World Savvy Monitor

The Rise and the Impact

“Since 1979, the world has witnessed what happens when you unleash the entrepreneurial activity of more than one billion people, most of whom will work for the monetary equivalent of a Starbucks latte per day, and then combine this with the insatiable desire of foreign firms to tap this labor and also sell products to the world’s biggest markets.”
(Joshua Kurlantzik, Charm Offensive)

Overview

The Chinese economy has undergone a rapid transformation since Deng Xiaoping undertook a series of reforms beginning in 1978 that were designed to roll back the socialist system cobbled together in the Revolution years.   Over the course of thirty years, China’s economic development has been astronomical:  annual growth of Gross Domestic Product (GDP) in the double digits for three straight decades; 400 million people lifted out of poverty; literacy, life expectancy, and infant mortality rates brought up to that of the developed world.  However, not all of these benefits have been shared equally.  Although China ranks as the third largest economy in the world behind the United States and European Union in total GDP, with 1.3 billion people, it has 4x the population of the US and 3x the population of the EU.  This means China has a GDP per capita that puts it in the company of poor nations (rank of 130 by the CIA World Fact Book).  And, finally, the time-compressed development of the Chinese economy has wrought attendant damage on the natural environment, with serious global complications for generations to come.

History

For two thousand years, China long occupied a position at the top of the world economic ladder; its position was largely due to its vigorous trade along the famous Silk Road.  However, the Middle Kingdom’s prosperity dropped precipitously during the century in which it was exploited by outside imperialist empires, weakened by internal warlords and corrupt government, and wracked by both civil war and WWII (1842-1949).

By 1950, the newly proclaimed Communist People’s Republic of China (PRC) accounted for only a small fraction of global GDP.  To make matters worse, the revolutionary Marxist policies of the Mao era that attempted to modernize China’s largely peasant society resulted in negligible growth and widespread famine at a time in which the West was growing rapidly.   The infamous Great Leap Forward and Cultural Revolution (see timeline) violently disrupted Chinese social, cultural, and economic systems without enhancing productivity, and isolated China from the rest of the world.  By Mao’s death in 1976, Socialist doctrines were largely discredited in the eyes of China’s new generation of leaders.  Upon taking power in 1978, Deng Xiaoping set the populous nation on a course toward modernization based on two key principles:  the re-introduction of capitalist or free-market (profit) incentives in agriculture, industry, and technology, and the opening up of China to global trade and investment.

First, giant state-run agriculture collectives from the Mao era were dismantled, and family farms restored.   Under the “responsibility system,” farmers were given the freedom to make decisions based on a profit motive, and productivity rapidly increased.  As farms became more productive and efficient, workers were freed up to enter the industrial sector.

Industry in China in the 1970s bears little resemblance to what we know today.  In 1978, the country had not yet gone through the Industrial Revolution that the West experienced in the late 19th and early 20th Centuries, and was badly in need of incentives, capital, innovation, and labor.  The Chinese Communist Party (CCP) rapidly mobilized all four through the adoption of capitalist principles of ownership and production, creating a system that combined the competitiveness of the open market with government support and direction, and the courting of foreign investment.  Not fully trusting either the “invisible hand” of the market, nor the influence of outsiders, the CCP remained very much the overseer in the early stages of the Chinese Industrial Revolution.

By the 1980s the Communist Party’s mantra was “to get rich is glorious.”  Special Economic Zones (SEZs) were established along the coast near British-controlled, and capitalist, Hong Kong.  SEZs benefited from tax incentives, entrepreneurial local management, and unprecedented market freedoms directed toward rapid industrialization.  By the mid 1980s nearly twenty SEZs had been established and were spreading along China’s Eastern coastline where they shipped their goods overseas.  In the 1990s, this development began to spread inland and factories sprung up in provinces throughout the country.  Furthermore, foreign companies began to have more discretion and control over the manufacturing of consumer goods and electronics.

What is extraordinary about China’s modernization is that while most developed nations underwent the Industrial Revolution in the late 1800s and the Information and Technology Revolution in the late 1900s, China has tackled both concurrently.  In short, what took the US and Europe close to a century to achieve, the Chinese largely accomplished over the course of thirty years.  Of this feat, James Kynge has said, “the sheer scale and speed of the renaissance puts it in a class of its own (where) centuries of developmental time have coalesced into a concentrated vigor.”

