BREE China Review (June 2013)

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Resources, Energy and TourismChina ReviewJune 2013


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Resources, Energyand Tourism

China ReviewJune 2013


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ii China Review June 2013

Commonwealth o Australia 2013

This work is copyright, the copyright being owned by the Commonwealth o Australia. The Commonwealth o Australia has,however, decided that, consistent with the need or ree and open re-use and adaptation, public sector inormation shouldbe licensed by agencies under the Creative Commons BY standard as the deault position. The material in this publication isavailable or use according to the Creative Commons BY licensing protocol whereby when a work is copied or redistributed,the Commonwealth o Australia (and any other nominated parties) must be credited and the source linked to by the user. It isrecommended that users wishing to make copies rom BREE publications contact the Chie Economist, Bureau o Resourcesand Energy Economics (BREE). This is especially important where a publication contains material in respect o which thecopyright is held by a party other than the Commonwealth o Australia as the Creative Commons licence may not beacceptable to those copyright owners.

The Australian Government acting through BREE has exercised due care and skill in the preparation and compilation o the

inormation and data set out in this publication. Notwithstanding, BREE, its employees and advisers disclaim all liability,including liability or negligence, or any loss, damage, injury, expense or cost incurred by any person as a result o accessing,using or relying upon any o the inormation or data set out in this publication to the maximum extent permitted by law.

ISSN (Print) 978-1-922106-07-0

ISSN (PDF) 978-1-922106-08-7

This publication was jointly undertaken by the Bureau o Resources and Energy Economics (BREE) , Tourism Research Australia(TRA), and the Department o Resources, Energy and Tourism (RET).

Authors: Fast orward? Chinas uture and the implications or Australia: Roger Rose and Kate Penney; China iron ore andsteel: prospects or the industry and implications or Australia: Kate Penney; The energy consumption, emissions and incomeinequalities o Chinese urban households: Jane Golley; Study tourism rom China: opportunities and implications or Australia:Byron Keating and Amy Godrey

Other contributors: A number o colleagues at BREE and TRA have contributed to the preparation o this report as well as thestatistical tables including: Tom Shael, Oliver Hough and Clare Stark.

Acknowledgements: Special thanks to Quentin Graton and Leo Jago or their valuable guidance and contributions.

Design and production: Typeyard Design and Advertising Pty Ltd

Cover image: Paul Gunning

Postal address:Bureau o Resources and Energy EconomicsGPO Box 1564Canberra ACT 2601 Australia

Phone: +61 2 6276 1000

Email: [email protected]: www.bree.gov.au
http://www.bree.gov.au/http://www.bree.gov.au/


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China Review June 2013 iii

ForewordOver the past three decades China has undergone a remarkable transormation to become the

worlds second largest economy. This growth was in large part driven by liberalisation o economicpolicy, demographic conditions and access to technology and trade opportunities.

Some o the actors that acilitated Chinas rapid growth, including a low-cost labour pool and

massive capital investments, are receding. As recognised by the Chinese leadership, to maintain itscurrent economic growth the Chinese economy will, over time, need to transition into a greater level

o consumption, undertake urther market liberalisation and increase the role o the services sector.While the scale o the challenges acing the Chinese economy is large, they are achievable, especiallygiven the announced commitments to policy change by the new Chinese leadership.

Australia has been a major beneiciary o Chinas growth over the past decade. Chinas investment in

the Australian economy, particularly in the resources sector, increased substantially over this periodand China is now Australias largest merchandise trading partner, accounting or around 30 per cento Australias total exports in 201112. China has also become a key market or Australias tourism

exports, and in 2012 it became the second largest inbound market or visitor arrivals and the largestmarket or total expenditure and visitor nights.

Looking orward, changes in the Chinese economy will present challenges or Australias major exportindustries, but will also create new market opportunities. Some sectors that have the potential tobeneit rom opportunities in China include: agriculture, mining and energy technology and services,

inancial services, education and tourism.

The Chinese education market has been growing rapidly and now accounts or around 28 per cento Australias international education exports. This has low-on eects or the tourism sector because22 per cent o Chinese students have visitors rom home during their stay in Australiaan average o

ive visitors per student.

In this, the second issue oResources, Energy and Tourism China Review, BREE and TRA provide adetailed discussion on some o the opportunities and challenges acing the Chinese economy over

the next two decades and an overview o the implications or Australias major export industries. Thisrelease also includes a review o the prospects or Chinas iron and steel markets; a detailed analysis o

the energy consumption, emissions and income inequalities o Chinese urban households; and theopportunities and challenges or Australia stemming rom Chinese study tourism.

As in the 2012 release, BREE and TRA have updated the Reviews unique collection o statistical tables,igures and charts about China and how China relates to Australia and the rest o the world.

Quentin GraftonExecutive Director/Chie Economist

Bureau o Resources and Energy EconomicsJune 2013

Leo JagoChie Economist/General Manager

Tourism Research AustraliaJune 2013


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iv China Review June 2013

ContentsForeword iii

Acronyms and abbreviations v

Overview

Fast orward? Chinas uture and the implications or Australia 1

Reviews 41

China iron ore and steel: prospects or the industry and implications or Australia 42

The energy consumption, emissions and income inequalities oChinese urban households 63

Study tourism rom China: opportunities and implications or Australia 76

Statistical tables and figures 101

Part I: Chinese trends: economic and social indicators 108

Part II: Chinese trends: resources and energy activities 121

Part III: Chinese trends: tourism activities 131

Part IV: Australian trade with China 133


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China Review June 2013 v

Acronyms and abbreviationsAAGR annual average growth rate

ABS Australian Bureau o Statistics

ADS scheme Approved Destination Status scheme

BOF basic oxygen urnace

BREE Bureau o Resources and Energy Economics

cm cubic metres

DFAT Department o Foreign Aairs and Trade

EAF electric arc urnace

ELICOS English language intensive courses or overseas students

FDI oreign direct investment

FOB ree on board

FYP Five Year Plan

GDP gross domestic product

GFC global inancial crisis

ICT inormation and communications technology

IEA International Energy Agency

ILO International Labour Organization

IMF International Monetary Fund

IO input-output

IVS International Visitor Survey

kg kilogram

kgce kilogram o coal equivalent

koe kilogram o oil equivalent

kWh kilowatt hour

LGFV local government unding vehicles

LNG liqueied natural gas

LPG liqueied petroleum gas

MJ megajoules

MEP Ministry o Environmental Protection

MPE marginal propensity to emit


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vi China Review June 2013

Mt million tonnes

NBS National Bureau o Statistics o China

NDRC National Development and Reorm Commission

NTAF National Tourism Accreditation Framework (also known as T-QUAL Accreditation)

OECD Organisation or Economic Co-operation and Development

PISA OECD Programme or International Student Assessment

PPP purchasing-power parity

R&D research and development

RET Department o Resources, Energy and Tourism

RMB Renminbi

SASAC State Owned Assets Supervision and Administration Committee

SCE standard coal equivalent

SOE State-owned Enterprise

TEQSA Tertiary Education Quality Standards Agency

TFC Tourism Forecasting Committee

TITE total inbound tourism expenditure

Tn tonne

T-QUAL tourism quality assured

TRA Tourism Research Australia

TVE town and village enterprises

UN United Nations

UNCTAD United Nations Conerence on Trade and Development

UNESCO United Nations Educational, Scientiic and Cultural Organization

VET vocational education and training

VFR visiting riends and relatives

WTO World Trade Organization


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China Review June 2013 1

Overview:

Fast forward? Chinas future and theimplications for AustraliaRoger Rose and Kate Penney*

IntroductionSince the beginning o its market-oriented reorms in 1978, China has undergone an

extraordinary economic transormation. In little more than 30 years, the Chinese economyhas been transormed to become the worlds second largest economy. Real gross domestic

product (GDP) per capita increased at an annual rate o about 9 per cent over those threedecades. As a consequence o that growth, the proportion o Chinas population living in

poverty declined rom 65 per cent to less than 10 per cent.

Since 1978, Chinas economy has evolved rom a centrally planned and predominantlyagricultural base to a largely market driven industrial economy. Its economic transormation

has been closely tied to ongoing changes in economic policy, supported by a unique set odemographic conditions and access to technology and trade opportunities on world markets.

