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Discussing China's new growth model: the role of consumption

David Dollar's picture

The Hebei province produces one-quarter of China's steel, and has felt sharply the country's slowdown in investment during the financial crisis.
Last week I had the honor to be the first foreigner to speak at the Hebei Provincial Party School in Shijiazhuang, China. The school provides a range of mid-career training programs to local officials from this province, about the size of France. The topic was the global economic crisis and China's need for a new growth model.

These officials, close to the ground, understand the need for a new model. More than half of China’s growth in recent years has come from exports and investment. Hebei is not an especially export-oriented province, but it still has a large number of exporting firms, whose orders have dried up. Officials are particularly worried about what happens to small and medium firms in this situation. Hebei is also a major producer of the heavy industrial products like steel and cement that are inputs into construction. The province produces one-quarter of China’s steel, and hence has felt sharply the country’s slowdown in investment. The stimulus package to finance infrastructure investment helps limit the damage, but it is not likely to replace all of the lost investment in real estate and manufacturing. The fundamental problem is that real estate and manufacturing have large excess capacity, so that it is hard to see much incentive to invest further in those sectors.

Thus, consumption has to play a greater role in driving growth in China, and local officials asked what specific measures can help increase consumption in the country. Three types of measures come to mind.

First, consumption has been growing at a healthy rate above 8 percent during the boom period, so that simply maintaining that would be a good start. Reportedly, 20 million migrant workers have lost jobs in construction and manufacturing, so the risk is that their consumption will decline and have a spillover effect on others who increase precautionary savings as they see this distress. The Premier’s work report to the NPC noted an increase of 18 percent in central funding of the safety net.  Not all of the lost jobs will be reconstituted this year, so it is important to have transfer programs that support unemployed workers through the downturn. This kind of central funding of the safety net can help keep up consumption.

Second, in national accounting we count spending on education and health as consumption. This is a great time to expand government support to education and health. About 7 million college graduates will go on the market in June, and at the same time there are glaring needs to improve rural education, especially at upper secondary level. So, government support to education and health will be immediate stimulus that creates jobs, and will be an investment for the future. Most of the rural kids of today will end up working in cities tomorrow. There is a real risk that they won’t have the human capital foundation for the required jobs in what is likely to be an increasingly sophisticated, knowledge-driven economy.

Third, we have to recognize that consumption habits are not going to change overnight. But the potential problem of insufficient demand for China’s output is also not going to go away overnight. Even after the U.S. and other developed countries start to recover, it is likely that their consumption and hence imports will grow at slow rates for the foreseeable future. Hence, China needs not just to get through a temporary downturn, but a different, sustainable growth model. Right now relatively few people are covered by reliable pensions that they can carry from job to job. Reform of the pension system would reduce the need for households to save so much for an uncertain future. This last item will not have an immediate effect, but China needs both short-term stimulus measures as well as long-term structural changes.

I came away impressed that local officials have a good understanding of the dimensions of the global crisis and a willingness to think innovatively about changes to the growth model.

Image credit: 2_dogs at Flickr under a Creative Commons license.

Comments

Submitted by Uln on
It is great to read you again about China, it's been a while. Like usual, some interesting insight on the economy. And like usual too, an overly optimistic point of view. Really, can officials understand the dimensions of the crisis when they are fed articles like this one? http://news.xinhuanet.com/english/2009-03/08/content_10971771.htm

