China could become world’s largest exporter by 2010

China could overtake the US and Germany to become the largest exporter in the world in the next five years. By then, Chinese goods and services could represent as much as 10% of global trade compared with 6% at present, according to the OECD.

In its first Economic Survey of China, the OECD says the current pace of economic growth – averaging more than 9% annually over the past two decades – shows no sign of slowing. But although economic dynamism has helped reduce the number of Chinese living in absolute poverty, income levels are still low and inequality is on the rise, not only between the cities and rural regions – average incomes in the countryside are only one third of those in the cities – but also within the more prosperous coastal provinces.

To reduce the gap in incomes, the government should make it easier for people to move from the country to the cities, but urbanisation should be carefully managed, the survey says. Legal restrictions to migration will need to be reduced and land law reformed. The funding of different levels of government will also have to be adapted to meet the health and education needs of a growing urban population as local authorities’ responsibilities are not always matched by their ability to raise revenues. In addition, anti-pollution laws will need to be enforced more effectively.

As a result of profound shifts in government policies, the private sector is now driving China’s remarkable economic growth. Well over half of China’s GDP is produced by privately-controlled enterprises. But more needs to be done to improve the business environment, the survey says. For instance, the amount of capital required to start a company is relatively high. Priorities in this area should be to revise company law, pass a new bankruptcy code and provide stronger protection for property rights.

China’s market economy also requires further reform of a financial system still dominated by banks, virtually all of which are government-controlled. The cost to the government budget of recent reforms to remove the burden of bad loans accumulated by the banks will be high but should be manageable, says the survey, especially as economic growth has reduced this debt to under 30% of GDP from nearly 50% in 1999. But the survey warns that without greater private sector control the future health of the banking system remains uncertain.

The survey points out that improving the allocation of capital is a key to sustained growth. Companies need to have easier access to stock and bond markets in order to raise funds. Making government-owned shares completely tradeable would improve the governance of listed companies, while the corporate bond market, presently representing less than 1% of GDP, would also benefit from less government control.

The report argues that a more flexible exchange rate for the Chinese currency would reduce price volatility and provide a more stable macroeconomic environment. The July 2005 decision to revalue the Renminbi and move the exchange rate system away from a US dollar peg toward one where limited fluctuations are allowed around a central rate set by a basket of currencies, was a step in the right direction.

China’s public finances are in good shape, with a budget deficit below 1% of GDP in 2004 and public debt stable at around 23%. But public spending on health and education is low and should be increased. The pension system also requires further reform as the next two decades will see a rapid increase in the proportion of elderly people in China. Among the survey’s recommendations are raising the retirement age, extending coverage of the system and making pension rights transferable across the country.

Published on 16 September 2005

Executive summary

An Economic Survey is published every 1½-2 years for each OECD country. Read more about how Surveys are prepared.

The OECD assessment and recommendations on the main economic challenges faced by China are available by clicking on each chapter heading below. Chapter 1 identifies the challenges for which the subsequent chapters provide in-depth analysis and policy recommendations.

Foreword by OECD Secretary General Donald Johnston

Preface by OECD Chief Economist Jean-Philippe Cotis

Chapter 1. Key challenges for the Chinese economy
China’s economy has grown rapidly so far this decade. Government policies have moved markedly towards allowing market forces influence economic activity. Polices covering the price determination, foreign trade, exchange rates, foreign investment, entry barriers, internal markets, the operation of state-owned enterprise and the financial system have all been changed. These reforms have boosted growth that stems, in an accounting sense, mainly from a rapid pace of capital accumulation, relying on a level of national saving that is approaching half of GDP. The policy changes have allowed a much increased role for the private sector and substantial foreign investment. Sustaining the recent pace of growth will require further reform to ensure that there is a continued improvement in the framework for the private sector, to complete the reform of the banking sector and ensure a stable macroeconomic environment. There are also a number of imbalances in the economy whose resolution would help improve growth and wellbeing. In particular, policy changes are needed to reduce the disparities between rural and urban incomes and increase the pace of urbanisation. Welfare would also be improved by further reductions in the high level of pollution.

Chapter 2. Improving the productivity of the business sector
This chapter appraises the performance of China’s businesses, relying on new empirical analysis of an up-to-date panel dataset of almost a million observations of firms. China’s privately controlled companies operate in very competitive product markets and are highly productive, creating most new jobs. However, their growth is still limited by various regulatory weaknesses that have yet to be fully addressed, even though considerable improvements in the regulatory framework have been made over the past few years. Key priorities include revising the company law, passing the new bankruptcy code, and proving greater regulatory support for protecting property rights. The state sector remains large and generally wasteful of resources; programmes that have transferred control of enterprises to outsiders and facilitated restructuring need to be expanded. If restructuring is combined with reforms in the factor markets for labour and land, growth will be made more sustainable and potential output growth raised.

Chapter 3. Reforming the financial system to support the market economy
This chapter considers the changes that are needed to the financial system in China before it can adequately serve the growing private sector of the economy and provide diversified saving vehicles for individuals. Much progress has been made toward developing market oriented financial institutions and improving their internal capabilities to assess and manage risks and the stock and government bond markets have been developing rapidly. The basic institutions for an effective regulatory system have been put in place, and regulatory authorities are making good use of international standards and practices in their policies. Going forward, financial reform involves five main and related challenges. The first is to deal with the legacy of the banking system: a very high stock of non-performing loans and low capitalisation. The second is to reform the structure of the banking system so that it can better support the real economy. The third is to further develop the capital markets and foster the growth of institutional investors. The fourth, and ultimately the most important, is to strengthen the ability of financial institutions to behave commercially and manage risks prudently, while the fifth is to continue improving the supervisory structure so that systemic risks are contained. These issues are all the more daunting given that the business environment is still evolving away from a state administered towards a market economy.

Chapter 4. Reforming public finances to better serve growth
Fiscal policy in China has followed an extremely prudent path, keeping the level of government debt low and stable but following counter-cyclical polices when needed. Public expenditure relative to GDP is lower than in the OECD area largely owing to much less developed social transfer spending. Public spending may need some restructuring away from capital expenditure towards education and health spending. Social transfer spending also needs reform, which should build on the existing system of individual retirement accounts. Taxation has been kept low and has taken, on the whole, a pro-growth stance. But domestic corporate tax rates need to be lowered significantly as do the higher marginal tax rates on earned income. At the same time the base of the value-added tax needs to be widened partially making up for revenue losses elsewhere. Expenditure is to a greater extent decentralised than revenue, making a large part of sub-national governments dependent on transfers. There is scope to reform the inter-governmental fiscal system including bringing expenditure responsibilities at each level of government in line with financial resources and improving accountability. Finally, the budgetary system in China needs to be made more comprehensive and transparent.