China’s Development – Now For The Hard Part

by John West, Asian Century Institute

China is now beginning the “hard part” of development — as its growth is slowing, debt is increasing sharply, adverse demographics are biting and the inefficiencies of state capitalism are visible.

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Pragmatic policy-making has driven China’s rapid development since 1978. But with growth now slowing, debt increasing sharply, demographics now biting, and the inefficiencies of state capitalism increasingly visible, China is now beginning the “hard part” of development.

China’s development is well documented.  Annual economic growth rates of 10%, before slowing more recently to a new normal of 7%. Poverty, based on a poverty line of $1.25 a day, fell from 84% in 1981 to less than 10% today.

China is the world’s second largest economy, and is now arguably the world’s largest in purchasing power parity terms. It is also the world’s biggest trading nation. The Chinese currency, the renminbi, is internationalizing as it is increasingly used for international trade transactions. In recent years, China’s state-dominated economy has seen the rise of successful private companies like Alibaba and Xiaomi.

How did this once poor and isolated country achieve such rapid success?

The government of Deng Xiaoping progressively unleashed the energies of the talented Chinese people. Key to this was removing the shackles of central planning, privatising old state-owned enterprises (SOEs), opening up to international trade and investment, and allowing new economic freedoms. The government has also invested strongly in infrastructure and education.

Despite China’s veneer of hyper-capitalism, the government has always intervened in the economy in a multitude of ways. This may have helped Chinese enterprises succeed in the earliest stages of development.

Prior to the 1990s, such intervention included industrial policies like high tariffs, investment incentives, export subsidies and domestic requirements on foreign firms. Some of these policies had to be phased out with membership of the World Trade Organization, although SOEs still have access to subsidized finance, land, energy etc. Over the past decade or more, Chinese companies have benefited more from an undervalued exchange rate.

Even today, there are continual complaints about Chinese government discriminating against foreign companies on the basis of anti-monopoly law, and also state-sponsored intellectual property theft and cyber-espionage. And restrictions on foreign direct investment (FDI) remain widespread. China’s FDI policies are the most restrictive of 58 countries surveyed by the OECD in its FDI Regulatory Restrictiveness Index.

The big picture hides a multitude of nuances.

China may well have the world’s biggest economy, but its GDP per capita is still only 13% of that of the US. It ranks a lowly 89th in the world for GDP per capita, on a par with Peru or the Maldives.

Much of its importance is due to its enormous population. China may be the world’s biggest exporting nation, but half of its exports still comes from foreign-investment enterprises, rather Chinese enterprises, even if the Chinese share is now rising.

China has benefited from a demographic dividend, thanks to its large youthful population. But due to the one-child policy, China’s work force has already started declining, and the demographic dividend is passing. In contrast to Japan, China is becoming old before it becomes rich. As evident from rising wages these past years, China can no longer rely on cheap labor as a source of growth. Growth must now be driven by productivity, human capital and innovation.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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