China Switches to a Service Economy

For the first time ever, if China's official figures are to be believed, the country's services sector surpassed manufacturing as a driver of the economy. The fact seems to have escaped widespread attention in the confusion over why gross domestic product dived so dramatically, to 1.6 percent quarter-on-quarter without official warnings.

Driving up the services sector has been a goal of the Chinese government for more than a decade. Services include finance, real estate, retailing, transport, information technology, health and human resources and education among other things.

If the country's statistics are to be trusted, and they aren't, China has long been well behind the rest of the world's major economies although some economists believe services are under-represented because statistics are so difficult to measure. Nonetheless, even if the figures don't absolutely represent the true figure, the fact is that they do represent a trend. It's also certain that that more balanced economies feature a far higher services component than China's does. For instance, 79.6 percent of the US economy comprises services, Japan's service sector encompasses 72 percent, the Eurozone 72.5 percent.

As early as 2007, then-Premier Wen Jiabao said there were "structural problems in China's economy which cause unsteady, unbalanced, uncoordinated and unsustainable development." He defined "unsteady development" as overheated investment, excessive credit and liquidity, and merchandise trade and current account surpluses. "Unbalanced development" was described as economic disparities between rural and urban areas, regions of the country, and between economic and social development.

But while China's leaders have continued to reiterate such goals, most recently at the National People's Congress held in Beijing in March, to move away from the current fast-growth at any cost model towards a more balanced economy has been difficult. Energy-intensive and high-polluting industries, for instance, while driving up GDP at a feverish pace, have played a major role in wrecking the environment rely more on high technology, green energy, and services.

There are other problems. As many as 100,000 public protests take place in China every year, according to official figures, an indication that despite burgeoning urban incomes, many Chinese are not benefiting from economic reform. A 2005 United Nations report stated that the income gap between the urban and rural areas was among the highest in the world and warned that the gap threatened social stability.

Since former paramount leader Deng Xiaoping dramatically announced the shift to an export-led economy in the 1970s, the country has emphasized break-neck growth over other considerations, paying relatively less attention to the households and the wellbeing of its citizens. Incoming premier Li Keqiang is the latest to be entrusted with the job of rebalancing the economy, which he set out to do with a major speech to the NPC in which he described as a more equitable society and a smaller government, in which environmental protection would belatedly begin to play a role in a country devastated by pollution. Social welfare spending, he said, would rise.

The key to this, Li said, is urbanization – moving hundreds of millions of the rural poor into urban communities. Construction, revitalization of cities – and building entirely new ones – and long-term investment and consumption via a series of policies are designed to spread the benefits of the country's transformation, reducing the urban-rural income gap and the disparities between the prosperous coastal province and the poorer inland ones, a goal that largely eluded the country during the 10-year tenure of a President Hu Jintao and Premier Wen Jiabao despite strenuous efforts and widespread publicity.

The details of Monday morning's releases on first-quarter GDP and point to the growing possibility of evidence that Beijing's policy efforts to reorient the economy are working, however. The chart below is an illustration of the changing nature of the economy.

There are political and economic dangers in this policy, however. A service economy doesn't grow as fast as an export-led, manufacturing-based one does. Indeed, GDP growth decelerated sharply in the first quarter, with the quarter-on-quarter pace slowing to 1.6 percent from 2.0 percent – an annual growth rate of 6..4 percent, considerably below the median forecast for a pickup to 8.0 percent.

As services picked up, manufacturing led the decline, sliding further to 7.8 percent annually from 8.1 percent in 2012 at the same time the services sector posted its fourth consecutive gain, to 8.3 percent annual growth.

That is a description of the growing pains Beijing must endure to rebalance the economy, although it is greatly encouraging to see the services sector continuing to develop.

Analysts are still seeking the reasons for the major disappointment for industrial production growth, at just 8.9 percent annually, compared against a consensus forecast for a rebound to 10.1 percent. The slowdown was fairly consistent across both heavy and light industries, which fell to 9.1 percent and 8.2% year-on-year, respectively. The top two losers by sector were IT equipment makers and power producers, which confirmed the poor growth outlook from the computer manufacturer Lenovo. Adding further concern is a report that China's electricity usage eased to just 2.0% year-on-year in March. Electricity usage is considered a reliable bellwether for the full economy.