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2010-08-02

China's next economic transformation

Comments on Ross Garnaut “The turning period in Chinese development”, 1/08/2010, http://www.eastasiaforum.org/2010/08/01/the-turning-period-in-chinese-development/
Excellent analysis and insight into China's next phase of economic development.

The impact of diminishing labour surplus and the consequential rise in wages are likely to be complex and will require very prudent management of both macro and micro economic issues. The rise in raw material and energy costs will further erode China's international competitiveness.

While currency appreciation may offset some of the pressures of inflation due to constraints from labour supply, it would further exacerbate the loss in its international competitiveness associated with supply side issues. It could lead to significant slowdown due to a potential double whamming effect, if currency appreciation is excessive. Any benefits from lower inflation due to currency appreication is likely to be insignificant, as compared to its negative effects on growth.

Adding to that is that further real urbanisation is likely to expand domestic demand not only from housing and urban infrastructure, but also general consumption.

A prudent course is likely to be:

1. Focuse on structural change and raising labour productivity to compensate the rise in labour costs, by investing in more capital intensive technologies, industries and products, using the currency surplus as a temporary buffer for adjustments

2. Adjust the exchange rate at appropriate time when productivity transformation is showing dividends in international competitiveness and well entrenched

3. Further focus on sustained expansion of domestic demand

From micro point of view, labour market reforms to reduce discriminations and better reflect productivity, reforming capital market to increase the efficiency of capital allocation especially accessibility to capital by the private sector including small and medium sized firms, reduce monopolies by increasing effective competition and barriers to entry, reduce transition costs for industries and firms by deregulation especially government red tapes and barriers (including local government's land management), as well facilitating industry adjustment to raise labour productivity.

However, one factor may facilitate this productivity transformation process is the currently under employment of its higher education graduates. Those would become one of the key factors in upgrading the skills of its labour forces.

Nevertheless, the adjustments will be a very complex and difficult process that must be accompanied with prudent management.

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