The uture prospects or growth in Chinas economy in relation to: markets; regulations;

demography and skills; and technology are reviewed in the ollowing sections. These issuesare evaluated using the World Banks 2012 study and its projections o the Chinese economy

to 2030. The 2030 projections are explicitly linked to the development and implementation oa broad program o policy changes, which largely relate to markets and regulations, but alsoinclude policies designed to improve Chinas environmental perormance, including those

to manage CO and related greenhouse gas emissions. The overview concludes with theimplications o uture growth and structural change in Chinas economy or Australias major

export industries.

Chinas economic transition

Chinas transition started with the replacement o communal responsibility or meetingproduction quotas with the household responsibility system in agriculture in 1978. Under

household responsibility, producers were paid government prices or meeting their quota, butcould sell any surplus at market prices. The consequence was a dramatic increase in agricultural

productivity. This dual price system was subsequently expanded to other industries.

* The views expressed in this review are those o the authors alone and are not necessarily those o the Bureauo Resources and Energy Economics nor the Department o Resources, Energy and Tourism. The authors aregrateul or the insights and assistance o Quentin Graton in the preparation o this overview.


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There are also questions about the appropriateness o structures and incentives or stateowned enterprises (SOEs), which dominate banking, telecommunications and most heavy

industries.

Some analysts, such as Das and NDiaye (2012), Garnaut (2010) and Huang and Wang (2010),suggest that China has reached a turning point, either in terms o a need to rebalance the

economy, or an end to the opportunity to rely on low-cost labour, or both. Whatever theuture may hold, there is limited prospect o an ongoing era o abundant cheap labour. Wage

rates have increased rapidly and growth in labour availability will decline as Chinas populationagesa consequence o a low birth rate over the past 30 yearsand limits workorce

expansion. Ultimately, what may matter most in terms o uture economic growth is therelationship between growth in the labour orce and wages, and growth in productivity.

Questions about rebalancing the Chinese economy all into one o two broad categories. The

irst includes issues such as the need or greater emphasis on consumption as a proportiono GDP, an expansion o the service sector and the need to manage the external balance andexchange rate. The second includes actor marketsincluding the reduction o impediments

to rural-urban worker migration, the provision o health and social security services and theremoval o distortions in banking and other industry sectors dominated by SOEs.

Looking orward, some o the actors that acilitated Chinas growth may remain, but others

will not. The comparative advantage o very low wages has passed; China is now clearly amiddle income country (Figure 1). Further, an abundant supply o cheap labour may soon be in

the past, i it is not already. Future growth will depend on the ability o both government andindustry to adapt. The central government appears keen to pursue urther policy change, but

aces major challenges.

Figure 1: Cross country income distribution, 2011

1

2

3

4

5

6

USDper capita

(ln scale)

Low income Middle income High income

United

StatesJapan

India

Australia

China

Source: World Bank 2013b.


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4 China Review June 2013

Key opportunitiesChina has developed an extensive network o transport and communication inrastructure.In the our years rom 2007 to 2011, the total length o railway in operation was extended by

20 per cent and the total length o reeway by 58 per cent (Table 1). Over the same period,the capacity o mobile telephone exchanges doubled. While signiicant gaps in transport and

telecommunications inrastructure, particularly in Chinas west and rural areas remain, Chinascurrent inrastructure will provide the base or a more integrated economy.

Table 1: Chinas ICT and transport infrastructure

2007 2011

% increase

20072011

Mobile subscribers (per 10 000 people) 54 731 98 625 80.2

Capacity o Mobile Telephone Exchanges (per 10 000 people) 85 496 171 636 100.8Internet users (per 10 000 people) 21 000 51 310 144.3

Length o rail in operation (10 000 km) 7.8 9.3 19.6

Length o highways in operation (10 000 km) 358.4 410.6 14.6

Length o reeways in operation (10 000 km) 5.4 8.5 57.6

Length o petroleum and gas pipelines in operation (10 000 km) 5.4 8.3 53.0

Source: National Bureau o Statistics China 2012.

China has a much more educated workorce than beore its economic reorms began. For

example, o people aged 2529, the percentage who had completed secondary studies roseprogressively rom 9.8 in 1980, to 47.5 in 1990 and to 75.5 in 2011. The share o that age group

that have completed tertiary studies was 0.5, 1.5 and 8.8 per cent or 1980, 1990 and 2011,respectively (derived rom World Bank 2013a).

With a larger private sector, particularly in export-oriented manuacturing, China has a set o

entrepreneurial skills that should prove invaluable in making the adaptations necessary toadapt to changing domestic and international market conditions. These skills, along with a

more educated workorce, will also provide opportunities to increase the domestic technologycontent o Chinas exports.


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Key challenges in the absence of policy changeRapid economic growth does not come without challenges (Table 2). A driving orce orChinas growth has been the sequential, and to some extent experimental, dismantling o

centralist policy in avour o allowing market development. There is no guarantee, however,that the economic structure resulting rom such a process will be balanced. In particular, there

are evident imbalances in the current structure o Chinas economyconsumption is low andhas declined as a proportion o GDP (Figure 2). Chinas service sector is relatively small andundeveloped, and its economy is heavily export dependent. During times o sluggish world

economic growth, high export dependence may contribute to a less resilient economy.

Figure 2: Chinas contribution to GDP, by source

20 40 60 80 100

20062011

20012006

19962001

%

Consumption Investment Net

exports

Source: CEIC 2012.

Chinas very high savings rateat around 50 per cent o GDPhas allowed its extremely highinvestment to be largely domestically unded. Over an extended period, investment has been

strongly oriented toward inrastructure and the heavy industries which provide essential inputsto inrastructure spending. Large investment in the manuacturing sector has allowed it to use

abundant low-cost labour. As a result, production o manuactured goods has underwritten

Chinas burgeoning exports. Chinas strong GDP perormance has been supported by thisdomestic investment and oreign demand. Thus, with slowing investment and externaldemand, China will require stronger domestic consumption to sustain growth.

While Chinas high savings rate supported high economic growth in the past, it is now a key

hurdle in the transition to a consumption-led economy. A high savings rate is, typically, seento be unavourable to balanced economic growth because it reduces the demand or goods

and services. Several actors contribute to Chinas relatively high savings rate. One is the policystructure that promotes a high level o precautionary saving by much o the population

(Figure 3). The dominance o SOEs in some industry sectors and the policy environment inwhich those enterprises operate supports both high levels o proit and rates o corporate

saving by some o those enterprises. Further, a combination o interest rate controls and limitson overseas investment by Chinese residents oblige individual savers to subsidise industry and

government at the expense o potential consumption.

Chinas social services system and social saety net have many gaps relative to developedeconomies. Until reorms o SOEs were undertaken in the 1990s, many employees wereprovided with health and other insurance by their employers. Relieving SOEs o employee

welare obligations contributed to improved enterprise proitability, but let employees witha stronger incentive or saving as they could no longer rely on welare assistance rom their

employers.


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Currently, both employees and employers are typically required to contribute to employeepension unds, at least or urban permanent residents, although there is limited portability o

pensions. Rural migrant workers mostly do not have access to these arrangements, nor do theygenerally have employer-sponsored health. Education expenses, at all levels, are at least partly

privately unded, adding to the precautionary saving incentive.

China has a high rate o corporate saving. A major part o that corporate saving is by SOEs.The same set o reorms that transerred the costs o health care and, initially, pensions to

employees encouraged increased proitability in those enterprises. SOEs also have potentialsources o proits beyond the level that would persist in a competitive environment. The

IMF (2011) notes that, while SOEs are notionally owned by the Chinese people, they have noobligation to pay dividends. Thus, income that might otherwise have gone to households and,

at least in part, expanded consumption has become part o corporate saving. Banking andinance regulation urther adds to incentives to save.

Figure 3: Gross national saving as a percentage of GDP

10

20

30

40

50

60

2002 2003 2004 2005 2006 2007 2008 2009

%

government

corporate

household

Source: CEIC 2012.

Largely as a consequence o strong export perormance and high savings rate, China has

maintained a very high external balance or an extended period (Figure 4). Since the GFC,there has been some moderation in Chinas external balance stemming rom weaker oreign

demand, declining terms o trade and strong domestic investment, although it still remainshigh.

