HISTORY shows that China’s embrace of a market-based system, combined with trade liberalization, an abundance of cheap labor and massive foreign direct investments (FDI), sparked an explosion in its manufacturing sector.
As the Associated Press (AP) reported six years ago, the Chinese population of 1.3 billion provided an almost inexhaustible supply of low-cost labor. The average factory wage in China at the time of the AP report was about 40 US dollar cents per hour, which was one-sixth that of Mexico and one-fortieth of what US factory workers were paid. Naturally these low labor costs presented an enticing opportunity for foreign firms to decrease average production costs and expand their scale of operations; thus, FDI in China had increased dramatically. In fact, starting from a baseline of less than $19 billion in 1989, FDI in China grew to over $300 billion in just 10 years. China’s economic prospects looked bright and the country was widely touted as the de facto “factory of the world.”
Lately, however, it appears that China’s fortunes are already shifting dramatically. A recent Cable News Network (CNN) article sharply poses the question of whether China’s economy is really growing as briskly as its government claims: http://money.cnn.com/2015/08/21/news/economy/china-economy-slowdown/. The Chinese government has been doing the following: 1) making a surprise devaluation of the yuan in an effort to boost exports; 2) propping up markets by actually buying stocks; and 3) spending big and cutting interest rates in an effort to stimulate the economy. It does look odd for China to be taking all these actions if it were really chugging along at the 7-percent growth rate its latest government statistics show.
As a result, stock markets around the world are tanking mainly because investors are afraid that the world’s second-largest economy will drag other countries down with it. As the CNN article notes, China is a major buyer of commodities, like oil and copper. If it turns out that China will not be able to purchase as much of these commodities as earlier anticipated, countries, like Australia, Canada and Brazil, which supply these commodities to China, stand to suffer considerably.
In the US, China’s economic condition has been one of the most widely discussed issues among company executives in the latest round of earnings reports and investor calls. Top corporate officials are trying to figure out how to operate in a China that’s “not booming anymore.”
The problem here is that nobody knows exactly how to calibrate expectations. After all, there could be a huge difference between China in a major slowdown (2-percent growth) and China in a minor slowdown (5 percent to 6-percent growth). A recent article from The Economist discusses the causes and consequences of China’s market crash: http://www.economist.com/news/business-and-finance/21662092-china-sneezing-rest-world-rightly-nervous-causes-and-consequences-chinas. Another recent article from Business Insider features what market analysts are saying about China’s “Black Monday”: http://uk.businessinsider.com/analysts-reaction-china-black-monday-2015-8.
These recent developments are casting doubt on China’s growth numbers appear to have something in common with this year’s news reports of fake rice, as well as older reports (those from seven years ago) of melamine-tainted milk. It’s no secret that many Chinese firms tend to favor quantity over quality, and they’d do whatever they could to increase profit margins. Such candid observations can be found in Paul Midler’s exposition of China’s quality control issues in his work, entitled “Poorly Made in China”: http://www.economist.com/node/13642306. In July of this year, CNN published a similarly themed article on whether China is “cooking its books”: http://money.cnn.com/2015/07/15/news/economy/china-gdp-economic-statistics/?iid=EL. All these events, both recent and old, serve to highlight China’s focus on expanding its economic muscles and reach without carefully balancing potential social and environmental impacts.
Indeed, history will also show that systems lacking in transparency or clarity run a huge risk of collapse. Lest it be forgotten, it was seven or eight years ago when the global financial system was crippled by the proliferation of mortgage-backed securities and other complex derivatives, which largely originated from the US.
The US government, of course, had to take the lead in purging these toxic assets from the system. So, in the spirit of clarity and fairness, it should be acknowledged that China is not the only country in history that has succumbed to the temptation of “taking shortcuts.” Be that as it may, reality is quickly catching up with China, and the proverbial house of cards comes to mind. By all indications, China could be turning itself into one right now, with potentially dire consequences for its economy and the rest of the world. One can only hope that the damaging effects will be contained sooner rather than later.
This article was written by Ser Percival K. Peña-Reyes, lecturer on Macroeconomics at the Department of Economics, Ateneo de Manila University.