Development of China's Economics

CHINA 2014

Table of Contents

1. Is China a developing country?

2. Theories/ Models of Growth and Development Applied on China

2.1. Rostow’s Stages of Growth

2.2. The Harrod-Domar Model Growth Model

2.3. Lewis’s Theory of Development

2.4. Structural Change and Pattern of Development

2.5. International Dependence Revolution

2.6. Neoclassical Counterrevolution

2.7. Coordination Failure and the Big Push

3. Poverty in China

3.1. Headcount Index & Gini Co-efficient

3.2. Poverty Gap

3.3. Poverty Trend & Analysis

4. Bibliography

5. Word Count:

1. Is China a developing country?

China is a big economy in absolute terms, with GNP second only to the United States. Despite its remarkable economic development over the past decades, China remains a developing nation.

China is the world’s most populous country, with a population of 1.3 billion in 2011. It’s not far behind India, which contains 1.2 billion people and is predicted to overtake China in the next two decades. China ranks below the 100th place in the world in terms of per capita GDP, which is 3700 US dollars and the country is classified among middle and low income level countries. China is behind the majority of the developed world in terms of per capita possession of natural resources, in some cases, even far below the world’s average. Its fresh water reserve is only 1/3 of the world’s average, coal consumption 1/2 and natural gas 1/5. Moreover, a population of 150 million is caught in poverty and, is living on less than 1 US dollar a day. 83 million people are living with disabilities in the country. With the second largest number of poor in the world after India, poverty reduction remains a fundamental challenge. (WorldBank, 2014)

China’s trade mix is dominated by commodity trade that is resource and labor consuming, putting it at the lower end of the global industrial chain as the knowledge based trade in services only accounts for a small portion in foreign trade. There are shortfalls in scientific and technological innovation capacity that impede the country’s core competitiveness. Furthermore, the country faces challenges in the areas of investment in education which is low and in the areas of medical services and social security. Inequality remains high, rapid urbanization poses threat to environmental stability and there are external imbalances. China also faces demographic pressures related to an aging population and the internal migration of labor. (ChinaDaily, 2013) (Euractiv, 2012)

2. Theories/ Models of Growth and Development Applied on China

2.1. Rostow’s Stages of Growth

Rostow’s theory states that each country needs to go through five imminent stages of development. Observing China in the context of the Rostow’s Model of Development, it is reasonable to claim it to be in the fourth stage, which is the drive to maturity. China remained in the third stage for several decades due to its inclination towards remaining a closed economy. As it opened its doors to the world in the 1990s, it saw itself elevating to stage four. China benefitted by a great increase in its GDP (as shown by the graph below) and foreign investment as their interaction with the world increased (Jacobs, 2014)

Figure 1 Index of China’s Real GDP Growth

Figure 2 Cumulative FDI in China

Economicreforms of 1978 caused China’s economy to grow nine times. In 2002, China replaced US as the biggest receiver of foreign direct investment amounting up to $52.7 billion. It accounted for 25% of the global trade expansion. Apart from being a high exporter to US and Japan, China is a high consumer as well. China also became the world’s second largest importer of oil, right after the US. Its consumption of raw materials such as steel and copper became greater than that of the US. In 2003, it consumed 55% of the world’s cement. As China secured its membership of the World Trade Organization, it became a dominant player in the economy (Marcos Chamon, 2011).

2.2. The Harrod-Domar Model Growth Model

Harrod-Domar model extrapolates that development is a phenomenon driven by savings and investments. China, in light of the model, faced some ups and downs in terms of savings and investment. The biggest dip in the investment came 1960 to 1962 as the government initiated the ‘Great Leap Forward’ campaign leading to immense nationalization and hence a major fall in investments. Post Economic Reforms in 1978, China saw a stable but increasing rate of investment in China, with the usual cyclical fluctuations. Simultaneously, China has seen a rise in savings from 35% in 1990 to approximately 50% by 2012. Interestingly, mainly the younger population and the elder population have shown a saving trend. This is due to decreasing public provision of facilities such as education and health prompted the younger generation to save for future education costs and the older generation to save for future health costs. (Marcos Chamon, 2011), (Labaria, 2012)