Some concerns have been raised about the sustainability o Chinas present economic

structure. The high current account balance, along with what is perceived to be anundervaluation o the Renminbi, has been the cause o considerable tension with Chinas


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trading partners. The long term viability o the export-oriented manuacturing industry whichsupports that balance is under threat. To date, Chinas competitiveness in export markets has

depended on its abundant cheap labour, an advantage that is diminishing. Most o Chinasmanuacturing exports have relatively low endogenous technology content, while the high-

technology industry is relatively less eicient and is also reliant on imported components(Zao and Yang 2012). Maintaining competitiveness with less abundant labour will require an

upgrade in Chinas technological input which, in turn, will require a more skilled workorce.

Figure 4: Chinas current account balance

-100

100

200

300

400

500

1982 1986 1990 1994 1998 2002 2006 2010

$USb

surplus

decit

Source: World Bank 2013b.

Perhaps the greatest set o challenges that China aces over the next two decades is relatedto an inevitable shit in the age and regional structure o its workorce. These changes will

have implications or labour market policy and or policies more broadly, particularly thosein relation to education and other aspects o local government inance. Over the past 20

years, Chinas growth has been bolstered by a particularly avourable population structure. Acombination o actors, including the low-on eects o Chinas one child policy, gave rise to a

population with a proportionally large working age component and low dependency (Figure

5). Between 1980 and 2011, the proportion o Chinas population aged between 16 and 65rose rom 59 to 73 per cent (World Bank 2013b). While Chinas total population grew by 37 percent over that period, its working age population grew by 67 per cent and supported aster

economic growth. Wei and Hao (2012) estimate that since the 1990s, Chinas demographicscontributed to one-sixth o its economic growth, acilitated by increased market competition.


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Figure 6: Chinas population structure, 2010 vs 2030

Male Female

80 60 40 20 0 20 40 60 80

0-4

5-9

10-14

15-1920-24

25-29

30-34

35-39

40-44

45-49

50-54

55-59

60-64

65-69

70-74

75-79

80-8485-89

90-94

95-99

100+

millions

20102010

2030 2030

Source: UN 2011.

The impending changes in the age structure o the population, along with other changes in

the labour market, raise the question: when will China reach a Lewis turning point at which

there is no longer any low o surplus labour rom agriculture to other sectors? Garnaut (2010)suggests that, by 2009, there was limited or no excess labour. The basis or that assessment isan observation that wage rates are rising across the board and that rural residents ace rising

opportunity costs o migration. He observes that most rural residents are already employedlocally, so have less reason to move than in the past. Li et al. (2012) examine evidence that

broadly supports Garnauts assessment. They observe that real wage rates are increasing in allregions and across all skill levels (Figure 7). Further, they point out that wages have risen much

aster than labour productivity. They estimate that Chinas economy will reach a Lewis turningpoint somewhere between 2020 and 2025.

By contrast, Meng (2012) argues that regional shortages o labour are a direct eect o the

hukou system and that there is a potentially vast pool o low-cost labour. The combinationo restrictions that migrants ace means that they currently spend only a very limited time in

citiesabout seven years on average. Meng observes that 62 per cent o migrants surveyedin the Rural-Urban Migration in China and Indonesia Project say they would move to the citypermanently i given the option. In essence, she argues that easing discriminatory access to

urban jobs and resolving social security and education problems would expand the number omigrants and the length o time they spend in urban areas.


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Regardless o actions taken to resolve migration issues, the impending changes in the agestructure o Chinas population will have serious eects on Chinas comparative advantage and,

thereore, on the possible pattern o economic development. Das and NDiaye (2012) estimatethat Chinas labour surplus is currently around 169 million, but will decline to 30 million by 2020.

They estimate that Chinas economy will reach a Lewis turning point somewhere between 2020and 2025. Changes to labour supply conditions, such as modiication o the hukou system, are

calculated to change the timing o the turning point, but only by a ew years.

Figure 7: Migrant wage growth in China

-5

5

10

15

20

25

30

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

%

migrant real wage

productivity insecondary and

tertiary sectors

Source: OCED 2013.

Although market-oriented reorms have been underway or decades, China is not a completemarket economy and has substantial government participation through its SOEs. As well as

being dominant players in China, a number o SOEs are becoming more signiicant globally.While SOEs are, typically, highly proitable they are, typically, less eicient compared with

their private counterparts. It is unlikely that ull reorm o these enterprises will occur whilethe government pursues socialism with Chinese characteristics which, to date, has given

prominent role to state ownership, particularly in strategic industries. The avourable operatingconditions aorded to SOEs through policy and regulation have contributed to the slow pace

o reorms in some industry sectors, such as banking and inance. These sectors remain heavilyconstrained and the Chinese stock and bond markets are ar rom ully developed.

China also aces emerging issues in terms o the distribution o income and opportunities, and

also the treatment o unpriced environmental amenities. Rapid growth has resulted in risingprosperity in urban areas, however, rural residents still have restricted and inerior access to

education and welare, particularly those with rural hukou living in urban areas. One o theconsequences o Chinas pursuit o economic growth has been a widespread deterioration

in the condition o natural resources, including land, water and air quality. Addressing thesechallenges may create some growth opportunities in the uture, but remedial environmentalaction will have a cost.


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Policy challenges that may create growth opportunitiesHuang and Wang (2010) suggest that it is diicult to directly link any single policy challengeto a particular actor. Thus, successul policy action to maintain Chinas growth rate is likely

to involve a package o reorms. Some o the key changes to redress existing economicimbalances include:

improved competition in SOE dominated industries;

labour market reorm;

improved provision o social services and saety net;

liberalisation o the inance market; and

reduction o input subsidies.

Reorming the labour market and improving the social services and saety net is unlikely

without substantial change in the system o allocation o responsibilities to, and unding, osubnational governments.

While the scale o Chinas challenge to sustain economic growth over the next two decades islarge, it is not insurmountable. Policy change to address these issues will create opportunities

or the expansion o the Chinese economy (Table 2). China has aced and overcome majorchallenges in the past, and has generally exceeded expectations. In this sense, the challengesacing the Chinese economy over the next ew decades are not dissimilar. However, this

time the adjustment is required in the context o increased global pressures and Chinasmore important role in the global economy. Enacting the required restructuring to maintain

domestic growth, while taking on increased responsibility or global stability and governance,will not be straightorward and there is likely to be dips and troughs in its growth pattern. In

any event, the outcome in China will have ar-reaching global implications (Spence 2011).

Chinas Leadership Transition

A once-in-a-decade leadership transition in China was ormalised during the National Peoples Congress

and Chinas Peoples Political Consultative Conerence in March 2013. Chinese President, Xi Jinping, and

Premier, Li Keqiang, lead the seven-member Politburo Standing Committee that eectively governs

China.

The newly-installed government have announced three key priorit ies or the government during their

term. These include: (1) maintaining economic growth; (2) improving the well-being and livelihood o its

citizens; and (3) saeguarding social justice.

Maintaining economic growth is considered to be the governments most important task. Premier Li

has stated that China needs to acilitate economic restructuring and oster new sources o growth by

leveraging o domestic demand and innovation potential so as to improve the quality and eiciency o

its economy, create jobs and income, and improve environmental outcomes.


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The task o improving well-being will ocus on increasing urban and rural incomes, in par ticular those

living in poverty as well as expanding the middle-class. Premier Li has emphasised that, to promote

social justice, the Chinese government will need to create a solid social security net that supports

compulsory education, medical care, social insurance and housing.

In May 2013, the National Development and Reorm Commission released plans or its reorm agenda

during 2013 which includes: changes to the inancial and taxation systems, the promotion o private

sector investment, accelerating urbanisation, and reducing inequality.

Competition and distributions in SOEs

From the beginning o the reorm process in 1978, there has been a development andexpansion o private enterprise in product markets. Nevertheless, despite decades o reorm,

SOEs continue to dominate many strategic industry sectors in China, including inance,telecommunications, inrastructure construction, energy and signiicant raw material

industries. SOE dominance o those sectors is supported by avourable regulation, includinggovernment-imposed entry barriers.

