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China Starts Looking Beyond Its Era of Breakneck Growth

By ANDREW BATSON And BOB DAVIS
Updated July 15, 2010 12:01 a.m. ET

DASHIMEN VILLAGE, China—In this corn-growing hamlet in northern China, signs are emerging that the nation’s supercharged economic growth may be reaching its limit.

A bottomless pool of inexpensive migrant labor has long been one of China’s greatest resources, fueling its manufacturing boom. But all the able-bodied workers have left this village already, leaving mostly the elderly. “All the young men have gone out to work,” says Wang Shuzhen, 58 years old, whose two sons left town, one to work in construction, the other as a driver.

Fewer migrant workers are heading to China’s manufacturing zones along the coasts because villages like Dashimen are tapped out, putting pressure on wages and sparking worries about labor shortages. Job centers in the Pearl River Delta, the manufacturing heartland of southern China, had 9% more vacancies than applicants in the first quarter, according to a survey by China’s labor ministry.

The Chinese economic juggernaut is still outrunning these trends. Government data issued Thursday showed continued robust growth, but at a slightly slower pace. Second-quarter gross domestic product grew 10.3% from a year earlier, down from the 11.9% growth posted in the first quarter.

Some big engines of long-term growth look unlikely to sputter: consumer spending by China’s newly affluent, and the migration of hundreds of millions of people to the nation’s cities. Chinese industries from sheet glass to automobiles to electronics are emerging as potentially deadly rivals to American, Japanese and European champions.

But managing China’s economic trajectory is getting trickier, Chinese officials and economists say. “The growth rates of the past can’t be sustained forever,” says Li Shantong, an economist at the Development Research Center, a government think tank in Beijing. China needs to adapt to a future where exports and infrastructure are less important, and more growth comes from technology and innovation, she says. “It may not be as fast as in the past. But we can’t continue with the same resource-intensive pattern.”

Higher wages at home and low-wage competition from other countries will make it harder for China, already the world’s largest exporter, to maintain rapid export growth. Real-estate bubbles have developed in places like the tropical island province of Hainan, prompting the government to take steps to try to cool those markets so they don’t threaten the financial system.

The favorable demographics that have supplied manpower for economic growth are changing. China’s working-age population, age 15 to 64, has grown continuously. But partly because most families are limited to one child, growth of this working population is slowing, according to the United Nations. The labor pool is expected to peak around 2015, and then decline, according to U.N. projections. In China, manual laborers tend to stop working before age 65, due both to the demands of the work and to employers’ preference for younger workers.

China’s favored tool for supporting growth—vast, bank-financed investments in infrastructure—may not work as well in the future, as it becomes harder to find worthwhile projects. China’s great economic challenge is likely to be ensuring that a transition to slower growth is gradual and manageable, rather than sharp and disruptive.

Growth here has stemmed in part from China’s drive to catch up with wealthy nations on technology, infrastructure and education. Japan, South Korea, Taiwan and Singapore went through similar periods, and the rapid growth there eventually slowed.

“No country grows at 8% to 10% indefinitely,” says Dwight Perkins, a Harvard University economist who correctly forecast the Chinese economic boom ignited three decades ago by market reforms. “In all countries, that growth rate comes to an end.” China’s economic growth has averaged more than 9% a year since 1978. Mr. Perkins figures the high-growth phase has, at most, a decade left to run.

Diminishing growth in China would have profound consequences for the global economy. Resource-rich countries in Latin America and Africa depend on expanding Chinese markets. Mature economies such as the U.S. and Europe look to China as an export market and a new place to invest.

Inside China, sustained high growth has made it easier for the government to put off dealing with a host of problems, from bad loans created by state-controlled banks to sharp social divisions between rural and urban residents. The country’s grand political bargain has been simple: Communist Party rule in exchange for increased prosperity and higher living standards.

Government officials are giving voice to the need to plan for a different kind of economic future. “The international financial crisis has caused a major change in the external conditions for China’s development,” Vice Premier Li Keqiang said earlier this year. The government needs to accelerate overhauls to the structure of the economy, he said, in order to lay a foundation for “stable and rapid economic growth over the long term.”

The most anticipated problem is an end to some 35 years of steady growth of the working-age population, which fueled the expansion when China liberalized its economy. The demographic changes added about 1.8 percentage points of economic growth annually since the late 1970s, according to the Center for Strategic and International Studies, a Washington think tank. But by 2030, the CSIS predicts, the contraction in the working-age population will reduce growth by 0.7 percentage points a year.

In places like Dashimen, in the hills in northern Hebei province, everyone who can physically labor is already working in jobs in the cities. Yin Zhen, the 61-year-old husband of Ms. Wang, says he was a migrant worker himself until employers started passing him over for younger men about five years ago.