2.3. Lewis’s Theory of Development

The essence of this model is to allocate resources more efficiently in the developing world where there is an overflow of labor in the traditional agriculture sector that needs to be dissolved into the industrial sector workforce (Anon., 2008) China’s agricultural percentage to GDP is around 12% and catering to almost 43% of the agricultural employment share, showing that China’s labor force is still not fully transferred to the industrial sector. However, China is still growing fast. According to Spence, high Savings and investment where public spending was on education, infrastructure, international trade, technological up gradation and productive employment were all factors that led China’s phenomenal growth. Although there was agro to industrial migration, people were more towards private sector than state owned enterprises. For example, between 1995 and 2005, the ownership of enterprises fell by 38% whereas private, foreign and individual grew in total by 35%. The reason for this could be that the capital to output ratio for private was much greater than the state owned ones i.e. 6.7 vs. 3.3. Along with investment, China focused on improving its exports from 2004 onwards. China used the investment for technology that proved beneficial from 2000 where the number of patent applications were 100000 that shot up to 275000 by 2004. As a result, China was the one with the most patent applications from the BRIC nations.

Figure 3

In compliance with the Lewis model the economy was able to absorb the extra agricultural labor with a rise in the marginal productivity of labor which is still lower than the wage for the average productivity of labor. (MARCO G. ERCOLANI, 2010) In 2010 China had not reached the third stage as such as there was still a gap in labor productivities between both the sectors.

2.4. Structural Change and Pattern of Development

Chenery’s structural change model assesses the characteristic features of development process derived from the different levels of per capita income of countries. For China, the shift from the agricultural to industrial production is seen in the city called Shenzhen which was once farming and fishing village in 1980’s and grew into the richest city in 30 years, as a result of foreign investment and manufacturing. (Shenzhen Facts, 2013) This example only can also explain that there was steady accumulation of both physical and human capital. The rapid growth in Shenzhen was possible due to the capital, labor, technology and information. (Shen, 2008) . These changes were accompanied by shift in consumption patterns to more appropriate ones of demand for manufactured goods and services. Although one can say that China has tried to achieve the decline in family size to cater to its overall population, the disparity between different regions is still prevalent. Hence it cannot be inferred if the child quality is preferred over the child quantity in China.

2.5. International Dependence Revolution

The trend of aid received by China has experienced various fluctuations. Up until late 1970s, China was a net donor, but when the Chinese economy started its openness policy, it became a net receiver of aid to finance the industrialization, mainly from Japan. However, this aid rather than being pure loans or grants was more in the form of economic co-operations agreements which gave both China and Japan a ‘win win’ situation rather than China getting exploited by Japan. Post mid 90s however (after the success of industrialization was manifesting), the aid received by China started to drop drastically; and due to the introduction of the ‘Grand Plan’ of 1994,China started to realize the potential of securing resources and export markets abroad and started investing heavily in Africa, the trend of which continues to today . Hence instead of China being exploited by the cores, it is now in a position to exploit Africa. The neocolonial dependence model cannot be applied to China. (Shimomura & Ohashi, 2013)

The Dualistic Development Thesis however applies extremely well to China, as evidenced by the disparity in public and private spending on education and health (public spending is almost constant whereas private is increasing (WorldBank, 2014)) or by the vast income disparity amongst China’s urban and regional areas. Reasons for this co existence phenomenon are discussed under Poverty in China.

2.6. Neoclassical Counterrevolution

Neoliberals suggest that by allowing competitive free markets to function, economic growth will begin because world markets are efficient. In 1979, China was a stiff command economy prey, to majorinefficiencies making it poorerthan India. The government focused on heavy industries, ignoring agriculture and the private sectors. Their leader Chen, recognizing the importance of market and socialism ended“The Leap Outward”, allowing the firms tobenefit with the government from the market functioning, showing that Market Friendly approach is needed.

Public-choicetheory discusses that by the self centered intervention of government, not only does misallocation of resources occur, but people are left with lesser choices and freedom. China has now shifted to a mixed economy with reforms which shall allow China to reach 60% of America’s per capita GDP. (TheMoneyIllusion, 2010)

In the last 30 years, the Chinese economy has seen a shift to a hybrid economy after China joined the World Trade Organization in 2001. Theprivatization of 90% of the urban residential schemes and real estate can be marked as an economic success because it led to a growth in per capita income 8.1% from 1978 to 2004.

