A continent in itself

China is a continent in itself, vast by any measure. As large as West Europe yet with 1.3 billion people a challenge to any imagination. The Kingdom of the Middle has re-emerged in the last twenty years, and is on its way to an unprecedented future. Will it continue become the second largest economy in the next 15 years or will it succumb to its weight of history and unattainable expectations?

The Chinese economy will probably keep on growing by about 7% and within margin of errors in line with other economies. To break down the forces of this growth you might outline four driving forces. Minimum GDP growth might be

-1% by the increase in its labor force, 

- 3% by capital expenditure and investment, 

-1% by productivity growth,

 the rest by macroeconomic policy and the global economy. GDP growth of about 1% will be contributed by its labor force growth and China’s demographics: The population growth is presently quite low at 0.7% and is reaching 0% by 2020. Then the working level will be declining, subsequently the labor market will be tight. Eight to nine million new urban jobs will be needed per annum to absorb new graduates, rural migrants and early-retired people. Wages over the next five years will diverge with labor wages facing downward pressures and management wages upward. Farm income will hopefully rise. The World Bank expects that from 2008 onward there will be significant pressure on all wage sectors following the “flying geese” pattern. This will effect industry patterns in regions pushing labor intensive industry into central and western regions.

This could be of tremendous interest to German companies that now focus on the Yangtse Delta around Shanghai. More labor intensive industry will certainly leave the city and settle in the surrounding provinces. The dependency ratio is rising, with 20 million children less in the next ten years. The aged population is rising very fast and subsequently the social pension burden is rising. Taxes are likely to rise, disposal income will fall and this can lead to a depressive effect on the economy.
GDP growth about 3% by investment growth: Domestic savings are likely to fall as spending goes up on big ticket items: houses, cars, yet also on soft items e.g. education, leisure etc. The capital account is likely to be liberalized within the WTO process due to the impracticality to handle the steep increase in volume trading. Net foreign savings are likely to stay at 50 to 60 billion US-Dollar p.a. as foreign direct investment (FDI), though outflow will go up as PRC companies increasingly invest overseas. Primarily the oil companies Sinopec, PetroChina and CNOOC in their search to secure overseas oilfields as Chinese import dependency on oil rose from 0% in 1993 to 37% last year, and will reach 50% in 2015. But also Chinese companies will go on a shopping spree in the US, to a lesser degree in Germany (though TCL bought Schneider DUAL in 2002). Chinese investors want to diversify (Taiwan pattern) and will not keep savings at home, Portfolio diversification is the flavor of the day. Foreign investment flow on PRC equities will remain slow, approx. 1 to 1.5 billion US-Dollar p.a. and more security and bond financed investment will take place in China. So declining domestic saving and stagnant foreign savings are likely and subsequent investment will be lower (the good old formula I=S).
GDP growth about 1% by productivity growths and gains: So far, productivity growth was only about 1.5% with spurts of 2.5%, which is in line with the best OECD countries. This is not enough to sustain economic growth in China. Most productivity growth comes from reassigning workers from low productivity to higher productivity jobs, i.e. rural (farmers 300 USD p.a.) to manufacturing (900 USD p.a.) to services (restaurants, logistics, engineering 3000 USD p.a.), last being the high impact area. The government plans for large migration (40 million) from rural to urban areas in the next years.
GDP growth about 1% by short term macro-stimulus: These growth drivers that China used heavily in the last years are primarily budget, off budget and financial/bank credit stimuli. All were utilized too heavily in the past by the government, but Beijing is now looking for an exit strategy, as the governments deficit is rising (3.3% of GDP in 2002 against 3.2% in 2001). But the government could run this for an even longer time as the revenue base expands.

China is a domestic economy
Contrary to everybody’s belief, the global development will likely have a smaller negative impact on China’s GDP growth. China’s share of the world trade from 2002 5% rising to 7-8% by 2007. However China’s domestic consumption still drives the economy, i.e. by 2020, China’s domestic market will consume 70-80% of its industrial production with only 20% for export though China’s share of world trade will rise. China is primarily a domestic economy!
Is growth sustainable? A scenario of a GDP collapse or a sharply reduce growth is unlikely with the present government administrative control and the Chinese pattern of investment/ saving. China’s economy is strongly resistant to recession. Beijing has enough tools/resources to boost its economy and no scenario shows that the GDP growth will fall below 5% in the next years.