The global credit crisis freezing up the world's finances may be a blessing in disguise for China as it aims to modify its economic structure after three decades of breakneck growth.

With its banks shielded from the worst effects of the crisis by its capital account control, plenty of liquidity and limited exposure to sophisticated derivatives, China still faces the effects of recession on its main export markets, the United States and Europe.

"With such a high reliance on international trade, it's impossible for China to avoid the impact of the global turbulence, so economic slowdown is inevitable," says Tang Min, deputy secretary-general of the China Development Research Foundation, which was initiated by a policy advisory body of the Cabinet.

"However, the crisis is a timely warning that China's growth is unsustainable in the traditional pattern, relying too much on external demand," says Tang. "It can force us to change for the better."

China's economy has maintained an average annual growth of about 10 percent for 30 years since the reform and opening-up policy was adopted, compared with a mere 3.3 percent for the world economy. For the last five years, it expanded 10.6 percent each year on average. But can it continue?

GROWING PAINS

Exports have been slackening since the credit crisis started last year. China grew 10.1 percent in first half of 2008, 2.5 percentage points slower than the same period last year.

"There's little chance for a successful modernization if China continues along the old path," says Beijing-based economist Wang Xiaoguang. "We must change our development strategy."

He points to the diminishing international competitive edge of the labor-intensive manufacturing industry in coastal regions, the main driver of China's robust output growth. That was due to more expensive labor and raw materials, waning external demand and the emergence of other exporters such as Vietnam.

Resources and energy pressures and environmental costs are also hampering capital-intensive heavy industry, which had propelled the recent round of high growth in China since 2002, says Wang.

From 2002, China's strategy of development has been too exposed to foreign investment and the property sector, making China's own enterprises and industry less competitive and risking a failure like the 1997 southeast Asian financial crisis.

Foreign-invested companies accounted for almost 60 percent of China's exports last year and almost 90 percent of high-tech product exports.

Wang says the booming real estate sector, the fastest growing sector in China's fixed-asset investment since 2002, requires relatively low technology, resulting in the prosperity of energy-intensive, smokestack industries like steel and cement.

"What's more, because it's easy to make fast money by investing in property, this sector absorbed too much capital which could have gone to technological innovation and energy efficiency," he says.

Senior economist Louis Kuijs, of the World Bank Beijing Office, says strong investment and domestic financing of that investment was an outstanding feature of China's growth, helped by facilitating fiscal policies and pro-business local governments.

Nevertheless, worsening energy shortages, pollution and labor conflicts persuaded the government that this mode of economic expansion was unsustainable, says Kuijs.

"It's fair to say the government now thinks that it's time to go back a bit, that it's probably too aggressive in encouraging industry," he says.

Another daunting challenge is the expanding rural and urban inequality. Industrial output in China surged 186 percent from 2002 to 2006, but the employment growth of industry had been only 22 percent.

The industry, capital-led kind of growth has not created as many jobs in urban areas as a different pattern could have created, says Kuijs.

This means many people have not been fully absorbed by the urban economy, he says, adding that too many people in agriculture also kept productivity low there.