Is China's rise sustainable?

Since 1980 China's economy has grown at an average rate of 9.8 percent a year — that's compared to 2-3 percent for developed economies like the U.S. Most economists believe that even if China grows at just 8 percent a year (with an annual 3 percent RMB appreciation), its economy will surpass the U.S. by 2020. But although China's growth has been called a "miracle" by many, it is not sustainable, says Buck Pei, associate dean of Asia Programs at the W. P. Carey School of Business. "China's rise to become a global economic power in just three decades has been amazing — one of the most transformative of our time," Pei said. "But today China faces enormous challenges, and overcoming those challenges will be critical to continued economic growth."

Since 1980 China's economy has grown at an average rate of 9.8 percent a year — that's compared to 2-3 percent for developed economies like the U.S. Over the last decade, Chinese GDP has seen about a 14 percent annual compound growth rate (from $1.2 trillion in 2000 to $5.88 trillion). Most economists believe that even if China grows at just 8 percent a year (with an annual 3 percent RMB appreciation), its economy will surpass the U.S. by 2020.

But although China's growth has been called a "miracle" by many, it is not sustainable, says Buck Pei, associate dean of Asia Programs at the W. P. Carey School of Business. "China's rise to become a global economic power in just three decades has been amazing — one of the most transformative of our time," Pei said.

"But today China faces enormous challenges, and overcoming those challenges will be critical to continued economic growth." Speaking in Phoenix recently, Pei said "China can confront and resolve its challenges then continue to grow, and with it, expand the global economy. Or it may collapse under the weight of its own domestic challenges."

China's challenges fall into three categories, Pei said: economic structures, income and regional disparities, and energy and the environment. "Those challenges are interconnected," he said. "To solve China's problems requires a comprehensive view, with policy mandates that address all three areas and are executed simultaneously."

China as the world's factory

When China opened its economy to the world in 1978, its strategy was to attract manufacturing from other Asian countries, from the U.S., and from Europe. China competed largely on cheap land for building factories and on cheap labor for working in them. As China began reforming its state-owned enterprises (SOEs), it gave local governments more leverage to attract investment.

"Most local governments will provide land at virtually no cost, will grant a five-year tax holiday, and will build the infrastructure for any company that would like to come," Pei explained. "Those kinds of incentives very quickly turned China's coastal provinces into the world's factory, where low value added commodities like textiles and toys were made."

Even today, while China exports a fair amount of the world's consumer electronics, the value that China adds to those products is relatively low. In a study recently conducted on the manufacture of Apple's iPhone researchers found that while the value of the iPhone is $178.96 — and all of that value is attributed to China as the final exporter — China actually adds only about $6, or less than 4 percent.

"Work in China is primarily low value added assembly," Pei said. "We can extend the iPhone analogy to almost every high-tech consumer product that is made in China. They are not made by China, they are assembled in China." While the assembled-in-China strategy has been very good for the overall economy (China is now the world's second-largest economy), those gains have not filtered down to China's workers as one might expect.

"Even with an average of 10 percent GDP growth, China's employment barely rose — employment growth was only about 1 percent. Labor productivity increased enormously but wages did not. Why? Because of an enormous amount of investment in equipment — industry became more capital intensive. In other words, industry needs less people and people who do work there don't get paid very well," explained Pei.

That explains why household consumption as a share of GDP has actually fallen — quite dramatically — as China has grown. Since 2000, household consumption fell from nearly 50 percent of GDP to about 35 percent. Government spending also declined — from about 15 percent to just over 10 percent. At the same time, capital investment has shot up from just over 35 percent to nearly 50 percent. "Why do the Chinese save so much?" Pei asked.

"It's precautionary saving. Government payments to households have declined, so people are saving in case they get sick, for their children's college education, for when they get old." And that saving is funneled to investment — to upgrading industrial structures (from light manufacturing to heavy and from labor-intensive to capital-intensive) and public infrastructure (seaports, airports, highways, etc.).

200 million migrant workers

When China's coastal provinces became the world's factory, workers came in droves from inland areas to work. Estimates are that there are some 200 million migrants at work in China's factories today. And they are absolutely instrumental in China's rise; according to Pei, migrant workers contribute about 50 percent of China's economic growth. But their take is less than one-tenth of that.

Even though China's total GDP ranks number 2 in the world, in terms of per capita GDP it ranks somewhere around 100th. And there is a huge disparity across regions of China. Overall China's GDP is about $4,000 per capita; on the coast it is about $6,000; inland it is about $3,000.

