China’s Service Economy

China’s rapid economic growth into an industrial production powerhouse is well-documented but recent developments suggest this trend could be reversing. Known as the world’s largest production/expenditure economy, China is slowly transitioning into an economy centered on consumption and service. Growth in China’s industrial sector has slowed from 7.3% to 6.0% over the past 3 years as services grew at a rate of 8.3% in 2016 compared to 7.8% the year before. In addition, consumer spending increased by 9.6% in 2016. This increase can largely be attributed to a 26.% rise in online retail sales which is quickly becoming a staple of the Chinese economy. The development of China as a consumer/service economy in recent years mirrors the slowing of overall economic growth. In 2016 China’s economy grew by 6.7% percent down slightly from 6.9% in 2015 and more significantly from 7.3% in 2014. What is the relationship between China’s service/consumer growth and the slowing of overall economic growth?

The Chinese government paints the increase in consumption and the service sector of the economy as a successful policy pivot. President Xi Jinping touts the growth of consumer spending as a result of his plan to double citizens income between 2010 and 2020. However, many independent analysts see the rise of consumption and the service sector as more reflective of a weakening industrial sector rather than a successful policy pivot to service sector growth. This is why many see the increase the proportion of service as a part of GDP, up to 64.7% last year, as merely compensating for a lagging Chinese industrial sector. Slowing markets and lack of fiscal support for new industrial projects, especially in construction, have contributed to the relative decrease in Chinese industrial power.

It remains to be seen whether this trend of slowing industrial growth in China will continue into the future. Despite growing at lower rates than the previous two years, Chinese manufacturing still grew throughout 2016 and even outperformed projections of slower growth. The same factors that allowed China to grow into a powerful production economy (massive population, low barriers of entry) could certainly continue to sustain China as an industrial power. However, the data suggests that consumption and services will continue to grow relative to production over the next few years and possibly even further into the future. How Chinese policymakers handle the transition to a service/consumption economy will be interesting to observe over the next few years.

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11 Responses to China’s Service Economy

  1. Charlie says:

    It is not surprising to see China making the transition from a manufacturing economy to a service economy; there is extensive literature on the tendency for economies to trend this way as they mature. Many Western nations, the US included, serve as case studies for this reality.

    It is interesting that some analysts see this shift, when accompanied with falling GDP growth, as a negative sign for China’s economic fortunes. To hear many economists tell it, there is no substantial downside to losing one’s manufacturing sector to lower-cost competitors as a result of globalization. Perhaps the reality of seeing falling growth rates accompanied by outsourcing from China to Southeast Asia, much as the US’s manufacturing base was once outsourced to China, has changed the tune of some free trade purists.

  2. Alden Schade says:

    I agree with the above post and would venture that this is representative of a broader cultural and societal shift as wealth continues to be generated within China. As more people reap the benefits of increased industry, their discretionary spending power increases as well. With less of their wages spent on essentials, the obvious conclusion is that Chinese people will spend more money on goods and services they desire, like cell phones and cars. Considering the rapid growth of its industrial output, it only makes sense that plenty of people within China would arise and fill the need for more consumer-oriented goods and services, leading to a greater focus on this sector relative to heavy industry.

  3. Ryan Curto says:

    I agree that this is not a surprising trend to witness. The same conversion from industrial based economy towards a more serviced oriented one is similar to the United States riding the wave of industrial success into our consumption and service based economy today. While China is reaping the benefits of its heavy industrial sector and discretionary spending becomes common place, it will be interesting to observe if China runs into similar financial troubles through this transition much like the United States did. As we witnessed through Hessler’s accounts of the Chinese attempting to institute infrastructures of the west, they didn’t always look back on the mistakes of our past in planning and executing their projects (i.e. the complicated and unintuitive highway system). It would also make sense for China’s industrial sector to slow eventually after such a long period of elevated and unsustainable growth. It could be that China’s industrial sector is approaching the carrying capacity for increased economies of scale.

  4. bonesc18 says:

    I think part of this certainly has to do with a growing Chinese middle class. While it’s hard to find exact data on this for specifics for just how much, there is no doubt that disposable income has exploded in Chinese society. This leaves citizens free to spend beyond the basic necessities of food and shelter. I think our visit to the Reeves center illustrates this as well. Chinese artifacts are being bought up by Chinese consumers in large quantities, really for the first time. These same wealthy and upper middle class households are likely to employ a maid, make additions to their homes, take cabs, etc. It’ll be interesting to see if this trend continues or levels off.