The protection provided to strategically placed SOEs has allowed the perverse result that

such enterprises are highly proitable, but o low operating e iciency (Geng et al. 2009). In thiscontext, Szamosszegi and Kyle (2011, p.53) cite McKinsey and OECD estimates that productivity

o privately owned enterprises in China is about twice that o SOEs. Hong and Nong (2013)estimate the rate o return on equity in 2009 at about 8 per cent or SOEs, compared with

around 16 per cent or non-SOEs. The low returns or SOEs occur despite the considerablesubsidies on land, inance and other inputs received by many o these enterprises. Integratedwith price controls over key inputs, such as water and energy, the SOE arrangements have also

served to deliver signiicant support to export-oriented manuacturing and other industries.

The accumulation o proits within SOEs has important implications or the overall structureo the Chinese economy. SOEs account or about hal o all production. Thus, retention o

their proits makes a signiicant contribution to the relatively low rate o consumption in theeconomy. Retention o proits by SOEs also contributes to high levels o investment in the

economy as a whole. In particular, Lee et al. (2012) analyse Chinas investment using an optimalinvestment, cross country model. They ind that eective subsidies to large corporations,

through inancial regulation, results in overinvestment and a transer rom households tobusinesses equivalent to around 4 per cent o GDP.


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State Owned Enterprises in China

State Owned Enterprises (SOEs) are corporations run by the central or local (provincial, municipal and

county) government. Typically, they are classiied according to the nature o their assetsproductivestate-owned assets, administrative public institutions, and resource assets and other equity assetsor

how they are managed by the governmentcentral SOEs, local SOEs and under the supervision and

administration o the Ministry o Finance (Hong and Nong 2013).

In 1949, a large proportion o industrial enterprises in China became centrally controlled, with

production, prices, wages and employment primarily determined by the government. Since the late

1970s, reorms have acilitated a transition towards private enterprises and partnerships where the

government continues to hold a majority interest. Consequently, the number o SOEs in China has been

steadily declining over the past decade. The 12th Five-Year Plan outlines objectives o creating National

Champions and strategic industries, while also grasping the large and letting go the small. This will

ensure the continued existence o large and powerul SOEs, but the total number may decline asenterprises are merged, privatised or restructured.

In 2011, SOEs accounted or around 5 per cent o the number o industrial enterprises with revenue over

20 million Renminbi (National Bureau o Statistics China 2012). However, the role SOEs play in the Chinese

economy becomes more apparent when the proportion o total output value (26 per cent o total),

proit (15 per cent), total assets (42 per cent) and employment (20 per cent) are considered. Typically, the

average assets o SOEs (17 million Renminbi) are much larger than non-SOE unded enterprises (1 million

Renminbi). Chinese government statistics or SOEs do not include collective-owned enterprises or

majority-owned SOEs, indicating the contribution o SOEs to the economy are likely to be understated.

SOEs can ensure the reliable provision o essential services; improve coordination between industryand government or implementing policies; and contribute to higher employment. However, SOEs

ace dierent market conditions compared with private enterprises, leading to a clear comparative

advantage, including: cheaper and easier access to inancing, improved access to grants and tax breaks,

and advantages in procurement processes and selection. There are also barriers to entry imposed on

strategic or priority industries.

SOEs oten have conlicting objectivesthey are required to reach production targets and generate

proits, but they are also tasked with implementing polic y, generating employment and providing

other social welare unctions. Because these enterprises are not purely working to the objective o

proit maximisation, their eiciency can be poor. Further, public service restrictions may prevent the

recruitment o the best managers (Gra ton and Squires 2002). It has been estimated that the productivityo privately owned enterprises in China is about twice that o SOEs (Szamosszegi and Kyle 2011).

Liberalising the fnancial sector

The e iciency o Chinas inancial sector is constrained in a number o ways including: interestrate controls and supporting capital account controls; state ownership o banks; restrictions on

oreign direct investment (FDI) in the banking sector; regulations and reserve requirements,and security markets.


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Chinas banking sector is dominated by state-owned banks. Johansson (2012) calculates that,in 2009, state controlled banks owned 73 per cent o total bank assets. State ownership helps

ensure that a large proportion o lending is directed to SOEs in other sectors. Hong and Nong(2013) observe considerable sta exchange between state banks and client SOEs that would

acilitate loans to SOEs. In practice, state-owned banks, at least in part, serve as instruments toimplement government priorities. As a direct consequence o state-owned banking structure

and practice, lending may not be directed to the most proitable uses, and credit availability toindividuals and private businesses is constrained. Perkins and Rawski (2008) argue that banking

sector eiciency would be improved by promoting entry and removing the non-proit actorsrom credit allocation.

Interest rates in China are controlled by the imposition o maximum deposit rates and

minimum lending rates. Chinas real interest rates over recent years have been low, sometimesnegative. A primary eect o maintaining low real interest rates has been to subsidise SOEs,

the main borrowers. Low interest rates have also had a direct beneit to government and anindirect eect o making it cheaper to maintain an undervalued currency. Conversely, it hasimposed a major cost to households, who are the primary lenders. The resulting reduction in

household income contributes to a rate o household consumption lower than in many othercountries.

The combination o banking arrangements and credit rationing that avour SOEs means that

private businesses are, by comparison, credit constrained. Limits on oreign direct investmentin China urther limit growth o private businesses. Thus or some private businesses, the only

option is to und uture operations rom savings. At best, such credit pressure raises the cost ounds to private businesses.

Chinas stock and bond markets are ar rom ully developed. In particular, severe limits on

oreign involvement in Chinas stock market restrict development. Supervision is under-resourced and there is a perception there may be market manipulation (Johansson 2012). The

absence o well-developed and e icient stock and bond markets reduces options and raisescosts or private sector businesses.

Removing price distortions for key inputs

While most o Chinas product markets are competitive, there are signiicant policy induceddistortions in a number o key input markets. In many cases, these distortions are closely tied

to the avoured position o SOEs in input markets and their ties with state-owned banks.

Rural and suburban land in China is collectively owned, except or some state-ownedparcels. While armers generally have 30 year use rights, governments have exclusive right

to appropriate rural land and designate it or conversion to urban or industrial uses. Oneconsequence o this arrangement is that leases or industrial purposes may be made available

to industry at little or no cost (IMF 2011). Service delivery through SOEs and associated pricecontrols in the markets or oil, gas and electricity mean that there are large eective subsidies,

particularly to major industrial consumers. Recent changes in electricity taris have lessenedthe size o the subsidy to some major users and oil pricing arrangements now more closely

link the domestic price to the world price. Nevertheless, Huang and Wang (2010) estimate the


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total value o input subsidies, including SOE gains rom interest rate controls, at 10 per cent oGDP. Two key eects o price regulation are to bias investment towards strategic industries and

support manuacturing exports while constraining growth in the service sector.

Energy price reorm

As part o its eorts to move towards a more market-based economy and improve environmental

perormance, the Chinese government announced new pricing arrangements or diesel and gasoline

in March 2013. Under the new system, the price adjustment cycle has been reduced rom 22 working

days to ten working days so that the domestic oil price more closely relects international market prices.

The our per cent tr igger b and or domestic price changes has been removed and the types o crude

used in the adjustment calculations have been altered. I international price changes are less than 50

Yuan over the adjustment cycle, the domestic price will not be changed. Similarly, the timing and size o

price increases may be changed in some circumstances, such as at times o high domestic in lation or

dramatic changes in world oil prices.

The previous pricing system encouraged distributors and consumers to stockpile oil products during

periods o high international prices so that they could sell or a proit ater the government price

adjustment. The new system may disadvantage Chinese consumers should international oil prices

increase suddenly, but will beneit reiners who have struggled to remain proitable amid price controls

and had little incentive to improve uel quality because they could not pass on higher costs.

The government has announced that it will promote price reorm in 2013. Analysts believe that reorms

in pricing or coal, gas and electricity are likely to make progress this year. This is particularly important

or the gas market i China is to meet its goals o increasing the share o gas in the energy mix.

There is a growing divergence in the price o domestically produced and imported gas. This gap is

expected to expand in the uture as China imports more gas, especially in the orm o LNG. End-use

prices also tend to be kept low to avoid inlationary pressure, restricting the ability to pass on rising gas

prices to inal consumers (IEA 2012a).

