In Premier Li Keqiang’s Government Work Report on March 5, “innovation” was shown as being of great significance for the Chinese economy in its new normal.
China’s economic growth has been slowing for some time. Though still at 7.4 percent in 2014, the government’s target is around 7 percent in 2015. This will be well below the long-term average rate of growth that the Chinese economy has been recording for several years.
There are global implications for the slowdown in the Chinese economy. China is not only the world’s largest exporter of goods, it is also the second-largest importer of goods. At the same time, it is also the world’s second-largest importer of commercial services. Thus, apart from being the main source of a variety of manufactured items for the rest of the world, China has also been a big engine for the global consumption of goods and services.
The effect of lower demand from the Chinese economy is already being felt on exports of natural resources and commodities. Chinese demand has been driving the demand for oil, coal, minerals and a large number of other commodities over the last two decades. Global prices of these commodities are now falling sharply. Countries relying heavily on exports of these commodities, including resources exporters in Asia, the Americas and Africa, are already feeling the pinch of less Chinese demand.
Revival of consumption and greater absorption of imports by China will depend on how fast its economic growth picks up. Historically, China has followed a model where growth has received its primary push from investment. The important question now is whether the Chinese authorities will continue to follow this approach.
Although much has been said about foreign investments in China, there is no denying that the Chinese economic success would not have happened without large State investments. Investments in infrastructure and other public goods were accompanied by a generous supply of credit to export-oriented enterprises. However, there could be a problem in using the same strategy now.
Low value-added manufacturing relying purely on processing might not be able to bring the same results for China any more. Labor costs have increased, making China less competitive compared with countries such as Vietnam, Cambodia and Bangladesh, which are now more efficient in producing a variety of cheap manufactured items. Some of these countries, in industries such as garment manufacturing, for example, are more attractive than China for foreign investments because of their ability to assemble quicker with cheaper labor.
China’s fantastic economic success was a result of its ability to combine low costs with large scales. These scales were first created by domestic investment, and later supported by investments from multinational investors. Many of these investors might now be tempted to relocate elsewhere. This would be a natural response to the new advantages in value chains noticed in other countries.
What should China do then to revive growth?
Wages cannot be artificially controlled or depressed given that cost of living in China has also increased rapidly. If advantages arising from cheap labor do not exist anymore, then efficiency and competitiveness must be maintained through innovation.
Innovation is clearly what the Chinese economy needs for its next stage of economic growth. But it is important to understand the characteristics of innovation that will bring growth. China’s focus on becoming an innovation economy by investing in strategic emerging industries is a step in the right direction. But investments in R & D and innovation in these industries, particularly cutting-edge industries such as aerospace, energy-efficient automobiles and biotechnology, are going to yield returns only over a long period of time. It can take up to 15 to 20 years for these industries to produce world class innovative products that can be commercially developed and sold in world markets.
China obviously cannot wait that long. It must locate other areas where short-term and simple innovations can give it results. It is here that it must plan innovations in enterprises and institutions. Chinese enterprises must introduce innovative practices that can maintain productivity despite rising labor costs. Chinese institutions, particularly financial institutions, should introduce more innovative financial products schemes that will help the growth of the financial services industry.
What China requires now is using innovation at the basic and fundamental level. This will bring gains for the present. More critical innovations can follow later.
The author is senior research fellow at the Institute of South Asian Studies at the National University of Singapore