For more than 30 years, China’s Gross Domestic Product (GDP) has been growing at an average annual rate of 9-10 percent. In 2010, China’s economy became the second largest in the world after that of the United States (US). Further, the International Monetary Fund forecasts China’s economy will surpass the economy of the US in 2016. However, with a population of 1.34 billion people, China’s per capita GDP is only US$8,400 compared to US$48,100 for the US. Therefore, on a per capita basis, China’s economy is ranked 120th, compared to 12th for the US. China’s growth however has brought 400 million people out of poverty, but there remains 173 million people that live on less than one US dollar per day. China’s economic prowess has garnered a lot of attention from politicians, governments, investors, economists, and defense analysts throughout the world. Some argue that China’s rising economic power will eventually surpass that of the US. Others argue that demographic, social, and economic factors will ultimately undermine China’s rise. This paper will examine whether China is likely to become an economic peer competitor of the US within the next 20 years given its demographic, social and emerging economic challenges.
The analysis will be conducted within the framework of Michael Porter’s stages of economic development. In The Competitive Advantage of Nations, Michael Porter defines a model to describe the nature of the economic development of countries. According to Porter, there are four stages of economic development based on competitive advantages: factor-driven, investment-driven, innovation-driven, and wealth-driven. We utilize Porter’s model to examine China’s economic development during the period from 1978 to 2011 because it represents a major transformational time for China. For example, China implemented significant economic policy changes during this time leading to unprecedented growth, as well as its one-child policy. Specifically, we explore the potential for China to move from the investment-driven to the innovation-driven stage of development to become a possible economic peer competitor of the US. In doing so, we investigate the major prevailing issues that are challenging China’s ability to achieve this stature.
As a final step, our research uses various economic data from the US and Japan as a means for comparison and as a forecasting mechanism, with Japan being the bridging economy between China and the US. Both the US and Japan are in the innovation-driven stage of economic development. For the US, we examine the period 1919 to 1952. This is when the US entered and thrived in the innovation-driven stage of economic development. The year 1919 was chosen to begin the comparative assessment because it is generally accepted as the year the US surpassed the United Kingdom to become the world’s dominant economic power. For Japan, we examine the period 1945 to 1978. This period encompasses the rebuilding of Japan’s post-war industries. This period also includes Japan’s transition from the investment-driven stage to the innovation-driven stage of development. We also selectively draw upon more recent data outside these periods to show trends and outcomes resulting from events and policies taking place during the targeted analysis periods.
These comparisons will shed light on aspects of the Chinese economy that may lead to a successful evolution into the innovation-driven stage of development and peer competitiveness, and those that portend potential decline. This comparative assessment will lead to a prediction of whether China is likely to become a peer competitor of the US within the next 20 years.
Demographic Factors in China and their Economic Effects
China’s demographic problems include an aging population and an excess of males. As the number of elderly become a larger percentage of the population, the dependency ratio will increase, creating a more substantial burden on a decreasing working population. Additionally, the 30 million excess males that will be around by 2020 will likely continue to increase the social burden in China. Although the one-child policy is part of the cause of these problems, there is evidence that the one-child policy is not the sole reason for the developing problems.
From 1978 to 2011, the working age population increased each year, going from 57.9 percent to 72.6 percent. This increase in the working age population is what economists refer to as the demographic dividend. The term refers to the increase in economic growth that often accompanies an increase in the percentage of the working age population. China’s demographic dividend has added 1.8 percentage points per year to China’s GDP growth rate. The end of China’s demographic dividend will subtract 0.7 percentage points per year from China’s GDP growth rate by the 2030s.
From 1978 to 2011, the elderly population increased from 4.9 percent of the total population to 8.3 percent. Researchers expect this percentage to rise to between 20 and 21 percent by 2035. The working age population will peak between 985 million and 1.01 billion in approximately 2016. This corresponds to a percentage of the total population of approximately 73 percent. By 2035, it is anticipated that the working age population will decrease to somewhere between 60 and 66 percent. As a comparison, Japan’s working age population has declined from 69.9 percent to 63.3 percent from 1992 to 2011. During this time, Japan’s average annual GDP growth rate was only 0.75 percent. From 1979 to 1992 when Japan’s working age population was approximately 68.5 percent, Japan’s average annual GDP growth rate was 4.2 percent. Based on Japan’s experience, the peaking of China’s working age population, and the end of China’s demographic dividend, China’s economic growth should still remain relatively strong for approximately the next five years. Afterwards, China’s economic growth will experience a demographic drag unless the Chinese government intervenes soon.
The Chinese government intended to use the one-child policy to keep the fertility rate down to replacement levels; however, there is evidence that the fertility rate has fallen far below replacement levels. A replacement level fertility rate is generally defined as an average of 2.1 children per woman. China’s fertility rate over the last decade has likely been lower than 1.45. Further, this low fertility rate is likely not caused by the one-child policy. Therefore, removal of the one-child policy would need to be accompanied by a cultural change to result in an increase in the fertility rate. However, an increase in the fertility rate would take at least 15 years to affect the working age population. The combination of an increasing elderly population with a low birth rate will lead to a decreasing working population. As the working age population declines, the dependency ratio, the ratio of the number of dependents to the number of workers, will increase.
Another option the Chinese could use to stabilize the working age population is immigration. Immigration is one reason the working age population of the US has not significantly changed in the last 30 years. However, since 1980 China has lost approximately 940,000 people each year due to migration. Additionally, the government could raise the retirement age in order to increase the work force. This would likely only extend the time to find a more enduring solution. Therefore, there are few options available to the Chinese government to resolve the issue of an aging population.
In addition to the aging population, China faces problems from an excess number of males. There are currently 118 newborn boys for every 100 girls; this will lead to 30 million excess males by 2020. This excess number of males has created and will continue to create social problems. Though some researchers explain excess males could lead to increased military participation, this has not yet happened in China. Total armed forces personnel in China have decreased from 3.9 million in 1989 to 2.9 million in 2010. The excess number of males has, however, led to an increase of violent crimes. One-seventh of the 13.6 percent annual increase in criminal offenses that occurred between 1988 and 2004 can be attributed to the rising ratio of males to females. During this time period, the ratio of males to females, in the total population, increased from 1.066 to 1.077. In 2011, the ratio of males to females was 1.080. That ratio will continue to increase as long as the ratio of boys born to girls born is higher than the ratio of males to females. Therefore, the number of crimes will continue to go up for at least the next 15 years.
