China Economy Examining the Current

China Economy

Examining the Current Status and Future Trajectory of China's Economy: Growth, Risks, and Response to the Financial Crisis

The recent global financial crisis and ensuing recession that is only now beginning to draw to close (or is simply gearing up for a second drop, according to some analysts) has caused a major reanalysis of the financial world and the world's major economic powers. Most of these large economies, of course, suffered greatly due to the downturn precipitated by -- and here there is a great deal of disagreement that will doubtless continue for decades if not centuries -- the poor use of credit and the over-valuation of specific assets, and specifically the "toxic" mortgaged-backed securities that became the mainstay of many financial institution's portfolios in the preceding decade. The collapse of several major banking institutions and a general lack of available credit cut consumer spending drastically throughout the large consumer societies, which of course had a negative impact on manufacturing countries as well.

China, however, actually managed to do fairly well during this period. It definitely took a hit, of course, but rather than taking a few economic steps backward like most of the world's nations, China simply experienced a slowed rate of growth. Given how quickly its economy has been growing since the beginnings of the economic reforms that loosened the Chinese government's stranglehold on the business and commerce in the nation, the growth of the country's economy even after the "set-back" that China experienced would have been seen as a banner year in many fully developed nations even during the good years prior to the crisis.

This paper will examine in greater detail the effects that the global financial crisis had on China's economy, beginning with a look at some basic macroeconomic features of the country. The factors that determine economic growth in the country will be detailed, including the various inputs and the international dimension of the country's economic growth that is vital not only to China's continued expansion but also to the rest of the world's economies as they are currently structured. Following this, an assessment of the country's economy during and after the global financial crisis will be conducted, and finally an evaluation of ongoing risks as well as there significance will be provided along with a potential growth strategy for the nation that addresses these risks and the previously identified growth determinants. By following these steps, an accurate and comprehensive understanding of China's economy will be developed that will provide a firm basis for investment decisions involving Chinese businesses and economic predictions regarding the country as a whole.

Basic Tools of Analysis

One of the tools that will be utilized to determine China's economic strengths, risks, and growth determinants is the Gross Domestic Product. Simply put, a country's gross domestic product or GDP is the sum of all goods and services produced by the people in that nation, including wages earned and products created purely for their own use and no further economic ends (Statistics Finland 2010). While a useful measure, GDP measures cannot for practical reasons include transactions/economic activity for which there are no records (Statistics Finland 2010).

The concept of a balance of international payments is also something that must be understood and applied when examining any economy of size in the global system, and is especially essential when analyzing China's economy. The name of his concept provides a fairly clear idea of what it entails: the sum total of a country's debts to and from other countries, or the total of its debit and credit transactions, reflects the degree of balance that exists, and ideally these two sides will be even or there will be a surplus of credits/debts owed to the country (Helicon 2009). When the cost of imports -- the debts owed to other countries -- becomes significantly higher than the price of exports -- the debts owed to the target country -- the target country is in a precarious and ultimately untenable position due to the off-balance nature in favor of the other countries' bottom lines (Helicon 2009). Buying and selling reserves is typically used to bring these numbers in balance, but when the balance is too far off even this is not a viable solution to a country's credit problems (Helicon 2009).

Another factor that must be considered when examining trade balances is the exchange rate between the currencies of trading partners. Typically, when one country's currency weakens against that of a trading partner, it imports less of the partner's goods (because they become more expensive), and the partner purchases more of the first country's goods (because they become cheaper) (Moffat 2010). This usually helps to maintain an overall trade balance through ever-shifting currency exchange rates based on perceived risks and strengths of a given currency (Moffat 2010). For China's non-free-floating yuan, this has even more complex effects.

A final macroeconomic concept that bears a separate explanation before an analysis of China's economy is undertaken is that of economies of scale, which refers to a tendency for companies to become more cost efficient at higher levels of production (Investopedia 2010). This is because the per-unit cost of production typically goes down as more units are produced; fixed costs (costs that are the same regardless of how many units are produced, such as the land and structures that a factory occupies, management expenses, and often labor when enough automation is involved) are spread out over more units, and variable costs (costs that do change on a per-unit basis such as the materials used in the production of an item) are automatically offset by the price paid by the consumer for each finished unit (Invetopedia 2010). Producing more costs less and creates more profits, all other things being equal.

Determinants of Growth in the Chinese Economy

For much of the twentieth century, China was run as a communist dictatorship, and the economic activity of the country was centrally planned. Over the past thirty years, however, economic reforms that began in the late 1970s have allowed the economy to become more free, and this has increased China's annual gross domestic product by a factor of more than ten since 1978 (Stanley 2010). This growth has not taken place due to increased domestic demand, however, where the increased cash flow is largely saved by the population, but due to the international demand for the cheap products China is able to provide (CIA 2010). China's artificially low currency increases the country's rate of exportation (Montgomery & Faiola 2009).

