China's Economic Growth: Cause, Pros, Cons, Future

It's Good That China's Growth Is Slowing. Really.

China cargo trade
Port at Qinhuangdao,Hebei,China. Photo: View Stock/Getty Images

China's economy has enjoyed 30 years of double-digit growth, making it the world's largest. Its success was based on a command economy that drove growth through government spending.  

China's economy is measured by its gross domestic product. In 2016, growth was $19.39 trillion, the largest in the world. That's 6.9 percent more than in 2015. China grew 7.3 percent in 2014, and 7.7 percent in 2013. When people talk about China's economic slowdown, they are comparing it to the 10 percent rates of prior years.

Causes of the China's Spectacular Growth

Massive government spending went into state-owned companies that dominate their industries. This includes the big three energy companies, PetroChina (CNPC), Sinopec, and CNOOC.  They are less profitable than private firms. They return only 4.9 percent on assets compared to 13.2 percent for private companies. 

China requires several things of foreign companies who want to sell to the Chinese population. They must open factories to employ Chinese workers. They must share their technology. That allows Chinese companies to learn how to make the products themselves. 

The People's Bank of China, the nation's central bank, tightly controls the yuan to dollar value. It manages the pricing of exports to the United States, making them a little cheaper than those produced in America. 

Advantages of Growth

China's growth has reduced poverty.  China has 20 percent of the world's population.

As they get richer, they will become bigger consumers. More companies will try to sell to this market, the largest in the world. They will tailor their products to Chinese tastes. 

Growth is making China a world economic leader. China is now the world's biggest producer of aluminum and steel. Exports rose 25 percent in 2015.

Chinese tech companies are quickly becoming world-class. Xiami and Huawei are number one and two producers of smart phones in China. Xiami is exporting to Brazil and India. Huawei is exporting to Peru and South America. Lenovo is a world-class maker of personal computers. (Source: "China," Wall Street Journal, August 29, 2015.)

Disadvantages of Growth

Government spending created a debt-to-GDP ratio of around 200 percent. It may have also created an asset bubble. That growth created public panic with pollution, food safety scandals, and inflation. 

It also created a class of ultra-rich professionals who want more individual liberties. They primarily live in urban areas, since that's where most of the jobs are. In 2012, 52.6 perecent of the nation's population lived in urban areas. That's more than double the 20 percent that did so in the 1980s.

Local governments are charged with providing social services, but aren't allowed to tax locally to fund them. As a result, families are forced to save because China doesn't provide benefits for people who've moved from the farms to the cities to work. Interest rates have been low, so families don't receive much return on their savings. As a result, they don't spend much, keeping domestic demand low.

(Source: "China's Banker Leads Push to Overhaul Economy," Wall Street Journal, November 5, 2013.)

Future Growth

To move forward, China needs more innovative companies. These only come from entrepreneurship. State-owned companies make up 25 percent of total industrial output, down from 75 percent in 1970. However, China must do even better.  (Source: "Beijing Endorses Market Role in Economy," Wall Street Journal, November 13, 2013.)

The worst risk is the ticking time bomb within the nation's financial system. Banks are state-funded and owned. This means the government sets interest rates and approves loans. They pay low interest rates on deposits so they can lend cheaply to state-owned businesses. As a result, banks have channeled government funds into an unknown number of projects that may not be profitable.

 (Source: "China's New Leap Forward?" Wall Street Journal, November 23, 2013.)

Bank loans are nearly 30 percent of the economy. One-third of these may be the "off-balance sheet" loans that aren't regulated. They are above the lending limits set by the central government. If interest rates rise, if growth slows too fast, if the government cuts back on stimulus, these loans will probably default. That could set off a collapse in China similar to the 2008 financial crisis in the United States. (Source: "China's Banking Monitors at Odds," Wall Street Journal, January 15, 2014.)

China's leaders now walk a fine line. They must reform to remove asset bubbles. On the other hand, as growth slows, the standard of living may fall. This could cause another revolution.  People have been willing to turn over personal power to the state only in return for rapid increases in personal wealth. China's leaders must reform the economy or it will ultimately collapse

Leaders must take steps to boost domestic demand from its 1.37 billion people, so it can rely less on exports. It must diversify into a more market-based economy. This means relying less on state-owned, and more on privately-owned, companies to reap the rewards of a competitive environment. 

One way it is doing this is by boosting investment in China's stock market. That allows companies to rely less on debt, and more on selling stocks, to fund growth. It also helps the tech companies that are listed on the Shenzhen exchanges. China recently installed the Connect program between the mainland exchanges and the Hong Kong stock market.