A new chapter is opening in China's development. The country is starting to turn the corner to becoming an economy where private consumption will replace investment as the major driver of gross domestic product growth. Our projections suggest that the acceleration of growth in private consumption will result in it becoming the largest contributor to GDP growth by 2020. By around 2025, private consumption will overtake investment as the largest share in GDP overall.

Nowhere are these broad trends in China's economy likely to manifest themselves more dramatically than in its cities. The urban landscape thus provides a lens to see how these dynamics and changes could play out.

First, while China will see continuing urbanization over the next two decades, the urban labor pool will stop growing by the end of the period. This is due to the aging of the population: from 2012 to 2030, the 0-to-14-year-old population cohort will see a decline of 1.2 percent per year, while the over-65 cohort will grow at 3.9 percent per year. Thus there will be fewer people available for the future labor force, and the likely result is that the nonworking population will account for a larger share of the total.

While migration will continue on a large scale, it will be at a slower rate compared with previous years. In the next decade, with the change in the population's age profile, there is likely to be a reduced supply of working-age rural migrants available to move to cities.

Large-scale migration is especially likely to decline to the southern coastal cities, which have traditionally been home to export-oriented industries. Instead, rural workers in inland provinces are now more likely to want to work in cities close to their hometown.

One reason is that workers in the emerging manufacturing bases of Henan, Hubei, and Sichuan provinces are seeing incomes grow more rapidly than in the past.

In addition, as total employment opportunities expand in inland cities, rural inhabitants in these regions may prefer to stay close to home, retaining the residence privileges of living in their rural home areas but working in urban areas.

Increasingly wealthy

The urban population, meanwhile, will become increasingly wealthy. The tighter supply of workers could lead to further wage inflation in coastal cities.

Already, manufacturing-labor costs in the Pearl River Delta rose 11 percent during 2011 and wage rates at factories in Guangzhou and Dongguan have increased 10 percent in the past year.

The upward trajectory in wages is being supported by improving productivity. This has put China in the leading position when it comes to productivity growth compared with other countries - albeit from a low base.

In the future, productivity gains could be captured in the service sector, as well as in China's expanding high-end manufacturing sector. These developments will in turn require initiatives to improve education and training - both hallmarks of a blossoming urban society.

By 2030, consumption growth will be dominated by rapidly growing middle- and higher-income urban population groups. The number of urban households in these categories will rise from 71 percent in 2012 to 87 percent in 2030.

Within those groups, the wealthiest households will grow to account for a proportionately larger share of consumption - accounting for one-quarter of urban households by 2030 but fully half of total urban consumption at that date.

Shift of spending

The result will be a shift of spending toward discretionary categories, including personal items, recreation, education and cultural expenditures, and transportation and communication spending.

In the countryside, the market will grow even as employment shrinks. For those who remain, the Chinese government is instituting policies that aim to narrow the gap between urban and rural incomes by lowering rural taxes, increasing consumption subsidies, and putting in place measures to enhance the rural social-security net and improve rural living conditions.

To think of China as a single economy is to make a similar mistake as thinking of Europe as one single country: the quality and pace of urban development is likely to vary sharply across China. Cities are at different stages of development, and the development paths they will follow are likely to vary and reflect strengths specific to each city.

Our projections suggest that growth will be fastest outside China's megacities. In the next two decades, the dozens of smaller cities with current urban populations of less than 1.5 million will make the largest contribution to growth.

A large number of these cities - now at earlier stages of development than the larger cities and so with more growth potential - will expand to become cities with populations in the 1.5 million to 5 million range. This group will represent the single largest growth cohort and contribute 40 percent of total China urban GDP growth through 2030.

Cities that currently have a population in the 1.5 million to 5 million range will contribute about 25 percent of GDP growth over the same period, while cities with populations that are already above 5 million will contribute about 35 percent.

The small cities will form hub-and-spoke type clusters around the megacity or big-city hubs that are already in existence: we have identified 22 such emerging economic clusters, each the size of a midsize European country. For example, the GDP of the Shandong cluster (around Jinan and Qingdao) will by 2020 be similar to the size of South Korea's today, while the GDP of the central cluster - cities around Zhengzhou in the center of China - will be similar to Denmark's.

Comparative advantages

Cities will compete based on their comparative advantages in terms of productivity or population growth. For example, cities that are rich in natural resources and have an abundant labor supply but historically low productivity have typically developed "traditional" industry sectors such as mining, textile manufacture, or energy production. Those sectors have developed extensively over the past three decades since China's economy started to open up.

Production processes in these industries tend to be mature and standardized, and as a result, simply increasing input, for example, additional labor supply, leads to growth.



Jonathan Woetzel is a director in McKinsey's Shanghai office, where Lillian Li and William Cheng are consultants. The article is condensed by Shanghai Daily from their report "What's next for China?" The opinions expressed are their own.