Today, China is a magnet for foreign cash, companies, and entrepreneurs who cannot resist the lure of its 1.3 billion workers and potential consumer base.  By 2007, China’s share of global GDP as reported by the International Monetary Fund was 15.8%, a three-fold increase in less than thirty years.

How Did They Do It?

Theories abound about China's modernization and there is a different list of factors in every analysis.  From a review of various experts on the Chinese economy, we’ll try to reconstruct the ingredients of the uniquely potent recipe for this phenomenal and unprecedented industrial expansion:

• The Embrace of Market Forces to Incentivize the Process:  With profit linked to productivity and efficiency, enormous incentives for entrepreneurial activity were unleashed as barriers were simultaneously removed.
• People:  Many Chinese were motivated, not surprisingly, by the lure of better wages, especially from impoverished rural areas in a country with limited arable land for farming. People who were largely well-educated and willing to uproot their lives for work mobilized; this created an inexhaustible labor supply wherever and whenever it was needed.  Strict regulation of workers by the central government prevented the growth of independent labor unions, and tightly harnessed the labor pool to output quotas.
• Foreign Investment of Capital and Transfer of Technology:  Direct Foreign Investment (FDI) in the form of partnerships or wholly-owned foreign companies brought global buyers and sellers from highly developed nations to China’s door.  Just as important as their dollars, pounds, euros, and yen were their advanced production technologies that allowed modern factories to be built practically overnight.
• Government Facilitation and Subsidization of the Effort:  With the public/private sector lines blurred, the state has been able to enter and exit industries both formally and informally as needed. The CCP has been involved with everything from securing raw materials and markets, to moving laborers, to controlling the flow of information and connections, to propping up weak links in the system; through this involvement, the CCP has been able to accelerate progress in seen and unseen ways that are typically not tolerated in traditional Western liberal economies.  Although the Reform era has been characterized by a move away from a heavily state-directed economy and toward a private, free-market directed one, the influence of the state continues today and is pervasive throughout all sectors.  This produces some efficiencies that truly free market economies do not enjoy; it also suppresses healthy checks and balances found in liberal market economies.  Today, the Chinese state retains its most influence in the area of strategic resources like water, electricity, oil, steel, and coal.  The state heavily regulates the price and production of these goods, which are crucial to social stability, rather than leaving their supply and demand up to fluctuation in global markets.  As a result, the Chinese people enjoy artificially low prices for these basic services and goods.
• High Levels of Savings and Investment:  Substantial individual and government savings in China mean ample cash is available, unlike in economies such as the United States where citizens and the government live beyond their means.  This liquidity can be used to influence domestic development, trade terms, and even the policies of foreign governments whose debt can be purchased with these funds.

These forces combined over a thirty year period (1978-2008) to create a nearly unstoppable force that can’t really be called Capitalism or Socialism, is definitely not Communism, but retains features of Leninism.   It is an anomaly in history:  a largely free-market based force that is not democratic in nature, and makes no claim to be; a hybrid economy combining the best and worst of both state and private systems; a first world power economy in a developing world nation.  However it has been labeled, it is a force to be reckoned with, and its success or failure impacts each of us in an era of ever-expanding globalization.

Because the Chinese economy is so complex, it defies easy dissection and categorization.  The best framework we found to explain the different moving pieces is the one used by David Lampton in his book The Three Faces of Chinese Power.  Lampton elegantly presents the Chinese economy in terms of the roles it plays in the global system as buyer, seller, innovator, investor, and donor.  Below we use this basic scaffolding to organize information gleaned from a wide variety of sources to show how China’s economy affects the destinies of its own citizens and those of people around the world in a myriad of ways.

As a Buyer

With its 1.3 billion people and the voracious appetites and resource needs of both its population and its industries, China is potentially the world’s largest market for exports from other countries (goods and services imported into China).  China is a net importer of food and fuel, as well as other natural resources such as timber and iron ore, which it often gets from other developing nations.  Lacking the capacity (currently) to produce advanced manufactured products such as aircraft, China is a large market for developed nations’ wares as well.  Add to this an appetite among new Chinese millionaires and billionaires for luxury goods and services produced in the West, and the economies of countries all along the development index are connected to the fortunes of Chinese people and companies.  Nowhere else in the world is there a similar market, based on the sheer size and demand of the consumer base, and as a result, many corporations and public entities are eager to gain a foothold in the Chinese market.

