Feb 27 2008

China: formerly the world’s factory, now a nation of consumers…

Economics focus | From Mao to the mall | Economist.comChina - a nation of consumers

China, long acknowledged as the world’s factory, could suffer if falling demand for its exports in the US results in a decline in aggregate demand and GDP here as some economists believe it will. But not all economists agree on the importance of exports to China’s domestic economy:

The increase in net exports (exports minus imports) has never been the main source of China’s growth. It contributed two to three percentage points to annual GDP growth between 2005 and 2007, whereas domestic demand (consumption and investment) added eight to nine percentage points.

But the latest figures show that exports have become even less important as a driver of growth. The World Bank’s latest China Quarterly Update suggests that net exports contributed only 0.4 percentage points to GDP growth in the year to the fourth quarter of 2007 (see left-hand chart). Overall GDP growth slowed only modestly (to 11.2%) because of faster growth in domestic demand, which contributed an impressive 10.8 percentage points.

In other words, the China of today depends on exports for its economic well-being far less than the China of yesterday; rather, today’s China is a nation of spenders. Many forces are at play here, but two that have a significant impact are slowdown in consumption and aggregate demand in the US and the weak dollar, which combined to reduce China’s trade surplus (meaning exports from China are declining while imports from the rest of the world increase):

So if exports are making up less of China’s GDP now than in years past, then what accounts for the biggest slice of China’s GDP pie? Investment, long China’s largest component of GDP, may have slipped to second place for the first time last year, as Chinese households have opened their wallets to spur growth in 2007 to 11.4%:

Mark Williams, an economist at Capital Economics, a London-based research firm, calculates that in 2007 consumption accounted for a bigger slice of GDP growth than investment for the first time in seven years. Government restraints on bank lending caused investment growth to slow slightly, whereas consumer spending picked up.

These figures are good news for more than just Chinese consumers, who clearly are enjoying access to more goods and services than ever before, a sign that economic growth has led to real improvements in quality of life for those Chinese lucky enough to participate in the thriving market economies of the rich eastern provinces. Also happy about the rise of Chinese consumption, however, is the American government and the domestic firms whose interests they often represent.

A consumption-focused Chinese middle class will increase demand not just for China’s output, but for foreign output as well, hopefully leading to a more balanced trade between China and its trading partners including the US. Higher levels of domestic consumption in China will lead to rising price levels and corresponding increases in wages, reducing the international competition for manufacturing jobs that has led to the “off-shoring” of so many American factory jobs.

Of course, the wage competitiveness in China will assure its dominance in manufacturing for the foreseeable future, but for those American firms still manufacturing products in the US, rising wages and price levels in China may improve the chance that some jobs threatened by globalization will remain in the US for a while longer. The weak dollar also bodes well for US manufacturers, who will enjoy increased exports to China, which may in fact help fend off a US recession in 2008.

As I’ve mentioned in both my IB and AP Economics classes repeatedly in the last year, a slowdown in exports from China might be just what is needed to fix the most dire macroeconomic problem faced by China today: inflation (estimated at over 7% in January of this year!) And even if a US recession and a weak dollar strike a substantial blow to China’s net exports, it appears that this nation of spenders will be able to keep its economy afloat just fine in the future, without having to depend on consumers from the rest of the world.

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

27 responses so far

27 Responses to “China: formerly the world’s factory, now a nation of consumers…”

  1. Kellye Calladoon 30 Nov 1999 at 1:00 am

    Bart: “Otto, you’re the coolest adult I know.”

    Otto: “I’ve never been called an adult before….(thinks for a moment)…..I’ve been tried as one.”

  2. Charlie.Gaoon 28 Feb 2008 at 11:14 am

    I think this very good for China's economy. As we learned in class, a majority of China's GDP comes from foreign exports. However, as domestic spending increases, this will increase GDP even more and may save the GDP if exports DO decrease someday. Graphically, China's aggregate demand curve would shift outward, thus increasing GDP and the price level.