Gas prices in China are currently based on three elementsthe cost o gas, the cost o transpor t and the

end-use. The National Development and Reorm Commission (NDRC) have been piloting pricing reorm

in the Guangdong and Guangxi regions. Under the new system, gas prices in these regions are 60 per

cent linked to uel oil prices and 40 per cent linked to liqueied petroleum gas (LPG) prices. While this

pricing mechanism relects the competitors to gas in the industry and household sectors, respectively, itdoes not account or the competition rom coal (IEA 2012a).

Removing labour market distortions

Chinas labour market is distorted by its household registration system, and the ties between

that system and provision o social services. Under the hukou system, Chinese citizens areregistered at their place o birth or access to education, health and other social services.

Around 70 per cent o Chinas population has rural hukou. People with rural hukou can migrateto urban areas, and it is estimated that there are around 145 million such migrants (Meng 2012).

What is not currently possible, in most circumstances, is or those migrants to take with them


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their rights to access social services. Generally, migrants do not have cover or health or workaccident insurance or pensions, nor can they access public education or their children in their

places o urban residence. Further, the urban job market is highly discriminatory. Migrants oany skill level are ar more likely than workers with urban hukou to be placed in low skilled, low

paid, jobs (Meng 2012).

There is a strong interaction between the hukou constraints and the rights to use agriculturalland. Rural land is communally owned and access rights are managed at the village level.

A migrant who is absent rom the village or too long, or at the wrong time, may risk losso access rights in a reallocation (De La Rupelle et al. 2008). Given the insecurity o urban

employment and lack o saety net or most migrants, maintaining access to land in the homevillage can be an essential insurance.

A direct impact o the hukou regulations and their interaction with the land tenure system is

that migrants stays in cities tend to be short. Chan (2010) argues that the hukou system hasacilitated cheap access to young labour (under 30s) by the export-oriented manuacturingindustry. However, short stays may mean that either worker skills are not developed or,

when they are, are not ully utilised. The system eectively deprives urban businessesaccess to a large group o older workersChan (2010) puts the number o unemployed or

underemployed rural workers aged 35 plus at 100 million.

O particular importance over the next two decades will be the dierence in age structurebetween those parts o the population with rural hukou and those with urban hukou. Meng

(2012) observes that greater ertility in the rural population since the mid-1980s, and the actthat 70 per cent o Chinas population have rural hukou, means that the vast majority o new

entrants to the workorce will be rural. Consequently, ailure to resolve the hukou issues willseverely restrict the size and availability o Chinas workorce.

Reorm o the hukou system would have cost implications both or subnational governments

and or enterprises employing migrant workers. In most cases, urban employers o migrants donot contribute to their pensions, health or other insurance. Huang and Wang (2010) estimate

that to cover those services at the level provided or employees o urban hukou would add a3040 per cent loading to current migrant wage costs.

The choice to recognise migrants as permanent residents, or not, is made at a township,

city, or provincial, government level. Assigning urban hukou to migrants would add to costsborne by those governments or education, housing and medical services and possibly add

to some general inrastructure costs. Where governments do oer urban hukou to migrants,access is oten rationed on the basis o some mix o actors such as: length o residence;

educational qualiication, and social security contributions. Many migrants will not meet thequaliicationsor example, when Guangdong Province adopted a points system or urban

hukou in 2010, 20 million migrants then working in the province, but with rural hukou romother provinces, were excluded (Tam 2010).


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Both the World Bank (2012) and OECD (2013) point out that eective provision o social servicesis possible i there is reorm o subnational government unding arrangements. The potential

size o the migrant population, and thus the costs o additional services, would add pressureor reorm i meaningul changes were to be made to the hukou rules.

Addressing environmental issues

One o the consequences o Chinas pursuit o economic growth has been a widespreaddeterioration in the condition o natural resources, including land, water and air quality. In

eect, over much o the reorm period, natural resources such as clean air and the wasteassimilation capacity o waterways have been priced at, or close to, zero and, consequently,

overused. That overuse has downstream eects including higher costs or industries usingpolluted water and health costs rom urban air pollution. The need to address this issue is

recognised in Chinas 12th Five-Year Plan (FYP), which contains extensive targets or improvingenvironmental perormance.

The World Bank (2012) suggests a program o green development or the uture. The Bank

couches its policy in terms o improving the quality o economic growth. Nevertheless, a keypart o the policy recommendation is aimed at reaping gains rom improved technology or

cleaner industry and products. There are possibilities or improvements in measured nationalincome rom some orms o pollution reduction. For example, in the case where an upstream

industry cuts water pollution, the savings to downstream users who now have access tocleaner water may exceed the cost o mitigation.

There may be potential income gains rom developing cleaner technology. However, moving

to a cleaner industry and environment will generally involve signiicant measured costs,oten with beneits which do not appear in ormal measures o national income. Many o

the beneits o better environmental conditions, such as clean air and water, either do notenter national account measures or do so only indirectly and with long lags. Some o the

costs o mitigation, however, are immediately evident1. Thus, while policies to address Chinasenvironmental issues may improve the quality o lie they may not contribute to measured

growth in GDP.

1 For example, in the case o a reduction in urban air pollution, the increased amenity value o clean air is not

measured, but improved health may be reected in higher uture income (less sick days) and lower uture medicalcosts.


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Moving on upThe point at which there is no cheap surplus labour in China is a matter o much debate. Amongother actors, the timing o that turning point will depend on the degree to which the labour

market is reormed. Lesser, or slower, reorm will mean that the point at which urban industryaces labour shortages will come sooner. Regardless o the precise timing, much o Chinas

economic growth has been driven by rapid productivity growth (Zhu 2012, Perkins and Rawski2008) and much o that productivity growth has been derived rom reallocation o resources,including abundant labour. With the abundance o labour alling, new sources o productivity

growth will need to be ound or the pace o economic growth to be maintained.

In the context o rising real wages and uture labour supply constraints, it is worth consideringthe path o development o some o the other middle income countries. The transition to high

income is diicult and the growth momentum o many countries has stalled. Those middleincome countries that have made the transition have done so by advancing rom dependence

on manuacturing exports based on relatively low technology inputs and cheap labour.Moving to the next stage requires some combination o two actors: (1) a more technologically

sophisticated industry sector and (2) greater domestic consumption. A more technologicallyadvanced industry is achievable only with a highly skilled workorce. Higher levels o

consumption are supported by: (1) a reasonably equal distribution o income; (2) the presence oa relatively large middle class, and (3) a low workorce dependency. China aces challenges on all

o these ronts.

Kharas (2010) calculates that Chinas middle class currently accounts or 12 per cent o thepopulation. That compares with 53 and 48 per cent or the Republic o Korea and Japan,

respectively, at the time that each reached a middle income level. Both the Republic o Koreaand Japan have since grown to high income levels. Conversely, Brazils middle class accounted

or only 29 per cent when it reached middle income level. It has so ar ailed to grow to a highincome level.

Zhang et al. (2012) observe that no country with a Gini coeicient2 greater than 0.40 at the time

it reached the middle income level has grown to a high income level. The National Bureau oStatistics estimated Chinas Gini coeicient was 0.48 in 2012, although other estimates are as

high as 0.61 (Yao and Wang 2013). These indings suggest that China aces a signiicant challengein its quest to overcome inequality. Further, the impending rise in the aged dependency rate as

the population ages will be another constraint on uture economic growth.

Other challenges exist or China in its transition to a high income level. Eichengreen et al.

(2013), or instance, ind a negative association between exceptionally high investment levelsand undervalued exchange rates in the progression to a high income level. Both o these are

currently eatures o Chinas economy. Similarly, poor enorcement o property rights overintellectual capital detracts rom incentives or endogenous development o technology

(Agnor et al. 2012).

2 The Gini coecient is a commonly used measure o inequality. Its value ranges between 0, which indicates completeequality, and 1, complete inequality. Calculation o the index requires accurate GDP and income data.


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Endogenous development o technology appears to be a necessary eature o progressionbeyond dependence on manuactures based on cheap labour and borrowed technology.

Agnor et al. (2012) suggest that Chinas investment in high-end communicationsinrastructure is consistent with development o an advanced and eicient economy. Further,

Chinas 12th FYP includes recognition o the importance o technology development, withtargets or signiicant increases in research expenditure and patents. Chu et al. (2011) indicate

that as the potential beneits to domestic innovators rom protection o intellectual propertyhave increased, Chinas government has tightened that protection. They demonstrate a

consistency between the evolution o Chinas intellectual property rights to date and anational welare maximising progression. Nevertheless, the World Bank (2012) argues that a

good deal more needs to be done to und, coordinate and make eective use o research.

