HSC Economics Revision Module 1

Anthony Liang


# China Case Study
Syllabus requirement Syllabus requirements
Case study
A case study on the impact of globalisation on an economy other than Australia
must be undertaken, along with the strategies that this economy is using to
promote economic growth and development.

Previous questions Discuss the impact of globalisation on an economy, with reference to
economic
development and environmental consequences. (2004)
Explain the impact of globalisation on the economic performance of
EITHER the Australian economy OR an economy other than Australia.

1. Introduction The Globalisation of China
Deng Xiao Ping implemented a range of economic reforms (from 1978-1997)
to improve Chinas economic performance, largely based on rapid
industrialisation. As part of the reforms, the one child policy was introduced to
contain Chinas population growth.
Agricultural reforms (1978-1994) involved de-collectivisation (abandoning
the commune system)

International
convergence
China has had a significant improvement in living standards as a result of
its substantial economic growth, most visible on the reduction of poverty of
400 million people in the last 25 years and most rapidly between 1990 and
2001, falling by 130 million (World Bank estimates).
Chinas rapid rate of economic growth has led to rising real incomes and
significant improvements in material indicators (GDP per capita) and non
material indicators of living standards (e.g. life expectancy and literacy)

Economic growth From 19601978, GDP growth averaged 5.3%. There are claims that this is
overstated due to the Great Leap Forward (1958-1960) and Cultural
Revolution (1966-1976)
o Great Leap Forward attempt to modernise agriculture and industry,
but failed to raise national output significantly, resulting in widespread
famine and poverty
o Cultural Revolution attempt to revive communism; many schools
closed and many lost ability to be formally educated, affecting them
for life and the quality of the labour force
Between 2003 and 2009, China sustained an average annual rate of
growth in real GDP of 10.1%
China has relied on foreign investment and international trade on the path
to industrialisation
China is the 7
th
largest economy in terms of nominal GDP and the 2
nd

largest economy in GDP (PPP) behind the US
Chinas share of global GDP was estimated at 11.4% in 2008 and share of
world exports of good and services was 8.4% in 2008 and the share of
world population was 20.1% in 2007.
The main drivers of the high rate of economic growth were business
investment and net exports.
o In 2006, investment spending was 45% of GDP
o Foreign investment funds (42% of GDP in 2007) are used to finance
export industries, allowing China to have a large CAS and a low
HSC Economics Revision Module 1
Anthony Liang


external debt


Economic development
and quality of life
China has raised its level of economic development with citizens enjoying
rising per capita incomes, improvements in quality of life and a substantial
reduction in poverty
The World Bank estimates that over the past 25 years, poverty has been
reduced by 400 million people in China
Chinas rapid growth in the 1980s to 2000s was based on an export
oriented strategy financed by foreign direct investments. This led to rising
real incomes and improvements in material (GDP per capita) and non-
material indicators (life expectancy, literacy rates etc) of development
Chinas HDI value rose from 0.530 in 1975 to 0.777 in 2005
Life expectancy rose from 63.2 years in 1975 to 72.5 years in 2005.
Adult literacy rose from 78.3% in 1975 to 90.9% in 2005
GDP per capita (PPP) grew an average of 8.2% pa between 1975 and
2005 to reach US$6 757 in 2005
In 2005, China ranked 81/177 countries in the UNDPs HDI, which was an
improvement of 13 spots from 94
th


Distribution of Income
and Wealth
Chinas growth has not benefitted all provinces equally, with large
geographic disparities in income remaining across provinces
o Per capita incomes are higher in urban areas in the east and south
of China, compared to rural areas in the north and west
o Per capita incomes are higher in the southern coastal provinces of
China compared to the north, and in the eastern coastal provinces,
compared to western provinces
China is one of few countries in the world performing well overall in
indicators for the Millennium Development Goals, yet in recent decades,
China has shown large disparities in economic and social outcomes
between coastal and inland regions differences between urban and rural
areas
Coastal areas have consistently experienced the fastest economic growth
as they benefit from their proximity to Special Economic Zones (e.g.
Shanghai and Shenzhen) where employment and income opportunities are
greater (e.g. 11% pa per capital income growth 1978-1988)
The performance of coastal areas sped up in the 1990s, with annual growth
averaging 13%, which was 5x the level in Chinas slowest growing NW
regions (e.g. Tibet and Xinjiang).
The bulk of national income is concentrated in metropolitan and coastal
regions. The wealth of coastal areas with large ports and harbour cities
owes much to exports. The poorest provinces had the greatest inequality
and may not achieve the Millennium Development Goals (esp western
provinces)
In 1999, Chinas 3 riches cities, Shanghai; Beijing and Tianjin, were at the
top of the HDI rankings, while those at the bottom were all western
provinces