  3. Jackon 28 Feb 2008 at 5:37 pm

    All the previous investment in businesses in China has resulted in a richer China. China will soon become a developed country like the West and their GDP will become dependent on their CONSUMER SPENDING rather than their net exports.But this exponential growth in demand may cause demand-pull inflation. Which isn't usually a good thing…

  4. emilyyehon 28 Feb 2008 at 8:19 pm

    I think China becoming a nation of consumers on top of its booming factory industries means that economic growth in China will not slow down too soon, even as international exports decline. China's growing consumer market, with its gigantic population, may have the ability to allow domestic consumption to outweigh losses in the export sector as a result of higher wages and much stronger currency.

  5. Jessica Ngon 28 Feb 2008 at 9:39 pm

    Although China is suffering some losses in the export sector, reducing its AD, its growing consumption I believe will outweigh those losses, thus causing the entire AD curve to shift out. As RMB is appreciating, I believe that this increases imports of foreign resources, and with the added supplies of resources,as the prices of imported resources AS shifts out as a result. This is a great combination: there is real GDP growth, full employment, and relative price-level stability.

    Although China proabably hasn't reached that yet, I think China has a pretty bright economic future.

  6. Richard T.on 28 Feb 2008 at 11:21 pm

    As jack said, China will gradually be dependent on the vast consumer spending instead of it's net exports. Although net exports will still be a great factor of GDP in China, but consumer spending will be rising rapidly since China itself is becoming more and more developed. And this incredibly vast amount of consumers in China, i believe will shift the aggregate demand to the right. However, just as Jack said, it might cause a demand pull inflation, due to the lack or inability to supply the high consuming ability.

  7. alicesuon 28 Feb 2008 at 11:36 pm

    What's interesting is that China's previous position as "the world's factory" is actually what pushed it to its place today as a vibrant market of consumers for the world's product. While being "everyone's source for cheap labor" may have seemed an undesirable place to be, the remarkable thing about economics that plays out in China's story is that the economic growth this nation got from utilizing cheap labor was able to bring progress that has now changed the nation to the side of MDCs with a heavier emphasis on consumption as part of their GDP than investment. Maybe this would be a good example for other LDCs to look at as a sign of hope that their current position as just sources of cheap labor will eventually bring their countries up to a higher economic level and actually transform the very factors that are contributing most to their GDP, vastly improving their citizens' standards of living on the way.

  8. Rebecca Sungon 01 Mar 2008 at 12:39 pm

    In the increase of consumer spending, the blog says that there will be increased demand for not only Chinese products, but foreign products as well. In my opinion, Chinese products that are sold domestically are not has high quality as the ones that are exported to other countries. The introduction of more foreign goods creates competition; this might possibly make Chinese firms produce better quality products that are close in quality to foreign goods. Also, a more balanced trade between the US and China would be good for expats, since currently, some American products are difficult to find here.

  9. Jo Loon 01 Mar 2008 at 3:19 pm

    As Charlie said, the fact that domestic spending is on the rise will help offset if and when the exports decline further. Domestic spending may be on the rise but China is still the world's factory. Pretty much everything I bought from the US is made in China and if people go to other countries, they will see the same thing.

    On another note, since the US dollar is cheaper everyday, the exports from the US will increase. This will further China's domestic spending as more and more US products are cheaper.

  10. Drew Venkatramanon 01 Mar 2008 at 5:30 pm

    Maybe China's spending is more important because they have such a huge population, and now that these people are starting to spend money and make their own investments a previously nonexistent part of their GDP can grow.

    And as jolo and those before him said, this is only helped by the nature that the RMB is gaining on the dollar.

  11. kevinhuangon 01 Mar 2008 at 8:50 pm

    In response to Rebecca's post I don't think there will be much competition between foreign manufacturers and domestic ones. Many Chinese people live near the international poverty line and can't afford to buy more expensive, better brands, and thus they will stick to the Chinese-made products. In addition to this, there is also brand loyalty to these Chinese products. Chinese people want to support and buy Chinese products.