An educated workforce

A key to advancing to greater technology use and a higher income economy is eective

education and training. Two aspects o education appear to inluence a countrys likelihood ogrowing to a high income level: (1) the breadth o access to education across the population

(Figure 9) and (2) the percentage o the population who graduate at upper secondary andtertiary levels (Figure 10).

Zhang et al. (2012) compare the case o the Republic o Korea and Japan, both o which had

universal access to education when they reached the middle income level, with Mexico, whereaccess to education was eectively restricted to a small high-income group. They note that

Mexico has not grown to a high income level. Eichengreen et al. (2013) also ind that increasingthe share o the population with secondary or tertiary training reduces the chance that a

countrys growth will stall and that high quality human capital is most important. They notethat, in education terms, China is slightly ahead o the modal value or countries that have

stagnated at a middle income level.


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Figure 9: Average years of education for the age group 2529, selected countries

2

4

6

8

10

12

14

16

Kore

a,Re

p.of

Japa

n

Unite

dSt

ates

Mala

ysia

Germ

any

Russi

anFe

derat

ion

Mex

ico

China

Sout

hAfri

ca

Thail

and

Braz

il

Turke

yInd

ia

years

2000

2010

Source: OCED 2013.

In terms o overall participation in education, China has made substantial advances, as isillustrated by Figure 10. Despite these major improvements China still aces a undamental

problem in achieving broad access to high quality education i its current economic structureand policy settings remain in place. The level o public unding, and the quality, o education

in China varies greatly between rural and urban areas, and also between regions. A signiicantpart o a childs education is oten provided by the parents. Given Chinas currently skewed

income distribution, there is a risk that a large proportion o children will have less thandesirable prospects o achieving a high level o education.

Zhang et al. (2012) estimate that up to 50 per cent o new entrants to Chinas workorce over

the next 20 years will come rom rural poor areas3. I the current education access and unding

arrangements were to remain in place, a large proportion o Chinas new workers would haveeducation and skills well below the level needed in an economy with rising skill requirements.In this context, Golley and Kong (2012) ind that, while 80 per cent o children in large city

school districts attend high school, only 30 per cent o those in rural areas do. At the next level

ofeducation, 54 per cent o urban children attend tier 1 or 2 colleges, but only 9 per cent romrural areas do so.

3 Estimates are that 20 per cent o new entrants will come rom the 500+ counties ocially defned as poor or that 50per cent o new entrants will come rom rural counties in western China.


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in revenue base are even more skewed, with total per capita tax revenue or the lowesttax province (Tibet) only 6.3 per cent o that or the highest tax province (Shanghai). Those

problems will increase with responsibility or greater service delivery.

The reliance o subnational governments on land taxes, especially land development taxes,is an additional distortion (Figure 11). The World Bank (2012) argues that dependence on land

development taxes has also led to an ineicient pattern o urbanisation. The Bank suggeststhat moving to a land value tax would lead to some improvements in eiciency and security

o unding, but would entail a signiicant adjustment period. Further, the Bank argues thatuncertainty about land titles discourages eicient decisions in both agriculture and urban

development.

Figure 11: Gross revenue from sale of land-use rights as percentage of GDP and of nationaltax and social security revenues

5

10

15

20

25

30

2

4

6

8

10

12

1999 2001 2003 2005 2007 2009 2011

%%

GDP (LHS)

government revenue

(RHS)

Source: OECD 2013.


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Emerging debt pressures in the Chinese economy

While the Chinese economy responded better to the global inancial crisis (GFC) than most other

countries, there have been some growing imbalances that present a risk to Chinas growth prospects. Inparticular, there are concerns that Chinas rising debt may result in overinvestment in inrastructure or a

inancial crunch that might require the government to bailout the banking sector.

Chinas debt has surged since the GFC and large sums o money have been allocated to investments that

are unlikely to generate suicient returns to cover the loans used to und them (Chancellor and Monnelly

2013). Some analysts are worried that China may ollow the path o other nations that experienced

economic downturns ollowing a large build-up o credit. Fitch Ratings have estimated that Chinas

non-inancial debt to GDP was more than 190 per cent in 2012, around 60 percentage points higher than

in 2007. This is larger than the credit booms witnessed in Japan in the late 1980s and the United States

prior to the GFC (Chancellor and Monnelly 2013).

A large proportion o Chinas debt came rom government stimulus, which helped maintain economic

growth over the course o the crisis through inrastructure spending. This stimulus quickly ed-through

to the property market, supported by incomplete inancial market reormlow and sometimes negative

real deposit rates, volatility in the equity market, exp ectations o an appreciation o the Renminbi and

capital controlswhich encouraged savings to be directed to property (Wang and Sun 2013). This

resulted in elevated property prices and increased investment in new housing. Some believe that

there has been overinvestment in Chinas housing market. For example, there have been reports o

underpopulated cities with over resourced inrastructure, such as Ordos in Inner Mongolia province,

Chenggong in Yunnan province and Zhengdong in Henan province, where large volumes o new

residential units remain unoccupied as investors struggle to ind tenants that can aord the rent.

Further contributing to the increased debt has been shadow banking which includes non-bank

institutional lending, such as trusts and bank credit that is kept o o icial balance sheets, such as loans

to local government inrastructure projects, policy bank debt and borrowings by asset management

companies (Chancellor and Monnelly 2013). Many believe that this sector is poorly regulated and not

transparent and is a growing risk to inancial stability. Standard and Poors Ratings have estimated that

outstanding debt in the shadow banking sector was around US$3.7 trillion, or around 44 per cent o GDP,

at the end o 2012 (Standard and Poors 2013).

Although high levels o debt are not necessarily a problem, concerns have been raised about the rate

o growth o net debt and credit arrangements that increase the possibility o bad debts. Real estate

collateral and inputs to housing constructionincluding commodities such as steelunderwritesmost o Chinas outstanding debt. Given the weakness in proper ty markets and commodity prices,

there is increased potential or deault. For example, land is commonly used as collateral by property

developers and local governments, the latter through local government unding vehicles (LGFVs). Local

governments rely heavily on land sales as a source o revenue. I there were to be a sharp decline in

land sales and/or land and property prices, the eect would quickly spread to the inancial sector as the

ability o LGFVs and property developers to repay outstanding loans would be diminished (Chancellor

and Monnelly 2013). Analysts at Nomura estimate that local governments hold about 14 per cent and

property developers some 6 per cent o outstanding bank loans (Silk 2013).

A number o Chinas largest banks are state-owned. Thus, i they come under pressure rom bad debts,

the government will likely need to bailout the banking sector. To reduce building inancial pressures, theChinese government is trying to ensure banks and other lending institutions reduce credit.


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A broad economic outlook for growth in China

World Bank view to 2030

The 2030 outlook provides a comprehensive analysis o the prospects and challenges or

the Chinese economy, pinpointing what is required to maintain its growth trajectory. Theunderlying message is that China has the potential to sustain economic growth with little

global, environmental and social disturbance over the period to 2030, but only i undamentalpolicy and institutional reorms are implemented.

Assuming the required policy changes occur, GDP growth is projected to decline gradually

rom an average annual rate o 8.5 per cent during 2011 to 2015, to around 5 per cent a yearbetween 2026 and 2030 (Table 3). Over this time, Chinas economy is expected to become

more complex, market-driven, knowledge-centred and services-oriented. Further, Chinais expected to become even more integrated into the global economy as it increases its

participation in world trade and inancial markets. Its own inancial market is also expectedto mature, establishing the oundation or the acceptance o the Renminbi as an international

reserve currency.

Although there are considerable opportunities or continued economic expansion, there aremany emerging challenges that will likely slow economic growth. The extent to which these

actors have a major eect on Chinas economic progress will depend on the policy changesmade over the coming years. The major challenge will be to support growth while avoiding

sudden slowing o growth or major crises. Some required reorms will be easy to implementover the short to medium term while others will require undamental, structural change.

