Introduction and Overview

Anoop Singh, Malhar Nabar, and Papa N'Diaye
Published Date:
November 2013
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Anoop Singh, Malhar Nabar and Papa N’Diaye 

By the time China joined the World Trade Organization (WTO) in 2001, its economy had already experienced slightly more than two decades of “reform and opening-up.” The shift from a domestically oriented, planned economy to an outward-looking, more market-driven one had, on the eve of WTO accession, placed China in the bracket of the world’s 10 largest exporters. What happened next, with its WTO membership, was almost inevitable, but the speed at which China shot to the top was astounding. To put this rise in perspective, in 2001, China’s exports were roughly three-quarters of Japan’s, just under half of Germany’s, and about a third of U.S. exports. By 2003, China had overtaken Japan to become the world’s third-largest exporter; in 2006, it moved into the second spot ahead of the United States; and by 2008, its exports had surpassed those of Germany, the leading exporter at the time.

External Imbalances in the Aftermath of WTO Accession

Reflecting the proliferation of Chinese exports in global markets, the statistics told a story of an economy becoming ever more reliant on external demand. Exports as a share of the national economy grew from 20 percent in 2001 to 35 percent in 2007; the net contribution of external demand to China’s growth doubled compared with the 1990s; and the external imbalance captured by China’s current account surplus grew from 1¼ percent of GDP in 2001 to more than 10 percent of GDP in 2007.

Within a few years of this rapid acceleration in the outward orientation of China’s economy, analysts began to worry about China’s widening current account in the context of growing global imbalances—mainly the financing of U.S. external deficits by a combination of East Asian, German, and oil-producer surpluses.1 The concern was that the large imbalances were unsustainable and would unwind chaotically once investors became wary of financing the U.S. external deficit. Higher borrowing costs would then push the U.S. economy into recession. Emerging markets that had come to rely on U.S. demand for their exports would suffer growth collapses and rising unemployment rates.2 Even the seemingly unstoppable Chinese economy would not emerge unscathed. Against this backdrop, the leadership in China publicly acknowledged concerns with its pattern of economic growth.3

And then just as suddenly as China’s external surplus had emerged, it began to shrink. From a peak of more than 10 percent of GDP in 2007, the current account surplus declined to less than 2 percent of GDP by 2011. The trigger for the correction was different from what experts had predicted in that it was the collapse of U.S. housing, not a broad flight from dollar-denominated securities, that led to the worst contraction in global economic activity since the Great Depression. China’s exports as a share of GDP fell to 26 percent in 2011. And net external demand subtracted from growth in China for two out of the four years following the onset of the global financial crisis. Remarkably, the economy continued expanding at more than 9 percent each year during 2008–11, in part because of a forceful policy response from the Chinese authorities.

China’s declining external imbalance raises the prospect of a new phase for the economy in which domestic engines of growth play a more important role. In the first instance, this would be in the best interests of China’s economy, allowing its vast manufacturing capacity to be deployed domestically, reducing its dependence on uncertain external demand, and ensuring more sustainable growth. At the same time, the shift would also place the world economy on a more solid footing, with China providing a steadily expanding market for exports from elsewhere, helping to compensate somewhat for the weak demand in advanced economies. Considering its importance for contributing to stable and sustainable global growth, a central question is to what extent this transition is already under way in China. More specifically, is the compression in China’s current account a sign of a durable shift in the drivers of its growth away from exports and investment toward consumption?

