China Has Proven It Is a True Heavyweight Global Contender

It goes without saying that China has proven it is a true heavyweight global contender. The herculean growth achieved by China over the past two decades is unprecedented in the annals of human history. China has overtaken Japan to become the world's second largest economy. This is a landmark achievement in itself but it is certainly not the last. Clearly, China is poised to become number one and overtake the U.S. economy sometime within this decade.
   
In what appears to be a prelude to such a happening, Standard and Poor's (S&P) took the first bold action against the U.S.'s credit rating after many warnings from numerous circles about its out-of-control deficit and debt situation. Although the U.S.'s credit rating was not actually changed S&P did downgrade the U.S. economic outlook from "stable" to "negative." Translating this financial jargon means that there is a 33 percent chance that the U.S.'s top-tier credit rating will be lowered within the next two years. This would have a long lasting adverse impact on the vast majority of U.S. citizens in some fashion.

The S&P projection has started a negative financial news avalanche for the U.S. The International Monetary Fund (IMF) has now issued a report stating that China's economy will most likely surpass the U.S.'s by as early as 2016—much sooner than most experts had forecasted.
 
There has been a lot of controversy about the S&P action and the IMF's prediction. A number of economists and political pundits have ridiculed the IMF prediction, but others warned that what the IMF has predicted could happen even sooner. The U.S. leadership, embroiled in what is likely to be a difficult political election in 2012 has attempted to downplay the S&P and IMF statement. However, it is very clear to all observers that the U.S. economy is in deep trouble. No agreement between political leaders can be reached regarding how to turn things around. Both parties are grappling with raising the debt ceiling. Neither political party has offered a plan that will result in significant changes in the short-term thus making the distinct possibility of China overtaking the U.S. economy much more likely.

Financial projections

IMF data has calculated that in five years, using gross domestic product (GDP) figures based on "purchasing power parity," that the Chinese economy will represent just over 18 percent of the world total, up from around 14 percent right now. According to the IMF's projections, China's adjusted GDP will rise from about $11.2 trillion in 2011 to $19 trillion by 2016.

On the other hand, the $15 trillion U.S. economy, which currently accounts for almost 20 percent of global GDP, will decrease to about 17.7 percent of the international total by 2016, said the IMF. During the next five years, according to the IMF forecast, it will grow by a mere $3.5 trillion. That is if the U.S. can curb its spending, get unemployment back to a reasonable level, reform a number of entitlement programs and stop the erosion of the housing market, among other issues, none of which are likely to be addressed in the current U.S. election climate.

An historical perspective of China's foreign exchange reserves

You might be wondering how this could ever happen. Wasn't it just a few decades ago that China was rationing its Foreign Exchange Reserves (Forex)? Looking back to the late seventies, at the start of the reform era by China—end of 1978—China's Forex reserves were minimal at $1.6 billion, but enough to cover the requirements of a country with a very small import bill. As China moved into the early 1980s, export growth contributed to an initial rise in Forex reserves to a peak of $17.4 billion by 1984. Unfortunately, high trade deficits in 1985 and 1986 seriously eroded the reserves in those years. In 1987 the surplus on trade in services slightly exceeded the merchandise trade deficit, producing a small current-account surplus, and a comfortable net capital inflow helped push up reserves to $16.3 billion. The reserves were held above this level for the next two years.

When China joined the World Trade Organization (WTO) in 2001 this contributed to a rapid growth in imports, but exports also expanded at a fast pace, while foreign direct investment (FDI) inflows exceeded $60 billion a year by 2004-2006.

In October 2006, China's Forex reserves exceeded $1 trillion for the first time. By the end of September 2008, the reserves topped $1.9 trillion, equal to nearly $1,500 per head for the entire population of China. It remained around this level until the end of 2008 as trade growth slowed and foreign investment inflows declined. Then, as 2009 progressed, the upward march resumed, with reserves rising above $2 trillion in April and reaching a record $3 trillion in April 2011.

