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China’s Economy Faces Nine Major Challenges

[Editor’s Note: Li Zuojun, Deputy Director of the Institute of Resources and Environmental Policy Research at the Development Research Center of the State Council, published an article discussing the major problems that the Chinese economy faces. The Development Research Center of the State Council (DRC) is a leading policy research and consulting institution directly under the State Council. According to Li, the nine problems are: declining economic growth, inflation, economic bubbles, the changing economic growth engines, adjustments in our industries and regional business structures, environmental constraints, the social costs of development, the deteriorating international environment, and resistance to reform. The following are excerpts from Li’s article.] [1]

Now that the stage of China’s 30 years of rapid growth has ended and the restructuring and development stage has begun, the Chinese economy faces the following problems and challenges.

The Challenge from the Slowdown in China’s Economic Growth

First, China’s economic growth is slowing down. It is a fact and a trend. The 2012 second quarter GDP growth rate dropped to 7.6 percent. This is not temporary, but, rather, it reflects the market’s direction.

The slowdown in economic growth means that the demand for products has subsided, orders have declined, and markets have shrunk. It means that many companies may incur losses to the point of bankruptcy, leading to a reduction in jobs. An important reason why we pursued rapid economic growth in the past was to solve the unemployment problem. As China’s economic growth has slowed down, the pressure of unemployment has increased. We must constantly adapt to the economy’s slowing down and actively respond to the challenge.

The Challenge of Long-term Inflation

In 2011 China’s CPI was as high as 6.5 percent. In June 2012 it dropped to 2.2%, but may rebound any time. The past two years saw negative interest rates (rates that were lower than inflation). Now we finally have positive interest rates. What we need to be concerned about is whether inflationary pressure is a short-term problem, an intermediate-term problem, or a long-term one. It is most likely an intermediate to long-term problem. So we must increase our tolerance for inflation and our resilience.

What has long-term inflation brought us? Inflation means that the wealth of the people has shrunk, that their standard of living has declined, that the wealth has transferred from one social class to another, that the gap between rich and poor has widened, that the costs for the development of some industries have risen, and that the environment for economic development has deteriorated.

The Challenge of Accumulating Economic Bubbles

Along with the rapid economic growth, economic bubbles have also accumulated. High housing prices are one good example of an economic bubble. High-priced assets represent another bubble. We no longer engage in manufacturing. Rather, we have all dived into the financial market, which in and of itself has created a bubble. Many industries suffer from serious overcapacity, another bubble. Many local governments have invested a great deal in development and spent heavily on financing, directly “engaging in the business of land” and “city management,” with low efficiency and with many “repercussions,” which is likewise a bubble.

Many people are concerned that these bubbles will burst. If the government uses a superb macro-control technique, lets the air out of the bubbles little by little without triggering an economic crisis or social unrest, and timely cultivates new economic growth and new competitive advantages so that businesses are restructured and upgraded, this would be considered a “soft landing,” and the bubbles would not burst. However, in 2013 there will be unprecedented pressure, which will warrant a high degree of vigilance and attention.

The Challenge of the Changing Economic Growth Engines

After 30 years of sustained rapid growth, China’s economy is facing changes, mainly in four areas. First, the transition from relying primarily on external demand to relying on domestic demand; second, the transition from an economy driven by investment to one relying on consumers; third, the transition from relying on government investment to relying on private investment; and fourth, the transition from relying mainly on traditional elements of production to advanced elements of production.

China must promote the restructuring of its economic growth engines in order to maintain its growth momentum. Otherwise, China’s rate of growth may be difficult to maintain. The problem is whether this transformation will be easy to achieve. It is probably not so easy. Japan and Latin America have gone through this transformation, but they did not do well and fell into the “middle-income trap” or the “high-income trap.” We also face this challenge.

The Challenge of Adjustments to Our Industries and Regional Businesses Structures

Changing the structure of the economy is the main direction in transforming economic development. It involves a number of factors. The most important is to change how our industries and regional businesses are structured.

