Charles Ogier

Non-graduate Student

China's Opening Up & Reforms

Households Consumption in China : Toward Rebalancing ?

June 2011 Introduction
In 2004, the Chinese leadership decided to change its growth model and increase its reliance on private consumption. This declaration was highly publicized and welcomed by many countries around the world has a way to reduce global imbalances. While the Chinese leadership has a strong interest in managing the global economy and help the world achieve a more balanced and healthier growth, they also realized that the current growth model, with a heavy reliance on exports and fixed investments, was unsustainable on the long term. In addition, this growth model is increasing social tensions because of the rising inequalities (geographically and financially) and has a big impact on environment. There are a lot of economical challenges China has to manage, but amongst them are several key issues. At the heart is the growth model in which households consumption was neglected. Indeed, private demand has been very low compared to other countries in the region or all around the world: for example, India or Turkey, which are both emerging countries with a strong export sector, still rely on about 60% of domestic demand, while developed economies like the USA or Great Britain also have 60 to 70% of their growth coming from households consumption. In China, households consumption is about 38% now which raises many questions about the future of the economy. In this paper, we will have an overview of the policies the government implemented in order to raise domestic consumption, their effects and the challenges the country currently faces.

The Proposed Policies

In December 2004, Wen Jiabao made a speech calling for raising domestic consumption as share of GDP. At this time, the economy was booming with very high growth rates and the country was modernizing very fast, attracting capital from all around the world. However, households consumption was low and declining, while fixed investment was an ever bigger share of the GDP growth. Indeed, Martin Wolf, the famous Financial Times columnist, was writing in 2005 that what was impressing about China's growth was not how fast it was growing, but how slow it was growing given the size of investment as a share of GDP. During the last decade, investment was about 50% of GDP growth while households consumption was declining quickly. In 1980's, domestic consumption was about 50% of GDP growth. By the 1990's, it had fell to 46%, and in 2009, it was about 38%. The following graph shows how it gradually decreased while capital formation started to grow very quickly at the beginning of the 2000's.

Investments help economies grow faster and improve overall welfare of the population. However, when there is too much, capital allocation is less efficient and excess capacity arise as a result. China's investments were at first in line with the similar experiences of neighboring countries who went through the same development pattern process. But in 2004, investments were much higher than the peaks other Asian countries had experienced, and was continuing to rise. As a result, productivity gains declined, employment growth did not match GDP's growth and energy demand was increasing very rapidly. These were big concerns for the Chinese leadership who decided to take action and curb the investment craze by raising private consumption. At the same time, exports were becoming a bigger share of the GDP growth and the fast rising trade surplus that China accumulated was threatening to create a trade war with

the United States of America. In 2005, exports accounted for about 7% of GDP growth. Here is the composition of GDP growth from 1978 until H1 2009:

In addition to these serious concerns, the banking sector was faced with a potential tidal wave of Non-Performing Loans, especially from companies in the excess capacity sectors, which could quickly go belly up should the domestic sector not be able to absorb all the output. In order to cope with all those challenges, a number of policies were implemented. First, fiscal policies to decrease personal taxes and increase government spending were put in place. Since the mid 1980's, the Chinese government has reformed many of its public services and has been paying less and less for education, health, pensions and welfare. This has led to a rise in saving rates by households, in the form of bank deposits, from 15% in 1990 to about 27% in 2009. This huge increase in savings fueled the investment boom by providing an enormous amount of cheap capital. The idea is that by providing more public services, the Chinese government would actually free a big portion of households incomes for consumption and slow down the investment boom. A previous example of such policy was done successfully in Taiwan, were health care coverage was extended from 57% of the population to 97%. As a result, households increased their consumption on average by 4%. In 2006, only 20% of rural workers and 50% of urban workers had health coverage. 14% of all workers have no unemployment insurance and retirement benefits are provided to only 17% of the working population. And even those 17% can only claim 20% of the average local wages, which doesn't insure against much of future uncertainties or provide a decent life. Providing those people with a better welfare would make them more

confident in the future, reduce their saving rates, which would then translate into an increased consumption. In addition, personal taxes reductions would also obviously free some more of the income of the households, while the introduction of a minimum wage was proposed to boost households consumption. To raise domestic demand, some additional policies were also taken at the corporate level. In the early 2000's, corporate started increasingly saving and reinvesting profits to avoid depreciation of their holdings. Given that bank deposit yield negative interest rates, reinvestments made more sense, thus providing another major source of capital in the investment boom. In addition, a reduction of the agricultural tax was also proposed to increase rural's households propensity to consume.