One potential economic effect resulting from the excess number of males will be from higher savings. Parents of an only son who live in a region with a highly skewed sex ratio tend to increase their savings in order to improve the chances the son will be able to attract a wife. From 1990 to 2007, the savings rate in China increased from 16 percent to 30 percent. More than half of the increase of the savings rate can be attributed to the increasing sex ratio. This phenomenon has the additional effect that it tends to increase housing sizes and prices in regions with high male to female ratios. This trend implies it may be difficult for the Chinese government to effect increased domestic consumption. China could face a problem similar to Japan if circumstances like the above inhibit the transition to a consumption-based economy. Japan faced a recession from 1985 to 1987 when the Japanese government attempted to transition from an export-driven economy to a consumption-driven economy because the domestic companies were not competitive enough.
Global aging could increase China’s economic difficulties. Global aging could cause a reduction of foreign capital inflow into China. By 2050, the worldwide population of children under the age of five will have fallen by approximately 49 million. At the same time, the number of elderly people worldwide will have increased by 1.2 billion. Elderly people tend to spend their money rather than invest it. Therefore, as a larger percentage of the population of a nation reaches retirement age, foreign capital flowing out of any given country will decrease, potentially reducing flows into China.
Economic Problems in China and their Economic Effects
Inefficiencies in China’s banking system and China’s state-owned enterprises, as well as other economic issues, are areas that reveal potential problems in China’s economy. China’s investment-driven growth has been focused on manufacturing for export and financed by high savings and foreign direct investment. Additionally, subsidies, currency management, and protection of domestic companies have provided a boost to China’s economy. However, these practices could have consequences that hinder China’s long-term economic growth.
From 1999 to 2008, the number of state-owned enterprises decreased from 37 percent of total enterprises to less than five percent; however, the size of assets owned by state-owned enterprises only decreased from 68 percent to 44 percent. The government has been reducing the number of state-owned enterprises by keeping and consolidating the bigger enterprises while closing the smaller enterprises. Further, the central government decided to regain control of the economy by naming specific industries where the central government must have complete control.
The central government directly controls 121 very large state-owned enterprises. There are also thousands of other state-owned enterprises that are not directly controlled by the central government. In 2010, there were 42 Chinese companies on the Fortune 500 list of the world’s biggest companies; the Chinese government owned 39 of the 42. These state-owned enterprises receive substantial subsidies in the way of low interest rates on loans, forgiveness of debt, access to credit, and protection from foreign competition. According to a report by the Unirule Institute of Economics, state-owned enterprises received 365.3 billion Yuan in subsidies between 1994 and 2006, and the average annual interest rate for financing a state-owned enterprise was 1.6 percent compared to 5.4 percent for private companies. The report also said the average return on equity of state-owned enterprises was 8.2 percent compared to 12.9 percent for larger enterprises that are not state-owned. Finally, the report stated that after accounting for the costs of the subsidies, the real return on equity for these state-owned enterprises between 2001 and 2009 was negative 1.47 percent. In addition to the financial subsidies, state-owned enterprises also benefit since strategic industries are restricted to Chinese companies; foreign companies are not permitted to operate in these industries. Analysis suggests these state-owned enterprises would not survive if not for government support.
The central government controls subsidies to the state-owned enterprises through control of the state-owned banks. Similar to the state-owned enterprises, state-owned banks are somewhat protected from foreign competition. The Office of the US Trade Representative considers the capital requirements for foreign banks desiring to operate in China as a “barrier to entry.” Additionally, there are “overly restrictive” requirements for foreign banks to offer financial services in renminbi, and it is “too slow and cumbersome” for a foreign bank to obtain approval to open a new bank or branch.
The central government uses control of these state-owned banks to subsidize state-owned enterprises. The central government requires the state-owned banks to give below market interest rate loans to state-owned enterprises and sometimes forgive these loans. Up until 1999, China’s banking system was nearly insolvent due to a large number of nonperforming loans. Local governments and state-owned enterprises would default on their loans, making the assumption the central government would continue to provide capital to prevent banks from going bankrupt. In 1999 and 2000, the State Council attempted to resolve this issue through the use of newly created asset management companies. However, as of 2006, the asset management companies only recovered 24.2 percent of the assets and 20.8 percent of the cash. In order to raise revenue for these asset management companies, the Ministry of Finance permitted Chinese banks to become partial owners. As a result, though 1.4 trillion Yuan in nonperforming loans were originally removed from the balance sheets of four of China’s major banks, the nonperforming loans effectively returned as differently named assets. This practice of subsidizing inefficient companies through below market interest rate loans is not sustainable in the long-term.
The Chinese government’s treatment of China’s state-owned enterprises is similar in some ways to the Japanese government’s treatment of Japan’s domestic sector companies. According to Eisuke Sakakibara, a former vice minister of finance for international affairs for Japan’s Ministry of Finance, Japan’s domestic industries, which included textiles, food processing, construction, and agriculture, were tightly regulated and received a lot of government subsidies. As a result, these companies were not competitive. This lack of competitiveness on the part of the domestic companies has been a problem for Japanese economy.
The government typically has a substantial role in the investment-driven stage of economic growth. Porter explains that governments are “important in such areas as channeling scarce capital into particular industries . . . providing temporary protection to encourage the entry of domestic rivals and the construction of efficient scale facilities . . . and encouraging exports.” The Chinese central government has protected the state-owned enterprises through subsidies and restricting competition. However, Porter explains “protection must be temporary . . . in order to spur improvement and innovation.” Porter further explains that subsidies rarely aid a company or a nation gain “true competitive advantage.” Instead, subsidies often inhibit innovation. Additionally, there are only three conditions under which protection of new industries may work. The first condition occurs when the industry already has an “effective domestic rivalry.” The second condition occurs if the nation has the potential to develop a strong national “diamond”. The third condition is that the protection is temporary. Protection of established industries for the sake of helping the industry regain competitive advantage seldom works. Based on this, there is little justification for the Chinese government’s continued protection of certain industries.
