IE Focus | By Rafael Pampillón, Professor at IE Business School

One of the major landmarks of the 20th century has been China’s spectacular awakening, but the country now faces a series of challenges that will require deep change to maintain rates of growth.The economic boom in China is one of the most important events of the 21st century. The boom has come on the back of China’s great demographic potential (with a population of 1,350 million), its high internal rate of saving and the way it has opened up to the rest of the world, turning it into the biggest exporter on the planet. 

Since 1978 the economy has been gradually freed up and prices have been progressively deregulated. There has been encouragement for foreign investments and the private ownership of businesses has been made legal. In 2001, foreign trade was deregulated when it joined the World Trade Organisation. Since then, China´s trade relations with the rest of the world have grown spectacularly.

As pointed out in a recent article by Enrique Fanjul, former trade director of the Spanish Embassy in Peking, China´s economy still has an unquestionably high level of state intervention and state businesses continue to play a key role. However, it cannot be considered as a socialist economy: most of the production takes place under private-sector conditions and products are marketed at free prices. There is a tendency towards a growing importance of private players in the economic systemAs a result of the deregulation process and liberalization, the growth of China´s annual average GDP has stood at around 10% over the last 30 years. In 2010, when the world is set to grow by 3.3%, China will grow by 10%. This means that its role in the world economy will continue to gain in strength. In the coming years, the Chinese economy will maintain its significant growth, albeit more slowly than to date. Further liberalization of its markets in the services sector will be one of the main drivers of this growth. Another trend which will emerge sooner or later, will be the revaluation of the Yuan. Accordingly, internal demand will gradually replace external demand as a catalyst for economic growth and there will be an increase in internal consumption that will notably improve the population´s well-being. The reduction of the foreign surplus in recent years (down from 11% of the GDP in 2007 to 6.4% last year) confirms the trend towards a higher level of internal consumption. 

Freedom of speech is another pending issue that will have to go down the same road as economic reform. Citizen participation in politics and the media must progress to the point that China becomes a democratic society.
Finally, China must solve its problem of inequality. In its economic report on China, the OECD states that social programmes need to be put in place in rural areas and there must be greater migration to towns and cities to reduce inequality in the distribution of income. 

China´s rapid economic growth over the last three decades and more (1978-2010) has rescued hundreds of millions of people from the claws of poverty. However, the income of those at the top end of the scale grew much more quickly than others, which has led to conflicts in a society for which the Mao era was one of the most egalitarian in history. Social tension has led the Chinese government to attempt to reduce the huge difference in income between rich and poor. The constant emigration of farmers from rural to urban areas is allowing them to increase their income significantly. According to the United Nations, the inequality in income in China, as measured by the Gini index (in which zero is perfect equality, where everyone has the same income, and 100 is absolute inequality, where only one person has all the income), stood at 49.6 in 2005. However, the OECD has just set the Gini index for China in 2007 at 40.8.

The OECD´s figures show that there is less inequality in China than in South Africa, Brazil, Colombia, Bolivia, Sierra Leone, Russia or Mexico. For some years now, the international bodies (IMF, World Bank, OECD, etc.) have pressed China to narrow the income gap and avoid any increase in the inequality of its population. This inequality comes mainly from the gap in per capita income between the rural and urban areas. Last year, the annual per capita income in urban areas was around $2,500, more than three times the $750 earned in rural areas and the proportion increased in the last decade.

Much of the gap between urban and rural income is due to the fact that urban workers have higher levels of education than their rural counterparts. In its report, the OECD suggests that the low level of government debt in China means that it can spend more on social programmes to improve health and education in rural areas, especially when public expenditure on projects to encourage the economy and leave the crisis behind are gradually disappearing. 

At the present time, the Chinese government is applying economic policies to avoid real-estate and stock-market bubbles and the overheating of an economy that is growing at a much faster rate than the rest of the world. These measures consist of withdrawing public expenditure and controlling the monetary and credit situation. Consequently, the increase in social expenditure to reduce inequality will have to be offset by reductions in other areas of public spending.