As an energy buyer, China gets a great deal of attention because of the nature of oil and gas-exporting countries.  China can get its grain from multiple sources at a range of prices; but there are only so many oil-producing countries and only so much (nonrenewable) oil in the world.  This is a commodity that is central to attaining the kind of Western lifestyle to which many Chinese aspire:  cars that run on oil, food/alcohol products that are energy-intensive to produce, high-rise buildings that are inefficient to heat, to name a few.  Which suppliers the Chinese procure this energy from makes a big difference, not only economically in terms of global gas prices, but also geopolitically.  China’s oil purchasing power has been used in ways that many believe are harmful to international norms when it courts suppliers such as Iran, Nigeria, Angola, and Sudan.  The contention is that China's oil purchases not only prop up unsavory regimes, but they also exacerbate extreme poverty and inequality within these nations, since oil revenues do not typically reach the impoverished masses in these countries.  The Chinese have argued otherwise; they contend that they have little choice of who to solicit for their oil needs. Other, often equally unsavory, sources are tied up by Western powers who got there first.  Further, China’s purchasing power and the scale of its needs buys it political friends as well as oil.  These friends often return favors in weapons purchases and in votes against China’s enemies (Taiwan, in particular) in the United Nations General Assembly.

As a Seller

As Lampton notes, this is the role that gets the most attention as China is alternately celebrated and reviled as the world’s factory floor; it is a supplier/exporter of everything from shoes and clothes, to cell phones and pharmaceuticals, to steel and cement.  China's unique recipe described above allows it to produce all of these things at substantial discounts over similar goods produced in other countries.  Often, this is devastating for domestic industries in other nations (from African countries’ textiles to Italian artisan products to German steel).  Other countries simply cannot compete with China’s extraordinary efficiency and resulting low prices; the power to drive competitors out of the marketplace is a significant one that can be wielded for a variety of purposes.  The United States has a giant imbalance of trade with China, but they’re in good company – nearly every nation does.

This competitive advantage, however, has hidden costs for China and the world at large. Consider the following:

• Low wages for the Chinese laborer perpetuate his dispensability and prevent his upward mobility.  This thwarts poverty eradication efforts for the welfare of families throughout the country.  It will ultimately create the need for more government spending to help people meet basic needs; it also encourages the continuous migration of labor, which disrupts families and societies and puts communities at risk.
• Poor health, safety, and environmental standards and regulations in Chinese factories result in preventable accidents, illnesses, and premature deaths, as well as catastrophic levels of pollution.  The injured and sick will have to be cared for and their care factored into rising health care costs.  Workers’ lost productivity will take its toll on the economy, and pollution will take its toll on the productivity of the natural environment as well.
• Piracy and counterfeiting produces knock-off or inferior consumer goods and ineffective pharmaceuticals, toxic baby formula and unsafe auto parts.  This results in not only endangering the health and safety of unwitting consumers around the world, but also stifles innovation as intellectual property laws are flouted.  Costs will be paid out in illness, death, liability expenses; and a dearth of new Research and Development (R&D) efforts and inventions.
• Undervalued currency makes Chinese exports cheaper in the short term.  This actually forestalls and ultimately intensifies the downgrading of Chinese economic strength once the yuan is ultimately valued correctly against other currencies.  The Chinese economy will have to account someday for the 15%-40% undervaluation, as the international community increases pressure on China to adopt a floating currency standard.
• Subsidies and corruption help make otherwise expensive products cheap to produce.  This is government money that has to be made up in tax revenue.  The corruption diminishes faith in Chinese business and government, a valuable commodity in and of itself.
• Valuable natural resources are used inefficiently and wasted.  Because people and companies in China enjoy state-managed, artificially low prices on commodities such as oil, gas, and water, they are often inefficiently used.  This waste further depletes global sources of non-renewable resources, disrupts global pricing, and opens up further opportunities for corruption.

