Problems Loom For The Chinese Economy

In 2010 China became the world's second largest economy, exceeded only in gross domestic product (GDP) by the U.S. economy. Japan was a distant third, eclipsed by China in 2001 and every year thereafter. By any measure, China's success over the last three decades has been extraordinary. China's agricultural and industrial production both surpassed the dollar value of the U.S. output for 2010; yet some analysts see problems looming for the Chinese giant in the years ahead.

SEE: Investing In China

As hard evidence of China's current economic power, as of December 2011, the nation held $1.1529 trillion in U.S. debt. Although China is America's biggest creditor, a recent trend indicated that China wasn't buying U.S. securities at its previous rate, and although the Chinese economy appears to be booming, and many a new millionaire has been created in recent years, per capita income remained below the world average.

This disparity in income and additional economic and structural issues facing the Chinese economy have been cited as potentially major problems for China in a new study by the World Bank.

China 2030
In the World Bank's report, titled "China 2030," the Chinese government is urged to transform their currently hybrid economy - much of it is still controlled by the state - to a complete market economy. The government was also urged to reign in the excessive power of state-owned industry to encourage private enterprise and to close the gap on the increasing inequality of income.

The nation's development pattern over the past 30 years or so, since China's transformation from communism to state capitalism with remnants of communist control, has been uneven. A major issue beyond economics, although related incidentally, is the degradation of China's environment. Unless this, among a slew of problems, are addressed and resolved, says the World Bank's report, China's growth is unsustainable.

The World Bank's report is especially timely, as China has recently come under new governance, and the report could have a major impact on government policies proposed and initiated by China's new leader.

Among the pressing economic challenges confronting China's new leadership is the struggling global economy, which could seriously impact China's flourishing export business. The economies of China's principal buyers of its goods - the U.S., Japan and Europe - are weak and facing increasing debt, which threaten to curtail import purchases.

These global issues translate into domestic issues for the Chinese economy. Major state-owned banks face increasing risk, as the economy gears down due to declining exports. Add to this the risk of inflation, the state's financial support of public works and industry, and ever-increasing global and local debt, and the economic picture turns grim.

Further exacerbating these problems is China's low consumer demand and high savings rate, its questionable ability to provide new jobs for people entering the work force, and its need to fight corruption and economic crimes.

Challenges also exist in China's real estate sector. A real estate boom, driven by debt, and once encouraged by the government to stimulate domestic consumption, now seems shaky.

One almost universal complaint against the Chinese economy is its currency manipulation. The Chinese global exchange rate - the value of the yuan against other national currencies - is set by the government and not by the foreign exchange market, and it's pegged against the greenback.

Currency plays a key role with trade between China and the United States. China deliberately undervalues its currency, making its exports to the U.S. cheaper, and U.S. imports more expensive. As a result, U.S. manufacturers post smaller profits, U.S. jobs are lost and the U.S. has an enormous trade deficit with China; the deficit was recently reported to be at $31.5 billion.

The Bottom Line
According to the Chinese government, a long-term plan is currently in place to combat these issues. The government has started to develop nuclear and alternative energy sources as a supplement to its oil and coal production. Plans are also in the works to increase domestic consumption in order to replace dependence on exports for growth. If the plan is implemented and the changes are made, the Chinese economy is expected to keep growing at about 8% annually for the next few years, and it will then slow to about 5%.

At this rate, by 2030, the Chinese economy would surpass that of the U.S., but without far-reaching government economic, financial and environmental reforms, potentially disastrous recessionary consequences may hit China, and could affect the entire global economy.

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