The Rebalancing of China

China has rebalanced before. It did so when introducing radical reforms in 1978 in order to move towards a socialist market economy, and again after 1993 when control over policy, previously ceded to more conservative factions after Tiananmen, returned to the reformers.

Today, China’s elite and intellectuals have again embarked on an as-yet-inconclusive series of significant debates about whether and how to reform.

Consequently, the most important issue for China-watchers is not what its GDP might be in 2030. It is whether or not the social, political and economic thinking that gained traction from the 1990s onwards can bend and adapt in the 2010s in a constructive way to address China’s new challenges at home and in its international relations.

It bears repeating that while exports and capital investment have generated the lion’s share of economic growth, Chinese consumers have been anything but frugal. In 2009, Chinese consumption rose faster than GDP for the first time in a decade, thanks to the government’s attempts to offset the impact of the crisis.

It created a lot of construction jobs, raised social transfer payments and lowered taxes to stimulate automobile purchases. The fact remains, though, that consumption’s share of GDP remains very low. In the early 1980s, it was about 50%, but as China prioritized the export and capital investment sectors of the economy, it has fallen to about 36%.

This is a mark of an unbalanced economy, and the big policy challenge is to rebalance it by redirecting jobs and capital permanently towards the consumer and domestic goods and services sectors, and by taming the investment boom before it goes bust on its own.

Fixed investment, especially in heavy industries, such as steel, cement and aluminum, has accounted regularly for 60-80% of economic growth.

The emphasis could swing away from investment in heavy industry output, which doesn’t create a lot of jobs anyway, to investment in service-producing industries, which is more labor intensive.

Investment booms never last. Eventually, the returns to investment decline, the debts incurred to finance them become more burdensome, and capital spending retrenches to allow demand to catch up with capacity.

Over the next several years, China will either manage capital investment and the property cycle down gently, or it will experience a more abrupt slump, most probably accompanied by some form of banking crisis, in which the consumer will have to pick up the tab.

The chances of the former are normally quite slim, and so if China does not seize the opportunity to rebalance the economy towards more consumption and domestically focused production soon, the latter is more likely.

Editor’s Note: This feature is excerpted from George Magnus’ book, “Uprising: Will Emerging Markets Shape or Shake the World Economy?,” published by Wiley on December 28, 2010. Copyright 2010 George Magnus. Reprinted with permission of the author.