Big is not always better

Most would think that this phenomenal wealth accumulation along with seemingly endless growth would be a good thing for China. Think again. Sometimes, too much of a good thing is bad.

According to recently published comments, Zhou Xiaochuan, governor of the People's Bank of China, said that China's huge stockpile of foreign exchange reserves have become excessive and the government must diversify investments using the reserves. "Foreign exchange reserves have exceeded our country's rational demand, and too much accumulation has caused excessive liquidity in our markets, adding to the pressure of the central bank's sterilization," he said.
Obviously this statement was a not so subtle hint aimed at the U.S. dollar. The intent of this statement was confirmed by the State Administration of Foreign Exchange (SAFE) which said that the U.S. government should take responsible measures to protect the interests of investors. "U.S. Treasuries reflect the credit of the U.S. government and are an important investment product for domestic and international institutional investors," the ministry said in a statement carried on SAFE's website. "We hope the U.S. government takes responsible measures to protect investor interests," the ministry went on to say. The Chinese shouldn't hold their breath waiting for the U.S.'s politicians to get their act together and do something about debt and spending, especially in a major election year.

Notwithstanding its concern about having too many U.S. dollars, China's remarkable growth and attempts to remake itself into a global powerhouse may sound like the stuff that fairy tales are made of but unfortunately, in China's situation, there does not appear to be a "happy ending" to this story. The phenomenal growth that China has enjoyed for the past several decades did not come without a price and the price paid appears to be very, very high indeed. Even with all its growth it is obvious to any observer that China lags behind its Asian neighbors in so many measures that matter to the people that live here.

Impact of growth on average Chinese citizens

Even though China overtook Japan as the second largest economy in the world, its huge population means the average wealth per head is a mere fraction of that in Japan. Living standards are considerably lower in much of the country, particularly in rural areas. But it could also be because of concerns about how sensible and how sustainable the current growth model is in the long term, and what "real costs" are being incurred in the dash for growth.

As an example, the city of Wuhan in central China is not well known to outsiders. It is not as famous as Beijing or Shanghai, but in many ways, it is more like the rest of China than either of them. Wuhan is a sprawling, rather unremarkable industrial town with a population as large as the entire country of Sweden. The biggest employer in Wuhan is a steel mill, which employs about 90,000 people. Cutting through the middle of Wuhan is one of China's great rivers, the Yangtze. Today it is hard for the residents of Wuhan to make out the buildings on the other side of the river. The city is shrouded in a grey haze, which residents blame on pollution from the region's factories.

But it's not just the air that is polluted. In Wuhan, Hebei province dead fish have plagued the Donghu Lake, where officials say an estimated 100,000 pounds of fish have been killed by a combination of pollution and hot weather. The foul smell of the dead fish has seriously affected local residents' lives.

In the lead up to the 2008 Olympics in China headlines around the world proclaimed a major concern about China's pollution problem. Television viewers around the globe got their first view of life in China during the 2008 Olympics and the view was disturbing to say the least. During the Olympics, China shut down factories and forced people to reduce their driving around the city to clear up some of the city's famously bad pollution.
 
How bad is the pollution in China?
 
According to the World Bank, 20 cities in the world with the worst air pollution are located in China. China's Ministry of Science and Technology has estimated that 50,000 newborn babies die every year due to the effects of air pollution. It is believed that the air pollution level in most Chinese cities is leading to the premature deaths of 350,000-400,000 people each year. A further 300,000 people are believed to die prematurely each year from exposure to poor air indoors.
 
China has already surpassed the U.S. in one area. Its emissions of carbon dioxide, the most important global warming gas, surpassed those of the U.S. in 2009, according to the International Energy Agency. At a marathon race during the 2008 Olympics, the pollution index read 149. Anything over 100 is considered extremely unhealthy. Many experts say that China's pollution, if left unchecked, will drag down China's economic growth and result in huge healthcare costs. In addition, China's pollution will over time erode its competitive position in the global economy.

What is the Chinese government doing about pollution?