Labor supply and costs are a huge part of the growth observed in China's economy; the country has a huge population and still suffers from high unemployment, meaning there is no shortage of willing workers for the manufacturing jobs that exist on an increasing business; this ready supply also helps to drive wages down to a mere eighty-one cents per hour on average in 2006 (Lett & Bannister 2009). Populations are becoming increasingly urbanized as people migrate away from impoverished rural areas to industrial centers and cities where the jobs exist, and productivity continues to increase despite a series of major quality control issues in many unrelated industries (Lett & Bannister 2009). The country has abundant and relatively untapped natural resources in the form of carbon fuel deposits (including coal, petroleum, and natural gas), minerals, and metals useful in the manufacture of a wide variety of items (CIA 2010). This also helps to drive the country's economic growth.

Capital is also a necessity to any enterprise or nation undergoing a growth spurt, and the increased availability of capital in China is another determinant of its growth. The increased profitability of Chinese businesses following a lifting of controls and restrictions from the Chinese government has allowed for much of this capital to be generated internally, and other reforms enacted by the government have allowed for foreign investment in Chinese enterprises, supplying other large sources of capital (Stanley 2010; CIA 2010). The government even sold off large interests in banking institutions that were formerly controlled by the state to foreign investors, fully connecting the country to the international money supply (Stanley 2010).

All of the labor, natural resources, and capital in the world would not lead to economic growth if they were not effectively combined and put towards productive use, however, and thus there is one more immensely important factor determining the growth of the Chinese economy -- that of the Chinese business managers and, perhaps even more importantly, the entrepreneurs. Entrepreneurial activities in the country have largely been supported by local governments, and this support is integral to the success of businesses that begin operations at the town or village level (Li & Matlay 2006). Larger corporations must deal more directly with the national government, and despite reforms there are still many regulations and restrictions on these corporation's actions, but at the same time the rigid hierarchical nature of Chinese culture and politics is useful to many managers in developing and executing plans for the increased growth and productivity of their firms (Li & Matlay 2006).

China's Economy During and After the Economic Crisis

All of these factors created major growth for China for the three decades following the beginnings of its economic reforms, and then the financial crisis hit. China began the twenty-first century with a growth rate of 8.4% in 2000, peaking in 2007 with a 13% growth rate (IMF 2010). In 2008, this rate fell to 9.6% -- a significant drop, but still a significant growth rate as well (IMF 2010). The estimated growth rate in 2009 showed a slower drop to 8.7%, and forecasted growth in 2010 showed the rate climbing back up to 10%, with an average rate for the decade still at 9.9% despite the hiccup caused by the global downturn (IMF 2010).

A large reason hat China was so insulated form the economic shock that was so devastating in other parts of the world was because of the swift and sure action that the Chinese government was able to take in response to the crisis, something that earned them high praise form the International Monetary Fund (Mingxin 2010). A four-trillion-yuan (approximately $590 billion) stimulus package was enacted in late 2008, creating many jobs and other economic opportunities and pumping much needed cash into the system, signaling a clear shift from a "prudent" to a "proactive" fiscal policy (Mingxin 2010). The Chinese government also quickly lifted credit growth restrictions and lowered interest rates, increasing the amount of bank lending in the country enormously and further stimulating the economy with its now "moderately loose" monetary policy (Mingxin 2010). These actions largely offset the drop in demand for Chinese-manufactured products in other countries.

The sudden change in the global economic structure also created a sharp increase in the demand for imports by the Chinese populous, as well as driving up demand for the consumption of resources found within China, and thus domestic spending increased while the country's trade surplus was significantly diminished (Mingxin 2010). The overall macroeconomic policy that was enacted by the Chinese government in response to the financial crisis was similar to that of other nations in its attempts to both free and increase the flow of cash into and through the domestic economic system. This country was far more successful than others in this endeavor due to the ability for the government to act almost immediately even on such large issues.

The macroeconomic policies that were enacted by the Chinese government as a means of avoiding and/or mitigating the effects of the economic crisis also worked in microeconomic ways to stimulate domestic consumption and spending. Many public works projects created jobs at the local level, increasing the profitability of businesses in many traditionally impoverished areas as these projects created greater numbers and greater degrees of discretionary income; as more cash existed in the system on a large scale, more individuals and individual businesses were able to reap the financial awards and sustain higher standards of living (MacLeod 2008). Thus, it was the specificity with which the Chinese government determined to spend the stimulus package as much as if not more than the existence of the stimulus money itself that helped ensure the continued growth of the Chinese economy during this period of near-global recession (MacLeod 2008).

Risks and Their Significance

There are several risks currently facing the Chinese economy that should give both domestic and foreign investors some cause for concern and wariness. The continued careful control of the yuan's exchange rate has the effect of taxing domestic private consumption, as it is a better long-term strategy to save the slowly appreciating currency until it has reached a higher exchange value (Goldstein & Lardy 2007). Uncertainty also looms large in the global economy, and China's still-large dependence on international consumption of its goods leaves it especially vulnerable to the possibility of another downturn (Shasha 2010).