Seen through these lenses, as it is by numerous experts, the Chinese economy can be said to contain a range of expensive deferred maintenance costs.  Some costs are not recoverable; others will take their toll on future generations, from health care and environmental clean-up to lost goodwill and spiking long-term prices.  It is interesting to note that some believe, were these hidden costs to be factored into China’s GDP, China’s impressive double-digit annual growth might actually become negative.  Many believe it is time to develop more intelligent statistics to capture growth in the context of collateral damage and deferred costs.

It bears remembering, though, as Chinese suppliers are reviled for “not playing by the rules,” consumers globally seem complicit.  Much of the pollution in China is pollution that has effectively been outsourced from developed nations along with the industries that produce it.  Low-priced Chinese manufactured goods allow for a healthy retail mark-up that benefits the stores outside China that sell them.  The average American consumers also save a considerable amount of money when they buy these goods, and many are able to afford electronics and other products they would not otherwise be able to purchase at all.  China’s role in the world as a low-cost supplier, the good and the bad, is a role the world confers freely on the Chinese.

Finally, it must be noted that some of the perceived benefits accruing to China as a supplier are often overstated.  In many instances, only one stage of a product’s development takes place in a Chinese factory; the profits are largely retained by the foreign company that owns the patents, designs, and overall production process.

As an Innovator

In the process of manufacturing goods based on Western designs provided by their FDI partners, many Chinese companies apply their considerable engineering talent to develop derivative value of others’ inventions by finding new ways to make products more cheaply and use them differently.  This is applied in both legal (selling close knock-offs under similar Chinese brand names) and illegal (counterfeit name-brand pharmaceuticals and pirated DVDs) ways, and both figure significantly in the Chinese economy.  China’s legal innovation in making laptops, cell phones, and digital cameras more cheaply, either in partnership with a foreign company or on their own, has made these products affordable to the world.

However, there is a significant downside to this reverse-engineering of Western goods.  Chinese innovation comes at a considerable price to other nations, in the form of brand degradation, lost revenues, damaged incentives for R&D, and money and energy spent fighting intellectual property infringement.  When the products are poorly copied or intentionally downgraded or contaminated, the costs affect foreign consumers and companies in health care costs, liability, and potentially, loss of life.  Economist James Kynge has written that the loss to foreign companies in 2004 as a result of intellectual property theft actually exceeded the total flow of FDI into China that year.  He estimates that US, European, and Japanese companies lost a total of $60 billion that year through piracy; China only received $56 billion in foreign investment.

Recently, China’s role as an innovator has been growing in the area of medical research.  In November 2007, Time Magazine published a story describing the allure of cheap Chinese clinical trials for drug R&D.   The Chinese education system puts a high value on scientific and technological knowledge, and there is no dearth of qualified researchers who have the capacity, and the supply of willing patients, to run clinical drug trials for up to one tenth of the cost of US-based trials.  Different from the counterfeiting described above, these trials are conducted at the behest of multinational brand-name pharmaceutical firms who are under increasing pressure to develop new drugs as lucrative patents expire and aging baby boomer populations demand new medications to offset the vagaries of aging.  Ironically, these companies lose giant sums of money each year to Chinese counterfeiters, but return to China to get clinical trials done quickly and cheaply on new drugs to replace lost revenue on old ones.

Chinese firms have also played a valuable role as innovators in the area of stem-cell research.  Unbound by ethical and moral constraints imposed on human embryonic stem-cell research in the United States and some other countries, Chinese scientists may come up with the cures for Parkinson’s, Alzheimer’s, or other diseases in which stem cell therapies are suspected to be effective.  This adds to the irony between the deleterious health effects of some kinds of Chinese innovation (unsafe food and drugs) and the notion that the future of medicine may lie in the PRC.

As an Investor

China is also steadily increasing its own foreign investments to over 100 other countries so far.  Its considerable savings rate allows Chinese investors to become shareholders in blue chip Western companies, buyers of US Treasury Bonds, partners in African oil companies, mine concessions, and transportation projects.  Chinese investors are also sending their FDI to factories throughout Southeast Asia where it sometimes makes financial sense to outsource the production of some components of Chinese products, not unlike Western companies’ designs in China.

Again, this economic role confers a considerable amount of power on China.  When China holds a substantial portion of US debt (in treasury bonds) and thus keeps US interest rates low (and US citizens spending), it gives the Chinese an important lever on American policies and behavior.

