Sunday, 14 July 2013

The unprecedented growth of China

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China has been the world’s largest growing major economy over the last 30 years.[1] But how has this been achieved?

Following the death of Chairman Mao in 1976, China was taken under new leadership that sought for economic improvement. The reformist leader of the Chinese communist party, Deng Xiaoping, put huge emphasis on increasing trade and raising personal incomes in China. The effect is that over 66 million people have been brought out of poverty in China over the last 30 years and the size of the economy has almost doubled every 7 years.[2] This has created major new opportunities for China and its people.

The Structure

The political system in China is different to many other major economies. There is only one political party, the Communist Party of China, in which its leaders are changed every decade. The new leaders are decided by the Chinese Central Committee, which mainly consists of party leaders and army generals. This contrasts to most democratic systems, such as the UK and US, in which multiple parties compete every 5 years for votes from the whole population.

This system allows for long-term policies to be implemented that provide benefits to China’s economy over time. Democratic political parties generally have a myopic approach when creating policies. They make short-term policies, which have short-term benefits to their economy, so they can create a ‘feel good’ factor within the country. This is so that the political party can be voted into power for more than one term.

The Effect

China’s long-term approach has clearly been beneficial to its economy, as seen by is extremely rapid growth in recent years as a result of policies implemented in the early 80’s. Below is a chart comparing Gross Domestic Product (GDP) of China with the US since 2000 and growth predictions till 2025:

The rate of growth in China is significantly greater than the US. It is predicted that soon China will overtake the US to become the world’s largest economy by 2018.[3] 

The Cause

The main drivers of growth have been from an increase in the quantity of its factors of production, which accounts of 70% of China’s economic growth. This has increased due to large state investment in capital, which has risen by 50%.2 A rise in the number of workers has also contributed to the increase in the quantity of factors of production. This has been mainly due to China’s large population growth, and a shift in culture that has seen increased female work participation.

China’s impressive growth has also been driven by a rise in total factor productivity, which accounts for 30% of China’s growth.2 This is much greater in the UK, where rising total factor productivity has only contributed to 5% of economic growth.[4] Total factor productivity has increased in China due to a rise in human capital by 11%. This has come from state investment in higher education and the creation of more universities. Privatisation within China has risen, with initially over 10 million state owned enterprises being reduced to 250 thousand from early to late 90’s.2 This benefits China’s economy because the private sector is much more efficient than the state sector. This makes the firm more productive and is due to motives having changed towards making profit. Factor productivity has also been driven by a 17% rise in innovation within China, mainly due to state subsidies for research and development, making firms allocate resources much more effectively.2 This will cause growth to rise as increased efficiency will cause a long run increase in the productive potential of the Chinese economy.

However, China’s rise in innovation is starting to peak. This is because China has been playing ‘catch-up’ with other major economies and has imitated technology rather than innovated themselves. True innovation in China is limited by China’s underdeveloped legal system.2 This means firms are unable to protect their intellectual property rights and so firms are unable to secure returns on their innovations. This reduces the incentive to innovate and so total factor productivity is not likely to rise as significantly. If left unaddressed, this could be a problem for China’s future as will limit growth. This does not limit other major democratic economies; they have well-developed legal systems that allows firms to protect their innovations with patents.

Major political reforms over the last 13 years have contributed to China’s impressive growth. These include the re-opening of the stock markets in 1990, membership within the World Trade Organisation in 2001 and the expansion of the ‘open door’ policy.[5] These changes have been put into place to increase Foreign Direct Investment into China. The effects of these policies, put into place by the new leaders of the Communist Party, have helped to increase China’s huge export market, which is by far the largest in the world. China’s large export market is the biggest factor that has contributed to its rapid economic growth. No other major economy has been able to implement as many reforms as China in recent years, mainly due to the political opposition that democratic countries face when a new reform is proposed. This therefore increases the time it takes for a reform to be implemented, which then restricts the potential to grow.

The Side-effects

Inequality is a major problem within China. It has one of the world’s largest income inequality ratings. The richest 10% of the population have 35% higher incomes than the poorest 10%.[6] Additionally 13.4% of the 1.3 billion strong population live below the poverty line of $1.25 per day.[7] This is equivalent to twice the population of the UK living in extreme poverty. China’s inequality divide is between its urban areas, such as Beijing and Shanghai, and its rural areas, such as Lijiang - the poorest city in China. The chart below shows the increasing rise in income inequality between the urban and rural areas:

Average income in urban areas is around 17000 Yuan ($2800), compared to 5000 Yuan ($815) in rural areas, nearly three and a half times less. This is a persistent and increasing problem that needs to be addressed by the Communist Party as is causing social unrest within China.4 China is attempting to tackle this problem by removing one million people per month from below the poverty line. However with 127 million people in extreme poverty this is simply not enough.5 This is limiting growth because if these people were in work, they would be increasing the quantity of labour. This would further increase China’s productive capacity, leading to economic growth.

