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Page 1: China's Economy: What Does the Future Hold? by Luc Berlin 2011

CHINA’S ECONOMY: WHAT DOES THE FUTURE HOLD?

By

LUC M. BERLIN-UNKAP

March 5, 2011

Abstract Not many people would have accepted the now fact that China’s Gross Domestic Product (GDP) would grow to become the 2nd largest of the world, eclipsing longtime holder Japan. Since the introduction of economic reforms in 1979, China has become the world’s fastest-growing economy. Moreover, the Chinese government has made strategic investments both economically and socially to ensure its relevance in the business world. Will China’s economy keep its trend and propel the country to the top of the world economy echelon? This research paper examines and evaluates the sustainability of China’s current economic conditions to see how they shape its future. Luc Berlin is an avid fan of global business management and macroeconomics. He has held critical business roles with innovative technology and ecommerce organizations and consults with visionary companies on developing international expansion strategies. A passionate globetrotter, Luc has lived in three continents, speaks fluent French, English, moderate Spanish, and is learning Mandarin. He is also the founder of www.miigle.com, an online platform that allows people to share, develop, and fund ideas from around the world. He has been a recipient of the ACS scholar award and a Finalist at the 2011 American Business Awards for Best Marketing Campaign in Computer Software. Luc is a graduate of Pepperdine University’s Graziadio School of Business and Management. You may contact him at [email protected].

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Table of Contents  Preface   3  

Economic Past   4  Prior to Economic Reforms   5  Doing Away with Communism   5  

Current Economic Condit ions   7  Abundant and Cheap Labor Force   7  Investment in Education   8  Manufacturing and Export   9  A Growing Middle Class   11  

Economic Future: Opportunit ies and Long-Term Challenges   12  Opportunities   12  Long-Term Challenges   14  

Conclusion   16  

Page 3: China's Economy: What Does the Future Hold? by Luc Berlin 2011

CHINA’S ECONOMY: WHAT DOES THE FUTURE HOLD?

Preface Not many people would have accepted the now fact that China’s Gross Domestic

Product (GDP) would grow to become the 2nd largest of the world, eclipsing longtime

holder Japan – at least not so fast. Since the introduction of economic reforms in

1979, China has become one of the world’s fastest-growing economies. From 1979

to 2005 China’s real GDP grew at an average annual rate of 9.6%.1 Over the past

decades, China has quickly risen from a developing country to a global economic

powerhouse – sprinting past every other Western economy, with the U.S. as the only

exception. An online survey of over 723 economic researchers around the globe

undertaken by Fast Future and Global Futures and Foresight (GFF) yielded the

following results about China:2

- 34% believe it will grow at over 8% between 2011-2020 – and 72% believe it

will grow at over 6% in that period

- 38% believe China’s GDP will have overtaken that of the USA by 2025 and

73% believe it will grow at over 6% in that period

- 78% of respondents believe that the Chinese stock markets will overtake the

New York Stock Exchange in size – 56% think the milestone will be reached by

2040

1 Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf 2 Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF

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- 60% believe that Chinese companies could become the largest grouping

amongst the global 500 by 2040.

These findings seem to affirm a growing consensus that China’s reign as the largest

economy in the world is no longer a matter of if or when but how soon. However,

many people still believe that the U.S. will retain its crown as the world’s economic

superpower. In his book “The Next Hundred Million: America in 2050,” Joel Kotkin, a

presidential fellow at Chapman University in Orange, CA, predicts that population

growth based on fertility rates and immigration pattern will increase the U.S.

population today by roughly 100 million.3 Kotkin argues that this population growth

will be a blessing to American prosperity and eventually help the U.S. maintain its

edge on China.

Will China’s economy keep its trend and become the number one economic power in

the world or will the United States, fueled by a boost in populace as Kotkin predicts,

remain the global economic superpower? To help answer this question, I will start by

looking at China’s economic history and how it has influenced present days.

Following the same approach, I will examine and evaluate the sustainability of

current economic conditions to see how they shape China’s economic future.

