China recently became the second largest economy in the world. According to the IMF, in 2010, the Chinese economy was $5,878,257 million – second only to the US economy. If we use GDP at purchasing power parity, the size of the Chinese economy is estimated to be even larger, at around $10,119,896 million. However, it also has an enviable growth rate of close to 10%; at this rate of economic growth, China is forecast to become the dominant world economy within 10 or 20 years.
The rise of the Chinese economy (and also other Asian economies such as India) pose some interesting questions. – Who will benefit? and what should we be concerned about it?
This is a simplified look at the impact China might have on the world economy.
Potential Threats From China
- Demand for Commodities. Growth in the Chinese economy will lead to an increased demand placed on raw materials and commodities. This will push up prices and could lead to shortages of basic commodities.China accounted for 33% of the recent increase in demand for oil.
- Economic Imbalance between East and West. China has a very high saving ratio and low levels of consumption. The effect of this is to cause a flow of savings from east to west. This encouraged large current account deficits in the west. Arguably, the desire for China to buy US assets has led to excess liquidity and artificially low interest rates in the US. This contributed to the asset and credit bubble of 2008.
- Cost Push Inflation. In 2010-11, we have seen a rise in inflation due to higher food and oil prices. This inflation in the west occurred during a period of low growth – where you usually expect low inflation. Because of rapid growth in the east, the west experienced inflation at a time of economic stagnation – this didn’t used to occur.
- Environmental Costs. The rapid economic growth in China has led to higher levels of pollution which will contribute towards global warming and other environmental problems which will impose costs on all countries.
- Increased Ownership of Foreign Assets. China is accumulating vast amounts of foreign capital. This gives China much greater political and economic sway over other countries. For example, China owns over $1.1 trillion of US bonds. If China sold these bonds, it would impose a substantial cost on the US economy.
- Undervalued Yuan. A criticism of Chinese economic policy is that they have sought to keep the Yuan deliberately undervalued. This has given them a large trade surplus at the expense of other countries such as US. (Chinese Currency Manipulation)
Evaluation of Chinese Threat to World Economy
- China has helped keep inflation low through very competitive manufactured goods. Cheap Chinese goods have helped increase living standards in the west.
- China has the potential to become a large consumer of global goods and services. For example, we may not be able to compete with China in manufactured goods, but they will want to increasingly consume services such as education (learn English) and other products where we have a comparative advantage.
- China is catching up with Western living standards. We have been consuming and polluting for many decades, we can’t really complain if developing countries wish to have the same living standards as we do.
- Commodities. It is true that growing Chinese demand for Commodities could lead to shortages and higher prices, however, this was always going to happen. The growth of the Chinese economy is merely speeding up the process. As prices increase it will create incentives for firms to develop alternatives (e.g. solar power)
- With higher economic growth, wages are starting to slowly increase in China. This is reducing their competitive advantage and will put pressure on the Yuan to appreciate.
- Although China has a large accumulation of US assets, it is unlikely to suddenly sell them. This would cause a rapid appreciation of the Yuan and improve the competitiveness of US exports.
I wrote a short essay here about the future impact of the Chinese economy.