After the co-ordinated rate cut in October, the Chinese cut interest rates in a show of solidarity. Now the rest of the world is talking about fiscal stimulus, and China is charging ahead. The State Council has announced a vast fiscal stimulus programme to pull China through the coming grim years. The stimulus, however, is taking the wrong form. Rather than trying to prop up the Chinese economy as it was, this is an opportunity to turn it into the economy China wants – one where consumption at home has more than a cameo role. The government must seize it.
There should be no surprise that China is slowing down. A global slowdown was bound to hit the world’s second-largest exporter. The International Monetary Fund now sees Chinese output, which grew by 11.9 per cent in 2007, growing by 9.7 per cent in 2008 and 8.5 per cent in 2009. This sounds strong to western ears, but few countries can absorb 3 percentage point falls in annual growth without problems.
Having cut interest rates three times within the past month, the Chinese State Council has now taken the advice of the IMF and the World Bank, and authorised $586bn of stimulus spending over the next two years. Housing, utilities, disaster relief and transport are expected to be the main beneficiaries.
Parts of this scheme have been announced before; so the true size of the new stimulus is not clear. But the problem for China is not whether it can build enough train lines, ports, pipes and houses to weather a global slowdown. It is that the Chinese economic model needs a substantial redesign.
China’s growth to date has been phenomenal, but it was based on exports and investment, at the expense of consumption. China almost aimed to be a supersized South Korea: in 2005, capital investment made up more than half of China’s gross domestic product. The capital-intensity of its growth also meant profits grew strongly as a share of GDP. But employment growth has slowed since the 1980s, so workers have gained small benefit.
With an undervalued renminbi also making imports dear, the Chinese public has proved loath to spend. China has far too little domestic consumer demand. Whereas household consumption made up more than half of China’s GDP in the 1980s, it now contributes little more than a third.
In the absence of a domestic safety net, Chinese household savings have been as high as a quarter of disposable income. In addition, corporate and government savings have soared. Overall, China has been saving close to 60 per cent of GDP. This contributed hugely to the global savings imbalance. Some of the deepest roots of the current crisis lie in the plugging of western deficits with Asian savings.
The Chinese government recognises that it must build domestic consumer demand, but it is time for the leadership to put its money where its mouth is. Alas, the planned stimulus does not attempt to boost public and private consumption. It aims, instead, to keep the economy ticking over until it can start exporting again. This will not work. This is the golden opportunity to redirect the pattern of growth towards consumption and away from the previous massive reliance on exports and investment.
In a country with light household taxes, there is little room to do much with cuts. A cash rebate would be more effective. Public spending on schools and health services would also help, directly and indirectly. Since fears about paying for health and education keep savings high, this would also encourage household consumption.
China’s leaders were right to propose a fiscal stimulus. But they will be missing a chance for meaningful reform if they focus on pouring concrete, and do not look at promoting household spending, as well. China’s problem is more than a mere global downturn. Its development model is no longer sustainable. The time for change is now.