Economic Past Once an economic superpower, China’s economic, cultural and technological

superiority decline began when in 1433 emperor Xuan De stopped foreign trade and

3 Levingston, S. Washington Post. China is Not Likely to Surpass United States as Global Economic Superpower, New Book Predicts. Retrieved on Mar 5, 2011 from http://voices.washingtonpost.com

Page 5: China's Economy: What Does the Future Hold? by Luc Berlin 2011

construction of big naval vessels.4 Isolated from the rest of the world, China began a

cycle of decay that lasted until the late 1970s at the end of Mao Zedong’s Cultural

Revolution.5

Prior to Economic Reforms Prior to 1979, a central goal of the Chinese government was to make China’s

economy relatively self-sufficient. China maintained a centrally planned, or

command, economy.6 A large share of the country’s economic output was directed

and controlled by the sate, which set production goals, controlled prices, and

allocated resources throughout most of the economy.7 Foreign trade was generally

limited to obtaining only those goods that could not be made or obtained in China.8

Private enterprises and foreign-invested firms were nearly non-existent.

Government policies kept the Chinese economy relatively stagnant and inefficient,

mainly because there were few profit incentives for firms and farmers; competition

was virtually nonexistent, and price and production controls caused widespread

distortions in the economy.9

Doing Away with Communism Beginning in 1979, China launched several economic reforms. The central

government, led by Deng Xiaoping created ownership incentives that allowed farmers

4 EH.net. (2010). Economic History of Pre-Modern China (From 221 BC to c. 1800 AD). Retrieved on Mar 3, 2011 from http://eh.net/encyclopedia/article/deng.china 5 EH.net. (2010). Economic History of Pre-Modern China (From 221 BC to c. 1800 AD). Retrieved on Mar 3, 2011 from http://eh.net/encyclopedia/article/deng.china 6 Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf 7 Ibid. 8 Ibid. 9 Ibid

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to sell a portion of their crops on the free market.10 The government also established

four special economic zones along the coast of the purpose of attracting foreign

investment, boosting exports, and importing high technology products into China.

Additional reforms included a decentralization of economic policymaking, tax and

trade incentives, development zones, and the elimination of state price controls.

Since Deng Xiaoping began the modernization process in 1978 by decollectivising

the farms, China’s economy has grown substantially faster and the country has gone

on a remarkable and unprecedented program of “urbanization, marketisation,

privatization and globalization” in the words of University of Michigan’s Kenneth

Lieberthal.11

Table 1. China’s Average Annual Real GDP Growth Rates, 1960-2005

Source: Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf

10 Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf 11 Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF

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Current Economic Condit ions The Chinese economy is expected to continue developing rapidly. Increasing

domestic consumption and low cost labor are currently seen as the biggest drivers of

growth, with bureaucracy and corruption perceived as the most significant growth

barriers.12 Critical concerns have been raised about human rights, the environment,

freedom of speech, inequality, internal tensions, stresses on the banking system and

the potential for overheating.13 Regardless, one cannot refute the amazing

economical progress China has made, taking 400 million people out of poverty and

laying the foundations for future development.

Let’s look at China’s “commanding heights” in their economic growth – in other

words leading factors that are driving their economic prosperity.

Abundant and Cheap Labor Force The constant flux of large populations of villagers, looking for a more modern

lifestyle, into the cities has given China a large pool of low-cost labor against which

many other countries cannot compete. Only India stands out to be a clear exception.

Indeed, in the GFF and Fast Future online survey, the scale of the market, low cost

labor and China’s growing capacity for innovation were identified as the top 3 factors

attracting people to establish a presence in China or grow an existing one.14

12 Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF 13 Ibid. 14 Ibid.

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Many companies have shown an interest in the Chinese market but have no direct

experience. Others are concerned by the country’s communistic stance and might be

waiting to see if China shows real signs of evolving into some form of capitalism.