Until recently, the Chinese government has turned a blind eye to their pollution problem. Following the issuance of the World Bank Report, which said 20 of the most polluted cities in the world were located in China, a follow up report sponsored by the Chinese Government uncovered potentially scary information and was edited to "prevent social unrest."

The quality of air in Chinese cities is increasingly tainted by coal-burning power plants, grit from construction sites and exhaust from millions of new cars squeezing onto crowded roads, according to the government study. Other newly released figures show a jump in industrial accidents and an epidemic of pollution in waterways.
 
The report's most unexpected findings pointed to an increase in inhalable particulates in cities like Beijing, where officials have struggled to improve air quality by shutting down noxious factories and tightening auto emission standards. Despite such efforts, including an ambitious program aimed at reducing the use of coal for home heating, the average concentration of particulates in the capital's air violated the World Health Organization's standards more than 80 percent of the time during the last quarter of 2008. Although some improvement has been achieved the air quality is still felt to be at unsafe levels.

A spokesman for the Ministry of Environmental Protection told the official China Daily newspaper, "China is still facing a grave situation in fighting pollution." The ministry spokesman went on to say that the number of accidents fouling the air and water doubled during the first half of 2010, with an average of 10 each month. The report also found that more than a quarter of the country's rivers, lakes and streams are too contaminated to be used for drinking water. Acid rain, it added, has become a problem in nearly 200 of the 440 cities it monitored. Over the past year the state media have provided a grim sampling of China's environmental woes, including a pipeline explosion that dumped thousands of gallons of oil into the Yellow Sea, reports of a copper mine whose toxic effluent killed tons of fish in Fujian Province, and revelations that dozens of children were poisoned by lead from illegal gold production in Yunnan Province. Chinese officials themselves estimate "50 percent of the water should not be drunk, and between a third and a quarter of that should not be used for anything," even industrial uses. Still, the polluted water continues to be used, contaminating soil, preventing crops from growing and poisoning the public. The Ministry of Water Resources in China has said, "Seven-hundred million people drink contaminated water every day, and 100 million people drink water that's so contaminated it makes people sick."

During the past few months the state media reported on thousands of residents in the Guangxi Zhuang Autonomous Region who clashed with the police as they protested unregulated emissions from a local aluminum plant.
 
A spokesman for the Institute of Public and Environmental Affairs in Beijing said many of the government's efforts to curtail pollution had been offset by the number of construction projects that spit dust into the air and the surge in private car ownership. In Beijing, driving restrictions that removed a fifth of private cars from roads each weekday have been offset by 250,000 new cars that hit the city streets in the first four months of 2010. Many of the most polluting industries were forced to relocate far from the capital before the 2008 Summer Olympics, but today the wind often carries their emissions hundreds of miles back into Beijing.
 
In a recent interview, Environment Minister Zhou Shengxian said, "In China's thousands of years of civilization, the conflict between humanity and nature has never been as serious as it is today."  He went on to say, "If China means to quadruple the size of its economy over 20 years without more damage, it has to become more efficient in resource use." Otherwise, he said there will be a painful price to pay.
 
Some say, especially its citizens, that China is already paying that painful price. Shengxian's comments came ahead of China's annual session of parliament, which opened on March 5. They also came a day after Premier Wen Jiabao said China was lowering its annual economic growth target from 7.5 to 7 percent, in part because of its impact on the environment. In recent decades, development has been prioritized over the environment, meaning that China now has some of the most polluted skies and waterways in the world. It is a situation that will take decades of extensive work to rectify.
 
In an effort to start doing something productive about stemming the current air, water and land pollution new rules have taken effect in China that restrict car purchases in an effort to combat serious traffic and pollution problems in the capital Beijing. City authorities will allow only 240,000 vehicles to be registered for 2011—one-third of 2010s total. As a result, during the close of 2010 car buyers were swamping dealers in anticipation of the new rules, which will still leave about five million cars on the road in the capital.