HSC Economics Revision Module 1
Anthony Liang


Trade, Investment and
Financial Flows
In 2002, China contributed 10% to global growth and accounted for 5% of
world merchandise trade.
By 2003, China surpassed Japan as the 3
rd
largest goods trading country in
the world, being responsible for 17% of global imports and 6.7% of global
exports.
The fast export expansion has been associated with the significant CAS,
which reached 3.2% of GDP in 2007 (US$360.7b). Since 1994, 65% of
Chinas export growth is from Western companies set up in China and
TNCs account for 54% of Chinas total exports.
China accounts for 10% of the worlds consumption of resources because
of the large population, high economic growth rate and reliance on
resource and energy imports. (Chinas demand as proportion of world
demand - 25% steel, 35% iron ore and coal, 20% aluminium, copper and
zinc)
China records trade deficits with East Asian trading partners as it spends
more on imports than it receives from exports, but are offset by large trade
surpluses with the USA and Europe
The majority of chinas trade is with countries in the Asian regions (e.g.
Japan, Hong Kong, Korea and ASEAN) with about 53% of exports sold to
this region and 65% of imports sourced from it (intra-regional trade grew
strongly between 1999 and 2002
Other major export markets and sources of export markets are USA,
Europe and Asia
Chinese exports are dominated by manufactured goods, with intermediate
manufactured goods comprising of a higher share of imports than exports,
reflecting the role China plays in processing higher value added goods
(incl. ICT equipment)
Export success has been assisted by an undervalued currency to maintain
the price competitiveness of exports
Under pressure from the USA in 2005, China revalued the RMB and
adopted a managed peg system

- Trade and
Investment
Between 2004 and 2008, the value of Chinese exports grew by 30% pa
and exports now account for 35% of GDP, with much of the growth
reflected in the expansion in the processing of goods that have been
imported from other countries
Imports account for 30% of GDP, and while some are subject to value-
adding and re-export, the rest of Chinas imported goods have been for
domestic usage, emphasising that domestic demand (incl.
household consumption and business investment) is an important
future source of growth, which finances growth in Chinas productive
capacity through:
o New factories, industrial complexes and technology parks
o Retail shopping malls and centres
o Commercial office complexes and residential development (incl.
apartment and houses)
Chinese domestic demand has grown 14% pa between 2003 and 2008
compared to 15% growth in nominal GDP over the same period, while
investment growth averaged 19% and investment is estimated to
account for 40% of Chinas nominal GDP
While investment in manufacturing was 12% of GDP in 2006, most was
for increased infrastructure, buildings, water and environmental
HSC Economics Revision Module 1
Anthony Liang


management. A large share of infrastructure investment was for the
construction of inter-provincial highways to allow the movement of
goods and people. Urban fixed asset investment suggest:
o of urban investment was in infrastructure (utilities, water and
environmental management)
o of urban investment was in the real estate sector (incl.
housing construction and land purchase)
Investment in urban areas is the result of the rapid urbanisation of China.
The 4 trillion RMB fiscal stimulus packages is aimed to boost public
infrastructure investment to support economic growth

- Chinas
acceptance into
the WTO
China became a member of the WTO at the Doha Conference in 2001, with
its admission reflecting its status as an economic superpower and opened
its domestic market of 1.3 billion people to global exporters and increased
Chinas access to other countries markets. Membership will help achieve
goals in its future growth and development
o Diversification of its export base to include more value added
ETM and service exports
o Attracting greater FDI into the Chinese economys service
sector
o Encouraging more innovation and use of ICT in the Chinese
economy
The gains of membership need to be balanced with higher unemployment
and structural change in domestic industries that face more competition
(e.g. retailing, finance and telecommunications)
It also means China was adhere to international rules for free and fair trade
set by the WTO, including intellectual property rights

- The revaluation
of the RMB
On 21 July, 2005, China abandoned its fixed exchange rate against the
$US and moved towards a managed peg against a basket of selected
currencies of its major trading partners
This was done in response to criticism that China gave its exports and
import competing firms an unfair advantage in world trade as the RMB was
undervalued, increasing international competitiveness
The new exchange rate arrangements should provide greater flexibility for
China to set is exchange rate in the medium term, to help the Peoples
Bank of China to gain more control over Chinas domestic monetary
conditions and inflationary pressures in good and asset markets

