A big event this October was Chinese President Xi Jinping’s address to the 19th Congress of the Communist Party of China. While marking his attainment of cult status, Mr Xi’s speech, as widely reported, is also a definitive statement of China’s ambition and vision to be centre stage in global power. Of special note, among other aspects, are the statements with respect to economic development. There is a clear recognition about what China needs to do to consolidate its economic might. Mr Xi’s speech points to further opening to global trade and investment, pushing ahead with economic reforms in the financial sector and foreign exchange rate management, and encouragement of innovation to make the Chinese industry move up the value chain. While the speech does not lay out a concrete action plan, the recent past provides evidence that it may not be hard for China to convert intent into reality. Some salient features of recent growth and reform in China may help in better understanding the context and forming realistic expectations about the country’s future economic trajectory.
First, even though the evolving macroeconomic outlook for China over the past decade has included the possibility of a crisis on account of rising domestic debt levels, China has continued to be the world’s fastest-growing large economy for almost the entire period. Dented by the global financial crisis and recession and some natural deceleration of a very large economy, China’s growth has undoubtedly slowed down. The sustained double-digit growth rates now belong to the past. But a strong growth trajectory has not been derailed. Economic growth over the past five years has averaged 7 per cent, an unprecedented feat for such a large economy ($11 trillion in 2016). Recent growth projections by international agencies predict a positive outlook for the next few years. According to the latest IMF World Economic Outlook, China is expected to grow at 6.5 per cent or higher over the period 2017 to 2021.
However, the continuing threat to this positive outlook posed by rising government, corporate, and household debt remains. Total debt could increase to 300 per cent of gross domestic product (GDP) by 2022, up from 200 per cent in 2016. Even though this creates the possibility of a sharp decline in growth in the medium term, the IMF outlook points to some signs of corrective policies and prospects of deleveraging. The credit-to-GDP gap seems to be narrowing down. In addition, the ongoing 13th Five-Year Plan (FYP), 2016-2020, recognises the need to develop suitable policy and systemic responses to financial risks that may arise in the process of debt deleveraging. Furthermore, it is important to remember that banks in China are state-owned; so that debt restructuring, as and when undertaken, may be less difficult and far less likely to culminate in a major economic crisis than in nations where private banks dominate. Finally, some restructuring of state-owned enterprises is already underway in China.
Second, innovation-based movement up the value chain has been the Chinese mission for some time. China’s 13th FYP places major emphasis on innovation. The ambitious “Made in China 2025” strategy that is aimed at achieving dominance in high-tech industry also identifies innovation as the main motivating force. China’s structure of comparative advantage has evolved in recent decades with underlying dynamism shifting from low value added to high value added industries. There is growing evidence of China evolving from its ‘factory of the world’ status that was achieved through perfecting its assembly line production processes. Recent trade trends for China show a greater decline in imports relative to exports. This suggests that China’s participation in global value chains (GVC) is increasingly getting domestically consolidated with a rising proportion of intermediate inputs being sourced domestically rather than through imports. While in the initial stages of GVC participation, foreign direct investment and technology transfers played an important role in up-gradation of China’s comparative advantage structure, the recent development of domestic intermediate goods replacing imports is largely based on innovation. In the 2016 World Intellectual Property Organization (WIPO) Global Innovation Index (GII) China’s performance was among the 25 most innovative economies in a set of 128 countries. According to the GII report this is the first time that a middle income country has joined the ranks of highly developed economies that have dominated the index since its inception nine years ago. China has continued its upward movement in the index and ranked higher at 22nd on the GII in 2017. China’s research and development (R&D) investment has grown in the last two decades with the rate of growth being greater than that of the top performing US and EU. According to UNESCO data, China is the second largest spender of absolute amounts of R&D and accounts for 20 per cent of the world expenditure on R&D, second only to the US share of 30 per cent.
Third, moving towards a floating exchange rate system is imperative for China and has been long overdue. Some movement towards greater market orientation and transparency was initiated in August 2015. Additional reforms towards evolving a mechanism for the central parity rate that reflects the demand supply conditions in the foreign exchange market through linkages with a basket of currencies based on previous day closing rates were indicated in 2016. However, the subsequent introduction of a ‘countercyclical factor’ has invited criticism. The opacity with regard to motivations to manage market rates and exchange rate volatility has once again revealed the ever present state control of the market mechanism.
Summing up, sustained progress on the “socialism with Chinese characteristics” path may continue to ensure China, strong growth and associated potential for expanding economic and strategic influence.
The writer is professor of economics, Centre for South Asian Studies, School of International Studies, JNU. An earlier version of this article was published by the Institute of Peace and Conflict Studies in its monthly column, Regional Economy, on October 30