The rapid rise of China as a major economic power within a time span of about three decades is often described by analysts as one of the greatest economic success stories in modern times. From 1979 (when economic reforms began) to 2011, China’s real gross domestic product (GDP) grew at an average annual rate of nearly 10%. From 1980 to 2011, real GDP grew 19-fold in real terms, real per capita GDP increased 14-fold, and an estimated 500 million people were raised out of extreme poverty.
China is now the world’s second-largest economy and some analysts predict it could become the largest within a few years. Yet, on a per capita basis, China remains a relatively poor country. China’s economic rise has led to a substantial increase in U. S. -China economic ties. According to U. S. trade data, total trade between the two countries surged from $5 billion in 1980 to $503 billion in 2011. China is currently the United States’ second-largest trading partner, its third largest export market, and its largest source of imports.
Many U. S. companies have extensive operations in China in order to sell their products in the booming Chinese market and to take advantage of lower-cost labor for export-oriented manufacturing. These operations have helped some U. S. firms to remain internationally competitive and have supplied U. S. consumers with a variety of low-cost goods. China’s large-scale purchases of U. S. Treasury securities (which totaled nearly $1. 2 trillion at the end of 2011) have enabled the federal government to fund its budget deficits, which help keep U. S. interest rates relatively low.
However, the emergence of China as a major economic superpower has raised concern among many U. S. policymakers. Some claim that China uses unfair trade practices (such as an undervalued currency and subsidies given to domestic producers) to flood U. S. markets with low cost goods, and that such practices threaten American jobs, wages, and living standards. Others contend that China’s growing use of industrial policies to promote and protect certain domestic Chinese industries firms favored by the government, and its failure to take effective action against widespread infringement of U.S. intellectual property rights (IPR) in China, threaten to undermine the competitiveness of U. S.
IP-intensive industries. In addition, while China has become a large and growing market for U. S. exports, critics contend that numerous trade and investment barriers limit opportunities for U. S. firms to sell in China, or force them to set up production facilities in China as the price of doing business there. Other concerns relating to China’s economic growth include its growing demand for energy and raw materials and its emergence as the world’s largest emitter of greenhouse gasses.
The Chinese government views a growing economy as vital to maintaining social stability. However, China faces a number of major economic challenges which could undermine future growth, including distortive economic policies that have resulted in over-reliance on fixed investment and exports for economic growth (rather than on consumer demand), government support for state-owned firms, a weak banking system, widening income gaps, growing pollution, and the relative lack of the rule of law in China. Many economists warn that such problems could undermine China’s future economic growth.
The Chinese government has acknowledged these problems and has pledged to address them by implementing policies to boost consumer spending, expand social safety net coverage, and encourage the development of less-polluting industries. China’s Economy Prior to Reforms Prior to 1979, China, under the leadership of Chairman Mao Zedong, maintained a centrally planned, or command, economy. A large share of the country’s economic output was directed and controlled by the state, which set production goals, controlled prices, and allocated resources throughout most of the economy.
During the 1950s, all of China’s individual household farms were collectivized into large communes. To support rapid industrialization, the central government undertook large-scale investments in physical and human capital during the 1960s and 1970s. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled, state-owned enterprises (SOEs), according to centrally planned output targets. Private enterprises and foreign-invested firms were generally barred. A central goal of the Chinese government was to make China’s economy relatively self-sufficient.
Foreign trade was generally limited to obtaining only those goods that could not be made or obtained in China. Government policies kept the Chinese economy relatively stagnant and inefficient, mainly because most aspects of the economy were managed and run by the central government (and thus there were few profit incentives for firms, workers, and farmers), competition was virtually nonexistent, foreign trade and investment flows were mainly limited to Soviet bloc countries, and price and production controls caused widespread distortions in the economy.
