China towards a model of increased domestic consumption

China towards a model of increased domestic consumption
The Chinese economic challenge for the next decade.


The weakness of the main Chinese export markets, combined with a model based on investment and foreign trade have generated distortions that require correction. The prescription is to turn the Chinese model towards greater reliance on domestic consumption to generate sustainable growth at high rates.

In recent years China’s top leaders have repeatedly described the country’s current economic model as “uncoordinated, unstable, unbalanced and unsustainable” This language is in stark contrast to what has been a decade of apparent success: economical growth at high speed and fast Chinese rise in the ranks of middle-income countries. What explains this inconsistency between rhetoric and financial records? The Chinese authorities have correctly assessed that the country’s economy and its rapid growth in the last decade have been based on high levels of investment and private consumption systematic repression. This has resulted in a model of capital-intensive growth that has not generated adequate increases in domestic consumption and employment. Instead, it has built significant distortions in the economy.

Rebalancing an economy as large as China is a long and complicated task. Fortunately, economic policy prescriptions are relatively clear. The imbalances in the Chinese economy distortions were created by three of the most fundamental economic prices: interest rate, exchange rate and energy prices. An undeveloped social safety net and high levels of income inequality have exacerbated imbalances. These rebalancing policies must focus on enabling these key prices to be more determined by the market. The government should increase social transfers and guide the economy toward a more equitable distribution of income. Most of these economic policy proposals are nothing new. The nature and evolution of the Chinese economy, however, have changed the relative importance of these various reform policies. Specifically, the decline in the current account surplus of China, and therefore lower rates for intervention in the exchange market, have reduced the importance of the reform of the exchange rate on the reform of the interest rate. In addition, new data on the high levels of income inequality in China have led to weigh explicitly the relationship between income inequality and economic rebalancing.

China towards a model of increased domestic consumption

The savings-investment equation indicates that the difference between national saving and domestic investment equals the current account surplus. More simply put, the production that is not consumed or invested in the country is sent abroad. China’s policies that repress consumption include negative real interest rates on bank deposits for families, an undervalued exchange rate, a thin social safety net and restrictions on the ability of workers to organize and demand higher wages. This level of suppressed consumption combined with subsidies to a super-production generates a large trade surplus.

While external rebalancing has taken place in recent years is real, it has not been produced in an ideal way. To balance the savings-investment equation, in recent years, the investment rate in China has skyrocketed, so that the current account surplus has shrunk.

This only aggravates the problem of over-investment in China. A much more convenient way to reduce external imbalances would have been to lower the excessively high Chinese savings rate, pouring resources into the domestic market consumption. This would bring great benefits to the global economy, as China’s actual demand, thus generated, would help developed economies find their path out of recession or slow growth, by means of exports of goods and services with high added value. In addition, the global economy would be more harmonious and balanced.

The highest Chinese authorities are working along these lines. Former Prime Minister Wen Jiabao said in 2012: “We must accelerate the restructuring of economic policy adding to domestic demand, especially consumption, innovation and energy savings for a socialist construction in all economic, political, cultural and social matters, also preserving stability. Wen also asserted, “We must overcome the imbalance and lack of coordination and address pressures on employment, development of agriculture, an increase in farmers’ income, excess capacity in certain sectors and excessive energy consumption.” Wen then confirmed that consumption is key to unlocking the full potential of domestic demand in an economy of about 1,300 million people, reducing excess, inefficiency and inequality. “We must firmly take the road of expanding domestic demand, as our long-term strategy for economic development,” Wen told the delegates gathered in the Great Hall for the annual meeting of the National People’s Congress of China. The annual meeting ended in March 2013, with the change of guard of the highest authorities of China. The plan is the road map that will guide the incoming administration led by Xi Jinping, who formally took over as president at the end of the session, with Li Keqiang taking the post of prime minister.

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