By Caijing chief economist Shen Minggao
From Caijing Online

After founding the People’s Republic, China spent the first 30 years building a planned economy and the next 30 years reforming it. What, then, will be the theme of the 30 years to come?

Thanks to decades of reform, China’s share of the world’s GDP grew to six percent in 2007, still less than a quarter of the U.S. economy. Various forecasts predict China will surpass the United States. Angus Maddison, a British economist, predicted this will happen in 2015 in Chinese Economic Performance in the Long Run, counting the GDP in purchasing power parity (PPP); PricewaterhouseCoopers allows an extra 10 years. But whomever you listen to, China is said to be on the way to becoming the biggest economy within 30 years.

China is the only country believed to challenge the United States for the leading role. Since the Second World War, the former Soviet Union, West Germany and Japan have each once been seen in this light. None of them, however, turned out to overtake the United States.

Could China shatter these predictions? In our opinion, the key lies in a modernized and strengthened manufacturing sector. And the starting point is proper consolidation of the industry.

Two forces, withering external demand and growing production costs, have already been pushing consolidation of China’s manufacturing sector.

Dependency on export seems too important for the Chinese manufacturing sector to break with. But the conventional gauge, the export-GDP ratio, might have exaggerated the extent of export dependence, because export figures are gross, while the GDP is incremental. A better measure would be export deliveries against overall sales by the industrial sector. In 2004, export deliveries peaked at 20 percent of total sales and dropped to 16.5 percent by November 2008.

Competition within the industry, as well as normalization of the input price, has been elevating production costs. According to the National Statistical Bureau, the number of manufacturers almost doubled between 1998 and 2006, making the marketplace much more crowded, although sales increased fivefold during the same period. As competition heats up in the margins, managers might also have to bid farewell to artificially depressed input prices in the wake of 2008 fuel pricing reform. Prices of land, commodities, interest and exchange rates may all rise, swelling production costs.

The current global financial crisis and economic recession has accelerated the process of consolidation. As a result, the industry will mature as weak companies are washed out and robust ones remain. The companies that survive will benefit from economy of scale and stronger pricing power.

China’s comparative advantages, in the meantime, will continue to energize growth of the manufacturing sector. Such advantages include, first of all, inexpensive labor. At present, China’s average labor cost is no more than 5 percent of that of the United States. In light of the experiences of South Korea and Taiwan, this ratio is expected to grow beyond 25 percent but not exceed 50 percent during the next 30 years.

Secondly, China has developed an extended industry chain, a major plus for Chinese exporters in competition with their foreign rivals. A recent survey indicated that only 40 percent of Chinese manufacturers outsource overseas, compared to Germany’s 47 percent and India’s 67 percent.

Finally, China’s enormous potential in the consumer market lays a solid foundation for long term growth of its manufacturing sector.

With its manufacturing accounting for only eight percent of the world’s output in 2005, China still has a long way to go before occupying the global center of manufacturing. The current slump may soon hit bottom as companies take the opportunity to consolidate and expand rapidly.

Chinese manufacturers are also beginning to shift their target markets from overseas to domestic consumers. As China’s GDP per capita approaches US$ 3,000, we are likely to see a boom in domestic consumption, creating huge demand shared by an emerging service sector and an empowered manufacturing sector.