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China's Investment/Consumption Dilemma

Posted by: Dexter Roberts on November 14, 2008

The $586 billion stimulus package’s rationale is clearly to serve as a major investment push for the slowing Chinese economy with an immediate aim—helping those industrial sectors of the economy that are most ailing. Above all, the plan to spend hundreds of billions of dollars (or four trillion yuan) much of it on roads, rail, energy infrastructure, and housing intends to boost the construction sector, help the steel, cement, and other related industries, and so of course the struggling real estate markets.

That undeniable focus on investment is not necessarily a bad thing at all however. First of all, China can afford this massive spending (it is capital flush and has low debt levels) unlike most of the rest of the world. China too continues to have tremendous unmet needs for new infrastructure, particularly in the countryside—China is far from even approaching the Japan dilemma of building bridges to nowhere or using excess infrastructure build just as short term economic booster. And secondly, the stimulus package clearly does have a secondary purpose, albeit one that will take much longer, of boosting the ongoing rebalancing effort aimed at weaning China’s economy off this same heavy spending, and eventually creating a more consumption-driven economy. Therefore the sections aimed at welfare housing, healthcare, relief for the poorest in urban and rural China, higher grain prices, etc.

This long term goal of rebalancing that is also part of China’s latest five year plan, so far has had decidedly mixed record however. Indeed, China’s consumption as a percentage of gdp is still low—under 40%, and worse yet has actually been declining since 2000. That is because of a continuing policy bias that favors corporations over consumers in China, including with near zero real interest rates for individual deposits. But it also has much to do with continuing uncertainty about the future and an incomplete social welfare net, which keeps Chinese saving their cash rather than spending it. Wage income as a portion of gdp too has declined which hurts the rebalancing effort. And growing unemployment will only make things worse.

This is not all bleak however. On the positive side, one reason that wage income and consumption haven’t grown in percentage terms, is simply because they can’t keep up with the torrid growth we have seen in investment and trade in recent years. There is a parallel to the urban/rural income disparity issue: while China has made progress in boosting rural incomes these last few years, the gap between rural and urban incomes has continued to widen. That’s largely due to the remarkable growth in urban incomes. And the ongoing massive urbanization now underway will help China move towards a more consumption driven economy too. Short term however, things look very tough for boosting consumption.

China’s economy faces a “formidable challenge” due to the “severe situation at home and abroad” warned NDRC vice chairman Mu Hong at a briefing today. However, “we have a market of 1.3 billion people which has great potential and we also have great potential to boost investment and consumption,” Mu said. “We still have large room to maneuver to ramp up domestic demand.” The potential is there but unlocking it anytime soon is another matter.

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Bloomberg Businessweek’s team of Asia reporters brings you the latest insights on business, politics, technology and culture from some of the world’s biggest and fastest-growing economies.

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