The Chinese Economy

With the world’s second-largest economy by GDP and purchasing power parity, China has a substantial influence in the world market and thus must be economically analyzed thoroughly to derive information relevant to major economic decisions and agreements. China currently leads the East Asian economy and competes ferociously with the United States, the world’s largest economy. With an annual growth rate of over 10 percent in the last decade, China also is considered the world’s fastest-growing economy. Being the largest manufacturing economy in the world, China interacts with the global market at all times; thus, it is important to analyze Chinese economic structure in order to predict future economic relations with China and other countries, potentially apply successful growth strategies to less-developed nations and predict the future of trade volume and direction. Many developed industrial nations consider China’s unrivaled growth rates as a “threat” to their power in the global economy- this is another important reason to unveil the mysteries behind China’s historically secluded economy and validate or disregard these assertions.

Historically, China has maintained an isolationist economy and kept very little contact with other nations. In recent years many economic and political reforms have changed this drastically. The Maoist isolationist period began to disintegrate when the modernist Deng Xiaoping became China’s leader in 1973. But China’s great advantage truly occurred in 1992 when the General Secretariat of the Chinese Communist Party announced that China was transitioning to a socialist market economy (Unay 135). This announcement piqued the curiosity of global investors, and prospects looked good for the Chinese and global economy. Thus China received a massive influx of FDIs (Foreign Direct Investment) from foreign investors with high expectations. These FDIs were almost solely used to transform the manufacturing sector; they were used to finance market-access and export production (Unay 138). Thus the Chinese economy has been growing ever since, based on the enormous manufacturing sector. But in some ways, the manufacturing dominance in China has limited the Chinese people, which will soon be discussed in greater detail.

The Chinese government is a decentralized government- local and regional authorities make and enforce the local laws. This system is in place as an “experiment” in China’s growing economy, as it allows the implementation of many different economic systems at once to evaluate their power (Witt 4). The decentralized system also allows the Chinese, a people rich in cultural tradition and history, to maintain their customs from region to region. In a transitioning economy and society, it is also difficult to put a system in place that is acceptable to all and enforceable by all in such a large and diverse nation. However, this decentralization is a great cause of skewed income distribution and inflation in China. Combined with FDIs almost solely being distributed to areas with great manufacturing productivity, decentralization has impeded wealth equality in China. The federal government has a harder time addressing the negative consequences of income inequality without the revenues that the local governments collect in their stead.

Meanwhile, inflation is also becoming a major problem associated with decentralization. Though decentralization may have been a major cause of the high growth China has experienced recently, it has been proven to be responsible for increased inflation (Feltenstein and Iwata 1). Decentralization allows for different localities and regions to institute different pricing at levels that may differ from the price levels of other areas. Thus when producers price their goods, they may have imperfect information about the expected price and relative price of their goods and therefore set prices higher to guarantee to cover their costs. This aggregate misinterpretation of price levels eventually leads to higher average price levels or inflation. It also can help contribute to the income inequality; if Town A’s farmers see Town B’s prices, which are relatively low, and set their prices based on Town B’s prices. Thus Town A and Town B both have relatively low prices. Meanwhile, Town C and Town D may be on the other side of the country, far from contact with Town A and Town B. Town C then might see Town D’s relatively high prices, assume these high prices are the prices across the nation and set their prices high as well. As this pattern continues, one area may have relatively low prices while the other has high prices, based on nothing more than simple misinterpretation and lack of communication. Fiscal decentralization also adds to the level of inflation by creating local autonomies, which decrease the revenue of the central government by collecting that same revenue for the local government to use. The central government, in turn, must meet this loss of revenue somehow, and often does so via the creation of money. An increased money supply, combined with the lack of price control, leads to increased inflation (Feltenstein and Iwata 1). Several channels in the current Chinese economy contribute to the inflation issue.

In this highly export-oriented economy, laborers do not have the upper-hand in negotiations. Though labor unions do exist, such as the All-China Federation of Trade Unions (ACFTU), they are countered by managerial unions, such as The China Enterprise Confederation (CEC). Additionally, labor unions are government-controlled and the government most often sides with managerial wishes (Witt 7). Labor turnover in China is also notably high, which is a sign of low worker productivity. In 2007, stricter labor regulations were put in place to try to help secure laborers’ jobs, but these are often overridden by the previous fixed-term labor contracts that often involve very few restrictions for management (Witt 8). China scored a 4.10 on the Global Competitiveness Report of 2010 in terms of ease of hiring and firing, with 1 being impeded by regulations and 7 being flexibly determined by employers (Witt 8). This score is higher than the global average.

The high labor turnover is a sign of unskilled workers in the Chinese economy. This is supported by evidence including the decreasing number of schools and graduates alike in China, and the general rather than specific focus of their coursework. Since 2002, the demand for technical employees in China has exceeded its supply, and so the manufacturing dominance in the economy is hindering innovation and human capital development (Witt 9). Job creation has also recently slowed significantly in China, suggesting the implausibility of sustained growth in the long term as a manufacturing economy. Growth in personal income levels has also begun to lag behind GDP growth when previously this had been the opposite (Unay 137). Though GDP may indicate a growing economy, the standard of living for most Chinese citizens is not improving as much as might be expected.

Chinese firms, for the most part, are government-run. One major cause of this is that private businesses encounter many difficulties in acquiring official bank loans or accessing capital markets. In 2008, for example, private business loans only accounted for about 0.8 percent of official bank loans, with state business loans acquiring the majority (Witt 5). Loans from family and friends and unofficial financial operations are nearly the only way for private businesses to acquire financing. Thus, Chinese citizens do not have many financial opportunities and are often economically forced to act as unskilled labor. Chinese intellectual property rights are also notoriously unenforced, which leads to technology dispersion occurring on its own (Witt 10). Thus there is little motivation for investment and innovation in this economy because profits from them are not protected. These premises help fuel the manufacturing sector by providing an inelastic labor force. As education and private business become increasingly faded options for Chinese citizens, income inequality becomes an even greater issue.