Table 3: World Bank projected growth assuming steady reforms and no major shock

19952010 20112015 201620 202125 202630

GDP growth (% per year) 9.9 8.6 7.0 5.9 5.0

Labour growth 0.9 0.3 0.2 0.2 0.4

Labour productivity growth 8.9 8.3 7.1 6.2 5.5

Structure o the economy (end o period %)

Investment/GDP ratio 46.4 42.0 38.0 36.0 34.0

Consumption/GDP ratio 48.6 56.0 60.0 63.0 66.0

Industry/GDP ratio 46.9 43.8 41.0 38.0 34.6

Services/GDP ratio 43.0 47.6 51.6 56.1 61.1

Share o employment in agriculture 38.1 30.0 23.7 18.2 12.5

Share o employment in service 34.1 42.0 47.6 52.9 59.0

Source: World Bank 2012.


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The World Bank has outlined six strategic priorities that need to be addressed i China is toachieve its goal o becoming a modern, harmonious and creative society by 2030. These

include:

Changing the role o the government and private sector, such as the reorm andreorganisation o SOEs, developing the private sector, promoting competition andcontinued reorm o actor markets;

Encouraging innovation through an open system linked to global research and development

(R&D) networks that provides an enabling environment (through iscal, inancial andregulatory measures) to oster innovation eorts rather than targeted attempts at

developing speciic technologies;

Encouraging green growth that takes advantage o the opportunities provided byenvironmental pressures by tapping into global markets and green technologies;

Promotion o equality and social protection or allthrough reorms that expand opportunities

and social security or everyone such as equal access to employment, inance, andeducation;

Building a sustainable inancial system that is resilient to macroeconomic shocks,

accommodating o changing public expenditure demands and is transparent andresponsive to policy change; and

Developing mutually beneicial relationships with the rest o the world through continuedintegration into the world economy and participation in multilateral institutions andrameworks.

Some o these policy directions have been included in the 12th FYP, which ocuses on

achieving higher quality, inclusive growth. Key targets in Chinas 12th FYP are outlined in Table4. The 12th FYP aims to transorm the economic development model towards the expansion odomestic consumption. There is also high priority given to improving the wellbeing o Chinese

citizens, developing high-end manuacturing and improving environmental perormance.

Achieving the 2030 view

The World Bank presents its 2030 economic growth orecasts as assuming steady reormsand no major shock. Implicitly, then, achievement o those growth rates is dependent on the

proposed package o policy changes being realised. Many elements o the package can beviewed as long term propositions either in the sense that they will take time to implement or

that beneits will low regardless o the timing o change. For some other reorms, the timingand sequence o policy changes may be critical, particularly in terms o labour markets.

The aster China transitions to policies that provide greater equality o access to education,

the higher is the potential or continued strong economic growth. Nevertheless, the ullbeneits o improved education access will not be realised or decades. A child beginning

primary school under a new education regime in 2014, or example, will not be expected tograduate rom senior high school until 2025. While it is possible or policy changes to inluence

the attendance and perormance o children already at school, the evolution o policy andchanges in the education system will take time. Further, successul reorms o the labour

market and education unding will only be possible with signiicant changes to the allocationo responsibilities and inances or subnational governments.


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Table 4: Selected key targets in Chinas 12th FYP

Category Target (by 2015)

Economic

Average GDP growth 7%

Service sector (as % o GDP) 47%

Urbanisation 51.50%

R&D (as % o GDP) 2.20%

Patents per 10 000 people 3.3

Population

Rate o nine-year compulsory educational attainment 93%

Rate o high school enrolment 87%

New urban jobs created 45 million

Urban per capita disposable income >26 810 RMB

Rural per capita disposable income >8 310 RMB

Urban population with basic retirement insurance 357 million

Resources and Environment

Reduction in energy intensity per unit o GDP 16%

Reduction in carbon emissions per unit o GDP 17%

Non-ossil uel as a % o primary energy consumption 11.40%

Source: Casey and Koleski 2011.

Finally, a more eicient banking and inancial sector could underpin investment and

productivity improvements across other sectors. As well, a move to market-based interest rateswould most likely expand household income and, thus, consumption. For both these changes,

speedy reorm is required.

Few, i any, o the changes necessary to ensure continued rapid growth will be easy to make. Inparticular, changing the competitive environment o the banking and inance sector and SOEs

more widely will undermine key interests. Nevertheless, all the changes suggested above arepromised in some way or another in the 12th FYP.


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Economic measurement in China

The compilation o economic indicators is di icult. This is especially true or China, because o the size o

the economy and the speed with which it is changing. Given the limited resources devoted to nationalaccounts in China, there is the potential or large margins o error in oicial estimates compared with

many other countries (Xu and Ye 2000).

There is strong interest in developments in China because o its importance to the global economy and

commodity markets. Concerns have been raised about the accuracy and reliability o Chinese economic

indicators given they are used extensively or analysis and decision making.

Statistical reorm has been a priority o the Chinese government over the past 30 years, and much has

been achieved. International cooperation and the uptake o harmonised methods will expand the

capabilities o Chinese statisticians and improve the reliability o economic data over time. Increased

availability o alternative data sources, such as the HSBC purchasing managers index, will also providemore inormation on changes in the Chinese economy (Koch-Weser 2013).

Implications for Australias export industriesThe e ect o Chinas economic expansion on the Australian economy to date is welldocumented. The rapid increase in demand or energy and mineral resources since the

mid-2000s prompted a period o structural adjustment to the strong terms o trade; exchangerate appreciation; increased resource investment; reallocation o productive actors and strong

employment growth in the resources sector (Graton and Liu 2012). The relatively smoothadjustment to the resources boom over the past ew years bodes well or the ability o the

Australian economy to react to uture changes (Plumb et al 2012).

The structural change driven by the resources boom is most evident in investment andexports. Chinas resource-intensive growth contributed to historically high commodity prices,

which supported the expansion o Australias resource output. Given the capital-intensivenature o resource production, the growth in productive capacity has resulted in a large-

scale increase in resource-related investment. New mining-related capital investment as aproportion o total new capital investment has reached new highs, accounting or 52 per cent

in 201112 compared with 21 per cent a decade ago (ABS 2012a, Figure 12). Over the same

period, Chinas investment in the Australian economy, particularly in the resources sector,increased dramatically although it still remains a relatively small overall investor in Australia(ABS 2012b).


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Figure 12: Australian mining investment expenditure by private enterprises

15

30

45

60

75

20

40

60

80

100

198788 199091 199394 199697 199900 200203 200506 200809 201112

%201112

$b

new mining investment

share of total investment

Source: ABS 2012a.

There has also been a clear transition in the composition and direction o Australias trade,

with the resources and energy sectors increasing the share o export earnings to 60 per centin 201112 rom 49 per cent a decade earlier (ABS 2012c, Figure 13). China is now Australias

largest merchandise trading partner and resources trade has been reoriented to China. Chinaaccounted or 29 per cent o Australias total exports in 201112. The main exports were iron

ore, coal, gold and crude oil. Australia sources 18 per cent o its total imports rom China,mainly purchasing electronics and clothing. Australia is less important as a trading partner to

China, accounting or only 4.7 per cent o their total imports (ranked ith) and 1.8 per cent ooutbound trade (ranked eleventh) (DFAT 2012).

Figure 13: Resources and energy share of total export earnings, Australia

10

20

30

40

50

60

70

197576 198182 198788 199394 199900 200506 201112

%

Source: ABS 2012c.


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The resource intensity o Chinas uture growth, particularly given plans to move to aconsumption-led economic growth model, is uncertain. However, there are a number o

actors that will support strong demand or commodities over the short to medium term.While the pace o growth may begin to decline, the scale o Chinas growing demand still

represents large volumes in absolute terms.

Chinas urbanisation and rising household income have increased investment in new, higherquality housing. Residential construction has been a key contributor to strong demand growth

over the past decade, particularly or steel, and is expected to remain important over themedium term (Figure 14). Construction activity is expected to wane over the longer term

as the rate o urbanisation slows and the building stock improves, requiring ewer rebuilds.Inrastructure development, such as rail and electricity networks, will also contribute to

commodity demand over the short to medium term. Further, the central and western regionsare still largely undeveloped in terms o inrastructure and are targeted or expansion by the

government.

