Satyajit Das: Low consumption is the flaw in China's economy
Midweek View: While China's rise is important its ability to support the global economic and financial system is overestimated
Satyajit Das writes the Das Capital Column in the Independent. He has worked in financial markets for over 35 years, as a banker, a corporate treasurer and now as a consultant to banks, fund managers, governments, companies and regulators around the world. He is also the author of Traders Guns and Money and Extreme Money as well as a number of reference books on derivatives and risk-management, which double as 'door stops'. He became a banker because he wasn't good enough to be a professional cricketer, but would give up finance if anyone offered him a job as a cricket commentator or allowed him to pursue his other passion- wildlife (he is the co-author with Jade Novakovic of In Search of The Pangolin: The Accidental Eco-Tourist). He lives in Sydney, Australia.
Wednesday 18 April 2012
The Chinese economy is forecast to expand by around 60 per cent in the period between 2007 and 2012, compared to about 3 per cent for developed economies. The Middle Kingdom has contributed significantly to global growth since the start of the financial crisis.
A key theme of China's emergence is the hope it can become a significant source of global demand, replacing the US as the consumer of last resort.
Consumption totals around 35-40 per cent of China's GDP, a decrease from more than 50 per cent in 1980. Even by the thrifty standards of Asia, Chinese consumption is low. Japan, India, Taiwan and Thailand are at 55-60 per cent, while South Korea and Malaysia are around 45-50 per cent. US consumption is around 65-70 per cent of GDP.
In contrast, Chinese fixed investment is around 46 per cent of GDP, an increase over the last decade of 12 per cent from 34 per cent.
China's consumption has been growing at around 8 per cent per annum over the last decade but growth in consumer spending has been slower than that of the overall economy. Between 2000 and 2010, gross fixed investment grew at an average annual rate of over 13 per cent, while private consumption grew at around 8 per cent. In the same period the share of private consumption in GDP fell from 46 per cent to 34 per cent, while the share of fixed investment rose to 46 per cent.
One factor has been an underdeveloped social welfare system. When the state-owned enterprises (SOEs) were reformed almost a decade ago, Chinese workers lost their state-provided health care and education. They must now save to cover the expected costs of education, retirement and health care. The government's expenditure on health, education and social security is around 6 per cent of GDP compared to an Organisation for Economic Co-operation and Development average of 25 per cent.
Another factor is the falling share of national household income. In contrast, corporate earning has risen faster than wages. This means China's high growth rate has not created a commensurate boost in new jobs or incomes.
Investment-driven growth also favours SOEs and large projects. Lending policies, exchange-rate policy and control of input costs such as land and energy, favour infrastructure and manufacturing rather than services, limiting employment and income growth.
Higher savings and lower consumption has been encouraged by an inefficient banking system, low interest rates, limited access to individual credit and limited investment products. Chinese saving rates have increased to around 24 per cent of income from a low of 12-15 per cent around 20 years ago. Companies have also increased surpluses, contributing the bulk of domestic savings.
Over the past decade, nominal lending rates in China have been about 6 per cent, well below nominal GDP growth rates of 14 per cent. Assuming Chinese interest rates have averaged 4-6 per cent below the required rate, this equates to a net transfer from savers of about 5 per cent of GDP each year. This keeps China's cost of capital low, facilitating its investment strategy as well as helping cover the non-performing loans made by banks.
At the same time, China was investing 10-12 per cent of its GDP each year in low-yielding foreign assets, through its current account surplus and currency reserves – equating to a third of the country's total consumption.
The level of consumption growth needed to rebalance China is large because of its low existing base. If China grows at 8 per cent per annum, consumption needs to grow by around 11 per cent (3 per cent above growth) to increase the share of consumption from 35 per cent to 36 per cent of GDP in a year. Assuming a growth rate of 8 per cent and consumption increases of 11 per cent, it would take around five years to increase consumption to 40 per cent of GDP. To increase consumption to 50 per cent over 20 years, it would take consumption to grow at least 9 per cent, 2 per cent above an average projected growth of 7 per cent.
Increasing consumption at the required rate requires an increase in household income, reduced savings or a combination. It needs a rapid increase in wage and employment levels. It will require reform of the welfare system, especially health, education and pensions. It requires changes in banking, especially the process of allocating credit and higher interest rates, which would boost incomes and also increase costs to businesses. It requires changes in regulations that favour manufacturing, as well as land reform and changes in the mobility of the labour force.
While China's rise is important, its drivers are often misunderstood and poorly analysed. China's economic structure is flawed and fragile. Its ability to support the global economic and financial system is overestimated. A failure to redress the balance between consumption and investment is at the heart of China's economic dilemma.
Satyajit Das is author of 'Extreme Money: The Masters of the Universe and the Cult of Risk (2011)'
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