Submitted by Non Arkaraprasertkul on
Export-led business alone does not lead to the more stable ground for China’s long-term economy. It needs to develop its internal market. Let’s set a stage by taking a closer look at the cheap labor factor. Since the 1980s, a large number of migrant workers leave their home and come to the cities to seek employment in urban areas (the term “floating population” is a result of this ephemeral migration) to become workers in factories producing products mainly for export. In order to keep the price of the product cheap, the government keeps the wages for these workers very low yet still higher than the average of peasants in the agricultural parts of the country. Because these workers have no security due to the lack of social welfare, (for instance, personal health insurance is too expensive for them to afford), the workers save at least two-third of their salary and only spend a very small amount on necessary expenses. This does not induce the demand required to spin the wheel of capitalism. The money that could be circulated in the system – compulsory for the capitalistic economic system to operate –becomes highly stagnant in the governmental owned financial institution: having excess savings is as equally unproductive as using the fund to support unprofitable state-owned enterprises which is one of the heavy strains on China’s economy. So, while having to continue investment growth by virtue of its absorption of technological advancement through foreign trade, China has to increase domestic consumption to re-balance its growth. Hence, the institutions, by ways of the central government, have to consistently inject stimulus packages (Premier Wen announced in 2008 a USD586 million over the next two years) to encourage entrepreneurs activity so that “the free market characteristics” of the economy become more apparent. The decision to lower or increase the interest rates of the state-owned financial institutions in favor of a small number of private companies – not by the real market demand – tends to cause trouble. This, again and again, not only enlarges the already-dominant role of private actors in the business arena, but also increases the position of private initiative and market forces, especially in urban areas. That is, the stimulus plan does not solve anything but could instead worsen the balance growth by “tilting” the fund even more towards investment and an export-led agenda rather than toward much-needed private consumption. In the rural areas, the role of the central government in making broad decisions on priorities and policies is extremely influential. The central government usually disregards the free-market entrepreneurial economic system and uses its own judgment on the basis of its political agenda to determine what to produce: they would determine current supply merits a decision to allocate scarce resources to state enterprises manufacturing products that, most of the time, do not have the corresponsive demand. Without careful planning taking into account the social welfare of the workers, it does not matter how much money the government could bring to show off its magnificent GDP every year. The government would be perpetually burdened to inject more stimulus plans and continue to invest in large-scale infrastructure project that would only widen the gap between two social classes. That is, China needs to be extremely considerate about the development of the domestic market and seek a more balanced trade position. That is to say, its financial system needs to be reevaluated to encourage the citizens to consume more, which could only be done when the robust government safety net has been provided. In addition, China might have to shift its attention from export and industry to the fundamental topics: agriculture, land, and the peasant. To add to that, without cautious awareness to be drawn to the development of its internal demand, “three worst-case scenarios” are possible: the breakdown of the economic mechanism as a result of a possible budget crisis for which China has never been prepared given its control over its undervalued currency; the flaw of the governance due to the internal inequality and corruption; and, the collapse of its environment resulting in the collapse of China’s exports. On the other hand, through time, there have been a series of signs that China’s economic system possesses a high level of flexibility and opening to the suggestions from both local and foreign advisers on trade agendas which have constituted improvements in many areas of the system. China is “crossing the river by feeling for stones,” Deng said: experimentation and pragmatism at the core. Entry to the World Trade Organization (WTO) and normalizing US-China trade relations also amplifies the high level of flexibility.

Submitted by Anantha Nageswaran on
Back in November, in your post dated 19th, Nov. 2008 on China's need for a new growth model, you ended the post with these sentences: "Is the stimulus package big enough? I think that question is less interesting than the question of whether China is using the stimulus to make a transition to a new, more sustainable growth model." Nearly five months after this post, do you have clarity on whether China is using the stimulus to transition to a new, more sustainable growth model? A candid discussion on this given recent surge in bank lending, rise in FAI, etc., would be most useful for all - inside and outside China. Thank you.

China is definitely making progress on the new growth model. The momentum of income growth in recent years plus government programs aimed at rural households have kept consumption growing at a high rate despite the growth slowdown. So in the first quarter of 2009 consumption contributed 4.3 percentage points to China's 6.1% growth. Investment only contributed 2 points and the contraction of net exports subtracted 0.2 percentage point from growth. This is only one quarter but the effort to bolster consumption seems to be working. Also, many of the projects in the stimulus package are aimed more at household welfare than at increasing production capacity: projects such as passenger rail, urban public transport, wastewater treatment, and earthquake reconstruction. But it is early days so there are things to watch out for: what is the big increase in lending actually financing? If it increases capacity in sectors that are already over-built it will lead to future problems. Probably some local governments want the same kind of projects they had in the past, building industrial zones and increasing manufacturing and export capacity. The next year will be very interesting to see if the forces of rebalancing (consumption, investment to improve quality of life, service sectors) win out over any tendency to hang onto the old growth model (exports, industry, economic infrastructure).

Submitted by Anantha Nageswaran on
thank you, David. will be watching this space for validation or otherwise, of this hypothesis that China is transitioning to a new growth model. Area there historical precedents for this?

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