Rising income has increased the demand or consumer durables, which are resource intensive

in both production and use. The extent to which China demands materials or the productiono these goods depends on the structure o its manuacturing sector. As China loses its

competitive advantage in cheap labour, low-technology manuacturing based on scaleeconomies will likely be shited oshore, thereby changing the resource intensity and demand

composition o its manuacturing sector.

Between 2014 and 2018, Chinas steel consumption is projected to grow at an average rate o 3per cent a year to total 822 million tonnes in 2018. China is expected to remain the main driver

o consumption growth in base metals over the short to medium term. Chinas aluminiumconsumption is projected to increase at an average annual rate o 8 per cent between 2013

and 2018, zinc by 8 per cent, copper by 7 per cent, and nickel by 3 per cent (BREE 2013).

Figure 14: Projected increase in built area from 2010 to 2020

40

80

120

160

200

City districts,

2010

Other urban,

2010

Needed for

increased urban

population

Needed for more

living space

billionunits

maximum allowable built area

Source: OCED 2013.


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The composition o Chinas energy consumption is expected to change considerably overthe course o the next two decades, with the government ocusing on energy conservation

and the utilisation o clean energy sources. The 12th Five Year Plan on Energy Development,released in January 2013, outlines the major targets or energy development. Energy

conservation is a major component o the plan with Chinas energy consumption to be cappedat 4 billion tonnes o coal equivalent and power use at 6.15 trillion kilowatt hours in 2015.

Energy use per unit o GDP in 2015 is targeted to be reduced by 16 per cent compared with2010; a broader energy eiciency improvement o 38 per cent has also been announced. In

terms o energy security, the government plans to keep oil imports to no more than 61 percent o total demand.

Greater utilisation o non-ossil energy is also expected over the period, with the share o

non-ossil energy in primary energy consumption targeted to increase to 11.4 per cent. Naturalgas is expected to account or 7.5 per cent o primary energy consumption by 2015. In order to

achieve this goal, China will look to ast-track the development o its coal seam gas and shalegas resources over the next ew years. The installed generating capacity o nuclear power isexpected to reach 40 gigawatts electric by 2015.

Further reinorcing the clean energy targets in the energy development plan, China has

announced its intentions to introduce a carbon tax. The government is also assessing thepossibility o taxing energy-intensive products such as batteries. In 2010, the Ministry o

Finance suggested implementing a price starting at 10 Yuan a tonne o carbon dioxideequivalent (around US$1.60) in 2012, increasing to 50 Yuan (around US$8) by 2020. Regional

pilot programs are being developed and implemented. These are expected to transition to anational scheme in the uture.

China is the worlds largest consumer o coal and it is the dominant source o energy,

accounting or around 66 per cent o primary energy use in 2010. According to the IEAsmost recent medium term orecast (IEA 2012b), its coal consumption is projected to grow by

25 per cent over the period to 2017. This will be largely driven by the power sector, whereconsumption is expected to expand by one-third. Non-power demand (steel, coke, chemicals,

cement and household use) is expected to ease over the same period as more modernenergy sources are increasingly utilised and cement production slows (Cronshaw 2013). Given

the eorts to reduce reliance on ossil uels, Chinas total coal demand can be expected tomoderate over the longer term.

Chinas energy consumption will be aected by developments in the transportation and

industry sectors. For example, its energy proile is likely to be more oil-intensive i the transportsector develops to be more road-based than i it were based on mass public transportation

systems like rail.

According to the IEAs World Energy Outlook, Chinas share o coal in the primary energy mixunder the new policies scenario is projected to decline rom 66 per cent in 2010 to 51 per

cent in 2035 (Figure 15), representing the slowest growth among the ossil uels. The strongestgrowth is expected to occur in the nuclear sector, albeit rom a small base. The share o nuclearin primary energy consumption is projected to increase rom 1 per cent in 2010 to 7 per cent in

2035. Gas use is projected to increase at an average rate o 7 per cent over the same period, toaccount or 12 per cent o total primary consumption in 2035 (IEA 2012c).


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Figure 15: Chinas primary energy consumption mix

10

20

30

40

50

60

70

Coal Oil Gas Nuclear Hydro Bioenergy Other

Renewables

%

2010

2035

Source: IEA 2012c.

Australias role in meeting Chinas resource demand will depend on (1) the volume andcomposition o Chinas demand, (2) Chinas ability to meet its own demand and (3) the ability

o other countries to meet this demand.

China has vast reserves o minerals, but they can sometimes be insuicient to meet domesticrequirements or, like the case o coal, be located ar rom regions where they are required.

China aims to be as sel-suicient as possible in the production o resources, and someindustries have been investing in overseas assets, including Australia, to ensure supply security.

Australian producers are not, typically, marginal producers, so will continue to supplycommodities to the Chinese market despite an expected decline in commodity prices (Findlay

2011, BREE 2013). However, there will be increasing competition rom abroad to provideresources to China. For example, the United States has the potential to rapidly expand liqueied

natural gas (LNG) export capabilities based on its vast resources o shale gas. Australias abilityto compete will continue to rely on the provision o a stable investment environment, control

o capital and operating costs and improvements in productivity. The mining equipment,technology and services sector will play a key role in addressing these challenges, ensuring

that Australian companies remain low-cost, eicient producers that capture a large proportiono global mining investment (Scott-Kemmis 2013).


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Deal to trade Australian Dollar and Chinese Yuan

In April 2013, Australian-based banks Westpac and ANZ were granted the right to directly trade

Australian dollars or Chinese Yuan in mainland Chinai.e. granted market maker status. The dealhighlights the growing relationship between Australia and China, particularly trade ties that have

increased the demand to directly convert the currencies. The Australian dollar is only the third major

currency granted this right, ater the US dollar and Japanese Yen.

While China introduced a Yuan-Australian dollar exchange rate in November 2011, trading has been

conducted indirectly through the US dollar because o an absence o market makers. It is expected that

the deal will make it easier, and cost less, to conduct business between the two countries as the need to

convert to US dollars will be bypassed. The irst trades occurred shortly a ter the deal was made.

The Chinese government is encouraging companies to invoice in Yuan rather than US dollars. However,

according to The Executive Director o the Australian Financial Centre Task Force Geo Weir, the shit toYuan invoicing has been slow, particularly in the commodities sector where products are priced in US

dollars. He believes that Australian companies have little incentive to accept payments in Yuan because

they have limited exposure to liabilities denominated in Yuan (Winestock 2013).

The beneits accruing to Australia rom Chinas development over the medium to longer

term are not guaranteed and will depend on Chinas economic structure and progress aswell as Australias ability to make the most o market opportunities. Despite strong economic

growth in China since the 1980s, Australia has only realised beneits rom that growth sincethe mid-2000s as commodity prices increased. There are varying views on whether Chinas

economic growth can be sustained, and the resource intensity o that growth. However, aseconomic growth and urbanisation slows, it is likely that the growth in demand or the current

set o products Australia has a competitive advantage in supplying, such as iron ore and coal,will decline and the absolute demand or commodities may even peak and possibly decline bythe 2030s.

I Australia is to continue to beneit rom Chinas economic expansion, it will need to seek

new opportunities and develop the required capabilities, skills and experience today. Theseopportunities include developing a sound understanding o Chinas culture, business practices,

institutions and regulations; ongoing reorms to ensure open market access and broadening

Australias social and economic relationship with China. Some sectors that have the potentialto beneit rom opportunities in China outside the resources and energy sectors include:

Agriculture: As Chinas population and incomes grow, more and di erent ood productswill be consumed. China does not have the capacity to be ood sel-suicient, so will rely

on imports to meet demand. Australia has a strong reputation in producing high-quality,sae grains or human consumption and meat products and would be well-placed to

meet these needs. There are also opportunities in R&D and agribusiness that would allowChinese producers to improve yields and manage water use and environmental impacts.

Mining and energy technology and services:With planned expansions to Chinas

resources and energy output, along with the need or increasingly sophisticated extractionand processing techniques, there is the potential or increased collaboration and exportso mining and energy technology and services.


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Niche manufacturing: While some manuacturing industries will struggle to remaincompetitive, others will be able to capitalise on new market prospects or parts o the

supply chain where Australia has an advantage. For example, ther

BREE China Review (June 2013)

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