To change our industries, we must solve two problems. We must eliminate over-production and upgrade our industries. To shut down businesses that are over-productive involves changing the views of many interest groups, none of which want these businesses to be done away with. Even if they must be forced to close, [we] must prepare well in order to compensate them. Industrial transformation and upgrade require technology, highly qualified personnel, and modern management. We can make the leap forward only when all the conditions to do so are present. This is a thrilling jump, and many companies may not make it. So far, few regions and companies have successfully transformed or upgraded.

The central and western regions are developing rapidly. These regions depend mainly on the advantage of having many resources and on industries that consume substantial energy. However, we must now increase our efforts to conserve energy. This presents a problem for the central and western regions. The central and western regions hope the government and the eastern regions will compensate them because they must now focus on protecting the environment. Unfortunately, the nation’s fiscal revenues have decreased substantially and economic growth in the eastern regions has slowed down, resulting in a corresponding decline in the ability to provide compensation.

The Challenge of the Increasing Constraints of Resources and the Environment

Greater pressure has resulted from the fact that the prices of energy and raw materials have increased. China accounts for between 70 and 80 % of the increased global demand for crude oil. This demand influences the price of the world’s available energy and raw materials.

At the same time, pressure is growing to protect the environment. Due to global warming, China faces increasing pressure in the international arena to reduce carbon emissions. China’s 2008 carbon dioxide emissions were the highest in the world. If this pattern continues, by 2020, China will produce more than 30 percent of the world’s carbon emissions. At that time, China will face unprecedented international pressure.

The Challenge of the Increasing Social Costs of Economic Development

In recent years we have emphasized economic and social development because economic development is not an end in itself. Rather, meeting human needs is the goal. However, from the economic point of view, social development increases expenses. Governments and people must pay for these expenses in order to make sure that pensions, health care, housing, education, and other social undertakings are well covered.

For many local governments, the pressure on spending continues to increase. Administrative expenditures, infrastructure spending, the construction of affordable housing, social welfare spending, and stability maintenance expenditures are mandatory or must increase. Government revenue, however, is declining, industrial and commercial taxes are declining because small and medium enterprises have less income, and government income from land use is also decreasing because of falling housing prices.

The Challenge of a Deteriorating International Environment for Economic Development

First, the international environment is less interested in China’s exports. The main reason is the ongoing international economic crisis.

As the international economic crisis continues, the international economy will remain depressed for two or three years, having a greater adverse impact on our exports.

Second, the international environment for China’s overseas investments is deteriorating. … Other countries do not welcome our investments, unlike the way we welcome their investments. When we want to invest in their high-tech companies and projects, they are worried that we will steal their technology. When we want to invest in their resources, they say we will control their resources. When we want to apply our experience from the construction of our domestic development zones, they say we will control their land. In short, they restrict China’s investments under the pretext of national security or other reasons.

Third, the international environment regarding adjusting the RMB exchange rate has not been good for some time. … So, [Western countries] have been pushing to weaken the competitiveness of Chinese exports through RMB appreciation.

Meanwhile, the RMB exchange rate is also directly subject to changes in the U.S. dollar: If the U.S. dollar depreciates, the RMB automatically appreciates. At the same time, China’s overall external environment has deteriorated. Because China is the world’s second largest economy, the United States places more emphasis on China as its main competitor and has shifted its strategic focus to the Asia-Pacific region.

The Challenge of Increased Resistance to Reform

First, vested interests resist reform. In the past three decades, the reform strategy has been uneven, leading to a serious imbalance and a lack of coordination in political reform, cultural reform, social reform, and economic reform. Along with rapid economic development; the reform has also brought a widening gap between the rich and the poor. This process has bred vested interests. Vested interest groups have benefitted from this imbalance and the lack of coordination in the transition. These vested interests have thus become an obstacle to the next round of reform.

Second, there is resistance to reform due to notions. …. For example, many people attribute the widening gap between the rich and poor and the increase in corruption to market-oriented reform. As everyone knows, market-oriented reform did not bring about these problems. Rather, they were brought about by incomplete reform and the imbalance between political reform and economic reform.

[1] Shanghai Security News Online, “Nine Challenges that China’s Economy Faces,” August 8, 2012.