China has a heavy reliance on exports from other countries. Due to the policies promoted by the communist party, exports in China now make up 70% of GDP2, compared to just 32% in the UK.[8] This creates a problem when major importing countries decrease their demand for imports. This has happened recently as a result of the global financial crisis. The US and Europe are big importers from China, the decline in the amount of imports into these countries has been a major factor in the decrease in growth China has seen in the last few years.[9] This problem is likely to persist for some time as many countries in Europe have been focusing on austerity measures, meaning demand for imports will remain low for the foreseeable future. This is expected to last until 2020[10], partly due to the large debt in Europe but also because many political parties, especially the UK, will face strong criticism if they change their economic plan. China is suffering as a result of this. The Communist Party has been putting huge emphasis on growing exports since Xiaoping took over leadership and now they have become too reliant on demand from other countries. China’s communist party now needs to focus on rebalancing the economy and increase domestic demand to compensate for decreasing exports and to maintain growth.

However increasing domestic consumption will not be easy for the Communist Party. Domestic consumption has been falling from 50% to 35% from 2000 to now.2 This is significantly lower than in the UK where domestic consumption is 64%.[11] This has been caused by a rise in total savings within China, which is in part due China’s businesses saving more. This is because their firms are being taxed lightly and have been paying increasingly fewer dividends to their shareholders.2 It is also in part due to high household savings within China. Each Chinese family on average saves 47% of their household income, compared to just 7% in the UK.[12] Chinese families save a high proportion of their income due to the lack of an adequate welfare state provided by most democratic countries. With the lack of state pensions and benefits, the typical Chinese family saves their income so they can sustain their standard of living in the future.

China is also facing is an inefficient state sector. Despite China’s aggressive privatisation policy, the largest firms, such as China Mobile, are the most inefficient and still remain. State owned enterprises account for 1 in 5 jobs in urban areas of China.2 Because of this, a huge amount of resources are wasted every year due to the lack of research and development, required for innovation, within state firms. This means that these firms do not increase efficiency therefore receive the lowest return on their assets when compared to private companies.  The communist’s party’s firm grip on these large firms is limiting China’s future growth potential.

Due to its communist nature, there are many social policies that have been implemented that are highly unpopular. The one child policy brought into effect in 1979 is an example of this. It was brought into effect due to an unsustainable rise in the population growth in China. The policy has been successful in the sense that it has reduced China’s population growth; however this has led to government failure as a larger problem has been created. By primarily favouring men, major gender imbalance faces the country for the next generation of the population.  The effect of this is that there will be a rise in the number of unmarried men within the country. Unmarried men are generally unhappier and suffer from poor physical health as well as poor psychological health.[13] With poor health, labour productivity will fall, decreasing China’s growth potential.

A Comparison

China’s rapid economic growth is comparable to the growth in India in recent years. Both India and China are included in ‘the BRIC economies’. This refers to the economies of Brazil, Russia, India and China, the counties expected to develop the most in forthcoming years. India is the world’s largest democratic nation and is therefore ideal for comparing with China’s communist nation. There are many similarities between the Chinese economy and the Indian. Like China, India has recently undergone major reforms to its economy to boost its manufacturing and services sectors. Similarly to China, these have been funded by state subsidies. India has also been experiencing recent falls in economic growth.[14] This is due to the uncertainty of the state of the future of the Indian economy as there is a general election approaching in 2014. This means investment has fallen within India, slowing growth. In China they do not have this problem, as there is only one political party whose leader is changed only every 10 years. This creates more stability within the economy, therefore investment can be maintained, which is used to drive economic growth.

India also faces similar problems to China. This includes large regional inequality and pollution.[15] However due to the government’s desire to be re-elected, these issues are being tackled much more actively. An example of this is a supply side policy the Indian government has been implementing to try to create jobs outside of its urban areas. They have increased spending on rural areas to try to stimulate development.[16] This is actively trying to raise the incomes of people in rural areas, which boost their standard of living. This can also create a multiplier effect within the economy, as those in rural areas will spend more within their region. This can lead to further development of those areas, leading to economic growth.

However, the Indian economy is suffering from growing debt, 68% of GDP.[17] This is over double that of China, which is 32% of GDP.[18] India’s debt is in part due to its supply side policies, which require the government to borrow money for investment. It is also because of the fact that vast amounts of unnecessary spending go on in India to improve the image of the political party in power in the run up to an election. This year, the year before India’s general election, an austerity budget had been expected to be announced to focus on tackling their rising debt. However, total budget expenditure was announced to rise by 16% in 2013/14 fiscal year.[19] Many believe this is because the current coalition government in India has been performing poorly in recent election polls, so this boost in spending is hoped to cause a short-term growth boost to improve the chances of the political party. China does not have this problem. The democratic flaws, such as the need of being re-elected, do not influence the communist leaders of China. They have no need to spend on ‘vanity projects’ to improve their image and so are able to spend on policies specifically targeted for long-term growth.

The Conclusion

I believe China’s communist party has been the reason China has been able to grow so rapidly over the last three decades. By implementing forward thinking policies, they have driven large amounts of economic growth. However, being a communist nation has been both beneficial and a hindrance to the Chinese economy. There has been a large disregard for the social and environmental effects that the growth has caused. When compared to democratic countries such as India, China is falling behind in maintaining the standard of living of its population. The communist leaders now need to focus on a rebalancing strategy that creates sustainable growth that does not adversely divide its population. If they manage to do this, China will maintain its dominant position within the global economy and its communist nature may even set the standard for future economies to follow in its success.  

[2] Linda Yueh - China's Growth: The Making of an Economic Superpower (2013)

Image Sources:

Figure 1: Gold Price Network:
Figure 2: The Economist:
Figure 3: National Bureau of Statistics of China:

If there are any copyright issues with the photos, please contact me and I will take them down immediately.


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