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As of the year 2010, People’s Republic of China ranked the second largest world economy after the USA (Starr). For the last 30 years, it has been the fastest growing economy, having a highly consistent growth of approximately 10%. Today PRC is the world’s largest exporter as well the second largest world importer of goods Since China initiated new economic reforms in 1979, the country has become the fastest growing economies in the world with per capital GDP of $7,544 as of the year 2010 (rank 94th in the world)(Brainerd 5-8). Between the years 1979 to 2005, real GDP of China grew with an annual average rate 9.7% and 9.9% specifically in the year 2009. Between 2006 and today, china’s economy has been growing with an alarming rate of 10% annually. In the year 2010, China valued its GDP at $5.87 trillion, which surpassed second world largest economy, Japan, who’s GDP for the same year valued at $5.47 trillion (Brainerd 6). Many economist projects that China could the next world’s largest economy (in terms of Nominal GDP) by 2020
Trade has been the main driver of China’s thriving economy. The country records the highest trade surplus in the world, in 2005, China’s export rose by 28.4% to $762 billion while imports only grew by 28.4% to $762 billion. This gave the China a trade surplus of approximately a $102 billion. Trade boom experienced in China has mainly been facilitated by large inflows of direct foreign investments (FD1) into the country. Foreign firms investing in China contribute to over half of the country’s trade (Wang & Liu). China’s remarkable growth is facilitated by the liberalization of surplus labor in the economy which leads to a high saving rate. Today China is one of the major players in the world economy and very few countries in the world can match the pace of its sustained economic growth.
A major component that has greatly supported Chinas economy growth is the exports growth. The vision and planning for the economic development in China is very much different from other nations. (Mario) China mainly focuses on implementing long term development plans which include natural resources, rare earths, green energy and bicycles. On the issue concerning natural resources, China has greatly invested in Africa and Australia so that it can have the right to get access to minerals. This is a very wise decision since the natural resources in China are limited and they cannot sustain its future economic growth.
China has also done so much investment in the rare earths, that is, it has encouraged the growth of a deep pool of research projects and technical experts in the field. This has made china to have the most number of researchers and other experts in the ‘rare earth’ science.
China has also encouraged the need to use green energy so as to limit the harmful pollution from industrialization and urbanization which poses a very large threat to public health. The use of green energy involves the use of clean energy technologies and products like wind turbines. The use of bicycles as means of transportation in China has also boosted the growth of its economy. Since 1991, when the Chinese government made the manufacturing of electric bikes also known as “e-bikes” an official technology goal, the world bike production has outstripped the global car production by almost triple. (Jung).By now, there are 2,600 manufacturers of e-bikes in China.
Conceptualization of GDP (Gross Domestic Product)
Economic growth is a plan that aims at social and economic wellbeing of people. It is an increasing capability of the economy to satisfy the needs of a society. Economic growth is brought about by increase in productivity for a given amount of output and also population growth and it is measured as a percentage change in the Gross Domestic Product (GDP). (Douthwaite).It is a trend of market productivity and rise in GDP so as to lead to economic development. GDP can be defined as the market value of all goods and services produced within a country in a given period of time probably one year. It can also be defined as a measure that is used to compare the relative values of goods and services produced in different years. It includes all goods and services produced by citizens or non-citizens within that country (Mankiv 855). It should be noted that GDP includes the value of final goods, which are the goods purchased for final use by the consumer, rather than intermediate goods, which are the goods purchased for resale or for further processing.
GDP can be determined by product approach, the income approach and the expenditure approach. The most used is the product approach which sums the outputs of all the enterprise classes to bring up to a total. It should be noted that GDP does not express change in a country’s quality of life, real savings, standards of living, transactions in the black market, and intangible valuables like feeling secure and unpaid labor.
Product approach involves three stages in estimating GDP: Estimating the gross value of the domestic output in various economic activities, determining the cost of supplies and services that were used to produce the final goods and services, and getting the difference between the gross value of domestic output and the cost of production to get the remaining value of domestic output. This is also known as the Net Product Method.
Income approach determines the GDP by adding up all the incomes that firms pay. These incomes can come either from payments of factors of production, that is; land-rent, labor-wages, capital-interest and entrepreneurship-profits. Expenditure approach involves measuring the total expenditure of money used to buy things by customers. This method accounts for only the sold items.
Real GDP vs. Nominal GDP
Nominal GDP gives a GDP figure without accounting for inflation thus it gives a misleading figure since the GDP could appear higher that it is in actual sense. In case the GDP has risen up by 10% but inflation rate has increased by 5% that means that the real GDP has increased only by 5%. In terms of “nominal GDP”, Real GDP is the nominal GDP a given year expressed in the base-year level 2 price. On a yearly basis, Real GDP growth is both the abnormal and nominal GDP growth rate measurement adjusted or accounted for changes in price, inflation and then expressed in percentage (Mankiv.856).
Real GDP can be viewed as the “purchasing power” since it has been adjusted to inflation and changes in prices all over the year. Real GDP divided by the population in the country gives per capital Real GDP which reflects the individual’s purchasing power on their average income from the economy. GDP calculated at the prevailing or current prices in the market gives the Nominal GDP. Nominal GDP includes all changes in the market prices observed in the current year either due to inflation (rise in overall prices of goods and services), or deflation (fall in the overall prices of goods and services) (Zarazusthra).
To abstract changes in commodity prices and inflation, real GDP is used. It evaluates GDP using the market price of another base year. Looking at an example, if China took 1995 as the base year, its real GDP for 2000 will be calculated by first taking all the output (goods and services) produced or purchased in the country in 2000 and then multiply the value obtained with their 1995 prices.