  12. Annie Sungon 02 Mar 2008 at 1:49 am

    I read a news article on msnbc.com recently that relates to this issue: http://www.msnbc.msn.com/id/23278830/

    It talks about "Chinese factories losing competitive edge." According to the article, rising prices in energy, materials, and labor are also causing a rise in the products, meaning the thousands of Made-in-China consumers will be paying more than before. More consumers in China might also mean higher standard of living; China is progressive, and as labor and environmental regulations are tightened, the cost of producing will go up. More small factories in China are expected to shut down and relocated to cheaper places such as Vietnam, Indonesia, and Bangladesh. Seems like China will soon lose its place in the eyes of investors.

  13. kevinmaon 02 Mar 2008 at 7:10 pm

    I agree with what Annie said about how China is about the "lose its place in the eyes of investors". I have heard many times that it is not cheap to live in China anymore, that the prices of everything are rising. The standard of living in China has definitely gotten a lot better since I arrived in China a while back. When wage rate rises and corporations don't receive as much profit, they tend to find and relocate to somewhere cheaper. That might hurt China because many people will lose their jobs and their skills would be kind of useless.

  14. Jonathan Lauon 02 Mar 2008 at 7:29 pm

    Even though labor costs are rising in China, other aspects of the economy like real estate are booming. So even if some companies are looking for cheaper countries to produce their products, I don't think the overall real GDP will be affected that much. Other things like real estate and the rising value of the RMB will make up for it. In addition, since more people in China are becoming wealthier, China's own domestic consumption will continue to increase its real GDP, as mentioned in the article.

  15. serenatuon 02 Mar 2008 at 8:55 pm

    Just like what the article has mentioned, China's domestic goods is a big component to China's rising GDP, and the consumption on the domestic goods will keep increasing China's real GDP.

    China is slowly developing right now, the wages and rent of factory has definitely gone up. Some business are not willing to raise wages for labors because then they won't get as much profit. Just like Kevin said, those business might start relocaing their factories and stuff to somewhere that they can get cheap labors.

  16. julie.linon 02 Mar 2008 at 9:49 pm

    with increase in consumption of chinese goods, this may help boost china's economy because this is one of the big factors that could affect the GDP. i have to agree and disagree with what serenatu says, china is actually developing very quickly, and yes, cheap labour is an advantage in china, and is helping firms who employ these cheap labourers to increase profit, by a lot more than, say, US with expensive labours.

  17. jenniferchoion 06 Mar 2008 at 6:08 am

    Before, China's GDP growth used to depend on the foreign export, but now as China's domestic consumer spending increases, China is experience even a greater GPD increase. As we learned in class this will make China's aggreate demand curve to shift to the right.

  18. James Tsaoon 09 Mar 2008 at 10:07 pm

    This trend of increasing domestic spending is evident in all growing economies. China cannot depend its economy on cheap labor and foreign demand forever because these are often characteristics of countries that are less developed. China's growing independence from relying on its exports to boost GDP is another sign that this country is acquiring a stronger market power globally. If this is the case, China would have acquired a stronger trading position due to its rising domestic demand

  19. TimChuon 17 Mar 2008 at 8:26 pm

    Personally, I don't mind that China is growing so fast. It's interesting to be able to live in a society that is growing so fast economically AND socially. Throughout my past 15 years in Shanghai, I've come to realize that not only has Shanghai changed physically (and in air quality) but it's people have changed along with it. I really hope that this growth will continue. Hopefully the inflation will subside…somehow and everyone will live happily ever after. or at least the Chinese will.

  20. Gabrielon 16 Sep 2008 at 6:20 am

    China used to be an exporting country and as the article says it has moved to a country of consumers. China used to make the products for everyone but now the Chinese, who have experienced an increase in the quality of life, are enjoyed the benefits of consuming. The fact that China used to depend on cheap labour meant that is was considered a less developed country, but now they are focusing on producing other more high tech products, like the lenovos we got in school. After Mao, China has not only opened up to other countries, but also to its own consumers.

  21. Oliveron 15 Dec 2008 at 11:21 pm

    I agree with Gabriel, China has moved from producer cuntry to a consumer country. Dont get me wrong China still produces a ton of finished goods tha they export all over the world, but as the standards of life in China increase the demand to consumer goods from overseas increases.