Neoclassical free-market argument emphasizes onliberalizationof national markets, which draws additional domestic and foreign investment, increasing the rate of capital accumulation. China has acceptedliberation by allowing free trade, to the extent that China, a part of the BRIC nation now has the power to shake the strength of the US Dollar; however the role and hold of government is still strong on the economy and the people. An example of this is the enforcement of one child policy. Although the government has now relaxed these rules, to extending to a two child policy, this was needed to control the geometric progression of the population versus the arithmetic progress of resources which would have led to increased poverty. (Coase & Wang, 2013)

2.7. Coordination Failure and the Big Push

According to Todaro coordination failure occurs because of the inability of economic agents to coordinate their behavior resulting in an equilibrium in which everyone ends up being worse off and occurs because of pecuniary externalities, asymmetric information, and high wages of workers which warrant government intervention which Todaro named the Big Push. (Todaro & Smith, 2012)

In October 1949 the People’s Republic of China was established by the Communist Party. The party aimed to nationalize the agricultural sector and use it to finance the growth in industrialization to coordinate the activities of the economic agents in the industrial sector. As a result of this the Industrial sector thrived and grew. (Young, 2014)

In 1958 the Great leap forward was announced. Under this communes of farms were formed and private farming was abolished. The purpose of this was to increase output via greater cooperation and greater physical effort. However this failed resulting in drop in agricultural production, three years of famine and millions of deaths. The government responded by initiating policies contradictory to that of Big Push model, i.e. the government allowed for private farming and slashed investment in industrial sector which led to improvements in the industry. (Young, 2014)

Lastly the Great ProletarianCultural Revolution of 1966 resulted in a negative impact on industry production resulting in a decade of confusion and strife. (Young, 2014)

So it can be inferred that the Big Push model advocating government intervention has resulted in more costs than benefits for the Chinese.

3. Poverty in China

3.1. Headcount Index & Gini Co-efficient

Figure 4 WorldBank, 2014

The trend shows that the headcount ratio was decreasing rather at a slow rate from 1990 till 1999, however the headcount reduced by almost 50%. By 2005 the headcount further reduced by 50% and then gradually till 2009 the headcount came to about 11.8%. It should be keep in mind that the population of China had been increasing around 0.01 billion each year and still the headcount was reduced. From the highest 743.3 million poor in 1992 to almost 157.1 million poor in 2009 is an achievement. (WorldBank, 2014)

According to Yu Xie, a sociologist from Michigan University, China suffers from one of the highest levels of income inequality in the world. Inequality prevails even in comparison to other countries that have similar standards of living. The Gini Coefficient has shown an increasing trend reaching 0.472 in 2012. (Gapminder, 2014)

3.2. Poverty Gap

The World Bank index presents that Poverty Gap in 2009 was 2.8, but data for the latter years was not available.

Beijing and Shanghai have reached high developmental levels equivalent to Cyprus and Portugal because of the government’s efforts via provision of healthcare, education and welfare, but provinces such as south-western Huizhou are comparable to Namibia or Botswana. The city life is becoming increasingly expensive and the middle class is being squeezed.

3.3. Poverty Trend & Analysis

Extreme poverty defined by percentage of people living below $1.25 per day fell till 1987 in China after which it increased sharply to 64% in 1992. After which it declined in 1993, increased again in 1994 and then declined continuously to 13% in 2008. However there were stalls in poverty reduction during the late 1920s and late 1990s. So the significant increase in poverty in China during the late 1980s was because of the Communist Party’s policy to nationalize the agricultural sector part of their Great leap forward strategy which backfired leading to a significant increase in poverty in the rural areas of China. (Ravallion & Chen, 2007)

The number of people below the poverty line started to decrease after the peak in 1992 because of:

• migration from rural to urban
• growth in primary sector due to the about face policy after the Great Leap Forward
• economy wide policies including agrarian reforms
• controlling of inflation
• increase in government spending as part of the effort to achieve the MDG on poverty and hunger

The rate of decline in poverty varied from industry to industry and among provinces because the rate of growth in these was not the same. (Ravallion & Chen, 2007)

As shown by the figure below, economic activity is prevalent at the coastal regions and declines as we move towards the interior of the country.

