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Friday, September 11, 2009

Domestic markets can't sustain China's growth

Now this is new to me. Had always figured, thanks to popular opinion, that China would be able to ride any wave of global economic calamity thanks to its hugely undeveloped domestic markets.

Assistant Professor Yu Maojie at the China Center for Economic Research at the highly esteemed Peking University has different ideas...

Quotable quote - "The export-oriented growth model is an unavoidable choice for China based on two key features of the economy: its low age dependency ratio and low level of urbanization."

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Domestic markets can't sustain China's growth
By Yu Miaojie
Source - Global Times, 25 August 2009

With the global financial crisis and the precipitous drop in external demand, there are many voices urging China to upgrade its industrial structure and put domestic consumption as the new engine of China's economy.

However, China's current economy means that it cannot give up the export-oriented growth model.

One of my recent studies along with Yang Yao, Professor of Economics at Peking University, found that the export-oriented growth model is an unavoidable choice for China based on two key features of the economy: its low age dependency ratio and low level of urbanization.

China's age dependency ratio, the ratio of population below age 16 and above 64 relative to those with ages in between, was only 40 percent in 2007, which is one of the lowest levels in the world. In addition, only 45.68 percent of China's population is urbanized, which also lags behind its income level when compared with other countries.

Both low age dependency ratio and low urbanization rate jointly determine a large supply of labor and a slow growth of labor income, which in turn leads to fast accumulation of capital and the manufacturing sector.

The two factors also determine a relatively small domestic market, and the only way to clear the market is to export. Our estimation suggests that China's export-oriented model will continue till 2025.

However, today exports are much more difficult for China given growing global protectionism. To some extent, export-oriented growth model seems like an audacious hope. The key point is: How to guarantee huge exports for China?

In my opinion, Chinese manufacturing firms should try to upgrade the quality of exporting goods, which is more important than the quantity. The idea is intuitive. Goods with higher quality have higher market prices and generate higher revenue with fixed or even slightly declined quantity of goods sold. From a macro perspective, a country with high-quality exports would become a favorable exporter. Goods labelled “Made in China” should not be treated as cheap-labor and low-quality.

In addition to the quality, credit constraints are another important factor that affect company's export. To export, firms need to set up their distribution network abroad. However, with severe liquidity constraints, firms are unable to cover their export entry fixed cost.

According to the 2007 Investment Climate Assessment, China is among the group of countries that have the worst financing obstacles. Research found that, all else equal, firms find it easier to export if they have easier access to external finance from financial intermediates.

How then to produce high-quality goods and alleviate the credit constraints for firms? The answer is simple. Firms should improve their productivity. Paul Krugman, a Nobel Laureate in Economics, once said that productivity is not everything, but in the long run it is almost everything. Many other economists also find evidence that good firms lead to more exports. Recently Marc Melitz, a Princeton professor in Economics, has theoretically shown that firms with high productivity have the intrinsic capability to export and even invest abroad.

Indeed, the most efficient firms export and earn extra profits abroad. The less efficient firms can only serve the domestic market since the entry to the foreign market would generate profits loss due to fixed entry cost. In contrast, the least efficient firms die and exit from the market.

The last question remained is how to improve firms' productivity.

The first way is to reduce firms' various variable costs.

Another strategy is to have the Chinese government impose more favorable production policies or trade policies to support exporting firms within WTO rules.

But the crucial thing is better enforcement of the laws and stronger protection of property rights, which help create, both domestically and internationally, a fair and competitive market for firms.

There are many useful ways to foster China's exports if Chinese firms and the Chinese government can take appropriate actions or adopt the right policies.

The author is an assistant professor in the China Center for Economic Research at Peking University

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