Chinese living standards were substantially lower than those of many other developing countries. The Chinese government in 1978 (shortly after the death of Chairman Mao in 1976) decided to break with its Soviet-style economic policies by gradually reforming the economy according to free market principles and opening up trade and investment with the West, in the hope that this would significantly increase economic growth and raise living standards. As Chinese leader Deng Xiaoping, the architect of China’s economic reforms, put it: “Black cat, white cat, what does it matter what color the cat is as long as it catches mice?
” The Introduction of Economic Reforms Beginning in 1979, China launched several economic reforms. The central government initiated price and ownership incentives for farmers, which enabled them to sell a portion of their crops on the free market. In addition, the government established four special economic zones along the coast for the purpose of attracting foreign investment, boosting exports, and importing high technology products into China. Additional reforms, which followed in stages, sought to decentralize economic policymaking in several sectors, especially trade.
Economic control of various enterprises was given to provincial and local governments, which were generally allowed to operate and compete on free market principles, rather than under the direction and guidance of state planning. In addition, citizens were encouraged to start their own businesses. Additional coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment.
In addition, state price controls on a wide range of products were gradually eliminated. Trade liberalization was also a major key to China’s economic success. Removing trade barriers encouraged greater competition and attracted foreign direct investment (FDI) inflows. China’s gradual implementation of economic reforms sought to identify which policies produced favorable economic outcomes (and which did not) so that they could be implemented in other parts of the country, a process Deng Xiaoping reportedly referred to as “crossing the river by touching the stones. ”
China’s Economic Growth Since Reforms: 1979-2012 Since the introduction of economic reforms, China’s economy has grown substantially faster than during the pre-reform period (see Table 1). According to the Chinese government, from 1953 to 1978, real annual GDP growth was estimated at 6. 7%, although many analysts claim that Chinese economic data during this period are highly questionable because government officials often exaggerated production levels for a variety of political reasons. Agnus Maddison estimates China’s average annual real GDP during this period at 4.
4%. China’s economy suffered economic downturns during the leadership of Chairman Mao Zedong, including during the Great Leap Forward from 1958 to 1960 (which led to a massive famine and reportedly the deaths of tens of millions of people) and the Cultural Revolution from 1966 to 1976 (which caused political chaos and greatly disrupted the economy). During the reform period (1979-2011), China’s average annual real GDP grew by 9. 9%. This essentially has meant that, on average China has been able to double the size of its economy in real terms every eight years.
The global economic slowdown, which began in 2008, impacted the Chinese economy (especially the export sector). China’s real GDP growth fell from 14. 2% in 2007 to 9. 6% in 2008 to 9. 2% in 2009. In response, the Chinese government implemented a large economic stimulus package and an expansive monetary policy. These measures boosted domestic investment and consumption and helped prevent a sharp economic slowdown in China. In 2010, China’s real GDP grew by 10. 4%, and in 2011 it rose by 9. 2%. The International Monetary Fund (IMF) projects that China’s real GDP will grow by 7. 8% in 2012.
From 2013 to 2017, the IMP projects that China’s real GDP growth will average 8. 5%. Table 1- China’s average annual real GDP growth. Causes of China’s Economic Growth Economists generally attribute much of China’s rapid economic growth to two main factors: large-scale capital investment (financed by large domestic savings and foreign investment) and rapid productivity growth. These two factors appear to have gone together hand in hand. Economic reforms led to higher efficiency in the economy, which boosted output and increased resources for additional investment in the economy. China has historically maintained a high rate of savings.
When reforms were initiated in 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinese savings during this period were generated by the profits of SOEs, which were used by the central government for domestic investment. Economic reforms, which included the decentralization of economic production, led to substantial growth in Chinese household savings as well as corporate savings. As a result, China’s gross savings as a percentage of GDP has steadily risen, reaching 53. 9% in 2010 (compared to a U. S. rate of 9. 3%), and is among the highest savings rates in the world.
The large level of savings has enabled China to boost domestic investment. In fact, its gross domestic savings levels far exceed its domestic investment levels, meaning that China is a large net global lender. Several economists have concluded that productivity gains (i. e. , increases in efficiency) have been another major factor in China’s rapid economic growth. The improvements to productivity were caused largely by a reallocation of resources to more productive uses, especially in sectors that were formerly heavily controlled by the central government, such as agriculture, trade, and services.