Another potential issue with China’s banking system is from loans to local governments that resulted from China’s stimulus after the global financial crisis in 2008. China enacted a four trillion Yuan (US$629 billion) stimulus, of which local governments were responsible for 70 percent. In order to raise revenue to fund stimulus infrastructure projects, local governments created “local investment companies.” According to Bloomberg News, 231 of these investment companies had accumulated 3.96 trillion Yuan (US$622 billion) in debt as of December 2011 to fund infrastructure projects as part of the stimulus. The National Audit Office reported in June 2011 that 6,576 of these investment companies had accumulated 4.97 trillion Yuan in debt. A Hong Kong economist estimates local governments will need an additional seven trillion Yuan in order to complete many of the projects. One unintended side effect of the stimulus was inflated real estate prices. Some of the stimulus funding went to real estate investments, which raised property values in many cities throughout China. A drop in property values could be bad for the investment companies, the local governments, and the banks. Some property values have already begun to decline. From April to May 2012, home values in China fell in 54 of the 70 cities measured by the government.
Local government debt, as of June 2011, had risen to somewhere between 10.7 trillion Yuan (US$1.7 trillion) and 14.2 trillion Yuan (US$2.2 trillion). Several financial analysts estimate the ratio of nonperforming loans to total loans in China will rise as a result of this local government debt. Fitch ratings estimates the ratio will rise to somewhere between five percent and 15 percent. China Orient Asset Management Company estimates the nonperforming loan ratio could be as high as 15 percent by 2013. A Credit Suisse report estimates the nonperforming loan ratio will rise from eight percent to 12 percent. Japan’s banking crisis in the 1990s, which was partially due to a real estate bubble, resulted in a peak non-performing loan ratio of approximately 11 percent and caused losses that approached 20 percent of GDP. China seems to be on the verge of a banking crisis that could lead to a significant recession.
China’s economic structure is another potential problem area. GDP consists of the sum of consumption, investment, government spending, and net exports. In 1978, government consumption made up 13.2 percent of GDP; household consumption made up 49.5 percent of GDP; exports made up 6.6 percent of GDP; and imports made up 7.1 percent of GDP. In 2011, government consumption made up 12.7 percent of GDP; household consumption made up 37.7 percent of GDP; exports made up 29.3 percent; and imports made up 26.5 percent of GDP. Household consumption decreased as a percentage of GDP, while exports increased. Going from above 60 percent in 1977 to approximately 50 percent of GDP from 1978 to 1989. Household consumption continued dropping as a percentage of GDP in 1990. Household consumption has made up between 30 percent and 40 percent of GDP since 2005. In current US dollars however, household consumption has increased from US$73 billion in 1978 to US$2.8 trillion in 2011, an average annual increase of 8.9 percent. Whie exports have increased at an average annual rate of 12.7 percent. However, Porter states it is vital in the investment-driven stage for the nation to prefer growth to current consumption.
Foreign direct investment (FDI) inflows into China were US$430 million in 1982, making up only 0.2 percent of GDP. In 1993, FDI had increased to US$27.5 billion, reaching a peak of 6.24 percent of GDP. FDI inflows continued to increase reaching US$185 billion in 2010; however, FDI decreased as a percentage of GDP dropping to 3.12 percent of GDP. According to Porter, FDI can help a nation upgrade its economy because the foreign investment will “raise national productivity by stimulating improvements by domestic firms and supplanting the less efficient rivals.” However, large amounts of FDI can indicate the nation’s firms lack the ability to defend their home market against foreign competitors.
China’s currency policy is another area that could potentially affect China’s economic growth. Prior to 1994, China used a dual exchange rate system. The government used the official fixed exchange rate, while importers and exporters used another market-based exchange rate. This method severely restricted imports. Between 1994 and 2005, the Chinese government maintained a policy of keeping the Yuan at a constant exchange rate of approximately 8.28 Yuan relative to the US dollar. Between 2005 and 2008, the Chinese government allowed the Yuan to float with respect to the US dollar; however, the government controlled the rate of change of the Yuan, allowing the Yuan to appreciate “steadily, but very slowly.” From 2005 to 2008, the Yuan went from 8.28 to 6.83 Yuan per US dollar. Between 2008 and 2010, the Chinese government maintained the Yuan relatively constant due to a decline in global demand for Chinese products. The Chinese government allowed the Yuan to continue appreciating in June 2010. From the middle of 2010 to November 2011, the Yuan appreciated from 6.83 to 6.35 Yuan per US dollar.
Though many nations intervene in currency markets to improve the nation’s ability to compete, currency market intervention is seldom of long-term benefit to the nation’s competitive advantage. Competitive advantage based on cost is a basic factor. Industries need more advanced factors to gain competitive advantage in industries with potential for high productivity. In these industries, competitive advantage is based on innovation. Affecting the value of the currency relieves the need for industries to innovate. When the US dollar was revalued compared to other major currencies in 1985, which resulted in a higher Yen to US dollar ratio, the US auto industry gained in the short-term but lost in the long-term. The US auto industry raised prices to collect profits while the Japanese auto industry, faced with a cost disadvantage, worked hard to improve productivity and increase their ability to compete. Currency devaluation can benefit a nation in the factor-driven and early investment-driven stages; however, currency intervention will ultimately inhibit economic upgrading. Therefore, China should remove control of the currency soon in order to encourage innovation through competition.
Social Problems in China and their Economic Effects
Social factors could also affect China’s economic development. Corruption throughout business and the government could have long-term deleterious effects if China does not make significant efforts to reduce it. Though it is difficult to determine the exact magnitude of corruption, it appears that corruption has been increasing over the last three decades. From 1997 to 2002, there were approximately 6,000 local officials prosecuted for corruption each year. China’s National Audit Agency determined that between 1996 and 2005, there were 1.29 trillion Yuan (US$170 billion) worth of misappropriated and misspent public funds. In 2005 alone, corruption cost the Chinese government approximately US$35 billion due to misuse and embezzlement. A similar report by China’s National Audit Office showed Chinese government officials had misused or embezzled approximately US$35 billion worth of government funds in the first 11 months of 2009. In a 2007 study, the Carnegie Endowment for International Peace estimated that corruption cost China at least three percent of GDP per year. By that estimate, corruption would cost China approximately US$200 billion today. However, that estimate only considers the direct costs of corruption.
