1818 Society Presentation

The China Conundrum

Yukon Huang

Senior Associate Carnegie Endowment

Former World Bank Director for China

1

Views on ChinaAsk five economists for their prognosis on China’s economy and you will get ten different answers.

At the two extremes, China is seen as:

• A irrepressible economic power that will soon overtake the US

or

• A house of cards, built on financial shenanigans, that will collapse on a mountain of wasteful investments

2

Perceptions shaped by political and social values

• China is not a democracy yet it is doing so well economically

• China’s institutions are weak yet implementation is so strong

• China’s prices and incentives are distorted yet its products are so competitive

• China’s income distribution is deteriorating rapidly yet 500 million have escaped poverty

• China’s creative energies are being repressed yet the arts are flourishing and patents issued soaring

3

The West is fixated on three contentious issues

• Is China’s unbalanced growth a source of strength or a vulnerability?

• Can China moderate its trade surplus to reduce global trade tensions?

• Will China challenge or work with the West in moving up the innovation/technology ladder?

Answers lie in understanding China’s growth process

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Deng Xiaoping’s intellectual godfathers

• W. Arthur Lewis, Nobel Laureate for his model on economic development with unlimited supplies of labor.

• Paul Krugman, Nobel Laureate for his model integrating economic geography and trade.

• The World Bank for its operational model in using preferential access to resources to spur investment and outward looking growth policies.

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China rolled out incentives along the coast and border areas to spur trade

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Increased share of investment in favor of the coastal region

0%

10%

20%

30%

40%

50%

60%

70%

coast inland

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Concentrated infrastructure investment along the coast but now moving inland

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Massive migration of labor to the coast

GDP growth – spurred by regional divergence but now converging

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%GDP Growth Rates - national and regional

China East Central West

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1111

Globalized industries are concentrated along the coast

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Other industries are more widespread

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High investment rates coupled with spatial agglomeration effects increased labor productivity

-8

-6

-4

-2

0

2

4

6

8

10

10 15 20 25 30 35 40

Labor Productivity Growth (%), 1980-2005

Investment to Output Ratio (%)

China

1414

But China has suffered from increasing inequalities

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2

2.5

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3.5

Inco

me

(GD

P) p

er c

apita

ratio

0

5

10

15

20

25

30

35

40

45

50

Gin

i

urban to rural income coastal to inland GDP per capita Gini (unadjusted)

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Processing trade drives China’s trade surplus

-40

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Processing trade

Normal trade

Trade balance (RMB bn)

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The Basic Income Equation

• Y = C + I + G + (X-M)

GDP is sum of consumption, investment, government expenditures and trade balance (exports minus imports)

• 1 = C + I + G + (X-M) Y Y Y Y

.35 .45 .17 .03 (Illustrative shares for China)

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Investment and Private Consumption(Percent of GDP)

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Composition of National Saving(Percent of GDP)

0

10

20

30

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50

60

Household savings Corporate savings Government savings Total

China’s view of the West has changed because of the U.S. financial crisis

Crisis shattered a 30-year-old presumption that the US model was the best and that China should emulate it.

Crisis elicited a strong stimulus response in China, which succeeded in insulating China.

Leadership concluded that having a strong government working within a managed market economy is superior to a U.S. style system .

Shifting Development Strategies

Deng’s Strategy – high input, high output

Hu-Wen Administration - develop a “harmonious” society with a stronger technological basis and environmentally more sustainable

- More emphasis on indigenous innovation, green growth technologies and human capital

- Greater urgency in dealing with social and economic disparities and unbalanced development process

- Recalibrate Deng Xiaoping’s advice that China should refrain from becoming active global policy player.

Global sensitivities are being raised by China’s:

Indigenous innovation policies that create friction with foreign partners and technology providers.

Continued trade penetration that may affect other developing countries and not just the US/EU

Potential for influencing the rules of the game regarding: climate change, the international financial architecture and security arrangements

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