China's Rebalancing

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It is now generally agreed that China cannot go back to the export-led growth it had enjoyed in the run-up to the global financial crisis even with a return of the US and Europe to vigorous growth.  It needs to expand the domestic market by reversing the secular decline in the share of private consumption in GDP, which has been hovering around wartime-like levels of some 35 per cent.  It should do so not so much by reducing the household propensity to save as by increasing the share of household income in GDP which has been in a downward trend for almost two decades.  This would require a judicious combination of wage, agricultural pricing and tax policies and significantly increased government transfers, particularly to poor rural households, financed with dividends from state-owned enterprises (Export Dependence and Sustainability of Growth in China).

The appropriate response to fallouts from the crisis in 2008-09 should thus have gone beyond countercyclical macroeconomic policy and included fundamental reforms to boost household incomes.  In the event, however, China responded with a massive debt-financed investment, mainly in infrastructure.  Policies supporting real estate demand, including sharp cuts in interest rates and an unprecedented growth of mortgage lending created a bubble in the property market.  All these pushed the investment rate towards 50 per cent of GDP.  Consumption held up but lagged GDP both in 2009 and 2010.

After reaching double-digit levels in 2010, Chinese growth has been falling continuously in the last 6 quarters.  The official figure for 2012/Q2 is 7.6 percent, lowest since the first quarter of 2009.  On some independent estimates, the slowdown may even be steeper, below the target of 7.5 per cent set for 2012.

Domestic factors appear to account for much of the slowdown in China so far.  The expansionary impact of the stimulus package is fading, giving way to deflationary impulses associated with rapidly accumulated debt by private and state-owned enterprises and local governments.  On the other hand, restrictions imposed to curb property speculation have dampened construction and related industries.  Although exports slowed in 2011 after a surge in 2010 from very depressed levels in 2009, they still registered a respectable year-on-year growth of some 11 per cent as of June 2012.   However, sluggish growth in the US and the double-dip recession in Europe are likely to pull them down considerably during the rest of the year.

Strong downward pressures have given rise to calls by Chinese Premier Wen Jiabao for more aggressive pro-growth measures, including consumption-boosting measures.  Interest rates were cut twice in a month, following three rounds of cuts in reserve requirements and the Bank of China has made large injections of liquidity since the beginning of the year.  New start-ups are expected in industrial and infrastructure projects as well as low-cost social housing.  Although the stimulus package is unlikely to match the size of the earlier one, the Chinese authorities are likely to use monetary and fiscal tools to secure sufficient investment in order to prevent growth falling below the target.

Thus, once again, investment will play the central role in stabilizing domestic demand and growth.  Cuts in interest rates are unlikely to bring much increase in private consumption.  Households have limited access to credits from formal institutions – consumption loans barely reach three percent of total credits.  The focus on public housing may help reduce precautionary savings, but in the absence of a significant boost to household incomes, this would not be enough to provide adequate offset to what looks like a permanent slowdown in exports.

Chinese policy response to the global crisis no doubt constitutes a rebalancing between domestic and external sources of demand, as also manifested by sharply declined trade surplus.  However, it leaves domestic demand unbalanced between consumption and investment.  On one view, this should not be a cause for concern.  It is argued that China is engaged in an unprecedented pace of urbanization which calls for large investments in infrastructure and housing (China Has Massive Firepower to Battle Global Slowdown).  Besides, despite a very high share of investment in GDP, Chinese capital stock per capita remains low (Capital controversy).  All these imply ample space for investment to expand to fill the demand gap created by the slowdown in exports.

However, the composition of aggregate demand matters for the sustainability of growth.  When investment continuously outpaces consumption, the capacity created would become underutilized, depressing revenues and making the debt incurred unpayable.  The 2008-09 package has already left a legacy of excess capacity and a relatively large stock of potentially unpayable debt.  Adding to these could make eventual adjustment more severe and painful even though they may help restrain slowdown in the short-term.  It is thus becoming more difficult for China to maintain socially acceptable and stable growth without a major income redistribution – an endeavour which also presents undeniable challenges.

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