As the world’s most populous country posted double-digit GDP growth rates through much of the last decade, it seemed a no brainer: China is on a record pace to becoming the biggest consumer market in the world.
Or so most people thought.
Nicholas R. Lardy, a Senior Fellow at the Peterson Institute for International Economics, told a packed house in April attending the N.T. Wang Distinguished Lecture series that the country is suffering from a savings/consumption imbalance that threatens the country’s growth juggernaut. “Almost half of the country’s GDP goes to investment — it’s been above 40 percent of GDP for eight years,” Lardy said. Simply put: Without domestic consumers to buy Chinese goods, it’s only a matter of time before the economy stumbles.
Lardy, the author of Sustaining China’s Economic Growth After the Global Financial Crisis (2012, Peterson Institute), outlined causes and effects of the imbalance that could have a pronounced affect not only on China’s ability to sustain growth but also on the multinationals that are betting their market share on Chinese consumers. Chief among the culprits is the lack of a social safety net, which leads Chinese households to save furiously in an attempt to self-insure in case of illness.
The government greatly exacerbated the problem in 2003, explained Lardy, when it lowered real interest rates on bank deposits from above 3 percent to the current negative level. Contrary to what would likely occur in most developed economies, Chinese households actually began saving more money in an attempt to make up any shortfalls as interest income fell.
The Guiding Hand, The Dictatorial Hand
A second problem is where well-to-do Chinese chose to put their savings. Rather than channel cash into stagnant bank deposits or the Chinese stock market (returns are down 60 to 70 percent since the Shanghai Stock Exchange Composite Index peaked in 2007), an increasing hoard is buying property — primarily residences in new high-rises in China’s burgeoning cities.
In fact, more than 9 percent of China’s 2011 GDP went to build residential housing (compared with about 2 percent in the United States). Lardy suspects that up to half the properties were bought as investments rather than homes, pointing to wealthy Chinese who own multiple residences. “Scan the lists of the richest people in China,” he suggested. “Somewhere between two-thirds and three-quarters of the 100 richest have made their money in property. This is very different from the oligarchs in Russia who stole state assets to make their fortunes.”
To be sure, investment in property has helped the Chinese economy stay afloat in a world where trade remains muffled. As they move to new homes, Chinese consumers buy household goods, furnishings, and cars to commute from the suburbs. But Lardy worried that such a property surge cannot last. Rather than a bursting of the bubble, he predicted a substantial and prolonged construction slowdown either when housing demand is met, when interest rates rise enough to encourage bank deposits, and/or when the rapidly growing price of housing just becomes too much for would-be homeowners to stomach.
If the country doesn’t get its act together, that drag on the economy could be substantial — and have political implications. The purchase of so much property by China’s wealthy minority has created an income imbalance between classes and geographic regions of the country. Although all economies have some imbalance between rich and poor, he indicated that China’s gap is growing rapidly and doesn’t leave enough consumers with disposable income to keep the economy humming.
“Financial repression is a zero-sum game,” Lardy said. “In China it involves redistributing small amounts of money out of the pockets of large numbers of people and putting it in the hands of a smaller group that benefits enormously.” The winners, he said, include commercial banks and property developers as well as manufacturers who receive preferential loans. Losers include small businesses, the service sector, and domestic consumers; China’s inland provinces that have seen far less development than the coastal cities; and first-time home-buyers faced with soaring property costs.
Lardy outlined four broad reforms — two financial and two social — that could help correct the imbalances, thus encouraging consumption and giving the economy an on-ramp to continued growth.
By raising bank deposit rates, the government could help redirect savers’ cash out of property and into more fluid bank savings. Also crucial is rebalancing the economy to rely more on domestic consumption and less on internal investment and exports. The government could encourage this by allowing the renminbi to appreciate further against the dollar and other currencies, which would make exports more expensive and imports cheaper. A stronger renminbi would also have a better shot at becoming a reserve currency, lessening the need for the Chinese government to stock its coffers with dollars.
The social reforms that Lardy recommended begin with broad healthcare and insurance reforms that will create a safety net and thus free the Chinese people from the need to self-insure. Finally, the government should reduce preferential treatment aimed at exporters so that domestic aspects of the economy can grow. For example, a grid that now directs 75 percent of China’s electricity to the manufacturing sector should be broadened to the service sector, which employs more people and supports domestic commerce.
“If those four planks are implemented,” Lardy said, “China has the prospect of gradually reversing this long-term slump in consumption, which means they could still sustain relatively high economic growth — but with a much different structure of demand that will benefit more of the Chinese population.”
Although government officials have paid lip service to many of the reforms he mentioned in the past, Lardy said he is optimistic that China will take steps to rebalance its economy, giving the country at least a fighting chance to continue its consumer-aided growth. “Nothing focuses the mind like the prospect of a slowdown,” he said.