  22. maddi Don 15 Dec 2008 at 11:43 pm

    I found it very interesting how in the article, it is stated that the chinese economy is more domestic-consumption orientated rather than fueled by exports. You always here of china as a nation who's citizens consume little, but who's trading partners consume much of it's goods. I think its great to hear the chinese are beginning to enjoy the domestically produced goods that are avaliable to them, which of course signifies an increase in living conditions and wages to chinese. This shift of produced goods being sold to domestic consumers now is obviously a positive development for the chinese, who, what with the new domestic consumption, should not be hurt by the decrease in Americans buying their imports.

  23. Aegglion 31 Oct 2009 at 8:34 pm

    The US recession will assist China to improve their domestic firms and therefore, it will help China to improve the living standards of their own people. Since the US no longer is financially able to buy as much goods form China, demand for the Chinese products decrease. This means that China has to find another solution to sell their products. One solution could be to motivate the people in China to buy more domestic products. However, since many people in China have a very low income, the government would have to make sure that the people have enough income to buy the domesic products. Once they have a better income they are able to buy domestic products and rise their living standards. This also means that domestic firms are better off and are therefore safe although the Americans stopped buying their products. Like this China learns to become independent form the spending of other nations.

  24. GDuboison 02 Nov 2009 at 8:36 pm

    That's some good insight to the Chinese perspective, Andrea.

    China is fundamentally successful in being the world producer because of its currency, which the government attempts to maintain quite low relative to the dollar, specifically. This, as we know, allows the US to produce and manufacture goods at a very competitive, low, price abroad which not many other economic centers can.

    Now, with the US recession, the dollar depreciates – this brings its value closer to that of the Chinese RMB. This recession brings higher demand for American goods, services, and especially capital which have become cheaper in relation to foreign currencies. Although the standards of living in the US can not exactly increase significantly due to these increased exports of goods as had occurred in China, aggregate demand will shift outwards (increase; net exports has increased) and unemployment will fall.

    Essentially, the US economy has benefited from losing its currency value.

    I think this is an interesting point as many students like me have believed that a stronger currency was always beneficial, and always the best situation to be in. This may be the case in some situations, but it is important to know that this isn't always the case.

  25. Virginiaon 07 Nov 2009 at 7:16 pm

    I think that it is a good thing for China, that they do not depend so much on trade anymore. The reason for this, is that one never knows how the futur is, and if one will always have good trade partners in the world. Therefore, if most of the GDP growth comes from the country itself, then this is something good. As mentioned in the article it says that investement and consumption give the 'biggest slice' of the GDP in China. This means that the Chinese themselves, are the ones willing to invest in their own country, and they buy goods from their own country, probably because it is cheaper. Furthermore, in the article it mentions the decrease in the USD, which is a good thing for the country, because it can increase trade, jobs, etc. This is one of the topics, we just had on a test, and it also mentioned that it is only a positive aspect if the dollar depreciates.

  26. Lailaon 09 Nov 2009 at 2:57 am

    I think that, even if China has losses in its exports and AD, it will keep on growing due to its potential. China has only just begun growing these past few years and has no plans in discontinuing its growth any time soon. Although it is the exports dragging AD down, we cannot forget another factor that influences AD greatly: consumption. So if consumption is increasing I believe that it will balance the fact that exports are decreasing. A growth in consumption will make the AD curve shift out signalizing a growth in GDP. Therefore, because of China's huge population and their increased demand for consumption, China will most probably keep growing at a steady rate.

  27. Janne and RObon 19 Apr 2010 at 6:15 pm

    The Increase in spending of the Chinese and the shift of exports being the main component of China's GDP to investment is a relief for American consumers and factory workers. As America's reccesion goes on China could be the answer to help America get out and start the growth of the economy once more. The increase in consumption of the chinese will increase exports for the US which is good for America. This is also good for China because the Chinese are now getting access to more goods and services which improves their quality of life.