Nominal GDP is used to measure the total value of goods and services produced in a country within a given year using the prevailing prices. Prevailing level of prices always change due to inflation (Zarazusthra). This will in turn raise the nominal GDP without even a change in the volume of output (goods and services) produced in the country. Real GDP on the other hand measures the total value of goods and services produced within two or more years (different years) through valuing output produced adjusted to the rate of inflation. Nominal GDP is calculated using current prices while real GDP is calculated using constant prices (Mankiv.856). If the price level and the “nominal GDP” doubled between 2000 and 2010, “real GDP” will not change. Most economist use real GDP to measure economy growth as they believe it gives a more accurate result or view of the economy. Prevailing inflation in the market is what creates the difference between nominal and real GDP.
Real GDP measures the value of output in different years, may be two or more by valuing the goods and services modified for inflation. It is calculated using constant market prices. It can also be calculated using the formula;
Assessing the graph of nominal GDP vs. real GDP growth of China from the year 1994 to date, we can see that the real GDP has not changed much over the years but the nominal GDP has had very big changes over the years. In the year 1994, the nominal GDP was at almost 40%. It then dropped to 5% by the year 1998. It remained at that level for two years where it then rose to approximately 13% by the year 2000. Since then the growth has been rising and falling up to the year 2009 where it dropped to 5% again. Due to good governance and good strategic plans on development and investment, the nominal GDP has been on the rise since the year 2009 to date because it is now at 22% and it will still keep on rising as predictions show. The real GDP growth has not exceeded 15% over the years since the value of output has not been increasing by the same margin. This graph also indicates similar observation from the previous graph. Nominal GDP has had a constant increase but Real GDP has been rising and falling between the years. Real GDP is lower than Nominal GDP which is ever accelerating indicating a rising rate of inflation as observed in the previous Graph (1978-2009).
Inflation and how it affects China’s Real GDP Growth
One of the main factors affecting real GDP growth in China is the high rate of inflation experienced in the country (Brainerd 5-7). Inflation refers to rapid increase in price of goods and services mostly as a result of rising demand for goods that does not match supply. The government of China faces a huge problem of inflation in its economic system. Inflation decreases the purchasing power of China’s currency (decreases value of money). Recently the Chinese government is applying tight fiscal and monetary policy to curb stagflation experienced in the country. Particularly, government intervention through monetary policy has had a huge impact on lowering the inflation rate. Chinese government has also used interest rates to achieve and maintain price stability.
Stagflation causes the economy to have a negative growth on aggregate supply side of the Chinese economy. It causes the purchasing power of money to decrease as the prices of goods and services increase rapidly but the wages remain the same. The graph below show Inflation in China and how it affects the Real GDP.
Assessing the diagram above, it explains vividly how China’s aggregate supply is pushed back (Negative effect) by the cost push effect of inflation. Inflation in China causes two negative effects on the economy at the same time. It decreases real GDP and decreases aggregate supply. Chinese government is faced with the challenge of controlling the real GDP fall and the rise in prices of good. To achieve the two at the same time, the government controls money supply in the economy using interest rates and monetary policies.
Money supply is controlled mainly using the reserve ratio (money held in banks for borrowers and companies), The Chinese government tightens the reserve ratio or increases the money the central bank is supposed to withhold and not lend to borrowers and companies. This in turn raises the cost of borrowing, and with only few investors borrowing the money supply or flow in the economy is decreased. The government maintains price stability by raising the interest rates (Eswar). With increased interest rates the Chinese government decreases the consumers spending which reduces the demand for goods and services; this in turn lowers the prices of goods and services. Lowering of prices lowers the rate of inflation and increase real GDP. With a low inflation rate, Real GDP growth can match Nominal GDP growth (Brainerd 7).
Source: national bureau of statistics
A few probabilities exist. There might be a big difference between the basket of things for the GDP deflator and that of the consumer in such a way that GDP basket prices are rising steadily and more rapid than consumer price. This is quite possible. Another explanation may be that consumer price inflation is worse than the CPI data presented. This may also occur. The two scenarios indeed may occur. Something worth noting also is that, as growth in nominal term accelerates; real term growth has been slowing remarkably. This is a consequence of rising inflation.
In conclusion, despite Peoples Republic of China achieving remarkable economic growth since the economic reforms were initiated in 1978, the country has not achieved a high Real GDP growth as projected due to high rate of inflation. Real GDP growth has not been constant like Nominal GDP which has been accelerating at a constant rate up to date. The government of China has been working tirelessly to cool down inflation pressure which has been pushing down the real GDP growth in most years when the Real GDP has fallen down. Chinese government has been applying monetary policy and interest rates to curb inflation; this has worked though it has not been completely efficient.
China is known to be a fast growing country home to the largest population in the world.. China’s performance or GDP growth is at times over emphasized as a result of the official intake and investment deflators that are applied when changing nominal GDP to real GDP are so slow that other alternative steps, like the consumer index or price indexes for the capital objectives. If this choice of indexes is most effective when estimating the price increases, they may as well be applied for use in deflating the nominal GDP so as to acquire a better measure of the real improvements in the living trend of the citizens of China. To achieve a higher Real GDP growth that will match the Nominal GDP growth, the Chinese government ought to start using fiscal policy together with the monetary policy it has been using to lower inflation and the price levels. This will in turn raise aggregate supply and the real GDP growth.