For example, agricultural reforms boosted production, freeing workers to pursue employment in the more productive manufacturing sector. China’s decentralization of the economy led to the rise of non-state enterprises (such as private firms), which tended to pursue more productive activities than the centrally controlled SOEs and were more market-oriented, and hence, more efficient. Additionally, a greater share of the economy (mainly the export sector) was exposed to competitive forces.
Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, FDI in China brought with it new technology and processes that boosted efficiency. As indicated in Figure 2, China has achieved high rates of total factor productivity (TFP) growth relative to the United States. TFP represents an estimate of the part of economic output growth not accounted for by the growth in inputs (such as labor and capital), and is often attributed to the effects of technological change and efficiency gains.
China experiences faster TFP growth than most developed countries such as the United States because of its ability to access and utilize existing foreign technology and know-how. High TFP growth rates have been a major factor behind China’s rapid economic growth rate. However, as China’s technological development begins to approach that of major developed countries, its level of productivity gains, and thus, real GDP growth, could slow significantly from its historic 10% average, unless China becomes a major center for new technology and innovation and/or implements new comprehensive economic reforms.
As indicated in Figure 3, the EIU currently projects that China’s real GDP growth will slow considerably in the years ahead, averaging 7. 0% from 2012 to 2020, and falling to 3. 7% from 2021 to 2030. The Chinese government has indicated its desire to move away from its current economic model of fast growth at any cost to more “smart” economic growth, which seeks to reduce reliance on energy-intensive and high-polluting industries and rely more on high technology, green energy, and services. China also has indicated it wants to obtain more balanced economic growth. Measuring the Size of China’s Economy.
The rapid growth of the Chinese economy has led many analysts to speculate if and when China will overtake the United States as the “world’s largest economic power. ” The “actual” size of China’s economy has been a subject of extensive debate among economists. Measured in U. S. dollars using nominal exchange rates, China’s GDP in 2011 was $7. 2 trillion, less than half the size of the U. S. economy. The per capita GDP (a common measurement of a country’s living standards) of China was $5,460, which was 12% the size of Japan’s level and 11% that of the United States (see Table 2).
Many economists contend that using nominal exchange rates to convert Chinese data (or that of other countries) into U. S. dollars fails to reflect the true size of China’s economy and living standards relative to the United States. Nominal exchange rates simply reflect the prices of foreign currencies vis-a-vis the U. S. dollar and such measurements exclude differences in the prices for goods and services across countries. To illustrate, one U. S. dollar exchanged for local currency in China would buy more goods and services there than it would in the United States.
This is because prices for goods and services in China are generally lower than they are in the United States. Conversely, prices for goods and services in Japan are generally higher than they are in the United States (and China). Thus, one dollar exchanged for local Japanese currency would buy fewer goods and services there than it would in the United States. Economists attempt to develop estimates of exchange rates based on their actual purchasing power relative to the dollar in order to make more accurate comparisons of economic data across countries, usually referred to as a purchasing power parity (PPP) basis.
The PPP exchange rate increases the (estimated) measurement of China’s economy and its per capita GDP. According to the Economist Intelligence Unit, (EIU), which utilizes World Bank data, prices for goods and services in China are 41. 5% the level they are in the United States. Adjusting for this price differential raises the value of China’s 2011 GDP from $7. 2 trillion (nominal dollars) to $11. 4 trillion (on a PPP basis). This would indicate that China’s economy is 76. 0% the size of the U. S. economy. China’s share of global GDP on a PPP basis rose from 3. 7% in 1990 to 14.
3% in 2011 (the U. S. share of global GDP peaked at 24. 3% in 1999 and declined to 18. 9% in 2011); see Figure 4. Many economic analysts predict that on a PPP basis China will soon overtake the United States as the world’s largest economy. EIU, for example, projects this will occur by 2016, and that by 2030, China’s economy could be 30% larger than that of the United States. This would not be the first time in history that China was the world’s largest economy (see text box). The PPP measurement also raises China’s 2011 per capita GDP (from $5,460) to $8,650, which was 17. 9% of the U. S. level.
