economy has taken off since Deng Xiaoping’s economic reforms in 1978. Contrary to the conventional wisdom that China’s economic growth has been driven by exports, it is investment that actually contributes the most. China’s fixed capital formation and inventories jumped from 30% of GDP in 1980 to around 47.5% in 2010. Fixed capital formation, which corresponds to infrastructure such as factories, roads, and housing, had risen to the unprecedented high of 18.2 trillion renminbi at the end of 2010. And it is still rising.
Continued high national savings fully finances Chinese investment and sustains it at a very high level. High profits of state-owned enterprises re-invested into capital-intensive projects could keep the ball rolling for quite a long time. It is noteworthy that foreign direct investment (FDI) also plays a proactive role in the Chinese economy, particularly in coastal regions. FDI not only provides the coast with capital but also with technology and know-how, which help the development of more productive projects (Naughton 2007 and Huang 2010).
Of course, the export boom has been spectacular. But it is only a recent phenomenon dating back to around 2003 (Horn et al 2010). China’s rapid urbanisation is the key source of its supply of cheap labour that flows from agriculture to industry. With China’s integration into the world economy after WTO accession and huge external demand, low-priced manufactured products poured into foreign countries and created China’s economic ‘miracle’.
China’s productivity fallacy
Most economists argue that total-factor productivity’s (TFP) average annual growth – 3% in1978–94 and 2.7% in 1995–2009 – explains much of China’s rapid economic growth (Kuijs 2009). However, according to Harry Wu’s calculations, average TFP growth was only 0.3% a year and negative in 1984–2001 (Green 2011). The numbers suggest China’s growth in the past three decades was generally TFP-poor, with underlying inefficiencies in the growth model.
Over-reliance on investment and exports makes China’s economy very unbalanced, vulnerable, and unsustainable. Prolonged investment on a massive scale creates significant overcapacity in a range of sectors such as steel and solar heating, which diminishes productivity improvements. Additionally, huge investment including the 4 trillion renminbi stimulus plan leads to increasing debt. Much of the medium- and long-term bank lending for infrastructure flows to local quasi-government agencies. At the end of 2009, local debt incurred by China’s investment reached to 6 trillion renminbi (Lardy 2010) and now stands at 10.7 trillion or even more (New York Times 2011 and Wang and Hu 2011). It is not likely that those local quasi-government agencies will go bankrupt, because local governments repay the debt through household wealth transfers. Too much dependence on exports is also risky for China, as the West may start to save and consume much less. During the global economic crisis, the depression penetrated China’s 31 provinces, and in the fourth quarter of 2008, millions of migrant workers lost their jobs.
Bumpy road ahead
The road towards more consumption-driven growth will be bumpy. With the stimulus package that has poured a huge portion of the country’s GDP in financial resources into the state sectors, the momentum of investment will continue for several years. In the meantime, China has the fiscal resources to spur another round of massive investment in the seven emerging strategic industries, although in light of current inflation and local debt a new stimulus package will not be introduced soon. FDI, as a minor part of the story, is also expected to grow as a consequence of openness of interior city clusters, continued global economic recovery, very low interest rates in developed economies, as well as renminbi appreciation (Wang and Hu 2011). As such, investment growth will remain high and its share of GDP will be reluctant to pick up sharply until rebalancing measures become more effective in the medium term.
China is diversifying its export markets, yet most of its exports are manufactured products. In the next two to three years, exports may rebound strongly and current-account surpluses will continue. After the mid-2010s, exports might face more challenges as a result of smaller supply of young skilled labour and China’s move towards higher value-added and technology-intensive industries in central and western areas. On balance, imports are likely to rise faster than exports, reflecting strong demand and the higher price of oil, commodities, and capital goods (Consonery et al 2011).
Spurring private consumption and leveraging its share to 50% will also be a challenge. In 2012, private consumption will grow faster than GDP, supported by solid employment and wage growth and increased government social expenditures on pensions and healthcare (Wang and Hu 2011). But the Chinese stimulus programme and ongoing massive investment in the emerging strategic industries have already led to overcapacity and huge nonperforming loans, which will ultimately be paid off by Chinese households. Chinese private consumption will be hampered (Pettis 2011). In the past two decades, China’s consumer confidence index and consumer expectation index have trended downward overall. Future improvement depends on systemic reform.
In 2011–20, China’s economy will become even bigger, but its growth rate will somehow wane down. China’s average investment growth will be around 10%, private consumption growth around 9%, government expenditure growth 12%, and net exports growth at -1%. In 2020, after gradual structural changes, China’s investment, private consumption, government expenditure, and net exports as share of GDP will possibly to be 40%, 42%, 15%, and 3%, respectively. The nation’s GDP is thus expected to reach 78.4 trillion renminbi with an average growth rate at 7.8% per annum.
References
Consonery, Nicholas, Evan Feigenbaum, Damien Ma, Michal Meidan, Henry Hoyle (2011), “China’s Great Rebalancing Act,” Eurasia Group, August.
Green, Stephen (2011), “China – Masterclass – The Next 5,000 Years,” Global Research Report, Standard Chartered,May.
Horn, John, Singer, Vivien and Jonathan Woetzel (2010), “A Truer Picture of China’s Export Machine,” McKinsey Quarterly, September and Personal Conversation with Jonathan Woetzel on China’s Exports and Economy, 26 September.
Huang, Yukon (2010), “Reinterpreting China’s Success Through the New Economic Geography,” Carnegie Paper, November.
Kuijs, Louis (2009), “China Through 2020 – A Macroeconomic Scenario”, World Bank Research Work Paper No.9, June.
Lardy, Nicholas (2010), “The Sustainability of China’s Recovery from the Global Recession,” Policy Brief, Peterson Institute for international Economics, March.
New York Times (2011), “Moody’s Sees Much Bigger Local Debt in China”, 5 July.
Naughton, Barry (2007), The Chinese Economy: Transitions and Growth. Massachusetts, MIT Press.
Pettis, Michael (2009), “Sharing the Pain: The Global Struggle Over Savings”, Policy Brief, the Carnegie Endowment for International Peace, November.
Wang, Tao and Harrison Hu (2011), “China By the Numbers”, UBS Investment Research, August.
