After the export boom, where to from here?

No single growth model can be successful forever, and for China the time of reckoning has come

China's economic development has relied heavily on external demand since the reform and opening-up process began more than 30 years ago, and manufacturing has relentlessly been pushed as a way of bolstering national finances and advancing the public good.

But as China has gradually become more enmeshed in the world economy in recent years, the global financial crisis that broke out in 2008 has dented the country's foreign trade performance and reined in growth.

Clearly, export-led economic growth at a time of accelerating industrialization and urbanization is no longer a magic elixir that can guarantee the country's economic good health. But expanding investment and domestic consumption have created great potential for domestic demand that may alleviate the economic pain that falling exports bring. That means China has to transform itself from growth driven by exports to growth driven by domestic demand.

Fortunately, the country is becoming less dependent on foreign trade. That is not because of exchange-rate fluctuations or rising labor costs in China but because of shrinking demand from the US and Europe. Last year that dependence fell below 50 percent. The US, Japan and Brazil's dependence on foreign trade is about 30 percent. With the challenges and uncertainties that the Chinese government faces, including the eurozone debt crisis and US monetary easing, it is looking to maintain economic stability by stimulating domestic demand.

In 2010 the government devoted an entire chapter in its 12th Five-Year Plan (2011-15) to the importance of expanding domestic demand, spelling out, among other things, what could be done to improve macro controls and to adjust the structure of investment.

The fact that China can even nurse the ambition to make its domestic market one of the biggest in the world points to the great strides that have been made in the economy.

Now the key for the country is to convert the cost advantages it has enjoyed into technological advantages and to replace a model dominated by almost unfettered growth into one that pays due respect to the environment. But doing so poses difficult problems relating to investment, human resources, technology, capital, financial development, micro-economics, national finance, real estate and infrastructure investment.

Many countries are dependent on overseas markets, the biggest being China. These countries need it to provide them with the raw materials for production and the products themselves. So their growth depends on China's growth. That means the days of China's important role in international competition and the distribution of labor are not over, but that the country is beginning to give the issues of domestic demand and external demand much greater priority.

In the process, many Chinese companies have become more competitive with prices and with quality. That in turn has spurred more domestic demand. Three of the countries biggest companies, Huawei, ZTE and Lenovo, have become world famous, and their products now give those of Europe, Japan and South Korea a good run for their money.

But there is a nagging concern: most Chinese businesses remain where they have always been - in the low-end market. For them it is no easy task to emulate the innovative qualities that so many US companies display, and at the same time, the domestic market cannot consume their products in the volumes that they would like. Faced with this quandary, what do these companies do? They invest in the financial sector or in real estate, resulting in the virtualization of industrial capital.

The current economic structure is characterized by imbalances, particularly between domestic and external demand, and between investment and consumption.

Investment remains the country's economic growth engine, while manufacturing is still at the low end of the international industrial chain, and the share of service-added value in GDP is still well below the world average. Energy consumption per unit of GDP is relatively high. China's consumption rate is lower not only than that of developed countries, but quite a few developing ones as well, including South Africa, India and Malaysia.

If the status quo is maintained in China, investment returns will fall and there is always the risk of orders drying up. This is a flawed growth model, something of which the Chinese government is only too well aware. More importantly, no single growth model can be successful forever. That means China must continue to change, and of course that changes need to be effective.

The push toward urbanization will foster the building of infrastructure and the expansion of the consumer market, which in turn will promote industrialization.

Finance and insurance, and information and computer services, among others, also rely on increased urban development. Moreover, urban industrial prosperity and high returns will draw in more capital, technology and knowledge.

The integration of these elements will in turn beget technological innovation and liquidity, and foster new industries.

This will also scale up the economy so the average, marginal cost of economic activity can be significantly reduced.

To achieve that, the government will need to take a tough line against wildcat speculation, especially irresponsible investment behavior. As urbanization continues, emphasis will need to be put on harnessing the great potential of cities. Part of that will be ensuring that they create a favorable economic environment, such as bringing down rocketing real estate prices and stimulating domestic demand.

The author is a post-doctoral fellow at the School of Economics, Renmin University of China.