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West get ready, here comes China 2.0

China's three decades of rapid growth have lifted hundreds of millions out of poverty. Now the country's leaders face a new challenge in extending that prosperity to inland areas.
A shopper walks past a familiar-looking display at a Wal-Mart store in Beijing. China's red-hot economy has raised the living standards of urban households. But hundreds of millions of rural workers earn about $2 a day.
A shopper walks past a familiar-looking display at a Wal-Mart store in Beijing. China's red-hot economy has raised the living standards of urban households. But hundreds of millions of rural workers earn about $2 a day.John Schoen /

On a sultry September morning, in a brightly lit, air-conditioned Wal-Mart at the New World Shopping Center in Beijing's Chaoyang district, the search is on for everyday low prices.

Shoppers stroll past bright red price signs adorned with large yellow numbers and the familiar six-point asterisk. The 1970s hit “Seasons in the Sun” wafts through speakers in the store.  On the wall beyond the checkout lines, the faces of 16 Wal-Mart employees, their photos arranged in an inverted pyramid, smile down at paying customers.

“The managers are at the bottom of the pyramid, supporting and maintaining a balance for the rest of the pyramid,” a caption explains. “They listen to the associates, guide, support and encourage and provide opportunities for every associate to be successful. They are the servant leaders of Wal-Mart.”

China's own economic pyramid has become taller and steeper, forcing the government's “servant leaders” to scramble to keep a promise to China's 1.3 billion people that their society will remain in balance. If that balance is compromised, the result could be a wave of social upheaval not seen since the Tiananmen pro-democracy protests of 1989.

Over the past 30 years, China’s red-hot economic growth has lifted hundreds of millions of people out of poverty, reshaped the global economy and given rise to a new power on the global stage. But that breakneck growth has also created an expanding wealth gap, major environmental problems, widespread corruption, a growing imperative to innovate and popular pressure for political reforms.

This country's “experiment” with capitalism can safely be deemed a success. China's economy, which lay in ruins in the late 1970s after the failed Cultural Revolution, has developed faster than any in history. China has emerged as a growing economic, political and military power.

But as this phase of China's economic development draws to an end, a new phase has begun. Call it China 2.0.

China’s Communist Party recently wrapped up four days of meetings to develop the country's next 5-year development plan, set to begin next year. In a communiqué, the central committee pledged "major breakthroughs in economic restructuring" to "maintain stable and relatively fast economic growth,” according Xinhua, the state-run news agency.

But even China’s leaders worry about growing too fast. Premier Wen Jiabao said in March the expansion is "unbalanced, uncoordinated and unsustainable." To address that, the next five-year plan incorporates reforms already under way and charts a roadmap designed to keep the economy from veering off the track.

China 2.0
It’s a monumentally ambitious plan that will require huge new investments and innovative policies to remake the Chinese economy again. The goal is to keep the economy growing, spread wealth from the industrial coastal cities to inland provinces and rural areas, encourage more domestic spending, spur innovation and deliver expanded social services to sparsely populated areas that lack them.

In many ways, the transformation of China’s economy over the next 30 years presents even greater challenges than the first phase of former leader Deng Xiaoping’s “opening up” policy begun in 1978. To maintain social order and preserve their political power, Chinese leaders need to maintain economic growth at or near double-digits. That is one reason why Chinese leaders are fighting so hard against pressure to radically revalue their currency to address global trade imbalances.

"The way the political regime survives is largely by focusing on domestic issues," said Romnesh Lamba, head of market development at the Hong Kong Stock Exchange. "Thanks to some previous politicians they have linked their story to growth. But growth can be a bit of a drug. So they have to keep growing."

The original recipe for growth — leveraging low-wage labor to drive high-value export growth — may not work much longer. Labor unrest, combined with increasing global pressure to boost the value of China's currency, the yuan, are signaling the end of the first phase of China's hyper-industrialization. China's leaders are well aware that the transition to China 2.0 may be bumpy.

"If the yuan is not stable, it will bring disaster to China and the world," Chinese Premier Wen Jiabao warned this month in a speech to European leaders. "If we increase the yuan by 20 percent or 40 percent, as some people are calling for, many of our factories will shut down and society will be in turmoil."

Western leaders say China's currency manipulation gives it a home field advantage. But even so, China faces domestic pressures.

Strikes and labor unrest have pushed wages higher, squeezing profits for manufacturers that rely on a steady stream of low-skilled workers migrating from rural and western regions to the coastal cities. To offset that profit squeeze, Chinese leaders say they need to create tens of millions of new higher-value, higher-skilled jobs.

To fill those jobs and continue to compete with developed countries, China needs a world-class education system that promotes innovation. That means opening up access to Western ideas — and to Western ideals of human rights, personal freedom and democracy.

Unintended consequences
Cheap exports produced by low-wage workers have gotten China this far. To continue growing, China 2.0 will need to diversify its economic base by boosting domestic consumption. The slowdown following the recent global recession gave Chinese leaders a stark reminder of the perils of relying too heavily on trade.

China’s phenomenal economic growth has produced some nasty, unintended consequences. Rapid industrialization has created major environmental problems including serious air pollution caused by heavy use of coal and tens of millions of new cars. Untreated waste has fouled many of China's rivers. Clean water supplies are still lacking for millions of households, mostly in rural areas.

As far back as 2007, Xinhua reported irreversible pollution contaminating large stretches of the Yangtze River — the longest in Asia, third longest in the world, and home to one-third of China's population.

Meanwhile, massive government spending, along with property reform granting farmers long-term leases on their land, has brought widespread corruption. In May, the Ministry of Supervision announced that more than 3,000 officials had been punished for various forms of graft and corruption, including bribes and embezzlement related to land sales and government stimulus spending. Economic reform has increased pressure on the ruling party to pick up the pace of political reform.

China is also wrestling with the social aftermath of an urbanization plan that created a mass migration of more than 150 million workers to dozens of new industrial cities. Under a system known as hukou, many rural workers can’t access state-subsidized social services like education and health care unless they're officially registered in their new address after moving from the countryside. Officials in Beijing face yet another set of challenges trying to deliver those services to those who remain on the farm in sparsely populated rural areas living on subsistence wages.

It's also not clear where China will find the next generation of urban factory workers to keep its low-wage export machine humming. China's "one-child" policy, initiated a generation ago to curb population growth, has begun to restrict the supply of labor.

Chinese officials insist the new plan is on track.

“By 2020, development of the rural areas will be complete,” said Yang Shi Zuo, executive deputy director of West China development for the Sichuan government. “Total volume GDP will double by 2020. Living standards, quality of life and environmental quality will be achieved.”

Moving low-skill jobs to western China will be hard enough. But to keep its economy booming, China is banking on boosting production of high-tech, higher-value products that produce higher profit margins. The government is also hoping to develop world-class “China brands” that attract the kind of global demand, and higher profits, that Western brands enjoy domestically in China.

The price tag for all this is unknowable. But when the Panic of 2008 sent the world into recession, China responded with a 4 trillion yuan ($586 billion) stimulus package as a down payment on China 2.0. Much of that money is expected to come from private investment. The appetite for cash on the mainland has brought a huge influx of business to Hong Kong, which is ramping up its role as the investment gateway for capital flowing in and out of mainland China.

The success of China 2.0 is as uncertain as the outcome of Deng's original "opening up" experiment. For thousands of years, China's people have endured multiple, often tumultuous, transformations.

Now the world's most populous country is embarking on yet another chapter - one that will be written largely by a new generation of Chinese workers who were largely untouched by the economic tumult of Mao's Cultural Revolution.

NEXT: China looks to create a new generation of innovators.