By now, even the most optimistic of analysts recognise the deep structural imbalances from which the Chinese economy suffers. These distortions are striking. China accounts for roughly 17 per cent of the global economy but only about 12 per cent of global consumption, with Chinese investment estimated to make up an astonishing 30 per cent of the global total.
This clearly isn’t sustainable. As part of its gross domestic product, China’s investment level is already very high. If it wants to maintain this while still growing by 4-5 per cent for the next decade, its share of global investment would have to rise to nearly 40 per cent. In that case, to prevent a global demand crisis, the rest of the world would have to reduce their investment share to well under half of the Chinese level.
This is highly unlikely. The United States, Europe and India (along with many smaller economies) are all determined to implement policies that boost domestic investment and support domestic manufacturing. The world simply cannot sustain such high investment levels relative to demand.
The problem is compounded in China’s case by the rise in non-productive investment needed to maintain Chinese growth. For decades, when the Chinese economy was characterised by severe underinvestment, it made sense for China to rely on a development model that forced up domestic savings and channelled them into investment in infrastructure, property and manufacturing.
But those days are long over. Roughly two-thirds of China’s investment – an exceptionally high share – is directed into the property and infrastructure sectors, which have become increasingly wasteful economically.
The consequence has been a surge in China’s debt burden over the past 10-15 years. That is why, after years in which China’s imbalances were the result of disproportionately rapid investment growth that pulled GDP growth behind it, China must spend the next decade with investment growing more slowly than GDP. That is the very definition of rebalancing.
Simple arithmetic shows what this implies. While the rest of the world invests roughly 23-24 per cent of GDP, high-investment economies see 30-33 per cent. China, which invests an astonishing 44 per cent of its GDP, must allow GDP growth to outpace investment growth by at least 2-3 percentage points every year just to become a “normal” high-investment economy in 10 years.
In that case, consumption – the main source of demand besides investment – must pick up the pace and lead GDP growth.
But that’s easier said than done. Before the pandemic, Chinese consumption was growing at roughly 4 per cent a year. To maintain GDP growth of 4-5 per cent while rebalancing its economy, Beijing must put into place policies that drive consumption growth to at least 6-7 per cent annually. In an economy driven disproportionately by investment growth, Beijing must get consumption growth to accelerate sharply as investment growth declines.
Is this even possible? Yes, but it will almost certainly require a disruptive transformation of the country’s development model, which is probably why no country has ever pulled it off. Beijing must get household income growth to accelerate, either directly, in the form of higher wages and transfers, or indirectly, via a stronger social safety net. But with fewer jobs building bridges, train stations and flats, the only way to force a rise in household income is through transfers from other economic sectors.
This is just arithmetic. If investment growth decelerates, Chinese consumption cannot accelerate without implicit or explicit transfers from elsewhere in the economy.
Businesses, for example, can be forced to fund these transfers by paying substantially higher wages, but with China’s manufacturing competitiveness based primarily on the very low share Chinese workers retain of total production, this would almost certainly undermine manufacturing exports, and would lead, in the short term, to a rise in unemployment which, paradoxically, would reduce consumption growth.
The only other way to fund the transfers is if Beijing and local governments were to partially liquidate their considerable assets in favour of Chinese households.
By my calculations, if the government could directly or indirectly transfer roughly 1.5 per cent of GDP every year to households, it could drive growth in household income – and with it, household consumption – to around 7 per cent annually. This, in turn, could generate GDP growth of 4-5 per cent even as investment growth dropped sharply.
But it won’t be easy. It requires reversing a decades-old development model that implicitly transferred income from households to local governments through hukou restrictions, repressed interest rates, an undervalued currency, directed credit, overspending on logistics and transport facilities, and other policies that implicitly or explicitly underpinned government growth and power.
Beijing would probably try to push the costs of reversing these transfers down to the local government level – there is evidence it is already doing so – but that would imply a destabilising transformation of local business, financial and political institutions.
But however difficult it might be, the arithmetic of rebalancing is unassailable. Given its status as the world’s second largest economy, and by far the world’s largest investor, China simply cannot maintain its current investment share of GDP while continuing to grow relative to the rest of the world.
That is why the growth rate of Chinese investment must decline, and by definition, this means that either consumption growth must rise sharply or GDP growth must drop sharply. The only way the former can happen requires major, and politically contentious, transfers from government to households. This won’t be easy, but the arithmetic of rebalancing allows no other option.
Source : SCMP