China's changing development pattern

The recent publication of the 2013 data for the world's two largest economies, China and the United States, provides an opportunity to take stock of China's economic prospects for 2014 and the challenges facing its economic development strategy.

The immediate trends are clear. China's economic growth decelerated marginally from 7.8 percent in 2012, to 7.7 percent in 2013. U.S. economic growth slowed more substantially -- from 2.8 percent in 2012, to 1.9 percent in 2013. In money terms, China's GDP in 2013 grew by US$1,030 billion and U.S. GDP by US$560 billion. The Western media hype about the "strong recovery" of the United States and China's "major slowdown" was therefore the opposite of reality.

More significant for China's development strategy than simply one year's figures are the fundamental trends in the world economy. These show that since the beginning of the financial crisis, developed economies have entered what is best described as a "Great Stagnation." This unavoidably implies major consequences for China's overall development pattern.

During almost all first three decades of China's reform, from 1978 to 2007, the last year before the financial crisis hit, China's economic development was aided by tailwinds from the world economy. China skillfully utilized these in order to achieve an annual economic growth of 9.9 percent -- compared to the world's 3.0 percent and advanced economies' 2.7 percent.

Nevertheless, from 2008 onwards the tailwinds turned into headwinds. Even assuming the IMF's latest estimate was achieved in 2013, growth in the advanced economies in the six years after 2007 averaged around a mere 0.6 percent. As advanced economies were traditionally China's largest export markets, this sharp deceleration naturally entailed negative consequences for China's previous growth model.

Given the scale of slowdown in the advanced economies, China came through this rather well. China's economic growth slowed only to an average 9.0 percent in 2007-2013. China's growth lead over the high income economies actually increased: in 1978-2006, China grew an average 7.2 percent more rapidly than the advanced economies, while in 2007-2013 this even increased to 8.4 percent.

Taking only bilateral comparisons with the United States, over the whole period 2007-2013, the U.S. economy grew by only 6 percent -- while China's grew by 67.7 percent. Since the beginning of the financial crisis, China overtook the United States to become the world number one in trade in goods, in industrial production and in annual savings -- the finance available for investment.

Yet despite China coming through the international financial crisis more successfully than other major economies, it would be utopian to imagine it would suffer no bruises from the world's greatest economic crisis in 80 years. China therefore simultaneously faces the challenge of repairing any economic damage as well as preparing for the next period of economic development -- as will be seen the two coincide.

Internationally speaking there is no reason to anticipate a sharp acceleration in the advanced economies. In all major developed economies, investment -- economic growth's main driver -- remains below pre-crisis levels. In the last five years, the United States and EU persistently underperformed projections made in advance by the IMF, meaning its 2.2 percent projection for advanced economy growth in 2014 is probably best taken as an upper bound. In contrast, despite some slowing down, economic growth in developing economies remains more rapid due to higher investment levels and the IMF projects a 5.1 percent growth in 2014.

The consequences for China's trade are evident. Towards the end of 2013, in inflation adjusted terms, imports by developed economies were 7 percent below pre-crisis levels, while imports by developing economies were 29 percent above them. The reorientation of China's trade towards developing economies will therefore continue.

However, this requires the continuing changing of China's internal economic structure. Many of China's exports to developed economies were components for advanced industries, with China's labor costs being very low compared to theirs. Yet outside parts of Asia, such advanced manufacturing does not exist in developing economies and China's wages are increasingly high compared to those of many developing economies. For example, China now has a higher per capita GDP than all developing countries in Southeast and South Asia -- except Malaysia.

Henceforth, China increasingly cannot compete in developing economies through low wages. It can only maintain a competitive edge through continuously developing cost innovation -- securing competitive prices not via low wages, but by technological development and management strength. This, however, requires growing investments in technology, the capital equipment embodying it, R&D, new capabilities such as high level brand development, management training, and so on.