Traffic and air pollution in Beijing is among the worst in the world. Beijing officials are trying to balance the desire of a growing middle class to have the convenience and status of car ownership, with a huge congestion problem. Officials said the new rules that will be invoked would not solve the full extent of the city's problems, only slow down the rate at which they are worsening. Car registrations will be allocated by a license plate lottery system. Under the new rules, government departments will not be allowed to increase the size of their fleets for five years. About 750,000 new cars appeared on Beijing's streets in 2010, raising the total of registered vehicles for the city to 4.8 million. China overtook the U.S. as the world's biggest car and van market in 2009, with 13.6 million vehicles sold within the country. Will these new rules reverse that achievement? Only time will tell.
 
Chinese citizens view of the governments effort

As for the feelings of the general public in China there remains a high level of skepticism about how well the new measures will work. Most feel that the government's actions came far too late to make a significant difference. As an example of this skepticism, a spokesman for Greenpeace China said, "Everything in China now happens so quickly, and the government always fails to anticipate what's coming, and as a result policies are only introduced when things are already out of control." Residents say that Beijing's roads sometimes resemble car parks. A record 140 traffic jams were recorded on one evening in September of 2010. A spectacular 75-mile long traffic jam formed on the Beijing to Tibet route last September, only a week after another 62-mile jam had been cleared in the same area.

It would appear that China, like the U.S. and other highly developed countries, has discovered that unbridled growth brings with it unbridled problems, pollution being one such problem. Although one of the many achievements of China's growth has been to raise hundreds of millions of its citizens out of poverty, that same growth has resulted in increased health concerns and the lowering of living standards for others. Growth in China has indeed been a double-edged sword.

Other problems associated with growth

Inflation in China is officially running at almost five percent but food prices have surged by 10 percent, creating a lot of public discontent. The lowering of the stated growth rate from 7.5 to 7.0 percent for China is mainly symbolic as economic growth has exceeded the 7 percent target every year in the last six years. In 2010 China's growth reached 10.3 percent, making China the world's fastest-expanding major economy. But along with the breakneck growth have come enormous price rises, particularly for food and housing, which China's Prime Minister, Wen Jiabao, acknowledged were affecting people's livelihoods and even social stability. He went on to say, "We absolutely must not any longer sacrifice the environment for the sake of rapid growth and reckless roll-outs. That will lead to production capacity gluts and deepening pressure on the environment and resources so that economic development will be unsustainable." The Prime Minister's comments have done little to abate the anxiety and anger by citizens over pollution, rising prices and overall deterioration in quality of life. Although carefully controlled by the authorities there are now low-level protests by citizens every Sunday afternoon in Beijing and Shanghai.

China now has the third highest labor costs in emerging Asia

In addition to inflation in staples such as food, clothing and housing, China has also seen a significant increase in manpower costs. An average worker in China costs more than the average worker in any other emerging Asian economy, except Malaysia and Thailand, when considered in terms of combined salary and welfare payments.

A review of minimum labor costs, determined by the legal minimum amount stipulated in 15 different countries, and added together with the pertinent mandatory welfare payments due, it is apparent that since the introduction of the revised labor law in 2008, China's workers are now amongst some of the best paid in Asia.

A recent survey took samples of minimum wage levels from each of China's provinces and 40 cities and based its figures on the mean average. China's minimum wage varies both on a provincial and an urban basis. This was then compared with similar data from other Asian countries.

However, it is expected that China's next five-year plan will see mechanism's put in place to double the country's minimum wage by 2015. That will raise the Chinese figure to $3,000 plus welfare of 50 percent, assuming the latter payments remain the same. This provides a total minimum salary overhead of $4,500. In reality, most salaries will be far higher. That will make China's average labor cost second only to Malaysia and significantly more expensive than any other Asian country. This represents mixed fortunes for foreign investors in China. It signals that an exodus of export driven manufacturing may occur, principally to competing, lower-cost Asian nations for China's residual export driven manufacturing. Such a move would have a definite negative impact on the future growth aspirations of China.

