What are the main problems in China that can derail its economic growth - Essay Example

? WHAT ARE THE MAIN PROBLEMS IN CHINA THAT CAN DERAIL ITS ECONOMIC GROWTH? Table of Contents Table of Contents 2 Introduction 3 International Trade and Exports in China 5 Foreign Exchange Regulations and Chinese Currency 9 Problems of Aging Population in China 12 Increasing Level of Income Inequality 15 Problems in Chinese Banking System 17 Conclusion 18 References 20 What are the main problems in China that can derail its economic growth? Introduction China, which is considered to be the fastest growing and emerging nations of the world, is experiencing a setback in its economic growth rate in the recent years. Decline in investments and the decreasing demand of Chinese services and products in some of the key international markets of the world like UK and USA are causing concerns for the economic development of China. The exports of China have reduced significantly in the recent years. In March 2012, the Chinese government declared that the Chinese economy and its gross domestic product (GDP) are expected to grow at a slower rate of around 7.5% during the year 2012. The slowdown in the rate of economic growth in China had an adverse impact on the overall condition of the global economy. This is so because China is responsible for around 20 percent of the total economic output of the world. Besides, many Asian countries are also highly dependent on the Chinese economy and its market conditions (Hart, 2012). It would be a daunting task for most of the multinational corporations engaged in the manufacturing industrial sector to register significant profits if the Chinese economic growth rate slows down. The Central Bank of China has already started taking steps through reduction in the interest rates to help the economic recovery process of China and boost the lending process in the country. This step was taken up by the Chinese Central Bank to protect the country’s economy from the adverse effect of ongoing financial crisis situation in the European nations. The eminent economists worldwide suggest that capital infusion would not be able to solve these growth issues of the Chinese economy in an effective manner. It is so because with the increase in funds being pumped into the economy by the Chinese government would ultimately lead to increased consumer costs and inflation. Previously it was projected that China would experience a robust economic growth in the future but there are many barriers in the path of the economic development of the country. Some of those barriers include bureaucracy, shortage in energy, reducing levels of export because of decreasing demand of Chinese manufactured products in some of the major markets like UK and USA, social unrest in the country, increase in aging Chinese population, and so on. According to a report published by BBC News in the month of July 2012, China experienced a slowdown in its economic growth rate to around 7.6 percent. This study entails about discussing and analysing the various negative effects that certain economic factors are having on the Chinese economic growth at present and in the foreseeable future. China contributes significantly towards the overall growth of the world economy. Hence, unstable and unsustainable Chinese economy is having a significant impact in deterring the global economic condition. This study would try to shed light on some of the major problems faced by China which can be responsible for slowing down the economic growth rate of the nation in the forthcoming years. Five such major factors have been discussed in details in this study. They are : a) International trade and exports by China, b) Problems related to Chinese currency and the foreign exchange regulations prevalent in the country, c) Problems associated with the increasing aging population of the country, d) The rising levels of income inequality within the country, and e) The present bad conditions of the Chinese banking industry. All these five reasons can hinder the path of economic development of China in a significant manner. The central idea of this study is to present a detailed analysis of these five issues faced by the Chinese economy at present and how it can limit the economic growth rate of the country in future. International Trade and Exports in China The international trade sector of China and its changing trade policies have had an adverse impact on it economic growth and development in the recent years. If we look at the international trade and global market, it can be observed that China has successfully changed its traditional inward oriented trade policies and has adapted itself with the outward oriented trade policies. This was a challenging task for the country to transform itself into an open economy system from a closed economy system. During the course of this transformational change China had to go through several evolutionary changes like from its dependence in Soviet Union to its involvement in the World Trade Organisation (WTO) and also the bilateral trade system under the Export-Import (EXIM) framework. It was since the year 1978 when China started to integrate trade liberalisation policies into its economic development framework. It resulted in China gaining tremendous success in the international trade arena (Hart, and Lach, 2012). However the Chinese government did not encourage increase in imports in the country and set several limitations on the import of foreign goods by imposing high trade tariffs on those products. China became the member of WTO recently in the year 2001 (Centre for Policy and Development Systems, 2007). Soon after its inclusion in the WTO, China amended around 2,300 trade policies with the objective of matching the WTO standards and be at par with the other developed nations of the world. Trade barriers were also significantly reduced in the country. The country started taking several international trade initiatives to strengthen the global as well as the country’s economy. The Figure – 1 shown below indicates the growth of international trade in China during the period 2001 to 2010. It can be observed that the country experienced a significant growth in trade balance from 2001 to 2008, mainly due to the fostering growth