Investment in Education Another commanding height in China’s current and future economic growth is

investment in education. In 2010, the Chinese government vowed to increase its

spending on education from about 3.3% to 4% of the country’s gross domestic

product (GDP) in 2012, narrowing the gap with the US which education spending

roughly equals 4.8% of its GDP.15

Fig 1.a Education spending as percentage of GDP – Comparing U.S. and China

Source: Environmental Scan. (2003). OCLC. Worldwide Education and Library Spending. Retrieved on Mar 3, 2011 from http://www.oclc.org

15 Environmental Scan. (2003). OCLC. Worldwide Education and Library Spending. Retrieved on Mar 3, 2011 from http://www.oclc.org

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The Chinese government’s National Outline for Medium and Long Term Educational

Reform addresses almost all major issues from the education system and the quality

of teaching to school enrollment.16 China understands that although low-cost labor is

having a significant role in driving its economic growth, it would need a well-educated

and highly skilled workforce to maintain it. University enrollment in China has

reportedly risen from under 10% of young people in 1999 to over 21% in 2006.17 As

recently as 1996, China produced just 5,000 PhD students a year. That was only

about half the number in the UK, Japan or India. Since then, China has overtaken

every other country in the world except the US in terms of the numbers of doctoral

degrees awarded.18 However, the dilemma that China faces is that many of their

college-graduates face long stretches of unemployment. As Cindy Fan, associate

dean of social sciences and professor of geography at the University of California, Los

Angeles, perfectly states, “Unemployment among college graduates is a hot-button

issue in China. A large number of young people have little other than materialism and

consumerism to believe in — a general description of Chinese society today since

socialist ideology lost its grip. Not having a job is a perfect recipe for social unrest.”19

Manufacturing and Export As the U.S. economy increasingly becomes mostly service-driven and U.S.

manufacturers relocate to foreign countries, China’s manufacturing industry is

picking up its pace and is well on its way to leading the world. The U.S. is poised to

16 Jia, C. (2010). China Daily. Government to Increase Spending on Education. Retrieved on Mar 3, 2011 from http://www.chinadaily.com. 17 Baker, M. (2007). BBC News. China’s Bid for World Domination. Retrieved on Mar 5, 2011 from http://news.bbc.co.uk/2/hi/uk_news/education/7098561.stm 18 Ibid. 19 The New York Times. (2010). Educated and Fearing the Future in China. Retrieved on Mar 3, 2011 from http://roomfordebate.blogs.nytimes.com

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relinquish its crown as the world’s biggest manufacturing crown by output to China by

the end of 2011.20 In 2009 the US created 19.9 percent of the world’s

manufacturing output, compared with 18.6 percent for China.21 The major driver in

China’s manufacturing prowess is its large pool of cheap labor. China’s poor human

rights record, corruption and relaxed environmental regulations are also seen as

strong and unpopular contributors to its competitive advantage against Western

manufacturers. China has also taken leadership in developing areas such as

sustainable and renewable energies, high technologies, which will only reinforce its

position.

Along with manufacturing, China’s export shows no sign of slowing down. China’s

foreign trade maintained its powerful growth momentum in 2010, as the country’s

overall trade volume reached 2.97 trillion U.S. dollars, a 34.7 percent increase year

over year.22 Of the total trade, exports accounted for US$1.58 trillion, growing 31.3

percent, while imports made up nearly US$1.40 trillion, rising 38.7 percent over

2009.23 China's trade surplus last year hit US $183.1 billion, down 6.4% from

2009.24 The Chinese Customs Administration said on its website that China’s trade

surplus is on a continuous decline in the past few years, which proves that the

country is moving towards a gradual balance of trade.25 China’s foreign trade

statistics in 2011 are keeping with the trend of 2010. According to news from the

20 Marsh, P. (2010). Financial Times. U.S. Manufacturing Crown Slips. Retrieved on Mar 3, 2011 from http://www.ft.com 21 Ibid. 22 People’s Daily Online. (2011). People’s Daily. China Trade Hits $2.97 trillion in 2010, rising 34.7%. Retrieved on Mar 3, 2011 from http://english.peopledaily.com 23 Ibid. 24 Ibid. 25 Ibid.

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Ministry of Commerce’s website, China’s foreign trade amounted to 295 billion U.S.

dollars in January 2011, a 44% jump year over year (#16).26

Manufacturing and foreign trade will continue to play significant roles in shaping

China’s economic future. The trade surplus will continue to decrease as China’s

middle-class grows and Chinese people’s contribution to the domestic economy

expands.