The EIU projects this level will rise to 34. 3% by 2030. Thus, although China will likely become the world’s largest economy in a few years on a PPP basis, it will likely take many years for its living standards to approach U. S. levels. Foreign Direct Investment (FDI) in China China’s trade and investment reforms and incentives led to a surge in FDI beginning in the early 1990s. Such flows have been a major source of China’s productivity gains and rapid economic and trade growth. There were reportedly 445,244 foreign-invested enterprises (FIEs) registered in China in 2010, employing 55.
2 million workers or 15. 9% of the urban workforce. As indicated in Figure 5, FIEs account for a significant share of China’s industrial output. That level rose from 2. 3% in 1990 to a high of 35. 9% in 2003, but fell to 27. 1% by 2010. In addition, FIE’s are responsible for a significant level of China’s foreign trade. In 2011, FIEs in China accounted for 52. 4% of China’s exports and 49. 6% of its imports, although this level was down from its peak in 2006 when FIEs’ share of Chinese exports and imports was 58. 2% and 59. 7%, respectively, as indicated in Figure 6.
FIEs in China dominate China’s high technology exports. From 2002 to 2010, the share of China’s high tech exports by FIEs rose from 79% to 82%. During the same period, the share of China’s high tech exports by wholly owned foreign firms (which excludes foreign joint ventures with Chinese firms) rose from 55% to 67%. According to the Chinese government, annual FDI inflows into China grew from $2 billion in 1985 to $108 billion in 2008. Due to the effects of the global economic slowdown, FDI flows to China fell by 12. 2% to $90 billion in 2009.
They totaled $106 billion in 2010 and $116 billion in 2011 (see Figure 7). Chinese data for January-October 2012 indicate that FDI fell by 3. 5% on a year-on-year basis; FDI into China will likely total around $112. 1 billion for the full year. Hong Kong was reported as the largest source of FDI flows to China in 2011 (63. 9% of total), followed by Taiwan, Japan, Singapore, and the United States. The cumulative level (or stock) of FDI in China at the end of 2011 is estimated at $1. 2 trillion, making it one of the world’s largest destinations of FDI.
According to the United Nations Conference on Trade and Development, China was the world’s second-largest destination for FDI flows in 2011, after the United States (see Figure 8). The largest sources of cumulative FDI in China for 1979-2011 were Hong Kong (43. 5% of total), the British Virgin Islands, Japan, the United States, and Taiwan (see Table 3). According to Chinese data, annual U. S. FDI flows to China peaked at $5. 4 billion in 2002 (10. 2% of total FDI in China). In 2011, they were $3. 0 billion or 2. 6% of total FDI (see Figure 9). From January to October 2012, U. S. FDI in China rose by 3. 8% (year-on-year).
China’s Growing FDI Outflows A key aspect of China’s economic modernization and growth strategy during the 1980s and 1990s was to attract FDI into China to help boost the development of domestic firms. Investment by Chinese firms abroad was sharply restricted. However, in 2000, China’s leaders initiated a new “go global” strategy, which sought to encourage Chinese firms (primarily SOEs) to invest overseas. One key factor driving this investment is China’s massive accumulation of foreign exchange reserves. Traditionally, a significant level of those reserves has been invested in relatively safe, but low-yielding, assets, such as U.S.
Treasury securities. On September 29, 2007, the Chinese government officially launched the China Investment Corporation (CIC) in an effort to seek more profitable returns on its foreign exchange reserves and diversify away from its U. S. dollar holdings. The CIC was originally funded at $200 billion, making it one of the world’s largest sovereign wealth funds. Another factor behind the government’s drive to encourage more outward FDI flows has been to obtain natural resources, such as oil and minerals, deemed by the government as necessary to sustain China’s rapid economic growth.
