China will take over the world's economy. This was quite a slogan about China chanted for a long time, as the country witnessed a tremendous growth for 3 decades in a row.
The country's economic strength existed in its abundant labor supply. But, how long is that labor power going to uphold the growth?
American Economist Paul Robin Krugman in his column on New York Times has warned about China's economic model crashing as a result of the "lopsided balance between consumption and investment".
According to Krugman, successful economies devote part of their current income to investment rather than consumption, in order to be able to consume more in the future. China, on the other hand, keeps its consumption as low as possible and invests a lot to expand its future ability to invest even more.
It is worth mentioning that despite the gigantic amount of investment , China has not run into diminishing returns. This is where China's labor market plays an important role.
Krugman explains that surplus labor, as is this case in Chinese economy, has two effects. First, it allows to bring in new labor from the countryside whenever needed and the country can continue investing heavily in any sector without having to fear about hitting diminishing returns. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer.
China, however, is running out of surplus labor. Wages are rising, forcing China to rebalance its investment and consumption sectors. As investment is now running into sharply diminishing returns, consumption must go up to take its place. But, is China able to "rebalance" itself this easily?
China's economic measures for a long time involved keeping its currency undervalued and flooding cheap credit into is economy, while no significant measure was taken towards enhancing consumption.
One of the main factors holding Chinese consumption low is that some of the income generated by the country's economy flows to a "politically connected elite", while much of it simply stays "bottled up in businesses."
