Consumption is flavour of the month in discussions of China’s economy these days.
In the past six months, everybody and his dog has jumped in with theories about how China should “rebalance” its economy in favor of consumption over investment. As veterans of the American hot-air bombardment of Japan in the 1980s will recall, this is code for “cut your trade surplus.”
It is likely that the headlines of Chinese and foreign newspapers over the next year or two will be filled with announcements about policies to promote consumption. The major function of these announcements will be political: to enable the US administration to pacify China’s critics on Capitol Hill, rather than to effect any actual change in how the Chinese economy is managed.
In reality, however, it is highly unlikely that China will switch to a consumption-driven economy any time soon. China has clearly benefited over the past quarter century from an investment-driven economy that delivered far higher growth than, for example, India achieved with more of a consumption bias.
Yet statements that China invests “too much” and consumes “too little” rely on official investment and consumption data that look ever worse the more closely one inspects them. It is very likely that China’s supposed savings rate of over 45 percent of GDP and investment rate of 40-45 percent are overstated, and that the consumption rate is understated – and therefore that the “problem” of excessive reliance on investment is exaggerated.
Structurally, it makes sense for China gradually to encourage greater consumption growth. There are, however, three main impediments that ensure this will be a lengthy process:
1) People don’t have much money. Even under the revised GDP numbers, per capita income is around US$1,700. At this level of income a high rate of consumption is simply not compatible with high GDP growth.
2) Incentives for precautionary saving are high. In the past decade households have been forced to shoulder risk for housing, education, medical and pension liabilities that were formerly held by state enterprises. This creates a severe disincentive for urban households to spend money.
3) Corporate saving is not intermediated. Corporate profits have contributed mightily to national saving in the past four years, but China’s primitive capital markets and financial system do not permit profits to be distributed through the economy and recycled into consumption. Instead they stay in the companies and finance further investment.
The ultimate cure for No. 1 is for people to get richer, and this will take time. The shortcut that the government has hitherto relied on is to make goods cheaper by encouraging an ultra-competitive manufacturing sector which drives down the prices of goods to affordability for those with limited incomes. This increases volume consumption but does little in the short run for the value side.
On No. 2, households will not cut back on precautionary saving until they have confidence that the government has credible health insurance and pension programmes.
As for No. 3, it will take at least five years to get the stock market and banks working well enough that significant amounts of corporate profits get redistributed into private consumption.
Thus the only mechanism that Beijing has to boost the consumption share of growth in the short term is to start spending more aggressively on social services, mainly health but also education. Once this spending has been in place for a few years and the institutional framework is perceived as credible, precautionary saving will decline.
The government has plenty of fiscal room: the true budget deficits in 2004-05 were significantly smaller than the Ministry of Finance has admitted, since they included one-offs such as debt repayment and payment of VAT rebate arrears owed to exporters.
Fiscal policy has in effect been fairly tight for the past two years. A more expansive policy, with the focus shifting from infrastructure to social services, is likely to emerge over the next two or three years.
The initial moves this year will likely be modest, but if GDP growth slows sharply then the fiscal pump will be primed more aggressively to keep growth above the 8 per cent mark.
The China Economic Quarterly is an independent newsletter devoted to analysis of the Chinese economy and business environment since 1997. It draws on the 25 years of combined experience of its editors, veteran financial journalists Joe Studwell and Arthur Kroeber, and also publishes articles by leading China-focused economists and journalists. This column appears exclusively on FT.com on alternate Mondays.