In June 2005, the China National Offshore Oil Corporation (CNOOC), through its Hong Kong subsidiary (CNOOC Ltd. ), made a bid to buy a U. S. energy company, UNOCAL, for $18. 5 billion, although CNOOC later withdrew its bid due to opposition by several congressional Members. Finally, the Chinese government has indicated its goal of developing globally competitive Chinese firms with their own brands. Investing in foreign firms, or acquiring them, is viewed as a method for Chinese firms to obtain technology, management skills, and often, internationally recognized brands, needed to help Chinese firms become more globally competitive.
For example, in April 2005 Lenovo Group Limited, a Chinese computer company, purchased IBM Corporation’s personal computer division for $1. 75 billion. Similarly, overseas FDI in new plants and businesses is viewed as developing multinational Chinese firms with production facilities and R&D operations around the world. China has become a significant source of global FDI outflows, which rose from $2. 7 billion in 2002 to $67. 6 billion in 2011 (see Figure 10). In 2011, China ranked as the ninth-largest source of global FDI, according to the United Nations (see Figure 11).
The stock of China’s outward FDI through 2011 is estimated at $384. 9 billion. China’s data indicate that the top five destinations of its FDI outflows in 2010 were Hong Kong (which accounted for 56. 5% of total), the British Virgin Islands, the Cayman Islands, Luxembourg, and Australia (the United States ranked seventh). In terms of the stock of Chinese FDI outflows, the largest destinations were Hong Kong (62. 8% of total), the British Virgin Islands, the Cayman Islands, Australia, and Singapore (the United States ranked seventh).
According to China’s Ministry of Commerce, 4 out of 10 of the biggest overseas Chinese corporate investors were oil companies (based on FDI stock through 2010). According to A Capital Dragon Index, a firm that tracks China’s FDI, 56% of China’s outbound FDI in 2011 was in greenfield projects (such as new plants and business facilities) and 44% involved mergers and acquisitions. In terms of sectors, 51% of China’s 2011 FDI went to resources (such as oil and minerals), 22% to chemicals, 14% to services, 12% to industry, and 1% to automotive.
SOEs accounted for 72% of Chinese FDI that involved mergers and acquisitions in 2011. A Capital Dragon Index estimates that China’s first quarter 2012 outbound FDI was $21. 4 billion and that SOEs accounted for 98% of mergers and acquisitions, which were largely in resources. China’s Major Trading Partners Table 5 lists Chinese trade data on its major trading partners in 2011, which included the 27 countries that make up the European Union (EU27), the United States, Japan, and the 10 nations that constitute the Association of Southeast Asian Nations (ASEAN).
China’s largest export markets were the EU27, the United States, Hong Kong, and ASEAN, while its top sources for imports were the EU27, Japan, ASEAN, and South Korea. According to Chinese data, it maintained substantial trade surpluses with the United States, the EU27, and Hong Kong, but reported large deficits with Taiwan, South Korea, and Japan. China reported that it had a $206. 2 billion trade surplus with the United States, but U. S. data show that it had a $295. 5 billion deficit with China. These trade imbalance data disparities occur with many of China’s other major trading partners as well.
China reported that it had a $46. 7 billion trade deficit with Japan, while Japan reported that it had a $22. 1 billion trade deficit with China. These differences appear to be largely caused by how China’s trade via Hong Kong is counted in official trade data. China treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for statistical purposes, while many countries that import Chinese products through Hong Kong generally attribute their origin to China for statistical purposes, including the United States.
Major Chinese Trade Commodities China’s abundance of low-cost labor has made it internationally competitive in many low-cost labor-intensive manufactures. The average hourly labor cost for manufacturing in China in 2010 (at $2) was 5. 7% the cost in the United States (at $35). As a result, manufactured products constitute a significant share of China’s trade. A substantial amount of China’s imports is comprised of parts and components that are assembled into finished products, such as consumer electronic products and computers, and then exported.