The indirect costs of corruption are potentially worse than the direct costs. Corruption causes an “increase in socioeconomic inequality and the public’s perception of social injustice.” Indirect costs include “efficiency losses, waste, and damage to the environment, public health, education, the credibility of public institutions, and the morale of the civil service.” Comparison with other East Asian nations that have undergone rapid economic growth reveals potential problems for China. South Korea, Thailand, and Indonesia suffered financial collapses caused partially by corruption during the Asian financial crisis of 1997. Additionally, corporate and political systemic corruption resulted in the stagnation of Japan’s economy for more than a decade. According to Transparency International, which measures the perception of corruption in a country using survey data, China has a Corruption Perception Index score of 3.6 while the US has a score of 7.1. Japan’s score is 8.0. According to the index, measured on a scale of 1 to 10, corruption is perceived to be higher in countries with lower scores. Corruption has undermined the economic growth of other countries; therefore, corruption could very well inhibit China’s economic growth.
Some of China’s social problems have come about because of the Chinese government’s focus on economic growth. Since the government has centered efforts on growing the economy to maintain employment, the Chinese government has paid little attention to social goods, such as health care, education, and environmental protection. In 1980 and 1985, China’s public spending on education was 2.5 percent of GDP. In 1993, an outline of China’s national plan for education reform and development stated the Chinese government should increase national spending on education to four percent of GDP by the year 2000. National spending on education in China was 1.86 percent and 1.91 percent in 1998 and 1999, respectively. Figures released in 2010 showed that China’s national spending on education had increased to 3.66 percent. Also in 2010, the central government released a 10-year education reform and development plan that promised to raise national spending on education to four percent of GDP by 2012. The average spending on education for developing countries is 4.1 percent of GDP, while the average for developed countries is 5.1 percent of GDP. Therefore, reaching four percent will leave China still below the average for developing countries. However, the Chinese government, according to the 2010 10-year education reform and development plan, intends to continue increasing the proportion it spends on education.
Environmental problems, on the other hand, cost the Chinese central government an estimated US$200 billion, or approximately 10 percent of GDP, in 2005. Central government expenditures to control pollution in 2005 amounted to approximately 1.3 percent of GDP. China’s Twelfth Five Year Plan provides for 3.1 trillion Yuan (US$454 billion) to be spent on environmental protection. This amounts to approximately 1.5 percent of estimated GDP for the years 2011 to 2015. This amount is less than the two to four percent of GDP each year some economists estimate the Chinese government needs to spend to clean up the industrial waste that has accumulated for the last 30 years. Vice Chairwoman of China’s National People’s Congress, Chen Zhili, stated environmental investment is likely to rise 14.5 percent per year reaching approximately 2.3 trillion Yuan by 2020.
In addition to the financial costs from environmental problems due to lost productivity, health problems, crop degradation, and pollution-related accidents, China’s environmental problems also have a significant social effect. From 2002 to 2005, pollution-related protests increased 30 percent per year to 51,000. Similarly, Chinese citizens use petitions and letters to complain about environmental abuse and seek problem resolution. The number of letters received by China’s environmental protection agency increased from 100,000 in 1997 to more than 600,000 in 2006, and there has been an average of 80,000 environmental related petitions each year during the same time.
Though there is significant water pollution in China, the central government has been putting forth some effort to clean up the pollution. According to China’s “Report on the State of the Environment in China” for 2002, 70.9 percent of China’s river waters were not fit for drinking, and 40.9 percent of China’s river waters were not even fit to be used for irrigation. By 2010, 40.1 percent of China’s rivers were not fit for drinking, with 16.4 percent not fit to be used for irrigation. Though China’s rivers have shown some improvement, China’s lakes have shown very little improvement. In 2003, 75 percent of China’s lakes were not fit for drinking, with 35.7 percent not fit to be used for irrigation. In 2009, 76.9 percent of China’s lakes were not fit for drinking, with 34.6 percent not fit to be used for irrigation.
Air pollution is also a problem for many of China’s cities; however, the Chinese government has made significant progress cleaning the air in the last decade. In 2002, approximately two out of every three cities failed to meet China’s passing standard for air quality. In 2010, only one in five cities failed to meet this standard. However, China’s standard for passing air quality is below the standard recommended by the World Health Organization. Though China seems to be getting a handle on its pollution problems, the government still needs to continue significant efforts to clean the air and water, both for health reasons and to prevent increasing protests.
As a comparison, the US began significant federal efforts to clean up and control pollution in 1970 with the creation of the Environmental Protection Agency. Prior to this, pollution control was considered the domain of local and state governments. In 1972, pollution control cost approximately 1.5 percent of GDP. By 1990, the cost of pollution control had risen to approximately two percent of GDP. There is disagreement on the ultimate economic effect of pollution control. Some economists contend that pollution control has cost the US as much as 2.5 percent in economic growth. Other economists argue pollution control has not hurt economic growth because of job creation and innovation. Simiarly, Japan established the first central government standards for pollution control in 1967 with the Basic Law for Environmental Pollution Control. In all three cases, the governments began enacting pollution control measures after pollution had become a significant problem.
Income inequality in China is getting worse; however, inequality typically does get worse before it improves in a developing economy. China’s Gini coefficient, according to the World Bank, went from .2911 in 1981 to 0.4248 in 2005. The US Central Intelligence Agency’s World Factbook records China’s Gini coefficient as 0.415 in 2007 and 0.48 in 2009. However, the International Institute for Urban Development in Beijing calculated China’s Gini coefficient to be 0.438 in 2010. Analysts state a Gini coefficient above 0.4 usually indicates there is a higher likelihood of social disturbances.
Income inequality exists in Japan and the US as well. By way of comparison, Japan had a Gini coefficient of 0.249 in 1993 and 0.376 in 2008. The Gini coefficient for the US fell for most of the period from 1919 to 1953 reaching approximately 0.36 in 1953. However, the Gini coefficient for the US has been rising since about 1970, reaching 0.408 in 1997 and 0.45 in 2007. The rise of income inequality in China is following a normal trend for economic development. Income inequality typically rises with economic development before it begins to fall. Then, after a period of stability, where inequality is at a low level, it may rise again, as in the case of the US.
