China’s Post-Crisis Economic Rebalancing

China Money

Years from now, we may look back at 2009 and see that it marked a critical turning point in China’s economic development strategy. The global financial crisis deprived China of a paradigm for economic development, casting strong doubts about western countries’ abilities to restore growth momentum while sustaining domestic fiscal and international financial stability. For the Chinese, the crisis also confirmed that the state must firmly control markets, especially financial markets; must maintain a strong, direct role in key industries; and must reduce China’s dependence on external demand and promote domestic consumption.

More importantly though, the crisis confirmed to the central government that China must begin to take steps to shape its future in the face of a series of converging social and economic trends that will increasingly affect economic growth and development in the years ahead.

To sustain robust growth, China has begun making important changes to policies affecting labor markets, dependence on external versus domestic demand, urbanization and related infrastructure, foreign trade and investment, and China’s overall strategic orientation. The aggregate effect of the many new challenges facing China is likely to be somewhat slower, yet still robust economic growth, but the new policy orientation towards domestic economic rebalancing should have a stabilizing effect on the economy in the medium term, a good thing for China and the rest of the world.

Labor and demographics

In the early months of the crisis, many economists predicted high unemployment and stagnating real wages for an extended period. Yet the available informationsuggests that the opposite has happened. Labor shortages have been reported since late 2009, not only in China’s manufacturing hubs in the East and Southeast, but also in the interior. Media reports indicate real wages for unskilled labor rose 15-20 percent since early 2010, while wages for skilled and experienced labor are rising faster. The only segment of the labor market where supply continuously exceeds demand is university graduates.

Reaching the Lewis turning point (where manufacturing competitiveness and the pace of growth begin to turn down as labor costs rise) will be significant for industries where labor costs represent an important share of total production costs. Such industries will seek to reduce labor costs, either by closing down, upgrading technology to reduce labor intensity, or relocating elsewhere in China or other countries. Many of these changes are already occurring.

Economic rebalancing

The financial crisis strengthened the government’s determination to reduce dependence on external demand. Simultaneously, the contribution of domestic consumption to growth – both household and government consumption – is increasing for the first time in over a decade. Both factor critically in economic rebalancing strategies. Nevertheless, it will take many years of rebalancing before China’s economy appears more “normal.”

Crude "high growth" is no longer China’s main yardstick for measuring national economic performance. As part of rebalancing, the government is prioritizing increased energy efficiency, improved environmental protection, and domestic innovation. These policies may be associated with tendencies to favor domestic companies over foreign-invested companies operating in China. The policy environment for non-Chinese corporations in or doing business with China is reported to have become more difficult. Unless this trend reverses, foreign companies and their contribution to China’s growth are likely to become relatively less important.


China has been urbanizing rapidly since the start of market reforms in 1979, but the pace accelerated in recent years due to very high growth, better education, and new housing policies. At the end of 2008, China’s urban population reportedly comprised 45.7 percent of the total. It is likely to reach 50 percent by 2015, and, as some 200-300 million people are expected to migrate from rural areas to cities and towns in the next 20 years, the share of China’s urbanites will rise to around 60 percent by 2030.  This marks a historic change for a country that used to be predominantly rural.  

Concerned that housing in the major cities is becoming unaffordable for first-time buyers and determined to avoid large-scale slums, Beijing introduced massive affordable housing programs in the 2008 anti-recession stimulus program subsidized by the central budget.

It is evident from budgetary outlays and recent policy speeches by top leaders that the provision of “affordable housing” is increasingly moving center stage in China’s development strategy. China may be the first large developing country to use its urbanization and related infrastructure development strategy for stable long-term economic growth and social development. The quality of urbanization and related infrastructure will not only determine the quality of life but also influence future productivity growth, energy efficiency, and international competitiveness.

Foreign trade and investment

The crisis convinced China not only that it must rely more on domestic demand for long-term growth, but also that it must promote south-south trade and use its foreign exchange reserves systematically to secure access to global markets, raw materials, and energy. To advance south-south trade and reduce reliance on the U.S. dollar, China is advocating the use of its currency for regional and investment. For both economic and political reasons China has intensified efforts to promote relations and trade with Taiwan. In addition to several recent regional trade pacts , China and Taiwan signed (late June 2010) an important cross-Strait Economic Cooperation Framework Agreement, which provides for the phased reduction duties and privileged access to markets for a wide range of goods and services in China, while Taiwan will slowly reduce barriers to mainland investment.  

A free trade agreement between ASEAN and China became effective January 1, 2010. The promotion of good relations with other Asian countries, including Japan, is given high priority. Western consumer markets (mainly EU, U.S., Japan, Australia, and Canada) will remain important for many years, but the share of China’s trade with Asian countries and emerging economies elsewhere, already over 50 percent, will further increase. Meanwhile, Chinese corporations gain valuable experience investing abroad, not only in resource-rich countries in Africa and Latin America, but in practically all countries worldwide. All this is consistent with China’s apparent desire to reduce dependence on the West. 

Strategic orientation

Against the backdrop of reducing Chinese dependence on the West, bilateral relations between the U.S. and China appear to have become tenser since the 2008 financial crisis. Although China now appears to be much less interested in U.S. economic and financial advice than it used to be, the May 2010 Strategic & Economic Dialogue was taken very seriously by both sides. In the absence of a constructive military-to-military relationship, however, the reach of economic dialogue remains limited.  Strategic bilateral mistrust remains high. Nevertheless, responsible leaders on both sides remain strongly aware that the U.S.-China relationship is uniquely important, not just for the two countries but also for East Asia and the world; both sides recognize that their relationship needs to be insulated from extreme elements.

Ironically, because of the sovereign debt crisis in Europe and the inability of EU member countries to agree on a common foreign policy, the relative importance of the U.S. to China has remained very great. As long as there are no acute economic or political reasons to change course, China will continue to stabilize international capital markets by buying U.S. Treasuries, and it will also seek increased investment opportunities in the U.S. China agreed to return to its earlier policy of a more flexible exchange rate on 19 June 2010, in part because China is sensitive to the concerns expressed by the U.S., India, and Brazil about its undervalued currency, but also  to advance domestic economic restructuring. China, however, remains opposed to rapid currency appreciation as some U.S. politicians demand.

For strategic and other reasons China likely will continue to seek constructive relations with the U.S. in the medium term. Nevertheless, because of the financial crisis and other global events, as well as a desire to reduce dependence on Western consumer markets and technology, China will try to perfect its own form of state capitalism. It will place greater emphasis on domestic innovation and domestic demand. In the political arena it will continue to promote transparency and accountability without changing the fundamentals of its political system.    

Pieter Bottelier is Senior Adjunct Professor of China Studies at Johns Hopkins’ School of Advanced International Studies. Patrick deGategno, Associate Director of the Atlantic Council Asia Program, edited this from a much longer manuscript.

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