With respect to its investment in the developing world, China’s strategy has been described by many as neo-mercantilistic.  It first pries open the door of emerging markets containing lucrative natural resources (Sudanese oil, Zambian copper, Congolese coltan) with investments in infrastructure, such as transportation, pipelines, hospitals, schools.  It is then able to negotiate deals on the natural resources, often locking up reserves that would otherwise be on the world market at (usually much higher) prices.  It has also been accused of “dumping” cheap Chinese manufactured goods on nascent textile markets in other countries, effectively destroying indigenous industries.  This is not a new economic behavior, however, and history illustrates that mercantilistic colonialism was practiced by the British on American, and later African, colonies, and has been copied by industrial powers ever since.  This paradigm is directly linked to much of the underdevelopment and uneven development that plagues Africa today.  African countries are perpetually at the whim of the needs of more developed nations, and are relegated to providing raw materials and unable to grow local industries.  In addition, the resulting failure to diversify their own economies makes them more susceptible to the internal corruption that often accompanies the extraction of valuable minerals.

In some cases, investment is not done in the name of resource extraction, but in strategic transportation. As America’s Navy patrols the key shipping lanes and chokepoints for Middle Eastern oil to China and much of the world, the Chinese have begun to look west across their Central Asian neighbors’ land masses and ports as an alternative way to move oil.  The giant construction project underway in the Port of Gwadar in Pakistan is such a strategic investment, as is China’s purchase of the company currently controlling the Panama Canal.

These projects and connections in Africa, Central Asia, and Latin America do not just benefit the Chinese, however.  Regardless of the intentions of the Chinese, infrastructure is being built where it otherwise would not be, and being built quickly and cheaply by Chinese laborers working for Chinese companies.  See the External Players section for a more thorough discussion of what this means for sustainable economic development and good governance in these countries, as well as in Latin America.

One footnote is worth considering on the future strength of Chinese investment potential.  One of the reasons why individual savings rates are so high is that the health and welfare safety net of the Communist era has largely been eroded.  Many people save money because they do not have health insurance or pensions and cannot count on the government to provide for their care should they become unable to work.  At some point in the future, people may begin to draw on their savings to provide for themselves, which will decrease the amount of money in Chinese banks available to use for foreign investment.  How this will affect overall Chinese investment around the world remains to be seen.  However, most feel that the amount of foreign currency reserves China holds from debtor governments will keep this investment pool healthy for years to come.

As a Donor

China gives a considerable amount of foreign development and humanitarian assistance, soft loans, and in-kind gifts to poorer nations.  Though this generosity is often in their economic and political self-interest, the same is also true of many other donor countries around the world.  As they have become wealthier, the Chinese have left the ranks of assistance recipients and joined the global community of donors who “give” in accordance with their strategic interests around the world.  While Chinese aid does much good around the world, China’s support for unsavory regimes such as Sudan, North Korea, Burma, and Zimbabwe receives considerable treatment in the Western press. However, Western aid for similarly unsavory regimes such as Saudi Arabia, Egypt, and Colombia bears a striking resemblance. This kind of power is considerable; the geopolitical world order is impacted when rogue nations are sustained artificially even though internal weaknesses would otherwise lead to collapse.

The Underground Economy

China, like other nations, has a considerable underground economy comprised of illicit activities that can be quite lucrative. Manufacturers of counterfeit or pirated consumer goods here are distinguishable from their illegal counterparts in their intent to recklessly deceive.  This sector includes companies and individuals who sell purposefully ineffective or even toxic products under brand names, not just generic products or knock-off items with a knock-off name.  These include flu shots that are actually saline or even something harmful, fake replicas of cholesterol-lowering drugs, sleeping pills, Viagra, and cancer medication, and even machine parts made of dangerously inferior materials.  These goods make their way into the supply chains of unwitting distributors and consumers who think they are ordering from legitimate pharmacies on the Internet.

The underground economy is also fueled by openly illegal activities such as narcotics production and sales.   Prostitution and sex slave/child labor trafficking are similarly lucrative in a populous country struggling to deal with enormous migration and dislocation of families.  Again, this underground economy is not unique to China – all nations have organized crime - it’s just amplified by the sheer size of everything in China.  Furthmermore, because the workings of the Communist Party at the central and local level are largely hidden from view, corruption among state officials aids and abets.