in the export sector. However the trade balances have shown a declining trend since the year 2008. Figure – 1 International Trade by China (2001-2010) Source: (The US-China Business Council, 2012) The present statistics indicate that China is heavily dependent on exports for its economic growth and development. The present economic scenario in the country indicates that the country has shifted its focus from being an export oriented economy towards a demand oriented economy, especially in relation to the household consumption levels (Hong Kong Monetary Authority, 2009). This shift in strategy was planned in the year 2011. There has been a significant decline in the current account surplus of China in the recent years. This fall in the current account to GDP ratio of China has been explained by the International Monetary Fund (IMF) as being the effect of rising commodity prices in the country and the prevalent weak international economic environment. On the basis of past records, it can be concluded that the external economic position of China is highly sensitive towards the global economic conditions. It implies that the rise and fall of the global economy would have a direct impact on the economic condition prevalent in China (Kotz, and Zhu, 2008). The recent global financial crisis (GFC) in 2008 had an adverse impact on the economic conditions of China. In order to improve the economic condition in the country the Chinese government introduced stimulus package amounting to around USD 634 billion in 2008. This increase in investment resulted in considerable reduction of current account surplus to GDP ratio of China (United Nations Development Programme, n.d.). Stimulus packages were further introduced by the Chinese government to improve the weakening economic condition in the country. All these facts resulted in China successfully rebalancing its exports after the global economic downturn. There was a 30% appreciation in the Chinese currency exchange rate which helped in rebalancing the exports again (Akyuz, 2011). China surpassed the European Union in terms of being the second largest exporter of the world in 2007. Since then there has been a declining trend observed in the export figures of the country. This is considered to be an indicator of the declining trend of economic conditions in China. There was a diverse impact on the export levels of China mainly due to the fact that the global financial crisis weakened the economic conditions of some of the major export buyers of China like Japan, Europe and United States. The purchasing power of all these export buyers of China got reduced considerably and resulted in reduction in the export levels of China by around USD 114.99 billion during the period of recession. Prior to the advent of global financial crisis, China was totally an export oriented country and this backfired on them during the recession. There was a considerable decline in the GDP levels of the country during and after recession with a slow growth observed in 2010 (Asian Economic Institute, 2012). This rapid decline in GDP is mainly attributed towards the significant dependency of the country on exports. Hence, the only alternative left for China is to shift its focus from being an export oriented country to a demand or consumption oriented economy. However, this strategic transformation in the Chinese economy requires major industrial restructuring process to be carried out in the country. As mentioned earlier there has been a significant decline in the export levels and economic growth rate of China in 2009, soon after the global economic recession. The GDP growth rate of China in 2009 remained at around 3% below the levels observed during the period 2004 to 2007. This condition resulted even after the infusion of around 15% of the country’s GDP as fiscal package initiated by the Chinese government (Christensen, 2012). The huge export surplus can prove to have a detrimental effect on the economic growth of China in future. Even if the external accounts are balanced by China, the rising export surplus to GDP ratio would still possess a major threat for the Chinese economy. Greater dependency on exports can pose a significant problem for a large economy like China because exports are expected to grow by around 2% to 3% annually as against the 10% overall growth rate of the Chinese economy. Generally a situation resulting in exports of country being greater than the world’s GDP is considered to be good for the country’s economy and it is supposed to be having a high economic growth. However the underlying condition behind this situation is that the imports and exports of the country should balance each other. However, a sudden increase in the growth of a country’s economy is also not good which is instrumental in case of China and this can have detrimental impact on its economic growth in the long run. With the rising globalisation, most of the nations of the world are found to be globally interconnected with each other. The economic loss or profit of one nation can easily get transferred to the other countries of the world (Bradsher, 2012). The short term problem that can be faced by China due to this prevalent situation of high export surplus might be the impact of prevailing global economic downturn condition which has resulted in the significant decline in the export levels of the country in the recent years. The long term effect on China could be a sluggish growth in economy in the forthcoming years. A rapid economic growth can be experienced by any country if it is relied on the domestic market conditions and not on the external market environment. However, the recent upsurge in globalisation have minimised this scope for most of the emerging nations of the world like China. Hence, in the context of China, it might face problems because with the present rate of increase in exports it can even surpass United States very soon. However, with increasing Chinese exports in United States, it would result in greater degree of economic integration and mutual interdependence which may not be welcomed by many superpowers of the world (Sun, and Heshmati, 2010). Hence, it is always advisable that China should reduce it export dependency and shift its focus towards increasing household