Often, the value-added to such products in China by Chinese workers is relatively small compared to the total value of the product when it is shipped abroad. China’s top 10 exports and imports in 2011 are listed in Table 6 and Table 7, respectively, using the harmonized tariff system (HTS) on a two-digit level. Major exports included electrical machinery (such as computers and parts), machinery, knit apparel, and woven apparel, while major imports included electrical machinery, mineral fuel, machinery, and ores. China’s Growing Appetite for Energy.
China’s rapid economic growth has fueled a growing demand for energy, such as petroleum and coal, and that demand is becoming an increasingly important factor in determining global energy prices. According to the International Energy Agency (IEA), China overtook the United States in 2009 as the world’s largest energy user (in comparison, China’s energy use was only half that of that of the United States in 2000). According to IEA projections, China’s demand for energy from 2008 (the baseline year) to 2035 will account for 30% of the projected increase in global demand for energy during this period.
By 2035, China is projected to consume 70% more energy than the United States (even though, on a per capita basis, China’s energy consumption will be less than half of U. S. levels). China is the world’s second-largest consumer of oil products (after the United States) at 9. 8 million barrels per day (bpd) in 2011 (compared to 3. 9 million in 1997), and that level rises to 16. 9 million bpd by 2035. 35 China became a net oil importer (i. e. , imports minus exports) in 1993. Net oil imports grew from 632,000 bpd in 1997 to about 5.
0 million bpd in 2010 (see Figure 17), making it the world’s second-largest net oil importer after the United States. China’s net oil imports are projected to rise to 13. 1 million bpd by 2030, a level that would be comparable to the European Union in that year. China’s Regional and Bilateral Free Trade Agreements The Chinese government has maintained an active policy of boosting trade and investment ties around the world, especially with countries in Asia. To that end, China has entered into a number of regional and bilateral trade agreements, or is in the process of doing so.
China currently has free trade agreements (FTAs) with ASEAN, Pakistan, Chile, Hong Kong, Macau, New Zealand, Singapore, Pakistan, Peru, and Costa Rica. China also has an economic cooperation framework agreement (ECFA) with Taiwan. China is currently in the process of negotiating FTAs with the Cooperation Council for the Arab States of the Gulf (which includes Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and Bahrain), Australia, Iceland, Norway, Switzerland, and the Southern African Customs Union (which includes South Africa, Botswana, Lesotho, Namibia, and Swaziland).
In May 2012, China, Japan, and South Korea agreed to begin negotiations for an FTA in 2012. China has also considered negotiating an FTA with India, but with little progress to date. Major Long-Term Challenges Facing the Chinese Economy China’s economy has shown remarkable growth over the past several years, and many economists project that it will enjoy fairly healthy growth in the near future. However, economists caution that these projections are likely to occur only if China continues to make major reforms to its economy. Failure to implement such reforms could endanger future growth.
They note that China’s current economic model has resulted in a number of negative economic (and social) outcomes, such as over-reliance on fixed investment and exporting for its economic growth, extensive inefficiencies that exist in many sectors (due largely to government industrial policies), wide-spread pollution, and growing income inequality, to name a few. Many of China’s economic problems and challenges stem from its incomplete transition to a free market economy and from imbalances that have resulted from the government’s goal of economic growth at all costs.
China’s Incomplete Transition to a Market Economy Despite China’s three-decade history of widespread economic reforms, Chinese officials contend that China is a “socialist-market economy. ” This appears to indicate that the government accepts and allows the use of free market forces in a number of areas to help grow the economy, but where the government still plays a major role in the country’s economic development. Industrial Policies and SOEs
According to the World Bank, “China has become one of the world’s most active users of industrial policies and administrations. ” According to one estimate, China’s SOEs may account for up of 50% of non-agriculture GDP. In addition, although the number of SOEs has declined sharply, they continue to dominate a number of sectors (such as petroleum and mining, telecommunications, utilities, transportation, and various industrial sectors); are shielded from competition; are the main sectors encouraged to invest overseas; and dominate the listings on China’s stock indexes.
One study found that SOEs constituted 50% of