Domestic Imbalances Advance as External Ones Retreat

This book brings together recent research by IMF staff on questions concerning the rebalancing under way in China. The decline in the current account surplus to nearly a fifth of its precrisis peak is no doubt a major reduction in China’s external imbalance, and policy efforts have contributed much in reorienting the economy toward domestic demand. So far, however, the decline in the external surplus has not been accompanied by a decisive shift toward consumption-based growth. Instead, the compression in the external surplus has been accomplished through fixed investment rising higher as a share of the national economy. The continued reliance on investment raises questions about how durable the compression in the external surplus will be and whether the current growth model, which has had unprecedented success in lifting about 500 million people out of poverty during the last three decades, is sustainable. In a nutshell, even as external imbalances appear to be receding, domestic imbalances seem to be on the rise. This turn of events creates risks of persistent overcapacity, deflationary pressures, and large financial losses. Alternatively, if final domestic demand is not forthcoming, Chinese firms may look outward and push the excess capacity onto world markets at the risk of depressing prices and triggering retaliatory trade action.

The analysis in this volume covers three main themes—the reasons for the decline in China’s current account and signs of growing domestic imbalances; the implications for China’s trading partners; and policy lessons for seeing the process through to achieve a stable, sustainable, and more inclusive transformation of China’s growth model. The first section begins with an overview of China’s current account surplus in the context of global imbalances and the factors that account for its sharp decline since 2007. Undoubtedly, the shrinking external imbalance has been directly influenced by the collapse in external demand when the global financial crisis broke and the subsequent weak recovery. But other factors also appear to be at work, including changes in the terms of trade, a gradual appreciation of the renminbi, and a step increase in investment as China builds infrastructure and capacity in new areas of manufacturing.

The remainder of Part I examines various dimensions of rising domestic imbalances. Chapters 2 through 4 focus on investment. An important distinction in this discussion is between the stock of capital and the flow of investment: the chapters find that although China’s capital-to-output ratio is within the range of that of other emerging markets, its investment ratio appears too high according to multiple metrics. Sectoral analysis indicates that manufacturing, real estate, and infrastructure have been the main drivers of investment in recent years. The heavy dependence on investment and capital accumulation has meant that capacity has run ahead of final demand, and China has operated with excess capacity for most of the 2000s.

Chapter 5 looks at household saving and consumption in more detail. In urban China, households living in an environment defined by rapid change, reforms to the social safety net, and growing aspirations regarding house purchases have self-insured to provide a buffer against fluctuations in income and health. Declines in the rate of return on those savings have induced them to save more out of disposable income to meet their saving targets. The key implication is that an increase in the real return on saving would enable households to achieve their saving goals more easily and could curb the high propensity to save.

The Impact on Trading Partners

Part II of the book explores the potential consequences for other economies of China’s growing domestic imbalances. Chapters 6 and 7 analyze the impact on trading partners of China’s external rebalancing and the tilt toward investment. Economies that have benefited from China’s rapid investment may see their exports suffer if domestic imbalances were to disrupt growth in China. Specifically, regional supply chain economies and commodity exporters with relatively less-diversified economies would be most vulnerable to an investment slowdown in China. The spillover effects from investment in China would also register strongly across a range of macroeconomic, trade, and financial variables among G20 trading partners, particularly Germany and Japan.

A related question, examined in Chapter 8, is the more specific impact of real estate investment activity on trading partners and the potential fallout from a disorderly correction in the real estate sector. Real estate investment is about a quarter of total fixed asset investment in China. A sudden decline in real estate investment in China would have an appreciable impact on overall activity in China and large spillover effects on commodity prices and economic growth in a number of China’s G20 trading partners. Machinery and commodity exporters among the G20 would suffer the largest impact from a correction in real estate activity in China.

Policy Implications

The final part of the book explores what remains to be done to secure the transformation to a consumption-based and more inclusive growth model in China. Chapter 9 provides the motivation for reform through the lens of demographics. China’s growth miracle has thus far relied heavily on absorbing excess labor from the countryside into factories in export-oriented manufacturing. Although China still has a pool of surplus labor and is not expected to reach the Lewis Turning Point (at which this excess supply will be exhausted) until about 2020, time is running out on when the existing framework can be modified with relatively low adjustment costs.

