Is China's rapid economic development over the past two decades sustainable? Yes.

October 2, 2007 - By: Lee Anderson, J.D., M.L.S., Staff Analyst

GDP Growth Sustainable

The consensus is that China’s economic development is sustainable, short of an extreme catastrophe defined as a world war or civil war, or a major environmental crisis. Few economists are concerned over China’s growth in GDP. The real economic issue for economists comes in the form of an ‘asset bubble.’

GDP growth has consistently been in double digits. Officials this year raised interest rates in an attempt to control inflation and prevent the economy from overheating. Liquidity and inflation are the economic issues facing China. Too much money in the system can push up asset prices, particularly real estate and stock market prices, and these are the issues that concern policy makers.

Economic growth is rapid in China which has developed a large trade surplus and capital flow. This adds cash to the system, and as that money moves into the system, it is important to remove it from circulation to prevent inflation. This is done principally by by raising reserve ratios. There is no cap on China’s central bank reserve ratios.

China has a pattern of raising reserve ratios by half a point every month or two. As this continues inflation is being controlled. This is a tried and true mechanism for controlling excess liquidity in countries that are facing large inflows of capital.

China is no longer a controlled economy. The fact is that over 57% of the non-farm portion of China's economy is controlled by the private sector.

China’s consumer represents a diverse market both culturally and economically. The 1.3 billion inhabitants speak a variety of languages. Living standards are divergent.

China’s development is much like the United States 200 years ago with a highly developed Eastern and a promising, underdeveloped inland "frontier."

Eight percent of foreign-owned companies in China are profitable.

Unlike the U.S., China has made it a national policy to train the scientists and engineers whose research drives growth. This will continue to be a strong driver of economic growth for China.

Promoting Consumption and Developing Capital Markets

In terms of China’s real economy the promotion of consumption is well underway with the rapid expansion of the middle class. In addition China’s Central Government is strongly supporting the development of the capital market.

China's growth has generated significant corporate profits, which typically re-invested in production. China has historically had a strong saving rate which translates into returning dollars to the system through savings. Foreign money flows into China’s assets including real estate, factories, services, and other means of production. These investments raise domestic liquidity.

Excessive liquidity has the potential to create overcapacity in production causing asset inflation in stock and property markets. Overcapacity in a fast-growing economy can check inflation by keeping the supply of goods ahead of the demand. Production overcapacity can impact specific sectors but that situation does not currently exist in China.

Investing in Science and Engineering

An oft-cited (and often-disputed) statistic is that China every year graduates 600,000 engineers from its institutions of higher learning. The United States produces about 70,000 engineers a year. The latest such end-of-U.S.-supremacy prophesizing can be found in the 2007 National Academy of Sciences report titled, Rising above the Gathering Storm: Energizing and Employing America for a Brighter Economic Future. Many academics dispute the accuracy and/or significance of those numbers, saying they don't reflect that on a per capita basis, the U.S. is still significantly ahead in producing engineers. On a general level much China's population lacks education.

There is voting at the local level but China remains a communist country run by non-elected officials. China's current leadership, led by premier Wen Jiabao, is considered "progressive" and to be the most likely system of government for China in terms of economic growth.

Investment banking firms and major accounting firms who once focused on multinational clients doing business in China, now seek out local small and medium enterprises. Mergers and acquisitions are fertile ground in China and these businesses require IT capabilities, auditing and insurance.

Auditing Challenges

The risks in China, from an audit perspective, are high but companies are trending toward world-class accounting standards. These are the companies to pursue.

China’s Great Challenges

While China produces 40 million new members of the middle class annually there continues to be a significant underclass. There is a strong concern regarding the dissatisfaction of this class and disparity in living condtions.

Pollution is a problem in China with acid rain falling on thirty percent of the country. Healthcare issues remain unresolved with an unprecedented numbers of Chinese entering retirement and placing a great strain on the national health care system. Intellectual Property protection laws in China remain relatively weak.

Skilled and experienced labor is in great demand and white collar workers with 10 to 15 years experience are extremely difficult to find.

A Strong Economy Forward

It is likely that China’s economy will continue its growth of 10% or more per for the next three to five years led by investment and exports," said Shen. General discussion of China’s overheating began in 2003, and that has been wrong quarter after quarter, year after year, for the last four years. The consensus is that there are no economic signs of overheating in China.