Why do Investors love China?

Q. We all know the history,what has happened to USSR and Japan. In 1970’s we all extrapolated that these countries will surpass US GDP. Yet, USA is the biggest economy in the world.

Second we know the growth theories, China can only ‘catch-up’ the US economy but cannot go further. So I believe that there is a natural balance ‘like in Arbitrage Theory’, that the world will benefit from China until China’s economic growth increases the price level and that will also lead to an increase in wage rates. Also as a country's productivity rises, their real exchange rate appreciates. Then, as production costs rise, the US and the rest of the world will stop importing goods from China.

Do you think that this scenario works or am I making a specification error?
Orhan Yarar, Istanbul Bilgi University

A. China is already experiencing wage rate increases, at least in the more developed regions, and its exchange rate is gradually appreciating (it has just passed the Hong Kong dollar on its way up against the US dollar). However, the scenario you depict is still a long way off. There is a huge reserve of surplus labour in China generated originally by productivity improvements resulting from the reform of agricultural production in the early 1980s and added to by redundancies resulting from the reorganisation of inefficient state-owned industries. This reserve is variously estimated at between 100 million and 300 million people; even at 100 million it is larger than the total workforce of most other countries. There are also regions of China where resources are less intensively exploited compared to the industrialised coastal area. So the potential for continued economic development based on low-cost resources exceeds that of Japan in the 1960s and 1970s.

Unlike the USSR in the 1970s, China no longer has a centrally-planned siege economy, is continuing to reform its economic institutions, and is developing domestic demand by encouraging household consumption. Even when China's dollar GDP exceeds that of the United States, individual incomes in China will still be far below those in the US. But you are right in signalling the importance of moving from a competitive advantage based on low labour costs, which is being eroded by the emergence on the world economic stage of other developing countries such as India, towards one based on innovation and high quality. China's efforts to develop R&D centres and to promote technology transfer through both inward and outward FDI show that its leaders are aware of this.


Q. Why do investors love China? Because of its domestic market, consumption, or just the costs of production?
Danuta Pawlowska, Warsaw

A. China is a rapidly growing market. The old pipedream of selling a toothbrush or a pair of shoes to every Chinese has been replaced by the reality of a China with over 437 million mobile phone subscribers at the end of last year. Not all products are in such high demand, but consumer goods ownership is rising rapidly and Chinese consumers are happy to buy foreign brands if they are value for money. China is also an attractive base for export manufacturing: approaching 60% of the country's exports are produced by foreign-invested enterprises. True, Chinese wage rates are far lower than in developed countries, so companies can lower their labour costs by setting up production facilities there. But other countries have even lower wages, so why choose China? China has many other advantages, including: relative policy stability; good communications; good basic skills; rapid economic growth.

For all the questions and comments see the OECD's Ask the economists: Made in China. Is the game changing?