I ‘ve already stated my views on China’s growth momentum and the main driving forces for it so far, based on various well written papers ([1][2][3]). I will summarize these views again here, in English this time:

China’s net export growth can be broken down in two distinct routes. A strong growth in exports and a stagnant increase in imports. The first factor can be attributed to:

  • China’s membership in WTO increased its competitive advantage in labor-intensive sectors like textiles and furniture, strengthening its exports (up to a point at expense of other production countries).
  • Metals and other related products (steel etc) took advantage of low energy costs (China is the number one user of coal in energy production in the world) as well as modernization of state controlled enterprises. The latter decreased their labor costs (they used to provide packages including housing, health care and pensions to their workers) and increased investments in expanding their production facilities.
  • Machinery and technology sectors like LCD screens, laptops and cell phones gained in production, due to low labor costs, huge internal market and mass production capabilities hard to find in other countries in the world.

In general, the dollar peg was not the driving force for China’s growth but mainly allowed for both prices and FDI profits to have a low currency risk.

As for imports, their growth has not followed exports, creating an ever increasing trade surplus. The main driving force has been a very high savings rates (especially compared to its main export markets), which can be attributed to structural factors inside the Chinese society:

  • Productive age population has been on the increase, with rural workers/farmers moving to urban centers pressuring wages. Furthermore, private house ownership (instead of state/company provided) is on the rise, pushing for a high savings rate with savings invested in common bank accounts.
  • Especially since the 90’s, state enterprise employment was lowered, while the social security fabric was deregulated, both the health and pensions sector. Private means of protection gained weight, with workers saving in order to create a readily available safety liquidity buffer.
  • The financial and private insurance sector is still far from mature which, coupled with strong capital controls (which place barriers in private investment abroad), create an insentive to invest savings in bank accounts, with commonly negative real interest rates.
My view has been that export growth will face barriers shortly, both due to energy costs (domestic coal usage has reached a peak, oil production has not much room to grow, China now functions as a ‘price setter’ for global commodity/energy prices) and because it now accounts for a large part of world exports, removing export share (and income) from other developed countries, although we might see China moving to higher quality product sectors (like cars for example). In the internal front, urbanization will face limits sooner or later, while the ‘one child policy’ will kick in, leveling the labor force numbers. The savings rate is an open question. Being more of a structural factor, it will probably play a key role in the medium to long-term, stabilizing the terms of trade.

IMF released an excellent, detailed paper on recent developments in China and its future perspectives. I will copy a small part of it here, though i strongly recommend reading all of it:

The sustained strength in imports of commodities and minerals has reinforced a dynamic that has been at work for several years now, going back to well before the global financial crisis. Over the past several years, imports have become more linked to commodities and minerals, where supply is relatively inelastic and global prices have been rising. At the same time, exports have become increasingly tilted toward machinery and equipment where supply is relatively elastic, competition is significant, and relative prices have been falling.

As a result, aside from 2009, China’s terms of trade has been steadily worsening. This may not be surprising from a historical context. Several other economies that have witnessed export-oriented growth (notably Japan and the NIEs) were affected by similar terms of trade declines along their development path. In China’s case, this dynamic is further fueled by the fact that, in both export and import markets, it has become so large as to no longer be a price taker. As a result, to some modest degree, China may well be generating a decline in its own terms of trade, creating a self-equilibrating mechanism that drives China’s terms of trade and creates countervailing downward pressures on China’s external surplus, through global prices.

Finally, a few words on the net income flows are warranted. It is something of a puzzle that, as China’s net foreign asset position has accelerated, there has not been a corresponding increase in net income flows. Looking first at the asset side, the rise in foreign assets in China has largely tracked the evolution of the central bank’s reserve portfolio and China Investment Corporation’s (CIC) investment position. Liabilities, on the other hand, have mirrored the growing stock of FDI flowing into China. The low net income flow numbers (which were actually negative in 2011) suggest a significant differential between the return on FDI into China versus that on the reserve holdings of the central bank. Indeed, it would appear, for much of the past several years, that return differential has been of the order of 3−4 percentage points, resulting in net income flows that are close to zero despite a growing net foreign asset position.

The Chinese government has rightly focused its policy efforts since the global financial crisis in a range of areas designed to accelerate the transformation of the Chinese economic model, improve livelihoods, and raise domestic consumption. Access to primary health care has been improved through the construction of new health facilities, particularly in previously underserviced rural communities. A new government health insurance program has been launched nation-wide, with the objective of achieving near universal coverage by the end of 2012 and subsidies for a core set of prescription drugs have been introduced. In addition, the existing government pension scheme is being expanded to cover urban unemployed workers across the country by end-2012 and to make those pensions more portable within China. Also, the absolute level of pensions has been increased, particularly for the elderly poor.

In addition to health care and pensions, improving access to affordable housing has been an important policy objective. The 12th Five Year Plan, launched in 2011, aims to construct 36 million low income housing units by 2016. The wider availability of low cost housing has the potential to ease the budget constraints of low income groups and release savings currently locked up toward financing home purchases.