An Overview of China’s Growing Economy

Because of my background in economics I’m often asked by people made anxious by some news story or another what the future outlook is for US and Chinese economies.  The most common theme seems to be a fear of losing our number one  spot on the list of global economic superpowers.  Other common themes include the US – China trade deficit, dollar – yuan monetary strife, and US national debt owned by China.  These are complicated problems, with no sure outcome.  It would be impossible for me to write, with any certainty, what exactly will happen in regard to each problem, but I will share several thoughts I have on the matter.

It is very likely that China’s economy will overtake our own on the measure of national GDP within the next decade or so.  Accept that.  But because they have several billion people in the country, they will not overtake us in the measure of per capita GDP for the forseeable future.  Before anyone goes out and jumps down my throat for saying that we could be bumped to #2 (or lower depending on what kind of mistakes our country’s leadership continue to make) in terms of GDP, let me explain what China is doing right, what they are doing wrong, and some other important events I see in their future.

China’s economy is thriving on production, even with the economic downturn.  They produce a wide variety of goods that are shipped virtually everywhere in the world.  This has allowed them to build and grow the industrial sector on a fairly sustainable basis.  They have a comparative advantage in production because they have access to large pools of cheap labor. Because labor is often the number one ongoing expense in production, their advantage has been absolute for years.  The advantage in cheap labor that China leverages comes from a surplus of labor in the agricultural industry.  For years, many in rural areas experienced very low marginal productivity.  That is, their personal contribution to the farm, the orchard, etc. was very low.  This is, in part, because of the low level of capital (farming equipment) available, and in part because of a huge population spread out over the land with nothing to do but farm.  When industrial jobs in the city are available, they quickly and eagerly accept the more productive work and higher wages, leaving rural China behind them.  For many years, there was a virtually unlimited supply of labor willing and available at very low wages.  (This situation appears very similar to the Lewis two sector model).

This trend will change.  At some point, and many economists believe soon, the surplus labor will be absorbed by the industrial sector.  Labor will become much more scarce, and the equilibrium wage will rise.  This will put a damper on the productive prowess of China’s industrial sector.  The article notes, “Marshall W. Meyer, a China specialist at the Wharton School at the University of Pennsylvania, says that demographic changes in China are reducing the supply of young workers entering the labor force and that this is behind some of the wage pressure.”  The effect this will have on the world’s economy is mixed.  It may decrease China’s net exports and boost domestic spending.  This could be a good thing, but it depends on how much access the government allows its citizens to have to international goods.

China has also had reliable access to resources, largely because of their wide sweeping trade relations with most of the Western world.  Resource availability has not always been abundant for them, but it’s always been somewhat steady.  This, too, has allowed for reliable growth.  Their ability to import oil and coal – the energy of their production has been heavily reliant on the US, whether for the coal (which is mined in the US), or for the oil (in which international trade exchanges are facilitated in US dollars).  Increasingly, however, China is able to deal with resource exporters in Yuan – their own currency, making these international trades for resources faster and less costly.  Many countries are seeking China out as a primary customer over the US and other Western nations.  This is especially true of other Eastern and middle-Eastern nations.  China has little respect for the views of the US in regard to their trading partners and strategic allies.  They are willing to deal with countries like Venezuela, N. Korea, Russia, and Iran, with whom the US has rocky foreign relations.  They are commanding an increasing percentage of the world’s resources, a trend that isn’t likely to change soon.  This means China will continue to have a preferred customer status among many resource producers, with preferred customer pricing as well.

Another positive aspect of the Chinese economy is the personal savings rate of the people.  The people of China save an astounding 40% of their income year over year.  This savings rate has allowed the Chinese to become the creditors of the world (esp. of the US), as their savings are used to purchase government issued bonds.  The savings rate has allowed China to build at unprecedented levels (providing evidence that the paradox of thrift exists only in a nation run on fiat currency and deficits - and only in the short term).  As long as this trend continues, China will have funds to invest in projects that will promote growth and prosperity for years to come.  This is because as consumers save, they are signalling to the market that they will defer spending now to a future date.  The savings can then be used to make capital investments, which increase productivity, making goods and services more abundant (usually cheaper as well), and the economy expands.  Later, money is withdrawn and spent on the cheaper, more abundant goods, and the market thrives.  This is how market spontaneously create order.  This produces wealth and abundance.

This analysis of China’s economy is not by any means exhaustive.  But for these and many other reasons, the general economic outlook of China is overall quite positive.  The future of China, however, is not without some very disturbing and harrowing trends and demographic issues that may prove to check the nations ability to expand and grow.

Because China has a centrally planned economy, it’s prone to malinvestment.  Many of the projects undertaken by the government and the economy as directed by the government are misdirected.  Resources used on these various projects promoted by the government’s central planners are not invested where demand is consummate with supply and there are often shortages of resources in that or other markets, or an overabundance of the particular good or service.  Distortions are created in the market, and wealth is essentially destroyed.  There are, for instance, masses of homes, shopping centers, and entire towns in China that are devoid of people.  They were built with resources that could have been directed to enriching the people, expanding the economy, etc, but were instead used on projects that are benefiting no one.  This massive destruction of wealth counters any good their high savings rate can do.

Additionally, just like the welfare programs of the United States, China’s social welfare programs are reliant upon a growing population.  China’s population growth rate, just like most Western nations, is declining.  As the growth rate of the population declines, the tax base shrinks and liabilities are increasingly difficult to meet.  As the population ages and there are fewer people to replace them in the workforce, government funded retirement, among other programs, becomes unsustainable.  The aging population begins to draw more resources from the benefit pool than are fed into it, drying it out.

China’s one child policy is taking it’s toll on population growth.  But it’s also setting up what could be a serious implosion. As of right now, China has something like 100 million fewer women than men.  Female children tend to get less nourishment, less education, and are even killed shortly after birth or simply aborted pre-term.   A society can replenish itself with relatively few men and many women (as Europe did after the ravages of WWI and WWII), but not the other way around.  Women who do not exist cannot raise the next generation.

Another concern, though somewhat fleeting, regarding a lopsided population with many more men than women is the rise of male aggression.  History has shown societies where men, unable to find mates, lash out in violence.  This event can manifest as either civil or international conflict.  Either way, it would not prove to support a thriving nation.

Another effect of dwindling population growth is rising wages.  Demand for labor will likely remain relatively consistent (though not constant) as population growth falters.  The stagnation in demand for labor will lag behind the shrinking population growth to the extent that demand for labor will exceed supply relatively, driving wages up.

In Summary

There are so many things that could be said about China’s future, good and bad.  But it appears as though China will be a competing superpower for some time to come – likely another generation or two.  There are some very good things in store for the Chinese people.  Very soon China will have the most numerous English speaking population in the world.  The middle-class is growing.  If the government of China can get itself and its destructive policies out of the way, China could grow into flourishing member of the first world.

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