A critical part of this adjustment will involve making growth even more inclusive. China’s urban-rural income gap has widened since 2000, and wage disparities across provinces appear to have risen as well. Chapter 10 examines the policies that could make growth more inclusive in China. The main point is that there is room to expand spending on health and education, and to broaden the benefits of growth by improving the functioning of the labor markets. More broadly, enhancing the inclusiveness of growth and widening labor market opportunities will entail dismantling barriers to entry across various sectors. As Chapter 11 documents, removing these barriers is especially relevant in services and domestically oriented industries. Encouraging the entry of new firms and improving contestability would substantially raise China’s income per capita, mainly through gains in total factor productivity.

Some of the challenges China faces in making these adjustments are similar to the ones encountered in preceding decades by other economies in the region. Chapter 12 looks at the insights from Japan’s experience with the transition to a services-based economy in the 1980s and potential hurdles China may face as it embarks on a similar transformation. Japan provides lessons on the limits to an export-oriented growth strategy; the mix of macroeconomic, structural, and exchange rate policies for rebalancing the economy toward the nontradables sector; and the role of financial sector reform in structural change.

The insights related to financial liberalization are especially relevant for the current phase of China’s development. Financial sector reform, particularly interest rate deregulation and continued real effective exchange rate appreciation, would lower investment and help rebalance growth toward private consumption. As Chapter 13 highlights, delays in financial liberalization, or pursuing reform simultaneously on multiple fronts, could pose risks for China. Instead, proceeding according to a clearly defined sequence during the next half-decade would help expand employment opportunities across the economy, contribute to improvements in living standards, and allow the economy to rebalance toward private consumption while maintaining stable and strong growth.

The stakes associated with seeing the process of domestic rebalancing through are high for China and for the world economy. In 2011, China offered a glimpse of its potential to act as an engine of final demand when it became the single largest contributor to global consumption growth (Barnett, Myrvoda, and Nabar, 2012). But this large increment to global consumption was the result of its overall economy growing much faster than that of other economies, not from an appreciable increase in China’s household consumption as a share of the national economy. As the chapters in this book indicate, there are multiple aspects to rebalancing China’s growth model away from exports and investment toward private consumption. Addressing these various dimensions will make China’s growth model more stable, sustainable, and even more inclusive. Such an outcome for the world’s second-largest economy will, in turn, contribute substantially to improving medium-term global economic prospects.


    BarnettS.A.Myrvoda and M.Nabar2012Sino-Spending,Finance and Development Vol. 9 No. 3 (September).

    ObstfeldM. and K.Rogoff2005Global Current Account Imbalances and Exchange Rate Adjustments,Brookings Papers on Economic Activity Vol. 1 pp. 67123.

    RoubiniN. and B.Setser2005Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005–2006,” Paper presented at the Symposium on the “Revived Bretton Woods System: A New Paradigm for Asian Development?” organized by the Federal Reserve Bank of San Francisco and the University of California BerkeleySan FranciscoFebruary 4.

This is the downside scenario envisaged in the IMF’s 2006 Multilateral Consultation initiative, which led to commitments by the large current account surplus and deficit countries (China, the euro area, Japan, Saudi Arabia, and the United States) to reduce global imbalances through a shared strategy that included structural reforms, fiscal consolidation, and greater exchange rate flexibility.

See Premier Wen Jiabao’s press conference at the National People’s Congress in March 2007, Premier Wen acknowledged “There are structural problems in China’s economy which cause unsteady, unbalanced, uncoordinated, and unsustainable development. Unsteady development means overheated investment as well as excessive credit supply and liquidity and surplus in foreign trade and international payments. Unbalanced development means uneven development between urban and rural areas, between different regions and between economic and social development. Uncoordinated development means that there is lack of proper balance between the primary, secondary, and tertiary sectors and between investment and consumption. Economic growth is mainly driven by investment and export. Unsustainable development means that we have not done well in saving energy and resources and protecting the environment. All these are pressing problems facing us, which require long-term efforts to resolve.”

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