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David Caploe PhD

David Caploe PhD

David is a writer for the popular economic news site Economywatch.

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Chinese Leaders Looking to Re-Engineer the Nation’s Economic Model

For years, Chinese leaders looked to the millions of poor workers from the country’s interior as the engine of a roaring export economy.

They would move to coastal provinces, toil in factories and churn out the world’s household goods. These days, the workers are crucial for China’s economy in another way:

They must start buying the very products they manufacture, spending their paychecks on lipstick and lingerie, plastic lawn chairs and plasma television sets.

Officials see them as the linchpin of China’s move away from a lopsided economic model that relies too heavily on export-led growth.

Some of China’s top leaders, including Prime Minister Wen Jiabao, have emphasized the need for that restructuring for years, especially since the global financial crisis pummeled the export industry.

But China’s move this week to make its currency, the renminbi, more flexible
and the authorities’ apparent tolerance of recent factory strikes that have led to significant wage increases both signal that Chinese leaders could be serious about re-engineering the nation’s economic model.

The currency shift brings immediate political benefits, since China will now presumably come under less pressure at the Group of 20 summit meeting this weekend.

But there are important domestic considerations as well, according to this crucial article in the New York Times.
The breaking of the renminbi’s de facto peg to the dollar means the currency is likely to appreciate in value, making Chinese exports somewhat less competitive in the global marketplace but strengthening the purchasing power of Chinese consumers.

Likewise, government policies to encourage wage increases for poor laborers -
there are an estimated 150 million migrant workers in cities - could also spur consumption, if the pay increases outpace inflation.

“The central government attitude toward raising wages is undoubtedly positive because it’s directly tied to boosting domestic consumption and restructuring the economy,” said Liu Cheng, a scholar of labor law at Shanghai Normal University.
“For a long time, wage growth has lagged behind economic growth, and that has forced China to continue to depend on exports.”

Chinese leaders have little choice but to overhaul the model.
For one thing, the pool of cheap labor is drying up.

China’s population of 15- to 24-year-olds has already peaked and will continue to shrink over the next decade, even if China were to change its one-child policy, according to projections by the United Nations.

Just as important, young workers these days are no longer willing to toil under the same conditions tolerated by laborers a decade ago.

Some Chinese leaders have been vocal in recent months about the need to raise household consumption.
Li Keqiang, the vice prime minister, who is viewed as a likely successor to Mr. Wen,
stressed that as a priority in public addresses this year.

On June 1, Seeking Truth, an official journal of the Communist Party, published an article by Mr. Li in which he wrote that “increasing citizens’ consumption is the key to expanding domestic demand.”

Raising wages is only one of several actions the government must take if it wants to stimulate household consumption.

The savings rate in China is much higher than that in Western nations, at least partly because people rely on savings to finance much of their education and health care needs.

In January 2009, China announced that it intended to spend $123 billion by 2011 to set up universal health care for its 1.3 billion people, but that plan is vastly underfinanced, scholars say. Keeping a lid on inflation is also crucial.

Low wages have helped hold down the inflation rate, despite years of extraordinary double-digit growth, and huge government investments in projects.
But in May, the consumer price index edged up to 3.1 percent from the previous May;
the government wants the average in all of 2010 to be no higher than 3 percent.
That was most likely one factor that pushed the People’s Bank of China to announce recently that the renminbi would become more flexible.

Analysts say that a currency revaluation by itself will not necessarily make China’s exports significantly less competitive or rein in China’s dependence on its export industry.

From mid-2005 to mid-2008, the renminbi appreciated 21 percent against the United States dollar, but China’s trade surplus with the United States continued to grow by an average of 21 percent during that period.

In recent months, China’s exports have shown a strong recovery, with nearly 50 percent growth year-on-year in May.
Chinese officials obviously felt confident enough in the recovery to go forward with the currency shift.

Besides exports, China’s economic growth has depended on state-led investment,
especially infrastructure building, and that too leads to big risks, some analysts say.
Stimulus spending and a surge in lending by state banks during the economic crisis helped China power through the slump.

But the lending spree has contributed to inflationary pressures and a soaring property market that the central government is trying to cool down.


Victor Shih, an associate professor at Northwestern University who studies the political economy of China, said a significant portion of $1.6 trillion that has been lent to companies run by local governments is likely to pile up as bad loans, posing a risk to state banks, and thus the entire economy.

“There will be a big cost,” he said. “China is trying to recapitalize its banks before a lot of these bad loans show up on the balance sheets.”

As with export dependence, some Chinese leaders are starting to see the danger and have moved to slow bank lending. But effective infrastructure projects are literally the road to more widespread wage increases across China, and thus greater domestic consumption.

An explosion of highways and rail lines in the central interior provinces means companies are now operating more factories in those areas, where costs are lower.
Some workers in the interior are seeing wages increase at the same rates as those on the coast, or at even higher rates.

Anne Stevenson-Yang, head of the Beijing office of Wedge MKI, an equity analysis firm, saidher research into at least 15 companies across China showed that some in the interior had raises of up to 30 percent this year, a higher rate than those on the coasts. But absolute wages are still lower in the interior, so more and more low-margin manufacturing companies are setting up shop there, especially as provincial governments on the coast slowly push out some assembly-line factories in favor of higher-end businesses.

In theory, many laborers will no longer have to flock to the coast, and consumption in the interior will rise, leading to more uniform economic growth across China.

“Probably the factory cities and dormitories of the ’80s will disappear,” Ms. Stevenson-Yang said,“and one day people will think, ‘Wow, what was that all about?’

David Caploe PhD
Chief Political Economist
Economy Watch

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