China’s Challenges: Lower Growth And An Environmental Crisis The old "cheap labor" economic model does not work anymore. Meanwhile the country will have to fix the disasters caused by past break-neck growth. A huge agenda for policy-makers

By Paolo von Schirach

September 17, 2013

WASHINGTON – The gravity-defying Chinese economic growth model is not working anymore. Furthermore, this “growth at all cost” model has left behind a disastrous legacy of environmental damage that may have caused irreparable damage. And do not forget that all this is happening within an authoritarian, one party state, in which the leaders have to reconcile objectives of increased prosperity with self-serving goals of political survival.

China’s growth

In an over simplified fashion, here is China’s boom secret. The Chinese managed to exploit (quite expertly) their inherent advantage of ultra cheap labor to become the workshop of the world. After China’s opening that started after 1978, China was able to become the cheapest and most efficient place where to “make things”. By combining cheap labor and heavy investments in modern infrastructure, China’s manufacturers could demonstrate to foreign customers that, even adding transportation cost, product made in China would be by far cheaper than anything made in any other location.

Export-led boom

The ensuing export-led boom allowed China to grow at staggering 10% rates year after year, for almost 3 decades. This boom was fueled by a seemingly inexhaustible supply of cheap labor that flocked from the country side to brand new manufacturing centers.

As this was going on, a parallel construction boom was unleashed. This was fueled by the ability of local governments to essentially confiscate farm land that was then resold at a profit to eager developers. The construction boom in turn fed enormous growth in the demand for basic materials: cement, steel, copper; along with pipes, fittings, appliances and what not.

The problem with this model is that it was premised on the untenable assumption of endless demand growth and on the continuation of China’s inherent low-cost advantages. But this could not be.

Not sustainable

Even in a best case scenario, it is impossible to grow your export markets by 10% a year essentially for ever. At some point you will reach saturation and foreign demand will start declining. In addition, nobody realized that the seemingly endless cheap labor supply at some point would end, while labor cost would start rising.

But this is exactly what happened. On account of its “one child policy” China, notwithstanding its incredible 1.3 billion population, is beginning to experience manpower shortages. And this means that, going forward, China’s traditional “cheap labor advantage” will disappear. Over time, more expensive labor will translate into more expensive goods. Likewise, the construction boom has clearly turned into a bubble. In many regions there is over supply of high-end housing and commercial properties for which there is no market. 

Impossible to gauge the extent of the problems

China is not a transparent market economy. Therefore issues do not come easily and clearly to the surface. Besides, the Central Government still has tremendous amounts of cash reserves  that can and will used to cushion even major blows. Still, be that as it may, even if holes will be plugged and money losing companies will be rescued, it is abundantly clear that the rather unique favorable factors that created China’s 30 year boom are rapidly withering away.


In this new scenario, China  will be able to do well if it manages to create a new edge, this time based on quality and innovation, rather than low prices. But this is more easily said than done. ” Marketable Innovation” is the Holy Grail that the entire world is pursuing. At the moment it is not clear that China can reproduce the innovation friendly ecosystems that encouraged innovation in the USA or elsewhere. In other words, the desire to innovate, even assuming adequate investments ands skilled professionals, does not translate into achieving the goal.

Given all that, It is safe to assume at the very least lower growth rates for China.

Environmental disaster

But this is only half the story. Indeed, as all this is unfolding, the Chinese people are beginning to assess the damage caused by the break-neck growth decades. Simply stated, incredible growth and high profits were achieved in part because of complete disregard for any investments in environmental protection. In such a vast country, it is difficult to understand the exact extent of this damage. But it is fair to say that it will take years and huge investments to repair what amounts to an ecological disaster.

Most of China’s water is contaminated and its soil is contaminated; while many large Chinese cities have some of the worst air quality in the world. According to several reports, one of the key issues is that so far there is very little incentive to change course.

Indeed, in most cases it is much cheaper for heavy polluters to pay fines than to make the investments that would bring them up to the required standards. So, unless public polices change dramatically, the current set up is a guarantee of increased pollution levels. By the same token, Chinese firms that are now competing for hard to come by new business from foreign buyers, (outsourcing is no longer what it used to be), have every interest in keeping their costs down. And for this reason they have no incentive to spend more money to clean up their processes.

This unfolding environmental problem at some point may reach crisis levels. A better educated Chinese population now understands the price of “development at any cost”. The people see quite well that improved material conditions have no value if their health is negatively affected.

Lower life expectancy

Case in point, a recent study indicates that most people living in Northern China have seen their life expectancy reduced by at least 5 years on account of greater exposure to foul air caused by coal-fired power generation, (70% of China’s electricity is produced with coal), and more.

So, here is at least one price tag for the old growth model: you die younger.

It is really impossible to say how all this –lower growth rates, real estate bubble, demands for improved environmental controls– will play out economically and politically. But I would say that the new Beijing national leadership is facing a huge and in many ways unprecedented challenge. In order to retain their legitimacy, they need to show that there is still a bright future ahead, while they will have to demonstrate that they can and will improve quality of life for tens of millions by fixing the environment. Are they up to all this? 


, , ,

Leave a Reply

Your email address will not be published. Required fields are marked *