Article

China towards a model of increased domestic consumption

            There seems to be a growing consensus that China’s growth model heavily reliant on exports and investment may have run its course. Not many challenge that China will have to adjust to slower global trade growth over the next decade. However, views differ on the role of investment.

By Gateway to China Staff

            In recent years China's top leaders have repeatedly described the country's current economic model as "uncoordinated, unstable, unbalanced and unsustainable" This language is in stark contrast to what has been a decade of apparent success: economical growth at high speed and fast Chinese rise in the ranks of middle-income countries. What explains this inconsistency between rhetoric and financial records? The Chinese authorities have correctly assessed that the country's economy and its rapid growth in the last decade have been based on high levels of investment and private consumption systematic repression. This has resulted in a model of capital-intensive growth that has not generated adequate increases in domestic consumption and employment. Instead, it has built significant distortions in the economy.

            Rebalancing an economy as large as China is a long and complicated task. Fortunately, economic policy prescriptions are relatively clear. The imbalances in the Chinese economy distortions were created by three of the most fundamental economic prices: interest rate, exchange rate and energy prices. An undeveloped social safety net and high levels of income inequality have exacerbated imbalances. These rebalancing policies must focus on enabling these key prices to be more determined by the market. The government should increase social transfers and guide the economy toward a more equitable distribution of income. Most of these economic policy proposals are nothing new. The nature and evolution of the Chinese economy, however, have changed the relative importance of these various reform policies. Specifically, the decline in the current account surplus of China, and therefore lower rates for intervention in the exchange market, have reduced the importance of the reform of the exchange rate on the reform of the interest rate. In addition, new data on the high levels of income inequality in China have led to weigh explicitly the relationship between income inequality and economic rebalancing.

            The savings-investment equation indicates that the difference between national saving and domestic investment equals the current account surplus. More simply put, the production that is not consumed or invested in the country is sent abroad. China's policies that repress consumption include negative real interest rates on bank deposits for families, an undervalued exchange rate, a thin social safety net and restrictions on the ability of workers to organize and demand higher wages. This level of suppressed consumption combined with subsidies to a super-production generates a large trade surplus.

            While external rebalancing has taken place in recent years is real, it has not been produced in an ideal way. To balance the savings-investment equation, in recent years, the investment rate in China has skyrocketed, so that the current account surplus has shrunk.

Data source : Peterson Institute for International Economics   

     

            This only aggravates the problem of over-investment in China. A much more convenient way to reduce external imbalances would have been to lower the excessively high Chinese savings rate, pouring resources into the domestic market consumption. This would bring great benefits to the global economy, as China's actual demand, thus generated, would help developed economies find their path out of recession or slow growth, by means of exports of goods and services with high added value. In addition, the global economy would be more harmonious and balanced.