China's rebalancing of the economy is toward domestic consumption.
The relationship between China and the world is changing, and a key choice lies ahead: more engagement or less. That choice could lead to a powerful economic boost for both sides, or a lost opportunity.
New McKinsey Global Institute research finds that China's exposure to the world in trade, technology and capital has fallen in relative terms. This reflects the rebalancing of the economy toward domestic consumption.
In 11 of the 16 quarters since 2015, consumption contributed more than 60 percent of China's total GDP growth.
How will this play out? The answer is hard to anticipate because, to an extent, the road ahead depends on political and strategic decisions on all sides. We can, however, note three key current realities.
First, less engagement between China and the world would mean higher tariffs, more limited trade and technology flows, and continuing gaps in addressing key global challenges. More engagement would see China importing more from the rest of the world, greater two-way flows of technology, and a more competitive Chinese services sector, as well as making solutions to global issues more likely.
Deeper engagement would create value for China and the world of an estimated $13 trillion to $20 trillion - an additional 9 to 14 percent of global GDP - by 2040. Less engagement could put $9 trillion to $17 trillion, or 6 to 12 percent of economic value at risk over the same time frame.
On the other hand, China has achieved global scale, but the country still has plenty of scope to deepen its global engagement and reach. Specifically, China, which became the world's largest economy in terms of purchasing power parity terms in 2014, is a global power in scale but not always in reach.
Although China has 110 Global Fortune 500 companies, more than 80 percent of their revenue is still earned at home. China's banking, securities, and bond markets rank in the global top three in size, but its international players have limited presence. China's spending on R&D was $293 billion in 2018, the second-highest in the world behind the United States. However, China imports six times the intellectual property it exports.
Further, homegrown Chinese companies have progressed rapidly, reaching considerable scale in many cases, but they are not yet able to cater entirely for domestic needs in key sectors.
In technology markets, local producers are able to provide 60 to 80 percent of the technologies we studied. However, this means that China still uses inputs from multinational corporations in at least 20 to 40 percent of cases. It continues to rely on imports for critical components such as reduction gears (robotics), power electronics (electric vehicles), and equipment.
Nevertheless, the world also needs Chinese technology. Chinese suppliers may be able to achieve performance on a par with, or better than, global suppliers in 40 to 50 percent of the technologies studied. In some emerging technologies (for instance, 5G, artificial intelligence and quantum computing) where a global standard may not yet have been defined, China has become a leading player (although it still uses foreign equipment, talent, and investment). Consider, too, China as a market - its robotics market is the largest in the world, accounting for 36 percent of total industrial robot unit sales.
In addition, China' s consumption and consumer market are also important links between the country and the world. China's consumer markets have long been open to the world, but now Chinese players are increasingly competing with multinational corporations. Of 30 consumer categories, multinationals have lost share in 11.
However, Chinese players are still not meeting all the desires of domestic consumers. They are demanding more choice and higher quality goods and services, and often look to foreign companies to provide them. Evidence of this is rapid growth in cross-border e-commerce, which almost doubled between 2015 and 2017.
Another opportunity for the rest of the world is the increasing number of Chinese traveling overseas. Outbound trips have grown at 13 percent per year since 2010 and reached 150 million in 2018, making China the largest source of outbound tourists in the world. That can have a large impact on consumption in destination countries.
Obviously, there are dynamics at work that appear to argue against deepening engagement. China is more than ever dependent on domestic consumption rather than on industry and investment. It is less exposed to the rest of the world than before. While, the rest of the world is more exposed to China, but protectionism is rising and there is discomfort among citizens worried about globalization.
Yet the benefits of mutual engagement are compelling, mutual dependency is still real, and many of the world's most challenging issues need collective action from reforming the global trading system to tackling climate change.
If China were to launch 2.0 of its globalization rather than stay still or reverse its international engagement, and if the world were to encourage more economic collaboration rather than less, there would be benefits for all.
This article appeared first in China Daily.