• Thu
  • Oct 23, 2014
  • Updated: 6:06am
PUBLISHED : Friday, 19 July, 2013, 12:00am
UPDATED : Friday, 19 July, 2013, 5:08am

Logic of China's economic growth policies Orwellian

Rebalancing away from investment and towards consumption while growing at 6.5 or 7 per cent is just not possible, simple arithmetic shows

There is a scene in George Orwell's masterly political satire 1984 where the Party interrogator O'Brien uses high-voltage electric shocks to convince Orwell's everyman protagonist Winston Smith that two plus two equals five.

Barring the electric shocks, it looks as if Beijing is trying to work a similar trick on the world's economists.

China's new leaders have persuaded the world they are genuine reformers, and that they will accept slower growth, in exchange for a healthier, more balanced economy.

In a nutshell, that means they want to wean China off its unsustainable dependence on investment, which last year accounted for a record 46 per cent of gross domestic product. Instead, they want to engineer a greater contribution from consumer spending, which in 2012 made up a feeble 36 per cent of GDP (see chart).

At the same time, however, Premier Li Keqiang has pledged the government would not permit economic growth to fall below a minimum acceptable floor rate, which, judging from recent comments by senior officials, has been set somewhere around 6.5 or 7 per cent.

Unfortunately, basic arithmetic dictates that these two policy objectives - rebalancing and maintaining growth above a 6.5 per cent floor rate - are contradictory.

To see why, we need only do a simple back-of-an-envelope calculation.

First, we have to determine what would constitute rebalancing. For simplicity's sake let's assume Beijing's target is a straightforward reversal of the 2012 investment-consumption mix.

So, in a successfully rebalanced economy, household consumption would make up 46 per cent of GDP, and fixed investment 36 per cent, with government consumption, inventory changes and net exports contributing the remainder.

Second, let's assume the current leadership wants to hit this target by 2021, which will give them the best part of a year to bask in the glory of their achievement before they are expected to step down in favour of the next generation of party bosses.

Third, given the conservative nature of consumers, let's assume that household spending is already growing as fast as it can, and that it will continue to grow at its current pace of 9 per cent a year over the next few years.

Working from those assumptions - that household spending will continue to grow at a real, inflation-adjusted rate of 9 per cent a year and that the economy will rebalance by 2021 - it is a matter of simple arithmetic to calculate how fast investment growth needs to slow to achieve rebalancing, and how quickly the overall economy will grow as a result.

The results are not encouraging for Beijing's policymakers.

If household spending grows at 9 per cent a year to make up 46 per cent of China's GDP in 2021, and if the contribution of fixed investment rebalances to contribute 36 per cent, then the real growth rate of fixed investment must fall to just 2 per cent a year.

That contrasts with an average real growth rate over the last five years of 13.4 per cent.

Further, if household spending grows at 9 per cent, and investment grows at the 2 per cent rate necessary to achieve rebalancing (with the share of the other components of GDP remaining constant), then the average growth rate of China's GDP between now and 2021 will have to fall to a mere 4.4 per cent a year.

That's less than half China's average annual growth rate over the last five years. Clearly, it is far below anything Beijing is likely to consider an acceptable minimum rate.

Admittedly, there is a problem with these back-of-the-envelope sums. They assume household spending and investment are independent of each other. In reality, a fall in investment growth from 13 per cent to just 2 per cent a year would hammer incomes in a whole range of sectors across China's economy.

That in turn would depress consumption growth, further weighing on GDP. But the principle that the sums illustrate still stands: Beijing's twin policy aims - rebalancing the economy while maintaining growth above a 6.5 or 7 per cent rate - are mutually exclusive.

The only way China's leaders will ever be able to persuade anyone that they can achieve both will be to get the electrodes out and convince them that two plus two equals five.



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This article is now closed to comments

Good piece, but a bit too simplistic.

To use a corporate accounting analogy, it only takes into account the P&L flow of the national economy, not its balance sheet. Mr Holland's analysis assumes this flow is a static, zero-sum system without a temporal (save/borrow for/from the future) dimension. It is not.

Chinese consumers have long displayed excess savings. Their saving rates (% of income saved) have been consistently just north of 50% for a nearly a decade (compare: post-2008 US 10~15%, Japan 20~25%, Hong Kong 30~35%). In RMB savings accounts alone, we find over 100 trillion RMB stashed away. And that is just the tip of the iceberg: much more is held in the infamous WMP's, bonds, home equity and so on. (perspective: GDP is approx 52 trillion RMB).

Of course, those excess savings are just the other side of the accounting entity that also includes the (excess) investment. The huge pile of saved money has facilitated the credit boom in the private sector.

But the point is that Chinese consumers have a big balance sheet to dip into, if they wanted to, and if they were given the right incentives to. Reducing the demand for their savings (ie, reducing investments) will help immensely.

So yes, it will surely be tough, but a 9% growth of consumer spending may turn out to be a very conservative assumption. Aggregate consumption can grow faster than income (GDP) without violating basic arithmetic: it will just have to involve breaking the iron piggy bank.
One thing that will work against consumption led growth in China is the demographics.
One year doesn't make a trend but the year 2012 was the first time there was a reduction in workforce size. But given fertility rate has fallen from 1.85 in 2000 to 1.40 in 2010, the shrinkage of workforce is unavoidable. Even if the one child policy is repealed, it is unlikely that people will suddenly change their mindsets to have more children.
With a shrinking workforce, the capacity to spend will also shrink.


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