- FDI in China FDI in China is the key driver of Chinese economic growth, although capital
flows eased due to the GFC
The Chinese government has extensive capital controls to encourage FDI
rather than portfolio investment
China attracts record levels of FDI, as companies continue shifting
production toe major Chinese cities to exploit the cheap labour market, with
factory wages between <5% of those in USA
Foreign investment in factories, supermarket chains and apartment
buildings rose 13% to US$52.7 billion in 2002
China surpassed the USA as the top recipient of FDI in 2002
TNCs locate in China to manufacture goods for exports and Chinas
growing middle class in cities. Foreign investment into Shanghai alone was
US$10.58 billion in 2002, up 48.4%
HSC Economics Revision Module 1
Anthony Liang


With a large CAS, high growth and increasing demand for resources,
Chinese investment has grown in resource projects
In 2008, FDI totalled US$92.4 billion, with the majority in wholly foreign
owned enterprises and equity joint ventures
FDI continued to flow into China after implementing WTO commitments to
open up its domestic market to free trade in 2007 and the surge related
with the Beijing Olympics have helped to support growth in domestic
consumption and investment

Chinas rapid rate of economic growth has led to severe environmental
problems associated with resource depletion and environmental
degradation
The Chinese Government commissioned the OECD to conduct a study of
the environment in 2007. It was found that:
o If pollution is not controlled, by 2020 it will cause 600 000
premature deaths in urban areas and 20 million cases of
respiratory illness per year
o 7% of Chinas annual GDP is lost because of pollution, which
could rise to 13% if stronger environmental laws are not
implemented and enforced
CO
2
emissions were 6 200 million tonnes in 2005, 6% higher than the USA,
mainly from electricity and cement production. In 2003, China contributed
16% to total global CO
2
emissions. This is because China relies on coal
fired power stations for over 70% of its electricity
It is estimated that 300 million people are drinking contaminated water
everyday in China, with many environmental issues including:
o Loss of natural grasslands and forests from expansion of
agriculture and industry
o Loss of topsoil and subsequent desertification from the removal
of vegetation
o Loss of lakes and wetlands with total areas of lakes shrinking
15% since the 1950s and wetlands 26%
o Shortages of water due to drought and the loss of water due to
inefficient irrigation systems. Chinas major cities suffer from
water shortages due to excess demand and lack of available
water supplies. To overcome this problem and generate more
hydro electric power, Chinese authorities have completed
massive dam building projects
o Inadequate disposal of household and industrial wastes with an
estimate of only 20% of solid waste per year is properly
disposed of an 10% of sewage is treated
o Severe levels of air pollution, as China emits the most (17
million metric tonnes) of sulphur dioxide each year. Carbon
dioxide emissions are amongst the highest in the world
o A high incidence of respiratory diseases, with China having the
highest rates of chronic respiratory disease. Outbreaks of SARS
and Bird Flu were due to pollution and lack of health and
hygiene standards
The Chinese Government has set targets for pollution levels and there is a
policy to move way from reliance on coal fired power generator to the use
of hydroelectric and nuclear power and a market has been given for
tradable emission permits, which give firms and incentive to reduce
HSC Economics Revision Module 1
Anthony Liang


pollution levels
The Government has banned the logging of domestic timber since 1999
and tightened environmental legislation by passing a law on Environmental
Impact Assessment in 2003, applying to all new development projects
Under the 10
th
Five Year Plan (2001-2005), China increased its spending
on environmental protection from 0.8% of GDP to 1.3%
The World Bank estimates that pollution costs China between 8% and 12%
of its GDP annually in direct damage to the environment from acid rain on
crops, medical costs and lost output from respiratory illnesses, money
spent on disaster relief following typhoons and floods and the costs of
depletion of natural resources

