From time to time, the topic of rebalancing the Chinese economy away from exports and investment is discussed here. Truth be told, exports are less of a growth driver to-date (but do note than nothing can stop it from having negative contribution to GDP growth), so for the past 3 years or so, investment is the main game here. The goal is that the Chinese economy would be rebalanced into a domestic demand drive, i.e. consumption.
We have people like the ex-Morgan Stanley Stephen Roach, who has been becoming more like a Chinese rather than an American when it comes to his view on the Chinese economy. He thinks that China will not be following Japan’s footstep because this time is different China has “strategy”, whatever it means:
Strategy. Since 1953, China has framed its macro objectives in the context of five-year plans, with clearly defined targets and policy initiatives designed to hit those targets. The recently enacted 12th Five-Year Plan could well be a strategic turning point – ushering in a shift from the highly successful producer model of the past 30 years to a flourishing consumer society.
Recently, he repeats it:
China has no choice but to move quickly to implement the pro-consumption initiatives of its recently enacted 12th Five-Year Plan. Strategic transition is what modern China is all about. That’s what happened 30 years ago, when economic reform began. And it needs to happen again today. For China, a soft landing will provide a window of opportunity to press ahead with the formidable task of increasingly urgent economic rebalancing.
No human being would question the Chinese’s desire to rebalance growth to consumption-driven rather than investment. But the reality is that policymakers have started talking about not in the 12th Five-Year Plan, but the previous one. Unfortunately, they have had absolutely no success as the share of consumption continued to shrink. In fact, the financial crisis of 2008 forced China into a even more investment-driven economy as exports collapsed.
Source: National Bureau of Statistics
In his newsletter (which I urge everyone to subscribe), Michael Pettis tried to compute the kind of growth in consumption China needs to get back to the old days when consumption as a percentage of GDP was in the low 50s per cent (which is actually not that high compared to more advanced economy, say the United States). And here is what he has to say:
If you think China will grow at 6% a year for the next 10 years, and you think Chinese household consumption will grow to 50% of GDP in 10 years, then implicitly you are projecting annual household consumption growth of 10.2%. If you think China will only rebalance to 46% of DP in 10 years, then you are implicitly projecting a 9.3% annual growth in consumption.
The reason this is so interesting is that it implies that consumption growth will be a very tough and substantial upper limit to GDP growth. If China grows by 6% a year, and if we expect a minimal rebalancing to 46-50% of GDP, we would need consumption growth to surge to around 10%, a number never achieved before.
Is that achievable? I don’t have the answer, and nor does Michael Pettis has. It certainly isn’t impossible (nothing is impossible), but I would be very sceptical.
The key reason to be sceptical here is that China is facing a very sizeable bubble in the real estate sector (along with other things like the debt mess and over-investment in infrastructure), my base case remains that we might see a very dramatic slowdown of the economy. In that scenario, my worry is that policymakers might be tempted to do what they did in 2008-09 again, namely, to throw money into the economy and build even more useless things to counter the contraction, so that the GDP could still end up be growing at 7-8% rate. That would once again increase the share of investment of the GDP.
Alternatively, if policymakers decided not to act this time, we might be seeing GDP growing at low single-digit rate, or even a outright contraction. That would be negative for household consumption as income can’t grow.
This article originally appeared here: Rebalancing Chinese Economy: That Almost Impossible maths
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