consumption levels in the country. In such situation, technological up gradation could prove vital for increasing the economic growth rate of China. The whole idea is centred on making maximum utilisation of the manufactured goods and products within the country itself. This would help in reducing exports and minimising imports at the same time. The ultimate result would be reduced dependency on the external market conditions, thereby boosting the economic condition in the country. Foreign Exchange Regulations and Chinese Currency The official currency of China has been named as Renminbi (RMB) or Yuan. The Chinese currency is another major hindrance in the path of economic development of the country. It is so because the economic growth of countries is directly related with the condition of international trade flowed in the nation which again is largely dependent on the currency foreign exchange rates. RMB is issued by the People’s Bank of China who has the responsibility of regulating the foreign exchange rates in the country. It has been proclaimed by the People’s Bank of China that RMB would not be directly pegged with USD and it would be simply added to the foreign currency reserve of the country (Poleg, 2005). RMB would be traded within the minor 0.3% band along with other foreign currency reserves of the country. The foreign exchange reserve of China mainly comprises of certain currencies like USD, Pound, Euro, Yen, Rubble and Baht. If we consider the foreign exchange rate between USD and RMB, it can be observed that during the period 1994 to 2005, RMB was supposed to follow USD and thus the value of RMB was determined through the value of USD. However, in the year 2003, this system of foreign exchange valuation was criticised since the reducing USD value led to the corresponding decline in the value of RMB. This made the Chinese exports more competitive in the global market. Chinese government was under huge pressure from the outside world to increase the value of RMB that could encourage imports and reduce exports. However, the Chinese government resisted this pressure of revaluation of its currency mainly because of the fact that there was an increasing concern about the declining job rates in the country. It would have also resulted in increasing the currency risks faced by the Chinese banks which they were not ready to handle then (Li, n.d.). It is a common belief of most of the world economists that floating interest rates are feasible only in the long run. However, if the foreign exchange rates are changed once in a while it might result in speculations and fluctuations in the exchange rates of the currencies thereby creating a pressure on the government to float the currency rates in total effect. Some of the analysts also concluded that the RMB was undervalued so as to limit the Chinese people moving away to foreign countries. Moreover, this situation of appreciating the value of RMB also raised concerned in the United States because many of the US based organisations were mainly dependent on the factories located in China for certain goods and products like computer accessories, aerospace products, etc. These companies were totally against the decision to appreciate the value of RMB. The financial costs associated with free valuation were also complex in nature (Hua, 2011). Appreciating the value of RMB would have an adverse effect on the US economy because it would result in reducing the purchasing power of Chinese government and they would not able to buy many treasury bonds from United States, thereby reducing the US bond prices significantly. It was declared by the Chinese government that the market supply and demand forces would be institutional in determining the exchange rates of RMB or Yuan. However, after 2005, the Chinese government allowed gradual appreciation of RMB and at the end of the year 2008, the exchange rate of RMB was adjusted to 6.83 from 8.11. The market supply and demand forces were mainly institutional for these movements in the prices of RMB. Nevertheless, this increasing rate of appreciation of RMB was slowed down through the market intervention by the Chinese government. This step was taken up by the Chinese government to prevent the adverse effect of economic downturn during the onset of the global financial crisis. Although the value of RMB depreciated to 6.83, the Chinese government was successful in maintaining the exchange rate at this level until 2010. The depreciation of RMB as a consequence of the financial crisis had a significant adverse effect on the Chinese economy (Morrison, and Labonte, 2011). In the recent times, the Chinese government allowed RMB to be traded in the international foreign exchange spot market with the notion that it has developed the capability to compete in the international currency market. This was done by the Chinese government with the motive of promoting trade in the country. It also helped to decrease the dependency of RMB on USD. It is expected that very soon RMB might outperform dollar as the vehicle currency all around the world. Russian government also agreed to allow trading Rubble in the spot market. It meant that RMB can now be traded with Russian Rubble without requiring the intervention of USD in the process. Hence, both Russia and China are trying to eliminate the usage of USD in their bilateral trade activities. The undervalued Chinese currency, RMB has ultimately resulted in increase in inflation in the economy. The fuelling of export economy of the country through undervalued RMB is having an adverse effect on other economic sectors of China. Moreover, the cheap products manufactured in China are not high quality products. This is hampering the business and economic growth of the country as well. Another negative effect of undervalued RMB on the Chinese economy is that the foreign products available in the country are too expensive and thus its demand is also low within the country. This is preventing the multinational corporations to enter into the market of China as well. All these factors are not good signs for the sustainable growth of China in the forthcoming years. Problems of Aging Population in China Population aging has been observed in most of the nations of the world. It is expected that in