This news about wage increases comes on the heels of a report issued by the American Chamber of Commerce in China (AmCham-China) on April 26, 2011. According to the AmCham-China report, 85 percent of their respondents reported revenue growth in 2010, while 78 percent said that they were profitable or very profitable. The report went on to say that about 41 percent of members reported their margins in China are higher compared to worldwide margins. This number has been fairly consistent over a long period of time. It is not a new phenomenon. The major opportunity and advantage that the Chinese market offers is scale, size and growth, as well as low labor rates. The question to consider is that with the plan to increase worker wages combined with putting the brakes on growth, will American companies be as profitable in the future as they have been in the past?

Summary remarks

Clearly, China has chosen growth over all else and has paid a price both in terms of its environment and the living standards of its people. Having people who are earning more and living in less than desirable conditions doesn't seem to be working for China. Although China had lots of examples from watching other countries pursue growth objectives over the years it is fairly clear that the lessons learned were not implemented inside China. Although I am very optimistic about the long-term situation for China I am very pessimistic about short-term change.
 
The Chinese Government has indeed done too little too late to resolve their tremendous pollution problems, the outcome of which is likely to haunt China for many years to come. I do believe that China will be able to curb its growth and hopefully keep its spiraling inflation in check. If not, I fully expect to see more citizen protest and most likely, more government crackdown on such protest.
 
In so many ways China is a true enigma in that it has its hands on the future but its feet are stuck back in the past. One can but hope that this time the Chinese leaders truly understand the plight of both the country and its people. However, the facts don't give us much hope. On average China spends about 1.3 percent of GDP on environmental protection, which most scientists feel is not enough by half to keep the pollution problem from getting worse, let alone improve.
 
Though it has grown in recent years, The Ministry of Environmental Protection still only has about 300 full time staff employees, compared with the nearly 9,000 employed by the U.S. Environmental Protection Agency. This lack of government sponsorship has given rise to non-governmental organizations (NGOs). A number of analysts say that NGOs have emerged as more effective voices for change in recent years. According to a recent survey, there are probably more environmental NGOs than any other type though they do face challenges from government regulations on registration, fundraising and membership numbers. In other words, rather than assign resources to fix the problems the Chinese government appears more inclined to assign resources to control, keep in check and stifle the effectiveness of the NGOs. As the old saying goes, "the more things change the more they remain the same."  Thus it is with China where control of the situation appears to be more important than fixing the situation.

It is clear that China has made remarkable growth over the past few decades. What is not so clear is the extent and magnitude of the price that China has already paid and will continue to pay for that growth. In America, we are still paying a price for many of our past pollution problems. My suspicion is that China will have a much longer list of "wish we hadn't done that" items.
 
Regarding the IMF's projection that China will overtake and surpass the U.S. economy by 2016, I have no doubt that most in the Chinese leadership would relish such a feat, perhaps if in doing so means once again turning a blind eye to the sins of the past. However, there are signs of reality creeping into the Chinese growth strategy. With the decision by Beijing to restrict the number of vehicles to be registered by two-thirds of the number registered in 2010 there is clear evidence that some sort of correction is underway. If all major Chinese cities adopt a similar restriction then the obvious has to happen in the form of a cut back in total auto production inside China.
 
If that happens there will be higher unemployment not only in the auto industry, but for all the suppliers to that industry. If the Chinese also start addressing their many environmental woes with the objective of fixing them this will mean a genuine slowdown in development activities and of course lower growth projections all of which may increase the number of unemployed in China.
 
If there is a bright side to this happening it might be that such actions would aid in controlling inflation, which at the moment is poised to cause a lot of serious problems in China. My bet is that China will choose a middle road whereby some environmental issues will be addressed but that growth will still be favored, however, not at greater than 10 percent. The Chinese leaders have indicated a scale back to about seven percent in earlier statements but this seems to be more of a ploy to allow them to attack inflation, not correct or address their environmental woes.
 
What is happening is that China is simply building a huge debit against future remedies for the environment they have destroyed in their headlong charge to secure growth. Somewhat similar to the U.S. debt issue, China will have to address their environmental debit at some point in time and that in itself may make it impossible for them to overtake and surpass the U.S. economy. That is unless the U.S. refuses to get its spending and debt under control.