Make or Break Time for China?

December 2001 marked an important point in China’s economic revolution – on this date, after discussions spanning nearly two decades, China became a member of the World Trade Organization (WTO). By finally coming to terms with the other member nations, China signaled that it was officially committing to its policy of economic reform within the framework developed and mandated by the Western economic powers. Now, nearly ten years later, China has continued to expand its economy and appears to be on the verge of replacing the United States as the planet’s dominant economic force.

Even as little as a generation ago, this would have seemed absurd – but with the adoption of a more open economic model beginning in the late 1970s, China has witnessed record yearly growth. In the last twenty years, China’s economy has increased more than 400% and is expected to double again in the next ten.[1]

The remarkable growth in China’s manufacturing sector and its ability to attract record levels of foreign investment, have played a significant part in the country’s recent developments. It’s massive pool of both skilled and unskilled workers provides a cheap source of labor which has enabled China’s breakthrough as a manufacturing powerhouse.

China is now the world’s centre for production and consumes fully one third of the world’s iron and steel. It is also the planet’s largest user of coal with which it powers its many factories.[2] Initially, China relied more on foreign-owned companies seeking to take advantage of its low-cost labor and incentives to establish production facilities, but China is now taking its first steps to creating its own products. This is very much the case with regards to China’s growing automotive and aerospace industries.

Despite rapid growth and improved living conditions, there are warning signs suggesting that China could be at a crucial point in its emergence as an economic superpower. Decisions and actions taken now could very well determine if China continues to grow in global dominance or if she falls victim to internal conflicts and pressures that could derail the reforms of the past thirty years.

Will Increased Consumerism and Social Changes Clash with Current Politics?

It is impossible to discuss the future of China without examining the politics that have defined the country for the past sixty years. For those of us in the West, communism – particularly the brand practiced under Chairman Mao – was something to be feared. The Tiananmen Square riots and subsequent string of arrests and executions are still vivid images for anyone old enough to follow the news in 1989, and the recent crackdown of dissidents over the question of Tibetan independence suggests that authorities are not yet prepared to allow too many unfettered freedoms.

Thus, for many, the question remains – how effectively can an open market economy exist within a totalitarian regime? Conversely, as more ordinary citizens gain greater wealth, how much of the government’s ability to maintain control peaceably is tied directly to its ability to maintain economic growth and how sustainable is this in the long term?

One of the key events in China’s recent history is the moving of several hundred million peasant workers from rural areas to towns and cities thus providing the cheap labor largely responsible for the manufacturing advantage China counts on to remain competitive. As farmers tied to the state-owned farms, these people were poor, but they could usually grow enough produce and meat to provide sufficient food for their families; but as factory workers receiving small wages, many find it a struggle to buy enough food on the open market to meet the needs of their families. Experts note that China has gone from having one of the most equal distributions of income in Asia, to one of the least equal.[3]

Indeed, this has been exacerbated by the high inflation creeping ever steadily into China’s economy. Inflation for April and May 2008 was 8.5% and 7.7 % respectively with increases in food – particularly fresh produce and meat – accounting for much of the increases.[4] Many families already spend in excess of 50% of their pay just for food, leaving very little for any luxuries over and above the basics of food and shelter.

This trend is alarming to economists observing from outside the region. China experienced wide-scale riots in the 80s and 90s as inflation pushed the price of food basics out of reach of many and fears abound that we could see a repeat of the same. The world has witnessed food riots in parts of Asia and Africa already this year as staples including rice and grain prices have doubled on the world markets.

Other Issues Brought on by Rapid Change

England had it’s time in the sun thanks in large part to the wealth generated by the Industrial Revolution; the United States has been dominant since the end of World War II when its ability to produce machinery and other heavy goods helped propel the Allies to victory; and now, perhaps, China is set to take the same route to the head of the line.

