China’s economic rebalancing is already underway | vox – Research-based policy analysis and commenta ry from leading economists
The international community, and particularly policymakers in the US, put great expectations on the contribution that China can make to a global economic recovery by rebalancing its economy through promoting consumption growth (see, for example, O’Neill 2010 on this site).
The Chinese authorities broadly accept this priority and have put in place a number of policy measures that aim to achieve it.
Piecing together a complete picture of Chinese consumption by drawing on both official and unofficial data reveals some interesting insights about how far China is along the way to boosting domestic consumption.
China’s consumption share of GDP was probably underestimated by an average of 3.1 percentage points during the past decade, as it declined steadily from 64% in 2000 to 50% in 2008, in line with official statistics, but recovered afterwards to 54% in 2010.
These figures could mean that China’s long-awaited economic rebalancing has already begun, especially if the sharp decline in the country’s trade surplus from 7.5% of GDP in 2007 to 2.1% in 2011 is taken into account. If these changes continue, the Chinese economy may transition from an economic “miracle” toward more normal development, as growth slows, inflation rises, industrial upgrading accelerates and economic cycles become more dramatic.
Boosting China’s domestic consumption has been a key government policy in trying to rebalance the economy. But according to official statistics, the consumption share of GDP declined persistently from 62% in 2000 to 47% in 2010, highlighting a serious policy failure.
Even more surprising is the widening gap between retail sales growth and total consumption growth in recent years. The fact that consumption-related retail sales grew increasingly faster than total consumption indicates the relative weakness of components of consumption unrelated to retail sales. This weakness is mainly in China’s services sector. But this is at odds with common sense, as normally the income elasticity of demand for services is much higher than that for other consumer goods.
The Chinese National Bureau of Statistics derives consumption data from household survey data. If household income was significantly underreported, as various studies have suggested, then it is quite possible that household consumption was also grossly underestimated, and likewise consumption growth rates in general.
A re-estimation of China’s consumption share of GDP, taking into account these distortions, suggests that China’s consumption share of GDP actually declined from 64% (with official statistics recording only 62%) in 2000 to 50% (officially 48.4%) in 2008, but then recovered to 54% (officially 47%) in 2010.
What could have driven the improvement?
There is a strong argument that both China’s “growth miracle” and its economic imbalances during the country’s reform period are attributable to widespread distortions in factor markets. These distortions generally repress factor costs and, therefore, are like subsidies to producers, investors and exporters (Huang 2009). At the same time, they also tax households. This explains both the increasing dominance of investment and exports in Chinese growth and weakening consumption during the past decade. This implies that the key to rebalancing China’s economy lies in further liberalising its factor markets and removing cost distortions.
Anecdotal evidence suggests that the climate for increased consumption has started to improve in recent years. This seems to have been mainly triggered by changes in factor costs and returns, but more importantly, the changes are by and large natural market responses, instead of deliberate policy adjustments. The government certainly took steps to reform pricing mechanisms for factor markets, most clearly in energy prices and exchange rates (Drysdale 2012). But a rapid growth in wages and the increased role of market-based interest rates were still the most significant changes.
While the People’s Bank of China has not taken concrete steps to liberalise interest rates, those that are market-based have started to play an increasingly important role in China’s financial intermediation. Changes in both labour and capital markets are also positively impacting on consumption in at least two ways. First, they increase household income, while also reducing ‘subsidies’ to Chinese enterprises. And second, rising wages and interest income advantage low-income households, and should help improve income distribution.
This analysis has encountered both disbelief and scepticism.
Some critics have argued that retail sales are a poor proxy for consumer demand, since China’s figures must incorporate wholesale business, and government and business procurement. But Chinese retail sales figures do not include wholesale business, and the analysis does not use retail sales as a proxy for consumption.
Others object to the analysis because China’s undervalued currency, relatively low wage growth and repressed interest rates show little signs of reversal, and these are crucial factors in repressing household income growth.
But with a decreasing trade surplus, declining foreign exchange reserves and even occasional expectations of currency depreciation, estimates of the renminbi’s undervaluation have been significantly re-evaluated downwards. Wages have in fact grown rapidly, and while regulated interest rates did not change much, the proportion of financial intermediation subject to market-based interest rates has risen sharply. These are exactly the types of changes that are driving a rebalancing of the Chinese economy and recovery of consumption.
Reports of China’s declining consumption share are exaggerated, and the official statistics are partly to blame (Lardy 2012). Rather, the opposite appears to be true, with China’s consumption share already starting to expand.