With growth of the labor force slowing, migrant workers are in a stronger position to bargain with employers. A central-bank survey this year showed average wages for migrant workers, who traditionally fill the least-skilled slots and have little economic power, rose 17.8% from a year earlier.

Those gains will improve the lives of the poorest urban workers. They also will make it tougher for Chinese exporters of low-end merchandise like apparel and toys to continue to compete mainly on price. Exporters will have to keep boosting productivity to make up for higher wages, and start making higher-end products that are less price-sensitive.

That puts trade, one of China’s great growth drivers, under pressure. China’s exports have grown by an average of 21% a year over the past decade. With markets in Europe and the U.S likely to grow slowly over the next few years, China will be hard-pressed to sustain that pace.

Qi Lihong, import-and-export department manager of Tonglu Spring River Knitting Group, a garment maker in Hangzhou, says higher wages and government-mandated benefits have pushed her labor costs up about 10% this year. To attract workers in the tightening labor market, the company is building nicer dormitories.

The higher costs complicate Spring River’s effort to rebound from the global economic slump. Annual revenues dropped to $28 million last year, from a peak of $40 million in 2006. For labor-intensive products like textiles and clothing, there are now cheaper places to manufacture than China. Average wages in Vietnam and Pakistan are just one-third of China’s. “We can see that more orders are flowing to the low-cost countries,” Ms. Qi says.

On the beaches of Hainan, off China’s southern coast, another threat to China’s continued growth has risen. The office buildings in downtown Haikou, the provincial capital—evidence of a real-estate boom and bust in the early 1990s—now are dwarfed by new luxury apartment buildings and resorts.

Apartments at the Serenity Coast development in the resort town of Sanya start at around $1 million. “Chinese people are getting rich and learning how to consume,” says Xu Nengli, director at Kinderly Real Estate, the project’s sales agent.

Serenity Coast’s sales averaged more than $400 million a month in 2009, and more buildings are still going up. “Everyone thinks this business is easy to do and wants to jump in the market,” Mr. Xu says. New investment in Hainan real estate has more than doubled this year, according to official figures, and prices are up an average of 50%.

Concerns are mounting about a real-estate bubble in Hainan and many other places where the rush to profit from real estate has pushed up prices. Attempting to head off a crisis, Beijing is requiring banks to tighten mortgage-lending standards. Many cities have restricted purchases by nonresidents.

Partly as a result, sales have cooled somewhat, especially in the hottest real-estate markets. But if Beijing applies too many restraints, it could hurt construction, a major source of jobs.

So far, the government has been successful in shielding China from the worst of the global financial crisis, thanks in part to a surge in construction projects such as roads, bridges and airports.

Even before the stimulus, investment accounted for 44% of China’s economy, a higher level than Japan or South Korea ever reached in their modernization drives. The returns on those investments matter enormously for how China grows.

The latest round of public works, however, might not boost the economy as much as core first-wave infrastructure projects, such as the national highway system, did in earlier years.

In Qingdao, a thriving port city in Shandong province, the construction boom is in full swing. The city is squeezed onto the eastern edge of Jiaozhou Bay, with the only room for expansion to the north and west. A highway curves around the bay, but it is often choked with traffic. In response, the local government has begun building a 17-mile bridge across the bay. The cost: $1.4 billion, mostly covered by bank loans. “Economic development drives traffic, and traffic drives economic development,” says Shao Xinpeng, chief engineer of Shandong Hi-Speed Qingdao Expressway Co., the state company building the bridge.

But the bridge will face competition from a much-shorter tunnel also linking downtown Qingdao to the bay’s west side. Min Zhengliang, an economist at Qingdao University, is skeptical. “To spend so much money to save only 20 minutes of driving time is just not worth it,” he says.

China’s banking system, which is mainly state-controlled, has financed many such projects. Banks made loans last year worth one-third of economic output, and this year they are on track to hit 20% of GDP—a total of roughly $2.5 trillion in new credit over two years. (At the peak of the U.S. credit boom, new borrowing through banks and credit markets amounted to 18% of GDP, though China is growing much faster.) That credit load could limit China’s ability to drive future growth through such spending.

Yet China has flourished the past 30 years by constantly reinventing its economy, abandoning failed experiments and pursuing successful ones. Xiao Geng, the Beijing-based director of the Columbia Global Center in East Asia, ticks off a number of must-do policy fixes: improve the social safety net, ease price controls on energy and capital, and alter the dominant role of state enterprises.

“It really requires very dramatic, deep and consistent reforms to have sustainable growth in the future,” he says. “I’m worried about it, but still quite confident they will manage to do it.”

—Kersten Zhang contributed to this article.