The Balance Sheet

In all of these economic roles (buyer, seller, innovator, investor, donor), China has been inexorably integrated into the globalized market economy. Most nations profit considerably from China’s rise.  In 2001, China joined the World Trade Organization.  Many hope it is in this forum where China (and all industrialized nations) may have the potential to address the by-products of free-market capitalism, including unfair business practices, wealth gaps between different sectors of the population, corruption, and degradation of the global commons.

Although China’s rapid rise and sheer size have intensified the downsides of industrial capitalism, China's struggles are issues all industrial nations face.  How do you provide a basic minimum standard of living for all people as wealth grows disparately?  How do you temper the rapacious self-interest that creates this wealth in the first place so that the rising tide truly can lift all boats?  How do you protect traditional values and families in an era of rapid mobility?  How do you protect the natural inputs for growth to ensure sustainability on an increasingly fragile planet?  How can you balance short-term and long-term appetites and needs?  These questions are not unique to China, but common to all nations that have experienced rapid industrialization and the accompanying cultural, economic, and political changes.

There are those who would like to punish China for its rapid rise.  Supporters of this viewpoin point out the tendency of China to ignore international trade rules and norms, and mobilize its tremendous size advantage in a cut-throat way.  Some lobby for erecting protectionist trade barriers and/or shaming the Communist Party internationally for its way of dealing with market failures.  But this suggestion presents an enormous bind:  the world benefits from China’s rise in numerous ways, and its downfall would be everyone’s downfall.  Many economists predict that if the Chinese were to halt or limit their role as investor, innovator, buyer, seller, or donor, the world would unquestionably be impacted in the form of higher prices, higher interest rates, potential recession, and in the view of many, erosion of quality of life.

The conundrum has become determining how China can be engaged in solving global economic ills by establishing rules and norms accepted by all.  In addition, competitor countries who are being left behind will have to consider how education, re-training of workers whose jobs have been outsourced, and increased savings and investment can improve their position globally.  Many critics argue that China should not be allowed a free pass for the various ills produced by its rapid modernization, but history shows us that its path is not entirely unique.  Most of its failings and crimes have been perpetrated by other nations as well, at other times in history, during their respective industrial ascent.  Regardless, the Chinese economy is here to stay; it consists of a market of 1.3 billion consumers, a factory of 1.3 billion producers, a major destination for foreign currency permanently woven into the economic well-being of the world.

This primer on China’s economy does not address perhaps the greatest inherent contradiction of its unique system – that despite ever-increasing economic and social freedoms, the Chinese people do not enjoy significant political freedoms.  The liberalization of the economy has not extended to the political sphere. China remains under the control of a one-party, authoritarian government.  The people who help power this economic force, for the most part, do not elect their officials; they do not take part in policy decisions; they do not enjoy complete freedom of expression or association.

The question on everyone’s mind, and one that we will not attempt to answer here (an entire industry exists to ponder this anomaly) is this:  is China’s economic miracle sustainable without the evolution of representative government and expansion of individual freedoms?  Will the people continue to put up with the bargain of economic prosperity in return for compromised individual liberties?  No one knows if the Communist Party can maintain its legitimacy forever or what its motivations are in this realm.  As International Relations expert Ian Bremer has said, the CCP currently “uses its open economy to finance its closed political system.”  It counts on continuous economic growth to forestall protest of its governing policies, which, in turn, puts enormous pressure on the Party to maintain double-digit growth.  That such an unprecedented rise cannot likely continue forever presents a dilemma for China’s rulers.

Projections indicate that China's growth should not slow any time soon, if no forcing events intervene.  The CCP is very aware, however, that both the demise of the Chinese Empire in 1911 and the fall of Nationalist China in 1949 were accelerated by economic hardship.  At the very least, it should be acknowledged, as the Center for Strategic and International Studies writes, “The political system that existed in 1978 when annual income per capita was $200 had to adapt to manage the $1700 per capita Chinese economy of today.  The $10,000 per capita China of tomorrow will likewise require dramatically different governance.”

Next:  Key Internal Players:  The Chinese Communist Party (The CCP)