Just imagine the change that Chinese citizens now in their fifties and sixties have seen as China transitions from a feudal land-based society to one based largely on supply and demand economics – they have gone literally from the rice paddy to the space age. Essentially, these people are experiencing a high-speed version of the Industrial Revolution and here’s hoping that China can avoid some of the pitfalls that befell England and others transitioning from an agrarian society to one actively participating in the global marketplace.

Like we have noted in China, the English Industrial Revolution gave rise to its own middle class consisting of industrialists and businessmen that – as their money and power grew – usurped the nobility and gentry that had controlled England for centuries. Tenant farmers were relocated to work in the new mills and factories where they endured great hardships in return for subsistence-level wages. Workers were entirely at the mercy of the factory foreman and owners and corruption was rampant.

In China today, there are countless “rags to riches” stories, but there are also many parallels with England’s history, and one area of concern is the growing number of migrant workers now living in the major cities. This large group – estimated at 400 million – lives a marginalized existence without the financial means or authorization to move freely between cities. Migrant workers are forced to endure long hours and receive few medical benefits and, due to their vulnerability, are often forced to kick-back parts of their earnings to corrupt officials to ensure continued employment. [5] Lacking the education and skills needed for most of China’s new workplace, migrant workers have neither the ability to find good jobs nor can they rely on any form of state-sponsored safety-net as the old “cradle-to-the-grave” system of socialism is rapidly disappearing.

Future Concerns

We have already mentioned the detrimental effect that inflation is having on the economy; but if China cannot reduce inflation from its current 7 – 8% to something more inline with the desirable inflation rate of around 2% which most Western economies strive for, than China is liable to find itself in an inflation spiral. An inflation spiral – a period of continuous price increases – places upward pressure on salaries as workers seek wage increases that keep pace with inflation. For those living on fixed incomes such as retirees and the elderly, continued high inflation could be disastrous.

If wages do increase with inflation, then China may lose some of its appeal as a manufacturing center and off-shore corporations may turn to other jurisdictions such as India and the Philippines to build and assemble their products. How will the Chinese government respond if competition from other countries threatens its position? Will it freeze wages to maintain its market dominance? Raise interest rates perhaps?

And what if the global economy continues to worsen and China’s traditional export markets continue to reduce their volumes? In 2007, China exported more than $2 trillion USD with over 60% going to its three main trading partners – the EU (29.3%), the US (17.7%), and Japan (16.4%).[6] With the U.S. teetering on the brink of a recession and energy prices and other woes affecting the economies of Europe and Japan, demand for China’s exports have already declined with further reductions likely.

While China clearly faces some key decisions that will shape its economic future, a great deal of foreign investment continues to find its way into the country. China also has an estimated $1.6 trillion USD [7] in reserves so the country does have the means to ride out any short-term economic speed bumps, but today’s actions will directly impact the China we find ten to twenty years from now.

Interestingly, both Japan and Taiwan were in similar positions during their own economic expansions of the 1970s and 1980s, and both discovered how difficult it is to sustain growth indefinitely. Only time will tell if China can take lessons learned from its neighbors and avoid the problems that plagued the earlier Asian trailblazers.


References

  1. ↑ The Rise of China and the Future of the West – Can the Liberal System Survive? – G. John Ikenberry, 2008
  2. ↑ The Rise of China and the Future of the West – Can the Liberal System Survive? – G. John Ikenberry, 2008
  3. ↑ The Rise of China and the Future of the West – Can the Liberal System Survive? – G. John Ikenberry, 2008
  4. ↑ www.cnn.com – June 11th, 2008
  5. ↑ Migrant workers feel like ‘slaves’ to Beijing’s Olympic projects – Geoffrey York, Globe and Mail, March 12, 2008
  6. ↑ China Today – www.chinatoday.com
  7. ↑ China Today – www.chinatoday.com



About the Author

Scott Boyd has been working in and writing about the financial industry since the early 1990s. As a technical writer and project manager with several of Canada’s leading financial institutions, Scott has produced educational materials for investment system end-users including portfolio managers and traders. Scott now administers and contributes to OANDA FXPedia and regularly provides commentaries for the OANDA FXTrade website.


This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.