the forthcoming 10 years or so, the global population of people having ages 60 or greater than that would increase at an unprecedented levels (Figure - 2). Figure – 2 Projected increases in aging population of the world Source: (Banister, Bloom, and Rosenberg, 2010) China is also no exception and the same trend is expected to follow in case of China as well. It is expected that the elderly aged people in China would increase at a significant rate in the forthcoming years (Figure - 2). Figure – 2 Aging Population of China Source: (Banister, Bloom, and Rosenberg, 2010) This increasing percentage of aging population can raise concerns for China mainly for three reasons. First of all, the elderly population in China do not contribute towards the economic development of the country in a same way like the working-age population in the country. Hence, with the increasing share of old aged people in the Chinese population it is expected that the economic growth rate of the country would slow down in the forthcoming years. Secondly, the relatively large proportion of elderly people observed in the Chinese population in recent years as opposed to the previous years are required to be supported by the relatively smaller proportion of adult population of the country who are economically active. Another major problem that could be faced by the country is that the large volume of elderly population would prove to be an economic burden for the country because the medical expenses for the old aged people is considerably more than the younger generation of China. The increasing trend of elderly population in China is mainly attributable towards three major causes behind it. They are: a) Declining trend in the fertility rate, b) increasing levels of life expectancy, and c) the age structure dynamics of China. If we look at the fertility rates trend in China in the past it can be observed the country has experienced a significant decline in the fertility rate and it went below the level of 2 by the end of the year 1995. This declining trend in the fertility rate was particularly prominent during the period of 10 years between 1970 and 1980. It was a result of a number of policies taken up by the Chinese government to curb the fertility rate in the country like the policy of late marriage, higher age at first child birth, fewer births, long intervals between births, etc. Apart from these steps, the Chinese government also implemented the one-child policy in the year 1979. This resulted in a significant reduction in the fertility rate in China. The fertility rate is expected to remain below 2 in the forthcoming years as well. As regards the life expectancy rate in China, it has increased at an alarming rate in the recent past. It is expected that the life expectancy would reach around the levels of 80 years by the end of 2050. These two major factors have led towards the increasing percentage of old aged people in China in the recent and are expected to continue in the forthcoming years. Now, since most of the Chinese people above the age of 60 cease to work, the demographic trend has raised serious concerns for the economic growth and development of China because with the increase in aging non-working population the productive labour population is expected to fall significantly in future. The ratio of working aged population to non-working aged population increased significantly in China during the 1970s and has reached its peak level now. Hence, it is expected that this ratio would start declining in the coming decade. Since this ratio is a representative of the number of dependents that the working people in China are required to support, it implies that the economic growth rate of the country would slow down in the future. Thus, the main negative impact of the increasing aging population of China would be a significant rise in total healthcare costs incurred by the younger generation which in turn would have an adverse impact on the economic growth rate of the country. Another major economic consequence of this increasing aging population of China is that there would be a reduction in supply of skilled labours required in most of the manufacturing industries in China. With the shortage of skilled labour in the country, it would result in increasing manufacturing wages and thereby reduce the export competitiveness of China. Hence, the rising aging population can pose a major threat for the Chinese economy in the forthcoming years. Increasing Level of Income Inequality The rising level of income inequality in China can also be considered as a major hurdle in the path of economic growth of the country in future (Shih, 2011). If we look at the geographical trends in economic growth of China it can be found that most of the growth has been confined to the eastern and southern parts of the country only. The northern region of China is mainly dependent on the agricultural income. This region lacks economic growth and development as compared to the other parts of the nation. The Chinese people in the northern part of the country are mostly farmers who are very poor and have to work hard to fulfil their basic necessities in life. Hence high levels of income inequality can be observed in the country like other nations of the world such as Philippines or Russia. It has been observed that the rural income of China accounts for almost one-third of the income generated in the cities and urban areas. One of the major reasons behind this fact could be the economic system prevalent in China which limits around 150 million workers in the rural areas to have access to certain necessary amenities of life like healthcare, pension and education. Due to these reasons the rural working population in China are required to save more of their earnings for food, medical expenses, retirement plans and other basic necessities of life. Apart from this the increasing inflation levels is also proving to be a burden for the migrant workers of China. If we look at the wealth gap of China it can be found that it has increased to 0.5 percent from 0.3 percent and it is continuing to rise day by day. It has been observed that the wealthy class of people in China has an earning which is around 65 percent more than almost 10 percent of the rural class