"Although the current situation is not sustainable, it is likely to continue for the foreseeable future in the absence of much more aggressive efforts to force change," says Pieter Bottelier, Professor of China Studies at Johns Hopkins School of Advanced International Studies, and Senior Advisor to The Conference Board. He is co-author of the report with Gail Fosler, President and Chief Economist of The Conference Board.
The sectors mainly responsible for China's rapidly widening trade surplus include steel and steel products, heavy machinery, textiles, garments and electronics.
Says Fosler: "China's fast growth and rapidly expanding trade surplus are driven by a number of factors that together have created a momentum that is hard to slow and may intensify internal and external economic imbalances for some years."
The Gathering Storm: Addressing China's Internal Imbalances
China's over-reliance on capital formation and net-exports to maintain strong growth is its most serious macro-economic problem. To make the country's economic growth model more sustainable, the government has been trying for some years to increase consumer spending. But the share of wages and household disposable income in China continues to lag GDP and investment growth, while the share of profits in GDP has increased.
The current economic imbalances actually foster other important policy problems in China. For example, while the government has attempted to boost energy efficiency, progress since 2002 has been slow because of the shift in manufacturing toward heavy industry and energy-intensive processing of ores and minerals, sometimes for foreign customers. A second serious problem is social inequality — underscored by a vast urban/rural income gap. Inequality would probably be even greater without the government's aggressive efforts to promote investment in the nation's interior provinces and autonomous regions, its extensive anti-poverty projects and its more recent efforts to channel additional subsidies to basic rural education and healthcare.
Third is environmental pollution that is made worse by the industrial imbalance in favor of heavy industry. Many of the problems are related to the insufficient enforcement of official laws and regulations, especially at local levels - but the push toward higher rates of industrial production do not help.
Why China's Economic Growth Model is Not Sustainable
The Conference Board study concludes that China's model for investment, output and net-export growth is not sustainable. Correcting forces in the form of a decline in corporate profits due to rising labor costs, an appreciating exchange rate, and rising land and utility costs will undoubtedly kick in at some point, but the cycle of high profits and high investment is still intensifying. China will probably continue to enjoy global cost advantages in many industries for years to come. Internal and external imbalances are likely to grow significantly before the current cycle ends.
The worsening of China's external and internal economic imbalances suggests that there's too much investment in manufacturing and too little in social infrastructure (health, education, social security, low-cost housing, environmental clean-up). Additional measures aimed at slowing investment growth in manufacturing are needed, the report emphasizes, along with renewed efforts to reduce the need for precautionary household savings and promote consumption. Faster exchange rate appreciation, especially if combined with greater flexibility, could support such measures by reducing net exports and by shifting the domestic incentive framework in favor of services, which remain relatively under-developed in China, but offer enormous potential for future employment growth.
Notes The Conference Board report: "If current dynamics are allowed to continue, the trade surplus, which may exceed 9 percent of GDP this year, is likely to balloon, which will intensify international trade frictions with unpredictable consequences."
