Economic growth in China has been occurring at a phenomenal rate in the last two decades. Given the fact that the Chinese economy is set to be the number one contributor to global GDP in the next fifty years, the phenomenon that is the economic growth in China has generated interest among macroeconomists worldwide. Of course it is not certain yet that the current phenomenal momentum will be maintained in the future or even that given the current rate of growth which is outpacing structural reform the result will not be an economic implosion as many macroeconomists fear. But at the very least, the economic transformation that has happened in China has been so spectacular that the process by which this transformation occurred has been the number one topic of interest among macroeconomists worldwide.
Economic transformation in China: a mixed blessing for the West.
At its basic level, the nature of the transformation has been one of a closed economy slowly and strategically integrating itself into the world economy. Before the 1980s, China used to be a closed economy. That is, the products and services that the Chinese economy was producing was limited to internal use only and it did not export any of the goods and services. But the Chinese government slowly liberalized economic controls and these liberalizations resulted in the country joining the world trade organization which allowed it to export its goods and services worldwide. This has had huge repercussions worldwide and particularly for the business organizations in the mature and aging economies of the West. In this regard, the tremendous economic growth in China has been an extremely positive sign for the economically mostly stagnant countries of Europe and America. Because these economies have matured and reached the limits of their potential, consumer demand in these economies has been less than spectacular. That has obviously had a negative effect on the business firms’ incentive to conduct research and development activities in the interests of bringing out more innovative products and services. But when there is an economy like China which is practically exploding in terms of economic growth, then there is a concurrent explosion of consumer demand which fuels massive investments on the part of the European and American business firms to find out how to grab market share in the tremendously vibrant new economy and in the process to completely revamp their product line not only to the benefit of the Chinese consumer but to the rest of the world as well. In this respect, the management community in the highly developed but stagnant economies of the West are gloating over the tremendous potential for profits that their business firms have access to in a country that is going to be the economic superpower in the 21st century.
However the Chinese economic phenomenon has been a mixed blessing because there are certain problems associated with it not the least of which is the extremely low cost of labor in the current economy. As a result, all the businesses in the West are rushing to set up plants and equipment in China so that they can lower their manufacturing costs to the maximum extent possible. As a result of this trend, millions of people are losing their jobs in the West. However, it is not clear if the management is to blame either as Adam Smith’s invisible hand directing the price mechanism dictates that business firms must keep their costs down and in this way maximize their profits. Of course, firm owners could continue their manufacturing operations in their home countries and thus save the governments in the west from crippling unemployment rates, but then they would not be able to manufacture products that would be within the purchasing capacity of the biggest market in the world which is China. The middle class in China is still growing and they still do not have the purchasing capacity of the middle class in the West. But they are getting there fast and any business firms that stay home and do not seek market share in this phenomenally growing market will not be able to survive internationally. As a result, business firms are having to shift their manufacturing operations overseas to China even though it is affecting millions in their home countries. In this respect, the unprecedented economic growth in China has been a mixed blessing at best for the West.
According to the above, the low cost of labor has been causing high unemployment in the West. However once again, this might have a positive effect on the unemployed millions of the west. If the Chinese economic growth had not occurred and everyone had been employed with job security intact, then there would have been no incentive on the part of the workforce in West to upgrade their skills further. In fact this has been one of the reasons that the economies in the West have been stagnating, the fact that college graduates whose skills are long outmoded are still gainfully employed. Of course automation has forced millions to lose their jobs and attracted the governments’ attention to investing in retraining the unemployed so that they will have skills with which to compete in the modern economy. But automation is always a risky investment in most business operations as managing organizational change is still a hotly debated issue. But now that business firms are rushing en masse to China leaving millions in the West stranded without a paycheck, the issue of upgrading the skills of the workforce so that they can still find jobs is gaining attention. As a result, massive investments in China are an unmixed blessing in disguise.
Economies in the west are already cutting their reliance on agriculture and manufacturing and relying on the service sector as the number one contributor to their GDPs. This has been another indirect benefit of the Chinese economic expansion. Given the low cost of labor that is the prime feature of the current Chinese economy, it is not sound macroeconomic judgment to try to compete with the manufacturing prowess of the Chinese economy. So the effect is complementary when economies in the West specialize in service rather than in manufacturing. However the service sector is a highly specialized sector and it needs highly skilled manpower which manufacturing does not. China is gobbling up all the manufacturing investments like a black hole and in the process forcing millions in the West to retrain themselves for the service sector. It is no wonder therefore that everyone is keeping their finger crossed about the continued momentum of the economic growth in China. However migration to service on the part of the West is not a recent phenomenon. The trend had started back in the 1980s and currently the migration is almost complete. The problem is that the labor market economics that operate in the manufacturing sector follow exactly the same dynamics in the service sector. As a result, salaries in the service sector have reached a very high level as well. This is forcing services as well to shift their operations offshore to India. Just as China has become the destination of choice among the manufacturing firms, India has become the destination of choice among the service firms. While India has been growing at a somewhat slower rate compared to that in China, its specialization in the field of information technology has been impressive to say the least. Almost all the operations of the value chain in this field are moving from the West to India. Once again we see the reluctance on the part of the Indian government to focus too much resources on the manufacturing sector as China is completely dominating in this sector worldwide. The scale of the phenomenon that is the Chinese economic growth can be well assessed by the extent to which economies in the rest of world are adjusting their policies to maintain a competitive edge in the face of the roaring economic titan that is China.