In addition to income inequality, the gap between rural and urban living has been increasing for the last 33 years. From 1978 to 2010, the percentage of population living in urban areas has increased from 18 percent to 45 percent and will possibly grow to 60 percent by 2020. The income gap between urban and rural residents increased for most of the last three decades. A report by the Chinese Academy of Social Sciences stated that, though the ratio of urban to rural income is just over three to one, urban dwellers effectively have 5.2 times more income than rural dwellers due to certain work related expenses that rural dwellers have. This figure is 68 percent higher than it was in 1985. Data from the National Bureau of Statistics shows however, that the ratio of urban income to rural income reached its peak in 2009 at 3.33 to 1.0. The ratio fell to 3.23 in 2010 and 3.13 in 2011. This indicates the income gap may be decreasing.
Besides the income gap, the rural population has poorer schools and less access to medical care. A 2010 Ministry of Education report on the implementation of education funding in China showed that budgetary spending per student in Beijing is 10 times higher than in Guizhou province. Additionally, one survey showed 74 percent of urban teachers in one province held bachelor’s degrees compared to 42 percent of rural teachers.
As a result of China’s social problems, protests, petitions, and riots have increased over the past three decades. Protests have grown from 8,700 in 1993 to 180,000 in 2010. There are many various causes for these protests; however, the majority of the protests are caused by a few major reasons. Environmental problems have caused an increasing number of protests in the past three decades. Recently, the number of protests caused by environmental reasons has risen at an average annual rate of approximately 29 percent. However, the most common cause, resulting in approximately 60 percent of the protests in China, is illegal land seizures. Illegal land seizures are a form of corruption in which local officials steal land from farmers and sell it to commercial developers. Other causes of protests include rising unemployment, income inequality between the rich and the poor, and unfulfilled government promises. Protests, riots, and petitions are not uncommon in a developing or developed society. The US saw large numbers of incidents during the Great Depression of the 1930s. The difference between the protests of the US and those of China is that the protests in the US occurred primarily during a time of economic hardship. China has seen the number of protests increase with their economic growth. Protests have increased in number because economic growth has brought increasing inequality, corruption, and environmental pollution. Unless the government handles these growing problems, the number of protests will continue to grow.
Growth of GDP provides an insight into the size and growth of the economies. Growth of per capita GDP shows the effect the overall growth is having on the population. The ratio of debt to GDP shows how much debt the countries used to grow the economy. The structure of the economy and how that structure changes as the economy develops will provide insight into why differences have occurred or might occur between China’s development and that of the US and Japan. Additionally, government spending on research and development provides insight into the economy’s potential future because, as Porter explains, “an upgrading economy demands a steadily rising level of technology.” The nation’s investment in education can, likewise, provide insight into the ability of the economy to compete. According to Porter, “improving the general education system is an essential priority of government, and a matter of economic and not just social policy.”
We also examined how the quality of life for citizens changes as a country develops. To do this, we looked at several factors. To gain an understanding of how income inequality changes over the course of a country’s development, we looked at the Gini coefficient of China, the US, and Japan over time.
Our analysis also looked at comparative population demographic data. By comparing China’s population demographics to those of Japan and the US, our study assessed the extent to which China’s demographic issues might negatively affect China’s economic growth.
China and Japan both had very rapid growth during the periods examined. Japan’s GDP increased at a real average annual rate of 9.38 percent from 1946 to 1960 and 8.26 percent from 1960 to 1975. China’s real average annual growth rate from 1978 to 2011 was 9.97 percent. The US, as expected for a developed country with the world’s largest economy, from 1919 to 1952, had a real average annual growth rate of 2.89 percent. However, the period 1919 to 1952 includes the anomalous period of the Great Depression. Looking at the periods surrounding the Great Depression, the US had a real average annual growth rate of 2.99 percent from 1919 to 1930, and the real average annual growth rate from 1939 to 1960 was 4.39 percent. Similarly, per capita GDP for China increased at a rate of 8.84 percent, going from US$165 to US$2,635. Japan’s rate of increase of per capita GDP was similar, though slightly lower; however, Japan’s per capita GDP was significantly higher than China’s throughout Japan’s development, reaching US$21,575 in 1978. The per capita GDP of the US started at US$6,640 in 1919, reaching US$14,333 in 1952. Summarily, China’s rate of growth of GDP has been very high, and China’s GDP is large, second in size only to the US. However, China’s per capita GDP is still very low relative to China’s large population. China’s per capita GDP in 2011 is less than half of what the per capita GDP of the US was in 1919. The majority of the countries on the list of developed countries established in the Central Intelligence Agency’s World Factbook have a per capita GDP above US$15,000. By that measure, China still has a lot more growth to go before becoming a developed country. China would need to grow at an average annual growth rate of nine percent for the next 20 years in order for its per capita GDP to reach US$15,000. However, if China’s growth rate is slightly lower, at seven percent, then China would need 26 years to reach a per capita GDP of US$15,000. Therefore, based on the one statistic of per capita GDP, China is not likely to become a developed country within the next 20 years.
Research and development spending by the government can benefit a nation’s economy because it encourages innovation and factor creation that can help the nation compete. China’s research and development expenditure has increased from 0.57 percent of GDP in 1996 to 1.47 percent in 2008. Japan’s spending on research and development has increased from 1.9 percent of GDP in 1971 to 2.8 percent in 1987. Research and development spending in the US made up less than 0.5 percent of GDP in 1940. After World War II, research and development spending increased rapidly, peaking at approximately three percent in 1964. Between 1996 and 2008, research and development spending in the US has typically been between 2.5 percent of GDP and 2.8 percent. The data suggests China will need to approximately double its investment in research and development in order to effectively compete with other nations. Based on Japan’s experience, it is unlikely China will reach this level of investment in research and development prior to 2032.