China withstood the financial crisis of 2008 relatively well compared to other economies, because of the way its financial system is setup. From 1978 to 2005, China maintained strict government controls over the financial sector. In 2005, China largely deregulated the financial sector and allowed it into private hands, right in time for the global economic crisis. China remained primarily robust during this time though due to economic policies put in place in 2003 to avoid the danger of capital flight (Unay 139). These policies made it very easy for capital in the form of short term and international capital flows to enter China, but very difficult to leave China. Therefore the country did not fall victim to the vast quantity of capital outflow that many nations experienced in the financial crisis.

Still, though Chinese capital was not highly affected by the crisis, global demand was. Since an economy based on exports relies so heavily on global demand, the Chinese have instituted an expansionary fiscal policy since the crisis in an effort to alleviate the impact of diminishing export demand in global markets (Unay 140). The government launched massive programs of public investment, as many nations did to alleviate the negative effects of the crisis. But unlike the United States, which placed public investment into private banking and financial sectors as rescues, China invested in infrastructure and social support projects in an effort to boost domestic demand to somewhat offset the declined global demand and continue economic growth (Unay 132). Whereas the United States tackled the crisis via financial markets and private company rescues, China’s economic structure enabled its government to spend its money within its own realm- on government structures and projects.

With the relative stability economic growth has brought for the Chinese, the government may begin to focus on addressing more particular problems within the economy. This year, China is planning to raise its budget deficit by 50 percent, to a 1.2 trillion yuan gap (Avery, Tan and Li 1). This will take place in the form of decreased taxes in the hope to continue boosting consumer demand. Growth is also expected to decline below 10 percent for the first time in years, with a target rate of 7.5% (Avery, Tan and Li 1). Though a decline in growth is not necessarily ideal, the slowdown is expected to help alleviate some of China’s growing economic issues including income inequality and unemployment. The federal government has also announced that local government debt management will be improved to not let the budget deficit get unruly. The central government is now expected to stop some authorities from defying laws or regulations in order to obtain financing, as well as integrate a system that “warns” the central government when local government debt becomes too high (Avery, Tan and Li 2). This should give the central government greater control and management over Chinese debt without taking away significant rights of the local governments.

Though China’s budget deficit may start to widen now, China is still a net creditor in the world market and maintains a negative government debt. As China has exceeded the United States in receipt of non-stock shares and FDIs, it has accumulated a massive amount of U.S. dollar reserves (Unay 130). China maintains over 2.5 trillion US dollar reserves, which are mainly invested into U.S. Treasury bonds. The nation thus acts as the United States’ largest creditor and finances American budgets and trade deficits. Maintenance of this position has been achieved via the Chinese state’s dominating control over finance and banking, with four major state-owned banks controlling more than 70 percent of the total deposits and advances in the banking industry (Unay 140). The strict control China maintains over its money has indubitably been a major factor in China’s rapid economic development.

Within the last decade, citizens of other nations may have noticed the increasingly large volume of their domestically purchased goods advertising the label “Made in China”. China is responsible for more than 10 percent of all global exports, with 90 percent of those exports from the manufacturing sector (Unay 144). These significant numbers highlight China’s newfound importance in the global economy and reliance on manufacturing. The trade surplus accounts for about 10 percent of China’s GDP and is fueled by growing investment links and massive import capacity of intermediate goods with developed East Asia (2, 130). Again, this massive trade volume would not have been attainable without the inflow of FDIs to China allowing exports to rise significantly. To maintain the surplus, China instituted many import restrictions and protected domestic markets via high tariffs and quotas. Civilian lack of currency convertibility, state-set exchange rates, and limited external access to financial markets also discouraged imports (Unay 137). This half-closed aspect of the Chinese economy also aided in economic resilience during the financial crisis, as the Chinese public had not previously needed to rely on imports and depended on their own production. Thus, supply and demand shocks were partially absorbed by Chinese policy and the financial crisis’s effects were assuaged. China continues to expand its trade prospects as production capabilities and global integration improve. In 2010, the China Free Trade Area (ACFTA), also known as the China-ASEAN Free Trade Area, was established. This agreement enabled free trade from then on between China and ten geographically near nations (Unay 139). The lower costs of transportation and capital mobility that comes with this agreement will enable China to expand its exports even further, further increasing its GDP growth.

China has used many different policies to achieve economic goals as a newly industrialized economy experiencing high rates of growth. Decentralization may have enabled rapid growth, but its negative consequences are beginning to become problematic for the Chinese public. Though annual GDP statistics may prove China successful in one regard, there are still policy-derived social and economic problems that must be addressed to continue improving all-encompassing economic status, including income inequality, depreciating education, a mismatched labor force, inflation, and general inconsistency. China must now find a way to stabilize its remarkable growth and improve general welfare, while it continues to look for more opportunities to integrate itself into the global market.

Works Cited

Witt, Michael A. “China: What Variety of Capitalism?” INSEAD Working Paper, 88 (2010): 1- 16. Web.

Feltenstein, Andrew and Shigeru Iwata. “Decentralization and Macroeconomic Performance in China: Regional Autonomy has its Costs”. Journal of Development Economics, 76.2 (2005): 481-501. Web.

Unay, Sadik. “From Engagement to Contention: China in the Global Political Economy”. PERCEPTIONS. 18.1 (2013): 129-153. Web.

Avery, Nerys, Regina Tan, and Liu Li. “China to Raise Budget Deficit by 50% to Boost Demand”. Bloomberg Businessweek. 4 March 2013. Web. 6 December 2013.