5 reasons behind the rise of China

A rising China has not only inched closer to the US, it has also developed backward linkages - through the 'disassembly line' - with a host of other countries, including developed ones, says Ashok K Lahiri.

Recently, China made a splash on the world stage by holding two spectacular events: The Olympics in August 2008, and the 60th anniversary celebration of the People's Republic on October 1, 2009.

These dramatic events in the midst of the global financial crisis changed the climate of the times. Particularly with the western economies in trouble, these events changed the world's perception of China.

The media started talking of a world dominated not by G-7, but by G-2 consisting of the US and China. Three economic questions that arise in this context are: What have been the major distinguishing features of this rise of China? How durable is the rise? And, what does it portend for the rest of the world?

In the centre-periphery paradigm of international development, the post-war economic development is a story of the US as the centre and countries in succession on the periphery. The US plays a pivotal role with an open capital and goods market, while the countries on the periphery pursue a development strategy of undervalued currencies, capital controls, reserve accumulation, and the use of the centre's region as a financial intermediary. Immediately after the War, Western Europe and Japan were on the periphery.

The US lent long-term support to these countries, mostly through foreign direct investment (FDI). After their reconstruction, in the 1970s, Western Europe and Japan graduated from the periphery to the centre. Then some Asian countries, such as South Korea and Taiwan, joined the periphery and graduated to close-to-centre.In the same process, the recent rise of China can be seen as a graduation of the People's Republic from the periphery to close-to-centre.

There are five distinguishing features of this rise of China. First, the pursuit of capitalism with a communist political system. Chinese authorities have defended this combination as "seeking truth from facts". According to the 2009 annual Hurun Report, there were 130 known dollar-billionaires in China compared to 24 in India.

Way back in 2000, according to the Economist, socialist China had the world's brashest capitalist economy. Starting from 1978, Deng Xiaoping liberalised the economy without changing the political system. While Soviet leader Mikhail Gorbachev simultaneously launched Perestroika and Glasnost in the late 1980s, China's handling of Tiananmen Square demonstrations in 1989 spoke loud and clear about how it intended to control the politics of the country.

Second, China, like the East Asian Tigers, pursued a policy of state-sponsored capitalism in the Japanese style, albeit in a much more accentuated form. There was a pronounced reliance on state-owned enterprises.

Third, China invested heavily in physical infrastructure. The pace of accelerated investment in physical infrastructure is illustrated by how, relative to India, China ramped up its rail network. With only 55,000 km of railways in 1985, China had a smaller rail network than India (62,000 km). By 2006, with 75,000 km of railways, China had overtaken India which had 64,000 km. In 2006, as a proportion of GDP, Chinese annual investment of 14.4 per cent in infrastructure such as power, transport, drinking water, irrigation and telecom was almost three times that of India.  

Fourth, in sharp contrast to Japan, China became the factory of the world, relying mostly on FDI. After the US, China is the second-largest FDI recipient in the world. While FDI inflows into China from 1979 to 1999 amounted to $306 billion, annual average non-financial FDI in China was about $60 billion during 1999-2008. Much of Chinese exports are by foreign-owned firms. In 2007, only four of China's top 25 exporters were Chinese companies. 

Fifth, for most of the post-reform period, China followed an exchange rate policy designed to promote competitiveness. The renminbi which had been rapidly devalued from RMB 1.50 per US dollar in 1980 to RMB 8.62 per US dollar by 1994, was maintained at RMB 8.27 per US dollar from 1997 to 2005.

It moved to a managed float in July 2005, the renminbi gradually appreciated to RMB 6.82 in May 2009, and remained more or less unchanged thereafter. China has had to intervene heavily to prevent the renminbi from appreciating, and in the process, has accumulated over $2.2 trillion.

In a way, China's rise could be described more as redemption of its historic role. After all, the country gave the world gunpowder, the magnetic compass and printing technology. Right up to 1820, China accounted for almost a third of the world output.

Yet, doubts have been expressed about the durability of China's recent rise. In March 2007, Premier Wen Jiabao at the National People's Congress declared the economy as "unstable, unbalanced, uncoordinated and unsustainable".

The doubts are mainly on four counts: The danger of turbulence in the eventual transition to a democratic form of government; the risk of civil conflict involving the Tibetans, the Uyghurs and cultists such as Falun Gong; the eruption of the Taiwan question; and a growth slowdown resulting in even higher unemployment and large non-performing loans in banks' balance sheets and a domestic financial crisis.

While the sustainability question is a valid one, many naysayers about China have had to eat their words in the past. Serious doubts were raised during China's WTO accession in 2001.

Books came out with titles such as the Coming Collapse of China. But, China managed the WTO accession with remarkable success.

Many experts believe that it will do the same with future challenges. Even in the difficult transition to a multi-party democracy, many believe that China will evolve along the path of countries such as South Korea, Taiwan, Chile and Spain.

The spectacular rise of the West in the 19th century proved to be a disaster for most of Asia. What does the rise of China portend for the rest of the world? While the future is difficult to foretell, it appears that on the economic front, the rise of China has already created, through what has been called the "disassembly line", quite a bit of backward linkages with many other countries.

Foreign exporters from China, in their search for the lowest-cost place to make each component of their products, have created a seamless connection between multiple factories in multiple countries.

Furthermore, while competition by China has worsened the employment situation in some of the developed countries, the consumers in these countries have also benefited from the availability of cheaper goods from China. The global implications of the rise of China, however, go far beyond pure economics, and such implications are beyond the scope of this article.

The author is an executive director, Asian Development Bank (ADB), Manila. The views expressed here are personal and do not reflect those of ADB.