Tricky rebalancing act
The Chinese consumer is the “single most important thing in the world economy”, says Jim O’Neill, a former Goldman Sachs chief economist. “The next 40 years of global growth might be about the Chinese consumer. It is very unlikely that any other country could step in to drive global consumption.”
With its housing and industrial sectors mired by overcapacity, greater production of consumer goods and services should provide a more sustainable basis for economic growth in China.
But with investment in new production the cornerstone of the country’s development, economists expect a more consumption-driven economy to be a slower growing one. Indeed, the shift has coincided with a slowdown in Chinese growth, which last year fell to its lowest rate, 6.6 per cent, since 1990.
Beijing faces a tricky rebalancing act, therefore, as it tries to avoid a “hard landing” for the economy: investment remains critical to growth and slowing it too rapidly could deflate consumption. But if consumption remains at its current level – still low by international standards – then wasted investment and lack of demand will drag down the economy anyway.
“Investment is still driving demand, that’s what creates jobs,” says Keyu Jin, a professor at the London School of Economics. “You can see clearly that as soon as investment slows down the economy slows down.”
As a recent rattling of global stocks on fears of a slowdown in China showed, the challenge reverberates beyond the country to the fortunes of consumer goods groups from carmakers to technology and pharmaceutical companies.
But Beijing could tolerate a short-term slowdown for the sake of longer-term growth, analysts say. “Changing China’s growth model, or ‘economic rebalancing’ for short, was never aimed at boosting GDP growth, but at making growth more sustainable,” says Pieter Bottelier of the Carnegie Endowment’s international economics programme.
Domestic demand is key
Jiang’s annual household income of about 90,000 yuan ($19,000) is a reminder that most Chinese consumers remain poor by developed world standards. It puts the family above the median Chinese income of 68,000 yuan, according to the China Household Finance Survey, but at $US23,000 ($32,000) in purchasing power parity terms, the figure is well below the US median of $US31,000.
However, Chinese household income has grown at a much faster pace than in the developed world in recent years. Median individual disposable income grew more than 9 per cent annually between 2011 and 2017, according to CHFS data. This growth was aided by the accumulation of capital and technology which has made workers more productive. But the rise in household income has outpaced growth over the same period.
Underlying this are the changing employment dynamics, which saw the share of labour compensation as a percentage of GDP rise from 46 per cent in 2007 to more than 60 per cent in 2016. By then China’s labour pool had begun to decline, while labour-intensive service industries became the main source of economic output, pushing up wages.
Jiang and her husband, also a teacher, do not work in the private sector, which accounts for most of the country’s jobs. But schools have increased pay and benefits such as healthcare in recent years and Beijing hopes Zhang and consumers like him pick up the baton of growth.
With global growth tepid and rising political resistance to trade imbalances, China cannot look overseas for demand as it did before the financial crisis so has to look for it at home. Investment, which surged in property and heavy industry sectors such as steel production after the financial crisis, is becoming less efficient.
“China needs to start making higher-return investments … those that successfully anticipate or create demand from the growing middle and upper classes,” according to analysts at Gavekal Dragonomics, a consultancy.
The current level of rebalancing has already helped that process: services accounted for more than half of fixed asset investment last year, a record. And as the rise of Chinese consumer goods companies – especially telecoms groups such as Huawei and Xiaomi – has shown, Chinese companies are capable of hitting a high level of productivity based on domestic demand.
“China doesn’t need to rely on international trade to the extent its east Asian neighbours did,” says Nicholas Lardy, a fellow at the Peterson Institute for International Economics in Washington. “Its domestic market is big enough that all the economies of scale can be gained through domestic sales.”
But just as China needs them most, consumers are growing cautious. Vehicle sales in the world’s largest car market fell for the first time since the 1990s last year, while retail sales growth slipped to 8 per cent – a 15-year low – and the smartphone market is shrinking.
With the US-China trade war creating uncertainty, despite more emollient noises from the White House, and a tightening of credit growth which has led to a curbing of corporate investment and increasing bankruptcies, consumers appear to be cutting back on large discretionary purchases such as cars.
In Wuhu, the largest employers – carmaker Chery and Anhui Conch Cement – are both trimming investment. Government infrastructure projects, such as the construction of a series of six bridges in the city, are also slowing.
Yet closer analysis suggests fears about falling consumption are exaggerated. The reasons behind the drop in car sales are often sector-specific factors, such as tax cuts being reversed.
Likewise, retail sales offer an imperfect picture of household spending. The figures include corporate and government purchases, while as Chinese households become more affluent, more of their spending goes on services than goods. Zhang, for instance, says 15 per cent of the family’s household income is spent on tourism. Their daughter’s education is another big expense.
