EVENTS

Date:	Thursday, April 21, 2005
Time:	10:00 AM -- 11:30 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

April 2005

How Sustainable Is China's Economic Growth?

Is China really the economic powerhouse that some describe? How serious are China’s structural weaknesses? What role will foreign investment and foreign multinational corporations play in the Chinese economy in ten years? How will burgeoning demand for energy, raw materials, and other natural resources shape Chinese policy towards Asia? Will China rely primarily on global markets, exclusive bilateral deals, or direct control to get the inputs its economy needs? What incentives or pressures will China use to persuade Asian countries to supply it with resources? On April 21, AEI and the National Defense University continued its series of seminars addressing these and other questions relating to the growth of Chinese power and influence in Asia.

Nicholas Lardy
Institute for International Economics

Chinese economic growth is likely to be sustainable. Critics cite a laundry list of potential problems and argue that one or more will derail Chinese economic growth. Bad loans and financial sector weakness, water shortages, growing energy demand, rising inequality, and environmental damage are all real challenges. These challenges existed twenty years ago, and China has managed them successfully so far.

A better approach is to examine the key factors that have produced China’s economic success and ask whether they are likely to continue. The first key factor is the rise of the market. In stark contrast with twenty years ago, prices of almost all products and labor in China are now set by market forces that reflect scarcity and supply and demand. Previously, prices were set by administrative fiat, which misallocated resources and meant that enterprise profits were determined by whether firms could buy cheap inputs and sell output at higher prices. This system is gone; most sectors of the Chinese economy are now characterized by strong competition. China now has a much more efficient labor market where there is competition for jobs and labor turnover. The Chinese capital market is inefficient in allocating capital, but the fact that reinvested profits are the most important source of investment capital helps to compensate for these weaknesses.

A second key factor is China’s very high savings rate, which has supported a high investment rate. China’s savings rate has risen from 30 percent in the 1970s to more than 40 percent today. This is the highest savings rate in the world (except for Singapore).

A third factor is the inter-sectoral transformation of China’s labor force. Workers have been moving from the low productivity agricultural sector to the higher productivity manufacturing and services sectors. China has moved from having 90 percent of the population in the agricultural sector to about 50 percent today.

A fourth factor is China’s openness to foreign trade and investment. China differs greatly from Japan and India in its openness, which forces increases in competition, efficiency, and productivity. Chinese import tariffs are quite low, with an applied rate of less than 10 percent and an actual rate of less than 3 percent. This helps the manufacturing sector get imported parts, and contrasts with Indian tariffs which are three times higher, making the Indian manufacturing sector uncompetitive. China has also eliminated almost all import quotas and licenses. Economic openness forces domestic firms to improve their efficiency in order to survive.

In assessing the future, the biggest challenge is the poor efficiency of the capital market. China would benefit greatly from equity and bond markets that really work. The current system is so bad that “there is nowhere to go but up.” One to two hundred million more farmers are likely to move to the manufacturing/service sector over the next ten to twenty years, helping to extend productivity growth. China’s goods market is relatively open, and China’s WTO commitments mean that the services sector will open further in 2006 and 2007. One big uncertainty is a possible decline in the savings rate as China’s society ages and the ratio of workers to retirees shifts in ten to twelve years. However, this could be offset by increased efficiency in capital allocation. China could continue to enjoy growth in the high single digits for at least another decade or longer.

 Despite this overall conclusion, there is a possibility of a significant economic slowdown in the next two to three years. One problem is accumulating risks in the financial sector. The extremely high rate of fixed-asset investment (about 45 percent of GDP) is being used inefficiently and is likely to decline; neither increased consumption nor government spending will fully compensate. China will likely seek to maintain growth through increased net exports, but there are real questions about whether the world would accept a Chinese current account surplus of more than 5 percent of GDP. This is an indication that China’s currency is significantly undervalued.

Mikkal Herberg
National Bureau of Asian Research

China’s increasing energy demand to fuel rapid economic growth is changing the face of global energy geopolitics and forcing Beijing to become a major player in the Middle East, Central Asia, Africa, and Latin America.

Energy demand in China is high and projected to grow rapidly over the next fifteen to twenty years, but supplies will come mainly from “dirty” sources such as coal and oil. By 2020, coal use will increase by 40 percent and oil use by 30 percent, with disturbing environmental implications. A key challenge is meeting growing electricity demand without excessive reliance on coal. Despite tremendous investments in nuclear power and hydropower to generate electricity, energy in China always faces a problem of scale. China plans to build two nuclear power plants a year for the next twenty years, but this will fulfill only 3 percent of energy demand. The huge Three Gorges Dam project will only meet 2 percent of China’s energy needs. Because Chinese firms use energy inefficiently, price reforms that reflect the actual price of energy are the key to reducing domestic demand and increasing efficiency.

Chinese demand is not the only factor driving energy prices: energy demand is on the rise throughout developing Asia. Asia’s future oil import needs will rise from 14.4 million barrels a day in 2002 to almost 40 million barrels by 2030. Most of this oil will come from the Middle East. China will make up over 50 percent of Asian energy consumption growth, and 20 percent of global energy consumption growth.

Increasing demand and high oil prices are causing consternation throughout Asia. The belief that global oil production will peak in the near future (which I do not share) fuels a sense of scarcity and anxiety about securing energy for future growth. Chinese “oil angst” has produced a strategy of “energy nationalism.” China’s leadership views energy through a mercantilist, zero-sum lens and feels energy security is too important to leave to the market. Chinese oil companies are converging on regions where energy resources are available—the Persian Gulf, Western Africa, Russia, Central Asia, and even Venezuela—in a rush to secure rights to supplies. They are also increasingly concerned about potential choke points like the Strait of Malacca.

How China’s energy consumption affects the rest of Asia depends on general Asian approaches to handling China’s rise. If the process is peaceful, then energy should not become a major issue. If the rise is bumpy, energy could become a bone of contention and further aggravate existing regional rivalries. The Asia-Pacific Economic Cooperation organization has been trying to carve out a cooperative role, and there is potential for cooperation on a gas pipeline in Northeast Asia. Progress has been slow on both fronts.

Will energy become a bone of contention between China and the United States? The issue is highly politicized in both countries. China worries about growing U.S. influence in the Persian Gulf and Central Asia and about U.S. control over the sea lines of communication from the Middle East to Asia (including the U.S. ability to cut off Chinese oil supplies in the event of a Taiwan crisis). The Middle East-China nexus will continue to grow. In the future, China will have the ability to use energy diplomacy and stronger bilateral ties to affect the security architecture of global energy.

National Defense University research assistant Tamara R. Shie prepared this summary.