Editor’s Note: In this piece, David Dollar examines how China’s rebalancing creates opportunities and challenges for other developing countries through three mechanisms.
China’s growth has been extremely reliant on investment in recent years. Investment as a share of gross domestic product (GDP) has risen above 50 percent, fueling the expansion of housing stock, local infrastructure and manufacturing capacity. The problem with this pattern of growth is that after some years excess capacity starts to build up and the return to further investment falls. The best evidence for these diminishing returns is the fact that while China’s investment rate has been rising, its growth rate has been slowing—by more than three percentage points. It takes more and more investment to grow at a slower and slower rate.
For this reason, China’s new leaders are trying to implement reforms that would rebalance the economy. On the supply side they aim to generate more innovation and productivity growth while reining in wasteful investment. On the demand side they would like to see increases in household income and consumption that would lead to a more sustainable balance between consumption and investment.
In Finance and Development I argue that this Sino-shift creates opportunities and challenges for other developing countries through three mechanisms.
1) Easing of Commodity Prices as Investment Slows
First, over the past decade the growth of investment in China has averaged about 15 percent per year and has been an important source of demand for minerals such as copper and iron and for energy, sustaining high prices for these commodities. The price of copper, for example, is 200 percent higher than a decade ago even after some recent easing. If China succeeds in rebalancing then the growth rate of investment should slow down to less than half that prior rate: that is, it should grow less rapidly than GDP, whose sustainable growth rate is around 7 percent. It is notoriously difficult to predict commodity prices, but China’s rebalancing should lead to an easing of prices compared to a business-as-usual scenario. The commodity-rich countries that have benefited from China’s investment boom are now likely to see some reversals in their terms of trade.
2) Manufacturing Jobs Shift to Lower-Wage Countries as China’s Wages Rise
Second, China’s wages have been rising rapidly, changing comparative advantages among developing countries. Real wages for semi-skilled workers in China have been rising at 15 percent per year since 2008, compared to low-single-digit gains in most developing countries. These rises started as partly a supply-side phenomenon as China’s demographics reduce the flow of workers to the urban labor market. But rebalancing will be important to sustain this trend. In the first quarter, despite much slower investment and GDP growth, China created 3.44 million new urban jobs, the most since this quarterly statistic began to be reported in 2008. Most of the job creation is in the service sectors, which are far more labor-intensive than manufacturing. Rebalancing towards consumption on the demand side and services on the supply side should keep the labor market tight, with rising incomes for Chinese workers. One result of these wage gains is that China is losing comparative advantage in labor-intensive manufactures so that some production is shifting to lower-wage developing countries. Since China still has a large trade surplus and a tight labor market there is nothing bad about this adjustment.
3) Chinese Outward Investment in Manufacturing and Services
Third, China has emerged as a major supplier of foreign direct investment (FDI) around the world. With diminishing investment opportunities at home, it makes sense that more Chinese firms will take their expertise and capital abroad. China’s outward investment is different from other FDI in that up until now a larger share of it has gone to developing countries. Probably some of this is owing to China’s search for mineral resources over the past decade. If I am right that China’s appetite for minerals is diminishing, then this pattern may change. But there has also been a lot of Chinese outward investment in manufacturing and services, much of it coming from private firms, and much of it going to other developing countries.
China’s rebalancing provides an opportunity to developing countries that can put in place good investment climates and infrastructure in order to attract some of the manufacturing that shifts out of China, including through China’s own overseas investment.