By  on March 21, 2006

WASHINGTON — China's economy has been growing by leaps and bounds, but faces serious structural and social issues that could stunt further expansion.

The country's prowess in manufacturing, including apparel and textiles production, helped spur 9.9 percent growth in its gross domestic product last year, but has also created huge environmental problems and a massive shift of people from the countryside to the cities.

The U.S. has a solid middle class, the rule of law and a stable democratic government, but China's 1.3 billion people live under an authoritarian regime that is struggling to control the country and create a more market-based economy.

"There are many governments in China and the central government's not necessarily in control," said Marshall Meyer, professor of management at the Wharton School of the University of Pennsylvania. "The central government depends on local governments for their revenue and can't really control them as effectively as they'd like. It's like Elizabethan England; you've got a crown and you've got a nobility, and nothing gets done unless they agree."

If China is going to continue to develop and become not only a manufacturing powerhouse, but a consuming one as well, much needs to be done and the government will have to guide the process.

Development has raised the living standards in eastern coastal cities, but the rural areas lag behind. The rich-poor, rural-urban divide no doubt contributed to the reportedly 87,000 instances of social unrest in the country last year. China has been on an economic growth spurt since the late Eighties, and it is unclear what impact slowdown in growth would have on the social dynamic.

China's leaders are well aware, however, of the volcano they sit atop.

"China remains the biggest developing country in the world that features a huge population, weak economic basis, uneven development and heavy environmental pressure, and its people's living standards are still not so high," said Chinese President Hu Jintao at a G20 Finance Ministers and Central Bank Governors meeting in Beijing last year. "Hence, modernization in China remains a long and uphill journey that will entail many years of hard work."

The country, which organizes its development efforts around five-year plans, has set out on a more balanced approach for the 2006 to 2010 period. The plan calls for a "scientific approach to development" and "constructing a harmonious socialist society" that pays closer attention to humanity, society and the environment.Attention will also be paid to further developing industry, but the focus will be on strength and not scale. Under the five-year plan, GDP is slated to grow 7.5 percent annually.

Finding a balance that addresses social and economic concerns, such as unemployment and workplace safety issues and environmental problems, will be difficult. Highlighting this, a quarterly update on the state of China from the World Bank last month noted the local growth targets remain lofty.

"To achieve these high growth rates, local spending is likely to continue to be directed at investment rather than at social services needed for a harmonious society and a more balanced economy," said the report.

How the government directs its investment and the degree to which it allows market forces to take over will greatly influence how the economy grows.

"They're making good progress toward a market economy," said Ira Kalish, Deloitte Research's global director of consumer business.

Still, he said a substantial amount of state ownership in some sectors has spurred inefficiencies.

"It has a negative impact in that companies that are state-owned, their principal motive is to stay in business and keep people employed," he said. "They wind up borrowing money from state-owned banks in order to cover their loses or even in order to undertake investments that don't necessarily make economic sense."

Such inefficient investment can stunt economic growth and might be fueled by the country's currency policies, which require China to create money to help keep the yuan stable. Kalish said this could lead to loans that aren't really necessary.

Critics, including the U.S. textile industry and lawmakers on Capitol Hill, claim the currency is undervalued by more than 30 percent, keeping Chinese exports unduly cheap while making it more expensive for foreign companies to sell in China.

Last year, China made what most economists contend was a small step in reforming its currency, when it changed the peg to a basket of foreign currencies from just the dollar.

"In the long run, it would be in China's interest to revalue the currency," said Kalish. "It would quell inflation, but more importantly, it would help in the process of shifting growth away from exports and more toward consuming."Right now, only a handful of large U.S. retailers are looking at China as a consumer market, but it is an area companies will grow increasingly interested in, said Erik Autor, vice president and international trade counsel at the National Retail Federation.

China, which agreed to open up its market more to outsiders when it joined the World Trade Organization in 2001, has made "pretty good strides" when it comes to retailing, said Autor.

"Compared to other countries at similar levels of development, China is pretty open," said Autor.

This process could be helped along by the ongoing Doha trade talks in the WTO, which could further open China not only to foreign retailers, but other necessary support businesses, such as in transportation.

"You can't really have true market access for goods unless you have the distribution network to sell them," said Autor.

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