Effects of China’s Economic Situation

China’s economy is the second largest in the world by nominal GDP and the largest in the world by purchasing power parity (The World Bank, 2018). The country is the world’s largest trader. Embracing neo-mercantilism that has seen the public sector accounting for a bigger share of the national economy than the rapidly developing private sector, the country’s economy adopted market forces in 1978, consequently becoming the world’s fastest growing economy – a trend that continued until 2015. The tremendous growth has been driven by a vibrant manufacturing sector, leading to the country being dubbed ‘the world’s factory’. It became a member of the World Trade Organization in 2001 and has several free trade agreements with such countries as Australia, South Korea and Switzerland (China Power Team, 2017). China initiated the establishment of the Asian Infrastructure Investment Bank in 2015.

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However, since the start of the millennium, China’s economy has experienced a slowing of the growth rate to hit an all time low in 2016 when the economy grew at 6.5%. 2017 saw a rebounding of the economy, for the first time since 2010, when it hit 6.9% growth rate (Tan, 2018).

The rebound is attributed to signs of a good transition between the “old economy” mostly driven by manufacturing and the “new economy” driven by services, high-tech and parts for manufacturing industry. China’s economy is the world’s largest manufacturer and the world’s largest exporter of goods. It is the fastest-growing consumer market albeit still a net importer of services products (Trading Economics, 2018). Despite more government stringent controls of the real estate sector, the sector showed resilience as one of the major sectors of the Chinese economy.

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Beijing is to experience the five-yearly change of political guard in 2018 with President Xi Jinxing likely to usher in new faces in the regime. The performance of the economy will play a major part in shaping the political destiny. President Xi has said that there should be loosening of investment rules and more financial controls in real estate (Tan, 2018). The country is also allocating more resources towards innovation and research and development (R&D) with a view to high-tech industries with low carbon emissions. In line with this, Shenzhen is dubbed as the next Silicon Valley. The coastal regions of the country have generally experienced more economic development compared to the hinterland, with huge disparities in per capita income between the regions. Concomitantly, the Chinese government has prioritized the coastal regions in their economic policies, viewing the areas as beacons for the country’s economic growth.

China’s economic policy

China’s economic policy is built around neo-mercantilism. In 1978, it initiated economic reforms that adopted market principles more. This witnessed reform of the then agricultural sector in the 1980s and of the industrial sector in the 1990s. Efforts to reform the financial sector that would reduce the economic disparity in the country have not been as successful; with unstructured state-owned corporations, lots of non-performing loans, a floating exchange rate and strict government control of current and capital accounts (Sutter, 2017).

The central government also has five-year plans that guide the country’s economic development, with the thirteenth five-year plan currently under implementation covering 2016-2020. This includes plans to upgrade infrastructure with a multi-tier transport network for a new economic belt along the Yangtze River. Other national strategic projects involve transmission of electricity, gas and water (China Power Team, 2017). There are also regional economic development strategies that include acceleration of economic development in the central regions of China, capital investment and natural resource development in the western provinces as well as rejuvenation of industries in northeast China

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China’s rapid economic development has posed various problems that include environmental damage due to industrialization, social strife mostly due to inequality and such economic crimes like corruption and counterfeiting. Other issues include unsustainable job growths, uneven population demography and irrational and outdated pricing systems (Sutter, 2017).

China has constantly undervalued the Yuan compared to other country’s currencies, especially the American dollar. This has the advantage of both discouraging importation of products while it encourages exportation of the same, especially finished products (Dollar, 2016). The concomitant inflated balance of trade is a situation the Trump government has made a policy priority.

Rather than importation of finished products, China encourages importation of raw materials. It is the largest world consumer of steel, iron ore, lead and copper (Trading Economics, 2018). This import substitution policy has China sourcing these minerals from such countries like Brazil, South Africa and Australia, among many other countries. It is also increasingly importing agricultural products from Brazil, Kenya and Peru. These imports drive such industries as manufacturing and high-tech, leading to various finished products for different world market segments, a situation that encourages exportation, consumption and demand.

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In turn, China offers many developing countries subsidized infrastructure as evident in Ethiopia, Ghana and Peru. It also enables migration of some of the Chinese population to establish themselves elsewhere.

China has high trade and foreign exchange surpluses. The autarky, a neo-mercantilism tendency, is further evident in the country not freely floating its currency. This grants the country enhanced political power (Sutter, 2017).

Countries can manage neo-mercantilism by limiting imports. This can be through implementation of international import quotas. It can also be through development of national manufacturing industries by affected countries; to serve local, national and international demand. Through development of good relations, countries can also share the raw materials more.

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Current situation

Nonetheless, China has been experiencing reduced manufacturing in the recent past, notably in 2015-2016. This led to a decrease of demand for oil in the country, leading to oversupply of the commodity in the world market. This in turn led to reduced oil prices that continue to impact many countries, especially the OPEC countries that supply oil. There has seen contracting of some economies such as Russia while other countries have had to diversify their economies to reduce dependency on oil (e.g. United Arab Emirates).

The reduced manufacturing and economic growth of China has led to reduced demand for raw materials, among other commodities. This has negatively affected the mineral producing countries and other countries that export commodities to China, including such countries as South Africa, Australia and Brazil. This has put deflationary pressures on the world economy (The World Bank, 2018).

