China's Economy and its development

IB economics Portfolio (unit 3), 05/05/2007

Louis Redman

China’s Economy and its development

Development is a key point raised in the article and how this may burn out. The indicator that is commonly used throughout the article to assess the growth of China is GDP (Gross domestic product, which is the value of everything produced in the economy in a year including expenditure taxes). Growth usually increases a countries development. This is one of many ways of measuring economic development in a country. The figures show us that the economy of China has increased as China’s GDP ‘grew by 9% in the year (2003) to the third quarter.’ This is showing a growth in the Chinese economy as the GDP has increased. Although there limitations of using the GDP as the sole indicator of development. The GDP does not take into account who the money is generated by and who it is distributed to as you may have the extreme rich and the extreme poor. The extreme rich may generate a huge amount of the GDP yet only represent a very small amount of the population. The GDP may not be an accurate view of people’s economic welfare and also the welfare of the country. Other indicators could be used such as the human development index (which is a score based on life expectancy, adult literacy/education enrolment and GDP per capita, PPP$) birth rates, population growth, literacy rates energy consumption etc.... The way the use of the GDP could be improved to provide more useful information would be by dividing it by the population as you then see the spread of this GDP per person in the country. The GDP could also be measured using the Purchasing Power Parity which generates a fair currency exchange rate based upon the purchasing prices of certain products in different countries reducing the problems of over valued and under valued currencies.

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Investment levels may also give an indication of the development of a country. High levels in investment are likely to result in development of an economy. The article says that investment in China is running at a ‘scorching 32% higher than a year ago, accounting for 2/3rd’s of GDP growth in the 3rd quarter. This is a large amount of investment and is mainly being made by foreign firms who believe that China’s economy will flourish and produce abnormal returns. This idea follows with the economic theory of Harrod and Domar who were economists in the 1930’s. This theory stated that investment, savings and technological change were key variables in growth. This is what has happened in China as investment has been made to bring about technological change, i.e. from manufacturing by hand to by machine. The increase investment, according to Howard and Domar’s theory, shifts out the production possibility frontier (PPF), as seen below. However this may not happen due to barriers of development. The current communist government may try to stop the investment because of the outcomes of the investment. There may also be problems with human resources such as a poorly trained work force. The workers for the urban areas are brought in from the rural areas. Lewis focuses on the role of migration in development. Lewis argued that growth could be sustained by gradual movement of the workers from primary industries in rural areas to secondary and tertiary industries in urban areas. His theory was that industrialisation, which is what has taken place in China, leads to development. However, workers may not add much to the productivity. The model assumes stable wages and this may not be true. Skilled labour may not be available and training takes time.

Diagram 1: Howard and Domar’s theory using the PPF

The article talks about how investment in China has increased and ‘is running at a scorching 32% higher than a year ago.’ The increase in investment (40% of GDP in 2002) will increase the aggregate demand in the Chinese economy and sets off the multiplier effect. This is an injection into the economy and the circular flow of income.

The article also says that there are ‘growing signs of overinvestment in sectors such as cars, construction and coastal properties.’ Overcapacity may push down profits and profits are taxed which will reduce the tax revenue available to the government and may slow down the development of China due to the lack of funds to spend on education, healthcare etc… which are a large part of development. The article refers to this as overheating which usually implies excess demand. This excess demand (according to the theory of supply and demand) leads to shortages and higher inflation. Economists believe that the economy will keep steaming for the moment but one day the investment boom may turn to bust.

Article reference:

(15th November 2003), China’s economy. Steaming, The Economist, p93/94.

Word count: 747 words