Is China pushing its economy too quickly to a consumption/services-led growth?
If anything it might not be pushing fast enough
If anything, I think policymakers can afford to move even more quickly, primarily by letting investment growth decline even faster. There is very little they can do to force consumers to spend their money faster. What they can do is (i) support policies that transfer even more wealth into the household sector and (ii) get out of the way and let the entrepreneurs build the next generation of services-oriented businesses for middle class Chinese consumers.
First, let me say that I think folks are way too focused on headline GDP growth. To measure progress of China’s economic transition and re-balancing, the consumption component is really the only one that matters. The gross capital formation / investment components of GDP are unimportant except for how it relates to job losses (which I will go into more detail below). Net exports don’t really move the GDP needle anymore, although the sector still matters for its implications on employment.
In the chart above, you can see how overall GDP has come down since peaking in 2007.
At first (a) this was driven by the abrupt decline in net exports as a result of the Global Financial Crisis.
In response, in 2009 (b) the government put in place a massive stimulus program which super-charged the investment component, fueled primarily by debt going into capital-intensive industries.
It was only until sometime in 2013-2014 (c) after the Xi administration came on board and kicked off its economic reform program that investment growth slowed and today consumption is finally driving more than half of GDP growth.
Another very important metric is job growth, particular in the services sector (i.e. jobs tied to consumption growth as opposed to investment). This is because major job losses in a short period of time can be quite de-stabilizing. So far we haven’t seen that; according to Caixin:
Services-related companies also continued a recent trend by hiring more workers. Nevertheless, growth in services sector employment was not enough to offset the number of manufacturing jobs that disappeared last month. Thus, employee headcounts at the composite PMI level decreased in October, albeit at the slowest rate since July.
What’s going on here is that the services sector is doing an “okay” job of creating jobs, but these gains are being outweighed by job losses on the manufacturing side of the ledger. This is probably the pace that policymakers are aiming for, and should be expected to continue for some time to come. The danger would be if the services sector stops creating jobs, but so far that hasn’t happened.
To the extent that growth slows down in the services sector, expect policymakers to open the debt spigot to stimulate economic activity. Debt and fiscal stimulus are their main policy tools to make sure economic re-balancing are moving at the right pace. I personally think that policymakers could afford to let the investment component of GDP decline faster by holding off from any stimulus-type activity.
Under such a scenario, you could conceivably see GDP growth falling to zero. This might scare the bejeezus out of some analysts out there, but it probably isn’t actually a bad thing, as long as consumption growth remains steady. All this would mean is that China is taking a little more pain up front but will ultimately adjust to the “New Normal” (e.g. consumption-led economy) sooner.
In any case, based on what I’ve seen thus far, this process seems manageable. While there has certainly been plenty of malinvestment out there over the past decade, the Chinese economy is big and diversified enough to absorb these losses over a reasonable period of time.
GDP growth will slow, but it will be much higher quality and more sustainable over the long-term. The changes that need to be made in the SOE (state-owned enterprise) sector are easier to implement than the 1990s, when upwards of 40% of SOE employees were fired.
China is less dependent on the outside world than before, and you can see this in the commodities slump we are seeing today. Creating service sector jobs is fairly easy if consumer demand remains strong.
On this topic, I believe there is also enormous pent-up demand in the Chinese middle class, whose consumption habits had been held back by a fairly regressive “financial repression” tax [1]. If you thought the boom in Chinese spending (especially luxury categories) was eye-opening over the last decade, keep in mind that this was probably driven primarily by less than 3% of the population [2].
I think it was only the tip of the iceberg – the hundreds of millions of real middle class Chinese have only begun to open their wallets. There’s a decent chance that you see consumer growth even accelerate at some point – the phenomenal recent growth in outbound tourism might be a taste of things to come in other spending categories.
If China wants to break through the “middle income” bracket, it has no choice but to re-orient its economy around the virtuous cycle of consumer demand and innovation. We’ve already seen a spate of liberalizations – particularly in the financial sector – and I think we are still only in the second or third inning of this re-balancing process and don’t expect it to end until well into the 2020s.
Notes
[1] Before 2012, most Chinese people had no choice but to put their liquid savings into bank savings deposits where interest rates were well below the inflation rate. Effectively, these deposits would gradually lose value over time and this acted like a transfer from the household sector to borrowers, who were disproportionately in capital-intensive sectors and state-owned enterprises.
The easiest way to think about this is as a tax. It was “regressive” because wealthy Chinese people had the means to get past traditional restrictions and invest their savings in better asset classes. This tax has now largely been lifted.
[2] That is also why you saw what I call the “First Chinese Consumption Boom” impact sectors that you would expect wealthy people to frequent, like luxury goods. However, I also think it will be mostly Chinese companies that are going to rise up to meet this demand. Look across the services sector of any country, and you will find that most services businesses are local.
This was originally published in Quora in January 2016.