Elliott Parker: How China stays on fiscal fast track

With a fifth of the world's entire population and an annual growth rate in real per-capita Gross Domestic Product averaging more than 9 percent for the last decade, China has become the world's second-largest economy. Even if you discount the accuracy of the statistics, it still is clear to anybody who has studied about and traveled to China - as I have during the last 25 years - that this is one of the greatest economic transformations in history.

Of course, it is easier to grow fast when you are starting from a small base, and China was starting from almost nothing. Add a dime to a dollar and you have faster growth than if you add a quarter to a $10. There also is a catch-up effect, since it is easier to learn from more-advanced economies than it is for those advanced economies to keep advancing.

There are other reasons. Unlike Americans, the Chinese have been saving and investing a big share of their GDP, putting it into public infrastructure and education as well as into housing and private factories. Even if some parts of that investment are not spent well, China's capacity to produce keeps growing.

Chinese culture also values education and hard work, especially in the southern rice-based economy. Given appropriate opportunities - as we have seen before in places like Hong Kong, Singapore, and the United States - Chinese have often prospered.

However, much of China's growth can be explained by a simple shifting of workers from low-productivity to high-productivity pursuits, in an internal migration of incredible size.

China has more than four times our population but still only 40 percent of our GDP, so its average per-capita income is about one-tenth that of the U.S. But these averages disguise a lot. For example, most Americans earn significantly less than average because our many millionaires and billionaires skew the distribution. Similarly, China now has large coastal cities with almost First World living standards, but also a huge rural population living in Third World conditions.

The majority of Chinese still live in rural areas, and most of those are farmers. China has much less arable land than we have here, so it works out to a tiny amount of land per person. No matter how hard they work, there is a very low limit to the incomes these farmers can generate. Similarly, many workers in the cities once spent their lives in poorly managed state-owned enterprises, producing goods nobody wanted.

The rapid expansion of small industry in the countryside and the dismantling of many state-owned firms, helped along by an export-oriented economy and direct investment from American firms, have been putting these workers to more productive use, and each worker moved results in a one-time increase in China's GDP. It will take at least another decade or two before this growth potential dries up.

To those who study China, there is something unsurprising about China's rapid growth. For more than a millennium, China was the world's most prosperous nation and the source of many of the world's great inventions. That China was able to feed its huge population was a feat in itself, but just as the Western economies began to take off a couple centuries ago, China was drowning in cheap labor, with too many mouths to feed and both its government and its culture so enamored with China's magnificent past that China was unable to create the conditions for its future.

Eventually the old imperial regime collapsed and decades of revolution and war followed, but it took the death of Chairman Mao and a new government that put economics over politics before China truly began to grow. It is most remarkable that this growth occurred in a state controlled by the Communist Party, but this party is no longer Marxist in any meaningful sense. A truly Marxist party would not admit capitalists to party membership, and would not view markets, foreign investment, and private ownership as somehow consistent with a socialist economy.

But China's party still is Leninist, both in its paternalistic self-identity as the "true" representative of the people and in its ruthless means of holding on to power. Beyond that, China's Communist Party sees economic growth as its main goal, and it has been quick to respond to any threat to growth. This can be seen, for example, in China's exchange rate policy and in its fiscal policy.

China's current exchange rate policy started in 1994, when China devalued its currency to the black market rate, in response to those who argued that it was overvalued. When a financial crisis occurred in Thailand, Korea, Indonesia and elsewhere in 1997, China learned a lesson about protecting its banks, keeping adequate foreign exchange reserves, and maintaining a stable exchange rate. China was seen as a stable place to invest, and foreign direct investment took off.

A decade later, the same exchange rate was now considered undervalued, but China's government was more concerned with the movement of labor to the export sector than with any criticisms from the West. So and it kept its currency cheap by holding on to our dollars instead of using those dollars to buy our goods.

Next week: How a slowdown in China's economic growth can hurt America's own economy.

• Elliott Parker is professor and chairman of the Economics Department at the University of Nevada, Reno.