A Growing Middle Class Despite holding communist political views, the Chinese government seems to

understand that a country’s economic prosperity is built on the back of the middle

class, much like the United States in the 1940s and 1950s. Therefore, it is no

coincidence that the growth in China’s GDP mirrors the growth of its middle class,

which according to a report by the McKinsey Global Institute, will reach 612 million by

2025, accounting for 40 percent of China’s population then.27 Even as China’s

overall economic growth moderates, according to the report, incomes in urban areas

will rise faster than GDP because of higher labor productivity and rising education

levels.28 The growth of the Chinese middle class will also be driven by the country’s

continued urbanization.29 More importantly, as China’s economy re-balances toward

domestic consumption, it will reduce its reliance on exports. A large, well-educated

and highly skilled Chinese middle class will emerge as a driver and sustainer of the

country’s economic growth.

26 Jun, L. (2011). People’s Daily. China’s Foreign Trade Up 44 percent in January. Retrieved on Mar 3, 2011 from http://english.peopledaily.com 27 Wang, H. (2010). Growth of China’s Middle Class. Retrieved on Mar 3, 2011 from http://helenhwang.net 28 Ibid. 29 Ibid.

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Economic Future: Opportunit ies and Long-Term Challenges

Opportunities Based strictly on present conditions, China’s economic future looks very promising.

The country’s GDP is growing at astonishing rates, millions of people are being lifted

out of poverty, unemployment is low, the middle class is expanding, the government’s

investment in education is producing highly skilled workers, foreign trade is pacing at

double-digits growth, and the doors have been opened to foreign investors. Going

back to the survey undertaken by GFF and Fast Future, 37% of respondents thought

that by 2020 it would be common for American and European workers to be

employed by Chinese companies.

One question amidst the mouths of many economists is: Will China fully adopt a

Capitalist economic model? Many people seem to believe that China will introduce a

new economic model – a sort of hybrid between communism and capitalism. The

answer to this question will certainly play a role in the future economic picture of

China. I personally believe that the Chinese government is not ready to give up its

reins on the people and will not adopt a purely capitalist economic model. That said,

China has seen and tasted the benefits of a free-market system and will be willing to

ride that wave as long as it promotes economic fortune but does not interfere with

the government’s rule.

China’s economic success will also be driven by foreign investors and businesses

seeking to tap in the increasing purchasing power of the Chinese people. Similar, to

what we saw here in the United States, this new middle class is anxious to throw

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away the rags and live in riches. This Western, mostly American, influence of heavily

consumer-driven markets at the expense of savings could propel China into even

faster economic growth; but not without bringing a few problems that the American

public is too familiar with.

Fig 1.b Survey results of when U.S. and European workers will be more commonly employed by Chinese-owned companies

Source: Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF As the Chinese market place grows, it will play an increasingly important role in

influencing the way Western businesses operate. American and European companies

will evolve and adopt new paradigms to cater to the Chinese population. We will most

certainly see more Chinese occupying high-level executive positions in Western

organizations.

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Fig 1.c Survey results of the impact of the Chinese marketplace on Western business operations

Source: Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF

Long-Term Challenges China’s economy has shown remarkable economic growth over the past several

years and many economists project that it will enjoy fairly healthy growth in the near

future.30 However, China still faces several reforms it needs to implement before it

can enjoy the full potential of its economy. According to Wayne Morrison’s Brief on

30 Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf

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China’s Economic Conditions to the U.S. Congress, failure to implement the following

reforms could endanger future growth.31

- State-owned enterprises (SOEs), which still account for about one-third

of Chinese industrial production, put a heavy strain on China’s economy. Over

half are believed to lose money and must be supported by subsidies, mainly

through state banks. The subsidies divert resources away from potentially

more efficient and profitable enterprises.

- The banking system faces several major difficulties due to its financial

support of SOEs and its failure to operate solely on market-based principles.

China’s banking is regulated and controlled by the central government, which

sets interest rates and attempts to allocate credit to certain Chinese firms.

Corruption poses another problem for China’s banking system because loans

are often made on the basis of political connections. This system promotes

widespread inefficiency in the economy because savings are generally not

allocated on the basis of obtaining the highest possible returns.

- Public unrest over pollution, government corruption, and growing

income inequality poses threats to social stabil ity. The Chinese

government reported that there were over 74,000 protests (many of which

became violent) involving 3.8 million people in 2004 (up from 53,000

protests in 2003) over such issues as pollution, government corruption, and

land seizures. The Chinese government often disregards its own

environmental laws in order to promote rapid economic growth. A 2005

31 Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf

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United Nations report stated that the income gap between the urban and rural

areas was among the highest in the world and warned that this gap threatens

social stability. The report urged China to take greater steps to improve

conditions for the rural poor, and bolster education, health care, and the

social security system.