Financial markets China has one of the highest savings rates in the world mainly due to rising
incomes, but also the lack of a robust social safety net
The high level of savings in China has enabled gross capital formation to
be funded from domestic as well as foreign sources, despite the banking
system in China not being well developed and requires additional reforms
(e.g. adequate prudential standards and improvement of lending practices
to ensure savings are efficiently allocated for investment to support medium
term growth)
The banking sector was opened to foreign competition at the end of
2006, with Chinas regulators working towards making Chinas banks
strong ad efficient enough to compete with international banks
A challenge of the banking system is to ensure state owned banks improve
efficiency, by not allocating low cost loans to state owned enterprises that
run at the loss and use funds that could earn higher returns in the private
sector (70% of enterprises in Chinese economy)
Another challenge for Chinese policy makers is to strengthen corporate
governance in the stock market for listed companies
Since the Shanghai and Shenzhen stock markets were established in the
early 200s, share trading volumes have expanded rapidly as Chinas
largest public companies were listed on the 2 exchanges
The main group of investors on the Chinese Stock Exchange are small
individual investors, leading to the quick rise of share values and trade
volumes
In 2007, the US Federal Reserve chairman, Alan Greenspan, warned that
the Chinese stock market was overvalued and may face a large correction
is the speculative bubble was not addressed by the government
In May 2007, the Peoples Bank of Chinas governor, Zhou, Xiaochuan
raised interest rates and increased reserve requirements on banks to curb
lending growth, esp for purchasing shares
The China Banking Regulatory Commission has implemented a program to
educate investors about share trading and risk management and much of
the concern was over excessive risk taking by first time small investors

International business
cycle
China has a high volume of trade and experiences fast economic growth,
which is boosted by high rates of economic growth internationally. Chinas
demand for resources and trade has also assisted in propelling world
growth
However, greater integration has made China more exposed to external
shocks (e.g. Asian Financial Crisis and GFC), which spread to China,
greatly affecting its growth rates that were 13% in 2007 fell to 9% in 2008,
HSC Economics Revision Module 1
Anthony Liang


showing the greater synchronisation of the international business cycle



Implications for
government economic
policies
The model of market socialism socialism with Chinese characteristics
have continued under the leadership of Hu Jintao with the endorsement of
Communist rule and co-existing with a large, but inefficient state owned and
run enterprise sector
There has been little political including movement to more democratic
freedom for the Chinese people or rapprochement with Taiwan, Tibet and
Xinjiang over sovereignty
Hu Jintao has continued to open the economy to market forces in
embracing the potential benefits of globalisation and has maintained good
diplomatic relations with the United States and the focus of the world was
on China during the Beijing Olympics in 2008
Hu Jintaos political priorities are in continuing the economic development
and social stability in China and in 2008-2009, the governments top priority
was to maintain its economic growth target of 8%. A US$586 billion fiscal
package was approved in late 2008 to counter the economic slowdown,
boost domestic demand and prevent a rise in poverty.
The Chinese government also instituted an easing of monetary policy in
response to the economic slowdown by cutting interest rates and lowering
the reserve requirements on Chinese commercial banks

Challenges for
government economic
policy
1) Dualistic economy Chinas growth and development are dependent on
the SEZs in southern and eastern provinces, which are dominated by
TNCs. However, the northern and western provinces remain less
developed and reliant on agricultural production [creates inequality in
income distribution and employment opportunities]
2) Agricultural reform improving the performance of Chinas agricultural
sector remains a priority for establishing a system of enforceable land
rights, provide greater access to funds for farmers and allowing freer
migration of rural workers from country to city regions for work
3) Income and social inequality inequality in China has grown between
rural and urban populations; and rich southern provinces and the poorer
northern and western ones (e.g. In 1994, per capita incomes in Guangdong
was over 8 000 RMB, while it was between 500-999 RMB in northern areas
<200km away)
4) Political stability income and social inequality between urban and rural
areas have led to political instability and social divisiveness, with a push for
democratic and economic reforms to be implemented by the Chinese
government to reduce the inequality. [widespread revolts by peasants]
5) Inflationary pressures more effective management of macroeconomic
policy is needed as high rates of growth have led to continuing inflationary
pressures
6) Reform of the financial sector the almost entirely state owned banking
system is overwhelmed by non performing loans to SOEs, making the
privatisation of banks and reform for the financial sector, difficult for the
government to achieve. China needs a more efficient payments system
incl. foreign exchange, EFT and ATM access for consumers and
businesses.
7) Reform of fiscal policy this is needed as there is widespread tax
HSC Economics Revision Module 1
Anthony Liang


