Gopi Krishnan asked: Is China's economic development sustainable? Once the wages increase?

Smita Purushottam replies: This question is increasingly being asked in the wake of the economic crisis, which China coped with by investing in massive domestic stimulus packages, but which contributed to overheating in the property market and greater indebtedness in the banking sector. China’s exports to the developed world, which fell at the height of the crisis in 2009, are also projected to face challenges (though first half yearly 2010 trade statistics show a rebound at 43 per cent, with the trade surplus shrinking by 42.5 per cent), as the latter shift to savings over consumption, boost exports, and maintain pressure for yuan appreciation. In addition, inflation, inequalities (China’s GINI coefficient is 0.47), environmental and societal problems, demographics and related dips in savings rates - are the near to long term challenges for China (please see http://www.chinadaily.com.cn/opinion/2010-06/29/content_10032151.htm).

However, China’s economy has a robust base. Chinese reforms in the 1980s were directed at building a strong infrastructure and supporting China’s manufacturing and export sectors. The Chinese manufacturing sector thus got its factor inputs at relatively lower rates than India’s - cheaper electricity, currency, land, labour, and capital - and is 48 per cent of GDP compared to India’s 29 per cent. This led to creation of many virtuous cycles and assets like a competitive workforce. China later shifted to a more high-tech production strategy. Its export basket now more closely approximates the export baskets of advanced economies (after making allowances for processing trade – i.e. exports minus imported inputs) than India’s.

To tackle these problems China has announced it will encourage greater consumption, manufacture more high value-added manufactures/exports to cope with currency appreciation, invest in China’s less developed, western regions, etc. Rising wages are being seen as a means to increase domestic consumption and shift to a more high value added economy.

It may be recalled that a 2000 projection by Chinese strategic experts had forecast a US $2.5 trillion economy in 2010, but, in reality, nominal GDP has reached nearly US$5 trillion (at current prices) in 2010.

As mentioned above, there are problems in the Chinese economy with Chinese growth rates expected to moderate to 8-9 per cent. The challenge will lie in managing the issues raised in the transition as the economy is restructured and slows down.