The standard of living of the average Chinese was so poor 30 years ago that China could only grow by selling to richer countries, in particular to its two main current trading partners, Europe and the United States. In the 1970s, the Chinese government embarked in a program of massive investments aimed at building the country’s manufacturing capabilities and infrastructure. This enabled Chinese workers to move from agricultural to industrial jobs and by doing so China was able to take advantage of its abundant and cheap labor force. The Chinese economy grew by inundating the world with low cost, low tech goods. The standard of living and purchasing power of the Chinese people leaped ahead and so did the cost of the labor force.
There is a limit as to how much low cost, low tech goods China can sell to the world and with one of its main competitive advantage dwindling, low-cost labor, China realized it needed a new economic model, one which relies less on cheap exports and more on the purchasing power and appetite of the largest population in the world.
Moving to a consumer-based economy is easier said than done, however. The Chinese have become sophisticated consumers who have access and appreciate western fashion, autos, electronics, food, and services. Some may argue that the Chinese are patriots and will prefer to buy Made in China. American consumers are among the most patriotic in the world and yet they didn’t hesitate to dump U.S. cars 20 years ago in favor of superior foreign models. Chinese consumers might favor the Made in China designation but only if the Chinese made products as good as or better than imported ones. If it is to succeed in its economic transformation, China is going to have to distance itself from its image as a copycat, low cost, low tech producer and compete head to head with the rest of the world on branding, innovation and quality. This is a drastic change for China and there are plenty of challenges ahead. Education, pollution and corruption are just the most looming ones.
It is no wonder the Chinese economy has slowed down in 2014 and is expected to continue to do so as it is moving from an export-driven economy to a consumer-based one. Still, China is forecasted to grow at twice the rate of the U.S., averaging around five percent by 2050.
China’s economy has grown at an astonishing 9.9 percent annually over the last 30 years. In comparison, the U.S. grew at just under five percent during the same period. Meanwhile the GDP per capita for China went from $293 in 1985 to $7,591 in 2014, without taking into account the effect of Purchasing Power Parity (PPP) which would double those numbers.
The U.S., in comparison, went from $32,682 to $50,212 in GDP per capita for the same period. Even though China remains far behind the U.S. in absolute numbers, it is catching up fast. In 1985 the GDP per capita of China was 0.9 percent of the U.S. Fast forward to 2014 and China’s per capita GDP rose to 15 percent of the U.S.
In 2014, U.S. GDP was $17.4 trillion versus $10.3 trillion for China. For China to have surpassed the U.S. in 2014, its GDP per capita would have had to be 69 percent higher than it actually was in 2014 or $12,820. Yet even that remains far below the GDP per capita of the United States of $50,212. China only needs a GDP per capita equals to 25 percent of that of the US to become the world largest economy.
I will not venture to predict when China will surpass the U.S. but as long as the Chinese economy continues to grow faster than the U.S., it is mathematically impossible for the U.S. to remain the number-one economy in the world, since Chinese need to produce far less than their American counterparts to come up ahead.
So where is China headed? China will continue to experience teething pain as it transforms to a mature economy. As a result growth is expected to fall below historical levels or around five to six percent on average. It will nevertheless continue to be a force to reckon with as it will grow faster than the United States and Europe.
Chinese companies will start competing more directly with the rest of the world as they try to capture the lion’s share of their local market. However, the constantly rising purchasing power of the Chinese consumers will also generate more opportunities for foreign companies to sell in China as the number of able consumer greatly increases. There will be less and less cheap Chinese made goods exported abroad as China’s salary levels reach parity with the west. Yet competition from Chinese enterprises outside of China for products and services considered today to be the exclusive territory of western companies will intensify.
Louis Osmont is a partner and international services leader at WeiserMazars LLP. He has considerable experience assisting international companies setting up affiliates in North America. In addition to planning and supervising audit engagements, Louis is involved in due diligence and evaluation with respect to acquisitions and restructuring.