Similar to research and development, investment in education can also help a country upgrade its economy through factor creation. China’s spending on education has been significantly below the average of 4.1 percent of GDP for developing countries. In the 1980s, China’s public spending on education was 2.5 percent of GDP. National spending on education in China was 1.9 percent in the late 1990s. In 2010, China’s national spending on education had increased to 3.66 percent. Japan’s spending on education was 3.9 percent of GDP in 1971 and 5.2 percent in 1975. However, Japan’s spending on education dropped to an average of 3.6 percent of GDP between 1998 and 2010. Education spending in the US fluctuated between 1.5 percent of GDP in 1919 and four percent of GDP in the 1960s. Spending on education in the US has been as high as 7.4 percent of GDP in 1971, though it averaged about 5.5 percent of GDP between 2001 and 2009. The data suggests China does need to continue to increase its spending on education. Based on the significance that education has in creating factors in Porter’s model, China should have been investing more heavily in education since 1978. However, despite China’s relatively low investment in education, literacy has improved among youth, those aged 15 to 24, from 89 percent in 1982 to 99 percent in 2009. If China continues to invest four percent or more of GDP in education, then the education system will likely be strong by 2032.
Examining economic sectors, China had more value, as a percentage of GDP, coming from agriculture and less from services in 2011 than Japan did in 1978. The value added as a percentage of GDP for agriculture for China went from 28 percent in 1978 to nine percent in 2010. The value added as a percentage of GDP for manufacturing went from 40 percent in 1978 to 31 percent in 2010. The value added as a percentage of GDP for industry went from 48 percent to 44 percent. The value added as a percentage of GDP for services went from 24 percent to 46 percent. The increase in services as a percentage of GDP that occurred during China’s growth was also seen in the growth of Japan and the US. For Japan, value added as a percentage of GDP for services reached 57 percent by 1978. For the US, value added as a percentage of GDP for services reached 61 percent by 1970. The data suggests China’s economic structure is certainly headed in the right direction; however, China’s economic structure in 2011 is not as advanced as Japan’s was in 1978. China’s value added as a percentage of GDP for services will likely stay below 60 percent until after 2032.
Additionally, a significant portion of China’s economic growth was due to exports. Starting below five percent of GDP in 1977, exports grew to 10 percent of GDP by 1980, surpassing 20 percent of GDP in 1994. Exports peaked as a percentage of GDP in 2006 at 39 percent. In 2011, exports made up 29 percent of GDP. Exports were also a significant contributor to the economic growth in Japan. From 1960 to 1969, when Japan’s GDP grew at an average annual rate of 10.4 percent, Japan’s exports grew at an average annual rate of 15.9 percent. Rapid economic growth based on growth in exports was also used by many East Asian nations in the second half of the 20th century. In addition to Japan, the Republic of Korea, Hong Kong, Singapore, Taiwan, Indonesia, Malaysia, and Thailand all promoted export growth and achieved rapid economic growth.
In both Japan and China, the low value of the country’s currency relative to the US dollar aided the large export market. When the US dollar was reevaluated with respect to other major currencies at the Plaza Accord in 1985, Japan’s exports fell over the next couple years, due in part to the appreciation of the Japanese Yen. From 1985 to 1986, the Japanese Yen appreciated from 239 Yen per US dollar in 1985 to 169 Yen per US dollar in 1986. Over the same time period, exports fell 5.12 percent, going from US$277 billion, or 14.1 percent of GDP, to US$263 billion, or 11.1 percent of GDP. Though exports began increasing in real terms in 1988, exports remained below 11 percent of GDP until 2002. From 1987 to 2008, the Japanese Yen has fluctuated between 100 Yen to the US dollar and 150 Yen to the US dollar. The ability of Japanese firms to recover from the currency shock was, according to Porter, reflective of the existence in the industry of “strong advantages throughout the ‘diamond’.” China would need a similarly strong “diamond” to recover from a currency shock. The slow appreciation of the Chinese Yuan that the Chinese government has been enacting since 2005 is similar to the slow appreciation of the Japanese Yen from 1971 to 1985. A slow steady increase of the currency, “reflecting normal market forces, is most likely to encourage upgrading.” Though China’s control of the exchange rate does not reflect normal market forces, the controlled appreciation of the Yuan with respect to other major currencies is probably China’s best plan since China’s national “diamond” is not as strong as Japan’s was in 1985.
The use of debt, as measured by looking at the ratio of debt to GDP, was similar for China and Japan during the time periods examined. China’s gross government debt to GDP ratio went from 0.97 percent in 1984 to 33.5 percent in 2010 according to data from the International Monetary Fund. International Monetary Fund data shows that China’s gross government debt to GDP ratio lowered to 25.8 percent in 2011. However, Yang Kaisheng, president of the Industrial and Commercial Bank of China, said that adding in local government debt, the debt to GDP ratio is approximately 43 percent. Further, Gordon Chang suggests that, when China’s hidden liabilities are added in, China’s debt to GDP ratio rises to somewhere between 90 percent and 160 percent. During the majority of Japan’s post-war rapid economic growth, Japan’s debt to GDP ratio remained below 20 percent. From 1954 to 1976, Japan’s gross government debt to GDP ratio was below 20 percent. After 1976, Japan’s gross government debt to GDP ratio increased, reaching 50 percent in the 1980s, surpassing 80 percent in the 1990s, and was 230 percent as of 2011. The US, on the other hand, had a higher ratio of debt to GDP, especially during the war period, from 1943 to 1952. From 1919 to 1931, the debt to GDP ratio of the US remained between 32 percent and 45 percent. Between 1932 and 1942, the debt to GDP ratio for the US remained between 60 percent and 74 percent. From 1943 to 1952, the debt to GDP ratio of the US was above 80 percent, peaking at 129 percent in 1946. After 1953, the debt to GDP ratio of the US continued dropping reaching 68 percent in 1960. This data suggests nations do not need a significant amount of debt for economic growth.
However, instead of debt, China did use a significant amount of FDI. FDI in China was higher as a percentage of GDP during China’s economic growth than it was in Japan or the US. FDI net inflows into China increased from 0.2 percent of GDP, or US$430 million, in 1982 to 6.2 percent of GDP, or US$27.5 billion in 1993. In 2010, FDI net inflows into China were 3.1 percent of GDP, or US$185 billion. By comparison, FDI net inflows into Japan were US$20 million, or 0.003 percent of GDP, in 1977. Similarly, FDI net inflows into the US have historically been small as a percentage of GDP. Between 1970 and 1995, FDI net inflows into the US were above 1.0 percent of GDP in only three years: 1987, 1988, and 1989. Though the large amount of FDI has helped China’s economic growth, it indicates Chinese firms lack competitive advantage. Chinese companies will need to continue enhancing productivity to compete with foreign firms.
