China’s DNA Problem

Dec 12, 2024

Production has long been the focus of modern China. This dates to the early days of state-directed central planning in the 1950s, when Mao Zedong borrowed heavily from the Stalinist economics template of the former Soviet Union. China’s State Planning Agency was tasked with drawing up a series of complex five-year plans that provided detailed, yet often inconsistent, sector and industry targets for production, investment, employment, and prices.

The plans of the 1950s and 1960s were unmitigated disasters, especially the Second Five-Year Plan (1958-62) which featured the calamitous “Great Leap Forward.” But the message was unmistakable: Production was seen as the essence of Chinese economic development. This strategy did not bear fruit until Deng Xiaoping’s “opening up and reforms” of the 1980s ushered in a 35-year period of hyper-growth and development. Led by spectacular increases in exports and capital investments, Chinese per capita incomes increased by over thirty-fold from the late 1970s, lifting between 300 and 400 million citizens out of poverty. There was seemingly no stopping the world’s “ultimate producer,” as I wrote in my 2014 book, Unbalanced.

That was then.  Since peaking at 11.7% in 2007, China’s five-year real GDP growth rate is likely to slow to 4.8% in 2024. And the latest IMF projections call for a further downshift in the five-year growth rate to 3.7% over the next five years (ending in 2029)—fully an eight-percentage point deceleration from China’s peak growth rate recorded 17 years ago.  This dramatic slowing in the Chinese economy, which is even sharper than the 6.5 percentage point growth compression that afflicted Japan for three lost decades, when real GDP growth slowed from 7¼% from 1946-90 to just 0.8% from 1991 to 2023, reflects a complex interplay of cyclical and structural factors.

I have written extensively about this over the past couple of years, focusing on the property crisis and the scarring from China’s zero-Covid lockdown policies as the major cyclical impediments, while emphasizing the Japanese-like structural interplay of demographic and productivity headwinds. At the same time, I have long focused on China’s chronic under-consumption problem as an added major impediment to the structural rebalancing imperatives famously noted by former Premier Wen Jiabao back in 2007. I argued that, by comparison with US economic growth driven predominantly by America’s “ultimate consumer,” China’s growth dynamic would ultimately be stymied if it failed to wean itself from the Deng Xiaoping model of the “ultimate producer.”

I am the first to concede, as I have noted on more than one occasion, that I now sound like a broken record in having made the case over the years for China’s consumer-led rebalancing. I first wrote about this topic in 2006, and it was featured prominently in all three of the subsequent books I have written on Asia and China, to say nothing of countless presentations I have made on China’s subpar consumer at annual gatherings of the China Development Forum over most of the past 20 years, or so. While feeling frustrated at times at the seemingly impenetrable reception to this idea inside of China, I am now somewhat encouraged that Chinese policy discussions are now at least paying more serious attention to the nation’s chronic under-consumption. Needless to say, China has a long way to go in overcoming this problem. The chart below highlights the current sub-40% consumption share of Chinese GDP, fully thirty percentage points below the 67.9% share prevailing in the United States.

The widely reproduced figure above is a bit misleading in the following sense: It shows consumption shares normalized as a percent of GDP. That doesn’t mean consumption growth is necessarily weak in the absolute sense. In the case of China, growth in household consumption averaged a seemingly impressive 8.8% over the 1996 to 2022 period; however, that was fully three percentage points less than 11.8% average growth for total Chinese GDP over the same timeframe. In other words, the declining consumption share of China’s GDP is more a reflection of much stronger relative growth in the nonconsumption parts of the economy—namely, fixed investment and exports. The opposite is true of the consumer-led US economy, where real consumption growth averaged 2.8% from 1996 to 2022—fully six percentage points slower than that in China but faster than the 2.5% average growth in overall US GDP.

Notwithstanding that statistical caveat, there can be no mistaking the structural disparities in the growth dynamics between the Chinese and US economies. The consumer has been consistently the laggard in China’s growth equation whereas the opposite has long been the case in the United States. Consequently, both nations are facing diametrically opposite rebalancing imperatives: China needs to consume more (and save less), whereas the US needs to consume less (and save more).

In that vein, there has long been a big debate over China’s consumer-led rebalancing strategy. Recent policy discussions, including the just-concluded Central Economic Work Conference (CEWC), have underscored Beijing’s commitments to pro-consumption stimulus, but little detail has been provided on any such initiatives; the CEWC readout, for example, was purposely vague in suggesting that broadly-defined pro-consumption campaigns would be launched next year.  Most recently, the government has thrown its support to a “trade-in campaign” for motor vehicles, home appliances, and other consumer durables. I think this is a partial solution, at best. Accelerated trade-ins are more of a one-off stimulus that brings forward purchases of long-lasting durables that would have occurred in any case. It is hardly sufficient to move the needle on a chronic underconsumption problem.

My emphasis, instead, has long been on the imperatives of social safety net reform — namely, sharply improved coverage and funding levels for nationwide healthcare and pension plans. I have stressed that these reforms are essential in order to reduce the excesses of fear-driven precautionary saving by Chinese households. China has taken only small steps in that direction; for example, a just announced private pension initiative is only mildly encouraging in that it offers funding of up to only $1,650 per year. China is not suffering from a shortfall of personal income generation but rather from an unwillingness of households to put newfound income to work in supporting discretionary consumption. Aggressive social safety net reforms are necessary to convert the fear of an uncertain future for a rapidly aging Chinese population into the confidence required of consumer-led growth.

But that raises an even deeper question: While necessary, is social safety net reform sufficient to boost the long-depressed household (HH) consumption share of Chinese GDP? That gets to one of my biggest concerns on China’s overarching economic development strategy: While there can be no doubt of China’s DNA as the ultimate producer, there is no guarantee that Chinese policymakers grasp the DNA of consumer-led growth. In the same sense, I concede that it may take more than social safety net reform to bring the Chinese consumer to life.

After all, converting fear into confidence requires a shift in the behavioral norms of human beings. This is a radically different undertaking than requiring state-directed banks to boost lending for infrastructure or property investment by state-owned enterprises. Under the heavy hand of the state, companies are effectively forced to comply. This distinction between human behavioral incentives and state-directed controls of banks and enterprises is critical. It could well be the crux of the DNA challenge facing Chinese policy makers, a topic that I will take up in next week’s dispatch.

Next week: China’s Social Engineering Pitfalls

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