How the transformation occurred
As mentioned before, China was essentially a closed economy to begin with. However now it has opened up to international trade. The process is a tricky one but the Chinese government seems to have managed it well by strategically relaxing price controls. This was part of the economic liberalization process that started 1978 when the total amount of GDP was Rmb 362.4 billion. The success of the liberalization policy can be well assessed by the fact that GDP in 2004 was Rmb13.7 trillion. In the five years between 2001 and 2005, the economy has grown at an average rate of 9% as can be seen from the chart in the next page. According to this chart, although the growth rate leveled off beginning in 2004, the total amount of GDP has been growing constantly. This success on the part of the Chinese government can be
Source: OECD economic survey of China
explained by the fact that it has also invested on a massive scale in improving its infrastructure which has in turn consistently attracted a very high level of foreign investment. However remnants of the past when the government was controlling everything are still there threatening to upset the whole process. When the economy was a closed one, the state owned enterprises were completely protected from outside forces. As a result, inefficiencies proliferated in the form of cozy relationships in which bank officials signed off on loans to business organizations not on the basis of those organizations’ profit making potential but on the basis of the quality of their relationship. It is not surprising therefore that all the state-owned enterprises currently are riddled with non-performing loans. However the state-owned enterprises are not the ones which will have to bear the burden of these non-performing loans. The government will have to compensate for those losses from some other sources one of which is privatization. However it is not clear at all whether the Chinese Government will be able to find buyers who will be willing to put their money into propping up chronically struggling enterprises. As long as these enterprises remain the government’s responsibility, it will be a huge liability that can only hold back the government from keeping up the good work in terms of economic liberalization which has its costs such as the uncertainty of its currency when it has been set free from governmental control.
The effect of the phenomenal Chinese economic growth on the US economy has been one of a trade deficit and a current account deficit. The current account deficit has mainly resulted from the Chinese government’s insatiable hunger for the American dollar. This is a hedging strategy on the part of the Chinese government should the Chinese currency devalue drastically once it has been stripped of governmental control. Currently, the US is the world’s leading debtor nation as it is financing all its costs by means of Chinese money. Should the Chinese government decide to invest its money elsewhere, then the US government will be helpless in paying its bills. Apart of the Chinese government buying up T-bills like nobody’s business, the process of controlling the exchange rate which is what it is cannot be continued in the long term as it is anti-competitive. By deliberately keeping the value of the currency down, the Chinese government is maintaining the phenomenal level of its exports worldwide thus resulting in the massive trade deficits with the US. However the Chinese government cannot be blamed either for adopting this process because it is uncertain what the effect will be if the Chinese currency were floated. Given the massive inflow of investment in the Chinese infrastructure, it is a safe bet, with the phenomenal economic potential taken into consideration, that there will be a massive demand for the Chinese currency which will shoot up its value. It is primarily for this reason that the Chinese government is buying up American bonds to an extent that is to all intents and purposes once again phenomenal. However the government has no choice in the long term but to slowly ease up on the exchange rate and by the time it has been set free, it is hoped that the market conditions that it will have created will be able to hold the currency in balance.
So far the Chinese government has done a fabulous job in progressively creating an environment where free market can operate. Macroeconomic theory suggests that it is capital accumulation and the labor market that are the two most important factors in driving the engine of economic growth. That has not been the case in Chinese economic growth however. The engine of growth in this case has been surging productivity. This productivity has probably resulted from the government progressively granting greater and greater ownership rights to the citizens so that they can set up their own businesses and make money without having to worry about the government taking all the money away. There has been a marked decrease in dependence on agriculture since the government set off on the path of economic liberalization. This has happened because more and more farm owners are now structurally reforming their sources of income in order to avail themselves of their new found freedom to sell their produce at a profit. As a result, farmers are turning into business owners. This extension of ownership rights has had a pronounced effect on attracting foreign investment as business owners worldwide are now confident that their business interests will not be nationalized at the first sign of trouble. It is no wonder that the number one business strategy for multinationals in the 21st century is to expand to China.
As mentioned before, there are still problems in the Chinese economy which can halt its progress even now. There is always the threat that reactionary political interests will take over the running of the economy and take the country back to square one by undoing all the structural economic reforms implemented successfully so far. However as long as business interests in the West continue to invest in China thus showing the Chinese population the benefits of economic liberalization, that possibility remains minimal. Continued economic growth in China is an opportunity for growth worldwide.
McConnell, Campbell R., and Stanley L Brue. Macroeconomics. South western college pub. 2007.
Blanchard, Olivier. Macroeconomics. McGraw Hill/Irwin. 2005.
Mankiw, N Gregory. Principles of Macroeconomics. McGraw Hill/Irwin. 2005.
Moss, David A. Concise Guide to Macroeconomics: What Manager, Executives, Students Need to Know. McGraw Hill/Irwin. 2005.
Naughton, Barry. The Chinese Economy: Transitions & Growth . McGraw Hill/Irwin. 2005.
Wu, Jinglian. Understanding and Interpreting Chinese Economic Reform. Wiley. 2007.
Case, Karl E., and Fair, Ray C. Principles of Macroeconomics. McGraw Hill/Irwin. 2007.
Sowell, Thomas. Basic Economies: A Common Sense Guide to the Economy. McGraw Hill/Irwin. 2005.
Rodrik, Dani. One Economics, Many Recipes: Globalization, Institutions, and Economic Growth . McGraw Hill/Irwin. 2006.
Cateora, Philip, and John Graham. International Marketing. Wiley. 2007.