China in Transition

China Seeking to Transform its Economic Development Pattern

Chi Hung KWAN
Consulting Fellow, RIETI

(Published in the December 9, 2011 edition of the Allatanys Newspaper Guide)

In China's 12th Five-Year Plan (2011 to 2015), the transformation of economic development pattern is regarded as the key to achieve quality improvement as well as quantitative expansion of the economy. "Transformation of economic development pattern" means three shifts: one in the demand structure from investment and exports to consumption, another in the industrial structure from the manufacturing industry to the service industry, and the third one in the mode of production from the expansion of inputs to the improvement of productivity. Since launching its reform and open-door policies at the end of the 1970s, China has been achieving high growth at an average annual rate of nearly 10%, while facing a number of structural problems. China has begun to accelerate the transformation of its economic development pattern because of the changes in the internal and external environments it faces such as labor shortages, the advent of an aging society, depressed overseas markets, intensifying trade frictions, and the escalation of resources and environmental problems.

Higher consumption—Transformation of the demand structure

The first transformation of economic development pattern that China seeks is a shift in the demand structure from growth driven primarily by investment and exports to one joined by consumption as an additional engine.

Following the global financial crisis triggered by the collapse of Lehman Brothers, China also saw a substantial decline in its exports and, as a result, experienced an economic slowdown. Given that strong growth in exports to the United States cannot be expected as in the past, China has to boost domestic demand as well as diversify export markets if it is to maintain its rapid rate of economic growth. This will contribute to reducing the trade surplus with the United States and, in turn, eliminating trade friction. Domestic demand consists of investment and consumption. While the investment ratio (the ratio of capital formation to GDP) reached 48.6% in China in 2010, the ratio of private consumption to GDP is extremely low by global standards, at just 33.8%. Since a fall in investment efficiency is inevitable if the investment ratio is raised further, China must rely on higher consumption to boost domestic demand, and in this respect, improving income distribution is the key.

Focus on the services sector—Transformation of the industrial structure

The second transformation of economic development pattern is a shift in its industrial structure from growth driven mainly by the secondary industry (manufacturing) to balanced growth among primary (agriculture), secondary, and tertiary (service) industries.

Rapid industrialization has resulted in the depletion of resources, environmental degradation, and trade friction. As many countries have experienced, the core of an economy shifts from the primary industry to the secondary industry and then to the tertiary industry as the economy develops. The secondary industry as a percentage of GDP reached 46.8% in China in 2010, extremely high compared with not only developed nations but also emerging countries that are at a similar stage of development as China. China has already become the largest energy consumer and the biggest carbon dioxide emitter in the world, and the shift from manufacturing to services will conserve energy and improve the environment. Rising exports of industrial products are supporting economic growth in China on the one hand, but intensifying friction with other countries through an expanding trade surplus on the other. In contrast, the development of the service industry will help shift the growth engine from external demand to domestic demand through creating new demand at home. This, in turn, will alleviate trade friction.

Improving productivity—Transformation of the mode of production

The third transformation of economic development pattern is a shift in the mode of production from one that relies on the quantitative expansion of inputs such as labor, capital, and resources (extensive growth) to one that depends on higher productivity (intensive growth).

As the Chinese economy develops and grows in size, constraints on growth in terms of resources and the environment, as well as labor input, have emerged. In particular, as symbolized by the tighter supply of migrant workers in the coastal areas, labor has moved from a state of excess to one of shortage. In addition, with the imminent aging of the population, the high savings rate that has been supporting heavy investment to date is expected to decline. Conceptually, the growth rate of GDP is equivalent to the sum of the contribution from expanding labor and capital inputs and the growth rate (or contribution) of (total factor) productivity. In China, as the contribution from labor and capital inputs is likely to fall going forward, the growth rate of productivity has to rise if high growth is to be maintained. Promoting industrial development through a shift of resources from low-productivity to high-productivity sectors will be the key to transforming the mode of production.

Opportunities and challenges for Japan

The transformation of economic development pattern in China provides the Japanese economy with numerous opportunities and challenges.

First, the growth in domestic demand centering on consumption in China will boost exports and sales there for Japanese companies. In fact, the center of gravity of external economic relations of Japan has been steadily shifting from the United States to China. In 2009, China overtook the United States to become Japan's largest export market, the first change in the top spot in the postwar era. In addition, reflecting growth in domestic demand in China, the proportion of local production by Japanese companies in China (including Hong Kong) being directed to local sales has been rising from 35.1% in 2002 to 63.4% in 2010 (the "Quarterly Survey of Overseas Subsidiaries" of the Ministry of Economy, Trade and Industry). Thus China is becoming more and more important for Japanese companies not only as a workshop but also as a market.

In addition, although investment of Japanese companies in China has been centering on the manufacturing industry, the weight of the service sector is rising in concert with the shift in the core of the China economy from the secondary to the tertiary industry. In particular, China needs to strengthen actively its alliances with foreign companies to absorb the most advanced technologies and management know-how in the modern service sector. Joined by the lifting of restrictions on foreign capital, business opportunities for Japanese companies in China are likely to increase in areas such as finance, logistics, and telecommunications.

Meanwhile, in step with progress in industrial development in China, Japanese companies have begun to look to increase the production of higher value-added products in China when making foreign direct investment, while transferring the production of lower value-added products from China to Southeast Asian countries where labor is cheaper. This can be regarded as an opportunity for Southeast Asian countries and emerging countries such as India to accelerate their industrialization, with the inflow of direct investment as the driving force. At the same time, however, concerns about hollowing-out are likely to continue to mount in Japan. As in the case of China, to avoid this, Japan needs to upgrade its industrial structure by developing new growth areas.

The original text in Japanese was posted on December 13, 2011

December 13, 2011