High Altitude, Low Visibility

China's GDP surpassed Japan in the second quarter of 2010.  The international media gave this milestone considerable attention.  The domestic media hasn't paid as much attention.  As natural disasters, environmental degradation and property bubble at the center of attention, the domestic media isn't likely to focus on this number. Besides, China has 10.5 times as many people as Japan does. The same GDP still puts China's per capita income at less than a tenth of Japan's, which is hardly a moment to celebrate.  Nevertheless, it would be useful to look back on how far China has come, study the risks in China's future, and, if the country can overcome the existing challenges, how much further the country can go in the next ten years.

China's economy took off in 2002: nominal GDP has grown at 18.5 percent, exports in dollars at 21.7 percent, and electricity consumption at 12.8 percent in the following eight years.  (I extrapolated the economic performance for the remaining months of 2010.)  In terms of levels the nominal GDP has increased by 2.9 times, exports by 3.8 times in dollars and 2.9 times in yuan, and electricity consumption by 1.6 times in eight years.  Japan had similar performance in 1960s, Korea and Taiwan in 1980s. But, they were much smaller. What China has done is unprecedented in terms of scale.

When growth lasts many years, it makes a huge difference over time. It is the miracle of compounding.  China and India had about the same value in GDP twenty years go. In 2010 China's GDP is roughly four times India's.  There is little doubt that China has done many things better than India or most other emerging economies. Otherwise its economy couldn't be so much bigger in relative terms.

The "Reform and Opening Up" (改革开放) policies have been the center of China's economic policy in the past three decades. This has undoubtedly been the most important factor. China's exports have become the largest in the world from virtually nothing three decades ago and almost nothing two decades ago. In the last decade alone the exports have risen 5.2 times. Being the workshop of the world has been the most important part of China's economy so far. Without China's export success China's economy wouldn't be near where it is today.

Joining the WTO was the critical difference to the country's export success.  It has given multinational companies the confidence to base so much production in China.  As China's domestic market becomes big, it gives MNC's another powerful reason to keep production in China.  No other country could offer the economies of scale from selling locally and exporting abroad plus low production cost.

China's production cost is no longer the lowest.  Bangladesh's labor cost is merely one fourth of China's.  Indonesia's labor cost was twice as high as China's before 1997.  It is now comparable to China's and is rising slower. Some industries that don't require the supply chain all nearby are likely to leave China. Shoe and garment industries, for example, may move to other countries.  But, most other industries will stay in China.

Infrastructure development has been China's second important competitive advantage.  China has continually delivered strong infrastructure development due to the government's ability to mobilize resources. The state ownership of land and banks are the critical factors.  Land and credit are usually the constraints to infrastructure development in most other countries. Without such constraints, China could go for size to achieve economies of scale.