China is the world’s leading trade nation, accounting for more than 10% of world trade. With decrease of imports to China as discussed in a previous paragraph, countries that export to China have had their balance of trade and concomitant economies affected. Moreover, this has led to reduction of China’s exports, leading to reduced choices on the world market. The stifled supply of finished goods on the world market is likely to lead to uncompetitive practices.

Shrinking of China’s economy will have a domino effect, affecting countries and multinationals that supply finished products to China. This is because there will be reduced demand for these products, affecting such economies as USA and companies such as Microsoft and IKEA. The domino effect will be indirectly felt by such companies that provide machinery and labor for countries exporting agricultural goods to China. For example, John Deere will be indirectly affected since it sells farm machinery to South American and African farmers that export a lot of their produce to China (Sutter, 2017).

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China’s economy and the USA

Economic relationship between China and the USA, the two biggest economies in the world, is built on extensive trade with the US being China’s largest export market and China being America’s third largest export market after Mexico and Canada. There is also a lot of foreign direct investment between the two countries, with foreign investment stock from the USA into China being over $60 billion in 2013 (China Power Team, 2017). Further, after the 2008 world financial crisis, China has been financing most of US debt, with the US having a big trade deficit and China holding about $1.2 trillion of US debt. Treasuries are safe and stable for the export-based economy and for a country’s creditworthiness. The trade deficit enhances China’s economic and political power at the expense of the United States, with the worst-case scenario being China dumping America’s treasury holdings that would lead to a devalued dollar which would in turn put pressure on profits, share prices and yields.

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As China’s economy slowed, the country’s manufacturers drastically reduced the prices of finished products. The depressed commodity and oil prices had some deflationary spillover effects in the USA, potentially making US exporters uncompetitive on the global marketplace. To remain competitive, the US exporters would have to reduce prices, consequently suffering lower profit margins and equity prices. Further, this would impact on America’s government policy regarding interest rates (Sutter, 2017).

Confidence of American investors is affected when the second biggest economy slows down. This lack of confidence is spiked by the China government allowing the Yuan to trade more freely, leading to a decline in commodity prices. The lower commodity prices make China’s competitors, who include the USA, to follow suit by devaluing their currency.

The devaluation of China’s currency coupled with lower consumer spending directly affects such American exporters such as General Motors whose 30% of sales are in China and Caterpillar. This is through sales, reduced profitability and reduced stock price. OECD notes that a decline in domestic demand of 2% in China during 2015-2016 led to a decrease of 0.3% in USA’s GDP growth rate.  Notably the domestic demand decline leads to a decline of world’s economic growth by 0.5-0.6% (Sutter, 2017).

That American multinationals trading in China are big companies means that impact on their performance impacts on their indexes such as the S&P 500. Consequently this affects the mutual funds and ETFs held by American investors.

China’s “new economy” is shifting from being investment-driven to being consumption-driven. This has seen increase in innovation and consumption of goods and services in the country, a trend supported by various government stimuli that include cutting of interest rates. This adds competition to foreign companies offering similar goods and services to not only China but the rest of the world. The companies affected include various American multinationals that in a bid to remain competitive and profitable, may engage in such cost cutting measures as staff layoffs (Dollar, 2016). Especially affected are multinationals that, due to the lower labor wages and readily available raw materials, have their manufacturing plants in China.

Lack of confidence   in trading between US and China is further fuelled by lack of trust in the economic statistics from the Chinese government. The statistics are viewed as inflating stock market bubble, affecting the market prices of such US companies as Apple, Exxon Mobile and KFC. It also led to many Chinese investors retreating from the stock market to invest in US’s real estate market (Trading Economics, 2018). The consequent inflated house prices and gentrification cause economic, political and social pressures in the USA.

The intertwining of global stock markets means that a slowdown of the Chinese economy impacts markets worldwide. This is especially because as the world’s largest trading country, China does a lot of business with many companies throughout the world. The impact on the world markets impinges on the USA stock markets.

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Nonetheless, a positive for the US economy emerging from China’s economic slowdown was lower oil prices (China Power Team, 2017). Being the largest importer of oil, China’s slowdown led to reduced demand for the commodity, with suppliers adjusting their prices accordingly. This benefited other countries, including USA which is the world’s second largest importer of oil.

Conclusion

China is the second largest economy in the world. The fate of its economy is thus intertwined with that of many economies including the largest economy, the USA. Changes in the Chinese economy hence impact greatly on the performance of the other economies including that of the USA. Some of the effects of the changes are on investment, trade and employment. The US-China balance of trade that is skewed in favor of China has the deficit partially financed by capital flow from China, leading to precarious economic, political and social situation for the USA.

It is hence important for the US to look for solutions to curb the negative effects on its economy by the Chinese economy. Import quotas, strengthening of American multinationals and markets as well as common solutions to mutual economic issues are some ways US policy makers can mitigate the potentially adverse effects China’s economy can have on the US economy. 2017 signaled commencement of the recovery of China’s economy from a gradual decline that has been especially evident in this decade; a bit earlier than envisaged. The recovery is attributed to successful integration of consumption-driven economy to the traditional investment-driven economy. Just like decline in Chinese domestic demand negatively impacts on America’s GDP, a rise in the demand will positively affect USA’s GDP. Hence, the USA, and indeed other countries, needs to position themselves to benefit from the windfalls from this economic upturn.

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