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By now, the “China miracle” is deeply ingrained in the lexicon of economic development. And with good reason. Over the past 30 years,the performance of the Chinese economy has been nothing short of spectacular—surpassing even the most wildly optimistic expectations with respect to GDP growth, poverty reduction,and improved living standards in the world’s most populous nation. Long skeptical of China’s ability to stay the course, the global consensus has now embraced the China miracle with openarms—more than willing to extrapolate these stunning accomplishments well into the future.
I it were only that easy. As impressive as the past 30 yearshave been, there are no guarantees that the Chinese ormulaor economic development will work as well in the yearsahead. In act, China’s increasingly unbalanced macrostructure—with a highly disproportionate share o nationaloutput being concentrated in exports and ixed investment—is already raising serious questions about sustainability.In the end, no economy gets special dispensation rom thebasic laws o supply and demand. I China were to stay its present course, there is a serious risk that its powerulgrowth dynamic would eventually succumb to overwhelmingimbalances. he key word in that warning is “eventually—leading to a alse sense o complacency over a rebalancingagenda that can always be put o or another day.In the post-crisis era, however, the time dimension o the“eventuality excuse” has been shortened. he sustainability question has taken on a new urgency. hat’s because theexternal demand underpinnings o China’s growth modelare likely to remain impaired or several years to come.he reason: America’s over-extended consumer—long thedominant orce on the demand side o the global economy—must now ace the imperatives o deleveraging and saving. At the same time, China’s powerul investment impetus isnow hitting key macro sustainability constraints. In short,Beijing can no longer aord the luxury o the endless giveand take o the rebalancing debate. he crisis, and the lastingexternal demand shock it has spawned, is China’s wake-upcall. he time is now at hand or a decisive transition to anew Chinese growth model—one that relies much more onthe potential o internal consumer demand rather than on thevicissitudes o external demand.here is good reason to believe that this transition will be thedeining theme o the upcoming 12th Five-Year Plan to beenacted by the National People’s Congress a year rom now. A consumer-led China can thrive only i Beijing emphasizesnew policies aimed at broadening the employment base,addressing the income disparities that threaten a moreharmonious society, and providing a secure social saety netthat tempers the excesses o ear-driven precautionary saving.hese goals can best be achieved by a undamental shit inChinas development model—moving away rom capital-intensive, manuacturing-led growth toward labor-intensive,services-led growth.I executed correctly, this plan could well be the answer toPremier Wen Jiabao’s amous critique o the old model as“unstable, unbalanced, uncoordinated, and unsustainable.” Well-designed pro-consumption initiatives have thepotential to address these “our uns” head-on. Not only  would a pro-consumer China oer better macro balancebut it would also be much more eective in coping withthe negative externalities o excess resource consumption,environmental degradation, and mounting trade rictions.he new model has the potential to turn China insideout—with proound and lasting impacts on the rest o Asiaand the broader global economy.
This paper was prepared for the 11th annual China Development Forum, held in Beijing on March 20-22, 2010.
March 22, 2010
Stephen S. RoachChairman, Morgan Stanley Asia
 A ale o wo Models
China’s ormula or success over the past 30 years has beendominated by an externally oriented growth model. wo sectors—exports and ixed investment—more than doubled theircombined shares o GDP by soaring rom 34% in 1979to a peak o approximately 75% in 2007. At the margin,the export dynamic was, by ar, the most powerul source o incremental growth, going rom 5% to 36% o Chinese GDPover the 1979 to 2006 interval. At the same time, the ixedinvestment share went rom 30% to over 40% during thisspan o nearly three decades (
see Figure 1
Figure 1: ChiNa’s growth MiraCle
050403020105255586164677073767982858891949700030609Fixed Investment as % of GDPExports as % of GDP
Source: CEIC, Morgan Stanley Research
hese two sectors are joined at the hip in driving the all-powerul Chinese export machine. Export lows, whichincreased nearly six-old since the turn o the century—romabout US$250 in 2000 to over $1,400 billion in 2008—recently surpassed those o Germany, making China now thelargest exporter on the world. But the export surge didn’t occurin a vacuum. It was acilitated by investments in state-o theart inrastructure and manuacturing acilities in coastal China.In other words, the investment surge was part and parcelo the export boom—providing the building blocks or theproduction, assembly, supply-chain logistics, and distributiono China’s large and still rapidly expanding export platorm.China’s externally oriented growth model also beneitedrom two important exogenous developments—the nationsaccession to the World rade Organization in 2001 and anunprecedented burst in global trade that took world exportsrom 24% o global GDP in 2001 to a record 32% in 2008.he Chinese export model was in the right place at the righttime—resulting in a spectacular dividend or the economy as a whole. he export share o Chinese GDP nearly doubled in theshort span o seven years—rising rom 20% o GDP in 2001 to36% in 2007. As a result, real GDP growth surged well aboveits 30-year average o 10%—hitting nearly 12% over the 2005-07 period and spiking to 13% in 2007, alone. he export-ledChina miracle was hard to deny. Who could ask or more?In act, none other than Premier Wen Jiabao has been quitevocal in asking or a good deal more rom the Chineseeconomy. And with good reason. While he has been quick todraw great satisaction rom China’s top-down perormance,the Premier has been equally rank in warning o an economy that looked ar more problematic beneath the surace. In hisview, as irst publicly expressed three years ago, the export-and investment-led growth dynamic let the Chineseeconomy increasingly “unstable, unbalanced, uncoordinated,and ultimately unsustainable.” his critique relected Premier Wen’s well-placed concerns over excess resource consumption,pollution and environmental degradation, widening incomeinequalities, capacity overhangs, and a serious shortall o internal private consumption. While the old growth modeldelivered spectacular top-down results over the past 30 years,the Premier has cautioned that it may well be incapable o taking China to the next stage o its development journey.
