Consumption, not investment, now key to growth
Scholars and policymakers in China have not yet reached a consensus on whether stimulating consumption is the top priority for the Chinese economy at the moment. Some economists argue more about the need to boost growth by expanding investment, as they believe that stable investment will be the fastest way to encourage economic expansion.
My understanding is that competent policymaking departments and economists need to better realize and identify the importance of boosting consumption. Under China’s 20 years of stabilizing investment through infrastructure construction, it is necessary to completely change such concepts and realize the significance of encouraging consumption. There is still a lot of work to be done on this front. If this year’s policy is still the same as last year’s and the year before, it will affect growth stabilization performance in 2023.
What makes stimulating consumption for growth so important? The main reason behind it is that China’s economic structure has changed. In normal situations, consumption contributes about 65 percent of GDP growth in China. Therefore, as the proportion of fiscal funds spent to stabilize growth conforms to the economic structure, roughly 65 percent of fiscal funds are used to stabilize consumption, and the remaining 35 percent are put toward stabilizing investment. Yet, in practice, most of the fiscal funds are used to stabilize investment. This disrupts the overall growth structure.
With China’s economy developing and upgrading rapidly, consumption has now become the core factor in economic growth. The country has moved beyond the stage of 20 years of rapid urbanization and rapid industrialization, and infrastructure investment has been oversaturated. Therefore, if the method of stabilizing investment is once again applied to stabilize growth, it will seriously distort the driving force of China’s economic growth. However, I think such understanding has not yet been widely recognized by economists and policymakers, and therefore, further study on this matter is needed.
China’s previous strategy of stabilizing investment has caused distortions in the overall fiscal expenditure structure. Last year, China’s total GDP reached 114 trillion yuan ($16.2 trillion). The total amount of investment in fixed assets was 55 trillion yuan, while fixed-asset investment accounted for 48 percent of GDP. In comparison, in developed countries such as the United States, Australia, Japan and European nations, the annual total investment in fixed assets accounts for only about 20 percent of the country’s GDP. Long-term distorted structure caused by China’s large proportion of fixed asset investment in GDP is unsustainable.
I would argue that if the current economic structure is corrected and adjusted in the next 10 years, investment in fixed assets will drop from 55 trillion yuan to 30-40 trillion yuan and then decline further. Its high growth will undoubtedly crowd out consumption in the economy, and have a negative impact.
Here are some ways to boost consumption:
First, efforts should be made to promote consumption in terms of raising incomes, instead of working from the production standpoint. Since 2020, in Europe and the United States, the key measure to stabilize consumption has been to issue consumption vouchers to residents, and this has generated a notable effect in boosting the economy. If people’s disposable incomes decline, consumption will definitely drop. Therefore, efforts must be made to find a way to increase disposable income of Chinese consumers. However, if we talk about increasing disposable incomes and only work on stabilizing employment, it would not be sustainable over the long term. It is a long-term policy to stabilize employment as well as improve the social security system, medical system and education system, whatever the circumstances are. The core of stabilizing consumption is to increase household incomes. One way to bring this about is to increase current incomes; that is, issue consumption vouchers or money to residents. It is the correct way to stabilize consumption from the income side. Another way of effecting this is to increase investment income, such as making the stock market more prosperous, so that everyone makes money, thus leading to higher consumption.
Second, efforts should be made to increase the public’s marginal propensity to consume by cutting interest rates. The best way to increase the marginal propensity to consume in the short term is, in fact, by reducing interest rates, which frees up credit. The two methods for stabilizing consumption in Europe and the US in 2020 were distribution of money and lowering of interest rates. By raising incomes through distribution of money and lowering of interest rates, it is possible to increase the general public’s marginal propensity to consume. People’s incomes are divided into two parts. One part is used for saving and the other part is used for consumption. When savings increase, consumption decreases. Savings are closely related and very responsive to interest rate changes. When Europe and the US faced economic downturn pressure in 2020 and wanted to stabilize consumption, they once lowered interest rates to zero or even negative. But China seems to be more conservative with regards to cutting interest rates.
There are many reasons for China to be shy about cutting interest rates. These include the need to prevent real estate bubbles, avoid a stock market sell-off, safeguard against rampant inflation, and stabilize the RMB exchange rate. The goal of monetary policy is complicated and has many facets. It needs to work not only to maintain economic growth, but also to stabilize prices, support the capital market, undergird the housing market and stabilize the exchange rate. Currently, in terms of the stock market, the Chinese bourse has a flat performance during the past 10 years, and share prices of many listed companies have fallen to historic lows. A rise in the stock market can increase investment income and benefit consumption. In terms of prices, China’s producer price index has entered negative growth since October. Currently, we do not have serious inflation, so from the perspective of prices, cutting interest rates will also work. In terms of the RMB exchange rate, now that the appreciation of the US dollar has ended and interest rate hikes outside China have slowed, the pressure of RMB appreciation is gradually picking up. Therefore, to increase the public’s marginal propensity to consume and to stabilize consumption, we should cut interest rates.
In addition, it is also very important to boost consumption by creating consumption scenarios with engaging consumption activities, where consumers can truly interact with shops and products. If consumers cannot have such interactions, contact consumption in many scenarios will not be realized. This involves the impact of COVID-19 and how to contain the pandemic in a science-based, accurate way, instead of a one-size-fits-all approach.
To sum up, only by realizing the importance of consumption and work on the income front, cutting interest rates and creating more engaging scenarios for consumption can the Chinese economy likely see a rebound in the first quarter of next year.