Chinese economy's gear shift will enable it to go the distance
Zhang Monan says the rebalancing now in progress will, if successful, strengthen its foundations
After more than 30 years of extraordinary growth, the Chinese economy is shifting onto a more conventional development path - and a difficult rebalancing is under way, affecting nearly every aspect of the economy.
For starters, China's current-account surplus has shrunk from its 2007 peak of 10 per cent of gross domestic product to just over 2 per cent last year. In the third quarter of 2014, China's external surplus stood at US$81.5 billion and its capital and financial account deficits amounted to US$81.6 billion, reflecting a more stable balance of payments.
This shift can partly be explained by the fact that, over the past two years, developed countries have been pursuing re-industrialisation to boost their trade competitiveness. In the United States, for example, manufacturing grew at an annual rate of 4.3 per cent, on average, in 2011-2012. Indeed, America's manufacturing industry has helped to drive its macroeconomic recovery.
Meanwhile, as China's wage costs rise, its labour-intensive manufacturing industries are facing increasingly intense competition, with the likes of India, Mexico, Vietnam and some Eastern European economies acting as new, more cost-effective bases for industrial transfer from developed countries. As a result, the recovery in the advanced economies is not returning Chinese export demand to pre-crisis levels.
These trends - together with the continued appreciation of the renminbi - have contributed to the decline of Chinese goods' market share in developed countries.
Incipient trade agreements like the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership will accelerate this process further, as they eliminate tariffs among certain countries and implement labour and environmental criteria. Add to that furtive protectionism, in the form of state assistance and government procurement, and Chinese exports are facing serious challenges.
China is also undergoing an internal rebalancing of investment and consumption. As it stands, declining growth in fixed-asset investment is placing significant downward pressure on output growth. Investment's contribution to GDP growth has also fallen.
One reason for the decline is that China has yet to absorb the production capacity created by large-scale investment in 2010-2011. Aside from traditional industries like steel, non-ferrous metals, construction materials, chemical engineering and shipbuilding, excess capacity is now affecting emerging industries like wind power, solar panels and carbon fibre, with many using less than 75 per cent of their production capacity.
But the decline in investment is also directly correlated with that of capital formation. In 1996-2012, China's average incremental capital-output ratio - the marginal capital investment needed to increase overall output by one unit - was a relatively high 3.9, meaning that capital investment in China was less efficient than in developing countries with similar levels of growth.
Industrial firms' profits are likely to continue to fall, making it difficult to sustain high investment.
Meanwhile, the expansion of China's middle class is having a major impact on consumption. Last year, China surpassed Japan to become the second-largest consumer market in the world, after the US.
To be sure, Chinese imports remain focused on intermediate goods, with imports of raw materials like iron ore having surged over the past decade. But, in the past few years, the share of imported consumption goods and mixed-use (consumption and investment) finished products, such as cars and computers, has increased considerably. This trend will contribute to a more balanced global environment.
The final piece of China's rebalancing puzzle is technology. As it stands, a lag in technological adoption and innovation is contributing to the growing divide between China and the developed countries, stifling economic transformation and hampering China's ability to move up global value chains.
But, as China's per capita income increases, its consumer market matures, and its industrial structure is transformed, demand for capital equipment and commercial services will increase. Indeed, over the next decade, China's hi-tech market is expected to reach annual growth rates of 20-40 per cent.
If the US loosens restrictions on exports to China and maintains its 18.3 per cent share of China's total imports, American exports of hi-tech products to China stand to reach more than US$60 billion over this period. This would accelerate industrial upgrading and innovation in China.
China's economy may be decelerating, but its prospects remain strong. Once it weathers the current rebalancing, it could well be stronger than ever.