In addition to FDI, China also relied on a high domestic savings rate to sustain economic growth. Japan’s domestic savings rate was also high. From 1982 to 2010, China’s gross domestic savings rate has increased from 36 percent of GDP to 53 percent of GDP. Japan’s domestic savings rate was 16 percent in 1946, increased through the 1950s and 1960s to 40 percent in 1970 and then dropped to 32 percent by 1978. By contrast, the US had a significantly lower savings rate than either Japan or China. With the exception of the early 1930s and the early 1940s, when the savings rate dropped significantly, the savings rate of the US between 1920 and 1960 primarily remained between 10 percent and 20 percent. High savings rates were another commonality among the East Asian nations during their rapid economic growth. However, according to a 1993 World Bank study, for the cases of Japan, Indonesia, Korea, Taiwan, and Thailand, high savings was an effect of rapid growth rather than a cause of it.
Economic indicators suggest that FDI, high savings, and exports have been some important elements in stimulating China’s growth. High savings and exports were also important for Japan’s economic growth. Based on Japan’s experience, exports worked well to accelerate economic growth until currency revaluation resulted in a drop in international demand due to increased prices. Appreciation of the Yen was meant to aid the transition to a consumption-based economy. Instead, as exports dropped, the “tightly regulated” and “uncompetitive” domestic companies were unable maintain the Japanese economy with consumption. Therefore, as the economy slipped into recession, the Bank of Japan lowered the official discount rate in an effort to stimulate the faltering economy. This quantitative easing created an asset bubble that eventually crashed in 1990. Revaluation of the Chinese Yuan could similarly affect China’s export market and the Chinese economy. However, the Chinese central government will not likely release control of the exchange rate based on the lessons they learned from Japan’s experience. Therefore, China will probably not face a currency shock the way Japan did in 1985.
Demographic data reveals that China’s age demographics are similar to an aging developed country. From 1920 to 1950, the US had a shift in elderly population that was similar to the shift seen in China from 1978 to 2010; however, there was very little change in the percentage of working age people in the US. While the total population of the US increased from 105.7 million people to 150.7 million people, the elderly population increased from 4.7 percent to 8.1 percent, and the working age population went from 63.4 percent to 65 percent. China’s elderly population, similarly, went from 4.9 percent to 8.2 percent; however, the working age population went from 57.9 percent to 72.4 percent. This increase in the working age population is one factor that has helped China’s economic growth. China’s percentage of children, meanwhile, has decreased from 37 percent in 1978 to 19 percent in 2010. By comparison, Japan’s children population had decreased to 24 percent by 1978, and currently stands at 13 percent, with a 23 percent elderly population. The demographic situation of the US does not appear quite as dim as China’s. Although the elderly population in the US, at 13 percent, is higher than China’s, the percentage of children in the US is also higher, at 20 percent. Additionally, population growth in the US is higher than in China. This is due, in part, to immigration. The US has had approximately five million immigrants annually since 1980. China, by contrast, has lost approximately 940,000 emigrants annually since 1980.
China’s excess males have created a social burden through increased violence. Regardless, the social problems caused by China’s excess males are unlikely, by themselves, to significantly hinder economic growth. The issue of income inequality and the gap between rural and urban living will not play a significant role in affecting the growth of China’s economy over the next 20 years. It is normal to see inequality grow during development. As long as the standard of living is increasing throughout the country, China will be able to maintain its growth without too much concern for the growing gap. Excess males and income inequality add to the risk that there will be unified mass protests; however, these issues alone are not likely to spark a significant protest by themselves.
China’s environmental problems, however, are likely to cause problems for China’s future growth. The cost of environmental damage and pollution control is significant. The social cost from protests is also substantial. Increased spending on environmental damage and pollution control diverts money away from infrastructure projects and other investments. Tighter regulations on companies to control pollution could inhibit their ability to expand. Since the central government has not regulated companies to control pollution, most of China’s enterprises would need to expend substantial amounts of money to modify their production processes to meet pollution control requirements. Additionally, some infrastructure projects would need to be modified or not accomplished due to the environmental damage they would cause. Though this might slow infrastructure development and economic growth, it is also likely the innovation required to develop environmentally friendly solutions would be of long-term benefit to China.
Failing to make efforts to control pollution, however, will result in an increasing number of protests. As pollution and environmental damage grows worse, protests will become larger and involve more people. Eventually, the protest could become a movement that forces the Chinese government to take action. The Chinese Communist Party does not want a unified movement because Chinese history is replete with examples of peasant rebellions overthrowing governments. Therefore, the Chinese central government will likely put forth enough effort to control pollution so that environmental related protests do not increase. As a result, China will likely be able to manage the environmental issues and keep the economy growing.
Since the number of protests has been growing faster than the economy, the Chinese government needs to resolve the root causes of these disturbances before a unified mass incident results in irrevocable damage to China’s economy. Corruption, specifically illegal seizure of land by local government officials, is the number one cause of protests in China. If the Chinese government fails to resolve corruption issues, it is likely protests will increase until a unified movement results in a transformation of the Chinese political system. The Chinese Communist Party will not let this happen. Therefore, the central government will likely take actions to reduce corruption enough so that it is no longer the major issue. However, removing or reducing corruption from Chinese society is important for more reasons than just reducing the number of mass incidents each year. At three percent or more of GDP, the direct costs of corruption are significant. When combined with the indirect costs, however, corruption is a very formidable and costly problem. Whether the central government chooses to reduce corruption or ignore it, economic growth will suffer due to the direct and indirect costs.
On the other hand, China’s economic indicators present a relatively positive outlook for a nation in the investment-driven stage. However, China’s national “diamond” is not strong enough for China to enter the innovation-driven stage. In order to improve the national “diamond,” China needs to improve its ability to create advanced factors. China will need to increase its investment in education, and research and development. The school system in China has been improving with the enlarging education budget. If China continues to increase the amount spent, then the Chinese education system will be a strong boost to the economy in 20 years. However, it will likely take 20 years or more before China’s investment in research and development is comparable to other advanced nations.