- The lack of the rule of law in China has led to widespread government

corruption, financial speculation, and misallocation of investment funds. In

many cases, government “connections,” not market forces, are the main

determinant of successful firms in China. This limits competition and

undermines the efficient allocation of goods and services in the economy.

Conclusion Since 1979, China’s economic growth has surpassed any other nations and I believe

the country is well on its way to become the world economic superpower. China has

strategically invested both domestically and abroad to pave its way into the number

one spot. For example, the rising ownership of U.S. government debt gives the

Chinese government great leverage on economic and political matters. Along this

line, China has achieved numerous milestones such as the world’s largest

manufacturer and exporter, the fastest growing middle class, leadership in

technological innovation, the second nation with the highest number of doctorates,

and so on to ensure its relevance in the global economic forum. Regardless of

whether or not China eventually overtakes the United States as the world’s largest

economy, China is and will remain an economic power that will continually shape the

world.

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Reference

Baker, M. (2007). BBC News. China’s Bid for World Domination. Retrieved on Mar 5, 2011 from http://news.bbc.co.uk/2/hi/uk_news/education/7098561.stm Carey, W.P. (2010). China’s Economy Now Second Only to U.S.: What Does the Future Hold? Retrieved on Mar 3, 2011 from http://knowledge.wpcarey.asu.edu China Orbit. Overview of the Chinese Economy. Retrieved on Mar 3, 2011 from http://www.chinaorbit.com EH.net. (2010). Economic History of Pre-Modern China (From 221 BC to c. 1800 AD). Retrieved on Mar 3, 2011 from http://eh.net/encyclopedia/article/deng.china Environmental Scan. (2003). OCLC. Worldwide Education and Library Spending. Retrieved on Mar 3, 2011 from http://www.oclc.org Farrell, D., Gersch, U., Stephenson, E. (2006). McKinsey Quarterly. The Value of China’s Emerging Middle Class. Retrieved on Mar 3, 2011 from http://www.mckinseyquarterly.com Guardian.co.uk. (2010). Chinese Economic Growth Surges Again. Retrieved on Mar 3, 2011 from http://www.guardian.co.uk Gunde, R. (2005). UCLA Asia Institute. The Future of the Greater China Economy. Retrieved on Mar 3, 2011 from http://www.international.ucla.edu Jia, C. (2010). China Daily. Government to Increase Spending on Education. Retrieved on Mar 3, 2011 from http://www.chinadaily.com. Jun, L. (2011). People’s Daily. China’s Foreign Trade Up 44 percent in January. Retrieved on Mar 3, 2011 from http://english.peopledaily.com Levingston, S. Washington Post. China is Not Likely to Surpass United States as Global Economic Superpower, New Book Predicts. Retrieved on Mar 5, 2011 from http://voices.washingtonpost.com Mallesons Stephen Jaques. (2006). China’s Current Economic Performance and Growth. Retrieved on Mar 3, 2011 from http://www.mallesons.com Marsh, P. (2010). Financial Times. U.S. Manufacturing Crown Slips. Retrieved on Mar 3, 2011 from http://www.ft.com Morrison, W. (2006). CRS Issue Brief for Congress. China’s Economic Conditions. Downloaded PDF on Mar 3, 2011 from www.fas.org/sgp/crs/row/IB98014.pdf

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People’s Daily Online. (2011). People’s Daily. China Trade Hits $2.97 trillion in 2010, rising 34.7%. Retrieved on Mar 3, 2011 from http://english.peopledaily.com Talwar, R. (2007). The Future of China’s Economy: The Path to 2020 – Opportunities, Challenges and Uncertainties. Downloaded PDF on Mar 3, 2011 from www.stanford.edu/~ljlau/Presentations/Presentations/022800.PDF The New York Times. (2010). Educated and Fearing the Future in China. Retrieved on Mar 3, 2011 from http://roomfordebate.blogs.nytimes.com Wang, H. (2010). Growth of China’s Middle Class. Retrieved on Mar 3, 2011 from http://helenhwang.net