Figure 5 GDP/Capita by province 2002 (US$)

As the economy opened its doors to the world, it saw an inflow of investment in this coastal region. However, the benefit has not been transferred to the inner regions, the urban residents located at the east earn thrice as much as the rural residents (Roberts, 2014), (GeoCases, 2002)

Figure 6 (GeoCases, 2002)

4. Bibliography

Anon., 2008. Introduction to Economics of Development. [Online] Available at: http://www.pauldeng.com/teaching/development/lectnotes_8_econ175a.pdf [Accessed 2014].

Bertaud, A., 2010. GOVERNMENT INTERVENTION AND URBAN LAND MARKETS: THE CASE OF CHINA. Journal of Architectural and Planning Research, 29(4), pp. 335-346.

ChinaDaily, 2013. China Daily. [Online] Available at: http://www.chinadaily.com.cn/opinion/2013-01/10/content_16100813.htm [Accessed 2014].

Coase, R. & Wang, N., 2013. How China Became Capitalist. [Online] Available at: http://www.cato.org/policy-report/januaryfebruary-2013/how-china-became-capitalist [Accessed 2014].

Euractiv, 2012. Euractiv. [Online] Available at: http://www.euractiv.com/global-europe/china-developing-country-analysis-498377 [Accessed 2014].

GeoCases, 2002. China: A Third Generation Newly Industrialised Country. [Online] Available at: http://www.geocases2.co.uk/printable/China a third generation NIC.htm [Accessed 2014].

Jacobs, J., 2014. Rostow’s Stages of Growth Deveopment Model. [Online] Available at: http://geography.about.com/od/economic-geography/a/Rostow-S-Stages-Of-Growth-Development-Model.htm [Accessed 2014].

Labaria, E., 2012. China and Development. [Online] Available at: http://elirozz_labaria.tigblog.org/post/7228633?setlangcookie=true [Accessed 2014].

MARCO G. ERCOLANI, Z. W., 2010. AN EMPIRICAL ANALYSIS OF THE LEWIS-RANIS-FEI THEORY OF DUALISTIC ECONOMIC DEVELOPMENT FOR CHINA. Changsha, Chinese Economist Society.

Marcos Chamon, K. L. E. P., 2011. The Puzzle of China’s Rising Household Saving Rate. [Online] Available at: http://www.voxeu.org/article/puzzle-china-s-rising-household-saving-rate

Ravallion, M. & Chen, S., 2007. Poverty, China’s (uneven) Progress against. Journal of Development Economics, pp. 1-42.

Roberts, D., 2014. China’s Income-Inequality Gap Widens Beyond US Levels. [Online] Available at: http://www.businessweek.com/articles/2014-04-30/chinas-income-inequality-gap-widens-beyond-u-dot-s-dot-levels

Shen, J., 2008. Urban Growth and Sustainable Development in Shenzhen City 1980-2006. Open Environmental Sciences, Volume 2, pp. 71-79.

Shenzhen Facts, 2013. Shenzhen Facts. [Online] Available at: http://www.chinahighlights.com/shenzhen/shenzhen-facts.htm

Shimomura, Y. & Ohashi, H., 2013. A Study of China’s Foreign Aid: An Asian Perspective. 1st ed. Tokyo: Palgrave Macmillan.

TheMoneyIllusion, 2010. The money illusion. [Online] Available at: http://www.themoneyillusion.com/?p=5363 [Accessed 2014].

Todaro, M. P. & Smith, S. C., 2012. Economic Development. s.l.:Addison-Wesley.

WorldBank, 2014. Poverty Data by World Bank. [Online] Available at: http://povertydata.worldbank.org/poverty/country/CHN [Accessed 2014].

WorldBank, 2014. WorldBank.org. [Online] Available at: http://www.worldbank.org/en/country/china/overview [Accessed 2014].

Young, E. P., 2014. China. [Online] Available at: http://www.britannica.com/EBchecked/topic/111803/China/71007/Economic-policies [Accessed 24 9 2014].

5. Word Count:

2571 excluding cover page, ToC, Bibliography and In-text Headings

Development Economics ReportPage 1