China's Economy at an Inflection Point

Under its new five-year plan, China's economy will shift away from reliance on export growth, write columnists Anil Gupta and Haiyan Wang

By Anil Gupta and Haiyan Wang

The world's second-largest economy is now at a strategic inflection point. China's National People's Congress, the country's legislature, on Mar. 14 approved the latest five-year plan. That will just add more momentum to the ongoing structural changes in China's economy, which will almost certainly grow at a slower pace in the next five years than it has during the past five. In his recent statements, Premier Wen Jiabao signaled the expected slowdown by noting that the official target for annual GDP growth during the next five years will be 7 percent, down from the target of 7.5 percent in the previous five-year plan. Our analysis suggests that, unlike earlier five-year periods, when the actual growth rate far exceeded official targets, the coming five years are likely to see a much closer alignment between the two.

There are several reasons for this. No. 1, there will be a sharp slowdown in the rate of growth in exports from China. With an average annual growth rate of about 20 percent over the past 10 years, China's share of world exports increased from 3.5 percent in 2000 to more than 9 percent in 2010, making it the largest exporter in the world. Continued growth at this rate would increase China's share to 25 percent by 2020, a political impossibility. A sharp slowdown in export growth rate is therefore inevitable.

Furthermore, over the past 10 years China dramatically boosted its investment in infrastructure and real estate as well as feeder industries such as steel and cement. While we expect China to continue building out its infrastructure as well as providing housing to more of its citizens, the growth rate in these investments will be sharply lower during the coming decade than over the past one. Demographic trends will also take their toll. The proportion of China's population that is of working age (i.e., between 15 and 64 years) has been growing since 1980 and reached a peak in 2010. This proportion is now declining and will continue to act as a drag on GDP growth.

Stronger Social Safety Net

A second major change is also underway. As part of a serious drive to reduce growing economic inequities in the society, China is strengthening the social safety net for its citizens. This change is being implemented through several measures. The government has set up a rural pension scheme that provides a basic monthly pension of 60 yuan to 300 yuan to every enrollee. In addition, reforms are under way in the urban pension system—such as portability of pensions across provinces. The government has also launched a comprehensive reform of the health-care system to ensure that the entire population will be able to receive reliable and affordable health care by 2020. Importantly too, during 2010, a large number of provinces have increased the mandatory minimum wage 20 percent or more; along with the enactment and enforcement of a new labor law, workers now have much greater protection from abuses by employers. The new five-year plan is also likely to raise the threshold for taxes on personal income. The combined effect of all of these reforms will be to reduce the imperative to save and to boost consumption by the vast low- and middle-income segments of China's population.

Third, China is emerging as one of the world's leaders in its commitment to become more energy efficient and reduce the carbon intensity of its economy. The new five-year plan proposes to cap the country's energy use at 4 billion tons of coal equivalent a year by 2015 (up from 3.25 billion in 2010). This target will result in a very aggressive push in such areas as electric cars and green buildings. The new plan also proposes that nonfossil fuels will account for 11 percent of primary energy consumption by 2015 and 15 percent by 2020 (up from 8 percent last year). Even though China already has the world's largest installed capacity for wind power, massive investments can be expected to boost energy capacity in all nonfossil areas, including wind power, solar power, hydropower, biomass, and geothermal power.