The Chinese economy’s Great Wall

As we move through 2021, there are more signs of a return to pre-pandemic normalcy, at least in countries not reeling from dangerous new variants of the coronavirus. High-frequency economic indicators in many parts of the world are strengthening, concerns about mass unemployment are giving way to inflation fears, and the G7 has just held an in-person summit.

But there is a problem at the heart of the global economy: China’s interactions with the rest of the world appear to have taken a further negative turn because of the pandemic. Having created the BRIC (Brazil, Russia, India, and China) category in 2001, I have closely followed China’s ascent, and have come to be seen as a China bull. I became excited about the country’s economic potential in 1990, when I visited Beijing for the first time while working for the Swiss Bank Corporation. As I strolled the capital’s bustling street markets, I was surprised by how normal it felt. Might this supposedly “communist” country become a major force in the world economy?

That question stayed in my mind throughout the 1990s, partly owing to international macroeconomists’ persistent hand-wringing about the world economy’s growing dependence on US consumption. Those concerns had been building since my earliest days as a professional economist in the 1980s, when I found myself at the center of the policy dilemmas surrounding the Plaza (1985) and Louvre (1987) Accords.

At the time, US policymakers were eager to boost domestic demand in other developed countries (namely, Germany and Japan). And following China’s relative success in handling the 1997 Asian financial crisis, I came to see it as the alternative global engine that everyone had been looking for. But the goal of boosting domestic consumption poses a dilemma for the Chinese development model. Most data show that Chinese consumer spending still probably accounts for less than 40% of the country’s overall GDP. Investment spending and exports are what have fueled the Chinese juggernaut for most of the past three decades (and especially the early years). China’s modest consumption-to-GDP ratio stands in stark contrast to that of the United States, which, at around 70%, is probably excessive. The upshot, in terms of the global economy, is that Chinese consumer spending is technically only about one-third that of US consumer spending.

But several additional points are worth noting. While Chinese consumer spending remains relatively low, it has increased from around one-sixth that of the US over the past 20 years. Moreover, this marginal growth has had a much more powerful effect on the global economy than have changes in US consumption. And the Chinese consumer’s global influence has enormous potential to rise further relative to that of the US.

It is therefore in everyone’s interest that Chinese consumption demand continue to increase. While it is unlikely that China’s consumption spending will ever reach 70% of GDP, an increase to 50% is a perfectly reasonable and desirable target for both China and the world. If China’s GDP (in current US dollars) were to grow to match that of the US by 2030, a 50% consumptionto-GDP ratio would imply an additional $4 trillion of consumer spending globally.

In their latest deliberations, China’s leaders expressed a desire to double household incomes over the next 15 years, which would imply an average annual increase of around 4.5% in real (inflationadjusted) GDP. Given China’s aging workforce, this target is much more realistic than one attempting to match the doubledigit growth rates of the past, and it would be broadly consistent with the Chinese economy’s rise to parity with the US. But if China’s consumption-to-GDP ratio does not increase, I doubt it will achieve its goal.

Productivity and labour force

Like any other country, China’s economic growth will be driven over the medium term by the rate of productivity growth and the size and composition of its labour force. Because the labour force has stopped growing, additional economic growth will have to come from increased productivity.

Here, China must resolve a major contradiction. Typically, an economy’s most productive sectors are in manufacturing, not services; and it is in manufacturing that additional productivity gains are easiest to achieve. But China must simultaneously boost the role of personal consumption, which generally implies higher demand for services. Achieving both objectives simultaneously is easier said than done.

I suspect that Chinese policymakers have not yet thought enough about this dilemma or about how it might affect China’s other international challenges. Even before the COVID-19 pandemic, it was clear that China’s economy is simply too big for its policymakers to ignore the global implications of their decision-making. Issues ranging from Chinese tech giants like Huawei to the presence of Chinese students at Western universities had become sources of tension. And, of course, there are international concerns about China’s human-rights record and the domestic failures that allowed COVID-19 to escalate from an outbreak to a pandemic.

At the end of the day, China will need the rest of the world if it is to increase both domestic consumption and productivity. The best way that China can improve its international standing is through soft diplomacy that respects other countries preferences and aspirations, rather than treating them as sources of confrontation. Without such a change in attitude, China will not reach its goal of doubling incomes within 15 years, leaving its people – and the rest of us – worse off as a result.