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ECONOMIC ANALYSIS: China's economic engine may be starting to sputter

November 27, 2006

It seemed like a reasonable forecast at the time. After an extraordinarily violent and deadly hurricane season in 2005, predictions of a second straight severe summer in 2006 made big headlines. But 2006 has turned out to be a year where not a single hurricane-rated storm has made U.S. landfall, one of only 21 years on record here that has been hurricane-free.

It's hardly the first time forecasters have eaten humble pie. And the experience serves to remind us that extraordinary events are, well, extraordinary. Which is to say they don't last. And our projections of the future should keep that in mind.

One of the most extraordinary events in the world economy of late has been the emergence of China as a global economic power. It's hard to overstate the superlatives. For 20 years now, the Chinese economy has grown an average of 9 percent a year. During much of that time, the exports of China have doubled every three years. And during its fastest expansion, in the early 1990s, foreign direct investment in China increased an astounding 150 percent per year.

The impact of these developments has reverberated around the globe. The huge appetite of the Chinese economy for goods of all kinds has driven up prices for steel, concrete, oil and many other commodities. Opportunities there have captured billions of foreign investment dollars, as well as entrepreneurs and capitalists of every persuasion. And the huge trade imbalances with some countries, like the United States, have raised calls for protection and concerns over impending currency adjustments.

But the impact on, and within, China itself is the real story. And as a new National Bureau of Economic Research study concludes, the story of growth in the world's most populous country is really the tale of two economies.

The 20 percent of the Chinese economy that comprises enterprises receiving foreign investment has accounted for more than 40 percent of the country's meteoric growth, according to the NBER. That growth has been concentrated in nine coastal provinces in southern and eastern China, widening already large disparities between them and the country's remaining 20 provinces.

The NBER study reveals just how different the two sides of China are. The companies receiving foreign investment are overwhelmingly export-oriented, accounting for more than half of all exports and 60 percent of imports. They are also modern and efficient, employing only 3 percent of the total work force even as they account for 20 percent of total output.

But social pressure to redistribute the proceeds of growth is just one warning flag for China's future. Investments made first by Asian neighbors-and later by U.S. and European companies-seeking to exploit low production costs have begun to taper off as those costs rise. And the capacity of developed countries to absorb the enormous growth of Chinese exports, economically or politically, is not endless.

With these challenges ahead, another decade of growth in the 7-percent to 10-percent range is not in the cards for the Chinese economy, in all likelihood. What does that mean for Indiana producers and consumers?

That's hard to precisely quantify. A Chinese economy falling back to Earth remains a formidable competitor-and a fertile market-for Indiana companies. And even if the export orientation of that economy changes, there will be plenty of other nations eager to take up the slack.



Barkey is an economist and director of economic and policy study at the College of Business, Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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