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February 28, 2013

Will China Slow Down? Not So Fast.

After three decades of barely-checked expansion, the world is waiting for China's economy to run out of steam. Shang-Jin Wei argues that China's unique features will likely help it offset some of the slowing forces and maintain speed for the next decade.
Shang-Jin Wei

In the popular imagination, China’s economy is often viewed as a lopsided three-horse chariot: exports and investment are steroid-fed giants, while consumption is a dwarf, perhaps intentionally stunted by government policy. But there are a few things wrong with this image.

While China does need to adjust to the fact that exports can’t outpace imports forever, there is nothing wrong in and of itself with high export growth, and China will continue to benefit from high exports volume, even as a share of GDP, as long as imports keep pace.

Its investment to GDP ratio may need to be moderated somewhat. But the primary problem is not the level of investment, it’s the composition. China can — must — improve its financial system by capping the allocation system to allow more domestic and foreign capital to be allocated away from the less efficient majority state-owned entities toward more efficient privately-owned entities.

Consumption does need a boost, but it’s hardly a dwarf among giants: per capita real consumption in China, adjusted for inflation, has increased by 80 percent cumulative over the last seven years, in spite of a global recession in more recent years. No other country of a reasonable size can match this rate of growth during the same period.

It is true that GDP has grown over the same period by more than 80 percent, which means that consumption relative to GDP is not holding up.

Three things need to be done to address this. First, the country needs to strengthen its social safety net so that people, especially low-income people, can feel less compelled to save a lot for the uncertainty associated with retirement needs or health care needs. The country has made important strides in this dimension.

Second, the government has announced its intention to improve income distribution, redirecting it toward households, and especially toward lower income households. The idea is that with more income, households can consume more. One of the risks is that some policy initiatives, such as an aggressive increase in the minimum wage, could achieve the opposite result if it discourages firms from employing low-skilled workers. A more effective way to do this would be to raise the subsidies to low-income households in health care insurance, retirement funds, and children’s education. Reforming the household registration (the "Hukou" system) would be another way to improve the income distribution.

Third, the country needs to find a way to reduce competitive savings triggered by a high sex ratio imbalance. This is a hard problem but the first challenge is for the policymakers to recognize the significance of the competitive savings.

The competitive savings motive is a less immediately tractable aspect of consumption. China must alter the consumption habits of its citizens. But this is considerably more difficult to address because it is directly linked to why Chinese people save so much.

Some experts attribute China’s high savings rate, which depresses consumption, to artificially depressed interest rates. But a rise in the interest rates would have two competing effects on savings. Higher rates may give people a little more income to consume but they also make saving more attractive relative to consumption. Some years ago, the Chinese Central Bank tried to alter the incentive to save by introducing (and then removing) a tax on interest income. This of course altered the after-tax interest rate, but the aggregate household savings rates before and after the tax remained unchanged — there was no net effect.

The status competition triggered by a high sex ratio also has important implications for the country’s growth rate. There are well-known factors that could tend to slow down the growth rate for China over the next few years — rising labor costs, a declining share of the labor force in the total population, environmental challenges, and the need to switch from cost-based competition to innovation-based competition. And we know that most countries that experience decades of high growth will start to slow after 30 years.

But China has some unusual features that will partially offset the conventional factors: before 2002, the ratio of men to women in China was close to 1 to 1, which is where it should be. Today it is 1.15 to 1. A difference of .15 sounds small, but it has major implications for growth. It translates into the fact that, mathematically speaking, 1 out of every nine men cannot get married.

Most young people want to get married, and most Chinese parents with a son want him to get married. How do you respond to the 1 in 9 chance — a very real possibility — that your son may not be able to get married? You see wealth as a useful comparative weapon in the marriage market and, suddenly, accumulating wealth, which was already important, has become even more important. And the desire to accumulate more wealth leads to more savings, working harder, being more productive, and an increased willingness on the part of more people to take entrepreneurial risks, all of which collectively translates into extra growth.

Interestingly, the enhanced desire to accumulate wealth by young men and families with sons can spill over to other families, including families with daughters. This is a subtle argument. On the one hand, families with a daughter may free ride and work less. On the other hand, if families with a son start to save more, buy and live in a bigger house or apartment, other families may feel compelled to do the same in order not to lose their own social status. Moreover, parents with a daughter may wish for her to be matched with the best possible man. If men or families with a son also prefer women from a relatively wealthy family to one from a poor family, other things equal, this could translate into a race for more wealth by families with daughters. In any case, the net effect of a sex ratio imbalance on economic growth can be estimated with household and regional data.

In recent research with Dr. Xiaobo Zhang of the International Food Policy Research Institute, I estimate that this has given China about 2 percentage points extra growth over the last decade. We know this will get stronger over the next 10 years. Why? Because demographic data tells us the sex ratio of today’s 15- and 20-year olds, who will be looking to get married sometime over the next decade and half.

The sex ratio imbalance at birth has already started to moderate since around 2009. However, the sex ratio imbalance for the age cohort looking for a marriage partner will continue to be bad, and in fact, to deteriorate over the next decade and half, eventually becoming 1.2 to 1.

This means that China’s competitive saving motive — the tendency to oversave to compete in the marriage market — will likely get stronger over the next decade before it gets weaker. [Read Wei’s research on the competitive saving motive here.] And until we see a significant shift in the demographic trend, China’s competitive marriage market and the extra work effort and extra entrepreneurship it engenders will offset the slowing growth that the world expects to see from China.

Shang-Jin Wei is the N.T. Wang Professor of Chinese Business and Economy in the Finance and Economics Division and director of the Jerome A. Chazen Institute of International Business at Columbia Business School.

This article is based on remarks made at the February 13, 2013 Chazen symposium, The World Economy: What Now? You can read the full transcript here.