Some notes on China’s economy

As the world’s third largest economy, the dynamics of China’s development have a strong impact on the rest of the world. As one example of a country that relies on export-led growth (although this has been contested), and needs to change the balance of its development, it provides an interesting case-study. If indeed China’s enormous current account surplus has had a malign effect global financial processes, despite representing in another sense tremendous progress, how is it to be reduced in a sustainable way, and also with the minimum of social and political upheaval? How is China to reorient its growth towards domestic demand and consumption?
China is distinctive among large economies in that it is relatively open and exports constitute a relatively large proportion of GDP. The current slowdown in world economic growth, in credit-driven consumption in the US and other major economies, seems to be impacting China strongly. It’s tightening of monetary policy to prevent inflation in recent years may also have had an effect. It is also notable that China’s trade surplus has in fact grown despite the slowdown in export growth. This is partly due to the fact that 50% of imports are are used to produce goods for export. In addition, the construction sector has experienced a marked slowdown, and it is a heavy user of imported materials. Lastly, the fall in commodity prices has also reduced the value of imports.

China’s eastern seaboard acts as an industrial dynamo for the economy, with its export processing zones acting as magnets for foreign and domestic investment. As mentioned above, companies import materials and components for use in production and export the goods once assembled. The global slowdown has hit manufacturing industry particularly hard. The credit crunch has made it harder for firms to obtain credit for payment in advance for their inputs. Since one firm’s inputs are another firm’s outputs, the whole supply chain is affected.

The slump in international trade has left 20 million migrant Chinese workers unemployed in towns and cities. Many of them will be forced to return home to their families in the countryside, since welfare protection is minimal. This is likely to reduce rural incomes too, as the remittances sent home by urban workers will be falling.

It is clear that China needs to boost domestic demand to combat the recession, and it is taking steps to do so with a fiscal stimulus package, the size of which has been disputed. Maybe structural reforms are needed too, for the longer term reorientation of the economy towards domestic consumption. This would likely accelerate the emergence and growth of a consumer society in China, which seems inevitable. In addition, not only must growth be sustainable economically, but also environmentally.

The Economist argues that the structural reforms must include raising government expenditure on health, education and social welfare and to shift their economies away from capital-intensive manufacturing towards labour-intensive services. This should have the effect of reducing household saving and increasing consumption expenditure. They have argued that some liberalisation of finance would boost the growth of credit and from there consumer spending as a proportion of GDP. But China should be careful with how it sequences and times reforms, as it has been in the past. It is still a poor country in terms of income per head and has a long way to go to catch up with the West materially. A too rapid freeing of finance could lead to unsustainable bubbles as has been the case in many countries, rich and poor, and any subsequent collapse could slow GDP growth for years, hitting the population hard, especially so with no welfare safety-net in place.

Measures to enable a more rapid growth of rural incomes and productivity in China are also important. These would likely allow further rural-urban migration and could help to slow or reverse the rampant inequality in the country. China still seems to have substantial surplus labour in terms of the ‘Lewis Model’ of development which keeps rural wages down and encourages migration to urban and industrial regions. It also predicts that wages in industry are kept down by this process. As surplus labour is gradually exhausted, a process that has been set back by the current slowdown, competition among employers will bid up wages in industry and newly-developing services and stimulate increased consumption in the economy and new sources of demand and growth.

750 million people still live in rural areas in China, out of a total population of over 1 billion, which indicates that the country has a long way to in its continuing industrialisation and urbanisation. It is not clear that China needs to fully liberalise (whatever that means) its economy yet, as the past thirty years have been dramatically successful in terms of a number of development goals (increase in incomes, reduction in poverty etc).


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