China's steady rise looks unstoppable

A productive work force is much better paid, lancing the boil of a widening income gap. Purchasing power has surged, thanks to a stronger renminbi. Beijing is a leader in improving energy efficiency.

After investors’ bearish reaction recently to a moderate slowdown in economic growth in July this year, it is time to make again the unabashed long-term bullish case for China. Ross Garnaut, an economics professor at Australian National University in Canberra, is among those who are confident that China is about to enter an era of higher-quality growth.

First and foremost, there will be a number of large and continuing increases in real wages and in the wage share of income, Garnaut wrote in The East Asia Forum, an online newsletter.

This is critical. Pay has risen briskly in China, but profits and the government’s share of national income have risen even faster, squeezing workers. “The powerful tendency since the 1980s towards increased inequality in income distribution is likely to be reversed,” Garnaut wrote. In this virtuous circle, spending will rise and the national savings rate will fall, thus reducing China’s external surpluses and easing tensions with Beijing’s trading partners. Garnaut said there was no basis for assuming that a shrinking of the work force, would dent the productivity gains; the economy could keep expanding at close to the near double-digit average of the past 30 years of market reform.

That headlong growth catapulted China past Japan last quarter to become the world’s second-largest economy, according to an estimate by the Japanese Cabinet Office.

Growing with others

Urbanisation, development of the interior and investment in a low-carbon economy will sustain annual growth at more than 9 per cent in the coming decade, according to Li Daokui, an economics professor at Tsinghua University in Beijing. If he is right, the consequences for the rest of the world will be far-reaching. Two International Monetary Fund economists, Vivek Arora and Athanasios Vamvakidis, calculate that over the past two decades, a percentage point of extra Chinese growth has been correlated with an average rise of 0.5 percentage point in the growth of other countries. “Moreover, while China’s spillovers initially only mattered for neighbouring countries, the importance of distance has diminished over time,” they wrote in a working paper.

Garnaut of Australian National University predicts that even richer vistas could open up for the likes of India as China’s comparative advantage shifts to technologically complex goods from simple manufacturing. Think high-speed trains, not plastic toys. Like Garnaut, Amar  Gill, a researcher at the brokerage firm CLSA, says the share of consumption in China’s gross domestic product can only rise.

The increase in the dollar value of China’s consumption has exceeded that of the United States since 2007. Yet Chinese households consume less than 36 per cent of GDP, the lowest rate among major economies.So if China’s GDP grows at 8 per cent or 9 per cent a year, real consumption could expand by 9 or 9.5 per cent annually, he estimated.

“Beijing can see that, and thus they are now allowing income growth of 15 to 20 per cent a year to shift a bigger part of the GDP into the hands of households and also increasing the buying power of the consumer , ” Gill said.

It is the inflation-adjusted exchange rate, together with the pace of real GDP growth, that dictates how quickly dollar incomes in developing countries catch up with those of rich economies.

If China does indeed have little surplus labour left to move off the land, the real exchange rate could rise rapidly as wages sprint ahead, pushing up unit labour costs in services. Louis Kuijs, a World Bank economist in Beijing, has doubts about whether the Chinese labour market has reached a turning point. That makes it tough to forecast the currency’s trend. So Kuijs, in a recent paper, maps two paths. One assumes a rise in the renminbi’s real, trade-weighted exchange rate of 0.8 per cent a year; the other assumes a 3 per cent rise, in line with the experience of Japan from 1965 to 1990 and South Korea from 1970 to 1996.

What is striking is how little difference this makes. Under the slow appreciation scenario, China overtakes the United States as the world’s biggest economy in 2029; if the exchange rate rises faster, it does so by 2023.