China's Role in the 21st Century

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China's explosive growth over the past decade was driven by its booming export business. Built on cheap manufacturing and low-cost labor, China's economy accelerated consumption in the developing world.

In the six years after China joined the World Trade Organization, from 2002 to 2007, its exports increased each year by an average of 29 percent.

At the same time, its domestic market languished. Quite simply, the wages of China's factory workers were so low that they couldn't even afford the cheap products they made.

All of this worked as long as wages remained low and overseas demand remained high. But in recent years, wages in China have been rising, while demand in foreign markets has been falling:1

  • In 2001, Chinese factory workers earned a mere 72 cents per hour. But after years of increases averaging 15 to 20 percent, wages are projected to rise to $6.31 per hour by 2015, according to the Boston Consulting Group.  While still lower than the U.S. minimum wage, this is a 900 percent increase in just 14 years.
  • That has led to higher prices for Chinese-made products, while U.S. consumers have been curtailing their spending and paying down debt in the aftermath of the recession. These factors have caused demand for Chinese goods to drop, as evidenced by an 18 percent decline in China's exports in February 2014 compared to a year earlier.

Suddenly, China's growth engine isn't firing on all cylinders.

The solution for China, as we've made clear in previous issues, is to evolve from an export-driven economy to one based on consumption. That will entail converting the Chinese population of 1.35 billion people—which is more than four times the population of the U.S.—into the world's largest consumer class. It also implies a rise in consumer spending from today's 38 percent of GDP to a more normal 65 percent.

To do so, the ruling Communist Party of China will need to radically shift its focus toward a free-market economy. Until now, its policy has been to focus on creating jobs at literally any cost. The lending policies of China's banks stressed preventing unemployment by funding massive infrastructure projects as well as commercial and residential developments, and by keeping businesses going, even when they were inefficient.

As explained in our October 2013 issue, a huge dilemma has emerged: If the Chinese continue aggressive lending to failing businesses, they will trigger inflation...

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