China slowdown may be overstated

October 23, 2012: 10:50 AM ET

China's growth may shift more than it will decline. In the years ahead, less developed parts of the country could pick up where development in bigger cities cool off.

china-constructionFORTUNE – As China's economy slows, many have wondered if record growth in the world's second-largest economy has approached the beginning of the end. During the latest quarter, China's gross domestic product rose 7.4%, still a healthy clip but also the seventh straight quarter of decline, the National Bureau of Statistics reported last week. Economists widely expected this, but there's reason to believe that the slowdown won't be permanent or at least not as severe as some think.

The topic is especially important today, given that the health of China's economy impacts growth in the U.S. and the rest of the world. We saw the relevance Monday night during the third and final Presidential debate. The all-out China bashing that most had expected never really materialized. Perhaps President Obama and Governor Romney got the memo that China's economic rise probably does more good than harm to America.

China's growth might have peaked in bigger cities, such as Shanghai and Beijing. However, there's plenty of room for development across the country's seemingly endless swaths of rural lands, according to two economists at the San Francisco Federal Reserve. In a report released last week, Israel Malkin and Mark Spiegel build an interesting case for why investors should be bullish on China.

MORE: Why China will open up further

History has shown that countries don't usually grow at rapid rates forever. At some point, typically when income per capita reaches about $17,000, growth on average starts to decline about 2% a year as higher wages gnaw at a country's ability to compete with other economies, studies show. Think of the U.S., which has lost countless manufacturing jobs to Asia, Latin America and other places where pay is a lot lower. As of 2011, income per capita in the U.S. was $48,442. While China lags far behind at $5,445, it will soon approach the $17,000 threshold at which economists say growth has peaked.

But China's growth story has already proven to be quite different. As Malkin and Spiegel point out, it has seen rapid growth for over 30 years – far exceeding other economies where record growth on average lasts for no more than 10 years.

What's more, development in China is deeply uneven. So in the years ahead, growth across less developed parts of the country could pick up where development in bigger cities cool off. Based on the way other Asian economies have expanded over the years, the researchers created a model for how this could play out: Whereas China's more developed provinces may slow to 5.5% by the close of the decade, growth in the country's less-developed provinces is expected to rise to 7.5% -- closer to the 8% rate that economists widely say is needed to maintain jobs growth and therefore social stability.

While all this could pan out, the researchers point out a caveat. Much of China's growth has been from manufacturing and other industries driven by exports. As a result, coastal provinces have generally developed much more quickly while the country's inland regions languish behind. For these areas to see faster growth, they'll need the kind of infrastructure and access to shipping and export markets that coastal provinces have enjoyed.

MORE: A tale of America's two economies

More importantly, though, China's future will rest largely on how well its government can ease income disparities by putting more money in the pockets of consumers and less on investment and exports. Officials have talked about rebalancing the economy for years. And while government efforts are under way to boost spending on everything from healthcare to education, the growing divide between rich and poor persists and has increasingly contributed to the pullback on growth.

China's richest 10% control 57 % of household income, says Li Gan, a professor at Texas A&M University. He expects the economy to slow down in all regions over the next decade. "Since rich households have already consumed at their desired levels while poor households are constrained by their income, no one should expect a fast-growing domestic consumption before drastic changes in income distribution occur."

Those changes could include measures such as granting migrant workers urban residency. The country's rigid system denies them access to healthcare and education benefits in the cities many have helped build and clean.

There's no dismissing China's potential for continued growth. The question is will the country's vast low and middle-income households drive it?

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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