Also, though China’s GDP is very large, it is still a very poor country. China will not reach developed country status within the next 20 years. China would need to maintain its average annual growth rate around nine percent in order to reach the per capita GDP level of a developed country by 2032. Given the various social, economic, and demographic factors, China will not be able to maintain this level of growth. The Chinese government will want to maintain its export-driven growth model for as long as possible in order to sustain rapid growth. Therefore, the central government will continue to control the rate of appreciation of the Yuan in order to suppress consumption and encourage exports.
Chinese companies are slowly being forced to become more productive. However, since China’s national “diamond” is not yet strong enough to support a rapid change in currency valuation, the currency appreciation will need to be slow. A rising Yuan will also slowly reduce savings and improve domestic consumption, as Chinese consumers will have more buying power. Reduced savings means less money available for investment. This combined with lowering exports will slow economic growth. Though consumption will be increasing, it will not be able to keep up with the drop in exports. However, exports may not significantly drop if Chinese companies are given sufficient time to become internationally competitive. This is the reason the Chinese government will control the appreciation of the Yuan for at least 10 to 15 years.
The Chinese government’s control of the Yuan and the protection of state-owned enterprises and banks are likely to be a hindrance to China’s long-term development. This protection may work well for an economy in the investment-driven stage of economic development; however, these firms may not thrive well enough to push themselves or the economy into the innovation-driven stage. Central government influence in some of China’s industries may affect the ability of these enterprises to survive as the economy grows. Inefficiencies that exist due to central government influence may ultimately harm these companies’ ability to survive when they are faced with global competition. Additionally, because of the numerous nonperforming loans and the potential insolvency of China’s state-owned banks, China’s banking system appears fragile. Further, the increase in overdue loans and the expected increase in nonperforming loans over the next few years will potentially make it more difficult for the central government to maintain the economic growth China has experienced over the last 30 years.
Specifically, with the real estate bubble in China, the strength of the economy will be tested as the number of nonperforming loans increases. The central government will again have to fortify the banks reinforcing the model where the government always pays the loans. Eventually, Chinese depositors will question the safety of their money and switch to one of the few foreign banks from which they can choose. The government will lose its foundation of cheap money and will no longer be able to fund economic growth. China will slip into a recession never having reached developed status. Though this scenario may be highly unlikely and a long way off, it displays the severe weaknesses in China’s banking system. Unless China’s banks and enterprises become more competitive, China will not reach the innovation-driven stage of development.
Finally, China’s aging population and the end of the demographic dividend are the most significant issues. Since removing the one-child policy would have little effect on the birth rate, the Chinese government has little hope of correcting its demographic issues in the short term. Immigration and delaying retirement are both possible options. However, China currently loses close to one million people each year to migration. Therefore, immigration is unlikely to work. Delaying retirement will only postpone the problem. The end of China’s demographic dividend is likely the biggest obstacle to China’s long-term economic health.
As the ratio of dependents to workers rises, health care costs will increase, pension costs will go up, savings rates will drop, and consumption will decrease. Additionally, global aging may cause a reduction in investment flowing into China. The loss of savings and foreign investment money will remove the ability to fund continued investment-driven growth. Additionally, there will not be enough consumption to transition to consumption-based growth. China will have no strong engine for economic growth. Therefore, China’s growth will slow significantly before it becomes a developed country. Without action, this slowed economic growth will begin within the next 20 years. Preventing this demographic nightmare from collapsing China’s economy will require immediate action that may not have an effect for 15 to 20 years.
China will not become a peer competitor with the US in the next 20 years, there are too many internal issues impeding its growth to such stature.
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118. Ibid., 13.
119. CIA, “United States,” The World Factbook 2012.
120. Nielsen and Alderson, 13.
121. World Bank Data, “China.”
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124. Bi Mingxin, ed., “Income Gap Between China’s Urban, Rural Residents Narrows in 2011,” Xinhua, 20 January 2012, http://news.xinhuanet.com/english/ china/2012-01/20/c_131371091.htm (accessed 10 October 2012).
125. Starr, 104.
126. Su Jie, ed., “Despite Efforts, Rural-urban Education Gap still Widening,” Ecns.cn, 15 March 2012, http://www.ecns.cn/2012/03-15/10302.shtml (accessed 10 October 2012).
128. Shirk, 56.
129. Tom Orlik, “Unrest Grows as Economy Booms,” Wall Street Journal, 26 September 2011, http://online.wsj.com/article/SB1000142405311190370360457 6587070600504108.html (accessed 11 October 2012).
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131. Pei, “Occupy Beijing?”
133. Irving Bernstein, The Lean Years: A History of the American Worker, 1920-1933, (Chicago, IL: Haymarket Books, 2010), 421-426.
134. Porter, 630.
135. Ibid., 628.
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137. Author’s calculations. World Bank Data, “China.”
138. Author’s calculations. National Bureau of Economic Research, “The American Business Cycle: Continuity and Change,” http://www.nber.org/data/abc/ (accessed 13 October 2012), appendix B.
139. Author’s calculations. World Bank Data, “China.”
140. World Bank Data, “Japan.”
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143. Porter, 631.
144. World Bank Data, “China.”
145. Porter, 398.
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151. World Bank Data, “Japan.”
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153. World Bank Data, “China.”
154. Porter, 627-630.
155. World Bank Data, “China.”
157. World Bank Data, “Japan.”
158. World Bank Data, “United States.”
159. World Bank Data, “China.”
160. Ito, 226.
161. World Bank Data, “Japan.”
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165. Porter, 642.
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173. World Bank Data, “China.”
174. World Bank Data, “United States.”
175. World Bank Data, “China.”
176. Historical savings rate was shared by Alan Taylor. Alan M. Taylor, “A Century of Current Account Dynamics,” Journal of International Money and Finance 21 (2002): 725-748.
177. Andrew Leigh, and Alberto Posso, “Top Incomes and National Savings,” Review of Income and Wealth 55 no. 1 (March 2009): 61.
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184. World Bank Data, “China.”
186. World Bank Data, “Japan.”
187. World Bank Data, “United States.”
188. World Bank Data, “China.”