In Shanghai, Beijing, and eight other Chinese cities, per capita GDP is a little over $10,000. According to Pei, there are two primary causes of those regional income disparities. One is the social and industrial structure. "Inland provinces are not like those on the coast.

They don't attract foreign investment, multinationals; they don't even attract companies from Beijing. They missed the boat for about 20 years," Pei said. "But at the same time, what happened to people living inland? They go to the coastal provinces to look for jobs. What kind of jobs? Mostly low-paying manufacturing jobs or low-paying services jobs."

An "American" thirst for energy

Everyone knew that energy consumption in China would surpass the U.S. eventually. China is, after all, a country with 1 billion more people than the U.S. "But economists thought that China wouldn't surpass the U.S. in total energy consumption until 2015," Pei said. Surprise — China has consumed more energy than the U.S. since 2010. "There has been a very steep rise in China's energy consumption from 2000 to 2009," Pei said.

In 2000, China consumed just over 1 billion tons of oil equivalent; by 2009 it was consuming more than double that. On a per capita basis, the U.S. still out-consumes China by a large margin — 7 tons of oil equivalent per capita compared to China's 1.6. "But what happens if the Chinese consume energy the same way as you and I in the U.S.?" Pei asked. "I tell you this: this planet can't support it, regardless of price."

And what about cars? Americans have long been known for their love affair with their personal automobiles. China is joining the tryst as well — China is now the largest market for auto sales in the world. "GM sells more cars in China than in the U.S.," Pei said. "China's auto market grows by 30 or 40 percent a year; every car company views it as a strategic marketplace where they have to win."

As with energy consumption, Americans still own more cars per capita than the Chinese do — vehicle penetration (the number of cars per 1,000 people) is at about 80 percent in the U.S. and less than 10 percent in China. But by 2030, China's 37 million cars will be 370 million.

So what's the plan?

The same factors that have propelled China's economy to number 2 in the world in just three decades also make it likely that the country will be able to overcome the challenges it currently faces. It certainly has a plan to. On energy, China committed in its most recent five-year plan to develop renewable energy. It aims to nearly double its renewable energy electricity generation and to build 400 nuclear power plants by 2035 (China currently has 12, Pei said).

To address the disproportionate share of GDP growth it derives from manufacturing, China plans to develop its services industry, which also decreases its dependence on energy (you expend a lot less energy trading stocks than making steel). And the country's infrastructure plans — beyond the plan to build nearly 400 nuclear power plants in 25 years — are notable.

China is already far ahead in the development of its high-speed transportation infrastructure, with 8,000 miles of 220mph rail lines built and 2,000 more planned by 2020. In addition to making business more efficient, the improvement of transportation infrastructure will help reduce energy consumption and decrease regional disparities (by shortening the travel time between cities). China also has big plans to invest in cutting-edge energy technology.

All of the key "strategic" industries, marked in the five-year plan for heavy government help, relate to energy. And as it invests in more cutting-edge energy technology, it plans to retire old, inefficient ones. "There are close to 7,000 steel factors in China," Pei said. "80 percent of them are inefficient and will be shut down.

In heavy industry, if you are not energy efficient you will be subject to consolidation or elimination." "The current economic development is not sustainable, even though it has been successful. It is not healthy, not shared, and taxing to the future generations," Pei said. But China plans to change that.

Bottom Line:

• "China can confront and resolve its challenges then continue to grow, and with it, expand the global economy, or it may collapse under the weight of its own domestic challenges," said W. P. Carey School Economics Professor Buck Pei.
• Pei categorized China's challenges into three areas: economic structures, income and regional disparities, and energy and the environment. "Those challenges are interconnected."
• "Work in China is primarily low value added assembly. We can extend the iPhone analogy to almost every high-tech consumer product that is made in China. They are not made by China, they are assembled in China," according to Pei.
• While the assembled-in-China strategy has been very good for the overall economy (China is now the world's second-largest economy), those gains have not filtered down to China's workers as one might expect.
• Even though China's total GDP ranks number 2 in the world, in terms of per capita GDP it ranks somewhere around 100th. And there is a huge disparity across regions in China.
• On a per capita basis, the U.S. still out-consumes China by a large margin — 7 tons of oil equivalent per capita compared to China's 1.6. But if China wants to consume like America does, the planet cannot support it.
• China's plans to improve the sustainability of its economic structures, regional income distribution, and energy efficiency include the development of renewable energy sources; improving transportation infrastructure; and investing in cutting-edge energy technology.