China's Rebalancing Act
| Author | Jahangir Aziz and Steven Dunaway |
| Position | Division Chief/Deputy Director in the IMF's Asia and Pacific Department |
| Pages | 27-31 |
Page 27
China's economic miracle may be at risk unless the country relies more on domestic consumption
IN THE past 20 years, China has added about $2 trillion to world GDP, created 120 million new jobs, and pulled 400 million people out of poverty. these are big numbers-equivalent to adding a country of the economic size of Portugal every year; creating as many new jobs each year as the total number of people employed in Australia; and eradicating poverty in ethiopia, nigeria, tanzania, and Zambia combined. In recent years, China has grown more than 10 percent annually while keeping inflation below 3 percent. today, it is the fourth largest economy in the world and the third largest trading nation.
Despite these remarkable achievements, there is growing unease within China and abroad about the state of its economy. At the national People's Congress this March, Premier Wen Jiabao cautioned, "the biggest problem with China's economy is that the growth is unstable, unbalanced, uncoordinated, and unsustainable." More generally, the question is whether the pace of growth is sustainable or whether the imbalances in the economy might slow growth, perhaps significantly. And this is why China's policymakers are looking to rebalance the economy to rely less on exports and investment and more on consumption as the source of growth.
What are the underlying causes of these imbalances and how should they be addressed? those are critical questions not only for China but also for much of the rest of the world, whose prosperity is linked to China. For as China has grown, its economic impact on many countries has magnified, whether through its large trade imbalances, exchange rate issues, or its large and growing need for resources and food. there are many suggestions about the policies China should pursue to rebalance its economy-and some even argue that the rebalancing will occur "naturally" as a result of market forces (see "Solving China's Rebalancing Puzzle" on page 32). We believe that a rebalancing will not happen on its own and lean toward an effort that relies on monetary policy, price liberalization, financial market reform, and changes in government expenditure policies.
China's liberalization is usually separated into three phases-the reforms of 1978, 1984, and 1994-each of which further opened the economy. the 1994 reforms had three prongs: the unification of the official and market exchange rates and the removal of restrictions on payments for trading goods, services, and income; the opening of the export sector to foreign direct investment; and the reform of the state-owned enterprises (SOes). the first two changes turned the export sector into a powerful engine of growth, and the third unleashed domestic entrepreneurship.
Page 28
Foreign enterprises, on their own and in joint ventures, used China's cheap but skilled labor to convert the coastline into the "world's workshop" and a critical node in the global supply chain. Meanwhile, domestic enterprises, relieved of costly social responsibilities and not required to share profits with the government, began to invest in new technologies, expand rapidly, and seek out new markets. Domestic private sector firms also developed. A plethora of incentives from both the central and the local governments-in the form of tax breaks, cheap land, and low utility prices-helped to keep production costs low and raise profits to be reinvested in further expansion.
With capital controls and an underdeveloped capital market limiting investment choices, China's large pool of savings provided these enterprises with a captive and cheap source of financing through a state-controlled banking system. And with this, China began an economic expansion of unprecedented pace driven by investment and exports. But consumption growth, in particular, could not keep pace with the capacity created by rapid investment. As a result, the share of investment in GDP rose, while that of consumption declined, with the difference picked up by a rising trade surplus (see Chart 1).
The concern is that China's rapid growth could slow, perhaps even sharply, if the continued expansion of capacity eventually leads to price declines that reduce profits, increase loan defaults, and undermine investor confidence. As the imbalances grow, so does the probability...
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