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. ompanies 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. %. 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. % 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. evel. 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. 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).