China's Rise and Reckoning

July 11, 2007

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China's economy has seen staggering growth over the past few decades, and the country's manufacturing sector has skyrocketed in recent years. Yet the growth model behind this success is showing signs of anxiety: excess capacity; trade-surplus criticism among principal trading partners; exports straining global supply chains; dramatic wage increases and, of course, the country's public image amidst lethal safety failings.

The Chinese economy grew even faster in 2006 than previously reported, the government said today. The National Bureau of Statistics raised its estimate of China's 2006 growth rate from 10.7 percent to 11.1 percent. It nudged up its estimate of total output by 146.4 billion yuan ($18.8 billion) to 21.1 trillion yuan ($2.705 trillion).

The revision brought China closer to Germany, the world's third-largest economy after the United States and Japan, The Associated Press reports. Germany's 2006 output was $3 trillion, but its 2.5 percent growth rate was well below China's.

When sales revenues (gross output) that are earned by the manufacturing sector are used to measure the size of output, China will grow to outrank the U.S. as early as 2008. However, if the value added of the manufacturing sector is used to measure relative size, China will not outrank the U.S. until 2013. Ever further, when output is measured using real (inflation-adjusted) "1997 U.S. dollars," then the manufacturing value added in China will not exceed that of the U.S. until after 2020, according to Global Insight.

The sectors where the U.S. is forecast to lose the most ground in terms of share of the world: textiles, basic metals, computers, electrical equipment and household appliances.

Day of Reckoning? China has been able to grow so rapidly by investing massively in its production capacity and the infrastructure necessary to support it, according to Thomas Duesterberg, president and CEO of Manufacturers Alliance/MAPI. On the other hand, Dr. Duesterberg recently wrote at IndustryWeek, "personal consumption expenditures, which represent over 70 percent of U.S. GDP and 61 percent in India and Thailand, was only 35 percent in China, down from early 40 percent earlier this century."

This massive investment is leading to excess capacity in many individual sectors … Breakneck expansion in … metals, manufacturing and materials sectors has placed a premium on exporting goods because of relatively weak domestic demand — the exact opposite of the U.S. model, where the consumer reigns supreme. An undervalued Chinese currency exacerbates these forces by promoting exports, creating massive liquidity to finance investment and discouraging consumption.

This cycle is weakening corporate profits and the Chinese banking system. It may also undermine political stability by keeping purchasing power artificially low. Moreover, criticism of the Chinese trade surplus is growing among the principal trading partners. In addition, the rapid pace of export growth is starting to strain supply chains in the U.S. and Europe.

The country's trade surplus soared to $112.5 billion, up 84 percent from a year earlier, according to statistics released yesterday by the General Administration of Customs. The trade surplus adds pressure not only on China but also its trade partners to adjust their economies.

According to Xinhua News Agency:

Although the remarkable growth was largely attributed to the fact that many Chinese exporters rushed to sell abroad as much as possible before lowered export tax rebate rates took effect in July, it is expected to deepen the tension between China and some of its major trade partners.

All of these numbers, including the National Bureau of Statistics' updated numbers, are also adding to fears of overheating.

So, too, are wage increases.

Wages in China have nearly doubled over the past four years, "outpacing the rate of growth of the economy," Forbes recently reported of data released at a recent official forum:

Combined annual wages reached 2.34 trillion yuan ($308 billion) at the end of last year, up from 1.32 trillion ($173 billion) in 2002, representing an average annual rate of increase of 13.5% after inflation, according to a report from state-owned on official figures released at a meeting put on recently by the China Association for Labor Studies.

The corresponding figure for Chinese GDP growth during the same period was 10.3 percent, Forbes noted.

The speed of growth in annual wages was 1.9 times faster (per capita GDP) than in the preceding four-year period, and the fastest pace of wage increases China has seen since it began to make the switch from a closed communist economy to capitalism in 1979. Accounting for inflation, though, the real rate of growth was 12 percent a year. (Note: This pace of wage growth leaves out the nation's largest group of laborers, the 800 million farmers.)

Lately, China's safety failings have drawn world attention since mislabeled chemical exports were found in cough syrup in Panama and pet food in the U.S. China, the world's biggest exporter of consumer products, is under pressure to strengthen regulation after a series of contamination scares that led to recalls and bans on items ranging from toys to toothpaste to seafood, not to mention the shutting down of 180 factories.

The approach of next year's Olympic Games, which will draw an estimated 1.7 million visitors to Beijing, has increased the urgency of bolstering its global credibility, public confidence and social stability.

In a warning that the country intends to deal sternly with corruption, and in an attempt to boost worldwide consumer confidence, the Beijing court has executed the former director of the country's top food and drug safety agency after he pleaded guilty to corruption and taking bribes. The state-run Xinhua (via Reuters) reported the unusually swift and severe execution yesterday after he was sentenced to death in May. The high-ranking official, who had held his position between 1997 and 2005, took bribes in exchange for licenses to produce drugs without preliminary clinical tests. Within that period, he sanctioned production of more than 277 medications.

Officials separately outlined a plan to improve drug and food safety, conceding the system isn't strong enough and the trend "isn't promising," according to Bloomberg News.

Will the country's industry and economy fall as quickly as it has risen? Or will the global juggernaut overcome its obstacles to become the global leader?

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