Why Is It So Hard for China to Boost Domestic Demand?

Overview:

This article was written by Michael Pettis at Carnegie Endowment for International Peace.

• The Chinese Communist Party's recent Third Plenum communiqué focused more on supply-side measures than demand-side initiatives, despite widespread consensus that boosting consumption is essential for sustainable growth.
• Structural, supply-side changes are vital to enhancing consumption’s role in China’s economy, but these are complex and have far-reaching consequences.

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Key Quotes:

• "Beijing has been unable to shift the economy away from its overreliance on investment—and, more recently, on its trade surplus—to maintain high growth rates."
• "Thanks to these direct and implicit transfers, in other words, China’s extremely competitive manufacturing—and the world’s best transportation and logistical infrastructure—should not be thought of as separate from the country’s extraordinarily low domestic consumption."

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What They Discuss:

• Consumption accounts for approximately 75% of GDP globally, but only about 53-54% in China, with investment constituting 42-43% of GDP.
• Despite general agreement among economists, China remains heavily reliant on investment rather than consumption for economic growth.
• Structural transfers in China—such as repressed interest rates and a rigorous credit system—have subsidized businesses and investment at the expense of households.
• China’s hukou system and other policies have kept wages and household income growth subdued, further limiting consumption.
• Inefficient investment, particularly in infrastructure, has led to rising local government debt without corresponding economic benefits.

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What They Recommend:

• Implementing fiscal stimulus directed at the demand side would offer a temporary boost to household consumption but is not a sustainable long-term solution due to debt concerns.
• Gradually reversing structural transfers to allow household income to grow faster than GDP presents a more sustainable, albeit challenging, approach.
• Reforming inefficient investment practices and ensuring more resources go towards households would support sustainable consumption growth.

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Key Takeaways:

• Boosting consumption in China is a complex challenge deeply intertwined with the country’s overall economic structure.
• Temporary fiscal measures alone are insufficient; long-term structural changes are necessary to sustainably enhance the role of consumption.
• Any significant shift in policy could potentially impact China’s manufacturing competitiveness and lead to short-term economic contractions.
• Structural reforms pose a challenge as they involve redistributing resources from businesses and local governments to households.

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This is a brief overview of the article by Michael Pettis at Carnegie Endowment for International Peace. For complete insights, we recommend reading the full article.