China's Shift To A Consumption-Driven Economy

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Includes: CN, CXSE, FCA, FXI, FXP, GXC, MCHI, PGJ, XPP, YANG, YAO, YINN, YXI
by: Cornell Current

By Jeffrey Fung of Cornell Current

Ever since the late 70′s, China has witnessed its transformation from a nation living in isolation into one that is progressively opened to the world. With Deng Xiaoping’s rise to power, China began to embrace the importance of foreign trade as Deng improved international relations and encouraged foreign investments, capitalizing on the country’s low cost advantage. This fuelled an export-led growth economy along with the government’s commitment to capital investment and technological development. This extraordinary period is widely known as the “30 year growth miracle,” underlining the fact that China’s GDP growth rates were largely in the double digits.

However, China realized that its export and investment-led engines of growth were unsustainable in the long term. During those first 30 years, China’s growth was heavily dependent on its low cost advantage compared to those of other countries. Foreign companies flocked to China, setting up production facilities and factories to capitalize on this cost advantage. Though this contributed to the economic growth and increasing importance of China on a global scale, China became excessively reliant on exports for its economic growth as the low wages translated into low domestic consumption levels. The global financial criss exacerbated this problem by causing a severe lack of demand for China’s exports, visibly demonstrating the flaws in an economy so reliant on the conditions of other nations.

Today, China’s GDP growth has dipped to around 7.5% as the country’s leaders are determined to accept a slow-down as the necessary cost of rebalancing the economy and shifting China’s growth to rely more on private enterprise and domestic consumption. In China, consumption’s share of GDP is a measly 35%, compared to that of an established U.S. economy – around 70%. As such, there is substantial room for improvement in this regard. In fact, retail sales, a key indicator of consumption, have been growing at double digit rates around 12% year on year, and it is expected that this economic transformation will continue to support China’s GDP growth while turning the country into a more independent nation, reliant on its internal demand and spending.

With rapid urbanization occuring in China, the middle class is becoming an increasingly important constituent of China’s future. The middle class currently represents approximately 50% of China’s urban population. As more people become employed in stable and better-remunerated jobs in the main cities, these same citizens will gain a strong appetite for spending and consumption, contributing to a more sustainable economic growth. However, the downside of this is the ensuing higher input costs for companies. It will have a ripple effect on the global economy as foreign companies have started to scale back their production in China. In the short run, this may have a denting impact on employment. In addition, with the world generally in a growth-starved scenario, countries such as the United States will need more markets to export to, in order to prop up their economic outlook. As China becomes more self-sufficient, other countries are already feeling the effects. In particular, producers of commodities such as iron ore will see their prices plummeting due to China’s conscious decision to scale down its government investments. Countries such as Australia, whose economies are very much dependent on exports of natural resources, will be amongst the first ones to feel the pain as China embraces internal consumption for long-term growth.

An exemplification of the potential rewards of this economy shift is Alibaba’s recent IPO – the largest ever in the world. This IPO not only attests to a much more vibrant services sector and improved consumption level in China, but also conveys the message that global investors are now more receptive to China’s economic, social, and political conditions. Alibaba changes the way China does business internally, providing consumers and businesses with a web of information that is available to the 560 million Chinese residents who use it. Alibaba now accounts for the majority of all physical boxed deliveries in China and in 2012, the value of the transactions processed through Alibaba exceeded those of Amazon’s and eBay’s numbers combined. Alibaba’s success epitomizes China’s desire and ability to thrive as a self-sustaining economy through bolstering its domestic consumption and embracing the services sector as a main pillar of growth.

Despite the current shortcomings of China’s economy, this transition towards a more sustainable economic growth model will immeasurably improve China’s long term prospects. Through this change, China will become a more economically independent nation, thriving on increased domestic wages and consumption – which will, in turn, benefit the global economy as a whole.

Sources:

http://www.investopedia.com/articles/investing/081214/5-things-know-about-alibaba-ipo.asp

http://www.nytimes.com/2014/01/21/business/international/for-china-a-shift-from-exports-to-consumption.html?_r=0