About me.

Andrew M. Mwenda is the founding Managing Editor of The Independent, Uganda’s premier current affairs newsmagazine. One of Foreign Policy magazine 's top 100 Global Thinkers, TED Speaker and Foreign aid Critic

Monday, August 25, 2014

Behind China’s rapid growth

The opportunities and risks China faces as it begins its transition from middle income status to a rich nation

I spent the whole of last week in China literally flying from one city to another – sometimes covering two cities per day. The speed of change in China is mind boggling. I had not visited Beijing since 2008. In just six years, I could not recognise it. Even cities that I had visited in 2011 have expanded so rapidly I could not recognise them either. Skyscrapers grow like mushrooms even in rural areas where small towns are building high raised apartments to accommodate the mass of people leaving farms.

In 1984, Beijing was a city ruled by bicycles. From the video documentaries of that age that I have, you can hardly see cars on the streets. Today, China has overtaken the United States as the largest car market in the world. During rush-hour, it can take someone four hours to drive the 40km from the airport to Tiananmen Square in spite of the impressive investments in rails, highways and flyovers. Even in the small cities and municipal towns I visited, like Wei Hai and Qingdao, China’s success is evident.

China’s nominal GDP per capita in 1978 was $150 while that of the USA was $10,000 – so the average American was 66 times richer than the average Chinese. Today China has leapfrogged the USA; its nominal per capita income is $6,800 while that of the US is $53,000 – meaning an average American is now only 7.8 times richer than an average Chinese. Compare this to Uganda whose nominal GDP per capita in 1978 was $ 200. An average Ugandan was 50 times poorer than an average American. However, today, Uganda’s nominal per capita income is 600. Therefore, an average Ugandan is poorer than an average American by 88 times. Thus, while China has been converging on America, Uganda has been diverging.

China is now navigating the transition from a middle income (a per capital income of $5,000 to $10,000) to a rich country status. With GDP growth remaining at an impressing 8% or more per year combined with negative populations growth (even with easing of the one-child-per-family policy, China could double its per capita income every five years. If China can sustain its current rate of growth, it will have a nominal per capita income of $17,000 ($30,000 in PPP) in 2024.

However, only a few countries have transited from middle income to rich country status smoothly and successfully – South Korea, Taiwan, Japan, Western Europe, North America, Australia and some small Island nations. It is always difficult to break out of middle income status because the industries that drove growth in the early period start to become globally uncompetitive due to raising wages. The temptation of many governments is to try and protect them, rather than let them die.

This is already happening in China as I wrote in this column (see “Who will succeed China”, The Independent July 4-11). Labour intensive manufacturing has already begun moving from China to low wage countries. This demands that China now moves from low wage manufactures to knowledge-intensive industries where the critical resource is highly skilled labour i.e. human capital. The transition becomes difficult because politicians are always tempted to seek to save industries that employ masses of people – even when they have become globally uncompetitive.

Thus, governments may use subsidies, trade barriers like high tariffs and quotas, foreign exchange manipulation, etc. to protect uncompetitive industries from the cold winds of international competition. This is possible because such industries have powerful domestic interests to promote their cause politically – rich business persons who own them and labour unions whose members have jobs in them. Yet in such cases, the best solution would be to protect people (who lose jobs) not the companies. People can be protected through unemployment income support, free or affordable healthcare, and education for them and their child.

The challenge China faces today therefore is whether its leaders will resist the temptation to protect companies (many of which are owned by government or by persons allied to the Communist Party) or protect people. It is difficult to tell because China seems to be doing everything at the same time – moving towards knowledge intensive sectors (witness the amount of public and private investment into research and development). But equally China is trying to protect uncompetitive industries through different forms of government subsidies, cheap loans, and foreign aid to poor countries tied to purchase of Chinese products.

The other source of vulnerability for China is the growing debt levels in the country. Bank credit grew from $10 trillion in 2008 to $24 trillion in 2013 – an unprecedented development in history. Now compare this with the US where total credit is $14 trillion accumulated over 100 years. China has done it in 5 years. China’s debt is double its GDP. Debt has grown rapidly because China’s investment has been driven by debt, not equity. Local governments promote debt driven development projects of limited economic value and little rate of return because local politicians profit from corruption and partly because they want to impress Beijing.

Also, as new skyscrapers pierce the Chinese skyline almost every month, the property market is grossly overvalued. Property prices go up by 20% per year. It will not take long for this to reach economically unsustainable levels. If property prices collapse, banks will be exposed to collapse as well. And many Chinese who have invested in housing as their social security (pension) will come to grief. Equally worrying is that many state companies are over leveraged. As already mentioned, they have been expanding on debt. China, like America, is addicted to debt – and worse.

There is a lot of corruption in china: In local governments, in state owned companies – everywhere. China may need to slow down growth because sustaining high growth on debt is a big risk. Secondly, average household savings in China are 30% of income. So you have overproduction and under consumption. May be China needs more private sector ownership and market principles in this state-led economy.

But reform will be difficult because there are now entrenched interests profiting from the status quo to accept change. It is therefore more difficult for China to carry out economic reform without political reform. To change the current economic system requires changing the power structure – now, that is political. Will China do it?

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