China needs to shift its model from export-andinvestment-led growth to consumer-led growth.
hat poses the alternative o a very dierent approach toChinese economic growth—a consumer-led growth model that would draw increasing support rom the internal demand o 1.3 billion Chinese people. Not only would that allow Chinato wean itsel rom excessive reliance on external demand,but it would also shit the growth bias away rom capital- andresource-intensive manuacturing activity toward labor-intensiveservices. his would be nothing short o a undamental rewiringo China's long successul growth paradigm.wo numbers underscore the open-ended upside o apro-consumption Chinese growth model—a 35% privateconsumption share o GDP and a 40% services portion o theeconomy (
see Figure 2 
). Both o these shares represent majorshortalls rom the optimal macro structure o any majoreconomy. China’s consumption share—currently at a recordlow - was above 50% in the early 1990s. he services share was on an upward trajectory until 2002 beore lattening outat the 40% level in the past several years—well below normsin the 50% to 60% range.
Figure 2: ChiNa’s MaCro DeFiCieNCies
8070605040302010525660646872768084889296000408Personal Consumption as % of GDPServices as % of GDP
Source: CEIC, Morgan Stanley Research1. See “Unstable, Unbalanced, Uncoordinated, and Unsustainable,” in Stephen S. Roach,
The Next Asia
, John Wiley & Sons, Inc., 2009.
Chinas rock-bottom consumption and services shares area double-edged sword: hey point to glaring deicienciesin the nation’s macro structure but they also highlight theextraordinary potential o structural rebalancing. he pro-consumption model not only addresses these shortcomingsbut it also alleviates many o the stresses and strains o the oldexport-led growth model. he challenge or China is to seizethe moment and inally embark on this critical transition.
he Wake-Up Call
here are two key underpinnings o an export-led growthmodel—export competitiveness and the state o externaldemand. China does not have a problem on the irst count. Wage increases in export-led manuacturing industries havebeen matched by outsize productivity growth, leaving overalllabor costs in a highly competitive position.
Inrastructureis irst rate, as is the modern technology endowment o Chinas relatively new production platorm. his enhancesthe logistics o an increasingly China-centric pan-Asiansupply chain, with China drawing heavily on its Asiantrading partners to source components and parts that are thenassembled in the mainland and shipped overseas.
The crisis of 2008-09 is likely to imparta lasting shock to external demand andexport-led Chinese growth.
But the old model has a new problem—the likelihood o a protracted post-crisis shakeout in external demand. Ater12 years o excess, the over-extended American consumeris tapped out. Bubble-dependent US amilies are severely burdened by record levels o indebtedness and by savingrates that remain ar too low to und retirement liestyles oran aging generation o 77 million baby boomers. And now they have been hit by devastating shocks—the bursting o property and credit bubbles, soaring unemployment, and amassive shortall o labor income generation. As a result, realconsumer spending growth in the United States is likely toaverage just 1.5% to 2% over the next 3-5 years—hal thepace o the outsize 3.6% gains that were realized in the 12years prior to the bursting o the subprime bubble in 2007.Nor is any other consumer in the world likely to step in illthe void that is about to be let by a multi-year consolidationo the American consumer. hat’s especially the case orthe Asian consumer, who is lacking the scale to play a rolein driving post-crisis growth in global consumption. Forexample, while China and India collectively account orclose to 40% o the world’s population, their combinedconsumption is only about US$2.5 trillion. By contrast, while the United States contains only about 4.5% o the world’s population, its annual consumption bill is running atabout a $10 trillion rate. Notwithstanding the likelihood o rapid demand growth o Chinese and Indian consumers, thescale dierentials make it mathematically impossible or themto oset the oregone consumption growth likely in post-crisis America. he only consumer with the scale to compensate orprotracted weakness in US consumption is the one least likely to do so—the European consumer (
see Figure 3
Figure 3: the global CoNsuMer
Personal Consumption: 2008120001000080006000400020000US EU-15 Japan China IndiaUS$ billions
Source: National Sources, UN, Morgan Stanley Research
 All this paints a picture o a much slower growth rate inglobal consumption over the next 3-5 years—underscoringa post-crisis prognosis o a protracted shortall in theexternal demand underpinnings o export-led economiessuch as China. Consequently, while Chinese export growthis currently rebounding ater the precipitous collapse inlate 2008 and early 2009, this improvement is likely to betemporary—driven mainly by inventory adjustments andthe “base eects” o easy comparisons rom crisis-induced weakness a year ago. With the largest consumer in the world likely to remain under pressure, the external demandunderpinnings o the Chinese export machine should beimpaired or years to come. his is likely to be a powerulheadwind restraining China’s export sector—the major drivero the nation’s economic growth since the turn o the century.China, o course, could elect to counter the shortall inexternal demand by taking actions aimed at improving itsexport competitiveness. Currency depreciation and othermercantilist eorts to grab market share rom competitors arepossibilities in this regard. But those options underscore thedark side o the export-led growth model—the potential ortrade rictions and protectionism. Worrisome concerns arealready mounting on these counts. I China elects to go downthis route and sustain its export-led growth dynamic throughcontentious trade policies, there is a distinct risk this approachcould backire—especially with its trading partners in the
2. See “China’s Rebalancing Challenge,” in Stephen S. Roach,
The Next Asia
, ibid.. Research by the staff of the International Monetary Fund has found that, “Most intraregional trade in Asia is occurring within vertically integrated regional supply chains, that, by andlarge, ship intermediate goods that are then assembled in China into final goods for shipment to industrial countries.” See Chapter II of the IMF’s
Regional Economic Outlook: Asia andPacific
, April 2008.

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