China’s Economic Rise on Global Economic Power: Challenges and Opportunities for Indonesia’s Economy

The People’s Republic of China’s Economic Development in Brief

Since the economic reform initiated in 1978, the economy of the People’s Republic of China (hereinafter is referred to as China) has been growing phenomenally. It is believed that the rise of China’s economy was even more advanced than Japan’s economic miracle during 1960s to 1980s.

Prior to the economic reform, the China’s economic performance was slipping steadily. In 1960, China’s economy was listed fourth in the world economy, higher than Japan’s economy that was ranked fifth. However, in 1978 the rank of China’s economy dropped to the tenth of the world economy with the output size of only 6.5 percent of the output of the United States, and not surprisingly, China was regarded as one of the poorest countries in the world. According to World Bank, the poverty ratio of China, i.e. the ratio of the number of people to total population who live on less than $2.00 a day (PPP, at 2005 international price), stood as high as 92.9 percent in 1984. For comparison, the ratio of Indonesia was 88.4% in that same year. Meanwhile, Japan’s economy at that time had risen to become the world’s second largest economy. The output gap between these two countries was very significant:  China’s output was only 19.88 percent of Japan’s output in 1984.

After the economic reform, China’s economy has been increasing tremendously and caught up with other advanced economies to become a major global economic power that contributes significantly to the world’s economic growth. In 2006, China’s economy took over the United Kingdom’s economy to become the world’s fourth largest economy; in 2007, China became the world’s third largest economy replacing Germany.  China’s economy eventually surpassed Japan’s economy to become the world’s second largest economy in 2010, forming a New G2 with the United States, the world leading nation, and the world’s largest economy for almost a century. As a result of the enduring economic growth, China’s poverty level (i.e. people who live on less than $2 a day (PPP, at 2005 international price)) has been reduced from 92.9 percent in 1984 to 27.2 percent in 2009, which is far below the poverty level of Indonesia and the Philippines.

Figure 1: People’s Republic of China’s Economy and World Economy

China’s economic performance since the economic reform in 1978 is simply the greatest in the history of world economy. China’s economy is now (in 2012) about 138 percent of Japan’s economy, and 53 percent of the United State’s economy. Many believe that China’s remarkable  economic growth will still continue for a long while, which ultimately could surpass the United States to become the world’s largest economy: according to Goldman Sachs, a prominent US global investment banking and securities firm, China’s economy will surpass the United States’ economy in 2027.

Main Drivers of China’s Economic Growth

Investment and export play a critical role in China’s economic growth since the economic reform started in 1978. Investments became an engine that boosted the production side of China’s economy. However, it was not easy in the beginning of the reform. In 1988 China experienced a runaway inflation, and the government had to revoke huge investment projects to stabilize the inflation due to overheating economy of prior years. In 1994, China officially adopted a fixed exchange rate system that pegged Chinese Yuan to dollar with one dollar equivalent to 8.27 Chinese Yuan. Since then the economy of China was growing rapidly, as if it would never overheat again: investment to GDP ratio had increased sharply from 35 percent in early 1990 to almost 50 percent in 2011.

Next to investment, export is a critical success factor of China’s economic growth performance. Exports to GDP ratio grew significantly during the reform period, from as low as 6.6 percent in 1978 to almost 40 percent in 2006. As a result of this export-led economic growth, the ratio of household consumption to GDP has been decreasing steadily, from around 50 percent in the beginning of the reform to about 35 percent in 2011. The decrease of the household consumption ratio to GDP contributed to keeping the domestic price at a relatively low level, which made a prolonged economic growth possible. See Figure 2.

