Business Studies Critical Thinking Paper on Factors Impeding China’s Economic Performance and the Wider Impact upon the World Economy

Factors Impeding China’s Economic Performance and the Wider Impact upon the World Economy

Statistics indicate that China’s economy is slowing down. Gross Domestic Product (GDP), one of the valued measures of economic performance in terms of productivity, indicates a steady decline. Up to 2010, the country had averaged at 10% but started slowing down to a 6.9% in 2015. IMF forecasts a further decline to 6.3% this year. The significance of China’s economy to the world has elicited concerns about the effect to the world economy. According to a 2015 World Bank data, China’s GDP stood at $10.35 trillion following the United States at $17.42 trillion. With the world GDP estimated at $77.86 trillion, China contributes about 15 percent of the GDP and USA 22 percent. In terms of growth, China contributes 0.9 percent of growth and has been a major driver of world economy. For the last three decades, economic reforms in China led to astounding development that catapulted the nation from number nine to number two. Prior to 1978, the country had a closed economy with low volume of foreign trade (Chow, 2004, 131). According to Chow, an open-door policy together with a change to a market-oriented economy boosted growth by attracting foreign investors. Foreign trade contribution to GDP was only 7% in 1978 compared to recent 42% in 2015. Due to favorable industrial market, China hosts close to a half million foreign enterprises (FocusEconomics 2016, n. p). It has the second highest foreign direct investments (FDI) and ranks second in importations of goods and commercial services. Therefore, what is ailing the economy of the country that is home to 1.3 billion people, and what is the wider impact to the global economy?

Following the global financial crisis of 2008, the Chinese government pumped in a $586 billion stimulus and passed policies that decreased interest on loans. Providentially, the country was able to withstand the effects of the crisis. Massive investments on infrastructural projects were implemented and the local economy seemed to have been affected. China came out of recession with an impressive 9 percent GDP growth and manageable inflation rates (Morrison 2015, 1). However the growth model employed focussed on investment and increased competition in businesses. The result has been an excess capacity for business growth increasing competition. The high leverage has led to companies making similar products, thus forcing businesses to lower prices. This is because the demand had not relatively increased as the supply, therefore, making businesses operate at low margin profits. For instance, a sales manager in Zhejiang Lanxi Shanye Machinery Company declared that they were being forced to sell at low prices due to the aggressive competition. However, despite the imbalances, the Chinese economy has other impediments as described below.

First, government control of the economy through various socio-economic policies makes China not to be a complete free-market economy. For example, the government controls rural-urban migration through the “hukou” system. Thus, despite growth of industries in cities, the Chinese citizens are not free to choose between agriculture and manufacturing jobs. In addition, despite a socialistic approach, there is a huge gap of income among the Chinese people. Although some people claim the economic challenges to be structural adjustments from industrial production to services, the structural changes have occurred from changes in demand for investment to consumption. However, the imbalances have resulted from government model of economic growth. The economy is still not a free market but is dependent on government policies. The leading political party, Communist party leaders have a big say on China’s economic model. A report by Szamosszegi and Kyle (2011) indicates that half of China’s GDP from non-agriculture originate from state owned enterprises (SOEs).  The enterprises are largely involved in telecommunications, utilities, oil and mining, transport, and other industrial sectors. The majority shareholder of the SEOs is the government of China. Despite them being few relative to other manufacturing companies, they control 30 percent of revenue in the manufacturing sector. Nevertheless, these companies are poorly managed and a quarter of them lose money according to World Bank report. Thus, such SOEs have contributed to bad loans in the banking sector (Chow 2004, 144)

In the banking sector, the government exercised too much control on the issuance of loans. The loans are provided to SOEs at low interests and without considering the risks. On the other hand, private companies are discriminated with high interest being charged. In 2009, 85 percent of all bank loans amounting to $1.4 trillion had been borrowed by the SOEs. The government had also imposed low interest on bank deposits, lower than inflation rates, which has left the banks operating at low profits. The government has borrowed heavily, with debts of up to $3 trillion in 2013. The problem of debt has affected even other Chinese corporations. By mid-2014, China’s total debt totalled to $28 trillion equivalent to 282%of the GDP (Morrison 2012, 26). The increased borrowing could be unsustainable if there is no balance in investment to all sectors. Critics have termed investments in real estate as excessive with neglect of other services.