“We expect consumption growth to ease further this year but to continue to outpace investment and be a key driver of economic growth,” says Tianjie He, an analyst at Oxford Economics in Hong Kong. “Concerns about China’s consumers are largely overdone”.
The recent wobbles in consumer confidence reflect a fundamental fact about the economy. Growth in worker productivity comes mainly from investment undertaken by companies and local governments. And last year, fixed asset investment in China recorded its slowest growth since the 1990s, while income growth fell below 7 per cent.
High house prices
In theory, the share of investment in GDP can fall without slowing growth, as long as the investment becomes more efficient.
“It is impossible to efficiently invest 40 per cent or more of GDP, just too much gets wasted,” says Lardy. Increasing consumer-focused investment will help with efficiency, as consumer-focused firms tend to be more privately dominated. Chinese companies such as Tencent and Alibaba are investing billions in consumer infrastructure online and offline.
But Lardy warns that “if you continue to invest inefficiently and slow down the investment rate, you are going to slow down your growth”, estimating that increases in GDP could slow to 4 per cent in the next few years if credit allocation does not improve in China. “That is why you shouldn’t dial back the investment ratio [too] quickly.”
There is a danger that the growth in overall consumption could end up being stifled by rising inequality. As of 2015, the top 10 per cent of Chinese owned more than 65 per cent of household wealth, with the bottom 50 per cent owning less than 10 per cent. This is partly reflected in China’s high household savings rate, which peaked at 25 per cent of GDP in 2010 but has since dipped. Reducing it is essential to ensuring that the rebalancing is sustainable.
The IMF recently warned about the shortfall between household income and consumption, saying there was room for growth. “GDP per capita in PPP terms [is] similar to Brazil’s, [yet] consumption per capita in China is only comparable to Nigeria,” the IMF wrote in December. “If Chinese households consumed comparably to Brazilian households, their consumption levels would be more than double.”
Economists agree that high house prices are a crucial factor keeping savings by Chinese households at 37 per cent of income and putting a brake on consumer spending.
For years Jiang and her husband paid into a scheme to fund a house purchase. But buying a property in 2016 with a large downpayment enabled them to increase discretionary spending. An expanded social safety net in China, including a partial health insurance system, and a larger population of pensioners who tend to draw down their savings have also boosted discretionary spending.
But they are fortunate. Towards the bottom end of the income scale, households borrow heavily to afford housing. China’s household borrowing has risen to 49 per cent of GDP, mostly due to an increase in mortgage debt.
Made at home
With Chinese income taxes making up a negligible portion of government revenue, and a long-awaited property tax delayed, most redistribution is happening within families rather than through the fiscal system. Jiang’s daughter, Zhang Siyuan, has parents and grandparents willing to transfer some of their savings to a younger generation that is more likely to spend it.
China’s Generation Z, born after 1998, accounts for 15 per cent of all household spending in China, compared with 4 per cent in Britain and the US, according to OC&C Strategy Consultants.
“A new generation of consumers who are low savers are beginning to enter the market,” says the LSE’s Jin. “But this is taking time.”
Apple’s revenue warning in January, prompted by slowing sales in China, was a reminder of just how important the country’s consumers are to the profits of multinational groups. GM sells more cars in China than it does in any other market, and Starbucks has more stores in the country than any other country except the US.
These companies carry out the vast majority of their production for Chinese consumers in China itself, meaning the benefits of these sales flow overseas only via remitted profits, or higher equity values for the companies. Chinese consumer imports amounted to just $US205 billion in 2015, according to the most recent World Bank data, or about 12 per cent of total imports. And while 23 million passenger vehicles were sold in China last year, fewer than 1 million were imported. Tourism is a notable exception, with outbound spending reaching $US258 billion in 2017.
There are some goods that Chinese consumers demand but which cannot be produced domestically at a lower cost or at equal quality. Most notable are luxury goods. Imports of dairy products from New Zealand and avocado, cherries and other fruits from Latin America have surged.
But that does not detract from the fact that China has already become the production site for most consumer goods, reducing the need for imports. That contrasts with its investment, which remains stubbornly reliant on imports of commodities. The import-intensity of Chinese consumption – a measure of the percentage of final household consumption directly due to imports – is about 10 per cent, says Diana Choyleva of consultancy Enodo Economics. For investment that figure is closer to 20 per cent.
“A consumer-led recovery, unlike the investment-led revivals of the past, will be a lesser growth engine for the rest of the world,” warns Choyleva. “China will be producing more of the manufactured goods it will be consuming.”