avoidance and an ongoing problem with budget deficits, thus tax reforms
and more efficient spending programs are needed
8) Reform of SOEs Chinas SOEs are inefficient and only remain in
operation through direct government subsidies and loans from the central
bank. Bureaucratic corruption is also a problem with many SOE managers
9) Infrastructure development Chinas growth has stretched domestic
freight and logistics capabilities, resulting in bottlenecks in moving goods
and basic resources, so there is widespread construction of infrastructure
to need private sector demand. Inadequate electricity production capacity
and distribution, limits Chinas manufacturing capacity. Social and
economic infrastructure (e.g. transport, hospitals) are poorly developed in
some regions
10) Legal infrastructure China needs to develop commercial laws and
regulations to protect private property rights and investors and creditors;
law to protect the environment and eliminate corruption in government and
bureaucracy
11) Social security reform To reform SOEs and deal with a n ageing
population, the government needs a large social security system with
unemployment benefits and pensions
12) Unemployment Unemployment is a major issue for China with the urban
jobless rate rising form 4% in 2002 to 5% in 2009, but the Chinese figures
are misleading as the 10 million workers made redundant from failed SOEs
or unemployed peasants are not included.
13) Reform of the labour market The Household Responsibility System in
China restricts the freedom of movement of people between provinces,
which affects peasants who wish to migrate to urban areas. This is
inefficient as the allocation is not responsive to demand and supply in the
labour market.
o Chinas lack of OHS regulations exposes workers in dangerous
industries (e.g. coal mining) to industrial accidents and unnecessary
health risks
o Another issue is exploitation of workers (incl. child labour) by
underpayment or non payment of wages

Despite this, China has made substantial progress in reducing poverty and
improving living standards, which has been achieved by:
o Sustaining a high rate of economic growth
o Utilising natural and labour resources and raising productivity
o Increasing integration with the global economy

Demands for increased democratic reform arose in the 980s as
modernisation gathered pace. Since 1989, the global outrage over the
Tiananmen Square massacre has modified the socialist ideology of the
Chinese government but there has been little progress on democratic
reform.
Priorities of the Chinese government are to maintain the pace of economic
development and social stability under Communist Party control.

2. Strategies the economy
is using to promote
economic growth and
development
The government has expressed that it intends to keep the overall
macroeconomic policy stance broadly unchanged and acknowledged the
need to balance the relationship between boosting growth, rebalancing the
economy and managing inflationary expectations.
HSC Economics Revision Module 1
Anthony Liang


However, the government has decided to keep fiscal policy proactive and
monetary policy relatively loose, relying mainly on administrative
measures to contain risks of asset price increases and worsening asset
quality
However, it is best to focus on measures to rebalance and get more growth
out of the economy

- Monetary and
exchange rate
policy
The authorities have taken several steps recently to mitigate risks of asset
price bubbles, misallocation of credit and bad loans by tightening monetary
conditions since July
The loan-loss coverage ratio was increased, banks with large loan
expansions have had to buy low yielding central bank bills and banks have
been urged to ensure that loans for real investment are not diverted to the
property or stock market
Eventually, general monetary tightening will be needed to dampen these
risks as Chinas current inflexible exchange rate regime, policymakers
consider the ability to increase interest rates to be constrained by the fear
of capital inflows, so monetary tightening has tended to rely on
administrative measures, including credit quotas
However, such instruments are distortive and is not in tandem with efforts
to makes banks more commercially operated
More exchange rate flexibility would make monetary policy more
independent, giving room to change interest rates whenever desired
Several types of financial market policies could enhance financial stability
and reduce risks on asset prices and quality
o Increasing the availability of financial titles would allow
diversification of invests portfolios and could reduce stock market
volatility
o Easing the interest ceiling on bank deposits, encouraging financial
institutions to develop more long term contractual savings
instruments and increasing interest rates on longer term deposits,
could put more liquidity into the banking system
o Introduction of a capital gains tax on equity
o Opening up the capital account in a controlled manner could help
increase capital outflows
The government has continued with steps to increase the role of the RMB
in international finance and trade, which allows lenders in selected
economies to buy or borrow in RMB from mainland lenders
To support the development of the RMB-denominated financial and bond
markets, the China Development Bank and Ministry of Finance have issued
RMB-denominated bonds in Hong Kong

- Fiscal policy China implemented a fiscal stimulus package worth US$585 billion, citing
priorities including: support lower rungs of the economy and developing
infrastructure in farming villages.
The Chinese government has also taken steps to stimulate consumption
(e.g. by providing state subsidies for residents of rural areas to purchase
electronic home appliances)
More central funds are allocated to training and vocational programs, esp.
for the unemployed and migrant workers. Additional funding is also directed
towards the provision of education and medical services, esp. to rural and
disadvantaged areas
HSC Economics Revision Module 1
Anthony Liang





Much of the stimulus package showed up in infrastructure-orientated
government-influenced investment, which should help fuel prospective
economic growth

- Microeconomic
reform
increasing the government presence in health, education and social safety
improving access to finance in rural areas and for SMEs and providing
other support to them
mitigating resource use and environmental damage