On fiscal control, the government has at times made policies against market performance. The Chinese stock markets’ trade at Shanghai and Shenzhen Stock Exchanges, where local firms trade are very unpredictable. The investors have little influence on stock market; therefore, they focus on short-term benefits to sell shares. Sometimes stock bubbles have led to loss of capitals amounting to trillions. For instance, Shanghai Stock Exchange stocks fell by 32 percent from June 12, 2015, to July 7, 2015 leading to losses of $1.9 trillion. Similar losses were made at Shenzhen Stock Exchange of $1.7 trillion. Reports indicate that the government may have used $235 billion to stabilise the markets through brokerage companies. Besides, the government halted initial public offering and prohibited SEOs from selling shares. In the end, both stock markets struggled to stabilise and losses to the tune of $5 trillion were made. The volatile stock market full of speculators and dominated by government does not make the stock market attractive in China (Morrison 2015, 1).

The economic model of China has led to imbalances leading to relatively low private consumption compared to the GDP. There are high savings and inflexible investment. The Chinese high savings have led to decreased private consumption. A reasonable argument could be that since GDPs growth depends on consumption, policies that hinder consumption can be detrimental to growth. For example, the “hokou” system has slowed movement of people to cities where consumption rates are high. Another reason is lack of social support systems, such as unemployment welfare, pension, health care, and education. It causes people to save in order to care for personal needs. Another reason is lack of affordable private loans. Additionally, the government has restricted deposits to foreign banks whereas the local banks offer low interests on deposits lowering household incomes. On the other hand, despite high investment of capital, increase in consumption has been sluggish (Semmens et al. 2016, 4). Fixed investments also did not have adequate returns due to the global financial crisis. It affected the demand for goods lowering the volume of exports.

It is no doubt that China is a force to reckon with on global economics. China has been an attractive location for international investment due to the cheap labour, cheap capital as well as a large market for goods. With a GDP of $11.4 trillion, a population of 1.3 billion contribute 10 percent of global imports and 13 percent exports. Thus, the country’s economy cannot slow without a ripple effect to the rest of the world. The decline of GDP from 10 to 6.3 percent has caused a drop of 0.75 percent to the world GDP. Despite continued growth of exports, a decrease in demand of imports affects growth in the exporting countries. The demand for minerals and textile raw materials in China accounts for a significant percentage of global imports. For example, more than half of minerals including iron, copper, aluminium, coal, tin, zinc, steel and cotton are exported to China. Excess production in China will affect prices in other countries and export of the surplus. Australia’s exports to China account for about 5 percent of the country’s GDP.  25 percent of South Korea’s exports are sold to China. The contribution of exports from both developed and developing countries account to about 2.3 percent of GDP for each, with Germany exporting much of the capital. It may appear to be low but the goods exported are reprocessed and sold to other countries world-wide (Ha et al. 2016, 11)

In the banking sector, corporate sector is also indirectly exposed to a decline of China’s economy. The European banks, such as Standard Chartered and HSBC have provided funding including mortgages. Low profits from sales in China will imply that the companies are not able to service loans and growth could be hampered by tighter borrowing conditions. China does not float its currency and the situation has led to an undervalued renminbi (RMB). The situation has caused their imports to be more expensive than the exports. It is also difficult to monitor inflation and make fiscal policies in China.

In conclusion, China’s growth is dependent on government reform models. Since the political class has been setting and controlling trade, a free market analysis using conventional measures may not offer an accurate forecast. However, the government need to reform its economic policy to avoid further increase of debts. Local governments should be encouraged to generate revenue for growth rather than borrow heavily from banks. Shadow banking has led to weak banking systems that operate at high risks. However, since much of the debt is local and large savings of about $600 billion, the economy is shielded from a debt crisis. The Chinese Yuan still remains guarded to the capital account, and it needs to be popularized to other countries. A transition from an investment to consumption needs a socio-economically empowered population. Inequality and low wages for workers in the manufacturing sector need to be tackled for private consumption to increase. The control of capital investment to the Chinese corporations has caused the Chinese citizens to settle for minimal domestic banking interests. Thus, as China embarks on measures to stimulate growth, an improvement of social life to all citizens would be crucial to China.


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