Fundamental Problems With China’s Economy, Part Two of Two

China’s international competitiveness is weakening

By Tianlun Jian Created: February 6, 2013 Last Updated: February 6, 2013
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People view a model of a property development being sold at the Beijing Property and Investment Show on Sept. 20, 2012. Soaring housing prices have helped increase income inequality in China, as the rich have gotten richer while the poor have found housing increasingly difficult to afford. (MARK RALSTON/AFP/GettyImages)

People view a model of a property development being sold at the Beijing Property and Investment Show on Sept. 20, 2012. Soaring housing prices have helped increase income inequality in China, as the rich have gotten richer while the poor have found housing increasingly difficult to afford. (MARK RALSTON/AFP/GettyImages)

Recent economic data suggests China’s winning streak is coming to an end. Is this a temporary pause or is China’s economy taking a turn for the worse? If so, what are the causes for the change?

Part One of this article showed that consumption cannot drive growth in China in the future unless macro policies change to support real disposable income growth. The question remains whether exports and investment can continue to support high GDP growth in China.

Since the 2008 global financial crisis, economic demand for manufactured goods drastically weakened worldwide. In the wake of the crisis, demand for China’s exports has grown at a much slower pace. The export growth rate declined from around twenty percent per year between 2000 and 2007 to 8.8 in 2011. It further slowed to 1.0 percent and 2.7 percent in July and August of 2012 compared to the same months in 2011. 

In addition to global demand which is already slowing, low cost competition from emerging Asian economies is replacing China’s export goods.

China’s Exports are no Longer Cheap

Systemic undervaluation of the Chinese currency, the Renmimbi (RMB), has caused price distortions in international trade. Chinese manufactured products have been sold at low prices to increase China’s export volumes. However, under international pressure, during the past few years, China allowed the RMB to appreciate somewhat. Slowly, Chinese exports are losing their price advantage caused by currency undervaluation, which they have relied on for decades.

Changes within China also reduced its international competitiveness. Domestic wages have gone up at a double-digit rate each year in the past several years. Favorable demographics seem to be ending, in part because of effects of the one-child policy. Labor abundance is no longer a China characteristic. Between 2000 and 2010, China’s working population decreased by about 3 million each year. Labor shortages and rising wages have largely pushed up costs of exports, weakening China’s competitiveness.

Despite these increases in income, China is finding itself between a rock and a hard place. Wage increases push up costs relative to competition from other Asian countries and hurt exports. Yet, wages rise from such a low level that an increased consumption share remains elusive. In many cases, increases in wages merely compensate workers for inflation and sometimes not even that. 

Most Sectors Suffer from Overcapacity

Apart from increasing costs and a strengthening currency, the export sector suffers from chronic overcapacity. An endless array of factory buildings and machinery has been accumulated during the country’s decade-long investment spree.

China’s investment grew at high rates during the past decades, spurred by near zero real interest rates and the pursuit of GDP growth. As a result, China’s capital formation share of GDP went up from 35.1 percent in 2000 to 48.4 percent in 2011. 

In contrast, global capital formation declined during the same period. In South Korea, Hong Kong, Singapore, Japan, Malaysia, United States and Germany, global capital formation declined to a range between 15 to 29 percent.

Overcapacity is pervasive in most of China’s industrial sectors according to statistics released by the Ministry of Industry and Information Technology. 

For example, China has a production capacity for crude steel of 900 million tons, up about 300 million tons from 2008. According to the Committee of Development and Reform, the steel sector has an overcapacity of 160 million tons.

Overcapacity frequently leads to selling products below cost to generate revenue to service fixed costs. For the first seven months of 2012, 33.8 percent of the steel sector operated at a loss. If one excludes investment income from other sources such as property, the entire sector is losing money.

Even though steel companies know that they cannot sell their steel products, they are still producing at almost full capacity. A reduction of steel production will lower GDP growth rates—an indication of administrative failure. As a consequence, none of the local governments want to see steel production reduced. 

China’s solar sector has perhaps the worst overcapacity. Andrew McKillop writes in his report China and the Global Economic Crisis of Overcapacity: “Massive subsidies and state intervention have driven China’s overcapacity in solar power panels and systems to more than 20 times total Chinese national market demand for these panels, and close to two times the total of world demand.” 

Not surprisingly, shares of China’s solar companies, such as Trina Solar and Suntech Power, have dropped over 80 percent in the past five years. 

Overcapacity is a serious issue in China’s manufacturing, mining, aluminum, iron ore, cement, and other industries. Continued investment will only create more problems, waste resources, and do nothing good to balance the economy. Investment in productive capacity can only grow at lower rates than before and won’t be able to meaningfully contribute to GDP growth. 

Housing Bubble Ready to Pop

Investment in the real estate sector has also grown at breakneck speed in the past years. It accounted for 13 percent of China’s GDP in 2011, pushing up associated sectors as well. During the housing bubble years, it has made a significant contribution towards China’s high GDP statistics, creating ghost towns such as Erdos in the process. 

However, the coexistence of soaring housing costs and high vacancy rates indicates that China’s housing bubble is ready to pop. With a price-to-income ratio at 30-to-1, the vast majority of Chinese cannot afford purchasing a home. Vacancy rates of about 30 percent demonstrate a huge mismatch between supply and demand. 

As demand for housing dwindled, many land developers have already left the sector. This exodus will lead to a reduction of investment, create unemployment, and also reduce demand for steel, aluminum, and other materials, which in turn will affect different sectors of the Chinese economy.

Local governments will also be affected. During the past decade, easy and vast amounts of revenue from land sales have supported larger and larger local governments. Now, shrinking real estate demand directly affects local governments’ cash flow. Some may even become insolvent. Recently more and more local governments have found themselves in financial difficulties.

Throughout the past decades, the RMB undervaluation has made China’s exports cheaper. While this has helped push up export volume, China’s natural resources were priced too cheaply and used up too rapidly, also creating environmental problems. 

Through low interest rates capital has been freely and unfairly transferred from depositors to corporations and governments, depriving ordinary Chinese people of such resources. 

Ending Remarks

In sum, the undervaluation of China’s currency, a distorted interest rate policy, policies to support a financial monopoly, a deformity of industrial policy, and the predatory land policy form China’s unbalanced economic development model. It systematically fosters income inequality and is driving down the consumer share of GDP, year after year.

Deng Xiaoping’s order, to “Let some people get rich first” was indeed carried out. “Some people” have indeed “gotten rich first.” How? Here is the secret: The root cause of the widening gap between rich and poor has nothing to do with ability or effort, it is purely the product of power (and policy).

The most heartbreaking consequence is the over-exploitation of natural resources, which has caused serious environmental pollution and the destruction of resources and living environments on which future generations rely for survival. The masses of ordinary Chinese people will have to pay for these consequences and endure the disasters this economic reform has brought upon the land.

Tianlun Jian, Ph.D., writes regularly on the Chinese economy and advises The Epoch Times on economics. His blog is

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