China's economy during the global financial crisis and recovery

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).

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).

Other risks stem even more directly from the country's response to the financial crisis. Specifically, the large increase in bank loans made by Chinese banking institutions to Chinese businesses and individuals in the wake of cheaper credit and lifted restrictions are bound to have a greater rate of defaults than is standard in the country, leaving some question as to the future reliability of these banks (Shasha 2010). Increased building during this period due to both direct stimulus spending and simple optimism about the growing economy has led to a real estate development excess in the country, and it could take many years before this surplus is actually utilized and begins to make true economic sense in balancing out expenditure and profitability (Sinocism 2010). Wage inflation brought about by currency control and the increasing frustration and condemnation by the international community of the large trade surpluses China is already returning to also make the future success and growth of the Chinese economy more uncertain than it would otherwise be (Sinocism 2010).

These problems are joined by the simple lack of sustainability inherent to the country's current economic stimulus policies; government spending and significantly relaxed credit rules have enabled the Chinese economy to continue to grow despite significantly reduced foreign demand and a still-low domestic demand, but this cannot be kept up forever. When the lack of demand catches up to the country's production enterprises, the excess capacity could create a sharp spike in unemployment, increasing defaults on capital loans, and other signature features of a recession that would form something of a correction on China's growth.

Finally, China is also plaged with a host of social problems, and the country's leadership has demonstrated either a lack of interest in truly addressing these problems or a lack of ability to effectively tackle these issues, or possibly both. Massive corruption at all levels of government with direct implications on business proceedings in the country, a lack of infrastructure in many of the rural areas of the geographically vast nation that leaves a large portion of its population at significant disadvantage, lack of adequate healthcare and basic necessities for many individuals, and a host of other human rights issues including religious and political persecution as well as worker exploitation all threaten to boil over into internal turmoil and external restrictions and sanctions (BBC 2010). Though these problems have been ongoing for many years, they continue to erode confidence in the Chinese economy for some investors on both ethical and practical grounds, and with good reason.

Conclusion: The Way Forward

China cannot simply un-peg the yuan from other world currencies and allow it to float free; the results could be internally as well as externally disastrous. A more carefully controlled yet aggressive move to a free floating currency is advisable, however, as is increased spending on infrastructure and social issues as a means not only of stimulating the economy but also laying the groundwork for truly sustainable growth and security. Bringing trade more in balance and accomplishing these other goals would make China a better integrated part of the world economy, poised for greater future success.