The Effects of the Policies

If we looks at the data, there is little evidence that the policies carried out had any meaningful effects on the households' consumption. The trend that started in early 2000's continued at the same rate and private consumption as share of the GDP continued to decrease. There are many reasons for it: first, the policies carried out by the government were only implemented modestly and thus were not able to revert the trend. For example, tax cuts on rural households have not declined significantly while those on urban incomes were too modest. Bank deposits still yield negative interest rates which pushes households to continue to save as much as they can. Agricultural and urban tax cuts were too small or offset by an imposition of other sets of taxes, thus failing to make any change. Finally, the minimum wages increases had a modest positive effect on private consumption but were not enough to raise it significantly. Finally, the proposition to make SOEs pay dividends to its owners (the government) did not bring any meaningful changes since a small fraction of the companies was concerned. Companies continued to save and reinvest. Many believe that an increased government's expenditures in education, welfare, pensions and health would support households and thus free more income for consumption. Since 2004, the government has been investing a lot of money in those programs, expanding healthcare coverage, reducing school fees and providing subsidies to an increasing number of areas. There are hints that these policies could eventually succeed in raising households' consumption, but these programs need to be carried out over a number of years to contribute to any meaningful effects. In other words, even though there is much talk about it and a number of policies

have been implemented, the rebalancing announced by the Chinese government in 2004 has not translated in reality.

The Challenges Ahead

As the Chinese economy continues to rely on exports and investments, the leadership is facing an increasing number of challenges. The financial crisis of 2008 to 2010 had a very big impact on China: in order to avoid any negative effects on the economy, the government used ultra loose fiscal and monetary policies, effectively flooding with liquidity the economy by triggering a $1.5 trillion credit lending which kept the economy growing at very high rates through all the crisis. However, this ultra loose policies resulted in a investment boom which accounted for 90% of GDP growth in 2009. Such boom is unsustainable and actually worsen the balance of growth by relying even more on exports and investment growth. As credit lending tightens, a rise in NPLs threatens growth and thus the employment growth as well as the households' income. In addition, there are many underlying issues that are seemingly contradictory in the attempts to rebalance growth. This will not happen painlessly and the Chinese government cannot satisfy all interests at the same time. It will be difficult for the government to keep a high growth as well as high employment if the economy is to be reoriented inward. Many employees of the exporting companies are low skilled and will experience employment difficulties in the transition period, as the 40 million SOEs workers who were laid off during the reforms of the 1990's. During that time, many reemployment centers were set up by SOEs to mitigate unemployment and help people find opportunities, but the government was under heavy pressure to solve this issue as it threaten social stability. Something worth noting is that during the last decade, investment driven growth did not translate into higher employment growth. In fact, between 1978 and 1993 employment expanded by 2.5% per annum, but from to 1993 and 2010, when the investment share of GDP was much higher than in the 1980s, employment growth was only about 1% per annum. The export sector was one of the main job creator in that decade, and while moving from such growth model will be beneficial on the long term, it will be painful on the short term. During the 12th National Party Congress, fighting inflation was clearly the top priority of the leadership, and this goes head to head against the attempts to raise private consumption as policies oriented toward that effect might actually increase inflationary pressures. In addition, inflationary pressures make people save even more in order to

meet future uncertainties. Policies aimed at decreasing saving rates while keeping inflation down might be very difficult to manage given that they will worsen the one or the other. To add fuel to the fire, the current housing prices rise has given incentives to people to save even more, and start to do it even earlier in order to be able to buy themselves a house later on. China cannot continue to have strong growth without inflation in those conditions. To answer all those problems, there might be a solution which is not very popular within China but might actually solve many issues at the same time: an appreciation of the renminbi against the dollar. This would give more flexibility and independence to the People's Bank of China to raise interest rates to control the investment boom and limit the credit lending frenzy which is making the economy boiling. This would also reduce the exports as share of GDP by making them more expensive, thus helping to rebalance the economy. It would give households a higher consumption power, which might not however not help to keep inflation down but will definitely bring the current account surplus down by increasing the imports. Bringing the trade surplus down would also ease the tensions with the US by reducing the global imbalances, and make energy prices cheaper. Overall, a Renmenbi appreciation is definitely in China's interest. Yet, while it will help rebalance the economy and help improve the welfare of its people, it will not be painless, and a structural unemployment could result out of it. Such policy has been declared to be on the table by Chinese officials, yet it is not widely supported within the government. Many still believe that the current growth model has not yet reached its limits and while all agree on raising households consumption, there are bitter infighting about how to proceed. With the change of leadership approaching, we might still wait a couple more years before a more aggressive set of policies being implemented. By then, a consensus about how to raise private demand might be reached and the long awaited rebalancing of the economy might finally take place.

References
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