people in the country. The Chinese government has taken several preventive measurement steps to reduce this rising levels of income inequality like creating provisions for improved education and healthcare, abolishing the agricultural tax, and so on. However, corruption at every level has proved to be a major hindrance in the path of implementation of such reform policies taken up by the Chinese government. The aid or benefit that is meant for the rural and needy people are not actually received by them in the due process. The economists form the World Bank group suggests that China needs to restructure its fiscal policies in order to reduce the income gap between the wealthy and rural class people in the country. The increasing income gap and income inequality in China is expected to deter the economic growth of the nation because economic development is not only measured through the status of foreign exchange rates or the current account balance of a country but is also dependent on the growth and development of all the people in the country. The weak economic condition in the northern region of China proves the income inequality in the country in spite of China having a stable currency and overall picture of the country’s good economic condition. Hence, it is expected that China would not be able to hold on to its good economic condition for a long time with certain activities like manipulating the Chinese currency value and gaining undue advantage in the export sector. Problems in Chinese Banking System The prevailing condition in the Chinese banking sector is also a major threat for the future economic growth of the nation. The Chinese banking sector do not have good reputation in relation to the bad debts suffered by the banks in cases of failure in the loan recovery process. The Chinese government organisations receive loans from the banks most of which are not repaid to the banks. Hence, it can be considered as a legacy of the communist government of China. As a consequence of this prevailing condition in the Chinese banking sector, capital funding required for initiation of genuine business ventures is becoming difficult for the banks. During the period of global financial crisis in 2008, the Chinese government ordered the banks to lend money without any interests in order to improve the economic conditions of the country. This was an effective decision taken up by the Chinese government in the midst of financial crisis situation in the global economy. However, it proved to be effective only for the state owned and government business institutions and not for the privately owned small business firms in the country. Funds were being borrowed by the Chinese government to invest in the real estate sector and the infrastructure projects in China. These infrastructure projects initiated by the Chinese government were termed as Local Government Financing Vehicles (LGFVs) (Bloomberg News, 2012). However, many of these projects turned out to be frauds and some resulted in generation of only revenues and no profits. On an average the amount of bad debt that the Chinese banks had to bear from all those loans lent to the local government was estimated to be around RMB 3 trillion or 470 billion in terms of USD. These borrowed amounts were meant to be stimulus packages offered by the Chinese government to improve upon the financial crisis situation existent in the country. This further worsened the banking conditions in the banking industry of China. It proved to be a difficult task to raise funds for the infrastructure projects because already a huge sum of money were declared as bad debts and the local governments in China were unable to fund the projects. This situation resulted in a Chins possession bubble in the country’s economy (Hunt, 2012). The owners of the real estates in China were unable to purchase land from the government because of shortage in financing supply by banks. The government was thus not able to sell of the lands possessed by them and could not generate revenues that could support the LGFVs. All these processes resulted in accumulation of more and more bad debts in the Chinese banking system. The funds required by the small and medium-sized enterprises (SMEs) also fell short of supply because this rising bad debts in the Chinese banks. This had an adverse effect on the export sector of China as well. Hence, the real estate, loans and tax revenue sectors had to suffer eventually (Heaton, 2011). Conclusion China has experienced a robust growth in its economy in the past and is expected to continue in the future as well. However, there are certain existing issues associated with the Chinese economy which can have an adverse impact on the overall growth rate of the country’s economy in future. The present study discussed about the five major factors which can come in the way of China’s economic development in the forthcoming years. One such issue cited in this study is the dependency of the Chinese economy on the export sector to boost its economic growth. Since China is heavily relied on its exports to some of the major markets of the world like UK and USA, the prevailing economic downturn situation in these markets have greatly affected the exports of China in the recent years. Apart from this, the Chinese currency and issues related to its valuation can also have a significant impact on slowing down the economic growth rate of China. The increasing aging population is leading to the increased costs for the working population in the country and the overall economic growth is slowing down in China. Moreover, the income gap between the wealthy and rural class people in China also pose a threat towards slowing down the China’s economic growth in future. Lastly, the rising levels of bad debts in the Chinese banking industry us also creating financing problems and limiting many industrial developments in China. Hence, China needs to address all these hindrances in the path of its economic growth in order to sustain its economic development at present and in the foreseeable future. References Akyuz, Y., 2011. Export Dependence and Sustainability of Growth in China. China & World Economy, 19(1), pp. 1-23. Asian Economic Institute, 2012. 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