China’s Economic Prospects: 2006 – 2020 Sandra Polaski Carnegie Endowment for International Peace April 17, 2007

1. China’s Economic Prospects:2006 – 2020Sandra PolaskiCarnegie Endowment for International PeaceApril 17, 2007

2. Overview of presentation • The Evolution of the Chinese Economy from 1980 – 2005 • The Impact of China’s Accession to the World Trade Organization • China’s Growth Prospects for 2006 – 2020 • Conclusions and Key Challenges

3. The Evolution of the Chinese Economy from 1980 – 2005 • Over the past 25 years, annual GDP growth has averaged over 9%

4. The Evolution of the Chinese Economy from 1980 – 2005 • Capital accumulation has been the most important source of growth

5. The Evolution of the Chinese Economy from 1980 – 2005 • Trade’s role in China’s economy has increased • However processing trade represents a significant share; value added in China is less than implied

6. The Evolution of the Chinese Economy from 1980 – 2005 • Growth has lifted incomes • Percentage of population living on $1/day has fallen from 80 percent in 1980 to 20% today • Yet 70% of population still lives on $2/day (Source: World Bank)

7. The Evolution of the Chinese Economy from 1980 – 2005 • Urban/rural disparities remain pronounced • 2005 Rural average net income: $397 • 2005 Urban average net income: $1281 • Sustained growth will require generating higher-productivity and higher-income employment opportunities for the 45% of the population still engaged in low-productivity agriculture

8. Looking Ahead: Two Models • Two existing models built by the DRC: • One used to model the impact on China of accession to the World Trade Organization—projections to 2010 • Simulations updated to include imposition of export restraints by US and EU on Chinese textile and apparel exports • Two different labor market assumptions were employed: full employment and surplus labor • The second model is the basic national macroeconomic model used by the DRC

9. The Impact of China’s Accession to the World Trade Organization • Why use a model to study what has already happened? • Model projects impacts to 2010 • Investigate impact of textile and apparel restraints, imposed after last modeling exercise • Isolate causal relationships • Explore impact of different labor market assumptions

10. The Impact of China’s Accession to the World Trade Organization Surplus labor assumption versus full employment assumption: • In China unemployment in urban areas and underemployment in rural areas is a reality • Surplus labor puts downward pressure on wages and enhances competitiveness of Chinese production

11. The Impact of China’s Accession to the World Trade Organization Results with surplus labor compared to full-employment assumption: • Overall gains are higher • Gains from manufacturing liberalization are closer to level of gains from agricultural liberalization • Investment growth is much stronger

12. The Impact of China’s Accession to the World Trade Organization • Distribution of gains from accession by household income type • Gains are fairly evenly distributed between rich and poor households within urban and rural household groups (S7 and surplus labor assumption) • % gains ranges from 2.8 -3.2 urban, 1.5-2.1 rural

13. The Impact of China’s Accession to the World Trade Organization • However, urban households as a group gain significantly more than rural households as a group (S7 and surplus labor), primarily because urban households unambiguously benefit from agricultural liberalization, while increased agricultural imports hurt many rural agriculture-producing households

16. The Impact of China’s Accession to the World Trade Organization • Employment Changes (surplus labor assumption) • Agriculture • Net job creation: 800,000 jobs • Gains: 2.4 million jobs in livestock production • Losses: 1.8 million jobs in rice • Manufacturing • Net job creation: 4 million jobs • Gains: 965,000 in apparel • Gains: 865,000 in textiles • Losses: 217,000 jobs in automobiles • Services • Net job creation: 7.75 million jobs • Gains: 670,000 in commerce (trade) • Gains: 548,000 in construction

17. The Impact of China’s Accession to the World Trade Organization • Employment Changes (surplus labor) • Net 13 million jobs created • Current labor force numbers 918 million • 300 million additional jobs needed to reach full employment • Policy conclusion • Trade alone cannot solve employment challenges • Domestic demand and government policy must be main drivers of job creation

18. Growth Prospects for 2006 - 2020 • Areas of uncertainty • International • Rise in protectionism • Dollar crash • Worsening terms of trade (cost of imports v. exports) • Financial liberalization leading to volatility • Domestic • Savings patterns of aging of population • Persistent rural poverty • Sluggish employment generation

19. Growth Prospects for 2006 - 2020 • Model explores three scenarios • Baseline • Optimistic • Increased trade • Improved resource allocation • Pessimistic • Less trade growth • Less efficient allocation of resources

20. Growth Prospects for 2006 - 2020 • Trends in composition of output and employment • In all scenarios the share of agriculture in employment and output will fall • Employment and output of secondary sector will grow through 2010 but then decline as growth in service industries begins to pull in larger numbers of workers • Pace of this transformation will depend on level of domestic investment in human capital and growth in the technologically-advanced service industries that serve manufacturing industries

21. Growth Prospects for 2006 - 2020

22. Growth Prospects for 2006 - 2020 • Sources of Growth: 2006-2020 • In all scenarios, capital accumulation continues to drive growth • Growth in TFP varies according to gains in efficiency • Contribution of labor does not grow in any scenario (demographics)

23. Growth Prospects for 2006 - 2020 • Returns to labor in 2020 relative to 2002 (percent change) • Agricultural workers stand to gain the most but also face greatest losses relative to baseline if risk scenario materializes

24. Growth Prospects for 2006 - 2020 • Projected changes in household income in 2020 relative to 2002 (percent change) • Rural households stand to gain the most but also face greatest losses relative to baseline if risk scenario materializes

25. Conclusions • Capital accumulation will continue to be single most important driver of economic growth • Sustainability of growth will depend on improvements in total factor productivity (TFP) • Costs of adverse developments in international environment and/or domestic policy missteps will be borne disproportionately by the rural poor

26. Key Challenges • Despite the importance of trade to China’s economy, results from the WTO model suggest that trade can play only a limited role in creating employment opportunities • Broad-based domestic demand will be required to sustain growth; additional advantage that it relieves international pressures and risks

27. Key Challenges • Generating broad-based demand will require adequate job creation at all skill levels and particularly in rural areas • Pace and quality of job creation should be a key focus of policy makers • Where can jobs be created?

28. Key Challenges • Labor intensive service sector industries, such as education and health care, represent promising sources of new jobs • Demographic structure of China means demand for health care by aging population will grow • Moving up technology ladder means China will need more and changing mix of skill—more education services

29. Key Challenges • This demand will require adequate supply and adequate provision of finance. Policies required: • Boost domestic demand for services • Stronger social safety nets (health, pensions) • Supply social infrastructure (schools, hospitals) • Support for education (tuition, fees) • Provide appropriate education and training opportunities

30. China’s Economic Prospects:2006 – 2020Sandra PolaskiCarnegie Endowment for International PeaceApril 17, 2007