  5. gristt18 says:

    Ryan makes a good point when he notes that the Chinese have not always looked back on the mistakes that other developed nations made as they transitioned from industrialization. What is interesting in watching this trend is considering what will happen as China moves away from industrialization. As the production of many products like clothing and plastic moves south to Vietnam and other countries, what will China do with the infrastructure that is left behind? Massive buildings, technology (both physical and intellectual) and millions of people will remain in China as the industrial jobs move south. While many, as Sam noted, are moving to the consumer sector, what sorts of opportunities exist for those left behind. Or perhaps more importantly, what sort of opportunities will the Chinese create through innovation in the next decade or so?

  6. feldsteinp18 says:

    I think that this provides an interesting point and it shows the natural progression of a large economy. The United States went through a similar transition, from industrial to consumer based, albeit roughly a century ago. I think this proves that there comes a point to where an economy can mature to the point where it must shift and change. This is happening in China right now as it continues to pivot towards a consumer based economy. The emergence of online retailers such as Taobao and alibaba serve to prove this as well.

  7. sackettm18 says:

    I will add on to what others have mentioned: this is a natural progression of economic growth. Local, agriculture based society becomes industrialized with the release of economic control by the government. Eventually this industrialization will reach diminishing returns. The upside for the Chinese economy is the birth of a middle class, arguably the most important goal of economic expansion. The idea that the average Chinese citizen will be able to receive an education, find non-factory work, find a home, and truly make a life for themselves is part of the “dream.”

    It will be interesting to see how the Chinese people begin to view their government as they become more economically empowered. It could be argued that the next step will be a demand for more democratic reform as Chinese citizens begin to see themselves as agents of change.

  8. masonw17 says:

    I think you’re touching on a really important issue of development here, which is the pivot from export-based industrial growth to a more domestically driven consumer based economy. Just as in the US and Europe, Chinese leaders must successfully navigate both the economic and cultural issues which arise from rising wages and declining surplus labor. The most successful nations have used these forces to develop a robust domestic consumer market, even though doing so results in a much slower rate of growth. Furthermore, a domestic service driven economy has the potential to provide higher standards of living for Chinese workers and make the Chinese economy somewhat less dependent on high-externality production like the pleather factories mentioned in Hessler.

    • the prof says:

      Were exports ever the driver? The highest growth was in the early years, when exports were a trivial share of the economy. Exports are visible from the outside, but the power of economics should be in helping us know what to look for and not stop with what we see.

  9. kaminerm18 says:

    I think the numbers indicate that China is at a crossroads as it pertains to its trend toward becoming a service/consumer based economy. 2015 marked the first year that China’s economy was primarily composed of services at 50.5 percent of GDP, and 2016 saw much of the same due in part to the statistics on consumer spending and online retail sales that Sam mentioned. However, an analysis of the GDP composition of the world’s largest economies shows that there is a larger trend toward the service/consumer economy. Among large economies, the United Kingdom, the United States and France continue to pace the world with services accounting for 79, 78 and 78 percent of their GDP, respectively; Spain and Italy are not far behind at around 74 percent. As for the the question of how Chinese policymakers should respond to the shift in GDP composition, it might be wise to let the economy run its natural course, as that seems to have garnered fruit for other massive world economies.

  10. the prof says:

    Yes, as per all of you, the income elasticities of demand mean that services expand and goods shrink. In addition, boosting productivity is harder in services, so relative prices rise as incomes rise. In practice that amplifies the effect.

    One point that you all miss (no reason you wouldn’t miss it) is the wider “rebalancing” framework. If we look at Y = C + I + G + (X – M) is that the proximate driver of growth has been investment. Capital accumulation faces diminishing returns, as we’ve repeated noted, so “buying” growth by boosting investment is today a waste of resources. It also stresses the financial system. Now the last term (net trade) has shrunk to zero already. The government isn’t seeking to add to the bureaucracy, quite the opposite. So the only route forward is to “grow” consumption. And that means services.

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