Figure 2: China’s Household Consumption, Investment and Export Ratio to GDP

Another critical factor of the success of China’s economic performance is an increase in productivity during this period, which contributed largely in keeping inflation rates at a low level, which prevents the economy overheating. The real productivity boom happened after the last phase of the economic reform in 1992: exports increased significantly although investments decreased and household consumption is more or less steady. This productivity increase was a result of a rapid shift in China’s industry structure from primary sector to secondary sector, and followed by a rapid shift of export goods from labor intensive industries, such as footwear, textile and garment, to a more capital intensive and hi-tech industries, such as Electronics, Machinery and Transportation Equipments, Mechanical and ICT. See Figure 3.

Figure 3: China’s Export Composition Change

Source: Enrico Marvasi’s Paper, China’s Exports: What Products Are Sophisticated?

The question remains if China can maintain its economic growth at its current pace. With the current size of its economy, it is almost impossible for China to keep up with its export-led growth policy. This is especially true in the immediate coming years as the European Union countries in general and the eurozone member states in particular are still falling into recessions due to the sovereign debt crises, whereas the economic recovery of the United States is still unstable. Apparently the economic problems of these two main trading partners of China will continue for some time.

China’s export-led economic policy caused its exports to grow incredibly. From 2001 to 2011 its exports grew more than 7 times. However, in 2012, the exports slowed down and grew by 8 percent only, which was significantly lower than in 2011 where it grew by about 20 percent. In terms of value, China’s exports had reached USD 2.05 trilion in 2012, the largest in the world for a single country.

Considering the above mentioned challenges, China has no option but to develop its domestic markets to substitute for the potential decline of its exports in order to prolong its current pace of economic growth. In that case, China has to pay close attention to a threat of runaway inflation and a price bubble that could develop in the domestic market. Considering that the Chinese Yuan is still undervalued, the inflation is a real threat to China’s future economic development.

Challenges and Opportunities for Indonesia’s Economy

The rise of China’s economy surely provides opportunities as well as challenges to other nations, including Indonesia. However, as China follows an export-led economic development, trade imbalance between China and the rest of the world becomes the characteristic of China’s economy. Indonesia’s trade deficit with China is also widening. The total trade between the two countries had increased significantly during 2004 to 2012, from USD 8.4 billion to USD 51 billion. During this early period, Indonesia had recorded a trade surplus every year until 2007. These surpluses were mainly credited to the commodity price hikes that happened during the 2000s prior to the global financial crisis in 2008. Since then Indonesia had recorded trade deficits with China and booked a record deficit of USD 7.7 billion in 2012 (see table 1).

Table 1: Trade Relations Between Indonesia and China 2004 – 2012

As shown in table 2, Indonesia’s exports to China were dominated by natural resources goods and their derivatives, such as coals, palm oils, rubbers, and minerals. In 2012, those four commodities contributed to as high as 68 percent to the total exports to China. As the prices of those commodities collapsed in 2012, this made Indonesia’s total export in 2012 significantly lower than in 2011. Indonesia’s export performance is, in fact, dependent on the development of commodity prices.

Table 2: Indonesia’s Selected Export Goods to China in 2012

On the other hand, Indonesia’s imports from China were mainly dominated by sophisticated manufactured goods under SITC 6 and SITC 7 product group, which altogether contributed to 64 percent of Indonesia’s total imports from China (see table 3).

Table 3: Indonesia’s Selected Import Goods from China in 2012

The above described trade relations between the two countries could not sustain in the long run. Indonesia exports low value-added goods to China while it imports high value-added goods from china (see the figure below). As a result, the trade imbalance between the two countries would   inevitably widen. This export-import structure of Indonesia becomes the characteristic of Indonesia’s economy. Therefore, we can expect that the current Indonesia’s economic development will not sustain. Sooner or later, Indonesia will be facing serious economic threats, particularly during the decline of the above-mentioned commodity prices. In 2012, Indonesia booked a trade deficit of USD 1.7 billion, the first time since 1961. In the first quarter of 2013, Indonesia’s trade balance is still recorded a mild deficit as the commodity prices are still going down. Will the deficit continue to get worse? Time will tell.

Figure 4: Unsustained Trade Relations between Indonesia and China