In 2010 China became the world's second largest economy, exceeded only in gross domestic product (GDP) by the U.S. economy. Japan was a distant third, eclipsed by China in 2001 and every year thereafter. By any measure, China's success over the last three decades has been extraordinary. China's agricultural and industrial production both surpassed the dollar value of the U.S. output for 2010; yet some analysts see problems looming for the Chinese giant in the years ahead.

SEE: Investing In China

Disparity
As hard evidence of China's current economic power, as of December 2011, the nation held $1.1529 trillion in U.S. debt. Although China is America's biggest creditor, a recent trend indicated that China wasn't buying U.S. securities at its previous rate, and although the Chinese economy appears to be booming, and many a new millionaire has been created in recent years, per capita income remained below the world average.

This disparity in income and additional economic and structural issues facing the Chinese economy have been cited as potentially major problems for China in a new study by the World Bank.

China 2030
In the World Bank's report, titled "China 2030," the Chinese government is urged to transform their currently hybrid economy - much of it is still controlled by the state - to a complete market economy. The government was also urged to reign in the excessive power of state-owned industry to encourage private enterprise and to close the gap on the increasing inequality of income.

The nation's development pattern over the past 30 years or so, since China's transformation from communism to state capitalism with remnants of communist control, has been uneven. A major issue beyond economics, although related incidentally, is the degradation of China's environment. Unless this, among a slew of problems, are addressed and resolved, says the World Bank's report, China's growth is unsustainable.

The World Bank's report is especially timely, as China has recently come under new governance, and the report could have a major impact on government policies proposed and initiated by China's new leader.

Among the pressing economic challenges confronting China's new leadership is the struggling global economy, which could seriously impact China's flourishing export business. The economies of China's principal buyers of its goods - the U.S., Japan and Europe - are weak and facing increasing debt, which threaten to curtail import purchases.

These global issues translate into domestic issues for the Chinese economy. Major state-owned banks face increasing risk, as the economy gears down due to declining exports. Add to this the risk of inflation, the state's financial support of public works and industry, and ever-increasing global and local debt, and the economic picture turns grim.

Further exacerbating these problems is China's low consumer demand and high savings rate, its questionable ability to provide new jobs for people entering the work force, and its need to fight corruption and economic crimes.

Challenges also exist in China's real estate sector. A real estate boom, driven by debt, and once encouraged by the government to stimulate domestic consumption, now seems shaky.

One almost universal complaint against the Chinese economy is its currency manipulation. The Chinese global exchange rate - the value of the yuan against other national currencies - is set by the government and not by the foreign exchange market, and it's pegged against the greenback.

Currency plays a key role with trade between China and the United States. China deliberately undervalues its currency, making its exports to the U.S. cheaper, and U.S. imports more expensive. As a result, U.S. manufacturers post smaller profits, U.S. jobs are lost and the U.S. has an enormous trade deficit with China; the deficit was recently reported to be at $31.5 billion.

The Bottom Line
According to the Chinese government, a long-term plan is currently in place to combat these issues. The government has started to develop nuclear and alternative energy sources as a supplement to its oil and coal production. Plans are also in the works to increase domestic consumption in order to replace dependence on exports for growth. If the plan is implemented and the changes are made, the Chinese economy is expected to keep growing at about 8% annually for the next few years, and it will then slow to about 5%.



At this rate, by 2030, the Chinese economy would surpass that of the U.S., but without far-reaching government economic, financial and environmental reforms, potentially disastrous recessionary consequences may hit China, and could affect the entire global economy.

Related Articles
  1. Economics

    Is a Recession Coming?

    In the space of a week, the VIX Index, a measure of market volatility, spiked from 13, suggesting extreme complacency, to over 50, evidencing total panic.
  2. Active Trading Fundamentals

    The Top 5 Impact Investing Firms

    Learn what impact investing is and obtain information on some of the top impact investing firms ranked by total assets under management.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Hong Kong

    Learn about the iShares MSCI Hong Kong fund, which invests in various equities of companies listed on the Hong Kong Stock Exchange.
  4. Investing News

    September Starts With 8% Drop in Oil Prices

    Oil started September with a steep decline of more than 8% amid recent reports from China pertaining to their weak manufacturing data
  5. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  6. Investing News

    Mexican Energy, Telecom Reforms Please Foreign Investors

    Two years into his first term, Mexican President Enrique Peña Nieto is following through on radical campaign promises he made to Mexican citizens for sweeping multi-industry reform.
  7. Investing Basics

    Tuesday Intel: U.S. Stocks Continue Lower

    A summary of news that moved markets yesterday and what to expect today.
  8. Forex

    The Pros and Cons of a Fully Convertible Rupee

    Amid the rising economic power of India, the talks of making the Indian currency fully convertible are gaining momentum. We look at the pros and cons.
  9. Economics

    Four Emerging Markets Economies Poised for Growth

    Which emerging market economies will soon make the leap to a developed economy? Here are four to watch.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR Dow Jones International RelEst

    Learn how the SPDR Dow Jones International Real Estate exchange-traded fund (ETF) is managed and for whom the ETF is most appropriate.
RELATED TERMS
  1. Brazil, Russia, India And China ...

    An acronym for the economies of Brazil, Russia, India and China ...
  2. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced ...
  3. Optimal Currency Area

    The geographic area in which a single currency would create the ...
  4. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  5. Caribbean Community and Common ...

    The Caribbean Community and Common Market (CARICOM) is a common ...
  6. Caribbean Development Bank (CDB)

    The Caribbean Development Bank (CDB) is a multilateral financial ...
RELATED FAQS
  1. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
  2. Is Brazil a developed country?

    Brazil is not a developed country. Though it has the largest economy in South America or Central America, Brazil is still ... Read Full Answer >>
  3. Are Social Security payments included in the US GDP calculation?

    Social Security payments are not included in the U.S. definition of the gross domestic product (GDP). Transfer Payments For ... Read Full Answer >>
  4. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  5. Why should an investor include an allocation to the telecommunications sector in ...

    An investor should include an allocation to the telecommunications sector in his portfolio, because telecom offers an investor ... Read Full Answer >>
  6. What portion of the telecommunications sector will benefit most from continued growth ...

    The portion of the telecommunications sector that is projected to benefit most from the continued growth in the use of cellphones ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!